In the year 2012, the key decision makers in Eurozone has jumped in the bandwagon for austerity measures despite the poor economic growth rates and high employment rates in countries such as Spain and Greece. Austerity is a word used to characterise the poor levels of government spending in their fiscal policy measures in light of high governmental debt levels. Such measures have led some to believe that government spending is no longer an important factor in stimulating economic growth, which is defined as the amalgamation of actual growth, marked by a real GDP increase, and also potential growth, which is marked by an increase in full production capacity in the economy. However, the stagnant economic indicators seem to suggest that the absence of government spending has done little to help the eurozone’s recovery. In the context of Singapore, the importance of government spending is understated because it is a crucial factor for growth in both the short run and long run.
Main point #1
Critics often put down the importance of government spending for Singapore because of her small multiplier and therefore the minimal contribution to the growth of actual GDP.
The multiplier is a function which relates the increase in real GDP to the initial injection. It is calculated using the following equation:
K=1/MPW, where MPW is the marginal propensity to withdraw (Savings, import expenditure, taxes)
I.e. Actual increase in real GDP = k(Amount of injection). The assumption here would be that there is no inflation, as any inflation present could undermine the workings of the multiplier.
Singapore is a small and open economy where import expenditure can amount up to almost 250% of the GDP. This is because the Republic grows her economy through value-adding imported products, such as semi-conductors and pharmaceutical drugs and repackage into a new export product for revenue. Industries also import many raw materials and finished goods for direct consumption given the limited land space and production technology. Therefore, there is a high level of withdrawals from the economy. Given that there is also a high savings rate as a result of the Government’s Central Provident Fund Scheme, we can expect that the marginal propensity to withdraw in the economy remains high. This, coupled with high import expenditure, will result in a small multiplier.
When the government spends on the economy, different amounts taken from the government’s budget may be used to develop new educational programs, subsidize businesses, or perhaps to invest in social infrastructure, as seen in the heavy investment in SMRT’s Circle Line projects. All these spending have an effect of increasing aggregate demand which leads to a multiplied rise in real national income. Yes, government spending may bring about actual economic growth. However, this could only be an illusion for growth because the small multiplier would require huge amounts of spending by the government which may bring the government’s budget into a deficit position. In order to bring back budge t levels, the government may be forced to collect more taxes (which is contractionary in nature) or take on an austerian fiscal approach in the next business cycle. Hence, we see that for economies such as Singapore with a small multiplier, government spending alone will not be effective in achieving sustainable growth on a cyclical count.
Main Point #2
The importance of government spending is greater towards smoothing out structural weaknesses for the Singaporean Economy than the cyclical recessive tendencies of the business cycles.
This is because although government spending may not be able to increase real GDP much as a result of SIngapore’s small multiplier, the type of spending as well as the post-fiscal confidence may be able to overcome structural weaknesses in the economy to bring about long run potential growth. For instance, the government’s recent Wage Credit Scheme (Subsidizes 40% of employee’s paychecks) may provide more financial freedom for firms to purchase new technology or send employees for restraining programs to attain new skills and productivity. This will result in a lowering of firms’ cost of production because along with productivity gains, the labour costs per manhour falls. This has an effect of increasing the aggregate supply of the economy and ease overheating pressures with singapore faces right now. The import of new technology may also increase Singapore’s potential aggregate supply in the long run. What’s more important here is that the very action of Parliament passing an fiscal stimulus package creates a climate of post-fiscal confidence to our investors (both local and foreign) as well as speculators who holds short term assets. This is because the prospect of a potential economic boost due the government’s spending may suggest greater yields and returns from investments, possible rise in asset prices and stock prices. Given that Singapore has an open capital market, this news will result in a greater inflow of Investments and hot money flows which will not only boost Singapore’s aggregate demand in the short run but also in the long run. Therefore, we see that the importance of government spending in Singapore is still very much emphasized here because it produces the impetus for the increase in aggregate demand along with the increases in aggregate supply due to investments and productivity rises.
However, at this point, critics may further question the value of government spending here because if the effect of government spending lies more on increasing singapore’s aggregate supply rather than demand (again, rmb our small K), isn’t there a possibility that our aggregate supply may increase at a faster rate than aggregate demand? This widens our output gap, results in deflation and falling wages and ultimately increases our unemployment rate, causing a fall in real GDP growth.
Yes, there is a possibility that this could occur. However, we have to bear in mind that increases in aggregate supply tend to take a more long term perspective and more often than not, effects of government spending on AS may only reach fruition in the next business cycle. Also, when the government spends, the climate of post-fiscal confidence may also encourage local consumers to spend more because of the prospect of rising wages and possible inflation in the future.
In conclusion, government spending is important in achieving economic growth in singapore because it conditions the structural weaknesses in the economy and provides the conditions for growth in both the short run and the long run. As compared to its long run effect, the importance of government spending tend to be downplayed in the short run as aggregate demand is more effectively managed by our exchange rate policy. This is the reason why in response to a bad quarter of growth, the government doesn’t spend but it allows the exchange rate to float in the band and ride us through the cyclical fluctuations of demand and supply in the business cycle, and rather spends the money on our healthcare, transport and educational sectors to increase our competitiveness and accommodate any risks of inflation in the long run. #
-Sitong
Rethinking utopian economics. 