Webb-site Reports

The US-based Heritage Foundation has, as always, ranked HK as the freest economy in the World. For once, the Government doesn't accuse foreign forces of interfering in HK's internal affairs. But this rosy view is not held by those who take the time to study the domestic economy. Here are a few things that Heritage may have overlooked.

Hong Kong's not-so-free economy
4 February 2018

In the wake of The Heritage Foundation declaring HK to be the World's Freest Economy for the 24th year running, here is a list of just a few things that they may have overlooked, in no particular order:

Transport

The Government sets the fares of buses and green Public Light Buses (PLBs, or minibuses) and decides who can run bus routes and which bus routes they must run in exclusive franchises, cross-subsidising loss-making routes with profitable ones.
The Government sets taxi fares in each of 3 geographic territories (Urban, New Territories and Lantau). Within each territory, the tariff must be the same for all operators, eliminating any price competition between them.
To drive a taxi for a living, you must pay someone else not to, by renting or buying their licence. There are only 18,163 licences. There have been no red (Urban) or green (New Territories) licences issued since 1994, despite huge demand, resulting in a current premium of around HK$6m per licence. When 25 blue (Lantau) taxi licences were tendered in Apr-Aug-2016 (the first since early 1997), they fetched an average HK$5.64m each.
There have been no new Public Light Bus licences issued since 1976. There is so much excess demand that the 4,350 licences are currently worth about HK$4.44m each, based on the 30-Sep-2017 interim report of AMS Public Transport Holdings Ltd (0077).
There is a de facto cap of 7,000 Non-Franchised Buses (NFBs), which are used for residents' shuttle-buses, school buses and tourism amongst other things. The excess demand for these results in a premium of about HK$2.5m per licence. That was the value attributed to each licence when the largest operator, Kwoon Chung Bus Holdings Ltd (0306) bought companies which owned 98 of them on 1-Sep-2016.
No wonder then, that at peak times, many people can't get a seat on a minibus or in a taxi, and resort to driving a private car to get kids to school or go to work.
What's holding back reform? Vested interests who elect the Chief Executive. We also note that there is no public declaration of family interests in taxi, PLB or NFB licences by members of the Government, Executive Council or Legislative Council.
There are statutory caps on the numbers of Private Hire Car licences (400 for Hotel Service, 400 for Tour Service, 1500 for Private Service). In practice, the Government has not even issued all of those (only 162, 116 and 648 respectively at Jul-2017), making it practically illegal for anyone to drive a private hire car for Uber or its competitors. The Government has reacted to Uber et al by proposing yet another quota-based "franchised taxi" scheme for 600 fixed-term licences in 3 franchises of 200 cars each, a mere 3.3% increase in supply.
Meanwhile, the Consumer Council has gently suggested that if the franchised taxi scheme doesn't "deliver its promise" (whatever that means), the Government should consider at least issuing the remaining 852 Private Hire Car licences, which would barely make a difference, and even then, they suggest vehicles should not be older than 7 years. Our Toyota Picnic is just fine and perfectly roadworthy at 12+ years, so why can't we start driving it for hire?
While you can't get a taxi, a minibus seat or rent a hire car with driver, this is not a problem if you have a private driver for your own car, or hold a senior government position which includes a chauffeured car, leaving many of the elite clueless as to why the public are so unhappy with the system.
For more on the transport cartels, click here.
By the way, the Government unfairly competes with private parking operators by charging only up to HK$2 per 15 minutes for metered parking spaces and even then, only sporadically enforcing the charge.

Finance

We have a statutory monopoly stock exchange. The law prohibits anyone from operating a stock market unless they are The Stock Exchange of Hong Kong Ltd (SEHK) or its controller, Hong Kong Exchanges and Clearing Ltd (HKEX, 0388). So we have no competition for exchanges. The result is higher transaction costs, wider bid-offer spread tables and more rigid practices than a competitive market would produce. It is no coincidence that HKEX's future profits are valued at some 1% of the entire market, making it the 15th largest HK-listed company at the end of January.
Despite only holding 6% of HKEX, the Government controls it by a statutory scheme which only allows shareholders to elect 6 out of 13 seats.
The Government has exempted HKEX and its subsidiaries, including SEHK, The Hong Kong Futures Exchange Ltd and their respective clearing houses, from the Competition Ordinance.
Although hundreds of different bond issues are "listed" on the Stock Exchange, they almost never trade there. The HK Monetary Authority allows retail banks to distribute new bonds to the public, but does not require the banks to obtain "best execution" (the best available price) when customers want to sell or buy existing bonds. That results in wide bid-offer spreads to captive bank customers, and deters the public from moving their cash out of bank deposits, which protects the cheapest source of funding for banks. This protectionism is why HK does not have a liquid retail bond market. The HKMA is more interested in bank stability than in competition, when it has to make a choice between these goals.

