SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - Will the adoption of a welfare state erode competitiveness of countries in Asia? - China & Germany New Found Marathon Companions? - Is No Wage Cut a Free Lunch? The Fortnight In Brief (13th November to 10th December) US: Looming Fiscal Cliff Still Top of the Priority List Despite Superstorm Sandy, the US unemployment rate fell from 7.9% in October to 7.7% in November. While the unemployment rate is the lowest since December 2008, the drop was mainly due to fewer people looking for work and dropping out of the unemployment count. Whether companies in US are truly ready to hire is left to be seen. In Washington, policy makers are in heated debate over how to balance US debt problem with its progression. With US debt just $154 billion below the $16.394 trillion debt ceiling as of last week, a failure to reach a consensus on the fiscal cliff might push congress to a re-enactment of political brinkmanship in 2011. Asia Pacific ex-Japan: Signs of Recovery The Asian Development Bank expressed its optimism in the Asian region with a 6.6% growth forecast over next year thanks to strong private consumption and investment. However, it also cited weak external demand for export-oriented countries such as Singapore, South Korea, Taiwan and Hong Kong as the Europe and US regions continue to wrestle their own colossal economic problems. Optimistic Purchasing Managers Indices (PMI) suggested a pickup in most Asian economies. With the year-end festive season buying and the approach of Chinese New Year, Chinas official PMI rose from 50.2 in October to 50.6 in November. This possibly indicates that business in the region is picking up despite the drag in the west. EU: Pessimism Expected to Continue Deep into 2013 The European Central Bank has slashed its forecasts for the Eurozone 2013 GDP growth from a range of -0.4% to +1.4% to a range of -0.9% to +0.3%. With the Eurozone officially back in recession in the third quarter, many expect the weak activity to extend deep next year. With inflation forecasts at 1.6% next year, down 0.9% from its 2.5% level in 2012, the ECB has decided to keep rates low. ISSUE 29 10 DECEMBER 2012

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Will the adoption of a welfare state erode competitiveness of countries in Asia?

By Tan Yong Beng, Singapore Management University
Asias concept of social welfare With many Asian countries becoming richer in the last decade, there is a growing emphasis on providing social rights and safety nets1 for the societies marginalized citizens. It is heartening to see that the governments of Asian countries have not neglected the poor people, yet a pertinent question as to how governments are going to afford to foot the bills of welfare policies without affecting competitiveness. The common perception that most people from Asia have about welfare state is that it is an idea derived from the West. It is a concept that will only lower the countrys productivity and is unsustainable in the long run as fertility rates decrease leading to a significantly heavier burden on the working population. Nonetheless, Indonesia, Philippines, China, South Korea have introduced some schemes that show semblance to those in welfare states. Figure 1: Percentage of citizens above 65

Governments in Asia typically view social welfare as a tool that can either legitimize their rule or develop the economy. For those who implement welfare policies to garner support at the poll, funding will be difficult and more so during recession periods. If, on the other hand, the governments focus on using social welfare to boost their economies, it will not only ensure political but also economic stability. In Philippines, PhiHealth, a government owned health insurance has expanded the number of people insured from 62% to 85%. Similarly, China has announced the formulation of a social security system. South Korea has schemes that provide basic pension and insurance for elderly couples with income tax credit2. Indonesias Health Insurance Program Indonesia has announced that it will introduce a health insurance program starting from 2014. The government will pay premiums for people who cannot afford the insurance and this amount totals roughly about Rp 25.68 trillion for 96.4 million of people. There will be higher costs for employers to bear once this program commences as they will be required to pay extra for their employees. The joint

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payment for insurance by workers and employers will no doubt lead to higher costs of doing business in Indonesia, affecting Indonesias competiveness. Japans welfare problem Japan is one country that needs a welfare scheme overhaul. Japan currently not only has the highest progressive tax system3 in the world but also the second highest corporate tax amongst developed nations. Individuals are taxed from 5% to 40% and companies are taxed at 38.01%. Many schemes have been implemented to cater to Japans aging population such as the new Gold plan in 1997. Schemes that only benefit the aged are not sustainable if the population is constantly aging. Japans debt problem is becoming more serious as debt levels are projected to exceed US$13 trillion of debt within the current fiscal year. Perhaps Japan should shift its focus to help women with the household. A way to do this is by subsidizing childcare so that more women in Japan will be able to contribute to the economy by entering the workforce and thus easing the burden of supporting the aged. Hong Kongs economic approach Under the Britishs rule, Hong Kongs government introduced free education, social and health care service. These schemes were later expanded to include the public housing program. The aim of the government was to quell the rioting which was rampant in 1960s and to instill loyalty into immigrants. Social policy in Hong Kong is primarily used to support economic activity. After the Asian Financial Crisis, there was a surge of immigrants from China. Hong Kong introduced a new form of welfare policy known as the Mandatory Provident Fund, a fully funded social security scheme. This scheme is similar to Singapores Central Provident Fund where it is mandatory for both employee and employer to contribute 5% of the employees salary to the fund and will ease the burden on the government. This form of welfare is perhaps the best panacea in ensuring a safety net for the citizen without loading the government with debt making the country competitive at the same time. A possible rationale for social welfare Figure 2: Competitiveness in countries

