Intro. [Recording date: September 13, 2018.]
Russ Roberts: My guest is Neil Monnery.... His latest book is Architect of Prosperity: Sir John Cowperthwaite and the Making of Hong Kong, which is our subject for today.... So, why did you think to write this book? Most of us have never heard of John Cowperthwaite. He's not famous in the least. Perhaps he deserves to be. What caused you to think about writing it and what did it take to actually write it, given that there's not a lot of other biographies of the man?
Neil Monnery: Indeed. I think it's the only one. Well, I came across--like you, I was worried after the Great Crash as to the problems that are caused by not having enough growth in the world. And I wanted to see whether there were areas, countries, and the like which had overcome that and had good levels of growth. And I came across Hong Kong. And, as I learnt more about Hong Kong, this name Cowperthwaite kept coming up, keeps coming up as the person who is responsible for the economic policies and who really set the course for Hong Kong. And that's what got me interested in that.
Russ Roberts: So, a little background on Hong Kong and Cowperthwaite. It's about a thousand square miles. It's the size of Rhode Island, for those of you in America. It's about 3 times bigger than New York City's 5 boroughs. It's about 50 times the size of Manhattan. And I was surprised at this: In my mind it's just a little tiny rock with a lot of tall buildings. But it has some actual land space. It's population--tell me if I've got this right--at the end of WWII was about 600,000--
Neil Monnery: It collapsed during the Second World War from about a million to about 600,000, yeah--
Russ Roberts: And now is about 7 and a half million--
Neil Monnery: Yeah, that's right.
Russ Roberts: It was about 3 million in 1960. So, for those of us who don't have much background in the history of the island--I know it was basically British; and now it's Chinese. Talk about how it was run during the crucial period we're going to be talking about, which is post-WWII [World War II] until the handover to the Chinese.
Neil Monnery: Well, it became a British colony in the 1840s, really in many ways to support trade with China and in particular of the opium trade. But in the period we are talking about, it was like a standard British colony: run by a Governor, supported by a set of civil servants many of whom, some of whom were sitting on the Executive Committee. And then there were also unofficial members of the Executive Committee; and those are people who were appointed by the Governor--typically local businessmen or something like that. We would balance out and give a bit of a sense[?] as to what the normal people thought, because it was not a democracy in the normal sense of the world. It was a country run by a Governor.
Russ Roberts: And, what kind of economic activity is there? Today it's famous for its banking and financial sector. I was surprised to learn how economically active it was, post WWII, doing lots of other things.
Neil Monnery: Yeah. Because of that original basis of being an entrepot ready for Chinese trade, that's where the first hundred years of the economy were--
Russ Roberts: Tell our listeners what an entrepot is. It's a word that doesn't crop up much in American English.
Neil Monnery: Right. So, it's basically a trading harbor--so, people trading want to get stuff out of China, or want to get stuff into China, would use it for warehousing, shipping, breaking[?] goods, things like that. And from that it started to build adjacent activities like shipbuilding and insurance and so on. But, in fact, most of that trade ended--a lot of it ended--with China when America imposed sanctions on trade with China during the Korean War. So, that in a sense destroyed that business. And Hong Kong moved very quickly into trying to build a manufacturing base, predominantly in things like textiles, but wickmaking[?], enamelware, and so on; and then it moved into electronics in the late 1960s, became very powerful in radios and television and so on. And then it's, as you say, it's ended up being now very much in advanced financial services and other services economy.
Russ Roberts: You used an interesting language back a minute ago. I don't know--I don't think you intended to, but it's a common language that we always use in these kind of contexts. It's somewhat misleading. You said, 'Hong Kong then moved into'--or you maybe even said--I don't think you said, 'decided.' But you implied it was sort of a top-down decision. One of the themes of your book is that there's remarkably little economic planning of the standard kind. So, the things you are talking about--the move to textiles, the move to electronics--those were the result of the independent decisions of hundreds or thousands of entrepreneurs and business-people, many or most, I guess almost all Chinese.
Neil Monnery: Fair enough, so. So, that is absolutely right. So, that's, at various points, people in government, or people in business, suggested that it would be good to have some top-down planning to see which sectors they wanted to move into, or whether or not they'd grown certain sectors too far, and therefore they should be constrained in some way. And really, that was the battle of ideas that Cowperthwaite was so strong on, and really set the course for Hong Kong. Not doing that in a top-down fashion, but rather allowing the various entrepreneurs, the people who were deploying their own capital to make those decisions as to where to invest. Some of which worked. Some of which didn't work. But very much a bottom-up entrepreneurial system. And also very much allowing the greater destruction of those industries that no longer were competitively advantaged, because Cowperthwaite was always being assailed by various people who wanted to enter into supporting one sector or another; and he pretty much always turned them away, and said, 'If it's a good industry it will work; if it's a bad industry, it won't work.' 'But it has really nothing to do with me.' And that was a very powerful stance through that period of the 1950s, 1960s, and so on afterwards.
Russ Roberts: And one piece of that economic history I want to make sure I mention--and then we'll turn to Cowperthwaite's role and his various duties[?] over this time, post-War period. But, one fascinating thing that happens over this time period is that Hong Kong becomes a very, very important exporter of textiles and yarn, and various stuff for making clothes. And gets, makes political challenges for the two great leaders of free trade in the post-War era of the United States and the United Kingdom. And yet they, of course, violate, as they often do, their own so-called free-trade principles, for domestic political reasons to protect the case of England--is it Lancastershire?
Neil Monnery: Lancastershire. Yeah.
Russ Roberts: And in America I'm sure it was the Carolinas, in that period. Probably although it still could be some textile actively in New England, but I think most of it moved to the Carolinas at that point.
Neil Monnery: Yeah.
Russ Roberts: And so, here, the two leaders of the free trade era are putting tremendous pressure in this time to limit Hong Kong's exports. And Hong Kong, although it wants to not do that, is forced by its relative lack of power, even though it's a Hong--even though it's a British colony--domestic British, political import is such that--bad word--significance is such that they have to be, they have to deal with quotas in both the United States and England.
