The Spirit of Mambo Jumbo

You know what I am talking about - Mambo Jumbo nights at Zouk. It had been many years since I last went Mamboeing, but yes, I would not be ashamed to admit that I used to enjoy it. But sometime in the late 1990s, I realised that I was looking too old the part compared to the other clubbers there and I told myself then that it was time to move on. Also, even as the familiarity offered comfort, I had become increasingly bored with retro music. It was the same songs every Wednesday, so much so that specially co-ordinated moves were used for specific songs.

The longevity of Mambo nights is truly amazing. At least, people of my generation can claim that we actually lived through the 80s, and much of the fun of Mambo nights was to go dance to the tunes we grew up with. Yet, my generation moved on but the clubbers at Mambo remained as youthful as ever, people who were clearly babies when the present day aunties of Bananarama were strutting their stuff. The success of Mambo also led other clubs to use retro music. It was like, as one of my friends noted, the 80s arrived at Singapore and never left.

Well, Singapore politics has seen its massive Mambo injection in recent weeks. MM Lee is again leading the charge on almost everything - public sector pay hikes, extradition treaty with Indonesia, population issues and even the debate on homosexuals - strutting around like the political colossus which he is, and making the political weather that the rest of us, including blogosphere, are only reacting to. In its peculiar way, MM Lee's "tell-it-as-I-think" style is reassuringly familiar. I think the Alpha-S union of Singapore Airlines will soon get a big dose of Mambo reality if the pilots remain intransigent over the pay issue. But one could again be forgiven for thinking that the 80s never left Singapore.

On this note, I leave you with the lyrics of the very first MTV I watched - Pet Shop Boy's "Rent" released in 1987. Has it really been 20 years?

You dress me up, I'm your puppet
You buy me things, I love it
You bring me food, I need it
You give me love, I feed it

And look at the two of us in sympathy
With everything we see
I never want anything, it's easy
You buy whatever I need

But look at my hopes, look at my dreams
The currency we've spent
I love you, oh, you pay my rent

Fiscal Finagling or Journalistic Bollocking?

Last week, the article Fiscal Finagling supposedly highlighted some "structural weakness" of Singapore's growth and argued that it "augurs ill" for Singapore's long tem prospect. Lucky Tan set me up with a few questions on what myself as a student think about these issues.

Old Wine in Recycled Bottles

First of all, I would like to point out that many of the points raised in the article are not in fact new. In one guise or another, many of these criticisms have been levelled at Singapore for decades. Fifteen years ago, Alwyn Young who is now at LSE, famously made many similar arguments in a respected economic journal (QJE) - how Singapore over-invested to boost growth with little efficiency gains. That then prompted Paul Krugman to liken Singapore to the Soviet Union.

It is a time honoured tradition for academics and journalists alike to criticise Singapore's high rate of savings and investment. When the economy is routinely growing at 7 per cent, what else can you say to generate headlines? More good news is hardly the correct strategy! The important thing for readers is therefore to have a balanced perspective and not get carried away by any arguments.

The starting point for any discussion about growth should be the recognition that there is a lot we do not know. Countries are by definition different (jargon: heterogeneous) and growth theories are an inexact science. History, culture, institutions, geography, natural resources - no two countries are exactly the same in these dimensions - are only some of the determinants that explain the differences in income levels between countries. In many cross-country analyses, Singapore often stands out as a statistical outlier even as researchers fit all kinds of regressions to explain growth.

Global Time Bombs

Turning more specifically to Singapore's fiscal stance, in particular to the question whether our system of old age provision is adequate, it is useful to take a global snapshot. The UK is just waking up to a pension crisis. A combination of ageing, over-optimistic forecasts, and bad fiscal policies mean that many companies are no longer able to pay their retired employees the promised pensions. In Europe, many governments already have public debts more than 100 per cent of GDP and like the UK, have unfunded pension systems with open ended obligations. With ageing population, one just have to wonder who is going to service and repay these debts, let alone meet the future liabilities.

Cross over to fast growing China. Despite the phenomenal growth rates, China is in fact one country that is ageing faster than it is getting rich due to the one child policy. When China shifts, it does so with astronomical numbers - what is going to happen when many hundreds of millions chinese retire in 20 years' time? The biggest time bomb, at least in absolute terms, is the US. Greenspan and Bernanke repeatedly warned of a Social Security crisis that was beginning to unfold as baby boomers retired. US public debt is already US$8 trillion by some estimates not even accounting for social security liabilities. Do Americans feel secure about their social security cheques?

