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What Policies should Hong Kong Adopt

1.      Introduction

The sick economy of Hong Kong has confused the HKSAR Government since 1997.  It seems the confidence of the Government in recovering the economy has reduced; so as its citizens・ confidence on the management of their Government.  Monetary policy is difficult to implement due to fixed exchange rate; while fiscal policy takes time and efforts to implement.  If the Government has a choice of using either fiscal or monetary policy to stimulate Hong Kong・s economy, and that the ease and effects of implementation for the two policies are equivalent, how should the government choose to do its job?

2.      Discussion

Fighting deflation is possibly the main objective of the Government in order to restore consumer confidence.  Deflation poses a great challenge to policy-makers as it is much more difficult to tackle than inflation.  In deflation situation, the government should consider adopting expansion fiscal and monetary policy.  Expansion fiscal policy means increasing the government spending and reducing the taxation; while monetary policy is to increase money supply through open market operation.

2.1  Feasibility and efficiency of the policies

Both policies have their pros and cons.  The feasibility and efficiency of the policies are discussed.

Fiscal policy

In Keynes・ view, government economic policies during a depression should create budget deficits.  Government spending and transfer payments should exceed tax revenues.  However, in the Hong Kong situation, the government is now suffering a high deficit (HK$72.36 billion in April-October 2002).  This is not a common symptom under deflation situation.  Under deflation situation, the government should have surplus budget rather than deficit but it is not the case.  Obviously, the current deficit situation was caused by many reasons, for example misspending.  The deficit situation makes it difficult for the Government to further expand the economy. 

Of course, the Government can borrow by issuing government bonds to finance the deficit and increase the spending.  This issue has been put it in the forum but was not adopted by the Government because it wants to maintain a non-debt place to defend the fixed exchange rate as well as its concern on the credit rating. 

The other option is to levy tax to finance the deficit.  The suggestion of tax increase on middle-class and company profits is controversy.  As Heng Seng Bank (2002) and the Asian Wall Street Journal (2003) argues that tax increase is sure to generate far less revenue than expected.  It would only worsen the deflation situation.

Monetary Policy

The Government can increase the money supply to stimulate the economy.  Increasing money supply will lower the interest rate and hence, attracts the investments.  However, this policy seems not effective in the case of Hong Kong. 

Hong Kong is now in a deflationary situation.  The symptoms are general prices fall, wages fall (though the decrease of nominal wage might not be a bad thing if the real wage has not been decreased) and unemployment exists.  There are several reasons for the causes of deflation.  In the financial sector (this is the component of investment in the AD function), firms are unable or less likely to invest due to changing business environment, no prospect investment project and no profit prospect projection for future demand.  As a result, spending and income fall when the saving leakage exceeds the investment injection.  In the government sector (component of government spending), the Government・s budget should show a surplus which means that tax leakage exceeds the spending injection.  However, this is not the case in Hong Kong because it is suffering deficit.  Finally, in the foreign sector (net export), income falls in spending on imports is greater than export sales.

Consequently, if the contraction of AD (since AD = GDP) is sustained, deflation exists.  Moreover, Hang Seng Bank (2002) argues that interest rates theoretically cannot go below zero, leaving real interest rates high when deflation sets in and this is what the experience of Japan during the past decade.  Under this situation, we can see low interest rate can do nothing; and it is difficult to attract the firms to increase their borrowing for investments even though there might be potential projects in front of them. 


The discussion of the feasibility and efficiency of the policies show that no one policy can recover the Hong Kong・s economy in the best way. 

However, expansion fiscal policy by increasing government spending is more favorable than monetary policy.  The purpose is to avoid further shrinking in private consumption.  The Government should increase expenditure significantly, especially giving supports to those unemployed and with negative assets.  Promoting public works is essential such as developing information infrastructure so as to contribute to activating economic dynamism for medium- and long-term.  The Government may invest public money in advance into such projects that will be surely necessitated in the future, and then the government could privatize them.

Tax cuts would be an option to stimulate the economy.  The Asian Wall Street Journal (2003) warns that the Government・s set on heading down the tax-raising road would risk losing much of competitive advantage of Hong Kong in comparing to its neighbor countries.  It argues that recent US package of tax cuts reflects a pattern also seen in Asia: Singapore lowered its corporate and personal taxes last year; Thailand and Japan have also cut taxes recently. 

But it is not sufficient to persuade people to change their confidence in consumption, and the Government spending would just increase the people saving without effect on private consumption.  Hang Seng Bank (2002) argues that while restoring a balanced budget is a necessity, engineering a full economic recover is more urgent and the pre-requisite for fiscal health.  Therefore, the lack of confidence in the market is a bit more fundamental (Barron, 2002).     

