How to Profit From China's Economic Role Model: Singapore

China's economic model has been extraordinarily successful. But the Asian giant didn't create it out of thin air.

It had a role model.

A generation before China began to take off, another smaller country – also dominated by an ethnic Chinese populace – demonstrated how rapid growth could be combined with political stability.

I'm talking, of course, about Singapore.

Last week, Singapore demonstrated yet again that it might well have the answer to some of China's current problems. The Asian island city-state said its economy grew at an annualized rate of 32% in the first quarter – and then revalued its currency in order to prevent the Singapore economy from overheating.

As investors, we need to look at the mentor, as well as at the pupil.

A Global Leader Gets its Start

Singapore gained independence from Britain in 1959 and immediately elected Lee Kuan Yew as prime minister. He ruled the country for 31 years, after which his handpicked deputy ruled for 14 years. Lee's son, Lee Hsien Loong, took over in 2004 as the third and current Singapore prime minister.

So essentially Singapore's economic success is the work of one family, even one man (Lee Kuan Yew is still with us, in fact, serving as Singapore's "Minister Mentor.")

Although Lee Kuan Yew had been elected in a loose alliance with the Communists, he followed a free-market economic policy, but one in which the overall direction of the economy was set by the government. Taxes rates in general were low, government spending was kept at a remarkably low level – currently 15% – in terms of gross domestic product (GDP), and foreign investment was aggressively encouraged in most sectors.

Lee also solved the problem that is currently vexing the United States and other rich countries by privatizing social security and unemployment insurance: It forced employees to pay contributions into a " Central Provident Fund" that operated individual accounts out of which unemployment payments, health-insurance premiums and, eventually, pensions were paid.

Thus the area of the economy over which the state exercised direct control remained limited, while the Central Provident Fund exercised considerable influence on behalf of its account holders.

Overall, Singapore became the world's leading trade entrepot, aggressively moving up the global value chain as its per-capita GDP increased and its citizens became richer and more educated. With per-capita GDP now estimated at $50,300, Singapore is actually now richer than its U.S. counterpart.

And that's not all the sovereign city-state has going for it. Singapore's economic openness is actually quite remarkable by world standards: It ranks second in the world on the Heritage Foundation's Index of Economic Freedom, and has also remained remarkably uncorrupt, ranking third on Transparency International's 2009 Corruption Perceptions Index.

A Role Model for China

This combination – a free-market economy under a high degree of direction by a government that retains firm political control (though Singapore was and remains a democracy) – was highly attractive to China's leaders, particularly the late Deng Xiaoping, as they sought ways to open up their economy from the 1980s.

The Chinese leadership has maintained tighter political control than the Singapore government, imprisoning – and even executing – dissidents, and not allowing free elections. It also retained a high degree of state control of industries it considered strategic, such as oil, steel and anything related to defense.However, like Singapore, China has welcomed foreign investment – and at least on the surface has pursued a policy of relatively free trade, low taxation and relatively low public spending.

Apart from its lack of democratic freedoms, China's principal failure to match Singapore has come in the areas of economic freedom (including secure property rights) and corruption – the Asian giant ranks only 140 th out of 179 countries on the Index of Economic Freedom and 79 th out of 180 countries on the Corruption Perceptions Index.

Still, China has labor costs that are nowhere near as high as those of Singapore, meaning the larger country retains considerable room for inefficiency. Nevertheless, as it gets richer, moving up the Heritage Foundation and Transparency International lists should be a top priority for China.

How to Play Singapore for Profit

Singapore's recovery from the 2008-09 recession has been rapid. By advancing at an annualized rate of 32%, Singapore's economic growth for this year's first quarter outpaced the same measure for the first three months of 2009 by a stunning 13.1%.

The Monetary Authority of Singapore (MAS) – the nation's central bank – raised its exchange-rate target for the Singapore dollar by an undisclosed amount of 2% to 3%. The objective: To keep the Singapore economy from overheating and boiling over.

Needless to say, rapid economic growth and danger of overheating is a problem for China, too, and a modest revaluation of the yuan may well prevent economic overheating and inflation, quite apart from making the U.S. Congress happy. For all those reasons, China is believed to be carefully watching the results of the MAS' reaction to Singapore's torrid growth.

While Singapore is a relatively small economy – with a GDP of only $165 billion in 2009 – its exalted positions in wealth, economic freedom, clean government and clean business make it a highly attractive place to invest in. Of course, the rest of the world is aware of this, so the Singapore stock market normally trades at a fairly steep valuation. Still, its current valuation of 19 times earnings make it an absolute bargain when compared with its much-slower-growing U.S. counterpart (the Standard & Poor's 500 Index is currently trading at an almost-equally lofty Price/Earnings (P/E) ratio of 18).

The problem with Singapore investments is that the Sarbanes-Oxley mess has deterred Singapore companies from obtaining New York listings, so there are now no companies with U.S. listings beyond the so-called " Pink Sheets." If you have a broker that allows you to invest directly on the Singapore Stock Exchange, that is not a problem.

For those who don't have such a broker, I recommend the iShares Trust MSCI Singapore index Exchange-Traded Fund (NYSE: EWS), which has net assets of $1.6 billion and an expense ratio of only 0.55%.

[Editor's Note: Martin Hutchinson has terrific foresight. He warned investors about the dangers of credit-default swaps – half a year before those deadly derivatives ignited the worldwide financial firestorm. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

To find out more about The Permanent Wealth Investor, please just click here.]

News and Related Story Links:

• Money Morning Special Report:
  International Investing: Why U.S. Investors are "Boxed Out" of Big Global Profits
• MarketWatch.com:
  Singapore revalues currency after first-quarter-growth surge
• Wikipedia:
  Singapore
  
• Wikipedia:
  Lee Kuan Yew
• The Free Dictionary:
  Entrepot
• Wikipedia:
  Singapore's Central Provident Fund
• The Heritage Foundation:
  The 2010 Index of Economic Freedom
• The Heritage Foundation:
  The 2009 Index of Economic Freedom
• The Heritage Foundation:
  The 2008 Index of Economic Freedom
• Wikipedia:
  Deng Xiaoping
• Transparency International:
  The 2009 Corruption Perceptions Index
• Monetary Authority of Singapore:
  Official Website
• Investopedia:
  Pink Sheets