Economics Model Essay 18

Discuss whether Singapore should switch away from the export-driven economic growth strategy as it has led to an increase in income inequity. [25]

Introduction

Economic growth refers to an increase in real national output. The export-driven economic growth strategy refers to the strategy of achieving economic growth via increasing exports. The question can be discussed with reference to the concepts of the export-driven economic growth strategy, the domestically-driven economic growth strategy, inclusive economic growth and income inequity.

Body

The export-driven economic growth strategy in Singapore has led to an increase in income inequity. 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. An increase in exports in Singapore will lead to an increase in aggregate demand which will induce firms to increase production resulting in an increase in national output. When firms increase production, they will employ more factor inputs from households and hence will pay them more factor income which will lead to an increase in national income. Furthermore, due to the multiplier effect, the initial increase in aggregate demand due to the increase in exports will lead to a larger increase in national output and hence national income. The production of high value-added goods such as pharmaceuticals requires high-skilled labour. Singapore has a comparative advantage in producing high value-added goods due to the large amount of high-skilled labour. Therefore, the increase in exports in Singapore due to the export-driven economic growth strategy has led to an expansion of the high value-added industries and this has increased the demand for high-skilled workers resulting in a rise in the wages. Furthermore, as the supply of high-skilled labour is inelastic due to the long period of time needed to acquire advanced skills, the increase in the demand has led to a large rise in the wage rate.

 

 

Diagram

 

 

In the above diagram, an increase in the demand for high-skilled labour (DHSL) from DHSL0 to DHSL1 leads to a large rise in the wage rate (w) from w0 to w1. The rise in the wages of high-skilled workers has led to an increase in income inequity.

Singapore should not switch away from the export-driven economic growth strategy as the alternative which is the domestically-driven economic growth strategy is ineffective for achieving economic growth. The domestically-driven economic growth strategy refers to the strategy of achieving economic growth via increasing domestic demand which comprises consumption expenditure, investment expenditure and government expenditure on goods and services. An increase in domestic demand in Singapore will lead to an increase in aggregate demand resulting in an increase in national output and hence national income. However, the domestically-driven economic growth strategy is ineffective in Singapore due to a several reasons. As consumption expenditure, investment expenditure and government expenditure on domestic goods and services are small components of aggregate demand in Singapore, domestic demand accounts for a small proportion of aggregate demand. Therefore, an increase in domestic demand is likely to lead to only a small increase in aggregate demand. The measures to increase consumption expenditure are subject to several limitations. A cut in interest rates will decrease the incentive to save and the costs of borrowing and this will lead to an increase in consumption expenditure. However, as a small and open economy, Singapore is an interest rate-taker in the sense that it is unable to change the money supply to influence interest rates which are determined by foreign interest rates. If the MAS increases the money supply to lower interest rates, hot money inflows will decrease and hot money outflows will increase which will lead to a decrease in the money supply. Due to the small and open nature of the Singapore economy, the effect of the changes in hot money flows on the money supply will be substantial. Therefore, the decrease in the money supply will lead to a rise in interest rates back to the initial level. Furthermore, consumption is interest inelastic in Singapore. A fall in interest rates in Singapore is likely to lead to a small increase in consumption due to the culture of thrift. A cut in direct taxes such as personal income tax and corporate income tax will increase disposable income and this will lead to an increase in consumption expenditure. However, the marginal propensity to consume in Singapore is low due to the culture of thrift, the compulsory savings scheme and the absence of a generous welfare system. Therefore, an increase in disposable income is likely to lead to only a small increase in consumption expenditure. The measures to increase investment expenditure are subject to several limitations. A cut in interest rates will decrease the costs of borrowing which will increase the number of profitable planned investments and this will lead to an increase in investment expenditure. However, as discussed earlier, as a small and open economy, Singapore is an interest rate-taker and hence is unable to cut interest rates. Furthermore, investment is interest inelastic in Singapore. A fall in interest rates in Singapore is likely to lead to a small increase in investment as a large proportion of it is foreign direct investment which is made by foreign firms with foreign sources of funds. A cut in corporate income tax will increase expected after-tax returns on planned investments and this will lead to an increase in investment expenditure. However, decreasing corporate income tax has become a global trend and hence lowering corporate income tax in Singapore may not lead to an increase in foreign direct investments. For example, the United States has recently cut its corporate tax from 35 per cent to 21 per cent. Furthermore, as corporate income tax is the largest source of tax revenue in Singapore, the government is unable to cut it by a large extent as it is likely to lead to a large decrease in tax revenue which may result in a persistent budget deficit. A persistent budget deficit will lead to a persistent rise in the public debt which may result in adverse consequences such as a higher tax burden on future generations. The government can increase expenditure in areas such as education, healthcare, infrastructure and national defence. However, a continual increase in government expenditure on goods and services in Singapore will lead to a rising budget deficit resulting in a continual fall in government reserves. As Singapore has a high public debt-to-GDP ratio, a continual fall in government reserves will in time to come induce people to lose confidence in the government’s ability to repay its debt which will cause the government to lose its ability to borrow. When this happens, the government will not be able to meet its debt obligations which will lead to a sovereign default resulting in a recession.

