MODULE 3

MACROECONOMIC PERFORMANCE

1 INTRODUCTION

The performance of an economy is often measured in terms of economic growth,

unemployment, inflation and the balance of payments. An economy with high
economic growth, low unemployment, low inflation and a balance of payments
equilibrium is generally considered well performing. In contrast, an economy with
low or negative economic growth, high unemployment, high inflation and a persistent
balance of payments disequilibrium is generally considered poor performing. As the
performance of a government is often measured in terms of the performance of the
economy, all governments aim to achieve high economic growth, low unemployment,
low inflation and a balance of payments equilibrium. This chapter provides an
exposition of economic growth, unemployment, inflation and the balance of
payments.

2 ECONOMIC GROWTH

2.1 Sources of Economic Growth

Economic growth refers to an increase in real national output.

The economic growth rate is calculated as the percentage increase in real national
output.

GDP 2021 300M

GDP 2020 280M
GDP 2019 310M

EGR(2021) = 300M-280M/280M x 100

= 6.7%

EGR(2020) = 280M – 310M/310M x 100

= -9.7%
Real National Output (t) – Real National Output (t–1)

Economic Growth Rate (t) = ——————————————————— × 100%

Real National Output (t–1)

It is important to note that the economic growth rate is calculated as the percentage
increase in real national output rather than nominal national output. As the size of the
economy is measured by the amount of goods and services produced, the economy
grows when the amount of goods and services produced increases. As nominal
national output is national output measured at current prices, an increase in nominal
national output may be due to a rise in the prices of goods and services rather than an
increase in the amount of goods and services produced. However, as real national
output is national output measured at base-year prices, an increase in real national

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output can only be due to an increase in the amount of goods and services produced as
base-year prices do not change. Therefore, real national output is a better measure of
economic growth than nominal national output. Developing economies such as China
generally have higher economic growth than developed economies such as the United
States. Singapore has a record of high economic growth. Economists distinguish
between two types of economic growth: actual economic growth and potential
economic growth.

Actual Economic Growth

Actual economic growth is an increase in actual output. This basically means

that the economy actually produces more goods and services. An increase in
aggregate demand will lead to actual economic growth.

AD = C + I + GS + NX

In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1
leads to an increase in actual output (Y) from Y0 to Y1. Aggregate demand may
increase due to an increase in any of its components. Consumption expenditure is
determined by several factors such as consumer sentiment, the wealth of households,
interest rates, expectations of price changes, the availability of credit and the
distribution of income. For example, when households are more optimistic about the
economic outlook, they will expect their income to rise and hence increase
consumption expenditure. Investment expenditure is determined by several factors
such as interest rates, business sentiment, business costs, capital costs, corporate
income tax, technological advancements and the availability of credit. For example, a
fall in interest rates will decrease the costs of borrowing and this will lead to more
profitable planned investments resulting in an increase in investment expenditure.
Government expenditure on goods and services is largely determined by the objective
of the government. For example, the government may increase expenditure on
infrastructure to attract foreign direct investments. Net exports are determined by
several factors such as the exchange rate, domestic inflation relative to foreign
inflation, domestic income and foreign income. For example, an increase in foreign
income will lead to an increase in net exports. X – M

Apart from an increase in aggregate demand, an increase in aggregate supply due

to a fall in the cost of production in the economy independently of demand will also
lead to actual economic growth.

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 In the above diagram, an increase in aggregate supply (AS) from AS0 to AS1 due
to a fall in the cost of production in the economy independently of demand leads to an
increase in actual output (Y) from Y0 to Y1. The cost of production in the economy
may fall independently of demand due to several reasons. For example, firms may
bargain for lower wages when they have greater bargaining power due to a looser
labour market. The prices of imported intermediate goods will fall when there is
deflation in other economies. A rise in the exchange rate will also lead to a fall in the
prices of imported intermediate goods in domestic currency. The cost of production in
the economy will also fall independently of demand due to a decrease in oil prices or
the goods and services tax. An example is the substantial fall in the cost of production
in the economy due to the sharp fall in oil prices from June 2014 to February 2016 as
a result of the boom in the shale oil industry in the United States.

Actual economic growth in Singapore is export-driven. Exports in Singapore are

generally increasing as the world economy is generally expanding and hence the
world income is generally rising. As Singapore is a small economy that is highly
dependent on external demand with the domestic exports accounting for a large
proportion of the aggregate demand, an increase in aggregate demand is mainly due to
an increase in exports. For example, the increase in exports in Singapore in the global
economic recovery in 2010 led to a substantial increase in aggregate demand. Actual
economic growth in Singapore also occurs due to an increase in domestic demand but
to a smaller extent. Domestic demand in Singapore constitutes a smaller proportion of
aggregate demand and hence an increase in domestic demand has a smaller effect on
aggregate demand. Consumption expenditure generally does not increase substantially
due to the high savings rate which is a result of the culture of thrift, the compulsory
savings scheme and the absence of a generous welfare system. Government
expenditure on goods and services generally does not increase substantially due to the
prudent fiscal policy.

