Singapore's Next Economic Challenge
As we reach the end of the 14th Parliament of Singapore’s administration, the city-state’s economy faces several structural challenges.
In the run-up to the incoming Prime Minister’s administration, the incumbent government commissioned the “Forward Singapore” Budget where they sought to cater to the concerns of the Singaporean public. Although a noble effort, some structural issues were left unaddressed.
Source: Singstat, TAM
The most obvious challenge is the secular decline in the 10-year average Real GDP growth. Concerningly, the robust growth pathway that characterised Singapore’s pre-2000 economy has faded. The only uptick in the average GDP growth occurred in the mid-2000s when immigration regulations were loosened, and Singapore enjoyed a short boost in labour pool expansion-derived growth. After some domestic backlash and the increasingly marginal return from labour growth, immigration regulation slightly tightened and the decline in average GDP growth continued.
A slowdown in economic growth is expected as Singapore end its “catch-up” growth phase and its growth slows to match other developed economies. However, policymakers are reluctant to accept this, as the next Prime Minister Lawrence Wong puts it, “If we were to experience similarly slow growth for several years in a row, we will be in trouble”. He also said that slowing growth means that “we will not be able to afford the social services we need, and in the end, workers and families will be hit the hardest,”.
Ever-improving growth is an assumption baked into the Singaporean system which puts pressure on the government to find solutions to anaemic growth rather than accept that 2-3% growth is expected of developed markets.
To rectify the secular decline in average GDP growth rates, the government has to solve 2 key structural issues. Firstly, it must address Singapore’s increasing reliance on the global economy for growth at the expense of domestic growth drivers. Secondly, it must avoid overly relying on “lazy growth” in the manufacturing sector.
Challenge 1: Increased Reliance on the Global Economy
Source: Singstat, TAM
When GDP is decomposed to its expenditure components, data shows that Net Export have enjoyed a meteoric rise in importance to our economy. However, Consumption and Gross Fixed Capital Formation (GFCF) have seen a corresponding fall. Prima facie, great Net Export growth is expected as Singapore’s domestic market is too small to sustain significant growth.
However, the “small domestic market” assumption might be too simplistic. As Net Export rises, the gains from trade expansion are expected to be distributed to domestic consumers and businesses, raising the economy’s Consumption and Gross Savings (which in turn raises investments). In short, Net Export gains should boost growth in the other expenditure segments to roughly maintain GDP composition.
Decline of GFCF as a proportion of GDP
Source: World Bank, TAM
World Bank data suggest that as relative GFCF has fallen through the years, Gross Savings has risen and roughly stagnated since the 2000s while the net inflow of Foreign Direct Investments (FDI) has strongly increased. By all accounts, it appears that on absolute terms, GFCF has greatly grown through the years but the exceptional rise in Net Exports has allayed these effects on relative terms.
We may glean two insights from this decomposition. Firstly, we see that aggregate Gross Savings from disposable income has not grown significantly on relative terms, this suggests that consumers are either earning less or spending more than proportionate to gains made from Net Exports. In other words, consumers are either reaping less than expected from Net Export gains or are spending more than expected of what they have accrued. We will later understand that the former is more likely than the latter.
Secondly, since Gross Savings has failed to grow in recent years, FDI inflows have more than made up for this stagnation. This arrangement is rather fortunate but hints at a growing issue, Singapore is now more reliant on foreign capital than ever before. While its small and open economy has always been exposed to the global market cycle, Singapore’s historically high savings have always been able to buoy investment in the domestic economy. Using its vast deposits, local banks could provide extremely competitive loan rates to firms and help negate the effects of poor global market conditions. Worryingly, should foreign capital continue to play a greater role in investment funding, any global market downturn may amplify its effects by choking the domestic market from private credit origination or loan underwriting.
Before we move on, it should be acknowledged that this Gross Savings figure cited is a mere proxy for total saving in the economy. Government-mandated saving schemes greatly inflate this number which may not increase domestic investments.
Decline of Consumption as a proportion of GDP
Source: Singstat, TAM
Singapore has enjoyed spectacular growth in Consumption since independence, although there appears to be a secular downtrend in average Consumption growth, it is still healthy at ~3% in the latest decade. This might be surprising as the decline in Consumption as a % of GDP is greater than what the 10-year average Consumption growth implies. Similar to the problem with assessing relative GFCF, relative Consumption growth has been overshadowed by the exceptional growth in Net Exports.
