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By The Independent

Good news on GDP. But MTI confirms that importing more foreign workers in 2003-2008 led firms to substitute workers for machines, dampening productivity growth.

The Ministry of Trade and Industry increased its GDP forecast significantly, from the 1% to 3% range to the 2.5% to 3.5% range. This came on the back of a final Q2 GDP figure that was higher than the flash estimate: 3.8% versus 3.5%. The quarter-on-quarter figure – a scorching 15.5% versus an anemic 1.7% in Q1 – suggests an economy picking up momentum.

All this will come as a relief to Singaporeans and rightly so. However the report makes clear that structural improvements remain elusive. Singapore citizens unemployment rose slightly, and productivity growth, while significantly improved, is still negative.

The improvement on the GDP front was essentially driven by four factors:

a stellar performance from financial and insurance services, especially “financial intermediation and sentiment-sensitive clusters”

a less-bad-than-expected manufacturing performance thanks to biomedical production

decent growth in business services, particularly engineering and architectural services; and

an uptick in wholesale services, driven by electronics re-exports.

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Unemployment rose slightly, from 1.9% in Q1 to 2.1% in Q2. The unemployment rate for Singapore citizens, however, stubbornly stood at 3.1%, up from 3% in Q1 and higher than that for the population as a whole, in line with historic norms.

The Q2 Economic Survey paints a picture of an economy that is being increasingly defined by two things: services as a growth driver, and productivity growth as a speed-bump.

Much of the growth in the past few quarters has come from services. In Q2 2013, some sub-sectors stood out as growth turbo-chargers: financial services, retail and tourism, logistics and professional services. Tourist arrivals, for example, rose 7.5% year-on-year in Q2, driving revenue in hotels and food-services.

Clearly these rising stars should command maximum attention from both policy-makers and companies, so that Singapore can wring even more high-value exports and productivity increases from these sectors. At the same time, risks from an overly exuberant financial services sector need to be watched closely. The recent policy moves in respect of mortgage financing show that MAS is taking a vigilant stance on this front.

The manufacturing sector is also showing signs of improvement, but some of this is due to the artificial stimulant from bio-medical exports, which are notoriously volatile and tend to drive export figures more than job creation. Manufacturing contributed very little to net job creation in Q2. However manufacturing does seem to be on an upswing, with robust quarter-on-quarter growth. Moreover, the manufacturing sector does have many positive linkages with services industries such as finance, construction and professional services. The bigger question may be how to restore manufacturing’s role as a mid-to-high end job creation engine.

MTI’s optimistic prognosis for the second half of the year may yet be challenged by some economic realities. The fact that external demand grew 3.1% in Q2 while contracting 4.1% in Q1 suggests that the full effect of the Q2 slowdown in China, to which Singapore is more vulnerable than many other economies, has not yet been fully felt. Financial services growth may be crimped by an outflow of global funds into the US as the US dollar appreciates on the back of Fed tapering. Moreover, MTI’s composite of leading indicators – its basket of more predictive indicators of economic performance – showed a mere 0.2% increase in Q2, versus a 0.4% hike in Q1. This suggests that the outlook is less sunny than might be thought.

On productivity growth, some improvement was noted in Q2. Labor productivity fell by only 0.3% in Q2, in contrast to the 3.8% drop in Q1. However this is probably due in large measure to the pick-up in economic growth, which tends to give productivity a short-term lift. Moreover, the picture differs sharply by sector, with productivity growth being pulled up by financial services (which grew by a whopping 10%) and contracting significantly in almost all other sectors. In tackling the fundamental structural impediment of low productivity growth, a hard struggle lies ahead.

Perhaps the most striking element in MTI’s Q2 report was an econometric study that demonstrated how the liberalization of foreign worker importation in 2003 to 2008 led companies to substitute workers for machines, with dampening effects on productivity growth. In mitigation, the MTI report did point out that the substitution effect was small and the “the government has already taken steps to reduce firm’s reliance on low-skilled FWs”. This is in keeping with the past practice in government statements of qualifying admissions of past policy mistakes by pointing out that corrective measures have already been taken. However this still leaves one question unanswered – do the measures that have been taken to control FW influx go far enough?

While this conclusion is hardly surprising and has been the opinion of many commentators and economists for years, the MTI team should be commended for their intellectual honesty in publishing this conclusion so forthrightly. This admission is a timely reminder of the urgency of Singapore’s productivity challenge. It is also a useful warning to future generations of policymakers about the perils of putting headline GDP growth on steroids, to the detriment of long-term economic fundamentals.