(This essay was published in Hong Kong Economic Journal on 1 March 2017.)


Economic liberty and political equality are two of the most important ideas that define modern civilization. The free market capitalist industrial economy is founded on the principle of economic liberty based on private property. The democratic political system is founded on the principle of equal political rights for all men (and women of course) without privilege from birth.


Yet these two important ideas have long shared an uneasy coexistence – with many believing free markets worsen inequality. Left-wing radicals, progressives and social liberals have persisted in the belief that free markets should be either abolished (together with private property) or restrained through government regulations to moderate economic inequality and protect political equality.


Even among members of my own tribe of economists, there are some who believe that free markets worsen inequality and prefer bigger governments and smaller markets. Some of them have become quite well known to the general public because of their popular writings – Thomas Piketty, Paul Krugman and Joseph Stiglitz.


Left-leaning liberalism traces its origins to the important work of utilitarian philosopher John Stuart Mill, who believed that free markets were good for solving problems of economic production, but not problems of distributional equality. (He was also an advocate of equal political rights for women.)


Left-leaning liberal, progressive, and even socialist ideologues, none of whom  like markets, are delighted that someone like Mill, who supported both political and economic liberty, provided an argument that markets cannot solve distributional issues. John Rawls, who combined Mill’s utilitarianism with Kant’s idealist philosophical principles, became the social liberal’s favorite twentieth century philosopher.


Mill’s socialist inclinations prompted a search for taxes to redistribute income and wealth to achieve equality goals without negatively affecting incentives for economic production. This effort failed. Even Henry George’s favorite tax on land or landed property did not pass the test because taxes would affect how land would be used relative to other resources, and where economic activities would be located if not all land were taxed by the same amount.


The idea of a “lump sum tax” that could redistribute income without negatively impacting incentives on economic production simply could not be found. This has not, however, prevented economists from proposing taxes to redistribute income. Low taxes are obviously less distortionary than higher taxes on production incentives, and some taxes are obviously less distortionary than others.


Milton Friedman favored using the negative income tax to redistribute income to low-income families because it would be a more cost-effective way of promoting equality than the myriad of social welfare programs the government was supporting. The main effect of those programs was seemingly to create jobs for civil servants and other service providers to manage the programs. The US government adopted Friedman’s proposal, but the existing social welfare programs were not phased out. So instead of replacing the cost-ineffective programs, it simply became an additional one.


A second question prompted by Mill’s socialist inclinations is whether enlarging the role of markets in the allocation of economic resources would lead to more or less inequality. ‘Trickle down economics’, also known as Laffer’s supply-side economics, reasoned that lower taxes, especially for the rich, would promote economic growth and benefit low wage workers through job promotion. In theory this is possible, but not necessarily in practice.


Hostility towards markets has led many left-leaning liberals to believe that markets cannot lower inequality. Many of them argue that expanding markets, such as through global economic integration, increases inequality within national economies. This is not as obvious as it seems. Is the increased inequality a result of growing market integration? Is it a consequence of skill-biased technological progress that has increased relative wage differentials between skilled and unskilled workers? Or is it the higher incidence of family breakdown among low-income families the source?


If the latter is the case, then ending global economic integration would not arrest growing inequality. Indeed, it could worsen the lot of low wage workers by making imported consumption more expensive, as has been demonstrated empirically by many economists. It is, therefore, not correct to point the finger at global economic integration for rising inequality.


What other factors could be at play, then? Let me consider the most important source of rising economic inequality in Hong Kong (and also elsewhere) – ownership of housing capital. As evidence, I shall cite the empirical findings of the left-leaning Thomas Piketty of Capital in the Twenty First Century fame.


Piketty’s study showed that the ratio of capital to income in the rich industrialized nations has risen since World War II and especially since the 1980s, when the pace of global economic integration sped up.  He goes on to show that income and wealth inequality have also increased over the same period. He then concludes that the political economy of markets has led to the concentration of capital in the hands of the few through a process where the returns to capital are higher than the growth of incomes or wages.


He proposes all nations should together impose a global tax on capital to reduce inequality (and also to restore economic growth as a consequence).


Piketty’s error in interpreting his own evidence has been exposed by a graduate student of economics at the Massachusetts Institute of Technology Matthew Rognlie, who showed that the entire increase in the ratio of capital to income could be attributed to the rising value of housing capital. The ratio of business and financial capital to income had not changed at all over the postwar period. The puzzle of the declining share of labor’s income in the national income can also be entirely accounted for by the rising share of income due to housing capital.


A simple explanation for Piketty’s empirical findings is that rising global economic integration has increased income in the world. Demand growth has driven up the values of housing assets in most countries, especially those in major metropolitan centers. In cities with secure property rights due to a robust rule of law regime, property values have appreciated even more spectacularly because investors who do not live there are also buying in the market.


The situation has been worsened by the failure of the housing supply to increase commensurately due to all kinds of regulatory barriers to development and redevelopment. An important part of the rising inequality of wealth ownership (and consequently of incomes) can then be explained to a considerable degree by the inequality of housing capital ownership. This phenomenon is found in many parts of the world and in democratic or non-democratic countries. It does not depend of the nature of the political system.


