SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION

ISSUE 11 27 February 2012

- Vietnams Uncertain 2012 - Capitalism Goes Beyond Mere Self-Interest - Social Security Source of I nsecurity Part 1 of 2
The Fortnight In Brief (19 January to 26 February )
US: Passing the budget: A Political Tug-of-War? On February 13, President Obama proposed a US$3.8 trillion budget for fiscal year 2013 (October 2012September 2013). Continuing with proposed tax increases on the rich as in previous years as well as a reaffirmed commitment to reduce the deficit, it proposes increased tax rates on dividends, as well as penalties for firms that outsource jobs. The budget is expected to raise taxes on companies and wealthy individuals by $2 trillion in the next ten years, as well as implement several tax reforms that seek to reduce loopholes and preferential treatment for big corporations. However, the Republicans are maintaining a united front against tax increases and the Republican-majority House is unlikely to pass the budget in its current form. Asia Pacific ex-Japan: Warning signs for China Regulators have told China's state-owned banks to roll over an estimated RMB9 trillion of local government debts linked to the massive 2008-10 stimulus effort in order to give them time to find a more comprehensive solution to the problem. China is also leading regional monetary easing trends by cutting the reserved required ratios of banks, with the effect of releasing RMB400 billion of deposits for lending. The recent move by the People's Bank of China was to counter the hot money outflows of US$44 billion and US$15billion in December and January respectively. EU: Ups and Downs Despite reported declines in February, both composite PMIs of Germany and France stood above the 50 level while the index, including its manufacturing and services subcomponents for the Eurozone on the whole fell below the break-even mark of 50. Some positivity surfaced though, as the contractions rate of new businesses for services and manufacturing sectors in the Eurozone seems to be slowing. More notably, the recent liquidity pledge by ECB has eased the pressure on both sovereign bond yields and bank funding. While the ECB and most Eurozone authorities are in favour of combining the European Financial Stability Fund (EFSF) and its successor, the European Stability Mechanism (ESM), the alpha Germans on the other hand, rejects the idea and further quells the hopes of bolstering the lending capacity of the ESM above the current 500 billion.

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Vietnams Uncertain 2012

By Hang Dieu Quang, Singapore Management University This article seeks to briefly discuss macroeconomic issues in Vietnam and its future outlook. Vietnam has been hailed as an upcoming Asian Tiger in the past decade. Stunning double-digit GDP growth brought higher living standards that are visible in the streets of her big cities. However, it also revealed the flaws in her economic structure and infrastructure. Vietnams inflation made headlines in 2008 as it peaked at around 23%, dwarfing those of her neighbors. Since then, the South East Asian country has experienced unprecedented macroeconomic volatility. The latest Socio Economic Development Strategy for 2011-2020 reflects Vietnams aspirations to become an industrialised and modern economy according to the World Banks Vietnam Development Report 2012. However, meeting these aspirations will not be easy. Faced with double-digit inflation, a depreciating currency, capital flight1, loss of international reserves as well as eroding investor confidence, all eyes are on the government as they issue resolutions and decrees one after another to overcome these challenges. The question is: Will it be enough? Challenges Vietnams economy has grown so rapidly in recent years that one may overlook the major challenges it faces. Between 2003 and 2008, the countrys economy expanded from US$40 billion to US$90 billion in just 5 years. Exports more than tripled from US$20 billion to US$63 billion. She also joined the WTO during this period which led to private capital inflows peaking in 2007. Everything seemed to be on the right track until 2008. Vietnams growth in the last decade relied on factor accumulation rather than productivity growth (see Figure 1.2 below from year 2007). This was a reversal compared to the 1990s. Excessive reliance on factor accumulation2 for growth has limited scope and is unsustainable in the long run. Without productivity growth, a shortage of skilled workers to support the rapidly developing and growing economy becomes a real problem. At the same time, the swift accumulation of capital, fueled by the accelerated growth in credit, has led to macroeconomic instability in recent years.

