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Release No. 32/MARCH
08-1/97/03/22
97-HR-3
MACROECONOMIC
POLICIES IN SINGAPORE:
PRINCIPLES, MILESTONE!; AND FUTURE PROSPECTS
Speech by Dr Richard Hu,
Minister for Finance and Chairman of the
Monetary Authority of Singapore
at the Annual Dinner of the Economic Society of Singapore
Royal Pavilion Ballroom, The Singapore Regent
22 March 1997 at 7.30 pm
INTRODUCTION
Sound monetary and fiscal policies are the foundation of a stable
economy. Although stability by itself does not lead to development, without it,
all other efforts are likely to be in vain.
Just compare the experience of the East Asian economies with that
of Latin America. Despite an abundance of natural resources, heavy inflows of
foreign capital, and a talented and skilled workforce, growth in Latin America
averaged 2.3 per cent per annum since 1980. Over the same period, East Asian
economies grew three times faster.
Monetary stability and fiscal prudence
created a hospitable climate for private investment and productivity growth in
East Asia. Fiscal profligacy, mounting debt, overvalued exchange rates and high
inflation robbed Latin America of at least a decade of growth.
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Singapore’s own development experience highlights the importance
of macroeconomic stability for economic growth.
Our commitment to sound
monetary and fiscal policies has underpinned investor confidence, encouraging
sizable inflows of foreign direct investment.
The aim of both monetary and fiscal policies in Singapore is the
same, namely to promote sustained, non-inflationary growth of the economy.
Monetary policy has a more macro orientation, focusing on the management of
aggregate demand to ensure low inflation.
Fiscal policy has a more micro
orientation, focusing on supply-side issues like addressing market failures and
providing the right incentives for saving, investment, and enterprise.
This evening, I would like to reflect on the fundamentals and
challenges underlying the making of monetary and fiscal policies in Singapore.
First, I will touch on the basic philosophy and premises, setting out our
objectives and the strategies to achieve them. Then, I will take stock of the key
monetary and fiscal developments since the recession in 1985. Finally, I will
share with you what I think are the key monetary and fiscal challenges in the
years ahead.
MONETARY
POLICY
Let me begin with monetary policy.
A fundamental principle
governing monetary policy in Singapore is that low inflation provides the basis
for sustained economic growth and long term competitiveness. The reasons for
this are clear. Low and stable inflation reduces uncertainty in business decisions,
and encourages investors to take a long-term stake in the country.
Stable
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consumer prices also moderate wage pressures, underpinning the long-term
competitiveness of our exports.
The world has come a long way from the old economic orthodoxy
that moderate inflation may have to be tolerated to achieve higher growth. This
view is now widely discredited. Among developing countries, economies with
lower rates of inflation have tended to have higher rates of income growth per
capita. Quite clearly, there is no long-term tradeoff between the two major
economic policy objectives - of growth and price stability.
Hence, the
appropriate goal for monetary policy is to focus on the long-term and keep
inflation low. And this has been the operating philosophy of MAS.
How do we achieve the goal of low inflation in Singapore? There
are two objectives we need to fulfill: first, is to keep out imported inflation; the
second is to contain domestic cost pressures. And the monetary policy strategy
to achieve both objectives is the same: to maintain the strength of the Singapore
Dollar. A strong currency acts as a shield against foreign inflationary pressures.
This is an important factor in an economy where 60 cents out of every dollar that
is spent is on imported goods. A strong currency also helps to moderate external
demand when the economy is overheating, thereby helping to relieve labour
market pressures.
Yet, in my 12-odd years as Chairman of the MAS, I have had no
shortage of complaints about the strong Singapore Dollar. I can understand the
calls from some of our manufacturers and exporters for an easier exchange rate.
It is true that a weaker exchange rate makes our goods cheaper in foreign
currencies and thereby helps boost exports and GDP in the short run. But such a
policy has adverse macro consequencesin the long run.
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Ultimately, what is relevant to the ability of our exporters to
compete in international markets in the long term is not the nominal exchange
rate but the real exchange rate, i.e. the nominal rate adjusted for cost or inflation
differentials across countries. A weaker nominal exchange rate translates into
higher prices domestically.
