Friday, April 28, 2006

The oil price stabilization tax - US version

Amadeo has pointed out in a comment entry in this weblog that some US legislators are also pushing for their version of the oil price stabilization tax. The issue has been picked up by US econobloggers. Manuel Lora of is rendered speechless by the plan, which combines a $100 rebate plus stronger anti-price-gouging measures.

James Hamilton has a thoughtful post on the Chief Executive's policies towards the oil price hikes. He says:

There is currently an almost religious conviction by many Americans that the price of oil, rather than being determined by world markets, is controlled by a few big oil companies, as if the 2.5 million barrels of crude oil per day that ExxonMobil produced last year somehow give it the ability to control the price of the other 82 mbd that got sold. The certainty with which people hold this conviction seems directly related to the complete absence of any supportive facts..

Indeed. Even the fact that OPEC countries control 40% of oil exports is no slam dunk case for international "price gouging". OPEC has been around for about thirty years; did they all just get their act together all of a sudden, just when China and US ratcheted up their oil demand? Does not compute.


I think there is an overwhelming political instinct in the current situation to do something huge, drastic, and ultimately quite harmful.

This is exactly how the average grandstanding politician would act. When something this big is going on, one must give the appearance of activity, inasmuch as passivity is the ultimate political crime. Hippocrates was right: a physician confronted with a baffling ailment is tempted to apply all sorts of mysterious nostrums. So he said: First do no harm!

Greg Mankiw also gives advice on how not to deal with higher gas prices. One interesting point: the US deficit is on a unsustainable path, so a tax rebate would be most unhelpful in moving towards fiscal sustainability.

What is a "sustainable deficit", anyway? There are several definitions, but two are most easy to remember: first is the "no Ponzi game" definition. In a Ponzi game, interest payments on debt can only be financed by borrowing. The analogy to pyramid schemes is perfect: in a that scheme/scam, the scammer's promise of high returns can only be met by new investors also chasing high returns. Insidiously, government may be playing a kind of pyramid scam with its deficit management. Second is that the public debt-to-GDP ratio must be constant or decreasing. The idea is that the GDP is the base from which to extract revenue, and therefore service the debt. The debt itself must not grow out of proportion of this tax base. Both these definitions are long run definitions; in the short run some violation of these rules is possible, but these violations cannot be pursued indefinitely. The creditors will eventually wise up, the way scammed pyramid investors do, and the whole thing comes tumbling down. The government becomes insolvent. Or it pays its debt by printing paper - fueling hyperinflation.

This time the message is: between taxes and excessive public borrowing, which one does less harm?

Tuesday, April 25, 2006

Oil Price Stabilization Tax

What's going on? As oil prices go up, legislators in the Philippines are again calling for suspension of the value added tax on petroleum, which is 12%.

I remember the good old days of the Oil Price Stabilization Fund. (This is what passes for sarcasm among economists.) It worked as a variable subsidy: at a given domestic price, when the foreign price went up, the oil firms would be subsidized by the fund; when the foreign price went down, oil firms would put money back into the fund. Well it might work if the regulated domestic price equalled the long run equilibrium price. It doesn't take an ijit to guess that the regulated price was set way lower than that, so that the "fund" was perpetually in the red, burning holes through government coffers.

What the legislators are proposing is in effect a variable levy. Foreign price up: suspend tax; foreign price down: impose tax. It is more feasible to implement because government doesn't actually have to cough up financing for a subsidy. But the idea is as flawed as the Stabilization Fund, and the effects are more insidious.

First, does anyone really know the long run trend in the world price of oil? Is US$ 65 per barrel it, as Rep. Salceda is guessing? Nobody knows. If anyone did, they would make a killing in the futures market. (If it were different, that is.) Suppose the oil price hold steady at today's high levels. Does anybody seriously think this tax can be reimposed?

Which brings us to the second point: suspension of the tax would forego, by some preliminary estimates, revenue of about 40 billion pesos. Representative Salceda recommends restrictions on spending and the scrapping of the rationalization program. But these are truly lousy ways of meeting government borrowing targets.

How about the "hardship to the people"? Well excessive government borrowing, or restrictions on public spending, are themselves sources of "hardship to the people." I am pleasantly surprised with Senator Recto, who shows lots of good sense, by claiming that the suspension would hurt people more.

