The Role of the Global Economy in Financing Old Age: The Case of Singapore

Asher, Mukul G. Working Paper The Role of the Global Economy in Financing Old Age: The Case of Singapore ADBI Research Paper Series, No. 37 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Asher, Mukul G. (2002) : The Role of the Global Economy in Financing Old Age: The Case of Singapore, ADBI Research Paper Series, No. 37, Asian Development Bank Institute (ADBI), Tokyo, https://hdl.handle.net/11540/4143 This Version is available at: https://hdl.handle.net/10419/111128 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/ ADB INSTITUTE RESEARCH PAPER 37 The Role of the Global  Economy in Financing Old Age: The Case of Singapore Mukul G. Asher May 2002 ADB INSTITUTE TOKYO ASIAN DEVELOPMENT BANK INSTITUTE ASIAN DEVELOPMENT BANK INSTITUTE Singapore is the only high-income, rapidly ageing country to rely almost exclusively on a mandatory savings second tier central provident fund to finance old age pensions. This fund’s broad and significant investment activities has enabled it to become a substitute for the mortgage market. Yet the development of financial and capital markets may be adversely affected because of such concentrations of savings. International diversification of the asset portfolios of pension funds will be important in the future to generate the income growth necessary to fund pension schemes. The author lays out the fundamental reforms which are needed to provide economic security to the elderly in Singapore. ADB Institute Research Paper Series No. 37 May 2002 The Role of the Global Economy in Financing Old Age: The Case of Singapore Mukul G. Asher II ABOUT THE AUTHOR Mukul G. Asher is the Professor of the Public Policy Program at the National University of Singapore. He was a Visiting Scholar at the ADB Institute during the final quarter of last year. Prof. Asher specializes in the economics of social security and is a frequent consultant and resource person for the United Nations and World Bank groups. ADB INSTITUTE RESEARCH PAPER 37 Additional copies of the paper are available free from the Asian Development Bank Institute, 8t h Floor, Kasumigaseki Building, 3-2-5 Kasumigaseki, Chiyoda-ku, Tokyo 100-6008, Japan. Attention: Publications. Also online at www.adbi.org The Research Paper Series primarily disseminates selected work in progress to facilitate an exchange of ideas within the Institute's constituencies and the wider academic and policy communities. The findings, interpretations, and conclusions are the author's own and are not necessarily endorsed by the Asian D evelopment Bank Institute. They should not be attributed to the Asian Development Bank, its Boards, or any of its member countries. They are published under the responsibility of the Dean of the ADB Institute. The I nstitute does not guarantee the accuracy or reasonableness of the contents herein and accepts no responsibility whatsoever for any consequences of its use. The term "country", as used in the context of the ADB, refers to a member of the ADB and does not imply any view on the part of the Institute as to sovereignty or independent status. Names of countries or economies mentioned in this series are chosen by the authors, in the exercise of their academic freedom, and the Institute is in no way responsible for such usage. Copyright © 2002 Asian Development Bank Institute & M.G. Asher. All rights reserved. Produced by ADBI Publishing. III PREFACE The ADB Institute aims to explore the most appropriate development paradigms for Asia composed of well-balanced combinations of the roles of markets, institutions, and governments in the post-crisis period. Under this broad research project on development paradigms, the ADB Institute Research Paper Series will contribute to disseminating works-in-progress as a building block of the project and will invite comments and questions. I trust that this series will provoke constructive discussions among policymakers as well as researchers about where Asian economies should go from the last crisis and recovery. Masaru Yoshitomi Dean ADB Institute IV TABLE OF CONTENTS About the Author II Preface III Table of Contents IV 1. Introduction 1 2. Economic, Demographic and Labor Force Characteristics 2 3. Current Pension Arrangements in Singapore 6 4. Singapore’s Pension System and the Global Economy 14 5. Suggestions for Reform 19 Figure and Tables (in body of text) Figure 1. Singapore’s CPF: Average Annual Compound Growth Rate (AACGR %) 8 Table 1. Singapore: Macroeconomic Indicators, Selected Years 3 Table 2. CPF Withdrawals by Members Migrating Abroad, 1990-2000 15 References 22 1 The Role of the Global Economy in Financing Old Age: The Case of Singapore Mukul G. Asher 1. Introduction As Singapore has grown into a more affluent and rapidly ageing society, the issue of financing the aged has become more pressing, requiring reassessment of the country’s existing arrangements. This paper thus examines the role of the global economy in financing the aged in Singapore and suggests possible reforms. There are two broad avenues through which the global economy could assist in financing old age. This follows from the well-known proposition that the economy’s growth rate is the most important variable in providing economic security to both the young and the old (Barr, 2000; Orszag and