Macro

N2008 N08 Q4 Discuss the most appropriate policies that a government could adopt to encourage both actual and potential economic growth. [25] Introduction

Clarify actual and potential growth Clarify the type of policies that a government can adopt to achieve the 2 goals

o Expansionary FP: increase G and/or reduce direct taxes o Expansionary MP: increase Mss and/or reduce interest rates o Exchange rate policy o SS side policy o Others

Body (remember to make use of the AD/AS framework)

Fiscal policy to boost actual growth o Explain what is FP briefly o Explain how FP achieves actual growth and illustrate the multiplier process

(assuming idle resources are present; the economy is not operating at Yf) Advantage of using FP useful esp when consumers and firms are

reluctant to spend due to low business confidence / pessimism o Evaluate the limitations of using FP to achieve actual growth

Size of k might be small explain why Burden on the govt’s finances Crowding out effects might be substantial if the govt needs to borrow

from the private sector to finance its G Longer implementation time lag eg US’s tedious parliamentary

debates compared to MP or ER policy Ricardian equivalence (taxes)

Monetary policy to boost actual growth

o Explain what MP is briefly o Explain how MP achieves actual growth

Advantages of using MP shortest implementation time lag compared to FP and SS side policies

o Evaluate limitations of using MP to achieve actual growth Confidence in the economy / expectations of business confidence Interest elasticity of MEI

Exchange rate policy to boost actual growth

o Devalue the currency / bring about a depreciation of currency (sell currency) consider the impact this will have on the components of AD (both X and M) Impact on X as a component of AD

Improves price competitiveness of X (Px in terms of foreign currency falls) Qdx increases TRx increases (TRx in

terms of domestic currency increases this is because Px in dom currency did not change, but Qdx increases)

Impact on M as a component of AD Since Pm in terms of domestic currency rises, consumers will

switch away from the dearer imported goods and services to the relatively cheaper domestic substitute (substitution effect)

Assuming PEDm > 1 more than proportionate fall in Qdm TEm falls

Explain how this leads to a fall in rise in net X (TRx increases, TEm falls) ceteris paribus, AD rises more than proportionate increase in real NY

o Limitations of weakening the ER Limit as to how much the ER is allowed to devalue / depreciate before

other countries retaliate Possibility of imported inflation occurring especially if M are

significantly raw materials and intermediate goods and basic necessities COP increases increase in GPL (higher cost push inflation) rise in COL SOL falls especially for the unemployed and those workers whose wages do not rise as fast as costs increases (desirability issue)

Higher cost push inflation makes it more difficult to manage wage expectations workers fight for higher wages in order to maintain their SOL lead to wage price spiral price instability in the economy in future.

Economic growth cannot be sustained in the longer run price instability makes it difficult for businesses to calculate future profits leads to fall in I (effectiveness issue)

Note o No need to bring in ML condition if analysing impact of a devaluation /

depreciation on X and M as components of AD. AD is plotted against GPL and real NY. Hence holding GPL constant, so long as there is a change in Qdx and Qdm when ER changes, AD curve will shift

o MUST bring in ML condition when analysing the impact of change in ER on X and M as components of BOT or Current Account or BOP because values in the BOT/Current Account/BOP are measured in nominal terms.

o Don’t worry if you are confused just stick to the lecture notes!

Supply side policies to boost potential growth o Explain what is meant by SS side policy briefly o Explain how SS side policy achieves potential growth

Advantages of using SS side to achieve potential growth Dampens inflationary pressures (desirability issue)

o Evaluate the limitations of using SS side to achieve potential growth Longest operational time lag compared to FP and MP Requires funding Results not guaranteed

Conclusion To encourage both actual and potential growth, the govt has to use both DD side and

SS side policies Evaluate the economic conditions that will allow FP to be more effective than MP

vice versa If fiscal measures with SS side effects are employed Fp can not only promote

actual growth but also potential growth Others

N08 Q5 Discuss the relative significance of the multiplier, the price elasticities of demand for imports and exports and crowding out in influencing macroeconomic policy decisions. [25] Introduction

Clarify what is meant by macroeconmic policy decisions o Decision on which policy to take to affect the macroeconomic goals of the

country o Policies include:

