Challenging Conventional Wisdom about the Philippines

We could characterise our country as being stuck in a developmental trap where the only way to make it more competitive is to improve the productivity of its labour force. The primary way to do that is through capital deepening. But without capital, productivity declines relative to other countries where investments flow. The nation’s inability to raise productivity deters future investors, and on it goes.

It’s that time of the year, the month of Janus, when people take stock of what has gone before and produce an outlook for what lies ahead. Most balanced and fair commentators in the Philippines (and there are some) often highlight the things that year in, year out don’t change. It is funny because year after year, all they seem to offer are the same old platitudes, which our leaders do take to heart, but it all seems to lead to the same old results.

Let us start with the economy. Most analyses about the economy point to our strong macro-economic fundamentals. This year is no different. The growth registered in 2012 was 6.5 per cent. It is about the same as the average for the financial years 2000-01 to 2009-10 which was 6.1 per cent based on the national statistics board. The first two years of PNoy’s presidency have tracked closely to that long-run average. Nothing new there.

Aside from respectable growth, the country has experienced a relatively mild inflation rate of 3.2 per cent in 2012. Again, over the past half dozen years, apart from the blip in 2008 when the global financial crisis was in full swing and food prices soared, the country’s annual inflation rate has fluctuated within a narrow band of 3-5.5 per cent. There is nothing new or surprising here either.

The third item is employment. The latest data shows that from October 2011 to October 2012, the country suffered a net loss of 900,000 jobs. That would seem alarming. But considering that in the previous year, employment rose by 2.5 million, a truly anomalous situation, the recent decline (or correction in my view), means that over the two years, the nation created an average of 800,000 new jobs per year. Again, there is nothing new there. Net job creation has hovered around that mark for the past decade.

In order to prove that there has been some progress made, most analysts usually point to the intangibles. A change in the national mood due to renewed efforts to address intransigent issues is usually heralded as a precursor to better times ahead. Again, this year is no different. Without a doubt, there has been progress with the enactment of several laws, the impeachment of the chief justice, the improvement of budget rules for transparency, and the reaching of an agreement that might settle the conflict in the south.

Another way to argue that there has been renewed confidence in the Philippines is by pointing to the property market, buoyed by the business process outsourcing industry, the peso, buoyed by the country’s credit rating upgrades, and the stock market, buoyed by our sound macro fundamentals.

The only problem with all this is that it has yet to translate into what really counts —growth in fixed investments. Again, there seems to be no change here. In 2012, foreign direct investments have amounted to a mere $1.5 billion. That is about 3 per cent of the total that flowed into the ASEAN-5. This is a very dismal result, as usual.

The question here is why? The reasons given usually are a lack of competitiveness, restrictive investment policy, and poor governance and institutions. I would like to tackle these one by one, and offer my own insights into why I think the conventional wisdom surrounding them are misguided, and offer my own solutions.

Competitiveness

It is a bit farcical but after the National Competitiveness Council’s efforts over the past two years to improve the country’s score in the World Bank’s Ease of Doing Business report by talking to foreign experts, understanding their methodology and working to satisfy their requirements, the result for 2013 was that the country slipped by two places down to 138th place in a league table of 185 nations. There had been a change in methodology, as there often is, which did not reflect the nation’s efforts, the NCC said, but needless to say, it is still a dismal record.

Disparities in administration across local government units as well as in- and outside of special economic zones and inefficient systems at national agencies are often cited as the causes for the abysmal performance, as is petty corruption among bureaucrats. While the Ease of Doing Business report indicates that government regulatory red tape has not improved, it would be wrong to say that the country’s overall competitiveness has not.

The Global Competitiveness Survey by the World Economic Forum takes a broader look at the issue –not just at how different a country’s rules, regulations and tax policies are from the leading economies of the world where most investments come from, but also at how well its labour force, infrastructure and innovation systems, to name a few, stack up in comparison. Here the country performed a bit better by advancing 22 places. It is now in the upper half of the league table. Whether this is enough to make investors change their minds is subject to speculation. We have to wait and see.

However, one of the main obstacles is the rising peso. It appreciated by 7 per cent last year. This makes the cost of producing things in the country for export relatively more expensive, particularly for the labour-intensive business process outsourcing industry. We could characterise our country as being stuck in a developmental trap where the only way to make it more competitive is to improve the productivity of its labour force. The primary way to do that is through capital deepening. But without capital, productivity declines relative to other countries where investments flow. The nation’s inability to raise productivity deters future investors, and on it goes.

Something has to break the cycle, and this won’t occur by simply relying on the Invisible Hand of the market, as private players suffer from the free rider problem—waiting for the first mover to take action before joining in. It will take some coordinated effort by government, and I will have more on this, shortly.