Stiglitz, 2001). To enhance the growth rate, an appropriate level and type of integration with the world economy is needed. As Rodrik (2001) has argued, globalization should not be regarded as a shortcut to development; and there is no alternative to a home-grown business plan that not only takes advantage of opportunities in international trade and investment, but also mobilizes the capabilities of domestic institutions and investors. This is of relevance to Singapore as it has set up an Economic Review Committee (ERC) to recommend ways to find new growth niches in the globalized era, and to sustain its international competitiveness (for details of the terms of reference and composition of the ERC, see www.mti.gov.sg). One of the seven sub-committees of the ERC is on taxation, the CPF system, wages, and land. The second broad avenue concerns international diversification of pension fund assets, designed to obtain higher risk-adjusted returns. In 2000, total worldwide pension assets, both private and public, amounted to US$12.2 trillion, and these are projected to increase to US$18.2 trillion by 2005 (InterSec Research Corp., 2001, Table 12, p.8). According to the study, non-domestic investment as a proportion of the total was 70 percent for Hong Kong, China; 32 percent for Europe; 21 percent for Japan; 11 percent for North America; and only 3 percent each for Latin America, Africa, the Middle East and non-Pacific Asia1 (Table 13, p.9). In US dollar terms, 97.5 percent of non-domestic investment was by North America, Europe and Japan (Table 14, p.10). The study does not specify the destination of non-domestic funds, but it would be reasonable to assume that these three entities invest primarily among themselves. This is not surprising as ageing trends tend to differ considerably among these countries (Dang et al., 2001, Table A1, p.44), providing opportunities for higher rates of return and/or risk diversification (Reisen, 2000). While the share of emerging markets in cross-border pension investments is growing, it is likely to remain relatively minor. Because of this, and because of the various politically and economically challenging requirements, 1 The study reports that Singapore’s provident and pension funds had no investments abroad. Reasons for such an understandable error will become clear in Section 2. 2 investments in emerging markets could only be a minor factor at best in addressing the financing of the aged in the more affluent countries (Holzmann, 2000). The above discussion suggests that using the global economy to finance the aged is a major challenge. There is a need to carefully design, implement and constantly monitor measures undertaken to achieve this objective. For a small open economy such as Singapore, it may be useful to systematically monitor the difference between gross domestic product (GDP) and gross national product (GNP) as a possible indicator of the extent to which the objective is being achieved. This is because it is the GNP that is potentially available for the consumption of the citizens, therefore it should exceed the GDP by an adequate margin to help finance the aged. The word “potentially” in this context is particularly relevant for Singapore, because currently there is no mechanism to channel income from investment of national provident fund savings abroad to benefit the members (see Section 3). This paper is organized as follows. A brief overview of economic, demographic and labor force characteristics of Singapore is provided in Section 2. This is followed by an analysis of Singapore’s current pension system in Section 3. Section 4 summarizes the manner and extent to which current arrangements are able to benefit from the global economy. The final section provides suggestions for reforms. 2. Economic, Demographic and Labor Force Characteristics The brief overview of economic, demographic and labor force characteristics in this section is designed to indicate the extent of the ageing problem, and of the internationalization of Singapore’s economy. Economic Characteristics: The main economic characteristics of Singapore are presented in Table 1, on the basis of which the following observations may be made. In 2000, Singapore had a per capita GDP of $39,585 and per capita GNP of $42,212, placing it firmly in the affluent group of countries. The higher value for per capita GNP reflects the fact that as a net lender, Singapore is able to transcend the limitations of its domestic economy by generating income from investments abroad. The share of wages and of private consumption in GDP, at around 40 percent in 2000, however, remains low. This suggests that Singapore has the resources to meet the challenges of financing old age. But whether the political system enables a greater proportion of the elderly (those older than 65 are expected to comprise a quarter of the electorate by 2030) and near elderly to express their preferences for meeting these challenges remains an open question. Much will depend on the extent to which the current mono-centric power structure evolves to accommodate greater political and social contestability. 