In 1945, after four years of harrowing martial law, Hong Kong was starving and destitute. Britain sent out a team of civil servants to help get the colony back on its feet. One of them was a quiet, determined and deeply principled Scotsman by the name of John James Cowperthwaite.
Cowperthwaite had studied economics at the University of St Andrews and was deeply versed in the ideas of Adam Smith. By 1961 he had risen to the position of financial secretary. “For about 25 years,” says his biographer, Neil Monnery, “he was absolutely central to Hong Kong economic policy.” During that period, Hong Kong experienced one of the most extraordinary periods of economic expansion the world has ever seen.
What made it all possible was the colony’s tax policy.
The civil servants’ first task was to get industry up and running again. The governor announced that Hong Kong was a free port with no tariffs on any goods bar a few commodities, no export subsidies and few import restrictions. Trade grew quickly, as those who fled the war began to return home.
Cowperthwaite would walk the streets, and visit the factories and ports to keep an eye on activity. The more he watched, the more progress he observed – all without the civil service having to do anything. Hong Kong did not need an economic plan, he decided. He was beginning to formulate a theory he would later call ‘positive non-intervention’. His idea was that government intervention in an open economy often does more harm than good. The default position should be not to intervene. ‘Clumsy bureaucratic fingers’ should be kept out of the ‘sensitive mechanism’ of the economy, he said. It is better to rely on the ‘hidden hand’.
Hong Kong’s tax policies were the polar opposite of those pursued by Britain over the same period. Where Britain – and most of the West – had high levels of taxation, government spending, deficit financing, industrial planning and economic intervention, Hong Kong went the other way. Most people – ‘all but the well-to-do’ – paid no income tax at all. Even higher earners only paid 15 per cent. There were no tariffs or duties, no sales taxes or VAT, no taxes on capital gains, on interest or on overseas earnings. But there was a land value tax. The overall tax burden never exceeded 14 per cent of GDP.
Government borrowing was also avoided. “High national debt... is the surest precursor of high taxation,” he said. “I am sceptical of the theory that we have a right, if we could, to pass on our capital burden to future generations... Our predecessors had not passed any significant part of their burden on to us.”
Red tape was reduced to the point that a new company could be registered with just a one-page form, and the tax code itself was kept short and simple. Even today, international tax lawyers regularly deem it the world’s most efficient. At 300 pages and fewer than 150,000 words, it is 1.5 per cent the size of the UK’s.
Hong Kong was no transparent democracy. It was a British colony. In the wrong hands, it could have been easily corrupted. And Cowperthwaite and his fellows were only able to do what they did because of the unique circumstances in which Hong Kong found itself: in need of rebuilding, located far away from societies where Keynesian ideology had taken hold of government policy and not answerable to anyone.
The economic consequences to Britain and Hong Kong of their differing tax policies would be dramatic, though it is hard to put numbers on it, because another of Cowperthwaite’s policies was to avoid compiling statistics. He believed such figures led officials to start fiddling in the economy. “If I let them compute those statistics, they’ll want to use them for planning,” he said.
But we do know this much.
In 1945 Hong Kong was destitute and broken. Many were starving. Yet in the span of little more than a generation, this tiny territory with no significant natural resources to speak of would become the world’s busiest port and an international manufacturing and financial powerhouse. Its population would grow by over ten times.
From little more than a shanty town in the 1950s, housing millions of refugees fleeing war in China, today Hong Kong is a futuristic city state.
We do not have official GDP per capita for the 1940s, of course, but it’s likely that it was below $300, on a par with much of Africa. In 1960, it was $429 (according to the OECD, not Cowperthwaite), compared to $1,380 for the UK and $3,007 for the US.
By 1993 its GDP per capita exceeded that of the UK. By 2010 it overtook the US. Today it ranks among the ten richest nations in the world with a per capita GDP 40 per cent higher than the UK’s.
On the supply side, Hong Kong has the fourth best education system in the world, and it ranks top of Bloomberg’s healthcare index. Its public transport was ranked the world’s best last year, achieving a 99.9 per cent ‘on-time success rate’ with 94 per cent of the population living within one kilometre of a railway station.
Cowperthwaite was adamant that his policies were for the good of all. The interests of those at the very bottom were close to Cowperthwaite’s heart, and a booming economy, he felt, put the government in the best possible position to help them. Lower taxes meant greater profits. Greater profits meant more growth. More growth meant more jobs, better-paid jobs and greater wealth for all. “I am more concerned with the creation of wealth than with its distribution,” he said.
Other Asian nations noticed Hong Kong’s success. Soon after Lee Kuan Yew became the first prime minister of Singapore, in 1959, he adopted the colony’s low-tax, non-interventionist model, with similarly successful results. South Korea and Taiwan, even Japan to an extent, all had their own adaptations of low-tax, high-export models and all enjoyed huge periods of economic growth of their own. China itself would do something similar.
After Chairman Mao’s death in 1976, reformers in China, who had observed the extraordinary growth of Hong Kong and Singapore, thought Cowperthwaite’s model could work on the mainland too. In 1980, Shenzhen was chosen to be a ‘special economic zone’ – light on taxes and regulation. The population then was 30,000. It has grown to nearly 13 million, as more and more people have gone there seeking their fortune. At one stage its growth rate was an astonishing 40 per cent. Today it is another Hong Kong.
China wanted to ‘appropriate capitalism for the good of socialism’, as the National People’s Congress put it in their legislation. “We didn’t pay enough attention to developing the productive forces,” said Deng Xiaoping in his famous 1984 speech, ‘Build Socialism with Chinese Characteristics’. Given what these tiny islands had achieved, what was China capable of? Today China, with its own brand of authoritarian capitalism, is the second-largest economy in the world, in purchasing power parity terms perhaps the biggest.
There is no doubt that Hong Kong was an extraordinary situation in an extraordinary time, but its low taxes and positive non-intervention are where the Asian economic miracle began. Cowperthwaite’s achievement lay not so much in what he did do, but in what he didn’t. “I did very little,” he said with typical humility. “All I did was to try to prevent some of the things that might undo it.”
Dominic Frisby’s book and audiobook Daylight Robbery, How Tax Shaped Our Past And Will Change Our Future, is published by Penguin Business at £20. Out now.