FP MP ER policy SS side policy

Relative effectiveness of these policies depend on the unique characteristics of the different countries and the economic conditions they are experiencing

The relative significance of these concepts in influencing macroeconomic policy decisions in a country can depend on the size and openness of the country

o Compare a small and open economy like Singapore vs a large economy like the US

Body Relevance of the multiplier

o Define, formula and explain the k process (diagram) o Increase G increase AD real NY increases more than proportionately

via the k process actual growth increases o Explain why the bigger the leakages the smaller the size of k and hence the

multiplier effect This is because the bigger the leakages, the smaller the increase in

induced consumption spending at each subsequent stages fewer rounds of induced consumption will result multiplier process ends faster.

o Policy implications: FP Effectiveness of FP in different types of economies Small and open economies expected to have smaller size of k to

achieve the same desired increase in real NY, the govt will now have to spend more strain on th govt budget not sustainable in the LR

Relevance of crowding out o Clarify what is meant by crowding out effect

Crowding out (financial) effect may occur if the govt borrows to finance the increase in G

According to the loanable funds framework, if the govt borrows to increase G increase in DD for LF c.p, i/r increases autonomous C (opp cost of current C increases) and I falls (MEI theory) dampens the increase in AD due to increase in G dampens the increase in real NY and economic growth

o Policy implications: FP Effectiveness depends on whether the govt needs to borrow from the

private sector and the extent to which they compete with the private sector for funds and the MEI

The greater the crowding out effect the greater the dampening effects on increase in real NY which in turn limits effectiveness of FP

Eg: Singapore does not have to borrow from the private sector cos of our substantial reserves, hence there is minimal financial crowding out occurring. However, she faces crowding out in terms of physical resources (resources and talent)

Govt competes with the private sector for land and labour (talent0 Could stifle local entrepreneurship

Relevance of PED for X and M o State the ML condition correctly

Explain the effect of a change in the exchange rate on the price of X in terms of foreign currencies and on the price of M in terms of domestic currencies

o Policy implications: ER policy According to ML condition, for a devaluation/depreciation to be

successful in improving the BOT and hence CA and BOP, the sum of price elasticities of dd for X and M must be greater than 1, regardless of their individual PED

For Singapore for eg, to improve her BOP, she can allow her ER to depreciate. This was done in 2008 during the global financial crisis. (S’pore’s X is a significant component of her CA and in turn BOP)

However, ML condition may not hold in th SR due to the rigidity of contracts and tastes and preferences tend not to change in the SR.

Evaluation o There are other factors influencing macroeconomic policy decisions

Other than size of k and crowding out effects influencing the use of FP in Singapore, implementation and operational time lags and the Ricardian equivalence also affects the choice of fiscal tools elaborate

Other than PEDx and PEDm influencing the use of ER policy in Singapore, the fear of imported inflation also influences its use, Singapore does not allow her ER to depreciate most of the time. Instead she allows her ER tp appreciate most of the time explain

why with reference to the importance of keeping out imported inflation and hence cost push inflation price stability

The root cause of the problem also influences macroeconomic policy decisions. Eg need for other policies such as the SS side policies to reduce structural unemployment, improve quality and price competitiveness of X and to achieve potential growth.

Conclusion N08 Q6

(a) Explain the determination of the pattern of trade between Singapore and the rest of the world [10]

(b) Discuss whether the Singapore govt should change its policies for managing the balance of payments [15]

Part (a) Introduction

Clarify what is meant by pattern of trade o Shows the composition of trade or the types of goods and services we are

exporting and importing o Shows the countries which we choose to trade with

Body

The determination of pattern of trade between Singapore and the rest of the world can be explained by the Theory of CA

o Explain the theory of CA State the Law of CA Why do differences in opp cost arise between countries? due to

differences in factor endowments and technology o Explain how CA leads to Singapore’s pattern of trade

Be familiar about what are Singapore’s main X and M Provide specific egs to show that Singapore’s areas of specialisation

and main X are consistent with her factor endowments Also provide examples to show that Singapore’s main M are consistent

with her lack of her factor endowments Use tables / diagrams to illustrate differences in opp costs

