Inflation is defined as the sustained increase in the general price level of goods and services in an economy. Inflation in Singapore can be caused both by domestic and external demand-pull and cost-push factors.
Singapore mainly suffers from demand-pull inflation, which may occur when increases in aggregate demand (AD) persistently exceeds that of aggregate supply (AS), causing excess demand when the economy is near or at full employment. Inflation, in this case, is due to the rise in AD, which can come from the rise in C, I, G and (X-M), therefore causing the upward pressure on the general price level (GPL).
In the case of Singapore, the major source of demand-pull inflation would be the rise in income of her trading partners, which lead to the increase in the purchasing power of households. This, in turn, causes greater an increase in the demand for Singapore’s exports. When there is a rise in Singapore net exports, her AD rises, leading to the rise in the general price level, assuming the economy is already at near or full employment. This was evident when countries like the US recovered from the 2008 global financial crisis. As the US is one of Singapore’s largest export market, and when the latter’s national income rises, the demand for Singapore’s export rose. Since the value of Singapore’s exports is more than twice the size of her domestic economy, this will have a significant impact on the AD and hence GPL.
In addition, there might also be an increase in Foreign Direct Investment (FDI) given a higher expected rate of return of investing in Singapore when external demand rises, given that multinational corporations (MNCs) which produce in Singapore tends to be export-oriented. An increase in FDI will lead to a rise in AD, and should the economy have limited sparse capacity, a persistent increase in AD will likely lead to upward pressure on prices on the GPL.
Singapore can also face demand-pull inflation from domestic sources. For example, with the recovery of the Singapore economy after the financial crisis, the purchasing power of household rose. Together with the influx of foreign workers coming into Singapore, this also increased the domestic C and AD, and hence GPL.
Cost-push inflation occurs when prices are forced upwards by the increase in the cost of production not caused by excess in AD. If firms face a rise in unit costs, they will respond partly by raising prices, partly by passing the costs on to the consumer, and partly by cutting back on production. The causes of cost-push inflation are from the supply-side. The rise in costs may originate from wage-push, imported inflation and depreciating exchange rates.
A source of cost-push inflation in Singapore would be the increase in global demand for raw materials or commodities such as food and oil. This increases the unit cost of production as these raw materials are the important factor of production, causing the AS to rise upwards and therefore raising the GPL in Singapore, leading to cost-push inflation. For example in 2012, the average crude oil price was at historically high levels because the OPEC restricted their oil production. This was an important contributing factor to Singapore’s high inflation rate that year since demand for her imports are price inelastic, and with little or no substitutes to the imported raw materials like oil, the GPL in Singapore rises.
Another cause of Singapore’s cost-push inflation would be the government’s efforts to reduce the inflow of foreign workers. Tightening of foreign labour policies has led to the overall labour force rising slower than the demand for labour, thus resulting in a labour shortage. With the rise in wage rate and productivity growth lagging behind, unit cost rises. Hence AS shifts upwards and lead to cost-pull inflation.
In order to help mitigate the effects of inflation in Singapore, the Singapore government has considered the use of the exchange rate, supply side and trade policies.
Exchange rate policy is the main policy tool to mitigate the rise in prices of imported factor imputs leading to cost-push inflation. In this case, the MAS should adopt a slow and gradual appreciation of the Singapore dollar so that the price of imports in domestic currency falls. Imported inflation falls due to in the price of raw materials and intermediate goods. Unit cost of production falls leading to a downwards shift of the AS, leading to a fall in GPL. This is useful in the context of Singapore, which is a country dependant on imported raw materials. Also, by maintaining a strong Singapore dollar, it will be effective in curbing high imported inflation.
If Singapore experiences demand-pull inflation due to the strong demand for her exports, a gradual appreciation of the Singapore dollar may address this type of inflation. A strong Singapore dollar will lead to the fall in demand for Singapore’s exports and thus export revenue will decrease. At the same time, imports will become cheaper in domestic currency, leading to the increase in quantity demanded for imports. Therefore, this will lead AD to fall and reduce demand-pull inflation.
A strong Singapore dollar would reduce the price competitiveness of Singapore’s exports. However, since it also causes the price of imported goods to be cheaper, this may off-set some of the adverse effect of the strong Singapore dollar on the price competitiveness of the exports. Net exports revenue decreases but only by a small extent and hence, exchange rate policy may not be able to curb demand-pull inflation.
The government should also ensure that the appreciation is gradual and domestic cost pressures are contained, or else the erosion of export competitiveness may be severe, and the fall in AD may be large which will result in negative impact on actual growth and employment.
If the cost-push inflation is caused by domestic cost pressures due to the rise in wages, then the Singapore government can implement supply-side policies. The policies should focus to raise productivity of workers and firms so that the growth in productivity id greater than the growth in wage. This would help to lower unit cost of production, AS will shift downwards and this causes a fall in GPL.
Growth in productivity can be achieved through R&D and the use of better technology to create more efficient production processes. One policy that has been used to encouraged this is the Productivity and Innovation credit (PIC) scheme. Low skilled workers are also encouraged to upgrade their skills so that they can be more productive in the workplace. The SkillsFuture programme is another scheme that provides all Singaporeans with the opportunities to acquire grater skills proficiency, knowledge and expertise.
In the last few years, the government has also curbed the influx of foreign workers with the aim of getting firms to switch to utilise more technology in their production and encouraging the retraining of low skilled workers.
These supply side policies not only curb cost-push inflation but also helps to increase the productivity capacity of the economy, and therefore reduce demand-pull inflation in the long run.
Despite the fact that the Singapore government has been actively promoting policies to raise workers’ and firms’ productivity, the growth in productivity in sectors like construction and services are lagging behind, as the scope for increasing productivity in certain sectors may be limited. Also, newly acquired skills can be obsolete quickly due to the rapid advancement of techonolgy.
The reduction in the inflow of foreign workers have caused the shortage of workers, especially in the F&B and manufacturing sectors. With the supply of labour rising slower than the demand, it will result into labour shortage and cause wages to rise. Thus in the short run. These productivity driven policies may also rise with the restructuring of the economy into a more productivity-based one.
The government may choose to sign the Free Trade Agreements (FTAs) with countries that are important sources of imported raw materials and food products. Though these trade partnerships, Singapore is able to diversify its sources of imports. Should there be a disruption in the supply of these raw material or commodities in a particular foreign market, Singapore is able to import them from other countries instead and this helps to minimise imported inflation. AS the fall in price of imported raw materials affect the cost of production of firms, AD curve will shift upwards.
In conclusion, the government has to first diagnose and ascertain the type of inflation, then implement the correct effective policies to address the root cause of the inflation problem. IN times when there is a high level of imported inflation and external demand is strong, a strengthening of the Singapore dollar would be the most appropriate policy since allevation of inflation via this method will not compromise economic growthy that much. In times when there is high cost-push domestic inflation with weak external demand, the government should have to rely more on supply-side policies that address rising domestic costs. Singapore government has to consider the combination of policies in order to alleviate inflationary pressure while keeping in mind the other macroeconomics goals. In the last few years, Singapore’s inflation rate has been caused mainly by domestic reasons, namely due to the slow growth in productivity. Therefore, supply side policies which reduce structural rigidities in the labour market and certain production markets should be the priority of the government.