In the first of a two-part essay on the implications of inflation and rising costs in Singapore, IPS Adjunct Senior Research Fellow Manu Bhaskaran and Research Assistant Ng Yan Hao look at why inflation increased dramatically between 2007 and 2013. Read the second part of the essay here.

When discussing costs in Singapore, it is important to distinguish among three different types of “inflation”. There is consumer inflation where prices of final consumer goods and services go up, which affect the livelihoods of residents. There is asset price inflation, where the prices of assets such as housing property rise rapidly. And there is business cost inflation, where the costs of inputs, be they rentals, labour costs or costs of intermediate goods and components, rise sharply.

All three matter and all three appear to be a challenge to Singapore.

Singapore’s consumer inflation rate over several decades had been typically lower than the trade-weighted inflation of trading partners, such as China, Malaysia and the US. That means that Singapore and the Singapore Dollar were steadily gaining competitiveness over a long period of time. This pattern reversed strikingly in the period 2007–2013, when Singapore’s domestic costs rose much faster than its trading partners, with inflation rising as well as becoming more volatile. A loss of cost competitiveness can take a long time to reverse.

Source: Centennial Asia Advisors

Between 2006 and 2015, the Consumer Price Index (CPI) grew by 2.79%. However, several prices showed above-average inflation, namely, housing and utilities (4.44%), transport (3.30%), education (3.29%) and food (2.90%). In particular, accommodation registered high growth rates of 4.94% from 2006–2015.

Rising Business Costs

Businesses too faced rising costs. For example, aggregate manufacturing data from the EDB’s Census of Manufacturing Activities 2013 showed that growth in total business costs in manufacturing from 2004 to 2013 compounded by 5.37% year-on-year. The figure was 4.81% for materials, 4.9% for remuneration and 7.71% for operating costs, including rentals. This led to a fall in net operating surplus margins from 13.02% in 2004 to 10.51% in 2013.

Indeed, rental costs for commercial retail have increased by 20.7% and 12.6% in Central Area and Fringe Area since Dec 1998. In the office rental markets, suburban and prime office rents have seen 52.8% and 92.3% in total growth over the period 1998 to 2014, with much of the increases occurring during 2005–2014. In the industrial space, the median monthly rental rate for multiple-user factory and warehouse space rose by 92.9% and 64.8%, respectively, between 2005 and 2013.

The persistence of high business costs compromises the development of an enabling environment for startups and the startup ecosystem, and raises overall entry barriers across industries, favouring the incumbents and reducing the level of competition in the economy.

High business costs also reduce the capacity of smaller firms to invest in capability development and R&D, and increases the need for government subsidy and grants in these areas, with its associated problems of handout dependency, informational inefficiencies and bluntness of policy tools.

Source: Census of Manufacturing Activities, 2013 (EDB)

What caused the inflation?

Between 2007–2013, high inflation was caused by:

• Increased global liquidity: Low interest rates and loose global credit conditions contributed to credit growth, spurring asset inflation and business cost pass-through as well as increased business activity that contributed to the output gap.

• Rising property prices: Population and income growth has contributed to rising asset prices; in addition, the privatisation and institutionalisation of retail space has led to the removal of implicit subsidies and the escalation of rents to market prices, which led to corresponding cost pass through to consumer costs.

• Positive output gap: The economy was running at a positive output gap through most of the period. Due to high demand pressures, it was producing at a high rate of capacity utilisation, which led to corresponding price increases as unit production costs rose.

• Reduced effectiveness of exchange rate targeting in controlling inflation: Population growth and lags in infrastructure development led to reduced excess capacity in the domestic economy. Expectations of gradual appreciation of the Singapore Dollar resulted in low domestic interest rates and domestically-sourced inflation (see IPS: The Seventeenth Singapore Economic Roundtable); which were exacerbated by conditions of land scarcity that increased transport and accommodation rents.

 

Over the longer term, the rise in costs are partly a consequence of a policy shift by the government. Where Singapore’s growth model used to be based on its cost competitiveness, the price mechanism — where the forces of demand and supply determine prices — has been adopted to move Singapore towards a higher value-added economy.

Thus, the combination of state-subsidised industrial land and housing, low labour costs, and exchange rate appreciation aimed at keeping inflation low before 2004 has given way to privatisation of retail and industrial space aimed at introducing market efficiency and increasing the productivity of existing land and labour resources. Since 2013, inflationary pressures have come from tightening in the labour markets.

However, the tendency of markets to exhibit excessive price volatility has led to a period of adjustment in which existing policy tools to calibrate price increases have been relatively less effective in a domestic economy which has become more market-driven.

Despite a disinflationary monetary policy and the introduction of successive rounds of property cooling measures from 2009–2014, inflation still averaged at 4.2% from 2010–2012, which was the longest period of sustained inflation above 4% in Singapore’s history.

This calls for a continuous review of the policy tools to contain rising costs given the market conditions and underlying constraints.

Manu Bhaskaran is an Adjunct Senior Research Fellow and Ng Yan Hao is a Research Assistant at IPS. Their work focuses on the causes and impact of rising costs in Singapore.

Top photo from wikipedia