(This essay was published in South China Morning Post on 11 November 2015.)
Should governments intervene in the capitalist free market to promote economic activities?
Economists have debated this issue at considerable length on two occasions. The first time concerned industrial policy and the most efficient way of allocating scarce resources.
This debate focused on whether governments should pick winners or leave the task to the market. The market system and the price mechanism were seen by most economists to be the most efficient at allocating resources. Public intervention was only considered justified when markets failed.
Yet these views not withstanding still led to protectionist policies by government, supposedly to help nurture nascent national industries, that ultimately failed themselves. In reality, they resulted in rent-seeking and reduced competition, and to a politicization of the process to decide which industries to protect.
Hong Kong’s positive non-interventionism has been both an argument that the free market could pick winners better than the government and a strategy to insulate government decisions from rent-seeking lobbies.
The second debate concerns technology and innovation and sees wealth production as the result of transforming new ideas into new products that could be profitably supplied. Is government policy or the market the best approach for nurturing ideas to foster growth and productivity?
This debate emerged from the University of Chicago in the late 1970s and early 1980s when two economists, Paul Romer (then a graduate student) and Professor Robert Lucas (Nobel Laureate 1995), began separately to develop two different but related models of economic growth.
Both Romer and Lucas took the view that outputs are “things” and so are labor, capital and human capital, and “things” are different from ideas. Human beings possess an infinite capacity to reconfigure “things” by creating new recipes for their use. And the great thing about ideas is that they are nearly limitless.
The two economists also saw ideas as having consequences. If output is driven by the stock of ideas, then investing in human capital enhances the chance for discovering new ideas (or learning the ideas of others); in turn, learning new ideas augments the stock of human capital. More output can be produced from the same amount of input, which overcomes the law of diminishing returns.
Taking a product or service that results from new ideas to market requires numerous supporting institutions, such as an appropriate level of intellectual property protection and innovative marketers. Are there conditions a government can create to encourage knowledge creation and profit making businesses to feed on each other? There are differing views on this.
Michael Porter, a Harvard economist, has argued that competitive firms within a concentrated single-industry cluster are more conducive to the spread of knowledge among similar firms to maximize the gains from knowledge spillovers.
Romer believes there are fewer incentives to produce knowledge among competitive firms than among monopolists or near-monopolists. He sees government as having an active role in building hard and soft infrastructure and a supportive regulatory environment.
Lucas endorses urban writer and activist Jane Jacobs’s\ notion that new ideas and knowledge spread most readily in cities with competitive, not monopolistic, businesses and with a diversity of businesses. He emphasizes making cities attractive for the skilled and talented to want to live and work there.
Places such as Singapore, Israel and Shenzhen have all developed as bases for innovation and technology following government policy that brought in large numbers of skilled workers.
Empirical work comparing cities in the US supports the view that competition is more conducive to growth than monopoly, and that a diverse city economy is better than one with a concentration of a few industries.
The evidence is thus consistent with Lucas and Jacobs, but not Romer. Porter is not entirely wrong because for a period of time a single-industry cluster can work, as in the example of Detroit, but diversity is needed to achieve sustainability.
Both the industry and innovation debates demonstrate that government has a role to play in developing infrastructure and rules to facilitate innovation activities, and investing in training and recruiting people – especially the latter. At the end of the day, skilled and talented people are the most important element of success in fostering innovation.
Population policy should be the central focus of the Hong Kong government’s strategy to promote innovation here. One must not forget Hong Kong’s economic miracle was also built on a massive wave of immigration in 1945-51. Positive non-interventionism alone would not have been sufficient.