(This essay was published in Hong Kong Economic Journal on 29 April 2015.)

The globalization of the world economy and China’s economic opening have been the most important processes behind Hong Kong’s transformation into one of the world’s most vibrant economic metropolises. Both processes started around 1980 and they have brought prosperity to Hong Kong and created numerous billionaires in the city. I conjecture at least two-thirds of households here are millionaires.


There is no doubt that the entrepreneurship and industriousness of the people of Hong Kong have been highly relevant in creating this wealth, and so has the facilitating role of our legal institutions and market system. But the enormous prosperity that emerged could not have been possible without globalization and China’s opening. Even if everyone knew a miracle was in the making, they could not have imagined its eventual scale.


A large part of this prosperity has been reflected in highly escalated property prices. In almost every discussion of what ails Hong Kong, the subject of housing rents and property prices always turns up as the number one problem. Most people are unhappy with the problem, many are frustrated, and some are downright angry, even militantly so. High and rising property prices and housing rents are touching nerves economically, socially and politically. They are taken as proof that not everyone has benefited from Hong Kong’s economic miracle.


The political divisions in the city and increasing difficulty of governance are blamed on glaring disparities in income and wealth, divisive politics, and in some cases Beijing and the tycoons, who are probably indistinguishable in the eyes of the angry and disgruntled. For not a few they appear like Voldemort in the Harry Potter stories.


Yet Hong Kong is not alone in its property woes. A recent cover story in The Economist (April 4th-10th issue) entitled “Space and the city” testifies to the growing recognition among economists today that high property prices and housing rents are a universal problem in all economically successful cities in the world. The greater the success, the bigger the problem.


When an economic theory becomes a cover story in one of the most widely read and respected international magazines, we know it has attained significant recognition among economists and practical relevance for the public.


This rise in housing property prices and rents started in the late 20th century and it is the result of two opposing factors: fast-growing demand and slow-growing supply.


The fast-growing demand was caused by economic forces underlying economic globalization. Economic recovery and population growth after World War II increased housing demand in many large cities around the world. Then in the 1980s, the discovery of information technology made work in knowledge-intensive industries far more lucrative, for example, the finance and software sectors.


Knowledge-intensive industries began to concentrate in certain cities, creating a virtuous circle. The clustering of knowledge workers and lots of idea industries caused knowledge to accumulate even faster. More new jobs were created. And these cities became magnets, drawing more skilled workers to them.


As these workers arrived, they pushed up demand for property and housing. Land in these cities became scarce.


The cities affected by these developments included many old metropolitan areas like New York and London, as well as new places like Austin and Bangalore – a consequence of globalization.


Hong Kong also attracted knowledge workers from all over the world as China opened up and reformed its economy, creating a huge demand for financial and numerous other high valued-added services.


But in the face of rapid growth in demand, these great cities responded by slowing down supply through regulation. Property and housing in these great cities was artificially held back through regulatory limits on the height and density of buildings, which constrained supply and inflated prices. Estimates have found that land-use regulations in the early 2000s in the City of London inflated the price of office space by about 450% (for the West End of London by 800%), in Milan and Paris by around 300%, and in San Francisco and Manhattan by about 50% in 1998. This is the “shadow tax” on property and housing costs.


My own estimate is that the average “shadow tax” due to regulatory costs increased by about 75% in Hong Kong between the periods of 1980-1989 and 1992-2014 (see Figure 1). The change in regulatory cost was approximated as the average percentage difference between the property price index and the building works tender price index (using the Rider Levett Bucknell private market index) in the two periods. The additional “shadow tax” in the latter period remained very stable and was unaffected by the business cycle.


The cities I have mentioned all failed to accommodate new arrivals, which resulted in escalating property prices and housing rents. There is of course a rationale for limiting urban development. Unconstrained urban growth in the 19th century fostered crime, disease, and filthy air and water. This led to the proliferation of green belts and rules on zoning. Later, incompatible uses of land due to, for example, conservation, environmental, heritage preservation and the myriad of “not-in-my-back-yard” concerns, prompted even more regulations.


