Hong Kong Land for Hong Kong People : Fixing the Failures of Our Housing Policy [1 ed.] 9789888313044, 9789888208654

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Hong Kong Land for Hong Kong People Fixing the Failures of Our Housing Policy Yue Chim Richard Wong

Hong Kong Land for Hong Kong People

Hong Kong Land for Hong Kong People

Fixing the Failures of Our Housing Policy

Yue Chim Richard Wong

Hong Kong University Press The University of Hong Kong Pokfulam Road Hong Kong www.hkupress.org © 2015 Hong Kong University Press ISBN 978-988-8208-65-4 (Hardback) All rights reserved. No portion of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage or retrieval system, without prior permission in writing from the publisher. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

10 9 8 7 6 5 4 3 2 1 Printed and bound by Paramount Printing Co., Ltd., Hong Kong, China

For my dearest children, Michael and Christina

Contents

List of Illustrations Preface

ix xi

Section I: Hong Kong Housing Policies over the Years 1.

Time to Count the Social Cost of Uniting a People Divided

3

2.

Setting the Scene: An Overview of Long-Term Housing Strategies in Hong Kong

7

3.

Supply and Demand Factors in Housing

17

Section II: People, Public Housing, and Serfdom 4.

On the Nature of Public Sector Housing Policies in Hong Kong

27

5.

Comparing Public Sector Housing Policies in Hong Kong and Singapore

35

6.

Equal Yet Unequal: The Occupants of Private and Public Housing Units

41

7.

The Inequity of Small Housing Units

47

8.

Small Housing Units and High Property Prices

57

9.

On Public Housing Policy and Social Justice

65

10.

Economic and Social Consequences of Public Housing Policies

73

11.

Demand for Homeownership and the Housing Ladder

77

12.

How to Warm Up the HOS Secondary Market

83

13.

Divorce, Remarriage, and the Long-Term Housing Strategy

91

14.

Divorce, Inequality, Poverty, and the Vanishing Middle Class

99

Section III: The Wider Economic Influences on Housing Policies 15.

The Impact of Global Economic Forces on Housing in Hong Kong

107

16.

The Linked Rate, Domestic Stability, and Dual Integration

115

17.

Reasons for Keeping the Linked Rate

123

18.

Why Speculation Is Not a Bad Thing

131

viii

19. 20.

Contents

Speculators, Property Agents, and the Spreading of Risk in the Presale Housing Market

137

How the Application List System Became the Winner’s Curse

143

Section IV: The Political Economy of Land Use 21.

Is There a High Land-Price Policy in Hong Kong?

151

22.

Lima’s Other Path, Tsoi Yuen Village, and the Northeast New Territories

157

23.

Stranded between Singapore’s Way and Lima’s Other Path

165

24.

Subsidized Housing and Stability: Lessons for China

171

25.

Diversity and Occasional Anarchy: Land, People, and Growth

179

26.

Population, Poverty, and the Triumph of the City

183

Section V: Creating a City of Homeowners 27.

Eighty Percent Homeownership (Part 1): A Cost-Free Solution

191

28.

Eighty Percent Homeownership (Part 2): Benefits and Challenges

199

29.

Conclusions and Reflections

207

Epilogue: Homeownership and the Youth Protest Movement

215

Illustrations

Figures 2.1 8.1 9.1 13.1 13.2 13.3 13.4 14.1 14.2 15.1 15.2 15.3 18.1 21.1

Number of domestic households and housing units 10 US real home prices, 1890–2013 (with building costs, population, and longterm government bond interest rates added) 58 Real per capita GDP in Singapore and Hong Kong (including projected Hong Kong real per capita GDP), 1965–2010 (normalized to 100 in 1965) 67 Increases in housing supply equal increases in demand 92 Increases in housing supply fall behind increases in demand 93 Growth of single-person households 94 First marriages, divorces, and remarriages 95 Number of divorced and separated men per 1,000 households by housing tenure 100 Number of divorced and separated women per 1,000 households by housing tenure 100 Real property price inflation rates and real interest rates 109 CPI and GDP deflator inflation rates 110 Cumulative annual percentage change in selected foreign exchange rates against the Hong Kong dollar 111 History of Hong Kong property prices and real estate market interventions, 1980–2011 133 Property price index and tender price index, 1979 Q4–2013 Q1 152

Tables 2.1 3.1 4.1 4.2 4.3 5.1

Summary history of public housing 11–12 Characteristics of non-elderly one-person household applicants on the public rental housing waiting list 21 Number of public sector housing units produced, 1954–1974 28 Percentage of households by type of housing and occupancy, 1971–2011 31 Original sales price and 2011 market price of HOS units (per square foot) 32 Households by type of dwelling and tenancy in Singapore, 2000–2010 38

x

6.1 6.2 7.1 7.2 7.3 7.4 12.1 13.1 16.1 24.1 26.1 27.1

Illustrations

Percentage of public and private tenants and homeowners by income deciles, 1976–2011 42 Number of domestic households and housing units 45 Median size of existing stock and new supply of housing units by type, 1980– 2010 (in square meters) 47 Domestic households living in private residential flats by types of quarters, 1981–2011 49 Subsidy and benefit per household per month, and the efficiency ratio of the public rental housing program, 1976–1996 53 Percentage of households with positive benefits and positive gains in housing consumption 54 Estimated stock of units with unpaid land premium in the HOS secondary market, 1998/99–2012/13 90 Housing tenure of married and divorced individuals, by sex (in thousands) 96 Friedman’s foreign exchange trichotomy 118 Comparison of GDP per capita and labor force in emerging economies 172 Population rank of selected metropolitan areas 187 Eighty percent homeownership and the distribution of households by housing tenure with adoption of the proposed New Subsidized Housing Scheme, 2011–2023 196

Preface

This is my second collection of essays on social and economic affairs in Hong Kong. In this volume I focus on land, property, and housing issues, which I began to study 30 years ago. As my understanding has grown over the years, I have concluded that land, property, and housing are the central factors impacting economic growth and economic equality in Hong Kong. Moreover, they are relatively easy to put right. I believe that doing so will bring considerable immediate political benefits for our society as well as longer-term economic and social benefits, and it will help to address one of Hong Kong’s deep economic and social contradictions: the need to accommodate the conflicting requirements of dual integration with the global economy and the economic opening of the Chinese Mainland. I will explain how a simple set of policies that requires hardly any new resources, creates no losers, contributes to economic growth, promotes economic equality, and fosters social harmony and political stability can address Hong Kong’s deep contradictions. All the government has to do is to sell public rental housing units to the sitting tenant, provide a more generous subsidy through land premiums, and reform the public sector housing program along the lines of the Singapore Housing Development Board’s approach. Adopting these policies would release valuable public resources now committed to housing development that can be used to address other pressing issues, such as health care, that an ageing population needs badly. Over the years I have spent considerable time explaining my ideas and analyses to politicians, officials, legislators, opinion makers, other academics, entrepreneurs, property developers, and ordinary people. I have received two types of reactions. There are those who do not like my ideas because they think half of society (the haves, I presume) would not agree to give the other half (the have-nots?) such a big free lunch. But they fall silent when I tell them the capital gains reaped by the haves in the past decades have also been free lunches. Some tell me my ideas have been tried before and many tenants are not interested in buying their units. But they fall silent when I tell them previous attempts have not allowed tenants to sell the unit they owned on the open market without first settling

xii

Preface

an exorbitant unpaid land premium, which effectively taxes away most of the capital gains they achieved. Others tell me managing an estate with owners and tenants is complicated, that, in short, my ideas are troublesome to put into practice. But I have not found out what exactly are these difficulties they mention. In the private housing estate where I live, there is also a mixture of owners and tenants. I suppose the housing managers must consider the residents a rather nasty bunch to deal with, especially when it is time to negotiate management fees. Then there are those who say they like my ideas and agree with my analysis. I hope they will get to implement them and overcome the opposition and vested interests before it is too late. The first of the essays is an article I wrote in 1997, when I was asked to reflect on the challenges and opportunities that Hong Kong would face after the handover. At that time, I thought there were four challenges, and I chose to write about two of them: housing and population. Sadly, the concerns I raised then have not been addressed, and the challenges they bring to Hong Kong have deepened. This book focuses on the challenge of housing. The population challenge, and specifically the issue of immigrants from the Mainland, has to be taken up in a future publication. In preparing this collection of essays I am fortunate to have the unfailing support of Ms. Kathy Griffin to help me edit my drafts and turn them into the clear, crisp manuscript you see today. Dr. Tsui Sio-Ming, my former University of Chicago schoolmate and apartment mate, translated my first drafts into Chinese and provided numerous editorial improvements. Ms. Ginnie Tsoi Sio-Wai provided superb research support in finding information and analyzing data at very short notice. Mrs. Diane Law managed the production process in getting these essays edited and completed. Mr. Chan King-Cheung of the Hong Kong Economic Journal and his editors worked on the drafts that I first published in their newspaper. Two anonymous referees provided valuable comments and suggestions for improvement. The South China Morning Post gave kind permission to reproduce an earlier article of mine in this volume. The Hong Kong Centre for Economic Research provided invaluable support and sponsorship for this project. This work would not have been possible without the enormous sacrifices made by my family. My wife, Jane, and two children, Michael and Christina, had to endure long periods of my absence and silence in order for me to finish each draft. To you all, I thank you from the bottom of my heart. Yue Chim Richard Wong May 2014

Section I Hong Kong Housing Policies over the Years

1 Time to Count the Social Cost of Uniting a People Divided

May 1997 The world’s interest in Hong Kong in the months ahead will be focused on the political transition that will take place. As Hong Kong comes under the political microscope, every event and act will be scrutinized for clues about whether the promise of “one country, two systems” will be honored and, indeed, survive the 50 years guaranteed by the Joint Declaration and enshrined in the Basic Law. By any yardstick, 1997 will be a significant year for the future of both Hong Kong and China. However, the economic and social forces unleashed in 1979 in China’s open door policy and Hong Kong’s response to them may ultimately determine our fate. China’s opening has had a momentous and highly visible impact on Hong Kong. Within a span of 18 months between 1978 and 1980, some 300,000 individuals crossed the border into Hong Kong. The impact on labor market conditions was swift. Real wages failed to grow for several years, but Hong Kong’s labor-intensive manufacturing industries received a new lease on life as competitiveness was restored with the injection of a new army of workers. Nevertheless, the sudden influx quickly led to an agreement between Chinese and Hong Kong authorities to regulate and limit the flow to 75 individuals per day as a result of public concern over the consequences to labor markets, social-educational provisions, housing, health care, and infrastructure services. Although the number of one-way entry permit border crossers has been increased to 150 over time, illegal flow continues to be a permanent problem. The fear of population inflows from the Mainland is a cause of anxiety to many local residents. However, there is a clear difference in the attitudes of capital and labor towards such inflows. The fact that everyone in Hong Kong must carry an official identity card at all times and police are empowered to check it in public is a constant reminder to all that political factors are not the only threats to civil liberties. The opening of China began to have a more perceptible impact on the economy as our manufacturing base migrated northwards across the border. At its peak, our manufacturing enterprises employed some 900,000 workers in Hong Kong. Today,

4

Hong Kong Land for Hong Kong People

they reportedly employ as many as 6 million workers on the Mainland and fewer than 250,000 in Hong Kong. These changes have important social dimensions that have had an enormous impact on the lives of individuals and families in Hong Kong. As many as 500,000 workers have had to seek new jobs in service industries due to the loss of manufacturing jobs, and many of those workers are middle-aged. Organized labor in Hong Kong has since found an enduring agenda in hostility to free-market labor inflows—an alien concept throughout the history of Hong Kong—where most inhabitants before the war were sojourners and those after the war first-or second-generation immigrants. Today, hundreds of thousands of individuals in our workforce commute regularly across the border to work on the Mainland, and millions from Hong Kong enter China every year for short visits. As social and economic contacts continue to grow, a rising number of marriages are taking place between Hong Kong and Mainland residents. The presence of draconian laws to limit the flow of individuals from China into Hong Kong has created a heartrenching phenomenon. An increasing number of families now have members who are forced to live apart for years, separated by a border. The sight of children and mothers torn from their loved ones and forcibly repatriated to the Mainland is a familiar one on television. They, too, remind us that civil liberties are not limited to politics. The human cost is immense today. Tomorrow it will be even more staggering as numbers and the prolonged agony of those waiting to be united keep growing. It is inconceivable how people living in two economies and societies so close to each other with such intense contact will fail to develop closer ties and relations. Divided families lead eventually to a society of alienated individuals, fostering social divisiveness. The day of reckoning for Hong Kong will arrive when the social pressures of a distorted family life, a lonely and isolated childhood, maladjusted youth, and lasting memories of despair, humiliation, anxiety, and unfulfilled promises finally erupt in full force. Hong Kong will pay dearly for its current policies to regulate and limit population inflows. I cannot imagine how any amount of social welfare spending can heal the scars from these self-inflicted wounds. And if society erupts, the civil liberties and economic freedoms that are so dear to Hong Kong will fall by the wayside to be eclipsed by a culture of authoritarianism, paternalism, and social welfarism. If these views appear to be alarmist, it is useful to remind ourselves that not too long ago we witnessed a sort of pre-staging that took the form of the “great society” undertakings of former governor, now Lord, Murray MacLehose, who took charge of Hong Kong in 1971 in the wake of the civil disturbances of 1967–68. Even if society does not erupt dramatically with deft management, the drift towards the great society will be difficult to resist.

Time to Count the Social Cost of Uniting a People Divided

5

In contrast to the worrying social forces that have been released by the opening of China, the economic impact on Hong Kong is far more positive. The enormous complementaries between the Mainland and Hong Kong have created numerous opportunities for economic cooperation to the benefit of both Hong Kong and the Mainland. These developments are so well known to the people of Hong Kong that any further elaboration here would add little value. Nevertheless, the huge economic strides made by Hong Kong have a price. Inflation is now a permanent feature of an economy that is always operating at full capacity, even during cyclical downturns. The capacity constraint is to a large measure a result of the policy to regulate and limit the inflow of population and labor from the Mainland. The damaging effects of inflation are most serious in its impact on savings. Families in Hong Kong have little choice but to buy property as a means to protect their savings, thereby further fueling property prices in a market already suffering from severe shortages. Property ownership today divides society into the “haves” and “have-nots”; and the gulf that separates them appears to be ever widening. This, too, is socially divisive. Fortunately for Hong Kong, there is a choice that could take us a long way towards alleviating these social pressures. I have long supported a plan to sell the existing stock of public housing to sitting tenants as a solution to many problems. The sales must take place at prices well below market levels, and tenants must be allowed to have the right to transfer the unit on the free market and to keep any capital gains that arise from the sale. Today this proposal is even more relevant and urgent. More than a third of our households live in public housing, so privatization would provide them with a genuine asset that could be an effective hedge against inflation. The asset could be used as collateral for financing business activities, as an annuity to provide for old age retirement, or as a bequest to loved ones. At one strike and at almost no cost to society, the inseparable gulf between the haves and the have-nots would be largely eliminated. As Hong Kong becomes a predominantly propertied society, the hostility of local residents toward immigrants will be greatly reduced. The arrival of immigrants will be perceived to enhance property and capital values and not to depress wages and take away jobs. I believe our government should announce a clear, credible policy to allow spouses and children to arrive in Hong Kong after July 1 any time they wish. It need not trigger an immediate rush into the city. Most parents are, after all, responsible individuals who will not send for their dependents until arrangements for settling them in Hong Kong have been made. In the longer run, such a policy would also enhance the attractiveness of local residents as marriage partners for Mainlanders, while Hong Kong would be able to

6

Hong Kong Land for Hong Kong People

attract better-quality immigrants through marriage. Indeed, Hong Kong has much to gain from a long-term policy to reunite separated families. If these proposals sound incredible, then it is only that too many of us are overwhelmed by the idea our public housing, public education, public health care, and public welfare services will be stretched to their limits in the short run. It is useful to refresh our memories to the time when 300,000 individuals crossed the border into Hong Kong over an 18-month period in 1978–80. The economy and society adapted very well to that sudden shock. Similar episodes have existed throughout the postwar period in Hong Kong’s history, and we have always handled it well, even when the resources that were at our disposal appeared meagre by current standards. Perhaps the real problem lies with the way in which we view our housing, education, health care, and welfare services. It is a mistake to believe that individual problems are always and everywhere a public responsibility. This is a false premise that Hong Kong must shake off if we are to avoid being overwhelmed by the challenges of managing population and labor inflow. Otherwise, we will be permanently condemned to holding the floodgates to a raging torrent. Our puny efforts to devise interim solutions to control the inflow will eventually corrode the foundations of our free economy and open society. In the final analysis, they will also be futile, inhumane, and self-defeating. We should, on the contrary, make provision for Hong Kong to develop as a metropolis with a population that is much larger than is currently contemplated in official forecasts. And we should privatize our public housing units to help our residents become a propertied class. In doing so, we will soon be gladly welcoming all those who have a legitimate and humanitarian claim to be here. (Reprinted from the South China Morning Post, May 19, 1997, p. 12.)

2 Setting the Scene An Overview of Long-Term Housing Strategies in Hong Kong

The aim of this book is to propose a better approach to housing provision in Hong Kong and the social and economic benefits that this could bring. But before considering the options and aims for a new long-term housing strategy, we have to consider how Hong Kong got to where it is today. The history of Hong Kong’s housing strategy in the postwar era—and the one we still pursue—is best described as a massive attempt by government to provide rental shelter and homeownership (or more accurately pseudo homeownership) for the population. Most people in Hong Kong are so accustomed to this provision that they hardly stop to think about what the government’s role in housing should be. Should it continue to build more rental shelters and pseudo-homeownership units? What is the proper balance between publicly and privately provided housing? And more importantly, how does a housing strategy fit into the economic, social, and political development of Hong Kong for the long term? I believe Hong Kong’s long-term housing goal should be to provide a mixture of public and private units so that at least 80% of permanent residents can become bona fide homeowners. This 80% represents an advancement over the missed targets for homeownership previously proposed by the government, of 60% by 1997, in A Review of Public Housing Allocation Policies (1984) and of 70% by 2006, in the Ten-Year Housing Plan (1998). The rest of the population, including visitors, can rent housing on the open market. I will explain why this approach is justified for Hong Kong. I will also propose a strategy to achieve this goal quickly and to the advantage of all.

Brief History of Misguided Government Policies In most countries, governments are not involved in providing housing, and certainly not on the scale of Hong Kong, where some 50% of the population live in public housing units. This is a postwar phenomenon: until 1954, the Hong Kong government was not involved in building homes. The decision to adopt such an approach was the product of a set of unique circumstances and misguided government policy in the immediate postwar years.

8

Hong Kong Land for Hong Kong People

First, housing supply could not be easily increased at that time. Private developers faced formidable constraints in redeveloping the urban housing stock. Rent control imposed on prewar housing in 1947 made it difficult to evict tenants for redevelopment. Second, the massive influx of immigrants increased the population from 600,000 in 1945 to 2.3 million in 1951 and led to an explosive growth in demand for housing. No society in peacetime had experienced such a phenomenon. It was a unique situation. Land available for development was invaded by about 300,000 squatters seeking alternative housing from the old private tenement apartments. Third, the government was initially reluctant to facilitate housing development despite intensive lobbying from private business interests. There was general hostility towards private developers, many of whom took part in building squatter housing. The government therefore became a provider of public housing by default. This path may have been motivated in part by public relations reasons, to put a humanitarian face on its actions to clear squatter housing, but this secondary reason subsequently became the main justification for the continued growth of the public housing program. After the social disturbances of 1967, the public housing program became the centerpiece of a policy to restore public confidence and calm the community. There could have been other strategies, but these were not explored. Singapore, for example, saw public housing as an instrument of land reform, the foundation for a socialist vision of society, and a nation-building tool of the People’s Action Party to capture the hearts and minds of the people. In 1959, fully six years before Singapore became an independent nation, Lee Kuan Yew created the Housing Development Board very shortly after being elected prime minister. In another example, the city of Lima, Peru, decided against building homes for rural migrants and simply chose to tolerate their presence in shantytowns after it became politically infeasible to get rid of the newcomers and their settlements. Ultimately, the Peruvian government learned to appreciate the broader social, economic, and political benefits of allowing the squatters to gain legal titles to the shantytown property that they had illegally occupied and developed. Economist Hernando de Soto saw legalization of land and property titles in the shantytowns as part of an economic answer to the terrorism in Peru. Hong Kong’s housing strategy has lacked any such forward-looking goals. Moreover, it is characterized by a high level of government involvement in the housing market.

Supply-Led Development in the Early Years Usually the number and type of housing units a society builds are determined by demand and supply conditions. Increases in population, income and the number of

Setting the Scene

9

households, and changes in business cycle conditions, can all affect the demand for housing. Changes in building costs (including construction costs for labor and materials), planning and building regulations, the politics of development, compliance with environmental restrictions, and so on can affect the supply of housing because of their potential to cause long and uncertain delays that affect the time needed to build new units. Most societies leave these decisions to the market, where developers and contractors can make huge profits or losses (and even become bankrupt), depending on whether they make good or bad forecasts of demand and supply conditions. This is a hazardous business, especially over the long term. The list of failed private developers, in Hong Kong and elsewhere, is very long. Fifty years ago Hong Kong had a thousand developers; overwhelming numbers of them have since gone out of business. But in addition to these market factors, the Hong Kong government has become unavoidably involved in the business of forecasting the demand for housing because it is the monopoly supplier of land and the predominant provider of housing. As land supplier, the government need not have become a supplier of housing, but it ended up in this role for reasons that I have mentioned and shall elaborate on in this book. Since 1954, the government has been the undisputed hegemon in property development. Unlike private developers, the government does not face financial losses or profit rewards for the accuracy of its forecasts. Good and timely forecasts are sometimes rewarded with political praise; bad and mistaken ones draw political condemnation. Praise and condemnation are, however, blunt instruments for motivating government officials to deliver performance. In the three decades from the mid-1950s to the mid-1980s, the government had a pretty much effortless task in making demand-side forecasts. Because of a severe chronic shortage of housing units, planning could be conveniently approximated by the excess number of households over the number of housing units. The figures in Figure 2.1 show that, in 1971, the ratio of domestic households to permanent housing units was 1.27. The ratio fell to 1.02 in 1986 and then to 0.92 1991. The ratio has since remained within the range of 0.98 to 0.93 despite considerable variations in supply and demand conditions.

Demand Starts to Matter The planner’s problem until the mid-1980s did not require forecasting the many complex factors that drive market demand. Rather, the job was to fix a supply shortfall based on a simple arithmetic rule: count the number of housing units in supply, and drive the ratio of domestic households to permanent housing units to slightly above one. The aim of the long-term housing strategy was to determine how long it would

10

1.30

Hong Kong Land for Hong Kong People

1.27

Domestic households per housing unit 1.20 1.14 1.10

1.10

1.02 1.00 0.92

0.93

1991

1996

0.90

0.89

0.90

0.91

2001

2006

2011

0.80

0.70

0.60 1971

1976

1981

1986

Figure 2.1 Number of domestic households and housing units Source: Robert J. Shiller, Irrational Exuberance, 2nd edition (Princeton: Princeton University Press, 2005; Broadway Books 2006), as updated by author.

take for government to achieve this goal, so the only constraints on the accuracy of the forecasts were on the supply side. The demand side could be totally ignored. This was a planner’s ideal environment. The government, however, failed to deliver its targeted number of housing units. Under Governors Robert Black and David Trench, it was supposed to supply 220,000  units in the period 1964–73, and under Governor Murray MacLehose to supply 350,000 units in the period 1973–83. Both plans famously fell short of their targets by about half (see Table 2.1).This did not bode well for government long-term housing strategies after the mid-1980s, which depended on accurate forecasts of both supply and changing demand conditions. But until then, the severe chronic shortage of housing units in effect meant that accurate demand-side forecasts were unimportant. It was not possible to get it wrong because demand was unsatisfied and the correct thing to do was simply to increase supply. And since the market was not producing housing units fast enough, the government decided to build them. The public provision of housing units year after year was driven only by supply. When the supply fell short of the target, another plan would be put in place. This practice continued even after the mid-1980s, when such a strategy had outlived its use and the number of housing units exceeded the number of households. At that point, demand ceased to be simply a matter of counting households. Business cycle effects

1985–2001 Youde, Akers-Jones, and Wilson

Mid-Term Review of the Long-Term Housing Strategy (1993)

Long-Term Housing Strategy (1987)

A Review of Public Housing Allocation Policies (1984)

Ten-Year Housing Program (1972)

1997 60% ownership

1993–2001 343,200 public units built

1985–2001 1,085,000 public and private units built 1985–93 605,600 public and private units built

350,000 public units built

1997 46.6% ownership (continued on p. 12)

1985–93 350,000 public and 262,000 private units built

Net increase in persons housed was 669,000

177,000 public rental and 23,000 HOS units built

1,535,000 persons housed

1973–83 MacLehose

1,000,000 persons rehoused

240,000 persons allocated Low-Cost Housing

600,000 persons resettled

Housing Outcomes

1,980,000 persons rehoused

Review of Policies for Squatter Control, Resettlement, and Government Low-Cost Housing (1964)

1964–73 Black and Trench

Housing Targets

Major goal to resettle squatters, minor goal to provide low-cost housing for 500,000 persons resettled financially disadvantaged people

Policy Statement

1954–64 Grantham

Period / Governor or CE

Table 2.1 Summary history of public housing

11

Review of the Institutional Framework for Public Housing (2002)

Ten-Year Housing Plan (1998)

Long-Term Housing Strategy Review (1997)

Policy Statement

32,000 public and 23,000 private units built per year 2007 53.1% ownership

50,000 public and 35,000 private units built per year 2007 70% ownership No targets announced

1997–2007 50,000 units built per year

Housing Outcomes

2001–06 39,000 public and 34,000 private units built per year 1997–2007 85,000 units built per year

1995–2001 54,000 public and 31,000 private (See note.) units built per year

1995–2006 47,000 public and 23,000 private units built per year

Housing Targets

Note: This table summarizes the historical development of Hong Kong public housing programs conveniently divided into sometimes overlapping periods, from Governor Alexander Grantham to Chief Executive Tung Chee Hwa. It provides an outline of every housing plan announced by government and the main goals and outcomes.The period 1995–2006 under Chris Patten was short-lived and quickly superseded by Tung Chee Hwa’s era.

1997–2007 Tung

1995–2006 Patten

Period / Governor or CE

12

Setting the Scene

13

and the formation of new households became incredibly important in determining the demand for housing units. The number of adult children who wanted to leave the old household and the number of couples who wanted to divorce now mattered. The challenge was no longer simply one of meeting housing production targets, as  in the 1950s to 1980s. An even more important task was to set the criteria for allocating units to households. And what a mess that turned out to be!

Competing Objectives From the 1980s, there have been three incompatible objectives in the government’s housing strategy: the resettlement objective, the income support objective, and the homeownership objective. These have continued to create problems to this day. The resettlement objective was a response to squatter clearance and did not require means testing. Although urban squatters have largely been cleared, the problem of rural squatters continues to be troublesome for the government’s development plans in the New Territories. The income support objective aims to help poor households obtain decent shelter. Yet many households in the public housing program are quite well-off, and many living in the private housing market are quite poor. Progress in recovering public housing units from well-off tenants in order to make more of them available to private housing tenants in need has not only been slow, but it has also become hugely expensive. More than half of the Homeownership Scheme (HOS) units are allocated to public housing tenants as an incentive for recovering the units they occupy, which they are not keen on surrendering. Without a market for public housing units, it is difficult to rectify the widespread misallocation of public housing resources created by the two incompatible objectives of resettlement and income support. This situation started becoming apparent in 1987, when the Long-Term Housing Strategy was being prepared by Governor Edward Youde, Chief Secretary David Akers-Jones, and Governor David Wilson. The severe chronic shortage in housing was gradually being alleviated as more public and private units were built. But the supply shortage problem was replaced by a more complex and diverse set of supply and demand factors. The effects of rent-control legislation were also fading as the share of prewar housing units in the total housing stock declined over time. Private developers were returning to the market. The annual production of public and private housing units was about the same, but economic growth and the rise of the middle-income class created a growing demand for better-quality and larger private housing units. At the same time, it was becoming more difficult to determine the proper balance between public and private housing units because clients in both sectors

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Hong Kong Land for Hong Kong People

aspired to be homeowners. Their incomes overlapped to a considerable extent: many well-off households in the public sector, and many poor households in the private sector. The homeownership objective aimed to address the situation by increasing the rate of homeownership in the community. The Long-Term Housing Strategy (1987) wanted to achieve a 60% homeownership rate by 1997. This was revised to 70% by 2007 in the Ten-Year Housing Plan (1998). Both targets have been missed. The actual homeownership rate was 35.1% in 1986, 44.5% in 1996, 52.8% in 2006, and 52.1% in 2011. Over the past 25 years, the homeownership targets have slipped both when the private housing market was bullish and when it was bearish. When markets are bullish, buying homes becomes unaffordable, and when the market is bearish, nobody is interested in buying homes. The Long-Term Housing Strategy (1987) reflected a realization that important changes were happening in the population’s demand for housing. Most importantly, the housing strategy envisaged both public and private housing units playing significant roles in meeting housing goals. By incorporating private units into the housing strategy, the role of market demand became relevant and important for meeting housing goals because, at the end of the day, the number of private housing units supplied would depend on whether developers could make a profit from them. The government’s original planning horizon was from 1985 to 2001, even though its strategy was released in 1987. But it could not have anticipated the dramatic events that were soon to unfold. The rising demand for homeownership and private property as an investment asset in the period after the mid-1980s coincided with the globalization of the world economy. Subsequently, the rapid growth of the Chinese economy beyond all imagination and the onset of the Asian financial crisis and the global financial tsunami together made government forecasts of housing demand largely irrelevant. Private property prices surged by 332% from 1989 Q3 to 1997 Q3, then plummeted by 65% from 1997 Q3 to 2003 Q3, then rose again by 314% from 2003 Q4 to 2013 Q4.

Tung’s Unfortunate Timing Combining market and planning forecasts to achieve multiple long-term housing objectives, such as efficiency, equity, and homeownership, became a nightmare compared with the previous strategy of setting quantitative targets to provide relief for severe chronic housing shortages. Planners everywhere have difficulty delivering strategies with multiple objectives. In Hong Kong’s housing arena, it is even more difficult because of the long and variable development lags and wildly fluctuating market demands.

Setting the Scene

15

And let us not forget that, even in the simpler days of the 1950s to 1980s, when planners had to worry only about supply and not demand, the proposed targets were still missed. They fell short by about half! By the time Chris Patten and Tung Chee Hwa got into the business of addressing Hong Kong’s housing situation, the problem had changed enormously. In the decade before the restoration of sovereignty, housing demand outstripped supply for many reasons, but not because there were more households than housing units. China’s opening and the migration of manufacturing across the border had created enormous wealth in Hong Kong. Inflation here reached double-digit levels brought on in part by a weak US dollar. Real interest rates were negative, and property prices famously shot through the roof as households across the city invested in property and became homeowners. The labor market was so tight that some businesses were buying homes for their staff, to prevent them from leaving. Households wanted better housing, to own their own homes, to own more than one home, and to invest in property. Therefore, although the housing production targets of the 1987 housing plan attributable to Youde, Akers-Jones, and Wilson were successfully achieved, they fell short of the rising housing demand. In the wake of this, Tung Chee Hwa developed his Ten-Year Housing Plan (1998), which unfortunately was unveiled just after the onset of the Asian financial crisis. Tung’s housing plan was in fact quite similar to Governor Patten’s earlier proposal. Ironically, unlike the plans under Black, Trench, and MacLehose, the public housing targets under Tung’s plan were executed with more success than that of his predecessors under the leadership of two highly determined and skilled individuals: Rosanna  Wong, Chairman of the Housing Authority, and Tony Miller, Director of Housing. The lesson from all this is that the task of developing a long-term housing strategy must incorporate both demand and supply factors once the number of housing units is greater than the number of households. It is not enough to look alone at the supply side, as early housing plans had done. But what are the dangers of devising a longterm housing strategy today? What should be the goals? These are vital questions that will determine not only the housing situation but the economic and political future of this city.

3 Supply and Demand Factors in Housing

The goals and tasks of a long-term housing strategy in which the number of housing units is greater than the number of households is different from the goals and tasks when the opposite is true. In the immediate postwar period, most immigrants arriving in Hong Kong had relatively undifferentiated housing needs. Their immediate goal was to find shelter, any shelter. The government’s task, under this scenario, was simply to tackle a severe housing shortage, so a plan and command approach was a convenient solution even though decades later it would come to haunt society. But by the mid-1980s, the housing situation had completely changed. Hong Kong’s increasingly prosperous community had developed diverse housing and property investment needs. When shortages occur today, they are no longer general shortages but shortages in a particular segment, for example, a defined type of housing unit, a particular type of housing tenure, the availability of choice between investment and shelter purposes, or the demand from a specific group of households. Matching demand and supply today is no longer simply about matching the number of units to the number of households. It is also about meeting the preferences of different households for different types of units, recognizing why these preferences will change over people’s life cycle, and understanding why they are influenced by market conditions such as business cycles. The demand of households is far more dynamic than that of previous generations and requires a multidimensional dynamic market approach, not simply a plan and command approach.

One Step Forward, Two Steps Back: The Homeownership Scheme An early but flawed attempt at merging the two approaches happened in the MacLehose era, when the Housing Authority devised the Homeownership Scheme (HOS). It encountered a problem in that initial batches of the new HOS units in the early 1970s were sold to eligible buyers at a subsidized price set at 70% of the prevailing market level. The pricing policy embodied three features: (1) the price was set to be affordable to eligible households, (2) the subsidy rate was fixed, and (3) the unit was sold to the household with complete ownership (including the right to dispose of

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it on the open market 10 years after purchase without having to settle any unpaid land premium, because in those days there was none). This pricing model had to be subsequently abandoned when property prices in the market increased rapidly a few years later. The HOS units became unaffordable to eligible households, but the HOS pricing policy had failed to appreciate the full implications of this possibility. An important lesson was learned. When market demand changes, property prices often change even faster, leaving many households behind in the dust. More importantly, demand changes cannot be foreseen by the planner. Even if the planner turns out to be a clairvoyant, it is unlikely he or she will be able to persuade other stakeholders to change an approved plan. It was apparent that the level of subsidy had to be varied to make the units affordable, but the authorities chose not to do this and instead avoided the issue. They decided to deny the purchaser title to the full value of the land under the pretext that only the user’s right to the property was sold, not the right of free disposal. The latter right became conditional on repaying the remaining portion of the unpaid land premium. The purchaser therefore had only a half title under his or her name. Unfortunately, the value of the unpaid land premium appreciated over time at a rapidly rising rate as land values surged ahead of income growth. The government could easily have extended the purchaser a mortgage loan at the time of purchase to cap the value of the unpaid land premium, but for reasons I am unable to fathom it chose not to do so. This has become the central issue of the subsidized public homeownership scheme: that instead of acting as a banker and extending a mortgage loan to the subsidized buyer, the government has chosen to retain part ownership and sell only a half title to the property. Purchasers become pseudo owners of housing units that they cannot sell on the open market, without paying a hefty premium. Due to extremely limited turnover, land has been assigned to an inferior use that is value-destroying. As a consequence, the HOS has become locked into the public housing sector rather than gradually integrated into the market, which would have enabled land values to appreciate to the benefit of the homeowner. In future, when HOS buildings are rundown with age, the issue of redevelopment will become impossible to resolve without addressing the question of titles. The owners will have no right to redevelop the buildings without the government’s approval nor could they afford to do so on their own. Developers and other intermediaries will be reluctant to enter this messy situation. Complicating the housing scenario is the fact that, because of allocation decisions made in the past, many households in the public housing sector are well-off, but many households in the private sector are not. As a result, the mix of large and small units between the public and private sectors is wrong and certainly misallocated. Forecasting changes in demand and supply in such a market is theoretically

Supply and Demand Factors in Housing

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and practically difficult, as it is in any highly regulated market, but errors in prediction have potentially profound economic and political consequences.

Supply Factors Supply is affected by the straightforward production costs of supplying land, labor, and materials for building and construction. The lack of productivity gain in the local construction industry and the shortage of skilled construction workers will drive up costs. But more significant are the numerous regulatory-related transaction costs involved in property development, including navigating planning rules, complying with building codes, negotiating costs associated with land acquisition due to holdouts, and holding public consultations that often result in long delays. The uncertainty over how long these things will take makes development ever more costly. Large teams of advisors and professionals are now retained by developers and government to facilitate development. The expertise required to successfully manage these transaction costs forms a formidable barrier to entry for less experienced prospective developers. Many have left the market. I have estimated that, since 1989, such regulatory uncertainties and delays have increased the gap between property prices and construction costs by about 67% on average. In Essay 21, I examine these “regulatory costs” of development. The case of the old Kai Tak Airport site is a vivid illustration of these costs. It has taken an inordinate amount of time to develop the site. For years it remained a huge vacant lot. Imagine how long it takes to develop sites that are not vacant. Always, delays add to the final cost of development. Reducing these transaction costs will make a huge difference to the success of any long-term housing strategy—and, indeed, have an impact on the high prices of non-residential properties, which are also affected by transaction costs. It may not be customary for a housing strategy to address the cost of property development, but in Hong Kong today this factor is a major determinant in the success of any housing proposals. Many people have argued that the scarcity of land in Hong Kong is the reason property prices are high. This is blatantly false. Consider Singapore, where over 90% of the land has been developed; by contrast, less than 25% of the land in Hong Kong is developed. The real problem is that our planning rules and regulations have made most land unavailable for development or subject to long and uncertain delays that deter development. There are many ways to lower the regulatory cost of development. The most radical approach is to remove zoning rules that differentiate land into agricultural, residential, industrial, and office and commercial categories. Town planning approval could then focus only on the intensity of development and narrowly specified incompatible

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uses of land. The volume of development each year or every 3 to 5 years could be controlled. This approach may sound iconoclastic but should be studied seriously. Quite a lot of property in Hong Kong is indeed zoned for mixed use, and it does not appear to be a problem in the service economy of today. Another approach is to set and preannounce each year the rates of compensation for land use conversion on every plot of land. These preannounced rates would be totally transparent to all and be valid for a period of, say, 12 months. This would significantly lower the negotiation costs in settling land conversion premiums. It would also remove suspicion and concern over the opportunity for corruption in these negotiations. Would government revenues suffer as a consequence? This is not obvious, because the transaction process would be speeded up, and this could lead to more successful negotiated outcomes. Moreover, even if government revenues suffered, society would benefit from less costly transactions, speedier development, and less risk of corruption. It is useful to appreciate that, when government revenues suffer, society benefits from the transfer. In recent years, government transfers of benefits have come under much criticism, but this is targeted at selective transfers that benefit the few and not the many. My approach benefits all equally and is therefore a non-discriminating transfer to the public.

Demand Factors Demand is affected in the long-term by economic and population growth. The critical policy variables relevant for economic growth are investments in human capital (education and health care) and the lowering of the transaction costs of development. The relevant variables for population growth are immigration policy and the drivers of household formation. Most of these variables can be estimated, and some depend on what other policies will also be implemented and when they will take place. A difficult issue in forecasting the demand for new housing units is that it depends on the pace of formation of new households. For example, children will leave the household as they grow up and form new households, but the pace of this will depend on the available supply of new housing on the market and in the public housing sector. When supply is tight, the process will be delayed. This means that estimating the growth in the number of new households is itself dependent on the demand and supply of housing units. Moreover, one cannot use past trends (even recent past trends) to make accurate forecasts of the future pace of new household formation. Untangling these interactions is not going to be trivial. As adult children leave the home, there is also the particularly intriguing question of what happens to the original housing unit. The answer depends very much on whether it is a private or a public housing unit.

Supply and Demand Factors in Housing

21

If it is a public housing unit, then the adult children move out and the parents stay behind in order to retain the unit. When the original unit is private, then one can think of three other possible outcomes: the parents leave and the children stay, the children and the parents stay, or both leave to find a new arrangement that may include them living together or living apart. Many young new purchasers of private housing units rely on their parents to make the initial downpayment, and parents may refinance their existing home to do so. This phenomenon is common in other societies as well, where homeownership is an important channel to enhance the value of one’s savings and achieve upward mobility. So, while household formation is part of all households’ life cycles, it leads to demand for different housing types and tenures in the private market, but only one solution in the public housing sector. The lack of choice for those living in public housing means that a large portion of the population—the public housing tenants and pseudo homeowners—see limited prospects for homeownership for future generations. Faced with fewer choices, young adults who live in public housing have chosen to become early applicants for their own public housing units. Table 3.1 shows that the number of non-elderly single-person households on the public rental housing applicants’ waiting list has grown from 35% in 2007 to 49% in 2013. Those under 30 have risen from 13% to 26% of applicants. As the table shows, most of them live with their parents, and the majority have postsecondary or tertiary education. Table 3.1 Characteristics of non-elderly one-person household applicants on the public rental housing waiting list Non-elderly households on waiting list Under 30 30 or over Not living alone Living with parents Under 30 30 or over Postsecondary and tertiary education Under 30 30 or over Private permanent housing Public rental housing Subsidized sale flats

2007 35% 13% 22% 67% – – – – – – 53% 28% 14%

2009 38% 14% 24% 71% – – – 21% 37% 7% 53% 31% 12%

2011 42% 19% 23% 86% 79% 93% 58% 33% 53% 11% 48% 28% 21%

2013 49% 26% 23% 88% 85% 94% 70% 40% 67% 10% 45% 29% 23%

Source: Housing Authority, Memorandum for the Subsidized Housing Committee of the Hong Kong Housing Authority, Survey on Waiting List Applicants for Public Rental Housing 2013, December 31, 2013.

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Meanwhile, the percentage of non-elderly one person households on the waiting list who live in private permanent housing has decreased from 53% in 2007 to 45% in 2013. A growing number of applicants are now residents in subsidized sale flats, increasing from 14% in 2007 to 23% in 2013. Another important and growing source of demand for household formation since the 1990s has been the rising divorce rate, but this has largely gone unnoticed. I discuss this issue in greater detail in Essays 13 and 14. A society with a large public housing sector reduces the upward mobility of the next generation, because the occupants are denied the opportunity to benefit from appreciating housing values available to those who are homeowners in the private sector. The long-term consequence is to create a more polarized society. The next generation, whose parents could have helped them if the sale of HOS units had not ended up in the awkward compromise of selling only half a title, looks to the government for assistance. The issue of a lack of intergenerational mobility is likely to be magnified by the advent of rising divorce rates among low-income households.

Demand and Market Equilibrium Two factors that affect housing demand are very difficult to forecast: the demand from non-domestic sources, and the business cycle. For an open city like Hong Kong, these external factors inevitably play an important role in influencing housing demand. For example, when property prices are high in Hong Kong, some of the domestic demand may spill over across the border to Shenzhen. Moving in the other direction, cross-border family reunion has created an additional housing demand in Hong  Kong. For some people, regular commutes across the border have become a way of life and will be facilitated if regulatory barriers are lowered (for example, by lifting local residency requirements for receiving welfare payments or privatizing public housing). This of course raises the question of whether a long-term housing strategy can be developed if Hong Kong is viewed as an isolated entity. There is a need for a broader vision of the future of the Special Administrative Region so that all related policies can be coordinated to form a coherent whole. Similarly, the availability of cheap credit in recent years has fueled property prices in Hong Kong, including demand coming from buyers on the Mainland. By its very nature, foreign demand is likely to be primarily for investment rather than consumption. Forecasting this demand is difficult because it is driven primarily by business cycle factors and cannot be differentiated from business cycle effects, such as the Asian financial crisis and the global financial tsunami. Whatever the source, the most difficult thing with forecasting long-term changes in housing demand is that it is subject to considerable short-term fluctuations, some

Supply and Demand Factors in Housing

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of which may last a few years. Given that the supply of new housing units takes several years to come on stream, the housing planner faces a dilemma: If the planner heeds political calls to speed up supply, then reverses course a few years later, society will be faced with a huge property market glut. What was supposed to be a countercyclical intention will have become a procyclical mistake! And society belatedly will scream that the property market bubble has burst and go after the politicians and bankers. But the fluctuations in demand and long lags in supply mean property prices in the market inevitably make large upward and downward swings. These periodic swings are necessary for demand and supply to equilibrate in the market; no long-term housing strategy can avoid them, because this is the nature of the property market. Many recent commentators have proposed that a large land bank should be established so that the supply of housing can be readily increased when demand rises and vice versa. This view fails to appreciate that it is difficult to know when demand will increase until after it has happened. Such calls are always made only after prices have started to increase. Even then, most policymakers are still not certain whether the increase is temporary or the start of something permanent. They may consult economists and entrepreneurs, but most likely these experts will advise the government to wait for more signs before making a move. By the time everyone from Tuen Mun to Ap Lei Chau knows what has happened, so does the policymaker, but it is already too late to commit. The politician, however, has no choice and commits to a given path in order to curry favor with constituents. If the market collapses in a few years, then he or she just re-enters the scene as a new white knight to save the fair maiden from another dark night. Just how difficult it can be to forecast demand is evident in the failed housing plans proposed by various administrations. Youde, Akers-Jones, and Wilson met their targets but failed to build enough units to meet the surging demand. Tung’s housing plans also met the targets, but demand collapsed and too many units were built. Tsang had no housing plans and no targets to meet, so he is now blamed for doing nothing in the face of surging demand. This short history is not to apportion blame or praise. It merely observes that getting it right is a difficult job.

