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Economic performance 2018 and beyond

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Analysis

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PHILSTAR/MICHAEL VARCAS

By Filomeno S. Sta. Ana III

What are the Philippine economic and development prospects on the basis of current performance?

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To answer this sufficiently and satisfactorily, we review the basic indicators.

The Philippine economy (measured in terms of gross domestic product or GDP) has been growing at a rate of 6.5% since 2012. (The growth rate was spectacular at 7.63% in 2010 but was dismal in 2011 at 3.66%.)

The growth rate for the whole of 2018 will miss the original lower bound target of seven percent, which is disappointing in terms of expectations. That target was revised downward in October to 6.5-6.9%. But the growth rate by the end of the year will be in the vicinity of 6.5%. (See Figure 1, which tracks GDP growth since 2010.)




Year Ender Chart: Gross Capital Formation

If seen from a historical perspective, what may seem to be a so-so performance in 2018 is nothing to be ashamed of.

In the late 1980s and in the 1990s, more than a generation ago, the economists calculated that a sustained growth rate of more than six percent was necessary for the Philippines to catch up with the level of development of newly industrializing Asian economies like Malaysia and Thailand. Then, the Philippines could manage to squeeze a growth rate of six percent or higher but could not sustain it. Once the economy reached a peak of say 6.5%, it began to slow down or decelerate.

The economy then was compared to a Sisyphus. Sisyphus would exert great effort to move a giant boulder up a steep hill. Once he succeeded in having the boulder reach the top, it would roll down. And this became an everlasting act.

Another idiom used to describe the economy was boom and bust. The challenge thus was to break away from the boom-and-bust cycle that happened in different administrations.

Since 2012, we have seen a burst of uninterrupted high growth, averaging 6.5%.

Now, the indicators show that the economy is out of the rut, that the boom and bust is a thing of the past. In fact, we are seeing, in the main, a restructuring of the economy, even in the face of persisting binding constraints and failed policies.

Consider the following:

Growth
1. The high average growth rate of 6.5% since 2012 has been accompanied by a significant contribution of investments in accounting for growth. This is in contrast to the previous pattern of growth that was skewed towards consumption. In the same vein, manufacturing growth has even outpaced GDP growth. Before, growth was dependent on consumption. (See Figures 2 and 3.) Manufacturing performance is a bellwether of industrialization. A solid manufacturing base is also a necessary condition to move from low middle-income status to the category of high middle-income country.

Year Ender Chart: GDP Growth Rates

Year Ender Chart: Growth Rates

2. The main thorn is the bad performance of agriculture. In 2016, agriculture growth was negative; in 2017, it increased by a mere 3.95%. What ails agriculture is the dominance of vested interests and captured politicians hiding behind the rhetoric of being pro-poor. They are more concerned over accumulating the private gains through rent seeking that the rice, sugar, coconut, and tobacco industries provide. They foist on the public a distorted interpretation of social justice, which violates the economic freedom of farmers and which stifles them from becoming efficient and productive. The end result is that the farmers are not liberated from poverty.

Further, the current spike in inflation is attributable to a failed food and agriculture policy. The evidence is clear that food prices specially the price of rice accounted for the unexpected higher inflation rate in 2018 (more on this later).

Employment and Poverty Reduction
3. The high growth has been accompanied by an improvement in the quality of employment. The rise of manufacturing has led to an increase in the number of wage and salary workers. Based on the preliminary data obtained from the latest Labor Force Survey (October 2018), the age of wage and salary workers increased from 62.3% in October 2017 to 64.4% in October 2018. The data from the Family Income and Expenditure Survey suggest that among sources of income, the wages or salaries of workers have the biggest impact on poverty reduction.

4. The conventional wisdom is that high growth leads to poverty reduction (although it can also be said that reducing poverty is also good for growth). To illustrate, poverty incidence among the population dropped from 25.2% in 2012 to 21.6% in 2016. During this period, the growth rate averaged close to 6.5%.

We can expect a further dent in poverty reduction in the succeeding years. Despite the absence of a more recent official household survey since 2015. We make an inference from other indicators. Per capita income (adjusted to inflation) grew by more than 5% in 2016 and 2017, and more importantly, the bottom 20% of households had a higher rate of income growth than the average household (Annual Poverty Indicators Survey).

