Friday, May 03, 2019

The London-Singapore Comparison Fallacy

By Ben Scott
CTO & Founder 

London has the potential for a new industrial revolution, but politics and power will always get in the way.

(This article appeared originally on Data Driven Investor)
In Linda Lim’s Bloomberg article“Why Brexiteers should stop fantasizing about Singapore-on-Thames” much of what the author writes is correct. As are her observations on how Singapore works.
However, she does misses the point on what makes Singapore successful, and how these differ from the UK today.
Countries develop over time, and most of that change occurs at critical junctures and it is the nature and timing of these junctures that shape a country’s institutions. These institutions include (but are not limited to) an inclusive form of government that is elected by the people (all people, men and women irrespective of their social standing or age, wealth, relationship status, sexual orientation, criminal record or if they pay tax), law and order, property rights, the judiciary (one that is independent of government and can hold Government accountable), how and to what extent the population are educated, health care, and a free press (this is not libertarian fluff, but an essential part of holding Government and others in power accountable).
The key success factors are inclusiveness, understanding that all are equal [at law], property rights protected, and being able to sell our labor how we chose. For the UK, some of the critical junctures that led to the formation of inclusive and pluralistic government include the Black Death, the Glorious Revolution, and the repealing of the corn laws.
Lastly, for an economy to be successful, the people (and the Government that represents them) must accept creative destruction [failure] and innovation [challenge]. These things only come from instability, which is why good democracies provide a framework of instability: challenge and constant change that is driven from the people — the ground up. This is essential as it is the foundation for the incentives that reward risk, investment and thus enable the population.

To Singapore.

