SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - Beyond Indonesia - Indochina as ASEAN's Next Frontier - The Eurozone Crisis: Reviewing Expansionary Austerity - Rethinking Human Capital
The Fortnight In Brief (18th March to 31 st March) US: Continued Commitment to Low Interest Rates In the FOMC meeting March 20, the Federal Reserve committed to keeping interest rates near zero as long as unemployment remained above 6.5% and inflation outlook stayed below 2.5%. The scale of the Feds asset purchase is expected to continue but may be altered as the economy continues to heal. The U.S. economy grew at a 0.4% annual rate in Q4 of 2012, up from a 0.1% estimate earlier due to an increase in net trade and non-residential construction. Slower consumer spending however offset the gains. 10-year treasury notes also fell for a second quarter as investors sought higher yielding assets as the economy continues to improve. Asia Pacific: Chinas Property Cooling Measures and Japans Escape from Deflation China attempts to cool its property market by banning single-person households from buying more than one residence and increasing the m inimum down- payment for all second home buyers in Beijing. The city also implemented a 20% tax on property capital gains in a bid to reduce the 5.9% increase in the capitals home prices. Meanwhile, Japans Consumer Price Index fell 0.3%, extending its losing streak for the fourth consecutive month. The country has been plagued with deflation for two decades. While the new Bank of Japan Governor Haruhiko Kuroda has vowed to achieve a target of 2% inflation in two years, the recent fall in the CPI has shown that this is an uphill task. EU: Controversy in Cyprus Last Saturday, Cyprus' central bank confirmed that major depositors in Cyprus' biggest bank, Bank of Cyprus will lose around 60 percent of savings over 100,000 euros. Initial signs that big depositors would take a hit of 30 to 40 percent - the first time the euro zone has made bank customers contribute to a bailout - had already unnerved investors. Thus, the toughening of the terms could very well indicate the end of Cyprus as a hub for offshore finance and could accelerate economic decline and bring steeper job losses. Meanwhile, Cypriot President Nicos Anastasiades said on Friday that the 10-billion euro b ailout had contained the risk of national bankruptcy and would prevent Cyprus from leaving the euro.

ISSUE 36 1 APRIL 2013

IN COLLABORATION WITH

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STOXX Europe 600

1570
1560 1550 1540

S&P 500

546 542 538 534 530

MSCI AC Asia Ex.

297 295 293 291

Beyond Indonesia - Indochina as ASEAN's Next Frontier

By Kenneth Ho, Singapore Management University
In recent years, Indonesia has been the darling of the ASEAN region and has been the target of massive foreign direct investments and many MNCs expansion plans. In 2012, FDI of US$23 billion exceeded even the governments ambitious target by 10%. From the ashes of the 1997 Asian financial crisis1, Indonesia duly learnt its lessons and implemented broad reforms to improve competitiveness and political leadership. Today, the story of Indonesia is well understood by the international community. It has one of the youngest populations in the world and, domestic consumption and a rising middle class will drive its future growth. The question then becomes: what is the next frontier for ASEAN? Which is the next Indonesia? Certainly, in 2012, attention has been focused on Myanmar for finally opening up the country. Increased political stability will certainly improve its business environment in the next five years. In addition to Myanmar however, the broad region of Indochina (Vietnam, Myanmar, Cambodia and Laos) holds immense potential. Over the next five years, the Indochina region could very well experience the greatest improvement in its business environment. Large, young and growing population, growth in GDP per capita are drivers of growth As a collective, the Indochina region has a population of 180 million. This is only slightly smaller than that of Indonesia (240 million). Indochinas population is also very youthful with a median age of between 21.4 to 29.9 years. This is comparable with Indonesia's median age (28.5 years) and in sharp contrast to most of the developed world which currently faces ageing population issues. This young and vibrant workforce is a key strength for the region as it strives to grow its GDP per capita which is currently only between US$900 (Cambodia) to US$1,400 (Vietnam) . If leaders are able to deploy the labour resources into key industries, the Indochina region might be able to enjoy the same miraculous growth that Indonesia has enjoyed. From 2003 to 2012, Indonesia's GDP per capita more than tripled from US$1000 to US$3500. At its core, the Indochina region has rich potential and is structurally similar to Indonesia. To successfully realize its potential however, strong leadership is required to improve the political landscape, build necessary infrastructure, educate its population and drawn international investments and expertise into the region. Fortunately, this process has already begun. Improvement in political landscape and friendly policy has drawn investments into the region The region has already set itself on the development path by improving the political stability in each of the five countries. The most notable example is Myanmar, which took a major step in 2012 by holding an election and easing up military control after almost 50 years of military 2 Copyright 2012 SMU Economics Intelligence Club

