Singapore as financial corporation

Over the last quarter Singapore’s gdp fell at an annualized rate of 4.6%, in large part because of China problems (that’s your “China fact of the day”).  And household debt is about 75% of gdp.  Yet the nation’s finances are much sounder than that may sound, and it is worth thinking through why.

I think of the government of Singapore as having three main fiscal arms.  One is a tax collection authority, one is like a life insurance company, and the other is like a hedge fund.  In fact it is a hedge fund.

The tax collection angle is pretty straightforward.  Singapore does an excellent job of both collecting taxes and keeping the overall (direct) tax burden low.  As the population ages, however, we can expect these taxes to rise somewhat, but in a predictable and manageable way.

Now consider the financial side, in particular the question of what the government earns on the investment of people’s retirement funds.  Here it gets more interesting.

Singapore’s social security and welfare system relies on forced saving.  Overall this policy has served Singapore well, and has kept down government as a share of gdp, but in an era of low rates of return it may stumble.  Imagine for instance that the retirement fund were to earn zero percent or so (real) over a period of ten years.

There is already a perception that people put in a lot of forced savings for what they get back for retirement.  I’ve heard Singaporeans claim that they “save for forty years and get paid for twenty,” and similar such assessments.  By no means is everyone happy with the system.

Here is a good survey of criticisms (pdf), including this one:

Those dissatisfied with CPF [Central Provident Fund, the forced savings body] interest rates argued that, given the comparatively higher returns from investment bodies like the GIC and Temasek Holdings who invested government funds, the government should rightfully offer a higher rate of return to CPF holders. The failure to do so was thus perceived as proof that the current government was miserly and profit-seeking at the expense of CPF holders’ welfare. Some also highlighted that annual dividends provided under Malaysia’s Employment Provident Fund (EPF) 83 were higher than the 2.5-3.5% annual interest provided on the OA and the 4-5% on the Special, Medisave, Retirement Accounts (SMRA), as proof that CPF rates could be higher.

Here is a useful ADB history of the Central Provident Fund (pdf, and I’ll use the shorter CPF).  In its early years the fund did well by investing in the low-hanging fruit of Singapore’s housing stock.  That option will not be as socially or financially potent looking forward.  Here are concerns about the sustainability of CPF investment plans (pdf).

The CPF balance sheet states that funds are invested in high-quality government securities, but in fact there is a sizable surplus and a lot of the money is invested abroad, basically as part of sovereign wealth fund activities (see pp.13-15 in this pdf, the link is interesting more generally too).

In essence, one part of this system has the financial structure of a life insurance company, and another part has the financial structure of a hedge fund.

Singapore as a financial corporation has amassed an enormous amount of wealth, due to the earth-shattering performance of its fund managers.  You can think of modern Singapore as in part built on the phenomenal “hedge fund” returns of the 1990s.

I read in the Business Times that Temasek, one of the two major Singaporean funds, has averaged a 16 percent rate of return since its inception in 1974.  That is impressive, and even if you think that exact number is somehow cherry-picking, everyone agrees the returns have been high.  The problem of course is that we do not expect the next few decades to be anywhere near that performance, especially as Asian growth has been slowing down and China is no longer an easy path to riches.  Singapore runs the risk of being the next Warren Buffett, so to speak.  That said, Buffett is still a pretty rich guy, as is Singapore; imagine shouting to a bum on the street “Hey, buddy — you’re going to be the next Warren Buffett!”  He wouldn’t feel so distressed.

For all the talk of forced savings, you can understand the current CPF as (partially) a pay-as-you-go system, where some of the CPF funds are transferred to government holding companies and then the higher returns are kept within the state.  I cannot ascertain the size of that transfer, but I believe it to be large.  As a public choice issue, the market-oriented defenders of forced savings programs need to come to terms with the fact that there is far less than full pass-through.  That said, the private savers mostly would not have earned those high rates of return on their own.

Singapore built up a strong state rather rapidly, but partially at the expense of retirees, and those who must save along the way for retirement, and you can think of that as Singapore’s major hidden tax.  “State capacity,” when turned to beneficial ends such as infrastructure and wise decision-making, benefits the young most of all.  In my view it is good policy to be investing so much in the more distant future, rather than in the elderly, but of course opinions here will differ.

One implication, by the way, is that if you measure wealth rather than income, Singapore’s government is much larger than it may at first appear.  On the flow side, Singapore is small government — about eighteen percent of gdp by many measures — but on the stock or wealth side it is big government.  That is one reason why the country has fans on both sides of the political spectrum.

Of course as retirees ask for more, as is the political trend, Singapore will have to increase payments. That will be a massive de facto privatization of the wealth held within the Singaporean state apparatus.  But of course the privatized flows will, to a large extent, be soaked up by household debt and recycled to the financial sector.

It will be tricky to maintain the balance between having a strong state and meeting voter demands.  Such is the tension of living at r> g, and in a funny way the Singapore scenario has, at least until now, fit Piketty’s model fairly well, albeit with a much larger role for the state.  The problems will come when those rates of return on capital start to fall as indeed I believe they are about to.

But don’t worry just yet — Temasek a few weeks ago announced that they pulled in a return of over nineteen percent during this last year.

I continue in my belief that Singapore is one of the most fascinating places in the entire world.  If you have not yet been, I envy you for the experience of visiting the first time.


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