http://www.singapore-window.org/sw03/030808a1.htmReinventing Singapore's economy Asian Wall Street Journal
August 8, 2000
COMMENTARY: By MANU BHASKARAN SINGAPORE impressed many observers when it embarked on a process of economic reforms -- months before the Asian financial crisis erupted in 1997 and made economic restructuring almost compulsory for policy makers. Since the initial rethink started in 1996, the Singapore authorities have accelerated deregulation in the financial and telecommunications sectors. The deregulation was bold -- breaking long-held policy taboos for instance regarding the role of Singapore-owned banks -- and succeeded in dramatically altering the landscape in the banking sector.
However, when the comprehensive study of the economy by the government's Economic Review Committee was announced earlier this year, many Singaporeans expressed disappointment that the government had not extended this radical transformation to other sectors. A major reason for this disappointment was the feeling that the critical changes necessary for Singapore to adjust to a tougher economic environment had not been made. The Singapore economy has been subject to a number of shocks in recent years which have depressed the dynamism of its economy -- the regional hinterland that its financial and trading hubs service has lost vigor after the Asian crisis; and the global economy has become much more competitive. A number of issues stand out in particular:
• The high-cost structure in Singapore hurts returns to investors and produces a weak domestic private sector. Data from the US Department of Commerce on returns to US.companies shows that, compared to the Asian average, Singapore no longer provides the superior rate of return that it once did. Once a premium economy charging premium prices, it is now a less-than-premium economy -- but is still charging premium prices.
To address this problem, the government is now working hard to create a more flexible wage structure. However, such wage-centered strategies may not suffice. The key is to address costs which have deviated from market levels because of some distortion. Since wages as a percentage of gross domestic product is actually quite low in Singapore compared to most economies, high wages are probably not the most critical reason for a high-cost structure.
The more likely areas for distortions will be in land prices (and its effects on wages and rentals), high transportation costs resulting from the government's forceful anticongestion policies (which drive up the cost of distribution and logistics) and high regulatory costs. But without adequate measures to bring costs down, the economy will restructure with companies laying workers off, cutting wages, squeezing subcontractors' margins, forcing landlords to cut rentals, etc. This will produce deflationary headwinds in the Singapore economy.
This challenging domestic-cost environment probably accounts for the relatively weak private-sector companies in Singapore. The government has acknowledged that entrepreneurial vigor is lacking in Singapore. Returns on capital to locally-owned businesses tend to be lower than returns in foreign-owned corporations. Singapore has produced few privately-owned global success stories compared to the other city-state economy, Hong Kong -- where the government's role in the economy is much more muted.
• The all-pervasive role of the government in economic decision making potentially reduces the flexibility of adjustment to such external challenges. The prices of major inputs -- land, labor and capital -- in Singapore are substantially influenced by government. The government owns most of the land, effectively becoming the monopoly supplier. The incremental supply of labor is controlled by the government through its controls on foreign-worker inflows. And Singapore's financial capital is also heavily influenced by government. The government owns a substantial proportion of domestically-owned corporations, and a huge chunk of national savings flows through government channels rather than market channels. This means that key prices in the economy -- wages, interest rates and rents -- are inordinately influenced by government rather than market forces. Since prices play a major role in signalling and incentivizing businesses on where to allocate capital, it is critically important that such prices not be distorted by government.
One issue of particular concern is how this economic structure leads to correlated errors. In a normal economy, errors by some businesses or individuals tend to cancel out, but in an economy where one player -- the government -- dominates, the risk of errors reinforcing each other increases. The overallocation of the nation's capital to real estate is one example of how such behavior has been evident in Singapore.
• Singapore has a savings regime which produces the highest savings rate in the world, but does not appear to benefit from this much. Singapore savings rates have averaged more than 50% of GDP in recent years. Only part of this can be accounted for by the Central Provident Fund, Singapore's forced-savings scheme. Actually, much of it is due to massive government surpluses that have only recently started to recede. The result is that a large percentage of savings is channelled through the government budget mechanism or through the CPF rather than through financial markets.
High savings in Singapore did not, therefore, nourish the growth of its stock market or bond market -- nor did it generate the growth of dynamic and competitive broking, investment-banking and fund-management industries. Thus, the country with the highest savings rate in the world does not have a domestic-savings industry to match. There is also another anomaly. Despite having the highest savings rate in the world, separate studies by economists at two universities in Singapore suggest that a good number of Singaporeans will retire with less-than-adequate cash flows to sustain a high standard of living. This is a result of poor returns to Singaporean savers.
This brief analysis shows why it is so difficult for even the boldest reformers to reinvent the Singapore economy. The problems are not as straightforward as overvalued exchange rates or a banking sector burdened with bad assets. The problems in Singapore are deeply embedded in the economic structure. Removing one distortion could have significant adverse effects for some groups, or even pose systemic risks for the entire economy. For instance, if land costs are allowed to fall to levels which allow Singapore's cost structure to adequately improve, property owners, including virtually all households in Singapore, could see a major decline in wealth.
So, what should we expect in the future? A global cyclical recovery could well take some of the pressure off Singapore for a year or so, but the structural headwinds remain strong. In fact, some of the challenges facing Singapore are growing -- neighboring Malaysia is now aggressively expanding its services sector and in some cases competing directly with Singapore -- with a substantially lower cost base.
The good news is that these competitive challenges will encourage further policy reforms. Businesses with interests in Singapore can expect the following: (a) more cuts in income taxes; (b) a more cautious exchange-rate policy, meaning that the Singapore dollar is unlikely to see the secular trade-weighted appreciation it saw in the past three decades; (c) intensifying efforts to pare down costs in Singapore through deregulation and cuts in government-related charges; (d) a substantial change in the role of key government institutions such as the Housing and Development Board, to reduce government intervention in the housing market; and (e) further liberalization of the savings regime in Singapore.
Economic restructuring in Singapore is thus a work-in-progress. If further policy changes are made, there is no reason why the Singapore economy could not leverage off its substantial advantages -- for instance critical mass as a regional center and competitive advantage in high-value manufacturing -- and resume its role as an economic dynamo in Asia.
Mr Bhaskaran is partner and head of economic research for the Centennial Group