Trade, capital accumulation and structural unemployment: an
empirical study of the Singapore economy
Hiau Looi Keea,, Hian Teck Hoonb
aDevelopment Economics Research Group, The World Bank,1818 H Street N.W., Washington, DC 20433, USA
bSchool of Economics and Social Sciences, Singapore Management University, 469 Bukit Timah Road, Singapore 259756
Abstract
This paper studies the factors responsible for the secular decline of Singapore's unemployment
rate over the period 19662000 in an environment of low and stable inflation rates. We introduce
wage bargaining and unions into a specificfactors, twosector economy with an export sector and a
nontradable sector to obtain an endogenous natural unemployment rate. Increases in the relative
export price and capital stock in the export sector are predicted to reduce structural unemploy
ment. These hypotheses could not be rejected based on structural estimations and cointegration
regressions. Empirically, capital accumulation in the export sector explains most of the decline in
Singapore's unemployment rate.
Keywords: endogenous natural rate of unemployment, wage bargaining, specificfactors model,
StolperSamuelson effect, Rybczynski effect.
JEL Classification: E24, F12, J51
The authors thank two anonymous referees for their detailed comments on an earlier draft of this paper. The authors
are also grateful to Marcelo Olarreaga, seminar participants at the University of California at Davis and the World Bank.
Corresponding author. Tel.: +12024734155; fax: +12025221159. Email addresses: hlkee@worldbank.org (H.L.
Kee), hthoon@smu.edu.sg (H.T. Hoon).
1
Nontechnical Summary
The past three and a half decades witnessed a distinctly declining trend in Singapore's unemploy
ment rate, which dropped from an average annual rate of 7.85% in 196670 to 2.74% in 19912000.
This paper seeks to identify and empirically examine the factors that have influenced Singapore's
unemployment rate in an environment of low and stable inflation. We incorporate a union bargaining
framework into a standard specific factor trade model, in which an increase in the relative price or
capital stock in the export sector raises the demand wage that firms can afford to pay relative to
workers' fallback income, and consequently lowers equilibrium unemployment. The magnitude of the
effects depends on the fallback income, the weight unions attach to employment and the elasticity of
labor demand. The empirical section of the paper focuses on estimating these parameters using data
on Singapore. The results show that labor unions in Singapore care more about employment than
wages. Together with a small fallback income and elastic labor demand, we show that given the same
percentage change in relative export prices and capital accumulation in the export sector, the effect
on unemployment is larger for the former. However, the empirical importance of capital accumulation
in the export sector dominates increases in relative export prices in reducing unemployment since
the manufacturing sector experienced a tremendous increase in capital inputs throughout the sample
period, whereas the relative price of exports experienced a far smaller increase and only in the early
part of the sample period. We conclude that through a very open trading regime, the tremendous
increase in capital stock of the exporting sector has been the main reason behind Singapore's declining
unemployment rate.
2
1 Introduction
Prior to the seminal papers by Friedman (1968) and Phelps (1968), which introduced the expectations
augmented Phillips curve and the concept of the natural rate of unemployment, it was commonly held
that a policy maker could use fiscal and monetary stimulus to keep the economy at a permanently low
rate of unemployment as long as it was willing to tolerate a high enough rate of inflation. Friedman
and Phelps, however, argued that the actual unemployment rate could remain below a certain natural
rate only insofar as the monetary authority could generate an actual inflation rate that exceeded the
expected rate of inflation. Absent expectation errors, the economy would settle down at the natural
rate of unemployment.
That natural or equilibrium structural rate of unemployment was argued to be invariant to mon
etary changes though not necessarily to real factors. However, there was little understanding about
how exactly real factors affected the natural rate. Things changed when several economists, including
Phelps himself, were spurred by the phenomenon of a persistent rise of unemployment in Western
Europe without unexpected disinflation to begin research into the set of factors determining the nat
ural rate. The noninflationary structural boom in the US as well as in a number of other OECD
economies in the late '90s gave further impetus to this research. The result of the research is a set
of complementary theories that pinpoint the determinants of the equilibrium structural rate of unem
ployment: the union bargaining model (McDonald and Solow, 1981 and Layard, Nickell and Jackman,
1991), the efficiency wage model (Shapiro and Stiglitz, 1984), the insideroutsider model (Lindbeck and
Snower, 1989), the search and matching model (Pissarides, 2000), intertemporalequilibrium models
(Phelps, 1994), and the social programs and wage instability model (Ljungqvist and Sargent, 1998).1
Factors that have been highlighted as being relevant in determining the natural rate in these models
include demographic factors, social and unemployment insurance programs, minimum wage policies,
tax structure, productivity growth, and capital accumulation. In addition, theoretical pieces by David
son, Martin and Matusz (1988, 1999), Matusz (1985, 1998), and Hoon (2000, 2001) also incorporated
equilibrium unemployment into general equilibrium trade models to show that the path of equilibrium
unemployment rate can be shifted by various forces acting on economies that are interlinked via the
international trading system.
On the empirical front, although Staiger, Stock and Watson (1997) points out that estimates of
1See Phelps and Zoega (1998) and Salemi (1999) for a review of the literature.
3
the natural rate of unemployment tend to be imprecise, there have been several recent studies that
attempt to estimate the natural rate of unemployment as well as test the natural rate hypothesis.
Gordon (1997) estimates a time path of the natural rate for the US from 1955:21996:2, and concludes
that the natural rate declined in the '90s. Using a technique that embedded the Kalman filter within
the fullinformation maximum likelihood procedure, Salemi (1999) finds substantial postwar variation
in the US natural rate, although actual unemployment can deviate from the natural rate through price
surprises. While Gordon estimated a timevarying natural rate by assuming that the natural rate
takes a random walk, Salemi shows that a model where the natural rate responds to economic forces
outperforms the random walk model. Empirical results from both studies support the timevarying
natural rate hypothesis. Finally, studying the extraordinary structural boom of the late '90s in the
US, Staiger, Stock and Watson (2002) concludes that the US natural rate had indeed declined.
Adopting an endogenous natural rate framework, this paper seeks to identify and empirically
examine the factors that have influenced Singapore's unemployment rate, which came down from
nearly 9 percent in 1966 to less than 3 percent in the '90s in an environment of low and stable inflation.
We are still left, however, with a choice of which theory of the labor market to use? Given the lack
of formal social programs and unemployment benefit system in Singapore, we could not adopt models
where such programs are crucial to the determination of equilibrium unemployment, such as that of
Ljungqvist and Sargent (1998).2 On the other hand, the strong influence of trade unions, organized
both at plant and industry levels, in determining labor market outcomes in Singapore suggests that
the adoption of the union bargaining model would bring us a step closer to reality.3 This explains our
modelling choice.
In particular, we adopt the McDonaldSolow union bargaining apparatus, which we apply to a
specificfactors trade model to study the determinants of the natural rate in a small open economy. The
equilibrium unemployment rate is determined at the intersection of a downwardsloping aggregate labor
demand curve and an upwardsloping wage curve, the latter being the outcome of a wage bargaining
process. Since there is a rent going to an employed worker, his welfare is unambiguously higher than
2It was only in October 2003 that a modest unemployment compensation scheme with an initial budget of S$40
million was introduced in Singapore. The scheme, called the Work Assistance Programme, provides a monthly allowance
of S$400 for three months to unemployed individuals.
3See Singapore National Trades Union Congress (1987) for a chronology of trade union development in Singapore.
Any dispute that arises in the process of negotiation between a trade union and management over collective agreements
can be referred to the Industrial Arbitration Court, which, since 1972, could make reference to the annual wage guidelines
issued by the National Wages Council in its deliberations.
