Agricultural price stabilization is a faulty development strategy

Price stabilization involves stockpiling reserves during high-supply/low-price periods, for release during low-supply/high price periods. This is an activity that either the private or public sector can undertake. Consumers benefit from less volatile prices; traders benefit from being able to buy low and sell dear ("intertemporal price arbitrage" is the fancy term.) In many Asian countries, government-owned traders do price stabilization especially for agricultural staples. In the Philippine case we have the National Food Authority which trades in rice and corn.

From the NFA website, we see the following mission statement:

Stabilization of grains supply and prices, both at the farm-gate and consumer levels. Farm-gate prices shall be kept at levels that provide farmers a reasonable return on their investment. Retail prices shall be kept at reasonable levels for consumers.

The NFA is also given the monopoly right to import rice and corn, ostensibly to support its mission.

Public intervention is called for when an activity is characterized by public good features or externalities. What is the public good feature or externality associated with price stabilization? Answer: none. The private sector can do this very well all by its lonesome. There is in fact strong reason to suppose that public intervention (as done by the NFA) imposes costs in excess of benefits. Just look at the mission statement - it essentially says, "buy dear, sell low"! A private enterprise can never get away with this - not unless there's a Big Brother who can foot the bill using the general tax fund, as well as enforce restrictions on competitive trade. The excess social loss from NFA operations has been estimated to be in the order of 50 billion pesos yearly (Roumasset, 2000; unfortunately unavailable online.)

Abolish the NFA. Absolish the NFA now.


Reference:

Roumasset, J., (2000). "Market Friendly Food Security: Alternatives for Restructuring NFA." Unpublished paper, Department of Economics, University of Hawaii,Honolulu.

Land reform gone awry

The Philippines has been conducting what is probably the longest running land reform program in the planet. The latest news on the Hacienda Luisita dispute illustrates the iffy situation in implementing land reform in corporate farms. The background is that in these farms, workers are entitled to the corporation's land, but not its other assets. The owners of the corporation have the option of liquidating their company and leaving the workers (now landowners) to fend for themselves. However both parties may be interested in continuing the existing arrangement. A number of options is open, one being the "Stock Distribution Option" (SDO). In lieu of land ownership, the workers receive a share of the corporation's stock.

According to the investigation of the HL case, the terms of the agreement governing the SDO were routinely violated by the majority owners. If the SDO is revoked, legally land ownership would revert to the workers (and their shares back to the Hacienda). Expect more litigation, and more delays.

This sad affair should not obscure the fact that there are many corporate farms in which land reform was implemented without much controversy or friction. This is true for many big farms in Mindanao (Southern Philippines). Often workers remain landowners, but enter long term leases, or contract farming, or similar such arrangements, with the corporation owners. The business more or less continues undisturbed. In many of these arrangements, workers find themselves better off.

I hope the HL problem remains merely an isolated case of business dispute, against the norm of a healthy relationship between landowners and capitalists in large-scale farms.

Intervention in agriculture: where is it needed?

Roads, irrigation, education, research, and safe water. There is reason to suspect that, left alone, markets will systematically undersupply these goods. One reason is the public nature of these goods - in economics, we use the terms "non-rivalry" and "non-excludability". The first denotes a condition in which my consumption doesn't reduce yours - think of the act of reading this weblog entry (doesn't prevent others from reading it too; however, my site's bandwidth and your ISP connection is a rival good.) The second denotes high cost of preventing others from using the good. For example, while large high-speed roads can be made into tollways, rural roads cannot be feasibly made into tollways! Related to this are "externalities" - outcomes that inadvertently spill over to others - associated with these goods. Safe water prevents the spread of contagious diseases (the "contagious" should clue you in on the externality.) Education supposedly makes people nicer, more respectful of social order, and more informed about political and social options - crucial when decisions have to be made collectively, like choosing the President.

Knowledge is a public good. It's non-rival; excludability is often difficult (but not impossible for some types of knowledge - remember Coke's famous trade secret?) So R & D, which produces scientific knowledge, will be undersupplied by the private sector.

Pop quiz: government intervention in agriculture often involves supply of "postharvest facilities" - mechanical driers, storage centers, etc. - as well as "price stability" - the government engaged in commodity trade to reduce price volatility (as exemplified by the Philippines' National Food Authority). Can you explain why postharvest facilities and price stability will be systematically undersupplied by the market?

Agriculture - the missing link in the MDGs?

From the CGIAR (Consultative Group on International Agricultural Research ): Agriculture is essential step to meeting the MDGs. The argument for agriculture as a key element in the MDGs has been succinctly articulated here. First, agriculture is mainly what the poor are doing.

There are strong, direct relationships between
agricultural productivity, hunger, and poverty. Threequarters
of the world’s poor live in rural areas and
make their living from agriculture. Hunger and child
malnutrition are greater in these areas than in urban
areas. Moreover, the higher the proportion of the rural
population that obtains its income solely from
subsistence farming (without the benefit of pro-poor
technologies and access to markets), the higher the
incidence of malnutrition.

Second, there is a vicious circle of poverty, hunger, and development:

Hunger, and the malnourishment that
accompanies it, prevents poor people from escaping
poverty because it diminishes their ability to learn, work,
and care for themselves and their family members. If
left unaddressed, hunger sets in motion an array of
outcomes that perpetuates malnutrition, reduces the
ability of adults to work and to give birth to healthy
children, and erodes children’s ability to learn and lead
productive, healthy, and happy lives. This truncation of
human development undermines a country’s potential
for economic development—for generations to come.

Empirically the importance of agriculture in the redution of poverty is clear:

Empirical research provides stark evidence of the
benefits of agricultural productivity. In Africa, for
example, a 10 percent increase in the level of
agricultural productivity is associated with a 7.2
percent reduction in poverty. In India, a similar
increase in productivity has been estimated to
decrease poverty by 4 percent in the short run and 12
percent in the long run.

Calculations from a world food model suggest that an investment scenario for MDGs rquires an extra 161 billion dollars investment in agricultural development (a total of 591 billion over a 25-year period). This is sufficient for achieving the goal of cutting the world's proportion of undernourished children by half. There are five "key drivers" for agricultural development: education, rural roads, agricultural research, irrigation, and clean water.

One hundred sixty-one billion dollars. If implementing agencies and the international community can deliver, it's money well-spent.

Forgotten freedoms in the Philippine constitution

The Philippine Constitution of 1987 is big on political freedoms. Its protection of economic freedom though leaves much to be desired. Consider Article XII on "The National Economy and Patrimony." Section 1 starts off as: The goals of the national economy are a more equitable distribution of opportunities, income, and wealth; a sustained increase in the amount of goods and services produced by the nation for the benefit of the people; and an expanding productivity as the key to raising the quality of life for all, especially the under-privileged. The State shall promote industrialization and full employment based on sound agricultural development and agrarian reform, through industries that make full and efficient use of human and natural resources, and which are competitive in both domestic and foreign markets. However, the State shall protect Filipino enterprises against unfair foreign competition and trade practices.


Nice. Equitable production is defined as the primary goal of the economy. Expanding productivity is pinpointed as the "key" to increasing living standards.

Sinister undertones however can be seen in the phrase "protect Filipino enterprises." How does one define "unfair" foreign competition and trade practices? These days any cheap foreign product becomes a magnet of accusations of unfair trade.