Ensure tables demonstrate differences in CA and not absolute advantage

However, the determination of pattern of trade between Singapore and the rest of the world cannot explain Singapore’s pattern of trade with the ROW completely. This is because:

o Theory of CA is a production theory or SS side theory. It can help to explain Singapore’s pattern of trade but not completely there are reasons other than the differences in opp costs (differences in factor endowments) that affect Singapore’s trade pattern with the ROW. These reasons include

DD side reasons Tastes and preferences for a variety of the same good giving

rise to intra-industry trade. Explain with egs The inability to fulfil assumptions made under the Theory of CA

Identify these assumptions and explain how the pattern of trade is affected using egs

No transport costs in reality transport costs can be significant affects pattern of trade egs

No barriers to trade in reality countries may set up barriers to trade for various reasons infnt industry arguments or sunset industry argument or diversification, strategic industries argument. Although Singapore does not engage in protectionism, other countries can/do set up trade barriers against Singapore’s X egs

Some useful information:

Early industrialisation phase: 1960s – late 1970s o Geographical location deep ports o Abundant low cost labour

Industrial restructuring phase: 1980-1985; early 1990s o Geographical location o Well trained and skilled labour force o Enhanced mechanisation and automation and higher technology level

Late 1990s onwards o Geographical location world class ports, proximity to the greater Asian region o Highly skilled professionals and knowledge workers. Hardworking, effectively

bilingual o Excellent technology o Excellent infrastructural support (efficient transportation, safe, punctual – air and

land), telecommunications (high % of population have access to internet and are mobile phone subscribers; hotspots available in most parts of the island can use national Wifi service Wireless @SG for free); industrial parks like Biopolis, Biomedical Parks, Tuas, housing systems readily available for use , wide choice of high rise and low rise offices (Jurong Town Corporation, CBD)

o Supportive business environment o Political stability

S’pore’s main Xs today o Goods

High end machinery and equipment high end electronics like semi-conductors, precision engineering and transport engineering equipment like oil rigs and aircraft parts

Chemicals pharmaceuticals and petrochemicals Consumer goods (processed food) Mineral fuels

o Services Banking and finance Logistics services

S’pore’s main X partners today o Malaysia 11.8% (2010)

o HK 11.7% o China 10.4% o Indonesia o US o Japan o South Kores

Singapore’s main Ms today o Consumer goods like foodstuff, low to mid end electronics (transistor radios,

hairdryers, iPhone o Machinery and equipment, heavy machinery o Iron and steel o Electronics hard disk drives o Chemicals and mineral fuels (eg crude oil)

Singapore’s main M partners o Malaysia 11.7% o US 11.5% o China o Japan o South Korea o Indonesia

Manufacturing sector today o Electronics industry leading o Govt prioritising devt of chems and biotech industries o Aviation industry aerospace maintenance and repair overhaul centre o Third largest oil refining industry o High value added manufacturing activities

Services o Financial services banking and accounting o Telecommunications o Aviation 6th busiest airport; 4th busiest cargo hub in Asia o Legal services o Biomedical o Education o Tourism related activities and industries IRs, F1 race, entertainment, retail,

restaurants Major exporter of cut orchids and ornamental fish to countries like Japan, Australia, US,

Greece etc o Tropical climate, technology intensive, innovation

Part (b) Introduction

Clarify key terms BOP (both CA and KA/Financial account Clarify policies Singapore is currently employing to manage her BOP

o Managed float ER system o SS side policies o FTA

Body Should Singapore change her current policies to manage the BOP? Are her current

policies effective managing her BOP? o Managed float ER system

Why does S’pore allow the S$ to appreciate most of the time and only allows the ER to depreciate when there is a global recession that adversely affects her X and in turn BOT, CA and thus BOP?

Most of the time, MAS allows S$ to appreciate modestly and in a gradual manner to keep imported inflation out this in turn helps to manage expectations in order to maintain price stability necessary for sustained economic growth

ONLY during the global financial crisis, MAS allowed the S$ to depreciate (zero appreciation) so as to boost X competitiveness. This was because of the adverse fall in her X.

o Why should Singapore consider changing the policy? US Financial Crisis / Euro zone debt crisis fall in dd for her X fall in

TRX worsens BOT, CA and thus BOP c.p To improve her BOP, MAS allows S$ to depreciate:

Px in terms of foreign curr falls Qdx increases Pm in terms of S$ rises Qdm falls ML condition satisfied PEDx + PEDM 1 improvement in

the BOT, CA and hence BOP Synthesis

However the ML condition may not hold in the SR due to the rigidity of contracts and tastes and preferences tend not to change in the SR allowing depreciation of S$ may worsen the BOP in the SR.

