ReInventing Philippines Inc.,

Incentives matter.  Recognizing that people will contribute more to the public good by working towards their self interest is a principle that should be recognized.

In the 1950s, Mao Ze Dong unveiled the Great Leap Forward whose goal was to transform China from a primarily agrarian economy into a leading industrial state. His plan – to become a leading steel producer by encouraging each household to set up backyard furnaces and melt scrap iron for steel.  Millions of backyard furnaces were set up, and peasants started to melt down their pots, pans, and equipment.  The effect was devastating. It was almost like melting forks to produce forks, but with a difference – much of the produce from the furnaces was unusable as authorities only focused on meeting the quotas demanded by the state.

The agricultural policy was even more devastating.

The government made a study on how to increase agricultural produce.  One of the conclusions was that to increase yields, farmers have to do closer planting and deeper sowing.  The other was to kill grain –eating birds, which unfortunately had also the effect of increasing the population of insect pests.

Mao Ze Dong would ride the train to inspect the fields, and the party officials, anxious to please their chairman would build furnaces along the railroad, and transplant the rice from faraway fields and replant it on the officially designated density in fields near the tracks.

Food production declined, but the officials were keen to report surpluses.  Thus, China exported grains, and state warehouses reported ample stocks, but there was hunger in the countryside.   An estimated 30 to 50 million people died of starvation in what was dubbed as probably the greatest economic failure of the 20^th century.

China’s agricultural output per person did not improve much from the 1950s to the 1970s, and part of the reason is that the country had a very perverse incentive plan.

First is that farmers were organized into collectives of twenty or thirty families, and people were rewarded with ‘work points’ if they produce over quota, which was given to the collective itself.  There was no opportunity for personal improvement, and thus many individuals did not have any incentive to provide extra effort.

Moreover, in the interest of the collective good, the surplus one region produced was bought at a very low price to aid other regions, which has the effect of discouraging the more fertile regions of improving productivity.

When Deng Xiao Ping came into power in early 1980s, he first started to raise the price paid for surplus crops by more than 40 percent.  The now better price was incentive for fertile areas to produce more.

Then he allowed the collective to subcontract land to individual households.  The household now had more incentives to work harder, because the crop prices were better, and they could now be directly rewarded for their increased production.  In 1979, over 99 percent of production was by collectives.  By 1983, over 98 percent of collectives were now subcontracted to households.

The result was a growth of more than 10 percent of production a year for the first half of the 1980s.

As we now all recognized, it was not Mao who brought the Great Leap Forward.  For the last 30 years, China had achieved the great leap by recognizing the power of markets, prices, and self interest.

The Philippines was named after King Philip II of Spain.  During his reign, Spain was the foremost Western European power. Spain was at its zenith of influence and power, directing explorations all around the world and settling the colonies in all the known continents.

Philip II was a profligate spender, the result of which caused the decline in Spain.  He financed many expensive expeditions, and also created the Spanish Armada, which after its defeat by the English, Spain was never able to recover.  He was the first ruler who declared bankruptcy.  As if that was not enough, he actually went officially broke at least four times.

Our country was not only named after him, but we have inherited his profligacy.

The bulk of government spending is not on capital projects, but on pork barrel.  Pork barrel refers to projects  whose main goal is to appease and please constituents and where return of investment is unclear.  40% of the total collections of the government goes to IRA ( internal revenue allotment) which is divided by the province, municipalities, cities and barangays. A significiant percentage goes to the office of the president, the senators, and the congressmen. Another 20% goes to debt servicing, and a significant part goes to the salaries and maintenance of its huge bureaucracy, which has increased by  leaps and bounds every year

Do you wonder why the tax man is so unreasonable?  VAT went from zero to 12 percent in 20 years, and they have doubled their collections the last 9 years even when growth was minimal, and yet more money is needed to feed the growing monster.  We are already on our 12^th year of record deficits.

Government is not investing much in the future, and there is almost none left for business and citizens to invest for the future either.

