Singapore’s Economic Growth Model: Too Much or Too Little?

ETHOS Issue 06, July 2009

Singapore’s economic growth model of the past forty-odd years, like those of its fellow “Asian tigers”, has been based on the export of initially labour-intensive manufactures to world markets, followed by a move up te technology and valueadded ladders as comparative advantage shifts. Like Korea, Taiwan and Japan, economic development in Singapore has been substantially state-directed and features a managed-float currency regime; like Hong Kong, it is based on free trade and capital flows.

Over the past two decades however, Korea and Taiwan have reduced the state’s role in their economies, while Hong Kong is still the world’s freest economy. Singapore’s economy, on the other hand, continues to be firmly statedirected while diversifying into highvalue services, with heavy reliance on an imported workforce. Most notably absent, outside of banking and property, is the strong domestic private sector participation that is such a distinctive feature in Japan, Korea, Taiwan and Hong Kong.

Can Singapore’s state-heavy growth model be sustained in the long term, especially after the systemic shock and global rebalancing of the current financial crisis?

ECONOMIC THEORY AND LIMITS TO STATE-DIRECTED GROWTH

Asia’s economic growth follows the theory of comparative advantage, which says that countries can increase the value of their production and consumption from a fixed resource base by participating in international trade, i.e., by each country specialising in making and exporting only what it is relatively more efficient in producing, compared with other countries. Comparative advantage in one or more sectors means comparative disadvantage in others—a country cannot be internationally competitive in every sector. Despite its abundance, in absolute terms, of labour, skills, and now capital, China will not end up producing everything in the world; if it tries to do so, demand for its fixed resources will cause inflation, undermining its initial cost advantage.

Resource-based comparative advantage is not the only determinant of international competitiveness and trade f lows. According to strategic trade theory (most closely associated with Nobel Laureate Paul Krugman), a country can become competitive in an industry by exploiting economies of scale or learning through exports. Agglomeration advantages (observed by Alfred Marshall and later popularised by Michael Porter as “clusters”) may lead to the development of industrial concentrations in particular locations, where the proximity of suppliers, customers and competitors allows an area as a whole to be internationally competitive in a specific sector or industry: think Silicon Valley for high tech, or Wall Street for finance.

Such location-specific competitive advantage can complement or overcome resource-based comparative advantage or disadvantage—but it too is limited. Not every country can have scaledup economies in the same industry; often, when countries try to develop these artificially, excess capacity results and everybody loses. There are also disadvantages to agglomeration, or clusters—most notably congestion costs (such as land and labour shortages when too many firms chase the same scarce resources in a given location, pushing up each other’s costs) and negative externalities (such as environmental pollution and dissipation of intellectual property).

Comparative and competitive advantage both allow for government policy to influence a location’s competitiveness in particular sectors— through selective investments that shape resource endowments, and tax incentives and subsidies to target resource allocation toward particular sectors.

However, these policies can be imitated with relative ease, leading to “beggar-my-neighbour” outcomes¹ (where neighbouring countries compete to attract foreign investors with ever more attractive and costly tax breaks) and excess capacity.

As a national economy moves up the technology ladder, the capital and opportunity cost of further statedirected shifts in comparative or competitive advantage escalates, given diminishing returns. Furthermore, competition based on advantages created by government policy rather than market forces introduces a large element of political risk into private business decisions, encourages inefficiency in the allocation of resources, and reduces world welfare.

There is also the risk of falling into the “fallacy of composition”: the error of inferring that something is true of the whole because it is true of some part, or even every part, of the whole.² In government industrial policy, a tax cut for sector A can stimulate its growth and development by attracting resources—capital, labour and entrepreneurship—to that sector. But if every other sector—B, C, D, etc.—also gets a tax cut, then no sector is better off. The Government budget may simply end up running massive deficits, saddling the economy as a whole with higher inflation.

IMPLICATIONS FOR SINGAPORE’S GROWTH MODEL

These time-tested economic maxims boil down to one prognosis for Singapore’s economic model—you can’t have everything, even without size and resource constraints. Trying to achieve comparative advantage in too many sectors at once will only push up resource costs, aggravate negative externalities such as inflation and environmental degradation, and result in reduced competitiveness overall.³ Competitive advantage based on economies of scale, first-comer and agglomeration or cluster advantages derived from government policy, rather than geographical resources, are probably unsustainable.

