Monday, October 25, 2010

Singapore Economic Policy Forum

Oct 25, 2010
Pragmatism, eclecticism are S'pore's two 'isms'

These are excerpts of a speech by Permanent Secretary (Trade and Industry) Ravi Menon at the Singapore Economic Policy Forum last Friday.

ECONOMIC policy is at an inflexion point. The financial crisis of 2008 to 2009 has altered the way we perceive the free market. The idea that competitive markets are sufficient to ensure efficient outcomes and stable economies is under heavy intellectual fire. Barry Eichengreen says the crisis has 'cast into doubt much of what we thought we knew about economics'. Paul Krugman says that much of the past 30 years of macroeconomics was 'spectacularly useless at best, and positively harmful at worst'.
But rumours of the demise of market-based economics are premature.
The balance between markets and government is the central issue in policy debates over economic development.
The crisis has revealed significant imperfections in market mechanisms: information asymmetry, moral hazard, systemic risks, and behavioural or non-rational motivators of choice. It has also revealed the inherent limitations of government: In a globalised and complex economy, governments have fewer levers to pull, and these levers are less potent than before. Neither market fundamentalism nor central planning has worked.
As we look for a new paradigm, each country will have to find its own balance between markets and government.
The two 'isms' that perhaps best describe Singapore's approach are: pragmatism - an emphasis on what works in practice rather than abstract theory; and eclecticism - a willingness to adapt to the local context best practices from around the world.
Singapore's approach can be summed up as: Governments need markets and markets need government.
First, governments need markets. That the market plays a central role in Singapore is well-known. According to the World Bank, Singapore is the easiest place in the world to do business. According to the Heritage Foundation, Singapore is the freest economy in the world, after Hong Kong. There are virtually no import tariffs, no export subsidies, no exchange restrictions, no price ceilings, no minimum wage, no rent control. Income tax rates are among the lowest in the world, and government expenditure as a percentage of GDP well below most countries.
Equally, if not more importantly, government policies have been strongly guided by the application of market principles. Be it in industrial policy, medical insurance, congestion pricing, social security, regulation of utilities, or allocation of land, Singapore has assiduously applied market mechanisms and price signals. 'Getting the economics right' has been a hallmark of governance.
Second, markets need governments. Economic development does not occur naturally. It needs pre-conditions, and if these do not exist, government needs to create them. Markets function best under some exacting conditions - rule of law, perfect information, absence of coordination failures, and no monopoly power.
But the irony is that governments sometimes have to be in markets to en-able these conditions.
This is where free marketers are disenchanted with Singapore - the Government has never hesitated from guiding the development process or intervening in markets where it believes such intervention will lead to superior outcomes.
The objective of government intervention in Singapore is neither to suppress nor to supplant markets, but to support and sustain them. Government intervention has sought to harness the power of the market to manage and grow the economy.
Reasonable people have argued - and quite rightly so - that not all of the Singapore Government's interventions have worked. But that is a reason to scale back, modify or even withdraw the intervention, not to reject the role of government altogether.
Adapting from a framework first proposed by Dani Rodrik to describe the role of institutions, let me illustrate how government in Singapore has intervened to try to make markets work better, in four key respects.
First, the Government has sought to enable markets. This includes ensuring rule of law, property rights and public infrastructure - functions that most governments perform. But in Singapore, enabling markets has also included industrial policy and capability development, subjects of continuing controversy in policy circles around the world.
Second, the Government has sought to regulate markets. This includes supervision of the financial sector, competition regulation, and taxation of negative externalities. A key feature of Singapore's approach has been the shift towards lighter regulation accompanied by risk-based supervision.
Third, the Government has sought to stabilise markets. This is the bread-and-butter of macroeconomic management. Singapore's basic approach in monetary and fiscal policy is not far from global practices.
But its efforts to address asset price inflation and credit crises are interesting examples of targeted interventions that harness market forces.
Fourth, the Government has sought to legitimise markets. Globalisation, free trade, and open markets lead to significant dislocations. Some of the sharpest debates over the role of governments centre on this: To what extent should governments facilitate adjustments, redistribute incomes or provide social safety nets, so as to maintain public support for market-oriented policies? Singapore has sought to find its own middle ground on this complex challenge.

