Hong Kong may be back in the hands of mainland China, but direct government spending in Hong Kong remains less than 15 percent of national income--versus some 40 or 50 percent here in the United States. Hoover fellow and Nobel Prize winner Milton Friedman considers these facts worth pondering.
Which country would you guess has the higher gross domestic product per capita? The United States, with a population of 260 million occupying a land rich in natural resources stretching from sea to shining sea and a history of more than two hundred years of democracy and economic growth, or Hong Kong, with a population of 6 million people crammed into a tiny area with a population density 225 times that of the United States,
no natural resources other than a great harbor and the skills of its people, and a tenfold multiplication in population since the end of World War II driven by refugees from mainland China?
Your guess is right. The United States. What will surprise you is how small the difference is. In 1950, the United States had a GDP per capita nearly six times that of Hong Kong's; in 1996, only 7 percent higher. If growth continues in both countries at present rates, Hong Kong will have a higher GDP per capita than the United States in less than five years.
What accounts for the remarkable success of Hong Kong? Clearly not the special qualities of either its Chinese inhabitants or its former British governors--or else mainland China too would be one of the high-income areas of the world and Hong Kong's per capita GDP would not exceed Britain's by more than a third.
The answer to the puzzle is simple: the role of government. Direct government spending is less than 15 percent of national income in Hong Kong versus 40 percent in the United States. Indirect government spending via regulations and mandates on private individuals and businesses is negligible in Hong Kong but accounts for around 10 percent of national income in the United States.
We are more productive than Hong Kong. But we have chosen, or been led by the vagaries of politics, to devote roughly half of that capacity to activities to which Hong Kong devotes 15 to 20 percent. Are we getting our money's worth for that extra expenditure? I believe not.
Consider the most basic functions of government, the protection of person and property and the maintenance of the rule of law. Most observers would agree that Hong Kong has been performing those functions better than we have. Because it is doing so many things that it has no business doing, our government is doing those things that it should be doing badly, less well than it did in the past, when government spending was lower.
Government has an essential role to play in a free and open society. Its average contribution is positive, but I believe that the marginal contribution in going from 15 percent of the national income to 50 percent has been negative. I firmly believe that we would be better off if we were free to use that part of our production in accordance with our individual tastes and values rather than turning it over to the political authorities. The result would be a per capita GDP 70 percent higher than Hong Kong's, not 7 percent.
The obvious occasion for these remarks is the turnover of Hong Kong to China. A less obvious but more important reason is the recent budget agreement in this country.
Most of the emphasis is on the proposed tax cuts. I have long favored cutting taxes at any time, in any manner, by as much as possible as the only way of bringing effective pressure on Congress to cut spending. Like every teenager, Congress will spend whatever revenue it receives plus as much more as it collectively believes it can get away with. Reducing spending requires cutting its allowance.
The tax cut in the agreement is trivial: $96 billion over five years, or $19 billion a year, one-quarter of 1 percent of national income. If that cut were being financed by reducing spending, and were to be repeated year after year, it would take more than sixty years to bring the share of national income controlled by the government down to the same level as that in Hong Kong today.
Unfortunately, the cut in taxes is not being financed by reducing spending. On the contrary, the "balanced budget" agreement calls for higher spending in coming years. The hypothetical balance is to be brought about by higher tax revenue, not by lower spending. The tax cut is being financed by the unlegislated increase in the effective tax rate produced in a growing economy by a graduated income tax combined with incomplete indexation of taxes for inflation. Taxes are going up, not down.
Neither cutting explicit taxes nor balancing the budget is an end in itself. Both are means to the ultimate objective of increasing the freedom of individuals to use their own resources in accordance with their own values--as President Reagan put it, to get the government off our back. A real cut in direct and indirect government spending as a fraction of national income is required to achieve that basic objective.
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Milton Friedman, recipient of the 1976 Nobel Memorial Prize for economic science, was a senior research fellow at the Hoover Institution from 1977 to 2006. He passed away on Nov. 16, 2006. He was also the Paul Snowden Russell Distinguished Service Professor Emeritus of Economics at the University of Chicago, where he taught from 1946 to 1976, and a member of the research staff of the National Bureau of Economic Research from 1937 to 1981.
Reprinted from the Wall Street Journal, July 8, 1997. Used with permission. © 1997 Dow Jones & Company, Inc. All rights reserved.
Available from the Hoover Press is The Essence of Friedman, edited by Kurt R. Leube. Also Available from the Hoover Press as part of the Essays in Public Policy series is Freedom's Fall in Hong Kong, by Alvin Rabushka. To order, call 800-935-2882.
Illustration by Karen Stolper