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As a remote and indefensible British colony perched on the edge of China which did not recognise London’s right to rule, Hong Kong was a political anachronism whose survival was always at risk. Its economic strategy was also a relic from the 19th century: free trade and no import or currency restrictions; low taxes and small government; negligible state borrowing and regular budget surpluses; minimal interference with market forces and no state planning; no development subsidies and no investment incentives. The city, nevertheless, boasts an exceptional record of economic success against even more extraordinary odds. World War II had left it ‘the most looted city in the world’.1 Its pre-war population of some 2 million had been reduced to 600,000 during the Japanese occupation. By 1949 Hong Kong had been overwhelmed by a million immigrants seeking refuge from civil war and the Chinese Communist Party’s revolution on the Mainland, yet it was to receive almost nothing in foreign aid and no international development assistance. Although Western governments were to seek to shut their markets to Asian exports of light industrial goods, Hong Kong managed to become ‘the de facto control centre of the world’s textile and garment trade’, a status that lasted until the end of the century.2 Its GDP increased every single year in real terms from at least 1961 until 1998, and its 6.5 million people had achieved prosperity faster than any other society in history, it has been claimed.3 At the same time Hong Kong stood out by Asian standards for its political and social stability even though the British declined to introduce parliamentary democracy.4 Remarkable, too, was Hong Kong’s ability to function as an autonomous international financial centre with its own currency despite its lack of political sovereignty. It maintained a free currency market when the rest of Asia and most Western nations imposed severe exchange controls , and its banking system was the most open and international in the region. Hong Kong became the largest source of the external investments that financed China’s breakneck growth from 1978. Until the final 5 Hong Kong — From Scandals to Stability 96 Reluctant Regulators years of the British era, its financial affairs were controlled by expatriate colonial officials remote from the community and whose judgments were deeply flawed, as will be discussed in the analysis that follows. All the same, China’s leaders regarded its contribution to the nation’s economic wellbeing as so important that they took extraordinary measures to preserve its capitalist system and its economic, financial and commercial autonomy after the end of colonial rule in 1997. As this chapter will explain, however, its achievements as the nation’s principal interface with the international financial system were accompanied by a history of regulatory misjudgments and financial crises that had much in common with the defective performance of American and British central bankers and financial regulators in recent decades. This chapter will recount how Hong Kong learnt the lessons of its scandalous banking history. Financial stability became a goal for which laissez-faire doctrines had to be sacrificed. Financial markets were the special case, the one sector of the economy in which traditional noninterventionist policies were discarded because they had proved unacceptable to the business community and the general public alike. In the process, Hong Kong discovered that strict regulation of financial markets and their players did not stifle either growth or innovation nor did it diminish its attractions as an international financial centre. The discussion will also recount how disturbing observers have found this disparity between Hong Kong’s staunch free-market reputation and its increasingly strict financial regulation. The Hong Kong challenge The contrast between Hong Kong’s apparent vulnerability and its ability to prosper in an unpromising environment was very evident during the 2007–09 international financial crisis. Why were some economies so much less affected by the global disaster than countries with much the same financial systems and regulatory arrangements, an International Monetary Fund (IMF) team has asked. The explanation, it suggested, was ‘simply “better supervision”’.5 Hong Kong’s record supports the IMF’s verdict. ‘As one of the most open economies in the world and with its focus on financial and trade services’, Hong Kong could have been especially vulnerable ‘to the unfolding crisis in international financial markets and to the slowdown in the global economy’, the IMF observed.6 New York and London were its closest trading and corporate...

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