(Reprinted from HKCER Letters, Vol. 15, July 1992) 


The Folly of Industrial Policy:
Hong Kong and Singapore Compared

Y.C. Richard Wong



There is a growing popular perception that Hong Kong may become less competitive than the other new industrialized economies (NIEs) in the Asia-Pacific region. This perception stems from the observation that Hong Kong is undergoing structural change. The manufacturing sector is declining because industries are moving out to take advantage of cheaper labor and land elsewhere. New and technology-intensive industries have not been developed to the levels found in Singapore, South Korea, and Taiwan. Industrialists are calling on government to follow the example of its neighbors and play a more active role in pursuing an industrial policy. Organized labor favors such a policy as a measure to raise the productivity of manufacturing workers.

Industrial policy means different things to various people. Many economists would support an industrial policy aimed at investing in infrastructure and human capital that benefit all sectors. In this respect, Hong Kong has performed quite well when compared with the other NIEs. The main disagreement is over whether the government should adopt an industrial policy of "picking winners," a practice which has been pursued to a far greater extent by Hong Kong's neighbors. The fact that laissez-faire Hong Kong does not have as many new and technology-intensive industries is a consequence of the absence of such a policy. In other words, the market has chosen not to produce these advanced industries; to have them, one must actively encourage them through the public provision of additional incentives.

Whether a more active industrial policy will promote economic growth is an important issue, for if not, there would be no reason to encourage these advanced industries. In Singapore and South Korea, where a strategy of "picking winners" is pursued with great vigor, one finds that all the growth in output is a result of the increasing utilization of labor and capital. Indeed, productivity growth does not contribute positively to output growth. An industrial policy to encourage advanced industries to enhance productivity fails to contribute to economic growth. In Hong Kong, where such a policy is absent, one finds that productivity growth contributes to 17 percent of output growth. Taiwan is an intermediate case. The prima facie evidence does not favor the adoption of such an industrial policy to promote growth.

The above figures are calculated directly from published data. However, such comparisons made across countries are always subject to qualifications because of differing circumstances that prevail in each economy and because of availability of data. A recent study by Professor Alwyn Young of the Massachusetts Institute of Technology entitled "A Tale of Two Cities: Factor Accumulation and Technical Change in Hong Kong and Singapore" is more interesting because it compares in great detail the relative performance of two of the more similar economies using high-quality revised data. His findings and conclusions are summarized below.

Hong Kong and Singapore Compared

A combination of broad similarity of institutions and economic structure, and yet striking dissimilarity in industrial policy, makes the comparison of Hong Kong and Singapore a useful case study.

The two economies are similar in that both were British colonies which served as entrepot trading ports with little domestic manufacturing activity. Hong Kong processed trade between Mainland China and the rest of the world, and Singapore served as a conduit for world trade with Malaya and Indonesia. In the post-war era, however, both economies developed large export-dependent domestic manufacturing sectors. Both economies have passed through a similar set of industries, moving from textiles, to clothing, to plastics, to electronics and then, in the 1980s, gradually moving from manufacturing into banking and financial services. GDP per capita in the two economies was quite close in 1960, and they have subsequently grown at the same remarkable rate. From the political economy perspective, one can note that both economies inherited a fairly efficient and rational administrative structure. The post-war population of both was composed primarily of immigrant Chinese from Southern China. Both economies are really small cities, with no significant agricultural interests, economic or political.

The two economies are, however, dissimilar in other aspects. The early post-war population of Hong Kong was considerably better educated than that of Singapore. While the Hong Kong government has emphasized a policy of laissez-faire, the Singaporean government has, since the early 1960s, pursued the accumulation of physical capital via forced national saving and the solicitation of a veritable deluge of foreign investment. These policies have been astonishingly successful, with the share of investment in Singapore's GDP rising from 9 percent in 1960 to a high of 43 percent in 1984. In stark contrast, Hong Kong's investment rate has fluctuated around some 20 percent of GDP. The Singaporean government has also pursued an active policy of industrial targeting, which has led to rapid structural transformation and allowed the Singaporean economy to catch up and surpass Hong Kong's initial lead in manufacturing.

