Foreign Direct Investment in Singapore’s Manufacturing Sector
(Source: Statistics Singapore – Foreign Direct Investment, 2017)
The economy of Singapore is one of the most open economies in the world. It is also the 7th least corrupt economy. One of the most prosperous nations of world, Singapore, is a country with dominance of service sectors and it is one of the primary manufacturers of chemicals and electronics. Singapore has received major foreign direct investment (FDI), during 2010 to 2014, and the value of FDI has almost doubled from 2010 to 2014. In 2010, the value of FDI was 665,113.4 million Singapore dollars, and it was 1,113,273.4 million in 2014. Hence, the trend is upward rising (Rodan, 2016).
(Source: Statistics Singapore – Foreign Direct Investment, 2017)
Manufacturing, wholesale and retail, financial and insurance, and investment holding companies drew the maximum amount of FDI in these five years. The economy grew leaps and bounds due to huge growth in the above-mentioned sectors. Since, Singapore has dearth of land, it has excelled in the manufacturing and other services sectors, rather than in agriculture. The figure above shows the share of FDI in respective sectors from 2010 and 2014.
(Source: Statistics Singapore – Foreign Direct Investment, 2017)
The manufacturing sector of Singapore is one of the strongest sectors of the economy. In 2015, this sector contributed almost 20% of nominal GDP. Over the years, the activities in the manufacturing industry grew along with the supporting services. The research and development activities have also contributed in the manufacturing activities. The figure shows that the trend is upward rising in the manufacturing sector (Mora & Singh, 2015).
The Heckscher-Ohlin theory is a theory of comparative advantage. The theory states that, a country would export only those goods which use its abundant resources and import those goods, which uses its scarce resources. Hence, according to the theory, if a country is capital abundant, then it would export capital intensive goods and services, and if it is labor abundant, then it would export labor intensive products (Negishi, 2014).
Since Singapore has scarce land, it is a capital intensive country. The manufacturing industry is one of the pillars of Singaporean economy. The increase in FDI inflow in manufacturing shows the fact that the production level has increased, and exports have increased as well. Singapore cannot have comparative advantage in labor intensive production, thus, it has excelled in capital intensive activities. Therefore, as per Heckscher-Ohlin theory, Singapore still has the comparative advantage in manufacturing (Rodan, 2016).
Heckscher-Ohlin Theory and Singapore’s Comparative Advantage
Optimum currency area refers to the geographical area, which would maximize the economic efficiency for having a single currency for the entire area. It addresses the ideal features for merging of currencies or creating a new currency for a particular region. This is the final stage of economic integration (Snaith, 2014). Economist Robert Mundell formulated the theory of optimum currency area. This theory is used to evaluate the situation of a certain area if it is eligible to become a currency region. Such a region is mostly larger than a nation. Many countries come together to form an optimum currency area. For example, many countries in Europe have formed a Euro zone, they have the common currency euro. Here, a single country does not form an optimum currency region. The major advantage of a common currency area is that, it facilitates the investment and trade among the member countries, and hence increases the growth of income within the region. It also reduces the transaction costs associated with cross border business, and removes volatility in the exchange rates of the region (Henderson, 2014).
ASEAN is the Association of Southeast Asian Nations, formed on August 8, 1967. It is the regional organization of 10 Southeast Asian countries. The ASEAN Economic Community was formed in 2015. It is major step towards economic integration with new and bigger opportunities of a huge market worth of USD 2.6 trillion and people more than 622 million. The advantages of having a common currency in ASEAN can be explained as follows. Many countries had a record of fluctuating inflation, and exchange rate. Such countries could be beneficial from a credible monetary policy by a stable central bank. In case of factor mobility, ASEAN has relatively high capital and labor mobility. The workers can move freely between the member countries, hence, a common currency could be beneficial for all the countries. ASEAN also positioned high in the flexibility of price and wage. They can adjust to the price shocks quite rapidly compared to that in Western Europe. Moreover, the trade-to-GDP ratio and trade-intensity ratio are higher in ASEAN countries than many other currency unions of the world. Hence, it is beneficial for ASEAN to have an optimum currency area (Madhur, 2012).
