Speech by the Financial Secretary, Mr Donald Tsang,
at the opening ceremony of
Far Eastern Meeting of Econometric Society

Friday, July 25, 1997


Professor Liu, distinguished scholars, ladies and gentlemen,

INTRODUCTION

I am particularly honoured to address this symposium today. The Far Eastern Meeting of the Econometric Society is a highly prestigious event for the economist profession the world over. Hong Kong is privileged to host this event for so many distinguished participants just several weeks after our re-unification with the Mainland and the commencement of the Hong Kong Special Administrative Region of China. I welcome you all at this unique juncture of Hong Kong's history.

HONG KONG - AN INTERESTING CASE STUDY

Few people would disagree that Hong Kong as always, but particularly now, presents a rich case for economic research. It is constantly on the move and a clear pace setter in Asia. To institutional economists, the "one country, two systems" concept which keeps Hong Kong's economic system, policies and practices separate and autonomous from those of the Mainland but under Chinese sovereignty, must be an very attractive topic. So is the substance of the Basic Law which provides, among other important things, that Hong Kong will continue with its free market, free enterprise, open economy, prudent fiscal planning and free flow of people and capital. Rarely, if ever, are the crucial attributes of economic freedom so clearly and thoroughly embedded in the constitution of a territory.

People here and in the Mainland of China are confident that this innovative arrangement for Hong Kong will work. There is simply no better practical alternative to this for us and our motherland. From now on, it will be for Hong Kong people themselves to make the best use of this arrangement and to seize the opportunity to enhance the region's economic growth and prosperity.

To development economists, Hong Kong is unusual in that it has been undergoing profound structural change over the past decade, at a very rapid pace but with few stresses and dislocations. In essence, structural change in our economy not only propels strong growth, but also comes in earnest as a consequence of growth. Then why is Hong Kong encountering so few problems while reaping so much benefit from the structural change? How should Hong Kong position itself to sustain the favourable outcome of structural change? These questions are certainly interesting to me and, I hope, also ones that will make your research worthwhile.

As an economy devoted to the virtues of the free market, Hong Kong has ample observations to offer. Professor Milton Friedman once said that " For those who want to see how a free market works, look at Hong Kong". His comment is as pertinent today as it was when he first made it years ago, and I trust equally so in the future. We readily accept that Adam Smith's invisible hand functions most effectively when private entrepreneurs, not government bureaucrats, steer the economy and when market forces are unimpeded by bottlenecks and restrictions. The Helping Business Programme I have launched is squarely aimed at facilitating business by cutting government red-tape and removing unnecessary regulations.

No one would deny that a modern government has an essential role to play in its economy. In Hong Kong we generally believe that the government should best exercise this role by supporting, instead of leading, the market, and by maintaining a highly profitable environment for businesses to flourish. That environment includes a sound legal system, a simple tax regime with low tax rates, a robust and stable financial sector, a lean and clean administrative machinery, and a stock of physical infrastructure and human resources which are efficient and responsive. They constitute a strong foundation for our economy to continue to grow and thrive.

FOUR TOPICAL HONG KONG ECONOMIC ISSUES

In the presence of so many experts on East Asian economic development, I do not propose to go into the same subject myself. This is an occasion where I should learn from them. Rather, I would like to talk about several issues of much current attention here in Hong Kong. They are four of them, first, the choice between manufacturing and services as the anchor for the economy; second, provision for retirement; third, trade unionism and collective bargaining; and fourth, the regional currency situation.

MANUFACTURING VERSUS SERVICES

Understandably, there has been persistent concern among many commentators that Hong Kong's manufacturing activity is hollowing out. They are concerned because of the rapid shrinkage in local manufacturing employment as our manufacturers shift their production processes into the Mainland. They take little comfort in Hong Kong's increasing specialisation in services, and view Hong Kong's position as probably the most service-oriented economy in the world as a sign of fragility. The policy implication of their argument goes is to resurrect the manufacturing base in Hong Kong. This approach, if pursued, would, however, go against the direction of the market where relocation of manufacturing processes occurs entirely as a result of private sector initiative. Are these concerns justified and are these arguments valid?

