policy design, institutional framework and macroeconomic management: the case of singapore policy...

Policy Design, Institutional Framework and

Macroeconomic Management: The Case of Singapore

39

Policy Design, Institutional Framework

and Macroeconomic Management: The Case of Singapore

1

Ng Beoy Kui*

1. Introduction

Since its independence in 1965, Singapore has undergone four major

economic crises. The first crisis was the 1985 economic recession arising

mainly from its loss of international competitiveness. This was due to increase

in labour cost and too sharp an appreciation of Singapore dollar. These were

the consequence of its eagerness to restructure the economy from a labour

intensive economic structure to that of capital intensive. The second crisis was

the Asian Financial Crisis from July 1997, emanating from the contagion

effects of severe economic recession and massive capital outflow from its

Southeast Asian neighbours. The third crisis was relatively less severe but it

still reflects Singapore’s vulnerability to external factor and in this case the

crisis was due to bursting of dot.com bubble in the United States on 10 March

2000. However, the impact on the Singapore economy pales in comparison

with the Global Financial Crisis in 2008. This fourth crisis encountering by

Singapore affected not only the financial sector but also the real sector.

Confidence was somehow shaken with gloomy prospects.

Singapore with its trade and financial openness cannot spare the

inevitable impact of external influences, especially external shocks or

contagion effect from its neighbouring countries, despite its strong and sound

* Professor, Faculty of Business and Management, Southern University College, Johor Bahru,

Malaysia. Email: [email protected]

1 The author would like to express his gratitude to Dr. Sng Hui Ying of Nanyang

Technological University, Singapore who kindly prepares Figure 1-3.

Southern University College Academic Journal • 南方大学学报• August 2014

40

economic fundamentals. However, the impact of the four crises on the

Singapore economy, unlike its neighbouring countries had not led to massive

unemployment, hyperinflation, economic collapse and serious bank runs.

Singapore despite its vulnerability still appears, however, to be vibrant,

resilient and ever competitive; with its economy rebounded strongly

immediately after the crisis (see Figure 1). The main reason behind this

success is its adoption of basic organizing principles for policy design and the

establishment of flexible and yet dynamic institutional structure to implement

and execute such principles. The purpose of this paper is therefore to layout

such organizing principles and the institutional framework that Singapore has

set up to ensure macroeconomic stability. Secondly, the paper intends to draw

useful lessons from which developing countries can learn and emulate for

their economic prosperity.

Figure 1: Singapore: GDP at 2005 market price and Real GDP

Growth

Source: www.singstat.com.sg



41

The paper is divided into six sections. After the introduction, the second

section establishes an analytical framework for the use of exchange rate for

internal balance and the deployment of labour cost and productivity to

promote external balance in the Singapore context. The third section lays out

the institutional structure for the implementation of the analytical framework

while the fourth section describes how these principles are applied in

economic restructuring and crisis management during the current Asian

financial crisis, in particular in stimulating economic recovery and promoting

the nation’s competitiveness. The fifth section then illustrates the organizing

principles that Singapore uses for macroeconomic stabilization and draw

lessons which are useful for developing countries for emulation purpose. The

paper ends with a concluding remark in the final section.

2. Analytical Framework for Policy Design

Singapore is an open economy with a small domestic market. It lacks

natural resources and therefore depends on foreign countries for consumer

products, capital goods, intermediate inputs and raw materials. As a matter of

fact, consumer inflation is subject to foreign influences. To be more specific,

the major component of domestic inflation is imported inflation and thereby

exchange rate plays a crucial part in maintaining macroeconomic stability,

especially through dampening imported consumer inflation, reducing costs of

imported inputs and moderating external demand.

To analyze the impact of exchange rate on consumer prices and

imported inputs, an analytical framework developed by Carlin and Soskie

(1990) is used here. In this framework, domestic price level is the weighted

average of consumer prices of domestically produced goods and imported

goods, as follows:

P = Pd + (1 - ) Pm (1)

Where

P = the general price level represented by Consumer Price Index

(CPI)


42

Pd = prices of domestically produced goods and services

Pm = prices of imported consumer goods and services

Assuming that purchasing power parity (PPP) condition holds, prices of

imported consumer goods and services can be expressed as follows:

Pm = ePm* (2)

Where

e = exchange rate, expressed as domestic currency price of a unit

of foreign currency

Pm* = foreign price of imported goods

Price of domestically produced goods is, in turn, a weighted average of

prices of domestically produced tradable goods and price of non-tradable

goods, as follows:;

Pd = PT + ( 1-) PN

= (ePT*) + ( 1-) ePN*) (3)

