A History of Stability and Growth
Hi there, let's talk about Singapore. This small nation has weathered numerous economic storms, including the 1997 Asian financial crisis and the 2008 subprime mortgage crisis, emerging relatively unscathed. Its economic growth over the past two decades has been remarkable and consistent, a feat rarely seen among developed economies. Singapore's GDP per capita has even surpassed that of Japan, a former economic powerhouse. Hong Kong, once on par with Singapore, has also fallen behind since 2008, leaving Singapore standing tall as the world's second-highest GDP per capita.
In the previous installment, we delved into Lee Kuan Yew's leadership and his instrumental role in Singapore's economic journey. We discussed how he stabilized the volatile situation of ethnic conflict, developed robust infrastructure, and rapidly improved the education level of the entire population. While impressive, these achievements represent just the foundation. It's difficult to attribute Singapore's economic dominance solely to these factors. Today, we'll explore Lee Kuan Yew's final and arguably most crucial step: attracting foreign investment.
Attracting Foreign Investment: A Cornerstone of Singapore's Success
Since becoming Prime Minister, Lee Kuan Yew recognized Singapore's limitations. Its small size and limited natural resources meant that rapid economic growth and prosperity hinged on industrialization and foreign investment. In 1961, he established the Economic Development Board (EDB) with a laser focus on industrial development and attracting foreign investment.
Singapore poured national resources into building industrial parks and established the Development Bank of Singapore to finance industrial projects. The EDB embarked on a global campaign, reaching out to Fortune 500 companies through letters, calls, and visits. They touted Singapore's advantages: a strategic location, a large port, low costs, and a pro-business government committed to supporting foreign investors.
Attracting foreign investment, however, requires more than just talk; it demands tangible incentives. What do you think foreign investors value most? That's right – taxes! Initially, Singapore offered tax breaks to companies setting up factories. Later, they took the bold step of reducing tariffs to zero and progressively lowering corporate income tax from over 40% to a mere 17%. This means foreign companies operating in Singapore only pay 17% income tax, retaining the rest – often a lower rate than their home countries. Additionally, personal income tax benefits further cemented Singapore's reputation as a tax haven.
Singapore streamlined the process of investing and doing business, implementing a "single window" system. This system minimizes bureaucratic red tape and trade barriers. No antitrust laws, licensing approvals, or foreign exchange controls – just register, build your factory, sell, and earn. Today, the World Bank ranks Singapore second only to New Zealand in ease of doing business.
In the 1960s, Singapore's strong labor unions posed a challenge with frequent strikes. Lee Kuan Yew, understanding the potential deterrent this posed to foreign businesses, implemented policies to weaken unions, ensuring a smooth path for foreign companies. Some argue that Singapore's pro-foreign investment stance went too far, leading to a dominance of foreign companies and potentially undermining local businesses.
Nevertheless, a wave of multinational corporations began setting up factories in Singapore starting in the late 1960s. Initially, these were labor-intensive industries with low value-added products like garments, toys, and wood products. The arrival of Texas Instruments in 1968 and Hewlett-Packard in 1970 marked a turning point, igniting Singapore's electronics industry. The influx of multinational companies fueled Singapore's manufacturing sector, with its share of GDP surging from 10% to 25% between 1960 and 1980. This growth propelled Singapore's GDP growth rate to an astounding 10% with consistently low unemployment rates, even amidst two oil crises.
As Singapore prospered, labor costs rose, making it challenging to sustain manufacturing expansion. The solution? Firstly, a shift towards higher-tech industries. Secondly, leveraging Singapore's position as a global trade hub. Instead of solely focusing on manufacturing, Singapore capitalized on the constant flow of goods through its port by offering high-value-added downstream processing services. For instance, they offered crude oil refining to Middle Eastern countries, refining their oil and shipping the finished product to its final destination.
Similarly, while unable to compete in upstream chip design and manufacturing, Singapore excelled in downstream assembly and testing. Chip manufacturers could ship their products directly to Singapore for seamless packaging, testing, and distribution. By integrating downstream operations with port logistics, Singapore created a one-stop shop, solidifying its manufacturing sector's significance.
The government's policies, such as lowering taxes, weakening unions, and simplifying processes, not only attracted multinational corporations but also propelled Singapore to become the world's second-largest trading port, trailing only Shanghai. While many countries impose restrictions on foreign companies to protect domestic industries, Singapore adopted a radically open approach, welcoming foreign investment with open arms.
Singapore: A Global Crossroads
This approach has positioned Singapore as a bustling crossroads in the global economy. Countries are like neighborhoods within a city, with larger ones like the US and China representing larger districts, each with its own set of entry and exit barriers. Singapore, however, resembles a busy intersection, strategically located, with wide roads, low tolls, and efficient traffic management. This naturally makes it a crucial transportation hub.