Potential Economic Growth 50 B Potential

45 B Actual

Potential economic growth is an increase in the full-employment national output

which is also known as potential output. This basically means that the economy
can potentially produce more goods and services. An increase in aggregate
supply due to an increase in the production capacity in the economy will lead to
potential economic growth and to a lesser extent, actual economic growth.

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The production capacity in the economy may increase due to an increase in the
quantity or the quality of the factors of production in the economy. The quantity of
labour in the economy is determined by several factors such as the retirement age,
government support to working mothers to care for their children, personal income
tax, foreign worker policy and immigration policy. For example, loosening
restrictions on foreign workers will lead to an increase in the size of the labour force
in the economy. The quality of labour in the economy is determined by several factors
such as education and training, foreign worker policy and immigration policy. For
example, education and training will lead to greater human capital which will increase
the skills and knowledge of labour in the economy. The quantity of capital in the
economy is determined by several factors such as interest rates, business sentiment,
business costs, capital costs, corporate income tax and the availability of credit. For
example, an increase in business sentiment will lead to an increase in investment
expenditure resulting in a more rapid increase in the size of the capital stock in the
economy, assuming net investment is initially positive. The quality of capital in the
economy is determined by several factors such as research and development and
government support to firms to adopt better production technologies. For example,
research and development will lead to technological advancement which will increase
the efficiency of capital in the economy. Factors that will lead to an increase in the
production capacity in the economy and hence aggregate supply will be explained in
greater detail in Chapter 12.

Potential economic growth in Singapore is mainly due to an increase in the quantity

and the quality of capital and labour in the economy, largely due to the use of
government measures.

The Singapore government has lowered the corporate income tax from 40 per cent in
1986 to 17 per cent currently to increase expected after-tax returns on planned
investments in order to increase foreign direct investments. It has improved the
infrastructure of the economy to attract more foreign direct investments. For example,
it has built Jurong Island for high-end chemical manufacturing and Biopolis for
pharmaceutical manufacturing. The Singapore government has signed over 20 free
trade agreements to attract more foreign direct investments. Free trade agreements
will be explained in greater detail in Chapter 13. The increase in foreign direct
investments has led to a more rapid increase in the quantity of capital in the economy.

The Singapore government has allowed more foreign workers and immigrants in the
economy. It has attracted more foreigners to migrate to Singapore by increasing after-
tax personal income through lowering the marginal tax rate in the top personal income
tax bracket from 40 per cent in 1986 to 22 per cent currently, with corresponding
reductions in the marginal tax rates in other personal income tax brackets. The
Singapore government has increased the retirement age to allow Singaporeans to
work longer. The increase in foreign workers, immigrants and retirement age has led
to an increase in the quantity of labour in the economy.

The Singapore government engages in research and development directly, by setting

up research institutes, and indirectly, by giving subsidies and tax incentives to firms to
encourage them to engage in research and development. For example, it has set up the
Biomedical Research Council (BMRC) and the Science and Engineering Research
Council (SERC) under the Agency for Science, Technology and Research (A*STAR)

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to engage in research and development. The Singapore government incentivises firms
to adopt better production technologies through subsidies and tax incentives. It has
improved the intellectual property rights regime to attract more foreign research firms
to invest in the economy. These efforts have led to an increase in the efficiency of
capital in the economy.

The Singapore government provides education and training directly, by setting up

educational institutes, and indirectly, by giving subsidies and tax incentives to firms to
encourage them to send their workers for education and training. For example, it has
set up the Institute of Technical Education, polytechnics and Continuing Education
and Training campuses to provide education and training. The Singapore government
has allowed more foreign high-skilled workers and talented immigrants in the
economy. It has attracted more foreign talents to migrate to Singapore by increasing
after-tax personal income through lowering the marginal tax rate in the top personal
income tax bracket from 40 per cent in 1986 to 22 per cent currently, with
corresponding reductions in the marginal tax rates in other personal income tax
brackets. These education and training efforts and the increase in foreign talents have
led to an increase in the skills and knowledge of labour in the economy.

Note: Apart from the aggregate demand-aggregate supply analysis, economic growth
can also be illustrated with the production possibility curve. Actual economic growth
can be shown by a movement from a point inside the production possibility curve to a
point nearer to it. Potential economic growth can be shown by an outward shift in the
production possibility curve.

