Cielito Habito

Spend More, Talk Less

With the release of third quarter GDP figures upsetting all but the most ardent economic apologists for this administration, the time has come for it to re-think its priorities.

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The situation is nearing a critical level. As the whole of Europe is placed on credit watch and as recovery in the US struggles for momentum, the vibrancy in the domestic economy is being sucked out by government’s poor infrastructure spending rate just at a time when it is needed. Cabinet officials throughout the year have been promising a more rapid deployment, but this has so far not materialized.

The incorrigible ‘prophet of boom’ from the Ateneo Graduate School of Business Cielito Habito despite his best efforts at painting a rosy picture for the government has himself acknowledged the third quarter results to be disappointing. Here is how this professor of ‘Aquinomics’ concludes his most recent column for the Inquirer entitled, Is confidence dissipating?

(W)hat worries me most is the possible dissipation of the initial confidence surge that greeted the new administration and led to brisk private domestic investment growth over the past year. With these private domestic investment numbers now apparently slowing down while price increases have been speeding up, the President and his men on top of the economy should keep a close eye on the ball—or risk losing steam altogether (emphasis added).

That’s it—the penny has finally dropped. Only a delusional person would keep insisting that the government is headed in the right direction when it comes to managing the economy. Will this lead to a teachable moment, or will the administration remain antagonized by criticism seeing sinister plots behind them, spooked by shadows and haunted by the spectre of its immediate predecessor?

Throughout the year, the government has continued to fall back on its good poll figures to demonstrate that it has been performing to the satisfaction of the people. Poll figures however may not be a good barometer of the government’s competence in economic affairs given the ‘halo effect’ that has made the administration appear more creditable than it should.

Market analysts have already pointed out and the Bangko Sentral agrees that stimulating greater demand to address the slowdown in growth lies not in the hands of monetary authorities at this point but with fiscal managers. What this means is that the government has to spend more and talk less. Or in the words of Jerry Maguire, it has to “show me the money!

All talk, no action

The government talks profusely about the need to ramp up infrastructure spending in its Philippine Development Plan released early this year (see page 17). “An inefficient transport network and unreliable power supply”  is what has created a poor investment climate according to the Plan. Solving this meant greater spending, but when it comes to actually delivering on this, the government fell short of its rhetoric. Next year’s appropriations will hit a mere 2.5%, when the benchmark for a middle income country such as ours is 5% of GDP.

P-Noy in his first SONA said that the infrastructure build-up would be achieved through public-private partnerships, but nearly eighteen months on and counting, the fulfillment of the now diminished scope of this program remains to be seen. The confidence of the business community will eventually wear thin as Habito suggests if delays persist.

When the president addressed a meeting of the Makati Business Club, a community highly supportive of his candidacy, there was some disappointment over his over-emphasis on the case against former president Gloria Arroyo and his squabble with the Supreme Court. As these businessmen suggest, the risk is for P-Noy to get so focused on prosecuting Mrs Arroyo that he fails to keep his ‘eye on the ball’.

And it requires some doing. To ramp up spending by 2.5% of GDP will require as much concentration as he can muster. In a ten trillion peso economy, this will mean doubling the present effort of 250 billion pesos a year. This will dwarf  the growth of the CCT or conditional cash transfers which cost about thirty billion.

Because the president closed off the avenue of raising revenues through new taxes, he found himself left with no other option but to fund his development plan through private financing. That has proven tricky as well, which is why he now needs to consider a third option.

That third option which I had first written about late last year which then got echoed by no less than the BSP Governor a few months back is for the government to issue infrastructure bonds to the BSP which is at present earning negative returns on its foreign currency reserves.

Better returns

By offering the Bank a better yield, the government would be doing it a favour. Raul Fabella a former dean of the UP School of Economics has lent this proposal his seal of approval. He believes the risk from runaway inflation to be negligible under the proven monetary stewardship of the BSP.

The continued growth of foreign remittances from OFWs makes this option feasible, but if the government needed further convincing, then the following points should help build the case for it:

  1. Infrastructure spending is needed as we face a slowdown of demand from Western economies for our goods and services.
  2. It is the best vehicle for avoiding the ‘Dutch disease’ that afflicts countries experiencing windfall profits from resource booms (in our case, this stems from human not natural resources).
  3. Unlike increased social entitlement spending during a boom which becomes painful to retract at the end of the cycle, infrastructure spending leaves a tangible legacy and productivity dividend.
  4. It will help our exporters remain competitive because the increased spending will lead to a modest rise in inflation which will stem the appreciation of the peso against the greenback.
  5. It will unlock complementary investments by the private sector which is being deterred by poor public infrastructure.
  6. Government failure will be minimized as most transport and power projects can be turned over to the private sector under a PPP arrangement once completed. Revenue earned from transport and power projects would settle the interest and debt owed to the BSP.
  7. It will help prop up employment and growth which will spur increased tax collection.
  8. It will reduce the cost of doing business for most firms, not just exporters.
  9. It will help achieve the government’s growth target of 5-7% in the medium term.
  10. It will fulfill the government’s own development plan and set us on a higher growth plane.

Greater public infrastructure spending not by new taxes, nor by increased external or internal borrowing (as per Mrs Arroyo’s stimulus program in 2008/09), but by tapping our excess foreign currency reserves is not only appropriate, it would be the most effective and innovative way for this government to sustain economic growth through the turbulence in the global economy and beyond.

