29 August 2019

China’s patronage economy is the real root of the Hong Kong protests

By Leo Austin

The conventional explanation for the protests that have gripped Hong Kong in recent weeks is that they have been triggered by opposition to the government’s extradition bill, but the true causes run much deeper.

Planning consultants Demographia have named Hong Kong the world’s least affordable housing market for nine years in a row, yet its problems represent the future of China. Hong Kong’s youth is rebelling against wage slavery and there is no-one to represent them because their representatives are the same people who enslaved them.

According to Hong Kong’s Midland Realty, average property prices have risen almost five times since their trough in 2003. It costs a median Hong Kong family 19.4 years of gross pre-tax income to buy an apartment. That’s up from 11.4 years in 2011 and it’s much higher than anywhere else in the world. In Sydney – the second least affordable – that multiple would be 12.9.

Sky-high property values are driven by money laundering and cartel pricing. The M3 money supply in Hong Kong is four times today what it was in 2003. That is a reflection of how much money people are putting into Hong Kong. It’s worth noting that the Hong Kong Dollar (HKD) is pegged to the US dollar, so Hong Kong doesn’t have an independent monetary policy. The Hong Kong Monetary Authority provides as many dollars as demand requires.

Hong Kong has well been known to be the money laundering channel of choice for mainland China. The numbers can be huge. In 2013, a 22-year-old delivery man was convicted of laundering 13bn HKD (£1.3bn) through his personal accounts. In late 2018, the deputy Communist Party chief of neighbouring wonder-city Shenzhen, Li Huanan, was arrested with $144 million in cash stashed in one of his properties. He had reportedly offered underground bankers a 50% split if they would move his money to safety in Hong Kong. A conservative estimate of the money flowing illegally from mainland China to Hong Kong each year would be in the hundreds of billions of HKD and the huge influx has meant a field day for business.

The money goes into the Hong Kong stock market and into buying property. A 2012 study by Kenneth Chung, of Hang Seng Management College, showed that 97% of historical changes in Hong Kong property prices could be explained by four variables: rental rates; excess liquidity (the money supply); stock market prices; and interest rates.

Hong Kong is a cartel economy and business can resist change. There is a supermarket duopoly, a bus cartel, a port oligopoly and four families dominate the property business. Pressure from the young for lower-cost housing has been continuous. They have got close several times in the past. Each time, the plans have been beaten back primarily because they don’t coincide with the needs of the industry or the government finances.

The property system is that the four families buy land from the government in huge lots for which few others have sufficient capital resources. They then build and sell on at a three to four times mark-up. Land sales have been a key source of government revenue since well before the handover to China in 1997. The model has been copied across China and land is now the key source of revenue for other local governments as well.

Business runs Hong Kong. The city has a version of representative democracy based on restricted suffrage, similar to the livery elections for the Lord Mayor of London that were granted in the Magna Carta. In Hong Kong, the Chief Executive is elected by the 1,200 members of the Electoral Committee, of which the first 900 are representatives of different sectors of business. The 300 other representatives include deputies to the Chinese National People’s Congress and 70 members of the Legislative Committee (Legco). In total, just 35 of the 1,200 electors are appointed by the wider public.

The Communists like this system. It is negotiated agreement, the normal practice of the 80 million Communist Party members who rule China’s 1.4 billion people. The Hong Kong Electoral Committee representatives are people with a strong stake in the patronage system and are therefore easily controllable. The model has at times been seen as a test-bed for potential reform in the rest of China.

China’s highest ‘political legislative advisory body’, the Chinese People’s Political Consultative Conference (CPPCC) works in a similar way. It is meant to represent civil society but it is dominated by businessmen whose fortunes have been built by working closely with government.

Until 2018, these were senior figures in real-estate, state-owned companies and “princelings” – the relatives of senior Party officials. This year it’s technology entrepreneurs.

In Hong Kong, the results of the last Election for Chief Executive were not representative of popular opinion. Polls before the vote showed 56% of the public supporting former Financial Secretary John Tsang and only 29% supporting the eventual winner and Beijing favourite, Carrie Lam. She won because Beijing made its opinion known and the restricted electorate’s interests are slanted in Beijing’s favour. The irrelevance of the wider electorate was made very clear.

The young of Hong Kong can build no stake in their own society and they find themselves wage-slaves to the patronage economy. They have been waiting for the promised universal suffrage to force through changes which could make Hong Kong liveable again, but it’s not coming.

This will happen in the mainland too. The boom of the last thirty years has been an exercise in printing money. In the five years to 2017, M3 – the broadest measure of the money supply – nearly doubled in China. In the eight years to 2017 it nearly tripled.

The loans which delivered this fresh cash were not handed out equally. State-owned enterprises represent maybe a third of GDP in China today, but according to the IMF they still receive around 82% of all corporate loans. They hand them on to their relationship networks and those networks in turn play the markets. So much of the money went into buying property that it distorted the entire Chinese economy. House prices in Beijing and Shanghai rose seven-fold from 2003 to 2019.

Loans are the tool by which the patronage class gets rich and the inequality is created. Loans are not provided equally, so these are just as much revolts against the money supply as they are against patronage and the cartels. Hong Kong’s money supply just reflects the availability of easy money in China. The patronage class get it in one region and stash it in another.

Demographia don’t publish their analysis on housing affordability for the mainland. According to CBRE, the average price of a house in Shanghai is now more expensive than Los Angeles, New York or London. In Beijing and Shanghai, young educated migrants pack themselves into shared rental flats to survive. Described as ‘the ant groups’ by the media, unable to pay rents on their own and maybe unable to buy an urban house in their lifetimes. The average price of a house in Shanghai is nearly 50 times the average individual pre-tax annual income. As China enters its inevitable slowdown and future prospects look less rosy, who will they reach out to for recourse?

As the shouting has grown louder in Hong Kong, the government-controlled media has blamed foreign ‘black hands’. Nationalism is used to deflect attention and it works. Young nationalists rage in their condemnation of Hong Kong traitors and arrogant foreign forces. How bad might things get when protest begins in the mainland and this becomes an existential problem for the Communist Party?  How much nationalism would you need to deflect from that – and what would the implications be for the rest of the world?

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Leo Austin is a UK-based businessman. He is Senior Advisor to The Conference Board China Centre.