Political Reality The government’s central role in providing land and housing means any long-term housing strategy requires not only good forecasts but also continuity in policies across administrations. This was more possible under British colonial rule because we did not have political elections. Today, the new political dynamics of electioneering are changing public perceptions of the continuity of any policy. A long-term housing strategy today has to straddle administrations, making it less secure than in the past. Policy uncertainty reflects the underlying uncertainty of a

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political system that is still in transition and has become an additional dimension to the market—one that magnifies the existing market uncertainties. The question for Hong Kong is: What kind of long-term housing strategy would be prudent, given market fluctuations and the need for political approval to meet private housing demands? As I will show in these pages, a great expansion in homeownership could address not only housing but economic and social issues in Hong Kong. Past attempts at this have been well intentioned but flawed. I will examine the development of public sector housing and propose a readily available and easily achieved means of increasing homeownership: let sitting tenants in public housing purchase their units outright and curtail the land premium to make this option affordable. Through these purchases, and the subsequent creation of a market for the housing units, Hong Kong and its people stand to gain in terms of wealth and a stake in the future: to realize the goal of “Hong Kong land for Hong Kong people.”

Section II People, Public Housing, and Serfdom

4 On the Nature of Public Sector Housing Policies in Hong Kong

Every person who grew up in Hong Kong has been taught that, after a 1953 Boxing Day fire in Shek Kip Mei, which left 53,000 immigrants homeless, the government initiated a policy to develop Resettlement Estates to house these stranded people. The program continued until eventually more than 200,000 such units were built. It is easy to conclude that a Christmas fire triggered the greatest humanitarian policy initiative in postwar Hong Kong. This is, of course, part of the urban myth we all grew up with. At the very most, the Christmas fire was only one of many relevant reasons for this building program.

Rent Control and Squatters The victims of the Shek Kip Mei fire, and many of the new arrivals to Hong Kong, were largely squatters living in illegal units built on Crown land at the fringes of the urban area. From an economic perspective, it is valid to ask why, after the Second World War, private developers chose to build these units in these places. Why didn’t they build housing units in urban areas, especially through redevelopment of the existing three-and four-storey tenement blocks? The population of Hong Kong increased rapidly between 1945 and 1951, from 600,000 to 2.3 million. Surely, there was a large enough pressure on housing to make redevelopment economically worthwhile. Urban geographers from the University of Hong Kong who surveyed housing conditions at that time found that old tenement blocks were far more congested than squatter units. Indeed, Cantonese movies have correctly portrayed these conditions, showing congestion in old tenement blocks and spaciousness in squatter units. Why did many of the 1,000 or so private developers operating back then choose to construct illegal squatter housing units rather than redevelop tenements? The answer is surprisingly simple. In 1947, shortly after the end of the war and in anticipation of the return of Hong Kong residents who had fled the city, the government imposed rent control on prewar housing units. This effectively killed any possibility to redevelop the housing stock through private initiatives. As experience

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Table 4.1 Number of public sector housing units produced, 1954–1974

Resettlement Estate Government Low-Cost Housing Housing Authority Housing Society Total

Number of Units 1954–64 1964–74 97,349 136,710 5,544 62,102 16,710 18,157 7,047 12,976 126,650 229,945

in all other parts of the world has shown, rent control cannot hold down rent if the landlord can evict the tenant at the end of the lease and then raise the rent with a new tenant. So, to make rent control effective, the law soon disallowed the forcible eviction of tenants. Once this happened, demolition of the existing housing stock for redevelopment purposes became impossible through private initiatives. Rent control basically halted urban redevelopment. The old tenement blocks were packed with massive numbers of immigrants and returning residents. Most became subtenants. A small proportion of the new arrivals spilled over into squatter areas on the fringes of the urban areas by occupying land illegally. The government soon realized that development had become impossible because rent control had made it difficult to redevelop land within the urban areas, and land on the perimeter was illegally occupied by squatters. The only politically feasible way to secure land for development was to resettle squatters into public sector housing units and reclaim the land they had occupied. The Shek Kip Mei Christmas fire in 1953 provided an ideal opportunity for the government to introduce Resettlement Estates as a solution for dislocated households and to clear squatter areas. Table 4.1 shows the number of public housing units produced in the two periods, 1954–64 and 1964–74.

An Incentive to Squat In the first 10-year period of the public housing program, 126,650 units were produced, averaging 12,650 units per year. Of these, the largest share, 97,349, was made up of Resettlement Estate units. Admission into Resettlement Estates was not based on a means test but was due to the clearance of squatter housing areas. As a result, two perverse incentives were created. First, tenants admitted into the Resettlement Estates were not necessarily the lowest income groups in society. Indeed, some were able to afford the purchase of an expensive squatter housing unit. Second, once such a policy was in place, many households living in crowded old tenement blocks now chose to become squatters, with the expectation that they, too, would be resettled in time. The policy rewarded adventurous, opportunistic

On the Nature of Public Sector Housing Policies in Hong Kong

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households. Surveys of squatter settlements in 1957 showed that half of them had lived in private housing before becoming squatters. As a consequence, for each existing squatter area that was cleared, more new ones soon appeared. The number of squatters actually increased from 300,000 in 1954 to 600,000 in 1964. The Resettlement Housing program came under pressure for ignoring those without means in allocating public sector housing. This led to the production of other, means-tested Government Low-Cost Housing units. In 1964, following the publication of a White Paper with a 10-year public housing production plan, a more balanced approach to squatter clearance and means-tested housing was introduced. A  total of 229,945 units were produced, of which 62,102 were Government LowCost Housing units, a huge increase from 5,544 in the previous decade. However, Resettlement Estates still took up the lion’s share at 136,710 units, or more than 65%. These pre-MacLehose era public housing production figures clearly reflect that the major goal of public sector housing policy in the first two decades was not to provide support for poor households: It was to clear squatter areas for development. Other concerns such as alleviating poverty, preventing social unrest, and humanitarian concerns were present but probably of secondary importance. The public sector housing program was a response to the consequences of rent control that prevented development from taking place and to the program’s own perverse incentives that led to the further mushrooming of squatter areas that required renewed efforts to clear.

Public Rental Housing under MacLehose: Nailed to Their Flats (Part 1) Murray MacLehose assumed governorship in 1971, after a period of civil unrest following rapid economic growth in the territory and political turmoil across the border. He quickly recognized the stabilizing value of expanding the public sector housing program, as well as other initiatives in education, social services, and health care. He made housing policy the centerpiece of his first speech to the Legislative Council in 1972, calling for the construction of 350,000 units over a 10-year period. Ultimately, a total of 176,623 public rental housing (PRH) units and 23,020 Homeownership Scheme (HOS) units were built. MacLehose essentially expanded the existing public sector rental housing program. As squatter areas were disappearing, the program metamorphosed into a means-tested program for eligible households, delivered by the Housing Authority. But the large scale of the earlier resettlement program meant that households in PRH units would always be a mixture of former squatters and those who were without means at the time of their admission. The effect of such expansion was to bring an increasingly larger proportion of the population into the program. It led to the establishment of large public sector housing

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estates in satellite towns with multiple long-term consequences. The crucial one is that these inhabitants became immobile and nailed to their units in estates that were far away from choice jobs, choice schools, and relatives and friends. The inhabitants became essentially “housing serfs” who were bribed with low rent to accept their condition.

HOS under MacLehose: Nailed to Their Flats (Part 2) The HOS program conceived under MacLehose’s tenure recognized that Hong Kong residents aspired to become homeowners. Such an aspiration could have been easily met in the 1970s, by allowing existing rental units to be purchased by tenants at subsidized rates as was the policy in Singapore (see Essay 5). This did not happen. Instead, the new category of HOS units was created and kept separate from subsidized rental units. No consideration appears to have been given to uniting these two into a single program, a situation that implicitly assumed only households that improved their economic circumstances should become homeowners. The rest of PRH—a significant 30.8% of all households in Hong Kong—were condemned to remain tenants for life. The MacLehose housing program was poorly thought through in this respect. There was no attempt to harness the power of the market to meet the needs of households. In 1978, when the HOS program was first launched, the Housing Authority did not anticipate future changes in property prices. Initially, the units were sold at a 30% discount from the market valuation, a boon for purchasers. The government originally intended to provide an explicit subsidy for HOS units with no requirement to repay the subsidy if the unit was resold subsequently on the open market after a 5-year or 10-year period of occupation. The significance of such an arrangement was that it made the HOS owner a bona fide owner of the property. But this arrangement was abandoned in 1982, after property prices in the market escalated rapidly. The 30% discount off market prices was no longer affordable for eligible households. As an alternative, the government decided to sell HOS units at development cost. However, the value of land was deemed unpaid, and as a consequence the HOS unit could only be sold on the open market after the premium had been paid up, a figure that was based on the market value at the time of the sales transaction. A 10-year occupation requirement was also introduced. These arrangements meant that the option to sell the HOS unit on the open market was conditional and was not often exercised. Thus, HOS occupants also become nailed to their units in the same way as PRH tenants did. The two different HOS purchase arrangements meant that only those who purchased in the first two years of the program were bona fide owners, who could realize the appreciation in value of the unit they acquired.

On the Nature of Public Sector Housing Policies in Hong Kong

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Table 4.2 Percentage of households by type of housing and occupancy, 1971–2011 Owner-Occupiers Private Public Renters Private Public Temporary Housing

1971 18.1% 18.1% – 73.5% 42.4% 31.1% 8.5%

1976 23.2% 23.2% – 67.0% 32.6% 34.4% 9.8%

1981 27.9% 27.3% 0.6% 62.9% 29.5% 33.4% 9.3%

1986 35.1% 31.1% 4.0% 57.3% 21.8% 35.5% 7.6%

1991 42.6% 35.3% 7.3% 53.2% 16.8% 36.5% 4.2%

1996 44.5% 33.7% 10.7% 53.2% 17.8% 35.5% 2.3%

2001 50.8% 35.2% 15.6% 47.9% 17.4% 30.6% 1.2%

2006 52.8% 36.5% 16.3% 46.5% 15.4% 31.0% 0.8%

2011 52.1% 36.2% 15.9% 47.1% 16.8% 30.3% 0.8%

Source: 1971–2011 Census and By-Census, various issues.

Incomplete Ownership and Tenancy Rights The twists and turns of subsidized housing policy in Hong Kong have had lasting and pervasive influences on the development of Hong Kong’s people, economy, society, and politics. One of the main problems is that property ownership and occupancy rights are applied unevenly in Hong Kong. There are now four broad categories of housing tenure: private sector owner-occupiers, subsidized public sector owner-occupiers, private sector renters, and subsidized public sector tenants. Rights differ between the private and public sector. Table 4.2 shows the percentage shares of households by type of housing and occupancy in the period 1971–2011. The classifications are primarily the result of over 50 years of government involvement in public sector housing policy. The PRH tenant in the subsidized sector is not a true tenant; this is a misnomer. A tenant anywhere else has the right to choose the unit he or she rents within the limits of his affordability. But to do so there must be a market for housing units. This does not exist for public sector housing units in Hong Kong, because the tenant is in effect constrained to live almost permanently in the unit he or she was given in the first instance; the only other option is to leave the sector altogether. His or her rights are therefore different from those of the private housing tenant.

Unpaid Land Premium Uncertainty The HOS is also a misnomer, because the occupant of an HOS unit does not have the same set of property rights commonly conferred by private ownership. The requirement to repay the land premium is a formidable obstacle to true ownership, because the value of this land premium is determined with reference to the market value at the time when repayment is to be made. Based on history, the expected value has often risen at a rate faster than inflation and household income.

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The HOS property ownership right is therefore only the right to occupancy granted at the time of purchase and the option to have the right to sell on the open market after repayment of an unpaid land premium whose future value is not known. Ownership of an HOS unit is at most a form of quasi-ownership because the owner is effectively not free to dispose of the property he or she “owns.” To illustrate this with a concrete example, Table 4.3 provides the average sales price of two of the earliest HOS units: Sui Wo Court Phase I, Sha Tin, completed in 1980, and Chun Man Court, Ho Man Tin, completed in 1981. The original sales price had a 30% discount over the estimated market value; therefore, the true market price per square foot (psf) for these two developments would have been about $320 and $317 at the time of their completion. In 2011, the open market price of transacted units in these two developments was $4,066 and $5,685 psf. This represents an appreciation of 12.7 and 17.9 times over a 30-year period. It outpaced by a wide margin the increase in consumer prices of only four times over the same period. As a consequence, the occupant of one of these HOS units is highly unlikely to be able to sell the property on the open market because, after returning the land premium to government, he or she may not be able to afford the purchase of another unit on the market. The occupant becomes effectively a permanent occupant of the unit. Having paid for the development cost of the structure, the occupant household can remain in the unit for “free” but, because it cannot afford to pay the land premium, it is restricted to these premises. Even when the unit is no longer suitable due to the changing aspirations of household members over their life cycle, there is no choice but to stay there. The consequences of “forced” staying in a public sector housing unit are many, and almost all of them are detrimental to the healthy development of society, the economy, and politics. I shall return to these topics later. In many respects this situation creates what amounts to an implicit version of the hukou system (or household registration system) for tying down households, which the Mainland is trying to remove.

Table 4.3 Original sales price and 2011 market price of HOS units (per square foot)

1980/81

Sui Wo Court Phase I, Sha Tin $224

Chun Man Court, Ho Man Tin $222

1980/81

$320

$317

2011

$4,066 12.7 times 8.85%

$5,685 17.9 times 10.10%

Year Average original sales price After adding back a 30% discount to the original sales price Open market transaction price Value appreciation Value appreciation p.a. in percent

On the Nature of Public Sector Housing Policies in Hong Kong

33

Housing Policy Is Always Political Housing is not merely shelter. For most households, home ownership is the most important form of their savings and therefore a means of wealth accumulation and upward social mobility. This is especially true in Hong Kong, where land values are high and rising. For some households it can be a form of ready financing if the property can be remortgaged, especially for those who otherwise would have poor access to banks or financial help from relatives and friends. It could play a pivotal role as a source of social security for old age. Its effects span more than a single generation, because it can also be used as a bequest. At the aggregate macroeconomic level, home ownership is an important form of fixed investment and directly affects consumption, savings, and aggregate output over the business cycle. It is also affected by these cycles. Most important of all, land and housing are valuable scarce resources, and whether they are efficiently deployed has important consequences for the growth and prosperity of a city and a nation. It is almost inevitable that a public sector housing program will have significant effects on households, and through them both society and the economy will be affected. Housing policy is necessarily a highly politicized issue. For developing societies, the absence of a public sector housing policy or the existence of a badly designed one can often be a source of social, economic, and political disaster. Housing often generates various kinds of externality or spillover effects that are poorly handled by fledgling and weakly formed market institutions. A well-designed and implemented government program could improve upon these market institutions. I do not, however, think it is necessary or desirable to introduce a public sector housing program like the one in Hong Kong that replaces the market mechanism entirely in its design. The important effects that the choice of housing tenure and functioning markets play in a public sector housing program, and the considerations and consequences for society, the economy, and politics, are explored in subsequent essays.

5 Comparing Public Sector Housing Policies in Hong Kong and Singapore

Both Singapore and Hong Kong have massive public sector housing programs on a scale that is unprecedented in free market capitalist economies. Approximately fourfifths of Singaporeans and half of Hong Kong residents live in government-provided subsidized housing. But the two programs are critically different because of their different policies on homeownership and tenancy rights. Singapore has allowed for the establishment of an active market in public sector housing for rental and for purchase and sale. But in Hong Kong, restrictions have made the market for such units nonexistent and nonfunctional, with grave consequences for matters beyond housing issues. To consider a way out of this morass, it is useful to study the case of Singapore.

Singapore Redevelops Rent Controls Singapore’s postwar situation was very similar to Hong Kong’s. Its population expanded rapidly although not on the same massive scale as Hong Kong’s. Between 1949 and 1959, Singapore’s population grew at an average rate of 5% a year. The British colonial government, which returned to power in Singapore at the end of the Second World War, decided to impose rent control in 1947, the same year that it took the same decision in Hong Kong. Redevelopment of the old tenement apartments became extremely difficult, and public discontent mounted. However, the rest of the history of Singapore’s public sector housing program took a very different course from that of Hong Kong. One of Lee Kuan Yew’s major electioneering points during the 1959 campaign that swept him into power was the ineffectiveness of the Singapore Improvement Trust (SIT), whose record in building homes was “insufficient even to cater for the annual population growth, let alone alleviate the slum problem.” Once in power, he promptly set up the Housing Development Board (HDB) to replace SIT and provide incontrovertible proof of the capacity of the People’s Action Party (PAP) to fulfill its pledges to the people.

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Hong Kong Land for Hong Kong People

Most would agree that, although the Singapore government’s national economic development accomplishments were impressive, its showpiece achievement was its low-cost housing scheme. This changed Singapore’s physical landscape and gave Lee his first opportunity to demonstrate that he was doing things for Singaporeans. The government built 80% of the homes in the city-state. Singapore literally became “the public housing laboratory of the world” even though Hong Kong’s housing resettlement program had been initiated five years earlier. By the end of the first Five-Year Plan in 1965, the HDB had built 54,000 units, well over twice the number completed by SIT between 1927 and 1959. The breakneck pace of HDB housing development improved the housing shortage problem but also resulted in a huge scarcity of land available for development. Swamps were filled, and land was reclaimed from the sea. Most of the fishing villages that were cleared were Malay, and a cry arose that Chinese Singapore was persecuting its Malay minority and disrupting the traditional Malay kampong or village way of life. Still, they had rights—for a short while more. Between 1963 and 1965, when Singapore was part of the Federation of Malaysia, Article 13 of the Constitution of Malaysia provided that no person should be deprived of property except as specified by the law, and that no law should provide for compulsory acquisition of property without adequate compensation. In 1965, when Singapore became independent, Lee immediately enacted a central piece of legislation for land nationalization called the Land Acquisition Act of 1966, which enabled the government to secure more land at low prices for HDB projects. This ordinance conferred powers on the state to acquire land for any public purpose or for any residential, commercial, or industrial purpose. The rate of compensation was set by statute and independent of both market value and the landowner’s purchase price. This exercise wiped out land rent gains for affected landowners, some of whom suffered actual losses, having purchased their land at prices above the statutory determined value. Some landowners even had to continue with mortgage repayments for land that had already been acquired by the government. The result of this was that the proportion of land under state ownership increased from 44% in 1960 to 76% by 1985. What the Singapore government did, but the Hong Kong government avoided doing, was to take away the rights of property owners of private housing by forcing them to sell to the state at very low prices set by the law (not the market). As a consequence, the effect of rent control in preventing redevelopment was offset. A considerable proportion of the land “taken” from landlords was used for constructing HDB units. T. J. S. George (1973) described another process by which land in the slum areas became available for redevelopment:

Comparing Public Sector Housing Policies in Hong Kong and Singapore

37

Sometimes nature felt obliged to help. In 1968 a major fire broke out in a Havelock Road shantytown which had refused to liquidate itself despite constant government warnings about disease, theft and fire. It was Singapore’s worst fire in seven years. It was suddenly discovered that only five engines were available to fight it. Water pressure in the neighborhood turned out to be inexplicably low. The hydrants were insufficient, the hose damaged or leaky. Even winds proved treacherously changeable. To cap it all the firemen did what a press report at the time described as “rather odd target selection.” In no time the fire completed its course and cleared an area occupied by some 200 huts. Soon another high rise building covered it. [A] fire that had raged seven years earlier was strikingly similar. It too had completely razed a shantytown and immediately made way for another Housing Board estate. There were other smaller fires in other recalcitrant slums, each followed by housing development. Singaporeans began happily talking about “fires of convenience.”

This is probably one of the reasons why the government of Lee Kuan Yew has not been able to shake off its populist authoritarian image despite being one of the first democratically elected governments in Asia (and one of the few) and having a stellar record of being free of corruption. In Hong Kong, the decision not to take away the rights of private property owners reflected in part the influence of the capitalist free market philosophy of John Cowperthwaite, who was not a socialist statist like Lee Kuan Yew. Cowperthwaite served as Financial Secretary from 1961 to 1971. Perhaps the bounded legitimacy of a colonial government in postwar Hong Kong also prompted it to tread more lightly on the rights of residents. Singapore, in contrast, designed a public housing program that was far more market oriented than Hong Kong’s. In an odd way this is not surprising. Having forcibly taken away the rights of private property owners under the Land Acquisition Act and offered them HDB units in return, the Singapore government had to make these units sufficiently attractive. Allowing a market in HDB units enhanced the appeal of these units. What Singapore ended up doing was replacing large tracts of private housing stock with public blocks. Property rights were first taken away and then returned in another form. This is also why most of Singapore appears sanitized and sterile. Overall, Singapore has had a far more “big brother” government.

A Free Market in Singapore HDB Housing In Singapore, all public sector housing stock can be either rented or owned; renters may come to own their flat if they subsequently choose this option. The units are rented and sold to eligible households at a subsidized price. After 5 years from the date of effective purchase, owned units can be sold on the open market. There are no

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Hong Kong Land for Hong Kong People

Table 5.1 Households by type of dwelling and tenancy in Singapore, 2000–2010

Percentage share HDB dwellings Condominiums and private flats Landed properties Others

2000 2010 Total Owner Tenant Others Total Owner Tenant Others 100% 92.0% 6.9% 1.1% 100% 87.2% 11.6% 1.3% 87.7% 81.5% 5.5% 0.7% 82.4% 73.0% 8.6% 0.8% 6.3%

5.1%

1.0%

0.2%

11.2%

8.7%

2.3%

0.3%

5.1% 1.0%

4.5% 0.8%

0.3% 0.1%

0.2% 0.0%

5.7% 0.7%

5.0% 0.4%

0.5% 0.2%

0.2% 0.0%

Source: Statistics Singapore.

basic restrictions on such sales and no requirement to repay the subsidized premium. In addition, the owner of HDB units can “sublet” the unit, in whole or in part, on the open market. As a consequence, there has been no impediment to the emergence of a market for public sector housing both for renters and owners. In addition, because there are no restrictions in switching between renters and owner-occupiers, they form basically one single category, and residents are in fact predominantly homeowners (see Table 5.1). The Singapore system effectively allows all residents of HDB units to reap the full benefits of the subsidy on the land premium and to obtain the entire appreciation in value over time—things that are not available to Hong Kong tenants and homeowners. It is not only more generous to eligible households but far more market oriented than Hong Kong’s program. In Singapore today, 73% of households live in HDB units as bona fide homeowners and 8.6% as tenants. In Hong Kong, 47% of households live in public sector housing units of which two-thirds are renters in public rental housing (PRH) units, and onethird quasi-homeowners in HOS units. Some 80% of these quasi-homeowners have not yet repaid the outstanding land premium to government. They are effectively mere occupants and not bona fide homeowners like their counterparts in Singapore. The critical difference between Hong Kong and Singapore public sector housing, therefore, is neither the physical attributes of the units nor the amount of subsidy on their prices or rents but the restrictions on tenancy and homeownership enjoyed by the resident. The paramount issue is whether a resident in the public housing sector can have essentially the same choices as a tenant or property owner in the private housing sector. These restrictions govern whether a market of public sector housing is allowed to emerge and function properly.

Creating a Market in Public Housing Hardly anyone in Hong Kong who lives in public sector housing ever becomes a bona fide tenant or property owner of the unit occupied in the same way as their

Comparing Public Sector Housing Policies in Hong Kong and Singapore

39

counterparts in the private sector do, for the reasons mentioned above. The result is that half the population of Hong Kong is stuck with the same public sector housing unit they first moved into, for almost the rest of their lives. This is despite the fact that the preferred housing tenure of most households will change over their natural life cycle. Events like work patterns, marriage, divorce, childbirth, child schooling, migration, retirement, and death affect the demand for housing and tenure form. Moreover, these events vary across households in different and uncertain ways. The impacts can also be felt the other way, because the course of these natural life cycle events can be affected by housing supply and the available tenure choice. The renters and owners in Hong Kong’s public housing sector have significantly fewer rights than those in Singapore’s HDB units, because the Hong Kong government has failed to create a market for them. But it is not difficult to rectify this situation. The government could adopt measures proposed in Essays 28 and 29 to create a market for public sector housing units that is absent now. It could remove the arbitrary distinction between rental and homeownership programs. It could provide an explicit subsidy on land values to residents who wish to be homeowners. These proposed measures could restore the homeownership ladder that has vanished in the past decade. I will return to these points throughout this book.

Reference George, T. J. S. Lee Kuan Yew’s Singapore. London: Andrée Deutsch, 1973.

6 Equal Yet Unequal The Occupants of Private and Public Housing Units

A crucial question in the discussion on housing is whether most households in the public housing sector are on the whole poorer than those in the private sector. Or, does the distribution of household income among public housing occupants and private housing occupants overlap significantly or minimally? A well-known result from the economics of housing demand is that households with higher incomes prefer or demand bigger homes, and the size of accommodation is expected to be positively related with income. Given the large difference in the median size of the housing units between the private and public housing sectors (about 40%), an efficient or optimal housing arrangement would require that there be very different income levels between the occupants of these two sectors. Research undertaken by me with Chinese University’s Professor Liu Pak-Wai and by Dr. Yan Wai-Hin (see Wong and Liu 1988; Yan 2000) found that household income distributions overlapped significantly between public and private housing tenants and between public and private homeowners. Table 6.1 presents current figures on these distributions for the period 1976–2006. All households in the population were divided into 10 deciles, from the top 10% to the bottom 10%. We then assigned households in the 4 categories of public tenants, private tenants, public homeowners, and private homeowners to each of these 10 deciles and determined their income distribution. The results are alarming indeed. In 1976, 51.7% of public tenants were in the bottom 5 deciles. For private tenants the proportion was 53.9%. Since 50% of all households must be in the bottom 5 deciles, our findings clearly show that the bottom 50% of household income distribution was filled by both public tenants and private tenants almost equally. There was a complete overlap of the two distributions, and this overlap was considerable even when comparing the percentage of households in other decades, including those at the top. The public rental housing program therefore was clearly not achieving equity through subsidizing housing consumption. In 1976, the incomes of the wealthier half of public tenants were also equal to those of the wealthier half of private tenants. Yet the wealthier public tenants were still living in housing units that were about 60% of the median size of private housing

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Hong Kong Land for Hong Kong People

Table 6.1 Percentage of public and private tenants and homeowners by income deciles, 1976–2011

Bottom decile 2nd decile 3rd decile 4th decile 5th decile 6th decile 7th decile 8th decile 9th decile Top decile Bottom 5 deciles Top 3 deciles

Public Tenants 1976 2011 8.4 12.6 9.0 20.3 10.9 15.2 12.2 14.0 11.2 12.9 9.6 10.0 14.1 7.9 11.4 4.8 9.4 1.9 3.8 0.4 51.7 75.0 24.6 7.1

Private Tenants 1976 2011 11.1 4.2 11.8 6.9 10.3 8.7 10.9 10.3 9.8 9.2 8.1 8.8 10.3 9.9 8.8 10.9 8.4 13.1 10.5 18.0 53.9 39.3 27.7 42.0

Public Homeowners 1981 2011 0.8 8.4 1.9 5.4 1.9 7.1 3.0 10.3 7.2 12.2 9.6 13.6 16.5 14.6 17.3 13.9 20.0 10.9 21.8 3.6 14.8 43.4 59.1 28.4

Private Homeowners 1981 2011 7.7 10.5 7.1 5.3 7.5 5.7 8.7 6.7 8.5 8.8 8.8 8.5 10.3 10.3 11.0 12.1 12.8 14.3 17.6 17.8 39.5 37.0 41.4 44.2

Source: Estimated from population census data (various years). Note: The income deciles are constructed from the sample of all households by distributing an equal number of households, 10% of the households into each decile. They vary from year to year and are applied to all four types of housing tenures—public renters, private renters, public homeowners, and private homeowners—in any given year.

units. Obviously, these units were too small relative to what they could afford in the private market. Those who stayed in public housing tolerated their housing condition only because of the exceptionally low rent. It is also likely that many had private housing units but did not return their public unit to the Housing Authority. By 2011 there was some improvement, but the problem of overlap in the distribution of public and private tenants remained substantial. Some 75% of public rental tenants were in the bottom 5 deciles, but so were 39.3% of private rental tenants. The increase in the proportion of lower-income households in public housing has grown because more of them have been admitted into the public rental housing program than previously. Some of the units allocated to lower-income households became available through the recovery of public rental housing units from well-off tenants. Since the 1980s, the Housing Authority has implemented a “double rent policy” for well-off tenants and preferential treatment for public housing tenants in their applications for HOS units, to encourage the surrender of rental units. Nonetheless, nearly half the tenants in the private sector are among the less well-off who might benefit from a public housing allocation.

Equal Yet Unequal

43

Means Tests and Double Rents The public rental housing program benefits many households, but not all of them are the less well-off, and certainly many of the poorest do not benefit, including low-income households renting in the private sector who do not qualify to apply for public sector housing. The failure to target housing benefits to the poorest in society is not surprising. The resettlement program was aimed at rehousing squatters and was not means-tested from the beginning. Early squatters were unlikely to be the poorest members of society since they paid market rents and their housing units were more spacious than the old private tenements. Later, squatters were primarily those who were evicted when old private tenements were torn down or those who took advantage of the resettlement policy and turned themselves into squatters by exiting from the tenements. There was no presumption that they would be the least well-off in society. The public housing program began to acquire a reputation of helping the poor only after more than a million squatters had been resettled. But by then, the main bulk of the public housing population had been admitted without a means test. The government’s reputation as a provider of housing for less well-off households therefore should be viewed with some very serious reservations. A means test was eventually introduced for those who were not squatters, but initially this was administered only at the time of entry. A well-known trick to lower measured household income was to have one’s working spouse temporarily drop out of the labor force at the time of assessment. Tenants did not have to be continually means-assessed as a condition for remaining in the program after their admission. Over time, many tenants became well-off. It was only in the 1980s, when land availability became tight again, that there was an attempt to introduce means tests for existing tenants. The double-rent policy resulted from this and is imposed on well-off tenants 10 years after they were admitted into the program. This has had only a limited impact on recovering units from existing tenants although it has made tenants who do not wish to be means-tested pay higher rents.

The Housing Leviathan The Homeownership Scheme (HOS) has also been used to recover public housing units from well-off tenants. Progress has been painfully slow, and this is to be expected. Administrative measures have limited effects unless they are draconian, but this is unlikely to be the approach adopted when the objective is not to drive out tenants but to entice them to leave with an HOS unit as the carrot. Most of the public rental housing units that have been recovered were surrendered after a successful

44

Hong Kong Land for Hong Kong People

application for HOS units. Between 1978 and 2010, a total of 186,000 HOS units were awarded to existing public housing tenants; these are the Green Form applicants. In the same period, 146,000 units were awarded to qualified applicants who reside in private housing; these are the White Form applicants. Expanding the Housing Authority’s reach to build new HOS units became the modus operandi for recovering public rental housing units from the well-off tenants. This meant that, to recover one public rental unit, a new HOS unit had to be built. There can be only be one logical reason for maintaining two types of public housing scheme, one for rent and the other for ownership, instead of a single scheme with housing units for both rent and purchase as in Singapore’s HDB program: it is empire-building by a public institution. The Housing Authority’s land portfolio has grown to include even more public rental housing and HOS units. Since these units have very low circulation, large tracts of valuable land are being put to inefficient and inequitable use. This also kept well-off residents in the public sector. In 1981, 59.1% of public homeowners were in the top 3 deciles. For private homeowners, the proportion was 41.4%. Again, one finds an enormous overlap in the distribution of household income between these two groups. By 2016, the overlap was reduced but was still significant. Some 28.4% of public homeowners were in the top 3 deciles, against 44.2% of private homeowners.

The Hidden Truth The inequities of the public housing program are well known to all those who have been involved with it. That the program has gained a widely and firmly held reputation for being Hong Kong’s most successful benefits redistribution policy is a truly inexplicable myth. This mistaken view is even popularly held among broad segments of academia, another puzzle that probably deserves a separate essay someday. What is obvious now is that many registered public housing tenants are not the less well-off. They have also been an important source of rising property prices in the private sector. In the 1980s and 1990s in particular, many were buying private housing units to expand their living space or as an investment. The Housing Authority estimated in the early 1990s that about 13% of public rental housing tenants, or about 74,000 households, owned private domestic properties. Their flats accounted for as much as 11% of all private housing units; 84% of these were owner-occupied, the remaining 16% rented out. What was happening was that some members of the household who were registered as living in the public rental housing unit were in fact residing in the household’s private flat. These were the children or the parents of the heads of these households.

Equal Yet Unequal

45

In extreme cases, all members of the household resided in their own private flats, leaving the public rental housing units vacant. A random sampling of 2,000 transactions between October 1992 and March 1993 provided by the Rating and Valuations Department showed as many as 24% of private housing units were purchased by public rental housing tenants, suggesting considerable absenteeism in public rental housing. A survey taken by the Housing Department in August 1992 showed as many as 18% of public rental tenant households had some registered members not currently living in their flats. Many of these well-off tenants have little incentive to give up their public housing unit even when they acquire a private unit. At the same time, the less well-off private tenant is made to endure often years of high rent in the private market while waiting for a public housing unit. When that unit is finally allocated, the tenant often discovers it is in a bad location, but the waiting time has been so long that he or she can wait no more. The tenant adjusts his or her life to fit the housing unit, making sacrifices that used to be told in comic books about communist nations. This has been happening in Hong Kong for 60 years. No wonder Hong Kong has persistently underperformed Singapore.

A Puzzling Housing Shortage What is particularly disconcerting about a situation like this is that, even though the data show a surplus of housing units over the number of households, there can be a housing shortage. Figures in Table 6.2 show that, from 1971 to 1986, the total number of private and public housing units was below the number of households. But from 1991 to 2011, the total number of housing units was above the number of households. The excess Table 6.2 Number of domestic households and housing units

1971 1976 1981 1986 1991 1996 2001 2006 2011

Total Number of Households 846,670 990,290 1,237,643 1,445,689 1,580,072 1,853,248 2,053,412 2,226,546 2,368,796

Total Number of Housing Units (Permanent Quarters) 668,200 897,110 1,093,220 1,410,100 1,722,100 2,004,900 2,310,000 2,477,300 2,601,800

Source: Population Census and By-Census.

Number of Housing Units Per Household 0.79 0.91 0.88 0.98 1.09 1.08 1.12 1.11 1.10

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Hong Kong Land for Hong Kong People

of housing units over households has fluctuated between 9% and 12%. These variations probably reflect changes in market conditions in both the housing market and the overall economy. The composition of a household is sensitive to the state of the economy. For example, during bad economic times, more members may live together to save on expenses. In good times, members move out to enjoy better individual standards of living. Similarly, an increase in divorce rates will increase the demand for separate housing units. And there is another reason: the size of public rental housing units is too small for a considerable fraction of the households living there. This is what encourages well-off tenants to buy property in the private market, but it creates a problem. These tenants see no reason to relinquish their public rental housing unit, so they end up withholding these units from less well-off households and individuals in society. Property prices in the private sector will continue to rise, but old public rental units will not be released because there is no market for them. This state of affairs is one of the terrible legacies of MacLehose’s Ten-Year Housing Program (October 1972) and the subsequent Long-Term Housing Strategy (April 1987). I look at this problem in detail in the next essay. A simple solution is to revive the halted Tenant Purchase Scheme (TPS). A nontrivial, perhaps even substantial, share of these units would become available for rent in the open market, provided this was allowed by the Housing Authority. It would meet the needs of those who are currently occupying subdivided rooms and on the waiting list for public rental housing. Moreover, competition from the TPS would help to make subdivided rooms more affordable.

References Wong, Y. C. R. “How Severe Is the Housing Shortage in Hong Kong?” HKCER Letters, Vol. 42, January 1997, 1–3. Wong, Y. C. R., and Pak-Wai Liu. “The Distribution of Benefits among Public Housing Tenants in Hong Kong and Related Policy Issues.” Journal of Urban Economics, Vol. 23, No. 1, January 1988, 1–20. Yan, Wai-Hin. “Efficiency in the Distribution of Hong Kong Public Housing Resources (’70s–’90s).” PhD Dissertation, School of Economics and Finance, The University of Hong Kong, 2000.

7 The Inequity of Small Housing Units

When Hong Kong’s resettlement housing program was introduced in the 1950s, it initially targeted a limited number of squatters but quickly mushroomed into a massive public rental housing program. At its peak, it accommodated two-thirds of the population. Like all public sector programs, it provided a uniform standardized product administered by one set of rules and regulations with limited flexibility, an approach intended to avoid criticisms of unfairness and corruption. One important standard was the size of the accommodation. The initial size was set with reference to the cramped conditions of the old private tenements. But once the size was determined, it became formally institutionalized. Changing the standard became politically divisive, subject to criticisms and reservations from all quarters. Numerous protracted bureaucratic meetings were required to achieve consensus, leading to prolonged indecision. As a result, the standard of accommodation in the public rental housing sector changed very slowly and lagged far behind developments in the private market. The gap between the public and private sectors has not narrowed much over time. I found in the period 1982–96 that the average public rental housing (PRH) unit was about 60% the size of its equivalent in the private sector (see Wong 1997). The current figures for the median size of the various housing units are given in Table 7.1. Table 7.1 Median size of existing stock and new supply of housing units by type, 1980–2010 (in square meters) Year 1980 1985 1990 1995 2000 2005 2010

Existing Stock of Public Rental Housing Units 23.1 24.5 28.3 29.6 31.9 34.0 33.8

Existing Stock of HOS Units 51.3 51.8 52.4 53.7 54.0 – –

Existing Stock of Private Housing Units 53.9 46.1 47.1 48.0 49.5 50.4 51.1

Source: Wong, Housing Authority, Rating and Valuation Department, 1997.

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Hong Kong Land for Hong Kong People

There is evidence that the size of PRH units has grown over time relative to private housing units, but the average size was still about 60% for the period 1980–2010. At the time, I proposed a new measure of the housing stock by counting each public housing unit as equivalent to 60% of a private housing unit based on the average size of the units, called the standardized housing stock. Using this measure, I  demonstrated that the “housing shortage” situation between 1982 and 1996 was substantially worse if we compared the number of households with the standardized housing stock. The nature of this housing shortage is not a shortage of housing units compared with the number of households. Rather, it comes from the small size of the housing units in the public rental housing sector. If tenants in that sector are all very poor, then this housing shortage would not occur because they would not be demanding larger private sector units. They would be willing to settle for the very cheap and small units in the public sector. But if some significant fraction of these households is not so poor and can afford private housing units, then there will be pressure for private property prices to rise, due to unsatisfied demand for housing accommodation. In an odd way the increase in private rents over time has provided a perverse rationale for the smaller size of public rental housing units, since their rents have become lower relative to rents in the private sector. Our public housing policy is therefore the direct reason why an unreasonably large proportion of housing units in Hong Kong are too small. Any public housing program is unavoidably committed to building uniform-sized units for all. But when these units are small, then a considerable number of them will be occupied by better-off households who aspire to live in better and larger units. The public sector provision has fallen short of the aspirations for the past 60 years, generating enormous pressure on home prices in the private market to rise even when there is enough housing in Hong Kong to accommodate everyone.

Mini Private Housing Units Public attention has recently become focused on mini-units in the private market: rooms, cubicles, bedspaces, cocklofts, caged homes, etc. Figures in Table 7.2 show that these mini-units are a diminishing problem according to figures published by the Census and Statistics Department. In 1981, there were 262,576 households living in such mini-units. Their numbers declined to 21,699 in 2006 and by 2011 had fallen further still to 8,870 households living in rooms and cubicles and 766 living in bedspaces and cocklofts. I believe the continuing presence of mini-units is also, to a large extent, a consequence of the public housing program. The HA has historically given priority for public housing units to married households, especially those with larger households.

The Inequity of Small Housing Units

49

Table 7.2 Domestic households living in private residential flats by types of quarters, 1981–2011

1981 1986 1991 1996 2001 2006 2011

Private residential flats Bedspace or Former subsidized Whole quarters Room or cubicle cockloft etc. sale flats – 324,262 262,576 – 447,937 188,202 585,885 120,800 714,568 95,519 856,149 70,501 976,764 21,699 67,745 996,407 8,870 766

Source: Population Census and By-Census.

There are obviously good reasons for doing so, but the poor, single individual often has to find housing in the private sector. Worse than being poor is to be without a family, because these individuals cannot pool together meager resources with other family members. For a single individual, a mini-unit close to job opportunities and work has a distinct advantage over a housing unit in a distant public housing estate where job opportunities are few, especially for those who do not have regular work or have to work odd hours. An iSun Affairs (陽光事務) report on February 9, 2012, estimated that urban areas accounted for about 80% of mini-units: 7,200 mini-units on Hong Kong Island and 9,900 in the old Kowloon areas of Sham Shui Po, Kowloon City, Wong Tai Sin, Kwun Tong, Mong Kok, Yau Ma Tei, and Tsim Sha Tsui. These units continue to exist in the private sector because housing demand in these areas is not met by the public housing program. This demand is coming in part from the members of the younger generation who want to split from the family to form new households. In 2013, the average age of non-elderly one-person households on the waiting list for public rental housing was 30. Of these, 85% lived with their parents (94% for those under 30). Some 40% had at least postsecondary education (67% for those under the age of 30). Interestingly, 53% of those under 30 were still students. The corresponding figure for the year 2010 was only 18%. It has been reported that recent orientation programs organized by university student associations for new students included a session to counsel them on how to apply for public rental housing. Surveys by the Housing Authority over 2007–13 show the impact of this age shift. While the number of non-elderly one-person households on the waiting list for public rental housing grew by 197% in that period, from 37,500 names to 111,500 names, the general waiting list (excluding non-elderly one-person households) grew by only 67%, from 69,800 to 116,900. Of the non-elderly one-person households, the largest

50

Hong Kong Land for Hong Kong People

increase came from applicants under 30 (born in the 1980s): their numbers increased by 341%, from 13,700 to 60,400. This is a new development, and it is a consequence of a policy change adopted by the Housing Authority during the Asian financial crisis. At that time, many HOS and PRH units had been completed, but there were no takers. To fill the vacant units, the Housing Authority found justification in opening up the applicant pool to singleperson households. Many students applied for these units and were admitted. Clearly, there is a growing desire among the younger generation to move out of the parents’ home to form single-person households. There are many reasons for this. The parents’ home may be too cramped for comfort, especially in public housing. The desire for greater privacy is another factor. Proximity to work and social life in the urban area is of course a convenience that living with parents may not always provide. A survey by the Housing Authority in 2013 found that, among the younger generation on the waiting list, about 29% lived with the family in public rental housing and 23% lived in subsidized sales flats. If these single individuals applied successfully for a public housing unit, then the family would have more space in the original living unit. Could this be simply another way for a public housing tenant to increase the original accommodation space, given that moving into the private sector has become more expensive? And if so, is the Housing Authority willing to provide additional public housing units to meet the aspirations for more living space for these families? This would accomplish a cross-generational feat: The “original household” would get an additional unit through splitting. The dilemma for the authorities is that, if they continue to give preferential treatment to married households, then these non-elderly one-person households will have to seek housing in the private sector. The demand for mini-units may well rise again, and the declining trend we have observed over time may reverse itself. This is a no-win situation. If society deems it appropriate to provide public housing for these one-person households, it will not be easy to find urban land to build the new units, and it will certainly not be cheap.

