Journal of Policy Modeling 29 (2007) 505522

Facing the challenge of rising China: Singapores responses

Yunhua Liu
Division of Economics, School of Humanities and Social Sciences, Nanyang Technological University, Nanyang Avenue S3-B2C-109, Singapore 639798 Received 1 March 2006; received in revised form 1 April 2006; accepted 1 January 2007 Available online 2 April 2007

Abstract Singapore economy stumbled after the outbreak of 1997 Asian nancial crisis. Competition is largely from globalization and the rising of Chinese economy, which hit the region in two-fold by taking away much of the share of export market and FDI. Recent development however shows a good signal for Singapores exports to Chinas market. This paper examines the trade and investment relationship between Singapore and China, and reviews the policies that Singapore had taken to cope with the changing world. The strategy of moving toward a knowledge-based economy becomes Singapores must choice. However, the smooth engagement in the transition with developed economy and the dynamic Chinese economy could be a challenge to Singapore. 2007 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
JEL classication: O53; O19 Keywords: Singapore policy; Rising of China; Challenge

1. Introduction 1.1. The background of Singapore economy The outbreak of Asian nancial crisis in 1997 was critical for Singapore economy. Since then, the development road became stumble and the future was getting unclear (see Table 2).

Tel.: +65 67904949; fax: +65 67917180. E-mail address: ayuliu@ntu.edu.sg.

0161-8938/$ see front matter 2007 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved. doi:10.1016/j.jpolmod.2007.01.004

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Table 1 National accounts, million Singapore dollars, calendar year, at current market prices Item 1 2 3 4 5 6 Manufacturing Construction Trade Transport and communications Finance and business servicesa Public administration and othersb 1985 8,467.3 4,149.4 5,189.0 5,192.3 8,916.9 7,489.3 38,923.5 % 21.8 10.7 13.3 13.3 22.9 19.2 2004 48,960.5 7,671.7 25,249.5 19,525.4 42,454.8 29,867.9 180,554.4 % 27.1 4.2 14.0 10.8 23.5 16.5

GDP by industrial originc

Source: Asian Development Bank (ADB)key indicators 2005 (http://www.adb.org/statistics). a Covers nancial and business services. b Covers other services industries, hotels and restaurants and owner-occupied dwellings. c Reects reclassication using SSIC 2000.

Before the crisis, however, the city-state documented a long-term high growth rate since its independence in 1965. With a population size of 4.35 million people and land area of 700 km2 , Singapore has no natural resources except human capital and the geographically strategic location as a world shipping center. The outward looking policies of Singapore had virtually made a good use of the two main endowments and successfully turned the country into a world shipping and trading center and industrialized with foreign investment initially in labor intensive and export-oriented industries in 1970s and 1980s. In 2005, Singapores trade volume reached S$715.7 billion, 3.7 times of its gross domestic production, and Singapores port serves as the worlds largest trans-shipment hub. The stock of foreign direct investment as at 2003 is S$244.3 billion. Starting from late 1980s, Singapore began upgrading its industries toward capital intensive, high-tech and high value-added economy. Meanwhile, the economic structure has been shaped into a healthily diversied one with relative balance in manufacturing, services, construction, trade, transport and communications (see Table 1). Among them, manufacturing and nancial and business services become increasingly important in the economy. The economic success of Singapore of being one of the worlds advanced and wealthy nations received worldwide recognition. Strong and efcient government, rigorous legal system, well-developed infrastructure, high-quality labor force and well-organized society made Singapore a very competitive country in the current world. With a highly ranked per capita national income of US$ 26,800 in 2005, however, Singapore economy has reached the stage of a namely matured economy. High labor cost and high land cost become two major disadvantages which are gradually eroding the countrys competitiveness in world export market and in attraction to foreign direct investment (FDI). The competition was initially in a harmlessly narrow area among four Newly Industrialized Economies (NIEs),1 and later from neighboring countries like Malaysia, Thailand, Philippines and Indonesia. In fact, the accelerated globalization and regional integration are all pushing forces for Singapore to upgrade its production level to less labor-intensive industries.

The four newly industrialized economies in Asia, Hong Kong, Taiwan, Korea and Singapore.

Y. Liu / Journal of Policy Modeling 29 (2007) 505522 Table 2 Key indicators of Singapore economy 19942005 Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 GDP growth rate (%) 11.6 8.1 7.8 8.3 1.4 7.2 10.0 2.3 4.0 2.9 8.7 6.4 Unemployment ratea (%) 1.7 1.8 1.7 1.4 2.5 2.8 2.7 2.7 3.6 4.0 3.4 3.2 Per capita GDP (S$) 31,556 33,886 35,555 37,520 35,161 35,440 39,784 37,130 37,976 38,599 42,852 44,666

507

Exchange rate (S$ per US$)a 1.5274 1.4174 1.4101 1.4848 1.6736 1.6949 1.7239 1.7917 1.7906 1.7422 1.6903 1.6646

Source: http://www.singstat.gov.sg/keystats. a Annual average.

