JC Economics Essay Globalization & Singapore Dollar Policy Model Answers
Since the onset of COVD-19, the topic of globalization has been in the list of Common Last Topics (CLT) that have struck off in Cambridge exams 2020 and 2021. Likely from 2022 onwards, Cambridge and JC examiners will want to re-include this section into the eventual exams, and so may set much harder questions by mixing concepts across Micro and macro Econs topics. A-Level Economics students beware!
(Read more on globalisation and WTO here.)
The following question requires JC Economics students to recognise the two components of globalisation; increased trade and increased factor mobility, and to account for how there are both costs and benefits from globalisation. Also will require pupils to assess whether Singapore’s exchange rate policy (ie the S$) is appropriate to tackle all the costs of globalisation. Students are to demonstrate understanding of the workings of exchange rate policy and justify if exchange rate policy alone is sufficient to minimise the costs of globalisation.
Question
Globalisation has its benefits and costs. In 2020, Singapore was ranked first in the globalisation index, an index which ranks the world’s 60 largest economies according to their degree of globalisation relative to their GDP. (Source: Statista.com)
Explain the economic impacts of globalisation on an economy and discuss whether the exchange rate policy is an appropriate measure to minimise the costs of globalization for the Singapore economy. [25]
Economic Impacts of Globalization
Introduction
Define globalization: Globalisation refers to the increasing integration and interdependence of the world’s economies arising from increased trade and greater international mobility of factors of production like capital and labour Briefly state the importance of globalisation to an economy. o Globalisation offers extensive opportunities for economic growth for economies, especially for a small open economy like Singapore, and partially accounts for why Singapore is ranked second the 2012 globalisation index. o Unfortunately, the openness of the Singapore economy also makes her more vulnerable to the pressures of globalisation.
Explain how globalisation benefits the economy
With freer trade, a country’s citizens can enjoy higher consumption possibilities and hence higher material living standards. According to the law of comparative advantage, a country which specialise in the production of a good that it has comparative advantage in and then trade it for other goods will be able to raise its consumption level as compared to an autarky situation. With increased consumption levels, citizens can consume more quantities of goods and services and hence enjoy higher material living standards.
Access to larger world markets is also made possible with trade and could potentially result in actual economic growth. Being a small country with a small domestic market, trade enables Singapore to overcome her domestic demand constraints and produce for a much larger world market like China and India. The additional demand for Singapore’s exports would utilise otherwise unemployed resources, raising net exports and hence aggregate demand will increase from AD, to AD₂. Real output rises from Y₁ to Y₂, and unemployment falls, achieving actual economic growth (explanation with diagram). Alternative point: In the process, economies of scale may also be reaped as fixed costs of firms can now be spread over larger quantities. This allows Singapore firms to become more cost competitive and these lowered costs of production may be passed on to consumers who then enjoy lower prices.
The inflow of foreign direct investments (FDI) from increased factor mobility also raises the rate of capital accumulation, raising long run sustainable economic growth. For instance, by basing part of its operation in Singapore, Shell plays a key role in shaping the development of Singapore’s oil and petrochemical industry. The advanced technology in oil refining and business practices brought in by Shell also increased Singapore’s overall productivity, stimulating investments, and caused the AS to shift outwards faster from AS, to AS₂, achieving potential economic growth and raising real output (diagram with explanation). Globalisation hence arguably acts as an engine of growth as it enables both AD and AS to increase farther than under autarky. In the long run, with both increases in AD and AS, long run non-inflationary growth may be attained.
Main points which include greater variety of consumption, transfer of technology, higher quality goods, the acquisition of factors of production, and overcoming labour shortages as benefits from freer trade and increased factor mobility are also accepted. Despite the abovementioned benefits from freer trade and increased factor mobility, globalisation also imposes costs on the economy.
Explain how the economy incurs costs from globalisation These can include greater vulnerability to external shocks, structural unemployment and a widening income gap. Singapore’s reliance on imports (due to her lack of natural resources) and dependence on exports mean that she is very vulnerable to external demand and supply shocks. External supply shocks, such as sudden rises in oil and agricultural prices, would greatly impact Singapore, leading to a significant rise in imported input prices, raising costs of production and resulting in imported inflation.
External demand shocks, such as a recession in other countries, is also likely to affect Singapore due to the export oriented nature of the Singapore economy. If the relative incomes of other countries fall, this would lead to a fall in their demand for Singapore’s exports, and could result in a fall in Singapore’s net exports and aggregate demand. Due to the reverse multiplier effect, there would be a further decrease in Singapore’s real income [an example of how the Global Financial Crisis has impact Singapore’s exports can be included]
Increased international labour mobility from globalisation might result in structural unemployment and greater income inequality in developed countries In Singapore, with globalisation, changes in the structure of demand and production would be more rapid. Sunrise industries, which experience high demand for their products, would enjoy faster income growth and greater job opportunities. Skilled and more highly educated labour would be in greater demand as Singapore focuses its growth on technology-intensive and knowledge-based industries. Conversely, workers in sunset industries workers may be occupationally immobile and not have the necessary skills to transit to sunrise industries. They hence become structurally unemployed.
