fiscal consolidation

The halo effect

image courtesy of listverse.com

The halo effect is a cognitive bias first studied by Edward Thorndike in 1920 whereby the perception of one trait (i.e. a characteristic of a person or object) is influenced by the perception of another trait (or several traits) of that person or object. An example would be judging a good-looking person as more intelligent or believing a politician’s policies are good, just because the person appears good.

In the case of President Aquino and his high public satisfaction ratings, there seems to be a substantial amount of this effect taking place. The general impression of P-Noy is that he is honest. This comes from being who he is, the only son of two national heroes. This has translated into very positive sentiment towards the actions taken by the government under his watch.

Part of this has to do with the anti-GMA sentiment or the reverse halo effect. So pursuing cases against his predecessor is seen to be the legitimate thing to do, and rightly so, given the shenanigans that her administration was accused of. It also ties in with the president’s retraction and review of contracts and projects already approved for fear that they would somehow benefit her proxies within certain departments and sub-contracting firms.

But if you look at the outcome of these actions, it becomes immediately apparent, leaving our cognitive biases aside, that the positive evaluations given to P-Noy by the public are probably unjustified.

First of all, with respect to the way in which his justice department has gone after Mrs Arroyo, certain questionable legal manoeuvres have actually undermined the rule of law rather than upheld it. And secondly, with regards to the handling of the economy, the third quarter GDP figures clearly show that the overly cautious due diligence performed on public contracts undermined economic growth rather than encouraged it.

On the first point, I am referring to the use of a joint panel composed of the Department of Justice and the Commission on Elections that investigated allegations of vote rigging in the 2007 elections. This is said to have been anomalous in that a supposedly independent constitutional body such as the COMELEC is not meant to be seen as partial or collaborating with the administration in any way. Also, when their joint findings were published, it took a judge a few hours to read their eight ring-binder document and issue an indictment on Mrs Arroyo.

The undue haste with which such decisions were reached coming on the back of a temporary restraining order issued by the Supreme Court on the hold departure order issued by the DOJ on Mrs Arroyo that was “in effect” despite the dissenting opinion of some justices makes it highly likely that politics rather than due process was observed. This TRO was issued because the legality of the DOJ’s hold order was questionable to begin with.

Had these actions been undertaken by Mrs Arroyo while she was running the country, the protests from civil society regarding the “creeping authoritarian” nature of her government would have occupied public discourse. But because it was attempted by the meek and mild administration of the “benign one” there does not seem to be the same level of public indignation, although the result is the same—if upheld, it would grant vast powers to the state to curtail individual freedoms.

If we turn to the second point, on economic governance, the promised economic take-off billed as a public-private partnership by the president did not take place. Instead the economic deceleration has been rather remarkable in a region that is seeing quite robust growth despite the downturn in Europe and the US. The government which was prepared to take the credit for positive growth in agricultural output in the first half when early rains produced a bumper crop is now shifting the blame for poor production on storms both natural and man-made.

Public construction continued to show weakness despite the government’s promise to fast-track the roll-out of resources in response to the slump in the first half. Even with the announcement of a “stimulus” to deal with the effects of the EU debt crisis, there still appears to be little traction on this front. All hopes are pinned on the fourth quarter, but as the country’s chief statistician has pointed out, to attain even the lower end of the government’s modest growth target range for the full year, the economy would have to expand at a pace rarely seen.

In attributing the weak economic performance registered this year, there are certain factors that lie outside the government’s control (storms and financial crises overseas) which have to be acknowledged, but a portion of it definitely lies within its sphere of influence (public construction spending). It is clear that external factors did dampen growth, but the government’s action or inactions dampened it even further.

Again, had this occurred under Mrs Arroyo, the government would have been pummelled. Hounded by questions of legitimacy, it was her economic credentials that proved her only saving grace. Now that the government is run by someone whose electoral mandate is unquestioned, his now sullied economic credentials don’t seem to be much of a problem.

To counter the cognitive bias associated with the halo effect on the part of an evaluator, “blind-fold” tests or blind experiments are often administered where the person rates a product based on its actual attributes or performance, not on the subject’s perceived reputation. Respondents are often surprised with the results when they remove their blindfolds. I wonder what would happen if a poll was conducted that used the same principle in evaluating the performance of our presidents.

