inclusive growth

What the Philippines Can Learn from Rwanda

How has Rwanda managed to overtake many developing nations in the global race for competitiveness and transparency?

Landlocked, under-endowed, war-ravaged, Rwanda a nation of 10.5 million people has faced a number of challenges, not the least of which was the ethnic strife that led to genocide twenty years ago. And yet it in spite of all this, it has managed to regain stability and posted sustained economic growth averaging 7.4 per cent per annum that has led to improved social well-being over the past decade.

As an indication of its progress, Rwanda has successfully undertaken significant reforms in its regulatory environment. Just consider the following:

So how has a country which suffered many years of war and as much corruption as any other impoverished nation in the past, managed to turn things around?

Well the short answer is they did this through an accommodative political settlement and the help of both conventional and unorthodox institutions and economic strategies.

A troubled past

Rwanda has had a long history of ethnic violence between the two main rival tribes.  From pre-colonial times up to 1959, the pastoralist Tutsis were the ascendant political class over the agriculturalist Hutus. Ethnic differences were exaggerated under colonial rule. In the lead up to independence in 1962, Belgian colonists transferred their support to Hutu elites. This led to mass killings of Tutsis many of whom fled the country.

Two Hutu regimes ruled the country from 1961-94. Having a single-party dominate politics for most of this period did not prevent the nation from succumbing to decentralised rent-seeking and clientelist behaviour. A group known as Akazu was at the apex of this system. It was related to but not controlled by the administration.

Tutsis sought to regain control of the country through an invading Rwanda Patriotic Army. This culminated in the genocide of 1994 by retreating Hutus. After consolidating their hold on the country, the Rwanda Patriotic Front (RPF) established a government of national unity incorporating moderate Hutus, one of whom led the country as its president.

A reformist regime

Although a certain amount of political repression in the guise of preventing a return of “ethnic ideology” has occurred, the coalition governments comprised of all legal parties in parliament being proportionately represented in cabinet (the ruling RPF holds no more than fifty per cent of the portfolios) has succeeded in keeping the nation stable. This inclusiveness along with its program of restorative justice known as gacaca has fostered reconciliation and allowed the country to experience improvements in social and human development not previously seen.

The intrusive intervention of government in everyday life at times borders on social engineering as the government has sought to follow the Singaporean model in both economic and social policy implementation. President Paul Kagame (elected in 2003 and then again in 2010) has been labelled the global elite’s favourite strongman for improvements to public service delivery, particularly in health and education.

Departmental line agencies have been managed through an institution of performance contracts known as imihigo which Tim Kelsall describes as “modern performance agreements supported by a significant component of moral pressure and neo-traditional gloss.” This combination of formal scientific management and homegrown practices has permeated down to the grassroots by roping in local officials and civil servants.

On the economic front, Rwanda has applied a hybrid approach to investment promotion. On the one hand, it has adopted policies and institutional arrangements considered best practice by the World Bank’s Doing Business surveys. Responsibility for managing this has been assigned to the Rwanda Development Board (RDB). But this works in parallel with a more activist approach in industrial policy with the RPF’s holding company, Tri-Star Investments getting involved in joint ventures and start-up companies.

The holding company has initiated many successful ventures with demonstration effects for the rest of the economy. Telecoms is one example. When Tri-Star sold part of its stake in Rwandatel in 2007, it got five to ten times its initial investment in the company.

Because profits from Tri-Star that are not ploughed back into its businesses revert to RPF, the party is financially independent. It uses this to fund its political campaigns without having to resort to political donors. Kelsall explains what this does:

The RPF’s financial solvency obviates the need for party officials to engage in election-related corruption, which in turn allows the party to take a very tough line on corruption among its leading supporters and in the bureaucracy.

Apart from Tri-Star the government has also orchestrated the formation of other funds, the Horizon Group belonging to the army, which undertakes socio-economic projects to produce productive enterprises, and the Rwanda Investment Group, a consortium led by domestic and diasporic elite.

The purpose of the second group is to raise capital other than through foreign borrowings to invest in high impact projects of strategic national importance. Without such an interventionist approach, much of the agricultural and industrial transformations currently underway in different sectors of the economy simply would not be happening.

The case of Rwanda demonstrates many similar traits to that of the Northeast Asian developmental states. The RPF led government faced existential threats from the opposition in exile and from a potentially hostile ethnic majority at home just as the South Korean and Taiwanese states did from North Korea and from mainland China. 

These threats have kept the ruling RPF focused on improving social and economic well-being for its citizens to maintain its legitimacy and hold on power. The regime has exercised a capacity for long-range vision and forward planning contained in its Vision 2020 roadmap, free from the influence of rent-seeking, private interests. It has ruthlessly pursued its policies at times through heavy-handed regulations and enforcement of rules.

The low crime, low corruption, low red-tape environment this has fostered was not enough. The RPF has used its clout to address market failures and encourage the adoption of productivity enhancing new technology. Through its holding company and other private-led investment groups that it has brought into being, jobs have been found for talented managers and skilled workers that might have otherwise gone overseas.

The Rwandan experience demonstrates the capacity of poor nations to bring about a system of governance that is relatively competent and free from corruption within a short span of time using home-grown institutions, resources and talent. The extremely harsh and disadvantageous position it faced did not become a hindrance, but rather provided greater incentive for it to go down the road it has followed. Surely, any emerging economy seeking to do the same should take heed the lessons from Rwanda.

