The tiny island state managed to survive the last economic crisis, but it has become one of the first countries in Southeast Asia caught in a free-fall into recession. This will bite more deeply and cause more severe pain than to its neighbors.

Singapore's third-quarter gross domestic product (GDP) continued to fall on a year-on-year basis by 5.6 percent in advance of estimates released in October. The decline is dramatic when compared with last year's buoyant growth. In 2000, third-quarter growth was 10.3 percent.

In annualized quarter-on-quarter terms, the economy fell 9.9 percent, after declining 10.4 percent in both the first and second quarters this year. The Ministry of Trade and Industry has downgraded the 2001 growth forecast from 0.5-1.5 percent to about minus 3 percent with no recovery in 2002. It started the year forecasting a growth rate of 5-7 percent.

Singapore acknowledges that the "biggest drag" has come from manufacturing, with output dropping 21 percent in August, the sharpest fall since the 1985 recession. Electronics output declined sharply by a record 37 percent in August, down from minus 33 percent in July.

Singapore is hostage to the global environment. Its total external trade declined by 13.8 percent in August. Non-oil domestic exports dropped by almost 30 percent year-on-year, while exports of electronics were down nearly 31 percent. Exports of integrated computer chips, telecommunications equipment, personal-computer (PC) parts and disk drives to Taiwan fell by 42.1 percent. Exports to all of Singapore's largest markets contracted in double digits, with the United States, its largest market, leading the way (down 34.4 percent), followed by Malaysia (down 23.6 percent).

Cash-rich Singapore will attempt to prop up its domestic economy with stimulus packages. Deputy Prime Minister Lee Hsien Loong announced an off-the-budget package, worth S$11.3 billion (US$6.2 billion), in October. The package is comprehensive, aimed at countering the impact of the global deceleration. It offers generous assistance to business, individuals and the unemployed and needy.

As is the tradition in Singapore, the government will bring forward some 100 infrastructure projects, estimated to cost S$3.5 billion, including plans to improve two universities over the next three years. The latest package came on top of a smaller S$2.2 billion package handed down in July. Singapore now faces a budget deficit of S$4 billion this year.

Singapore is resilient and generally nimble-footed. It will get out of this recession when the external environment becomes less hostile. But the current problems facing Singapore unmask longer-term fragilities, such as over-reliance on the electronics sector.

In recent years, the buzz word in Singapore has been "reinventing" (the economy) to turn it into a "knowledge-based economy" to lessen reliance on manufacturing of electronics.

Arup Raha, chief economist with UBS Warburg, Hong Kong, recently warned that, more than anything else, it is the growing economic cooperation between China and Taiwan that threatens the long-term viability of Singapore's manufacturing sector.

In the latest issue of Asian Economic & Strategy Perspectives, Raha and his team raise three specific problems facing Singapore:

Singapore's electronics industry could lose competitiveness in the global market as Taiwanese firms outsource components at a lower cost from the mainland.

Localization strategies by Taiwanese firms will impact Singapore's exports to China.

Migration of manufacturing to China is forcing Taiwan to diversify into services and intellectual property.

China has been the major beneficiary of outbound investment from Taiwan since Taipei lifted its ban on Taiwanese companies investing in the mainland. UBS says China is estimated to absorb roughly 40 percent of total outward investment from Taiwan, with almost 74 percent of Taiwanese firms investing there. The electronics industry accounts for 56 percent of total Taiwanese investment in China, while the output of Taiwan-invested electronic manufacturing operations accounts for 60 percent of China's production of electronics hardware.

UBS says continued economic cooperation between China and Taiwan has serious implications for the Association of Southeast Asian Nations (ASEAN) and especially Singapore. Their cooperation is expected to heighten after they both enter the World Trade Organization. As Japan appears to have reached saturation, China is emerging as an important export market for Singapore. Singapore's problem is going to be competitiveness.

"The solution to this problem is a shift in Singapore's economic strategy from export of goods to capital," says UBS.

For more than a decade, Singapore has developed key strategies to encourage an "external wing" to its economy precisely to relocate some of its output to other locations, such as China. Singapore has had mixed experience investing in China, where it is rated as the fifth-largest foreign investor.

Wang Pien, associate professor of the Department of Business at the National University of Singapore, estimates Singapore's investment there totals about $S15 billion. "Some Singaporean firms are doing quite well in China. However, my surveys have shown Singapore firms generally feel less satisfied with the performance of their China ventures than other investors," said Wang. Singaporean interest peaked in 1994-95 when investors realized that making money in China was not as easy as they thought. "Some became disillusioned about investing in China," he noted.

This is not surprising considering figures produced by Taiwan's Ministry of Trade and Industry, which reinforce this view. UBS quotes the findings, which show that the average break-even time in China for Singaporean corporates was 6.5 years compared with roughly four years for investments from Hong Kong or Taiwan.

In a paper published last year, Morgan Stanley's Singapore office estimated the size of Singapore's external economy at S$395 billion against the governments figure of S$339 billion at the end of 1999, or 2.4 times GDP. The investment is held in the form of direct equity, portfolio investment and other foreign assets. Morgan Stanley's Daniel Lian says the Singapore government owns more than 50 percent of the external economy through GLCs (government-linked corporations), which control about 60 percent of offshore investment.

As Morgan Stanley's research paper says: "The external economy needs to secure a minimum 8 percent nominal return to avoid dragging down the overall economy from achieving its long-term growth potential of 6.5 percent. The task of raising returns lies in the hands of the government and the GLCs."

But offshore return has been declining as GLCs step up their investment. One probable cause, says Morgan Stanley, is poor investment judgment. Singapore wants to move into new high-tech industries, including biotechnology areas requiring high human and intellectual capital. But in an economy essentially driven by government policies, Singapore lacks a crucial ingredient - entrepreneurship.

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