Fiscal Policies (SG Context)

TYS 2020 Q5

(b) Discuss the policy measures that Singapore’s government should take to address the economic consequences of these population changes on its economy. [15]

Introduction

Singapore’s ageing population poses risks to both aggregate demand and long-run productive capacity. To mitigate these challenges and sustain economic growth, the government must adopt a mix of demand- and supply-side policies tailored to support spending, raise labour supply, and enhance productivity.

R1: Fiscal policy to support AD in response to falling consumption and investment

One major economic consequence of ageing is a fall in aggregate demand (AD), as retirees have lower marginal propensity to consume, reducing consumption (C), while firms facing a shrinking customer base cut back on investment (I) due to weaker long-term demand prospects.

To offset this decline, the government can adopt expansionary fiscal policy. This works by increasing government spending (G) or reducing taxes (T). Since government spending directly contributes to aggregate demand (AD = C + I + G + (X–M)), a rise in G raises AD. Reducing personal income taxes raises disposable income, encouraging greater consumer spending (C), especially among the working-age population. Similarly, cutting corporate taxes increases after-tax profits, incentivising firms to undertake more investment (I) in machinery, technology, or expansion. Together, these fiscal tools aim to raise AD and stabilise economic activity.

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As government spending (G), consumption (C), or investment (I) increases, aggregate demand (AD) rises, leading to an increase in national income (Y). With higher income, households experience increased disposable income, prompting higher consumption. This induced consumption further boosts AD, resulting in subsequent rounds of income increases. However, each round sees a smaller rise in consumption due to leakages such as savings, taxes, and imports. This cycle continues until the incremental rise becomes negligible. Through this multiplier effect, national income ultimately increases by more than the initial injection. Graphically, AD shifts rightward from AD₀ to AD₂, raising real output from Y₁ to Y₂, thereby achieving economic growth and reducing unemployment.

EV1: Fiscal sustainability concerns and limitations of demand-side responses

Expansionary fiscal policy, which involves increasing government spending (G) and/or reducing taxes (T) to stimulate aggregate demand (AD), may conflict with the objective of sustainable economic growth, especially in Singapore. Such policies often result in significant budget deficits. However, unlike most countries, Singapore does not borrow to fund these deficits. Instead, it must either cut spending elsewhere or draw on Past Reserves. Over-reliance on reserves undermines the government’s ability to respond to future crises, such as global recessions or public health emergencies.

Over time, if fiscal pressures mount due to rising healthcare and aged care costs, the government may be forced to restore discipline through fiscal austerity—a set of measures aimed at reducing deficits and restoring resevres by either cutting government spending (G) or increasing taxes (T). This diverts resources away from long-term, productivity-enhancing investments in areas such as infrastructure, education, and healthcare, thereby weakening the foundations for future growth. Moreover, the need to raise taxes for the future generations in the form of income and corporate tax can lower households’ disposable income and firms’ profitability, reducing consumption (C) and investment (I). This results in a fall in AD and national income (Y), lowering material standard of living (mSOL) and impeding sustained growth for the future generations. 

R2: Supply-side policy to address falling productive capacity and rising cost pressures

Another key economic consequence of ageing is a fall in productive capacity, due to shrinking and ageing labour supply, which shifts LRAS leftward and contributes to long-run cost-push inflation.

To counter this, the government can implement supply-side policies to improve labour's quality, quantity, and mobility, thus enhancing the economy’s productive capacity. For example, the Singapore government increased the retirement age from 62 in 2017 to 63 in 2022 and plans to further raise it to 64 by 2026. Raising the retirement age retains more workers in the labour force, thereby increasing the quantity of labour. Additionally, retaining senior, experienced workers enhances the quality of labour due to the workforce being more experienced, and the older workers can also improve the quality of labour for the younger workforce through knowledge transfer. This results in an increase in Long-Run Aggregate Supply (LRAS), shifting the LRAS curve from LRAS0 to LRAS1 and increasing full employment output from YF0 to YF1.

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Furthermore, higher retirement ages also increase the disposable income of senior workers, boosting their purchasing power. This rise in disposable income encourages greater consumption(C). Since consumption is a component of Aggregate Demand (AD), an increase in C shifts AD rightward from AD0 to AD1, creating a multiplied rise in national income from Y0 to Y1 through the multiplier effect. Thus, supply-side policies effectively contribute to both actual and potential economic growth, hence achieving sustained growth which is the steady continuous rise in national output or Gross Domestic Product (GDP).

Assuming that the increase in LRAS outpaces the increase in AD, this would lead to a fall in General Price Level (GPL) as seen in the fall of GPL from P0 to P1, helping the economy bring down high inflation and achieve non-inflationary growth. 

Final Conclusion + Evaluation
In conclusion, Singapore must combine expansionary fiscal policy to manage short-run demand-side effects with supply-side measures to address structural productivity constraints. While supply-side policies are more effective in ensuring long-run resilience, their success is limited by factors such as skills mismatch, the physical limits of raising retirement age, and diminishing returns from upskilling alone. In the long term, Singapore may also need to consider adjustments to foreign manpower policy and greater investment in capital-intensive technologies to boost productivity in the face of demographic constraints. A diversified, forward-looking strategy is essential to maintain economic dynamism amidst an ageing population.