Macroeconomics[Problems & Policies]
1
Policies to solve Unemployment
Fiscal Policy:
Solution for demand-deficient recession was for the
government to spend on the people’s behalf. Eg. Singapore
government’s 2009 budget of $20.5 billion and US$787
billion fiscal stimulus in the USA in 2008.
In addition, income tax cuts are adopted to raise people’s
disposable income, and hence domestic consumption.
Corporate tax rates are reduced to increase after-tax
profit of the firms, and increase their expected rate of
returns, hence encouraging more investment. Given an
autonomous increase in investment, it will increase the
level of AE and lead to an unplanned decrease in stocks. As
firms increase production to raise stock levels back to the
desired levels, they will hire more workers, thus
employment levels rise. This will generate income for
households employed by firms in the capital goods
industry. These households tend to spend a proportion of
their additional income on consumption, depending on
their MPC. This further creates additional income on
consumption. This cycle of spending and re-spending on
consumption will continue until increase in income
becomes negligible. The eventual increase in NI is several
times the initial increase in AE. The multiplier k thus
represents how many times the NI increases will respect to
the initial change in AE.
Limitations
Size of multiplier: In Singapore, due to very high
withdrawals from the circular flow in the form of savings
and import expenditure, the size of the multiplier is very
small. High savings in Singapore is caused in part by the
Central Provident Fund scheme, which enforces over 30%
of earned income by households to be saved, and in part
due to conservative finance by the government, keeping
the budget almost always in surplus. The high level of
imports has been a result of limited resources and hence
Fiscal Policy is defined as the use
of government spending and/or
taxation to influence the level of
economic activity through the
aggregate demand (AD)
Monetary Policy is the deliberate
attempt by the Central Bank to
regulate the money supply or
manipulate the interest rate or
exchange rate to influence the
level of economic activity so as to
achieve economic and social
objectives such as maintaining full
employment, curbing inflation,
attaining economic growth and a
satisfactory balance of payments
position
Supply-side policies are mainly
micro-economic policies designed
to improve the supply-side
potential of an economy, make
markets and industries operate
more efficiently and thereby
contribute to a faster rate of
growth of real national output
SR SSP: reduce business costs
during recessions/inflation
LR SSP: improve productive
capacity of economy and make
markets and industries operate
more efficiently
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Macroeconomics[Problems & Policies]
2
most of our inputs for production as well as consumption are imported. The resultant small size
of the multiplier meant that even if the government were to raise its spending, the eventual effect
on NI would be rather limited.
Small proportion of government spending: given the relatively small size of government spending
relative to other components of AD, a fall in export revenue of say 5% would require an increased
government spending by some 100%, as export revenue is more than 20 times government
spending. This alone makes fiscal policy infeasible as a demand management policy tool.
Time Lags: There is often a serious time lag between the identification of the problem to be dealt
with and the time when the fiscal measures begin to take effect. This may mean that fiscal policy
takes effect at the wrong time. Hence, fiscal policy could even be destabilising when such time lags
are considerable. For example, expansionary fiscal policy to stimulate unemployment may not
come into effect until the economy has recovered. This may result in an overheated economy
instead.
Crowding-out effect: If the government chooses to finance their increased expenditure through
borrowing from the banking system, there will be an increase demand for loanable funds, and
hence an increase in interest rate. As a result, private businesses will cut back on investment.
Hence government spending crowds out private spending – consumption and investment.
Therefore, the increased government spending may simply be offset by lower private household
consumption and lower private sector investment.
Evaluation: Although fiscal policy may not be as effective for an economy with low multiplier like
Singapore, given ΔNI= ΔAE x k, even k is small for Singapore, an increase in AE will still lead to
increase in NI, which is better than no increment at all to offset the falling NI during recession.
Thus, knowing k is small due to huge leakages, the Singapore government still uses fiscal stimulus
with a supply-side slant and spend on projects such as training and infrastructure.
Monetary Policy: i/r
Generally, an expansionary monetary policy is adopted when the government, through the
Central Bank, seeks to reduce interest rates. This will in turn encourage consumption and
investment since the cost of borrowing is lower ie. AD will rise and real output will increase,
creating more employment. Alternatively, the Central Bank will increase the money supply in the
economy by buying bonds or printing money, which will lead to a fall in interest rates, to stimulate
production and to increase the level of economic activity.