4
that of an unemployed worker. We show that an increase in the capital stock in the export sector
raises the demand wage that firms can afford to pay relative to the worker's fallback income, and so
consequently lowers equilibrium unemployment. Also, with no unemployment benefits and the family
providing a kind of insurance in the form of food, transport and housing in the event a member loses a
job, the worker's fallback income can be thought of as indexed to the nontraded good.4 Consequently,
a rise in the relative price of exports also raises the demand wage relative to the worker's fallback
income and so lowers the natural rate. In comparison to a traditional (Walrasian) fullemployment
specificfactors model, an increase in the relative price of exports and an increase in the capital stock
bring about a smaller rise in the wage because in our model, aggregate employment also expands in
response to these shocks. In other words, by relaxing the assumption of fullemployment, the model has
a smaller StolperSamuelson effect and Rybzynski effect than in traditional fullemployment models.
The theoretical model is tested using annual data for Singapore, from 1966 to 2000. We first present
some reducedform regressions which capture the cointegration relationships among the variables in
longrun equilibrium, á la Engle and Granger (1987). Results of the cointegration regressions provide
support for our hypotheses that an increase in the relative price of exports and capital accumulation
in the export sector decrease the longrun equilibrium unemployment rate. We then apply a three
stage least squares regression to estimate the structural nonlinear model, assuming that both relative
export prices and capital accumulation are exogenous. The estimation results once again provide
support for our hypotheses. We further instrument relative export prices and capital accumulation
with GMM estimation, correcting for heteroscedasticity and MA(1) autocorrelation of the error terms.
The results remain quantitatively and qualitatively robust. Based on the estimated parameters, we
show that given the same percentage change in relative export prices and capital accumulation in the
export sector, the effect on unemployment is larger for the former. However, the empirical importance
of capital accumulation in the export sector dominates increases in relative export prices in reducing
unemployment since the manufacturing sector experienced a tremendous increase in capital inputs
throughout the sample period, whereas the relative price of exports experienced a far smaller increase
and only in the early part of the sample period. These results are robust to omitted variable bias and
autoregressive heteroscedastic errors.
The rest of the paper is organized as follows: Section 2 presents some preliminary evidence that
4Close to 90 percent of Singaporeans live in public housing developed by the Housing Development Board.
5
the natural rate of unemployment in Singapore has declined over the past three and a half decades. In
Section 3, the theoretical model for estimation, namely the McDonaldSolow union bargaining model
with the specificfactors setup, will be presented. The empirical strategy of the paper is discussed in
Section 4, followed by data description in Section 5. We present the empirical results in Section 6,
and conclude the paper in Section 7.
2 Preliminary evidence of Singapore's declining natural rate
The past three and a half decades witnessed a distinctly declining trend of Singapore's unemployment
rate, which dropped from an average annual rate of 7.85% in 196670 to 2.74% in 19912000. Most
of the decline took place within the first two decades (see Table 1). Figure 1 shows the scatter
plot of the change in Singapore's inflation rate from the last year to the current year against the
contemporaneous unemployment rate from 1966 to 2000. If a stable Phillips curve with a constant
natural rate exists, we ought to observe a negativelysloped schedule. Instead, the plot depicts a near
horizontal line, indicating that a steady decline of the unemployment rate has occurred in Singapore
without fuelling inflationary pressures. Such a relationship could be verified by a simple ordinary
least squares regression of the change in inflation rate on the contemporaneous unemployment rate,
as shown in Table 2. Since the estimated coefficient is not significantly different from zero, we cannot
statistically reject the hypothesis that a stable Phillips curve with a constant natural rate does not
exist.
A similar result is obtained for a sample of other fastgrowing economies in the Asian region.
Figure 2 presents the same scatter plot for the other "miracle" economies, including Hong Kong (H),
South Korea (K) and Taiwan (T), as well as some neighboring countries, Indonesia (I), Malaysia (M)
and Thailand (L), controlling for country and year fixed effects, from 1980 to 2000. It is clear from the
plot that the slope of the regression line is very similar to the previous plot for Singapore, being flat
across countries and years in the sample.5 The preliminary evidence gives us encouragement to test
formally (in later sections) a theory of an endogenous natural rate based on Singapore data, and as
5The slope of the line is estimated by fitting the change in inflation rate on unemployment rate in the following panel
regression:
ict = 0 + c + t + uct + ct,
where subscript c and t denote country and year, respectively. White robust standard error is reported. Total number
of observations is 92, with Rsquare of 0.39. Data source: World Bank (2003).
6
we shall see, there is strong evidence that real forces, in particular, relative export prices and capital
accumulation in the export sector, strongly influence the natural rate of unemployment. The evidence
is suggestive that such a theory may also be applicable to some of the other Asian economies but a
formal test will have to await future research.
The following sections formally develop and test a model that captures the effects of international
trade and capital accumulation on the natural rate of unemployment of a small open economy.6
3 Theoretical model
In this section, we incorporate the McDonaldSolow union bargaining apparatus within a specific
factors model. We assume that there are two sectorsX and Y and two factors of production
labor (L) and capital (K). X is assumed to be the export (manufacturing) sector and Y is the
nontradable service sector. We assume that there are numerous firms in the two sectors of the
economy and that wage bargaining takes place with firmlevel unions.7 (Although we model wage
bargaining explicitly, as McDonald and Solow (1981) note, the results of the union bargaining model
apply even where an informally organized labor pool bargains implicitly with one or more longtime
employers.) Nevertheless, workers are free to move between the two sectors. On the other hand,
capital is heterogeneous and sector specific. Hence it is not free to move between the manufacturing
and service sectors.8
Let's assume that there are I identical firms in sector X, each with a production function (x)
presented in (1), and J identical firms in sector Y , each with a production function (y), as shown in
(2), I and J being large numbers. As characterized in (1) and (2), the technology is assumed to be
constant returns to scale, that is, homogeneous of degree one, with being the capital elasticity in
the production of both sectors.9 The sectoral production of either good in the economy is simply the
product of the output of a typical firm, x or y, and the number of firms, I or J, respectively, in the
6Singapore's total merchandise trade to GDP ratio stands at nearly 300 percent, reflecting the importance of re
processing of intermediate inputs for export.
7Given our simplifying assumption of a common elasticity of labor demand across sectors, our results below are robust
to the alternative assumption of wage bargaining at the sectoral level.
8The immobility of capital between manufacturing and service sectors may not be as restrictive an assumption as it
first appears since at least 80 percent of the capital investment in the manufacturing sector is foreign direct investment
from MNCs. It is not unreasonable to suppose that the MNCs stay within the manufacturing sector since the Singapore
based subsidiaries are just part of the global production networks of the MNCs.
9Alternatively, under the neoclassical assumptions of perfect competition and constant returns to scale, we can
interpret as the aggregate (average) capital share of the economy.
7
sector.
Assume that each firm maximizes its own profits and that the goods markets are perfectly compet
itive. Labor, while participating in firmspecific unions, is free to move between sectors, so the return
to labor in both sectors will be equalized in equilibrium. Capital, assumed to be nonhomogeneous, is
the specific factor that does not move across sectors. The equilibrium return to factors will be equal
to the respective values of marginal product.
