Simon Johnson believes that the replacement of right of center governments with left of center ones won't change a thing as options are limited. The Austerity Has Just Begun is the way Johnson states their predicament.
Robert Reich draws lessons from Europe for the US as the presidential campaign season kicks off. For Reich it is not enough for the Democrats to say that "things would have been worse" under the Republicans. With trust in both their parties running low, neither camp has been able to establish a statistically significant lead over the other as the anemic economic recovery plods along.
The UK budget recently passed by the Conservative-led coalition government might provide a few clues to US voters as to what life would be like under a Republican White House and Congress. Aside from effectively cutting entitlements to pensioners and reducing state spending at a rate unseen since the end of the second world war, the treasurer George Osborne eased taxes on the top marginal tax bracket by 5%. This has subsequently led to a precipitous fall in their polling.
Even in Australia, the debt and deficit debate is raging even as the government promises to deliver a surplus as it hands down its budget next month. Although it might be the sole advanced country that can afford at the moment to incur a deficit, the Labor government is being cornered into this box by the conservative opposition which promises to outdo them in reining in spending (despite the fact that they too have spending proposals of their own).
Psychological experiments involving groups and leaders have shown that when voters identify with their leader or consider him or her "one of them", they are more likely to accept withdrawal of resources (austerity) from that leader than if it were imposed by some outsider. When a leader who does not fit in with their group favors his own group with resources (tax cuts), they are also more likely to perceive this as unfair.
If elections are to be framed as a contest of who voters trust more in handling the economy, the likelihood is that conservatives will have an edge (as in the case of the UK where tories still poll better than Labor in terms of economic management).
If elections are fought over which party voters are more likely to trust to scale back entitlements in a socially responsible manner, the party associated with the broad middle and lower income classes is more likely to pull ahead. Likeability and trust is perhaps what it all boils down to.
At the start of his campaign for president, Benigno Aquino stated in an advertisement that he was not a thief and that he would not steal using a play on the filipino word "magnanakaw" which means both "thief" and "to steal". A similar statement was issued by his late mother, ex-president Corazon Aquino twenty five years earlier when she ran against Ferdinand Marcos.
So ingrained and apparent was the greed that motivated candidates to pursue public office that it had been assumed to be the case among all of them. With the installation of president-elect Aquino at 12 noon on June 30 2010, there are a few assumptions regarding the state and its role in society that also need to be challenged.
In a paternalistic society such as the Philippines, it is the role of the state to dole out benefits to the connected, by that I mean both the wealthy and the needy. The state is captured from both above by the wealthy who seek regulations that favor their commercial interests and from below by the incessant demands of constituents whose need for support drives their elected representatives to capture "rents" from government transactions to provide personal help and thus perpetuate their electability.
This it would seem is the existing social contract as it stands - it is one based on personal dealings between (1) Big Business and the power brokers of the state and (2) the disenfranchised and their political bosses. A society based on personal kinship and relations does not reward individuals who want to strike out on their own, away from the established networks. It is one where one cannot get ahead simply by working hard and relying on fair play. That is why so many have sought to pursue their fortunes outside the country.
Many commentators have seized on the potential for transformation under a new Aquino presidency based on its reputation for probity. In order for it to be transformational, it would have to restructure the "rules of the game" or negotiate a new social contract between the state and its stakeholders. The new arrangement will have to resource the state appropriately to lessen the need for its constituents to rely on personal interventions by their representatives.
It will have to ensure that the wealthy contribute a fairer share of their profits to the state. The productive sectors in turn would expect a predictable regulatory environment and a skilled laborforce enabling them to take advantage of new opportunities. For this to happen, a series of reforms are needed in areas such as social welfare, human capital, regulation and taxation which are discussed here.
Social Welfare Reform. This includes the re-alignment of poorly targeted, improperly designed and ineffective programs towards those with greater impact. The rice subsidy program is one example of a program which has suffered a leakage of 71%, whose coverage of intended recipients is a mere 18%, and is costly to administer. It cost the government about Php40 billion in 2008 alone. Other similar programs that provided rebates on electricity suffered similar flaws, but were hurriedly engineered during the height of the global financial crisis and are non-recurring. The grains program on the other hand represents a recurring expense for the government. Manasan of the government think tank PIDS suggests that the same expenditure if it were spent on the more effective conditional cash transfer program or 4Ps targeting public school children would have a greater impact in terms of alleviating poverty by providing support to poorer households while improving school participation and completion rates (see her slideshow below). They are also proven to be less costly to administer and have a reduced level of leakage. At the same time preventive programs like child immunization and maternal health connected with the 4P's program would help reduce the cost burden of treating diseases and supporting larger families.
