Taking economic stock at 50

Singapore has benefited from 'extensive growth', adding more labour and capital to boost the economy. But future constraints compel it to shift to innovation-driven growth.
By Linda Lim, Published The Straits Times, 26 May 2015

IN THIS year of retrospection, what does the recent slowdown in the Singapore economy tell us about where we have been, where we are now, what brought us here, where our future lies, and what will bring us there?

The most important reason for the slowdown in Singapore's GDP growth, exports and job creation is the slowing global economy.

China's slowdown has been the most significant, with its ripple effects on other emerging economies and commodity exporters now integrated into China-centric global supply chains.

But stagnation in Europe, Japan and even the United States (in the first quarter of this year) have added to the sluggishness of global growth.

For modern Singapore, the adverse consequences of extreme openness to global market forces are nothing new.

Our economy has been subject to externally-induced boom-and- bust cycles since being "born global" in 1819.

The first three decades after independence in 1965 were unusual in that recessions occurred relatively infrequently - about once a decade - and rapid growth was quickly restored.

But since the Asian financial crisis of 1997-98 downturns have been both more frequent and more severe, even as the trend rate of growth itself has fallen.

This greater volatility is partly explained by global forces - particularly worldwide financial-market liberalisation and the increased globalisation of capital flows, which most heavily impact the most open and financial-sector-dependent economies like Singapore.

Technological change has also become more rapid and fashionably "disruptive", adding a structural element to cyclical causes of economic downturns in specific locations.

Domestic dimension in downturns

BUT downturns, volatility and adjustment to them also often have a domestic or local component. Thus some attribute Singapore's current slowdown to government policies to slow (not stop) the increase of foreign labour and talent, and to dampen the previously booming debt-fuelled property market through credit restraints and various macro-prudential measures.

A look back on past economic growth sheds some light on how we got here and why these difficult policies are necessary.

Independent Singapore's early development of labour-intensive export manufacturing for global markets through multinational supply chains was so successful that full employment was reached by 1972 and labour shortages appeared.

Policymakers resorted to importing foreign labour to "maintain competitiveness", thus prolonging employers' dependence on low-cost labour even as the country was losing comparative advantage in labour-intensive activities.

The inevitable result was the depression of wages and labour productivity, even as gross domestic product continued to grow.

Recognising this, policymakers then instituted what was called a "second industrial revolution", recommending a high-wage policy from 1979 to 1982 to incentivise employers to upgrade skills, increase productivity, and substitute increasingly abundant capital for increasingly scarce and expensive labour.

However, the onset of a severe recession in 1984-85 led to a retreat from this policy and since then policymakers have essentially relied on ever-increasing imports of foreign labour, skills and capital to achieve high growth.

This is what economists call "extensive" growth based on the addition of more inputs to produce more output - rather than producing more (or more highly valued) output with the same or fewer inputs.

Incomplete transition

SINGAPORE did make the transition "from Third World to First" in terms of citizens' rising average income levels and other social and economic indicators.

But this transition has been uneven and incomplete. Construction and many services (retail, food and beverages, cleaning, domestic services) are clearly not at First World levels in terms of technology, operational efficiency, productivity and wages - which is unsurprising, given their prolonged reliance on Third World labour.

At the same time, the simultaneous policy pursuit of multiple high-tech manufacturing and high-value services "clusters" - everything from highly volatile electronics, petrochemicals and pharmaceuticals to finance, digital media and "creative industries" - aggravated skills shortages, requiring a large influx of high- and even mid-level "foreign talent" to fuel continued extensive growth.

Predictably, this policy ran into what economists call "diminishing returns" - eventually it takes more inputs to produce an additional unit of output, particularly when the inputs (labour, skills and capital) are added to a fixed amount of a scarce resource - in this case, land.

This in turn pushes up land costs and property prices, generating monopoly rents for (corporate and individual) owners of multiple properties while raising business costs, and making new household formation less affordable.

Property price inflation also diverts capital and skills away from potentially productive uses into rentier "investments" which, for a while, yield higher returns than employment or more risky entrepreneurial ventures.

The over-leverage and high household debt encouraged by a long period of low-cost borrowing (due to both global and local factors) could pose a threat to macroeconomic and financial stability when, for example, global interest rates rise even as global growth slows.

Thus both the less rapid increase in foreign labour and property market cooling measures are necessary policies to enable Singapore to complete its delayed transition to a fully developed economy.

Rich countries - and we are one of the richest - always grow more slowly than developing ones. On the supply side, the latter can grow fast just by catching up to the technological frontier, at which increasing productivity becomes more difficult. On the demand side, market saturation sets in.

Innovation-driven growth

OVERCOMING both these sets of constraints requires innovation, which always comes from private enterprises, especially start-ups, responding to (or creating) new market forces.

Even a large-market middle-income state-dominated country like China recognises that it needs a vibrant small and medium- sized private enterprise sector to reverse its slowing growth, and that further shrinking the state sector and over-investment in properties are necessary to bring this about.

China is also trying to "rebalance" its economy away from exports, investment and manufacturing to domestic consumption and services, while manufacturing itself is increasing productivity as the number of new entrants to the labour force declines for demographic reasons.

Limits to importing skills

CONTINUOUSLY importing foreign capital, labour, skills and technology to serve distant global product markets arguably served Singapore's economy well in the 20th century, enabling it to maintain GDP growth rates above what developed economies can usually achieve, though at the cost of increased volatility, inequality and negative externalities such as congestion, social tension, and rising living and business costs.

Even without these growing local constraints, the extensive growth model is no longer sustainable in the 21st century, because of fundamental changes in the global economy.

Besides the slowdown in global growth - in young emerging as well as ageing developed economies - the big multinationals to which we hitched our wagon are both losing market share to newcomers, and revamping their global strategies, in line with technological and market changes.

Global supply chains are being regionalised and consolidated in fewer countries, prioritising production at the point of final demand, which also reduces exposure to currency and political risk.

State-provided investment incentives including tax breaks and infrastructure - on which Singapore has relied heavily to attract foreign investment - are both less effective due to "beggar-my- neighbour" competition from many locations, and increasingly prohibited as unfair or illegal "subsidies" by international trade and investment rules.

Future growth

WHAT then does the future hold for Singapore's economy at age 50, and how do we get there?

The fashionable management- speak term VUCA - volatility, uncertainty, complexity and ambiguity - suggests that long-range planning - and thus the 20th century-style industrial policy favoured by states in catch-up mode, is futile in an age of constant market, technological and possible political disruption.

In such a low-visibility environment, investment decisions involve great risk and are best left to market forces and private capital, without the state directing the allocation of resources to specific industries.

Instead, the state should reduce its own claims on scarce resources and focus on developing and maintaining the basic institutions and infrastructure, including a more robust social safety net, that will encourage entrepreneurial risk-taking and allow new businesses to emerge.

Very likely, in Singapore, market forces will dictate a relative shift in GDP from exports and manufacturing to domestic consumption and services, including for a regional customer base.

Slower growth is in our future, but it could be more stable, sustainable and better distributed, driven by innovation and entrepreneurs, based on productivity rather than extensive growth, and on value-creating rather than rentier activities.

The financial and human capital resources accumulated over the past 50 years should stand us in good stead for the next 50, if we apply them to the development of lasting local capabilities, and differentiating competitive advantages, rooted in our own unique circumstances.

This is not something that Government can or should do, but something we need to do for ourselves, to become more truly independent.

The writer is professor of strategy at the Stephen M. Ross School of Business, University of Michigan, in the United States.