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Speech by Mr Tharman Shanmugaratnam, Minister for Finance, at the Launch of Economics in Public Policies The Singapore Story, at the Lee Kuan Yew School of Public Policy on 22 July 2009 at 5.00 pm

23 Jul 2009

Mr Kishore Mahbubani
Dean, Lee Kuan Yew School of Public Policy

Mrs Tan Ching Yee
Permanent Secretary, Ministry of Education

Distinguished Guests

Ladies and Gentlemen

A very good afternoon to all. I am happy to see among the audience today many students from our junior colleges, and their Economics teachers.

2. We had planned for this launch to be held at an earlier date. It was pure serendipity that we ended up holding this launch today, for the 22nd of July marks the 80th anniversary of the official opening of the Bukit Timah Campus.

The Bukit Timah Campus

3. From the time the Bukit Timah campus was built in the 1920s, it has been the crucible of higher education in Singapore not once, but a few times over. It has been home to Raffles College; the University of Malaya (1949-1962); the University of Singapore (1962-81); the Institute of Education which then became the National Institute of Education (1982-2001); and the first home of the Singapore Management University in 2001. In August 2005, things came full cycle, when the campus became part of the National University of Singapore, the successor institution of Raffles College.

4. Its transitions mirror Singapore's short but eventful history. Each transition a new confidence and a new investment in our youth.

5. Kishore has already spoken about how this campus in Bukit Timah nurtured generations of Singapore leaders. In fact, MM Lee Kuan Yew met Dr Goh Keng Swee here during their student days. The campus also produced several Malaysian leaders, including Tun Abdul Razak who was Malaysia's second Prime Minister.

6. You could say that the campus was an investment in educational infrastructure that yielded extraordinary returns for Singapore. The architects of Singapore's economic strategies, and the early generations of professionals and captains of industry spent their formative intellectual years here.

7. Ironically, when Raffles College was first started in 1928, it taught only Arts and Science subjects relevant to the teaching profession. A proposal to establish an Economics department was opposed by officials in the colonial administration for fear of Raffles College heading towards becoming full higher education institution. It was not until 1933 that a Readership in Economics was inaugurated, in response to overwhelming demand for economics courses. Not coincidentally, this was also the same year the Straits Settlement Civil Service was formed, in response to similar pressures to move locals into higher echelons of the civil service.

''Economics in Public Policies - the Singapore Story''

8. The study of economics, and public policy, it would seem, went hand-in-hand even back then, and the Bukit Timah Campus was at the centre of it all. It is thus a most fitting venue for today's launch of the book ''Economics in Public Policies - the Singapore Story.''

9. The book provides a significant contribution to public education. It deciphers and explains the economic reasoning and principles underpinning Singapore's public policies. It covers a wide range of areas, ranging from fiscal policy, to microeconomic analyses of Singapore's policies in transport, healthcare, labour and education.

10. I have no doubt about the value of the book to our JC students, and indeed for university students. It would give them an understanding of the role that economics plays in designing sound policies, and of the art of policy-making that takes social and political realities into account before arriving at the final shape of policies.

11. It will also be very relevant reading for our civil servants, who in almost every field will find that their work involves economic reasoning and choices - what to spend on; whether there are market failures or externalities that warrant a role for Government; how Government services and the use of public infrastructure should be priced to encourage efficient use; or how citizens with lower incomes can best be helped. The book will also give both Singaporeans and interested foreigners insight into the thinking that lies behind public policies in Singapore, and provide a framework for useful discussion and debate on the policy options we face as we go forward.

12. This is in fact one of the best, accessible books that I have come across on the economics of public policy. MOE and the LKYSPP have done us all great service in publishing the book. I congratulate especially the team of education officers who put great effort into researching and writing the book, and all those who reviewed the various chapters or lent their expertise and advice in various other ways.

Economics in Crisis

13. A book on why economic principles work for sound public policies is timely coming at a juncture when economics is facing a crisis of faith around the world. The world is in the worst recession since the Great Depression. The IMF expects the world economy to contract by 1.4% in 2009, with every developed economy in deep recession, and to expand only modestly in 2010.

14. The first crisis is in macroeconomics. Many economists did point to the unsustainability of the US housing bubble and the under-pricing of investment risks. But few economists (or for that matter non-economists), expected the complete meltdown of the financial system. Mainstream macroeconomics has provided little insight into the workings of financial markets. Like many banks and financial market participants, economists typically assumed away the possibility of markets running out of liquidity - where funds dry up, short term debts cannot be rolled over and securities cannot be sold - which is what we saw in extreme form over the last year.

15. The other crisis is in microeconomics. An overriding faith in efficient financial markets (the ''efficient-markets hypothesis''), amongst both financial market participants and the leading regulators, contributed to this crisis. The crisis has dramatically underlined what history has repeatedly shown - that markets often do not price financial assets correctly; and that herd behaviour amongst investors allows mis-pricing and deviations from underlying value to last for a long time. Bubbles are not the exception but a recurrent phenomenon, and their eventual correction can be destabilizing.

Economic fundamentals still matter

16. The no-holds-barred view of market efficiency has therefore not been borne out in reality. But to throw out all economics would be a gross overreaction. The fundamental economic principles that underlie public policy have not been much dented in the crisis. However, application of these fundamentals, whether in macroeconomics or microeconomics, has to be pragmatic, and shaped by reasoning and evidence rather than ideology.

17. The book explains many of these principles, which continue to guide public policy in Singapore. It focuses especially on the microeconomics, or the reasoning underpinning the way we allocate scarce resources and redistribute incomes. I will take this opportunity to highlight just a few principles behind public policy, which I will summarise under the rubric of 3 'S's - sustainability, scarcity and support for the poor. I will start with sustainability in macroeconomic policies.