Neil Monnery: That's right. I mean, the textile industry really started up in the late 1940s. And China itself turned to Mao and Communism--many of the entrepreneurs in that sector decided to relocate into Hong Kong, or a number of them did. And they brought with them skills and machinery and understanding. And a lot of industry started to grow very rapidly. And, as you rightly point out, both the United Kingdom and the United States have large heritage of textile industries. Which were complaining continuously around: How could Hong Kong do it? And they came up with the most remarkable set of hypotheses as to they were doing it. But losing money, or they were treating[?] in some way. Whereas the reality was they were simply, you know, you see more efficient machinery and using it more hours per day, and the like. But that put, as you say, a huge amount of pressure on the British and on the American political system, because they had to stay true to their involvement with Gattans[?]--[?] to the World Trade Organization. And so they had to get Hong Kong to voluntarily agree to limitations in their exports. Which was not so straightforward. But, Harold Macmillan[?] in the United Kingdom in the 1960s was very concerned about that. And Kennedy, in the United States, who was running for election and then getting elected was very concerned also to keep that textile constituency. So you are right: These great bastions of free trade, when it comes to the crunch, not surprisingly, find it very difficult to navigate a political and economic course through these difficulties of dislocation of the domestic industries.
Russ Roberts: There's a certain irony there, obviously. And there's another irony, which is that in many ways Hong Kong is between a rock and a hard place. One of those is China--
Neil Monnery: yeah--
Russ Roberts: The other is the UK [United Kingdom]. Which is, I dunno--12,000 miles away, 15-- I don't know. A long way away, depending on which way you go. But they are--even though they are snug up against China, they are involved with the rest of the world because of the nature of their economic activity.
Neil Monnery: Yeah. A very open economy, connected to markets throughout the world. But as you say, from a political standpoint in this difficult position of being a British colony. And in a way even worse: A British colony that had a clock ticking on it because there had been an agreement to hand back the key parts of Hong Kong to China in 1997. And so as time was passing through the 1960s and 1970s, the people were increasingly concerned about what that would mean, as Hong Kong would get returned to China. So, yes: A very complicated political situation. And one which required a certain amount of dexterity amongst the Governor and senior civil servants and so on in Hong Kong to manage, politically.
Russ Roberts: Yeah; I would just mention one of my favorite lines from your book was that that 1997 handover was negotiated in 1897. I wrote this down somewhere. I can't seem to find the exact quote. But 1897, the British negotiator decided on 100 years because a hundred years is like forever. But in 1995, or 1975--that was definitely not the case.
Neil Monnery: Exactly. It seemed like [?] at the time. But for the people actually left dealing with it a hundred years later, it was quite a great pressure in how to manage into the system that has evolved since 1997.
Russ Roberts: And for the last bit of background, tell us about Mr. Cowperthwaite himself. He was Scottish. And tell us what his responsibilities were in Hong Kong, and when--and when he retired, and give us some background on the man.
Neil Monnery: He came from a middle-class family who had been involved in things like tax collection and surveying and so on in Scotland. A lot of the people involved in running the British Empire bizarrely came from Scotland. And he was one of them. He was a very bright guy. He read the classics, Latin and Greek. At St. Andrews University got a First. He then read the same again at Cambridge--
Russ Roberts: That means--getting a First means Good--for those who--
Neil Monnery: [?]Good. Yeah. He did very well. He could read Greek and Latin texts directly, and he did through the rest of his life, as well as also reading French texts in 18th century French, and so on. And I think if it hadn't been for the Second World War he probably would have ended up as a classics teacher at a university or even a private school. But, the Second World War intervened. And, he then ended up applying to become part of the Civil Service Cadet--the Hong Kong Cadet Corp. Which is a very elite form of Civil Servants who are marked out for fast[?] promotion and the like. He fortunately was on his way to Hong Kong who, as it got, captured by the Japanese, and so he didn't end up in Hong Kong. Otherwise he would have been interned for the whole of the war. But instead arrived in 1945 as Japan surrendered and gave the colony back to Britain. And his first job, his substantial job, was to try and get industry back on its feet and to get supplies coming in to the colony. And so he spent a lot of time actually running a department, which was involved in trading, involved in purchasing rice, fuel, and the like. And I think that was a very formative influence for him later on in his life, to see how difficult it was for a set of civil servants to run a trading business and the like. He then became Deputy Financial Secretary, which is Finance Minister, effectively, between 1951 and 1961. And then he was Financial Secretary between 1961 and 1971. So, for about 25 years he was absolutely central to the economic policy formation that was going on in Hong Kong, both because of his role but also because of his intellect and his strength of feeling about what the right approach was for Hong Kong.
Russ Roberts: Now, Hong Kong is famous for its free market policies. It's been held up by Milton Friedman and others as an exemplar of sort of a minimal, laissez faire, Adam-Smithian state. And one of the things I was surprised about in reading your book was how interventionist they were. Now, it turns out they are not so interventionist. But, relative to what I had sort of believed or been told--and this is where my own biases come in: being a free market person I've always like the idea that Hong Kong's free market policies explain their great, explosive growth. But it's a little more complicated. So, give us a summary of the role of government in this post-War period, say, of Cowperthwaite's involvement, say--obviously, right after the War there were some price controls. Those go away. But, once the--we've gotten past the worst of the post-War era--they've recovered from the devastation of the war--and the island was devastated; and a lot of the economic infrastructure was destroyed. Once that starts to come back, try to describe how active or inactive government was. And of course, there's an irony here that: Here's a bunch of "experts" running the place, by not running it. Or, by running it less than elsewhere. So, tell us--give us a feel for how much running they were doing.
