PJC H2 ECONS P2 Q5 Suggested Ans

1 PJC 2018 JC 2 H2 Paper 2 Question 5 Singapore's economy expanded a faster-than-expected 1.8 per cent in the last quarter of 2016. Moving ahead, growth remains uncertain. Internally, Singapore has adopted a policy of restricting foreign labour and restructuring towards productivity-driven growth. Externally, higher US interest rate may lead to higher interest rates in Singapore. Source: Adapted from Channel Newsasia, 3 January 2017 (a) Explain the possible conflicts in government macroeconomic objectives caused by a policy of restricting foreign labour and restructuring towards productivity-driven growth. [10] (b) Assess the impact of higher US interest rate on Singapore’s macroeconomic performance. [15] (a) Explain the possible conflicts in government macroeconomic objectives caused by a policy of restricting foreign labour and restructuring towards productivity-driven growth. [10] [ 1 0 ] Introduction To achieved a more sustained economic growth, Singapore has adopted a policy of restricting foreign labour and restructuring towards productivity-driven growth. However, in the short run, this might conflict with her other macroeconomic objectives such as price stability and low unemployment. Body The policy of restricting foreign labour and restructuring towards productivity-driven growth leads to a healthier BOP and higher economic growth in the long run. This is because by restricting foreign labour, this will decrease the supply of labour and increase the wage cost. Hence, firms will be incentivise to sw itch away from labour-intensive methods of production towards more capital-intensive method of production. In addition, Singapore government also encourages firms to make use of better technology in its production by giving more subsidies such as the Productivity and Innovation Credits. This will help to speed up production and increase the labour productivity of firms. With higher lab our productivity growth than wage growth, the unit labour cost of firms will fall. This will lead to lower cost of production and hence lower price of exports. Assuming demand for exports is price elasti c, the more competitive exports will bring about greater export revenue and hence Singapore’s balance of trade will improve. In addition, higher productivity with the use of better technology will increase the productive capacity of the economy shifting Singapore production possibility curve (PPC) outwards. With both higher AD and AS, Singapore ‘s will experience a more sustained economic growth. Thus, a policy of restricting foreign labour and restructuring towards productivity-driven growth aims to promote a more sustained economic growth by reducing firm’s reliance on labour and incentivizing firms to use better technology. However, while the policy of restricting foreign labour and restructuring towards productivity driven growth leads to more sustained economic growth in the long run, it may conflict with the macroeconomic aim of price stability in the short run.

2 In the short run, it is likely that the restriction in foreign labour will cause wages to rise faster than labour productivity. This is because productivity takes a long time to increase. Efforts to improve the work flow and finding and implementing appropriate technology to speed up the work flow takes time. Hence, in the short run, while the wage cost has increased, labour productivity may not have increased. Hence, unit labour cost will rise. With the higher cost of production, the short run aggregate supply (SRAS) will fall causing the SRAS curve to shift upwards. This will lead to higher general price level resulting in higher cost push inflation. Hence, in the short run, a policy of restricting foreign labour and restructuring towards productivity- driven growth may conflict with the macroeconomic objective of price stability. Furthermore, the policy of restricting foreign labour and restructuring towards productivity-driven growth may also conflict with the aim of achieving full employment. This is because with the restructuring towards productivity-driven growth, firms may adopt more labour-saving technology. This will lead to a falling demand for lower skilled workers and a higher demand for higher-skilled workers. The lower skilled workers may be less educated and thus lack the knowledge and skills to take up jobs take require k nowledge of information technology. Furthermore, retraining to equip workers with new skills takes a long period of time and older and less educated workers may also be less receptive towards the use of technology. Hence, this may result in rising structural unemployment. Hence, while the policy of restricting foreign labour and restructuring towards productivity-driven growth leads to more sustained economic growth, it may conflict with the aim of achieving low unemployment in the economy. In conclusion, the policy of restricting foreign labour and restructuring towards productivity-driven growth is desirable to in achieving a healthier balance of payments and a more sustained economic growth for Singapore in the future, in the short run, there is likely to be higher inflation and unemployment. Hence, Singapore government should adopt policies to minimize these conflicts so that overall this policy is beneficial to Singapore’s macroeconomic performance. Interpret the Question – Part (b) (b) Assess the impact of higher US interest rate on Singapore’s macroeconomic performance. [15] [ 1 5 ] Introduction Singapore’s economic growth remains uncertain due to the rising interest rate in US. This is because higher US interest rate may cause higher interest rate in Singapore as Singapore is an interest rate taker. However, the higher US interest rate also results in greater capital outflow from Singapore to US. This may result in a depreciation of Singapore dollar which may benefit Singapore. Thus, the net effect of higher US interest rate depends on whether the negative effect of higher Singapore interest rate outweighs the positive effect of a weaker Singapore dollar. Body Being an interest rate taker, Singapore interest rate tends to mirror foreign interest rate, particularly US interest rate. Hence, a higher US interest rate will lead to a higher Singapore interest rate. With higher interest rate in Singapore, this will lead to higher cost of borrowing. Consumers will hence be less willing and able to consume big ticket items on credit. In addition, the opportunity cost of consuming rises and hence consumers are more willing to save rather than consume. Hence, consumption will fall. In addition, with the same expected returns to investment, a higher interest rate will lead to falling profitability of investment. Thus, firms are less able and willing to invest resulting in

3 a fall in I. As C and I fall, Singapore’s aggregate demand (AD) is likely to fall leading to a multiplied fall in the national income of Singapore due to the many rounds of fall in income-induced consumption. The effect of a fall in AD on Singapore depends on the degree of resource utilization. If Singapore’s economy operates at or near full employment, a fall in AD is actually beneficial to Singapore economy as it brings about a fall in general price level hence causing a fall in demand-pull inflation. However, if the fall in AD occurs when the economy is functioning below full employment, there will be a fall in real GDP and hence resulting in a fall in derived demand for labour causing higher demand-deficient unemployment in Singapore. This may be undesirable for the Singapore economy. A rise in interest rate may also be undesirable for property buyers who purchase their houses through bank loan. The higher interest rate will result in higher interest payments for their monthly interest payments f