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Singapore: Selected Issues

Author(s):
International Monetary Fund
Published Date:
May 2006
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III. Trends and Variation in Domestic Competition and Markup Costs1

1. Over the past decade, the Singapore economy has been buffeted by increased competition from low-cost regional economies and a series of external shocks. In response to these challenges, the government adopted the recommendations of the Economic Review Committee (ERC) in 2003 and has begun implementing a reform agenda focused on improving external competitiveness, enhancing labor market and wage flexibility, reducing business taxes and costs, and upgrading and diversifying Singapore’s manufacturing and services sectors. The ERC also recommended the need to improve private sector entrepreneurship and promote domestic competition, including through the recently legislated Competition Law.

2. This chapter examines quantitative, industry-level measures of the intensity of domestic competition in the manufacturing and services sectors during the past two decades in Singapore. The measures, which are estimates of the markup or margin above average or marginal cost, are typically used in the economic literature to assess the intensity of domestic competition. In this chapter, these estimates for Singapore are compared with similar estimates for Hong Kong SAR and other countries at the aggregate and industry level.2 In addition, the measures are used to access trends and cyclical variation in competition in Singapore. Finally, the measures are employed to correct for biases in estimates of total factor productivity (TFP) growth, reflecting the impact of imperfect competition on observed labor shares in the national accounts.

A. Methodology and Data

3. In the literature, three broad approaches have been taken to estimate price to average (or marginal) cost markups and margins. The first is a direct measurement of price-average cost margin (P-AC) and follows the methodology of Domowitz, Hubbard, and Peterson (1986) and Allayannis and Ihrig (2001). The main advantage of this method is that it allows for a calculation of P-AC margins for each year, even allowing estimates from short time series. The main drawback is that P-AC margins are more difficult to interpret as measures of competition than P-MC (price-marginal cost) margins.3 P-AC margins are calculated both on a gross output basis and a valued-added basis.4 The second method makes econometric estimates of P-MC margins. It is based on Hall (1988), Domowitz, Hubbard, and Peterson (1988), and Roeger (1995), but does not allow for time-varying estimates of the margins.5 A third method estimates P-MC and P-AC markups using a structural model, following Morrison (1990).6 In this chapter, the results from primarily the first method are presented for Singapore so as to examine the time variation in markups/margins.

4. The quantitative measures of domestic competition are estimated at the industry level for the period 1983-2003. The industry-level data are on an annual basis based on the Singapore Standard Industrial Classification (SSIC 2000). Manufacturing sector data are primarily from the annual Census of Manufacturing Activities, while services sector data (which are more limited) are from the annual Economic Survey Series (ESS) published by the Department of Statistics.7 Data on wages are based on the official release of average monthly earnings, with labor assumed to be homogeneous across sectors. The average of lending rates from the 10 leading banks is used as a proxy for the rental cost of capital.

B. Main Results

5. Margins in Singapore are similar to those found in the United States and the average of OECD countries at the aggregate level and for most industries, but generally somewhat higher than in Hong Kong SAR (Table 1). Margins measured on a gross output basis are always smaller, particularly more so for the services sectors, than the margins measured on a value-added basis. In a few industries, the margin is higher in Singapore than in the other countries on both the gross output and the value-added output measures, possibly suggesting a lower level of domestic competition in those sectors, assuming that the elasticity of demand for the listed sectors are constant across countries. These industries are the non-metallic minerals sector, the machinery and equipment sector, and transport equipment sector in manufacturing; and the transportation, storage, and communications sector in services. Moreover, it is noteworthy that industries in Hong Kong SAR, another small open economy, generally have lower margins. Regression estimates of P-MC margins show similar results.8

