“By concentrating exclusively on keeping the value of its currency stable, a country can grow consistently, but it must allow all around flexibility in its economy and not mind macroeconomic volatility.”

This month I do not write from Europe but from Hong Kong, where I attended the General Meeting of the Mont Pèlerin Society (MPS), founded by Friedrich Hayek in 1947. On our free day, I took the ferry from mainland Kowloon to the island of Hong Kong proper. The ticket machine returned me a one penny and a ten penny coin with on the obverse the head of Queen Elisabeth II, Defender of the Faith. The penny dropped, so to speak, and I was reminded of the fears rampant the previous time I came to Hong Kong. The year was 1978, the occasion, another general meeting of the MPS. Mao Zedong had only recently died. Hong Kong still was a Crown Colony, but in another twenty years the territory would probably have to be handed back to China. Would freedom subsist, we wondered? In 2014 the question was whether the new Chinese masters had changed the legal and economic regime bequeathed them by the British. Had the typhoon clouds then looming over this merchant city cleared? Would it still be free in the future? The serried ranks of sky-scrapers awaiting me on the other shore seemed to indicate that nothing much had changed. Was this impression a reality or a dream?

In 1978, when the first Mont Pèlerin meeting in Hong Kong took place, we were all awed by the prosperity and dynamism of the territory. After that conference, Milton Friedman stayed on to film one of the episodes of his revolutionary television series “Free to Choose”. My wife and I joined the team. Friedman was able to show how much the ordinary Chinese of that tiny enclave had seen their lives bettered by capitalism, in contrast with the appalling poverty in which Mao had left the People’s Republic of China. Of course we were not allowed to cross the border with our cameras, but the number of immigrants trying to enter the colony confirmed our expectation that, if they could, numberless Chinese of the Pearl River Delta would flee the darkness of mainland China for the multicolored lights of capitalist Hong Kong.

The miracle of a free economy

After World War I, the British governed their subject territories across four continents with an administrative paternalism that showed their low opinion of their subjects’ economic capacities. It was the time of Imperial Preference in the commercial affairs of the Commonwealth. Measures had been taken to stop the cheap textiles of India from competing with those of Lancashire. The farmers of Africa could not sell their tea, cocoa, and sugar in the wide world but had to export their produce to privileged private companies or through state Purchasing Boards. After World War II, the treatment became even more poisonous. The Labour Party, in power in the United Kingdom after 1945, added a social dimension to this commercial paternalism. Bleeding hearts in London expected colonial administrators in far off lands to control prices, extend state schools, subsidize housing, introduce unions, and change labor laws. A creeping welfare state was the less admirable part of the legacy of the British in the world.

Despite all this, the city that welcomed the MPS in 1978 was free for a crucial reason: the Colonial Office in London had not been able to tame what would later be called the ‘savage capitalism’ of the colony. Unilateral free trade was the rule in the Colony, as it had been in Britain up until the First World War. The budget was small and strictly balanced. Prices moved freely, labor was unregulated, and taxes were low. Hong Kong could be thankful that Sir John Cowperthwaite (1915-2006) was its Financial Secretary from 1961 to 1971. It was he who consolidated the foundations of the free Hong Kong we saw in our 1978 visit. His portraits show the face of a deceptively benign bureaucrat, but in truth this civil servant had steel in him. Interfering politicians feared him for the elegant and precise way he yielded the rapier of argument. It was he who coined the phrase “positive non-intervention” to mark the economic regime he wanted for Hong Kong. In his first budget speech he said:

In the long run, the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralised decisions of a government, and certainly the harm is likely to be counteracted faster.1

He was faithful to this principle even to the extent that he refused to collect statistics unless of the most innocuous kind, for, he said, statistics led governments to try and fix perceived ills that fix themselves if the economy is left alone.2

Low taxes and good laws

The Colonial Office in Britain had made Singapore raise taxes, especially on the rich. When Labour Secretary of Defense Dennis Healey asked Cowperthwaite to levy more funds so that Hong Kong bore a larger share of the military expenditure of the Colony, Cowperthwaite flatly refused. This was his tax regime, still in force in Hong Kong today. When paying income tax, people could choose either a flat salary tax of 15% or a rate going from 2% to 17%. The tax on profits was 16.5%. Dividends and capital gains were exempt. The tax on property was limited to 15% on the income obtained.

