Last month's mass demonstrations in Hong Kong continue to echo. Never in Hong Kong's history has popular opposition - uniting investment bankers, street hawkers, civil servants and artists, among others - been so loud.

Now China's communist rulers are dithering about how to respond.

One objective of the demonstrators was to voice their desire to select Hong Kong's future leaders through universal suffrage. Today, 800 electors handpicked by the mainland Chinese government - who mostly represent big business - choose Hong Kong's chief executive.

Resistance to the second five-year term of Hong Kong's incompetent and sycophantic chief executive creates a grave dilemma for China's communist rulers. Before July's protests, they had hoped that Hong Kong would provide such a good example of "one country, two systems" that Taiwan would be lured into accepting the sovereignty of the government in Beijing.

But now Taiwan's leaders point to Hong Kong as a failed model of a flawed concept.

Indeed, Mr Tung Chee-hwa's anticipatory subservience to the real or imagined wishes of China's rulers exposed the congenital flaw in the political architecture of uniting a liberal society with a dictatorship. That flaw infects the heart of the "one country, two systems" notion: the idea that genuine autonomy can exist in a country whose supreme leaders do not believe in rule by consent.

Now China's communist rulers find themselves in a bind. If they back Mr Tung unconditionally for the rest of his term, they can look forward to the collapse of their long-term strategy to reabsorb Taiwan, for the alternative to peaceful reunification is coercion. But this increases the likelihood of military confrontation with the US, Taiwan's protector.

In this context, the steady build-up of China's short- to medium-range missile capability is a cause for alarm. Such a nightmare scenario isn't at all likely in Hong Kong, but a steady rot of Hong Kong's vitality is. For if the frustrations of ordinary Hong Kong citizens are allowed to fester without a genuine commitment by China to allow for universal suffrage by 2007, a far more serious eruption of social and political unrest beckons.

Such frustrations are growing. Unemployment now stands at almost 9 per cent - unimaginable before the handover in 1997, when both Mr Tung and China promised that Hong Kong would do even better under Chinese sovereignty than British rule. China's leaders and their handpicked servants in Hong Kong may still believe that Mr Tung's popularity will improve if and when the economy does. So they comfort themselves with the thought that demands for democratisation reflect Hong Kong's economic woes, nothing more.

But six years of divisive and dismissively haughty misrule by Mr Tung's administration, which pits one group against another as its preferred method of governance, suggest that Hong Kong's problems are much deeper.

It is now an acrimoniously divided society harking back to the days when Chinese communists routinely classified their own citizens as either "the people" or "enemies of the state".

Most of Hong Kong's people now recognise that their stagnating economy is not merely a matter of bad policy. It also results from deeply flawed political structures. In an oligarchic economy such as Hong Kong's, the costs of stagnation and the fruits of growth are distributed in grossly unfair ways. This cynical structure must be changed if people are to have enough confidence in the future for the economy to recover.

If China's rulers heed the wishes of Hong Kong's seven million people to have the right to elect their own leaders through direct elections, however, they face the prospect that China's 1.3 billion people will demand the same right. Perhaps so. But a political system is only ever truly put at risk when leaders consistently misrule.

Indeed, democracies are so stable because they allow misrule to be ended through regularly scheduled elections. Because stability is their great goal, China's communist rulers, if they are wise, will allow Hong Kong to show the way to a system in which Chinese govern themselves democratically, peacefully and prosperously.

Taiwan has already done so. Hong Kong, linked physically to the mainland, provides a more intimate case study for China's people to watch and one day follow.

But if the goal is merely for the communists to retain their monopoly on power in both Hong Kong and China, then the rot that has settled into Hong Kong's polity and its economy may begin to infect the mainland. At that point, China might wish it had never heard of Tung Chee-hwa. Indeed, it might wish it had never secured Hong Kong's return.

Sin-ming Shaw was formerly a leading Hong Kong investment fund manager. He is now a resident scholar at Oriel College, Oxford University.

