industry policy

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.

ADB tells Aquino to start “picking winners”

According to the Asian Development Bank, the Philippines needs to beef up its industrial policy if it is to achieve rapid and inclusive growth.

Taking the right road to inclusive growth, the report that Norio Usui penned is chock full of evidence in support of this position. The ADB has added its voice to UNIDO in arguing the case for industrial policy to be adopted by developing countries. This is against the grain of thought held by the World Bank, the IMF and the WTO which continue to hold on to the “Washington Consensus” that free markets and good governance are all that is needed for countries to prosper.

Unlike other reports that are full of analysis that mostly describe the problem but offer very little advice (mostly motherhood statements) this one drills down to specific prescriptions and targeted sites for intervention. Usui uses the analytical and methodological tools developed by Dani Rodrik of Columbia University and Ricardo Hausmann of Harvard (both of whom I have featured here and here) to plot out the “product space” into which the Philippines could best diversify its manufacturing and export base.

On a personal note, I was quite excited to see the “Top 20” charts he assembled of products which were closest to our current revealed comparative advantage, which had the greatest potential for spillover, and which had the greatest impact in terms of labour employment. Having done a similar exercise for a development agency in Australia which identified the technology intensity and revealed comparative advantage of the jurisdiction, I was never able to identify the areas in which to diversify. What Usui has done represents the cutting edge of developmental diagnostics at an industry level.

The irony is that the Philippines has demonstrated the capacity for producing highly sophisticated products which is normally associated with richer countries (a point that Hausmann made in The Economist). The problem is that without sufficient public intervention to deal with coordination and information problems and other market failures, such diversification will not occur.

Usui makes the point that while the decline of manufacturing has in part been offset by the growth of services (business process outsourcing being the most recent trend that supported growth throughout the 2000s), growth in employment, productivity and incomes have not kept pace with our ASEAN counterparts. To catch-up, growth would be required in manufacturing to supply “a second leg” with which the economy could pick up the pace.

Despite the presence of broad based programs to attract investments, reduce regulatory red-tape and corruption through the BOI and the PEZA, incentives have been largely redundant and used inefficiently. Although poor infrastructure and costly energy costs the oft cited reasons why investor shy away have some basis, Usui shows how that it may not necessarily be the overriding barrier or cost driver across the board.

In short, specific, targeted, industry-supported interventions and incentives are what would be needed for our manufacturing sector to grow and diversify. These interventions could range from supplying concessional loans or co-investment (something I discuss here), supporting the entrepreneurial process of self-discovery over how to adapt foreign technology to local capacity through research and development (something borrowed from Rodrik), coordinated infrastructure investments to providing subsidies for training (something I discuss here).

To counter the argument that such measures are difficult for weak governments to implement and merely give rise to cronyism and rent-seeking, Usui supplies the remedies acquired through practice by the East Asian economies in their path to development: sunset clauses and exit strategies, clear targets, monitoring and evaluation and contingent cost-recovery mechanisms.

In a previous post I have estimated the quantum of investment required to bring unemployment down to manageable levels along with the policy instruments required for encouraging such investments. What Usui has done is basically identify the sectors to target and engage.

If the government were to spend 200 billion pesos over the course of the next four years to co-invest in private-led initiatives that would generate five times that amount in counterpart funds (we currently have over one trillion pesos locked away in special drawing assets in the banking system) that would raise GDP by about 3% points a year. Add that to the 4-5% growth trend at present, and the government would just about hit its growth target of 7% over six years.

Unlike the scattergun approach being used to implement good governance which like the fiscal incentives program could prove highly inefficient and ineffective, I have recommended a targeted approach appropriate for our level of economic development by focusing on revamping the economic bureaucracy (covering both industry policy and revenue collection and enforcement). Usui supports this view by endorsing industry councils based on the East Asian model.

As I have mentioned before, it is not necessarily a lack of resources that is the problem (we can tap our foreign reserves if we have to, which incidentally will dampen our currency which at the moment is overvalued and hurting manufacturing). Rather it is the poverty of ideas and the ideological and dogmatic blinkers that have prevented successive governments from putting into practice pragmatic solutions to mend the country’s ills.

As the ADB points out, the country is well poised for economic growth given its openness to trade, sound banking system, and benign macroeconomic environment. External events like currency adjustments and wage inflation in China could also provide a precious window of opportunity for us. But there is no time to waste as other countries in the region are rapidly acquiring the capacity to produce highly sophisticated products as we have. The report concludes by saying

Structural transformation, by its nature, is a long process. Challenges may look overwhelming. It cannot happen tomorrow, but in a future within our reach. The Philippines has a huge potential to become a key production base within the regional production network … The government needs to be pragmatic enough to exploit the precious opportunities. Strategic public sector support that embodies a long-term vision of the economy makes it possible to change the economic structure that drives inclusive growth in the Philippines. Success is not always as distant as it seems.

I couldn’t agree more. Let’s hope someone in the Palace is listening.

The Thai experience (or why P-Noy <3 Yingluck shouldn't be the headline)

The Philippines it seems is engulfed in all things Hollywood at the moment. With the filming of the Bourne Legacy taking place in Manila filling the nightly news with human interest stories surrounding both actors and extras, another “courtroom drama” was unfolding in the Senate with the impeachment trial of Chief Justice Renato Corona.

