Scott Sumner  

What's wrong with Hong Kong? (Too much government)

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You often read very thoughtful progressives explain why the government sector in the US is too small. You'd think 40% of GDP would be enough, but they insist we have "unmet needs" for a single-payer health care system (18% of GDP), universal preschool, etc. We should be spending something closer to 50% to 55%, like France or the Nordic countries.

If you ever find yourself starting to be persuaded I suggest you visit Hong Kong. I just got back from a trip to Hong Kong (previously I had visited in 1991 and 1999), and marveled at the world class infrastructure. Others seem to have been similarly impressed, as a recent study ranked Hong Kong's infrastructure number one in the world. This in an economy where government spending is 18.5% of GDP, vs. 41.6% in the US.

I don't know how good their schools and health care are, but their life expectancy is third highest in the world (trailing Japan and Singapore) despite bad air pollution. And they score very well on international education rankings.

Hong Kong does have its share of problems. I've mentioned air pollution--although in fairness a lot of that is beyond the government's control--drifting down from the heavily industrialized Pearl River Delta. They also have a lot of income inequality. I'd say that's partly offset by two factors. Many of the poor are immigrants from much poorer countries, who come to HK to do jobs like housekeeping. And all classes in Hong Kong are vastly better off than a few decades ago.

Hong Kong's per capita GDP (PPP) is now about the same as the US. The appearance of the city is a real hodgepodge, with older buildings in Kowloon looking awful, unless you have nostalgia for the HK of films like Chungking Express and In the Mood For Love. (And what movie buff doesn't?) But those old concrete tenements are rapidly being replaced by glitzy new buildings. There's a big hole in the ground where they're building a new high-speed rail station. Imagine getting on the train in tropical HK, and getting off the train in wintry Beijing, the very same day.

What impresses me the most is not so much the current position of Hong Kong, but rather it's trajectory. Unlike the US and Europe, it is still seeing rapid improvement. The fact that an economy can do so well with the government spending only 18.5% of GDP makes me even more skeptical of the progressives' call for a bigger welfare state in the US. If we are spending 41% of GDP, then the problems here are not due to any lack of resources for the government.

Now let's consider what is universally viewed as Hong Kong's greatest failing---housing. It's very expensive, and even middle class people live in very small apartments in high-rise towers. Now consider that real estate is the one sector where Hong Kong's government is heavily involved in the economy. They own most of the land, and sell only very limited amounts of land for new construction. Many people in otherwise laissez-faire Hong Kong live in public housing projects. So it appears that the biggest problem in relatively libertarian Hong Kong is too much government. More specifically, too much government involvement in housing. They should privatize both the land and the public housing projects. Here's an interesting article by Richard Wong of the University of Hong Kong:

The value of Hong Kong's housing capital last year was estimated at HK$6.8 trillion, or 320 per cent of gross domestic product. This is the net value of private residential housing at market prices, based on gross market value minus the value of outstanding mortgage loans. Total loans were a modest HK$900 billion - a mere 11.8 per cent of the gross market value.

French economist Thomas Piketty, in his book Capital in the Twenty-First Century, obtained similar figures internationally. . . .

In Hong Kong, private residential housing only accommodates about half the population. The other half is in government-provided public rental housing and subsidised ownership homes, mainly tenant purchase scheme and homeownership scheme flats.

The market value of government-provided housing is very substantial, but because there are extremely severe restrictions limiting their use either as rental property or as assets for sale on the open market, their values are highly discounted. They simply provide shelter for the original occupants. As such, they are marginal to the market economy and measured GDP.

Privatisation of public rental units and deregulation of sale restrictions for ownership units, on the other hand, would substantially enhance the market value of government housing. What would be their market value if such steps were taken?

Based on the open market transaction prices of HOS and TPS flats, the gross market value of public rental housing units is estimated at HK$2.45 trillion, TPS homes at HK$410 billion, and HOS flats at HK$1.56 trillion. The total value of government subsidised housing is therefore HK$4.42 trillion, or 208 per cent of GDP.

What will be the economic gain to society from the privatising of public rental housing and waiving or substantially lowering of unpaid land premiums on all government-subsidised housing units? The value of private and public housing stock would easily amount to HK$11.24 trillion, or 528 per cent of GDP.

To put this percentage into perspective, consider Piketty's estimates of the value of all forms of capital (and not just housing capital) as a percentage of GDP. He found this to be 617 per cent in France, 543 per cent in Britain, 418 per cent in Germany, 417 per cent in Canada, and 456 per cent in the US.

Hong Kong could be a very capital-rich city if only government housing units were privatised and deregulated, which would put an additional HK$3.36 trillion housing value in the market.

