Category Archives: Biz Pinoy

TaxWatch35MakatiLawyersweb_041614-01_zps15fe337a

Truth in Advertising?

A closer look at the BIR’s name-and-shame campaign

The BIR serves it’s latest volley in its name-and-shame campaign. This time, it targets lawyers—Makati lawyers, specifically—implying that their tax-avoiding ways are a burden to the country.

Before anything else, let me get this out of the way: a lot of lawyers in private practice are most probably not paying the correct taxes. But that is true for most independent service professionals in this beloved country of ours. The only sector of society that you can count upon to be paying the correct taxes is the employees, whose salary is held hostage to the prior withholding of taxes due.

Having gotten that off my chest, let’s proceed to the BIR’s latest creative masterpiece.

TaxWatch35MakatiLawyersweb_041614-01_zps15fe337a

The ad leads with the a controversial statement: “[O]nly 53.7% of all taxpayer lawyers in Makati filed their income tax returns.”

We need to break down this statement though to understand 1) what the BIR is trying to say, and 2) what the statement really means.

First of all, the ad is disingenuous. The fact is that non-filing of an income tax return is not equivalent to non-payment of taxes. Since lawyers are covered by the expanded withholding tax system of the Tax Code, income taxes arising from their professional fees are already withheld from the payments they receive from their clients. This means that the taxes have been paid, whether or not the lawyer actually files an income tax return.

Based on the footnote, the ad defines the term “taxpayer lawyers” as “[L]awyer taxpayers who have filed BIR Form 1701 or Annual Income Tax Return for Self-Employed Individuals, Estates, and Trusts for return period 2012.” In the case of lawyers, who are those required to file BIR Form 1701? They are lawyers who are engaged in trade, business or practice of profession and those lawyers who, in addition to practicing their profession, receive a salary as well (meaning those with more than one source of income). This eliminates lawyers who work as employees and law firm associates and those who are members of a partnership of lawyers. This leaves us with lawyers who are in solo private practice.

The ad next mentions 840 as the total number of lawyer taxpayers registered in BIR Makati Revenue Region. Again, the footnote explains who they are: “Taxpayers registered with PSC 7411 (Legal Activities) in BIR Makati Revenue Region which covers RDOs 44 (Taguig Pateros), 47 (East Makati), 48 (West Makati), 49 (North Makati), 50 (South Makati), 51 (Pasay City), 52 (Paranaque), 53A (Las Pinas City), and 53B (Muntinlupa City).”

The explanation shows that the total is not limited to Makati lawyers but actually includes those from other cities that fall under the Makati revenue region. And yet, the ad goes on to mention that 451 is the number of Makati lawyers who filed their income tax returns in 2012. So which is it? Is the ad referring to registered lawyers under the Makati revenue region or just those lawyers registered in Makati? The ad does not make this clear.

For all we know, all Makati lawyer taxpayers actually number 451, which would bring the percentage of Makati lawyers who filed their income tax returns to 100%.

The BIR attempts its own version of the coup de grace with its comparison of the 2012 income tax due as declared by “a certain lawyer in Makati” versus the income taxes withheld by a public school teacher for the same year. The implication is quite sinister and you could probably not be faulted for concluding that the Makati lawyer cheats on his income tax return.

You could be wrong though.

Here’s why:

The BIR is comparing apples to oranges. Note that with respect to the Makati lawyer, the ad uses “tax due” while it cites the “income tax withheld” on the part of the teacher. These are not the same. The “tax due” is the amount still to be paid by the taxpayer after taking into account his gross income and deducting the expenses he has incurred in practicing his profession and the taxes that have already been withheld from him during the year by his clients. Thus, it can happen that the Makati lawyer has a low “tax due” since the income taxes were already deducted from the payments he received. What the ad should have shown instead is the “income tax withheld” from Makati lawyer so that we can get a more accurate picture of whether Makati lawyer cheated on his income taxes.

Makati lawyer pays other taxes aside from income tax. Makati lawyer may be required to pay value-added taxes or percentage taxes, depending on the amount of gross professional fees he receives within a 12-month period.

The Tax Code entitles Makati lawyer to claim deductions from his income that are different from the deductions enjoyed by the public school teacher. Thus, Makati lawyer may, within limits, deduct expenses such as restaurant bills from meeting with clients, gas and transportation expenses, cellphone bills, office supplies, and other ordinary and necessary business expenses from his income. You can imagine that these things may add up and result in significantly reducing the amount of income tax that Makati lawyer has to pay. Unfortunately, this is a privilege that is not available to the public school teacher. Applying the deductions does not make Makati lawyer a cheat because the Tax Code allows him to do so.

So you see, while Makati lawyer may have a tax due of just P2,975, it does not necessarily mean that a) he is a cheat, and b) that amount is all he paid.

I agree that when you don’t pay your taxes, you are a burden to those who do. But it is a bigger burden to society when government—who should know better—deliberately obfuscates issues. This is a teachable moment that the BIR unfortunately squanders. The BIR is building up and exploiting the people’s fear of the taxman when the better approach is to make the tax system coherent and taxpayer-friendly.

What the Philippines Can Learn from Rwanda

How has Rwanda managed to overtake many developing nations in the global race for competitiveness and transparency?

Landlocked, under-endowed, war-ravaged, Rwanda a nation of 10.5 million people has faced a number of challenges, not the least of which was the ethnic strife that led to genocide twenty years ago. And yet it in spite of all this, it has managed to regain stability and posted sustained economic growth averaging 7.4 per cent per annum that has led to improved social well-being over the past decade.

As an indication of its progress, Rwanda has successfully undertaken significant reforms in its regulatory environment. Just consider the following:

So how has a country which suffered many years of war and as much corruption as any other impoverished nation in the past, managed to turn things around?

Well the short answer is they did this through an accommodative political settlement and the help of both conventional and unorthodox institutions and economic strategies.

A troubled past

Rwanda has had a long history of ethnic violence between the two main rival tribes.  From pre-colonial times up to 1959, the pastoralist Tutsis were the ascendant political class over the agriculturalist Hutus. Ethnic differences were exaggerated under colonial rule. In the lead up to independence in 1962, Belgian colonists transferred their support to Hutu elites. This led to mass killings of Tutsis many of whom fled the country.

Two Hutu regimes ruled the country from 1961-94. Having a single-party dominate politics for most of this period did not prevent the nation from succumbing to decentralised rent-seeking and clientelist behaviour. A group known as Akazu was at the apex of this system. It was related to but not controlled by the administration.

Tutsis sought to regain control of the country through an invading Rwanda Patriotic Army. This culminated in the genocide of 1994 by retreating Hutus. After consolidating their hold on the country, the Rwanda Patriotic Front (RPF) established a government of national unity incorporating moderate Hutus, one of whom led the country as its president.

A reformist regime

Although a certain amount of political repression in the guise of preventing a return of “ethnic ideology” has occurred, the coalition governments comprised of all legal parties in parliament being proportionately represented in cabinet (the ruling RPF holds no more than fifty per cent of the portfolios) has succeeded in keeping the nation stable. This inclusiveness along with its program of restorative justice known as gacaca has fostered reconciliation and allowed the country to experience improvements in social and human development not previously seen.