Meanwhile, as the president hosted the Thai PM Yingluck Shinawatra, you could be forgiven for thinking your were watching an episode of “The Bachelor” unfold as all the major dailies focused on these two eligible single ASEAN leaders visibly at ease in each other’s company. Kris Aquino, the president’s irrepressible match-making “gossip girl” kicked things off. Such a diversion might have been timely, as the president’s ex-girlfriend was betrothed to marry a prominent congressman barely a few years after their own public version of “The Break-Up”.

All this talk of romance swamped the more substantive purpose of the Thai PM’s trip. Investment and trade flows are not quite as important as the bonds of friendship and affection it would seem. However, despite the superficiality with which this visit has been depicted, there is one important lesson that the Philippines needs to heed from the Thai experience.

With “love brewing”, it is easy to forget the controversy swirling in both the Thai PM’s and the Philippine president’s countries. Political instability and turmoil have hounded both nations. But the lesson from Thailand that I would like to draw on comes from its path to development which led to its overtaking the Philippines back in the 1980s. Their experience could be very instructive for us today as we grapple with how to make our local industries more competitive.

Back in the 1970s, the price of Thai garments were found to be 30% more expensive compared to the world market. To deal with this situation, the local association of garments makers decided to raise a levy on each spindle. The revenue raised was used to subsidize exporters. The amount of transfers depended on the volume of exports. A subcommittee set up by the Thai Textiles Manufacturing Association monitored and enforced such an agreement.

But even after taking this collective course of action, garments were still 20% more expensive when compared with competing products overseas. They then turned to the Bank of Thailand to cut energy rates and lower interest on trade bills for exporters. They persuaded the government to grant rebates on business taxes and import duties. This effectively dealt with the remaining price differential. As a result Thailand was able to break into international markets.

From this specific case*, we can begin to make some general inferences. The Thai experience shows us that the private sector should not simply wait for government to come to its aid. Domestic players need to band together and work out solutions for themselves. It is only when they have taken the initiative but still fall short that government needs to step in and provide them with the necessary incentives and support to bridge any remaining gaps.

As our exporters grapple with high fuel and energy costs and a rising peso, there is the temptation to think that we simply need to let the market dictate what products we specialize in in terms of the global supply chain. The prevailing economic philosophy governing our policy elite frowns upon subsidies and tariffs, viewing them as distortions that make markets less efficient. Worse, they tend to view these things as symptomatic of poor governance and as sources of corruption and rent-seeking.

What the Thai experience tells us is that this is not necessarily the case. Rent-seeking, particularly the kind that encourages innovation and productivity, can play a central role in national development. It takes a set of very broad minded policy and business leaders to propose such unconventional solutions. Even the leading exponents of market orthodoxy are beginning to acknowledge that without such out of the box thinking, we may end up with no manufacturing base to speak of.

If the president is interested in leaving behind a legacy beyond simply jailing his predecessor and her cohorts, it is time his administration began looking beyond the traditional policy toolkit. Such a new direction would help push the country’s growth and employment rate above its historical trend. The sustained trajectory of Thailand’s economy since the 1980s and our own under-performance during the same period should provide us with enough reason to chart such a new path.

It is not a romance with Thailand’s PM that we should be encouraging, but rather, a love affair with their formula for economic success. In the parlance of reality TV, it should be less, “The Farmer Wants a Wife” and more “Celebrity Apprentice”.

*The case of the Thai garments sector during the 1970s discussed here is based on the chapter of Richard F Doner and Ansil Ramsay in a book edited by Mushtaq Khan and Jomo K. S. entitled Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia first published in 2000 by the Cambridge University Press.

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.

Jammed

Does public infrastructure represent the best use of private investment?

It seems that our corporate titans have nothing better to do with their excess cash than to pour it into the growing public utilities and infrastructure sector. Whether it is San Miguel the beverage giant which went heavily into power or the Metro Pacific group a major player in telecoms which operates the NLEX-SCTEX road networks, there does not seem to be anything which competes for their attention than this sector.

About one-and-a-half trillion pesos is sitting in Special Drawing Accounts with the BSP deposited by banks which are unable or unwilling to lend them out. With a country as underdeveloped as ours, one would think that such excess savings could be put to better use. Why for instance isn’t San Miguel investing to develop coco juice exports which it has the capital and expertise to do?

Since our lost decade in the 1980s when a banking crisis followed by a political upheaval reduced our economy to tatters, manufacturing has never really recovered from the heights it once achieved by the end of the 70s and early 80s (see chart). Meanwhile, our ASEAN neighbors Indonesia, Malaysia and Thailand overtook us in moving their economies towards industry. Our gross capital formation as a percentage of GDP is the weakest in the region as a result.

Vietnam, a relative latecomer in the game has seen its manufacturing sector grow by leaps and bounds, while Singapore cannot be held up as an example for us to follow since it is a city-state with a tiny population and workforce. It can afford to de-industrialize its economy, while we can’t. While some would argue the high value services sector is nothing to sneeze at, it still cannot be relied on to provide the kind of jobs that match the skills held by our bulging population. The answer lies with manufacturing.

The Philippine Development Plan identifies infrastructure as the “binding constraint” to speedier growth. The reason it claims Philippine goods remain uncompetitive is our inability to bring them to market efficiently. Apart from that there is the implicit “tax” that comes by way of corruption which increases the cost of doing business and the unfair competition from smuggled or pirated goods that discourages domestic manufactures, the result of weak rule of law.