Industrial policy: Guts to let losers go

SINGAPORE'S industrial policy makes a good case for how judicious government intervention has enabled the market to spur structural transformation and growth.

It is not simply a case of 'picking winners'. Rather, the Government has focused on addressing market failures that stand in the way of cluster development.

One common market imperfection is coordination failure. The demand for a particular activity often depends on whether other complementary activities are already in place. This requires some form of central coordination. For example, hotels will be built next to a beautiful beach resort only if there is an airport and roads to bring tourists to the resort.

The growth of Singapore's chemicals cluster illustrates this well. Singapore had managed, in the 1960s and 1970s, to grow a viable petroleum refining industry despite having no oil and gas of its own.

The next step was to move up the value chain to petrochemicals. The 1980s saw a global boom in petrochemicals and an unprecedented wave of investments into Asia. But competition from low-cost locations was keen. To overcome Singapore's cost disadvantage and grow a viable chemicals cluster, it was necessary to move 'downstream' to the production of higher value-added speciality chemicals. But such an integrated development would require much land - which Singapore was obviously short of.

The Economic Development Board, or EDB, hatched an innovative plan to reclaim and amalgamate seven islands in the south-western part of Singapore, where the existing oil refineries were located. The Jurong Town Corporation, or JTC, led the Government effort to create an integrated 'chemicals island' - Jurong Island.

In the years that followed, company after company came to Jurong Island: a 'who's who' of the global chemical industry - Chevron, Sumitomo, Mitsui, Exxon, Shell and others. When Jurong Island officially opened in October 2000, petrochemical-related companies had invested more than $20 billion on the island.

The key to Jurong Island's success was not infrastructure per se, but government-enabled industry integration. Companies came together in one location, supported by common pipeline corridors and a fully integrated logistics hub. They could buy and sell their products and services from one another 'across the fence'. Horizontal linkages allowed different plants to outsource and share common services such as warehousing and waste treatment.

Another source of market failure that Singapore's industrial policy has sought to address is information and learning spillovers.

Firms under-invest in economic activities where the private returns to these investments are lower than their social benefits. The Government provided firms the incentive to invest in higher value-added activities while building the capabilities of the workforce to undertake these activities. Take for example the growth of the electronics cluster - the linchpin of Singapore's industrialisation. The engineering and technical capabilities associated with the electronics industry are highly transferable.

Singapore's electronics industry began in the 1960s with the packaging of semiconductors. The Government awarded pioneer status tax incentives to multinational semiconductor companies, like General Electric and Texas Instruments, to set up assembly plants in Singapore.
If the story had ended there, Singapore's industrial policy would have been quite unremarkable. In the 1970s, Singapore started to lose competitiveness in labour-intensive activities like semiconductor assembly. The Government allowed them to be phased out. Then Minister for Finance Goh Keng Swee, the architect of Singapore's economy who shaped Singapore's approach of combining markets and Government, took a cold, rational approach. He famously characterised semiconductor assembly operations as employing workers who were 'less skilled than barbers'. Dr Goh told EDB that he would no longer approve pioneer status tax incentives for semiconductor assembly operations. Singapore was forced to move up the technology ladder.

At this time, Seagate was looking for a low-cost location in Asia to manufacture hard disk drives. EDB collected quotations from small and medium-sized enterprises based in Singapore to convince Seagate that Singapore could provide the necessary components at a lower cost. Thus began disk-drive manufacturing in Singapore, which soon became the world's largest producer of Winchester hard disk drives.

The same thing happened in the 1980s and 1990s. As the hard disk drive industry came under competitive pressure, the Government started to create the market conditions to woo computer manufacturers. Singapore also went into hard disk media and wafer fabrication of microchips.
The capabilities built up in electronics have positioned Singapore well for the industrial clusters of tomorrow, such as clean technology and medical devices.

