1. The Performance and Prospects of Hong Kong’s Economy Are Hong Kong People Correct in Their Current Pessimism?

2. Hong Kong People are Depressed About Our Economy What did you say at the beginning of the semester? High unemployment Deflation Falling share and property prices/negative equity Threat from Shanghai Poor quality of HK Government Government deficit

3. How Can We Judge Our Economy? The Most Basic Judgment Concerns Macro-economic performance !!! Output per capita, measured in $US, (and its growth)!!! Unemployment Inflation/Deflation Balance of Payments

4. How Can We Judge Our Economy? Macro-economic performance is closely related to the institutional and micro- economic setting Is the structure of markets competitive? Does the legal system protect property rights and contracts? Is there a culture of corruption or fair dealing?

5. Output per capita? Output is measured as NATIONAL INCOME, with slightly different concepts and bases for measurement GDP – Gross Domestic Product – the value of all goods and services produced in HK – the output of the HK economy GNP – GDP plus NET PROPERTY INCOME FROM ABROAD – the income of Hong Kong residents ‘At factor cost’ or ‘at market prices’ ‘At current prices’ or ‘at constant (1990) prices’

6. Output per capita? GDP at constant (1990) prices 1996 -$HK 790bn 2001 -$HK 895bn 1996-2001 growth – 13% over 5 years 1996 – $HK122,718 per head = $US15,733 2001 – $HK133,026 per head = $US17,054 1996-2001 growth – 8.4% over 5 years Is that poor performance? Remember this is also $US performance!

7. Where Does Our GDP Come From? GDP = Gross Domestic Product – the value of all goods and services produced in HK Calculate by adding all EXPENDITURES together Component $HKbn 19962001 Consumption532571 + Investment270261 + Govt spending6069 + Goods exports13231582 - Goods imports14311644 + Service exports218267 - Service imports132140 GDP790895 GDP/head123k133k

8. Where Does Our GDP Come From? GDP = Gross Domestic Product – the value of all goods and services produced in HK Calculate by adding all OUTPUTS together (at current factor cost) Component %19962001 Agri and Fish0.1 Manufacturing7.35.9 Elec, Gas, Water2.43.0 Construction5.85.3 Wholesale/Retail/ IMPEX/Hospitality 26.726.1 Fin & Bus Services25.123.2 Transp&Comms9.810.3 Social services17.621.2 Ownership of premises 13.112.9

9. What To Conclude So Far? Total income growth has been good Per capita income growth has been lower but reasonable Note the relative unimportance of property in the make-up of national income – it contributes through construction and the services imputed to ownership of property Property is an asset, the stock of property yields a flow of services which are part of income

10. What About Unemployment? Unemployed persons 1996 - 82,000 – 2.6% of the workforce 2001 – 210,000 – 6.1% of the workforce What causes unemployment? MACRO-ECONOMIC LEVEL Too little spending in total – either spending must rise or all wages fall MICRO-ECONOMIC LEVEL Enough spending in total to employ everyone at current wages but mis-matches in the labour market ‘Structural’ unemployment – supply of a few types of worker exceeds demand and skills not being developed

11. Which Type Do We Have? HOW TO TELL? Simultaneous unemployment and vacancies suggests ‘structural’ unemployment Employment has been rising rapidly -74,300 extra jobs July-Dec 2002 Some categories of vacancy are difficult to fill Immigrants from the Mainland are often unskilled

12. What About Inflation/Deflation? Prices for consumer goods have been falling at around 1-2% p.a. for 3-4 years. Asset prices have fallen much more Property down 60% since 1996 HSeng Index down ?? from peak

13. Why Do We Care About Inflation/ Deflation? Tell me why you worry about INFLATION – personally I was very grateful for it!! TELL ME WHY! Tell me why you worry about DEFLATION – personally I am very grateful for it!! TELL ME WHY

14. Why Do We Care About Inflation/ Deflation? Tell me why you worry about INFLATION – personally I was very grateful for it!! My first house in England went from ₤12,000 to £40,000 and my second from £40,000 to £200,000. Tell me why you worry about DEFLATION – personally I am very grateful for it!! My PolyU housing allowance allows me to rent a much better place than before

15. Why Do We Care About Inflation/ Deflation?

16. INFLATION OR DEFLATION would not matter very much if price changes were perfectly anticipated by markets, and fully reflected in all wages and prices. IMPERFECTLY ANTICIPATED INFLATION OR DEFLATION shifts income and wealth between creditors and debtors. We care about it when it hurts ourselves! INFLATION erodes the value of savings, DEFLATION increases it.

17. Why Do We Care About Inflation/ Deflation? INFLATION AND DEFLATION shift the timing of spending in ways that may exaggerate macro-level problems IMPERFECTLY ANTICIPATED INFLATION OR DEFLATION reduce the information content of prices, thereby increasing transactions costs and reducing the efficiency of market economies

18. Should We Be Concerned About HK Deflation? Falling consumer prices are good for those on fixed incomes and those with savings The “delay spending” effect is not so large that it is creating a real macro-level problem (unlike Japan) Why be concerned about those who bought property as a calculated business proposition? They chose to gamble and they lost! BUT

19. Should We Be Concerned About HK Deflation? Falling share prices reduce the wealth and therefore income of shareholders Imposing negative equity on owner-occupiers is a social problem and a major reason for the government’s loss of legitimacy – hurt the middle class at your peril! Stable general price levels are to be preferred but we do not have a disaster on our hands if deflation continues at current rates

20. What About The Government Deficit? It is a cause for concern because: Government deficits can lead to balance of payments deficits and then either Link rate collapses as in Argentina OR Local prices and wages must fall further If the Government has to borrow to finance its deficit interest rates may have to rise significantly But fiscal reserves are very large and there are signs that action is being taken

21. What Needs to Happen? Hong Kong has never really been the ‘low tax’ place we think of – but the taxes were collected via the property sector and were hidden in high property prices Widen the tax base – the activities and groups that attract tax. Salaries tax is paid by a tiny % of the workforce – expand it Sales taxes are easy to collect Cut government expenditure – but see this week’s report from Civic Exchange (Feb 24 2003)– we need spending on education and infra-structure

22. What About Shanghai and the PRD? The PRD is a major source of support for Hong Kong. Shanghai competes for inward investment but remember the basics – places trade with each other in order to develop and trade is not a zero-sum game

23. What About Structural Matters? Do we have competitive or contestable markets with easy entry and exit? YES for the traded sectors NO for the non-traded sectors We need a competition policy Do we have a sound legal structure which protects property rights YES, it is a major asset Do we have a corruption-free culture and set of institutions? YES, it is a major asset

24. So Why Be So Depressed? We can reasonably expect steady growth, as long as China remains stable We can reasonably expect to stay in employment We can reasonably expect levels of inflation/deflation that are not too damaging Even if asset prices never return to their previous levels mortgages will be paid off out of increasing incomes

25. The Conclusion? CHEER UP, HONG KONG!! (but not so much that people refuse to accept lower wages and prices when they are needed)