Two decades ago Vanuatu was in a deep debt driven crisis. The Government, the National Provident Fund and the National Bank had run out of money. This had occurred after politicians had systematically undermined the civil service following their 1994 strike action. Around the region there was similar financial turmoil, and in their desperation many countries turned to the international community for help. The solution at the time (in its simplest and crudest terms) was to borrow more, introduce new taxes, spend less and sell the nation’s assets. In a word what we now know today as ‘austerity’. In the case of many countries, including Papua New Guinea and Vanuatu, the programs also introduced new taxes like VAT and slashed Government spending in line with donor requirements. What followed in every Pacific island that undertook this ‘economic’ medicine was usually the deepest economic recession in their histories. Poverty in Vanuatu (according to the ADB) reached a record high of 40% immediately after the Comprehensive Reform Program, more commonly known as CRP.
Much has been written about the failure (and few successes) of many parts of these reform programs, so there is no need to go over that again. But it appears that to some extent history is being repeated. With many Pacific islands now entering into a fresh wave of debt related budgetary problems it might be a good idea to look at what did, and did not, work in the past. There is now quite a degree of consensus amongst development economists that the ‘structural adjustment programs’ of the 1990s that were forced on many countries from Africa to the Pacific actually made matters worse, which is why they were followed by a huge program of debt relief.
Yet, it seems as if there is a lack of desire to learn from the past. Take Greece for example – the current ‘austerity’ package is just a re-labelled old IMF program – raise debt, raise taxes, slash Government spending, sell state assets and assume the economy will grow. But even here the majority of economists in Europe now accept that this has failed, and that Greece needs some 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, and in the case of both Vanuatu and PNG into a period of unprecedented economic growth? To be fair neither PNG nor Vanuatu face the same problems today as they did in the mid-nineties. In Vanuatu the financial sector is much healthier and better run than it was before and in PNG, despite their current cash flow challenges, the long term prospects remain bright – so they are certainly not in a Greece-like situation by any means. But there are some similarities with the situation both countries faced in the past namely:
1. For both Governments the debt crisis is far bigger than the public understands and is the real driver behind the current budget problems and therefore revenue reforms
2. The past several years have seen a constant, almost relentless, effort by politicians and donors alike to undermine the civil service which is already under severe pressure having to deal with major crisis like cyclone pam in Vanuatu and the drought in PNG.
3. There is a mistaken belief that introducing new taxes or raising taxes will raise revenue.
Let’s take a bit of a look at these issues.
How big is the Government debt?
Donors and politicians have been hiding the true extent of both PNG and Vanuatu’s debt problems for years. Let’s be clear, they may not have lied, they have possibly not broken any laws, but they have presented the data in ways that it has made it almost impossible for the average person to really know what is going on. Technical officials had warned for years that the design of almost every major infrastructure project in both countries for the past half-decade was seriously flawed in the financial sense – and history has repeatedly proven the civil servants correct. Every single project whether they be from international lenders, to the various bi-lateral Chinese projects have either had their costing significantly revised upwards or had the technical 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 that was generously provided to the Pacific islands failed to account properly for debt servicing because it (in simple terms) 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 … yes even more borrowing! The model also is incorrectly designed so that it (perhaps unintentionally) assumes donor money can be used to pay off debt. This is simply incorrect and meant that the actual debt profiles of many Pacific islands are far more fragile than official documents suggest.
Once again the civil service had repeatedly warned that this and other similarly flawed analysis only served the people ‘selling’ the loans and not the nations ‘receiving’ the borrowing. But instead of heeding the warnings of the civil service numerous Governments first changed the law to allow for loans to be signed without Parliamentary approval, and then went about undermining the very civil servants that were trying to protect the nation.
The other problem is the size of the debts that are not shown in the budget papers. In technical terms these are known as ‘contingent liabilities’. So things like how much money is owned in terms of pensions, how many debts do the state owned enterprises such as airlines or power companies have and how much of that will the Government have to eventually pay. In both the case of PNG and Vanuatu these are likely to be very high indeed – so high that there is a reluctance to even try and work out what it is. In Vanuatu the case is slightly clearer as the Ministry of Finance does produce what is known as ‘accrual’ accounts and so in those documents they do try and have a guess at this figure and it is truly staggering! Sadly, most people will ignore it as simply another statistic in another boring report.
