Fiscal conservatism, which champions a balanced budget and expenditure restraints, is often hailed as a politico-economic philosophy as well as a policy of financial responsibility. In practice, it has been used as an argument against free spending by governments which can lead to high levels of debt and inflation. It has not been a positive philosophy which advocates the pro-growth and stability benefits coming from balanced budgets. Rather, it is a negative one - reacting against excessive spending and its consequences. This is probably why modern examples of fiscal conservatism in the United States and the United Kingdom have not led to sustainable growth or a significant reduction in public debt. Instead, in the case of the Ronald Reagan era in the US in the 1980s, public debt soared as fiscal conservatism and other policies were abandoned.

In advanced societies, facing intense competition from emerging economies, it would be difficult, if not impossible, to restore competitiveness if investment is constrained and past debts are repaid from current revenue. The reductions in investment, whether in physical outlays or human capital, deny any chance for the economy to improve its competitive edge, unless there is a quick and drastic lowering of people's living standards to lower production costs and restore fiscal balance. But this will surely spell political suicide - even for the most popular conservative leaders. So any government which proclaims fiscal conservatism is only paying lip-service to it. Instead, it will allow economic competitiveness and long-term social development to deteriorate. Falling investment and lower public revenue will cause serious structural problems for the economy.

The Hong Kong case is an interesting one which is different from other advanced market democracies simply because it was once a British colony. It had been a policy priority of the British to avoid its colonies having any fiscal deficits. The motive was not so much fiscal prudence, but colonial selfishness. Britain benefited from profits and resources from its colonies, but refused to pay for any local development in them.

In the case of Hong Kong, the colonial administration also wanted to defend the autonomy of its rule, no matter how corrupt or bad it was, against any intervention from London. This is what we have learned from a British colonial government insider, Leo Goodstadt, who was head of the Central Policy Unit of the last colonial administration in Hong Kong. The financial secretaries in the colonial era insisted on fiscal balances and surpluses. But Goodstadt has revealed that there were great shortfalls in welfare and infrastructure investment under British rule. Except for a few years, every year from the end of the World War II until 1997, the colonial regime achieved annual budgetary surpluses. The surpluses not only reconfirmed the ability of the Hong Kong administration at self-financing, but also provided benefits to the British government. The surpluses and reserves were incorporated into the British foreign exchange reserves. They then provided guarantees for large pensions for British expatriates and naturalized Britons from Hong Kong after they retired.

It is an impressive record for the British colonial administration to achieve all these budget surpluses while Hong Kong still advanced to become a major world financial city. However, the great deficit in infrastructural and human (social and cultural, not just manpower) investments allowed other developing Asian economies to catch up with Hong Kong. In the 1960s, Taiwan and South Korea were yet to start their industrialization, and Singapore was still struggling with independence. Ten years later, they had become Asian dragons along with Hong Kong. In the early 1980s, Hong Kong could still claim to be the leader of the four, but by the 2000s it had fallen behind in terms of economic growth and innovation.

It is unfortunate that after the 1997 handover, Hong Kong did not overhaul the colonial regime. It even went so far as to enshrine some of the old colonial governing principles - notably fiscal conservatism - in the Basic Law. It has enforced them in the post-1997 period via British-trained bureaucrats. The results were as expected. Despite slow-to-stagnant economic growth and the erosion of international competitiveness, the government has achieved annual surpluses. It has also built up one of the world's largest pools of financial reserves. Part of the surpluses came from the initial reduction in social and infrastructure investment planned before 1997, which includes extending the years of residency for welfare eligibility for new migrants and the delay and suspension of public housing projects. The latter two have become major sources of tension which have threatened political and social stability in recent years.

Editor's note: The second part of this article will follow tomorrow.

The author is director of the Public Policy Research Institute and head of the China Business Center, Hong Kong Polytechnic University.

(HK Edition 02/13/2014 page1)