With its low tax collection rate and chronic fiscal deficits, partly to do with an aggressive liberalization policy pursued since the 1990s, the government was more than willing to let the private sector fill the breach in public infrastructure.

Since private business seems so gung-ho about providing public goods, it seems the identification of infrastructural bottlenecks was the correct diagnosis of the problem of underdevelopment. One wonders, however, if these firms are moving into such projects because there is no attractive alternative in other sectors, or is it because of higher returns now currently on offer from public-private partnerships?

Also, if indeed there are “bottlenecks” causing the cost of doing business and cost of living to skyrocket, then one would expect the public would be willing to absorb the fees charged by private operators under existing PPP arrangements. That is not what has been observed though (think MRT and LRT). One would then have to conclude that either the private operators have negotiated prices above the market-clearing level or that the demand for such infrastructure was not sufficient to begin with.

Investing in public goods by their very nature would often produce a private return lower than the commercial rate of return. That is why it is often financed in capital scarce countries through “concessionary loans” from foreign governments and multilateral institutions. If private operators borrow at prevailing market rates, then they cannot possibly make a profit unless the government provides a subsidy to pay for the spread between the “risk free” government borrowing rate and the commercial lending rate.

Turnaround

The sudden flash of insight Sec Mar Roxas used to interject into the president’s faltering public-private partnerships roll-out was that it would be better for the government to borrow at the risk-free rate and contract out the construction phase of some projects in effect passing on the cheap cost of capital to contractors. It could then auction off the operations and maintenance contract separately minimizing the need to subsidize fees charged to customers.

The question then is can government afford to borrow more in order to finance its infrastructure roll-out? It could if it chooses take-up the BSP’s offer to borrow against the country’s excess international reserves that accumulate each year. The state would effectively be borrowing against itself. Given the total cost for the original projects of about one hundred billion pesos, the surplus of reserves flowing into the country each year of four to five billion dollars is enough to cover these projects twice over.

If the public sector is then able to deal with the cost of providing infrastructure, how can it stimulate complementary investments needed in the private sector? If the lack of domestic capital and skilled labor are not responsible for the observed underinvestment, neither are low rates of return (low taxes and labor market flexibility are found in special economic zones), then what else could it be?

There are a number of candidates. Government failures which include corruption or weak property rights and rule of law are one option. A second possible candidate is market failure due to inabilities to coordinate investments in complementary upstream and downstream sectors or to internalize the benefits of innovation and experimentation.

The first has been identified by the National Competitiveness Council and the government as an area of concern. The decline of the Philippines ranking in the latest Ease of Doing Business survey by the World Bank reflects the country’s inability to address government failure. On the other hand, if these are the causes for underinvestment, why is it that manufacturing has suffered a decline relative to services in terms of investment and output? Shouldn’t they all be suffering the same fate?

This leads me to identify the problem of market failures as well. The systematic break that occurred in the mid-80s when the country turned away from industry policy and underwent an aggressive reduction of tariffs unilaterally ahead of WTO commitments left our manufacturing sectors at a disadvantage vis-à-vis our ASEAN neighbors. This is perhaps the reason services have oustripped manufacturing since it represents non-tradables which can only be provided domestically. Think retail, housing, commercial property and yes, utilities. Mining is a similar story. How then could the government begin to stimulate activity within the tradable industries? The following five measures would represent the most important steps.

  1. Partially rollback tariffs to within acceptable levels still within WTO commitments targeting in particular greenfields. Sustainable technology is one example of greenfields. To partly offset the modest rise of inflation that would come with this, tax cuts and (conditional cash) transfers should be directed to low income families.
  2. Finalize the list of investment priorities to signal the areas that government wants growth to occur in. Government must consult with business groups in compiling this list, but it must also exert some independence and take the lead in some areas and not simply take a market follower approach.
  3. Rationalize fiscal incentives and gradually fine-tune the selectivity of sectors for promotion. This has already been initiated by the BOI, but follow through and institutional capacity building needs to occur, which leads to the next item.
  4. Strengthen the economic bureaucracy to solve investment coordination problems across related sectors. Improve the ability of state agencies like the BOI, PEZA, DTI and other government agencies to undertake a consultative and promotional role.
  5. Create a research and innovation fund jointly run by public and private enterprise to encourage commercialization of ideas. Given the excess foreign reserves cited earlier, the state can also afford to undertake this strategy in partnership with academe and the business community.

Compared to the strong-arm tactics being employed by Argentina and Brazil which like us bought into the liberal free trade argument in the 1990s and have like us seen their manufacturing sectors stagnate (see chart), these measures would be considered rather tame.

From 1949 to 1959, the Philippines used heavy handed trade and industry policies similar to what LatAm countries pursued from the 1930s to the 1980s. This led to the fastest growth ever sustained in our history (and theirs). Unfortunately, it did not last long enough for investments to expand beyond light industries as Paul D Hutchcroft notes. The direpute to which import-substitution subsequently fell was the result of the Filipino First policy instituted in 1958 towards the end of the decade of growth, an over-reach of the “elite” nationalists. The poor administration and outright corruption that the policy bred stymied it and led to the liberal policies of the 1960s supported by the landed agricultural exporters.

Pres Marcos tried to weaken the landed aristocracy and revive our nascent industry sector in the 1970s, but the lack of checks to the predatory nature of his regime led to its collapse. The Philippines has been following the liberalization paradigm ever since. The stagnancy of our manufacturing and overall weak economic performance is hard to explain given the structural reforms undertaken from the late-80s. The Philippines since the early 2000s has become a net saving country due to overseas remittances and is rapidly accumulating foreign reserves (it has more than enough to pay off all our external debts). With some tweaking, we can unlock this capital and put it to better use.

