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 Singapore’s 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 effective
countries 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 for
rapid and sustained growth. This in turn is essential for enhancing a society’s 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 1
Singapore’s Relative Price Level
1.4

1.3

1.2

1.1

1.0

0.9

0.8
80 82 84 86 88 90 92 94 96 98 00 02

PRICE = REER / NEER