(This essay was published in Hong Kong Economic Journal on 13 January 2016.)
One of the most horrible political consequences of the Great Depression was the rise of Fascism in Europe. The ascendance and consolidation of fascist power in Germany occurred eight years after 1929 and drew almost every major nation into another world war. Severe financial and economic crisis that are not corrected quickly can have severe political consequences.


The return of populist political extremism in many corners around the world, now eight years into the 2008 global economic crisis, demonstrates that once again prolonged economic insecurity together with xenophobia has further polarized and fractionalized the political landscape. The rise of extremist right wing political voices – Trump in the US, Le Pen in France, Orban in Hungary – is disquieting to say the least. Corbyn in the UK and Syriza in Greece represents the other end of the political pole – left-wing extremism. And then there is the ISIS threat.


Our knowledge of macroeconomic crises is imperfect, but we know that a severe financial crisis, if not averted, promptly snowballs into an economic recession. And an economic recession will linger if deflationary expectations originating from deep fears of economic uncertainty and insecurity are not corrected quickly with confident and inspiring economic and political leadership.


Deflation, unemployment, stagnant growth, and economic disparity will polarize a fractionalized political landscape and breed extremism. History has shown that when such forces are formed and unleashed they can become politically terrifying. Fascism in Germany rose when the electorate became fearful of the threat posed by the communist movement.


This is the leading appeal of right wing and left wing populists who argue that mainstream democratic politicians are failing to get us out of this crisis. This was the case in the 1930s and it made things worse. People who otherwise would never have voted for extremist politicians were willing to listen to them. Once the democratic alternative loses its appeal, extremists and populists will gain ground.


Milton Friedman blamed the economic and political consequences of the Great Depression in the US mostly on the tight monetary policy of the Federal Reserve Bank in failing to arrest a financial crisis from snowballing into an economic collapse. He subsequently also came to the conclusion that the Gold Standard was also to be blamed for spreading economic doom around the world because it limited the freedom of governments to conduct independent monetary and fiscal policy to stabilize the domestic economy.


Under a fixed exchange rate regime, governments can only resort to devaluing their currencies in a bid to push the pain of domestic adjustment onto other countries by spreading economic doom overseas. For this reason, Friedman advocated the adoption of free-floating exchange rates among major open economies as a means to restore the autonomy of macroeconomic policy.


The Euro is also a fixed exchange rate arrangement and it has worsened the ability of many European countries to pursue independent domestic stabilization programs in the aftermath of the 2008 global economic crisis. Friedman opposed the Euro project from the very start, fearing that a financial and economic crisis would push Europe into precisely the present situation.


There are also economic and political parallels to draw between the effects of the Great Depression in the 1930s and the Eurozone countries today, and the effects of the 1997 Asian financial crisis in Hong Kong. With the benefit of hindsight, the economic and political events that have emerged in our city in the past 18 years appear to confirm that Hong Kong is suffering from the after effects. The Asian crisis was Hong Kong’s “great depression” and the linked exchange rate its “gold standard.”


The Asian crisis that occurred in 1997 was a very severe economic shock for Hong Kong.  The scale and impact of deflationary pressures were second only to the Great Depression in terms of intensity and duration. Cumulative nominal GDP in Hong Kong fell by 9.5%; the drop in the US in the 1930s was 11%. The unemployment rate in Hong Kong reached a peak level of 8.8% while that in the US reached 24.9%.


The less severe impact on unemployment in Hong Kong was thanks largely to a much more flexible labor market and the demographic shrinking of the youth labor force. Hong Kong’s economic ordeal ended only when the US Dollar began to weaken in 2003 and deflationary pressure was lifted.


The economic plight of those who lived through the economic crises of 1997 and 2008 is not from insecurity brought on by unemployment, which only reached alarming heights for a relatively short period in the depths of the 1997 Asian crisis. A tight labor market due to demographic factors ensured work was available for all those who wanted it, especially after travel limits from the Mainland was loosened.  No, our deep economic problem has not been job security, but wealth disparity and the insecurity of being without property in a city with rising housing prices.


When property values began to recover after 2003, many families had been struggling with negative equity values on their mortgaged homes for 6 years. The population had barely recovered from the 1997 Asian crisis when the 2008 global economic crisis struck. Quantitative easing triggered a new round of escalating asset prices everywhere. Existing property owners saw their negative equity values fully recovering, but newcomers to the property market suddenly found homes had become unaffordable again.


Between the two crises, few families in Hong Kong became first-time property owners. The fraction of homeowners in the population has remained stagnant for two decades. The propertied wealth divide has grown further apart.


Other factors also contribute to the general sense of a growing economic divide. Divorce rates have taken off among low-income families, worsening the economic plight of single parents and the opportunities for their next generation. Young families have found themselves struggling to live in ageing sub-divided housing units in old urban areas. More and more of the poor and elderly have become concentrated in public rental housing estates, often in remote areas from the city center. There is a growing sense of imposed isolation and helplessness.