Exemplification: Generally during times of recession and high unemployment, central banks tend
to keep interest rates low. One way interest rates can be kept low is by injecting liquidity into the
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Macroeconomics[Problems & Policies]
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economy via the purchase of bonds from the public through the workings of the open market
operations or a reduction in the banks’ liquidity ratio.
With the interest rates remaining low, this means that the cost of borrowing for the firms will be
reduced and hence the expected rate of return on private investments will increase, leading to a
greater incentive for firms to increase their level of investment. At the same time, the cost of
borrowing for the average household is reduced, and this will lead to an increase in autonomous
consumption.
Moreover, there will be an outflow of hot money as short term investors convert US$ for foreign
currency to earn arbitrage from the speculation exercise, thus leading to an increase in the supply
of US$ in the foreign exchange market. As a result, the value of US$ drops, and exports will be
encouraged while imports discouraged. Assuming Marshall-Lerner condition holds, net exports
will increase
With an increase in domestic consumption, net exports, and investment, AD will rise, leading to
unplanned fall in stocks. Producers will thus demand more factors of production during the next
round of production to maintain stock levels and hire more workers. This will reduce cyclical
unemployment.
Limitations: depends on interest elasticity of C & I. Changes in C and I are greatly influenced by
consumers’ and investors’ economic outlook. Generally, a pessimistic outlook among producers
and consumers will limit the growth in C or I even though interest rate is kept at a low level.
Also, even when the Federal Reserve reduces the interest rate, commercial banks which are
saddled with bad debts will scrutinize the borrowers and will be unwilling to give out loans easily.
Moreover, a low interest rate may not be effective to stimulate a pickup in employment if the
problem of unemployment is due to structural rigidities. In light of the financial crisis, US firms
had outsourced jobs to lower wage countries such as India or China to reduce cost. This source of
unemployment is unlikely to be affected by changes in interest rates. Also, in the case of a
liquidity trap in Japan, interest rates are regarded to be lowest possible rate, and everyone only
expects it to increase. This makes any expansionary MP ineffective to stimulate C & I.
Monetary Policy: Exchange Rate
Monetary Authority of Singapore (MAS) adopts a gradual and modest appreciation of S$ to
ensure price stability which will lead to economic growth. However, during times of high
unemployment, MAS has shifted its stance. By depreciating the S$, it makes Singapore’s exports
cheaper in terms of foreign currency, and hence allow the exports to gain price competitiveness.
Assuming PEDx > 1, quantity demanded of Singapore’s exports will rise more than proportionately
and hence increase export revenue (X), improving trade of balance, and subsequently an increase
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in AD. Since there are unplanned fall in stocks, producers will hire more workers to meet this
shortfall and hence cyclical unemployment will be solved.
Limitation: However, considering that Singapore’s exported goods’ PEDx might be <1 due to the
nature of our exports and lack of substitutes: high value-added capital intensive goods such as
microchips and refined oil, with few substitutes. Hence given a fall in price, quantity demanded
may only rise by less than proportionately, leading to an actual fall in X instead.
Moreover, Singapore’s PEDm is also likely to be less than 1, due to the fact that she has limited
natural resources and needs to import for consumption and production of exports. Hence,
depreciation of S$ will lead to a less than proportionate fall in quantity demanded for imports and
overall increase in M. Hence, net exports will fall, leading to a fall in AD and hence worsening of
the unemployment situation.
It may also lead to import price push inflation in SG due to Singapore’s exports having high import
content.
Evaluation: However, as long as the Marshall-Lerner condition holds, net exports will still
increase, though one has to take note of the J-curve effect which shows that depreciation will first
worsen the BOT before eventually improving it due to the less responsiveness of both quantity of
exports and imports to price change at the beginning as time is needed for people to adjust to try
out new alternatives and some contractual obligation.
