Cowperthwaite’s ‘un-Keynesian’ Hong Kong

(Cayman Financial Review, 2017/02/01, Bill Stacey)

The story of the emergence of Hong Kong in the post-war era from city devastated by war to a light manufacturing and transport center for Asia, to the financial and services hub for the region is an encouraging tale of the dynamism of markets left largely to their own devices. It owes much to the inspirational achievements by millions of refugees creating a new and prosperous home and offers a real-world comparison that allows an assessment of the classical liberal policies of open borders, free trade, low taxation and light-handed regulation that were pursued in Hong Kong at the time, even when abandoned in other parts of the world.

The path Hong Kong took was no accident. It was the result of the approach by the then-colonial administration and the institutions it had created. In the 1960s, as Hong Kong began to thrive, it had a vigorous Legislative Council. This was no rubber-stamp colonial parliament. The people of Hong Kong were well represented by the eminent Chinese and businesspeople in the chamber and civil servants with a strong sense of duty to justify the public trust in their judgment. The Hansard record of Legislative Council debate leaves a window to a world that seems distant, but faced issues that are very contemporary.

At the center of these debates was Sir John Cowperthwaite, Hong Kong’s financial secretary from 1961-71, who is remembered today by advocates of free market policies as a champion of “positive non-intervention” by government: low taxation, a stable currency, lean regulation and prudent financial management. (He is also pilloried by some, largely based on the writing of aggrieved civil servants whose grand plans he thwarted.)

Cowperthwaite’s deliberations on policy-making are very relevant to financial centers today. He starts his task as financial secretary from a very clear view that the economy is not synonymous with the government, saying:

“I am known for my opposition to state planning of the economy; but planning, so far as that is practicable, the state’s own exercise of its compulsory powers of appropriating and spending the resources of the community is a very different matter.” (Budget 1968-69)

Legend has it that Sir John refused to collect statistics because it would facilitate government intervention. The truth is a little more complex. He did fund the Census and Statistics Bureau and facilitated the purchase of new computer equipment. However, having studied the issue, he was a vigorous opponent of national income accounting, informing legislators that:

“…relating to the need for formal Gross National Product figures. Such figures are very inexact even in the most sophisticated countries. I think they do not have a great deal of meaning, even as a basis of comparison between economies. That other countries make use of them is not, I think, necessarily a good reason to suppose that we need them. … I suspect myself, however, that the need arises in other countries because high taxation and more or less detailed Government intervention in the economy have made it essential to be able to judge (or to hope to be able to judge) the effect of policies, and of changes in policies, on the economy … we are in the happy position, happier at least for the Financial Secretary where the leverage exercised by Government on the economy is so small that it is not necessary, nor even of any particular value, to have these figures available for the formulation of policy. We might indeed be right to be apprehensive lest the availability of such figures might lead, by a reversal of cause and effect, to policies designed to have a direct effect on the economy. I would myself deplore this.” (Budget debate 1970)

Small open economies and financial centers are closely integrated with the global economy, and while national accounts are meaningless, the unit of account and currency are a vital element of stability. Well before the link to the USD was established in 1983, Cowperthwaite set out the principles for suitable monetary arrangements, stating that “it was not easy for a currency in an economy like ours to function as it should without a strong link with an established reserve currency or with gold.” (Budget Reply1968-69) In his view, the goal of monetary arrangement in a financial center is stability, not active management:

“[The] Hong Kong dollar’s exchange rate is in a sense irrelevant, so long as it is stable, because the cost and price structure of our economy, including wages, adjusts itself automatically to rates of exchange; while, on the other hand, the long and stable relationship with sterling and our established use of it as both a trading and a reserve currency, had set up a complex of financial relationships, and had evolved trading practices, based on the existing rate, which it was likely to be disruptive, and possibly dangerous, to upset.” (HKD Devaluation debate 1967)

International financial centers have long been criticized for their low rates of taxation, but Cowperthwaite makes the case that low tax has both moral (saying, in 1970, when introducing tax legislation, that “all taxes are in principle bad things”) and economic foundations:

“I have a keen realization of the importance of not withdrawing capital from the private sector of the economy, particularly when it is responsible for an important part of the public services. I am confident, however old-fashioned this may sound, that funds left in the hands of the public will come into the Exchequer with interest at the time in the future when we need them.” (Budget Speech 1962)

His long experience in fiscal administration also convinced him, well before Art Laffer gave a name to the idea, that:

“Economic expansion remains the door to social progress and I am convinced that in our circumstances low taxation can in general produce a greater growth in revenue than can tax increases.” (Budget Speech 1964)

