The Philippines Needs Economic Freedom More Than New Laws

``Excess and inequality of taxation, however disguised in the means, never fail to appear in their effect. As a great mass of the community are thrown thereby into poverty and discontent, they are constantly on the brink of commotion; and, deprived, as they unfortunately are, of the means of information, are easily heated to outrage. Whatever the apparent cause of any riots may be, the real one is always want of happiness. It shows that something is wrong in the system of government, which injures the felicity by which society is to be preserved.” Thomas Paine (1737–1809) was an English pamphleteer, revolutionary, radical, and classical liberal. Society Is a Blessing, but Government Is Evil

Recently I stumbled upon an article descriptive of the supposed excesses of the lower house of the Philippine Congress. While the general idea-the supposed extravagance from the enormous allocation of the pork barrel funds coming at expense of the economic development- seems accurate, what prompted this response is the seeming counterfactual projection of causation: the alleged inertia of the Philippine Congress to pass laws which has resulted to our economic plight. In short, the Philippine economic malaise has been imputed as an offshoot to a dearth of laws!

Of course, the narrative comes with a tacit political slant; its dubious silence on the performance of the Philippine Senate. This seems to imply that the lower house has been inadequately doing its job (yet undeservingly gets its disproportionate share of Development “Pork” funds) because it remains supportive of the administration, while the upper house which has been conducting a series of “trial by publicity” of the recent scandals by several key figures of the administration purportedly “in aid of legislation” appears deserving of their perquisites (thus the suspicious silence).

Nonetheless, such straw man argument ignores the fundamentals of why the Philippine legislative branch or other government agencies are allotted with such humongous discretionary funds for its elected officials. The problem with most politically colored analysis is that it mostly focuses on the symptoms while discounting the roots of the problem.

Let’s revert to government basics: Every enacted law requires attendant administration personnel, logistics and corresponding police power to effect its implementation or an organization called as a bureaucracy. This means that funding for this public hierarchical entity comes from you and me or the taxpayers. In essence, ceteris paribus or all things being equal, more laws equal to more taxes!

So by sheer logical deduction; if economic nirvana would be attained by paying more taxes via more regulations then why not simply tax 100% or all of our income by regulating each and every activity? Yet, would you be willing to work your guts off under such circumstances?

We have seen the failed experimentation of such model in the nomenclature of “communism”. But, history’s lesson tell us that such paradigms simply don’t work, otherwise Mao’s China or Stalin’s USSR would still be functional and stand as the most economically prosperous…but where?

Ironically, the only remarkable achievement communism has brought upon to this world is the undue death of 94 million people- estimated 20 million in USSR, 65 million in China, 1 million in Vietnam, 2 million in North Korea, etc… (Black Book of Communism) aside from amazing feat of equality-every one is poor (of course except the leadership)!

So the argument of absolute regulation is by itself impractical.

Costs of Laws: Compliance Costs

And since everything has a cost; laws have their own costs too.

One has to deal with compliance costs-directly or indirectly-which means aside from the direct costs of paying taxes, indirect costs implies costs from the loss of productive time, efforts, expenditures in manpower or resources used in conforming to government regulations or laws, as shown in Figure 1.

Figure 1: World Bank’s Paying Taxes: Compliance Costs

From World Bank’s report on Paying Taxes 2008, ``Making the tax rules for businesses complex is unlikely to generate more revenue – quite the opposite.”

So, essentially the more complicated the regulations in the form of ambiguous laws, many laws per tax and mandatory forms, the higher the costs of compliance.

The point is that the tax structure based on the underlying laws determines the cost of compliance. High compliance costs increases the cost of doing business which basically deters investments, the primordial reason for a nation’s economic development.

Regulations In A Complex Society Leads To The Law of Unintended Consequences

And importantly, the costs associated with the laws of unintended consequences or unforeseen consequences. Alex Tabarrok of Marginal Revolution has a splendid definition of this phenomenon (highlight mine),

``The law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple, it operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society in contrast is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences.

``Unintended consequences are not restricted to government regulation of society but can also happen when government tries to regulate other complex systems such as the ecosystem (e.g. fire prevention policy that reduces forest diversity and increases mass fires, dam building that destroys wet lands and makes floods more likely etc.) Unintended consequences can even happen in the attempted regulation of complex physical systems (here is a classic example involving turbulence).

``The fact that unintended consequences of government regulation are usually (but not always or necessarily) negative is not an accident. A regulation requiring apartments to have air-conditioning, for example, pushes the rental contract against the landlord and in favor of the tenant but the landlord can easily push back by raising the rent and in so doing will create a situation where both the landlord and tenant are worse off.

``More generally, when regulation pushes against incentives, incentives tend to push back creating unintended consequences. Not all regulation pushes against incentives, some regulations try to change incentives but incentives are complex and constraints change so even incentive-driven regulations can have unintended consequences.”