The intrusive intervention of government in everyday life at times borders on social engineering as the government has sought to follow the Singaporean model in both economic and social policy implementation. President Paul Kagame (elected in 2003 and then again in 2010) has been labelled the global elite’s favourite strongman for improvements to public service delivery, particularly in health and education.

Departmental line agencies have been managed through an institution of performance contracts known as imihigo which Tim Kelsall describes as “modern performance agreements supported by a significant component of moral pressure and neo-traditional gloss.” This combination of formal scientific management and homegrown practices has permeated down to the grassroots by roping in local officials and civil servants.

On the economic front, Rwanda has applied a hybrid approach to investment promotion. On the one hand, it has adopted policies and institutional arrangements considered best practice by the World Bank’s Doing Business surveys. Responsibility for managing this has been assigned to the Rwanda Development Board (RDB). But this works in parallel with a more activist approach in industrial policy with the RPF’s holding company, Tri-Star Investments getting involved in joint ventures and start-up companies.

The holding company has initiated many successful ventures with demonstration effects for the rest of the economy. Telecoms is one example. When Tri-Star sold part of its stake in Rwandatel in 2007, it got five to ten times its initial investment in the company.

Because profits from Tri-Star that are not ploughed back into its businesses revert to RPF, the party is financially independent. It uses this to fund its political campaigns without having to resort to political donors. Kelsall explains what this does:

The RPF’s financial solvency obviates the need for party officials to engage in election-related corruption, which in turn allows the party to take a very tough line on corruption among its leading supporters and in the bureaucracy.

Apart from Tri-Star the government has also orchestrated the formation of other funds, the Horizon Group belonging to the army, which undertakes socio-economic projects to produce productive enterprises, and the Rwanda Investment Group, a consortium led by domestic and diasporic elite.

The purpose of the second group is to raise capital other than through foreign borrowings to invest in high impact projects of strategic national importance. Without such an interventionist approach, much of the agricultural and industrial transformations currently underway in different sectors of the economy simply would not be happening.

The case of Rwanda demonstrates many similar traits to that of the Northeast Asian developmental states. The RPF led government faced existential threats from the opposition in exile and from a potentially hostile ethnic majority at home just as the South Korean and Taiwanese states did from North Korea and from mainland China. 

These threats have kept the ruling RPF focused on improving social and economic well-being for its citizens to maintain its legitimacy and hold on power. The regime has exercised a capacity for long-range vision and forward planning contained in its Vision 2020 roadmap, free from the influence of rent-seeking, private interests. It has ruthlessly pursued its policies at times through heavy-handed regulations and enforcement of rules.

The low crime, low corruption, low red-tape environment this has fostered was not enough. The RPF has used its clout to address market failures and encourage the adoption of productivity enhancing new technology. Through its holding company and other private-led investment groups that it has brought into being, jobs have been found for talented managers and skilled workers that might have otherwise gone overseas.

The Rwandan experience demonstrates the capacity of poor nations to bring about a system of governance that is relatively competent and free from corruption within a short span of time using home-grown institutions, resources and talent. The extremely harsh and disadvantageous position it faced did not become a hindrance, but rather provided greater incentive for it to go down the road it has followed. Surely, any emerging economy seeking to do the same should take heed the lessons from Rwanda.

Lessons for the Philippines?

The Philippines may have already attained middle income country status, a milestone that Rwanda is still aiming to achieve by 2020, but there are certain elements in Rwanda’s development experience that it can learn from.

  • Financially autonomous political parties:

We have seen how  gaining financial solvency allowed the RPF to govern without fear or favour. This enabled it to take a long-term view in planning and executing its economic development strategy. It enabled it to rule with moral ascendancy and punish erring, corrupt officials, putting an end to the patrimonial, rent-seeking behaviour of its bureaucratic and business elite.

  • Inclusive, participatory governance:

We have already seen how the RPF has shared power with other political parties. The proportion of cabinet appointments follows the same proportion of parties represented in the parliament. In the 2013 elections, an unprecedented 64 per cent of seats were won by women. This is the highest level of female participation in political office anywhere in the world. With this level of representation, laws that uphold women’s rights and promote women’s health and well-being are being enacted.

  • Home-grown solutions:

Although a certain amount of repression of the press and political opposition has taken place, in the guise of preventing ethnic tensions from flaring up once again, such suppression it can be argued would have taken place anyway, given conditions prevailing in Rwanda. Rather than relying on foreign models of governance and economic development, Rwanda has charted its own path. It uses institutions like gacaca and imihigo to bring about restorative justice and better governance.

  • Robust government role:

In promoting economic development, Rwanda didn’t follow the Washington Consensus that simply limits the role of government to creating a level playing field. It followed the example of East Asia, which meant addressing structural issues in its economy through interventionist industrial policy aimed at catalyzing investment in productive sectors in agriculture, industry and services to raise the standard of living of those residing at the base of the socio-economic pyramid. Ironically this has emboldened the private sector to take risks as well, to invest in the future of the country.

  • Political succession.

Many commentators are wondering whether President Kagame intends to step down at the end of his second term in 2017. A third term is constitutionally prohibited. As early as 2012, the ruling party held a conference to tackle the issue of political succession at Kagame’s request. At this early stage, the RPF has begun to look for ways to bring about an orderly succession, but one that does not put in jeopardy the advances made already. It is seeking ways to institutionalise mechanisms for bringing this about.

It would not be right to recommend that the same set of policies be adopted in the Philippines. The message here is that countries need to chart their own developmental path based on the conditions they face. The universal prescriptions of the Washington Consensus are becoming less influential as the balance of economic power shifts to the East. While that may be true, certain key principles can be gleaned from the success of other countries.

Considering the way the RPF developed its Vision 2020, opened up participation of women, included its political opponents in a cabinet that advises the president, and managed the bureaucracy through formal and informal contracts, what changes could the ruling Liberal Party make that would improve the way it governs under President Aquino? More importantly, how could it ensure that the positive changes it makes continue beyond 2016 when he steps down?

My Juanstore story: An Epicness journey into online retailing

Juan Store

It was late in May 2013 when I heard a chime. It was that familiar distinctive sound. Like a doorbell. The chime was about a notification on my Mac. It was a direct message from Marissa, a former officemate. She was going to send some materials to me via email. I said sure. Minutes after reading through her deck, I was hooked. So began my journey into online retailing. Epicness was born.

From the perspective of the seller, the Juanstore idea is simple. It makes online selling, easy. Create an account— as simple as tying your JuanStore account with your Facebook (that’s it!). Name your store. Pick items you want to sell. And BOOM. You’re good to go.

Screen Shot 2013-08-07 at 2.24.40 PM

Juan Store takes care of everything. Like, literally, everything. The inventory, the stocking, theirs. You pick up to 30 items from their list of cool stuff, and you’re all set. There is a huge variety of items. Home and living items like this stainless cocktail shaker. There are toys for kids, and organic, reusable diapers too. There are items for the ladies— watches, and bags. There are mud soaps, hand sanitizes, coffee, and of course, gadgets, phone cases, portable speakers, headphones, and others. You can change the line up anytime you want. It is as simple as pointing, and clicking and saving. That’s it. You can change as frequently as you want to change the entire set of items— or just remove one and swap another. Doesn’t matter so long as you meet their 30 items on the list.

