In an attempt to obtain more satisfactory explanations for sustained differences in growth experiences, both over time and across countries, much attention has been focused recently on endogenous sources or engines of growth. It has been increasingly recognized that models of endogenous growth hold the potential for explaining aspects of growth that the standard neoclassical aggregate growth model of Solow (1956), and its many variants are either directly at odds or ill-equipped to deal with.1
An important prediction of the neoclassical model is that initial conditions or disturbances have no long-run implications for growth. Regardless of an economy’s initial per capita endowment of capital, it will converge to the same steady state per capita capital stock, after which growth in per capita output is determined purely by exogenous technological progress. There is, therefore, no room for an analysis of alternative phases or stages of growth induced by particular initial conditions. Moreover, the role for government intervention in the neoclassical model is limited. The model predicts, for example, that policies that succeed in increasing savings rates will increase the long-run level of per capita output and consumption, but will have no sustained impact on the growth rate of per capita output.
This paper analyzes a particular episode in the growth experience of Singapore—that of economic restructuring, which encompassed changes in both the technique of production and in the composition of output.2 Singapore is a small, highly open economy whose development strategy has passed through several stages. A remarkably successful low-wage, export-led period of industrialization from 1966–79 transformed it from a labor-surplus economy to one where domestic labor constituted an important constraint on growth.3 By the late 1970s, a development strategy based on labor-intensive and relatively low-wage, export-driven growth was proving to be unsustainable for several reasons. First, full employment of the labor force was generating upward pressure on wages. With limited prospects for growth in the domestic supply of labor, a continuation of the strategy would have required a growing reliance on imported foreign labor. This was ruled out as a socially and politically viable option. Second, the Government realized that wage restraint had resulted in excessive investment in, and retention of, labor-intensive activities. The maintenance of low wages, it was felt, had hindered the natural process of economic upgrading and restructuring with technological progress, because it encouraged investment in relatively labor-intensive, low-technology goods. Third, the small wage increases in Singapore had been accompanied by lower growth of labor productivity than in other newly industrializing economies (NIEs), where wage increases had been more rapid. It was felt that preventing wages from rising to higher levels had stunted productivity growth by reducing incentives for labor-saving investment and organizational rationalization.
In 1979 the Government adopted an economic restructuring strategy, designed to shift the structure of production from low-technology, labor-intensive activities to technology-and-skill-intensive, higher value-added activities. This shift was intended to place the economy on a sustainable growth path by allowing it to economize on the use of labor and to enter markets for high-technology and knowledge-and-skill-intensive goods and services. It was perceived that if this restructuring were not brought about, the labor constraint and consequent wage pressure would eventually lead to a deterioration in competitiveness and a declining share in traditional export markets. Moreover, the move toward high-technology goods would increase labor productivity and thus output.
Three complementary policy initiatives were involved in the restructuring strategy. First, significant wage increases were encouraged by the National Wage Council (NWC) to compensate for the previous wage restraint, which may have held wages at an artificially low level.4 This policy of allowing wages and, more generally, labor costs to rise in excess of productivity growth has been referred to as a “high-wage” or “wage-correction” policy.5 It was envisaged that, with an increase in the relative price of labor, capital would be substituted for labor, and consequently, low-wage, labor-intensive activities would be phased out. Concomitantly, to reinforce this shift, labor supply measures were adopted to limit the inflow of foreign workers into lower-paid unskilled occupations, and eventually to phase foreign workers out. The measures recommended by the NWC raised labor costs for all employers, but the form of the recommendations, which comprised a uniform lump-sum increase and a percentage increase, also affected wage relativities by increasing the lowest wages proportionately more than higher wages.6 Thus, firms engaged in low-skill, labor-intensive activities experienced the largest increase in labor costs.
Second, restructuring was perceived to be constrained by an inadequately skilled labor force, and the Government therefore embarked on an ambitious and successful program for increasing labor skills. In addition to various adult education and worker training programs, the Skills Development Fund (SDF) was formed in 1979. Financed by a tax on employers, the SDF was designed to provide incentives to employers to upgrade the skills of their employees and to increase on-the-job training.7 Third, incentives were offered by the Economic Development Board, to encourage investment in technology-and-skill-intensive activities, and to promote automation of existing production facilities.