The equilibrium real wage rate, w, and rental rate, r, with good Y as the numeraire, are represented
by (3) and (4). Notice that in (4), the returns to capital in both sectors are not equal under the
assumption that capital is not a homogeneous factor that can easily move between sectors. On the
other hand, (3) shows that the real wage rate is equal in both sectors due to the assumption of perfect
labor mobility.
x = Nx Kx, X =
1 x = Ix, (1)
y = Ny 1 Ky , Y = y = Jy, (2)
Kx Ky
w = p(1  ) , (3)
Nx = (1  ) Ny
Kx (1) Ky (1)
rX = p = rY = , (4)
Nx Ny
PX W RX RY
p , (5)
PY , w PY , rX PY , rY PY
N = NX + NY , NX = Nx = INx, NY = Ny = JNy, (6)
KX = Kx = IKx, KY = Ky = JKy, (7)
N
u 1  > 0. (8)
L
It is clear that the relationship between the relative price of goods and the capitallabor ratio is
crucial for understanding the other relationships. The higher the relative price of good X to good Y ,
the lower the capitallabor ratio in sector X as labor, the mobile factor, is attracted to sector X to
work with the given stock of capital. Eq. (5) gives us the identity of relative price of goods, p, and
the real factor returns, w, rX and rY with PX, PY , W, RX and RY denoting their respective nominal
values. Eq. (6) shows the sectoral distribution of total employment in the economy, with N being the
total employed labor force in both sectors. NX and NY are the sectoral employment levels, which are
the summation of the number of workers employed in each sector. Similarly, KX and KY denote the
8
sectoral capital stocks, which are the summation of the capital stocks of all the firms in each sector. As
shown in (8), and will be proven later, total labor force, L, in this nonWalrasian economy is greater
than the total employment, N. In other words, the equilibrium unemployment rate, or the natural
rate of unemployment, u 1  (N/L), is positive.
Assume that within each sector there are identical firmspecific labor unions that only bargain
over the real wage of the members and let the respective firms decide on employment at any set
wage. The objective of each of these unions is to maximize the wage difference between members and
nonmembers, as represented in the CobbDouglas utility function of the union, subject to the labor
demand function of the firm. For a representative firmspecific union in sector X, the optimization
problem is:
max Ux = Nx (wx  A)1

Kx
s.t. wx = p(1  ) ,
Nx
A (1  u)w + uB.
Here, Nx is the number of workers employed in firm x for a given bargained wage according to the
labor demand function given in (3). Both Nx and wx enter the utility function of the union with the
weights of and 1  , respectively. A higher implies that the union cares more about employment
than the wage difference. As will be shown later, indeed is an important parameter that determines
the wage bargaining equilibrium, and hence the natural rate of unemployment.
The real wage, wx, is set by the union and A is the expected real income elsewhere should the
worker lose his job at the current firm. The variable A is the sum of two terms; the first term depends
on the wage that can be earned elsewhere in the economy, w , adjusted by the probability of getting
a job should a worker leave his or her current firm, which we proxy by the rate of employment, 1  u.
(Of course, in the symmetric equilibrium we consider, with workers freely mobile across sectors, we
ultimately have wx = wy = w .) The second term in A is given by unemployed income B. In theory,
the unemployed income, B, could be taken as the unemployment benefit or nonwage income when
the worker is unemployed. In Singapore, however, there was no official unemployment benefit given
by the state until its introduction in October 2003. Nevertheless, a worker, while employed, and
his employer are required to make a contribution to the Central Provident Fund (CPF). The CPF
contributions are a kind of compulsory saving that can be withdrawn with interest after a specified
9
official retirement age.10 Although workers might face liquidity constraints and can only draw out the
money after retirement, not when he becomes unemployed, the CPF savings could serve as a kind
of strategic wealth á la Bernheim, et al. (1985) that encourages intrafamily transfers when a family
member is unemployed. Moreover, it is arguable that there is some social obligation in an Asian family
to provide for the basic necessities of a family member if he or she is in financial difficulties. We can,
therefore, think of B as the family insurance support that a family member can draw upon in the
unfortunate event that he or she loses a job. When one of the family members is thrown out of job, it
is very likely that the family will act as a supporting unit that provides food, housing and transport
in kind. For this reason, we can think of B as indexed to the price of the nontraded good.
In partial equilibrium, the bargained wage will be set at the level where the union's indifference
curve is tangent to the firm's labor demand curve. At the point of tangency, the slope of the indifference
curve equals to the slope of the labor demand curve. It is clear that in equilibrium, the wage markup
of the union is affected by the labor demand elasticity, 1, which is also the inverse of the elasticity
of capital in a CobbDouglas production function.11 The more elastic the labor demand function, i.e.
the lower , and/or the higher the employment weight of the union's utility function, i.e. a larger ,
the lower the wage markup, as shown in (9):
wx  A 1
= (9)
wx  1 ,
A
WSCx : wx = . (10)
1   1 1
The equilibrium relationship between wx and Nx is defined on a firmlevel wagesetting curve
(WSCx), as shown in (10), obtained by rearranging (9). Notice that at the firm level, given the
constant elasticity of labor demand, which is a property of the CobbDouglas production function, the
wagesetting curve does not depend on employment. It only depends on the labor demand elasticity,
10Subject to a minimum sum requirement that has to be left in the CPF, members can withdraw their compulsory
savings after age 55.
11Labor demand elasticity, , is defined as
lnN
= 1,
lnw
according to (3). Given (1), the CobbDouglas production function, is also the elasticity of capital input, i.e.
lnx
= , where
lnKx
0 < < 1.
Thus, the derived labor demand function has an elasticity that is greater than one.
10
1, weight of employment in the union's objective function, , and the worker's alternative income,
A.
Finally, given that the objective function of every union in both sectors X and Y is the same
and each small union faces an identical labor demand function in its respective firm in the sectors,
the general equilibrium of this decentralized wage bargaining economy will be reached when all the
identical unions in each firm bargains with the firm and sets the same wage. Therefore, in the general
equilibrium, we have the relationship given in (11), which leads to the aggregate wagesetting curve
(WSC) of the economy:
w = wx = wy, (11)
B
WSC : w = . (12)
1  ( 1)
1
1(N )
L
Thus unlike the firmlevel wagesetting curve, the aggregate WSC depends not only on the labor
demand elasticity and the weight of employment in the union's objective function, it also depends
on the total employment, and hence the unemployment rate of the economy. More specifically, when
total employment, N, is below a critical level given by LU, where
1
LU L 1  ,
 1
< L if < 1,
the equilibrium bargained wage is positive and increasing with total employment. This critical level of
LU corresponds to a critical level of unemployment rate equal to (1  1), at which the bargained
wage rises to infinity as union bargaining power becomes unusually strong. Using our baseline estimates
of = 0.98 and = 0.785 derived later, this critical unemployment rate corresponds to 1.6 %. Above
this critical unemployment rate, the WSC is positively sloped in the (1  u,w) planethe higher
the employment rate (or the lower the unemployment rate), the higher the equilibrium bargained
wage. The McDonaldSolow union bargaining model, in effect, generates a pseudolabor supply curve
(WSC) that takes the place of the perfectly inelastic neoclassical labor supply. A decrease in the
labor demand elasticity, or a decrease in the weight of employment in the unions' objective function,
will lead to a decrease in LU, and move the aggregate WSC to the left. Juxtaposed against a given
aggregate labor demand curve, this implies an increase in the equilibrium unemployment rate.
11
The aggregate labor demand curve is derived as the horizontal summation of the sectoral labor
demand curves given in (13) to give (15):
1 1
NX = p(1  )
KX, NY = 1 
KY , (13)
w w
NX + NY = N = (w) (1  ) pKX + KY ,
1 1 1
(14)
Nd : w = 1  1
pKX + KY (15)
N , N L.
The intersection of the aggregate wagesetting curve and the aggregate labor demand curve will
determine the equilibrium wage rate, w, employment, N, and therefore the natural rate of unem
ployment, u. Given the equilibrium employment, the intersection of the sectoral labor demand curves
will determine the distribution of total employed labor in the economy, NX and NY . Therefore using
(3), (8), (12) and (15), we can solve for the general equilibrium of the economy as shown in Figure 3.
