Chapter 3: FOP Immobility onwards

Question 1

Immobility of FOP

Answer 1

Resources cannot respond to incentives to produce goods and services demanded by consumers or disincentives to stop or cut production.

Question 2

Types of FOP

Answer 2

Labour Immobility (Occupational, Geographical)

Capital (Functional, Geographical)

Question 3

Occupational Immobility

Answer 3

• As an economy progresses, there tends to be a shift in the composition of the types of industries in the economy / Technological disruption
• For instance, a developed economy may create more employment opportunities in the service sector whereas the manufacturing industries are facing a decline due to a loss in comparative advantage. However, despite greater opportunities in the service industries, workers are not able to switch jobs immediately to work in the service sector due to occupationalimmobility. They lack the skills to work in this sector.
• Thus, even though there may be abundant supply of workers in the economy, they will not be able to fill the job vacancies that are created in the service sector. Thus these workers become structurally unemployed.
• This implies that there is amismatch of skills between the unemployed and those required in the expanding sunrise industries in Singapore. Clearly, this leads to a waste of scarce labour resources and results in market failure.

Skills mismatch between the unemployed and jobs required by growing industries → Structural unemployment → Waste of labour resources → MF

Question 4

Geographical Immobility (Labour)

Answer 4

• Geographical immobility are typically more serious in large countries (USA, China and India) when there are barriers to people moving from one region to another in search of jobs. These barriers include social ties and costs involved in moving between regions such as rental costs.
• Thus market failure occurs because resources are not being reallocated from areas where demand for labour is low and unemployment high to other areas where demand for labour is high and have plenty of unfilled job vacancies.
• Wastage of labour leading to MF

Question 5

Functional Immobility

Answer 5

Certain capital goods are difficult to transfer from one use to another. A train cannot function as a car or plane.

In general, specialised equipment and tools designed for specific purposes are immobile (not suitable for multi-function).

The more specialised the equipment, the more functionally immobile it is.

Question 6

Geographical (Capital)

Answer 6

For other capital goods, it is difficult to transfer it physically from one geographical location to another. For example, a petrochemical plant built in China cannot be easily uprooted and transferred to the US.

Question 7

Policies to overcome occupational immobility of labour

Answer 7

Provide and/ or subsidise retraining/ reskilling programmes to help workers obtain the requisite skills for the new economy

With greater labour (occupational) mobility, resources can respond to incentives to produce goods andservices demanded by consumers or disincentives to stop or cut production. It is hence easier for markets to achieve a socially efficient allocation of resources.

Limitations

Funding issues

- To what extent retraining of workers can be done is dependent on the level and access to funding.
- Constraints to the government's budget for such purposes and the amounts available need not necessarily be sufficient to entice workers to pick up the required skills for the sunrise industries.

Success rate or take up rate

• Success of training subsidies would depend on the motivation of workers to undergo training. Motivation in turn is affected by several other factors such as Age gap, Attitude gap, Aptitude gap & Expectation gap with regards to training & job openings can be bridged.
  
  • For instance, in a recession, workers might be reluctant to go for training if the prospects for employment is bleak. Moreover, if promotion prospects arepoor, workers may be de-motivated to upgrade their skills.

Question 8

Policies to overcome geographical immobility of labour

General

Answer 8

(1) Bringing workers to work: E.g. Better transportation system
(2) Bringing work to the workers: E.g. relocate businesses or decentralised business locations.

Question 9

Workers to Work

Answer 9

Singapore government - Improve the transport network system such as the extension of the MRT lines to more parts of the country and the building of more expressways network systemto improve the accessibility and connectivity between parts of the island.
Reduce geographical immobility so that workers are able to travel more easily to different partsof the country to work.

Large countries like USA or China, the availability of affordable housing is another factor to encourage the movement of labour from one geographical region to another to look for work. The ease of finding suitable accommodation would help to improve geographical mobility of workers.

Question 10

Work to Workers

Answer 10

Decentralise or spread out business centres/hubs to various parts of the island so that workers need not travel too far away from their homes to work.
Singapore - the government has deliberately developed regional business hubs (e.g. Tampines, Jurong,Woodlands). This will save transport costs and time for workers to commute to work.

Larger countries like USA, geographical immobility may result in regional unemployment problem (i.e.unemployment confined to certain depressed regions). A good example is the defunct coal mining district of Appalachia in USA. Many ex-coal miners have remained unemployed because they cannot move out of their hometown to find work in other places.

