deficits and bad budgeting
version of what should have been published in the SCMP on November 4.
What was actually published was a bowdlerized and ill-edited version
With Budget-making time upon us, it will be interesting
and important to see whether Antony Leung Kam-chung can stamp a modicum
of coherence on the government's economic policies. At present there
is none. He also needs a vision of how much needs changing if Hongkong
is not to follow the path of Japan, beholden to the past and to entrenched
The Chief Executive, as ever muddled in his thinking,
simultaneously stresses the dangers of deflation and of budget deficits
while simultaneously stressing the inviolability of the dollar peg and
the need to ramp up property prices. Meanwhile the representatives of
vested interests far too close to his ministerial system continue to
make a laughing stock of Hongkong's supposed free market principles,
and to extract monopoly profits from essential public services from
ports to stock exchange.
But first spare some sympathy for Mr Tung and others
trying to achieve coherence when Standard & Poors downgrades Hongkong's
currency rating and casts long term doubt over the long term sustainability
of the peg. S&P delivered a homily about belt-tightening etc and suggesting
dire consequences if Hongkong's deficit persisted.
Forget for a moment that on its record S&P should be
regarded with utmost caution. It is representative of the same kind
of received wisdom which has given us Mary Meeker, Henry Blodget, Abby
Joseph Cohen and other "professional advisors" who have suckered foreign
as well as domestic investors into Wall Street's scams and fads. It
is no surprise either that S&P sometimes stands accused of failing to
apply the same standards to US debt issuers as to foreign ones. (Just
look at the easy ride S&P gives to Fannie Mae and Freddie Mac, two of
the most over-leveraged institutions on earth).
Forget S&P. Look at some of today's facts about the relationship
between budget deficits and currencies. Look at Europe. There the stability
pact which limits government deficits is daily being accused of responsibility
for weak domestic demand and hence for a relatively weak Euro! If government
deficits were a major ingredient in currency valuations, where would
the yen now be?
Of course, government deficits can cause huge currency
problems - witness Argentina. But that is because much of the debt is
foreign currency funded or is borrowed short term and at volatile rates.
An economy with a private savings surplus can easily fund government
deficits without any problem. Indeed, in times of recession that is
what is needed. Hongkong is in just such a position.
Without the government deficit, now running at around
4% of GDP, the economy would be in a lot worse shape than it is. If
private sector demand revives the deficit will automatically contract.
Until then, a 3% or so deficit is desirable. Hongkong has an excess
of savings, high bank liquidity, a huge current account surplus etc.
What is lacks are good investment projects and consumer confidence.
For now, official reduction in government foreign exchange
holdings to cover the budget deficit is roughly matched by private sector
acquisition of foreign assets. To suggest that there is any significant
link between the deficit and the sustainability of the peg runs contrary
to the rationale on which the peg is based - the expansion or contraction
of money supply. The only threat to the currency is an exodus caused
by the perception that it needs to be abandoned for good economic reasons.
But instead of abandoning the peg, as I have long argued,
the government now seems determined to make it even more of an albatross
by cutting the budget deficit out of fear of S&P's parachute experts
and an often irrational market. If the peg is to force us into a deflationary
fiscal as well as monetary policy, that is all the more reason to dump
That said, it is also true, as I have been writing in
this column for years, there is a structural fiscal problem which has
long been avoided but has to be addressed. Fiscal reform must proceed
independently of the macro-economic considerations in framing the budget.
Even at the macro level, there is an argument to be made that given
Hongkong's savings excess, higher taxation would be less damaging than
drastic spending cuts in bringing the deficit down to the 3% of GDP
Direct tax increases would be preferable to a sales tax
from the points of view of equity, simplicity and impact on demand.
That means slightly higher standard tax rate - on salaries as well as
profits -- higher property rates and cuts in the very generous salaries
tax allowances, particularly for upper middle income earners. Spending
cuts need to be concentrated in two areas: infrastructure projects of
unproven economic or social value, and pay and staffing levels in the
upper echelons of the bureaucracy.
It is alarming to hear demands for cuts in social security,
particularly from the well-heeled leaders of the Liberal. Most social
security spending goes to the elderly, already Hongkong's underclass.
Only a minority of unemployed people receive welfare and, contrary to
the stories put about by fat cat officials, very few receive anything
approximating the median wage. Welfare spending also has a direct and
immediate impact on consumption while infrastructure spending goes either
to imported equipment or labour.
The Budget is also the place to address issues of private
exploitation of public assets. It could start with the industry with
which Mr Henry Tang and Mr James Tien are familiar: textiles. Although
the demise of the Multifibre Arrangement should, three years from now,
consign textile quotas to history, the fact is that quotas, which are
a scarce commodity which belong to Hongkong as a whole, are given out
freely to select groups. This process has always lacked the degree of
transparency it warrants. It is well known in the trade that some old
established groups make a handsome living by selling quota. These rentier
capitalists are not only living off the past, they are taking from the
public purse. If Mr Leung is brave, he will announce that from now on
all quotas will be auctioned.
He should also announce an inquiry into the pricing policies
of the oligopoly that causes Hongkong container handling charges to
be two to three times levels in most Asian ports. At the same time port
charges, which are levied by the government, remain very low. The gigantic
profits that Hutchison has made from Hongkong terminals has enabled
it to become a global player. This may be fine for its shareholders,
but can hardly be of benefit to Hongkong. If this government is serious
about making Hongkong more competitive, and in showing that it is not
beholden to Mr Tung's former business associates, it will go head to
head with Hutchison, Wharf etc on the ports issue.
In the recent traffic rights negotiations with the US
it finally showed willingness to put Hongkong's economic interests before
those of Cathay Pacific. It must now do the same with other key transport,
trading and utility concerns and introduce real competition into cosy,
Likewise it must represent the public interest, not the
interests of its friends and certain business and family groups over-represented
in Legco, in addressing the issues of land supply and border opening.
It is quite obvious that these interest groups, not the mainland, not
technical issues, are frustrating cross-border movement.
Likewise it is obvious that lower land prices are of
benefit to the majority of people and businesses in Hongkong. A government
which refuses to spend money on old peoples' welfare or needed public
transport because it refuses to sell land to help out its property pals
is worthy of being compared with the latter years of the Suharto government
Likewise, one which fails to recognize that entrenched
anti-competitive structures must be broken up if Hongkong's overall
vibrancy is to be restored will lead it down the path of Japan. Budgets
are not just about balancing books or even about macro-economic policy.
They help define a government's view of its responsibility to the society
for whose interest it is supposed to govern. ends