If faced only with the indicators of success and not the name of the person being rated, what marks would be given this president? What the government under him did this year countered its aims of fostering good government, rule of law and economic growth, but somehow its acts of commission and omission get glossed over and given a positive spin. Not only that, but the public by and large is willing to accept the message given them that all is well. So it seems the halo effect can cover a multitude of sins.

Defying Gravity

Faltering growth prospects for the economy and paralysis over how to kick-start big infrastructure projects do not seem to have dampened public support for the president.

Its economic managers remain fixated on ‘fiscal consolidation’ (a euphemism for shrinking public works expenditures to close the fiscal gap) as its roll-out of PPP (public-private partnerships) hits yet another snag with a new ‘review’ announced by the government. The confusion over how to proceed with its centerpiece program demonstrates how that it entered office armed only with platitudes and no real plan.

Yet even as punters from multilateral institutions, ratings agencies and think tanks alike place a down-side risk to the country’s growth prospects, the poll numbers of the president have headed upward. This strange phenomenon needs some explaining. How has P-Noy been able to defy gravity with his public approval ratings?

Some would point to his campaign against corruption as the source of such levitation. Yet, the same reason was given when his poll numbers were slipping early this year. The explanation was that as the public became familiar with so much corruption occuring in high places their faith in government collapsed. So why is the opposite happening now?

Perhaps it is because previously the pursuit of justice seemed to be going nowhere; whereas now, with the help of a few unexpected whistle-blowers, it seems to be heading in the right direction. That is one plausible explanation.

Another comes from the notion that growth and development do not necessarily go together and that despite sinking growth figures, the government has attended to the material needs of the populace through such programs as the CCT or conditional cash transfers.

Indeed one can characterize the government of P-Noy as following the script laid out by the Washington Consensus of promoting macroeconomic stability (to the detriment of growth) while providing social safety nets (to buy-off public support) and pursuing good governance (despite setbacks in providing public infrastructure).

In fact, some are pressing P-Noy to take advantage of his high popularity to pursue charter change and maximize the liberalization agenda by opening up the remaining sectors of the economy reserved for local participation and ownership. No less than the leaders of both the Senate and the House concur in this. As I pointed out in a previous post, the president is right to be a little wary of this move (although his reasons may differ from mine).

Others would have him go the other way and review the existing liberal trade and investment policies that have been in place for the last three decades as the country’s manufacturing and exports base suffers from a strong peso and seems highly concentrated within a few sectors, import dependent, and without much depth.

The PPP conundrum is emblematic of this confusion. P-Noy’s government started out with complete faith in private markets to ‘get prices right’, but it seems to be coming around to Sec Roxas’ belief that the public sector can do better. His proposal for the state to finance and build the projects itself, and then sell them off to the highest bidders to operate and manage would be a complete turnaround from the president’s previous position.

The idea behind Mr Roxas’ plan is that to get the ‘right price’ the government should use its access to cheap capital that is not available to private firms. That makes perfectly good sense, but the problem with his proposal is that government has not been known to be an efficient producer of public works projects. This could wind-up making the government penny-wise, pound foolish in the end.

A third way was actually proposed by me in another earlier post. The idea would be for the government to access cheap capital and create a fund that would either partner or loan these out to projects for either infrastructure or regional development needs. This would allow the cost of financing and construction to be lowered by leveraging the advantages of both public and private institutions achieving the best of both worlds.

This approach I must admit is hardly original. It was applied by South Korea in promoting industrial development through partnering with the private sector during its fast growth phase of development (see Alice Amsden’s book Asia’s Next Giant). The emergence of light and heavy import substituting industries which supplied export-oriented manufactures owed much to this strategy.

The economic bureaucracy there was a master at engaging in entrepreneurial self-discovery by importing licenses to operate foreign technology and then auctioning them off to private firms while at the same time providing them with sovereign guarantees and cheap project financing (I recommended a similar approach through an innovation fund which the government could create by borrowing some of the excess dollar reserves of the Bangko Sentral).

Indeed the government cannot live on macroeconomic stability and social insurance alone. For its growth trajectory to shift upwards, it will need to have a credible employment and industry strategy. Its PPP program was touted in P-Noy’s first state of the nation address as the vehicle for achieving this. In addition, the government will need to foster innovation and investment.