There are some factors that need to be considered before adopting common currency in ASEAN. The sustenance of the common currency is more difficult than the adoption. The major factors to consider are: diversities in economic developments of the countries; the weak financial sectors of some countries; inadequate mechanisms for region-level resource pooling and institutions needed for formation and management of a currency union, and absence of political preconditions for a common currency and monetary cooperation across the countries (Henderson, 2014).
Feasibility of an ASEAN Common Currency
The ASEAN countries have a large economic diversity. Singapore is the richest country with per capita income 300 times more than that of Myanmar, the poorest in the group. This diversity is greater than that in the member countries of EU. This may possess problems for sustaining the common currency among the region. However, if the co-movement of relative outputs and prices is low across the countries, even if there is equality among the per capita incomes, maintaining a common currency is difficult. There should also be free movement of labor and capital across the countries and regulations should be removed regarding free movement of the goods under free trade agreement within the ASEAN region (Costantini, Fragetta & Melina, 2014).
With financial crisis, the countries with weaker financial and banking sector and substantial dependence on foreign capital could fall into exchange rate crisis. Hence, a weak banking system in not suitable for establishing common currency in the region. The inadequacy in the mechanisms for reserve pooling across the region, institutions for supporting regional monetary cooperation and absence of regional reserve sharing arrangements could pose problems for common currency. Finally, the ASEAN region might have the economic conditions for establishing common currency, but it does not have the political preconditions required for the move. Developing political support for monetary integration is crucial challenge for ASEAN to form an optimum currency region (Alvarado, 2014).
The Balance of Payments (BOP) of a country is the record of financial transactions, made by individuals, businesses and government of one country with other countries in a financial year. This record shows the amount spent by individuals and businesses on the imported products and services and the amount of exports (Kyle, 2015). In 2015, the BOP surplus of Singapore was $1.5 billion. The goods balance surplus rose to $113 billion in 2015, from $101 billion in 2014. The deficit in services balance remained almost unchanged in the third and fourth quarter of 2015. However, the over deficit reduced to $5.3 billion compared to $6.0 billion in 2014. The current account surplus increased almost 20% of the GDP, worth of $79 billion. The overall BOP surplus reduced to $1.5 billion in 2015, from $8.6 billion in 2014. Current account witnessed a surplus, while capital account showed a deficit of $77 billion (Balance of Payments, 2016).
The BOP surplus of Singapore has experienced a narrow down effect in 2015. It was $8.6 billion in 2014, while it was only $1.5 billion in 2015. This is caused due to higher net outflow from capital and financial account. This has outweighed the rise in current accounts surplus. The official foreign reserves of the county reached $351 billion in 2015, which is equal to imports worth of merchandise imports. In 2015, the country has performed well. There has been a large surplus in the goods balance, under current account balance. It contributed $67 billion, i.e. 17% of the GDP in 2014, while it was $79 billion, (20% of total GDP) in 2015 (Balance of Payments, 2016). As manufacturing sectors grew significantly, there has been increase in the production of goods and that led to more export than import. Hence, there are surplus in the goods balance. As services are not exported much, thus there is deficit for the services. On the other hand, there has been deficit of $77 billion in capital and financial account in 2015, while it was $59 billion in 2014. The net outflow has increased in the form of investments that exceeds the net inflow. Overall it was a good performance of the economy in 2015 (Feenstra, 2015).
Factors to Consider Before Adopting a Common Currency in ASEAN
Current account in BOP consists of balance of trade, net primary income and net transfer of cash in a given financial year. It generally addresses the transaction of goods and services over the financial year. Current account deficit refers to the situation, when the value of the economy’s net foreign assets decreases, i.e. value of imports becomes greater than the value of exports over the given period. The reduce the deficit in current account, government can devaluate the nation’s currency, as it would raise the price for imported goods and lower the price of exports. Thus, volume of exports would increase. The government can also go for a tight monetary policy by raising the interest rate, or deflationary fiscal policy by raising the income tax. The government can also go for deregulation and privatization, which would increase the efficiency and competitiveness of the economy due to private sector’s profit motive. This would lead to higher production, as well as higher exports due to lower production costs (Kumhof & Laxton, 2013).