Eq. (16) represents the labormarket equilibrium by equating the aggregate WSC given by (12)
to the aggregate labor demand curve given by (15). The effects of the change in the relative price of
goods and capital accumulation can then be easily shown by partially differentiating (16), according
to the implicit function theorem, to obtain the comparative statics in (17) and (18). It is clear that
with the capital share being less than one and both the effects being positive, the price elasticity will
be greater than the capital elasticity:
1
b  ln 1  N1 1
1  = ln (1  ) + ln pKX + KY  lnN , (16)
L
1
p KX
N/N 1
p KX+KY
= > 0, (17)
p/p
1 + ( 1)NL
1
(1NL )(1NL ( 1))
1
1
p KX
N/N 1
p KX+KY N/N
= = . (18)
KX/KX 1 + ( 1)NL
1 p/p
(1NL )(1NL ( 1))
1
In summary, increases in both the relative price of the traded good and capital stock, ceteris
paribus, will result in a rise in the real wage rate (measured in terms of the nontraded good) and total
employment of the economy. In other words, the natural rate of unemployment will be reduced due
12
to the increase in the above two factors. On the other hand, a higher nonwage income (B), measured
in terms of the nontraded good, or a lower employment share () in the union's objective function,
will lead to a higher equilibrium unemployment rate. Furthermore, although it is presented as a fixed
parameter in the model, it is reasonable to assume that the unemployment income, B, may actually
depend on the wealth of the workers, such that an increase in the general affluence of the country may
increase B, which leads to a higher unemployment rate. This could be interpreted as the presence of
a wealth effect in the wagesetting curve. We will formally test for the presence of such a wealth effect
in the data.12
The main hypothesis put forth in this paper is that the long investment boom achieved through
steady inflows of foreign direct investment operating under a liberal trading system contributed to
the decrease in Singapore's natural rate of unemployment. Traditional HeckscherOhlin or specific
factors trade models focus on the reallocation of resources in an economy under the assumption of a
Walrasian auctioneer who ensures full employment. In such a situation, an increase in the relative
price of exports only has an effect on factor rewards with no impact on aggregate employment.13 In our
model, however, given that the economy is necessarily not at full employment, an increase in the relative
price of exports not only leads to an effect on factor prices, it also changes aggregate employment.
Given a positivelysloped WSC, moving the aggregate labor demand schedule to the right will cause
the equilibrium wage rate to be higher and, very importantly, the equilibrium unemployment rate to
be lower.
On the other hand, an increase in factor endowment, say an increase in capital stock, in tradi
tional HeckscherOhlin or specificfactors trade models leads to the Rybczynski effect of reallocation
of resources across sectors and consequently changes in the output mix. In our model, besides the
traditional Rybczynski effect of changes in output mix, capital accumulation also increases aggre
gate employment. Juxtaposed against the wagesetting curve, a rightward shift of the aggregate labor
demand curve again leads to a higher equilibrium wage rate and a lower natural rate of unemployment.
To illustrate the smaller relative price effect on wages in our nonWalrasian economy due to an
endogenous adjustment of jobs, we differentiate the equilibrium wage rate with respect to the relative
12We thank a referee for this suggestion.
13The standard assumption is a perfectly inelastic supply of labor that is fully employed, and that is invariant to trade.
13
price along the aggregate labor demand curve:
ln w = ln(1  ) + ln pKX + KY  ln N (p,KX,KY , ,B, ) ,
1
lnw 1
pKX
= lnN. (19)
lnp 1
pKX + KY  lnp
According to (19), the total effect of a relative price change on wages consists of two parts: the direct
effect, which is due to the upward shift of the labor demand curve at given employment, and the
indirect effect due to the movement along the positivelysloped aggregate WSC. In other words, as
long as lnN > 0, an increase in the relative price would have a smaller effect on wages since some
lnp
upward pressure on wages is relieved by the increase in total employment of workers from out of the
unemployment pool.
4 Empirical strategy
To test the effects of trade on unemployment in the model, (12) and (15) have to be estimated
simultaneously, with B, and being the three parameters to be estimated. Real wage, w, and total
employment, N, are the two endogenous variables. All the rest of the variables are taken as exogenous.
There may be a concern that export prices, and capital inputs may not be exogenous, since for example
an increase in productivity will most likely lead to an increase in wages, employment, export prices
and capital inputs all together. Some instrumental variables will be used to control for this possible
endogeneity problem in the estimation.
It is clear that (15) is exactlyidentified because the number of excluded exogenous variables (L)
equals to the number of included endogenous variables (w and N) minus one. On the other hand,
(12) is overidentified since the number of excluded exogenous variables (KX, KY and p) is more
than the number of included endogenous variables (w and N) less one. Since it is mathematically
equivalent to the original, we can take the logarithm on both sides of (15) and (12) to give (20) and
14
(21) , respectively:
1
ln w = c + ln(1  ) + ln pKX + KY  ln N , (20)
1
ln w = b  ln 1  N1
, (21)
1  L
b lnB.
In (20), a constant term c is introduced with the similar purpose of any other constant term in normal
regressions, that is, to capture the effect of other important variables that are not included in the
model so that the residual will have a zero mean and therefore all the estimators will be unbiased.
Finally, given that the parameters in (20) and (21) are not linear to the dependent variables, we
first employ a nonlinear threestage least squares estimation with iterations, which is both consistent
and efficient if the exogenous variables are truly exogenous and the error terms are not autocorrelated
or heteroscedastic. To control for possible endogeneity, autocorrelation and heteroscedasticity, we also
fit the system of nonlinear regressions using GMM estimation, which is both consistent and efficient.
5 Data description
The estimations were carried out using yearly data from 1966 to 2000, most of which are available in
the Report on the Census of Industrial Production and the Singapore Yearbook of Statistics. Besides
that, the Report on the Labor Force Survey and the Singapore InputOutput Tables 1988 also provided
some of the data. All nominal variables have been converted to real variables with 1990 as the base
year using appropriate price indices.
According to the Singapore Yearbook of Statistics, labor force data are based on the midyear
Labor Force Surveys since 1974. For 1990, 1995 and 2000, labor force data were based on Population
Censuses and the middecade (1995) General Household Survey (GHS). Population Censuses and
the GHS collect data on the economic activities of the population, including detailed information on
employment and unemployment, characteristics of the labor force and economically inactive persons.
The data refer to persons aged 15 years or older. Unemployed persons refer to those who did not work
during the reference period but were available for work and were looking for a job with pay. Persons
in the process of starting their own business or taking up a new job after the reference period are also
considered as unemployed. Unemployment rate refers to unemployed persons as a percentage of the
15
total labor force, which includes both employed and unemployed persons during the reference period.
Given that Singapore follows the International Conference of Labor Statistics, such an unemployment
measure is standard and comparable to that of the US.
Wages of labor are defined as the total remuneration per worker. The coverage of total remuneration
includes the basic salary, employers' and employees' contributions to the Central Provident Fund,
bonuses, pensions paid by employers and other benefits provided. It is the total cost of hiring workers.
Real wage of workers is constructed by deflating the nominal wage by the price of nontraded goods.
To capture the effect of international trade on employment, according to the model, the price of
exports is needed to compute the value of the marginal productivity of worker in the export sector.
However, the published export price series is too short with the earliest available year being only 1974.
Thus it will decrease the degrees of freedom of our estimation. This problem has been solved after the
GDP deflator for the export of goods and services is used as a proxy for the export price index. It can
be checked that these two series of data are highly positively correlated, due to the fact that export
of services is relatively small compared to that of goods.14 As such, it is reasonable to use the GDP
deflator for export goods and services as a proxy for the price of exports.
An econometric concern regarding the use of Singapore's data on the export price or the GDP
deflator for the export of goods and services is that it could be endogenous, and would lead to incon
sistent and biased estimation of the parameters in the model. For example, higher productivity growth
of the export sector could lead to higher export prices and wages, which creates a spurious correlation
between the two variables. One way to tackle the endogeneity issue would be to use some instrumental
variable that is exogenous to domestic wages and yet highly correlated with export prices. Given that
most of the exports of Singapore are done by MNCs, the really relevant price that they face are the
exogenous world prices denominated in US dollars.15 Hence we use the price of export in constant
1990 US$ as instrument.
Similarly, the price of the nontraded good is needed to compute the value of marginal productiv
ity of labor in the nontraded good sector. A series of the GDP deflator for the nontraded good is
generated by taking the weighted average of the GDP deflators of all the nontraded sectors in the
14After plotting the deflator together with the export price index, it is found that these two series of data almost
overlap with each other.
