Discuss the assertion that the concentration of economic power in the public sector undermines the foundations of economic growth.

Economics ‘S’ Paper Assignment

In this essay, the concentration of economic growth in the public sector will be taken to mean the proportion of the economy that is governed by public ownership in the production of goods and services. Foundations of economic growth refer to the potential for the economy to expand, and hence this would be represented by an outward shift of the Production Possibility Curve. Therefore we shall discuss how a higher proportion of the economy that the government is directly involved in leads to a diminishing potential for future progress of the economy.

How can the public sector hinder economic growth? Economic growth is determined by the potential of the country to produce additional outputs of goods and services. This is in turn dependent on two factors- availability of resources and productivity. Therefore if the public sector influences these two factors negatively, then it would undermine the foundations of economic growth

The government can affect the capital aspect of resources. Assuming ceteris paribus (other factors like land, natural resources- oil, timber, etc are also rigid), it is commonly recognized that heavy involvement of the public sector could hinder capital generation. This is since with majority of the workforce employed by the public sector, there are few entrepreneurs and the extent of free enterprise is limited. Hence with the lack of entrepreneurship and business ventures, there is also the lack of profits and hence the inflow of capital into the country. The lack of capital results in inadequate funds for investment. Investment is the key to sustained future economic growth because capital is needed to fund the economy. The economy cannot solely rely on the profits of the government and subsequent government injection. This has been illustrated in previously communist regimes like China that suffered from numerous deficits and a deteriorating economy by solely depending on the state initiative.

Since investments and capital generation through entrepreneurship and enterprise is restricted with the concentration of economic power in the public sector, then the only other major source of investments to fuel economic growth is foreign direct investment. While this source of investment could singly sustain economic growth, the prospects of a public sector dominated economy may not be appealing. The labour force available for Multi-National Companies contemplating investing in a country would be small and not very skilled. This is since the public sector would very likely have the first pick and recruit the ‘cream of the crop’. In addition, foreign direct investments may be severely leaked out of the country with the lack of proper regulations, and hence the effect of the investments on economic growth is mitigated. The economic growth cannot solely depend on foreign direct investments due to this reason.

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The concentration of economic power in the public sector also undermines the foundations of economic growth by affecting the labour as a resource. The per capita income of labour does not have the potential to expand rapidly because of the lack of free enterprise and entrepreneurship. Workers are not encouraged to take the private initiative to better their present state due to the stable source of income from the public sector. This labour rigidity is also partly influenced by government initiatives in a bid to secure the ‘brains’ of a country. This is done through providing attractive bonds and scholarships to promising talents. As a result economic growth is stagnant and this is coupled with a public sector that progresses slowly. This is attributed to the inefficiencies and problems associated the public sector, such as complacency and lack of motivation in individuals, lack of motivation to be efficient in firms, etc.

However, the concentration of economic power in the public sector does have its merits in promoting economic growth. Decision making processes made by the government allows for a coordinated direction to economic progress and promotes stability and structure. This is particularly crucial in the starting up of economies and hence we can use the case study of Singapore since gaining independence to illustrate how the concentration of the public sector actually aids economic growth.

Singapore’s main economic activity was entrepot trade back in the 1940s-1950s and this was a continuation of the post-colonial legacy. This single sector could not successfully sustain economic growth and the economy was underdeveloped and in a disarray. Labour was plenty but unskilled and uneducated. Organisation was needed to kick-start the economy. Hence in the early stage of economic growth, the government is necessary to provide a coordinated direction and to develop the essential infrastructure to facilitate economic growth.

The diversification of Singapore from a trading centre to something more proved to be the success to Singapore’s economic growth. The pragmatic and far-sighted government set up an extensive public sector in order to achieve this. The government saw that to best speed up economic growth, manufacturing was the way to go. Hence numerous state funded factories came into operation under the supervision of the Jurong Town Council. Ship building industry was also developed and Jurong island was a site for agglomeration of similar factories. This government initiated move proved that coordination was efficient and the factories enjoyed economies of scale, sharing and quick assimilation of knowledge, lower transport costs, shared infrastructure, etc that promoted economic growth. Engaging in manufacturing also tapped on the latent potential of labour at that time. Unemployment dropped drastically and per capita incomes rose due to the employment of cheap labour in the public sector, and these were indicators of strong economic growth.

