Given the soaring inflation rate and economic crisis in the country, Phil Allan, a Macroeconomic Policy Analyst, opines on what reforms could transform the economy to take advantage of the current crisis and get growing again at a rapid pace.
A Production-Centric Economy
A Production-Centric Economy can be created by channeling incentives away from land speculation, pollution, short-term gains, and consumption; and instead towards labor, long-term investment, and production. As a country reforms its economy, there is a tendency to attract dangerous hot-money inflows and direct scarce resources toward land speculation and debt-fueled consumption. With lessons learned from economic history, we can create the right incentives ahead of time, to ensure rapid growth on rock-solid foundations. For Laos, production is the way forward; with rapid but harmonious growth, while preserving the Laotian culture and identity.
Background
Until recently, Laos, a country with immense potential and an impressive pre-pandemic economic performance, had been advancing at a remarkable rate. The country now faces serious headwinds as fuel shortages and a debt crisis cast a shadow on the country’s prospects. With aggressive and immediate reforms, Laos, can stave off crisis and emerge as one of the world’s fastest-growing economies for the decades ahead. The following reform package would achieve such a result.
Tax Reform:
Set the personal income tax rate at 0% / Set the corporate income tax rate at 0%
By eliminating the tax on all earned income (and effectively turning the rates negative due to income support policies), Laos can become the premiere place in Asia to invest. Businesses that were reluctant to enter the formal economy will also have a much greater incentive to do so.
The competitive pressures by new business entrants into the domestic market will result in downward pressure on prices and prevent the emergence of oligopolies. These taxes can be replaced by an LVT and VAT, thereby transmitting economic power towards the real productive output.
Implement a Land Value Tax (LVT) to collect the unimproved land rental value
A tax on the unimproved value of land is the only significant source of tax revenue that does not decrease economic activity. Placing the burden of taxation on land values is key to Laos getting its fiscal house in order while improving economic growth. It has the additional positive externality of lowering housing costs by maximizing incentives for efficient land usage and housing supply growth. This is in contrast to a property tax which penalizes development by taxing the building on top of the land (although property taxes can be used to incentivize architectural guidelines). Existing government revenues (from damaging revenue streams) can be partially replaced with an LVT.
Raise the VAT rate to 24% with exemptions for food, medicine, and housing
A progressive consumption tax whose revenues are partly distributed as cash payments can provide a robust safety net, promote domestic investment, and rapidly raise government revenues simultaneously. By placing more of the burden of taxation on domestic consumption, Laos can conserve its foreign exchange reserves thereby strengthening the Kip and enabling greater purchases of capital equipment.
Incentivize long-term capital gains
Investment can be maximized without the risks of hot money and short-term capital flight by taxing capital gains (and potentially dividends) from 0–24% depending on the length of time the investment is held on a scale of 0–8 years. For example, if one were to buy and sell security the same day, the profits would be taxed at 24%. If it were sold after 4 years, 12%. If 7 years, then 3%, 8 years 0%, etc. Maintaining these rates lower than the rate of VAT also sends a message of prioritizing investment over consumption.
Furthermore, Laos may need to implement taxes on short-term capital inflows, as Chile did throughout the 1990s, to ensure an independent monetary policy, prevent currency crises, and channel the inflow of investment into expanding real productive capacity.
Welfare Reform:
Cash Payments – Sharing the Economic Growth
Welfare payments would be most effective if transformed into a universal cash payment system based on the revenues raised. A quarter of the VAT revenue should be dedicated toward a universal dividend, and another quarter towards a wage subsidy and these values would increase as the VAT revenues grow over time. Revenues from capital gains should move to individual investment accounts from which citizens can draw from. This would be a more effective and less costly welfare system for Laos while encouraging long-term investment.
Public Services Vouchers
Education funding can be more effective and affordable to the state if replaced with a voucher system, where parents choose their children’s schools and the schools receive their funds based on the number of students enrolled. The same can be applied to health care and other public services, to maximize coverage while minimizing waste.
Financial Reform:
Universal bank accounts and investment accounts
Universal bank accounts and investment accounts would be a necessary precursor to some of these reforms, especially for receiving cash payments.
Sectoral Banks
Creating Sectoral Banks (capitalized with the aid of a quarter of VAT revenues) as outlined in the New Physiocrats platform would be key to rapid industrialization and technological advancement in Laos. Industry sectors could then use these funds to bolster capital reserves for their respective banks, create sector-specific technical education programs, subsidize productive activity, engage in venture capital funding, and meet the needs of each sector however they see fit, in line with Laos’ national objectives.
Further Banking Reform
Banking regulations could be eased and focused on eliminating risks of foreign-currency-denominated debt and hot money inflows if many regulations were replaced with higher reserve requirements. By simultaneously streamlining financial regulation while raising reserve requirements, more domestic lenders could enter the market, increasing competitive pressure in the banking sector to the benefit of productive borrowers and with fewer risks to the financial system.
Monetary Reform
The central bank ownership structure would be best changed to a corporate structure, shared equally between the Sectoral Banks, Lao citizens, and the Lao state (preferably under the domain of a national sovereign wealth fund at arms-length from the government). This would allow the population and industry to share in the bank’s success and improve access to capital. Furthermore, a shift to a rules-based monetary policy targeting not only inflation (as now), but also money supply growth and price-level targeting, would allow monetary flexibility while maintaining low inflation and a floating exchange rate.
Fiscal Reform
By implementing constitutional fiscal surplus/deficit rules, and tying expenditures for the outlined programs to revenues, budgetary sustainability can be ensured. As a positive externality of such a policy, the stability of the Kip would be secured without the need for intervention in the FX markets.
Regulatory Reform:
Gradual Privatisation
State-owned industries will need to be gradually privatized. This should be done in conjunction with the individual investment accounts and tax & welfare reforms that would allow Lao citizens to own a stake in the country’s growth.
One Minute Business Registration
Rapid and fully digital business registration would further Laos’ position as a destination for investment, bring more small domestic businesses into the formal economy, and keep price pressures subdued.
Replace Regulation with Incentives
Byzantine regulations need to be abolished, and some regulations (e.g. protecting the environment from emissions) can be partially replaced with taxes (e.g. pollution taxes) rather than with bureaucracy and permits. This way there will be fewer avenues for corruption, greater flexibility for business, and a new stream of public revenue.
Judicial Reform:
Protection of Property
Laos needs to inspire confidence with judicial reform, enshrined in a business bill of rights that guarantees the right to start a private enterprise and the protection of private property free of interference. Only then can businesses make long-term investment decisions.
Conclusion
While these recommendations may sound like an Economist’s wish list, bold reforms will be necessary for the survival and continuity of Laos’ political and economic survival, especially if the country is to do so without the tradeoffs that come with appealing for outside aid. Laos has proven to the world that it can maintain a rapidly growing economy. If the country is to implement such reforms, it will prove that it can do so with even more vigor, and greater continuity.
