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Still Number One By: John Fund
American.com | Monday, March 26, 2007

At the stroke of midnight on July 1, 1997, China took over Hong Kong from the British, and fears of economic and political decline were rife. Today, Hong Kong remains number one in the global rankings, and, by some measures, it’s a better place to do business than ever. John Fund tells why.

A decade ago this summer, as Britain transferred its prize colony to Chinese control, the gloom about Hong Kong’s future was thick and pervasive. Robert Burns, a trade consultant with McKeon-Burns international associates, was a typical mourner. “I don’t think the Chinese bureaucracy can resist the impulse to screw it up,” he said at the time. “In a few years you’ll have an isolated Vatican City on the island of Victoria.”

Journalists were also full of gloom and doom. Fortune magazine proclaimed in 1995 that Hong Kong was dying: the “world’s best city for business” was “destined to become a global backwater,” the magazine predicted. Polls of Asian executives taken by the Far Eastern Economic review found a majority believing that that the shift to Chinese control would hurt international confidence in Hong Kong’s legal system—and thus damage business.

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But fears of Hong Kong’s decline have turned out to be wildly exaggerated. Yes, within weeks of the July 1, 1997, handover, the city—which China terms a “special autonomous region”—suffered a setback from a broad Asian financial crisis. The global slowdown after 9/11, coupled with the severe acute respiratory syndrome (SARS) scare in 2002 and 2003, hurt the economy. But China has largely left its hands off what one of its officials once called “the economic goose that keeps laying eggs,” and British traditions of jurisprudence are still in place. As a result, the economy has rebounded—gross domestic product grew nearly 7 percent last year, with unemployment at just over 4 percent and inflation a minuscule 1.3 percent. Per capita income is $33,500 in U.S. currency, a figure exceeded by only seven nations. Rating services continue to rank Hong Kong number one in the world in economic terms.

Hong Kong has been immune to major meddling because Chinese officials realize it’s the engine for much of China’s explosive growth. But Hong Kong is also expanding into a world financial center in its own right. In 2006, it was the number-one market for stock offerings worldwide. While enthusiasm for Shanghai—the apple of the Beijing regime’s eye—is high among foreign business leaders, it is still Hong Kong that’s leading China.

The top income tax rate is 16%, the top corporate rate is 17.5%, capital gains and sales taxes are zero, and there is complete free trade.

Hong Kong is China’s largest urban economy and, in comparison with the rest of the People’s Republic, an oasis of political and media freedom. While Hong Kong’s seven million people represent only one two-hundredths of China’s population, they account for one-eighth of China’s economic output. Hong Kong companies also employ 11 million people in neighboring Guangdong Province. The Pearl River Delta region, as the two areas are called, comprise one-fourth of the Chinese economy and one-third of its foreign trade.

“The story of modern China is being written here,” says Hugo Restall, editor of the Far Eastern Economic Review. Hong Kong provides the international connections that smooth trade and generate the capital investment that fuels the Chinese economy. Hundreds of Chinese firms are lining up to list their shares on Hong Kong exchanges. At the same time, thousands of foreign businesses are using Hong Kong as a safe launching pad into the Chinese market.

The secret of Hong Kong’s success isn’t hard to find. It’s economic freedom, and everywhere a visitor is struck by how much of it there is. Red tape is almost unknown; registering a company requires only a one-page form. “A businessman can walk off a plane in the morning and start operating a firm in the afternoon,” reports The Economist. As it has every year since the ratings system began, Hong Kong ranks first, by a wide margin, on the 2007 Index of Economic Freedom compiled by the Heritage Foundation and The Wall Street Journal. The United States is fourth; Canada, tenth; France, 45th; China, 119th. Since the 1997 handover, Hong Kong’s score has stayed steady. “Hong Kong remains a model of economic freedom,” said the 2006 Index. “It is a free port with no barriers to trade; has simple procedures for starting enterprises, free entry of foreign capital and repatriation of earnings, and transparency; and operates under the rule of law.”

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Local entrepreneurs agree. “The top income tax rate is 16 percent, the top corporate rate is 17.5 percent [half that of the U.S.], and there are no capital gains taxes or sales taxes and complete free trade,” says Jim Thompson, the American-born chairman of the Crown Worldwide Group, a logistics company. Thompson, a Hong Kong resident for 28 years, says, “There’s no better place in the world to do business.”

The origins of the city’s laissez-faire attitudes are found in Britain’s lax supervision of colonial officials who governed Hong Kong for more than 150 years. Sir John Cowperthwaite, who died last year at 90, exercised almost complete control over the colony’s economic policy as its financial secretary throughout the 1960s. Cowperthwaite, a fervent free-marketeer, was a direct philosophical heir of Adam Smith, a fellow Scot. When the late Milton Friedman visited Hong Kong in 1963, he asked Cowperthwaite why there were so few published statistics on the economy. The response: “If I let them compute those statistics, they’ll want to use them for planning.”

While Cowperthwaite abjured mindless data, he defended the colony’s economic policies with clear rhetoric. In a debate over Hong Kong’s budget, he declared: “In the long run the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralized decisions of a government, and certainly the harm is likely to be counteracted faster.”

