Microeconomics in Public Policy: A Practitioner’s View*
1. Introduction
One of the most important roles for any government is to grow and maintain a well-functioning economy.
The theories about how best to do so are well-studied, going all the way back to Adam Smith. He explained how the invisible hand of self-interest plus the free market give rise to co-operation between strangers on an economy-wide and even international scale, to produce good outcomes (Smith, 1776).
250 years later, Smith’s insights into human nature and how markets work remain valid and relevant. So much so that Dr. Goh Keng Swee, the architect of Singapore’s modern economy, once said provocatively that “Developing nations need not go beyond Adam Smith for guidance on their economic policies” (Goh, 1972a, p. 456).
Adam Smith envisaged a very limited role for governments. He saw them as only responsible for public institutions that benefit the whole society but are unprofitable for any individual to maintain, such as national defense, the administration of justice (establishing and enforcing property rights), certain types of public infrastructure, basic education for the population and hardly anything else.
This was how societies worked in Adam Smith’s day.
But societies and economies have become vastly more complicated and modern governments have correspondingly expanded their public policy objectives and roles. Most governments deliver a wide range of public services. They promote, regulate and participate in many economic activities. They administer elaborate social, health and education systems. They redistribute income and resources.
Almost by definition, these are areas where the free market does not work well by itself, thus necessitating government intervention. But how should governments best perform these tasks?
One approach is to rely exclusively on non-market means and to perform these tasks directly — creating departments and bureaucracies to do the work themselves, or to regulate and require businesses and individuals to do what the government wants.
Alternatively, governments may create an overall policy framework, but in implementing these policies, use economic laws and market forces to accomplish their objectives.
2. When Designing and Implementing Policies, Use Economic Principles and Market Forces
Singapore has adopted the second, more market-oriented approach.
Ours is not a purist laissez-faire model, where the government does as little as possible.
The Government actively intervenes in many areas to achieve public policy objectives.
But we have adopted the philosophy that when intervening and pursuing these goals, we need to be cognizant of economic laws, market forces and incentives. This way we work with, rather than against, human nature. The better we understand these powerful forces and the more we use them in designing and implementing policies, the more effectively we will achieve our goals.
2.1. Public housing
One example is public housing, a signature policy of the Singapore Government.
Today, around 80% of Singaporeans live in public housing and 90% of Singaporeans own their own homes.
This would never have been achieved had the Government not intervened on a massive scale to acquire large swathes of private land, plan and build public housing, enact elaborate rules and sales conditions to govern how to allocate these flats, and institute systems and policies to make public housing affordable and pervasive home ownership a reality.
Yet in implementing the public housing program, we have recognized economic principles and used market mechanisms to achieve the overall political and social goals of universal home ownership and good quality, affordable public housing for Singaporeans.
For example, we set up the Housing & Development Board (HDB) as a statutory board to build and sell flats, instead of doing this through a government ministry or department.
When HDB needs land to build flats, it has to buy the land from the state at fair market value. This recognizes that there is an opportunity cost to using land for public housing, that land is a scarce resource which has value and that this value can and should be objectively ascertained and costed into the flats. This creates the right price signals and incentives for HDB to make full and optimal use of the land that it takes for public housing.
HDB does not design or build all the flats itself. It designs some of the flats so as to retain core expertise, but tenders out most projects to private sector architects and construction firms. This allows HDB to exploit the flexibility, efficiency and innovation inherent in the private sector operating in a competitive market. It helps HDB keep costs low and deliver value for money.
As flats are built, they are sold to the public. To achieve social objectives such as home ownership, affordability, and social and ethnic integration, HDB imposes restrictions on who can buy the flats and conditions that homeowners must comply with.
But the key question is how to price the flats.
By policy, flats are sold at a discount to their market value, to make them more affordable and to help households build up a nest-egg for retirement.
But not all flats of the same type have identical value. Where the particular unit is located, which direction it faces and which floor it is on, all make a difference.
HDB has to take this market reality into account and price each flat accordingly. Taking its offerings as a whole, HDB can then offer affordable flats for every income group and homebuyers can select a flat matching their preferences and within their budgets. We avoid large and unfair windfall gains accruing arbitrarily to a lucky few, as would happen if all flats of a given type were priced equally.
After the flats are sold, their new owners are required to live in them for a Minimum Occupation Period.
But ownership ultimately means being able to sell one’s flat and perhaps buy another, when one’s life circumstances change.
How should this be done?