2.2  What should the Government do?

A lean, efficient and responsible government is definitely a must.  It is impossible to implement fully democratic system, direct election of the Chief Executive and all seats of legislative council.  Some economists say that the key to turn around Hong Kong's gloom rests with the Government's policy.  In the past five years, the Government has changed policy direction several times.  Steven Xu, an economist at SG Securities, says that the tragedy in Hong Kong is the Government's refusal to address the tough issues (Granitsas, 2002).  He stresses that policies do matter but the repeated policy inconsistency of the Government has damaged Hong Kongers' psyche (Granitsas, 2002).  For example, the civil servants・ salaries should be cut to the market level in response to the public expectations and also reducing budget deficits to help the economy but there is no action so far.  Until recently, the main political parties in the Legislative Council have reached broad agreement that civil service pay should be cut by six to seven percent and such a reduction would bring salaries down to their 1997 levels (RTHK, 2003).

Hong Kong is paying a heavy burden in maintaining the fixed exchange rate.  It is risky but forgets the peg might be a solution.  Despite of deflation, the operation cost of Hong Kong is still high and depletes its competitive advantages in the Asian region.  Floating exchange rate regime can help Hong Kong dollar to be traded at more reasonable and competitive level.  There are two advantages in doing this way.  Firstly, exports can be improved with more competitive prices.  Secondly, lesser reserve will be required and thus more reserve can be used to induce growth.

Hong Kong・s economy continues to be driven by external demand.  Exports are expected to remain healthy due to improved regional demand, in particular from China.  Recent weakening in the US dollar also helped to lift exports.  Loh (2002) reminds that the thing to watch is Hong Kong・s export of services.  Hong Kong is already the most service-oriented economy in the world.  Over the past ten years, Hong Kong has already undergone a remarkable restructuring.  According to Loh・s report, services contribution to Hong Kong・s GDP rose to 85.6 percent in 2000 from 74.5 percent in 1990. 

With the diminishing competitive advantage, education is crucial as long-term investments for Hong Kong to improve human talents for the knowledge-based economy.  The business environment of Hong Kong should be improved by addressing domestic concerns like attracting and retaining high-tech personnel, improving language education (especially in Putonghua and English), and improving the quality of management people. 

The Mainland China can absolutely play a role in Hong Kong economy.  Under the .One Country, Two Systems・, China cannot directly influence the administration of Hong Kong.  Instead, it can help Hong Kong by its economic policies and regulations in the Mainland.  For example, the China Government can move fast on joint developments with Hong Kong such as the Pearl River Delta.  Hong Kong provides the higher-end value services and does not compete with the Mainland in land and labor.  Loh (2002) argues that Hong Kong・s entrepreneurs supply the capital and know-how in order to exploit the production inputs across the border.  It is the perfect marriage and can only get better if the Pearl River Delta can become an even more efficient supply-chain system for light industries.  How the Pearl River Delta develops as a whole will be fundamental to Hong Kong・s own continued development in the longer term.  Meantime, the China Government should remain the stability of its political situation and currency, as well as steady economic growth because these are the fundamentals of the economic stability of Hong Kong.

3.      Conclusion

As a conclusion, fiscal policy by Government spending and tax cuts would be more favorable than monetary policy.  But it is not sufficient because the lack of confidence in the market is a bit more fundamental.  It is a well-known fact that Hong Kong・s pervious superior position has gone.  The only thing that the Government can do in the short term is to restore the confidence of its citizen.  In long term, a revival of external demand for Hong Kong and inflows of foreign investment are critically important.


Barron, Lisa (2002), HK Steps in to Save Property Prices・, CNN.Com, November 13, [Online, accessed 28 January 2003]

Granitsas, Alkman (2002), .Not Enough・, Far Eastern Economic Review, Hong Kong, September 12, [Online, accessed 28 January 2003]

Loh, Christine (2002), .Linked Fortunes of Hong Kong and Guangdong・, CLSA, October, [Online, accessed 13 February 2003]

Hang Seng Bank Limited (2002), .A Tale of Two Economies: Economic Outlook for Mainland China and Hong Kong in 2003・, Hang Seng Economic Monthly, November/December 2002, [Online, accessed 12 February 2003]

RTHK (2002), .HK political parties call for CS pay cut of up to 7%・, RTHK on Internet, 13 February, [Online, accessed 13 February 2003]

The Asian Wall Street Journal (2003), .Hong Kong・s Tax Blunder・, The Asian Wall Street Journal, 14 January

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