Heritage Foundation

That Vision thing part 3: Credible commitment

The last thing the president needs to secure is credible commitment in support of his social compact.

There are several commitment problems in the strategy and vision of the benevolent one’s regime. For one, there is no way of knowing whether its budgets will be worth the paper they are printed on given the kind of expenditure contractions they are forced to exercise whenever revenues fall short. Secondly, the deadlines of several strategic infrastructure projects keep being delayed as contractors miss important milestones. Thirdly, the lack of party discipline in enforcing its program of government has impeded progress on a number of fronts.

From reform to de-formed budget?

Currently, the administration may have a social compact with several programs in the pipeline–an expansion of basic education, health coverage, and social insurance programs–but no sure way to fund them. The reform budget could very well turn out to be a de-formed budget. The pipeline could very well turn out to be a pipe dream.

That is unless the president finds a way to rally his forces behind his vision. That vision includes an expansion of the role of the state, but at the moment the fiscal component of that vision is the weakest link. Among the rich countries of the OECD, the general size of the state is about 30-40% of GDP. Even some emerging economies like Brazil are able to achieve that ratio.

For developing economies the size of government is limited to 10-20% due to a small formal sector and narrow tax base. At the start of the global financial crisis in 2008 when the fiscal position was nearly in balance, public revenues and expenditures had leveled off at about 17% and 16% of GDP respectively.

Budget analysts believe it has to be restored to 18% which is what it previously had been prior to 2003, to resource social programs adequately. In 2009, the tax take declined to 14.6% of GDP, while a stimulus program made expenditures go up to 18.4% increasing the budget gap to 3.9%. In 2010, that gap was down to 3.25%.

With an 10 trillion peso economy in 2011, a one percent rise in the tax take would rougly equal 100 billion pesos. It would cost the government around 300 billion pesos to plug the fiscal gap, while it would need another 100 billion to pay for its social compact. Nearly half a trillion pesos is roughly 4% of GDP. Budget experts believe going after tax cheats would raise around half a percent of GDP in revenues. The remaining 3.5% (350 billion) has to be sourced elsewhere. Assuming we are content to keep an annual deficit of 1-2% of GDP, then that would mean finding a way to raise between 150-250 billion pesos from the tax and revenue system.

Without a carefully considered roadmap for raising revenue, a credible commitment towards meeting the vision would be wanting. The notion that we can aspire for greatness without the required sacrifice is nonsensical. Tradeoffs have to be presented to the Filipino people, not the hopeful “stretch targets” provided by our economic managers.

Incomplete contracts

Secondly, many equate improved governance with smooth running public transport and infrastructure. The poor state of our airports, seaports and railways is another reason why a credible commitment on the part of government seems to be wanting. Having resorted to the “magic of the market” to construct most of our major projects, the state failed to resource the screening of the private contractors properly.

As a result, an inadequately designed and costed project like the North Railway line was approved leading to subsequent cost adjustments to the tune of half a trillion pesos without any substantial improvement in its quality or completion rate. This railway is crucial to connecting the two major airline hubs in the country. The original delivery date was 2010, then it got pushed back to 2013 and now it seems it will be 2015.

Similar problems have hampered the upgrade of airports, highways and transit systems around the metropolis. The administration has partially adressed this situation by appointing competent cabinet secretaries over key portfolios. This will help ensure that future public private partnerships are screened properly. It does not necessarily address the problems of past faulty contracts.

A government takeover of failed projects and subsequent re-bidding seems to be the answer to a number of them, but will this kind of contractual failure continue to hamper projects in the future? Properly resourcing the agencies that examine their commercial viability with competent staff is a must for that to be avoided.

Institution-building

Finally, party discipline while it seems to be upheld in the impeachment of the ombudsman, seems to fall apart when it comes to important pieces of legislation. Certain senators that ran under the president’s banner do not support his entire platform of government.

This anomaly needs to be addressed. The expansion of conditional cash transfers and the reproductive health bill are two vivid examples. There needs to be a kind of credible commitment towards important pieces of legislation. Such a smorgasborg of support in the upper chamber continues to hound our presidential form of government.

In a chamber where every vote counts, this kind of feeble partyline is a hindrance towards achieving the vision. Certain institutions have to be designed and built prior to the congressional elections of 2013 to improve on this. One such institution could be the drafting and signing of a common agenda. This has to be developed if we are to see any meaningful development in our political culture. Not penalizing political turncoats is one thing, but not imposing a cost for party membership is another.

