infrastructure

There’s too much fun in the Philippines

A certain pizza place we shall now disguise behind the name Norwich Pizza had been acquired by a large food conglomerate we shall call Bumblebee Food Corporation for purposes of discussion. BFC sought to turn Norwich from a simple mom and pop type of operation into a highly profitable nationwide franchise.

It set about doing this by hiring a very prominent ad agency to deliver a strong and appealing message to the public. The firm wisely picked a celebrity, a certain Ms Nonita Flowers, to be in their commercials.

Within months of the launch of the media campaign, sales rose rather well in line with projections made by the company’s bean counters. Unfortunately, after a quarter of stellar performance, revenues started to head south quite dramatically. This puzzled the head honchos at BFC. Everything had been proceeding according to plan until very recently. What had happened?

To investigate and remedy the situation, one of BFC’s vice presidents who successfully steered another major acquisition, the Chun King Express, was brought in. The vice president proceeded to inspect the premises of Norwich. Within a month or two, he had not only arrested the decline in sales, but restored it to its previous trajectory.

So how did he do it?

Well, having cut his teeth in the fast and furious world of Chinese takeaway, the vice president of Chun King knew the importance of maintaining good customer service. This could only be achieved if the stores were equipped with proper equipment particularly in the kitchen. Within the first few weeks of his assignment, the new manager had placed orders for new ovens to replace or augment the standard kit that had been originally installed in Norwich stores, which he deemed highly inadequate.

The capital investment paid off and Bumblebee proceeded to earn a positive return on its acquisition of Norwich, albeit at a lower rate in the first year than previously expected due to the unforeseen expenditures. The vice president was given a fat bonus for his efforts in rescuing the venture. Money well spent from the point of view of BFC’s board and stockholders.

This case study demonstrates the importance of coupling good marketing with good operations. Without a quality product, no amount of spending on ad campaigns could restore or improve the brand’s sinking reputation. In the fast food business, it doesn’t matter how tasty the food might be, if customers have to wait too long, they won’t be coming back.

The same can be said of tourism and travel. The Department of Tourism under Sec Jimenez is looking to increase the flow of visitors into the country with a catchy slogan, “It’s more fun in the Philippines” and the usual slick marketing campaign. It is in talks with Singapore to co-brand the two nations as the “sunshine belt”.

These ideas are brilliant, but the problem is that the Ninoy Aquino International Airport is already operating above its normal capacity with visible signs of wear and tear all too evident. Even with the renovation of Terminal 1 and the recent conclusion of the decade’s long case involving Terminal 3 paving the way for the full use of it for international flights, these developments will not unclog the bottlenecks due to the limited number of runways. No amount of renovations will fix that as there is no more room for expansion. As arrivals are slated to rise from 3.9 million in 2011 to 4.2 million this year, how will the airport cope?

This problem is compounded by the growth in domestic flights. During my recent visit to the Philippines, I spent an hour waiting at the departure lounge of the domestic terminal in Manila for a flight to Kalibo. The reason given for the delay was “heavy congestion”. After boarding the plane, we were grounded for close to another hour waiting to be cleared for take-off. As the plane finally taxied onto the runway, I stared at my watch, then at the frustrated businessman seated next to me.

Only two hours delayed, not bad,” I jokingly uttered. He laughed. That was all we could do to cope with the situation.

The same thing occurred on the way back. As the voice boomed in the speaker stating that our flight was behind schedule, a power outage stopped it in mid-sentence. It was nearing nightfall and the blackout was quite a shock to the passengers.

“It’s more fun in the Philippines!” I heard a man snicker in the darkness.

Meanwhile on a separate road trip up to Northern Luzon, our convoy experienced a very weary trek. Each town we passed through, every ten kilometres or so, caused us to slowdown as their town hall plazas, central markets, public schools and cemeteries were all located along the main artery causing both vehicular and pedestrian traffic.