According to the figure 2, Singapore has managed to remain competitive. This is in spite of its Central Provident Fund (CPF) where employers would need to contribute more for labor. A possible explanation might be that the government can afford to lower tax due to the increased revenue from CPF and hence improving competitiveness. Comparing Asian countries with the western ones, the amount Asian countries spend on welfare is still relatively low. However, this is set to change as Asian families are now forming nuclear families where it will be difficult for family members to provide adequate support in times of need. Hence, it is

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important for Asian countries to develop a welfare policy that can support their aging population without being forced to collect high corporate or individual income tax which will turn away investments and reduce the desire to work.
1 Programs

preventing the poor from falling below a certain level of poverty. Usually in place to ensure that the poor have a way out in difficult times. 2 A tax benefit to a taxpayer in the form of a deduction from the total amount of taxes that has to be paid to the state. 3 A system by which the tax rate increases as the taxable base (income, in the case of individuals) increases

Sources: Bloomberg, NY Times, Reuters, Economist, Jakarta Globe, Bank of Japan, Hong Kongs
Information Services

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China & Germany New Found Marathon Companions?

By Vera Soh, Singapore Management University
Consider a group of people who link themselves up with a strong rope and run a marathon together when one trips, the others falter. When pudgy Uncle Sam who is right in front suddenly falls and sprains his ankle, he sparks off a domino effect because everyone else behind trips over him. China - Next in Line She has been the most promising runner since the start of 2008. Premier Wen Jia Bao and his team have been steadily maneuvering her forward. However, China has been starting to show signs of fatigue. Her Manufacturing Purchasing Managers Index1 (PMI) fell to its lowest in August 2012, hitting 49.2, below the crucial 50.0 threshold that signifies expansion. With the governments emphasis and attempts to grow the services sector, Chinas overall non-manufacturing PMI rose to 56.3 in August, from Julys 55.6. However, as shown in Table 1 below, with new orders and business expectations sliding further, the Chinese economy still faces risks and a shaky outlook. Table 1: Chinas Official Non-Manufacturing Purchasing Managers Index Official Non-Manufacturing Purchasing Managers Index July August Component Sub-indexes Overall New orders New export orders Current orders Stocks of finished goods Intermediate input prices Charge prices Employment Suppliers' delivery time Expectations of business activities Source: Xinhua News 55.6 53.2 49.4 45.3 47.2 49.7 48.7 51.4 52.5 63.9 56.3 52.7 49.6 44.7 47.8 57.6 51.2 51.7 52.6 63.2

Noting that prices charged to consumers have risen by a staggering 2.5 percentage points, the highly anticipated September 1st Value Added Tax (VAT)2 indirect tax reform in Beijing (initially) might be the extra boost China needs. Designed to help small and medium businesses cut tax expenses and save an overall 16.5 billion Yuan each year, most businesses are expected to experience significant cost savings. These savings can be passed on to consumers, stimulating household expenditure. The main aim is to boost domestic consumption in the midst of an unreliable external economic climate. With the unforgiving global economic climate coupled with a fairly moderated goal of 7.5% GDP growth for 2012, Premier Wen Jia Bao would not want to be remembered as a leader who allowed Chinas GDP growth to slip below targets. With less than 7 months in office, it can be said that Premier Wen is racing against time to achieve this goal. Germany Team Leader, Cheer Leader & Cleaner Across the Atlantic, Germany is seen to be the strongest, most influential and largest economy in the Eurozone at present. With most of the Eurozone economies suffering from stunted or negative growth, German Chancellor Angela Merkel is struggling to keep the Euro team together. Orders for German products have been down since April this year, following Chinas slowdown in infrastructure projects.