Limit as to how much MAS can allow the ER to depreciate because Singapore is highly dependent om imported raw materials and goods as she lacks natural resources allowing ER to depreciate results in higher imported inflation higher cost push inflation higher COL fall in SOL for the unemployed and those whose wages cannot keep up with cost increases (desirability issue)

In addition, allowing S$ to depreciate can lead to price instability which can hurt economic growth in the longer run. Higher cost push inflation makes it more difficult to manage wage expectations as workers ‘fight’ for higher wages to maintain their SOL wage push spiral price instability in the future economic growth cannot be sustained in the longer run. Eg. Price instability makes it more difficult for businesses to calculate future profits can lead to a fall in I and hence actual growth and growth in productive capacity (potential). (effectiveness issue)

o SS side policy Why should Singapore employ SS side policies to manage her BOP?

To improve price and non price competitiveness (quality) of her X provide egs (think of R&D efforts)

Why should Singapore consider changing this policy?

Synthesis: Should she change this policy? Fine tune the policy? How? o Free Trade Agreements

Does Singapore sign FTAs to manage her BOP? If yes, why? Eg. No tariffs on M into Singapore; no tariffs on Singapore’s X by member

countries; relatively free capital mobility (improves inward and outward FDI)

Why should Singapore consider changing this policy Synthesis: Should Singapore change this policy? Fine tune the policy?

How?

Conclusion Make a stand on whether Singapore should change her current policies to manage her

BOP and explain why? o Suggest what changes Singapore can make to her current policies to manage

her BOP Suggest new policies that Singapore can implement to improve her BOP if any

N2010 N10 Q4 The recent worldwide recession caused many governments to re-assess their use of fiscal policy in order to stimulate their stagnating economies. (a) Explain what would reduce the effectiveness of fiscal policy as a stimulus to the

Singapore economy. [10] (b) Assess alternative policies that might be more appropriate in managing the Singapore

economy when faced with a worldwide recession. [15] Suggested Outline: Part (a)

1. Identify that Singapore economy is also experiencing a slowdown in its EG- real output is increasing at a decreasing rate. The cause is a slowdown in global economy that leads to a decrease the demand in our exports. Since Singapore economy is export driven, the EG slows down naturally during this period.

2. Therefore, govt is implementing an expansionary fiscal policy to stimulate EG here. 3. The increase in G or decrease in tax rates will increase AD, then will kick off the

multiplier effect on the national income. Give a short account of the multiplier process. 4. However, the effectiveness of the FP may be dampened by: 5. The decrease in X. Since X is much more significant than G in Singapore as can be

seen by X is 200% of GDP while G is only an insignificant % of GDP as compared with X. Therefore, the net change in AD is still a decrease, leading to no increase in national income.

6. The pessimism of the households and firms. Since the global economy is not improving, domestic households may save more of the disposable income when income tax rate is reduced. Firms may not invest even when profit after tax is increased after corporate tax is reduced. These decrease in C and I may negate the increase in G, causing no or little effect on national income.

7. The small multiplier value. In Singapore, due to the high MPS( 20%CPF rate and Asian saving culture) and MPM( lack of resources here lead to importing of raw materials and consumption goods), our k value is small. Therefore, any increase in G is withdrawn out of the circular flow through savings, taxes and imports, leaving very little being re-injected to induce further consumption. Therefore resulting limited effect in national income.

8. Hence, govt has to be aware of the limitation of this policy and perhaps implement other policies at the same time in order to achieve EG more effectively.

Part (b)

1. Since our economy has a relatively small domestic market and small domestic firms, increase in C and I are not going to cause a large impact on EG. Our reliance on X is the only hope to stimulate EG. Therefore, alternative policies will be targeting at improving the price competitiveness of our exports.