In a simplistic perspective, the argument is that manufacturing activity is solidly based whereas service activity is fickle. Manufacturing processes mostly involve tangible, fixed assets and render tangible products. Services, on the other hand, are intangible and footloose and, as such, provide an insecure anchor for the economy. Is that really so? Production theory at the micro level suggests that economic efficiency is maximised when productive resources are deployed to yield the highest added value. This dictum makes no distinction whatsoever between manufacturing and services. It follows that, depending on the resource characteristics and comparative advantage of the economy concerned, manufacturing compared to services is not necessarily always the superior activity. What in practice is superior is where the activity proves to be the most competitive and bears the highest added value. That is to say whether it provides better profits for our companies and better paid jobs for all our people.

To borrow an analogy from our late patriarch Mr Deng Xiaoping, it does not matter whether it is a white cat or black cat as long as it catches mice. In the same way, we should not have any fixation about a minimum amount of manufacturing which Hong Kong must retain in order to achieve so called "balanced development". Rather, we should choose an industry, manufacturing or service, which yields the highest growth for our economy and the highest reward for our labour force. We in Hong Kong must lift our mental horizon beyond the geographic boundary of the SAR in developing our longer-term economic strategy, and cast our sights on the whole of our nation, the whole of our China nation, embracing particularly neighbouring provinces and regions on the Mainland. It makes no sense to fashion the future physical and economic development of Hong Kong on the basis of a totally self-contained and self-sufficient entity with provision for farming, manufacturing and services in nicely planned packages. I see Hong Kong in the same role as Frankfurt in Germany, London in the United Kingdom or Manhattan in the USA.

Pursuing this argument, it is also clear that the possession of physical assets is advantageous only if they are productive and viable. In other words, the underlying assets have value only if the demand for the activity requiring these assets is there. If not, the assets, even though highly tangible, would be economically redundant, creating liability rather than strength. On the other hand, we should not ignore the substantial productive capacity that is embraced in intangible human capital. This is now recognised as a vital ingredient for growth. In the services sector, and indeed increasingly also in manufacturing, service capability, flexibility and innovation are a pivotal factor for competitiveness and success. The remarkable service capability which Hong Kong has developed over the years, and the flexibility and innovation that characterise Hong Kong's entrepreneurs and workers, are our real assets. They have sustained full employment and created higher paid jobs for more workers in our economy.

Our services sector relies heavily on our re-organised and enlarged manufacturing base. A sizeable proportion of the services provided in Hong Kong supports the manufacturing activities managed by Hong Kong companies locally and in the Mainland. In this regard, our manufacturing ventures have not hollowed out, but have undergone a manifold expansion across the border. They are now employing three million people in the region around us. Taking our extended manufacturing base into account, the predominant trend of service orientation observed in the local economy is entirely rational. It is also economically efficient, as our finite yet better-skilled manpower resources are increasingly deployed for the crucial control and innovative functions of our manufacturing network rather than on the factory floor where such resources are no longer cost-effective. That is where the high added value lies. In short, our manufacturing industry is doing remarkably well compared with their Asian competitors. It has changed its shape, and it has expanded both in breadth and depth into other parts of our Nation. To attempt to reverse this trend would be counter-productive.

RETIREMENT PROTECTION

Let me now turn to a different topical issue: the provision for retirement. With our population ageing, as a community we have expressed a strong desire for some form of statutory retirement protection. After grappling with the issue for nearly three decades, we have reached a consensus on a mandatory provident fund system, or MPF system for short, as it is known in Hong Kong, based on individual contributions, largely run by private fund managers, and operating within a statutory framework. We have got the main legislation passed, and we are now working intensively on the detailed regulations for the system which we will launch within this year.

