ASIAN AFFAIRS ANALYSIS ON HONG KONG

COMPETITIVENESS DID NOT MATTER.

DOES IT TODAY?

by Serge Berthier

(extract of Asian Affairs nº19)

Fernand Braudel's observations, fitting Hong Kong like a glove, have a corollary of importance that has escaped the scrutiny of many economists and also more importantly of the Hong Kong leadership. Competitiveness was not what mattered. Why would it matter today? And if it does, what does that mean?

We have already mentioned that the high cost of living in a world-city is not detrimental to its development, but rather an element of it. Competitiveness has no bearing on a world-city.

Of course, some might argue that it is important to be competitive, having in mind the pseudo-theorem of David Ricardo that the relations between two given countries depend on “competitiveness”, expressed as the difference between “comparative costs” obtained in each of them at the point of production.

The basic concept of the argument is that all foreign trades tend towards a mutual balance and can only be profitable to both sides since ‘it binds together, by one common tie of interest and intercourse, the universal society of nations. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.' (6)

But the Ricardo theorem leaves aside a core issue that destroys its validity: if comparative costs were the heart of the system, when and why did the division of tasks begin? Indeed nowadays, after so many centuries of trade of all kind, why do poor countries remain poor, and rich ones rich? Why are world-cities invariably expensive and other cities less so?

The truth is that, over time, not a single data is really backing up the claim that comparative advantages are the fundamental rational to economic intercourse. Nor is there any serious scientific data to backup the claim that the trade has to be mutually beneficial. If anything, the reverse is happening most of the time. As an economist, Ragnar Nurske, seriously said in his book “Problem of Capital”, ‘a poor country is poor because it is poor’. Why it remains so is still a crucial question left with no proper answer if the debate is confined to pure economic considerations.

Competitiveness was certainly not the reason at the root of Hong Kong’s success. It was rather the lack of competition that let Hong Kong fix the rules and rig the game, taking advantage of every event coming its way (such as the embargo against China, the Korean war, the Vietnam war, the open door policy).

If economic competitiveness is not at the origin of a world-city, then it is hard to argue that it mattered at the end of its era. Rather, it is the tide of history that is against the survival of the city in its former status. It is natural evolution that matters most. Orders have always existed in space, and time, each with its own history and its own domain.

Hong Kong today is facing a new future, which does not imply a poorer one but certainly a more modest one. In view of the inevitability of this evolution, what matters today is whether the city is using the wealth accumulated during its glory for the benefits of its citizens or squandering it as if there were no tomorrow . The signs are that it is doing the later rather than the former, because institutions and systems established during its heyday are not willing to disappear easily, if at all.

If competitiveness did not matter in the past, it probably does now. Yet, all the rules that were designed to impede it are for most sectors still in place. Some will object that it can't be. The Heritage Foundation (7) is claiming that the Hong Kong economy is the freest of the world, ranking Singapore as second best.

There is little scientific work backing up such a claim. Like Singapore, Hong Kong is a place where a “free market economy” has lost its meaning entirely. Both cities enjoy a managed economy where cartels and organized oligopolies control the market. The difference is that, in Singapore, the largest owner is the State, while in Hong Kong, it is a small number of people that Fernand Braudel has identified as the merchant elite.

What “free” means for the Heritage Foundation is entirely different from the concept of freedom for the consumers to chose. Free, for this foundation, means the freedom to maximize the return on invested capital. What matters is not the people of Hong Kong, but the investors investing in Hong Kong (or actually through the Hong Kong financial market).

Indeed Hong Kong is a city where investors enjoy extraordinary privileges. Those were born out of the colonial system, since to attract anyone to the colony, the government had to offer some kind of incentive and a protection. Over time, those privileges became entrenched. The freedom to maximize return is heavily regulated through franchises and licenses. The rule of law is a formidable guardian of the regulation, which is not tailored to favor the community at large but the investors. The beneficiaries of such a system were for a long time the British merchants (the Hongs), not the Chinese coolies. Starting after 1950's, a Chinese elite, mostly coming from Shanghai, started to dislodge the British hongs. Only two of them managed to survive the onslaught. Yet, the system built around them never disappear, as they transferred extensively their privileges to their predators.

That is why Hong Kong does not have anti-monopoly laws. It was deemed unsuitable because, in a colony, monopolies were granted in exchange of services whenever possible. Then monopolies were turned into franchises. Cartels were organized and tightly controlled (8).

'We don’t think that a blanket law would be good for Hong Kong, says James Tien, a member of the elite. If we had it, you will have to dismantle the franchises of Hong Kong Electric and China Light and Power. How would you deal with the six oil companies that supply Hong Kong? In fact, I don’t think it would improve the economy because large companies are more efficient than small ones. Take the retailer Park and Shop (which, by the way, is part of the Li Ka-shing empire). We receive many complaints against it because its pricing is too low and the small grocers are going out of business. Park and Shop is accused to be too good and too cheap! A blanket anti-monopoly will not result in an improvement. It might in fact result in a loss of efficiency in some cases. When it can be done, it is done and the government is sector by sector dismantling anti-competitive practices. We support this sectarian approach. Telecoms were deregulated and there is a severe competition. It is good for the customer. Other sectors will follow.'

The above arguments are vintage. They have been used all over the world whenever a dominant position was challenged.

The Hong Kong inhabitants have nevertheless started to realize that something must be wrong with the fact that the flat they buy was built by company A, which runs a bus company that provides transport from the housing estate to an office block that belongs to the same company, which provides a telephone line through one of its subsidiaries, owns the supermarket, provides the power needed for the fridge that came imported through one of its subsidiaries, supplies the equipment and the stationery at your office, and is on the board of the bank which is around the corner.

