IMF

The Tyrrany of Cousins

Altruism towards other people of the same blood-line is widely practiced and literally embedded in our DNA. The Hamilton Rule named after the British evolutionary biologist William Hamilton states that we are pre-disposed to behave altruistically to those with with whom we share a greater proportion of genes. This biological imperative to pass on our genetic code to the next generation is quite powerful.

Hunter gatherer societies tended to exhibit a high degree of inter-locking marriages based on kinship. Alliances between tribes were sealed through bridal exchange allowing genes to be distributed across a wider area. This had implications for early rulers and states. As agricultural societies gew within a defined space, its rulers found it more and more difficult to govern independently sufferering what is called the “tyranny of cousins” which puts the needs of the tribe above the rest.

China is credited with forming the first modern state to address this problem. The Qin and Han dynasties (221 BCE-220 CE) instituted a civil service staffed based on a rigorous examinations process. It was tasked with raising taxes used to secure the populace against enemy invasion or domestic exploitation as distinct from local lords who extracted rents from their serfs. China’s political history from then on can be told on the basis of how this tension arose between the state and elite families. Following a few “bad emperors” it eventually succumbed to repatrimonialization.

Medieval Islamic rulers sought to counteract tribal rivalry by erecting a warrior caste made up of slaves. The Mamluk slave warriors and their Ottoman Janissary counterparts were responsible for the administration and protection of Islamic civilization because they acted as a coherent ruling class looking after the broader interests of society and not any one particular tribe. Just as in China, however, the integrity of this institution began to erode over time.

Altruism based on reciprocal relationships rather than kinship played an active role in the modernization of East Asia. The Japanese keiretsus were organized on the basis of inter-locking boards led by former bureaucrats who were parachuted into senior executive positions. Korean chaebols had a reciprocal relationship with state finance and grew into large corporate family-owned entities with high debt-equity ratios. The management style of these conglomerates was based on consensus between parties. Life-time employment was the norm.

In communist China, investors partnered with local Township and Village Enterprises to gain access and participation in China’s economy. Going to bed with local governments protected assets from expropriation for as long as they continued to reciprocate with profitable performance. There was no formal recognition of property rights or an independent judiciary to enforce contracts, just a tacit agreement based on reciprocity and credible commitment based on mutual interest.

Guanxi a term denoting close networks has been behind informal credit markets supplying start-up capital to Chinese entrepreneurs the world over. Again, no formal agreements eforceable through the courts operates here. Trade and credit has been made possible through closely linked networks built on family and kin relations or reciprocal relationships based on one’s honor and reputation.

From trust to contracts

The West took a very different more protracted route. After the conversion of Germanic tribes to Christianity in the sixth century, the church promoted changes to interlocking marriages based on kinship. This tended to weaken in the long-run political and economic ties based on kin selection. They moved away from trust to contracts through the centuries.

In the twelfth century the English common law administered by the king’s court to which subjects could appeal the decisions of local lords established a system known as “the rule of law” to which eventually even the monarch was made subject by the nobles who feared expropriation by the state. Contracts became enforceable and property rights made more secure without the need for personal connections or networks.

Across the English Channel, the Dutch established the first stock exchange in the early seventeenth century. This made corporate management distinct from its owners and spread risk through tradable certificates lowering their average exposure and leading firms (such as the Dutch East India Company) to be less conservative in business expansion. Capital-raising went through an impersonal market rather than through personal networks.

Management in the West tended to be more individualistic than consensual motivated by incentives rather than trust. Short-term, risk-taking behavior leading to rich rewards and bonuses became more prevalent. Maintaining reputation continued to be important, but only in terms of improving one’s value in the impersonal labor market rather than protecting one’s “word of honor” within a tightly knit community.

Where to begin?

The Philippines is obviously stuck in transition. Many formal institutions have been transplanted from the West, but they remain weak and porous to the tyranny of cousins. It has been difficult for a strong central state to emerge where one’s loyalty to the country ends where one’s loyalty to one’s family begins. The thick network of kumpadres, kamag-anak, and kaibigan (now augmented by kaklase, kabarkada and kabarilan) makes it difficulty to determine where to even begin the reform process.

Getting to Denmark” is the problem to be grappled with: how to emulate Scandinavia which has the highest levels of human development and cleanest governments in the world. It almost sounds tautological. In order to gain the living standards of the West, we need to adopt their political and economic institutions including a strong state, rule of law and democratic accountability. If our society had the means to create and maintain such institutions, it wouldn’t be poor to begin with.