Location has become the major factor determining inequality in the world – a result confirmed by the massive empirical research of Branko Milanovic, who concluded that geography rather than economic class is a far more important factor in global inequality today. This creates enormous pressure for people to emigrate from poor regions to rich ones. Rich countries with an ageing population and a declining workforce also selectively welcome immigrants. Immigration is thus driving increasing global economic integration, but it is also fueling domestic conflict and international protectionism.


Turning to Hong Kong, where domestic property prices have risen continuously since the early 1980s (except in the period following the Asian financial crisis), housing capital ownership has become the single most important source of inequality. In 2016, 54% of households lived in the private housing sector and 46% lived in the public housing sector. Homeowners comprised 15% of public sector households and 36% of private sector ones.


Homeowners in the public sector have only limited property rights because until the outstanding land premiums have been repaid to government, the property is essentially co-owned with government as home equity partner. So in effect, only 36% of households are bona fide homeowners, making housing capital the single most pervasive source of inequality in wealth.


Unless the public housing stock of ownership and rental units is fully privatized, the 46% of households in that sector will not be able to share in the appreciation of housing wealth as property prices rise and put homeownership further out of reach. Inequality in housing capital will continue to persist.


The public housing program must also be reformed to help future eligible applicant households become genuine homeowners, otherwise more and more households will be locked out of the private housing market and deprived of an opportunity to accumulate wealth. At present the household income eligibility criteria for a family of four to qualify for the Homeownership Scheme is $52,000 per month. This qualifies some 80% of all households in Hong Kong.


By implication, our public housing policy promises to provide housing for fourth-fifths of the population without explicitly stating so. This target is of course the stated policy of the Singapore government, where 80% of households live in government-provided Housing Development Board units, of which some 95% are ownership units without a Hong Kong style unpaid land premium. The difference between the two is glaring: Hong Kong promises implicitly to provide 80% of households with public housing but delivers only 46%, while Singapore has met its 80% target in full (and these are not the same type of units).


Unsurprisingly, the Hong Kong public is frustrated. Alongside this shortfall, the number of units being built falls far short of expectations. Moreover, the public housing program remains mainly for rental rather than for homeownership, and even the latter is only for partial ownership because of the issue of unpaid land premiums. So the vast majority of the public still has to look to the private housing market if they wish to become a homeowner and escape the fate of being excluded from the upper segment of the wealth distribution.


Hong Kong’s political unhappiness is not primarily due to the voices from the lower echelons, but more from those in the middle segment. The latter are the most politically vocal and active and they are now blaming their condition on a political system they perceive to be dominated by a closed elitist establishment.


The situation for the middle-income household is very depressing not only because property prices are high, but more so because the mortgage market prevents them from having access to capital.


Before 1991, private property could be mortgaged at loan to value ratios of 90%. So a 10% down payment of the property value was sufficient to buy property. Subsequently, the loan to value ratio was decreased to 70% in 1991 because of fear that there was a bubble in the property market, which when pricked would result in a systemic banking crisis that would hurt everyone. But the loan to value ratio was lowered again to 60% in 2009. For properties in excess of $12 million, the loan to value ratio was lowered to 50% in 2011.


The result today is that the home mortgage loan market is available only to those who have saved up a huge down payment. The middle-income class is effectively precluded from having access to the market for loans. In the early 1990s, the down payment was a less formidable barrier because incomes were still rising rapidly; this ceased to be the case after the Asian financial crisis.


The killing of the mortgage loan market has worsened inequality in the last two-and-a-half decades. This illustrates vividly that free markets do not worsen inequality; rather their absence worsens inequality.


Lowering the loan to value ratio for mortgage loans may have its economic rationale, but it also kills the opportunity of hardworking low income households from improving their economic position. This makes it imperative that government change its public housing program from mostly rental units to homeownership units.


Instead of being a home equity partner that helps middle- and low-income households afford their own homes, the government should take on the role of creditor for the unpaid land premiums. In this manner, the unpaid land premiums would be capped at their original values and would not increase as property prices rise. The government would then in effect restore the ‘market for mortgage loans’ for eligible households with middle and low-incomes. Since such a ‘market for mortgage loans’ is limited to public sector units, there is no risk of market bubbles as it all takes place on the government’s ‘balance sheet’.


Sometimes asset markets suffer from runaway bubbles. But killing the mortgage loan market has made middle and low-income households suffer and broken the housing ladder essential for upward mobility. One could easily restore such a market function on the government’s balance sheet since it is the sole supplier of land for public housing. This would go a long way towards alleviating inequality and arresting political polarization to the benefit of all. Not restoring the market function for mortgage loans for public sector units in Hong Kong where housing is so valuable is criminal. Vive le marché!




Branko Milanovic, The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality, 2010, Basic Books, New York.


Branko Milanovic, Global inequality: A New Approach for the Age of Globalization, 2016, Harvard University Press.


Thomas Piketty, Capital in the Twenty-First Century, Belknap, 2014.


Matthew Rognlie, “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?” Brookings Papers on Economic Activity, Spring 2015.



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