But we have to get real now. When faced with a possible course of action that is within the feasible set as defined by technocrats, what often prevents governments from acting is not the lack of rational arguments but the incentive problem. What led to this whole debacle in the first place was the administration’s fear of spending that would benefit internal patron-client networks left behind by its predecessor. In other words, politics rather than economics has been driving its decisions.

Making daang matuwid work

In the past we have seen how corruption and rent-seeking have reduced the amount of money available for developmental spending, but now we see how the opposite has reduced that amount even more. In the words of Samuel Huntington, “In terms of economic growth, the only thing worse than a society with a rigid overcentralized, dishonest bureaucracy is one with a rigid, overcentralized honest bureaucracy.”

The challenge for P-Noy is to make his mantra of daang matuwid work for the country rather than against it. Through the discipline and hard work of Filipinos working overseas, the country has a rather unique opportunity to make up for the shortfall in taxes generated internally. The current situation reminds me of the parable of the talents where the honest, but slothful servant dug a hole in the ground to store the talent that was entrusted to him by his master for safekeeping.

The Aquino government is like that servant. It was entrusted with a small but buoyant economy at the beginning of its term. So far, it has managed to keep it afloat, running while standing still, growing on aggregate but shrinking in real per capita terms. At the end of the story, the master reprimands the servant by saying, “To everyone who has will be given, and he will have abundance, but from him who doesn’t have, even that which he has will be taken away.”

That sound a lot like where the economy is heading under the president’s watch. The little that the Philippines had at the start could be taken away from it, while the plenty that our ASEAN neighbours have keeps on growing. It is time this government put its money where its fiscal mouth has been and start showing us the money. From another biblical parable comes the saying, “to whom much is given, much is required.” P-Noy was given a huge electoral mandate back in 2010. It is time he used it.

Of buses that kill and untrammeled markets

Just as we auction out public utilities, why not apportion bus routes to the most professional and competent bidders?

With the release last week by the LFTRB of the Top 10 Killer bus companies, a very unsavory picture of the road transport sector seems to emerge. A total of 163 accidents were tallied in the course of a year. Topping the list was NOVA Auto Transport, the same bus line that was involved in the road accident which claimed the life of UP Professor Chit Estella-Simbulan.

That particular incident highlighted the public safety risk that buses posed not just in the provincial bus routes but in the metro as well. Upon issuing three lists of top ten offenders (distinguished in terms of number of accidents, number of fatalities and accidents resulting in damage to property), the partylist group 1-UTAK cried fowl declaring that officials from the bureau could be subjected to criminal and administrative prosecution for releasing such information to the public.

After originally announcing that recidivist bus operators would have their franchises cancelled, the LTFRB was put on the back foot defending their release of such lists as not a form of “blacklisting”. Such a feeble response to the overt threats posed on it is quite typical of a government that is not autonomous from private sector interests. Such a hapless state of affairs persists in which the public regulator lacks the teeth to discipline erring providers of public transport.

It is worth retracing our steps to see how we got here.

After 1986, in an averse reaction to the monopolistic crony capitalism fostered under the Marcos dictatorship, the new regime sought to strip any visible vestiges of the former dispensation. This included privatizing the bus routes in Manila which was previously the domain of the Metro Manila Transit Corp under Imelda Marcos’s Metro Manila Commission.

The plying of bus routes was then liberalized and the importation of second hand buses was encouraged through tariff reduction or customs exemption. Echoing the policy consensus en vogue in Washington, Manila’s elite sought to introduce the “magic of the market” in areas that had been dominated by a state owned enterprise.

The role of the government was revised to simply set the rules, lower the cost of entry into the industry, stand back, and let the market rip. Even now, if one visits the LTFRB website, one will find that the cost of entering the market are quite low with a bank balance of 30,000 pesos the only capital requirement needed from a prospective franchisee.

Fast-forward to the present, with the advent of mass transit light rail systems that offer quicker, cheaper trips around the metro, there is now a glut of bus operators vying for a more limited number of bus patrons. With their fares being regulated, the only way for them to maximize profits versus their competitors plying the same route is literally to jostle on the streets of Manila for them.

Under the pre-existing policy, the goals of attaining a free and open competitive market with many small operators unable to distinguish themselves on the basis of product or price and where the customer is king has been achieved. With diminishing profitability, bus operators and their employees have increasingly taken to very risky practices to shore up their market share by snaking through our roads picking up passengers indiscriminately from any particular point on their route.

The response of the government has been to promise a rationalization of bus operators (to reduce the number of buses) through an attrition program scheduled to take effect in the medium term and to rely on stricter traffic monitoring and enforcement by the Metro Manila Development Authority to catch unlicensed and erring bus operators. Meanwhile, life threatening practices and accidents continue to happen on our roads.

Changing Course

With the benefit of hindsight, it is clear what the policy stance of the government should have been. The government should have planned and managed the issuance of licenses to ensure that operators had a reasonable let alone a sustainable level of profit expectation. Instead of leaving it to the market to determine the number of operators, the state should have studied the transport capacity of the city and acted accordingly.

One study by two engineering undergraduate students has shown that the market on EDSA is currently 75% overcapacity or over-serviced compared to the DOTC’s own computation of 60%. This would tend to imply that quite drastic cuts are needed if for every bus that is required, there is another one to two buses competing for the same set of passengers. That would tend to mean a loss for both operators who would be running on less than half their normal capacity, thus leading to slimmer margins.