What if you want to sell your own stuff? How does Juan Store take care of this?

Sure you can do this. All you need is to submit the appropriate documentation to them. The usual business permits, is necessary of course.

I’ve sold mainly small items. Notebooks, and iPad bag for men. They ship really quickly. The iPad bag shipped within 24 hours of payment.

Paying

Paying is easy. As a merchant, it’s great that Juan Store facilitates all this. For the buyer, whip up your Credit Card or Debit Card, and route it via Paypal and you’re done. You can also go and pay via Dragonpay (online banking and over-the-counter).

They do charge an additional PHP50 for shipping in Manila.

The thing that I haven’t been satisfied with is the lack of shipping outside of Manila. It doesn’t ship to Batangas, for example. They do ship to Laguna though. They also ship to Cebu City, and as far away as Zamboanga and Davao in the South, and also up North to places like Dau, and as far as Baguio.

For Juan Store, they believe this curated discovery of taste is the way to go for selling.

Juan Store of course takes the 70% cut of the selling. They after all, provide everything, and merchants opening up their store are basically, agents on commission. Which is fine. For a merchant like me, the innovation is the easy of use by which they can set something like this. They really take the complexity out of the whole business of e-commerce. To extend this is to extend the product line of things people are interested in.

How is it that I managed to sell?

People basically see the automatic Facebook posts and the tweets. When you open your Juan Store, there is a setting there for publishing your store items online. I just think of it as advertising. “To take advantage of my network.” That sounds awful, reading it back to myself.

There is some hesitancy on my part though. I don’t know when it starts being spammy. Juan Store doesn’t auto post frequently mind you. It is simply for me— a matter of being how tacky. You get me right?

Right before I signed up for JuanStore, Marissa sent me a deck explaining what Juan Store was about. It also contained who ran it. Certified geek technopreneur Timothy Go, and backed by such directors as Manny Ayala (Chairman of Moanima), and Nix Nolledo (Co-Founder of IMMAP) were enough to convince me that this is a serious venture.

Looking at the months I’ve been a member, the question now in my head is: how do you sell more? Is it because people aren’t interested in the items? Hard to pay? Hesitant to buy stuff online? I’ve certainly asked people about it. There is always that mistrust at the back of your head that the item you bought won’t get delivered.

I’ve long since moved passed it. Online shopping for me is about getting things, the local stores don’t normally have, or cheaper items. For others, who frequent online stores, it is about saving time. Who has time to shop during weekends when you would rather spend it with family and loved ones?

What about people who want to sell items? I think Juan Store is a perfect avenue for people who want to get a taste of online selling. Certainly, I think this is the Multiply idea, version 2.0. There are other variations of the same idea. People buy and sell items all the time on Facebook, for example. Juan Store, and others like it is the step towards formalizing, and democratizing online selling. Juan Store makes it easier for the buyer and the seller to get together online. It’s brilliant and simple.

Looking back now, I think the choice of “Epicness” as a name for my juanstore was serendipitous. The experience as a merchant is epicness. When I hear from buyers that they got the package, and love the items, I hope that too was an Epicness experience for them.

Close-Open

What’s better for economic growth?

In the debate over the economic provisions of the constitution, we often hear that it would be better for the Philippines to lift all restrictions on foreigners. These are what prevent investments from flooding into the country, its advocates say.

One way of arguing for full liberalisation is to point to our progressive regional neighbours and say that they are less restrictive towards foreign participation in their domestic markets. Since they are growing much faster through investments, what we ought to do is adopt their policies and completely liberalise all the sectors of our economy.

This notion is often repeated and reinforced by politicians, businessmen, think tanks and commentators in the media. They portray opposition to full investment liberalisation as either based on selfish interests or irrational xenophobia.

The problem with this stylised argument is that it may not necessarily be grounded on fact. It could be a situation where a lie repeated often enough can become true in the minds of the public.

To test the assumption that our regional neighbours are not restrictive towards foreign investments, I consulted the World Bank’s Invest Across Borders report which contains the most authoritative information on statutory rules and regulations that govern foreign investment in domestic economies around the world.

This allowed me to answer the question, which region in the world is the most open to foreign direct investments? Is it:

a. East Asia and the Pacific (EAP)

b. The Middle East and North Africa (MENA)

c. Latin America and the Caribbean (LATAM&C)

d. Eastern Europe and Central Asia (EECA)

e. South Asia (SA)

f. Sub-Saharan Africa (SSA)

g. High income OECD nations (OECD)

Most would rank the OECD nations as the least restrictive followed by East Asia and the Pacific. This is based on the notion that richer and more prosperous countries generally tend to be more open to investment from abroad. No other region in the world has bridged the gap between rich and poor like EAP with MENA coming in second.

So what does the data tell us? The rich OECD countries are definitely the most open to foreign investments. But among all these regions, the EAP region is astonishingly the most restrictive. The following table comes straight from the World Bank’s findings:

Ownership Limits for Foreign Investors by Sector

Region/Economy Mining, oil & gas Agriculture & forestry Light manufact-uring Telecom Electricity Banking Insurance Transport Media Construction, tourism & retail Health care & waste manage-ment
East Asia & Pacific 78.4 82.9 86.8 64.9 75.8 76.1 80.9 66 36.1 93.4 84.1
Middle East & North Africa 78.8 100 95 84 68.5 82 92 63.2 70 94.9 90
South Asia 88 90 96.3 94.8 94.3 87.2 75.4 79.8 68 96.7 100
Latin America & Caribbean 91 96.4 100 94.5 82.5 96.4 96.4 80.8 73.1 100 96.4
Sub-Saharan Africa 95.2 97.6 98.6 84.1 90.5 84.7 87.3 86.6 69.9 97.6 100
Eastern Europe & Central Asia 96.2 97.5 98.5 96.2 96.4 100 94.9 84 73.1 100 100
High-income OECD 100 100 93.8 89.9 88 97.1 100 69.2 73.3 100 91.7

Source: World Bank (2010), Invest Across Borders.

Note: The table shows the average levels of ownership caps placed on foreign investors across eleven of the most regulated sectors (with a score of 100 indicating complete openness or full foreign ownership permitted). There were 87 countries in the sample.

For all but two of the eleven sectors featured, EAP is the most restrictive—and even in the case of those two sectors, electricity and transport, EAP came second only to MENA. The IAB report acknowledges this by saying,

East Asia and the Pacific has more restrictions on foreign equity ownership in all sectors than any other region.

The caveat is that EAP also shows the greatest intraregional variance with less populated jurisdictions like Singapore and the Solomon Islands having fewer restrictions and highly populated ones like China and Indonesia imposing more in their service sectors.

When it comes to private ownership of land, the IAB report also shows EAP being the most restrictive to foreigners. The following is a screen grab. It shows that only 33 per cent of the EAP’s economies allow foreign ownership of land compared to 52 per cent for SSA, 80 per cent for MENA and SA, 95 per cent for EECE and 100 per cent for LATAM&C and OECD. Only three of the ten economies surveyed allow it. Most economies only lease land to foreigners and provide weak lease rights at that (the leases cannot be used as collateral for loans, subdivided or sublet).

land ownership

When it comes to ownership rights, EAP scored 83.3 out of 100 coming in fifth after the OECD (100), LATAM&C (98.2), EECE (97.6) and SA (93.8), ahead of SSA (77.3) and MENA (68.8). This again runs counter to the prevailing view that EAP provides greater security to foreign investors over their property rights, more than other regions.