Last month's massive demonstrations in Hong Kong, when over half a million residents poured into the streets in protest against the government of Chief Executive Tung Chee-hwa, continues to echo. Never in Hong Kong's history has popular opposition--uniting investment bankers, street hawkers, off-duty civil servants, and artists, among others--been so loud. China's communist rulers are dithering about how to respond.
One objective of the demonstrators was to voice their desire to select Hong Kong's future leaders through universal suffrage. Today, 800 electors handpicked by the mainland Chinese government -- who mostly represent big business -- choose Hong Kong's Chief Executive.
The unpopularity of Hong Kong's incompetent and sycophantic Chief Executive, chosen by China for a second five-year term that will only end in 2007, creates a grave dilemma for the country's communist rulers. Before July's protests, they hoped that Hong Kong would provide so attractive an example of the idea of ``One Country, Two Systems'' that Taiwan would be lured into accepting the sovereignty of the government in Beijing. Now Taiwan's leaders point to Hong Kong as a failed model of a flawed concept.
Indeed, Mr Tung's anticipatory subservience to the real or imagined wishes of China's rulers exposed the congenital flaw in the political architecture of uniting a liberal society with a dictatorship. That flaw infects the heart of the ``One Country, Two Systems'' notion: the idea that genuine autonomy can exist in a country whose supreme leaders do not believe in rule by consent.
Now China's communist rulers find themselves trapped in a bind. If they back Tung unconditionally for the rest of his term, they can look forward to the collapse of their long-term strategy to re-absorb Taiwan, for the alternative to peaceful reunification with Taiwan is coercion.
But any resort to coercion increases the likelihood of military confrontation with the US, Taiwan's protector. In this context, the steady build-up of China's short- to medium-range missile capability is a cause for alarm, such missiles being the principle threat against Taiwan. As the US Defense Department's ``Annual Report on the Military Power of the People's Republic of China'' recently put it, ``The primary driving force for China's military modernization is Beijing's perceived need to prepare credible military options in any potential conflict in the Taiwan Strait.''
Such a nightmare scenario isn't at all likely in Hong Kong, but a steady rot of Hong Kong's vitality is. For if the frustrations of ordinary Hong Kong citizens are allowed to fester without a genuine commitment by China to allow for universal suffrage by 2007, a far more serious eruption of social and political unrest beckons.
Such frustrations are growing. Unemployment now stands at 9%--unimaginable before the handover in 1997, when both Tung and China promised that Hong Kong would do even better under Chinese sovereignty than under British rule. In fact, many observers believe that Hong Kong's real rate of joblessness is much higher, and fear that the trend is not encouraging.
China's leaders, and their handpicked servants in Hong Kong may still believe that Tung's popularity will revive if and when the economy does. So they comfort themselves with the thought that demands for democratization reflect Hong Kong's economic woes, nothing more.
But six years of divisive as well as dismissively haughty misrule by Tung's administration, which pits one group against another as its preferred method of governance, suggest that Hong Kong's problems are much deeper. Hong Kong is now an acrimoniously divided society harking back to the days when Chinese communists routinely classified their own citizens as either ``the people'' or ``enemies of the state.''
Most of Hong Kong's people now recognize that their stagnating economy is not merely a matter of bad policy. It also results from deeply flawed political structures. In an oligarchic economy such of that of today's Hong Kong, the costs of stagnation and the fruits of growth are distributed in grossly unfair ways. This cynical structure must be changed if people are to have enough confidence in the future for the economy to recover.
If China's rulers heed the wishes of Hong Kong's seven million people to have the right to elect their own leaders through direct elections, however, they face the prospect that China's 1.3 billion people will demand the same right. Perhaps so. But a political system is only ever truly put at risk when leaders consistently misrule.
Indeed, democracies are so stable because they allow misrule to be ended through regularly scheduled elections. Because stability is their great goal, China's communist rulers, if they are wise, will allow Hong Kong to show the way to a system in which Chinese govern themselves democratically, peacefully, and prosperously. Taiwan has already done so. Hong Kong, linked physically to the mainland, provides a more intimate case study for China's people to watch and one day follow.
But if the goal is merely for the communists to retain their monopoly on power, in both Hong Kong and China, then the rot that has settled into Hong Kong's polity and its economy may begin to infect the mainland. At that point, China might wish it had never heard of Tung Chee-hwa. Indeed, it might wish it had never secured Hong Kong's return.
Sin-ming Shaw was formerly a leading Hong Kong investment fund manager. He is now a resident scholar at Oriel College, Oxford University.
Copyright: Project Syndicate, August 2003.

JAKE VAN DER KAMP, in his Monitor column on Wednesday, produced a graph showing GDP per capita and nominal wage per capita relative to the mainland. It claimed to prove Hong Kong is 20 to 50 times more productive than China. Jake is missing the point. Hong Kong is, of course, more productive, but certainly not by such a large amount.

Second, what counts, as he should know, is the change "at the margin". The speed at which productivity is increasing in China relative to Hong Kong is the relevant factor. That narrowing gap is relevant to Hong Kong's deflation. Indeed, to the world's deflation.

Third, one should not use nominal figures that incorporate the distortion of inflation. Fourth, using overall economic figures comparing Hong Kong and China - which has a huge rural and inefficient state sector - is comparing the proverbial apples and oranges.

The process of "arbitraging" between Hong Kong and the mainland does not mean prices in Hong Kong will hit mainland levels. It simply means the relevant prices will eventually meet somewhere in between.

If Goldman Sachs can find a graduate from Peking University who can do as good a job, if not better, at a lower wage than a graduate from Hong Kong University, the Peking University graduate will get the job. Over time, wages of newly graduated workers in the two cities will converge. One will go down, the other up - in real terms.