Earlier in a separate post, I commented on the preponderance of avowed bachelors or males with no offspring holding sensitive posts in the current government, the president being one of them. This harks back to the time of Mamluks, Jannisaries and Imperial Chinese eunuchs. This is purely coincidental and fleeting in the broad scheme of things.

Prescribing Western-style political institutions again might have its pitfalls. Public finance of parties does not necessarily weaken the influence of campaign donors even in the US where it is practiced. It might dampen but not eliminate it. And, at any rate, the need for donors features more at the national level. At the local level, political and economic dynasties are one and the same.

A majority of seats in Congress is dominated by dynasties including within the president’s Liberal Party (albeit by a smaller majority). Rather than decoupling the political from the economic classes or dismantling dynasties, shouldn’t we like Japan, Korea and Taiwan find a way to make this coupling work for our country by directing it to more productive ventures?

Yes, we can

The problem is not reform incapacity by our leaders. I would argue that under Mrs Aquino, the state exhibited a considerable degree of efficacy in achieving substantial economic reforms under difficult situations. From tax reform to foreign investments deregulation, flexible currency exchange to trade liberalization, wage decentralization to monetary independence, privatization to democratization, the list is quite impressive from a Western perspective.

The problem was that the agenda was perhaps too comprehensive instead of building one reform on the proven success of another. We shouldn’t blame Mrs Aquino for this. Her government was put in an institutional strait jacket by the IMF which today is imposing a heavy burden on some weak European countries. What EDSA-I demonstrated is that the country can achieve a consensus over a broad set of reforms and pursue it diligently.

The difficulty of governing in the shadow of one so revered as Mrs Aquino is much like the dilemma faced by the successor to Apple’s visionary CEO Steve Jobs. His mission now is not to “stuff up” the legacy. The overly cautious approach this breeds could prevent the sort of imaginative thinking that led to success in the first place.

East Asia didn’t buy into the comprehensive reform package that international donors, aid agencies and multilateral organizations were foisting on them. It opted to target areas that were more appropriate for its needs and developed its own recipe based on local ingredients. It caught up with Western living standards and then reformed some of its earlier idiosyncratic institutions which had by then become less useful.

Rather than applying the “second generation” reforms of the augmented Washington Consensus, following the “first generation” reforms tackled by Aquino I, the policymakers in advising Aquino II need to escape the poverty of ideas this represents. They should develop imaginative arrangements that will immediately unlock the productive capacity of our country. Only then can the son escape another sort of tyranny that seems to be afflicting us…the tyranny of low expectations.

Guanxi diagram courtesy of: China Australia consult

Is the Good Governance path a dead end?

Is the “markets plus good governance” formula indeed the enlightened way to economic Nirvana that its adherents say it is?

Warning: I am following Paul Krugman’s tradition of labeling some of my posts ‘a bit wonkish’. Some of the succeeding material might be a bit taxing, but for those who persevere, the results can be quite rewarding.

The Fork in the Road

During his first state of the nation address, President Noynoy Aquino or PNoy told us that the country faced a fork in the road. On the one hand was the destructive path of evil tread by the Inglorious Beast, on the other was the righteous path of good governance that he the Benign One would lead us down.

Nearly one year on and it seems the righteous path is headed nowhere with allegations of BFFism floating around, corruption and smuggling continuing unabated, and a government that cannot seem to spend its own lean budget in a timely manner.

Despite these setbacks, the Palace continues to put up a brave face. PNoy after all has become the new poster boy for Washington’s policy consensus having been endowed with a grant by the US Milennium Challenge Corporation to pursue its Milennium Development Goals to halve poverty.

This follows the Philippines belated exit from the IMF emergency loan program. The ADB for its part turned on the tap by partly financing the expansion of the Conditional Cash Transfers program, the government’s flagship project for ending poverty. Meanwhile private investments were being sought to fund the government’s public infrastructure program.

The present seems to echo the 1950s and 60s when the country was held in such high esteem by international donors during the last “big push” towards development. We can of course see what that era of donor dependency produced when it culiminated with Ferdinand Marcos’s debt driven boom and crash of the 1970s and 80s.

The Righteous Path

The 1990s saw the rise of economic fundamentalism among policy circles the world over. The precepts of this view bordered on religious zeal. The high priests and prophets of this pseudo-religion proclaimed that there was but one model, the Market.

All those on the path to the Promised Land had to be guided by the Invisible Hand of the Market. Thou shalt have no other models before me was the first commandment. The Philippines under the yolk of the IMF had to follow these strictures. We soon found that the Market could be very exacting and vengeful. Many of the vulnerable, “uncompetitive” and at risk sectors would fall by the way-side and suffer from its discipline.