First, half the population would be happier because the gap between the rich and the poor would be sharply reduced in one fell swoop.

Second, the pressure on government to finance rising health care costs, old-age social welfare payments, education spending, and even housing investment would be indirectly alleviated, as many underutilised public housing units would become unlocked and return to market circulation.

Third, new economic activity at the grass-roots level could be spawned. Mortgaging parents' homes is often a key way to raise capital among those without credit rating.

Fourth, mortgaging parents' homes would also provide an important source of upward intergenerational mobility, both in providing human capital investments to children and making down payments for their home purchases.

Fifth, these benefits would come at no one's expense. The government would not even need to raise taxes.

PS. Whenever I do these posts people complain that Hong Kong is not a typical country. It's a single city, with only 7.3 million people. That's true, but of course there are many European economies with similar populations, and in most modern economies only about 3% of the population is farmers. You could argue that at least in terms of demographics Hong Kong and Sweden are more alike than either place is like the US, which has a much larger and more ethnically diverse population. I don't claim that Hong Kong proves that small government can work everywhere, but it certainly demonstrates that it can work somewhere.

Comments and Sharing

COMMENTS (25 to date)
David R. Henderson writes:

Excellent post, Scott.

Cloud writes:

Good argument, if we are still talking about the HK 10 yrs ago.

The big government issue is more common in UK nowadays, as Chinese government wasn't too have more control in hk politics. Not only in housing market but also in finance, tourism etc

And the privatization argument,i agree but doubt if it is still useful. Maybe I am too pessimistic, yet there are too powerful monopolist in to property market, which are almost conglomerate which have presence in almost every markets, privatization without a politic reform will possibly leave everything unviable, if not worse. Afterall, the property conglomerates are used as political helpers for the Chinese government, as an anchor of the stabilizer of HK economy before the handover. That's why they outgrow everything else in HK.

Without stopping the corny capitalism in the property sector, privatization is worrying.

Damien writes:

Is it not rather difficult to compare spending as a % of GDP figures between countries that may use very different instruments to implement similar public policies? To have a social security system, do you tax people and provide universal benefits, or have mandatory savings with minimal government top-ups? To have child care, do you have a universal, government-funded system, or use tax expenditures to reimburse most people? Unless the figures are adjusted for that kind of differences, which I suspect is not the case in most cross-country comparisons due to the amount of work involved, it's very hard to have meaningful comparisons. One example would be housing, as shown in this article: other countries typically use vouchers or transfers to help low-income people, rather than outright ownership which has a lower impact on government expenditures.

That being said, it's clear that there are large differences between the Hong Kong and OECD countries, including the US. There's the obvious difference that Hong Kong doesn't need spend on national defense. But, more importantly and as you've mentioned, there's a lot of income inequality and the pre- and post-tax Gini coefficients are very similar. Most of the difference boils down to the fact that Hong Kong does very little income redistribution. Social expenditures are in the single-digits of GDP. Infrastructure is cheap: public investment is maybe 4% of GDP in the US. Based on the 2013-2014 budget, it looks like Hong Kong also spends roughly that % on infrastructure. Not much difference when it comes to education either. But total (public + private) spending on healthcare is only 5% of GDP

So it mostly means: if you're willing not to do much income redistribution or social expenditures, you can have very low government spending even though you spend about as much on infrastructure and education. Especially if you also control health care costs (which means that perhaps equating single-payer healthcare with 18% of GDP is not ideal).

Mr. Econotarian writes:

San Francisco needs those 60-story apartment buildings that Hong Kong has!

BC writes:

"The fact that an economy can do so well with the government spending only 18.5% of GDP makes me even more skeptical of the progressives' call for a bigger welfare state in the US."

It's understandable why progressives might be surprised that Hong Kong can do so well "despite" spending only 18.5% of GDP on government. After all, many of them are similarly surprised when prison populations grow "despite" falling crime rates.

Scott Sumner writes:

Cloud, Good points, but in this post I'm looking at what's optimal, not what's feasible.

Damien, There is a huge difference between a government funded pay-as-you-go pension system like America's Social Security, and a compulsory savings scheme like they have in Singapore and HK.

And you can't just look at spending. Hong Kong's subway system is privately owned and earns a profits. NYC has a horrible system, which is publicly run, and loses money. NYC airports are also horrible. It's not just about whether infrastructure is 4% of GDP, it's also about quality and efficiency.

As far as "controlling health care costs" I'll take that into account as soon as America's progressives come up with a plan for doing so.

Very little of America's social spending goes to the poor, so I don't see that as an argument for big government.

Dennis writes:

if Hong Kong devoted as much on defense as % of its GDP as the US does, its government spending as % of GDP would be 36.5%

michael pettengill writes:

Hong Kong is much closer to single payer than the US is, or even Canada.