The argument is, in fact, broader. As China becomes more integrated into the world economy, the arbitraging process is between China and the rest of the world. It also means Hong Kong cannot live happily in the erroneous view that its real estate is non-traded, hence ignoring world price levels.

That argument, albeit in a different guise, was advanced to me by an SAR minister, who defended the off-the-chart public servant salaries in Hong Kong. "Why should we compare ourselves with what an American or a German minister gets?" he asked. We should, because public sector salary levels work into the entire price structure of the economy. Of course, the minister's wage bill is also contributing to the potential fiscal insolvency of the government.

Why is real per capita income in Hong Kong higher than Taiwan, which in turn is so much higher than that of mainland China? Are the Chinese on the mainland born inherently less intelligent, less productive than the Chinese in Hong Kong or in Taiwan? Last time I checked, they all shared similar cultural and racial DNA. The income disparity is due almost completely to different economic systems producing disparate incentives, or the lack of them.

The descendants of Adam Smith that took laissez-faire as the bible, so to speak, ran Hong Kong for the past 150 years. Taiwan is run historically by confucian bureaucrats who thought they could "proactively enable markets".  China is still trying to shed its central planning apparatus that sought to replace market forces with a handful of planners making investment and consumption decisions on behalf of 1.3 billion individuals. If all three societies had exactly the same economic system, all the residents would enjoy roughly the same per capita income.

It follows that as China sheds more of its institutional shackles, the economy will expand. We have had convincing evidence of that.

Due to decades of economic mismanagement, the overall productivity of the mainland economy is understandably below that of Taiwan and Hong Kong.

But one should be comparing Hong Kong with similar urban cities such as Shanghai or Guangzhou, using real gross domestic product figures.

Jake's statistics fly in the face of common sense, not to mention reality. He should ask Johnson Electric management whether its mainland engineers or factory workers are 20 times less productive.

Of course, Hong Kong remains more productive in certain activities. That is not the point. If it were not, the SAR's per capita real income would already be the same as that in Taiwan and the mainland.

Let us try a different question that should help educate the pro-peg fundamentalists. Hong Kong's per capita income at the current exchange rate is roughly the same as America's. If productivity drives income, one could legitimately ask whether Hong Kong society is as productive as the US. Is Hong Kong's intellectual community as creative as its counterparts in the US or elsewhere?

It should, in fact, be greater, as academic wages in Hong Kong are much higher than those of scientists at institutions that have helped shape the world as we know it. What has Hong Kong done to reshape the world?

Is Hong Kong's business community as innovative as America's? What are Hong Kong's best companies and how do they stack up against US ones?

Hutchison, Johnson Electric and Cathay Pacific are excellent companies. But even there, the intellectual content of what these companies do is far below what we would consider cutting edge. These companies are still run on hand-me-down knowledge imported from elsewhere.

Even in the SAR's much-vaunted financial sector, which are the best companies? All are imported, together with the imbedded know-how. So, the question remains. Should Hong Kong enjoy the same per capita income at the current exchange rate?

The forces of arbitrage, sometimes known as "factor price equalisation", are, in fact, already providing the answer. Wages and other prices in Hong Kong are too high and they are being forced to converge, not merely relative to mainland China, but also the rest of the world in comparable sectors. One moves up, the other moves down - meeting in between. That is the logic of markets. Globalisation is speeding up that process. It seems too many in Hong Kong are still in self-denial. There are no free lunches.

Sin-ming Shaw teaches at the American University of Paris

IT IS OFFICIAL. Chief Executive Tung Chee-hwa and Financial Secretary Antony Leung Kam-chung have both said the government will do "something" to support the property market to reduce deflation in Hong Kong. Mr Tung even promised to push the market "up a bit".

If higher property prices mean a better Hong Kong, all the government has to do is announce that for the next 10 years it will sell no land by auction or by private treaty, build no subsidised flats, and reinstitute a height limit on buildings on the Kowloon peninsula. There can be no doubt prices will go up and property stocks will rebound sharply. The only uncertainty is by how much.

But then what? How long will these prices remain high? Will the economy recover? Hong Kong is in deflation for two principal reasons. First, the world is finding the mainland an increasingly profitable alternative.

In technical terms preferred by Morgan Stanley economist Andy Xie Guozhong, investors are arbitraging between Hong Kong and China, especially Guangdong.

If two areas are producing the same goods or services, the prices, over time, should be the same in both societies save for transaction costs (transport, exchange risks) or country risks (legal, political, social and the like). There are fewer and fewer such barriers separating Hong Kong and Guangdong, except in the financial business. Hong Kong has a convertible currency and a financial infrastructure that is part of global finance. China does not - at least not officially.

