Lehman Brothers

So what now?

With the economic turbulence now gripping world financial markets once again, and the possibility of either a double dip recession or stagflation looming, governments around the world will be unable or unwilling to respond with another round of stimulus.

Only the monetary authorities both in the EU and the US stand in the way of a full blown debt crisis. It is quite ironic that S&P, the credit rating agency which figured in the first global crisis should have sparked this one.

Then it had caved in to Goldman Sachs to provide triple A credit ratings to the toxic sub-prime mortgages that led to the collapse of Lehman Brothers and brought AIG to its knees. This time around, it refused to cave in to pressure from the Obama White House which had legitimate reasons for questioning the downgrade that it gave the US economy.

In Manila, economic managers were closely watching as events overseas unfolded. The question on everyone’s minds must be, so what now? The best case scenario out of all this might be for the global economy to experience tepid growth accompanied by high inflation. And so then what? What options does the government face if that happens?

When the GFC hit three years ago, the government was on a path to fiscal sustainability with the budget nearly in balance. It had averted a debt crisis of its own early in the decade by raising and expanding the value added taxes from 10%-12%.

The stimulus initiated by the Arroyo administration led to deficits of 3-3.5% in the three years leading up to 2010. Spending in order of 200-350 billion pesos went to fuel and electricity subsidies as well as targeted discounts for seniors. A conditional cash transfers program was launched to help indigent families weather the storm.

Alongside these social programs, a relaxing of rules for granting fiscal incentives at business parks and economic zones was legislated by Congress. While the increased social spending could easily be retracted (and much of it was) when better economic conditions prevailed, fiscal incentives couldn’t.

They are partly the reason why the government now struggles to balance its revenues and expenditures. Having imposed a heavier form of regressive taxation on the broad sections of the public, the government of the day then took the money raised from that and gave it to special interest groups which arguably did not result in its stated policy goals to boost overall investment.

The present crisis now provides an opportunity to correct that. Firstly by rescinding redundant tax perks that have eroded government revenues, and secondly by making room for the expansion of both social and infrastructure programs, the government of PNoy can create a more equitable incidence of taxes and benefits while fostering a return to fiscal balance and growth.

What would be the incentive for Congress to do this right now?

Well let’s just say there are ways of making them come around. In Australia, the government’s stimulus measures during the GFC involved a school building program in every electoral district irrespective of the political affiliation of the local member.

The same thing could happen in the Philippines. Even without a fiscal responsibility bill, the Palace could pressure Congress to enact legislation to provide revenues for an expanded school building program under a 2012 supplementary budget. The timing of this, right before the 2013 elections would be impeccable.

In fact the same thing could happen if the government were to index sin taxes on alcohol and tobacco and earmark the spending for primary health clinics for each congressional district. It would be hitting two birds with one stone: making the tax system more effective while improving health outcomes.

They say, a crisis is a terrible thing to waste. That’s what happened the last time a financial crisis hit. Let’s hope this time around, the government does not waste the opportunities this current one presents it with.