Where

PT = Domestic price of tradable goods

PT* = Foreign Price of tradable goods

PN = Domestic price of non-tradable goods

Domestic price of non-tradable goods is determined by wages (w) and

prices of imported capital goods, intermediate inputs and raw materials as a

group (Pk), as follows:

PN = w + Pk

= w + (ePk*) (4)

Substitute (2), (3) & (4) into (1), gives

P = [ ( 1-)] w + [ (1-) Pk* + PT* + (1-) Pm*]e (5)



43

From the above it is noted that both wages and exchange rate affect the

price level. The latter affects the price level through three channels, namely,

prices of imported final goods, Pm*; prices of foreign tradable goods, PT*; and

prices of imported capital goods, intermediate inputs and raw materials, Pk*.

In this respect, Singapore has to make a choice as to use exchange rate or

wages to achieve price stabilization (internal balance) or export

competitiveness (external balance). Since there are two targets and two

instruments, it would be more effective if one instrument target with only one

policy target.

According to Teh and Shangmugan (1993), exchange rate policy was

the main policy instrument in reducing consumer inflation in Singapore. For a

one percentage appreciation of Singapore dollar, it was able to reduce 0.7 per

cent in consumer inflation. The main source of inflationary pressure hence

stems from domestic non-traded sector such as rentals, domestic transport,

health care and utilities charges which, in turn depend largely on domestic

labour costs.

Exchange rate also affects the Singapore economy through its

influences on external demand. As a small open economy, external demand

accounts for the bulk of total aggregate demand. Accordingly, exchange rate

changes will have a significant impact on aggregate demand through its

influence on external demand. For instance, during times of economic

over-heating, exchange rate appreciation will be able to moderate external

demand so as to be consistent with aggregate supply to ensure

macroeconomic stability.

Finally, as Singapore lacks natural resources, all raw materials, capital

goods and intermediate inputs have to be imported from abroad. The change

of exchange rate will affect costs of production. With the appreciation of

Singapore dollar, costs of production are reduced and in turn this effect will

be translated into lower consumer prices.

As external demand constitutes a large portion of total aggregate

demand, export competitiveness would become critical in sustaining

economic growth for Singapore. Export competitiveness as represented by

real exchange rate (RER) is determined by nominal exchange rate (e), wage

rate (W), labour productivity (LP) and profit rate or mark-up rate (m) vis-à-vis


44

that of its competitors. This can be seen from the analytical framework

developed by Sachs and Larrain, (1993).

First, assume that both domestic and foreign economies use mark-up

principle in their price determination, as follows:

LP

W

mP

)1(

1

(6)

*

*

*)1(

1*

LP

W

mP

(7)

Where

P = price level

m = mark-up

W = nominal wage

LP = labour productivity, output (Y) divided by number of workers (L)

P* = foreign price level

m* = foreign mark-up

W* = foreign nominal wage

LP* = foreign labour productivity, foreign output (Y*) divided by

number of foreign workers (L*)

Real exchange rate is expressed as follows:

P

ePRER

* (8)

Where

RER = real exchange rate

e = exchange rate, expressed as domestic price of foreign currency

P* = foreign price level

P = domestic price level

Substitute (6) and (7) into (8) gives:



45

LP

W

m

LP

W

me

P

eP

)1(

1

*

*

*)1(

1

*

(9)

Re-arrange the terms:

**)1(

*)1(

WLPm

LPWmeRER

(10)

Form the above equation, it is noted that for an economy to be

competitiveness, a country can implement the following policy measures, as

follows:

Nominal exchange rate depreciation (increase e);

Reduce mark-up (m)

Increase labour productivity (LP)

Lower nominal wage (W)

Any combinations of the above

All of the above at the same time

To be more focus, equation (10) can be rewritten as relative unit labour

cost of two countries, as follows:

ULC

eULC

P

ePRER

** (11)

where ULC* and ULC are unit labour cost of foreign countries and

home country respectively2.

From the above discussion, it is obvious that the appropriate policy

design for Singapore is to use exchange rate policy to achieve internal balance,

ensuring price stability and low unemployment rate. Wage policy together

with other measures of promoting labour productivity, on the other hand

2 The ratio of nominal wage to labour productivity, W/LP can be re-arranged as follows:

W/LP = W/(Y/L) = (W.L)/Y = ULC = W/(Y/L) = (W.L)/Y = ULC. Similarly, for foreign

country, W*/LP* = ULC*.


46

should be used to enhance international competitiveness. As Singapore uses

two policy instruments to achieve two different policy objectives, this is in

accordance with the Tinbergen principle3 that the number of policy objectives

must match with the number of policy instruments.