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 In addition, turbulence in the global economy in 2008 caused Vietnams level of committed FDI to decline (see Panel B of Figure 1.3 below from year 2008). Investors are worried about economic volatility as well as uncertainties from future changes about to be effected by the government. They are now more cautious than ever.

Source: World Bank Vietnam Economic Development Report 2012

Source: World Bank Vietnam Economic Development Report 2012 Macroeconomic instability, the chronic disease in the economy, has started to capture the attention of the government and the majority of the population. For the past four years, Vietnams inflation has been among the highest in Asia. Besides inflation, the troubled economy is also dealing with pressure on its currency, declining foreign reserves, as well as domestic capital flight (see the circled portion in Figure 1.4 below) among other things. This is in stark contrast to her peers in the region. 3 Copyright 2012 SMU Economics Intelligence Club

 Source: World Bank Vietnam Economic Development Report 2012

Government Responses In the past, the government used to address economic issues with piece-meal, superficial attempts. When the situation stabilized, these measures were quickly ignored or removed so that the economy could refocus on rapid growth. More often than not, when issues recurred, the story repeats itself without consideration for tackling the root causes. In the past two years, many critics and supporters of the governments economic policies were awed by the pace and efficiency with which the government designed and effected several bold measures to curb inflationary expectations. Although these measures mostly relied on tight monetary policy and widespread price and interest rate controls, they effectively brought inflation in check. The efficacy of these measures have caused many forecasters to predict that inflation will be down to single digits this year if the government is steadfast in following Resolution 113, implemented since February 2011. Another surprise came when the government announced that it would restructure the entire banking industry within the next five years. Although this is unprecedented in an economy dominated by State-Owned Enterprises (SOEs) with very limited transparency, the announcement was well-received by both the local private banking sector as well as their foreign counterparts. Many foreign banks hope that such a campaign will level the competition, leading to a healthier competitive environment. On the other hand, many local banks view this as an opportunity to expand, rebrand, and weed out smaller competitors. While it is not entirely clear who will benefit from this development, consumers of banking services will definitely benefit as a whole. The Verdict While it seems that the government has taken the right steps to address various economic issues and achieve sustainable growth, one should not be fooled into thinking that turbulent times are over. There are forces resisting change, especially if those changes threaten their interests. The SOE is perceived to be inefficient by many, including government officials. In extreme cases, some suffer losses of billions of dollars. The majority of public infrastructures 4 Copyright 2012 SMU Economics Intelligence Club

managed by SOEs also fail to cope with rapid economic growth. However, past and present incidents indicate that nothing much will be done about these problems. Another problem that prevents the government from implementing all necessary reforms is the fragmentation and localization of development. The government is too weak to direct economic activity toward a national goal and common regulatory framework; it is too much to expect any government reforms to be carried out effectively. Furthermore, local administrations, subsectors of the central system, have developed networks with SOEs making it difficult for the government to exercise control effectively. One thing is certain: reforms will be made. But how effective and thorough they will be is another matter. At a time when opposing economic forces vie to gain the upper hand; foreign investors, SOEs, local private enterprise; the government will be hard-pressed to design policies that accommodate everyone, and yet are effective in dealing with the issues at hand. Gone are the days when the government was able to get away with its policies. Investors are harder to fool, the population is tired of recurrent problems, and forces within its own administration are difficult to deal with. Will they be able to do it? Perhaps it is time for the government to bite the bullet.
1 A situation where assets or capital rapidly flow out of a country or when investors lower the

valuation of assets in the country. This can be due to an economic event that causes investors to lose confidence in the health of the economy. 2 An increase in the quantity of the four basic factors used to produce goods and services in the economy--labor, capital, land, and entrepreneurship.
3

An inflation-fighting strategy that was implemented by the Vietnamese government since February 2011. It contains a wide range of bold, mutually reinforcing and consistent monetary and fiscal policy targets and commits the government to undertake several structural measures including reform of the state-owned enterprises (SOEs), improving communication with the market and protecting the poor from future episodes of macroeconomic instability. Source: The World Bank Vietnam Economic Development Report 2012

Capitalism Goes Beyond Mere Self-Interest

By Andrew Tan Liwen, Columbia University This article seeks to revisit Adam Smiths concept of the free market capitalism in light of the 2008 financial crisis.

