Growing wealthy without bubbles

This story was first published in The Straits Times on April 23, 2013

NOT since its founding has Singapore gone through such significant structural and social change. The next few years will be critical as Singapore considers different types of growth models.

Until the mid-2000s, Singapore's economy operated like an income-driven community. It was focused on generating income to increase savings and investment.

A few years ago, however, it shifted to a wealth-consumption model where the focus of the community became one of consumption and increasing asset-based wealth. The 2010 opening of two integrated resorts and the inaugural F1 race in 2008 are the more visible outcomes of the pursuit of the wealth-consumption model.

Societies are never entirely one or the other, of course. But this theoretical distinction can put things in perspective as we ponder the long-term alternatives.

Sweat and toil

AN INCOME-DRIVEN economic community strives for maximum employment and steady income growth. For any aspiring family, hard work and high savings are seen as the key to prosperity.

While economic well-being is measured in terms of the goods and services consumed, consumption is a by-product of consistent production and income-generating activities.

Sustainable income-driven growth requires a country to be very focused on cost competitiveness. Policymakers are required to proactively clip the excesses of business and price cycles to ensure a full employment-sustaining environment. Economic value is derived from the manufacture and sale of goods and services that are highly price-competitive.

The biggest indicator of whether a society is pursuing an income-driven model of growth is its willingness to disappoint asset owners and the markets when the economy or markets begin to rise fast.

Asset owners love higher asset prices. So any policy suppressing asset price surges are branded as needlessly painful, anti-market or the result of excessive interference in the economy. Yet this is what is required to maintain lower costs and competitive prices. Lower costs and prices in turn enhance consumption, lead to longer growth cycles and more happiness and stability, even if people do not feel super-wealthy.

A great policy example was when the Government in 1996 introduced stringent and innovative rules to curb rapidly rising property prices. Many rued the lack of excitement in Singapore asset prices compared with the runaway spikes in unhindered markets like Hong Kong.

The rest - in the form of the Asian financial crisis - is history. Singapore avoided the worst that befell so many others.

But such vindications from policy choices are a rarity. Income-driven growth models in reality require a policy of going for reasonably high, positive real interest rates.

Higher interest rates compensate society by producing higher yields on savings and other economic activities, compared to the possible gains to be made from asset flipping and capital appreciation.

An income-driven society is effectively a society trying to accumulate prosperity brick by brick while avoiding the allure of the get-rich-quick approach.

The joy ride

UNLIKE the sweat and toil required to build up a foundation brick by brick, the ride to riches from asset flipping is exhilarating and fast. Buy the right asset - a property, a piece of land, a chunk of commodity stocks - and sit tight while the value appreciates.

The trouble, of course, is that such a wealth-driven goal can end in tears when an unsustainable short-term rise in asset prices suddenly reverses direction.

Take the case of a society where the prices of some widely owned assets - like stocks or property - begin to rise sharply but consistently over many years on account of justifiable factors. These could include changes in regulations or the lower cost of capital. The wealthy do not just ramp up consumption. They also feel "smarter", concluding that they had made the correct choices.

But there are side effects to these easy gains.

Society as a whole becomes reluctant to tighten policies designed to limit these wealth gains. Pundits extol the death of business cycles and the need for ever lower interest rates and income yields.

Most people struggle to make ends meet as prices rise. Aspirations and expenses rise with the notional rise in wealth levels. Meanwhile, savings fall. This is partly due to slower-rising incomes, but is also linked to inflation. People may also save less due to higher perceived wealth.

While savings decline, investments in assets rise. So does faith in soaring asset prices. Society turns increasingly to debt.

The effects of wealth inequality tend to be far larger than income inequality. While the going is good, these inequalities are fine. But they become a source of friction as the wealth gains slow and the population feels the gap between income and costs.

Those who do not acquire assets during this period of asset price appreciation will find themselves far behind in the economic stakes.

Many economies have become far more wealth-driven. As a result, the widening wealth gap cannot be ignored.

A new United States Urban Institute study shows that Americans under 40 have accrued less wealth than their parents did at the same age. And this has happened despite the fact that the average wealth of Americans has doubled over the last quarter-century.

Rising unhappiness, debt, cash flow difficulties and inequality alongside rising wealth may appear counter-intuitive, but these possibilities are built into the nature of such growth.

Weaning off wealth

AT WHAT point does asset accumulation become unhealthy for a society? Here are a few warning signs:

  • Low or negative real interest rates, even when the economy is doing well. This is the gap between interest rates on deposits or loans and general inflation.
  • Falling savings among median households during times of good economic growth.
  • Growing interest from non-residents in owning the country's assets rather than productive, income- or employment-generating businesses.

How can these effects be countered?

Belatedly jacking up interest rates would prove excruciatingly painful given high debt levels and tight cash flows.

A far better approach would be to find ways of stabilising asset prices. Policymakers must consider measures that apportion greater pain on those who are investing exclusively for financial gain.

A wealth tax on non-owner-occupied high value property would create the right precedent for the future while generating funds to ease the pain of the poor.

It is good to remember that GDP growth is not the only measure of success. The United Nations Human Development Index (HDI) takes account of other factors such as education, health and income. The most recent data shows that countries that have improved the most do not necessarily have the highest GDP growth.

In South Korea, per capita income rose by only 4.5 per cent between 1990 and last year.

But its standing on the HDI improved much faster than China's, where incomes grew by 9 per cent over the same period. By contrast, the US ranks 16th after adjusting for internal inequality.

Singapore faces a choice: to encourage a society built on rising incomes, or one built on rising wealth. To be sure, the two are not mutually exclusive. But it is vital for us as a society to know what kind of activity we want to encourage. This will ensure that policies are consistent in delivering the right message, and that, as a society, we understand and support these policies.

The writer, a fund manager, is currently president of CFA Society Singapore, a society of Chartered Financial Analysts.

This story was first published in The Straits Times on April 23, 2013

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