Role of the Hong Kong Government

For most of the post-war era, the Hong Kong government adopted a policy of minimal intervention, with limited policy intervention prompted only by the most enormous popular pressure. Thus, the post-war population inflow and the huge squatter shanty towns it created ultimately led to public housing program, with the initial allocation of floor space being 24 square feet per adult. The program has grown steadily, and by 1982, housed 40 percent of the population with, however, as a result of continued immigration, 125,000 families still living in squatter huts. Similarly, widespread riots in 1966 led to an expansion of social services, such as a public assistance scheme covering the elderly and the passage of labor legislation restricting child labor and mandating four rest days per month. In the 1970s, microeconomic intervention grew, perhaps due to growing local participation at all levels of government, with the establishment of a (completely unsuccessful) Loans for Small Industry Scheme in 1972 and an Industrial Estates Corporation to encourage industrial diversification in 1977. Despite these significant and growing departures from laissez-faire, over the post-war era as a whole, Hong Kong government intervention in the domestic economy is best characterized as limited.

Of particular interest is the Hong Kong government's influence on infrastructure development. The Hong Kong government is the sole owner of all of the undeveloped land in the territory. In the absence of government land sales, which are a major source of revenue, private developers have no means of expanding the available living and working space. Government land sales and infrastructure development, however, have been slow and restricted, and only undertaken when demand reached astronomic proportions. For most of the period, the rate of infrastructure development was totally out of keeping with the demands of the rapidly growing population.

Policies of the Singaporean Government

In stark contrast, in the post-war era, the government of Singapore has pursued maximalist policies involving widespread state participation in economic activity financed, in the main, by extensive taxation of labor income. The 1950s and early 1960s were a period of economic stagnation in Singapore, as trade, which was the lifeblood of this entrepot economy, failed to expand. The 1961-1964 development plan actively sought domestic industrialization, erecting trade barriers, providing tax incentives to foreign investors, and initiating a large infrastructure investment program. The early 1960s, however, featured continued political conflict, this time with Singapore's principal trading partners, Malaysia and Indonesia. Consequently, despite the expansion of construction activity, real GDP per capita rose only 2.9 percent per annum between 1960 and 1965. In 1966, Singapore witnessed a brief resurgence of trade (as international political relations improved), but in 1967, growth slowed. In July 1967, Britain announced that it would withdraw all of its military forces from Singapore by the mid-1970s. British military bases are believed to have employed, directly and indirectly, 16 percent of the workforce and accounted for 13-20 percent of GDP. Meanwhile, Singaporean attempts to industrialize and attract foreign investment drew mixed results, as manufacturing expanded slowly and the giant government-built Jurong Industrial Estate turned into an empty white elephant.

In 1968, the Singaporean government dramatically expanded its direct investment in manufacturing and the economy. The Development Bank of Singapore (DBS) expanded its financial commitments (loans, equity investment, etc.) from S$45 million in July 1968 to S$340 million in December 1970, by which time its holdings of quoted and unquoted shares amounted to 25 percent of all shareholders?funds in the economy. One-third of all financial commitments were in the electrical machinery and petroleum products industries. It is small wonder that between 1968 and 1970 the number of workers in manufacturing increased 60 percent, with value added in chemical and petroleum products increasing 87 percent and value added in electrical machinery increasing seven-and-a-half-fold!

