JC Econs Essay Internal Stability of Singapore Economy Model Answers
In Singapore, maintaining internal stability is one of SG Gov’s main objective, and it includes achieving full employment (or low unemployment, unN), particularly 2.6% to 2.8%, compared to 4-6% for the rest of the world. (Why is S’pore so much more stringent for her unemployment objective?), low inflation rate, and high and sustained economic growth.
To achieve this goal, the S’pore gov has to adopt myriad of macro econs policy such as Exchange Rates Policy, which is the lowering of the Singapore Dollar. What other polies are required?
Question
Due to COVID-19, the global outlook for 2021and 2022 is uncertain. USA continues to recover. However, Europe’s growth remains weak and Asia is facing the effects of a slowdown in China. We may have to expect prolonged stagnant growth in the global economy, which would affect investor confidence.
(a) Explain how the prolonged stagnant growth in the global economy would affect Singapore’s internal stability. [10]
(b) Discuss alternative policy measures that the SG government could adopt to maintain rising real incomes in S’pore . [15]
JC Economics – Internal Stability: Inflation, Unemployment & Economics Growth
Suggested Answers for Part (a)
Introduction:
Singapore is highly dependent on external trade for economic growth with exports comprising around 400% of our GDP. imports and Weak growth and a slowdown in our major trading partners will result in a slowdown of our own economic growth and hence employment. As hinted in the preamble, if the growth is expected to be stagnant for a prolonged time period, it could lead to negative expectations and a fall in economic growth instead.
Body:
Scope 1: Sluggish growth in the global economy leading to a fall in expectations (i.e. negative growth in NY of global economies) The effects of growth in the global economy on the Singapore economy can be analysed using the AD-AS model.
Define stagnant growth: Economies in the world are experiencing low growth rates, meaning that national incomes are increasing at a slower rate. Due to the negative expectations of lower future incomes and lower profitability, consumers in the rest of the world would cut but on consumption. Firms expecting lower profitability would also cut back on investment spending. The combined effect of a fall in consumption (C) and investment (I) would lead to a fall in AD and national income in these nations. They would thus consume less including Singaporean imports leading to a fall in demand for Singapore’s exports.
As the demand for Singapore’s exports are likely to be income elastic as we tend to export high end electronic components as well as pharmaceutical products, a fall in world incomes would lead to a significant fall in the demand for Singapore’s exports. Hence there would be a fall in export revenue, ceteris paribus. The poor business confidence as explained above would also lead to a fall in FDI into S’pore and hence a fall in I for SG. The combined effect of a fall in C and I would lead to a fall in AD and a more than proportionate fall in national income/output due to the reverse multiplier effect.
The multiplier is based on the proposition that expenditure generates income and income generates expenditure. With an fall in national output due to a fall in aggregate demand, there would be a fall in demand for labour which is a derived demand. This will lead to an increase in cyclical unemployment. The fall in AD would also lead to a decrease in GPL as producers faced with falling demand would see an increase in their inventories and cut back on production and reduce prices.
Scope 2: Sluggish growth in the global economy (i.e. slower increases in NY of global economies) Slower increases in national incomes in these countries which would lead to a smaller increase in consumption of goods and services including demand for imports from other countries. This would lead to a slower increase in demand for Singapore’s exports, The smaller increase in demand for exports would lead to an smaller increases in export revenue a smaller increase in net exports ceteris paribus. The increase in net exports is unlikely to be very large due to the weak economic growth in Singapore’s trading partners.
The smaller increase in (X-M) will increase AD by a smaller extent as illustrated by a smaller rightward shift of the AD from AD, to AD, in Figure 1 below. Brief explanation of the multiplier process. Real national income may not increase by the full multiplier effect if the economy is nearing full employment, as there is also an increase in general price level. Real national income increases by the full Keynesian multiplier only when there is existence of a lot of spare capacity in the economy (i.e. on the horizontal. part of the AS curve.) Therefore, the actual growth achieved would depend on the state of the economy.
In the case of S’pore, the economy is likely to be operating close to the classical range and hence the increase is real national income will not significant. With an increase in national output due to an increase in aggregate demand, there. would be an increase in demand for labour which is a derived demand, in order to meet, the increase in output. This will lead to a fall in cyclical unemployment.
The increase in AD would also lead to an increase in GPL as due to limited spare capacity in the economy, the increase in AD causes prices of inputs to rise upwards as more resources are needed to increase output. Producers faced with rising input prices, will also raise the prices of their products, resulting in an increase in general price level.
