19 July 2018
An elderly woman prays at a temple. Estimates put the number of residents over the age of 65 at 33 percent of the population by 2041. Photo: Internet
An elderly woman prays at a temple. Estimates put the number of residents over the age of 65 at 33 percent of the population by 2041. Photo: Internet

Invest now or save for the future?

At first glance, John Tsang’s budget presented on Wednesday did not fit the classical definition of austerity given a raft of policy sweeteners totaling HK$34 billion (US$4.38 billion) that includes tax breaks for workers, fiscal subsidies to develop creative industries as well as financial aid and fee waivers for businesses negatively impacted by last year’s democracy protests.

The specter of future austerity, however, punctuated the financial secretary’s analysis. Although the government registered an estimated fiscal surplus of HK$63.8 billion, this was not the time to lavishly spend, at least not on long-term investments.

Hong Kong will face a long-term structural deficit due to an aging population and shrinking workforce starting in 2018.

There is more than a kernel of truth to this claim. However, the focus on insuring against a future revenue shortfall obfuscates the current costs incurred by not investing in the future, particularly in the face of an aging society.

To be fair, the budget did address issues related to aging.

The government (ultimately) plans to use HK$50 billion set aside from the 2008-2009 budget to subsidize a high-risk insurance pool and individual private insurance to be purchased under the voluntary health scheme.

Funding was increased for the deteriorating public health and clinical delivery infrastructure.

Tsang also ostensibly made a good-faith effort to support pensions by setting aside HK$50 billion in the current budget for the abstract idea while simultaneously excoriating the fiscal chains associated with establishing a “pay as you go” pension system.

Recipients of comprehensive social security assistance, old age allowance and disability payments will receive an additional two months of benefits and funding for work training.

These initiatives, while arguably a step in the right direction, do not address the long-term problems. They are either short-term in nature or do not offer the financing scale and details needed to address the critical long-term issues of the health system, pension, and work reform that will be needed in Hong Kong.

There are two reasons this may be the case.

First is the scale and potential interconnectedness of problem relating to Hong Kong’s aging population.

Estimates put the number of residents over the age of 65 at 33 percent of the population by 2041.

With findings that middle-aged individuals and elderly people living in poverty on average tend to suffer from worse health outcomes and higher levels of unemployment, the unwillingness to invest now could negatively impact government plans to extend the retirement age or promote later-age worker retraining programs.

The second reason is that the strategy to excessively save rather than invest misinterprets the nature of the fiscal challenge.

Many governments, particularly in the west and Japan, are saving for aging-related costs as they face prohibitive contingent pension liabilities and promised health care expenditure that will significantly increase over the next 15-20 years.

Hong Kong, however, is not in this group. It does not have a statutory pay-as-you go pension system with guaranteed payments and healthcare funding comes out of general revenue rather than as a carved-out benefit such as Medicare.

The overall message from the budget is that large-scale saving is the best way to tackle these problems.

Indeed, Tsang’s bold investment thesis can be best summed up in one big idea: “future fund”.

The government estimates that total fiscal reserves will be roughly HK$950 billion in 2019-2020 or 33.5 percent of gross domestic product, the future fund being a substantial portion of this.

Although lacking detail regarding the exact funding mechanism (except for the integration of the current land funds) and its use, the future fund represents the ultimate long bet that current marginal investment in social and health infrastructure will win the day.

Proponents of this strategy claim that even with a minimal 5 percent investment return on the fund, the bet will fund future expenditure; some expect a higher upside: state-managed funds such as Temasek initially posted returns close to 10 percent.

However, these investment returns were largely a function of preferential access to state-owned assets and they were certainly not achieved in a market similar to the current low-interest rate environment.

One potential solution if the government wants to pursue the future fund strategy is to discount investment returns on the future fund with a “social discount rate”.

The social discount rate essentially serves as placeholder to express what the general investment return would be if that money was invested in other projects.

That is, the government could choose to boost budget surpluses now in order to fund future expenditure. However, the public accounting for the future fund should acknowledge the explicit opportunity cost of saving by subtracting a social discount rate of about 4 percent plus inflation.

Although some may argue that this is merely an accounting trick, it would actually bring the government’s fiscal strategy into clearer focus: an arbitrage play.

By choosing to save rather than invest now, the government calculates that future investment returns will exceed the returns possible in current investments.

Overall, Tsang’s budget is defensible given that one of fiscal policy’s main uses is to smooth out cyclical volatility in the business cycle.

But by focusing on short-term rather than long-term problems and attempting to arbitrage the difference through excessive saving, Tsang must acknowledge the long-term financial and social costs of such a strategy.

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Freelance economic analyst

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