Singapore used to be a British colony. However, before this, it was actually part of the English East India Company’s empire. The modern history of Singapore is similar to all other countries that were colonies of European empires. By this, the systems of government established in these colonies started off as one based on extraction and coercion. The colonizing country needed the local population to work and work for as close to free as possible in order to extract at a maximum profit the respective country’s resources. Thus where slavery didn’t work, taxes, coercion, marketing boards, and other tools of the State were employed to keep the local population down. This was carried out most effectively (and brutally) in Southern Africa. The only exception to this was Australia and the United States (for reasons that I will come to in a later piece).
Therefore, today what you observe in Malaysia, Indonesia, and Singapore are not only the impact of these extractive regimes but what happens over time as critical junctures shape the country, its institutions and impact the founding principles.
For Malaysia and Indonesia (just like most other former colonies), the post-independence governments were no different to the ones they replaced. The new Governors found that they could use the apparatus left behind to enrich themselves in the exact same way the colonizing countries had done. There were no incentives for changing the system to one that is pluralistic and inclusive or creating the institutions that protect the people’s interests and incentivize them to invest and take risks. Those in power had all the incentives to expropriate anything of value for their own personal gain — if it ain’t broke, don’t fix it.
In the case of Singapore, there are many differences.
Singapore (as we know it today) was established by the English East India Company (see 1819 Singapore Treaty). This was a 3-way Treaty that was mutual and required the East India Company to pay an annual fee to both the Sultan of Johor and the Temenggong for the right to establish their port and a factory. Free ports attracted trade and investment, but also vice and thus administration and policing costs. Singapore became part of the British Empire in 1824 and ultimately an independent country in 1965. The critical junctures that helped shape Singapore include the above, but also the race riots of 1964 (there had been much instability prior to this and race riots before this time). These riots were the result of tensions between the Malay and Chinese populations within Singapore. The Malaysian government sought to destabilize Singapore by exploiting the racial tension, as both the Governments of Malaysia and Indonesia did not like the Chinese due to their ability to succeed in the most adverse of conditions.
However, one of the most critical junctures for Singapore was the election of Lee Kuan Yew in 1959 as Singapore’s first Prime Minister (MM Lee). MM Lee was a Cambridge University Law graduate and thus understood the importance of a functioning legal system and an independent judiciary. His selflessness, focus, and self-discipline were a productive accident of his election.
In 1963, Singapore joined with Malaya, Sarawak and North Borneo to form Malaysia (the ‘si’ in Malaysia is to recognize Singapore’s membership to the Malaya club). MM Lee was a strong advocate of equality and fair treatment for all which riled the other members. This, with the economic dominance of Singapore, and because the other members were unable to control Singapore or extract what they wanted, Indonesia and Malaya decided to punish what they saw as a Chinese problem by expelling Singapore from the “Club.”
Racial tensions then only increased.
One of the critical insights MM Lee drew from this time was that if people were treated equally and fairly, had opportunity and work (income), stability would follow. MM Lee and his government also understood well the challenges Singapore faced as a small country with no natural resources to extract and sell. Another productive accident as it turns out. It was then decided that the country should be modeled on the pluralistic principles that treated all equally (the choice of English Law and thus the English language was also an astute choice (at the time), as not only was this the legal system of the business world, it was also the language of the business world at that time), had an independent judiciary, respected property rights, and incentivized investment (risk-taking) and work (the right to choose how we sell our labor).
This resulted in the creation of inclusive institutions of education, law and order, and a functioning legal system. This fostered openness (essential for pluralism) which included opening up to international trade. Labor was truly mobilized.
The focus on inclusive institutions and a legal system that protects people’s fundamental property rights is the foundation of Singapore’s success.
Foreign investment poured in, as no other country in the region had such a reliable foundation. This trust brought certainty to financial decisions and meant that investments were made in Singapore that otherwise would have gone to Indonesia, Malaysia, Thailand, Taiwan, or Japan.
Today, Singapore’s competitive edge is its legal and financial systems (even Japan and Korea’s legal systems can be unpredictable). Thus, it is better for many companies to work here than in any other Asian country. It also means that much of Asia’s wealth is managed and banked in Singapore.
Until other countries understand this, they will remain where they are and continue to lag behind. This includes China. One should not mistake breakneck short-run economic growth brought about by authoritarian and extractive government with long term success.
The labor market. This is Singapore’s Achilles heel. It appears that many in Singapore correlate economic growth only with the mobilization of labor (the first stage of economic development), rather than total factor productivity.
To put this in equations, GDP = C + I + G + NX (Consumer Spending + Investment + Government Spending + Net Exports) rather than AKN (Total Factor Productivity x Capital Stock x Labor).
The differences in these two equations are important to understand. The first says that people spend money and save (investments) and Governments spend and the country trades. All good stuff, but in order to have more GDP all you can do here is have more people spending more money and hopefully saving and investing more, with the worst sin being increasing Government spending to increase GDP. However, a focus on the second produces different results as it is clear that the biggest gains to GDP come from investment in capital items (machines, factories, infrastructure) and productivity.
You can’t double your workforce during the life of a government, but you could double productivity and capital invested. The challenge is that most governments like the first equation, in which spending is convenient and as a result, in Asia, you see huge infrastructure spending and continued investment in housing and other easy ways to push up GDP and soak up labor.
In Singapore, there was never enough labor to soak up, so it's imported. The dependence on foreign labor is also a subsidy and also results in extractive and coercive practices (crap management and nonexistent productivity). Worse, it results in a lack of innovation and thus an absence of productivity gains. Business in Singapore is in the same place as the Cotton Barons of the Southern United States. They (The Southern States) lost the Civil War but won the slavery battle. The access to cheap, almost slave labor, means no incentive or need to invest in productivity and slavery remained, only in different clothes.
This is why productivity in Singapore is so low and continues to fall — there is no incentive on management to change. If you compared the patent filings in the Southern United States with those in other agricultural states that did not rely on forced labor, you would typically observe an average twelves times more patent applications filed per year in states that had competitive labor markets.
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The most basic right is for a person to decide how they sell their labor.
Coercive markets are not competitive and thus always fail. In order to succeed a nation must protect and incentivize its people — everyone is the same and no-one has executive power. Again, this is not libertarian fluff or a political view, this is evidence-based economics. The evidence is clear and unambiguous.
Lastly, Singapore’s savings.
The very fact that Singaporeans have been required to save via the CPF, and that the Chinese population is prolific savers has resulted in vast cash resources. These resources are deployed via GIC and Temasek in investments that are designed to improve Singapore as well as preserve and grow these savings. These investments are both domestic and international.
Private investment is also strong. People and companies have significant sums to invest and invest they do. They invest in their own business as well as other people’s and other countries. The only Europeans who think like this are the Germans and Norwegians. The UK has no savings base, no government surplus to invest and shows no sign of satisfying its rapacious appetite for public borrowing to fund social spending (much of which is important, but doesn’t create wealth or get people to work). Money continues to flow into Singapore and the Singapore Dollar continues to appreciate. Money flows out of the UK and Sterling declines.
The markets have confidence in Singapore, but not in the UK. So, as a Caucasian, if you feel aggrieved that rich Asians are buying up companies and housing stocks, maybe try to compete — get out and work and save, there is no secret sauce, just hard work and self-discipline. You too could own assets in other countries.

What does this mean for the UK?

