The Philippine Economy from the Perspective of Growth Economics, (Part II)

Alba, who obtained his doctorate from Stanford University, is a professor of economics at De La Salle University.  This article was published in the Opinion Section, Yellow Pad Column of BusinessWorld, November 27, 2006 edition, page S1/5 & 6.

Massive, widespread corruption in the post-dictatorship period is a main factor that explains the Philippines’ poor long-term growth performance. Nonetheless, it remains to be asked why the Philippines has not made significant strides in improving its relative living standard like its high-flying neighbors. After all, both Hong Kong and Singapore had notorious histories of corruption as well.  This paper draws from stylized facts and analytical models of growth economics to formulate some answers.

An important stylized fact in growth economics is that tremendous improvements in living standards can be achieved by persistent growth over long periods of time. In table 1 , which shows the 1960 and 2000 relative living standards of some countries as well as the implied average annual growth rates over 40 years, this power of continuous compounding is illustrated by the tale of two countries, Hong Kong and South Korea. In 1960, the difference in living standards between the two countries was 4.1 percentage points (18.9 percent for Hong Kong versus 14.8 percent for South Korea). But growing  at 3.6 percent  per  year  above  the  U.S. GDP per worker  growth rate, versus  South Korea’s 3.4 percent—a difference of a mere 0.2 percentage points—Hong Kong by 2000 had achieved a living standard that was 80.9 percent of that of the U.S. and 23.8 percentage points above South Korea’s 57.1 percent.

This tale notwithstanding, South Korea’s performance glows in comparison to the Philippines’. Between 1960 and 2000, the Philippines grew at 0.7 percentage points below the growth rate of the technological frontier. No wonder then that its 2000 living standard at 13.0 percent of that of the U.S. was even lower than in 1960 (17.4 percent).

Thus, one answer to why the Philippines remained poor between 1960 and 2000 is that the country was stuck in a low-growth trajectory.

The answer just given, however, begs the question, Why has the Philippines been stuck in a low-growth trajectory? One way to answer this is to draw on the predictions of the neoclassical growth models. Specifically, the higher the steady-state value of output per worker is, the higher are the saving rate, the effective units of human capital per worker, and the level of technology or total factor productivity, and the lower is the population growth rate.  In the same vein, the farther output per worker is from its steady-state level, the faster the economy will grow.

For the Philippines, the steady-state value of output per worker is apparently low, because of the magnitudes of its low saving rate, its high (worker) population growth rate, and the effectiveness of its human capital (education). In addition, the level of technology is horrendously low.

Thus, the implications for the Philippines are doubly tragic. They suggest that (a) the Philippines has been on a low-growth trajectory apparently because it is near its steady-state level of output per worker and (b) the country is near its steady-state level because it is headed (in the far future) toward a low-level steady state that is far below the convergence point of the advanced economies—all because the country has not allocated much of current output for saving and investments and its population has been growing more rapidly than can be given high quality training by its education system and can be productively absorbed by its economy.

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Another way to answer why the Philippines is stuck in a low-growth trajectory and has consequently remained poor is to undertake Hall and Jones’s (1999) level decomposition of relative living standards, which breaks down the ratio of a country’s GDP per worker to that of the U.S. into the relative contributions of physical and human capital and of total factor productivity.

Table 2 reports the productivity calculations for selected countries, which decompose output per worker into three multiplicative terms, viz., the contributions of the capital-output ratio, human capital per worker, and total factor productivity. For comparability, the variables are expressed as ratios to U.S. values.

From the table it can be gleaned that in 2000 the living standard of the Philippines was only 13.0 percent that of the U.S. Two other ways of interpreting this statistic provide a better sense of the income gap between the two countries: It can be said that the living standard of the U.S. in 2000 was 7.7 times higher than that of the Philippines or that the average worker in the U.S. earned in 47.5 days what the average worker in the Philippines earned in a year.

For the Philippines, the contribution of the capital-output ratio to output per worker turned out to be 86.0 percent of that of the U.S.—a rather high estimate, which derives from the fact that the contribution of the capital-output ratio is its square root. In other words, even if the difference in capital-output ratios of the two countries may be quite large, the effect on output per worker is attenuated because it is the square root of the explanatory variable, not its magnitude per se, that is the contribution to the living standard.

Similarly, the effectiveness of Filipino human capital—at 73.4 percent of the U.S.’s—may be an overestimate, because the declining quality of education is not reflected in the years of schooling data on which the estimate is based.

