Pubpol 542 International Financial Policy Professor Kathryn M. E. Dominguez Course Group Project Due Wednesday, April 13, 2005 Economic Perspective in Singapore Kok Pieo Benjamin Tan (UMID# 66412871, kptan@umich.edu) Tetsuya Hirata (UMID# 10327616, tetsuya@umich.edu) Yuki Hayashi (UMID# 97048732, yhayashi@umich.edu)
I. Introduction Throughout the late 1980s and early 1990s, Singapore has been performing extremely well, maintaining a high and sustained GDP growth rate, price stability and a current account surplus. However, the country has been hit by a few external shocks since 1997, starting with the Asian currency crisis in that year, a slowdown in the U.S. economy in 2001, and SARS i in 2003. As a small country, Singapore has been vulnerable to external shocks that have left a negative impact on its economy. In this paper, we will highlight its vulnerability to shocks and the higher unemployment rate it has experienced since then. Section II will discuss Singapore s performance in some macroeconomic indicators, while section III will look at the actions the government took in this period. Section IV focuses on Singapore s current main problems of unemployment and vulnerability to shocks. We will then discuss some policy options that the Singapore government can adopt in section V and finally conclude the paper in section VI. II. Recent performance in macroeconomic indicators In this section, we discuss Singapore s recent performance with regards to its GDP growth rate, unemployment, inflation, exchange rate and current account. Table 1 ii shows several macroeconomic indicators provided by International Monetary Fund (IMF). 1. GDP growth rate Singapore's sound macroeconomic policies and relatively high degree of openness has helped it to recover rapidly from the effects of the Asian crisis. GDP growth hit 12.2% in 1999 compared with 1.5% the previous year. However, Singapore has had to deal with several additional shocks subsequently: the global economic slowdown in 2001 especially in the United States, leading to weak demand for its exports in electronics; the war in Iraq and rising oil prices; and the SARS outbreak in 2003, which affected Singapore s tourism industry badly. As a result, GDP fell by 0.3% in 2001 and remained sluggish in 2002 and 2003 (see Table 1). The economy's openness to trade and investment has played an important role in Singapore s development. Since 1999, trade in goods and services has accounted for some 360% of GDP iii. Nevertheless, growth in merchandise exports and imports has been erratic reflecting the change in the world economy. Growth in services trade has slowed. Singapore is a major supplier of services (e.g. seaport and airport services, and trading services), but it is now facing stiff competition from other service suppliers in the region. 2. Unemployment and inflation rates According to the IMF, the unemployment rate has been climbing since 1996. The unemployment rate stood at 2.4% in 1997, compared with 5.4% in 2003. On the other hand, the inflation rate (CPI, percentage change) has been very stable, ranging from a high of 2% in 1997 to a low of 0.4% in 2002. Figure 1 shows the Phillip s curve derived by logarithm approximation based on the IMF data. While not a perfect fit, it suggests that we may be able to get lower unemployment rates if we are willing to accept a rise in inflation as a trade-off. 1
3. Exchange rate Using 2000 as the base year (2000 = 100), the real effective exchange rate for the SGD has largely followed the SGD per USD exchange rate, depreciating from 108.7 in 1996 to 110.6 in 1997, appreciating to 99.7 in 1999, before depreciating slightly to 100.8 in 2001. It has been appreciating since then to 93.3 in 2004. The only difference in trends between the real exchange rate and the SGD per USD exchange rate is in 1999, when the real exchange rate appreciated from 106.5 the previous year to 99.7, while the SGD per USD exchange rate depreciated slightly from 1.6605 to 1.6660. Since the SGD per USD exchange rate only captures the change in the exchange rate for countries that use the USD or is pegged to it while the real effective exchange rate gives a better sense of how the SGD is performing against all the currencies in general, we will be using the real effective exchange rate for our subsequent analysis. 4. Current account Between 1996 and 1998, the current account improved from 13.977 billion USD to 18. 