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Amidst the slow growth in the EU, the persistently high budget deficit and ballooning public debt have become major concerns for many governments in the EU. As a result, they have implemented ‘austerity measures’ to reduce their budget deficit by raising taxes and cutting back on public spending.

Discuss the extent to which the austerity measures in the EU will have an adverse impact on the Singapore economy.[15]

The impact of the austerity measures in EU will have an adverse impact on Singapore and this can be observed from how the slowdown of the economic activities in Europe will affect Singapore’s trading and investment activities and the flow of fund. These adverse impacts can be observed from how it lower our economic growth and employment and worsen the inflationary and balance of payment.

Main body

1. Explain how the austerity measures will worsen the standing of living of Singapore

The austerity measure will cause a slowdown in the economic growth of European Union and this will mean a reduction in the standard of living of the member nations. There will be a reduction in the real GDP per capita of the citizens, which will mean the purchasing power of the people will reduce and this will contribute to a fall in import expenditure made by the member nations. As for firms in these economies, they are likely to face bleak business development and there will be lower revenue and profitability will be adversely affected, influencing the firms in Europe to cut down their investments in Asia and thus, Singapore too. As the economic adversity will also mean that the EU may cut their interest rate to stimulate their economic activities, there is likely an outflow of fund from EU and inflow of fund into Asia and Singapore due to interest rate differences.

2. Explain how the adverse developments in the EU will affect Singapore’s balance of payment

This adverse development in EU will cause a fall in Singapore’s export demand to the EU and the inflow of foreign direct investments from EU into Singapore will be adversely affected. The adverse development in the EU will worsen balance of trade and long term capital account, which undermine production activities while the inflow of fund from EU in terms of hot money will destabilize the short term capital account and the exchange rate of Singapore.

3. Explain how the decrease in export demand and inflow of foreign direct investments will decrease aggregate demand via the reverse multiplier process

The reduction in export demand and the inflow of FDIs will also contribute to the fall in aggregate demand which will lower the value of real GDP via the reverse multiplying effect. In the multiplier process, the initial reduction in aggregate expenditure contracts the circular flow of income and then reduces the income of factor earners, which will further reduce the circular flow of income with further reduction in consumption activities. As long as consumption activities are reduced, circular flow of income will continue to contract at the respective level of economic activities until the withdrawal effect is finally equal to the initial reduction in aggregate demand, which will cease the contraction of circular flow of income. Consequently, the national income will reduce by several folds, depending on the value of the multiplier which is determined by the sum of the MPW (Marginal Propensity to withdraw – MPS + MPT +MPM), indicating that there will be negative growth.

4. Explain, with an aid of the diagram, how the decrease in aggregate demand will decrease real GDP

Economics Tuition - Macroeconomic Policies and Aims of Government - Q7a - Decrease Aggregate Demand Diagram

As seen from the diagram, the reduction in aggregate demand from AD0 from AD1 will lead to a fall in real GDP from Y0 to Y1.

The adverse impact can also be seen from how the rise in unemployment rate as the fall in export demand for Singapore and the reduction in the inflow of FDIs will mean that there is lower production level and there will be lower level of demand for labour. With the rise in unemployment rate and the condition of slow economic growth, this will lower the standard of living as the real GDP per capita falls.

5. Explain how austerity measures contribute to price instability in Singapore

It is also likely that there will be excessive rise in price level, especially contributed by asset-based inflation. Inflow of hot money from EU will raise the money supply in Singapore, lowering down the interest rate to encourage borrowing for speculative activities as seen in property market. This will contribute to the rise in the price of property which are the non-core inflation but are significant in the influence of inflation in Singapore; rising price of property will raise the amount of mortgage payment and this will lead to higher cost of rental which will aggravate cost-push inflation. Consequently, price instability sets in.

6. Evaluate the extent of impact of austerity measures on Singapore’s trade

In this review of the extent of the adverse impact on Singapore, there are several factors to take note. First, Singapore is highly dependent on EU for trade as EU is our largest trading partner and the EU’s main composition of FDIs are mainly in the field of pharmaceutical industries which are Singapore’s key industries. Thus, it is inevitable that Singapore’s economic growth and production level will be affected.

7. Evaluate the extent of impact of austerity measures on Singapore’s economic growth and employment level

Furthermore, the inflow of hot money from EU and other regions like US as investors look for more lucrative returns on their fund will lead to extensive inflow of hot money. As Singapore is an open market and the financial sector is another key industry, it is difficult to restrict the inflow of hot money and its impact on the property market which are likely to be destabilizing on the price level and social stability.

As Singapore’s market demand is from the international market due to the concentration of MNCs in our production capacity, the negative development in EU will affect the global economy, given its significance. This will affect Singapore’s export demand extensively since it is highly export-oriented, given that trade is 4.5 times to GDP. Thus, the impact on economic growth and employment is inevitable and consequential.

8. Explain why Singapore can minimize the adverse impacts of austerity measures affecting the economy

However, it is still possible for Singapore to dampen these adverse impacts as Singapore has been able to diversify the trading dependency with EU by expanding the trading activities with other major trading partners. At the same time, it is also raising the size of domestic market demand through her population growth and development of local enterprises and this will help to raise the local production and employment, thus dampening any adverse impact from EU.

9. Explain how government policies in Singapore can help minimize the adverse impacts of austerity measures in EU

The government of Singapore is also capable to introduce policies like expansionary fiscal policies to help to cushion the unemployment condition with provision of public services. For other problems like inflationary condition, it is able to introduce rues and regulation like Additional Buyers’ Stamp Duty to curb speculative activities. Long term plan like manpower development are also introduced to develop the skills of the workers to raise their skill competency to prepare for problems from EU

In sum, it can be seen that Singapore is greatly affected by the development in EU with issues like austerity measures as Singapore relies extensively on trade and FDIs from EU but the government has attempted to reduce this impact through short and long term policies. It is quite impossible for Singapore to completely shield herself from it but the policies will make it feasible to dampen the impact and make responsive recovery from the adverse situation.

Simon Ng

Founder, JC Economics & General Paper Tutor at Economics Focus
JC Economics Tutor Simon Ng of Economics Focus has been teaching A Level Economics and A Level General Paper since 2003. Simon set up Economics Focus to assist students in their pursuit of academic excellence at the examination by providing economics tuition for H1 and H2 students. JC1 and JC2 students are inspired by Simon's clear teaching methods that enabled them to comprehend economics terms and concepts. Simon developed the Rational Thinking methodology to aid students to excel in their JC economics essays and CSQs.