These are not Singapore government propaganda, these are facts. Compared to these global time bombs, our problems if indeed there are, would at best be considered small fart. If Singapore's high savings paradigm points to a "bleak" future as some critics suggest, what would they say about a high consumption, low savings, high-deficit high-debt model? Are these structurally sound as opposed to Singapore's structurally weak development model?

Enough to Retire?

If you ask me, Singapore's fiscal position is in rude health. There is however an important caveat: The fact that the system as a whole saves enough and is on a financially strong footing does not mean every citizen is. If an individual has not saved enough, or has over-withdrawn for property and made losses, or has made bad investment decisions, old age retirement provision can become a big personal problem. Does the CPF ensure that every one can retire with a huge stash of retirement fund? Probably not. Can CPF as a system meet its future obligations? A highly likely yes. There is no contradiction between the two positions.

The author Shawn Crispin however made no distinction between the financial health of the system and the financial health of the individual, and instead rather naively suggested that CPF would face a "fiscal crisis" because of withdrawals for housing and medical needs.

Hidden Taxes or Crouching Subsidies?

Lucky is not the first to claim that CPF returns are too low, it has been discussed extensively. I have even heard of the term "Financial Repression" - to describe how the government forces the citizens to save at absurdly low interest rates, which is yet another hidden tax. To be honest, I have always been rather bemused by this allegation. Here's why.

We get a 'lowly' 2.5 - 4.0 per cent (OA, SA and Medisave) but people forget this is a RISK-FREE rate. Adjusted for zero risk, are the returns still low? Also, CPF contributions are not taxable and this creates a tax shelter which boosts overall returns. As I recall, financial institutions were offering a meagre 1 per cent or even less for fixed deposits over the past few years.

Furthermore, whether interest rate is too high or too low from a personal welfare point of view obviously depends on whether one is a borrower or saver. When I applied for the HDB loan for my flat a couple of years ago, I wanted to liquidate my savings to pay for the flat and borrow as little as possible (for some reason, I am irrationally debt-averse). Short of saying it outright, the HDB counter officer pretty much implied that I was stupid not to want the maximum loan since it was so cheap at 2.6 per cent interest, pegged 0.1 per cent above OA rate. His advice was that even if I had the money, I should take the maximum loan and invest my cash elsewhere.

That was obviously sound advice. My investment has given me, let's just say, significantly higher returns than the 2.6 per cent interest I paid. Which financial institution offers only a 0.1 percentage point spread between saving and borrowing? When we complain that CPF rates are too low, are we forgetting the flip side of the coin - that many of us are in fact borrowers at the early part of our life cycles, in which case low interest rate is a good thing!

But of course, net of housing and other uses, there is still a large balance held in CPF accounts. If one is still not satisfied with the 2.5 per cent for OA, there are always alternative investment available but how many Singaporeans are financially savvy enough to manage the associated risks? Many people who invested and burnt their fingers in fact blamed the government for liberalising CPF for investment purposes. How on earth is it possible for the government to guarantee high returns to citizens without someone having to bear the risks? There is really no free lunch here.

Double-Dealing Accusations?

I am not suggesting that Singapore's saving or fiscal systems are in any way perfect. One can indeed make a honest intellectual case that Singapore's national saving rate is too high, such that any future benefit from today's savings is outweighed by the cost of today's consumption foregone. However, to provide a proper analysis or critique, one has to exercise some intellectual discipline.

To on one hand accuse Singapore of building up too much savings and on the other claim that there is "lingering concerns about the financial health of the CPF" or that it is facing a "fiscal crisis" is a bit like double-dealing, using the ace of spade twice. If it is indeed true that Singapore saves too much nationally relatively to some estimates of its future needs, then there should not be any concerns about the financial health of its key retirement fund.

The author, perhaps rather too conveniently, also made no reference to Singapore's sovereign rating. It would be very odd indeed for the ratings to be AAA if there were any doubts about the government's ability to meet future obligations of its key retirement fund. These are just some thoughts on the article, and I leave you to decide whether there is more fiscal finagling or journalistic bollocking.

Expected Career Income Hypothesis

If you feel that many of the arguments about public sector pay have been reused and rehashed, this post can hopefully offer an antidote. One of the recurring themes in many posts concerns the issue of moral authority. KTM (and many others) basically argued that the increase in pay would cause office holders to lose moral authority and many readers undoubtedly would agree. It is not that I disagree that there might be a moral dimension to the issue but as an economist, I am naturally circumspect about framing a political economy problem, which the pay hike essentially is, around morality and ethics*. This is not an issue about life and death. Consider therefore an alternative perspective.