Liberate Small Units A faster, less expensive and non-wasteful solution exists; it is even “shovel-ready.” Restarting the halted Tenant Purchase Scheme (TPS) and lowering the unpaid land premium would immediately increase the supply of existing units onto the market. If the TPS were restarted on a large scale, plenty of units all over Hong Kong would become available, providing competition for mini-units in the private market. Both

The Inequity of Small Housing Units

51

private and public tenants would have more options to choose from. I elaborate on this idea in Essays 28 and 29, but let me briefly outline here the issues involved. The inequity in the allocation of public rental housing generates huge economic inefficiency affecting everyone. Economic inefficiency occurs when somebody gives you a good that cost $100 to produce, but you only value it at $50. The inefficiency loss in this case is 50%. But if another person values it at $100, is it not better to give it to that person? Transferring the unit to that person requires a decision by the owner of the product to approve the transfer. The best mechanism to get the product to the right person is the market. However, the fundamental nature of the public housing program is a non-market approach to subsidizing housing. The beneficiary does not receive a cash subsidy or a housing voucher that can be applied to the rental of a housing unit on the open market. The beneficiary has no choice about the size of the housing unit and very little choice about most other attributes of the unit such as location and floor. Units are offered with a take-it-or-leave-it option only. It is crucial to remember that the demand for housing will change over time as society prospers and over a household’s life cycle. Job locations can change, people get married, students start school or change schools, households decide to move closer to grandparents, parents, children, or grandchildren in a different part of the territory, and so on. The cost of being unable to change one’s housing unit over the life cycle and as society prospers places an enormous burden on everyone and on the economy. The public rental housing program has existed for almost 60 years. More than two generations and over half the population have lived in public housing units, most of them in the same unit. It is to be expected that a very large segment of them are welloff enough to prefer more spacious accommodation. The small-sized housing unit should ideally become available to meet the needs of less well-off tenants. However, without a market it is not possible for public housing tenants to make such choices. They are forced to stay in the unit they started with. At any moment, this means an extremely large proportion of tenants in the public housing program is stuck with a unit that does not meet their ideal needs.

Mong Kok or Ap Lei Chau: Counting the Cost to the Occupant How do we know the proportion of unsatisfied households is very large? The answer is in the inequity of the public housing program. I showed in Essay 6 that the distribution of household income between public and private renters overlaps enormously. The housing demands of many public housing tenants cannot be substantially lower than those of private renters. Policymakers in Hong Kong simply fail to appreciate this absolutely important fact. Their ideas about public housing are based on gross misunderstanding.

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Hong Kong Land for Hong Kong People

Since public housing tenants are not allowed to exercise choice over their housing units, the value they attach to their units must be lower than the true worth of their unit or its worth to another person. The only way you can get a well-off person to accept or tolerate a small unit is to offer a huge discount. Let me quickly add that the housing unit is only undervalued to the person who is occupying it. If a market exists and the occupant can rent out this unit to anyone on the market, its true value would be realized. For example, a PRH unit for which the Housing Authority charges a monthly rent of $1,000 to the sitting tenant may readily be rented out on the open market at, say, $6,000 per month, conditioned on size, location, and other attributes. The sitting tenant, however, values it at less than its true market value because its attributes do not fit his or her preferences. A person who is reasonably well-off may be unhappy that his Ap Lei Chau unit is not only too small but also far from the workplace in Kwun Tong and the children’s school in Kowloon, thus requiring long and costly commutes. There are also no direct transport routes to Tsim Sha Tsui, where his wife could work full-time, so she takes a part-time job in Aberdeen. There is no direct link to Ho Man Tin, where his wife’s mother lives, thus making it difficult for her to see her grandchildren. He is willing to tolerate all this because the rent he pays the Housing Authority is only $1,000 per month. He would, however, be much happier if the Housing Authority would allow him to sublease his Ap Lei Chau unit on the open market for $6,000 per month, allowing him to net $5,000 per month. He could then contribute another $4,000 per month himself and rent a $9,000 private unit in Mong Kok, which he could pay for by saving on transportation costs and having his wife switch to a full-time job in Tsim Sha Tsui. The family would enjoy a larger unit and save on commuting time so they could spend more time together, including seeing the grandmother. This is the kind of happiness and joy that a public housing bureaucracy cannot provide. Only the market can do this. Notice the cost of the subsidy the Housing Authority provided to the tenant is $5,000=$6,000–$1,000 (ignoring other costs of operating the Housing Authority’s program). The value of the benefit received by the household can be estimated as follows: Living in Ap Lei Chau, the tenant pays $1,000, but his happiness is less than living in Mong Kok, where he has to pay $4,000 extra; therefore, the benefit of Mong Kok over Ap Lei Chau must be greater than $4,000. Since the subsidy that the Housing Authority provides is $5,000, the benefit received by the tenant must be less than $1,000=$5,000–$4,000. This means that the efficiency of the program is less than 16.7%, and more than 83.3% of the subsidy is not valued. Dr. Yan Wai-Hin of the Chinese University of Hong Kong estimated the utility gains that the average public housing tenant derived from his or her housing benefit from1976 to 1996. Table 7.3 presents his estimates, which are calculated as the ratio

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53

Table 7.3 Subsidy and benefit per household per month, and the efficiency ratio of the public rental housing program, 1976–1996 Average Household Income ($) Subsidy Granted per Household ($) Benefits Received per Household ($) Efficiency Ratio Estimated Cost of Inefficiency Losses ($bn) Estimated Cost of Inefficiency Losses as a Percentage of GDP Gains in Housing Consumption per Household ($) Ratio of Gains in Housing Consumption to Benefits Received

1976 $1,560 $399 $243 0.61

1981 $3,374 $559 $351 0.63

1986 $5,680 $1,167 $873 0.75

1991 $10,072 $1,696 $1,231 0.73

1996 $16,547 $2,971 $2,090 0.70

$0.65

$1.04

$1.82

$3.21

$6.95

1.03

0.60

0.57

0.46

0.56

–

$118

–

$351

–

–

0.34

–

0.29

–

Source: Yan (2000).

of the benefit to the subsidy. The subsidy is the cost to the government, whereas the value of the benefit is what the tenant perceives he or she has received. Dr. Yan also gives an estimate of another kind of gain to the household according to the increase in housing consumption provided by the PRH unit compared to what the household would otherwise have consumed if it had to rent a unit on the private market; in other words, whether the public rental housing tenant consumes more housing under the public housing program, which can be in size and other housing attributes. The average gap between the subsidies granted and the benefits received is enormous. A fully efficient program would have an efficiency ratio of 1. The estimated efficiency ratio varied between 0.61 and 0.75 in the period 1976–96. For each dollar the taxpayer spent on the public rental housing program, the tenants valued it at only 61 to 75 cents. The remaining 25 to 39 cents were deemed wasted because the household had to stay in a unit that was not its choice. Resources were grossly misallocated and therefore wasted. The hidden annual economic costs of these economic inefficiency losses varied between 0.46% and 1.03% of GDP in the period 1976–96. These are large numbers. The actual yearly dollar losses increased from HK$0.65 billion in 1976 to $6.95 billion in 1996. More recent estimates have not been made, but given the rising market values of property, the annual economic cost of these inefficiency losses is likely to be even higher. The average gains in housing consumption in size and other housing attributes for the tenant household were $118 and $351 per month per household in 1981 and 1991. This is a very modest gain compared to the value of the subsidy that the Housing Authority provided at $559 and $1,696 per month per household. The ratio

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of the gains in housing consumption to the value of the subsidy provided was 0.34 in 1981 and 0.29 in 1991. How is this possible? It means that, for many households, the housing consumption gain is negative; in other words, these households were consuming less housing than what they would have if they had freely rented on the private market. They were enticed to join the public rental housing program because of the low rent and not because they were offered a better housing choice. A central issue critical to my thesis on the effects of the public housing program is that well-off tenants consider the units they occupy to be too small given their income. If this is indeed the case, then the gains in housing consumption for these well-off tenants would be negative in value. At the same time these well-off tenants may still be enjoying positive benefits from being a public housing tenant because of the very low rent they pay even though the size and other attributes of the housing unit they are occupying are worse than what they could willingly afford to consume. The share of households in the public rental housing program that enjoyed positive benefits and had positive housing consumption is given in Table 7.4. It is worth pointing out that households that enjoyed positive benefits could be consuming less housing and therefore suffer from negative consumption gains. These households benefit only because the rent is low enough to induce them to accept a worse housing unit. In 1981, only 52.0% had positive housing consumption gains, implying that half the households in the public housing program were living in units that were too small and had less desirable other attributes given their incomes. The ratio increased to 64.5% in 1991. This is consistent with the fact that, over time, the proportion of welloff households in the program had declined. Table 7.4 shows that the proportion of households enjoying positive benefits from the program was 84.4% in 1981 and rose to 94.9% in 1991. This probably also reflects a decline in the proportion of well-off tenants in the program. Why did an estimated 15.6% of the households in 1981 and 5.1% in 1991, that received negative benefits, still stay in the public housing program? Perhaps the estimates reflect indirectly that at least some members of these households were residing elsewhere. Even though many well-off public housing tenants live in units that are too small for their needs, many poor households living in the private sector have no access to these same units, which would be suitable for their needs. Without a market, the

Table 7.4 Percentage of households with positive benefits and positive gains in housing consumption Percentage of Households with Positive Gains in Housing Consumption Percentage of Households with Positive Benefits Source: Wong (1998).

1981

1991

52.0%

64.5%

84.4%

94.9%

The Inequity of Small Housing Units

55

rematching of tenants and housing units cannot take place legitimately. The Housing Authority may not wish to see such rematching take place and certainly does not allow it to happen at the present time. Black market transactions, however, do occur, although there are likely to be few of them. But such transactions do not have to be illegal. The Tenant Purchase Scheme was initiated then halted during the Tung Chee Hwa administration, but it could be reactivated on a much larger scale. A market in these units would then quickly emerge, and the economic inefficiencies we discussed would be quickly eliminated in one fell stroke. For this mechanism to work well, it is important, as I have mentioned, to significantly lower the unpaid land premium that purchasers are required to pay at the time of purchase at the current market rate; otherwise, there would be no incentive for trading to take place. I have been told by many that it is not fair for public housing tenants to get double benefits. They argue that the public has provided them with a subsidy to rent a public housing unit cheaply in the first place; therefore, to subsidize them again on the unpaid land premium is unfair to others who miss out. My counterargument is that they are not seeing the complete picture, as I discuss in Essays 9 and 10.

References Hong Kong Housing Authority, The. Memorandum for the Subsidized Housing Committee of the Hong Kong Housing Authority, Survey on Waiting List Applicants for Public Rental Housing 2011. August 12, 2011. Wong, Y. C. R. “How Severe Is the Housing Shortage in Hong Kong.” HKCER Letters, No. 42, January 1997, 1–3. ———. On Privatizing Public Housing. Hong Kong: City University of Hong Kong Press, 1998. Yan, Wai-Hin. “Efficiency in the Distribution of Hong Kong Public Housing Resources (’70s– ’90s).” PhD dissertation, School of Economics and Finance, The University of Hong Kong, 2000.

8 Small Housing Units and High Property Prices

One of the unique aspects of life in Hong Kong is that, after 60 years of sustained economic growth that has dramatically increased the incomes of individuals and households, people still live predominantly in housing units whose sizes have not grown very much over the years. Many in Hong Kong may have memories of life as depicted in the 1973 movie The House of 72 Tenants (七十二家房客). While standards of accommodation have certainly improved, most would agree progress has been limited and slow. Apart from the 72 subtenanted housing units of the movie, there is rented bed space popularly known as caged homes, and more recently subdivided rooms. I am sure Hong Kong sets the benchmark for high-density living in square feet occupied per person. Asking why housing units are so small is but another way of asking why housing prices are so high. Housing prices per square foot have increased by leaps and bounds in Hong Kong. In contrast, prices for single-family homes in the US, adjusted for inflation, size, quality, and other attributes, have remained quite stable over 130 years. Figure 8.1 shows that housing prices in the US have been largely unchanged since 1890 even though the population and building costs have increased steadily except for the periods of the Great Depression and the housing bubble before the 2008 financial tsunami. These figures are taken from Yale University Professor Robert Shiller’s study of housing prices for single-family homes, which measures price changes for the same unit over time. According to economic principles, one would predict that, as individual and household incomes rise, people would spend more money on housing. Since US home prices per unit have not changed for over a century, it can be concluded that American households must be paying for bigger and better homes. The housing units Americans live in today are indeed bigger and better than they were. By contrast, households in Hong Kong are living in units that may be better but are not a lot bigger. And housing is getting more expensive in Hong Kong, unlike in the US. Why is this? Simply put, for Americans, housing is primarily a consumption commodity; for Hongkongers, it has become primarily an investment commodity. On the surface, many may find the US housing price figures puzzling. Have not .

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Hong Kong Land for Hong Kong People

1000

250

900

Index or Interest Rate

Home Prices

700 600

150

500 400

100

50

300

Population

Building Costs

200 Interest Rates

0 1880

1900

1920

Population in Millions

800

200

1940

1960

1980

2000

100 0 2020

Year

Figure 8.1 US real home prices, 1890–2013 (with building costs, population, and long-term government bond interest rates added) Source: Robert J. Shiller, Irrational Exuberance, 2nd edition (Princeton, NJ: Princeton University Press, 2005), p. 13, updated to 2013.

housing prices in major cities in the US risen a lot over time? Casual observation can be misleading. US home prices did rise during periods of inflation in the 1970s and 1980s, and more relevant to our immediate experience there was a housing bubble in many cities beginning in the late 1990s that lasted for a decade. But home prices were kept in check for over a century by the move to suburbanization in the US, which also saw single-family homes grow in size. In Hong Kong, the great attractiveness of housing has not been its size, quality, and other attributes, but its long-term appreciation potential. This is intertwined with the issue of why housing units are so small in Hong Kong. I believe that, by focusing on size, we will be able to gain a deeper understanding of the reasons behind Hong Kong’s high housing prices. More importantly, it will then become more apparent to all that it is totally wrong-headed to anchor the aims of today’s public housing policy in the continued provision of housing as a consumption commodity. One crucially important factor affecting the supply and pricing of housing is regulation. In Essay 21, I explain why the new Town Planning (Amendment) Bill on July 7, 2004, made rigid planning rules and regulations even more rigid. When these regulations are combined with political lobbying from various interest groups and advocacy organizations, they often create huge delays in development. This leads to higher prices and smaller units. As a consequence, in the past decade the

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already considerable gap between housing prices and building costs in Hong Kong has become even wider. Regulatory rigidities make it very difficult, costly, and timeconsuming to make land available for housing development. This slows down the supply of housing in the face of rising demand. A natural market equilibrating outcome is to build smaller units so that the total number can be increased, given the fixed permitted floor space. As I describe below, the implementation of many major regulatory interventions in the past decades has slowed down the supply of housing units and contributed to Hong Kong being stuck with small housing units. Each and every one of these interventions added new burdens to the development process, slowed down supply, compressed unit sizes, and fuelled further property price increases.

First Intervention: Rent Control The first major intervention came in 1947, when the Hong Kong government imposed rent control on all prewar housing. Between 1945 and 1951, the population in Hong Kong increased from 600,000 to 2.3 million, placing huge pressure on housing provisions. The original intention of rent control was that it would be a temporary measure for one year, but once enacted it was renewed again and again. The British government in Singapore also imposed rent control in the same year. Rent control of course reduced the incentive for developers to build housing. It also encouraged landlords to evict tenants on expiry of the old lease, in order to raise the rent on leases for new tenants. To protect existing tenants, rent control measures were further augmented to make it impossible for landlords to raise the rent even on new leases. It was then impossible for the landlord to evict tenants, making it very difficult for prewar housing units to be redeveloped. Faced with one of the worst housing shortages in human history, the Hong Kong government chose a policy that made it impossible for the problem to be properly addressed. The aim of the Landlord and Tenant Ordinance (1947) was to protect the immediate interests of the local residents from new arrivals, but it ended up making property development more difficult and most landlords worse off and caused all tenants to suffer, except for the main ones who could often reap the benefits of subletting their unit. But they, too, had to reduce their living space. Some tenants found the congested environment in the old private tenements intolerable and moved into squatter units constructed without authorization on illegally occupied Crown land. Their numbers were quite limited compared with those crowded into the tenements. Between 1945 and 1948, the total number of people in Hong Kong increased from 600,000 to 1,800,000. Only 30,000 were squatters in 1948, representing less than 2% of the population. Even by 1953, when there were 300,000 squatters, they made up only 15% of the total population. The private prewar

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Hong Kong Land for Hong Kong People

tenements had managed to accommodate the vast majority of the new arrivals. The extremely cramped conditions in these tenements need no description. Rent control had set the stage for small compact housing accommodation and high-density living in the private sector. Despite its onerous effects, rent control was not enough on its own to permanently condemn Hong Kong to small housing units for over half a century. In fact, rent control legislation was amended under the Landlord and Tenant Ordinance (1955) to facilitate redevelopment of the old private tenements. Unfortunately, another policy intervention was inaugurated that made withdrawing from the small housing units syndrome that much more difficult.

Second Intervention: A Resettlement Policy to Reclaim Land Squatter units had been built on Crown land without permission. These were illegal structures. The builders were often construction companies that also built houses legally in the private sector. Such behavior did not ingratiate them with the colonial administration, which often regarded them as opportunistic speculators engaging in illegal, unethical, and exploitative practices. Their contribution to meeting the housing shortage was discounted. At the peak there were an estimated 1,000 developers operating in Hong Kong. This meant the property development business had to be highly competitive, making the allegation that this was a lucrative business rather unlikely. The typical squatter unit provided housing accommodation that was much more spacious than the cramped conditions in the old private tenements. This is corroborated by movies about life as a squatter at that time, featuring well-known child performers Lai Siu-Tien and Fung Po-Po. These films depict living conditions that were much more pleasant than those seen in The House of 72 Tenants (七十二家 房客). Squatter units were either sold or rented out to households that could afford to pay what government officials at the time described as “exorbitant prices” to a “racket.” This official view was seriously flawed and completely failed to acknowledge why builders had resorted to constructing illegal structures. If developers had not built these illegal structures, then housing prices would have been even higher. That the squatters were able to afford the so-called exorbitant prices suggests they were not the poorest in society. Fires in the squatter areas were common, and there were many investigations of them; but one fire, in Shek Kip Mei on Boxing Day in 1953, triggered the inauguration of the resettlement policy. As I have detailed in Essay 4, the popular urban myth that this policy was intended to help the poor get decent housing was just that, a myth. The real purpose was to clear squatter areas for redevelopment, since land in the urban area was scarce as a consequence of rent control.

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From 1945 to 1958, no more than 200 acres of land were made available in the urban area for development and less than 30 acres were auctioned. The rest of the land on which building took place was granted by private treaty, primarily for nonprofit projects. Since rent control prevented redevelopment, clearing squatter units that had invaded undeveloped land became in effect the only option for obtaining new land for housing (other than lifting rent control). Clearance was the easier option because it affected fewer households and recovered more land, given that squatter areas were less densely occupied than were the old private tenements.

A Policy Not Aimed at the Poor Denis Bray, former Secretary of Home Affairs during 1973–77 and 1980–85, wrote, “The resettlement program of the fifties was not a housing program for the poor. It was a means to clear land for redevelopment. You could not apply for a resettlement flat. You were offered one if your hut was about to be pulled down” (Hong  Kong Annual Review 1991, p. 9). These considerations clearly meant that being poor was not a necessary criterion for resettlement. As suggested above, households that became squatters before the resettlement policy was introduced were unlikely to be the poorest in society. When their squatter units were torn down, they were provided with a very basic small unit at low rent. The size of the new resettlement estate unit was in all likelihood even smaller than the squatter unit but likely to be more spacious than the cramped conditions in the old private tenements. Once the public sector program started to provide housing, the stage was set for Hong Kong to become permanently locked into the supply of small housing units. The poor and not so poor were provided with a uniform standardized housing space, whose only redeeming feature was the low rent that made it somewhat tolerable. A strange thing also happened. The number of squatters increased from 300,000 in 1953 to 600,000 in 1964, by which time they represented 20% of the population. The growth in squatters cannot be attributed to the arrival of new immigrants, because the inflow slowed down enormously after 1954. Two factors contributed to this phenomenal increase. First, the government resettlement policy provided powerful incentives for tenants living in cramped old private tenements to move out into squatter areas, with the expectation that they would be resettled in due course. There was widespread speculation on which squatter area would be cleared next. For tenants of the old private tenements, becoming a squatter was an intermediate step to resettlement and getting cheaper and better housing. The more squatter areas the government cleared, the more there were to be cleared; such were the perverse incentives of the resettlement policy.

62

Hong Kong Land for Hong Kong People

The injustice of the resettlement program was that, rather than targeting and helping the poor, it rewarded “bold entrepreneurial” ones who were willing to risk becoming illegal squatters. A means test was eventually introduced as another criterion for admission into the public housing program in a belated effort to respond to criticisms of unfairness. But for decades, the authorities struggled to balance the competing claims of poor households against the need for redevelopment clearance, and the debate spilled into the political arena.

Mini-Units Become the Norm Since the rent control introduced in 1947 made it difficult to repossess buildings, and redevelopment of the old private tenements became close to impossible, amendments were made to the Landlord and Tenant Ordinance in 1955, to facilitate repossession. Many of the old buildings were falling apart and becoming dangerous. Landlords were allowed henceforth to make monetary compensation to tenants for the loss of their tenancies, the compensation rate determined by the Tenancy Tribunal. This was followed in 1956 with an amendment to the Buildings Ordinance to allow for a more generous plot ratio. Taller buildings could now be built, significantly enhancing the incentives to redevelop old ones. There ensued a rush to redevelop, because rent control had delayed housing construction for over 10 years. Unfortunately, the Tenancy Tribunal set a low rate of compensation that was essentially frozen from the late 1950s to the early 1970s, setting the stage for excessive reconstruction to take place. Huge numbers of tenants were evicted. The ranks of the squatters swelled. And housing conditions in the squatter areas became as cramped as the old tenements. The public housing program had to accommodate growing numbers from two different groups: those who were evicted from buildings that were being demolished and those who voluntarily enrolled to become squatters in search of resettlement. For our narrative, the most devastating long-term consequence of the rapid explosive growth of the resettlement program was that vast numbers of Hong Kong people were offered small housing units at very low rent, and this would essentially become their permanent housing condition. Such a condition would of course spill over into living conditions in the private sector. The historical evolution of our public housing program, initially as non-meanstested resettlement units and subsequently as means-tested housing for the poor, guaranteed that those in public housing would be very heterogeneous in their economic situation. Some would be poor, others well-off, but all lived in similar housing units. This created a gross mismatch of public housing units with the aspirations of the incumbent occupants.

Small Housing Units and High Property Prices

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The mismatch has become worse over time as economic conditions have improved for some households but not others. This situation has generated an additional demand in private housing for larger units. But since the reference has been the cramped conditions of the old tenements and resettlement units, developers of private housing have not been very generous in their provision of space. The effects of rent control and the scale of the resettlement program have therefore had long and permanent consequences for the development of housing in Hong Kong. Small housing units have become the standard, and it is no longer possible to depart from this pathdependent development. Even worse, many units in the public housing program remain mismatched to their occupants and are underutilized or even vacant, because households that leave the public housing estate do not always surrender their units.

References Hong Kong Annual Review 1991, p. 9. Shiller, Robert J. Irrational Exuberance. Second edition. Princeton, NJ: Princeton University Press, 2005.

9 On Public Housing Policy and Social Justice

Any proposal to reform Hong Kong’s public sector housing policy and to create a market in public sector housing units should consider whether justice is served by providing an asset on subsidized terms to less well-off households. On the issue of social justice, there are general considerations as well as considerations specific to Hong Kong’s situation. Some commentators disapprove of using taxpayers’ money to subsidize less welloff households when they purchase an asset, but they do support using taxpayers’ money to provide these households with shelter. This sounds like a very sensible position on the surface. But let us think through carefully what it means. To make it simple, consider the public sector housing unit as two separate components: the physical premises and the land that it occupies. This entire unit is both an asset and a shelter. As an asset, let us suppose the market value of the unit when it was completed in 1980 was $500. This value is divided between the land value, assumed to be $400, and the construction cost of the housing premises, assumed to be $100. Now let us say a household is willing to pay $200 for the use of the unit. This is the shelter value of the unit to that household. The household obviously cannot afford the unit, so the government steps in and lets the household use it at the price of $200. If the household wishes to sell the unit in future—and thereby convert it from a shelter into an asset—then the unpaid land premium must first be repaid. In 1980, this unpaid premium would have been $300. If the unit is to be used only as shelter, some commentators argue the occupant should not benefit if its value appreciates over time. So if the land value doubles from $400 to $800 by 1990, these commentators would only agree to convert the unit to an asset if the household paid the unpaid land premium of $700. And if the land value doubled again to $1,600 by 2000, then the unpaid land premium would rise to $1,500. The rapid increase of land values in Hong Kong implies that only a relatively low percentage of households are able to afford to convert their units from shelter to assets. Most others are in effect only able to use their units as shelter. It appears from the comments I have received that commentators are quite happy with this outcome. They believe they have defended the interests of taxpayers.

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Evaporation of Resources Benefits No One But let me point out two consequences. First, the taxpayer hardly ever collects the unpaid land premium, because very few households ever pay it. A receivable that cannot be collected after many years should be written off and not carried on the books. It is foolish to believe that it is still there. What is even worse is that, 60 years after construction, many of these units will be so rundown that they will have to be redeveloped. I can easily imagine the unpaid land premium to be astronomical by then (assuming Hong Kong continues to prosper). The only party that could redevelop these units would be the government. And taxpayers would be forced to foot the bill again. Second, the subsidy provided by taxpayers to the household is the difference between the market value of the unit and the price the household pays for its use as shelter. This is $500–$200=$300. Over time, the amount of the subsidy will increase as land values increase. The odd situation here is that the cost of the subsidy paid by the taxpayer is larger than the benefits received by the household. The taxpayer pays for the asset value of the unit, but the household receives only the shelter value of the unit. This difference is a loss to society. Economists call this the deadweight social welfare loss. Nobody gains. Let me use another way of explaining this idea, because it is not familiar to those who have not studied economics. Society in general supports subsidizing education for children from less well-off households so they have opportunities in life without being constrained by a lack of family resources. This is called investing in their human capital. It is the same as providing them with an asset, but this asset is embodied in the person. Sometimes the subsidy is provided in the form of a loan (usually a low-interest loan), and the student has to repay the loan; but still the amount to be repaid is equal to the cost of the education and not the future value of that education in the marketplace. The student becomes the full owner of the knowledge and skills he or she acquires, and society does not usually put any restrictions on how the student uses them. Any attempt to do so is considered to be tampering with the student’s personal freedom. Moreover, imposing such restrictions as limiting the student to applying his or her human capital in only one country or one line of business would reduce the value of the education to the student. The mechanism through which people can change their jobs voluntarily is the job market. Not everyone changes jobs or indeed line of business, but without a market, it is not possible to change either voluntarily. Similarly, not many people change their residence, but the right to do so from time to time is a very valuable option. This can only be done if there is a market for public housing in which they have full ownership of their housing unit. The real issue is not whether households will reap a windfall

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that they can realize but whether they have the option to exercise choice when there is a need for them to do so.

Different Economic Consequences of Housing Programs in Hong Kong and Singapore It may be useful to consider what taxpayers lose when they give away a housing asset but then limit the recipient to using it only as a shelter. In Essay 7, I report that estimates of these annual economic losses were 1.03% of GDP in 1976 and 0.56% of GDP in 1996.These are very large losses for society in one year. And when we compound such losses over more than 50 years of public housing, the losses are astronomical. I believe these are likely to be low estimates, because the losses depend on the market value of the land premium. The premiums have increased considerably since 1976– 96, when these estimates were made. Just to illustrate the magnitude of the losses, it is useful to compare the per capita GDP growth rates of Singapore and Hong Kong, starting from Singapore’s independence in 1965, to 2010. Figure 9.1 gives the real per capita GDP profiles for the two cities in their own currencies. For ease of comparison, the values have both been normalized to 100 in 1965. The two lines show that, throughout the period, Singapore grew faster than Hong Kong at an average annual rate of approximately 1.35%. As a 1,400

Index (1965=100) Singapore - real GDP per capita index

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Figure 9.1 Real per capita GDP in Singapore and Hong Kong (including projected Hong Kong real per capita GDP), 1965–2010 (normalized to 100 in 1965)

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consequence, a Singaporean who started with $100 in 1965 was making $1,167 in 2010, but his or her Hong Kong counterpart was making only $655. The Singaporean had 78% more income. As I explain in Essay 4, Singapore allows for an active market in public housing units. This means it does not suffer the kind of deadweight social welfare losses that are present in Hong Kong in both public rental housing (PRH) and Homeownership Scheme (HOS) units. This factor alone could easily account for most, if not all, of the differences in per capita real GDP growth between Singapore and Hong Kong. The same figure also plots the projected real per capita GDP profiles for Hong Kong under two scenarios. Scenario 1 adds 0.5% to the growth rate, and Scenario 2 adds 1%. I conjecture that both Scenarios 1 and 2 underestimate the losses to society of not allowing a market for public sector housing units because they measure only static losses, those that result from denying households the ability to obtain the appreciation in land values. The dynamic losses have not been included; these would represent the forfeiture of potential gains that could have been realized if a person with more resources spent them on enhancing his or her productivity and that of others.

“Phantom Banks,” Government’s Role, and Options for Creating a Market in Public Housing Another issue that has been raised in regard to public housing is the appropriate level of subsidy and what form it should take. In a functioning public sector housing market, it is important to consider whether the household can afford to purchase another unit upon selling the original unit. If this is largely impractical (for instance, if  a substantial portion of the proceeds from the sale have to be returned to the Housing Authority as unpaid land premium), then there is no incentive to sell, and the market ends up with very few transactions. So, the issue is not one of greed or windfall gains but whether the market is real and active or simply exists on paper. Consider the following three conceptual options for how the unpaid land premium could be settled and a market thus created for these units. Let’s say for now that these options could apply to existing HOS or Tenant Purchase Scheme (TPS) units, or new units to be built in the future. Option 1: The owner of an HOS or a TPS unit has the right to pay the unpaid land premium at a time of his or her choice after an initial holding period, during which sale is prohibited. Under the HOS, this was initially 10 years and later modified to 5 years. So if Mr. Wong purchased an HOS unit in 1985, he could choose to repay the land premium any time after 1995. Suppose he decides to repay in 1999, when the property market hits bottom. If he cannot afford the required amount, he can theoretically find a “phantom banker” to mortgage his unit at an interest rate of 3%, which is approximately the average real

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mortgage interest rate after inflation over the period 1980–2010. He then signs his unit over to the bank as collateral and structures his loan so that he will pay back both the accumulated interest and the loan principal at the time he sells the unit. He and the banker can agree that the period during which he can exercise such an option is very long, say, 50 years. He then takes the borrowed money from the banker and repays the Housing Authority and settles the land premium. The problem, of course, is that such a banker does not exist in the marketplace. No  banker would be willing to make such a deal. This is a case of capital market imperfection. Bankers are unwilling to lend to a household with a poor credit rating on such terms; that is why this is a “phantom banker.” The government is ideally positioned to step in and become this phantom banker and even make the 3% real interest rate. This would enable Mr. Wong to exercise his right to “fix” his land premium in 1999. When he sells the unit on the market in 2008, he will just have to surrender to the Housing Authority a sum equal to the land premium as fixed in 1999, plus 9 years of interest accumulated at a 3% real rate. Actually, there is no subsidy in this interest rate, since 3% is the market rate. It is possible the rate could be set below 3% or even at zero if that is what society feels is acceptable. The public may even be willing to grant an unlimited period for Mr. Wong to sell his unit. This method of settling the unpaid land premium is exactly the present arrangement, except for having government step in to play the role of a phantom banker. In other words, government is stepping in to correct a capital market imperfection that households with poor credit ratings face in borrowing money. The right to choose the date to fix the land premium is a right Mr. Wong already has. All government has to do is to help him exercise it. Since society, including taxpayers, benefits from establishing a market in public sector housing units, then there is a case for government to charge less than a 3% real rate. Indeed, without an active market in public sector housing it is unlikely for the taxpayer to ever collect any significant amount of the unpaid land premium, because there will be no transactions. Option 2: An alternative approach is to fix the unpaid land premium at the original date of purchase. For Mr. Wong, this would be 1985 rather than anytime after 1995, as proposed in Option 1. Once the land premium has been so fixed, the government would show up to perform the role of the “government as banker.” Of course, if 1985 is at the bottom of the market, this will be great for Mr. Wong, but if it is at the peak then he would have a nightmare and most likely would refuse to accept the unit if given a choice. Option 3: A third approach is to fix the unpaid land premium as a multiple of the qualifying household income for admission into the program. While this has clear predictability, it is ad hoc and may from time to time diverge substantially from

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market levels. But it would provide a clear signal that government has adopted a policy of providing subsidized homeownership at affordable prices. As with the other two options, once the land premium has been fixed, the government would be the phantom banker. To fix the unpaid land premium for future public sector housing units, one could adopt either Option 1 or Option 3. For existing HOS and TPS units, either Option 2 or Option 3 could be used. I personally used to prefer Option 1 for future units and Option  2 for existing units, because Option 3 requires a new policy commitment to providing subsidized homeownership for eligible residents that I thought needed some more thinking. Today, I am convinced that government should make such a commitment, and Option 3 is the best choice for fixing the unpaid land premium. It would also be a single-policy option that could be uniformly applied to both existing and future units. For government to sell a unit at a discount and retain an equity interest in the land value is almost a feudal practice. It is almost like a master telling his serfs that their offspring must work for him and so must their offspring. With phantom bankers, the worst you get is a 3% real interest rate.

So What Is Social Justice? If we do not allow public sector housing occupants to trade their units on the housing market, then society will lose the value inherent in that asset. Such a loss is borne by everyone, including taxpayers. What is happening is this: Well-off households are giving valuable assets to less well-off households, but their use is restricted to shelter only. The land values are partly dissipated and therefore lost to all. All households suffer a decline in income as resources are destroyed by limiting their use. If instead we allow a market to exist, then less well-off households gain a share of the value of the land that would otherwise be lost, and in so doing they put the land resources to better use and raise the incomes of everyone. It is a win-win scenario. Which outcome is more socially just? Consider, for example, Hong Kong’s fiscal situation. The Financial Secretary has, in his 2014 Budget Speech, alerted the public to a possible structural fiscal deficit that the government could face as early as 2021/22. Government spending on health care, social welfare, education, and housing will outstrip government revenues within a decade. Citing figures from the long-term forecasts of the Working Group on LongTerm Fiscal Planning, he warned that even the accumulated fiscal reserves could be depleted as early as 2028/29 if nothing is done. It appears to me an obvious solution for balancing the long-term fiscal budget and meeting the challenge of government spending of our aging population is to adopt a new way of funding public housing expenditures. Our present public rental

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housing program is operated at a recurrent loss year after year. Developing more public rental housing units is a big drain on public spending. Historically, the cost of rental units was financed with cross-subsidies from the sale of HOS units. Since the HOS units are sold at a discount, the land values are not fully monetized. The HOS buyer pays for a fraction of the total land value and the Housing Authority holds onto the rest. In essence, both public rental housing and HOS housing in Hong Kong are financed through monetizing part of the land values of the HOS units. The land values are not fully monetized because part of the land premium is still unpaid and not wholly settled with the Housing Authority. It would make good sense today to develop a single subsidized housing program so the units are available for both rent and purchase, tenants having the option of renting first and purchasing later, as in the case of Singapore’s public housing scheme (see Essay 5). Our low-income households would be more than willing to purchase these units if they were priced at an affordable level for them. As long as they are priced to cover at least full development costs, the government would be able to finance the entire cost of providing subsidized housing through monetizing land values. These lowincome households would be able to benefit at nobody else’s expense. This would drive government spending on housing down to zero and would help reduce government spending pressure enormously, making scarce government revenues available for other uses. Surely what we want is to yield more resources for all, allow people to have greater freedom of choice, and build a better community. These were the central concerns of justice among the great philosophers of the last century. John Rawls wrote about helping poor and how this depended upon having resources. Peter Nozick wanted to uphold the rights of individuals and argued for more freedom of choice. And Michael  Sandel was concerned with how to achieve justice through community building. Unlocking land values would benefit all society.

Reference 長空無二：評王于漸活化公營房屋市場之建議，2011年9月28日。http://www.hkej.com/ template/forum/php/forum_details.php?blog_posts_id=74010

10 Economic and Social Consequences of Public Housing Policies

The most important issue in designing public housing policy is to have a functioning market that allows households to choose housing tenure, between tenancy and homeownership. This is especially important in developing economies with weak institutions that are experiencing rapid urbanization and industrialization, because the choice of housing tenure matters on both economic and social grounds. In Hong Kong, 47.3% of households live in public sector housing units, of which 30.8% live in public rental housing (PRH) units and 16.5% in Homeownership Scheme (HOS) units. As I have shown in previous essays, the restrictive tenancy arrangements and requirements to pay exorbitant land premiums for HOS flats mean that households cannot move to a location that is more convenient for them for work and personal reasons. Nearly half the population of Hong Kong therefore is destined to stay in the same initially assigned premise for most of the rest of their lives. Households are compelled to make inferior or suboptimal decisions conditioned on the location of their residence. A person living in Tuen Mun, for example, is more likely to give up a good job opportunity in Ap Lei Chau and accept a less preferred one in Tsuen Wan because of the inconvenience and cost of commuting.

Restrictions on Mobility Hurt All Compared to residents of private housing units, who can more easily move house and are more likely to do so, those in public sector units have reduced mobility. They are more likely to have to tolerate much longer commutes or compromise their job opportunities, schooling choices, and family togetherness than households in private housing are. Over the years, as a rising proportion of households has been absorbed into the public housing sector, the number of PRH and HOS estates located in satellite towns in the New Territories has grown. Since the urban areas are where the best jobs are concentrated and the preferred schools are located, to be stranded in remote locations far away from these opportunities cannot be an advantage. Such developments

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inevitably increase the hidden costs of foregone opportunities. The lower-middleincome class today is less likely to tolerate the restrictions on mobility imposed by the public sector housing programs than their counterparts were in years past. Unemployment and underemployment become a concern. Research in Europe and the US has shown that the unemployment rate is higher in cities with a larger proportion of homeowners because they have to bear higher costs than do renters, or even give up their existing premises to take up a new job opportunity in another location. By the same logic, households in Hong Kong’s PRH units face even more restrictive and costly constraints. They cannot afford to give up their present unit without exiting the public housing sector altogether. Relocating to another public housing unit in the vicinity of their job is prohibitively more difficult for them than even for private sector homeowners. The problem with satellite towns is that they fail to recognize the benefits of mixed developments. Old areas should coexist with new ones, and areas where people live should be better mixed with where they work. Moving large numbers of people to huge public housing estates in a new satellite town means moving people away from where jobs are located. The flaw in such an urban planning philosophy is best exemplified by Tuen Mun and Tin Shui Wai, probably some of the worst cases of satellite town development in Hong Kong’s history. These towns were created with huge public housing estates. Connecting their residents to jobs requires a very long and often expensive commute. Even though the Mass Transit Railway system has now been connected to these remote towns, the damage that was done to a whole generation of existing residents cannot be reversed. Speaking to families who live in these remote satellite towns is revealing of the plight they face. A family with a young child can only afford to have one parent commuting to an urban area for work. The other parent stays home to care for the child because the family is stranded in a remote housing estate where neighbors are not necessarily relatives or friends. The level of income is barely sufficient. On weekends, the entire family stays in the housing estate because a trip into the city is unaffordable. Only major holidays are occasions for family outings away from home. The grandparents often live in another part of Hong Kong, making it difficult for them to care for their grandchild. Often the grandparents might well be living in another public housing estate. Within the housing system, it is almost impossible to make arrangements for relatives to move closer to each other for mutual support. These, too, are opportunities that are foregone. One wonders if some of the family tragedies that we hear of could have been avoided with more robust and immediate family support. As the young child reaches adolescence, both parents can go to work. The child is then stranded alone at home and may acquire undesirable peer group habits without

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a parent, relative, or grandparent to provide oversight. Oftentimes the child grows up with little access to the world outside the remote neighborhood and is unable to develop friendships with people who do not live in the neighborhood. Family ties become weaker over time because relatives do not get together. Adult children who do not live near their parents are more likely to neglect them. Grandchildren who are not accessible to their grandparents also get neglected. The inability to move closer to each other encourages a greater reliance on professional social workers to step in to take care of both elderly people and young people, so adults can make long, expensive, and tiring commutes to work.

Land Values Evaporated Modern urbanized living probably contributes to the breakdown of the extended family in many ways, but do we have to exacerbate the process through a public housing program that leaves relatives and family members even more isolated from each other than is necessary? Even the professional social worker could achieve more if family ties survived better in Hong Kong’s urban environments. I often wonder why we have adopted public housing policies that worsen our social, family, and economic problems, and why we address these problems by making remedial investments in even more publicly funded social service and welfare programs. The hidden social costs of foregone opportunities and remedial measures are rarely understood and fully appreciated. As I have shown in Essay 7, “deadweight social losses” arise from regulatory restrictions imposed on the use and sale of PRH and HOS units. The restrictions reduce the value of a very valuable asset like land, because many uses are not allowed. The losses to tenants and homeowners are not gained by anybody else, because no one can develop the occupied land. Economists call this an efficiency loss due to the misallocation of resources. When this occurs, part of the value of the land has effectively evaporated. But this is not the stuff that politicians focus on or care about. The costs are hardly ever measured, but they are undoubtedly very large for the simple reason that so many households are impacted and over such long periods. In Essay 7, I reported that the estimated annual economic losses were equal to 1.03% of GDP using 1976 data and 0.56% of GDP using 1996 data. These are large numbers. I believe the annual economic cost of these deadweight social losses has to be even higher today. There is another factor to consider. The opening of China in the past 30  years has increased cross-border mobility between Hong Kong and the Mainland. How might this alter preferences for public sector housing and for home ownership in Hong  Kong? I am sure that, as some households choose to live on the Mainland side of the border, the requirement to occupy PRH and HOS units in Hong Kong in order to remain an entitled resident will become increasingly constraining. The

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foregone opportunity costs will keep rising over time if housing policy continues to hold people in their premises by suppressing the development of a market for public housing units. Singapore has provided a model for achieving such ends by allowing for the establishment of an active market in public sector housing for rental and for purchase and sale. But Hong Kong has succeeded only in providing affordable shelter. It has failed to provide an effective vehicle for low-income households to protect their savings and to share in the rising prosperity of a growing urban community. Without being able to own property, many low-income households also find it difficult to support the many critical decisions they have to face over their household’s life cycle. I believe the inability of low-and middle-income households to share in the rapidly rising prosperity of the community is behind the deep animosity against property hegemony in Hong Kong today. It is a misplaced animosity, because the real failure is a failure in the design of the city’s public sector housing policy.

References Wong, Y. C. Richard, and Pak-Wai Liu, “The Distribution of Benefits among Public Housing Tenants in Hong Kong and Related Policy Issues.” Journal of Urban Economics, Vol. 23, No. 1, January 1988, pp. 1–20. Yan, Wai-Hin. “Efficiency in the Distribution of Hong Kong Public Housing Resources (’70s– ’90s).” PhD dissertation, School of Economics and Finance, The University of Hong Kong, 2000.

11 Demand for Homeownership and the Housing Ladder

In 1997, a Ten-Year Housing Plan was announced by Tung Chee Hwa, with the goal of helping 70% of households achieve homeownership by 2006. The plan relied mostly on public provision for its delivery and to a lesser extent on the TPS. The TPS was announced in December 1997 to provide an opportunity for at least 250,000 families living in public rental housing to purchase their flats at affordable prices. The 1997 vision ground to a halt in the midst of the worst recession and deflation in Hong Kong’s history. In mid-2000, a Review of the Institutional Framework for Public Housing was commissioned by the government to map out a way forward. The Review indicated that public resources should be (1) focused on meeting the demands of families in the low-income group rather than those of middle-income households, and (2) administered increasingly through direct fiscal subsidy rather than a bricks-and-mortar approach. These revised policies represented a major departure from the MacLehose welfare state approach that had dominated housing development since the 1970s. The report also halted the HOS and TPS programs. The proposal to use direct fiscal subsidy to help the lower-income group, however, has not been followed up. The government’s new approach to policy decisions as a whole is now the source of much public criticism in the wake of rising property prices and excess demand. Public pressure on government to reintroduce the HOS reappeared after 2010. when the US Federal Reserve announced a policy of quantitative easing to jumpstart the US economy. American funds flowed into the emerging economies in the world, and in Hong Kong rising home prices in the private market reignited concern among middle-income households that their aspirations for homeownership were being frustrated. It is obvious there is an enormous desire within this community for people to own their own homes. The past 30 years have convinced the people of Hong Kong that property prices are highly volatile but will rise, and those caught without a flat to call their own will have much to regret later in life.

