The Multiplier Effect in Singapore

Effect of a rise in Investment

Investment is an important determinant of current national income and
economic growth of the country. Hence, governments all over the world
adopt measures to attract investments to their shores. Investment is a
component of aggregate demand (AD), the other components being
consumption, government expenditure and net exports. With any given
aggregate supply, the level of aggregate demand determines the equilibrium
level of income. Hence an increase in Investment leads to an increase in
aggregate demand and national income.

Effect on long-run aggregate supply and AD

The growth of the Singapore economy can be in the form of actual (shortterm) or potential (long term) growth. Actual growth refers to the actual
increase in output or national income while potential growth refers to the
increase in the productive capacity of the country.

The multiplier effect

When the level of investment changes, for example, increases, there will be
a multiple rise in the national income through the multiplier effect. This
affects actual growth and can be explained as follows.
Assume that the Singapore economy is below full employment and there is
an increase of investment of $100 million in the form of the building of a new
plant. Let us also assume that Singapore is a 4-sector economy and the
marginal propensity to consume (MPC) is 0.5. This means that the marginal
propensity to withdraw (MPW) which comprises of the marginal propensity to
save (MPS), the marginal propensity to tax (MPT) and the marginal
propensity to import (MPM) is 0.5, which is calculated by the formula, (MPW
=1-MPC). With the increase of $100 million in the building of a new plant, the
initial (first round) effect of this increase goes to the factor owners in the
form of wages, rent, profits and interest. In the second round, the factor
owners use, say, $50 million of this income to spend on consumption while
the other $50 million leaks out of the circular flow in the form of savings,
imports and taxes. In this way, the national income increases by $50 million.
This process goes on until the additional spending is zero. The final total
national income generated thus increases by $200 million, which is twice the
initial investment. It should be noted that the increase in the national income
is dependent on the size of the multiplier and this in turn is dependent on the
marginal propensity of leakages in the Singapore economy.

In Singapore, the MPM is rather high due to its lack of natural resources and
its high dependence on imports. The MPS is also high due to the compulsory
savings of workers (CPF) and the thriftiness of Singaporeans. Thus the
multiplier tends to be small in the case of Singapore. This means that an
increase in investment does not lead to a significant growth in the national
income.
Moreover, with the multiplier-accelerator interaction coming into play, a
growth in national income can lead to further increases in net investments
and this further leads to increase in the national income. Thus growth in the
national income can multiply rapidly.
However some short-run sacrifices on current consumption may have to be
incurred in order to save for investment purposes. When more resources are
used for capital formation, less is available for producing consumer goods.

Improvement in balance of payment and standard

of living
The external effects of higher investment are that it increases productivity
and leads to higher export competitiveness. When exports increase,
Singapores balance of trade and balance of payment improve. Hence more
foreign reserves can be accumulate by Singapore. With the rise in demand
for Singapore exports, the exchange rate tends to be strengthened, making
imports cheaper to local residents. This allows local consumers to buy their
products at a lower price, which increases consumer welfare and leads to a
higher standard of living.

Job Creation
When national income increases, there is growth. Jobs are also created to
produce the additional output and employment rises. The extent of the
increase in employment, however, depends on the nature of the industry. As
labour cost tends to be high in Singapore, investment tends to be in capitalintensive and industries tend to have high values. This means that while
employment increases such increase may not be large. For example,
investment in a petrochemical complex, which cost Shell Eastern in
Singapore a few billion US dollars, created only about 200 jobs in the first
instance. Sometimes it is also possible for there to be jobless growth. This
occurs when growth does not bring about any increase in jobs mainly due to
restructuring of the economy.

Technological advancement

In addition, when firms invest in research and development, it leads to

technological advancement, which provides firms with better methods of
production, hence increasing productivity. This leads to further increase in
potential output.
However, it should be noted that an increase in investment will only lead to
growth in Singapore if the economy is below full employment. IF the
economy is at full employment, such investment will only lead to demandpull inflation if the economy is operating at near/full employment level of
resources.
Investment is only one component of aggregate demand. Hence, while it
may be an important driver of growth in the Singapore economy, other
factors are also important. Consumption expenditure is another significantly
component of AD in Singapore, contributing to about 50% to the total
aggregate demand. Some of the other factors that influence the growth of
consumption expenditure in Singapore are the interest rate and the
expectation of an increase in future income level. While increases in
government expenditure does not contribute significantly in making
Singapore a conducive place to attract investment. In addition, Singapore is
a small and open economy and change to the level of net export is also
another important driver for the Singapore economy.