3. Institutional Structure for Policy Implementation

The major thrust of price stabilization to ensure internal balance is to

reduce imported inflation through exchange rate appreciation. Accordingly,

the institutional design as such must ensure that exchange rate appreciation

will prevail eventually. The design covers basically five aspects. The first

aspect is the setting-up of a channel through which Singapore dollar funds are

immobilized at the Monetary Authority of Singapore (MAS), the de facto

central bank. Secondly, the design must include a means through which

demand for Singapore dollar funds in the foreign exchange market is

stimulated to ensure an overall excess demand. The third aspect is to provide a

shield against speculative attacks by international currency speculators.

Fourthly, there must be a mechanism through which Singapore dollar funds

are re-channeled back into the banking system to moderate any sharp

appreciation, and at the same time, to smoothen disruptive fluctuations in the

foreign exchange market and domestic money market. Finally, there must be

an element of flexibility to allow MAS to change policy stance as required by

the prevailing circumstances. And this frequent change will have nothing to

do with time inconsistency problem as noted in the economic literature.

In the first institutional design, three institutions are involved in

channeling Singapore dollar fund to MAS (See Chart 1), thereby reducing the

supply of Singapore dollar in the foreign exchange market. The first is the

Central Provident Fund Board (CPF) which mobilizes on a monthly basis,

both employers' and employees' contributions (about 30% of employees') and

the funds are in turn, placed as advanced deposits with MAS for the purchase

of government securities as and when they are issued (Ng, 1996). The second

3 The idea was expounded by Jan Tinbergen, a Dutch economist but it was Robert Mundell

who lays down the principle and applies to the Mundell-Fleming model.



47

is government fiscal surpluses that will help net increases in government

deposits with MAS. The third institution is the banking system in which all

banks are required to open deposit accounts with MAS for cheque clearing

and meeting reserve requirements, in particular the cash ratio. In addition,

banks are required to hold government securities for complying with liquid

asset ratio to a limited extent. Moreover, banks are required to use

government securities for its repos operations with MAS. If banks were to

borrow funds to meet its liquidity needs in time of tight liquidity situation,

only government securities are allowed to be used as collaterals for such loans.

The purchase of these government securities in such captive market represents

an eventual immobilization of bank funds with MAS.

Chart 1. MAS Operations and Flows of Funds

Source: Teh, K. P. and Shanmugaratnam, T., (1992) and Monetary Authority of Singapore

The second part of the institutional design involves the stimulation of

demand for Singapore dollar in the foreign exchange market. Apart from the

usual international trade transactions, the government through the Economic

Development Board (EDB) attracts direct foreign investment. The inflow of

such long-term capital represents an increase in demand for Singapore dollar.

Secondly, the setting up of many offshore banks (45 as at end of 2013) which

are allowed to mobilize only foreign currency denominated deposits

represents another source of demand for Singapore dollar in the set-up. These


48

banks have to convert part of their foreign currency assets into Singapore

dollar funds to meet their day-to-day operations in Singapore, such as

payments of office rentals, utilities charges, administrative charges and staff’s

salaries and wages. In this way, these banks thus exert a constant demand for

Singapore dollar in the market.

The third component of the institutional design is to have effective

control over the supply of Singapore dollar and also provide a shield over

which Singapore dollar is protected somewhat from any possible speculative

attacks on the currency. With this in mind, the institutional design requires

MAS to make Singapore dollar fund more expensive as to discourage the

formation of Singapore dollar off-shore market in other parts of the world.

Accordingly, MAS imposes extraordinary high reserve requirements on

Singapore dollar deposit liabilities (21% as compared to about 8-10% in the

case of the United States). The imposition of high reserve requirements,

which include 3 per cent cash ratio and 18 per cent of liquid asset ratio is to

deliberately increase the relative costs of Singapore dollar fund. As for

off-shore non-Singapore dollar deposits, they are exempted from the

imposition of reserve requirement. As a consequence, there exists a wedge

between on-shore Singapore dollar market and offshore non-Singapore dollar

market. This is to discourage banks from lending in Singapore dollar for uses

outside Singapore. However, a more effective control over

internationalization of Singapore dollar is the restrictions on bank lending in

Singapore dollar for uses outside Singapore. Previously, the MAS imposed a

lending limit of S$5 million and the approval was on case by case basis. Since

November 1999, there has been a significant liberalization on such

restrictions4.

