Economic challenges in the 2nd year of the Duterte government

By Gerardo P. Sicat (The Philippine Star), Jul 5, 2017

The Duterte administration is now transitioning to its second year. Public commentary regarding the first year of governance has been characterized by a generally positive review of its accomplishments and the development programs on the way.

To judge how the current government is succeeding requires a longer period of time. The economic challenges facing it in the second year would likely extend to the coming years.

Economic challenges. The feasibility of success in its goals depends on how the government deals with the economic challenges it faces.

For convenience, I discuss the challenges into three main groups:

(1) Maintaining the macroeconomic balance of the national economy.

(2) Putting a brake on government consumption spending to achieve fast economic growth along the investment path of “Build Build Build.”

(3) Expanding the economy’s “absorptive capacity” by removing structural bottlenecks due to regulatory complications and restrictions.

Space limits me today to discuss only the first two of the challenges.

Macroeconomic management. Maintaining what economists call macroeconomic balance is very important.

A cap on price inflation is often used as an objective or anchor of monetary policy. In the Philippines, monetary policy tries to maintain the inflation rate within three percent per year.

The government, however, would want output or GDP growth to be sustained at close to seven percent per year. It is possible to have both goals achievable, but economic forces might try to pull them out of harmony with one another.

The larger goal is to keep the two – the growth goal and the inflation goal – to be in harmony as far as possible.

Price stability within the three percent inflation rate could prove a challenge, if the economy “overheats” when overall spending outperforms domestic output productivity.

Signs of such discrepancies appear in other prices, for instance, the peso exchange rate. When the peso falls in value (that is, it depreciates from P49 to P50 or more), domestic inflationary pressures are induced. Yet, that might be one further way to encourage exports to rise or imports to be discouraged.

The managers make a choice when they can and if they can!

Hidden behind such trade-offs are situations that could signal the presence of economic imbalances, e.g, deficits of the fiscal branch or of the balance of payments, or of both.

Historically in the past, the country’s main imbalances were in the form of high fiscal deficits and also high balance of payments deficits. In the course of recent decades, and as an aftermath of the economic crisis of the 1980s, changes in economic policy had conspired to make fiscal deficits to be less drastic and the balance of payments more prone to balance or to surpluses.

In Duterte’s time, and reading into plans to spend more for infrastructure and other social programs, the fiscal deficit is likely to worsen. The government wants to keep this within a deficit level of three percent of GDP to have a lid on inflationary forces.

As far as the balance of payments is concerned, much depends on how the government’s program is able to raise exports and maintain a good surplus on non-merchandise exports and on the level of OFW remittances.

This is less predictable in present day terms. The import requirements of the Build Build Build program are likely to be high and exports earnings are more problematic in the current “Trump” era of trade protectionism.

Controlling public consumption spending. A big “plus” for the Duterte administration is the likelihood of passing a major tax reform program.

It is important that the tax reform effort has been pushed early in the first year of the President’s term. The main tax reform measure is likely to pass this year, the second year of Duterte’s government.

This tax reform could be a game changer for Philippine development. It revamps the tax structure and makes it more revenue productive. Success of the tax reform in pushing the development frontier further depends on how it conserves the new revenues it gains for investment, not for satisfying immediate wants.

While more revenues will be made available for the government’s infrastructure and other development programs, the list of subsidies being underwritten by government is expanding.

Some of the expenses are needed to keep the goals of income redistribution and fairness intact. But the new revenues from the tax reform must open new roads for financing public investments and strengthening the capacity to invest for the whole economy.

There is a long list of subsidies that are lined up to consume part of the new tax revenues collected. Quite a few of these are new subsidies. Mr. Duterte’s list of populist programs threaten to eat up a large part of the new revenues.

The conditional cash transfer program (CCT) is recognized as a major transfer of money to help the poor. The program is also designed to encourage schooling of children by the poor. It is essentially well-targeted to the poor and deserved to be, for a time, essential. The cash component, however, is being supplemented with a rice subsidy component.

The President has also decided to give away irrigation services free to rice farmers. As a result, the National Irrigation Administration (NIA) has lost its revenue source and will now have to depend on the government for its upkeep.

With no money to be plowed into maintenance of existing irrigation systems, the budget shoulders what used to be a fee-based service. New communal irrigation system investments also will need to be financed from government coffers.

There are moves to introduce free university public education in government-run colleges and universities. This is likely to create a new general entitlement program.

The government must look for alternatives to reward only those who are highly capable to handle university education through more widely available scholarships for poor students.

There are many good things to improve the wage bill for government employees, for soldiers and policemen and for the government to spend on essential improvement of defense and national security. In this age of vigilance against terrorism, there are also new expenses to be incurred to assist in making the war on drugs a success.

The challenge is how to keep the lid on excessive demands on tax resources so that we have room for growth in investments to be achieved.

My email is: gpsicat@gmail.com. Visit this site for more information, and commentary: http://econ.upd.edu.ph/gpsicat/