2.2 Inclusive Economic Growth

Inclusive economic growth is a concept of economic growth which includes

everyone, regardless of their economic class, religion, gender, etc, in the pursuit
of economic growth with the objective of creating equitable opportunities for
them during economic growth. The focus of inclusive economic growth is on
productive employment rather than direct income redistribution as a means of
increasing the incomes of relatively poor and excluded groups and raising their
standards of living.

In the context of Singapore, inclusive economic growth focuses on the inclusion

of low-skilled workers in the pursuit of economic growth. The Singapore economy
has achieved a high rate of economic growth over the last few decades which has
propelled it to near the top of the world ranking of GDP per capita. According to the
International Monetary Fund, Singapore now has the third highest GDP per capita in
the world, behind Qatar and Luxembourg. However, the high rate of economic growth
in Singapore has come with a price, namely, a wide income gap. The Gini coefficient
in Singapore, which is a measure of inequality of income distribution, is above the
internationally recognised alarming level of 0.4 and is one of the highest among
developed countries. Even after taking into consideration taxes and transfer payments,
the Gini coefficient in Singapore still remains above 0.4 while those of other
developed countries all fall below 0.35. This is largely due to globalisation,
technological advancement, a loose foreign worker policy and a shift from direct
taxes to indirect taxes. Income inequity may lead to failure of the free market to

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allocate some goods and services to the people who need them more. Therefore, in an
effort to reduce income inequity, the Singapore government advocates inclusive
economic growth which focuses on the inclusion of low-skilled workers in the pursuit
of economic growth.

Education and training can be used to increase the skills and knowledge of low-
skilled workers. An increase in the skills and knowledge of low-skilled workers will
lead to an increase in their productivity resulting in a fall in the cost of production in
the economy. When the cost of production in the economy falls, expected returns on
planned investments will rise which will lead to an increase in foreign direct
investments. When this happens, aggregate demand will rise which will lead to an
increase in economic growth. An increase in the skills and knowledge of low-skilled
workers will also lead to an increase in the production capacity in the economy. When
the cost of production in the economy falls and the production capacity in the
economy increases, aggregate supply will rise which will lead to an increase in
economic growth. In this sense, low-skilled workers are included in the pursuit of
economic growth and hence the term inclusive economic growth. Education and
training will also equip the low-skilled workers who have been displaced by
globalisation, technological advancement and economic restructuring with the
relevant skills and knowledge to find jobs in the expanding industries which require
high skills resulting in an increase in economic growth.

Inclusive economic growth which focuses on the inclusion of low-skilled workers

in the pursuit of economic growth will reduce income inequity. When the productivity
of low-skilled workers rises as a result of education and training, firms that employ
these workers will experience a fall in their costs of production. When this happens,
they will be able to increase the wages of the workers which will lead to a decrease in
income inequity. The low-skilled workers who were displaced but who are now
employed as a result of the new skills and knowledge that they have acquired will
start earning income again resulting in a decrease in income inequity.

2.3 Sustainable Economic Growth

Sustainable economic growth refers to economic growth which occurs in a

manner that will not impede economic growth in the future. There are several
necessary conditions for sustainable economic growth which include potential
economic growth, conservation and development of resources and protection of
the environment.

Potential Economic Growth

Actual economic growth can occur only when there is excess production capacity in
the economy. However, as the economy continually produces more goods and
services, it will eventually reach the full-employment equilibrium. In the absence of
excess production capacity in the economy, unless potential economic growth occurs,
actual economic growth will not be possible. Therefore, actual economic growth is
constrained by potential economic growth. As actual economic growth is constrained
by potential economic growth, potential economic growth is essential for achieving
sustained economic growth. Therefore, potential economic growth is necessary for
achieving sustainable economic growth.

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Conservation and Development of Resources

The production of goods and services requires resources. As many resources are
non-renewable such as fossil fuels, over-exploitation of resources will result in limited
resources being available for future use which will hinder future economic growth.
Therefore, the government needs to conserve resources to achieve sustainable
economic growth. There are several measures that the government can take to
conserve resources. For example, it can impose a tax on resources which are overly
exploited to discourage their use. In addition to conserving resources, the government
needs to develop new sources of energy such as solar power and wind power. As
these sources of energy are renewable, they are necessary for achieving sustainable
economic growth. The government can develop new sources of energy directly, by
setting up research institutes, or indirectly, by giving subsidies or tax incentives to
firms to encourage them to develop new sources of energy.

Protection of the Environment

Economic growth may lead to an increase in the amount of negative externalities

such as carbon emissions which will result in a more polluted environment. An
increasingly polluted environment will lead to a less healthy and hence less
productive labour force. A fall in labour productivity in the economy will lead to a
rise in the cost of production in the economy resulting in a decrease in aggregate
supply and hence lower economic growth. In addition, an increasingly polluted
environment will lead to a shorter life expectancy which will lead a decrease in the
size of the labour force. A decrease in the quantity of labour in the economy will lead
to a decrease in the production capacity in the economy resulting in a decrease in
aggregate supply and hence lower economic growth. Therefore, the government needs
to protect the environment to achieve sustainable economic growth. There are several
measures that the government can take to protect the environment. For example, it can
impose a carbon tax or a tradable emissions permit scheme to reduce carbon
emissions.