Conclusion
The effect of the sluggish growth on Singapore’s internal stability depends largely on the state of economy of Singapore’s trading partners will be like. Due to the uncertainty in the global outlook which could affect Singapore negatively, there is a need for Singapore to have policies that could help mitigate any negative impacts.
Essay Mark Scheme:
L3: Excellent explanation of how all 3 macro goals (inflation, economic growth and unemployment) would be affected due to the sluggish economic growth. Clear linkages made between how changes in national income would affect cyclical unemployment.
Analysis is well supported by appropriate AD-AS diagram(s) showing how there would be changes in national income, unemployment and the general price level. Brief explanation of reverse multiplier effect. Recognition of Singapore’s trading partners, and her dependence on trade and FDI.
L2: Good explanation of at least 2 macro goals (inflation and/or economic growth and/or unemployment) would be affected due to the sluggish economic growth. Linkages made between how changes in national income would affect unemployment but does not recognise the type of unemployment that will result OR explanation of how changes in AD would lead to changes in GPL is not clear.
Analysis not well supported by appropriate AD-AS diagram(s) showing how there would be changes in national income, unemployment and the GPL, however may not be well referenced. Limited recognition of Singapore’s context.
L1: Answer shows some knowledge of possible effect of sluggish growth on Singapore’s internal stability but no mention of AD/AS or there are basic errors in theory and/or mere listing of points without much development. Answer is mostly irrelevant with no evidence of understanding about effects on the macro goals.
Economics Teacher’s Marking Comments:
1. This part of the question is a straightforward question that asks candidates to explain how changes in the global economy would affect Singapore. Surprisingly, most candidates were unable to score 13 marks and most were in the 12 range. Many chose either to explain how the prolonged sluggish growth would affect investment expenditure due to a fall in FDI or (X-M) due to a fall in demand for exports instead of looking at the combined effect of a fall in FDI and (X-M). This resulted in these candidates to be in the 12 range or at best low L3 range.
2. in general, there is a lack of rigour in analysis with candidates choosing to lift directly from the pre-amble instead of explaining the underlying causes. The majority of candidates chose to explain that due to the prolonged sluggish growth, there was a lack of investor confidence and hence I would fall. These candidates had not explained why the sluggish growth would lead to a fall in investor confidence. The correct way would have been to explain how there is increased risk and uncertainty about future rates of return and hence a choice by firms to cut back on investments.
3. Question Analysis:
Candidates were unable to interpret the term “prolonged sluggish growth” as given in the preamble. Instead of defining it as growth in the global economy as increasing at a slower rate, most chose to explain it as a fall in national incomes. This affected the rigour of their analysis as they were unable to account for the fact that because the growth was slow and over a long period of time, the negative sentiments would result in consumers cutting back on their spending. While in both cases, there would be a fall in (X-M), the more accurate way in which (X-M) would fall in through negative expectations rather than an actual fall in incomes. A significant majority of candidates also had issues with trying to understand the phrase “Singapore’s internal stability choosing to explain all 4 macro goals as well as making links to the consequences of not meeting the macro goals. Very often, these candidates explained the impact on material standard of living as well as the negative impacts of unemployment such as a higher crime rate and stress levels. Candidates need to read the question more carefully and have a better grasp of what the question is asking for so as not to waste unnecessary time elaborating on points that are not expected in the question.
4. Many explained the secondary effects of the prolonged sluggish growth rather than addressing the events directly. A common argument was that due to the prolonged sluggish growth, the inflation rate in Singapore would be higher than in other countries and this would lead to a fall in demand for Singapore’s exports. While this is theoretically correct, there is no evidence in the pre-amble to suggest that Singapore was experiencing relatively higher inflation as compared to other countries. This also works through the effects of a higher inflation in Singapore versus other countries and how it would affect us rather than looking at the direct impact of the sluggish growth. Another common argument was that due to the sluggish growth in the US and Europe, their governments would undertake expansionary monetary policy that would lead to a fall in interest rates. Due to this fall in interest rates, there would be an increase in FDI into SG. This argument was worse as it didn’t even take into account the information given in the pre-amble that clearly stated that there was a fall in investor confidence.
5. Content: Several JC Econs students explained that when there was a fall in 1, the LRAS would shift left. This is inaccurate as the fall in I would mean a fall in potential growth as there is a smaller increase in capital stock. It would only cause a fall in LRAS if the I falls below capital depreciation (l.e. replacement investment) . Some candidates chose to bring in the concept of PED to explain that the demand for Singapore’s exports would fall significantly as the PED value for our exports is greater than 1. It is however inappropriate to bring in PED as there is no change in the prices of our exports. PED cannot be used to explain why demand fell significantly, it can only be used when the price of our exports changes and the effects qty demanded. In this context, as there was no change in the price of our exports, PED is not relevant.