Diminishing Outside Option

Preventing the loss of senior public service talent to the private sector is one of the key arguments put forward to justify the pay increase. Actually, it is difficult to buy this logic for it is not at all clear if senior civil servants indeed have a lot of outside market value. However, allow me to turn this logic on its head and instead suggest that we should increase their pay because they have NO or few private sector alternatives!

In this current boom, my friends in the financial sector hop from one job to another, always getting another hefty pay increase in the process. Industry knowledge, networks, and experience are easily portable from one job to the next, thereby enhancing the so-called outside option of the individual - yesterday he was a UBS analyst, today he is a Morgan Stanley vice-president etc, tomorrow who knows. But you get the point.

Turning to the public sector, many jobs in the civil service are critical to the nation but in truth have very little marketable value. Furthermore, young returning scholars (loosely though not exclusively defined as talent here) do not always have the luxury of deciding the positions they get posted to. Imagine the years of experience chalked up in Mindef, MICA or Community Development etc. It is not that that the work is unimportant but how much of it would truly add to the resume for a private sector job application?

After serving 6 to 8 year bonds, many scholars in fact find that outside options are pretty much closed. If you recall, it was only recently that the media highlighted the fact that many private sector firms had a rather dim view of ex-scholars from the civil service. The likely loss of outside options weighs heavily on the minds on bonded scholars. If there is indeed a sacrifice, it is not because of present pay but the reduction in the set of realistic future career alternatives. Worse still, this foregone opportunity is the highest for the most able thereby resulting in an adverse selection problem which I will elaborate on later.

Many bloggers might well be correct to point out that many senior civil servants would not command such a high salary in the private sector. However, I suggest that this argument ignores the fact the lack of private sector alternatives may be precisely due to their earlier commitment to the civil service. For the sake of argument, let's push the logic further still: if they do not have realistic private sector alternatives, why bother to increase their pay in line with the private sector? Here, the justification becomes a little more subtle.

The Role of Expectations: Expected Career Income Hypothesis

Expectations about the future play a crucial role in affecting the decisions made today (the logic is similar to the Permanent Income Hypothesis). Why do accountants, lawyers, auditors, consultants endure years of all-work-no-play lifestyles? Can it just be attributed to the couple of hundreds or even thousands of dollars more they receive? Many people in these professions will readily show you how their pay is in fact quite low on a per hour basis.

Quite simply, it is the anticipation of the huge economic reward when they become partners that drives these people. Forward looking agents care not only about the present but also form rational expectations about the future which then affect their course of action today. How senior civil servants are remunerated when they have few alternatives (ex-post) therefore anchors the expectations of young Singaporeans who are making the career decisions (ex-ante) on whether to take up a scholarship, to join the civil service, or to go to the private sector.

A Credible Commitment to Prevent a Lemon Market

There may be specific disagreements about the benchmark - whether it is representative enough, whether it is set too high, whether it has suitably adjusted for the relative security of public sector careers. All these are valid concerns, but it would be difficult to settle on a formula that pleases every one.

Another important issue emerges here: adverse selection (or the famous Lemon problem). A big public-private sector pay gap results in a bad selection process whereby good officers self-select to exit the public sector since, as I mentioned earlier, the cost of opportunity foregone is the highest for them. The larger point about the pay benchmarking, particularly when it is carried out in face of public opposition, is that it serves as a highly credible signal that Government will not allow public sector pay to lag too far behind the private sector. It anchors the expectations of present and future civil servants.

A Process of Self-Revelation

This goes a long way in ameliorating the adverse selection problem. One does not have to increase the pay of junior civil servants to attract or retain them. In fact, increasing junior civil servants' pay may not reduce the information asymmetry. Talent is a hard to observe attribute, the individual in question knows much better what his outside options truly are. The increase in senior civil servants' pay therefore provides strong incentives for the good officers to self-select to remain in the civil service since they know that they can (in expectation) beat their peers in the long run and reach the senior positions (jargon: self-revelation process).

If you pay a bunch of bananas, there is no guarantee you will get a 300 pound gorilla. But if you pay peanuts, you will surely get monkeys (or Akerlof's Lemons so to speak). Worse of all, paying peanuts may turn gorillas you have into monkeys (this is the non-shirking or efficiency wage argument if you care to follow further).

I am of course not qualified to say how much is enough, but it is clear that the public-private sector pay gap will almost certainly have long term consequences. The pay hike may not change the career calculus of today's senior civil servants. Through rational expectations however, it will affect the decisions of younger civil servants making career decisions today.


* PM has just stated his decision to donate the increment to charity. Has it therefore increased his moral authority?