History Is NOT A CLOSED BOOK: The View from IMF

``We'll tax and tax, spend and spend, elect and elect because the people are too damn dumb to know the difference." -Harry Hopkins, advisor to FDR

Our basic function is to profit from opportunities presented by market asymmetries. This by acting on perceived favorable probabilities presented by themes, be it momentum (technical) or fundamental (growth, value, economic or business cycles etc...). Yet as previously expounded, the marketplace is NO different from the economy as it is CLOSELY linked with the political trends. In the analogy of an Elementary song “Dry Bones”.... ``your toe bone is connected to your foot bone which is connected to your ankle bone which is connected to your leg bone which is connected to your knee bone...”

Yet, in discerning for themes we aim to EXTRICATE signals from noises, since noises could entrap us to false premises and lead to senseless losses.

On the same grounds, when we hear of camouflaged political noises veneered in the context of moral issues such as “Maid Exports” or “Flawed Culture” or “Rapid Population Growth” circulating to influence the mindsets of public, our response is to challenge the “wisdom of conventional thinking” founded on the popular but on highly specious grounds. Our viewpoint comes in the lexicon of “what we see depends on where we stand” framework.

Our recent series of “History is Not A Closed Book” aims to show of how macro dynamics are MASSIVELY TRANSFORMING both the global economic and political landscape, where domestic politics are likely to take the shape under its growing influences rather than the circulating political bunk masquerading as virtuous “moral” ascendancy.

Yes, while we understand that there are risks to such evolution as signs of rising tide of protectionism, where the recently imposed tariffs by US on China’s paper products could be a symptom of a possible snowballing trend in the US (a political and economic hara-kiri in my view) which may serve to impede on the present developments, we think that to some degree technological advances, economic and financial integration and demographic trends will eventually COMPEL the adaptation of political economies that would best fit into today’s rapidly evolving environment.

For instance, the massive productivity growths in emerging market economies have resulted to tremendous impacts to our lives today. While we have been witnessing a trend of decreasing prices in manufactured goods, as a result of expanded capacity, rapid technological advances on the pace of “Moore’s Law” and surplus labor, on the other hand, increasing price pressures on raw materials and commodities, which reflects the strain by rapidly expanding demand on the on the supply side, is an outgrowth mostly from rising per capita income of emerging market economies.

Since most of these countries have benefited from recent globalization trends, chances are that they won’t opt to spoil the party, and would even work further to improve on this preferred avenue for development.

As testament, China, one of the leading forces in today’s seismic shifts, recently undertook a landmark legislation to protect property rights of its constituents. In the same breadth, China will also undertake a programmed expansion of its financial markets to include financial futures contracts and options beginning April 15^th, and as well, plans to establish a sovereign wealth fund or the world’s largest investment company that would manage its excess reserves which has reached over US$ 1 TRILLION.

These measures serve as growing manifestations of the country’s RECOGNITION of allowing market forces to determine the efficiency of resource allocation for the political SURVIVORSHIP of its ruling class. It is a growing realization that unless wealth spreads, the preservation of their power is jeopardized.

I think it will be no different here, unless of course we decide to do the extremes ala Chavez of Venezuela.

While global investments have been on a general decline as a result of the IT bubble implosion but seen with cautious recovery at present, this has NOT been the case in the local arena as investments have been on a steady declining trend far more than our neighbors as shown in figure 4.

Figure 4 IMF: Rising Share of Services sector while Gross Fixed Capital Formation is on a decline.

According to Wikepedia.org, the concept of statistical aggregate of Gross Fixed Capital Formation (GFCF) which is a flow value, is the ``measure of the net new investment by enterprises in the domestic economy in fixed capital assets during an accounting period.” In other words, residents have not partaken into investing domestically, which shows of a declining trend. This has been rightly pointed out by some observers.

However, in contrast to the belief that investments withheld by domestic investors could represent some innate asymmetries, the IMF thinks that present trends could be indications of a transition shift from that of remittances based economy to services based one, also shown above in Figure 4.

According to the IMF (emphasis mine),

``However, the lack of response of investment could also be a transitory phenomenon. Over time, a rise in remittances can cause an endogenous change in consumption-investment decisions. The shifting skill and regional patterns could also have potentially powerful implications for the saving patterns of the dependents in the Philippines who are the end users of these funds. In 1991, nearly 60 percent of families in the Philippines who considered their main income source as coming from abroad came from the bottom two quartiles of the income distribution. By 2003, this share had dropped to just under 18 percent, implying that the share of families in the top two brackets counting income abroad as their main source of income rose from 40 percent to 82 percent. The most likely interpretation of this fact is that the skill set of remitters has shifted exogenously, and there are both “pull” and “push” factors taking higher skilled workers abroad. Given that some 80 percent of families that receive income from abroad as their main source are now middle and high income families, it is much more likely now than in 1991 that the uses for this income go beyond consumption and subsistence, and are put toward saving and investment. This suggests that the lack of a relationship between investment and remittances could indeed be transitory, and that going forward, one may see a pick up in investment in physical capital.”

