Thursday, March 01, 2007

Milton Friedman May Have Misunderstood the Lesson of Hong Kong

The example of Hong Kong as a bastion of non-intervention by government in markets is well known. Milton Friedman made a particular point of the great example that Hong Kong was for free markets and for a low proportion of GDP to be used for government spending. These thoughts tended to morph into the idea that this arrangement was one of Adam Smith’s ideas about the minimalist role that should be accorded into government, a long running misperception in economics from the middle of the 19th century.

While British governments tended to keep out of economic interventions in markets in the so-called age of laissez-faire, they also tended to take a fairly large role in the ‘international balance of power’ – a sort of mercantile doctrine for state spending, as false as that for hoarding gold and silver bullion – which meant that defence spending, colonisation and fighting local wars, played an overly large role in economic affairs, albeit somewhat hidden.

Hong Kong was another example of the hidden hand of government. Asia Sentinel carries an article suggesting that Friedman’s explication of Hong Kong’s relatively small government role in the economy misses some significant areas where government spending played a less obvious, but still important role that was overlooked.

“At one time 60 percent of the people lived in subsidized housing, mostly rented cheaply from the government, and some in Home Ownership Scheme flats, provided with cheap land and sold to lower-middle-income households. Even now that public housing has low priority and the home ownership scheme has ended, some 50 percent of the people still benefit from this massive intervention in the marketplace.
The intervention also partly accounts for the low apparent ratio of spending to gross domestic product. If the cost of the subsidized housing land were accounted for at market prices in the government budget, the ratio would be significantly higher.

Hong Kong people have also enjoyed almost free medical treatment at government clinics and hospitals. Friedman was against “free” medicine elsewhere but failed to notice it in Hong Kong. Likewise, education, at least up to the secondary level has long been almost entirely funded by the government.”

Moreover, the government of Hong Kong did not contribute to the costs of its defence. That fell on the British government (and now on the Chinese government), These factors – defence, housing, and health – raise government spending in the economy considerably. But the specific proportion is not as important as the more general point: there is a necessary role for government in a free market economy, and, Adam Smith was well aware that some government spending (and taxation to pay for) is an essential component of a free society, as discusses in Book V of Wealth Of Nations.

Smith was not the ‘night-watchman state’ advocate that laissez-faire economists often claim. Interestingly, libertarians sometimes criticise Smith for not being laissez-faire enough (some have actually read Wealth Of Nations). I am writing that section of my book on Smith at the moment and it is clear, what many scholars of Smith recognise, Smith was far more nuanced in practice than his epigones give him credited for.

His prescriptions for the appropriate role of government spending included defence (in 18th-century Britain the largest, and growing, share of government expenditure, destined to get larger as the 19th century colonial empire grew); justice (an absolutely essential, even pre-requisite, for a successful commercial society); public works (his actual programme was massive, potentially); education (also massive if implemented, with its emphasis on the education of the ‘common people’); health (initially confined to ‘loathsome and offensive disease’); and necessary expenditures of the apparatus of government (‘maintaining the dignity of the sovereign’).

This did not make Adam Smith a ‘socialist’ (a nonsensical claim, except among ideologues). His assault on mercantile political economy was a critique of government intervention in pursuit of wrong policies and not a critique of all and any government expenditure.

But neither was it an endorsement of government expenditure with an ever widening remit to cover large sections of the economy in which markets could perform much better. Understanding the difference is what makes a Smithian scholar.

[Read Asian Sentinel at:]


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