Debt
5. Even though the debt stock has risen to finance growth and development programs, what matters is the ability to pay. In this regard, the debt indicators are sound. For example, the debt-to-GDP ratio was 42.09% in 2017. Government’s estimate is that the ratio will settle at 42.9% by the end of the term of Rodrigo Duterte. The current as well as projected Philippine debt-to-GDP ratio is comfortably below the stability threshold of 60% (and this is a stringent, conservative ratio applied to high-income countries like members of the European Union).

Similarly the debt service ratio (principal and interest payments as a percentage of exports of goods and receipts from services and primary income) was 6.2% in end-2017 and stood at 6.5% for January-August 2018, compared to 6.1% for the same period in 2017. The benchmark is 25%. (At the height of the debt crisis in the 1980s, the demand of the Freedom from Debt Coalition was to reduce the debt service payments to 20% of export receipts.) The Philippine credit rating is maintained at a notch above investment grade.

Trade
6. The current account deficit has widened and will likely overshoot the government target of limiting it to 0.9% of GDP. But the context of the widening current account deficit is a surge in imports consisting of capital goods and raw materials. Infrastructure spending, which is essential to removing the bottlenecks that impede further growth and investments, is import intensive. In other words, the imports are productive and serve long-term growth.

The wider current account deficit has translated into deeper depreciation. Again context matters here. The peso depreciation, although it contributes to higher prices of imports like oil, is unavoidable, even necessary, to keep the nominal exchange rate aligned to the real rate. Defending the peso (or preventing it from depreciating) and making it overvalued will be more damaging to the real sector of the economy — both to import substitutes and exports.

Meantime, export growth has been mediocre, growing by 3.3% (year on year) in October 2018. Partly this can be explained by a weakening of global trade amid the trade war between US and China, the retreat by mature countries like the US and UK from multilateral rules, and China’s growth that has been below expectations.

But internal problems have long beset the Philippine export sector. More than half of Philippine export earnings come from electronic products, and this sector grew by a measly 0.6%, year on year, in the same period above. Worse, semiconductors or components, which make up the biggest share of electronic exports, went down by 2.3%.

Semiconductors have low value added. The rules governing investments have not nudged the semiconductor companies to move to a higher value chain. This suggests that our incentive system has merely reinforced complacency in innovation and competitiveness.

Tax Reform
7. Also stymying export growth is the uncertainty created by the inaction on the proposed legislation to rationalize fiscal incentives. The bill opponents want to scare the public and the business community, declaring that the reforms will drive away investors. On the contrary, the fiscal incentive rationalization intends to modernize the rules by providing the menu of appropriate incentives that investors can avail themselves of. At the same time, the reform aims to remove redundant incentives (activities that readily generate markets and profits do not need tax incentives) and check abuses by making incentives time-bound, performance-bound and transparent.

Sadly, in 2018, we see the drop by more than half in the number of potential investors and the amount of pledged investments at the Philippine Economic Zone Authority (PEZA). But this is not because the investors are afraid of the reform. Rather, investors are holding back because of the uncertainty caused by the delay in resolving the new rules. In this case, the PEZA, for opposing the bill, and the gutless senators are the ones responsible for the setback in the PEZA investments.

8. The fiscal incentive rationalization is one of several packages that make up the comprehensive tax reform program also known as Tax Reform for Acceleration and Inclusion (TRAIN). TRAIN itself has become controversial, and has been used as a political weapon. TRAIN should have been done many years ago. The tax system has long needed an overhaul to make it equitable and efficient. Thus: Adjust specific taxes on fuel to inflation; correct the low excise rates for automobile; lower personal income tax rates to address the bracket creep, lift the many unjustified value-added tax (VAT) exemptions, etc.

At the same time, the country needs to generate additional resources for AmBisyon 2040, the goal of which is to eliminate absolute poverty and make the Philippines become a high middle-income country.

Although the binding constraint of a narrow fiscal space was resolved by the Benigno S.C. Aquino III administration, it was not able to achieve its target on tax effort, the amount of taxes as a percentage of GDP. By the end of Mr. Aquino’s term, tax effort was below the desired ratio of 17%. (See Table 1.)