As David Hume argued, trade balance should even out over time when we factor in income gains from trade. Hume posits that due to the income effect from trade surpluses, trade surplus erosion is natural and expected in an open and free economy. Simply put, as an economy gains from a trade surplus, consumers who enjoy income gains from trade would be expected to increase consumption and demand more imports. Therefore, rising imports from wealth effects should lead to trade balance normalisation and exert a downward pressure on Net Export growth. The failure of this phenomenon to manifest suggests two potential problems regarding Singapore’s growth model.
Potential Problem with Increasing Reliance on Net Export
The first potential problem is that it implies the existence of market-distorting factors that may lead to an inaccurate understanding of Net Export data. It is difficult to accurately identify the precise instrument that distorts the market, but its persistent occurrence hints that this is a systemic issue.
A best guess could be Singapore’s unique form of monetary policy where the Monetary Authority of Singapore (MAS) controls the money supply by managing the trade-weighted exchange rate. Historically, the MAS has preferred to gradually appreciate the Singapore Dollar (SGD) within a stipulated range, ensuring that the SGD does not excessively appreciate or depreciate. This careful management of the strength of the SGD then influences the domestic interest rate levels through uncovered interest rate parity. The controlled appreciation of the SGD also means that in times of great demand for the SGD, the currency’s value will be capped through MAS intervention in the open market. Market expectation of MAS interventions also means that market participants will trade with this intervention in mind, placing less emphasis on the fundamentals of the currency. The SGD would not trade at its “fair value”. Thus, the true purchasing power of Singaporean consumers is distorted from its “fair value”, depressing import demand which allows for a lasting trade surplus.
The second potential problem is that it suggests that trade-related gains are being concentrated in segments of society that do not benefit the local economy. As illustrated in the argument presented by Hume, income gains from trade surplus should lead to higher consumption if we accept the non-satiation assumption. If the suggested "best guess” does not hold, it implies that trade income gains are concentrated in individuals or firms that hold their earnings offshore. This problem is particularly concerning as it suggests that workers in this sector are not experiencing material gains that are proportional to the value of their work. This is potentially a source of inefficiency in our growth model, should workers fully enjoy their gains, we should see an increase in consumption or savings in the economy. Both would be a balancing force in Singapore’s domestic economy that induces a more balanced GDP composition and serves as a new source of growth.
Implications
A potential implication of Singapore’s increasing reliance on the global economy is the increased exposure to global risks. Growth led by exports and investment led by foreign capital means that international monetary policy becomes even more relevant to Singapore’s economic growth prospects. After all, the US would only consider its domestic inflation-growth dynamics when considering its interest rate hiking cycle. If Singapore lags in its disinflationary journey or growth cycle, more monetary policy intervention or fiscal spending is needed.
Increasing sensitivity to global market conditions introduces more moving parts and opportunities for mistakes. In comparison, a consumption-led economy like Indonesia has more policy space when deciding on monetary policy. In 2023, while the US was in the middle of its hiking cycle, many economies suffered slowing growth due to dampening demand for capital goods from higher borrowing costs. Indonesia was uniquely positioned as its consumption-dominated economic growth allowed Bank Indonesia to prioritize disinflation over facing the inflation-growth dilemma that many export-reliant economies faced. Singapore has much to gain from encouraging more consumption within the economy. It helps to buffer against global cyclical risks while giving MAS some policy space and wiggle room.
Secondly, the issue of currency distortion implies that Singaporeans are consuming less than they otherwise would if Singapore did not adopt an exchange rate monetary policy. That said, we are not advocating for a reformation of Singapore’s monetary policy, it is understood that this policy regime is best for a small and open economy. Switching to a new policy regime will likely incur more costs than gains from consumption. However, should the “best guess” ring true, it is imperative for policymakers to consider the distortionary effects of the exchange rate monetary policy regime on trade balance data. Persistent Net Export growth may be coming at the cost of building domestic Consumption as a key growth driver. Relieving some of this distortion will go a long way in taming import inflation and freeing up real income for consumption.