rule. The international community has taken this very positively with the US and EU partially lifting economic sanctions on Myanmar. This has opened the doors for various conglomerates and corporations who have begun investing heavily in the country for the first time. In the Oil & Gas sector, various International Oil Companies such as Chevron have bided for Exploration and Production rights. Coca-Cola Co. also made its first shipment to Myanmar in more than 60 years. Beyond Myanmar, the entire Indochina region has had a similarly positive experience. Cambodia and Laos have been the targets of various resource exploration investments in recent years. In 2011, two significant projects in Laos were the development of a Bauxite and Alumina plant by Sino Australia Resources Co as well as a steel facility developed by Lao Iron and Steel. These investments will drive development in these nations and result in a positive feedback loop. In general, initial investments drive much needed infrastructure development such as roads, railways, power grids and education spending that makes subsequent investments more attractive. The demonstration effect from the success of initial investments will also attract subsequent investments to the region and bring additional capital and expertise into the region. Manufacturing and resources to be key industries in the near term As with most nations that follow the traditional development path, the Indochina region's comparative advantage lies in the primary and secondary sectors2. Specifically, resources and manufacturing are its key industries. The Indochina region is blessed with a wealth of natural resources from metals, oil and gas to agriculture and forestry. In fact, international investments in resources have been pouring in to the various countries for some time now. Today, Vietnam is already producing Gold, Bauxite, Copper, Tin and Titanium to name a few resources. In Cambodia, the Okvau gold exploration project discovered 729,000 oz of gold in 2010. Much of this investment has been spurred by the resource potential and friendly investment policy in the region. For example, Cambodia allows investors to lease land for up to 70 years and foreigners are allowed to own 100% of investments. This is in contrast to other countries like Indonesia, which has turned slightly more protective of its resources. From an agricultural standpoint, Indochinas favourable climate is a strong advantage. In Vietnam for example, Rice yields are among the highest in the world at 5.6 million tons per hectare per year vs the global average of 4.3. Going forward, there are plans to exploit cash crops such as Arabica coffee in Laos and Robusta coffee in Vietnam. This favourable climate ensures that these nations are among the lowest cost producers in the world. Other cash crops under review include rubber, pepper and cassava. The second engine of growth is likely to be manufacturing. The region has a low labour manufacturing cost of only US$80/month for a worker which is even lower than China's at US$250/month. With China's labour cost set to rise further, China might lose its edge as a lowest-cost manufacturer in the world. Indochina might start to steal market share and 3 Copyright 2012 SMU Economics Intelligence Club

become one of the factories of the world. Already, MNCs such as Nike have begun shifting their production to the Indochina region. Longer term, a shift to domestic consumption will likely be necessary Longer term however a more sustainable growth path can only be achieved if there is a shift towards domestic consumption fuelled growth3. Fortunately, the region certainly has the necessary conditions for this. Its large and youthful workforce, if deployed and educated appropriately, can become a rising middle class and enjoy GDP per capita growth that could spur domestic consumption. All this however, still requires the establishment of key institutions and social safety nets. Hopefully, the region can draw from the lessons in China, which is currently trying to restructure social security so that its people feel comfortable spending their savings instead of saving excessively for future medical costs. ASEAN Economic Community and regional cooperation might be further catalysts Increased regional economic cooperation might be an additional catalyst to the development of the Indochina region. Specifically, the ASEAN Economic Community, which aims to create an integrated economic region by 2015, is the cornerstone piece in this puzzle. Thus far, 67.5% of the targets of the AEC have been achieved and regional leaders are confident that most of the key agreements will be implemented by 2015. The ASEAN Economic Community aims to create a single market and production base in ASEAN, remove trade barriers and allow free flow of goods and services as well as capital and labour across the ASEAN region. This gives the nations of Indochina a much larger market for its resource and manufacturing exports and also reduces trade barriers such as import/export taxes across the ASEAN region. It would also give the ASEAN block more bargaining power in international trade negotiations much like the European Union. Another key concession in the AEC that is in Indochinas favour is the Equitable Economic Development clause which aims to narrow the development gap for Cambodia, Laos, Myanmar and Vietnam (CLMV nations). These nations get more favourable terms and a longer implementation timeline for various AEC targets. Conclusion As a collective, the Indochina region is structurally similar to Indonesia with a large, growing and youthful population and strong potential GDP per capita growth. Recent improvements in its political stability and friendly investment policies have drawn in initial FDI that has put the region on the development path. These initial investments are likely to drive infrastructure development, spur additional interest in the region and lead to a significant improvement in the business environment. In the near term, Indochinas edge lies in resources and manufacturing but for sustainable long-term growth, it will have to implement structural reforms and develop key institutions to spur domestic consumption. The ASEAN Economic Community, if successfully implemented