Year Ender Chart: Tax effort, 2010-2017

Inflation
9. In the political arena, opponents have accused TRAIN of being the cause of the rise of the inflation rate to 5.2% (the 11-month average), which has exceeded target. Yet breaking down the factors reveals that what can be attributed to TRAIN is half a percentage point or less of the total inflation rate. TRAIN’s contribution to inflation is thus minimal. The principal culprit: the unacceptable spike in the price of rice. The second primary factor was the rapid increase in the world price of crude oil.

10. The rise in prices of rice and other basic food items like vegetables, fish and meat (due to weather disturbances and policy or institutional failures) has the biggest impact on the poor. For the poorest of the poor, the bottom 20% of the population, at least 60% of their consumption is related to food.

Rice Policy
This brings us back to our earlier discussion regarding the serious problems of the agriculture sector. The failed policies and institutions pertaining to agriculture — most stark is the disastrous rice policy, deceptively called “self-sufficiency in rice” — is the main cause of the persistence of poverty. Furthermore these failures have impeded production and have diminished consumer welfare.

11. But a good has come out from a bad thing. The rise in inflation hurts, but the unintended effect was to force the Executive to remove the quantitative restriction on rice and adopt a rice tariff policy in its place. The revenue from the tariff will then serve to fund safety nets for the rice farmers. The positive effect on food prices by the increased rice importation and the removal of non-tariff barriers on imported food commodities is immediate. Food prices and over-all inflation have begun to stabilize.

What any President — even Rodrigo R. Duterte — could not do in the past (because of a populist mindset or a political economy calculation) has finally been done.

12. The new rice policy is now embodied in a law, and this will have a long-term effect not only on Philippine agriculture but also on over-all development. The law can shift behavior of institutions from being oriented towards narrow sectoral interests towards enabling the whole of agriculture to contribute to all-round, inclusive growth. In so doing, agriculture will raise the welfare and standard of living of both Filipino producers and consumers.

But competent leadership is necessary. The current Agriculture secretary, Emmanuel F. Piñol, is a throwback to the old, failed agriculture regime.

Policy Continuity
In summary, we are now seeing growth that can be sustained for the medium term.

And despite bumps along the way, the current growth path is transforming the Philippine economy.

What accounts for this? It cannot be just luck.

I take off from the evident observation that the economic turnaround began in 2012. (2010 could have been a reference year, but economic performance in 2011 was dismal because of deliberate government under-spending.)

This suggests policy continuity. Finance Secretary Carlos G. Dominguez III has several times acknowledged how the present gains are an offshoot of the reforms from the previous administration.

In concrete terms, the TRAIN is actually an extension of the Aquino administration’s reform agenda. The first critical tax reform was the dramatic sin tax reform in 2012. The next in line is reforming the other excise taxes like fuel, the value-added tax, the fiscal incentives, the income and corporate taxes, etc. Secretary Dominguez, his Undersecretary Karl Chua and the professional Department of Finance have stepped up to the plate.

Another example of policy continuity is AmBisyon 2040. It has become the reference for the Duterte administration’s medium-term development plan. AmBisyon 2040 was conceptualized and formally launched by the Aquino administration.

On the budget, the reforms being pursued by Budget Secretary Benjamin E. Diokno, including the cash-basis budgeting that Congress disdains, are no different from those espoused then by former Budget Secretary Butch Abad. Mr. Diokno’s proposed Budget Reform Act, with a little tweaking here and there, contains the same essential features of the Abad-endorsed Public Finance Management Bill that the 16th Congress ignored.

Today, we see a surge in manufacturing. The Department of Trade and Industry during the Aquino term set up an unpublicized program for manufacturing revival. Current Trade Secretary Ramon M. Lopez has boosted this program. Nowadays, this program is no longer timid in asserting industrial policy, still a dirty word for neoliberal economists. Yet, it is this industrial policy of the new type that is helping drive manufacturing growth.

Independent BSP
And we should not forget the essential role of the Bangko Sentral ng Pilipinas (BSP) in creating a healthy macroeconomic environment. The move away from a sole focus on a strong (but overvalued) peso to secure low inflation towards a policy of maintaining price stability but in tandem with supporting growth and employment happened during the term of former Governor Amando M. Tetangco, Jr.

