Contents Page
CONTENTS
SIMES Annual Newsletter 2012
SIMES aNNUAL NEWSLETTER 2012
FEATURES
SIMES
eUROPE
DEPARTMENT
3 Editor’s Note
6 Slaughtering of Portugal, Italy, Greece and Spain:
Effectiveness & Efficiency of Austerity
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Spanish Meltdown
aSIA
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SIMES ECONOMICS WEEK
4 Highlights of SIMES Economics Week 2012
The Indian Economic Miracle
BiBLiOGRAPHY
A means to an end?
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us
Research References and Photo Sources
22 Differing Opinions on the Current State of the US Economy Hayek Vs Keynes
SINGAPORE
26 Wage Shock Therapy
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Photo source: http://www. transitioning. org/2012/04/21/ my-lousy-paycheck/commentpage-1/
A Remedy for Income Disparity in Singapore?
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SIMES Annual Newsletter 2012
SIMES
EDITOR’S NOTE
SIMES Annual Newsletter 2012
EDITOR’S NOTE The global economy, once bristling with vigour and vitality, now sees itself in a state of uproar, trying to tackle the onset of a stagnant growth in US, euro-zone crisis and the Asian slowdown. The SIM Economics Society (SIMES) has taken it upon itself, to examine and present the abovementioned issues for Economics Week 2012.This newsletter will provide an in depth analysis and description of everything Economics week promises to offer. The SIMES editorial team has attempted to deliver comprehensive coverage on the woes the global economy is currently trying to grapple with. At times, the writers have expressed their personal views about various economic issues which are aimed at spurring discussion and debate within the economic fraternity in SIM. We commence by discussing opposing economic views of two of the most influential economist of the 20th century- Hayek and Keynes. The article deliberates how the varying economic views of Hayek and Keynes can be applied to the US economy, which is struggling with a stagnant growth thus far. The report that follows examines the Euro-zone crisis and evaluates the failure of policy responses thus far. We then switch gears and move on to the Asian region. We take a closer look at the colossal economies of China and India and attempt to explain how the dampening economies in the US and Euro-zone could be a plausible reason for the Asian slowdown. The report does spill over into the implications on the Singaporean economy due to sluggish economic growth in the US and Europe. The global economy is most definitely in a stage of turmoil that has left some baffled, and some, wishing it was over soon. We do encourage you to turn over the pages, and take a read, as we bring you down the road of events that has brought the global economy to what it is now and what lies ahead of us in the near future. We most definitely hope that you enjoy the reports that await you. To those interested in sharing their views on the articles in this issue, and/or those interested in contributing to our upcoming SIMES January newsletter, kindly email to at sim.economics.society@gmail.com. We would be more than delighted to receive your feedback.
Keethanjali Narayanasamy
Disclaimer: All the views and opinions reflected in the articles are the authors’ own. Neither SIMES nor SIM are to be held accountable for the authors’ views. Access our SIMES website by reading our QR code (displayed at the back of this issue) with your smartphone. Download the QR code reader at your App Store.
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SIMES
Highlights of SIMES Economics Week 2012
SIMES Annual Newsletter 2012
Simes Economics Week 2012 Economics Week is an annual event held by the SIM Economics society ( SIMES).It captures the true essence of SIMES’s vision and is a platform to showcase the work of the cream de la cream of our society. Economics week also aims to bring together economic enthusiasts to provide them an opportunity to immerse themselves in an electrifying atmosphere filled with individuals who share a similar passion towards economics. SIMES is proud to conduct Economics Week 2012 in conjunction with its fifth anniversary. Economics Week 2012 will be a week-long event stretching from the 27th of September to the 5th of October. It will comprise of exhibitions and economics-inspired games to state the least. This year, SIMES is honoured to have the chairman of SIM, Mr.Gerard Ee and CEO of SIM, Professor Lee Kwok Cheong, present for the opening ceremony of Economics week. RMIT Head of Business School, Dr Tony Naughton will also be present as the guest speaker for our seminar, where he will be addressing on the topic “Global Financial Crisis 5 years on”. SIMES is honoured to have such a distinguished speaker accept our invitation to speak at the seminar. We will also be showcasing our economics exhibition throughout Economics Week at the atrium. This year, SIMES has decided to address issues such as the US liquidity trap, Eurozone crisis and the Asian slowdown. The panels are the results of months of arduous preparation on the part of the members of SIMES and executive committee members. What is Economics Week without a little fun and games? SIM-conomics is an economics inspired, life-sized board game version of the famous “Game of Life”. SIMES would like to invite you to participate and enjoy this game that will take place from 28th September to 3rd October. A life size version of the game will be played at the SIM atrium on the 28th of September. Henceforth a “mini version” of the game will be played outside the student life services office from the 1st to 3rd October. The game promises to test your economic intellect beyond the textbook and be fun-filled.
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SIMES Annual Newsletter 2012
SIMES
Highlights of SIMES Economics Week 2012
SIMES Annual Newsletter 2012
The society’s vision is to provide an environment for learning economics beyond the classroom context and understanding the applications of economics to the world around us.SIMES aims to stretch the potential of an individual to the fullest and attempts to prepare its members for the challenges they would eventually face in the working world. I would like to take this opportunity to invite individuals whom are willing to join SIMES to write to us at sim.economics.society@gmail.com. We assure you that your time spent with us will be rewarding. Keethanjali Narayanasamy
SIMES Annual Newsletter 2012
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AUSTERITY
SIMES Annual Newsletter 2012
BY LOUISE, BOFI & STAN
For years, the Southern European countries, namely Portugal, Italy, Greece and Spain (also known as the PIGS), have struggled to keep their economies afloat. Portugal is plagued by chronically low saving rates and a lack of competitiveness for its exports. Italy is entangled in sluggish economic growth. Greece is feeling the toll of tax evasion and thriftless spending behaviours while Spain is suffering from the downfall of its property and construction sectors. The Euro zone remains grappled with downturns and pessimism even today. Desperate times call for desperate measures the PIGS have turned to bailout funds given by other members of the Euro zone with the Nordic countries, Germany and France as the biggest paymasters. Unfortunately for the PIGS, the Germans’ tolerance for the bailout programs are already running fray - the unpopularity of the bail-out programs has contrib
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uted to a string of defeats for German Chancellor Angela Merkel in the German state elections for the past year. Under immense pressure by its own voters, Germany has announced to cease all bailout funds unless the PIGS reinforce strict austerity packages as part of the deal. We have known since the time of Keynes, the folly of such deflationary spirals. Sadly, there is little choice for the PIGS.
Efficiency of Austerity Portugal Prime Minister of Portugal, Pedro Passos Coelho, announced the austerity package released in the 2nd half of 2011 as a “National Emergency” and it was essential to comply with the requirements set by the EU and IMF for the €78bn bail-out programme.
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If the country fails to meet the fiscal targets agreed with EU and IMF - to cut the fiscal gap from 9.8% to 5.9%, 4.5% and 3% in 2011, 2012 and 2013 respectively, the paymasters will cease the bailout and the economy will enter a downward spiral that would “paralyse” the state.
SIMES Annual Newsletter 2012
aly unless it get to grips with spending cuts and boost anemic growth levels. In order to appease them and to reduce the country’s budget deficit, Italy’s policy makers launched an austerity package in July 2011. Italian General Confederation of Labour (CGIL), the country’s biggest trade union held a strike on 6th September 2011, which shut down public transit, including air traffic, underlining a sense of emergency in the Euro zone’s third largest economy. Leader of the CGIL, Susanna Camusso, labelled the labour law as “unjustified” and threatened more strikes if it was not removed.
