Hong Kong: A model for China

The third plenum of the 18th Communist Party of China Central Committee will open Saturday. We will not know the conclusions of the plenum for a while but reformers in China hope that the leadership will use this opportunity to consolidate the economic reforms started by Deng Xiaoping in 1978.

In the last 35 years, China has become the workshop of the world and is now the world’s second-biggest economy. There are indications however that the state-driven industrialization process is largely exhausted. To avoid the middle-income trap, China should start a new wave of free market reforms.

The experience of Hong Kong shows how the road to capitalism could strengthen the dynamism of the Chinese economy and increase the prosperity of 1.3 billion Chinese citizens.

The Special Administrative Region of Hong Kong is one of the most striking and conclusive examples in the world of a society that succeeded in escaping underdevelopment by relying on economic freedom.

Between 1961 and 2009, Hong Kong’s real GDP per capita multiplied by a factor of nine. Today, its GDP per capita at purchasing power parity is the 13th highest in the world. Hong Kong therefore succeeded, in just a few decades, in transforming its economy of small fisherman villages into one of the wealthiest in the world.

The reason for this success is capitalism. Under the “one country, two systems” principle, Hong Kong has retained since 1997 its capitalist system as well as its way of living and is guaranteed to do so for a period of 50 years, until the year 2047.

According to the Fraser Institute’s Economic Freedom of the World index, Hong Kong’s economy has been the freest in the world since 1970. This economic freedom rests on three elements:

1. Smaller government. Government spending as a percentage of GDP is just 19.2% in Hong Kong, compared to 42.9% in Canada. Personal income tax is a flat 15% and the corporate tax rate is set at 16.5%. There is no sales tax and no tax on dividends or capital gains.

2. Flexible, efficient regulation of economic activity. Hong Kong is the second easiest place to conduct business in the world, according the World Bank’s Doing Business report, which measures the cost of business regulation for companies each year. Hong Kong has always had a flexible labour market, although in 2011, the legislature adopted, for the first time in its history, a minimum wage law. Finally, the Hong Kong dollar is a stable, fully convertible currency.

3. Openness to international trade. Hong Kong charges no customs duties and imposes no quotas. There are no restrictions on the entry or repatriation of capital either, nor on the conversion and transfer of profits and dividends from direct investment. This explains why Hong Kong ranked third in the world after the United States and mainland China in terms of inflow of foreign direct investment in 2012, and fourth after the United States, Japan and mainland China in terms of outflow.

The free flow of capital has helped make Hong Kong an international financial centre of the first order. In September 2012, the Hong Kong Stock Exchange was the sixth largest in the world and second largest in Asia in terms of market capitalization. According to the Global Financial Centres Index, Hong Kong is also the most competitive financial centre in Asia and the third most competitive in the world behind only London and New York.

The strength of Hong Kong’s economy is its flexibility.

Hong Kong’s development immediately after the Second World War had relied on the manufacturing industry. However, when the manufacturing sector began to decline in the late 1970s due to increases in the price of land and rising salaries, it relocated its production to the special economic zones in the bordering province of Guangdong. Industry’s share of the economy started to decline and the service sector increased its share considerably.

As a result, Hong Kong’s economy has become since 1997 a centre for high value-added services (finance, management, logistics, business consulting, trade, etc.), as much for Chinese businesses seeking to break into international markets as for businesses around the world looking for access to the markets of mainland China and the rest of Asia.

For all these reasons, the ongoing economic miracle of Hong Kong should not only be an inspiration for the Chinese leadership but also to the western critics of capitalism who tend to forget how wealth is created.

Jean-François Minardi is public policy analyst and Michel Kelly-Gagnon is president at the Montreal Economic Institute. The views reflected in this op-ed are their own.

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