Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive. [25m]

Free Trade Agreements (FTAs) are highways that connect Singapore to major economies and markets. With FTAs, Singapore-based exporters stand to enjoy many benefits like tariff concessions, preferential access to certain sectors, and faster entry into markets.

Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive. [25m]

Note: The original essay was edited two-fold - first, to fit into this JC Economics Essay blog post; second, to remove diagrams/graphics. Hence it is entirely in verbal (English) form. 

A Free Trade Agreement (FTA) is a legally-binding agreement to liberalise trade and bring about closer economic integration between member countries. FTAs aim to remove barriers to trade and investment and create a free flow of goods, services, investment, and people. Under a FTA, member countries provide each other with favourable treatment for goods, services, and investment. Such favourable treatments include reduced tariffs, easier access to markets, and opening up of various sectors for investment opportunities. Thus, FTAs help to foster and facilitate the flow of trade and investment between Singapore and its trading partners with the aim of achieving economic growth and development. FTAs bring about both positive and negative impacts on the Singapore economy. However, the government has implemented policies to mitigate these negative impacts and the overall impact of FTAs on the Singapore economy is largely positive.

The Singapore economy is open to the world, in trade and investment. This openness to trade is a necessity because of its small size and lack of natural resources.

Figure 1 illustrates the effect of a tariff on imports. The original import expenditure for country A is shown by area Oaeq0, the price of imports is Oa and the quantity of imports is Oq0. For a country with price-elastic demand for imports, when the tariff is imposed, the price of imports rises to Ob and the quantity of imports fall to Oq1. Import expenditure is represented by area Obfq1. There is a reduction in import expenditure as the fall in quantity demanded of imports is greater than the rise in price of imports. For a country with price-inelastic demand for imports, when the tariff is imposed, the price of imports rises to Oc and the quantity of imports fall to Oq2. Import expenditure is represented by area Ocdq2. There is an increase in import expenditure as the fall in quantity demanded of imports is less than the increase in price of imports.

This illustrates the positive impact of free trade on the Singapore economy and is one of the key reasons why Singapore campaigns actively for the removal of tariffs and the setting up of FTAs. It has a relatively price-inelastic demand for imports since it has no natural resources and has to import both food as well as inputs for production. Imposing tariffs on such goods will have more adverse effects for its economy than gains.

On the export side, domestic producers in Singapore gain from an enlarged export market. Thus, they are able to reap internal economies of scale and earn greater export revenue. In addition, the reduction, or removal, of tariffs results in cheaper exports, which will lead to an increase in export demand and revenue. The increase in net exports increases aggregate demand and in turn increases national income, employment, and short-run growth if the economy is operating below full employment. On the other hand, if the economy is near or at full employment, the boost of net exports might lead to demand-pull inflation.

The other benefit that FTAs bring to the Singapore economy is that it allows countries to specialise in producing goods in which they have a comparative advantage in to a greater extent. Comparative advantage is the idea that relative opportunity costs of production must be taken into account when trading between countries. Consumers benefit from lower-priced goods, as Singapore’s trading partners are able to produce these goods more efficiently due to their comparative advantage. Also, there is both a greater variety of goods available and better quality of products. The removal of tariffs means that domestic producers face greater competition from foreign producers, which will boost the efficiency of domestic production and the quality of products.

Lastly, Singapore benefits from greater foreign direct investment. Foreign Direct Investment (FDI) refers to long-term capital inflows, which typically takes the form of a Multinational Corporation (MNC) investing in an enterprise that is outside the economy of the MNC. The greater inflow of capital will have a positive impact on the Balance of Payment (BOP), creating a surplus in the BOP. Foreign direct investment will also result in an increase in capital accumulation, which increases the productive capacity of the economy and short-run economic growth. In addition, the diffusion of technology from the MNCs to domestic producers will increase the level of productivity and lead to long-run economic growth.

On the other hand, FTAs bring about negative impacts on the Singapore economy. First, structural unemployment arises in industries that are in direct competition with other lower-cost trading partners due to a loss of comparative advantage.  There will be a decline in production levels and employment in some of Singapore’s sectors such as manufacturing. This results in structural unemployment, as these workers are not equipped with the skills required to work in the newly-created sectors. In addition, new technology increases the importance on skills and substitutes for relatively low-skill inputs. Technology replaces low-skilled jobs, exacerbating the problem of unemployment.