2. Monetary policy: Since Singapore is an interest rate taker, govt can only implement depreciating our exchange rate to improve the price competitiveness of our exports. This means ‘0appreciation of S$’. This means that price of our exports will be relatively cheaper in foreign currency, demand will then increase. While imports will be now be more expensive in S$, hence demand will fall. Assuming M-L condition, net export value will increase, AD will increase, then stimulating multiplier effect on the national income. Since economy is below Yf, there will be increase in real national output. However, M-L condition may not exist in the short run due to change in taste and preference may take time and importers may be binded by contracts. Therefore, in the short run, net export value may still decrease, leading to a fall in AD, therefore limiting its effect on national income. In addition, the cost of production of exports with high imports will increase with the depreciation of S$. However, the depreciation of S$ will cushion this increase to the extent that the lower the import content in exports, the more price competitive is the exports.

3. Supply management policies such as income policy, manpower policy. Income policy is to encourage firms to increase the wage rate slower than productivity rate. NWC made forecast of productivity rate each year. Firms may actually use it as a guideline to raise the wages of their workers. This helps to prevent an increase in the cost of production of the firm. However, the productivity rate is computed across industries, different firms in different sectors may have different productivity rates. Hence firms may not follow the general guidelines. Manpower policy refers to govt subsidize the firms in training of their workers through SPURS for eg. These workers productivity rate may increase after training and hence help the firm to reduce its average cost per unit of output, improving the price competitiveness of its goods in the long run . This will also help to attract FDI into the country. However, training may take a long time to complete and workers may not achieve the desired productivity rate due to unreceptive attitude of the workers.

4. Find new markets such as emerging economies such as BRICs, Indonesia, Middle east countries. Break into these markets by signing FTAs with them. Such emerging economies have a rising middle income group who has rising purchasing power, therefore will buy our exports.

However, these countries usually buy low value added goods or mass produced goods whereas Singapore produce high value added services and goods.

5. Conclusion: There are benefits and costs to each policy, there is no one policy that is better than the other. Govt has to be aware of the tradeoffs of the policies and try to minimize such tradeoffs by implementing a package of policies to maximize the benefits and minimize the cost of those policies. In addition, given the characteristics of the Singapore economy, the global recovery is most critical. If recession continues in the world, those policies that Singapore implement can at best dampen the fall in EG, they are not able to increase EG.

N10Q5 When there are large increases in the price of oil and other primary products, they are usually expected to lead to rising inflation throughout the world’s economies. Discuss the extent to which these factors are likely to affect the rate of inflation in Singapore. [25] Introduction -Define inflation and identify types of inflation: demand-pull, cost-push

Body -Explain how large increases in the price of oil and other primary products lead to inflation in Sg

Sg is an importer of oil and other primary products

Increases in the price of oil and other primary products represent an increase in costs of production AS shifts up inflation

-Explain how there may be other factors that lead to inflation Government action: Expansionary fiscal or monetary policy, devaluation (demand-

pull + imported)

Demand pull inflation due to increased population and consumption (increase C increase AD)

Demand pull inflation due to inflow of FDI (increase I increase AD)

Demand pull inflation due to inflow of ‘hot money’ (increase MS lower i/r increased C and I)

Other possible demand-pull factors

Imported cost-push due to currency changes (depreciation *note: not the same as devaluation)

Cost-push due to increased labour costs

-Evaluate extent that each factor is likely to affect the inflation rate

Government action: Effect of fiscal policy is small due to small multiplier (small shift in AS). Sg government can’t affect interest rates so cannot have inflationary effects due to fall in i/r. Devaluation may have significant effect but SGD long-term path is largely

one of mild appreciation. MAS has not had any significant devaluation since AFC in 1997.

Increases in price of oil and primary products: Effect should be significant for two reasons. First, increases in prices were large. Also, Singapore imports close to 100% of these products. No chance of substituting with domestic (and presumably cheaper) products. Second, these products affect the prices of other secondary products that Singapore imports. Increase in costs is felt at all levels.

Increased population: Only leads to inflation in the event of economy operating close to full employment. However, increase in population largely due to inflow of foreign labour. AS shifts out at the same time. Hence, inflationary effects moderated.

FDI inflows: Similar argument as increased population. FDI also increase productive capacity of economy.

