Singapore An economy in transition

Measures to curb the inflow of low-skilled foreign workers could lead to near-term challenges, but in the long term, these measures will help Singapore remain one of the world’s most competitive nations.

Singapore_spotSingapore has made a stronger start to the year than was initially estimated. Economic activity gathered pace in Q1 2015, and the economy is on track to achieve the target growth range of 2.0–4.0 percent this year. 2015 is of particular significance to the city-state, as it marks 50 years of its existence as an independent nation, as well as the halfway point of a 10-year economic restructuring plan launched in 2010. The plan focuses on increasing productivity in the economy and on moving up the value chain across all sectors, thereby setting the stage for strong and sustainable growth in the long term. The 10-year plan also aims to curb the inflow of low-skilled foreign workers, while trying to improve social welfare for Singapore’s citizens. Consequently, sectors that have depended on low-skilled foreign workers are likely to face near-term challenges. Complicating matters is the unevenness in the global economic recovery. However, over the long term, current policies are likely to support Singapore’s focus on high-value addition, thereby helping it remain one of the world’s most competitive nations.

GDP growth on its way up in Q1 2015

Singapore’s economy grew 2.6 percent year over year in Q1 2015, up from 2.1 percent in Q4 2014, faster than the advance estimate of 2.1 percent. The economy gained from strong contributions by two key sectors in Q1—finance and insurance (7.9 percent) and wholesale and retail trade (4.1 percent). While the former contributed 0.9 percentage points to GDP growth in Q1, the latter’s contribution was 0.7. Within finance and insurance, banking was the dominant sector, thanks to factors such as growth in loans and gains from higher net interest margins. Consumer loans (up by 4.6 percent) contributed most to the growth in loans, while loans to businesses remained subdued (0.8 percent).1 For the wholesale and retail trade sector, strong growth in Q1 was a welcome relief from the previous quarter’s meek 0.6 percent rise. According to the Ministry of Trade and Industry, Singapore, wholesale trade benefited from a 5.2 percent rise in non-oil re-exports in Q1, up from 1.8 percent in the previous quarter.2

There was, however, some disappointment in Q1 from manufacturing, which was dragged down by declines in output in the transport, engineering, electronics, and biomedical clusters.3 Manufacturing contracted by 2.7 percent, thereby shaving off 0.5 percentage points from GDP growth in Q1. This follows a 1.3 percent decline in Q4 2014.

Singapore_Figure 1. GDP growth (percent, year-over-year) slowed down in Q1 2015

Immigration policy burdens manufacturers

An important factor burdening Singapore’s manufacturers is the upward pressure on wages. Overall unit labor cost in the country climbed 5.3 percent year-over-year in Q1. The unit labor cost of manufacturing increased by 7.2 percent in Q1, up from 5.5 percent in the previous quarter. Consequently, the overall unit business cost of manufacturing edged up in Q1, rising by 0.9 percent and continuing from a 0.7 percent increase in 2014.4

At present the attempt to shift from labor-intensive to skill- and knowledge-intensive manufacturing has affected output growth, not least because of an already tight labor market.

The rise in cost of manufacturing is closely linked to the administration’s policy on foreign workers. The quota and levy system used to regulate the size of the foreign workforce has been tightened in recent years to discourage firms from hiring low-skilled, low-wage foreign workers. The measures are aimed at boosting employment, wages, and productivity among citizens while restructuring all sectors toward high-value economic activity. However, this transition is likely to be painful in the near term as Singapore has so far relied heavily on foreign labor, particularly in sectors such as manufacturing, where up to half the workforce comprises of foreigners.5 In 2003–2008, when the foreign worker policy was liberalized, manufacturing firms substituted low-skilled foreign workers for machinery,6 stifling productivity growth in the sector. At present the attempt to shift from labor-intensive to skill- and knowledge-intensive manufacturing has affected output growth, not least because of an already tight labor market.

Singapore_Figure 2. Manufacturing activity has been suffering of late

Tight labor market and muted growth in productivity

Singapore’s already tight labor market is tightening further. Unemployment dipped to 1.8 percent in Q1 from 1.9 percent in the previous quarter.7 Employment growth has slowed and labor force participation has been edging up steadily over the last three years, standing at 67.0 percent as of 2014.8 It is not surprising then that the curb on low-skilled foreign labor has resulted in labor shortages and higher business costs, particularly in sectors such as manufacturing. Additionally, while wages have been moving up, labor productivity has not kept pace; in fact, it declined in both goods-producing, as well as services industries. In Q1 total labor productivity declined (by 0.6 percent) for the fourth straight quarter.9

Declines in labor productivity bring to light the fact that restricting inflows of low-skilled and low-wage foreign labor is not enough. Encouragingly, the government has announced the introduction of the SkillsFuture initiative in the budget for 2015.10 The initiative focuses on lifelong learning and skill development. Toward this end the average spending on continual education and training is set to double over the next five years. Furthermore, the government has deferred the increase in levies on the employment of low-skilled foreign workers by one year for all sectors, and by two years for the manufacturing sector.11

Singapore_Figure 3. Declining labor productivity is a worry

Facing an uneven global recovery

Singapore’s total services trade edged up by 1.2 percent in Q1 from a year ago but total merchandise trade dipped by 10.5 percent during the same period. Merchandise imports fell by 16.1 percent, while merchandise exports dropped 5.4 percent on account of low oil prices. However, the country’s non-oil domestic exports (NODX) grew by 4.8 percent in Q1, speeding up from a lackluster 0.5 percent in Q4 2014. The electronics and non-electronic goods segment fared well in Q1. Notably, there was strong growth in exports to the United States (10.2 percent) and the European Union (22.2 percent) in Q1 after a decline in the previous quarter. However, slowing economic growth in China, Singapore’s largest trading partner, is a concern for the city-state’s exporters. In Q1, exports to China fell 5.6 percent, deteriorating from a decline of 4.9 percent in Q4 2014. Given the supply chain links between the West, China, and other key Asian exporters, it was not surprising that Singapore’s trade performance with regional partners was mixed in Q1. While exports to Malaysia, Hong Kong, Thailand, and South Korea grew during the quarter, exports to Japan, Indonesia and Taiwan declined.12

Risks to Singapore’s exports and, hence, GDP growth, are not likely to go away any time soon given that global growth continues to be uneven.13 China’s economy is likely to remain under pressure this year, and weakness in the Eurozone is expected to continue. Growth in the United States, however, is likely to rebound in the second half of the year after a weak first quarter. According to International Enterprise Singapore, non-oil domestic exports will grow 1.0–3.0 percent in 2015.14 This is encouraging given that NODX contracted by 0.7 percent in 2014 and by 6.0 percent in 2013. Nevertheless, expectations of export growth are modest at best.

Still a long road ahead

In the short term, given the better-than-anticipated performance in Q1, Singapore is likely to achieve its target growth range. However, for growth to continue in the long term, the country will have to continue on the track of economic restructuring with a focus on high-value addition and improvement in productivity. The latter assumes importance in the context of Singapore’s aging population, dependence on foreign workers, and tight labor market. Far-reaching policy measures such as the SkillsFuture initiative are likely to play a critical role in determining the long-term performance of the economy. The administration must remain focused on implementing such policies in order to build a highly skilled, knowledge-driven workforce, particularly in the clusters identified for future growth. Given that the country is one of the richest economies in the world, the current path is likely to help Singapore retain its competitiveness in the global economic arena.