The Investment Slide: Can the Philippines Catch Up?

Op-Ed / Opinion | 27 January 2005

The Philippines has a lot going for it. It has concerned, committed and competent economic managers; there is a raft of essentially sound economic, social, environmental and regulatory legislation on the books; appropriate institutions have been established; the workforce is educated, entrepreneurial and eager; nature's gifts are in abundance; traditional Filipino friendliness is everywhere.

Yet, compared with its neighbors (even compared with itself not so long ago), the country has fared short of expectations on the platform of economic performance. Relative to other economies in Southeast Asia, the Philippines' performance has been lackluster in several respects, including growth in per capita income, which has been one of the region's lowest in the last decade, and even negative during 1981-1990. While almost all the other economies that suffered from the 1997 East Asian financial crisis have greatly recovered, the Philippines' labor productivity and investment indexes have stalled. For example, despite recently surprisingly strong economic growth, gross domestic investment declined from about 24 percent of the economy's output in 1997 to just over 17 percent in 2003, and foreign direct investment dropped from a high of $1.8 billion in 1999 to $0.2 billion in 2003.

Why? What makes the Philippines less productive and less globally competitive in a region that has been characterized as "tiger-like" in economic performance? To an important extent, the answer lies in matters related to an investment climate that has limited incentives for more capital formation, faster productivity improvements and better competitiveness. By taking concrete steps to improve the investment incentive framework -- and that doesn't mean a slew of tax breaks for business -- the Philippines can unshackle itself from these constraints and move more rapidly toward its vision of a country free of poverty.

A recent survey (conducted by the Asian Development Bank in collaboration with the World Bank) on investment climate and productivity interviewed chief operations officers, human resource managers and financial managers from 716 randomly selected establishments in major industrial areas covering four major manufacturing sectors -- food and food processing, garments, textiles and electronics. The survey confirms that the Philippines has some catching up to do in three areas that determine the attractiveness of the investment climate: macroeconomic stability, governance and infrastructure.

The survey found that 40 percent of the respondents consider weak macroeconomic fundamentals as a major constraint to doing business in the Philippines. This broad factor includes things such as the fiscal imbalance, competitive markets for productive inputs and outputs, level of interest rates and social and political stability. With the national government's debt at about 78 percent of the gross domestic product, and total public sector debt at 138 percent of GDP in 2003, respondents perceive the government as having a weak grasp in managing the economy. The debt statistics are the flip side of weak revenue generation, whereby expenditures have had to be financed by borrowings. Consequently, in the public sector, expenditures for maintenance and new investments have been compressed. This, in turn, has eroded the attractiveness for new private investment. In addition, the fiscal imbalance and associated debt issues, accompanied by perceptions of country risks for lenders, have raised interest rates, increasing the cost of borrowing.

The survey indicates that just as problematic for investors is corruption. Thirty-four percent of responding firms ranked corruption as a severe constraint to doing business. Transactions at the Bureau of Customs are perceived to be problematic for a large number of firms -- more than 50 percent of exporting and foreign firms surveyed finding customs administration as a moderate to major obstacle to business. Another commonplace cost of doing business is the pattern of informal payments or gift-giving to government officials in securing regulatory permits and licenses.

Investments are attracted to areas with adequate roads, ports and other essential infrastructure. How does the Philippines fare in this aspect? About 62 percent of the firms surveyed rate public infrastructure and services in the Philippines as "somewhat inefficient to very inefficient." Poor shipping services, for example, led to a 4.7 percent loss in production compared to a 2.2 percent loss in Indonesia and to just 1 percent in Bangladesh and China.

Public works (roads) in the Philippines appear as one of the most unsatisfactory in the region. Approximately 54 percent of respondents consider it to be a problem. Although this is comparable with India's (69 percent) and Bangladesh's (49 percent), it is far higher than the 20 percent rating for China and Malaysia.

Can the Philippines catch up with its neighbors, whose economic performance indicators -- including investment -- are often better than the Philippines? The short answer is "yes." The caveat is "with concerted effort."

For example, the productivity study shows that if the overall investment climate could be improved to a level equivalent with that in the Philippines' special economic zones (SEZs), then labor productivity of firms could double. While part of the higher productivity of firms in SEZs might relate to their special characteristics, an appreciable extent is considered to be due to the superior investment climate. This does not mean that SEZs should be set up all over the country. It does mean, however, that SEZs provide insights into the importance of the quality of infrastructure, simpler regulatory systems, and availability of skilled labor and ready access to finance. The SEZs provide examples of best practice, which can be replicated; they are evidence that things can be done right, with commensurate returns.

Urgent action to move the Philippines to a higher, sustainable growth path is needed to make serious progress in reducing poverty. More investment is an important ingredient. A conducive investment climate is a necessary -- albeit not sufficient -- condition for this. The time has come for moving beyond diagnosis and prescription to concrete action. The process of addressing constraints relating to the fiscal imbalance, poor governance and inadequate infrastructure has begun. The Philippines has in place a solid base that can be leveraged to reap the returns it so richly deserves. Delay is the enemy of success in this important adventure.