Then, wages rise to reflect both these higher
domestic prices and the tighter labour market arising from the initial increase in
export demand. Rising prices and wages feed on each other, and lead to an
appreciation of the real exchange rate that offsets the initial gains in
competitiveness. Studies by M A S suggest that the bulk of the initial gains in
competitiveness arising from a weaker exchange rate are lost within three years
through higher inflation. Worse, the higher inflation tends to become entrenched,
with adverse consequences.
Some of you may not be entirely convinced. You may look at
Singapore’s real exchange rate and point out that it has risen despite low
inflation. And indeed it has. But the relevant comparison is with what the real
exchange rate might have been if we had prevented the nominal exchange rate
from appreciating and allowed inflation to creep up. In all likelihood, the real
exchange rate would have appreciated just as much, if not more.
A comparison with Hong Kong’s experience may be illuminating.
Singapore and Hong Kong are city-state economies extremely open to
international trade and capital flows. But their monetary policy regimes differ
sharply. Hong Kong’s maintains a pegged exchange rate, at 7.8 Hong Kong
Dollars to one US Dollar. Singapore’s monetary policy over the last decade has
been characterised by a trend appreciation of the Singapore Dollar against most
major currencies.
5
The divergent movements in the nominal and real exchange rates of
Hong Kong and Singapore provide an interesting perspective. In nominal terms,
the Hong Kong Dollar has been relatively more stable. Against a trade-weighted
basket of currencies, the Hong Kong Dollar has appreciated by a cumulative 19
per cent since 1990.
During the same period, the Singapore Dollar has
appreciated by 24 per cent. But in real terms, that is taking account of cost
differentials, the Hong Kong Dollar has appreciated by 42 per cent while the
Singapore Dollar has appreciated by 29 per cent. 1
During this period, both countries faced conditions of tight labour
markets and economic overheating which required a real exchange rate
appreciation.
Singapore chose to accommodate this through a nominal
appreciation while keeping inflation low. Hong Kong, on the other hand, with its
nominal exchange rate pegged to the US Dollar, had little choice but to allow
inflation to rise. As a result, it experienced a much faster real exchange rate
appreciation that posed difficulties for its export sector. Manufacturing exports
have stagnated in Hong Kong since 1990, while they have nearly doubled in
Singapore during the same period.
It is not my intention to f ind fault with the Hong Kong economy,
which remains one of the most vibrant and resilient in the world. Indeed, a good
part of Hong Kong’s poor export performance can be explained by the shift of
much of its manufacturing base to southern China. Moreover, the importance of
the political and economic stability that Hong Kong’s currency peg has made
possible is not to be underestimated. My point is a more limited one: that the
relative stability of Hong Kong’s nominal exchange rate has come at the price of
higher inflation and has not translated into unproved export competitiveness.
Singapore’s NEER is from published IMF sources.while Hong Kong’s NEER is from the Hong Kong
Monthly Digest of Statistics, Both NEERS are basedon MAS estimates,derived by adjusting the
NEERs for relative unit labour costs in the two economiesvis-a-vis their top ten export markets.
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More broadly speaking, empirical studies have shown that countries
experiencing rapid productivity growth, increased savings rates and strong capital
inflows tend to have an appreciating real exchangerate. These factors are at play
in Singapore as well as in many of the economies in this region, indicating that
our real exchange rates will have to appreciate over time. The question really is
whether this occurs through a strengthening of the nominal exchange rate, or
through a less desirable way via inflation. Singapore’s approach of allowing the
nominal exchange rate to adjust upwards has helped us to avoid the kind of
macroeconomic problems that have plagued some of the East Asian economies,
such as excessive monetary growth and destabilizing capital flows.
Looking to the future, what are the main challenges for monetary
and exchange rate policy in Singapore? On the positive side, the global
inflationary environment has become more benign. There are reasons to believe
that this is reflective of a structural disinflationary bias rather than just a cyclical
phenomenon.
First, the globalisation of economic activity has led to increased
productivity and efficiency in the manufacture of a wide range of products. This
has exerted downward pressures on prices in general. Second, the supply shocks
of the 1970s and 80s - in the prices of crude oil and primary commodities - are
not likely to be repeated, certainly not in the same magnitude. Indeed, the supply
shocks of today - whether it is in consumer electronics or memory chips - have
tended to be disinflationary. Third, central banks the world over are much more
focused on the pursuit of price stability. Monetary policy has become more preemptive, striking at inflation before it has a chance to take root.
What do these trends mean for Singapore?
