Under reconstruction

AFTER more than a year of furious but rarely public debate, this week Hong Kong was about to adopt a minimum-wage law. The legislature's decision was due after The Economist went to press, but all sides expected a bill to be passed. The pay floor will be low, probably between HK$23 ($3) and HK$33 an hour; the higher figure is trade unionists' target (see picture). More important than the level is what the law signifies about the territory's economy. Once famous—or notorious—for its swashbuckling, free-market ways, Hong Kong is becoming a more regulated place. Will it become less prosperous too?

The minimum-wage law follows other employment legislation, as well as government forays into business, expanded public services and industrial policy. Such things have long been normal in other countries, but were novelties in Hong Kong. You might suppose them to be a product of the handover of sovereignty to China 13 years ago, yet they have as much to do with steps taken in the final colonial years, when government spending as a share of GDP increased notably (see chart 1) and with the (limited) post-colonial expansion of political rights. Indeed Chinese officials, fearing the consequences of costly economic populism, have often been vocal advocates of restraint.

Because changes have come incrementally, direct taxation remains low and Hong Kong has been spared the costs of armed forces, the shift is easy to overlook. But their collective impact reflects a dramatic turn in what Milton Friedman once described as the world's greatest experiment in laissez-faire capitalism.

Impure freedom

Of course, Hong Kong was never entirely free of state interference. Immediately after receiving a semblance of legal title in 1841 under the Convention of Chuenpi, the British began their first municipal building project, a cemetery for the legions of colonisers taken by dysentery and malaria. The colonial government kept control of a critical resource: land. It granted only limited leases, with the sole exception of the local headquarters of the Anglican church. The property market that has since developed, an almost impenetrable blend of government and tycoons, could satisfy no free-market purist.

The property market's distortions feed through to other sectors, such as retailing. Another exception to the free-market rule is the currency's peg at around $7.80 to the American dollar. And the state has also had a habit of granting or tolerating monopolies, for example in gambling. Hong Kong's way has by no means been synonymous with perfect competition.

Yet as state intervention grew elsewhere, especially after the second world war, Hong Kong remained free of controls on prices, wages and imports, of regulation of business and employment and, in Friedman's words, of officials' instinct “to spend other people's money and meddle in other people's affairs”. As The Economist put it in 1977: “A businessman setting up shop in Hong Kong finds low taxes, no foolish government interferences…a government leaning over to encourage him to make as much money as he can. He finds, blessed discovery, no politics.”

Often, this was the result of resistance to the British government. No fewer than three times, starting in 1947, instructions came from London to raise tax rates “as high as possible” to lay the foundation of a modern welfare state, says Michael Littlewood of the University of Auckland. But each time the peculiar men sent to govern Hong Kong balked, with the support of locals, notably Chinese businessmen who perhaps learned too much about socialism from the devastation unfolding on the mainland to encourage importing it.

Free-market faith reached its apogee in 1961-71, when Sir John Cowperthwaite was the colony's financial secretary. Defending his first budget, Cowperthwaite rejected subsidies for start-ups (“an infant industry, if coddled, tends to remain an infant industry”); cheap land for strategic businesses (anything but an auction “leads to an inefficient use of our resources”) and most of all, industrial policy (“better…to rely on the…hidden hand than trust the clumsy bureaucratic fingers”).

His belief in Adam Smith withstood tests that would have shrivelled fainter souls. Two banks went bust in 1965, leading to calls for depositors to be made good by the government (which would then recover what it could from the liquidation of bank assets), for the introduction of deposit insurance and the creation of a government-backed industrial bank. Cowperthwaite dismissed all out of hand, saying the core of the financial system was sound. Depositors' losses served as a lesson in moral hazard.

The government was not entirely inactive. Liquidity was provided to maintain credit lines that might otherwise have evaporated. Another troubled bank was folded into HSBC, with a guarantee, according to some. But any state pledge was granted in secret, out of shame at the appearance of intervention.

Cowperthwaite was similarly opposed to five-year development plans, noting that revenues to offset expenses were not predictable. The publication of official statistics was curtailed, for fear that it would encourage civil servants to meddle. When the tourism industry asked for help, Cowperthwaite responded by taxing hotels to recover costs—and to discourage other petitioners. Even public services were privately run. The government built piers for cross-harbour ferries, but the ferries, as well as the buses and the tunnels under the harbour, were put into private hands.

Austerity was maintained despite pressing social needs and a torrent of immigrants. Penniless refugees from China poured over the border; the territory's population doubled between 1948 and 1965. They found public order and freedom but not much else from the government until a belated housebuilding spree in the 1970s—carried out, naturally, within rigid financial constraints.

