RED FLAG OVER HONG KONG

Wednesday, February 26, 1997

Hoover fellow Alvin Rabushka and Stanford professor Larry Lau discuss the impact of China assuming control of Hong Kong on July 1, 1997.

Recorded on Wednesday, February 26, 1997

ROBINSON: Welcome to Uncommon Knowledge. I'm Peter Robinson, a fellow at the Hoover Institution. Our show today Hong Kong. Afternoon tea at the Governor's mansion in Hong Kong. All very proper, very British, careful of the pinky, but this summer all that will change. At midnight on June 30th, Hong Kong, a British crown colony for more than a century and a half and one of the freest, most vibrant economies on Earth will revert to Chinese rule becoming a special administrative region of the Peoples Republic of China. It's a safe bet that from that from that moment on, tea at the Governor's mansion will look less like this and more like this. Not tea and a service made in Staffordshire but china made in, well, in China. None of this would matter, of course, if only tea were at stake but there are a few things that go with British rule besides cucumber sandwiches. The rule of law, freedom of speech, freedom of religion and independent judiciary. And likewise there are a few things that go with Chinese rule besides dim sum. Communism, repression. Now, the Beijing government has promised to permit Hong Kong to retain its free markets and the phrase that Beijing uses to describe this approach is "One county, two systems for fifty years." So the question for our show today is simply this: Will Beijing live up to its promise? Our guests, Lawrence Lau, a professor of Economics at Stanford, and Alvin Rabushka, a senior fellow at the Hoover Institution and a co-author of the book, "Red Flag Over Hong Kong." Larry Lau tends to trust the mainland Chinese. Alvin Rabushka most certainly does not.

ONE MANDARIN, ONE VOTE?
ROBINSON: In an interview that Milton Friedman recently gave in Hong Kong, he distinguished among three kinds of freedom: Political freedom which means you get to vote for the people who rule you, Civil freedom which means that you get to talk, to express your views, freedom of association and so forth, and economic freedom which means you get to own property and buy and sell it at freely established prices. At midnight on June 30th when Hong Kong ceases to be a British colony and becomes a special administrative unit of the mainland Chinese government what happens to political freedom, Alvin Rabushka?

RABUSHKA: Well, political freedom that developed in the 1990's virtually disappears overnight. By way of background, one should note that up until the early 1990's, there was seen to be little reason to have democratic institutions, that is, widely and popularly elected legislatures. But as the transition approached, it seemed that Hong Kong people needed to have some kind of representation of their own as they were to be reabsorbed into China. What China has done is to announce it will dissolve this elected legislature...

ROBINSON: This is a formal announcement?

RABUSHKA: This has already been done, and they will put in place a new legislature they call the provisional legislature. Its people has already been selected, and that they will hold a new set of elections in 1998 to replace to those temporarily appointed people.

ROBINSON: For 150-some-odd-years Hong Kong was run from London, but I think you'd both agree, correct me if I'm wrong about this, I think you'd both agree in a benign manner.

LAU: Self-interested. Self-interested manner.

ROBINSON: Self-interested manner.

RABUSHKA: I would say exemplary manner.

ROBINSON: Oh, okay, so you wouldn't. But you don't disagree that for 150 years it was run from London? My question is, as a British crown colony, as of July 1st, will Hong Kong be run from Hong Kong or from Beijing?

LAU: I feel it will be run from Hong Kong, basically, except for two things: defense and foreign policy. And even under the British, the British controlled foreign policy and defense for Hong Kong, in any case.

ROBINSON: And Alvin?

RABUSHKA: Everything will be run under instructions from Beijing.

LAU: No, I think...

ROBINSON: That is the fundamental difference between you two.

LAU: But let me continue, going back a little bit. The entire civil servants is this: the very top Department Secretaries, in effect the bureaucrats, have all been retained, okay, CH Tung, the new Chief Executive for Hong Kong, appointed by or selected by this group, and he actually has announced. He is going to retain the entire top level of the civil service. And anybody in the civil service will be asked to stay on. And I think that is actually a good deal because among the civil service there are lots of people who have openly criticized China, very openly, and I think that tells you that for domestic Hong Kong politics, I think Hong Kong would be supreme. Now if Hong Kong wants to interfere in affairs in China, that is the same as people in Hong Kong now trying to interfere in the affairs of Britain, they would get in trouble.

