Rising growth, declining investment: the puzzle of the Philippines

If you are interested in development economics, here is an interesting puzzle.

According to conventional wisdom, investment is a key ingredient for economic growth. If you invest, you grow - not immediately of course, as everything takes time. If you don’t invest, your economy stagnates.

Basically - so the wisdom goes - the accumulation of physical (e.g.: infrastructure – roads, dams) and human (i.e.: education and health) capital brings about growth and prosperity.

So, what is happening in the Philippines? The Filipino economy is growing fast, but - over the last few years - domestic investment shrunk as a share of GDP. Being an open and growing economy, one must wonder: why the decline? (click on the graph in the top left corner).

I got very interested in understanding this, and - hoping to contribute - I wrote a paper on the subject. I hope you don’t mind me summarizing my own findings.

In the Philippines, three factors explain why investment does not grow at the pace of GDP:

1.    The public sector cannot afford it;
2.    The capital-intensive private sector (i.e.: those businesses that, when operating, utilize more capital than labor) does not want to expand that fast; and
3.    The rest of the private sector does not need it.

Here is why - I’ll try to be short … but bear with me, the devil is in the details:

•    First, the public sector is constrained by serious fiscal pressures, due to decades of weak revenue performance (i.e.: not enough tax-money to cover the expenditures) and a weighty debt service. Hence, it cannot keep public investment growing at GDP growth rates;

•    Second, the capital-intensive private sector does not find it convenient - as it expects little returns on each dollar it spends - to expand investment at the economy’s fast pace. For two reasons:

a.    The public sector does not invest enough to provide incentives for private investment. If there is no road, and the supply of electricity is spotty, why should you invest to open a business?

b.    Élite-capture in the traditional sectors of the economy. Assume you are part of the local élite; your company enjoys favorable rules and regulations - and is allowed to charge high prices; if this happens in a systemic way, this protection reduces other companies’ incentives to invest. In the Philippines, inputs are expensive because a few politically-connected corporate conglomerates enjoy barriers to entry and oligopolistic market power, and sell at a high price the products (agricultural commodities, transport services, electricity, cement, etc.) that are critical for the economy (a typical situation in developing countries, … but also in developed ones). Also, with their rents these conglomerates pay higher wages - relative to other Asian countries - to the salaried insiders, thus securing “national labor peace”; and

•    Third, the fast-growing businesses in the service sector - electronics assembly, voice-based business process outsourcing, and information technology - do not need to increase their investment at GDP growth rates to enjoy fast-rising profits. It’s the nature of the business: it needs little capital and lots of skilled labor.

Still reading? I’m sure at this point you are thinking: “OK, these three reasons explain why domestic investment is low. But what about conventional wisdom?”. Despite the decline in investment, the economy keeps growing. Why?

Because its least protected sectors - the informal labor market and the non-capital-intensive activities - stimulate demand and drive supply.

•    On the demand-side, work-seekers – denied entry into the formal labor market - migrate massively to industrialized economies, attracted by better remuneration; the resulting remittances and transfers (which, combined, account for over 13 percent of GDP) fuel consumption-led-growth (i.e. Filipinos abroad send money to their families in country, and these spend it).
•    On the supply-side, the innovative service sector and a few non-capital-intensive manufactures, still free from regulations that favor the local élite, boost exports.

What’s happening in the Philippines is quite common in developing countries. But, is it sustainable? And, more importantly, if the conventional wisdom is right – the current situation has a cost: growth is slower and less inclusive than it could be. 

In my paper, (which was cited in the Asia Times and well received by the Filipino press - see the op-ed in the Manila Times and the two articles in the Business Mirror: Article 1 and Article 2) I recommend that the Government  reduces unemployment and poverty and boosts investment via better-performing ecozones, a competitive exchange rate, greater Government revenues, and fewer élite-capturing regulations.

Do you agree? What else should the Government do - to make economic growth speedier and more sustainable?