In the heyday of the Reagan administration, Washington Conservatives frequently sported Adam Smith neckties, paying homage to the economic theory that they held dear that competition and non-interventionist policy would result in the most efficient allocation of resources. Observers credited Reaganomics with spurring strong GDP and productivity growth, low inflation, and ultimately the rejuvenated American economy of the 1980s. Yet, the 2008 financial crisis and the Wests anemic recovery have led many to question market 5 Copyright 2012 SMU Economics Intelligence Club

capitalisms laissez-faire nature. Is market capitalism no longer relevant? No, but its recent dysfunction is a result of the combination of increasingly loose moral and legal strictures which underlie western markets. The Invisible Hand Adam Smith has largely shaped our impression of capitalism. In the The Wealth Of Nations, he proposed that an individuals self-interested actions in a market economy results in an invisible hand which improves society. Self-interest leads to competition between parties, to higher productivity and innovation, and ultimately to an ever-increasing level of consumption and wealth. Adam Smith had a strong case. The Wealth of Nations was published just as the Industrial revolution was beginning, and wealth accumulation was taking place at an incredible rate. Historians and economists describe the invisible hand as responsible for the great divergence, where Western countries surged ahead of eastern counterparts in wealth levels. Niall Ferguson, author of Civilization: The West and the Rest, described competitive forces of the free market in the west as superior to the political and economic uniformity in the east. In light of recent events, however, it is increasingly clear that there is more to capitalism than mere self-interest. First, a strong legal framework is necessary: clear laws that represent societal values and the rule of law where the law is accepted, enforced, and not open to influence by political leaders or individuals. Capitalism was possible hundreds of years ago after the rule of law was clearly established, which secured property and individual rights, and allowed individuals to trade without restriction. Das Adam Smith Problem Moral principles are also necessary. The modern father of capitalism Adam Smith alluded to this in his earlier work, A Theory of Moral Sentiment. He argued that humans have an innate capacity for sympathy which drives us to act morally, a seeming paradox of self- interest and sympathy which 19th century German Philosophers termed Das Adam Smith Problem1. Smith made an important point moral principles allow us to make self-interested yet morally sound judgments in the marketplace, allowing capitalism to succeed on the whole. Unfortunately, the legal and moral framework was insufficient in the lead-up to the 2008 financial crisis. The U.S Congressional post-crisis report identified specific examples of organizations within three groups that were guilty of misrepresentation and malpractice: Washington Mutual (a mortgage lender), Moodys and S&P (rating agencies), and Goldman Sachs/Deutsche Bank (Investment banks). The woefully insufficient law and regulation, coupled with a culture of corporate compensation structures that incentivized risk and escalated the moral hazard2. In the case of Goldman Sachs, there was little oversight of Goldmans creation of its Abacus CDO from risky subprime loans, following which traders even decided to bet against their firms own clients. In addition to insufficient regulation, the rule of laws strength has become doubtful in recent years. Take Greece, for example. The perception that Greek law is unfair and corrupt because the rich influence lawmaking has resulted in a low tax morale, or low moral obligation to contribute to the common good. As a result, persistent tax evasion by individuals (highest levels in the EU) has resulted in large government deficits and the looming risk of debt default. 6 Copyright 2012 SMU Economics Intelligence Club