Singapore can pursue inclusive economic growth to reduce income inequity while pursuing economic growth. According to the Organisation for Economic Co-operation and Development (OECD), inclusive economic growth is economic growth that is distributed fairly across society and creates opportunities for all. In Singapore, the government seeks to achieve inclusive economic growth through focusing on the inclusion of low-skilled workers in the pursuit of economic growth via engaging them in productive employment. To achieve inclusive economic growth through the inclusion of low-skilled workers in the pursuit of economic growth via engaging them in productive employment, the Singapore government can engage in education and training to increase the skills and knowledge of low-skilled workers. An increase in the skills and knowledge of low-skilled workers will lead to an increase in the production capacity in the economy. An increase in the skills and knowledge of low-skilled workers will also lead to an increase in their productivity resulting in a fall in the cost of production in the economy. When the production capacity in the economy increases and the cost of production in the economy falls, aggregate supply will rise which will lead to an increase in national output and hence national income. In addition, when the cost of production in the economy falls, expected returns on planned investments will rise which will lead to an increase in foreign direct investments. When this happens, aggregate demand will rise which will lead to an increase in national output and hence national income. Education and training will also equip the low-skilled workers who have been displaced by globalisation, technological advancement and economic restructuring with the relevant skills and knowledge to find jobs in the expanding industries which are typically high value-added industries and hence require high skills resulting in an increase in national output and hence national income. When the productivity of low-skilled workers rises as a result of education and training, firms that employ these workers will experience a fall in their costs of production. When this happens, they will be able to increase the wages of the workers which will lead to a decrease in income inequity. In addition, the low-skilled workers who were displaced but who have found a job as a result of the new skills and knowledge that they have acquired will start earning income again resulting in a decrease in income inequity. A decrease in income inequity in the pursuit of economic growth will lead to a more equitable distribution of the benefits of economic growth. However, low-skilled workers are generally less willing and able to expend effort on education and training and hence engaging in education and training to increase the skills and knowledge of low-skilled workers may not reduce income inequity significantly. Furthermore, education and training will increase the skills and knowledge of workers only in the long run and this long effectiveness time lag makes it ineffective in the short run. In addition, as Singapore is a small economy that is more dependent on external demand with the domestic exports accounting for a large proportion of the aggregate demand, an increase in investment expenditure may not lead to a significant increase in aggregate demand resulting in an insignificant increase in national output and hence national income.

Evaluation

In the final analysis, instead of switching away from the export-driven economic growth strategy, the Singapore government should complement it with the inclusive economic growth strategy to reduce income inequity while pursuing economic growth. In order for the inclusive economic growth strategy to be effective, the Singapore government should adopt a policy mix. In addition to the provision of education and training directly by setting up educational institutes and indirectly by giving subsidies or tax incentives to firms to encourage them to send their workers for education and training, it should conduct campaigns to increase the awareness of the beneficial effects of skills upgrading and use its lever as a major employer of cleaning, security and landscape services from private firms to induce them to increase the wages of their workers. In fact, the Singapore government adopts a policy mix to increase the effectiveness of education and training as a measure for achieving inclusive economic growth. In addition to reducing income inequity while pursuing economic growth through including low-skilled workers in the pursuit of economic growth via engaging them in productive employment, the Singapore government should seek to achieve inclusive economic growth in order to achieve a more equitable distribution of the benefits of economic growth through other measures such as transfer payments, progressive taxes and foreign worker policy. Although these measures do not help achieve economic growth in Singapore, at least not significantly, they help make economic growth more inclusive through reducing income inequity when the Singapore economy is expanding which is the normal state of the economy. The Singapore government should also provide subsidies for essential goods and services which low income individuals consume such as healthcare, education and housing. Although these subsidies will also benefit high income individuals, the benefit will be greater for low income individuals as these subsidies expressed as a percentage of income are higher for low income individuals than for high income individuals.

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