While some restructuring of output toward knowledge-and-skill-intensive and high-technology activities had already taken place in the 1970s, the pace of restructuring accelerated considerably after the adoption of the wage-correction policy in 1979 (Figure 1). The share of financial and business services, representing relatively skill-intensive activities, which was virtually unchanged during 1971–79, rose from 18 percent in 1979 to almost 29 percent by 1987. The share of electronics, a relatively high-technology activity, also increased sharply. Accompanying the restructuring of output was a shift in the composition of the labor force toward more highly skilled and higher-paid activities.8
In assessing the economic restructuring policies, one needs to address several key questions. First, if the policies had not been undertaken, would restructuring have come about naturally? Second, while restructuring was expected to raise the level of productivity and, hence, the level of output, is there any reason to believe that it might have also resulted in a permanent increase in the potential rate of growth of the economy? Third, what effects did changes in wage differentials and in the rate of return to capital have on the direction and pace of restructuring?
For a labor-constrained and otherwise naturally resource-poor economy such as Singapore at the end of the 1970s, productivity increases must eventually become the primary source of sustained growth in the supply of output. Productivity of the raw labor force can be increased directly by investment in human capital, as emphasized recently by Otani and Villanueva (1989); or it can result from a process of “learning-by-doing.” The potential importance of learning-by-doing in endogen-ously determining productivity growth was first advanced by Arrow (1982). Subsequently, Bardhan (1970) and Krugman (1987) have emphasized its role in dynamically determining comparative advantage, and it is identified by Lucas (1988) as a potential, endogenously determined, source of growth. In the following, the questions raised above on Singapore’s economic restructuring program will be addressed in a simple model incorporating learning-by-doing.
Section I extends Lucas’s (1988) model of endogenous growth to examine the process of restructuring that took place in Singapore in the 1980s. The model shows that in the absence of exogenous shocks or government intervention, an economy will, over time, tend to one of two long-run equilibrium growth paths—a “high-growth” path and a “low-growth” path—depending on the initial endowment of resources in each sector and, hence, historical comparative advantage. Thus, any government intervention that results in a diversion of resources from one sector to another can affect the pattern of growth and trade over time, indeed even to the extent of putting the economy on a high-growth or low-growth trajectory. The analysis presents an example of a change in the level of aggregate output, resulting from a shift in its composition, inducing a sustained change on the potential growth rate of the economy. Effects of stylized versions of actual policies followed in Singapore and exogenous shocks are analyzed. Section II offers concluding remarks.
Arrow, Kenneth J., “The Economic Implications of Learning by Doing,” Review of Economic Studies, Vol. 29 (June 1982), pp. 155–73.
Bardhan, Pranab K., “Optimum Trade Policy in a Model of Learning by Doing,” Chapter 7 in Economic Growth, Development, and Foreign Trade (New York: Wiley-Interscience, 1970).
Kouri, Pentti, “Profitability and Growth in a Small Open Economy,” in Inflation and Employment in Open Economies, ed. by Assar Lindbeck (Amsterdam; New York: North-Holland, 1979).
Krugman, Paul, “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Thatcher,” Journal of Development Economics, Vol. 27 (October 1987), pp. 41–55.
Lucas, Robert E., Jr., “On the Mechanics of Economic Development,” Journal of Monetary Economics, Vol. 22 (July 1988), pp. 3–42.
Otani, Ichiro, and Cyrus Sassanpour, “Financial, Exchange Rate, and Wage Policies in Singapore, 1979-86,” Staff Papers, International Monetary Fund, Vol. 35 (September 1988), pp. 474–95.
Otani, Ichiro, and Delano Villanueva, “Theoretical Aspects of Growth in Developing Countries: External Debt Dynamics and the Role of Human Capital,” Staff Papers, International Monetary Fund, Vol. 36 (June 1989), pp. 307–42.
Romer, Paul M., (1987a), “Growth Based on Increasing Returns Due to Specialization,” American Economic Review, Papers and Proceedings, Vol. 77 (May 1987), pp. 56–62.
Romer, Paul M., (1987b), “Crazy Explanations for the Productivity Slowdown,” NBER Macroeconomics Annual, ed. by Stanley Fischer (Cambridge, Massachusetts: MIT Press, 1987).
Shleifer, Andrei, “Externalities as an Engine of Growth” (unpublished; Graduate School of Business, University of Chicago, 1989).