If correct, the study shows that the reduction through natural attrition cannot be relied on to achieve the required number of buses in the near term. What if the better behaving operators have their franchises cancelled simply because these are due to expire earlier than the worst offenders? There is nothing rational about a natural attrition policy.

What the government should do is simultaneously revoke or cancel all licenses for the same over-supplied routes at some future date and auction them out in the same way it intends to bid out projects under the PPP program for public transport.

This implies that the government needs to intervene in the market. Instead of relying on Adam Smith’s “invisible hand” to intensify competition which creates cut-throat business practices that puts the motoring public at risk, the government needs to show its “visible boot” and kick the industry back into shape.

To do that, it needs to parcel out bus routes and auction them out to the best bidder. This will tend to favor fewer numbers and much larger bus operators resulting in an oligopoly with a credible threat of cancelling and re-auctioning routes for poorly performing ones. Small operators will need to either form consortia or cooperatives to compete with large operators in terms of scale.

Among the criteria used to approve and renew bus licenses should be the safety record of bus liners, their compliance to traffic rules, their capacity for adequate repair and maintenance and their ability to service their routes well. Technocrats should be hired to determine a reasonable auction price range for specific routes that would still allow for an acceptable return to prevent a “rigged” auction.

With monopolies over certain bus routes, the operators will no longer need to engage in dangerous driving practices. Passengers should only be allowed to board and alight from buses at designated stops. Operators would be assured of sustainable passenger volume along their routes and would find it in their interest to schedule the deployment of buses along their routes. Traffic congestion would ease, and enforcement could be made much simpler to monitor and track.

The government should also embark on a training programs to educate drivers on safe driving practices by benchmarking with other jurisdictions. With a greater assurance of profits, bus operators should be made to provide decent work hours as well as comply with occupational health and safety standards.

Transitioning arrangements

With this new arrangement in place, the question remains what to do with the remaining operators and their assets. The cancellation of their franchise would result in lost income and livelihood for them. Wouldn’t the government have to compensate them for this?

On the loss of livelihood, the damage caused the industry may not be as big as one would imagine. To achieve sufficient scale, winning bidders might need to purchase or lease buses from unsuccessful companies. Secondly, the cost of compensating the remaining bus operators could be partially offset with the revenue earned from auctioning bus routes. Thirdly, the government could require metro and provincial operators to maintain excess buses for use during peak periods during the day or peak seasons during the year. A pool of reserve buses could be established to accommodate this. The remaining assets could potentially be used for chartered services to the tourist industry.

If need be, the LTFRB should be given “legal cover” to undertake this drastic policy shift by our legislators. It should be allowed to invoke “public safety” as a criterion for re-structuring the industry. It also needs to be granted the authority to auction out routes under the PPP arrangement found in other mass transit systems.

On the way to market

The chaos on our streets is emblematic of the state’s governance in our country as a whole. The ideology of the free market was adopted as a way to expand service at a time when the public sector was strapped for cash. On our way to achieving that ideal state of open market competition, we allowed the industry to become unwieldy. No forward planning was conducted when the mass rail transit system was constructed to determine whether bus routes would continue to be viable. As a result, the untrammeled market created perverse incentives for operators to put the public’s safety at risk with the burden of monitoring and enforcing traffic safety placed on toothless regulators.

After a period of stepping back and letting markets rip, it is now time for the public sector to govern the market to bring it back to a sustainable level. In a similar fashion, the government needs to identify strategic sectors in the economy that could do with similar industry structural adjustments and develop a plan for deepening and broadening their scope of activity.

It is quite ironic that the economic planner who coined the phrase “narrow, shallow and hollow” as a way to describe the Philippines and its industrial base was the same person at the proverbial wheel when tariffs were being indiscriminately lowered ahead of external commitments under WTO. “Asleep at the wheel” is probably the phrase we can use to describe this strategy.

Like our streets, untrammeled markets could simply foster cut-throat competition or lead to investments in unproductive sectors of the economy and impede investments in more productive ones. This could literally spell life or death for those that rely on them for a living.

How long is a piece of string?

What yardstick are we using to measure P-Noy’s performance?

The arbitrary, rule of thumb of the first year in office is about to come and go for this administration. The obligatory journalistic pieces assessing the president’s performance have consulted the usual suspects.

Political analysts, polling firms and pundits, the business community and the average man on the street express varying degrees of satisfaction, from impatience on the part of Conrad de Quiros for instance, to a more sanguine position on the part of Mon Casiple. Regardless of their positions, they are essentially in agreement that while one year is too brief a period to expect major change, some demonstrably concrete level of progress or achievement is lacking in the president’s first 365 days in office.

As expected the president’s men were engaged in a charm offensive to address these complaints with Undersecretary Manolo Quezon of the Communications Group appearing on ANC, Deputy Spokesperson Abigail Valte on Twitter, and Budget Secretary Butch Abad polemically addressing the issue of economic management. The to-ing and fro-ing has been at times entertaining as in the case of the Valte-Magsaysay twitterverse exchanges and insightful as in the case of Quezon’s revelations about the president’s love life.

The advocates of the president (both in and out of government) say that much has been accomplished. The emphasis on government frugality and public spending restraint has created domestic private investor confidence and a credit ratings dividend according to Cielito Habito. Plugging the leaks in infrastructure spending has generated fiscal space to expand social spending by the end of the year according to Abad. Public private partnerships are “on track” to be consummated this year according to Finance officials.