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 both the case of PNG and Vanuatu the civil servants did deliver – in the middle of the recessions that followed the 90’s structural adjustment programs the civil servants, usually led by the Ministries of 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 (so borrowing to refinance expensive loans and saving money that way) and then investing in projects with better financial rates of return (i.e. projects that they knew would generate more Government revenue then they cost of finance). These policies worked and both countries went through economic booms and the Government’s cash positions improved immensely. Sadly, the civil servants became a victim of their own success. The advice of the conservative civil servants was neither popular with donors who wanted to sell loans, nor politicians who wanted to spend money on their own pet projects – and so both countries saw a ‘purge’ particularly on their finance ministries. The private sector and public were blinded to what was going on because, particularly in Vanuatu, they failed to understand the economic reality of what was happening to such an extent that under the previous Vanuatu 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 of selling more loans or investing in areas that were not supported by the Government, but may have been supported by their capitals. The impact of this is being felt today where years of political and donor interference in these crucial areas has meant that the Government is critically short of the very skills it needs right now.
There is a mistaken belief that introducing new taxes or raising taxes will raise revenue
In both PNG and Vanuatu, the idea of raising VAT has been mooted as a way of collecting more revenue and in Vanuatu’s case even the prospect of introducing some sort of income tax. But several studies of tax reform in the Pacific 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 in every case the revenue falls and then maybe recovers two to three years later.
The people and businesses of Vanuatu are suffering post cyclone Pam and the same goes for PNG post drought. Although there are no official figures it is almost certain that these events have resulted in a huge migration of people into the major cities and a significant increase in peri-urban poverty. Raising taxes will simply make both people and businesses worse off – this is exactly what we have seen in austerity hit Europe – so ironically by raising taxes you reduce investment and slow the economy down – at exactly the time you want to do the opposite.
In both PNG and Vanuatu it was the growth in the economy that led to increased revenues NOT THE OTHER WAY AROUND.
This is not to say there is not work to be done in terms of improving revenue compliance especially by reducing or undoing the various tax deals given by politicians over the years – but these more practical strategies seemed to be overlooked for the same ‘magic bullet’ of new or increased taxes that failed to work before.
So what did work?
First of all, accepting the reality of the situation – this means being honest with the people. The best example is Vanuatu where for many years successive Governments ran national consultation workshops that were eventually replaced by business workshops. In PNG the Government spent two years negotiating with the private sector in order to design a holistic fiscal reform program by bringing them into the debate. Whilst this can be a painful experience it enables the Government to get consensus on the way forward which is so critical, especially in Melanesia. Having an open and inclusive debate about the challenges also means that ordinary people will be more willing to accept some of the more challenging aspects of the reforms. 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 and not technical babble that most people know is used to confuse and fool them into the wrong conclusion.
Secondly, cutting out unnecessary spending and eliminating various tax loopholes and subsidies will hurt some people and even though it is the right thing to do – this dialogue must be held in an open manner. In PNG one of the successes of the fiscal reform was when the private sector themselves were complaining that subsidies to one part of the economy was hurting another – and this made the policy debate from the Government side much stronger as it built a ground up demand for change in things which would have been more difficult to impose had they been done ‘top down’ by politicians.
Thirdly, there needs to be a significant element of debt re-financing. In both PNG and Vanuatu domestic and international lenders have over lent to the Government – this is very very risky as it means that in the future a failure by Government to repay will lead to a massive collapse in the financial sector and through that the general economy. This is one area where the international donors can and should play a role – instead of lending money for endless infrastructure projects that everybody knows could never be realistically re-paid it would be better to directly finance the Government to enable it to restructure its debt. The savings from this restructuring should then be used for critical investments in front line services such as health and education and also to maintain economically critically infrastructure structure such as roads and airports. Both the ADB and World Bank could be suitable partners if they could re-prioratise out of infrastructure and more into re-financing.
Fourth – the inevitable slight reduction in Government spending must be countered by a more direct and smarter use of the aid budget (in the short term) – this way the economies do not slow down at exactly the point in time when they need to expand. The only donors who have this capability and has successfully intervened in such a manner in the past are Australia and to a lesser extent the European Union. Whilst there may be many challenges in the current environment where the aid program appears to be driven by a small minority of Trump-esque angry white men from Foreign Affairs with the strategic foresight of a goldfish – the geopolitical reality is that Australia has already lost much traction in the Pacific and it needs to find a way back in. The close relationship between the people of Australia and the people of Pacific may not be mirrored in what we see in diplomatic terms but it shows that Australia (and New Zealand) will always remain part of the Pacific family and will need to be a part of any solution. So whilst interventions like PACER might currently seem like a dreadful piece of time wasting nonsense – the intention to develop more meaningful economic ties is correct, even if it has been poorly executed.
Finally, both donors and politicians need to start to re-build the trust of the current and former 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. The good news is that history does show that you can get out of such an economic mess if you get support from the people and that, especially in Melanesia, can only come from an honest and inclusive debate where solutions come from ‘within’.
So it really would be a great shame to ignore the skills that exist in-country in both the public and private sectors and instead go for an ‘externally’ driven ideology of a tax based magic bullet that history has shown will not work.