Challenge 2: Economic Concentration in Manufacturing
Source: Singstat, TAM
As goods export make up 63.64% of total exports in 2023, manufacturing is an important part in assessing Singapore’s outlook. Data suggests that Manufacturing growth has been the main driver of economic growth since 2019, a much-needed catalyst to make up for the lacklustre construction sector. If we exclude manufacturing growth from the data, Real GDP from 2019 to 2023 would have only grown 8.5% or 2.5% lower than current figures.
While the electronic upcycle might be a relevant consideration, the structural drivers of manufacturing growth are more relevant in discussing manufacturing’s long-term viability. Outside of cyclical tailwinds, manufacturing growth has been led by labour pool expansion and capital deepening, an unsustainable growth model.
Labour Force Expansion as a Manufacturing Growth Driver
Source: Ministry of Manpower, TAM
Labour force expansion from an increased inflow of foreign workers is likely a key ingredient in driving manufacturing growth. In the past 5 years, the resident workforce has been somewhat stagnant as it hovers at 2.4mn workers. Since work permit is only issued to lower-skilled labour, we see the quick recovery in work permits as a % of the total workforce as indicative of a surge in reliance on low-skilled foreign labour This is corroborated by the 10% growth in the foreign workforce in these 5 years, a significant factor when we consider that total workforce growth only amounted to 7% in this period.
Part of this observation may be attributed to the recovery in the post-pandemic economy. But foreign workers as a proportion of the workforce had risen past pre-pandemic levels in 2022, this indicates that there is a concerted effort to raise the quantity of labour in the economy. Labour force expansion is a tried-and-true strategy for expanding output growth, but it comes at a cost to Singaporean workers.
According to Ministry of Manpower data, residents consist of 49.34% of total employment in the manufacturing sector. The first concern is that the continued expansion of foreign labour within manufacturing may apply downward pressure on wages for resident workers. Despite levies and wage controls, it would be difficult for resident workers to compete with foreign labour in wages. Since foreign workers’ primary aim is to remit funds back home, they are willing to accept lower wages as exchange rate differentials will benefit the recipients. In comparison, resident workers will have to compete in a race to the bottom where they will have to face local living costs and do not benefit from exchange rate differentials. Furthermore, as work permits are contingent on employment, it forces foreign workers to accept poorer wages or risk being sent back. This adds another dimension that local workers have to compete. Failure to address the associated issues with the reliance on foreign workers will cause residents to experience a continued race to the bottom and inhibit the consumption growth of resident workers in manufacturing.
The second concern is that the reliance on foreign workers may mask the erosion of the comparative advantages in the Singaporean economy. As the cost of labour and the cost of business rises, relying on foreign workers to fill the gap and give some cost relief may breed inefficiency in the economy. Perhaps, the natural endowments that Singapore provides have shifted away from low-level manufacturing and the true growth driver in Singapore could come from capital Intensive and labour-light manufacturing. By allowing firms to continue to wholeheartedly rely on foreign labour, Singapore might be preserving these firms while crowding out higher-value manufacturing. Firms, under this regime, are disincentivised from raising productivity. This point will be further elaborated on later.
Capital Deepening as a Manufacturing Growth Driver
Source: Singstat, TAM
Capital Deepening, the attempt to increase output by raising capital density, has also been a key driver of growth in the manufacturing sector. We observed a rapid increase in machinery investments after the pandemic ended with Machinery GFCF growing by 20.6% from 2019 to 2023. Despite machinery investment dip in 2023 due to higher global interest rates, it still outpaced manufacturing output growth by nearly 2%.
While Capital investment is typically indicative of an ever-expanding market environment, its benefits taper off once a critical mass is reached. The maximum return from capital is incurred when levels of capital accumulation are low, as investments grow, the return on capital is diminishing. This is attributed to the fact that physical capital is rivalrous and crowds out, after a certain point, one additional unit of machinery will not yield better growth outcomes. Long-term growth from Capital deepening is simply not feasible.
Are the capital and labour expansions due to post-pandemic recovery?
Critics may suggest that this accumulation is not a strategy but a mere statistical consequence of post-pandemic recovery. Perhaps, the data is exaggerated due to the base rate fallacy. Of course, this argument leaves out the third factor in production, productivity.