The ease of doing business, particularly the cost of entering a country is the last thing we will look at. The ease of establishment is measured by the number of steps and length of time needed for setting up a foreign business. The following table also comes from the IAB website:

Starting a Foreign Business

Region/Economy Procedures (number) Time (days) Ease of establishment index (0-100)
Middle East & North Africa 9 19 58.6
High-income OECD 9 21 77.8
Eastern Europe & Central Asia 8 22 76.8
South Asia 9 39 62.5
Sub-Saharan Africa 10 48 51.5
East Asia & Pacific 11 64 57.4
Latin America & Caribbean 14 74 62.

Note: Ease of establishment index (0-100) evaluates the regulatory regime for business start-up.

MENA and the OECD are at the top of the league table with 19 and 21 days for each of them respectively to open a new business. LATAM&C and EAP are the worst performers in that order providing additional hurdles to them. It takes 64 days on average in EAP and 11 steps to open a new business. In China it takes 65 days on average and 18 steps, which is above the regional average. In the ease of establishment index which reflects the regulatory regime of regions, SSA and EAP are the worst performers in that order, meaning their regulatory regimes are the most difficult and least familiar to foreign firms.

Given its lack of openess, poor accessibility of industrial land, and larger regulatory burden, it is astonishing how the EAP experienced faster growth and pulled in larger investments compared to other emerging markets in the world as shown in the following charts.

These results will seem counterintuitive, especially for those who have been fed a steady staple of neoliberal ideology. It’s a case of empirical evidence contradicting normative beliefs: the most restrictive EAP region grew fastest and attracted the greatest value of foreign direct investments.

So why has the Philippines managed to lag behind its regional neighbours in terms of growth and development? What factors allowed them to take-off and overtake us? That is a subject for a much longer conversation and a later post. Suffice it to say that framing the problem around liberalisation in certain sectors, accessibility to land, ease of establishment or even property rights does not provide a convincing answer.

Let me conclude with what that this discussion demonstrates, and that is opening up our domestic market to foreign competitors is not a guaranteed way to bring about economic transformation. It is not a panacea. It does not necessarily follow that if you open up, you will attract more investments or grow much faster. There is a missing ingredient in all this, an “omitted variable”, as it were.

In part two of this series, I will discuss the various strategies employed by the East Asian tigers in their quest for economic prosperity and how the political and economic history of the region diverges from common public perceptions of what happened.

The Binary World of James Robinson: a rebuttal to Why Nations Fail

He came at the invitation of the Angara Centre for Law and Economics to present his ideas from the book Why Nations Fail which he co-authored with Daron Acemoglu. This pair along with Simon Johnson had originally published back in 2001 an article in the American Economic Review entitled The Colonial Origins of Comparative Development: An Empirical Investigation.

Their book could be seen as an essay expounding on the themes uncovered by their earlier research which credits economic development to the institution-building conducted during the colonial era between the fifteenth and nineteenth centuries. It begins by drawing our attention to the differences between Nogales, Arizona and Nogales, Sonora, towns on opposite sides of the US-Mexican border.

The basic thesis of the book is that nations with institutions that promote greater inclusion in both political and economic spheres prosper while those that foster extractive or predatory policies wind up becoming impoverished and backward. The seminal moment in history, according to the book, happened in England back in 1688 during the Glorious Revolution.

For those not familiar with this event, I provide a brief background here. The basic argument goes a little like this: security of ownership and property rights is essential to investor certainty; investor certainty is needed to foster capital markets, and a set of political checks and balances that guarantee this is best suited for capitalism to flourish.

These principles were essentially what The Glorious Revolution was supposedly fought on and why the Industrial Revolution subsequently took place first in Britain, rather than in Continental Europe. The rights and ideals that Englishmen fought for were transplanted to their American colonies and became the basis for the American declaration of Independence in 1776.

Acemoglu, Johnson and Robinson (AJR) sought to prove empirically that institutions mattered to development. Previously, it was argued that climate and geography had a lot to do with it, i.e. that the industrious, temperate, northern states of Europe were more prosperous than the sluggish states in the southern Mediterranean and the tropics.

AJR sought to dispel this using colonial history. Why was it that not all colonised countries developed along the path of the United States? The difference lay in institutions. Their article demonstrated that in places where diseases led to high mortality rates among early European settlers, and where consequently hardly any permanent settlements were planted, centuries later, the lack of institutional legacy was found to be significantly correlated with low development.

The main lesson was that geography was not destiny, and that even history was not destiny. Less developed nations could begin adopting the institutions that promoted greater inclusiveness and discard extractive policies that left them in squalor. This dove-tailed with the agenda promoted by Washington on good governance, as it searched for a way to rescue the failed Washington Consensus from repudiation.

What came about was the augmented consensus that said free markets and good governance promote economic growth and development. After decades of telling less developed countries to shrink the role and capacity of the state and let markets rip, they were now saying that government needed to be strengthened once again.

The liberal democratic states of the West act as an ideal to which other societies need to aspire to. No other path leads to sustainable economic growth other than this. Just as Calvinist preachers of old would proclaim that no one cometh to the Father, but by His Son, these economists present a case that no other path leads to economic Nirvana, but through the Market (with Institutions performing the role of the Holy Ghost).

This rather binary view of the world is actually contradicted if you go deeper into the colonial history of the Americas which is what John H. Elliott did in Empires of the Atlantic World: Britain and Spain in America 1492 to 1830.

Here he wrote that it was actually the exclusionary racial policies fostered by the English settlers that led to greater social cohesion among settlers around Enlightenment principles of individual rights and liberties, which in turn led to greater independence and prosperity.

Meanwhile in the Southern hemisphere, the Spanish settlers had an “organic conception of a divinely ordained society dedicated to the achievement of the common good” which was “more inclusive rather than exclusive in approach”. The granting of rights both economic and political to natives consisting of mestizos, creoles and freed slaves led to a mixed-race society prone to greater divisions than existed in the North.

The irony here is that a more inclusive colonial policy led to greater exclusivity as subsequent societies were stratified and organised into “pigmentocracies” which made it harder to achieve the egalitarian principles espoused by the Enlightenment. In the Philippines, the outpost of New Spain, the situation was worse in that apart from developing this multi-racial caste-like system, the facility of a common language was not provided as it was in the Americas.

This is the difficulty of using colonial history to prove or disprove that institutions matter in the way attempted by the authors of Why Nations Fail. They do matter, but in different ways, which is the point I highlighted previously in this column (see here).

Secondly, there is the anomaly of the benign dictators of East Asia and the desarollista states of Latin America. Robinson has taken the view that the East Asian growth formula, what is termed the BeST Consensus (BeST consisting of Beijing, Seoul and Tokyo), represent a unique moment in history that cannot really be duplicated or sustained.