Effectiveness
The effects of an increase in investment depends on the state of the
economy. Higher investments may be desirable if the economy is currently at
less-than-full employment. Higher investments lead to a fall in
unemployment, with minimal impacts on prices. If the economy is at full
employment, higher investment only results in higher prices, with no change
in real output.
The extent of income increase depends on the size of the multiplier. In the
case of Singapore, due to its high marginal propensity to imports (as it has
limited resources of its own) and to save (Singaporeans are thrifty and all
have to abide by the compulsory savings scheme called CPF), its multiplier
size is small. Hence the impact of an increase in investment on income is
limited. However, given the impact that investment has on the long-term
growth of the economy, an increase in investment does help to expand the
productive capacity in the long run and bring down prices, if there is any.
Given the volatile nature of investment, it is important for the government to
monitor the level of investment in the economy and to carry out policies to
stimulate it so as to provide employment opportunities and maintain a
healthy growth of the economy. Investment is an important driver of growth

in Singapore. It has also created many jobs for its people and, with
globalisation, the challenge for Singapore is to continue to find new niche
areas that will continue to attract investment. Aside from focusing only on
investment, other sources of growth are also important, especially growth in
private consumption and exports. Both demand and supply-side measures
can be used to further stimulate the economy and increase income. In the
event when there is difficulty in stimulating investment, the government may
have to take the lead to increase government spending to boost the
economy and provide more employment opportunities.

Suggested Policies
Monetary policy
The government can increase monetary supply by decreasing the interest
rate, which lowers the cost of borrowing and the effect would be a rise in
Investments. However, the effectiveness of such a measure depends on the
interest elasticity of consumer expenditure and Investment. Investment
maybe affected more by non-interest factors such as the expected rate of
returns, which is in turn affects by the level of income, government policies,
development of infrastructure, availability of a suitable labour force, and the
ability of tis monetary authority to vary or control money supply (not the
case for Singapore). Hence Singapore does not employ such policies to boost
its economy, as it is a price-taker in the international economy and adheres
to the interest rates set by banks instead of trying to alter them.

Fiscal Policy
Fiscal policy involves the increase in government expenditure and/or the
lowering of taxation to increase investment. Increased government spending
on research and development funds to foreign firms that deal with highvalued investment can help to stimulate private investment. An increase in
government expenditure increases national income through the multiplier
process. High-value investments like those in the biotechnology,
pharmaceutical and chemical industries, are likely to have a spin-off effect
on other industries like transportation, logistics, tax, food and entertainment,
which then leads to even more investments. Reducing tax or providing tax
holidays to firms also reduces corporate tax rates. A fall in corporate tax rate
increases the profitability of firms and hence may encourage firms to
reinvest their undistributed profits. This measure reduces the governments
revenue in the short run but may increase in the long run if it is successful in
attracting more investments. More taxes will be collected in the long run with
these new investments and these can probably over losses in tax revenues
collected in the short run. Increased government spending coupled with a fall

in tax rate may lead to a greater budget deficit and increase the national
debt, which may have an undesirable effect on the economy. However, the
deficit may not be a concern if past reserves can be used to meet the
shortfall of the deficit.

Supply-side Policies
Expanding potential industries
Singapore has always been keen to initiate, explore and expand potential
industries. The Singapore government can consider exploring and taking the
lead by building up new potential industries like education and tourism. The
Economic Development Board (EDB) can help to promote industries like
education and tourism. The EDB can help to promote Singapore as a regional
hub for education, financial and international conventions to attract new
investments to Singapore. Since Singapore aims to become an education hub
in the region, she needs to provide a good infrastructure and legal
framework so that entrepreneurs and existing firms are encouraged to put in
their investments so seek for higher returns. Another example is the
integrated resorts. By initiating the project, entertainment firms from all over
the world are attracted to bid for a part in this project. A huge investment
involving billions of dollars on the integrated resorts would eventually help to
sustain the long-run economic growth of Singapore. Singapore has to take
certain calculated risks to initiate such projects and be prepared. However,
given the huge potential of such new industries, it is worthwhile for
Singapore to take such risks

Provide and prepare a skilful workforce in

anticipation of new industries
If Singapore wants to explore a new market, it has to prepare its workforce to
acquire the necessary skills. The approval of building an integrated resort in
2010 has already spurred higher institutions to offer more related courses,
such as hospitality and tourism, in anticipation of upcoming jobs in these
sectors. Likewise, in order for the biotechnology sector to be successful, the
government has to attract relevant talent from all over the world to
Singapore.

Initiate investment overseas

The Singapore government is also taking the lead to bring along local firms
to invest in other countries, such as in Suzhou Industrial Park in China. This
can come in the form of joint venture. For example, OCBC bank has set up
branches in China, DBS in Hong Kong and SingTel in India. The government

has also provided aid in the set-up of local firms like Old Chang Kee and
BreadTalk to break into overseas market. Instead of targeting the local
market, firms can tap into the potential bigger market of other countries.
Singapore has to continually establish good relationships with other countries
in order to promote trade. The government and firms may have to take
calculate risks for their overseas investments and joint ventures with their
overseas counterparts.

Conclusion
The Singapore government has to be quick in responding to any new
changes in the world environment, identify new areas of growth and
implement appropriate policies in order to keep its investments going.
Despite challenges faced with the small multiplier of Singapore, investments
are still considered the most vital factor in the long-run economic growth of
the country. Hence knowing that Singapores multiplier is small, the
government has to monitor the economy carefully to ensure that injections
into the Singapore economy has to be large in order to have a significant
impact on Singapores national income.