Hong Kong

Every year since 1995, Ernst and Young has released an index of countries listed according to how globalised their economies are viewed. And nearly every year Hong Kong has topped this index.( Ernst and Young 2011 ) Another highly recognised group, The Wall Street Journal and The Heritage Foundation, produces its version of what it considers to be the Index of Economic Freedom and again, almost every year since it started in the midnineties, Hong Kong has come first. ( The Heritage Foundation 2011 ) What is it about the Hong Kong Economy that makes it so highly regarded in the economical world? Is Hong Kong possibly the freest economy in the world?? Both of these indices are compiled using a composite of quantitative and qualitative different, showing the subjective-ness of the reports. However it is hard to dispute that Hong Kong holds that special something in free market ideology. I will delve into the current economic situation of the country, and look at data going back from 1988 to 2008 to see if there are trends, policies or otherwise which helped shape events. Firstly I will establish the history of Hong Kong, mainly looking at its monetary situation and highlighting major economic events.
A Brief History

For those of us old enough to remember, the changeover of power of the state of Hong Kong from Britain to China was an historic event. Britain had ruled for 156 years, and handed back its sovereign right to China in 1997. ( BBC 2011 ) Hong Kong had operated as a separate economic entity under colonial rule and this continued upon the changeover. Although Beijing holds Veto rights and control over defence and foreign affairs, Hong Kong operates as a Special Administrative Region and even has its own currency, the Hong Kong Dollar. ( Hong Kong Monetary Authority 2011 ) However it is not a free floating currency as it is pegged to the US dollar. This operates under a fixed exchange rate mechanism. The Monetary Authority in Hong Kong lists its objectives as:

maintaining currency stability within the framework of the Linked Exchange Rate system promoting the stability and integrity of the financial system, including the banking system helping to maintain Hong Kongs status as an international financial centre, including the maintenance and development of Hong Kongs financial infrastructure managing the Exchange Fund. (HKMA 2011)

So what are the main indicators which we should look at to check the idea that Hong Kong is economic heaven. The main economic interests of most governments and central bank functions are its inflation rate, its unemployment rate, and its growth rate.( Leddin 2004 Page 1 ) These three are usually representative of the state of an economy and we will look at Hong Kong under the three headings:

1. 2. 3.

GDP/Economic Growth The Labour Market Consumer Prices/Inflation.

GDP/Economic Growth

GDP % Yearly Growth 1988-2008

20 15 10 5 0 -5 -10 GDP % Yearly Growth 1988-2008

(Data Source: Hong Kong Monetary Authority 2011)

The average GDP growth over the period 1988-2008 was 7.4%, an astounding growth rate. From basic macro-economic study, it can be fair to say that the people of Hong Kong have at least doubled, if not tripled, their standard of living over these twenty years. It is an impressive record, and to perhaps understand this better, we will examine the GDP further.
3500000 3000000 2500000 2000000 1988 1500000 1000000 500000 0 GDP PC GOV CAP EXP G EXP S IMP G IMP S 2008

(Data Source: Hong Kong Monetary Authority 2011)

. (PC = Private Consumption, GOV = Government SpendingCAP= Capital Formation, EXP G= Export of goods EXP S= Export of Services, IMP G= Import of Goods, IMP S= Import of
Services)

The main components of GDP are Private Consumption, Government Spending, Capital Investment and its balance of payments figures. The above graph shows the components of GDP in both 1988, and 2008 It is clear from the above representation that there is a massive trade market in Hong Kong, for both the import and export of mainly goods. All components appear to increase over the period, however both the import and export of goods accounts for over three times the GDP of the country. Further analysis could look at whether this trade was of a volumous, or prestige nature. Is Hong Kong trading 1000 $1 million diamonds, or is it trading 1 million $1000 TVs? What policies could have shaped such an open, export and import driven economy?

The Labour Market

Hong Kong Unemployment Rate 1988-2008

9 8 7 6 5 4 3 2 1 0 1985

Hong Kong Unemployment Rate 1988-2008

1990

1995

2000

2005

2010

(Data Source: World Bank Databank 2011) There was very low unemployment in the early nineties and this corresponds with the period of high growth as shown in the first figure. There seems to be a correlation between the business cycle variables, GDP and the unemployment rate. The latest figure of just over 3% for 2008 shows a reduction of almost 5% since 2004, where it peaked at 8%. The average rate over the period of 3.8% is again close to full employment.