Peter Evans disputes this saying that just because the East Asian miracle emerged from a unique blend created by the Cold War policy of the United States, it does not mean that we cannot distil a few basic principles and emulate them today. Just because these states were predominantly autocratic does not mean that weak democratic states cannot adopt the policies that made them succeed in fostering rapid industrialisation (see here for a deeper discussion).

What’s more is that both Germany and the United States, late industrialising Western nations after Britain and France, followed the same industrial policies a century earlier. It was just that after scaling the development wall, they felt the need to “kick the ladder” away to prevent others from following them up because not doing so would disadvantage them.

In Latin America, the record of developmental or desarrollista states of the 1970s and 1980s in Brazil and Mexico is more spotty than in Chile but nonetheless more successful than in Africa or South Asia as these countries made their way into middle income status ahead of countries like Malaysia, Indonesia and Thailand. This is the evidence that Robinson conveniently sidesteps.

Another point James Robinson makes in the book and in interviews is that collective action, which he equates to people power, is key to expanding opportunity for people if the system is closed. He cites the experience of the Philippines and of the Middle East a la Arab Spring to underscore his point. Again, the use of people power is problematic. Why?

Well as Elliott points out, people power features in Spanish colonial traditions as well because

(b)y the laws of medieval Castile the community could, in certain circumstances, take collective action against a ‘tyrannical’ monarch or minister.

Cortes in fact used this against governor Velasquez who ordered him to survey and not to invade the territory of Montezuma in the Yucatan peninsula. It was based on the notion of a social contract between the prince and his subjects which if broken gave the right of the governed to say, “I obey, but I do not comply” (se obedece pero no se cumple).

From time to time, commoners or comuneros resorted to acts of dissent bordering on revolution. But these were simply seen as a way to get the authorities to the bargaining table. Once their grievances were heard and the tyrannical laws or ministers were replaced, they would go back to living as loyal subjects of the monarch. Direct democracy rather than representative democracy ruled until very late in the piece, which left them with very little in terms of a genuine parliamentary tradition.

This swinging of the pendulum from uprising to dictatorship and then back again is exactly what we are witnessing in Egypt today. The problem with equating collective action, i.e. people power, with greater openness, is that the relationship does not always hold.

Finally, let me address the fallacy that only the Anglo-American form of capitalism works well. Francis Fukuyama is right to point out that this is not the only successful Western model that exists. Scandinavia demonstrated another path, which did not require revolts against oppressive monarchs. Theirs was more along the lines of an enlightened, benevolent monarch based on egalitarian religious rather than secular beliefs.

What I hope to point out through this discussion is that the world that we live in is more complex, more multifaceted than what Robinson tries to portray. While it is easy for him to be parachuted into the Philippines to spread his brand of institutional economics, we don’t necessarily have to buy into his whole message.

I agree that the Philippines needs greater openness and participation in political and the economic life, and that collective action to widen the sphere of participation probably needs to be organised, because elites won’t surrender their privileges willingly, but that is as far as I would go.

We don’t need a whole theory based on a faulty or perhaps selective reading of history to back this up. We have seen how people power can be hijacked or used for narrow political ends. We need to guard ourselves against simplistic arguments that say unseating this corrupt ruler here or that autocrat there is going to bring about nirvana for us. Institution-building is not accomplished by this alone, but through a sustained, deliberate, evolutionary process.

The social innovation of Oportunidades and Bolsa Familia more widely known as conditional cash transfers which have been credited with reducing poverty in Mexico and Brazil were not developed by the World Bank or the IMF.

They were experiments conceived by indigenous policy makers who were thinking ‘outside the box’. The East Asian industrial policies responsible for creating economic prosperity and convergence were pursued against the advice of international economists from the IMF and the West. Japan’s Ministry of International Trade and Industry sought to deceive their Western minders that they were complying when in fact they were doing their own thing.

Similarly if the Philippines were to find its way in the world, it will have to be by taking into account its own unique blend of ideas, capacities and institutions. It won’t be by applying some universal one size fits all formula promoted by a Western economist armed with some statistical regressions, a few case studies and a loose reading of history.

Since the era of Martial Law we have had technocrats sing from the same hymn sheet as their Western counterparts while ironically supporting a system that undermined the very principles they were espousing. We need to be smarter and wiser this time around.

We need to accept that the world is not a binary system, comprised of dummy variables that say you are either inclusive or exclusive, free or unfree, open or closed. We need to admit that we live in a multi-polar world, where things are not as clear cut, as some experts would have us believe, and that many paths lead to development. Ours in fact still needs to be found.

Remittance Driven Growth

Monthly remittances inflows (US$ millions)
Source: World Bank

If anyone needed an explanation for the robust growth of the Philippine economy for the last nine years (two of which under the present dispensation), then the chart above would go a long way towards providing it. It shows monthly foreign remittances flowing from January 2003 to February 2012 into the country compared to that of some Latin American, Caribbean and South Asian countries of similar size or income to the Philippines.

In terms of its foreign remittances, the country is an absolute stand-out rising from about $600 million a month in early 2003 to about $1,500 million in early 2012. In the twelve months leading up to February 2012, the total inflows to the country was about $20.2 billion. If we convert that to pesos using the average exchange rate in 2011, that is roughly equivalent to PhP875 billion. In an economy of roughly PhP9.5 Trillion, that is about 9.2% of GDP. Given the multiplier effect that this income has, it would be safe to say that remittances contribute about double or about a fifth of the economy.

Unlike, Mexico which is dependent on its Northern neighbour the United States for providing a market for their cheap labour, the Philippine work force has its eggs in many baskets, not only in different countries, but many occupations, both high- and low-skilled. This is reflected in the data which shows that as the Great Recession unfolded in the US from September 2008, the growth in remittances to Mexico hit a ceiling, while that of the Philippines maintained its upward trajectory catching up with its North American counterpart towards the end of 2011.

As of October 2012, the nation’s gross international reserves reached a record high of $82 billion, 8% higher than it was a year ago at $75 billion. This would be enough to pay for close to a year’s worth of imports or settle half a year’s worth of debt resettlements. One can clearly see that without these foreign remittances, the gross international reserve position would be shrinking, not expanding.  In fact, if you took away the growth in remittances which was 7.1% year-on-year from 2010 to 2011, then you probably wouldn’t have seen any growth in the Philippine economy during that time.

These dollar remittances inflows are roughly the size of the Philippine government’s tax and revenue intake for a year. They could finance the government’s annual deficit three times over. The recent upgrade to the country’s credit status to one notch below investment grade owes more to this phenomenon than to the government’s “fiscal consolidation” and “debt management program”.

In its recent report for the third quarter, the global investment monitor Thomas White has said

The Philippine economy is in a sweet spot mainly due to the high infrastructure spending the country has unleashed. Adding to this, strong remittance income from oversees Philippine workers, a fast-growing domestic services sector, and increasing confidence from foreign investors bolstered to the country’s buoyant economic outlook.

If you averaged out the growth for the last four quarters, you would find that it would be  4.85% , the same as its average growth for the last ten years. The confidence of foreign portfolio investors in the local stock market comes largely from the country’s ability to keep the economy chugging along as events from Europe have dampened the outlook for other countries. This was admitted to by a senior official of investment bank Goldman Sachs in a recent visit to Manila. The White report continues by saying

With the country’s government awarding $16 billion worth of contracts to build social infrastructure that included constructing thousands of classrooms, the outlook for the infrastructure industry has grown rosy. The construction sector posted a growth of 10% during the quarter up from the 7.6% registered during the first quarter. As public spending rose, employment outlook also improved during the quarter, boosting consumer demand. Household consumption jumped 1.4% during the quarter, up from the 0.9% during the first quarter.