‘Hot money’ inflows: Extent of inflows may not be great as portfolio investments have seen a trend of going towards developing economies. Also, C and I in Sg may be i/r inelastic due to the general lack of borrowing to spend (for C) and high business confidence (for I).

Currency changes: Sg did not show depreciation during this period. In fact it appreciated and took the edge off the imported inflation.

Increased labour costs: No significant increase in wages in this period. In fact, inflow of foreign labour increased labour supply and moderated wages. Effect especially apparent in more labour-intensive industries (e.g. construction) where wages take up the highest proportion of costs.

-Conclusion Increased prices of oil and primary products must have contributed to inflationary pressures in Singapore. However, extent of effect depends on how much the SGD appreciated too. Additionally, although other factors were likely to individually have had weak effects, the sum of them all may diminish the proportion that higher prices of raw materials contribute to inflation. N10Q6 There is a general consensus among economists that protectionism is a bad thing. (a) Explain why protectionism exists. [8] (b) Assess the extent to which the Singapore government’s approach to international

trade may need to be adjusted in response to a growth in worldwide protectionism.[17] Part (a) Define Protectionism Protectionism is a policy of sheltering domestic industries from foreign competition through the imposition of trade barriers on imports.

Reasons for protectionism (Explain any 3 reasons) 1. To protect strategic, infant or mature industries from cheaper imports In the case of strategic industries e.g. it is a good the government aims to reduce dependence on foreign countries e.g. agriculture.

Infant industries will not realize potential comparative advantage if they are not guaranteed demand from the domestic market. Mature industries that have lost their comparative advantage may be in decline. The government may need to slow down the decline to prevent massive structural unemployment. Use tariff diagram to analyze how by imposing tariffs will lead to increase in domestic production and producer’s surplus (and increase employment in the case of sunset industries).

2. Expenditure switching (especially in times of recession)

To divert consumption from foreign goods to domestically produced goods fall in M, cet par, improve trade balance boost domestic consumption increase AD actual economic growth Use AD-AS model to analyze growth effects and improvements in BOP

Examples: Import substitution strategies pursued by many countries e.g. Singapore and Japan during the early phase of industrialization; The recent global financial crisis also led some countries to resort to protectionism as an emergency measure.

3. To protect domestic workers against competition from low wage countries

Pauper labour argument – Low wages in developing countries due to weak labour laws that allow workers there to be exploited results in low priced products. Competition from these cheap imports will drive wages in developed countries down if domestic firms are to survive the international competition.

4. Other possible reasons (to protect against unfair trade practices prevent dumping, to diversify the economy, to increase government revenue).

Conclusion: The existence of protectionism goes against the Law of Comparative Advantage and limits the gains from trade. The existence of protectionism is difficult to justify in the long run.

Part (b)

Introduction: Clarify world-wide recession – more countries like USA, Japan, European countries

set up higher trade barriers for various reasons Clarify Singapore’s current approach to trade and policies employed by the govt:

Approach to trade is seen in the county’s openness to free trade and policies undertaken to promote export growth. In view of its small domestic market and high degree of openness, Singapore has been active as a free trade advocate and its current trade policies include supply side policies aimed at increasing the competitiveness of export industries, exchange rate policies, and preferential trading (spearheading regional and bilateral free trade agreements [FTA])

Body Thesis (1): In terms of openness, Singapore should not adjust its approach to free trade by turning protectionist because it is detrimental to our economy. Restricting imports will lead to imported inflation and cause a rise in our cost of production

Singapore’s lacks natural resources. Raw materials and intermediate goods need to be imported.

Higher price of imported inputs leads to an increase in cost of production due to the increase in after tax prices of imported raw materials that are used to produce goods and services.

The aggregate supply curve will shift upwards to the left, driving prices up rise in COL.

Ultimately higher prices would affect export competitiveness as a high percentage of exports comprises of re-exports..

Other reasons to remain open: Too small a domestic market, openness to trade allows Singapore to produce on a

larger scale, enjoy iEOS and export to its trading partners. By being open to free trade, its domestic industries will be subjected to heightened

competition, impetus to raise productivity levels, to innovate in order to stay competitive.

