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Economic Recovery follows Rules

 (Article China Daily ¡V 2003.7.27)

The economy of Hong Kong is market based. It follows the rules of supply and demand and the system is mainly driven by profit motives of the individuals. However, despite the undisputed reputation of Hong Kong as a leading free market of the world, it is still far from being a perfect economy unfettered by arbitrary interventions.

Arbitrary interventions that distort a free market can take many forms. The most significant form of which is Government interventions grounded on political considerations. However, a mature political process will help strike a balance to make the individuals forgo painlessly some of their profits or future profit opportunities for the common good. For example, taxation and national debts are forms of intervention and economic distortion. In the same vein, public expenditure and regulations to protect consumer rights are also forces that work against the motivation of the entrepreneurs and the disciplines of the marketplace. Nonetheless, it is widely accepted that a moderate use of the political process is essential to help resolve societal disputes and hence, the stability and smooth operation of a modern harmonious society. The excessive use of interventions can, on the other hand, lead to greater corruption opportunities and a loss of enterprise spirit. Capital investment will flow out of the economy as a penalty for a heavy handed, off beam set of economic policies. This analogy is particularly true in the present highly competitive global environment where foreign investments are highly prized.

Hong Kong has thrived in the past decades on its ability to attract foreign capital and skilled manpower. This additional injection of resources to the small domestic economy had regularly provided us with the fastest and strongest fuel to feed the engine of growth. With a relatively small public sector, we have never depended on the Government alone to bale us out of an economic downturn. The open-ended nature of our economy and the linked exchange rate with the US dollars have also tied the Government¡¦s hands in deploying some, if not all, of the more effective financial tools in fine-tuning the economy. I shall briefly discuss them in turn below.

The most common financial tools within the Government¡¦s arsenals are currency exchange rate, money supply, interest rates, direct public expenditure and taxation. These tools are, however, inter-connected in the way that they deliver their impact on the economy. In sharp contrast to a close economy where these tools are most effective, an open economy like Hong Kong ¡¥leaks¡¦ heavily where the population and the wealth they carry is very mobile. This phenomenon creates an added dimension of uncertainty to the implementation of Government fiscal policies like using direct spending to try stimulating the economy.

The deliberate policy to peg the Hong Kong dollar to the US dollar means not only that the Government has surrendered its ability to use the currency exchange rate as a financial tool. At the same time, it causes the interest rate of Hong Kong to move in sympathy with the US economy rather than that of the wishes of the local Government. The need to back the Hong Kong dollar with hard foreign currencies also restricts the possible use of money supply or credit expansion to inflate the depressed economy. The only feasible tools then left to us are public expenditure but the effectiveness of that too, has to suffer serious leakages as Hong Kong people are more inclined to save, spend the money in cheaper cities nearby rather than on local consumption.

Given the above serious constraints, viable policy options open to Hong Kong to inflate the economy is therefore very limited. In fact, we are seriously in need of some creative unconventional financial tools to try to do just that in the long term.

The golden rules in public financial policies for Hong Kong to follow in times of depression can be simple. We must contain government expenditure in earnest, cut tax moderately in targeted areas to encourage new investments and the hard works put in by the most productive middle-class. We must also continue to invest in education and economically viable infra-structures. After having kept our own house in order, then we compete whole-heartedly as a city for new foreign investments.

The said rules are often easier said than done. In the case of Hong Kong, political interventions and pressure from civil services unions have seriously hampered and delayed the Government¡¦s efforts in cost cutting. In the last few years, the final score of all the cost cutting exercises of the Government is hardly noticeable. In the light of successive fiscal deficits of mega proportions, the Government has chosen to raise taxes on all fronts rather than to try reducing it. Although it pleases the international accreditation agencies and would help putting financial snipers at bay, the final policy package is not conducive to assisting our economy in pulling itself out of the economic low pit. In extreme anxiety, our Government was on the verge of becoming unselective in its investments on physical infra-structures. Fortunately, financial discipline wins the day when the Government decides to pull the plug on a number of its uneconomical projects e.g. Tamar site, in the last minutes.

As Hong Kong still struggles to keep its own house in order, the SARS epidemic unexpectly strikes. This causes a temporary derailment of the course of our economic adjustments. However, the silver lining behind the dark clouds is that it also creates a window of opportunity for fundamental and daring reforms. Like the project ¡¥team clean¡¦, we are, for a short while now, focused on the immediate problems at hand and are willing to make bold moves to ratify some old problems e.g. spitting and filthy private streets.

On the economic front, I believe that the occasion provides a perfectly legitimate reason for deploying our reserves and to postpone the rigid timetable set to balance the Budget by 2006-07. We could ease off the pressure to raise new taxes and to consider new tax concessions. The abolishment of the unfair Estate Duty tax which has unwittingly inhibited foreign investments is a good case in point. At present, this antiquated tax will only succeed in catching middle-class families and unsuspecting overseas investors. It has degenerated into a voluntary tax for the rich because of good tax planning tools available to people with high net worth. The revenue forgone is small at $1.5billion only but the potential for attracting new capital into Hong Kong as a home base for international investment holding is high. It is also one of the best marketing tools sending the welcome signal to international investors at a very reasonable price tag and the financial services sector will definitely benefit as well as local families. The only thing lacking now is the political will of the Government in testing the community¡¦s reaction.

The second case in point is a system of ¡¥local consumption vouchers¡¦ with a specified cash value to be used in defined groups of local retail outlets for a limited period of time, say two months. As I have argued earlier, Hong Kong lacks an effective financial tool to stimulate the local economy. The circulation of ¡¥local consumption vouchers¡¦ is like sending short bursts of energy down the local economy that is free from ¡¥leakages¡¦. It should have no conceivable harmful side effects in the long term because of its limited life span. It will be a useful tool to add to the limited range of the Government¡¦s arsenal not only now, but also for future occasions. We should seize the chance to launch it now!

Besides what we can do to help ourselves, any tangible offers from the mainland are most likely to be well received and much appreciated. The recent announcement of the CEPA arrangements is seen to be a major breakthrough. The new arrangements open the door of new opportunities that allows Hong Kong businesses to ride on the fast train of growth of the China economy. Already many Hong Kong companies are poised to test the water out in the financial services, retail, logistics and manufacturing sectors. However, though the direction of the CEPA arrangements are most welcomed, we are still in need of the many detailed rules to be put in place before the cautious and law abiding Hong Kong business sector will make a real move. Given the fact that it will also takes time for us to benefit from the investments in the China market, CEPA will give us little more than a big confidence boost and a glimmer of hope in the short and intermediate term.

I cannot possibly exhaust all the creative options here but would hopefully show that there are tools that might help and some basic rules to follow. In particular, any means to attract new investments and help check the monetary ¡¥leakages¡¦ that reduces the effectiveness of fiscal stimulants. A strong political will to see that costs are cut and that taxes are reduced. The time is right for bold attempts to raise short term borrowings and help to bolster our inadequate debt market in the long run. Opportunities knock but once and there are nothing worse than stalling our feet and do nothing. If we are willing to try, the SARS episode can end on a more venturous and positive note for Hong Kong. The gift of CEPA from the Central Government has just helped to set the right tone. All that we require now is the right Financial Secretary to steer and guide us along the well carved out path of economic and financial disciplines.

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