583 billion USD. The current account subsequently deteriorated to 13.245 billion USD in 2000, but has been improving since then reaching 28.187 billion USD in 2003. Though the values may fluctuate, Singapore has managed to maintain a current account surplus throughout this period. The current account is affected by changes in the exchange rate, domestic income and the world income. Running a regression using the information from 1999 to 2003, we get the expected signs for the coefficients of the domestic income (negative) and world income (positive), but get a negative coefficient for the real effective exchange rate (see Table 2). This suggests that a depreciation in the real exchange rate (positive increase in the index) will lead to a negative effect on the current account. While care must be taken not to rely too heavily on a regression result obtained from limited data, it does suggest the possibility of a J-curve. III. Government action 1. Monetary policy The money supply (M2) has generally been increasing from 123.4 billion SGD in 1997 to 194.8 billion SGD in 2003 as seen in Table 1. Money supply increased the most in 1998 by 30.2%, probably as a response to the Asian currency crisis. The only times the money supply contracted was in 2000 and 2002 by 2.0% and 0.3% respectively. With inflation rates stable and low the government probably concluded that an expansionary monetary policy could be adopted during this period especially in reaction to the negative external shocks, in hopes of stimulating the economy. 2. Fiscal policy Fiscal policy has also been expansionary in this period as seen in Table 1. Government spending increased steadily from 13.2 billion SGD in 1997 to 19.1 billion SGD in 2002 before declining slightly to 19.0 billion SGD in 2003, with the biggest increase of 2.4 billion SGD taking place in 2000. Government revenues also fell in this period by half from 57.0 billion SGD 2
to 27.7 billion SGD in 2002 before increasing to 33.1 billion SGD in 2003. This suggests that the government has been cutting taxes throughout this period, since GDP has not fallen that drastically. Increased government spending with lower taxes point to an expansionary fiscal policy between 1997 and 2002, again probably in reaction to the external shocks Singapore suffered. While the combination of expansionary fiscal and monetary policy of this period was insufficient to smooth out Singapore s annual growth rates or even prevent a recession in 2001, Singapore s performance could have been worse without these policies in place. IV. Assessment of macroeconomic problems in Singapore Problem 1. Vulnerability to external shocks Singapore is a small open economy, and as such is extremely vulnerable to external shocks. As shown above, the contraction of the economy and subsequent sluggish growth can be attributed to external shocks such as the United States economic slowdown in 2001, the war in Iraq, and even SARS. Although such vulnerability to external shocks is somewhat intrinsic for a small open economy, its effects can be somewhat mitigated using appropriate government policies. The recession in 2001 was caused by the slowdown of electronics exports to the United States. Electronics accounted for around 40% of Singapore s merchandise trade and the United States was the biggest trading partner at that time, so the change of US electronics demand affected the economy of Singapore (see Figure 2). Thus Singapore s heavy reliance on one particular industry (electronic goods) and heavy dependence in one market (the US) may have aggravated its vulnerability to external shocks. Problem 2. Unemployment While 5.4% is still a very low rate, especially compared to the double digits seen in some parts of Europe, unemployment has more than doubled since the boom years before 1997. Moreover, the WTO reports that the government regulates wages based on the annual recommendation by the National Wage Council (NWC), aiming to keep Singaporean wages competitive. The bargain in the past has been lower wages to guarantee full employment, but the NWC has been unable to keep unemployment from rising in this period. This combination of repressed wages together with higher unemployment rates has stirred plenty of disgruntled citizens and the government has been under political pressure to do something about the situation. V. Policy options available to the government Confronted with the 2 problems described above, in this section we discuss the policy options available to the Singapore government to address these challenges. Policy option #1: Diversification of exports (goods and destination) 3
