Budget should adopt 'supply driven' strategy

The fiscal role of the government in market economies is to generate macroeconomic stability. In an economic boom, the government reduces expenditures to avoid economic overheating. In a recession period, expenditures are increased to ease economic hardship. However, that traditional stabilizing role was disrupted in the mid-1990s when the colonial British Hong Kong government narrowed the salary tax by massively increasing personal exemptions, increased the number of welfare items and increased expenditures on each item. The post-1997 Hong Kong SAR government suffered an unprecedented fiscal deficit after the outbreak of the Asian financial crisis. The deficit issue subsided when the economic recession ended, and there has been more talk than action about widening the tax base.

Fiscal surpluses mean the government can save more for "rainy days" or the surplus could be used to enlarge future economic capability and capacity. Unfortunately, people's attitudes on the role of the government have been distorted. After the Asian financial crisis when economic difficulties called for short term actions by the city government to rescue the economy, "demand-driven" policies were adopted, typically by spending more to aid the weaker part of the population. Such government expenditures ended up aiding the consumption needs of the people, but were not growth oriented, since not many jobs were generated.

Unfortunately, it was taken for granted the government must aid the needy regardless of the economic situation. On the contrary, it would be advisable for the government to adopt a "supply-driven" strategy that would expand the able segment of the population, so that more jobs and investment opportunities could be generated. It is only through "supply-driven" strategy that would generate virtuous economic circles and allow the government to collect more revenue to help the needy.

There is thus confusion in fiscal management circles between crisis and non-crisis situations. During a crisis, the government is expected to play a more short-term role to alleviate economic difficulties. In normal times, when the economy is confronting no crises, the government should look more to develop the long-term capacity of the economy. In normal economic times, it would be inappropriate for the government to look for short-term ills as if the economy were in a crisis. On the contrary, a long-term vision should be nurtured so that people could see the economic future of Hong Kong in 20 or 30 years' time.

It would be appropriate to revise Hong Kong's fiscal structure in preparation for future crises. There should be a "built-in" element so that the fiscal system is not severely disrupted in a crisis. Secondly, the large expenditure in both good and bad economic times by various governments since the mid-1990s has cultivated a "welfare-prone" society in Hong Kong, as if it would be wrong should the government fail to aid the needy.

There is a welfare system in Hong Kong known as the Comprehensive Social Security Assistance (CSSA) scheme. Despite the absence of difficult times, the government has recently established the Community Care Fund to provide additional help to the needy. There are also the various one-time financial supports, provided either through the annual Policy Address or the Budget. As a result, instead of perfecting the CSSA scheme, there are at present multiple layers of social welfare assistance provided to the needy. Between the fiscal years of 1980-1981 and 2006-2007, nominal GDP in Hong Kong has increased by 929 percent, but welfare expenditure has increased by 7,824 percent.

There has to be an instrument within the fiscal structure so that crisis situations will be addressed. One possibility is to create a Crisis Fund used purely for future crises. The government can inject capital into the Crisis Fund, especially in years of budget surpluses. The Crisis Fund will grow on itself in non-crisis situations. The advantage is that the government can run its fiscal budget in normal circumstances, and surpluses can be added into the fund that can prepare "for the rainy days". And if crises do strike in future, the Crisis Fund can then be used to address the various immediate needs without creating undue pressure on the normal trend of the fiscal budget.

The author is an associate professor in Department of Economics and Finance, City University of Hong Kong.