Opening Remarks by Mr Heng Swee Keat, Managing Director, Monetary Authority of Singapore, at Singapore Centre for Applied and Policy Economics (SCAPE) Workshop, 14 September 2006
1 It is a pleasure for me to be here for this inaugural workshop of the Singapore Centre for Applied and Policy Economics (SCAPE), organised in cooperation with the World Bank and the Institute of Policy Studies. To our many overseas guests, may I bid you a warm welcome. I congratulate SCAPE for bringing together key policymakers and renowned academics for this occasion. As there will certainly be a lively exchange of views in these 2 days of the workshop, I shall focus my remarks on the policy challenges of the economic transition taking place in Asia.
Fragmentation and Outsourcing
2 In the last 30 years, from 1975 to 2005, global trade has grown by 6%, twice the rate of global GDP growth. The dismantling of trade barriers, reduction in transport costs and increasing cross-border investment by MNCs have driven much of this growth. The welfare gains from increased trade and investment were significant. In Asia, the four dragon economies, and subsequently, the tiger economies, prospered. Their development in the 70s and 80s followed largely a flying geese formation, with Japan and other developed economies in the lead, progressively transferring technology and know-how to those behind, even as the developed economies themselves moved up the value chain.
3 Progressively, but especially in the last 10-15 years, this flying geese pattern has given way to a more dynamic fragmentation of production and outsourcing. Intensifying competition, together with advances in IT, just-in-time production techniques and supply-chain management have caused the production value chain to be broken up into small fragments. The agglomeration economics associated with production processes was fundamentally changed. Even the production of a simple pair of jeans - much associated with the 'old economy', can be broken down into 24 stages and allocated among economies as diverse as Pakistan, China, Hong Kong andMalaysia. The classical paradigm where commodities and final goods are traded in the world markets is no longer sufficient to account for international trade flows. Trade of intermediate parts and components has become significant, growing from US$400 billion in 1992 to over US$1 trillion in 2003. Their share in total world manufacturing trade grew from 17% to 23% during this period. Increasingly, in analyzing trade trends, we need to peer beneath the headline numbers.
4 This trend towards production fragmentation is particularly pronounced in Asia, with China's emergence as a manufacturing powerhouse serving as a powerful driver. Intra-Asian trade has grown remarkably. Since 1990, intra-regional exports have grown about fivefold in Asia, compared to fourfold in NAFTA and threefold in the EU. The share of intra-Asia exports in East Asia's total exports rose from 40% to 50% over the same period. I believe this trend will continue, as Asian economies enter into free trade agreements that will bind tariff elimination and provide certainty for further integration.
5 In the services area, advances in info-communications technology have also enabled outsourcing and offshoring of activities on a large scale. While India's success is best known, many countries in Asia, including Malaysia, the Philippines and Singapore are also important providers. Production fragmentation has moved beyond goods to services and this trend is likely to continue into the future.
6 A positive effect of all these changes is the significant growth of global productivity. As Prof Paul Samuelson observed, beyond the Ricardian gains from trade in finalgoods, trade in input and components allows each country to make the best use of its factor endowments and production technology, and to raise capabilities through technology transfer and learning-by-doing.
Beyond an Integrated Factory, to a Growth Engine?
7 However, it is important to recognise that at this stage, economic integration within Asia is driven largely by production integration, especially that of the manufacturing sector. Asia has become a large integrated factory, but has yet to fully exploit the opportunities for closer integration of consumption. An important issue is whether such integration will better sustain Asia's growth, and enable the region to develop into another engine for global growth in its own right.
8 There are several key forces that are already shaping this next phase of integration. China and India, with continental-size economies, are developing their domestic engines to propel future growth. China in particular is already importing many consumption goods from the rest of Asia. Low cost Asian manufacturers and services providers have, in the process of working with MNCs, been acquiring technical and managerial skills, and are moving to produce consumer goods. The proliferation of cheap mobile phone services, low-cost computers, and budget airlines are early signs of this development.
9 Over time, the integration of production and consumption within Asia is likely to be further entrenched. The process will be driven by the middle-class across Asia which is likely to see significant growth not just in number but also in wealth. Increasingly, there will also be greater penetration of local firms into each others' markets, resulting in more intra-regional investment. All these will work towards transforming Asia into a new growth engine.
10 These developments will be aided by policy measures that governments in Asia are taking. For instance, free trade agreements being negotiated within Asia will liberalise certain services, and eliminate tariffs for final goods. While Asia is creating a network of trade agreements to deepen economic integration, it needs to remain connected to the global economy. Open regionalism serves Asia's interest best, and trade liberalization at the multi-lateral level remains the first best policy for Asia, and indeed, for the world. In this regard, it is crucial that major players work to revive the Doha Round of talks.
11 To sustain Asia's new phase of growth, a significant improvement in the intermediation of savings is necessary. Banks and financial markets need to play their proper role in the efficient allocation of resources. Compared to the US or Europe, financial markets in Asia are not as deep or as efficient. This will affect productivity and growth. For instance, a study by SCAPE suggests that differences in financial intermediation costs and the rigour of contract enforcement can account for much of the difference in output per capital between countries. To realize the true potential of Asian economies, further reforms in the banking systems, and the development and integration of financial markets across Asia, will be needed.
12 So would a stable macro-economic environment. For the last decade or so, the world economy has, in an unprecedented way, enjoyed both high growth and low inflation. While the policy responses and credibility of central banks have played a role, production fragmentation and the integration of emerging economies, especially those in Asia, are now widely regarded as a positive supply shock that underpins this benign global environment. The extent to which this positive shock will persist will affect inflationary trends, monetary policy responses, and global growth paths, all of which will feed back on Asia's own growth prospects.
Challenges of Adjustments
13 But perhaps the most important policy issue that we must all address is how to sustain the global support for integration, and to help millions of workers cope with the changes. As Prof Jagdish Baghwati famously observed, comparative advantage is now kaleidoscopic, where slight changes in relative costs and endowments can lead to quick shifts in the pattern of advantages. This is putting intense pressure on both emerging and developed economies. Countries will need to find new sources of comparative and competitive advantages, create new jobs, and re-train displaced workers to fill these new ones. Labour markets will need to undergo significant changes, including greater flexibility in order to respond to changes. A whole new pattern of specialization across countries will emerge. First order changes will trigger second and third order changes, and in this regard, economists who work in the area of general equilibrium analysis can contribute to the policymaking process.
14 Allow me finally to briefly share Singapore's experience, as a microcosm of the changes that each country has to undergo. As the Singapore economy is small and open, we are acutely sensitive to changes around us. While we have benefited from the recent trends of globalisation, rapid technical progress in China and the emergence of India is creating a new pattern as both countries move up the value chain. To make ourselves relevant, we have since 2001 embarked on re-structuring the economy, to one that is knowledge-intensive and innovation-driven, with a focus on high-tech manufacturing and high-value added services. In effecting these changes, we have to reach deep into the system - starting from a revamp of the education system, under the "Thinking School, Learning Nation" paradigm. To help workers continually learn new skills, a new Workforce Development Agency was created. Much effort is underway to shift attitudes and policies from lifelong employment to lifelong employability. In the course of this restructuring, I am sure many new policy issues will emerge, and we welcome your views on these.
15 Ladies and Gentlemen, we live in exciting times, but the policy challenges are complex. All of you present here today have a strong interest in deep economic analysis to inform policymaking. I am heartened that the organiser, SCAPE, has brought so many of you together. I wish you fruitful deliberations, and hope that this inaugural workshop serves as a catalyst for building a special network of researchers to continue to study these critical issues. Thank you.