How crucial is Singapore to global trade? A country's reliance on trade is often measured by its trade-to-GDP ratio, which considers total trade (exports plus imports) rather than just net exports. For example, two countries with equal imports and exports have a net export of zero, but a country with higher total trade relies more heavily on trade.
The US has a trade-to-GDP ratio of 27%, while China's stands at a significant 38%. Now, guess what Singapore's ratio is? A staggering 337%! Its total trade volume exceeds its GDP threefold, and this figure has remained above 200% since 1960.
This highlights the importance of foreign trade as Singapore's primary economic driver, making internal economic indicators secondary. Consequently, Singapore's central bank manages its monetary policy by directly controlling exchange rates instead of interest rates. If the Singapore dollar depreciates too much, the central bank uses foreign exchange reserves to buy it back, and vice versa. This unique approach requires a highly capable central bank and substantial foreign exchange reserves.
Why does the Monetary Authority of Singapore (MAS), Singapore's central bank, choose this method? Recall the primary objective of a central bank – not economic development, but controlling inflation. Most central banks prioritize controlling interest rates because they regulate the domestic flow of funds. Lower interest rates increase money circulation, potentially leading to inflation.
However, Singapore's unique position as a global crossroads means its currency circulates not only domestically but also internationally. Even with stable domestic prices, external factors can impact Singapore. If overseas prices rise, Singapore's prices may follow. While interest rate adjustments are possible, they might not be as effective or immediate. A more straightforward solution is to appreciate the Singapore dollar, effectively lowering the cost of imports and controlling domestic inflation.
This stability in exchange rates is crucial for Singapore, providing reassurance to its global trading and investment partners. A volatile currency with a high risk of collapse would deter foreign investment and disrupt supply chains.
Some might wonder about Japan's central bank and its stance on the Yen's valuation. Both appreciation and depreciation have their pros and cons, but the key is to avoid drastic fluctuations. Most partners prefer currency stability, and volatility is a major concern for central banks. This is evident in the recent intervention by the Bank of Japan to curb the Yen's sharp decline.
While both Singapore and Hong Kong are considered top choices for foreign investment in Asia, Singapore's approach to exchange rate management differs from Hong Kong's peg to the US dollar. The Singapore dollar has a wider fluctuation band, historically ranging from 0.69 to 0.76 against the US dollar. This approach balances stability with flexibility for the government to manage its economy without being entirely beholden to the US dollar.
The ability to directly control exchange rates, however, requires significant financial resources, which most countries lack. While central banks can typically print money to influence domestic interest rates or implement quantitative easing, managing exchange rates requires using foreign currency reserves like Euros or US Dollars to buy or sell the local currency. This necessitates substantial foreign exchange reserves, a requirement that disqualifies most countries.
How does the Singaporean government accumulate such wealth despite low tax rates and a hands-off approach to the real estate market? The answer lies in the virtuous cycle created by the Lee Kuan Yew government's efforts: stabilizing the political landscape, developing infrastructure, investing in education, attracting foreign investment, and fostering a thriving manufacturing sector. This virtuous cycle has enabled Singapore to maintain a consistent trade surplus, with exports consistently exceeding imports, generating substantial wealth.
Singaporean companies, earning US dollars, exchange them for Singapore dollars at the central bank, effectively transferring those reserves to the government. This accumulation of foreign currency reserves empowers the central bank to manage the Singapore dollar's exchange rate effectively.
While trade surplus contributes to Singapore's wealth, the primary driver is a current account surplus, representing a net inflow of capital, including foreign direct investment (FDI). Even with a balanced trade balance, a country with substantial foreign investment will experience a current account surplus and accumulate wealth.
Sustaining this inflow of foreign investment requires maintaining attractiveness. The Asian financial crisis demonstrated the devastating impact of capital flight. Singapore, however, has excelled in attracting FDI, reaching a record US$140.8 billion in 2022 – the third-highest globally, surpassing much larger economies.
Unsurprisingly, the financial sector attracts the lion's share of this investment, accounting for over half, while industrial FDI has diminished. Notably, Singapore's inward and outward FDI are roughly balanced. While the US leads in FDI inflows, followed by Japan and the UK, Singapore primarily invests in mainland China. Interestingly, the Netherlands is the second-largest investor in Singapore, highlighting their strong economic ties.
This substantial influx of foreign investment, coupled with a current account surplus, has bolstered the MAS's foreign exchange reserves, empowering them to manage the Singapore dollar and providing confidence to global partners considering establishing their regional headquarters in Singapore. This stability minimizes the risk of economic collapse seen during the Asian financial crisis.
Sovereign Wealth Funds: Investing for the Future
Instead of simply holding these reserves, Singapore's central bank channels them into sovereign wealth funds for investment purposes. These funds act as investment vehicles, seeking profitable opportunities globally. Singapore boasts two prominent sovereign wealth funds: GIC (Government of Singapore Investment Corporation) and Temasek, with a combined estimated value of US$1.2 trillion. If distributed equally among Singapore's citizens, each person would receive a substantial US$220,000.