With the revenue generated from manufacturing, state control of funds allowed the government to best use the funds to expand economic growth. Infrastructure was rapidly developed and improved and the foundations for economic growth were built up. The public sector was responsible for the managing of key infrastructure and services and this included previously known as city council - PUB (power and water), SingTel (telecommunications), SIA (airlines), Temasek Holdings (trading), NOL (shipping), DBS (banking). These facilities further consolidated Singapore’s entrepot status, as well as persuaded many foreign investors to invest in Singapore, being the most developed nation in the region whilst enjoying cheap labour at that time. The installation of this key infrastructure by the public was the crux for Singapore’s strong economic growth in the 1980s.

The public sector had immense economic power during that early period of Singapore’s development and contrary to the stated assertion, did not undermine the foundations of economic growth but instead, promoted rapid economic growth. This is because concentration of economic power in the public sector allows the government, a large body, to direct the economy towards the perceived most viable route. The dominance of the public sector was also essential because the labour force at the time lacked the necessary skills and education to efficiently pursue business prospects. Entrepreneurship and private enterprise could not sustain itself, hence requiring the public sector as a ‘nurturer’ of the economy. The active role played by the public sector led to the Singapore government becoming commonly regarded as the ‘nanny state’, but despite this assertion, Singapore prospered under the concentration of economic power in the public sector.

However as mentioned, the dominance of the public sector is only beneficial during the early stages of development in order to build the foundation and provide the framework for future economic growth to take place. In the later stages of development, it has been observed that continued concentration of economic power in the public sector would prove detrimental to sustained economic growth. This problem has been discussed earlier in this essay.

This is the reason why the Singapore government is taking a step back and the public sector is shrinking. Previously state controlled utilities and services have virtually all been converted to private ownership, or at least a significant portion of shares has been sold off, with government having a much reduced stake in the companies. This is includes PUB, SIA, Temasek Holdings, NOL which have all changed ownership. This is the government’s intention to shift the developed infrastructure to the care of the private ownership and the market system, in order to allow the price mechanism to function and keeping these firms efficient and competitive. Hence in doing so stagnation is avoided and economic growth is assured.

The government has recognized that a ‘brain drain’ is occurring, with talents either stuck within the public sector or migrated overseas. With the shrinking public sector, employment potential is shrinking as well, but the government has managed to keep the ‘brain’ within the Singapore economy while fueling the economy. This is done by promoting entrepreneurship and the government has offered numerous monetary incentives including tax rebates, temporary tax-free status, subsidies, etc. In addition, Small Medium Enterprises is encouraged and more licenses has been issued with deregulation.

To sum this up, the shrinking role of the public sector in the production of goods and services is a clear recognition that in the later stages of development, the concentration of economic power in the public sector does undermine the foundations of economic growth. However, an appropriate amount of economic power must still be allocated to the public sector to maximize economic growth.

This is due to some important tasks that the private sector is responsible for. This is since the public sector is involved in the production of certain good and services such as public goods and merit goods. Public goods must be produced by the public sector because it is desirable to produce it but due to the characteristics of non-excludable and non-rivalry for pure public goods, the market system is unwilling to produce it. Such goods are hence left to the public which would otherwise be unprofitable but necessary to the market system. In addition, some of these include important infrastructure like traffic lights and street lamps, without these, transportation is troublesome and visibility is not existent at night. Without such basic infrastructure, investors are reluctant to invest in the country.

Secondly, the public sector is responsible for undertaking the task of goods and services with high start up costs. This includes telecommunications and subway system, which led to the rise of SingTel and MRT. Other new services include cable television and this is undertaken by Starhub. With such high costs involved, the public sector steps in with government funding to provide these value-added facilities that indirectly promote economic growth. Note that once these firms have been established, the role of the public sector has diminished, with MRT being privatized with the merging of SBS and MRT to SMRT and the deregulation of the telecommunications industry with the introduction of M1 and Starhub.

Furthermore, the public sector is responsible of promoting economic growth by providing merit goods. Such goods are socially desirable but often under produced because their worth is under valued. This includes education for youths, Research and Development for firms and industries, as well as retraining for existing workforce. All these services provided by the public sector are crucial to the sustained economic growth of Singapore.

Therefore in conclusion, a temporal scale must be considered with this assertion. In the early stages of development, the concentration of economic power in the public sector actually promotes economic growth. But in the later stages of development, the assertion is true that the concentration of economic power in the public sector undermines the foundations of economic growth, though it must be stressed an appropriate size of public sector must exist to ensure economic growth.

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Done by: Shawn Quek

2AHR