Table 1.International Comparison of Price-Average Cost Margins (Selected Industries)(In decimal points)
Gross Output MeasureValue-added Measure
HongHong
SSICKongOECDUnitedKongOECDUnited
CodeSelected industriesSingaporeSARcountriesStatesSingaporeSARcountriesStates
15Food and beverages0.1550.2010.1170.1340.2520.3020.4810.478
17,18,19Textiles and textile products0.1100.1110.0970.0880.2730.1780.2730.271
20Wood and wood products0.1100.1120.1190.1360.2160.2180.3210.309
21Paper and paper products0.2350.1040.1230.1390.3190.1930.3270.309
24Chemicals and chemical products0.3340.1570.1590.1080.4260.2470.4790.417
26Non-metalic minerals0.1780.1410.0840.0950.3200.2350.2000.265
27Basic metals0.1430.0640.0880.0670.2870.0910.3250.266
28Fabricated metal except machinery0.1520.1240.1510.1250.2910.2060.3010.227
29Machinery and equipment0.1740.1670.1450.0630.3200.2510.2890.204
30,31Electronic products0.1470.1480.1100.1740.2710.2290.2410.266
33Transport equipment0.2750.1520.0640.0510.4960.2260.2010.237
34Other manufacturing0.1020.1010.1000.2160.2220.1610.2020.327
Total manufacturing0.1630.1340.1150.1180.2830.2030.3480.308
70-74Business services and rentals0.2050.1820.6010.3480.7720.788
55Hotels and restaurants0.1500.0970.4110.2770.4290.406
60-64Transportation, storage and communications0.2520.2220.1400.6490.5780.3700.333
50-51Wholesale and retail trade0.0240.0450.5210.5890.4500.417
Total services0.0910.1590.1400.5510.4210.4640.445
Sources: Staff estimates for Singapore and Hong Kong SAR; estimates for the OECD and the United States are reported as in Zitzewitz (2000). The industrial classification across countries may not be entirely consistent.
Sources: Staff estimates for Singapore and Hong Kong SAR; estimates for the OECD and the United States are reported as in Zitzewitz (2000). The industrial classification across countries may not be entirely consistent.

6. Margins have generally increased in Singapore in the manufacturing sector in recent years. The pattern has been more evident since the late 1990s. In the manufacturing sector, the margins (on the value-added basis) were stable at around 25 percent before 1997 but increased to around 32 percent by 2003.9 This partly reflects the shift in the composition of manufacturing toward chemical and chemical products, a sector that includes the fast-growing pharmaceutical and bio-pharmaceutical products industry.10 Indeed, this sector has higher margins than the average manufacturing sector, and these margins have increased in recent years. Margins in the electronic products sector, which is the largest manufacturing sector accounting for roughly a third of manufacturing output, have also increased in recent years, although the margins are about at the level of the overall manufacturing sector. Margins in some of the other sectors, such as refined petroleum products, have declined recently.

Manufacturing Sector P-AC Margins

(In percent)

Source: Staff estimates.

7. By contrast, margins have decreased in the services sector. For most industries, the decline began in the early 1990s, although the pace of the decline appears to have accelerated in the late 1990s. Deregulation of services, particularly financial services, may be partly responsible for the improvements in competition. Margins, however, remain higher (on a value-added basis) than in the manufacturing sector. With services now accounting for about 65 percent of the aggregate GDP, improved competition in these sectors will likely drive improvements in the overall level of domestic competition.

Services Sector P-AC Margins

(In percent)

8. Mark-ups appear to be slightly countercyclical in Singapore for the aggregate manufacturing and services sectors and for most industry sub sectors (Table 2). Statistical tests suggest, however, that acyclical markups cannot be rejected in the aggregate or for most sub sectors.11 By contrast, the margins are generally procyclical in the average OECD country and generally acyclical in Hong Kong SAR.12 Rotemburg and Saloner (1986) showed that imperfect competition that leads to countercyclical markups could slow down price adjustment, leading to difficulties for open economies with fixed exchange rates. This is, of course, less of a concern in Singapore given the managed float exchange rate regime. However, Singapore’s dominant services sector appears to be more countercyclical than manufacturing, with statistical significance at the 5 percent level for the community, social, and personal services sector and the hotels and restaurants sector.