Diversification of export goods and their destination countries will mitigate the vulnerability of Singapore s economy to shocks originating from just one part of the world or affecting only one particular good, helping to achieve more stable economic growth in the process. Singapore has already taken steps to spread its exports more evenly among its trading partners. For instance, the United States accounted for 24.6% of domestic exports in 1999, but this figure has been lowered to 15.5% in 2003 (see Figure 3). Singapore should continue this effort and increase trade with countries which it has a low trade volume relative to their wealth and in different geographical locations. One way to achieve this is to negotiate free trade agreements (FTAs) with countries such as those in Oceania and South Asia, which accounted for only 7.9% of domestic export in 2003. As for the diversification of export goods, Singapore should increase its exports in technology intensive and knowledge intensive industries to avoid reliance on just electronic and oil-based products. The biotechnology industry is one possible field Singapore can venture into since its well-educated nationals may give it a comparative advantage and the industry will not strain its limited land resources as it does not require much space. The government has taken steps to encourage growth in the life sciences, and it is our recommendation that such efforts should continue and in fact be stepped up. To achieve this, increased government spending may be required initially, investing in this sector to create a critical mass that would subsequently attract other biotechnology firms to set up in the country. Infrastructure needed such as roads, transportation, power lines and buildings should be upgraded to meet the needs of the sector. Tax cuts and tax holidays may be given initially to attract firms to set up operations in Singapore. Expanding the service sector is another avenue to avoid over reliance on the electronics sector. Singapore is already a financial center catering to the immediate region, and steps could be taken to further advance its standing as a financial hub, taking advantage of its stable political environment and English speaking population. It can also move into the education sector, building more schools to cater to overseas students interested in studying in Singapore and attracting well known universities to establish their campus in the country. Again promotion of the services sector would probably involve increased government spending, cuts in taxes or a combination of both. Policy option #2: Expansionary monetary policy Judging from the rapid rise in the unemployment rate, the current level of output is likely to be below the natural level of output iv. This rise in the unemployment rate is due to the external shocks, shifting the DD curve to the left. Since the external shock (such as US recession, SARS) is usually temporary, theoretically the DD curve should shift back to the right and we will get back to full employment eventually. However, instead of waiting for the DD curve to shift back on its own we can use temporary expansionary monetary policy to shift the AA curve to the right to get full employment. The monetary expansion has to be temporary or we risk getting higher prices (inflation) when people change their expectations. The monetary expansion causes the Singaporean dollar to depreciate, giving the economy a boost by reducing prices of exports leading to an improvement in the current account. Figure 4 depicts this shift in DD-AA diagram. 4
Policy option #3: Expansionary fiscal policy Alternatively the government can adopt a temporary expansionary fiscal policy to restore the economy to full employment output. Expansionary fiscal policy simply shifts the DD curve right, back towards its original position. This will set Singapore back to full employment and restores the pre-shock exchange rate, as seen in Figure 5. VI. Conclusions and recommendations The three options are not exclusionary and can be used concurrently. Policy 1 and 3 work best together, with the government adopting a fiscal expansion to shift the DD curve to the right, using the increased government spending or tax cuts to promote certain industries and hence achieve its target of further diversifying the economy. Policy 2 can also be adopted together with policy 1 and 3. With a simultaneous monetary and fiscal expansion, we will shift the DD curve partly to the right but not all the way to its original position, with the AA curve shifting to the right as well to achieve full employment (see Figure 6). The main difference in this case is that the exchange rate is maintained at S 0, while without the monetary expansion of policy 2 we will have the exchange rate appreciating back to its pre-shock exchange rate of S f (see figures 5 and 6). As we have seen in section 2 however, there is a possibility of a