Friday, 4 June 2010

The underground economy

Written by John Mangun
Outside the Box
Business Mirror

While the politicians grab at each others’ throats to take credit for (or take credit from) the economic results, the truth is that the government may have very little to do with economic activity outside of the broad framework of regulation and incentives.

The probable president-in-waiting says the prior administration did not do a good job of sustainable economic growth. The past administration challenges the new one to meet or beat its numbers. In fact, evidence shows that government may be almost useless in “managing the economy” in a country like the Philippines.

The World Bank estimates that more than 40 percent of the Philippine economy is underground, in the shadows, off the books. This is an important fact for several reasons.

Have you noticed how often the “experts” both in and out of government are surprised by the economic activity numbers? While there are those who say that the numbers are invented, most thinking people agree that the National Statistics Office does a pretty good and accurate job of counting. What the experts cannot figure out is how the numbers can be so far up or down from what they expect.

But the experts cannot see all the economic activity that eventually makes up the economic numbers just as has occurred with the first-quarter 2010 results. How could the economy grow at 7 percent when there does not seem to be the drivers that the economists look at?

Let’s use San Miguel Corp. as an example. The first-quarter 2010 results were amazing. Revenues were up 7 percent from 2009. Operating income grew by 35 percent. How could that be? Where did the consumer money come from to generate those numbers?

Government and private experts looked at export revenue, remittances and investment funding, among other factors, and concluded that economic growth would be about half of the official numbers. But what they could not measure was the underground economy of the taho venders, the taxi and jeepney drivers, the tuberos, and all the rest of the economy that never issues an official receipt; these receipts being used to measure the economy.

But eventually all that underground-economy activity does show up in the final official numbers, such as in the amount of San Mig beer and Ginebra San Miguel that were purchased.

Read this from the first week of March 2010: ‘The domestic economy is projected to grow below 3 percent in the first quarter of 2010 with a 2-percent to 3-percent decline in agriculture output due to El Niño and a strong peso that would limit the stimulative effect of overseas Filipino workers.” This is from the “experts” at Metro Bank and the University of Asia and the Pacific Capital Markets Research, and, honestly, those groups are not foolish or unintelligent. They just never asked one of the sari-sari store owners, who sell 85 percent of the beer in the Philippines, how their businesses were doing.

So exactly how does government intend to manage the economic activity of ten of thousands of sari-sari stores and do a good job of it?

Several studies have shown that more government “managing” and more government policy tend to grow the underground economy. Higher taxes and higher mandated government minimum wages grow the underground economy. More government regulation, from environmental regulations to licensing requirements, pushes businesses to do their business off the books.

The underground economy exists and flourishes as a result of government attempting to manage the economy and not doing it well.

Government economic-policy planners do not have a clue on a real-time basis what is happening off the books. The underground economy grows larger, and perhaps stronger and more profitable, as a reaction to the government not being able to manage the economy well, if at all.

Now here is where it gets interesting. I am sure you have heard countless times the complaint that Thailand is so much better economically than the Philippines, and how we should do whatever the Thai government has done. Which has the larger underground economy? Thailand’s, of course, at over 50 percent of the total economy. We also wrongly assume that it is only “basket case” countries like the Philippines that have a shadow economy. Taiwan does 20 percent of its business activity off the record. Malaysia is over 30 percent. India, over 20 percent. South Korea matches Malaysia’s percentage. Russia is at 45 percent.

Now look at the other side: the US, 9 percent; Japan, 11 percent; the UK, 13 percent; Ireland, 15 percent; Spain, 20 percent, Greece, 2 percent. Notice the names. So they sound familiar? They are the nations that have the worst economic track record in the last two years. The conclusion may be that those countries with a substantial underground economy may be able to adjust more quickly and more effectively to changing times.

Most nations with small shadow economies and economic growth are like China and Singapore, where the economy and many other aspects of individual and corporate life are very closely and stringently controlled.

It is a simple truth that too few in government and too few in the academic world would want to hear or admit; the free market is ultimately the best driver for economic success. The underground economy is perhaps the freest market, responding to a nation’s economic needs more efficiently, effectively, smarter and profitably.

Instead of the politicians and leaders promising to have all the solutions, maybe we should hope that they promise not to interfere in the economy too much.

Perhaps, if government did a little less in trying to manage the economy, it would be the balut vendors driving Mercedes and SUVs, instead of the economic-policy experts.

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