Biting the invisible hand.

THE GREAT SOCIETY COMES TO HONG KONG.

Not since Lord Macartney refused to get down on all fours and perform the ritual "Three Kneelings and Nine Prostrations" at the feet of an 18th-century emperor has one of Her British Majesty's representatives upset the court of China as much as Chris Patten, the current governor of Hong Kong. A 20th-century politician sent to fill a 19th-century seat, Patten made it clear from the day of his arrival in 1992 that it would no longer be business as usual. The Chinese took the announcement of his political reform package as a declaration of war. The result has been an impressive stream of personal invective directed at Patten and emanating from Beijing: "a dictator," "a strutting prostitute," the "greatest villain in all history."

Insofar as people pay any attention to these epithets, they have probably served only to persuade the Hong Kong public that their governor must be doing something right. But now the Chinese have come up with a label that is not as easily thrown off: a welfare statist. In Hong Kong these are still fighting words, and when China's representative to the budget talks of the Sino-British joint Liaison Group, Chen Zou'er, accused Patten just before Christmas of allowing Hong Kong's welfare spending to run amok, the charge made headlines. Over Patten's term as governor, Chen pointed out, welfare spending had jumped 66.5 percent in real terms. Likening the increases to a Formula One racing car that had sped out of control, Chen warned that "if it goes on at the same speed, in some years' time the car must crash and the passengers must be killed."

% OF HONG KONG GOVERNMENT EXPENDITURES

                 1963-64   1974-75   1984-85   1994-95(*)

Health             8.7%      8.7%      8.1%       11.0%
Education          9.2      18.9      16.5        17.1
Housing            3.0       4.1       5.1        12.1
Social Welfare     0.4       2.7       5.6         6.4

* estimates
Source: Hong Kong Government Information Services Yearbook

Leave aside, if you will, the irony of a Chinese government still officially committed to socialism attacking as welfarist the policies of what the Heritage Foundation and Fraser Institute in separate studies have each labeled the freest economy in the world, the same place of which Milton Friedman said, "If you want to see capitalism at work go to Hong Kong." Leave aside, too, the grudge China nurses against Patten for his success in having pushed through his political reform package against Beijing's express wishes. Leave aside, finally, the crowning irony that this latest of Chinese attacks came at the very moment Patten had just returned from a trip back to Britain where he took a leading role in defense of Tory efforts to trim back state spending. Because all this notwithstanding, Chen has a point.

The truth is that Hong Kong has seen an explosion in its welfare spending - an explosion important less for its amount (still tiny in both absolute and relative terms) than for the decisive philosophical shift it represents in a place like Hong Kong. Add to this a British director of social welfare who vows to leave behind a "First World welfare system" to go with Hong Kong's First World economy and the introduction into business-oriented Hong Kong of something it never had before - politics - and you begin to understand the fear among many that Hong Kong may be losing hold of the very qualities that made it so special. And so as the colony lurches toward 1997 it faces two threats: the threat to its civic life posed by its soon-to-be-overlords on the mainland, and the threat to its economic freedoms posed by a new class of politicians running fast and hard toward the very government programs the rest of the world is trying to leave behind. As Hong Kong entrepreneur Gordon Wu puts it, "You now have the Great Society being imported to Hong Kong."

That, of course, is just what some of Hong Kong's new legislators think it needs, and here they have the enthusiastic support of the English-language press. It is easy to understand this enthusiasm, however misguided, for Hong Kong's very success makes for strong contrasts: old men living in cages (a de rigueur feature of all TV documentaries), veterans who can't afford medical treatment, widows left with even less than a mite, and so on. The idea is that Hong Kong may have had to scrape by in the past, but with budget surpluses surely there is room to spread a little around to the less fortunate. "They think you can just take 10 percent here and put it there," says Jimmy Lai, the garment-maker turned media baron - he publishes Hong Kong's most popular weekly, Next, and daily, Apple. "What they don't understand is that Hong Kong is so small. If you squeeze it even just a little, you can end up losing the whole thing."

To understand the dynamics at work here, it is important to understand both how Hong Kong came to be what it is and what 1997 is doing to it. At the end of World War II, Hong Kong was still a dusty entrepot, clear second fiddle to Shanghai, its sophisticated cousin to the north. All that changed irrevocably when the Red Star was raised over China in 1949. The result was to strangle Shanghai as a competitor and send its people, along with hundreds of thousands of their cousins from other parts of the mainland, over the border into Hong Kong. They came by plane, train, and boat - some even swam through shark-infested waters - but mostly they arrived on foot. And they lived anywhere they could: in the streets, under trees, on the hills, in homes that were little more than a few sorry square feet of old boards and tin. In its 1957 annual review the Hong Kong government admitted its desperation in a bleak lead chapter titled "A Problem of People."