The first two institutional structures will ensure that the Singapore

dollar will appreciate against currencies of its trading partners as a group to

reduce imported inflation. However, with persistent overall balance of

4 For more details on non-internationalization policy, please refer to MAS website: MAS

Notice 757,

http://www.mas.gov.sg/regulations-and-financial-stability/regulations-guidance-and-licensi

ng/commercial-banks/notices/2004/notice-757--lending-of-singapore-dollar-to-non_residen

t-financial-institutions.aspx. For the discussion on liberalization on non-internationalization

policy, please refer to Ong (2002) and Chow (2008).



49

payments surpluses over the years, it is possible that the excess demand for

Singapore dollar may result in too sharp an appreciation of the currency at the

expense of export competitiveness. There is a limit to which the appreciation

will adversely affect Singapore international competitiveness. Secondly,

persistent withdrawals of funds by CPF, government surpluses and the

banking system also lead to a tightening of the Singapore dollar money

market. These two pressures therefore, require MAS to re-inject Singapore

dollar funds back into the banking system and foreign exchange market to

ease the tight money market and exchange appreciation. In addition, there is

also a need to smoothen interest rate and exchange rate as and when necessary.

In this connection, open market operations in foreign exchange market are

used to influence the direction of the exchange rate. Other instruments such as

foreign exchange swap, repurchase agreements, and net issues of Treasury

bills are used mainly for smoothing interest rate and exchange rate volatility5.

As a result of this policy design and implementation since 1982, inflation rate

in Singapore was on average less than 2 per cent during 1982-2013 period

(see Figure 2).

The institutional design for external balance comprises two categories

of institutions. The first type is to influence labour costs and this includes the

National Wages Council (NWC), CPF (employers' contribution rate), and

Ministry of Manpower (imposition of foreign worker levies). The second

category is more concerned with raising productivity. The institutions

involved comprise the Skills Development Fund (SDF), Standards,

Productivity and Innovation Board or SPRING Singapore (formerly known as

Singapore Productivity and Standards Board, PSB), Agency for Science,

Technology and Research or A*STAR (formerly known as National Science

and Technology Board) and Infocomm Development Authority of Singapore

(IDA)6. The first category has an immediate impact on cost competitiveness

while the second category involves more with skill development, research and

development as well as developing core competencies for restructuring and

5 For a detailed discussion on the use of the instruments, please refer to Ng (1996a).

6 IDA was formed in 1999 by merging the National Computer Board and

Telecommunication Authority of Singapore.


50

upgrading of the Singapore economy.

Source: www.singstat.com.sg

Through the National Wages Council, a flexible wage system had been

introduced in Singapore since 1986. The stickiness in wage determination has

been removed through the introduction of variable components in the wage

composition, such as monthly and annual variable components (bonuses). In

time of deep recession, these components can be reduced as part of the

strategy to reduce labour cost, so as to promote or at least to sustain

international competitiveness. Likewise, in time of economic boom,

companies are expected to increase bonuses (one of the annual variable

components) so that labour share in national income will be somewhat

maintained. This is a way employees have a chance of enjoying fruits of

economic success and also be prepared to sacrifice for the nation whenever

the economy is suffering from economic recession.



51

As noted earlier, CPF plays a significant role in channeling funds from

the private sector to MAS for the effective implementation of exchange rate

policy (see also Ng, 1996b). In ensuring external balance, CPF plays a key

role in increasing national savings which are in turn rechanneled for domestic

investment. Compulsory savings through CPF constituted about one third of

the national savings. Partly as a result of this forced saving, Singapore has

been able to enjoy current account surpluses since 19867.

Apparently, employers' contributions to CPF on behalf of their

employees (ranging from 10% to 25% in the period of 1965 to 2014)

represent a significant portion of labour cost. This contribution rate can be

varied to influence the labour costs depending on the prevailing circumstances.

For instance, in 1985, the contribution rate by employers was reduced from

25% to 10% to help revive the economy from the recession. Immediately after

the economic recovery, the contribution rate was restored partially. We will

discuss in detail the use of these instruments in the next section.

4. Policy Experiences and Crisis Management

Economic restructuring has been an on-going process in Singapore.

However, the most classic example is the period in late 1970s during which

industrialization in Singapore was transformed from a focus on labour

intensive industries to capital intensive industries. Institutional framework

was set up to allow policy tools being used deliberately to accelerate the

transformation. In another instance, institutional framework has also been

designed to facilitate crisis management. Since independence in 1965,

Singapore has experienced four major crises. These crises include a severe

economic recession in 1985, the Asian Financial Crisis in 1997, dot.com bust

in 2000 as well as 2008 Global Financial Crisis. In this section, we will

illustrate how Singapore had used its institutional design as well as its policy

tools in restructuring the economy in the 1970s and early 1980s and also for

crisis management, especially in the case of the Asian Financial Crisis and the

Global Financial Crisis.

