Aquinomics: Financial doom for the Philippines?

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Ben D. Kritz

Ben D. Kritz

As I wrote a few columns ago (“The hand you hold is the hand that holds you down,” October 10), if we really want to understand why the various funds at the center of the ongoing “pork barrel” scandal are truly wrong and must absolutely be abolished, we need to look beyond the legal and moral issues of their evident misuse.

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The current focus on what seems to be wholesale plunder, bribery and other forms of institutionalized thievery is obviously not misplaced—no breach of public trust and especially not one on such a breathtaking scale should be tolerated and go unpunished—but the real problem is not that funds like the Priority Development Assistance Fund (PDAF), the hastily contrived “Disbursement Acceleration Program [DAP],” the President’s Social Fund, the Special Purpose Fund and the Malampaya Fund have been misused, it’s that they exist in the first place.

Except for the DAP, all of these funding mechanisms have existed through several administrations, and in all likelihood have always been an unnecessary drag on economic growth. The negative effects have been minimized, however, simply by limiting their scope. For example, the PDAF under former President Gloria Arroyo in her last three years in office averaged P7.8 billion per year, but upon taking office, President Benigno Aquino 3rd immediately increased the fund to more than triple its Arroyo-era level.

Doing that was dictated by the basic logic (however practically inappropriate that word may be here) behind “Aquinomics,” which is based on the flawed premise that government spending is the primary driver of the economy: By keeping a large, liquid amount of funds under Executive control, those funds could be rapidly applied to short-term expenditures to boost growth indicators. On the face of things, it actually worked; except for a slow start caused by “realigning priorities,” to put it kindly, the first three years of the Aquino administration have been marked by rapid economic expansion (in terms of gross domestic product growth), rapid stock market growth, and expanded availability of both liquidity and credit.

The slow start is one clue to what was actually happening, and the fact that it was happening under conditions of negative job growth, flat per capita income growth, and increasing income inequality is another. Aquinomics is essentially a large-scale manifestation of a Cantillon Effect, named for the Irish-French mercantilist (to some, the father of political economy) Richard Cantillon, who first described it in the Essai sur la Nature du Commerce en Général, published in 1735 (the book is better-known by its title in translation, An Essay on Economic Theory).

A Cantillon Effect, in the simplest terms possible to describe it, is a change in the allocation of resources caused by the increase in the availability of money and the change in relative prices of goods. In other words, resources are invested in things in which they would not have been in otherwise “normal” circumstances.

An elementary example would be when a worker who has just received his paycheck chooses to go out for dinner rather than eating at home as he would the other four nights of the workweek. The price of a restaurant meal relative to his money supply is, in that instance, much lower than it ordinarily is; that is a Cantillon Effect.

Interest rates, in the sense that they represent the difference in relative prices of consumption and capital goods, also play a role as an effect of the way money enters the economic system; the rate declines (i.e., the relative price ratio narrows) when money enters by way of traditional borrowers—manufacturers, developers and merchants—and increases when money enters through consumers’ spending. Actual interest rates, such as those set by the Bangko Sentral ng Pilipinas (BSP), generally work in the opposite direction, because central banks try to keep that real interest rate from moving too far from the natural rate of interest. So in the Philippines’ case, because the flow of money into the economy is largely the result of consumer spending, the BSP has kept its interest rates much lower than the positive economic indicators suggest it should, in an effort to counteract the climbing real interest rate—lower central bank rates should encourage more capital spending, which would bring down the real interest rate.

Unfortunately, that effort is severely hampered if not canceled out completely by an administration team who, if we take them at their word and do not presume they are simply manipulating spending for nefarious purposes as many people have come to believe, have a grasp of macroeconomics so tenuous it borders on the incompetent. Government spending affects the economy in a largely indirect way—the government can never have nor spend enough money to move the needle on the gauge very far on its own, but the manner of its spending is a signal, and a catalyst for a multiplier effect. Thus (to use another simple example) if the government invests in a new road, the improved access to an area will encourage follow-on private sector investment in housing, retail businesses, perhaps manufacturing, and the further infrastructure like electricity, water, transportation and telecommunications that all those things require.

If on the other hand the government primarily pursues consumption spending, as this government does, it reduces or eliminates the potential multiplier effect—a covered basketball court built “through the efforts of” honorable congressman so-and-so does not support much in the way of related business activity, after all—and encourages more consumption spending in the private sector. That is one partial explanation for the rapid climb in the local stock market; investors have money but nowhere to spend it, since the economic activity, while impressive, does not signal permanence or sustainable expansion.

The adjustment for a Cantillon Effect gone too far, or to put it precisely, for a significant imbalance between the real and natural interest rates, is made through prices. When the real interest rate is too far below the natural interest rate, prices drop (a phenomenon known as the ‘Skyscraper Effect’). The problem in this country is the opposite; the real interest rate is much higher than the natural interest and there is too much money in the economic system, and therefore it will correct itself by an increase in prices. We are already seeing the hints of that process beginning with a significant jump in the official inflation rate and a spike in the prices of some specific commodities, such as rice. And there are hints that policymakers are at least partially cognizant of the risk, with recent increases in government borrowing—largely done to shift to domestic debt sources, to soak up some money out of the economy—and the BSP’s continued holding of a huge foreign currency reserve to hedge against the almost-inevitable devaluation of the peso.

All of this makes the economy extremely susceptible to shock; it would be possible, though difficult, to let the air out of the bubble slowly by forcing the administration to redirect their fast-expenditure funding pools to hard investments, and let consumer prices slowly increase to cool spending, but if there are any potentially destabilizing factors—not an assumption we can take to the bank by any means, if recent events are any indication—Mr. Aquino’s “fastest-growing economy in Asia” could very quickly become noteworthy for collapsing even faster, an achievement for which he can, and should, be given all of the credit.
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And if I may be so self-indulgent as to add a little personal note to this, today marks the ninth wedding anniversary for me and my lovely wife, best friend, and occasional sparring partner Julie. I love you, honey.

benkritz@outlook.com

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2 Comments

  1. thank you for your piece sir…we are in deep sh*t with the way our country being managed by our leaders. :(

    happy anniversary to you and your wife :)