COVID-19 Shocks to Singapore — Macroeconomic Impact and Stabilisation Policy

Answer

Part (a) [10]

This part explains how poor investor confidence and a reduced foreign-worker quota harm Singapore’s economic growth, price stability and employment.

Poor investor confidence — falling actual growth and demand-deficient unemployment. Weak global demand depresses investor confidence, reducing investment expenditure (I), a component of aggregate demand. Via the reverse multiplier, the initial fall in I produces a larger fall in AD: the initial drop raises firms’ unplanned inventories, prompting them to cut output and employ fewer factors, which lowers household income and hence induced consumption, and so on until a lower equilibrium national income is reached.

Fall in actual growth. A fall in investment shifts aggregate demand left from AD₀ to AD₁; real national output falls from Y₀ to Y₁ along the intermediate range of LRAS.

As AD falls, firms cut output and the derived demand for labour falls, raising demand-deficient unemployment.

Foreign-worker quota — cost-push inflation and falling output. A tighter quota reduces the quantity of labour available. With labour scarcer, its price rises, raising firms’ cost of production; and because labour is a factor of production, the economy’s productive capacity falls. Both effects shift the long-run aggregate supply curve upward and to the left.

Cost-push inflation and falling output. Higher labour costs and reduced productive capacity shift LRAS up and left from LRAS₀ to LRAS₁; the general price level rises from P₀ to P₁ and real national output falls from Y₀ to Y₁.

The general price level rises from P₀ to P₁ — cost-push inflation — while real national output falls, a further fall in actual growth.

Part (b) [15]

To mitigate the fall in actual growth, the cost-push inflation, and the higher demand-deficient unemployment, Singapore can use exchange-rate depreciation, expansionary fiscal policy, or supply-side policy. The stand of this essay is that supply-side policy is the most effective, because it alone addresses the root cause and avoids the retaliation risk that depreciation invites.

Exchange-rate depreciation. Singapore can depreciate the SGD by selling domestic currency in the foreign-exchange market, raising its supply and lowering its value. Cheaper exports and dearer imports raise net exports (X − M), provided the Marshall–Lerner condition holds, shifting AD right and mitigating the fall in actual growth and the rise in demand-deficient unemployment.

In-body evaluation. Depreciation does nothing for the cost-push inflation caused by the quota; if overdone, by raising AD faster than capacity, it can add demand-pull inflation.

Expansionary fiscal policy. Raising government expenditure (G) and transfer payments and cutting tax rates raises households’ disposable income and firms’ post-tax profits, lifting consumption (C) and investment (I); via the multiplier, AD rises, mitigating the output and unemployment effects.

In-body evaluation. Effectiveness depends on the size of the multiplier, which is small in Singapore owing to mandatory saving (CPF) and high import leakage, so a given injection raises AD only modestly. It also depends on the government’s fiscal space.

Supply-side policy. The government can subsidise R&D and worker-retraining schemes. Reskilling raises the quality of labour and R&D raises the quality of capital, both expanding productive capacity; process innovation raises productivity and lowers unit costs. The LRAS curve shifts down and to the right, lowering the price level (easing cost-push inflation) and raising real output (raising actual growth).

In-body evaluation. Supply-side policies require government spending and so may strain the budget, carry an opportunity cost against other goals, and act only in the long run, with effectiveness contingent on firms’ and workers’ take-up.

Judgement. Supply-side policy is the most effective. On root cause: reskilling workers directly offsets the fall in the effective quantity of labour caused by the quota, and a higher-quality workforce can itself restore investor confidence — so the policy attacks both shocks at source, whereas depreciation and fiscal expansion are symptomatic, propping up AD without curing the supply-side damage. On sustainability: as a trade-dependent economy lacking natural resources, Singapore is exposed to retaliation; persistent depreciation invites tariffs or competitive devaluation from trade partners, which would raise imported inflation and cut export revenue — a large share of national income. Supply-side policy carries no such risk. Its weaknesses — cost and time lag — are real but are the price of a durable correction; on balance it is the most appropriate of the three.