Strategy of managing public finance in the HKSAR

1) Has the Government managed public finance prudently? 2) Can the Government afford not to intervene in face of economic downturn nowadays? Is the concept of ‘positive non-interventionism’ incompatible with the strategy of managing public finance nowadays? 1) The size of the public sector in Hong Kong has been small until recently. In general, the traditional financial/fiscal strategy of the Government is that the trend growth rate of government expenditure should be in line with trend growth rate of Gross Domestic Product, and trend growth rate over a period of time is not the same as annual growth rate.

This is the principle underlying the ‘Financial Prudence’. However, in recent years, with reference to the diagram below, it has been brought to public attention that if we measure trend growth rate in real terms, by and large, for the past decade, the financial strategy as outlined above is followed. However, if we focus on the nominal growth rate, then the nominal growth rate of government expenditure has outstripped the nominal growth rate of Gross Domestic Product since the mid 1990s.

(For the distinction between real growth of GNP and nominal growth, please refer to separate worksheet: Distinction between real and nominal GNP) The gap between the nominal growth rate of government expenditure and nominal growth rate of GDP seems to be diverging in recent years. In simple terms, that means, we are spending more money than we earned locally, this is one of the reasons that explains the emergence of structural deficit in Hong Kong.

In the past, the golden rule of keeping growth rate of government expenditure in line with growth rate of GDP is always emphasized, however, now it is clear that it is only true as far as real growth rate is concerned. Another point to note is that since 1998, the ratio of public expenditure/Gross Domestic Product has exceeded 20%, meaning that the public sector has absorbed a relatively large proportion of the society’s resources, and less will be left for private sector allocation.

2) Traditionally, the Government has done minimally in face of economic downturn; the Government did not stimulate local domestic demand directly by massive injection of public funds into public works projects and create jobs directly. However, for the past few years, the Government has been engaging in policy initiatives to ease unemployment problem directly. These involve a) accelerating public works and infrastructural projects b) strengthening employment service c) enhancing vocational training and employees retraining d) promoting continuing education and combating illegal employment.

Our attention in this discussion will focus on (a). In the 2001 Policy Address, the CE announced a series of enhanced services and accelerated works projects to create jobs in response to worsening unemployment situation in Hong Kong. The Government’s improved services in the area of education, environmental protection, public sanitation and greening, health care and welfare, housing, school improvement projects and leisure and cultural projects, a total of 30000 jobs will be created as a result of the Government efforts in addition to 15000 jobs created in 2000.

The point for discussion is: is this attempt to create jobs directly and stimulate local economy effective? The technical answer is that given the open nature of the Hong Kong’s economy and a high propensity to imports, the effects of government fiscal action like the job creation initiatives are likely to generate over limited effects and outcome. (For this technical part, please refer to another outline exercise called: The issue of effectiveness of fiscal policy in Hong Kong) Here we shall focus on the socio-political context of the issue.

Actually, classical economic prediction is that given sufficient time and given flexibility in wages and domestic cost price structure, the economy is able to adjust itself through deflation. Given sufficient time and deflated price, the cost level will adjust downward. With the lower cost of production, profit margins will improve and business firms would like to employ more labour. However, all these sort of automatic adjustment will take time to complete. It would be socially undesirable if the economy just follow this classical automatic adjustment mechanism.

There may be social instability if the adjustment time is too long. In fact, prolonged period of mass unemployment will create a problem for effective governance. So, despite the sound economic logic of allowing the economy to deflate, it would be quite unacceptable if the Government does not do something to ease the unemployment situation. Even though the decision makers may know that long term improvement in employment situation will ultimately depend on foreign economic conditions and external trade, but in the short run, the Government should be doing something and provide a cushion to the general public.

Hence in recent years, we observe a change in the mentality of the decision makers in the field of public finance, the Government must be doing something to ease the economic downturn even though the effects are only short term. The attempts by the SAR Government to create temporary jobs directly and advance capital projects to stimulate economy can be interpreted in this way. Hence, now the term ‘Positive Non-Interventionism’ is seldom used again even though the term initially does not mean that the Government is not doing anything.

Nowadays, the Government intervenes, not just in times of major economic crisis like the fight against hedge funds in 1998, not just in terms of providing infrastructure, but also actively tries to stimulate local employment and stimulate the local economy through fiscal action. From the perspective of effective governance, economic logic is not the only considerations, the SAR Government, like the Government of Singapore (which is also an open economy) must be undertaking some economic initiatives to help ease unemployment problem.

However, despite the difference in policy stance, there is one fundamental assumption underlying the past (Positive Non-Inteventionism in the years of Philip Haddon Cave, consensus capitalism in the years of Hamish Mcleod, Maximum Support, Minimum Intervention in the years of Donald Tsang) and the present policy (small Government, big market), that the source of economic growth lies in the private sector and the market.

Conclusively, for effective governance, the SAR Government must be deploying some sort of short term measures to ease the unemployment situation; this is not contradictory to the fundamental premise that the source of economic growth in Hong Kong is still the private sector.