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Why Homeownership Is Difficult for the Younger Generation Public interest in homeownership is fuelled by a combination of rapid increases in property prices, low nominal interest rates, negative real interest rates, and low unemployment. We witnessed a similar situation in the mid-1980s, so the public is familiar with it. The difference between then and now lies in the economic circumstances of the typical household. In the mid-1980s, the transformation of Hong Kong from a manufacturing to a service economy was just beginning. Household income among the middle-income group was rising rapidly and was expected to keep doing so. People were confident that they could, over time, beat the cycle of rising property prices. Today, while we are facing the same set of conditions in the property market, the typical middle-income household is much less confident of its ability to get ahead of the economic cycle. The structural transformation of the economy is complete, and many in the middle-income group are less certain of how rapidly their incomes will rise in the future, making them more anxious and desperate as property prices keep rising. Those among the younger generation who are fortunate enough to have wealthy parents can make property purchases with their parents’ help. Negative real interest rates and rising inflation have allowed existing owners to refinance their properties to make new purchases, often for their children’s use. My own observations suggest that most local purchases of new flats in Hong Kong in recent years have been made by households that have property of their own to begin with. Housing wealth is increasingly becoming concentrated among the haves. The have-nots are increasingly left out, and they certainly feel this. Governments everywhere have always reacted to public disquiet when property prices surge, by clamping down on speculators. Such measures curtail price rises for a time, but they do not address the underlying reason for price surges, which is excess demand. Clamping down on speculation is sometimes justified to prevent the advent of asset bubbles. This is only a problem when there is excess leverage in the banks, not when there is excess demand in the housing market. Excess leverage can be controlled through the regulation of bank mortgages. Excess demand must be addressed through one of two channels: increasing housing supply or subsidizing the purchases of the have-nots.

Trading Up Is Limited to Existing Homeowners The C. Y. Leung government is boldly attempting to suppress demand by slapping on high punitive transactions taxes called Special Stamp Duty and Buyer’s Stamp Duty. The government is also aggressively trying to correct the present excess demand by

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finding new land and other approaches to increase the supply as soon as possible. Whether it will happen in time, and at what point of the business cycle we will be when supply hit the market, is difficult to know in an uncertain economic environment. Manipulating housing supply to accommodate the business cycle is in general a fool’s policy, a point that was recognized in the Review published in 2000. We may be lucky once in a blue moon, but most governments have a questionable track record in stabilizing the business cycle. The real policy issue for the government is whether it is possible to meet lowerand middle-class aspirations for homeownership—a vision embodied in the 1997 Tung Chee Hwa plan—through reviving the HOS program, which would continue the MacLehose legacy, or whether it should be accomplished through some other means. The previous boom-bust property cycle straddling the Asian financial crisis of 1997 left many of Hong Kong’s middle-income households devastated. But some came through in decent shape. The current boom-bust cycle is likely to help many of the survivors of the last boom-bust cycle to get ahead again, while most of the havenots will be left out once more. This will polarize society because the housing ladder, so often seen as the means to savings protection and wealth enhancement, is no longer at work for the have-nots of today, since they are so far behind the curve. Intergenerational mobility is now only available to those who already have propertied assets. Restoring the homeownership ladder would provide many of the havenots in our society with an opportunity to hitch onto the rising economic future of Hong Kong and the Mainland. In this way they would not be left behind. Owning their own property would expand their choices in an infinite number of ways. I can imagine some enterprising households starting a new business by refinancing their flat to obtain an affordable loan they would otherwise be prevented from borrowing. This would help small enterprise start-ups. I can also imagine a household choosing to relocate permanently, or temporarily, across the border, where their lifestyle would be partly supported by the rental income on their Hong Kong flat. Another scenario is an elderly household supporting itself with a reverse mortgage on an owned HOS or TPS flat. And if banks are not interested in making such loans, children may do so if they are in line to inherit the flat from their parents. Imagine, too, if elderly couples could rent out their flats and move closer to their children, thus becoming highly productive grandparents. Children who have left home might visit their parents more frequently if the flat is part of a future inheritance. If piety exacts a price, then at least let elderly people have the option of affording it. I can imagine some elderly households moving closer together to be in a common neighborhood. Hong Kong is aging, elderly people need more options, and they need to be empowered to make their own choices. They should not have to be totally dependent on the support of the state, even if they are poor. Likewise, low-skilled workers feel limited in their options in this rapidly changing world. But they need not be reliant on

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state programs for their livelihoods. If we empower them with a piece of our future, we can lift their hopes again. I believe Hong Kong must adopt a bold but practical plan to enlarge homeownership in the community so that even the have-nots can benefit. This cannot be achieved through supplying more land, building more flats, and introducing measures like Hong Kong land for Hong Kong people alone. These policy measures take too long to work and have too many inherent uncertainties, which I discuss in Essay 29. Instead, as I show below, we already have mechanisms that could be tweaked to achieve both possible solutions to excess demand: to increase housing supply and subsidize the purchases of homeowners.

Giving HOS Owners a True Subsidy At the end March of 2013, a reported 323,300 or 13.5% of domestic households were HOS owner-occupiers. In the 30 years since HOS flats were first introduced, a total of only 70,400 or 22% had completed payment of the unpaid portion of the premium on land. As a consequence, 252,900 or 78% of the flats were still unavailable for sale on the open market. The low turnover is shocking and is entirely the result of high unpaid land premiums, which are set at levels that are unaffordable to the vast majority of occupants. The value of the subsidy government has provided to HOS homeowners is too mean and not generous at all. By removing the incentive of HOS owners to sell these flats on the open market, the government also fails to collect the locked-up unpaid land premium. The HOS unit owners therefore hold on to their flats for too long. The government should review its policy on unpaid land premiums for HOS units with a view to lowering the premiums substantially to help occupants become full homeowners and enable more market transactions to take place. This would be a triple-win policy. First, the Housing Authority would be able to collect more unpaid land premiums and sooner, too. Second, HOS owners would know with greater certainty what they actually owed the government from day one, rather than seeing unpaid land premiums fluctuate and over time escalate with market conditions. (The premiums should obviously be set at levels that are much lower than present ones.) Third, some HOS units might then become available on the market for rent or sale. If only 5% of the 252,900 HOS flats were to become immediately available for sale on the open market, then 12,000 to 13,000 units would be added to the new supply right away. Aspiring new homeowners would not have to wait several years for new units to be built as proposed in various government initiatives, for example, the My Home Purchase Plan. Operationally, the “wins” could be achieved very quickly because the original price of HOS flats is known and so is the original discount. Would this be considered as

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giving away valuable land resources by the government? I do not believe so, because the land has no possible alternative use. The land is merely jointly held by the occupant and the government, and the government cannot utilize the land in any way, physically or financially. The present arrangement literally obliterates the unpaid value of the land, which the government cannot recover. Allowing the land to be fully transferred to the occupant at a further discounted value would restore its full value for the benefit of everyone. In this manner, many in Hong Kong who are not HOS occupants would benefit indirectly from injecting the restored land value into the economy. Moreover, since the first HOS flats were sold some 30 years ago, in another 10 to 20 years some buildings will be in need of redevelopment. How can this take place if there are still outstanding unpaid land premiums for some of the flats in a building? Negotiating redevelopment would be a minefield, given the ill-defined property rights. Even if government were to permit the owners to redevelop, would they be able to finance it if they did not possess the full land value of the premises? If nothing is done, these HOS estates could someday become the worst ghettos in the city.

Revise and Reactivate TPS Reactivating the 1998 TPS with a new method for calculating the unpaid land premiums would address this problem. The original plan was to sell 250,000 PRH flats within 10 years. Until the plan was halted in 2002, a total of 183,733 flats had been designated for inclusion in the TPS, of which 123,008 had been sold. As of end-March 2013, only 1,340 TPS flats had their unpaid land premium completed, less than 0.5% of the sold TPS flats. As with the HOS flats, the discounted land premium should be reset at a significantly lower level, to facilitate market transfer. This would increase the number of available TPS units for sale on the open market, to meet the aspiration for homeownership within the population. The remaining 60,725 unsold units could also be sold off sooner if the new terms for calculating the unpaid land premium became more favorable and known to the sitting tenant. In addition, more PRH flats could be identified for inclusion in the TPS. The total number of new PRH flats constructed since 1998 amounts to 301,471 units (1998–March 2013), which could all be included in the reactivated TPS program. This means a total of about 360,000 PRH flats would be converted into homeownership units within a very short time. Older PRH flats could also be identified for progressive redevelopment and conversion into homeownership units. My proposal does not require any changes to existing arrangements. The only change is to reset the unpaid land premium on the HOS and TPS flats sold by the Housing Authority. Operationally, this means minimal and easy-to-adjust changes: It is a “shovel-ready” proposal. The construction plans in the pipelines of the Housing

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Authority and Housing Society would be unaffected. All that would change is that they would be building mostly ownership units rather than rental units. The occupants of these units would be able to pass the units to their children as gifts or bequests. And these units could be redeveloped by the market. In the long run, the fiscal burden on society would be lighter. The pay-offs would be enormous. The very rigid MacLehose legacy would be loosened and the market framework utilized to immediately meet some of the aspirations for homeownership. And it would cost the government nothing. In the best of circumstances, it could even bring in a faster flow of land premium revenue.

12 How to Warm Up the HOS Secondary Market

One of the most important reasons why housing prices in Hong Kong are high is not the absence of land but the rigidities of planning rules and regulations that govern its use. This is discussed in Essay 21. These rigidities make it very difficult, costly, and time-consuming to make land available for housing development, whether in the public or the private sector. The inflexibility of regulatory control is not only limited to land use but also applies to existing housing units, both public rental housing (PRH) and Homeownership Scheme (HOS) units. As noted in my previous essays, these units, once assigned to an occupant, seldom become available for other users even when the occupant no longer wants to remain in the unit. The lack of circulation is the major source of inefficiency and inequity in the public housing sector.

Origins of the HOS Secondary Market HOS units have always been tradable on the open market but subject to two requirements. First, there is a resale restriction period after initial purchase, which was first shortened to 5 years from 10 years in June 1999 and then to 2 years in May 2005. Second, since the launch of Phase 3B of the HOS in May 1982, the subsidy, in the form of unpaid land premiums, has to be returned to the Housing Authority. As I have mentioned in previous essays, the latter restriction offers little incentive for owners of HOS units to sell their units on the open market, so trading activity has always been very limited. I estimate that less than 1% of the stock HOS units in each year are sold. Over time, as the land premium has continued to rise, the possibility of settling the unpaid land premium has become more remote for HOS homeowners. The amount of unpaid land premium is the critical element that chains all housing units in the public housing sector to the Housing Authority. Every economist knows that tariffs and quotas can be equally effective in reducing and eliminating international trade. A quota set at zero eliminates all trade. Similarly, a tariff rate set at 1 million percent would achieve the same effect.

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The government tried to liberalize things in 1997, when a secondary market for HOS units was created as a liberalizing measure to encourage the circulation of housing units within the public housing sector. Two categories of “eligible households” were permitted to buy units in the HOS secondary market without having to settle the unpaid land premium. These were (1) Green Form applicants, which included existing public rental housing tenants and those on the waiting list for public rental housing; and (2) existing homeowners in HOS units. This definition of eligible households that could now trade in the HOS secondary market added up to about 37% of all households in the population. White Form applicants for new HOS units, defined as eligible tenants living in private housing units, were excluded from this market. Unfortunately, these measures did not have the desired liberalizing effect.

Dominance, Market Competition, and the Role of the Housing Authority From 1997 to March 2014, the total number of units transacted on the HOS secondary market without settling the unpaid land premium was 37,686, which is less than 0.8% of the available stock of HOS units in each year. The creation of the HOS secondary market was a well-intentioned initiative to encourage public rental housing tenants to purchase HOS units so they would surrender their rental units back to the Housing Authority and free up “locked-in” public rental housing resources for those on the waiting list. But it has fallen short of expectations, because many well-off tenants continue to hold onto their PRH units. The reason for this is the Housing Authority’s narrow focus on generating circulation of housing units only within the public housing sector. I stress the word within because these policies center on accommodating the internal concerns of the Housing Authority. While the Housing Authority wants to shorten the time for those on the waiting list, it is equally keen to retain its role as the developer and landlord for the public housing sector in Hong Kong. Any changes it is prepared to make inevitably are constrained to those that would not threaten its role as Hong Kong’s preeminent developer and landlord. The Housing Authority also does not want to encourage the circulation of housing between the public and private sectors, except in a highly limiting way: by retaining the exorbitant unpaid land premium. It views the HOS secondary market as a mechanism for recovering PRH units, but no more. This thinking is trapped in a linear logic that sees only one path for Housing Authority clients to progress through the housing sector: from public rental housing, to the HOS, and to private housing. When this does not happen often enough, it seeks to give the odd push and pull but without any intention of changing the separation of the public and private housing sectors or the linear progression of households through the Housing Authority sector.

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Tenant Purchase Scheme: A Promising Initiative Falters The Ten-Year Housing Plan announced in 1997 promised to achieve the goal of 70% homeownership. It also introduced the Tenant Purchase Scheme (TPS) to sell 250,000 public housing rental units to sitting tenants. If this had been delivered, it would have gone a long way towards alleviating the gap between the haves and the have-nots. Although the public has always chosen to focus on the development of 85,000 new units as the centerpiece of Tung Chee Hwa’s housing policy, I believe the TPS initiative was the truly innovative feature of his plan. It was a bold initiative that held out promise of transforming the public provision of rental housing. The total stock of PRH units at the time was about 670,000, so the scale of Tung  Chee  Hwa’s proposal was vastly greater than previous failed attempts to sell PRH units to sitting tenants. Unfortunately, the Housing Authority imposed restrictions on the TPS that were essentially similar to those that applied to the sale of HOS units. While the TPS units could be sold on the HOS secondary market without settling the unpaid land premium, they could only be transferred on the open market 5 years after the initial purchase. And then, owners would have to return the exorbitant unpaid land premium to the Housing Authority. These requirements effectively created a powerful barrier that kept the TPS units from flowing into the open market. Similar to HOS units, there was really no strong incentive to sell TPS units on the open market. As before, the HOS secondary market of TPS and HOS units could not be integrated into the open market, except in a very marginal way. Tenants who acquired TPS units were also allowed to apply for new HOS units within 10 years as White Form applicants, as if they were tenants in the private housing market. This decision probably reflected the Housing Authority’s hope to encourage the circulation of housing units within the public housing sector. It still kept the HOS secondary market largely separated from the open market and posed no real threat to the existing institutional set up. As an economist, I see the HOS secondary market as a protectionist measure familiar in international trade practice and policy. The completely rigid quota system was replaced by a more flexible tariff scheme, but the protectionist effects were essentially unchanged. Of course, there were some marginal gains for some HOS and TPS homeowners.

TPS Wrongly Blamed for Property Market Crash The onset of the Asian financial turmoil in 1997 and the subsequent world economic recession of 2001 led to a double-dip economic recession in Hong Kong. This sent property prices plunging by 70% from their peak in 1997, leaving the public to languish. The cumulative consumer price level fell by 11.6%, the cumulative GDP

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deflator fell by 17.4%, nominal GDP fell by 8.5%, and about 57% of the decline in consumer prices was due to the decline in property prices. With a public facing negative net worth, widespread concern emerged over the large supply of public sector housing units that were being produced and brought to the market. The TPS was one of the factors incorrectly blamed for contributing to the fall in property prices. On November 13, 2002, the Secretary for Housing, Planning and Lands announced nine new housing policy measures, including putting a halt to the TPS. Only about 118,609 units were sold after it was introduced. I believe the decision to stop the TPS was based on an erroneous concern that it had contributed to the decline in property prices and would further weaken the property and housing markets. But there are a number of reasons why the TPS could not have contributed to the post-1997 decline in property prices. First, the 118,609 units under the TPS were voluntary transactions; therefore, they could not dampen property prices on the open market. If anything, the creation of additional wealth should have had a positive effect on prices. Of course, given the restrictions on reselling TPS units on the open market, the true benefits derived from TPS homeownership were not large, but they could not be negative. Second, for TPS units to have weakened property prices on the open market, they would have had to increase housing supply on the open market. This would be possible only after TPS households first settled the unpaid land premiums on their units, which they seldom did because they could not afford to do so. I showed in Essay 11 that only about 0.5% of TPS units settled the unpaid land premiums, so the feared effect on property prices on the open market could only have been minimal. Third, TPS units sold on the HOS secondary market without settling the unpaid land premiums could only be sold to eligible households. These were occupants living in PRH units or on the waiting list for public rental housing. Since such transactions involved clients within the public housing sector, they were unlikely to produce any spillover effect in the open market. In reality, very few TPS sales transactions were recorded in the HOS secondary market for the simple reason that there was very little interest in these units from within the public housing sector. For these reasons, fears that the TPS initiative dampened the private property market were unfounded. There was simply not enough activity in the HOS secondary market to produce any effect. Moreover, the Housing Authority had tried hard to minimize the connectivity between the public and open markets. The fact that the exorbitant unpaid land premiums had to be settled effectively eliminated any meaningful possibility of an impact on property prices on the open market. They provided a barrier to separate the HOS secondary market and the open property market. Almost a decade after the TPS program was halted, the government proposed allowing 5,000 White Form applicants to buy existing TPS and HOS units in the HOS secondary market each year, to revive the HOS secondary market. Interestingly,

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this proposal is direct confirmation that the TPS program had not contributed to the weakening of the open property market in the period after the Asian financial crisis. In fact, consider what would have happened had the Housing Authority allowed the exorbitant unpaid land premiums to be settled at a much more affordable rate. The HOS secondary market would have become more attractive, and more public rental housing tenants would have taken up the TPS offer. This would have produced a considerable positive wealth effect that would have stimulated the faltering property market. Had this happened, there would also have been no calls to halt the TPS plan of selling 250,000 units. The goal of 70% homeownership would have been closer to realization, helping to reduce the gap between the haves and the have-nots. And today, society would not be so divided and public trust in government would not have fallen so low.

Pricing in the HOS Secondary Market If there was sound reason to believe the TPS and HOS could be positive for the housing market, that still does not answer a paramount question: How much should be paid for these units? What would be the market rate? This is not a straightforward matter. The HOS secondary market has three types of client: (1) Green Form applicants who, as mentioned, are existing public housing tenants or on the waiting list; (2)  White Form applicants, who are eligible tenants living in private housing; and (3) open market purchasers. The first two groups do not have to settle the unpaid land premium at the time of purchase, but the latter group does. The inclusion of White Form applicants, which began in 2013 and was limited to 5,000 applicants, was a positive move to relax one of the many restrictions in the public housing sector. It was intended to revive the HOS secondary market and assist more private sector tenants to become HOS homeowners. Unfortunately, some criticism of the government for fuelling the property market surfaced after prices for small-sized units jumped in both the HOS secondary and private markets. Such criticism is beside the point. How can a market be revived if prices do not rise? But do these prices, at which HOS units are transacted, represent a genuine market price? To get an answer to this question, let us consider the supply and demand for HOS units. In the HOS secondary market there were 263,250 units that had not settled the unpaid land premium in 2012/13. They represented the supply pool of HOS units. We  cannot know with the same precision the potential number of eligible White Form applicants in the market, but it was likely to be quite large given the criteria was set at income levels of $40,000 per month for families and $20,000 per month

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for single individuals. In addition, there were asset restrictions. The actual number of submitted White Form applications in 2012 was reported to be 66,000. The market price paid for the units is determined by successful matches of eligible White Form applicants with the occupant vendors of the HOS units. Out of this large potential pool there will always be some who are willing to pay a very high price for a suitable HOS unit in the secondary market. The suitability of an HOS unit will depend on the attributes of the available housing units with respect to location, size, and quality of the unit in meeting the individual preferences of applicants. It is entirely possible that some potential buyers will be willing to pay very high idiosyncratic prices because of their specific personal preferences. But what is the minimal price the occupant vendors would be willing to accept to sell their units? This is not too difficult to figure out. A vendor without idiosyncratic preferences for his or her own unit would be willing to sell, provided he or she is able to get back a somewhat equivalent unit somewhere in the private sector. The unit can but may or may not be in a nearby location. This means the buyer would have to be able to pay approximately the market price for a similar private housing unit. If this is the case, then a natural question that arises is: Why didn’t the buyer just go ahead and buy a private housing unit instead? Isn’t the whole purpose of the exercise to allow those who could not afford to buy private housing units to purchase presumably cheaper HOS units? If so, then isn’t this much ado about nothing? And why would these private housing tenants be willing to pay close to private market prices to purchase an HOS unit with an unsettled land premium on it? The key to understanding what this exercise accomplishes is that it allows vendors and purchasers with idiosyncratic preferences to find each other. In other words, there is a match or a successful transaction. Let me illustrate in somewhat dramatic terms what is happening. Let us start with an occupant vendor living in an HOS unit in the Pokfulam area. This occupant now prefers to live in the Tin Shui Wai area because she travels frequently to Shenzhen to mind a small business she has started there. But as an HOS occupant who has not settled the unpaid land premium, she cannot afford to buy a private housing unit in the northwest New Territories. Next comes an eligible White Form applicant living in the Aberdeen area who is only interested in living in proximity to this area. If he can afford to purchase a Tin Shui Wai private housing unit, then these two parties could do business. The White Form applicant can pay enough money to help the HOS unit occupant vendor purchase a Tin Shui Wai unit in exchange for her Pokfulam unit. The White Form application exercise allows these two parties to find each other. This is the beauty of the market and free exchange. It allows parties to fulfill their idiosyncratic wishes. Now we are ready to return to the issue of whether the transacted prices are genuine market prices. The transacted prices observed are those that resulted from a successful match. So what is the nature of these transacted prices? They are prices

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that occupant vendors of HOS units are willing to accept. The occupant vendor still needs a place to stay and is only willing to give up his or her unit in exchange for a somewhat equivalent unit somewhere in the private sector. The market price for HOS units will be determined by the price of a similar private housing unit in Hong Kong that the occupant vendor is willing to accept. The vendor here prefers to sell his unit to a White Form applicant rather than on the open market because the White Form applicant does not have to settle the unpaid land premium. The reason why so few HOS units are sold on the open market is not difficult to understand. The occupant vendor is often unable to afford a similar unit in the private sector if he or she has to settle the unpaid land premium after selling his or her own unit on the open market. A White Form applicant who is willing to offer the occupant vendor a price higher than what the seller can get on the open market net of the unpaid land premium— and that is sufficient for the occupant vendor—has a better chance of getting the unit. Both parties have strong idiosyncratic preferences. This explains why, when we add the unpaid land premiums to the transacted prices, they can sometimes be even higher than the open market’s valuation of the HOS unit. But the vast majority of HOS secondary units that will be sold will have to be priced similarly to a somewhat equivalent unit somewhere in the private sector. This also explains why there are so few such transactions.

The Supply Squeeze Deregulation would create trading opportunities previously not available. What is the volume of such potential matches in the market? Nobody really knows. By restricting the exercise to only 5,000 qualifying applicants, the full potential has not been realized. Removing that limit would allow more such mutually beneficial matching transactions to occur. Property prices in the HOS secondary market would obviously increase, but one must appreciate that the total stock of units in the HOS secondary market will remain fixed for many years. The total number of units that could be traded in 2012/13 without first settling the unpaid land premium was 381,859, of which 263,250 were HOS units and 118,609 were TPS units (see Table 12.1). It is highly unlikely that these numbers could be increased over the next few years, because new HOS units have yet to be developed. We have a situation of rising demand not matching increasing supply. In fact, the supply of housing stock is not only fixed but also quite limited in size. Faced with such a set of conditions, I believe the government has little choice but to proactively consider increasing the available supply of units in this fixed pool. The only immediately available source of supply is to revive the TPS program that was halted in the year 2000.

Table 12.1 Estimated stock of units with unpaid land premium in the HOS secondary market, 1998/99–2012/13

1998/99 2000/01 2002/03 2004/05 2006/07 2008/09 2010/11 2012/13

Total

HOS/PSPS/ BRO/MSS/ FFSS

TPS

178,708 231,301 322,052 357,847 353,825 371,144 377,020 381,859

178,708 211,494 264,184 267,238 258,845 258,695 261,709 263,250

0 19,807 57,868 90,609 94,980 112,449 115,311 118,609

Units held for 2 to 5 years and are available for sale on the HOS secondary market only 25,563* 69,067 129,607 96,966 23,528 25,848 24,545 11,111

Units held for over 5 years and are available for sale on the HOS secondary market and the open market 153,145 162,234 192,445 260,881 330,297 345,296 352,475 370,748

Note: *Before 1999, units available for sale on the HOS secondary market only had to be held for 3 to 5 years. Source: Hong Kong Housing Authority, Hong Kong Housing Society.

13 Divorce, Remarriage, and the Long-Term Housing Strategy

The Long-Term Housing Strategy (LTHS) Consultation Document was issued by a government-appointed Steering Committee in September 2013. This was an attempt to address some of the underlying issues I have mentioned in this book and provide a vision for Hong Kong. Unfortunately, it lacked ambitious goals and bold ideas. While it covered many fine points and suggested some reshuffling of priorities regarding the housing needs of elderly people, non-elderly singletons, inadequately housed households, young people, first-time buyers, and plot ratios, it offered few breakthrough ideas. The development of new towns, renewal of old urban areas, reforming of the small house policy, and tradeoffs regarding a more spacious living environment were all relegated to be issues addressed beyond the next ten years. Older ideas, like reissuing Letters B to facilitate the redevelopment of agricultural land and the easy and feasible option of reactivating the TPS, were not mentioned. There was also no mention of homeownership goals which have been a centerpiece in the housing policies of previous administrations. More worrying were the housing targets it set for the next 10 years. These targets were very modest. Only 470,000 units would be built, 60% in the public sector and 40% in the private sector, working out to 47,000 units a year. This figure was arrived at on the basis of a projection that first put the future annual increase in domestic housing demand at 29,400 new households each year. To this were added 17,600 new units to make up for a shortfall due to the demolition of old units and to meet the needs of inadequately housed households, satisfy demand from external sources, and so on. But this target is based on a significant underestimation of the projected increase in long-term housing demand. There are both methodological problems and substantive issues. The core methodology driving the government’s projection of long-term housing demand is a two-step “life cycle” model. This approach is used in many countries. In the first step, future changes in the size of the population and its age-sex distribution are predicted. In the second step, the results obtained from the first step are used to predict future changes in the number of households (or headships). Past trends are assumed to be sustained into the future, 10 years in this instance. The long-term

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projected change in the number of households (or headships) would then constitute the projected change in the demand for housing. Using this methodology, the annual net increase from 2011 to 2021 is projected to be 294,000 new households, which is slightly less than the actual increase of 315,000 households from 2001 to 2011. However, the figure for the latter decade does not reflect the fact that some households wanted to set up new households but could not afford to do so. In other words, the actual number of new households in 2001–11, observed to be 315,000 households, should be seen as an understatement of the true underlying increase in housing demand. Therefore, there was unmet demand, which was the reason housing prices rose rapidly and subdivided units appeared.

Theoretical Errors in the Projection Methodology Let us examine theoretically the changes in the demand and supply of housing for the years 2001, 2011, and 2021, using Figure 13.1. In this figure, the demand in year 2001 is denoted by the demand curve D2001, in year 2011 it increases to D2011, and in year 2021 it further increases to D2021. If over these same years the supply curve also increases by the same amount as the demand curve, then the increases in the number of households will be matched by increases in the number of housing units, and these will be Q2001, Q2011, and Q2021. P

S2001 S2011 S2021

D2001 Q2001

Q2011

Q2021

Figure 13.1 Increases in housing supply equal increases in demand

D2011

D2021

Q

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However, if the increase in the supply of new housing units is less than the increase in the new household demand, a situation will emerge that is shown in Figure 13.2. The outcome will be a provision of Q*2001, Q*2011, and Q*2021 housing units in equilibrium. These numbers would underestimate the underlying growth in housing demand. In this second figure, supply increases less than demand. How do households get accommodated under these circumstances? Housing prices will naturally have to rise. Some households will then be accommodated in the new housing units, some in subdivided housing units, and some will have to share their living space with other family members in older households even though they prefer to be separately accommodated. Figure 13.2 is a better description of what actually happened in Hong Kong over the period 2001–11, a situation that I believe is continuing in the decade up to 2021. The projections of the two-step life cycle model did not predict the hypothetical situation shown by Figure 13.1. Instead, the model predicted the actual market outcome depicted in Figure 13.2. The predictions assumed that increases in housing demand were the same as the number that could be accommodated in a tight housing market. But the number accommodated is a market outcome and will underestimate the underlying increase in market demand.

P

S2001 S2011

D2001 Q*2001

Q*2011

Q*2021

Figure 13.2 Increases in housing supply fall behind increases in demand

S2021

D2011

D2021

Q

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What Is Wrong with the Projections? What drives the increase in the demand for housing? Figure 13.3 shows that the percentage of single-person households rose from 14.9% in 1996 to 15.9% in 2001, 16.5% in 2006, and 17.1% in 2011. The number of single-person households over 5-year periods grew by 42,983 in 1991–96, 44,205 in 1996–2001, 46,542 in 2001–06, and 36,535 in 2006–11. This means about 7,000 to 8,000 new households were added each year. But these numbers are only market outcomes and therefore underestimate the underlying interest in forming new households, because the wishes of some could not be accommodated for reasons of affordability. Another driver of housing demand is the rapid acceleration of divorce and marriage rates (see Figure 13.4). The divorce rate has been rising since 2001 and is still trending in that direction. In 1991, there were 31 divorced individuals per thousand households; the numbers increased to 70 in 2001 and 107 in 2011. In 2012, there were about 21,125 divorces, 40,841 first marriages, and 19,542 remarriages. At the present time, divorces and first marriages alone could increase new households by more than 60,000 per year and thus fuel demand for 60,000 more housing units, which is substantially above the 29,400 per year figure projected by the life cycle model in the consultation document.

450,000 400,000

(No. of households) 15.1

350,000

14.7

16.5 14.7

15.6 14.8

14.8

14.9

404,088

16

367,653

14

321,111

Number of single-person households

300,000

12

276,906 Ratio of single-person households to total households 233,923 (%) 214,981

250,000

10

189,087

200,000

8

147,440

150,000 100,000

15.2

17.1 (%)18

6

124,460 100,662

4

50,000

2

0

0 1961

1971

1976

1981

1986

1991

1996

2001

2006

2011

Figure 13.3 Growth of single-person households Source: HKSAR Census and Statistics Department, Population Census and By-Census, various issues.

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50,000 45,000

No.

40,000 35,000 30,000 25,000

First marriage of both parties

20,000

Divorce decrees granted

15,000

Remarriage

10,000 5,000 0

Figure 13.4 First marriages, divorces, and remarriages Source: HKSAR Census and Statistics Department.

The life cycle model is not a bad model to use for projecting future household demand for housing, but it inevitably produces underestimates when the future is projected on the basis of an extrapolation of past trends in a tight housing market. When housing demand is growing faster than housing supply, the number of households that can be accommodated will necessarily be less than the underlying increase in demand. By extrapolating past market outcomes into the future, we will only be meeting part of the future increase in housing demand. This means the pressures that cause housing prices to rise and housing units to be subdivided will continue.

Rising Divorce and Remarriage Rates and the Goals of the Long-Term Housing Strategy We know that in Hong Kong, as well as elsewhere, divorce rates are higher among lower-income households. This is indirectly evident from the higher proportion of divorced individuals living in rental units compared to homeownership units (see Table  13.1). Remarriage rates have increased significantly over time. Remarriage opportunities are much higher for men than they are for women, which means a growing proportion of divorced men are remarried, while women remain divorced. In 1991, within the whole population, 21,140 men were divorced compared to 28,540

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Table 13.1 Housing tenure of married and divorced individuals, by sex (in thousands) Marital Status and Sex Married men

Married women

Divorced men

Divorced women

Year 1991 2001 2011 1991 2001 2011 1991 2001 2011 1991 2001 2011

Public Renter 473 506 502 464 470 481 8.3 21.4 41.0 9.2 32.6 78.0

Private Renter 244 242 267 198 219 258 5.9 15.1 18.9 6.6 23.6 32.5

HOS 101 281 304 103 278 302 1.1 5.6 10.5 2.1 11.4 23.1

Private Owner 467 579 679 476 567 679 5.9 13.4 21.0 10.6 24.9 42.0

Total 1,285 1,608 1,752 1,240 1,537 1,721 21.1 55.6 91.5 28.5 92.4 175.9

Source: Hong Kong Population Census and By-Census, sample datasets.

divorced women; the corresponding figures for 2001 were 55,620 and 92,420, and for 2011 they were 91,540 and 175,940. What is apparent in Table 13.1 is that the number of divorced women living in public rental housing has increased rapidly compared to the number of divorced men living in public rental housing. In 1991, there were 8,260 divorced men and 9,220 divorced women living in public rental housing. By 2011, the figures had risen to 41,080 divorced men and 78,360 divorced women. It is likely that divorced women remain as public rental housing tenants while divorced men move out. Some of these divorced men who remarry subsequently would apply for public rental housing again, if their incomes still qualified. The rise in applications on the waiting list for PRH units in recent years may be reflecting in part such a phenomenon. To what extent this is the case has to be further ascertained. The current public rental housing allocation criteria favor married couples but do not discriminate between first marriages and remarriages. Implicit in such allocation criteria is a positive incentive that subsidizes divorces and generates a penalty on children who inevitably suffer from broken families. The growing numbers of divorced women living in public rental housing units imply a rising number of children growing up in broken families in public rental housing estates. This is not conducive to upward social mobility but sets the stage for the production of a new underclass that perpetuates intergenerational inequality. Another likely consequence of rising divorce rates is that low-income divorced men who move out of the public rental housing unit probably occupy a significant proportion of subdivided housing units. Some may remarry and eventually re-enter

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the public rental housing program; others may become permanently stranded in these private sector units. Neither conjecture can be demonstrated quantitatively at this time, because the data are not available. But I believe they should not be dismissed, because they have grave implications for the kind of long-term housing strategy Hong Kong should adopt. As divorce and remarriage become increasingly prevalent in Hong  Kong, the aims and consequences of our long-term housing strategies need a fundamental rethinking. Are our present housing policies creating an underclass and making divorce too easy? The rise of subdivided housing units is a symptom of a tight housing market, but it is also the product of the rising interest in forming new and separate households, some of which stem from rising divorce rates! A housing strategy is not merely about how many housing units to build. It is also about what kind of society we will be encouraging through policies that influence household allocation choices. It is important that we think through more clearly and examine more carefully what is at stake. Are we encouraging divorce? Will we help create an underclass? Will we exacerbate future intergenerational inequality? Errors in forecasting demand can be easily remedied. Errors in policy will haunt many future generations.

14 Divorce, Inequality, Poverty, and the Vanishing Middle Class

Hong Kong’s divorce rate in 2011 of 2.89 persons per 1,000 people (excluding domestic helpers) places it among the top 10 highest divorce rate areas in the world. Increases in the divorce rate distort measured household income inequality and exaggerate the rise of static poverty. Static poverty is concerned with the relative inequality between households at a given time. If poverty alleviation policies are formulated only on the basis of the observed distribution of household income at a given time, then it could lead to badly designed policies, as the experiences of the US and Europe have shown. Even more important is the effect of divorce in lowering upward social mobility and generating dynamic poverty. Dynamic poverty differs from static poverty in that it concerns poverty across generations due to the lack of upward mobility. This essay discusses how these interrelated phenomena could develop in Hong Kong at an alarming pace. Figures 14.1 and 14.2 show the number of divorced men and women per 1,000 households by the type of housing tenure they are in. The highest number of divorced persons is found among private housing tenants, closely followed by public housing tenants. The number of divorced persons is much lower among owners of subsidized sale flats and lower still among homeowners of private housing units. In the first decade of the 2000s, the divorce rate was on average about 50–60% higher among renters than homeowners. The difference in the divorce rate between renters and homeowners was much smaller in the 1980s and 1990s, only about 10–25%. For most people in Hong Kong, housing wealth is the most important part of household wealth. Housing tenure is therefore a very good proxy for whether a family is wealthy or poorer. We can conclude from the charts in Figures 14.1 and 14.2 that the divorce rate is much higher among poor families than it is among wealthy ones. We can also see that divorce rates are rising rapidly over time, most dramatically among those who are poor. When the divorce rate is rising, especially when it is rising disproportionately for poorer people than for wealthier people, then the measurement of household income inequality will become fairly distorted. This is a purely statistical point about the way

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Figure 14.1 Number of divorced and separated men per 1,000 households by housing tenure Source: Hong Kong Population Census and By-Census Sample Databases, 1976–2011.

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Figure 14.2 Number of divorced and separated women per 1,000 households by housing tenure Source: Hong Kong Population Census and By-Census Sample Databases, 1976–2011.

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household income is measured. Below is a stylized example to demonstrate what I mean. Suppose there are only two households in society, each consisting of a working husband and wife. One household has an income of $40,000 (the husband and wife each earn $20,000), and one has an income of $20,000 (the husband and wife each earn $10,000). The average household income in this two-household society is $30,000. Now suppose the husband and wife in the lower-income family get divorced. They each keep their jobs. Now there are three households, one earning $40,000 and two earning $10,000. The average household income has fallen from $30,000 to $20,000, a drop of 33% even though everyone’s individual income is unchanged. This example shows that, during a time when individual income is actually unchanging, a rise in the divorce rate among families below the average income is going to pull down the measured rate of average household income. This effect is stronger if the wife of the poorer family was not working before the divorce. If she takes a job or receives social welfare support, it is likely for a variety of reasons to be at a lower salary than her husband’s. Notice in this example that there is also a decrease in the number of persons per household. This has nothing to do with having fewer children or spreading income over a smaller number of people. It is a result of the divorce rate that leads to measured household income being a misleading representation of what is going on in the economy and in society. These statistical effects are not small and explain, for example, why the household income gap between wealthy people and poor is rising much faster than is the gap in individual income. The measured increase in household incomes at the bottom 10th percentile of the income distribution was stagnant after the mid-1990s, but it rose in the case of individual incomes. In other words, rising household income inequality may be, at least partly, a statistical artifact due to a misreading of the data caused by demographic changes. Calculations similar to those in this example can also be applied to show why the growth of elderly households and single-person households can statistically produce an increase in the measured inequality of household income. This reminds us once again why it is hazardous to interpret changes in static inequality based on a single number and to thereby infer there has been a rise in poverty. It is even more hazardous to anchor policies to this interpretation.

The Reasons behind Hong Kong’s Rising Divorce Rates The rapidly rising number of divorces is suggestive of some very real and alarming concerns about how poverty is being formed in Hong Kong and how it may affect upward social mobility and cause dynamic poverty across generations. It is

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conceivable that wealthy people could continue to prosper over generations while the poor continue to stay behind or even fall further behind. Of particular concern is the growing number of divorced women, because remarriage rates are much lower among women than among men. In 2011, the remarriage rate of previously divorced, separated, and widowed men was 48.1 per 1,000, but it was only 8.4 among women. Divorced women often have low incomes and try to raise children in broken families. Some become increasingly dependent on the state for support. Rising divorce rates are the product of many factors, and some of them can have a profound impact on dynamic poverty. Divorce becomes a sad but necessary solution for unhappy marital partners when the benefits of divorce outweigh the costs. An important driver of rising divorce rates in contemporary society is the ability of divorced women to find alternative support and economic opportunities after marital dissolution. Several factors have shifted the balance in favor of the divorce solution. First, women have become better educated today relative to men than they were in the past. This has improved the opportunities for women in the labor force, making them less dependent on men for support and better able to lead a meaningful independent life. So, when marriages become unpleasant, women are less willing to tolerate an unhappy situation. Second, government provision of welfare support for divorced women with low incomes and dependent children has also tilted the balance, making it less costly and more feasible for women to accept divorce. Government assistance is provided with the intention of helping those who are already divorced and in need of support, but inevitably these assistance programs create incentives that tilt the balance for those who are still deciding whether to get divorced. Third, closely related to the rising education and growing labor market opportunities of women is the declining demand for a larger number of children in the family. Time spent together and raising children are the joint assets of the parents. Getting to a settlement on how best to divide up joint assets is always a complicated problem when marriage breaks down. Fewer children mean the number of joint assets in a marriage decline, especially among poorer households, that often cannot afford to make many investments in their children and in have few other jointly held family assets such as owned homes. The net result is that divorce is relatively less costly now. The propensity to become divorced is thus higher among poor families. Fourth, the introduction of divorce laws in favor of “no-fault, unilateral” divorces has also increased the divorce rate. To some extent the laws themselves are responding to the social and economic forces that are the primary drivers of the divorce rate. But, in accommodating these forces, the law at the very least has made it easier for divorce to take place by permitting an unhappy party to exit.

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In the US, it has been estimated that no-fault, unilateral laws led to a short-run increase in the divorce rate of about 10% for about 10 years. There are many reasons for the limited long-term effect in the US. Laws were subsequently changed to stem the tide of divorce. People also adjusted their behavior to prevent unilateral walkouts from unhappy marriages. In Europe, the introduction of no-fault, unilateral divorce increased the divorce rate by about 30%, where the average rate of divorces was 2 per 1,000 in 2002. It appears the impact of these laws is much larger and more permanent in Europe. In Hong Kong, following the recommendation of a 1992 report by the Law Reform Commission, the Matrimonial Causes Ordinance was amended in 1997 to permit divorce after a one-year period of continuous separation, down from three years previously, provided there was proof of an irretrievable breakdown of the marriage and, hence, legitimate grounds for divorce, and provided both parties consented to the divorce. The period of separation was set at two years if only one party consented. This change, while formally preserving the “proof of fault” nature of divorce, effectively made it closer to a no-fault, unilateral law.

Public Housing as a Driver of Divorce The divorce rate in Hong Kong accelerated upward from the mid-1990s and rose to 2.89 per 1,000 in 2011, placing it in the top 10 in the world and ahead of Japan, China, and Europe at 2.0 and Singapore at 1.5 but behind the US at 3.6. What explains this? I conjecture a fifth and unique driver of the rapid rise of divorce rates in Hong Kong is the public rental housing program. Hong Kong has operated a public rental housing program since the 1950s. But since the 1980s, private property prices have been rising relentlessly as a result of demand growth due to economic globalization and China’s opening, and the slow process of making land conversions. Homeowners experienced an enormous capital gain as property wealth rose. Public rental housing tenants could not partake in this considerable appreciation of wealth. These families literally became the have-nots of Hong Kong society. The deterioration in their relative wealth position, and sometimes also their absolute wealth position as inflation took a toll, was immense. Most of this drop was unanticipated and therefore likely to create considerable marital stress for families who were have-nots, including sometimes prospective families. The original marriage contract became suboptimal for some families. During this period, more women also joined the labor force while fewer men did. So, divorce appeared less fearful and more attractive to some women. The public rental housing program had an in-built incentive that provided encouragement for unhappy couples to divorce. After divorce, they became single divorced

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parents with dependent children. One parent was able to remain in the public rental housing unit, while the other divorced parent ended up renting housing in the private rental market. This created considerable demand for private housing where supply was limited. Subdivided housing became the market’s response to this new rising demand. It is interesting to note that the number of divorced persons in private rental housing has risen even more rapidly than that in public rental housing (see Figures 14.1 and 14.2). A low-income divorced parent could apply for readmission to the public rental housing program, often with preferential consideration, if he or she had dependent children or remarried. These perverse incentives further tilted the balance in favor of divorce among low-income families. They also exacerbated the demand for both public and private rental units. This additional demand resulting from higher divorce rates was neither well understood nor unforeseen by government and by society at large. Unfortunately, there is still a failure to acknowledge this impact. The high and rising divorce rate in Hong Kong is both a cause and an effect of higher housing prices and rents. It distorts the measured inequality in household incomes, leading to exaggerated alarms by the political left and social democrats about the rise of static measures of inequality, which have origins in economic globalization and China’s opening. These economic and social changes have been magnified through a public rental housing program that at best has failed to protect the relative and absolute wealth position of families without property, and at worst has created perverse incentives that have increased the divorce rate among those who are the poor. Rising divorce rates in the US and Europe have led to the decline of the middle class. Broken families descend into poverty and hold out less hope for their children’s future. The effect of no-fault, unilateral divorce laws and social welfare policies designed to help the poor has also led these families to become more dependent on the state. The children of these families in these affluent societies are losing their ability to become economically productive individuals capable of leading meaningful happy lives. Hong Kong is facing similar risks. These are being made worse by a public housing program that reproduces poverty across generations against a background of sustained rising private property prices.

References Allen, Douglas W. “Do No-Fault Divorce Laws Matter? A Survey, 1995–2006.” Unpublished manuscript, Simon Fraser University, February 2006. González, Libertad, and Tarja K. Viitanenb. “The Effect of Divorce Laws on Divorce Rates in Europe.” European Economic Review, Vol. 53, No. 2, February 2009, 127–38.

Section III The Wider Economic Influences on Housing Policies

15 The Impact of Global Economic Forces on Housing in Hong Kong

In Hong Kong, as elsewhere, people want to become homeowners because they think property prices will rise in the long run and provide a cushion for their future. However, these aspirations have become unaffordable by a large margin for a large segment of the city’s population. Macroeconomic factors have provided the backdrop to these circumstances. In an international, open, urban city economy like Hong Kong’s, the value of land and property is not tied to supply and demand factors in the local economy alone but also to global financial and economic conditions. Under the linked exchange rate regime, the business cycle in Hong Kong is affected by interest rates and price movements in the US, over which it has neither control nor influence.