While trade and technology can become a win-win, government intervention is a zero sum game. More likely than not, government allows somebody to win at the expense of somebody else.

Milton Friedman, a Nobel Prize-winning economist once observed that he would prefer a federal government budget of $1 trillion even with a big deficit than a federal budget of $2 trillion that was balanced.His obvious point is that a bigger government puts more burden into the economy whether it finances its spending via taxation, borrowing or printing money.

When the government gets taxes, it gets the money from consumers who could have spent it, or the businesses who could have invested it.  When it borrows, it competes with businesses.  When it prints money, it stokes inflation.

When given two choices  a.) get from Peter to help Paul  b.) allow Peter to help Paul with the proper incentives, then government should do the second.

The unwinding of the Soviet Union, Eastern Europe and China into market economies show that government is not the best agency to create economic growth, manage a business, or even help the people get employed.

The best way to reduce poverty is to put in place policies that deliver sustained, strong economic growth.  Simply redistributing wealth will not cut it, not with our current track record. The late Ravjiv Gandhi, former prime minister of india, famously said that only 15 percent of the government funds intended for the poor actually reached them.

My hope is that by taking the steps we are taking today…the government can get out of the way and let the private sector do what it does best — innovate, create jobs, and grow the economy.                                 – US President Barack Obama

Whatever you say about opening up for globalization ( it has its bad sides), no country anywhere has achieved sustained high economic growth without opening up. Japan started to grow after they opened up in 1860, so did China in 1980, and so did India and Eastern Europe in the 1990s.

The last 50 years owes its greatest growth due to technology and globalization.  World GDP rose 240 percent from 1900 to 1950 and grow even further by 700 percent from 1950 to 2000, as technology and trade accelerated. Before that, it was almost negligible.

Technology enables better products for lower prices, and improves productivity.  The increases means more money for consumers to spend, and more profits for the business.

In 1962, President Kennedy declared that the major challenge of the sixties is how to maintain full employment at a time when automation will be replacing men.  Well, not only were no jobs  lost, but tens of millions more were created due to tech advances.

When NAFTA ( North American Free Trade Agreement which allows free trade between Canada, United States and Mexico without tariff) was to be signed, Ross Perot, a presidential candidate, declared that this will result in the giant sucking sound of jobs going to Mexico since the salary there was  much cheaper.

It did not happen. In fact, the next few years after that agreement, the United States generated 22 mllion new jobs, and unemployment rate feel from 7 percent to 4 percent as new technology and trade created new jobs.

Trade has been the weapon that have made numerous countries rich.  You cannot find a country that is rich that does not trade.  And you become competitive in trade by investing in people and technology.

The Soviet Union, former Eastern Europe, China, Latin America, and  India experimented with various forms of communism and socialism in order to redistribute wealth more equitably.  They failed.

This philosophy of redistribution is anchored on the thinking that people are entitled to their share of the pie, and therefore have created the fundamental policy of taking from Peter to give to Paul.  However, the growth of the Philippines the last 50 years have been limited to 3 to 4 percent.  At this rate of growth, and especially if the population is growing 2-3 percent as well,  no amount of redistribution will lift people out of poverty, and we have failed as well.

According to Arthur Okun, whose saying has become known as Okun’s law, GDP growth of 3 percent will not be able to lower the unemployment rate.

The experience of the 4 tigers ( Hong Kong, Singapore, South Korea, Taiwan) , SouthEast Asia and lately of China and India have shown us that when the GDP is growing faster than 7%, then it is like a tide that lifts all boats.   The wonder of China’s economic growth is not only that it created millions of millionaires, but that it lifted a few hundred million people out of poverty.

Philippines should adopt a policy of fast growth, and should do what it can to insure the competitiveness of its industries, by insuring that the cost and ease of doing business is competitive, and remove all hindrances to growth.

It is great to talk about justice or land reform, but above all else, we need to grow…. Fast!  The number 1 priority should be to lift people out of poverty and the only proven way is to grow the pie by focusing on positive sum strategies, not zero sum policies.