This paper will give an elaborate analysis of the economic growth of Philippines with regards to its output, labor, and technological factors. Formerly referred to as the “sick man of Asia” the country has been able to reshape its economy and is currently enjoying high economic growth rates that have been in this region from the early 2000s. The economic analysis presented in this paper will be from 1986 to 2010. In addition, the paper will give qualitative reasoning for this performance, as well as the implications of major economic events in the country.
For a long period, Philippines economic growth rate has been much lower than that of fellow Asian countries. In fact, in the 1950s, it had the highest per capita GDP in Asia. In comparison to countries in Southeast Asia such as Thailand, Singapore, Malaysia, and Indonesia, the country’s economic growth has lagged behind. To a large extent, this weak economic performance is attributable to the country’s own policies. In particular, the country’s little investment in education, agriculture, infrastructure, and research are to blame for this economic performance. The military rule and the huge debt levels that the country incurred before 1986 have also played a major role in undermining the country’s economic progress (Petrakos, Paschalis, and Sotiris, 2007).
Methodology and Data
This section will have data, which will be used in this study. The Solow’s Growth Model will be used for the production function. This model factors in capital (K), labor (L), and technology (A) as components that determine the rate of growth of an economy. Parameter α represents the share of use of either capital or labor in the production process.
Overview of Solow’s Model
A basic overview of the Solow’s Model is essential in enabling us to have a thorough and informed analysis of Philippines economy
To begin with, this model occurs due to factor accumulation, which is categorized as labor and capital that are both subject to technological changes.
- Labor increases exogenously with the population of a country.
- Capital accumulates due to savings.
Noteworthy, since technology exhibits the form of diminishing returns per capita capital, there is a limit beyond which an increase in capital would result in increased per capita income.
Y=AK α L1- α (equation 1) (Romer, 2011)
In this model, K measures the capital stock of Philippines. The table will show the gross value of fixed capital stock formation (GFCF) and the consumption of fixed capital from 1990 to 2015.
Table 1: Capital Stock
|Year||Gross Fixed Capital Formation||Consumption of Fixed Capital||Capital Stock|
Source: World Bank, 2016
Capital stock is computed using the formula
KT = capital stock for the period in question.
KT-1 = capital stock preceding the period of interest.
Ct-1 = consumption of capital stock for the period preceding the period of interest.
GFCFT = the gross fixed capital formation
The number of individuals employed in the Philippines was derived using yearly employment rates provided from the World Bank. Table 2 shows the values of the country’s GDP, capital stock, and employment.
Table 2: Employment Level and GDP
|Year||Capital Stock||GDP Per Capita||Employment||Population Annual Growth|
Source: World Bank
After gaining independence in the 1940s, Philippines took into industrialization as a way of growing its economy. In the period between 1950 and 2006, the country’s GDP grew by 11.2 times, which is roughly 4.4% per year. Nonetheless, this growth was cut short a number of times by economic contraction such as in the 1984-1985 period, 1990, and finally in 1998 (ADB, 2007). The country’s population also rose sharply during this period, from 19 million in 1950 to 87 million in 2006. In the 1960’s, the country’s per capita GDP was $612 when discounted to the year 2000 US dollars. During this period, its GDP per capita was ahead of Indonesia which was $196, Thailand at $329. However, by 1984, Thailand’s GDP was $933, and more than Philippines which was a $908. By 2006, Thailand’s GDP was more than double that of Philippines. It was $2,549 while Philippines was $1,175. These figures clearly indicate that while other economies grew at a fast pace, Philippines economy was sluggish.
Although there is no single reason that is proclaimed to have led to the success of Asian Tigers in rising out of poverty, export promotion, agricultural transformation, high savings culture, accumulation of skills, economic flexibility, and the developments of the private sector are thought to be the common reason (ADB, 2007). On the contrary, Philippines poor economic performance is blamed on weak institutions, fiscal pressures, corruption, political instability, and economic protectionism (Nelson, 2007). The Asian Development Bank narrowed the causes of the poor economic performance of Philippines to inadequate infrastructure, a small and narrow industrial base, inequitable access to development opportunities, tight fiscal situation, weak investor confidence, and inadequate social protection (ADB, 2007).
