Commentary

Big Market, Small Government

This article appeared in the South China Morning Post on January 18, 2007.

The adherence by Hong Kong to a “big market, small government” vision is now more important than ever, as governments around the world stray from market liberalism and call for greater intervention and protectionist measures. Limited government and the rule of law are slowly giving way to open-ended legislative agendas designed to achieve some vague notion of “social justice”. In the process, private property and freedom of contract are diminished.

Compromise is a part of political life, but in a constitutional democracy, “the sacred fire of liberty”, as US founding father George Washington called it, must be kept burning by principles that protect life, liberty and property.

The central tenet of liberalism is that limiting the use of force to the protection of people and property will create economic and social harmony. As the great 19th century French liberal Frederic Bastiat wrote: “It is under the law of justice, under the rule of right, under the influence of liberty, security, stability, and responsibility, that every man will attain to the full worth and dignity of his being, and that mankind will achieve … the progress to which it is destined.”

Indeed, from a liberal perspective, economic development means an increase in “the range of effective alternatives open to people,” as the late economist Lord Bauer was fond of reminding his contemporaries who advocated state-led development. Restricting trade reduces personal freedom, politicises economic life and reduces wealth creation. Although Hong Kong has few natural resources, its institutions and adherence to the rules of a liberal market order have provided a framework for peace and prosperity.

Against that background, the question raised by Chief Executive Donald Tsang Yam-kuen in his 2006-2007 policy address last October regarding “when and to what extent the government should ever intervene in the market” cannot be answered without first knowing the legitimate functions of government. Likewise, a discussion of the “optimal” size of government and the issue of tax reform can hardly be discussed without first having a moral and political philosophy on which to anchor o’e’s vision.

That is why Hong Kong’s future will not depend on the stability of its tax revenues but on the smooth transition to a constitutional republic in which the state’s power is limited and individual rights are protected.

If Hong Kong is to remain a beacon for economic liberty, the government must not succumb to interventionist policies on the pretence of progressivism or the need for “a steady revenue source”. Introducing aminimum wage would not help the poor but would undermine freedom of contract. Imposing a goods and services tax on top of the existing tax structure would not secure Hong Kong’s “future growth and prosperity” but would expand government and shrink legal market exchanges.

Most importantly, giving the government more resources takes them away from the private sector and ensures the growth of the welfare state, which means greater dependence and less individual responsibility. Instead of strengthening civil society, such actions would weaken the social fabric.

What Mr Tsang should be considering is how to use the market and privatization to reduce dependence on social security and other social welfare programmes. Ownership and choice need to be expanded not restricted.

A liberal reform agenda would call for a flat tax on all sources of income and apply equally to all income earners. There would be no loopholes. The poor as well as the rich would pay a low marginal tax rate to finance government spending that was consistent with economic and personal freedom. But there can be no legitimate tax reform when the people have little or no voice in government.

In theory, a consumption tax would increase saving and investment and increase wealth compared with an income tax. It could be administered by allowing all individuals to defer taxes on income that is saved or invested. As permanent income increased, so would consumption and tax revenues. In cyclical downturns, the government could borrow against expected future revenues by tapping the global capital markets. Hong Kong’s credit rating would not suffer.

Thus, there is a case for introducing a consumption tax, but only if it replaces income tax. Adding a GST to the existing tax base would be detrimental to Hong Kong’s future prosperity and dim its shining light of economic freedom.

James A. Dorn is a China specialist at the Cato Institute in Washington and coeditor of “China’s Future: Constructive Partner or Emerging Threat?