Singapore’s Productivity Drive: Entering the Second Half

A mid-term report card on Singapore's Productivity Drive and a forecast on the road ahead.

By Vaninder Singh, Southeast Asia Economic, RBS

 

In 2010, Singapore embarked on a 10-year programme to boost its economy’s productivity, with the ultimate aim of reducing income inequality. Its goals were twofold: to grow productivity by 2–3% a year on average between 2010 and 2019, and to raise wages by 33% over the decade. The government hoped to achieve these targets by tightening foreign labour supply and encouraging automation and the retention of higher-skilled workers.
 
Now in its fifth year, the restructuring drive is starting to have a significant impact on the economy’s structure and pace of growth. Wages are beginning to rise in a tight labour market, helping the government to achieve success in its objective of narrowing income inequality.
 
But some of the productivity gains may fall short of their goals, especially in the target sectors of construction and food and beverage (F&B). While foreign labour intake has been significantly tightened since 2010, productivity increases have yet to be seen. Labour productivity has been essentially flat since 2011, the first full year following the start of the plan. It rose slightly in the second half of 2013, but the gains were not broad-based, with productivity in construction and F&B falling even further.
 
This has important consequences. Without the necessary boost from productivity growth, overall trend growth—the economy’s average rate of expansion in the medium-term—is likely to edge down. And if productivity fails to pick up in the longer term, Singapore’s progress towards reducing inequality may be threatened by inflation, which is likely to continue facing upward pressure.
 
 

Changing sectoral landscapes

 
As the transformation process continues, this mid-term report assesses the likely impact of the productivity measures in the second half of the 10-year restructuring drive. We believe that sectors such as construction and manufacturing, which have historically been allowed the highest shares of foreign workers, may be fundamentally altered by the end of the decade.
 
In construction, identified as the biggest underperformer in raising capital intensity, part of the recent rapid decline in productivity has been due to an industry downturn. Firms have yet to reduce their headcount despite this downturn, as is clear from the steep rise in wages as a share of overall output. This is likely due to the difficulty and costs involved with having to bring the workforce—typically comprising a large number of foreign workers—back in a subsequent upturn.
 
 
 
But we expect the construction downturn to last through most of this year and 2015, forcing firms to start implementing cost-cutting measures to preserve margins. As the government tightens the tap on foreign workers, construction firms will have to substitute labour with capital. This will eat into the margins of smaller players, which are likely to be squeezed out, while remaining players will benefit from greater scale. Consequently, we expect productivity gains from construction to start rising in the coming quarters.
 
Productivity is also forecast to improve over time in the manufacturing industry, on the back of a similar attrition among companies unwilling or unable to step up automation. The number of Singapore residents employed as plant/machine operators and assemblers has been consistently falling since 2005, as more of them prefer to work in white-collar jobs. This automatically caps the number of employees available to manufacturing firms, given that they have to hire a minimum ratio of local workers relative to foreign ones.
 
The tight labour market is likely to lead manufacturers of certain products to exit Singapore, as they opt to utilise low-cost labour in other parts of the region rather than invest more capital to automate their production in the Republic. This process probably has not started in earnest yet—as suggested by the share of wages in manufacturing output rising 10% in 2013 alone—but is probably imminent. As such, we believe parts of the manufacturing industry, particularly electronics, are likely to become unviable.
 
The firms that decide to remain in Singapore are expected to adopt more automation, leading to greater productivity gains. But the overall size of the manufacturing sector will likely shrink further from its current one-fifth share of the economy and Singapore’s manufacturing exports will continue to decline.
 
 

Limited room for productivity gains

 
The situation is different for Singapore’s services industries, which, by their very nature, have lower levels of productivity.
 
In the F&B sector, it is difficult for the mostly small owner-run businesses to embark on significant automation. Building more shared services and improving processes, as the government has been urging, would help somewhat. However, this would largely apply to food courts, where a number of these measures are already in place.
 
 
As such, productivity in F&B has continued to decline at a rapid pace, falling a cumulative 3.3% over the past two years. A wholesale improvement is unlikely. Instead, operating costs are likely to increase in the short term and businesses will end up passing these costs on to consumers.
 
Finance and business services, which together make up more than a quarter of the economy, should continue to do well, although their ability to achieve higher productivity gains will be similarly limited. Within these sectors, business activities that have high manpower costs and requirements are likely to be adversely affected. We believe more software development work could be moved offshore given that the IT sector is marked by high manpower costs and requirements.
 
Overall, we are not entirely convinced that the higher productivity growth rates are attainable in the time frame the government has set for itself. Productivity may indeed rebound once the transformation process is complete, but in the interim, the drag from unwinding industries is likely to prove stronger.
 
This has important implications for Singapore’s trend growth rate. Without productivity gains in excess of 2% per year on average, achieving the government’s targeted 3–5% economic growth rate in the medium term may be difficult.
 
 

Reducing inequality

 
On the bright side, the productivity drive has put upward pressure on wages, contributing to the government’s agenda of reducing inequality. Income inequality as measured by the Gini coefficient declined from 2012 to 2013, especially when government transfers are taken into account.
 
Higher pay is also raising the participation rate, especially among women and seniors. The female participation rate in the workforce has risen to nearly 50% in 2013 from 45% in 2010, while the participation rate for workers aged 60 and above has climbed to about 38% in 2013 from 30% in 2010.
 
Consequently, the government is starting to see some success with its objective of reducing inequality, the main reason behind the productivity drive.
 
However, it is important to ensure that higher inflation, which tends to disproportionately affect lower-income households, does not wipe out these gains. If productivity growth continues to disappoint and labour policies remain tight, unit labour costs—the inflation-adjusted cost of labour to produce one unit of output—should continue to edge up as wages rise faster, resulting in rising inflation.
 
 
The Monetary Authority of Singapore (MAS) estimates the country’s non-accelerating inflation rate of unemployment (NAIRU) to be 2.5%, which means any unemployment rate below this level will result in inflation. In fact, the estimate for NAIRU may have to be adjusted higher still to 2.7%, as the share of non-residents in the overall population falls. Unemployment in the non-resident workforce has historically been lower, thus inflationary pressures may turn out to be even stronger as upward pressure on wages continues.
 
Monetary policy is likely to be the primary tool to curb inflation, in our view. Therefore, we expect to see the broad settings for the Singapore dollar exchange rate to remain unchanged.
 
In summary, we expect success on the higher wage and lower inequality dimensions to continue, but the government’s productivity target will be elusive for this decade. Overall, we believe the combination of lower growth and higher inflation witnessed over the past two years will persist until the transformation is largely complete.
 
 
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