Where is the constitutional protection of the Filipino consumer's freedom to choose?

Section 2 is on natural resources: All lands of the public domain, waters, minerals, coal, petroleum, and other mineral oils, all forces of potential energy, fisheries, forests or timber, wildlife, flora and fauna, and other natural resources are owned by the State. With the exception of agricultural lands, all other natural resources shall not be alienated. The exploration, development, and utilization of natural resources shall be under the full control and supervision of the State. The State may directly undertake such activities, or it may enter into co-production, joint venture, or production-sharing agreements with Filipino citizens, or corporations or associations at least sixty per centum of whose capital is owned by such citizens. Such agreements may be for a period not exceeding twenty-five years, renewable for not more than twenty-five years, and under such terms and conditions as may be provided by law. In cases of water rights for irrigation, water supply fisheries, or industrial uses other than the development of water power, beneficial use may be the measure and limit of the grant.

Okay: private enterprises in mining, water supply, etc. must be sixty percent owned by Filipinos. Why the restriction? Ownership is vested in the state, so whatever benefits are due to the state can be had through production sharing agreements, etc. The restriction may prevent the state from gaining access to the best value-for-money investors worldwide. More of this constricting effect from the following:

Section 10: In the grant of rights, privileges, and concessions covering the national economy and patrimony, the State shall give preference to qualified Filipinos.

Section 11. No franchise, certificate, or any other form of authorization for the operation of a public utility shall be granted except to citizens of the Philippines or to corporations or associations organized under the laws of the Philippines, at least sixty per centum of whose capital is owned by such citizens; nor shall such franchise, certificate, or authorization be exclusive in character or for a longer period than fifty years.

The following may be abused:
Section 17. In times of national emergency, when the public interest so requires, the State may, during the emergency and under reasonable terms prescribed by it, temporarily take over or direct the operation of any privately-owned public utility or business affected with public interest.

The justice secretary has been mulling current oil pricing conditions as the "trigger" for a takeover. Triggers such as breakdown of law and order, crippling labor strikes, etc. may conceivably be an excuse for such temporary takeover. But high input prices? When the government takes over, it's going to pay the high input prices anyway. If it sells the product at low prices, then it will have to foot the bill from the general tax fund, sooner or later. Moreover government can invoke "emergency powers" to run amok with its fuel rationing schemes. But markets under free competition already have a rationing scheme in place - prices. This system preserves the freedom to trade and to refuse trade as warranted by individual choice. Where is the constitutional protection of this freedom?

Amendment of the charter should involve repeal of Constitutional provisions against foreign ownership. (Die-hard nationalists still have recourse to Congress for imposing restrictions.) The Constitution should also contain explicit statements about protecting economic freedoms of all individuals, particularly those of consumers, who are the most encompassing of the economic classes. This way it gets easier to argue against protectionist pressures. Finally, a Constitutional provision on controlling public debt to manageable levels may also be contemplated, if only to protect the freedom of future generations from the profligacy of their forebears. This makes it easier to argue against the entitlement-and-subsidy mentality.

Strange how economic tyranny can persist, even under a democratic government. Charter change provides a wonderful opportunity to rectify this inconsistency.

Growth isn't the only thing good for the poor

The old saw, "the rich get richer, but the poor get poorer", is all bunk. Economic growth is good for most people, including the poor. What's better is: The rich get richer, but many of the poor get left behind. This is the misfortune of uneven growth. However this doesn't mean we should stunt the economy. That would be a terrible tragedy. Poverty can only be eradicated once and for all by a healthy and growing economy.

However this fact should not paralyze anti-poverty efforts. Much can be accomplished to alleviate poverty without compromising rapid economic growth. In many cases antipoverty programs can simultaneously address growth and poverty reduction - for example, public health measures can simultaneously address a basic need and raise worker productivity.

The latest Human Development Report (United Nations Human Development Program) highlights this very well. They rank countries based on the Human Development Index (HDI, a broad indicator of a country's well-being) as well as per capita GDP (an income indicator of average well-being). If you look at the last column of Table 1, you will see the difference between per capita income rank and the HDI rank. A positive difference means that per capita income rank is below the HDI rank - meaning, the country does relatively better in delivering human development, given relatively inferior incomes. Lots of "bang for the buck". A negative difference means a country is underperforming - average income is relativeley high, but its ability to deliver human development relatively low.

So look at Cuba - the rank difference is +40! (Whatever damage socialist policies have done, they should be recognized for their accomplishments.) Oil states Oman and Saudi Arabia are -30 and -37 respectively. Wonder where all that oil revenue is going.

The Philippines (ranked right in the middle at 84 with respect to HDI) has a rank difference of +19. Not bad, not bad at all. China, despite growing income inequality in the last three decades, still weighs in at +11 (to be socialist once seems glorious!)

Now scrolling down to the bottom are some eye-popping numbers: South Africa, -68, Equatorial Guinea, -93; Botswana, -70. (A lot of this has got to do with diminished life expectancy due to the AIDS epidemic.)

Everybody should get busy making money and getting the growth engine running. But general-benefit institutions (government, donor agencies, noprofits, etc.) should be even busier, and be adequately funded. (That means your pocket, and mine too.)

Thumb twiddling is not an option.

More on stimulating aggregate demand

A reader asks the following question:

Consider for example an employer that, instead of giving the household helper a raise, keeps the money under the mattress, or another situation where the household helper is given a raise but instead of spending also keeps the money in the wallet. But what good to the economy is that money or purchasing power? It is in the exercise of purchasing power where the magic of Hyperwage Theory begins. If the employer is an entrepreneur, he may use the savings (purchasing power) to expand or conduct a new business, employing more people in the process. By the labor of these additional employees and use of other economic resources, more goods and services are produced or rendered. Additional profit or savings is made and the purchasing power is further increased. If the employer is just a saver and does not conduct any business, he may transfer the purchasing power or deposit the money in a bank that will in turn loan it to an entrepreneur, employing more economic resources and increasing further the purchasing power.

So we see that purchasing power is increased by additional labor and other economic resources that are employed through the exercise of initial purchasing power. Otherwise, these economic resources would remain idle and be wasted by mere passage of time. This is why if the economy is stagnant or sluggish, investors are encouraged in business and the government is urged by economists to spend in order to stimulate the economy. Now, here is a question: "Who should be in a better position to exercise the initial purchasing power for the economy, the employer or the household helper?" Let's discuss your answer next time.

Pol Espanola
Saudi Arabia


I'll break up my answer into two parts (see my hyperwage posts for a background):

First, when there is unemployment, then increasing demand will stimulate output momentarily. Maybe hyperwage theory entails a transfer of income from a sector with low propensity to consume to a sector with high propensity to consume. I'll grant this for the sake of argument. (Hyperwage is not actually a transfer unless government also enforces a no lay-off policy.) We can represent this by an income transfer from "employer-households" (direct purchasers of labor, and owners of business firms) to "employee-households" (those who obtain income mostly from selling labor). I'll use simple maths in the following, so bear with me.

I need to introduce the concept of "marginal propensity to consume", or MPC. This is the amount of extra spending that a household will undertake given an extra dollar of income. This is a fractional number. Suppose employer-households have a low MPC, say 0.5. Employee-households have a high MPC, say 0.9. Let there be a fifty-fifty split of total income Y between these two household-types. For simplicity, suppose consumption is the only form of spending in the economy. Consumption unrelated to income ("autonomous consumption") is symbolized by A. Then equality of aggregate income and aggregate demand requires:

Y = A + 0.5(0.5Y) + 0.9(0.5Y)
Y = A + 0.7Y

Y = A/0.3 = 3.33A. So if A = 100, equilibrium national income is 333.33.