A miserly government, a lack of natural resources and a hostile northern neighbour became a backdrop for what people can achieve when left to their own devices. Economic growth was staggering (see chart 2). Over a few short decades Hong Kong was transformed from one of the world's poorest places into one of its richest, as it remains (see chart 3).

The struggle over the minimum wage reflects a gradual shift, not a sudden one. Legislation giving the colony's governor the right (but not the obligation) to impose a minimum wage was enacted in 1932, augmented in 1940 and considered again in 1999. A voluntary plan for a minimum wage was proposed in 2006. Only now is a pay floor becoming law. Lee Cheuk-yan, a union leader and member of the legislature, says this has occurred despite the private opposition of Donald Tsang, Hong Kong's chief executive, and many business groups. But with the notable exception of the Lion Rock Institute, a free-market think-tank, public comment has been minimal. The few groups to raise objections, such as caterers and restaurateurs, have been criticised in the press and have retreated.

In August the government will set the level of the minimum wage. Even at the low end of expectations, it will be about HK$1 more than leading fast-food outlets often pay—a good guide to market conditions—so many poorly paid people will get a boost. Legislation will then be introduced to limit working hours. Following that a push is expected for collective bargaining, a right granted by the colonial government just before the handover but reversed immediately after it. Mr Lee thinks there is popular support for both.

Secondary consequences are inevitable. Miriam Lau, a Liberal member of the legislature, says that even at HK$24 an hour, the minimum wage would cost 30,000 jobs, or 1% of the workforce. At HK$32, 170,000 jobs would go, doubling unemployment. Young people and immigrants from China, who are scooped by the territory's abundant restaurants, building sites and cleaning and delivery businesses, would be the likeliest to be out of work. Such industries also employ disabled and older workers on low pay. Subsidies to support such people may have to be expanded if they lose their jobs.

The minimum wage will also expand the rules involved in doing business in Hong Kong. Especially at the entrepreneurial end of the spectrum, business people long enjoyed a lack of red tape. Until 1999 companies were required to tell the government when an employee arrived or departed, and to provide information on their incomes once a year so that taxes could be calculated. But because income tax was paid only above HK$90,000 and then HK$100,000, perhaps 60% of the population paid nothing. Tiny businesses often did not bother to file and their non-compliance was largely ignored. Even sophisticated multinationals could set up a representative office in hours without concern for continuous paperwork.

This changed in 2000 with a compulsory pension scheme, one of many social-policy efforts championed by the last colonial administration. Companies were required to file monthly data to one of a few selected intermediaries and to remit 5% of pay for any employee on more than HK$5,000 a month. The minimum wage will increase the demand for paperwork again, and by a lot. Hours and wages will be filed for all workers, right down to people in the knick-knack shops and markets that have been a vibrant component of Hong Kong's economy. The government will have to spend more money on collecting data and inspecting firms.

Rules for all

Other labour-market rules have come along. You may say some were overdue: in 1996 discrimination on grounds of sex, disability and family status became explicitly illegal; in 2009 the ordinance was expanded to include race. Professions began imposing local standards. Hong Kong had, for example, been an appealing destination for doctors from around the world. During Cowperthwaite's tenure, more than half of physicians born in Hong Kong had been educated overseas. But in 1997 new licences were restricted to those who were locally certified. Foreign-trained specialists have become increasingly scarce. A provision in the minimum-wage law bans unpaid student internships for all but those attending Hong Kong schools.

Product markets have more rules too. Hong Kong's enthusiastic embrace of free trade made its food shops a collection of the world's favourite goodies. But on July 1st a food-labelling law came into effect with the usual laudable motivations—better information and concern about tainted products from China—and the usual unintended consequences. The Hong Kong Food Council, a trade association, released a survey shortly before the law's introduction concluding that 10% of all the prepackaged products sold in the territory would not comply and would have to be withdrawn. A large grocery chain has already pulled more than 1,000 items, including commonly available breakfast cereals, from its shelves. Small shops selling ethnic and health food say the rules may wipe out their entire stocks.

In finance also, intervention has been on the rise. The Hong Kong Mortgage Corporation was created just before the handover with the overt aim of encouraging home ownership, rather like Fannie Mae and Freddie Mac, the American behemoths that were at the core of the recent global crisis. Hong Kong banks have conventionally been conservative lenders, extending mortgages that cover less than 70%, and sometimes even less than 50%, of property values.