RABUSHKA: I want to actually comment on that exact point, because in our book "Red Flag Over Hong Kong" we do a forecast as to the autonomy Hong Kong will enjoy. And the forecast is in the very short run after July 1 there will be the appearance of autonomy. Very soon thereafter there will be an erosion of autonomy and three years later it will be snuffed out almost completely. So carrying all of these cabinet secretaries through is consistent with this view that they do want to make it look like Hong Kong.

ROBINSON: Window dressing?

RABUSHKA: Well, yes, from my point of view, I believe Peking will see this as appropriate window/dressing to assure the people of Hong Kong to assure investors, but , it will be durable.

ROBINSON: Second category. Political freedoms. Larry says Hong Kong will be run Hong Kong. Alvin says "Oh, no. It will be run from Beijing." Now, what about the civil freedoms? When Hong Kong is run by the people who sent the tanks into Tienemen Square, what hope will there be for freedom of speech?

ROBINSON: Will civil freedoms be stomped down on? Larry?

TANKS FOR THE MEMORIES
LAU: I think they will not be. The amendments of the public orders ordinance was passed in 1995-1996. Before that, all demonstrations required a permit, as required permission. Now let me give you an analogy. I am not sure whether the June 4th demonstration would be permitted or not permitted, you know, but I would say that the IRA, if the IRA from Ireland were going to set up shop in Hong Kong and demonstrate against the British government, I am sure they would not be allowed. So I think you have to look at that certain power has shifted. That there are certain limitations.

ROBINSON: Alvin?

RABUSHKA: There is two points I think that need to be understood in order for us to really continue this in a, as productive as possible. First, the Basic Law which is the constitution under which Hong Kong will be administered...

ROBINSON: This was negotiated between the British and the.....

RABUSHKA: No, it was not negotiated. The Basic Law, in fact let me back up a little bit, the joint declaration is a document that the British and Chinese negotiated signed in 1984 which produced this promise of fifty years of autonomy and Hong Kong people ruling Hong Kong and having their own way of life. But the more precise details, the constitution of Hong Kong is something called the Basic Law. And the Basic Law is provided for under article 31 of the mainland Chinese constitution which provides for the creation of special administrative regions which is why the new government will be called the Hong Kong Special Administrative Region. It was a law passed by the National People's Congress of China on April 4, 1990. It is a law that can be amended, over-ridden, adjusted, changed, interfered with by the passage of another law by the National People's Congress. It is not a thing that can be blocked, interfered with or stopped by any act inside Hong Kong from a purely legal standpoint.

ROBINSON: You assent with all this? This is all factual?

LAU: This is all factual but there is no difference, Peter, from what had been before the early 90's because the British can override anything in Hong Kong.

ROBINSON: It is as if the American constitution were a subset or act of legislation in Ottawa, Canada, say, and all that you had to do was get a simple majority.

LAU: I do not think the constitution cannot be changed by simple majority, but what I am trying to say is that is exactly the same situation that Hong Kong had before the early 90's for 150 years.

ROBINSON: Okay, so it's no worse?

LAU: London could have done anything in Hong Kong without consulting anybody.

RABUSHKA: This is...

LAU: And I think was you really have to do is you have to decide is that...Alvin's argument can be summarized by three words, four words: He doesn't trust China. And I think that is why you look for guarantees and guarantees and so forth.

ROBINSON: Well, okay...

LAU: But, but, but people who don't trust China in Hong Kong, they left, they have left already, and the people who trust China they stay. So I think it really comes down to whether one should this play out: the prediction of three years...we have no history. I mean, this is the first time in the world that we have the formula "one country two systems" being implemented. Alvin doesn't think it will work. I think it will work out fine. And so we just have to see.

ROBINSON: Okay now economic freedom. Today Hong Kong's markets are among the freest in the entire world, but under Chinese rule?


BITING THE INVISIBLE HAND THAT FEEDS YOU
ROBINSON: The question is on July 1st, what will happen to the economics?

RABUSHKA: Most of it will remain in tact for awhile except cronyism, corruption and preferences to China state-owned firm is going to increasingly rule the day and what is going to happen is the level playing field is going to gradually give way to protection and favoritism and cronyism.

LAU: I really disagree with Alvin's characterization of a paternalistic, colonial attitude. You know, you should talk more to Chinese people in Hong Kong how they felt about British domination over this time. Anyway, that aside...