Another example of insufficient legal and moral constraints: lobbying congress in the United States, a $3.5 Billion dollar industry which has resulted in corporations and individuals having a legal but arguably improper influence over law making. Lobbying initially arose out of Self- Interest, where special interest groups (such as minorities) exercised their right to petition. But today, large corporations lobby to serve their own interests. Lobbyists were responsible for some of the financial deregulation after Reagan (e.g. exempting derivatives from regulation), and have also contrived to create tax loopholes which hugely benefit some parties. For example, household names like General Electric and FedEx, which spend large tens of millions of dollars on lobbying, paid a negative tax rate on a combined total of $16 billion in profits in 2010. These examples show that self-interest of capitalism can quickly turn into greed, which usually leads to inequity, if left unchecked by the law and moral constraint. Regaining our Moral bearing Looking forward, the solution to capitalisms problems is both political and moral in nature. Some progress has already been made. One measure in the Dodd-Frank Bill for banks the Vockler Rule3 prohibits most types of proprietary trading and requires greater transparency. The bill attempts to reduce the moral hazard: it lowers the risk of trading losses (which would necessitate a bailout), and makes illegal activity more likely to be discovered. More importantly, however, change must permeate our politics, corporations, and society. We should no longer stand by and watch unfettered greed and the rising socioeconomic inequality it causes. We should acknowledge the unfairness of the political process and a lopsided tax code instead of accepting that the rich getting richer is solely a result of free- market forces. We should understand that we have moral obligations towards society, which is to inform and change our propensity to seek short-term gains. The list goes on. Obviously, this is not a panacea to the Wests problems. Structural problems remain a workforce not fully equipped for high-value industry, infrastructure issues, just to name a few. But regaining our moral bearing, along with our strong, fair legal controls, is what we should do to allow capitalism to thrive once again. Smith's emphasis on sympathy in his Theory of Moral Sentiments and the key role of self- interest in the Wealth of Nations. Economist Joseph Schumpeter referred to this in German as the Adam Smith Problem. 2 Moral hazard is a tendency to take undue risks because the costs are not borne by the party taking the risk. Moral hazard arises because an individual/institution does not take the full responsibility of its actions, and hence has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. 3 The Volcker Rule is a specific section of the DoddFrank Wall Street Reform and Consumer Protection Act to restrict United States banks from making certain kinds of speculative investments that do not benefit their customers. The rule is often referred to as a ban on proprietary trading by commercial banks, whereby deposits are used to trade on the bank's personal accounts Sources: The Wealth of Nations by Adam Smith, The origins of Political Order by Francis Fukuyama, Fortune 500, Levin-Coburn Report, Greeknewsonline, opensecrets.org, TED talk 7 Copyright 2012 SMU Economics Intelligence Club
1 There had been considerable controversy as to whether there was a contradiction between

Social Security Source of Insecurity Part 1 of 2

By Vera Soh, Singapore Management University Part One of this article aims to identify major loopholes in social security models and explores possible means of further improving Singapores social safety nets to suit the changing needs of citizens. Have some compassion, even policy makers are insecure. The once so attractive pay-as-you-go social security model is sending shivers down the spines of the United States (US) and European countries. This is the ugly truth that we are all aware of but are all afraid to face that the system cannot be sustained and needs to be reformed. An average US citizen acknowledges that he is receiving more welfare benefits than he has worked for and deserves. However, people want security and they want to be shielded from the increasing volatility that the entire world is facing. Key Areas to Note in Social Security Policy Formulation The entire world is still harping on these slowing economic activity, increased volatility with an increasingly globalized world, rising inequality, depleting natural resources, increased global competition and the list goes on. Social safety policy formulation is closely linked to the level of economic activity of the given country. With higher levels of economic activity, government bodies will be able to channel more resources to improving areas that directly affect benefit programmes. With more resources poured into improving social security, citizens will have more to fall back on in difficult times. Policy makers also need to consider the given countrys resistance to shocks. If the government has sufficient fiscal space1 to tap upon during any unexpected crisis, social safety nets can serve to meet the more basic needs of retirement, healthcare and education. That is not to say that countries with larger fiscal space can overlook the importance of a comprehensive social security web. It simply means that the weightage of resources used to secure the basic needs in such a country can be greater relative to that aimed at countering involuntary unemployment during periods of economic slowdowns. The changing demographics and mindsets also mean that policies need to be constantly tweaked and reviewed. Areas that affect wealth and welfare, such as support for elderly parents, quality healthcare and higher education become more pertinent issues in the lives of citizens. Thus, policy makers need to be flexible enough to make necessary changes to accommodate these changing needs. Social Security the Singapore Style The Singapore government has always believed in rewarding work and preventing a decay of work hazards that help must not be so readily available that people do not feel the societal cost of being unemployed. Under the pay-as-you-go welfare system, each employed and tax paying citizen pays the unemployed citizens a monthly income. 8 Copyright 2012 SMU Economics Intelligence Club

