CONFIDENTIAL
otherwise be possible.
It has been good for Hong Kong to become uncompetitive in low level manufacturing, because this has been accompanied by a move up market. So I take these complaints with a pinch of salt parts of the economy will have to adjust, and they will not like it. It is worth noting that Japan had very high inflation during its period of rapid growth in the 1960s and Korea in the 1970s. Hong Kong is an unusually flexible economy, and its adjustment processes are better than most.
9. Nevertheless, there are costs in high inflation and, especially, in rising inflation. Small savers tend to suffer most, and adjustment is painful to particular firms and their employees. Inflation can also develop momentum, and there is a danger that inflationary expectations can only be reduced by a period of very slow growth. High inflation may also become a deterrent to long term investment.
10.
A particular concern at present is that, after a period of relatively contractionary fiscal policy, in which the government has been piling up surpluses, we now face a more expansionary policy as these accumulated surpluses are run down to finance the PADS. This may prolong the period of excess demand. In the summer I was still concerned that the economy would not pick up quickly enough to validate the government's financial expectations. Now it is clear that the danger is of an inflationary boom, and of the self correcting mechanism described above taking too long to operate and, perhaps, of eventual overshooting.
11. Against this background, there are three sorts of policy option: first, improving the supply capacity of the economy; second, tighter fiscal policy; and third, adjustments to the monetary/exchange rate regime. Nearly everybody seems to agree that importing some labour to relieve supply shortages is desirable, and the only debate is about the extent of this and the exact arrangements for doing so. Even those who dislike this because it undermines the interests of existing labour groups nevertheless call for a human resources policy which emphasises better education and improving the skills of the labour force. The latter is really a policy for the medium term policy. The most obvious way of coping with the PADS bulge is to adopt as liberal a line as possible on bringing in extra labour. As with other economies around the world, this will be more congenial to citizens and their incomes if it is reversible.
12. To the labour constraint I would add land. As I hinted in my summer report, the policy of limited release of land to keep the price up seems misguided. Land prices are well above the cost of production through reclamation, and this is potentially quite a serious source of distortion in Hong
CONFIDENTIAL
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