On 8th November 2011, Italy’s 10-year bond yield surged to sky high levels of 7.5%. Further austerity measures were approved on 11th November The austerity package received ferocious re- 2011, including a pledge to raise €15 billion from real sistance by Portugal’s largest labour union; a strike estate sales over the next three years, labour reforms, was organised with strong slogans such as “Occupy opening up closed professions within 12 months and the street, block everything”. The country’s railway a gradual reduction in government ownership of local system was paralysed, subway was totally shut down services. These measures have brought down the disand many hospitals only accepted emergency cases. astrously high borrowing cost from more than 7.5% The public transport was shut down which stopped a week before to 6.6%; this indicated that the market people from working. was pleased with the actions executed by policy makers. Such a tough austerity package faced serious challenges as three main trade union federations (CGIL, UIL, & CISL) launched a week of nationwide strikes. The unions claimed that Monti’s cuts were unfair, citing the austerity measures as possessing an unfathomable degree of inequality.
Greece
Despite the strike and forecasts of tough times, the centre-right government still commanded strong support, suggesting that many Portuguese believes that the austerity measures would eventually lead to recovery.
Italy Germany was persistent in its stance that indebted Euro zone countries must impose sweeping austerity programmes to get their finances under control. Rating agencies also threatened to downgrade It-
SIMES Annual Newsletter 2012
By far, this was already the 6th austerity package to have taken effect in Greece since May 2010. Similar to its precedents, the austerity package involved severe belt-tightening measures such as having 150,000 jobs cut in the state sector by 2015, a 22% cut in minimum wage, reductions in welfare budget and even changes to labour law to ease retrenchment procedures. Needless to say, such measures posed a threat to the standard of living for all Athens, with the lower and middle-class taking the greatest brunt; tens of thousands of civilians protested against such “atrocities”. The upheavals evolved around the lack of commitment by the Greek government to curb the endemic tax evasion by the elite and instead, sought to further increase common taxes and cut social welfare to
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cover the budget deficits.
shrinkage of 3.5% this year. Equally worryingly, unemployment rate had skyrocketed to a record of 14.9% Austerity is indeed a perilous political issue as policy makers use fiscal policies to meet the terms that has proved too overwhelming for 3 successive of bailout aid from EU and IMF. This surge of unemPrime Ministers of Greece. Should the Prime Minister ployment has two consequences; the original deficit in office decide to deliver his promises to the troika targets will not be met, and the young and educated of the EU and implement the austerity measures, he are leaving the national ship in increasing numbers. will incur the wrath of his people and face the treacherous triangulation of the opposing political parties. If he chooses to do otherwise, Greece will incur the wrath of Germany, one of the paymasters of the bailout funds; an unassisted Greece will slip into debt defaults and eventually face an eviction out of the Euro zone.
Spain Prime Minister Mariano Rajoy of Spain imposed his latest package of tough austerity measures that included a rise in the sales tax that contradicted his initial stance. Another main element was the increase in value-added taxes from 18% to 21%. Mr. Rajoy’s fourth set of budget measures in seven months was intended to cut back the budget deficit by €65 billion, over two and a half years. This was in response to the change in Spain’s deficit targets by the European Union Finance Ministers – from 5.3% of GDP just four months ago to 6.3%. The Finance Ministers also mentioned that they expect Madrid to continue proving progress on its deficit cutting.
Italy Similar to Portugal and Ireland, after the implementation of austerity measures, the deficit was scaled down from 5.4% in 2010 to 4.6% and 3.9% in 2011 and 2012 respectively. However, Italy’s recession deepened due to economic growth that has been contracting for four consecutive quarters and the lowest was in the first quarter of 2012 at -0.8%. Italy’s unemployment rate rose from 8.2% in 2011 to 10.8% in July 2012, the highest since 11.5% in 1998. Increasing economic uncertainties were created from the fear that Italy would need a sovereign bailout if its borrowing rates rise further.
Thousands of protesters from the two largest Spanish unions rallied in several Spanish cities for a nationwide strike against austerity. Workers ranging from mine workers to public sector workers participated in the unrest, disrupting public transportation It can be concluded that austerity measures and forcing factory closures across the country. contribute to a reduction in budget deficit, with the intent to reduce the overall debt burden, measured by debt to GDP ratio. However, there is a sharper rise in the public debt to GDP ratio due to the shrinkage of Effectiveness of Austerity economic growth caused by spending cuts and tax increases that discourage consumption.
Portugal
During the year when the austerity package was implemented, Portugal’s budget deficit plunged from 9.8% in 2010 to 4.2% in 2011. Nonetheless, Portugal remains in a recession due to economic contractions since the 2nd quarter of 2011 and expected
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In addition, austerity has created a new problem, a heightened unemployment rate. The well-known social costs associated with high and persistent unemployment: higher incidence of unhappiness, higher crime rates, higher inequality, higher fiscal costs in terms of foregone output,
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lower tax revenues, higher political and social tension. Therefore, dramatically cutting spending in a fragile economy can pull the rug out from nascent economic growth.
Greece All Greeks alike, they are now paying for decades of imprudent spending and venality. The sideeffects of the harsh austerity measures have started to surface in 2011; the Greek’s real GDP growth rate was at its worst at -6.9% with 27% more companies to declare bankruptcy leading to a spike in unemployment rate.
SIMES Annual Newsletter 2012
Presumably they succeed in doing so, Greece is projected to evade the much dreaded debt defaults and set out to the route of recovery. Austerity has undisputable short-term detrimental effects and the long-term benefits promised remain ambiguous but currently, it appears to be the only way out. Greece has just pulled through a tumultuous period fighting against social unrest, political triangulation and economic deadlines but the next precipice is lying just around the corner. With the political gamesmanship over, the new Athens government now has to continue to bite the bullet and earn the next bailout fund by delivering the austerity measures as promised. Should they fail, they risk a disastrous kick out of the Euro zone, throwing its economy into a hastened downward spiral. Now the world is watching with an eagle eye and chattering teeth.
Spain
Despondency will be everywhere by the end 2012 – a Greek Ministry of Health study revealed a surge in suicide rate by an alarming 40%. This is the social price tagged to the reduction in Greece’s primary deficit before interest payments from €24.7 billion (10.6% of GDP) in 2009 to just €5.2 billion (2.4% of GDP) in 2011. The government budget deficit has also improved from 10.3% in 2010 to 9.1% in 2011. The question now is: How long can the population hold out before austerity’s true benefits set in? It has been reported off the streets of Greece that children are fainting in schools out of hunger, half of the youths are unemployed and criminal acts are in abundance with a notable burglary incident where the Ancient Olympia Antiquities Museum was robbed of antiquities up to 3,200 years old. The social fabric of Greece is being shredded into pieces; with the fundamentals of the society breaking apart, it will be strenuous for the Greek government to restore the world’s confidence in Greece in the years to come.
SIMES Annual Newsletter 2012
Spain’s 10-years bond yield decreased from 7.4% to 6.71%, indicating a slight easing in Madrid’s borrowing cost but the interest rate is still at a record of 1.31%, higher than that of Germany bonds. On 20th July 2012, Spain finally got the approval from the other 16 members of the Euro zone to gain access to up to €100 billion in loans to aid its banks which are weighed down by €180 billion worth of soured real estate investments.
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The Bank of Spain highlighted that the economy has shrank by 0.4% during the second quarter, compared with the previous three months. Spain also needs to cut its budget deficit in 2013 to 4.5% of GDP instead of 3%, and to 2.8% by the end of 2014. The administration forecasted that the economy will not return to growth until 2014 with the new austerity measures in place that will weaken consumption and investments. The government intends to have an overhaul of taxation of the electricity sector, which numerous separate taxes overlap at present, and consumers pay both VAT and a special electricity tax. As part of the negotiations over the structure of the European aid money being used to recapitalise Spanish banks, the government has accepted in principle to establish a “sector-wide-called bad bank”, which would house assets collected from lender and manage them jointly. These plans, which will improve the ability of European authorities to oversee the further restructuring of the country’s financial sector, had been considered several time by the Spanish Government, but dropped due to its cost, and the resistance of larger banks.