So far from encouraging private investors to get into public utilities, the government should actually follow Sec Roxas’s advice to break-up build, operate and transfer contracts to lower their cost to the public. Finally, the government must look to revive investments in the industry sector (which includes high value agricultural and services too) through pragmatic policies. It must create as much policy space within existing WTO arrangements to maximize the benefits of industrialization. Without this its vision for a rapid, sustained and inclusive pace of development might simply come to naught.

Defying Gravity

Faltering growth prospects for the economy and paralysis over how to kick-start big infrastructure projects do not seem to have dampened public support for the president.

Its economic managers remain fixated on ‘fiscal consolidation’ (a euphemism for shrinking public works expenditures to close the fiscal gap) as its roll-out of PPP (public-private partnerships) hits yet another snag with a new ‘review’ announced by the government. The confusion over how to proceed with its centerpiece program demonstrates how that it entered office armed only with platitudes and no real plan.

Yet even as punters from multilateral institutions, ratings agencies and think tanks alike place a down-side risk to the country’s growth prospects, the poll numbers of the president have headed upward. This strange phenomenon needs some explaining. How has P-Noy been able to defy gravity with his public approval ratings?

Some would point to his campaign against corruption as the source of such levitation. Yet, the same reason was given when his poll numbers were slipping early this year. The explanation was that as the public became familiar with so much corruption occuring in high places their faith in government collapsed. So why is the opposite happening now?

Perhaps it is because previously the pursuit of justice seemed to be going nowhere; whereas now, with the help of a few unexpected whistle-blowers, it seems to be heading in the right direction. That is one plausible explanation.

Another comes from the notion that growth and development do not necessarily go together and that despite sinking growth figures, the government has attended to the material needs of the populace through such programs as the CCT or conditional cash transfers.

Indeed one can characterize the government of P-Noy as following the script laid out by the Washington Consensus of promoting macroeconomic stability (to the detriment of growth) while providing social safety nets (to buy-off public support) and pursuing good governance (despite setbacks in providing public infrastructure).

In fact, some are pressing P-Noy to take advantage of his high popularity to pursue charter change and maximize the liberalization agenda by opening up the remaining sectors of the economy reserved for local participation and ownership. No less than the leaders of both the Senate and the House concur in this. As I pointed out in a previous post, the president is right to be a little wary of this move (although his reasons may differ from mine).

Others would have him go the other way and review the existing liberal trade and investment policies that have been in place for the last three decades as the country’s manufacturing and exports base suffers from a strong peso and seems highly concentrated within a few sectors, import dependent, and without much depth.

The PPP conundrum is emblematic of this confusion. P-Noy’s government started out with complete faith in private markets to ‘get prices right’, but it seems to be coming around to Sec Roxas’ belief that the public sector can do better. His proposal for the state to finance and build the projects itself, and then sell them off to the highest bidders to operate and manage would be a complete turnaround from the president’s previous position.

The idea behind Mr Roxas’ plan is that to get the ‘right price’ the government should use its access to cheap capital that is not available to private firms. That makes perfectly good sense, but the problem with his proposal is that government has not been known to be an efficient producer of public works projects. This could wind-up making the government penny-wise, pound foolish in the end.

A third way was actually proposed by me in another earlier post. The idea would be for the government to access cheap capital and create a fund that would either partner or loan these out to projects for either infrastructure or regional development needs. This would allow the cost of financing and construction to be lowered by leveraging the advantages of both public and private institutions achieving the best of both worlds.

This approach I must admit is hardly original. It was applied by South Korea in promoting industrial development through partnering with the private sector during its fast growth phase of development (see Alice Amsden’s book Asia’s Next Giant). The emergence of light and heavy import substituting industries which supplied export-oriented manufactures owed much to this strategy.

The economic bureaucracy there was a master at engaging in entrepreneurial self-discovery by importing licenses to operate foreign technology and then auctioning them off to private firms while at the same time providing them with sovereign guarantees and cheap project financing (I recommended a similar approach through an innovation fund which the government could create by borrowing some of the excess dollar reserves of the Bangko Sentral).

Indeed the government cannot live on macroeconomic stability and social insurance alone. For its growth trajectory to shift upwards, it will need to have a credible employment and industry strategy. Its PPP program was touted in P-Noy’s first state of the nation address as the vehicle for achieving this. In addition, the government will need to foster innovation and investment.

Let us hope that the administation finally gets to find a set of workable arrangements to get its pipeline of projects off the ground. Defying gravity with its poll numbers is one thing the government can do at the moment, but keeping developmental projects suspended in the air is something the nation simply cannot afford.

UPDATE:

DOTC Sec Roxas’ recent announcement of a five year plan involving 380 or 426 billion pesos (depending on which paper you read, the PDI or Business Mirror respectively) sheds more light on the new policy direction.

Essentially, a couple of things came out of the press release. The first is that aside from the PPP vehicle the government will be entertaining other conventional ways of financing infrastructure projects including overseas development assistance, foreign loans and items in the national budget. The second is that the Chinese contract to construct the NAIA to Pampanga rail line has now been superseded by a fast-rail project which will extend to Clark instead of Mabalacat.