Figure 5: Gavekal Research: Growing Signs of Massive Capital Investments Boom?

If the IMF thinks that a domestic investment recovery is underway, so did we since last year, as we wrote in Want a Stock Market tip? PGMA’s SONA was a Mouthful, or as early as 2004 [November 29 to December 3, 2004 see Domestic Investment to Help Drive the Phisix?].

Like us, the Gavekal Research team believes that a massive investment boom is imminent in Southeast Asia, where in their recently (February 28^th) issued handbook, Asset Allocation & Economic Research they wrote (emphasis mine),

``One of the key themes of research in 2006 was that Southeast Asia is currently going through a massive capital spending boom (thanks to cheap Chinese machines, higher exchange rates and lower real rates). And everything we look at continues to point towards an unprecedented capital spending boom in ASEAN countries.”

In Figure 5, courtesy of Gavekal Research, the chart of Philippine Imports of Capital Goods shows of a healthy uptrend. This indicates of a reversal from its previous decline following the Asian Crisis. Are we perhaps now witnessing the unfolding of our gradual BOOM scenario?

According to the Gavekal Team, ``As ASEAN starts to spend real money on infrastructure (for example, Mrs. Arroyo just announced a US $20 billion, 4-year infrastructure spending plan for the Philippines), there could be less money making its way to reserves.” Hmmm, sounds familiar?

In a similar plane, we have noted of how the seeds of the infrastructure boom have been sown in India last week, which to the extent reflects the booming Infrastructure theme in Global latitude, and how this should affect the political, economic and investment dimensions.

Now of course, if one would ask WHY the shift to the services industry instead of manufacturing industry? Asian Development Bank (ADB) during their latest development outlook shares with us their insight on the existing malaise of our much maligned industry (emphasis mine),

``In the 1950s, a sophisticated manufacturing sector emerged in the Philippines, supported by protection and a well-developed human capital base (Hill 2003). The problems for manufacturing began subsequently. A combination of factors appear to have played a part, including a period of costly and badly directed interventions, a tendency to focus on protecting rents rather than improving efficiency, poor physical infrastructure, and, to a lesser extent than in India, some problems with labor market regulation. High levels of corruption, disputed property rights and difficulties with contract enforcement have also played their part (ADB 2005). These facets of everyday economic life seem to reflect deeply embedded institutional difficulties including high concentration of wealth and a political system based on patron-client relations (World Bank 2005, p.3).”

So essentially what the ADB in its “Growth Amidst Change” outlook mean is that instead of allowing for market forces to determine the industry’s wellbeing, the country has been engaged in a slew of anti-market forces in forms of policies that cater to protectionism, costly interventions, protection of favored interests (rents), choking regulations, questionable implementations of property rights and contract enforcement.

In short, most politicians and their statist retinues have had a blighted “long-term” record of “saving the country” and in fact, as the ADB shows, have been responsible for compounding our self-inflicted miseries. As Julius Caesar once said, ``All bad precedents begin as justifiable measures.”

Where we always argue that stifling regulations lead to both massive inefficiencies, and imbedded corruption, and where economic opportunities are determined by politicians or by their factotums rather than the market itself (meritocracy; market efficiency determined by efficiency of resource allocation), the result has always been market distortions, little productive savings and investment and the lack of entrepreneurs and or of market opportunities. As been said before, our poverty is a result of dysfunctional and underdeveloped markets.

Here the IMF gives us a list of suggestions for our betterment (emphasis mine),

``Therefore, to move to a decisively stronger growth path, the Philippines needs to prioritize the following areas:

• First, improvements in infrastructure are necessary to support the emerging service sector. For the BPO industry, these include not only continuous upgrading of the technological hardware that has made the Philippines competitive thus far, but also access, in terms of roads and transportation to cities that are new emerging centers for these industries beyond Metro Manila.

• A renewed emphasis on the provision of stronger education, including across engineering and scientific disciplines, are essential if higher value-added overseas jobs, or high value offshore servicing industries are to make the Philippines their home.

• The need for education is further underscored, if the Philippines is to turn its relatively high population growth into a demographic advantage in an “aging” world. Otherwise, sustaining a growing population on income sources that emanate directly or indirectly from abroad with a stagnant set of labor skills could prove untenable.

• Finally, as the demographics of the end-users of income from service sector jobs (domestically and abroad) change, besides education, there is also a need for greater savings out of these incomes, and more productive investments being made using these savings. Absent this, the strong indirect effects from the growth of services which have been seen in other countries may not be realized.”

Except that these proposals come from the IMF itself, have we not dealt with most of these since?