J-curve in the Singapore economy at least in the short run. If that is the case the appreciation back to S f may actually lead to an improvement in the current account in the short run, and thus expansionary fiscal policy will have a greater than expected effect causing output to increase beyond full employment levels, leading to inflation. Theoretically it is possible for the government to recognize the negative external shock and immediately implement an expansionary fiscal policy to offset the effects of the external shock. If done swiftly, the exchange rate may not depreciate in the first place to S 0 due to the shock and instead stay at S f. In practice it is rare for the government to be able to react that fast or for expansionary fiscal policy s effects to be felt that quickly. Thus it is our recommendation that the Singapore government adopts all three policies concurrently: a temporary fiscal and monetary expansion (policy 2 and 3) in the short run to reduce unemployment, and use the increased government spending and tax cuts to promote other industries to diversify the economy (policy 1). This keeps the exchange rate from moving at S 0 (avoiding the potential effects of a J-curve) and still achieves full employment levels. In addition, the Singapore government should work towards trading with more countries to avoid over reliance on any single market and thus make it less likely to be adversely affected by external shocks that are regional specific. Apart from policy 1, the simultaneous adoption of policy 2 and 3 is little different from what the government has already done between 1997 and 2003. Seeing how expansionary fiscal and monetary policy thus far has failed to lower unemployment to pre-1997 levels, it suggests that the government can afford to adopt an even more aggressively expansionary fiscal and monetary policy, especially with inflation rates low and well under control. 5
Appendix Table 1 Macroeconomic indicators 1997 1998 1999 2000 2001 2002 2003 GDP (SGD in million) 141,641 137,085 137,935 157,700 152,066 155,727 159,135 Real GDP growth rate (%) 8.1 1.5 12.2 5.2-0.3 1.7 1.5 Inflation rate (%) 2.0-0.3 0.1 1.3 1.0-0.4 0.5 Unemployment rate (%) 2.4 3.2 4.6 4.4 3.4 5.2 5.4 Exchange rate (SGD/USD) 1.6755 1.6605 1.6660 1.7315 1.8510 1.7365 1.7008 Real effective exchange rate 110.6 106.5 99.7 100.0 100.8 98.0 93.8 Current account (USD in billion) 14.918 18.583 15.284 13.245 16.104 18.873 28.187 Money supply (M2, SGD in million) 123,443 160,784 174,474 170,898 180,909 180,308 194,829 M2 growth rate (%) N.A. 30.2 8.5-2.0 5.9-0.3 8.1 Government spending (SGD in million) 13,180 13,883 14,007 17,410 18,684 19,052 18,996 Revenue (SGD in million) 57,048 59,724 49,950 52,255 35,393 27,703 33,108 Source: International Financial Statistics, IMF 6
Table 2 Regression results; relationship between current account, exchange rates, domestic and world income Standard Error 14.13723 Observations 5 ANOVA df SS MS F Significance F Regression 3 2839.721 946.5737 4.736151 0.322874 Residual 1 199.8614 199.8614 Total 4 3039.582 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 15.74573 21.03318 0.748614 0.5909-251.505 282.9964-251.505 282.9964 Exch -7.34016 3.413425-2.15038 0.277111-50.7117 36.03133-50.7117 36.03133 GDP -7.72833 3.022495-2.55694 0.237335-46.1326 30.67594-46.1326 30.67594 GDP* 3.643103 10.16108 0.358535 0.780838-125.465 132.7513-125.465 132.7513 RESIDUAL OUTPUT Observation Predicted Y Residuals 1-19.3711 1.618304 2-11.9509-1.38981 3 16.25986 5.325644 4 28.6757-11.4812 5 43.42385 5.927073 Source: International Financial Statistics, IMF and WDI Data Query, The World Bank Group 7
Table 3 Trade in services, 1999-03 (S$ million and per cent) 1999 2000 2001 2002 2003 Services balance 3,550.1 3,382.9 1,293.0 443.7 1,980.5 Export of services 44,683.3 50,699.7 52,139.9 53,676.1 53,494.9 of which in %: Transportation 40.5 40.4 39.4 40.0 38.4 Travel 19.3 17.8 15.9 14.9 13.0 Insurance 1.4 1.7 2.3 2.5 2.8 Government services 0.3 0.3 0.3 0.3 0.3 Construction 0.6 0.5 0.7 0.7 0.6 Financial 4.5 4.7 4.1 4.3 5.9 Computer & information 0.9 0.8 1.1 1.1 1.0 Royalties 0.3 0.3 0.6 0.6 0.6 Social 0.0 0.1 0.1 0.1 0.1 business services 32.2 33.4 35.7 35.6 37.2 Import of services 41,133.2 47,316.8 50,846.9 53,232.4 51,514.4 of which in %: Transportation 45.7 46.7 43.6 43.0 45.4 Travel 15.9 16.5 19.3 21.2 16.7 Insurance 4.7 5.4 5.1 5.6 6.2 Government services 0.5 0.4 0.5 0.5 0.5 Construction 0.8 0.5 0.6 0.5 0.5 Financial 1.3 1.5 1.3 1.3 1.2 Computer & information 0.7 0.8 1.0 0.7 0.7 Royalties 15.9 13.2 12.0 10.6 11.3 Social 0.1 0.1 0.1 0.1 0.1 business services 14.4 15.0 16.5 16.4 17.4 Source: Data provided by the authorities of Singapore. 8