Okay, let's transfer 50% of income from employer-households to employee households. Then the income share of the former is down to 25%, tne latter up to 75%. We get:

Y = A + 0.5(0.25Y) + 0.9(0.75Y)
Y = A + 0.8Y
Y = A/0.2 = 5A. So A = 100 implies national income of 500.

If full employment is 500, that's it; even more transfers of income from employer-households to employee-households will not increase output any further.

Which brings me to the second point: failure of an economy to grow in the long term is not due to lack of demand. Think of the maximal output that a country can produce given its available resources. That is the full employment output. There is no aggregate demand "magic" that will push the economy beyond this frontier.

The full employment output of a developing country cannot reach the per capita output of developed countries. The per capita income of the Philippines is about US$ 1,000; this is less than 1/30th that of the US. Eliminating unemployment (even though it stands now at about 11%) cannot close this gap. The above cartoon example gives a good indication of the orders of magnitude involved: from 333.33 to 500 may look like a big jump, but this is nowhere near the twenty or thirty-fold increase we are looking for to reach developed country standards.

For that, we need to look beyond the demand side, to the supply side: the amount of resources available, and the aggregate level of productivity. I have an earlier post about it here.

Hope this helps.

Cutting the pie fairly makes it bigger

The size of the pie is independent of how you cut it up. This is a central claim in economic theory: markets allocate resources efficiently, no matter how wealth is distributed. Of course you need some assumptions to obtain the market efficiency result (perfect competition, no externalities, etc.) These deviations from the ideal, or market failure, for a long time lay in the dark underbelly of economics.

Equity however is a widely accepted dimension of development. Many underdeveloped countries are characterized by gross inequities, which goads the state to undertake redistribution. The old conventional wisdom saw a trade-off between enforcing equity and achieving efficiency. After all, markets are efficient (regardless of wealth distribution), while redistributive measures would create distortions. For example, income taxes to finance income transfers to the poor would be a disincentive to supply labor. Subsidies on goods patronized by the poor would either weigh the economy down with onerous taxes, or else penalize investment through government borrowings. Another source of investment disincentive would be expropriation of the assets of the rich in favor of the poor.

Now the conventional wisdom appears to be moving the other way: inequality is thought to be associated with various inefficiencies. The latest World Development Report ("Equity and Development") provides plenty of evidence for this emerging view (hat tip: Pablo Halkyard of PSDBlog.) See especially chapters 5 and 6. Hence, equity is not just a dimension of development in its own right; correcting it would improve the allocation of resources. Cutting up the pie fairly makes it bigger.

After decades of research, complementaries between equity and efficiency are now front and center of development economics. For example, it's widely held that capital markets are afflicted with "asymmetric information", i.e. the creditor doesn't have the same information about investment risk that a borrower has. So they typically require collateral; this obviously works against the poor, who need the loans to undertake productive investments in themselves (e.g. education) or their enterprises.

This doesn't mean markets should be dispensed with, or that any redistributive measure will do. The equity-efficiency trade-off still holds if the wrong redistribution policies are implemented. Crafting the right set of policies and institutions to simultaneously improve equity and efficiency is the big challenge of economic development.

How to jack up oil prices even more

As oil prices soar, so does the worldwide public outcry against Evil Big Oil. Consumers are squeezed dry as Evil Big Oil soaks up the profits. Why don't they flood the markets with oil to give consumers some relief?

Informative article from BusinessWeek. To quote: There's no way the oil majors can flood the markets, for the simple reason that it takes years to find the oil, build the refineries, and construct the pipelines that will turn a shortage into a surplus.

The shortfall in refining capacity is appaling: No new refineries have been built in the U.S. since 1976, because of a combination of regulatory hurdles and local opposition. And the majors still see refining as a poor business, although profits on refining are now very lucrative at $20 per barrel, vs. under $5 per barrel as recently as the fourth quarter of 2004.

Nor is finding the oil a walk in the park: Despite the risks, oil companies have boosted exploration substantially. Norwalk (Conn.)-based consultants John S. Herold Inc. report that 200 oil companies have roughly doubled exploration spending to a combined $180 billion for this year. "They're certainly spending a lot more. Whether or not they are spending enough, that's up for some debate," says research director Nicholas Cacchione. But while they explore more for oil, the oil is harder to find. Companies are being forced to replace their depleted sources of oil and gas in the West with new supplies in politically and geologically more challenging areas, from Russia to the deep water off West Africa. "The companies are making more money, but they have more risks," says J. Robinson West, chairman of Washington-based consultants PFC Energy.

The biggest risk comes from the inability to predict the long term trend of oil prices: Executives need to make multibillion investment decisions without knowing whether oil prices are going to keep rising or plunge to the $20 range that prevailed through the 1990s and inched up gradually until 2004. Now companies are slowly increasing their pricing assumptions. Browne says BP figures prices will remain around $40 per barrel for the next five years. But the industry's leaders, who rose up the ranks in the relatively lean times of the '90s, are still being conservative -- some think obstinately so. No oil executive will cut a deal for five years out assuming that today's spot price of $65 will prevail.

Do you want to make sure that oil will cost over a hundred dollars a barrel? Easy. Compound the uncertainty facing Big Oil by threatening taxes on windfall profits. Send them a signal that whenever it becomes more attractive to invest in oil drilling and expanding refinery capacity, along comes Big Government to take it all away. Since you've pushed the return on investment down, don't be surprised that investment to expand oil supply goes down. Supply stagnates, while demand continues to grow.

It's that simple. Let's give it a try.

Are the poor catching up with the rich?

Imagine - a world which enjoys a standard of living similar to that enjoyed by the citizens of an OECD country. This is the dream scenario for economic development. Can this ever happen? One way to answer this question is to look at the trends. If the poor are catching up with the rich, then perhaps in the long run the dream may come true.

The famous Solow model of economic growth predicts that the rate of economic growth should converge over time - that is, poor countries should catch up with the rich countries. However, Pritchett (1997), in a Journal of Economic Perspectives paper, points out that the gap between incomes of poor and rich countries is widening - and therefore world inequality is worsening over time. In 1870 the ratio of the richest to the poorest countries' incomes was 8:1; by 1990 the ratio was a staggering 45:1.

Fortunately this finding is not the whole story. It turns out that the economic growth in the last few decades has been concentrated in a number of countries with large populations of the poor. And two of them dwarf all the rest - China (rapid growth since the 1980s) and India (moderate to rapid growth since the 1990s). Hence a population-weighted measure of income inequality across countries shows convergence of living standards over time (Xala-i-Martin, 2002).

Finally, Becker et. al. (2005) showed that inequality analysis based only on a simple income measure is incomplete. A better measure is "full income", which adjusts a country's per capita income with improvements in average longevity. Their findings fully reinforce the convergence hypothesis, even at a country level. Gains in life expectancy were substantial even for the poorest countries in their sample. Full income in developing countries nearly doubled between 1965 and 1995, while that of developed countries grew by less than one-and-a-half times. Gains in longevity were realized through public health improvements and the spread of medical technology.