1.2. Recently appeared problems The occurrence of 1997s Asian nancial crisis seriously hit the region, caused unstable currencies and signicant withdrawal of FDI. Although weathered the crisis smoothly,2 Singapore was put into a deep uncertainty for its future. Worldwide economic recession in 2000, September 11 attack in the US in 2001, outbreak of SARS in 2003 and the recent bird u all form a shock to the small-sized economy. The ever-worried fragility of a world market dependent small economy becomes reality. For the past 8 years since 1998, Singapore suffered the pain of drastic uctuations in employment, stock prices and property wealth and is now still haunted by the unclear future (see Table 2 and Fig. 1). 1.3. Challenges and opportunities with the rise of China Accompanying the stumble road for Singapore economy since late 1990s is the emerging Chinese economy. Though Chinas no depreciation policy during the crisis helped the region out of the downturn trend eventually, but some also believe that the devaluation of Chinese Yuan in 1994 and then fast expanded Chinas exports in labor-intensive products were one of the important factors to the crisis occurrence. And the consequently well-developed Chinese economy brought an unpresedented shock not only to the region of Southeast Asia and but also to the rest of the world. The immediate challenge from Chinas rising is the competition in world export market for labor-intensive products and in attraction of international FDI. Before Chinas emergence, Southeast Asian countries enjoyed a good inow of FDI from developed countries and easy access to the markets of developed economies. With Chinas joining competition, both previously enjoyed
2 At the height of the Asian Crisis in January 1998, Singapore dollar depreciated by only 1.1% on a real effective exchange rate basis, compared to 54.8% for Indonesia, 36.2% for Malaysia, 35.7% for Korea, 34.2% for Thailand and 292.9% for the Philippines. The Singapore economy was also not as volatile as in the other countries in ination, employment and stock market (Lim, 2002).

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Fig. 1. Singapore property price index (4Q 1998 = 100).

benets shrunk. On the other hand, however, the opportunity appeared is Chinas large market. The negative and positive effects from Chinas rising are already fully experienced by Singapore. Singapores exports to US market slowed down since 1996, accompanied by the fast market share increase of Chinas exports in US market (Table 4), the FDI inow decreased from US$ 13.5 billion in 1997 to US$ 5.53 billion in 2003, while FDI inow to China increased rapidly throughout the past two decades, in 2003, and annual inow reached US$ 53.5 billion (see Table 6). In summary, a paragraph from a recent report by the Economic Review Committee in Singapore may give us a brief description of the current status of Singapore economy.3 The Singapore economy has been undergoing two very signicant changes in that it is graduating from being an investment-driven economy to an innovation-driven economy, and it is also transiting from an era of growth continuity to an era of growth discontinuity. With full awareness of the vulnerability of small states, Singapore government had done a lot in shaping their economy to avoid the risks by heavy reliance on and active participation in regional and international organizations (Low, 2002). Very unfortunately, it is still not enough given the ever-changing world environment. How should Singapore face the new challenges? What will be the new prosperous road? To survive and to maintain growth, new niches must be developed and new strategies must be assembled. There are no sure answers for these questions, but it can only be left for future exploring. The purpose of this paper is to examine in detail (1) how the rising China inuences Singapores economy in different aspects, (2) what are the responses of Singapore to these changes, and (3) how well these responses might work. Section 2 examines the challenges and opportunities to Singapore in facing rising China. In this section, we will examine the competition in world export market and in FDI market, also examined is the economic complementarity of the two economies in trade and investment. Section 3 reviews policies that Singapore adopted in facing the challenge

3 An Economic Review Committee of 85 professionals was formed in 2002 in the Institute of Policy Studies (Singapore) to review the economic strategy for Singapore, the report Restructuring Singapore economy, published by Times Academic Press, 2002.

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of rising China and evaluates the possible consequences of the effectiveness of these policies. Section 4 concludes the paper. 2. Challenges and opportunities to Singapore facing the rising China 2.1. Competition in world export market The success of Chinas economic reform generated tremendous economic power as a huge trade nation and magnetic eld for international investment capital. The abundant labor and land have turned China into a world production factory for labor-intensive products. Chinas WTO entry in 2001 further ensured the world market access for its exports in the coming time. Within just 10 years, Chinas exports increased from US$ 120 billion in 1994 to US$ 762 billion in 2005, ranked second largest exporting country in the world, after Germany. Given the steady slow growth of world market demand for labor-intensive goods in the past 10 years, fast expansion of Chinas exports will inevitably take certain market shares away from traditional labor-intensive products exporting countries. The NIEs are the immediate affected ones, among them, Singapore is the most likely affected because a large proportion of Chinas exports production is relocated from Taiwan and Hong Kong, which produce the similar goods as Singapore does. Table 3 shows that since 1997 nancial crisis, Singapores exports experienced drastic ups and downs while Chinas exports grew often at a high rate of more than 20%. Table 4 indicates that within US market, Singapore maintained a steady market share of around 2.5% in early 1990s, but declined all the way since 1997, while Chinas market share in US increased persistently. Although there could be many reasons for the change in Singapores exports, by just looking at the data, we can prove that the competition from China is the most important factor. To further check the extent of impact and time period of Chinas competition in specic type of industry, a simple market share regression model is used as follows, MSs = a + bMSc + u
Table 3 Singapore and Chinas world total exports in billions of US dollars Singapore Exports in billions of US$ 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 96 118 125 125 110 115 138 122 125 144 184 232 Growth of export (%) 31 23 6 0 12 4 20 12 3 15 28 13 China Exports in billions of US$ 121 149 151 183 184 195 249 266 326 438 593 762 Growth of export (%) 33 23 2 21 1 6 28 7 22 35 35 28

(1)

Source: Asian Development Bank (ADB)key indicators 2005 (http://www.adb.org/statistics).