Much of anything else Hong Kong can do - logistics, tourism, even education - Guangdong, Shanghai or Beijing can do as well. In arbitrage, the end result is straightforward: prices (including wages) in these two separate economic domains will converge. This means Hong Kong prices have some way to fall.

The Hong Kong dollar is over-valued. As long as the nominal rate of 7.8 to the US dollar remains unchanged, then the real rate of exchange must adjust. The adjustment process is better known as deflation. The decline of the property market is just one manifestation of that process.

Pro-peg diehards argue real estate is a "non-traded" good and hence irrelevant to the over-valuation calculus. It is true the Robinson Road flat cannot be moved to Shenzhen or Shanghai, but the "services" that flat provides can be relocated. The most important service a flat provides, other than shelter, is proximity to gainful employment and future income prospects. If a flat in Shanghai costs a small fraction of one in Hong Kong, and if the occupant can do a similar job up north, then there is no point in keeping that person in Hong Kong. The immovable flat is, indeed, irrelevant to the argument about non-traded goods.

Hence the demand for Hong Kong real estate falls relative to its competition. Today it may be Shanghai, tomorrow it could be somewhere else. Human capital, like financial capital, is highly mobile. As the world moves away from a hardware-centred world to one dominated by software, or brain power, it is increasingly important to look at the content of services provided instead of focusing on real estate that seems non-traded but in fact has substitutions.

Contrary to popular perception, the fixed nominal rate of 7.8 has brought only superficial stability. Hong Kong's core growth has declined over the past 20 years to a low single digit while bringing huge swings in the property market. A flexible exchange rate would not have resulted in years of negative real rates of interest and would have choked off speculative capital inflow into the property market because the nominal exchange rate would have appreciated.

Now Hong Kong has an over-valued exchange rate that is fixed, and that demands deflation as a price for its nominal stability.

The second reason for declining property prices has to do with the nature of bubbles. Just about every bubble in the history of bubbles declined by at least 80 per cent from its peak. The most recent exhibit is PCCW. Its share price on Friday of HK$1.14 is down by more than 96 per cent from its high. That is not totally abnormal in historical context.

The ever-changing official SAR attitude about land prices reflects a fundamental misconception about what makes an economy grow, as well as the government's own role in that process. Growth means profits, reinvestments, jobs and the confidence that job prospects are secure. Sound growth comes from businesses making a profit by doing things on a recurrent basis, by reinvesting, creating jobs, but not by trading assets which are considered non-recurrent.

Boosting property prices by administrative measures can only have a short-term, one-off impact, without a lasting consequence on economic activities. Hong Kong should have learned by now the bitter lesson of asset inflation mis-labelled as growth. Growth in Hong Kong has to come from productivity. Productivity has to do with what you can create in goods or services at a competitive price. Globalisation means competitors who have a winning idea can eat your next lunch at a speed unimaginable only 10 years ago. For Hong Kong, there is a competitor an hour away and whose currency, the yuan, is grossly undervalued against the Hong Kong dollar, and hence, against the US dollar.

That under-valuation is the principal reason for its phenomenal export growth. The export growth in hard goods has translated into re-export margins, read profits, for Hong Kong manufacturers and investors who have wisely poured their overvalued Hong Kong money into undervalued yuan assets. For the past two decades or so, Hong Kong has been living off the returns on investments in China. The Hong Kong government can try once again to fiddle with its land policy to support the market. Unfortunately this government will not be able to change the deflationary forces demanded by a fixed nominal exchange rate that is overvalued. The best thing it can do is to institute a clear, transparent, rules-based, land supply policy, the way the US Federal Reserve Bank prints money.

It should announce a quantitative target and then live within the allowable margins of error. That target could be 50 hectares, zero or 200 hectares a year. But announce it and then get out of the real-estate business totally. There are no free lunches. If you want a stable nominal exchange rate, you can have it. The price of that is that prices of the entire economy will fluctuate up and down as they have done in Hong Kong.

The more overvalued it is, the more domestic prices need to fall. Further, the more efficient China becomes, the more its nominal exchange rate, now fixed, becomes undervalued, which will prolong Hong Kong's deflation.

While the economics strongly favours a much lower Hong Kong dollar, the institutional prerequisites do not exist to support a change.

Hong Kong has a credibility problem in its economic management and it lacks a properly staffed potential central bank - both necessary for a successful regime change.

Property prices in Hong Kong are down 60-65 per cent from their peak. If an 80-85 per cent decline is what defines a bubble bursting, then another 30-40 per cent decline from today's level should not be considered extraordinary. You may not like it, but that's the way the world works.

The government can stop that decline by a zero-growth land policy. The price of that policy would be to drive Hong Kong further down the path taken by Japan. There are no free lunches in this world.

