Tsang's budget flip-flop turns economic wisdom on its head

PUBLISHED : Friday, 04 March, 2011, 12:00am
UPDATED : Friday, 04 March, 2011, 12:00am

John Tsang surely deserves a Nobel prize. Our visionary financial secretary has turned accepted economic theory on its head to come up with a whole new way of fighting inflation.

Last week, Tsang declared in his budget speech that 'fighting inflation is our major task this year'.

Well done John - problem correctly identified.

After Hong Kong's gross domestic product grew 6.8 per cent last year, and with the economy forecast by the International Monetary Fund to grow by between 5 and 5.5 per cent in 2011, the city's growth engine is firing on all cylinders. So, there's no need for Tsang to worry there.

The job market is looking healthy, too. With the unemployment rate down to 3.8 per cent, from 5.5 per cent just a year and a half ago, the government doesn't have to get to work creating new jobs.

And with retail sales up 28.2 per cent in January compared with the same month last year, people are spending with a will.

The only fly in Hong Kong's economic ointment is rising prices. Inflation in January was running at 3.6 per cent, the fastest rate in almost two and a half years.

And we can be certain that rate is going to climb further over the coming months. The increase in the housing component of the consumer price index as landlords renew expiring leases at higher rents, coupled with rising food and fuel prices, looks sure to push Hong Kong's rate of inflation above 5 per cent this summer.

At this point, a lesser man than Tsang would have paused to consider that one of the main purposes of fiscal policy is to act as an economic counterweight, damping what would otherwise be excessive gyrations in the business cycle.

When the economy turns down, governments typically increase spending to stimulate activity. And when the economy looks like overheating, they should turn off the taps to make sure they don't add more fuel to the fire.

In Hong Kong, which has no monetary policy of its own, this role is especially important, because officials can't raise and lower interest rates to push against the cycle. Fiscal policy is the most powerful counter-cyclical tool they have.

So according to conventional economic wisdom, Tsang should increase government spending when times are tough, and rein it in again when the economy is booming.

But Tsang has little time for conventional wisdom. Back in February 2008, with Hong Kong's economy severely squeezed by the tightening credit crunch, Tsang delivered a budget that defied common sense and actually cut real government spending by 7.6 per cent compared with the previous year. Economic relief measures amounted to just HK$8.4 billion, or a derisory 0.5 per cent of gross domestic product.

(To be fair, Tsang did hand out a few extra goodies three months later, although his belated stimulus effort was woefully inadequate and failed to prevent a steep contraction in economic activity.)

Then, last week, with the economy booming once again, Tsang presented Hong Kong's most expansionary budget in years. While revenues are expected to be flat, government spending will rise by HK$67.6 billion. That's a 22.3 per cent increase over the last fiscal year, and pushes government expenditure up to a hefty 21 per cent of GDP - in excess of the government's long-standing ceiling of 20 per cent - at a time when most governments would be cutting back to avoid exacerbating economic over-heating.

Then, this week, Tsang executed his fastest policy flip-flop to date, throwing good money after bad when he caved in to political pressure and decided to claw back the HK$6,000 he had promised to inject into every Hongkonger's pension fund, instead proposing to hand the money directly to the city's residents in a move which, along with a tax handout, will inject an additional HK$40 billion worth of cash into the economy.

By any standards, Tsang is taking a highly unusual approach to fiscal policy: plan to cut spending when the city is obviously heading into a slump, and then go on a spending binge when the economy is in danger of over-heating.

To the casual observer, Tsang's approach appears to be drawn straight from the headless-chicken school of policymaking. But then the casual observer may be underestimating Tsang's economic genius. If he succeeds in his 'major task' of fighting inflation by throwing money at the problem, as he is clearly trying to do, then he will have completely rewritten the economic policy textbooks, and will richly deserve that Nobel prize.