These two moves by Mr Roxas clearly indicate a stronger more interventionist role for the state on offer from the one originally envisioned by the president. While P-Noy was only interested in handing infrastructure projects to the private sector, standing back and watching it work its magic, the DOTC secretary is willing to roll-up his sleeves and seek a better bargain or boot out in this case a poorly performing contractor to deliver a much better outcome.

His promise of a scorecard for his 5-year plan underscores the managerialist aspect of his approach to strategic projects in contrast to the laissez faire attitude of the president. The 90 billion a year average spend represents almost 1% of annual GDP. If he is able to roll this out on time, it will help provide a much needed stimulus to the economy at a time when the global economy goes through an adjustment to slower growth.

It makes me wonder what his rival Vice Pres Jojo Binay will now seek to do in order to outshine Mr Roxas. Will he adopt the proposal of Councilor Lagman of Quezon City and push for a 1% real property national tax as proposed by some fiscal experts to fund a national social housing program? Will he push for the creation of a housing department? Time will tell.

The National Development Project, part 3: Renovating the Bureaucracy

This is the third of a three-part series on the Philippine Development Plan 2011-2016.

We have looked at the PNoy government’s development strategy in Part 1 in which infrastructure was seen as the problem to unlock investment and that better governance of projects would work a treat. In Part 2, Re-defining Good Governance, we scanned three possible models for good governance. We concluded that the best approach, the East Asian model, was difficult to emulate but not insurmountable.

In this third part, we investigate specific ways of renovating the bureaucracy along East Asian lines. In part 2, the work of Peter Evans* on the lessons of political institutions and development illuminated much of the discussion. It will also help inform this one.

The task at hand

Finding a recipe for good governance is something that every nation has to figure out on its own as the East Asian experience has demonstrated. There is no ‘one size fits all’ policy. While Evans attests to the importance of establishing minimum levels of probity, he also does not recommend that we attempt this renovation with the bureaucracy universally.

The main focus of capacity building in East Asia has been the economic bureaucracy. The role and scope of this project covers tax and subsidy policy, industry, trade and investment policy, planning and development as well as regulatory policy. In the Philippines, we have to include some enforcement mechanisms as well.

When he announced his presidential bid, PNoy talked about his recipe for countering the calculus of corruption. The two basic ingredients include both carrot and stick. The president has yet to outline basic reforms to put that in action. It is towards informing that agenda, that the following policy recommendations are submitted.

Policy Recommendations

1. Corporatization of Revenue Agencies.

So far the government has been emphasizing the ‘stick’ component of the recipe through schemes aimed at enforcing the law against tax cheats, smugglers and the colluding elements within the bureaus of internal revenue and customs.

Though it has produced some modest returns, it is time to put the next element, namely the ‘carrot’ in place to address long-term improvements in the professionalism of our revenue agencies. This implies tweaking the career and compensation systems working within them.

Corporatization is the way by which the government has been able to pay its agents salaries commensurate to, if not exceeding that of, their private counterparts. Singapore achieved this for its entire bureaucracy, but it is the sole Confucian state to do so. The others achieved it through a combination of salaries, allowances and benefits.

The newly minted GOCC law now provides greater safeguards against abuse done by non-performing companies. It will govern the corporatization of the BIR and BoC. In exchange for the higher compensation, transition into the new agencies must be based on merit and not guaranteed for old bureau officials.

The boards of the new revenue agencies should be allowed to appoint people from among the ‘best and brightest’. Tougher qualifying exams, educational attainments, and past performance should all be part of the selection process. Where posts cannot be filled with existing staff, recruiting externally should be the resort.

2. Economic bureaucracy renovation.

To complement the corporatization of revenue agencies, key elements of the economic bureaucracy have to be beefed up. The Department of Finance, parts of the Department of Trade and Industry, those relating to industry and trade policy and the National Economic Development Agency need to be covered.

The idea is to strengthen and coordinate its policy making capacity. I will have more to say on this below under number 6, but what I would like to pay attention to here is again the recruitment, compensation and performance package.

For the independence of our economic bureaucracy to be secured, requirements for hiring have to be made more stringent. Salaries for managers and executives which might be 2/3 that of their private sector equivalent need to be augmented with benefits and allowances that could cover a more attractive retirement and health package, housing, transport, childcare and education, and communications.

What will they be expected to do that would merit such an upgrade in their compensation and why just target these agencies? Well, under the good governance model of East Asia, the economic bureaucracy is responsible for increasing the flow of investments into and from within the country.

To do that, they need to be adept at wielding both the carrot and the stick to investors. They will also need to be coherent in pursuing a development agenda and in orchestrating it using taxes and subsidies. To make them immune to outside influence whilst engaging with the business community, their rewards including both monetary and non-monetary have to be upgraded.

3. Limitations to presidential appointments.

When the controversy surrounding LTO Chief Virginia Torres a presidential appointee and shooting range pal first showed up, I took the opportunity to advocate for more serious limits to the president’s appointive powers.

I was met with skepticism at first by a fellow contributor to this space, but in the end some kind of consensus was formed. The issue then was cleansing the roster of the past president’s appointees.

Now that the GOCC law has in effect dealt with that, it is now high time to revisit the larger issue. From several thousands, I believe the presidential appointments need to be scaled down to several hundreds. That might be hard given the number of boards and government authorities that abound.

I believe the GOCC Commission needs to act like the Civil Service Commission in screening appointments to government boards and heads of GOCCs, just as I believe the CSC should do the same for the line agencies and the NAPOLCOM for the police. Either by convention or by law the president’s appointments should be restricted to his Cabinet and a few cabinet subalterns.