Meanwhile, large numbers of new immigrants have been coming across from the Mainland for family reunion purposes as cross-border marriages and remarriages continue to stay high. The city’s residents, its social and economic milieu, have been remade in the process. Every single one of these changes has been happening gradually at the micro level, but together their scale, variety and pace are massive.


The city is home to the old and the new, the rich and the poor. The community is in a sense enriched through greater diversity, but it is also polarized and fractionalized, which is breeding political forces and practices that are new to the community and foreign to our past political culture. The contradictions of 30 years of rapid social and economic transformation have become manifest after two economic crises of 1997 and 2008.


Pockets of political extremism found both on the left and on the right in Hong Kong – sometimes on the streets, sometimes in the legislature, and sometimes even seen in government – are the products of three decades of change. They are the manifestations of the failure of policy to recognize and prevent the rise of huge economic disparity and to allow it to remain untreated. The left wants massive redistribution and the right wants to keep out outsiders through violently discriminatory practices. The origins of both types of radical populist politics are similar to experiences found elsewhere in the world, today and in the past.


The Great Depression also created lasting political consequences in the US. The New Deal under President Roosevelt was a watershed event and led to the end of the domination of the Republican Party, which won every election from 1860 to 1928 except in 1876. The Republican platform of commercial and industrial growth had led to huge economic disparity, which were reined in through redistributive social welfare programs, hence, forestalling any serious threat that could come from either fascism or communism.


This did not translate into equivalent electoral dominance for the Democratic Party, which since 1932 has won 12 presidential elections but been defeated by the Republicans eight times in 1952, 1956, 1972, 1980, 1984, 1988, 2000, and 2004.


Moreover, the 2008 global economic crisis has so far failed to deliver a clear victory for the Democratic platform due in part to the revolt of the electorate against ballooning public debts and rising fiscal deficits. American voters have seen it fitting to check the powers of a Democratic President with a Republican Congress and Senate.


The traditional middle and working class support behind the Democratic Party’s welfare programs have been faltering for another reason – the rise of various hot-button cultural issues that cut across economic lines. The emergence of post-materialist issues has neutralized income-based political participation. The social basis of support for the left wing of the Democratic Party has increasingly come from members of the middle class concerned with environmental, abortion and same-sex marriage issues.


At the same time a substantial share of the working class has shifted its support to the Republican right over similar issues, with racist and xenophobic tendencies. The American electorate has clearly moved more from income-based bi-polarization toward value-based multi-polarization. The political landscape is more fragmented and polarized.


Elements of these cultural issues are emerging on the Hong Kong political landscape, including xenophobic elements in the extremist nativist thinking. There are many layers of diversity each seeking to defend the values they hold dear, some championing new causes, others old ones. Calling this smorgasbord of anti-establishment “pan-democrat” does not help us understand who these views actually represent or their collective political goals.


And on top of all these layers of cultural political issues sits the growing economic disparities in society. Unless this final problem gets addressed, populist politics – whether on the right or the left – will continue to have a market.


Interestingly, Friedman did not support free floating exchange rates for a small open economy like Hong Kong, arguing that the puny tools of domestic monetary and fiscal stabilization policy would be futile against the tide of cross-border capital movements sweeping through the markets. It would be far better to endure the external shocks by preserving the robustness of the underlying economic foundations to facilitate a fast adaptation to these external shocks.


High on the list of these foundations are such features as fiscal prudence, banking safety, and flexible labor markets with minimal labor legislation. Friedman counseled that government policy should avoid becoming part of the problem by creating uncertainty.


Hong Kong has by and large stayed close to this course of action. And that is why we have been able to come out of the severe Asian crisis without an American New Deal or a German fascist dictatorship.


Living through this era, I came to appreciate the resilience of the public spirit of the Hong Kong people, who not only took economic adversity in stride, but also displayed an unusual communal and selfless spirit when the SARS epidemic struck in 2003.


But correcting the lingering economic disparity still needs smart government intervention. The root cause of such economic disparity is the unequal incidence of rising property prices. The problem Hong Kong faces today is quite different from what the generation after the Great Depression encountered. Asset price inflation did not become a problem there until half a century later.


This is why recurrent transfers delivered by welfare programs were helpful back then, but are inadequate and inappropriate today. Half a century of state welfarist policies has bankrupted governments. Moreover, the problem today is wealth disparity – housing capital and human capital – not income inequality as such (although there is a connection between the two, they are distinct).


In Hong Kong, the government has an undeniable responsibility in this matter because of its monopoly over land ownership and its supply, and its role as the dominant provider of medical care and education services. If Hong Kong wants to avoid extremist politics, it must cure the ailments, pains and lingering effects of the social and economic transformations that have taken place in the past three decades and the ravages of the Asian financial crisis and the 2008 global financial crisis. This requires government to address the economic disparities first in housing wealth, and second to invest in education (especially early childhood education) to prevent the current inequalities from passing onto the next generation.

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