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For the bulk of 2012, Germany has been sustaining minimal economic growth by relying on its own domestic private consumption and as seen in Graph 1 below, growing exports to China. Figure 1: German Exports (in thousand Euros) to China
7000000 6000000 5000000 4000000 3000000 2000000 1000000 0

Source: CEIC Database With German exports to China dipping recently, it is only logical for Germany to attempt to encourage Chinas economic growth. This can be done with continued project developments that would support demand for German construction machineries. Likewise, a growing middle class in China would fuel consumer demand for high quality German consumer products. As reported in the China Economic Review on 1st September 2012, German carmakers such as Volkswagen and BMW are the largest stakeholders in Chinas automobile industry, taking up about 80% of automobile sales in China. With an expected slide in domestic consumption in the coming quarters due to ongoing Eurozone concerns, Germany needs China to keep demand up. As seen in Graph 2 below, the expected fall in German domestic consumption can be attributed to the increasing unemployment figures in Germany in recent months. Figure 2: Germanys Unemployed (in millions), Seasonally Adjusted
2.92 2.9 2.88

2.86
2.84 2.82 2.8 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12

Source: CEIC Database With growth expected to average near zero or even negative, Merkel will be faced with the dilemma of supporting her ailing Eurozone neighbors while having to placate three-quarters of Germans wanting a Grexit3. This balance she has to strike is not simply a matter of pleasing and pacifying her own

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people anymore - It has turned into a major issue that will determine the course of direction the world economy will take. Joining Forces, Running Together The rest of the world, just like the two protagonists, wants something out of this growing German-Sino relationship. Faced with an unsupportive global climate, Germany and China share parallel concerns and interests. As shown in the next paragraph, these two economically resilient global players understand the power of focus and cooperation. Merkel - Running with a Dash of Hope Instead of her usual annual trip, Merkel has made an exception just before Premier Wen steps down early next year with her second visit to China this year accompanied by high level ministers and a massive entourage of business leaders. The leaders witnessed the signing of more than a dozen bilateral contracts regarding transport, communication, clean energy and healthcare industries. With Chinas biggest firms still in the lower-end of the value chain, these new agreements represent a valuable opportunity for China to leverage on this partnership to enforce a transfer of skills and knowledge to her economy. Yet, it is important to note that German firms are weary of the difficulty of doing business in China in particular due to rampant corruption, overwhelming presence of intellectual property thieves and the lack of transparency. With rising labor costs in China, many German firms have been pulling out of the mainland. Moreover, Chinas endeavor to move up the value chain poses potential conflicts of interest between the two countries economies. During both visits to China, Merkel has sought Premier Wens help in aiding the EU. She hopes that China would be willing to buy European bonds, especially Italian and Spanish. In fact, it is not just the Germans the whole of EU is hopeful. The EUs cry for help from China is magnified by the fact that Merkel brought up the exact same issue on both her visits this year. This visit came concurrently with Merkels confession that she preferred to handle the dispute over Chinas dumping of solar panels herself, showing increasing disillusionment in the European Commissions ability in resolving economic issues. Germany might seem to be better off without other European countries tying her down in the midst of this global crisis. However, with recent developments, chances are that this crisis will pass sooner or later and the EU would still exist and with Germany as a part of it. Yet, acting individualistically and increasingly leaning towards China without sufficient diversity in Asian relations might be a shortsighted approach. Moreover, despite the close friendship between China and Germany, China still has not given a concrete answer regarding the buying of European bonds. Unlike previous visits, Merkel steered clear of human rights, placing strong emphasis on economic issues Chinas chronic area of interest. It points towards a mutual understanding of what both countries deemed as the most critical, expanding their scope and willingness to cooperate despite having a history of clashes in other areas. Premier Wen - Running With the Finishing Line in Mind Having a closer relationship with Germany is a step forward to having an even louder voice in international institutions such as the International Monetary Fund (IMF) and the G20. Germany is able to play the role of door-opener for China, potentially fostering closer ties and increasing Chinese influence over European countries and eventually the US. In fact, building up a warmer relationship with the European Union (EU) could mean an absolute end to the EUs two decade long arms ban on China as well as less demands on Chinas human rights and more open dialogue. Keeping in mind Germany and Japans emergence from WWII, as well as the incredibly vexing SinoJapanese spat over Diaoyu/Senkaku Islands, Chinas showy display of affection to Germany might have been a deliberate act. Moreover, it presents to the rest of the world Chinas blooming relationship with her new found ally.

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1 An

indicator of the manufacturing sectors economic health. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. 2 A form of consumption tax placed on a product whenever value is added at any stage of production and at final sale. 3 Greeces possible departure from the Eurozone. Sources: Xinhua News, CEIC Database, China Economic Review, Channel News Asia, New York Times, Korea Times, Wall Street Journal and Turkish Weekly.

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Is No Wage Cut a Free Lunch?