So - are the poor catching up with the rich? Well, they are gaining ground. The dream lives.

The Millenium Development Goals

What is does "development" consist of, in the medium term? According to the Millenium Development Goals (MDGs), the global deliverables by 2015 are:

1. Halve the incidence of poverty and hunger.
2. Ensure universal primary education.
3. Eliminate gender disparities in primary and secondary schooling.
4. Reduce the child-under-5 mortality rate by 2/3.
5. Reduce the maternal mortality ration by 3/4.
6. Halt and reverse the spread of AIDS, malaria, and other major diseases.
7. Ensure environmental sustainability.
8. Develop a global partnership for development.

Do you see the odd persons out? Well 1 to 6 seem like measurable indicators. Goals 7 and 8 are much more amorphous (see the expanded list of objectives here.) It includes "significant improvement in the lives of 100 million slum dwellers", "make available the benefits of new technologies, especially ICT".

Aside from un-measurability, the MDGs suffer a confusion between ends and means. Surely we are less interested in a person gaining access to the internet, compared to a hungry person getting food. Perhaps wider ICT dissemination may improve economic growth to the point that hunger can be eliminated; but then that is an end, not a means.

John Bolton, the US representative to the United Nations, is critical about these goals. In one sense I agree with him. It's such a crying shame that very laudable objectives 1-6 are held hostage by the incoherent and instrumentalist elements in goals 7 and 8. But advocates of the goals (who privately acknowledge defects in their statement) seem unwilling to budge, under the idea that any revision may open the floodgates for watering down the entire Declaration.

At the global stage, politics has shown itself, yet again, as the art of the impossible.

A millenium debt swap?

Following the debt relief extended to highly indebted poor countries, it's the turn of the middle income countries: Philippine president Gloria Macapagal-Arroyo has proposed a debt swap to support the Millenium Development Goals (MDGs). According to her statement: In their case we propose a large-scale 50% conversion of debt for Millennium Development Goals financing programs. We are not asking for debt forgiveness or debt cancellation. What we propose is that the debt service or principal amount should be converted into equities in new projects of at least equal value and with their own potential earnings.

How does this work? Well suppose the Philippines needs to pay debt servicing of 1 billion dollars in 2006. The debt swap proposal means it will only pay 500 million; the remainder will be invested as equity in new projects that contribute towards the MDGs. Presumably, the project earns income, part of which goes to the participating creditor as dividend. After all, the main proponent (the Congressional House Speaker Jose de Venecia) claims that “the proposal does not call for new monies from the parliaments and governments of rich countries and participation by creditors in the debt-for-equity program would be voluntary. He said the proposal would not reduce the value of the creditor's financial assets. “They would have the option of choosing which profitable or allied MDG projects to support in specific debtor-country,” he said.

Essentially, the foregone debt payment is replaced by project earnings. Earnings can come from user fees (e.g. from irrigation and potable water schemes), product sales (e.g. from an agroforestry program), and the like. Alternatively, project earnings could have instead been collected for debt servicing. What difference would the debt swap then make? I can see four:

First, creditors would now presumably assume part of the risks in obtaining earnings from a project. These risks include: collection problems, poor project design, faulty implementation, economic and natural shocks. I see this as the major sticking point: if project earnings are backed by guarantee by the domestic government, then I really don't see the advantage of the swap.

Second, the swap would force both borrower and creditor to design projects with a serious income generating component. Very often projects are implemented without this component, leaving only the general tax fund as the source of debt repayment.

Third, half of the debt service bill is precommitted to MDG projects. The precommitment serves as a guarantee that the borrowing government will invest in MDG projects; moreover, the borrowing country is assured of a floor commitment for donor funding (indirectly, that is) in the medium term.

Fourth, a debt swap will be seen favorably by private lenders as a reduction in the effective debt burden of a borrowing government (if does not extend dividend guarantees.) This may widen the borrower's access to private funds for development.

The President's wish is that this debt for MDG proposal will find its way into the Summit declaration and that the Paris Club, the G-8 governments, the IMF and the World Bank, the regional development banks, and the world's large commercial banks will approve this proposal.

However the Outcome statement from the Summit says: We further stress the need to consider additional measures and initiatives aimed at ensuring long-term debt sustainability through increased grantbased financing, cancellation of 100 per cent of the official multilateral and bilateral debt of heavily indebted poor countries and, where appropriate, and on a case-by-case basis, to consider significant debt relief or restructuring for low- and middle-income developing countries with an unsustainable debt burden that are not part of the Heavily Indebted Poor Countries Initiative, as well as the exploration of mechanisms to comprehensively address the debt problems of those countries. Such mechanisms may include debt for sustainable development swaps or multicreditor debt swap arrangements, as appropriate. These initiatives could include further efforts by the International Monetary Fund and the World Bank to develop the debt sustainability framework for low-income countries. This should be achieved in a fashion that does not detract from official development assistance resources, while maintaining the financial integrity of the multilateral financial institutions.

In short, sympathetic but non-commital. Problems abound where the devil is, so instead of a blanket endorsement, the statement just refers to some "case to case" assessment. However there are other forums and meetings where the proposal can be taken up. Let's see whether there will be a millenium debt swap, after all.

Measuring the wealth of nations

Incredibly useful new indicator from the World Bank: the wealth of nations.

How did they do it? Total wealth is equated to the present value of the consumption stream. The WB also calculated the value of natural resources and capital. The difference between the value of physical stocks and total wealth is attributed to "intangibles", such as human capital and institutions. (Hence, the value added of the publication is not mainly in its estimates of total wealth, but rather in how total wealth is broken up into components.)

Some results: Globally, most wealth is in intangible form (77%); this is followed by capital (18%) and natural resources (5%). Needless to say, most wealth is in the hands of high income countries (which is to be expected given the method of computing total wealth). However in low income countries the share of natural resources is much greater, at 29% (with only a 16% share of capital in total wealth).

Assuming the now wealthy economies started out like today's low income countries, what they were able to do therefore was convert their resource stocks into other forms of assets. Thus the World Bank data gives us a quantitative handle on the issue of "sustainable development" - often mystically restricted to maintaining natural resource flows, neglecting the possibility that these resource flows can be converted into other forms of wealth.

Evaluating hyperwage theory - or, what have you learned from your basic economics? (3)

In this post, I examine the economic adjustments ensuing in the aftermath of a hyper minimum wage. First, businesses would be able to pass on some of their higher cost to their downstream buyers. That way they spread around, at least in part, the redistribution in purchasing power I was talking about. So this passing on of cost gets measured as the inflationary effect of the hyperwage. This is a one-off price increase, unless (as I explained earlier) driven by money creation.

So far it sounds like redistribution of purchasing power, but the same economic output. Sorry, it's not as benign as that. Let's look at the second effect.

As labor becomes more expensive, employers cut down on their use of labor. (The problem is worsened if the minimum wage is set in real terms; even the offsetting effect from cost-push inflation will fail to materialize.)

This is because demand curves for labor slope downward. It really can't get much simpler than that. Many middle class households will have to say goodbye to their helpers. Too costly. What will they use instead? In the home, substitute household help with work done by household members themselves. (Poor Mommy!) In the factory, substitute with machinery or computerized systems. Or just simply shrink your business if you can't afford this either.

So the economic output will not remain the same. Because workers have been thrown out of work, economic output falls. Hyperwage theory is really better called hyper-unemployment theory.

