Nobody Knows Anything

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Cowperthwaite.  Sir John Cowperthwaite.

An unlikely guru, to be sure.

But at the end of the week in which the Republican Party lifted caps on discretionary public spending by $300 billion over the next two years, putting the US on what appears to be a path to permanent $1 trillion deficits; in which the era of austerity was said to come to an end; in which the Dow Jones Industrial Average swung wildly and declined sharply for no apparent reason: Cowperthwaite was the authority who came to mind.

It was Cowperthwaite who, along with a small cadre of other civil servants, turned Hong Kong into one of the world’s most prosperous economies over the course of the 70-plus years since the end of World War II – this in the judgment of no less an authority than Milton Friedman, a regular visitor to the British Crown Colony, as it was for most of his lifetime. The story is set out by independent investor Neil Monnery in Architect of Prosperity: Sir John Cowperthwaite and the Making of Hong Kong (London Publishing Partnership, 2017).

No more originally than a handful of islands in the mouth of the Pearl River, Hong Kong today occupies 403 square miles, including Kowloon City in the stub of the New Territories on the edge of mainland China. Great Britain had been there since 1711, when the Qing emperor Kangxi permitted the East India Company to establish a trading post on the main island. For a hundred years, Britain paid for its tea with silver; by the late eighteenth century, the British had invented the opium trade, shipping opium from India to pay for the tea. War with the Qing dynasty eventually followed, and Britain seized Hong Kong in 1841. Twenty years later, gunboats again enlarged the colony, as China tumbled into a terrible civil war. For a hundred years, the British operated the city as a warehouse and distribution center for all manner of goods leaving and arriving in China. The Japanese conquered Hong Kong in 1941.

Cowperthwaite was a Scotsman, a native of Edinburgh, born 1915 and well-schooled in classics at Merchiston Castle School (it had been logarithm inventor John Napier’s home), the University of Saint Andrews, and Christ’s College, Cambridge. World War II broke out and he returned to St. Andrews for another degree, this one in economics, with James Wilkie Nisbit, (1903-74) a Glaswegian exponent of free trade and critic of Keynes. Next he served in the military, stationed in Scotland, at one point guarded the Nazi prisoner Rudolf Hess, then applied for training as a Hong Kong Cadet– two years learning Chinese before entering the elite corps of civil servants that governed the colony. He was accepted in 1941. Cowperthwaite spent the years waiting for the war to end in Sierra Leone and finally arrived in Hong Kong in 1945.

Four years of Japanese occupation had left the city with little more than a good location and a quirky system of government. The colonial governor had extensive power – to create laws and enforce them, to appoint civil servants who would become members of a responsive Legislative Council, and to consult on the appointment of outsiders as well.  The English language, English common law, and British traditions did the rest. Civil servants were expected to behave: Colonial secretary David MacDougall, a war hero, was sent home to his family in England by the governor after he began an affair in Hong Kong.

Cowperthwaite’s first assignment was in the Industry and Supplies department, where he was supposed to somehow get industry back on its feet. The experience in the real world was critical to his later success, Monnery asserts, in the current newsletter of the Royal Economic Society:

One job was to stop the export of rationed or scarce products, for example glass…. [H]e noticed that shortly after the exportation of glass was banned that several dealers were exporting glass bottles that were then recycled abroad. The government banned the export of glass bottles. Then he discovered that dealers were exporting broken bottles, since there was no ban on that. The re-export of broken bottles was quickly prohibited. The following month a new tactic was in use. Glass bottles were filled with colored water, labelled as dye, and exported. ‘Beer bottles filled with other than beer’ were added to the prohibited export list. A few months later, shortly before export controls were lifted, he observed that the new approach was for the export of picture frames with five or six sheets of glass in the frame, which were then dismantled abroad.

Rather than bristling with frustration, Cowperthwaite noted the ingenuity and flexibility shown by manufacturers and traders. He quickly learnt to harness this to create a speedy post-war recovery. And more generally, it would give him a belief that entrepreneurs had an ability to adapt and adjust to market changes much faster than any government could. This was one of the reasons he rejected economic planning and believed in the power of markets.

China went communist; the entrepôt trade declined: Hong Kong could no longer make its way as a huge warehouse.  In 1952, Cowperthwaite became deputy financial secretary; in 1961, financial secretary and chief trade negotiator. He visited shops, markets and factories incognito, annoyed when television finally made his a familiar visage; he welcomed new competitors and avoided capitulating to the desires of those whose industries he had seen grow robust.  The textile industry was an especial success, never mind the strain on relationships with Britain and the United States. By 1961, Monnery writes, “Many thought that his economic approach had run out of road and were proposing heavier government management of industry, centralized economic policy, larger government (financed by higher taxes), loose fiscal policy and a shift away from free trade.” Instead, Cowperthwaite  pursued his old-fashioned policies into the digital era, slow to regulate new industries, cautious about adding governmental services, at least at first mention of them, reluctant to raise taxes to pay for those services, and stubbornly opposed to deficit financing.

A banking crisis in 1961 was instructive.  A real estate boom; a stock market bubble; a run on an overextended bank with little or no deposit insurance was quietly turned aside. New banking regulations were drafted and, in 1964, put into effect.  But Cowperthwaite was slow to learn that banking wasn’t like other industries (as Adam Smith himself had been 180 years before). And in 1965, A much bigger panic depleted much of the government’s surplus and threatened the Hong Kong dollar before it was staunched.  Britain’s evaluation of sterling, and trouble with China, then just starting its Cultural Revolution, deepened the downturn.   This time Cowperthwaite drew the right conclusions; bank regulation was toughened considerably, and the colony began to build up its reserves.  Hong Kong had had no net reserves when Cowperthwaite arrived in 1945; in 1961 they were still only $500 million. Ten years later, when he stepped down, they were $2.5 billion, and by 1997, as China prepared to take back the booming colony, they were $330 billion – “a princely dowry,” in the words of then Governor Chris Patten. Per capita income in Hong Kong was 40 percent greater than in Britain.

But Hong Kong is just an island, right?  No real country could succeed the way it had, could it? In fact the People’s Republic of China pursued a highly similar strategy as it entered global markets after 1978, encouraging foreign investment; entering light and medium industries first, rather than capital-intensive ones; turning agriculture back to its farmers (a sources of explosive growth that tiny Hong Kong never enjoyed); and, piling up enormous reserves as a precautionary measure. Much else has been going on , of course, or not going on, especially in the huge government-owned heavy industries.

It is melancholy to think that perhaps this is simply what up-and-coming nations have always done, on their way to becoming great; and that, once great, nations inevitably fall to bickering within the nation itself, and spend themselves into decline. No sensible person today can doubt that American political leadership is a mess. Indeed, thinking about Washington makes one recall the Oscar-winning screenwriter William Goldman’s line about Hollywood, in Adventures in the Screen Trade:  “Nobody knows anything…. Not one person in the entire motion picture field knows for a certainty what’s going to work. Every time out it’s a guess and, if you’re lucky, an educated one.”

The difference is that movies are a fashion business, whereas economic policy is a matter of remaining on a steady course over decades. In fact, it hasn’t changed much since Adam Smith wrote an admirably terse prescription for it 250 years ago: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.” He might have added, even then that, because nations tend to get financially tangled up in each other’s affairs, it helps to have money in the bank