SIMES Annual Newsletter 2012
CONCLUSION In a nutshell, the harsh austerity measures are clearly politically-unfavourable and have brought unrest to the streets but it is inevitable in the governments’ attempt to salvage their economies. If austerity is such a disaster, why is this failed policy being adopted? If the definition of insanity is to repeat history after it has been proven to be a failure, does that mean the pro-austerity forces are insane? Apparently, austerity is regarded as the best measurement against the debt crisis occurring in the Euro zone; only a few debt-laden countries defy it. However, more nations are starting to doubt the effectiveness of austerity. Countries that implemented austerity measures have been struggling with recession and skyrocketing unemployment rate. Apart from that, austerity contributes little to government revenue, which depends on a thriving economy. “The boom, not the slump is the right time for austerity” declared by John Maynard Keynes in 75 years ago, and he was right – cutting spending in a slumping economy is a self-defeating strategy, which deepens the depression. Austerity measures are a calamity for individuals and the whole economy, furthermore it has failed in fulfilling its purpose.
We can tell that the austerity measures implemented will help to cut budget deficit and reform Spain to become a healthy economic structure. On the downside, ordinary workers will face unfair wage deductions and even retrenchment. When coupled with increased tax rates and decreased welfare benefits, social unrest is sure to sweep across Spain. Economically, immoderate austerity measures will also cut core economic ability, stumping growth in the short-run, making it even harder for the economy to recover from the over-stretched recession.
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SPANISH MELTDOWN
SIMES Annual Newsletter 2012
THE SPANISH MELTDOWN
BY WEN ZHU EN
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As the European sovereign debt crisis reaches a critical phase, we take a closer look
at the fourth-largest economy in the eurozone, Spain, as it struggles to reduce its budget deficit while going through recession as well as suffering record levels of unemployment rates and 10-year bond yields. Al-
though Spain is similar to other debt-laden euro zone countries of Greece, Portugal, Italy and Ireland, it has a nominal Gross Domestic Product (GDP) of $1.494 trillion in 2011 and can be considered as too big to fall. A collapse of the Spanish economy could have unparalleled repercussions on the rest of the world. As EU leaders attempt to salvage the situation in Spain, we will take a look at what caused the crisis in Spain, as well as measures the Spanish have implemented to weather the crisis, and possible implications on the rest of the world.
SIMES Annual Newsletter 2012
only a matter of time before it became unsustainable, as regional savings banks (known as Cajas) became laden with bad debts when the property bubble burst. Property prices plunged and many could no longer pay off their mortgages. As foreclosures mounted, banks found themselves stuck with a large number of empty homes, which according to some analysts’ estimates, were up to 20% of the total stock of empty homes. Many of them went bankrupt as much of the collateral that was acquired became literally worthless. Spain had officially entered recession in the fourth quarter of 2008, largely due to the housing bubble burst. Spain was supposed to have been relatively well sheltered from the worldwide liquidity crisis caused by the Subprime Mortgage Crisis in the United States, but disaster struck in the form of its banks.
Evidence of a Bank Crisis: Bankia
Formed as a merger of 7 cajas, Bankia was Spain’s largest mortgage lender. However, it was nationalised on 9 May 2012 as it almost collapsed due to the sheer size of its portfolio of bad loans. Spain’s government converted Housing Bubble and its €4.5 billion worth of preferred shares into voting shares, which gave it a controlling share of 45% in Recession the bank. The new management, led by José Ignacio As a result of the property boom in Spain, Goirigolzarri, had restated their 2011 profits of €328 property prices had tripled between 1995 and 2007. million, as reported by then head of Bankia, Rodrigo According to International Monetary Fund (IMF) sta- Rato, into losses of €4.3 billion. The overstated profits tistics, construction and real estate loans grew from and hidden losses were a result of an accounting tech10% of GDP in 1992 to 43% in nique known as dynamic provisioning. 2009. With the real estate boom came insurmountable amounts of mortgage loans. As price of housing Dynamic Provisioning increased, debt increased with it. The Bank of Spain reported that the price of housing in Spain had grown Due to the procyclical nature of the lending 150% in nominal terms and 100% in real terms from business, lending mistakes are more prone during 1997 to 2006. This was accompanied by the fact that periods of strong growth. Banks tend to relax credit by 2006, household savings had been overwhelmed by standards towards borrowers as they would be able to debt. bear higher levels of debt, while the opposite would hold true in a recession. With so much debt in the economy, it was
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In order to reduce this inherent nature, Bank of Spain had made it a requirement for Spanish banks to undertake dynamic provisioning as of July 2000. Impact of the Bank This technique involved understating past profits and Crisis on Sustainabilshifting them into later periods, so that companies can mask volatility and bury future losses. Provisions dur- ity of Spain’s Debt ing a boom could then be used to cushion the impact of a decline in lending during a recession, ultimately From the looks of it, Spain will most likely slowing the decrease in consumption and investment be unable to survive by self-sustenance. As foreign expenditure and hence, real output. demand fell, foreign investors (“hot money”) have been withdrawing from Spain. Liquidity levels have Charlie McCreevy, who served as the EU’s dwindled, as reflected by the bid/offer spread of its commissioner for financial services from 2004 to 10-year bonds of almost 100 cents on 27 Jul 2012. As 2010, and was also Irish Finance Minister, had pur- of now, Spanish banks had to step in to buy governposely let Spain’s flouting of International Financial ment bonds in order to prevent the sovereign borrowReporting Standards (IFRS) continue, because Span- ing cost from rising even higher. However, the more ish banks survived the crisis “better than anyone else foreign investors leave Spain, the less sustainable this to date”. becomes. There will be a point whereby the Spanish banks will be unable to afford buying Spanish govern His way of thinking was that if banks could ment bonds anymore. Where were they going to get hide their financial condition from the public, it is the money then, when their coffers were empty? Enter perfectly acceptable for banks to violate accounting ECB’s cheap three-year loans with just 1% interest, the standards, if that is what it takes to pull through a cri- Long-Term Refinancing Operation (LTRO). sis. What this means is that when banks employ dynamic provisioning and hide their losses (postpone their losses to a future period where it could be offset by future profits), this creates a facade that the banks are in a healthy position as of that time. This would normally work well if they had sufficient reserves to tide through the crises. Reducing provisions during negative growth would prevent confidence in the stability of banks being undermined by weak balance sheets. This would help to prop up the banking sector in periods of recession. However, when banks eventually ran out of reserves and had difficulty with even day to day operating expenses and required massive bailouts from the central bank, the façade shattered, as was the case with Bankia, who was nationalised by the Spanish government. On the flipside, one could argue that the implementation of dynamic provisioning had allowed the Spanish to enter the recession on a much higher buffer. If not for this buffer, they would surely be in a larger mountain of debt.
SIMES Annual Newsletter 2012
LTRO A lifeline for the euro zone came in the form of the LTRO in December 2011. Designed to help banks pay off maturing debts in the first three months of 2012, as well as provide liquidity to lower sovereign borrowing costs. It had come at an appropriate time when liquidity was dropping as each day passed. As expected of the troubled euro zone countries, Spanish banks, amongst others, quickly borrowed a total of €489.2 billion, with a second round of €529.5 billion worth of loans being issued in February 2012. That’s approximately €1 trillion of credit that the ECB had injected into the euro zone! This move freed up credit in the euro zone for banks like Banco Bilbao Vizcaya Argentaria SA (BBVA) which borrowed close to €22 billion. As a result of the injection of credit, banks find themselves being able to purchase higher-yielding sovereign bonds which lowered sovereign borrowing costs, as well as provide loans of their own to creditstarved entities who desperately require financing to grow. Decreases in savings and increases in borrowing would boost the economy by way of consumption and investment expenditure.