Macroeconomics and Government Policy Economists have long recognized that the ability of governments to fine-tune monetary and fiscal policies to offset the effects of business cycle fluctuations is quite limited. First, it takes time for a government to recognize the onset of a business cycle downturn; this is the recognition lag. Second, it takes time to devise a policy response; this is the decision lag. Third, it takes time to get the policy approved and to take action; this is the implementation lag. Fourth, it takes time for the effects of the policy to act on the economy; this is the impact lag. Policies announced today may only start to take effect after conditions have changed. For example, in an economic downturn, the various time lags may be so long that any stimulus takes effect only after the economy has bottomed out, which can actually end up causing overheating. Instead of stabilizing the economy, the stimulus leads to instability. All these time lags are variable and not known. The decision and implementation lags for fiscal policy are quite long compared with those for monetary policy. For this reason, economic stabilization policy has mostly relied on monetary rather than fiscal policies. Moreover, economists such as Milton Friedman and Robert Lucas have favored the use of a policy rule rather than have the government exercise discretion. They fear that, given the unpredictability

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of government stabilization policy and its effects on the economy, it may introduce more uncertainty and worsen economic fluctuations.

Business Cycles, Bubbles, and Property Prices Such economic fluctuations affect property prices. Housing property is developed in periods of medium length lasting 3 to 5 years and financed by banks through construction loans to property developers and mortgage loans to households. All these features make housing hostage to economic fluctuations in the medium run and to economic growth in the long run. When an economic upturn leads to more demand for property and housing, prices and rents increase rapidly, because supply cannot be increased in the short run. Although development and construction activity speeds up, new supply only appears a few years later. These dynamics of the property and housing markets often lead to the appearance of a bubble-like phenomenon. As property and housing prices increase, existing property and housing owners experience capital value appreciation. This wealth effect fuels further demand for property and housing. The push to increase supply becomes more forceful. But the new supply often arrives when the economic upturn has reversed direction. All of a sudden it appears as if supply is in excess, because demand slacks off. Prices then plummet and property wealth contracts further, exacerbating the collapse of demand. Everyone now draws the conclusion that there was a bubble earlier, and it is now bursting. Actually, the exaggerated boom and bust cycles in property and housing markets are part of the inevitable outcome of uncertain policy time lags, long construction cycles, and the exaggerated effects of capital gains and losses when property prices change. Property bubbles and their bursting are part of the adjustment dynamics driven by economic fluctuations. They are a natural outcome. These cycles are one of the macroeconomic factors affecting housing and property prices. Another significant factor is the situation in the banking sector. Sometimes when property and housing prices plummet, the assets of the banking sector may be seriously impaired because banks often provide most of the financing for property development and mortgages. When this happens, there is the risk of a bank run and a contagion-induced financial crisis. For this reason, mortgage loans are vigilantly regulated in Hong Kong, especially the proportion of the property value that must be paid as mortgage down payment. Over two decades, bank regulations on down payments have risen from 10% to 40% for property purchases and 50% for luxury properties. While these regulations may be necessary to maintain the stability of the banking system, they also mean that property purchases have become prohibitively expensive for first-time purchasers. This situation has created a compelling reason for

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supporting home purchases for permanent residents who cannot reasonably afford to do so otherwise. If they are only provided with shelter and no ownership potential, they essentially become permanently enslaved to their housing units and have little hope for upward mobility.

Middle-Class Confidence Battered Property prices have been a persistent barrier to wider homeownership in Hong Kong despite two dramatic collapses in real property prices over the past 30 years (see Figure  15.1). The first was during 1981–85 (the Volcker Shock) and the second during 1998–2003 (the Asian financial crisis). Each of these periods was followed by a sustained period of soaring growth in real property prices. As a result, despite the high volatility, real property prices have shown a continued increase over the past three decades. The Volcker Shock raised US interest rates to double-digit levels to break inflationary expectations. The effect on Hong Kong was to create a huge disinflation pressure as local interest rates also soared. Price increases, in consumer prices and the 40

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GDP deflator, fell from an annual high of 15% to a low of 3–4% (see Figure 15.2). Real interest rates remained high at 4–5%. Real property prices fell by a cumulative 44% during this period. In the two years from 1981 to 1983, real property prices fell by more than 22% a year. In 1983, the government adopted the linked exchange rate regime, to stabilize market sentiment as political uncertainty over the future of Hong Kong burst open amid a period of considerable economic turmoil in global and local markets. In the aftermath of this, Hong Kong saw exuberant growth. Real property prices rose for a decade from the mid-1980s, as the economy prospered and fortunes were made in the property market. A weak US currency and low interest rates fuelled domestic inflation. Tight labor markets lulled many people into overconfidence. The exuberance ended with the onset of the Asian financial crisis. During 1997– 2003, Hong Kong experienced the worst deflation since the Great Depression in the United  States. Consumer prices fell by a cumulative 11.6% and the GDP deflator declined by a cumulative16.2% over this period. In 1998 alone, real property prices fell by 30% and for the next five years fell by about 10% a year. The real interest rate never fell below 4% and was as high as 12% at its peak. At one point, an estimated 20% of mortgage loans were under water, as property values fell below their outstanding mortgage loan value. Young households that bought property a few short years before the property market crashed saw their future vanishing with each passing month and then with each passing year. When the crisis finally ended, real property prices had fallen by a cumulative 57.3%. 20

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Many Asian currencies were devalued after the Asian financial crisis struck. Hong  Kong did not have this option, due to the linked exchange rate regime. The strength of US currency worsened deflationary pressure in Hong Kong. Figure 15.3 plots the annual percentage change in the exchange rate of selected foreign currencies against the Hong Kong dollar, using 1995 as the base year. The Hong Kong dollar was not only appreciating against these currencies but doing so at an increasing rate. The terrible price deflation in Hong Kong was made inevitable by the linked exchange rate regime. Deflation finally ended after 2003, when the US currency weakened and the Hong Kong dollar fell with it. As consumer prices began to rise again, interest rates also began to fall. Finally, property prices began to recover. They would rebound remarkably in the years ahead, but in the meantime, Hong Kong’s middle class had been half devastated by the property crisis. Those that survived lost precious time in the prime of their careers, and their entrepreneurial and risk-taking spirit was dulled. The subprime mortgage crisis in 2007 and the subsequent global financial crisis and economic recession have left Hong Kong—and its property prices—relatively unscathed. Hong Kong’s economy has remained buoyant thanks to growth in the Asian economies, especially Mainland China. The weak US dollar and low interest rates were fuelling property price increases in Hong Kong. Inflation was rising rapidly, and the real interest rate had turned negative. It reached a historical low of-4% in 2011and was still falling. But one of the macroeconomic consequences of 60

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the economic shocks of the past three decades has been to worsen the distribution of propertied wealth among households in Hong Kong. Entering the property market at the wrong time often leaves a persistent difference between the haves and the have-nots.

Housing Ladder beyond Reach I have described these big-picture developments to show that property prices in Hong Kong are subject to many unexpected and unknown influences from afar. Even eminent economists have difficulty foreseeing them. The Queen once asked professors at the London School of Economics why nobody had predicted the credit crunch in 2008. They replied through a letter that “the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.” I quote the above passage not to apologize for the failures of an arrogant profession. It is to show the complexities and difficulties of predicting what will happen next. Similarly in Hong Kong, policymakers have faced harsh questioning over their inability to have more foresight in their policies. In 1997, Tung Chee Hwa tried to increase the proportion of homeowners in Hong Kong to 70% to help the population fulfill its homeownership dream. But he ended up pushing the supply of housing at a time when Hong Kong was hit by the Asian financial crisis and faced rising real interest rates, deflating prices, and a strengthening currency. His successor, Mr. Tsang Yam Kuen, confronted with the memory of the Asian financial crisis and a global economy slipping into the worst recession in 70 years, failed to increase the supply of housing when real interest rates turned negative, prices were inflating, and currencies were weakening. Both have been criticized for their error and failure. What were they thinking? What were their advisers thinking? A bright economics student might suggest that Hong Kong should leave the linked exchange rate arrangement and insulate itself from the unknown and unexpected influences from afar with a more refined policy instrument. But to whom should we entrust this decision? Delinking the exchange rate will not necessarily make the economy more stable. It can be an overwhelming task, and politicians in the US and Europe have shown us most vividly its unpleasant side. What, then, can Hong Kong do to meet people’s aspirations for homeownership? Despite the volatility of property prices over the past 30 years, they have surged to levels well beyond the reach of the have-nots. Even waiting for the next property cycle downturn may appear unreal or too far off. These people are not merely young men and women trying to form a household but the 47% of people living in public

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sector housing, those who are on the waiting list and those who do not qualify for the waiting list. Hope should not vanish for such a large segment of society. Government has failed to address the long-term nature of this problem. Instead, it has deployed short-term solutions to dampen the volatility of property price fluctuations, such as increasing punitive transactions fees and mortgage down payments and introducing ad hoc housing programs like the Private Sector Participation Scheme, Middle Income Housing Scheme, Sandwich Class Housing Scheme, Flat for Sale Scheme, and My Home Purchase Plan. None of these gets at the heart of the issue: the need to provide a subsidy on land values. Policies that dampen property price increases do not address this problem.

Deregulate Public Housing Market This brings us back to the points I made in earlier essays and that I discuss in greater detail in Essays 28 and 29. I believe the best solutions for establishing a market in public sector housing to be (1) reactivating the Tenant Purchase Scheme (TPS) on the existing stock of public rental housing units, (2) reducing the unpaid land premium on existing TPS and Homeownership Scheme (HOS) units to the level prevailing when the units were first completed, so they can become affordable, (3) unifying all future supply of public sector housing units as available either for rent or purchase, and (4) setting an affordable sales price for these new public units so that a substantial subsidy on land values is provided outright. The subsidy on land values is not something that society loses to the household. The household already occupies the premises. The premises and the land it takes up cannot be used by anyone else, and therefore there is no cost to society. Providing a larger subsidy to the occupant-owners means they can then choose to sell those units on the open market and can therefore unlock the hidden value to be redeployed for a better use—a use that would not have been possible or permitted if the right to sell the units were infeasible. It is not a double benefit. It is merely completing the other half of the benefit that was not initially provided. At present, 16% of households live in HOS units, and 31% live in public rental housing (PRH) units. Accepting this proposal would transform these households into bona fide homeowners. Together with the 37% who are private sector owners, the total percentage of homeowners in Hong Kong could become as high as 84%. Half the population of have-nots would become haves. The have-nots would then own a piece of Hong Kong and have a stake in its future not as house serfs but as property owners. Society would regain the land value that had been evaporated by regulations disallowing bona fide ownership.

16 The Linked Rate, Domestic Stability, and Dual Integration

Mr. Joseph Yam, former Chief Executive of the Hong Kong Monetary Authority (HKMA), published an academic research paper on June 15, 2013, calling on the Hong Kong authorities to review whether the linked exchange rate system was still fit for purpose. Economic conditions in the world have changed since the original arrangement was introduced in the 1980s, and Mr. Yam delineated a number of different monetary and exchange rate arrangements that could be considered as alternatives to the present linked rate. Insofar as I could detect, he did not seem to express a strong preference for any specific arrangement. Exchange rates exist because people in different nations wish to conduct transactions with each other using fiat money issued by their governments. Fiat money is declared by a government to be legal tender. It has no intrinsic value and is neither convertible by law into any other commodity nor fixed in value. Historically, commodity moneys were most commonly in the form of gold, silver, and copper. In a world with commodity money, exchange rates between nations need not exist.

Fixed Rate as Monetary Union The widespread adoption of fiat money in modern times reflects the growing competence and trustworthiness of governments, which is sufficient for the public to be willing to hold and use fiat money. It is also a sign that governments have gained enormous power. Fiat money embodies an important contractual relationship between a government and its people. This conceptualization brings out the fundamental cause of exchange rate or currency crises: the loss of confidence and faith in a government by the peoples of the world. Because fiat money has no intrinsic value, unlike commodity money, there is the possibility that the value it is said to represent can totally evaporate. Nations have adopted different rules for determining the exchange rates of their fiat currencies. There are conceptually three distinct types of exchange rate regime— floating, fixed and flaky—each with different characteristics and different results.

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At one end of the spectrum is the completely freely floating exchange rate in which the central bank never intervenes to offset market pressures on that rate. At the other end is the firmly fixed exchange rate with no fluctuations allowed. These two extremes often do not apply to exchange rate regimes in practice. The three main global currencies—the US dollar, the Japanese yen, and the euro—float freely against each other, as do a number of smaller currencies, such as the Canadian dollar, Swedish krona, British pound, Korean won, and New Zealand dollar. However, the de jure commitments to freely float exchange rates have not prevented the central banks of these nations from intervening actively in foreign exchange markets from time to time. An example of a fully fixed exchange rate, which in principle is the same as a monetary union, is the Hong Kong dollar. The HKMA is obliged at all times to exchange US dollars for a fixed amount of Hong Kong dollars (HK$7.8 per US$1). This means in essence that Hong Kong is in a monetary union with the US, the only difference being that Hong Kong issues its own banknotes. A second example of a fixed exchange rate is the European Monetary Union, where all members have given up monetary independence and left monetary policy decisions to the European Central Bank. Although floating and fixed rates appear to be dissimilar, they have one common attribute that is not fully appreciated and seldom recognized explicitly in most economic discussions. Both regimes adopt a free-market mechanism to balance payments in international transactions. The adjustments do not require any form of government intervention.

Monetary Competence Determines Choice of a Floating or Fixed Rate With a floating rate, the monetary authority sets monetary policy but has no exchange rate policy. The exchange rate automatically adjusts to equilibrate demand and supply in the foreign exchange market and achieve external balance or balance in the balance of payments. The internal balance or price-level stability is attained through control of the monetary base by the monetary authority. If Hong Kong had a floating rate, it would gain control over its own monetary policy, and the HKMA would be responsible for achieving domestic price-level stability. With a fixed rate, the monetary authority sets the exchange rate but has no monetary policy. Monetary policy becomes the passive outcome of excess demand or excess supply in the foreign exchange market, and it is determined by the imbalance in the balance of payments. When a country’s official net foreign reserves increase, its monetary base increases, and vice versa. This determines the rise and fall of the domestic price level. Again, the adjustments do not require any form of government intervention.

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Since both of these are free-market exchange rate mechanisms, there cannot be conflicts between exchange rate and monetary policies, and consequently balance of payment crises cannot occur. Indeed, under floating and fixed-rate regimes, freemarket forces act to automatically rebalance financial flows and avert such crises. Table 16.1 gives a summary description of the exchange-rate regimes based on Milton Friedman’s foreign exchange trichotomy and summarizes our discussion of the floating and fixed exchange-rate regimes. Contrary to popular perception, Friedman did not favor floating exchange rates over fixed exchange rates. In fact he favored both, depending on the circumstances. He preferred floating rates for countries with strong monetary authorities, which are usually found in developed economies. Floating rates allow a country the independence in choosing a monetary policy to suit its domestic situation. Countries with floating rates do not have to worry about whether business cycles across interconnected economies are synchronous or asynchronous. Friedman, however, favored fixed exchange rates for countries with weak monetary authorities, which are mostly found in developing economies. Their authorities are more vulnerable to economic mismanagement and political misconduct. Economists have articulated six criteria that a small economy should consider in deciding whether to fix its exchange rate to an “anchor country.” Hong Kong’s anchor country over the past 30 years has been the US. The six criteria are: 1. 2. 3. 4. 5. 6.

How important is foreign trade to the small economy? How flexible are wages and prices in the small economy? How mobile is labor across borders? How mobile is capital? How good is monetary policy in the small economy compared with the policy in the anchor country? How good are political relations between the small economy and the anchor country?

Luck Matters These six criteria define conditions for an optimal currency area. If there are close trade ties, high wage and price flexibility, and high capital and labor mobility between the small economy and the anchor country, then the two economies can beneficially form a monetary union with a common currency. One of the most obvious benefits is that the small economy does not have to assume the burden of having an independent monetary policy and the economic uncertainties associated with it. Hong Kong’s linked exchange rate system is close to a monetary union.

Floating Fixed Flaky: adjustable peg and dirty floating

Type of Regime

No Yes

Yes

Yes

Exchange Rate Policy

Yes No

Central Bank

Table 16.1 Friedman’s foreign exchange trichotomy

Yes

Yes No

Monetary Policy

Domestic and foreign

Domestic Foreign

Source of Monetary Base

Yes

Conflicts between Exchange Rate and Monetary Policy No No

Yes

No No

Balance of Payments Crisis

Yes

No No

Exchange Controls

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Friedman stresses, however, that a small economy should not abandon its monetary policy independence to another country if that country is expected to pursue a poorer monetary policy than the small economy would have done on its own. He places the greatest emphasis on this criterion. Friedman argues that floating exchange rates do not perform well in developing economies, and this has been empirically supported by evidence of their weak monetary authorities and histories of monetary instability. He therefore advises these economies to form a monetary union with an anchor country whose monetary policy is reliably well conducted. The choice between fixed and floating rates is difficult, and countries have achieved both good and bad results with them. For example, in 1985, Israel successfully implemented a fixed exchange rate policy against the dollar that helped cut inflation without causing any negative long-term economic repercussions. Chile also implemented a fixed exchange rate policy against the dollar in 1976. Results were good for the first year, but when US monetary policy was severely tightened between 1980 and 1982, causing the dollar to surge, monetary policy in Chile also had to be tightened. This caused Chile to suffer a serious economic setback, and in 1982 it abandoned its fixed exchange rate policy. These two cases underline how identical exchange rate policies can lead to different results. The outcome of the fixed exchange rate policy depends on how “lucky” one is with regard to the monetary policy in the anchor country. Israel was fortunate to introduce a fixed exchange rate policy at a time when monetary policy was relatively accommodative in the US. Chile was unlucky to fix it just before US monetary policy had to be vigorously tightened. Friedman has warned, “Never underestimate the role of luck in the fate of individuals or of nations.” Coming back to Hong Kong, the linked exchange rate has worked very well in the past 30 years despite quite pronounced spells of “bad luck.” When China opened up in the 1980s, Hong Kong’s economy boomed as manufacturing moved across the border, precipitating the city’s rapid transformation into a high value-added service economy. Inflation reached double-digit levels as a result of supply bottlenecks. Unfortunately, the US was heading into a period of low interest rates with a weak currency. Hong Kong’s link to the US dollar in this instance meant a decade of inflation and escalating property prices as the business cycles of Hong Kong and the US were out of phase. The opposite happened during the Asian financial crisis of 1997. At that time, the US economy and dollar were strengthening. When the property price bubble went bust in Hong Kong at the time, deflationary pressures were reinforced. Hong Kong went into a deep recession and did not recover until 2003, when the US dollar softened. An even stranger story occurred with the financial tsunami of 2008. As the wealthy economies went into recession, Hong Kong’s economy remained robust because

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China successfully executed a huge fiscal stimulus package that helped to keep the emerging economies going. Hong Kong was faced with a weak US dollar and low interest rates but a full employment economy, a lethal combination that prompted many to invest in property, sending prices soaring. One could simply conclude that Hong Kong is not very lucky, but what is really worth noting is that Hong Kong was able to stay with the fixed rate because it possessed one of the world’s most flexible economies in wages and prices, a robust banking system, and a sound fiscal policy. This helped Hong Kong to weather the shocks better than most other economies, although it did not save two Chief Executives from being the targets of massive public protests. Friedman regarded a system of fixed but adjustable exchange rates as the worst of all worlds. This system is also known as the adjustable peg which, together with “dirty” floating rates (which I explain below), has been called the flaky exchange rate system by Professor Andrew Rose. An example of an adjustable peg is the European Monetary System (EMS) 1979–98. Members of the EMS pursued a mutual fixed exchange rate policy; exchange rates were allowed to float within a narrow band and the various central banks obliged to ensure that they remained there (for example, via changes in interest rates or intervention in the foreign exchange market). A country with an adjustable peg in principle abandons the option of an independent exchange rate policy. However, at times of pressing domestic need, governments may be willing to succumb to irresistible political pressure and adjust exchange rates (devalue or revalue) or completely abandon the fixed exchange rate policy. In addition, they can introduce various means to “control” prices and impose capital control measures. The system sows uncertainty in the foreign exchange market about just how “fixed” the policy is in reality. In so doing, it becomes a potential “target” for speculative attack whenever threats appear that could lead to a balance of payments problem.

Instability under Flaky Regimes The dirty floating rate suffers from the same problem. Many countries that claim they float actually intervene a lot to smooth out the exchange rate, a phenomenon known as “fear of floating.” Some countries that officially claim to float their currencies adhere to a monetary policy that explicitly targets inflation, unemployment, monetary growth, or some combination of the above. Others have what can be referred to as an opaque monetary policy. For example, why is it that the Bank of Japan targets have never been spelled out? The uncertainty arising from dirty floating rates is just as bad as the system of adjustable pegs. They are different only on paper. In practice they are often indistinguishable. In these exchange rate regimes, the central bank conducts both exchange rate and monetary policy, which breeds uncertainty and causes instability, and the source of

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the monetary base is a mixture of domestic and foreign assets. In these respects they are totally different from both the fixed and the floating regimes. These are in fact flaky regimes. Adjustments occur in the foreign exchange market as a result of government interventions and market forces—a mixture of politically driven and market-driven factors that creates conflict between exchange rate and monetary policy. Under both the adjustable peg and the dirty float, the market knows but cannot tell exactly when the government will act and so from time to time will second guess government behavior. The “speculation” that results precipitates crises in the balance of payments and the currency. Fortunately, Hong Kong’s linked exchange rate system is not a flaky system even though the HKMA has given itself some powers to intervene in the foreign exchange market. But the scope for such intervention has been narrowly prescribed within a tight band of buying US dollars at 7.75 and selling at 7.85, known as the Convertibility Undertakings. It is worth pointing out that, according to estimates by Klein and Shambaugh (2010), even such a tight band means it takes almost eight months before an increase in interest rates in the anchor country (the US) causes Hong Kong to adjust its own interest rates even halfway. The ability of countries with an adjustable peg or dirty float to prevent adjustment would no doubt be even more potent. Such delays put pressure on the balance of payments and build up currency crises in those countries. Ever since China’s opening, Hong Kong has taken on the task of attaining dual integration, first with the global economy and second with the Mainland economy. Hong Kong’s exchange rate system has a role to play in this process, as I discuss in my next essay.

References Klein, Michael W., and Jay C. Shambaugh. Exchange Rate Regimes in the Modern Era. Cambridge, MA: MIT Press, 2010. Rose, Andrew. “Exchange Rate Regimes in the Modern Era: Fixed, Floating, and Flaky.” Journal of Economic Literature, Vol. 43, No. 3, 2011 (September), 652–72.

17 Reasons for Keeping the Linked Rate

Should Hong Kong adopt a different exchange rate regime from that linking it to the US dollar? Ever since China’s opening, Hong Kong has become more integrated with the Chinese economy, a development likely to increase over time as the Chinese economy continues to grow faster than the advanced economies of the US, Japan, and Europe. So, is the linked exchange rate system fit for purpose in this emerging global economic landscape? This may seem an important question to ask, but it is the wrong question. Hong Kong must strive to achieve dual integration—first with the global economy and second with the Mainland economy—in order to provide continued support for China’s progressive integration into the global economy. I discuss the question of dual integration in Wong (2013). Ideally, Hong Kong’s exchange rate regime should support its dual integration role and not simply its economic integration with the Mainland.

The Risks of Linking to the Renminbi For a small open economy like Hong Kong, which has extensive international transactions with almost all major countries, there is very limited choice when it comes to choosing the currency for fixing the exchange rate. Three factors figure prominently. First, while the rate should ideally be linked to an economy with which the selecting country has increasingly closer economic integration, this may not hold true for Hong Kong. True, China is likely to become its major trading partner over time even though Hong Kong still trades heavily with the rest of the world. And Hong Kong’s business cycle will become more synchronized with that of China’s, making China a potentially suitable anchor economy. However, synchronized fluctuation over the business cycle is only one relevant consideration when it comes to economic integration. Another equally important consideration is the implications of Chinese economic growth on the value of the renminbi. China is a developing economy, so the renminbi

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is likely to appreciate as its economy develops, similar to Japan’s yen in the postSecond World War era. Pressure for China to appreciate its currency will rise as its economy transforms from manufacturing towards services, especially non-traded services. This will lead to structurally generated domestic inflation. Again, this is a long ongoing process, given that China still has a sizable agricultural sector. If the Hong Kong dollar were anchored with the renminbi under such a scenario, then its exchange rate would have to appreciate against the rest of the world in tandem. Hong Kong would then be faced with the long-term prospect of importing deflationary pressures as China modernized. Alternatively, keeping the currency fixed against the US dollar would import inflation as Hong Kong continues to integrate with China. This makes it in fact an easier choice. Economically and politically, the deflationary pressures that would likely link to the renminbi are much more difficult to manage than inflationary pressures, as we have learned from the experience of the Asian financial crisis. The second factor affecting Hong Kong’s choice of an anchor currency is the need for the monetary policy of the anchor economy to be well behaved. At present there are no obvious credible alternatives to the US Federal Reserve Bank. The People’s Bank of China does not have a long enough track record for us to judge its behavior. In the best of circumstances, it will be focused on accommodating the needs of a modernizing economy, and this may not fit the needs of a developed open city economy like Hong Kong. If the People’s Bank resists market forces in order to achieve other state-determined developmental goals, then its monetary policy will be subject to considerable policy uncertainties and possibly undisclosed reversals. This would not be regarded as a well-behaved monetary policy and would not meet Hong Kong’s needs for a stable, reliable currency anchor. The third factor is the difficulty of linking Hong Kong’s currency to a currency with limited convertibility, such as the renminbi. Hong Kong’s role as an international financial center would be immediately jeopardized because demand for Hong Kong dollar-denominated assets backed by the renminbi would suffer. The advantage of linking to an international reserve currency like the US dollar is its full convertibility. China’s economic reforms are facilitated by Hong Kong’s continued vibrancy as an international financial center. Hong Kong serves as a benchmark, a source of funds, and a facilitator for institutional innovation and reform. Linking to the renminbi before it becomes a stable and fully convertible currency would be in the interests of neither Hong Kong nor China. The only way for the renminbi to become reliably stable and fully convertible is if China resolves the glaring internal and external imbalances of its economy. Unless China weans itself off an addiction to investment-driven growth and rebalances towards consumption, its economy will hit a wall. These imbalances cast a long shadow over the future monetary policy of the People’s Bank of China,

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whose sole policy consideration has to be the growth and stability of the Mainland economy. Milton Friedman has often warned that a small economy should not abandon its monetary policy independence to another country if that country is expected to pursue a poorer monetary policy than the small economy would have done on its own. By the same token, we should not abandon the link to the US dollar in favor of the renminbi unless we can be reasonably certain that the monetary policy of the People’s Bank of China will be more reliable and favorable for Hong Kong than the US Fed’s policy. In choosing between currency anchors, Friedman places the greatest emphasis on this consideration.

The Case against Baskets and Floats Another option for Hong Kong would be to fix its currency against a basket of convertible currencies from countries that are our major trading partners but not including the renminbi. However, it is not clear what advantage this would have over the US dollar link, because it is impossible to know if such a basket would appreciate faster than the US dollar. Moreover, calculating the effect of second-by-second changes in the value of the currency basket is not straightforward. The weights used in a currency basket in general change as the value of each currency in the basket changes. A rise in the value of a currency increases its weight in the basket, and vice versa. This is a highly undesirable property to have when currency volatilities are high. If such a basket were not preannounced and therefore not rule-based, we would have to hand over to the HKMA the power to make discretionary decisions over the value of the exchange rate. In effect, we would migrate from a fixed exchange rate system to a flaky rate. How would the HKMA decide the exchange rate? Would its mandate be to stabilize domestic prices, maintain unemployment, maintain nominal GDP, or all or some of the above? Would domestic price stability be limited to consumer prices, core consumer prices, producer prices, property prices, or all or some of the above? None of these decisions can be reduced to a simple formula. There will be ambiguity about the mandate given to the HKMA, and there will be considerable scope for discretion. Worse, the public might suspect that there would even be scope for indiscretion. Questions would also arise about the HKMA itself. Would it act under the instructions of the Financial Secretary, or be independent? Is there sufficient political authority for the government or the HKMA to take the required discretionary decisions? I have always suspected that some of the things the Singapore government can do are not within the reach of the Hong Kong government. The Singapore government rules with the political authority of the People’s Action Party, which has won every single election since the founding of the Republic of Singapore by an overwhelming

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majority and can assume much greater authority. The Chief Executive of Hong Kong does not even have a political party to call upon. The problems of an undisclosed basket of currencies are of course also present with a floating rate. A floating rate would allow the HKMA to control its own monetary policy, which would have to be announced. If domestic stabilization were the goal, then it would have to state that this was the rule that it intended to follow to conduct monetary policy. The rule could require that there be price stability, full employment, stability in money growth, or stability in nominal GDP growth, or some combination of the above. Experience from most countries has shown that hitting any one of these targets is not easy, in part because they are not precise. Perhaps the greatest skepticism relates to whether Hong Kong’s small, open economy would be able to meet any of these targets with capital flowing freely across borders. I have included nominal GDP in the list of targets, and this deserves an explanation. Targeting nominal GDP was first proposed by Professor James Meade, Nobel laureate in 1977 in economic sciences, but it has never been tried. Currently, though it is getting a popular revival among the Market Monetarist group of economists posting in the blogosphere led by Scott Sumner, a University of Chicago graduate, the idea has not been endorsed by economists associated with the Chicago School of Economics. However, it does have the support of Keynesians like Paul Krugman, Brad DeLong, Christina Romer, Jeffrey Frankel, and others. Indeed, The Economist has held up the successful revival of this idea as an example of the benefits to society of the blogosphere. I have included a paragraph on this because I suspect it will become an important idea in getting the world out of its current doldrums. Coming back to the original discussion, it is worth noting that Singapore, like Hong Kong, has also decided against a floating rate. Instead, it chooses to fix the exchange rate under the pretext that it is pegged to an unannounced basket of currencies. Presumably its exchange rate adjustments aim to achieve some degree of domestic stability. However, the domestic stabilization rule is not explicitly stated, thus avoiding the need to bind the monetary authority to intervene in the foreign exchange market. Nevertheless, Singapore has from time to time imposed capital controls to achieve its domestic stability goal, including controls over the purchase of property, in a bid to stem property price increases due to capital inflows.

US Link Rate Still Preferred Based on economic considerations alone, our discussion of floating, fixed, and flaky exchange rates so far has not uncovered any compelling reasons for why any of the alternatives that have been raised over the years, and in Mr. Joseph Yam’s research paper, are preferred to the present linked exchange rate, at least for the foreseeable future.

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Both fixed and floating exchange rate regimes have inherent free market adjustment mechanisms that accommodate economic shocks (both domestic and external) to avert a balance of payments or currency crisis. The adjustments are market-driven and do not require government intervention, yet governments everywhere have often chosen to intervene. As a consequence, real-world exchange rates often end up becoming flaky exchange rate regimes by default, in which governments adjust the exchange rate after promising to uphold a fixed rate, or intervene in the foreign exchange market after promising to uphold a floating rate. Governments break commitments because of the political pressures they face, so the drift into flaky rates is therefore political and not economic. Once we recognize the unavoidable propensity of governments to accept political expediency, then the choice of exchange rate regime has to recognize the political consequences. Hong Kong’s linked exchange rate system is one of the most robust fixed exchange rates in the world today. It has remained robust because the Hong Kong population realizes instinctively its intrinsic value to Hong Kong. Staying with the linked rate requires economic policy discipline in a number of areas to make it function well. When the exchange rate cannot be adjusted in the face of external shocks, then wages and prices must remain flexible to absorb the shock. A high degree of capital and labor mobility will make resource reallocation more responsive. The presence of a large private sector generally will make the economy more flexible and able to adjust rapidly to shocks. Fiscal discipline that avoids budget deficits and public debts keeps government small and makes the linked rate stronger.

Weathering the Asian Crisis The robustness of Hong Kong’s linked exchange rate was severely tested during the Asian financial crisis. All economies in East and Southeast Asia were affected. Every economy except Hong Kong and China devalued its currency to soften the impact of the negative shock. During 1997–98, Japan devalued by 7.4%, South Korea by 32.0%, Taiwan by 14.2%, Singapore by 11.3%, Thailand by 24.8%, Malaysia by 28.2%, Indonesia by 71%, the Philippines by 27.9%, and Vietnam by 11.9%. Hong Kong, with its linked rate, had to endure a period of intense deflationary pressure. As explained in Essay 16, between 1997 and 2003, the cumulative consumer price index fell by 11.6%, the cumulative GDP deflator by 16.3% and nominal GDP by 8.5%, and unemployment reached a peak level of 8.8%. Real interest rates reached their highest levels since the Second World War: The real Best Lending Rate hit 12.9% and real HIBOR hit 9.8%. It is useful to compare these numbers with US figures during the Great Depression of 1929–39. The cumulative consumer price fell by 18.7%, the cumulative GDP

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deflator fell by 19%, nominal GDP fell by 11%, and unemployment reached a peak of 24.9%. Deflation and economic output decline were comparable between Hong Kong and the US during these two episodes although the unemployment impact was far less severe in Hong Kong. The economic downturn and the consequences of the Asian financial crisis would have been worse had it not been for an impeccable record of fiscal prudence, stellar sovereign credit ratings, flexible labor and product markets, a robust banking system, and an ethic of self-reliance. These attributes allowed Hong Kong to weather the economic crisis under the linked exchange rate, an ordeal not conceivable in any other economy. The people of Hong Kong should be proud of what they achieved during the six years when their economy was ravaged.

The Rise of Property Prices Divides Society Since the financial tsunami of 2008, Hong Kong has had to endure a different adjustment process due to the weak US dollar and low interest rates. Inflation, especially asset price inflation, has created a deep division within the community between those with property and those without. The widening economic gap in Hong Kong is not so much one of income but more of wealth. The latter gap is to a large degree the effect of external shocks on property prices over the past two decades, which were amplified by a fixed exchange rate regime. This consequence was not difficult to foresee even 20 years ago. Fortunately for Hong Kong, there is a simple solution to address the widening wealth gap, as I have mentioned. If the government were willing to sell subsidized housing premises to the occupants at a price they could afford, without having to repay an exorbitant land premium, then the wealth gap would be immediately narrowed. Every household in Hong Kong would possess an asset that could protect it from the shocks that arise under a fixed exchange rate. The problem of housing in Hong Kong is not primarily about having affordable shelter. It is about having an asset that can be hedged against inflation for wealth preservation and enhancement. I believe the linked exchange rate is a valuable arrangement that should be usefully continued for all of the reasons discussed above. Its more onerous effect on the widening wealth gap can be relatively easily and effectively ended. As I noted in the South China Morning Post article that appears at the beginning of this book, in 1997, Hong Kong’s inflationary housing issue had already divided the city into haves and have-nots. It was time back then to address this issue. Sadly, it has remained an unfinished task. Resolving this contradiction would remove one of the obstacles to dual integration with China and the rest of the world, in addition to addressing unwelcome fallouts from our housing policies such as rising prices.

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Reference Wong, Yue Chim Richard. Diversity and Occasional Anarchy: On Deep Economic and Social Contradictions in Hong Kong. Hong Kong: Hong Kong University Press, 2013.

18 Why Speculation Is Not a Bad Thing

In 1991, I wrote an essay titled “Greater Vision Needed to Curb Speculation” in the South China Morning Post. I hoped at that time to explain to the public why it was not a good idea for the government to intervene in the presale market for housing units. What was clear to me then, as it is now, is that there was no compelling reason to believe the market was failing or that government intervention to curb speculation was warranted. Speculative activities improve economic efficiency. I had hoped that a better appreciation of the mechanism behind the presale arrangements would lead to a more enlightened view about regulating the market for presale housing units. To my disappointment, this has not happened although Mr. Tang Kwong-Yiu, who later became Government Economist, congratulated me for a most illuminating article after it was published. I was gratified that at least one person in government understood what was happening, but in the past 20 years this has not amounted to anything. The government has repeatedly intervened in the market to curb speculation whenever there is a public outcry against property price surges.

Curbing Speculation Has Only Temporary Effects The public often believes mistakenly that speculation causes property prices to rise. And when government intervenes to curb speculation, this mistaken belief is unfortunately reinforced. In reality, speculation is the result of anticipated property price increases, and it is such anticipation that drives up property purchases. This anticipation arises from underlying supply and demand conditions that lead prospective purchasers to believe prices will rise and speculators to become active. The perception that speculators drive up property prices is an easy popular misunderstanding that has been around for a long time. The evidence that speculation is not the main cause of surging prices can be seen in the history of government attempts to curb it. Every time a measure is introduced, it is followed by a short correction, and then prices surge again.

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In 1991, in response to rising property prices, the government introduced several measures to curb speculation in the presale market. First, units reserved for internal sales were limited to 50%. Second, confirmor transactions in presold units (forward delivery) were subject to stamp duty at the rate of 2.75% of the value. As a consequence, property prices made a minor correction before surging upwards again (see Figure  18.1). In 1992, the Sandwich Class Housing Scheme was announced, and property prices again briefly corrected before continuing their upward surge. In 1994, two additional measures were introduced to curb speculation in another bid to halt continuing property price increases. First, presales of residential units under construction could be undertaken only within 9 months of their completion. Second, purchasers had to pay a 10% deposit instead of 5%, and a charge of 5% was made if the transaction was subsequently cancelled. Property prices corrected before continuing to surge upward again. After 1997, some of these measures were rolled back as the Asian financial crisis took its toll on the economy and the property market. But after 2003, property prices began to surge forward again. There was another price correction in the wake of the global financial tsunami in 2008, then another surge shortly afterwards. Speculation was no longer limited to the presale market but had spread to the secondary market for existing units. The government stepped in with a further raft of measures. In 2009, the loanto-value ratio for property transactions above $20 million was lowered to 60%, and tighter regulations on presales units were introduced. In 2010, the stamp duty for property transactions above $20 million was raised to 4.25%. The government also pledged to launch more land sites for sale. Later that year, confirmor transactions for units under construction were banned, and a 10% levy was charged on all cancelled transactions. In 2011, a special stamp duty was levied for property transactions that were sold within 2 years. These last measures effectively ended the forward housing market. The government also launched the My Home Purchase Plan and later introduced the revised new-style Homeownership Scheme. Throughout this period, property prices continued to surge even though there was a slight halt whenever measures to curb speculation in the presale market and the secondary market were introduced. Back in 1991, my article explored the evidence, or lack of it, of speculation in contributing to market failure. There is some personal background to that article. About a year before I wrote it, I purchased my first-ever property in Hong Kong in the presale market. It was an eye-opening experience for me as I observed firsthand how the presale housing market functioned. I began to follow the practices of developers through the newspapers to try to understand their rationale. After about a year, I had enough of an understanding of how the presale housing market was organized to construct an economic interpretation of the main features

Figure 18.1 History of Hong Kong property prices and real estate market interventions, 1980–2011 Source: Adapted from Also Sprach Analyst 2011.

0

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Confidence crisis on the future of Hong Kong as Margaret Thatcher fell down the steps outside the Great Hall of People in Beijing

3. The British-Hong Kong government can at most grant 50 hectares of land leases each year until 1997

2. New Leases granted by the British-Hong Kong government will expire 2047 the latest

Sino-British Joint Declaration 1. Leases which expired on 1997 will be extended automatically to 2047

Confidence crisis after the crush-down of Tiananmen Square Protest

1987 Stock market crash

2. Confirmor transaction of presold units (i.e. forward delivery) will be subjected 2.75% of stamp duty

Government to curb home prices 1. Units reserved for internal sales will be limited to 50% of total flats available

Land sales were suspended for 9 months

“Sandwich Class Housing Scheme” announced

September 11 terrorist attack

Government cut construction of Home Ownership Scheme(HOS) flats

Government launched the new “Land Application List” system and ran it in parallel with regular land auctions

SARS epidemic further weakened the economy

The Chief Executive Tung Chee Hwa said that the 85,000 building target no longer existed since it was not talked about since 1998

1. Banned confirmor transactions for units under construction 2. 10% will be charged for cancelled transactions 3. Put more sites for sales 4. Loan-to-value ratio for HK$12m+ transactions lowered to 60% 5. Required banks to stress-test the ability of borrowers

Quantitative Easing I

1. Halt regular land sales for unspecified time and land application list system for one year 2. Ended Home Ownership Scheme 3. Cancel internal sales restrictions

Dot-com bubble ended

Quantitative Easing II

Guidelines to regulate sales procedures

1. Stamp duty for HK$20m+ transactions were raised to 4.25% 2. Pledged to launch more sites up for sale

1. Special Stamp Duty 2. “My Home Purchase Plan” announced

1. The presales of residential units under construction can be done 20 months before completion 2. Lifting the restrictions of confirmor transactions and non-individual buyers

Asian financial crisis hit Hong Kong

85,000 Building target announced

The government used the Exchange Fund to intervene in the stock market

4. Buyers must pay 10% deposit instead of 5%; 5% will be charged if transactions are cancelled

3. The presales of residential units under construction can be done only at most 9 months before completion

2. Confirmor transaction of presold units (i.e. forward delivery) will be subjected to 2.75% of stamp duty

Stricter measures to curb speculations 1. Units reserved for internal sales will be limited to 50% of total

1. New-style HOS Plan announced 2. The proposed regulation of developers’ sales practice

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of its practice. Why do they choose to sell some of their units internally to speculators in advance of the announced date of sale? Why do they choose to make prospective buyers wait in lines? Why don’t they use auctions, which could ideally maximize their expected gains because it allows them to price discriminate?

Speculation Is Economically Positive In 1991, when the government succumbed to popular pressure and intervened to curb speculation, there were major public concerns about the methods used by developers to sell uncompleted housing units in advance. Some of these concerns are still valid. First, triad members wishing to turn a quick profit often used strong-arm tactics to jump the line, making it difficult for law-abiding buyers to acquire the units directly from the developer. (This concern is probably no longer important.) Second, units sold by developers were marketed in ways that provided misleading information to the public. Third, final users who waited in lines on the announced date of public sale often found that many of the choice units had been privately sold ahead of time to property agents or speculators through internal sales. Many buyers were therefore compelled to pay a considerable premium in order to acquire their units from the property agents and speculators. Speculative activities were blamed for creating such a situation. These concerns have a long history, and each time property prices surge in the residential market, there are renewed calls for regulating the sales of these units to ensure fairness in the market and to curb speculation. This article will not address the first two concerns but deal with the more difficult and controversial issue concerning the need to curb speculation. From an economic point of view, it is not obvious why speculation should be curbed. Speculation is economically desirable because it spreads risk. It can occur only when there are differences among people in their attitudes towards risk and their assessment of future prospects. As long as banks remain prudent in making mortgage loans, there is hardly any rationale for regulating a purely voluntary exchange arrangement. When the threat of systemic banking risks is absent, the case for market failure arising from speculation in asset markets cannot really exist. Perhaps a case can be made that the presale of new residential units in a large housing estate development has an element of market power because of locationspecific monopoly power, in which the developer has a dominant market position. It can be argued that developers of large housing estates may possess location-specific monopoly power, which is enhanced by the fact that housing units are not homogeneous, making it legitimate to charge different prices for different units. The location-specific monopoly argument cannot be ruled out in principle, but is it empirically plausible? To exercise such monopoly power, developers have to possess

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a mechanism that would allow them to sell units to their respective highest bidders. In other words, price discrimination must be present. This can only be achieved through auctions, because developers cannot possess information about who is the highest bidder for each unit in advance.

