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Competitiveness in the Global Economy with Reference to Singapore

by

Ramkishen S. Rajan

1. Introduction

Despite the seeming preoccupation by governments with what needs to be

done to remain competitive in the global economy, there is, rather surprisingly, a

general lack of awareness of the exact meaning of the term. To be sure, while it is

fairly clear to most of us what it means for a particular business to be globally

competitive, what about an entire nation that is made up of a myriad of firms,

industries, sectors, products and factors?There exist a large number of indices that supposedly measure national

competitiveness, such as the ones by the World Economic Forum (WEF), the Swiss-

based International Management Development (IMD), or the United Nations

Industrial Development Organization (UNIDO) which focuses more narrowly on

industrial competitiveness. Singapore is probably exceptional in the degree of

attention it pays to these indices. While the indices may act as useful benchmarks in

certain areas, their analytical basis as proxies for national competitiveness is open to

question.

2. Defining Economic Competitiveness and the Real Exchange Rate

When an economist thinks about economic competitiveness at a macro or

national level, the focus is usually on the real effective or trade-weighted exchange

rate (REER). This in turn refers to the nominal effective or trade-weighted exchange

rate (NEER) adjusted for relative prices between foreign and domestic prices. To put

this in more concrete terms, assume that the exchange rate is measured in terms of

foreign currency per Singapore dollar. The REER is then simply the NEER multiplied

by the aggregate price index in Singapore divided by a trade weighted foreign price

index. A rise in the REER would thus imply a real appreciation of the Singapore

dollar. This rise in the real value of the Singapore dollar, especially if it takes place

suddenly, might be taken as an indication of loss of price or economic

competitiveness of Singapore goods and services in global markets (as they become

more expensive in foreign currency terms).

Accordingly, steps to regain economic competitiveness in the short-run centre

on either the NEER or domestic prices/costs or both. In most countries nominal costs


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and prices tend to be fairly rigid downwards, leaving the nominal exchange rate as

the sole short-term instrument to regain economic competitiveness. This, however, is

not true in Singapore, where there is an ongoing debate as to whether a downward

adjustment of the REER in the context of a downturn ought to be engineered via a

nominal depreciation of the Singapore dollar or through a reduction in domestic unit

business costs.

Available data suggest that the Monetary Authority of Singapore (MAS) has

historically pursued an asymmetric policy. Periods of overheating have been

confronted with a NEER appreciation (which is indirectly deflationary). Periods of

economic downturn have generally been dealt with via domestic cost reductions

(which is directly deflationary) rather than through a nominal depreciation (which is

expansionary). Hence, it is not surprising that Singapores prices relative to those of

its trading partners have experienced a long-term downward trend (Figure 1). This is

taken as evidence by some that domestic macroeconomic policy has imparted a

strong deflationary bias over time, and may have skewed aggregate demand too

heavily to external demand (net exports) at the expense of internal demand

(consumption).

3. Limits of Nominal Exchange Rate Depreciations

There are sensible reasons for limiting the use of the NEER as a policy

instrument. The most cited rationale is that the high import content of manufactured

goods implies that, other things being equal, a nominal depreciation may not

translate into a significant real depreciation, as domestic prices may rise as well.

Certainly, repeated use of exchange rate depreciations by itself to boost

competitiveness quickly loses effectiveness as costs and prices rise in anticipation of

-- or simultaneously with -- a currency depreciation. Given the high stock of non-

inflation indexed wealth that households and firms in Singapore have accumulated,

concerns about keeping a tight lid on inflation are understandable.A secondary reason why NEER depreciation is used sparingly in Singapore

as a policy instrument to regain economic competitiveness is the desire to promote a

greater degree of internal price flexibility in the downward direction. Nominal

exchange rate rigidity may force domestic prices to become increasingly flexible,

thereby reducing the need for significant nominal exchange rate variations. While this

may be true in the Singapore context, it has certainly not been the case in some

other countries like Argentina in the late 1990s which had to forsake its US dollar-

based currency board arrangement (CBA) in the face of a deep domestic recession(an inevitable outcome of inflexible factor markets).