Neil Monnery: Yeah, I think one of the things that's probably striking you from reading the book [?]is that there are certain sectors where they get quite a large amount of involvement in different ways. So, for example, Hong Kong doesn't have the ability to collect enough water. Fresh water. Thee aren't enough supplies. And so there needs to be a huge effort to build reservoirs and water collection and the like. And the government becomes quite involved, typically, in a regulatory basis on some of that; and they are involved in things like the telephone structure, because they viewed this as natural monopolies. But, in terms of the normal trading economy--trading, manufacturing, services, and the like--there, there's relatively light involvement. Usually, possibly some level of regulation, but even that is generally relatively light. And its places that get them into problems in Britain's own banking. But by and large it's a relatively light involvement in that and allows that part of the economy to operate through markets--either domestic markets, or because Hong Kong has always been a free port and there's no import duties or tariffs, the world market was obviously very important in many sectors and provided the discipline for efficiency or [?] forward, for example, the export of textiles to the United States and the European Union, as we were talking about. So, all of those sorts of parts of the economy are very much more left in the hands of the entrepreneurs. And, like everywhere, I suppose, there's a growing provision of some of the social elements--education, health, and the like. Although, in Hong Kong in general that has been slower in terms of that provision being put in place than it has been elsewhere; and indeed, one of Cowperthwaite's key points is really to try and ensure that that's affordable and that that's built relatively slowly over time rather than being, for example, put in place through deficit financing and the like. So, I think, overall, I think it would still be fair to say it has been quite a government-light, or has been a government-light economy: about 15% of GDP [Gross Domestic Product]--15-20% of GDP was spent by the government of the sort of period we are talking about. Today, that's probably, I guess 35% in the United States and typically 40-50% in Europe. So, it's still there; but it's much smaller. I mean, Cowperthwaite was not a man [?]. He did believe that there should be a government and that it should have certain important roles in terms of providing, you know, rule of law, basic support for people in need, the likes. But it was of a smaller scale than was happening, certainly at that time, in Europe.
Russ Roberts: And the tax system is--there's a ton of little taxes. Which, he abolishes of bunch of them, whenever they run a surplus. He gets rid of a tax on televisions or whatever it is. But the larger, more significant tax--there's an income tax. Correct? Is it a flat tax above a certain amount? Is that the right description?
Neil Monnery: It's a tax which tops out at 15%, income tax during this period, or lower--rising over the time we're talking about to about 15%. And if you earn less than that, you could pay [?] for lower rate, and of course about half the population don't pay income tax at all. So, there's a sort of level you need to earn. And, one of the interesting things about the Hong Kong tax system throughout this period and up till now, is you get a separate tax on your income and you get a different tax on property earnings, which bears no relationship--it's not consolidated--into your income earning part and the like. So, you have different schedules for tax, which means that the overall tax rate is much lower because you get an allowance on each one.
Russ Roberts: And--by the way, that's not much different from the United States today, although it's a little bit misleading. About a third to a half, depending on how you define the denominator--whether you are looking at tax returns or actual people--pay no income tax in the United States. They do pay payroll tax, though, quite a bit--all workers do in the United States. They are lied to and told that's to pay for their Social Security; in fact it goes into the government coffers and is spent out the door. Pardon me for that crude honesty there. But, there's no payroll tax in Hong Kong, if I'm correct. And the other part that I found extremely interesting--I wish you'd gone into more detail--is that, even though the government is providing, say, education or health care, it's not providing it universally; and it's often charging for it. So, even though the government schools, they're government-run schools, there is a fee. I know that because at one point you mention that they cut it in half, when times were good. Let's talk a little bit now about how Cowperthwaite--and by the way, you've pronounced it now both 'Cowperthwaite' and 'Cooperthwaite', [?], because you mentioned before we started recording that it's not 100% clear what his actual name is, but--
Neil Monnery: People have used [?]--
Russ Roberts: Mr. Thwaite, Mr. Cowperthwaite, he was very insistent on not providing welfare to the middle class and the rich, through government services.
Neil Monnery: I think that's absolutely one of his key beliefs. He was passionately concerned with helping the most needy in society, but was very worried that if that started creeping in to providing a lot of support for middle-income people, that would both create incentive problems but would also slow the growth rate. And his logic went something like this: which is, Hong Kong is clearly over this period a developing economy. He believes that if entrepreneurs are left with enough income to [?] surplus to reinvest in new opportunities, that will push up the growth rate going forward. And therefore if he starts taxing that in order to provide free education for the middle classes, then that will be at the expense of future growth, which he sees as central to his mission, if you like to try and push the growth rate up in Hong Kong. So, education is actually in a way the most dramatic, because he at one point says he believes education is a very good thing; but even good things have to be paid for. And so his strong preference is not to provide universal, universally-free education or indeed anything else, but rather to charge market prices and then to give complete subsidies to the most needy. So that there's very targeted use of state funds--taxation is very well targeted onto those needing it the most. He at various points loses that battle; and indeed lost that battle in due course in education. But his starting point is nearly always to say, 'Let's try and be clear about what the market costs of these things are and try as far as possible to put that into the market price. But, whilst getting subsidies or grants for those who are most in need and those who otherwise couldn't afford it.' It also affects--for example his, he has a very interesting set of arguments about water provision, coming back to water. Which is, if you want 24-hour provision of water in Hong Kong in the 1950s and 1960s, that's a very much more expensive set of capital expenditure that would be needed than if you wanted, say, water provision 4 or 5 or 6 hours of the day. And he says, 'Well, you know, I'm not sure that it's the right aim to have 24 hour water provision. There's a huge amount of resource that we would be expending on that. And it would make it, at market prices, unaffordable for the least well off in our society.' So, he would much prefer, for example, even on something like water provision, to say, 'Well, let the state intervene to try and ensure some basic level that can be afforded by even the most needy in society; and then allow the market and private forces to provide things that are beyond that.' And, almost all his battles in defining the environment of the state are around those sorts of issues about who should be getting it, how much should they be getting, is there a way to do it while still allowing market forces to work.
Russ Roberts: I'm going to read a quote from him. I'm going to read some quotes later as well. But this one's related to what you just mentioned. He says the following:
"I find myself considered inhumane or unprogressive or sometimes merely odd, by some of my colleagues as well as members of the public, when I suggest that it is not axiomatic that a twenty-four hour supply in all circumstances must be our immediate aim. I cannot myself see any grounds for the belief that a twenty-four hour domestic water supply is an inalienable right of civilized man. It may be, if he can afford it and is prepared to pay the price."
So that gives you--as you mention--that gives you a really good look into his philosophy of government. Very, very odd, and unprogressive by modern or even--but even his day. Which I think is one of the fascinating things about the book, is that he's espousing a fairly limited view of government at a time when the world is very much turning toward, first, deficit spending, or countercyclical activity, as well to help get rid of recessions or downturns, as well as an increasing role for government, especially in his home market of the United Kingdom where government is nationalizing, becoming much more socialistic. And he's standing really athwart the tide of economic history. So, even though--what I found fascinating about the book--is that even though it isn't the free market paradise I think it's been portrayed by some, relative to the rest of the world it's way out of step.