Investment Policy

Another oft-cited problem is the country’s overly restrictive policy on foreign ownership in selected industries. The 1987 Constitution is identified as the culprit. Actually, prior to adopting the present constitution, there were more industries in which foreigners could not invest or own a majority stake in. Under the present charter, foreigners are restricted from owning a major share in the mining, utilities and education sectors. They are also prohibited from owning land.

Removing these restrictions analysts say will unlock the investment potential of the country, creating jobs for millions of Filipinos, allowing them to escape poverty and the country to realise its true growth potential. The representatives of the foreign chambers, local economists and some foreign bankers claim this is what is needed. Are they right?

If we look at the size of the industries in question, mining accounts for about 0.9 per cent of our gross national income, utilities 2.7 per cent, and education is so small it does not even merit a separate line in our national accounts reporting. With respect to employment, the mining industry employs 250 thousand, utilities 153 thousand, and education 1.2 million. That is about 1.6 million out of a total work force of 37.7 million!

That means that to make a serious dent in the number of  unemployed which was at 2.7 million in October, 2012, we would have to at least double the size of these industries so that they could employ twice the number of people. I cannot really see this happening in the utilities sector or education. To double the size of those sectors would require a doubling in the demand for their services, which is close to impossible.

Mining, one might argue could double its size, but it only employs 250 thousand. Also, the problem here is in guaranteeing world-class labour and environmental regulations while ensuring that the nation derives a fair share of the profits from mining operations, since what is being dug up out of the ground belongs to the nation, and mining firms are only seeking ownership of the right to mine it on their behalf.

When it comes to the ownership of land, foreign investors do not really see that as a deterrent since they can obtain long-term leases and very favourable rates at the special economic zones in the CBDs of the nation and in the regions. Where it proves a deterrent is to small-time investors who want a piece of the property boom. Again, does the property sector look like it needs a boost? I would even argue that it needs to be slowed down because of possible overheating.

Governance, Institutions and Political Reform

The final missing ingredient that is currently the flavour of the month among our business and political elite is good governance and institutions. The improvement in this aspect is cited by the World Economic Forum as the reason why the country improved its business environment in 2012. Faith in institutions is grounded on the belief that this is why the Industrial Revolution took place in England in the 18th century and not in China, which was just as prosperous as Western Europe at the time.

To attain the foundations for rapid economic growth, the same set of of superior cultural norms, institutions and technology have to take over the ways of “traditional societies” or the “primitive mode of production” found in the the developing world today, so the theory goes. According to one author who has written a very short introduction to global economic history, however

The English constitution had many features that promoted economic growth, although they were not the ones stressed by modern economists, who emphasize restrictions on taxation and the security of property. Parliamentary supremacy actually resulted in the reverse…the English state collected about twice as much per person as the French state and spent a larger fraction of the national income.

…France suffered because property was too secure: profitable irrigation projects were not undertaken in Provence because France had no counterpart to the private acts of the British Parliament that overrode property owners opposed to the enclosure of their land or the construction of canals or turnpikes across it. What the Glorious Revolution meant in practice was that the ‘despotic power’ of the state that ‘was only available intermittently before 1688…was always available thereafter’. [emphasis mine]

Over the past decade, there has been a new school of thought emerging called the California School of Economic History which has challenged the paradigms of the New Institutional Economics school. Its general conclusion is that the Industrial Revolution took place in England because of the discovery of coal as a cheap substitute for wood as an energy source and the Americas as a source of metals and farmland. Coal led to steam power which in turn lowered transportation costs. The so-called Scientific Revolution of the 17th century had very little to do with such inventions.

What allowed England to compete with China and India which were then the leading centres of manufacturing in the world was their investment in labour-saving technology such as coal-powered steam engines to increase the efficiency of their cotton mills. A population boom in the hinterlands of China led to labour-intensive production which made the adoption of such mechanised production technology uneconomical, since capital was expensive and labour cheap.

Multifactor productivity is what led to competitiveness which led to higher wages for English workers, which led to further productivity improvements and so on. The entire 19th and 20th century was all about the de-industrialisation of Asia and the catching up to England by other Western states such as Germany and the US and later by East Asia which belatedly includes China. This was achieved through deliberate state policy which sought to channel limited capital into strategic sectors.

Failed Wisdom

The failure of conventional wisdom to explain why the nation’s competitiveness is in such a rut should force us to look elsewhere. Posing the problem in that manner is misguided to begin with. The first question we need to ask ourselves is, why do we even need foreign direct investments in the first place? The conventional answer to that question is that we need them because we don’t have the capital to finance development ourselves.