Conclusion and Recommendations

At the start of this series, I said that the president needs a roadmap that focuses on the big picture of his administration. Before he gets bogged down too much by official duties, he needs to create space and time for him and his team to have a re-think about their current strategic priorities.

This could be an opportune moment for that. He needs to first of all discard the outdated mental models he used earlier to define the role of the state under his presidency. He also needs to scope out his role as the guy who focuses on “that vision thing” and to focus on steering while allowing competent managers to do the rowing for him. Finally he needs to find a way to engender credible commitment towards his broad agenda.

The manner by which he accomplishes these three things will determine to a large extent how successful his administation will be and how he is remembered. Although he may have had a slow start, there is still time for him to recover, regroup and regain momentum.

The following are a number of policy recommendations for the president to consider at this time:

Policy recommendation #1: create a strategy unit within the office of the president to draft a strategic roadmap based on a long-term view but with action items to cover the next five years.

This strategic roadmap would look at the long-term trends that impact the social, economic, cultural, environmental and physical development of the population and align inter-agency goals and strategies for meeting these challenges.

The rolling mid-term development planning system which is managed by the NEDA is not strategic enough. It needs a higher level plan which models projections for the country over the next twenty to fifty years to frame the policy direction needed to shift the country into a higher growth trajectory.

The NEDA which is a technical agency used for asssessing development projects has no coordinating role in terms of implementing the medium-term development plan. A more central agency located in the Palace needs to take on the role of coordination and monitoring.

Policy recommendation #2: convene a commission to review both the revenues and expenditures sides of the budget.

The purpose of this commission would be two-fold: (a) to lay down a multi-year expenditure program for the attainment of the social compact and/or the fulfillment of the Millenium Development Goals, and (b) to determine the kind of tax structure that would produce the kind of revenues needed for meeting (a) in an efficient, effective and equitable manner.

Unlike the current revenue projections of the government which are based on “stretch” targets for the different agenices, the commission should take a dispassionate view towards what the revenue picture would realistically be over the medium-term given the current tax structure in place.

It should then determine how to reform the present system to account for any structural gaps that exist in our fiscal position. An eminent person well-versed in both the theoretical and practical side of instituting tax and spend reform should be appointed to head this commission. Its report should form the basis for proposed legislation.

The beauty of having a review of both the tax and spend sides of the budget is that it should allow the administration to propose to the Filipino people a price tag for a better equipped government in 2013. The nation has to be faced with a tradeoff. There ought to be no more free lunches (what I mean is no promise of a promised land without tough choices). If we want government to provide for better services, then we must be prepared to bear the cost.

The commission would allow the Palace to deal with the politics of tax and spend reform. Having an independent body provide advice would de-politicize the process. It would form the basis for a program of government which could be put to the people in 2013. Victory for the administration party would translate into a mandate for such reforms.

Policy recommendation #3: improve discipline within his coalition by imposing rewards and sanctions to its members who fail to toe the party line.

Within the ruling party, there should be a time and place for differences of opinion to be threshed out. A joint legislative-executive party caucus comprised of elected members of both congress and the executive branch needs to be convened to affirm their position on many legislative proposals.

A “contract” must be drafted and signed that would commit members towards the enactment of crucial bills and building of support for it among different constituencies throughout the country. Those that rode on the coat-tails of the president all the way into congress and local government posts need to know that there is a price for doing so. That price is to adhere to party rules and decisions.

The bottom-line

Underpinning these recommendations is a basic philosophy regarding the correct role of the state. The old Washington consensus supported a declining role for it and concurrently a lower level of taxation to “starve the leviathan”. The new balanced consensus recognizes that the state needs to be robust enough to engage with the market.

The role of strategy within government is to pose critical questions to policymakers involving tradeoffs. We can continue on the road we are on with a feeble state unable to raise revenues and pay for its programs adequately, or we can change course and have a state which has the capacity to make credible commitments towards commonly held objectives.

Those that seek to succeed him in 2016 must see it in their interest to support the success of this presidency. They must find themselves all in the same boat and be willing to work cooperatively to get the job done. All the president’s men must see it in their interest to keep the administration’s support afloat until he steps down in 2016.

The task of the president now is to determine how to navigate in this terrain. Beyond the 24 hour news cycle, the palace has to focus on the long-term frame. The president himself needs to devote a good proportion of his time and energy in developing this grand vision and oversee the development of a roadmap that brings us closer to it within the next five years.

<<<<return to part 2: That Vision thing: Curing dysfunctionalism

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)