- LECTURE – Hong Kong and the Context of Laissez-Faire: Myths and Truths about a 'Free Market Paradise' By Catherine Schenk History of Capitalism Series 2 June 2016 * * * Hong Kong has developed a reputation for open markets, opportunity and free trade from its founding in 1842, when the British took the ‘barren’ island to function as the headquarters to open up the trade between China and the rest of the world and escape the constraints of trading through Canton and Macao. Hong Kong is persistently ranked as the world’s most economically free market by the Fraser institute (1970-2015) and by the Heritage Foundation (1995-2015). It thus forms a kind of bench mark for free market capitalism and seems at first sight to conform to the idea of laissez faire, or leaving business and markets to do what they do best without interference. Moreover, Hong Kong is an important case study to understand the components of effective regulatory reform. While many states struggled with banking regulation in the new era of integrating capital market in the 1970s, Hong Kong carved its own path to establish a regional and then global international financial centre, in the absence of a central bank (the Hong Kong Monetary Authority was formed in 1993). Milton Friedman particularly lauded Hong Kong as a preserve for free markets even when its imperial master, Great Britain, was at its most interventionist, promoting nationalised industry, strong labour unions and a large and generous welfare system. 1 Among Friedman’s final publications (a month before his death in November 2006) was a contribution to the Wall Street Journal where he described Hong Kong as ‘a shining symbol of economic freedom’.2 In 1998, Friedman specifically attributed the relatively poor economic growth of Britain compared to Hong Kong to ‘socialism in Britain, free enterprise and free 1 M. Friedman, ‘Asian values: right…’, National Review, 31 December 1997. M. Friedman, ‘Hong Kong Wrong’, Wall Street Journal, 6 October 2006. 2 Friedman, ‘Hong Kong Wrong’. 1 markets in Hong Kong.’3 In 1960 Hong Kong’s per capita income was less than a third that of the UK, but by the time of the handover of sovereignty to China in 1967 per capita income in Hong Kong was more than 10% higher than in the UK. The characterisation of unfettered markets is certainly true for international capital flows and the foreign exchange market, which operated more freely than almost any other centre in the world in the 1950s.4 But how well does this characterisation conform to more detailed historical evidence? Certainly, Hong Kong’s post-war economic development was remarkable and demonstrates a wealth of entrepreneurship, resilience and appetite for trade. Despite Britain’s imposition of protectionist tariffs on Hong Kong’s exports of textiles in the 1960s, entrepreneurs in Hong Kong were able to nimbly shift production to new areas and deploy new models such as sub-contracting for large US and European distributors to follow markets. Looking at Hong Kong’s history more closely reveals a more complex system, vulnerable to bargaining between big business and the state. A stylised version of Hong Kong’s post-war economic success is that the colony thrived originally on the principles of free trade as an entrepot for Chinese trade with the west. After the Communist revolution on the mainland in 1949, China’s trade was disrupted throwing Hong Kong into a new and challenging environment. Partly through the influx of manufacturers and labour from across the border, labour intensive industry was quickly established in the colony to replace the traditional entrepot role. The persistence of free markets then supported the rapid industrialisation of Hong Kong during the 1960s and 1970s through export-led growth. Low tax rates, freedom from controls on investment, open-ness to trade and competition led to a resilient and vibrant economy that flourished in an environment of cheap labour, predominantly English language, the strong British legal tradition and advantageous geographical position. The growth of labour-intensive production of textiles, toys and other light manufactures led to rising incomes per capita. When local wages began to rise after the 1960s, exports began to lose their competitiveness, but Deng Xiao Ping’s launch of China’s Open Door Policy at the end of 1978 provided the outlet for Hong Kong firms to shift their production to the low cost Special Economic Zones on the 3 M. Friedman, ‘The Hong Kong Experiment’. 4 C.R. Schenk, Hong Kong as an International Financial Centre: emergence and development 1945-65, London: Routledge, 2001. 