Despite all the pain that followed from swallowing this bitter pill, the economy did not grow sufficiently fast enough to deliver our people from the clutches of poverty. Why our leaders cried, has the Market abandoned us? We found more and more of our countrymen being led into exile, into servitude abroad. Where have we fallen short? they asked.

Then from on high came the answer.

In the 2000’s, a new covenant was sealed. We were now told that we needed an intercessor to mediate on our behalf. That Intercessor was called Institutions. For the magic of the Market to come into our lives, we needed to repent of our evil ways and follow the path of Good Governance. To convince us, the apostles of the new covenant showed us this sign (click to zoom):

From the pages of the IMF’s journal Finance and Development, Kaufmann and Kraay sought to demonstrate that good governance is the path through which all nations need to pass to get to economic salvation. It shows by implication that countries which have adopted Western standards of governance flourish economically, and countries that have shunned them tend to have floundered.

Indeed though it sounds tautological the very simple and coherent nature of this message, a message that puts it all on our ability to be born again to a re-awakened sense of right and wrong, has enamored most of our elders in the political and business community. Even Mrs Arroyo claimed to tread on this path, but she had stumbled along the way. In 2010, Mr Aquino pledged to bring us back on it.

We would soon be joining the rich club with his slogans like Kung walang corrupt, walang mahirap (no corruption, no poverty) and Daang matuwid (the Righteous Path). PNoy was singing from the same hymn book of the new Washington Consensus (Markets + Institutions = Economic Nirvana).

The real Fork in the Road

The development experts, who had once written us off, welcomed us back in the fold like a Prodigal Son. In his first year in office, PNoy relaxed on spending thinking that we had already been saved and that through the grace of the Market we would soon be rolling in the clouds along with our richer ASEAN neighbors who had already passed on to the other side.

Such a seductive world view, with everything tidily falling into place–that is until you consider the Inconvenient Truth from the real world. It turns out that things don’t necessarily follow according to the message. Take a look at this contradicting sign courtesy of Mushtaq Khan from the UNCTAD’s Discussion Papers (the UNCTAD being the IMF’s poorer cousin).

It draws on a similar data set that Kaufmann and Kraay used covering indicators of good governance and economic well-being from the 1990s predominantly. We find that countries can actually be grouped into three: the rich ones (circled in the upper right-hand corner), the poor ones (circled in the bottom left-hand corner), and the ‘convergence club’ countries (circled in the upper left-hand corner).

From the chart we can see that the members of the converging economies (on the upper left-hand corner) advanced economically first before improving institutionally. In fact the convergence club performed on average just as poorly on the corruption scale as the diverging economies (on the lower left-hand corner).

(Update: Although the regression line is upward sloping, indicating a positive correlation between anti-corruption and economic growth, an analysis of the three clusters of countries comprised of rich, poor and convergence club members reveals the direction of causality to flow from growth to control of corruption, not the other way around)

Indeed if we examine the economic histories of the convergence club members, we will find that they did not adhere strictly to the ‘righteous path’ of Markets plus Institutions. Japan, Korea and China developed not by relying on the Invisible Hand of the Market alone, but by wielding the Visible Boot of the State to coordinate, reward and punish industry players in accordance with their rational industrial policies.

Instead of relying on impersonal contracts under the Market framework, they used informal contracting under different guises, the keiretsus, chaebols and guanxi, to create secure property and contract rights to protect investors in strategic sectors within their economies. These institutions did not come from Western capitalism but were home grown. Indeed the alternative of implementing Western-style rule of law throughout the system would have been beyond their reach at the time they were emerging.

Chalmers Johnson who documented the rise of industrial policy in Japan by studying MITI the lead agency of its industrialization, wrote that

(a) part of the MITI perspective is impatience with the Anglo-American doctrine of economic competition. After the war MITI had to reconcile itself to the occupation-fostered market system in Japan, but it has always been hostile to American-style price competition and anti-trust legislation. Sahashi likes to quote Schumpeter to the effect that the competition that really counts in the capitalist system is not measured by profit margins but by the development of new commodities, new technologies, new sources of supply, and new types of organizations.

What this points to is the fact that rather than the fork in the road being a choice between the Righteous Path of good governance versus bad governance, the decision we are faced with is whether we continue down the same old road of the (new) Washington Consensus or change course and move more towards the BeST Consensus (Beijing, Seoul and Tokyo Consensus) bearing in mind that no other country has successfully traveled down the path of the former into the promised land.

A wake-up call

So is the good governance path a dead end? If we are to look at economic history, the answer seems to be a resounding YES. Unfortunately, the tribe of PNoy seems to have fallen head over heels for it. They will not accept any deviation from this course. The eunuchs and high priests surrounding him are all advising their leader to stick to their teachings.

