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This article is adapted from a report by Morgan Stanley, Asia Pacific Economics: Singapore Lessons for China, Written by: Daniel Lian, Southeast Asia Economist (Daniel.Lian@morganstanley.com)
We recently challenged the conventional wisdom that the rapid rise of China and the ascent of India's economy have squeezed and will continue to pressure the living space of Southeast Asia (see "Living Space", April 28, 2005). Here, we focus on the efforts by Singapore to preserve its manufacturing base, and the potential lessons and economic implications for China's economic development.
Southeast Asia has preserved its global manufacturing share despite the challenges presented by China. After 11 years (1994-2004) of rapid inroads into manufacturing by China, Southeast Asia's share of global manufactured exports is at 4.4%, while its manufactured final output has grown by 61.4% from US$133.8 billion to US$216 billion (Exhibit 1).
As China aggressively started its second-wave ascent via a manufacturing and trade development model in 1994, most people expected the high-wage Asia Tiger economies - Singapore, Hong Kong, Taiwan and S. Korea - to quickly hollow out their manufacturing sectors and surrender their manufactured export shares to China. The economic rationale was simple - indigenous S. Korean and Taiwanese and MNC industrialists based in Hong Kong and Singapore would not be able to resist the competitive manufacturing outsourcing platform offered by China, and would move manufacturing aggressively to China.
However, things did not quite turn out that way. China has hollowed out manufacturing, but mainly in the developed economies. For the Asian Tigers, S. Korea has increased its domestic manufacturing production substantially and raised its global share of manufactured exports, while Singapore, Taiwan and Hong Kong have experienced varying degrees of manufactured export share losses (of the three, Singapore's losses were the smallest). However, these losses do not accurately portray the countries' domestic manufacturing strengths or weaknesses. In the case of Singapore, the fact that its ASEAN neighbors are handling more of their own cross-border trade may have contributed to its moderate loss of global share.
Singapore's manufacturing output has risen sharply (US$17.1 billion to US$29 billion), while Taiwan's has stagnated (US$70.8 billion to US$78 billion) and Hong Kong's has fallen substantially (US$11.4 billion to US$6.3 billion). Why hasn't China's competitive manufacturing platform forced Singapore manufacturing into a retreat?
Over the past decade, China's economic competitiveness appears to have crowded out Singapore's economy; Singapore's growth averaged 6.2% versus China's 9.9% over 1994 to 2004. However, Southeast Asia's relatively sub-par growth in recent years is due mainly to its sluggish rate of domestic investment rather than its export growth (Singapore's domestic investment-to-GDP ratio fell from 33.1% in 1994 to a mere 18.3% in 2004). We believe this is due to the country's lacklustre domestic capital formation rate. By comparision, China has enjoyed strong growth in both domestic investment and exports over that period.
However, Singapore's manufacturing sector has remained resilient, expanding its share of GDP from 24.3% to 27.1% - implying no Sino hollowing of manufacturing. The value of Singapore's manufactured output has increased by more than US$1,800 per capita to US$6,800, significantly more than the increase in the value of manufactured output per capita in China (from US$187 to US$584). Singapore's nominal manufactured output per capita is almost 12 times that of China. Most significantly, Singapore continues to leverage its excellent logistics and transport infrastructure, as well as its ability to maintain multinationals' presence in the island republic. As a result, its nominal manufactured exports have grown from 113.7% of GDP in 1994 to 141.8% in 2004. Singapore's nominal manufactured export per capita is a massive 87 times that of China.
Singapore's efforts to attract and retain foreign direct investment (specifically, manufacturing FDI) go hand-in-hand with its relative manufacturing success. The ASEAN 5 attracted US$121.3 billion of net FDI from 1994-2004, with Singapore accounting for 42%; its net FDI per capita is 37 times that of China. Singapore also accumulated some US$45.5 billion of net investment commitments in manufacturing over 1996-2004, almost 10% of what China captured over the same period.
The vast FDI and foreign manufacturing investment over the past decade is rendering the Singapore economy more capital-intensive, helping it to upgrade its manufacturing to higher value-add and diversify away from its dependence on electronics. In contrast, China is focused on volume expansion in low value-added mass-manufactured products.
Economic commentators and analysts have questioned the Singapore government's desire to preserve a large manufacturing sector. We have become less skeptical over time. Here's why:
- Manufacturing is so important to Singapore's employment and output that it simply cannot afford to let it hollow away. By the mid-1990s manufacturing had grown to around 25% of Singapore?s GDP. Global service trade is less than a quarter of global merchandise trade, so relying on growth in services as the sole economic strategy would be risky. In our view, Hong Kong and Taiwan are now paying the economic price of not preserving enough manufacturing.
- Singapore has been criticized for using 'excessive' government incentives to lure 'low employment creation' and 'low multiplier' chemicals investment to balance its dependence on electronics manufacturing. As long as the broad macro policy environment is competitive and incentive-based, it does not create resource misallocation, in our view. If Singapore has a deep pocket, it should leverage it, in our opinion. In terms of chemical investment, while the chemicals sector does not generate as many jobs as the electronics sector, it diversifies Singapore's manufacturing sector as it is not tied to the same volatile electronic capex cycle. The cushion has been valuable to Singapore's economy.
- While aggressively preserving its manufacturing, Singapore has not rejected the strategy of economic integration and ownership. It has been one of the leading players in terms of fostering economic ties with China. This should allow Singapore to ride China's economic growth, while Singapore's maintenance of a sizeable manufacturing sector should ensure that its own economy remains well diversified.
Bottom line: We think China could learn a few lessons from the Singapore experience, as outlined below:
(1) Lower costs in China do not necessarily lead to manufacturing hollowing out in its higher-wage neighbors. The assumption that higher-wage economies 'will' as a matter of course hollow out their manufacturing in favor of China must be challenged, given the experience of Southeast Asia and Singapore.
(2) Currency manipulation is not a pre-requisite for manufacturing competitiveness. Singapore does not rely on a cheap Singapore dollar policy to maintain its manufacturing or economic competitiveness. The steady currency has provided a macro policy anchor as Singapore policy-makers have made real domestic economic adjustments and restructured to stay competitive.
(3) Keeping the currency cheap could impede the move up the value-chain. The present Chinese policy on currency risks creating a misallocation of resources, in our view.
(4) Excess unproductive asset formation is likely to lead to painful macro adjustment. All domestic investment booms must come to an end and countries that indulge in asset bubbles and investment excesses will eventually have to pay the price. In its frantic growth phase from mid-1980 to mid-1990, Southeast Asia used the twin growth engines of exports and domestic investment. Post the Asia Crisis Singapore resisted the urge to use these levers to reignite growth. Such prudence appears to be paying off. While China's appetite for domestic investment is well justified by the need to raise its capital stock, the massive asset formation involves a great deal of unproductive investment and is enlarging systemic risk in the Chinese financial system, in our view. At some point, we expect a painful macro adjustment to set in as occurred in Southeast Asia during the 1997-98 Crisis. |
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