To the extent that
foreign inflationary pressures become more muted, our exchange rate does not
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have to appreciate as much as it did before. Indeed, many of you watching the
Singapore Dollar would have already noticed the much more gradual rate of
appreciation in recent years. If the global inflationary environment continues to
l
be favourable, it is not unreasonable to expect a continuation of this more modest
rate of appreciation.
I must sound a note of caution, however. While central banks seem
to have successfully tamed consumer price inflation, the spectre of asset price
inflation continues to haunt many countries. Central banks are still grappling
with the issue of how to deal with rapidly rising asset prices against a
background of relatively stable consumer prices. This could well be the main
challenge facing central bankers in coming years. And we, in Singapore are not
immune to this challenge.
Cur exchange rate appreciation has successfully dampened inflation
in tradeable goods, but has not been as effective against inflation in the nontradable sector, particularly in asset markets like property. It appears that the
crux of the matter is this: surplus domestic savings and strong inflows of foreign
capital, in the context of an appreciating currency, have led to low interest rates.
This helped fuel the property market
inflationof recent years. Our dilemma is
that we cannot raiseinterest rates in an attempt to dampen asset inflation because
our monetary policy is centred on the exchange rate, which remains the key
macroeconomic variable. This was why we had to introduce the package of
fiscal measures in May last year to curb excessiveprice inflation in the property
market. M A S will continue to monitor both consumer and asset prices as part of
its mission to ensure a stable macroeconomic environment in which the country
can grow and prosper.
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FISCAL POLICY
Let me now turn to fiscal policy. A fundamental premise underlying
our fiscal policy is that the private sector is the engine of economic growth.
Government’s role, through tax and expenditure policy, is to provide a stable and
conducive environment for the private sector to thrive.
A basic principle of fiscal policy in Singapore is to avoid running
persistent deficits. Our aim is to run modest surpluses in good years to augment
our foreign reserves. These reserves provide an important buffer, given the small
and highly open nature of our economy and virtual lack of natural resources. A
healthy reserve position also instills confidence among foreign investors and
underpins Singapore’s status as a major financial centre.
Unlike many other countries, fiscal policy in Singapore does not
play an active role in counter-cyclical demand management. It is true that in
times of economic slack, we have accelerated some of our infrastructure
spending, as we did to some extent with the MRT and other projects during the
1985/86 recession. But, by and large, we have avoided the kind of Keynesian
pump-priming that many countries have resorted to during periods of weak
economic growth.
There are two reasons for this. First, as a highly open economy
with a large import leakage, an expansionary fiscal policy has limited effects on
boosting GDP. Second, and more importantly, our philosophy has always been
that tax and expenditure policies be justified on microeconomic considerations.
If a project is not worth doing on the basis of a social cost-benefit analysis, we
will not do it merely to pump prime the economy.
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The Singapore government has been running fiscal surpluses in
almost every year since the late 1960s.2 These surpluses are a major component
of our national savings. Since 1984, budget surpluses have averaged 4 per cent
of GDP.
In more recent years, it has risen to 8 per cent of GDP, partly on
account of cyclical factors that helped boost revenues. But the main structural
factor underlying our healthy budget position has been the relatively low level of
operating expenditure, Development expenditure in Singapore has actually been
higher than in the G7 economies, reflecting the high priority we place on building
a world class infrastructure. Likewise, differences in revenue intake cannot
explain Singapore’s more favourable fiscal position.
In fact, Singapore’s
operating revenue as a percentage of GDP has been significantly lower than that
in the G7 economies, although comparable to that in Taiwan and Korea, and
slightly higher than in Hong Kong.
Quite apart from the macroeconomic implications of the overall
fiscal stance, revenue and expenditure policies affect resource allocation at the
micro level. I would like to touch on these in somewhat greater detail.
On the revenue side, we have two key objectives. The first is to
raise sufficient revenue to finance both operating and development expenditure.
The second is to maintain an internationally competitive and socially equitable
tax regime. The challenge, of course, is to strike a balance between these
objectives.
Our strategy has been to build a broad revenue base. This reduces
the vulnerability of revenue intake to adverse changes in economic conditions.
2
The budget surplus for Singapore is defined as operating revenue less operating and development
expenditure. Unlike the case for the other countries, it does not include investment income, capital
receipts and interest payments.
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We have, over the years, achieved a better balance between tax and non-tax
revenues, and within tax revenues, shifted more towards indirect taxation.
