Manufacturing firms in Singapore relied on low-skilled foreign workers as substitutes for machinery between 2003 and 2008, sacrificing productivity levels in the process, according to a study.

The Ministry of Trade and Industry (MTI) study released yesterday, however, found that other factors - unrelated to foreign workers - could have also caused the decline in automation, underscoring the need for greater R&D and product innovation.

The five years in question mark the government's most recent period of liberal foreign labour policy. Between 2003 and 2008, the dependency ratio ceiling - which specifies the maximum proportion of foreign workers that companies can hire - was raised to 65 per cent; levies for unskilled work permit holders were reduced; and firms were allowed to hire work permit holders from China.

In its study of 1,500 manufacturing firms over that period, MTI found that those which hired relatively more low-skilled foreign workers relied less on machinery for production.

"This implies that during the period of foreign worker policy liberalisation from 2003 to 2008, low-skilled foreign workers were substitutes for machinery, thereby discouraging machinery investments," said MTI economists Alphonsus Gomez and Tan Di Song, who authored the study.

On average, MTI found that a one unit increase in the ratio of low-skilled foreign workers to high-skilled production workers would lead to a 9.1 per cent decline in machinery intensity. Smaller manufacturing firms were found to be more prone to this substitution effect.

In real terms, however, MTI found that the actual impact on machinery intensity - and hence productivity - was "likely to have been small", with a decline in machinery intensity of less than one per cent.

This is because the ratio of low-skilled foreign workers increased by just 0.1 of a unit between 2003 to 2008, thus creating only a slight dampening impact on machine use.

"Given that the machinery intensity of firms in our sample declined by a much larger 10 per cent between 2003 and 2008, our simulation results suggest that non-foreign worker related factors could also be affecting the machinery intensity of these firms," said the authors.

"One possibility is the increasing servitisation of manufacturing, which could have depressed the machinery intensity of manufacturing firms as they moved into activities such as consulting, intellectual property, and the administration of regional headquarters."

Lam Joon Khoi, secretary-general of the Singapore Manufacturing Federation, told BT that this trend of servitisation - where businesses add services to products, or replace products with services entirely - is "set to continue" as manufacturing firms restructure to cope with a changed business landscape.

"The current business model of SMEs is heavily dependent on low foreign labour costs. This business model is now not sustainable . . . SMEs need to change their mindset, human resource development, and corporate culture to embrace the new normal that is to be less dependent on foreign labour costs," said Mr Lam.

Yesterday, MTI said that labour productivity declined by 0.3 per cent in Q2 2013 compared to the same period a year ago. Employment grew by 32,500 people in the second quarter, while the overall unemployment rate increased to 2.1 per cent, up from 1.9 per cent in Q1.

MTI permanent secretary Ow Foong Pheng said that it was "heartening" to see an improved take-up rate in the government's productivity schemes for businesses.