Hong Kong may be the world’s freest economy. But does this have its downsides?
Economic freedom is defined as the ability to pursue a wide range of business activities without intervention from a government or economic authority. It would hence be perfectly reasonable for one to believe that countries with high political freedom would be economically free as well. This, however, does not necessarily seem to be the case. The most economically free country in the world is Hong Kong.
Hong Kong, you say. Isn’t Hong Kong under the rule of communist China? (China is, by the way, ranked 111th in the world on the economic freedom index).
So why is Hong Kong so economically free?
The Economic Freedom Index, which is published annually by the Heritage Foundation, judges economic freedom on four key pillars: rule of law, limited government intervention, regulatory efficiency and open markets.
Hong Kong enjoys a high degree of autonomy from mainland China under the ‘One Country, Two Systems’ principle. Under this agreement, China is not to impose its socialist policies on Hong Kong and must allow Hong Kong a high degree of autonomy in all matters except foreign and defense policy.
Ed Feulner, the president of the Heritage Foundation, told CNBC: “Hong Kong is free because it has a better right to higher wages, longer lives, a better environment—all of that comes with economic freedoms,” noting the city’s transformation from a manufacturing-driven economy to one that’s now 97 percent service-oriented. It is worth noting that countries with service-oriented economies are generally much higher up on the economic freedom index. Hong Kong and runner-up Singapore both heavily rely on their service sectors.
Trade is extremely important to Hong Kong’s economy. As such, the city requires an open economy. High quantities of trade are generally used as an indication of how open an economy is. Hong Kong is very open to global trade and investment. According to the 2016 World Investment Report published by the UNCTAD, Hong Kong was the 2nd largest recipient of Foreign direct investment (FDI) in the world in 2015, behind the United States and ahead of China. Hong Kong is also the second largest supplier of FDI flows in the world.
Hong Kong’s tax system is also simple and efficient. The overall tax burden equals just 14.4 percent of total domestic income. Public debt is equivalent to 0.1 percent of GDP. As of March 2015, Hong Kong’s fiscal reserves stood at HK$842.9 billion, and former financial chief John Tsang Chun-Wah has often been criticized for being a “miser” by tightening the public purse strings. This tight government spending is a telling indicator of the city’s economic freedom; there is little intervention when it comes to the economy.
Another reason for reduced government intervention is the Hong Kong Dollar itself. Unlike most states, which manipulate their exchange rates through monetary policy schemes, Hong Kong gives this up for a fixed exchange rate that is pegged to the US Dollar. Therefore, Hong Kong does not use any monetary policy schemes such as quantitative easing. This also means that less money is spent on currency manipulation as compared to other countries.
The regulatory and legal environment focuses on ensuring transparency. There are no restrictions on foreign banks, which are treated in the same manner as domestic institutions. Transparency encourages entrepreneurship, and the overall environment is conducive to the formation and operation of start-up businesses. Hong Kong has very few price controls, but it does fund some subsidies, while also regulating residential rents, prices for telecommunications, public transport, and electricity. Reduced government regulations has helped Hong Kong become the open and free economy that it is today.
With low tariffs, high amounts of trade (FDI flows), efficient regulations, and low government intervention, Hong Kong has been able to keep its top spot on the Economic freedom index. That being said, the index itself is not perfect. The index only factors in the figures of an economy’s fiscal reserves. The index, however, has overlooked the fact that such hefty reserves were accumulated at the expense of the government’s longterm commitment to welfare, health, and education systems. Hong Kong also has the 10th highest income inequality in the world. Unsuccessful attempts to establish standard working hours and implement a universal pension scheme remain hot-button issues. All the while, residents complain of long working hours, unaffordable housing and costly retirement.
Despite its high income inequality, Hong Kong remains the most open and free economy in the world. Perhaps the government of Hong Kong would be wise, however, to invest more in infrastructure, healthcare, and education. This would, of course, mean increased government intervention and possibly the loss of the top spot on the economic freedom index. However, for a better quality of life for many of the city’s residents, it may just be necessary.