Why would output fall? Because resources are idle. Why are resources idle? Because labor has been made artificially expensive by the minimum wage law. Workers would be willing to work at a lower wage than the minimum. (This is an unquestionable fact, look at the market right now.) They would prefer it to having zero labor income from being unemployed.

It gets worse - who would be the workers who remain in the work force? Why only the best and brightest, from whom employers are getting their money's worth at the hyperwage. The brunt of the unemployment problem would fall on the unskilled, i.e. the poor. So we can also call hyperwage a hyper-poverty theory.

This concludes our lesson on Basic Economics in Action: the case of the Hyperwage theory. Class dismissed.

Evaluating hyperwage theory - or, what have you learned from your basic economics? (2)

Okay the action is heating up in the comments section of Part 1 of this post. But on to Part 2, which is actually in reply to the following questions:

"why wouldn't Keynesian economics work in this situation - where increasing demand will create its own supply?" - Micketymoc

"Let's say it's early in the process, and people can all of a sudden afford to buy these goods. Given that the supply remains constant (nothing indicates any productivity increase), wouldn't that jack up the price?" - AT

Answer: there will be no surge in demand, because hyper-mininimum wages do not actually increase purchasing power in the economy, even temporarily.

Why? Suppose you give your household helper a raise, equivalent to 12,000 a year. So her purchasing power goes up by 12,00. But you the employer, suffered a loss in purchasing power, by exactly that amount of 12,000. So there is no net increase in purchasing power in the economy.

Suppose hyper-minimum-wages are in place, and (at current employment levels) it will require employers paying an additional (number-pluck) 2 trillion pesos. This is a simple transfer of purchasing power of 2 trillion from employers to employees. Again, there is no net increase in purchasing power.

Let's see how this transfer effect can be avoided:

1. Suppose employers are entitled to a free cash voucher from the Central Bank to enable them to pay the hyper mininum wages. The vouchers, once converted to cash, must be supported by printing money. Then purchasing power of workers (as they perceive it) goes up, while that of employers (as they perceive it) remains constant. Then perceived purchasing power in total goes up. However this will be the case of high perceived spending power chasing the same amount of goods; this will drive the average price level up. Then the nominal hyperwage goes down. If the minimum hyperwage is kept constant in real terms (through wage indexation), then the CB will always have to print money - and that is the source of hyperinflation.

What about the argument that imported goods will have the same price, and therefore there will be no hyperinflation? Wrong again. Foreign goods and services will appear temporarily cheaper to Filipinos. In a liberalized forex market, they will bid for dollars to buy cheap foreign goods and services. Again, lots of money chasing the same amount of foreign goods: the peso value of these goods go up, i.e. the peso must depreciate.

2. Suppose government pays an additional 200 billion pesos in minimum hyperwage for its employees, but this is not supported by CB printing more money or by new taxes. Then government has to borrow to support what is essentially a transfer payment. Suppose it borrows using T-bills.

2.1. If the economy is under full employment, then the goods procured by the additional spending (of employees) will have to take resources away from other uses, because there can no longer be additional production. This happens essentially through rising T-bill rates, which shifts resources from investment goods to consumer goods. In a sense, purchasing power shifts from investors to consumers, because investors have to pay higher interest rates. This is the "crowding-out" effect.

2.2. Suppose instead there is unemployment due to a shortfall in aggregate demand. Then consumption of government employees can rise, even without taking away resources from investors; idle resources (the unemployed) are given jobs due to the injection in aggregate demand. If the shortfall in aggregate demand (to reach full employment) happens to be 200 billion pesos, then there will be no crowding out and no increase in interest rates. This was Keynes' central insight: if full employment cannot be supported because it fails to generate enough private sector demand (in violation of Say's Law), then the demand gap can be filled by public sector demand.

However the original hyperwage theory has none of these qualifications. Just a sheer assertion that the "circular flow" will take care of it. Sorry, the circular flow is a flow of value and goods; value (and goods) are shifted from one party to another party in the case of a hyperwage policy, but it's still the same value (and goods) flowing around. The policy can not possibly increase aggregate demand, under any circumstances, full employment or underemployment. Hyperwage theory is dead in the water.

Hyperwage claims to be a revolutionary new theory. However it is merely another variation in the endless quest for the free lunch. In physics, this is seen in the perpetual motion machine. In economics, we have Congressmen advocating public debt to be charged to the Central Bank; we also have hyperwage theory. We need honest-to-goodness science to remind us: there ain't no such thing as a free lunch.

[Next post: will the employers take their additional wage bill sitting down? Not at all - let's explore the implications of their reactions in Part 3 of this series on hyperwage theory.]

Evaluating hyperwage theory - or, what have you learned from your basic economics? (1)

I’ve been requested by a reader of this Weblog to take a look at “hyperwage theory.” In response, I’ve decided to review Street Strategist’s (SS) series of articles in Business World presenting this theory. I think it will prove to be instructive illustration of the usefulness of basic economics. Note: Not being a Business World subscriber, I requested a copy of the collated articles personally from SS (streetstrategist@gmail.com), so if want a copy I suggest you do the same.

My interest was piqued by the following:

If you have a PhD in economics, ah, there you are. My ideal audience. Why? Because by this time, with your PhD you have shall been brainwashed by the theories of economics. And I consider it a good challenge to turn your entire education head over heels. If you hear me out, and afterwards, you still say I’m an economic idiot, I always was. (p. 9)

Hmm. I have a Ph.D. in economics. And am directly insulted as a voluntary victim of brainwashing. In fact the entire work is one long slanderous tirade against economists. We’re in good company then – astronomers have been vilified by Velikovsky, archeologists have been damned by von Daniken, biologists have been bashed by any number of creationists. What’s new? In the following though I have decided not reciprocate SS, as I have recourse to infinitely superior tools of logic and evidence.

First, let’s look at the basic claims of hyperwage theory:

The minimum wage shall be set to a level that shall give purchasing power to the minimum wage earners, including domestic helpers, unlike current levels wherein the domestic helpers have almost zero purchasing power. A hyperwage resulting in real purchasing power will stimulate domestic demand which in turn will stimulate production which in turn will stimulate employment. This domestic demand, under the power of the economic multiplier will result in increased production of goods or services which in turn will result in more employment in a positive upward spiral.
The theory rests on the proposition that hyperwage does not automatically result in the same amount of hyperinflation in a Third World country. The logic for this is that many goods and services in Third World countries are already being sold at First World prices. (p. 12)

For discussion purposes, the minimum wage shall be set to be P20,000 per month for domestic helpers; about P70,000 for fresh college graduates. This is deliberately set comparable to Hong Kong and Singapore to avoid the labor wage arbitrage that is causing our school principals to work in Hong Kong as domestic helpers.(p. 14)

To back up his claim that wages across countries are misaligned, SS argues:

Why not equal pay for an equal amount of work? Or better stated, equal working hours to buy the same amount of goods? (p. 76)

He argues moreover that price increases due to hyper minimum wages will not increase prices of other commodities (much):

If the minimum wage of the domestic helper rises from P2,000 to P20,000, or ten-fold, will those assets also rise by ten-fold? Your computers, your TVs, your stereos, your cement, and everything, think about them. Where were they manufactured and what are the prices of these goods in the First World countries? And then think about your domestic helper. If she has P20,000 how many stores and how many products will benefit from this purchasing power? Will there be deflation? No? Will there be inflation yes, and I welcome it. Think about this. Make a matrix, a table of comparison of prices before Hyperwage and after Hyperwage. Will your HP Compaq Tablet PC currently worth P100,000 rise ten-fold to P1 million? Or will it be lower because many people can now afford to buy them? Higher volume, lower price. Think, go ahead, think. Think of al lteh [sic] product you see in the world. Will oil prices rise ten-fold? Cars? Nokia? Aircons? (p. 95)

Before I proceed, let me throw it back to you, faithful reader. Are any of these claims valid? If invalid, how would you go about refuting hyperwage theory? This exercise is a great illustration of the usefulness of economics - as device for rigorously identifying bad economic policy. So I'll post my evaluation later to give yourself a chance to exercise!