The UK has the institutions necessary for success, but these institutions are not the same as they were. The industrial revolution happened in the UK because the UK respected property rights and had an inclusive form of government that operated under very different incentives than those in Europe. Thus the UK welcomed inventors, new ideas, and those that wanted to work and take risks. Whereas, most governments in Europe wanted to prevent labor market reforms and wealth creation because these threatened their position.
Today, I would argue that the UK is not as inclusive as it was (there has been a decline in institutional quality) and we see this in the increase in extreme political views and social instability.
Many people feel unheard.
Economic stagnation is a signal of declining institutional quality.
This, coupled with a corporate culture that is extractive in nature, leads to many companies engaging in unfair and ethically questionable practices, reaping benefit but shouldering none of the responsibilities such as paying taxes or wages that people can live on and raise a family on.
(See the commentaries on the impact of a poorly functioning labor market, particularly one where extractive, coercive and other anti-competitive practices appear.)
From an economic perspective, the UK cannot be like Singapore because it is surrounded by developed countries with functional legal and financial systems. There is no inherent incentive for companies to invest in the UK. They can invest in other European countries and gain access to those (local) markets at a lower cost.
Competitive strategy 101: To compete you must bring something new to the table.
In order to attract inward investment, there has to be a reason and it has to be more profitable than the alternative. In the short run, the EU will win over the UK because of risk aversion, but in the long run, as trade flows establish and the new business model and transaction costs of this model become observable, things could be different.
However, the UK will always have to compete on taxes. A great example of this is the reason that Silicon Valley is in the US and stays in the US: tax.
Taxes shape economies — the labor market, the products we buy, but most crucially, it shapes the investment landscape and peoples’ risk appetite. People in the US are no more or less creative or ingenious than those in any other country, they are only incentivized differently.
Taxation requires reform. People are understandably uncomfortable about this, but if we learn anything from the Chinese, it must be pragmatism. What most people tend to want, is to work at something meaningful, be paid and treated fairly and have not only some certainty that their future is in their hands, but that there is hope and opportunity that they can make a better life and leave something better for their children. It is critical to understand how what you wish for impacts these desired outcomes.
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The government does not build countries, the people do.

Government creates the institutions and incentives — structures and controls that enable the people, which are the economic growth engine of all economies.
For example, it was not the British Government that built the empire, it was private enterprises using contracts and joint stock companies. People who wanted to invest in the enterprise without risk of their assets being expropriated on the whim of authority. The industrial revolution happened in the UK because of its inclusive institutions, and that innovators and entrepreneurs could pursue what they wanted without a monarch or authoritarian interfering with their property rights. In simple terms, it was people responding to incentives.
Authority fears industrial growth as the wealth it creates challenges their power base. There could always be a second industrial revolution in the UK, a renaissance, but this would be dependent on better policies and rebuilding the democratic base. This means looking hard at some of the institutions to determine what needs fixing. It requires people to work and work hard. I say this as not only because the institutional drift in the UK resulted in a loss of pluralism, but also too many people in the UK have forgotten what real work is, and what it takes to succeed.
Get out of the narrative of politics, or how you feel, and look at the evidence.
One of the downsides of EU membership is that the EU is a closed shop — rather like the guilds of the middle ages. These Guilds prevented growth as they preserved a status quo that benefited its members by shutting down the competition.
The EU is anti-competitive by design. The main selling point for EU membership is that life is easier (in the short-run). However, as we see now, life is not easy and governments across Europe are reaping what they have sown, and there is now a little opportunity and no growth. Germany, France, and Italy are (at the time of writing) in technical recessions. The only tool the EU thinks it has is monetary, but you can’t buy your way into prosperity.
Prosperity requires reform of incentives to enable people. In particular, reforms of the labor market and taxes. People make better decisions than the government. The challenge here is that politicians don’t like giving up power and this makes them similar to the self-appointed monarchs democracy was supposed to replace.
Barriers are high in Europe, it is difficult to start a business in countries like Italy and France. It is these factors that create an opportunity for the UK. The correct strategy for the UK going forward is to create the incentives for Europe’s brightest and best, the most driven, to come to the UK to set up their businesses there instead.
This brings not only capability but also a capital — the seeds of creative destruction.
It’s about getting the real working-class entrepreneurs, the ones who give you the most value for money. These businesses employ more people, pay better, treat people better, and pay more taxes. Not only that, they are more innovative and bring more reliability, because a sustainable economy is built on creative destruction — the acceptance of failure and the instability of innovation that only comes from a functioning democracy.
The last thing that really bothers me about the article I mentioned in the first paragraph, is not what’s written, but the headline. The very fact that politicians talk of “Singapore-on-Thames” reinforces some very sad facts that those in London think no further than London. What’s worse, it implies that the only sector in an economy is the financial sector.
How offensive is that?
The financial sector is a secondary sector that grew from peoples’ trading activity. When we trade we need banks and ways to pay bills (settlements and settlement instruments), we need lawyers and contracts and stock and bond markets to raise funds for our businesses. Putting the city before the industry is rather putting the cart before the horse.
I think the worst thing about this is that its clear that Westminster has no industrial policy, plan, or strategy and certainly nothing that would benefit anyone who lives outside of London or the Home Counties.
This means that Westminster has no plan for most of the people that work in the biggest part of the economy. The economy that actually puts the most number of politicians in Westminster and pays the biggest piece of revenue to the Exchequer.
In plain English. If politicians are serious about improving the state of the UK economy and enabling growth, then there is much work to do and many thorny reforms to undertake. If the UK government approaches the UK’s current problems like MM Lee and his post-independence government did — with humility and honesty and a genuine drive to make the country better for everyone while being clear in what the desired outcomes are, and then exercising iron discipline in execution, anything can be achieved.
Sadly, it is more likely that it will be business-as-usual in Westminster, the Singapore-on-Thames will remain a fantasy, and the people will only be poorer.

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