 For this very reason, Singapore has adopted a contrasting fully funded social security system with occasional vouchers given to lower income families. As much as it might force citizens to save more than they would like during their years of work, it promotes individual responsibility. In addition, to further provide aid for the lower income group, the government introduced the Workfare Income Supplement (WIS) scheme in 2008. This scheme benefits those who are engaged in economic activity and drawing an income of below SGD1,700 per month. It thus encourages work and helps those who help themselves. Still Impossible to Cope? The social security system in place has indeed encouraged work and prevented a compromise on work morals. However, it is becoming increasingly difficult to cope with social immobility and involuntary unemployment. Moreover, with the bulk of Central Provident Fund2 contributions to the Ordinary Account (60%) being used up to pay off housing loans, there is little left for rainy days and retirement. With Singapores great emphasis on meritocracy3, reward is channeled mainly to those at the top, thus resulting in constant rise in income among the higher income group (see Figure 1).

Figure 1

Source: IMF

At the same time, Singapores drive to increase reliance on low skilled foreign labor to allow Singaporeans to move away from these necessary but less desirable jobs has depressed the wages of the lowly skilled (see Figure 2).

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Figure 2

Source: IMF

Indeed, it is necessary to push every citizen up the value chain. However, we must bear in mind that those who possess less aptitude will always exist. It is thus important to ensure that there is a sufficient quantity of blue collar jobs available for this group of local workers instead of relying too heavily on low cost foreign workers and compromising the wages of locals. Social Security and the Low to Middle Income For the most of it, Singapores social security policies have been obsessing a little too much over the individual. It aims to achieve what I would call the Powerpuff Girls Scenario, where the government plays the role of Professor X, the individual being either one of the Powerpuff girls and the family/community acting as the other two characters. Reality being reality, the Powerpuff Girls do not exist. The current social safety net is pushing people to become superheroes, where they can save for their own retirement, pay for their own flat, secure their own job by being super productive, pay for their own healthcare and on top of that, support their parents and pay for their childrens education fees to compete for space in our highly recognized and competitive tertiary institutions. Has the well-intended social safety policies resulted in a nation of individualistic workaholics, fearing lack and insufficiency?
1 The capacity for further increase in public debt levels without compromising sustainability.

2 A mandatory benefit account set up to provide Singaporeans with a healthy retirement plan.

The Central Provident Fund (CPF) was first introduced in 1948 by the Progressive Party to help ensure that Singaporeans would save up for retirement.

Sources: Central Provident Fund, Singapore Statistics, IMF, Singapore Budget 2012 10 Copyright 2012 SMU Economics Intelligence Club

3 System where individuals are rewarded by talent and ability rather than birth or wealth

 The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Shane Ai Changxun (Vice President, Publication) Ben Lim (Vice President, Publication) changxun.ai.2010@smu.edu.sg ben.lim.2010@smu.edu.sg Singapore Management University Singapore Management University Singapore Singapore Kwan Yu Wen (Vice President, Operations) Tan Jia Ming (Publications Director) ywkwan.2010@smu.edu.sg jiaming.tan.2010@smu.edu.sg Singapore Management University Singapore Management University Singapore Singapore Herman Cheong (Marketing Director) Vera Soh (Liaison Officer) wq.cheong.2011@smu.edu.sg vera.soh.2011smu.edu.sg Singapore Management University Singapore Management University Singapore Singapore Randy Lai (Editor) Seumas Yeo (Editor) tw.lai.2010@smu.edu.sg Seumas.yeo.2010@smum.edu.sg Singapore Management University Singapore Management University Singapore Singapore Hang Dieu Quang Andrew Tan Liwen dqhang.2010@economics.smu.edu.sg andrewtan89@gmail.com Singapore Management University Columbia University Singapore New York, United States of America
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