JC Economics Essay COVID-19 Recession & Singapore SOL Model Answers
In 2020, Singapore slumps into a recession, the worst since independence in 1965, with a 41.2% fall in quarterly GDP. Imagine this, despite over S$100 billion into the economy, S’pore still experienced a record 5.8% in a pandemic-hit 2020! The next obvious question is, how did it impact SOL? It is less obvious than it seemed…
(More info in Macroeconomic Review.)
Question
In 2020 the Singapore economy was facing a recession. GDP grew slightly by 1.3% in 2019, according to World Bank, but in 2020, it fell 5.8%. Several business bodies have suggested the government to consider reductions in corporate tax rates. (PwC SG and Deloitte )
(a) Explain one factor of the reason for the recession in SG during COVID crisis, and explain what might happen to national income if the Singapore government were to reduce corporate tax rates.
(b) Discuss whether the fall in GDP mentioned above necessarily meant that the standard of living (SOL) for the average person in S’pore also worsened.
JC Economics – National Income Changes, Leakages & Multiplier
Body:
Singapore is a small and open (SOE) economy, so for her, AD = C + I + G + )X-M, with (X-M) being the largest aggregate demand (AD) component. So the health crisis, leads to an economic crisis. X fell. Reasons for the fall likely is for in demand for X. Foreign incomes fall, our trading partners view Singapore goods as normal goods, so fall in comes lead to fall in demand for our exports.
Also possible is our strong S$. This implies a higher price of exports. The demand for our S’pore exports are likely to be price elastic. (Justify with a determinant). So quantity demanded for exports fall by more than proportionate , hence export revenues fall, leading to a lower AD, and therefore a sharp recession.
next, national income refers to the income generated from the production of goods and services by residents of a country within a specific period of time (usually a year). It is often used as an indicator of the level of economic activity in a country.
A reduction in income tax rates essentially raises disposable income, and raises aggregate consumption (c). This in turn stimulates the demand for consumer goods and services. The consumption function and hence the Aggregate Expenditure (AE) function, shifts upwards. Similarly, a cut in corporate tax rates (flat rates) would be favoured by the business community as this has a great impact on firms’ profitability. A reduction in corporate tax can help to increase firms’ after-tax profits and boost investment outlays by firms, resulting in an increase in investment expenditure, leading to an upward shift of the AE function.
However, as the marginal propensity to consume (MPC) rises (since MPC=1-MPW, where MPW-MPS+MPT+MPM), the joint effect is a non-parallel upward shift of the AE function. The personal income tax cut raises the opportunity costs of leisure so that an extra hour of leisure now involves a bigger sacrifice in consumption. Moreover, tax cut increase the willingness of women to return to employment after having brought up a family. Thus, people substitute work for leisure and work more, resulting in an increase in Come. Corporate tax cuts can lead to substantial increase in economic activity and national income via the multiplier.
With reference to Figure 1, AE shifts from AE, to AE₁, ceteris paribus, resulting in an increase in national income (NY) from Yo to Y₁. The increase in NY is greater than the increase in AE (AAE), as explained by the multiplier process.
(This Y=AE diagram is no longer in the new syllabus of 9757. Use the table to illustrate multiplier process instead)
For example, if MPC=0.8, this means that 80% of any additional income received will be spent on consumption. Thus, if AE initially rises by $100m due to higher level of investment (due to the tax cuts), the immediate effect is an increase in NY of $100m. This leads to an increase in demand for capital goods. Firms involved in the production of capital goods will increase their output level to meet the increased demand. This will lead to more factor of production being employed in this industry. This then induce households to spend a portion of this increased income according to their MPC. Hence, this will be an increase in consumption by $80m and a leakage of $20m. The increased consumption will further induce firms producing consumer goods will employ more factors of production to meet the increased demand. Household receiving extra income will spend part of the additional income ($64m) and a portion ($16m) is leaked away from the circular flow.
The rounds of spending and re-spending will continue, however, the increase in spending diminishes in each round. The process stops when the change in C is too small to further affect NY. The eventual increase in NY is the sum of the successive rounds of spending generated by the initial increase in AE. The total effect on national income will be ANY=$100m + $80m + $64m +… $500m. The final increase in income is five times the initial increase in AE, which implies that the multiplier has a value of 5. However, the rise in Y, resulting from cuts in tax rates could make households increase net imports and/or save more through an increase in disposable income. These leakages have potential effect of reducing the value of the multiplier and hence reduce the resultant increase in income.