Location-Specific Monopoly Powers May Be Spurious And yet developers have chosen not to use auctions to sell their units, which is prima facie evidence that exercising price discrimination to maximize profit cannot be the explanation. Moreover, according to economic theory, price discrimination only allows developers to cream off all the consumer surplus of the buyers. It does not, strictly speaking, result in any economic efficiency loss that is the correct understanding of what market failure means. It has been argued that auctions have not been adopted by developers because they are costly to administer, but it is not immediately obvious that there is much empirical merit in this claim. Even if this were the case, the monopoly argument still breaks down because it implies that price discrimination is too costly to implement. Since monopoly power cannot be effectively exercised, there is no case for regulation to constrain location-specific monopoly powers. It is interesting to note that, if auctions were adopted, short-term housing speculation would be reduced because the units would then be held by those with the highest bid. These are more likely to be final users than property agents and speculators, because a competitive bidding process is likely to reduce significantly the scope for making speculative profits. This means that, if price discrimination could be effectively employed, then the incentive to engage in speculation would be reduced significantly. In other words, speculation takes place only when monopoly power, if it exists at all, is not exercised. Location-specific monopoly power, however, is not the same as monopoly power over the whole market. The latter involves an alleged ability to reduce the total supply of housing units in order to raise prices. While Hong Kong’s property development market is heavily concentrated today, it is not obvious that developers can control the total supply, behaving as if they are in collusion with one other. It is a common mistake to use monopoly power to explain price increases. Prices will rise if a competitive market is monopolized, but this is only a one-off effect. It can only explain why prices are higher, not why they continue to increase. If prices were to rise continuously over time, as they do in Hong Kong, it would have to mean that monopoly power is also continuously rising. For this to make sense it is necessary to assume that not only is there monopolistic collusion among developers, but their monopoly powers have been continuously increasing. This cannot be correct or sensible, theoretically or empirically. A monopoly power

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argument cannot account for the large price surges that we have seen in the past 20 years. The puzzling issue that will be explained in the next essay is, why do developers choose to sell their units the way they do?

Reference Wong, Y. C. R. “Greater Vision Needed to Curb Speculation.” South China Morning Post, August 12, 1991.

19 Speculators, Property Agents, and the Spreading of Risk in the Presale Housing Market

Why do developers choose to presell their units by placing them with speculators and property agents through internal sales rather than using other arrangements, for example, auctioning? The sale of a new residential unit in advance of its completion date is similar to the selling of a forward contract, which spreads risk or provides liquidity. In all forward markets, it is not always easy to distinguish between speculators and final users. But housing forward contracts for presale units have two important distinguishing features. First, residential units are necessarily heterogeneous. Second, the final users are typically homeowners or small landlords and usually not the speculators. Speculators and property agents who trade in housing forwards perform these dual functions and therefore offer an incentive for developers to sell some of their presale units to them rather than to final users. Developers are also motivated to sell some of their units to speculators and property agents because they can sell units in a single development in a number of stages. Clearly, the price one is willing to bid for a unit depends to a large extent on its expected future value. This value will change over time as more information becomes available, which will alter the likely bid. A developer could try to pick the best time to sell units but can never be completely certain when that will be. An optimal strategy would be to space out sales over time to balance risk against expected return, but there is a limit to such sales, dictated by relevant cost-benefit considerations.

The Role of Speculators and Property Agents Speculators and property agents, in contrast, have a comparative advantage over developers in searching for prospective buyers for units because they are in a better position to fine-tune the pricing and timing of each sale. This advantage allows them to be comfortable bearing more risk than the developer. But it also means that the price of acquiring a unit from speculators and property agents will be higher because they have to bear this risk.

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Speculators and property agents prefer to acquire prime units from developers and sell them to final users at prices above the developers’ initial sales prices rather than trying to sell non-prime units at prices similar to those of prime units purchased directly from developers. This explains why, in the period following the initial sale of new units by developers, the prices of prime units tend to rise proportionately more than those of nonprime units in the same development. Incidentally, this explanation also makes it clear that developers are not systematically making bad forecasts of the prices of different units, as the evidence would superficially suggest. The final user in this situation is faced with three choices: (a) purchase a prime unit from speculators and property agents immediately, (b) purchase a non-prime unit from the developer, or (c) postpone purchase until some future date. In making a choice, the user is aware that many prime units are held by speculators and property agents who will not sell unless a premium is paid now. This information alters the user’s assessment of the value of the non-prime units available from the developer. It induces the user to be motivated to bid for these units from the developer, which raises the probability that the non-prime units will be taken up by the final user. From the developer’s perspective, then, selling prime units to speculators and property agents increases the probability that all the units will be sold within a limited period. The developer has in effect temporarily withheld some of the units from the final users and created a situation in which the speculators and property agents help him or her space out the sale to final users. The speculators and property agents therefore take up some of the risk of picking the right time to sell the units, since they are better searchers for final users than the developers are. The most fascinating aspect of this arrangement is that the developer is able to obtain part of the gains from allowing others to help him or her space out sales more efficiently over time. This occurs because the probability that all the units can be sold quickly has been increased, which translates into higher expected revenues after adjusting for risk. Note also that the developer would have little incentive to sell to speculators and property agents if it were not possible to improve his or her own situation. One variation on this arrangement is that a developer may sell a large block of units to a single investor at a discount with a provision that the investor not resell the units in smaller parcels for a predetermined period. The discount represents compensation to the investor for taking higher risks. The restriction on reselling the units in smaller parcels ensures that the investor will indeed take higher risks, for otherwise there is no reason to offer a discount. The goal of this arrangement is to ensure the units do not end up in the hands of small final users too quickly.

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Spreading Risk in a Market with Heterogeneous Products I asked at the beginning of this article why developers did not use auctions to presell their units. Auctions have the advantage of extracting the highest revenue for the developer, given the information available to all parties at the time of the auction. However, they have a distinct disadvantage over the present method. Many of the units that are put up for auctioning are likely to end up with final users, which limits the scope of the developer to space out sales to final users. The developer therefore has to assume a higher risk of picking the right time to conduct the auction and deciding how many and which units to put up at each auction. It is useful to compare the situation with wine sellers, who often use auctions. Wine is homogeneous in the sense that two identical bottles of wine must be the same. Housing units are inherently heterogeneous, so no two units can be identical, and therein lies a non-trivial matching challenge. Naturally, developers will want to be compensated for taking on additional risk, and they can expect to earn higher total revenues through auction because of the higher risks. The fact that they have instead chosen the present method suggests it is superior not because it brings in more expected revenue but because it optimizes between return and risk. Final users are not worse off either under the present method. If search activity is highly efficient, then the expected amount they would pay the developer under auctioning may not be significantly different from what they pay now, which includes payments to both the developer and to speculators and property agents. However, the risk to the final user increases under auction, as it does to the developer. The final user may be worse off if the developer picks a good time to conduct the auction and better off if he picks a bad time. More importantly, the final user has less scope to decide when to buy the unit, because fewer such units will be available from speculators and property agents. An alternative to auctioning is to operate a lottery, so that whoever comes first will have first pick of the units offered by the developer. This may reduce the probability that the prime units will end up in the hands of speculators and property agents (on the assumption that they will not gain privileged odds in the lottery). Lotteries will reduce the amount of speculation if more units end up in the hands of final users; however, auctioning is likely to be even more effective in reducing speculation. If developers are not prevented from selling the units to speculators and property agents in advance of the lottery, then the lottery will be little different from the present method unless restrictions are imposed on subsequent sales. These comparisons with auctions and lotteries highlight the important advantage of the market for housing forwards: It diversifies risks for both developers and final users. The developer has a lower risk of selling most of the units to final users due

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to their bad timing, while the user is protected from having to buy when the timing is right for the developer. This arrangement works because a significant number of units are held by speculators and property agents, who perform the dual function of assuming risk and searching for the final user. Another important function of the forward market in presale units is to help stabilize spot prices in the housing market. Measures to curb speculation in housing forwards are basically a contradiction in terms. If all the units can be placed directly with final users, then why bother with a forward contracts market? It is natural for final users to complain that they are often unable to purchase the units directly from developers when the sentiments are bullish, but then they have no obligation to buy from developers when the sentiments are bearish. Even when the allocation of units for internal sales is reduced, and speculators and property agents end up with fewer units, it is not necessarily beneficial to the final user. The fortunate final user may be able to purchase directly from the developer and may believe that he or she has saved money because of being able to sidestep speculators and property agents. But the user does not realize that the developer’s price is now higher because less risk can be passed on to those speculators and property agents, and matching is less efficient. The less fortunate prospective final user who is not able to purchase directly from the developer will discover that fewer units are now available from speculators and property agents; he or she too may have to pay a higher price. Speculation may also be curbed by limiting the period allowed for presales, imposing a stamp duty on confirmor sales, disallowing confirmor sales altogether, and levying penalties for cancelled transactions. But, as with the case of restricting internal sales, these measures limit the scope and ability of the forward housing market to spread risk and perform its unit matching function. This is not in the interests of developers or final users.

Curbing Speculation Hurts Final Users Society today frowns on the high market concentration of property developers as suppliers of new private housing units. But curbing speculation in the presale market makes it even more difficult for smaller property developers to diversify development risk. Over time, market concentration could only worsen. Ironically, this becomes a perfect excuse for bringing in new regulations or legislation to promote greater competition. This is what “regulation begets regulation” literally means. When forward markets become ridden with various measures to curb speculation, the price signals become less informative. The use of presale prices to inform transactions in the spot housing market suffers. The stabilization effects of forward sales on the spot market therefore also become less effective. Four of my colleagues

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at the University of Hong Kong (Professors S. K. Wong, C. Y. Yiu, M. K. S. Tse, and K. W. Chau) studied the impacts of anti-speculation measures on the volatility of spot housing prices from August 1991 to March 2001. They divided their time horizon into three periods during which anti-speculation measures varied. In period 1 (August 1991–May 1994), there were no restrictions in the presale market, so this was an “on” period. In period 2 (June 1994–May 1998), activities in the presale market were greatly restricted, so this was an “off ” period. Period 3 (June 1998–March 2001) saw the relaxation on most of the restrictions imposed in 1994, except that on stamp duty, so it was a partial “on” period. My colleagues hypothesized that the spot market in period 2 would be more volatile than that in period 1. Period 3 would fall in the middle and have an intermediate effect on the volatility of the spot price. Their results show that the volatility of spot prices did indeed increase significantly after forward sales were severely dampened by the regulatory control measures introduced in 1994 but decreased when the measures were partly relaxed in 1998. Their results agreed with the proposition that speculation in the presales market has a dampening effect on price fluctuations in the spot market. The implication is that anti-speculation measures increase the information cost in the market, and more transactions take place at the “wrong” price. This increases price volatility in the spot market. This has implications for final users as well as developers. Final users who make presale purchases and final users who transact in the secondary markets of existing units both end up worse off. Such are the unintended consequences of measures to curb speculation.

Henry Fok’s Wisdom Faces Challenge The method devised by developers to sell housing units in Hong Kong is unique and probably the result of the higher risks they have to bear in developing property in this city economy. Since Hong Kong is a single local market, there is limited scope to diversify development risks across multiple local markets. This factor may have prompted developers to be highly innovative in crafting this unique arrangement for selling units. Some years ago, I learned that the man who first introduced the present method was Mr. Henry Fok Ying-Tung. No wonder he became the founding President of the Real Estate Developers Association of Hong Kong and was later named Honorary Life President. I once shared a ride on his boat to Nansha to visit his development project there and took advantage of the opportunity to ask him about the presale idea. He was very modest and said it was a trial to see if it could help purchasers to buy units and vendors to sell units. He told me he had struck on the idea after noting

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how installment payment plans work. It was a simple idea, but over time the market improvised on it, and it became elaborate and sophisticated but seldom understood. What is clear, though, is that there is no compelling reason to believe the method represents market failure. Speculative activities improve economic efficiency. In the words of Lord Kaldor (1939): “In a world of imperfect foresight, the existence of speculators enables the system to behave with more foresight than the average individual in the system possesses.” When I first wrote about the economic logic behind the presale arrangements 20 years ago, I had hoped it would lead to a more enlightened view about regulating the market for presale housing units. Unfortunately, my hope has yet to be realized. The market for presale housing units was ended in 2011, after the government banned confirmor transactions. Presales by developers will still take place, but the market for resales has ceased to exist. Throughout history, speculation and speculators have been blamed for imbalances in the market. Since time immemorial, the prince has been willing to curb speculation and sacrifice speculators to appease the mob. Will this be the final fate of one of Hong Kong’s most creative institutional innovations? I hope this essay will not be its eulogy.

Reference Wong, S. K., C. Y. Yiu, M. K. S. Tse, and K. W. Chau, “Do the Forward Sales of Real Estate Stabilize Spot Prices?” Journal of Real Estate and Financial Economics, Vol. 32, 2006, 289–304.

20 How the Application List System Became the Winner’s Curse

Property markets in Hong Kong have seen major boom and bust cycles. This phenomenon is well known in economics. It is the product of fluctuations in demand and long lags in the supply of housing. The pattern was first observed in hog markets and came to be known as the Hog Cycle. The basic mechanism is that a short-term increase in demand increases the price of pork. Pig farmers then decide to keep more pigs for breeding, which decreases the immediate supply, so prices rise further. After a year, the increased production of pigs begins to be felt in the market, and the price for pork begins to fall. In response, pig farmers keep fewer pigs for breeding, which increases the immediate supply of pork and the price falls even further. After a year, the decreased production of pigs begins to be felt in the market. Another round of price and output cycles begins.

The “Hog Cycle” in the Property Market The Hog Cycle phenomenon is found in many commodity markets. In the property market, it is worsened by much longer supply-side lags in the production of housing. These lags are exacerbated by the lengthy time required to develop land, due to the high and rising regulatory cost of making land available. Building a large land bank would address only one part of the problem, land availability. It would not tell us how much housing should be supplied. Demand shocks in the property market also have a cascading effect that magnifies the initial effect of a shock. When demand increases, property prices rise initially. Existing property owners experience an increase of wealth as the equity value of their property appreciates. The wealth effect and the opportunity to refinance the original mortgage loan allow the homeowner to purchase a second property or a larger unit. The multiplier effect further fuels property price increases. The effects are similarly exaggerated when prices collapse. The feedback loop from demand to price, to wealth, and back to demand magnifies price changes. Futures markets allow suppliers and demanders to hedge against risk from the fluctuations and smooth out some of the ups and downs.Hong Kong once had

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a short-lived property price index, but the trading activity was so thin that it was mostly one-sided interests that were either longing or shorting the index. A more sophisticated instrument to hedge against property development risk was the presale of housing units before their completion, first introduced by Mr. Henry Fok Ying-Tung (see Essay 19). A secondary presale market developed in trading these instruments, known as confirmor transactions. Although they were only useful for hedging against risk when the market was in an upswing, during such periods they proved to be valuable in conveying information on market expectations. However, since they were only traded privately, the information conveyed to the public was necessarily imperfect, and the timing of their release by the parties involved was probably intended to influence public sentiment. The information was biased upwards in a booming market, a problem that could have been easily corrected if the government had required price information on all such transactions to be publicly disclosed within, say, a day. The government, however, viewed the trading of presale units as speculative activity that was responsible for fuelling price increases in a tight property market. Since the 1990s, the government has on numerous occasions imposed punitive measures to dampen transfer transactions of presale housing units. Today, the volume of such transactions is minimal. The secondary presale market has lost its role in conveying information on market expectations, and the public has to make transactions without the benefit of this information.

The 2002 Review of the Institutional Framework for Public Housing My colleagues at the University of Hong Kong have researched the consequences of curbing speculation in presale housing markets. They found that the volatility of property prices increased signicantly after the secondary market from presale housing units was curtailed by regulatory control measures. Anti-speculation measures, therefore, had increased the information cost in the market. More transactions now take place at “wrong” prices, and price volatility in the market has increased. How, then, can property price volatility be addressed? In the depths of the Asian financial crisis, the government reexamined its role in housing. The policy document Review of the Institutional Framework for Public Housing (2002) set out revised goals for a long-term housing strategy: 1. 2. 3.

To ensure that adequate housing is available to all households. To promote and help satisfy the demand for home ownership. To provide 50,000 subsidized housing units each year, including public rental housing, Homeownership Scheme (HOS), and Home Purchase Loan Scheme (HPLS) units.

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4. 5. 6. 7. 8. 9.

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To reduce the waiting time for public rental housing to 3 years. To suspend the HOS but maintain the building of 2,000 HOS units each year. To secure the most effective use of the resources of the private sector in housing production. To publish periodically the long-term demand forecasts, not as targets but as indications of planning requirements only. To adopt a private sector-led strategy in the development of private housing units. To suspend scheduled land sales via public auctioning and replace it with an Application List System (ALS).

The review broke some new ground on private housing, but it also renewed government’s commitment to the public provision of subsidized housing on a scale similar to that of previous administrations under Youde, Akers-Jones, Wilson, Patten, and Tung Chee Hwa. In retrospect, almost none of the objectives relating to subsidized housing was achieved, with the possible exception of reducing the waiting time for public rental housing. Only about 600 HOS units were produced, and the number of new public rental housing units each year also fell far behind target. In 2011–12, fewer than 13,000 Public Rental Housing units housing units were built; the corresponding number for private housing units was just over 13,000. However, a significant change was seen in the long-term strategy for private housing units. For the first time, the government recognized that a command approach towards private housing was futile. Long-term demand forecasts were needed that would prepare an adequate supply of land for use by property developers, while not being seen as production targets for private developers. The ALS effectively achieved this aim by shifting the initiative for private development from government to the market and abandoning the old system of scheduled land sales via public auctioning. The guiding principle was to let the private sector lead private housing development. Government’s role was to set the reservation price for the sale to be effective and to prepare land for inclusion in the Application List according to long-term demand forecasts.

The Application List System in Practice The ALS uses both tenders and auctions in a single system, the difference being that tenders use sealed bids and auctions use open outcries. It works like this: The government updates and announces the sites available for sale in the next financial year. A developer interested in a site on the application list can make a sealed offer to the

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government. If the trigger offer is accepted, then an auction for the site is arranged in about 10 weeks. The triggering developer is required to pay a deposit immediately. The accepted offer (or trigger price) is the starting bid of the auction. If the final bid at auction exceeds or equals the trigger price, the deposit is returned to the triggering developer (without interest). If the final bid falls short, the triggering developer’s deposit is forfeited. The government can also withdraw the site if the auction fails to reach the updated reservation price (based on assessed open market value). The use of ALS over scheduled auctions has a distinct advantage for the government when market sentiment is very weak, because it eliminates the need to impose a moratorium on land sales in order to stabilize the market. Let me explain. When the market sentiment is very weak, developers will make very poor offers or no offer at all. If the government accepts or rejects a low offer, then the weak sentiment gets confirmed. The government is in the unenviable position of acting to destabilize the market. By comparison, the ALS lets the market trigger land sales. This system, though, also has its drawbacks. In most years, the ALS has not worked to increase land supply because developers have been generally reluctant to make initial offers even in a rising market. For example, no residential sites were successfully triggered for almost a year, from October 13, 2004 to September 26, 2005. This situation arose because the government initially set the trigger price at equal to or higher than the reservation price, which was a very high price for triggering developers who had to pay upfront. They were assuming all the risks but receiving neither compensation nor advantage. Developers urged the government to lower the trigger price. The government responded by modifying the ALS in 2005, to reduce developers’ commitment. The trigger price was set as low as 80% of the reservation price, the deposit was standardized at 10% of the trigger price with a cap of $50 million, and the time between a successful trigger and the auction was shortened from 10 to 7 weeks. But these measures only had a short-term effect. Three sites were triggered and the auctions held in September 2005, but no other sites were triggered in 2005–6. Developers saw two solutions: further lower the trigger price or reinstate scheduled auctions. But my colleague, Professor Stephen Ching, outlined a far better solution.

The Problem of the Winner’s Curse Professor Ching argued against lowering the trigger price to avoid selling land too cheaply. He feared if a low trigger price was set, then the highest bid in the subsequent auction may fail to reach the reservation price. Government would then have to withdraw the site and precipitate negative market sentiment.

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The government was leaning towards reinstating scheduled auctions (at least for some sites), presumably because it also believed that the ALS was not working as intended. But this also concerned Professor Ching for two simple but related reasons. Scheduled auctions would set back the goal of letting the market drive the land sale process and once again put the government back in the driver’s seat of putting land up for auction. The government would also be at risk of again having to withdraw a site if the bid price ended up lower than the reservation price, a situation it had wanted to avoid from the very start. Professor Ching pointed out that the ALS suffered a classic problem of the “winner’s curse.” The central idea is that the true value of a site is uncertain because every developer has his or her own assessment, and none can be certain that it is correct. In an open auction, the bids of all developers are known to all. Developers can estimate their bids using information not only from their own assessments but also those of other bidders. If the offers are sealed, then no developer knows what the others are bidding. Under the ALS, you get a mixture of the two systems, to the detriment of the trigger developer. Developers make offers based only on their own assessments of the value of the site, and the developer with the highest valued assessment will trigger the auction. He or she is then obliged to make this offer or stand to lose the deposit. But while all the other developers know that developer has made the highest offer, he or she does not have information about their assessments of the site. This is the winner’s curse. Developers are of course aware of this problem even if they have not heard the term winner’s curse. To avoid falling into this trap, they submit offers that are lower than their own assessments. This explains why sealed offers submitted by developers are very low and often fail to trigger an auction. The conservative offers work against the seller’s interest. The winner’s curse backfires and becomes the “seller’s curse.”

A Solution for the ALS Professor Ching observed that triggering developers’ concern over the reasonableness of their bids could be partly alleviated if the developer knew that at least one other developer was willing to make a similar offer, a situation that occurs in auctions. He therefore proposed to modify the triggering mechanism for an auction to require two offers instead of one. An auction would only be triggered when two independent offers, each exceeding 80% of the reservation price, had been made. If the government received an acceptable offer, both the developer and the public would be informed. The identities of the developers and the amounts offered would not be disclosed. Consider Professor Ching’s reasoning in the following two situations:

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Would a second developer be more willing to make an offer high enough to trigger an auction, knowing that an earlier offer had been accepted? Very likely, because he or she now could surmise that two somewhat similar offers were on the table. Each of them would be committed to making a bid in the auction equal to the accepted offers they submitted, or stand to lose their deposit. The probability of over-offering would be approximately halved, because there would be another developer who was very likely making an acceptable offer of similar magnitude. This would ease the winner’s curse and induce the second developer to bid more aggressively. Would an initial developer be more willing to make an offer high enough to be acceptable even when no such offer had yet been made? Any developer making a first offer would know that an auction would not be triggered even if he or she made a high offer, unless the government accepted a second offer. The two developers would have similar commitments, and the relevant considerations would be the same as in the previous situation. The winner’s curse would again be eased. Professor Ching recommended that the first developer to make an acceptable offer should be required to pay a deposit only when a second acceptable offer was received. He also recommended that the deposit be halved between the two developers. This would further ease the winner’s curse and encourage more aggressive bidding. He also suggested that the government should pay interest on the deposits. Another recommendation was to allow the first developer the option of triggering an auction alone, without waiting for a second acceptable offer. In this case, the first developer would have to pay the full deposit. If he or she chose to wait for a second acceptable offer, then he or she would only have to pay half the deposit. It is important to acknowledge that the low number of Application List sites that were successfully triggered in previous years may have been the result of design flaws in the system. These flaws can be remedied. But it would be incorrect to conclude that the market-driven system has failed or that there has been collusion among developers. This would be far too sweeping a conclusion. Reverting to scheduled auctions would be premature and carry other risks if market sentiment turned negative, either because economic prospects had dimmed or policy uncertainty had increased.

References Ching, Stephen. “Unlocking the Winner’s Curse in the Application List System.” HKCER Letters, Vol. 85 January–March 2006. Wong, S. K., C. Y. Yiu, M. K. S. Tse, and K. W. Chau. “Do the Forward Sales of Real Estate Stabilize Spot Prices?” Journal of Real Estate and Financial Economics, Vol. 32, 2006, 289–304. 程 騰 歡 ， 「 完 善 勾 地 制 勝 恢 復 賣 地 」 ， 《 香 港 經 濟 日 報 》 ， 2011年 4月 18日 。 http://www.hket.com/eti/article/34ea209d-063f-4ba0–8c2e-b55baa978770–800347

Section IV The Political Economy of Land Use

21 Is There a High Land-Price Policy in Hong Kong?

Most people in Hong Kong believe that the city is once again in the midst of a housing affordability crisis. Housing prices are of course determined by both demand and supply. High housing prices may reflect high consumer demand for housing. However, they may also reflect restrictions on the supply side. Housing prices fluctuate with market conditions and the business cycle. This cyclical dimension may be a policy concern, because high housing prices affect low-income households and those without property assets for a time, but these effects are eventually self-correcting. But there is also a separate belief that, in Hong Kong, housing prices are high because the government has a “high land-price policy.” This is a very popular view with the public and even among experts with knowledge of economics and markets. Interestingly, this view cannot be easily proved or disproved. By and large most people have taken it as self-evident, on the basis that housing prices are high so there must be a high land-price policy. This notion has achieved the status of being an obvious truth like the proposition that “my mother must be a woman.” The closest we come to proof of this proposition is to note the very large observed gap between housing prices and construction costs. This gap reflects high land values and is cited as evidence that it must be the result of government policy to limit the supply of land. Housing prices per square foot increased by 1,022% from 1979 to 2011 (see Figure 21.1). This is equal to an annualized growth rate of 7.6%. Over the same period, the tender prices per square foot for building works conducted in the public and private sectors respectively increased by 316% (based on the Architectural Services Department Index) and 250% (based on the Rider Levett Bucknall Index). This is equivalent to annualized growth rates of 4.5% and 3.9%. The tender price indices are approximations of the expected construction prices and include labor, materials, and management expenses, as well as anticipated profits at the time of tendering. The average gap between housing prices and construction costs during this 32-year period was 147%. But can this large observed gap be interpreted as the land value? And if so, who gets the land value? The government? The developer? The unit owner? If we spend a

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little time thinking through these questions, then we cannot be sure that the government has a high land-price policy.

Evidence against a High Land-Price Policy First, why would the government want a high land-price policy? Many people have argued that it allows government to raise a large public revenue without resorting to higher taxes. If the goal is to raise revenue, then we must ask if the government has taken the necessary measures to ensure that it is able to obtain most if not all of the land values. A moment’s reflection will convince everyone that this has not been the case. If the government wanted to get the maximized revenue, it could choose not to sell land to developers through auctions but instead to share profits with them. The most prominent example of this is the Cyberport Project, but there are very few other similar cases. Second, while the government can deliberately reduce the supply of land in order to raise its price, does this maximize its revenues from land sales? This is not entirely obvious. Government revenues depend not only on land sales but also on the overall level of prosperity of the economy. Government revenues may not be maximized if businesses and employees are driven out by higher land values. At the very least, one should investigate the tradeoff between revenues gained from land sales and revenues lost from a less prosperous economy. The traditional view that the high cost of land is a result of the so-called high land-price policy of government should not be taken as self-evident. Students of economics should not fall victim to this type of sloppy thinking: It is bad economics. There is, however, another view as to why the supply of land has been restrictive. Professor Edward Glaeser has shown that the cost of development can be driven up by government regulations in the form of planning, zoning and building restrictions, and other transactions costs. According to this view, properties are expensive because of artificial limits on development and construction created by restrictive regulations. Property values are high in Hong Kong, but even a casual visitor would find that there is plenty of land that is not developed. In fact, more than 70% of land in Hong Kong is not developed but is mere empty space. What prevents that land from being developed is regulatory prohibition, a very formidable barrier to development. Many individuals and groups in Hong Kong have a significant pecuniary and nonpecuniary interest in preventing development.

Land Value and Regulation Tax Regardless of the reasons why development may be prevented or delayed, it results in barriers and creates a wedge between housing prices and construction costs. This

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wedge is a combination of two things: (1) the value of land; and (2) what can be called the regulation tax. The regulation tax includes at the very minimum the cost of assembling land, acquiring planning and building permission, and overcoming political resistance from various interested parties and bureaucratic inertia. Mathematically we can express the relationship as follows: Housing price (P) – Construction cost (C) = Land price (L) + Regulation tax (R) Housing prices (P) and construction costs (C) can be found by observing the data. However, it is not possible to directly observe the land prices (L) and the regulation tax (R) in the data. For this reason, L and R cannot be directly identified. Indeed, most people mistakenly call the sum of L + R, which is the difference of P – C, the value of land. So, what is the primary driver of the wedge between housing prices and construction costs, land value or regulation tax? If the driving force is land value, then developments with bigger lots and lower density should be much more expensive than those with smaller lots and higher density. If you double the lot size and halve the density, then the total number of units is the same. In this situation, one is likely to see a very substantial increase in property prices. If the driving force is regulation tax, then developments with bigger lots and lower density would not be much more expensive than those with smaller lots and higher density. One is unlikely to see a substantial increase in housing prices by doubling the lot size and halving the density. Empty unbuilt land is not worth much. The gap between housing prices and construction costs will be larger the higher the regulation tax. From Figure 21.1, we find that the gap between housing prices and construction costs in Hong Kong was relatively narrow until the late 1980s. Hong Kong’s economy boomed after China began to open up after 1979. Housing prices rose dramatically, because supply could not respond in the immediate short term. As a result, the gap between housing and construction prices started to widen. It is useful to divide the post-1979 period into two: one from 1979 Q4 to 1988 Q4, the other from the end of 1988 Q4 to 2011 Q3. The average gap between housing prices and construction costs in the private sector during the earlier period was only 98%, but the corresponding figure in the later period was 165%. This amounted to a 67% increase in the gap. Why didn’t the average gap in the later period narrow over time and return to its earlier level? Even during the deflationary period from 1997 to 2003, immediately after the onset of the Asian financial crisis, the average gap between housing and construction prices was 156%, representing a very modest reduction in the gap

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compared to the levels of the earlier period. Supply had simply failed to adjust in the later period.

Failure to Convert Industrial Land Use Two factors altered the housing supply environment in the later period. The first was the failure of government to efficiently rezone industrial land after manufacturers had left. More bold and sweeping measures to facilitate the conversion from industrial land use to commercial and residential uses would have supported more rapid redevelopment. Instead, there were case-by-case negotiations of conversion premiums, a cumbersome process that failed to address the massive need to redeploy land resources into better alternative uses in the aftermath of rapid structural changes that were taking place in Hong Kong and on the Mainland. It would have been better for government to announce across-the-board land conversion premiums on all properties, based on updated rating values that would be good for six months. The land conversion premiums for many properties would then have become public information. Moreover, an additional step could have been explored to allow these premiums to be paid not as a lump sum at the outset, but as a new component of land rent to be collected in perpetuity. Such a proposal would in effect have allowed vast tracts of land to become automatically converted, subject to payment of a premium. The recent development strategy for East Kowloon is a limited step in this direction.

New Planning Ordinance Delayed Development The second factor affecting housing supply was the approval of the Town Planning (Amendment) Bill in 2004, which produced an environment that increased the transaction costs for property development. The bill was seen as opening up the planning and development system to greater accountability. But in changing the rules, it increased the regulation tax and raised land values. Development was delayed and the supply of all forms of property was reduced, including the supply of housing. As a consequence, the initial increase in the gap between housing prices and construction costs resulting from China’s opening could not be closed. Housing prices, as well as other property prices, continued to stay above construction costs. Interestingly, Professor Glaeser also found that the estimated costs of the regulation tax were on the order of 20 times higher than land values in major cities like Boston, Chicago, New York, and Los Angeles. In San Francisco they were about 10 times higher. His results clearly showed that, even in the US, regulation tax was by far the most important driver of higher housing prices. He concluded that the US was

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facing a nationwide affordable housing crisis, not because of either high construction prices or high land values, but because of the high cost imposed by zoning and other land use controls that increased the regulation tax.

A Society Divided Almost everyone in Hong Kong believes the government has a deliberate policy to reduce the supply of land in order to raise its price for the purpose of enhancing government revenues from land sales. Is this true? I think perhaps the real culprit is not a high land-price policy but a combination of factors. First, there is an elaborate land planning and control system that presents a rather formidable barrier of entry for novice developers. Second, the development approval process is open and accountable, so the public and numerous stakeholders can participate in the consultation and decision-making process. This inevitably produces uncertainty, results in delays, and increases the cost of development. Third, in recent years the public environment has become politically charged, and there is increased concern about fairness and regulation compliance in decision-making. The combination of these three factors has produced an arrangement that is becoming highly inflexible and very cumbersome in facilitating development. A planning and control system that is rigid and has high transaction costs works in the interests of all existing property owners, including property developers. Increasing regulation tax increases housing prices and benefits existing property owners but at the expense of prospective property owners. It is not a wholly winning situation for property developers, though, because those that have a comparative advantage operating in a high transactions-cost environment lose out in the competition under the new rules. Many former property developers have therefore ceased to be active in Hong Kong in the last two decades. Addressing these issues entails tackling bureaucratic inertia, divided interests, and opposing views within society over development. Changing the present planning and control system will not be easy, because there are so many stakeholders. If Hong Kong has to continue to live with high property prices, then the demand for more public housing will not cease. And the division of society into haves and have-nots will also become permanent. For this reason, the reform of the public housing sector to confer bona fide property ownership is the only hope for avoiding a divided society.

Reference Glaeser, Edward L., Joseph Gyourko, and Raven Saks. “Why Have Housing Prices Gone Up?” NBER Working Paper No. 11129, February 2005.

22 Lima’s Other Path, Tsoi Yuen Village, and the Northeast New Territories

The rise of Hong Kong’s public housing program can be ultimately traced to three factors. First was the arrival of new immigrants that increased the population from 600,000 in 1945 to 2.3 million in 1951. Second were the effects of the government’s disastrous imposition of rent control on prewar housing in 1947. And third was the government’s hostility to development in the early years of the postwar period. The huge increase in the demand for housing was met with policies that made it extremely difficult for developers to redevelop the existing housing stock. An effective private sector supply response thus was prevented. But are their alternative solutions to an explosive growth in housing demand resulting from the arrival of immigrants into urban centers? Economist Hernando de Soto’s account of the efforts to understand and resolve the squatter settlements in Lima, Peru, shows an alternative approach that Hong Kong should seriously consider adopting to resolve its housing problem.

Breaking a “Racket” in Hong Kong Let me first recapitulate how Hong Kong has dealt with its squatter problem. Very little of the land that came available in this period was allocated to private development. From 1945 to 1958, no more than 200 acres of land were made available for development in the urban areas, of which less than 30 acres were auctioned. The rest was granted by private treaty, primarily to nonprofit projects. A South China Morning Post editorial urged “the government to form sites for sale to builders to resolve the housing shortage since many squatters can afford regular dwellings” (December 31, 1953, p. 8). Private developers, meanwhile, were building squatter housing units to be sold or rented out to those who either could no longer tolerate the old private tenements or were prospecting for resettlement opportunities. The squatters could afford to pay what was described by government officials at that time as exorbitant prices and rents. Given all the constraints, the market accommodated the influx of immigrants well although the population paid for it in high rents, overcrowding, and inadequate

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facilities. The supply of legal private housing units was constrained by the rent control on prewar housing and by the government attitude towards development. Private developers supplied illegal squatter housing by building on Crown Land without permission, especially agricultural land. Some of these illegal structures were even elaborate, multistory, reinforced concrete buildings. At one point there were over 1,000 developers operating in both the legal and squatter markets. The real difference between the two markets was whether permission had been granted by government to use the land and build on it. The government naturally blamed private developers for exacerbating the squatter problem. It is amusing to read the appalling hypocrisy in an official justification for the housing resettlement program: “[B]y this resettlement program we are breaking a ‘racket’ . . . If we can give these people living space at a fair rent, and if we can do this on a really large scale, we shall knock the bottom out of a ‘racket’ which helps keep the cost of living up” (Hong Kong Hansard, March 2,1955, p. 40).

Lima’s Other Path The population in Peru grew rapidly from 7 million in 1940 to almost 18 million in 1981, a rate of about 2.3% a year. The increase was substantially greater in the capital city of Lima, where the population multiplied by 7.6 times from about 600,000 in 1940 to 4.6 million in 1981. In 1940, the city housed 8.6% of Peru’s population; by 1981 it was housing 26.0%. A substantial part of the increase came from migrants, whose numbers increased from 300,000 to 1.9 million between 1940 and 1981. When the migrants arrived in Lima, they encountered a hostile world. The urban dwellers did not want the peasants to descend on the cities. Assistance and development programs for rural areas were designed to ensure that the peasants improved their lot back home, well away from the cities. Civilization was expected to go to the countryside; the peasants were not expected to come looking for it. The hostility was extreme. A ban was imposed on the construction of cheap apartments. Migrants found that it was tremendously difficult for them to access many legally established social and economic provisions, such as housing and education, and to enter business or get a job. Peru’s legal regulatory system had been developed to meet the needs and bolster the privileges of dominant groups in society. Before the peasants arrived, the implicit discrimination in the legal regulatory system was not apparent. But it quickly was revealed when large numbers of migrants showed up. In order to survive, the migrants had to live a life outside the formal economy and society, without the protection of the law. They lived, for example, in illegally built houses in shantytowns—equivalent to Hong Kong’s squatter areas—and they worked as illegal street vendors, again a common sight in postwar Hong Kong.

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These individuals were not criminals as such, but they violated specific legal regulations that denied them their rights. As a result, they became branded as the “informals.” In the late 1980s, 61.2% of work hours were devoted to informal activities, and the informals constituted 48.0% of the economically active population in Peru and contributed 38.9% of Peru’s GDP. Their neighborhoods were acquired and built outside of the law in exactly the reverse order of what happens in the formal world: they first occupied the land, then they built on it, next they installed infrastructure. Subsequently, they could gain title for their dwelling, and only at the end did they acquire ownership. de Soto estimated that the replacement cost of the informal housing built in the period 1960–84 amounted to US$8.3 billion, accounted for 42.6% of Lima’s dwellings, and housed 47% of its population. In the same period, the total public investment in housing in the formal economy, including in middle-class housing, totaled US$862.2 million. This was a mere 10.4% of the informal investments.

Property Rights and Economic Prosperity de Soto found that life in the informal settlements was neither anarchic nor disorganized as many erroneously imagined. The settlers had evolved a set of extralegal norms to regulate social relations in the settlements. These informal settlements had elaborate governance and management organizations to foster stability and security for the acquired dwellings and the inhabitants. The order in these settlements can be better understood by looking at the process by which the migrants acquired property. Land was acquired in two ways: by illegal purchase of agricultural land and by invasion of government land. Invasions that were organized could be gradual or violent and involve anywhere from 100 to 40,000 settlers. The invaders drafted meticulous plans, including an invasion contract, with the help of professional invaders comprising unionists, lawyers, entrepreneurs, politicians and others. The planning covered operational, organizational, political, legal, and publicity dimensions. The establishment, demarcation, and distribution of the land to be acquired were drawn up in an invasion contract agreed among the invaders beforehand. Once the invasion was executed, informal governance and management organizations of the settlement were rolled out. The invaders quickly set up various facilities within the settlement, like day care centers and communal kitchens, and negotiated with the nearest minibus operators to extend a route to the new settlement. Street vendors sold food, and building materials and other provisions would appear. Law and order was maintained through organizing defense pickets. A common practice was to name the settlement after the president’s wife or some prominent political figure, in an attempt to persuade that person to endorse the settlement.

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The immediate effect was the establishment of a right to the land. But this right was merely an “expectative property right,” established by one’s own initiative outside the legal framework. It applied temporarily until such time as the government conferred definite ownership on the members of the informal settlement or, with the passage of time, popular organizations became able to defend it as effectively as the state could. The route to legalizing the settlements was difficult. As many as 159 bureaucratic steps had to be completed in order for residents to receive title to their lots and incorporate the neighborhood into the city, a process de Soto estimated would take on average 20 years to complete. When this occurred, the settlers had enhanced security and stable rights to the dwelling they acquired through invasion. However, this did not signify complete integration into the formal legal system; rather, it was exceptional recognition. Still, the settlers regarded this recognition as decisive for increasing their investment in their dwelling and settlement. Thus, the greater the security of their property, the greater the investment they would make in it, and vice versa. de Soto studied a sample of 37 informal settlements across Lima and found that the average value of buildings whose owners had received full legal title was 9 times that of buildings whose owners did not have title. These figures suggest that expectative property rights did not provide sufficient incentive to invest large sums of money in one’s house and in the settlement. People had to be able and willing to invest at least 9 times more to get some measure of protection from the formal legal system. Without a definitive title, selling the land and renting out the buildings resulting from an invasion were prohibited by law. Residents therefore were always vulnerable, which forced them to take a number of costly precautionary measures. The situation was particularly difficult when it came to disposing of property. When informals wanted to sell, they would claim they were transferring the buildings but not the land itself, in order to disguise the sale. Moreover, because there were still no definitive rights and the system of extralegal norms only protected those who had devised it, the transfer had to be approved by the residents of the settlement. Buyers also had to demonstrate their adherence to the invasion contract and any supplementary agreements. Renting was equally tricky. Because the tenant occupied the dwelling, informals feared the government would come to recognize the tenant as the owner of the land. Informals often preferred to disguise the tenancy as a lodging arrangement, and the owner stayed or pretended to stay in the building with the actual tenant. de Soto’s study became enormously influential throughout Latin America and the world. Many countries have established research centers devoted to the study of informality. In Peru, the government adopted his proposal to grant immediate legal land and building titles to all the settlers for free, to bring them back into the formal legal economy. Half the population in Lima became empowered literally overnight. A  massive makeover was initiated in the shabby-looking informal settlements as

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settlers began to invest in their dwellings and the community. The Peruvian economy experienced prolonged recovery and growth. The work to bring the vast informal Peruvian economy back into the formal economy also had important political consequences. It undercut political support for the Shining Path (a guerilla insurgent organization claiming to be Maoist) and restored political stability in Peruvian society.

The Different Property Rights of Indigenous and Non-Indigenous Villagers Hong Kong has its own modern-day informal settlements, which have come under the spotlight in a government plan to reclaim land to build three new towns, known as the Northeast New Territories New Development Areas. The project has raised the troubling issue of differences in the treatment of indigenous villagers who lived in the New Territories before the British took control in 1898, and those who arrived more recently, the non-indigenous villagers. The conflict came to the fore over Tsoi Yuen Village, which was demolished in 2011 to make way for the high-speed railway link to Guangzhou. This conflict stems from complications over landownership. Indigenous villagers are owners of the village land they live on. They possess legal title to their land and dwellings. Non-indigenous villagers are more like squatters, whose presence on government land has been “tolerated” as long as they do not develop it. Unlike urban squatters, they have not occupied land that is keenly sought after for redevelopment, so for decades they have not been resettled into public housing. Some of them have bought land from the rural gentry but received no paper records of the transactions. The origins and status of non-indigenous villagers in relation to their occupied land and dwellings are essentially similar to the Peruvian informals in their settlements. Indigenous residents occupying village land are protected under the law, including the Basic Law. Since they own the land, they are naturally entitled to at least fair market compensation from the government, including continuing their chosen lifestyle in another location. They therefore have good reason to support government initiatives to redevelop their property. Most non-indigenous villagers, however, are not granted such protection because they do not have and cannot possess legal title to the property they occupy. Like Lima’s informals, they are either squatters on land without legal permission or purchasers of agricultural land without land title. If their land is reclaimed for development, they will be offered at best limited compensation (for example, $600,000 in the case of the Tsoi Yuen villagers) or a place in urban public housing when they are forced to move on. In essence, their options are identical to the ones available to squatters whose homes burned down in the Shek Kip Mei fire some 60 years ago (see Essay 4) .

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The non-indigenous villagers in Tsoi Yuen Village and the Northeast New Territories have been settled in these villages often for decades. Their dwellings have long been tolerated by government just as Lima’s informal settlements were tolerated. The villagers have made investments in their dwellings, many of which are spacious, and they are familiar with and attached to their village neighborhoods. It is far from obvious that a public housing unit in the urban area would be adequate compensation. As with their village home, a public housing unit would not offer full private property ownership rights. The villager would become either a tenant or a partial owner of an HOS unit that cannot be disposed of without paying an exorbitant land premium. The compensation package would have no upside potential because the government-subsidized housing unit provides shelter only; it is not a bona fide asset.

Divided and Politicized Is it surprising, then, that the attitudes of non-indigenous villagers, who oppose redevelopment, are completely different from those of indigenous ones? The difference stems from property rights as they are recognized by the government. The expectative property right of the rural squatter today is different from that of the urban squatter of yesterday. If the government wants to redevelop land in the New Territories, it has two choices: either recognize that the non-indigenous villager has legal property rights over the dwellings and land, or offer a better compensation package. The former path is similar to Peru’s, the latter to Singapore’s (see Essays 23 and 24). But if the government sticks to the present policy, it will have to pay a very high transaction cost for every redevelopment project. And society will be divided again and again. Just as the Peruvian informals had the service of a team of professional invaders who helped them to organize an invasion contract, settle in, keep order in the settlement, and fight for their expectative property right, Hong Kong has political and social advocates who support the non-indigenous villagers. They are motivated by their civic opposition to government, a conservationist ideology to preserve an alternative lifestyle against urbanization, resistance to encroachment by anything associated with the Mainland or Mainlanders, or a “city-state” political mindset. Many are politicians and politicians in training. In a political show of force at a public forum on redeveloping the Northeast New Territories, a scuffle broke out when some participants raised the British flag. I  have no idea whether these individuals were loyalists to the ex-colonial government, but the Peruvians similarly found dramatic gestures to be worthwhile (such as naming their newly invaded settlement after the president’s wife). Political theater is the same the world over, whatever your history. It took the Peruvian government 60 years and the political need to weed out the Shining Path to change its policy.