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Now, this loan programme could very well become a double-edged sword in 3 years time, when the current three-year loans mature. Banks could become complacent to the fact that any liquidity crisis could be solved by similar actions by the ECB, and might not make efforts to clean up their act in order to sustain their operations. The problem is, would Spain even make it to the year 2015 without more help?
SIMES Annual Newsletter 2012
banks need a €100 billion bail-out in the first place? Put simply, to prevent a bank run. If a large number of people withdrew all their cash at the same time, banks would definitely not have enough cash to even handle day to day operations, and the entire Spanish economy would probably crash within days.
According to Bank of Spain data, overseas investors have been cutting their exposure to Spanish debt. As trading volume dropped and low demand As mentioned earlier, despite the injection of continues to push cost of debt, benchmarked by Span€1 trillion into the euro zone from the ECB’s LTRO, ish 10-year bonds, through the roof. Spanish banks were still unable to close the gaps in their accounts, due to the combined effects of dynamic provision and the property market crash. This led to a call by Spain’s Economy Minister, Luis de Guindos, for a formal request for assistance for Spain’s troubled banks.
The €100 billion bailout In June 2012, eurozone finance ministers agreed to provide up to €100 billion from eurozone funds to bail out Spain’s troubled banks. They will receive this through either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM). However, this would count as sovereign debt, which would add approximately 10% of GDP to Spain’s 2012 debt burden. Public debt could hit approximately 90% of GDP if the bailout fund was used in full, just 2% higher than the euro zone average of 88% of GDP at the end of 2011. This means that it would be highly unlikely that Spain would meet its target budget deficit of 6.3% by the end of 2012. Now, we have a problem: €100 billion to save Spanish banks will not end up in the real economy, where it promotes growth, especially for companies who have potential to grow, but need credit. Banks, in their current positions, are too afraid to lend and only want to save themselves.
Figure 1: Yields for Spanish Government Generic Bonds - 10 Yr Notes (Source: Bloomberg)
Yields on benchmark 10-year bonds passed the 7% mark on 14 June 2012 and further hit a record high of 7.75% on 25 July 2012 as a result of Moody’s cutting Spain’s credit rating to just one level above “junk” (from A3 to Baa3). High borrowing costs will deter investment expenditure which would likely push the Spanish economy deeper into recession. As investors continue shying away from Spain, Spanish banks have found a need for heavier reliance on the European Central Bank (ECB), as can be seen from the trend in Figure 2. Compared to €42.2 billion in April 2011, they have borrowed a record €365 billion from the ECB in June 2012, and a further €375.5 billion in July.
Bank run
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Now, the real question is: Why do Spain’s
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them,” said Prime Minister Mariano Rajoy.
Figure 2: Italian and Spanish Bank Borrowings from ECB (Source: Zero Hedge)
Figure 3: Personal Income Tax Rates in Selected European Countries (Source: Observatorio de Coyuntara Económica, Instituto Juan de Mariana)
Policy Response
Increases in income tax (Figure 3) and an increase in VAT from 18% to 21% will cause the average family’s disposable income to fall, which will further strain their finances as many of them are still struggling to repay their debts. Increases in capital gains tax (Figure 4) will cause a decrease in foreign investors investing in Spain. These increases in tax will eventually lead to falls in consumption and investment expenditure as people have less purchasing power and “hot money” flows out of the country to seek better or safer returns elsewhere. This would severely undermine the effectiveness of increasing taxes, as economic growth is traded for reducing the budget deficit.
Austerity
In exchange for the €100 billion bailout fund, Spain had to implement tough austerity measures to cut their budget deficit from 8.9% of GDP in 2011 to 6.3% in 2012 as required by EU leaders. Measures such as increases in personal income tax, capital gains tax and value-added tax (VAT) would lead to higher tax revenue, while cutting government expenditure on subsidies and schemes like unemployment benefits Similarly, cutting government spending by would all contribute towards a smaller budget deficit. introducing pay cuts to government workers, reducing unemployment benefits and other subsidies could also lead to reduction in disposable income and investment expenditure, possibly lowering the country’s GDP.
“I said I would lower taxes and I am actually raising Figure 4: Increased Investment Income Tax Rates for them. Circumstances change and I have to adapt to 2012 and 2013 (Source: Wall Street Journal)
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These austerity measures will eventually lead to a potential €65 billion reduction in the budget deficit over two and a half years. However, this could come at a cost of prolonged recession, record levels of unemployment, as well as reduction in output in many of Spain’s industries.
and his organisation would do “whatever it takes to preserve the euro” and has caused expectations for ECB intervention to increase. However, there is a dilemma for PIIGS at the moment. Mr. Draghi insists that the other euro zone members start purchasing sovereign bonds of PIIGS in order to lower their borrowing costs, before the ECB would step into the bond market as well. However, this can only happen if the Obstacles to Bailout troubled countries requested aid first. However, the negative stigma and conditions such as tougher austerity measures that comes with such a call for help is politically undesirable, rendering country leaders Germany and other eurozone members’ re- apprehensive on such aid. Spain’s Economy Minister, action Luis de Guindos, however, mentioned that Spain is in no rush to request for such aid as they have covered While pushing for the implementation of 70% of their 2012 financing needs and will wait until tough austerity measures by EU countries seeking ECB has materialised plans to help lower borrowing bailouts, German Chancellor Angela Merkel is facing costs. growing dissent from Germans, even from her own party. Many feel that her stance on aiding troubled Impact and possible euro zone members like Greece has been draining the country of her resources and best described by Markus outlook of a full Söder, the Bavarian Finance Minister, as “pouring wablown bailout of ter into the desert.” Several polls have even shown that a majority of Germans are strongly against continuing Spain funding countries like Greece. The important question now is, if Spain does run out of money and asks for a full blown bailout, will Germany and other major contributors to the fund pro- It is becoming increasingly obvious that the vide? Germany is the largest contributor to the bail- current policies employed in Spain are ineffective. As out fund. If they insist on certain conditions to be banks become increasingly broke, more banks will met, and if Spain does not meet them, they will not have to be bailed out by the Spanish government, get their bail-out fund. which is also running short on funds itself. Moreover, austerity measures to slash budget deficit to the target The stance taken by Finland who is another of 6.3% will only push the country further into recesmajor creditor to struggling EU nations, is contrarian sion. It is a vicious cycle that will not end until Spain to other major countries though. The Finnish govern- collapses and a full blown bailout is inevitable. ment is opposed to bond purchases, and has also demanded guarantees for its share of the bailout loans However, a Spanish meltdown is highly unto Greece and Spain. According to Finland’s Finance likely to happen. This is because Spain is considered Minister, Jutta Urpilainen, the collateral given by the as “too big to fail”. The consequences of Spain failSpanish deposit guarantee funds to Finland total ap- ing and the amount of funds it would need would proximately €770 million, in case the Spanish need be humongous. This could very well trigger another €100 billion. This covers the risk for Finnish taxpay- worldwide financial crisis. There is also concern that if ers, who supply the public loans. Spain were to fall, then Italy would be next. Similarly, if Spain were to be given a full blown bailout, there is concern that the remaining bailout fund would not be ECB Stance large enough for Italy in the event that Italy falls too. ECB President Draghi has mentioned that he The world is still recovering from the 2008 GFC and
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SIMES Annual Newsletter 2012
EUROPE
SPANISH MELTDOWN
SIMES Annual Newsletter 2012
another crisis within 4 years could put recovering economies back into recession. Hence, starting with Merkel’s Germany, this would lead to pressure on the rest of the EU members to put their political differences aside and cooperate to salvage what’s left of the economy of Spain.
A Spanish Exit from the EU? Spain’s exit from the EU is not likely to happen. The costs for a Spanish exit from the EU are too high for the euro zone to bear. Though there have been no estimates for a Spanish exit yet, some estimate that a Greek exit would cost the euro zone €1 trillion, and they only have an economy of €230 billion. Therefore, it would definitely cost the Eurozone much more since Spain had a much larger GDP of €1.494 trillion in 2011. With Italy also facing a need for a bailout in the near future, the EU just does not have that kind of money to spare.