Note: Students should not confuse sustainable economic growth with sustained
economic growth. Although potential economic growth is essential for achieving
sustained economic growth, sustainable economic growth requires more than potential
economic growth. Therefore, sustainable economic growth is a broader concept than
sustained economic growth.

2.4 Benefits and Costs of Economic Growth

Benefits of Economic Growth

Rapid Rise in the Standard of Living

High economic growth may lead to a rapid rise in the standard of living. Recall that
the standard of living refers to the material and non-material welfare of the people. A
rapid increase in national output may lead to a rapid increase in the amount of goods
and services available for consumption. If this happens, the material standard of living
may rise at a fast rate.

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Full Employment

High economic growth will help the economy achieve full employment. The labour
force in the economy is generally expanding. An increase in national output will lead
to an increase in the demand for labour in the economy. Therefore, high economic
growth will ensure that sufficient new jobs are created in the economy for the new
entrants in the labour force which will help the economy achieve full employment.

Redistributive Benefit

Economic growth will increase the ability of the government to redistribute income
from high income individuals to low income individuals. When national output and
hence national income rises, the government will automatically collect more tax
revenue which can be used to finance transfer payments to low income individuals.
Therefore, the government can redistribute income from high income individuals to
low income individuals to reduce income inequity without increasing direct taxes and
hence lowering anyone’s disposable income.

Environmental Benefit

Economic growth may lead to a cleaner environment. When people’s income

rises, they will become more concerned with a clean environment. This is because
pollution will become a matter of social concern when economic growth has ensured
the provision of basic necessities such as food and housing to the majority of the
population. A cleaner environment will lead to a rise in the non-material standard of
living.

Costs of Economic Growth

Lower Amount of Goods and Services Available for Consumption

Achieving economic growth may lead to a fall in the amount of goods and
services available for consumption. Economic growth may be achieved through a
diversion of resources from the production of consumer goods, such as ice creams and
cookies, to the production of capital goods, such as factories and machinery. If this
happens, the amount of goods and services available for consumption will fall which
will lead to a fall in the material standard of living.

Generation of Demands

Economic growth may generate demands which may make people feel less
contented. An increase in national output will lead to an increase in the amount of
goods and services available for consumption. However, when people have more to
consume, they may want to attain an even higher level of consumption. Therefore, if
economic growth generates demands and makes people more materialistic, it may
make them feel less contented which will lead to a fall in the non-material standard of
living.

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Environmental Costs

Economic growth may lead to environmental costs. An increase in national

output may lead to an increase in the amount of negative externalities such as carbon
emissions which will result in a more polluted environment. If this happens, the non-
material standard of living will fall.

Depletion of Non-renewable Resources

Current economic growth may preclude future economic growth. Economic

growth will deplete non-renewable resources such as fossil fuels which include crude
oil, coal and natural gas. When this happens, there may be lack of resources to
achieve economic growth in the future.

Worsening Income Inequity

Achieving economic growth may worsen income inequity. To achieve economic

growth, the government may cut corporate income tax to attract foreign direct
investments, and it may cut personal income tax to attract foreign talents. However, as
income taxes are progressive, a decrease in these taxes will worsen income inequity.
Furthermore, to avoid a budget deficit, the government may raise goods and services
tax to offset the fall in income tax revenue. However, as goods and services tax is
regressive, an increase in this tax will also cause income inequity to worsen.

High Structural Unemployment

High economic growth may lead to high structural unemployment. High

economic growth may occur due to rapid technological advancement. However,
although rapid technological advancement may lead to high economic growth, it may
lead to substantial losses of low-skilled jobs resulting in high structural
unemployment.

Balance of Payments Deficit

High economic growth may lead to a persistent balance of payments deficit. High
economic growth will lead to high import growth. However, if export growth is low,
high import growth may lead to a persistent balance of payments deficit resulting in
adverse consequences such as high imported inflation, lower national output and
hence national income, higher unemployment and rising public debt.

High Demand-pull Inflation

High economic growth may lead to high demand-pull inflation. High economic
growth usually occurs due to a rapid increase in aggregate demand. However, when
aggregate demand rises rapidly, demand-pull inflation will be high if aggregate supply
does not also rise rapidly. This is particularly true when the economy is near the full-
employment equilibrium.
Note: Although economic growth brings about both costs and benefits to the
economy, the benefits generally outweigh the costs which explains why
governments around the world aim to achieve high economic growth.