2 mainland. The subsequent rise of the international financial centre, logistics and tourism sustained the economy through the difficult decades of the 1990s and 2000s. On the eve of the hand-over of sovereignty to China in 1996, the colony’s per capita income had soared to 10% higher than that of the UK. But this stylised view of Hong Kong’s success is open to question when viewed in greater detail. The sections that follow will challenge the assumption that economic relations with China were suspended from 1950-1978, that markets were free and that the state did not intervene in the economy. Evidence of Hong Kong’s economic success Figure 1 shows the dramatic rise in per capita gross domestic product from 1961 to 2013. The consistent and accelerating growth from the 1980s to the 1997 Asian Financial Crisis is particularly striking although nominal output per person then fell from Figure 2 shows how output changed in each year from 1961 to 2014 in constant dollars, which shows that the only years in which output fell in real terms was in the 1997 Asian Financial Crisis and the 2008 Global Financial Crisis. This emphasizes the vulnerability of Hong Kong to global factors, partly because of the 3 open-ness of its economy. What is also striking is the higher average rates of growth during the years 1962 to 1989 (8.4% per annum) compared with the period from 1990-2014 (3.9% per annum). Hong Kong joined other so-called East Asian economic miracles much praised for their rapid development.5 A few years of slower growth in the mid-1960s were associated with local political disturbances. This was followed by another brief slow-down at the time of the first OPEC oil crisis and again a decade later during the negotiations for the transfer of Hong Kong to Chinese rule in the early 1980s. In the early 2000s, the SARS health crisis interrupted tourism and business travel to Hong Kong which adversely affected economic activity. Nevertheless, Hong Kong grew quickly relative to most of its neighbours and certainly much faster than Britain during the 1960s and 1970s. Year-on-year % change in GDP (2013 dollars) 20 15 10 5 0 1975 2001 1961 1963 1965 1967 1969 1971 1973 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2003 2005 2007 2009 2011 -5 2013r -10 Figure 3 shows the dramatic transformation of the economy that was achieved by integration with the mainland economy. What is particularly striking is the absolute decline in the value of manufacturing output from the end of the 1980s as production was shifted across the border to Shenzhen and other coastal centres. Hong Kong has continued to be by far the largest source of foreign direct investment into China. The decline in manufacturing in Hong Kong was more than matched by an upward surge in the value of production in the service sector, particularly financial and commercial services. That this restructuring was achieved without faltering rates of growth or employment is a testament to the resilience and vitality of Hong Kong’s economy, and the importance of economic integration with the mainland two decades before the handover of political sovereignty. 5 See for example, World Bank, The East Asian Miracle: economic growth and public policy, Oxford University Press, 1993. The others included South Korea, Taiwan and Singapore. 4 Hong Kong GDP HK$ million 1980-2007 500000 450000 Wholesale, retail and import and export trades, 400000 restaurants and hotels 350000 Transport, storage and communications 300000 250000 Financing, insurance, real 200000 estate and business services 150000 Manufacturing 100000 50000 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Figure 4 confirms the increasing role of mainland China in Hong Kong’s trade. Before the open door policy, only about 10 per cent of Hong Kong’s trade was with the mainland, but by 2008 this had increased to close to 50 per cent. Almost all of the increase in the intensity of the trade relationship has been through imports and re-exports, most of which is related to the export processing industries located on the east coast of mainland China. China’s international trade and investment are thus closely related and Hong Kong’s trade is increasingly dependent on the vibrant mainland economy. 5 Hong Kong’s financial centre is also increasingly dependent on the mainland. Figure 5 shows the share of China-related companies in Hong Kong’s stock market capitalisation since the early 1990s. Hong Kong Stock Market Capitalization (% Total) 60% 40% 20% 0% 2004 2013 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2005 2006 2007 2008 2009 2010 2011 2012 2014 2015* H shares % of market Red chips % of market By the time of the Global Financial Crisis, Chinese companies represented over half of Hong Kong’s stock market capitalisation and although this share has subsided, it is still significant at over 40 per cent. Thus far, the evidence supports the traditional story of Hong Kong’s rapid economic growth as a free market economy first through trade then manufacturing and the importance of integration with the mainland starting in the 1980s.