Academic journal article Contemporary Economic Policy

Privatization of Public Housing: Did It Cause the 1998 Recession in Hong Kong?

Academic journal article Contemporary Economic Policy

Privatization of Public Housing: Did It Cause the 1998 Recession in Hong Kong?

Article excerpt


Privatization is often believed to be conducive to economic efficiency. Even though this effect is still controversial, any suggestion that privatization could lead to the erosion of wealth and economic inefficiency would seem ludicrous to economists.

This article presents evidence that suggests such a possibility. A privatization scheme, if managed poorly, could lead to counterintuitive results. As shown through the "housing ladder effect," otherwise called the equity effect or the downpayment effect, as described by Stein (1995), Bardhan, Datta, Edelstein, and Kim (2003), and Ortalo-Magne and Rady (2003), privatizing public housing cheaply could lead to the erosion of equity values among homeowners, which could spread throughout the housing market via the housing market quality continuum. The erosion of wealth works dynamically and wipes out any static efficiency gains that could result from the privatization.

Hong Kong's plunge into a major recession in the wake of the Asian Financial Crisis (AFC), which broke out in October 1997, is a mystery. The Hong Kong economy had been known for its legendary resilience. Despite a number of momentous setbacks, which included the Great Proletariat Cultural Revolution that broke out in 1966 and 1967, two major oil crises that plunged most countries of the world into recession during the 1970s, and several episodes of financial and banking crises, in not a single year since 1961 up to 1997 was there recorded negative economic growth (see Table 1). Indeed, the Hang Seng Index plunged from over 1,700 in 1973 to little more than 150 in 1975 without causing an economic decline in any of these years. The banking crises of 1965-1966 "at a point posed a threat to the entire banking system in Hong Kong," (Jao, 1993, p. 242), while those of 1982 to 1986 "were even bigger in scale and produced more far-reaching repercussions" (Jao, op.cit.).

In sharp contrast, the years during and following the Asian Financial Crisis were far less tumultuous. Hong Kong's major trading partners, the United States and Mainland China, continued to grow rapidly during the time, while stock market declines were far milder than what happened from 1973 to 1975. Moreover, not a single bank failed. Yet the Hong Kong economy shrank by over 5% in 1998. This turnout deviated so much from predictions that Jao referred to it as "one of the most bizarre and egregious failures in the history of economic forecasting" (Jao, 2001, p. 140).

Table 1 also shows that the rebound in 1999 was extremely weak, quite unlike the rebounds that had followed earlier recessions.

The dramatic and sudden reversal of economic fortunes in 1998 was also strange. In a matter of a few months, Hong Kong's unemployment zoomed from 2.2% in the last quarter of 1997 to 4.3% in the second quarter of 1998. By the end of 1998, the unemployment rate had reached a high of 6% (see Table 2).

The often-cited explanation for Hong Kong's deep recession, that the AFC burst the property price bubble and thus produced a gigantic negative wealth effect, is simply unconvincing (Jao, 2001, p. 140). The transmission mechanism whereby the AFC burst the property price bubble is not clear. First, although foreign participation in the office building sector was indeed quite significant, foreign participation in the housing market has never been significant. There is no evidence that a big withdrawal of foreign capital from the housing market produced a collapse. Second, although inter-bank interest rates went up in the wake of the currency troubles in Southeast Asia, mortgage rates had been relatively stable. Hong Kong had seen bigger mortgage rate hikes before but had never encountered such serious depression in the housing market. (1) Third, it is not true that confidence collapsed overnight. Indicators suggest that people had regained confidence not long after the Asian Financial Crisis (see Table 3). …

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