A. Major Flaws in the Urban Development Model

The two urgent tasks of general sanitation improvement and economic recovery faced by Hong Kong are closely related to its urban development model, which features three Hs (high density, high cost and high degree of autonomy) and one E (extensive development). High density refers to the uneven distribution of urban planning that concentrates the overwhelming majority of the population and business activities on 20% of Hong Kong's lands, resulting in the city having one of the highest construction densities of the world. High cost refers to the high commercial and residential costs brought by the mix of high land price and low tax policy. High degree of autonomy refers to the mainly market driven urban development and little government interference. Extensive development means expanding by reclamation in order to develop new towns but lagging improvements on environmental quality and living standards, especially in the refurbishment of the old districts.

Such a unique model long existed under special historical circumstances has resulted in Hong Kong's temporary prosperity on the surface. Nevertheless, it has two fatal flaws. Firstly, residential environment was sacrificed and living conditions were slow to improve, sowing the seeds of the disease outbreak. The high degree of densities of residential buildings caused severe noise and air pollution. The high costs and price exceeded the purchasing capability of ordinary citizens, hampering improvements on living conditions. Though efficient, the high market autonomy produced the giant property bubble back in 1997 on the back of massive speculations. Therefore, it is fair to say that the ups and downs of Hong Kong's property market in the last ten years were the typical result of market malfunctioning, which had less to do with the land supply or the government's policy around 1997. As a result, there was little improvement in the living quality no matter how high the property prices went up. For instance, between 1989 to 2001, Hong Kong's per capita GDP doubled from USD12,000 to USD24,000, while the average size of a private residential unit only had a meager increase from 55 square meters to 57 square meters. Many buildings and their associated facilities aged without being properly maintained or renewed. And the conditions of public housing fared even worse. Residential building complex such as Amoy Gardens that saw a severe outbreak of SARS all have less than satisfactory living environments.

Secondly, unilaterally pursuing higher property exchange values has meant that opportunity of leveraging the property market to promote economic development has been missed. The idea that higher land price could maintain lower taxes through land sales and stimulate domestic consumption and economic growth through property price reflation proved to be an illusion. Setting higher property price to maintain lower tax is the equivalence of spending tomorrow's money. It would only work if property price kept climbing. Since the bubble bursted in 1997, the motion was set in reverse and tax hike pressure has been building up. On the surface, property owners benefited from rising price even though they paid more for the land. But this was merely an internal game. The gains quickly evaporated when property price plunged. It is estimated that from 1990 to 1997, Hong Kong's real estate market cap rose by HKD4.5 trillion. But from 1998 to 2002, it declined by HKD5.0 trillion, giving up all the gains from the past ten years. Thus, the game of asset price reflation could only bear short-term economic fruits. Once asset price deflation sets in, the negative wealth effect would emerge. Therefore if we take a longer term view, this strategy made little economic sense or even pose negative effect. As for the property market itself, the prosperity prior to 1997 was short lived and the added value it created had dropped from 9.6% of GDP in 1990 to only 5.9% in 2001. Judging from the above, the three Hs and one E model failed to either maintain lower taxes or stimulate economic growth. Instead, it has left many damages to the economy. If not rectified promptly, it may further slow down the pace of Hong Kong's social and economic developments.

B. Transformation of Urban Development Model

The post SARS rebuilding of Hong Kong requires that the urban development model be transformed from the three Hs and one E nature to an intensive model that aims to improve quality.

(A) Transform the high density development

Due to the scarcity of land in Hong Kong, it only makes sense to try to lower the overly high development density and ease the congestion in the municipality. Over the past ten years, due to rising population, more people lived in the urban area although the proportion has been declining. In order to lower the development density, besides maintaining negative growth in people living in the urban area, the more important task is to modify the urban planning accordingly. Two measures can be considered. One is to develop the peripheral areas of the city to expedite population decentralization. Recent surveys showed that potential house owners make such developments their first choice. Another measure is to reduce development density within the urban area. This can be achieved by combining small and separate sections of land into a large lot through planning, fully utilizing the unused plot ratio of the old districts and lowering the land coverage ratio, widening the space between buildings and houses, and expanding outdoor space. When multiple measures are taken, the reduction of development density may not be as difficult as originally thought.

(B) Reduce urban development costs

Hong Kong's high construction cost is one of the forces hindering the progress of urban development and improvement on general living standards. The transformation should try to lower such costs. But this phenomenon wasn't formed overnight and has already become an integral part of Hong Kong's pricing structure. Further cost reduction may bring forth more economic pain and make it a very difficult choice. An effective way to resolve the problem is to adopt a policy of returning the hidden land to the people, i.e. to utilize the government's land to support property owners' trading up. For example, if a property owner sells his old unit for HKD1.2m and purchases a new one for HKD2.5m, the government will subsidize on the land price component. Assuming the land price is 50% of the HKD1.3m price difference between the two properties, then the government issues a land purchase certificate of HKD650,000 (50% X HKD1.3 m) in value to the owner who can use it to pay for the new unit. Developers in turn accumulate these land purchase certificates to pay for the land they purchase from the government. By so doing, property prices can remain relatively stable, the property market can become more robust with increased home purchases. The general living environment can be improved and in turn, the economy can be successfully stimulated.

