Hong Kong is one of those places fortunate enough to have benefitted from the reforms of the underdeveloped socialist command economies and their integration into the developed capitalist world. This change has been of seismic proportions, flooding the global market with a sudden abundance of labor. Not since the 14th Century when the Bubonic Plague, wiped out 30-60% of Europe¡¦s population, have we witnessed such a dramatic change in the ratio of capital-to-labor.
In the wake of the Black Death the capital-to-labor ratio rose dramatically and created the opportunity for several novel conditions ¡V labor-saving technological innovations, an agricultural revolution, the rise of commerce, the dawning of the Renaissance and later the Reformation, heralding in the modern era. In the final decades of the 20th Century the world¡¦s capital-to-labor ratio fell dramatically when the socialist and developing nations began integrating with the capitalist economies. The consequences for the world have been enormous and are still continuing.
Mainland Confidence in Hong Kong
Hong Kong under ¡§One Country Two Systems¡¨ will share many of the emerging opportunities of this new era. It is revealing that last year alone 40,000 Mainland mothers voted with their feet by choosing to give birth in Hong Kong. It is the most robust evidence of their confidence in what our city has to offer. The people of Hong Kong are, however, quite divided on the many events and issues emerging from all these changes. This is not at all surprising. Hong Kong feels acutely the tremors and aftershocks of the continuing seismic changes of two worlds colliding.
The collision on the global stage is manifested locally in the incongruities between the Cowperthwaite and MacLehose legacies, free markets and the welfare state. The free market¡¦s supporters are eager to reach out to the emerging opportunities sprouting everywhere. The welfare state¡¦s sympathizers are gripped by a siege mentality and wish to be protected from the competitors at the gate. All over the world, beneficiaries of the welfare state are hostile towards outsiders who come to share their subsidies. Our existing political arrangements encourage politicians to become populist advocates of the welfare state. Hong Kong therefore paradoxically moves away from the system that ¡§One Country Two Systems¡¨ was created to preserve.
Hong Kong¡¦s economic advances are reflected in the rise of real property values since the early 1980s ¡V apart from the break of the Asian Financial Crisis from 1998-2003 (see Chart 1 ). Rising property prices reflect rising incomes, both actual and expected, due to a prospering economy. In the period 1984-1993 the rise in the value of smaller units was more rapid. During this time property prices tripled across units of all sizes. In contrast, from 2003-2010, the rise was more significant among larger units. While prices on smaller units doubled, it tripled on larger ones.
When China began opening up, the majority of Hong Kong¡¦s population during 1984-1993 experienced an increase in productivity as the economy evolved from manufacturing to services. The value of their human capital appreciated. As a consequence, the economic benefits reached households with different incomes and the resulting property price increases was spread across all unit sizes. Prosperity was thus shared amongst households of differing incomes. Naturally not everyone was able to purchase properties before prices rose. And these price rises created an economic division between the haves and have-nots. This led to numerous calls to curb soaring prices and on many occasions the government adopted measures to control speculation. It also introduced the Sandwich Class Housing Scheme to pacify those who had missed out.
When property prices collapsed after the Asian Financial Crisis of 1997 both the haves and the have-nots suffered, and incomes faltered across the board. Then when the property market took off again after 2003, it was the have-nots who found themselves shut out once more. And government is yet again responding with measures to curb speculation, and introducing a ¡¥My Home Purchase Plan¡¦. But the question remains: Will the have-nots have an opportunity to enter the property market in the next cycle? I suspect for many of them their chances are not promising. The majority of the population will not receive another windfall appreciation in the value of their human capital as the experience of 1984-1993 is unlikely to be repeated. Property prices in Hong Kong will rise and fall over the cycle, but with each upward spiral it is likely to outpace the rise in income.
Rise of Luxury Properties
Those who succeeded in transforming the gains from human capital into property during the previous cycle are well-positioned to continue benefitting from future cycles and further widen the gap between the haves and the have-nots. This explains, in part, why the prices of larger units are currently rising faster than those of smaller ones. There is of course also an externally-driven demand; Hong Kong property serves as an investment and value store for buyers. Those who own property can hitch onto the rising fortunes of the economies of Hong Kong, Mainland China, and the global integration of two disparate worlds. But the have-nots are deprived of this opportunity. Upward mobility is no longer an option for those without property ¡V they have become partially unhitched from Hong Kong¡¦s economic future. This division in society will widen and spill over into the social and political realms.
