Illustrating the Benefits of Economic Freedom: Hong Kong and China

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By Lyndon Epp, MA Public Administration, University of Victoria

Introduction

If one could get economic development theorists to do a blind taste test of sorts and ask which nation, Hong Kong or China, would be one of the richest in the world, it is safe to say that few would vote for Hong Kong. Most would probably vote for China instead. The truth, of course, is that Hong Kong is one of the richest nations in the world with a per capita GDP of $27,202 (1995 $US), while China has a per capita GDP of only $3,383. Reality is the exact opposite of what many would have predicted, because most theorists have not always accounted for the powerful effects of economic freedom in promoting economic growth.

Some of the traditional explanations for a nation’s strong economic performance are quite useless in explaining the disparity between Hong Kong and China. Hong Kong has virtually no resources, while China has large deposits of coal, great potential for hydroelectric power, and numerous other valuable minerals. Hong Kong, with about 6 million people, has a very small domestic market, while China, with a population of over 1.2 billion, has the largest domestic market in the world. While population pressures are a problem in China, they are even more severe for Hong Kong, with over 6 million people crammed into approximately 1,000 square kilometres.

Hong Kong did have a head start on China, as the principal British trading post in the Far East. Even so, Hong Kong lost much of its market due to disruptions brought on by World War II, and also suffered under an international embargo on China during the Korean War. In any case, Hong Kong’s head start does not explain the dominant position it has today.

There are other explanations for economic development, including improvements in the skills of workers, capital accumulation, strong institutional arrangements and improvements in technology. These factors do account for the differences in wealth, but only because Hong Kong possesses a great deal of economic freedom, which is the best, and ultimately, the only explanation for the large disparity in wealth.

Hong Kong and Freedom

Immediately after the war, the British government put John Cowperthwaite in charge of Hong Kong’s economic recovery. Cowperthwaite insisted on a classical liberal regime that minimized the role of government and imposed few restrictions on private property. He even refused to allow the collection of economic data, fearing that policy makers might use it for the purposes of planning.

Hong Kong has allowed its citizens a maximum of economic freedom. As a trading port, it has refused to enact barriers to the rest of the world, keeping international trade free. Monetary policy has been stable and predictable. Since the Hong Kong dollar is pegged to the US dollar, the government has not been able to impose wealth-reducing policies like inflation. Most importantly, Hong Kong’s government has restricted the urge to supplant the market as a distributor of wealth, limiting its functions to providing infrastructure and maintaining law and order. The top marginal tax rate is only 20 percent, and government expenditures are not even 20 percent of GDP. These policies have combined to give Hong Kong a score of 9.3 in the Fraser Institute’s Economic Freedom Index, the best in the world.

Hong Kong’s economic freedom has allowed its citizens to keep what they earn, which in turn gives them an incentive to invest in capital and to improve their own skills. This has also promoted risk-taking, which translates into new technology and innovative ways of doing business. Finally, economic freedom has meant a stable institutional environment that has provided the citizens of Hong Kong with secure property rights. This protection has allowed them to engage in productive activities, and has facilitated cooperation with others, so that the full benefits of specialization and trade can be realized. Not surprisingly, these policies have produced double-digit annual growth rates, transforming Hong Kong from a simple port of entry into the Asian market into a world class centre for manufacturing, trading, and financial services.

China and Communism

China, on the other hand, followed a much different course after World War II. Under the communism imposed by Mao Zedong, citizens were not allowed to dispose of their property as they saw fit. Of course, since basically everything was owned by the state, this was a minor concern for most. All production was directed by the state, and all transactions, domestic and international, were severely limited.

It is hard to imagine a system more hostile to economic freedom, and therefore, to economic growth. Under such a regime, the Chinese people had little incentive to engage in productive activity, since the results of that activity did not accrue to them. As a result, they did not invest in capital improvements, develop new skills, or come up with new and better ways of producing goods and services. In addition, by preventing trade between people, the Chinese economic system hindered people from realizing the mutual benefits that naturally flow from trade and specialization. The lack of economic freedom produced predictable results

in 1980, after 30-odd years of communism, China was not much richer than it was in 1945.

Conclusion

Two things serve to illustrate the superiority of Hong Kong’s approach. The first is the vast number of Chinese people that have escaped the mainland for Hong Kong, taking their skills and capital with them. The environment of economic freedom has made it possible for these immigrants to make a substantial contribution to the economic success of the former colony, and many have become quite rich.

The second is that China has begun to increase the amount of freedom in its own economic system. In 1978, Deng Xiaoping proclaimed an end to the communist system and slowly introduced capitalist-style reforms affecting agriculture, industrial enterprises, foreign trade, taxation, banking, and financial markets. Special Economic Zones were established in coastal areas and provided for lower taxes and increased foreign investment. These zones were so successful that they have been expanded to most major cities. In the area of agriculture, farmers have been given long-term leases on their land, and more rights to their production. In total, the private sector accounted for 29.4 percent of production in 1995, compared to 3 percent in 1985. According to The Fraser Institute’s Economic Freedom Index, China increased its rating from 2.3 in 1980 to 4.3 in 1995. Even though there is still much room for improvement, the increase in economic freedom has produced an average growth rate of around 8 percent since 1978. If China continues to increase its economic freedom, then it too will become rich like Hong Kong, and the traditional theorists will begin to think that they were right all along.

Editor’s note: This entry won Lyndon Epp the second prize in the Fraser Institute’s 1999 Student Essay Competition.

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