Tuesday, November 25, 2008

The longest crisis ever?

Nov 22, 2008

By Zakir Hussain

IT IS official: Singapore is in recession. As an open economy, Singapore's economic fortunes are closely intertwined with that of the wider world. When its major trading partners - America and the European Union - plunged into recession in recent weeks, Singapore followed suit.

In previous recessions - in 1985, 1998, and 2001 to 2003, the economy bounced back relatively quickly because conditions elsewhere improved. It also helped that during those downturns, only certain sectors or regions were badly hit.

This is not the case now. Economists note that during the 1998 Asian financial crisis, affected countries accounted for only 10 per cent of global gross domestic product (GDP). Today, they account for 50 per cent of global GDP.

The effects of the crisis, which some believe is the worst since the Great Depression of the 1930s, have yet to play out fully, here and elsewhere in the world.

Insight looks at what caused past downturns, how the economy recovered, and why this crisis is set to be a long one.

1985: Partly 'self-inflicted'

SINCE independence, Singapore's growth has largely been subject to the ebbs and flows of global trade swings.

So it was no surprise that a slump in world trade in 1985, especially with the United States, saw the economy contract for the first time since independence.

Gross domestic product shrank 1.4 per cent, when it grew 8.3 per cent in 1984.

Exports to the US rose only 3 per cent, compared to 50 per cent and 23 per cent in the previous two years.

Over a year, electronics production - one-quarter of the country's manufacturing output - decreased by 15 per cent, exposing the danger of excessive concentration in a few sectors.

Demand was also dampened by low commodity prices in key trading partners Malaysia and Indonesia.

It did not help that wages and business costs were deliberately high.

By the late 1970s, the Government had wanted the economy to move out of low-wage, labour-intensive activity into higher-skilled, technology-intensive manufacturing and services, in order to make the economy less vulnerable to trade competition and protectionist restrictions elsewhere.

Policymakers believed that if companies faced higher costs, they would be spurred to automate and mechanise their work and add value to the economy.

They also noted how higher wages in other economies saw productivity gains.

However, wage increases outpaced productivity gains in the early 1980s.

The Government also stuck by its policy of letting the Singapore dollar appreciate.

As a result, exports became less competitive and took a beating when world trade slumped.

Nanyang Technological University economist Choy Keen Meng notes that the crisis was 'partly inflicted on ourselves'.

'Costs were too high, construction was overextended, and when the bubble burst, that affected us,' he tells Insight.

The toll: 90,000 jobs, two-thirds of which involved foreign workers who were sent home. Unemployment hit 6 per cent.

The Government acted to reduce labour costs by slashing employers' Central Provident Fund contribution rates.

In 1986, the employers' CPF contribution rate was slashed from 25 per cent to 10 per cent, effectively cutting wages by 12 per cent.

Since then, the CPF rates have been used again and again as an economic tool during a recession to reduce wage costs.

But that year, other developed countries were not doing too badly, and this healthy external environment meant Singapore was able to export its way out of the crisis.

The economy recovered, growing 2.1 per cent in 1986 and 9.8 per cent in 1987.

Assistant Professor Choy's take is that while the cost cuts helped, the external environment was 'absolutely critical' to recovery.

'We are a small, open economy and our growth is driven by external factors like export demand. Our business cycles are transmitted from the rest of the world,' he says.

'We also recover because external conditions pick up.'

1998: Like a plane with two engines left

AT THE height of the Asian financial crisis in 1998, The Economist newspaper compared the world economy to 'an aeroplane that has lost two of its four engines, with a third now starting to splutter'.

Japan was in a recession, China was sharply slowing down, many emerging Asian economies were going through their steepest economic declines since World War II.

Economists made gloomy predictions that if the economies of America or Europe slowed too, the world economy could suffer its worst peacetime setback since the Great Depression of the 1930s.

Fortunately, this did not come to pass.

Not long after the aeroplane nosedived, some engine repair in mid-air saw the plane pick up speed and soar, propelled by the other engines - America and Europe.

The plunge began in mid-1997, when a fall in the value of the Thai baht sparked turmoil that hit Indonesia, Malaysia, the Philippines and South Korea hard. The contagion spread as far as Russia and Brazil.

Problems like excessive foreign borrowing or unsound banks dragged regional economies down, and Singapore, with its extensive trade and financial links, took a heavy beating.

With Asian countries accounting for over 50 per cent of Singapore's trade, economic growth plunged from 8.3 per cent in 1997 to -1.4 per cent in 1998.