The road widening still unfinished due to the slow spending rate of public works projects in 2011 delayed our trip in certain sections. We were told that an extension of the Subic-Clark-Tarlac Expressway would provide better access to the North bypassing most of these populous towns from Tarlac to La Union, but our guide said this had been halted by the new administration. It was clear though that such a road project was long overdue.

That’s as far as infrastructure and transport corridors are concerned. We haven’t discussed the problem of environmental degradation. In both Baguio and Boracay where I took my family, the effects of what urban planners call regional agglomeration were quite evident. Tourism was enticing a major “big box” shopping center to expand in Baguio. Such a move could upset the already congested situation, worsening the air quality, not to mention the aesthetic and cultural appeal of the tourist destination.

Meanwhile, I was shocked to see D’Mall in Boracay. It sort of depressed me actually. I ended up skipping lunch because I had lost my appetite after seeing this transplanting of Divisoria or Baclaran to the once pristine island. It made me wonder if there was such a thing as having too much fun in the Philippines.

If tourism was sold to our government planners as an environmentally safer path towards development compared to industry or mining, I say, think again. There are no free lunches as economists are wont to say. We can’t expect rapid development not to have an impact on the natural habitat. It would be dangerous to think so.

I actually prefer having a greater emphasis on industry, because you can at least concentrate the site of industrial projects within a confined area and choose the type of industries (say light industries or agro-industrial ventures with a smaller ecological footprint) or provide incentives and regulations to govern the heavy polluting ones.

The Philippines has a lot of catching up to do in this area. I am not simply speaking of tourism now. Wasn’t inclusive, sustainable growth and development at the heart of PNoy’s social compact though? This administration like its predecessors is fond of catchy slogans beginning with Daang Matuwid (Righteous Path). It’s more fun is just the latest. But apart from having these platitudes, where is the plan? We have yet to see a blue print for developing the infrastructure, the security, the regulations and incentives that would responsibly manage the growth in our economy? The case of Norwich must be heeded; otherwise, the Philippines could remain grounded for a bit longer.

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 long-term view

 

With experts calling tepid and jobless growth the “new normal” for North Atlantic countries for years to come, it is important for governments to assess how this impacts them in the long-run.

The administration seems to have put two and two together and realized that with weaker growth prospects come weaker revenues and in an environment where any sort of fiscal deterioration could lead to speculative attacks on an economy, it is aiming to shore up its fiscal position through tax reform before the effects of the crisis start washing on our shores.

There certainly is nothing like a crisis to focus the mind on issues that would have slipped under the radar otherwise.

Fixing the areas in our tax system where leaks occur is just as important as trying to avoid wasteful spending. Paying full-market prices for second hand helicopters may create more of a buzz in the media, but the impact of improperly crafted policies on fiscal incentives or sin taxes create much bigger losses for the government on an annual basis.

The uncollected portion of those taxes could easily fill-up the public sector deficit eliminating the need for forced fiscal contraction that prevents us from building the necessary social and economic infrastructure needed for attracting job-producing investments and for improving governance.

The long-term view would allow our leaders to make the tough decisions to undertake necessary reforms that would lift the long-run productivity of the Philippines instead of merely catering to populist sentiment and short-term political payoffs.

Take a look at the following chart which shows various long-term forecasts for average annual incomes per person in the Philippines.

The high-growth scenario comes from the analysis of Dominic Wilson of Goldman Sachs on the Next-11 group of countries with strong growth potential. You can see why all those toxic sub-prime mortgage backed securities could be endorsed by them to Standard and Poor’s for triple A rating.

The rosy positive outlook has our citizens earning $20,000 on average by the year 2050. We should take our cue from those crafty people at GS who bet against the very investment vehicles they packaged and sold to investors, by hedging our bets a little. Let us consider other possibilities.

