JC Econs Globalisation & Macroeconomic Goals Essay Model Answers
A sample question on Globalisation & Macroeconomic Goals, specifically recession, economic growth, & sustainable Growth and its application to Singapore economy, with the harmful effects of globalisation.
Question
The two casinos set to open in the Integrated Resorts (IR) in Singapore are part of the government’s longstanding effort to re-orient the economy toward higher-value service industries like tourism and blosciences as It loses manufacturing competitiveness to China.
Source: New York Times, 2010, 2006
Explain the rationale for the above policy and discuss whether it is the best policy to achieve the government’s macroeconomic goals in a globalised world. [25]
JC Economics – Economics Changes To Higher Value Added Industries in S’pore
Part 1: Explain the rationale to “reorient the economy toward higher-value services industries”
Loss of comparative advantage Many countries, including Singapore, have lost their comparative advantage in manufacturing to China with its abundant supply of labour who are willing to work for long hours at relatively low wages.
Effect on the macroeconomic goals
The shift in comparative advantage has repercussions on both investment and exports:
- China has emerged as a more attractive destination for FDI, giving Singapore a miss. Firms operating within Singapore are also shutting down their facilities here and relocating to China. With its lower cost of production and an under-valued yuan, exports from China are also cheaper relative to those from Singapore. Assuming a close degree of substitutability, demand for exports from Singapore will experience a greater than proportionate decrease as the relative prices increase.
- If nothing is being done about it, the loss of investment and export competitiveness may result in worsening BOP, an excess supply of the Singapore dollar in the foreign exchange market and a downward pressure on the Singapore dollar.
- For a country that relies on external demand to fuel its growth, the decline in FDI & export revenue will bring about sharp decline in the overall level of AD. Depending on the initial situation of the economy, a decline in AD may or may not be welcome. If the economy is facing demand-pull inflation, a decline in AD helps to curb the inflation. If the economy is not facing risk of over-heating, the reduction in AD may throw the economy a recession with NY falling and UN rising. [sketch diagram]
Explain the move to develop higher-value service industries like tourism and biosciences:
In view of the loss of comparative advantage in manufacturing, one solution is to move the resources into areas where Singapore has a potential comparative advantage as part of the country’s economic restructuring. The government hopes that investment and exports from the higher-value services industries will help to compensate for the loss in manufacturing and continue to provide growth and jobs for the local economy.
The range of possible policies:
Policy to deal with the competitive pressure of globalisation
Develop higher-value service industries like tourism and biosciences
This involves the government investing in the provision of infrastructure and training facilities. Fiscal incentives such as tax breaks could also be given to selected industries. For example, the government has built the Biopolis to house the various research institutes and laboratories and expanded intake into biosciences courses at the polytechnics and universities. The government might also relax certain rules. For example, the government has, for the first time, allowed casinos in the two integrated resorts.
Effect on the macroeconomic goals
Increase G, I and X
Improvement in CA and KA balance
Increase in dd for Sing dollar (S$)→ER appreciation Increase in AD → increase in NY and reduction in UN (reinforced by the multiplier & accelerator effects)
Increase in AD → may be inflationary in the SR Increase in AS in the LR non-inflationary growth
Evaluation of development of new growth industries:
Long gestation period-many years and months before the projects are completed and the facilities are ready.
This involves increased government spending which may result in budget deficit. Fortunately, Singapore has reserves accumulated from past surpluses. This helps to avoid deficit financing problems such as crowding-out effect and higher national debt.
May result in structural UN in the SR as workers who lose their jobs in the manufacturing sector do not have the relevant skills to be re-employed in the service industry
Depends on attitude of workers towards the training. Even as more training opportunities in biosciences are made available, students may not necessarily enroll in these courses, depending on their interests. In many developed countries, physical sciences and engineering courses are losing in popularity to the softer options like liberal arts and social sciences.
Compared to the countries in the region, Singapore has limited tourism resources e.g. beaches in Bali, rainforest in Sarawak, historical relics such as Angkor Wat. Whether the construction of the integrated resorts with casinos will be sufficient to draw tourists is still uncertain. Besides, competitors, with their huge expanse of land, can build many more of such resorts.
In contrast, the biomedical and pharmaceutical exports have shown strong growth. But biosciences, while helping to create high-end jobs, do not require huge labour force. It is also difficult to train workers with only secondary school education for jobs as researchers.
Exchange rate policy
To be competitive with the emergence of China, MAS can devalue the Singapore dollar.
Effect on the macroeconomic goals:
Px decreases in foreign currency terms, leading to a more than proportionate increase in quantity demanded, assuming dd for X to be elastic. TRx thus increase. At the same time, PM increases in domestic currency terms, leading to a more than proportionate decrease in quantity demanded, assuming demand for M to be elastic. TEM thus falls.
Investment in Singapore will be cheaper in terms of foreign currencies, attracting more FDI. With an improvement in both CA and KA, BOP improves.
