Reason, enlightenment and inflation

Yellow Pad
By Filomeno S. Sta. Ana III

 

It is said that reason and enlightenment have taken a beating amid the rise of the Trumps, Erdogans and Dutertes. These belligerent strongmen have polarized society. The consequence of extreme polarization is the emergence of biases and blinders from all sides.

Look at how the issue of Philippine inflation is now being tackled. The debate is driven no longer by sound economic reasoning but by a combination of ignorance, ideological biases, and political motives.

President Rodrigo Duterte himself does not help clarify the issues. He said that Philippine inflation was a result of Trump’s imposition of higher tariffs on goods from China and other countries. Trump’s slapping of higher tariffs has triggered retaliation. Philippine trade is surely affected by this trade war, for some of our products for export are part of the global value chain. On the other hand, the Philippines can take advantage of the situation to attract firms that export to the US from China to relocate to the country.

But Duterte, who has confessed his unfamiliarity with economic issues, cannot explain how Trump’s higher tariffs translate into higher prices in the Philippines. The curt response to Duterte’s remark then is “duh!”

But the political opposition is also barking up the wrong tree on inflation. It blames the tax reform program, particularly the increase in the tax rates of fuel products, as the culprit of higher inflation. But is it?

The Department of Finance (DoF) has a breakdown of the causes of inflation. For the August 2018 inflation rate of 6.4% (year on year), the contribution of the tax reform (otherwise known as TRAIN) was 0.4 percentage point. AER has vetted the DoF’s estimate, and our own calculation (but as of April 2018, for we do not have the raw price data after said period) is close to the DoF’s, that is, 0.45 percentage point.

Part of the obfuscation is to attribute the increase in fuel prices solely to TRAIN. But TRAIN accounts for a fourth (25%) of the rise in fuel prices. The main reason for the spike in fuel price is the rise in the global price of crude oil.

It is difficult to accurately forecast world crude oil price, given its volatile nature. When the TRAIN bill was filed in the Lower House in January 2017, the oil price was at $53.37 per barrel. The price even went down in May 2017 to $49.91 per barrel during the time that the Lower House passed the bill in May 2017. In August 2018, the price shot up to $71.90 per barrel. Be that as it may, TRAIN has a provision that suspends the excise tax on fuel when the average Dubai crude oil price based on Mean of Platts Singapore (MOPS) for three months prior to the month’s scheduled increase hits $80 per barrel.

If not TRAIN, what are the principal factors driving inflation? Global factors like the sharp increase in world crude oil prices and the hike in US interest rates (contributing to the peso depreciation) account for a significant part of the inflation. Typhoons or weather disturbances have resulted in higher prices of vegetables.

Food and non-alcoholic beverage constitute the biggest weight in the consumer price index. The most sensitive item is rice, accounting for almost 10% of the index. Rice alone contributed 0.7 percentage point to the 6.4% inflation rate in August 2018. This is much bigger than what can be attributed to the whole of TRAIN.

Here, the Duterte administration failed big time. The President sided with the incompetent head of the National Food Authority who prevented the timely importation of rice, discouraged the private sector from importing, and failed to buy sufficient palay from farmers during the harvest season.

Note, too, that higher purchasing power also pushed prices up. The higher purchasing power is a result of the following factors: the increasing number of both enterprise owners who create jobs and the workers who receive salaries or wages; the personal income tax relief from TRAIN; and the additional cash transfers also from TRAIN.

Despite the different factors that account for current inflation, the opposition is targeting TRAIN. The likes of Senator Bam Aquino even insist on attributing second-round inflation effects to TRAIN. This is mistaken. Second-round effects like rising inflationary expectations and demand for wage increases are a reaction to the overall increase in prices.

For TRAIN is the target, the opposition wants its implementation, specifically the increase in fuel excise tax, suspended. The opposition has filed House Bill No. 8171 and Senate Bill No. 1798, both calling for the suspension of the TRAIN’s excise tax on fuel.

Sadly, the proposed cure is worse than the perceived disease. Suspending the incremental fuel tax brought about by TRAIN can only shed a tiny part of overall inflation, less than a third percentage point of the total inflation rate. But suspending the increase in the fuel taxes will result in heavy losses. The incremental revenue generated from the fuel taxes is expected to fetch P53.5 billion in 2018.

Concretely, that amount is nearly equivalent to funding the controversial free college education that Senator Bam Aquino champions. Senator Aquino is no different from President Duterte in being a populist, but the former opposes the taxes necessary for such spending.

Further, suspending the fuel taxes, the main source of revenues from TRAIN, endangers the personal income tax relief and the provision of the unconditional cash transfers that benefit the poorest 50% of Filipino households.

If government would not reverse the income tax relief, the disbursement for cash transfers, and other expenditures, the suspension of fuel taxes would increase the budget deficit to an uncomfortable level. The bigger deficit, in turn, would lead the government to borrow more, thus risking debt dependence, or to print money, which in turn is inflationary. Either way, investors and creditors will punish the Philippines through a credit rating downgrade and capital flight.

The economic managers of course will not allow the suspension of the fuel taxes, precisely because of its severe consequences. For standing their ground, the economic managers will earn the respect of the investor community. But the political opposition will be seen as fiscally irresponsible and ignorant of economics.

My piece of advice to the opposition: Be reasonable. Be enlightened. And instead of concentrating fire on TRAIN, do target the high prices of staple food, resulting from the administration’s bungled rice policy.

 

Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.

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