It turned out, however, that Shanghai's fall was Hong Kong's gain. For while these refugees brought no money, they did bring something more precious: skills, knowledge, and a willingness to work. In almost no time at all, they proved to be the impetus for Hong Kong's first wave of industrialization. Not only did Hong Kong survive, it blossomed, and it did so despite the severe blow dealt by the loss overnight of its largest market, China, to a U.N. trade embargo imposed during the Korean War. "All of a sudden, you had the best people shoved into this tiny place," says Daniel Ng, executive chairman of McDonald's Restaurants (Hong Kong). "I suppose we are fortunate the government didn't have time to react. It was simply overwhelmed."

There is much to that. Much of Hong Kong's takeoff occurred simply because the colonial government had neither the will nor the resources to attempt too much. In fairness to the authorities, however, Hong Kong did benefit from a bureaucracy with enough horse sense to realize that the best thing to do with the Cantonese was get out of their way. If that legacy has carried over today it is largely the result of one towering figure: John James Cowperthwaite, financial secretary from 1961 to 1971 and de facto author of Hong Kong's budgets for a good part of the 1950s. Under Cowperthwaite's invisible hand, industrial wages doubled, exports grew at an average 13 percent each year, and the percentage of households in acute poverty shrank from more than 50 percent to 16 percent.

Not that Hong Kong didn't have its share of leaders constantly pushing pet schemes and preferential programs to develop the colony's manufacturing or trade. But Cowperthwaite's de facto control of the purse strings, his insistence that a place as small as Hong Kong could not afford to bet wrong, and - just as critical - his ability to defend this position intellectually in debate resulted in what was, for at least a short period, the freest economic experiment in world history. So scrupulous was Cowperthwaite about keeping government's role to a minimum that there is still no official recording of Hong Kong's national wealth for many of the years he was in charge. When I asked him about this years later he said it was deliberate. "If I allowed people to keep statistics," he told me, "they would only misuse them."

Yet even in the Cowperthwaite era there were some exceptions to the rule. After a disastrous Christmas Day fire in the Shek Kip Mei squatter area that left 53,000 homeless in a single night, the Hong Kong government assumed a new role: landlord. So diligently has the government pursued this aim that it is today the largest landlord in the colony, housing just over half of Hong Kong's 6.2 million people in government flats. Often hailed as Hong Kong's proudest achievement, the government's intrusion into the housing market provides a particularly apt metaphor for how difficult it is to remove dollars from the public ledger once they move out of private control. Public housing has come to be considered a birthright, and it is not uncommon to see BMWs and Mercedes outside public flats. And though the government talks about selling flats off to the public, the extent of the subsidies makes even ownership less attractive than the status quo: In some cases what people pay now would not even cover the monthly management fee. This has led to a strange contradiction which has seen the government's involvement in the housing market grow with affluence rather than decline: witness its vow to build 292,500 new flats in the years up to 2001.

Likewise with education and health, the other two big-ticket items of the Hong Kong budget. Today health accounts for 11 percent of the budget, most of it going to government hospitals. Again the Hong Kong yearbook tells the story. "Health promotive and preventive care services are generally free," it explains. "Under a policy that nobody should be denied adequate medical treatment through lack of means, other medical charges (especially for hospital treatment) are heavily subsidized." They aren't kidding. Patients in general wards are charged only $7.00 a day, and at some clinics charges are as low as 13 cents. Again the result is an increasing government control over the delivery system: Of the colony's 27,506 hospital beds, only 3,112 are private, and private hospitals are finding it tougher and tougher to make a go of things against the subsidized competition.

Finally, there is education. Despite Hong Kong's wealth, it has not managed to maintain even one independent institution of higher learning: Of the six universities and one college, all depend on the government for funding. The government also effectively runs the primary and secondary school system, albeit in a less direct way. Again the yearbook is refreshingly frank: "Most schools," it says, "are in the public sector." On the surface things may appear to the contrary, given the abundance of privately named schools (especially those with religious affiliations). Over the years, however, the schools have gradually ceded authority in return for government monies, to the point today where the vast majority of primary and secondary education is paid for by the state. As a consequence the schools have found themselves heavily regulated with regard to curricula, teacher's qualifications and salaries, fees, etc. Altogether the social sectors - education, health, housing, and welfare - now constitute 47 percent of Hong Kong's budget and are growing. And they would have grown even more had Patten succeeded in saddling Hong Kong with the social security program he wanted.

All these tendencies are only being exacerbated by 1997. For the same political reforms that gave Hong Kong people a greater say in the selection of their legislators also gave them a new political class in search of constituencies. Like legislators everywhere, Hong Kong's new politicians find it far easier to call for ways to divide up the pie than to grow it. In days past the executive-led government would have served as something of a balance here, but today it, too, is pushing for expanded welfare programs, at least as part of a broader effort to buy public support for its political reforms.