6. Almost all candidates were systematic in their arguments by presenting the cause followed by the effect. However, as with previous examinations, the ability of candidates to make meaningful use of their diagrams is severely lacking. Candidates often drew diagrams and did not properly reference them. Candidates are reminded that diagrams are supposed to aid in the explanation of their arguments. Having drawn a diagram without any referencing is as good as not having drawn one!
JC Economics – Stagnant Growth & Fiscal Policy in S’pore
Introduction:
The need to maintain rising real incomes for Singaporeans is to help ensure that Singaporeans will be able to have a higher material standard of living will continue to improve. While Singapore is likely to remain very trade dependent due to the nature of her small domestic economy and is vulnerable to changes in the external environment, the policies that are in place by the Singapore government would help to ensure that these effects are mitigated. In order to maintain rising real incomes, there is a need for Singapore to consider policies that will increase productivity and develop new capabilities to make ourselves more competitive, thereby maintaining the long term potential growth of the economy.
A. Fiscal Policy
The Singapore government could undertake expansionary fiscal policy by increasing government expenditure on education, healthcare or on infrastructure. The government could also reduce personal income taxes which would lead to an increase in disposable income and hence an increase in consumption expenditure. At the same time, a decrease in corporate income tax would lead to an increase in after tax profits leading to an increase in investment expenditure, Foreign direct investments could also increase as firms are attracted to the lower corporate tax rates they have to pay. The combined effect of an increase in C and I would lead to an increase in AD.
There would thus be a more than proportionate increase in national income due to the multiplier effect. However, the increase in real national income will not be by the full extent as predicted by the multiplier as the general price levels are also likely to have risen. In addition, the increase in government expenditure on infrastructure and the increase in investment expenditure have supply side effects too. With the increase in LRAS, inflation rates are also kept low as the economy’s capacity to produce continues to expand. This would allow for increases in real income to be maintained, as increases in AD would not outpace the increases in LRAS.
Limitations of Fiscal Policy:
The effectiveness of an expansionary fiscal policy to increase real incomes may be limited in Singapore due to her small multiplier size. Singapore’s multiplier is small due to the high MPM (due to import reliance) and MPS (due to compulsory policy of CPF), resulting in significant leakages from the circular flow of income. Less of the increases in autonomous increase in AE would be passed on in each round limiting the increase in real incomes. Singapore is also likely operating very close to the full employment level of output Increases in AD may not lead to increases in real incomes and instead there would be increases in the GPL.
However, the use of fiscal policy would be particularly important in times where consumer and business confidence is low and a direct injection of government spending is required to boost the economy. These increases in government spending can also lead to increases in the LRAS and hence help to maintain increases in real incomes. Fiscal policy in the context of Singapore is important to help kick start the economy in times of poor consumer and business confidence. However, as Singapore has a small domestic economy, trade is our key driver of economic growth. There thus needs to be measures that manage the exchange rate.
JC Economics – Exchange Rate Policy in S’pore
Gradual Appreciation of Exchange Rate Lower cost of production leading to increase in I/FDI
The use of a gradual appreciation of the Singapore exchange rate is to maintain price stability to promote sustained economic growth. Given Singapore’s reliance on imports for survival as well as for raw materials for production, there is a need to have a gradual appreciation of the exchange rate. Prices of imports in SGD would decrease with an appreciation leading to a fall in the cost of imported raw materials and intermediate products. This would lead to a fall in the cost of production and hence an increase in the SRAS. This would lead to a fall in GPL.
Low inflation would provide an environment that allows households to save and encourage investments by firms as they would not have to worry about the value of their assets being eroded from unexpected inflation. The increase in I would lead to an increase in AD and a more than proportionate increase in national income due to the multiplier effect. There would thus be an increase in real incomes. The increase in I could also lead to a rightward shift of the LRAS assuming that the investments lead to an increase in capital stock and increases the productive capacity of the economy. This would help to ensure that growth is sustained and hence real incomes would rise in the long run.
Positive Expectations leading to increase in FDI
With a gradual appreciation of S$, foreign investors would be more likely to invest in Singapore. A gradual appreciation would also attract foreign firms as they would experience a higher rate of return when their profits are converted back into their home currency. Foreign firms investing in Singapore would expect that there is likely to be higher economic growth and this would lead to increased profitability for firms as the demand for their products would increase with increasing incomes in Singapore. The increase in FDI would lead to an increase in leading to an increase in real incomes. At the same time, the increase in FDI could lead to an increase in LRAS helping to maintain increases in real incomes in the long run.