ROBINSON: Actually, that is a very important point. Is there resentment towards the British?

LAU: There is resentment for the British and Alvin just asked about special Chinese privileges, but if you look at what the British have enjoyed in Hong Kong, you know, the British firms, even the head of the American Chamber of Commerce a couple of weeks ago said in the International Herald Tribune, I think Mr. Hanks, he basically said, "Well, now that the British are gone maybe the privileged position of the British firms will disappear so we have a more level playing field because I think it is quite clear that the British enjoyed commercial advantages in Hong Kong by virtue of their being a sovereign power. I think there is absolutely no question of that. But, I mean there is a good article in Nicholas Christoff's in The New York Times, not usually friendly to China, whatever. But he said the following. He said, "What you have in China today is not Marxism and Leninism. He said it is Market-Lenninism."

ROBINSON: Market-Leninism?

LAU: Those are exactly his words: Market-Leninism. And what happens is that China in the last 18 years has completely transformed. The economy is now only 30% owned by the state. The other 70% runs...is basically in free-market principles.

ROBINSON: Right.

LAU: And the planned economy, if you look at how much of the transactions went through the plan, only about 10%.

ROBINSON: Alvin, address this point of Larry's, if you would, that damaging economic freedom in Hong Kong would violate the Chinese's own self-interest.

RABUSHKA: Um, China is not a homogenous single unit. What you have in China are a number of conflicting interests each of which have a different stake in Hong Kong from their own standpoint, whether it is the prosperous coast of Provinces, whether it is Peoples Liberation Army business units..

ROBINSON: Military..

RABUSKA: whether it is the Communist Party, whether it is the Reformers, whether it is the Old Guard, and generally speaking they all view Hong Kong as an asset in terms of what they can get out of it for themselves. But you know, there are some disturbing things that have occurred in Hong Kong recently. For example, businesses that are Chinese businesses in Hong Kong are not normal businesses. They are arms of state ministry, so for example, Civic Pacific is an arm of the Chinese State Consul...

ROBINSON: What is Civic Pacific?

RABUSHKA: Well Civic Pacific, for example, is a commercial holding group that recently bought..

ROBINSON: In Hong Kong?

RABUSHKA: In Hong Kong, that is an arm of the State Consul, it would be as though the U.S. Cabinet owned General Motors, and it recently bought a major stake in airlines at 20% discount to market. Now normally you buy control from somebody in the premium-to-market, never at a discount-to-market. It has just taken a big stake in Hong Kong electric. And what you are having is, and then China Resources is an arm of the Chinese Ministry of Foreign Affairs, and you have all of these Chinese companies in Hong Kong that are arm of provincial governments, local governments, state ministries, and these are going to have all kinds of favoritism and they are going to be able to buy control over Hong Kong utilities and major Hong Kong firms. They are already dealing at a discount-to-market -- this is the only place in the world where I know this goes on -- and you are going to have connections and cronyism and corruption and favoritism replace what has been much more of the open-market competition that has gotten Hong Kong rated number one by three separate world organizations on top of the Economic Freedom Index. I would be very comfortable telling you in three years Hong Kong will no longer be number one on anybody's economic freedom index largely because of corruption and because of increasing intrusion by companies that are arms and offshoots of Chinese government enterprises.

ROBINSON: Okay, bribery, cronyism, on and on, but will corruption remain a side issue or will it overwhelm Hong Kong's markets?

BAMBOO -ZLED?
ROBINSON: The Asian Wall Street Journal published an index ranking 53 countries by corruption. Hong Kong did pretty well, came out number 18. China came out in 49th place.

LAU: I can address that.

ROBINSON: Please.

LAU: There is no denying that there is corruption. But you have bigger corruption in the following way. Corruption depends on opportunities. Okay, so the more you have market operations, the less opportunity for corruption. Okay, like for example, Hong Kong is a free port. Okay, so there is no new point in bribing someone to input something because everybody else can input something. So a lot of the corruption that you see in different countries, China, whatever, really depends on the opportunities not on the morality of the people but on opportunities. If you look at Hong Kong was there corruption under the British? Plenty. I mean, that is why in 1976 there is an independent commission against set up totally independently of the government to investigate corruption in Hong Kong because there is huge corruption even among the British ex-patriots. I mean the Police Commissioners, lots of corrupt people. But what I am trying to say is that corruption will always stay but what you want to do is limit the scope, and you limit the scope by basically maintaining a market system because as long as government..

