(This essay was published in Hong Kong Economic Journal on 22 June 2016.)

 

Think tanks around the world publish all kinds of conflicting assessments about Hong Kong’s economy. Lausanne’s IMD not long ago announced that Hong Kong is the most competitive economy in the world.  Vancouver’s Fraser Institute and Washington DC’s Heritage Foundation continue to report Hong Kong as the freest economy in the world. But in 2014 London’s EIU ranked Hong Kong at the top of its newly developed crony capitalism index. Are these conflicting findings talking about the same place? How is it that the leading crony capitalist economy in the world can at the same time be called the freest market economy? This has to be a contradiction.

 

Free market capitalism requires governments to behave as neutral referees in order to maintain a level playing field and keep barriers to market entry low for all businesses. Market competition will then be open and free for all. Crony capitalism by contrast requires governments to practice favoritism. Market access becomes easier for some businesses but not others. Markets cannot then be open, free and competitive for all.

 

Has government behavior in Hong Kong changed from neutral referee to favoritism?

 

Beginning with Financial Secretary Hamish McLeod, there has been a gradual, albeit very gradual, retreat from “positive non-interventionism” as official policy. Most people in Hong Kong feel economic opportunities are fewer today than in the past. A growing number feel rent seeking activities have grown over time.

 

The current generation of university graduates bemoans the reduction in upward social mobility and the greater difficulty in starting businesses because of high office and retail rents. Some think the rise of rent seeking activity is responsible for the slow increase of individual incomes.

 

In politics, the young generation sees establishment politicians as rent seekers and defenders of growing cronyism, and opposition politicians as vote grabbing opportunists. A growing number among the young generation are now openly unhappy, angry, and want democratic change to stop cronyism. Their negative sentiments are targeted towards all elites and especially those in power.

 

The declining esteem of these elites is not a phenomenon unique to Hong Kong. American public distrust of politicians and officials in Washington has been on the rise for some time. Public resentment against elites and those in power is usually expressed as a moral protest against social injustice, unfairness, inequity, and corruption rather than rent seeking activities alone. But rent seeking is at the core of crony capitalism.

 

While I think the sentiments of the young generation have some merit, these sentiment are shared by only some in the young generation. Unfortunately young people fail to understand why rent seeking has risen in the first place. Much of their moral indignation is largely unwarranted and out of all proportions with the still rather modest growth of rent seeking activities in Hong Kong.

 

It is useful to examine what the EIU’s crony capitalism index actually measures. It seeks to track the extent of crony capitalism across countries and over time. To do so in a consistent way, it uses a common yardstick across countries that can be repeated over time, and for which the EIU can readily collect information on from a large number of countries on a sustained basis.

 

It does this indirectly by measuring the economic conditions that would be conducive to rent seeking activities rather than directly measuring rent seeking. Its proxy measure is the share of the economy taken up by industries where government regulation of business activity is usually more prevalent. The assumption is that a highly regulated industry is more likely to have more rent seeking activities.

 

Historically, governments have actively regulated industries like construction, property development, finance, media, transportation, and public utilities in the name of public interest. In these industries, government and business regularly discuss how to structure regulations. In some countries governments have chosen to nationalize some of these industries.

 

The outcome of these negotiations and the regulations they produce determine how much competition will exist in these industries, how much economic rent will be on the table, and who gets how large a piece of the rent. For example, employers, employees or third parties may be appropriating the economic rent, and in loss making nationalized industries the taxpayer may be paying for the rents enjoyed by some of the above.

 

If one wants to uncover cronyism then one should look in those industries that are most regulated by government. Industries where government regulation is least required are likely to be highly competitive with little economic rent available for capture.

 

Wall Street has recently been accused of being the epicenter of business cronyism. This is hardly surprising because finance is one of the most regulated industries in the economy. Government procurement practices have also long been an area where corruption has been of concern in most countries. In many developing economies, customs is another area where corruption is a serious concern.

 

There is a paradox here. Many critics of cronyism want to see more government regulation to prevent corruption and eliminate rent seeking, without realizing putting regulators and businessmen in the same room provides the most favorable condition for fostering such activity.

 

Some believe that political transparency through democracy would limit rent seeking and reduce cronyism and capitalism. I have always found this view naïve because it only focuses on the possibility that transparency and accountability would raise the cost of rent seeking. It fails to realize that more government regulations produce more economic rent and create more incentives for rent seeking.