For example, there are 12 private hospitals and 42 public hospitals, and the public hospitals provide 90% of the beds at $13 a day with 95% of the cost subsidized by the public.

The costs of healthcare which heavily emphasizes prevention and education from early age is 5.3% of GDP, which is not much lower than the NHS in the UK at ~6% of GDP before they adopted privatization to provide better service at lower costs, resulting in sharp increases in the share of GDP.

Hong Kong is trying to shift costs from the public sector to the private sector implementing "Health Protection Scheme (HPS), which is a voluntary and government-regulated private health insurance scheme." To make it possible for shifting public care to the private sector, a national medical records system is being implemented across the public and private sector.

Tied to the public hospitals are the medical training in two the major two public universities, which are being depended on to provide the additional medical professionals required.

"The healthcare system of Hong Kong runs on a dual-track basis encompassing the public and the private sectors. Public healthcare is the cornerstone of our healthcare system, acting as the safety net for the whole community, while the private healthcare sector provides personalised choices and more accessible services to those who are willing and may afford to pay for private healthcare services." - The HK sec of food and health.

The demographics of HK are changing as reduced fertility is leading to a rapidly aging population, but that will get them only to where the US is now.

Noah Carl writes:

Very nice post.

Zeke writes:


The US arguably doesn't need to spend that much on defense. Regardless, the same argument applies to the Nordic countries (and other western European social democracies). They essentially free ride on US military strength. So, I think Scott's point of comparing HK to Nordic countries becomes stronger when you recognize neither spends a lot on militarism.

Chris H writes:

How do you figure that Dennis? The US spends about 4% of it's GDP on defense, Hong Kong's current spending (which I'm pretty sure doesn't include any defense) is 18.5%. If Hong Kong spent 4% like the US does that's only 22.5% of GDP a government spending.

John Goodman writes:

I spent a week in Hong Kong a year or so ago as a guest of the Hong Kong government.

What I discovered was that most of the people there have no idea why they are so prosperous. In fact, I believe that if China gives them the right to vote, in about 10 years they will look just like France.

So I for one hope they don't get the right to vote. If they do, they will vote for bigger government, not smaller government.

Chris C writes:

@John Goodman: I suspect that most people in most wealthy and prosperous countries have no idea why they are so prosperous and that's what leads to the drift toward socialism.

Scott Sumner writes:

Dennis, The US spends about 3% to 4% of GDP on defense.

Michael, Are you claiming that the big increase in healthcare spending in the UK under Blair/Brown is due to "privatization?" That would be a rather far-fetched claim. Or are you claiming the costs fell while the spending rose? Do you have a source?

You said:

"The demographics of HK are changing as reduced fertility is leading to a rapidly aging population, but that will get them only to where the US is now."

I'm confused, the median age in HK is 43.2, well above the US 37.6.

When do you predict it will be equal to the US? Are you claiming HK will start get younger?

John, Maybe, but I doubt it. Residents of Taiwan and Singapore are also ethnic Chinese and do have the right to vote. Government spending is 17.1% in Singapore and 22.6% of GDP in Taiwan. I think HK would be in the same range---their residents don't want to pay a lot in taxes.

Switzerland is far and away the most democratic country in Europe, and has the lowest taxes.

Russ Abbott writes:

What is the public sector of the US spending so much money on? The first possibilities that come to mind are Defense and Social Security. Does HK have similar expenditures? Also, our medical system is especially inefficient--to a great extent because it is too market-oriented.

I'd like to know, though, where you think the major differences lie between our 40% of GDP and HK's 18%.

TeeJaw writes:

You’d have to pay for a reprint from the Wall Street Journal but it’s worth it for Nancy DeWolf Smith’s July 1, 1997 article, “The Wisdom That Built Hong Kong’s Prosperity.” The wisdom was that of Sir John Cowperwaite in the 1960s.

Margarita Uricoechea writes:

Help me understand how can the gap between rich and poor decrease in one fell swoop?

I live in Washington DC where the gentrification has made property very expensive in previously undesirable areas. The poor are not better off with longer commutes.

Same in NYC and in London where public housing is being replaced with buildings with two entrances and different amenities depending if you bought at market price.

The poor and even the middle class are being priced out of all major cities. What about the attacks in SF to young tech employees who are prepared to pay higher rents?

enronal writes:

Excellent post, especially about the dysfunction of the property sector. I live in Hong Kong, which doesn't give me any particular expertise, but you don't have to be here long before you learn about the government's involvement in property--decisions on when to sell more property into the market, how fast, how much, what price, whether to tax it, at what level, for what reason etc., etc. Hong Kong has the most expensive residential housing on the planet (with the possible exception of Monaco), yet there's acres of empty space in the New Territories that the Gov't holds on to. Why? Who knows. (Does public choice theory provide hints?)