Still later, rising prices and rents created windfalls for property owners who began lobbying for restrictions on development to enhance the value of their fixed assets. Political democracy with voting rules rooted in geographic constituencies facilitated the effectiveness of local lobbying. New rules proliferated that limited heights and building designs, imposed maximum densities and minimum parking requirements, set aside green belts prohibiting development, and were limited themselves only by the inventiveness of lobbyists and entrepreneurial politicians.


The net result of all these “shadow taxes” has been development delays. Economists estimate that lifting all barriers to urban growth imposed in the US since the 1960s could raise GDP by as much as 6.5%-13.5%, or by US$1-2 trillion.


In Hong Kong, I have estimated that lifting just one regulation – so as to allow the privatizing of the public rental housing stock – would have increased GDP by between 0.5% to 1% each year from the mid-1970s. This is an astronomical impact. When compounded over 40 years, Hong Kong’s GDP today could have been 21% to 47% larger, which is an additional HK$430-$950 billion. If the existing public rental housing stock were privatized today, it would create HK$2.5 trillion (more than the current Hong Kong GDP) simply by restoring value that had been eliminated by a single restrictive regulation.


Inequality in wealth and income are also worsened when property prices and housing rents rise. Property is a store of wealth and when its value appreciates, landlords reap a huge capital gain for doing almost nothing. Those with property benefit and those without don’t. The middle classes are not usually beneficiaries because their mortgage debts also rise. The poor experience soaring housing rents that erode their incomes, which have grown slowly in the knowledge intensive economy.


In the US, capital income from housing accounted for just 3% of the total national income in 1950, but is responsible for about 10% today. In Hong Kong, the effects of housing value appreciation on inequality is highly likely to be more severe than in other advanced economies because only 36% (51% if government subsidized ownership units are included) of all households are homeowners.


Twenty years ago I started urging Hong Kong to (1) sell public rental housing to the sitting tenant at affordable prices, (2) reduce the unpaid land premium on Homeownership Scheme (HOS) units, and (3) build subsidized homeownership units for eligible households instead of rental units. I believed these measures could help to arrest growing inequalities in income and wealth, but I saw the problem only within the context of our own peculiar local situation. This was prompted by the observation that prices and rents soared dramatically in Hong Kong in the early 1990s.


The same realization has emerged in other rich economies, triggered by the dramatic increase in housing prices in the US in the 1990s. The second edition of Professor Robert Shiller’s Irrational Exuberance published in 2005 contained a chart (that was not present in the first edition) that clearly showed housing prices began to spike in the late 1990s, after a remarkable half-century of stability following World War II (see Figure 2). The book itself was focused on macroeconomic and finance issues rather than housing policies.


Professors Edward Glaeser and Joseph Gyourko were the first to argue, in 2002, that the price of housing was significantly higher than construction costs in major cities in the US because of high regulatory costs.  They coined the term “shadow tax”. In 2008 they observed that in spite of the mortgage meltdown and the ensuing drop in housing prices, Americans continued to face housing affordability challenges because of the high regulatory costs of zoning and building restrictions.


In Hong Kong, regulatory costs have contributed significantly to greater inequality, less social upward mobility, slower economic innovation, and greater political divisiveness. It is time Hong Kong revisited our government subsidized housing policies and zoning and building regulations. Our future is being held hostage by these “shadow taxes.”




Edward L. Glaeser and Joseph Gyourko, “The Impact of Zoning on Housing Affordability: Policies to Promote Affordable Housing,” National Bureau of Economic Research, Working Papers (8835), 2002.


Edward L. Glaeser and Joseph Gyourko, “The Impact of Building Restrictions on Housing Affordability,” FRBNY Economic Policy Review, June 2003


Edward L. Glaeser and Joseph Gyourko, Rethinking Federal Housing Policy: How to Make Housing Plentiful and Affordable, Washington, DC: NRI, December 16, 2008


Robert J. Shiller, Irrational Exuberance, Princeton University Press, 1st edition 2000, 2nd edition 2005

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