Again, I would challenge that view. From 2000-01 to 09-10, investments in the country have grown by 7.1 per cent per year on average. That is even with our low attraction rate of foreign investors. Since the the last decade, national savings has exceeded investments, meaning we are a net saving nation now. Many have said that was because private investors were wary of investing under the Arroyo regime. But the Aquino government does not seem to have convinced them to change their minds and invest their surplus capital. There is something amiss there.

More importantly, the inward flow of dollar remittances from overseas Filipinos has created a national treasure amounting to $85 billion worth of foreign reserves. That is about the size of the Czech Republic’s entire economy. It is also about 75 per cent larger than the total official reserve assets of the Reserve Bank of Australia, which was at US$49 billion in December 2012. Let me ask then, what is an economy the size of the Philippines which produces about $250 billion a year doing with reserves of that amount compared to the Australian economy which is about $ 1 trillion a year? Do we need to maintain such a high level of reserves relative to our economy?

Policy Implications

The reason why our policy makers have not realised that they are sitting on a pile of untapped wealth is because they have been used for so long to go cap in hand to the foreign community for loans. There is a saying in business that banks will only be willing to lend to you when you don’t need to borrow. The same holds true in our case. Yet our officials continue to trumpet the ease with which they are able to borrow, without realising that they don’t need to do so anymore.

The preceding discussion leads to the following policy implications

  • Continue to raise taxes in order to close the fiscal gap. Continue tax reforms such as the sin tax law that has just been signed. Expand the tax base by closing loopholes and consider other measures to raise revenue such as fiscal incentives rationalisation and a one per cent national land tax piggy backed on local property taxes. If we can reduce the gap to within 1-2 per cent of GDP, that would be fine. If we could completely close the gap, that would be even better.
  • Undertake coordinated investments in strategic sectors by leveraging sovereign wealth. Japan and South Korea did not rely on foreign direct investments to boost their economies during their periods of rapid growth because they directed their banking institutions to lend to heavy industries with their implicit sovereign guarantees. We can adopt a new approach by setting up a sovereign wealth fund, which would serve as the main vehicle for channelling our excess foreign reserves into infrastructure, minerals exploration joint ventures, agro-industry clusters and clean technology hubs. I have outlined how this could be done here and here. There are enough internal resources currently to increase our growth rate by 1-2 percentage points a year for the next four years. Once government acts as the catalyst, other players, including foreign investors will follow. This will incidentally temper the rise of the peso, which is currently hurting our export sector.
  • Continue to improve and enhance our educational system. Higher educational attainment among our populace is one of the best ways to resolve our economic and political problems. A highly literate and skilled workforce not only is what our industries need, it is also what will help shape political reform. Tinkering with our political system won’t really address the problem. An educated voter will not be satisfied with handouts from the government but will demand much more.

If we focused on these three policy areas: improving our tax revenues, coordinating investments and enhancing educational opportunities, then we will be on our way to unlocking the development trap that we find our country in. It is important for our leaders to challenge conventional wisdom regarding what is hampering our nation’s growth potential. Otherwise, we might find ourselves attempting to improve our situation using the same methods, year after year, decrying the same problems, but achieving the same dismal results.

Doy Santos aka The Cusp

Doy Santos is an international development consultant who shuttles between Australia and the Philippines. He maintains a blog called The Cusp: A discussion of new thinking, new schools of thought and fresh ideas on public policy (www.thecusponline.org) and tweets as @thecusponline. He holds a Master in Development Economics from the University of the Philippines and an MS in Public Policy from Carnegie Mellon University.

  • manuel buencamino
    • Mr Mangun writes,

      “The problem is not the value of the peso or the amount we spend on imports. The problem is 30 years of continuing government policies that keep the economy from properly developing.”

      He seems to be hinting that the solution would lie in lifting the ban on mining and the constitutional limits and restrictions of foreign participation in mining, utilities and land. I of course have expressed a different view above.

