Sat, 05 Jul 2003

Free press essential for Hong Kong's success

A service economy cannot grow without the free flow of information

Zhiwu Chen Yale Center for the Study of Globalization Hong Kong

The Hong Kong Legislative Council is debating legislation that would potentially enable the government to restrict information in the name of national security. The basis for this legislation -- known as "Article 23" -- is reasonable, but its enactment could have unexpected consequences for the city's economy. It is not surprising that opponents of the legislation include not only professionals but leading businessmen, because freedom of information and the press is vital to Hong Kong's economic livelihood and future.

Unlike many of its neighbors, including mainland China, Hong Kong's economy does not depend on natural resources or agriculture. Usable land space is also very limited. Relative to the limited land, Hong Kong has a large and educated population. With over 6 million people but no natural resources, there are two ways to grow the economy. First, as it did from the 1950's to the 1970's, Hong Kong could try to rebuild its manufacturing sector. However, given the mainland's dramatic advantage in labor and real estate costs, this direction is a dead-end.

The other way to grow the economy is to further develop the service sector, which made up 86 percent of Hong Kong's GDP last year. Since Hong Kong cannot compete with the mainland in agriculture or mining and manufacturing, future economic growth will have to come from the service sector, including financial services, health care, and educational services. But the city's dense population alone cannot provide its competitive advantage in these areas, because there are many more people on the mainland and in nearby India and Indonesia. Thus, human capital per se cannot be Hong Kong's best asset.

We are then left with institutional capital: Hong Kong's rule of law, press freedom and economically non-interventionist government. These intangible institutions and traditions are the best capital of Hong Kong, and their protection is essential to ensuring the territory's continued economic vitality.

To understand the importance of the rule of law and freedom of information to a service sector economy, it's necessary to compare manufacturing and financial transactions. In auto manufacturing, for example, what you make and trade is a tangible item. A car buyer can look at the design style and colors, can open the trunk and even the engine to inspect the quality, and can do one or more test-drives.

Because of this, the manufacturer and the buyer have access to much of the same information. And the buyer may never need to open the informational brochures provided by the seller, because inspecting and test-driving may be sufficient. Of course, legal enforcement of product liability helps keep car sellers accountable and truthful. But, in the absence of reliable legal recourse, car buyers may still be able to make informed purchases -- as long as they inspect and test the cars well.

The informational advantage that comes with a tangible product explains why even countries with no rule of law or free press can grow their economies by engaging in the manufacture of goods. Some Asian countries of the 1970's and 1980's and China today are outstanding examples.

In contrast, what is traded in a securities transaction (say, a stock) is a financial contract written on a piece of paper or recorded electronically. It is a claim on future cash flow. This claim may not be worth much if it is not backed by an investor- friendly securities law and an independent, effective judiciary. In addition, precisely because of the intangible nature of a financial security, a stock buyer is at a severe informational disadvantage: The security being traded has no color, no style, no weight and no flavor; nor can the buyer test-drive it.

The buyer has to rely on the information disclosed by the seller, in order to make a judgment on the value of the security. If the transaction takes place in a market economy where the flow of information is not free, he will then have to buy stocks essentially on faith -- without knowing whether the information that he relies on is false or biased.

Since the rule of law and press freedom are highly correlated for each country, to understand the dynamics of an economy like Hong Kong's we can look at the relationship between press freedom and service-sector development. Based on the 1990 press-freedom ratings of 106 countries by Freedom House, one finds that a country's press freedom and its service sector's development (as measured by the service sector's share in GDP) are highly correlated: The more free a country's media in 1990, the better developed its service sector in 2002. The average service sector's share in GDP is 62 percent for free-press countries, 57 percent for countries with average press freedom, and 49 percent for countries with the least free press.

Given the strong correlation between the two, does the free flow of information cause the service sector to develop better, or does the service sector's development lead to a more free press? While a detailed explanation is beyond the scope of this article, economic theory and the fact that no country lacking rule of law or a free press has a deep capital market suggest that the above correlation is not a coincidence: Information freedom is necessary for the service sector to really grow.

Hong Kong's economy has been enormously successful. Its stock market is the 10th largest world-wide and the second largest in Asia. With a total of US$311 billion in assets under management in 2001, Hong Kong's fund management industry is ranked 7th globally and is also the second largest in Asia. Even with these achievements, there is still more room for Hong Kong to develop its financial service industry and hence grow its economy further.

Why would Hong Kong give away the sort of institutions that countries like Russia, Poland, and even China have struggled to build as they reform their economies? As all nations in the region attempt to broaden their appeal to the global financial community, international investors' preference for domestic press freedom and rule of law gives Hong Kong a clear economic advantage that should not be compromised.

The author is Professor of Finance at the Yale School of Management.