7 Since its independence in 1965, Singapore had been in current account deficits for almost

two decades.


52

After the successful implementation of its industrialization programme

in the 1960s and 1970s, Singapore began to show signs of labour shortage in

late 1970s. There was an urgent need for economic restructuring if Singapore

were to survive in the international market. The painful decision was to shift

Singapore away from the traditional labour intensive industry and move into

capital intensive industry, especially those with high-tech and

knowledge-based. Such a change in strategy required a significant change in

relative input prices in favour of capital input. Specifically, there was a need

to deliberately increase labour cost and lower prices of capital goods. At this

critical stage, institutional development was ready for such a shift. First, the

National Wages Council recommended a so-called "high wage" policy for the

period of 1979-81. Accordingly, nominal wages were increased by 8.8%, 13%

and 14% in 1979, 1980 and 1981 respectively. However, wage increases

gained momentum to reach 15.3% in 1982 and taper off to 7.9% in 1985. At

the same time, employers' contribution rate together with employees' also

increased steadily from 15% in 1976 to the highest 25% in 1985. Such high

contribution rates were in support of the restructuring policy and also as to

dampen any inflationary pressure arising from the high wage policy. These

two measures increased labour cost substantially such that real gross wage

rate (including employers' CPF contributions) rose to an average annual rate

of 7.8% in the period of 1979-85, as compared with only 3.9% in the period

of 1976-78. To make capital cost cheaper (and also as the price stabilization

measure from 1982 onwards), exchange rate appreciated significantly

between 1980 and 1985. Such a deliberate change in relative input prices had

helped Singapore in its economic restructuring, i.e. moving towards

automation, computerization and robotisation. Those labour intensive

industries were, however asked to re-allocate their plants to neighbouring

countries, especially Malaysia and Indonesia through the formation of the

Growth Triangle8.

The co-ordination among NWC, CPF and MAS in changing relative

input prices had brought about an over-whelming success in economic

8 The idea was mooted by the then Deputy Prime Minister, Goh Chok Tong in 1989 and

agreements were signed in 1990 and 1991 with Indonesia and Malaysia (Peebles and

Wilson, 2002, p. 198).



53

restructuring, especially between 1979 and 1983. After that period, sustained

nominal exchange appreciation and high labour costs (high wages and high

employer's contribution rate) had resulted in two adverse consequences. One

was that average real wage rate had increased at too rapid a pace so as to

exceed average productivity growth. This was especially true when the

Housing and Development Board (HDB) with its eagerness in achieving

home ownership had built many HDB flats to meet increasing demand arising

from higher income and wages as well as high CPF savings9. The massive

construction of HDB flats had increased demand for workers, thus causing

severe labour shortage and further increases in wages. At the same time, the

sustained appreciation of Singapore dollar, together with high labour cost also

resulted in real exchange rate appreciation, measured in unit labour cost term.

The outcome of such severe loss of international competitiveness was a deep

recession in 1985 with a negative growth of 1.6%, the first experience since

independence in 1965.

Despite the poor economic performance, the existing institutional

set-up allowed the Singapore government to turn around the economy within

one year and by 1987, Singapore returned to its high growth regime by

registering a real growth rate of 9.7%. The policy package included a sharp

reduction in employers' contribution rate from 25% to just 10%. Secondly,

NWC also called for a severe wage restraint during the recession year. The

old payroll tax of 2% was removed while SDF levy was also reduced from

4% of workers wages to 2%. Among other measures, corporate tax rate was

also significantly reduced from 40% to 33%. All this was possible because the

institutional set-up in Singapore was flexible enough to deal with economic

crisis.

To improve further the existing institutional set-up, the government

introduced further flexibility in its wage system through a series of wage

reform starting from 1986. As far back as early 1970s, the NWC

recommended a shortening of collective agreements from three or five years

to two or three years. In addition, NWC also recommended wage increase

9 Members of CPF are allowed to use part of their savings to purchase residential housing.

Purchases of new HDB flats by Singapore citizens were funded with interest rate normally

at below market rate.


54

over and above than those already agreed in the existing agreements (Lim,

1998). In later years, especially after the economic recession in 1985, more

drastic wage reform measures were introduced. In 1988, the government took

the lead in implementing a flexible wage system for its employees. Such

flexibility in the wage system rendered the government later an additional

policy tool in addressing the Asian Financial Crisis in 1997.

Singapore suffered from the Asian Financial Crisis in 1997-1998 not

because of its poor economic fundamentals but rather due to the contagion

effect, emanating first from the Thai financial crisis and then later on from

spreading of the regional crisis. This was because the Singapore economy has

already been well integrated with the regional economy since its adoption of

the regionalization policy in 1989.

