Business World, 29 July 2018


In the 2018 SONA, President Duterte affirmed his unequivocal ownership of TRAIN 1 and 2. What welcome news for TRAIN advocates who felt orphaned when, previously, the President hinted that he will leave the tweaking of TRAIN 1 (in view of inflation) to the ‘wisdom’ of Congress! A successful flagship economic program will ensure Duterte a bright legacy; a mangled one will sink that legacy no matter the political projects. Even so, TRAIN 2 still has ways to go.

Three questions are always posed on TRAIN 2:


In Economics, we are drilled to press upon policy makers the canon that “a market failure is necessary but not sufficient for an efficient government intervention.” A market failure is economist-speak for the social waste resulting from unbridled interaction of private actors pursuing self-interest. A government intervention in a market failure, if properly executed, can expunge the waste; but badly done, it can also produce a bigger social waste — a government failure. Good governance abhors intervention without a social waste to correct. TRAIN 2 can create a social mess if not targeted to a failure. In real economies such as the Philippines, government routinely violates the canon in either of two ways: (i) by intervening despite there being no failure; or (ii) by failing to lift an extant intervention even when the original market failure has long expired. The expiry may come about because the market has grown and/or technology has improved. Subsequent well-meaning administrations can try to clean up the mess left behind by past administrations and recoup the foregone welfare. Thus, the familiar canon should read, “A failure, whether market or government, is necessary but not sufficient for efficient government intervention.”

Let us apply this to the Philippines.

The prevailing VAT-, tax-, or tariff-free incentives enjoyed by some corporations were granted by past administrations. The idea then was that investors were shying away from the country because of institutional or market deficits. For example, the extant market may be too small for current fixed capital investment requirement — a ‘missing market’ failure. An analogous idea in trade policy is the ‘infant industry argument.’ No firm — not even a monopolist — will break even under laissez faire in a missing market failure. But a direct or indirect (tariff) subsidy or a tax holiday can push firms to profitability and induce entry. If so, such a subsidy or tax holiday could eliminate a social waste.

An incentive frequently offered to induce entry into a missing market is a franchise. The entrant loses money in the first years and recoups in the following years when the market has grown sufficiently. The franchise acts as an indirect subsidy in the form of future profits protected by the franchise in the remaining years. When the market has grown and matured sufficiently to allow for two or more firms to be viable, the continued protection from rivals now becomes a socially costly since other investors will now want to enter, based only on market returns. After sufficient recoupment, the franchise overstays its usefulness and becomes wasteful. This is usually taken care of by a sunset clause in the franchise contract — say, 25 years — specifying the number of years of effectivity. Unfortunately, many of the so-called pioneer or infant industry contracts did not have sunset clauses, thereby granting “forever incentives.”

In this paradigm, the current corporate incentive system has overstayed and now become a ‘government failure.’ And the sitting government is in the right to try to correct it. There may have been market failures at the start but which either market growth and/or technical progress have cured. TRAIN 2 is designed to lift or replace such government failures. We have done this to good effect in the past.

The NASUTRA sugar monopoly, the coconut levy, and the Oil Price Stabilization Fund (OPSF) were government failures that impoverished farmers and nation. Their abandonment was a great relief to suffering Filipinos. The second question is:


The most potent argument over the years in favor of maintaining overstaying incentives is the ‘cost-us-nothing’ argument. It goes this way: “You don’t collect from these firms what you otherwise will collect if the incentives aren’t there, yes, but you don’t collect anything anyway if nobody invests.” How valid is this?

The argument is valid if the extant problem is a missing market failure — in a missing market failure no investor will enter the market without a subsidy or some tax-free privilege! No tax revenue without entry anyway. The argument is, however, invalid if the market has grown enough and/or the technology has changed enough so that some investors will enter even without the subsidy.

For example, the cost of solar power generation has fallen so that by 2018, some investors are willing to enter even without the fit-in tariff. So the fit-in tariff for solar — though perhaps helpful in 2009 — may now be overstaying and wasteful. This is one reason why Germany has moved from granting to auctioning additional access to fit-in incentives. The burden of showing that the missing market still exists should rest on the shoulders of the retain-defenders.


Modality matters.

In the rule-of-law world, the state is obligated to recompense the holders for the loss of contractually granted privileges. One has to make the case that such a privilege to such a firm has already sufficiently recompensed the firm for its investment and could be lifted. The process cannot however be arbitrary.

For example, the water regulator, MWSS, cannot, in the rule-of-law world, unilaterally do away with tax incentives granted to water concessionaires in the concession contracts without proper compensation.

Institutions matter.

The old adage, “A bird in hand is better than two in the bush,” applies especially under weak institutions. That X pesos implied in automatic incentives are naturally valued more than X pesos still to be reimbursed by BIR. Different delivery modalities render the same nominally equivalent pesos as apples and oranges — non-comparable. And even if such comparability is provided for in the bill, can Congress be trusted to comply? A serious populist mangling looms if TRAIN 2 passes before the mid-term elections. The DoF TRAIN 1 took a beating in Congress and the demonization of TRAIN 1 is still strong and will threaten TRAIN 2. And mitigation measures taken will also need time to pull inflation down.

TRAIN 2 is needed but “haste makes waste” and we may regret a hasty and Congress-battered TRAIN 2.