Business World, 18 July 2016


Venezuela is the poster boy for how mindless populism runs an economy down to the ground. The country is in a free fall and Venezuelans are teetering on the edge of starvation. It is also a poster boy for how not to organize a federal system. Two centuries after its founding as a federal state in 1811, it has still to find a federalism that works. It has oscillated from the original decentralized federalism to a “Centralized Federal State” of the 1999 Constitution to the “transitional constitutional regime” where the president enjoys decree-making powers. Along the way, the central state has so disemboweled the subnational states that all the possible virtues that can adorn federalism have folded their tents and departed.

What are the possible virtues and frailties of meaningful federalism? My perspective will be economic and will be limited. Everything depends upon meaningful autonomy. With meaningful autonomy, these are possible: first jurisdictional competition: subnational states can engage their fellow states in competition for investments via lower taxes or more market-friendly labor policies in the same way that countries compete. One of the great attractions of PRC as investment destination is that labor unions are illegal. A sub-state can choose from different economic models, say, South Korea or North Korea as autonomy allows. The fate of the whole economy is thus not a wagered upon one model. It is risk diversification at the policy level. Modern Venezuela has, however, evolved no more than meaningless autonomy.

Second is that subnational states will implement a national policy as suits its needs and complementary assets.

A good example is the agrarian reform policy in India: different subnational states implemented different types of agrarian reform of which the three most important are (Banerjee and Mookherjee, 2005; 2007): (1) tenancy reform which changed the contractual terms in favor of tenants in rural India (crop shares and security of tenure associated most with Operation Barga in Punjab and West Bengal); (2) land ceiling and redistribution: imposed land ownership ceilings and the redistribution of land in excess of the ceiling (Kerala and CARP Philippines); (3) the abolition of tax farming intermediaries, the zamindari system. The robust favorable result on poverty reduction and farm productivity heavily favored contract and bargaining reform while land ceiling and acquisition produced the opposite result. The already agriculturally affluent Punjab and West Bengal benefited. The framers of CARP followed Kerala and got the same sad outcome. So one possibility under meaningful federalism is that land reform in the Philippines will diversify for the good.

The third virtue of the federal system comes via the Buchanan-Nozick federalism: the sub-states will differentiate by local public goods and citizens can vote with their feet — locate in states whose the Constitution and the local public goods congrue best with their individual values. One state may combine high income taxes with quality publicly provided local public goods and services (Scandinavian welfare state) and another combines low income taxes with less publicly and more privately provided public goods (most LDCs and the Philippines). This circumscription of citizen values by Tiebout voting (effectively violating the Arrow axiom of universal domain) avoids the Arrow paradox of democracy. A federal system like the Swiss cantons acts to homogenize the sub-state population and preferences thus enabling, for example, the median voter theorem.

Fourth is the “tragedy of the commons” argument: In presidential states viewed as a failure by its polity, different subnational groups will retreat to their own subgroups who view fiscal resources of the center as a common resource: they will play a zero-sum game of “grab as grab can”; in those same presidential states, “who pays and who loses” may not be very palpable because the contested resource is large and the competing claimants are numerous and faceless. When federated, the contested subnational state’s common resource as well as the number of claimants are smaller resulting in more visibility and salience on “who pays and who loses.” This should induce greater vigilance and accountability over the allocation and use of local resources — the classic argument for most decentralization effort.

But the frailties of meaningful federalism are also compelling: arterial infrastructure (those that span sub-national state jurisdictions) will find it harder to be engendered for two reasons: increased approval hurdles (we already experience this with the Local Government Code); two, because the fraction of fiscal resources in the control of the center decreases (as in, say, the Pimentel Plan), it is less able to bankroll those public works, ceteris paribus.

And then there is the equalization transfer issue: cross jurisdiction inequality will rise because capacity of the center to effect fiscal transfers (Internal Revenue Allotment) to poorer jurisdictions will fall — the Calabarzon region for example will retain more of its huge tax revenues while poorer regions such as ARMM can expect less in the form of IRA. Again cross jurisdiction mobility will mitigate but not eliminate this problem for citizens and household who can move. Poverty will thus rise in these poorer sub-states even as it drops in richer ones.

It is now canonical in the post-Piketty Capital era that income inequality will rise in market economies unless there is a determined pushback by the state. The capacity of the state to do that by transfers (say with an expanded CCT) will be diminished. It is a good bet that, ceteris paribus, net poverty incidence will rise.

Finally, the centrifugal risk: a successful sub-state in a national collective viewed as a failure will be tempted to go it alone (“Brexit” in EU, Catalan exit in Spain). The presence of a sub-state president and legislature makes it easier to bolt. If the economy tanks under the Duterte or subsequent presidency, the rush to the door will forthcome.

A paradox emerges: If Duterte turns out to be a gale force for the good, meaningful federalism will cramp his style. If Duterte turns out to be a force for the bad, meaningful federalism can limit the damage. This conservative posture may not jibe well with voters’ electoral expectation.

Of course, Duterte can always do a Hugo Chavez: chip away at federal autonomy using emergency decree-making powers and run the Philippine economy to the ground. Le plus la meme chose? Whether power is presidential or federal, only correct policies will redeem it.