The Singapore Economy

Tilak Abeysinghe, Keen Meng Choy

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134113576
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Singapore's phenomenal transformation from Third World to First World status has been of great interest to economists around the world yet there has been little quantitative research done on its economy and institutions. This innovative new research monograph fills the lacunae by presenting the Singapore economy through a macroeconometric model and laying the foundations for further research.

Using formal econometric analysis and novel modelling techniques, Abeysinghe and Choy offer rare insights into how the Singapore economy works. Each of the major chapters discusses the implications of the empirical findings for current policy and an entire chapter has been devoted to macroeconomic policy simulations.

This book is a unique introduction to the Singapore economy and would be of interest to econometric modellers and policy makers in Singapore as well as advanced undergraduates and graduate researchers interested in modelling small open economies.

1
Introduction

This is a book about the Singapore economy as seen through an econometric lens. Accordingly, we introduce the reader in this chapter first to the economy of Singapore, then to the ESU01 model from which we obtain our econometric perspective, and finally to the book itself. The aim is to provide the economic and technical background for the subsequent material. At the end of the chapter, we have included a summary flowchart of the model which will be useful for keeping track of the big picture.

1.1 A primer on the Singapore economy

Founded in 1819 by Sir Stamford Raffles as a British trading post on a laissez-passer ideology of free trade, Singapore is justifiably labelled as a small open economy. Combining a land area of just 699 km² and a labour force of 2.3 million workers with an ample capital stock and state-of-the-art technology, it produced a real gross domestic product (GDP) of US$181 billion in 2004. Even though Singapore is certainly one of the top league nations in per capita income rankings, the absolute size of its gross national income (GNI) in purchasing power parity terms of US$113 billion also placed it amongst the largest 40 economies in the world (World Development Indicators Database). It is more useful, therefore, to characterize Singapore’s “smallness” as its inability to influence global market conditions, with the corollary that local traders cannot really dictate the terms on which exports and imports are exchanged, since prices are effectively set in world markets.

As for the “openness” of the economy, total merchandise trade amounted to nearly three times the size of GNI. Perhaps a better measure of trade openness than this ratio in view of the voluminous entrepôt trade that passes through Singapore’s ports is the ratio of domestic exports to GDP, which stands at well over one. Even in terms of more comprehensive measures of openness, Singapore stands out as a totally open economy (see Sachs and Warner, 1995; Gwartney et al., 2000). All this can be explained by the tiny domestic market, as constituted by an initial population of about 2 million people when independence was achieved in 1965 (compared with 4.35 million now), which compels the Republic to export the bulk of what is produced domestically. A lack of natural resources, except for its excellent geographical location, also meant that Singapore could not have afforded the protectionism so prevalent in larger developing economies – import duties are essentially confined to a select few consumer items. Thus, the over-whelming dependence on exports is matched by a similarly heavy reliance on imports, which constitute a high proportion of both final consumption goods and intermediate inputs.

Mirroring the exposure to foreign trade, Singapore has also been completely open to financial flows since the last vestiges of capital controls were removed in 1978. Historically, foreign direct investment (FDI) has been the preponderant form of capital inflows since the late 1960s, even as short-term movements of monetary capital have increased significantly in recent times. This underlines the importance of multinational corporations (MNCs) to the economy, particularly in the manufacturing sector. In 2003, foreign firms (wholly and majority foreign-owned) accounted for 71% of net fixed assets in the sector, 73% of value-added and 44% of employment. The dependence on MNCs with their technological prowess, managerial skills and marketing networks could well have stemmed inadvertently from the dearth of indigenous entrepreneurs at the onset of the industrialization drive in the sixties, but is also a consequence of a deliberate government policy of cultivating foreign enterprise with a wide range of tax incentives and export benefits.

As a result, the manufacturing sector grew steadily in importance during the last four decades so that by 2004, its value-added made up a quarter of real GDP. Manufacturing has always been the country’s leading sector in a service-dominated urban economy and will continue to be so in view of the government’s plan to double its output by 2018. Within the sector, the electronics industry is dominant as it attracts more than half of inward FDI and churns out about a third of value-added. Refined oil, petrochemicals, pharmaceuticals and newly emerging biomedical products constitute the other pillars of the manufacturing sector. In terms of trade values, electronic products are even more critical as they account for two-fifths of Singapore’s merchandise exports to the rest of the world. These statistics, moreover, underestimate the true importance of electronics because the health of ancillary industries in precision engineering and the vibrancy of the seaport and airport are directly dependent upon it.

