currency wars

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.

image from wallpapers-diq.net

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.

They’re Baaaaaaack!

The APEC summit in Hawaii (photo courtesy of UPI.com)

In uncharacteristically blunt language, US President Obama as host of the APEC summit in Hawaii called on China to act like a “grown up” saying “enough is enough” and that it was time for the People’s Republic to “operate by the same rules that everybody operates” threatening dire consequences unless the yuan appreciates by 20-25%.

The US has been pressing China to allow its currency the yuan to appreciate more quickly to make American products more affordable to Chinese residents and similarly make Chinese exports less attractive to US based consumers. President Hu’s pragmatic response–allow imports to rise without necessarily liberalizing the currency exchange regime–is typical of the Middle Kingdom.

Unlike America’s faith in free markets, China would rather deliberately get prices wrong if it would allow it to maintain a healthy trade surplus with the US. This after all was the same path to development that the US took when it was still in its “catch-up” phase with Western Europe.

Yet America, with its penchant for universal principles (“we hold these truths to be self-evident”) is now in the game of preaching free trade, open markets and property rights in the Far East just as it preached democracy in the Middle East. China is instinctually groping for a particularistic response. Although sounding undiplomatic, I like Pres Obama’s rhetoric because it gave away an important concession in the development debate.

“Gaming the system” or the notion of applying the tools of industrial policy to generate a competitive advantage for nascent industries in global trade as a legitimate means to catch-up with more advanced economies while a country is still relatively underdeveloped has been acknowledged. In the local vernacular, “saling pusa” which refers to little children allowed to participate in a game without having the same rules applied to them would be the way America views the Chinese.

For those who believe that lowering trade barriers helps promote growth, the following graph taken from Dani Rodrik’s paper to the UN should help dispel that notion. It shows a positive albeit insignificant correlation between tariff levels and economic growth. At best, no correlation can be inferred between lowering barriers to trade and growth, which is why the Philippines despite having very low tariffs relative to its ASEAN neighbors, has not been growing strongly. As I mentioned in my last piece, higher barriers to entry actually have been found to induce domestic innovation that in turn leads to new exports.

Source: Dani Rodrik (2001), The Global Governance of Trade--As If Development Really Mattered: A UNDP Background Paper

This should help comfort those distressed by that CNBC press release that the Philippines is the worst place for doing business in Asia. It should also be noted that in their top ten worst places, India and Indonesia were included. If these are the sorts of countries that we are in league with, then we really should not be too bothered.

Despite that dubious title, one should actually pay attention to the fact that the CNBC pronouncement was based on the World Bank’s Doing Business Report. Many of the measures in this report simply do not apply to businesses within the special economic zones which is more relevant to foreign investors. Furthermore, petty corruption actually allows many of the so-called barriers for entry to be removed.

The main roadblock to foreign direct investments is actually the desire of business to operate with the same protection of contracts and property rights wherever they are along with low costs to entry without the necessary tax burden and industrial labor costs that are needed to foster this. On the other hand, ordinary citizens that politicians seeking re-election (as in the case of Obama) try to please don’t want unfair competition for their labor from less developed countries which try to create a system of arbitrage to attract foreign investors.

It isn’t that investors want a level playing field. Consumers by and large don’t really mind whether a producer competes fairly for a slice of their hip pocket. That means for a country seeking to attract foreign investors increasingly ceding a lot of its national policy-making abilities to Western bodies and institutions to gain access to its markets. Hence the rhetoric of Obama who is trying to create a narrative that would pit the economies in the region against China.

Having ceded the scene for the better part of a decade to Beijing which has forged a free trade deal with ASEAN (CAFTA, the China-ASEAN Free Trade Area), Washington is trying to regain the initiative with its Trans-Pacific Partnership agreement that boasts the commitment of nine APEC countries and counting. China has objected to not being invited to join the agreement. This is clearly a bid by the US to isolate it and strengthen its economic clout in the region.

This week, as he travels en route to the East Asia summit in Bali, Indonesia, the US president is scheduled to make a stopover in Canberra to address the Australian parliament and sign a deal that would increase US troop presence in a base located near Darwin. The two nations have already beefed up the ANZUS mutual defense treaty by allowing allies to invoke it in the case of cyber attacks just as it was used in justifying Australian participation in the US war against terror.

This posturing is clearly aimed at containing Chinese ambitions in the region. America is trying to prevent Australia and its other allies (Japan, Korea, Thailand, and the Philippines) from following in the footsteps of Germany which has been compromised as a NATO ally due to its economy’s dependence on exports to China. Australia sees the need to boost its military capability to help counter the military build-up of China while relying on iron ore exports to China for sustaining health in its economy. Other countries in the region notably Vietnam and the Philippines will seek protection under the US security umbrella given tensions with China over the Spratlys.