      The thing is our forests have been denuded to serve first world markets like Japan who have banned logging to the point that the PNoy govt is concerned if it allows mining to proceed in our remaining forested areas, we could worsen the situation even further. The Phils is a case of a country reaching its Malthusian limits. If it wants to develop further, it will have to be smart about it. Of course the miners claim they use sustainable methods. That may be so, but what the govt also wants to study is what any sovereign would do: determine the conditions for access to the deposits and the rates that firms need to pay for those rights. To borrow a very controversial quote from former PM John Howard,

      “We will decide who comes to this country and the circumstances in which they come.” (He was talking about refugees, which of course was reprehensible since he was playing on some fears in the community that had some racist elements. Of course, I don’t endorse these words in that context, but in this one, they seem more apt–we’re not being xenophobic, just prudent about our policies)

      The case of Australia of late, which despite being notable according to one economic historian for not turning its resource wealth into a resource curse because of its institutional adaptations in the past, is illustrative. It tried to impose a Resource Super Profits Tax of up to 40% on mining firms. The miners resisted, and a change of PM was effected. The new administration allowed the big mining firms to water down the proposal. The result was that in its first two quarters of operation, Mining Resource Rent Tax raised a big ZERO in revenue because minerals prices had weakened. A lot of infrastructure investments that were already budgeted based on these revenues are now going to be financed by budget savings in other areas, the treasurer says.

      The finance dept of the Phils should take not since it has been eyeing the Aussie MRRT as a model for a mining tax in the Philippines. Of course, I argue above that the best way we can guarantee that the Filipino people benefit from mining is to condition the issuance of mining permits on firms entering into joint ventures or consortia with Philippine government. As a co-investor, we would be privy to all their operational and financial details. That’s my counter-argument to the “simply lift all bans” argument. Of course, the problem would be corruption.

      They could bribe our officials to agree to unfavourable terms for the partnership. But that is no different to the current situation. With the latter, at least, the investment proposal would be submitted to an independent SWF board, which will have to detail the contents of their agreement in their quarterly and annual reports. We could subject the permits to something like an auction-like process, where the best offer wins. Better governance would lead to better economic outcomes.

      • manuelbuencamino

        Doy,

        I agree with all your reservations about mining. As a matter of fact I would even add that we shouldn’t mine what we cannot use for domestic manufacturing, that way we will be forced to industrialize.

        But what I wanted to get from you is your take on Mangun’s idea about letting market forces determine the peso-dollar rate because he cites data that says a cheaper dollar is better for our import dependent economy.

        • They were no different from the opinion of the IMF managing director who said that lowering the SDA rate would lead to inflation. I like Raul Fabella’s recent piece where he poses the question, do we reward the carpetbaggers and let them chart the destiny of our country, just like they did in the mid-90s which contributed to the Asian contagion.

          No, we don’t want to revert to a fixed exchange rate or devalue the currency, but neither do we want it to rise artificially because of all these carpetbaggers looking for a quick return because global markets are in the doldrums. We need to support the BSP’s policies in trying to hose down speculative investment.

  • GabbyD

    I have a basic question about using SWF locally. wont that increase the demand for local currency, appreciate the peso?

    • Let me try to answer your question as succinctly as I can. By the very nature of these projects (infrastructure, mining, etc) which require a lot of imported content (equipment, technical expertise, etc), a significant proportion of what is spent will leak out of the country. In the past, many of these projects were funded using ODA (official development assistance) from donor countries which meant dollars were entering the country (much of it re-exiting, admittedly via contractors from the donor country), which at best made the deal BoP neutral, or at best caused net inflows of dollars in the near term. But with the SWF, the projects would result in net outflows of dollars as we would be using existing currency reserves to fund them, and not be borrowing from overseas. As the proponent of such projects, however, the state would have greater leverage to ensure that technology transfer occurs in return for approving and (co-) funding the project. So it really becomes a winning proposition for us.

      • GabbyD

        thats an empirical question, whether the bulk of spending will be on foreign sources.

        or if u wish, make sure, as part of the financing, the the majority of the spending goes towards imports.

        • Airports, trains, light rail, seaports, dredging projects, etc. These use significant imports. Setting up a SWF won’t change that fact. In fact, what the SWF will seek to do is try and raise the local content of these projects.

          But even if the SWF is completely locally supplied, the wages of employees you hire–what is the import content of their consumption? Again, even if we concede that they all buy 100% Filipino made products (with no import content!), a very heroic assumption, it is still more preferable than to simply have them idly stored with our GIR.

          It has been reported today in one business daily that BSP governor’s position is that

          “the “ideal scenario” was to convert these inflows into real economic assets that would contribute to productive capacity, such as factories for the manufacturing industry or storage facilities for the agriculture sector.”

        • GabbyD

          true: my only point is that if one of the rationales for SWF is to keep the exchange rate from appreciating, then thats a potential plot hole.

          • It is to keep the appreciating currency from causing irreparable harm to the economy. It doesn’t necessarily have to lower the exchange rate per se. That is what the SWF aims to do.

  • ricelander

    So, why do we have such a huge pile in the first place? Is it ignorance of its presence or obliviousness to its potential? Or is it the huge risk involved in tapping into it.

    • manuelbuencamino

      The BSP’s discretion is limited by laws.