The financial secretary’s successors have followed his basic principles—for example, funding major government projects through leasing its land rather than through taxing or borrowing. Government in Hong Kong remains much smaller than in most countries; public spending is only 18 percent of GDP, less than half the average of the developed nations that are members of the Organization for Economic Cooperation and Development (OECD). The government has announced plans to reduce the number of civil servants to 160,000 from 172,000. “We adhere to the principles of free enterprise and free competition,” says Chief Executive Donald Tsang, who recently had to retreat from hints that he favored a future Hong Kong government that took “a pro-active yet pro-market approach.”

'Our success is giving Hank Paulson a few raised eyebrows,' Hong Kong's financial secretary told a group of visiting Canadians. 'Thank you, Mr. Sarbanes and Mr. Oxley!'

Patrick Cheung, the executive director of QED Global Ltd., a consulting firm, says some local government officials would like to meddle more in the economy but usually have to back down. In December, for example, the government abandoned plans to introduce the city’s first sales tax. This restraint comes even though Hong Kong has severely stunted democratic institutions. Both the chief executive and legislature are elected indirectly. While pro-democracy parties received 62 percent of the vote in the legislature, they hold only 41 percent of the seats; the rest are held by parties friendly to the regime in Beijing.

Cheung says the real secret to Hong Kong’s success is not traditional democracy but a strict adherence to the rule of law. To prove his point, on one of my recent trips to Hong Kong he told me a story about a friend who was a top official in Beijing. The official said he had done a favor for a counterpart in Hong Kong. That Hong Kong official, said the Beijing functionary, would no doubt be helpful to Cheung’s business if called upon. “I sat and asked myself what I could want from the government of Hong Kong,” Cheung told me. “I concluded that what I really wanted was the freedom I already had, and, what’s more, I didn’t think the Hong Kong official had the power to really pull strings for me in any meaningful way.”

This anecdote lies at the heart of China’s future. Will the mainland colossus eventually erode Hong Kong’s respect for the rule of law, or will it gradually adapt its practices as it enters the global economy? In other words, will China lead Hong Kong, or will Hong Kong lead China?

Looking back, Milton Friedman said that in the 1990s he offered three words of advice to countries escaping communism: privatize, privatize, privatize. “But I was wrong,” he said shortly before his death. “That wasn’t enough. It turns out that the rule of law is probably more basic than privatization. Privatization is meaningless if you don’t have the rule of law.” Economist Robert Lawson, co-author of the Economic Freedom of the World annual report, published by Canada’s Fraser institute, concurs: “Giving people property rights and the ability to settle disputes peacefully and fairly—that is the number-one thing that matters.”

Lawson notes that the two top countries on his economic freedom index are Hong Kong and Singapore. Neither is particularly democratic, but both once belonged to Britain and adhered to that nation’s common-law traditions, built from bottom-up practical experience over centuries.

Street in Hong Kong (325)Hong Kong has not been immune to Beijing’s interference. Last year, the central government blocked the sale of PCCW, the local telecommunications company, because it did not want such a “strategic asset” to fall into foreign hands.

But such interventions remain the exception. Henry Tang, the financial secretary, last month bluntly warned a visiting group from Canada that North Americans should worry first about government intervention in their own backyard. He noted that Wall Street’s relative decline as a financial trading center—in 2005 only one of the 25 largest initial public offerings took place there—can be directly traced to the Sarbanes-Oxley corporate accountability rules that were put in place following the Enron and WorldCom scandals. “Our success is giving [Treasury Secretary] Hank Paulson a few raised eyebrows,” he told the group. “Thank you, Mr. Sarbanes and Mr. Oxley!”

Despite its run of recent successes, Hong Kong faces challenges. Shanghai, with a population of more than 20 million, is clearly the favorite of Beijing’s communist mandarins. But Chinese economist Chi Hung Kwan, former editor of the Journal of the Asia Pacific Economy, a scholarly publication, says that while the data show that Shanghai is growing faster than Hong Kong, the raw numbers don’t tell the whole story. “When the comparison is expanded to inventory human resources, the legal system, languages, currency and general infrastructure, Hong Kong retains a distinct superiority, an edge that it will not easily forfeit,” he writes.

Despite those advantages, Hong Kong is certainly no paradise. For instance, Chinese officials continue to ignore complaints from Hong Kong about the choking pollution that often rolls in from coal-fueled factories in Guangdong. But those same officials aren’t intent on bending Hong Kong to their whims. So the city remains a powerful example of what people operating in a free market can accomplish. Hong Kong, with no natural resources other than a fine port, threatens to eclipse New York. As for symbolism: Hong Kong has ten buildings over 250 meters tall, and eight of them were finished after 1997; New York has seven buildings over 250 meters, and five of those were built in the 1930s.

In a competitive global economy, the United States has a good deal to learn from this unlikely source—a former British colony that’s now under the control of a communist regime.

John Fund writes the weekly "Political Diary" column for OpinionJournal.com and is the author of Stealing Elections.

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