Neil Monnery: Exactly. And the important thing is that he's not doing it just because he's mean or, horror, unkind, anyway. He's doing it because he believes that if the state, the level of spending that the state is engaged with is lower, that will enable more funds to stay in the private sector. And he hopes, believes that those will be reinvested in good capital projects. And through that, economic growth will be higher. And therefore, his belief is that, by being constrained in the near term, you can have a set of positive effects in the longer term. And he's very struck by the power of compounding, the like; and therefore understands that if he can get the growth rate a bit higher, that will have great effects for wages over the long term, great effects for employment. I mean, if you remember, this was the time when China is going through its cultural revolution, with a lot of refugees turning up in Hong Kong every day. And he's worrying about, 'Well, how are we as a society going to employ these people? And how are they going to find a role?' And so, he's really got a very different tradeoff or set of preferences. Whereas I think the modern politician wants to give satisfaction now. On a wide range of issues, he's sort of saying, 'Well, actually, if we hold back on that, we may be able to get higher levels of growth than we otherwise have. And we sort of need those to deal with the large influx of people; to deal with the aspirations, to deal with the long-term spending that we as a society want to have.'
Russ Roberts: Just as an aside, we recently had an episode with Frank Dikotter on Mao's Great Famine, which is roughly, it's during this period, and is right--1961, I think they are coming out of the famine, but Cowperthwaite is involved before that, during it, after. And, just a technical question: How easy or hard was it to get into Hong Kong during this time period? What were the immigration--I'm sure a lot more people wanted to get there than could. But a lot did. So, how was that managed?
Neil Monnery: It went through swings. So, at various points prior, obviously, to the Cultural Revolution, it was relatively easier to get into Hong Kong. It has a long land border with China at that time. But it tightened up enormously because there was a huge wave during the Cultural--as you know from that podcast. I mean, the effect on people in China of the Cultural Revolution was very worrying, with many people dying of starvation and the like. And so there was a great demand to try and get into Hong Kong. So that was managed as best they could.
Russ Roberts: Actually, technically, I think it's actually the Great Leap Forward that leads to the Famine. The Cultural Revolution is the next iteration of Mao's grand--
Neil Monnery: That's right. Yeah. Sorry. Yeah.
Russ Roberts: stuff. But Cowperthwaite is there during that, too. So it's all relevant.
Neil Monnery: Yeah. Yeah. So, that's right. He--I mean, the first one, of course, was the Hundred Flowers Campaign in 1956, where Mao said he'd like to get sort of feedback; but then he didn't really like the feedback he got. So that sort of ended. And then there was the Great Leap Forward, which was the more [?] one than the Cultural Revolution. But I think it's very, it's almost a fascinating contrast between what's going on in Hong Kong at that time, where just a few miles away across that border at that point, there's a very different set of policies being enacted. So, you can contrast the, you know, the success if you like over this period in Hong Kong with some of the issues that China had at that time.
Russ Roberts: Yeah, and of course, there is selection bias. Hong Kong is getting--
Neil Monnery: Yes--
Russ Roberts: Somewhat. It's not obvious which way it goes. Because Hong Kong is getting both the most entrepreneurial people--probably--because there is very little scope for entrepreneurial activity in China at this time. But they are also getting just poor, pitiful people who are getting abused. Now, of course, as you say, there are different times they can get in and out. It was harder for them to get in. All of this raises a fascinating question, which we could spend the rest of the time on. I don't want to, but it needs to be mentioned. Which is the following. I'm an American. I've been to England. And when I go, I am struck by how uneasy young people are with the colonial heritage of British policy. So, for example, my favorite example, this I've mentioned on the air before, is the British Museum. It's basically the--it's the--it's a bunch of looting and theft that the British army did, armed forces did over time. And, but that's the bad. That's the embarrassing downside part. It's shameful. The positive thing is that they preserved it all for the world. And displayed it in a magnificent way. Which is why they refuse to give back the Elgin Marbles--if that's how you pronounce 'Elgin.' Which are the Greek sculptures from the Parthenon, if I have that right.
Neil Monnery: I think that's right.
Russ Roberts: But, anyway, it's magnificent. And it's also not so nice: that England has become the storehouse of cultural history. At the same time, in its administration of its various colonies: Well, the United States--you know, we didn't like it, and so we had a Revolution; and we got "freedom." Other places took a lot longer. A lot of people died along the way. There were wars. Bad policy. Some people defended it as a form of paternalistic necessity because the rest of the world was too uncivilized. And, we look back on that now, most Westerners, with shame. Which is understandable. And yet, in Hong Kong, as far as I can tell, in this period that we are talking about--we are not talking about 1850 when England waged war against China and took stuff. Which was horrible. Like Hong Kong. But, in the administration itself, I kept thinking: What were they trying to do? What was their--in economics we would say 'what were they maximizing?' What were their goals? It sounds like it was to raise the living standards of the people who lived there. Which makes--and they were not were not a democracy. They did have this--the unofficials, the advisory board, but they were just an advisory board. What was it--was it a benign dictatorship? Was it, kind-hearted? It's weird to be reading about Mr. Cowperthwaite--who was a bureaucrat's bureaucrat. A great mind. But still, he's running the economy. Maybe with his very light hand. But he's not trying to get re-elected, so he doesn't have to kowtow to anybody. And yet, you'd have to ask: What was success for him? And who was his--what were the incentives that he faced? That's a long, rambling intro question. So, respond to that however you'd like.
Neil Monnery: But I think you are right: There is a mix of unease about some of the elements of, certainly, earlier colonialism. And that at one level also pans out into this period. And we have I think an unease about that and also unease about the limited democracy that existed in Hong Kong. But exactly as you are saying there is an interesting element of the story, particularly over this period, where, having read through the archives and so on, I think there were mostly quite good motives from the people involved: you can obviously argue whether they should have been involved and whether there should have been more self-determination and so on earlier on. But, I think, actually many of the motives of people like Cowperthwaite and various governors at various points are to try and do a good job for the Hong Kong people in a fairly clear way. And often, when they clash with the British government or with senior politicians or senior British civil servants located in Britain, they very much take the side of the Hong Kong people, the long term side of the Hong Kong people. And that causes a lot of problems over time, because they actually--[?] over how much people locally should pay for defense. They would have complete arguments with the British civil service saying, 'Well, we don't think the people here should pay that much.' So, I'll say they definitely had created a bit of an objective to try and do well for the Hong Kong people and maximize the progress of their society. But as you say, very much in an enabling and a facilitating way. That's not to say that was true, obviously, as you were saying--that was obviously not true at all times and in all places--
Russ Roberts: in India, say. Or places where there was enormous resource extraction.