ROBINSON: But that has to be what Alvin is concerned about is that the corruption will overwhelm the market system.

LAU: No, but as long as you maintain a free port and you basically have the same public procurement, public option policies it is very hard to find room for corruption.

RABUSHKA: I think that is the point I am trying to make.

ROBINSON: Let me press you with this question then. The Chinese government, communist or not, at least officially they remain communist, has before as the example of Mikhail Gorbachev who attempted to reform who attempted to reform the Communist system now, by the way, no more Communist as far as I can tell than the Communists in Beijing, that is to say they didn't really believe the stuff anymore but they had become a corrupt ruling elite..

LAU: Right.

ROBINSON: They attempted to reform the Soviet Union, they lost control because free markets tend to develop a momentum of their own and their whole lives came crashing down and the Soviet Union collapsed. And so the argument be the Chinese will never make that mistake. They will get the economic freedoms under control and permit only so much as they believe will not compete with their own position as the rulers of the country.

LAU: True. I think most people in power would like to continue in power. That is quite clear. I would say that the corruption in China today is probably comparable to what went on in other countries in the earlier period where you have an autocratic government and so forth. It is not different. Nothing is changing precisely because the distribution of assets between the state sector and on the state sector has really changed radically. I mean, it was 100 percent in 1979 state owned. Now it is only 30 percent.

ROBINSON: So your point is corruption still exists but things are getting better and they are getting better quickly. That is your point?

LAU: Yes because I think it used that people had to bribe people to buy foreign exchange at low official rate. China unified exchange in 1994 and overnight the whole underground, all the bribery connected to foreign exchange disappeared.

ROBINSON: Alvin, let me ask you this. What exactly is it that you fear happening? You would agree with Larry that China is moving in the right direction. There are freer markets, right?

RABUSHKA: Certainly in economics, China has had major and dramatic and positive changes in the direction of moving away from state-controlled and state-directed, toward more and more letting markets determine prices and the allocations of goods and services and labor markets.

ROBINSON: But that not withstanding, it is still likely to swallow this utter jewel of Hong Kong.

RABUSHKA: I don't have to summarize what I fear very, very quickly. More or less, the Chinese will dictate in terms of critical life in Hong Kong. More or less traditional Western civil liberties will gradually disappear and I have sat around small tables of people who represent the absolute leading political elements in Hong Kong and they told me to my face Chinese don't care about civil liberties and Western freedom: they only care about making money. They have also told me to my face "that if we run into a problem with China we pick up the phone, we make a call, we settle it behind closed doors. We don't do it out in the open the way Westerners do it." And then when it comes to the economy, I think that people will preemptively rush to strike relationships with representatives of mainland companies to insure their connections are good, and as a result you are going to have almost a preemptive surrender of what is today a kind of ruthlessly open competitive into what I would call a kind of modified competitive economy where more or less you will have a preferential lot of people with good connections and then everybody else will be on their own.

ROBINSON: Okay, so Hong Kong becomes a corrupt society..

RABUSHKA: No, I would say, well, I think to say it is a corrupt society is too strong. What I would say is it will become a less competitive, less free, less open society, but on the economic front it will stay in tact longer and better than all of the other dimensions from political and civil it will come to look like China.

ROBINSON: It will become another lump of China?

RABUSHKA: It will become a southern, coastal city of China.

ROBINSON: I see, so it begins to approximate Shang Hai.

RABUSHKA: In ten years, it will look exactly like Canton. It will be indistinguishable in political and civil liberties terms.

ROBINSON: Now, what is the role of the United States of America in all this?

DEAR MADELINE
ROBINSON: Alvin, there is an article here in the "Weekly Standard" by someone who shares your views and concerns.

RABUSHKA: Ellen Bork

ROBINSON: No. C.M. Lee, in fact. Chairman of the Democratic Party in..

RABUSHKA: Oh, Martin Lee.

ROBINSON: Let me read you one sentence. "What shocks the people of Hong Kong as much as the appointed legislature, that is, the Chinese appointing their own legislature to replace the Hong Kong legislature, is the refusal of the United States and other democratic countries to object." My question is should we be objecting? What should the United States do in this circumstance? And if you object, by the way, do we have any military power in the theater with which to make threats plausible.