Conclusion All in all, Spain’s future will most likely lie in the hands of the troika, as well as Germany, France and the Nordic nations who have been funding their bailout. Unless Spain’s government is able to address the root issues that plague the Spanish economy, they will highly be unlikely to crawl out of the recession anytime soon. As unemployment rates continue to sit at record levels, austerity measures, demanded by the EU in return for the bailout funds, will most likely cause Spain to sink deeper into recession as consumption and investment expenditure continue to fall. More austerity will definitely be out of the books due to the political upheaval it causes, as Mr. Rajoy seeks to continue his reign as Spanish Prime Minister. As the only fund that would be able to save Spanish banks without adding to sovereign debt, we can only hope that the €500 billion ESM funds will be available in time to prevent a collapse of the banking sector. Time is of the essence, and British rock band Muse probably sums up Spain’s situation with one of their signature songs: “Time Is Running Out”.
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Asia
India’s Economy
SIMES Annual Newsletter 2012
The Indian Economic Miracle – A means to an end? BY SRUTI PEGATRAJU
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Asia
India’s Economy
SIMES Annual Newsletter 2012
“ E c o n o m i c powerhouse”.“The emerging superpower of the 21st century”. These are just a sample of the headlines India has made for itself since its rise in the 1990s. The economy ex-
hibited consistent growth rates of an average of 9% from 20002010, and gained even more respect for its resilience through the 2008 financial crisis of the West. With the economical and
skilled labour force that it offers the world, there is an active demand for the nation’s BPO and IT sectors that have spilled the world over. Local businesses such as Tata, Reliance, Mittal Industries, have grown into empires, and still have attained positive growth plans. India has made a mark on the world stage, and even brought talk of becoming a superpower alongside China by 2050.
Figure 1: Annual Real GDP Growth (Source: OECD)
Not only have modest growth rates been a cause of concern, but in lieu of India’s high inflation rates affecting the middle class – this could be a deadly combination. Though the inflation rate has declined slightly, it has still been teetering stubbornly at 7% and is steadily expected to increase to 10% by the next quarter. This is attributed by the hike in food prices, which constitutes close to 47% of the CPI index of India. Food prices in the country have been rising rapidly by an average of 14% in the last few months, as a result of drought, food shortages and inefficiency in the agricultural production chain. In reaction, consumers have protested on the streets, unable to afford the rise in their daily expenses.
In the recent months however, the world’s biggest democracy has not been performing to its expectations and has brought to light the repercussions of inherent political inefficiencies in the system. Forecasters had noted that the global slowdown initiated by the American economy and the Eurozone would impact trade for India, but only to dip to an 8% average from 2011-2016 – not to the decade-low 5.3% GDP growth the country showed in its first quarter of this year. In response, ratings agencies such as S&P revised their growth figures to 5% for 2011-2012, but some Indian economists claim this rate could deplete down to 4% in the coming year. Industrial output also Figure 2: India Inflation Rates (Source: Tadingeconomics) only increased by a mere 0.1% from last year, compared to the predicted 1.7%.
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Asia
India’s Economy
The interconnectivity of low growth and domestic concern of inflation further aggravates another pre-existing problem India faces with its fiscal and trade deficits. Last year, the fiscal deficit jolted from a projected 4.6% of GDP to 5.9% of GDP. Higher government expenditure on welfare schemes and food programmes due to the rising inflation and unemployment, has not been compensated by the government revenues and economic growth that was expected. The trade deficit has grown to a historic high of US$ 185 bn, predominantly due to the rise in crude oil and gold imports. According to Union Cabinet Minister Anand Sharma the “rise in trade deficit is primarily because of crude oil prices, it is beyond [the Indian government] to control...crude prices in the foreign market”. Although Mr. Sharma raises a valid point about the external factors in play, it is a long term concern that India still has to import 80% of its crude oil needs, which leaves it vulnerable to commodity price volatility. This rise in imports has aggravated the deficit figures even further with the weakening of the Indian rupee, which has fallen by 25% to the US dollar in the past year.
SIMES Annual Newsletter 2012
more of a bane than a boon to its progress. The intricate mess of coalition politics within the currently elected Congress party has been unable to stir any significant reforms. Despite the acknowledgement by key party officials for economic improvement, there is little room to manoeuvre due to objections by smaller parties such as the Naxalites who have been gaining influence in remote villages of the country. The lack of political unity has made it difficult for Prime Minister Manmohan Singh to raise any effective economic reforms despite his sound expertise in the area. The multi-partisan form of the government has also created greater loopholes for alleged corruption cases that have swept across the country in a rather embarrassing fashion. The 2G licensing scheme amongst business leaders and politicians of the DMK party, suspected bribery in the defence sector to General VK Singh to buy sub-standard defence trucks and even in political parties for votes of confidence are just a few of the string of alleged scandals that have hit the nation within the Congress party’s reign alone. Even the anti-corruption chief PJ Thomas has faced corruption charges in March 2010, testifying to this deep-sowed cancer that has spread through virtually all sectors of the economy.
India Inc – the political factor Despite India’s economic ups and downs, the one factor that nobody could testify against was the preservation of its democracy. Ever since their independence in 1947, the nation has been able to maintain its constitutional guidelines and its name as the world’s largest democracy, despite the communist and socialist pressures it faced in the past and continues to tackle with. However at this critical juncture of India’s economic history, this very democracy has become
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With the combination of all these factors, the external audience watching the third-largest economy are less impressed by their system of running things. International companies that have set up shop in India are increasingly frustrated by the power cuts,
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SIMES Annual Newsletter 2012
Asia
India’s Economy
SIMES Annual Newsletter 2012
bribery and extensive paperwork they have to deal with. Even local businesses have stalled on their plans to set up factories and expansion projects because of their doubts on stability in the near future.
development with the vast majority of villages still in need of urbanisation, the bigger more populous states in India are growing healthily. As Zinnov Consulting Group points out “GDP of states such as Delhi, Chattisgargh, Maharashtra and Goa” have grown over 10% The Reserve Bank of India April 2012 over- in 2012” highlighting the potential in key existing inview even predicted a “sluggish” move in new project vestment centres in the country. investments for the coming year. Negative investor sentiment, alleged corruption and dismal economic India certainly understands that its current reforms have taken a toll on India’s ratings which is state is not perfect, and integral reforms are needed now threatened to lose its investment grade status. for long-term stability. The extent of alleged corrupFitch Rating agency reduced India’s economic outlook tion within the most powerful political and business to negative, commenting that it faces “structural chal- circles is not a trait that the country can continuouslenges in its investment climate”. With experts pub- ly adjust to if it wants to maintain its respect in the lishing such negative sentiments on the country’s eco- world’s eyes. Such radical transformations are complinomic future if key structural reforms are not put in cated procedures that will take time to facilitate effecplace, and the innate difficulty in imposing such nec- tively. Though the government has been rather inefessary reforms, raises concern in economists’ minds if fective on this issue, one can be optimistic to believe the Indian economic miracle is short-lived. that action will be taken more seriously if the current economic opportunity is jeopardised. India’s long term growth chart is still upward-sloping and it will Is India really heading South? rectify its current domestic inefficiencies to reach its There is no doubt that the nation that had such goal as a significant player on the global arena. an impressive run in the past decade is faltering now because of its own economic and political mishaps. If India truly wants to raise its status to become a great power in the world dynamic, it has to tackle its inexcusable inefficiencies with greater seriousness. However, if one were to be pragmatic about it all, one may find that India’s economic slowdown does not necessarily translate to its permanent demise. Low growth and inflation are indeed issues of concern, but as officials have been pointing out, once the global economy starts to pick up again, India would be able to bounce back. The undeniable fact is that India has already established itself as a key player in the global labour force and supply-chain. International companies such as Ford, Volkswagen continue to make statements that they are “in India for the long-term”, as everyone has an interest in tapping into the country’s 1.3bn consumer space. The IT sector remains a competitive advantage in the world market, with many MNCs extracting the technology expertise of India’s skilled labour. Indian businesses also have a promising future with 61 Indian companies already featuring in Forbes’s Top 2,000 and a further 110 companies expecting to join the ranks by 2020. Though there are only potholes of
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USA
Hayek V Keynes
SIMES Annual Newsletter 2012
Differing Opinions on the Current State of the US Economy Hayek vs Keynes BY LIU CAIJUN & SAKSHI
The way the world is governed has often been inspired by some academic writings by the greatest thinkers. On policy matters, the Keynesian school has always been quite popular. Recent Quantitative Easing policies and the government bailouts embody and advocate precisely that. Whether this is for the best, not just a mere moral consolation in the attempt to salvage, or it just seems better than the “do nothing” Hayekians, is polemic.
byproduct of the fiscal cliff is influencing expectations according to Mark Trumbull. Government spending and taxes uncertainty are distorting business investments and consumption patterns.