But what is the structure of the workforce? We can look at three broad categories, Industry, Services and Agriculture. The graph below shows the total of the workforce broken into the three, and its timeline from 1988 to 2008. We can see the structure of the labour market and its evolution.

100 90 80 70 60 50 40 30 20 10 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Argriculture Industry Services

(Data Source: World Bank Databank 2011) It is clear that Hong Kong is a Service led market. But this is in contradiction to the high imports and exports we have seen in our previous analysis. Hong Kong appears to have a unique trade balance, highlighted here through its reduction in Industry, with an increase in exported goods. The Service market is supporting the export of a goods market. So we have established that the labour market is almost solely supporting a service led market. Hong Kong is employing a lot of people in a service industry, but what of the people doing the work. The graph below shows us the structure of

the labour force, along with the percentage of the unemployed, and their education level.

100 90 80 70 60 50 40 30 20 10 0 % In Employment % Unemployed

Tertiary Secondary Primary

(Data Source: World Bank Databank 2011) Hong Kongs labour force is dominated by employees with secondary education, with around a third having tertiary education. Again it dominates the unemployed section, however those with Primary education are in greater proportion to those with third level education. Data has shown that the labour market is driven by a second-level educated workforce, working almost entirely in the services industry. The Census and Statistics Department of Hong Kong states:
Financial services, trading and logistics, tourism, and producer and professional services are

the Four Key Industries in the Hong Kong economy.

(http://www.censtatd.gov.hk/ 2011)

This supports our data above which shows a service dominated market.

Consumer Prices/Inflation

Hong Kong % Annual Inflation Rate

12 10 8 6 4 2 0 -2 -4 -6 Hong Kong % Annual Inflation Rate

(Data Source: World Bank Databank 2011) This chart looks very similar again to our very first diagram on the business/GDP cycle. It shows us high inflation at times of high growth, and vice versa, with huge variations. Inflation at over 10% at the beginning of the nineties would have been a worry, with deflation again for 5 years at the beginning of the new century. It is very rare that we see the rate at a level considered stable around 2-3%. Prices seem to move in line with the business cycle, and to investigate further it would be necessary to see if government policies or free market forces moved the two in tandem. The average inflation rate over the period was 3.8%. This is too high, and when you look at the average growth rate over the period of 7.3%, it puts it in a different perspective. Price variations as we can see are not healthy for the overall economy. The currency is pegged to the US dollar, while its main trading partner is China. As we have seen the agricultural section is non-existent so consumer prices are sensitive to the currency movements of its neighbours. If rice gets expensive. Hong Kong has to accept the market price. Consumer Prices can be measured in a number of ways which can show price variations. House prices, sometimes included in the headline inflation rate, are an economic indicator showing the healthiness and vibrancy of the economy. Lets look at two different measures, the prevailing interest rate, and house prices. These financial pieces of information should show some trends we would expect.

20 15 10 5 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 -5 -10 Interest Rate GDP Growth

(Data Source: World Bank Databank 2011) In this diagram we can see the interest never fluctuates from between 5 and 10%. The Asian Financial Crisis would have had an upward effect on price, however there was a lot of cheap credit which was fuelling the global economy in the early twenty first century. We can see a downward trend in the interest rate from 2000 until 2004. It appeared to have a positive effect on the growth rate if we considered these two variables ceteris paribus. Jeffrey Sachs does an interesting report on the financial crisis and shows that the banking system was relatively sound to withstand the Crisis, albeit with some losses. ( Sadalet/Sachs 1998) The IMF have also done numerous reports accessible on their websites looking at different angles of the crisis.(The Asian Crisis 1998) Although they did not help Hong Kong in this program, they helped the area recover from the crisis, providing assistance when liquidity was short. Next we will look at the housing market. Data is collected from the Hong Kong Government website, and the prices shown for the Hong Kong area are on mid-sized properties of 70-99m. House prices are indicative of a number of factors including the

confidence of the market and the credit policies of the banks.