He also sustained the independence of Hong Kong’s judiciary and the excellence of its legal system, widely recognized among the best in the world. This system is now constitutionally guaranteed to stay separate from that of the People’s Republic of China until 2047 at least. The Hong Kong Basic Law, drawn on the principle of “one country, two systems”, states in article 8 that all laws of before the handover, including

… the common law, rules of equity, ordinances, subordinate legislation and customary law shall be maintained, except for any that contravene this Law, and subject to any amendment by the legislature of the Hong Kong Special Administrative Region.

Human rights are protected by a Bill of Rights.3 Courts are known not to be at the behest of the authorities, in contrast with the mainland, where more than a quarter century since the death of Mao, civil law is only gingerly being built.4

There was a great deal of corruption in the police and among customs officials under British rule, so much so that Sir Murray (later Lord) MacLehose, Governor of Hong Kong from 1971 to 1982, set up an independent Commission against corruption, which still functions today. Slowly the habits of old China in matters of organized crime in gambling, prostitution and drugs were contained, and this has resulted in an absence of gross corruption, again in contrast with what happens on the mainland.

A sound currency

The keystone of Cowperthwaite’s financial policy was a sound currency. He refused to move the Hong Kong dollar/pound sterling exchange rate even when in 1967 the devaluation of the British currency caused Hong Kong a great loss in the value of its monetary reserves. This system of a fixed exchange rate was maintained by later Financial Secretaries and continues to the present day, except for nine years of free floating in the late seventies. From 1983, Hong Kong opted for tying the local currency to the US dollar at a rate of HK$7.80 to US$1.00.5

When a country fixes the exchange rate with the help of a currency board, the Monetary Authority must limit itself to buying and selling its currency on demand unconditionally. This has meant that Hong Kong must totally dispense with monetary management and has no need for a central bank. The government cannot take any measures to counteract or soften external shocks. Ever since Cowperthwaite’s time, Hong Kong has allowed external shocks to work themselves out in the economy without interference. How is this possible, a denizen of America or Europe will ask? The answer is that Hong Kong takes such external shocks in its stride because internal price and wage flexibility have allowed it to adapt rapidly to foreign losses and gains. Such a stoic attitude to economic ups and downs is what gives investors the confidence that the Hong Kong dollar is a solid currency.

So here we have an overarching policy principle: to fix the exchange value of the currency by keeping to the strict rules of a currency board. Maintaining a currency board in Hong Kong is subject to two conditions. One is that the Monetary Authority should be exclusively occupied with making sure that

… the Hong Kong dollar Monetary Base to be at least 100 per cent backed by, and changes in it to be 100 per cent matched by corresponding changes in US dollar reserves held in the Exchange Fund at the fixed exchange rate of HK$7.80 to US$1.6

For more on these topics, see Foreign Exchange by Jeffrey A. Frankel in the Concise Encyclopedia of Economics. See also the EconTalk podcast episode Burgin on Hayek, Friedman, and the Great Persuasion.

See also

China’s Growth: Planning or Private Enterprise? by Paul Gregory, August 6, 2012 at the Library of Economics and Liberty,


What’s wrong with Hong Kong? (Too much government), by Scott Sumner, September 20, 2014, EconLog.

Under a currency board regime, there is no one to manage interest rates or create fiduciary money. There will only be an Exchange Fund engaged in reactively buying and selling the local currency at the announced rate; and that Fund will have to keep a reserve that is equivalent to the base money of the economy and a little more.7

The other condition is that both the budget and the balance of payments should be in equilibrium, so as not to endanger the confidence of the public that the Fund’s reserves will not be unduly used. Hence, the government cannot borrow to cover budget shortfalls, and wages and prices must be flexible enough for the country to maintain its competitiveness in world markets.