Who can blame them? The gospel they have accepted is a truly seductive one. It does not require us doing our homework, building home grown institutions consistent with channeling resources into more producitive activities. It fits with our fatalistic, religious upbringing to rely on someone or something external to deliver us from evil.

The results of the alternative path trodden by the convergence club are evident for anyone to see. Singapore, Malaysia, Thailand and even Indonesia are heading down that road. The Philippines needs to wake-up to this reality. It needs to gain “a re-awakened sense” alright, not of right and wrong, but of self-empowerment and self-determination. That is the very essence of people power after all.

Snap, Crackle, Pop!

The media and blogosphere may have been mindlessly harping on the fumbling errors and bumbling missteps committed by the current administration of PNoy over the past six months in its first year in office, but the mood of the public and the markets seems to have taken it all in stride.

As latest polling by SWS reveals, PNoy and his policies continue to enjoy unprecedented confidence levels from the public. This exuberrant satisfaction is mirrored by the investor community which has driven the local bourse to all time highs following the normal transfer of power from one administration to the next during the middle of the year.

Despite its fiscal woes, the government very recently finds itself situated at a very auspicious moment in which it is able to borrow at very favorable terms. Its treasury issuance last month was oversubscribed four times leading to extremely low borrowing rates of just over three quarters of a percent for its 90-day treasury bill, nearly half what it was the previous month.

This makes it not far off from the yields of similar notes issued by the US Treasury and that of the UK, Eurozone and Japan! The governments of the struggling PIIGS economies of Portugal, Iceland, Ireland, Greece and Spain are having a much harder time raising funds to bridge their fiscal gaps having resorted to the IMF for credit while the Philippines exited from that program back in 2006 having paid all of its debts to the Fund in full.

With stellar economic growth predicted to hover around 6-7% per annum and a relatively benign inflation outlook predicted to continue over the next few years, the country is poised to take-off along with other emerging economies. The next decade could see the nation address some fundamental problems like infrastructure bottlenecks and social inequity if the government plays its cards right. Already the Gini coefficient a measure of income inequality reached its lowest point for quite some time.

What many will find most remarkable in all this is that there have hardly been any changes made to the socio-economic policy settings left behind by the previous administration despite all the campaign rhetoric about change. It could be seen as an acknowledgement that many of these settings prepared the conditions now evident for better times ahead.

As proof of this consider the following: the Conditional Cash Transfers program initiated in 2008 (CCT) is being expanded, the RH bill, which was drafted and vigorously pushed for in the previous Congress by the now leader of the opposition in the lower house and ally of the former president, is being supported, and reforms in education, training, research and development are continuing.

“Normalcy” restored

The boost in confidence has occurred because of the observance of the rule of law during and after the elections which led to a credible outcome. The political transition and stability this engendered has restored the notion of the Philippines as a “normal” state once again. The same transformation of perception occurred previously in Indonesia that led to it attaining G20 status (its recent setbacks notwithstanding).

Problems of corruption and conflict will still linger, but as was shown during the 90s under the Ramos administration, they can be tempered for as long as growth with equity is pursued (it should be noted here that it was during that previous period of expansion that poverty incidence as measured by the share of the poor to the overall population, fell to its lowest point since records were kept, and the country became relatively peaceful as a result, despite the fact that the poverty headcount, or the number of poor individuals kept rising-just not as fast as the rate at which the overall population grew, proving the point that equity is important).

What is crucial over the next six years is for the observance of good governance and the “market for rules” to be enforced. As demonstrated by two previous administrations, it is quite possible for political corruption and influence peddling to co-exist with an open market economy despite the enactment of “world-class” procurement laws and the application of electronic/automated processes in awarding government contracts.

The roll out of the PPP contracts beginning next year will be a litmus test as to whether the government can enter into such agreements without anomalous transactions occurring on the side. Another one will be the ongoing campaign to lift the tax take of the country which has not been buoyed by the recent recovery in economic activity.

With these key planks in place, the government will have sufficient funds to resource reforms in social policy arenas. Without them, an overall tax hike could loom as a distinct possibility which would threaten social cohesion particularly if an increase to the regressive VAT rate is pushed.

As the year draws to a close, it is worth considering the journey the country has taken. At the start of the year, there were doubts as to whether we would be faced with a doomsday scenario come election day. There were talks of civil unrest and military adventurism following a no-election or no-proclamation scenario.

At the close of the year, the country’s financial, economic and dare I say social outlook could not end at a brighter note. Indeed there is much cause to celebrate as the prospect for an economy that crackles and pops as opposed to one that merely sizzles but fizzles takes shape.