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Wednesday, November 12, 2003

The Frugal Country's Road to Depression

NOW that there's hope of a global economic recovery, the past three years are best forgotten. But if you bought the argument that Singapore's sound fundamentals put it in the best position to ride the recovery, the Monetary Authority of Singapore has poured cold water on it by warning that the pace of the recovery will be restrained by ongoing 'structural' changes in the economy.

So, just how well-positioned is Singapore to ride this global recovery - if indeed it is one?The official estimate is that we should grow between 3 and 5 per cent next year. While here last week, Mr David Robinson of the International Monetary Fund (IMF) gave an upbeat assessment: 'I see activity picking up solidly, especially in the US and many Asian countries.' The IMF expects Singapore's economy to grow 4.2 per cent.

If you consider that Singapore's economy was the worst-performing among the emerging Asian economies for the past three years, then the projected recovery next year is quite disappointing. It lacks the usual bounce from a low base. According to the IMF, emerging Asia averaged 6.2 per cent growth last year and should grow by 5.9 per cent this year. Singapore, in contrast, grew 2.2 per cent last year, and is expected to grow 0.5 per cent this year. Despite under-performing, Singapore's projected growth of 4.2 per cent next year will still lag behind the region's expected average of 6.2 per cent.

The reason for the poor performance? The usual suspect is the loss of competitiveness due to high wages.
However, consider also that Singapore really has few macro tools at its disposal when the cyclical storms blow. The small domestic market limits the range of corrective action. But we have also tied our own hands. Prime Minister Goh Chok Tong made it clear in a dialogue session last week that the Government's role is to safeguard and grow the country's reserves.

In other words, we should avoid budget deficits. In general, balancing the books is a good principle. To some extent, no matter how efficient the institution, there is always a tendency to waste when it comes to public expenditure. Mr Goh himself admitted to being surprised at the plush facilities in some schools. Certainly, future generations should not pay for present waste. But there are, broadly, two types of government expenditure. One is expenditure required for the effective daily functioning of public services such as enforcement of law and order, military operations, and social services. It is here that we should ensure expenditure does not exceed revenue. Then there is expenditure intended to improve future growth prospects, for example, investments to enhance our infrastructure. Here, borrowing is legitimate since it is future generations that will benefit.

In practice, it can be difficult to differentiate between these two types of expenditure. For example, investment in health care and education should result in a more productive workforce in the future, thus enabling a higher standard of living. At the same time, much expenditure on education and health care should also be considered current charge. So it's a judgment call. Based on the Government's definition, Singapore's operating revenue usually far exceeds operating expenditure. For example, last year, operating revenue (excluding net investment income) exceeded operating expenditure by about $6 billion. It doesn't show up as a surplus because 'development' expenditure is also charged against operating revenue. But there is room for us to run, by our definition, 'large' deficits. This doesn't mean running deficits as we like, just that we do have significant room to manoeuvre when the need arises. We shouldn't be afraid to take advantage of that. There is no question about the virtue of accumulating reserves in good years. But there is a question over just how fatal government debts are.

Economist Christopher Dow, in his 1998 classic Major Recessions, argues that in Britain, debt levels have varied greatly without noticeable effects on the performance of the economy. Britain's debt in relation to GDP was 200 per cent during World War I, and it didn't fall below 150 per cent during the inter-war years. When World War II erupted, Britain's debt shot back to 270 per cent. In the post-war years, it was growth and inflation that led to a steady decline in the debt ratio. Mr Dow writes: 'In the face of such variety, fixed rules about the permissible level of government debt can have little absolute validity.' Singapore is far from running into debt.

The question is only whether deficits should be used as a counter-cyclical tool (and how large they can afford to be).
Given the current volatility in the global economic climate, we end up imposing a deflationary bias on the economy by ruling out deficits but not surpluses. And what about maintaining surpluses to impress financial markets? In this we have largely succeeded, and in doing so, also driven up our currency. The strength of the Singapore dollar is not all hype, of course. It is supported by ever-larger surpluses in our trade account. During the first half of this year, we chalked up a trade surplus of about $23 billion or 30 per cent of GDP. A decade ago, the trade surplus was just 8 per cent of GDP.

We achieved these surpluses by saving a lot more than we invest, thus reducing consumption that could have led to imports. In other words, we forced upon ourselves a greater reliance on exports. But is this savings an evergreen virtue? For a country in a global trading system, there are complications. People in one country can save excessively only to the extent that someone somewhere is willing to borrow and spend. Ultimately, there are limits to the extent that foreigners will borrow and foreign governments will run budget deficits. When these limits are reached, the frugal country necessarily becomes depressed.
First Published in the Straits Times 31 October 2003

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