This is the second of ten articles I intend to write on Hong Kong’s so-called deep structural contradictions. In the first article on 23 February I considered the budgetary policies of Financial Secretaries since Cowperthwaite. The annual budget speech is the most authoritative statement of the government’s economic policy framework. Our administration has stated its commitment to a limited government and to allowing markets to guide economic activities. This commitment was reaffirmed in the recent budget delivered two weeks ago by John Tsang.

All activities – whether business or non-business related – require decisions that satisfy multiple demands with limited resources. From this perspective every decision incurs an opportunity cost, including those choices related to social, health, education, housing, and environmental issues. They are all economic in nature as they are subject to the laws of scarcity in meeting competing ends. And for this reason the provision of many non-business activities can be met in the same way as those for business activities; i.e. through the market place. But in Hong Kong many non-business activities are arranged and organized outside the “small government, big market” framework.

Understanding Economic Policy in a Transforming Economy

Under such an approach the provision of non-business activities like health, education, social welfare, and housing services, could be supplied, often with greater efficiency, by the private sector through a market mechanism. And any undesirable social distribution consequences can then be corrected with subsidized vouchers to help disadvantaged individuals and households. A more equitable outcome can certainly be achieved without sacrificing efficiency. The role of government would then be limited to correcting market failures, rather than to direct provision and extensive regulation as it is now. Unfortunately Hong Kong failed to adopt this ‘small government, big market’ approach during the governorship of Murray MacLehose (1971-1982).

Since that period Hong Kong’s policy environment has been characterized by two conflicting frameworks. In business activities, Cowperthwaite’s limited government policy framework prevailed and it existed not only to promote efficiency and growth, but also to fend off business lobbies looking for advantages from government. In other words it was a mechanism to keep a level playing field. I have argued in previous articles (on January 19 and 26) that the most important factor for maintaining competition in the market is the government’s  refusal to hand out advantages to firms, thus  maintaining a level playing field for all – an advantage that is also extended to potential entrants.  Limited government is not restricted to the size of government in an economy, but also encompasses the way in which it conducts its affairs to uphold equality of opportunity for all. However, in non-business activities British social welfare policies were adopted. The massive direct provision for health, education and housing by government are the consequence of this alternate policy framework.

While many commentators were of the view that British firms were favored under the colonial government, official documents, recently declassified, suggest that distancing itself from most business lobbies, especially British ones, appears to have been a conscious and deliberate government policy. Close government and business working relationships were common in obligatory areas involving regulatory issues in foreign countries. For example, as practiced in the negotiation and allocation of US textiles and garment quotas under the former Multi-Fiber Agreements.

As a general rule, governments everywhere often support declining industries, and have demonstrated a vulnerability to their lobbying efforts. It is no secret that agriculture is often the most heavily protected sector in rich countries. In Hong Kong lobbying efforts grew during the 1970s as our competitiveness in exported manufactured goods declined. Fears of being hollowed out intensified lobbying efforts, yet these worries proved to be much ado about nothing.

Manufacturing’s share in nominal GDP was 30.9% in 1970, and declined to 22.8% in 1980, 16.7% in 1990, 4.8% in 2000 and 1.8% in 2009 (see  Table 1 ). The decline is less pronounced when we compare changes in manufacturing’s share in real GDP (see Table 2 ). In 1980, the share of manufacturing in nominal terms was 22.8% but only 17.1% in real terms. This is because the price of services rose faster than the prices of manufactured goods. The rise of service prices is actually a sign of an improving living standard due to productivity gains from the migration, and subsequent expansion, of manufacturing production across the border.


The industrial transformation of Hong Kong to a service economy brought huge economic gains. The decline of manufacturing was fully compensated for by the rise of producer services to support the manufacturing base across the border. Manufacturing as a share of real GDP declined from 17.1% in 1980 to 1.8% in 2009; a fall of 15.3 percentage points.  Producer services as a share of real GDP rose from 29.8% in 1980 to 46.7% in 2009; an increase of 16.9 percentage points. Incomes and profits rose continuously during this period.