4. Outsourcing much of the Commission on Audit’s role.

Another thing I have been advocating here since the scams involving corruption in the military was uncovered was for the COA to outsource much of its functions to private auditing firms.

This has been the practice in Australia already where the Attorney General’s department merely sets policy and standards with regards to government audits. The actual audits must be done not by ‘in-house’ government auditors who are very susceptible to influence, but by external firms who must be rotated in accordance with the Code of Good Governance adopted by the SEC.

In fact the scope of audits should not be restricted to financial management alone, but to management of risk and occupational health and safety. Private auditing firms already have the capacity for performing this function. They are already subject to professional standards of excellence which if broken lead to the cancellation of their professional licenses.

5. Incentives for Prosecutors of Big Cases.

Catching and prosecuting the ‘big fish’ has been made a priority by this government. Yet, no real sets of incentives have been put on the table for addressing the task at hand.

When hundreds of millions, if not billions, of pesos are involved, the government needs to ensure that its prosecution team have a stake in winning the case. In the private sector that involves sharing in a portion of the damages.

The settlement by the previous Ombudsman in the case of Carlos Garcia demonstrates how difficult it would be to provide a similar incentive structure for the public sector.

If a reward based on a percentage of recovered ill-gotten wealth is instituted, that would have meant rewards to the past Ombudsman for settling the case. Perhaps the reward ought only to apply when cases are prosecuted and not settled out of court.

The Ombudsman and the Office of the Solicitor General (essential generals in the fight) which are given the task of prosecuting graft cases before the Sandiganbayan and Supreme Court respectively need to have more than a kind of altruistic motivation for performing their duties. The need to have protection and financial security.

Paying them higher salaries alone might not be enough to motivate them to exert maximum effort even in very winnable cases. Some sort of sharing in the spoils which would go both to their office and to chief prosecutors and their staff needs to be put on the table.

I know that some will argue that this is the people’s money and that any recovered ill-gotten or plundered wealth needs to be returned 100% to the coffers to fund social programs. This assumes that we are working with incorruptible Confucian super bureaucrats. That is not the case here. We need to live in the real world, not in some ideal fantasy land.

6. Creation of a Productivity Commission.

The importance of having a lead agency within the economic bureaucracy is one lesson learnt from the East Asian experience. This lead agency role was performed by MITI in Japan, the Economic Planning Board of Korea, the Industry Development Boards of Taiwan, the Economic Development Board of Singapore, and the Productivity Commission of Australia.

In the Philippines, I am proposing the creation of a Productivity Commission similar to Australia’s to be under the Department of Finance with direct access to the President. Elements of DoF, the government think tank PIDS, Tariff Commission, National Income Tax Research Center, and DTI need to be brought into this agency or at least made accessible to it.

Its role will be to advice the president on matters relating to government red-tape, taxes and subsidies (including to agriculture), telco, port and aviation policy and industry policy more broadly. A secondary focus could be in housing or economic development and climate change policy.

The commission in navigating the post-WTO environment should do so without engaging in what Evans calls ‘anticipatory acquiescence’ on the one hand by pushing the envelope a la China on protectionist policies when it suits our development goals, but use our external commitments as a shield against regressive private interests on the other hand (for example on sin taxes).

As part of the economic bureaucracy, it should have the same high recruitment and compensation standards as the rest of the economic bureaucracy. This will enable its agents to be immune from lobbying and rent-seeking by private agents.

7. Limitations to the scope of rent-seeking.

As highlighted by Evans, rent-seeking did continue to a surprisingly large extent in East Asia even as their economic bureaucracies forged ahead with many productivity enhancing measures.

Traditionally the agriculture or construction departments were used by reformist governments to engage in clientelism with their constituents usually ex-military men, party mates or in the case of Taiwan, former residents of the mainland.

This makes the task of emulating them within reach for countries like the Philippines where the practice of paternalism is embedded in our culture. This means that while the areas of rent-seeking are limited on the one hand, it will continue nonetheless and will be an essential part of governing.

The purists will argue against pork barreling and the dispensing of largesse through the PCSO, PAGCOR, DPWH, DOA and so on, but we must remember that a certain amount of populist clientelism is necessary. We have to take a balanced view of things. If it helps the executive push for more substantial reforms, then the area of rent-seeking will gradually diminish.

Conclusion

The long road to economic development has many twists and turns. Perhaps what PNoy’s government has to acknowledge is that sometimes the shortest distance between two points is not a straight line. An understanding of the lessons of good governance in East Asia is essential for appreciating this fact.

Without the ability to withstand rent-seeking on the part of private agents in the sphere of economic policy, the national development project never advances very far. The need for a solid economic bureaucracy is the first step in emulating the ‘fast-paced growth’ these nations experienced.

The ‘carrot and stick’ approach articulated by PNoy at his presidential bid announcement needs to be further developed into meaningful policies. So far the Philippine Development Plan only covers very generic non-targeted approaches. Zeroing in on the economic bureaucracy and some key enforcement agencies is needed.

The road ahead is fraught with risk. Our country did not start off with the auspicious initial conditions of an egalitarian society that our East Asian brothers had. Regardless, a path is laid out before us that makes it attainable despite initial infirmities. If we have faith and confidence in our abilities and not succumb to fatalism, we may at least further the project of nation-building along the way in the years ahead.