15In offering a wage to attract, say, a worker from the nontraded good sector to work in an MNC producing the export
good, the firm is interested in how much additional revenue the worker will generate in US$.
16
economy.16 The nontraded sector comprises Utilities, Construction, Commerce, Transport and Com
munications, Financial and Business Services, and Other Services. The shares of the value of export
of these sectors in the total value of export of the economy, in Singapore InputOutput Tables 1988,
were 0.13 percent, 0 percent, 8.6 percent, 12.8 percent, 3.5 percent and 0.19 percent, respectively. In
the same time period, the export share of the manufacturing sector was about 75 percent.
Capital stock series of both sectors is computed from the respective gross real investment series,
using a perpetual inventory method and constant rates of depreciation. We estimate the initial capital
stock in 1960 using an infinite sum of investment, assuming the average growth rates of investment in
the first five years are good proxies for investment growth prior to 1960.17 Normally, gross investment
is defined as the difference between the expenditure and sale of capital goods in a given year. Due
to data constraint, the total domestic capital formation of the economy is taken as the total gross
investment of the whole economy, less the gross investment of the manufacturing sector, which is
generated in the normal way, giving us the gross investment in the nontraded good sector. The
nominal gross investment series in both sectors are then deflated by the GDP deflator of the domestic
capital formation to convert to the respective real gross investment series. The capital stock of the
nontraded sector is therefore defined as the total capital stock of the economy that is not accounted
for by the traded good sector.
In the absence of published depreciation rates by asset category, we adopt those used by Jorgenson
and Sullivan (1981). The respective depreciation rates for the four categories of capital input are
machinery and equipment (0.1047), office equipment (0.2729), transport (0.2935), and plants and
building (0.0361). Unless otherwise stated, the above data can be found in the Report on the Census
of Industrial Production, various years.
Table 1 presents the main data set with the sample mean and the average annual growth rate of each
16We use the respective shares of these sectors in GDP as the weights.
17Specifically, let I1 be the first year the investment data is available, and let g be the average growth rate of investment
in the first five years. Let's assume that there are infinite periods prior to period 1 where the investment is growing at
the same rate g but no data was collected. By assuming that the growth rate of investment of the first five years is
representative of the growth rate of investment prior to year 1, it can be shown that the initial capital stock is
l
K1 = I1 1 
1 + g
l=0
I1
= .
g +
17
variable. The annual average growth rate of real wage and employment are 4.4% and 4% respectively,
which indicate that both wages and employment have been growing throughout the sample period.
At the same time, the relative exports price index in US$ shows signs of a gradual increase up to the
late '70s and remains relatively constant after that, while the growth rates of capital stock in both
sectors are more than 10% annually, with faster capital accumulation in the traded good sector. Thus,
even though both the relative price and the Rybczynski effects of trade are important theoretically,
the latter may have more relevance empirically. A series of selected variables is presented in Figure 4.
6 Empirical results
6.1 Reducedform regressions
Before we present the estimation results of the structural model, some reducedform regressions may
serve as baseline comparisons. Column (1) of Table 3 shows the log linear relationship between
the unemployment rate, the capital stock and the relative price of the tradable sector. It is clear
that increases in the capital stock and relative price of the tradable sector tend to reduce the overall
unemployment rate of Singapore. Both variables have statistically significant effects in decreasing
unemployment, and the movement of these two variables are sufficient for explaining 70 percent of the
movement of unemployment.
The next column controls for the capital stock of the nontradable sector. An increase in the capital
stock of the nontradable sector has two offsetting effects on the equilibrium unemployment rate.
First, according to the model, such an increase would raise the overall labor demand of the economy
by shifting the aggregate labor demand curve to the right and reduce the equilibrium unemployment
rate. Second, given that the level of alternative income of workers are likely to be indexed to the general
affluence of the country, which we can proxy by the increase in capital stock of the nontradable sector
owned mainly by Singaporeans, an increase in the capital stock of the nontradable sector would then
shift the wagesetting curve up and increase the unemployment rate.18 Empirically, the overall effect
of capital stock of the nontradable sector on unemployment rate depends on the relative magnitude of
these offsetting effects. Results reported in column (2) show that the latter is greater than the former.
18According to data obtained from the Singapore Department of Statistics, the share of foreign equity in the non
tradable sector is around 17% on average, for the period 1970 to 1999. This indicates that a large majority of the assets
in the nontradable sector is owned by Singaporeans, and makes it a reasonable proxy for the wealth of labor force, as
suggested by the referee.
18
Thus, we find some empirical support for the wealth effect of capital accumulation in the nontradable
sector, which increases the unemployment rate. However, controlling for capital stock of the non
tradable sector does not affect the statistical relationships established in column (1), where the export
price increase and capital accumulation of the export sector are shown to reduce unemployment.
We further control for the change in the general CPI inflation rate in column (3). This is to
allow for the potential Phillipscurve type tradeoff relationship between unemployment and price
innovation.19 If there is in fact such a relationship, we expect the estimated coefficient of the first
difference of inflation rates to be negative. The result presented in column (3) shows that while the
estimated coefficient is negative, it is not statistically different from zero. This is consistent with our
earlier result shown in Figure 1 and Table 2 that there is an absence of a stable Phillips curve with a
constant natural rate of unemployment in Singapore.
Column (4) controls for the log level of labor force in the reducedform specification. An increase
in the labor force leads to a less than proportionate increase in the number employed, with the result
that the unemployment rate rises. Thus, we expect the estimated coefficient to be positive. The
reported estimated coefficient, however, is not statistically different from zero, which indicates that,
empirically, most of the movements in unemployment rate in Singapore are due to the movements in
relative prices and capital stocks, rather than labor force size. In other words, controlling for the size
of labor force does not change the estimated coefficients in column (2).
Finally, the regressions reported in Table 3 may be spurious in nature, given that all the series
may be nonstationary. While we control for autoregressive error terms by reporting the NeweyWest
robust standard errors in the parentheses, it is however not sufficient to control for nonstationarity,
unless the series are cointegrated. In the event that the series are indeed cointegrated, while detrend
ing or differencing the series would not be appropriate, the reducedform regressions nonetheless are
consistent and have the nice interpretation of a longrun equilibrium relationship among the variables,
á la Engle and Granger (1987). Engle and Granger also propose a twostep procedure to estimate the
shortrun dynamic fluctuations of the variables by an errorcorrection model.
To test for cointegration, we would first need to verify that the series are integrated of order
one, I (1). Table 4 presents some unit root tests on the levels and first differences of the variables.
If the variables are I (1) , we would expect the levels to have unit roots and the first differences to
19We thank a referee for this suggestion.
19
be stationary. The unit root null hypothesis is rejected if the reported tstatistics is smaller than the
5% critical values. In the first row of Table 4, the level of unemployment rate is shown to follow a
random walk, while its first difference is stationary, since the respective tstatistics are 2.898 (>2.975)
and 5.923(<2.978). This indicates that unemployment rate is indeed I(1). Similarly, the log level
of relative export prices, employment, labor force and wages also follow random walks, while their
first differences are stationary, which signal that these series are also I (1). On the other hand, both
the log levels of capital stock of the tradable and nontradable sectors are shown to follow a random
walk with a sixthorder autoregressive error and have stationary first differences. This confirms that
both the levels of the capital stock series are I (1).20 To establish that the series are cointegrated, we
also perform a unit root test on the regression errors of column (2) of Table 3, which is our preferred
reducedform specification. The relevant tstatistics is 3.353 which is less than 1.95, the 5% critical
value as reported in Table 4. Thus we reject the spurious regression null hypothesis that the error has
unit root, in favor of a cointegration hypothesis. In other words, the unemployment rate, prices, and
the two capital stock series are cointegrated and the regression error is stationary. Thus the estimated
coefficients reported in column (2) form a consistent cointegration vector which represents a longrun
equilibrium relationship among the variables.