Rise of the Social Welfare State

After two decades of transformation, manufacturing production has finally disappeared from Hong Kong. In the process only a few high value added services have remained. We have now reached the end of this process, bringing to a close the enormous growth to which we have grown accustomed.

Likewise, China is suffering from labor shortages and must move up the technology ladder if it is to maintain its economic clout. Our government will no doubt be called upon to facilitate the development of technology and innovation, support commercialization of new technologies developed in China, make investments in human capital and training, facilitate international and cross-border circulation of talent, and strengthen cross-border coordination to harness economic opportunities that benefit both sides. Such requests fall in the areas of potential capital market failures and cross-border regulatory coordination failures, where a legitimate case can be made for appropriate government action. The lobbyists will be appearing soon again but the public must be kept informed over the government’s need to act and the manner in which it should do so.

If the public understands that the need for government actions is not only to help business interests but also the working public then there will be broad support for such policies. Concerns about whether government support for business would be vulnerable to accusations of government-business cronyism can then be dismissed. Public concerns over cronyism seem to be particularly focused on banks, large infrastructure investments, and property developments, where the involvement of big business is viewed with much greater suspicion. Such concerns must be addressed. Offering a helping hand to big business is viewed with increasing suspicion today and government officials have been known to delay decisions on difficult or controversial issues, shifting the onus onto the courts instead. But this only aggravates the problem, substituting economic expertise with legal expertise. More importantly, the task of moving an economy forward requires economic leadership, not judicial fairness.

How can the government decide on whom and what to support, and still maintain a level playing field for all and avoid being accused of cronyism? A competition law is not the answer as the issue is really about government behavior and not industry behavior. Even though the issues of what should be done can be explained to the public, this line has rarely been pursued.  And all too often the picture is not presented in its entirety and the public’s consent and support has not been secured before a discussion is launched. To avoiding incurring public wrath or, at the very least, suspicion of its motives, the government must keep the people of Hong Kong informed of what is at stake and keep them abreast of developments. But, all too often, the government mistakes the conflicting views of existing interests for the public’s view. In reality, the public is not organized and seldom presents its views. It is only the existing interests that have the incentive to do so. The task for government, therefore, is to reach out to the public and seek their support for its actions; in short, to get the silent majority behind its policies.

The growth of the social welfare state made huge headway under the charismatic authoritative leadership of Murray MacLehose. He, of course, had the mandate to heal a community in turmoil following the civil unrest of the late 1960s. The combination of a Cowperthwaite legacy and Haddon-Cave’s skills as Financial Secretary could not restrain MacLehose’s energetic and enthusiastic leadership in championing the British welfare state model for non-business activities.

The stage was therefore set for the coexistence of a dual policy framework. In business Hong Kong has the freest of markets, but in non-business activities it has a total social welfare state. The Financial Secretary and the Chief Secretary appear to stand at the respective apex of this conflicting dual approach to policy matters. The insider joke is that the Financial Secretary was responsible for raising revenues from the capitalist economy while the Chief Secretary was responsible for spending it on the socialist economy. The social welfare state grew incrementally, behind the commitment to a limited government, and was funded by the rapid economic growth that flourished from a vibrant and flexible market economy.

This conflicting policy environment is deeply entrenched in the institutional fabric of Hong Kong society and determines its many political alignments. The grass roots support for and the leadership of many pro-democracy organizations in the territory is very often the product of the MacLehose policies and the institutions it created. The social welfare state commands considerable mass support. It was, after all, established for the purpose of rebuilding government legitimacy in the wake of social unrest.

At the time a large proportion of the population was economically undifferentiated and relatively poor. As a consequence, the benefits were not generous and were widely and extensively provided. Hong Kong’s rapid economic growth made it possible to afford a social welfare state with large numbers of beneficiaries at minimal benefits for each. But the curse of improving living standards, an ageing population, and rising expectations threatens to drain government resources as benefits grow more generous.

The situation is further exacerbated by the original starting point of widely provided benefits which have now become almost impossible to claw back. This further threatens to cripple the economy. The extensive scale of many of these operations has also spawned a vast public bureaucracy and numerous external suppliers who rely on it for business. Together they form large vested interests supporting the continuation and expansion of this ample non-market collection of arrangements and organizations of public and quasi-public service providers.

