EJC H2 ECONS Essay6 Suggested ans and mark scheme

1 EQ6 The Singapore economy is likely to see mode st growth over the coming quarters, with GDP projected to expand by 1% to 3% for 2016. This is coupled with growing income inequality. With US adopting protectionism and its growth slipping further, global trade activities will continue to dampen. Discuss the relative effectiveness of an exchange rate policy and supply-side policies in addressing the above challenges. [25] Intro: From the preamble above, Singapore is set to face a series of challenges such as slow growth, worsening of its balance of payments as well as non-inclusive growth. This is due to the dampening of global trade activities caused by the US’ adoption of protectionism and fall in its growth. Therefore, the Singapore government will have to implement a string of policies such as exchange rate and supply-side policies to tackle the problem. Body: P1: Establishing the context and hence key issues facing Singapore i.e. The adoption of protectionism by US and its falling growth will pose some challenges to Singapore’s economy. The fall in growth rates in the US will result in a fall in demand for goods and services exported by its trading partners such as Singapore. With gr owth slipping further, consumers in the US will be less likely to purchase as many goods and services from Singapore due to a fall in consumers’ confidence. This fall in demand for Singapore’s exports will result in a fall in both its price and quantity causing total revenue from exports to fall. In order to protect its domestic industries and prevent its growth from slipping further, the US government has adopted protectionist measures such as that of a tariff on foreign goods. Such a measure will lead to a rise in pr ice in Singapore’s exports into the US causi ng a more than proportionate fall in quantity demanded assuming the price elasticity of demand for Singapore’s exports is price elastic due to the availability of substitutes in the US. This will again lead to a fall in Singapore’s export revenue. This fall in export revenue will cause aggregate demand (AD) to fall. This fall in AD (from AD1 to AD2) will counteract the rise in AD (from ADo to AD1) cause by the ot her components such as domestic consumption, government expenditure and investment expenditure. This results in slow growth from Yo to Y2 instead of Yo to Y1.

2 The initial fall in injection (X) will lead to a corresponding initial decrease in national income. Consequently, this fall in incomes will lead to a fall in induced cons umption and a fall in withdrawals (in the form of savings, taxes and import expenditure). The amount of fall in induced consumption is determined by the value of marginal propensity to consume. The higher the value of MPC, the greater is the fall in induced consumption and hence the larger is the fall in national income. The multiplier process continues until the initial fall in injections is equal to the total fall in withdrawals. Hence, the economy reaches a ne w equilibrium national income at a lower level than Y1 which resulted in a slowdown in economic growth, assuming the economy is not nearing full employment. With only a smaller rise in incomes, the Singapore government is not able to collect significantly higher amount of taxes that c ould have given it th e greater ability and l eeway to embark on infrastructural and social spending that could have benefited the citizens in a more pronounced manner. This fall in export revenue could also result in a fall in inflow of export receipts into Singapore. This will worsen the current account which in turn worsens the balance of payments of Singapore. If Singapore’s balance of payments were to experience a deficit, it may have to be financed by foreign borrowing (both private and government). The country’s foreign long-term debt will increase. The money borrowed has to be repaid sometime in the future with interest, which lowers the standard of living of future generations. P2: The growing income inequality will pose some challenges to Singapore. Economic growth should also be inclusive so that the rate of growth is not only sustained over a period of time, but also broad-based across economic sectors and creates productive employment opportunities for the majority of th e country’s population. It involves an equitable distribution of income, to ensure that the benefits from economic growth are enjoyed by the majority, instead of being reaped only by a few. The growing income inequality might be caused by the fall in wages for low skilled labour. As Singapore transit to a more knowledge-based economy, the demand for high skilled labour will increase while demand for low skilled labour falls due to outsourcing of low skilled production to other countries such as Vietnam and Cambodia. The change demand will result in a fall in wages for low skilled labour and a rise in demand for high skilled labour causing a more inequitable distribution of income. From the social point of view, this is undesirable as it causes factions of citizens to be marginalised and left unable to cope with meeting their basic needs as they are unable to purchase essential goods and gain access to merit goods such as healthcare and education. P3: Exchange rate policy of Zero Appreciation In order to address the mentioned challenges, the Singapore government may choose to change its exchange rate policy from gradual modest appreciation to a zero appreciation one like it did during the 2008 subprime crisis. This is done through skilful manipulation of currencies while maintaining zero NEER – depreciate against currencies of countries that it sells exports to and to appreciate against currencies of countries that it buys imports from. By flattening the band to allow more room for the Singapore dollar to depreciate, the price of Singapore’s exports will fall in foreign currency resulting in a rise in quantity demanded for Singapore’s exports. At the same time, the price of imports in Singapore dollars will increase resulting in a fall in quantity demanded.

3 The demand for Singapore’s exports is price elastic, to the availability of many close substitutes from other countries. Being a small country that lacks natural resources, Singapore is heavily reliant on imports resulting in the PED of its imports to be price inelastic. However, assuming that the sum of PED for exports and imports is more than one, depreciation in the Singapore dollars will lead to a rise in net export revenue due to the Marshall Learner Condition. This rise in net export revenue will result in a rise in AD causing it to shift from ADo to AD1. This rise in AD will then result in multiple increase in national income via the multiplier process causing national income to rise from Yo to Y1 assuming that the Singapore economy is not operating at the full level of employment. Thus there will be a rise in economic growth rates. Furthermore, the rise in inflow of receipts due to the rise in net export revenue could also improve the BOP position of the economy. With this rise in economic growth rates, the government could collect a higher amount of taxes that can be used to better redistribute income from the rich to the poor. As income increases, workers will progress to a higher income bracke t, requiring them to pay a higher percentage of their income as taxes. The progressive tax system thus has redistributive effects since workers in higher income brackets will pay more taxes. This redistributive effect is compounded too when the rich buy more expensive luxury goods and thus pay more taxes even at the same goods and services tax rate. With a higher government budget due to greater amount of taxes received, the government’s redistributive effect will be more significantly fe lt through targeted expenditure on the lower