Last year, when I delivered the Budget speech, the economy was in the throes of a recession, the worst in 20 years. No sector of the economy was spared. Overall, our GDP shrank by 1.8% in 1985, and about 00,000 jobs were lost. The recession continued into the first quarter of 1986. Companies were still folding and retrenchments continued, apparently unabated, with no prospect of recovery. The Government acted swiftly. Various cost-cutting and fiscal measures recommended by the Economic Committee were implemented. They represented important policy changes that decisively improved our competitiveness. The lowering of employer's CPF contribution rate to 10%, the substantial reductions statutory charges and other costs, and the 50% cut in property taxes all helped to reduce operating costs and improve company profitability. Other measures designed to stimulate the economy and restore business confidence included rebates on personal income taxes, increased Government spending on infrastructural projects and a lowering of the corporate tax rate to 33% with effect from Year of Assessment 1987. PERFORMANCE IN 1986 These measures have paid off. How successful they have been is evident from the performance of the economy in 1986. The details can be found in the Annual Economic Survey which has already been released. I will therefore only highlight the salient points: (i) The economy grew by 1.9% in 1986. This was an improvement over 1985, and was also better than our earlier projection of zero growth; (ii) The employment situation too has brightened. Overall, 11,000 jobs (net) were created in 1986. Unemployment, which reached a high of 6.5% in June 1986, fell to 4.6% in December 1986; (iii) Our non-oil domestic exports grew by 20% in 1986, compared to the 4% decline in 1985; and (iv) Investment commitments reached $1.4 billion, a 27% growth over 1985, although still less than the $1.8 billion registered in 1984. However, these statistics must be interpreted with circumspection. They merely indicate that taken as a whole, the economy is recovering from the recession. But the recovery is not across the board. Not all the sectors of the economy have recovered or are doing well. Only manufacturing and transport and communications, which make up about half the economy, are performing satisfactorily. We must therefore not throw caution to the wind. The recovery of our manufacturing sector was due mainly to the cost-cutting measures. These measures reduced total production cost by 10-15%, allowing our exporters to pass on some of the gains as price reduction in the international market. This, in turn, stimulated external demand for our goods. In the transport and communications sector, cost-cutting measures and particularly higher productivity have also generated robust growth, demonstrating how important it is for a price-taker like Singapore to be internationally competitive. I will elaborate on this point later. The other half of the economy, which includes construction, trade and commerce, and financial and business services, has not done as well. The construction industry remains badly depressed due to the oversupply of properties. Growth in the trade and commerce sector remains weak, largely because of the slowdown in the regional economies caused by low commodity prices. As a result, recovery of the fiancial and business services sector has been modest, except for the offshore markets, which have done well. We therefore cannot relax our efforts to restore the economy to steady growth. Our focus should be on the long term. We must aim for the targetted long-term growth rate of 4-6% per annum. Whether we succeed depends largely on the external environment, given the openness of our economy and our dependence on overseas mark everything to ensure that whatever happens, our chances of a sustained recovery are maximized. RESTORING INTERNATIONAL COMPETITIVENESS - WAGE RESTRAINT The importance of restoring our international competitiveness cannot be over-emphasized. We are a price-taker in international markets. We can only sell our goods and services if our prices are right. The loss of our international competitiveness was a key reason for our recession. From 1980 to 1984, wage increases in Singapore far outstripped productivity growth, while in the NICs, wage increases were either lower or at least matched by productivity increases. Our competitive position against the other NICs weakened by as much as 50%. Details are shown in the charts (Cols. 111 - 114) which are being distributed to Members. In this period, external demand for our goods and services grew by only 5% per annum, whereas that of the other NICs expanded by 11% per annum. In short, the other NICs expanded their share of the international market at our expense. charts - UNIT LABOUR COST OF SELECTED COUNTRIES, RELATIVE UNIT LABOUR COST AGAINST THE THREE NICs, 1980-1986 (Cols. 111 - 114) Thus, last year our priority was to restore our international competitiveness through cost reduction. The employer's CPF contribution rate was cut by 15 percentage points, resulting in a 12% saving in wage costs. Statutory charges were also reduced. In addition, unions and management reacted responsibly to the Government's call