(C) Leverage the government's unique function and specific role

As discussed above, the lop-sided development of the property market was more due to market malfunctioning than to government intervention. Looking to the future, the government's special role will have to be enhanced to compensate market inefficiency. Firstly, a new, 20-year urban development plan which comprises of centralized oversight, resources allocation and efficient management coordination should be in place. The key to transformation to an intensive model is to raise environmental quality and living standards. Secondly, the rigid property rights system needs to be revamped. Private property rights are a cornerstone of Hong Kong's market economy and must be maintained at all costs. However, this does not mean it cannot be modified. When conflicts arose between personal rights and public interests, the government should intervene to ensure proper compensation to personal rights and service public interests. Therefore, the land and property rights system related to urban development should be revamped as soon as possible to increase liquidity and to expedite urban redevelopment. At the same time, the principle of private property rights should be well respected. Thirdly, an optimal housing development model should be chosen. Singapore's success in this area can be a good example. It integrates the need for private and public housing and creates a comprehensive housing system that combines the functions between the government and the market. The problem with Hong Kong's housing policy today is its over-emphasis on the exchange value and market autonomy. Although Singapore's model should not be indiscriminately copied, it does remind us that a better model should be one that combines the government and the market functions and upgrades Hong Kong's living standards. Fourthly, new construction standards should be enacted to utilize new technology and raise the environmental hygiene concept.

C. Expedite Urban Renewal

The success to Hong Kong's transformation in urban development is, to a large extent, dependent upon its urban renewal. In the early 60s, the government had begun to plan for large-scale renewal. But so far, little progress has been made and the newly established Urban Renewal Authority (URA) runs into financial difficulties. A major issue is the overly complex land acquisition procedure that is extremely difficult to accomplish due to various reasons. If this problem persists, the post SARS rebuilding is nothing more than an empty talk.

(A) Reform the overly rigid property rights system

Relevant rules must be amended in order to create a more flexible legal environment for the redevelopment. It is necessary to strike a balance between private property rights and public interests, with the former serving the highest interests of the latter and being properly respected and compensated. The successful practices in the USA should serve as a good reference. The principle of the majority rules should be adopted. If 70% of the owners agree to the redevelopment or relocation plan, the rest should unconditionally follow. A reasonable period of notice should apply when the owner cannot be located, beyond which no dissent will be entertained. Then there is the compensation scheme. Current arrangements often result in a much higher compensation than market price warrants, hence pushing the URA further into the red. A more reasonable practice is to add a redevelopment premium of say 20% to the prevailing market price, so that the interests of small owners can be better served. It can also bring down the redevelopment cost, and expedite urban renewal.

(B) Expand the scope of urban redevelopment

Currently, major redevelopment projects concentrate on the run-down parts of the city. But in fact, many residential buildings do not meet the requirements of public hygiene and epidemic prevention. The problems found in Amoy Gardens such as the single pipe plumbing system or the narrow light well are common among many buildings in Hong Kong. However, these structural problems can only be solved by renewal instead of simple maintenance and improvement works. Therefore, the scope of redevelopment should be expanded to include building age limits (say 30 years). As for the run-down districts, once the amended rules are adopted, the renewal projects should commence immediately without delay.

(C) Encourage participation from various parties

Because urban renewal is such an urgent task with far-reaching repercussions, we have to solicit the cooperation of all the parties including private developers. Many private developers used to stay away because of the complex procedures and minimal profit margins. If related rules can be revised, the incentives to participate should be lifted significantly. With their experience, technology and capital, private developers should play a major role in urban redevelopment. The government can consider outsourcing the redevelopment projects to them based on the revised rules. Besides, private citizens should also be encouraged to make suggestions and demands to participate in the redevelopment. The government can consider offering trading-up plans that feature the sharing of property rights and the owning of living rights. Under the scheme, the small owners can trade up to a new unit with the same size inside/outside the same district by selling his old unit to the developers. The government pays partially for the difference in prices of the new and the old units, with the difference to be recouped from land sales of the redevelopment. The property rights are shared between small owners and the government proportionally based on their payments, and the living rights belong to the owners. Owners will have to pay back the difference to the government if they decide to sell or rent a new unit. Thus the incentives to participate in the redevelopment by citizens concerned will be significantly lifted as well.

(D) Reinforce the government's role in urban redevelopment planning and coordination

The government should restructure the current management framework to strengthen planning and coordination. An urban redevelopment department with full range of functions should be established to take charge of all the works including redevelopment planning, tendering, monitoring and coordination, etc. Developers should be in charge of land acquisition and development. As for the huge capital requirements, the government can consider issuing urban development bonds to citizens and international investors. The funds collected are for the sole purpose of redevelopment. The current low interest environment is ideal for such bond issuance. If urban redevelopment can bring along sizable investment opportunities and a new facelift for Hong Kong, such bond issuance should not cause a negative outlook or a downgrading on Hong Kong.

Wang Chun Xin
Senior Economist