Neil Monnery: Yeah. Yeah. So, this is definitely not an attempt to try and say this is a good model of government. Simply saying, 'Here's an interesting period where there's quite a stable economic policy, for some odd reasons it happens. But here's what happens because of that economic policy being stable for that 50 years or so that it has been.' And it is the slightly odd set of circumstances that have allowed such stability in economic policy. That is what gives it part of the interest in the natural experiment that came out of that.
Russ Roberts: So, you think about, say, China in 1850 and England in 1850 versus China in 1950 and England in 1950. In the later period--I mean, China was a very unmodern country in 1850. It had had an enormous, probably, high standard of living relative to the rest of the world for a while; then it closed itself off from the rest of the world--at least this is my simple narrative. And, they kind of stagnated. And the rest of the world had the industrial revolution. And, all of a sudden we're in 1950 and finally China gets some--it's a big place and it's hard to run a country: you don't run China in any real sense. Even today I'm not sure you can run China. And I'm not talking about the economy; I'm just talking about just figuring what's going on where given the state of technology and understanding. But, at some point, it's pretty clear that Mao is in charge and that China is a growing, or wants to be a growing power in the world. And it's weird that they didn't just take the island over. Now, I know that they don't want a war with England in 1950 or 1960. But when you talk about the defense of the island, what is it? Does the British fleet sit near there to try to do--could it do anything if China had just said, 'We want it'?
Neil Monnery: No. No. So, prior to the Second World War there was the concept of defending it. But, Churchill, before the Second World War knew perfectly well that Hong Kong was indefensible--at that point, from Japan. But the same is true later on, from China. And, if China had wanted to take it back by force, really, after the Second World War that would have been possible, say. I don't think it would have been defendable. At that time we were talking about, in terms of the Cultural Revolution, the beginning of the Cultural Revolution, in the sort of 1966-67 period, the British government even prepared a plan as to how they would evacuate Hong Kong and retreat from Hong Kong should that happen. China also had power for [?] to cut off the water supply and the like. So, it was a fairly precarious situation and required having China at least on side or at least to the extent they didn't want to invade, in that period of, say, 1960 onwards.
Russ Roberts: 1850--I understand that you wanted to sell stuff into China and you wanted to take stuff from China--tea and other things. But in 1950, you start thinking--I mean, I start thinking: Why does England care? One of the reasons it's such a--
Neil Monnery: So, in the 1950s and 1960s Britain is getting out [?]--
Russ Roberts: it's retreating--
Neil Monnery: It's retreating. Hong Kong is the only 'East of Suez,' as the phrase was, major colony that remains. Singapore is given independence, as are most other places, leaving, really, just Hong Kong. So, again, it's an anomaly in many ways that that was retained. And I think that's partly because of the original treaties that said it would be British until 1997. And also, the strength of feeling in Hong Kong and the number of people in Hong Kong who did not wish to at that point [?].
Russ Roberts: The British weren't Chinese. Yeah.
Neil Monnery: Yeah. Yeah. So, I think it is an anomaly, something that ran its course for longer than most colonies did, rather than part of a grand plan, if you like. In that period.
Russ Roberts: It's funny--when I was talking about the British colonial period, I was thinking in the back of my mind of "The White Man's Burden," Rudyard Kipling poem. And when you say, 'East of Suez.' Kipling doesn't get enough exposure on EconTalk, so I'm going to do this from memory. Maybe you'll help me. The line--it's from "The Road to Mandalay," [after the show, Russ corrected this to "Mandalay," and also slightly corrected the words of the poem, written correctly here], I think. He says:
Ship me somewheres east of Suez, where the best is like the worst,
Where there aren't no Ten Commandments an' a man can raise a thirst.
Neil Monnery: I'm very impressed.
Russ Roberts: Well, I could be cheating. You don't really know. But you'll have to trust me. But the--and I couldn't remember "Ten Commandments" till I started reciting it--but there was a different time--Suez being, of course, in Egypt: East of Suez, which was India, all the other areas--Singapore, Hong Kong, lots of British activity east of Suez. So, very different.
Neil Monnery: I think--interesting, actually--I would speculate that America was much keener that Britain retain Hong Kong--
Russ Roberts: Oh, I bet you're right.
Neil Monnery: Because--I mean, the largest consulate America had in the world was Hong Kong, at that time. So, I think there was probably some [?] activity going on.
Russ Roberts: Yeah. You said they had a lot of employees. They probably weren't just stamping things.
Neil Monnery: They probably weren't. So, I think that that time, where, if you remember, the reason for mentioning Suez was obviously America didn't support Britain and France when Britain and France tried to re-take control of Suez. And that let to, if you like, the [?] strategic inability to retain the Empire east of Suez. But I think America had a slightly different view on the value of Hong Kong. So, there was a slightly different answer for them.
Russ Roberts: And I encourage listeners to watch the first season of The Crown, where the Suez Canal crisis is covered in some detail. I don't know how accurate it is. It's pretty accurate.
Neil Monnery: Yes [?]. Quite accurate.
Russ Roberts: It's a great program, by the way. I have no interest in British royalty; and I found it--I couldn't stop watching it. It's phenomenal.
Neil Monnery: Yeah. I thought, 'Who on earth would make a series of this?' But actually, it's compulsive.
Russ Roberts: Yeah. It's tremendous.
Russ Roberts: Anyway, back to Mr. Cowperthwaite. One of the most entertaining parts of the book is the dog that doesn't bark. The dog that doesn't bark--I keep waiting, when I'm reading your book: 'When's he going to talk about GDP [Gross Domestic Product] and growth and some measurement?' As you say, he's very focused on growth; and I think actually was, whether--sometimes people say one thing and don't do it. But he was focused on growth. And I couldn't understand why you didn't give us any data. And then I came to this passage, which I have to confess I love dearly. This is a quote from the book:
Throughout his time in government, Cowperthwaite refused to compile and distribute official data for economic output. For most of his tenure as Financial Secretary, he simply batted away requests for the data. When Milton Friedman visited Hong Kong in the early 1960s, he asked Cowperthwaite why there was such limited information on national income.
