The same old CR?P

September 16, 2016 11:46 am | Posted in Features | Share now TwitterFacebook

By Nikunj Soni – Pacific Institute of Public Policy

Nik Soni asks if we’re about to repeat the sins of the past

Two decades ago Vanuatu was in crisis. The Government, the National Provident Fund and the National Bank had run out of money. Around the region there was similar financial turmoil, and in their desperation many countries turned to the international community for help. The solution was to borrow more, introduce new taxes, spend less and sell the nation’s assets.

In a word: ‘austerity’.

What followed was the deepest recession in history. Poverty in Vanuatu reached 40% after the Comprehensive Reform Program, or CRP.

There is now consensus amongst economists that the ‘structural adjustment’ of the ‘90s actually made matters worse, which is why they were followed by a huge program of debt relief.

So why is this relevant to Vanuatu and PNG today?

Instead of re-hashing the same failed responses, why can’t we look at what policies actually took struggling countries out of recession into a period of unprecedented growth?

To be fair, in Vanuatu the financial sector is much healthier and better run than it was before– they are certainly not in a Greecelike situation by any means. But there are some similarities:

• 1. The debt crisis is far bigger than the public understands and is the real driver behind the current budget problems;
• 2. The past several years have seen an almost relentless, effort by politicians and donors alike to undermine the civil service, which is already having to deal with major crises like cyclone Pam.
• 3. There is a mistaken belief that introducing new taxes or raising taxes will raise revenue.

How big is the Government debt?

Donors and politicians have been hiding the true extent of Vanuatu’s debt problems for years. They may not have lied, but they have presented the data in ways that it has made it almost impossible to really know what is going on.

Officials warned for years that the design of almost every major infrastructure project was seriously flawed financially— and history has proven the civil servants right.

Every single project either had its costing revised upwards or had the specification changed after they were signed—or have proven simply financially unviable. NONE of the projects has ever demonstrated where the Government revenue to pay off the loans would come from!

The World Bank debt model generously provided to the Pacific islands failed to account for debt servicing because it assumes that the Government can just carry on borrowing domestically forever, and so does not need to worry about interest payments or domestic debt, as they can be met by … even more borrowing!

The model also incorrectly assumes that donor money can be used to pay off debt.

Once again civil servants repeatedly warned that this flawed analysis only served the people ‘selling’ the loans and not the nations receiving them. Instead of heeding the warnings, Governments changed the law to allow for loans to be signed without Parliamentary approval, then went about undermining the very people who were trying to protect the nation.

Contingent liabilities are things like how much money is owed in pensions, debts of state-owned enterprises. These are likely to be very high—so high that there is a reluctance to even try and work out what it is. In Vanuatu, it is truly staggering!

Undermining the civil service

When times are tough politicians love to blame previous Governments and civil servants whilst at the same time asking the latter to come up with solutions.

In the recessions following the CRP, civil servants, led by Finance and Treasury, came up with a range of policies that combined making the economy more attractive, increasing revenue compliance (as opposed to raising taxes), re-structuring debt and investing in projects with better financial rates of return.

These policies worked and the Government’s cash positions improved immensely. Sadly, the civil servants became a victim of their own success. The advice of conservative civil servants was never popular with donors who wanted to sell loans, nor with politicians who had their own pet projects – and so Vanuatu saw a purge, particularly in Finance.

The private sector and public were blind to what was going on because they failed to understand what was happening. Under the previous Government (many of whom are now in jail) their main source of advice seemed to come from a narrow subsection of the private sector who were perhaps more interested in their own short-term interests than those of the nation.

Sadly, this decline was not stopped by those in the donor community who also saw it as assisting their own short term ambitions. The impact of this is being felt today. The Government is critically short of the very skills it needs right now.

Just a ruse?

So will raising taxes work – or is it a ruse to pay off the debts related to bad projects? In Vanuatu, the idea of income tax or raising the VAT has been mooted as a way of collecting more revenue. But several studies have shown that at the end of the day new taxes simply do not actually raise more revenue. Look at tax as a percentage of GDP before and after major fiscal reforms and you will see that revenue falls and then recovers 2-3 years later.

Raising taxes will simply make both people and businesses worse off—this is exactly what we have seen in Europe. By raising taxes you reduce investment and slow the economy down—at exactly the time you want to do the opposite.

In Vanuatu it was the growth in the economy that led to increased revenues NOT THE OTHER WAY AROUND.

So what did work?

Be honest with the people. In Vanuatu successive Governments ran national consultations workshops that were eventually replaced by business workshops. This can be a painful experience, but it enables the Government to get consensus on the way forward which is critical.

But if there is to be such a debate the information presented must be seen to be honest and complete. This means not only being accurate but also presented in a way that ordinary people can understand.

Cutting out unnecessary spending and eliminate tax loopholes and subsidies. It will hurt some people, even though it is the right thing to do.

Debt re-financing. International lenders have over-lent to the Government – this is risky. It means that in the future a failure by Government to repay will lead to a collapse in the financial sector and the general economy.

International donors can and should play a role. Instead of lending money for endless infrastructure projects that everybody knows could never be re-paid, directly finance the Government to enable it to restructure its debt. The savings from this restructuring should then be used for investments in front line services and to maintain critical infrastructure.

Both the ADB and World Bank could be suitable partners if they could re-prioritise out of infrastructure and into refinancing.

Fourth, the slight reduction in Government spending must be countered by a more direct and smarter use of the aid budget. This way the economy does not slow down.

The only donors who have this capability are Australia and the European Union. The aid program currently appears to be driven by a minority of Trump-esque angry white men from Foreign Affairs with the strategic foresight of a goldfish. But the geopolitical reality is that Australia has already lost much traction in the Pacific and it needs to find a way back in.

Finally, donors and politicians need to start to re-build the trust of civil servants. The good news is that many of the excellent local civil servants who drove the reform of the nineties in both PNG and Vanuatu are still in country either retired or working as private consultants. There is now also a new cadre of bright young people with immense talent in both countries civil services and so the skills and knowledge are there.

Recent elections in Vanuatu have also seen a greater number of these entering into politics, which is also a positive sign.

It would be a shame to ignore the skills that exist in-country in both the public and private sectors and instead go for an externally driven ideology: a tax based magic bullet that history has shown will not work.

Nikunj Soni is the chairman of the Pacific Institute of Public Policy. This column is a digest version of an essay originally published at pacificpolicy.org.