We completed the twostep procedure by fitting an error correction model based on the estimation
error terms from column (2) of Table 3. We report the results of regressing the change in unemployment
rate on its first lag, the error correction term, the first lagged changes in the tradable capital stock and
relative prices, and the second and fourth lagged changes in the nontradable capital stock in Table
5. The error correction term is significant and has the right sign, which further indicates that the
cointegration regression in column (2) of Table 3 represents a longrun equilibrium relationship among
the variables. Figure 5 shows the fitted longrun and shortrun unemployment rates, together with
the actual. It is clear that while the fitted longrun rate is declining, the fitted shortrun yeartoyear
unemployment rates fluctuate around the fitted longrun rate and track the actual unemployment rate
very well.21
20Notice that all of the series follow random walks and none of the series are trend stationary. This shows that it is
not appropriate to detrend the data, which could be counterproductive. For concreteness, we also include a time trend
in the reducedform regressions. As suspected, the estimated coefficient of time trend is not significant. This result is
available upon request.
21The correlation coefficients between the actual unemployment rate and the fitted longrun and shortrun rates are
0.78 and 0.97, respectively.
20
6.2 Structural regressions
The estimation of the system of equations is first performed using nonlinear threestage least squares
with various iterative starting values of b, , and c. Given that changing the starting values of the
parameters makes little difference to the estimation, we present one of the results of the estimation in
column (1) of Table 6 with the starting values of b, , and c at 0, 0.01, 0.4, and 0 respectively.22
All the parameters are estimated with high statistical significance. The equations for the aggregate
wagesetting curve and the aggregate labor demand function are estimated with acceptable Rsquares.
With the various starting values, after several rounds of iteration, the system converges to around the
point where the estimated values for b, , and c are 8.98, 0.74, 0.98 and 7.71, respectively.
Column (2) deals with the possible endogeneity of our regressors by using the lagged values of
capital inputs in both traded and nontraded sectors, world price of exports, the total labor supply,
wages and unemployment rate as instruments for the GMM estimation.23 Given that the error terms
are very likely to be autocorrelated, we also incorporate a firstorder movingaverage, MA(1), process
in our estimation. The result of the GMM estimation is presented in column (2) of Table 6, where
heteroscedasticconsistent standard errors are reported. It is obvious that controlling for endogeneity,
autocorrelation and heteroscedasticity does not change our previous results, where once again, all the
estimates are statistically significant and the system converges to around the same point.24
Column (3) includes the capital stock of the nontradable sector per labor force in the wagesetting
curve. The coefficient of this variable is positive and significant, which captures the wealth effect of
the labor force with the increase in general affluence of the country. In other words, with the increase
in wealth of the labor force, the fallback income of the workers increases, which pushes up the wage a
union would bargain for. Such an upward shift of the aggregate wagesetting curve, ceteris paribus,
increases the equilibrium wage rate and unemployment rate. On the other hand, the results of the
previous columns remain largely intact, where the estimated values for b, , and c are around 8.5,
0.8, 0.99 and 7.7, respectively. Thus including capital stock into the WSC does not change our results.
Column (4) further controls for the change in price level in the WSC with all the results remaining
22The estimates are robust to various starting values of b, , and c ranging from 0 to 50, 0.01 to 0.99, 0.4 to 1, and
0 to 30, respectively.
23Specifically, the following variables are included as instruments: KX(1), KY (1), pW , pW (1), L(1), u (1) and
w (1) , where pW = pE. E is the exchange rate of Singapore currency to the US dollar expressed as number of US$
given in exchange for one Singapore dollar.
24For completeness, we also test for unit roots in the regression error terms for log wages and unemployment rate.
Both series rejected the unit root hypothesis in favor of a stationary process. Results are available upon request.
21
similar.25
Based on the estimates reported in column (2), we obtain the value of the estimated average
monthly unemployment income of about $600 in 1990 Singapore dollars. If we include the wealth
effect generated by including capital stock in the wagesetting curve as presented in column (3), the
overall average monthly alternative income is about S$970.26 In addition, from 1966 to 2000, the
estimated capital share is about 0.8, giving a labor demand elasticity of 1.25. Finally, the estimated
weight on employment of the union's utility function in Singapore ranges from 95 to 99 percent. This
shows that the labor union in Singapore cares much more about employment than about a higher
wage.
All the estimated results are not only statistically significant, but also not far from our prior beliefs.
The estimated capital share of 0.8 is not significantly different from a capital share of 0.65 for the
aggregate economy obtained by Young (1992). On the other hand, the fact that Singapore's trade
unionists were willing to accept a nearly 20% wage cut in order to keep jobs during the three most severe
recessions of the economy in 1985/86, 1997/98, and 2000/01 supports the high estimated employment
weight in the union's objective function. This finding is corroborated by Lim and Associates (1988),
which shows that trade unions in Singapore do place more weight on employment stability than on
wage stability. Finally, the amount of S$600 to S$970 unemployment income is also reasonable given
Singapore's standard of living over the sample period. It is also realistic for the wealth adjusted
unemployment income to be higher, especially given that the per capita GDP of the economy has
increased from US$3,600 in 1966 to US$28,300 in 2000.27
25We also include time trend into the structural regressions. Given that none of the series is trend stationary, including
time trend is not only inappropriate, it also causes the estimation to fail to converge within a reasonable parameter range.
The results are available upon request.
26Average monthly unemployment income is obtained as follows:
KY
B = exp(b + ck ) /12.
L
Substituting b = 8.555 and ck = 0.011, and the sample average KY /L = 73.42, leads to the average monthly unemploy
ment income of S$970.
27In constant 1990 currencies, the average monthly per capita GDP for the period is about US$1,307, which is equivalent
to S$1,888, which makes the estimated S$970 quite reasonable. Data on GDP per capita is obtained from World Bank
(2003).
22
6.3 How large are these effects?
Substituting the estimated parameters into (17) and (18) and evaluating the rest of the variables at
the sample mean, we can simulate some hypothetical experiments to obtain a better sense of how large
are the potential effects of changes in relative export prices and capital accumulation on Singapore's
equilibrium rate of unemployment.28
Based on the estimates in column (2) of Table 6, we present the results of such thought experiments
in Table 7. We increase the relative price of the tradable good by 10 percent in the first row. This
leads to a 0.1 percent increase in employment and a 1.8 percent decrease in the unemployment rate.
Similarly, in the second row, we increase the level of capital input of the export sector by 10 percent.
This leads to a 1.4 percent decrease in the unemployment rate. Thus given the same percentage
change in the relative price of exports and capital input, the effect on unemployment rate is larger in
the former case.
Rows (3) and (4) of Table 7 present the estimated effects of changes in relative export price and
capital accumulation using the actual data from Table 1. From 1966 to 2000, the relative export
price index in US$ increased by 28%. This results in a 4.8% decrease in the unemployment rate. For
the same time period, capital input in the manufacturing sector increased by 789%, which causes the
unemployment rate to decline by a remarkable 109%, which implies that an initial unemployment
rate of 9 percent would decline to 3.0 percent. Thus Table 7 shows that even though the elasticity
of unemployment (in absolute value) with respect to a change in relative export price is larger than
that of capital accumulation, given the massive capital accumulation in the manufacturing sector, the
empirical relevance of the latter is much greater.