In any case, the upshot is that the low standard of living of the Philippines is mainly accounted for by the total factor productivity estimate, which is only 20.6 percent of that of the U.S. A simple counterfactual simulation suggests that if the Philippines’ total factor productivity (or the efficiency with which inputs are combined to produce output) were only equal to that of the U.S., the country’s living standard in 2000 would have been 63.1 percent of that of the U.S. (or about the level of South Korea). That total factor productivity is the key to raising a country’s standard of living is supported by the new view of economic growth and development as a process, not so much of factor accumulation, but of organizational and institutional change that solves coordination problems.

The question then is: Why does the Philippines have the wrong attributes for long-term growth?  For Hall and Jones (1996, 1997, 1999), the answer to the Philippines’ growth conundrum lies in what they call social infrastructure, which they define as the set of social norms, laws, and government policies, and the (formal and informal) institutions that enforce them. This is because a country’s social infrastructure determines the economic environment within which individuals accumulate skills and businesses accumulate capital, both of which are needed to create additional value. Thus, good social infrastructure is the bedrock of an economic environment that is supportive of productive activities, that encourages capital accumulation and skill acquisition, and that promotes inventions and technology transfer, which in turn lead to a high standard of living. In contrast, bad social infrastructure is the smog enshrouding an economic environment that allows resources to be diverted away from productive uses—through thievery, squatting, protection rackets, expropriation or confiscation, and corruption.

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The reason why bad social infrastructure is so bad for the economy is that productive activities are vulnerable to predation. If farm land is fair game for expropriation, for instance, then land grabbing becomes an attractive alternative to farming. Given the incentive structure, some people become land grabbers who do not contribute to producing output. Even more pernicious, because it gives rise to a vicious cycle, the success of land grabbers gives them and others who are similarly inclined added incentive to invest in sharpening their skills to become even more effective at land grabbing. The poor farmers then have to waste time fending off land grabbers, and devote less time to farming. They also become discouraged and very protective of their narrow self-interests.

In contrast, with good social infrastructure, productive members of the economy are able to reap the full benefits of their investments and their hard work. A virtuous cycle is created as they invest even more to enhance their productivity. Moreover, when social control of diversion is especially effective, private resources do not have to be expended to deal with diversion. There is no longer any need for people to hire security guards or to put up high fences; the threat of punishment—costless to society—is enough to deter diversionary activities, unless the threat is called (for which reason the dare must be vigorously punished to make the threat all the more credible).

The quality of a country’s social infrastructure, however, depends in turn on culture and history, as conditioned by geographic, climatic, and environmental factors.  On the other hand, for countries with a colonial past, the quality of social infrastructure may have been significantly influenced by the motive of the colonizing country. Hall and Jones (1999) point out that, in sparsely populated areas with the same climatic conditions as Western Europe (such as the U.S., Canada, Australia, New Zealand, and Argentina), settler communities were more likely to be established, into which the (high-quality) social infrastructure of the mother country was transplanted. In contrast, Acemoglu et al. (2002) draw the connection that, where the colonial masters did not settle (because they had high mortality rates) and extractive institutions were established, countries that emerged had weak social infrastructure, as evidenced by poor enforcement of property rights, endemic corruption, state capture by political elites, and highly unstable political processes. In other words, the flawed institutions left historical vestiges that continued to constrain economic performance long after the countries had gained independence. Acemoglu and his co-authors document that, in the post World War II era, these countries were more likely to have volatile economies and to experience economic crises.

Is there hope for the future? Recall that the Philippines is right on the demarcation line of countries headed for different futures. If it gets its act together—and this is a big if—the country may yet join the high performers that are tending toward the high steady-state level of output per worker. But to do so, it must exhibit a high growth rate (above that of the technological frontier) over a long period of time by persistently pushing out the steady-state level of output per worker to which it is headed through a higher saving rate, a lower population growth rate, and a higher quality workforce of high school graduates who are well versed in science and mathematics (so that the country can easily adopt or adapt to new technologies emerging from the advanced countries).

Growth and modern development economics tell us, however, that this is not so easily done, because it involves improving the quality of the country’s social infrastructure by taking on the vestiges of our history and culture that constrain us from growth. In particular, two absolutely essential strategies for social transformation are:an effective, efficient, and high-quality education system and a vigilant civil society that demands high accountability from the government.

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