Increase in Export Competitiveness
With a policy of gradual appreciation, exports will become more expensive in foreign currency. This provides an impetus for firms to increase their productivity to lower their costs of production and/or increase the quality of their products in order to maintain their international competitiveness. With an increase in productivity leading to a fall in costs of production, producers would be able to lower the price of the products sold in overseas markets. Moreover, if the firms engage in R&D to improve the quality of their products, they would also be able to maintain or increase their export competitiveness despite the appreciation of the SGD.
Evaluation for Exchange Rate Policy
An appreciation of the S$ would also make it more expensive to invest in Singapore as the prices of assets in SGD would be higher. Foreign firms would thus need to weigh the higher set up cost in Singapore against the lower cost of imported raw materials. (This would be worse if the revenue earned is denominated in foreign currencies that they are exporting to. Hence when it is converted back to SGD, they would be earning less.)
The gradual appreciation of Singapore’s exchange rate is one of a long term policy. In the short run, an appreciation of the exchange rate would actually lead to decreases in real incomes rather than an increase due to the fall in (X-M) and hence AD. However, in order to maintain rising real incomes, in the longer term, given Singapore’s dependence on imports, a gradual appreciation would be necessary.
Note: Candidates can explain the depreciation of Singapore dollar to explain how there would be an increase in AD and hence real incomes. However, they must evaluate this policy as a short-term measure and there should be an appreciation of SGD in the long run in order to maintain real incomes.
In the short term, there is thus a need to implement other policies that would help to increase real incomes in the short run. As an appreciation would be more of a long term policy. While fiscal policy is also important to help increase real incomes in the short run and are likely to lead to increases in the LRAS to help maintain increases in real incomes, supply side policies that focus on the labour force would be more targeted to help maintain rises in real incomes. In order to maintain Singapore’s international competitiveness, it is important. that wage increases do not outstrip productivity growth. Hence, in the long run, maintaining rising real incomes would require increases in labour productivity.
JC Economics – Supply Side Policy in S’pore
Supply Side Policy
The Singapore government may bring about improvement to labour productivity by providing incentives to firms to encourage research & development (R&D) efforts and innovation that allows firms to develop more productive and cost-efficient methods of production. To increase the level of innovation in Singapore, SMES would be able to apply for a flexible and customizable grant offered by SPRING Singapore. The Capability Development Grant (CDG) would have an easier application process and there would be enhanced funding support of up to 70% of costs. The government could also adopt policies to upgrade the skills of the labour force. For example, the Singapore Budget introduced the SkillsFuture initiative. It will increase Government funding on continual education and training from about $600 million per year over the last five years, to an average of over $1 billion per year from now to 2020. With the continual upgrading and skills that the labour force can undergo, the productivity of the labour force would likely increase leading to a fall in average costs for firms. The fall in cost of production would lead to an increase in the SRAS and at the same time, with the improvement in the quality of the workforce, Singapore’s productive capacity would increase.
The increase in SRAS would lead to an increase in real national income and the increase in the LRAS would help to ensure that increases in AD would not lead to inflationary pressures. Increases in LRAS would help to ensure that increases in AD would lead to increases in real incomes rather than increases in GPL.
Evaluation of Supply Side Policies
Supply Side policies such as promoting R&D, innovation to increase productivity and quality of products are typically long term in nature and take time before the results can be seen. The effectiveness of skills training and upgrading is dependent on the types of courses that the labour force goes for. If the courses that are offered are not directly applicable to their jobs, there would be very little increases in productivity and reductions in costs of production for firms.
Conclusion:
Given the climate of weak global growth, in the short term, the use of expansionary fiscal policy or exchange rate depreciation would help to ensure that real incomes would rise. However, in the longer term, the policies of gradual appreciation to help firms in Singapore move up the value added chain as well to increase productivity would be more appropriate as these would help to ensure that Singapore which is trade dependent can remain competitive in the world. The use of SSP would complement the policy of a gradual appreciation to help firms become more productive and help ensure that Singaporeans do not become structurally unemployed as Singapore’s comparative advantage changes over time. The use of supply side policies to increase the productive capacity would also increase the potential growth in the long run and thus help maintain rising real incomes.