The inherent contradiction of a social welfare state and a limited government is obvious to all, and is only conveniently ignored when one is seeking votes to win tomorrow’s election, or waiting for one’s retirement date.

These two approaches to public policy are antagonistic and growing increasingly incompatible. They were perhaps less so in the past, but today they serve as one of Hong Kong’s deep contradictions.  Contradictions that should have been resolved in the 1980s or, at the very least, in the 1990s before the challenges had become overwhelmingly complex. Unfortunately government attention was often distracted and the subsequent delay has made these problems even more intractable and now too unwieldy to reform. With the rise of divisive politics forging a consensus, and devising a coherent and feasible set of solutions, appears to be an impossible task.  Certainly, finding a solution has eluded foreign governments so why should Hong Kong be different? Pessimism prevails and even despair, but it does not reduce the continuing clamor for a solution.

The fiscal discipline of the government administration created in the time of Cowperthwaite continues to exercise a strong institutional influence on policy decisions. Many officials have continued to exercise fiscal restraint and have attempted to devise alternative solutions to meet public demands. The policy initiatives and responses they have sometimes put forward provide alternative solutions to meeting health, education, and housing demand. And their solutions often fall outside the social welfare state approach and make fuller use of market incentives and mechanisms.

These initiatives include direct subsidy for schools, associate degree colleges, private universities, subsidized voluntary medical insurance plans, selling public housing to the sitting tenant, ending the Homeownership Scheme, and divesting the commercial premises of the Housing Authority estates. Some of these proposals and policies might have been opportunistic, dictated by circumstances, with other objectives as their main aim. These alternative solutions often favor a market led approach and therefore one can detect a clear consistency in the modus operandi.  For a government perceived to be paralyzed and lacking leadership this represents an impressive list of achievements and should be highly commended.

And this may be the problem after all. The community needs to have a more clear articulation and interpretation of the contradictions it is facing. To avoid accusations of cronyism what must be addressed and explained is the need of a limited government to make complex economic decisions that move the economy forward. As a city economy in a constantly changing global and regional environment, the government must make challenging economic decisions to avoid falling behind. Renewing the commitment to limited government remains the best policy choice to keep us agile and flexible in order to survive the vicissitudes of global and regional uncertainties.

On the Need to Explain its Policies

Experiences elsewhere have shown that as the welfare state expands unrestricted the fundamentals of the private enterprise economy will ultimately erode. This erosion is gradual and often escapes note, but when a thriving market economy goes into decline only those bonded to the social welfare state will be persuaded to remain. Capital and talent will not commit themselves to such an environment. . New York City before the time of Mayor Rudy Giuliani suffered from such a predicament.

The need to prevent the social welfare state from expanding further in the face of growing public demand, thanks to rising expectations and demographic changes, is about preventing stagnation and decline. The social welfare state has to be reformed and tamed in areas where the net benefits from reform are highest after taking into account the political costs. Such strategizing is leadership in action. It is high time for government to issue a series of “green papers” to be followed by “white papers” to set forth the task of rebuilding Hong Kong’s future.

The inherent conflict between an expanding social welfare state in non-business activities and a limited government in business activities must be squarely faced. Without a social contract on what should be done and can be done, policy decisions will necessarily be fragmented and opportunistic. And the government will be seen to be lacking leadership. A more systematic alternative market-based approach to meeting rising public demand has to be articulated and the public has to be convinced of the way forward. The vested interests can only be overcome when public support for the way forward is present and ready. Such public support has to be built and nurtured.

Hong Kong has inherited its problems from a past that has undergone rapid transformation. Thirty years ago we sat at the interface between a closed China and a globalized world. Today China has opened up and is half integrated into this globalized world. Seismic changes have rocked our economic and social structures. Our flexible market economy has helped this process and, in turn, we have gained from it. But we should not be surprised by the still significant economic and social consequences that are yet to be addressed. The people of Hong Kong are only too aware of the inherent contradictions of the two policy frameworks, but we have yet to conceive what should be done and how it might be achieved. The government must seek beyond the existing interests for ideas and solutions. And this search must be cultivated by those free of the myopic quest for votes and the need to appease existing interests.

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