Lessons for the Philippines?

The Philippines may have already attained middle income country status, a milestone that Rwanda is still aiming to achieve by 2020, but there are certain elements in Rwanda’s development experience that it can learn from.

  • Financially autonomous political parties:

We have seen how  gaining financial solvency allowed the RPF to govern without fear or favour. This enabled it to take a long-term view in planning and executing its economic development strategy. It enabled it to rule with moral ascendancy and punish erring, corrupt officials, putting an end to the patrimonial, rent-seeking behaviour of its bureaucratic and business elite.

  • Inclusive, participatory governance:

We have already seen how the RPF has shared power with other political parties. The proportion of cabinet appointments follows the same proportion of parties represented in the parliament. In the 2013 elections, an unprecedented 64 per cent of seats were won by women. This is the highest level of female participation in political office anywhere in the world. With this level of representation, laws that uphold women’s rights and promote women’s health and well-being are being enacted.

  • Home-grown solutions:

Although a certain amount of repression of the press and political opposition has taken place, in the guise of preventing ethnic tensions from flaring up once again, such suppression it can be argued would have taken place anyway, given conditions prevailing in Rwanda. Rather than relying on foreign models of governance and economic development, Rwanda has charted its own path. It uses institutions like gacaca and imihigo to bring about restorative justice and better governance.

  • Robust government role:

In promoting economic development, Rwanda didn’t follow the Washington Consensus that simply limits the role of government to creating a level playing field. It followed the example of East Asia, which meant addressing structural issues in its economy through interventionist industrial policy aimed at catalyzing investment in productive sectors in agriculture, industry and services to raise the standard of living of those residing at the base of the socio-economic pyramid. Ironically this has emboldened the private sector to take risks as well, to invest in the future of the country.

  • Political succession.

Many commentators are wondering whether President Kagame intends to step down at the end of his second term in 2017. A third term is constitutionally prohibited. As early as 2012, the ruling party held a conference to tackle the issue of political succession at Kagame’s request. At this early stage, the RPF has begun to look for ways to bring about an orderly succession, but one that does not put in jeopardy the advances made already. It is seeking ways to institutionalise mechanisms for bringing this about.

It would not be right to recommend that the same set of policies be adopted in the Philippines. The message here is that countries need to chart their own developmental path based on the conditions they face. The universal prescriptions of the Washington Consensus are becoming less influential as the balance of economic power shifts to the East. While that may be true, certain key principles can be gleaned from the success of other countries.

Considering the way the RPF developed its Vision 2020, opened up participation of women, included its political opponents in a cabinet that advises the president, and managed the bureaucracy through formal and informal contracts, what changes could the ruling Liberal Party make that would improve the way it governs under President Aquino? More importantly, how could it ensure that the positive changes it makes continue beyond 2016 when he steps down?

The path towards “inclusive growth” – some indicators

In his fourth State of the Nation Address before a joint sitting of Congress, President Noynoy Aquino made reference to inclusive growth, inclusive progress or broad-based growth about thrice in his hour-and-a-half-long speech, but he mentioned the words transformation 15 times, change 14 times and reform 11 times. At the midpoint of his term, PNoy sought to bring home the message that change in the culture of “wang-wang” which he coined in his inaugural state of the nation address has taken place under his watch and that as a result of the reforms he instituted, the path for providing opportunity to all has been opened up irrevocably.

Inclusive growth as he declared in his speech was about providing everyone the chance to have a go at life, what the Australians call “a fair go”, which constitutes a social contract that if you work hard at bettering yourself, you can move ahead in life. It is not about guaranteeing the same outcome, however, meaning it is up to the individual whether to take advantage of the opportunities presented, or not. Providing equal opportunity means building human capabilities to pursue “the good life”.

The Asian Development Bank has come up with a Framework for Inclusive Growth which provides a set of indicators for measuring whether governments and societies develop that basic level of capacity in its people. The framework is comprised of three pillars: the first one supports economic growth to expand opportunity, the second one supports social inclusion to provide equal access to economic opportunity, and the third supports social safety nets for those who slip through the cracks. There are a number of indicators for each pillar.

I have sampled a few and collated the results for the Philippines and six other emerging economies from our region to compare the different paths we have taken down the road of inclusive growth and development. Let me start with the most basic one: income or the lack of it. Having a decent level of income is one of the most basic measures of material well-being. Social disadvantage comes from not having income sufficient to live on. The following chart shows the proportion of people living on less than $2 a day for us and our Asian neighbours at the start of the 90s and the end of the noughties.

income

At the start of the 90s, Vietnam had the highest rate of poverty at 85.7%, followed by China and Indonesia which were each at 84.6%, India at 81.7%, the Philippines at 55.4%, Thailand at 37.1% and Malaysia at 11.2%. By the end of the noughties, India had the highest poverty rate at 68.7%, followed by Indonesia at 46.1%, Vietnam at 43.4%, the Philippines at 41.5%, China (29%.8%), Thailand (4.6%) and Malaysia (2.3%). In percentage terms the countries that had the largest decline of poverty was Thailand which saw a drop of 88%, followed by Malaysia (-79%), China (-65%), Vietnam (-49%) and Indonesia (-46%).