The low-growth scenario is taken from the Institute of Future Studies online data available via Google’s public data explorer. It shows the country achieving a per capita GDP level of just above $4,000 by 2050. This is quite a low level of growth given that the NEDA projects a $5,000 per capita income by 2020 (assuming we grow by 7% for the next ten years).

The high-growth scenario assumes growth of 6.4% per year on average in the next forty years (net of inflation). The low-growth scenario assumes that it grows by 2.9%. Note that with the population rising, the growth of the overall economy needs to be 7.6% under high-growth and 3.9% under low growth for average incomes to rise as they are forecast here.

I have projected a middle case in between the high and low growth scenarios. This trajectory produces an average growth rate of 4.9% per year. Under this scenario, average incomes are set to rise to close to $10,000 by the end of the forecast period ($9,497 to be exact).

This level of income is important because as the World Values Survey suggests, $10,000 is right around the level at which the minimum material needs of a country are met. Above this level, the reported level of subjective well-being is less dependent on income growth than on other factors.

Based on this survey, the Philippines is punching above its weight in the happiness index (far above its material wealth would imply). Imagine what would happen if Filipinos attained an even higher level of income.

Considerations for the long-term view

The question now becomes, what sort of policy shifts in the next five years would spell the difference between each scenario. Even though its framework produces an overly optimistic case for the Philippines, it is worth looking at the Growth Environment Score of Goldman Sachs to see what kind of policy response is required.

Under the 13 components of the GES, the Philippines was considered at par or above average in four aspects in 2006, namely: inflation, trade openess, education and life expectancy. It was considered below average in three economic indicators: fiscal deficits, external debt and investment; three governance indicators: political stability, rule of law and corruption; and, three infrastructure indicators: computers, phones, and internet penetration.

Tax reform would allow the government to correct the below par performance in debt and deficits. Investments could be addressed through competition policy and an opening up of restricted sectors. Political stability, rule of law and lower corruption results from better fiscal capacity to provide social safety nets and a more professional bureaucracy. Finally, better telecommunications governance results from both better regulatory quality and bureaucratic effectiveness which come about by opening up the economy and compensating public officials better.

The bottom-line is that better fiscal capacity along with sound and rational policy result in better growth prospects for our country. Let us hope that our leaders are able to take heed of this maxim and resist the urge to pander to populist patrimonialism in the short-run. By 2050, there will be between 135 and 145 million Filipinos. It is for the sake of this silent electorate, that I hope our leaders fix their vision on the long-run.

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.

Why FDI inflow to the Philippines posted record decline

Makati Skyline
The Philippines: How can we contribute towards its progress?



Business World published an article, “Asian FDI gains noted by UN; investors bypassing Philippines?” In the BW piece, it was noted that our “Southeast Asian neighbors have been enjoying five fold increase in foreign direct investments, while the Philippines posted a sharp decline.” Benjamin Diokno was quoted by BusinessWorld saying, “that the disparity was likely caused by last year’s elections.” If it was simply a yearly snafu perhaps, but it is a known fact that for the past decade, FDI inflow to the Philippines has been on a decline.

The root cause has been two things. First: uncertainty in the business climate. For the past decade, investors have been repeatedly been burned by the schizophrenic policy the Philippines has employed. Contracts are not honored. Deals broken. A recent example is the SLEX project, which was in danger of it. If you will recall this is one of the questions raised when government launched PPP.

The second reason is the lack of infrastructure.

We’re not just talking about roads. We’re talking about Communications infrastructure. Our country’s network readiness is 85 out 133 countries in the world. Today’s business is data driven. That means, email more than Fax. That means Skype for a conference call. The infrastructure is that terrible and unless Government can untangle the mess of the ICT sector, people will be flocking to different countries.

We’re not talking about just communications infrastructure, on an industrial-agricultural dimension, the Philippines is an ideal spot for Contract Irradiation, yet we have none. Our friends in Vietnam, and Malaysia have several. The country is a great spot for it. Contract irradiation is a process where medical supplies like gloves, syringes are sterilized, as well as used to process talc for the fashion industry. It is also used to increase the shelf life of spices, kill fruit flies in mangos, just to name two.