That in essence is the shortlist of accomplishments brandished by Malacanang. Judging by his poll numbers, the public seems to give P-Noy the nod of approval with 64% expressing satisfaction with his performance.

Is that it, then? Should we give the president a pass too?

Unfortunately, what is missing is a solid discussion over, well…what sort of yardstick is appropriate for measuring the president’s performance. For instance,

• Shall we judge him on what he said he will do?

Based on the president’s anti-Gloria campaign theme, De Quiros now questions why the former president and her ilk have not been brought before any court to answer for her alleged transgressions. Based on his anti-corruption platform, the Management Association of the Philippines now asks why there have been no measures like the Freedom of Information bill or any meaningful reductions in business redtape progressed.

Civil rights advocates wonder what has happened to Jonas Burgos and many other like him. Women’s groups are still waiting for the RH Bill to be passed. Farmers are wondering what happened to the resolution of Hacienda Luisita. The ordinary man on the street wonders where the jobs are and the relief from the rising cost of living. These were issues PNoy promised to resolve once in office.

• On the other hand, should we judge him based on his ability to prudently modify or alter what he said he would do?

Those with a nationalist agenda like Teddy Casino say P-Noy is delivering more of the same as far as economic policy goes, and hopes he will re-think his developmental economic strategy. The anxiety felt by Casino and others like him (Walden Bello for instance) is that the quality of growth is poor and insufficient to make a dent on unemployment.

Budget analyst Ben Diokno is looking for a two-step tax reform process that will make the system fairer and more effective at raising revenues. Both of these policy prescriptions run counter to the “steady as she goes” pronouncements that PNoy made during the election season.

Measuring up

The answer to the question, what yardstick do we use, depends on whether you are a strict contractualist or not. Some will say, we should evaluate the president plainly on what he said he would do, and nothing more. For me, however, I believe that given the tenor of the campaign, there were promises that were bound to be made in the spur of the moment, which need to be reconsidered.

The problem for the president of course is, whether you adhere to the strict contractual sense or not, he has failed to register meaningful progress on many fronts. So the question then becomes, how much time should we give him before we start downgrading his performance assessment? How long before we start saying that the president has either reneged or foolishly forged ahead down a dead end path?

Should we give him another six months? A full year? Two years? It’s like asking the question, how long is a piece of string?

After all, for the marginalized groups awaiting resolution to decade’s old injustices, their well-being has been put on hold for far too long. The well-healed chattering classes may feel aggrieved that bringing justice to Arroyo has been delayed, but their grief is nothing compared to what farmers and human rights abuse victims have suffered.

Similarly for those denied access to education, healthcare, sanitation and protection from the elements, the experiment to improve tax collection without a root and branch reform process would prove to be the most costly of all, if it fails. Is it therefore worth the gamble?

Perhaps, it is in addressing the needs of the least of our brethren that the president ought to be judged. In his “Back to the Future” moment, the president like his mother in the mid-1980s seemed to have prioritized the needs of rich creditors and bondholders over that of poor and marginalized stakeholders. Private investments have improved the skyline, but public investment failed to raise more out of the poverty line.

How long is a piece of string? Well we will have to wait and see…

Back to the Future with Aquinomics 101

Perhaps PNoy should trade his Porsche for a Delorean.

In his self-appointed role as guru of the new Aquinomics, Prof Cielito Habito of the Ateneo Graduate School of Business alluded to the Reaganomics of the 1980s which preached that less government and lower taxes would promote growth through private investments.

Habito builds the case for an “economics of business confidence” where he points to the revival of private domestic investment which more than offset the drop in public and foreign direct investments during the first three quarters of the PNoy presidency. The hidden messaeg in all this is that when government gets out of the way, private investment soars.

He defends the underspending by the government in its first year by calling it the “economics of fiscal responsibility”. Here is how he explains it:

Some observers now fault the new administration for “underspending,” for indeed, not only has it spent less than it did last year, it has also spent even farther less than what had been programmed to be spent by this time. But before casting this government as inept and lacking absorptive capacity, one must remember that this year’s budget was still drawn up by the previous administration [emphasis added-ES]. And if the current government has been more prudent about spending the money, it could well be because they have found that they don’t have to spend as much as the former government would have, to accomplish as much.

And it seems they have. The Department of Public Works and Highways is one of the biggest “culprits” in the underspending. It turns out that the agency has made dramatic changes in the way public works projects are costed out, leading to substantial savings. For one thing, Public Works Secretary Rogelio Singson has significantly reduced allowable “indirect costs,” including contractors’ profit margins (and quite likely the so-called “bukol”), in public works projects. Coupled with a strict policy on transparent public bidding, the agency boasts of more than P2 billion in savings from 2,797 projects over the past year.

It seems quite astounding that Habito could claim that this year’s budget was drawn up by the previous administration. It beggars belief given that the president’s men spent the first six months engaged in a zero based budgeting process to weed out undesirable projects left behind by Mrs Arroyo.

While his explanation for the delays in DPWH disbursements remains plausible, it does not explain the delays in all the other departments. It would also appear dubious or incomplete when stacked against the DBM findings that delays in DPWH were due to re-alignments requested by regional offices.

But the more disturbing problem is that Habito conveniently disregards the evidence regarding spare capacity in the economy for capital spending. At a time when unemployment is rising, he has the audacity to suggest that it was a good thing for government to put its foot of the accelerator.