GLOBALISATION AND GROWTH

But doesn’t globalisation enable us to increase our resource base by importing labour, skills and capital; and to expand our market to the world and thus benefit from economies of scale, even though we are small? Don’t globalisation and technological innovation enable us both to tap more resources, and to utilise them more efficiently?

It is true that Singapore has benefited enormously from globalisation, in both factor and product markets. But there are also constraints, diminishing returns, and additional risks.

One risk was identified by Lee Tsao Yuan,⁴ then Alwyn Young^5,6 and Paul Krugman in the 1990s.⁷ They showed that Singapore’s economic growth in the 1970s and 1980s had occurred mainly through factor accumulation (the addition of inputs of labour and capital) rather than increased factor productivity (producing more with the same labour and capital).

Since 1990, however, Singapore’s growth has demonstrated increased product ivity (to which global competition and foreign inputs of capital, skills and technology have contributed). But the ready availability of foreign inputs potentially or actually deters better utilisation of domestic resources—because of the temptation to just add more input to get more output. Imports of unskilled foreign labour may artificially preserve the competitiveness of labour-intensive activities (such as construction), retarding the reallocation of complementary resources to more productive uses. Imports of skilled foreign talent and foreign capital may have the unintended consequence of “crowding out” or even “chasing away” local talent, capital and entrepreneurship, as would an over-present role of the state in the economy.⁸

Given Singapore’s land scarcity, foreign labour and capital contribute to domestic inf lationary pressures that could undermine the cost-competitiveness of various sectors. Imports of capital also add to persistent current account surpluses and large foreign exchange reserves in putting upward pressure on the exchange rate, again undermining cost-competitiveness.

CHALLENGES IN THE POST-CRISIS WORLD

Singapore’s small and open economy is extremely vulnerable to global contagion effects. As major markets in the US, Europe and Japan have fallen into recession, Singapore’s exports have declined, particularly in the highly capital-intensive, risky and volatile electronics and pharmaceutical sectors targeted by the state. Recessions also usually produce global consolidations of industry, with smaller, more peripheral locations the most likely to be abandoned first. Discretionary spending falls, especially for luxury consumption, and the global tourism sector—including the casino industry—has been hit hard.

Since the 1997-98 Asian financial crisis, the benefits of free capital flows have been increasingly challenged by academic research. Their costs have been heightened by the 2008 crisis, which saw even well-managed emerging market economies severely hit by capital flight. Capital deleveraging and increased risk-aversion and regulation worldwide post-crisis will shrink financial sectors and crossborder capital flows, with some possible retreat from globalisation toward “localisation of finance”. Increased political risk and uncertainty will also discourage investment in sectors where government policy influences returns, such as pharmaceuticals and medical tourism by American consumers, with health-care reform under the Obama administration.

The international community will continue to push for reduction in the international macroeconomic imbalances which have contributed to the current crisis. Undervalued managed-float currencies, large current account surpluses and massive foreign exchange reserves which are built up by Asian countries like Japan, China and Singapore and then recycled into financial and real assets in the West, will be less tolerated.

On the other hand, a retreat from quasi-mercantilist policies may well provide new sources of growth in expanded domestic consumption in Asia. Many Chinese economists, like Zhiwu Chen⁹ and Yasheng Huang,¹⁰ already recommend this change for China, which shares with Singapore the world’s lowest shares of consumption in GDP—about 40%.¹¹

AN ALTERNATIVE STRATEGIC VISION

Lee Soo Ann and I have argued elsewhere that Singapore’s economic growth model today is predicated on “more of the same” policies that may be out of place in a changed local, regional and global environment:

“This includes bureaucratic targeting of favoured sectors for receipt of (now much more costly) state subsidies and tax-breaks directed to attracting capital investment and technology from foreign companies and institutions serving international markets……the newly favoured sectors (such as “life sciences”, gambling casinos and high value-added services like finance, medicine and education) create disproportionately more jobs for foreigners than for locals, at all skill levels, and can only be sustained by massive immigration. They are also much more capital-intensive and risky, and subject to stronger global and regional competition… Because of these simultaneous “big bets” in a small place, the reliance on external factors of production, and the costs of failure, are much higher…”¹²

From an economist’s perspective, it seems relatively clear that Singapore’s recent economic growth model has tried to do too much and for too little benefit, in contradiction to what economic theory tells us. From a business strategist’s perspective, what should be done?