In short, these are the places where government needs to draw emphasis on. Though it may take years to do so, as the focus of the government is to strengthen its fiscal position, and patch the leaks in the system.

Forum cites development tasks

Forum cites development tasks
BusinessWorld Online

ASIA is now increasingly the focus of growth in the world, but individual economies like the Philippines and similarly less developed markets have to identify sectors that need support in order to boost their competitiveness, experts said at a forum yesterday in the Asian Institute of Management in Makati City.

In her presentation, Suzanne Rosselet, deputy director of the International Institute for Management Development World Competitiveness Center, noted that Asia’s population will hit 5.26 billion by 2050, compared to Africa’s 1.77 billion, the European Union’s 628 million and the United States’ 447 million.

“This pretty much sums up where the long-term growth will be. [It] will be in Asia,” she said.

In the Philippines, she said, the government needs to focus on supporting small- and medium-scale enterprises (SMEs) and services, which have been an engine of growth.

She added that “there has to be job creation for young people moving into the workforce.”

David Jay Green, a fellow of the Asian Development Bank-Asian Institute of Management Knowledge Hub for Trade and Investment, noted that within the Association of Southeast Asian Nations (ASEAN) are pockets of less developed clusters like that of the otherwise resource-rich sub-region grouped into the Brunei Darussalam-Indonesia-Malaysia-Philippines-East ASEAN Growth Area (BIMP-EAGA).

He noted this group, which was formally established in 1984, was formed precisely to enable the less developed component areas to pool resources and efforts to help them catch up with more developed urban areas in the same countries. The Philippine components of BIMP-EAGA are Palawan and Mindanao.

Experts have prescribed increasing trade and other economic ties within Asia, as demand recovery in the US and Europe remains sluggish.

But Mr. Green stressed the need to further streamline trade processes within BIMP-EAGA if it is to live up to expectations as a driver of growth in Southeast Asia.

This, in turn, requires more efficient government operations, better infrastructure and “connectivity policies” — all of which will facilitate the transport of goods and trade in services.

“It’s a whole series of things that has to be done to encourage the business environment, trading environment and the ability of people to invest in their own country,” Mr. Green said.

Sought for comment, Augusto B. Santos, deputy director general of the National Economic and Development Authority, said the government has been finding ways to provide cheap loans to SMEs, help localities focus on a few products and services they can excel in, and is poised to embark on an infrastructure buildup under public-private partnerships in order to lay the groundwork for sustained, faster growth. — JJAC

Infrastructure woes hinder MDGs

Infrastructure woes hinder MDGs
Written by Cai U. Ordinario
Business Mirror

DESPITE the country’s efforts to increase social spending through programs like the conditional cash-transfer (CCT) program to meet the Millennium Development Goals (MDGs), the Asian Development Bank (ADB) believes that addressing infrastructure constraints will still hold the key in achieving the goals by 2015.

In a statement, ADB president Haruhiko Kuroda said developing countries like the Philippines must address basic infrastructure constraints to achieve the MDGs in five years.

Kuroda said many areas in developing countries still do not have electricity, all-weather roads and other basic infrastructure. These limit access to health care and discourage children from completing their education.

He said the region is lagging in the targets for basic sanitation, infant mortality, maternal health, hunger and environmental improvements, and reducing greenhouse-gas emissions.

“Less developed countries, or those suffering from conflicts or disaster, will need more regional help to make progress, and the Asia and Pacific region must step up cross-border cooperation in trade, investment, knowledge and technology, to help bridge gaps in resources and capacities,” the ADB added.

Addressing these concerns is National Economic and Development Authority (Neda) Director General
Dr. Cayetano Paderanga, who delivered the Philippines’ statement during the High-Level Meeting on the Millennium Development Goals in New York City.