The Philippines and India saw the least amount of poverty reduction at -25% and -16% respectively from their initial states. Despite the periods of rapid growth that both these countries experienced during the past two decades, the relative insensitivity of their poverty rates to growth is a bit disconcerting.

The most important predictor of future income is of course the amount of schooling one receives. This is best measured by the years of schooling a person achieves by a certain age. The following chart shows the average total schooling for youth aged 15-24 at the start of the 90s and end of the noughties for the same set of countries.

school

At the start of the 90s, Malaysia and the Philippines recorded the highest totals with 10.2 years and 8.1 years for each of them respectively. China (7.6 years) and Thailand (7.2 years) came next, followed by Indonesia (6.5 years), India (4.6 years) and Vietnam (4.5 years). Two decades later and Malaysia retained the top spot with 12 years on average, but China with 10.9 years overtook Thailand (10.6 years) and the Philippines (9.7 years). Vietnam nearly doubled its number of years to 8.8 overtaking Indonesia (7.7 years) and India (7.1 years). Vietnam succeeded the most in this area lifting the average years of schooling by 4.3 years, followed by Thailand (3.4 years) and China (3.3 years). India lifted its average by 2.5 years, followed by Malaysia (1.8 years), the Philippines (1.6 years) and Indonesia (1.2 years).

The Philippines which started out as first runner up has been relegated to fourth in ranking among these seven countries with Vietnam closing in. The high tech industries of the Philippines and India demand college educated workers. This means that good employment opportunities in these two countries are available only to a few. To be able to perform well at school, children need adequate nutrition.

When people suffer starvation at a young age, it affects their future prospects in life. Malnourished children suffer learning difficulties as their mental development is set back. The prevalence of underweight children under five years becomes a significant predictor of future misery. The following chart depicts this for the same set of countries.

underweight

At the start of the 90s, the highest levels of malnourishment were found in India with 52.8% of children underweight, Vietnam with 36.9%, the Philippines with 29.9% and Indonesia with 29.8%. They were followed by Malaysia (22.1%), Thailand (16.3%) and China (12.6%). At the end of the noughties, India still had the worst result at 43.5% followed by the Philippines (20.7%), Vietnam (20.2%), Indonesia (17.9%), Malaysia (12.9%), Thailand (7%) and China (3.4%).

Both India and the Philippines saw their prevalence drop the least in percentage terms by 18% and 31% respectively, while China and Thailand saw it drop the most by 73% and 57%. The huge disparity of income in India and the Philippines is the main cause of their underperformance.

Finally, how can an individual seek human well-being if he or she does not even survive early childhood. The under-five mortality rate provides an indication of the quality of health care provided to mothers during pregnancy and children at the very start of their lives. The following chart shows the number of deaths per 1,000 live births across the same sample of countries.

child mortality

At the start of the 90s, India had the highest rate of child mortality at 115 deaths per 1,000 live births, followed by Indonesia with 85, the Philippines with 59, Vietnam with 51, China with 48, Thailand with 32 and Malaysia with 18. By the end of the noughties, the mortality rate in India dropped to 63, while in Indonesia it fell to 35, likewise in the Philippines to 29, Vietnam to 23, China to 18, Thailand to 13 and Malaysia to 6. In percentage terms Malaysia saw the largest drop at 67% followed by China at 63%. India saw the slowest reduction at 45% followed by the Philippines at 51%.

Baseline

These figures provide a good baseline for measuring inclusiveness within these countries. There are more indicators provided by the ADB, but these form the core set for anyone interested in studying inclusive growth. The Philippines seems to be in the same situation as India, in that they both experience the slowest reduction of social disadvantage among these countries–social disadvantage which is experienced at the very beginning of life. It is for this reason that the social reforms undertaken by the government are worth noting.

In his SONA, the president announced that he would be increasing the coverage of the conditional cash transfers to four million families and the period of eligibility up until children reach the age of 18. Patterned after successful programs in Brazil and Mexico that have been around for over a decade, the program screens participants based on a multi-dimensional test of social disadvantage. It provides cash straight to them through e-cards given to the mothers to avoid the usual bureaucratic double handling. They continue to receive a monthly cash transfer if they keep their children in school, make them undergo vaccinations and receive reproductive health counselling at health centres.

Their compliance and continuing eligibility is monitored regularly by the Department of Social Welfare and Development. A recent impact evaluation conducted by the World Bank shows that the intended program objectives are being met. School enrollment and attendance and better nutrition has been observed among children of CCT participating communities compared to non-participating ones. Although the poverty rate of the Philippines did not shift significantly between 2009 and 2012, it does not mean that this program was ineffective. The intergenerational nature of this reform implies that the Philippines will begin to reap the benefits of Pantawid Pamilya six to ten years after it was instituted. That means only by 2016 and beyond will this reform’s impact be noticeable through national family income and expenditure surveys when the children of Pantawid reach the working age of 15 years.

It will be PNoy’s successor who will reap the social dividend from the expansion of this program. It is true that this reform can now be considered irreversible in the sense that it will be hard for any successive administration to retract it. The only way to phase it out would be to make it obsolete by reducing the number of poor households. Although the president inherited the program from his predecessor, he can claim credit for rapidly expanding it. The other reforms which the administration instituted, such as closing the classroom gap, the sin tax law, expanding affordable healthcare, offering rent subsidies to informal settlers and the reproductive health act could also reap benefits for successive administrations.