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Table 4 US imports from Singapore and China in billions US dollars World total of US 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 424.4 459.5 492.9 517.0 508.4 553.9 603.4 689.2 770.9 822.0 899.0 944.4 1059.4 1259.3 Singapore s export to US 7.3 9.5 10.7 11.7 11.9 13.6 15.1 17.6 21.2 23.2 23.1 22.0 22.6 23.6 Singapores export share in US market (%) 1.72 2.07 2.17 2.26 2.34 2.46 2.50 2.55 2.75 2.82 2.57 2.33 2.13 1.87 Chinas export to US 3.1 3.5 4.7 5.8 6.8 9.6 18.4 22.5 26.0 28.9 35.4 41.2 47.4 62.3 Chinas export share in US market (%) 0.73 0.76 0.95 1.12 1.34 1.73 3.05 3.26 3.37 3.52 3.94 4.36 4.47 4.95

Source: World Trade Analyzer (WTA) CD-ROM, 2001 and International Monetary Fund, International Financial Statistics, 2001.

where MSs is Singapores total market shares in the US for a particular type of products, MSc is the Chinas market share in the US for the same type of products. The assumption is that the sign of parameter b should be negative if competition happened between Singapore and China for that particular type of product. If a positive sign appears for parameter b, the assumption of competition of China and Singapore should not hold in that product. Statistically, the method should also overcome the possible problems of heteroscedasticity when different products are pooled into one group. Another assumption is that the sum of the market shares of the two countries maintains a stable trend. The data covers one-digit and two-digit SITC goods and the time periods are 19871992 (Chew & Liu, 1998) and 19872000 (Liu & Luo, 2004). The results are presented in Table 5. It is so much clear that in the period 19871992, no competition was seriously appearing except in the group of manufactured good of SITC 8189. However, after
Table 5 Competition between Singapore and China in US exports market (19871992, 19872000) Products 19871992 N Primary goods (SITC 0, 1, 2, 3, 4) Manufactures (SITC 5, 6, 7, 8, 9) Food and beverages (SITC 112) Crude materials (SITC 2143) Chemical and related products (SITC 5159) Basic manufactures (SITC 6169) Machines and transport (SITC 7179) Manufactured (SITC 8189) 30 30 66 80 52 54 54 46 b 0.06 (1.62) 0.05 (1.00) 0.05 (3.46) 0.03 (1.62) 0.12 (0.68) 0.01 (0.69) 1.91 (5.46) 0.03 (2.49) 19872000 N 70 70 168 224 126 126 126 112 b 0.15 (3.45) 0.08 (2.06) 0.17 (4.35) 0.06 (2.17) 0.09 (1.30) 0.02 (3.42) 0.37 (1.86) 0.03 (4.16)

Note: (1) N represents the number of observations; numbers in parentheses following the estimators are t-values. (2) Details of the SITC can be found in United Nations, Commodity Trade Statistics. Data source: World Trade Analyzer CD-ROM, through the period 19872000.

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extension to the period 19872000, the big category of basic manufactures (SITC 6160) turned to be signicantly negative and the bigger group of one digit regression (SITC 15) also turned to be signicantly negative. Overall, we can conclude that the export competition in US market between Singapore and China was getting severe starting from the early mid-1990s. The results are not surprising and are consistent with our common believe that Singapore has a relatively advanced production level among the four NIEs, but as time passed, China caught up very quickly in the basic and mid range of industrial products. It means that in the coming years, Singapore will face further pressure from China, given Chinas fast learning ability. 2.2. Competition in attracting FDI No doubt, the diversion of FDI from Southeast Asia to China is an obvious fact. The main ow of FDI to Asia has changed the direction in recent years that more than 70% of the FDI is now owing into China instead to Southeast Asia as before. Table 6 shows the FDI diversion pattern for Singapore and China over the past two decades. Historically, Singapore relies on FDI heavily for its economic expansion and for its industry level upgrading. Even the economy size is small, the FDI inow to Singapore only fell behind China signicantly after 1991. Less capital inow and own capital outow could mean less economic growth and less jobs, but some argued that the competition could appear any time and the jobs might not be kept if one countrys economic environment is not competitive enough. FDI diversions need to be viewed in different perspectives (Chen & Ku, 2003). 2.3. Increasing importance of Chinas market to Singapore It is interesting to see that in 2003 and 2004 Singapores exports rebounded with a sharp increase of 15 and 28%, respectively, compared to the 3% increase in 2002 (Table 3). The destination change of Singapores exports for the past 10 years is shown in Table 7, from which we can observe clearly that the quickest expanded market for Singapore is China. In 2004, Singapores exports to China increased by 51.5%. In 2004, the trade volume between the two countries reached
Table 6 FDI inows of China and Singapore (US$ million) Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 China 57 265 430 636 1258 1659 1875 2314 3194 3393 3487 4366 Singapore 1236 1660 1602 1134 1302 1047 1710 2836 3655 2887 5575 4887 Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 China 11,156 27,515 33,787 35,849 40,180 44,237 43,751 40,319 40,772 46,846 52,700 53,500 Singapore 2,204 4,686 8,550 11,503 9,303 13,533 7,594 13,245 12,464 10,949 7,655 5,528

Source: (1) World Trade Analyzer (WTA) CD-ROM, 2001 and International Monetary Fund, International Financial Statistics, 2001. (2) Data after 2000 are from http://www.singstat.gov.sg/keystats/economy.html and http://www.uschina.org/statistics/fdi cumulative.html.