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by 2015, might also be a catalyst for development as it provides Indochina with a larger market for its resource and manufacturing exports while reducing trade barriers. Overall, the Indochina region has the most interesting and exciting story in ASEAN with significant parallels to Indonesia's miraculous growth story. With the right leadership and execution, it could very well experience the most significant improvement in business environment in the next five years.
1 The Asian financial crisis was a period of financial crisis that gripped much of Asia

beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. 2 The primary sector of the economy is the sector of an economy making direct use of natural resources. The secondary sector of the economy or industrial sector includes those economic sectors that create a finished, tangible product. 3 Domestic consumption fuelled economy is an economy that is primarily driven by its citizens consumption and is relatively less dependent on foreign trade. Sources:
1. 2. 3. 4. 5. 6. 7. 8. 9. Investment Coordinating Board (BKPM Indonesia) CIA World Fact Book World Bank World Development Indicators CIA World Fact Book United States Geological Survey United Stated Department of Agriculture (USDA) Food and Agriculture Organization of United Nations (FAO) ASEAN Economic Community Blueprint AEC Scorecard

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The Eurozone Crisis: Reviewing Expansionary Austerity

By Edison Yong, Singapore Management University
Austerity in the Eurozone The crisis besetting the PIIGS is a story of structural problems in the welfare states. To solve it, Austerity1 was sold by Germany as the bitter pill that the PIIGS had to swallow for its past fiscal profligacy. While this was true for Greece who had falsified its balance sheets to enter the Euro, Spain, on the other hand, had its fiscal house in order up until the crisis. The Spanish economy was soon ridden with a massive housing bubble, aided and abated by easy credit from German banks. Austerity hoped to reduce borrowing cost of these troubled nations which had, at the height of the crisis, peaked above the psychological 7% threshold. However, the fiscal belt-tightening only forced an already depressed economy further into depression. The policy failed to gain substantial traction among investors as interest rates remained high, missing its original goal to quell market fears; much less paving a credible path for countries to repay their debt. Figure 1: Unemployment Rates for the Eurozone and the U.S.

Source: The Conscience of a Liberal, Paul Krugman, The New York Times Nov 17 2011 Keynesian Stimulus vs. Austerity The Euro crisis served as a real world test for economic models, with the U.S. and Eurozone pursuing contrasting policies of Keynesian stimulus2 versus austerity. The divergence in unemployment rates (Figure 1) and economic recovery, albeit slow, between the Eurozone and America suggests the ineffectiveness of austerity and its confidence-inspiring policies once thought to foster recovery. For all its brutal belt-tightening policies aimed at appeasing the bond market and lowering interest rates, investors are still weary of holding Spanish and Italian bonds. Austerity programs push for reform by slashing government spending on public projects and social entitlements. While necessary in addressing the underlying structural problems, this has also resulted in a huge drag on the world economy. With Europe being a large customer for foreign goods and services, their belt-tightening has impacted the growth of many 6 Copyright 2012 SMU Economics Intelligence Club

exporting countries like the U.S. and China. In todays global economy where someones spending is income for another, these austerity results have been far from the ECBs President Jean-Claude Trichets vision of renewed confidence in Europes fiscal house. Though the Austrians are quick to note that all this easy money from the Federal Reserve and the ECB is very likely to cause a repeat of the Great Depression, others like Paul Krugman and Brad DeLong have refuted this claim. Inflation could become a problem in the future as recovery improves, but does not occur overnight as many fear mongers casually imply. Likening the possibility of runaway inflation, if the U.S., Britain or Germany pursues a more aggressive monetary policy, with the hyperinflation3 of Zimbabwe is to make a false equivalence. Unlike Zimbabwe, these countries have the ability to raise revenue and do not solely rely on printing money. The Dangers of Austerity Going further down the path of austerity has a higher chance of prolonging the recession, and does little for growth (which might be the only way the PIIGS can repay their debt). So is this an endorsement of deficit spending? Not in normal circumstances, no. But neither is this a normal recession. The pain of unemployment and austerity on the middle and lower income groups is real. And austerity does nothing to alleviate the hardship. But perhaps the most devastating effect of austerity that demands immediate attention is the threat of long term unemployment among youths. Addressing this issue must be the focal point of any discussion lest the long term unemployed become unemployable. Like Greece, creditors might one day lose confidence in U.S. or Britains ability to service its debt. However, empirical evidence thus far (treasury yields) has yet to suggest such a phenomenon is on the horizon. Up against a zero lower bound, with firms and consumers deleveraging, fiscal policy is required to put the global economy back on recovery.
1 Austerity describes policies used by governments to reduce budget deficits during