What is disconcerting is how many Filipinos among the educated and upper socio-economic groups still oppose the reforms just mentioned, begrudging the opportunities given to the poor as mere dole outs. It is a sign of just how exclusive and inequality tolerant we have become as a society. Perhaps it isn’t any wonder why our growth has not been very inclusive so far, and why the path towards inclusive growth needs to be pursued even more vigorously by the current administration.

Kurap at mahirap pa rin

Poverty does not seem to be abating, neither is good governance improving much.

This inconvenient truth is the conclusion derived by the National Statistical Coordination Board (NSCB) as of its latest data releases.

Back in April, it found that the change in poverty incidence in the country during the first semester of 2012 (27.9 per cent) was not statistically significant from what it was during the same period in 2009 (28.8 per cent) and 2006 (28.6 per cent).  This rather dismal outcome of the administration’s first two years in office was downplayed by the Palace. It came after the employment report for the April-2013 quarter showed signs that jobs generation was heading south despite the economy’s stellar growth posted in the same period.

Then last week, the NSCB released a set of indicators on Philippine development. When it came to our performance under the global scorecard for good governance, the report said,

The country’s percentile rank based on the World Governance Indicators (WGI) on control of corruption, rule of law, regulatory quality, and voice and accountability had low probabilities of attaining the 2016 targets.

It went on to say that the likelihood of us achieving a better score in terms of government effectiveness under the WGI by 2016 were high. Government effectiveness is different from control of corruption, rule of law, regulatory quality and voice and accountability, though. The former is probably what you would call, “good enough” governance as opposed to “good governance” which is what the latter implies. In the “light v darkness” narrative promoted by the ruling party, “good enough” governance is simply “not good enough”.

The most telling sign that the administration has failed to address the governance issue so far is that the country’s latest ranking in the Ease of Doing Business report slipped two places (from 134th to 136th) and that there was a drop in total investments in 2012. Reducing the cost of doing business is vital to attracting investments. Many say, that in order to open the floodgates to foreign direct investments, all we need to do is change the economic provisions in the charter that limit foreign participation in the local economy.

I personally have a different view, but even if, for argument’s sake that were to happen, if the cost of doing business remained high, it would still discourage investors from investing, as per the current situation in many sectors of the economy that already have been opened up to foreign investment.

It appears when it comes to fulfilling the administration party’s mantra of kung walang kurap, walang mahirap (there will be no poverty if there is no corruption) the government is making little headway, notwithstanding its herculean efforts to impeach the Ombudsman and the Supreme Court Chief Justice and jail the lady president that appointed them. By their own standards, the government seems to be failing in achieving its vision. As a result, income inequality, or the gap between the rich and the poor seems to be widening, as borne out by another NSCB paper released last week.

The government tried to put on a brave face by saying that income among all groups has risen. Unfortunately for the poor, their incomes have risen, but not enough to keep up with the higher cost of living to lift them out of poverty. The conditional cash transfers program which was given a significant boost by this administration was not sufficient. By the NSCB’s calculations, the cost of the government’s welfare program of about Php40 billion for the full year of 2012 was only half the amount required to deal with the problem in the first semester of that year.

The economic management of the nation does not seem to be progressing very well. The Philippine Development Plan talked about promoting inclusive and sustainable growth, but what we seem to be having is none of the sort. Despite all its efforts to improve the efficiency of tax collection and expenditure, to reduce debt and increase social spending and to promote the country as a destination for investment through good governance, these results show that we are just as far away from achieving that goal as we were before.

My advice to the government is not to seek to airbrush these blemishes from its record. It should acknowledge that its efforts thus far have fallen short. The president and his team need to then chart a different way forward. In other words, they need to attend to that “vision thing“, which is what I have been arguing it should have done from the start.

The Binary World of James Robinson: a rebuttal to Why Nations Fail

He came at the invitation of the Angara Centre for Law and Economics to present his ideas from the book Why Nations Fail which he co-authored with Daron Acemoglu. This pair along with Simon Johnson had originally published back in 2001 an article in the American Economic Review entitled The Colonial Origins of Comparative Development: An Empirical Investigation.

Their book could be seen as an essay expounding on the themes uncovered by their earlier research which credits economic development to the institution-building conducted during the colonial era between the fifteenth and nineteenth centuries. It begins by drawing our attention to the differences between Nogales, Arizona and Nogales, Sonora, towns on opposite sides of the US-Mexican border.

The basic thesis of the book is that nations with institutions that promote greater inclusion in both political and economic spheres prosper while those that foster extractive or predatory policies wind up becoming impoverished and backward. The seminal moment in history, according to the book, happened in England back in 1688 during the Glorious Revolution.

For those not familiar with this event, I provide a brief background here. The basic argument goes a little like this: security of ownership and property rights is essential to investor certainty; investor certainty is needed to foster capital markets, and a set of political checks and balances that guarantee this is best suited for capitalism to flourish.

These principles were essentially what The Glorious Revolution was supposedly fought on and why the Industrial Revolution subsequently took place first in Britain, rather than in Continental Europe. The rights and ideals that Englishmen fought for were transplanted to their American colonies and became the basis for the American declaration of Independence in 1776.

Acemoglu, Johnson and Robinson (AJR) sought to prove empirically that institutions mattered to development. Previously, it was argued that climate and geography had a lot to do with it, i.e. that the industrious, temperate, northern states of Europe were more prosperous than the sluggish states in the southern Mediterranean and the tropics.