With globalisation and increased labour mobility, the influx of cheap foreign labour would lead to competition between locals and foreign workers in labour intensive industries. Wages in these industries would decline. On the other hand, global competition for internationally high skilled talent causes the wages of such workers to increase, resulting in a widening income gap. In fact, Singapore faces a problem of income inequality evident from her relatively high Gini coefficient of 0.452 in 2020, a rise from 0.412 in 2013.), after adjustment for government transfers and taxes.
Note: Alternative points which include unfair competition, possible ‘brain drain’, labour exploitation and environmental degradation are also accepted.
Conclusion
While globalisation poses costs to the economy, the benefits of globalisation are also important to the economy. An economy should mitigate and minimise the costs of globalisation to reap the benefits of globalisation to its fullest.
Next, discuss whether the exchange rate policy is an appropriate measure to minimise the costs of globalisation.
Introduction Identify the costs of globalisation in Singapore
As mentioned earlier, costs of globalisation in Singapore include possible imported inflation due to increased vulnerability to external supply shocks, external demand shocks, widening income inequality and structural unemployment. Thesis statement: this essay would argue that while the modest and gradual appreciation of the Singapore dollar. (Singapore’s ER policy) may be an appropriate measure to minimise imported inflation, it may not be an appropriate policy to minimise the other costs of globalisation.
Thesis: ER policy is appropriate in managing low imported inflation .
Explain Singapore’s exchange rate (ER) policy: Singapore operates on a managed float regime for the Singapore dollar, which is managed against a weighted basket of currencies of Singapore’s major trading partners and competitors. The band, basket and crawl (BBC) system is used, where the trade-weighted exchange rate is allowed to fluctuate within a policy band. Singapore’s ER policy generally involves a modest and gradual appreciation of the Singapore dollar and helps to keep prices of imports relatively low, thus reducing the possibility of mild imported inflation. Also, the Singapore currency is generally undervalued. This allows the MAS to accumulate foreign currency reserves and enables the MAS to defend the Singapore dollar against a sudden depreciation. A sudden depreciation of the currency could potentially bring about severe imported inflation to the economy.
To appreciate the S$, the MAS would buy Sing dollars using her foreign currency reserves. This would increase the demand for Sing dollar in the forex. With an appreciation of the Sing dollar, Singapore’s exports becomes dearer while imported consumer goods and imported inputs become cheaper. The cheaper imported inputs would lower costs of production, and hence mitigate imported inflation. The exchange rate has emerged as an effective anti-inflation tool for the Singapore economy. Over the past twenty years or so since the exchange rate framework has been in place, domestic inflation has been relatively low, averaging 2.1% per annum from 1981 to 2012. Hence the ER policy is an appropriate measure in minimising mild imported inflation from globalisation.
Anti-thesis: ER policy is not appropriate
The modest and gradual appreciation of the Singapore dollar would be effective only against low imported inflation but not against severe imported inflation. This is due to the fact that having a sudden and large appreciation of the Singapore dollar to counter the severe external supply shocks could potentially lead to unintended negative consequences (e.g., affects the export competitiveness of Singapore’s exports). For example, the oil shock in 1973 saw oil prices rose by nearly four times and this led to a significant rose in imported input prices. This also resulted in a significant rose in production costs and the Singapore economy to stagnate. If the Singapore dollar were to be revalued by a large amount to counter the severe imported inflation, then her export competitiveness would be compromised.
S$ is not appropriate to mitigate the negative effects from external demand shocks A negative external demand shock is often caused by fall in income in Singapore’s trading partners and the corresponding decline in their demand for Singapore’s exports. In this case, the modest and gradual appreciation of the Singapore dollar would do little to help improve the fortunes of her trading partners and hence be an inappropriate policy to minimise the cost of the resultant demand-deficient unemployment and inevitable recession in the Singapore economy. Perhaps a more appropriate policy would include long term measures such as the diversification of the Singapore economic structure through the Economic Development Board (EDB) to hedge against the risk of external demand shocks.
Another appropriate policy would be initiatives like the Jobs Credit Scheme (JCS). The JCS helps mitigate the effect of a sharp downturn by alleviating business costs through the use of a subsidy and hence enables the economy to retain its productive capabilities in times of recession. With the scheme, the Government provides significant help to businesses by improving their cash-flow, retaining workers, and hence increase their ability to pick up production when the economy eventually recovers.
