Government's role in the Economy

Lacking a clear definition of its role, the Hong Kong Government seems to be intervening more and more in the economy. Not only is such intervention unlikely to succeed, but in the meantime Government is neglecting tasks that are properly within its domain. The Government should focus on the provision of public goods.

A search for the Hong Kong Government's idea of its role in the economy yields sparse and conflicting results.

During the colonial era, officials used to resort to the term "positive non-interventionism", but had little elaboration to offer. When challenged on the meaning of this term in a 1993 Legco debate, the then Financial Secretary Hamish Macleod referred to a speech given by his predecessor, Sir Philip Haddon-Cave, in 1980¹. In September 1998, Hong Kong Monetary Authority (HKMA) Chief Executive Joseph Yam quoted this 1980 speech in some detail to justify the HKMA's intervention in the stock and futures markets². And in justifying the Government's suspension of land sales in June 1998, Financial Secretary Sir Donald Tsang dismissed criticisms of intervention, declaring that "We have been intervening or messing with that market since the 1950s, when we started to build public housing"³.

It seems, then, that there has been no authoritative formulation of Government's economic role since 1980. And this original formulation, worthy though it may have been at the time, offers an analysis that is too simplistic to guide policy in a complex developed economy like Hong Kong's. The passages quoted by Joseph Yam categorise all government actions as "intervention", and require Government merely to weigh up the balance of advantage in deciding whether to intervene or not. Yam then cites instances of "intervention" that include the building of the airport, the establishment of the linked rate mechanism, the development of the payments system and, last but not least, the stock market intervention. It seems that almost any action can be justified against this loose framework.

A more rigorous formulation of the Government's role in the economy is needed. This article seeks to make a start on such formulation. It suggests that Government's primary role in the economy should be as a supplier of services that will not be provided by the private sector because of their "public goods" nature. Any duplication of private sector initiatives should be exceptional, and as such should be supported by exceptional justification. The article concludes with an agenda for the Hong Kong Government to get from where it is to a more optimal role.

 

Government's proper role

How can Government's proper role in the economy be defined? Is there any reference point other than historical contingency or the wishes of politicians? Delimiting the role of Government is difficult because Government appears able to do so many things. In addition to providing enabling conditions for the economy, such as a proper legal system to support property rights, a monetary system, security, etc, Government can also be a regulator of business, a director of business in the sense of setting policies or subsidies that will favour certain sectors over others, and through Government-owned enterprises even a participant in business. Where, if anywhere, should the line be drawn?

Some of the things in the above list, such as conducting business operations directly, can be done by the private sector. A starting point for definition of Government's proper role in the economy might therefore be to look at the things which only Government can do. Private businesses will not provide certain types of services, or will not provide them in optimal amounts, because the benefits of such services are widespread and so difficult for the provider to capture and thereby earn a commercial return. Such services are called "public goods". A starting point for Government's role would therefore be to look at the public goods that are necessary for an economy to function.

1. Provision of public goods

Public goods that are needed by the economy include the following:

• A stable monetary system. This should be administered by a governmental agency. Prior to 1983, Hong Kong's currency mechanism was administered by a private sector bank; and even for some years thereafter, this bank was the principal channel for administering this mechanism, through the so-called accounting arrangements. However, it was rightly concluded by the authorities that a private sector organisation did not have the incentive to take the broad public interest into account, and the entire administration of Hong Kong's currency arrangements was transferred to the HKMA.
• Education and public health. Although the private sector can and does provide these services, it is normally on a fee-paying basis. Reliance on the private sector alone will leave the poorer sections of the population under-served, which in turn will leave the workforce underskilled and in poor health. A Government role in the provision of education and health is therefore an essential for the good functioning of the economy.
• Legal system. Laws regulating the functioning of the economy, particularly the ownership of assets and governance of companies, and courts in which to resolve disputes, are important.
• Physical infrastructure. Bridges, roads, and similar infrastructure are important for the economy. Although these do not necessarily have to be built by Government, there being various forms of private sector involvement, such as build-operate-transfer, Government at least has to plan them and set up the framework within which the private sector can take on the project.
• External security and public order can only be provided by Government and make important if less direct contributions to the economy.
• Collection and dissemination of information on the economy. Although private firms can do surveys and economic studies, comprehensive and reliable statistics on the totality of economic activity can only be produced by Government because, for example, only Government can compel firms and individuals to complete survey returns.