3 Indicator Unit 1990 1995 2000 Gross Domestic Product (GDP) Million $ 66,464.4 117,768.4 159,041.8 Per Capita GDP $ 21,812 33, 404 39, 585 Gross National Product (GNP) Million $ 68,288.4 121,351.3 169,596.5 Per Capita GNP $ 22,411 34,420 42,212 Share of GDP Manufacturing Percent 27 24.8 26.5 Services Percent 66.3 68.1 67.9 Others Percent 6.6 7.1 5.6 Share of Wages of GDP Percent 43 42.9 42.2 Share of Expenditure of GDP Percent Private Consumption 46.4 41.5 40 Government Consumption 10.2 8.6 10.5 Gross Fixed Capital Formation 32.5 33.9 29.5 Net Exports of Goods and Services 6.9 16 18.5 Others 4 0 1.5 Gross Domestic Savings as % of GDP 43.6 50.7 49.8 Overall Budget Balance as % of GDP 10.8 13.2 3.0 Inflation Indicators Consumer Price Index Percent 3.4 1.7 1.3 International Trade (Goods and Services) Exports as % of GDP Percent 184 178.2 179.9 Imports as % of GDP 177.1 162.3 161.4 Total International Trade as % of GDP 361.1 340.5 341.3 Visitor Arrivals Million 5.3 7.1 7.7 Average Length of Stay Days 3.8 3.7 3.2 Table 1 Singapore: Macroeconomic Indicators, Selected Years Source: Calculated from ROS, 2001. Various Tables. Asher, 2002, Table 2. 10 As of December 2001, under the CPFIS scheme (from the Ordinary Account), $22.0 billion (US$12.2 billion) has been withdrawn by 650,000 members (22 percent of the total members). The average investment per member, thus, was $33,846 (US$18,700). The above investments were 30 percent of the potential amounts available to individuals under the current rules. The above investments were allocated as follows: stocks and loan stocks, $8.285 billion (37.7 percent); insurance policies, $11.571 billion (52.7 percent); unit trusts, $1.890 billion (8.6 percent); and others, $226 million (1.0 percent). The investment from the special Account of the CPF under the CPFIS scheme amounted to $3.43 billion as at end December 2001, representing 22.6 percent of the potential amounts available under the current rules. The number of members utilizing this facility were 331,228 as at the end December 2001, representing 11.4 percent of the total members. The overwhelming proportion of the investments (85.3 percent) have been in insurance policies; followed by unit trusts (17.1 percent). The potential for international diversification is only available through unit-trusts. But the amount invested in this vehicle has been only $2,390.6 million as at end December 2001. This suggests that international diversification through individual choice of CPF investments has been small. The possible reasons for low investments in unit trusts include high transaction costs, and a marked preference for insurance products. A spread of 5 to 7 percent between offer and bid (buy and sell) for unit trusts is common in Singapore. Although there has been an effort to address this issue, the low average investment and small size of the unit trusts market are considered constraints. In addition, there is an annual investment management fee of between 1 and 2 percent of total investments of members. As a comparison, an average diversified stock fund charges 1.41 percent per year (Asian Wall Street Journal, 5 February 2002, M5). Additional data are needed from the CPF Board to more rigorously assess the CPFIS scheme, in general, and the extent to which the international diversification has improved returns in particular. While such data are available to the CPF board, characteristically, they have not been made available to the public or to researchers. The decumulation phase: The decumulation phase is important because during retirement, it is essential to provide protection against inflation, longevity risks and to ensure benefits to survivors. Since women have a lower exposure to the labor force than men, and they earn on average less than men but have longer life expectancy, protection against the above risks is particularly important for them. At the time of retirement, four options exist in a DC scheme to convert accumulated balances into a flow of income during retirement: lump sum payment, periodic withdrawals, annuities or a combination of the three. It should be recognized that annuities are like any other financial product, so the cost of purchasing an annuity and therefore the rate of return from an annuity purchase varies with the market structure and the features of the annuity product (individual vs. joint annuity, inflation indexing, etc.).9 The CPF permits its members to withdraw all accumulated balances 9 In Singapore, expenses are estimated to be about 4 percent of the premium (which in the case of an annuity equals the principal amount that is invested to give a stream of income), including a 1 percent sales commission, plus a large management fee. The annuity products in Singapore rank favorably in “money’s worth” calculations, thus, neither commission nor adverse selection costs have been unduly high (James and Vittas, 1999). The lack of popularity of annuities in Singapore therefore is difficult to explain. 