Impetus for Singapore to keep shifting its comparative advantage in the face of changes global economic trends. Allows Singapore to explore and exploit niche areas and build new areas of comparative advantage so as to avoid its exports being subjected to protectionist measures.

Anti-thesis (1): In view of rising protectionism, the gains from trade are reduced, and the approach to free trade should be adjusted accordingly. The fall in dd for her X and hence export revenue when other trading partners

unilaterally impose tariffs on our exports, will result in a lower AD for Singapore. The fall in AD in turn leads to a more than proportionate fall in real NY (via the k process where one’s spending becomes the income of another). Actual growth slows down case for concern since Singapore is highly dependent on X for growth (X as a % of GDP is significantly high)

Also fall in DD for X worsening in BOT and hence CA and BOP There is thus some merit in boosting domestic consumption to act as a buffer against

a possible decline in AD caused by the trend in worldwide protectionism in light of the global economic downturn.

The objective of protectionism is to switch expenditure away from imports to domestic production boost domestic consumption.

The use of expenditure switching policies by Singapore may help to increase AD and achieve growth, even though it may be seen as unfair trade. However, this is at best a short-term measure given that the multiplier is small for Singapore.

Synthesis: Expenditure switching will not result in strong economic growth due to the small domestic market size. Due to the small market, the increase in domestic consumption from protectionism

may not be significant. Moreover, possible retaliation may further dampen growth by reducing exports Free trade is still the best approach for Singapore even if other countries are

protectionist since the benefits of restricting imports to Singapore are marginal.

In terms of current policies undertaken by the Singapore government: Thesis (2): Exchange rate policy is effective when protectionism is rising Current policy of MAS is to allow a gradual appreciation of the S$ most of the time

and non-appreciation (neutral stance) at some times basically to keep out imported inflation

Should Singapore consider changing this policy to allow the S$ to depreciate when there is world-wide protectionism?

With rising protectionism and slow growth in exports, if S$ is allowed to weaken, this leads to increase export competitiveness and improves the balance of trade, assuming the Marshall Lerner condition holds.

Anti-thesis (2): Use of exchange rate policy may need some reconsideration in view of rising protectionism Currency depreciation or non-appreciation of the S$ to boost export competitiveness

in a recession is a ‘beggar thy neighbour’ policy It hurts the exports of competing countries, and increases the trade deficits in importing countries.

In view of rising protectionism, such a policy may invite retaliation or lead to competitive devaluation among countries.

A trade war will have an adverse outcome on the balance of trade and subsequently AD and growth.

Thesis (3): The policy of free trade agreements should not be changed as it insulates the exports from rising worldwide protectionism FTAs are legally binding agreements to reduce barriers to trade.

o Singapore does not impose trade barriers on M o Other member countries reduce trade barriers on Singapore’s X Singapore’s X will increase AD increases more than proportionate increase

in real NY (assuming the economy is <Yf) Singapore has already signed FTAs with its major trading partners as well as

emerging economies (BRIC; South Africa, Turkey). Access to export markets is secured via the current policy of signing FTAs; FTAs with

emerging economies also helps to diversify Singapore’s X markets rise in dd for X by emerging economies can cushion the fall in dd from her Western partners (eg .during the Euro crisis)

Exports are likely to be unaffected by the wave of protectionism if Singapore has an extensive network of FTAs.

Evaluation: Limitations of FTAs Due to the numerous rules and regulations involved, FTAs may be not be fully

utilized by domestic firms (the noodle bowl problem). The current trend in regional free trade agreements e.g. ASEAN-China FTA may help

to establish a common set of regulations for firms to comply with and therefore lessen the problem.

Thesis (4): The use of supply-side policies should be continued as it is effective in increasing export competitiveness when protectionism is rising. Examples of supply-side policies include grants for R&D, provision of infrastructure,

subsidies for training / retraining, tax rebates for new start-ups etc. The aim of these initiatives is to the increase productivity and competitiveness in high

growth sectors.

Eg retraining to improve productivity of workers more output produced per worker lower unit cost of production result in price competitive and better quality exports. R&D also allows movement up the value added chain and development of new products

Export capability is enhanced in this way despite the protectionist measures imposed by foreign countries. Any fall in AD due to a fall in X arising from world wide protectionism can be cushioned

Supply-side policies are usually effective in the long-term, and are unaffected by temporary episodes of protectionism.