* Evans, Peter (1998). Transferrable Lessons? Re-examining Institutional Pre-requisites of East Asian Economic Policies, Journal of Development Studies 34 (6), p.21.

The National Development Project, part 2: Re-defining Good Governance

This is a continuation of Part 1: The National Development Project.

Governance is the cornerstone of the Aquino presidency, and this point is brought out by his development plan. Since Public-Private Partnerships which is the Plan’s centerpiece has been around since the mid-80s under the name Build-Operate-Transfer, better governance of them will provide the only new impetus to growth.

The question now becomes what sort of governance model best suits this strategy?

Peter Evans in an essay entitled Transferrable Lessons? Re-examining Institutional Pre-requisites of East Asian Economic Policies states that there are three alternative models of good governance. He describes them as:

  • The ‘market-friendly model’, best exemplified by the World Bank’s [1993] East Asian Miracle report, which focuses on ‘getting the fundamentals right’. In this model, “government must preserve macroeconomic stability and provide ‘rules of the game’ that are transparent and predictable.”
  • The ‘industrial policy’ model, which is best epitomised by Chalmers Johnson’s classic [1982] study of MITI (Ministry of International Trade and Industry), more demands are placed on economic policy makers…Policies nurturing the general macroeconomic environment must be complemented by “industry-specific policies that push setors most worth pursuing and shift capital out of sectors with declining returns and weak growth prospects.”
  • The ‘profit-investment nexus’ model [Akyuz and Gore, 1996] which shares with the ‘industry policy model’ the idea that policy must do more than simply provide a facilitative macroeconomic environement, but is not as demanding of industry-specific policies. Policies must simply increase the overall level of investment and not necessarily foster certain “sunrise” industries.

The relevant part of the Plan that describes the administration’s governance model is Chapter 7: Good Governance and the Rule of Law. From the elements and the tone of the text, it sounds like that the Plan is using the ‘market-friendly’ model with its four-pronged strategy of eliminating red-tape, pursuing anti-corruption, increasing citizen participation and accountability.

Ensuring a minimum level of probity is consistent with all three models of governance. As Evans states “if developing countries…could achieve the levels of bureaucratic capacity entailed in the ‘market friendly’ model, the additional capacity implied by other models would be institutionally within reach.

That should not be taken to mean though that emulating East Asia requires incorruptible super bureaucrats able to “out-manage their private counterparts from a distance.” As Evans explains,

Minimal norms of probity and competence need to be applied on a general basis, but East Asian reformers did not attempt to transform every ministry. Radical changes were reserved for key economic agancies; routinized behavour and surprisingly high levels of clientelism were allowed to persist in those considered less crucial to the national development project.

If there is any positive thing the economic rationalist theory has contributed to our understanding of governance, it has been the couching of rent-seeking in non-pejorative (or moralistic) terms, according to Evans. Rent-seeking which can take the form of lobbying or corruption is merely a form of profit-maximization on the part of rational agents.

When Mrs Arroyo in an interview at the start of her administration said for instance, that as an economist, she understood that markets did not operate in a ‘frictionless’ environment, she was acknowledging the need for transactions costs. Clientelism is sometimes needed by reformists to ‘payoff’ or compensate those hurt by reforms.

The East Asian countries did not try to reform the entire bureaucracy or weed out rent-seeking in one swoop. They took a different approach:

  • In Japan, the Ministry of International Trade and Industry performed the reformist role, while the Ministry of Agriculture continued to operate along clientelistic lines.
  • In Korea, a bifurcated bureaucracy existed, with the Economic Planning Board taking the helm of development while Construction followed along paternalistic lines.
  • In Taiwan the ruling Kuomintang Party ensured meritocratic appointments to key economic agencies while allowing a “back door” entry for retired military and party members to other parts of the civil service.
  • The pervasiveness of the Confucian ‘super bureaucrats’ in East Asia is a myth save for Singapore where civil servants are paid more than their private sector counterparts.

The Plan seeks to renovate the entire bureaucracy all at the same time. A very noble and ambitious goal, but it is difficult to imagine how this will be achieved given its meager resources and the quality of the civil service pool. This strategy is fraught with risk. Perhaps the biggest risk involves spreading the reform effort too thinly.

Avoiding Capture

A coherent economic bureaucracy was deemed necessary for the state to engage with but avoid capture by increasingly more powerful and wealthy private interests.

Initial conditions fostered the formation of this sort of governance model, namely, an egalitarian society, which was the result of land reform sponsored by the Americans after the War and the external policy environment that allowed market distorting industry and currency policy which was made possible by the US Cold War strategy of propping up capitalist states in the region.

The unlikelihood of duplicating such initial conditions is what causes pessimism with regard to the national development project for late bloomers like the Philippines. Yet, Evans encourages us to resist the fatalism of this view by saying

(w)hat puts East Asian practices out of reach is less likely to be external compulsion than antiipatory acquiescence by developing country governments to perceived constraints.

The rapid growth of China most recently proves that despite its signing up to the World Trade Organization, it has managed to resist measures to prevent it from exercising some of the tools under the industry and profit-nexus models. Singapore demonstrates in fact how the tools have evolved to more sophisticated measures that no longer involve the strong arm tactics applied elsewhere.

The more difficult problem has to do with large inequalities. While concentration of wealth should not necessarily hinder but in fact aid the formation of capital in productive areas, large inequalities have a corrosive function in the policy process.