Figure 1 Phillip s Curve Phillip's Curve 3.0 y = -1.6401Ln(x) + 2.8489 2.5 2.0 2.4, 2.0 inflation rate (%) 1.5 1.0 3.4, 1.0 4.4, 1.3 0.5 5.4, 0.5 4.6, 0.1 0.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 3.2, -0.3 5.2, -0.4-0.5 unemployment rate (%) Source: International Financial Statistics, IMF 9
Figure 2 Product composition of merchandise trade, 1999 and 2003 Per cent 1999 2003 Total: US$111.0 billion Total: US$68.6 billion Transport equip. electrical machinery 2.7 7.6 Total: US$46.0 billion Imports Non-electrical machinery semi-manuf. semi-manuf. 5.5 9.8 4.6 Non-electrical Chemicals 6.0 Chemicals 6.7 machinery Fuels 9.3 Fuels 9.1 Office machines & 13.6 Agriculture telecommunication 4.4 equipment Agriculture 3.7 38.1 3.3 3.0 Manufacturing Manufacturing 83.2 79.8 manuf. manufactures 8.9 7.2 Office machines & Textiles & clothing Textiles & clothing 2.3 telecom. equipment 2.5 38.4 Transport equipment Transport electrical electrical 5.6 equip. 4.9 machinery 7.6 machinery 5.8 manuf. 8.5 Domestic exports Re-exports Total: US$127.9 billion semi-manuf. Chemicals 1.8 Non-electrical machinery 17.0 3.6 Chemicals 8.9 Fuels Fuels 13.0 Office machines & telecommunication equipment 56.2 18.3 Agric. 1.7 1.2 electrical machinery 5.0 Manufacturing 84.1 Agriculture 1.7 1.6 manufactures 9.3 Manufacturing 78.3 Total: US$64.4 billion Source : World Trade Organization, Trade Policy Review: Singapore 2004. semi-manuf. 1.9 Non-electrical machinery 4.3 electrical Office machines & machinery telecommunication 3.8 equipment 42.0 Total: US$79.7 billion Non-electrical machinery Non-electrical machinery 9.1 7.9 Office machines & semi-manuf. Office machines & telecommunication 5.2 semi-manuf. 3.6 telecommunication equipment Chemicals 6.3 equipment Chemicals 5.3 55.8 Agriculture 47.8 Fuels 2.4 5.6 Agriculture 2.9 11.2 4.2 2.5 Manufacturing Manufacturing 90.2 92.3 manuf. manuf. 6.6 7.7 Textiles & clothing 2.9 Textiles & clothing Transport equipment 3.8 3.4 electrical machinery 6.8 10
Figure Chart I.3 3 Direction of merchandise trade, 1999 and 2003 Per cent East Asia 10.2 Chinese Taipei 4.0 Thailand 4.7 China 5.1 Japan 16.6 Oceania 3.4 East Asia 10.0 Chinese Taipei 4.3 China 3.4 South Asia 2.8 Japan 7.7 Hong Kong, China 7.6 South Asia 4.9 E. Asia 6.5 Korea, Rep.of 4.0 Thailand 5.4 Chinese Taipei 5.8 China 3.5 Japan 7.0 7.0 1999 2003 Imports 2.8 Malaysia 15.6 Total: US$111.0 billion Total: US$68.6 billion Oceania 3.7 East Asia 56.2 East Asia 45.1 Malaysia 12.1 4.7 East Asia 57.8 H.K., China 7.8 United States 17.0 EU15 12.7 United States 24.6 EU15 18.7 United States 11.1 Middle East 7.1 EU15 9.9 Domestic exports America 2.5 Middle East 2.4 Malaysia 23.3 Re-exports East Asia 9.6 Chinese Taipei 5.1 Thailand 4.3 China 8.7 East Asia 11.4 Japan 7.8 Japan 12.0 Oceania 5.1 South Asia 2.8 Chinese Taipei 4.4 China 7.2 Oceania 3.5 South Asia 4.1 East Asia 5.1 Korea, Rep. of 5.5 Thailand 5.3 Chinese Taipei 5.2 China 6.8 8.5 United States 13.9 Total: US$127.9 billion H.K., China 9.9 4.3 United States 15.5 Total: US$79.7 billion Japan 5.4 East Asia 56.5 East Asia 51.5 3.8 East Asia 65.5 H.K., China 10.1 Malaysia 16.8 Malaysia 10.7 United States 10.7 EU15 12.5 Middle East 8.6 America 4.7 EU15 16.0 EU15 10.0 Middle East 2.4 Malaysia 22.1 Total: US$46.0 billion Total: US$64.4 billion Source : Data provide by the authorities of Singapore. 11
Figure 4 Monetary expansion (Option #2) Exchange rate, S 1. External shock DD1 DD0 3. Makes S depreciate S1 S0 2. But, expansionary monetary policy Sf 4. Raises the output. AA1 Y0 Yf AA0 Real output, Y Figure 5 Fiscal expansion (Option #3) Exchange rate, S 1. External shock DD1 DD0 = DD2 2. Makes S depreciate 4. Makes S appreciate S0 5. And raises the output. Sf 3. But, expansionary fiscal policy Y0 Yf AA0 Real output, Y 12
Figure 6 Our recommendation (Combination of options #2 and #3) 2. Makes S depreciate Exchange rate, S 1. External shock DD1 DD2 DD0 S0 Sf 3. But, expansionary fiscal policy 5. Raises the output. 4. And, expansionary monetary policy AA0 AA1 Y0 Yf Real output, Y 13
Bibliography 1. International Monetary Fund, International Financial Statistics 2. World Trade Organization, Trade Policy Review: Singapore 2004, available at http://www.wto.org/english/tratop_e/tpr_e/tp229_e.htm (website visited Apr. 8, 2005) 3. The World Bank Group, WDI Data Query, available at http://devdata.worldbank.org/dataquery/ (website visited Apr. 11, 2005) i Severe Acute Respiratory Syndrome ii Some figures were derived based on the raw data in International Financial Statistics. iii The WTO, Trade Policy Review Singapore 2004 iv Also known as the full-employment level of output 14