Singapore: Plans for a future economy face challenges Asia Pacific Economic Outlook, Q1 2017

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Singapore is banking on technology, innovation, and skill development to build its future economy. But weak productivity growth, a rapidly ageing population, and slowing global trade could prove to be a hurdle.

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Faced with slowing economic growth, Singapore is revamping its economy toward value creation and higher value addition to sustain economic growth in the future. Technology, innovation, and skill development are at the heart of this economic transition. The “internationalization” of Singapore’s enterprises and capabilities is likely to play a pivotal role, too. We take a closer look at how technology, innovation, and related policy are driving transformation in the domestic economy as well as the domestic challenges to Singapore’s economic aspirations. We also look at the external environment for global trade, particularly the threat from protectionism to Singapore’s small and medium-sized enterprises (SMEs) and to Singapore’s status as a global trade entrepot. It is evident that the country’s plans for a “future economy” are likely to face challenges that are both internal and external.

Growth slows, services sector slumps

GDP growth slowed to 1.1 percent year over year in Q3 2016 from 2.1 percent in the previous quarter (figure 1). In the year until Q3, the economy grew 1.6 percent from a year ago. A quarter-over-quarter annualized measure reveals a bleaker picture—Singapore recorded growth of 0.1 percent in Q1 and Q2, and shrank by 2.0 percent in Q3.1

The goods-producing sector contributed 0.3 percent to the 1.1 percent growth in GDP in Q3, driven mainly by the manufacturing sector, which contributed 0.2 percent (figure 1). In Q3, manufacturing grew 1.2 percent from a year ago in Q3, supported by growth in the electronics and precision engineering clusters. The electronics cluster grew 15.0 percent, supported by higher global demand for semiconductors. The precision engineering cluster grew 3.6 percent, fueled by an increase in the production of semiconductor-related equipment stemming from improved global demand for semiconductors. However, manufacturing grew just 0.3 percent from a year ago on a year-to-Q3 basis, revealing weak overall performance in 2016.2

Percentage contribution to growth in real GDP

The services sector did not contribute to overall growth in Q3. In fact, the wholesale and retail trade sector subtracted 0.3 percent from overall GDP growth, while the finance and insurance sector subtracted 0.1 percent (figure 1). Wholesale and retail trade contracted 1.6 percent from a year ago. In the wholesale segment, the domestic wholesale index contracted by 5.1 percent year over year in Q3, primarily due to a decline in the sales volumes of petroleum and petroleum products, telecommunications, and computers and electronic components. The foreign wholesale index grew a tepid 0.8 percent. Retail trade sales volumes rose 1.0 percent in Q3 because of a 29.0 percent increase in the volume of motor vehicles sold. However, excluding motor vehicles sales, retail sales volume declined by 4.2 percent in Q3. Retail sales value excluding motor vehicles declined for the fourth straight quarter, reflecting weak domestic demand. Finance and insurance contracted 0.7 percent in Q3, reversing an expansion of 0.7 percent in the previous quarter. The contraction in Q3 was primarily due to weak offshore lending, particularly to East Asia (lending contracted 18.2 percent). Demand for trade finance also remained tepid.3

An economic slowdown due to external factors, such as weak global demand and competition from neighboring countries in low-value-addition sectors, as well as internal structural challenges, such as an aging population, are the primary reasons behind Singapore’s plans to restructure and retool the economy. Technology, innovation, and skill development are the tools being used to build Singapore’s future economy, but obstacles lie on the route to sustained prosperity.

High-growth clusters at the helm

Singapore has identified five growth clusters that are likely to drive the city-state’s economy of the future. These future-growth clusters are advanced manufacturing, applied health sciences, smart and sustainable urban solutions, logistics and aerospace, and Asian and global financial services. Unlike earlier plans for economic growth, which identified target sectors such as the electronics sector or the biomedical sector, these clusters are sector-agnostic and are areas in which Singapore already has a foothold. For instance, in the smart and sustainable urban solutions cluster, Singapore became the first country in the world to introduce driverless taxis for public use.4 Furthermore, Singapore is on its way to becoming one of the world’s first smart city—toward this goal, data collected from sensors and cameras across the city-state are to be aggregated on a 3D platform called Virtual Singapore, which will allow urban planners and researchers to run simulations and offer real-time solutions.5 Similarly, in the Asian and global financial services cluster, Singapore is already a dominant player. In fact, in a study conducted by Dell and IHS Economics that looked at human capital, infrastructure, and commerce, Singapore was identified as the most future-ready economy in the Asia-Pacific region.6

Singapore’s strategy to innovate its way to growth in the future is supported by investment in human capital through skill development and life-long learning initiatives such as the SkillsFuture program (Budget 2015) as well as support for Singapore’s SMEs (Budget 2016). As a result of the transition to new sources of growth that are rooted in Singapore’s existing domestic capabilities and human capital, economists will likely be increasingly concerned about what Singaporean enterprises are producing—gross national product (GNP) is therefore likely to be of increasing interest in addition to GDP.7