Higher interest rate of one country leads to higher return on investment. Hence, it attracts more foreign capital and results in a rise of the exchange rate. The USD will appreciate compared to euro, with a 2% more rate of interest. As investors would get 2% more return, there would be more capital inflow to the US. Exchange rate improves for US and USD appreciates in terms of euro. However, the amount of currency appreciation depends on the level of inflation in the US market (Chan, 2016).
If the forward and spot rates are same, then financial capital would flow towards us on the spot rate. Investors might speculate that the currency might devaluate in the future and exchange rate might fall, hence, they would try to reap the benefit of higher interest rate of the present date, and therefore would invest at the current date with effects of the spot rate (Hassan & Mano, 2014).
The economy in the question has fixed exchange rate, free capital mobility and economic recession. In this situation, an expansionary monetary policy would be less effective. According to Carbaugh (2013), when the economy is in recession, the expansionary monetary policy would cut the domestic rate of interest. This would lead to increased investment and consumption in the economy, and GDP would rise. However, the lower interest rate would discourage the foreign investors to invest their money in this economy. The currency of the nation decreases. Due to fixed exchange rate, the central bank of the economy intervenes and purchases the domestic currency in exchange for foreign currency. It results in lower money supply in the economy, less aggregate demand, and fall in GDP. Hence, the final effect would be a contraction of the economy.
References:
Alvarado, S. (2014). Analysis of the Optimum Currency Area for ASEAN and ASEAN+3. Journal Of US-China Public Administration, 11(12). https://dx.doi.org/10.17265/1548-6591/2014.12.005
ASEAN Economic Community. (2017). ASEAN | One Vision One Identity One Community. Retrieved 30 April 2017, from https://asean.org/asean-economic-community/
Balance of Payments. (2016). www.mti.gov.sg. Retrieved 30 April 2017, from https://www.mti.gov.sg/ResearchRoom/SiteAssets/Pages/Economic-Survey-of-Singapore-2015/Ch5_AES2015.pdf
Carbaugh, R. J. (2013). International Economics. 14. Aufl., South-Western (Cengage Learning).
Chan, S. (2016). US Federal Reserve raises interest rates: what happens next?. The Telegraph. Retrieved 30 April 2017, from https://www.telegraph.co.uk/business/2016/12/14/us-federal-reserve-set-raise-interest-rates-happens-next/
Costantini, M., Fragetta, M., & Melina, G. (2014). Determinants of sovereign bond yield spreads in the EMU: An optimal currency area perspective. European Economic Review, 70, 337-349.
Feenstra, R. C. (2015). Advanced international trade: theory and evidence. Princeton university press.
Hassan, T. A., & Mano, R. C. (2014). Forward and spot exchange rates in a multi-currency world (No. w20294). National Bureau of Economic Research.
Henderson, J. (2014). Reassessing asean. Routledge.
Kumhof, M., & Laxton, D. (2013). Fiscal deficits and current account deficits. Journal of Economic Dynamics and Control, 37(10), 2062-2082.
Kyle, J. F. (2015). The balance of payments in a monetary economy. Princeton University Press.
Madhur, S. (2012). Costs and Benefits of a Common Currency for ASEAN (1st ed.). Asian Development Bank. Retrieved from https://www.adb.org/sites/default/files/publication/28307/wp012.pdf
Mora, J., & Singh, N. (2015). Trade productivity upgrading, trade fragmentation, and FDI in manufacturing: The Asian development experience. Indian Growth and Development Review, 6(1), 61-87.
Negishi, T. (2014). Heckscher–Ohlin Theory (2). In Developments of International Trade Theory (pp. 81-86). Springer Japan.
Rodan, G. (2016). The political economy of Singapore’s industrialization: national state and international capital. Springer.
Snaith, H. (2014). Narratives of optimum currency area theory and eurozone governance. New Political Economy, 19(2), 183-200.
Statistics Singapore – Foreign Direct Investment. (2017). Singstat.gov.sg. Retrieved 30 April 2017, from https://www.singstat.gov.sg/statistics/visualising-data/charts/foreign-direct-investment
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