Aid and growth

Hat tip to the New Economist (in turn indebted to Ben Muse): Can More Aid Make Poverty History? - from Finance and Development, an IMF publication.

My highlight: "Aid and Growth." Their study indicates that:

1. "Early Impact Aid" (for projects with immediate growth benefits) has a strong and positive effect on economic growth. Roughly put, a $1 increase in aid increases income by $1.64 (where future income follows are converted to current income equivalent, or "discounted.")

2. Aid works even in countries with bad institutions, though it probably works better in countries with good institutions.

These findings do not detract from the reality of aid wastage in numerous individual cases. (Think Philippines, Marcos, Bataan Nuclear Power Plant. Think of tinfoil dictators in Africa and Latin America.)

However, the salutary effects of aid on growth raises serious questions about why there is an apparent struggle by heavily indebted developing countries to repay their loans. (By design, development assistance is largely in the form of "soft loans" with typically lower-than-market interest rates with generous terms of repayment. That's why it's called "aid".) I checked out the study cited by the article (available here). Turns out that within their data set, early-impact aid accounts for 45% of total aid; 46% is accounted for by aid with long-term impact (not measured in their study). The remainder (8.6%) is humanitarian aid (often disbursed as grants.)

Perhaps long-term impact aid does not really have that much of an impact. This would go a long way to explaining why some countries struggle with repayment and clamor for debt relief. But I suspect another reason: inability to raise tax revenues from beneficiaries of growth, whether from short-term or long-term aid. Particularly for countries were budget and budget finance is prey to populism, there is a natural proclivity to accumulate a massive debt burden across the board, not merely in the form of foreign aid. Since there is virtually no prospect for relief from domestic debt (largely held in the form of Treasury bills, bonds, and other government securities), the onus of relief falls upon foreign debt. However such debt relief can only be temporary, unless the root cause of the problem - spending and revenue policies of debtor governments - is decisively addressed.

Are we back to institutions and growth again? You bet.

Foreign exchange instability

From yesterday's Business World (excerpts):

Contagion from Indonesia feared; BSP cites inflation threat

SINGAPORE/MANILA -- Southeast Asian central banks are expected to raise interest rates more aggressively to pre-empt any contagion from spilling over from Indonesia and roiling their markets.

Countries such as the Philippines, Thailand and even larger economies such as India are vulnerable to speculative attacks unless they bump up rates and cut fuel subsidies, analysts yesterday said.

The comments reflect a growing uneasiness in markets that Southeast Asian central banks have been too passive in dealing with rising inflation expectations, the main spark for last week’s turmoil in Indonesia’s markets.

The Bangko Sentral ng Pilipinas (BSP), which raised rates in April for the first time in nearly two years, should raise them further to defend the peso, the Bank of Tokyo-Mitsubishi said.

WORST-PERFORMING CURRENCIES

After the rupiah, the Indian rupee and the peso have been Asia’s worst-performing currencies in the third quarter, reflecting market concern about the impact of soaring oil prices.

Philippine inflation has been running above the central bank’s target rate since August 2004, providing ample grounds for higher rates, Bank of Tokyo-Mitsubishi said.

"We could not help but notice the similarities between the Indonesian rupiah and the Philippine peso, such as a severely impaired fiscal balance sheet, a weak external trade position, policy inertia and modest foreign reserves," it said.

"Given the precedence set by the rupiah’s experience, we remain bearish on the outlook for the Philippine peso."



Something to watch out for: currency movements. The Indonesian rupiah has sunk to four year lows, and some analysts are warning of a contagion effect.

As usual speculative "hot money" has been blamed. However this speculative money is pouncing on real weaknesses. In the case of Indonesia, its inability to dismantle fuel price subsidies has further strained government finances. (At least we got the Oil Price Stabilization Fund albatross off our necks, years ago.)

How bad is a speculative attack on the currency? It is easy to overblow the problem. Hot money outflows imply that short-term financial investments are relatively less attractive at the same interest rate. Eventually expectations about currency movement should stabilize (and so should the currency itself). Inflationary pressures are unavoidable, but these represent one-off changes in the domestic price level in slow motion, as it were. On the other hand tightening domestic credit during an economic slowdown may not be such a good idea. A Central Bank which does a "dirty float" faces perrenial problems in balancing domestic objectives with the targeted exchange rate. Moreover if the domestic costs (of tight money) are deemed too high as to be unsustainable, the dirty float may perversely spawn speculative pressure on the currency. Finally a cheaper peso (superstitiously thought by some to be ipso facto bad for the economy) is a boost to exports. Some economists think that a cheap currency is an essential component of an export-oriented industrial policy - China's undervalued yuan is an oft-cited case. If so, speculators may be doing the Trade Secretary's job for him. And without the onus of "beggar-thy-neighbor" resentment - such as what China is getting from the US.

Stability and the take-off

Earlier I referred to the outward-oriented policies in the East Asian high performers as a key ingredient of their take-off. The Philippines has made considerable headway in reforming its trade policy towards an open economy. It has also implemented numerous other reforms, such as privatization (utiities, financial institutions, etc.) and deregulation (telecommunications, oil industry, domestic air travel, etc.) Where is the "reform dividend"? Why hasn't the country grown faster?

The usual answers:

1. Reform hasn't been deep and credible enough.


2. Policies have not been conducive to macroeconomic stability and high domestic savings.


3. Investment in infrastructure and human capital (education) has been insufficient and misdirected.


4. Political stability has eluded the state.


5. Institutions remain weak and vulnerable to entrenched economic interests and conflicting political forces.

Note that the fifth element is interrelated with the preceding ones. Tonight though I'd like to talk about the fourth factor.

We know by now the latest in the President of the Philippines' impeachment saga: the impeachment complaint has been thrown out by Congress. The motley crowd of impatient rallyists - including a former President, the widow of a demised Presidential candidate, assorted Leftists, and various holdover politicos from previous administrations - are taking to the streets. Invoking the "will of the people", they threaten to subvert the Constitutional process and force the President's ouster. (Ever notice that more crimes have been committed in the name of the people, than in any other name, except God? Now I know why they say, vox populi, vox Dei!)

I have nothing against people exercising free speech and saying the President should quit and so forth. However hinting of a forcible ejection of the occupant of Malacanang by a big enough mob - that is an entirely different matter. But that is precisely what the rhetoric of people power is suggesting.