Let us hope that the administation finally gets to find a set of workable arrangements to get its pipeline of projects off the ground. Defying gravity with its poll numbers is one thing the government can do at the moment, but keeping developmental projects suspended in the air is something the nation simply cannot afford.

UPDATE:

DOTC Sec Roxas’ recent announcement of a five year plan involving 380 or 426 billion pesos (depending on which paper you read, the PDI or Business Mirror respectively) sheds more light on the new policy direction.

Essentially, a couple of things came out of the press release. The first is that aside from the PPP vehicle the government will be entertaining other conventional ways of financing infrastructure projects including overseas development assistance, foreign loans and items in the national budget. The second is that the Chinese contract to construct the NAIA to Pampanga rail line has now been superseded by a fast-rail project which will extend to Clark instead of Mabalacat.

These two moves by Mr Roxas clearly indicate a stronger more interventionist role for the state on offer from the one originally envisioned by the president. While P-Noy was only interested in handing infrastructure projects to the private sector, standing back and watching it work its magic, the DOTC secretary is willing to roll-up his sleeves and seek a better bargain or boot out in this case a poorly performing contractor to deliver a much better outcome.

His promise of a scorecard for his 5-year plan underscores the managerialist aspect of his approach to strategic projects in contrast to the laissez faire attitude of the president. The 90 billion a year average spend represents almost 1% of annual GDP. If he is able to roll this out on time, it will help provide a much needed stimulus to the economy at a time when the global economy goes through an adjustment to slower growth.

It makes me wonder what his rival Vice Pres Jojo Binay will now seek to do in order to outshine Mr Roxas. Will he adopt the proposal of Councilor Lagman of Quezon City and push for a 1% real property national tax as proposed by some fiscal experts to fund a national social housing program? Will he push for the creation of a housing department? Time will tell.

…And PIIGS might fly

The following is an interesting chart that shows the projected debt positions of the various PIIGS economies (PIIGS stands for Portugal, Ireland, Italy, Greece and Spain), the US and other economies with triple AAA credit ratings or near investment grade ratings.

It demonstrates why these economies are in such dire straits at the moment. The debts of Greece are the highest at 1.5 times the economy (Greek tragedy). Ireland is next at 1.2 times (the luck of the Irish) and Italy is third at 1.15 times (Italian job).

The US which has been downgraded for the first time in eighty years is projected to breach the 100% debt to GDP ratio after this year given the tepid pace of its economy and expanding entitlement system. Spain has debts at a mere 64% of its economy but is expecting to see them rise on an upward trajectory to 75% by 2016.

Other triple A rated economies either have low debt to GDP levels (Austria, Australia, Denmark and Finland) or are on a downward path to sustainability (France, Germany, Singapore and the UK).

The Philippines and Indonesia which are both one notch below investment grade do not seem to share the problems of the PIIGS with moderate (Philippines) to low (Indonesia) levels of debt and they are both expected to decline over the next few years. The yield of their bonds are trading lower than the Portugal, Ireland or Greece (translation: creditors have greater faith in their ability to repay their debts than the P-I-G economies).

The Philippines stood at the precipice of a sovereign debt crisis back in the last decade with debts rising from 60% to above-70% between 2000 and 2003, but pulled itself back with a combination of increased taxes, fiscal consolidation and a currency appreciation with debts returning to a more manageable level of below-50% in 2007 right before the Global Financial Crisis broke.

The structural adjustment that occurred after 2004 allowed the country to weather the GFC from 2008 to 2010 relatively unscathed. Now that the new government has continued the cautious fiscal consolidation of its predecessor, the question is whether growth will be as robust as it was from 2007 to 2010.

Some might say the fiscal contraction that took place in Q4 of 2010 and Q1 of 2011 will provide the necessary cushion for the government now. The problem is with the slowdown of GDP that the country has experienced this year and into the next few, revenues might not scale up as they were originally projected leaving it with limited options now that fiscal stimulus has gone out of fashion.

Indeed, fiscal contraction has its merits, but it also has its drawbacks when used excessively. Can a country engage in it indefinitely and expect an economic takeoff? Yes, sure it can…and pigs might fly.