And then you quote Friedman, which I think is Free to Choose; and you write [?]:
Cowperthwaite explained that he had resisted requests from civil servants to provide such data because he was convinced that once the data was published there would be pressure to use them for government intervention in the economy.
Neil Monnery: That's right. He was constantly under pressure. Because, if you remember GDP-type statistics started to become common currency just before the Second World War. And since, as you say, he was articulating that he was interested in growth, people not unfairly said, 'Well, can you give me some measurement of that?' To which he said, 'Absolutely not.' He did a very bureaucratic wease--he got some poor academic, whose name I can't remember; and he said, 'I'm setting up a study,' I think this was about, yeah, 1962, 'I've set up a study to look at the feasibility of collecting that type of information.' And, when you read the files in the archives, you can see the complete pain that Cowperthwaite was to this poor man. And he was constantly sending him back his drafts and saying, 'I don't really understand this. This needs further involvement[?].' So, come 1969, 7 years later, at the Executive Council, he said, 'Yes, the professor I've asked is having difficulties coming to closure on how we would do it, and I think that's because it's not really useful information to collect.' And so on. So, this poor academic was lined up to be the fall guy. But Cowperthwaite had a reason, as you pointed out. Which was, he knew that GDP-type data really came along with the New Deal and with Keynes. And he was convinced that if you started collecting this data, then at various points people would say, 'Well, GDP is doing very well. We can spend more.' Or, 'GDP is not doing very well, therefore we must intervene--'
Russ Roberts: therefore we should spend more.
Neil Monnery: Spend more.
Russ Roberts: Strangely enough, it's always 'spend more.'
Neil Monnery: He sort of, therefore, was very clear in his own mind about what the second order impact was of collecting the data. And so he said, 'Well, I simply won't collect it. It doesn't affect anything. We will have the same policy whether it's a thousand dollars higher or lower. So it won't affect what we do as government, so therefore there's no point collecting it.' Of course, once he'd gone, his successor gave way a little bit on that and started collecting the data, and that's what we end up with today. It's a fascinating point, and I think he was probably proved right, actually.
Russ Roberts: Yeah; I have to--a lot of my listeners, a lot of you out there are economics grad students economists, practicing economists of various kinds. And I think it's a matter of complete faith in our profession that data and numbers are crucial for designing economic policy. And I'm somewhat sympathetic to that. I understand that. But I think we've neglected the reality that it also comes with a cost. And one of the costs is that GDP is one thing--it's not easy to measure; you do the best you can--so many things we measure are measured poorly, inaccurately in ways that are easily distorted. It's a complicated thing. It's not straightforward. I think it's probably a net good that we measure a lot of things in the U.S. economy. But, it does come at a cost, and it is a way that fuels demand for interventionism and the data give that demand a scientific patina.
Neil Monnery: I think that's right. I think the existence of that type of data in a way must have the second order effect of people therefore wanting to manage it and influence it and do stuff with it. And obviously the best [?] would be you're terribly careful about resisting those pressures. But being humans, that's not always possible.
Russ Roberts: And actually I think it's probably pronounced pa-ti'-na [Russ pronounced it pa'-ti-na above.--Econlib Ed]. I apologize for that.
Russ Roberts: I want to read a couple of excerpts from the book or from Cowperthwaite's own words that I thought were so extraordinary. I'll pause after each one and you can add footnote or caveat or whatever you'd like. The first is about a tax on Chinese-prepared--duties: Chinese-prepared tobacco. This is from the book:
Cowperthwaite's belief in reasonable tax rates was illustrated at the most micro level by a change he made the previous year to duties on Chinese-prepared tobacco. He noted that his experiment in reducing the duty had increased the yield from $110,000 to $1.2 million. When the unofficials replied to the budget, Li [Lee?], one of the unofficials in the Advisory Committee, would underline the benefits of low tax rates: "The reduction in the rate of duty has resulted in a tenfold increase in revenue. "[?] This gratifying result amply proves that a reasonable rate of duty rather than a high one ultimately brings in the revenue. It is sound policy to lay down a rate at which people could be induced to obey the law rather than to break it.
So, an aside here is, this is a--a lot of people believe we cut tax rates, we'll raise more revenue. I don't think that's true in America at the current level of tax. But there is a level of tax which, if set high enough, a reduction can increase revenue. And through this mechanism, which is to get rid of the black market and have people make legal activities that are now taxable.
Neil Monnery: Yeah. Cowperthwaite was extremely keen--he was a British civil servant, so he was extremely keen that people pay their taxes, and put a lot of effort into enforcement. But, in his head, the quid pro quo was the level which created natural encouragement to do the right thing rather than to turn to the black market. And, I think time and time again when he acted on these things he had the result that you've just mentioned. I think it's also interesting--your GDP point, coming back to that again: he would get a number of his ideas simply by wandering around and listening to people. He had a lot of friends in the various communities--Chinese, Asian, Indian, and so on, British in Hong Kong. And he would listen to the issues that were happening and develop policy on that, in many ways, rather than--and first principles. He loved going back to first principles: Why would someone behave the way they are? And once he could work that out, he could work out how to regulate or not regulate, how to tax or not to tax. And I think you're right: Hong Kong is a story of having very fast-growing revenues, really across all of the major tax areas, at relatively low levels of tax.
Russ Roberts: The next example is from his view of parking. Which I enjoyed immensely. Here is the quote:
He was concerned that providing government car-parking spaces at below their full cost would stifle the construction of private parking. Indeed, he was worried that that was already happening, and he wondered if it was preventing private capital from meeting the needs of the growing car-owning public, noting that "one trouble is, when government gets into a business, it tends to make it uneconomic for anyone else." ['You continue'--Russ Roberts] On this relatively minor issue, Cowperthwaite combined a fairly detailed knowledge of the economics of car parking with some insights into the effect of government involvement. He had no problem applying his broader framework to specific issues. For him, it was clear that the government did not need to involve itself in car parking; and if it did, because of its ownership of land, then a full market price should be charged.