11 over and above the required minimum sum at age 55. Although a significant proportion of CPF members have accumulated balances that fall below the minimum sum, in these cases, they do not have to make up the difference from other sources. Children are, however, allowed to top up parents’ CPF accounts. As of July 2002, the required minimum sum is $75,000, of which $35,000 must be in cash and $40,000 can be pledged in property. The minimum sum will rise to $80,000 in July 2003, with the amount equally divided between cash and property. There are no plans for further increases. The CPF Board permits three options for the cash component of the minimum sum: buy a life annuity from an approved insurance company, keep it with an approved bank, or leave it with the CPF Board. In 2000, about one sixth of the 22,829 individuals who were covered under the Minimum Sum Scheme purchased annuities. Thus, the annuities option is not popular.10 Under all three options, the first payment is not available until age 62, seven years after the withdrawal age. These arrangements effectively increase the politically sensitive withdrawal age for this component. However, the main weaknesses of the mandatory savings scheme center on inadequate balances for many individuals, and the need for protection against inflation and longevity, while the provision of survivors’ benefits is not addressed by the Minimum Sum Scheme. There is also an absence of social risk pooling in Singapore’s CPF scheme. There has been considerable discussion in Singapore of using housing equity for financing retirement. One such method concerns reverse mortgage which permits a homeowner to obtain a lump sum or periodic cash from the property without selling it. However, since 1997, only 160 reverse mortgage transactionsnone involving public housing in which 85 percent of the population livestotaling $ 42 million have taken place (The Business Times, Singapore, May 14, 2002). The Economic Review Committee (ERC) is examining the possibility of permitting owner-occupied public housing flats to be refinanced with banks, and use the proceeds for business purposes. A similar proposal for the use of CPF balances for business is also being considered (The Business Times, Singapore, May 14, 2002). These proposals, if implemented, will not directly or necessarily increase income flows during retirement, however. The CPF investments and international practices: The above discussion suggests that Singapore’s method of investing the balances meant for retirement financing is contrary to best international practices concerning pension fund management, and have the potential to generate high political risk. Such concentration of savings in the hands of non-transparent, non-accountable agencies also distorts the savings investment process and could lead to inefficiencies in the structure of asset returns. The development of the financial and capital markets may also be adversely affected due to such concentration of savings, and due to the use of CPF as a substitute for mortgage financing. The method, however, is consistent with Singapore’s monocentric power structure, and strong tendency towards social engineering and control. 10 In 2000, there were 22,864 annuity policies, and four million life insurance policies in force in Singapore (Asher and Newman, 2001). As a result, there may be an over-consumption of survivor benefits at the expense of an annuitized stream of income in one’s later life. 12 To the extent the Government earns a higher rate of return on the CPF funds than what it pays to members; there is an implicit tax on CPF wealth. This tax is likely to be fairly large11 and regressive, as low-income members are likely to have most of their non-housing wealth in the form of CPF balances. This vividly illustrates how political risks and non-transparency can arise in an individual account system. The International Monetary Fund (IMF) has, however, suggested that the implicit tax argument needs to be qualified for the risk-free nature of the CPF returns; and for the possibility of using CPF funds to repay housing mortgages at a fixed, low rate (0.1 percent above the CPF interest) (IMF, 2000, p.57). How valuable is the guarantee of 2.5 percent nominal return? As the long-term annual inflation rate in Singapore is about 3.0 percent, the guarantee does not even preserve the principal in real terms. Guarantees of principal, even in real terms, are cheap for a portfolio which is divided equally between equities and bonds. This cost is estimated by Smetters to be 2 percent of contributions ten years out, declining to 0.5 percent of lifetime contributions after 40 years (The Economist, May 11, 2002, p.72). This cost is low and declining because the share of the principal in the total declines due to cumulative interests and capital gains. The same study finds that the costs of guarantees of income floor, such as those by Chile, are higher, 8 percent of contributions over ten years, climbing to 16 percent over 40 years. The implicit tax on CPF wealth estimated in footnote 11 is certainly substantially larger than above estimates. The arguments that SGIF returns and the CPF returns are separate and should not be linked may have merits in a purely technical-legal sense, but has no merit in an analytical sense. This is because persistent fiscal surpluses mean that in a macro-economic sense, the bonds issued to the CPF Board do not finance government expenditure, but are passively turned over to the SGIF (and perhaps other government holding companies). So ultimate deployment of CPF funds is by the holding companies. The impact of the mortgage rate arrangement is more difficult to analyse. But there is a perception that this arrangement has contributed to public housing prices being less flexible to market forces, and may have indeed enabled overinvestment in housing. The political need to maintain high (and