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July 30, 1998

The Hong Kong Experiment

A controlled experiment in the field of economics? The last fifty years of history have provided just that. The free economy: Hong Kong. The mixed economy: the United States. The socialist economies: Great Britain and Israel. Nobel laureate and Hoover fellow Milton Friedman evaluates the results.


Economists and social scientists complain that we are at a disadvantage compared with physical and biological scientists because we cannot conduct controlled experiments. However, the experiments that nature throws up can be every bit as instructive as deliberately contrived experiments. Take the fifty-year experiment in economic policy provided by Hong Kong between the end of World War II and this past July, when Hong Kong reverted to China.

In this experiment, Hong Kong represents the experimental treatment; Britain, Israel, and the United States serve as controls. Immediately after World War II, Hong Kong had a population of about 600,000. A colony of Britain, it did not receive its freedom after the war as most other colonies did. The reason was obvious: China was next door. If Hong Kong had been set free, it almost surely would have been taken over by China. Instead, Britain retained Hong Kong as a crown colony. After the Communists took control of mainland China, a flood of refugees came to Hong Kong. Over the next fifty years, the population exploded. Today it is more than six million.

I take Britain as one control because Britain, a benevolent dictator, imposed different policies on Hong Kong from the ones it pursued at home. I take Israel as another control because, like Hong Kong, it had a small population at the end of the war and was then inundated by refugees. In both, the population increased by roughly tenfold. In both, the refugees were reputed to be intelligent and commercially able. And those two countries, alike in key respects, adopted very different economic policies. I take the United States as a third control because it is the richest country in the world and reputedly the exemplar of free markets.

HONG KONG AND BRITAIN
The difference in the economic policies followed by Hong Kong and Britain was a pure accident. The colonial office in Britain happened to send John Cowper-thwaite to Hong Kong to serve as its financial secretary. Cowperthwaite was a Scotsman and very much a disciple of Adam Smith. At the time, while Britain was moving to a socialist and welfare state, Cowperthwaite insisted that Hong Kong practice laissez-faire. He refused to impose any tariffs. He insisted on keeping taxes down.

I first visited Hong Kong in 1955, shortly after the initial inflow of refugees. It was a miserable place for most of its inhabitants. The temporary dwellings that the government had thrown up to house the refugees were one-room cells in a multistory building that was open in the front: one family, one room. The fact that people would accept such miserable living quarters testified to the intensity of their desire to leave Red China.

I met Cowperthwaite in 1963 on my next visit to Hong Kong. I remember asking him about the paucity of statistics. He answered, “If I let them compute those statistics, they’ll want to use them for planning.’’ How wise!

Nonetheless, there are some statistics, and in 1960, the earliest date for which I have been able to get them, the average per capita income in Hong Kong was 28 percent of that in Great Britain; by 1996, it had risen to 137 percent of that in Britain. In short, from 1960 to 1996, Hong Kong’s per capita income rose from about one-quarter of Britain’s to more than a third larger than Britain’s. It’s easy to state these figures. It is more difficult to realize their significance. Compare Britain—the birthplace of the Industrial Revolution, the nineteenth-century economic superpower on whose empire the sun never set—with Hong Kong, a spit of land, overcrowded, with no resources except for a great harbor. Yet within four decades the residents of this spit of overcrowded land had achieved a level of income one-third higher than that enjoyed by the residents of its former mother country.

I believe that the only plausible explanation for the different rates of growth is socialism in Britain, free enterprise and free markets in Hong Kong. Has anybody got a better explanation? I’d be grateful for any suggestions.

HONG KONG AND ISRAEL
The comparison with Israel is in some ways even more interesting than that with Britain. Israel had one major disadvantage and several major advantages compared with Hong Kong. Its major disadvantage was that it had to maintain strong armed forces to meet the threat from the enemies that surrounded it, with whom it fought several wars.

Israel, however, had what would be widely regarded as a major advantage, although I don’t regard it as such. Israel received much foreign aid from the U.S. government and other governments around the world and also from Jews living outside Israel—notably, American, South African, and British Jews. According to data that I analyzed during a visit to Israel in 1977, the bulk of its defense costs was being financed by such contributions. In an economist’s way of looking at things, military defense is an export industry for Israel. I estimated that the net cost of defense to Israel was something like 10 percent of its national income. That’s a substantial amount. But it’s not an intolerable amount.