The approach of innovation and skill development for future growth is not without challenges. The immediate one is weak productivity growth. Productivity gains, stemming from deep skills and expertise, rather than a larger workforce is Singapore’s strategy for generating sustainable future growth. However, productivity growth has been lackluster—value added per worker declined year over year in 2014 and 2015, and has slowed through 2016 despite the effect of a weak base.8 Output per employed person has also been stagnant (figure 2).9 This connects to another challenge that is likely to take center stage in the coming decade—a rapidly aging population. Singapore’s old-age support ratio—the number of working-age residents (20 to 64) per elderly person (65 years and above)—has fallen from 9.0 in 2000 to 5.4 in 2016 (figure 3).10 A low fertility rate—lower than the required replacement rate—implies a further deterioration of this ratio and a greater strain on the working-age population. By 2030, it is possible that for every two working-age people, there will be one senior citizen.11 If productivity gains do not pick up pace and if skilled migration does not contribute to both productivity gains and population growth, then the transition to the future economy is likely to slow down.

Weak productivity growth is a challenge to the economy of the future

Singapore’s old-age support ratio continues to fall, thereby increasing the burden on the working-age population

Weak global trade and potential protectionism

Other challenges to Singapore’s plans for building a future economy are external. Though the focus is on enhancing the role domestic Singaporean firms play in the economy, internationalization of Singapore’s enterprises and capabilities continues to be a critical factor for success. Studies show that the degree of internationalization positively impacts the performance of SMEs.12 Today, more than 50 percent of Singapore’s SMEs have overseas revenue.13 However, global economic growth and global trade growth have been weak. The World Trade Organization cut its forecast for world trade growth to just 1.7 percent in 2016, implying that world trade will grow slower than world GDP for the first time in 15 years.14 In fact, global GDP growth is forecast to be 3.1 percent in 2016, the slowest rate of growth since 2010.15 The International Monetary Fund, in its October 2016 “World economic outlook,” explains that much of the slowdown in global trade since 2012—as much as three-fourths of the overall slowdown—is due to weak global economic activity, primarily in terms of investment.16 However, other factors exacerbate the problem—China’s slowdown continues to be a drag on global trade, and the rising threat of protectionism and anti-globalization is likely to restrict a strong recovery by hampering the growth of global value chains. For instance, the Trans Pacific Partnership (TPP), a trade deal between the United States and 11 Pacific Rim nations, including Singapore, will not become a reality without US support. Even though the TPP was projected to add just 2.0 percent to Singapore’s GDP by 2025, it would have likely increased Singapore’s importance as a trade hub.17

Trade as a percentage of GDP in Singapore has fallen from a high of 440 percent in 2008 to 326 percent in 2015 (figure 4).18 Non-oil domestic exports have been in decline for the last three years and are likely to decline in 2016 as well (figure 5). All of this has implications for Singapore and its long-term strategy for SMEs. Weak investment activity abroad, coupled with protectionism, implies that Singapore’s SMEs will find it difficult to build and expand forward and backward trade linkages. This is likely to have a direct impact on Singapore’s strategy for future growth.

Trade as a percentage of GDP has fallen since 2008

Non-oil domestic exports have been stagnant after the global financial crisis

The outlook for policy and growth

Fiscal policy in Singapore is likely to remain expansionary over the short to medium term. The increase in planned budgetary expenditure in 2016 is 7.3 percent over the previous year.19 This is likely to result in Singapore’s largest primary deficit in history. However, increased government spending is covered by the inclusion of Temasek Holdings in Singapore’s National Investment Returns (NIR) framework. Temasek, a state-owned investment fund joins the Government of Singapore Investment Corporation (GIC, another state-owned investment fund) and the Monetary Authority of Singapore (MAS) as part of the NIR framework. The NIR framework, implemented in 2009, allows the government to spend up to 50 percent of expected long-term real returns on the net assets managed by Temasek, the GIC, and MAS. Government spending on infrastructure development and human capital development is likely to continue over the short to medium term.

At its monetary policy meeting in October 2016, the MAS decided to stick to its stance of zero appreciation in the nominal effective exchange rate of the Singapore dollar against a trade-weighted basket of currencies. This is likely to continue in the near term in order to prop up export-oriented industries in the face of an economic slowdown in China and weak growth in the United States. In fact, further monetary policy easing is a possibility when the MAS meets in April 2017. Additionally, rising treasury yields in the United States and a likely hike in the federal funds rate in December are likely to increase interest rates in Singapore. Rising interest rates would likely overlap weak inflationary pressure—the MAS core consumer price index (CPI) remains below 1.0 percent as of Q3, and headline CPI remains in deflationary territory for the eighth straight quarter.20 Household debt burdens also remain relatively high—the debt service ratio for the median income household in Singapore was 34.0 percent in 2015, much higher than 10.0 percent in the United States during the same period.21 Most of Singapore’s debt servicing is tied to mortgages for housing. A tightening of financial conditions and a cooling housing market will likely increase the debt burden for Singaporean households and, in turn, impact consumer spending and economic growth.

The growth outlook for Singapore remains soft. The Ministry of Trade and Industry announced that it expects Singapore to grow by just 1.0 to 1.5 percent in 2016.22 Growth in 2017 is also likely to remain tepid. Much will depend on how Singapore addresses its internal challenges to constructing a future economy. Global developments related to trade will likely shape how external challenges play out.