rising) property and land values in turn are acting as a severe constraint on restructuring of the CPF scheme (Asher, 2002). The SRS Scheme: The supplementary retirement scheme (SRS) is a taxadvantaged voluntary scheme effective from April 2001. It permits Singapore citizens and permanent residents to save in a special individual account 15 percent of their total labor compensation, subject to a ceiling. Expatriate employees are permitted to contribute at a rate of 35 percent, in recognition of the fact that they do not take part in the CPF scheme. Employers are not permitted to contribute to the SRS, but the selfemployed may join. The contributions and investment income (except dividend income) can be accumulated in a tax-advantaged manner until the statutory retirement age prevalent at the time first contribution is made to the scheme. At the time of statutory withdrawal, 11 IMF has estimated the returns of the SGIC for the 1990s to be 10 percent (2000, p.57, fn. 7), substantially higher than the average return of 3.4 percent paid by the CPF. Multiplying the difference (10.0-3.4=6.6) to the member balances as at end-2000 of $90. 3 billion would lead to an implicit tax of $5.96 billion, equivalent to 42 percent of contributions or 3.75 percent of GDP. It should be emphasized that this is a recurrent tax whose burden is felt yearly. 13 50 percent of the amount is taxed at the prevailing marginal income tax rate. The tax benefit, thus, varies positively with the marginal income tax rate. The benefit is reduced when income tax rates are lowered. As only about a third of the labor force is liable for individual income tax, the SRS scheme is of relevance only to the top third. Pre-mature withdrawals not only attract full tax, but also a 5 percent penalty. Foreigners must maintain an SRS account for at least 10 years, even if they leave Singapore earlier. The contributions to the SRS may be invested in a wide variety of assets, permitting substantial international diversification. However, property and real estate investments and certain types of insurance products are not permitted. Withdrawals from the SRS, however, must be made in cash, although they may be staggered to minimize tax and avoid adverse market conditions. Four locally (now three after a merger) owned and controlled banks have been designated as SRS providers. They are free to set their own charges for services and to determine interest paid on SRS savings. This limits competition and could substantially reduce the benefits from the scheme. In addition to the small proportion of the labor force that is likely to find the SRS of relevance, there are other reasons why it is likely to have only limited impact. First, the high target for the mandatory CPF contribution rate at 40 percent limits potential participants to the SRS scheme. Second, the source-based income taxation in Singapore, under which income earned abroad but not remitted to Singapore is not subject to income tax, also limits the benefits to be derived from the SRS, particularly for foreigners. Third, the transaction costs of the scheme are likely to be high given limited competition, absence of regulation on fees and charges, and small size of the unit trust industry. In addition, taxation at the withdrawal stage will reduce returns. Fourth, the income tax payable at the time of withdrawal is on both original investment and capital gains. Since Singapore has no tax on capital gains, under some circumstances, such as when a person joins the SRS at a young age and has a low marginal rate of tax, and when net returns on SRS investments are high, an individual may actually get a lower rate of after-tax return under the SRS as compared to not enjoying the tax benefit. Usually, it is the taxation of capital gains that makes the SRS type schemes tax advantaged. In Singapore, capital gains, with the exception of some property transactions, are exempt from income tax. Investment income from the investment of SRS funds is taxable at the life insurance company level, thus discriminating against the use of life insurance products by SRS participants. Fifth, the 10-year minimum period for which an expatriate must maintain balances in the SRS account could act as a hindrance for short-term expatriates. Sixth, expatriates must take into account exchange rate risks, as their liabilities are likely to be in non- Singapore currency; and the risk that income tax rates (and relevant transaction costs) are not known. The impact of the SRS on overall social security arrangements in Singapore will be marginal as it is not designed to address the fundamental limitations of the current social security arrangements, such as lack of protection against inflation and longevity, and absence of a tax-financed redistributive tier. 14 4. Singapore’s Pension System and the Global Economy This section focuses on how Singapore’s pension system has utilized the global economy and is organized around the two broad avenues indicated in Section 1. Impact on the Trend Rate of Growth: As a highly internationalized economy, Singapore has been dependent on external demand, human resources, capital and technology for domestic economic growth, while also acting as a net lender abroad to generate national income. In recent years, it has had a large positive current account balance ($32.0 billion in 2001), and