It's the jobs deficit, not the fiscal deficit stupid!

With 10 million Filipinos looking for work, the jobs deficit is the most urgent problem facing the country today. That is not to underestimate the seriousness of the growing fiscal deficit. But it is important to have the right perspective otherwise we are doomed to fail. Even as it deals with the fiscal crisis, government’s top priority must be to protect jobs and livelihoods. It must avoid destroying them; it must continue creating them.

From this perspective, the ‘pain package’ being peddled by the Arroyo administration poses grave danger. It was revealed in a recent Senate hearing that new tax measures and spending cuts will force the economy to contract. An economic contraction simply means fewer jobs when joblessness is already high and rising. It means lower incomes when real incomes are already falling. It means greater poverty in the midst of widespread poverty.

The growing recognition of the recessionary impact of government’s fiscal plan shows the real danger facing the Filipino people. It reveals the nature of the deeper crisis we are in.

The real danger is not that the fiscal crisis if left unresolved will soon turn into a full-blown economic crisis. Rather it is this: that an economic crisis is government’s solution to the fiscal crisis. The current crisis is not simply the lack of revenues. The deeper crisis lies in the lack of courage to set our priorities right, to go against conventional wisdom, and to find solutions that address the fiscal crisis without sacrificing jobs and incomes.

Government’s approach to the deepening fiscal crisis hinges on maintaining investor confidence. It is willing to bleed industries and households dry to prop up public finances, so lenders will continue lending, and government can go on borrowing. Obviously, this approach is doomed to fail. When industries and households are bled dry, when jobs are gone and incomes are down, investor confidence will soon collapse.

Is there a way out of this dilemma? Yes, certainly. But we must first be clear about our understanding of the fiscal crisis.

The conventional account of the fiscal crisis begins in 1997 when government last posted a surplus. In this view, the decline in local tax collections (as % of GDP) in the last six years account for the growing fiscal deficit. The explosion of debts incurred by the National Power Corporation in the last three years was the last straw.

A second look at the data shows that our current difficulties can be traced back to the mid-1990s when the fiscal balance began to deteriorate. In 1995, the government’s financial position came under pressure from declining revenues. The fall in revenues was triggered by the massive loss of Customs collections as a result of the import liberalization program. Tariff rates were brought down fast, but also exemptions from import duties were given away. Thus, between 1994 and 1997, the decline in total revenues was largely due to the drop in import duties.

True, declining internal tax revenues accounted for the bulk of the fall in total revenues for the period 1994-1997. But the loss of import duties continued to escalate. In fact, declining import duties explains the decline in total revenues for the period 1994-2003. The implication is clear: a reversal of the import liberalization program will infuse much needed cash into government coffers.

Our estimates show that a reversal of tariff rates to 1997 is sufficient to remove the threat from the fiscal deficit. Using 2003 import values, a 3% tariff on non-dutiable imports would raise P44 billion in revenues, or 1% of GDP. Imposing 1997 tariff rates on dutiable imports would generate another P64 billion, or 1.5% of GDP. Total new revenues from higher tariffs is estimated to exceed P100 billion or 2.5% of GDP. This is equivalent to the estimated revenue necessary to stabilize the public debt.

There is even more pressing reason to reverse import liberalization: protecting jobs in the face of rising unemployment. Our experience indicates that import liberalization may have worsened unemployment. In 1993-1995 and again in 1997-2003, GDP growth was accompanied by rising, not falling, unemployment. Import liberalization explains this perverse relationship between growth and unemployment. In particular, the data shows that a fall in the average tariff in agriculture raises the unemployment rate, while a rise in tariff rates lowers it.

The case for raising tariffs to protect existing jobs and create new ones is straightforward. Raising tariffs makes imported goods more expensive relative to locally produced goods, thereby raising domestic demand. The resulting increase in domestic production generates employment.

In sum, raising import tariffs will address the fiscal crisis and rising unemployment. There are short-term costs like higher prices for imported goods and local goods with imported components. But this will be offset by increased demand for local industries, higher invesment, more jobs, and, if this virtuous cycle is sustained long enough, better wages. The result will be more vibrant industries and a stronger domestic economy.

Nor are we saying that the solution to our fiscal woes should rely entirely on higher tariffs. Some taxes may have to be raised, unproductive expenditures slashed. Tax collection must be improved. And government must reduce its debt payments. But a reversal of the import liberalization program must be a major part of any solution that seeks to address the fiscal and jobs deficit. We believe that this is a superior approach to solving our problems, a better way to win investor confidence. It also provides a more solid basis for future growth.

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See APL study paper:

Our most urgent problem-the jobs deficit - final draft
(updated October 27, 2004)