The government leaders should be honest with its citizens about the dilemma and not promise more than they can deliver.

Sin-ming Shaw is a visiting fellow at St Antony's College, Oxford University

Byline: While it may not be on the brink of financial meltdown, Sin-ming Shaw writes that there are parallels between Argentina and Hong Kong

IS HONG KONG the "next Argentina"? Don't dismiss the comparison so readily.

The perception of Argentina is that it is a laid-back Latin country, mismanaged by leaders better at tango or drug-trafficking than public governance.

Before the peso collapsed last year, the country supposedly was heavily in debt, had a weak banking system and a public sector that was a bottomless pit. Further, the yawning gap between the rich and the poor was a social disaster waiting to happen. And it did.

According to conventional wisdom, Hong Kong cannot possibly become another Argentina. The SAR has a workaholic labour force, a strong banking system, abundant reserves and a public sector surely smaller than any of the Latin countries. It has no foreign debt to service. The people, imbued with Confucian values, respect authority and shun disorder.

Look closer. Argentina and Hong Kong have both relied on currency boards to regulate their exchange rates. The Argentine peso was fixed at one to the US dollar for nearly a decade, the Hong Kong dollar for nearly two decades at 7.8 to the greenback.

In 1998, the International Monetary Fund (IMF) praised Argentina for its prudent financial management and its currency board. In May of this year, the IMF gave Hong Kong a clean bill of heath, upholding the linked exchange rate system as ideal for the territory.

In 1998, the World Bank gave Argentina and Hong Kong the same score of 21 in terms of how well banks were regulated among a list of 11 potential problem countries. Indonesia, the worst, scored a 51. Singapore, the best, got a rating of 16. In terms of capital adequacy, Argentina and Singapore were rated 1, Hong Kong got a 3. Smaller numbers indicated a higher performance in the rating.

The public sector in Argentina in 2000 consumed about 24 per cent of gross domestic product (GDP), roughly the same as Hong Kong today. The SAR budget deficit is running at 5.5 per cent of GDP, against only 2.5 per cent for Argentina in 1997-98, and 3.6 per cent in 2000. Public-sector employment here is about 10 per cent of the labour force, against 12.5 per cent in Argentina.

Debt? In Argentina, domestic debt was 41 per cent of GDP in 1998, well below the 60 per cent ceiling imposed by the Maastricht Treaty on countries of the European Union. Total foreign debt was 51 per cent of GDP in 2000, better than several European Union countries. The IMF was clearly not worried in 1998. Malaysia's external debt was over 60 per cent. Hong Kong has no public debt, but external private debt is 220 per cent of GDP.

Anne Krueger, deputy managing director of the IMF, speaking with 20/20 hindsight in July this year, observed that there were essentially two factors that broke Argentina -  an overvalued peso, now above 3.6 to the US dollar, and an increasingly weak fiscal policy. That being so, then Hong Kong should be on red alert for it also faces these two problems.

Recent figures confirm SAR deficits are between $60 to $70 billion a year. At this rate, official reserves will evaporate in five years. If the deficit continues at this level for another year, it will convince financial markets that a currency crisis is a matter of when, not if.

Raising taxes to balance the budget now or later in a deflating economy would further depress demand and stifle growth. There is only one way out. The government must drastically cut its deficits.

The SAR pays 70 per cent of its budget in salaries. The over-paid civil service has agreed only to a two per cent cut after 30,000 officials took to the streets. The chief executive, lacking a mandate from universal suffrage, seems swayed easily by street politics.

Ministers can get $4 million a year. Some at such institutions as the Hong Kong Monetary Authority (HKMA) make more than $8 million. Shouldn't the wages of these public servants be cut more than the rank and file? Besides, the top 3.7 per cent of the civil service - fewer than 4,000 officers - receives 21 per cent of all salary outlays. The top 13.5 per cent get 52 per cent of outlays. The bottom 67 per cent receives a mere 8.2 per cent of the total.

An across-the-board cut is neither fair nor effective. The public pays local academics, part of the public sector, a 40 per cent premium over the top US payer, Harvard University. Are we that good?

Backed by huge reserves, the Hong Kong dollar is supposedly impregnable. However, it is, by most estimates, roughly 40 per cent overvalued against the US dollar and twice that against the yuan, prolonging deflation.

The 7.8 peg against the US dollar will stay only as long as holders of Hong Kong dollars remain confident the rate will not change. If enough lose conviction and wish to convert to other currencies, they will drive interest rates to a level that no society could tolerate without unrest. In Argentina, the end game began when its citizens lost confidence in the currency.

Would floating the currency now be a viable option, even if the chief executive were to go back on his commitment to the 7.8 peg for five more years? No. Hong Kong lacks a proper central bank. Without it, a float could be disastrous.