Initially, these funds primarily supported domestic businesses and the local economy. However, as their assets grew and domestic investment opportunities dwindled, both GIC and Temasek expanded their portfolios globally. Today, approximately 70% of their investments are overseas.
While wholly owned by the government, these funds operate similarly to private investment firms, actively seeking high-return investment opportunities. Temasek, with a more aggressive approach and a portfolio of over US$400 billion, focuses on equity investments, buying stocks and engaging in venture capital, holding stakes in companies like Tencent, Alibaba, Meituan, Visa, and BlackRock.
GIC, on the other hand, adopts a more conservative approach akin to traditional asset management, prioritizing risk diversification. It maintains a vast and diverse portfolio encompassing stocks, bonds, real estate, private equity, and more, ensuring a balanced approach.
Both funds utilize a portion of their investment returns to support the government while reinvesting the rest to grow their portfolios. This "dividend" to the government constitutes a significant portion of its revenue, accounting for approximately one-fifth.
This system, where the central bank allocates funds to sovereign wealth funds for investment, including potentially purchasing Singapore government bonds, generates returns that partially fund the government. This model highlights the close integration of Singapore's central bank and government, a structure that would be unsustainable for most countries.
Traditionally, central banks and governments operate independently to prevent conflicts of interest and potential abuse of power. However, Singapore's success with this model stems from its remarkably low level of corruption. Transparency International ranks Singapore as the fifth least corrupt country globally, trailing only Nordic countries and New Zealand.
This high level of transparency and accountability empowers the Singaporean government with strong execution capabilities, ensuring policies are implemented effectively without being diluted or misappropriated. This factor plays a significant role in Singapore's ability to deviate from traditional economic theories with minimal adverse effects. It allows them to prioritize efficiency and pragmatism.
How does Singapore achieve such a high level of transparency and efficiency within its government? While its small size simplifies organizational structures, two key factors contribute to this success: rewards and deterrents.
Firstly, Singaporean government officials receive some of the highest salaries globally. This approach incentivizes talented individuals to pursue government roles while minimizing the temptation for corruption. For instance, Lee Hsien Loong's annual salary is approximately US$1.6 million, making him the world's highest-paid leader.
To further deter corruption, Lee Kuan Yew established the Corrupt Practices Investigation Bureau (CPIB), a powerful agency reporting directly to the Prime Minister. The CPIB plays a crucial role in maintaining transparency and accountability within the government.
One notable deterrent employed by Singapore is caning, a form of corporal punishment that often sparks debate. Caning is a penalty for various offenses, including vandalism, illegal lending, rape, and robbery. It's important to note that caning is not a standalone punishment; offenders also face imprisonment.
While some may perceive caning as a light punishment, the reality is far more severe. The punishment involves whipping the offender's bare buttocks with a rattan cane. Offenders are not informed of the caning date, creating constant anxiety during the first third of their sentence. The caning is carried out by carefully selected, physically fit male officers who use their full body weight to deliver powerful strikes, reaching speeds of at least 100 miles per hour with a force of over 200 pounds. The cane, soaked in water overnight, inflicts excruciating pain and often leaves permanent scars. Many offenders describe it as the most painful experience of their lives.
Due to the severity of the punishment, caning is only applicable to physically fit males under fifty and limited to a maximum of 24 strokes. This graphic description highlights the deterrent effect the government aims to achieve. It's not merely a propaganda tool; over 1,500 people are sentenced to caning annually in Singapore.
The Price of Prosperity: Challenges and Considerations
Singapore's economic success, fueled by open policies, a skilled workforce, and strategic investments, has propelled it to become a global financial hub. However, this prosperity comes with challenges. The influx of talent and capital has led to increased living costs, making Singapore one of the most expensive cities globally, according to the Economist Intelligence Unit.
While food prices are high due to Singapore's reliance on imports and car ownership is expensive due to taxes, these costs are mitigated for citizens through public transportation, government housing programs, and education subsidies. While not without its challenges, Singapore offers its citizens a high quality of life, even for those with moderate incomes. In fact, many argue that cities like New York are even more expensive than Singapore.
Singapore's journey offers valuable lessons and insights into economic development. Its focus on education, foreign investment, and a business-friendly environment has yielded remarkable results. However, like many other successful Asian economies, Singapore faces challenges such as high living costs, a low birth rate, and increased competition. These issues are complex and interconnected, requiring nuanced solutions.
Overall, Singapore's economic success story highlights the power of strategic planning, strong governance, and a willingness to embrace globalization. While not without its challenges, Singapore's model offers valuable insights into achieving sustainable economic growth and prosperity.