• In such instances, the government may have to provide incentives to encourage businesses to relocateto these depressed regions to provide work for the workers.
• Consider recent development of work from home

Question 11

Policies to overcome immobility of capital

Answer 11

Incentives for investment In new capital goods
- In Singapore, tax cuts and subsidies such as the Productivity and Innovation Credit (expired after 2018) are used to encourage firms to invest in new capital goods to overcome the functional immobility of old capital goods.
Productivity Solutions Grant

Incentives to attract businesses to relocate

• Businesses are on the constant lookout for more attractive places to invest.
• Government can offer incentives such as tax rebates, advanced infrastructure or a skilled workforce to attract Foreign Direct Investment to relocate their businesses and reduce the problem of geographical immobility of capital.

Limitations

Informational Failure

• The government may not have the full information to know which new sunrise or growth industries to support with subsidies.
• Investment in new growth industries carries high risk as it typically requires a long gestation period to bear fruit. Hence information failure may result in funds being misdirected to support the wrong industries, resulting in the misallocation of resources.

Lack of Compliance

• In order to encourage firms to reinvest in new capital (e.g. investments to automate production) the government gives incentives such as grants and subsidies for firms to buy new equipment.
• However, in reality, the funds might not be used by firms to acquire new equipment. A good example is the PIC scheme introduced by the Singapore government to encourage local SMEs to upgrade their capital equipment. It has been found that some firms misuse the grants provided. This has an issue ofmonitoring and compliance.

Question 12

Market Dominance

Answer 12

Market dominance refers to markets in which the product sold is supplied by a single or a few large sellers. As a result the sellers have substantial market share or control over supply and the market price.

That being the case, it is in their self-interest to restrict the quantity supplied in order to maximise their profits. The most extreme form of market dominance is when there is only a single seller of MONOPOLY.

Under such imperfect competition, production is allocatively inefficient because the dominant firm(s) produce(s) at a output where price is above marginal cost (P > MC). Hence the market output is below the socially optimal level, resulting in a deadweight welfare loss to society and hence market failure.

Question 13

Market Dominance Solutions

Answer 13

The primary aim of regulation is to ensure monopolies do not exploit consumers by under-producing; over-charging and providing substandard products.

Government intervention is to “tame” the monopolist (or colluding oligopolists) and prevent them from undermining consumers’ welfare.

(A) Prevention/Prohibition

Laws are designed to prevent the formation of monopolies, for example, US antitrust laws such as the Sherman Act. These laws prohibit the monopolisation of a market by any firm, limit mergers between firms in an industry, break up monopolies by reducing the patent period for a product, etc.

The Competition Commission of Singapore is not against the formation of a dominant position but acts against abuse of dominant position (e.g. predatory pricing, price-fixing or limiting production).

(B) Deregulation

The government may choose to deregulate the industry to subject the incumbent firms to competition so as to keep price more competitive and improve efficiency.

For example, in Europe, the ‘open skies’ policy of a deregulated airline market has led to lower fares and a greater choice of airline for passengers.

Similarly, deregulation in the telecommunications industry in Singapore by licensing to Mobile One and Starhub led to lower subscription plans and better services such as free-incoming calls for consumers.

(C) Price Regulations: Marginal Cost pricing

The government can force the monopoly to charge a price equal to its marginal cost.

Question 14

Equity in Relation to Markets
Efficient allocation may not result in equitable outcomes. Equity could be defined as fairness in the distribution of economic welfare.

Answer 14

Market allocation

• A market allocates resources according to consumer preferences as expressed through their purchasing power. In other words, consumers indicate to producers to produce what and how much they want through their willingness and ability to pay the market prices for them.
• In reality, consumers do not have equal purchasing power due to income and wealth inequality within the society.
• Thus, markets are unable to provide for those who are unable to pay because of the lack of purchasing power.

Essential goods and services

• While it may be argued that it is alright for an individual in society to forgo the consumption of goods like luxury cars and condominiums due to the lack of purchasing power, the same cannot be said for essential goods like basic education and health-care.
• Thus market allocation results in inequitable outcomes as the poor are unable to gain access to essential good and services due to the lack of purchasing power. In such instances, the government is expected to intervene to provide essential goods and services for the needy.

Question 15

Income Inequality

Answer 15

Income inequality is the extent of income disparity between high-income and low-income households.

A commonly used indicator is the Gini coefficient. The value of the Gini coefficient ranges from 0 to 1. The larger the value, the greater the degree of income inequality.

Question 16

Inequality in Income and Wealth (Problem)

Answer 16

The market system will not respond to the needs and wants of those with insufficient economic (dollar) votes to have any impact on market demand because what matters in a market-based system is effective demand (willingness and ability to pay) for goods and services. The free market system thus fails to provide for those without the means to pay for goods and services.