Non-tax sources constitute a fifth of the Singapore government’s
current revenues.3 By way of comparison, in the G7 economies, they make up
less than a tenth of total revenues. Of course, about one-third of our non-tax
revenues derives from the sales of Certificates of Entitlement (COEs) for motor
vehicles, where revenue generation is not the objective. But a good part of the
rest of our non-tax revenues comes from a variety of user charges. User charges
reflect an important principle of our fiscal policy, namely that of partial or total
cost recovery for goods and services provided by the government. In addition to
broadening the revenue base, user charges serve a key economic function: they
prevent over-consumption of publicly provided services and minimise distortions
to the efficient allocation of resources.
The breadth of our revenue base is even more evident when we look
at our tax mix. In 1984, direct taxes accounted for two-thirds of our total tax
revenues. Today, they make up just over half. In comparison, direct taxes,
including social security taxes, contribute about three-quarters of the total tax
revenues of the G7 economies.
The growing importance of indirect taxation reflects our ongoing
shift towards taxing consumption rather than income. There are good economic
reasons for doing this. Taxing income discourages enterprise and incentive. It
also discourages savings. And looking. to the future, the twin factors of slower
economic growth and an ageing population must mean an erosion of the income
tax base. The move towards a more consumption-based tax system will help
3
This refers to revenuesexcluding investment income and capital receipts.
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make our fiscal position more resilient to demographic change. The Goods and
Services Tax (GST) implemented in 1994 was a step in this direction.
A broad base is only one element of a good tax system. To meet the
other objective of maintaining an internationally competitive tax regime, we must
also keep the rates of taxation low.
A cross-country comparison might shed some light on where we
stand in this regard. Singapore’s top marginal income tax rate for individuals has
come down from 45 per cent in 1984 to 28 per cent. The average for the G7
economies is 51 per cent; even the US, which has the lowest rate among the G7
countries, taxes those in its top income bracket at 40 per cent. The top rates in
Taiwan and Korea are also higher, at 40 per cent. Among our major competitors,
only Hong Kong has a lower rate than us, at 20 per cent.
Our corporate tax rate has also become very competitive. It has
declined from 40 per cent in 1984 to 26 per cent. Our current rate is much lower
than the average of 39 per cent levied on corporations in the G7 economies. The
effective corporate tax rates in Korea and Taiwan are also much higher as
dividends paid by companies are subject to withholding tax. Only Hong Kong is
lower at 16.5 per cent.
We are also competitive in terms of non-income-based taxes. Like
Hong Kong, Singapore does not tax capital gains. In contrast, both Korea and
Taiwan, as well as each of the G7 countries, have capital gains taxes. Our goods
and services tax, at 3 per cent, is only about a quarter of the rate of consumption
tax in most of the G7 countries. The average import tariff in Singapore is about
0.4 per cent, miniscule compared to the 6.5 per cent average in the G7 economies
and the 9 per cent average in Korea and Taiwan.
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Perhaps the ultimate test of a country’s low tax credentials is to
compare its total tax receipts with its national income. In Singapore, the tax-toGDP ratio during 1990-94 was just under 16.5 per cent. This is less than half the
average ratio in the G7 countries. The tax-to-GDP ratio in Korea and Taiwan is
also higher, at 20 per cent and 19 per cent respectively. Hong Kong, of course,
has the lowest ratio, at 11.5 per cent.
I am making these cross-country comparisons to illustrate two
important points. The first is that, Singapore is among the most lightly taxed
countries in the world. Second, in an environment where the global competition
for capital and technology has become very intense, it is important that we
continue to maintain a tax regime that is internationally competitive. And our
healthy fiscal position gives us the latitude to maintain our long-term
competitiveness.
Let me now turn to government expenditure policy.
Our first
objective is to maintain strict control over spending. We aim to keep government
expenditure below 20 per cent of GDP. The second objective is to invest in
areas which generate returns to the economy. Once again, the challenge is to
strike a balance between the two objectives.
Government expenditure is controlled by regulating state welfarism.
Our strategy has been to encourage economic self-reliance by promoting social
mobility. Instead of providing large unemployment benefits and price support
schemes, we prefer job creation and market competition. The provision of
subsidies has been selective and confined mainly to education, healthcare, and
public housing. The avoidance of large-scale public assistanceprogrammes also
serves to guard against a culture of dependence.