Second, FTAs cause member countries to become more vulnerable to external events. FTAs foster closer trade links among member countries, and as a result increases the interdependence of their economies. This means that a recession in one country may quickly spread to other countries, which are its trading partners, an effect known as the “contagion effect”. In the case of Singapore, higher reliance on imports makes the economy more vulnerable to the threat of imported inflation, while reliance on exports to drive economic growth may make Singapore more vulnerable to external shocks. There is also the possibility of an increase in long-term capital outflow due to greater opportunities in member countries.

The above illustrate that FTAs have both positive and negative impacts on the Singapore economy. The government has put in place measures to mitigate the negative impacts and has been largely successful in reducing the problems of demand-pull inflation, structural unemployment and vulnerability to external shocks.

To tackle the threat of demand-pull inflation due to the growth in exports and investment, as well as the threat of imported inflation, the Singapore government has put in place an exchange rate policy of gradually appreciating the Singapore Dollar. A gradual appreciation of the Singapore Dollar keeps the price of imports relatively low, reducing the possibility of imported inflation. A gradual appreciation of the Singapore Dollar also prevents excessive increases in export demand and hence aggregate demand, reducing demand-pull inflation.

To tackle structural unemployment, Singapore has adopted manpower policies to equip workers with the skills required to work in the newly created industries, for instance biotechnology. The government also spearheads Research & Development (R&D) projects to develop new areas of growth and new dynamic comparative advantage, such as the biomedical sector, in the face of the erosion of Singapore’s comparative advantage in an attempt to search for new markets.

The government uses supply side policies to deal with the third problem of vulnerability to external shocks. Singapore’s economic strategy is outward-oriented. Small and Medium Enterprises (SMEs) are encouraged to venture overseas to reduce the dependence of our current account on exports and hence, the Balance of Trade (BOT). With SMEs investing abroad, this will lead to an inflow in the current account in the long run. This helps to reduce the vulnerability of Singapore’s economy to changing global conditions.

There is evidence that the above policies have been successful. The exchange rate policy has been effective in keeping inflation at a consistently low and stable level. The government also managed to develop new high-value added industries such as biomedical and life sciences to replace jobs in the lower-skilled manufacturing sector, in which Singapore is rapidly losing its comparative advantage. The outward orientation policy has also proven to be effective in helping Singapore cope with changes in global conditions. However, it takes time for supply side policies to work. Thus, in the short run the drawbacks of FTAs appear to be large, but in the long run, the positive impact of FTAs outweighs the negative impact when the policies take effect.

In conclusion, the signing of FTAs brings about benefits and detriments. Nevertheless, the long-run benefits tend to outweigh the short-run drawbacks and the Singapore’s government policies to mitigate the negative effects of FTAs have been relatively successful. Singapore is a small economy with a lack of natural resources. It benefits from the removal of tariffs, as its demand for imports is inelastic. Domestic producers benefit from entry into the markets of its trading partners and consumer welfare increases as consumers are able to obtain lower cost goods produced by Singapore’s trading partners.  FTAs also encourage foreign direct investment and technology transfer from MNCs, which contribute towards economic development and growth of Singapore. The main negative impacts of FTAs are demand-pull inflation, structural unemployment and vulnerability to external shocks. These impacts have been mitigated by the exchange rate policy, supply side policy and outward orientation measures put in place by the Singapore government. The Singapore government continues to campaign for the setting up of FTAs as they seek new opportunities in emerging markets such as China, India, Russia, and Latin America.

JC Economics Essays - Tutor's Commentary:  Once again, note that the original was edited two-fold - first, to fit into this JC Economics Essay blogpost; second, to remove diagrams. It is well written and crafted, and was done professionally. Given that this essay was written professionally and not under examination conditions, if an Economics student could write about half the standard of this paper, he would get more than a decent grade. Having said that, the usual questions apply: how can I write an essay better? How can I improve on this paper? 

