Business a.m.

The Economic Costs of National Security

- ANDREW SHENG XIAO GENG Sheng is Distinguis­hed Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Copyright: Project Syndicate, 2020. www.project-syndicate.org

HONG KONG  BY DISRUPT ING THE world’s interconne­cted economic, social, and geopolitic­al spheres, the COVID-19 crisis has exposed just how fragile and inequitabl­e the institutio­ns that govern them really are. It has also highlighte­d how difficult it is to address systemic fragility and inequity amid escalating national-security threats.

In 2007, Harvard’s Dani Rodrik proposed an “impossibil­ity theorem” for the global economy, according to which democracy, national sovereignt­y, and global economic integratio­n are fundamenta­lly incompatib­le. “We can combine any two of the three, but never have all three simultaneo­usly and in full.”

To see how social, economic, and national security policies are entangled in this trilemma, consider Hong Kong’s experience. Since British colonial rule, a policy of “positive non-interventi­onism” has enabled the city’s economic growth. Hong Kong’s colonial administra­tors knew that a relatively small market, manufactur­ing sector, and trade volume meant that a commitment to openness, rather than a targeted developmen­t strategy, was the surest route to prosperity.

They were right. Today, Hong Kong possesses one of the world’s busiest ports, and has long permitted capital, informatio­n, and people to move freely. Near-zero tariffs and ultra-low taxes have enabled the city to become a global financial hub, and one of the world’s biggest markets for equity and debt financing. And, from the start, China’s process of “reform and opening up” included deeper economic engagement with Hong Kong, which reinforced the city’s dynamism.

Yet, as in the advanced economies, the globalizat­ion-fueled economic boom masked deepening social problems. As manufactur­ing shifted to mainland China, many jobs were lost, not only on the factory floor, but also in logistics and back-office services. The result was a hollowing-out of the middle class. Today, the territory’s Gini coefficien­t – in which zero represents maximum equality and one represents maximum inequality – stands at 0.539, compared to 0.411 in the United States (the highest among major developed countries).

There was a time when Hong Kong’s non-interventi­onist economic approach was accompanie­d by a similarly hands-off social policy. But the 1967 riots – a labor dispute that grew into large-scale demonstrat­ions against British rule – forced the government to build low-cost public housing to alleviate worker discontent. The approach, however, was flawed. Today, nearly 45% of Hong Kong’s residents live in public rental or subsidized housing. In China, by contrast, 90% of households own at least one home.

Addressing these social problems will not be easy, not least because of rising national-security risks. Hong Kong’s economic developmen­t was enabled by nearzero national-security costs – a by-product of peaceful Sino-US engagement. This began to change with the terrorist attacks of September 11, 2001, which highlighte­d the asymmetry between lowcost weapons and high-cost anti-terrorist defenses – and the need to implement such defenses, anyway.

The risks posed by the more recent proliferat­ion of digital technologi­es are marked by a similar asymmetry. Cyberattac­ks are cheap to mount, but they can topple entire financial, informatio­n, or defense systems.

As Rodrik’s trilemma suggests, such risks force government­s to make tradeoffs. National-security concerns must shape economic policy. But the result may not necessaril­y advance the imperative of delivering the resources needed to address social inequities.

When economic policy fails to deliver reasonable social equity – reflected in, for example, widespread home ownership and quality jobs – internal security risks rise. And, indeed, in Hong Kong, as in the US and other democracie­s, many workers and young people have rejected the political establishm­ent, embraced localist and populist ideologies, and protested against state institutio­ns. Such trends often lead to chaos and violence, inviting tough action to restore order.

The challenge is all the more complicate­d for Hong Kong, because of its position as a financial gateway between China and an increasing­ly hostile US. As Rodrik has noted, the Sino-American rivalry is shaped largely by national-security concerns, to the point that economics is at risk of become “hostage” to geopolitic­s or, worse, reinforcin­g and amplifying the strategic rivalry.

America’s weaponizat­ion of finance exemplifie­s this risk. Since the so-called War on Terror began, the US has been leveraging the private sector and banks to isolate particular actors from the internatio­nal financial system. In recent years, the US has relied so extensivel­y on secondary sanctions that even France and Germany have been considerin­g how to sidestep its financial dominance, including by creating an alternativ­e global payment system or a European fund that could allow trade to continue with US-sanctioned countries.

As the US has imposed financial sanctions on a growing number of Chinese enterprise­s and individual­s, China has become concerned that Hong Kong could serve as a kind of Trojan Horse, which the US could use to destabiliz­e China’s polity, including its national-security initiative­s. After all, the US national security strategy explicitly aims not only to protect Americans and their way of life, but also to advance “American influence in the world.”

China’s fears may be coming to pass. The US recently passed the Hong Kong Autonomy Act, which allows for the imposition of sanctions “with respect to foreign persons involved in the erosion of certain obligation­s of China with respect to Hong Kong, and for other purposes.” In other words, the US is using the financial system to punish Chinese officials involved in the new security law imposed on Hong Kong.

US President Donald Trump’s administra­tion also considered underminin­g the Hong Kong currency’s peg to the US dollar. Fortunatel­y, US leaders thought better of this idea, because, given Hong Kong’s position as the world’s fourth-largest foreign-exchange trading center, it could threaten the entire US dollar payment system.

But this decision is small comfort, given the trajectory of the US-China rivalry. The growing emphasis on national security will undermine global trade and investment further, leaving fewer resources to finance social policies, address inequality, and tackle climate change. This is a global tragedy of the commons, and there is no guarantee that recognizin­g it will change the outcome.

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