Dangerous Complacency

Next Magazine (Second opinion A002, 2013.01.17)


Overseas experiences can sometimes help us better understand our challenges. Australia’s mining industry is an apt example. Late last year BHP Biliton’s CEO Marius Kloppers showed how China-driven massive growth in demand had come after a lean period for the mining industry and low investment in the 1980s and 90s, and the subsequent supply lag drove commodities prices up. The Rogers international commodities index rose 354% from the year 2000 to its peak.

However he argued, it also led to mining companies pursuing volume rather than containing costs to drive value. As a result over 10 years costs across the industry exploded. Wages in mining construction grew 2.5x over the last decade and now are the highest in the world.

Yet markets do work well over time. Investment is creating new supply. Demand for some commodities in China is moderating as growth slows and investment spending becomes more sustainable. Even without a shock, commodities prices are well below peak levels and likely to be lower still in the long term.

Inevitably this will mean that companies will have to refocus on productivity. Costs will come down. High cost operators will exit the industry. Suppliers to mining will have to adjust to lower prices. Governments will have to adjust to fewer opportunities to raise revenue. The game will change, requiring companies, people and governments to be flexible and nimble. Those that don’t realize this and adapt quickly will likely suffer more painful adjustments.

Hong Kong should heed the Australian experience. We have also benefited tremendously from the growth in China. This has created challenges as the prices of everything from food to real estate have risen. We have responded well by increasing the supply in areas like financial services, transport and logistics, retail and other professional service industries.

Real estate values responded to direct demand from China and the derived demand of those who see Hong Kong as a great place to service their China businesses. Where policies are inflexible, like town planning and real estate, costs went up the most.

Challenges have been most intense for the domestic sectors. Punishing competition for resources with more revenue-rich China-exposed firms, retailers, local manufacturers and many small businesses have all seen their costs shoot up.

It is these pressures that seem to be driving local economic debate and the policy focus on “livelihood” issues. The risk for Hong Kong is that debate now revolves around the economics of yesterday, not adapting to problems that are likely to emerge.This debate presumes that tax receipts will continue to grow, that employers will have the revenue to pay for higher labor costs and that costs will not respond to changes in supply.The debate is most troubling when it comes to government expenditure. From 2002 to 2007, government spending dropped 1.8%. In the five years since it has risen an astonishing 68%. Health care, social welfare and government pensions as well as “temporary” counter-cyclical programs have driven growth. This spending growth fans expectations and begets more spending. Meanwhile, government revenue growth of 52% is well below spending growth in the same period. It is clear that government spending growth must adjust down. Responsible legislators and policy makers should be helping to lower expectations for government spending, not making unsustainable promises.Economic forecasts are fraught. Yet we must expect change. China’s economic growth is likely to be slower and more household oriented. Further opening and reform could reduce the demand for some financial and professional services in Hong Kong. More financial reform in China could reduce demand for property in Hong Kong. Yet new opportunities can also emerge. Too many Hong Kong policy makers seem to be presuming that we are in a tax and revenue rich world where the problems are just the distribution of gains. In reality we are probably moving to an economic environment where productivity, wage flexibility, low transaction costs and efficiently reallocating scarce resources will be essential. These are our traditional strengths. Higher wages, better health care and provision for the elderly all come from better productivity. Universal pensions, higher minimum wages and controlled working hours all reduce productivity, flexibility and leave the intended beneficiaries poorer.


Bill Stacey is in his 10th year as a resident of Hong Kong and is Chairman of the Lion Rock Institute.
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