[A-List] Henry C K Liu on Hong Kong

[Keaney Michael]

Free market not to blame for Hong Kong's woes
By Henry C K Liu
Asia Times, March 22, 2002

A recent Wall Street Journal editorial "Hong Kong heresy" shows misunderstanding of the situation in Hong Kong. The superficial impression of occasional visitors such as Milton Freidman notwithstanding, the Hong Kong economy has always operated as an oligopoly closely dovetailed with government policy, hardly "a testament to the wealth-creating power of the free market".

The property sector, the mainstay of the economy, is an obvious example, with the market dominated by a handful of super-developers where the supply of land is controlled by the government in an unabashed policy of market support. Hong Kong's manufacturing sector had long been nurtured by government industrial policy, providing land cost subsidies and export assistance.

All governments make use of industrial policy to varying degrees. Wholesale condemnation of industrial policy suggests ideological bias, while the implication that industrial policy is always anti-market is simplistic.

The United States historically relied on industrial policy prior to gaining economic world dominance and continues to subscribe to it today in fields in which the US is the unquestioned leader, such as technology, agri-business and communications. Alexander Hamilton was a strong advocate of industrial policy and the nation is much indebted to his efforts. The Clinton administration spent US$200 million in 1996 and $744 million in 1997 on an advanced technology program to subsidize high-tech, high-risk business ventures that the private sector had shied away from.

The US Department of Defense has participated extensively in reviewing proposed industry mergers and acquisitions to preserve essential competition for innovation and cost discipline to serve the nation's strategic aims. The Reagan and Bush Sr administrations attempted to revitalize domestic manufacturing and international competitiveness with a science and technology industrial policy.

The US government is by far the world's largest marketer of military hardware. US corporations dominate the production of military goods that involve large economies of scale. US government spending on military goods sometimes helps US corporations gain economies of scale that help them in international military and civilian markets.

Hong Kong's economic woes are more than just part of Asia's recent financial turmoil. They are structural problems caused by market failure coupled with the currency peg to the dollar. Hong Kong's unique success as Asia's trading and financial hub up to 1997 rested on three legs: below-cost capital, as domestic interest rates stayed below the inflation rate; inflated property values that supported the stock market and bank assets, while the government deliberately manipulated land supply, even as population pressure mounted; and access to cheap labor in China to generate manufacturing exports. The first two of the three legs were directly linked to the currency peg. The structural over-reliance on oligopoly property development and labor-intensive manufacturing exports is the result of market failure toward diversification and high technology.

Hong Kong's wealth had been generated on negative real interest rates caused by Hong Kong's currency peg to the undervalued US dollar beginning with the Plaza Accord of 1985, until 1997. The government, the oligopoly developers and the property-owning public all participated in a real-estate bubble that could not be sustained.

Hong Kong's trade and services surplus has been falling since the Asian financial crises of 1997. Its currency, pegged to the now strong US dollar, is way overvalued in global terms. Defending the peg becomes increasingly expensive in the form of high domestic interest-rate premiums. Hong Kong needs to find new ways of competing, both in manufacturing high-tech, high value-added products and in offering improved financial and logistics services.

An example of market failure is that in each of the eight main sectors of the economy, only a handful of companies dominate the market. This is the other side of Hong Kong's competitiveness problem: the need for massive market liberalization, which can be achieved by industrial policy to help small and medium enterprises in new markets.

One of the biggest dangers lurking in Hong Kong's future is capital flight. That would exacerbate the high cost of maintaining the peg over the near term. The present administration is officially committed to defending the peg. Yet the government needs adopt a strategy to gradually free float the Hong Kong dollar over the longer term, as the current fixed rate system constrains economic recovery and growth.

Hong Kong does not have a rule-based competition policy. A Competition Policy Advisory Group (COMPAG) was established in December 1997 under the chairmanship of the financial secretary to provide a high level, dedicated forum to review issues related to competition which have substantial policy or systemic implications, and to examine the extent to which more competition is needed in both the public and private sectors. A Statement on Competition Policy was promulgated in May 1998. It was a justification for a discretionary approach by fiat.

Hong Kong's corporate-governance practices are starting to fall behind global trends. It has launched a campaign to urge its listed companies to improve transparency and treat smaller shareholders better. More than half of all Hong Kong-listed companies have one shareholder or one family group of shareholders owning 50 percent or more of the issued capital, and this limits the effectiveness of any minority-shareholder action.

Aiming to address this problem, the Hong Kong exchange says it wants one-third of all company directors to be independent - that is, neither company employees nor associates of the controlling shareholder. The introduction of a voluntary code of best practice is a positive step, but the challenge remains as to whether a voluntary approach will be successful is promoting the true culture of good corporate governance.

Financial Secretary Antony Leung's "proactive market enabler" is an attempt to address these structural problems caused by market failure. It is unfair to label it as "backsliding" from free markets.

Henry C K Liu is chairman of the New York-based Liu Investment Group. 

Full article at:
http://www.atimes.com/china/DC22Ad02.html

Michael Keaney
Mercuria Business School
Martinlaaksontie 36
01620 Vantaa
Finland

michael.keaney at mbs.fi