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Sunday, June 15, 2003

Preferring a flexible wage policy to a flexible exchange rate policy

Eddie's at it again in Singapore. This time trying to explain that there are more ways than one to bring down export costs, and reminding us that the 'let the markets decide' mantra comes accompanied by a multitude of problems.

As Prime Minister Goh Chok Tong pointed out two weeks ago, costs in countries like Malaysia and China have become lower relative to Singapore. Their currencies are pegged to the United States dollar, which has depreciated. A new tripartite task force is being set up to drive wage restructuring.

But wait - so, we counter cheaper foreign currencies by cutting wages? A moment of reflection in the midst of haste is required. The exchange rate is, after all, only a relative value. Saying the ringgit is cheap is the same thing as saying the Singapore dollar is expensive. Why do we choose not to treat the problem directly?

The strength of the Sing dollar is not temporary. Its strength vis-a-vis the currencies of Singapore's neighbours has been obvious since the Asian financial crisis. For example, it appreciated 22 per cent against the ringgit in just one year, after the devaluation of the baht triggered the Asian crisis in 1997. Prior to 1997, it took eight years for the Sing dollar to appreciate by an equivalent amount. Indeed, since the Asian crisis, it has appreciated compared to most Asian currencies, except the Japanese yen and the Hong Kong dollar.

But that's nothing to crow about. The coincidence of strong currencies in Japan and Hong Kong contrasting with their weak economies is discomforting.......What this suggests is that the exchange rate does not automatically adjust to ease the pain of an economic slump. Instead, as with Japan, it reacts in opposition to the weakening economy. The strength of the currency ends up making a bad situation worse.

Still, intervening in the foreign exchange market is often a taboo subject. Policy-makers tend to see it as an excuse to put off fundamental reforms that might have a longer-lasting impact on currency valuations. So wage reforms are preferred. They have an air of solemnity befitting the serious occasion. But wage reform is essentially wage reduction. Like taking aspirin, while there are apparent benefits, there can be serious side effects.

The biggest is that it reduces the ability to repay debt. According to a Department of Statistics study, Singapore's household borrowings as a percentage of a household's disposable income was 174 per cent in 2000. It is probably close to the highest in the world and compares with 100 per cent in Japan, and 54 per cent in France.

As wages tend to resist downward adjustment, trying to force a deep reduction in wages may actually require a higher unemployment rate to achieve it.

Human nature makes it hard for wages to move down. A recent study by Washington's Brookings Institution notes that employers 'prefer not to cut their employees' wages since they fear that doing so will cause serious morale and staff retention problems'.

But there is another way to reduce the wage bill: Lower the exchange rate. Companies that export goods get more revenue, so the wage bill becomes less of a burden for employers. The employee, thankfully, gets to keep his salary.

Still, the awful truth is that poor global economic conditions mean the majority of Singaporeans must face the harsh reality of a reduction in living standards. By lowering the exchange rate, a country's citizens are less able to purchase foreign goods and services. On the other hand, lowering wages reduces the ability to purchase domestic goods and services.

But countries do have a choice when making this adjustment. It is a harsh decision indeed that forces the adjustment solely upon the worker's shoulder by exclusively preferring a flexible wage policy to a flexible exchange rate policy.
Source: Straits Times

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