.
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The ethos of financial rectitude extends throughout the public
sector. The government has always insisted that statutory boards and other
public enterprises operate commercially. There are no bailouts. This is how we
have managed to keep government transfers and subsidiesto less than 4 per cent
of GDP. In the G7 economies, they account for nearly 16 per cent, four times as
much.4
Prudence in spending has not been at the expense of our other
objective, namely to provide the necessarysocial and physical infrastructure that
the market might not provide efficiently. Our strategy has been to invest in
people, and to invest in the future. Education, infrastructure, and primary health
care have been key priorities. About 30 per cent of government expenditure is
devoted to development projects, like building schools, hospitals, roads, and
parks.
What are the main challengesfor fiscal policy in the 21st century? I
believe the main challenge will come from the twin effects of slower economic
growth and an ageing population.
Private savings rates will
decline.
Government expenditures per capita will increase relative to revenues, as the
proportion of taxpayers in the population diminishes. Spending on health care
will grow sharply, as it has in nearly all of the advanced economies undergoing
demographic change. There would also be substantial increases in expenditure
related specifically to the aged, such as homes for the elderly, institutions for the
destitute, senior citizens’ clubs, etc. It is not inconceivable that in 20-30 years’
time, the government’s primary operating budget could go into deficit. The only
buffer that we have against the overall government budget also going into the red
4
Transfers and subsidiesrefer to social assistancegrants. unfunded employeepensions and welfare
benefits, as well as grants to private industries and public corporations to cover operating losses.
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is the stream of investment income that the government will earn on its overseas
assets.
This is why it is of paramount importance that we generate
surpluses and accumulate reserves while the economy is still growing rapidly and
most Singaporeans are still in their working years.
Otherwise, a future
government would have to raise taxes on younger generations, or borrow from
abroad, to meet its financing needs.
It is equally important that we preserve the fundamentals of our
fiscal policy, namely to eschew state welfarism and emphasiseself-reliance and
community help.
The experience of the advanced economies suggests that
slower economic growth and the increased electoral power of senior citizens
could exert pressures on a future governmentto spend more on social services. It
is possible to accommodate a modest increase in welfare expenditures,
particularly subsidies for health care for the poorest sections of the aged
population. But a generalised increase in government welfare expenditures along
the lines of some Western European countries would be disastrous. It would sap
our economic vitality. We must be on our guard to avoid such a scenario.
CONCLUSION
Maintaining consistency in macroeconomic policies is not an easy
task.
In many countries, macroeconomic management does not exist as a
coherent package. Particularly in caseswhere political leadership is fragmented,
government’bodies in charge of different policies have different priorities and
views on how the economy should be managed. Monetary policy is often a
handmaiden of profligate fiscal policies, with the central banks operating as
15
nothing more than printing pressesfor ministries of finance. This is a sure recipe
for macroeconomic instability.
This is perhaps why central bank independenceis the current rage in
academic and policy circles. The argument is that an independent central bank,
insulated from political interference, will be able to focus on the long-term and
pursue policies aimed at low inflation. I have some sympathy with this view,
especially in countries beset by waves of populist economic policies.
But central bank independence is not a panacea for
all
macroeconomic problems. Over the last decade or so, many central banks have
become more independent and focused on their primary objective of price
stability. And indeed, inflation rates have come down the world over. But
national governments have continued to run fiscal deficits, driving up interest
rates and crowding out private investment. They have also failed to rein in
welfare expenditures or institute much-needed structural reforms, especially in
labour markets. Against a background of tight monetary policies, the result is
slow economic growth and high unemployment.
In Singapore, we have adopted a balanced approach. We have
macroeconomic coordination at the highest levels of government, but
considerable autonomy and independence at the operational levels of monetary
and fiscal policy. More importantly, both sets of policymakers share common
ethos of financial prudence and conservatism. A healthy fiscal position has
absolved the M A S of the need to finance the government budget and given it the
freedom to focus on its primary mission of price stability. In the final analysis,
fiscal soundness, rather than statutory independence, is the best guarantee of
central bank effectiveness.
A consistent macroeconomic package, where
monetary and fiscal policies reinforce each other in providing a conducive
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framework for sustained economic growth,
as we embark on the 21st century.
FINANCE(6)/mmar22.'97
will remain one of our greatest assets
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