An insurance scheme provided by the Mortgage Corporation enables local banks to advance loans of up to 95% of values. Like Fannie and Freddie it has become a huge force in the wholesale market by buying, packaging and reselling mortgages. It has ventured abroad too: in 2008 it created a joint venture in Malaysia to provide mortgage guarantees; in 2009 it created another in Shenzhen and it bought South Korean mortgage-backed securities.

In response to the Asian financial crisis of 1997-98, the government directly intervened in the Hong Kong stockmarket, buying up local shares. Though its stake was largely liquidated by 2002, HK$50 billion-worth was retained by a fund controlled by the central bank. This portfolio has since swollen and contracted more than the local market, suggesting that it is being actively managed.

And in 2008, in the midst of the global financial crisis, Hong Kong introduced universal deposit insurance, which it had explicitly rejected in the 1960s. The law is set to expire at the end of the year, but regulators and bankers say unofficially that it would be unthinkable for the territory to allow a bank to collapse.

Perhaps the most intriguing change, although little noticed so far, is a new monopoly law, a draft of which was entered into the government records on July 2nd. In principle, such a law should foster competition. In practice, it is likely to extend the purview of the state into private business, not least mergers—while leaving established monopolies, often associated with the government, entrenched. Behind the scenes some of these have been busily seeking exemptions.

One such monopoly is the Jockey Club, which owns the gambling franchise. It is simultaneously the largest direct taxpayer, responsible for 7% of total receipts, and through its contributions to schools, hospitals and other charities, drawn from profits, accounts for perhaps another 0.7% of spending on public services. Lots of companies would love to bust this monopoly—for evidence, look at their enthusiastic entry into neighbouring Macau—but because of its philanthropic role the Jockey Club is likely to be protected.

Under reconstruction

Other monopolists can expect to get similar treatment. In 1986 four stock and derivative exchanges were merged into a regulated monopoly. Shares in the exchange were publicly listed but in 2007 the government disclosed that it had 6% of the openly traded shares, making it the largest owner. Consequently it has a direct financial interest in the exchange's success. Attempts since to set up alternative markets in Hong Kong have been stymied by protective regulations.

The government is also increasing its role in transport. State involvement is common in many countries, but in Hong Kong this is at odds with the free-market past. The entrance to the Cross-Harbour Tunnel, which was built in the 1970s under a private tender but reverted to government control in 1999, is permanently gridlocked, partly thanks to tolls that are too low, especially at peak hours. The new airport was structured as an independent entity that could be listed, but any talk of privatisation has disappeared. Two vast new projects, a bridge to Macau and a high-speed railway to Guangzhou, are being handled directly by the government, with no tendering and no discussion of privatisation.

Only a few years ago it appeared that the government's steps into the economy would be curtailed by experience. Heavy subsidies to create a Disney amusement park and a place called Cyberport, to encourage the development of internet-related companies, both drew strong criticism. The park has not been a success and Cyberport is best known as an investment coup for the tycoon who was able to obtain cheap land under an industrial scheme that could be resold as luxury flats. But similar schemes abound. Disney recently received more land. New areas are being reserved for “science parks” and, turning the infant-industry argument upside down, money is being allocated to rejuvenate Hong Kong's faded film industry.

These are not disconnected episodes. Underlying them is a shift in officialdom's view of the economy. In 2008 Mr Tsang announced that he had succeeded in having Hong Kong included within China's five-year plans. Last year he said that in light of the global financial crisis, “we have to revisit the government's role in promoting economic development” and special efforts would be made to encourage the growth of six industries. Hong Kong, in other words, now has an industrial policy.

Milton's paradise lost

Cowperthwaite gave two plausible reasons for such efforts. First, a country might need to develop natural resources. But that did not apply to Hong Kong. Second, countries might be less interested in maximising wealth than distributing it. He also thought that a false step. Mr Tsang and his colleagues are all for wealth maximisation too, but it may be that Hong Kong, no longer being a poor outpost, has lost the stomach to work like one.

The huge growth in government spending during the last colonial administration was required, according to Lord Patten, the final governor, because “Hong Kong's economic vitality and strength were not matched by adequate social-welfare.” Many recent shifts in the law have elements of social policy, and many of the most vocal advocates of the shift reflect the opening of the political system, creating pressure for real problems to be addressed.

Hong Kong remains, by and large, a vibrant, entrepreneurial place, with government spending far below Western standards. The costs of rising intervention will take a while to appear—and may always be hard to measure, especially with mainland China growing so fast. Yet a remarkable economic experiment is at an end.