adverse economic conditions. These policies can include spending cuts, tax increases, or a mixture of the two. 2 A Keynesianstyle stimulus happens when policy-makers deliberately seek to stimulate one or more of the components of aggregate demand to boost output, jobs and incomes during an economic recession. 3 Hyperinflation occurs when a country experiences very high, accelerating, and perceptibly "unstoppable" rates of inflation. In such a condition, the general price level within an economy rapidly increases as the currency quickly loses real value. Sources:
1. Conscience of a Liberal, Paul Krugman 2. The New York Times 3. Trading Economics

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Rethinking Human Capital

By Timothy Ong, Singapore Management University
Rethinking Human Capital Human capital has developed over the past decades to become one of the central elements of modern economic growth theory evident in Research and Development (R&D) as well as the innovation process. Closer to home, human capital has become increasingly pertinent to us in recent years as echoed by mounting sentiments against the influx of foreign labour or talent deemed vital for our economic health. With this growing strain on our social fabric, it is critical that we understand the dynamics of human capital and its related agglomeration economies1 which lead to growth. Foreign Labour and Economic Growth One argument put forth is that increasing numbers of foreign labour would spur economic growth. This builds on the logic that denser and larger populations would create significant economic benefits for cities through agglomeration economies, which lead to the expansion and spread of knowledge. This would then generate externalities and spill-over effects which increase the stock of knowledge for each individual firm, leading to self-reinforcing increasing returns to scale that would spur economic growth. However, such broad logic overshadows the fine detail that this would apply only to certain industries in which high levels of skill and expertise play an essential role. As stated by several established economists here in Singapore, The benefits of agglomeration do not apply to low- cost, labour-intensive industries like construction, cleaning or security services. In these industries, more workers do not lead to larger increases in output per worker. Nonetheless, low-skilled foreign labour has a crucial role in urban life today despite possible negative externalities such as increased congestion or wage stagnation. We are balancing on a very fine tightrope. A reduction in supply of low-skilled workers may increase costs significantly and have major repercussions on economic growth and industries that heavily rely on them. On the other hand, a glut of these workers would depress wages and reduce the incentives for firms to upgrade workers and raise productivity. The pattern of growth in economies today have inadvertently resulted in low-skilled workers being complementary to highly qualified and professional workers by ensuring the maintenance of our networks, infrastructure and services that keep the entire urban system in operation. They are especially essential here in our local context as most of us would shun work as menial labourers. Creativity and Innovation Looking beyond the supply of labour for economic growth, we can also turn to creativity and innovation the hallmarks of highly skilled human capital which play a critical role through entrepreneurship. Knowledge, whose flow is facilitated by agglomeration effects, is also an essential input to budding businesses. Moreover, given the highly diversified and knowledge intensive nature of Singapores industries, such agglomeration effects would also give rise to Jacobian externalities2 conducive to further innovation. 8 Copyright 2012 SMU Economics Intelligence Club