The HKMA is not a central bank but a bank regulator with central bank ambitions. No senior staff have the appropriate education or the experience to conduct monetary policy.

The late Merton Miller, Nobel laureate in economics, said at a Legislative Council hearing in November 1998: "Joseph Yam [head of the HKMA] and I have somewhat different educational and professional backgrounds, and sometimes it turns out when we are discussing matters, he's talking about one thing and I'm talking about something else, even though the words are sometimes essentially the same."

The HKMA must be re-staffed before a float can even be contemplated.

The gap between the rich and the poor in Hong Kong is widening.

The Gini coefficient, a measure of income distribution, for Hong Kong stands at 0.53. In 1996 it was 0.476. The benchmark ratio of one means that one person gets all the income, the rest nothing. A zero means even distribution. Argentina's Gini coefficient was 0.49 in 1999, the same as the Philippines. China is at 0.42.

Hong Kong is under social stress. Polls show low and declining respect for top government leaders and for all political parties.

A month ago more than 500 triad members flaunted their presence in a prime tourist district in broad daylight.

Several months ago, the police chief openly challenged action by the head of the Independent Commission Against Corruption against a senior police officer. The row raged for more than a week, even after the chief executive reportedly had ordered the policeman to pipe down.

Hong Kong is not quite Argentina yet, but there are disturbing signs. Let's hope the world will not have to cry for Hong Kong one day.

Sin-ming Shaw, former chief international economist of The Capital Group and head of its office in Hong Kong, is a visiting scholar at St. Antony's College, Oxford University

ONLY TWO WEEKS into their job, some of the policy signals the cabinet has sent out are alarming.

The new Secretary for Commerce, Industry and Technology, Henry Tang Ying-yen, is considering investing public money in small and medium-sized enterprises to boost the economy.

All he needs to do is to call Premier Zhu Rongji and hear from China's top manager how much public money the country has wasted on businesses best left to risk-taking entrepreneurs.

Once a firm has public money involved, can the Hong Kong government allow it to go under if the investment does not pan out? How many demonstrations can Mr Tang ignore by laid-off workers if projects were allowed to go under?

Granted, not all government projects lose money. Those that do not are typically monopolies such as those for tobacco or alcohol. Not all public monopolies can make money, either; airlines are an example.

Small and medium-sized firms are by definition firms that have a lower barrier to entry - unless they have a unique intellectual property. If a company developed an operating system that could make Windows XP eat dust, it would certainly be a profitable project. If so, the company would have to fight off investors around the world trying to throw money at it.

Someone should give Mr Tang a quick tutorial on investments. The world is not short of money, only ideas. Bad ideas need government equity; good ones do not.

It is puzzling that the scion of a textile fortune, all made on private initiatives over two previous generations, wants to spend taxpayers' money playing venture capitalist. On second thoughts, maybe it is not so surprising.

Mr Tang has inherited money. But someone should remind him that it is taxpayers' money he wants to play with, not money from his family or friends.

Public investments have long had a disreputable record, and not just in China. The world is littered with money-losing public projects begun with the best of intentions.

The Europeans did not want commercial aviation dominated by Boeing. So they built the Airbus. The engineering is excellent. Even the Americans buy them. But Airbus still lives off taxpayer subsidies as it cannot turn a profit.

Once government assumes the role of investing money to make more, the supply of bad ideas usually is endless. Each of them can be counted on having at least one impeccable social objective such as providing employment.

As secretary of industry, commerce and technology, Mr Tang does have a useful role to play. If his contacts in Beijing are really as good as many presume, he should use them to help Hong Kong-owned firms in southern China get proper legal protection from corrupt official squeezers who have become a routine fact of life.

If he did just that and did it well, he would be a hero to Hong Kong's true wealth creators. Mr Tang should also organise more encounters between university engineering departments and local manufacturers to transfer know-how to the factory floor.

Hong Kong's true strengths are in medium-tech manufacturing. The prime exhibit is Johnson Electric. It is a world-class company with a near monopoly in supplying micro-motors to the best luxury vehicles in the world.

Johnson Electric is essentially a 19th century mechanical engineering firm updated with modern precision technology that has very little to do with "hi-tech". It became successful without any public handout. Nor has any successful Hong Kong commercial or industrial firm received any government subsidy.

Financial Secretary Antony Leung Kam-chung wants to raise taxes next year. He is worried about fiscal deficits that just refuse to go away. Since he cannot get the public servants to cut their wages voluntarily, he feels part of the solution is to increase taxes. But he is wrong to do so because he has not exhausted his options.

Rank-and-file civil servants are not going to take serious pay cuts lying down when senior public servants such as Hong Kong Monetary Authority chief executive Joseph Yam Chi-kwong, his deputies and those at other public service bodies make twice as much as Chief Executive Tung Chee-hwa.