Education and Skills Reform. The next step would be to undertake reforms that would improve the stock of human capital through educational and health reform. As school children improve their participation and completion rates, it becomes necessary to strengthen the content of their education to ensure they are equipped with necessary skills and knowledge needed in the workplace both here and abroad. Part of the solution lies in extending the years of schooling from 10 to 12 years with the option of leaving school after year 10. The senior years of high school should offer students the option of either college preparation or vocational education and training (VET). There is a need to address the imbalance between college and VET that is leading to the strange anomaly of skills shortages alongside high unemployment. Work-based apprenticeships and traineeships in partnership with industry can also be introduced. The "adopt a school" program can be leveraged in order to provide such a partnership. Metropolitan and provincial polytechnics could also be tapped to provide instructors and facilities for such training. A voucher or entitlement system that would allow public school students to take up a place in a technical college can be designed to allow the funding to move with the student to any local technical college or institution to complete the equivalent of years 11 and 12. It is also important for such VET courses to feed into the higher education system in a seamless manner. The lack of vertical integration currently is a disincentive to pursue technical training.
Health and social insurance reform. The Philippines has a health system akin to the US, where a mixture of public and private hospitals abound and the state funds them through what amounts to a health insurance program called PhilHealth, the key challenge here as it is in the US would be to increase the coverage of the program. This cannot be done without mandates and concurrent subsidies to firms that employ people to increase contributions. Part of the reform process also involves looking at the funding rate of various treatments. Chronic diseases are on the rise in developing countries. While the Philippines does not have an ageing population, there is a high dependency ratio. This means the problem confronted by households at-risk of slipping into poverty due to lost income of primary breadwinners has to be addressed through a combination of social and health insurance improvements.
Regulatory Reform. The cost of doing business in the country has to be lowered through regulatory reform. This entails opening up many sectors including aviation, ports, power and transportation to greater competition. It also involves red-tape reduction and strengthening the property rights of investors. A comprehensive review and consultation process needs to take place to give direction to many of the reforms in these areas. A mix of policy tools could potentially solve many of the bottlenecks in the process of business registration and licensing. Stakeholder consultation would shed light on which tools to use.
Tax Reform. From the mid-90s to the mid-noughties the tax collection effort measured in terms of collection to GDP ratio deteriorated from 17 percent to 12 percent. It recovered slightly with the hike of the VAT rate from 10-12%, but leakages such as the granting of fiscal incentives for the country's freeports and special economic zones and the non-indexation of sin taxes have offset much of the improvements in tax collection. The redundancy and inefficacy of many fiscal incentives have been extensively documented (see for instance the article by Dr Reside below). Meanwhile corporate and personal income taxes in the country remain higher than elsewhere in the region. The current deficit amounting to 4% of GDP or roughly Php300B has to be brought down to a sustainable level, say 1-2%. A mixture of improved collection efficiency, fiscal rationalization, indexation of sin taxes along with budget neutral adjustments to the tax system to lessen distortions and improve the country's competitiveness are all justifiable and in keeping with the spirit of Mr Aquino's campaign pledge of no immediate new taxes.
The first step of any reform process is for the leader to be honest and committed to it. Mr Aquino satisfies this condition with his probity and policy seriousness. During this period of transition, his first task involves assembling a competent team to help him in this effort. They should focus on assembling a coherent package of reforms with the help of partners and stakeholders in the community aimed at restructuring incentives in the Philippines that would transform the current set of assumptions about the state and its role in it.
Moving from a padrino society that depends on personal transactions based on kinship and wardship to one where citizens are empowered with greater access to improved services requires a new social contract between the state, market and society. It will be necessary to move towards the new mold in the next six years.
The state needs to be equipped with the resources necessary to improve the incentives towards human capital acquisition and productive activities. It requires reforms in social welfare, education, health as well as regulation and taxation. At the end of his six year term, if Mr Aquino is able to say that he brought the country forward in these areas, he would have done it a great service worthy of the term transformational.
Back in May this year, I blogged that as the Federal government stared down the barrel of a revenue write down, it had two options: to maintain a steady course of economic conservatism or to throw caution to the wind and engage in heavy borrowing to finance massive countercyclical spending.
It chose the latter of course. This past week, the Treasury revealed through its Mid-Year Economic and Fiscal Outlook, that its cash position would not be as bleak as it had previously thought (in its forward estimates). Two rounds of stimulus later and experience proves that it pays to be a risk-taker at the right moment.
Having dodged a technical recession and with unemployment set to peak at a much more moderate rate of 6.75% (compared to double digits in the US), Australians are now being warned to prepare for the unintended consequences of its debt-driven growth strategy, namely urban congestion, unaffordable housing and higher inflation.
