No Free Lunch

Government as growth driver

In recent talks on the economy, I’ve made the observation that government spending was a key growth driver last year, and will continue to be in the years ahead. This became particularly evident in the fourth quarter, when government appears to have rallied to spend money more quickly than it had in previous quarters. Data on both government consumption spending and public construction spending bear this out. From annualized growth rates of 0.1, 7.1 and 8.3 percent in the first three quarters respectively, growth in government consumption ramped up to 14.3 percent in the final quarter. Similarly, from 1.9, 12.1 and 12.5 percent growth in the first three quarters respectively, public construction spending jumped by 25.1 percent in the final stretch. Without that spending spree, we would have ended the year with gross domestic product (GDP) growth significantly slower than the 6.7 percent we achieved, the third fastest in Asia.

Directly, government spending accounts for around 15 percent of our GDP. Indirectly, it contributes much more, as it propels much more spending, hence production, in the rest of the economy via the textbook “multiplier effect.” That is, a one-off expenditure by the government actually raises total production and incomes by several times the amount of the original spending. If government spends P100 million to build a new road, for example, P100 million is received as incomes by those who built the road: contractors, engineers, construction workers, equipment suppliers, and others. But that’s not the end of it. Those various people now have money to spend or save as they choose. Ignoring taxes, if people save P20 on average out of every additional P100 income they receive, then the original P100 million of government spending turns into a new round of P80 million in spending on various things such as food, clothing, appliances, etc. that those income receivers in the first round would normally spend on. But one person’s spending is someone else’s income, so that second-round P80 million in incomes turns into a third round of spending of P64 million, which becomes yet another round of incomes spurring yet another round of spending, and so on ad infinitum. In the end, the P100 million originally spent by the government creates five times as much (P500 million) total production and incomes. (Mathematically, if the saving rate is 20 percent or 0.2, the multiplier works out to be one divided by that, or 5.)


How can government maximize the impact of this multiplier effect? First, it must be spent on domestically produced goods and services. If the money is spent to import new Mercedes-Benzes for top officials, it’s income of Germans that would be multiplied, not that of Filipinos. Second, it’s best spent on activities with wide linkages to the rest of the domestic economy. Mass housing is one such object of spending that would permeate more widely and more quickly across the various industries and sectors within the Philippines. Third, it must be spent on things most beneficial to society—more for schools rather than new air conditioners for government offices, more for hospitals rather than “fertilizer funds” that end up in the wrong pockets.

Looking forward, the ambitious “Build, build, build” program involving nearly P4 trillion in government infrastructure spending promises to be the prominent growth driver for the Philippine economy in the years ahead, in two ways. First is the direct effect of creating employment for thousands of construction workers that will have to be deployed to build facilities, and workers in ancillary industries, along with the spending multiplier effect that will ensue. And once completed, the new infrastructure would be magnets for more private domestic and foreign investment that should create more durable jobs for Filipino workers.


A cautionary note, though: of the 75 identified flagship projects under the program, 43 are in Luzon, with 25 in Metro Manila. If our future economic growth is to be more geographically inclusive, and not follow the same Manila-centric or Luzon-centric pattern that has been our historical bias, it looks like “Build, build, build” needs some tweaking.

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