Scott Sumner writes:

Russ, We spend 3.5% of GDP on defense, so that's part of the story, but not all. I believe our government spends more on health care, education, Social Security, etc.

Perhaps we also spend more on homeland defense, the war on drugs, etc, but I am not certain.

We probably spend more on things like subways, as in Hong Kong the subways are privately-owned and profitable.

I'd guess we also spend more on regulation, but again I am not certain.

Margarita, I certainly support deregulation of housing, which would cause housing prices in the big cities to fall sharply.

enronal, Perhaps the government is protecting the interests of large real estate firms, who don't want to see the value of their property decline?

Todd Kreider writes:
PS. Whenever I do these posts people complain that Hong Kong is not a typical country. It's a single city, with only 7.3 million people. That's true, but of course there are many European economies with similar populations,..."

(Some of us have problems with comparisons with Sweden and Finland as well...)

Floccina writes:

I sometimes marvel at how little difference social spending makes but it makes sense that it would have little effect. Take the huge programs for the elderly, SS and Medicare when they were implemented I would guess that maybe 10% of the elderly population really needed the programs so you would not expect so see a huge change in the lives of 90% the elderly. Take single payer healthcare maybe 10% of the non-elderly in any given country benefit from having free access to healthcare (those who would not buy insurance on their own and who run into a big medical bill sometime in their life). One interesting point is that often people in countries with single payer healthcare go bankrupt due to a health problem just like in the USA. There they go bankrupt because they cannot work and so cannot pay their non medical bills.) So you end up spending a huge amount of money in an inefficient way for the sake of a small part of the population.

Wai Hong writes:

Hong Kong's railway system is not private. It is a government-owned (77%) corporation listed on the stock exchange. It is a major supplier of residential and commercial properties developed to capture the benefits of ease of access brought about by railways. Profits from property development help build the railways. Fierce competition from privately run buses, fleets of minibuses, taxis, and minivans which together provide for 56% of public transport market keeps the state-owned railway corporation on its toes.For the last three years they had a person from New York running the system and the result was disastrous.

Lorenzo from Oz writes:

Governments typically restrict the supply of land-for-housing for two reasons
(1) drives up value of existing housing stock (or, at least, the land it is on)--so, the standard "protecting incumbent holders" (of property, qualification, certification, jobs ...) aspect of so much regulation.
(2) drives up taxes on/revenue from property.

I am betting both operate in Hong Kong.

Richard Davis writes:

Other examples of too much government on Hong Kong (my home):

A pro-Cantonese policy in the free schools at the expense of Mandarin and English.

Mainland spouses of Hong Kongers may not work until after waiting period of several years, even though mainland spouses of foreigners in Hong Kong can.

The Shenzhen border crossings are clearly designed physically to impede flow (physically isolated, severe traffic restrictions, minimal bus franchises). But it is a great success that there is cross-border activity at all.

Mainland women may not give birth in Hong Kong even with a visa and even in a private hospital (new as of 2013).

Too many paternalistic billboards (wash your hands, don't waste food, et cetera).

Specification of "domestic helper" as an inferior category in immigration law.

Onerous mandates for employers of domestic helpers (insurance, contract length, etc.)

But overall it is utopia. The "direct subsidy" scheme for schools is very nice. Kind of like a voucher system.

A commenter above notes that the government keeps land in the New Territories underdeveloped. Note that this land is in the *center* of the metro area (if you consider HK and Shenzhen to be a single metro area. I.e. If you see it from space).

myb6 writes:

You can't separate HK's classical econ success from their RE policy just because it's convenient for your ideology. The earnings from RE intervention reduce their need for other revenue sources (and the density reduces infra costs). It's smart strategy: taxing property is more efficient than taxing business, particularly if trying to recruit finance firms.

Because of the nature of living space, the deadweight losses show up in quality-of-life more than GDP, so it's hard to notice in international macro comparisons. Furthermore, to truly estimate HK government revenue, you'd need to somehow account for the opportunity cost of the RE they hold.

Yes, demographically HK is more like Sweden, but economically, HK is a financial metro with near-zero external obligations. Sherlock says classically-liberal policy is excellent for that sort of economy.

Last point: HK's GDP/c has only recently reached 1st world levels, so past entitlements are obviously low %GDP. Given Switzerland (amazing policy, wealthy but not racing ahead), I'd suggest that HK rapid GDP/c growth has more to do with catch-up than superior policy; we'll see if they can maintain the low spending once they've been closer to the frontier a couple generations.

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