Ethos Issue 6, Jul 2009

Singapore’s Economic Growth Model:
Too Much or Too Little?
Linda Lim

Singapore’s economic growth model of the past forty-odd years, like those of its fellow “Asian tigers”, has been based on the export of initially labour-intensive manufactures to world markets, followed by a move up the technology and valueadded ladders as comparative advantage shifts. Like Korea, Taiwan and Japan, economic development in Singapore has been substantially state-directed and features a managed-float currency regime; like Hong Kong, it is based on free trade and capital flows.

Over the past two decades however, Korea and Taiwan have reduced the state’s role in their economies, while Hong Kong is still the world’s freest economy. Singapore’s economy, on the other hand, continues to be firmly statedirected while diversifying into highvalue services, with heavy reliance on an imported workforce. Most notably absent, outside of banking and property, is the strong domestic private sector participation that is such a distinctive feature in Japan, Korea, Taiwan and Hong Kong.

Can Singapore’s state-heavy growth model be sustained in the long term, especially after the systemic shock and global rebalancing of the current financial crisis?

ECONOMIC THEORY AND LIMITS TO STATE-DIRECTED GROWTH
Asia’s economic growth follows the theory of comparative advantage, which says that countries can increase the value of their production and consumption from a fixed resource base by participating in international trade, i.e., by each country specialising in making and exporting only what it is relatively more efficient in producing, compared with other countries. Comparative advantage in one or more sectors means comparative disadvantage in others—a country cannot be internationally competitive in every sector. Despite its abundance, in absolute terms, of labour, skills, and now capital, China will not end up producing everything in the world; if it tries to do so, demand for its fixed resources will cause inflation, undermining its initial cost advantage.

Resource-based comparative advantage is not the only determinant of international competitiveness and trade f lows. According to strategic trade theory (most closely associated with Nobel Laureate Paul Krugman), a country can become competitive in an industry by exploiting economies of scale or learning through exports. Agglomeration advantages (observed by Alfred Marshall and later popularised by Michael Porter as “clusters”) may lead to the development of industrial concentrations in particular locations, where the proximity of suppliers, customers and competitors allows an area as a whole to be internationally competitive in a specific sector or industry: think Silicon Valley for high tech, or Wall Street for finance.

Such location-specific competitive advantage can complement or overcome resource-based comparative advantage or disadvantage—but it too is limited. Not every country can have scaledup economies in the same industry; often, when countries try to develop these artificially, excess capacity results and everybody loses. There are also disadvantages to agglomeration, or clusters—most notably congestion costs (such as land and labour shortages when too many firms chase the same scarce resources in a given location, pushing up each other’s costs) and negative externalities (such as environmental pollution and dissipation of intellectual property).

Comparative and competitive advantage both allow for government policy to influence a location’s competitiveness in particular sectors— through selective investments that shape resource endowments, and tax incentives and subsidies to target resource allocation toward particular sectors.

However, these policies can be imitated with relative ease, leading to “beggar-my-neighbour” outcomes¹ (where neighbouring countries compete to attract foreign investors with ever more attractive and costly tax breaks) and excess capacity.

As a national economy moves up the technology ladder, the capital and opportunity cost of further statedirected shifts in comparative or competitive advantage escalates, given diminishing returns. Furthermore, competition based on advantages created by government policy rather than market forces introduces a large element of political risk into private business decisions, encourages inefficiency in the allocation of resources, and reduces world welfare.

There is also the risk of falling into the “fallacy of composition”: the error of inferring that something is true of the whole because it is true of some part, or even every part, of the whole.² In government industrial policy, a tax cut for sector A can stimulate its growth and development by attracting resources—capital, labour and entrepreneurship—to that sector. But if every other sector—B, C, D, etc.—also gets a tax cut, then no sector is better off. The Government budget may simply end up running massive deficits, saddling the economy as a whole with higher inflation.

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