Paderanga, who is also the Socioeconomic Planning secretary, said while the Philippines made considerable strides in meeting some of the MDGs, like cutting child mortality, and malaria and tuberculosis incidence; increasing access to sanitation and safe and potable water; and providing equal education for girls, there is still a lot to be done.

The Neda chief said the measures that will be implemented by the national government to help achieve the MDGs will be included in the Medium-Term Development Plan for 2010-2016.

He said the MTDP will make sure this growth is inclusive and can help protect the vulnerable by ensuring access of every Filipino to quality health, education and employment opportunities.

These, Paderanga said, will be done through an appropriate mix of physical and social infrastructures, and by strengthening social safety nets, like CCTs and universal health care.

“Despite the gains attained in the last decade, we need to push ourselves more to meet the MDGs, particularly where we lag behind. Moreover, the Philippine scenario is characterized by wide disparities. Our latest progress report also shows that climate change poses a threat to the achievement of our targets. The population above the poverty threshold is declining as a result of low capacities to cope with the effects of shocks leading to more ‘transient poor,’” Paderanga said in a statement.

He urged development partners to also keep their promise of sharing a portion of their gross national income (GNI) to developing countries for MDG achievement. The United Nations official development assistance target is set at 0.7 percent of GNI.

“Excellencies, as we enter the last stretch, the Philippine government is exerting all means to deliver on its promise to realize its MDGs, not just as an international commitment but because our people demand it. Let us remember that each and every one of our citizens deserves a life of quality, meaning and dignity,” Paderanga said.

For its part, the Manila-based ADB said it is targeting increased support for basic infrastructure, such as roads, power and sanitation, which are crucial for meeting MDGs.

It also intends to scale up assistance for education, and for environmental improvements, including the use of clean energy, where ADB investments have grown to more than $1 billion a year, and which are targeted to double to $2 billion by 2013.

Kuroda added that countries in the Asia and the Pacific region, which is home to three-fifths of humanity and two-thirds of the world’s poor, represent the world’s best hope for achieving the MDGs by 2015.

“With more than 500 million people having overcome poverty since 1990, the target for reducing extreme income poverty is in sight. The region is also likely to achieve near universal primary school enrollment by 2015, attain gender parity in education, meet the target on access to safe drinking water, and halt the spread of deadly diseases such as TB and HIV,” Kuroda said.

The country’s fourth progress report on the MDGs showed it had a low probability of achieving indicators—such as increase elementary education net enrollment rate, elementary education cohort survival rate, elementary education completion rate, reduce by three quarters maternal mortality, universal access to reproductive health, halt HIV prevalence among 15 year olds, and provide comprehensive correct knowledge about HIV/AIDS to 15 to 24 year olds.

The report also showed the country had a medium probability of achieving the indicators on halving the proportion of population below the poverty threshold or P15,057 per year per person, halving the prevalence of underweight children under five years old, halving the proportion of households with per capita intake below 100 percent dietary energy requirement, universal access for the proportion of the population with advanced HIV infection to antiretroviral drugs, and halve the proportion of the population with access to safe water.

The indicators also showed the Philippines had a high probability of achieving of halving the proportion of population below the food threshold or P10,025 per year per person, all the indicators of Goal 3 which pertained to gender equality and women empowerment, indicators under Goal 4 of reducing child mortality, the malaria morbidity rate, the malaria mortality rate, the tuberculosis case-detection rate, tuberculosis-cure rate, and the proportion of the population with access to sanitary toilet facilities.

The MDGs are a set of eight goals, 22 quantitative targets and more than 60 specific indicators meant to serve as a focus for international and national development policy.

The first seven goals are concerned with outcomes, identifying the progress toward certain standards of human welfare and development that should be achieved globally and nationally by 2015. The eighth goal is concerned with “global partnership for development” to support the realization of all the goals.