AJR sought to dispel this using colonial history. Why was it that not all colonised countries developed along the path of the United States? The difference lay in institutions. Their article demonstrated that in places where diseases led to high mortality rates among early European settlers, and where consequently hardly any permanent settlements were planted, centuries later, the lack of institutional legacy was found to be significantly correlated with low development.

The main lesson was that geography was not destiny, and that even history was not destiny. Less developed nations could begin adopting the institutions that promoted greater inclusiveness and discard extractive policies that left them in squalor. This dove-tailed with the agenda promoted by Washington on good governance, as it searched for a way to rescue the failed Washington Consensus from repudiation.

What came about was the augmented consensus that said free markets and good governance promote economic growth and development. After decades of telling less developed countries to shrink the role and capacity of the state and let markets rip, they were now saying that government needed to be strengthened once again.

The liberal democratic states of the West act as an ideal to which other societies need to aspire to. No other path leads to sustainable economic growth other than this. Just as Calvinist preachers of old would proclaim that no one cometh to the Father, but by His Son, these economists present a case that no other path leads to economic Nirvana, but through the Market (with Institutions performing the role of the Holy Ghost).

This rather binary view of the world is actually contradicted if you go deeper into the colonial history of the Americas which is what John H. Elliott did in Empires of the Atlantic World: Britain and Spain in America 1492 to 1830.

Here he wrote that it was actually the exclusionary racial policies fostered by the English settlers that led to greater social cohesion among settlers around Enlightenment principles of individual rights and liberties, which in turn led to greater independence and prosperity.

Meanwhile in the Southern hemisphere, the Spanish settlers had an “organic conception of a divinely ordained society dedicated to the achievement of the common good” which was “more inclusive rather than exclusive in approach”. The granting of rights both economic and political to natives consisting of mestizos, creoles and freed slaves led to a mixed-race society prone to greater divisions than existed in the North.

The irony here is that a more inclusive colonial policy led to greater exclusivity as subsequent societies were stratified and organised into “pigmentocracies” which made it harder to achieve the egalitarian principles espoused by the Enlightenment. In the Philippines, the outpost of New Spain, the situation was worse in that apart from developing this multi-racial caste-like system, the facility of a common language was not provided as it was in the Americas.

This is the difficulty of using colonial history to prove or disprove that institutions matter in the way attempted by the authors of Why Nations Fail. They do matter, but in different ways, which is the point I highlighted previously in this column (see here).

Secondly, there is the anomaly of the benign dictators of East Asia and the desarollista states of Latin America. Robinson has taken the view that the East Asian growth formula, what is termed the BeST Consensus (BeST consisting of Beijing, Seoul and Tokyo), represent a unique moment in history that cannot really be duplicated or sustained.

Peter Evans disputes this saying that just because the East Asian miracle emerged from a unique blend created by the Cold War policy of the United States, it does not mean that we cannot distil a few basic principles and emulate them today. Just because these states were predominantly autocratic does not mean that weak democratic states cannot adopt the policies that made them succeed in fostering rapid industrialisation (see here for a deeper discussion).

What’s more is that both Germany and the United States, late industrialising Western nations after Britain and France, followed the same industrial policies a century earlier. It was just that after scaling the development wall, they felt the need to “kick the ladder” away to prevent others from following them up because not doing so would disadvantage them.

In Latin America, the record of developmental or desarrollista states of the 1970s and 1980s in Brazil and Mexico is more spotty than in Chile but nonetheless more successful than in Africa or South Asia as these countries made their way into middle income status ahead of countries like Malaysia, Indonesia and Thailand. This is the evidence that Robinson conveniently sidesteps.

Another point James Robinson makes in the book and in interviews is that collective action, which he equates to people power, is key to expanding opportunity for people if the system is closed. He cites the experience of the Philippines and of the Middle East a la Arab Spring to underscore his point. Again, the use of people power is problematic. Why?

Well as Elliott points out, people power features in Spanish colonial traditions as well because

(b)y the laws of medieval Castile the community could, in certain circumstances, take collective action against a ‘tyrannical’ monarch or minister.

Cortes in fact used this against governor Velasquez who ordered him to survey and not to invade the territory of Montezuma in the Yucatan peninsula. It was based on the notion of a social contract between the prince and his subjects which if broken gave the right of the governed to say, “I obey, but I do not comply” (se obedece pero no se cumple).

From time to time, commoners or comuneros resorted to acts of dissent bordering on revolution. But these were simply seen as a way to get the authorities to the bargaining table. Once their grievances were heard and the tyrannical laws or ministers were replaced, they would go back to living as loyal subjects of the monarch. Direct democracy rather than representative democracy ruled until very late in the piece, which left them with very little in terms of a genuine parliamentary tradition.

This swinging of the pendulum from uprising to dictatorship and then back again is exactly what we are witnessing in Egypt today. The problem with equating collective action, i.e. people power, with greater openness, is that the relationship does not always hold.

Finally, let me address the fallacy that only the Anglo-American form of capitalism works well. Francis Fukuyama is right to point out that this is not the only successful Western model that exists. Scandinavia demonstrated another path, which did not require revolts against oppressive monarchs. Theirs was more along the lines of an enlightened, benevolent monarch based on egalitarian religious rather than secular beliefs.