Beyond this, Israel has a much larger land area—its population density is one-twenty-fifth that of Hong Kong—and far richer natural resources. Corresponding to Hong Kong’s great port, it has a Mediterranean port and a southern port at Eilat. And yet from 1960 to 1996, its average per capita income went from 60 percent more than Hong Kong’s to 40 percent less.

Again, the most plausible explanation is that Israel followed a socialist policy and Hong Kong a free market policy. Government spending in Hong Kong was, at its maximum, about 15 percent of national income. Government spending in Israel was at times close to 100 percent of national income. (That may seem an impossibility, but it isn’t because of the mysteries of national income accounting.) The socialist policy was Israel’s folly, though it did less harm than the corresponding policy did in Britain, partly, in my opinion, because the British were much more law abiding.


The lesson of Hong Kong for the United States is that we’re using our resources inefficiently. Our government is spending our money both to subsidize childbearing and to discourage childbearing, both to build new housing and to tear down housing, both to subsidize agriculture and to penalize agriculture, and on and on.


When I returned from my first visit to Israel in 1962, I summarized my impressions by saying that two traditions were at war in Israel: a hundred-year-old tradition of belief in paternalistic socialist government and of rejection of capitalism and free markets and a two-thousand-year-old tradition, developed out of the necessities of the Diaspora, of self-reliance and voluntary cooperation, of getting around government controls, of using every ounce of Jewish ingenuity to take advantage of such opportunities as escaped the clumsy grasp of government officials. I concluded that, fortunately for Israel, the older tradition was proving the stronger. Unfortunately for Israel, the older tradition has since lost strength, while the newer tradition has gained. Maybe Benjamin Netanyahu can reverse that process, as he appears to want to do.

HONG KONG AND THE UNITED STATES
According to the latest figures I have, per capita income in Hong Kong is almost identical with that in the United States.

That is close to incredible. Here we are—a country of 260 million people that stretches from sea to shining sea, with enormous resources, and a two-hundred-year background of more or less steady growth, supposedly the strongest and richest country in the world, and yet six million people living on a tiny spit of land with negligible resources manage to produce as high a per capita income. How come?

The explanation is the same as for Britain and Israel. Direct government spending is less than 15 percent of national income in Hong Kong, more than 40 percent in the United States. Indirect government spending via regulations and mandates is negligible in Hong Kong but accounts for around 10 percent of national income in the United States. In both respects, the United States differs from Hong Kong less than either Britain or Israel, both of which have even higher government spending as a fraction of national income and even more intrusive and extensive regulations and mandates, which is presumably why per capita income in the United States is more than a third higher than that in the United Kingdom and nearly 80 percent higher than that in Israel.

We are more productive than Hong Kong. But we have chosen, or been led by the vagaries of politics, to devote roughly half of our resources to activities to which Hong Kong devotes 15 or 20 percent. Our higher productivity means that we can produce with 50 percent of our resources the same per capita income as Hong Kong can produce with 80 to 85 percent of its resources.

The real lesson of Hong Kong for the United States is that we’re using our resources inefficiently. Our government is spending our money to subsidize tobacco and to penalize smoking; to subsidize childbearing and to discourage childbearing; to build new housing and to tear down housing; to subsidize agriculture and to penalize agriculture; and on and on—not to mention converting square miles of forests into billions of paper forms and spending many man-years of labor filling them out and then filing them.

In the process, government tends to neglect its basic functions: as I once put it, “to protect our freedom both from the enemies outside our gates and from our fellow citizens: to preserve law and order, to enforce private contracts, to foster competitive markets.’’


Click here to see the Hoover project showcasing the works of Milton and Rose Friedman.

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 National Review, December 31, 1997, from an article entitled “TheReal Lesson of Hong Kong.”

Available from the Hoover Press is The Essence of Friedman, a volume of essays by the Nobel laureate economist. Also available is the Hoover Essay in Public Policy Freedom’s Fall in Hong Kong, by Alvin Rabushka. To order, call 800-935-2882.