Source: Singstat, TAM
Labour productivity indeed rebounded after COVID and behaved as we would expect, but the further out we go, the data suggest that labour productivity returned to contraction. Unlike labour and capital expansion, productivity gains were short-lived and are likely to be influenced largely by recovery tailwinds. Should the base rate criticism ring true, we would expect similar declines in capital and labour force figures.
Why relying on labour and capital expansion is unsustainable.
As mentioned above, marginal returns on capital are diminishing, more capital does not eternally produce proportionate output growth. As more capital is added, the growth from output slowly tapers off. However, capital depreciates at a more consistent rate and we would see that past a “steady state”, the rate of capital depreciation will outpace the return from capital accumulation. In effect, there is a ceiling to output growth from capital deepening, over-reliance on this will lead to a stagnant manufacturing sector.
Similarly, marginal returns from labour also experience a diminishing factor and output growth from labour expansion will taper off. However, reliance on labour expansion brings about a unique set of issues.
Firstly, consistent reliance on labour expansion is unsustainable unless Singapore diversifies its labour source. Currently, Singapore opts to source its lower-skilled labourers from South-East Asia, India and China. Considering the slowdown in fertility rates in these regions, the labour pool might become increasingly shallow. An issue complicated by India and China’s meteoric growth in recent years. Migrant labour tends to favour locations with similar cultural environments and support systems. Should these markets develop fast enough, these workers may opt for more familiar shores even if employment in Singapore may offer higher income. This increases the competition for labour and may choke out the cheap foreign labour Singaporean firms rely upon.
Secondly, it risks driving a wedge between resident workers and the government. As seen from the 2011 General Elections, Singaporean voters are dissatisfied with the unchecked influx of migrant labour. In response, the government had begun to tighten immigration regulations, but this might be insufficient. The rise of anti-immigration figures like Leong Mun Wai of the Progress Singapore Party suggests that Singaporean workers are not fully placated. The continued reliance on foreign labour as a growth driver may force the government to choose between economic growth, which it hinges its legitimacy upon, and losing its political dominance.
Thirdly, continued reliance on foreign labour will distort incentive structures which discourages innovation and the adoption of more productive modes of production. Overlaying the labour productivity graph with the labour force decomposition graph showcases some trouble correlations.
Source: Singstat, Ministry of Manpower. TAM
In the past 5 years, data suggest some negative correlation between labour productivity in the manufacturing sector and foreign workers under work permits. As the proportion of foreign workers rises, there is a stark decline in labour productivity. This observation could be due to a “Resource Curse”-like phenomenon. Since foreign labour is cheap and accessible, it could be possible that manufacturing firms are disincentivised to take risks to innovate to raise productivity and seek foreign labour. This allows firms to grow their output in the short-run but fails to increase efficiency which may hurt their long-run prospects of scaling their business. This perverse incentive is a structural issue as aggregated on a nationwide basis, this might be a key explanation for the lacklustre productivity growth in Singapore.
It is precisely because labour and capital have diminishing returns, therefore Singapore must ensure productivity grows to ensure long-run growth viability. It is not simple to raise productivity in the economy, but little progress will be made without addressing this distorted incentive structure that firms face. The government will likely have to pull the band-aid and clamp down on its reliance on foreign labour, a decision that would cause much short-term pain.
Conclusion
Singapore faces a twin structural problem of an unsustainable increase in reliance on the global economy and an unsustainable growth model in the manufacturing sector.
Source: Asian Productivity Organisation, TAM
There is a growing body of evidence that Singapore’s productivity woes in the manufacturing sector are also present in the wider economy. This presents some existential danger to the future of the Singaporean economy as its neighbours and economic rivals like Hong Kong and Dubai progress.
It is not all doom and gloom; Singapore still maintains many strong advantages and the services sector has remained a strong bulwark against the concentration of economic growth in the manufacturing sector. Although recent political scandals have surprised most observers, the core stability and trust in Singapore’s institutions remain intact.
Singapore cannot rest on its laurels and the 14th Parliament has some reflecting to do. Some serious economic reform has to be undertaken to preserve the long-term future of Singapore. This reformation will not be easy, but this is the cost of being too reliant on old-growth strategies that have entrenched some unhelpful paradigms.