The severity of the situation aggravated by this imminent fiscal cliff has led some pessimists—Steven Davis of the University of Chicago and Peter Morici of the University of Maryland—to believe that the US might be in for another The US government’s fiscal and monetary pol- recession. Today the unemployment rate is hovering icies are essentially Keynesian. Under such govern- around 8.3%, with no improvement from last year. ance, it is true that GDP has risen from -3.9% in 2009 GDP growth rate is lower than the 1.7% last year. to a predicted 1.5% in 2012. It is also true unemploy- Quantitative Easing seems to have lost its power. The ment rate has fallen from the 9.3% in 2009 to 8.3% in long run interest rate is already too low to be lowered 2012. any further and to prove its efficaciousness in boosting private spending. However, the statistics reveal something much more alarming. The economy is slowing down. A sickened fact: Quantitative Easing strategies have failed. The indiscreet motion to this incessant ex Furthermore, the “fiscal cliff ” is devastating pansion of the nominal money supply seems to have the US economy. The overwhelming uncertainty as a negligible impact on the real side of the economy.
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Hayek V Keynes
USA
SIMES Annual Newsletter 2012
Flooding the US economy with cheap money is clearly not the best option. At USD 15 trillion, the US debt is equivalent to the size of its economy. There are also risks of high inflation in the long run. Now, the economy is rapidly losing itself in what Keynesians call a liquidity trap.
spend money to maintain full employment. This serves to stimulating aggregate demand. Governments should smooth out the bumps in business cycles. The simplest way is to cut tax rates and spend more during recessions and hiking taxes and reducing spending during booms (to curb inflation). In times of recessions, if governments encourage the The seeming failure of the Keynesian model public to save more, the spending in the economy revived the great debate between Keynes and Hayek. falls. This leads to build-up of excess goods, which So the question is where to keep faith, in advancing leads to a fall in output and employment, and hence the Keynesian ideals or to slide into the Hayekian be- a fall in income. The economy keeps on shrinking liefs. Intervention, free markets, government spend- till some sort of stability is achieved. This is known ing or austerity? State leaders have to decide. as Under-employment Equilibrium. At such a time, governments should increase their own spending to make up for the shortfall in public spending. They should do so by running a budget deficit if necessary.
The Keynesian Approach:
Advocates and reason for insistence John Maynard Keynes (1883-1946) was one of the most influential economists of the 20th century. So much so that a whole school of thought is named after his ideas- Keynesian Economics. His expertise resulted in him being one of the principle representatives when the Treaty of Versailles was being drawn up in 1919 but he resigned because he felt it was overly burdensome on Germany. He was also one of the architects of the system of fixed exchange rates established at the Bretton Woods Conference in 1944. His influence did wane in the 1970s, but ever since the global financial crisis of 2007, economists going back to his ideas. Contrary to popular belief, while Keynes supported government intervention where necessary, he was not opposed to free markets. By his own admission, while Keynes and Hayek had obtusely differing views on economic policies, they ‘got on very well in private life’. Hayek is also said to have been impressed with Keynes, if not his ideas.
This is the exact policy the US followed in hopes of getting out of the 2008-2009 recession. Tax rate cuts promoted economic recovery and growth by increasing demand for goods and services. The government borrowed and invested into the economy what the private sector could not. Greece and other European countries on the other hand are undertaking austerity measures at such a point (increase in taxes, reduction in government benefits, et al), which is proving disastrous for them, with levels of unemployment reaching a record 23.1%. Despite the probable rebound of the economy, many are still pessimistic. Even Bernanke has admitted to the failure of the unconventional monetary policies. They did not boost the economy as much as the Federal Reserve would like. It is widely agreed and accepted that this is only a short run solution. In the long run, such a policy would burden governments by deepening the budget deficits, creating huge national debts in the future. Keynesians believe that we live in the short run. They quote Keynes’ famous ‘In the long run, we’re all dead’ to prove their point. It is not enough to live in the short run while not thinking about the burdens of debts we would be leaving behind for the future generations.
It is imperative to weigh the future consequences against the current benefits to allow for a rational assessment of whether to continue with Keynes’ beliefs that an expansionary fiscal policy According to Keynes, governments should would provide the intentional spending US needs to
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Hayek V Keynes
USA get out of a recession.
SIMES Annual Newsletter 2012
ernment and in the ability of the free market to heal itself. With much of the world deep-set in recession today, there is no painless recovery; nature needs to run its course. In the eyes of the Hayekians, the best thing the government could do is to not interfere in the forces of the market and impede recovery, throwing the economy backwards. Also, money neutrality has to be observed. It seems that the non-interventionist and non-interference approach is not popular as it resembles “doing nothing”. It lacks the false sense of security which the Keynesian model provides.
Now, Keynesians are saying that with the cheap money available, the state should turn towards investment and set up state-owned institutions to channel the cheap money into reliable investment. They believe that this is the truth if US wants to get out of the liquidity trap they are currently facing. Another issue remains, democracy and capitalism have to be compromised to concede for such plans. The politicians are stuck in this sticky misfortune. Should they concede? Or should they start believing that turning Hayekian is less mentally deranged and more feasible? According to Hayekian Professor George Selgin, Hayek saw a connection between booms and busts. The 2008 US financial crisis is the result of an earlier boom which involved unsustainable investment fuelled by irresponsible lending, easy monetary policies and greed.
The Hayekian Approach:
The truth which is to be listened and not dismissed The Hayekians—fiercest critics of the Keynesians—have always been undermined and sidelined; it has been denounced for being abstract, incoherent and irrelevant. The Hayekian Approach is unquestionably an ideology but heavily criticised for its practicality and viability in its judgement on the how-to or rather how-not-to conduct monetary and fiscal policy. According to Keynesian Professor Robert Skidelsky, the Hayekians have nothing concrete to provide any sound policy solution, all but mere words. Yet, Friedrich August von Hayek(1899-1992) is still considered to be, alongside John Maynard Keynes, one of the most influential economists in the 20th century. Friedrich August von Hayek was a proponent of classical liberalism and a fervent advocate of the Austrian School of thought. In a nutshell, Hayekians believe in a non-interventionist approach by the gov-
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Hayek argued against Keynes’ logic that booms and busts are inherent systemic and cyclic in capitalism and that during recessions there are no innate motivations which will cause the economy to self-heal or recover. Government intervention is essentially an exogenous force to provide for that shortfall in demand and lack of private spending during recessions. For Keynes, the huge increases in spending budget and excessive cheap money supply advocated by the Obama Administration are indeed necessary to resuscitate the economy. However, this to the Hayekians is dangerously delusional. After all, Quantitative Easing has failed miserably. This once again reinforces the idea that state actions handicap the natural recovery process. According to Hayek himself, understanding what causes busts—sudden shifts in the so-called “animal spirits” in investors is utmost important. What leads to misjudgment and unstable investment decisions and wastefulness of scarce capital resource that depresses such “animal spirits” is misguided government intervention in the form of careless monetary policy espoused by the public sector. In current context, the mindless and irresponsible creation of credit by printing what seems to be really cheap money, legalised by the central bank’s open market operations, is generating and injecting uncertainty. This uncertainty is twisting the fates of consumers and investors alike. Hayekians have been warning of the immensely
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USA
Hayek V Keynes
SIMES Annual Newsletter 2012
escalating distress the economy will be facing if the state keeps recklessly expanding the money supply. Hayekians believe that this leads to disastrous results: falsification of real interest rates and distortion of prices. This disrupts the reallocation of resources to engage in creation of new real, sustainable investment activities. People should end this economic perversion and return to non-intervention. The central concept of money neutrality must once be revived. That is the unequivocal truth to alleviating the US economy of its depressed pains.