(Sg’s multiplier value is 1.6)
The stimulus measures proposed by the biz bodies in Singapore, aimed at boosting domestic demand may only have limited effect. They are unlikely to shift income very much because Singapore’s future is tied to the global economy and without a recovery in key export markets (US, Japan, SEA and Europe), the economic effect is limited. Moreover, the negative economic outlook in this period of time will induce many to save rather to spend.
Hence, the temporary tax cuts are likely not going to receive the full effect as projected. It may briefly restore the competitiveness that was lost due to the high cost of doing business in Singapore. There is no single fiscal measure that will work miracle for the economy. What is needed is a package of carefully crafted fiscal measures aimed at boosting short and long term economic growth.
JC Economics – Standard of Living with Material & Non-Material Aspects
Suggested Answer for Part (b)
Gross Domestic Product (GDP) is the monetary values of final goods and services produced by an economy within domestic territory over a given period of time, usually a year. It gives an indication about the level of material standard of living (SOL), since it indicates the amount of goods and services available for consumption. SOL is a multi dimensional concept, which is not fully quantifiable because non-material SOL covers the intangible aspects, such as stress level, life expectancy and quality of environment.
Conventionally, SOL is measured by GDP per capita, to indicate the average purchasing power and thus material living standard of an individual. Theoretically, a fall in GDP over time would result in declining SOL, holding all other things constant. A diminished national output is now shared among the same number of people so that each person gets less now. In material aspect, this represents a fall in economic welfare. In SG, the continual rise in population would have led to falling living standards. But, a fall in GDP over a one-year period as mentioned in the question is unlikely going to result in any perceptible change in SOL. Moreover, the SOL of an average person is unlikely going to decline sharply, since the fall in GDP is shared among a large number of people. Hence, living standard of an average person declines but it may not decline sharply. In addition, the change in prices is not taken into account. There is a need to deflate GOP per capita to obtain real GDP per capita to eliminate effects of inflation on purchasing power over the one-year period. The possible decline in price level during economic downturn seems to suggest that the average person in Singapore might be better-off after all despite a falling GDP, where the decline in GDP is outweighed by the decline in prices.
Income distribution may have gone less skewed, which suggests standard of living of an average person may not have declined sharply. If the decline in real GDP is shared out in a more equal way, increasingly going to the vast majority the average person could not have suffered a sharp decline in SOL. Among the several other help given, there were rebates on utilities bills for the same group that cost the government nearly S$100B. A possible way to address this limitation is to obtain more information on the income distribution such as the Gini co-efficient values for years 2020 and 2021.
Finally, if we take the wider definition of SOL that includes the non-material SOL (or of GDP per quality of life), then even real GDP per capita is going to be inadequate as one needs to capita include intangibles, such as level of externalities and amount of leisure hours.
Negative externalities in both production (eg. environmental damage) and consumption (eg. traffic congestion, higher medical expenses) are all not captured by the GDP statistics. With a decline in GDP, the level of negative externalities may fall, possibly leading to an improved quality of life. Hence, one cannot accurately claim that the SOL of an average person had declined sharply. Longer working hours and more stress at work are also not captured by the GDP statistics to make any meaningful conclusion to the living standard. In fact, the shorter working week and compulsory extended leave from work enforced by many firms during recession resulted in increased leisure time for the people which can translate to more quality time for families. This may improve the non-material aspect of SOL and hence the living standard of an average person may not have declined sharply due to a decline in GDP.
In conclusion, real GDP per capita is not a perfect measure of the quality of life. However, it is still a useful yardstick of the living standard if the above limitations are addressed and its use is further supplemented by other social indicators such as life expectancy, literacy rates, health standards, and environmental data. Alternative measures which give a more comprehensive measurement of the SOL have surfaced. One such measure is the Human Development Index (HDI), which includes PPP-adjusted GDP per capita (in US$), adult literacy rate and life expectancy at birth. This measure is a better indicator of SOL as it takes into consideration both material and non-material SOL, hence it will help us to determine whether the SOL of an average person has indeed sharply declined in 2020.