If Mr Leung were to cut by at least 50 per cent the wages of the multi-millionaire public servants, then he could look the civil service in the eye.

Salaries at other subvented or semi-public institutions are equally appalling.

The combined salaries of the Hong Kong Stock Exchange and the Securities and Futures Commission last year were $841 million - about 10 per cent of the incomes received by every broker in the world trading through our stock exchange.

If the best ideas this cabinet can come up with consist of throwing public money at smaller enterprises or increasing taxes, then perhaps one cannot expect too much from Hong Kong's "first and best team".

Sin-ming Shaw is a writer and private investor

China has been celebrating the five year anniversary of Hong Kong's return to the motherland from British rule. Firecrackers, dragon dancers, and President Jiang Zemin's visit marked the festivities. Now that China's rulers have returned to Beijing, it is time to take a more realistic look at what those five years have wrought.

Hong Kong's ruling elite delights in telling foreign visitors how wrong pessimistic predictions of the territory's have proven to be. Fortune, for example, once entitled a cover story "The Death of Hong Kong." That article forecast heavy-handed meddling by Beijing in local affairs, which would allegedly emasculate the vitality of Hong Kong's economy. The article was wrong, because Hong Kong's deepest wounds have not come from China's ruler, but are self-inflicted.

Tung Chee Hwa, Hong Kong's leader, insists that the "one country, two systems" scheme devised by Deng Xiaoping works perfectly. The Financial Secretary, Anthony Leung, last year boasted that Hong Kong would become Asia's "Manhattan Plus." Chief Secretary Sir Donal Tsang calls negative assessments of the territory the product of second-rate minds.

But official bravura has little sympathy beyond this narrow circle. Among Hong Kong's public, there is a pervasive feeling that it has changed for the worse since 1997 -- not as a result of overweening interference from Beijing, but due to worrisome decisions made by local rulers.

Mr. Tung, the scion of a shipping empire, and his tycoon friends like to blame Britain's colonial government for leaving behind "time bombs" that make Hong Kong look bad. In 1998, for example, the government led a chorus blaming the British for the property price bubble that was punctured by Asia's financial crisis of 1997, causing the stock market to fall sharply. But the bubble was really manufactured by China's communist rulers over a decade earlier on the advice of local property magnates, who wanted to limit the amount of land British colonials were permitted to sell.

Local officials soon began to broaden their attack. In 1999, the government sought and received the Beijing government's direct intervention to overturn a decision by Hong Kong's Court of Final Appeals on an immigration issue because the verdict did not please the government. Humbled and humiliated, the Court has acted timidly since. Locals now call it the "Court of Semi-Final Appeals."

In 2000, one of Mr. Tung's political aides called on the president of the prestigious University of Hong Kong to express concern over a faculty member's opinion polls, which consistently recorded Mr. Tung's declining popularity. Soon after the meeting, senior university officials warned the pollster that further funding for his work might not be forthcoming.

Robert Kuok, the Malaysian owner of Hong Kong's major English language newspaper, the South China Morning Post , is one of Mr. Tung's friends and fiercely loyal to China's leaders. In 2001, the journalist Willy Lam, a respected China expert, was sacked from the paper after Mr Kuok publicly berated him for his views on China's rulers.

President Jiang and China's rulers have had very little, if anything, to do with any of these decisions. They were taken because Mr. Tung and his allies wish to demonstrate how in tune they are with official thinking on the mainland. But are they in tune?

The presumption that China wants Hong Kong to become more like the mainland is ludicrous. China has had entirely too much of the "one country." What it wants now is the "two systems." China's search for an alternative social and economic arrangement became urgent with the student revolt of 1989, the subsequent Tienanmien massacre, and the collapse of the Soviet Bloc. The Chinese communist party knew it had a legitimacy problem, and the driving idea behind Deng's ingenuous formula was to allow Hong Kong to show China a short cut to prosperity.

True, China's ruling elite remains a Leninist party prepared to crush all potential threats to its monopoly of power. Yet many officials working directly under the party leaders are earnestly scrutinizing western countries for institutional details that might shed light on what China can do for itself in the future. In other words, China is looking for a new system to replace the existing one.

Mr. Tung, whose moral precepts are informed by a doctrinaire interpretation of Confucian classics emphasizing obedience to one's superiors, seems oblivious to what China views as the fundamental challenge that it now faces. Instead, his behavior is reminiscent of a feudal district official whose main priority is to ensure that his superiors are treated with due reverence.

Nor is Mr. Tung alone. Much of Hong Kong's elite shares the same mindset, despite their training in Western business schools and their fortunes gained from property trading. Their priority is to nurture a cozy relationship with Chinese officialdom -- much of which can be easily bought. Whether Hong Kong remains an open, liberal society has never been a major issue for them.