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Table 7 Direction of Singapores exports and imports (US$ billion) Country 1. Malaysia 2. US 3. Hong Kong 4. Japan 5. P.R. China 6. Thailand 7. Korea 8. Germany 9. The Netherlands 10. Australia Total exports 1. Malaysia 2. US 3. Japan 4. P.R. China 5. Thailand 6. Korea 7. Germany 8. Saudi Arabia 9. Hong Kong 10. The Philippines Total imports 1995 22.7 21.6 10.1 9.2 2.8 6.8 3.2 4.0 3.1 2.6 118.2 19.3 18.7 26.3 4.0 6.4 5.4 4.3 3.8 4.1 1.1 124.4 1996 22.5 23.1 10.2 10.2 3.3 7.0 4.7 3.8 2.8 2.8 125.1 19.7 21.5 23.8 4.4 7.1 4.8 4.7 4.9 4.2 1.3 131.3 1997 21.8 23.1 12.0 8.8 4.0 5.7 3.6 3.6 3.0 2.9 125.3 19.9 22.3 23.2 5.6 6.8 4.1 45 5.3 3.9 1.9 132.5 1998 16.7 21.8 9.2 7.2 4.0 4.2 2.5 3.3 3.7 3.1 109.8 15.6 18.7 17.0 4.8 4.8 3.0 3.4 3.2 2.8 2.3 101.6 1999 18.9 22.0 8.8 8.5 3.9 5.0 3.5 3.2 3.8 3.1 114.7 17.2 19.0 18.5 5.6 5.2 4.1 3.6 3.2 3.1 2.9 111.0 2000 25.0 23.8 10.8 10.4 5.3 5.8 4.9 4.2 4.0 3.2 137.9 22.8 20.2 23.1 7.1 5.8 4.8 4.2 4.3 3.5 3.3 134.6 2001 21.1 18.7 10.8 9.3 5.3 5.3 4.6 4.2 4.0 3.1 121.7 20.0 19.1 16.0 7.1 5.1 3.8 3.8 4.2 2.7 2.5 116.0 2002 21.8 19.1 11.4 8.9 6.8 5.7 5.2 4.0 4.3 3.3 125.0 21.2 16.6 14.5 8.8 5.4 4.3 3.9 3.8 2.8 2.5 116.4 2003 22.7 20.5 14.4 9.6 10.1 6.1 6.0 4.4 4.6 4.6 144.1 21.5 18.0 15.3 11.0 5.5 4.9 4.8 3.9 3.0 2.8 127.9 2004 27.2 23.2 17.6 11.5 15.3 7.7 7.3 6.2 5.4 6.6 179.4 24.9 20.7 19.0 16.2 6.7 6.9 5.6 5.0 3.6 4.2 162.9

Source: Asian Development Bank (ADB)key indicators 2005 (http://www.adb.org/statistics) May 2006.

US$ 31.5 billion, increased by 48.6%, accounted 9.2% of Singapores total trade, while in 1995, it was only 2.8%. In 2004, China-replaced Hong Kong became Singapores fourth largest trading partner after Malaysia, US and Japan. The year of 2004 also marked that the sum of trade volume of Singapore with China and Hong Kong over passed Malaysia, making Singapores rst largest market, and this change only happened within less than 10 years. Imports of Singapore from China show another facet of its trade relationship with China, the increasing complementarity. More often than not, Singapore recorded a trade decit with China in the past 10 years. Chinas diversied resources, products and technology became Singapores important supplier in consumption goods and in production parts (Chew & Liu, 1998). 2.4. The composition of Singapores exports to China The composition of Singapores major merchandise exports to China from 1990 to 2000 indicates that machinery and transport equipment have taken over minerals fuels, lubricants and related materials (petroleum, petroleum products) as the top exports (see Table 8). As can be seen in the table, electrical machinery, apparatus and appliance have accounted for about a quarter of Singapores exports to China in 2000, a tremendous increase compared to 1990. This may seem surprising as Singapore rms are investing in China and China is gaining importance as an attractive production base for electronics products. However, from the data, China is also demanding electronics components from Singapore. According to an article by the Ministry of Trade and Industry (Loy, 2001) (MTI Singapore), China imports a large part of the electronic components

Y. Liu / Journal of Policy Modeling 29 (2007) 505522 Table 8 Singapores major merchandise exports to China (1990 and 2000) SITC categories Export share (% of total exports to China) 1990 7Machinery and transport equipment 77Electrical machinery, apparatus and appliance 75Ofce machines and automatic data processing 3Mineral fuels, lubricants and related materials 33Petroleum, petroleum products and related materials 5Chemicals and related products, n.e.s. 58Articial resins, plastic materials and cellulose esters 8Miscellaneous manufactured articles 6Manufactured goods classied chiey Source: World Trade Analyzer CD-ROM and authors computation. 16.0 1.8 1.3 39.4 39.0 15.0 9.5 3.3 4.9 2000 57.8 25.6 19.5 14.0 13.2 14.5 7.7 6.1 4.5