% Yearly Increase in House Prices Hong Kong

60 40 20 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 -20 -40 2008 % Yearly Increase in House Prices Hong Kong

(Data Source: Hong Kong Monetary Authority 2011)

The average growth rate in prices over the period was an annual return of 11.5 percent. However there is some volatility over the period. The early nineties again show huge returns, with deflation around the turn of the century. As with many of the variables examined, it follows the general path of the business cycle.

Conclusion
We have looked at three variables or criteria which can be indicative of the state of an economy. We have seen some mixed results, mainly positive, however there is great variation in the different yearly changes. The below table highlights the results we have obtained above, along with the standard deviation from the mean i.e. the average yearly rate. And what results have we found?

Measure GDP Unemployment Rate Inflation

Avg Yearly Growth 7.4 3.8 4.0

Standard Deviation 7.1 2.1 5.2

The first column shows us healthy average returns, aside from the inflation figure. As mentioned previously, this may have a dampening effect on the real growth in the economy. The second column, Standard Deviation, shows us great volatility in the period in review for Inflation and GDP. As we have seen in the first diagram on GDP, it

shows an erratic cycle, with little synchronicity with its real growth rate. Inflation also has a high standard deviation, showing it is normal for inflation to reach a figure of over 9%. So what has the data presented shown us on the economy of Hong Kong. It has a very interesting GDP profile, with massive figures for exporting and importing goods. Its yearly averaged growth figures are highly impressive, perhaps inflated by the abnormally high period of growth in the early nineties. But its inflation is a worry. The rate is eroding its headline growth rate in GDP. It has subsided in recent times, however there is an upward trend establishing again. If the inflation rate can be controlled, then perhaps Hong Kong could be viewed as an ideal in economic performance. Ernst and Young, The Wall Street Journal and The Heritage Foundation have their own criteria for assessing the economic freedom of an economy. The facilitation of massive trade figures highlights where Hong Kong could have earned its statuses of Economic Freedom. And reviewing the economy over the past twenty years has shown us some great results. But it has not shown us a perfectly performing economy. It has its flaws. It may not be absolute idealism however it possibly is the freest economy in the world. I guess it just counts on what you view as free.

References
BBC (2011), Region and Territories; Hong Kong, available http://news.bbc.co.uk/2/hi/asiapacific/country_profiles/3650337.stm [accessed 17 Feb 2011] CIA World Factbook (2011), Introduction Hong Kong, available https://www.cia.gov/library/publications/the-world-factbook/geos/hk.html [accessed 17 Feb 2011] Ernst and Young (2011), Winning in a Polycentric World- Globalisation and the Changing World of Business, available http://www.ey.com/Publication/vwLUAssets/Winning_in_a_polycentric_world__Globalization_and_the_changing_world_of_business/$FILE/EY__Winning_in_a_polycentric_world__Globalization_and_the_changing_world_of_business.pdf [accessed 15 Feb 2011] Hong Kong Monetary Authority (2011), About HKMA, available http://www.info.gov.hk/hkma/eng/hkma/index.htm [accessed 19 Feb 2011] Hong Kong Census and Statistics Department (2011) The Four Key Industries, available http://www.censtatd.gov.hk/hong_kong_statistics/four_key_industries/four_key_industries/in dex.jsp [accessed 20 Feb 2011] IMF (1998) The Asian Crisis and the Regions Long-Term Growth Performance, available http://www.imf.org/external/pubs/ft/weo/weo1098/pdf/1098ch3.pdf [accessed 20 Feb 2011] Leddin,A. and Walsh B.(2003) The Macroeconomy of the Eurozone: An Irish Perspective, Dublin: Gill and McMillan LTD pg 1 Radelet S. and Sachs J. (1998) The onset of the East Asian Financial Crisis, National Bureau of Economic Research Working Paper No. 6680, available http://bss.sfsu.edu/jmoss/resources/635_pdf/No_29_Radelet_Sachs.pdf [accessed 20 Feb 2011] The Heritage Foundation (2011), Index 2011 Executive Summary, available http://www.heritage.org/index/pdf/2011/Index2011_ExecutiveHighlights.pdf [accessed 15 Feb 2011] The World Bank Databank (2011), available http://databank.worldbank.org/ddp/home.do [accessed 18th Feb 2011]