Getting the diagnostics right 2 – BusinessWorld Online

(Part 2)

To efficiently use scarce resources and political capital at this given time, we need a set of policy priorities that addresses the principal bottlenecks, or the binding constraints. The binding ones, if not addressed, would disrupt investments and growth. Thus, targeting the binding constraints has the largest effects and benefits. The first part of this paper (BusinessWorld, Aug. 7, 2022) presented the growth diagnostics approach, as elaborated by Ricardo Hausmann et al. (2005). For the concluding part, using the growth diagnostics framework, we do an exercise and examine the post-2022 elections challenges.

The first question to ask is: What constrains private investments in the Philippines?

Using the problem tree introduced by Hausmann et al., we test the first possible constraint: the high cost of finance. While debt sustainability is a key concern for the country, with the National Governments total outstanding debt levels reaching P12.76 trillion at the tail-end of the Duterte administration in April 2022, the absolute amount of debt in itself is not worrisome. What matters more is the countrys capacity to pay.

Philippine interest rates remain low, notwithstanding the Bangko Sentral ng Pilipinas (BSP) recent series of increases in policy rate. The current rate is 3.25%, which is still below the current inflation rate of 6.4%.

While global interest rates are rising, the country is not dependent on external financing, with almost 70% of the National Governments debt portfolio being sourced from domestic borrowings. Thanks to fiscal reforms put in place during the Aquino and Duterte administrations, we have an investment-grade credit rating and can thus avail ourselves of lower interest rates.

With regard to the countrys capacity to pay, our debt ratios are not yet at unmanageable levels. Some express concern over our 63.5% debt-to-GDP ratio, as it leans towards the end of the threshold for emerging markets (according to Thomas Grennes et al., 2013). However, this paper was written way before the COVID-19 pandemic. Extraordinary circumstances or catastrophes necessitate much heavier spending and borrowing. Further, as Oliver Blanchard (2022), wrote, one cannot have some universal magic number to determine what is unsafe debt.

To illustrate, our current external debt service ratio (DSR), or the ratio of principal and interest payments to exports of goods and receipts from services and primary income, stood at 4.1% as of end-March 2022. Our DSR ratio in 1988, on the other hand, went as high as 56.9% before rescheduling.

We do acknowledge, however, that we must be careful. The current debt levels, long-term economic issues brought about by the pandemic, and the current issues brought about by the Ukraine-Russia war compel the government to be fiscally responsible and ensure that debt is being spent productively.

The discussion above eliminates the high cost of finance as a binding constraint to economic growth in the Philippines at this moment. We then review the possibility of low returns to economic activities. This rubric has two sub-categories: low appropriability and low returns to investment.

Under low appropriability, one macro risk we identify as a binding constraint is the countrys shrinking fiscal space. Although we have access to financing, given sound debt management and creditworthiness, the pandemic has increased borrowing and spending, causing an abnormally high deficit.

Thus, we have to gradually unwind the deficit spending, as the economy begins to recover. While we still have fiscal space, we cannot ignore the combination of an abnormal deficit and the pressure for high, productive spending for pandemic response, social protection, infrastructure, climate change, etc. And of course, we need to be prepared for lingering and future economic shocks which are becoming frequent. We need revenues to grow out of our debt and must avoid additional borrowing; this calls for a fiscal consolidation and resource mobilization plan, which the Department of Finance (DoF) is currently pursuing.

Other issues we identified as binding constraints under low appropriability include our inflation rate that has significantly exceeded government target (macro risk) and the weakness of our agriculture sector (micro risk). Inflation, which is at its highest since 2018, is caused mostly by supply shocks for fuel and food. The BSP has increased policy rates to address inflation expectations (quite aggressively, with a hike of 75 basis points), but addressing supply bottlenecks requires other solutions.

To address the supply bottlenecks, it is crucial to look at the agricultural sector and address the issue of inadequate food supply, which causes worrisome inflation. Data from the Philippine Statistics Authority (PSA) showed that the agriculture sector only grew by 0.2% in the second quarter of 2022. The low productivity and high prices of agricultural commodities can be attributed to the high trade protection for commodities (such as out-of-quota rates for sugar, corn, coffee, pork, and chicken) and low budgetary support for agriculture and misallocation of resources.

