A leading economist has warned of a cycle of economic contrac tion if the government makes drastic spending cuts to help balance the budget by 2006-07. Edward Chen Kwan-yiu, the president of Lingnan University, said the deficit was not caused by over-spending, but a sharp drop in revenue. He said a shock approach was needed to rejuvenate the economy, because unlike in the 1970s and 80s, 'market forces no longer work'. Professor Chen urged the government to establish a Pearl River Delta development corporation with mainland authorities to promote a regional development programme. The government could issue $300 billion worth of bonds to fund the project. Chief Executive Tung Chee-hwa has announced plans to trim government spending by $20 billion to $200 billion by 2006-07, while tax increases are expected to be announced by Financial Secretary Antony Leung Kam-chung in his budget on Wednesday. Last month, Hong Kong Monetary Authority chief Joseph Yam Chi-kwong warned of 'an interest-rate shock' if the budget lacked public support. The budget deficit for 2002-03 is expected to reach $70 billion. With the accumulative deficit representing almost 6 per cent of gross domestic product, Professor Chen agreed the level was unprecedented and must be addressed. 'It's a question of how we deal with it. The way the government is handling it now is piecemeal and driven by political expediency. It's not doing the right thing.' He doubts that the government had a clear idea of the cause of the problem before it started trying to fix it. 'Total revenue will only be about $150 billion, compared with about $200 billion before the Asian financial turmoil. It has gone down by one-quarter. The deficit is a result of a fall in revenue, not overspending. 'If we cut spending further, the economy will contract further. It will take longer for the economy to recover. A downward spiral will occur. 'You may be able to balance the budget by 2006-07. But a balanced budget for what? The economy will contract drastically.' Professor Chen said he believed the government might use the deficit as an opportunity to downsize the civil service. 'But first, what is the optimum size of the civil service? Secondly, is it the best time to do so?' he asked. Officials should consider reducing spending on retired civil servants' pensions in line with deflation. 'Our pension ordinance is outdated. Life expectancy is much longer now. It's also inconceivable that pensions can only adjust upward, but not downward. It's a question of whether the government dares to tackle the issue,' he said. Professor Chen said the best time for bringing in a broad-based sales tax was in the early 1990s and admitted it would be difficult to broaden the tax net during an economic downturn. 'If I was the decision-maker, the only thing I could do would be to take drastic and bold measures to stimulate the economy to bring back revenue through growth. The best hope for us is growth. 'It's not that difficult because we still have a lot of money in the bank.' He pointed to the $3.2 trillion of savings sitting in local banks, adding the government would have no difficulty in raising $300 billion to create the delta development fund. The economist said Hong Kong survived two cyclical economic recessions in the mid-1970s and mid-1980s due to growth in exports and China's opening up respectively. 'Our problem today is that we still live in the past and think we will be okay if we continue to do what we did in the past. We need to change our mind-set.'