What I hope to point out through this discussion is that the world that we live in is more complex, more multifaceted than what Robinson tries to portray. While it is easy for him to be parachuted into the Philippines to spread his brand of institutional economics, we don’t necessarily have to buy into his whole message.

I agree that the Philippines needs greater openness and participation in political and the economic life, and that collective action to widen the sphere of participation probably needs to be organised, because elites won’t surrender their privileges willingly, but that is as far as I would go.

We don’t need a whole theory based on a faulty or perhaps selective reading of history to back this up. We have seen how people power can be hijacked or used for narrow political ends. We need to guard ourselves against simplistic arguments that say unseating this corrupt ruler here or that autocrat there is going to bring about nirvana for us. Institution-building is not accomplished by this alone, but through a sustained, deliberate, evolutionary process.

The social innovation of Oportunidades and Bolsa Familia more widely known as conditional cash transfers which have been credited with reducing poverty in Mexico and Brazil were not developed by the World Bank or the IMF.

They were experiments conceived by indigenous policy makers who were thinking ‘outside the box’. The East Asian industrial policies responsible for creating economic prosperity and convergence were pursued against the advice of international economists from the IMF and the West. Japan’s Ministry of International Trade and Industry sought to deceive their Western minders that they were complying when in fact they were doing their own thing.

Similarly if the Philippines were to find its way in the world, it will have to be by taking into account its own unique blend of ideas, capacities and institutions. It won’t be by applying some universal one size fits all formula promoted by a Western economist armed with some statistical regressions, a few case studies and a loose reading of history.

Since the era of Martial Law we have had technocrats sing from the same hymn sheet as their Western counterparts while ironically supporting a system that undermined the very principles they were espousing. We need to be smarter and wiser this time around.

We need to accept that the world is not a binary system, comprised of dummy variables that say you are either inclusive or exclusive, free or unfree, open or closed. We need to admit that we live in a multi-polar world, where things are not as clear cut, as some experts would have us believe, and that many paths lead to development. Ours in fact still needs to be found.

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

The coconut serves as a good analogy for our under investment problem.

The five year Philippine Development Plan (aka “the Plan”) released by the government of President Aquino earlier this year identifies a number of “structural defects” underpinning the country’s poor economic performance. Depicting the problem was easy enough. Without a significant uptick in investments, inclusive growth will remain elusive and poverty will continue to hound us, so the Plan says.

Using an analogy inspired by Robinson Crusoe to grasp this, imagine living on an island where the only resource is the coconut and inhabitants keep arriving. The only way to feed a growing population is to plant more coconut trees. “Investing” in more trees requires hiring more laborers to climb them in order to harvest the coconut. Some coconuts could be consumed, while others could be traded for products from other islands.

The Philippines has lagged behind its Asian neighbors in investing, which explains why it is so poor. Exhibit A as provided by the Philippine Development Plan is reproduced here (see below). Since peaking at 25% in 1997, the country’s investment-to-GDP ratio has been steadily declining, underperforming Indonesia, Malaysia and Thailand. A familiar story for Philippine-watchers–we have all heard or read about this before.

Chart 1. Investment-to-GDP Ratios of Selected Asian Countries: 1994-2010 (in percent)

So what is the reason for this underinvestment? The answer given to us is a lack of competitiveness. The country’s lagging infrastructure, its poor governance and inadequate skill base are increasing the cost of doing business in the country. On the island for instance, a lack of tools to harvest coconuts, a lack of laborers with the skill at converting coconuts into useful products and a lack of boats to transport them offshore is the problem. Now what? Well, according to this narrative, massive infrastructure spending, improved governance and human capital development is warranted.

So beginning next year, the government will be bidding out four initial infrastructure projects amounting to twenty five billion pesos to improve infrastructure in the country. After a year of delays, the amount is about a quarter of what was originally slated. The projects include the construction and maintenance of three airports in Cebu, Bohol and Misamis Oriental and the ticketing system for Manila’s three light railways.

The government has also been busy this year fixing the internal procurement systems within the public works, agriculture and education departments. Much of the budgeted expenditures for this year was held back (a little over half of infrastructure budget as of September has not been spent) due to these efforts, but beginning next year, we are told, they should proceed much more smoothly. The DepEd also has a plan to close the gap in school buildings within the next five years mainly through build, lease transfer agreements with the private sector.

Assuming all these projects go ahead without further delay, we should expect the nation’s problems to be fixed in five years, right? Well, not exactly. One needs to get a sense of the scale of the problem first. This is why I did some very rough back-of-the-envelope calculations to determine the overall size of the employment and investment gaps. Using our island analogy it is like asking the question, how many coconut trees need to be planted to provide enough work for its growing number of inhabitants?

Climbing the coconut tree

Using data from 2005 to 2010, I tried to compute how much additional investments would be needed in the next five years to bring unemployment down from where it is currently at 7.4% to a more manageable level of say 4%. The country has about three million unemployed workers out of a total labor force of thirty-nine million in 2010. Each year about seven hundred thousand new entrants are added to this pool, which means a workforce of about forty-three million by 2016.

So for the country to produce jobs for all of these new entrants and reduce the pool of unemployed workers down to about 1.7 million consistent with an unemployment rate of 4% by 2016, about one million net new jobs need to be created each year. This is consistent with the government’s employment target. There is nothing new there.