Conclusion The continued prevalence and relevance of Keynesianism—regardless of the theory—might have something to do with the instinctive need of humans to take initiative to protect something they value. This provides comfort and assurance as humans appear to prefer to be in control, in the know, or believe that they can indeed do anything at all to relieve themselves from desolation. It is clear why the Hayekian Approach should be rather unpopular since it snatches away control and thrusts in the direction of Mother Nature. It is simply too dependent on the unknown, too reliant on fate. We need to question ourselves, in times where Keynesianism is in distraught, are policy makers turning towards the Hayekians? It is difficult to see the rights and the wrongs not purely grounded upon the theoretical but the empirical side. We have too limited real-world tests. Even so, such testing is morally costly. Yet, there is a need to understand that however fundamental the opposition in the approaches of these two economists, their goal is the same—to protect freedom and democracy.
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Wage Shock Therapy
SINGAPORE SINGAPORE
SIMES Annual Newsletter 2012
WAGE SHOCK THERAPY A remedy for Income Disparity in Singapore? BY KANG YONG KIA, WEN ZHU EN, LOUISE, BOFI & FARAAZ
INCOME DISPARITY “When a country becomes richer, you tend to see a widening gap in income. Over the last few years it has been worse,” said econometrics professor Anthony Tay at the Singapore Management University. There are certain features of disparity patterns in Singapore that make it especially worrying. This article examines the arguments for and against the proposal for “wage shock therapy” as put forward by Professor Lim Chong Yah. First, the influx of cheap foreign labour has arguably kept wages sluggish at the bottom of the employment pyramid. The income gap between the rich and poor in society has widened, as shown by Singapore’s growing Gini coefficient over the years (Figure 1), and threatens to widen even further in the foreseeable future. To exacerbate the situation, these issues are happening against perhaps Singapore’s somewhat infamous cultural backdrop of “compare and complain”. In a statistical study “Prices and Earnings” released and updated by UBS on 2011, Singapore is just one rank above Hong Kong in terms of wage levels but way ahead of Hong Kong and Taipei in terms of price levels. Moreover, Singaporeans spend an average of 2,088 hours at work per annum, clocking in more than many other 26
Figure1: Gini Coefficient Among Citizen-Headed Employed Households, 2000 - 2010 (Source: Singapore Department of Statistics)
countries. Hence, the general perception is that Singaporeans are faced with a high cost of living relative to wages along with longer working hours.
Professor Lim Chong Yah’s Radical Proposal In an attempt to reduce the widening income gap in Singapore, the proposal of a wage shock therapy has put forward for the consideration of policy-makers. In April 2012, former chief of the
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SIMES Annual Newsletter 2012
SINGAPORE SINGAPORE
Wage Shock Therapy
National Wage Council and Professor at the School of Humanities and Social Sciences at Nanyang Technological University, Prof. Lim Chong Yah proposed a radical plan to reduce the income gap. His proposal was simple: workers who earned monthly salaries of $1,500 or less would have their wages raised by 50% in the next 3 years – 15% in the first two years and 20% in the third year. Simultaneously, wages of those who earn over $15,000 a month will see their wages frozen over the same period. The rationale that drives professor Lim’s radical proposal might not be far-fetched, considering the similarity to the rationale applied in the up-lifting of the Polish economy. The shock therapy applied in Poland has been considered as arguably one of the most successful stories of such an economic plan.
SIMES Annual Newsletter 2012
Wage Labour Supply Unemployment W1 We
Labour Demand Ld
Le
Ls
Quantity of Labour
Figure 2: Unemployment in the Labour Market (Source: Taylor, 2006, Principles of Macroeconomics)
to rising structural unemployment in the long run, especially when workers expect a higher salary for the same set of skills that they possess. Professor Lim’s proposal was warmly wel comed by elated unionists but it has also left many The wage increase may also hit Small and policy-makers dismayed. In particular, Prime Minis- Medium Enterprises (SMEs) hard as they may not be ter Lee Hsien Loong has expressed his concern over able to cope with the higher costs relating to the wage income disparity, but does not seem to be keen in increases. Generally, the lower wage workers constisupporting the idea of wage shock therapy. PM Lee mentioned that this prevalent scenario could be simi- tute a large part of SMEs’ workforce, and an increase lar to the one in the early 1980’s when the cumulative in wages could see these firms directly passing the additional costs to the consumers through price insurges in wage by 20% per year were not accompacrements. Additionally, SMEs may shut down or may nied by a similar increase in productivity, causing a be forced to take their business elsewhere as a result fall in national competitiveness. Labour Chief, Lim of higher costs associated with the wage increases. Swee Say describes the wage shock therapy as too risky, as it could spell massive job losses and give rise Employers may also look to source for cheaper foreign labour to substitute for the more expensive to structural unemployment. If Professor Lim’s wage Singaporean workers. shock therapy fails, i.e. wages soar without a corresponding rise in productivity, Singapore could get advantages stuck in a low productivity-high wage rut, with job losses and structural unemployment as companies Nonetheless, it is arguable that Professor and industries lose their international competitiveLim’s proposal is not without merits too. With workness and are forced to downsize their operations in ers competing for higher-paying jobs, the increased Singapore. (Figure 2) competition for employment could result in skills improvements amongst Singaporeans and a conse Structural unemployment refers to a misquent increase in productivity. Moreover, with an match between the skills possessed by potential workers and the skills desired by firms and organisa- increase in wages, employers could be more willing to retain existing employees and invest in training, tions. The following scenario could thus develop: technology and development rather than to strain skilled workers may not be offered jobs in tandem with their skill sets, but at the same time, these work- their budgets with costly hiring and training of new employees. This would be beneficial for firms, the ers are unwilling to accept the low-paid, low-skill labour force and the economy as a whole. jobs. It is thus evident that the wage shock may lead
Disadvantages
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Wage Shock Therapy
SINGAPORE SINGAPORE
SIMES Annual Newsletter 2012
FOREIGN WORKER POLICY
Figure 3: Labour Force, 2001, 2006 and 2009 to 2011 (Source: Ministry of Manpower)
In the 2000s’, the government had adopted an economic strategy which allowed a large influx of foreign workers (Figure 3). To a certain extent, this has helped to lower labour costs for firms in their production processes. With wages held down for extended periods, any form of wage shock therapy has to be implemented carefully. This is because the rise in real wage could deter the local firms, particularly the SMEs, from hiring Singaporeans, thus resulting in unemployment within the domestic workforce.
CONCLUSION Although wage shock therapy could have been shown to be successful in countries such as Poland, Chile and Bolivia, the proposal demands careful consideration in its implementation. The negative effects of wage shock therapy such as structural unemployment and higher operating costs for firms which eventually translate into higher prices within the economy cannot be ignored. These disadvantages could well outweigh the advantages of a lower income gap and the hoped-for higher productivity among workers (which might not come eventually).
