The Economic Dynamics Of Federalism

Orion Perez D

For all Filipinos who keep asking about the economic dynamics of Federalism:

Under the Unitary framework in the Philippines, it’s essentially “From each according to ability, to each according to need.” Very communist-like. (It doesn’t work) And this need is defined by population size. An LGU that produces a lot of tax revenue but has a small population will tend to get a much lower “Internal Revenue Allocation” after much of that revenue is sent over to the Central Government.

LGU’s send most of whatever they earn to the Central Government, and the Central Government allocates funds to the LGU’s according to “need.” (Need being determined largely by population size).

Such a system does not really motivate LGU’s to work hard to bring in more investments and businesses whose operations would generate more tax revenues that the LGU’s can then benefit from. It generally promotes mendicancy and the only time that LGU’s do decide to concentrate on bringing in investments is when they have good leaders who understand the positive role that investments play in developing the local economy and the job market. When the LGU does earn more, most of the money still goes to the Central Government anyway. No wonder not that many are motivated to really focus on economic development.

Under Federalism, the paradigm is one of each region taking care of their own economic development. It’s “from each according to ability, to each according to performance.”

Each one must do all they can to really attract as many investors and businesses as possible because whatever tax revenues the regions earn, most of that goes to them and they send a smaller share to the Central Government.

The more they develop their economy, the more investors they invite, the more private-sector jobs are created, the better it will be for their region’s finances as they will have more funds they can tap to make even more improvements to their region.

There is a clear incentive for developing the economy: more tax revenues.

Now obviously not all Regions are economically self-sufficient. Some regions will require subsidies and supervision and assistance.

That’s why an asymmetric form of Federalism is worth doing.

Those regions that are economically self-sufficient can be granted a status with a higher level of autonomy while those that are not self-sufficient will need to be granted a status with a lower level of autonomy where the Central Government has the ability to supervise and assist them in their economic development planning.

In terms of labels, the self-sufficient regions with higher autonomy can be called States, while the not yet self-sufficient regions with lower autonomy who receive subsidy can be called Territories.

Naturally, those people in the Territories will want to achieve State status, so they will aim to choose leaders who can lead them to achieve such status by achieving the economic development and investment attraction goals set up by the NEDA.

The incentive is clear: work hard to become economically self-sufficient and you will earn State status which grants you higher autonomy and the ability to keep most of your tax revenues within your state.

And simply sticking to Territory status won’t cut it: A Commissioner appointed by the Central Government will be the Head of Territory and will regularly monitor the progress of the Chief Minister (like a mini-Prime Minister for a Territory) and his Cabinet in the achievement of the investment attraction and economic development targets.

Chief Ministers of Territories will want to break free from having to regularly answer to the Commissioner who will hold certain strong powers within the Territory, and the only way to do that is for them to achieve State Status by achieving economic self-sufficiency.

Commissioners on the other hand are also mandated to help and advise and provide useful suggestions to the Chief Minister and Cabinet on matters of economic development as the Commissioner will be a NEDA-appointed economist.

In time, all Territories will become self-sufficient States and as such, all of them will have surplus.

The Philippines needs to move away from mendicancy. When all regions become financially self-sufficient and his achieve State-status, then all of them will become net contributors instead of acting as a drain on the country’s resources.

This isn’t rocket science. It’s easy to see how regional governments will get motivated to make sure that they develop their economies by attracting lots of job-creating investments:

1) Not yet self-sufficient Territories will be motivated to become self-sufficient and not rely on subsidies so that they can become states and enjoy a higher level of autonomy.

2) Already self-sufficient States will be motivated to keep bringing in more investors and create more jobs because as States, most of the surplus tax revenue they earn will be theirs to keep.