Habito like most of our economists seems to be taking his cue from the West where austerity measures seems to be taking hold as deficit hawks seem to gain ascendancy in the debate in both Europe and America.

Nobel Laureate Prof Paul Krugman who argued for a much larger stimulus under Obama back in 2009 and has been proven right by recent events with the stalling US recovery notes how the “Triumph of Bad Ideas” (referring to Reaganomics) has taken place. He is not alone in this, another Nobel winning economist Joe Stiglitz backs him up.

The same sort of triumph seems to be taking place in Aquinomics with the Palace announcing it has no plans to introduce any new tax measures in 2012 despite its intentions to increase spending to 1.8 trillion pesos from the current 1.6. The hubris of this plan is that they believe efforts to improve collection will work wonders in their second year when it clearly has not happened in the first.

Despite Prof Winnie Monsod’s calls for higher tobacco taxes and Prof Ben Diokno’s proposal for fiscal adjustment plan, Malacanang seems to be confident in its Aquino doctrine that “no new taxes” are needed. This makes the fulfillment of its 2012 expenditure program a pipe dream, just as the 2011 one led to “trickle down” economics with social expenditures actually dipping while military and police spending increased.

We need to recall that it was the result of tax reforms adopted under Cory Aquino for whom Monsod and Diokno are proxies that revenues from taxes as a share of the economy went up, and those under Fidel Ramos for whom Habito is a proxy that they gradually got eroded. The problem however is that in the battle of ideas, it seems the argument of Habito trumps that of Diokno and Monsod.

That Vision thing

What the president needs is a roadmap that focuses on the big picture and provides substance beyond the spin, something which is sorely lacking at the moment.

For a president whose meteoric rise on the back of wall-to-wall coverage and fawning over by the media delivered him instant rock star political status during the campaign, the complaint that the media has now turned from doting parent to vengeful god, is rather questionable.

For the first time in our political history, a triumvirate (someone called it a three-headed beast) weaves and spins the yarn concerning the goings on in the palace. If three heads are better than one, then why should the Benign One not be receiving more favorable coverage from the echo chamber? The problem has got nothing to do with the messaging and all to do with the message itself.

Without vision, people perish,” so the biblical proverb goes. Every occupant of the Palace knows that after a while, the daily grind of official duties prevents him or her from thinking about the broad frame. It is easy to get lost in the day-to-day political tussle to get on top of the 24 hour news cycle. The most precious commodity for any leader is time to think and reflect. They say, the minute that goes, you’re basically a goner.

So it seems now with the Benevolent One, in his first year, his communications group has successfully come up with a plethora of platitudes that are an instant hit with the public. Kung walang kurap…, Daang matuwid, Bawal ang wang-wang: these make for good slogans and rallying cries. The problem is that the administration lacks a coherent roadmap that would convert these into the kinds of meaningful results that people have been craving.

Approaching the first full year in office, three alarm signals are flashing. They point to a lack of crispness in the strategic frame hampering this presidency. These signals involve a mix-mash of mental models to guide the broad philosophy of governance that defines the role of the state; personality-driven factionalism that breeds organizational dysfunction, and an absence of credible commitment to deliver on its promises. Together, these signals flag the need for Palace insiders to re-group and re-think their strategic priorities.

Outmoded mental models

When the president made his “no new taxes” pledge before the Makati Business Club forum during the 2010 election campaign, he was evoking a theme often presented during the 1980s and 90s by the Washington elite that espoused a limited role for government or the “magic of the Market” as a formula for development. This meant that the best state was a reduced one. Economic development could proceed if countries followed the mantra to “stabilize, liberalize, privatize.”

This dovetailed neatly with the post-EDSA-I contempt for anything to do with the state apparatus and crony capitalism fostered under the deposed dictator. The Aquino-I regime promised to honor all loan contracts entered into by the Philippine government regardless of whether they were tainted with corruption as a way to maintain its creditworthiness. To make room for debt repayments, it practiced fiscal austerity and reduced the state’s role in performing many of its social obligations.

In the breach, the (big M) Market would step in to provide public infrastructure and jobs that would reduce social dislocation. This was the underlying philosophy that prevailed at that time. To complement this strategy and to make good on its promises to meet its financial obligations, a comprehensive adjustment to the tax system was implemented in 1986.

This re-structure according to one of its chief architects allowed the tax-to-GDP ratio to steadily climb, so that by the early 90s, when Aquino-I stepped down, the fiscal situation was on a sound fiscal footing. The administration that succeeded it sought to bring about the full blooming of the Washington world view on local soil by accelerating trade liberalization and expanding fiscal incentives to foreign investors.

The early success in the 1990s of this formula eventually bred euphoric overconfidence. After reaching a high-water mark in the mid-90s of 19% (high for a developing economy with a limited tax base), the tax-to-GDP ratio began a steady decline as a result of the comprehensive tax reform package of 1997. Meanwhile the Asian Financial Crisis intervened and began challenging the mental frame of the policy elite.

From 1998 onwards, a new post-consensus consensus was being formed. Market liberalization was necessary but insufficient, it declared. State capacity had to be built up to ensure that the right institutions would govern market transactions to prevent “exuberance” of the kind that led to market crashes. It also had to provide social safety nets to protect those adversely affected by market reforms and business cycles.