Rising income inequality

Income inequality in many countries is worsening. In 10 of 17 OECD countries, income inequality increased. This too is happening in Singapore where the Gini coefficient is on a rising trend at 0.436 in 1990 to 0.463 in 2013.

The global increase in income inequality in recent times is mainly due to globalization and technological advancement. For the more developed countries, the transition to a knowledge-based economy leads to more opportunities being created in sectors requiring highly skilled labour while low-skilled production is increasingly phased out.

Those who are highly educated and possess the relevant skills experience a fast increase in income as the demand for such workers increase while those who are low-skiiled would have difficulty getting employment with the fall in demand for such workers.

Furthermore, as developed countries like Singapore open up to the freer flow of foreign labour due to globalisation, the supply of unskilled or Low-skilled workers increases, reducing the wages of such workers further and worsening the income gap.

Question 17

Normative Judgement - Equity, Essentials

Answer 17

• However, it should be noted that the concept of equity is normative.
• A value judgement is required to decide what goods are deemed essential in society and hence unfair for the poor to lack access to.
• While food, shelter and healthcare may be considered as essential universally, other goods are subject to the values different societies or governments may place on their consumption.
• For example, while petrol is considered an essential good in Indonesia and is subsidised by the government, it is not so in Singapore.

Question 18

Possible Causes of Income Inequality

Answer 18

In general, income inequality is due to differences in earnings and wealth. This in turn could be due various factors such as:

• Differences in educational qualifications or skills
• Differences in innate ability or talent
• Differences in the price of the product made by workers
• Ownership of assets or wealth e.g. property, stocks
• Discrimination e.g, female versus male workers, young versus old workers, local versus foreign workers

Question 19

Inequality in Income and Wealth (Solutions - Summary)

Answer 19

There are broadly 2 approaches to narrow the income inequality gap:

1. Levelling up
2. Levelling down

The first approach aims to narrow the income gap by helping the poor level up or catch up. Such measures typically include equipping the low income with more skills via education and training. This approach is linked to inclusive growth.
The second approach aims to narrow the income gap by taking from the rich to give to the poor. Such measures typically include progressive taxation and transfer payments to the poor.

Taxation
Subsidies
Minimum Wage
Training and Skills Upgrading Schemes 
WIS

Question 20

Taxation

Answer 20

Progressive income tax can be used to reduce income inequality. A progressive taxation system is one where the higher income earners are taxed a larger percentage of their income than the lower income earners, reducing the gap between the disposable income of the rich and poor.

Limitations:

• However, a tax system that is too progressive may reduce the incentive to work. Some people will also become dependent on unemployment benefits and are slow to find employment.
• This creates a burden on the government’s budget to fund the unemployment benefits. The disincentive on work effort will also adversely affect the productivity levels, hence the potential growth of the economy.
• In Singapore, the government’s tax policy is moving away from progressive tax by cutting income and corporate taxes towards a regressive indirect tax by increasing Goods & Services tax (GST).
• Although this is regressive and worsens income inequality, the objective was to encourage work effort and attract investments. To compensate for this, the Singapore government distributes GST vouchers which are progressive in nature as the payout is higher for low income families and those living in smaller HDB flats.

Question 21

Subsidies

Answer 21

The tax collected can then be redistributed to the low-income households through giving subsidies or unemployment benefits.

For example in the US, the unemployed can get up to 35% of their previous wages in the form of unemployment benefits.

In Singapore, subsidies are also given to lower income group in the form of medical subsidies. One good example is mean-tested subsidy for hospitalisation. Means testing is used to ensure the poor will be the ones who will receive the most subsidies. Heavily subsidised Class C wards in hospital are meant for the low-income/poor.

Question 22

Minimum Wage

Answer 22

Income inequality can also be reduced by imposing a wage floor or minimum wage.

An effective wage floor is a legally established minimum wage above the market equilibrium wage to protect the incomes of low-wage workers.

By legislating the minimum wage workers it raises the wages of the bottom earners, reducing the income gap.

Ld of workers enjoy the higher wage of Wm but this is at the expense of Lo-Ld workers who are being retrenched. Lo-Ls is the increase in number of workers due to the increase in wage from W0 to Wm but they are unable to find work. Hence Ls-Ld represents the number unemployed as a result of the minimum wage.

Singapore does not employ minimum wage. The government believes in raising employability and skills of the low-wage workers rather than mandate minimum wages for them. Thus, supply-side policies that enables Low-wage workers to be more skilled and productive are used to raise demand for workers to D1 and enable more workers L1 to be hired at a higher market equilibrium wage W.