In summary, since all the estimated parameters are significantly different from zero, given the
sample information, we cannot reject the hypotheses that increases in the relative price of exports and
capital accumulation in the export sector contribute to the decrease in Singapore's unemployment rate.
In addition, even though given the same percentage change in the relative price and capital stock in the
28Given that by definition,
N
u 1  , L
u/u N/L
.
N/N =  u
At the sample mean, the elasticity of unemployment rate with respect to an increase in employment is around 25.97.
In other words, for every one percent increase in employment, unemployment rate decreases by 25.97% from the sample
mean.
23
export sector, the effect of the former on employment is larger than the latter, the empirical importance
of capital accumulation dominates changes in the relative export price due to the tremendous increase
in capital inputs in the manufacturing sector from 1966 to 2000. This result is consistent with earlier
findings of Modigliani et al. (1987), Andersen and Overgaard (1990), and Horst et al. (1990), who
showed that the decline in capital accumulation is a fundamental cause underlying the persistent rise
in European unemployment.
7 Conclusion
To the best of our knowledge, this paper is the first to provide some empirical support for a theory
of an endogenous natural rate of unemployment in a pure trade model; we identify the real factors
that account for the noninflationary decline in Singapore's unemployment rate since the mid '60s.
We showed that by incorporating an endogenous natural rate into a traditional trade model, the
StolperSamuelson effect, which measures the change in factor returns due to an increase in relative
goods price, could be smaller than what is conventionally believed. This is because changes in relative
goods prices produce not only an adjustment in factor returns but also an adjustment in aggregate
employment in our model. Consequently, the pressure on factor returns to adjust in response to the
relative price shock is partly relieved through a quantity adjustment, namely, an adjustment of the
natural rate of unemployment. Similarly, in contrast to the traditional Rybczynski effect of a change in
factor endowment, which affects only output shares and factor returns in a conventional specificfactors
model, this paper shows that by incorporating an endogenous natural unemployment rate, increases
in capital endowments also affect aggregate employment. Empirical results based on Singapore data
show that such a modified Rybczynski effect of capital endowment changes is the main reason behind
the noninflationary decline in the unemployment rate, from nearly 9% in the mid 1960s to about 3%
in the late 1990s.
Neoclassical economics emphasizes the effects of industrialization on wages rather than on em
ployment. In giving attention to the simultaneous effects of industrialization on both wages and
unemployment in this paper, we follow in the footsteps of Fields (2001), who shows that improved
labormarket conditionsinvolving not only increased real wages but also reduced unemployment
characterize the growth experiences of Hong Kong, Singapore, South Korea and Taiwan. Such findings
suggest that it would be appropriate to adopt a labormarket model that entails jobrationing so the
24
unemployed cannot get a job by offering their labor for less than the going wage. The equilibrium
volume of joblessness then becomes an important economic variable to be determined in conjunction
with the equilibrium pay.
Finally, our empirical result indicates that it was the massive capital accumulation in the export
sector that brought down Singapore's unemployment rate in the past four decades. The question
that remains is why does the continued capitalization make economic sense? Although a thorough
examination of this question is beyond the scope of this paper, we believe that a key to the answer lies in
recognizing that Singapore has been successful in attracting new types of foreign direct investments in
manufacturing over the years. Over 80 percent of total investment undertaken in the manufacturing
sector is due to foreign direct investment, and over 75 percent of output produced by MNCs are
exported. Importcompeting manufacturing output is negligible. Singapore's investment policy with
regards to multinational corporations (MNCs) has gone handinhand with a liberal policy with regards
to the international flow of goods and services. MNCs based in Singapore are free to buy from and
sell to any country in the world. When unskilled labor was relatively abundant and cheap in the '60s
and early '70s, most foreign direct investments were in garments and textiles, as well as in simple
assemblyline electronics. MNCs brought in parts and intermediates from another part of the world
to assemble and reexport. Later, these laborintensive activities were relocated, and foreign direct
investments then flowed into higher valueadded activities. A steady inflow of foreign direct investment
into the manufacturing sector could be sustained because firms that moved out of activities that were
experiencing diminishing returns, such as textiles and garments, were replaced by new firms that
were drawn into more profitable activities higher up the value chain, such as disk drives and semi
conductors. In other words, due to the open trade policy, the massive increase in capital stock in the
past four decades has pushed the economy into producing a different mix of products, away from the
most laborintensive goods that were important in the 1960s. The change in output mix in production
and export is what keeps the return to capital from falling to a level that would prevail in a closed
economy with no change in output mix.
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28
Table 1: Main data set
Capital Input Capital Input
Total Total Labor Relative Relative in in Non
Annual Real Employment Supply Exports Price Exports Price Manufacturing Traded
Unemployment Wages in (thousand (thousand Index in S$ Index in US$ Sector (1990 Sector (1990
Year Rate (%) 1990 S$1 persons) persons) (1990=1) (1990=1) million S$)2 million S$)3
1966 8.90 6882.66 523.825 575 1.07 0.63 601.76 8718.09
1967 8.10 6956.87 552.319 601 1.06 0.63 780.85 10190.15
1968 7.35 6662.95 580 626 1.00 0.59 962.79 12216.14
1969 6.73 7324.69 610 654 1.01 0.60 1429.52 14500.39
1970 8.19 7585.64 644.2 701.7 1.06 0.63 2295.32 17255.40
1971 4.82 7915.32 691 726 1.03 0.61 3131.17 20875.61
1972 4.73 8091.42 725 761 0.99 0.64 4249.63 24680.45
1973 4.43 8189.51 793.4 830.2 1.00 0.74 5443.33 28397.73
1974 3.89 8619.34 818 851.1 1.23 0.92 6021.97 32952.13
1975 4.46 10112.50 828.7 867.4 1.24 0.94 6540.58 36966.53
1976 4.39 10483.30 864.5 904.2 1.29 0.94 6983.65 41227.37
1977 3.90 10485.90 900.4 936.9 1.49 1.11 7579.41 45142.76
1978 3.56 10656.44 955.7 991 1.47 1.17 8195.24 49581.10
1979 3.30 11149.94 1018.3 1053.1 1.48 1.23 9526.50 54027.36
1980 3.48 11724.86 1073.4 1112.1 1.49 1.26 11100.00 59795.65
1981 2.90 12871.36 1153.5 1187.9 1.44 1.23 12600.00 66896.07
1982 2.56 13937.65 1221.1 1253.2 1.36 1.15 14200.00 76353.11
1983 3.21 15051.87 1251.3 1292.8 1.26 1.08 15400.00 87570.31
1984 2.70 16817.00 1269.1 1304.3 1.19 1.01 16600.00 100188.80
1985 4.13 18613.69 1234.6 1287.8 1.20 0.99 17600.00 109705.22
1986 6.48 18259.70 1214.4 1298.5 1.06 0.89 18300.00 116600.63
1987 4.69 18021.24 1266.9 1329.3 1.14 0.98 19900.00 122233.13
1988 3.35 17606.14 1331.5 1377.7 1.06 0.95 22100.00 127542.18
1989 2.15 18862.28 1394 1424.7 1.02 0.94 25000.00 134267.91
1990 1.65 19554.16 1537 1562.8 1.00 1.00 27200.00 142762.38
1991 1.93 20768.84 1524.3 1554.3 0.95 1.00 29100.00 153439.64
1992 2.68 22211.83 1576.2 1619.6 0.90 1.00 31500.00 165347.21
1993 2.67 23316.89 1592 1635.7 0.86 0.96 34200.00 178578.00
1994 2.59 23867.26 1649.3 1693.1 0.81 0.96 37200.00 193061.36
1995 2.70 25094.56 1702.1 1749.3 0.80 1.02 41300.00 209203.04
1996 2.99 26335.37 1748.1 1801.9 0.77 1.00 46200.00 231525.77
1997 2.43 27870.01 1830.5 1876 0.76 0.93 53200.00 253706.17
1998 3.21 29273.73 1869.7 1931.8 0.77 0.84 55700.00 275177.00
1999 4.56 29991.29 1885.9 1976 0.81 0.86 59000.00 292690.92
2000 4.45 32209.89 2094.8 2192.3 0.84 0.88 65300.00 309015.77
sample mean 4.12 16096.46 1197.86 1243.99 1.08 0.92 20469.76 108639.76
growth rate4 0.020 0.044 0.040 0.038 0.007 0.009 0.134 0.102
Notes:1 deflated by the price of nontraded goods.