Notice that they say it was the “outlook” on employment from the “infrastructure outlook” that boosted consumer demand. That is either a lot of faith placed on the outlook or it was a result of hard cash pouring in from Filipinos living and working overseas (UPDATE: note that the construction boom is happening because the property and realty sector is benefiting from remittances, and this has actually gotten some analysts worried about a possible housing bubble). The report concludes by saying

…Meanwhile, despite maintaining a record low interest rate of 3.75%, inflation in the country fell to a low of 3.6% in September from 3.8% in August. The central bank has targeted an inflation of 3% to 5% for 2013.

The BSP has in fact cut interest rates recently to temper the appreciation of the peso that has been hurting the competitiveness of our export industries. The situation has been described as reaching a breaking point by industry insiders. The power of the peso relative to the US dollar is what is behind the low inflation figures as imports become cheaper. The so-called “sweet spot” of high growth, better employment and low inflation can actually be explained by the continued growth of remittances rather than any privately-financed stimulus that has yet to be spent.

 

Recto’s false smuggling report

In his sponsorship speech of his version of the sin tax reform bill, Sen. Ralph Recto says that “a higher tax rate does not automatically result in higher collections” and will result in smuggling.

The Recto report presents anecdotal data from a few carefully selected countries (with no references) to convey a general story that higher excise tax will lead to 1) smuggling 2) loss of government revenue and 3) loss of impact on smoking prevalence. We show how these short-term “trends” have been spliced from the long-term picture, then taken out of context to deceive the Senate and the public. The larger picture around the world is that an increase in sin taxes leads to increased revenues and declines in tobacco consumption. Smuggling bears little relation to tobacco price per se and is related more to regulatory measures in each country.

1. CANADA

The Recto Story: “High excise levels (22%), increased consumption of illicit cigarettes, undermined regulatory and fiscal objectives.”

The full story: From 1980 to 1994, the Canadian government enacted major tax increases on tobacco products. These actions initiated significant tobacco smuggling which the tobacco industry blamed on excessive taxation; it was later discovered that the tobacco industry had actually promoted smuggling schemes to increase their profits and provide an argument for tobacco taxation reduction. This has resulted in numerous U.S. and Canadian criminal convictions of tobacco industry officials and partners [Ref: Int J Health Serv. 2008;38(3):471-87.Public policy implications of tobacco industry smuggling through Native American reservations into Canada. Kelton MH Jr, Givel MS.]

2. HUNGARY

The Recto Story: “Sharp, above-inflation increase in excise rate led to increased revenues initially but eventually to a revenue decline.”

The full story: In Hungary, regular tobacco tax increases resulted in decreased cigarette consumption. State incomes have increased in spite of regular cigarette tax raises. [Ref: Cent Eur J Public Health. 2007 Sep;15(3):122-6. Higher cigarette taxes--healthier people, wealthier state: the Hungarian experience. Szilágyi T.]

3. IRELAND

The Recto Story: “Steep excise tax increase resulted in swift emergence of illicit trade, and virtually flat cigarette duty revenues.”

The full story: Illicit tobacco neutralized government revenues in Ireland, when they pushed for tax escalation in 1998. This was because, even before the tax increase, they were already the highest priced cigarettes in the region. This certainly does not apply to the Philippines, which boasts among the cheapest cigarettes in the region and the world. Despite the extreme situation in Ireland, government revenues did grow after tax escalation [Ref: Economics of Tobacco: Modelling the Market for Cigarettes in Ireland. Padraic Reidy and Keith Walsh. Research and Analytics Branch, Planning Division, Revenue Commissioners. February 2011.]
Furthermore, smoking-attributable deaths decreased after the tax increase. [Ref: Tob Control. 2012 May 26. The effect of tobacco control policies on smoking prevalence and smoking-attributable deaths in Ireland using the IrelandSS simulation model. Currie LM, Blackman K, Clancy L, Levy DT.]

4. MALAYSIA

The Recto story: “Staggering increase in excise tax (in 2011,172% of 2004 rates) led to illicit trade growing to almost 40% of the market.”

The full story: Analysis of previously confidential documents from BAT’s Guildford depository demonstrates that smuggling in Asia was driven by corporate objectives. [Ref: Complicity in contraband: British American Tobacco and cigarette smuggling in Asia. Collin J, LeGresley E, MacKenzie R, Lawrence S, and Lee K. Tob Control 2004;13:ii104-ii111 doi:10.1136/tc.2004.009357].

Malaysia’s solution was not to pull back on excise tax as Recto proposes. Their solution was to implement tracking and tracing systems to control tobacco smuggling in 2004. They were able to recover approximately US $100 million in extra revenue during the first year alone. [Ref: Bharu, K. 2004. Security ink and tax stamps on beer, liquor. New Straits Time, November 5th.]

5. NEW YORK

The Recto story: “Excise duty hikes above underlying inflation leveled to a sharp drop in legal volumes, decline in government revenues, decreased smoking incidence and illicit trade reaching almost 40% of the market.”

The full story: Sales did plummet immediately following the 55% tax increase in 2000, but this recovered to settle on a new level lower than the sales level before the tax increase. Despite the decline in sales, revenue increased dramatically, aided by stricter regulation to curb smuggling [Ref: State Cigarette Excise Taxes: Implications for Revenue and Tax Evasion, Final Report. Prepared for the Tobacco Technical Assistance Consortium, Emory University, Rollins School of Public Health. Farrelly M, Nimsch C, James J.]

6. ROMANIA

Recto story: “Continuous massive excise increases, increased government revenue, constant smoking incidence, illicit trade is more than ⅓ of total consumption.”

The full story: In Southeast Europe, smuggling is lowest in countries like Romania (25% of total cigarette consumption) where transnational tobacco companies have the largest presence and official market share. It is highest in countries like Albania (80%) where these companies are absent. Given the evidence of the tobacco industry’s complicity in smuggling this is unlikely to be a coincidence. [Ref: Tobacco use, a major public health issue in south-east Europe. Eurohealth Vol 9 No 4 Winter 2003/2004. Ivana Bozicevic, Anna B Gilmore, Thomas E Novotny]

Furthermore, the daily smoking prevalence in Romania dropped to 22% in 2011 from 29.7% in 2003, as revealed by a survey conducted by the Health Ministry with the support from the Bucharest-based Lung Diseases Institute [Ref: Romanian Business News – ACTMedia, Tuesday, November 22, 2011]

7. SINGAPORE

The Recto Story: “135% increase in 2005 over 2000, declining government revenues despite tax increase, smoking incidence was virtually unchanged from 2001, illicit trade grew.”
The full story: In the longer picture, we know from the Singapore Ministry of Finance, that the Government collected $621 million of excise duty on tobacco products in FY2006, $700 million in FY2007, and $794 million in FY2008. [Ref:http://app.mof.gov.sg]

In the long run too, Singapore excise tax policy has led to one of the lowest smoking rates in the region, and the prevalence continues to decline. Today, the country boasts of the biggest declines in smoking-related deaths among high income countries all over the world. [Ref: Cardiovascular Disease and Risk Factors in Asia : A Selected Review. Ueshima H et al. Circulation. 2008;118:2702-2709].