With the on-set of the crisis, there were calls for a Keynesian type of

budget deficit and a drawdown of its vast pool of external reserves to tie over

the difficult period. However, the government was resolute in its

determination to refrain from using the above approach. The rationale was

that the crisis was external in nature and competitiveness was the crucial

factor in bringing economic recovery. Secondly, Singapore is a small open

economy and any domestic fiscal stimuli would only lead to two large

leakages; one is saving through CPF contributions while the other is import

leakage, which is larger than the GDP. The government also refused to use

exchange depreciation in promoting export competitiveness. Firstly, the

depreciation would only exert more pressure on further devaluations in the

regional economies. Secondly, depreciation of Singapore dollar would only

bring about inflation and then a pressure for wage increases with adverse

consequences on international competitiveness. Thirdly, further depreciation

might enhance competitiveness in the short run but such a move during

uncertain and yet critical period would only erode foreign investors'

confidence, which was badly needed in such a critical situation. Finally,

Singapore, as an international financial centre, could not afford to let foreign

investors to have a slightest doubt in their confidence towards the Singapore

economy. Depreciation of Singapore dollar in this critical moment might well

spells a disaster for Singapore as an international financial centre. The only

way out was to reduce labour cost to promote international competitiveness in



55

the short run. The cost-cutting package (-S$10.5 billion) to deal with the

financial crisis included a reduction of employers' CPF contribution rate from

20% to 10% (-S$3.9 billion), a wage cut in variable components (-S$3.6

billion), and a fiscal deficit (-S$3 billion). Together with exchange rate

depreciation of 18%, the Singapore economy was able to rebound from a low

growth of 0.3% in 1998 to 5.6% in 1999.

Aside from financial policy to inject public confidence, exchange rate

policy in Singapore has been playing the role of dampening imported inflation

in normal time and a tool for promoting export competitiveness in severe

recession. However, in the Global Financial Crisis in 2008, exchange rate

policy was geared toward of maintaining confidence in the Singapore

currency and also towards dampening excessive volatility in the Singapore

dollar should needs arises (Lim and Maru, 2010, p. 36). Since the onset of the

Global Financial Crisis, MAS shifted its policy stance from gradual

appreciation since April 2008 to a zero appreciation of the policy band in

October 2008. In April 2009, MAS re-centred its exchange rate policy to the

prevailing level of the Singapore exchange rate. The currency depreciated

slightly against USD, yen and euro but appreciated against regional currencies.

The depreciation against key currencies was to stimulate exports, with the

deepening of the crisis while the appreciation against regional currencies was

to reduce imported inflation as Singapore imports a significant portion of its

consumer goods, especially food from its regional neighbours.

The manufacturing sector, especially electronics exports (Kesavapany,

2010) was the worst hit sector in Singapore during the Global Financial Crisis.

The Singapore government was very much concerned with massive layoffs

and retrenchment in the labour market. For the first time fiscal stimulus

package was introduced. In the past, fiscal policy was to maintain fiscal

surplus year in year out as part of “fiscal complicity” ’ (Moreno and Spiegel,

1997) and has insignificant role in macroeconomic management. In an

unprecedented manner, the government also dipped into its reserves to combat

the negative effects of the crisis on the labour market. The main objective of

the stimulus package was to help Singaporeans to keep their jobs rather than

provide them with unemployment benefits. Workers were encouraged to

accept lower pays and then their pays were supplemented with additional


56

income by the government under the Workfare Supplement Income Scheme.

In addition, low-pay workers were also encouraged to undergo training or

re-retraining under the Workfare Training Support (WTS) Scheme supported

by the Singapore Workforce Development Agency (WDA)10

. On the demand

side of the labour market, the government provided strategic industrial

support to drive down business costs and avoid corporate failures. Businesses

were encouraged to retain their workers by lowering their wages and the

government will provide workers with income supplement through the

Workfare Scheme.