In part because of liberal financial policies, Singapore has successfully developed into an international financial centre, with the attendant activities contributing another quarter of GDP. Much of the growth in the sector over the three decades from 1968 to 1997 before the Asian financial crisis struck the region was also actively promoted by fiscal measures and spurred by the economic development of Malaysia, Indonesia and Thailand. As in olden days, Singapore has acted as the financial hub of a thriving South-East Asia. Apart from the traditional niches in banking and insurance, the financial and business services sector now consists of stockbroking, foreign exchange trading, fund management, real estate, advertising, consultancies and all kinds of professional services. A major source of service export earnings also comes from the more than 8 million tourists who visit the country each year.

Though not sufficiently recognized by casual observers, Singapore’s economic circumstances have also been instrumental in shaping the framework and modus operandi of macroeconomic policies. The most obvious instance of this influence is in the conduct of monetary policy, where the large import content of domestic consumption and production has led the Monetary Authority of Singapore (MAS) since 1981 to adopt a policy of targeting the exchange rate as the most efficacious way of maintaining price stability. Once the central bank opted to do this, it does not have much leeway to manipulate domestic interest rates because of near-perfect capital mobility. Local interest rates are usually quoted at a discount to US rates because of market expectations of a persistent appreciation of the Singapore dollar. In such circumstances, any attempt by the MAS to exercise independent control over monetary targets would entail volatile fluctuations in the exchange rate as capital flows respond to the resulting cross-country interest rate differentials. Consequently, the domestic money supply expands and contracts passively to accommodate changes in economic activity, including the fluctuations caused by festive seasons.

In operational terms, the managed float of the exchange rate is carried out by changing the value of the Singapore dollar against a weighted basket of currencies of Singapore’s main trading partners and competitors – in short, the nominal effective exchange rate (NEER). The MAS intervenes in the foreign exchange market to keep the NEER within an undisclosed band, which is itself a moving target that reflects the central bank’s assessment of short-term risks to the economy and longer-term economic fundamentals. On the one hand, the aim is to neutralize imported inflation by gradually appreciating the NEER over time but on the other hand, a band that is set too high will have adverse effects on export competitiveness and hence, economic growth. The MAS therefore has to steer a delicate course between the Scylla of inflation and the Charybdis of recession, making its achievement of a low average inflation rate of 2% in the period after the second world oil shock all the more outstanding.

Another subtle implication of economic openness concerns fiscal policy in Singapore. The conventional wisdom holds that the high marginal propensity to import reduces the multiplier effects on domestic income of fiscal stabilization measures, although “crowding out” effects are limited because local interest rates are pinned down by foreign rates. As W.G. Huff (1994, p. 21) has noted in his excellent economic history of Singapore, this handicap was inherited from the colonial era. Nonetheless, public fixed capital formation in the form of construction works has consistently been used for counter-cyclical purposes. On the revenue side of the budget picture, the authorities have demonstrated their willingness to cut taxes and charges so as to reduce business costs when the need arises, in particular during the three classical recessions experienced by independent Singapore: the 1985–86 slump, the Asian financial crisis of 1997–98 and the recent electronics downturn in 2001. The overall fiscal stance, however, is one of extreme prudence and conservatism, with the consequence that the government routinely accumulates huge budget surpluses in non-recessionary years.

The last set of macroeconomic policies that need to be discussed has to do with the state’s ubiquitous regulation of the labour market. Such intervention can be traced all the way back to the legislation introduced in the late 1960s to bring about a disciplined workforce and peaceful industrial relations. By the early 1970s, these measures had secured full employment and incipient labour shortages began to develop, making the importation of workers necessary. Today, Singapore prides itself as being one of the most cosmopolitan cities ...

Table of contents

• Routledge Studies in the Growth Economics of Asia
• Contents
• List of figures
• List of tables
• Foreword
• Preface
• 1 Introduction
• 2 The aggregate consumption function
• 3 Modelling investment expenditures
• 4 The trade sector
• 5 The labour market
• 6 Sectoral production
• 7 Ancillaries and identities
• 8 Multiplier analysis
• 9 Policy simulations
• Appendix A: Computational methods of variables
• Appendix B: Listing of equations and variables
• Bibliography
• Index