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Bibliography
REFERENCES & PHOTO SOURCES
SIMES Annual Newsletter 2012
bibliography REFERENCES
PHOTO SOURCES SIMES logo, courtesy of www.simeconomicsociety.org
COVER PAGE
Picture, designed by Beryl Ijang Domino Effect of Portugal, Italy, Greece and Spain http://socioecohistory.wordpress.com/2012/07/20/nigel-farage-if-thishappens-in-europe-frankly-its-meltdown/ Wage Shock in Singapore http://www. transitioning.org/2012/04/21/my-lousypay-check/comment-page-1/
CONTENTS
http://en.wikipedia.org/wiki/European_ sovereign-debt_crisis http://www.bbc.co.uk/news/10162176 http://www.nytimes.com/2011/09/07/ world/europe/07italy.html http://www.ft.com/cms/s/0/12d09b0e24b7-11e1-ac4b-00144feabdc0. html#axzz231l6WYpA
SLAUGHTERING OF PORTUGAL, ITALY, GREECE AND SPAIN: EFFICIENCY AND EFFECTIVENESS OF AUSTERITY
Riot picture 1, http://marketday.nbcnews. com/_news/2012/06/10/12151561massive-bailout-for-spain-may-only-bestopgapRiot picture 2, http://www.huffingtonpost. com/2012/07/24/spain-economic-crisisexplained_n_1699659.html Spain Protest, http://en.wikipedia.org/ wiki/2011–2012_Spanish_protests
http://www.ft.com/intl/cms/s/0/ d66e3552-f5dd-11e0-bcc2-00144feab49a. html#axzz231l6WYpA
Euro crisis picture, http://www.bloomberg. com/news/2012-04-10/rajoy-says-spainfuture-at-stake-as-debt-crisis-persists.html
http://www.reuters.com/article/2012/03/22/us-portugal-strike-idUSBRE82L0BJ20120322
graphs, http://www.tradingeconomics.com
http://www.nytimes.com/2010/11/28/ world/europe/28dublin.html http://marketday.nbcnews.com/_ news/2012/06/10/12151561-massive-bailout-for-spain-may-only-be-stopgaphttp://www.huffingtonpost. com/2012/07/24/spain-economic-crisisexplained_n_1699659.html http://en.wikipedia.org/wiki/2011–2012_ Spanish_protests http://www.bloomberg.com/news/201204-10/rajoy-says-spain-future-at-stake-asdebt-crisis-persists.html http://epp.eurostat.ec.europa.eu/cache/ ITY_PUBLIC/2-23042012-AP/EN/223042012-AP-EN.PDF
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Bibliography
REFERENCES & PHOTO SOURCES
SIMES Annual Newsletter 2012
bibliography REFERENCES
PHOTO SOURCES
http://blogs.reuters.com/breakingviews/2012/06/12/don%E2%80%99tdrop-the-money-and-run/
Spanish crisis, http://www.financial-news. co.uk/tag/spain/
The Economist June 16th-22nd issue.
President Rajoy, http://www.euronews. com/2012/07/11/spain-rajoy-s-u-turn/
http://online.wsj.com/article/SB1000142 405270230481130457736925328017212 4.html http://www.bbc.co.uk/news/business-18794599 http://www.nytimes.com/2012/07/12/ business/global/daily-euro-zone-watch. html?pagewanted=all http://www.cato.org/pubs/edb/EDB15. pdf?utm_source=Cato+Institute+E mails&utm_campaign=85a418a1deEBD_15&utm_medium=email&mc_ cid=85a418a1de&mc_eid=9259bee961
SPANISH MELTDOWN
http://www.euronews.com/2012/03/13/ spain-handed-new-deficit-target/ http://www.euronews.com/2012/03/30/ austerity-bites-deeper-in-spain/ http://www.hs.fi/english/article/Market+re actions+to+Italian+austerity+measures+fr ustrate+Mario+Monti/1329104536974 http://articles.marketwatch.com/2012-0709/markets/32593574_1_budget-deficitfinance-ministers-deficit-reduction http://www.voxeu.org/article/savingprivate-euro-what-if-spain-falls
http://www.tradingeconomics.com/india/ inflation-cpi
THE INDIAN ECONOMIC MIRACLE- A MEANS TO AN END?
Indian economic slowdown, http://articles. economictimes.indiatimes.com/2012-0221/news/31082850_1_indian-cfos-indianh t t p : / / w w w. b b c . c o. u k / n e w s / b u s i - economy-european-debt-crisis ness-18501201 Economic slowdown, http://www.facenh t t p : / / w w w. b b c . c o. u k / n e w s / b u s i - facts.com/NewsDetails/16975/economicness-18406544 slowdown-fact-but-shed-pessimisim-:-pm. htm http://in.reuters.com/article/2012/04/13/ india-trade-deficit-anand-sharma-oil- Indian government, http://articles.ecoidINDEE83C05O20120413 nomictimes.indiatimes.com/2012-06-04/ news/32031575_1_gdp-growth-centralhttp://www.bbc.co.uk/news/world-asia- statistical-organisation-mining-and-quarindia-18291949 rying h t t p : / / w w w. b b c . c o. u k / n e w s / b u s i ness-18406181 http://timesofindia.indiatimes.com/ business/india-business/Indias-economic-outlook-is-positive-Zinnov/articleshow/14271365.cms LSE Ideas! Special Report ‘India. The Next Superpower?’
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For internal circulation only
SIMES Annual Newsletter 2012
Bibliography
REFERENCES & PHOTO SOURCES
SIMES Annual Newsletter 2012
bibliography REFERENCES
PHOTO SOURCES
http://spectator.org/archives/2011/07/22/ fatal-flaws-of-keynesian-econo/1
Hayek and Keynes, http://www.capitolreportnewmexico.com/?cat=59
http://www.econlib.org/library/Enc/bios/ Keynes.html h t t p : / / w w w. b b c . c o. u k / n e w s / b u s i ness-14366054 http://www.bloomberg.com/news/201110-06/keynes-and-hayek-s-great-debatepart-1-commentary-by-nicholas-wapshott.html http://econstories.tv/ http://www.investopedia.com/terms/k/ keynesianeconomics.asp#axzz24LF8rXp2
DIFFERING OPINIONS ON THE CURRENT STATE OF THE US ECONOMY: HAYEK V KEYNES
http://www.forbes.com/sites/paulroderickgregory/2012/03/18/note-to-krugmangreece-proves-keynesian-economicswrong/ http://www.nytimes.com/2012/03/12/ opinion/krugman-what-greece-means. html?_r=1 h t t p : / / w w w. a l h a m b r a p a r t n e r s . com/2011/11/06/2012-is-another-repassage-of-keynes-versus-hayek/ http://capitalism.columbia.edu/files/ccs/ Keynes%20 Vs.%20Hayek%202011-11-17.pdf http://www.adamsmith.org/research/articles/review-keynes-hayek-the-clash-thatdefined-modern-economics h t t p : / / w w w. b b c . c o. u k / n e w s / b u s i ness-14366054 Debate between modern day followers of Keynes and Hayek.recorded by BBC radio 4 www.ubs.com/2/e/medlib/wmr/pdf/Preise_Loehne_2011_e.pdf http://www.spp.nus.edu.sg/ips/docs/ events/p2012/SP2012_Bkgd%20Pa.pdf
WAGE SHOCK THERAPY
http://www.migrationinformation.org/ feature/display.cfm?ID=887
Wage shock therapy, http://ifonlysingaporeans.blogspot.sg/2012/06/limits-inlinking-productivity-to-wage.html Income disparity, http://theonlinecitizen. com/2012/03/income-disparity-and-itsperilous-inequality/
http://sg.news.yahoo.com/behind-singapore-inc---part-i---the-growing-class-of-working-poor-.html SIMES JULY NEWSLETTER ARTICLE 2012
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SIMES Annual Newsletter 2012
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