This became evident to the Philippine elite, whose business interests escaped relatively unscathed from the Asian flu, but saw them subsequently threatened by a number of anomalies involving the Securities and Exchange Commission and the Office of the President which nearly short circuited the banking system and local bourse. Meanwhile the costs of a war in the south began to hurt the bottom-line and a fiscal crisis loomed.

Corrective measures had to be put in place to raise personal and corporate income tax rates (temporarily) at a time when other nations in the region were cutting theirs. Meanwhile, the government was treating its sin taxes (which had switched from being a fixed percentage to a fixed level not indexed to inflation in 1997) as a sacred cow and began enacting numerous and redundant fiscal incentives and tax rebates that caused revenues that resulted from an increase to the consumption tax rate to erode.

The conservative Heritage Foundation which ranks countries based on their ability to provide economic freedom often gives a more favorable score to less developed nations in the area of fiscal freedom given their low level of tax collection as a share of the economy. The Philippines over the past decade having a low tax-to-GDP ratio would have fared better under  the Foundation’s scoring method but for its “relatively high” income tax rates.

The simultaneous presence of high income tax rates and low tax collections could only mean that either the tax base is too narrow, in which case the solution would be to flatten the rates and widen the base, or that many tax leaks exist and dishonesty in declaring income abound, in which case a closing of those loopholes and going after tax cheats is needed.

Enter the Aquino-II regime which re-branded the privatization model adopted under Aquino-I while expanding the state’s role to deal with a growing social agenda. Unfortunately, it failed to see that this expanded role required a shift in the tax structure. The “no new taxes” pledge was based on the idea that renewing the public’s trust in government would lead to better tax compliance–a view that is increasingly seen as untenable.

Even with a highly competent, honest and dedicated finance team going after tax cheats, the tax take as a share of GDP has fallen. Perhaps the notion that public trust in government engendering proper tax declarations is going to suffer the same fate as the idea that economic growth naturally lowering the incidence of poverty. The Philippines seems to be the graveyard of many grand theories on development.

Missed opportunity

Having declared during the campaign that there would be no new taxes has meant that any reasonable time table for tax reform would be at least until after the 2013 mid-term elections. That in turn would mean that any structural adjustment involving taxes (raising it from the current 13% back to about 19%) would only bear fruit during the latter two years of this presidency and that many of the Millenium Development Goals will be missed.

Having staked all his eggs in the Daang Matuwid basket, the president now is facing the distinct possibility of failing to deliver on much of his social compact: the result of relying too blindly on an unproven theory that makes for a good sound byte, but lacks a grand vision.

Even with the capitulation of the ombudsman opening up the prospect of jail time for the Inglorious One and her henchmen, the sad fact of the matter is that even if that were to occur, it would not help improve the finances of the government substantially nor bridge the yawning social divide that exists.

Before the president gets locked-in to a kind of group-think paralysis that eventually occurs when one hops on the treadmill of public office, he needs to find a way to re-assess the situation and come up with a strategy that will act as a game changer before it is too late. Key to this would be discarding some of the mental models that act as blinkers and prevent him from seizing opportunities for change.

>>> to be continued…(see part 2: Curing dysfunctionalism)

So much for public trust

It appears that when it comes to tax revenue, it is better to be feared than loved.

Improved faith in government was meant to improve the public’s willingness to pay the correct amount of taxes. That doesn’t seem to have happened.

The analysis of an economist on the tax collection effort of the Aquino administration over its first 10 months in office seems to have yielded a key finding: that relying on anti-corruption efforts to raise tax revenue was naive and illusory. Indeed the analysis showed that while tax revenues grew in response to an expanding economy, it fell as a proportion of it. In fact, despite the highly publicized legal cases of alleged tax cheats hitting the headlines during the period, the tax to GDP ratio actually declined in the second half of the year (the period under the present administration).

So it seems despite the astronomically high public approval rating enjoyed by the Benevolent One during most of this period, the public was not willing to pay his government its due. In fact, they were even more willing to pay a greater percentage of their income to the most distrusted administration since records of public trust were kept. As this reality began to dawn on the hapless economic managers of the current president, they announced that new taxes may be on the horizon.

True: the most benevolent one may have uttered the words, “no new taxes” during a campaign speech, but that was based apparently on the myth that an honest government would inspire reciprocal honesty from its citizenry in paying their taxes correctly. Having not lived up to their end of the bargain, the eunuchs in the Palace have found reason to renege on that campaign pledge made to the public. But not yet, at least not in this year. Perhaps in the next, 2012, a year before people go to the polls.

Such a timetable would appear to be political suicide for any congressman or senator up for re-election, but not for the politically tone deaf players in the Palace. It would seem strange for them to enunciate such a plan a year in advance. Is this their way of signalling to the public and the tax agents that this is their last chance to hold up their end of the deal? Well so it would seem. But what if the public calls their bluff?

This government doesn’t seem to be good at playing ‘the game’. It blinked in the run up to the LEDAC with the withdrawal of the RH Bill when the prelate began making noise. It could blink in the lead-up to the 2013 election campaign. It is a well-known fact that an election year is the worst time to conduct tax policy. The likelihood that perverse outcomes result is very high. It was back in 1997 when the government had finally posted a net surplus for the third year in a row that a major tax overhaul was churned through Congress. The result was a gradual erosion of revenues that have led to the current predicament: all because 1997 was a pre-election year.