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that it uses, thus Singapores exporters can benet from the growth of electronic components industries in China. The article pointed out that China imported a total of US$ 14 billion worth of semiconductors in 2000, and only exported US$ 3 billion worth of semiconductors. Even though Singapores exports of end products are dwindling, Singapore can play the role of a supplier of sophisticated, highly specialized electronic components to rms involved in other electronics production in the region, especially in China. The rise of the electronics industry can also benet Singapores domestic exports of chemical products for used in electronics manufacture. 2.5. The potentials of Chinas WTO entry and future FTA to exports of Singapore Facing the emerging Chinese economy, one major concern of the Asian countries was that the rising China could become a threat to other countries politically and economically. Recent development in the relationship between China and Asian countries, however, shows a very different trend. The strong demand for investment and consumption in the fast growing Chinese economy is appearing as a leading force to turn the economies of neighboring countries from stagnation or downturn to a rising trend. The fast increase of exports of Japan, Malaysia, and Singapore to China in recent years all shows the signal. The world largest market is functioning. With Chinas WTO entry and the on going progress of FTA between China and ASEAN countries, the impact of Chinas tariff reduction and trade restriction removal on trade and investment could be substantial to the related countries. To examine the effect of the policy and institutional change of China on specic industries in Singapore economy, a model of Singapores exports related to exchange rate, Chinas tariff reduction and time trend is estimated using the SITC data for the period of 19872000. EX = a0 + a1 ER + a2 TR + a3 YEAR + u (2)

where EX = Singapores exports to China (US$), ER = exchange rate between Chinese Yuan and Singapore dollar, Chinese Yuan/S$, TR = Chinas import tariff rate, average tariff rate in a specic industry (%). Tariff and exchange rate are two of the many factors that inuence trade. This model allows us to analyze the effect of changes in the two variables on trade. According to economic theory, both tariff and exchange rate share an inverse relationship with trade value. Therefore, the sign of parameter of both tariff and exchange rate should be negative. Another variable added to our model

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Table 9 Tariff effects for different products in China market from Singapore (19872000) Products Primary goods (SITC 0, 1, 2, 3, 4) Food and beverages (SITC 0012) Crude materials (SITC 2143) Manufactures (SITC 5, 6, 7, 8, 9) Chemical and related products (SITC 5159) Basic manufactures (SITC 6169) Machines and transport (SITC 7179) Miscellaneous manufactured (SITC 8189) N* 168 72 96 210 54 54 54 48 a2 732.63 (1.88) 392.32 (2.26) 2537.54 (2.49) 602.82 (1.56) 60.31 (0.15) 153.08 (2.30) 636.27 (2.33) 168.58 (2.54)

Note: N is the number of observations; due to the conversion from Harmonized System to SITC code and the difference in general tariff rates, the number of observation is not following the pattern that within each year there are ve observations (for SITC 0, 1, 2, 3, 4). Estimators are tariffs coefcients; numbers in the parentheses below the estimators are t-values.

is the year variable. This variable helps to account for changes in trade value that is attributed to economic factors other than tariff and exchange rate. Within the primary sector, there are ve individual industries. Hence, four dummy variables are introduced into the model. Dummy variables help to capture effects that are due to changes in any industries within the primary sector. Three dummy variables are also introduced to the manufacturing sector model for the same reason. The results are presented in Table 9. The results show that Singapore is beneting substantially in all manufactures with a rate from US$ 153,080 to 636,270 for each site two-digit item for 1% tariff reduction in China, and the current average tariff of China is 11.3%. By the end of fth year of Chinas WTO entry, the average tariff rate of China should fall to 9%, while once the China-ASEAN FTA is established in 2010, the tariff will be removed completely. The biggest effect is for the large item of crude materials, which is Singapores rened oil exports. If the tariff is eventually removed completely, the total stimulation to Singapores exports will certainly experience a big impact. 2.6. Singapore investment in China To develop the second wing of economic growth was one of the few strategies of Singapore since late 1980s and early 1990s. China became one of the major destinations of Singapores investment due to its abundant labor and land and the huge market potential. As at end of 2003, China is still Singapores top investment destination, with total effective direct investment reaching US$ 24.4 billion,4 being a major investor in China after Hong Kong, Taiwan, US and Japan. Singapores investment in China mostly went into manufacturing and real estate (Tables 10 and 11). More specically, according to China Development Gateway, major areas of Singapores investment include machinery manufacture, industrial and agricultural production and food processing, rubber production, textile, electronic, steel, real estate, etc. Trade and FDI have traditionally been seen as alternative means of transferring goods and services across countries. Outow of capital is often viewed as a negative factor to home economy. Recent literature, however, points out that these two activities could be interlinked either ways as substitutes or complements (Helpman, 1984). Some imperial works also tried to integrate FDI into the trade relationship. Chinas case shows that imports are positively linked to FDI inows,
4

Lianhe Zaobao, News, March 2, 2004.

Y. Liu / Journal of Policy Modeling 29 (2007) 505522 Table 10 Singapores total direct investment in China (19971998) Year Total direct investment (S$ million) 10,477 11,593 Distribution by activity within China (%) Manufacturing 60 61 Commerce 5.5 7 Financial 3 3 Real estate 21 20

515

Business services 1 1

1997 1998

Source: Department of Statistics (http://www.singaporeabroad.org.sg/). Table 11 Areas of Singapore investments in China (in 1998) No. of afliates set up and type of industry in China Manufacturing Construction Commerce Transport Financial Real estate Business services Others Total 651 19 147 56 33 139 48 59 1152 Direct equity investment and type of industry in China (S$000) 5,764,526 250,668 478,157 391,742 369,409 13,735,396 66,146 201,742 8,895,929 Total direct investment and type of industry in China (S$000) 7,042,881 262,656 786,062 463,767 380,476 2,264,764 76,220 316,515 11,593,341

Source: Department of Statistics (http://www.singaporeabroad.org.sg/). Table 12 Effect of FDI on Singapores exports (US$10,000) to China (19902002) Variable Constant (xed effect model) FDI (US$10,000, annual ow) Exchange rate (S$/rmb) Chinas average tariff rate (%) China GDP growth rate (%) Coefcient 10.165 0.374 0.569 0.497 0.279 T-statistics 2.868 1.033 2.109 1.602