Mr. Tetangco was appointed by then President Gloria M. Arroyo in 2005 and served two terms. Succeeding Mr. Tetangco is former Deputy Governor Nestor A. Espenilla, Jr., appointed by Mr. Duterte in 2017.

Mr. Espenilla cannot be considered a political appointee even though by law, the Philippine President appointed him to the office. He rose from the ranks of the BSP. He has no political link with Mr. Duterte and his personal association is with former Mr. Aquino, for they were high school classmates.

Be that as it may, Mr. Espenilla has affirmed in action the policy stance of his predecessor. He has risen to the occasion despite the overwhelming challenges in the face of the inflationary and political risks.

Binding Constraints
What is likewise common between the Aquino administration and the Duterte administration is how binding constraints are being resolved. Not being able to make sound diagnostics of the economy and not being able to address the binding constraints lead to poor outcomes.

During the Aquino administration, the binding constraints of political instability and narrow fiscal space were resolved. Mr. Aquino’s victory through credible, fair elections put to a close the issue of legitimacy, which hounded Ms. Arroyo since the “Hello Garci” exposé. Political credibility and legitimacy restored upon Mr. Aquino’s election lifted investors’ spirits.

Furthermore, the restricted fiscal space that the Aquino administration inherited from the previous administration was solved by way of the dramatic increase in sin taxes, especially the tobacco tax, in 2012. Revenue increased significantly for health spending. Even as the allocation for health increased, government was able to free funds for other programs. The reform also signaled that other hard reforms are capable of being passed.

In the case of the Duterte administration, its economic managers have correctly identified the country’s weak and insufficient infrastructure as the binding constraint. Without infrastructure upgrading, the burst of growth will dissipate and the economy will choke. Hence, “build, build, build.”

In this light, other measures like tax reforms and investment liberalization — while having merit by themselves — also serve the strategy of addressing the binding constraint that is infrastructure. TRAIN, for example, provides the credible commitment that funding for infrastructure — even if this means generating debt and deficit — will be met in a sustainable way. Ease of investment entry gives government an additional asset, in the form of private sector financing and technology, for infrastructure-related programs.

The Missing Essential Piece
Policy continuity and the proper specification of binding constraints, together the implementation of measures to resolve them, are the key elements that explain the high growth that has been sustained in the past six years.

Yet, gleaning from the lengthy discussion above, we categorically say that the economy has yet to reach its potential growth.

Said simply, the economy could have done better.

Agriculture performance remains poor. The inflation rate that has exceeded target is self-inflicted, not because of TRAIN but because of the anti-poor protectionist policy on rice. Even as investments have increased, a significant amount remains untapped because of policy uncertainty (e.g., fiscal incentives) and other risks.

The “other risks” deserve closer attention. One binding constraint that remains but which the Duterte administration is ignoring is the rule of law. Rule of law is associated with strong institutions. The consensus in economics and in the social sciences in general is that strong institutions are the predictor of having long-term sustained growth and achieving the level of a progressive, industrialized, upper-income economy.

Not only has the Duterte administration neglected the importance of rule of law; worse, it has violated it. The arbitrary and highly politicized application of rule of law and the violation of justice manifest in many ways: the incredulous acquittal of plunderers, political accommodation of the highly corrupt who are likewise human-rights violators, use of legality to commit a brazen political act to remove Maria Lourdes P.A. Sereno as Supreme Court Chief Justice, the physical harassment if not incarceration of political opponents, fabrication of non-bailable charges against communists, unresolved extrajudicial killings, etc.

The effect of the erosion of the rule of law on the economy is not immediately palpable. But the effect is immeasurably damaging. Any inconsistency or violation in the application of rule of law can easily spill over to enforcement of contracts and property rights.

The violation of rule of law is like a termite that will eat away at society’s foundations. Undermining justice and rule of law will deeply ensnare the country in the “middle income trap” and prevent it from eventually moving to what new institutional economists call “open access order.”

Thus, rule of law and justice must become our central concern. It must become the primary issue in the 2019 midterm elections and the 2022 presidential election.

 

Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.