We prefer this to a Pay-As-You-Go system. A Pay-As-You-Go system breaks the very important link between individual contributions on the one hand and the benefits on the other which individuals eventually receive, thus creating both moral and financial hazards for the community. We must avoid burdening our future generation. Kind intentions and political pressures often make bad economics in planning a retirement scheme. We must remember that without the discipline of a linkage to contributions, there would be irresponsible political pressure to increase pay-outs and to trim contributions. Experience elsewhere tells us that any committed pay-outs would be very difficult to trim, and agreed contributions very difficult to raise, once they are entrenched. This is likely to be so even when the projected demographic trend points to a continuously deteriorating financial situation for the system as a whole. This is ahead of earned experience elsewhere. In certain instances elsewhere, the Pay-As-You-Go system is running progressively into insolvency, leaving the entire community to pick up the pieces. We certainly do not want to fall into the same pit.

Nor do we want to run the provident fund system centrally. This would breed a new and large bureaucracy. Moreover, it would give individual contributors and their employers no choice at all, and the fund management segment of the system no competition at all, in regard to investment strategies and portfolio management skills. The result is that individual contributors would most likely not get the best deal in terms of investment return. The merits of a decentralised, private sector run system are highlighted by the fact that, in many places where centralised provident funds are the mainstream, measures are being taken to relax controls to give greater scope for the private sector.

A welcome spin-off from the mandatory provident fund system will be the strong boost to our own capital market. The substantial amount of savings institutionalised by an MPF scheme will create a huge new source of supply of long-term investment funds for our corporate sector to be mobilised through long-term debt instruments. I thus envisage a considerably more active debt market, providing additional resources and channels for investment. Against the foundation of a mature banking sector and stock market, the MPF would hence bring about a quantum expansion in our capital market, adding both volume and sophistication to our financial sector.

We are now evolving into a three-tier framework of provision for retirement and the elderly in very much the same vein as that the World Bank advocates. In essence, the World Bank suggests a social safety net at the bottom tier for those elderly people in need of help, a statutory retirement scheme on a contributory basis at the second tier to accord retirement protection to some degree, and a multitude of voluntary savings and insurance schemes to be offered by the private sector to meet the balance of the retirement protection needs. In parallel to the introduction of MPF, we are also reviewing the adequacy of our welfare provisions for the elderly at the bottom tier, as one of the three main policy initiatives recently announced by my boss, our Chief Executive.

LABOUR RELATIONS

I now turn to labour legislation, specifically the laws enacted recently on trade union powers and collective bargaining. What worries me in these legislative measures is that our long-standing wage setting practice based on market forces might give way to collective wage setting, where the union's bargaining strength is likely to dominate. As such, compulsory collective bargaining would distort the wage structure in the labour market. It would reduce the flexibility of wage adjustment, particularly during any downswing in an economic cycle. It would also impair the ability of our economy to adjust to external shocks. Hong Kong's economic strength, on which our own political stability ultimately depends, lies in the robustness and agility of our markets. I find any measure, such as compulsory collective bargaining, abhorrent if it tends to prolong the adjustment of our crucial labour market to changing economic conditions.

We have a fine labour force in Hong Kong. Everyone in it expects job security and aspires to better working conditions, including pay. Accordingly, our main task should be to provide an environment conductive to the creation of an abundance and variety of job opportunities, particularly those with better remunerations. I am happy to say that we, as a community, have been able to do so. This means that a worker who is not happy with his present job because he is not satisfied with his pay or other factors could look for and find a better job elsewhere. Against the backdrop of low unemployment rate and a tight labour market in Hong Kong today, only a short-sighted employer would underpay his employees. In dealing with such an employer, I do not think imposing collective bargaining by law is the answer. If the economy slows, collective bargaining could drive an employer's business to an early grave to the detriment of all employees. I believe that in a vibrant and efficient economy such as that in Hong Kong, there is simply no justification for a compulsory collective bargaining system which could legally force employers into a corner.