What is worse is that the eunuchs announced that they intend to target the tobacco and liquor industries. Such hubris! The pockets of these merchants are deep. So deep they have resisted attempts, most recently in 2005 when economic and fiscal conditions were most bleak, to have taxes raised on them. The palace seems unwilling to go for the big ticket items like raising the VAT rate or taking out many of the exemptions introduced back in 1997.

Such a move would be truly unpopular given the rising food and energy prices of late, but it may be inevitable if the administration ever intends to make good on its other campaign pledges (it would cost roughly Php350 billion a year to close the budget gap and another Php150 billion to meet its Millennium Development Goal targets). Doing so would raise the tax to GDP ratio to around 18.5%, back to the same level it had reached in the mid-90s.

Perhaps for these economic managers, the most sensible thing they could do would be to delay new tax measures until after the mid-term elections of 2013. Having gained a fresh mandate, congress could then approach the tax system with greater freedom and flexibility. The important thing would be to prepare the tax proposals in the interim and connect them to the president’s social reform agenda.

That way, they could go to the election with the question, what kind of Philippines do we want? One that is fairer and more equitable, or one that is not. If we desire the former, then here is the price tag. Having exhausted all attempts to raise revenues, they could be warranted in posing that choice. In the final analysis, we should not just demand for the kind of government we want, we have to be willing to pay for it as well.

Update: the original piece incorrectly made mention of the mid-term elections being held in 2012 instead of 2013 which is what the current version contains.

The joke is on us!

The Supreme Court ruling favoring former Marcos crony Eduardo “Danding” Cojuangco, Jr. demonstrates that kleptocracy is alive and well in the country.

As economist Cielito Habito will tell you, coconut farmers not rice farmers constitute the poorest of the poor in the Philippines. They also account for a larger bulk of the farming sector (whether you account for this on the basis of land area cultivated or number of individuals engaged in it). Improving their lot in life therefore should be on top of any poverty alleviation agenda.

Under Martial Law between 1972 and 1982, coconut farmers were burdened with a levy that was meant to be used for upgrading common facilities and infrastructure that would ultimately benefit the sector. The man in charge of what essentially could be regarded a monopoly was businessman Danding Cojuangco, an estranged cousin of the jailed opposition leader’s Benigno Aquino, Jr’s wife (mother of the current president who incidentally reconciled with his uncle prior to his election).

What did Mr Cojuangco do with the immense powers and resources entrusted to him? Well, he claims to have “borrowed” the funds from the United Coconut Planters Bank, an entity bought using the coco levy funds, to purchase a 20% stake in San Miguel Corporation, one of the biggest conglomerates in the country. So rather than going to the poorest of the poor, the funds were allocated to benefit the corporate and financial ambitions of the man whose responsibility it was to look out for their welfare.

Did he violate his duties not just as a public official in charge of the stewardship of their funds but as a corporate officer of the bank from where he had sourced his “loan”? The Supreme Court in a split decision seems to believe that he didn’t. This is despite the financial regulations that we have regarding banks lending a substantial amount of their funds to directors, officers, stakeholders and related interests.

Under normal circumstances, such an inequitable and imprudent decision by a public and corporate official would not have been condoned. Such a blatant disregard for the interests of those whose toil produced the resources would have only been possible under a dictatorship. It is that action that the Supreme Court has legitimized with its ruling.

Although the decision is still subject to a possible motion for reconsideration, if it were to stand, it would probably be one of the biggest transfers of wealth from the poorest and lowliest members of society to one of the wealthiest. It would be proof positive that kleptocracy is alive and well in a nation that has produced two among the top ten most corrupt leaders in modern history.

As Senior Associate Justice Conchita Carpio-Morales (who administered the oath of office to the current president) states in her dissenting opinion,

The argument that Cojuangco was not a subordinate or close associate of the Marcoses is the biggest joke to hit the century.

If that is so, then the joke is well and truly on us!

Principle or politics?

The policy elite continue to give President Aquino the benefit of the doubt as a stream of bad news regarding the state of the nation hit the headlines in the last couple of weeks.

A series of indicators seemed to point to the deteriorating state of governance in the country. Despite all this, expert commentators continue to give consideration to what they see as the genuine desire of the president to steer the ship of state safely through the rough seas. In the space of a few weeks, a number of surveys uncovered a not too rosy picture of the country. In quick succession the following came up:

To the policy elites, these reports would certainly be disconcerting as the consensus has formed that the actions taken by the Palace have allowed the country to turn a corner. Take for instance the PERC survey. Ateneo economist Cielito Habito asks whether corruption is really worse, stating that the sentiment of domestic investors who possess more complete information regarding the state of affairs in the country counts more than the views of foreign players. Domestic investments have surged under the new administration. He provides a plausible reason for the worsening perception of foreign investors identifying the senate hearings on corruption in the military in the first quarter which may have tarnished the entire government’s overall reputation in the eyes of these executives.

On the fall of the president’s trust ratings, UP economist Solita Monsod countered over the weekend that a number of appointments bode well for the president’s agenda on good governance. These good appointments may be just a fluke as the underlying current that runs through them may be factional infighting among his political supporters, but never mind, she says, as a win is a win.

On the rise of hunger, sociologist Randy David poses one possibility (remote though it seems) that the self-reporting on hunger may have gone up as many of those surveyed mistook the SWS interviewers for public social workers who were reportedly screening households for the conditional cash transfers program that would entitle them to receive monthly allowances. As for the fall in consumer confidence, this was attributed to external factors stemming from the uprising in the Middle East and North Africa affecting prospects of foreign nationals working in the area.