Singapore, Report of the Economic Committee, The Singapore Economy: New Directions (Singapore: Ministry of Trade and Industry, 1986).
Solow, Robert M., “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics, Vol. 32 (February 1956), pp. 65–94.
For a discussion of the failure of the neoclassical growth model to explain various stylized facts of growth, and its limitations in general, see, among others, Romer (1986, 1987a, 1987b), Lucas (1988), Helpman (1988), and Shleifer (1989).
With rapid economic growth, which averaged 9.4 percent a year from 1970–79, a large pool of unemployed labor was gradually absorbed into the work force; between 1970 and 1979 the unemployment rate fell from 6.0 percent to 3.4 percent—close to the natural rate of unemployment, which is estimated at 3 percent. During this period real wage increases typically lagged behind growth in labor productivity. It is estimated, for example, that while real product wages in manufacturing increased at an average rate of 2.3 percent a year from 1973–79, labor productivity grew by 4.4 percent a year. See Singapore, Yearbook of Statistics (various issues).
The NWC, a tripartite body comprising representatives from the Government, employers, and trade unions, was formed in 1972 with the mandate of recommending specific quantitative wage guidelines each year. The tripartite nature of the council ensured wide acceptance and implementation of its recommendations.
In June 1979 the NWC recommended a general wage increase amounting to approximately 14 percent of average monthly wages. In accepting the NWC’s recommendations, the Government made it known that similar wage increases were planned for the following two years. The measures to increase wages coincided with systematic increases in employer contribution rates to the Central Provident Fund from 16.5 percent of the wage bill in 1978 to 25 percent by 1984. For an analysis of the short-term effects of the wage-correction policy, see Otani and Sassanpour (1988).
The lump-sum dollar increase in the NWC recommendations for 1979/80 and 1980/81, for example, constituted approximately half of the total 14 percent recommended increase in wages.
At the time of the introduction of the SDF in 1979, the employer’s contribution rate was set at 2 percent of the wage bill; it was subsequently raised to 4 percent in 1980.
From 1979–87 the share of professional, managerial, and administrative workers in the labor force, representing the highest skill and pay occupational category, rose significantly from 11 percent to 17 percent; the share of production, transport, and other manual workers, representing the lowest skill and pay occupational category, fell from 39 percent to 35 percent. See Singapore, Yearbook of Statistics (various issues).
The implications of the presence of physical capital and the role of investment are discussed below in an extended version of the model.
Formally, there is a bottleneck to “high” growth, rather than growth.
This is particularly relevant in the case of Singapore.
Although such a differential tax or subsidy was not actually implemented, it is analytically equivalent to changing wages in the low-wage sector relative to the high-wage sector from employers’ point of view, and considerably more tractable.
This shift is not shown in Figure 3, since the effects are exactly opposite to those depicted for the previous exercise.
To talk meaningfully about relative labor intensities, physical capital needs to be included explicitly in the production functions. It is implicitly assumed that the capital stock in each sector is fixed in this subsection and is therefore suppressed from the notation. The next subsection endogenizes physical capital accumulation.
The effect of changes in the composition of investment is, of course, transparent. An increase in the share of total investment going into the high-technology sector will, by altering relative capital stocks, shift production and employment in favor of the high-technology good.
Kouri (1979) argues that such an investment function can be derived if expectations are static and there are adjustment costs to investment. The traditional neoclassical model of investment, as developed by Jorgenson (1963), posits the flow of investment to be a function of the difference between an optimal capital stock, determined by maximizing the present value of the firm, and the current level of the capital stock. The formulation here is adopted to emphasize that in a highly open economy, investment at home is a function of relative rates of return.
Formally, the Jacobian matrix, with elements defined in equations (13a) and (13b), has a negative determinant, so that the system has one stable and one unstable root and is therefore characterized by saddle-path stability; CC denotes the saddle path in Figure 4.
Sufficient conditions for an exogenous increase in wage or labor costs to reduce the rate of return to capital are that the labor supply curve be positively sloped and that the capital stock be predetermined at a point in time. In the tradition of two-sector trade models, it has been assumed, for simplicity, that labor is inelastically supplied.
If, however, investment at home is unresponsive to differences between domestic and international rates of return—for political risk reasons, for example—but is responsive to differences in rates of return across sectors, then an increasing proportion of the investment that does take place is likely to go into the labor-saving, capital-intensive sector, spurring restructuring.