Economics myths in the great population debate

The great John Maynard Keynes famously said that "practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist."

The debate on the Population White Paper has surfaced a number of myths and fallacies that seem to dominate the current discussion on Singapore's population policies. Economics provides us with a very useful set of analytical tools to clarify our thinking and to develop sensible, evidence-based policies. The purpose of this essay is to examine some of the ways these myths have inadvertently, or even subconsciously, been used to justify inaccurate thinking about policies.

Myth #1: If we don't have sufficiently large injections of foreign labour, business costs will rise, some businesses will shut down or move out of Singapore, and Singaporean workers will be laid off.

The first fallacy is a version of the misguided economic reasoning behind protectionism. The (flawed) argument for protectionism is that because our local firms cannot compete globally, they need to be subsidised by the state. By lowering costs for our firms, protectionism helps them compete against more efficient and productive foreign firms, thereby creating employment for citizens. Economists know this reasoning to be intuitively appealing, but wrong. The protection that is given to local firms does not raise their productivity; indeed, it explains their very lack of competitiveness. Meanwhile, the processes of creative destruction – the main source of dynamism in capitalist economies – are impeded, and the signals for the economy to adapt, innovate and move up the value chain are muted.

The business case for a liberal foreign worker policy rests on similarly flawed arguments. Businesses that rely on cheap foreign labour receive an implicit subsidy from the government. The low cost of labour encourages them to persist with low value-added production and discourages them from upgrading and improving their business processes. Meanwhile, cheap foreign labour discourages automation and holds down wages for citizen workers doing the same job.

Economists also know that the danger of protectionist policies comes not just from the practice of it, but also from the failure to provide an exit strategy. Countries that have benefited from the practice of protectionism are those where governments were tough enough to end protectionist policies that have outlived their usefulness.

If the Singapore government were to tighten foreign worker policies over a sustained period, there is no doubt some businesses would not be able to adapt and would have to move out of Singapore or shut down. Is this a necessarily bad thing? No, in a vibrant capitalist economy, this is exactly what we would expect. Businesses which cannot adapt should and would exit the market; the state should not be propping them up with ever more inputs of cheap labour. Their exit also frees up labour and capital resources for the growing, more productive parts of the economy.

Such “creative destruction” is a necessary part of the economic restructuring process.  In economic restructuring, there will always be some firms which are disadvantaged. The economically sensible decision is not to protect these firms in their existing labour-intensive state (which imposes high social costs) through easy access to cheap foreign labour. Instead, the government can help lessen the pain in this process. For instance, it can help local SMEs by ensuring that they have access to the cheap credit, new technologies and business restructuring expertise needed to adjust and adapt to the new environment.

What about workers who are laid off and who lack the skills to move to other industries (in the same way that getting rid of protectionist barriers might raise unemployment)? Again, the economically sound answer is not to artificially prop up employment, but for the state to intervene directly to help the workers whose livelihoods are affected – through unemployment protection, higher wage subsidies through the Workforce Income Supplement, skills retraining and upgrading programmes, and one-off social transfers. Public policy should be aimed at helping workers and local firms cope with economic restructuring, not at helping uncompetitive firms that rely on cheap foreign labour stay afloat.

Myth #2: Economic growth is a zero-sum game


A second fallacy is that with the emergence of fast-growing cities in Asia, Singapore will need to maintain a certain growth rate or else it would stagnate and eventually become irrelevant. This is the essence of the "competitiveness" argument. While competitiveness might be a useful concept at the firm level, its utility at the level of cities and countries is highly doubtful. To the extent that economists use the term at all, they use it to refer to attributes such as comparative advantage, total business environment, innovation, and the quality of a country's policies and institutions. The rate of workforce growth, especially in cheap labour, is not considered a sustainable source of competitiveness.

The argument that Singapore will stagnate if other cities in the region rise also has little basis in economics. Growth in a fast-growing and increasingly interdependent region like Asia is not a zero-sum contest. Just because Jakarta, Bangkok and Shanghai grow at a rate much faster than Singapore does not make Singaporeans any worse off. It is not the case that there is a finite amount of GDP growth for the whole world (or the region) and we must grab as large a share of it as possible. Indeed, the opposite is true. The growth of other cities in our region is more likely to raise our growth rate. The larger markets that their growth generates and the higher incomes their citizens earn should be viewed as economic opportunities for Singapore, not as "competitive" threats.

Similarly, the pursuit of foreign direct investments is also not a zero-sum game. If as a result of a more modest increase in our workforce, Singapore "loses" some investments that it would have received had it continued to grow its workforce as rapidly as before, this is not necessarily a bad thing. First, the marginal investments that we lose would probably be of the type that requires cheap labour inputs. So such investments do not raise productivity, and therefore incomes, by much. Second, such investments in lower-cost locations benefit Singapore via the standard comparative advantage argument. That is, as these lower-cost countries raise their output and and incomes, they can better afford the higher value goods and services that Singapore produces. Economic growth, rather than being a zero-sum proposition, is a positive sum one – all the more so in a fast-growing region where the individual economies are at different (and therefore, complementary) stages of development.