These moves have left Hong Kong people with a political Hobson's choice. On the one side lies the business community, which vigorously opposes the welfarist inroads on Hong Kong's market but remains distrusted by the public which believes, rightly, that these same businessmen will not stand up to China lest they jeopardize their considerable investments there. On the other side of the fence are the Democrats, who each day come more to resemble their American counterparts.

With the exception of the patrician Martin Lee, a leader of undoubted courage and spirit, the Democratic party is composed mostly of teachers, social workers, and activist types who know litre about business; it is no coincidence that their economics spokesman is a medical doctor. Since coming to office the Democrats have welcomed Patten's initiatives on spending and upped the ante, calling for everything from comparable-worth (yes, comparable worth) schemes to social security and populist freezes on stuff like the fare increases on buses and ferries. "It's not much of a choice," says Jimmy Lai, who has more credibility than most businessmen here if only because he's been willing to pay the price: When he criticized Chinese leaders in a column last year, they responded by shutting down the Beijing branch of his Giordano clothing outlet. "If the Democrats run things they will just vote in a free lunch. If the businessmen do they will just cave in to China."

For a brief moment there, it looked like Shih Wing Ching might change this equation. A former Marxist schoolteacher turned property developer, Shih surveyed the political landscape in late 1993 and found pro-business and pro-democracy sides but no one pro-market. In his own business, the problem of government intervention had become painfully obvious. When prices were going up, the government reversed its traditional hands-off approach by introducing regulations that prevented the resale of purchased flats before the development in which they were located was finished and that raised the deposit required for the purchase of a home from 10 percent of the price to 30 percent. Today the property market is in a slump and Shih points to the regulations as one reason why the supply of new flats hit a 10-year low in 1995.

But Shih bowed out of politics even before he really got started. For one thing, neither his wife nor his business partner really supported his entry into politics. But the more important consideration, says Shih, was that the reality of political quid pro quo was hard to square with his libertarian principles. "Libertarians like to promote their ideas," he says wistfully. "They do not usually form parties."

One might think that with their soon-to-be Communist overlords knocking at the door, the Hong Kong public and its political leaders might embrace Shih's idea of minimizing the potential for government abuse after 1997 by minimizing government. Unfortunately neither side seems much interested. The business community sees 1997 as an opportunity for pork and patronage in the form of development. Meanwhile, the Democrats push for the establishment of ever more government agencies and programs that will in less than 14 months' time be administered by the power they distrust most: China.

So mindlessly spendthrift have the Democrats become that several of their pro-market friends, led by Lai - who claims to be the only man in Hong Kong to have read all of Hayek - have instituted a regular set of meetings with party leaders to get them to see that a free market is really in their own interest. In some limited areas the meetings have succeeded (the Democrats did call for a slight tax reduction and have been persuaded of the merits of selling off public housing to the occupants), but it's an uphill struggle. And it doesn't help when leaders like Christine Loh, herself an advocate of huge new spending on behalf of the environment and other concerns, argue publicly that Hong Kong no longer needs economic growth. "In Hong Kong the irony is that it's the bureaucrats who are the good guys," says Yeung Waihong, publisher of Next, Hong Kong's most popular magazine and its stoutest free market voice. "The most distressing thing today is that there is no one in political life who seems to understand what made Hong Kong Hong Kong."

A glimpse of this was provided in 1993, when the Legislative Council debated a proposal to set up a fair trade council. On the surface, a Hong Kong debate over fair trade might be thought akin to the College of Cardinals getting together to review the doctrine of papal infallibility. Yet the truth is that the government doesn't really know what to call itself. It loathes the term laissez-faire but hasn't found a satisfactory replacement. Thus did the then-financial secretary, Sir Hamish Macleod, find himself on the defensive when pressed to explain the distinction between "positive non-interventionism" - the government's term for its philosophy - and "doing nothing." His answer goes a long way toward explaining why those who want to preserve the Hong Kong experiment are increasingly gloomy about the prospects. "The correct use is set out...by Mr. Philip Haddon-Cave in a speech to the Hong Kong Federation of Industries on 2 December 1980. I would be very pleased to offer to members who want it the six pages which summarize his interpretation of this phrase."

A six-page summary of a 13-year-old speech? This is the best a Hong Kong financial secretary can do?