R2 adjusted = 0.977; DW statistics = 1.533; N = 60 (ASEAN-5 sample used); log linear model used.

and further enhanced exports (Liu, Wang, & Wei, 2001). For the case of Singapores investment in China, we conducted an estimation by adding Singapores FDI in the export model used above, using the data of 19902002 within an ASEAN-5 sample. A signicantly positive relationship is found between Singapores FDI and exports to China (Table 12). Furthermore, the estimation included Chinas GDP growth rate in the model to replace the time trend variable. 3. The responses of Singapore facing rising China To resolve the hardship since 1997, Singapore had initiated a series of policy change which are not only responses to the challenges from China, but also overall strategies coping with the increasing competition from the accelerated globalization. Among all the competition that Singapore faces, disappearing of the countrys traditional competitive advantage is the essential one.

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That is, the labor and land cost is reaching the level of developed economies, while the production technology is not the same as in the developed economies. Once the multinational companies relocate their headquarters and production factories to China, the weakness of indigenous enterprises emerge. Upgrading the level of industries and to nd and to create new advantages become the unavoidable task, as Mr Goh Chok Tong, previous Prime Minister of Singapore, indicated Singapore has to remake their economy.5 For the long-term strategy, Singapore is investing in research and development in new industries like biochemical industry and life sciences to create new comparative advantages, and reforming the education system to encourage innovative thinking and talents to t the demand of knowledge economy. For the short term, business policies are changed to improve the investment environment by cutting corporation taxes and labor wages to keep Singapore as a regional base for company headquarters and factories. Efforts are also spent to expand international markets for Singapores exports by forging new trade pacts and to enhance regional cooperations in investment and production to overcome the size constraint. In the following section, we will review in detail the policies that Singapore has adopted. 3.1. International policies 3.1.1. Setup Free Trade Agreements to maximize all potentials in export opportunity As a small open economy being so dependent on trade, enhancing trade relationship with major trade partners has been an important economic policy in the past and will remain the same in the future. In order to ensure that external sources of growth are not limited due to structural impediments, Singapore has actively pursued the bilateral trade liberalization. Without agriculture and with a relatively advanced manufacturing sector, Singapore has a much less complicated position in negotiation of the FTA with other countries. The initial effort was in forming the regional free trade area (FTA), the agreement of ASEAN FTA (AFTA) in 1993. Substantial movement in forging bilateral FTAs started after the Asian crisis. Since 2001, Singapore had successfully completed the negotiation and concluded the FTA agreements with US (USSFTA, 2004), Japan (JSEPA, 2002), Australia (SAFTA, 2003), New Zealand (ANZSCEP, 2001) and European Free Trade Association (ESFTA, 2003). The coming ones with Canada, Jordan, India, Korea, Mexico, Pacic Three (Singapore, Chile, New Zealand), Sri Lanka and the ASEAN-China as a member are either in negotiation or in progress. AFTA had been a long effort of ASEAN countries for regional integration. Started in 1993 and targeted to remove all trade restriction within 10 years, as of 2003, tariffs have been reduced to an average level of 2.3%, with the highest 5% in Lao and zero in Singapore. As Singapores largest trade partner, Malaysia reduced the tariff from 3.4% in 1998 to 1.97% in 2003.6 Among the FTAs that Singapore engaged in, USSingapore FTA (USSFTA) is of special meaning to Singapore, since US is the largest market in developed countries and it is also Singapores second largest trade partner and largest foreign direct investor, while Singapore is the second largest Asian investor in US after Japan. After 2 years of negotiation, USSFTA passed by US congress on 31 July 2003 and entered effective on 1 January 2004. One estimation says that the agreement can save S$200300 million for Singapore. Under USSFTA, US will eliminate 92% of current tariffs on Singapore goods entering the US within the rst 4 years and all the rest within 10

5 6

BBC News, August 18, 2002. Source: ASEAN Secretariat.

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years. For example, previously 44% electronic and IT products are dutiable and the tariff remove applies to 39% of these products. The formal name of the agreement between Singapore and Japan is New-Age Economic Partnership (JSEPA). The agreement came into force on 30 November 2002. The signicance of this agreement is that Japan is Singapores fourth largest trade partner, and third largest foreign direct investor after US and The Netherlands. The tariff saving for Singapore under JSEPA is estimated to be S$330 within 5 years (Oo, 2004). Singapores FTA negotiation with China is scheduled once the FTA of ASEAN-China nished the rst stage arrangement. Singapore will go rst to setup the FTA with China ahead of the ASEAN group. As planned by ASEAN and China, the formation of ASEAN-China FTA will be completed by the end of 2010, 4 years from now. If Singapore is to nish the process ahead of 2010, it means that the process will be completed within 23 years. As we analyzed above, Chinas tariff reduction, GDP growth, FDI from Singapore all have a positive effect to Singapores exports. The current high tariff rate, steady GDP growth and FDI inow of China look set to provide a bright export expansion for Singapore in the coming time. With multiple FTAs and coming ones with the large economies and broad areas, Singapore is assuring and maximizing the potential in the world export market and is diversifying its market risks to avoid the sudden shock due to one area or one industry uctuation. The 15 and 26% strong rebound of exports in 2003 and in 2004, respectively, could be a good signal of the functioning of the FTAs. 3.2. Establish regional cooperations to overcome the constraint of being small in size Enhancing the economic integration with the region is another effort that Singapore has put to overcome the constraint of small in size. The Framework Agreement on the ASEAN Investment Area (AIA) signed in 1996 aims to enhance the regional cooperation in investment. The ASEAN Industrial Cooperation (AICO) scheme aims to promote cooperation in large production projects. ASEAN Frame-work Agreement on Services, eASEAN, and ASEAN Integration System of Preference are a few more mechanisms to enhance the cooperation and integration in ASEAN region (Yusof, 2003). In addition to the exploitation of the benet of complementarity among ASEAN members and possibly a larger scale production through these cooperation mechanisms, generating a better regional investment environment and attracting FDI is another goal of these integrations. However, instability in Indonesia and Philippines, as well as the slow recovering economy in the region, made this goal bleak. As developing countries, the regional cooperation among ASEAN members is much less signicant than the extent of their reliance on the investment and markets of developed countries. Regional cooperation to Singapore is, however, very important in other aspects, since Singapore is highly reliant on the region for water and food supply. 3.3. Internal policy changes 3.3.1. Restructure industries to increase competitiveness Singapore economy is characterized by strong state control and foreign investment. State and foreign entrepreneurship has been the driving force in the economy. The local private sector in comparison has been relatively weak, particularly in industry (relative to commerce and services). Large scale of government-linked companies (GLCs) and many statutory boards monopolized

