Use your coconut: Of investment gaps and how to fill them (conclusion)

The Philippines has been trying to crack open the investment nut by lifting its competitiveness for such a long time but has not been getting very far. Here’s why.

Continuing on from the first part where we looked at the country’s investment gap of over half a trillion pesos a year, we now turn to the problem of how to fill it and bring unemployment down. The imperative to boost competitiveness is based on the notion that low social returns on investment are due to a lack of opportunities to invest due to poor governance, inadequate infrastructure, and bad local finance.

Government failures caused by macro risks like poor fiscal, monetary and financial policies along with micro-risks including corruption, high taxes and weak property rights lead to a lack of incentives for investing in new ideas. These failures block the supply of innovation and investment. While this forms conceivably part of the problem, it does not necessarily explain the entire puzzle.

A missing piece is the demand not forthcoming from entrepreneurs for existing technology and capital even when it is available due to market failures. Dani Rodrik and Ricardo Hausmann talk about how this comes about when there are significant hidden costs associated with information and coordination. I will try to explain these failures using the coconut analogy.

Imagine that several decades after Robinson Crusoe left the island of Despair, a number of coconut plantations were established. The owners of these plantations were competing for a shrinking share of the coconut trade that existed between several islands in the vicinity. To improve their earnings, they each could find different ways of using the coconut. The process of discovering what types of products could be made comes with a cost caused by free-riders.

The evidence shows that low income countries actually develop first by diversifying their exports. The degree of specialization follows a U-shaped curve with income (diversifying more until reaching about the same level of income as Ireland before specializing). They do this by imitating technology already developed in rich countries. Instead of competing by creating new technology, they find cheaper ways of using existing modes of production in diverse sectors.

This process of “self-discovery” as Rodrik termed it often comes at a cost to the first-mover within a country, a cost which imitators do not incur. This creates a market failure because no one is willing to invest in this process since the information generated by it (“which goods can be produced more cheaply at home”) usually cannot be protected by patents.

This random process of discovery is why such countries as Pakistan and Bangladesh with similar levels of development and competitiveness produce very different products (the former produces soccer balls while the other produces hats). Korea and Taiwan also offer the same lesson (one produces microwave ovens and hardly any bicycles unlike the other). For the entrepreneurs who first ventured into these markets and were protected from the free-riding copycats, huge profits were on offer.

Bailey Klinger and Daniel Lederman have shown that their measure of export diversification, the frequency a country introduces new products into its export mix, is directly related to the height of entry barriers. This is a stunning result since it goes against the prevailing consensus on efficient and well-functioning markets.

Rather than the Global Competitiveness Index cited in the first part of this piece, which is based on subjective surveys, Klinger and Lederman used the World Bank’s Doing Business indicators for measuring barriers to entry which are based on objective measures like the number of days for starting and closing a business. They found that the higher the cost, the greater the returns to innovation from self-discovery.

The barriers in effect performed the role of greenhouses, protecting fragile innovative start-ups from the harsh winds of the free market. This counter-intuitive conclusion robustly supported by the evidence is consistent with the market failure argument. It violates the prevailing theory that increased specialization for poor countries and lowering costs of doing business is the way they should attract investments.

This is also borne out by the development experience of Japan which used “administrative guidance” to encourage many players within emerging industries to consolidate into oligopolies, Korea which offered loan guarantees as a way to subsidize the discovery costs of large diversified business conglomerates, India with its licensing raj which allowed a few pioneering software companies to gain economies of scale without the fear of new entrants, and Brazil which sponsored competitions for innovation with significant exclusive licenses going to the winner.

Klinger and Lederman state that this does not imply that there are no negative effects due to protection. What their study shows is that the positive effects swamp them. This means that rather than justifying protectionism, what it does is build a case for state support for emerging industries. I will have more to say regarding this in a moment.

Moving on to the second form of market failure which is due to coordination costs, picture the island once again. To transport various coconut products to other parts of the area, investments in seafaring ships and the training of sailors are necessary. These complementary investments are needed for an expansion of production to occur. Unfortunately, no one is willing to coordinate with the other inhabitants who live near the shore who could profit from such activities, so nothing happens.

Taiwan’s experience with the orchid industry is illustrative. When the world price of sugar declined, the state figured that shifting farm production to this high end product would prove beneficial. This required coordinated investments in things like greenhouses and storage facilities which the state encouraged and subsidized. The same type of intervention was performed by Fundacion Chile a partly state-owned enterprise which gave rise to a new salmon exporting sector.