As you can see no matter how noble the intention of a law maybe, the laws of unintended consequences can negate whatever the anticipated positive outcome simply due to the unforeseen complexity of societal dynamics.

Simplified “moral” thinking as basis for regulation frequently backfires. Popularity does not automatically translate to righteousness. So the concept of plainly churning more laws as the magical formula to economic upliftment is grossly misguided, if not daft.

Applied to the present political scenario, what we are seeing is exactly a backlash (law of unintended consequences) on the structural strangulation of the economy by political forces operating on the platform of rent-seeking (patron-client) culture emanating from the pork barrel system of governance. Personality based politics as advocated by media ensures that the same dynamics will be repeated again and again for as long as the political structures are not overhauled.

In fact, it is more laws or regulations that have led to the intensified empowerment of the domestic political hierarchy. Going back to basics, more laws mean more financing requirements for implementation or a bigger bureaucracy, sustained by a bigger share of taxes.

The Vicious Feedback Loop

``Taxes do not result from a market process, nor do they reflect allocation decisions of resource owners . . . In other words, taxation is a method of intervening, not an alternative to intervention or nonmarket allocation” (emphasis mine), excerpted from O'Driscoll and Rizzo, cited in Efficiency and Externalities in an Open-Ended Universe.

As we previously discussed The Economics of Philippine Election Spending, the costs of winning elections have surged dramatically in line with the explosion of government spending. Everybody wants to have a piece of spending other people’s money by the very virtue of more “moralistic” government intervention! Joining politics becomes a privilege to determine where to spend taxpayer money.

Yet, unwittingly the public’s desire for increased “moral” wealth redistribution translates to this very perverted political cycle.

The vicious feedback loop as follows:

1. More clamors for “morality” equals more government meddling and thus, more Pork or government spending.

2. More Pork equals higher occurrences of abuse of power and increased degree of corruption which leads to high costs of business and more taxes.

3. High cost of business and more taxes translates to a loss of the currency’s purchasing power (via inflation), ergo more poverty and social inequality.

4. More poverty incidences and social inequality results to more political pressure for the leadership “do something” via more “Moral” redistribution.

5. Go back to step 1.

As a caveat, media, politicians and high profile experts does not even attempt to distinguish social inequality between those engendered by policies and the other shaped by productivity, e.g. some bakers will produce more output of bread than the others, some will produce better quality of bread at the expense of output, some will not produce better quality or will also be inferior in the production output.

Likewise, as previously argued, the surfeit of Countrywide Development Funds or Pork Barrel has overtly skewed the incentive structure by the voting populace and its leaders which have effectively legalized corruption via kickbacks seen from the entire level of the nation’s political structure which has concomitantly fostered a culture of dependency and deeply embedded sense of “entitlement”.

Figure 2: World Bank’s Paying Taxes: Higher Taxes Reduce Business Incentives, Broadens Informal Economy

Yet, again unknowingly to the public, a bigger share of taxes from greater government expenditures results to reduced attractiveness for investments relative to other countries, as the stratospheric costs structures require a high hurdle rate for the Return of Investments (ROI) as shown in Figure 2.

Higher taxes constitute as a major obstacle for capital investments, where it also reduces tax participation. Tax evasion, a large informal economy and tax leakages are simply symptoms of a big government-high taxation regime.

Thus, the lack of capital investments, and not the lack of laws, results to our economic woes.

This instructive quote from Stephanie Medina Cas and Rui Ota, a multilateral government institution known as the IMF in a research paper Big Government, High Debt, and Fiscal Adjustment in Small States (highlight mine), ``Controlling the size and cost of government can make government more efficient and more effective in achieving its principal functions in the delivery of goods and services.”

Economic Freedom Relative to Corruption and Wealth

Our excessive dependence on the political leadership for the economic path results to massive distortions and imbalances in the economy, the sensitivity to abuse of power, and the vulnerability to corruption. While we have a “quasi” political democracy, paradoxically we lack the economic freedom so required in today’s globalized playing field.

Figure 3: Heritage Foundation: Economic Freedom and Corruption

It is this lack of economic freedom that has been closely associated with everybody’s favorite “moral” theme of “corruption” as seen in Figure 3, courtesy of Heritage Foundation. Yet, interestingly none of our “experts” undergird its importance.

Economic freedom as defined by Heritage Foundation, ``A country’s level of economic freedom reflects the ability of ordinary citizens to make economic decisions on their own. It includes the freedom to choose a job, start a business, work where one chooses, borrow money, and use a credit card. It ranges from buying a house to having a choice in health care, from being fairly taxed to being treated justly by the courts. The higher the economic freedom in a country, the easier it is for its people to work, save, invest, and consume.

