Monday, May 29, 2006

Ask the economist: foreign remittances and domestic inflation

I am aware of only one professional Filipino economist maintaining a regular weblog. (Ehem. I would be glad to know that I am mistaken.) With little power comes a little responsibility. So I am open to answering questions readers may have about the economy. Just post it as a comment, or email me (roehlbriones@yahoo.com).

A fellow blogger writes:

I really dig your blog. Learn a lot from it. Although I am not an economist (I'm a pol sci major), I am interested in reading about economics.

Anyways, the reason I'm writing is because I want to get your views on the following: I have this "theory" that OFW dollars, while they support our economy, are in the long run harmful because it promotes inflation and sort of "warps" the RP market. The reason I say this is because it is getting harder and harder for an ordinary salaried employee here to support a family. For example, residential real estate prices are up not because salaried people here are buying. Rather, it is fueled by OFW dollars.

I dunno if my suspicions have basis in reality... YOur thoughts?

Iloilo CIty Boy
www.iloilocityboy.blogspot.com
Thanks, Iloilocityboy. That is one issue other readers may be wondering about. Inflation is as you know the general rise in the price level. Inflation increases are either permanent or temporary. It can arise from a permanent increase in the growth of money supply, in which case it is permanent; or it may be caused by an increase in demand over a significant range of goods and services, in which case it is temporary.

Unless the BSP actively intervenes in the forex market (which apparently it does not), foreign exchange inflows do not in general cause an increase in domestic money supply. Inflows would only affect the exchange rate - which we are already observing these days. (There is a rather complicated and indirect mechanism in which foreign exchange inflows would affect domestic money supply, but I think it is in practical terms immaterial to this issue). This leaves us with a demand-increase explanation.

I believe you are concerned with the (temporary) inflation among "nontradables" arising from the sudden increase in income of families with overseas foreign workers (OFWs). When I say "nontradables", I mean those goods and services which are unavailable outside the country. Real estate (obviously), retail services, personal services (haircuts, car washing, medical care) etc., are examples of nontradables. This are most likely the targets of an increase in domestic demand. These goods and services will bear the brunt of the demand surge.

Now we have to be careful about what we mean by "warped" or "distorted" or "harmed". Clearly when price rises, someone is harmed - namely consumers who used to purchase at lower prices. If price had been stable for a long time and the price changes, we are tempted to say that the market got "warped" or "distorted" somehow, by some aberrant demand or supply force.

Now let's deal with this issue carefully. A "harm" to someone may be beneficial to someone else. An increase in price of real estate harms the real estate buyer but is beneficial to the real estate owner, developer, and brokerage industry. In fact this incentive is precisely what is needed to encourage greater supply of developed and marketed real estate in the long run. In the absence of a price increase the available supply of real estate may stagnate. Scarce real estate may have to be rationed by non-price means; say, first-come, first served. How would the late-comers fare under this arrangement?

A similar argument can be made for the other nontradable goods and services for which domestic demand increases. So in total is society harmed? That is a hard question to answer because it entails deep questions of what is "fair". It may seem unfair that I, a native of Laguna, may find real estate prices in my hometown out of reach because of a demand spillover from people who work in Metro Manila.

Using the principle "a peso is a peso is a peso" - that is a peso loss to me exactly offsets a peso gain to you, whoever you are or I am - society is not harmed by the influx of foreign remittances. The increase in purchasing power of OFW families is expressed in, er, more purchases. We who are competing with them for the same set of goods and services have to match the higher prices they are willing and able to pay.

Is this a distortion? Note that change is at the heart of the free market system. Price adjustments constitute a system of incentives to reallocate resources as supply and demand conditions change. Unless someone demonstrates a superior system, my money is on the free market.

3 comments:

Rizalist said...

Don't know if you already have a copy of this document, but it's from the Congressional Budget Planning Dept, an analysis of the 2006 budget. Chock full of info.
PDF

Econblogger said...

Hey thanks rizalist. I was looking for this. Will have a look-see.

Anonymous said...

"In fact this incentive is precisely what is needed to encourage greater supply of developed and marketed real estate in the long run."

Problem is there are lots of disincentive to create supply i.e. businesses. High taxes, corruption, voluminous paper work-these thing discourage would be suppliers.

Verdict: government induced inflation.