Neil Monnery: Yeah. I mean, that was his way of dealing with things. He had a set of philosophies that I think derives from classical economics, and understanding why people behave the way they do. And he would then apply it in great detail, whether that be car parking. I remember in one budget he started going on about a sports facility that they were building--it was a completely trivial kind of thing--where he clearly had some feel for the numbers for what it cost to build and different spec[?] levels that you could have. I mean, he dived into these things. But he was really always trying to get a bottom-up sense of the underlying microeconomics, if you like: How does this work? How do people pay? What are the costs? If the government is involved, what happens? How does it distort incentives? How does it distort capital allocation? He was very interested in trying to work his way through that, however small the issue. I mean, sometimes, obviously, it was much bigger issues on broad macroeconomic themes. But he was absolutely happy delving down into car parking, and the like.
Russ Roberts: And then the last quote, because this is just such an example of the economic way of thinking:
I regard education as a good thing. But we must still ask what a good thing costs, how much of it we can afford, and who is going to pay for it.
Neil Monnery: Yeah. Can you imagine a politician today trying that line?
Russ Roberts: He'd be accused of not caring about the children.
Neil Monnery: Exactly.
Russ Roberts: Now, as you mention, Cowperthwaite's successor did start to measure some aspects trying to measure GDP and income. People have gone back and reconstructed those measures. And there's been an enormous transformation in Hong Kong's standard of living over this period--and subsequent to it. Whether you want to give Cowperthwaite's policies credit for some of that, for setting a tone that his successors, even though they deviated to some extent, they still kept something of the same tone. But, one of the things you don't have--I mean, we have a lot of data on average income. The problem is that average income is of course distorted by people at the high end. So, you can have some incredibly wealthy financial folks coming into Hong Kong, pulling up the average, whereas the median might be stagnant or not moving at all. Do we have any information about what's happening to the poorest people? Because, again, when I think of Friedman, I think Milton Friedman's defense of Hong Kong--his claim was that the poorest people thrived through the policies that we're talking about. And yet, we don't seem to have any real measure of that. Is there any measure of that?
Neil Monnery: The only data I know of is that if you look at, I think it is the bottom decile versus the top decile in Hong Kong, about a factor of 18, I think, which is roughly the same as Singapore: I believe that's 16 for the United States. So, it is probably a slightly less equal society than the United States by a bit. Yeah. I think that--one of the things, though, that is very important for somebody who wants to dig into that a bit is to understand housing costs. Because, one of the most interesting elements of where Hong Kong has deviated from the free market approach is in housing. And, about half the population in Hong Kong is housed in government-built and -run combination. And, for the people who live there, they spend on average about 9% of their income on housing. Whereas, if you were living in the United Kingdom, you would be spending 2 or 3 times that amount as a percent of your income. So, there's a very interesting issue of how they've, through government intervention, made housing much more affordable for many in society. So, you'd need to build that in. But I agree: That would be a very interesting further piece of analysis to look at.
Russ Roberts: So, I'm not so interested in the inequality. I'm more interested in the potential for improvement among the poorest people. And my impression is that their opportunities did improve dramatically over this time period. But, I may be biased[?]--
Neil Monnery: Oh, yeah, definitely.
Russ Roberts: I just add an ironic note to our previous--I don't mean to use the word 'ironic'; I think it's my third time; I apologize for that. But, the last data that I saw in the United States, the top fifth earned 17 times--the average income of the top 5th was 17 times the average of the bottom 5th.
Neil Monnery: Oh, okay.
Russ Roberts: However--and this is why Cowperthwaite didn't trust the collection of numbers--that's a very large gap, obviously. You can debate whether it's good or bad. But, still, it seems kind of large. I suspect it was larger than it was in 1920, say, in the United States. Roughly a hundred years ago. However, this is shocking. In the average household--this is household income--the top 5th has--I'll let listeners think for a second. Guess how many earners there are in the top 5th of the household income distribution. Well, it turns out, it's over 2. It turns out in the data, I remember now, it was 2.04. Well, have can you have more than two earners? Well, you have my high school son, who did some work over the summer, so he adds a little bit to the household--not very much, but he still adds something. So, there's about--but it's over 2. Because most of the people in the top 5th have a husband and wife and they're working. Guess how many workers there in the average household, typical household in the bottom 5th? The answer there is about .45. It's less than 1. Because most of them are elderly, or young, or retired, or on welfare; they're single; they're not married. So, there's about 5 times the number of earners in the top than there is in the bottom. So, if you correct for that, the top 5th to the bottom 5th isn't really 17. It's more like 4. Or 3. So, it's--numbers are tricky.
Neil Monnery: Well, your point has to be right. You need--to make a claim on these sort of things, you need to dig into them in some detail, because of--yeah, there'll be effects like that; there'll be housing cost issues--
Russ Roberts: a huge point--
Neil Monnery: all sorts of things that you would need to adjust. Or at least know about it all to be clear as to what the effect is of people cycling in and out of the different quintiles, and so on.
Russ Roberts: I'm glad you mentioned housing. I meant to bring it up. Did they charge for it?
Neil Monnery: Oh, yes. Yeah. So--
Russ Roberts: It's crazy--given all the things you've said before, we've said before about his philosophy--that they provided it. That they charged for it, I understand. But that they built--that they wouldn't let the private sector build housing for poor people is surprising.
Neil Monnery: It is. It's very interesting, and I can't quite get to the bottom in my own mind about this, which is: there clearly was a market failure in the provision of housing prior to--there were some fires in some shanty towns in the late 1950s and early 1960s, and that really caused the government to say, 'We have to deal with this from the safety perspective, not just from an economic perspective.' You know, 'We can't have this level of people being exposed to danger.' So actually a lot of the momentum was the political one around safety. But, the way that Cowperthwaite and others around him sort of created[?] is they said, 'Well, we therefore need to build houses that are very low cost.' So they tend to be quite small, particularly the early versions in the 1950s and the 1960s.
Russ Roberts: Yeah. Tiny. Not just quite small. Because, I remember the square footage is--
Neil Monnery: It's tiny. But also [?] at a cost that people can afford to pay. And in Cowperthwaite's insistence[?], earns a return on capital [?] the government has put in. So he, that, squaring that circle constrains you quite a lot in terms of what sort of housing you can build. But I can't quite work out why the market failure was so great that that was and has pretty much remained driven by government. There's a huge private construction industry in Hong Kong building expensive accommodations, and when you look at some of these charts about where the most expensive to live in the world, Hong Kong is often towards the top. But that's not true if you live in government accommodation. So it's, again, one of those problems with data which what people are measuring is market construction, market built. And he told[?] people in Hong Kong--I've been in Hong Kong in the archives and so on; I often ask people about the housing. And they think it's brilliant because they end up spending really quite modest amounts of income: the average is 9% across the whole estate of their income being spent on housing, which is--
Russ Roberts: tiny--
Neil Monnery: a pretty good price. [?] but quite small [?].