Another way to approach the problem is this: suppose you are foregoing 40 billion in tax revenue anyway. Compared to repealing the VAT on oil, is there a better way to structure the tax system? My (very preliminary) simulations with the updated PhilCGE suggest there is. For example, halving the sales tax rate on petroleum products has about the same revenue loss as removing 5% off the sales tax rate across-the-board. However the latter involves a welfare improvement of about 30% more. This confirms that a more uniform tax structure tends to be less distortionary on the economy. Unfortunately the suspension of the EVAT moves towards a less uniform (and more distortionary) tax regime.

The de facto oil price stabilization tax is only good for one thing: political mileage. Yep, I can hear 'em downshifting to high gear all over.

Sunday, April 23, 2006

Blame-thy-neighbor policy

One of the charges levelled against China is a "beggar-thy-neighbor" policy: keeping its currency artificially cheap, effectively subsidizing its exporters (while penalizing importers). Last week's meeting between Presidents Hu Jintao and Bush provoked a comment from the latter: "There has been some appreciation in the currency. We would hope there would be more appreciation in the currency."

Some review: a currency peg is when one country fixes the conversion between its own and a foreign currency at a given value. It is said to be following a fixed exchange rate policy in contrast to a flexible or floating exchange rate policy. A domestic currency appreciates when the rate at which one unit converts to a foreign currency goes up (conversely, when it takes fewer units of a domestic currency to buy one unit of a foreign currency). A depreciation is the reverse. The real exchange rate, is the market value adjusted by relative inflation (the difference between domestic inflation and inflation in the country holding the foreign reference currency). The idea is that domestic inflation at given market exchange rate is equivalent to an appreciation of the domestic currency. Depreciation accompanied by the same rate of inflation yields an unchanged real exchange rate.

So now we are ready to consider the question: is the yuan undervalued? Most economists would agree: yes, but not by a lot. Certainly not by magnitudes of 27.5% called for by some US Congressmen. (Though revaluation of yuan by that magnitude would do wonders for the Philippines' trade surplus with that country. Whether that's economically desirable is doubtful.)

Since the mid-1990s China has been on a currency peg; based on ADB data, the yuan/dollar exchange rate has fluctuated within a narrow band of 8.3 to 8.28. Using inflation rates in China and the US from 1996-2005, the yuan has only depreciated in real terms by less than one percent. Finally, overall trade surplus of China is only 2.6% of GDP, around the same level as in 2000.

More arguments against the undervalued-yuan claim here. Brad Setser also has plenty of discussion on the China-US imbalance.

It seems that some elements of the US Congress have become very adept at the "blame-thy-neighbor" policy. China-bashing bandwagon, anyone?

Friday, April 21, 2006

The China chance

China has received blame all around. For rising oil prices. For vaccuming up all the foreign investments. For grabbing markets for consumer manufactures, such as apparel, footwear, textiles, toys...

China - a country of 1.2 billion, where per capita GDP (PPP-adjusted) has risen over tenfold from 1980 to 2002 (reference). Now the second biggest economy in the world, thanks to decades of rapid economic growth.

What's not to fear from China? Lots. (See this link.) It's showing the early stages of the classic Lorenz-curve pattern - with inequality rising initially during growth. Back in 1980, the Gini ratio was 0.2 (quite equal), but now it is 0.45 (about the same as the Philippines.) Not good for social stability. The type of growth that has been pursued showns signs of unsustainability, in the environmental sense:

Rapid industrialization is producing massive environmental devastation. China is the world’s second largest greenhouse gas emitter (the U.S. is first). About 60 percent of China’s major rivers are classified as being unsuitable for human contact. Seven of the ten most polluted cities in the world are located in China. Air pollution alone claims 300,000 lives prematurely per year. Acid rain falls on 1/3 of the territory. More than 1/3 of industrial wastewater and 2/3 of municipal wastewater is released into waterways without any treatment. Over the last few decades, increased industrial agriculture and commercial grazing has resulted in creating over 2.67 million square kilometers of desert land—around 27.9 percent of China’s total territory. Many claim that foreign investment and the introduction of “green” technology will help clean up the environment in China; however, this has not been the case to date. One of the reasons for this is because China’s State Environmental Protection Agency (SEPA) has little authority. SEPA estimates that although water treatment facilities are installed in most major industrial plants under government mandate, round one-third are not operated at all and another one-third operate occasionally. Often the fines it levies are less than the expenses of using the “green” technology. (Business Week, August 22, 2005)
Well I for one am hoping that it's rapid export-oriented growth is sustained. A competitive Chinese export sector means cheaper products which we can import. And a big Chinese economy means a big market to send our goods. In 2000 the export share of China was only 1.74%; in 2005 it was 9.86% and growing. In terms of value, exports to China in 2000 were only US$ 663 million; in 2005 it was over 4 billion, more than a sixfold increase. You may not realize this, but our imports from China in 2005 was only US$ 256 billion. (So what's all that "made in China" stuff? Well it turns out that China exports to other countries, which export back to us the made in China stuff.)

