Relief and economic recovery

The author is Chair of the Political Science Department, De La Salle University. (email: eric.batalla@dlsu.edu.ph). This was published in the November 9, 2009 edition of the BusinessWorld, pages S1/4 to S1/5.

Since acknowledging that the global economic crisis has reached Philippine shores, the government has stepped up its spending to stimulate local demand. Based on Bangko Sentral ng Pilipinas (BSP) data, the government has accumulated a deficit reaching P188 billion during the period January–July 2009. This compares remarkably to the deficit of P33 billion during the same period last year.

A higher deficit is expected by the end of the year, which is particularly worrisome if the private sector is not able to respond adequately to government pump-priming measures. Increased government spending attempts to offset the slowdown or even decline in private consumption and investment. While lending for household consumption rose by P5 billion from January to August 2009, production loans have been generally on a declining trend.

The slowdown in the growth of output and demand was already being felt when tropical storm Ondoy and typhoon Pepeng struck. Ondoy wrought not only massive physical damage but also extensive psychological trauma in the capital and surrounding regions. These regions are economically important to the country because they make up a considerable share of the national output. Typhoon Pepeng likewise caused considerable damage in Northern Luzon. The effects were also felt in the Southern Luzon regions, including the rise in food (especially vegetable) prices.

Policymakers recognize the Luzon calamities and the global economic crisis as problems that they must collectively deal with. They face the challenge of getting the country out of its dire economic situation. Their response is critical to actually addressing this challenge. In the midst of a global economic crisis, it is important to consider the accelerated economic recovery of the calamity-stricken regions as now fundamental to national economic recovery and growth.

The accelerated recovery program requires both textbook and unconventional strategies. While government borrowing is necessary to further boost badly needed social development expenditures and infrastructure repair, the limited amount that can be loaned and their economic effects may not be sufficient to spark the demand slack. Arguably, the slack in domestic private demand is related to spending capacity more than to shortages of goods in the local market. This suggests that recovery financing for households and firms is critical to jumpstart demand and sustain economic growth.

As one might expect, the ravage of the recent typhoons has heightened demand for housing, household goods, transportation, health care, etc. in economically dynamic regions. Likewise, many affected firms need repairs and replacements for damaged equipment and facilities. Relief has been generously provided on the liability side of households and firms especially through the extension of calamity and other loans. It is good that Congress is acting on urgent legislation for calamity relief.

Policymakers can also consider the provision of temporary relief in the equity portion of the asset equation. Particularly, they can reduce taxes to firms and households in the capital and other typhoon-stricken regions until economic recovery is within sight or at hand. They could study either slashing the EVAT or income taxes (e.g., straight 10%) or both in two stages.

Equity-based relief is a calculated risk which is a function of public entrepreneurship. While tax relief benefits private spending, it may also increase the government’s debt burden, which entails higher future taxes. Likewise, a tax relief program might not be so credible considering that the country chronically suffers from a low tax effort and significant financial leakages. So if the EVAT reduction—the more politically attractive option than income tax reduction—does not realize the intended effect, then the public bears the burden of having to pay higher taxes in the future. Likewise, demand stimulation through one-time tax refunds may not sustain the needs of economic recovery.  Thus equity relief alternatives have to be carefully studied.

The benefits of equity-based relief however cannot be underestimated in times of economic crises. The strategy could be likened to a firm reducing the prices of its products in order to boost sales revenues.  Of course, the government’s tax base is not as elastic as a firm’s product demand. But the amount of tax revenues also depends on the growth of household and firm incomes, which the proposal intends to stimulate.

Even before the storms, the decline in tax revenues due to the global crisis could already be observed. Government tax revenues for January-July 2009 were P32 billion short of the previous year’s level. Thus, the extensive physical and psychological damage that the calamities produced would likely exacerbate the fiscal situation. In other words, even without equity-based relief interventions, the steep decline in government tax revenues as well as the remarkable increase in government deficits would be realized owing to the global crisis and the storms. That trend at least is clear but the solution to reverse it isn’t.

Under an equity-based relief program, the government exchanges lower short-term tax revenues for higher long-term receipts. The funds that would have been transferred to the government as taxes for say six months to one year would serve to increase disposable incomes of households and firms.  Increased disposable incomes instead of calamity loans alone would boost private sector confidence in the economically progressive but typhoon-ravaged regions. It is that sort of confidence which is important to accelerate recovery and put the economy back on a sustained growth path.

Urgent legislation is needed to shape public expectations about their spending power before Congress adjourns in November or closes next year. As well, successful negotiations with government creditors in view of an expected higher deficit could provide relief from impending debt-service commitments.

No comments yet.