deficits

The long-term view

 

With experts calling tepid and jobless growth the “new normal” for North Atlantic countries for years to come, it is important for governments to assess how this impacts them in the long-run.

The administration seems to have put two and two together and realized that with weaker growth prospects come weaker revenues and in an environment where any sort of fiscal deterioration could lead to speculative attacks on an economy, it is aiming to shore up its fiscal position through tax reform before the effects of the crisis start washing on our shores.

There certainly is nothing like a crisis to focus the mind on issues that would have slipped under the radar otherwise.

Fixing the areas in our tax system where leaks occur is just as important as trying to avoid wasteful spending. Paying full-market prices for second hand helicopters may create more of a buzz in the media, but the impact of improperly crafted policies on fiscal incentives or sin taxes create much bigger losses for the government on an annual basis.

The uncollected portion of those taxes could easily fill-up the public sector deficit eliminating the need for forced fiscal contraction that prevents us from building the necessary social and economic infrastructure needed for attracting job-producing investments and for improving governance.

The long-term view would allow our leaders to make the tough decisions to undertake necessary reforms that would lift the long-run productivity of the Philippines instead of merely catering to populist sentiment and short-term political payoffs.

Take a look at the following chart which shows various long-term forecasts for average annual incomes per person in the Philippines.

The high-growth scenario comes from the analysis of Dominic Wilson of Goldman Sachs on the Next-11 group of countries with strong growth potential. You can see why all those toxic sub-prime mortgage backed securities could be endorsed by them to Standard and Poor’s for triple A rating.

The rosy positive outlook has our citizens earning $20,000 on average by the year 2050. We should take our cue from those crafty people at GS who bet against the very investment vehicles they packaged and sold to investors, by hedging our bets a little. Let us consider other possibilities.

The low-growth scenario is taken from the Institute of Future Studies online data available via Google’s public data explorer. It shows the country achieving a per capita GDP level of just above $4,000 by 2050. This is quite a low level of growth given that the NEDA projects a $5,000 per capita income by 2020 (assuming we grow by 7% for the next ten years).

The high-growth scenario assumes growth of 6.4% per year on average in the next forty years (net of inflation). The low-growth scenario assumes that it grows by 2.9%. Note that with the population rising, the growth of the overall economy needs to be 7.6% under high-growth and 3.9% under low growth for average incomes to rise as they are forecast here.

I have projected a middle case in between the high and low growth scenarios. This trajectory produces an average growth rate of 4.9% per year. Under this scenario, average incomes are set to rise to close to $10,000 by the end of the forecast period ($9,497 to be exact).

This level of income is important because as the World Values Survey suggests, $10,000 is right around the level at which the minimum material needs of a country are met. Above this level, the reported level of subjective well-being is less dependent on income growth than on other factors.

Based on this survey, the Philippines is punching above its weight in the happiness index (far above its material wealth would imply). Imagine what would happen if Filipinos attained an even higher level of income.

Considerations for the long-term view

The question now becomes, what sort of policy shifts in the next five years would spell the difference between each scenario. Even though its framework produces an overly optimistic case for the Philippines, it is worth looking at the Growth Environment Score of Goldman Sachs to see what kind of policy response is required.

Under the 13 components of the GES, the Philippines was considered at par or above average in four aspects in 2006, namely: inflation, trade openess, education and life expectancy. It was considered below average in three economic indicators: fiscal deficits, external debt and investment; three governance indicators: political stability, rule of law and corruption; and, three infrastructure indicators: computers, phones, and internet penetration.

Tax reform would allow the government to correct the below par performance in debt and deficits. Investments could be addressed through competition policy and an opening up of restricted sectors. Political stability, rule of law and lower corruption results from better fiscal capacity to provide social safety nets and a more professional bureaucracy. Finally, better telecommunications governance results from both better regulatory quality and bureaucratic effectiveness which come about by opening up the economy and compensating public officials better.

The bottom-line is that better fiscal capacity along with sound and rational policy result in better growth prospects for our country. Let us hope that our leaders are able to take heed of this maxim and resist the urge to pander to populist patrimonialism in the short-run. By 2050, there will be between 135 and 145 million Filipinos. It is for the sake of this silent electorate, that I hope our leaders fix their vision on the long-run.