Discuss if an increase in inflation is more likely to impact the domestic or the external sector of Singapore’s economy. [25]

Discuss if an increase in inflation is more likely to impact the domestic or the external sector of Singapore’s economy. [25]

Inflation is defined as a continuous and sustained increase in the general price level, and can be analysed as cost push or demand pull inflation, or a combination of such effects. Inflation causes problems for both the domestic and external sector of Singapore’s economy. However, it is more likely that the external sector of the economy will be worse hit, since Singapore is small and open. Inflation hurts the domestic sector because of the redistribution of income and lower economic growth and higher unemployment, which may lead to negative social issues. Yet, inflation also hurts the external sector because it hurts Singapore's export competitiveness and worsens the current account. In addition, we can expect a depreciation in the Singapore dollar, which hurts us even more because most if not all of Singapore’s inputs are imported from overseas.

Inflation hurts the domestic sector because of the redistribution of income and the impact on economic activity leading to lower economic growth and higher unemployment. First, the redistribution of income is in favour of variable income earners and not fixed income earners, and therefore many Singaporeans will suffer as they are wage earners. Borrowers will benefit from inflation and lenders will lose from inflation, and this will lower investment lending. Finally, people who hold Singapore government bonds will lose out because their Singapore government bond income cannot buy much due to inflation. In all, inflation hurts fixed income earners who are the bulk of Singapore’s workers, hurts banks and other lenders, and hurts people who own government or corporate bonds. Hence, inflation is damaging domestically due to the redistribution of income.

Secondly, if the inflation in Singapore is due to cost push inflation, unemployment will result, which hampers economic growth.

Insert cost push inflation diagram. Why does the author do this? Why this particular diagram? Think through the process of this essay to yourself. You can also try to draw out the diagram yourself from memory rather than referring to your Economics lecture notes. 

According to the diagram above, increasing costs push the general price level upwards, while reducing employment from the full employment level. This is because consumption falls due to rising costs, and investment falls because of the uncertain market outlook. Singapore might face this problem if, for example, workers producing manufacturing goods for exports are laid off due to rising costs due to increased wage push. Furthermore, Singapore’s export oriented firms might face the need for retrenchments if there is imported inflation, since inputs used locally come from overseas. Thus, Singapore might face unemployment and dampened economic growth if there is cost push inflation, which might be likely as Singapore is a small and open economy that relies on foreign inputs to make goods.

On the flip side, inflation hurts the external sector as well because it hurts export competitiveness and hence worsens the balance of payments. In addition, we can expect the Sing dollar to depreciate, which hurts Singaporeans even more because most of inputs are imported from overseas. First, why would the current account worsen? This is because when there is inflation in Singapore, goods and services become more expensive relative to other countries’ goods and services, decreasing export competitiveness. This causes other countries to demand less of Singapore goods and hence the current account worsens, since it is (X – M), where X is falling. One can also argue that the capital account worsens, since due to worsening economic conditions, capital flight might occur and foreigners might pull capital out of Singapore. Therefore, the balance of payments worsens when inflation occurs.

Secondly, when other countries demand less of Singapore’s goods, this lowers the demand for the Singapore dollar and hence the Singapore dollar depreciates vis-à-vis other currencies. Even though the government uses a managed floating exchange rate system, the lack of demand for the Singapore currency will still lead to depreciation and a rise in the inputs that are imported. When inputs that are imported are more expensive, export competitiveness is once again further worsened in some kind of a spiraling effect and that makes the current account worsen even further. Thus, depreciation due to inflation is not a positive impact.

In conclusion, which hurts the most – the domestic or foreign? To a large extent, the external sector of the Singapore economy will be worse hit, as Singapore is a small and open economy and therefore reliant on imports and exports. The local domestic sector is also hit, but nonetheless the external sector is linked with the domestic sector, and problems with BOP and depreciation will also lead to unemployment and cost push inflation as well as lack of economic growth. Therefore, in the final analysis, the external sector is always worse hit than the domestic sector in Singapore as a general rule, but the two are actually closely and intimately allied, and eventually their impacts are almost always intertwined and interacting.

JC ECONOMICS ESSAYS Economics Tutor's Comments: An excellent and very well-written economics exam paper. This student answered the question well. Note: this Economics essay was written under model examination conditions.