Anti-thesis (4): Supply side policies should target the exports in the services sector when protectionism is growing Government must bear in mind pertinent limitations of SS side policies

o Difficulties in retraining o Over reliance on the govt for subsidies; imperfect information regarding how much

to subsidize, costly to fund R&D (strain on govt reserves) where results are not guaranteed

The government should provide greater incentives (subsidies, training, infrastructure) to promote investments in the services sector e.g. education, healthcare, logistics, financial and legal services.

This is because, unlike manufacturing, transactions in services are usually insulated from protectionist measures e.g. tariffs or quotas. Many of these transactions involve the use of Information, Communication and Technology (ICT), and hence it is not feasible for foreign countries to restrict them.

Synthesis/Conclusion While the current approach to trade will yield benefits in the long-tem, the growth in protectionism requires some minor adjustments to be made in the short-term in order to level the playing field. Make a recommendation on which aspects of our trade policy should be adjusted and a judgment on the extent of the change required.

N2011 N11 Q4

Explain the process whereby an increase in government expenditure can lead to a bigger change in national income. [10] Discuss the extent to which conflicts in government macroeconomic objectives limit the scope for the use of fiscal policy in any economy. [15] Suggested Outline: Part (a)

1. Identify that this is an expansionary fiscal policy by increase in G. 2. This will lead to a multiplier effect on the national income. 3. Explain the process by either the numerical approach or the Keynesian step diagram

approach. 4. Conclusion: the multiple increase in national income can result in nominal increase or real

increase in national income. If economy is at full employment, there is only nominal increase, with no real increase in output but increase in GPL only. If economy is close to full employment, there is both real increase in national income and increase in GPL. If the economy has a lot of spare unused resources, it will result in real increase in output with no change in GPL. Examiners comments Most candidates recognized that this was a question about the multiplier process. Candidates used a range of approaches, including the use of diagrams, equations and tables, but many responses would have benefited from giving a detailed explanation of outcomes rather than stating them. Thus, for eg, a calculation would frequently be presented without an explanation of the underlying process. Several candidates explained the Keynesian multiplier using AD and AS curves, but most showed the AD curve shifting along an upward sloping AS curve. In many of these cases there was virtually no increase in national income. In strict economic analysis this is not the Keynesian multiplier but rather a ‘dampened’ multiplier. A minority did recognize that the full Keynesian multiplier only occurred on the horizontal part of the AS curve.

Part (b) 1. State the govt’s objectives – high economic growth rate (both actual and potential), low

unemployment, price stability and BOP equilibrium. 2. The expansionary effect on the national income through the use of expansionary FP is

explained in (a) already. We now look at how this may conflict with the other objectives: 3. Conflict between EG and Price stability

-If the economy is close to Yf, the increase in G may be more than the deflationary gap, causing too much demand going after too little goods, giving rise to demand pull inflation. Illustrate using AS/AD diag.

4. Conflict between EG and BOP equilibrium -the increase in G resulting in higher national income will mean households will get higher disposable income, assuming ceteris paribus. Their ability to buy imports will increase, this will worsen BOP current account, thereby upsetting BOP equilibrium.

5. However, besides these conflicts, there are also other limitations that affect the effectiveness of expansionary FP in achieving EG such as - whether the increase in G is negated by the fall in exports due to global recession for eg, if the fall in X is greater than the increase in G , there might be a fall in AD, hence there will be no rise in national income. - the decrease in I. When govt borrows to finance its expenditure, this increase in demand for loanable funds will drive up interest rate. Firms will decrease its investment base on MEI

explanation, therefore this may result in a small increase in net AD, therefore may dampen the effect on national income. - the value of the multiplier. If the k value is small, it means that a large part of the injection is withdrawn from the circular flow of income through S, T or M. The high value of MPS, MPT, MPM will cause k value to be small. Therefore, the effect on national income will be dampened.

6. Conclusion: The govt has to be aware that there may be conflicts with the objective or there can be tradeoffs, more than 1 policy is therefore required to attain the objective effectively and minimizing the conflicts or tradeoffs that may come along with the implementation of the policy. Other policies that govt may also consider will be monetary policy and supply management policies.