A. Sustainability - Deficit spending helps in recession, but only if everybody knows it can be funded

18. The evidence shows on balance that counter-cyclical macro-economic policies can work - such as running fiscal deficits when the economy slumps and running surpluses in good times. But deficit spending only works if it is not the beginning of process that will be unsustainable. If deficits are temporary and a clear exit strategy exists, they can provide a stimulus to an economy at a time when global or private domestic demand is down, and avoid larger losses in employment. But if people believe that deficit spending will lead to an unsustainable build up of government debt - that must result in higher inflation, higher interest rates for private borrowers or higher taxes in the future - the impact of government deficits will be dented by a loss of confidence and lower private spending. The confidence that can be brought by a government's fiscal stimulus can be taken away by what everyone can see in a government's projected debts.

19. Treasuries around the world have rolled out sizeable fiscal stimulus packages in the last year. In Singapore, we have budgeted for a large deficit through a Resilience Package aimed at supporting the economy and jobs at a time of unprecedented global crisis. Our basic budget balance of 6.0% of GDP, including Jobs Credits and other measures to help both employers and workers, is providing substantial fiscal support for the economy- with much of the impact being seen upfront, in 2009.

20. The case for strong fiscal responses in the last year was bolstered by the fact that this was an unconventional crisis of confidence caused by a breakdown in the financial system, as much as a conventional crisis of demand. Governments had to do what was necessary to reduce the risks of an uncontrolled downward spiral in their economies, and in the global economy. There was a very real risk of a self-reinforcing cycle of weakening confidence, job losses, home wealth destruction, consumption declines, losses in banks and further credit tightening. Governments had to step in, not just to mitigate the decline in demand, but to avoid a downward spiral in confidence.

21. The risk of an uncontrolled downward spiral has receded, but demand remains weak and is likely to stay that way for quite a while. However, Governments around the world are now more constrained in their ability to offset the reduction in private demand through further fiscal stimulus. Most governments have spent their bullets.

22. This is one of the most serious challenges that Governments, especially in the leading economies, face today. The protracted recession would normally call for further deficit spending by Governments. But there are also growing concerns about an already unsustainable fiscal situation. (The government deficit is already above 10% of GDP in the US, and public debt is projected to double as a share of GDP by 2014.) Confidence is eroding in governments' ability to fund these future debts, and fear is growing about the eventual hangover that the debts will bring.

23. Governments in many of the leading economies are therefore in a quandary. They are damned if they do, and damned if they don't. In fact, while they would have been damned six months ago if they did not implement substantial fiscal stimulus programmes, they will increasingly be damned if they don't.

24. There is however a simple underlying lesson for us that this crisis has underlined. If governments run deficits during good times, as many have, they will be constrained from doing the right thing in bad times. Sound public finances provide the fiscal buffer for government to undertake countercyclical policies when really required. Equally, short-term fiscal measures designed to cushion the economy during a severe downturn will have to be phased out as the economy gains a sounder footing. Otherwise, they weaken prospects for future economic growth.

B. Scarcity: Pricing of common resources is the most efficient and fair solution

25. Beyond macroeconomic investments and stability, rational microeconomic policies are required to ensure that scarce resources are allocated efficiently, and that there are incentives for every business and individual to innovate and upgrade.

26. Every economics student knows that prices allow for resources to move to where they are most needed. Pricing is generally straightforward in most markets for products and services, but gets complicated when it comes to public resources for which there are no markets. Such public infrastructure and scarce resources have to be managed to prevent overuse. What experience in Singapore and abroad shows is that the price mechanism offers efficiency, certainty, and ease of implementation. It also generates revenues which can then be used to mitigate the impact of any such taxes, particularly on the lower income groups.

Road Pricing

27. Roads are a classic example of a common resource. Each motorist - that's everyone here who drives - only considers his own travelling time, but not his impact on others. Roads tend to be congested in every city as result, with costs that range around 1-2% of GDP in most cases. The intuitive solution is to increase the supply of roads. But experience in most cities has shown that increased supply leads to at least as much increased demand to use roads. Congestion is eventually unchanged. Thus, some control over road usage has to be the key part of the solution to congestion.

28. The most direct way to do so is through road pricing. A small shift in traffic volumes can boost traveling times significantly. When a new ERP gantry was installed on the CTE before the PIE exit in November last year, there was a 10% drop in traffic volume between 6-7pm. This 10% shift was enough to improve speeds, up to 50kph, which was a 50% increase in traveling speeds.

29. However, road pricing is not our only tool. We also tax and restrict car ownership. There are at least two good reasons for this. First, many people will want to drive a car after buying it, regardless of the marginal costs of using the car on the road. Second, there is a need to restrict the total volume of cars owned, in order to limit peak traffic. Most rush hour traffic is into and out of the CBD. Setting a quota for ownership of cars - and allocating the quota through COE pricing - mitigates the worst traffic jams by limiting the peak load in the CBD.

30. It therefore also makes sense to tax car ownership. Nonetheless, taxing car ownership will always be more blunt than road pricing. A balance of all three tools is therefore required to manage traffic effectively.

31. Singapore is not the only one adopting these tools. Many cities have started adopting some form of these tools - London, Stockholm and Oslo have congestion charges. Shanghai has car quotas, and is considering road pricing as well.

Water Pricing

32. Water too is a scarce resource. Our local catchment water is complemented with water from Johor, recycled water (Newater) and desalinated water. As local demand rises in tandem with economic growth, demand for water will continue to grow. Singapore will then need to tap more and more on the expensive ways of getting water - Newater and desalination. These will take time to ramp up, and will also be more costly.

Continuation of speech in Part II.