In its 2002 review about Hong Kong, the World Trade Organization has deplored the lack of progress in this area. 'Hong Kong’s reversion to China in 1997 has not altered the territory’s trade and investment regime, it said. The absence of a comprehensive policy to address anti-competitive practices and the entrenchment of a few dominant conglomerates in the domestic market, could constitute an obstacle to greater competition from domestic and foreign firms, especially in the provision of services, thereby possibly discouraging foreign direct investment (FDI) in Hong Kong.'

The government dismissed rapidly the comments, as baseless since FDI (foreign direct investments) reached a record high of US$64bn in 2001. However most of the FDI are not really invested in Hong Kong but go to China, which in 2002 overtook the United States as the single largest recipient of foreign investments. So the government’s objection is misleading and unfortunate (9). Since then, FDI have dropped sharply but the government has refused to reopen the issue. It sticks to the view that, in the domestic economy, there is no relation between investments and competitiveness, having no problem to invert the same proposition when talking about other economies.

When the financial crisis of 1997 hit Asia, the Asean countries seized the opportunity to deregulate further their own domestic market to insulate the economy from the consequences of the collapse of some dominant companies. But the Hong Kong government did not have to deal with the potential collapse of a dominant conglomerate as the balance sheet of the Hong Kong companies remained quite healthy throughout the turmoil. It was so not because they were well managed, or efficient, but because their cash-flow was protected by the peg and therefore they did not have to cope with the massive loss of paper money the Indonesian or Thai companies had to deal with (10).

Although C.H. Tung’s government does not want to look at an anti-monopoly law, the integration of the Hong Kong's economy with the Pearl River Delta’s one and the entry of China in the WTO are bound to bring to the fore major problems linked to the lack of such a law.

One issue that has already come to the light is the utility franchise that grants to China Light and Power (CLP) and Hong Kong Electric (controlled by Li-Ka-shing) the monopoly of generation and supply of electricity in Hong Kong. As a result of badly written agreements drafted when Anson Chan was Secretary for Economic Affairs, the two franchises are guaranteed until 2008 a rate of return on their fixed asset investments that is far too high. As result, although Hong Kong has been through 52 months of deflation brought about by the collapse of the property prices, Hong Kong Electric and CLP have managed to raise tariffs substantially, offering token rebate to cover-up a general increase. Today, both companies that do not compete since the agreement is that one supplies the island of Victoria and the others the New Territories are the second most expensive power utilities in the world. Protected by their contracts, they are immune to the vagaries of the local economy.

'That some property tycoons complain about the price of electricity in Hong Kong which is fixed by a scheme of control does not surprise me at all, says James Tien. The scheme itself is a big mess. But it does not mean that a scheme cannot work. It means this one is pretty bad and has a flawed control mechanism. What we have is that the electricity companies used the hottest day of summer as the benchmark of the scheme to get approval for their investment. They follow the letter of the franchise (11). We now have an overcapacity. That is absolutely ridiculous and the customers pay for it! In winter Hong Kong uses about 40% of the capacity and in summer roughly 50%. Since the scheme allows a return not on the consumption but on the total invested capacity at a rather generous rate of return, nobody cared for a long time. Why the government of the day did not pick up that the day used as benchmark was the wrong day is a mystery. One wonders what the civil servants were doing when the calculation both companies presented where based on the hottest day of summer.'

The remarks of James Tien, who leads a party opposed to a blanket anti-monopoly law, point to the direction the government wants to go to avoid a frontal assault on entrenched positions. To say that the system is not flawed but the regulation is requires somehow further regulations. The irony of such logic is that Hong Kong might end up regulating what China is trying to deregulate. Hong Kong’s elite is still using the same logic that the Carnegie, Rockefeller, and Mellon applied when at the turn of the XIXth century they successfully cornered their economic sector, under the guise of efficiency.

'The most sensible solution is to have a rational index to control the price mechanism, confirms James Tien. The Democrats want to open up the sector to more companies. In the electricity sector, I believe it is just not practical. Elsewhere where competition can be enforced, it should be done.'

But when one tries to define in Hong Kong what "elsewhere" means, one is soon hitting a wall. Carrefour, the world leading company in mega stores has now developed 40 mega-supermarkets in China, as well as several in Indonesia, but it had to pull the plug on its Hong Kong operations, with a loss of hundred of jobs, complaining that it could not get a fair level-playing field. The government replied to its complaints that Hong Kong was a free market and that competition was welcome. If Carrefour was not able to succeed, it was the law of the market, no a government matter. In other words, the laws were the same for everyone.

But what laws, one is tempted to ask. In Hong Kong, the business sector was built up over the years not in the spirit of competition but rather the contrary. For a century, the main purpose was to enforce and protect the vested interests of the British merchants, originally a small group of former drug-dealers who reinvested their ill-gotten profits into lucrative monopolies. As the British government would not spend any money in Hong Kong, the agreement was that they would be the ones financing the colony. In exchange, they would get “concessions”, that is a monopolistic hold on specific trades and some pieces of land. Those privileges have never been abolished. They still permeate the economic fabric of the domestic economy.

Over the years, while the beneficiaries of the trade and the land may have changed, the principles of the regime have never been altered, and that is where the biggest problem of Hong Kong lies.

There are however more and more signs that the regime is under severe stress. In the long run, it is certainly unsustainable, the main reason being the pressure generated by the Guangdong economy on Hong Kong. The Hong Kong tycoons have sense that there was a danger to their dismay, have been unable to establish the control they have in the former colony (12).

(the notes are at the end of Chapter One - see Notes Chapter One)

© serge Berthier