The reason why we haven’t seen unemployment decline is because the number of net new jobs created each year is usually slightly below the number of new entrants (see Chart 2 below). Thus, the number of those unemployed steadily rises each year in proportion to the growing work force leaving the unemployment rate relatively stable at around 7.5%. The question now is how much additional investments have to be raised to bring this down to 4%.

Chart 2. Supply and Demand of New Jobs in the Philippines: 2006 to 2010

If one compares the average investments over the past five years of about one-and-a-half trillion pesos per year  (roughly 15% of GDP as shown in Chart 1–see preceding section) with the average number of net new jobs created of about seven hundred thousand per year, one arrives at a figure of about four hundred and fifty new jobs for every one billion pesos spent.

The number of jobs created per peso invested has actually been declining. Back in 1994, a billion pesos in today’s prices would produce about four times as many new jobs. This means that part of the problem has been the increase in productivity particularly in the manufacturing sector where technological progress has reduced the amount of workers required for any given level of output to be produced. In other words, new tools have been created that make climbing the coconut tree a lot easier. As a result, fewer workers are needed.

Assuming that the ratio of new jobs created per peso invested remains steady for the next five years, the amount of investments required to bring unemployment down is about two trillion pesos per year (20-25% of GDP, roughly where we were in the mid- to late-90s). Compared with the average amount of investment spending cited above, this would mean an increase of more than half a trillion pesos (close to six hundred billion) a year or an increase of about forty percent from the current base.

Had the government stuck to its original plan and rolled out a hundred billion pesos worth of projects and assuming an investment multiplier of two (which means a one-for-one additional investment in complementary projects amounting to two hundred billion in total), we would end up filling about a third of the required level of additional investments. Given its planned roll-out is now about a quarter of the original, we will only be achieving close to ten percent of the investment gap. In short, the “solution” does not seem anywhere near the required amount.

“The coconut nut is not a nut”

Here is another problem with the Plan: the assumption that improved competitiveness will steadily increase investments seems straight-forward, but reading the Global Competitiveness Report produced by the World Economic Forum, I find a few anomalies. The chart below shows the various country rankings from 2005 since the Report first came out until 2011 (click the play button).

The Competitiveness Index is a composite score made up of twelve components. These “twelve pillars” that hold up an economy cover things like institutions, macroeconomic policy, infrastructure, health, education, innovation and regulation. The Plan says that the “structural defects” in these pillars as shown by our declining ranking is the chief cause for our declining economy as measured by our investments-to-GDP ratio.

Our ranking has declined alright, but only because of the addition of more countries in the league table in the intervening years. Our score (which you can see by hovering the cursor over the appropriate column) on the competitiveness scale actually rose from 3.71 to 4.08 out of six during the period covered just above Indonesia’s score of 4.05 back in 2005.

Refering back to the first chart, it is clear that in 2008 when our score was actually 4.09, our investment-to-GDP ratio did not climb to anywhere near the level of Indonesia back in 2005. This is like saying two students who scored the same on their tests, did not receive the same final grade. There is an anomaly here.

One might argue that it is our ranking and not our score that counts, so that relative to our neighbors, our score continued to lag and that explains the poorer investment-to-GDP ratio. Makes sense if the grading of students is not based on their absolute scores, but on their relative rankings within the class, right?

Well then, according to that argument, Malaysia which ranked first among its neighbors in terms of competitiveness should have outperformed them in terms of its investments, but the first chart actually shows it slipping steadily below Indonesia and Thailand since 2002 and coming dangerously close to parity with the Philippines. In fact, Indonesia which has consistently come in third in the ratings and rankings of the four neighbors has steadily risen to outclass the Malaysian and Thai investment ratios by 2009 and 2010.

So perhaps, achieving “global competitiveness” is not what it is all “cracked up” to be. It would seem that some other dynamic is driving investments. As one song goes, “the coconut nut is not a nut.” This should give you a lot to think about, which gives me a few days to conclude this. Until then, let me leave you with this tune to fuel your ruminations…

Budget 2012: How it all stacks up

Among the nations in the developed world that follow in the Westminster parliamentary tradition, the most eagerly anticipated policy speech by the government is not the state of the nation address but the budget speech.

The budget tackles not only the spending side, you see, but the tax side as well. On budget night, citizens find out if they are to get some form of tax relief. They also look for any additional spending on things they directly benefit from, like schools, hospitals or infrastructure.

The rich nations that make up the OECD (Organization of Economic Cooperation and Development) have varying levels of taxation. The Scandinavians typically tax more and provide a high degree of social insurance and welfare. The Anglo-American nations of the UK, US and Ireland tend to have lower taxes but provide a smaller safety net for their people.

Australia, the nation I am most familiar with seems to have the best of both worlds, with a tax take much lower compared to the Nordic countries but providing a level of social insurance and welfare comparable to them. That is because its tax and spend policies are some of the most progressive in the world.

Australia spends about 16 per cent of GDP on cash benefits (pensions, unemployment insurance, healthcare and community services) compared to an OECD average of just over 19 per cent. It is able to keep this expenditure down by means-testing benefits enabling it to target spending on those that most need it. Its tax take is about 27 per cent of GDP compared to an OECD average of close to 35 per cent. It is the sixth lowest-taxing country in that group.

