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(b) To what extent is fiscal policy the most effective measure to lower the unemployment rate in Singapore? [15]


Singapore’s unemployment rate could surge to a 20-year high of 5 percent next year. This would be the highest level of unemployment since 1986.
Adapted from The Straits Times, February 2009

(b) To what extent is fiscal policy the most effective measure to lower the unemployment rate in Singapore? [15]

Fiscal policy is the use of government spending and taxes to affect the AD of an economy in order to pursue the macroeconomic goals of governments. In the case of unemployment, expansionary fiscal policy can be used – where the government increases government spending and lowers taxes (both personal income and corporate) in order to boost AD. This essay argues that to a large extent, while fiscal policy has the potential to work in Singapore, it is not the most effective measure to lower the unemployment rate and there are many other measures which are more effective given Singapore’s context.

Fiscal policy

It is clear that on the one hand fiscal policy in theory can reduce cyclical unemployment. With an increase in government spending and lowering of income taxes and corporate taxes, C, I and G increase and thus AD shifts to the right. Due to the multiplier effect, real national income would increase, and as real output increases, there would be a need for more workers. This would overcome cyclical unemployment.

Also fiscal policy, if spent on infrastructure and other areas such as skills upgrading, can lead to solving structural unemployment. For instance, the Singapore government spends a lot of money on the Workforce Development Agency. If the fiscal policy is directed towards increasing the supply side (supply side policy), then the skills gap between workers and those required by industries might be solved and thus structural unemployment might not be a problem. Hence, fiscal policy does have some strengths and could be used as a viable policy.

Limitations of fiscal policy

On the other hand, there are limitations of fiscal policy given Singapore’s context. The multiplier effect is small, given Singapore’s high MPM and MPS (marginal propensity to import and save). Alternatively, it can be said that there are many leakages given Singapore’s context – as it is small and open. Also, a cut in taxes may lead to a small shift in C and I if there is widespread economic pessimism, and a reluctance to spend more money. In addition, there is a time lag effect where it takes a long time to formulate policies to decide on the appropriate tax cuts and which type of government spending to raise.

Other policies might work better

Furthermore, fiscal policy may not be the most effective policy to reduce cyclical unemployment. There are two other policies that might be able to reduce unemployment better in Singapore’s context. The first is exchange rate policy and the second is signing of new FTAs (Free Trade Agreements).

First, given that Singapore is a small and export oriented economy, where the total value of exports and imports comprise more than her GDP, an exchange rate policy could be implemented. In Singapore’s case, due to the classic trilemma, Singapore does not pursue monetary policy but instead pursues an exchange rate policy through the use of a managed float system (dirty floating). Depreciating the Singapore dollar would lead to an increase in (X-M) and thus increase real output and lower unemployment in Singapore by shifting AD to the right to the full employment level. At the same time it should also be noted that there is no perfect policy because cost push inflation could be a result of this exchange rate policy as the higher prices of imported raw materials into Singapore could lead to higher prices. Given that Singapore imports a lot of her raw materials and goods and services, this is a distinct possibility.

Second, by signing more FTAs Singapore has more access to international, foreign markets. This will help Singapore reduce her reliance on major trading partners if those countries experience recession. Thus, if X goes up, then AD will also increase, and thus cyclical unemployment will be lowered as the economy experiences actual growth if the FTAs are successful. On the other hand there are also search costs and increased competition with local producers in Singapore which might not be politically acceptable, and Singapore might also become more susceptible to external shocks to her economy.

Third, by increasing information available to workers, the government can reduce frictional unemployment. This is a simple solution that does not involve fiscal spending or exchange rates or FTAs, and should be used to reduce frictional unemployment.

Conclusions

In conclusion, the dominant cause of unemployment in Singapore is likely to be cyclical unemployment because the economy is dependent heavily on external markets, and therefore while fiscal policy can be used, it is not effective to a large extent, given the small multiplier effect. Given the changing dynamic comparative advantage of Singapore’s economy, it is imperative that policies to lower structural unemployment have to be considered seriously as well. In the final conclusion, both fiscal and other policies have to be used together to reduce the various types of unemployment in Singapore.


JC Economics Essays - Tutor's Commentary: This H2 Economics essay is also very well written, and addresses the question pertinently. The usual questions are: what can I do better, what I can improve on, and what have I learnt from reading this essay? This essay and the previous part were both very professionally written and specially designed and targeted specifically to answer the question. Yes, there can be alternative views, and there should be different approaches - but what is the strength of this approach? What have you learnt from here?

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