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major social resources in infrastructure, nancial services, telecommunications, health services, education, port shipping services, housing, and so on, private sector has little space to develop. With the declining returns of GLCs investment, bold reforms have been carried out in privatizing many of the state-controlled business. Singapore is unlikely to succeed if enterprising activities continue to be stied by government policies and the macroeconomic environment. A lot of progress has been made by Singapore government in deregulating telecoms, power and nancial services, and in all areas market forces are encouraged, laissez faire wherever is possible. The Port of Singapore Authority was privatized a few years ago. The recent change was downsizing the largest statutory board, the Housing Development Board (HDB), two-thirds of the HDB function were privatized. 3.3.2. Increase investment in new industries to foster comparative advantages As a long-term goal toward a knowledge-based economy, Singapore has been actively fostering intellectual capital and advanced infrastructure to build strong industries with competitive levels of innovation and technology. To facilitate the new knowledge-based economy, the government is making further improvements in infrastructure. Terminal 3 at Singapores Changi Airport will be completed in the year 2006, which will increase the capacity of the airport to 60 million passengers a year. Singapore will be the rst country in the world to be connected by a single broadband network. Singapore ONEs collaboration with US-based @Home Network will expand its services beyond the domestic market. The National Science and Technology Plan 2000 aims to spend more than S$4 billion over 5 years to strengthen indigenous technological capabilities to support private R&D work. The Singapore government is spending S$2 billion on information technology for education. In 2002, there was a ratio of one computer for every two students. The government is also channeling resources to areas like biotechnology which is a future knowledge growth industry. 3.3.3. International talent policy Attracting professional talents from international market is a long existing policy in Singapore. The change in this aspect is that a new EntrePass scheme is introduced in 2003 to attract foreign entrepreneurs. The scheme is designed to allow global value-creating entrepreneurs and innovators to come to Singapore to start their business ventures. Unlike the current employment pass criteria, the EntrePass scheme does not rely solely on educational qualications and salary as criteria. In the spirit of promoting enterprise and innovation, Ministry of Manpower will also take into account recommendations and support by the relevant economic agency when issuing the EntrePass. 3.3.4. Reforming the education system adjusting to a knowledge-based economy In recent years, the government has initiated changes in education system intended to facilitate Singapores transformation into a knowledge-based economy and to meet challenges posed by globalization and new competition from China and India. Changes include revisions to school and technical education curricula, the introduction of information technology training in all public schools, and changes to tertiary education. For example, the universities, while still based on the British model, have adopted more aspects of their US counterparts.

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The government also has prioritized making Singapore a global education hub, and the Singapore Economic Development Board (EDB) has been tasked with drawing 10 world-class foreign universities to Singapore. To date, it has attracted seven. 3.3.5. Cut business cost to maintain Singapore competitive In cutting business cost, Singapore government has (1) reduced land rent, ofce rent, water and electricity prices; (2) cut labor wages and changed wage structure to exible wage scheme; and (3) cut corporation tax to 20% from 22%. (1) Government-controlled fees had been cut in a sizable percentage, for example, Jurong Group (a large GLC) reduced its rent for factory by 17%; the price of electricity had been adjusted downward of 9.5%; with the new water technology ready to produce, water price should be adjusted downward too. (2) The reduction in labor cost is done in two different phases in Singapore. In 1998, a substantial wage reduction was conducted such that a 58% wage cut was suggested by National Wage Council of Singapore. Further, employers contribution to the central provident fund (CPF) to employees is reduced from 20 to 10%. A total 15% wage cut was realized. With suggested exible wage schemed adopted, year-end bonus was also reduced. With short economy recovery in 1999 and 2000, the employers CPF rate was restored to 16%; however, in 2003, it was reduced to 13% again due to the world economic recession. (3) To retain the existent MNCs and to attract the potential new comers, incentives offered to new comers and corporation tax is cut to 20% in 2004 from 22% in 2003. Table 13 shows that corporation tax has been cut from 1986 high rate of 40% down to todays 20%, and the government also indicated that the corporation tax will be cut further, if necessary. In addition to the low corporation tax, special incentives are also offered to attract small companies, the regional headquarter incentive, which is awarded to smaller companies. The regional headquarter incentive allows companies to enjoy a concessionary tax rate of 15% for up to 3 years. There are currently 60007000 international companies in Singapore, of which about half have
Table 13 Singapores corporation tax rate in various years Year of assessment 1986 and before 1987 to 1989 1990 1991 and 1992 1993 1994 to 1996 1997 to 1998 1999 2000 2001 2002 2003 2004 Source: Department of Statistics (http://www.singaporeabroad.org.sg/). a Tax reduced to qualied rms. b Tax waived to qualied rms. Tax rate (%) 40 33 32 31 30 27 26 26a 26 25.5a 24.5a,b 22b 20