Commerce

We have a gambling monopoly. Nobody can operate a bookmaker or lottery in Hong Kong unless they are the Hong Kong Jockey Club, which takes bets on horse races, overseas soccer matches and runs the Mark Six Lottery. There are no betting exchanges. It is also illegal for anyone (including tourists) to place a bet from within HK with a licensed overseas bookmaker. This is a protectionist measure to bolster the Jockey Club's monopoly. The vast bulk of the profit goes straight to the Government as betting duty, but to provide a fig leaf excuse for the monopoly, some of the profit is washed through the Jockey Club Charities Trust which does things the Government would do anyway like build clinics or school buildings, or things the Government doesn't wish to justify to the LegCo Finance Committee, such as the Central Police Station project or the Palace Museum.
Casinos are illegal (unless you count the stock exchange). That's part of a national policy to protect the other Special Administrative Region, Macau, which has no stock exchange. However, China is now reportedly considering allowing casinos in Hainan, so if Hainan, then maybe HK too, but we wouldn't bet on either happening. The Hainan rumour could just be a wish inspired by HNA Group's reported problems.
It is illegal to resell entertainment tickets for more than their face value (except for events at venues controlled by the Leisure and Cultural Services Department). As a result, HK has no viable ticket agents or exchanges.
The Government, via the HK Trade Development Council, competes with private sector exhibition organisers.
The Government, via The Hong Kong Mortgage Corporation Ltd (with an implicit Government guarantee) competes with private sector insurers, providers of reverse mortgages and providers of "microfinance".
The Government, via the HK Export Credit Insurance Corporation, competes with private sector credit insurers.
The Government, via the Cyberport and the Hong Kong Science and Technology Parks Corporation (which also operates the less-sexy Industrial Estates), unfairly competes with private sector owners of industrial, office, retail and hotel space.
More generally, the Government distorts the efficient allocation of scarce land resources by designating land for specific purposes such as hotels or data centres rather than requiring those sectors to compete with others in land sales. It also micro-manages land lease conditions, sometimes specifying the minimum number of apartments that must be built on a residential site, or that a specific commercial development must include a cinema (as proposed).
The Government owns theme parks - 100% of Ocean Park Corporation and the majority of Hongkong International Theme Parks Ltd, the owner of HK Disneyland, which was given 126ha of land for only the cost of reclamation, accompanied by the usual claims of "economic benefits" without looking at the economic opportunity cost. An adjacent 60ha piece of reclaimed land sits vacant, under option to the company.
Information on companies is rationed behind the paywall of the Companies Registry, reducing transparency and facilitating fraud and corruption. The registry would make a huge profit from filing fees alone, although it should be run on a cost recovery basis, so it could easily afford to eliminate search fees, open up the data and cut filing fees.
Electricity is generated, distributed and supplied by two de facto geographic monopolies, one for HK Island and Lamma (where the power station is), and one for everywhere else. Under the "Scheme of Control" since 1964, they are permitted a fixed after-tax rate of return (now 8%, formerly even higher) on fixed assets, after depreciation, fuel, labour and all other costs. Think of it as a tax-free bond. The consumer tariff is tilted for political reasons, charging large households more per incremental unit than small households with lower consumption. Live alone, or get your own meter. In 2015, both the Competition Commission and the Consumer Council urged the introduction of competition in the sector, following the example of Singapore. The HK Government responded by locking in the Scheme of Control for another 15 years until 2034.

Access to Justice

Lawyers are prohibited from charging on a contingency fee basis in contentious proceedings.
The law (with narrow exceptions) prohibits champerty and maintenance, effectively outlawing third-party litigation financing. These medieval offences were abolished in the UK in 1967.
There is no class action system in HK to provide access to justice in cases involving a dispersed group of victims. In 2012 after 3 years of study and consultation, the Law Reform Commission recommended the introduction of a limited system for consumer actions relating to goods and services (but not investments). The Government deferred this by forming another committee to study the proposals which, over 5 years later, has yet to report back.