Government must provide its services in a cost-effective manner, i.e. it should provide value for money in respect of the taxes or changes it levies. Further, there should be proper channels for users of the services to express their wishes and, since the users have no choice of service provider, there should be mechanisms by which they or their representatives can scrutinise or hold the service provider, Government, to account.

 

2. Regulation

Another category of public good which perhaps deserves separate consideration is regulation. The International Organisation of Securities Commissions (IOSCO) identifies the following three objectives of securities market regulation. With one minor modification they can be taken as the objectives of business regulation in general:

1. The protection of investors (modify for these purposes to "protection of consumers");
2. Ensuring that markets are fair, efficient and transparent;
3. the reduction of systemic risk⁴.

Some Governments interpret their regulatory role in a rather special way, namely to protect the consumer against foreign producers, or producers who are not favoured by the Government. However, this is perhaps to be seen as protecting the producer, or a certain class of producers, rather than the consumer.

 

3. Government as customer

Government is a major consumer of business services. Consumers can contribute positively to business by articulating and communicating their demands so that businesses know how to perform and improve. In terms of Government, being a good customer would include having transparent and open procurement policies, accreditation of suppliers in accordance with objective standards (e.g. ISO 9000), and promotion of good practices such as environmental impact assessments.

 

4. Government as example

Government can set an example to business through its own practices, for example, in human resources policies (e.g. equal opportunities employer), management (performance standards and measurement), use of information technology and EDI.

 

5. Direction of business

Should Government go further than enabling business through the provision of public goods and regulating business? Should it, for example, seek to channel business activity into areas that it considers advantageous to the public interest?

The provision by government of public goods affects business. For example, the provision of nine years free education to every child reduces the business that would otherwise be available to private schools. But this is not the main aim of the policy; it is a side-effect of a policy the main aim of which something else, namely the equipping of the population with basic skills and knowledge for life. It is important not to jump from the undeniable fact that Government policy affects the economy to the conclusion that Government may, or even must, target changes in the economy as the primary objective of policy.

Most governments have tried at various times to direct their economies. Some of these economies have also been successful to varying degrees over quite long timescales. In the Asian region, one thinks of Japan, Singapore, Korea, and Malaysia. And it is quite widely claimed that the success is the result of the policies of industrial direction. Other studies claim that the economic success of these countries had little to do with their industrial policies, indeed that the economies prospered inspite, rather than because, of such policies⁵. The present article does not attempt to resolve the dispute, but instead to make two points of principle.

• Firstly, the hurdle of justification for industrial policy must be set higher than for policy decisions in more "normal" (i.e. public goods) areas of government. If Government does not act to ensure the provision of universal education, for example, universal education will simply not arise, because some people cannot afford it or will choose not to spend their money on it. However, if Government does not choose which industries to promote, the market will resolve the matter by picking its own winners. To justify industrial policy, Government must show that its decisions are superior to those of the market.
• Secondly, there must be the infrastructure within Government to support industrial policy. Such policy cannot be developed out of the air, or even out of the pronouncements of a commission, however talented. In a developed and complex economy like Hong Kong's industrial policy would have to be supported by a substantial corps of full time economists, statisticians and planners in the equivalent of a State Planning Commission or Ministry of Trade and Industry.

 

6. Participation in business

In the era following the Second World War, it was widely believed that the state should be a major player in the economy. In Britain, for example, the then Labour Government nationalised the "commanding heights" of the economy, such as the steel, rail, coal and shipbuilding industries. However, during the 1980s and 90s such thinking has fallen out of favour. Most governments now recognise that the private sector is better at innovating, meeting customer demands, and combining resources to meet business ends in the most cost-effective manner⁶. The present article restricts itself to the point of principle that the hurdle of justification for Government participation in business must be set high for the following reasons:

• The private sector can participate in business, if allowed to. The onus must be on Government to show why its participation will lead to a superior outcome.
• Government's participation in business will conflict with its objectives in other policy areas, for example, ensuring fair markets. How can Government be both a referee and a player? If it wishes to be a player, Government must show that the benefits of its participation will outweigh such disadvantages.