The faltering seaweed industry located mostly in the Autonomous Region of Muslim Mindanao and the nascent industry of coco juice seem to be suffering a combination of the market failure problems discussed above. Our electronics industry which is highly specialized in “screwdriver” assembly operations as South Korea once was could be expanded likewise to incorporate more value adding steps in the manufacturing process.

The usual ways by which governments address these market failures is by offering subsidies to defray the costs of “self-discovery” (by sponsoring contests which award a prize to the best solutions for example), financing high risk ventures at the pre-commercialization phase and coordinating complementary investments in specific areas such as research and development, infrastructure and general training.

Think of it this way: instead of borrowing from foreign governments to pay their suppliers to develop our infrastructure (think broadband and high-speed rail) we should be licensing their technologies and awarding these to local firms which can prove they can use it cost effectively to build what we need. This should also apply to contracts awarded to private firms partnered with foreign companies. They should be conditioned on meeting certain local content requirements. Defense contracts should increasingly source local producers as well.

The Department of Transportation and Communication is already on the right track by seeking to borrow to pay for the build while privatizing the operations and maintenance of certain projects like light railways. In time we could be exporting some of these products and services if we create local expertise. South Korea did this with its ship building industry in the 1970s with Hyundai Heavy Industries becoming the world’s leading exporter within a decade. It did this even as global demand for ships declined.

Where will the government get the money to do all this? From itself, by using the savings remitted by overseas Filipinos and stored with the central bank in the form of foreign currency reserves–an unorthodox view that even the “humbled” former dean of the UP Economics School holds! If the government were to set aside a third of the currency surplus flowing in each year (see previous posts on this) amounting to around fifteen billion dollars to fund these activities and assuming a one-for-one investment multiplier, a total of four hundred and fifty billion pesos worth of spending could be generated annually (adding 4.5% points to GDP growth!). This would fill up to eighty percent of the investment gap.

The need to diversify our exports is already apparent with an inordinately high specialization in electronics posing a huge risk to future growth in the face of uncertainty of demand from advanced economies. It is also clear that despite very benign inflation and low real interest rates, private firms fail to undertake investments that would lift the productivity of their idle capital. This underinvestment problem is why such a large proportion of our workforce remains unemployed or underutilized.

Stimulating demand for innovation and investment by addressing market failures should be the priority. The biggest barrier for the Philippines to adopting such a strategy will not be an inadequate bureaucracy as many of our top bureaucrats are well-informed and educated; it won’t be for lack of funds as a substantial amount of national savings remain untapped; it won’t be for lack of ideas as there is a wide gap between domestic and foreign technology that can be filled.

The biggest barrier will be attitudinal as it would mean countering the development mindset that has dominated for such a long time which is largely donor-driven. Having drunk the policy “cocktail” put together according to their orthodoxies to no avail, giving us the title of being “the sick man of Asia”, it is about time we developed our own recipes for stimulating economic dynamism in line with local conditions. I now leave you with a song about the coconut which should punctuate this final thought.

Reproductive Health: Lessons from Bangladesh

The first time a coherent population policy framework linked to family planning was adopted in the Philippines was during martial law. In 1968, contraception adoption in the Philippines (measured by the ratio of married women aged 15-49 who practice or whose sexual partner practices any form of contraception) was 15%*. By 1986, that ratio went up to 44%. The average number of births per woman during this 18 year period declined from 6.45 to 4.66.

The Aquino administration upon assuming office in 1986 and heavily influenced by the Catholic bishops of the Philippines abolished the population commission set up by Marcos. Over two years, the prevalence of contraception went down to 36%. Since then it has steadily risen to just over 50% where it stood in 2008. The number of births per woman went down to 3.08 (forty years for it to halve!).

During this time, something remarkable happened in Bangladesh. With the adoption of some sensible population and health policies, they have been able to increase contraceptive prevalence from 27% in 1986 (when records were first kept) to 53% in 2008. Similarly, the number of births per woman went down from 5.4 to 2.3 in that same period. It took them just over two decades to halve their fertility rate to roughly equal the replacement rate (meaning that over the coming years their population will remain stable).