In addition, the incomplete public housing reforms, initiated in 1997 created two housing markets in Hong Kong. The first is the private property market. The second is the secondary market for HOS and TPS flats that can be traded among half the households in Hong Kong. These households are the present occupants of subsidized housing and eligible households on the waiting list. HOS and TPS flats in this second market cannot be traded on the open market unless the discounted premium has been paid. I discussed these issues at some length in a chapter of the edited volume Fifty Years of Public Housing in Hong Kong published by the Housing Authority in 2003.
The simple economics of creating two housing markets ¡V one trading in subsidized housing and the other in non-subsidized private housing ¡V with considerable overlap on either the supply side, in terms of the attributes of the flats, or on the demand side, in terms of the characteristics of the households, can lead to only one predictable outcome. The subsidized market will suffocate most of the activity in the non-subsidized market.
This is Gresham¡¦s Law of bad money driving out good money, if their exchange rate is set at the same rate by law. The creation of two housing markets also explains in part why the supply of private housing, after rebounding in 2003, increasingly gravitated towards the high end of the market and away from the mass housing segment, where the two housing markets overlap most. Gresham¡¦s Law when applied to the housing market, deepens the economic divisions in society and further polarizes the haves and have-nots by destroying the homeownership ladder so critical for upward mobility in present-day Hong Kong.
Real Buyer False Owner
The metamorphosis of private housing supply from shelter to asset is now complete. Is it already becoming conspicuous consumption? If this happens then private housing supply will contract over time. The government will have no choice but to be gradually drawn into the role of monopolistic public developer. This will totally reverse the policy position painfully arrived at after the 2002 Review of the Institutional Framework for Public Housing to progressively shake off the MacLehose legacy.
The two housing markets can of course be reintegrated, but one has to convert bad money into good money, and this implies removing the present limitations that exist on trading HOS and TPS units on the open market. I believe reducing the unpaid discounted premium will go a long way towards achieving reintegration.
As a general rule, when a vendor sells a property to a buyer, the purchase price is typically determined at the time of the transaction. If government has the right to collect the appreciation on the unpaid portion of the flat then one must conclude that the initial transaction did not include the sale of the entire flat to the buyer. Conceptually the government has retained a fraction of the ownership. The real transaction includes the sale of user rights to the flat, and an option by the buyer to make a future payment for full ownership rights. The buyer¡¦s real right over the flat is basically that of an occupant rather than an owner. This arrangement is in sharp contrast to the practice in the private market, where the vendor surrenders ownership to the sold property. The buyer, in turn, secures ownership of the property through a mortgage loan. The bank has the right to take possession of the flat if the mortgagee fails to service the loan and defaults on it.
These sales rules imply that the buyer of a HOS or TPS flat does not in fact receive a subsidy on the purchase price. The unpaid portion of the sales price is considered a ¡§discount¡¨ given for the use of the property. But to secure ownership, its value must be paid for at the future market price. The buyer-occupant possesses only a user-right to occupy the flat and an option to purchase the unpaid share at a later date. The buyer-occupant also has the right to transfer his occupancy right to another person with some restrictions. The value of this occupancy right will depreciate as the condition of the flat deteriorates with age, and the prospect of redevelopment will also be difficult to resolve when occupants do not possess full ownership. The buyer is therefore a pseudo-homeowner.
Fixing the unpaid discounted premium at the original sale price is essentially equivalent to providing the HOS and TPS household with a mortgage loan at a zero interest rate. The subsidy provided by government to the eligible household in the HOS and TPS at the time of the initial sale is therefore an interest rate subsidy. This is an eminently defensible and legitimate position to take in housing policy. It is not without some parallel as the government today allows households to deduct a sum of up to $100,000 on mortgage interest payments from their personal income taxes for a 10-year period. It is a subsidy on mortgage interest rates and the deduction is not means tested. The proposal here is therefore similar in nature and the only difference is in the size of the subsidy recommended.
Most societies believe that a subsidy for homeownership has positive social benefits. A zero interest rate mortgage loan is not an exorbitant subsidy since the households that are eligible for these schemes are the less well-off.