for severe wage restraint. CPF records show that wage restraint has worked. Under this policy, nominal wages increased on average by only 0.7% in 1986 (December 86 compared to December 85), compared to 5.4% in 1985 and 12.3% per annum between 1980-84. However, so far we have only managed to restore our competitive position to the 1982 level. We need to go one step further - to narrow our cost differentials with the NICs back to at least the 1981 level when our competitive position was relatively strong. This requires another year of low wage increases and high productivity growth. The wage restraint policy must therefore continue this year. MAINTAINING INTERNATIONAL COMPETITIVENESS (A) Wage Reform We must also adopt a long-term perspective in addressing the issue of international competitiveness. It is not enough just to restore our cost-competitiveness. We must also ensure that we maintain our competitive position, once it is restored. This will only happen if we reform our wage system. The NWC Subcommittee on Wage Reform has published its Report. It explains clearly the need for such reform. There must be flexibility in our wage system, to allow us to cope with the uncertainties of the economy, by adjusting through wages rather than through unemployment. This is in the interests of both companies and workers. The report provides guidelines on introducing a flexible wage system to the private sector. The public sector too formed a subcommittee to look into wage reform in the Civil Service. We must not miss this rare opportunity to reform our wage system, while memories of the recession are still fresh and the euphoria of recovery has not set in. Government agencies such as the Ministry of Labour and the National Productivity Board will offer every assistance to help companies introduce flexible wage systems. I am pleased to note that so far, 64 companies including both MNCs and local firms, and three industry groups have taken active steps to introduce a flexible wage system. I encourage others which have not done so to act quickly. (B) Long-Term CPF Contribution Rate To tackle the problem of high wage costs directly, the Economic Committee recommended that the Government immediately reduce employer CPF contribution rates to 10%, for two years in the first instance. This was done. The Committee also recommended that "the Government should review the CPF scheme from a longer term perspective, to decide on the appropriate long-term rate and structure of contributions that would meet the basic needs of the CPF scheme". This is being done. Two different objectives have to be satisfied: we want to save as much as we can, in order to provide for the basic needs of retirement income, home ownership and Medisave; at the same time, the contribution rate must be one the economy can afford. Although the long term target CPF rate cannot yet be determined, it is already clear that any increase in the CPF rate after these two years will have to be gradual. It will have to take into account the state of the economy and the conditions of the labour market. Any CPF rate increase must be implemented as part of an overall affordable increase in labour costs, so that our competitiveness will not again be affected. Investors can rest assured that the Government will not let our costs rise out of line again. LONG-TERM TRANSFORMATION OF THE ECONOMY The principal priority of the Government in the coming financial year will be to restore the economy to full health. At the same time, we must not lose sight of longer term issues, in particular, our place in the world economy. We are already implementing the longer-term recommendations of the Economic Committee to transform the economy. The Government, and particularly agencies such as EDB, TDB and MAS are pressing ahead along the New Directions. We plan to develop the economy in four main areas, viz. the upgrading of local businesses, and the promotion of investments, trade and services. (A) Upgrading of Local Businesses Local businesses occupy an important role in our economy. We must build a solid base of thriving and resilient local businesses. In this connection, the Small Enterprise Bureau (SEB) has, since its inception, worked closely with SISIR, NPB and TDB to implement various programmes to help local businesses. These programmes improve access to capital by small firms, and encourage them to adopt modern management methods, to improve efficiency, to upgrade their technology, and to build up their product design capability. The response has been good, and more such programmes will be introduced. But the restructuring process will not be easy. Local businesses can be assured that the Government will give them every possible help to upgrade and modernise their operations to cope with the changing business environment. But Government help will not be enough. Our businessmen must have the will to adapt and adjust to changes, so that they can play their rightful role in the modern economy of Singapore. Government remains committed to the view that the private sector should be the engine for economic development. To this end, Government has been gradually reducing its role in business. Guidelines for Government companies were first issued