P-AC Margins and the Output Gap

(In y/y percent change)
Table 2.Cyclicality of P-AC Margins (Selected Industries)(In percentage point effect on the margin of a one percentage point change in the output gap)
SSIC
CodeSelected industriesSingaporeHong Kong SAROECD Countries
15Food and beverages−0.0390.415−0.780
17,18,19Textiles and textile products−0.037−0.117−0.240
20Wood and wood products0.0130.3190.030
21Paper and paper products−0.0500.0410.300
24Chemicals and chemical products−0.256−1.1680.150
26Non-metalic minerals−0.014−1.346−4.710
27Basic metals−0.0780.6000.720
28Fabricated metal except machinery−0.018−0.809−0.040
29Machinery and equipment0.150−0.8800.900
30,31Electronic products−0.0771.4330.610
33Transport equipment−0.2300.750−0.090
34Other manufacturing−0.038−0.0640.560
Total manufacturing−0.081−0.0580.32
70-74Business services and rentals−0.189−0.991−0.300
55Hotels and restaurants−0.2780.216−0.100
60-64Transportation, storage and communications−0.184−0.2640.060
50-51Wholesale and retail trade−0.167−0.215−0.390
Total services−0.215−0.1400.09
Sources: Staff estimates for Singapore and Hong Kong SAR; estimates for the OECD are reported as in Zitzewitz (2000). The industrial classification across countries may not be entirely consistent.
Sources: Staff estimates for Singapore and Hong Kong SAR; estimates for the OECD are reported as in Zitzewitz (2000). The industrial classification across countries may not be entirely consistent.

9. The counter-cyclicality of markups could be due to a variety of reasons. Cyclical patterns in price-cost margins, of course, reflect important underlying differences in cyclical responses of variables such as wages and prices, and decisions about production and inventory. In addition, given the high import content of output, the cyclical pattern of the margins could also reflect the behavior of import prices. Lam (2005) presents a model of imperfect competition with heterogeneous firms, subject to aggregate demand and idiosyncratic sectoral productivity shocks.13 Implications of the model are that firm entry is facilitated during business cycle booms and markups are counter-cyclical and an increasing function of market share. This model is broadly consistent with data in Singapore, where changes in margins are negatively related to firm turnover and positively related to changes in market share. Another explanation is that when external demand is high, the manufacturing sector—which is very export oriented—absorbs resources and puts pressure on wages. This shrinks the markup of the less export-oriented services sector producing counter-cyclicality.

P-AC Margins and the Number of Establishments

(In y/y percent change)

P-AC Margins and the Number of Establishments

(In y/y percent change)

10. The presence of high margins also distorts traditional growth accounting exercises for economies such as Singapore, where the capital-labor ratio has been rising. Intuitively, markups lowers the observed labor share of total income below the “true” labor share that would be applicable under perfect competition. This leads to an underestimation the contribution of labor in GDP growth and, in cases where capital-labor ratios are rising, the contribution of total factor productivity (TFP) growth. The impact is relatively larger for countries, such as Singapore, which have experienced very rapidly rising capital-labor ratios. Correcting for this bias using the estimated P-AC margins raises TFP growth estimates for Singapore by roughly 0.75 percentage points during 1983-2003 compared with traditional estimates made using the Solow residual with observed factor shares (Table 3). For industrial countries, such as the United States, Germany, and France, the comparative adjustment is 0.3 percentage points (Zitzewitz 2000).

