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Monday, January 30, 2012

GMA’s other ‘crime’

Introspective
By Calixto V. Chikiamco

Former president Gloria Macapagal-Arroyo stands accused of many crimes: electoral sabotage, masterminding the anomalous ZTE deal, complicity either with her husband or cronies in sweetheart deals or behest loans, and many others. She is said to have corrupted institutions, from the Catholic Church hierarchy (SUVishops), the Comelec (“Hello, Garci!), to the police (PNP chopper deal), the military (pabaon and pasalubong), and the judiciary (Corona, et. al).

However, she’s also guilty of one other crime: talking up the peso during her term. To score political points, she, who should have known better, having a doctorate in economics from the University of the Philippines, kept equating a strong peso with a strong economy. Not surprisingly, the peso was “overvalued” during her term, from January 2006 onwards, according to calculations on the Real Effective Exchange Rate (REER) by Dr. Vic Abola of the University of Asia and the Pacific, using 1980 as a base year. Not only did GMA talk up the peso, but her administration kept borrowing in dollars and keeping the peso strong even though peso funds were plentiful.


Why does praising the strong peso and “over-valuation” matter? Because it has strongly contributed to the weakness of the investment climate, the loss of manufacturing jobs, and the widening and persistence of poverty during her term. It’s also not true, contrary to her inflated claims, that she was responsible for the country’s above-average growth. Growth was consumption-driven, for Christ’s sake, and was madeon the backs of the sacrifices of our OFWs, and not because of, but despite, her policies. (And if we believe a former NEDA secretary, a statistical undercounting of imports could have artificially inflated GDP growth measurement.)

The fact is over-valuation is bad for growth, according to Dr. Raul Fabella, the only living national scientist in economic science and former dean of the UP School of Economics. Prior to 2007, the economic literature showed: 1) over-valuation is bad for economic growth using cross-country regressions, 2) exchange rate volatility is bad for growth, and 3) over-valuation is linked to macroeconomic instability and balance of payments crises.

According to Fabella, Harvard University economist Dani Rodrik went further in 2007 and 2008 and showed that undervaluation of the currency is good for growth, although the relationship between undervaluation and growth holds true only for poor countries. Rodrik argued for intervention because market distortions and institutional weakness harm tradables more than non-tradables, thus leading to less investment going to tradables than it should -- a market failure that can only be corrected through intervention.

We don’t have to delve deeply into the academic literature to know that undervaluation is good for growth. We just have to look at the experiences of China, Japan, Taiwan and South Korea, which all made strategic use of undervaluation to boost their respective economies. China brushed away criticisms from Western economists, used competitive devaluation at least twice and has deliberately controlled its undervalued currency to boost and sustain its growth engine.

If I may say so, a competitive exchange rate policy for the PNoy administration would even be better than just government infrastructure spending in stimulating the economy. The benefits of a competitive exchange rate policy would be across the board, not just in a specific sector. A competitive exchange rate policy would boost exports, protect local industries, boost agriculture, promote manufacturing and employment, and increase the spending power of OFWs, which will then go to education, real estate, and consumption goods.

The concern about intervening to undervalue the currency is misplaced. According to Dr. Vic Abola, there’s no evidence that money created through exchange rate intervention (creating pesos by buying dollars) boosts inflation. Furthermore, he said that money supply growth (M2) grew by 7.1% average per annum from 2000 to 2010, while M2 in other countries like China, Malaysia, and South Korea has grown by 15% or more without much inflation impact. There’s room for exchange rate intervention without sterilization, according to Abola.

Besides, according to Dr. Fabella, monetary policy should target variables other than inflation. He said that strict inflation targeting cannot target composition of output and could itself be problematic, especially when myopic and exclusive. The asset bubbles that led to the Great Recession resulted from a myopic fixation on price inflation alone, said Fabella.

The fact is that variables such as the weakness of manufacturing output, poor investment climate (why invest when importing is cheaper), high unemployment rate, and anemic export growth should be considered in setting monetary and exchange rate policy.

If PNoy wants to be the unArroyo, he would be well served to abandon the strong peso policy of his nefarious predecessor. A competitive exchange rate policy is the single most powerful stimulant to the economy. I have said this before and I will say this again: Archimedes said, “Give me a lever long enough and I will move the world.” For the Philippine economy at this time, that lever is a competitive exchange rate.

(Calixto V. Chikiamco is a Board Member of the Institute for Development and Econometric Analysis. For comments and inquiries, please email us atidea.introspective@gmail.com.)

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