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regional HQ status. Regional HQ is a renement to help smaller companies, it is extended from 3 to 5 years to capture smaller companies from India and China. To woo more rms to set up shops in Singapore, the government has also extended the pioneer incentive from 10 to 15 years. Companies with pioneer status pay 0% tax. The whole biotech, medical, healthcare industry, educationfor example, INSEAD has set up its campus here for the Asia Pacic region. Last year, EDB lured 27 rms with its HQ incentive. Investors are still drawn to Singapores infrastructure, and political and legal system. The cut in the corporate tax rate is a bid to keep business costs down as regional rivals stepped up their challenge to Singapore in the aviation, shipping and manufacturing industries, among others. 3.3.6. Special policies to develop Chinas market To engage with the fast development of Chinese economy, the initial movement of Singapore was to invest. Suzhou industrial part was a huge project invested by Singapore government. However, for Singapore, the project has proven to be a great disappointment. The lessons learnt from the Suzhou experiment were more in terms of how Singapore failed to engage the Chinese to complete the project as originally mooted. The most damaging implication was that Singapore could not deal with Chinese as they initially thought.7 After this experience, Singapore government not only sent government investors to China, but also sent young ofcials to learn in China. To enhance the relationship with targeted provinces, economic and trade councils are set up. 3.4. Impacts of the policy change and implications 3.4.1. Impacts on economic structure Naturally, with a strong government-led economy, the substantial investment and resources channeled by various policies will put Singapore economy on a track toward knowledge-based economy. However, with a fast expansion of exports to Chinas market, the choice of products and organization of production may be affected, since the demand from developed economies could be very much different from the one of China. The dynamic development of Chinese economy in fact is generating various demands. Viewing the shrinking market share in US markets, how Singapore government manages the industrial policy should be considered carefully. 3.4.2. Possible impacts on income distribution and social security system Promoting knowledge economy and attracting international talents will surely result in high wages for professionals, but cutting wage policy are lowering wages for unskilled labor. While wages for internationally mobile professionals are competitive at the international level, a proportion of locals remains to be at the low wage level. Even though the labor-intensive production moved to China, there are always non-movable sectors, like basic services. The deteriorated income disparity and a high unemployment rate may last. Reform in social security system is then required. 3.5. Different views The common controversial viewpoint toward Singapore economy model is about the heavy state intervention. Some argued that the strong state control sties the private sector and
7

See Straits Times and Business Times, June, 10, 11 and 30, 1999; and Far Eastern Economic Review, July 8, 1999.

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destroys the long-term future growth base, and of course suggested drastic change (Lian, 2000). But the record of good performance of Singapore economy in the past and small size in nature does not convince the Singapore government to change some of their belief. Surprisingly, there are few arguments in the major strategies that Singapore should take and little objection in what the government is doing from the society. The fortunate thing is that good performance of Singapore government in the past won the trust of its people, and the choice for future strategy for Singapore is very much straightforward. 4. Concluding remarks To face the challenge of rising China, like other NIEs, Singapore needs to remake their economy. Transiting the economy toward a high-tech and higher value-added knowledge-based economy seems a must choice. In general, as suggested by the Economic Review Committee (ERC), Singapore needs to work on three fundamental related areas to achieve this goal. They are as follows: (1) promote innovation, creativity and entrepreneurship; (2) deregulate and liberalize the economy to allow enterprise to ourish; (3) encourage self-reliance complemented by community support and minimize dependence on the government. To some extent, the above three areas are largely addressed by the current policies that Singapore is adopting. The economic transition by the current strategies in Singapore could face a possible problem of how it will engage the developed economies and the dynamic Chinese economy smoothly. Comprehensive studies on the development of Chinese economy are obviously needed. Another serious problem could be in the internal income distribution and an undesired employment situation, reform in social welfare programme could be called for. A very good growth record appeared again for the past 2 years, 8.7 and 6.4% for 2004 and 2005, respectively. In the long run, however, whether Singapore can succeed toward its goal and back to the track of high rate growth as in 1980s and early 1990s remains a question. Acknowledgements I am grateful to the generous research fund provided by the Korea Institute of International Economic Policy (KIEP) and the anonymous comments. References
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Liu, Y., & Luo, H. (2004). Impact of globalization on international trade between ASEAN-5 and China: Opportunities and challenges. Global Economy Journal, 4(1). Low, F. L. (2002). The limits of a city-state: Or are there? In F. D. da Cunha (Ed.), Singapore in the new millennium: Challenges facing the city-state (p. 9). Institute of Southeast Asian Studies. Loy, C. B. (2001). Declining global market shares of Singapores electronics exports: Is it a concern? Singapore: Ministry of Trade and Industry. Oo, N. N. (2004, January). The Singapore approach to FTAs in a multilateral trading world. Paper presented at the joint departmental and graduate seminar of the National University of Singapore, Singapore. Yusof, Z. A. (2003). Malaysias response to the China challenge. Asian Economic Papers, Spring/Summer.