(This essay was published in Hong Kong Economic Journal on 28 June 2017.)

 

Last Saturday Andrew Sheng, writing in the South China Morning Post about Asia’s future in the next market adjustment, correctly pointed out: ‘Ultimately, demographics and geography determine destiny’. Hong Kong has the most robust market institutions in Asia for weathering the looming uncertainties in the global economic environment. It also has the right geography. But unfortunately it has poor demographics.

 

The right geography is its location in the fastest growing area in the world. The share of world GDP of the G7 countries – the U.S., Germany, Japan, France, Britain, Canada, and Italy – declined from about 65% in 1990 to 45 per cent in 2010. This 20% share has shifted to six other countries, namely China, Korea, India, Poland, Indonesia and Thailand – four of them located in Pacific Asia. Hong Kong is at the center of this region. What better neighborhood is there?

 

Hong Kong’s poor demographics are the declining size of its labor force and the slow growth of its quality. Government projections show that the labor force will shrink by 3.9% in 2016-26 and 2.2% in 2026-36. More worrying, the younger labor force of 25-44 year olds will decline by 10.4% and 7.3% in these two decades, respectively. Projected labor force numbers to 2061 are shown in Figure 1.

 

 

Investing in Education and Attracting Skills and Talents

 

A declining and ageing labor force means investments and jobs will go elsewhere. To sustain investments in the highest value added jobs, the younger population has to be much better educated than it is today. Investing in the education of the young generation must be a top priority for the incoming government both for fostering economic growth and equity. Providing education vouchers to students attending self-funded tertiary programs will advance both goals.

 

In the absence of more investment in education, Hong Kong’s aggregate human capital stock as measured by the average years of schooling multiplied by the size of the labor force will cease to grow after 2016 (see Figure 2). In fact the aggregate years of schooling has plateaued since 1996 among 25 to 44 year olds. For 45 to 64 year olds, they only began to plateau in 2016.

 

 

 

Obviously it does not pay to educate everyone to the point of no net returns. This would be economically wasteful. And not everyone would want to be so educated. But current estimates of private and social rates of return to education are still very high, in the order of magnitude of 23.6% and 13.1%, respectively, at the first-degree level. The questions of how much to expand education investment, at what pace, and in which areas have to be addressed as a matter of considerable urgency by the government as these things take time to bear fruit.

 

Education investment, important as it is, will not yield results quickly enough to prevent the loss of economic opportunities in an increasingly competitive global environment. A more proactive and sustained effort to attract skills and talents from outside Hong Kong will be necessary to protect economic growth and grow quality jobs.

 

Contrary to the fears of many, importing skills and talents need not lower the wages of local employees because investments will expand to create more and better paying jobs. The shortage of a skilled and talented population deters investments that are crucial for economic growth and quality jobs.

 

Experience from Israel, which received a massive influx of Jewish immigrants after communism ended in Eastern Europe and the Soviet Union, proves that the arrival of more skills and talents help create a booming economy to the benefit of all, including domestic unskilled workers. More new companies were started and better jobs were created. Immigrants were crucial in helping Israel grow its new technology economy.

 

Hong Kong’s own experience after the war shows the important role immigrants played in bringing in new industries that did not exist previously. The idea that foreign workers can only drive down the wages of domestic workers assumes that the amount of investment will remain unchanged. This is not correct when there is no shortage of funds, but only of skills and talents.

 

Attracting skills and talents from overseas will not succeed without addressing housing and other necessary infrastructure to make Hong Kong attractive to them. The shortage of housing in particular is the most important issue and one that locals are most unhappy about.

 

Rethinking Public Housing Policy

 

Public housing is an area where government needs to fundamentally rethink its policies. The outgoing administration viewed the housing challenge as one of releasing sufficiently more land to build more housing. Increasing the supply of land and housing are viewed here as two stages of a single unified challenge – land is flour and housing is bread. So increasing housing supply must require finding more land. But this is not an entirely correct view.