First, there should be a national conversation on the purpose and nature of economic growth for an affluent and educated nation at our stage of development, and in our geographical location. While Singapore’s economic growth record to date has been admirable, it has emphasised quantitative targets over qualitative results and the distribution among beneficiaries. Focusing on “how much” growth does not necessarily tell us “how good” it is, or “for whom”. “People for growth” (growth as an end in itself) is not the same as “growth for people” (growth as a means toward greater welfare for people, presumably citizen workers and consumers). The assumption that the former will inevitably lead to the latter should itself be re-examined.

Second, the growth we choose should be sustainable—both financially (i.e., without ongoing subsidies in an intensely competitive world economy, and without generating inflation through the import of excess labour and capital) and environmentally (i.e., without creating congestion costs and negative externalities that undermine competitiveness and growth, in a world already running up against severe natural resource constraints).

Third, what is the best process for growth? Do we stake our carefully husbanded national savings, accumulated over generations of restrained consumption, on a few major, capital-intensive, risky and expensive projects dependent on foreign capital, foreign labour, foreign skills, foreign entrepreneurs and foreign markets in which we have much competition and no intrinsic comparative advantage? Or do we privatise the economy, releasing capital and talent to local entrepreneurs who can allocate resources according to market forces, and innovate, creating value in smaller but nimbler, more diverse and more locally-rooted enterprises (which, if they fail, will take only small parts, rather than big chunks, of the economy down with them)? Fourth, we need to identify our distinguishing advantage. What is distinctive about us, as a nation and as a place, that will enable us to build a unique niche in the regional and world economy that cannot be fulfilled by others, however much they try to emulate our strategies?

A time of global crisis and transformation, and of impending major economic, social and demographic shifts in our region, is an excellent time to reexamine not just Singapore’s economic growth model, but also our identity and values as a nation, since growth and identity are ultimately linked.

NOTES

1. In the current global financial crisis, the importance of coordinated interest-rate and bank-rescue policies is an instructive example of the need to avoid beggar-myneighbour consequences which would hamper recovery for everyone.
2. This concept is most associated with John Maynard Keynes’ “paradox of thrift”, but there are other examples.
3. Thus, Singapore is unlikely to be, simultaneously, internationally competitive in semiconductors, life sciences, health care, education, financial services, digital media, creative industries and casino tourism.
4. Lee, Tsao Yuan, “Growth without productivity: Singapore manufacturing in the 1970s”, Journal of Development Economics 19 (1985), 25-38.
5. Young, Alwyn, “A Tale of Two Cities: Factor Accumulation and Technical Change in Hong Kong and Singapore”, in NBER Macroeconomics Annual 1992, ed. O. J. Blanchard and S. Fischer (Cambridge and London: MIT Press, 1992), 13-54.
6. Young, Alwyn, “The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience”, Quarterly Journal of Economics 110 (1995), 641-80.
7. Krugman, Paul, “The Myth of Asia’s Miracle”, Foreign Affairs 73.
8. Over the last 40 years, Hong Kong’s GDP growth rate and per capita income have surpassed Singapore’s, and this was achieved with a smaller state sector, lower savings and higher consumption, suggesting a more efficient use of capital.
9. Zhiwu Chen, “Privatisation would enrich China”, The Financial Times, 7 August 2008.
10. Huang, Yasheng, Capitalism with Chinese Characteristics: Entrepreneurship and the State (New York, NY: Cambridge University Press, 2008).
11. Singapore economists like Tilak Abeysinghe, Choy Keen Meng, Lee Soo Ann and myself have similarly noted the extremely low share of both labour incomes and consumption in Singapore’s GDP, and its correlation, as in China, with increasing income inequality, between average and rich and also between local and foreign, private and state actors. In both economies, the state owns or controls much of the remainder, including investment by foreign multinationals which are largely controlled and incentivised by the state. See Abeysinghe, Tilak and Choy, Keen Meng, “The aggregate consumption puzzle in Singapore”, Journal of Asian Economics 15 (2004), 563-78.
12. Lim, Linda and Lee, Soo Ann, “Globalising State, Disappearing Nation: The Impact of Foreign Participation in Singapore’s Hub Economy”, in Management of Success Revisited, ed. Terence Chong (Singapore: Institute of Southeast Asian Studies, 2009) (forthcoming).