This is remarkable given that the per capita GDP (adjusted for purchasing power) in Bangladesh was in 2008 only about a third of the Philippines ($1,350 v $3,690). For those that argue that a change in fertility is affected by income, this might seem puzzling. Of course in general higher income levels lead to smaller families as demonstrated by the fact that fertility rates for both countries have been declining as incomes have risen. But policies aimed at providing options to families also play a determining role.

Continuity and stability of policy framework

Consider the different policies adopted by these two countries. I have already mentioned the almost stop-and-go nature of population planning and policy in the Philippines. In Bangladesh, they have sustained their policy framework close to forty years and have already graduated into second generation policies.

The first phase of their population policy lasted just over twenty years, from 1973 to 1996.  This phase focused on implementing programs aimed at reducing the population growth rate. These programs were centered on providing maternal and child health care services through home visitations, expanding the availability of contraceptives, multi-sectoral collaboration and encouraging the adoption of family planning services.

It took Bangladesh half the time it took the Philippines to halve its fertility rate. This is despite the fact that Bangladeshis are poorer on average than their Filipino counterparts.

The second phase began in 1997 and continues until the present. It has been more focused on integrating family planning services into a broader set of health programs affecting a wider target group.  From just focusing on reproductive and infant health it became concerned with the control of HIV/AIDS and other sexually transmitted diseases. From being home-based, the services concentrated on clinics to deliver a broad range of services.

The results speak for themselves. One area in which such programs have been effective has been in reducing adolescent fertility. In Bangladesh, the number of adolescents giving birth has gone down from 114 (per one thousand women) to just 70.5 in a span of just ten years (from 1998 to 2008).  In contrast the figure for the Philippines has hardly moved in that time moving from 47 down to 44.

This reduction in adolescent fertility might have helped Bangladesh increase the participation of women in school. In 1990, the ratio of girls to boys in primary and secondary education for Bangladesh was at 75%. By 2006, this rose to 105%. It went from 99% to 102% for the Philippines.

As a result of their integration of maternal and child health services, Bangladesh saw a reduction in the cases of infant mortality and a rise in immunization rates of infants. In 1986, infant mortality in Bangladesh was at 111 (per 1,000 live births), more than twice that of the Philippines which was at 50. By 2008, it was down to 43 for the former, while for the latter it had declined to 27. In 1986 immunization of children (between 12 and 23 months) was at a mere 3% in Bangladesh compared to 51% for the Philippines. By 2008, it rose to 89% for the former compared to 92% for the latter.

Lessons and assignments

As Father Joaquin Bernas, SJ wrote in his column for today’s Inquirer, the merits of the current RH bill must be debated on the basis of whether or not the use of state power to influence the behavior of the populace serves the public good and whether it is exercised in a reasonable manner, not coercive or oppressive.

These statistics demonstrate that the adoption of some kind of reproductive health service is defensible from a public benefit point of view. Whether the use of the public purse in providing “safe, effective and legal methods, whether the natural, or artificial that are registered with the Food and Drug Administration (FDA) of the Department of Health (DoH)” (notice how the wording avoids the use of prescriptive terms such as pill, intra-uterine device (IUD), injectables, condoms, ligation, vasectomy) is reasonable depends on the specific measures in the bill.

One of these provisions has to do with the way employers include such services as part of their worker’s entitlements. For Father Bernas, the specifics of the policy are worth debating, but not the policy aims. For him, you don’t “burn down an entire house to make lechon.” In other words, if there are certain objectionable parts to the Reproductive Health Bill, then these provisions should be revised, but that should not alter the need to have this all important bill passed.

The case of Bangladesh clearly demonstrates how a sustained implementation of an integrated health, family planning and population policy has had a massive positive impact on the welfare of its citizens within a generation. It should serve as a reminder to our politicians that a far-sighted policy outlook is needed in dealing with this issue.

For too long, the country has gone without a legal framework for determining its reproductive health policies. It is about time that our leaders and the public at large take a look at the proposals embodied in the reproductive health bill. Above the shrill cries of those who seem to be stuck over worries that this will lead to population control (a hangover from the 1970s’ debate) on the one hand, and on the other hand those who see in the bill a path towards the legalization of abortion, our leaders need to chart a sensible path based on reason and common sense.

* This and all other statistics cited in this article come from the World Development Indicators taken from the World Bank and available on Google’s public data explorer.

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