FOO Law and Economics

Tuesday, February 3, 2009

Stimulus arithmetic and the Keynesian multiplier

According to official statements, the “stimulus package” for the Philippine economy involves a total of P330 billion, broken down as follows: P160 billion (budgeted increase of the 2009 budget over 2008), P40 billion from a reduction in taxes (mainly due to a cut in the corporate income tax rate from 35% to 30%), P100 billion (from “a joint undertaking between the government and the private sector,” where the latter would contribute P50 billion, and the government’s share would be taken up by GSIS and SSS), and P30 billion from increased benefits from certain government agencies (GSIS, SSS, PhilHealth, and Pag-Ibig).

The effect on the economy should be viewed in terms of a “counter-factual” scenario: What would have happened without the stimulus? Several points may be made.

One, the P160 billion is a budgeted increase in government expenditures (which includes a “special” allocation for pump-priming of P50 billion). In other words, P110 billion is an increase that would have taken place because the economy grows (the population grows, so there is a greater need for government services for education, national defense, etc.). Therefore, only P50 billion should be counted as “stimulus.”

Two, the P40 billion in projected reduction in taxes has an expansionary effect, though much depends on what the beneficiary does with it. It is partly individual and partly corporate income tax cuts. In these times, it is reasonable to assume that half, or P20 billion, would be saved. Thus, the stimulus effect here is the balance of P20 billion.

Three, the P100 billion joint undertaking is more difficult to analyze. The pension agencies (GSIS and SSS) have authority to invest in government bonds, which may be used to fund the undertaking. But the private sector may join in by including P50 billion that they would have invested anyway, or a substantial portion of that, say half. This leaves a P75 billion stimulus element.

Four, the P30 billion increase in government-funded benefits is targeted to those who save little, so it is likely that most or all of this will be spent. All of that is stimulus.

In total, the stimulus package is perhaps something like P175 billion. This is roughly 2.5 % of 2007 GDP.

Whether the package is “large enough” is a question of how large the Keynesian “multiplier” is. The economist community is divided on this issue. One school (usually called the conservative Chicago School) believes that the multiplier is between zero and one. Another (the neoclassical Keynesian School) considers it to be more than one. The point is this: if the global crisis were to threaten to reduce Philippine GDP by, say, 5 percentage points from what would have been, a multiplier of two would mean that there would be no net impact on the economy. That would seem to be the most optimistic scenario. A multiplier of more than one but less than two would mean that the stimulus would offset a large amount of the negative impact. A multiplier less than one means there would have been only a limited impact.

What affects the size of the multiplier? The answer is that it depends on how “flexible” the economy is in absorbing the stimulus expenditures, and whether the stimulus is actually spent and not saved. In Keynesian economic models, stimulus works only when an economy has unemployed labor that can readily be absorbed. If OFWs and factory workers cannot readily be re-trained for other jobs, the multiplier will be small. If a tax cut is saved by the recipient, usually for lack of confidence in economic prospects, the stimulus effect is negated. Corruption can affect the multiplier either way. It rises (declines) if the funds are diverted to those who will spend (save).


jude said...

We've heard some faculty members of the UP School of Economics propose a P55:US$1 exchange rate. Aside from the possible diversification of exports away from electronics that might arise from this in the future, the boost in the peso income of OFW families is also expected to initiate a stimulus with a large multiplier. Can any information at all be generated about the likely behavior of households here who derive incomes from abroad or from the US more specifically. Jude E

Orlando Roncesvalles said...

I have not seen any empirical research on spending behavior of OFW families. I believe much of the transfers are spent on imports. For more, please see:’s-crisis-–-small-or-large/

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