 

Hong Kong’s housing market is enormously complex and heavily regulated. In 2016, 30.4% of households lived in government subsidized rental housing, 15.9% in government subsidized ownership housing, 13.0% in private rental housing, and 36.2% in private ownership housing.

 

But there is a big difference between public and private sector housing units. Units in the public sector cannot be rented out and severe restrictions are placed on the transfer of public ownership units. Only housing units in the private housing sector (amounting to 49.2% of the total housing stock) are freely transferrable on the open market and can be used either for owner occupation or rented out.

 

Public renters were admitted through either resettlement or lack of means. The former are not means tested, only the latter are. Over time more households that were initially without means have become well off tenants. The exact number of well off tenants cannot be accurately defined and their identities are not easily identified.

 

Well off tenants that fail to declare their true income and assets, and are subsequently discovered are often only required to pay double the normal rent and not necessarily evicted. As a consequence, the public rental housing units are probably inefficiently allocated to a non-trivial extent. In 1994, a survey found that 15 per cent of public rental households own private property.

 

There have been several attempts to evict well off public rental tenants from the program, but these have been extremely divisive and confrontational because it is difficult to accurately identify well off tenants using a snapshot of current income and assets that can be manipulated.

 

The application of summary criteria that appear as uniform need not be fair because a family’s true economic circumstance cannot be reduced to a few figures. Manipulation of numbers will further exacerbate the sense of unfairness and injustice of those victimized.

 

Before the ‘double rent policy’ was implemented in 1987 many households in public rental housing were living in very cramped conditions. The situation today has reversed. Cramped public rental quarters are no longer a serious problem. With the introduction of the ‘double rent policy’ many working children have deregistered themselves from their parents’ home in order not to breach the income and asset eligibility criteria.

 

Instead they have joined the application waiting list for public rental housing and are renting in the private sector. Average household size in the public rental sector has declined rapidly and is now no different from that in the private rental sector. As a result, the public rental housing sector is less cramped relative to the private rental sector among units of comparable size.

 

This situation has arisen because public rental housing cannot be sub-divided, rented out, and sold like private housing on the market. Cramped living conditions in the public housing sector of the past, and in sub-divided housing in the private sector today, are both evidence of a misallocation of housing resources among the population.

 

Such situations often result from regulations that target public housing tenants but generate spillover effects onto the private housing sector. The reversal of cramped conditions from the public sector is exacerbated because a relatively small private rental sector comprising 13.0 per cent of the entire housing stock has to absorb the shocks emanating from a larger public rental sector of 30.4 per cent. Favorite locations for sub-divided housing are even more concentrated.

 

I will not be at all surprised if the initiative launched in November 2016 to tighten the eligibility criteria of well off tenants will further exacerbate the sub-divided housing situation in the private rental sector. The reason is because it will incentivize more tenants to downsize their households in order to meet the eligibility criteria and remain in the program. This only sends more members to join the applications list where the wait keeps expanding and is used by government as an indication of the demand for public rental housing.

 

This produces an inbuilt dynamics to keep growing the public rental sector that will increasingly crowd out the private housing sector. Divorced households that split into two also increase the demand for public rental housing. This too lengthens the application list.

 

Tackle Housing and Demographics Together                 

 

A housing sector that becomes increasingly dominated by public rental housing units will not be conducive to attracting skills and talents from outside Hong Kong for both economic and political reasons.

 

Homeownership is the most important means for the general public to benefit from a growing economy. As the economy prospers, housing prices in the city will rise over the long run. A city of homeowners implies nearly everyone can share in the prosperity of a growing economy.

 

A city increasingly dominated by public rental tenants encourages a redistributive mindset, breeds envy and jealousy leading to political divisiveness that is detrimental to economic growth, and nurtures a shared poverty ethos.

 

When most citizens are public housing tenants, they will resist the arrival of skills and talents in fear that they have come to take away what is rightfully theirs. When most citizens are owners of private property, then they will welcome the arrivals as the bearers of shared prosperity, not shared poverty.

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