structural reform

Becoming Mexico

It could take thirty years for the Philippines to catch-up to where Mexico is.

A growing middle class, a net migration rate falling below zero, a major manufacturing power-house, these are outcomes that any developing country would happily aspire to deliver. They are what Mexico has achieved over the past decade. The Philippines can only dream of attaining them at this point.

To use a boxing analogy, the two nations Mexico and the Philippines may have started out in the same economic class back in the 1960s, but they are miles apart now. One is sparring as a welterweight, while the other is still stuck in the flyweight division. A change of regiment is needed for the latter to catch up with the former.

According to a World Bank report released in October, about 17 per cent of Mexico’s population of 115 million entered the middle class between 2000 and 2010. This means that close to 20 million began earning between $10 and $50 a day, the minimum standard for the global middle class.

The Pew Hispanic Center also showed that in 2012, net migration flows from Mexico to the US slowed, falling below zero for the first time in four decades, resulting in overseas dollar remittances to Mexico reaching a plateau following the Great Recession. This has not dampened consumer spending though as the Brookings Institution ranked its middle class within the top 10 list of “new big spenders”.

In fact, as the recession deepened in many parts of Europe, Latinos returned home joined by their Spanish compatriots to either work or start new businesses. In 2011, more than 9,000 from Spain moved to Latin America, up from about 3,600 in 2006. Between 2007 and 2011, the number of Spaniards emigrating to Mexico increased by 129 per cent.

Not only that, but the Spanish PM Mariano Rajoy went cap in hand to a Latin American summit of the Inter American Development Bank to seek investments from the former colonies to the Iberian peninsula as it reels from the EU debt crisis. This represents a reversal of fortune from the 1990s when Spanish companies took over prime assets in the region.

Jim O’Neill, the Goldman Sachs executive who coined the term ‘BRICs’ in 2001 has included Mexico in a new investment portfolio called ‘MIST’ which stands for Mexico, Indonesia, South Korea and Turkey. They comprise the four biggest markets invested in by the Goldman Sachs N-11 Equity Fund, which includes countries like the Philippines.

With the rising cost of wages in China, many manufacturers are considering re-locating production to Mexico. The country has turned into a powerful exporter and an unlikely challenger to the Middle Kingdom. As China’s working population ages, due to the one child policy instituted in the 1970s, the demographics ofMexico’s younger workforce seem to act in its favour.

The Philippines is about 30 years behind Mexico. Back in 2007, Goldman Sachs predicted that at current growth rates of 5-6 per cent, the Philippines would catch up to Mexico’s per capita income of about $8,000 by 2037. By then, Mexico would have achieved a per capita income of US$34,000 similar to what it is currently for France, Germany and Japan.

By 2050, the Philippines would attain a per capita GDP of around $20,000, around the same level as South Korea back in 2010, meaning it is about forty years behind its East Asian neighbour to the North. By then, Mexico will have attained a per capita income of $63,000, while Korea would have reached $90,000 having caught up completely with the West.

According to an Asian Development Bank report, only 4.5 per cent or 3.9 million out of a population of 93 million Filipinos back in 2006 earned $10 or above per day. About 23 per cent or 20 million live below the poverty line of $1.25 a day, while a similar amount earned between $1.25 and $2 a day and risked slipping into poverty. The remainder, about 50 million, earned between $2 and $10 a day, the ADB’s definition of middle class.

The same report says that in the two decades leading up to 2008, “the Philippines appears to have stagnated” as China zoomed past it in reducing poverty and increasing the middle class. In fact by 2030 under its most optimistic projection for developing Asia, only the Philippines along with India, Indonesia and Bangladesh would still have a significant proportion of people living in poverty.

If the growth of the middle class in Mexico is helping it avoid the “middle income trap” a term economists use to denote a country that can neither compete with low wage countries nor leapfrog into higher value economies, slow upward mobility in the Philippines is keeping it there.

Last week, the government announced that the economy had beat expectations and grown at 7 per cent in the third quarter, the fastest in Southeast Asia. Cielito Habito, a self-proclaimed professor of ‘Aquinomics’ was quick to point out however that though the GDP growth figure was stellar, jobs growth in the year remained dismal as only half a million net new jobs were created between 2011 and 2012, half of the targeted 1 million.

For the Philippines to become more like Mexico, it will have to foster growth in its manufacturing sector. Habito supports this view. Only sectors like tourism and manufacturing employ low-skilled workers who form the bulk of the unemployed and underemployed, according to him.

To reverse the premature stunting of our industrial sector, Raul Fabella, former dean of the UP School of Economics says that something will have to be done to limit the rise of the peso. This he says is causing severe stress to our exporters.

My question to these experts is given that the Philippines has lost its competitiveness in low skilled manufactures such as textiles and footwear and is focused more on elaborately transformed manufactures such as electronics, how will the low-skilled unemployed land a job in this sector assuming it is revived?

In boxing terms the two countries might be competitive, but economically, Mexico packs a much larger punch.

In Mexico the return to power of the PRI which ruled the nation for 71 years prior to 2000 after spending just 12 years in opposition is a stunning turnaround. Many had thought that this party which managed the country with an autocratic, transactional approach would be consigned to political oblivion for much longer.

From 2000 to 2012, the rise of China and the recession in America began to hit the Mexican economy hard. Having lost its majority in Congress, the successor to the PRI failed to pass structural reforms, and focused its energies on waging war with the drug cartels which has left 60,000 casualties in its wake. As a result, growth averaged a mere 1.8 per cent per annum. The newly installed president ran under a pledge to restore that growth to 6 per cent.

At his inaugural address the incoming president Enrique Peña Nieto departed from tradition by avoiding grand symbolism or rhetorical flourishes and honed in on two specific areas: education and competition policy. This signaled his willingness to take on the powerful teacher’s union and the two largest business groups that control the media.

The 46-year-old former state governor then went on to forge a pact with the five major political parties in congress to support his road map for the development of Mexico around five broad themes. There was no beating around the bush, here. No spending the first 100 days to settle in, no six to nine months to develop his legislative priorities. This president wasted no time in laying down a plan, spending political capital and getting the major players behind it.

For the Philippines to become more like Mexico, it will have to demonstrate the same sense of urgency at reforming itself from the top in a manner that Nieto has shown. Part of that requires arriving at a consensus on the way forward, forging an agreement around a shared set of values that would provide an organising principle to shape the development of policies and programs.

The Philippines may be thirty years behind economically, but if it reforms itself now, it might have a fighting chance to catch-up with Mexico much more quickly than previously thought. The question is whether our leaders have the courage to pass the much needed structural reforms that promote middle class values and reduce poverty before their time runs out.


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.


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.