The global economy is not a zero sum game where one country becomes better off only if others become worse off. Simultaneous growth is a very real, in fact very realistic, prospect.

Wednesday, April 19, 2006

Energy prices up again

Much has happened while I was missing in action beating a couple of deadlines: the Thaksin problem in Thailand has been resolved; in the Philippines, local governments are pushing for Constitutional reforms, while the President suspends all executions; but the global development I'd like to flag for now is the recent uptick in oil prices. In the past month, prices have gone up by 16%, with Brent crude exceeding US$ 71 per barrel.

While many analysts (cited in the article) point to uncertainties with respect to Iran as a proximate cause, James Hamilton thinks it's still a prosaic supply-demand story: oil production in the US is down, as well as in Nigeria (due to their political problems). "And demand remains strong, with U.S. economic growth resuming at a faster pace than some of us had anticipated, and Chinese use of petroleum continuing to climb. If demand is up and supply is stagnant, small wonder if we see the price continue to rise."

For the Philippines, what is the impact of this? Suppose a high crude price is sustained yearlong, leading to an increase in prices of petroleum products, within the range of say 20%. In 2005 the country's total imports was US$ 44.9 billion, of which about US$ 6.1 billion was in the form of mineral fuels, lubricants, and related products (except coke and coal). This accounts for about 13.6%. Hence the average import price (assuming constant shares) would rise by about 13.5% x 0.2 = 2.72%. For good measure I raised this to a worse scenario of 5%, and ran this average price increase scenario into a macroeconomic forecasting model I am currently working on. Voila, what did I get? The price increase shaves off a little over a percentge point off our GDP growth in 2006. So if the forecast is 5.2% growth for the year, then with the shock, growth is only around 4.2% or so. Interestingly, even if the average import cost was permanently higher, growth would recover to its unshocked trend already by 2007!

So the bad news: higher energy costs are a serious drag on growth. Good news: the economy is not going into a tailspin.

More good news: notice that demand remains a key reason for fuel prices rising, and China and the US remain a major source of this demand boost. And how is that good news? But that's for another post.

Monday, April 03, 2006

Termites in the woodwork

Interesting that the heads of government in both the Philippines and Thailand are both grappling with credibility crises. Under a Parliamentary system as in Thailand, elections can be called to test the mandate of a sitting government. Under the Presidential system of the Philippines, a President serves a fixed term and can only be removed by impeachment. Both solutions have been tried in each country. In the Philippines the impeachment bid failed in a Congress whose Lower House (where impeachment must be initiated) is dominated by the President's allies.

In Thailand meanwhile the crisis has probably gotten deeper, mainly because of the opposition boycott. This boycott has often puzzled me, given the relatively credible electoral system in Thailand. Why would the opposition intentionally attempt to undermine institutions that have served Thailand well, so far?

Well, as explained in the CNN report, a large bulk of the population remains rural (70%). Apparently agriculture-led development has worked in Thailand, preventing the massive rural-urban migration observed in other Asian countries, such as the Philippines. I hypothesize that the rural population tends to be more conservative in their voting strategy, as long as the sitting government is delivering basic services. Abstract values of governance tend to be dismissed as petty bickerings of a distant urban center. Knowing of their impending defeat at the polls, the opposition organized a boycott among urbanites - deepening the crisis of institutions in that country.

The case of the Philippines is different. In Thailand, there appears to be a strong urban-based constituency towards actively replacing the administration. In the Philippines, a loose oppositionist alliance with vague middle and lower class support has repeatedly called for the President to resign. However these calls have not provoked mass demonstrations. Ironically, an unpopular President continues to rule because extra-constitutional measures are themselves highly unpopular.

As an economist my biggest worry is that political paralysis and pessimissm would extend to economic decision-making, particularly in the area of fixed and financial investment. In the Philippines the "firewall" appears to be holding, but things seem more tenuous in the case of Thailand. Would an economic crisis the magnitude of the 1997 exchange rate debacle hit Thailand, again? Maybe not soon. But in both cases these credibility problems are simply burrowing deep in the woodwork - like termites.