Wednesday, 7 May 2014

Raising Productivity: Mid-term growth report a mixed bag

Higher productivity growth rates may not be attainable for several years. But the trend towards higher wages and lower inequality will probably continue.
By Vaninder Singh, Published The Straits Times, 6 May 2014

IN 2010, Singapore embarked on a 10-year programme to boost productivity, with the ultimate aim of achieving more sustainable and inclusive economic growth.

It aimed to grow productivity by 2 to 3 per cent a year on average between 2010 and 2019, in order to raise real wages by 33 per cent over the decade.

The Government hoped to reach these targets by tightening the foreign labour supply and encouraging automation and the retention of higher-skilled workers.

Now in its fifth year, it is becoming clear that the restructuring drive may fall short of some of its productivity goals, especially in the target sectors of construction and food and beverage (F&B).

While foreign labour intake has been significantly tightened since 2010, productivity increases have yet to be seen.

Labour productivity has been essentially flat since 2011, the first full year following the start of the plan.

It rose slightly in the second half of last year, but the gains were not broad-based, with productivity in construction and F&B falling even further.

On the bright side, wages are beginning to rise in a tight labour market, helping the country make some strides towards narrowing income inequality.

But without the necessary boost from productivity growth, the overall trend in growth - the economy's average rate of expansion in the medium term - is likely to edge down.

And if productivity fails to pick up in the longer term, Singapore's progress towards reducing inequality may be threatened by inflation, which is likely to continue facing upward pressure.

Changing landscape

AS THE transformation process continues, this mid-term report assesses the likely impact of the productivity measures in the second half of the 10-year restructuring drive.

We at The Royal Bank of Scotland believe that sectors such as construction and manufacturing, which have historically been allowed the highest share of foreign workers, may be fundamentally altered by the end of the decade.

In construction, identified as the biggest underperformer in raising capital intensity, part of the recent rapid decline in productivity has been due to an industry downturn.

Despite this downturn, firms have yet to reduce their headcount. This is clear from the steep rise in wages as a share of overall output. This is likely owing to the difficulty and costs involved with having to bring the workforce - typically comprising a large number of foreign workers - back in a subsequent upturn.

But we expect the construction downturn to last through most of this year and 2015, forcing firms to start implementing cost-cutting measures to preserve margins.

As the Government tightens the tap on foreign workers, construction firms will have to substitute labour with capital.

This will eat into the margins of smaller players, which are likely to be squeezed out, while remaining players will benefit from greater scale.

Consequently, we expect productivity gains from construction to start rising in the coming quarters.

Productivity is also forecast to improve over time in the manufacturing industry, on the back of a similar attrition among companies unwilling or unable to step up automation.

The number of Singapore residents employed as plant/machine operators and assemblers has been consistently falling since 2005, as more of them prefer to work in white-collar jobs.

This automatically puts a cap on the number of employees available to manufacturing firms, given that they have to hire a minimum ratio of local workers relative to foreign ones.

The tight labour market is likely to lead manufacturers of certain products to exit Singapore, as they opt to utilise low-cost labour in other parts of the region rather than invest more capital to automate their production in the Republic.

This process probably has not started in earnest yet - as suggested by the share of wages in manufacturing output rising by 10 per cent last year alone - but is probably becoming imminent.

As a result, we believe parts of the manufacturing industry, particularly electronics, are likely to become unviable. The firms that decide to remain in Singapore are expected to adopt more automation, leading to greater productivity gains.

But the overall size of the manufacturing sector will likely shrink further from its current one-fifth share of the economy.

Thus, Singapore's manufacturing exports will continue to decline.

Limited room for gains

THE situation is different for Singapore's services industries, which by their very nature have lower levels of productivity.

In the F&B sector, it is difficult for the mostly small owner-run businesses to embark on significant automation.

Building more shared services and improving processes, as the Government has been urging, would help somewhat.

However, this would largely apply to foodcourts, where a number of these measures are already in place.

Thus, overall productivity in F&B has continued to decline at a rapid pace - falling a cumulative 3.3 per cent over the past two years. A wholesale improvement is unlikely.

Instead, operating costs are likely to increase in the short term and businesses will end up passing these costs on to consumers.

Meanwhile, finance and business services, which together make up more than a quarter of the economy, should continue to do well, although their ability to achieve higher productivity gains will be similarly limited.

Within these sectors, business activities that have high manpower costs and requirements are likely to be adversely affected.

For instance, at The Royal Bank of Scotland we believe more software development work could be moved offshore.

On the whole, we are not entirely convinced that the higher productivity growth rates are attainable in the timeframe the Government has set for itself.

Productivity may indeed rebound once the transformation process is complete, but in the interim, the drag from unwinding industries is likely to prove stronger.

Reducing inequality

THE silver lining is that the productivity drive has put upward pressure on wages, contributing to the Government's agenda of reducing inequality.

Income inequality - as measured by the Gini coefficient - declined last year over 2012, especially when government transfers are taken into account.

Higher pay is also succeeding in raising the participation rate, especially among women and seniors.

The female participation rate in the workforce rose to nearly 50 per cent last year, from 45 per cent in 2010, while the participation rate for workers aged 60 and above climbed to about 38 per cent last year, from 30 per cent in 2010.

All this points to some progress towards more inclusive growth, one of the main reasons behind the productivity drive.

However, it is important to ensure that higher inflation, which tends to disproportionately affect lower-income households, does not wipe out these gains.

If productivity growth continues to disappoint and labour policies remain tight, unit labour costs - the inflation-adjusted cost of labour to produce one unit of output - should continue to edge up as wages rise faster, resulting in rising inflation.

The Monetary Authority of Singapore (MAS) estimates the country's non-accelerating inflation rate of unemployment (Nairu) to be 2.5 per cent.

This means any unemployment rate below this level will result in inflation.

In fact, the estimate for Nairu may have to be adjusted higher still to 2.7 per cent, as the share of non-residents in the overall population falls.

Unemployment in the non-resident workforce has historically been lower. Thus, inflationary pressures may turn out to be even stronger as upward pressure on wages continues.

In summary, we expect success in the higher wage and lower inequality dimensions to continue, but the Government's productivity target will be elusive for this decade. Overall, we believe the combination of lower growth and higher inflation - witnessed over the past two years - will persist until the transformation is largely complete.

The writer is South-east Asia economist with The Royal Bank of Scotland.

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