Fiscal report based on lunatic projection of capital spending

Fears of looming structural deficits will disappear if the government considers infrastructure spending that complies with actual needs

PUBLISHED : Tuesday, 04 March, 2014, 5:09am
UPDATED : Tuesday, 04 March, 2014, 8:42am

Yesterday the government's working group on long-term fiscal planning published its report.

The committee's 290-page document contained much that was worthwhile, prudent and eminently sensible.

Unfortunately it also took for granted a set of assumptions so arbitrary and flawed that they rendered its conclusions almost entirely worthless.

In a nutshell the working group argued that as Hong Kong's population ages, over the next three decades the number of over-65s living in the city will grow by 1.5 million.

As a result, measured at today's prices, public spending on healthcare and welfare for the elderly will more than double, from HK$69 billion this year to HK$143 billion in 2041.

Meanwhile, as Hong Kong's workforce shrinks, the economy's growth rate will slow from 3.7 per cent now to a modest 2.5 per cent a year. And as economic growth slows, so - all else being equal - will the government's revenue growth.

So far, all is reasonable, conservative and uncontroversial. It's with the next bit of the report that things begin to come adrift.

According to the working group, this conjunction of rising health and welfare spending with declining revenue growth will push the government's finances into a structural deficit within the next 15 years.

Under the committee's base case, which assumes no improvements in services, the government will have burned through its accumulated reserves by 2040, and will be reliant on borrowing to fill the HK$271 billion hole in its budget.

With only a modest increase in per capita spending on health and welfare, the report warns that by 2041 the city would have run up monstrous debts of HK$3 trillion.

This is indeed a scary scenario. However, dig a little deeper and the picture doesn't look nearly as frightening as the government's working group has tried to paint it.

For a start, far from projecting a slowdown in the growth of Hong Kong's capital spending as the economy matures, the report assumes that public spending on capital works will rise from 3.2 per cent of gross domestic product this year to 7.2 per cent in 2041.

There’s a limit to how many roads, bridges and tunnels Hong Kong needs

In 2013 dollars, that means government spending on infrastructure will rise from HK$72 billion in 2014 to an eye-popping HK$515 billion in 2041.

To put that sum into perspective, it is enough to build four new runways for Hong Kong airport each year.

The working group explains this runaway escalation in infrastructure spending by arguing that construction costs tend to rise faster than general inflation.

As a result, the report says that to maintain a constant level of capital spending in real terms, the government will have to pump up its dollar spending on infrastructure by 7.6 per cent a year for the next 28 years.

This is little short of lunacy. Construction costs have indeed risen faster than general inflation, but that's largely because the Hong Kong government has been spending so heavily on its pet construction projects that it has pushed non-traded prices in the sector sharply higher. If it didn't build so much, costs wouldn't rise so quickly.

In any case, even keeping capital spending constant in real terms would be crazy. There's a limit to how many roads, bridges and tunnels Hong Kong needs.

If you don't believe that, just look at Stonecutters Bridge, a HK$3.6 billion engineering marvel which carries next to no traffic on its glittering spans.

These flawed projections of capital spending undermine the report's whole premise.

Factor in more modest spending on infrastructure, in line with Hong Kong's actual needs, and the government's looming structural deficits evaporate entirely.

In that light, some of the report's recommendations look distinctly strange, if not actually suspect. But they will have to wait until tomorrow.

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