 

An Agenda for the Hong Kong Government

Applying the above principles, a tentative economic policy agenda for the Hong Kong Government can be developed as follows:

 

Better provision of public goods

The Hong Kong Government appears to do moderately well on the provision of many basic public goods. Points for improvement include the following.

 

1. Monetary system. The authorities' conduct of the monetary system has been flawed⁷, punctuated by macho displays that may have seen off speculators but which are unhelpful to long term confidence in the system. The seven measures implemented by the HKMA since September 1998 have improved matters. Further improvement would come if the mechanism for the currency board were made more transparent and accessible, for example by extending convertibility to the general public and not just the banks, and if the administration of the currency board were hived off to a separate institution.

2. Land policy. Unusually, in Hong Kong land is owned by the Government, which also derives a major portion of its revenue from the sale of land. The Joint Declaration restricted the annual release of land to 50 hectares, and the post-1997 regime has exacerbated this policy by suspending land sales for nine months. Overall, land is in too short supply for business and residential use, and there are further distortions created by the zoning regime. Major reform is needed in the system of land supply and allocation.

3. Education. It is now recognised by many that Hong Kong's education system is failing to meet the demands of the economy (or, indeed, meet its citizens' wider life needs). Areas needing attention include creativity, adaptability, English skills, and an end to the shared site policy for schools.

4. Legal system. Recent events, such as the failure to prosecute politically well-connected persons, and the decision to seek reinterpretation of the decision of the Court of Final Appeal on the right of abode, have put a question mark over the integrity of the legal system in Hong Kong (see article on page 3). Another area of weakness has been recognition and protection of rights to intellectual property; recent initiatives by the Government to enforce the law in this area need to be taken further to restore the confidence of producers.

5. Quality of life. A major factor in the decisions of foreign companies and their staffs to locate in Hong Kong, and of indigenous professionals to remain there, is the quality of life in the territory, in terms of environment, pollution, availability of recreational facilities, English broadcasting, etc. A United Nations study⁸ rated Hong Kong 22^nd among the world's territories (25^th taking the position of women into account). Too little attention has been paid by Government to these areas.

6. Data collection. Major improvements have been introduced in recent years, including the calculation of gross national income and balance of payments. Other areas in which progress is needed include Hong Kong's all-important economic relations with Mainland China, on which available data is very limited, and the timeliness of economic statistics.

7. Economic planning. Related to 6, the Government needs to improve its economic modeling so as to produce better forecasts. The Government was still holding to its original forecast of 3.5% growth for 1998 as late as August of that year, the outturn being negative 5.1%. It has consistently proved unable to estimate the budgetary surplus or deficit for the year. Improvements in the forecasting and modeling processes, and more transparency, would improve confidence.

8. Cost-effectiveness.

• It is difficult to evaluate the cost-effectiveness of Government because of the lack of a proper system of accrual accounting. Lacking a fully transparent accounting system of this kind, it is also difficult to hold the Government properly to account. Full accrual accounting with balance sheet and income and expenditure statements, along the lines of the system introduced by the New Zealand Government in the early 1990s, should be introduced for the Hong Kong Government without delay.
• In any event, the Hong Kong Government has clearly not been cost-effective, in that it has charged much more than it has spent on services, accumulating the excess in a substantial reserve. If no better justification can be given for these reserves than has been produced by the Government so far⁹, the bulk of the money should be returned to the citizens from whom it was taken and to whom it belongs.
• The basis for charging for Government services is in many cases flawed. The trading fund concept is conceptually unsound, in that these units are not charged with the full cost of their inputs (such as land or government services), and in some cases are not competing with private sector providers. As subsidised monopolies their pricing cannot be optimal. In other areas, such as hospital fees, Government charging falls between the two stools of cost recovery and welfare provision. A complete review of Government charging policies is needed. Activities that can be performed by the private sector should be sold or contracted out. Welfare objectives should be met by other means such as direct payments to identified needy recipients.