Besides a focus on overcoming market failures, a distinguishing feature of Singapore's industrial policy is its strict adherence to market principles. The Government has never subsidised the running costs of firms. There are no protective barriers. There are no bailouts. The market, not Government, decides whether a company is viable. Many firms have gone under; many others have relocated from Singapore to more cost-competitive locations. As Professor Ricardo Hausmann puts it: 'What distinguishes a good industrial policy is not the ability to pick winners, but the guts to let losers go.' Dr Goh would have agreed heartily.

Social safety nets: The right balance

IT IS sometimes said that Western economies adopted the welfare state to save capitalism from itself. There is some truth to this. But this model is now under pressure from rising expectations and ageing populations.

Globalisation has added a new twist to this challenge. Free trade and open markets are being blamed for widening income inequality and median wage stagnation. Hence, the rise in protectionism and xenophobia in many parts of the world.

Singapore has always subscribed to the principle of social inclusion. But the experience of other countries has given Singapore much reason to be cautious in the design of its social safety nets. The growth of the welfare state has been associated with an eroding work ethic, a deteriorating fiscal position, and a growing entitlement mentality.

Self-reliance is the basis for a healthy work ethic; it drives private initiative and enterprise. How does Singapore foster social inclusion while safeguarding the culture of self-reliance?
First, it provides massive subsidies for education. It is well known that education promotes social mobility. But in many parts of the world, this has not been the case because there are wide differences in educational opportunities that depend on socio-economic status.

Singapore has invested heavily in ensuring a high quality of education across the spectrum and made it highly affordable for all income groups. This is perhaps why the premium in test scores that Singapore students enjoy over students from other countries is widest for those in the bottom half of the education system.

This is not to suggest that starting positions do not matter in Singapore. They do. But they matter less because of the levelling effect of education.

Second, the Government has intervened substantially in making home ownership affordable for the vast majority of the population. Low-income families get a grant to purchase public housing flats, which are subsidised to begin with and come with a subsidised loan. Housing is an appreciating asset that promotes social mobility, financial security and a sense of pride and belonging.

Third, the Government provides a wage supplement to low-income workers. Faced with growing income inequality, Singapore has adopted a 'workfare' model instead of a 'welfare' model. Under a traditional welfare approach, the state insures citizens against a wide range of risks, especially unemployment and illness. But under a workfare approach, benefits are targeted at low-wage workers. Tying government transfers to work avoids the moral hazard problems associated with unconditional transfers to the poor. Workfare redistributes incomes, while preserving the work ethic and promoting self-reliance. It covers nearly 20 per cent of the workforce, providing wage supplements of up to 20 per cent of the incomes of low-wage, older workers.

But no government intervention is without distortion. It has been argued that Singapore's social safety net system is perhaps too heavily biased towards housing and that this comes at the expense of cash savings for retirement. Workfare payments may have contributed to reduced productivity by retaining in the workforce more lower-skilled workers than might have been the case.

There has also been criticism that Singapore's social safety nets are not sufficient - especially for the disabled, the aged destitute, the unemployable. We must continually seek incentive-compatible solutions to these problems, bearing in mind the risk of unintended consequences.
The crisis has shaken our confidence in both markets and governments. Both markets and governments have been found wanting. What we need is not more of one and less of the other. We need both to be more effective and to work in closer collaboration, so public interest and private initiative are better aligned. As economist Amartya Sen puts it: 'The invisible hand of the market has often relied on the visible hand of government.'

Singapore's experience is that market principles are necessary to help government work better, and good government is necessary to help markets work better. This is not to suggest that Singapore has got the balance right. Far from it. Singapore is still an experiment, a work-in-progress. If anything, the key take-away from the Singapore story is to keep an open mind, measure outcomes, continually review policies and learn from mistakes. Prag-matism and experimentation must become the watchwords in public policy.

The choice is not between big government and small government. It is about creating effective government. What matters is what governments do, not how big they are. The size of governments may well have to shrink - the revenue base in most countries will be capped by competition and demographics. But the responsibilities of government may well have to expand - to enable, regulate, stabilise and legitimise markets so they can work better. Getting the balance right between markets and government will be key to improving the standard of living and welfare of our fellow citizens.

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