Hong Kong faced a deep financial crisis in 1965 that saw two banks fail and Hang Seng bank taken over by HSBC. These problems were not isolated in Hong Kong, and Cowperthwaite’s explanation of the crisis could be applied to many that followed:

“Looking back on these events from the distance of a year, one can see their origins and nature rather more clearly than at the time. I am not referring to the immediate causes, which lay in the bad banking practices of the two banks which then failed, but to deeper causes. In a sense our local events were part of a pattern observable in much of the developed world (and frequently in much more serious form than here), a pattern of over-rapid expansion of credit and consequent strains in and pressures on economies; over-investment in real estate development and over speculation in stocks and shares; and, of course, the political situation in South-East Asia, sterling difficulties and the British import surcharge had brought a degree of economic unease in late 1964 and early 1965.”

However, he vigorously resisted over-reaction to the crisis; while he sought quickly to address the direct causes and costs, he did not think the structure of the system needed to be upended:

“The events of the last year have shown dramatically the great basic strength of our economy and its remarkable resilience; and unpleasant as has been the medicine we have administered to ourselves, it is a powerful and for that reason fast-working medicine (I have always said that we can expect no easy way out of any economic difficulties we may get into); and I feel sure that we are emerging from our recent troubles in a much healthier state, with some of the diseased parts of our economy excised and some of its strains and stresses alleviated; and can look forward with confidence to renewed, and more solid, growth. (Budget Speech 1965)

In times of crisis, the pressures for the government to do more were relentless, yet Sir John resisted what he saw as typical lobbying by vested interests:

“I must confess my distaste for any proposal to use public funds for the support of selected, and thereby, privileged, industrialists, the more particularly if this is to be based on bureaucratic views of what is good and what is bad by way of industrial development … What mystifies me is how he or anyone else can determine what is a desirable type of industry such as should qualify for special assistance of this kind. In my own simple way I should have thought that a desirable industry was, almost by definition, one which could establish itself and thrive without special assistance in ordinary market conditions. Anything else suggests a degree of omniscience which I, at least, am not prepared to credit even the most expert with. I trust the commercial judgment only of those who are themselves taking the risks.”

For Cowperthwaite, then, as for Nobel-Prize winning economist Friedrich Hayek, government’s capacity to act is inherently limited both by a lack of knowledge and by an absence of appropriate incentives. By contrast, businesses left to their own devices generally serve the public interest, not because businessmen are always right, but because – in the absence of intervention – failures are smaller in scale and are dealt with swiftly:

“I largely agree with those that hold that Government should not in general interfere with the course of the economy merely on the strength of its own commercial judgment. If we cannot rely on the judgment of individual businessmen, taking their own risks, we have no future anyway. …. For I still believe that, in the long run, the aggregate of the decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is likely to do less harm than the centralized decisions of a Government; and certainly the harm is likely to be counteracted faster.” (Budget Debate 1966)

Open financial centers have unique economic challenges, and Hong Kong’s financial secretary was an early scholar of the limits to the then-Keynesian economic orthodoxy. Indeed, he observed that “we have an un-Keynesian economy in the sense that we cannot spend our way out of depression.” (Budget speech 1966). He understood that in an open economy changes in prices and expectations rendered Keynesian proposals ineffective:

“Economists of the modern school will no doubt protest that I have said nothing of the use of budget deficits or surpluses for the control of the economy in general. I doubt if such techniques would ever be appropriate in Hong Kong’s exposed economic position; and I think they are certainly not appropriate at present, when in strict orthodoxy they would suggest the need to plan for a very substantial surplus “to take the heat out of the economy”.”  (Budget speech 1963).

As an administrator, Cowperthwaite was focused not just on economic measures, but also on the prosperity of individuals in Hong Kong. He understood that success as an economy and a financial center meant higher wages, changing prices and adjustments to business. He would not have shied away from Hong Kong’s ranking as an expensive city, so long as productivity allowed wages to rise:

“We hear much today about the danger of rising wages as if wages were the price of a commodity or a raw material, the increase in which should somehow be controlled … I myself welcome increasing wages which result by ordinary economic processes from the pressure of economic growth on our resources of labour, because they help to ensure both maximum export prices and the most productive use of our scarce resources; and at the same time redistribute more fairly our growing national income, even if this inevitably means, in our circumstances, generally rising internal price levels.” (Debate on inflation, 1970).

The template for how modern international financial centers can thrive was set by Hong Kong. That template requires a government vigorously ordering its own affairs and budget disciplines, but leaving the economy to businesses and risk takers. It requires a stable currency regime and low taxes. It means an “un-Keynesian” open economy, but leads to high wages and prosperity that are unmatched by the most carefully planned economy.

Bill Stacey


The Lion Rock Institute

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