Hong Kong is a market economy, and has been rated as the freest in the world for over two decades by the Heritage Foundation. Being a free economy brings many important advantages, but also comes at a price. The advantages include greater personal freedom and autonomy, more efficient allocation of resources, and more room for innovation and creativity. But the price exacts many things too. One of these is environmental degradation; another is loss of historical buildings; still another is income and wealth disparities.

Fortunately for Hong Kong, the government has recognized that unfettered free markets could endanger the environment. The Department of Environmental Protection (DEP) was established in 1986. Since the DEP was established, new regulations were established, and the economy has become less free. But Hong Kong has become a more livable city.

Economists accept that in the face of externalities, such as pollution, there is a role for government intervention. They also accept anti-monopoly policies to make markets fairer and more competitive. Economists agree that prices should be allowed to find their own levels. They believe that, generally, interfering with the free play of market forces will compromise efficiency.

For this reason, economists agree that the minimum wage, which sets a floor on wages, exacts a cost on society. But many economists, including me, believe that so long as the benefits still exceed the costs, setting a legal minimum wage may bring net social gains.

Exactly because of this - we do want to allow the free market to work - we need redistribution policies - both in kind and in cash. Economists can demonstrate easily and formally that redistribution in kind is less efficient than redistribution in cash. However, this conclusion is valid only under some assumptions, in particular the implicit assumption that all that matters to welfare is physical goods and services, and that such "merit goods" as housing and education do not have spill-over effects. In reality, apart from physical goods and services, there is such a thing called "mental goods". In-cash redistribution could lead to what is perceived as under-consumption of basic housing, education and healthcare. This will give a "mental bad" to concerned citizens who feel bad seeing people poorly housed and neglecting the needs of their children.

This is why Hong Kong needs a redistribution policy, and the latest Policy Address by the Chief Executive said: "... despite the protection offered by the statutory minimum wage, many grassroots workers, as the sole breadwinners of families, still bear a heavy financial burden. Providing them with suitable assistance and encouraging them to remain employed will help keep them from falling into the CSSA safety net."

Thus the Low-Income Working Family Allowance is a first step in transition from "welfare" to "workfare". It is warranted first and foremost because children should not be deprived of the opportunity to develop their potential and even risk being under-nourished. It is a "conditional" transfer - conditional on there being an employed person working at least the threshold number of hours as stipulated.

Some legislators worry that the Low-Income Working Family Allowance would end up relieving employers of the need to pay higher minimum wages. Others fear that the scheme may not be fiscally sustainable. Still others worry about the possible higher tax burden on the middle class, many of whom may not be that much better off. Indeed, after all the in-kind and in-cash transfers, they may be worse off than the lower-income people who qualify for the benefits.

The first worry is misplaced. Although it does mean that minimum wages would not have to be raised too much for workers to have a decent take-home pay, this is exactly what is intended. The fact is raising the minimum wage carries a cost in terms of fewer job opportunities, especially for young and inexperienced people. But the principle of raising the minimum wage as long as the marginal increase brings greater benefits than costs should be upheld.

The second worry requires more serious consideration. Although the proposed "workfare" may reduce expenditure on welfare, we may over the long run need to raise revenues from somewhere.

Finally, the possible unfairness to the middle class also needs to be addressed. I have already proposed that a more graduated subsidy that would allow those earning above the proposed threshold to enjoy benefits that "taper" with higher earnings should be considered.

The author is director of the Center for Public Policy Studies at Lingnan University.

(HK Edition 01/29/2014 page1)