Dual pronouncements by the RBA Governor and Productivity Commission Chair have pointed to these emerging issues. If you are a homeonwer like me who kept your job during the crisis, you would have seen the value of your property go up (according to WestPac chief economist Bill Evans) and interest rates go down to 50 year lows. This has both a wealth effect and an income effect (translation: you see yourself as being more wealthy and having more money to spend).
Granted that many of us used the temporarily low rates to reduce our indebtedness as a hedge against higher interest rates in the future, but the rise in the equity value of our homes is making many of us feel smug at the moment. We might just decide to use that equity in the coming months.
Another unintended consequence is the strong Aussie dollar which is back to its pre-crisis level nearing parity with the US greenback. That is fuelling a lot of online shopping primarily for luxury goods due to the price advantage of buying from American compared to local stores for the same item. As the Financial Review reported this week, e-Bay is experiencing a surge in spending compared to last year (ironically, it copped a massive fine last year for facilitating the sale of fake brands).
It is therefore not surprising that amid all these animated spirits released by Kevin Rudd's rubbing of the stimulatory lamp (a.k.a fair shake of the sauce bottle) that the voice of reason has cautioned the government to revert back to a more prudent approach (which the Treasury seems to be seeking to do although such spending as the school building program can only be "rephased"). In the past 12 months, such a warning might have been regarded as the voice of treason rather than reason, but not this time it seems.
The ongoing appreciation of the Australian dollar could mute the impact of the current fiscal stimulus working its way through the system.
A recent paper released by the Centre for Economic Policy Research in London sheds light on the ongoing debate of whether fiscal stimulus being coordinated currently by the G20 nations would have a significant effect on the long run growth of their economies. The problem essentially has to do with estimating the size of the government multipliers of the nations involved.
As highlighted by its authors, on one side of the fence are the likes of Robert Barro who argues that the peace-time multiplier has essentially been zero. On the other side sit equally learned people like Christina Romer, Chair of the US Council of Economic Advisers, who uses a figure as high as 1.6. The difference between these two views is 3.7 million US jobs by 2010.
The paper in analysing the multiplier effect of government spending distinguishes between developed and developing nations, those with open and closed economies, those with fixed and flexible exchange rates and those with and without large external debts.
The findings which I quote below show a stark contrast:
In developing countries, the response of output to increases in government spending is smaller on impact and considerably less persistent than in high income countries.
The degree of exchange rate flexibility is a critical determinant of the size of fiscal multipliers. Economies operating under predetermined exchange rate regimes have long-run multipliers of around 1.5, but economies with flexible exchange rate regimes have essentially zero multipliers.
The degree of openness to trade (measured as exports plus imports as a proportion of GDP) is another critical determinant. Relatively closed economies have long-run multipliers of around 1.6, but relatively open economies have very small or zero multipliers.
In highly-indebted countries, the output response to increases in government spending is short-lived and much less persistent than in countries with a low debt to GDP ratio.
The picture this paints is quite clear. Since most advanced economies have successfully floated their currencies and have maintained relatively open economies, their ability to benefit from their spending will be limited in the long run. While it is true that in the short-run, fiscal stimulus does provide a “quick hit” to the system, the problem in the medium term is that as the stimulus diminishes (assuming it is temporary in nature), it creates a "fiscal drag" (the opposite of the multiplier effect). As per the US stimulus, this drag will detract from its GDP by as much as 2.5% in 2011.
China, an emerging economy which does not have external debts to speak of and which has a pre-determined exchange rate, will be able to benefit much more from its stimulus without threatening its exports. Australia on the other hand has seen its dollar approach parity with the greenback and may even see it reach $1.1, as the banner story of the Australian today declared, which would be an appreciation of about 70% from its lows this past year. This will lead to the stimulus leaking out of the country in the form of higher imports and weaker exports).
Unfortunately, the criteria laid out for spending, that it be targeted, temporary and timely may have been too difficult to adhere to. The cocktail of spending measures that resulted to address both short-run and long-run growth needs might have already been countered by monetary and exchange rate policy with the effects of a rising dollar soon to take hold.
This animated chart put together by Glenn Beck of Fox Cable News using Reserve Bank of St Louis figures, mimicking Al Gore's slide show, helps to visualise the exponential rate at which the US Federal Reserve is devaluing its currency by way of increasing the notes in circulation, or what is commonly referred to as “printing more money”. For those whose environmental sensibilities may be offended, please excuse the exuberance of Glenn as it is obviously aimed at the average Fox News subscriber.