Table 3.Bias in Traditional Measures of TFP Growth (1983-2003)(In percentage points)
Share of
SSICAggregate
CodeSelected industriesSector 1
15Food and beverages−1.794.0
17Textiles and textile products−0.980.5
18Wearing and apparels−0.541.9
19Leather and leather footwear−0.040.2
20Wood and wood products0.350.5
21Paper and paper products−0.841.4
22Printing and reproduction of recorded media−0.534.5
23Refined petroleum products−0.126.0
24Chemicals and chemical products−0.7812.5
25Rubber and plastic products−1.002.9
26Non-metalic minerals−0.672.0
27Basic metals−0.980.8
28Fabricated metal except machinery−1.265.9
29Machinery and equipment−2.137.7
30Electrical machinery and apparatus−0.433.2
31Electronic Products−0.7233.3
32Medical, precision and optical inst.−0.792.5
33Transport equipment−0.918.3
34Other manufacturing0.501.8
35Recycling of metal and wastes 20.510.1
Total manufacturing−0.86100
70-74Business services and rentals−0.1422.0
75-95Community, social, and personal services−0.0717.1
64-65Financial services and insurance−1.4917.0
55Hotels and restaurants−0.084.6
60-64Transportation, storage, and communications−0.3819.7
50-51Wholesale and retail trade−1.4919.8
Total services−0.67100
Source: Staff estimates.

Average over 1983-2003. Value added as a share of total manufacturing or services.

Data from 1990 onwards, only.

Source: Staff estimates.

Average over 1983-2003. Value added as a share of total manufacturing or services.

Data from 1990 onwards, only.

References

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1This chapter is based on research by Raphael W.K. Lam, during a summer internship at the IMF, and was prepared by Ranil Salgado. More details of the underlying research can be found in Lam (2005).
2Markups are defined as Price/Cost and margins as (Price-Cost)/Price. The two concepts are closely related, as higher markups imply higher margins.
3Under Cournot competition, for example, the P-MC margin is proportional to the level of collusion or the inverse of the effective number of firms, which is equal to one if the firms are perfectively colluding or the actual number of firms if the firms are not cooperating. The P-AC margin is related to the P-MC margin by adjusting for capacity utilization and the long-run returns to scale (see Morrison, 1990). In addition, it should be noted that higher P-MC or P-AC margins or markups do not necessarily imply less competition as both measures are also inversely proportional to the market elasticity of demand. Thus, higher markups may be due to lower demand elasticity. However, if the elasticity of demand is constant across countries for a given sector, then differences in markups and margins can reveal differences in competition.
4The gross output measure is the ratio of gross output value less labor remuneration and material cost plus change in inventory to the sum of gross output value and change in inventory. The value-added measure is the ratio of value-added net of payroll expenses to the sum of value added and material costs.
5In this chapter, the econometric specification (panel, fixed effects on cross section) used is:
where y, k, l, and z are, respectively, output, capital, labor, and the parameter of technical progress; ^ represents the first difference in logarithms; μ, θ, and λ are, respectively, the P-MC margin, the observed labor share, and the scale of operations. The estimation included instrumental variables to identify changes in industry output not related to changes in its productivity—namely, contemporaneous and lagged real aggregate output and world commodity prices. Constant returns to scale are imposed, after checking that constant returns cannot be rejected for most of the industries. For details, including the derivation of the specification, see Lam (2005).
6The method requires measures of capital utilization not directly available in Singapore. However, a proxy using the ratio of utility expenses (on electricity, gas, and water) to gross output, shows little variation during the sample period for Singapore.
7A list of the industries in each sector and other details of the data are provided in Lam (2005). In the results below, services sectors are aggregated into broader groups following the classification of the annual ESS.
8See Lam (2005). Kee (2002), however, found substantially higher markups for Singapore during the period 1970-92.
9Henceforth, P-AC margins are based on the value-added measure (unless otherwise stated).
10Overall, chemical and chemical products have almost doubled as a share of GDP in the last two decades, and now account for about fifth of total manufacturing.
12 Zitzewitz (2000) found that the services sector margins are procyclical in Hong Kong SAR over the period 1986-97.
13The model is an extension of Jaimovich (2004), which has homogeneous firms/sectors.

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