Hong Kong’s capitalistic ways are changing

Thursday, October 16, 2008

When I think about Hong Kong, I visualize a fantastic airport with free wireless service, Nathan Lane with all its odd culinary delicacies, a phenomenal Kowloon art museum, a Victoria Peak that was too cloudy for us to see the view, and the sharp city landscape. Hong Kong’s strong financial ties with China have buffered it from the financial crisis so far – Asia’s total recorded losses to date are just $3 billion compared to the world’s $640 billion (from Bloomberg) – but signs of stress are emerging. Hong Kong’s dependence on export demand makes it vulnerable to the global slowdown. Although it exports heavily to Mainland China, a sharp decline from the U.S. and Europe is bound to hurt. Hong Kong’s outlook has become less sanguine, and policy makers are responding, but at what cost? It may cost Hong Kong its reputation as the freest economy in the world.

Hong Kong was rated number 1 on the Heritage Foundation’s “Index of Economic Freedom,” followed by Singapore, Ireland, Australia, and the United States. Hong Kong is well known for its capitalistic treatment of income and corporate tax rates, where overall tax rates as a share of GDP are small, limited business regulation, and flexible labor market. Trade subtracts from its freedom score – the Hong Kong dollar is pegged to the U.S. dollar, which is a direct intervention in trade flows between the two countries.

Hong Kong is significantly free relative to its competitors: Hong Kong is 90.3% free, while the average of the following 4 freest countries is just 83.1%. But expect Hong Kong’s Index of Economic Freedom score to fall next year, a consequence of two strong government interventions in 2008.

1. Fighting Inflation with a rent holiday

In July 2008, when oil prices were surging above $145/barrel, the Financial Times published Hong Kong rent holiday to fight inflation. The government intervened in the housing market directly by allowing residents in public housing to live rent-free for 3 months. Surely they couldn’t force private landlords to do this, but there would clearly be effects on the private market, via reduced demand. No rent increase = no increase in the housing component of CPI (consumer price index) = decelerating inflation.

Some may see this as innovative, but I see this as a ludicrous intervention. Markets later worked out the problem: with the emergence of a global slowdown, oil prices fell one month later, and consequently, so did inflation.

2. Fighting the credit crisis with a minimum wage?? From the Financial Times:
“That may change following an announcement on Wednesday by Donald Tsang, the indirectly elected head of government, that the territory is to impose a legally enforceable minimum wage for the first time.

“We should not see the free market and government intervention as two exact opposites,” Mr Tsang, the chief executive, said in his annual policy address to legislators. “The market is not omnipotent. Intervention is not necessarily an evil. If the market fails, the government should intervene.”

The territory’s move towards a minimum wage began two years ago with a voluntary “wage protection movement” aimed at improving the lot of low-paid cleaning workers and security guards. Mr Tsang admitted that the scheme’s results had been “unsatisfactory” and the government was “inclined to go for an across-the-board statutory minimum wage”.

Despite opposition from powerful business interests, political pressure has been building for a minimum wage to counter the territory’s growing wealth gap. Average monthly income is just HK$11,000 ($1,410, €1,000, £810).

Mr Tsang also warned that Hong Kong would soon feel the effects of the global crisis, noting that growth in gross domestic product had slowed to 4.2 per cent in the second quarter and was expected to slow further.

“The financial tsunami we now face is a global crisis,” he said. “Its destructive force is much stronger and more widespread than the Asian financial turmoil in 1997. The recovery will take longer, be more difficult and certainly cannot be taken lightly.”

A sharp fall-off in US and European demand for Chinese exports would have a big effect on Hong Kong companies, which have invested heavily in manufacturing facilities in southern China.

Hong Kong has been relatively untouched by the global financial crisis. The territory has, however, been bracing for worse to come. The Hong Kong Monetary Authority reduced interest rates by 150 basis points last week and has taken steps to increase interbank liquidity.

On Tuesday the territory’s government said it would guarantee all deposits until the end of 2010.”
Obviously, the “flexible” labor market component of the freedom index will be downgraded by this action, as a minimum wage is by definition “inflexible.” The article does not specify the number of employees that would be affected by this move, but I suspect that it will be enough to create higher unemployment. Firms will be forced to lay off workers in order to pay the higher cost to those workers who qualify for the minimum wage, and unemployment will result.

The chart illustrates the unemployment rate in Hong Kong, where the red lines are the forecast through February 2009. Previous to the announcement, unemployment would was set to rise to 4% in 2008 but fall back in 2009 to the 3-4% range, with the global slowdown and reduced export demand. But now, the unemployment rate in 2009 is set to rise – perhaps in the 4-5% range – with the new minimum wage.

In the Financial Times article, Sir Donald Tsang, Hong Kong’s Chief Executive, implies that the new minimum wage law is a move to protect the labor force amid a credit tsunami that is soon to blow through Hong Kong. However, key labor parties have been pushing for a statutory minimum wage without success, and as the economy slows, this is the time to get the bill passed. Eventually, Mr. Tsang will need to answer to problems associated with a rising unemployment rate. Admittedly, it will be a structural shift, but still, the transition will be arduous.

Hong Kong will still score highly on the free economy index, but recent actions indicate that the government may be pushing for a bigger role in Hong Kong’s economy.

Rebecca Wilder
p.s. Just saw a related article in the Wall Street Journal:


Janie October 16, 2008 at 8:56 AM  

Was it 1/1/200 when the Brits left? It is amazing the Chinese have mainly kept their fingers out of the economy this long.

Rebecca Wilder October 16, 2008 at 9:04 AM  

Hi Janie,

Close: Hong Kong was returned to China in 1997. I agree, it is remarkable how the Chinese government has adhered to the concept of One Country, Two Systems.

Thanks for reading! R

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