a large negative capital and financial account balance ($33.9 billion in 2001), suggesting significant net lending abroad; while by end- 2001, Singapore’s official reserves were $139.9 billion (ROS MTI, 2002, p.1). In 1999 and in 2000, about four fifths of the growth in total demand was external, while only one fifth was from final domestic demand (ROS MTI, 2002, Table 2.3, p.17). During the past quarter of a century, about three quarters to four fifths of investment commitments in manufacturing have been foreign (ROS MTI, 2002, Table A9.6, p.186). A recent study by the Singapore Ministry of Trade and Industry (MTI) estimated the contribution of foreign labor to Singapore’s economic growth using growth accounting methodology based on a solow-type growth model (Tan et al., 2001). The study found that in 1991-2000, 36.9 percent of the growth was accounted for by foreign workers in the professional and technical category, and an additional 3.8 percent was contributed by other foreign workers (Tan et al., 2001). In contrast, capital input contributed 26.5 percent, local labor 14.1 percent and total factor productivity (TFP) 18.8 percent to total growth. All types of labor combined contributed 54.8 percent to the growth of output in 1991-2000. Note a: Currently, those CPF members who are from West Malaysia are not permitted to withdraw unless they leave West Malaysia permanently. Thus, if a West Malaysian member of the CPF returns to West Malaysia, they must leave the balances with the CPF until the withdrawal age. Source: Calculated from various Annual Reports of the CPF Board. 15 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Total CPF Payments (Million $) 156.2 157.1 160.6 178.0 202.1 240.9 309.8 350.3 395.1 347.4 303.5 Average Payment (Thousand $) 32.5 31.8 34.9 34.9 34.2 30.9 35.2 42.7 45.2 45.1 37.9 As % of Total Withdrawals 3.9 3.4 3 1.6 2.8 3.3 2.9 3.1 2.9 2.7 2.1 As % of Total Contributions 2.2 1.9 1.7 1.7 1.8 1.8 2.1 2.2 2.5 2.7 2.2 Payment to Those: Leaving Singapore and West Malaysia Permanently Total Amount (Million $) 134.8 135.2 140.2 151.0 172.6 210.8 269.4 299.5 328.7 284.9 228.7 Average (Thousand $) 42.1 42.2 46.7 44.4 43.2 35.7 46.9 55.5 65.7 67.8 57.2 Malaysians Leaving for: East Malaysia Total Amount (Million $) 21.5 22.0 20.4 27.0 29.5 30.1 40.5 50.8 66.5 62.6 74.7 Average (Thousand $) 13.4 12.9 13.6 15.9 15.5 15.8 18.4 17.5 17.9 18.4 18.7 CPF Withdrawals by Members Migrating Abroad, 1990-2000 (Note a) Table 2 16 The study did not distinguish between local capital and foreign capital. If it had, the contribution of the global economy to economic growth would have been even higher. Studies by university economists have, however, found that the contribution of labor was substantially lower during this period. Thus, Owyong (2001) estimated the share of all types of labor to be 21.0 percent, capital to be 44.1 percent, and TFP to be 35.1 percent. Meanwhile, Thangavelu (2002) estimated the share of labor, capital and TFP to be 56.6 percent, 19.9 percent and 23.4 percent, respectively. Neither study disaggregated total labor into foreign and domestic components. There are at least four serious limitations to the MTI study.1 First, there is a possibility that the estimation of capital stock may be biased upwards, resulting in lower contribution of capital to growth. Second, the MTI study defines technology variable as a function of the existing capital-labor ratio and the share of professional and technical foreign workers. This assumes that technology is embodied in capital and foreign labor, an unusual assumption that the study does not justify adequately. Such a formulation also increases the multicollinearity problem and results in the coefficients having a higher value. Third, the study has not addressed the problems of simultaneity. If capital and labor, particularly immigrant labor, are major contributors to output growth, then this in turn will lead to greater flows of foreign labor and capital into Singapore. Last, there is little justification for using the fourth lagged specification for the capital-labor ratio and the share of professional and technical foreign workers. While there are significant differences among the studies concerning contribution of various factors to growth, there is little doubt that Singapore has participated in the global economy quite effectively to enhance its trend rate of growth and expand its economic space. The policies designed to attract foreign labor at both the high and low end of the human capital spectrum have been an important element in this participation. However, even as policymakers continue to pursue policies to attract foreign labor to Singapore, they will need to ensure that emigration from Singapore, particularly of professionals, does not accelerate. There are no official data published (though they must be available to policymakers) on emigration from Singapore. Table 2 provides data for 1990-2000 for those who emigrated from Singapore (and West Malaysia) and have withdrawn their CPF balances. The following observations may be made from the data in Table 2. The number of CPF members who have emigrated (and withdrawn their balances) has fluctuated during the 1990s, ranging from 3,096 in 1992 to 6,640 in 1996. The average amount withdrawn was higher than average balances of members as a whole. Thus, in 2000, the average amount withdrawn of those emigrating at $57,200 was 1.8 times the average balance for all members. The payments to emigrants have, however, been relatively small when measured against the CPF’s total withdrawals and contributions. The above figures are somewhat understated as some CPF members may emigrate but not withdraw their balances. Provisions of adequate financial security in old age, 1 I am indebted to Shandre Thangavelu for generously sharing his insights into the technical aspects of growth accounting in general; and for discussing implications of the key assumption of the MTI study. 