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    China Business
     Aug 4, 2012

China addicted to Hong Kong's 'opium'
By Wu Zhong

This concludes a three-part report.
Part 1: The myth of a free Hong Kong economy
Part 2: The rulers of the game

HONG KONG - In an analogy, Hong Kong can be likened to a small cat and mainland China to a giant tiger, when compared by their geographical size and economic strength. Interestingly, the analogy may remind one of a popular Chinese fable. It goes like this:
In the Middle Kingdom, people believe that, in the beginning, the tiger was weak and clumsy though big in physique, while the cat was smart, agile and skillful in capturing prey, albeit small. Despite the

differences, the two were good friends.

So one day, the tiger asked the cat to teach him kung fu. The cat agreed and was patient in teaching the tiger, which gradually learned how to stalk, run, jump, roll, grasp, tear, and strike as well as the cat. The tiger thought he had already learned all kung fu techniques from the cat, and an idea came to his mind: "I'm so much bigger than the cat. I will become peerless if I can get rid of this small cat."

So one day when the cat was taking a nap, the tiger stood up and approached the cat viciously. Just as that moment, the cat opened up its eyes, immediately realized what the tiger was trying to do, and swiftly climbed up to the top of a tall tree. "I have kept the last technique of the tree climbing from you just in case," the cat loudly told the tiger, which watched under the tree helplessly.
The first part of this fable may be said to vividly describe the relationship between Hong Kong and mainland China. It is a fact that in the past three decades mainland China has learned all the techniques from Hong Kong for building a capitalist-style free-wheeling market economy. Given its size and with its success, the mainland has inevitably become stronger and more powerful - to the point where it is now the world's second-largest economy.

The second part of the story may not be accurate is but relevant to the relationship between Hong Kong and the mainland. China's taking back Hong Kong in 1997 was non-violent and legitimate, as it was internationally recognized. However, many in Hong Kong still think that the city, like the cat in the fable, has reserved some things to enable itself to keep away from the tiger: in particular, the rule of law and freedom. This will also be at Beijing's mercy when its commitment to "one country, two systems" expires in 2047, but that will be another story.

Here we'd like to examine how the mainland, the tiger, has learned from the cat, Hong Kong, how to develop a market economy.

When Deng Xiaoping initiated his economic reform and opening up in late 1970s, he apparently thought of Hong Kong as a model for economic (not political) development, as he said later in 1988: "Now there is one Hong Kong; we must create several more 'Hong Kongs' on the mainland. That is, we must further open up." [1]

To lure foreign investment and learn about the operation of capitalism, Deng approved the establishment of four Special Economic Zones (SEZs) in 1980: Shenzhen, bordering Hong Kong; Zhuhai, bordering Macau; Shantou, in east Guangdong (with an eye on attracting investment from overseas Chinese in Southeast Asia); and Xiamen, in Fujian (to attract investment from Taiwan). Shenzhen SEZ is by far the most successful, largely because of its proximity to Hong Kong.

At the initial stage of economic reform and opening up, for the purpose of capital accumulation, China had also learned from Hong Kong to introduce foreign-invested, re-export-oriented, labor-intensive processing industries.

At that time, Hong Kong's processing industries began to suffer from increasing land and labor costs, so investors there were happy to move their factories across the border. At the peak time in 1980s and 1990s, it was estimated that there were about 100,000 Hong Kong-invested re-export enterprises, mostly small or medium-sized, in Shenzhen and the rest of the Pearl River Delta area.

Hong Kong investment brought into the mainland not only capital but also, more importantly, knowledge of modern management and trade, which helped China to build up a legal system governing foreign investment and trade to enable the country to further open up to the world.

Furthermore, Hong Kong also served as a model for China to privatize its property sector. In the early 1990s, Beijing decided to privatize the country's property sector (until then all housing was virtually state owned), but it faced a dilemma: China insisted at that time and still insists today that it is a socialist country.

The core of socialism is public ownership, so under the Chinese constitution all land belongs to the state. To privatize housing property would mean to abandon socialism, but without privatizing the real estate sector, China's market-oriented economic reform and opening up would stand stagnant as a private property sector is an important part of a market economy.

In this regard, colonial Hong Kong's system provided a perfect solution for socialist China. Under British colonial rule, most of the land in Hong Kong belonged to the "Crown". One could only rent, or buy the right to use a land lot, from the "Crown" for a certain period of time, and a land premium had to be paid if one wanted to continue to use it after the original contract expired. Thus selling and reselling the land-use rights became an important source of financial income for Hong Kong government. The system continues today.

It can be said literally that Beijing has simply copied Hong Kong's land system in its privatization of the property sector. Today in China, if you say you have bought a piece of land, it actually means you have bought the right to use that piece of land for a certain period of time, for legally all land still belongs to the state. Likewise, when one buys a house or flat in a building, one does not own the land (proportionally in the case of owning a flat) on which the house or building is erected.

But there is a fatal defect in Hong Kong's land system. During colonial times, the British simply saw Hong Kong as a "borrowed place" for some "borrowed time", so they did not care about long-term development. With limited sources of income, the design of the land system enabled the British Hong Kong government to have sufficient income to sustain its operation.

I need my (land) fix
In practice, it proves much easier for a city government to produce income by selling public land than collecting taxes or making efforts to create other sources of income.

But this also proves addictive - like "opium". Inherited from the British, today's Hong Kong government still has heavily relies on land premiums as its main source of income. The more it increases spending on social welfare under growing populist pressures, the more it has to rely on property development unless it can create other sources of income.

Nowadays, we see governments of many cities in mainland China also become addicted to this Hong Kong-style disposal of land. Many cities rely on land premium incomes to build subways and other infrastructure projects. It is too tempting not to do so. The more a city government spends, the more it has to rely on land premium income. Given China's autocratic system, it is much easier for a city government to take back a land lot from people who live or farm on it with little compensation. In this regard it can be said "the pupil excels the teacher".

But this has resulted, as widely reported, in abuse of power, injustice, corruption and skyrocketing housing prices. From this perspective, it is also not hard to understand why city governments are resistant to Beijing's repeated tough orders to bring down housing prices, for a downturn in the property market would mean less land premium income for a city government.

Now seems to be the time for the mainland to reform its land system to get rid of that "opium" - or defect - imported from Hong Kong. China is such a huge country with such a huge population and so many cities, it must not run a property market like Hong Kong.

Hong Kong may have provided many good examples of economic development for China. It is time for Beijing to draw a lesson from Hong Kong's bitter experience of making property development the "pillar industry" of the city.

1. Click here for full text (in Chinese).

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(24 hours to 11:59pm ET, Aug 2, 2012)


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