Supply-side policies: Cyclical Unemployment
CPF system
The CPF system is a compulsory savings plan requiring both the employees as well as the
employers to make monthly contributions to each employee’s CPF account. During 1985 recession,
the government reduced the employer’s CPF contribution from 25% to 10%, effectively lowering
labour costs of all firms without hurting employees’ take home pay. This helped trim costs of
productions significantly, allowing many firms to retain a large portion of their work force with
minimal retrenchments. By changing the size of the wedge, the government is able to lower
labour costs and hence production costs without affecting disposable income, thereby
cushioning the effects of a falling aggregate demand on cyclical unemployment. Also, other cost
cutting measures such as corporate tax rebates, utilities rebates, and rental rebates were adopted
in 1999 to help firms stay in the black.
Flexible Wage System:
The system was to replace the need for the government to initiate wage cuts or wage freezes
necessary to counter cyclical unemployment. This system incorporated an annual wage
supplement (AWS) and a monthly variable component (MVC) that varied with the performance of
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the economy as well as the firm. These flexibilities allowed firms to adjust labour cost by adjusting
wages so that they could avoid having to retrench workers as much as possible.
Supply-side policies: Structural Unemployment
Unemployed workers often do not have the skills demanded by employers. Structural
unemployment arises when changes in technology or international competition change the skills
needed to perform jobs or change the location of jobs. People are made redundant in one sector
of the economy cannot immediately find jobs elsewhere because they either do not have the
necessary skills or are unwilling to move to another area where prospects are better(occupational
and geographical immobility of labour).
The result of structural decline of industries and changing skill requirements result in a mismatch
between the workers’ skills and job requirements. Such a structural change can arise from demand
side or supply side:
1. There is a permanent fall in the demand for the product of a particular industry, output is
reduced
2. Supply is not forthcoming
3. More capital is used to substitute for labour (technological unemployment)
Exemplification: caused by structural changes in the SG economy coupled with occupational
immobility of labour. Unlike cyclical unemployment, this is typically industry specific as structural
changes may arise due to shifting comparative advantage or industry specific technological
advancements. For example, in recent years, the restructuring of the Singapore economy towards
a KBE has led to the demise of many labour intensive and low-end capital intensive industries in
Singapore. Many of the workers who were displaced in these sunset industries found that while
the job market had other vacancies, they did not possess the necessary skills to take on those jobs
and hence remained unemployed.
Retraining
The government focuses its spending on retraining of workers displaced from these industries,
helping them acquire new skills to enter the new industries which had arisen as a result of shifts in
comparative advantage, thereby easing structural unemployment. For Singapore, firms could tap
on the Skills Development Fund (SDF), as well as the Skills Programme for Upgrading and
Resilience (SPUR) which was implemented during the 2009 Budget. These initiatives provide
subsidies to firms who sent their workers for re-training or upgrading course so as to raise labour
productivity and retain their employability.
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Macroeconomics[Problems & Policies]
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Limitations: Given the changing requirement for labour skills, many of the redundant workers for
the older industries are simply not qualified for new jobs that are created. What is more, the
longer people are unemployed, the more demoralised they become. Employers would probably be
prepared to pay only very low wages to such workers. To persuade these unemployed workers to
take low-paid jobs, the welfare benefits would have to be slashed. Moreover, the cost of providing
or subsidising training can impose a burden on the government budget. There is also great
resistance in acquirement of new skills, especially among old workers. Furthermore, workers who
are lacking in basic education and literacy may find the acquisition of new skills to be extremely
difficult.
Supply-side policies: Frictional Unemployment: arises because of imperfect information in the
labour market as it takes time for workers to be matched with suitable jobs. Aka search
unemployment. Since both employee and employer spend time searching for what they believe
will be the best match available, frictional unemployment arises.
Exemplification: In Singapore, this is caused by imperfect information in the labour market.
Workers typically require time to go through the job search process. Inefficiency of information
exacerbates this delay, and jobseekers who are frictionally unemployed are usually unemployed
for short periods of time. In SG, school leavers typically take on average 3 to 6 months to get a job.
It should be noted that frictional unemployment will be made worse by cyclical unemployment,
where they are fewer jobs on the market.
Limitations: much of the success of policies that focus on improving labour market information
lies with the attitude of the job seekers, whether they are keen to get employed sooner.
Moreover, with the job fairs, frictional unemployment may not be solved quickly since workers
have more choices of employers to choose from and vice versa. This would have lengthened the
job searching process.
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