Lastly, under the sub-category of low social returns (e.g., human capital), the COVID-19 pandemic remains to be a binding constraint for our economic growth. We have insufficient investments in health, making our health system extremely sensitive to surges in COVID-19 cases. The pandemic has deeply scarred our economy and aggravated other social concerns such as education, nutrition, care, and social protection. Universal healthcare is still far from becoming a reality for all Filipinos, and without a robust primary healthcare system, we cannot ensure decongestion of hospitals when COVID-19 cases rise. As the virus evolves, our health system is still very vulnerable to infection spikes. Surges and the corresponding tightening of restrictions would impede our economic recovery in our heavily service-based economy.

Given the four binding constraints identified above (shrinking fiscal space, high inflation, weak agriculture sector, and the COVID-19 pandemic), the policy reforms we need to prioritize are the following:

First, to address the shrinking fiscal space, we need smart taxes which result in efficiency (for example, taxing harmful products and thus addressing negative externalities). Complementing new taxes are improving tax administration and rationalizing spending by removing waste and combating corruption.

In line with this, we support the proposals to push for Packages 3 and 4 of the Comprehensive Tax Reform Program of the previous administration, namely the Real Property Valuation Act and the Passive Income and Financial Intermediary Taxation Act. We also support the DoFs move to impose VAT on digital service providers. This, however, will only have an average annual revenue impact of P13.2 billion. A better source of revenue, as stated above, is an increase in excise taxes on sin products such as tobacco, e-cigarettes, alcohol, and sugar-sweetened beverages.

To address inflation expectations, we expect the BSP to pursue an independent monetary policy that will stabilize prices without sacrificing growth. We need to provide targeted, time-bound subsidies to protect the vulnerable, such as lower-income families, public utility vehicle (PUV) drivers, and farmers, from shocks. But we must also ensure the supply of food, even if it means increasing imports, while also increasing budgetary support for farmers productivity. We need to increase productivity and efficiency and boost farmers income by consolidating land to achieve economies of scale, introducing technological innovation, and making farmers bankable by allowing agricultural assets as collateral.

Lastly, to address COVID-19, we must make the country pandemic resilient by pushing for the adoption of the health in all policies framework. In this regard, we emphasize that 80% of health problems can be attributed to socio-economic factors and individual behavior, not to health or pharmaceutical care.

The prevention of severe diseases and deaths from COVID-19 requires a whole-of-government, whole-of-society mobilization. Take the case of airborne transmission, which is the dominant mode of COVID-19 infection. Everyone, not just the Department of Health or medical professionals, is now responsible for ensuring adequate ventilation in public spaces, especially in crowded spaces such as malls, schools, and public transportation.

The pandemic also highlights the urgent need to implement universal healthcare and anchor it in primary healthcare. Here, the tasks are: Strengthen the institutions that handle public health emergencies. Have sustainable health financing generated from a combination of general taxes, health taxes, premiums or contributions, and reallocation of general appropriations. Boost social protection through targeted cash transfers, unemployment insurance, and similar subsidies.

The objective of the growth diagnostics is to outline priorities and give attention to the binding constraints (and thus not to be distracted by the non-binding constraints). In this manner, we conserve political capital and use it wisely. Some can argue, understandably, that other issues are notably missing. However, the binding constraints identified are interconnected with other issues. Removing the binding constraints would likewise alleviate the constraints in other areas. For example, the education crisis in the Philippines is partially caused by the disruption brought about by the pandemic and the shift from face to face to online schooling. Mitigating the impact of the pandemic and capacitating ourselves to handle future shocks will subsequently aid the safe return of students to face-to-face classes. This is not enough, and much more needs to be done to strengthen the education system, but at this very moment, addressing COVID-19 will relieve much of the burden faced by our students, teachers, and administrators.

On infrastructure, the government must maintain higher spending as a proportion of GDP. But this can be enabled by having broad fiscal space.

The four binding constraints are deeply intertwined. The pandemic stands out as a critical bottleneck, as our poor pandemic response (which has consistently landed us at the bottom of global pandemic resilience indices) has been constraining economic recovery for the past two years. Even though we have reopened our economy and cases have significantly dropped, pandemic-induced supply shocks are still one of the primary causes behind soaring prices. These supply shocks, particularly addressing food and fuel, will require bold fiscal, trade, and agriculture policies. The pandemic, the supply shocks and the attendant high prices have led to shrinking fiscal space. This requires new revenues. Otherwise, we face the danger of budget cuts on key programs and the reversal of important gains made in fiscal reforms in the past decade.

The authors belong to Action for Economic Reforms.

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Getting the diagnostics right 2 - BusinessWorld Online