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References de Soto, Hernando. The Other Path: The Economic Answer to Terrorism. New York: Basic Books, 1989. Hong Kong Hansard. Reports of the Meetings of the Legislative Council of Hong Kong, Session 1955. March 2, 1955. Smart, Alan. Making Room: Squatter Clearance in Hong Kong. Hong Kong: Hong Kong University Press, 1992. ———. The Shek Kip Mei Myth: Squatters, Fires and Colonial Rule in Hong Kong, 1950–1963. Hong Kong: Hong Kong University Press, 2006. South China Mornng Post, Editorial, December 31, 1953, p. 8.

23 Stranded between Singapore’s Way and Lima’s Other Path

Squatter clearance everywhere is a brutal political process that generates considerable resentment. Hong Kong has dealt with it by providing resettlement in high-rise public housing blocks for affected households, but as I have discussed in this book, this provision is flawed. Since the Housing Authority requires exorbitant payments for land premiums on HOS units, the offer of an ownership unit as compensation is very unattractive. This was the situation for Tsoi Yuen Village (see Essay 22) and the North East New Territories development area. The Housing Authority unfortunately inherited these poorly conceived housing policy measures from the government in the 1960s, which have become a hindrance to development. But as the cases of Lima and Singapore have shown, there are other, more equitable, ways to deal with squatters and housing demands. Both cities have taken different approaches, but both have achieved more positive outcomes for residents and their cities. In Lima and in Hong Kong, squatter areas mushroomed in the fringe areas around the city. In Lima, the shantytowns grew so large that they eventually housed more than half the city’s population. As I explain in Essay 22, the decision to grant squatters their legal land titles and reincorporate them into the formal economy highlighted the sheer folly of denying them their rights to the property and settlements they had built up. The Peruvian squatters had made good economic use of the state land they invaded over decades and of the agricultural land that some had purchased without permission. In both cases, it was ultimately advantageous for society as whole to allow them the right to possess what they had occupied and built up.

Postwar Explosion of Squatters In Hong Kong, squatters have been handled very differently. The growth in squatter areas in the 1950s and 1960s meant land available for development became very scarce, which was increasingly evident as entrepreneurs could not find sufficient land to build industrial factories on. Jobs and economic opportunities were threatened in

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a city with a rapidly rising population. The situation was worsened by rent control legislation that made it extremely difficult to redevelop old private tenement blocks in the urban areas. In a bid to clear squatter areas for development, the resettlement program was adopted. Resettlement created powerful incentives for migrants living in cramped old private tenement blocks to become squatters and be resettled in larger public housing units. The original criterion was to provide for squatter households affected by government decisions to clear the land they occupied for development, and they were not means-tested. This in effect meant the resettlement program was a carrot to soften the political resistance of those who had to be cleared from the land. Means testing was introduced to assist and pacify poor households that did not benefit from land clearance, which served to make the resettlement program more politically and morally acceptable. Squatters who accepted subsidized housing essentially surrendered their uncertain rights to the dwellings they had occupied on squatter lands. This is a key difference with the Peruvian squatters, who never surrendered their uncertain rights and who were eventually triumphant in getting government to recognize that they possessed legal rights over their dwellings and the land they occupied. However, since the Tsoi Yuen Village incident in 2011 in which the non-indigenous villagers rejected the terms of settlement offered to them, Hong Kong’s rural squatters have also sought political recognition for their uncertain rights. The terms offered to them have changed little over the years, usually a tenancy in a public rental unit. A very few have been offered an HOS unit. However, since HOS units cannot be disposed of on the free market without first repaying the unpaid portion of the land premium to government, their real value is substantially reduced.

Singapore’s Private Property Populism Singapore’s Housing Development Board (HDB) offers a third way for dealing with squatters, which is more generous than that of Hong Kong. As detailed in Essay 5, households get full ownership of their units at an affordable price. Occupant-owners are free to sell the unit on the open market after five years and to keep any capital gains for themselves. Why have Hong Kong and Singapore taken such different approaches to public housing? Housing development was the cornerstone of Singapore’s national development strategy. It provided visual evidence of progress for all to see. It gave Lee Kwan Yew’s populist authoritarian government concrete confirmation of its concern for the ordinary people. It created a building boom that provided sustained stimulation for economic progress. Most importantly, it bought political support for the People’s Action

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Party. It dispelled and dispersed the leftist political forces that lurked in the slums, which were the breeding grounds of political dissatisfaction. On June 28, 1959, Lee told a gathering of workers that his mandate was clear: to  bring about by peaceful and constitutional means an independent, democratic, noncommunist, socialist Malaya. He said, “[i]t is necessary to state categorically that we are democratic socialists, and that we subscribe without reservations to the theory and practice of democratic socialism on which the PAP is based,” (see Josey 1968, 97). The government’s single most significant decision was to pass on to the HDB occupant the entire land rent obtained by the unit. This prudent measure has created a private propertied citizenry in Singapore that has provided unwavering, stable support for the political leadership over the decades. It has also created a free market in HDB housing units that strengthens the foundations of a free private-market economy. Singapore in effect has pursued a sort of selective discriminatory urban land reform. It has broken up some of the traditional old land ownership order to achieve national development objectives. Certain parcels of private land have been nationalized and redistributed to some 80% of ordinary citizens through the HDB program—although the government’s reputation in fostering economic equity and social fairness is far from untarnished, given the discriminatory nature of the nationalization of land. The Singapore and Hong Kong approaches to public housing therefore have been quite different. Lee Kuan Yew’s government was committed to nation-building and giving the people of Singapore a stake in their future. It gained legitimacy through its struggles against the British colonial government and other political rivals. It was also in a hurry to pursue national development. Its draconian policies to reclaim land from owners had to be justified on higher moral grounds and with more exalted social goals. By making the vast majority of Singaporeans homeowners, the HDB program has, in the view of Premier Lee Hsien Loong, given people an asset that allows them to benefit from a more prosperous Singapore. Everyone has an economic stake in the future of the nation. The HDB program has also ensured that land, a scarce and valuable asset in Singapore, is held privately and allocated through the market. As a result, it is used efficiently to the benefit of everyone and the economy as a whole. Because almost all land is held privately, everyone has a stake in Singapore. For example, the city-state’s environment is far better protected than that in Hong Kong even though almost all land in Singapore is occupied, whereas in Hong Kong vast tracts of land are held publicly for conservation purposes and not occupied. Privately held land gives everyone a stake in the environmental future and provides powerful individual incentives to safeguard against environmental degradation. It is truly ironic that a government proclaiming to be socialist made the decision to let HDB occupants either rent or purchase their flats at a deep discount and to possess

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the right to sell these flats on the open market without having to pay the government any land premium. It makes a mockery of Hong Kong’s famed reputation as a bastion of free market capitalism. Singapore adopted a policy to give all citizens private property at a price they can afford. Hong Kong chose to keep its citizens enserfed to their public housing units as tenants or pseudo homeowners without full possession of the units they occupy. In the end, Singapore has accomplished the same thing as Lima, which is to make almost all of its citizens property owners. There is one difference. In Lima the dwellings and settlements were built by the occupants. In Singapore the government built them. The two cities are visually very different. There is far more homogeneity in Singapore.

Lessons for Hong Kong In dealing with the problem of rising urban housing demand due to population increases, Lima, Singapore, and Hong Kong have demonstrated critical differences in their responses. All three cities had shantytowns or squatter areas. Lima did not embark on building a massive public housing program to replace its shantytowns in the manner that Singapore and Hong Kong did. The shantytowns in Lima were an important part of the informal economy and the breeding grounds of supporters for the Shining Path. The Peruvian government adopted the recommendations of Hernando de Soto to give legal land titles to the occupants in the shanty towns. The occupants were allowed to retain the entire value of the land premium for free and with full, unfettered, untaxed transfer rights. This strengthened the foundations for a private market economy and a stable political system. de Soto subtitled the first edition of his book The Silent Revolution in the Third World, but in the second edition he changed that to The Economic Answer to Terrorism. Both Hong Kong and Singapore decided to get rid of their shantytowns by resettling the occupants into high-rise, publicly built housing blocks. Singapore decided to allow the occupants to keep the value of the land premium for free. They became bona fide full owners of their housing units. The result is that most Singapore citizens became private property owners through the goodwill of the government. They naturally became staunch supporters of that government and supported policies to protect the value of their private property. Hong Kong rid itself of shantytowns gradually, compared with Singapore’s breakneck pace, but failed to share the value of the land premium with the occupants of high-rise public housing blocks. These occupants became tenants or pseudo homeowners who could not rent out their housing units or dispose of them without many restrictions. They have remained enserfed to their housing units and to the Housing

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Authority, and their many and growing complaints form a pool of cumulative demands that have turned them into critics of the government. Large swathes of land are locked into an inflexible land-use policy that does not allow the occupant to do anything but use it as shelter. Public housing without ultimate private ownership has worsened the division between the haves and the have-nots. Despite Singapore’s self-proclaimed commitment to democratic socialism, it laid a solid foundation for a people’s private capitalist economy to take root. Hong Kong’s private capitalist economic foundation is in this respect much less firm at the grassroots level. This is the cause of Hong Kong’s many woes in recent times. The public consultation process has also failed to mitigate things. Public consultation on the North East New Territories development area was initiated long ago, yet recent complaints from non-indigenous villagers suggest the only key stakeholders consulted were the indigenous villagers. Even then, it took a very long time to seek their views despite their well-established rights. The non-indigenous villagers only became a political force to be reckoned with because they were in the path of a highspeed railway project, and a decision on the project had to be made. There is certainly room to find a way to lower the transaction cost of developing the New Territories. I believe this will depend on greater clarity and recognition of the rights of all inhabitants, to give them better security and stability and, where necessary, to offer more attractive compensation in exchange.

References de Soto, Hernando. The Other Path: The Economic Answer to Terrorism. New York: Basic Books, 1989. George, T. J. S. Lee Kuan Yew’s Singapore. London: André Deutsch, 1973. Josey, Alex. Lee Kuan Yew: The Crucial Years. Singapore: Times Books International, 1968.

24 Subsidized Housing and Stability Lessons for China

What lessons can be gleaned from the experiences of Hong Kong, Singapore, and Lima for public housing in the large and fast-growing economy of Mainland China? When done well, public housing can sustain economic reform and growth, provide insurance for the disadvantaged, and support broad-based, market-driven development that enhances social harmony and political stability. The starting point for this discussion is a broad one: China’s transformation from a traditional agrarian society into a modern industrial economy. This transformation has been a momentous event in the history of human civilization. Its impact is not limited to the economic sphere but embraces every sphere: moral, social, and political. It has global dimensions. It redefines the way we live and think. Without oversimplifying matters, it is useful to think of this great transformation as the breaking down of the old order and the ushering in of a new one. In economic terms, what happens in such a transformation is that stagnancy is replaced with growth. Industry displaces agriculture as the dominant economic activity. Land-bound peasants with narrow, specialized agricultural skills migrate into densely populated cities to become mobile versatile workers. Politically, the transformation from a peasant to an industrial society entails the overthrow of the old landed ruling class, inevitably involving great convulsions and considerable violence. Few peasant societies, however, make a successful transformation to industrialization, and many remain poor, repressed, and traditional, or are stuck halfway between agriculture and industry.

Land Reform in China An important part of the transformation has been land reform, and China has struggled with this for over a century. The Guomindang did not pursue land reform when they were in power on the Mainland although after retreating to Taiwan they took bolder land reform initiatives. The power of the landlord class on the Mainland was only broken during the first 30 years of Communist rule, ending over 1,000 years of land ownership structures. What the Chinese Communist Party accomplished was

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not merely a nationalist revolution but a social revolution. The path towards building a socialist commodity economy with market-driven industrialization was cleared. China’s industrialization under Communist rule took place in two stages. In the first 30 years, the ruling party adopted central command and planning; in the second 30 years, it embraced a policy of openness and market reforms. Market-driven industrialization took off with a vengeance, when peasants were finally allowed to move into cities to become factory operators. The hukou system was quietly ignored to allow for urbanization on a broad scale. As a result, economic growth has soared for a miraculous three decades. The Chinese economic miracle was the product of two events: first, a political revolution that swept away the old order, and second, an economic revolution that harnessed the enabling powers of the market. The process of industrialization is never a purely economic phenomenon but a political economy challenge. The old order has to be cleared to make way for the new. Most transformations fail because the old order cannot be retired or because forced compromises result in half measures. China was able to build on the success of its political revolution to make way for a smooth transition to a market system with minimal political barriers and resistance. China’s industrial base is now quite impressive among emerging economies with large populations. Table 24.1 shows that China’s percentage share of the industrial labor force, at 28%, is fairly high given its GDP per capita (in purchasing power) and is comparable to more developed economies like Russia, Mexico, and Turkey. The 38% share of the agricultural labor force still leaves considerable potential to transfer peasants from agriculture to industry. And when this takes place, further urbanization and city development will have to follow.

Table 24.1 Comparison of GDP per capita and labor force in emerging economies GDP Per Capita 2010 (PPP USD) Russia Mexico Turkey Brazil China Egypt Indonesia India

$15,900 $13,900 $12,300 $10,800 $7,600 $6,500 $4,200 $3,500

Percentage of Labor Force in Agriculture 10% 14% 30% 20% 38% 32% 38% 52%

Percentage of Labor Force in Industry 32% 23% 25% 14% 28% 17% 13% 14%

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A Rebalancing Consumption Miracle Today, China stands at the crossroads of the next stage in its development. The 12th Five-Year Plan has outlined a strategy to address the serious imbalances that have appeared after 30 years of rapid growth. The most critical imbalance is that created by a heavy reliance on investment growth. Private consumption as a share of GDP has dropped dramatically in the past 20 years to 35%, while investment’s share has risen to 40%. Meanwhile, the sluggish global economy means that net external demand is likely to play a less important role in sustaining China’s growth in the next few years. International pressure is also mounting against China to reduce its external imbalances. China wants to sustain growth by stimulating domestic demand, which will entail promoting private consumption spending sufficiently so that its share of GDP increases. This is going to be very difficult. The numbers alone are a little worrying. If China grows by 8% a year, consumption would have to grow by a little over 11% just to raise the consumption share of GDP from 35% to 36% in one year. To do this in two years, consumption would have to grow by a little over 9.5% annually. To bring Chinese consumption up to 40% of GDP within 5 years, consumption would have to grow by nearly 10% each year, assuming a 7% annual GDP growth rate. To bring Chinese consumption up to 50% of GDP within 20 years, which is the low end for other high-saving Asian countries and far lower than any other large economy in Asia, consumption would have to grow just below 9% each year, assuming a 7% annual GDP growth rate. Consumption, in other words, must grow substantially faster than GDP for a sustained period for rebalancing even to begin to take place. China would have to accomplish another economic miracle to achieve that. Of course this will not be easy. Even under the most optimistic scenario, China’s rebalancing process will take many years before it can reach even the lowest consumption-to-GDP ratios achieved by other Asian countries. The retreat from investment-driven policies, which have been accompanied by too-low interest rates and an undervalued currency, will be a long process. In China, high corporate savings are the result of a transfer from household savings via low interest rates. The country’s growth strategies have basically forced households to subsidize investment and production, thus generating rapid economic and employment growth at the expense of household income growth. As long as the growth in household income is constrained, so is household consumption growth. Stimulating consumption will mean transferring income back from the state and corporate sectors to households. China’s investment-driven policies are in part a legacy of the central command and planning structures that still survive. They are also partly the result of fiscal arrangements between central and local governments. Some of the investments made in the past years have probably been misallocated, contributing to a future gap

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between overproduction and underconsumption. To correct this requires, first of all, a fundamental reform of interest rate management and banking governance. But this will take time and there will be a lot of political resistance, especially in the state and corporate sectors. It is unlikely to happen fast enough for consumption’s share of GDP to rise quickly. Raising wages to boost household income is a move in the right direction, but that would reduce corporate savings. While this would be a highly desirable development, it has other political and economic repercussions. Corporations and the state sector would be faced with a loss of savings and would resist financial reforms to raise interest rates. China’s growth strategies basically force households to subsidize investment and production, thus generating rapid economic and employment growth at the expense of household income growth. As long as the growth in household income is constrained, so will be household consumption growth. Household savings also face pressures. Rapidly rising economic growth improves the standard of living but can have a depressing effect when people contemplate life after retirement or the expansion of their family. Higher standards of living imply that the real value of household savings must be able to yield a return equivalent to those standards; otherwise, the future quality of life will deteriorate. If households find this impossible, then there will be no incentive to increase consumption, and people will try desperately to save. Unfortunately, in China’s repressed financial market this is likely to be the case for most households. Developing a social security system for retirement protection will take time, and it will be more difficult to implement in the current environment.

Migrant Workers and Housing Pressure The typical low-and middle-income earners have very limited opportunities to invest in reliable assets and protect their savings. The more rapidly their earnings grow from year to year, the more rapidly the real value of their savings lag behind what is required to pay for the many crucial expenditures their households will encounter over their life cycle: marriage, childbirth, childrearing, sickness, retirement, and old age. Yale University Professor Deborah Davis has found that young couples in major coastal cities in China are even keener than those in Hong Kong to own domestic property before marriage. Parents of both the prospective bride and groom contribute their life savings to help the young couple become homeowners before marriage. Clearly in China, homeownership is perceived to be a vital first step before one can proceed safely and securely to the next stage of the life cycle. As more rural migrants settle permanently in cities, the more rapidly the traditional family and village support structure will fade away. A new community and socioeconomic support structure has to be developed for stable and sustained

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progress. Homeownership and housing markets could provide the essential core infrastructure to meet such social needs. The massive influx of rural migrants into the cities from the early 1980s increased the proportion of renters. Thirty years on, a rising number of these migrants has chosen to stay in the cities and metropolitan areas and increasingly aspire to become permanent residents and preferably homeowners. There is little doubt that the migration of rural workers into the cities has greatly facilitated China’s economic development. Allowing this process to continue smoothly has to be one of the central features in China’s march towards modernity and long-term prosperity and stability. This does not require simply economic understanding but complex political negotiations among various organized interests. Economists are not trained to believe in miracles, much less to perform them. But if China has to perform such a miracle quickly, where should she be looking? Developing a nationwide public sector housing program could hold the key, and it is a matter of top priority in the 12th Five-Year Plan. This is related to the goal of sustaining economic growth through continued industrialization. Such a goal entails moving more peasants out of agriculture into industry and cities, which worsens the pressure on housing. China therefore needs to determine how it will cope with this pressure.

A Public Housing Market Stimulus The failures of Hong Kong’s housing program offer lessons for what the Mainland must avoid as its own housing program develops. A massive public housing program of the type developed in Singapore could address many of the issues in a more effective and less difficult way compared to other initiatives. One of the Singapore government’s first acts after independence was to pass the Land Acquisition Act of 1966, which conferred powers on the state to acquire land for any public purpose. The rate of compensation was set by statute and independent of both market conditions and the landowner’s purchase price. This exercise wiped out land rent increases for affected landowners, some of whom suffered actual losses, having purchased their land at prices above the market value at the statutory date. Some such landowners even had to carry on with loan repayments for land which had already been acquired by the government. Singapore in effect pursued land reform and broke up the old order of land ownership. Private land was nationalized and redistributed to 80% of its less well-off citizens through its public sector housing program. It was a bold socialist vision to redistribute propertied wealth. However, the government also prudently preserved the capitalist market system by turning public housing units into private property that can be freely rented and sold on the open market.

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For a country of China’s size, a market in public housing units would be especially important to avoid restricting the mobility of the population as and when economic conditions in different cities and regions evolved over time. Households could be given the option to either rent or purchase the unit. They could then be allowed to rent or sell their units on the open market after a period of, say, 5–10 years. Restrictions and additional levies upon sales could be kept to a minimum to encourage an active market in these housing units. The central and local governments could provide a subsidy on the development costs and land values for all households in the public housing program. The rest of the cost of each unit could be borne by the resident, but the rent or sales price could be set at an affordable level. Working out a sharing ratio among the three parties would be an urgent policy issue. Banks could also be involved by financing the development cost of the units in the first instance. Part of the cost would be recovered when the units were sold to households, which would take out individual mortgage loans to finance their purchase. These loans would become prime assets for banks, given that substantial subsidies have been provided by the state. And these loans could be sold off to investment funds and insurance companies as securitized assets. This in turn would facilitate the growth and development of China’s financial system. A market in public housing units would also provide property owners with a reliable asset to protect their savings for family formation, retirement, and the leaving of a bequest to the next generation, assuming China’s economy continues to prosper and land values in cities continue to appreciate because of dense living conditions. A nationwide initiative to develop a public housing program would thus create the middle class needed to encourage consumption spending, which to date has played a secondary role in driving economic growth. Over time, such a program would gradually displace the company-provided quarters that are still an important legacy from the past, so that a nationwide market for domestic housing could eventually emerge.

A Fair and Transparent Allocation System A broad-based propertied middle class in the cities would also be a stabilizing political force for industrialization. The experiences of Europe and North America over the past 150 years have shown that, while industrial conflicts may arise in urban centers, the violence and animosity of these conflicts subside when social insurance and protection schemes are put in place to insulate workers from some of the market shocks. A public housing program would thus be a quick and effective means of stabilization. The allocation of public housing units should be carefully managed. When substantial subsidies are being given out, there is always room for disagreement on whether

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the criteria are fair and whether they have been applied with fairness. Vigilance in the fair allocation of units will avoid fostering fresh grievances. It will also go far in enhancing the credibility of the government. It is not impossible to contemplate that a lottery can sometimes be perceived as fair in the eyes of the public. It is worth noting the case of Hong Kong by comparison. Hong Kong has pursued many public housing schemes, some means-tested and some not. But its approach has lacked Singapore’s bold vision. More importantly, it has lacked a market mechanism that would allow housing units to be freely rented and sold on the market. Over time, Hong Kong’s housing programs have become ossified and failed to meet the social and economic needs of the population in a rapidly changing economy. Singapore has succeeded in building a socialist commodity housing system. Its occupants see themselves as citizens of the nation and owners of their property. They have a stake in the future prosperity of their economy. Hong Kong, meanwhile, has ended up with a dual system, where 53% of the households live in a capitalist private housing market and 43% live in a communist-like, planned, non-market housing sector. Society has become arbitrarily divided into haves and have-nots because of our public housing schemes. This is Hong Kong’s self-inflicted tragedy and the source of our many deep-seated structural contradictions. It is a society divided from within by generations of well-meaning policymakers who nonetheless have failed to comprehend the long-term consequences of their policy actions.

25 Diversity and Occasional Anarchy Land, People, and Growth

Real incomes per capita in Britain have increased by a factor of about 16 since the eighteenth century. In China they have risen by a factor of 6 within a short span of 30 years. The mystery of economic growth has been one of the less understood areas of economics. There were many different narratives but very little scientific progress until the pioneering contribution of University of Chicago Professor Robert E. Lucas Jr., Nobel laureate in economic sciences in 1995. He elucidated the reasons why economic growth alone is not sufficient to account for what makes economies expand but rather that the economic expansion must be sustained and on a per capita basis. Lucas’s idea implies that, if an economy expands because of the discovery of a new technology, then explaining economic growth requires us to show how such discoveries can be ongoing and not merely one-off. Explanations like trade-led growth or investment-led growth cannot explain economic growth, because the mileage we can get from trade and investment has a limit beyond which it will come to an end. An economy cannot trade more than what it produces or invest more than what it saves. Once such a limit is reached, growth can no longer be sustained. For trade and investment to produce growth without limit, there must be an additional lever that can generate productivity improvements without bound. In other words, new technologies will have to be discovered continuously. Only this will lead to sustained economic growth. Professor Lucas draws on the ideas of Jane Jacobs (1916–2006) to formulate a theory of human capital-driven economic growth. Jacobs was a writer, thinker, and activist but never graduated from college. Her field observations of economic life in big cities led her to advance a thesis on economic growth that is centered on proximity and high-frequency human interactions in large urban cities.

Free Lunches in Knowledge For Jacobs, cities rather than nations are the originators of wealth creation. Her central thesis is that economic growth is a process through which people and businesses are constantly engaging each other to create “new activities” and add to existing ones

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already underway. The process starts with acquiring knowledge, gathering information, and discovering new activities to perform. These new activities represent discoveries and enhance productivity. This often requires a lot of work, a lot of luck, or a bit of both. If people are placed in a city environment that provides ample information and stimulation, then the process is facilitated as they gradually diversify and differentiate their economies. Concentrating a large number of individuals and enterprises that are diverse and have a rich opportunity to interact and learn from each other helps to create new things. The city environment also facilitates the commercialization of discovered knowledge. This means those who discover the knowledge and those who can make profitable use of it must find each other. Cities make diffusion of knowledge and discoveries convenient. Most new activities are in fact reinvented from old ones. Wealth creation very often lies in finding new uses for existing knowledge and technology. What Jacobs calls innovative economic changes is what economists call dynamic externalities. These are spillover effects that allow aggregate social returns for society to become greater than the sum of individual private returns. Economic growth can be seen as a technological free lunch. For Jacobs, innovation is always city generated and is stimulated by the proximity of people, industry, and information in the urban environment. City economies are able to sustain their position because they are the sources of innovative economic change. If cities are the cradle of innovation and economic growth, then why do some cities thrive and others die? Are these merely accidents of history? Jacobs found cities that were planned and regulated in ways that make it more difficult for individuals and enterprises to find each other, learn from each other, and imitate, copy, and innovate, suffocate the process of natural discovery. These cities gradually lose their vibrancy. Jacobs held very radical ideas. She was opposed to rigid master zoning plans because they fail to accommodate the inherent dynamism of economic exchange. She was in favor of mixed land use because human interaction should not be compartmentalized into the night and day uses or work and leisure uses that are so common in zoning plans. She railed against urban renewal projects that ended up demolishing entire neighborhoods that originally had organic mixed uses. She disliked settling people in self-contained communities, which seems to be the design goal of Hong Kong’s public housing estates. She was scathing about cultural precincts that are used only while a show is on but otherwise stand as ghostly shells devoid of life. Her ideas are commonplace nowadays and forever changed the way people view cities. Unfortunately, the mistakes of the past cannot be easily eradicated or remedied. Societies continue to suffer for decades the legacy of planning systems and policy decisions that increase the cost of individuals and enterprises to discover new activities and adapt to changing circumstances. The rigid system of public housing estates

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has inefficiently frozen large numbers of people in undesired accommodation and inconvenient locations. Households tolerate this only because of the low rent. The long, slow process of converting industrial land use after manufacturing industries have left is of course another disastrous outcome. Perhaps someday there will be a scholar who will rigorously estimate Hong Kong’s economic losses from such rigid and inflexible systems according to the growth rate that has been sacrificed. I personally believe the reason why there were so few new economic activities after manufacturing left across the border was to a considerable extent the result of the rigidities of the land-use conversion and supply system. When this system is married to an increasingly fragmented and divisive political system, the rigidities and inflexibilities are further multiplied. Jacobs’s ideas led to a new appreciation of why a diverse mix of uses does not lead to chaos but to a more developed form of order. What she advocated was organized complexity rather than either simplicity or disorganized complexity. Our own city provides a good example of this in Wanchai district, where the imposed simplicity north of Connaught Road stands in stark contrast to the spontaneous diversity south of it. Well-functioning urban areas spring from human action, not human design. Perhaps Jacobs’s greatest contribution is her view that it is precisely the diversity and occasional anarchy of great cities that make them great; diversity should be encouraged rather than tidied away by zoning regulations that pay little regard to the consequences. I hope it is not too late to put some of her ideas into practice in Hong  Kong. Reforming public sector housing will go a long way towards reviving the natural ebb and flow of life of half the city’s population. It will make inhabitants freer and less frustrated, encourage people to move around, and reactivate their natural economic instincts to build and create. It will end the labeling effect of living in the public housing sector. At the very least, the place they now live in will become a community that they will call their home and start investing in rather than treat as a public asset they do not own. A population policy that seeks to attract more talent to Hong Kong can only be beneficial for all if economic growth results from dynamic externalities produced by human capital. To date, there has been more talk than substance. With an aging population knocking on the door, we clearly should be planning for a much larger and better population mix and seek to attract migrants and contracted non-local workers based on their capacity to produce and innovate, rather than merely the assets or spending power they command. A recent policy insanity has been to curb the flow of Mainland mothers giving birth in Hong Kong just when the education standards of these mothers have finally approached the equivalent of those in Hong Kong. Their children born today will join the labor force in 20 years when Hong Kong’s aging problem reaches its peak.

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As the Essay 26 shows, those babies and their parents could be an asset to the city, not a burden.

References Jacobs, Jane. The Death and Life of Great American Cities. New York: Random House, 1961. Lucas, Robert E. Jr. “On the Mechanics of Economic Development.” Journal of Monetary Economics, Vol. 22, No. 3, July 1988, 3–42. ———. “Ideas and Growth.” Economica, Vol. 72, No. 301, February 2009, 1–19.

26 Population, Poverty, and the Triumph of the City

Urban poverty is a sign that a city is working, because it means it is attracting people seeking economic opportunity, according to Harvard economist Professor Edward Glaeser in his monumental work, Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier and Happier (2011). Glaeser is the leading thinker on urban affairs, and he follows in the footsteps of Jane Jacobs, who lectured everyone, including economists, for fundamentally failing to comprehend the role of cities in economic development and for not knowing the history of cities. Glaeser’s research extends Jacobs’s ideas and has transformed the entire study of urban economics.

A Miracle Emerges after Communes Dismantled Their thinking can easily be applied to China. If one were to summarize in one sentence why China took off economically in the past 30 years, I think it would have to be the introduction of more economic competition through less fettered markets under the leadership of the Chinese Communist Party. This closely relates to the effects of urbanization as follows. When the commune system in the rural areas was dismantled, the agricultural population was permitted and willing to leave their villages. Many migrated to the urban centers to find work in factories producing labor-intensive products. The rapid industrialization that took place finally allowed China to begin to transform its economic structure. The 220 million migrant workers who flocked to urban centers obtained no subsidies from any level of government; they came simply in search of economic opportunities. Their freedom to exercise this choice after 1979 made China’s economic miracle possible—a freedom people had not possessed in the 30 years before 1979 because the Chinese government had tied them down to the agricultural communes. The process of economic development is always very urban centered and urban driven. Successful economic cities are those that manage to attract economic

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migrants. When these migrants first come they are necessarily poor. If they were not, then they would not have come in the first place. If we roll back to the period 1945–50 in Hong Kong, we would have witnessed a similar phenomenon. Migrants flocked into the territory. Those who came were always more entrepreneurial, hardworking, and motivated than those who stayed behind. Together, these new immigrants created Hong Kong’s postwar economic miracle. Similarly, Shanghai was one of the most vibrant economic cities in Asia in the first half of the twentieth century, and there were plenty of poor migrants who went there in search of economic opportunities. Most of the famous Shanghai entrepreneurs were not natives of the city. They were economic migrants who were attracted to the city from near and far. Many came from as far away as Guangdong Province. For example, the founders of the four major department stores in Shanghai were natives of Heungshan County (today’s Zhongshan) in Guangdong.

Rigid Land Regulation Hinders Development Urban poverty is not a sign of a failed city. The fact that a city attracts people in search of economic opportunities is a sign the city is working. The urban poor have better access to opportunities and services than those in rural areas do. Cities are fundamentally places that bring people together and enable them to learn from each other. Cities are people, not structures. This emphasis on people is an important factor in urban regeneration. Struggling cities with skilled populations have a much better chance of becoming successful once again. In contrast, Glaeser cites the example of Detroit, whose long history as an innovative automotive center created a low-skilled population reliant on a single industry, making it difficult for the city to grow and adapt as New York City and Chicago had done. Overregulation of land use also hinders growth. One of the downsides of a successful city is that it becomes increasingly expensive to live there. Glaeser cites Mumbai as a city that has become unaffordable for the poor. The rigid land regulation makes it very difficult to start any new construction, and thus housing becomes beyond the means of many residents. Less restrictive regulations on new building allow cities to grow, for example, by building taller structures to accommodate growing populations. In Essay 21, I pointed out that land prices have been exceptionally high in Hong  Kong ever since the Town Planning (Amendment) Bill of July 2004 came into effect. This is a seldom understood and hardly ever discussed reason for why Hong Kong housing has become unaffordable to the middle class. Essay 8 also shows why rent control imposed in 1947 had stalled urban housing development. The waves of migrants that flocked to the city could not be adequately housed. It eventually

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became necessary to launch the public housing program in order to recover land that had been occupied without permission by squatters. But coming back to the question of people, the kinds of immigrants who come to a city—and the policies that attract them—can make a difference in a city’s success. Glaeser cites Detroit and its low-skilled workers. Hong Kong today is also not attracting high-quality immigrants, unlike in the past. Government policy has played a significant role in this. Hong Kong’s success in the postwar era was the result of the efforts of immigrants from the Mainland (the expatriate population also played an important role). However, the Mainland immigrants who came in the 1940s and those who came when China opened up in the late 1970s arrived under very different circumstances.

Immigrants’ Differing Profiles in Two Periods First, in the 1940s, the disparity in the standard of living between Hong Kong and the Mainland was quite limited, but by the late 1970s the gap had grown enormously. Second, in the 1940s and 1950s, the provision of public welfare benefits in Hong Kong was quite minimal, unlike those available in the late 1970s and afterwards. Third, immigrants who came in the 1940s often arrived with their entire families, who would be net additions to the labor force. Those who came after the late 1970s were joining spouses in Hong Kong and bringing young dependent children. They were predominantly family dependents who did not add to the labor force. Immigrants who arrived in the immediate postwar years brought talent, skills, and human resources. They found economic opportunities and they did not have to depend on welfare benefits. They and their children became productively employed in Hong Kong’s labor-intensive manufacturing sector in the 1960s. Those who came after the late 1970s, however, had limited skills of relevance to Hong Kong’s higher value-added service economy. Many of them would not be able to find a job and could not afford to live in Hong Kong without public welfare or private charity support. Fearing that too many people would be coming to free-ride on welfare subsidies and handouts, Hong Kong sought to limit the annual inflow of immigrants by introducing highly stringent quotas from 1980. The lion’s share of the quotas was taken up by family reunion cases. In this way, Hong Kong ended up with a de facto immigration policy to bring in primarily family and welfare dependents. The quota numbers started at 75 a day in 1980 and were adjusted upwards to 150 per day by 1995; they have not been changed since. The effect of these quotas is to keep bona fide families separated for long periods and to facilitate some Hong Kong individuals and Mainland officials to profit from arranged marriages of convenience. The profile of the migrant population in Hong Kong has transformed from economic migrants in the years following the Second World War to welfare-dependent

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migrants today. Let me hasten to add that, while the recent welfare dependent migrants do not contribute immediately to Hong Kong’s economy, they do contribute to the family life of their spouses who are Hong Kong permanent residents. This is a benefit for Hong Kong people, notwithstanding the occasional reports of family tragedies due to difficulties in adjusting to a new life.

Population Policy Shortsighted Many of the new migrants are a proximate cause of Hong Kong’s rising urban poverty. But this form of urban poverty is not a sign of a triumphant city in the sense described by Glaeser. It is a sign of failure due to the lack of vision in our government’s population and immigration policy. It fails for three reasons. First, an immigration policy that supports family reunion is entirely proper. Who to marry is a basic human right of the people of Hong Kong. The government should not be standing in the way of an immediate reunion. Leaving families separated by a border will only increase the eventual social cost society has to pay after they are reunited. It is terribly shortsighted, and our social welfare bureaucracies and organizations are only shooting themselves in the foot when they support this. The government may blame public sentiment for its policy actions, but this will not exonerate it from its responsibility for failing to safeguard Hong Kong’s long-term interest. Reuniting these families quickly holds the best promise for avoiding future family and social tragedies. It would make a huge difference to the city’s future benefit if Hong Kong were to invest in these new immigrants. Second, Hong Kong aspires to be Asia’s world city. But Hong Kong’s present population and immigration policy is entirely at odds with such an aspiration. Given Hong  Kong’s policy position to support family reunion, we should be adopting a complementary policy to attract more talented and skilled immigrants to ensure the quality mix of Hong Kong’s population. We should also be preparing to accommodate the resulting larger population. Successful cities today are no longer constrained by their official boundaries but have expanded economically to embrace neighboring areas and to form a metropolitan area where a growing proportion of the people commute from surrounding communities to the urban core in increasingly integrated labor markets. A study by Forstall, Greene, and Pick (2009) ranks Hong Kong as 12th in the world among such metropolitan areas (see Table 26.1). The population of Hong Kong and its surroundings ranks behind Shanghai (10th) and ahead of Beijing (19th).

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Table 26.1 Population rank of selected metropolitan areas Rank 1 2 4 9 10 12 13 18 19

Metropolitan Area Tokyo Seoul New York Osaka-Kobe-Kyoto Shanghai Hong Kong-Shenzhen Los Angeles London Beijing

Population (thousands) 32,450 20,550 19,750 17,375 16,650 15,800 15,250 12,875 12,500

Area (km2) 8,014 5,076 17,884 6,930 5,177 3,051 10,780 11,391 6,562

Population Density (people/km2) 4,049 4,048 1,104 2,507 3,216 5,179 1,415 1,130 1,905

Enhance Human Quality Hong Kong’s aspiration to be Asia’s world city has to be predicated on its successful metamorphosis into a vibrant metropolitan area, where an abundance of talented and skilled workers can be continuously drawn from outside its boundaries. Hong Kong is uniquely placed to attract these workers from the international community but much less so from the Mainland, where the largest talent pool is located. Our population strategy does not have a proactive immigration dimension targeting the Mainland population. Without this, some of our deep contradictions will be exacerbated, and our aspirations to be a world-class metropolis will not be fulfilled. The existing schemes fail to address the potential of immigration from the Mainland, given the immediate goal is to enlarge the daily quota so the backlog of family reunion cases can be cleared quickly. But, crucially, Hong Kong also needs to attract migrants with high levels of human capital attainment. This is not simply a matter of financial wealth: Hong Kong has no lack of funds and does not need more financial capital. Existing schemes to attract human capital talent allow Hong Kong firms to recruit to fill vacancies, but this is too confining a criterion. A successful immigration policy should be able to attract people who can quickly find jobs or create jobs after they arrive. Approval criteria should be developed, and an application process should be established and directly managed. For this to happen, it is necessary to first initiate consultations in both Hong Kong and on the Mainland. The existing policy for the admission of university students should be more effectively implemented so that the present quota can be fully utilized rather than half so. Consultations with the Mainland would be more congenial if our attitude towards pregnant Mainland mothers was more relaxed and we allowed them to give birth in our private hospitals. If both parents of the child are not permanent Hong  Kong residents, we could still give the child the right of abode but without

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access to all major subsidized services such as education, health care, housing, and so on. Glaeser’s work on the triumphant city identifies the critical role cities play in the economic development process: as centers of innovation, sources of productivity, and agents of change. If we were to implement a better immigration policy to enhance the population of Hong Kong, not just in quantity but in quality, we would take a giant step towards making the city Asia’s leading metropolis. We could reverse the progressively backward steps we have taken in recent years, during which our economic prospects have worsened and we have seen greater economic inequality, more welfare drive urban poverty, a failure to address the problem of an aging and declining working population, and worst of all, the creation of further divisions among our people. In a press interview, Glaeser was asked to name his favorite cities in the world. He identified Barcelona, London, and Hong Kong. I fully endorse his choice of Hong Kong, a city with enormous potential if only we could get our policies correct.

References Forstall, R. L., R. P. Greene, and J. B. Pick. “Which Are the Largest? Why Lists of Major Urban Areas Vary So Greatly?” Tijdschrift voor Economische en Sociale Geografie, Vol. 100, No. 3, July, 2009, 277–97. Glaeser, Edward G. Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Healthier, and Happier. New York: Penguin Press, 2011.

Section V Creating a City of Homeowners

27 Eighty Percent Homeownership (Part 1) A Cost-Free Solution

People today see property as more than a form of shelter. They desire to own property as an asset to insure against an insecure future, yet they know that a private sector home is unaffordable for many of them. That is why they try to climb through the PRH and HOS public housing ladder. But here their aspiration is constrained, because that ladder leads only to a compromised future of partial and incomplete property ownership, where they cannot sell their unit on the open market without paying the exorbitant land premium. Should this be the ultimate prize that the people of Hong Kong have to look forward to? More importantly, can Hong Kong afford to allow this situation to continue? Hong Kong needs a long-term housing strategy to increase homeownership over the next 10 years and beyond if it wants to address not only the housing problem but the economic and political issues with which it is intertwined. Currently, 52.1% of households own their own homes (36.2% own private units and 15.9% own subsidized public units). Setting a goal of 80% homeownership in the population will not only make it possible to address problems related to housing policy but have spillover benefits for the political and economic environment. By homeownership I mean those who have full title to their unit and can sell it on the open market without having to settle an unpaid land premium. At present Homeownership Scheme (HOS) and Tenant Purchase Scheme (TPS) occupants have to first settle this premium, which can be prohibitively expensive. Cooperative housing units, including those built by government and the Housing Society, also have restrictions on disposal. Units in the private sector do not, and HOS and TPS units that have settled the premium are classified as private sector, meaning they can transfer ownership without restriction. A long-term housing strategy that expands homeownership has to address five key related issues: (1) satisfy the demand for affordable housing, (2) recognize the critical role of housing assets as a store of value and for upward social mobility, (3) recognize that land values will be an important component of fiscal revenue for many years to come, (4) minimize systemic risk arising from periodic property market bubbles, and

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(5) ensure land and property development are aligned with the economic strategy of dual integration with the Mainland and the global economy.1

Why Increase Homeownership? Hong Kong is a prosperous society with a growing economy, situated in fast-rising Asia. Property and land values will rise faster than production in the longer run, due to both domestic and overseas demand. Households without property to protect their savings will likely fall behind as society continues to grow and prosper. As a totally open economy tightly integrated with the global financial and monetary system, Hong  Kong is also vulnerable to inevitable macroeconomic shocks. These shocks make it hazardous for individual households to risk their savings in property whose value may rise or fall quickly in the market. The high value of Hong Kong’s real estate today is the product of a rising China and our unique position as a Special Administrative Region under a common law jurisdiction. China’s growing prosperity enhances the value of our land to the detriment of less well-positioned residents. If not properly addressed, this situation will hinder our ability to achieve dual integration with the Mainland and the world market economy. It is worth appreciating that a whole generation of Hong Kong residents left China for an uncertain future in Hong Kong after the People’s Republic closed its doors in 1949. That generation struggled to create a successful economy that is fully integrated with the global world market. After China reopened its doors in 1979, Hong Kong residents had to readjust to the requirements of dual integration. Readjustment was made additionally difficult at times by our adherence to a linked exchange rate system. Not everyone was able to adjust with equal agility and luck, and this has led to a sense of insecurity among those left behind. Unless we appreciate such insecurity, it will not be possible to understand why some people in Hong Kong still bite the hand that feeds them. The government has been a major provider of housing since the 1950s. The huge clamor to have this continue reflects not just a lack of shelter but a deeper malaise. People are insecure about their future in this place. Such insecurity manifests itself in different ways: concern about jobs, family, future lifestyle, retirement protection, health, the next generation, environment and heritage, relations with our neighbors, and so on and so forth. These insecurities are therefore not confined to concerns about property ownership, but the lack of ownership makes them much worse.

1. For an elaboration of the meaning of dual integration, please read Chapter 1 in Y. C. R. Wong’s Diversity and Occasional Anarchy: On Deep Economic and Social Contradictions in Hong Kong (Hong  Kong: Hong Kong University Press), 2013.

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Having property may not be the answer to everything, but it helps to allay some of the fears. It provides households with another means to deal with the many other problems they have to manage. Hong Kong is not the only place in the region to face insecurity over shelter and property. On the eve of the independence of the Republic of Singapore, Lee Kuan Yew’s People’s Action Party understood what had to be done and resolutely tackled it, as I have described in Essay 5. A society of property owners was created. Hong Kong, in contrast, has become increasingly polarized into a society of haves and have-nots. In order to address this, it makes sense for the government to help permanent residents, especially those who are less well-off, to become property owners. This will provide them with not only housing but also a stake in the future of the community. As it stands now, many households regard the prospect of entering the market as a remote possibility, because land values have become so expensive. Government assistance in this specific manner would go a long way towards sustaining the confident, stable, and undivided community that has characterized Hong Kong for many years. An 80% homeownership goal has to be the primary goal of a long term-housing strategy today. How, then, can it be achieved?