RP STATEMENT DURING THE U.N.HIGH-LEVEL MEETING OF THE GENERAL ASSEMBLY

RP STATEMENT DURING THE U.N.HIGH-LEVEL MEETING OF THE GENERAL ASSEMBLY
http://www.neda.gov.ph/ads/press_releases/pr.asp?ID=1211
(Delivered by Secretary Cayetano W. Paderanga Jr.)

Mr. President,

Distinguished delegates,

The Philippines is one with the world in keeping the promise of achieving the Millennium Development Goals by 2015.

Ten years after the UN Summit that crafted the MDGs, our country has made considerable strides in meeting most of its targets. The Philippines is on track in meeting the targets on child mortality; malaria and tuberculosis incidence; increasing access to sanitation and safe and potable water; and providing equal education for girls.

But despite the gains attained in the last decade, we need to push ourselves more to meet the MDGs, particularly where we lag behind. Moreover, the Philippine scenario is characterized by wide disparities. Our latest progress report also shows that climate change poses a threat to the achievement of our targets. The population above the poverty threshold is declining as a result of low capacities to cope with the effects of shocks leading to more “transient poor.”

It has been over two months since our country had a peaceful transition of power. The fresh mandate from the people has given the government the needed political will for reforms. The new administration’s cornerstone of good and effective governance will be a potent force in addressing challenges impeding attainment of the MDGs by 2015. Thus, it is very crucial for the Philippines to eradicate graft and corruption, so that public resources will be efficiently channeled to attaining the MDGs.

The Philippine Government will unveil its Medium-Term Development Plan for the period 2010 to 2016. The policies and strategies outlined will reflect our commitment to prioritize the MDGs. The Plan will make sure that this growth will be shared with the poor and the vulnerable by paving the concrete access of every Filipino to quality health, education and employment opportunities through appropriate mix of physical and social infrastructures, and by strengthening social safety nets, like conditional cash transfers and universal healthcare.

Regional dimensions and dynamics are considered in the Medium-Term Development Plan to address development disparities. The next Regional Development Plans shall contain localized targets and strategies in the regions.

We will focus measures to adapt to the global effects of climate change. An archipelago with a diverse ecology, the Philippines is highly vulnerable to disasters. Periodic (natural) disasters increase the vulnerability of poor Filipinos, thus derailing our efforts to reduce poverty and achieve the MDGs. We will integrate climate change adaptation strategies and measures to protect what we have already achieved and continue our work toward meeting MDG targets. We urge all UN member-states to likewise take the necessary action of adapting to climate change and help fellow citizens of this Earth cope with its effects.

The Philippines has always recognized the role of various stakeholders in the MDGs. Our Medium-Term Development Plan aims to harness the partnerships between the public and private sectors, including those in civil society, business, the academe, media, religious groups, and our international development partners. We will put in place an enabling environment for these stakeholders so that the MDG outcomes will be felt even in remote areas.

We will also ensure that environmental sustainability shall not be compromised in the process of economic growth.

The legislative branch is likewise proactive in building the legal foundations for the MDGs. The Philippine House of Representatives retained the Special Committee on the MDGs which prioritizes measures responsive to the MDGs.

In line with our MDG strategies, we also ask the UN System to share their knowledge on successful development approaches in other countries, particularly in areas where we lag, such as reducing poverty and hunger, dropout rates in the schools, maternal deaths, and HIV/AIDS cases.

Finally, as developing countries struggle to achieve the MDGs, it is essential that international development partners keep their promise. Four decades ago, privileged nations pledged to share a small portion of their Gross National Income to developing countries. As 2015 draws near, we urge these economically advanced countries to fulfill their commitments.

Excellencies, as we enter the last stretch, the Philippine Government is exerting all means to deliver on its promise to realize its MDGs, not just as an international commitment but because our people demand it. Let us remember that each and every one of our citizens deserves a life of quality, meaning and dignity.

Thank you and Mabuhay!