Professional services

Barristers operate a semi-closed shop, resisting the inflow of competition from other common-law jurisdictions by requiring them to take a full examination and 6 months of pupillage even if they only wish to practice in their own expert area. Ad hoc admissions to work on specific cases are also routinely opposed in court by the Bar Association.
Doctors, via the Medical Council, also operate a semi-closed shop by requiring anyone moving to HK to take a full general Licensing Examination even if they only wish to practice in their specialist field. There is a form of "Limited Registration" for only 12 months at a time without the exam, but at 12-Jan-2018 there were just 12 such doctors in the Hospital Authority, despite the shortage of doctors in HK. The uncertainty of only a 12-month licence is obviously a deterrent to any professional who might move to HK. The shortage has been exacerbated by the increasing demand for medical services from mainland visitors, drawing talent from the public to private sectors, and also by the aging population.

Real estate markets

Companies and non-permanent residents (those who have lived less than 7 years in HK) are charged a prohibitive 30% stamp duty (including 15% Buyer's Stamp Duty or BSD) to buy staff quarters or a home in HK, forcing them to rent instead. At the high end, a lot of residential properties were already owned by companies before the relevant law took effect, so the companies are transferred instead.
If a person sells a home within 3 years of purchase, the transaction incurs a punitive "Special Stamp Duty" (SSD) of up to 20% of value, regardless of whether they have made a gain. This can catch out anyone who needs to relocate or downsize, or simply wishes to reduce risk after a rise in value, forcing them to wait until the 3 years are over, thereby keeping potential supply off the market. This has also stifled the industry of small businesses who would buy, renovate and sell old apartments.
There is up to 8.5% "Double Stamp Duty" (DSD) on the transfer of non-residential properties. This deters businesses from buying office or retail premises and fitting them out for long-term use, and traps landlords. Both have to work around it by transferring companies which own properties instead.
Even permanent residents must pay 15% stamp duty on a residential property unless it is or will be their only home. This also deters people from buying to let.
None of these higher rates of stamp duty were introduced for the purpose of raising government revenue (which would be a legitimate, if inefficient, form of taxation under Article 108 of the Basic Law). They were instead successively introduced to deter "speculation" or as "cooling measures", in the mistaken belief that reducing transaction volume by increasing transaction costs would affect the value of properties. Value is in reality determined by the net present value of expected future rentals, which incorporates assumptions about interest rates, supply of properties and end-user demand.
Basic Law Article 105 states that the HKSAR shall "protect the right of individuals and legal persons to the acquisition, use, disposal and inheritance of property". That includes real estate. Article 25 states that "All Hong Kong residents shall be equal before the law" and Article 24 defines "Hong Kong residents" to include non-permanent residents. Since the various extra stamp duties are not for the purpose of revenue raising, and since they lack any other legitimate purpose and (unsurprisingly) have not had the intended effect, they should be void for restricting rights promised by the Basic Law without constitutional necessity. However, no affected person has yet filed a judicial review of this, so the courts have not opined on it. In any event, the punitive and prohibitive stamp duties are clearly inconsistent with economic freedom.
The extra duties deter assembly of units in old buildings by the private sector for redevelopment, because if a would-be developer reaches the requisite 80% or 90% ownership threshold to trigger an auction of the whole block under the Land (Compulsory Sale for Redevelopment) Ordinance, then the developer may lose the auction and never recover the 30% stamp duty it has paid for residential units (or 8.5% for non-residential). Only the person who wins the auction, demolishes the acquired property and commences rebuilding can recover excess stamp duty.
This leaves the Government's Urban Renewal Authority with an unfair advantage in redevelopment. On request from the URA, the Government can invoke powers under the Lands Resumption Ordinance to compulsorily acquire properties without having voluntarily acquired 80% or 90% as the private sector must. To avoid opposition, the URA pays above fair value to owner-occupiers of the dilapidated properties by treating the flats as only 7 years old, handing windfalls to owners, distorting the market and, as they put it in their 2017 annual report: "posing serious threat to our financial soundness". Of course, any stamp duty that the URA pays loops back to the Government, giving the URA another unfair advantage.

We could continue, looking at cartels in various sectors, wasteful state-driven infrastructure projects which suck up taxpayers' resources, yet another Government-planned "innovation and technology" hub at the Lok Ma Chau Loop, or non-means-tested welfare spraying, but you get the picture. While HK scores high on freedom of international trade, it is domestically far from being a free economy and heading further away with every additional Government intervention.

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Hong Kong's not-so-free economy 4 February 2018