PM Julia Gillard earlier this year commissioned her own white paper that would create a strategic road map for Australia in the “Asian century.” Upon her return to Australia, she announced a new position on uranium exports to India, the other emerging power in the region. This back-flip on her party’s existing position to maintain a ban until India signs the Nuclear Non-Proliferation Treaty occurred after a meeting with President Obama .

Meanwhile State secretary Hilary Clinton is set to travel through Bangkok and Manila en route to Bali. She will no doubt seek to emphasize the theme that America is back in business in the region. P-Noy has been keen to float his own ideas about a solution to the Spratlys among allies, but membership in the TPP is very much in doubt as certain hurdles including constitutional restrictions on foreign ownership and weak protection of intellectual property rights prevent the Philippines from being admitted.

This means that the Philippines will engage in free trade with China via CAFTA, while having a military alliance with the US. This is probably the best possible outcome–a good way to counter-balance each competing force on either side of the Pacific. Australian PM Julia Gillard put it best when she said this week,

It is well and truly possible for us in this growing region of the world to have an ally in the US and to have deep friendships in our region including with China.

But for how long this formula will work only time will tell.

A Boy Scout Among Thieves

On the eve of the G20 meeting in South Korea, the Philippines through Finance Sec Cesar V Purisima voiced its aspirations for the outcome of talks to deal with the US-China disagreements over currency manipulation aimed at correcting stark trade imbalances.

On Monday’s issue of the Businessworld, he was quoted as saying that he hoped for

A framework… where there will be closer cooperation among countries in settling imbalances.

Such expressions of hope by our finance officials demonstrate not only their optimism that world leaders will put into practice their joint promises at such talk shops (when in reality they don’t-as demonstrated by the Global Trade Alert‘s findings about the increasing levels of trade protection committed by the same G20 members in violation of their first Communicade), but also the fact that they remain wedded to the development model preached by the Washington Consensus to the rest of the world regarding the reliance on free market principles that avoid government intervention in setting the prices of commodities and currencies.

The US Federal Reserve announced previously that it would exercise quantitative easing (QE) which in effect means it will print money to purchase US treasury bonds underwriting the deficits undertaken by the Obama administration. This has caused a weakening of the US dollar against other currencies which is expected to narrow their trade deficit with China.

This manipulation of the currency to “correct” trade imbalances is something that has been restricted by the WTO except that China seems to have gotten away with purposefully undervaluing its currency even after acceding to the terms of this world body. Decades earlier Japan did the same and benefited from it during its era of fast-paced growth. The US has been constantly at China for this but appears to have no qualms over effectively engaging in such behavior when it suits its interests. In the real politic of the global trading system, a nation can flout the rules for as long as it carries sufficient weight in political economic terms.

So it would seem that the Philippines remains stuck in the role of the perennial “boy scout” among nations that adheres to the rulebook while others blatantly invent their own rules. Because of the rise in the value of the peso against the US dollar, not only are exports expected to suffer, but so will the flow of imports (as much of the raw materials that go into producing these exports comes from overseas).

The Bureau of Customs which through the years has had to deal with a program of accelerated tariff reduction unilaterally set by the Philippine government ahead of international commitments will also have to deal with the rising peso in meeting its revenue targets. This along with all the perks needlessly offered to free ports and special economic zones will ensure that our budget targets will not be met.

A more proactive stance needed

In this space, I previously argued that the Philippines needs to take a more proactive stance vis-a-vis the currency wars to ensure the sustainability of its exporting industries and to guarantee the welfare of those dependent on income transfers from abroad. If we wait for a framework to be hammered out by the G20 which after all is just a loose, informal organization, then we could be waiting for a very long time indeed.

In fairness to our finance officials, they have proposed the Public Private Partnerships or PPPs as a way of generating investments in infrastructure which should lead to capital equipment and raw material imports as a means to generate demand for dollars domestically. Certainly that will help. But on the other hand, the Philippines is also issuing locally denominated bonds overseas which in effect increases the flow of dollars into the country and causes the value of the peso to rise. So it seems it is taking with the one hand while promising to give with the other.

Given that we already have the reserves to fund at least the public portion of the PPPs, I argued for a sovereign wealth fund that would along with private investments identify projects it would invest in. This could be a way of putting the dollar inflows to good use and avoid inflating our borrowings from overseas which simply help inflate the value of our currency.

Having exited the IMF program of macroeconomic stabilization after paying off its institutional loans, it is time for the Philippines to exercise some independence in setting its policies given the amount of “space” afforded by its advancing foreign reserves position. It is time we start shaping these policies by taking cognizance of the way the global economy actually works as opposed to the way we hope it would based on a literal interpretation of global accords or theoretical constructs contained in some textbook.

For this to happen, a new policy consensus has to be formed that would encompass both the officials in the executive branch as well as politicians in the legislative branch over a development framework. There does not seem to be any impetus from either branch of government to develop such a road map nor does there appear to be any public clamor for it.

Perhaps you, dear reader, have some views on this. Well then, let’s discuss them…