Explained economics professor Augustine Tan in a 1999 article: 'Singapore is South-east Asia's entrepot. The region is also a major market for Singapore's exports of services, especially in the areas of tourism and finance.

'It is easy to see why Singapore suffered when the financially-crippled Asian countries drastically reduced their imports.' Prof Tan is now with the Singapore Management University.

It did not help that investors fled and kept away from the region.

That the West was relatively unaffected proved a boon for Singapore, Nanyang Technological University economist Chew Soon Beng tells Insight.

He notes that the Singapore dollar's depreciation against the US dollar by 18 per cent then gave Singapore's exports to developed countries a lift.

And as the Singapore dollar appreciated against the currencies of its Asean trading partners, imports became cheaper for Singaporeans.

The Government also unveiled a $10.5 billion aid package to alleviate the burden on households, and offered tax rebates.

Wage cuts also played a role - the employers' Central Provident Fund contribution rate, which had been progressively restored to 20 per cent by 1994, was again slashed to 10 per cent. It was later progressively restored in 1999 and 2000, to 16 per cent.

Subsequently, the National Wages Council encouraged a monthly variable component for pay to enable firms to adjust labour costs quickly and effectively.

The healthy external environment, coupled with domestic measures, enabled the economy to get out of the crisis rather fast, Prof Chew says.

By 1999, growth reached 7.2 per cent, helped by a spike in demand for electronics worldwide. In 2000, growth was 10.1 per cent.

2001-2003: Dot.com bust, Sept 11 and Sars

PLANES hijacked by terrorists and crashed into New York's World Trade Centre on Sept 11, 2001, sent the United States and global economies reeling.

The dot.com bubble had already burst a year earlier, as many Internet start-ups in the US folded one by one, causing global demand to drop.

Economists who predicted a hard landing for the US economy did not expect the rest of the world to follow suit.

IT and electronics manufacturers were hit hard, and stock markets throughout the world collapsed, dampening spending and sending the world into a recession by mid-2001.

Said Mr Stephen Roach, chief economist at US investment bank Morgan Stanley, then: 'The loss of the US economic leadership reverberated quickly around the world. There was no other candidate to fill the void.

'Once that engine screeched to a standstill, the rest of the world tumbled like dominoes, first non-Japan Asia, then Japan, America's Nafta (North American Free Trade Agreement) partners, and Europe and Latin America.'

The key factor? Global dependence on the US, which Mr Roach reckoned accounted for two-fifths of world gross domestic product (GDP) growth over the previous five years by sucking in imports from other countries.

Supply chains had also become increasingly globalised as companies from developed economies outsourced production to cheaper destinations in Asia.

Fortunately, China's growth barely slowed, while Hong Kong, Singapore, Taiwan and Malaysia suffered full-blown recessions.

Singapore's economy, which had grown 10.1 per cent in 2000, shrank by 2.4 per cent in 2001. The Government moved to stimulate it.

In July 2001, a $2.2 billion package was announced to ease business costs, including rebates on taxes and rentals.

In October 2001, the Government provided another boost: an $11.3 billion help package that included tax cuts and emergency cash for the poor and jobless. The building of public infrastructure was also hastened to stimulate the economy.

Says Nanyang Technological University Assistant Professor Choy Keen Meng: 'What the Government does is mainly to alleviate domestic pain, stave off retrenchments, tide lower-income workers through bad times. But there's very little we can do to stimulate growth.

'As in past crises, we recovered only when the rest of the world recovered.'

But just as the economy was finding its feet in 2003, the severe acute respiratory syndrome (Sars) epidemic struck. The tourism, travel and services sectors, which together accounted for more than 60 per cent of GDP and 75 per cent of jobs, were hit hard as visitors stayed away and confidence dipped.

The Government poured $230 million into a Sars relief package for the travel and tourism sectors.

The recovery came swiftly, however.

Prof Chew Soon Beng of NTU notes that Sars affected mainly five cities: Singapore, Hong Kong, Taipei, Beijing and Toronto. 'Singapore was affected the most as we did not have a domestic market,' he says.

The resident unemployment rate hit a high of 5.2 per cent, as some big corporations retrenched workers.

Still, the economy, which grew 4.2 per cent in 2002, hummed at 3.5 per cent in 2003 - lower than its Asean trading partners - before bouncing back to 9 per cent in 2004.

2008-2009: A bumpy ride, but opportunities exist

FOR the first time in 60 years, the economies of developed countries are set to shrink overall next year.

