Published October 21, 2009

COMMENTARY
Spending is what the doctor has ordered

Comprehensive research, global experts point to some sobering conclusions

By VIKRAM KHANNA
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THE Singapore economy has staged a stunning recovery since the second quarter and economists are unanimous that it will continue into 2010. The STI has jumped 86 per cent from its low on March 9 and the property market has turned frothy.

Yet, Finance Minister Tharman Shanmugaratnam announced in Parliament on Monday that he will present another big-spending budget next year, on the heels of the extraordinary $20.5 billion stimulus package this year. Not only that, but government spending will continue to increase over the next five to 10 years, from around 15 per cent of GDP at present to 17 per cent.

Given the rapidly rebounding economy, does this amount to overkill?

Mr Tharman indicated that the government and 'seasoned observers all over the world' do not expect the next year or two to be very pretty. Given that such caution is totally at odds with the exuberance we are witnessing in the stock markets, it's worth considering its sources.



One of the most comprehensive pieces of research on banking crises comes to some sobering conclusions. Economists Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland - both former IMF economists - studied 18 banking crises in the developed countries in the post-war era. Their key finding: recessions that result from banking crises last longer than normal recessions and do much more damage. If the US economy follows the norm, it will take four years before it can return to pre-crisis levels of output, and unemployment will keep rising for three years, reaching 11-12 per cent in 2011.

Paul Krugman, the winner of last year's Nobel Prize in Economics, has also drawn attention to why the recovery from this recession will be unusually slow and weak. Speaking at the World Knowledge Forum in Seoul last week, he explained that this recession has been accompanied by a huge buildup of private sector debt. US household debt, which was 50 per cent of GDP in the 1980s, has now rocketed to more than 100 per cent of GDP. This points to a prolonged period of deleveraging, as happened in Japan in the 1990s. While the US economy will probably recover faster than Japan's, it's worth recalling that the latter oscillated between recession and sub-par growth for more than a decade.

Eventually, a surge in exports to China helped Japan emerge from recession. Export-led growth was also what enabled East Asia to recover from the Asian crisis of 1997/98. But the US - faced with a weak economy at home - cannot rely on export-led growth. Why? Because what we're witnessing is a synchronised, global slowdown. So the export-led route to salvation is closed, 'unless we find another planet to trade with', as Prof Krugman put it.

But why can't the US sell to China, which is growing fast, helped by a massive four trillion yuan (S$818 billion) stimulus package unleashed this year?

One of the peculiar features about China's recent growth is that it is overwhelmingly investment led. Fixed investment accounted for almost 90 per cent of China's GDP growth in the first half of this year. It cannot continue this way: eventually - in fact, soon - consumption has to take over as a growth driver, or else China's growth, too, will falter.

But consumption from where? US consumers are cutting back and so are the Europeans. Consumption in the rest of Asia is too small. Eventually, it's the Chinese consumers themselves who must step up to the plate. But they are busy saving, because they need to provide for their own health care, education and pension needs. Unless China builds out its social safety nets, it is unlikely that Chinese consumers will turn into big spenders. And that's a minimum condition; China would also need to strengthen the yuan to improve domestic purchasing power and rely less on exports.

With US consumers turning more frugal, the rest of Asia, too, is faced with a similar problem as China. It must also make what Stephen Roach, chairman of Morgan Stanley Asia, calls 'the daunting transition' from externally dependent to more internally dependent growth. 'The Great Recession of 2008-09 is export-led Asia's wake-up call,' he says.

Where does Singapore fit into this story? At the moment, Singapore's economic wagon is still essentially hitched to the US consumer, partly via China. Will the US consumer start splurging again? Not anytime soon. Can Singapore rely on consumers in China or the rest of Asia to pick up the slack? Same answer.

Thus, with the return of consumer-led growth from anywhere still a long way away, Singapore cannot afford to let up on its economic stimulus. The stimulus can be fine-tuned and better targeted, but it must essentially remain in place until external demand can be counted on to come back in earnest. That means another three to five years.

So, notwithstanding the rollicking stock market and rebounding economy, more expansionary budgets are what the doctor would prescribe for the Singapore economy. There is much more to the aftermath of the Great Recession than we have seen so far. We are still only at the end of the beginning.