Rich country, poor country

It is perhaps in this light that we need to focus on the Philippine tax and spend situation. Most poor countries are able to generate only as much as 20% of GDP from their tax systems. Yet the demand for public service is much higher than in advanced economies. The Philippines is no exception.

In 2012, the government projects it will generate about 1.5 trillion pesos worth of revenue out of a domestic economy that is expected to reach 11 trillion or about 13.6% of GDP. In the current year 2011, the government projects to earn 1.4 trillion out of an economy of 9.9 trillion or 14.2% of GDP. In 2010, the ratio was 13.3% (based on DBM papers).

In 2012, due to its low tax take and with a budget of 1.8 trillion, the government will incur a deficit of 286 Billion (up from the original 260 B) or 2.6% of GDP. That is compared to its projected deficit in 2011 of 300 Billion worth 3% of GDP and 314.5 Billion for 2010 or 3.5% of GDP.

Social services which include education, health, housing and land distribution are programmed to consume 556.2 billion pesos or 30% in 2012. That compares with 529 Billion in the current year equal to 31% of the budget in 2011 and 399.3 billion in 2010 worth 26.2% of that year’s total spend.

Among the social services, education takes the largest share. Next year it will amount to 309 billion or about 2.8% of GDP. This is up slightly from 2011 which was 272 Billion or 2.7% of GDP and from 2010 which was 225 billion or 2.5% of GDP. By contrast, Singapore and Thailand spend anywhere from 3.5-4% of GDP on education. Malaysia spends from 5-6%. If we were to match Thailand’s education to GDP ratio, we would need to spend an additional 70 billion on education.

As for health, next year’s budget includes 59 billion or 0.5% of GDP, up from 48 billion in the current year (0.48%) and 36 billion last year (0.39%). In contrast, Singapore spends about 0.9-1.5% of GDP, while Malaysia spends 1.8%, and Thailand 1.2-3%. If we were to match Singapore’s ratio, we would need to spend about 40 billion more on health.

Finally in housing, the 2012 budget contains 14.5 billion worth of spending or 0.13% of GDP compared to the current year’s 21 billion (0.2%) and 12 billion (0.13%) from 2010. Singapore by contrast spends about 1.8-2.5% on housing. Malaysia spends 0.3-0.6%, and Thailand spends 0.5-1%. If we were to simply match Malaysia, we would need to double our current spend by another 14 billion.

Living within our means

Judging from the magnitudes and ratios alone, we can plainly see that the country will continue to lag behind its neighbors in the region when it comes to providing basic social services for its citizens. As a result, it has much higher levels of poverty and inequality and lower levels of human development among the ASEAN-5.

If you take out the possibility of tax reform, “living within our means” confines the budget department to look for savings and improve the structure or mix of spending to improve the quality of the spend rather than the quantity. Past studies have shown that our education spending is already quite progressive, while that of our health sector tends to be regressive with its focus on the tertiary hospitals in urban centers rather than on primary healthcare in the community.

Certainly, there are opportunities to improve the progressivity of our spending program in health. One problem is that our health system follows the model in the US, Europe and Japan which relies of specific contributions. Those who earn more tend to receive higher reimbursements. While in Australia, health expenditures are financed from income taxes, but then are spent in a more egalitarian way by means-testing recipients so that those who earn more tend to pay more out of pockets than those who earn less.

Can afford more

The orthodoxy of constraining the budget because we have to live within our means can of course be challenged by simply asking the question, can society afford to pay more?

From his State of the Nation Address, the president hinted that we probably could afford to pay more when he cited to his own disbelief the close to two million self-employed entrepreneurs and professionals who declare incomes beneath the minimum wage. The BIR has said subsequently that it believes that the current 10 billion raised from these individuals should actually be about 100 billion.

Aside from professionals and self-employed individuals, the corporate sector might also afford to pay more. That is according to a five year old study by Dr. Renato Reside. His work showed that a very low correlation between investments approved by the BOI and PEZA with actual capital formation in all regions except Regions 4 and 7. He concluded that since investments did not materialize companies were simply using their fiscal incentive privileges to engage in tax avoidance. The recipients of such incentives read like a who’s who of Philippine business elite according to Dr Ben Diokno.

Because companies under this scheme are also allowed to sell as much as 50% of the goods they produce to the domestic market, Dr Reside also believes that much revenue is lost. According to him, back in 2004, we were losing as much as 59 billion pesos from revenues on imported capital goods, 135 billion on imported raw materials, 10.5 billion on the use of domestic capital goods, and 44 billion on income tax holidays provided to these so called exporters. If even half of these were recoverd, it would be an additional 125 billion in revenues.

Another form of tax incentive is provided to sin products because of the non-indexation of taxes imposed on them. It is an incentive because every year the prices of these products go up, but the taxes imposed on them don’t. Government revenues are eroded over time. By gradually increasing the taxes along with the rise of prices in general, the additional revenues from sin products estimated to be as much as 70 billion annually could help beef up our infrastructure which in 2012 will be 270 billion a mere 2.5% of expected GDP.

Indeed, from the combined tax breaks given to entrepreneurs, professionals and corporations, our society could afford to bridge the gap in social as well as economic infrastructure. We could become a more inclusive society. With a combination of better policies and stricter enforcement in revenue and incentive granting agencies, by renovating our economic bureaucracy, we could produce a more progressive tax and spend system.