There is evidence linking political stability to higher growth. The effect is typically through investment; investors may be unwilling to invest if they find policies and even property rights to be fragile, either due to a possible change in government, or due to actions by a government under threat of collapse. Barro (1991) conducted a cross-country regression and found that measures of political stability are positively related with growth rates. Brunetti (1997) showed that policy volatility and subjective perceptions were the most important among the political factors influencing cross-country growth rates. Commeau (2003) compares Latin America and East Asia and finds that growth in the former may have been retarded by sociopolitical instability; in turn instability was affected by adoption of policies that control inflation, foreign debt, and promote economic freedom. The case of Burundi (a country in Africa) shows that a country which has pursued significant trade policy reform may still fail to reap a growth dividend, without sustained sociopolitical stability (Milner, 2004).

Perhaps the President is guilty; however unless there's better evidence, the complaints - 1, 2, or 3 - are too weak to nail her. An illegal wiretap, which represents an explosive threat to civil liberties of every Filipino, cannot be the basis of removing her. There is one year in between, which may be the opportunity to gather more convincing evidence. And then file another complaint, which will have a better chance of going through Congress and thence an impeachment trial in the Senate. This is all part of the constitutional process and I daresay is not inimical to political stability (unlike the people power option).

Ideal? Yes, but then the "people" did say an overwhelming Yes to a Constitution in 1987. This is the true "will of the people."

I think Tolstoy said it best in the title of his famous story. "God Sees the Truth, but Waits."

References:

Barro, R. 1991. Economic Growth in a Cross Section of Countries. Quarterly Journal of Economics 106(2): 407-443.

Brunetti, A. 1997. Political Variables in Cross-Country Growth Analysis. Journal of Economic Surveys 11(2):163-190.

Comeau, L. 2003. The Political Economy of Growth in Latin America and East Asia: Some Empirical Evidence. Contemporary Economic Policy 21(4):476-489.

Milner, C. 2004. Trade Policy in Burundi: Reform Without Stability. The World Economy 27 (9), 1363-1376.

Calls for protection

It's not only JG Summit which is asking for tariff protection - to the detriment of manufactureres downstream, who use plastics, say for packaging.

The oil price hikes are provoking calls for domestic refining capacity. So the Energy Department is mulling a tariff differential (between imported crude for further refining, and imports of refined products). This is going to hit the new players, who do not have their own refining plants. And it will confer advantages on the Big Three, who are in the best position to invest in refineries. (Two maintain refineries; Caltex shut down its San Pascual refinery in 2003.) This is the kind of policy that promotes market power - not deregulation!

The rationale for the tariff differential has been expressed by Boo Chanco:

As we are now seeing, in times of crisis, the refiners have a better handle on managing the price surges than the product importers. The importers must reflect every convulsion in the spot market immediately. The refiners have a little more lead time. The refiners who buy crude usually on long-term contracts, also get better prices. It is also clear that having refineries here give us a level of security in supply, specially in these troubled times. It is also a source of export earnings and provide high technology careers for Filipino engineers.


But if these benefits are really there, justifying refinery investments now, why isn't the simple market-based ROR calculation sufficient?

And if market-based ROR turns out not to justify refinery investment, then why impose a tariff differential to justify it? The above-quoted argument hinges on the volatility of international fuel prices, for finished products versus crude oil. Is it true that, for prices of refined products, domestic volatility is really lower than international volatility? Note that the domestic refineries are also exporting, so that the vagaries of international markets also gets communicated to domestic prices. And even if domestic volatility is lower than international volatility, would this benefit really be worth the cost - that of relatively more expensive refined products from abroad?

Just asking.

How did the East Asian economies take off?

What does it take for an economy to keep on growing fast?

Output comes from combining inputs. Hence:

1. More input, more output.

Combining inputs in new and better ways make for more output. Hence:

2. Better technology, more output.

Since we are talking about economic growth, then "inputs" and "technology" also need to be imagined in very abstract, aggregative terms. So: the labor input aggregates all types of labor inputs in the economy; the capital input aggregates all kinds of capital in the economy. And technology aggregates all kinds of technical know-how in the economy.

There's a little danger in all this aggregation. It may conceal a lot of little goings on that make the aggregate phenomenon possible. For example, "capital accumulation" is a catch-all term, but this requires investment by a large number of firms across many industries; such investments only materialize if investors foresee high future returns from these companies in these industries.

The East Asian High Performing Economies (HPE) are typically listed as: Japan, South Korea, Taiwan, Singapore, and Hong Kong. Other Newly Industrializing Economies in the region are: mainland China, Thailand, Malaysia, and Indonesia.

We limit our list to the East Asian HPEs. Studies have suggested that economic growth was largely the result of accumulation of physical capital, investments in education, and increases in labor force participation (think women!) The importance of rapid capital accumulation is not debated (though there is some controversy about the importance of rapid technological change.)

Clearly, the East Asian HPEs did much to promote investments and education. Physical infrastructure was well provided. Macroeconomic policies kept government deficits trim and inflation well under control. Because of technology investments, the agricultural sector in these economies (except of course Singapore and Hong Kong). Finally, the HPEs started out with relatively low income inequality.

What is less clear is the role played by government industrial policies. While it appeared that the scope of government intervention was massive (a fact pounced upon by the "nationalist economists"), this does not mean that government intervention was partly responsibile for the take-off. In many other developing economies, government intervention was also massive, targeted at industrialization based on substituting domestic for imported manufactures. In such countries there was unfortunately no take-off.

Moreover, measures of government intervention suggest that the quality and severity of intervention differed greatly from the typical import substitution package. The most important difference is that industrial policy aimed at expanding exports, rather than restricting imports. Importation of inputs for export-oriented industries was in fact strongly encouraged. Seen in this light, the East Asian economies were unusually open and market-oriented (World Bank, 1994; Stiglitz and Yusuf, 2001).

So what does it take to take off? Stable macropolicies, an open economy, investments in education, and technical change (especially in agriculture) are all very important. Narrow sectoral promotion, if pursued at all, should be geared towards export competitiveness and not import substitution.

How well is the Philippines doing here? Well consider this news item, which is illustrative of how economic policy is conducted in this country. Open economy? Go figure.

References:

World Bank (1994). "The East Asian Miracle." Oxford University Press, Oxford.

Stiglitz, J., and S. Yusuf (2001). Rethinking the East Asian Miracle. World Bank: Washington, D.C.

Pack, H. (2000). "Industrial Policy: Growth Elixir or Poison?" World Bank Research Observer 15(1)47-67.

[Message edited: econblogger, 1700:5 September 05.]

Should we keep exempting oil products from EVAT?

I've written about this before, here and here. I'll write about it again: there is no good reason to keep on exempting oil products from EVAT.

Even some proponents of EVAT have backtracked on imposing EVAT on oil products. The reason? Rising prices of oil.

Now why was the implementation of VAT on oil products advocated in the first place? (Suppose we assume away the higher oil prices, for the sake of analysis). I can think of two reasons:

1. EVAT on oil products will raise revenue;
2. Exemptions on oil products represent a "distortion" which should be corrected by a more even application value added taxes on goods. The distortion arises from artificial cheapening of oil products, which provokes excess consumption and indirectly penalizes other production sectors who must pay VAT.

Okay now: the VAT flip-floppers are implicitly arguing that higher price of oil vitiates these two arguments. What could possibly be the reason? Let's deal with the common ones articulated in media sound bites:

1. Imposition of EVAT would drive inflation rates up to unacceptable levels.

Really now? Last year's increase in oil prices (where Dubai crude shot up by 44%), was estimated by a BSP study to have accounted for only 0.6 percentage point increase in last year's inflation rate of 8.6%.

