What's wrong with Hong Kong? (Too much government)

From Scott Sumner of EconLog.

"You often read very thoughtful progressives explain why the government sector in the US is too small. You'd think 40% of GDP would be enough, but they insist we have "unmet needs" for a single-payer health care system (18% of GDP), universal preschool, etc. We should be spending something closer to 50% to 55%, like France or the Nordic countries.

If you ever find yourself starting to be persuaded I suggest you visit Hong Kong. I just got back from a trip to Hong Kong (previously I had visited in 1991 and 1999), and marveled at the world class infrastructure. Others seem to have been similarly impressed, as a recent study ranked Hong Kong's infrastructure number one in the world. This in an economy where government spending is 18.5% of GDP, vs. 41.6% in the US.

I don't know how good their schools and health care are, but their life expectancy is third highest in the world (trailing Japan and Singapore) despite bad air pollution. And they score very well on international education rankings.

Hong Kong does have its share of problems. I've mentioned air pollution--although in fairness a lot of that is beyond the government's control--drifting down from the heavily industrialized Pearl River Delta. They also have a lot of income inequality. I'd say that's partly offset by two factors. Many of the poor are immigrants from much poorer countries, who come to HK to do jobs like housekeeping. And all classes in Hong Kong are vastly better off than a few decades ago.

Hong Kong's per capita GDP (PPP) is now about the same as the US. The appearance of the city is a real hodgepodge, with older buildings in Kowloon looking awful, unless you have nostalgia for the HK of films like Chungking Express and In the Mood For Love. (And what movie buff doesn't?) But those old concrete tenements are rapidly being replaced by glitzy new buildings. There's a big hole in the ground where they're building a new high-speed rail station. Imagine getting on the train in tropical HK, and getting off the train in wintry Beijing, the very same day.

What impresses me the most is not so much the current position of Hong Kong, but rather it's trajectory. Unlike the US and Europe, it is still seeing rapid improvement. The fact that an economy can do so well with the government spending only 18.5% of GDP makes me even more skeptical of the progressives' call for a bigger welfare state in the US. If we are spending 41% of GDP, then the problems here are not due to any lack of resources for the government.

Now let's consider what is universally viewed as Hong Kong's greatest failing---housing. It's very expensive, and even middle class people live in very small apartments in high-rise towers. Now consider that real estate is the one sector where Hong Kong's government is heavily involved in the economy. They own most of the land, and sell only very limited amounts of land for new construction. Many people in otherwise laissez-faire Hong Kong live in public housing projects. So it appears that the biggest problem in relatively libertarian Hong Kong is too much government. More specifically, too much government involvement in housing. They should privatize both the land and the public housing projects. Here's an interesting article by Richard Wong of the University of Hong Kong:

The value of Hong Kong's housing capital last year was estimated at HK$6.8 trillion, or 320 per cent of gross domestic product. This is the net value of private residential housing at market prices, based on gross market value minus the value of outstanding mortgage loans. Total loans were a modest HK$900 billion - a mere 11.8 per cent of the gross market value. 

French economist Thomas Piketty, in his book Capital in the Twenty-First Century, obtained similar figures internationally. . . .

In Hong Kong, private residential housing only accommodates about half the population. The other half is in government-provided public rental housing and subsidised ownership homes, mainly tenant purchase scheme and homeownership scheme flats.

The market value of government-provided housing is very substantial, but because there are extremely severe restrictions limiting their use either as rental property or as assets for sale on the open market, their values are highly discounted. They simply provide shelter for the original occupants. As such, they are marginal to the market economy and measured GDP.
Privatisation of public rental units and deregulation of sale restrictions for ownership units, on the other hand, would substantially enhance the market value of government housing. What would be their market value if such steps were taken?

Based on the open market transaction prices of HOS and TPS flats, the gross market value of public rental housing units is estimated at HK$2.45 trillion, TPS homes at HK$410 billion, and HOS flats at HK$1.56 trillion. The total value of government subsidised housing is therefore HK$4.42 trillion, or 208 per cent of GDP.

What will be the economic gain to society from the privatising of public rental housing and waiving or substantially lowering of unpaid land premiums on all government-subsidised housing units? The value of private and public housing stock would easily amount to HK$11.24 trillion, or 528 per cent of GDP.

To put this percentage into perspective, consider Piketty's estimates of the value of all forms of capital (and not just housing capital) as a percentage of GDP. He found this to be 617 per cent in France, 543 per cent in Britain, 418 per cent in Germany, 417 per cent in Canada, and 456 per cent in the US.

Hong Kong could be a very capital-rich city if only government housing units were privatised and deregulated, which would put an additional HK$3.36 trillion housing value in the market.

First, half the population would be happier because the gap between the rich and the poor would be sharply reduced in one fell swoop.

Second, the pressure on government to finance rising health care costs, old-age social welfare payments, education spending, and even housing investment would be indirectly alleviated, as many underutilised public housing units would become unlocked and return to market circulation.

Third, new economic activity at the grass-roots level could be spawned. Mortgaging parents' homes is often a key way to raise capital among those without credit rating.

Fourth, mortgaging parents' homes would also provide an important source of upward intergenerational mobility, both in providing human capital investments to children and making down payments for their home purchases.

Fifth, these benefits would come at no one's expense. The government would not even need to raise taxes.

PS. Whenever I do these posts people complain that Hong Kong is not a typical country. It's a single city, with only 7.3 million people. That's true, but of course there are many European economies with similar populations, and in most modern economies only about 3% of the population is farmers. You could argue that at least in terms of demographics Hong Kong and Sweden are more alike than either place is like the US, which has a much larger and more ethnically diverse population. I don't claim that Hong Kong proves that small government can work everywhere, but it certainly demonstrates that it can work somewhere."