Choose sound economic medicine

/ 11:45 AM April 08, 2011

In addition to the fuel subsidy to jeepney and tricycle operators, Malacañang is now looking at a wage increase, price controls and a reduction in the 12 percent value-added tax (VAT) on goods and services. These measures look good but only politically. Economically, they could be a disaster. The members of the President’s economic team know this. That‘s why they are cool to these proposals. Not so with our politicians who may use the nonstop increase in the price of oil as an excuse to increase wage rates, impose price controls or reduce the VAT rate.

Let us look at the VAT first. What will a cut in the VAT rate do? Reduced VAT rates will mean lower government revenues that would only cause more problems for the government, which would be forced to do either of two things which are equally unpalatable. One is to allow its fiscal deficit to balloon if it decides at the same time to continue its level of expenditures as programmed. The other is to cut down its spending rate in order not to exceed its deficit target.


However, by allowing the deficit to increase, this could lead to a higher cost of servicing government loans and worsen the fiscal position of the government. One the other hand, cutting down government expenditures would also force the government to lower its level of services to the detriment of many poor people who are dependent on them.

What about price control? Is this not good for the poor? No, if we consider its consequence—the disappearance of some goods and services from the open market. This happens when the government sets their maximum selling prices below what is necessary to justify their continued supply. A good or service will be supplied only when the price is enough to cover their actual cost with a reasonable profit. When people are unable to get what they want from their usual source, they will look for them in the underground or black market. In the black market, the actual price usually exceeds not only the government ceiling price, it also exceeds the original price when price control was still not in effect. This makes the poor even poorer.


Increasing wage rates is also very controversial when dictated upon by the government instead of resulting from the interplay of market forces or a collective bargaining agreement between management and labor. To my mind, collective bargaining is what really happens when representatives from management and labor sit down with representatives from the government during the deliberation of the Regional Tripartite Wage and Productivity Board to consider the petition of labor for a minimum wage increase.

As in any type of bargaining, however, the one with the weaker position can’t influence the result in their favor as what we can observe in the RTWPB where labor is hampered by the high rate of unemployment in the country. For lack of employment opportunities, many workers are willing to work for less than what is approved by the wage board.

This is not to say I am not in favor of a minimum wage increase. I do favor it but only for two reasons. One is economic, that is, for labor to get a fair share of the increase in output realized during a year.

For example, if in in real terms or after correcting for inflation, the Gross Domestic Product has increased by 7.3 percent like what happened last year, why shouldn’t labor get the same increase. Why allow all the increase to go only into the pocket of capitalists?

The second is for social consideration. If we find it unfair or troublesome to our conscience to see many workers unable to meet their basic needs, why not help them by giving them a decent wage above what the labor surplus market dictates? After all, the first requirement to increase labor productivity and therefore the return to capital is to meet the basic needs of man. If he is hungry at work or worried about his sick child at home, what kind of work can we expect from him?

The issue at hand is different though. Now price increases are due not from excessive demand but mainly because of rising production and distribution cost arising from an oil price increase that affects all sectors in the economy. If the actual increase in prices that we observed in the market are due mainly to this phenomenon, then increasing the wage rate may only contribute to more prices increases. Moreover, many of our poor people are self-employed or working as unpaid family workers. They will not benefit from any government-approved increase in minimum wages. The worst part is that while their income remains the same, they now have to face more price increases arising from the wage hike. Again, this is not to say I am against a wage increase. I am for it even now but for the reasons I mentioned above to make a strong case for it.

What else do I recommend to help the poor? The problem being economic, the solution must be also economic. For example, if the increase in the price of oil is due to the actual decrease or anticipated decrease in supply arising from the trouble in the Middle East and North Africa, then the solution is to reduce demand. This may not be possible immediately because of inertia (it is hard to change our driving habits) but eventually as what happened in the 1980s when a global demand dropped, the price of oil also went down after its rise in the mid and late 1970s.


What about the poor going to work by jeepneys and other common means of transport? Shall they cut down their number of days going to work? No, but this is where the government can help with a cash transfer to the poor but only to the really poor. Subsidizing transport operators is one answer but it’s a wasteful one because not all who take the public transport are really poor. A cut in VAT rate is also wasteful because even the rich will be helped by the cut. So much for government policy making.

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