17 and greater personal and political space are likely to be necessary if the requisite human resources are to be available to sustain Singapore’s growth. This will require substantive changes in the political and social environment in Singapore and will, therefore, be a major challenge. Singapore’s inward manufacturing investments have traditionally been in the manufacturing and financial business services. By end-1998, the stock of direct foreign equity investment in Singapore was $125.6 billion, while the stock of portfolio investment was $32.2 billion (ROS DOS, 2001, Table 5.11, p.70). The combined stock of foreign investment amounted to nearly 100 percent of Singapore’s 2001 GDP, and to $50,000 on a per capita basis—among the highest in the world. There are, however, concerns that one of the key areas of manufacturing investments—electronics—may not attract significant investment in the future due to declining competitiveness (ROS MTI, 2002, p.121-128). Singapore has embarked on a drive to attract investments in life sciences and the bio-technology and pharmaceuticals sectors to sustain the momentum of inflow of investments. But these areas require large resources and the payoff is considerably more uncertain. Singapore is also a significant investor abroad. By end-2000, Singapore-based (not necessarily owned) companies had set up 7,929 companies abroad, with a stock of direct equity of $63.9 billion (ROS MTI, 2002, p.19).2 In 2000, the external economy contributed 15 percent of GNP, nearly double the share in the early 1980s (ROS MTI, 2002, Chart 2.5, p.19). The above discussion suggests that Singapore will need to find new growth niches to continue to participate effectively in the global economy. Identifying and then devising strategies and tactics to find these niches is central task of the ERC, whose deliberations are still incomplete (as of May 2002). The indications however are that low personal and company income tax rates (counterbalanced by higher consumption taxes) are an important part of the ERC’s strategy to make Singapore more competitive. The budget proposes to cut both personal and company income tax rates to 20 percent (from 26 and 24.5 percent respectively). The activist industrial and fiscal incentive policies are to continue and the role of government and state owned or controlled firms will remain substantial. Thus, the managed nature of the Singapore economy is unlikely to be substantially altered. At the margin, however, domestic entrepreneurs are likely to be provided some incentives and encouragement. It remains to be seen whether the above strategy, which has worked well for the past three decades, will be effective in future. Singapore is now an affluent and rapidly ageing society; and globalization and associated forces and greater competitiveness of China, India and its neighbors have altered the context within which it was able to grow rapidly in the past. Singapore may need to rely more on being an effective net lender abroad to help generate income to finance consumption of its population. This may require a 2 It should be stressed that the basis of valuation of the above stock of equity has not been explained by the authorities. The importance of foreign companies based in Singapore in what the authorities curiously include as Singapore investments is also high. Thus, as at end-1999, foreign companies accounted for 44.4 percent of the reported total Singapore equity investments in India of $349.5 million (ROS MTI, 2001, p.64). The details of the Special Provident Fund for the armed forces are also not publicly available. The published data on Singapore investments abroad should, therefore, be treated with caution. 18 reconsideration of the non-transparent and non-accountable processes of decisionmaking in this area. Investment of Pension Assets Abroad: The second broad avenue through which the global economy can contribute to financing pensions is through the higher returns potentially made possible by international diversification. Provident and pension fund investments do permit such diversification. Therefore, in principle, this avenue is also feasible in Singapore. Analysis of the investment policies and practices of the CPF system in the previous section suggests that the potential benefits of international diversification are not being fully realized by members. The accumulated balances of the members with the CPF Board ($92.2 billion by end-2001) are, as noted, ultimately invested in a non-transparent and non-accountable manner.3 To the extent that the SGIC’s return on investments has been higher than the return actually credited to CPF members, a recurrent, highly regressive, large implicit tax on the CPF wealth has