  • ricelander

    You say: “…why do we even need foreign direct investments in the first place? The
    conventional answer to that question is that we need them because we don’t have the capital to finance development ourselves.”

    If we are sitting on top of a huge unused pile of cash ourselves, why do we need FDI indeed?

    I was thinking about that myself. Then I realized that a pile of cash is just a pile of cash until someone takes the courage and decides to take the risk and invest it in business, only then it becomes capital or investment. Investment is not just about funds. It is about the investor who plunges head on, win or lose, with his business idea— and his funds or funds he borrowed.

    It may also be about the difference between a Henry Sy and a Henry Ford. Or a Lucio Tan and a Lee Byung-chul. Or an SM Megamall and Microsoft…

  • ricelander

    One president had experimented with the model you are proposing albeit with foreign loans which were then cheap and overflowing. But for one reason or another, he failed. So now they call him a plunderer who moreover buried the country deep into debt. If we could identify the errors and pitfalls that doomed it and avoid them and the opportunities that were there but were not fully utilized, why not indeed?

    All presidents after him leaned more towards liberal concepts of free enterprise, having more of private enterprise and less government in business, more of private initiative, less government control.

    Why did we fail? What was missing?

    Theoretically, as an economic strategy, both should work— in certain conditions, with some givens. As in basketball or football, one game plan is good for one situation, another for another.

    • GabbyD

      actually, i agree that this is my issue with this thing cusp is proposing. i dont know how a national investment arm can invest in local companies without incurring any of the damage of previous attempts of doing so.

    • What was missing were systems of governance and transparency that protected the integrity of the processes for undertaking and managing the investments. These are arguably present today. For example, congressional oversight did not exist back then, neither was there a rational system for justifying projects that now exists through the PPP centre and NEDA.

      If I could borrow some terms from Chalmers Johnson, a developmental state is one that operates under a “plan, rational”. The Philippines under Martial Law operated under a “plan irrational” while today we are operating under a “market irrational” system. Sen Ninoy Aquino advocated central planning to coordinate investments with democratic institutions to provide transparent governance.

      That model has NOT been attempted in our history. PNoy has an opportunity to make good on his father’s vision.

      • ricelander

        “That model has NOT been attempted in our history.”

        In the ideal concept that you are envisioning it , I suppose.

        But hey, I am interested in the timetable, assuming someone gives the go.

        • UPnnGrd

          Another timetable to worry about is that gobyerno-corruption increases the last 18 months (or last 2 years) of outgoing administrations. Outrgoing officials (civilian and military) beginning to “solidify their retirement”.

  • manuelbuencamino

    Superb discussion grounded in common sense. The conventional wisdom is based on the acceptance of arguments put forth by those who want to tilt the playing field their way. What needs to be done as you common sensically proposed is to look more at the objective facts and less on elaborately constructed “realities”. Let’s take full measure of what we have on hand and start from there.

    And your version of a sovereign wealth fund needs to reach a wider audience. I discussed it with a colleague from AER and he likes the idea of a fund investing internally. Although he expressed concern about legal restrictions on the BSP to do such a thing. But those are obstacles that can be dealt with, they are not killers. Maybe you can send me a position paper or something that I can pass on to him so you can correspond and see if you are on the same page. AER, through Men Sta. Ana, was deeply involved in the SIN tax thing – from beginning to the end including rounding up votes for the ratification of the bicam report. It is also a key player, through Nepo Malaluan, in the FOI issue. And in the RH Bill through Guy Claudio. I know you have good contacts here yourself so maybe you don’t need AER. Anyway, I want your proposal and perspective to reach a wider audience because organizations like the FEF ( Foundation or Federation for Economic Freedom) are lobbying hard to get the “nationalist” provisions of the constitution amended to accommodate the conventional wisdom. We have to get an alternate view out there.

  • Superb discussion. I’m seeing rising within Philippine politics the semblance of American political platforms, UNA for decentralized power and small central government and every man for himself, LP for strong central government and assistance to the needy. Well, UNA is where we have come from, it seems to me, the land of dynasties and elite who wave million peso Christmas gifts about as if everyone got one. Strong central government is where we need to go. But it should not be socialist in style, or we get trapped on the wrong side of the “productivity” delimma. Do you build farm to market roads or power generators? Do you refrain from investing in equipment because it would put people out of work, thereby consigning you to be non-competitive? Do you continue to sell ore to foreigners at 2% markup while a local firm could generate 13% in tax revenues plus generate dividend wealth plus generate reinvestment wealth (earnings abouve dividends).

    Central government should be strong but focused on competitiveness, not social welfare.

    Thanks for the thought-inducing article.