 Simple terms yet with latent potential, creativity or innovation can be developed and expanded not only through a firms expenditure on R&D but also by simply increasing interaction among people the essence of agglomeration benefits derived from spatial clusters. The notion that interaction among individuals leads to positive growth effects is also consistent with the wider literature on learning and knowledge spill-overs in local labour markets. This also draws upon a key idea in the classics of urban sociology by German philosopher Ferdinand Tonnies that a climate of openness and tolerance in cities would free individuals from the chains of tradition or anxieties about being judged, and that in turn, encourages people to be more imaginative and inventive. On an individual level, many of us would possess a decent level of knowledge and some form of imagination or another. Should we then understand the value that accompanies creativity and innovation in todays economy, as well as the liberation of creative energies from having such an open climate, each person would thus be able to play a small role in shaping the future economy simply through the sharing of ideas and exercising of an open mind. On an aggregate scale, this would tend towards an ideal climate of openness and tolerance, which lends itself to greater positive externalities and knowledge spill-overs. Likewise, the openness of a city would also foster creativity or various opportunities and provide a connection to the global network of knowledge, capital and services. An added advantage of Singapore is that it does not suffer from deeply rooted local spatial segregation along the lines of class, colour or lifestyle which plagues many socially diverse cities around the world and leads to a disruptive climate for creativity and innovation. Naturally this would beg the question of how openness or a tolerant climate could be determined, being qualities which cannot be directly observed. According to the economist Richard Florida, tolerance is indicated by diversity which could then be measured by a composite index of the incidence of artists, gays and foreign-born in the population as these groups are generally suggestive of an atmosphere of openness and forbearance. On the macro level, the OPENCities project by the British Council gives the definition of the openness of a city as its capacity to attract international populations and to enable them to contribute to its future success, with Singapore being one of 25 cities with 25% or more foreign born residents. Figure 1: Cities with 25% or more foreign born residents (alphabetically arranged)

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 An interesting perspective to note as well would be Floridas theory of innovation3 which claims a particular creative and mobile class would congregate at places with an open, tolerant climate and lead to the accumulation of higher levels of human capital which then spurs creativity, innovation and ultimately leads to economic growth. However, difficulties lie in making the general assumption that people with talent have preferences for tolerance or diversity. Figure 2: Singapores Gini Coefficient among Employed Households, 2000-2010

In recent years, while Singapore has certainly become a prosperous city, it has also become increasingly unfair with greater social unrest and widening income disparities. This is reflected in the speed at which our Gini co-efficient rose from 0.430 to 0.452 in the span of ten years from 2000. Growth is indeed a crucial element we must pay heed to yet we should also not let it eclipse other important facets of our society. At the same time, we have to change the paradigm of our thinking and explore other ways in which economic growth may be possible. Conclusion To conclude, there are important dynamics, which could lead to economic growth in this three-way relationship between a diverse yet highly-skilled knowledge intensive sector, agglomeration economies and their externalities as well as a climate of openness and tolerance that fosters greater innovation and creativity. The salient point from this perspective would be that each individual could contribute towards the building of a better society through openness and tolerance in his or her own personal capacity, and this would indirectly but ultimately also lead to economic growth.

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1 Agglomeration Economies are the benefits that firms obtain when locating near

each other 2 Jacobian Diversity Externalities are the knowledge spill-overs between different industries or a diversified local production structure 3 Floridas Creative Class Theory is a theory positing that metropolitan regions with high concentrations of the creative class (technology workers, artists, musicians, lesbians and gay men, "high bohemians") would exhibit a higher level of economic development Sources:

1. IPS Commons: Economic Myths in the Great Population Debate (Donald Low, Yeoh Lam Keong, Tan Kim Song, Manu Bhaskaran) 2. Journal of Economic Geography Rethinking Human Capital, Creativity and Urban Growth (Michael Storper and Allen J. Scott) 3. Journal of Evolutionary Economics Agglomeration Economies: Marshall vs Jacobs (Gerben van der Panne) 4. MICRO-DYN Working paper: Agglomeration Externalities and Entrepreneurship micro level evidence from Sweden (Apostolos Baltzopoulos) 5. British Council: Understanding OPENCities

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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents : Vera Soh (Vice President, Publication) vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Samuel Ong (Publications Director/ Editor) samuel.ong.2010@business.smu.edu.sg Singapore Management University Singapore Ng Yongxiang (Marketing Deputy) yx.ng.2011@accountancy.smu.edu.sg Singapore Management University Singapore Edison Yong (Writer) Undergraduate Lee Kong Chian School of Business Singapore Management University edison.yong.2010@business.smu.edu.sg Kenneth Ho (Writer) Undergraduate Lee Kong Chian School of Business Singapore Management University kenneth.ho.2009@business.smu.edu.sg

Ng Jia Wei (Vice President, Operations) jiawei.ng.2012@economics.smu.edu.sg Singapore Management University Singapore Yingyu Zeng (Liaison Officer) yingyu.zeng.2010@economics.smu.edu.sg Singapore Management University Singapore Darren Goh Xian Yong (Editor) darren.goh.2010@business.smu.edu.sg Singapore Management University Singapore Timothy Ong (Writer) Undergraduate School of Economics Singapore Management University tyong.2011@economics.smu.edu.sg

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