HK's competitive mojo remains intact despite inflation
With property prices back at their 1997 peak and consumer prices at an all time record (see the first chart below), Hong Kong's business community is worried that the city is in danger of losing its competitive advantage over rivals like Singapore and Shanghai.
It's hardly a surprising concern. In recent months report after report has lamented the sky-high costs of Hong Kong's housing. Back in January, for example, a survey by US-based research house Demographia warned that Hong Kong boasted the least affordable homes in the world.
According to its figures, the city's median home price was a punishing 11.5 times its median gross annual household income. In other words, a typical Hong Kong family would have to save every single cent they earned over 11.5 years in order to buy a typical flat in the city. Since then home prices have climbed another 9 per cent, while salaries for many haven't budged.
Meanwhile, inflation in the city continues to accelerate. Consumer prices rose 5.6 per cent over the year to June. And despite tightening measures on the mainland and the Hong Kong government's own efforts to massage the figures, they are likely to carry on rising. HSBC economists expect the inflation rate to climb as high as 6 per cent by September.
But although these numbers have caught the headlines and raised fears for Hong Kong's future as an international business centre, it isn't obvious that the city's competitiveness is suffering. Partly that's because competitiveness is hard to measure. To do it properly, you'd have to include all sorts of indicators and even then it would be tough to get right.
Thankfully though, we don't have to go to all that effort, because there is a convenient shorthand indicator that analysts use to assess an economy's international competitiveness. It's called the real effective exchange rate. In a nutshell it's an index compiled by taking the weighted average of a currency's exchange rates against the currencies of its trading partners, adjusted for differences in inflation between the different economies. Fortunately, the Bank for International Settlements has done the hard work for us and publishes the indices on its website.
So in theory, to see how Hong Kong's competitiveness is faring compared with that of our rivals, all we have to do is look at how our real effective exchange rate has performed against theirs.
But that only tells in which direction we are going. It doesn't say anything about how competitive we are in absolute terms.
To get around the problem, I've looked back over recent history in an attempt to identify a point when we can be fairly sure that Hong Kong was in top competitive form compared with its neighbours.
One period stands out: August 2003. At the time, Hong Kong was just emerging from the outbreak of severe acute respiratory syndrome after years of deflation following the Asian financial crisis. There was plenty of slack in the labour market - unemployment was at 8.5 per cent. Also, property prices had fallen by two-thirds from their 1997 high, and consumer prices had slumped by 16 per cent.
If ever there was a time when Hong Kong's economy was competitive compared with its rivals, it was surely then - a belief supported by the vigour of the city's subsequent rebound. So on that basis, I've taken real effective exchange rates for Hong Kong, the mainland and Singapore, and rebased them to August 2003. The second chart shows how each economy performed in the years both before and since then.
As you can see, Hong Kong's real effective exchange rate soared in the run-up to 1997, indicating a severe loss of competitiveness. The Asian financial crisis helped boost Singapore's competitiveness, bringing it more in line with China's. But it took Hong Kong years to restore its lost advantage.
Since then however, the picture has changed. While both Singapore and mainland China have appreciated in real effective terms, implying their competitiveness is declining, Hong Kong's real effective exchange rate has continued to fall.
In other words, far from losing its edge, in recent years Hong Kong has become considerably more competitive compared with its rivals. Much of that gain can be put down to the slide in the US dollar, to which the Hong Kong dollar is pegged.
Of course, in time that could pose problems of its own, stoking runaway inflation which would boost Hong Kong's real effective exchange rate and blunt the city's competitive advantage. But it's not happening yet. For the time being at least, fears that price rises and the property market's gains are undermining Hong Kong's competitiveness look overblown.
Hong Kong still has its edge.