All this led Cowperthwaite to budget for surpluses year in year out, and also to leave large public works in the hands of private business. I was reminded of this during my second, more recent, stay in Hong Kong when being driven back to the mainland through the tunnel under the bay. In the sixties, a group of businessmen approached Cowperthwaite to ask for the government to finance this tunnel. He replied that if it was useful private capital would do it. And private capital did it: this was the tunnel through which I was being driven back back from the Island to Kowloon.8

No central bank

At this point I must lodge a complaint about our monetary sessions at the Mont Pèlerin Meeting this September in Hong Kong. We were told that monetary policy was difficult, as indeed it is. We discussed the Fed’s policies and lamented its mistakes. We heard contrary opinions about the dangers or virtues of deflation. The hall rang with demands for an active monetary policy to jump-start the economies of the world, mired in lackluster growth after the ‘Long Recession’. All this was no doubt interesting. But nobody, just nobody, alluded to the fact that we were in a city with no central bank. The question should have been: is it possible to dispense with a central bank, since Hong Kong seems to have done so well over the years with a passive Monetary Authority? Of course there have been wild swings in Hong Kong, some from monetary causes, some from real shocks: The Asian crisis of the 1990s hit the economy hard, as did the SARS epidemic. But according to the CEIC database9 the Hong Kong economy grew notwithstanding throughout this period: by 4% from 1966 to 1970, 6.2% in the 70s, 5.7% in the 80s, 2.1% in the 90s and 3.2% in the new century. The IMF classifies Hong Kong as third in the world by per capita income today, when in the 50s it was one of the poorest places in the world. If Hong Kong can do it, why not other countries?

The problem for interventionists is that such long term growth has been achieved by concentrating on the rule that there should be no budget deficits and that the economy should be kept highly flexible in terms of prices and wages. True, the U.S. dollar anchor to which the Hong Kong dollar is tied is not the best possible one: the Fed and the U.S. Treasury are wont to conduct a selfish monetary policy at the service of the electoral interests of the American government. Another anchor could be found for the Hong Kong currency or any moneys aiming at stability—gold, a basket of goods, a composite of world currencies. But the above discussion gives a clear and unwelcome answer to the question. By concentrating exclusively on keeping the value of its currency stable, a country can grow consistently, but it must allow all around flexibility in its economy and not mind macroeconomic volatility. This kind of monetary regime is not compatible with a welfare state.

The seeds of the welfare state

Cowperthwaite was a Gladstonian liberal who felt a sense of obligation towards the least fortunate.10 He organized an ambitious housing scheme for refugees from mainland China; he kept the system of free government schools that had been set up along the British model; he maintained strictly managed public hospitals that gave free quality medical services to the poorer part of the population. He thus planted the seeds of the welfare state in Hong Kong. These seeds started sprouting shoots under Governor MacLehose immediately after Cowperthwaite retired.11 He legislated nine years of compulsory free education for school-aged children. He re-hauled the healthcare system and also introduced Jobseekers, Elderly and Disability Allowances, paid holidays, redundancy payments, weekly rest days, and labor courts. Under him, the housing policy was extended to include a home ownership scheme. It is not surprising that MacLehose was the most popular Governor in recent memory.

Two remarks are in order here. The first is that the free economy was not inordinately affected by these welfare measures, so we can conclude that good laws, independent courts, a stable currency, free trade, and the unhindered movement of capital will keep the market capable of delivering prosperity. The second is the caveat that any kind of welfare policy harbors dangers, however small and harmless it may look in the beginning.

On our second visit this year I found that the welfare programs of Hong Kong were growing apace—a development that could become more dangerous with attempts by the Chinese Chief Executive to seduce the democrats in the region. At present, half the housing of Hong Kong is public, either rented or subsidized ownership. Public spending on education amounts to 17.6% of government expenditures, allowing state schools and fully subsidized private schools to offer education at no cost. Since 2010, Hong Kong has had a minimum wage, which Professor Richard Wong has shown principally benefits members of middle class families.12 The expenditure on health care by the government is well controlled (equivalent to 3% of GDP) but is given for free at fifty public hospitals compared with twelve private ones. As for pensions, a Mandatory Provident Fund was created in 2000, whereby 5% of the pay of employees is docketed and matched by employers. There are various other public pension schemes.

All this seems small, but the pressure to increase the span of welfare will not diminish. The Hong Kong government is pulled two ways by the wish to be seen as small and the inclination to widen the reach of these programs. The inclination to introduce “new and enhanced services” while not abandoning “the principle of keeping expenditure within the limits of revenue” indicates a split mind. Also, lamentations in the press abound that labor laws are incomplete, even after the imposition of a minimum wage: they do not ‘yet’ regulate working hours and overtime pay; make rest breaks mandatory; protect part-time workers; impose family-friendly regulations; recognize trade unions as bargaining units; or make collective bargains legally enforceable. I feel great sympathy for the students demonstrating for greater democracy in Hong Kong but I fear all these will come even if, or when Hong Kong becomes more democratic. Political freedom, if it comes, may play against the Hong Kong tradition of a free economy.