A Revised Subsidized Housing Scheme for Hong Kong Residents Targets for homeownership have been set in the past in Hong Kong. A 60% target was laid out in the policy document A Review of Public Housing Allocation Policies (1984). The target was reset to 70% in the Ten-Year Housing Plan (1998). Despite these goals, we know from the 2011 census that, of the 2,368,800 households, only 855,980 were homeowners in the private housing sector, and 377,615 were homeowners in the subsidized housing sector. These numbers represented, respectively, 36.2% and 15.9% of households, collectively, 52.1% of all households. This is not a proud achievement. Moreover, one-third of the homeowners are at best only partial homeowners, because they own subsidized HOS flats and will have to settle the unpaid land premium charged by the government before they can sell their flats. The issue will become more complicated over time. In less than a quarter-century, some of the HOS blocks will be physically deteriorating, and redevelopment will have to be seriously considered. But is this feasible without full ownership title? Who, after all, is the bona fide property owner who can agree to redevelopment? A responsible government would have to step in to facilitate redevelopment, perhaps even to take over the whole process. And what will that imply about homeownership under the HOS? The housing situation in Hong Kong needs to be addressed as a priority. As a first step towards a sound long-term housing strategy, I propose to revise and unify the existing Public Rental Housing (PRH) and HOS programs into a single Subsidized

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Homes Scheme (SHS) for Hong Kong residents. The key features of the proposed changes are: 1.

2. 3.

4.

5. 6. 7.

8.

9.

Housing units under the SHS could be provided by the government and conceivably operated by the Housing Authority, perhaps working together with the Housing Society. As long as there were eligible households, the government would continue to operate the proposed scheme. The rental and purchase prices of these homes would be set at levels that are affordable to lower-and lower-middle income households. SHS units would be available either for rent or purchase to eligible households. It would no longer be necessary to operate the PRH and HOS as two separate programs. Applicants for SHS units who choose to rent first would have the option of purchasing their units later. The SHS tenants might also opt to purchase newly available SHS units instead of the original unit they are occupying. SHS homeowners would not be allowed to sell their purchased units on the open market within 5 years of the initial purchase. SHS units could only be rented to Hong Kong permanent residents and must satisfy eligibility criteria. SHS units under the possession of the government must be sold to Hong Kong permanent residents. The SHS homeowner, however, could sell the units on the open market to any individual 5 years after the initial purchase. Any capital gains from the appreciation of land values would be retained by the SHS homeowner. The unpaid land premium on existing HOS units should be settled using a new formula. At least two options could be considered. (a) First, recalibrate the value of the property to the original market value at the time of purchase and apply a 70% discount.2 The discount on value is justified on the grounds that the original HOS was intended to be a form of subsidized housing. The unpaid amount of land premium should accrue an interest charge. The interest rate should be preferential, because such a loan is essentially risk free since it would have secured a government guarantee. (b) Second, recalibrate the value of the property to a fixed percentage of the qualifying income for eligible households and then multiply it by 30 years. The unpaid land premium would be calculated as the difference between this value and the amount paid at the time of the purchase. The unpaid amount should accrue an interest charge at a preferential interest rate. Existing PRH units could be sold to the sitting tenant in a manner similar to the TPS, except a new formula would be devised for setting the sale price.

2. This is the original discount provided in the first batch of HOS units.

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(a) A possible approach would be to adopt a method analogous to that proposed in paragraph 8b. (b) For TPS units that have been sold, the unpaid land premium could be settled, again in a manner analogous to the proposal in paragraph 8b. 10. The disposal restrictions on cooperative housing units would be relaxed, including those built by the government and the Housing Society, based on variations of proposals 8a or 8b. 11. The owners of SHS units (including those still held by government) should own the building so that together they possess the redevelopment rights to their building, similar to owners of private buildings. Under the SHS proposal there would be a lot of low-hanging fruit that could be plucked at little cost to society. First, we could sell the 60,725 (2013 Q1) TPS units that have been unsold since 1998. Second, all the PRH units built since that year (amounting to 301,471) could be earmarked for sale to the sitting tenants. This would immediately increase homeownership by 12.6% and bring the total homeownership rate in the population to 64%. Third, all new public housing sector units built in the next decade would be SHS units. If the government increased the homeownership rate by only 1.3% a year, the 80% target would be readily achieved by 2023. This translates to about 31,656 units in 2011, when the number of households was 2,368,800. Fourth, given the total stock of existing PRH units is 728,000, the remaining stock of PRH units in 2013 (365,804=728,000–60,725–301,471) could be converted into SHS units, either by inclusion in the TPS or when they are redeveloped in future. Bear in mind that we have not counted the contribution of the private housing sector. There is thus no reason why a homeownership target exceeding 80% cannot be achieved in 10 years. Table 27.1 provides an estimate of the distribution of households by housing tenure in the 2011 census and the 2013 General Household Survey. If the SHS proposed in this study is adopted in the government’s next Ten-Year Housing Strategy, then an estimated 188,000 private sector and 282,000 SHS homeownership units may be added. When combined with the conversion of all existing PRH units into SHS units, an estimated total of 82.8% of households would become full homeowners.

Full Homeownership for Hong Kong Residents SHS homeowners will be in a better position to adapt to Hong Kong’s changing and evolving future. Their savings will be protected by property values whose fortunes are tied to those of the local economy. Moreover, the substantial land values embedded in SHS properties will be a source of security for households weathering the effects of business cycles.

2013 Q1 (GHS) Domestic Households % (No.) 51.4% 1,278,200 53.6% 866,400 36.3% 411,800 17.3% 1,089,700 45.7% 360,100 15.1% 729,600 30.6% 59,006 2.5% 358,550 15.0% 312,044 13.1% – – – – 18,300 0.8% 2,386,200 100.0% 188,000 127,432 60,568 282,000 – – – – – – 282,000 – 470,000

10-Year Housing Strategy (2013/14–22/23)

2023 Domestic % Households (No.) 82.8% 1,466,200 51.3% 993,832 34.8% 472,368 16.5% 1,371,700 48.0% 360,100 12.6% 729,600 25.5% 59,006 2.1% 358,550 12.6% 312,044 10.9% – – 282,000 9.9% 18,300 0.6% 100.0% 2,856,200

Note: The total number of domestic households living in PRH units is 720,892 in the 2011 census. The total stock of Housing Authority’s PRH units is 718,000 in 2011 (728,000 in 2013 Q1). The total stock of Housing Society’s PRH units is 39,524 in 2008–13. Total Housing Stock = Number of Occupied Units + Number of Vacant Units. Small discrepancies in the numbers remain due to differences in the dates used in counting the stock.

Source: 2011 Population Census, General Household Survey, and author’s estimates.

Homeownership Rate % Private Housing Private Owners Private Renters Public Housing Subsidized Owners Subsidized Renters Unsold TPS Built before 1997/98 Built after 1997/98 Subsidized Homes Scheme (SHS) Built 2013/14–22/23 Temporary Housing Total

2011 (Census) Domestic Households % (No.) 52.1% 1,251,713 52.8% 855,980 36.2% 395,733 16.8% 1,098,507 46.4% 377,615 15.9% 720,892 30.4% 63,042 2.7% 370,106 15.6% 287,744 12.1% – – – – 18,580 0.8% 2,368,800 100.0%

Table 27.1 Eighty percent homeownership and the distribution of households by housing tenure with adoption of the proposed New Subsidized Housing Scheme, 2011–2023

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Conceptually, the redevelopment of the remaining stock of PRH units could even be undertaken as an urban renewal initiative. For example, households in an entire public housing estate or a subset of buildings could be given ownership of the unit they occupy for the purpose of redevelopment. They could then negotiate the redevelopment initiative as a group subject to the requirement that each household must possess a unit in the future redeveloped estate. For this to happen, it would be necessary to create some facilitating institutional arrangement, which we will not discuss here. The cost of redeveloping these estates and any interim housing arrangements could be financed entirely out of the land values that the occupants could unlock. As a self-financing project, it does not have to cost the taxpayer anything.

28 Eighty Percent Homeownership (Part 2) Benefits and Challenges

Allowing rental households to purchase their homes outright, as I have proposed through a unification of the existing public rental housing (PRS) and Homeownership Housing Scheme (HOS) into a single Subsidized Housing Scheme (SHS), would do a lot to increase homeownership. But the benefits are not limited to the SHS household. The SHS can also help resolve other pressing problems in Hong Kong, as outlined below:

Freedom to Deploy Embedded Housing Value Because SHS households obtain the land values embedded in their housing units, these resources will be more efficiently utilized. The gains will have spillover effects for the entire population of Hong Kong. In 2011, 15.9% of households lived in HOS units and 30.3% in PRH units. The effect of unshackling the land values locked into 46.2% of housing units would be very sizable. Trillions of dollars of assets would be liberated. Estimates I have conducted show that the GDP growth rate each year could be increased by 0.5–1.0%. This factor alone explains a large part of why the historical and present GDP economic performance in Singapore, which allows full ownership of subsidized housing units, is better than that of Hong Kong. It costs society nothing to unlock these values. The lands occupied by PRH and HOS units have no effective alternative use. By transferring them to the occupant at a cost he or she can afford, the units would be returned to economic use to the benefit of all. Hong Kong would then have a more valuable portfolio of propertied assets that belonged to the people. The government would also gain revenues from the transfer of land values even though these would be discounted because of the subsidy. At present it hardly collects any such revenues because most households do not settle the unpaid land premium on HOS and TPS units.

“Have Rod, Can Fish”: Greater Self-sufficiency The SHS could resolve the housing problem without incurring public expenses, which would make more resources available for other pressing needs such as improving

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the quality of health care, investing in education, providing for the elderly poor, and mobilizing more resources to help those who are poor through no fault of their own. Social upward mobility would be greatly improved if property assets are held by over 80% of the households. The fundamental reason why social upward mobility is lacking for those who are able and diligent is their inability to convince strangers to invest in their future. Unfortunately, their parents do not have the means to invest in them. “Your dad is poor” sums up the capital market imperfection problem. Microfinancing tries to address this problem in developing economies. In Hong Kong it could be alleviated by becoming a property owner. People have often asked me if it is fair to give away the land value to PRH and HOS occupants at such a low price. They have been given shelter already. Why give them an asset? Is it not a double benefit? But calling it a “double benefit” is entirely arbitrary. The Singapore government gives the double benefit all at once, and Singaporeans think of it as a single housing benefit. The Hong Kong government in effect provides an incomplete benefit and makes people dependent on it for shelter for the rest of their lives. There is a well-known saying, “Give a man a fish, and he’ll eat for a day. Teach him how to fish, and he’ll eat for a lifetime.” The real contention over fairness may be due to two other reasons. If it is related to eligibility criteria, this can be readily addressed. The rent and price charged could, in principle, vary across categories of households, depending on their income. More households would become eligible, but the level of subsidy provided would vary with household income. It may be, however, that the objections over fairness are an excuse for holding on to the status quo. This is becoming an increasingly untenable proposition because of the growing insecurities of the population and the rising gap between the haves and the have-nots.

Fresh Source of Housing Supply If PRH and HOS units are permitted to be turned into SHS units owned by the occupants, then some of those units will come on the market either for sale or for rent. This would provide a fresh supply of housing at a time when society is trying to address the problems of a “housing shortage” in the face of rising property prices, for example, the often-cited case of subdivided housing units. We know there are a number of households in the public housing sector that have more than one unit where they can live. By simply changing ownership and disposal restrictions on PRH and HOS housing, we could free up the excess units. We don’t know exactly how many, but it is unlikely to be a small number.

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New Tool for Land Assumption Rural squatters, beginning with those at Tsoi Yuen Tsuen in 2011, have created a new problem for development projects in the New Territories. At the heart of the matter is what constitutes fair compensation. Before, when urban squatters were resettled, they were provided with a PRH unit. At Tsoi Yuen Tsuen, they were offered an HOS unit, a more generous offer than before, because expectations are changing. But an HOS unit offering only partial ownership was still not sufficient to entice them into a deal. An SHS unit may well prove to be more attractive in land-expensive Hong Kong.

Possible Alternative for Small House Policy The introduction of SHS units provides an opportunity to craft a new framework to phase out the “small house policy.” The challenges of finding land to accommodate the supposedly 240,000 indigenous male villagers descended from recognized New Territories’ village residents in 1898 desperately needs an alternative solution. SHS units have many attractive features that small houses in the New Territories do not possess and will appeal to some of the village descendants, especially because of fewer restrictions on disposal rights.

Overcoming an Obstacle: Land Development Since the mid-1980s, the number of households has become smaller than the number of housing units. The housing strategies created in the era before the mid-1980s were based on the single-minded drive to build more units to meet the shortfall in basic shelter, but this is no longer relevant. Housing property serves a much more diverse purpose. The choice between renting, owning, and investing is far more fluid and is heavily influenced by macroeconomic business cycle factors often generated from abroad. China’s opening, the Asian financial crisis, and the global financial tsunami have all shown the difficulty of forecasting housing demand in an open economy that is trying to achieve dual integration with the Mainland and the world economic market. Deciding on the correct rate at which land should be supplied is a huge challenge. In retrospect, we all agree that the supply of land was not enough in the decade prior to the Asian financial crisis, too much after the crisis had occurred, and too little again after the crisis was over. Can we do better in the future? I am not optimistic. Election politics will ensure that even small errors of judgment will be seen as exaggerated policy failures by the people. In the Review of the Institutional Framework for Public Housing (2002) the government renewed its commitment to the public provision of subsidized housing on a

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scale similar to that of previous administrations. But it also broke new ground by recommending a private sector-led strategy for the development of private housing units. Long-term demand forecasts were to be published periodically, not as targets but as indications of planning requirements only. Scheduled land sales via public auctioning were suspended and replaced with the Application List System (ALS). Unfortunately, the ALS has not worked well, due to the design flaw of the winner’s curse, as detailed in Essay 20. The flaw can be corrected by taking on board recommendations made by my colleague, Professor Steven Ching of the University of Hong Kong. Another consideration behind the slow supply of housing in the period after the Asian financial crisis may have been the exceedingly cautious attitude of the government, which erred on the side of undersupply. Almost none of the commitments in the public sector housing provision was achieved. The government had not fully learned the lessons of its previous follies and was still trying to drive housing supply even though it claimed to have adopted a private sector-led strategy. It is imperative that the government sort out its role in private housing development and align it with Hong Kong’s mission of being an open economy with dual integration. It should study Professor Ching’s proposal carefully to correct flaws in the design of the ALS. A land bank would still exist, of course, but the crucial issue is the triggering mechanism that would release land supply onto the market.

Tangled Up in Regulation Another important reason for high home prices is the high regulatory cost of development associated with rigid planning rules and building codes. The complexities present formidable barriers to entry into the property development industry. Development projects are also held hostage to a myriad of social and political advocacy and action groups, each with its own agenda, that ultimately work to delay projects and raise costs. The numerous regulatory related transaction costs involved in property development, including navigating planning rules, complying with building codes, negotiating costs associated with land acquisition due to holdouts, and holding public consultations, often result in long and uncertain delays. These uncertainties make development more costly and sometimes impossible. Since 1989, according to my estimates, such regulatory uncertainties and delays have increased the gap between property prices and construction costs by about 67% on average. Ways to lower the regulatory cost of development have to be explored, especially in today’s increasingly fragmented political environment. At the very least, the zoning of land for industrial purposes should be dropped and its conversion into residential, office, and commercial uses be automatic without requiring long and complicated

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approval processing. The rates of compensation for land-use conversion on every plot of land and by plot ratio should be pre-announced each year so that the rates would be totally transparent to all and should be valid for a period of 12 months. This would significantly lower the negotiation costs in settling land conversion premiums. It would also remove suspicion and concern over the opportunity for corruption in these negotiations. The problem of regulation has a long history. Development in Hong Kong requires extensive consultation with the government due to its monopoly control of land, numerous lease conditions, and use of planning rules and building codes to vet all development proposals. These restrictions mean development cannot take place easily or quickly. In 1947, the unofficial members of the Legislative Council were very critical of government impediments to private development and called on the government to remove all unnecessary regulatory barriers. Professor Alan Smart, who studied the 1947 government decision, concluded, “for a combination of technical reasons, bureaucratic interests, distrust of private developers as speculators, concern for government revenues, a commitment to town planning and building standards, and a concern of some officials that the workers not be exploited by high rents and low standards, the government resisted these pressures” (1992, 38–39). These impediments remain, decades later. They are long overdue for a change.

Homes for Hong Kong Residents As I iterated in the previous essay, Hong Kong has to address five issues in developing a long-term housing strategy: (1) satisfy the demand for affordable housing, (2)  address the critical role of housing assets as a store of value for upward social mobility, (3) recognize that land values will be an important component of fiscal revenue for many years to come, (4) minimize systemic risk arising from periodic property market bubbles, and (5) ensure the alignment of land and property development with the economic strategy of dual integration with the Mainland and the global economy. The first two issues require the government to provide subsidies for permanent residents who cannot afford the high land values in Hong Kong’s vibrant, open economy. The government can do this by providing SHS units in place of the current PRH and HOS system, which would also have positive spinoff effects on the economy. Households that own their own property can make better choices for themselves when presented with important decisions that emerge over the life cycle, such as whether to accept a better job in another part of the city or overseas; where to send children for schooling; how to pay for expensive schooling overseas, fund a new business, help children finance their home purchases, pay for unexpected health care

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bills that insurance does not cover, support retirement in old age, bequeath assets to the next generation, and so on. The prevalence of divorce in recent times is another source of demand on housing assets. Households living in PRH and HOS units currently face constraints in dealing with these challenges. For example: (a) They cannot easily move their homes, (b) They have little or no equity in their homes, and (c) They cannot freely dispose of their homes when it is in their interest to do so. SHS households would enjoy better opportunity to synchronize consumption and investment decisions over their life cycle, thanks to bona fide homeownership and the substantial gain in equity value that that implies. More importantly, the benefits they gain would not be at the expense of anyone else, because the land used by the public housing sector has no alternative use other than to accommodate SHS units. The current PRH and HOS units provide no or little subsidy on land values; they are primarily subsidies on the development cost of housing as structures of accommodation. What the residents of Hong Kong cannot afford is the value of the land on which the housing units are built, not the development cost. The long-term housing strategy for Hong Kong must focus on this central fact. Nailing households for prolonged periods to their original housing unit is contrary to the needs of an open economy aiming for dual integration with the Mainland and the world market economy. The long-term housing strategy today should aim to provide subsidized homeownership units for Hong Kong residents that can be freely tradeable, without penalty or restriction after a 5-year ownership period. A subsidy on land values therefore should be the cornerstone of our future subsidized housing policy. It will help restore upward social mobility among our less well-off households, and provide Hong Kong land for Hong Kong people. It would be a grave mistake to restrict these transfers in any way, because this would lower the land values and diminish the value of the subsidy provided.

Broadening the Tax Base and the Unification of Public and Private Housing By analogy, it would also be a mistake to restrict the sale of designated housing units in the private sector to permanent residents, because this, too, reduces the value of land held in the private sector. Government policy should not seek to lower the value of land through restrictions on the disposal and use of private housing units but seek to maximize the value to the occupants. Doing so would encourage the efficient utilization of an important resource. It would also secure an important revenue base, addressing the third requirement of a long-term housing strategy.

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A system based on the SHS could expand the long-term tax base. Over the next 30 years, this will be necessary because government expenditure will face higher costs and lower revenues from a rapidly aging population. In a nutshell, the SHS would start off as public housing but metamorphose into private housing at a time chosen by the occupant. The have-nots would become haves over time. The two housing sectors would become integrated without division. Households would become stakeholders in the community as property owners. SHS owners nonetheless would be shielded from some of the vicissitudes of the property market because of the cushion provided by the subsidized equity value of their property. This would protect their homes from the cyclical effects of business fluctuations, thus addressing the fourth requirement of a long-term housing strategy. At the end of the day, it is up to the government to prevent the worst of property market bubbles by regulating the loan-to-value ratio on mortgage loans on the demand side. On the supply side, the task of government is to ensure the regulatory and transaction costs of development are reduced through adopting more transparent and user-friendly planning rules and building codes. A mechanism for supplying land to the market could begin by introducing improvements to the present ALS to encourage developers to submit bids to trigger more successful land auctions. Hong Kong land for Hong Kong people is a path-breaking idea. It forms the core guiding principle for a long-term housing strategy. In 10 years, not only would more housing be supplied, but we could definitely look forward to exceeding an 80% target for bona fide homeownership. The siege mentality of the population would fade away as the vast majority of households in Hong Kong became homeowners with a comfortable level of home equity. Such a community would feel secure and confident to take up the challenge of dual economic integration—the fifth point in a long-term housing strategy. The people of Hong Kong would then see that rising external demand for what Hong Kong offers could align with their interests as property owners. Hong Kong’s progress towards dual integration would thus be aligned with the interests of its people.

Reference Smart, Alan. Making Room: Squatter Clearance in Hong Kong. Hong Kong: Hong Kong University Press, 1992.

29 Conclusions and Reflections

In the early 1980s, I began to study public housing in Hong Kong as a minor detour from my other research work. I had no inkling that it would develop into a 30-year passion. The research experience has taught me a great deal about land, property, and housing. I have visited numerous public and private housing estates, their shopping malls, their front and back stairwells and parking lots. I have entered people’s homes as a welcome guest and an unwelcome Nosy Parker. I have gone to housing developments still under construction and attended presale launches. The only event I have not had the opportunity to experience is a land auction. I have also been to Singapore to learn about HDB housing and to Lima to see its shantytowns. In these 30 years, I have come to appreciate the difficulties of reform and change in different societies and in Hong Kong. I have, however, come to the realization that land, housing, and property are at the center of many of Hong Kong’s deep contradictions—economic, social, and political—in ways that are not often appreciated by other observers. Land and property can keep people permanently divided. Some of these contradictions have to do with Hong Kong’s history and the public policy choices made by the colonial government. Some have to do with the consequences of China’s opening, the globalization of the world economy, and Hong Kong’s interface with the external world through the policy of “deep economic intergration.” The latter is tied to the linked exchange rate regime and our policy of free trade and unfettered cross-border capital movements. These commitments are made for good reasons and benefit Hong Kong, but they also limit the choices that we can make. Moreover, they affect people’s livelihoods and business fortunes through their effects on land, property, and housing. By the mid-1990s, the consequences of this approach were abundantly clear when inflation and property prices in Hong Kong escalated to astronomical proportions. Since the 1990s, I have been advocating four policy measures: (1) sell PRH units to sitting tenants, (2) lower the unpaid land premium for occupants of HOS (and TPS) units, (3) reform and unify the existing public sector housing programs into a single program to build subsidized housing units that can be either rented or purchased by eligible households and traded on the open market, and (4) speed up the conversion

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of land zoned for industrial use by granting across-the-board permission for redevelopment and conversion, and set conversion premiums that are not only transparent and rule-based but pre-announced and readily available to the public. I was convinced that, unless these issues were addressed quickly, Hong Kong would turn into a society where new economic activities would fail to develop, economic growth would be compromised, and the gap between the haves and have-nots would widen. The middle class would become increasingly marginalized as the mobility of low-income households into middle-income status would dwindle. Even more serious would be the effects of a high and rapidly rising divorce rate. Low-income households, many of whom live in PRH estates, are the major victims of family breakups. Our existing housing policies encourage divorce, especially among the poor, and this is leading to the formation of a new “underclass” inflicted with poor prospects for intergenerational mobility. Watching these outcomes unfold has been worrying. I believe that, late as it may be, it is essential to halt this process before it finally sinks Hong Kong, the free, vibrant economy and open society that we know and care about. Without change, the policy to keep markets free, interventions minimal, and government limited will lose support among the people. As Hong Kong enters an era with democratic political aspirations, there should be a genuine concern that this experiment may also derail, as society is hopelessly divided into haves and have-nots. A socially and economically divided people cannot develop sufficient political consensus to make democracy function properly. My main purpose here is to summarize the main thoughts in this book in more or less the chronological order of the development of my ideas in the last 30 years. My analogy is the frog that sits in a comfortably warm pot of water. I hope to help this dear old frog before it is slowly boiled.

Consequences of Public Sector Housing without Markets My initial focus in the 1980s was on the efficiency and equity effects of the public housing program. To my surprise, I discovered the program was unbelievably inefficient. A huge amount of resources amounting to 0.5–1% of GDP was being misallocated each year. In 2013, 0.5% of GDP could have paid for 2,335 private sector units, assuming that the price of a small private residential flat of 40 m2 was $4.37 million. And 1% of GDP could have paid for 4,670 similar units. Over 30 years, the cumulative number of additional private units that could have been afforded would have averaged 230,836 in total, or 7,446 units each year. This is a huge sum to lose. The most appalling discovery was that many who lived in public housing were well-off and those who lived in private housing were not. In fact, the distribution

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of household income among public and private housing tenants was not very different. The housing subsidies did not improve equity of access in housing. Units in public housing were also smaller than what the occupants would have chosen had they decided to live in private housing. Many public sector occupants were therefore enticed to live in smaller public units because of the low rent, even though they were often well-off. The cramped living conditions in public housing units meant that it was not necessary for the private sector to build units that were much larger in order to be competitive, despite a huge demand for upgrading and space. The middle class in both public and private housing has similar living conditions, which adhere to public housing standards. Since the norm of a large stock of units has been determined in the public housing sector, it has become very difficult to change the dynamics of inertia. These findings have convinced me that public housing policies in Hong Kong have much room for improvement. I believe the only sensible and socially desirable policy is to sell public housing units together with their land values to the occupant at an affordable price. These owners must not be required to pay large unpaid land premiums, which present owners of HOS and TPS units have to do. In addition, I believe the unpaid land premium on the HOS and TPS units should also be adjusted downwards. Details on why and how this can be done are contained in the previous two essays. I have travelled to Singapore on many occasions to study their public housing system. Singapore has adopted a different approach that I think has resulted in better social, economic, and political outcomes. Since 1965, the Singapore economy has been able to grow at a rate faster than Hong Kong’s by 1.35% each year in per capita GDP. I believe that to a large extent this is attributable to their more sensible market-oriented public housing policy that does not obliterate land values. Although Singapore public housing units are heavily subsidized, they can be traded on the open market with much fewer restrictive conditions than those in Hong Kong. Singaporeans are therefore able to reap the full benefits of asset appreciation that are off-limits to public housing tenants in Hong Kong, as well as to HOS and TPS homeowners. They have a shared stake in the economic future of their city, whereas Hong Kong residents in government-subsidized units have a very different fate. In all societies where property values have risen over time, it is important to have the gains widely shared. The public is willing to accept big gaps in income and wealth if it perceives this is due to differences in ability and effort but not if it is the result of windfall capital gains due to other factors. People will come to view these windfall gains as the result of rules and regulations that are rigged to disadvantage them. This may not be true or accurate, but this is how it will be perceived because, when the same unintended consequences appear again and again but are not attended to, they will become viewed as a failure of policy. Government cannot legitimately deny responsibility.

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Supply Rigidity and the High Transaction Cost of Development Property prices in Hong Kong have also risen because of another factor. Land supply and building construction in Hong Kong are governed by planning regulations and building codes that have not responded to changes in the economy and demand. Indeed, the exact opposite has happened. In an attempt to enhance public participation and consultation in the decision-making process, the transaction costs of development and redevelopment have increased over time. Greater transparency and openness are desirable in themselves, but they inevitably increase the transaction costs because of the presence of conflicting interests and political divisiveness in society. The delays resulting from higher such costs have increased property prices by about 67% since the 1990s. To address these conflicts and political divisiveness, the government should have introduced new measures and institutional innovations to offset the increased transaction costs of development. Unless the adverse effects of the new planning regulations and building codes can be mitigated, supply will continue to lag behind demand. Unfortunately, this has not taken place. Huge increases in demand have been met with slow increases in supply. In this book I have also looked at housing development in Lima and Singapore, to show how clarity in property rights creates value for everyone and lowers transaction costs to facilitate urban development and help the poor and disadvantaged people in society. By giving the have-nots property ownership, Lima and Singapore have shown the way to a more prosperous, more equal, more harmonious society that would make it possible to resolve the divisiveness in Hong Kong over development and redevelopment. Their experiences have important lessons for Hong Kong and for the Mainland’s ambitious urbanization goals. The urban city economy is the source of innovation that drives economic growth. A successful city enables human interaction to take place without imposing high transaction costs. Through the cross-fertilization of ideas, individuals and enterprises can continue to discover new economic activities to replace old obsolete ones. A population policy that attracts talents to converge on Hong Kong is crucial to sustaining the vibrancy of the city and promoting economic growth. Through people working together and drawing on each other’s ideas, an urban city economy can reap dynamic positive externalities to sustain its continuous economic prosperity. By encouraging people to come together and engage with each other, we make the whole greater than the sum of the parts. Planning rules and building codes must create certainty and allow development to take place at a low transaction cost. Land uses have to evolve with changing market conditions. And when a major shock like China’s opening occurs that causes manufacturing to migrate across the border, then it is imperative for land conversion to

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take place quickly, so individuals and enterprises can discover new economic activities sooner rather than later.

Consequences of China’s Opening Hong Kong has benefited from the opening of the Mainland economy and its integration into world markets, but the benefits have not extended to everyone. In the early period of 1984–93, most people in Hong Kong experienced an increase in productivity. The value of their human capital appreciated as the economy evolved from manufacturing to services. Many saw their incomes rise every year. Manufacturers did especially well, and the demand for producer services grew rapidly and created new opportunities for many. The benefits reached numerous individuals, wealthy and poor. Households across the income spectrum were able to purchase property. An increase in wealth from housing was not a rare experience among low-income households. Naturally, not everyone was able to purchase property before prices rose. A social division between the haves and have-nots was in the making after property prices increased dramatically. These increases led to repeated government attempts to curb soaring prices and to control property speculation. The Sandwich Class Housing Scheme was introduced as a temporary measure to pacify the have-nots. Rising property prices made new economic activities more difficult to initiate. Start-ups often rely on considerable experimentation before they can get the business model right. High property prices eroded the required margins that are often necessary to keep a new business going before it becomes profitable. The pace of business innovation also slowed down considerably after manufacturing moved across the border. While I believe a shortage of quality human capital is a much greater problem than high property prices in deterring new innovative business, high property prices and high rents are clearly additional burdens. When property prices collapsed after the Asian financial crisis of 1997, both the haves and the have-nots languished as incomes faltered across the board. It was a difficult environment to start new businesses. Venturesome young men and women became more risk-averse after being saddled with high mortgage debts and negative net worth. Dramatic breakthroughs did occur, mainly in the fine-dining industry, where new start-ups took advantage of the upper floors in old middle-rise buildings that were zoned for mixed use, to make their debut. Jane Jacobs would have approved of Hong  Kong’s older buildings zoned for multiple uses. These buildings enabled not a few shining lights to appear during one of Hong Kong’s darkest hours. I should perhaps add that the lifting of duties on wine and alcoholic beverages provided belated icing on the cake. Much less fortunate has been the struggling creative digital

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animation business, which had to deal with high rents after an audacious beginning with the endearing Teenage Mutant Ninja Turtles that took the US market by storm when it debuted. When the property market took off again after 2003, the have-nots found themselves shut out of the market. Tsang Kam Yuen’s government responded with measures to curb speculation and proposed My Home Purchase Plan as a stop-gap measure. C. Y. Leung’s government slapped on even heavier punitive stamp duties to curb demand, because supply cannot be increased easily in the near term. The design of the ALS for land allocation may be flawed, but to simply get rid of it will bring back the problems that created it in the first place. These measures may win some plaudits, but they do not address the underlying problem. Managing demand through punitive measures is a common policy response of politicians everywhere. Speculators are blamed for rising prices and market chaos. But this is barking up the wrong tree. Market speculation has a positive role in society. Price signals in presale markets are good predictors of where the market is heading. Unfortunately, restrictions on presale markets have all but killed this innovative feature of the Hong Kong property market. In the absence of price signals, the market becomes more unstable and transactions are prone to occur at mistaken levels. This only makes the market more volatile. How does today’s population view the future according to their aspirations for homeownership and innovative work? With each cycle, the gap between the haves and have-nots widens. Those who own property can hitch onto the rising fortunes of the economies of Hong Kong, Mainland China, and global integration. The havenots appear to only possess the “privilege” of falling further behind. Upward mobility is a distant option for those without property; they have become unhitched from Hong Kong’s economic future. These economic and social divisions in society have spilled over into political divisiveness.

Consequences of Deep Economic Integration For Hong Kong, the opening of China happened to coincide with two unusually large macroeconomic shocks that amplified the effects of the linked exchange rate on the economy. Having forsaken monetary policy as a countercyclical stabilization tool, Hong  Kong has had to accommodate all external shocks to the economy through domestic adjustments that are very demanding in an open society with many different and conflicting voices. When capital flows in we experience price inflation, and when it flows out we have deflation, including even larger adjustments in property prices. The experience of Hong Kong under the linked exchange rate system during the Asian financial crisis is worth recounting. Hong Kong lived through a period

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of intense deflationary pressure. Between 1997 and 2003, the cumulative consumer price deflation was 11.6%, the cumulative GDP deflator deflation was 16.3%, nominal GDP growth was–8.5%, and unemployment reached a peak level of 8.8%. The economic downturn would have been worse had it not been for an impeccable record of fiscal prudence, stellar sovereign credit ratings, flexible labor and product markets, and an ethic of individual self-reliance. The episode was almost as devastating as the Great Depression of 1929–39 in the US, when the cumulative consumer price deflation was 18.7%, cumulative GDP deflator deflation was 19%, nominal GDP growth, 11% and unemployment 24.9%. Deflation and economic output decline were comparable between Hong Kong and the US during these two episodes although the unemployment effect was far weaker in Hong Kong. Without our flexible labor markets, the economic consequences of the Asian financial crisis would have been far worse. Hong Kong weathered the economic crisis without descending into chaos like Argentina did in the 1990s or Greece in 2013. Still, half a million people in Hong Kong marched peacefully on the streets on July 1, 2003, to express their frustrations. The examples of Argentina and Greece remind Hong Kong that our “deep economic integration” strategy presents us with a unique situation and many challenges. Hong Kong’s flexible labor markets, prudent fiscal policies, and vigilant banking regulations have been critical to maintaining economic stability in the face of such economic and financial adversity. But property price inflation creates large gaps between the haves and the have-nots. When half the population lives in subsidized housing, then this half cannot benefit from the capital gains associated with asset price inflation. Their disappointments are vented at the government and property developers, whom they view as co-conspirators. Rising property prices have affected not only households but also businesses. This in turn has frustrated the prospects of young men and women whose future seems to be destined to being agents in the buying and selling of assets. To make deep economic integration work for Hong Kong, its domestic policies must address both economic and social concerns at a time when society is politically divided. This limits the policy options available. What, then, can Hong Kong do under the circumstances?

Bona Fide Homeownership is the Best and Only Choice Hong Kong today is providing subsidized housing for 47% of households, 16% in HOS units, and 31% in PRH units. Making these households bona fide homeowners would eliminate in one fell swoop the big divide between the haves and the have-nots. Together with the existing 37% who are private sector owners, the total percentage of homeowners in Hong Kong could become 84%. Since there is no cost in giving away the land values in the public housing sector, it is the biggest free lunch policy

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Hong Kong can announce. A society with 84% homeownership has to be the best defense against the stresses originating from deep economic integration. And it could be achieved at no cost to society. This proposal is radical in conception but minimalist in actual administration. It requires small administrative changes that would make big economic and social differences. Increasing land and housing supply is a long march to a distant goal that an impatient population cannot wait for and that the government, beleaguered by divided views on how policy should be conducted and the political system reformed, does not have sufficient time to work on. The pot is boiling even though the dear old frog has yet to realize it. The younger generation in Hong Kong today feels estranged as the chances of lifting itself up grows dimmer over time. The haves and the have-nots live in the same community, but they do not share a common future and cannot aspire to the same dreams. My reflections from 30 years of research and observations have led me to conclude that land, property, and housing are the critical nexus for unlocking some of society’s deep contradictions. The solutions are not difficult to execute—but they need political will to build broad consensus. If a serious change in land and housing policy is not forthcoming to unlock value and unleash the creative forces of the people, then I have serious doubts that our economy can continue to prosper, that our society can foster consensus, and that democracy, when it arrives, can function properly.

Epilogue Homeownership and the Youth Protest Movement

The youth protest movement that started on September 26, 2014 is demanding greater political freedom, but there are also obvious economic and social causes behind their action. On one level, the youths are protesting that the present political arrangements are not sufficiently inclusive. They fear that these unfair and unequal arrangements will threaten Hong Kong’s core values, including compromising our present economic freedoms and civic liberties. Numerous reports from journalists, social workers, teachers, church ministers, and others who have spoken to the young men and women occupying the streets have found that the divergence in fortunes between Hong Kong’s wealthy and the general public is an underlying reason for the social tensions in the city (see Gu, 2014 and Chu, 2014). Although Hong Kong today is more prosperous than a generation ago, many middle-class residents feel squeezed. Landlords and homeowners have benefited. Property prices are at a record high, up by a third from a previous peak in 1997. Hong Kong’s retail rents are now the most expensive in the world. But the percentage of households with private homes has increased by a mere 0.6% since 1991, from 35.3% to 35.9% today. Back then, an apartment of 400 square feet in the city would on average cost $1.04 million and could be acquired with a 5% down payment. Median household income was $10,325 per month. Today, a similar apartment costs $4.63 million and there is a 40% down payment requirement. Median household income is now $22,900 per month. The down payment in 1991 was equal to 5.0 months of earnings; today, it equals 80.9 months—15 times higher and almost out of reach for the average family. Society inevitably becomes divided and the middle class no longer feels secure about its economic future. A society inevitably becomes restless when the majority of its people feel deprived. People also see that most of the things they spend their earnings on (housing, public utilities, groceries, transportation, telecommunications, entertainment, and the like) all appear to be supplied by a dozen or so corporations, many related to

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property development. The youths have easily embraced the radical view that tycoons dominate the economy and property developers are hegemonic. For them, society is unjust and the injustices stem ultimately from Hong Kong’s political arrangements, with Beijing as the master behind the curtains. This radical narrative of Hong Kong capitalism, in which non-inclusive political arrangements lead to non-competitive economic markets and unjust societies, is very persuasive in Hong Kong and especially among our youths. This was not the case in the past when the general public believed in the “establishment narrative” that promised a level playing field for all and where effort will be properly rewarded. The primary reason why our society has been divided economically and socially into “haves” and “have-nots,” however, is not the result of the political arrangements. True, these arrangements have failed miserably to tackle the growing economic and social divisions. But there are other reasons for the high property prices that are at the root of society’s divide. First, economic globalization during 1980–2008 created an era of rapid economic growth and accumulation of wealth worldwide. The demand for all kinds of assets rose rapidly, including financial assets, property in prime locations, jewelry, art, antiques, wines, and other rare items. The emergence of shadow banking as a financial innovation was driven by the rising demand for financial assets. Property in Hong Kong was valued worldwide because the city is a prime international economic and financial center where assets and contracts are protected by the common law and a robust legal system. Rising property prices have not been unique to Hong Kong. Thomas Piketty’s acclaimed Capital in the 21st Century finds that the ratio of housing capital to national income in industrialized economies rose dramatically from 1980 to 2010. In France it rose from 122% to 371%, in the United Kingdom from 134% to 300%, in Germany from 134% to 236%, in Canada from 121% to 208%, and the United States from 151% to 182% (see Wong, 2014). In Hong Kong it rose from 122% to 209% over the period 1980–2013. (All percentages are 10-year averages.) The high regulatory cost of development contributed to rising prices in all of these places, which brings me to my next point. Second, unlike financial assets, the supply of property is much less responsive to demand due in part to the scarcity of land in prime locations. Supplying new properties often requires redeveloping existing ones. Rigid planning rules and building codes often hamper the process of redevelopment, a pattern seen in most societies. Politics and the transactions cost of redevelopment result in long delays, pushing up property prices. In Hong Kong, I have estimated that since 1989 such regulatory uncertainties and delays have increased the gap between property prices and construction costs by

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about 67% on average (see Essay 21). The gap has persisted through both boom and bust cycles. Third, China’s opening and economic reforms, while part of the process of economic globalization, have been an independent factor because of their enormity, rapidity, and proximity to Hong Kong. China’s opening triggered a migration and expansion of our manufacturing industries across the border. Structural economic transformation and rising prosperity created a growing demand for domestically supplied services at a time when labor markets were very tight for demographic reasons. Prices in Hong Kong escalated rapidly and reached double digits in 1992. The process was so rapid that within two decades Hong Kong became a service economy. Property prices naturally shot through the roof. Those who failed to acquire property during this period soon discovered that prices had moved beyond their reach. Fourth, the linked exchange rate regime tied Hong Kong’s currency to the US dollar. During most of the past three decades US interest rates have been kept low. This has fueled property price increases in Hong Kong because international capital flowed into the city. As the share of bank loans exposed to home mortgages rose, the Hong Kong Monetary Authority began to raise the down payment ratio on fresh mortgage loans to protect the banking sector from exposure to systemic risk. This measure made the acquisition of homes even more difficult for the average household. All these factors took place well before 1997. So the post-1997 political arrangements cannot be the cause of high property prices. The radical narrative is fundamentally wrong. Even back in 1997, I wrote in the South China Morning Post that “[p]roperty ownership today divides society into the ‘haves’ and ‘have-nots’; and the gulf that separates them appears to be ever-widening” (see Essay 1). Large landlords and property developers in Hong Kong have been major beneficiaries of the four factors I describe. They have become extremely capital rich and able to make major acquisitions within Hong Kong and also abroad. Thus, it is those factors that have resulted in the growing concentration of wealth, not the post-1997 political arrangements. The creation of a tycoon-dominated economy was largely an accident of the circumstances Hong Kong found itself to be in during the 1980s and 1990s. Those who started with property or were able to acquire them reaped a huge windfall gain. The non-inclusive political arrangements are being defended by the establishment in Hong Kong because of their fear of populism. Beijing, on the other hand, is defending it because the political opposition is stubbornly critical of China. Rising property prices create multiple fissures in the economic and social fabric of any society. The deep divide between homeowners and renters is only one aspect of this. A young person starting life today faces a huge uphill battle to save enough for

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the down payment on a home without the support of a well-off parent. The generation born since the 1980s is the most affected. The advantage of homeownership is that it provides a cheaper means for arranging finances. By borrowing against home equity, a parent can provide a better education for his children, arrange financing for starting and operating a small business, and support themselves in old age, as children become an increasingly unreliable source of funding with declining fertility rates. Homeownership also provides a positive incentive for families to stay together when marriages come under pressure. Broken families inevitably take a toll on children. Upward social mobility in Hong Kong today is closely connected to homeownership. Without it, Hong Kong will be increasingly saddled with problems of rising intergenerational inequality. Unfortunately, the very high property prices we see in Hong Kong today will not go away. This creates two problems. The half of society that cannot afford to own a home complains about high prices. The other half does not want property prices to go down. Bridging the two is impossible. Even when the conflicts manifest in many different ways, high property prices are the fundamental source of division in society. Bringing down property prices would be the wrong solution because Hong Kong’s economy would drop, too. The correct approach is to turn the “have-nots” into “haves.” Fortunately for Hong Kong, there is an option: sell the existing stock of public housing to sitting tenants. The sales must take place at prices well below market levels and tenants must be allowed to have the right to transfer the unit on the free market and to keep any capital gains that arise from the sale. More than a third of our households live in public housing. Privatization would provide them with a genuine asset to help them face the many challenges in life. At one strike and at almost no cost to society, the inseparable gulf between the “haves” and “have-nots” would be significantly reduced. Privatization can be achieved in several ways. A modified Tenant Purchase Scheme should be revived. The amount of unpaid land premiums on our Homeownership Scheme units should be lowered. And the existing public rental housing and Homeownership Scheme should be combined into a single program allowing eligible applicants to have the option to rent, purchase, or rent now-purchase later with greater flexibility. The problem of high property prices is only a problem because half the population in the society does not have property. If Hong Kong becomes a predominantly propertied society, then the present divisions will be removed. Even the hostility of local residents toward Mainlanders will abate. Immigrants and visitors will be welcomed because they enhance property and capital values, not take away jobs and create congestion.

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Hong Kong is a capitalist society, but when capital is so unequally distributed it becomes a political problem. The voices of those on the streets come from a generation that has grown up amidst the rising gap in the ownership of capital. Only a bold housing policy initiative can help us break out of the political rut we are in. I believe this requires the courage and mandate of a popularly elected Chief Executive. If the housing problem is not resolved, every generation in future will continue to believe that our political arrangements are at fault.

References Chu, Kathy. “Hong Kong Protests as Much about Dollars as Democracy.” Asian Wall Street Journal, October 19, 2014. Gu, Wei. “Protests Also Fueled by Widening Wealth Gap.” Asian Wall Street Journal, October 9, 2014. Piketty, Thomas. Capital in the Twenty First Century. Cambridge: Harvard University Press, 2014. Wong, Y. C. R. “The High Regulation Cost of Development: What Thomas Piketty’s Famous Book Really Says.” Hong Kong Economic Journal, June 18, 2014.