By Devanshi Kanoi, Singapore Management University
The Euro Crises has left Europeans in an era of austerity1 as governments are trying to eliminate unsustainable budget deficits2 to fight the crises. The measure of fiscal deficit was included in the 78bn International bailout agreement that the government had signed in September 2012. The Bailout Plan Portugal Prime Minister, Pedro Sassos Coelho, embraces the embarrassing budget U-turn to meet the budget targets set out, under the International bailout agreement. The agreement is a controversial plan and involves increasing income taxes and social contributions from workers but keeping wages constant. Figure 1: Portugals proposed bailout agreement
12%

10%
8% 6% 4% 2% 0% 2009 2010 2011 2012 2013 2014
Source: IMF

Target agreed under bailout

Deficit as % of GDP

Figure 1 shows the proposed target deficit as a % of the GDP for Portugal by the International bailout agreement. The program requires Portugal to cut its deficit to 4.5% of GDP in 2013. The expected deficit is 5% for 2012, and was above 9% before the bailout agreement. The contribution of employees salary to social security schemes is expected to rise to 18% from 11%. The government in turn favors companies by reducing their contribution to social security schemes from 23% to 18%. The two faces of Fiscal Devaluation Fiscal Devaluation3 cuts wage costs and tackles the problem of Portugals low international competitiveness - rising unit labor costs had outpaced productivity gains. Labor costs have been falling since 2010, and IMF projects the fall to be approximately 4.5% in 2012. Figure 2 compares Portugals unit labor costs with other European countries. From a companys point of view, this shift is advantageous. Firms will be able to create more jobs and lower production costs. The government believes that reducing unit labor costs can be used to boost exports. This will help Portugal overcome the deficit problem.

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Figure 2: Eurozone Unit Labor Costs

Source: Datastream Critics say that the fiscal devaluation plan in itself was not wrong but the tight cutting down of workers pay package was the reason for discontent. This mechanism may allow companies to hire more workers, increase productivity and raise the competitiveness of products abroad. The government believes that it will fight the expected 16% unemployment rate of 2013. It believes that the tax increase instead of a wage cut would also encourage investments. However, it ignores the fact that an increase in tax reduces the motivation of employees to work. Moreover, business associations have criticized this social security contribution increase as it reduces the spending and purchasing power of individuals. This will in turn reduce domestic demand, causing companies to shut down, worsening economic conditions further. 2012 has been the second year of the three-year austerity program, taking away 24% of the workers income in the form of wage cuts and tax increases. Thus, the increase in taxes has been criticized and has led to protests. Armenio Carlos, leader of Portugals largest union confederation, CGTP, called for a protest against the government taking the peoples earnings in the form of taxes. This will result in the loss of popularity of the government. Tax increase or wage cut? To conclude, we have to ask the question, Is a tax increase better or a wage cut? Looking at the broader picture, we can conclude that a tax increase is essentially a wage cut. A policy of adopting no wage cuts is not a free lunch. Both the wage cut and tax increase would leave the workers with the same disposable income, thereby constraining their purchasing power. However, a tax increase would help the government battle the fiscal deficit. The government will have more control over the money in the economy and could pay back loans, boost spending and investments, helping the economy to regain its power. It could be called a wise move by the government, because cautious investors would be apprehensive to invest under the current economic conditions. They would probably save the money or invest it outside the country. However, with the use of a tax increase, the government can control the flow of money to help Portugal come out of the Euro crises.
1 When

more money is spent than earned. A government policy for deficit cutting by lowering the spending power of the population. It is usually done via the reduction of benefits and public services provided by the government. 2 When more money is spent than earned. 3 It resembles currency devaluation by cutting down labor costs of enterprises in one go. It shifts taxes from employers to consumers. Sources: IMF, Datastream, Worldbank, OECD

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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Ben Lim (Vice President, Publication) ben.lim.2010@smu.edu.sg Singapore Management University Singapore Tan Jia Ming (Publications Director) jiaming.tan.2010@smu.edu.sg Singapore Management University Singapore Vera Soh (Liaison Officer) Vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Seumas Yeo (Editor) Seumas.yeo.2010@smu.edu.sg Singapore Management University Singapore TAN Yong Beng ybtan.2012@economics.smu.edu.sg Singapore Management University Singapore Herman Cheong (Vice President, Operations) Wq.cheong.2011@economics.smu.edu.sg Singapore Management University Singapore Fariha Imran (Marketing Director) Farihaimran.2010@economics.smu.edu.sg Singapore Management University Singapore Randy Lai (Editor) Tw.lai.2010@smu.edu.sg Singapore Management University Singapore Vera Soh Vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Devanshi Kanoi dkanoi.2011@economics.smu.edu.sg Singapore Management University Singapore

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