ETHOS Issue 11, Aug 2012
In light of the recent global financial crisis, to what extent are the fundamental principles of economics still applicable?
The fundamental principles of economics remain relevant. For example, people respond to incentives; globalisation is on the whole good for national welfare. But we now have a richer and more nuanced understanding of these principles compared to say 10 years ago. Incentives operate in ways more complex than the rationality assumptions in classical economics. And the challenge with globalisation is not its overall effects (which are almost always positive) but its distributional effects (there are almost always some who lose).
So, the ways in which we apply economic principles to public policy must evolve and adapt. The operating context and circumstances have changed considerably. We should incorporate new paradigms such as behavioural economics to reinterpret these principles in light of changes to the operating environment so that they may be applied in more effective ways.
How have insights from behavioural economics influenced public policy?
In some sense, the Government has already been incorporating behavioural considerations in the design of its policies over the past decade. For example, the Government has adopted the use of default options for policies aimed at improving participation — offering an “opt-out” rather than “opt-in” option for
choices like human organ transplant and MediShield1 coverage.
Other insights from behavioural economics have been more recent. For example, we now have a fuller appreciation of how “loss-averse” people can be — something we perhaps did not fully understand when we shifted the emphasis from ownership taxes to user fees with respect to controlling congestion on our roads. User fees like Electronic Road Pricing (ERP) make economic sense because they are based on two key insights: one, that it is driving a car rather than owning it that causes congestion, and two, rational people make decisions “at the margin” — meaning, if the marginal cost of an action (an ERP charge) is greater than its marginal benefit, then the rational choice is not to undertake that action (make that particular trip by car). But we now know from observed behaviour that car owners are more likely to drive their cars around as much as possible to “recoup” their initial “investments” on their vehicles, not withstanding ERP charges! Economists call this the “sunk cost fallacy” — it is not rational behaviour, but it is real. And because it is real, we have to deal with it.
At the same time, we should not get carried away by these behavioural quirks and reject all notions of rational behaviour. While the behavioural school provides an alternative avenue for understanding human motivations and responses, it does not readily throw up solutions or prescriptions to policy issues. The bonus is still on policymakers to take a balanced view across different perspectives, apply judgement on the basis of reason and experience, and come up with workable solutions — all the while, maintaining a healthy dose of scepticism and a willingness to change and adapt if things do not turn out as expected. It is of critical importance that a pragmatic policymaker is prepared to hold opposing ideas in his mind and judiciously apply them according to different contexts and changing circumstances.
In what ways should the application of fundamental economic principles be reconsidered in light of changing contexts?
An area where we have been reconsidering existing paradigms is with respect to social safety nets. Singapore’s traditional antipathy towards welfare and safety nets is well-founded and premised on concerns about “moral hazards” — if something is subsidised, people consume too much of it; if benefits are given to those who have lost their jobs, they will prefer to remain unemployed. An entitlement mentality weakens the work ethic and moral fibre of society. And experience elsewhere has shown how real these effects can be.
But there is another dimension. The unfettered operation of the market will yield highly unequal outcomes, not to mention a high degree of volatility. There is also some evidence that growing inequality, in turn, leads to less social mobility. High inequality and low mobility also reduce public support for pro-growth policies. And all of this is indeed happening in many parts of the world, including Singapore. In our case, volatility will be exacerbated as we progressively transit to a high-wage, high-productivity economy. But how to design safety nets which blunt the more egregious effects of globalisation and yet preserve the work ethic? The Workfare Income Supplement (WIS) — which provides some income security to low-wage workers — is a recent example of how we have sought to do this.2 We will need to examine other areas of our social policies to see how we can design safety nets that are more robust yet compatible with the right incentives — to create hope as well as opportunity.
Another area where constant rethinking is required is in the choice between general subsidies and targeted subsidies. The Government has generally eschewed subsidies and transfers that apply across the board and instead opted for targeted, means-tested help. The two obvious exceptions are in education and in public housing. But even in other areas, it is not as targeted as often imagined. Take for example, hawker centres. I regard them as one of our safety nets. Singapore is one of the few First World cities which offer good quality meals at almost Third World prices — thanks to its hawker centres. How is this possible? It is in large part through the provision of “hidden” subsidies that keep rental costs low. It is therefore a general subsidy that is available to all those who patronise hawker centres — rich and poor alike. An economically more efficient approach would be to have the “correct” rentals (and therefore higher food prices at the stalls) and give food stamps and vouchers on a means-tested basis to target help to the poor. But this economically neat solution ignores the not insignficant transaction and coordination costs in administering a regime of food vouchers, not to mention the issue of adjudicating who would qualify. And so, our current regime is not a bad one.
There has been recent debate about the need to generate more “inclusive growth”. What are your views?
The pursuit of economic growth has never been for its own sake. It was, rather, for the purpose of serving the greater social good of enabling all Singaporeans to have rising standards of living. The sustained growth of the Singapore economy over the last four decades has been a critical factor in lifting most, if not all, boats. Robust economic growth has also afforded the Government greater fiscal space to redistribute resources to help those who have lagged behind. However, in recent times, changes to the quality of Singapore’s economic growth, due to a combination of external factors, such as the global financial crisis, and domestic factors, such as an ageing population, have raised questions over whether economic growth alone is sufficient for achieving that greater social good on a sustained basis. The problem is not growth per se, but the quality of that growth.
We also need to be clear on what we mean by “inclusive growth”. Some view it largely in terms of a “new social compact”, arguing that with globalisation and technological change, market forces will lead to worsening income redistribution and that the Government should therefore extend its social safety nets wider. The emphasis is on fiscal redistribution. Others have articulated the need for a “new growth model” which will focus on skills upgrading and higher productivity, which will enable the market mechanism to deliver respectable wage growth for the majority of the workforce. The emphasis is on economic restructuring. I think we need both aspects but economic restructuring should be the main approach. It is better to have a situation where 70% of the workforce enjoys good wage growth through higher productivity and we help the remaining 30%, than one where only 50% of the workforce earn good wages and the rest have to be helped through redistribution. The latter approach would not be sustainable.
Have public policies in Singapore been guided too strongly by economic perspectives, at the expense of social and other considerations?
This is perhaps a misconception about the purpose of economic analysis. Economics is not about dollars and cents; it is about scarcity and choice. Because resources are limited, we cannot have more of everything; we have to choose. This entails weighing costs and benefits, and making trade-offs among competing ends, which is what most public policies are about.
Some costs and benefits can be quantified, many others cannot be measured easily. But in making any public policy decision, we are implicitly imputing a value to the benefits and costs of dif ferent options. Sound economic analysis helps us to be clear about these costs and benefits and find the most efficient ways to achieve multiple objectives. Which particular efficient option we choose depends on the judgements we make about unquantifiable factors. Economics cannot tell us what our judgements should be; they depend ultimately on our values.
The choices in our public policies will become more complex and difficult: between safeguarding the environment and promoting growth, between lowering taxes and helping the disadvantaged, between reducing dependence on foreign workers and relieving cost pressures, and so on. Economic analysis can provide valuable rigour that will help us make better informed choices.
- MediShield is a low-cost catastrophic illness insurance scheme designed to help members meet medical expenses from major illnesses, which could not be sufficiently covered by their Medisave balance. MediShield operates on a co-payment and deductible system to avoid problems associated with firstdollar, comprehensive insurance.
- The Workfare Income Supplement Scheme provides more income and retirement savings when older, low-wage Singaporeans work and stay employed, while Workfare Training Support Scheme complements the former by encouraging them to go for and complete training, so that they take on more productive work, improve their employability and move out of low-wage employment. For information, see