As net exports and I increase, AD rises, bringing about increase in NY and employment. The increase in AD could be inflationary if there are no idle resources or in the presence of structural rigidities.
Evaluation of S$ Policy
In the SR, dd tends to be inelastic for reasons such as time required to collect info on prices & source for substitutes. As such, the CA could worsen in the SR can bring about a contractionary effect on the AD.
While the weakening Sing dollar may help to restore the economic competitiveness somewhat, it puts Singapore at risk of higher imported inflation. Given the high import content of Singapore’s exports, the benefits of a weaker exchange rate on export competitiveness is also questionable. The move by MAS to devalue the Sing dollar could be countered by competitive devaluation of the other currencies.
Supply-side policies
Productivity improvement: Training, R&D, adoption of latest technology or more efficient methods of production. Encouraged by fiscal incentives e.g. subsidies, tax breaks, low interest loans, etc
Productivity improvement helps to keep down unit labour cost (wage cost per unit of output) even as wages are higher than competitors
Effect on the macroeconomic goals
Productivity improvement enhances the economy’s productive capacity, shifting the LR AS rightwards. Economic growth rises while inflation decreases.
The reduction in inflation improves export competitiveness. As export prices fall, assuming dd for X to be elastic, quantity demanded increases by a greater than proportionate amount, adding on to the overall export revenue and the CA of the BOP. Productivity improvement also attracts FDI, adding on to the KA.
The increase in X & FDI creates greater demand for S$, pushing ER upwards. The FDI also helps to reduce unemployment and further adds on to AD in the SR & AS in the LR.
Evaluation
Long gestation period – particularly for R&D
The local pool of research scientists and engineers is limited.
Incomes and wages (Prices) policies
Incomes policy, by keeping labour costs down, helps to lower the overall cost of production. These include voluntary wage restraints and reduction in employers’ CPF contribution rate.
Alternatively, the government could set guidelines on the rate of wage increases permitted. For example, wages may not be allowed to rise faster than the rise in labour productivity. This helps to check the unit cost of production in the face of low-wage competitors.
Effect on macroeconomic goals:
Keeps down COP → increase in SRAS → reduce inflation & increase NY
Lower labour cost →less urgent for firms to resort to retrenchments to cut costs the maintain profitability. Lower COP attracts FDI & improves X competitiveness → improvement in BOP and appreciation of ER.
Evaluation
For such policies to work, there must be cooperation among the government, employers and trade unions. In Singapore, this tripartite body is the National Wages Council (NWC). The NWC wage recommendations may have limited effect because they are mere recommendations and firms are not obliged to observe the recommended wage restraints.
Wages are downward sticky, i.e. wages tend to rise but not fall in reality. Firms may be reluctant to cut wages for fear of impact on workers’ morale and productivity. Another reason is that wage restructuring to raise the variable component of wages has limited success among private employers. Given that productivity growth varies across industries and even between firms of the same industry, to have one blanket wage recommendation for all firms may not be very useful.
Where wages are reduced, this may spell hardship for the poorest workers. The reduction in wages depresses consumption and may cause NY to further contract and UN to rise.
Synthesis & Evaluation of Policy Option for SG: Comparison of possible policies.
. In a globalised world where new competitors emerge and comparative advantage keep shifting, countries cannot always rely on devaluation to maintain their economic competitiveness. The use of devaluation weakens the incentive of domestic firms to innovate and improve on their efficiency in order to compete. Frequent devaluation will also lead to a loss of investors’ confidence. All these impede the LR economic growth of the economy. Devaluation, is at best, a short-run policy in response to rising competition.
Similarly, where new competitors are constantly emerging, it is neither realistic nor possible to continuously cut wages to maintain competitiveness. The overall effect of wages policy on the level of AD and NY is also uncertain.
In contrast, the policy of developing high-value service industries is important in response to the shifting comparative advantage in a globalised world – as Singapore loses its comparative advantage in traditional manufacturing, it needs to develop new areas of growth as a long term survival strategy. By moving up the value chain, this helps Singapore to avoid direct competition with China. However, the problem with “picking winners” is that government may not identify correctly the industries with the potential to develop comparative advantage. Picking the wrong winners results in resource misallocation and a lower standard of living.
Despite the potential risk, the policy of developing higher-value service industries seems to be the best bet in a globalised world where comparative advantage are shifting rapidly as new competitors constantly emerge. However, one must note that it is not the movement towards higher-value service industries per se but constant economic restructuring that keeps the economy one step ahead of its competitors.
Other than developing new areas of growth, existing industries can maintain their competitiveness through productivity improvement. After all, in terms of manufacturing wages, China is not the lowest. Wages in Bangladesh and Vietnam. are even lower but China is able to continue to draw investment and outsell these other countries due to its more efficient infrastructure, higher labour productivity and the huge size of its domestic market. While the domestic market of Singapore is small, the eventual formation of the ASEAN Free Trade Area (AFTA) enlarges the size of the market, making it an attractive destination for FDI.