Economics Model Essay 15

Discuss whether a shift from reliance on foreign workers to improving labour productivity in Singapore would lead to an increase in international competitiveness. [25]

Introduction

Labour productivity refers to output per hour of labour. The question on whether a shift from reliance on foreign workers to improving labour productivity in Singapore would lead to an increase in international competitiveness can be discussed with reference to the effectiveness of the policy shift, exchange rate policy and trade policy for increasing international competitiveness in terms of the price of exports, the quality of exports and the ability to attract foreign direct investments.

Body

A shift from reliance on foreign workers to improving labour productivity in Singapore may lead to an increase in aggregate supply resulting in an increase in international competitiveness. Aggregate supply is the total supply of goods and services in the economy over a period of time and is determined by the production capacity and the cost of production in the economy. When labour productivity in Singapore rises, firms will need a smaller amount of labour to produce any given amount of output. Therefore, the cost of production in the economy will fall. Furthermore, to increase labour productivity in the economy, the government may increase the skills and knowledge of labour or the efficiency of capital in the economy. If this happens, the production capacity in the economy will increase. A fall in the cost of production and an increase in the production capacity in the economy will lead to an increase in aggregate supply. Assuming aggregate demand in Singapore is rising which is the normal state of the economy, an increase in aggregate supply will lead to a smaller rise in the general price level resulting in lower inflation.

In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to a rise in the general price level (P) from P0 to P1, assuming aggregate supply (AS) remains at AS0. With a simultaneous increase in aggregate supply from AS0 to AS1, the same increase in aggregate demand leads to a smaller rise in the general price level from P0 to P1’. When inflation in Singapore falls, Singapore’s goods and services may become relatively cheaper than foreign goods and services. If this happens, international competitiveness in terms of the price of exports will increase. Furthermore, an increase in the skills and knowledge of labour or the efficiency of capital in Singapore may lead to an increase in the quality of goods and services produced. If this happens, international competitiveness in terms of the quality of exports will increase. In addition, when the cost of production in Singapore falls due to an increase in the skills and knowledge of labour and hence labour productivity in the economy, expected returns on planned investments will rise. When this happens, international competitiveness in terms of the ability to attract foreign direct investments will increase.

A shift from reliance on foreign workers to improving labour productivity in Singapore may not lead to an increase in international competitiveness. Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports. To increase the skills and knowledge of labour in Singapore, the government may increase expenditure on education and training directly. For example, it has set up the Institute of Technical Education, polytechnics and Continuing Education and Training campuses to provide education and training. Furthermore, the government may increase expenditure on research and development directly to increase the efficiency of capital in the economy. For example, it has set up the Biomedical Research Council (BMRC) and the Science and Engineering Research Council (SERC) under the Agency for Science, Technology and Research (A*STAR) to engage in research and development. If these happen, government expenditure on goods and services will increase. To increase the efficiency of capital in the economy, the government may incentivise firms to adopt better production technologies through subsidies or tax incentives. For example, it introduced the Productivity and Innovation Credit (PIC) scheme which provided subsidies and tax deductions for research and development expenditures that led to improved production methods. If this happens, investment expenditure will increase. Furthermore, when the cost of production in the economy falls due to an increase in the skills and knowledge of labour and hence labour productivity in the economy, expected returns on planned investments will rise. When this happens, investment expenditure will increase. An increase in investment expenditure and government expenditure on goods and services will lead to an increase in aggregate demand resulting in a rise in the general price level and hence higher inflation. To induce firms to increase labour productivity, the government may tighten restrictions on foreign workers to increase their costs of production. If this happens, the cost of production in the economy will rise which will lead to a decrease in aggregate supply. A decrease in aggregate supply will lead to a shortage of goods and services resulting in a rise in the general price level and hence higher inflation. When inflation in Singapore rises, Singapore’s goods and services may become relatively more expensive than foreign goods and services. If this happens, international competitiveness in terms of the price of exports will decrease. Furthermore, when the cost of production in Singapore rises, expected returns on planned investments will fall. When this happens, international competitiveness in terms of the ability to attract foreign direct investments will decrease. Education and training will increase the skills and knowledge of labour and research and development will increase the efficiency of capital only in the long run. Therefore, they will not increase labour productivity in the economy and hence international competitiveness in the short run.