Myth #3: Denser, larger populations create significant economic benefits for cities

This myth has a strong element of truth to it. It is true that rich cities with larger populations enjoy something called agglomeration effects. When skilled workers cluster together, their output increases by more than the increase in the number of workers. Knowledge expands and spreads more quickly in dense cities than they do in sparsely populated ones; innovation tends thrives in denser, more populous cities. Indeed, this should have been the main argument the government uses for increasing the population and density of Singapore. So why didn’t it?

The reason is that these agglomeration effects apply only in certain industries, namely those which require highly skilled knowledge workers whose concentration generates innovation. Industries such biomedical science research, higher education, and business services like legal and management consulting clearly fall into this category. The benefits of agglomeration do not apply to low-cost, labour-intensive industries like construction, cleaning or security services. In these industries, more workers do not lead to larger increases in output per worker.

In the context of the White Paper, much of the projected increase in our labour force would be to serve our lower-skilled industries. These are exactly the industries which do not benefit from agglomeration effects but contribute to the externalities such as congestion and wage stagnation. Consequently, the argument in favour of a denser city with a larger population because of agglomeration effects does not really apply in this context.

Myth #4: Spending on healthcare and social services are costs which have to be financed by higher taxes, and are therefore a drain on the economy

The final myth is that some parts of the economy – like healthcare and social services – are a drain on the economy, while others are productive, “value-creating”, and generate “exciting jobs.” This characterisation of the economy has no basis in economic theory or evidence, although it is true that some sectors of the economy experience persistently lower productivity growth than others.

In the popular imagination, healthcare and social services are a drain on the productive parts of the economy. They have to be funded by taxpayers and are therefore seen as a cost that reduces national output. This is bad economics. Healthcare and social services, like other industries such as manufacturing, financial services or construction, also contribute to national output (or GDP) growth. Your spending in healthcare and social services is someone else’s income and his spending boosts another person’s income. So raising our spending in these two areas is not different from increasing spending in other parts of the economy. There is no economic basis for the common intuition that some industries are a cost while others are a form of investment.

What about the fact that healthcare and social services have to be financed by taxation? Doesn’t that mean they are a drag on the economy? Again, there is little economic basis for that argument. Many other things are financed by taxation too – MRT lines, public housing, law and order, security – but we don’t view these as a drag on the economy. Indeed, we may even see these things as productive investments.
But won’t taxes have to rise sharply to finance our higher spending on healthcare and social services? Not necessarily. First, Singapore has large fiscal surpluses which can be used to finance a well-planned expansion of such services in a sustainable way. Second, if productivity increases and people’s incomes across-the-board rise, we should be able to afford the rising costs of healthcare.

The real issue in healthcare spending is how the risks of incurring high healthcare costs are allocated. Most economists argue that given the low-frequency, high-impact nature of many medical contingencies, the most efficient way of financing healthcare would be through some form of risk-pooling or social insurance. That Singapore lacks a comprehensive and universal health insurance programme, combined with the fact that the bulk of healthcare spending currently comes from out-of-pocket payments, suggests that we can have a more equitable healthcare financing system without compromising on its efficiency.

With an ageing population, won’t rising health and social care expenditures hurt our economic dynamism, as it has in Japan and other rapidly ageing societies? Perhaps, but not for the reasons that are commonly cited.  Health and social care services tend to experience slower-than-average productivity growth. This is because they are more dependent on labour, and are much less amenable to automation and other labour-saving technological improvements. But despite productivity growth in healthcare and social services being lower than in other industries (such as manufacturing or ICT), wages in these “stagnant” sectors rise just as fast as they do in other sectors because if they did not, workers would leave these sectors. This means costs and prices rise in healthcare and social services rise faster than they do in other parts of the economy. Over time, healthcare and other social services will take up a larger share of our incomes – both individually and nationally. But this outcome does not spell doom. As long as we sustain labour productivity growth at historical rates of about 2%, we can afford more of everything even as the share of healthcare and social services in our total spending rises.

The real risk of the “cost disease” (a term coined by the economist, William Baumol) is not that health and social care costs are rising, but that policymakers misdiagnose the problem and deal with it in a kneejerk way. For instance, they may shift a larger share of the rising costs to citizens. This doesn’t solve the underlying problem and may, in fact, make the problem worse as privatised healthcare is likely to experience faster cost inflation than socialised healthcare.

Conclusion


These myths exist because they seem to be intuitively correct. They appeal to our everyday experiences, and are consistent with popular accounts of the economy. These popular accounts include the idea that cities or countries are locked in economic competition with one another, or that jobs must be protected in order for workers to be protected. Our experience with health and social care as costs we try to avoid also explains our intuition that at the national level, this must also apply. But these stories, although consistent and coherent to us, are neither correct nor valid. As cognitive psychologists have found, people tend to rely on explanations that are consistent with their own experiences or with conventional wisdom, rather than on careful deliberation and reasoned analysis.

Economics is not, and should not be, the only lens through which we examine, analyse and debate our country’s population policies. But when we do apply economics analysis, we should try to get it right.

This article was reposted from IPS Commons. It first appeared here.

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