ER policy is not appropriate to manage structural unemployment and income inequality As structural unemployment and rising income inequality is largely due to the influx of cheap foreign. workers, the aforementioned exchange rate policy would neither help solve the root cause of the problem, nor mitigate the costs of unemployment and income inequality. Therefore it is an inappropriate policy, as it neither helps make labour more mobile nor facilitates the transfer of income from the higher income earners to the lower income group.
To minimise structural unemployment and income inequality, supply-side policies would be more apt. For instance, the Workforce Development Agency (WDA) provides special assistance for low-wage workers to help them progress into better paying jobs through the Workfare Training Support (WTS) scheme. The WTS scheme heavily subsidises up to 95% of approved courses, and absentee payroll, better resolving the inherent market failure from the training of workers. This scheme gives workers with lower earnings an incentive to upgrade their skills and undergo training so they may obtain the relevant skills to transit to a job possibly in a sunrise industry, hence resolving structural unemployment.
To promote greater income equality, the Wage Income Supplement (WIS) scheme that is a form of “negative income tax is implemented. Cash and CPF grants are given to low-wage workers who are employed for at least 3 out of every 6 months. With these grants tied to employment, this creates an incentive for workers to find work and to remain employed.
Singapore’s progressive income tax structure that taxes higher income groups proportionately more than the lower income groups, and the giving of GST vouchers that serve as transfer payments to lower income households, also serves to redistribute income from the rich to the relatively poor. These measures to provide financial support to lower income groups in Singapore would thus alleviate income inequality. In general, supply-side policies would thus be more appropriate in resolving the costs of income inequality and structural unemployment from globalisation as compared to the ER policy.
Conclusion:
To assess whether a policy is appropriate in minimising the costs of globalisation, one needs to consider if the policy can help to alleviate the main costs of globalisation effectively. The appropriateness of a policy is often contextual, and will change with time and severity of the negative impacts. For instance, given the severity of Singapore’s current income inequality problem, policies that can effectively and efficiently distribute the gains from globalisation would be more appropriate than the other policies mentioned.
The question also assumes that there can be only one policy that is appropriate to minimise the costs of globalisation. In reality, the contributing factors to the costs of globalisation are much broader as an economy can suffer from more than a singular cost of globalisation. For example, while the ER policy would be useful in minimising imported inflation, it is arguably not entirely appropriate alleviating current inflationary pressures in Singapore. As domestic sources of inflation (e.g., rising housing prices due to cheap credit fuelled by quantitative easing) become progressively significant, the ER policy may not be as useful in managing the overall inflation in the economy since it mainly targets external sources of inflation.
The Tinbergen Principle, which states that for each and every policy target there must be at least one policy tool, dictates that a mixture of supply-side policy and exchange rate policy may be most appropriate strategy to manage the two sources of inflationary pressures in Singapore.
In conclusion, the use of exchange rate policy is appropriate in managing imported inflation but may not be appropriate in mitigating all the other adverse effects of globalisation. Alternative policies such as supply side policies may also be appropriate in managing the costs of globalization.
H2 Econs Essay Mark Scheme:
L3: (16-20m) For an analytical answer that conveys understanding and assesses whether exchange rate policy is an appropriate measure, and suggests alternative policies.
L2: (10-15m) For a developed but unbalanced argument on the benefits and costs of globalisation, and how the exchange rate policy can manage inflation, with limitations, OR an explanation on an alternative policy that addresses other costs of globalisation.
L1: (1-9m) For an answer that briefly displays knowledge of the benefits and costs of globalisation and exchange rate policy.
E2: (3-5m) For a well-substantiated opinion with economic analysis.
E1: (1-2m) For a non-substantiated opinion without economic analysis.
JC Econs Examiner’s comments:
Candidates were generally able to explain the benefits and costs of globalisation, and some used relevant, world examples that were specific to Singapore. However, there were several misconceptions. Some candidates discussed trade creation and trade diversion as benefits and costs of globalisation respectively. while others confused the trends or causes leading to globalisation as the benefits of globalisation.
Quite a number of candidates did not reflect awareness that the exchange rate policy aspect was the focus of this question. One major misconception was that a large minority of candidates wrote about the Marshall-Lerner condition in relation to the AD-AS model, instead of linking it to the balance of payments. Some students did not focus on the Singapore context and wrote about depreciation and appreciation in general. Candidates who were able to evaluate the exchange rate policy in the Singapore context, demonstrate understanding that the main objective of the exchange rate policy is to fight inflation, tended to score better. Overall, the discussion part of the question was not as well done as the earlier part. A minority of candidates. were able to integrate the two aspects together and presented a coherent argument, and they tended to fare better than students who spent much of their time on explaining benefits and costs rather than answering the question holistically.
Econs Essay #82 | Econs Essay #84 | More International Economy H2 Economics Essays