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4. Limits of Deflationary Policies

Singapore is also better able than most other countries to pursue a policy of

price deflation during a period of economic downturn as it has certain supply side or

incomes tools readily available to it, such as the Central Provident Fund (CPF). The

cordial tripartite alliance between government, management and labour has further

contributed to keeping wages in Singapore fairly flexible. Apart from keeping wage

costs in check, the government could also try to curb land costs, transportation and

other transaction costs and corporate and related taxes. However, the problem with

such a deflationary strategy is two-fold.

One, there is obviously a trough or limit to which a lid can be kept on cost

pressures. For instance, in the case of corporate or income tax cuts, the goal of fiscal

sustainability may be compromised. In the case of cuts in the employer CPF

contribution, this could compromise the savings-for-retirement objective. In the case

of land costs, there is a limit to how much they can be reduced in a land-scarce city

(though alteration in the current market structure of land ownership -- a virtual

government monopoly -- can reduce costs further). In addition, too steep a decline in

land prices may trigger asset price deflation with adverse consequences for

aggregate demand and short-term growth.

More generally, the repeated and aggressive use of deflationary instruments

tends to exacerbate the sense of economic insecurity of the general populace. It is

almost inevitable that as individuals face greater market risks - which are at least

partly an outcome of increasing globalization of economic activities - there will be a

yearning for economic security which the government will need to respond to. In the

absence of a comprehensive social safety net, some have argued that Singapore

might be better off relying relatively more on expansionary policies (fiscal and

exchange rate) during periods of downturn, their limitations notwithstanding.

Two, no matter how successful one may be in keeping costs down, an

established fact of the new global economy is that newer and more cost effectivecountries and regions continuously emerge (regions in China, India and Vietnam

among others). Thus, sustaining competitiveness over the medium and longer terms

requires that the focus be on what economists refer to as the production function,

namely, increasing the quantity and quality of factor inputs and technical efficiency,

and ensuring that available inputs are used in the best possible manner to generate

maximum output.


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5. Sustaining Economic Competitiveness over Time

In order to stay competitive over the medium and long-terms, focus should be

on enhancing physical and human capital stock (including via greater levels of

foreign direct investment and attracting more and highly skilled migrants), using

labour-saving technologies more intensively, and augmenting the stock of directly

applicable/commercial R&D to boost both technological progress and technological

effort.

In addition, while it is conventionally assumed that inputs are automatically

used efficiently, it is increasingly recognized that government policy and

entrepreneurship are key factors determining the effectiveness with which available

resources are utilized. Indeed, one could even think of these as being separate factor

inputs on their own. Accordingly, there is renewed interest in Singapore in finding

ways of nurturing local entrepreneurship and examining the appropriate role of

government and government-linked companies.

With regard to the latter, another important dimension of growth arises from

positive externalities due to scale economies or critical mass and pure external

economies. The presence of these factors act as centripetal forces leading to

cumulative causation and ensures that an economy remains an attractive location to

do business in despite rising costs. Thus, there may be a role for activist -- but non-

distortionary -- government policies to try and facilitate these positive linkages by

developing broad clusters of growth activity. Singapore, for instance, has actively

targeted the biomedical science cluster which comprises biotechnology,

pharmaceuticals, medical devices, and health care services with the aim of making

the city-state the biomedical hub of Asia.

6. Conclusion

In the final analysis, it is vital to keep in mind that national economic

competitiveness is important not for its own sake, but because it is a pre-requisite forrapid and sustained growth. This in turn is essential for enhancing a societys overall

quality of life. It is therefore important that there be a constant and active debate on

how best this shared objective can be reached.


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Figure 1Singapores Relative Price Level

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80 82 84 86 88 90 92 94 96 98 00 02PRICE = REER / NEER

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