State capture is what prevented the Philippines in the 1950s and 60s from following a similar path as its neighbors in the region although Malaysia and Singapore managed to avoid this despite having similar disparities among social groups. Here again is what Evans has to say

Entrenched inequality undercuts legitimacy of state autonomy…makes it hard for governments to credibly claim that they represent a national development project. Populist clientelism seems to offer at least a temporary relief to the excluded and close government-business ties which look more like a conspiracy for redistribution upwards than a joint project of national development.

It sounds like he is describing what happened to the country when it opted for a populist clientelist president in the person of Joseph Estrada. The perception was that growth under the elites was only favoring the rich.

Charting a new path

This brings us back to the questions of nepotism and cronyism that have started to emerge even in PNoy’s first year. In a country where only a small group of ruling elites hold much sway over the economy, it becomes difficult to prevent such rumors from floating.

If sanitizing all state agencies from clientelist practices can be ruled out (at least on the ground, despite its being paid lip service), the need to ring fence private rent seeking interest groups from crucial economic policies and infrastructure projects needs to be guaranteed.

That means boosting the capacity of the economic bureaucracy. The Plan which is the first one under the post-IMF oversight period, fails to break out of ‘perceived constraints’ by not examining other more effective governance models.

It remains wedded to the old generic formula of macroeconomic stability, open markets and establishing rule of law which has failed to produce results in places where it has been attempted, namely in Latin America and Sub-Saharan Africa. The challenge now is convincing the policy elite to chart a different path.

To be concluded…go to Part 3: Renovating the Bureaucracy

 

A Boy Scout Among Thieves

On the eve of the G20 meeting in South Korea, the Philippines through Finance Sec Cesar V Purisima voiced its aspirations for the outcome of talks to deal with the US-China disagreements over currency manipulation aimed at correcting stark trade imbalances.

On Monday’s issue of the Businessworld, he was quoted as saying that he hoped for

A framework… where there will be closer cooperation among countries in settling imbalances.

Such expressions of hope by our finance officials demonstrate not only their optimism that world leaders will put into practice their joint promises at such talk shops (when in reality they don’t-as demonstrated by the Global Trade Alert‘s findings about the increasing levels of trade protection committed by the same G20 members in violation of their first Communicade), but also the fact that they remain wedded to the development model preached by the Washington Consensus to the rest of the world regarding the reliance on free market principles that avoid government intervention in setting the prices of commodities and currencies.

The US Federal Reserve announced previously that it would exercise quantitative easing (QE) which in effect means it will print money to purchase US treasury bonds underwriting the deficits undertaken by the Obama administration. This has caused a weakening of the US dollar against other currencies which is expected to narrow their trade deficit with China.

This manipulation of the currency to “correct” trade imbalances is something that has been restricted by the WTO except that China seems to have gotten away with purposefully undervaluing its currency even after acceding to the terms of this world body. Decades earlier Japan did the same and benefited from it during its era of fast-paced growth. The US has been constantly at China for this but appears to have no qualms over effectively engaging in such behavior when it suits its interests. In the real politic of the global trading system, a nation can flout the rules for as long as it carries sufficient weight in political economic terms.

So it would seem that the Philippines remains stuck in the role of the perennial “boy scout” among nations that adheres to the rulebook while others blatantly invent their own rules. Because of the rise in the value of the peso against the US dollar, not only are exports expected to suffer, but so will the flow of imports (as much of the raw materials that go into producing these exports comes from overseas).

The Bureau of Customs which through the years has had to deal with a program of accelerated tariff reduction unilaterally set by the Philippine government ahead of international commitments will also have to deal with the rising peso in meeting its revenue targets. This along with all the perks needlessly offered to free ports and special economic zones will ensure that our budget targets will not be met.

A more proactive stance needed

In this space, I previously argued that the Philippines needs to take a more proactive stance vis-a-vis the currency wars to ensure the sustainability of its exporting industries and to guarantee the welfare of those dependent on income transfers from abroad. If we wait for a framework to be hammered out by the G20 which after all is just a loose, informal organization, then we could be waiting for a very long time indeed.

In fairness to our finance officials, they have proposed the Public Private Partnerships or PPPs as a way of generating investments in infrastructure which should lead to capital equipment and raw material imports as a means to generate demand for dollars domestically. Certainly that will help. But on the other hand, the Philippines is also issuing locally denominated bonds overseas which in effect increases the flow of dollars into the country and causes the value of the peso to rise. So it seems it is taking with the one hand while promising to give with the other.

Given that we already have the reserves to fund at least the public portion of the PPPs, I argued for a sovereign wealth fund that would along with private investments identify projects it would invest in. This could be a way of putting the dollar inflows to good use and avoid inflating our borrowings from overseas which simply help inflate the value of our currency.

Having exited the IMF program of macroeconomic stabilization after paying off its institutional loans, it is time for the Philippines to exercise some independence in setting its policies given the amount of “space” afforded by its advancing foreign reserves position. It is time we start shaping these policies by taking cognizance of the way the global economy actually works as opposed to the way we hope it would based on a literal interpretation of global accords or theoretical constructs contained in some textbook.

For this to happen, a new policy consensus has to be formed that would encompass both the officials in the executive branch as well as politicians in the legislative branch over a development framework. There does not seem to be any impetus from either branch of government to develop such a road map nor does there appear to be any public clamor for it.

Perhaps you, dear reader, have some views on this. Well then, let’s discuss them…