Sadly, it appears so. Had the issue been broached in Cowperthwaite's day, the financial secretary would doubtless have seized the opportunity to explain that while "doing nothing" would in practice mean yielding to an unending list of bright new spending initiatives, "positive non-interventionism" required vast expenditures of administrative energies to hold at bay this natural tendency of the government to expand. Although the motion on fair trade was put down largely out of a reluctance among the business community to establish another bureaucracy, there was little evidence of a philosophy and way of life defended. It was left to Martin Barrow of Jardine Matheson (the real-life counterpart to James Clavell's fictional Noble House) to suggest politely that "what keeps the local market fair and competitive is not rules and regulations but the lack of them."

For those of us who admire Patten's attempt to claw back for the people of Hong Kong some of the ground his predecessor had given away, his failure to appreciate the economic dimensions of Hong Kong's freedom comes as a special disappointment. In this Patten's reputation precedes him. Despite his newfound love for the magic of the marketplace, in Britain Patten was a member in full standing of the "wet" camp. Indeed, in a little book called The Tory Case published back in 1983, he made his distance from ascendant Thatcherism explicit. "Our aim," he wrote, "must be a welfare society."

In Hong Kong today there are those who believe that this is precisely the aim he has for them in this, the twilight of British rule. That is probably too harsh. Clearly Patten's time in Hong Kong has increased his appreciation for the virtues of the marketplace. The tragedy is that he appears to see it only as a question of balance, with Britain having gone too far in one direction and Hong Kong not yet far enough. Certainly this is the impression given by the governor's director of social welfare, Ian Strachan, who says publicly that "the most positive aspect about the government's policy is its rapid expansion."

It is true that with the government spending less than 17 percent of GDP, Hong Kong has a long way to go before it is ever confused with Sweden (or even Britain). It is further true, as the government points out, that government spending as a whole has not outstripped economic growth, and that Hong Kong has been faithful to the idea that it must first pay for whatever benefits it initiates.

But what is worrisome is the whole assumption that welfare spending is a good in itself, that the only issue is how to balance this spending against growth. And even within this assumption there are troubling signs. Though it is true that the amount spent on social programs is relatively small and that the overall government share of GDP has remained roughly constant, the potential problem may be bigger than anyone has thought because this share has gone up at a time when the economy was expanding; when bad times hit the percentage will become that much greater.

Looking at total government spending, moreover, it is also easy to overlook that this welfare spending is the fastest growing portion of the Hong Kong budget, that health, education, and welfare already account for almost half of all government expenditure, and that the figure would have been far higher still had Patten been successful in getting his original social security program through. Add to this the increasing political pressures coming from the legislative council and the short time Hong Kong has before it is handed over to China, and Hong Kong's days as a sort of free market Shangri La seem numbered. Clearly this is part of what worries China. "The Chinese attacks on Chris Patten on welfare are not so much about Patten himself as his limited horizon," says Richard Wong, head of the colony's only free market think tank, the Centre for Economic Research. "The worry in Beijing is that Patten will not have the resolve to resist the calls for more spending from the Democrats in the remaining few months of British rule."

The new competition coming from an increasingly global economy also makes Hong Kong's drift toward intervention particularly worrisome. This latter point has been particularly overlooked. In days past Hong Kong's low taxes and liberal trade regime constituted a strong comparative advantage vis a vis other nations. But Hong Kong has been steadily shedding manufacturing jobs as industry shifts its plants to the mainland; from 1984 to 1994, the manufacturing sector lost 466,322 jobs and saw its share of the economy move from 41 percent to 17 percent. In short, if Hong Kong has a future it will be as a service center, yet it is precisely here that the drift toward intervention will exact its highest costs. In a recent spat with Australia over air fights, for example, the government claimed that the best thing about the final agreement was that it limited the number of passengers Qantas could take to and from Hong Kong even if it had seats available. In addition to the high cost of housing, licensing regulations have become a key constraint in Hong Kong, and there are now proposals that would make it even more difficult for foreign professionals to find work here. As Shih points out, "The example Britain is setting for China in these final days is not a good one."

Given Hong Kong's relatively sound fundamentals, it is in no immediate danger of losing its economic soul, and talk about a "welfare state" is easily dismissed as alarmist. But in a city of only 6 million people, it will not take much for these worrying trends to get out of control, and the lack of any countervailing political voice raised on behalf of Hong Kong's classic non-intervention will make that task all the more difficult. Indeed, the crowning irony of Hong Kong is that at the very moment its economic system has been vindicated by history, there is not a single politician from either the business or democracy camps who gives any evidence of appreciating what really makes it tick, much less the precious link between the civil freedoms that make Hong Kong such a notable exception in Asia and the economic freedoms that make this life possible. All of which makes the current drift toward more social spending more troubling. "Nobody sets out to have a welfare state," says Next publisher Yeung. "What happens is that you wake up with one."

William McGurn ([e-mail]) is a senior editor of the Far Eastern Economic Review.