Vulnerable

In the aftermath of a devastating typhoon, as many communities wade in stagnant floodwaters, we get another piece of bad news. The Bangko Sentral ng Pilipinas (BSP) forecasts October inflation accelerating at between 7.1 and 7.9 percent.

The inflation forecast takes into account the spike in transport costs, persistently high fuel prices, rising agricultural prices and a weaker peso that magnifies the cost push. None of these factors are about to dissipate soon.

The BSP’s inflation forecast comes on top of recent news that Russia is withdrawing from the UN-brokered deal that briefly enabled Ukraine to ship out grain to the rest of the world. This will translate into food shortages in the West Asian and African countries dependent on grain imports from Ukraine. For the rest of the world, this translates into a spike in grain prices that will add fuel to global inflation trends.

In the US, curbing inflation is a politically urgent matter. Joe Biden’s approval ratings have sunk to about 39 percent because people perceive he has not been effective in fighting the cost-of-living crisis. The Democratic Party is in danger of losing their thin majorities in the two houses of the US Congress because Americans generally believe Republicans manage the economy better.

The main instrument the US uses to curb inflation is to raise interest rates. This is a blunt instrument, however, and one with a longer lag in its effect. Another hefty interest hike will almost certainly push the US economy into a recession.

Without intending it, the US exports its inflation problem by relying on interest rate hikes. The strong dollar is the immediate consequence of the US Fed’s high interest policy. All other countries have suffered substantial devaluation of their currencies in the face of a strong dollar.

Currency devaluations, as we very well know in the case of the peso, raise the costs of imports and magnifies inflation for the other countries. Certain vital imports such as oil is denominated in dollars. This is how US inflation is effectively exported.

Expect our economic managers to reassure us that our economy is strong. That makes very little sense to people unable to buy the goods they need.

The fact is, our economy is structurally vulnerable.

Decades of protectionism disabled us from competing with our neighboring economies. We export very little and import nearly everything we need – from fuel to capital goods to textiles. Much of the goods we export are made from imported inputs with very little value added.

Our “fundamentals” are indeed strong. This is because we exported human beings who bring in remittances from abroad or wages if they work locally in BPO companies. Strong “fundamentals” basically means we are still earning enough foreign exchange to pay for our imports. It does not mean we are effectively lifting our population from misery.

Inefficiencies in our domestic production systems in fact increase the cost-push for inflation. Our agricultural cost of production is higher than most other economies in the region. That makes smuggling a lucrative enterprise.

Higher energy costs make our manufacturing uncompetitive. High labor costs, an outcome of the high food cost regime we have had for decades, puts our economy at a disadvantage in the competition for industrial investments.

Our economic growth has been driven mainly by domestic consumption. Consumption demand is unavoidable and it is a bad signal that this, more than investments, drives our economic growth.

There has been much political noise, mainly from the economic nationalists, about the decision to import certain commodities such as rice, sugar and even vegetables that compete with domestic producers. The fact is that we either import these commodities or face shortages. If we did not import rice, for instance, the basic commodity would have to be rationed – and at astronomical prices. If we did not import the sugar we needed, many of our food processing firms will have to shut down.

If we prohibited importation of goods our domestic producers could not efficiently provide enough of, we will penalize our consumers and make their lives even more miserable. If the gang of sugar producers have their way, for instance, our consumers will have to buy their produce at well over double prevailing prices elsewhere. It will also mean we cannot export our expensive processed food.

The peso’s retreat in the face of an interest rate induced strong dollar affects not only the price of fuel we import entirely. It translates into higher fertilizer costs, more expensive canning costs, more prohibitive prices for capital goods we need to modernize our production systems, steeper construction costs since we import most of our steel and a larger share of the cement we use.

The devaluation cannot possibly be healthy for our consumers. Even if we drop the peso exchange rate, investments will not suddenly flow in because of other considerations: backward infrastructure, high power costs, lower factor productivity, expensive land, ideological trade unions and many others.

Because of all the factors mentioned above, our economy is increasingly reliant on the services sector. This is because services require the least amount of capital to produce one job. This is also why our best medium-term bet to keep pace with our neighbors is to grow the tourism sector.

Unfortunately, there is no silver bullet to cure the structural disabilities of our domestic economy. We will require a few decades of strategic economic planning to cure these disabilities. And some of the cure might be unpopular.