8. SWEDEN

The Recto story: “Reduction in excise rates used to counter extreme levels of illicit trade (late1990s); massive increase led to increased illicit trade (2007and 2008) and reduction in total cigarette consumption.”
The full story: In fact 1998 is one of the few years that Sweden posted a decline in excise tax revenue. They lowered excise tax by 17% with hardly any effect in revenue, and as a result, tobacco consumption went up by 20%. [Ref: Nordisk tobaksstatistik 1970-2002 and WHO calculations].

Today, Sweden is the best example of how there is no relation between tobacco price and illicit trade. The country boasts of the highest priced cigarettes in the world, the lowest rates of illicit sales, and among the lowest prevalence rates of smoking and smoking-related diseases. [Ref: Cigarette smuggling in Europe: who really benefits? Luk Joossens, Martin Raw; Tobacco Control 1998;7:66–71]

9. UNITED KINGDOM

The Recto story: “’Duty escalator’ tobacco taxation led to down-shifting by consumers, increased illicit trade, government revenue loss but with no impact on smoking incidence levels.”
The full story: The UK has posted significant declines in smoking consumption since they imposed the “tobacco duty escalator in 1993”. [Ref: Econometric Analysis of Cigarette Consumption in the UK. Magdalena Czubek , Surjinder Johal. December 2010. HMRC Working Paper Number 9].

Furthermore, through an action plan to curb illicit trade in 2000, the UK has successfully suppressed smuggling and posted earnings in revenues. [Tob Control 2008;17:399-404 doi:10.1136/tc.2008.026567 . Progress in combating cigarette smuggling: controlling the supply chain. L Joossens, M Raw.

Undervaluation: a second-best solution for growth? – part II

If an undervaluation strategy can indeed help support growth, how can it be implemented? Indeed, how does such a strategy relate to inflation targeting and to capital account liberalization?

Mr. Sta Ana is proposing a real exchange rate target, i.e. real undervaluation. As we know from the “impossible trinity”, a central bank cannot pursue a (nominal) fixed exchange rate, open capital accounts and an independent monetary policy simultaneously. One solution could be to (partially) diverge from one or both of the latter.

In the discussion on inflation targeting, I agree that a less doctrinaire approach could look at longer-term inflation prospects, which are also dependent on exchange rate stability. A mature monetary policy could also seek to prevent overvaluation, which could lead to sudden depreciations and hence risks to inflation over the longer term. Yet a change of approach should be well thought out, also for the impact on financial stability. In Europe and the US, there is a discussion on taking financial bubbles into account in monetary policy, which may require raising rates or “leaning against the wind” to prevent growing imbalances. But note that this latter strategy would go in the opposite, more “hawkish” direction. If monetary policy seeks to keep down the exchange rate – i.e. lowering interest rates more than justified by inflation expectation, a “dovish” policy – this can lead to negative real interest rates and the emergence of financial bubbles. This lends credence to the so-called “Tinbergen Rule”, that for each policy target there must be one tool, and that conversely, one tool cannot achieve two goals consistently. Look at what is happening in Turkey right now, where the central bank (CBRT) is clinging to a low policy rate to discourage capital inflows, even as inflation rises. Reserve requirements are being used in parallel, but are so far only partially effective in slowing credit growth. This is also clearly political; Turkish Prime Minister Erdoğan has attacked what he calls the [foreign] “interest rate lobby” and CBRT Governor Başçi has said that Turkey has “the most creative monetary policy in the world”. It is yet to be seen how effective this policy will be. In any case, this underlines that the central bank cannot achieve undervaluation alone, and again that consistency with government (especially fiscal) policy is needed. Run-away inflation would undermine real undervaluation.

One could also consider restrictions on the capital account. The case for a market-based control on inflows (i.e. a Brazilian tax on portfolio flows, or Chilean Unremunerated Reserve Requirement) is well-presented, but not uncontroversial. The IMF has also recently worked on a framework for capital flows, including capital flow management policies, and there has been significant debate on the issue. In the 1990’s, the IMF argued that, like trade restrictions, capital controls are an unnecessary distortion. This point of view has changed. There is some acceptance that – while the first-best strategy is more financial deepening and the development of a strong macroprudential framework – there could be a case for developing countries to liberalize capital accounts slowly, and even reinstate capital controls when other policy options have been exhausted. The point is that, while open capital accounts may be optimal in an idealized world of efficient financial markets, bringing risk diversification and savings to the most productive places, these conditions are not given in practice due to both national and global factors. In the volatile post-crisis environment, with financial de-leveraging and spillovers from unconventional monetary policy, we are even further from the idealized neo-classical world (if we were ever there in the first place). Kose, Prasad and Taylor (2009) argue that there are thresholds in financial development, below which it is not optimal to open the capital account. I am partial to this view, which seems to have informed the IMF’s recent work. Meanwhile, Rodrik (2008) ever the pragmatist, thinks that capital controls should simply be a permanent part of the international monetary system. This loses sight of the fact that capital controls tend to lose their effectiveness and be circumvented over time. Moreover, there are macro-prudential policies, such as limits on foreign exchange-denominated borrowing or open foreign exchange positions, which work similarly without explicitly targeting foreign investors. As Romeo L. Bernardo has written in this paper, such tools are also used in the Philippines. In the longer run, a sound macro-prudential framework, of the kind being developed in many developed and developing countries, could support financial stability, de-burden other areas of macro-economic policy and address the specific risks of cross-border flows. Yet for an intermediate phase toward development, it may be wise to be cautious with international investment flows, and to work on building the pre-conditions for open capital accounts (sound supervision, deepening, open equity markets) before the first-best solution can be pursued.

Undervaluation: a second-best solution for growth? – part I

In a chapter of Philippine Institutions: Growth and Prosperity for All (2010), Filomeno S. Sta. Ana III of Action for Economic Reforms makes the case for an undervaluation strategy for the Philippines. By this, he means not a specific nominal value for the exchange rate (a fixed regime) but rather a policy – led by the government, with central bank support – aiming at real depreciation of the peso, as measured by the real effective exchange rate.

He argues that this strategy would support export-led growth and help prevent costly balance of payments crises resulting from bouts of overvaluation. He notes that this is a “second-best” means of promoting growth, given that reform of institutions and markets – the “first-best solution” – will take a long time to be effective.

In this, he cites work by Harvard’s Dani Rodrik, which shows that real exchange rate undervaluation can have a positive and significant effect on growth for developing countries in general. Rodrik’s point that focusing only on institutions is like “telling developing countries that the way to get rich is to get rich” is well-taken.

Yet aside from Rodrik, there are other well-known economists who have made arguments along these lines. John Williamson, who coined the term “Washington Consensus”, also supports some undervaluation for developing countries, and also “intermediate exchange rate regimes” in between fixed and fully floating. Former Fed chairman Frederic Mishkin, who is cited several times in the paper for his 1997 paper with Bernanke, has pushed for a more flexible approach to inflation targeting – which could allow central banks to pursue an exchange rate goal alongside low inflation.