Demands for ‘progressive’ legislation take it as given that family help, private benevolence and individual foresight are always insufficient to deal with poverty, misfortune and illness. Experience shows that welfare policies tend to dry up those sources of social cooperation and often bring individual corruption through moral hazard.13 Further, if the welfare system grows excessively, it may come to affect the functioning of the market and thereby reduce growth.

In July 2010 The Economist magazine spoke of the “End of an Experiment” when noting that a minimum wage was in process of being approved by the Hong Kong Legislature. That article listed many of the distortions I have noted. I could also speak of the slow spread of anti-immigration and egalitarian feelings in the region. Introduced by British bleeding hearts and by favor-currying Chinese authorities, and now demanded by pro-democracy citizen groups and trade unions, those well-meant interventions are slowly undermining the system that has made Hong Kong prosperous. I am afraid that after my second visit to Hong Kong I am less optimistic than after my first.

* * * * *


Pedro Schwartz assumed the Presidency of the Mont Pelerin Society at the recent general meeting in Hong Kong.


Obituary of Sir John Cowperthwaite, The Daily Telegraph, 26 January 2006.

Remembering the Scottish referendum, I note that Cowperthwaite was one of those Scots who left behind Hibernia to prosper in London and the Colonies. Some were administrators who, like Cowperthwaite, governed according to the counsel of David Hume and Adam Smith; others went on to trade, as the Keswicks of the House of Jardine; or entered finance, such as the Sutherlands of the Hong Kong and Shanghai Bank, one of the three commercial banks issuing the currency of Hong Kong in the present day.

Thus the National People’s Congress of 2007 passed a law accepting the right of private property generally, but excluded land property: individuals could enjoy and transmit rights of use but not own land outright. In fact we are seeing reports of zoning definitions being used to expropriate existing dwellers to permit forced gentrification in favor of Party officials, which has resulted in a number of sometimes violent clashes.

The HK$ is allowed to float between a strong rate of (HK$7.75/US$1) and a weak rate of (HK$7.85/US$1). See History of Hong Kong’s Exchange Rate System, Hong Kong Monetary Authority.

Hong Kong Monetary Authority: “Monetary Stability”.

The monetary base is the source of monetary liquidity of the economy: it is the sum of coins and notes, of HK Government Certificates of Indebtedness, of Exchange Fund bills and notes and the clearing accounts of commercial banks held at the central bank. Since shocks or even panics can happen that make the public try to go liquid and turn their HK$ holdings into US$, it is prudent that the Fund’s reserve be larger than 100% of the monetary base.

Alex Singleton: Copperthwaite Obituary article, The Guardian, 8 February 2006.

CEIC data for Hong Kong.

Copperthwaite Obituary, The Daily Telegraph.

Not Sir Robert Black and Sir David Trench, who were supportive of the free market policies of Cowperthwaite. In the 1970s, however, MacLehose, a much more interventionist governor, partly rectified the Cowperthwaite stringent social policies. (Telegraph Obituary). It is typical of this Old Tory anti-market tradition that Chris Patten, the last British Governor, unsuccessfully proposed a ‘pay as you go’ pension system for Hong Kong 1997 just before standing down.

Richard Y.C. Wong: “Why the Minimum Wage Harms the Economy”,South China Morning Post, 12 June 2012.

A.C. Richard Wong has studied many examples of good intentioned interventions clogging up the wheels of the market, as when he analyzes subsidized housing in Hong Kong and proposes the privatization of ‘social’ home ownership. See his book On Privatizing Public Housing (City University of Hong Kong Press, 1998); and his many articles in the South China Morning Post, such as “Hong Kong Public Housing Policy, a Home Wrecker for Poor Couples”, 1 July 2014.


*Pedro Schwartz is “Rafael del Pino” Research Professor of at San Pablo University in Madrid where he directs the Center for Political Economy and Regulation. A member of the Royal Academy of Moral and Political Sciences in Madrid, he is a frequent contributor to the European media on the current financial and social scene.

For more articles by Pedro Schwartz, see the Archive.