Russ Roberts: Yeah. But, given his philosophy you'd think he would have--I assume that tragedy, which I remember reading about in the book, of those fires, created a tremendous clamor to "do something." One thing to do is to build housing; which is going to eventually, which Cowperthwaite admitted, going to create an impression that there's a market failure, because, as the government crowds out all the private incentive to build low-income, cheap, small housing, it's going to be easy to say that there's a failure. But, who knows what would have happened if he'd stepped back. And instead put, say, fire regulation--or he may have felt that would not look sufficiently strong enough. I don't know. There must have been a lot of dinner table discussions in the Cowperthwaite household about that break with his philosophy.
Neil Monnery: I think on that one because it was so dramatic--it was a fire, a lot of people got killed; it was on Christmas Day in 1953 I think--and so, because of that I think the political pressure, as you are saying, would have been very high. So I don't think it was [?]--he spent a lot of time saying, 'We need to be clear what the standards and sizes and costs are; we need to earn a return on capital.' I don't think he would have led with that policy. I think that was probably more led by the Governor and various other people. So he wanted to try and maintain the economic incentives in that sector as much as possible. But I agree--it's so large and so successful that it is quite interesting as to which is the chicken and the egg: the market failure or the government involvement. It's clearly very big. And substantial.
Russ Roberts: 10606 But, having said that, as you point out in the book, through most of this time period, government expenditure on actual things--on transfers, on goods and services--is under 10%, if I remember correctly.
Neil Monnery: Yeah, it's about that.
Russ Roberts: Which is a fraction, still. But it's an interesting exception.
Russ Roberts: The other thought I had on the poverty issue, and the impact of the growth on the poorest people there, is migration. The fact that so many people wanted to live there suggests it was a pretty pleasant place; and they weren't mostly rich people in the early days. They were the poorest of the poor, a lot of them. And they felt this was a place they could get ahead, presumably. Although the housing may have helped. Who knows?
Neil Monnery: Yeah. I mean, obviously. The vast influx of refugees and so on would go into jobs like textiles--so, very much low-paid, 2- or 3-shift stuff, and 3 shifts work. And that that was absorbing the people was one of the issues that Cowperthwaite and the others were concerned about around: well if we have this, that's great because it will help deal with people who are coming, as you say, relatively by and large poor people, [?] we're talking about millions of people here.
Russ Roberts: One last thing on the economy: As I was reading the book, I happened to come across a GIF [Graphic Interchange Format] on Twitter of--it's about 5 seconds long; I'll try to find it and link to it with the episode. It's a high speed animation of the transformation of one vista of Hong Kong. In the first vista--it's probably over 1960 to the present, roughly--in the first vista it looks like you are looking at an enormous swamp or almost wasteland, some kind of sea area, low, swampy area. And by the present, in the 5 seconds you watch it, it's transformed into this ridiculous, modern cornucopia of high rise buildings, apartments presumably and office buildings. And, how much of that do you want to give to Mr. Cowperthwaite, that transformation? Of course, some of it comes from Chinese growth over this time period: the Chinese economy waking up and its modernization, its somewhat capitalist bent, the investment from around the world coming in, pouring in there. But Cowperthwaite leaves in 1971. I'm sure it looked better in 1971 than it did in 1951 or in 1961 when he became Finance Secretary. But the last 40 years are really extraordinary.
Neil Monnery: Yeah. They are extraordinary. But they are a continuation. One of the things that I found interesting is that if you follow through after Cowperthwaite has left, his philosophy is still embedded in many budgets and macroeconomic policies and the like, even to the current day. So, you find that at various points, new financial secretaries will say, 'I'm absolutely going to stick to things like, for example, not running a budget deficit. I'm going to keep the state relatively small and taxation levels no higher than they were when he left.' So, I think he created such a success, if you like, that it's tended to me that financial secretaries, new financial secretaries, do refer back to that and argue that they are continuing that. And they still, in Hong Kong, have a relatively low state involvement. It's slightly higher than when Cowperthwaite left, but it's not materially. And I did, during the course of working with this book, talk to the current Financial Secretary of Hong Kong, and he would say there's great continuity between the policies that Cowperthwaite pursued in his time and the ones that are being pursued now. So, I think that is one of the fascinating things about it: it's a 50-year relatively consistent set of economic policies and the results thereof that we can look at. And, if anything, the growth rate is slightly lower as a percentage [?] you might want[?] to expect that in the last 20 years than it was in the 20-years of Cowperthwaite. But, I would tend to focus very much onto the continuity. If you read a budget, and I have done this--read the latest budget by Hong Kong, it could have been written by Cowperthwaite. Much of it is similar. There's more of a nod to dealing with some of the social issues. But, some of the fundamental beliefs about taxation and government expenditure and deficit financing and the like, they're quite similar to where they were in the 1960s and 1970s.
Russ Roberts: So, let's close with a related question to that, which is: In 1997, 'somewhere east of Suez' becomes--there's nothing east of Suez after this. They hand over the territory to the Chinese. What changed legally, if anything? Obviously, a lot. And what changed actually? To the best of your ability to summarize that.
Neil Monnery: Well, I think what happened in 1997 is obviously full sovereignty reverted to China. But China agreed to have what they call 'one country, two systems.' And said that for a period of 50 years, the nature of the Hong Kong economy and society would have some protection. And there were a set of protections laid out in what was called the Basic Treaty. In theory, those will run for 50 years. And they include things, for example, like conservative or [?] fiscal policy, low taxation rates: so they are embedded in the Basic Treaty. What sort of going to be interesting over the--and I guess we're 20 years into that 50-year transition--China may well want to have greater convergence. And depending on how they do that and what they do, it will be interesting to see how that affects the policies and therefore and therefore the economic outcomes for Hong Kong. But in principle, it should retain much of its characteristics that it has over the period we've been talking about.