It is wrong to believe that fixing the unpaid discounted premium at the original sale price amounts to forfeiting the ¡§right¡¨ to collect revenue that is owed to the public. In granting to HOS and TPS buyers the right of occupancy in perpetuity and partial ownership to these flats, the government has in effect defined away the rights of having any alternative use for these premises. The remaining unpaid value of the flats is effectively locked-up and destroyed. It can only be unlocked and resurrected if the buyer eventually chooses to pay for it.
Withering Demand for Old Structures
But setting the premium at the high future market valuation discourages payment. Over a 30 year period only 20% of HOS flats, and in over 10 years only 0.5% of TOS flats, have seen the premium paid. Setting the premium at the low original market valuation would encourage and facilitate the unlocking of the asset and thus restore its value.
This HOS statistic implies that every year approximately 1% of the occupants of these flats will pay the premium. This is a very low probability. At this rate less than a third of the stock will have its premium paid in another 20 years. By that time some of these flats will have been standing for five decades and very few households will be willing to pay the premium on flats that are over 50 years old. I would venture to speculate that when we reach that point the government should treat the unpaid premium as a genuine write-off.
I believe that the expected revenue that could be collected from the unpaid premium on HOS and TPS flats will be higher if the government sets a low premium rather than a high one. In asking for a high premium the expected revenue yield will actually be lower thanks to a disproportionate fall in the probability of successful collection.
Setting a low, unpaid, discounted premium would facilitate the sale of HOS and TPS flats on the open market. It would, in one fell swoop, make available thousands, if not tens of thousands, of housing units to meet the current urgent demand. Developers today are not operating in this segment of the market and would be unaffected. After the two housing markets have been reintegrated some of the hurdles to restoring a homeownership ladder that are currently missing would be removed. And private developers would have more incentive in the future to supply housing for the mass market.
Restoring the homeownership ladder will provide many of the have-nots in our society with an opportunity to hitch onto the rising economic future of Hong Kong and the Mainland. They will 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 some small enterprise start-ups. I can also imagine a household choosing to relocate permanently, or temporarily, across the border where their lifestyle will be partly supported by the rental income on their Hong Kong flat. Another scenario is an elderly household supporting themselves on a reverse mortgage on an owned HOS or TPS flat. And if banks are not interested in making such loans their children may do so if they were 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 was part of a future inheritance. If piety exacts a price then at least let the elderly have the option of affording it. I can imagine some elderly households moving closer together to share in a common neighborhood.
Hong Kong is ageing, the elderly 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 state programs for their livelihoods. If we empower them with a piece of our future we can lift their hopes again.
Tame the Green-eyed Monster
I have, on numerous occasions, heard that our society would refuse to accept a policy that might provide benefits for some but not others. The green-eyed monster among us all would try to kill all new initiatives and let society be dragged down. I hope the public will see the wisdom of taming the red-eyed monster within us. I hope the government can convince the public that this is not the only initiative to which they must be committed if they are to help lift the have-nots out of their predicament. After all, this is an era that promises a growing piece of the pie for all of us.
I believe the proposed policy change would go a considerable way to alleviating some of the deep contradictions in our society between the haves and the have-nots. It will create economic value for society, be relatively easy to execute compared to most other policies, and cost very little to the man in the street. It will not solve all of Hong Kong¡¦s deep contradictions ¡V we should not expect a single policy to achieve that. But we should not allow the search for a perfect solution to delay us from taking those necessary first steps. Deng Xiaoping, who could arguably lay claim to the title ¡¥the greatest reformer in human history¡¦ would endorse a policy that advances society by helping some grow rich and in so doing propel the rest of society forward. At the very least the politics in a city of real homeowners would be very different to one where half are homeowners and the other half are slaves to a welfare state.
A final note: once the unpaid discounted premium has been lowered to the level of the original sales price and the remaining unsold HOS flats and the planned 250,000 TPS flats have been successfully sold off, it would be appropriate for government to consider two more initiatives. First, to further strengthen the housing ladder and facilitate upward mobility of the have-nots more suitable TPS units, above and beyond the previously targeted 250,000 flats, should be identified for sale in stages to sitting tenants. Second, for some proportion of future newly-completed public housing estates to contain a clause allowing the sitting tenant the option of purchasing the unit, say after five years, at a predetermined price.
Richard Y C Wong, ¡§The Tenants Purchase Scheme and Home Ownership Scheme Secondary Market¡¨, in Y M Yeung and Timothy K Y Wong (eds.) Fifty Years of Public Housing in Hong Kong, Chinese University of Hong Kong Press, 2003, pp. 283-297.