Hong Kong’s axing from Heritage Foundation’s Economic Freedom rankings a gift that will keep on giving
- Market failures related to global finance and Covid-19 should have made policymakers realise that to function well, free markets require sound rules
- Hong Kong needs to consider how it can achieve a better state-market balance in a post-pandemic world rather than cling to outmoded ideas of the free market
The rankings see virtually all forms of government intervention – including taxes and redistribution, government stabilisation policies and public monopolies – as inherently bad. But as anyone with even a superficial understanding of economics would know, markets can fail in a variety of ways and those failures often justify government intervention.
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The same concepts of a public good and collective action problems also apply to (global) financial stability, a lesson we should have learned during the global financial crisis more than a decade ago. Then, a liberalised, loosely regulated financial market produced a credit boom in the world’s most advanced economy, fuelling a housing bubble and a borrowing binge. When interest rates started to rise, the inevitable crash and the rapid loss of confidence in the financial system “spilled over” (yet another type of market failure: externalities) to the rest of the global economy, causing herding and panic selling, a shortage of liquidity and the sharpest downturn the world had experienced since the Great Depression.
The global downturn caused by the current pandemic could be much deeper and more prolonged than the one caused by the financial crisis. But thankfully, governments (and central banks) around the world have mostly been quick to roll out rapid, broad-based emergency measures, whether in the form of emergency loans to small businesses, wage subsidies, expansion and extension of unemployment insurance, support for consumer spending and lower interest rates. But according to the Heritage Foundation, the economy that ends up with a larger fiscal deficit or share of government spending in its GDP after the pandemic would be reducing economic freedoms.
There is also now discussion in many advanced economies of the need for a new social contract after the pandemic, one that involves modernising the welfare state and achieving a more equitable distribution of risks between the state and citizens. This adaptation of the modern welfare state is badly needed; the prevailing neoliberal consensus of the late 1990s and early 2000s led to individuals bearing too much risk in areas such as health, retirement and unemployment financing. A correction is long overdue, not least in places such as Hong Kong, which has embraced the neoliberal paradigm in its most extreme form since the British colonial era.
Given the ubiquity of market failures, and the fact that the global financial crisis and Covid-19 should have made policymakers realise that to function well free markets require sound rules and regulations, government stabilisation, and various policy tools to deal with market failures, it is rather surprising that the Hong Kong authorities would pay any attention to an index produced by a think tank that is increasingly detached from economic realities.
The Heritage Foundation defines a free market as one that is free from government intervention. Even Adam Smith, the godfather of free-market economics, did not hold such an extreme view. When Smith wrote of the virtues of the free market, he was quite mindful of the collusive tendencies of private monopolies and oligopolies. For him, a free market was one chiefly characterised by competition and one that was free from monopoly power – whether private or public.
What all this means is that Hong Kong’s policymaking elites should always have been sceptical of being ranked the freest economy by the Heritage Foundation, when the city has also been ranked number one in terms of income inequality and housing prices. Hong Kong’s exclusion from the list should, in fact, be viewed as a blessing.
Back in 1998, one of us (Donald Low) was part of a Singaporean delegation of civil servants to call on Hong Kong’s senior officials. It was then the height of the Asian financial crisis, and the Hong Kong Monetary Authority had just intervened in the Hong Kong stock market to shore up prices. The Heritage Foundation warned in its 1998 report that although Hong Kong was still ranked first on its index, it would soon be replaced by Singapore if the Hong Kong authorities carried on with their interventions in financial markets.
What surprised the Singaporean delegates was that this warning by the Heritage Foundation was repeatedly mentioned by the senior officials they called on. This was quite mystifying to the Singaporean officials. They were also bemused that the Singaporean economy might be perceived as being as free as Hong Kong’s.
Singapore’s officials have never been apologetic or shy about their government’s interventions. Indeed, if one compares both economies, the parts where Singapore performs significantly better are due almost entirely to an activist state rather than liberated markets. For instance, Singapore has a superior public housing programme; it also has a more diversified economy in which high-end manufacturing (including petrochemicals, electronics, pharmaceuticals and aerospace engineering) accounts for 18 per cent of GDP. Both are clearly the result of “big government”: a monopoly developer of public housing and aggressive industrial policies to keep manufacturing viable in Singapore.
After years of job offshoring to the Pearl River Delta, now relabelled the Greater Bay Area, manufacturing now contributes less than 1 per cent of both Hong Kong’s GDP and employment. The lack of manufacturing activities has significantly limited the extent of technology transfer to markets and research and development activities here. The heavy reliance on services, in particular finance and trading, has also made the Hong Kong economy more vulnerable to external shocks and contributed to the city’s widening income gap. Part of the reason is the dearth of good jobs that offer opportunities for on-the-job skills accumulation and therefore, upward mobility.
The “big market, small government”, non-interventionism advocated by the British-Hong Kong government may have been appropriate during the period of hyper-globalisation between the early 1990s and late 2000s. But when the market does not reward companies and individuals who innovate, and which generate large positive spillovers to the wider economy, industrial policies should be considered.
Even in the United States, which has eschewed industrial policy over the last several decades, things are beginning to shift. President Joe Biden and both parties in Congress have begun to consider industrial policy, especially in semiconductors. Earlier this year, Congress enacted legislation to match state and local government incentives for new semiconductor fabrication plants, and new R&D and training activities. While Congress has not authorised funding, President Biden has indicated his support and announced a review of supply-chain vulnerabilities in industries such as semiconductors, batteries and pharmaceuticals.
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In Hong Kong, more than 20 years after the Asian financial crisis, little seems to have changed in its governing philosophy. Its policy elites still cling to an outmoded think tank ranking of the free market, at a time when most advanced economies are considering how they can strengthen and modernise their welfare states in a post-pandemic world in which inequality would increase further.
Instead of responding with a mix of wounded pride and unrequited love, Hong Kong’s policymakers should see its exclusion from the Index of Economic Freedom as an enduring gift. No longer shackled by the need to maintain its position in a ranking exercise based on an outdated neoliberal ideology, Hong Kong should strive to remake its economy and find a much better balance between state and markets.
Donald Low is senior lecturer and professor of practice in public policy, and director of the Institute for Emerging Market Studies at Hong Kong University of Science and Technology. Heiwai Tang is professor of economics and associate director of the Asia Global Institute at Hong Kong University.