Hong Kong’s Hugely Wasteful Fiscal System

Crying wolf over Hong Kong’s fiscal future has been a regular feature of the government in recent years but over the past few weeks almost daily wolf cries have been heard as the bureaucracy attempts to sustain its control of a hugely wasteful system of spending and reserve accumulation in the face of public demands for measures to reduce poverty.

Despite fiscal and other reserves totaling some HK$1.4 trillion (US1.8 billion), and soon to announce yet another large surplus for the fiscal year ending in March, officials are warning that welfare spending has risen too fast, that an aging population will result in a coming era of large deficits which will run down the reserves. A tame panel of so-called experts has suggested that to avoid frittering away money on recurrent spending, capital revenues must be ring-fenced so that they go to capital projects.

While the aging of the population is beyond doubt, bringing with it increased demands for health and welfare services, government remains geared to maintaining policies which have hugely distorted the economy and given the government itself inordinate power over resources. There is no more merit in accumulating constant surpluses than deficits. Are we to assume that the government is better at investing savings than is the private sector? Yet that is the implicit belief of a bureaucracy itself ring-fenced from competition for power and resources.

That HK$1.4 trillion hoard of money which should be in the hands of the its owners, the citizens, not the unaccountable bureaucrats investing it in low yielding foreign bonds and following the herd into London real estate. Meanwhile rapid aging is partly the result of the world’s lowest birthrate caused partly by the very high cost of parenthood – the other side of the coin of reserve accumulation. Now the bureaucracy is trying to preserve a system which itself contributes to the problem that the government purports to fear.

The demand for ring-fencing of capital revenue is itself indicative of the “we know best” attitude of the bureaucracy. Such revenue – mostly from land right sales – has effectively been ring-fenced for more than 30 years. Amounts raised (HK$75 billion projected for the current the fiscal year) have gone directly to the Capital Works Reserve Fund which can only be used for capital works. This itself has become a millstone around Hongkong’s neck as it results in spending on projects which suits political or narrow corporate interests but have little or no economic return.

Several such projects are underway at present including a HK$35 billion road tunnel to bring even more polluting traffic into Hong Kong’s central business district and a road bridge to Macau and Zhuhai which cannot possibly pay its way, and a high speed railway into the middle of Kowloon which has zero commercial or social justification but suits contractors and a few property owners close to the supposedly uncorrupt senior officials..

Almost invariably these projects also run way over budget thanks to the careless attitudes of the bureaucracy to public money. If they were commercially viable these projects could and should be financed by the private sector. The calls to ring-fence capital revenue is also dishonest given that government projections show spending on capital works to exceed capital revenue for the next four years by HK$40 billion a year! The government is also keen to build a third runway at Chek Lap Kok airport costing well over HK$100 billion. This ought to be viewed as a commercial enterprise which can be financed with equity and debt. But most likely it will be another millstone around Hongkong peoples’ next as the government uses public resources for a project to suit a narrow interest group.

The division into capital and recurrent revenue is itself artificial when the government itself controls the supply of land and hence its price. It would make for a much more stable income stream if the system of land sales (of which the government is the monopoly supplier) aimed at maximizing price by minimizing supply were replaced by a leasing system which increased recurrent revenue. But that would reduce funds for infrastructure boondoggles.

Land sales themselves are just one part of high land price policy that had led to riches for the government and a few developers and other early land owners but impoverished so many and deterred small business. Add in the land rents, stamp duties on real estate and property related share transactions, income tax on property profits and it becomes clear why the Hongkong government has, with a nominally low tax base, been able to accumulate huge surpluses while also spending heavily on dubious works projects as well as gradually raising recurrent spending.

But look at the result. Property-owning middle class households have had to have a very high level of savings just to meet their mortgage obligations, leaving little for other investments which could provide sufficient income for retirement – or for investment in the children who could then support their parents and the wider economy.

Those at the lower end of the income scale have had the benefit of relatively low rent public housing but their savings have been eroded by inflation – years of negative real yields on savings accounts and bonds. The peg to a weak – on a 30-year time scale – US dollar has generated gains for government reserves held in other currencies but contributed to Hong Kong’s relatively high inflation rate which has hurt local savers.

The introduction of a compulsory savings scheme, the Mandatory Provident Fund, has done little to improve the savings position of most households because its cost structure is outrageously high thanks to official collusion with the small group of providers selected to implement the scheme. The MPF is a classic government-protected oligopoly – one of a number in a city where small business and foreigners make the wheels turn while oligopolies collect the rent.

The wealth imbalances created by government policies and mindless reserve accumulation have led to demands for health and welfare spending that the government now faces but tends to meet with measures which add to bureaucracy. Instead of recognizing that a large chunk of that surplus is owed to a generation of hard-working people already in their 50s and 60s it seeks to keep these funds for its own use and abuse on projects of dubious value. Meanwhile it forces many in the public sector into retirement at 60, discouraging fit elderly people from being self-supporting.

Instead of recognizing that the structural flaws in its revenue and spending system, it seeks to treat as immutable, some sacred canon handed down from a mythical past. The system is damaging the wider economy, rewarding those who least deserve it and at odds with the real needs of an aging but high-skill, service oriented society.