5. Five Organizing Principles and Lessons Learnt

Because of its openness, Singapore economy is subject to external

influences, and sometimes to vagaries of economic fluctuation and contagion

effects. Singapore is just like a small boat in the ocean, and she needs a strong

anchor and resilience to stay afloat and steady. The anchor is political stability

and strong economic fundamentals. Resilience, on the other hand, depends

very much on its flexibility and competitiveness to deal with adverse

environment and also difficult periods. The Singapore experience has shown

that she is able to deal with various difficulties mainly because of its

institutional framework with built-in flexibility and also a ready policy

package which can be maneuvered to Singapore's advantage in economic

restructuring and crisis management. Apart from the importance of institution

building, the Singapore experience also provides a number of organizing

principles which are useful and relevant for macroeconomic management, as

follows:

(1) Choice of policy instruments depends on the structure of the

economy (e.g. the dominance of domestic demand vis-a-vis external demand)

as well as its relative impact on the economy. Since Singapore has a high

10 For details on the Workfare Scheme, please refer to Singapore Ministry of Manpower

website:

http://www.mom.gov.sg/employment-practices/employment-rights-conditions/workfare/Pa

ges/workfare-income-supplement.aspx



57

degree of openness in terms of trade and capital flows, exchange rate policy is

the automatic choice to deal with price stabilization. This is because exchange

rate changes have a direct impact on external demand which constitutes a

significant portion of aggregate demand. This choice is considered as

appropriate as evidenced by a study by Hwee, K.C., G. Lim and P.D. McNelis,

(September 2012)11

. As for international competitiveness, wages and labour

supply are critical variables in influencing production costs. Moreover,

Singapore adopts a flexible wage system which provides resilience in times of

financial crisis. Fiscal policy is not used actively for macroeconomic

management in Singapore because of its high leakages arising from high

saving (especially through CPF) and high import content. In view of the

above, exchange rate is directed at price stabilization while wages policy is

aimed at international competitiveness.

(2) The importance of adherence to the Tinbergen principle - the

matching of number of instruments and number of policy objectives- calls for

institutional development to provide adequate policy instruments for

macroeconomic management. Secondly, such adherence will ensure

transparency and accountability in managing the economy. In the context of

Singapore, exchange rate policy is assigned for achieving internal balance

while wages policy is expected to address the issues of international

competitiveness. Accordingly, MAS will just aim at price stability while

NWC together with other institutions will ensure that wage growth rate will

always lag behind productivity growth rate to ensure international

competitiveness.

(3) Institutional design and building must take into account of their

respective macroeconomic implications to enhance their effective

co-ordination. This is to ensure policy effectiveness and consistency in policy

implementation. The appreciation of Singapore dollar to dampen inflation

seems to be in conflict with the objective of export competitiveness. In closer

11 Their study notes that “…in terms of overall inflation volatility, the exchange rate rule has a

comparative advantage over the Taylor rule when export-price shocks are the major sources

of real volatility, while a Taylor rule dominates when domestic productivity shocks drive

real volatility.”


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look, this may not be so. Appreciation of Singapore dollar also reduce costs of

production by reducing costs of imported inputs such as raw materials,

intermediate inputs as well as machinery and equipment. Together with wage

policy, this will enhance Singapore’s competitiveness which in turn, leads to

appreciation of Singapore dollar. Such appreciation again helps to achieve

price stability.

(4) Policy design should observe the constraint imposed by

‘impossible trinity’12

or ‘eternal triangle’ as noted by Paul Krugman (1998)

or else the economy would lead to inconsistency in policy implementation.

The eventual outcome may be disastrous speculative attacks on its currency.

In the context of Singapore, she attempts to target at exchange rate (an

appreciation of exchange rate to achieve price stability) by giving up

independent monetary policy and also allowing free capital flows across

borders. However, if the economy is encountering an overheating situation,

MAS will accelerate appreciation of its currency to moderate the inflationary

pressure by dampening external demand. In a similar vein, if the economy is

on the downturn when inflation is no more an issue but unemployment is,

MAS will allow Singapore dollar to depreciate to help stimulate external

demand. This built-in flexibility has led to Reisen (1993a, 1993b) to conclude

that Singapore is exempted from the constraint of ‘impossible trinity’ by

having consistent fiscal surpluses as part of ‘fiscal complicity’. Moreno and

Spiegel (1997) refute this view and argue that “Instead, the tranquil

experience enjoyed by the Singapore economy appears to reflect some

willingness by the Monetary Authority of Singapore to allow exchange rate

adjustment in the face of foreign shocks.”

(5) As noted earlier, an element of flexibility has been built in the

policy design for exchange rate policy to deal with the changing

circumstances. In another instance, flexibility and novelty in policy

implementation was shown in the Global Financial Crisis in 2008. In such

critical situation, public confidence and addressing unemployment issues (see

12 ‘Impossible trinity’ refers to “…a country cannot simultaneously maintain an open capital

account, an exchange rate target, and a monetary policy that is geared to domestic

stabilization needs and is independent of the exchange rate target.” (Islam, I. and

Chowdhury, 2000, p. 96)



59

Figure 3) were the two most critical factors to ride out of the financial crisis.