The early investment commitments of the DBS turned out to have been only the initial steps in the development of a colossal interlocking web of off-budget government corporations and statutory boards. By the early 1980s, the Jurong Town Corporation ran 21 industrial estates and export processing zones (and was building 15 more), while the Housing Development Board housed more than 70 percent of the population. At this time, the government owned Singapore Airlines, INTRACO (a trading company), Neptune Orient Lines (shipping), Hotel Premier and, in manufacturing, held a 100 percent or majority equity stake in firms in food, textiles, wood, printing, chemicals and petrochemicals, iron and steel, engineering, and shipbuilding and repair. According to a 1984 Euromoney estimate, state-owned corporations and statutory boards earned profits equal to S$10 to 15 billion, or roughly one-third of GDP. The acquisition and expansion of this vast array of properties was financed by huge government loans to the statutory boards, which averaged 11.4 percent of GDP between 1981 and 1985, reaching a high of 16.5 percent of GDP in 1986.

To support its mammoth investment program, the Singaporean government has run prodigious surpluses of current revenue over current expenditure. Total revenue, at some 14 percent of GDP in 1960, had risen to around a quarter of GNP by 1970 and has remained there ever since. Current expenditure, however, has consistently been less than revenue, averaging, for example, only 58 percent of the latter during the 1980s. In addition to its own surpluses, the Singaporean government also borrows extensively from the Central Provident Fund (CPF). Established in 1955 as a social security program with individualized accounts, the initial contribution rate to the CPF was set at 5 percent of the employee's salary, with a matching 5 percent contribution from the employer. By 1975, these rates had been raised to 15 percent both, and by 1984 to a rather impressive 25 percent apiece. Participants may use their fund balances to purchase housing (usually built by the Housing Development Board) or government shares, but, otherwise have a limited ability to withdraw their balances, even upon retirement. As of 1980, fully 95.1 percent of the Fund was invested in government securities. At peak, in 1985, CPF contributions amounted to a staggering 14.9 percent of GNP, or 36 percent of gross national savings.

The year 1968 also witnessed an intensification of efforts to attract foreign investment. Labor legislation passed in that year standardized basic conditions of employment (e.g., hours of work, holidays) and made issues such as promotion, internal transfer, recruitment, retirement, dismissal, and allocation of duties all nonnegotiable managerial prerogatives. All disputes were henceforth subject to compulsory arbitration at the Industrial Arbitration Court, which was required to consider "the interest of the community as a whole." Man-days lost due to industrial stoppages fell from an average of some 40,000 per annum in the mid-1960s to nil (in all but two years) during 1978-1990.

Tax incentives for investors have expanded steadily since 1967. Under Pioneer Status, which was actually first introduced in 1959, firms (selected on the basis of capital expenditure and type of technology) are exempted from the 40 percent profits tax for a period of five, ten, or more years. Export incentives, introduced in 1967, provide a 90 percent tax exemption for five to fifteen years for export profits derived from sufficiently large investments. In addition, as of the early 1980s, there was an Expansion Incentive (five-year exemption for profits in excess of the expansion level for firms investing more than S$10 million in machinery and equipment) and a Warehousing Incentive (five-year 50 percent tax exemption on profits in excess of a fixed base for firms investing in warehousing), as well as an Investment Allowance Incentive, an International Consultancy Services Incentive, an Approved Foreign Loan Scheme, and an Approved Royalties provision. In general, all capital equipment can be completely written off in five to ten years, and R&D spending can be double-deducted, as can all expenses for export promotion. In principle, these incentives do not discriminate between domestic and foreign investors. In practice, because they are usually linked to sizable investments involving advanced technologies in new (targeted) industries, the overwhelming majority of participants are foreign.

Singaporean policies have been extraordinarily successful in attracting a growing deluge of foreign investment. Foreign direct investment in manufacturing, which averaged less than S$30 million per annum during 1960-1965, and only S$73 million during 1966-1967, reached S$151 million in 1968, S$708 million in 1972, and by the late 1970s was well in excess of S$1 billion per annum. According to estimates based upon IMF data, net long-term direct investment in tiny Singapore between 1975 and 1984 (US$11,568 million) vastly exceeded the inflow into either Indonesia (US$2,675 million), Malaysia (US$7,995), the Philippines (US$720), Thailand (US$1,679), South Korea (US$433) or Taiwan (US$925). By 1990, 35.9 percent of Singaporean GDP went as payments to resident foreigners and foreign companies.