One senior Chinese cadre doing graduate work at Harvard recently uttered in amazement that Hong Kong, with its leaders acquiescing dutifully in every inane utterance by China's rulers, struck him as more "leftist" than the mainland. Indeed, many Chinese officials privately laugh at Mr. Tung and his cronies sycophantic behavior and are increasingly confident that the mainland has nothing to learn from Hong Kong's example. What China regards as Hong Kong's comedy of deference is quickly becoming a tragedy of errors for Hong Kong's citizens.
Sin-ming Shaw is a leading investor in Hong Kong.
Copyright: Project Syndicate, July 2002

Hong Kong's leaders must learn to put the territory's interests before their own
Last week marked an important milestone for hong Kong. For the first time, the territory's governing Cabinet has been appointed directly by the Chief Executive, Tung Chee-hwa, instead of being drawn solely from the career civil service. The Cabinet's 14 members include eminent academics, market-savvy operators and political leaders, one of whom heads the local proxy of the Chinese Communist Party. In his second term, Tung won't be able to blame his failings on not having his own team. In fact, his new lieutenants can help Tung improve on his somewhat sullied legacy.

Hong Kong's problems can be tackled if there is the political will. There are many vexing issues—new laws against subversion could be abused, a tamer press seems less inclined to play watchdog—but Hong Kong marks its fifth anniversary under Chinese rule facing really just two major woes: economic stagnation and a deep, communal sense of disenfranchisement.

Hong Kongers view their leaders either as stooges of Beijing or of property tycoons with vested interests in every important business in town. Government in Hong Kong is decidedly nonparticipatory. If locals are looking toward a greater say in their affairs in future, they can forget it: Chinese Vice Premier Qian Qichen last week made it clear that full democracy is not an option for the territory. Hong Kong's pragmatic and stoic citizens could tolerate all that if they were assured that the plutocrats were repairing the ailing economy. Unemployment has risen to European levels. Growth is anemic. Public deficits are on the up. The Financial Secretary once let slip that Hong Kong could become another Argentina. Scary but true.
Beijing's aging leaders talk tough, but China's younger generation wants the country to become as open, rich and cosmopolitan as Hong Kong.
Tung's new ministers are no fools. Admittedly, not all are the best and the brightest, but the economic team has a long and credible record in the financial and industrial communities. Its members appreciate that pro-growth policies must be implemented even if it means hurting the interests of powerful cartels run by billionaires who have, in some cases, helped make the careers of several of Tung's appointees. Part of the problem has been that those same vested interests, with government collusion, have kept the territory's cost structure too high relative to its productivity and its competition, especially China. Real-estate prices in Shanghai are a quarter of those in Hong Kong. The issue is not whether the territory deserves a "Hong Kong premium," but rather how high that premium should be.

Local developers sit on $60 billion worth of land, enough to meet private housing needs for the next 10 years. These developers are in fact Hong Kong's largest speculative hoarders. Boosting property values may provide temporary relief, but it raises the hurdle of investment returns, deterring business expansions and start-ups. Given that much land is held by a cartel of property companies and not subject to market forces, the government should not allow the developers to dictate when they apply for rezoning or when they build. Initially, lower real-estate prices will arouse ire among homeowners and tycoons, but the alternative—becoming an uncompetitive, overpriced backwater—is even more frightening. Falling prices will quickly stabilize. The last five years of stagnation plainly show that short-term pain is far better than long-term torture. Even those who have complained loudly about "negative equity" in their real-estate portfolios now know better.

Then there's the matter of wages. Fiscal deficits may become permanent as 70% of the government budget goes toward salaries. The head of the Hong Kong Monetary authority makes $1.1 million a year, twice the pay of the Chief Executive and six times that of Alan Greenspan. These multimillionaire public servants defend their pay by using private-sector wages as a benchmark—which is pure avarice. They ought to feel a calling for service rather than lucre. Encouragingly, several new Cabinet members from the private sector have taken a pay cut, some well over 50%. No public servant should make more than the Chief Executive.
The territory also seems overeager to please Beijing. Last week's brief airport detention of U.S. Sinologist Perry Link—rumored to be on the mainland's visa blacklist, presumably because of his consistent forthrightness on the subject of human rights—sends out the wrong signal that Hong Kong is less "two systems," more "one country." True patriots should realize that Beijing's aging leaders talk tough but that China's younger generations want the country to become as open, rich and cosmopolitan as Hong Kong. Hong Kong can serve the motherland better by providing a "best practice" showcase. Aping communist behavior can only shrink the "Hong Kong premium." What Tung and his new team must understand is that China needs Hong Kong to be the dynamic, bustling, free place it has always been, not just another Chinese city. This is Tung's last chance not to blow it.

Sin-ming Shaw, a longtime professional investor in Asia, will be a visiting fellow at Oxford University in the fall