RABUSHKA: I can't unfortunately in the few minutes go into the details of what was involved in our book, but the conclusion we reached after some serious analysis is that if there is serious and carefully applied pressure by the global community, not the U.S. by itself, to China on matters of importance as it relates to things like civil liberties in Hong Kong, a level playing field and the like, the Chinese are likely to be responsive. This will only occur, however, if the rest of the world believes it is in its interest to do so and our analysis is the rest of the world does not see that it can succeed and therefore it will not do this, and mainly because of the view that it is not prepared to put at risk its relations with China with the China market, with the issues we have to engage China from nuclear weapons to Pacific security over what is going to become a purely internal matter for China.

ROBINSON: Briefly, you are advising Madeline Albright, you've got about two sentences in which to do it. What should be her..

RABUSHKA: She should call together the G7 and the everyone else and they should work out a list of priorities that matter to them and they should make their opinions plain and mobilize international business to support them when it counts.

ROBINSON: Larry, what should the United States do?

LAU: Well, I think I would say that I would go more behind the door because I think Chinese does not react well to public pressure, and I think behind the door explaining our interests would probably be much more effective. I think Martin Lee unfortunately is in the Democratic Party and he chose not to apply to stay in the position in legislature but I am very confident that the new legislature that will be elected will become very soon, as soon as practical after July 1, 1997, and I am quite sure that Martin and his group will be allowed to contest...

ROBINSON: They will not be thrown into jail?

LAU: No, everybody will be allowed to contest and they would be the market test, you know, whether they can be elected in such numbers or..

ROBINSON: My closing question is to get your predictions. Now correct me because I am giving you statistics as I found them on the net. The Hong Kong dollar is pegged to the U.S. dollar at the exchange rate of 7.8 Hong Kong dollars to one American dollar. A year from now, what will the exchange rate be? Alvin?

RABUSHKA: Could be higher, could be lower, probably the same.

ROBINSON: Larry?

LAU: I think it would remain the same. Let me give you a piece of evidence. I looked at some of the freer markets, you know, five years, ten years, and looked at the difference between the U.S. rates and the Hong Kong rates. You know that usually tells you the movement. And the implied movement is about a half a percent per year. If it goes down at all, you know, it will go down by half a percent a year which is really nothing. That is in the risk premium. So I think Alvin's answer is actually right. I think it will stay put, but it could be higher and could be lower.

RABUSHKA: When Alan Greenspan starts raising interest rates by say a quarter or a half up to three-quarters, and asset values in Hong Kong fall sharply from property and stocks, there is going to be some Chinese who are going to think that Alan Greenspan is interfering in the internal affairs of China, and that to have asset values in Hong Kong determined by what Alan Greenspan does would be regarded as unacceptable, and therefore..

ROBINSON: Be regarded from Beijing as unacceptable?

RABUSHKA: Correct, and I think they might even go so far while staying within the precise language of Hong Kong law, fix the Hong Kong dollar to the RENMINBI.

ROBINSON: Which is?

RABUSHKA: Which is the China currency, and the Basic Law doesn't stipulate what currency it will be fixed to.

LAU: But let me say this though. I think the Chinese leadership understands that for the sake of confidence they have to fix this peg. And that is really why I think that in five years I don't see any problem in changing.

ROBINSON: Okay. Let me ask one other question. We began with a question of economic freedoms. Political, civil and economic? Now my own judgment according to that cluster of freedoms, here is Hong Kong. Considerable political freedom, considerable civil freedom and wild, wildly open economic freedom. Here is Sheng Hai. Five years from now does Hong Kong move here, does Sheng Hai move here? Alvin, give me your fingers. Adjust my fingers. Hong Kong drops. Larry?

LAU: I think Sheng Hai will move up.

ROBINSON: And you think Sheng Hai will move up?

LAU: I think Hong Kong if anything happens will revert back to early 90's.

ROBINSON: Dr. Larry Lau, Dr. Alvin Rabushka, thank you very much.

LAU: Thank you.

ROBINSON: What will happen in Hong Kong? The coming years will say, of course, but this much is clear right now. China at the beginning of this century, a broken, divided country is now a rising power, and China will do what it wants in Hong Kong. There is very little that London or Washington can do but watch. I am Peter Robinson. Thanks for joining us.