``Yet the struggle for economic freedom faces determined opposition. Tariffs are just one example of protectionism that never lacks champions, and those who want special privileges will always pressure societies to expand the size and weight of government intervention. Special privileges for the few mean less prosperity for the many.”

As we have mentioned in Philippine Politics: Systemic Defects of the Pork Barrel Political Economy, it is this special privilege acquired through as an inadvertent offshoot to the intricate “web of laws” (derivative of the law of unintended consequences) or through purposive passage of laws which has kept the competitive edge of “privileged groups” through a phenomenon called as a Regulatory capture (wikepedia.org), ``…in which a government regulatory agency which is supposed to be acting in the public interest becomes dominated by the vested interests of the existing incumbents in the industry that it oversees”, which has spawned the country’s quasi oligarchic structure and crony capitalist tendencies.

Essentially, laws have become the favorite tools of financial enrichment or economic empowerment by the political connected and by those in power and their associates or “special interest groups”.

As you can see from the chart from Heritage Foundation, countries which allow their citizens to determine their own economic destiny, who are free from choking regulations, openly embrace competition and rely more on trade and adopt an entrepreneurial culture are least likely prone to abuse of power and corruption compared to nations that are economically repressed or heavily overregulated.

To quote Ana Isabel Eiras of Heritage Foundation (highlight mine), `` To fight corruption and informality, it is essential to understand that corruption is a symptom—of overregulation, lack of rule of law, a large public sector— not the root of the problem. The perceived problem is unethical/corrupt behavior of the private sector, which leads the government to press more on private-sector activities. The real problem is the government action/regulations causing undesired behavior of the private sector. The optimal solution would be to eliminate burdensome regulations so that unethical behavior does not occur.”

This view runs starkly in contrast to mainstream spin where the conventional expectations for governance seem like a quasi socialist “be all end all” for our society whose mindset can be described as:

‘We want to be free to do what we want to do, but when faced with obstacles we want government to do it for us. Anything that evolves favorably to our convenience we ask to remain free but anything that runs against us we demand socialization.

‘Yet my barrier, your impediment and the other’s concerns are likely to be different and would most probably be in conflict with one another from which government will have to choose among us whom it would protect. Yet, whoever is accorded with government’s blessings is privileged while the rest of us cry “FOUL” (and all attendant labels-corrupt, inept, imperialists, etc. etc.)!

‘Oddly too, is that as much as we expect so much from government we are averse to pay more taxes (citing lame excuses as corruption as rationalization)!’

In essence, our expectations for freedom, government’s role in our lives and paying taxes have been entirely divergent. We don’t know exactly what we want. We expect sweeping changes by the fillip of a finger or a “quick fix” or “lotto” mentality, which we deal with under a pretentious and fallacious dissection, to our problems. Thus, the retrogression of our problems has become a frustrating illusion to many.

Figure 4: The Fraser Institute: Economic Freedom and Per Capita Income

Whereas when we are left to our own devices, we tend to act on what we perceive as the best path for us. In short, we tend to optimize our output given the conditions we are faced with if there would be less intervention from government.

Figure 4, from the Fraser Institute shows how countries which espouse economic free policies have higher per capita income relative to countries which are overregulated repressed or least free.

This goes to show that societies or nations tend to improve significantly when their constituents are allowed do their best, when they are least regulated and significantly less economically dependent on politicians.

Remember, economic freedom is a policy choice as much as it is a moral choice. It requires the realization that we can benefit if we trade competitively more than simply hide under the skirts of government. It requires us the right and the ability to fail. It requires the acceptance of income disparities. It also requires a reduction of power by the government and the accompanying cutback of government spending or Pork barrel discretionary funds through subsidies, doleouts and other welfare programs as well as greatly reduced tax rates and a simplified tax structure. It requires more private sector participation in the broader economy with a greatly diminished role for government. It requires for the development of a pervasive market oriented platform. It requires a legal protection of property and intellectual rights as well as the enforcement of contracts. It requires a streamlining of laws and the attendant pruning of the bureaucracy. Lastly, it requires a sound money policy independent of political influence.

Unfortunately, such premises for structural change signify a Sisyphean Challenge for our politicians who seem perpetually addicted to power and to our economic experts who seem obsessed with their apparent presumption of pedestal omniscience of how to infallibly manipulate the economy to meet their desired ends (Unfortunately since our independence they have been proven repeatedly wrong. Moreover, they can’t even accurately predict the markets with their supposed wisdom! It is a puzzle-if they can’t predict markets with lesser factors involved how much more can they precisely analyze a rapidly evolving highly complex society with a larger universe of moving variables and prescribe the required policy measures with less impact from the law of unintended effects?). As Albert Einstein warned, ``The attempt to combine wisdom and power has only rarely been successful and then only for a short while.”