Part B Economics Essay Mark Scheme
L3: Answer shows excellent knowledge of all 3 types of policies and how they would lead to maintaining rising real incomes, both in the short run and long run. Excellent development and rigour in economic analysis. Excellent use of AD-AS diagrams that are correctly labelled to support analysis. Excellent knowledge of Singapore context with good illustrative examples. Answers should consider the role of FDI and/or (X-M) in helping Singapore maintain L1: rising real incomes.
L2: Answer shows good knowledge of at least 2 policies and how they would lead to maintaining rising real incomes, both in the short run and long run. Good development and rigour in economic analysis.
Good use of AD-AS diagrams that are correctly labelled to support analysis. However, referencing may not be very well done. Good knowledge of Singapore’s context with some use of illustrative examples.
L1: For an answer that is mostly irrelevant with discussion of policies that do not explain how the policies would help maintain rising real incomes. OR the answer is rather skeletal, with little development or lacking in breadth (eg. Only 1 policy is discussed). Conceptual errors in the explanation of policies
Evaluation.
E2: For a well-reasoned judgment on effectiveness of different policies maintaining rising real incomes in the short run and in the long run.
E1: For a mainly unexplained judgment
Econs Tuition teacher’s Remarks:
1. Most students did not get 20 or more marks out of 25m, cos they didn’t highlight real incomes’ impacts. More on this key point in our Econs revision lessons.)
2. Candidates did not score well in this part of the question with the majority of students scoring only a low L2 grade. The main reason being that students tended to state the policies rather than explain how they would help to maintain rising real incomes. The other reason is obviously due to a lack of time which saw answers that started off well but became gradually lacking in rigour. Policies explained also tended be generic ones that were taken from the notes and regurgitated for their answers with no proper consideration for the context of the question that asked about maintaining rising real incomes. This was particularly true for supply side policies.
3. A minority of candidates approached this question by discussing policies that the government could undertake to reduce inflation instead of maintaining rising real incomes. The mis-read the question and focused on the term “real” and went on to explain how rising real incomes could be maintained if there was a fall in general price levels. What they failed to realise was that a contractionary policy would result in a fall in real national output which meant that less labour would be required and consequently, real incomes would fall as well despite the fall in general price levels.
4. The majority of candidates are unable to explain with clarity the exchange rate policy. Very often choosing to explain how quantity of exports and imports would be affected rather than export revenue and import expenditure. These same candidates tended to explain what would happen to the price of exports in foreign currency and price of imports in domestic currency and then declare that because the Marshall-Lerner condition held in Singapore, (X-M) would fall/increase. Candidates should note that responses like this in a question that required them to explain HOW the policies worked would not be credited very much as this is mere stating. A minority of candidates also made use of the Y-AE model and AD-AS model interchangably. This group would make use of the YEAE model to explain the multiplier process in great detail (which is not required for this question) and then declare that real incomes increased. The Y-AE model measures nominal national incomes and hence even if there was an increase in incomes based on the Y-AE model, REAL incomes may not have risen as much or at all depending on the increases in general price levels.
5. In explaining limitations of fiscal policies, a minority of students incorrectly stated that because Singapore had enjoying BOP surpluses, we had a significant amount of reserves and hence we would be able to afford the increase in government expenditure. This is misconception as BOP surpluses would help to build up our Foreign Exchange Reserves. This is different from the government budget reserves that a government utilizes to conduct its fiscal policy.
6. Candidates need to work on how to structure their essays such that it flows. As opposed to just stating one policy after another and placing all the evaluation at the end, candidates should make use of the limitations of each policy to justify the need for the next policy. This would help the essay to develop and showcase the knowledge of candidates.
7. Candidates should NOT abbreviate exports to become X or imports to become M. X refers to export revenue as in the AD equation and ‘M’ refers to import expenditure in the AD equation. Hence abbreviating exports to be X’ and imports to be ‘M’ is extremely confusing and inaccurate. Related to the point above, candidates should note that there is a difference between writing imports and import expenditure, similarly there is a difference between exports and export revenue. Imports or exports refer to the quantity. However, import expenditure ($) or export revenue (5) refers to price X quantity. Candidates should note that they are expected to be accurate by writing import expenditure and export revenue when explaining the effects of depreciation of exchange rate and not just merely imports/exports.
8. Candidates are not using the proper terminology to explain changes in exchange rate. Instead of using correct terms like “appreciate” and “depreciate”, candidates used words like “increase” , “decrease” instead. Candidates should also note the proper terms in analysing elasticity concepts. For example, demand for exports is price elastic” instead of “exports is elastic” or “Price elasticity of demand value for exports is high” instead of “Price elasticity of demand for exports is price elastic”.