2 constructed using the perpetual inventory method from net investment series of the manufacturing sector.
3 capital input in the nontraded sector is defined as the difference between the aggregate and the manufacturing capital inputs.
4 average annual growth rate = (ln(XT)ln(X0))/T.
Data Sources: Report on the Census of Industrial Production, Singapore, various years; Yearbook of Statistics, Singapore, various years.
29
Table 2: Dependent variable  First difference of inflation rate (19662000)
Estimated Coefficient
Unemployment Rate 0.06
(0.22)
Constant 0.00
(0.01)
Note: Data is from the Yearbook of Statistics, Singapore,
various years. White robust standard errors are in paren
theses.
Table 3: Dependent variable: Unemployment rate
(1) (2) (3) (4)
Log of relative price 0.027*** 0.016** 0.017** 0.018***
of tradable (0.007) (0.008) (0.008) (0.006)
Log of capital stock 0.013*** 0.038*** 0.037*** 0.040***
of tradable (0.001) (0.009) (0.011) (0.010)
Log of capital stock 0.032** 0.030** 0.049***
of nontradable (0.013) (0.014) (0.034)
First difference of 0.005
inflation rates (0.014)
Log of labor 0.041
force (0.068)
0.259*** 0.091 0.096 0.100
Constant
(0.023) (0.078) (0.084) (0.069)
F Statistics 51.05*** 71.04*** 29.64*** 66.50***
(d.f.) (2, 32) (3, 31) (4, 29) (4, 30)
Note: *** and ** denote estimate that is significant at a 99% and 95% confidence
level, respectively. The estimations are performed using annual data from 1966
to 2000 (35 observations), with the exception of column (3), which covers 1967 to
2000. NeweyWest standard errors are in parentheses, which are robust to error
terms that are heteroscedastic and autoregressive up to a maximum of 2 lags.
30
Table 4: Dickey Fuller unit root tests
H0 : = 0 vs. H1 : < 0
Reject H0 if is significant (more negative tstatistics)
Level First difference
Variables
(34 observations) (33 observations)
tstatistics of from xt = c + xt1 + t.
Unemployment rate 2.898 5.923
Log of real wage 0.271 4.063
Log of relative export price 0.482 4.931
Log of labor force 1.088 4.511
Log of employment 1.611 4.118
5% critical value 2.975 2.978
6
tstatistics of from xt = xt1 + j xtj + t.
j=1
Log of capital in tradable 1.065 2.772
Log of capital in nontradable 0.805 2.551
5% critical value 1.950 1.950
31
Table 5: Dependent Variable: Change in unemployment rate
0.363**
Lag of error in unemployment rate
(0.146)
0.390***
Lag of change in unemployment rate
(0.079)
0.076***
Lag of growth rate of capital stock in tradable
(0.014)
0.035***
Lag of growth rate of relative export price
(0.010)
0.339***
2nd lag of growth rate of capital stock of nontradable
(0.056)
0.345***
4th lag of growth rate of capital stock of nontradable
(0.050)
0.001
Constant
(0.001)
Sum of squared residuals 0.0004
(Rsquare) (0.8757)
F Statistics 30.52***
(d.f.) (6, 26)
Note: *** and ** denote estimate that is significant at a 99% and 95%
confidence level, respectively. The estimations are performed using an
nual data from 1968 to 2000 (33 observations) by fitting the following:
ut= c0+c1eut1+c2 ut1+c3 lnKXt +c4 lnpt1+c5 lnKYt +c6 lnKYt ,
where eut1 is the error term from column (2) of Table 3.
1 2 4
32
Table 6: Dependent variables  Log of wages and total employment
(1) (2) (3) (4)
3SLS GMM GMM GMM
Parameters Estimated Values
8.978*** 8.884*** 8.555*** 8.575***
Log of unemployment benefits (b)
(0.124) (0.067) (0.024) (0.024)
0.743*** 0.785*** 0.803*** 0.816***
Capital share ()
(0.035) (0.018) (0.039) (0.043)
0.980*** 0.980*** 0.992*** 0.991***
Employment weights of the unions ()
(0.002) (0.002) (0.001) (0.002)
Controls
0.011*** 0.010***
Wealth per labor force
(0.000) (0.001)
0.729***
Inflation rates
(0.125)
7.714*** 7.700*** 7.724*** 7.729***
Constant (c)
(0.027) (0.014) (0.022) (0.038)
Sum of squared residual of WSC 7.030 9.607 0.210 0.228
R2 (0.235) (0.171) (0.973) (0.971)
Sum of squared residual of Labor Demand 0.615 0.479 0.493 0.497
R2 (0.927) (0.939) (0.940) (0.940)
Note: *** denotes estimate that is significant at a 99% confidence level. The estimations are performed using
annual data from 1966 to 2000. Least squares standard errors are in parentheses for the 3SLS estimation.
Heteroscedasticconsistent (robustwhite) standard errors are in parentheses for the GMM estimation, which
are also robust to the 1storder movingaverage autocorrelation. Lagged values of capital inputs, labor force,
world price of exports, real wages and unemployment rates are used as instruments for GMM estimation.
Table 7: StolperSamuelson effect vs. Rybczynski effect
% Change in
Unemployment Rate
1. 10% increase in relative export price 1.8%
2. 10% increase in capital stock of tradable 1.4%
3. 27% increase in relative export price 4.8%
4. 789% increase in capital stock of tradable 109.0%
33
Figure 1: Change in inflation rate vs contemporaneous unemployment rate for Singapore, 19662000
coef = .06037388, (robust) se = .21536096, t = .28
.174286 73
77
80
74
) 84 78 00 8771
X 90 89 88
99 72 6770
0 91 97 94938196
92 7901
95 69
di 98 85 86
83 68
e( 82 76
.196714 75
.02315 .042286
e( u  X )
Figure 2: Change in inflation rate vs contemporaneous unemployment rate for selected Asian countries,
19802000
coef = .59957357, (robust) se = .5602168, t = 1.07
.414525 I
X) M T
di
T H
K H K
e( K K TT T T
KM
T
M H HTM
K M THKHT
HTM
K TT TK K
IKT M T M MT M
TK K HTTT
T
0 T T KM MTK TT
T K
T TK TI TTKT TT TM TT
K K T
M
M K
T
T
H
I
.268498 I
.023313 .025247
e( u  X )
34
Figure 3: Labor Market Equilibrium
w d
N Y w
N d = N X + N Y
d d WSC
w*
w*
d
N X
O X N X * O Y = N* O N* L U L N
Figure 4: Data at a glance
2
1.8
1.6
1.4
)1 1.2
6=
1
961(0.8
0.6
0.4
0.2
0
9661 9681 9701 9721 9741 9761 9781 9801 9821 9841 9861 9881 9901 9921 9941 9961 9981 0002
unemployment rate relative price index
log of K stock in manufacturing log of K stock in nontraded
35
Figure 5: Unemployment rate: 1966  2000
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
1966 1971 1976 1981 1986 1991 1996
actual u short run dynamic u long run equilibrium u
Note: Shortrun dynamic unemployment rate is estimated from Table 5. Longrun
equilibrium unemployment rate is estimated from column (2) of Table 3.
36