What about EVAT? The maximum additional increase of oil prices should be 10%; in fact they should less than that, given that EVAT is imposed on value added only, and that other taxes on oil products will be scrapped. MBC research indicates regular gasoline to go up by 6.6%. This is comparable to the cost increases imposed by soaring international crude oil prices.

Another BSP document tallies estimates by forecasters on the impact of EVAT on inflation in 2005. Their estimates average at around 0.8% percentage point increase. As I have argued repeatedly, impact of either EVAT or oil price increases on overall inflation will be mild this year, to moderate next year. But crisis rhetoric drowns out sober analysis anytime.

2. Our people are already paying too much for oil prices.

This ignores the very reasons why VAT imposition was justified in the first place. The direct consequence of removing VAT exemption is higher government spending or lower government borrowing. Presumably it was worthwhile to impose VAT on oil products to get these benefits. It is still worthwhile to get these benefits despite higher oil prices. What is it in higher oil prices that changes the relative worth of these various benefits and costs? I cannot for the life of me think of the reason.

Go ask the VAT flip-floppers.

Is there a take-off?

As I discussed earlier, the idea of a "take-off" has received renewed interest, particularly with the idea of a "poverty trap". That is, there is a kind of balance of forces, or "equilibrium", in the economy which traps resources into inefficient uses. This inefficiency leads to underinvestment in industries with a high growth potential. There is however a better equilibrium, in which investment in these industries materializes - but there is no natural tendency for the poor economy to take-off from a lower to a higher equilibrium. Hence the need for a Big Push.

The "take-off", interpreted as a Big Push, is not well supported by the evidence, according to this paper by William Easterly of New York University. Virtually all the countries that are wealthy today, got there by gradual increments, rather than by a take-off. The exception? Japan, during the Meiji era. Among currently developing economies, the "take-off" is also very elusive. A major problem is actually defining a take-off - the term itself is difficult to pin down, against the reality of most developing economies, for whom the boom-bust cycle appears to be the norm. (So the Philippines is not so unique after all!) On the balance, only the East Asian high performing economies exhibit a take-off, and that of course only recently.

Because the Philippines is in this region, the East Asian high performing economies becomes the inevitable benchmark by which we gauge our own "take-off". What was the secret recipe of the high performing East Asian economies? Is this recipe replicable in countries like the Philippines?

EVAT will push through after all

Finally the Supreme Court has ruled that EVAT is constitutional. So perhaps we are not a Mickey Mouse country after all.

It couldn't have come sooner for the fiscal agenda of the administration. The 2006 budget deficit was conditional on EVAT being upheld. If the Supreme Court had ruled otherwise, either the 2006 budget needs to be downsized, or a bigger deficit would have to be planned - further increasing the national debt and damaging our country's reputation further in the financial markets.

The country's tax effort (revenue as a ratio of GDP) has dipped in recent years, and EVAT seems to be the best bet to lift that up again, despite its shortcomings. I hate higher taxes just like the next guy, but I need to think beyond my own pocket when discussing real economics.

Expect the usual fuss and bluster from the motley crowd of EVAT detractors and grandstanders. (They have another 15 days to file a motion for reconsideration, as I gather.) I have a simple question for them: what's the alternative? If they start talking about cancelling debt payments again, ask them the specifics. How would they deal with the repercussions on financial markets? Hey, they have some sloganeering to deal with that - institute nationalist industrialization! Impose national self-sufficiency! Close the economy to foreign trade and investment! Then the economy will prosper!

This is about the closest you can get to magical economics.

Making the "boom" in boom-bust permanent

Okay, back to the boom-bust topic: The bad thing about the "boom-bust" of the business cycle is, obviously, the bust. One may think more deeply about this in terms of actual GDP versus trend GDP. When trend GDP is growing flatly (say by 2.5% per year, around the population growth rate), then any boom above trend (say 5% growth) must eventually hit a bust (say zero or even negative growth). Of course policymakers can try to stabilize around a low trend - but this is not really exciting, is it?

However suppose it is possible to lift a low trend growth up to a high level, say from 2.5% to 7.5%. (Wow!) One can still have a business cycle, but at a higher level. (Kinda like China, which experiences a growth "slowdown" at 6% GDP growth!) Still business cycle stabilization is important, but that shift in GDP trend growth is by far the more interesting issue.

So I think the term "escaping the boom-bust cycle" is a misnomer - one should actually talk about "take-off", which is a picturesque way of talking about a sudden increase in the trend GDP growth. (Which President GMA highlighted several times in her last SONA). That means in real time, in a span of a decade or less, GDP reaches a dramatically higher trajectory, which has all the appearance of being sustainable. This has happened to several Newly Industrializing Economics (NIEs) in East and Southeast Asia - Japan, South Korea, Taiwan, Malaysia, Thailand, Hong Kong, Singapore, mainland China. Within the region, only two countries stand out as missing the plane entirely - the Philippines and Indonesia. The former kept a boom-bust cycle around a relatively low trend GDP; the latter appeared to coast along in a high trend GDP, but the 1997 financial crisis exposed the vulnerabilities that prevented sustained growth.

What is the secret of economic growth? The idea of "take-off" suggests that some degree of dramatic exertion affecting the whole (the airplane analogy), which suggests the need for a Big Push - some coordinated expansion across a wide array of economic sectors. Such coordinated expansion is necessary because one cannot achieve sustained growth by gradual increments. Furthermore, this coordinated expansion requires aggressive government intervention in the economy, combined with generous doses of external financing, i.e. foreign aid.

This ideas was very popular in the 1950s, fell into disrepute, but has lately become fashionable again. Is there any merit in this idea? Should a country like the Philippines undertake a Big Push to achieve "take-off"?

Pricing power of Oil Companies?

Just to summarize a major finding from the Independent Review of Oil Industry Deregulation (cited in my previous post):

Q: Is there evidence that market power is manipulating prices in the downstream oil industry?

A: None whatsoever. No evidence has been produced regarding collusion of the industry players, whether implicit or explicit.

Stupid congressmen or senators though may point to phenomena such as price matching as evidence for collusion. That is, competitors often charge the same price, with near-simultaneous adjustment of prices. As the Report blandly puts it: "Similar prices may also arise due to competition." By the way, I found similar (in many cases, exactly the same) prices on a variety of products across several supermarkets. I guess we should hale SM, Robinson, Rustan's, Cost-U-Less, Shopwise, plus innumerable smaller retail groceries, to court for anti-competitive practices!

Contra the claim of collusion, after deregulation (1998 vs 2005), the following are observed:

• The oil company share in revenues has fallen from 23% to 16%.


• Two of the top players, Petron and Shell, have earned a Return on Equity of only 3.0 to 3.7 percent.


• The new players' market share has risen from 4.3 to 13.3 percent. In certain sectors their share is large; in LPG it is 43%. They now account for one fifth of the gasoline stations in the country.


• Domestic fuel prices have risen more slowly than international fuel prices.

Henceforth any Senator or Congressman advocating "Reregulation" should first publish a point-by-point refutation of said study. The refutation should itself be critiqued by experts and academics, not least the authors of the Independent Review Report. That is my dream scenario for an intellectually respectable debate on the oil "crisis". I have a funny feeling though that instead, the usual stupidity will just play itself out. "August halls of congress" my ass.