The International Monetary Fund (IMF) in its latest forecast this month predicts overall growth in places like the United States, Europe and Japan to shrink by 0.3 per cent then.

Over a third of Singapore's exports are bound for these markets.

Well over half of exports are also bound for Asia, but demand there is also on the decline.

The IMF projects global growth will dip from 3.75 per cent this year to just over 2 per cent next year.

The prospects are bleak indeed.

Economist Shandre Thangavelu of the National University of Singapore's economics department notes that during the Asian financial crisis 10 years ago, Singapore could export its way out to economies like the US and China.

'This time, globally, we can't find any growth bowl where we can export our way out,' he says.

'It's very hard to see when the bottom is going to come, and when it does, we'll probably stay there for a while.'

Said Morgan Stanley's Stephen Roach recently: 'The recovery in the global economy is going to have a big, wide bottom and then a very gradual up-slope in 2010 or 2011 - an anaemic recovery.'

But he noted that Asia would come out better than the rest of the world.

Even so, the latest trade figures for Singapore give little room for optimism.

Last month alone, Singapore's non-oil domestic exports to key markets declined sharply - exports to the US fell by 31 per cent, to the European Union by 14 per cent, to Malaysia by 13 per cent and to China by 9 per cent. Overall, they fell by 15 per cent.

NTU's Choy Keen Meng says one factor is that many of the exports are further processed in the region to cater to eventual demand in the US and Europe.

'We have no buffers, no offsetting pockets of strength, with all markets slowing down together,' he says.

'If this slowdown had not been so synchronised, if China and India had been holding up the fort, we could see 0 to 2 per cent growth next year. Now it's certainly flat or negative growth.'

China is forecast to grow 9.7 per cent this year, but the IMF predicts this will fall to 8.5 per cent next year.

In Chinese terms, this is however close to zero growth, as the economy needs to grow at least 6 to 8 per cent a year to absorb population growth, surplus agricultural labour and maintain expectations of a rise in income for social stability.

This month, the Chinese government announced a 4 trillion yuan (S$896 billion) stimulus plan to boost growth and ward off the global slump, with the money going to infrastructure projects such as low-rent housing, roads and railways.

India's growth is forecast at 7.8 per cent this year, and 6.3 per cent next year.

Growth in the five biggest Asean economies - Indonesia, Malaysia, Thailand, the Philippines and Vietnam - is forecast at 4.2 per cent next year.

Professor Ilian Mihov, an economist at graduate business school Insead, points out that most economists believe the growth rate in world GDP next year 'will be delivered predominantly, if not exclusively, by Asia'.

'Even though we see some flows out of the region, these outflows are not driven by lack of confidence but by simple liquidity needs of US banks and financial institutions,' he adds.

He feels that with aggressive and well-coordinated policies, the world may start seeing recovery signs by mid-2009.

These policies include expanding liquidity in the US, a resuscitation of the financial sector and fiscal stimulus by the US and other governments to up spending and boost expectations for the future.

'Without these, the recession may last 18 months or longer.'

But Associate Professor Thangavelu says that for a small, open economy like Singapore's, fiscal stimulus and domestic spending alone will help but are not enough for recovery.

What can be done is to grow productivity and train workers to prepare for when the rebound comes, and to explore growth areas for small and medium enterprises to ride out the recession.

One area worth working on, he feels, is trade within Asean countries.

'Asean is quite a big market, and although its growth is linked to external demand, this is a good time to find areas of growth within Asean itself as much as we try to couple ourselves with China and India,' he says.

'Strong entrepreneurs emerge during a downturn,' he adds.

One growth area, economists note, can be the education and retraining sector.

Prof Thangavelu notes that the opportunity cost of training during a downturn is much lower, especially for those who are laid off.

Although Singapore cannot do much to get out of recession in a crisis like this, Prof Chew Soon Beng of NTU notes that Singapore's strong reserves and stable currency can help it to make key adjustments at home.

For example, the public sector can employ more temporary staff to do work like field surveys.

Local and government-linked companies can look out for good investments abroad, but he feels they should first expand their operations here to protect the social fabric.

'When people are unemployed in Singapore and business elsewhere is weak, why not develop extra capital locally?' he says.

'Crisis means opportunity,' he adds.

'If we have less retrenchment and more training than other countries, when the world recovers, we will be the first to benefit.

'There are also firms still looking for investment. As our society is more stable, reliable and focused, we can still attract foreign investment during this global crisis.'


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