It is worth emphasizing that the Pioneer Industries Ordinance, which provides the most significant tax holiday enjoyed by foreign investors, was actually introduced in 1959. By itself, however, it failed to attract much foreign direct investment until after 1968, when the Singaporean government began to expand its own financial participation in manufacturing and other sectors. Both the popular press and academic authors indicate that the Singaporean government uses its involvement in all facets of the economy to subsidize the return to foreign capital (beyond the tax incentives) by, for example, providing preferential loans, leasing land and buildings at reduces cost, shouldering labor training costs, and assuming large equity positions. As will be seen below, Young's estimates indicate that by the early 1980s, the real return on Singapore's massive capital stock was below 10 percent per annum. According to a Business International study, however, American corporations in Singaporean manufacturing in the early 1980s enjoyed a return well over 30 percent per annum. This suggests that the return on the Singaporean-owned segment of the capital stock is well below the average return.

In the post-war era, both Hong Kong and Singapore experienced rapid structural transformation, with the relative shares of employment and value added accounted for by different industries changing rapidly over time as the relative importance of each sector rose and then declined. One is left with the indelible impression, however, that, Singapore, which started much later, traversed many of the same industries as Hong Kong, but in a much more compressed time frame. By the late 1980s, Singapore seems to have surpassed Hong Kong on the technological ladder, with Singaporean finance increasingly dominating Hong Kong finance and Singaporean manufacturing industries producing en masse high-technology electronics goods which have eluded most Hong Kong entrepreneurs.

Accounting for Economic Growth

Young has found that overall, technical change has contributed to 35 percent of output growth in Hong Kong between 1971 and 1990, but a minus 1 percent in Singapore between 1970 and 1990. In sum, Hong Kong has experienced rapid total productivity growth, while Singapore has, on average, experienced no improvement whatsoever in total productivity.

Consideration of the interaction between learning on the factory floor and R&D in the laboratory would be helpful in the understanding of the growth process. Economic history and empirical studies of technical change strongly suggest that new technologies do not achieve their full productive potential at their moment of invention. Experience gained in the use of new techniques seems to allow large gains in productivity by introducing a series of small improvements on otherwise unchanged technologies. At the same time, it must be recognized that large technical breakthroughs emanate from the research laboratory, where individuals engage in purposeful attempts at developing new technologies.

In terms of costs, how much it costs to produce a new good depends upon a society's familiarity with the production of existing goods. Sustained invention depends crucially upon sustained learning since, in the absence of learning, new products are increasingly costly and unprofitable to produce. On the other hand, sustained learning by doing depends upon a sustained flow of new inventions. Thus, an economy has to balance between learning and invention. When to invest and what level of technology to use are essential questions to consider.

In the early 1960s, Hong Kong's learnt industrial maturity was far greater than that of Singapore. Hong Kong, endowed with greater quantities of human capital and aided slightly by foreign investment, was also finding it easier to copy foreign technologies and enter new sectors (e.g., plastics and electronics). Overall, Hong Kong produced a more advanced bundle of goods. By the early 1980s, Singapore had caught up and, if anything, had begun to surpass Hong Kong in the technical sophistication of manufacturing output. In the intervening two decades, both economies experienced substantial learning by doing, thus decreasing the cost of invention of new products. Nevertheless, because of the aggressive targeting policies of the Singaporean government, by the early 1980s, Singapore was mostly producing goods at a higher cost than necessary because producers were not familiar with the technology associated with the new products, i.e., they had not fully captured the advantage of learning by doing. The new products had been adopted earlier than they ought to have been. Singaporean costs of production would imply that a premature movement up the technological ladder results in a fall in measured productivity. Thus, fundamentally, Young argues that Singapore is a victim of its own targeting policies. In individual sectors, Singapore probably has experienced total productivity growth. This improvement, however, is masked by the further and further movement beyond the society's level of industrial maturity.


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