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Who Would Mortgage Their Children?

The following is an excerpt of the speech by Mr Norman Chan, Chief Executive of the HKMA, at the HKU Digby Memorial Lecture on 10 April 2015.

The movie “1942” was set against the backdrop of the great famine that occurred in the Chinese province of Henan (河南省) and its surrounding areas around 1942, when millions of people fled their homes for food and many parents even sold their children for a tiny sum of money or a bowl of rice.  While this may sound unthinkable in the modern times of relative affluence, many societies are unconsciously mortgaging their future generations, through excessive debts.

During World War II, the nations at war borrowed huge amounts of debts to finance the warfare.  Average government debt reached 200% of GDP.  As the industrial nations embarked on the journeys of post-war reconstruction, government debt shrank to below 30% of GDP in the 1970s while private sector debts grew steadily to around 85% of GDP.  However, during the last three decades, both the private sectors and governments in the developed countries repeatedly borrowed money at a rate much faster than their economic or income growth.  Average debt to GDP ratio of the developed economies increased to about 290% before the eruption of the Global Financial Crisis in 2008.  In the wake of the crisis, government debt levels in the US, Europe and Japan continued to grow by trillions of dollars through quantitative easing.

The rapid growth of public debt in developed economies reflects the lack of fiscal discipline and unrestrained spending behaviour of their governments.  Most European countries have been running budget deficits averaging 3-8% of GDP per year.  In the US, the federal government still persistently registers fiscal deficits, averaging 3.2% of GDP per annum since 1980s.  The governments have to continuously raise additional debt to finance their spending.

After the financial crisis in 2008, developed countries pursued quantitative easing policies to flood the market with liquidity and artificially suppress government bond yields.  Shorter-term government bond yields in some European economies have even turned negative.  Such distortions penalised prudent savers and pensioners very badly through meagre deposit rates and dwindling return from government bonds.

Debts have beneficial effects when put to such good use as investments in productive physical infrastructure or development of human capital.  These investments would bear fruit in the future by raising the productivity and competitiveness of the economy.  However, it is another thing if the government borrows to finance consumption, wasteful investments and excessive welfare.

The crushing debts incurred by the developed countries result from their excessive spending for the last 30 years.  One of the explanations for this behaviour is that many people in the developed world had taken prosperity for granted and regarded good life as their right.  So they kept on consuming and spending beyond their means and thought, rather mistakenly, that sovereign debt crises should be the kind of mishaps that can only occur in developing economies.

Another reason could be attributed to the “collective irresponsibility” syndrome.  When a voter elects politicians who promise continued and unsustainable spending, he is just one of the many voters.  The vote is cast in anonymity and the voters have no direct accountability for how they vote and for the consequences of such voting decisions.  Such mind-set tends to result in populist policies with unsustainable fiscal consequences in the medium to longer run.

It is very hard and immensely painful to try to get out of a government debt crisis.  It is hard because there is no short cut or easy way out.  The only solution to excessive borrowing is deleveraging.  First, the government must implement a credible fiscal consolidation programme to reduce public spending and increase revenues.  Second, the government should, within the reduced budget, strive to allocate resources to infrastructural and other productive investments that could facilitate the return of healthy economic growth in the medium to long term.  Third, the government must pursue structural reforms that would enhance the flexibility and capacity of the labour, product and services markets that would raise the productivity and competitiveness of the economy and its workers.

It is painful because deleveraging could result in economic recession, fall in asset prices, rise in unemployment, and drop in personal, corporate and government income etc. in the short run.  The effects are unpleasant and it is not surprising to see the very strong public pushback in some countries.  After the bursting of the property bubble in 1997 as a result of excessive leveraging, Hong Kong’s GDP shrank by around 9% in just over a year.  Housing prices dropped by 66% during the period between October 1997 and July 2003.  Unemployment rate shot up to 8.5% in June 2003, the highest level since Hong Kong started to compile unemployment statistics.  Prices in Hong Kong, as measured by the Consumer Price Index, went down by a staggering 16%, which was a very sharp fall within a fairly short time span of 5 years.  During this very difficult period, Hong Kong people endured the pain and did not give up.  We undertook many reforms and adjustments that have helped put our economy and financial system in a much stronger position to withstand future shocks and turbulences, such as the Global Financial Crisis in 2008 and the European Sovereign Debt Crisis in 2011.

The Emerging Market Economies, including Hong Kong where household debt to GDP ratio saw a record high, should learn from the mistakes of the developed world and take extra care in not getting into the mind-set or habit of spending beyond our means, whether at the household, corporate or government level.  We should guard against the temptation of “collective irresponsibility” by demanding or condoning public policies that entail spending that cannot be sustained in the medium to longer run.  It requires considerable wisdom of Hong Kong people and the courage and skills of our leaders to resist increasing pressure and temptations for unrestrained public spending, amidst a fast ageing population and structural budget deficits within a decade.

It will be the next generations who have to shoulder the costs and suffer the pains for excessive spending and stock piling of debts by the current generation.  If we don’t want to mortgage the future of our children, we must not pursue policies that would undermine the long-established fiscal prudence and discipline of the Government.  Our generation must seek to protect our children and grandchildren by standing ready to shoulder sacrifices from time to time for the benefit of a better Hong Kong in the future.


Norman Chan
Chief Executive
Hong Kong Monetary Authority

10 April 2015

Last revision date: 10 April 2015
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