The experience of China and some others shows that undervaluation may be helpful for domestic growth and exchange rate stability – even during the crisis, when financial contagion and the impact on growth were relatively limited. Of course, this also relates to China’s closed capital account, and says nothing of spillover effects of the fixed exchange rate regime on other countries.

I appreciate Mr. Sta. Ana’s point that the government should adopt the strategy first to ensure consistency with the central bank. Policies like fiscal responsibility – through strengthened taxation and avoiding populist spending – and limiting foreign borrowing would be important. These would support the exchange rate policy and ensure the central bank and government are not pursuing incompatible goals. I have a couple of further thoughts on this line of argument, some critical, some supportive.

First, not every country can have an undervalued exchange rate. As the experience at both the global level and in Europe shows, there are two sides to every coin. Exchange rate regimes have been one factor in the massive global imbalances between China and the oil producers on the one hand, and the US and some others on the other. Persistently higher inflation rates in Greece, Spain and Ireland, combined with wage moderation in Germany, have led to huge imbalances within the euro area. The problem is generally larger on the side of deficit than of surplus countries.

Yet, if the Philippines has an undervalued exchange rate, and with it current account surpluses, and export growth, someone else must have an overvalued exchange rate, and hence current account deficits, and import growth. The exchange rate is a relative price between two currencies, and bydefinition not all countries can pursue undervaluation. There could be an argument that developing countries should be the beneficiaries of undervaluation, as growth is a clear policy priority – also for the developed world, which spends significant sums on development aid each year. After all, the relative impact (cost) for the global economy is likely much smaller and more broadly borne than the impact (benefit) for the Philippines. Yet someone else would have to bear the burden of overvaluation.

Second, this is precisely the sort of question that should be discussed multilaterally. Specifically the IMF would be the forum to bring this up. It is true that it is difficult for countries like the Philippines to get strong backing for a change in IMF policy (and policy advice) on their own. But it is the job of the IMF to serve as “the machinery for consultation and collaboration on international monetary problems” (Article I.i of the Articles of Agreement) and to “promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation” (Article I.iii).

The last point is very sensitive in practice, especially given the criticism of China’s exchange rate regime, and the considerable pressure from the US. The IMF has recently done new work and created a methodology to assess exchange rate misalignments as part of the External Balance Assessment. This allows policymakers to better understand external imbalances. But this applies only to imbalances in the big systemic economies, i.e. China, the US, UK, Euro area, Japan, and a number of larger advanced and emerging economies. A little bit of undervaluation in a developing country could probably be tolerated, if this is seen as support for a development strategy. Yet it should be presented and discussed multilaterally.

Third, there is an important link with other policy areas like capital account openness, due to the so-called impossible trinity. In the next column, we will look at implementation of an undervaluation strategy, and specifically the relationship with inflation targeting and capital account liberalization.

Excising a killer

The term “excise” has come to mean to expunge or expurgate. Under taxation, it actually means a levy on an activity government seeks to control. This is achieved by making the activity more expensive by appending prohibitive taxes thus penalizing usage. The colloquial term “sin tax” is often interchangeably applied on excises slapped on goods deemed undesirable such as tobacco.

Under the technical definition, the levy on consumption is incorporated in a product’s price. Similarly, the technical definition of a “sin” tax is a state-imposed levy to discourage consumption without outlawing the product.

The similarities are profound. The etymology of “excise” is from the Latin accensare which means “to tax.” The expurgating aspect is, however, now part of current usage. The convolution is welcome and ironically helps us understand the objective of controlling undesirable activities.

While technically the tax should be paid by the producer or seller, in an excise system, the burden transfers to the consumer as producers and sellers recover the tax by raising prices. This is why the tax is a control mechanism and not simply a revenue-generating device.

Control is important where the activity sought to be controlled is deemed detrimental yet tolerated.
Note the economic costs of death and disability by smoking. According to Dr. Antonio Dans of the University of the Philippines College of Medicine, “To treat lung cancer alone, the leading cancer type in the Philippines, health-care costs are already at P1.97 billion.”

He adds “the loss of productivity—the days those afflicted must take a sick leave—costs P0.04 billion while the loss of revenue caused by premature death is a staggering P4.94 billion.” All told, these total P6.95 billion for lung cancer alone.

For the good doctor, “with the costs of chronic lung disease, coronary disease and strokes factored in, the total spent on these non-communicable diseases caused or worsened by smoking amounts to a whopping P188.80 billion per year.” That’s over 1.96 percent of our 2011 gross domestic product.
A presentation by Dr. Hana Ross of the University of Illinois at Chicago shows that the World Bank estimates a $100-billion net loss from tobacco use in developing countries.

That’s a hefty price to pay for the sybaritic pleasures of simulated farting through the mouth.

Critics and some government idiots claim cigarettes are price inelastic. Price elasticity is a function of purchasing power. Dr. Ross’s presentation shows demand in low-income economies can fall by 8 percent against a 10-percent increase in prices. The poverty demographics of tobacco use ensures prohibitive taxes will work if applied single-tiered and exorbitant enough to be painful, while government does its part to jail smugglers of criminally dumped alternatives.

Besides, whether as an excise or a levy on sins, both provide substantial government revenues. Such was the impetus in August 2004. Confronted with a fiscal crisis, Gloria Arroyo resorted to fiscal measures ranging from adjusting sin taxes by December, to the Attrition Act in January 2005, and then, the expanded value-added tax (E-VAT) law passed in May 2005.

The Attrition Act is a punitive mechanism to compel collections. Given the record so far, it doesn’t seem to have worked. This brings us to the 2004 excise-tax adjustments and the E-Vat.
Note the dates and the sequencing. Politics had so infected the 2004 measure that it necessitated a harsher E-VAT despite widespread public opposition.

What came out in 2004 was a watered-down statute caused by the removal of classifications. Brands prior to 1996 were protected, its taxes frozen while newer brands were slapped higher taxes. After a meeting among congressional leaders, Arroyo and lobbyists, the resulting excise tax structure virtually killed competition, institutionalized a duopoly, and effectively subsidized, if not encouraged, smoking cheaper cigarettes.

So much for curbing an undesirable activity.

Unfortunately, the political infection is endemic. A 2004 paper by K. Alechnowicz and Prof. Simon Chapman of the University of Sydney in Australia says the Philippines “has the strongest tobacco lobby in the region.”

Its findings are worth rekindling. Its abstract states “The Philippines has long suffered a reputation for political corruption where collusion between state and business was based on the exchange of political donations for favorable economic policies. The tobacco industry was able to limit the effectiveness of proposed anti-tobacco legislation.”

Its conclusion says “The politically laissez-faire Philippines presented tobacco companies with an environment ripe for exploitation. Against international standards of progress, the Philippines is among the world’s slowest nations to take tobacco control seriously.”

Exponentially indexing excise taxes to an inflation multiple corrects 2004’s aberration. Hopefully politicians see through the smoke they blow and legislate to snuff this obnoxious killer out. If not for the promise of increased revenues, then for the prospect of a higher quality of life and diminished socioeconomic costs.