Just a few months back, the president was claiming credit for the decline in poverty incidence saying that his reforms had already borne fruit. Never mind that what was being reported was the effect of reforms instituted by the previous administration.

Now it seems in a bid to counter the negative news, the president has been going out on the offensive running after the people close to his immediate predecessor. The impeachment of Ombudsman Merci Gutierrez has occupied much of the news of late. Her trial in the senate will no doubt hug the headlines in the weeks to come. Never mind that her term is expected to expire anyway.

When the proceeds of the sale of the confiscated property of Lt Gen Ligot was handed over to the government, the palace was quick to claim it as an endorsement of the integrity of the president. Never mind that this was the result of the actions of the lady whom they had just impeached in Congress through their party mates.

The tax fraud case filed against former presidential son Rep Mikey Arroyo is currently capturing media attention with continuing revelations of properties he is alleged to have left out in his tax declarations. While palace officials were quick to deny this move was a form of political harassment, Conrado de Quiros who many regard as a surrogate mouthpiece for the administration provided a reality check by claiming that the former presidential son was indeed targeted for this kind of treatment.

While these sorts of exposes and trials make for good political theater, allowing the administration to score political points, they do come at a cost. The cost is that the legislative agenda of the government will come to a standstill during the impeachment trial. Also there is a tendency to give the rulers a free pass on the more crucial bits of governance that go unnoticed.

Take the rise of poverty (by the proxy measure of hunger) for instance. This could have been a result of the phaseout of the grains program run by the National Food Authority. None of the policy elites want to acknowledge this because they are almost ideologically opposed to it. Yet this would explain why poverty rose in Luzon while it declined slightly in the rest of the country where the conditional cash transfers were mostly targeted.

As food inflation rises resulting from global production shortfalls exacerbated by the price of oil and transport, the timing could not be worse for the government which has withdrawn its support for the grains importation program. It is reported today that a possible rice shortage may be in the offing over the coming months.

At some point, the tendency to blame the administration immediately preceding it will become old hat. The current rulers will have to take ownership for the current state of affairs. While the policy elite might continue to give this president the benefit of the doubt, some time in the future there will be a reckoning. If the negative indicators continue to point down, that moment might come sooner than expected.

A sense of drift

A series of events seems to have blunted the reform agenda that PNoy promised and sought to deliver in his first months in office.

According to the Asia Sentinel, the Supreme Court dominated as it is by appointees of his predecessor Mrs Gloria Arroyo, seems to be conducting an effective rear guard action thwarting any attempt by PNoy’s administration to invalidate the appointments she made in the dying days of her term. Marites Vitug is quoted as saying

The Arroyo court is going to be an obstacle to Aquino’s anti-corruption program. The Arroyo allies’ strategy is to legally assault Aquino through the Supreme Court, which she still controls. This is baffling to me – because the political winds have changed. But now it looks like the ties that bind her appointees to her are deep. The court may strike down the Truth Commission, uphold GMA’s midnight appointees, and stop the Ombudsman’s impeachment.

Beset by factions within his government and lacking a coherent strategy to map out the steps needed to navigate through the minefield laid by Mrs Arroyo and her allies, Ms Vitug claims that what PNoy needs is a counterpart to Jose Almonte, the chief ideologue and behind the scenes operator of the Ramos presidency.

Cielito Habito chimed in through his regular column for the Philippine Daily Inquirer. He waxes nostalgic for the days when a meritocratic governance style was wielded that required cabinet to close ranks behind a consensus driven process and implement decisions through intergovernmental coordination: this as a kind of back-handed compliment to Malacanang’s current occupant whom he claims could “learn a thing or two” from the example of his former boss.

The lack of standards in handling the diplomatic faux pas committed by an assistant secretary and speech writer Carmen Mislang via twitterverse at his first official state visit to Vietnam is a continuation of the leniency demonstrated in the wake of the Luneta hostage drama. This is in contrast to the ongoing vacillation over the status of interior and local government Sec Jesse Robredo in his cabinet. Solita Monsod wrote a piece over the weekend appealing to PNoy to consider the merits of keeping him in his confidence given his sterling accomplishments in the area of governance reform.

These criticisms seem to cement the notion that PNoy’s presidency is adrift in a sea of division and chaos. It appears that although Mr Aquino’s personal integrity and character make him unwilling to countenance dishonesty; by the same token, it makes him more tolerant towards incompetence when it is committed by his trusted aides.

During the 2010 campaign, many criticisms were hurled at then candidate Aquino. One of these was his lack of executive experience and leadership qualities. I in fact argued back then that his ability to attract competent and reform-minded advisers to his side allowed him to narrow these competency gaps. It now appears that PNoy’s easy-going style seems to be ill-served by a mixed bag of competent AND trusted but inexperienced and naive appointees.  The latter may have the ascendancy as they often do when the leader remains unclear or ambiguous with his directives since they can always claim to have personal insight into the inner workings of his mind.

That is the crux of the problem moving forward. PNoy needs to consider either making adjustments to his team by allowing for greater meritocracy even if that means working with people that might rub him the wrong way, or making adjustments to his leadership style by being clearer about what he wants delivered to him and the consequences for failure leaving very little wiggle room on the part of his subalterns who claim to “know what the boss wants”.

So, dear reader, as always I leave it to you to assess the merits of this argument. What in your opinion would be the best way forward?