Exchange rate policy can be used to increase international competitiveness in Singapore. To increase international competitiveness, the Monetary Authority of Singapore (MAS) can devalue the Singapore dollar by lowering the exchange rate policy band and simultaneously selling domestic currency and buying foreign currency in the foreign exchange market. A fall in the exchange rate in Singapore will lead to a fall in the price of exports in foreign currency. When this happens, Singapore will become more competitiveness in terms of the price of exports. Furthermore, a fall in the exchange rate in Singapore will decrease the costs of investments in foreign currency. When this happens, Singapore will become more competitiveness in terms of the ability to attract foreign direct investments. However, when the exchange rate in Singapore falls, the prices of imported intermediate goods in domestic currency will rise which will lead to a rise in the cost of production of exports and this effect is likely to be large as Singapore’s exports have high import content. When this happens, firms which produce goods for exports will increase prices to maintain profitability resulting in a rise in the price of exports. Therefore, a fall in the exchange rate in Singapore may not significantly increase international competitiveness in terms of the price of exports. Furthermore, if the MAS devalues the Singapore dollar continually to increase Singapore’s competitiveness in terms of the ability to attract foreign direct investments, this may lead to a decrease in confidence in the currency. If this happens, Singapore may become less rather than more competitive in terms of the ability to attract foreign direct investments.

Trade policy rate policy can be used to increase international competitiveness in Singapore. A free trade agreement (FTA) is an agreement between two or more economies to remove or reduce barriers to trade with the objective of increasing the cross-border movement of goods and services between the economies. To increase international competitiveness, the Singapore government can sign more FTAs. When tariffs on Singapore’s goods are removed or reduced in the FTA member countries, firms in the FTA member countries that import and sell Singapore’s goods will experience a fall in their costs of production which will induce them to decrease prices to maintain competitiveness. When this happens, Singapore’s goods will become cheaper in the FTA member countries. Therefore, signing more FTAs in Singapore will lead to an increase in international competitiveness in terms of the price of exports. Furthermore, firms in non-FTA member countries that export goods to the FTA member countries and want to circumvent the tariffs will invest in Singapore. By setting up production facilities in Singapore, the goods that they produce in Singapore and export to the FTA member countries, which will be subject to lower or no tariffs, will be cheaper than those that they produce in non-FTA member countries and export to the FTA member countries, and this will lead to an increase in their sales and hence their profits. Therefore, signing more FTAs in Singapore will lead to an increase in international competitiveness in terms of the ability to attract foreign direct investments. However, it takes a long time to negotiate FTAs with the potential partners. For example, the USSFTA was only concluded in May 2003, about two and a half years after negotiations began in November 2000. Therefore, it will not increase labour productivity in the economy and hence international competitiveness in the short run.

Evaluation

In the final analysis, the Singapore government should restructure the economy from one which is labour-driven to one which is productivity-driven. This is not only appropriate but necessary for achieving sustainable economic growth. The labour-driven economic growth strategy requires the support of a loose foreign worker policy which will lead to rising population. However, as Singapore is a small country with a small land area of only about 720 square kilometres, rising population will exert a strain on the country’s infrastructure which may lead to problems such as severe traffic congestion, crowded public buses and trains and rapid rises in housing prices. Indeed, the rising population in Singapore was a major factor which led to the rapid rise in housing prices before the 2008-2009 Global Financial Crisis. Therefore, the labour-driven economic growth strategy is unsustainable in Singapore. In contrast, as the productivity-driven economic growth strategy will not lead to rising population, the small land area of Singapore is not a constraint for this strategy. However, as the policies for increasing labour productivity in the economy may not lead to an increase in aggregate demand in Singapore, at least not significantly, the government should complement them with policies that will boost aggregate demand. This is to ensure that the increase in the production capacity in the economy is actually used to produce more goods and services rather than lying idle. Given the high dependence of the Singapore economy on external demand, trade policy such as signing more free trade agreements to increase exports is the most effective policy to increase aggregate demand. Indeed, Singapore has signed over 20 free trade agreements to increase exports and foreign direct investments, which is the highest number in the world.

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