by my predecessor, Dr Tony Tan, in his 1985 Budget Speech, and I can do no better than repeat his statement: (a) Government will invest in new priority industries only where private entrepreneurs do not have the will or the money to undertake projects on their own or where it is essential for Government to provide the entrepreneurship; (b) Government will divest its shares in companies where it does not have a majority stake and where it is not essential for Government to have effective control; (c) unlisted Government companies will, wherever possible, be listed on the Stock Exchange of Singapore; and (d) for critical companies which are considered to be vital to the national interest, Government will maintain a controlling interest but where possible will invite participation from the public through listing on the Stock Exchange. Since that time, Government has divested its interests in several companies and reduced its holdings in a number of others. In January 1986, a Public Sector Divestment Committee, comprising private sector representatives and Government officials, was set up to review and propose a programme for the privatisation of Government-owned enterprises. The Committee's role was to identify Government-owned enterprises suitable for privatisation and to recommend a privatisation programme which will provide the widest possible public participation and also ensure continuity of quality management. This Committee, under the chairmanship of Mr Michael Fam, has completed its study and has presented its full report to Government. The report is being studied by the Ministry of Finance. (B) Investment Promotion While we do more to help local businesses upgrade and modernize, we must continue to attract more foreign investments to Singapore. We need foreign investments not only to generate and sustain economic growth but also to foster our economic restructuring and upgrading. The EDB's intensive marketing efforts and cost-cutting measures have paid off. Investment commitments as I mentioned earlier, reached $1.4 billion in 1986, 27% more than in 1985. But caution is necessary. Foreign investments will no longer come easily. The competition for the investor dollar is getting more intense and we are competing not only against developing countries but even against many developed countries. MNCs seeking investment locations are evaluating us against countries such as Britain, Spain and even some states in the US. EDB's aggressive marketing and promotion efforts alone will not succeed in attracting foreign investments to Singapore. Our fundamentals must also be right. We must continue to have a stable and rational Government which has the support of the people; we must preserve good industrial relations climate; we must improve our efficient, comprehensive infrastructure. Finally, we need a highly conducive business environment which can offer a higher rate of return than the OECD countries. Otherwise, there is no incentive for the investor to come to Singapore. Therefore, every effort must be made to keep costs low and competitive. (C) Trade Promotion TDB will continue its efforts to safeguard and expand our access to international markets. We will continue to use all available avenues, such as international dialogues and forums, to argue for the maintenance of the system of free trade. But we must be prepared for more protectionist measures in the developed countries, the result of rising budget and trade deficits and rising unemployment. To safeguard our GSP entitlement, we will also have to resist premature attempts to graduate us to developed country status, which do not take into account limitations and the vulnerabilities of our small open economy. Apart from resisting attempts to deny us market access, TDB will step up its efforts to promote Singapore's exports, particularly of new products and to new markets such as Latin America, India and China. The Market Development Assistance Scheme has helped local companies to export their products and services. So far $4 million has already been granted to more than 400 companies. Major Original Equipment Manufacturers have been encouraged to set up International Purchasing Offices (IPOs) here. In the electronic sector alone, there were 22 IPOs in 1986 compared to only 12 in 1985. TDB will also help local companies improve their product designs and packaging capability, to make them more competitive in international markets. In line with the Economic Committee's recommendations, TDB will upgrade and promote our entrepot trade and develop Singapore into a Hub City offering sophisticated services to support trading activities. Our warehousing and distribution facilities are being improved. More feeder lines will be encouraged to use Singapore as the pivotal cargo port of this region. In addition, the Pioneer Service Incentive will be used to encourage countertrading companies to set up their regional offices here. To date, six such companies have been awarded the incentive. These companies are expected collectively to generate $4 billion worth of business over the next three years. (D) Promotion of Services Our investment promotion efforts no longer focus on manufacturing alone. This is important as our