Question 23

Progressive Wage Model

Answer 23

FYI: Singapore has adopted an alternative to the min wage called the Progressive Wage Model. This model is different from the usual min wage laws in 2 key respects

• It is implemented for only selected sectors and not across the board viz. cleaning and security guard sectors.
• It is designed to be “progressive” i.e. wages will rise progressive in tandem with their skills and responsibilities.

Question 24

Training and Skills Upgrading Schemes

Answer 24

The main reason for income inequality is usually due to the differences in education and qualifications of workers. Hence with emphasis on providing a basic level of education and training opportunities for low income workers to upgrade their skills, they can find better paying jobs, reducing the income inequality.

This is the case for Singapore where workers can acquire new skills by signing up for training courses. Low-wage workers can apply for funding under the Workfare Training Support Scheme for training courses.

Through training, the workers would be able to acquire new skills so that they can improve their employability, upgrade to better jobs and earn more.

Question 25

Workfare Income Supplement (WIS)

Answer 25

Though providing training and education may be a good policy to target income inequality, the gestation period may be too long. There must be more immediate help given to the low-income.

The Singapore government recognises that and has in place together with WTS the Workfare Income Supplement (WIS) Scheme, which supplements their income and retirement savings through cash payments and CPF contributions. Unlike unemployment benefits, WIS is given to the low-income earners who are employed hence it does not create disincentives to work. It seeks to raise the income of unskilled workers without raising cost to employers.

The three components of WIS, WTS and Progressive Wage Model form Singapore’s own model of minimum wage.

Question 26

Gov Failure

Answer 26

Situation where gov intervention results in greater market inefficiencies than would otherwise occur without gov intervention

Government intervention causes the deadweight loss to be even greater than the case without government intervention.

Government intervention might introduce further inefficiencies into the market due to high administrative costs, information gaps and time lags resulting from red tape and bureaucracies.

Question 27

Causes of Gov Failure

Answer 27

Info failure / gap
Admin cost and compliance cost
Bureaucratic Inefficiency
Unintended Consequences

Political Factors
Short-termism or a tendency to look for short term solutions to economic problems rather than making considered analysis of long term considerations.
- The pursuit of self-interest amongst politicians and civil servants rather than operating on behalf of citizens leads to a misallocation of resources. For example, politicians and bureaucrats may gain prestige from starting a new spending program even if the cost of the program exceeds its social benefit.
- Electoral pressures leading to inappropriate government spending and tax decisions e.g decisions to bring forward major items of government spending on infrastructural projects or healthcare ahead of an election without the projects being subjected to a full and proper cost-benefit analysis.
Lack of voter support or political support

Policy Conflicts
Governments have multiple economic goals to achieve viz. growth, stability, efficiency and equity.

However the pursuit of these conflicting goals may result trade-offs such as:

• Growth versus efficiency: in the last few decades, China had focused on rapid growth at the cost of increasing pollution and environmental degradation. It is only recently that the government has attempted to strike a balance between growth and protection of the environment.
• Growth versus equity: The pursuit of growth conflicts with equity as economic growth brought about rising income inequality in many countries, including Singapore.

Question 28

Singapore Healthcare Financing

Answer 28

3 Ms (NOTE: Medisave and Medishield Life are not considered as subsidies)

3Ms - Medisave, MediShield Life, Medifund to ensure co-payment and prevent abuse of the system.

• Medisave is a national compulsory medical savings scheme which helps individuals put aside part of their income into their Medisave Accounts to meet their future personal or immediate family’a hospitalisation, day surgery and certain outpatient expenses.
• MediShield Life is a compulsory low cost catastrophic illness insurance scheme. It is a national health insurance scheme that provides lifelong protection for all Singapore Citizens and PRs against large hospital bills.
• Medifund is an endowment fund set by the Government, with capital injections coming from budget surpluses to help needy Singaporeans who are unable to pay for their medical expenses. It acts as a safety net for those who cannot afford the subsidised bill charges, despite Medisave and MediShield coverage.

The 3M framework that is used by the Singapore government has its benefits and limitations.

Benefits

• Ensures that healthcare is accessible to everyone which helps address the MF due to income inequality.
• Unlike using subsidy, Medisave and MediShield do not require the Singapore government to incur substantial expenditure.
• Medishield is a form of mandatory insurance coverage for large hospital bills.

Limitations

Medifund only covers a limited range of healthcare services.
Only a small proportion of the monthly CPF contribution goes to the Medisave account.