Tessa Oh 13A10

Tutorial 19 Section c: Essay Practice

(b) Discuss whether the Singapore government should change its policies for managing
the balance of payments (N/2008/6).

The Balance of Payments (BOP) for a country is a summary statement of the money value of all
economic transactions between the resident of the country with the rest of the world during a specific period
of time, usually a year. Singapores BOP position is usually in a surplus due to both its current and financial
account being in a surplus. This is due to Singapores export dependent economy and high volume of inward
foreign direct investment (FDI). However, due to the 2008 Asian Financial Crisis, Singapores BOP has suffered
slightly. This is because during an economic downturn, many countries would import less foreign goods in
order to cut costs and there will be a greater withdrawal of FDI out of Singapore due to the poor economic
outlook. Hence, the Singapore government needs to adapt some of their policies so as to manage its BOP
while coping with the economic downturn.

One of the policies that the Singapore government may need to adapt would be the exchange rate
policy. The default stance taken by the Monetary Authority of Singapore (MAS) during normal times would
be a gradual modest appreciation. The rationale behind this stance is an appreciation of the Singapore dollar
would cause the relative price of imports to become cheaper such that the price of imported raw materials will
decrease. Given the lowered cost of raw materials, the cost of production for Singapores exports will
decrease, so that the price of exported goods will also become cheaper, enhancing the price competitiveness
of Singapores exports, increasing demand for Singapores exports. Furthermore, given that with appreciation,
the relative price of exports will become more expensive, the increase in demand will bring in more revenue for
Singapore. However, in lieu of the 2008 Asian Financial Crisis, MAS should switch its stance to a zero
appreciation or slight depreciation so as to not cause a BOP deficit. This is because during an economic
downturn, foreign importers of Singapores goods will experience a fall in income, which in turn will lower their
purchasing power. Hence, it will cause the demand for Singapores exports will fall. Thus, depreciation will help
Singapores economy. A depreciation of Singapores currency will cause the price of its imports to be relatively
more expensive and the price of its exports to be relatively cheaper. The demand for Singapores exports tend
to be relatively more price elastic during an economic downturn as the goods produced by Singapores
exports, such as hard disks and computer parts, tend to have many substitutes in the market. Hence, as
Singapores goods become relatively cheaper, the demand for Singapore goods will increase, as foreign
importers will turn to Singapore as a cheaper alternative as they are more conscious of cost cutting. As a result,
quantity demanded will increase more than proportionate, resulting in an increase in export revenue. Hence, a
depreciation of Singapores currency is necessary during this economic downturn.

Whether the MAS should adopt a zero appreciation or slight depreciation stance depends on the state
of the economy during the period of time. The MAS might begin by taking a zero appreciation stance, and
adjust its policy according afterwards, as an immediate depreciation may lead to import-price push inflation.
Furthermore, the implementation of this policy might cause Singapores current account to worsen in the
short run, as Marshall Lerners condition may not be satisfied, as the price elasticity of Singapores exports may
be inelastic as many importers may be held to their previous import contracts and cannot easily switch to other
alternatives. However, in the long run, Marshall Lerners condition should be satisfied as over time importers
will be freed from their contracts and hence Singapores exports will be more price elastic. This can be
illustrated through the J-Curve effect, where the Balance of Trade of a country would experience a deficit first
before experiencing a surplus immediately after depreciation. Hence, if the economic crisis is only lasts for a
short period of time, the adoption of this policy may be rendered ineffective.

However, it is not necessary for Singapore to adapt all of its policies to manage BOP during the
economic downturn. Singapore does not solely rely on exchange rate policy to manage BOP as it also adopts
several supply-side policies to facilitate the management of its BOP. During the economic crisis, it is even
more imperative for the Singapore government to continue to put to action its supply side policies to ensure
that the BOP is in a surplus.

A supply side policy that should be retained is the governments investment in research and
development to improve the non-price factors of Singapores exports. Research and development can help to
improve the quality of the goods it produces, or even come up with new and innovative products that can
capture the foreign market, thus improving Singapores export competitiveness. Additionally, Singapore can
invest in skills development and training of workers through its Workforce Development Agency, which can
help improve the price factors of Singapores exports. This is because retraining workers will help improve the
efficiency and productivity of Singapores economy. With this increase in efficiency and productivity, the cost
of production of Singapores goods will also decrease the prices of Singapores exports and hence improve the
price competitiveness of Singapores goods. However, the effectiveness of adopting this policy depends on the
mindset of the workers that are sent for retraining. If many of these workers do not embrace the training and
upgrading of new or existing skills, the governments investment in retraining will be rendered useless.
However, ideally, these two policies will improve both the price and non-price factors that affect Singapores
exports, thus improving Singapores current account.

Supply side policies can also improve Singapores BOP surplus through its financial account. This is
because, the policies adopted previously that improve the efficiency and productiveness of Singapores
economy will attract inward FDI into Singapore, as the efficiency of Singapores economy provides a
favourable and attractive environment for FDI to set up its companies in Singapore. This, in addition to other
policies such as offering subsidies and decreasing corporate tax will further increase the inflow of FDI in
Singapore, thus improving Singapores financial account. Hence, as supply side policies have improved both
the financial and current account of Singapores BOP, its deficit will decrease.

In the long run, the adoption of supply side policies by the Singapore government may be more
effective in maintaining a BOP surplus in Singapore. This is because the supply side policies will not only tackle
and manage Singapores BOP during a time of economic hardship, but it will also improve Singapores
productive capacity in the long run, and help Singapore achieve sustained economic growth. Supply side
policies will also be effective as they depend on an increase in government spending of the countrys national
income, and given that Singapores budget is in surplus, the government will have no problem managing the
investments in research and development as well as retraining of workers. Hence, in the long run, Singapore
should focus on maintaining its supply side policies to ride out the economic downturn as well as improve
Singapores economy in the long run.