Ever since the mid-1970s, when Milton Friedman shot his Free to Choose television documentary, lionising Hong Kong as the world's most open economy, Hong Kong's bustling streets and markets have become synonymous with the creed of laissez-faire. For years when commentators in Europe and the United States needed a catch-all comparison for some imagined raw-in-tooth-and-claw market economy, Hong Kong offered rich imagery. Hence the dismay greeting last year's downgrade by the US Heritage Foundation. Some even believe the speed in merging the stock and futures exchanges was prompted by its stinging criticism. If so, and if recognition from right-wing think-tanks is what the Government desires, it will find little cheer in the new Global Competitiveness Report courtesy of the World Economic Forum. Being downgraded as a business city is becoming a bad habit for Hong Kong. This time, the SAR has slipped from second to third, with the resurgent US 'new economy' moving ahead. Less worried by last year's stock-market intervention, the survey compilers cited an over-valued exchange rate and the growing government deficit as its main bugbears. Singapore retains its number-one slot by dint of its managed currency depreciation and reduced wage costs. Perhaps none of this is surprising. The rankings are formed by objective criteria of economic prowess. Hong Kong, as everyone knows, is going through a recession. Economic activity is expected to slump 4 per cent this year. Unlike Singapore or the US, it has a fixed exchange rate and a taxation base tied heavily to property sales. If ever the defence of being caught at the bottom of the cycle was going to be made, this is surely the time. Moreover, the report continues to rank Hong Kong as number one in many traditionally strong areas: average tariffs, tax system, private investment in infrastructure, and labour regulations, to name a few. Given that the US looks near the end of an economic boom supported by high share prices and plentiful foreign capital, it is hardly surprising that its vital statistics are rosy. That point is made by a group of Harvard economic professors, led by Jeffrey Sachs, who argue that the US looks suspiciously like Japan a decade ago. Maybe, but for Hong Kong there is more worrying evidence that its jewel of an economy is falling behind the rest of the world. Most damning is the fact that, by microeconomic competitiveness, the SAR ranked at only 21, compared with 12 last year. Unlike the main survey, which focuses on big-picture things such as exchange rates, government indebtedness, independence of the judiciary and corruption (or lack of), the micro study assesses the nitty-gritty of commerce. Everything from the number of computers in the workplace to the depth of product branding by manufacturers is fed into a fitness measure of business. The worry for Hong Kong is that there are not enough of a great many of these elements. For example, not enough roads, not enough quality business schools, not enough venture capital. Most critical is the lack of domestic competition across a range of industries. Increasingly, economists are looking at such factors to explain economic growth and job creation. The survey measures competitiveness of companies and the environment they operate within. Drawing on fashionable ideas like 'clusters of innovation', it argues that low tariffs and small government alone are not enough. A long-held notion was that microeconomic betterment naturally followed improvements in macro conditions. For Hong Kong officials, this seemed like good news. It suggested they had only to manage their finances, provide basic services and administer the law and the rest would follow. Targeting both Hong Kong and Singapore, the survey pointed to 'weaknesses in institutions and company practices relative to other nations at their income levels'. Those 'others' are the long list of advanced Western economies that rank well ahead of both city states. The implication is that, while these Western economies might appear sedate (Finland, for example), most are winning out through good corporate governance, high levels of education and best-practice companies. For Hong Kong, the report comes at a pivotal time, with the Government infatuated with the idea of becoming a high-technology hub. A day barely seems to go by when some new flashy-titled initiative is not announced. More significantly, it comes as moves are made to deregulate previously closed areas of the domestic economy. A key feature in improving microeconomic competitiveness is identified as breaking up cartels and monopolies. This point has, of course, been forcefully made by the Consumer Council, but only recently has been seriously backed by the administration. In the high growth years, it was easy for Hong Kong firms to ignore much of the management innovation taking place elsewhere. With growing export markets and rising property prices, the intensive process of 're-engineering' trumpeted by many Western firms seemed a waste of time. What has changed in Hong Kong, at least, is the realisation that many of the protected franchises must be thrown open to competition. The telecoms industry provides a model that is likely to be reproduced across the domestic economy. Privatisation will play a key role. Contracting out by the Housing Authority of its estate management services is part of this trend. The power companies seem likely to face an overhaul of the scheme of control and, most radically, a review is taking place of the whole way the Government provides housing for the less well-off. Hong Kong is not unique in going through this transition. The merger boom in Europe is being driven by the same forces. In Britain, competition policy now sits at the heart of the government's agenda. In fact, many countries have quietly struggled with such reforms for the best part of a decade. For Hong Kong, time is of the essence. There should be nothing like an embarrassing report from a right-wing think-tank as a reminder that you have forsaken the straight and narrow.