 

Rent seeking activity is, however, not limited to organized businesses. It is present among many professions and occupations that have lobbied effectively for setting up barriers to entry and to regulate market practices, very often in the form of licensing requirements and best practices or codes of behavior.

 

Many social advocacy groups of the disadvantaged, and of those who are unwell, unfit and without means, also have private agendas to the extent that government subventions and transfers often fund their jobs and careers. In this sense, they too can be viewed as self-interested rent seeking groups, but they do so in the name of a constituency, a cause, or an ideology.

 

In general, more government regulations and bigger governments create more economic rents available for grabbing. It is precisely this type of thinking that is behind the design of the EIU crony capitalism index, rather than ideas of democracy and transparency.

 

If the EIU index were extended backwards to 1980, would Hong Kong have a lower score for crony capitalism? I conjecture that it would because of several economic, social and political changes that have taken place.

 

First, the industrial composition of the economy has changed since 1980. Manufacturing has declined and services have increased. Hong Kong’s manufacturing industries were export oriented which made them naturally profit earners in the world economy rather than rent seekers in the domestic economy.

 

Many services are far more regulated than manufacturing and this has increased the relative scope for rent seeking activity in Hong Kong. The growth of producer services has increased the demand for various professions and occupations. Industries where government regulations are important have also expanded relative to the economy, especially in finance, property development, and transportation. Structural transformation of Hong Kong’s economy has predisposed it towards more rent seeking.

 

Second, political reforms, both before and after 1997, have empowered new groups and constituencies. The introduction of elected representatives to the Legislative Council and the District Councils has lowered the organization cost for businesses, professionals, and other non-government interest groups and political parties to become more effective at rent seeking. This has also opened up new avenues and created new opportunities for rent seeking through government regulation.

 

For example, minimum wage legislation transfers resources from employers to employees, the mandatory provident fund transfers resources from the general public to the finance industry, compulsory building maintenance requirements transfer resources from property owners to the maintenance works industry, and so on.

 

All these transfers do not take place through government budgets and do not require any additional government spending that has to be financed. They are new avenues for creating off-budget economic rents through government regulations. Rent seeking through regulation is common in Hong Kong because it is difficult to press for bigger budgets under the provisions of the Basic Law, which requires budgets to be balanced.

 

Political reform has therefore contributed to the growth of rent seeking activities through more government regulation of market activities. It is likely that the total amount of rents made available for capture have grown. Such economic rents could be captured without passing through the government budget. They are transfers mandated by government regulations.

 

Third, a rising share of employment in the economy today is in non-profit oriented social enterprises that are supported partly by private donations and public spending. The primary reason is profit oriented private businesses have increasingly adopted technologies that have improved their productivity by so much that they no longer need to hire so many people. A secondary reason is long life expectancies have allowed more and more people to continue working beyond retirement age, but in social enterprises and at lower pay.

 

Non-profit oriented companies often have considerable economic rent that can be appropriated by staff. The main reason is that these social enterprises pursue objectives that are not efficiency driven and those who fund these organizations let staff, clients and other third parties appropriate a share of the government subventions and private donations. In the west, churches have been among the oldest non-profit oriented social enterprises and they are not known for being efficient.

 

Some political parties on both the establishment and opposition sides have been rent seekers and sought to capture economic, political and social benefits either for themselves or on behalf of their constituency. Public sentiment against some of their rent seeking activities has been on the rise. Radical elements of the young generation are beginning to view the ritualistic rent seeking activities of some establishment and opposition political parties (even when it is on behalf of their constituency) with great animosity.

 

Rent seeking activities have been increasing in Hong Kong’s economic, political and social spheres because the fastest growing areas of our economy (including our political economy and social economy) are precisely those areas where considerable economic rents are available for the grabbing. These are areas where the government plays a role in producing the economic rents. The EIU crony capitalism index measures the rise of some of these economic sectors.

 

On the other hand, the Fraser Institute and Heritage Foundation measure economic indicators like taxes, prices, exchange rates, unemployment rates, rule of law, and size of government in the economy. These indicators continue to show Hong Kong to be the freest economy in the world, even though a rising share of the government-regulated economy has created considerable potential economic rents available for capture.

 

Lausanne’s IMD is focused on measuring the productivity of the profit-oriented sectors and these show productivity in Hong Kong is leading the world, but their measure ignores the growth of the government-regulated economy, which the EIU index is capturing.

 

These different indicators all measure different things. Such is the picture of the modern 21st century economy that Hong Kong is a leader in all these indicators, and is reflecting the way the world is heading today.

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