present niche as a manufacturing base is constantly being challenged by the other NICs. They have more resources and cheaper labour than we do. While we will not abandon manufacturing, we must move aggressively into services, particularly knowledge-based and skill-intensive services where we have a comparative edge and advantage. This is the way to develop into an international total business centre. The EDB has set up a Services Promotion Division to lead and coordinate efforts to promote services. The Government is extending tax incentives which were previously confined to manufacturing to a broader range of non-manufacturing activities. The Operational Headquarters (OHQs) incentive was introduced last year to attract international companies to Singapore, to manage and provide a full range of services to subsidiaries in the region. OHQs are desirable as they bring with them substantial and pervasive direct and indirect benefits to the economy. EDB is working out together with international accounting companies and bankers the types of OHQs we want to promote in Singapore. Four companies have already been awarded the OHQ incentive, and many more have expressed interest. Last year, the pioneer incentive was extended from manufacturing to service industries. We hope that this will attract more knowledge- and skill-intensive services companies to Singapore. I will be announcing later a new incentive to promote offshore services, and encourage our companies to take advantage of overseas business opportunities. The Monetary Authority of Singapore (MAS) will continue to actively promote development of banking and financial services. The Stock Exchange has been reorganised and revitalised. Development of the domestic capital markets is being augmented by the opening of a second exchange and by the launching of a new issue of marketable Government securities later this year. Growth in the offshore banking sector and in fee based financial services has been encouraging, following the package of financial incentives introduced last year. With the opening up of Tokyo as a financial centre and the rapid internationalisation of banking, competition in financial services is expected to intensify rapidly. Government will ensure that Singapore remains competitive as a regional financial centre by continuing to upgrade its infrastructural facilities and to make available a sufficiency of skilled manpower. We will also ensure that the fiscal environment remains hospitable and I will have more to say on this subject later in my speech. FISCAL POLICY The tax cuts introduced in 1985 and 1986, at a cost of approximately $2.2 billion in lost revenue, together with other cost reduction measures and the wage restraint policy, have clearly worked to turn the economy around. However, it is not possible nor necessary to maintain some of the tax cuts indefinitely. The suspension of the tax on PUB bills, for example, and the concessions on property tax, will have to be reviewed when the economy has finally recovered. I can, however, give the assurance that tax concessions will remain in place for as long as necessary to maintain our international competitiveness. I should caution, also, that further significant cuts in direct taxes cannot be expected without the compensatory introduction of some form of consumption taxation, as direct taxes are the main source of Government revenue, and structural deficits cannot be sustained in the long term. Naturally, we will look first to greater prudence in all areas of Government expenditure. In addition, we must ensure that Government programmes should be self-financing as far as possible, with minimal subsidies. In this connection, the level of subsidies appropriate for tertiary education has been reviewed, as announced by the Minister for Education this morning. Concluding Remarks 1986 has been a watershed year in Singapore's economic history. For many Singaporeans, the recession was an awakening to economic realities. The lessons learnt from the recession were painful, but they were timely. We have to accept that the era of double-digit growth is over. The economy is in a more mature phase of development. Henceforth, growth will be more difficult to achieve. It will only be achieved if we successfully restructure our economy. To do this, we must capitalise on our only asset - our people. Education and training must therefore continue to be the focus of our development strategy. They are long-term investments that will yield social and economic returns. The Government will continue to expand and improve our various educational and training institutions. The successful infusion of skilled and trained manpower into the economy will provide the impetus for us to grow and progress into the 1990s and beyond. Longer term, we face the even more difficult problem of an ageing population, made worse by a rapidly declining fertility rate, particularly amongst the better educated. These trends, unless addressed now, and reversed, will inexorably lead to a Singapore lacking in the brainpower and vigour needed to compete internationally. Amongst other measures, I will be introducing, later in my speech, a package of tax measures designed to encourage procreation.