 

Regulation

9. Monopolies. Hong Kong's internal or non-traded sector is characterised by monopoly and cartel arrangements. Some of these arrangements actually result from, or are supported by, Government policy, for example, by the granting of monopoly franchises. Deregulation in recent years has eroded traditional monopolies in such areas as telecoms and banking. However, further action is needed in these areas, and in other areas, including air cargo, legal services, rice importation, gambling. Even in areas such as the property market where there are no explicit barriers to entry, there appears to be unhealthy dominance by a small number of players. Government action, including the establishment of a competition law and an authority for enforcement, is needed to protect the consumer.

10. Red tape. Procedures for obtaining permits, such as liquor licences, are in some cases unduly onerous. In other cases regulation may be excessive or not cost-beneficial. The work of the Business Services Promotion Unit should be vigorously pursued, and should not be allowed to decline because of the departure of the former head. Restrictions on labour movement, e.g. the entry of Mainland Chinese professionals into Hong Kong, should be reduced.

11. Proliferation of regulators. Related to the above, there has been a tendency for proliferation of regulators in recent years, with the establishment of the Mandatory Provident Fund Authority, the Insurance Commission, the Office of the Telecommunications Authority, etc. The direct and indirect costs of these institutions are significant and can be a drag upon the economy. There should be a review the possibility of merging regulators in related industries. For example, the UK has recently merged nine regulators in the financial sector into a single Financial Services Authority. Hong Kong could consider amalgamating some of its financial regulators.

12. Modernisation of company law. The review of the Companies Ordinance is proceeding too slowly. Hong Kong needs a modernised company law.

 

Government as customer

13. Although in some areas, Government procurement policies are good, the overall record is patchy. For example, the selection of architects for the much criticised Causeway Bay Urban Council Library was a closed process limited to local professionals. The granting of the Cyberport project to a single company without a tender process was serious error that undermines confidence in the Government. Major projects of this kind should be conducted under a much more open process.

 

Government as example

14. There is room for improvement in the example Government sets private sector firms.

• Management techniques and performance measurement are not advanced and are not sufficiently addressed even by the Government's current Civil Service Reforms.
• Use of information technology, EDI, etc, also has room for improvement.
• Over-aggressive policies of localisation, and the practice of using Administrative Officers rather than professionals in key policy positions, have had a detrimental effect on competence.
• The granting of a 6% pay rise to Civil Servants in a year which saw negative economic growth of 5.1% did not send a message of responsible management.

 

Direction of business

15. The Government has embarked on a major initiative to direct the future development of the Hong Kong economy by promoting the high technology industry in the territory. This initiative has not been properly justified, in terms of a demonstration of how identified benefits outweigh the costs. Nor is it supported by an appropriate infrastructure, e.g. a properly resourced planning commission within the Government.

 

Participation in business

16. Important sectors of the Hong Kong economy remain dominated by Government or Government-owned corporations, or by Government-funded enterprises. Examples include rail, airport, housing, urban cleaning, hospitals, education, water supply. Government operations and Government-owned enterprises should be privatised and, where possible, listed on the Stock Exchange. Although Government must ensure the provision of public goods, such as health and education, the private sector should have a much bigger role in the delivery of these goods to the consuming public.

17. Intervention in asset markets should be avoided in future. The policy objectives pursued in recent interventions, to the extent that they are considered valid, should in future be pursued by other means such as due regulatory process or changes in the law.

• Policy committee, HKDF

 

¹ Quoted in An Accident of History? Far Eastern Economic Review, 13 June 1996

² Intervention true to guiding policy, South China Morning Post, 24 August 1998.

³ $44b rescue bid for economy, South China Morning Post, 23 June 1998.

⁴ Objectives and Principles of Securities Regulation, IOSCO, September 1998.

⁵ See, for example, Picking Winners: The East Asian Experience, Ian Little, Social Market Foundation, 1996.

⁶ See Privatisation - Hong Kong's Next Frontier, HKDF Newsletter issue 10, March 1999.

⁷ Will the Link Break?, HKDF Newsletter, issue 3, November 1997.

⁸ Quoted in Territory just developing, UN believes, SCMP, 17 July 1996.

⁹ Reserves not justified, HKDF Newsletter, issue 7, August 1998