Inflation was not an issue then while confidence was. Exchange rate policy

was therefore geared to inject confidence rather than allowing the currency to

depreciate to stimulate demand, thereby affecting the confidence sentiment.

Cost cutting was equally important. Cost cutting through retrenchment would

erode public confidence and this was considered as undesirable in such

situation. Wage policy, therefore needs to be re-oriented to keep jobs and at

the same time, lower labour cost. The Workfare Scheme was thus introduced

to meet the three objectives, namely, confidence, no job loss and also lower

labour cost. With all these policy measures, Singapore was able to ride out

from the Global Financial Crisis in 2010 by registering a hefty increase in

GDP growth of 15.1% in 2010, as compared to -0.6% in 2009 and 1.9% in

2008.

Sources: CEIC database. Unemployment data for 1965 and 1970 are from Koh and

Mariano (2006), The Economic Prospects of Singapore.

Note: Official unemployment data start in 1974. In 1986, there was a switch from

using mid-year figures to annual average. In 1992, there was a widening of the definition of

the labour force.


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In summary, the five organizing principles which the policy design of

Singapore has incorporated are, as follows:

Policy design and choice of policy instruments depends on the

structure of the economy; policy makers need to choose instruments that have

most direct impact on the economy;

The matching of number of instruments and policy objectives in

accordance to the Tinbergen principle;

Institutional design and building must take into account of their

respective macroeconomic implications to enhance their effective

co-ordination;

Policy design should observe the constraint imposed by

‘impossible trinity’ to ensure policy consistency;

Flexibility in policy implementation must be part and parcel of

the policy design to deal with changing circumstances.

6. Concluding Remarks

Any policy design for macroeconomic management must have an

analytical framework within which policies are implemented. This is to ensure

consistency, transparency, and accountability on the part of government

agencies which are responsible for the policy implementation. Of no less

importance is that the analytical framework also provides a basis for

co-ordination among government agencies or institutions in implementing

policies. Moreover, the analytical framework also provides a guide to

institution building and also would require institutions to take note their

respective macroeconomic implications. A good example is CPF. While CPF

is basically a social security institution, yet it has tremendous impact on flow

of fund in the banking system which, in turn has an indirect influence on

exchange rate. Another example is HDB whose rapid development in the

1970s and early 1980s had led to a sharp demand for labour. This increase in

demand, in turn exerted upward pressure on labour costs. With no

corresponding increase in labour productivity, high labour cost would

eventually lead to a significant loss of export competitiveness.



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An effective policy design should also observe five organizing

principles as noted in the previous section. Policy makers have to

acknowledge the economic structure, the potency of each instrument, the

Tinbergen Principle, the ‘impossible trinity’ and lastly the flexibility in policy

design to address prevailing circumstances. These five guiding principles will

not only ensure strong and sound economic fundamentals but also avoid the

pitfalls of inconsistencies in policy implementation. Such inconsistencies

often lead to economic crises as observed in Latin America in the 1970s and

the Asian Financial Crisis in 1997.

In policy design, Singapore, unlike other countries assigns exchange

rate for price stabilization and wage policy for promoting export

competitiveness. This policy assignment is meant only during normal time.

However, in a crisis situation where inflation is no more an issue, exchange

rate policy will address the weakening of external demand instead. In another

situation where investors’ confidence becomes critical, exchange rate policy

will then focus on investors’ sentiment and the need to inject confidence. In

this case, creditability of MAS will become critical. Wages policy is used to

promote international competitiveness in Singapore but the critical guiding

principle is that wage growth rate must not exceed productivity growth rate.

In addition, a flexible wage system must be in place to allow flexibility in

labour costs in time of crisis. Supplementary income transfer such as the

Workfare Scheme implemented in Singapore to lower the labour cost is

another novelty to address severe unemployment in crisis time.

The Singapore case thus provides a classic example which can serve as

a model for other developing countries to emulate for their effective

macroeconomic management.

References

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Chow, Hwee Kwan, (Feb. 2008), “Managing Capital Flows: The Case of

Singapore,” ADB Institute Discussion Paper No. 86.


62

Hwee, K.C., G. Lim and P.D. McNelis, (September 2012), “Monetary Regime

Choice in Singapore: Would a Taylor Rule Outperform Exchange-rate Management,” http://www.bundesbank.de/Redaktion/EN/Downloads/Bundesbank/Research_Centre/Conferences/2012/2012_11_22_eltville_02_guay_paper.pdf?__blob=publicationFile

Islam, Iyanatul and A. Chowdhury, (2000), “Capital Flows and

Macroeconomic Management,” in The Political Economy of East Asia: Post-crisis Debates, Oxford: Oxford University Press, Chapter 3: 81-116.

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