Let us not be misled by the advocates of compulsory collective bargaining. It is not good for Hong Kong. This does not in any way create jobs. This does not mean that we reject all forms of collective bargaining. Indeed we have ratified the International Labour Convention No. 98 concerning the right to organise and to bargain collectively since 1975. We live up to our commitments under this convention and have been promoting voluntary negotiation and good communication between employers and employees. What we cannot agree is to make collective bargaining compulsory under the law for regulating the terms of employment at either plant or industry level.

We have taken legislative action to suspend the implementation of the relevant items. Some have criticised our move as undemocratic. This I cannot agree. On the contrary, we want it to be truly democratic. The problem is that those legislative items have not gone through proper consultation in the established forum such as the Labour Advisory Board. The implications of these laws have not been thoroughly deliberated by all parties concerned. We need more time to consider. Our move is merely designed to restore debate and deliberation to their proper tracks.

While I fully support the legitimate functions of trade unions and appreciate the services they render to our workers, I also believe that excessive trade union powers are not conducive to the efficient functioning of the economy. Nor do they, in the end, benefit the workers. As evidence elsewhere testifies, a high degree of trade union influence is often associated with rather higher unemployment, and possibly also slower economic growth. A World Bank study on a number of economies shows that wage distortions away from the market-clearing level are more prominent where trade unions are active. At the micro level, firms will understandably be less inclined to hire workers if their wages are pushed beyond what they can afford in terms of labour productivity, or if the discretion for retrenchment at times of adversity is impeded. Job creation for the labour force will be constrained as a result.

The concern underlying the labour legislation issue echoes the point I made earlier. Artificial restrictions on the workings of the market are detrimental to the vitality and competitiveness of the economy, and we should remove those restrictions as much as possible. In Hong Kong, we have economic machinery which is running smoothly. It would be unwise to clog it up by interference and undue regulations. For the labour market in particular, we should not become more rigid while other advanced economies, including our competitors, are consciously seeking to become less rigid. Again, taking to heart the wisdom of Adam Smith, we should continue to cherish the unfettered invisible hand.

EXCHANGE RATES

Finally, a word on the regional exchange rate situation. The recent upheavals leading to the depreciation of a number of Asian currencies have caused much anxiety in many countries in Asia. Blame has been levelled at speculators, and there are concerns about the likely ripple effect this could have on the stability of the entire regional currency network. Hong Kong, as an integral part of the regional financial market, is naturally concerned.

We are, nonetheless, confident in the ability of our exchange rate system to withstand shocks and speculative attacks. We have a robust monetary regime that has time and again stood up well to abrupt developments. We have effective monetary devices which we have no hesitation to use when our linked exchange rate comes under unwarranted pressure. We have ample foreign exchange reserves for maintaining exchange rate stability. And our banking sector is in a healthy financial state and subject to appropriate supervision. But that is not all. In my opinion, sound economic fundamentals are, in fact, the foremost factors buttressing Hong Kong's financial strength.

A key component of our sound fundamentals, apart from decent economic growth, moderate inflation, balanced external account, low unemployment, flexible labour market and minimum artificial constraints on business, is a prudent budget and tight discipline in the management of public finances. Experience from crises elsewhere shows that loss of control over the budget giving rise to unchecked spending, chronic deficit and huge public debt is invariably seen as a clear symptom of structural weakness laying the ground for financial vulnerability. In Hong Kong, a prudent and conservative budgetary stance has long been our habit, and now this is a formal requirement stipulated in the Basic Law. In particular, public expenditure growth is consistently kept within the trend growth rate of the economy, and the accumulation of substantial fiscal reserves from successive budget surpluses makes fiscal borrowing quite unnecessary. The message I would like to reiterate is that it is crucial to get the fundamentals right. This is far more important than devising effective, counteractive measures in times of currency trouble. It is the key to ensuring lasting financial stability.

In closing, may I say, once again, how honoured I am to be associated with this meeting and its distinguished participants.

I wish your symposium every success.

Thank you.