been borne by CPF members (see footnote 11). In Singapore’s mono-centric power structure, the need for provident and pension fund trustees who are simultaneously independent and competent has posed severe challenges. Absence of any provident and pension regulatory agency has made it difficult to take a system-wide perspective from the viewpoints of fiduciary responsibility to the members and international benchmarking in governance. Thus, the main concern in Singapore is not that the provident fund balances controlled by the CPF board do not benefit from the international diversification. The main concern is that members are not benefiting from such diversification. They also do not have information about the ultimate investment of their balances. Moreover, the government investment management companies make losses; it is the CPF member in their capacity as taxpayers who will need to bear the financial burden of potential losses. Thus, the contingent liability is borne by them, but without the benefit of transparency or accountability. International Investments by Individuals: The current CPF and SRS rules permit individuals to invest through unit trusts. As noted earlier, the investment in unit trusts from the CPFIS scheme is quite small. The data for the SRS are not available, but again the international investments are unlikely to be significant. This suggests that international diversification through individual choice of pension fund investments is under-utilized in Singapore. As noted, an important reason is the high transaction costs of unit-trusts, the marked preferences for insurance policies, by the CPF members. The reform proposals therefore should take into account the current impediments to fully realizing the benefits of international diversification in pension investments. 3 Similar non-transparency and non-accountability prevails for the pension fund designed to pay DB pensions of selected officials and politicians. Since the 1999-2000 budget (when the assets of this fund amounted to $10.5 billion), even the total assets have not been revealed in the Government budgets, let alone investment policies and performance. 19 5. Suggestions for Reform Before examining reforms needed to take more effective advantage of the global economy to finance old age, it may be useful to restate the limitations of the current pension arrangements in Singapore. The CPF scheme has come to occupy a predominant position in Singapore’s pension arrangements. The recent parametric reforms of the CPF scheme and the introduction of the SRS do not, however, address the main limitations of the arrangements. These include inadequate balances at retirement due to extensive preretirement withdrawals, particularly for housing and property, and due to low returns credited to members; lack of inflation and longevity protection; lack of survivors’ benefits; lack of transparency and accountability, particularly in investment management; inadequate weight given to fiduciary responsibility as compared to socio-economic engineering objectives; inadequate social risk pooling in health care financing (only about a quarter of the total national health budget comes from the Governmentthe rest is from individuals and businesses, while the opposite can be seen in high income countries of the OECD); and the virtual absence of a tax-financed redistributive tier. The limited nature of health insurance and the issue of long-term care of the aged also pose challenges to policymakers. The above list of limitations suggests that fundamental reforms are needed to provide economic security to the elderly in Singapore. Such reforms will require a change in the mindset, a paradigm shift in the philosophy of social security and substantive participation of all stakeholders in society. It should be stressed that the reforms will also require an increase in the Government’s budgetary allocations as well as total national expenditure devoted to social security and health care. As of mid-May 2002, only recommendations concerning the tax system have been announced by the ERC. The May 2002 budget has proposed significant reductions in individual and company tax rates to 20.0 percent over the next three years; and cuts in the income tax base, particularly for capital income. The expected revenue loss is to be partly made up by increasing the Goods and Services Tax (GST) by 2 percentage points, to 5 percent. These proposals are likely to further accentuate the already high income inequalities.4 They are also likely to reduce the real value of CPF wealth if, consistent with international experience, the 2 percentage point increase in the GST leads to a onetime increase in the cost of living by the same percentage. There is a strong case for offsetting this reduction through the fiscal system, particularly for those nearing the CPF withdrawal age of 55. As far as pensions are concerned, the press reports suggest that the ERC is considering permitting employers of foreign workers to deduct as business expenses pension contributions made on behalf of foreign workers. As currently such contributions are not tax deductible, this move is designed to retain and attract foreign professionals to Singapore. 4 The Gini coefficient of personal income was around 0.47 during the 1980s and 1990s, which is on the high side (Mukhopadhaya, 2002).