We do not want HDB to be the arbiter and administrator of these secondary transactions.
Hence, we do not require flat owners to sell their flats back to HDB and then apply for another flat from HDB. Instead, we allow households to buy and sell their flats on a secondary resale market, at market prices set by willing buyers and sellers. There are still some restrictions and interventions to maintain key social objectives. For example, only citizens and permanent residents can buy resale flats; each household can only own one HDB flat at any given time; the flat must be owner-occupied and may only be fully rented out if tight conditions are met; ethnic ratios at block and precinct levels must still be maintained; and Government provides some subsidies for eligible families. But overall, the restrictions and interventions on resale flats are much less than on new flats.
This approach creates a diversified but interlinked national housing market, ranging from flats bought directly from the HDB at a market discount, to resale HDB flats transacted on the secondary market at market prices but subject to HDB rules, to private property bought and sold more freely. This spectrum gives owners the flexibility to upgrade or downgrade their homes in the course of their lives and enables them to realize the true market value of the flats, while maintaining key social objectives.
2.2. Healthcare
Another example is healthcare.
Most modern societies see healthcare as a key social safety net, a basic need and even a human right. But it is also a vexed subject, famous for market failures arising from information asymmetry, principal–agent problems and misaligned incentives. Left to its own, the healthcare sector will tend to overprescribe, overservice, overconsume and underdeliver.
Developed countries have taken different approaches toward healthcare. At one extreme, the US relies heavily on the free market and private providers for both healthcare delivery and health insurance. But despite its high cost, this has yielded unsatisfactory outcomes.
Access is very unequal and beyond the reach of many households.
At the other extreme, the UK relies heavily on the public sector. The National Health Service delivers nationalized healthcare free at the point of use, paid for by taxpayers. In theory, healthcare is affordable and accessible to all British residents. But in reality, resources are finite and healthcare is rationed through queuing. Waiting times are long, sometimes lasting years, compromising the quality of care and causing considerable dissatisfaction.
There is also little incentive to improve efficiency and trim overheads.
Singapore has developed a hybrid solution that involves both the public and private sectors. It seeks to use economic incentives to produce the desired outcomes.
The Government is the major provider. But it does not deliver care through a government ministry or department. Instead, it has created three autonomous public healthcare clusters, which run 11 acute hospitals and assorted other public healthcare institutions such as polyclinics.
These public providers operate on a not-for-profit basis. They charge fees and receive subsidies, but are required to cover their costs. Their mission is not to maximize profits, but to deliver good quality, cost-effective healthcare to the population while being mindful of the costs. They deliver both unsubsidized and subsidized healthcare, which are distinguished by the right to choose your doctors, creature comforts and waiting times.
However, even for subsidized services, patients always co-pay for at least part of their treatment costs. Nothing is free at the point of use. This is to reflect the value of what they are consuming and to discourage excessive demand for treatments, procedures and prescriptions.
This is a fundamental philosophy that the People’s Action Party Government adopted right from the beginning.
But co-payment can only work if patients can actually afford it. Therefore, the Government created MediSave, a national compulsory health savings scheme which people contribute to and build up during their working years, and which they can draw upon to pay their medical bills. These savings need to be complemented by risk-pooling to protect against unexpectedly large medical bills. Recognizing this, the Government later created MediShield (which became MediShield Life) as a national basic health insurance scheme.
Its essential features include deductibles, co-payments (co-insurance) and claim limits.
These are necessary not only to keep premiums low, but also to reduce the risk of overconsumption common in medical insurance schemes.
The private sector too has a role in Singapore’s healthcare system. Privately-run general practitioner clinics service a large part of the primary healthcare market. Private hospitals offer an alternative to public healthcare institutions for those who prefer more comfort and choice and are willing to pay for it. We have also allowed private medical insurance, including Integrated Shield Plans (IPs) and riders that augment MediShield Life, to provide additional choice to those who wish to enhance their coverage.
But we have not allowed the private sector to run completely unrestrained, because market practices and market failures in private healthcare inevitably impact the public healthcare system. For example, we publish comprehensive fee benchmarks for private hospitals covering common surgical procedures and medical conditions, to enhance price transparency and discourage excessive charging. We have also intervened in the private insurance market to regulate the design of IPs and riders, which are continually at risk of market failure through a vicious spiral of the buffet syndrome, higher claims and higher premiums.
Managing our healthcare system is not a one-off exercise but a dynamic process. The system needs constant tending, especially as it is not a simple single-payer system.