On overall, the entire 1980-1990 period was a lost decade for the country’s growth. The average annual change in the country’s per capita GDP was -0.6%. There was a moratorium on foreign debt in 1983, which aimed at servicing the country’s debt. As a result, the country was in recession from 1984 to 1985. As from 1986 until 1989, the country’s GDP increased, however, this growth was not sufficient to offset the dismal performance that had been experienced from 1981 to 1985.
Between 1990 and 1991, the country’s GDP declined mainly due to natural disasters. At the start of 1990, there was a major earthquake in the northern Philippines which was followed by the eruption of Mt. Pinatubo in 1991. From 1992 till 1994, Philippines had a major electricity crisis that crippled its economic recovery efforts. After a short stint of economic recovery between 1994 and 1997, the country was affected by the Asian financial crisis that broke out in 1997. The country was also hit by a political shock in late 2000 when the country’s incumbent president stepped down. The country’s economy was also affected by an economic shock in 2001 when the global information technology industry declined. In particular, the country’s semiconductor exports declined, much to the disappointment of the country.
In 2001, the September 11 bombing in the war on terrorism endangered the country, especially in the autonomous region of Muslim Mindanao. To aggravate the situation even further, the severe acute respiratory syndrome (SARS) had indirect negative externalities on the country’s economy. Between 2000 and 2006, the country’s economy showed some resilience and grew by an average of 2.7%.
When compared to its South East Asia neighbors, the economic growth of Philippines has been suboptimal. In the supply side, the growth rate of agriculture, industry, and service sectors, grew steadily from 1950 to the 1970s, however, the economic crisis that occurred in the mid-1980s, early 1990s, and late 1990s slowed economic growth considerably. In the 1980s, the economic growth of this sectors declined from 7.9% to 0.6%.
Table 3: Market Sector Contribution to the Economy
|Year||Service Percentage of GDP||Agriculture percentage of GDP||Manufacturing percentage of GDP|
Source: World Bank
Generally, the share of agriculture in real GDP is expected to decline as the economy develops. On the contrary, industry is always expected to increase and pick up this slack. Interestingly, the share of industry did not increase to pick up the decline in the real GDP of agriculture as it declined. In 1987, the percentage share of agriculture was 24.009% while that of manufacturing was 24.844%, in 2010 the percentage share of agriculture was 12.314% while that of manufacturing was 21.444%. The decline in agriculture contribution to GDP was mainly replaced by the service sector. This performance was in contrast to that of Southeast Asian Nations (ASEAN) that experienced an increase in industry contribution during this period. For example, the industry contributed between 45 and 46% of the GDP for Indonesia, Thailand, and Malaysia. The service sector has exceeded the performance of agriculture and manufacturing during this period.
In the demand side, the country’s share of private consumption was the highest at 75% from 1950-1960. It later declined to 70% in the 1970s. Between 2001 and 2006, private consumption averaged 78%. In the 1190s, it averaged 89% and was the main driver for economic progress. On overall, private consumption has been the main driver for economic growth in the Philippines. Investment contribution to GDP growth has been below that of private consumption in all periods. In fact, between 2001 and 2006, it shrunk by 7.2%. on the contrary, other ASEA country’ have a small share of contributions from private consumption when compared to those from investments and exports.
The growth in real GDP in the 1960s until the 1990s was mainly due to an increase in capital and labor in the country. It was not driven by an increased in the total factors of production (TFP). Between 1970 and 1980, TFP growth was negative. From 2001 to 2006, the TFP growth was positive at 2.14%. On overall, the weak TFP performance during this period was the main cause for the slowed growth of Philippines. Actually, some periods such as the 1980s had negative TFP growth.
In eradication of poverty, Philippines has not been able to deal with these issues. In contrast, other Asian countries have been able to deal with poverty and eradicated it in most regions. Poverty in the Philippines is largely in rural areas, and predominantly in the agriculture sector. According to Balisacan (2007), poverty in the Philippines is due to inadequate human capabilities in health care, education, and agriculture.
In terms of inequality, the country has an unequal distribution of wealth. In terms of income inequality, the country’s Gini coefficient has been high at an average of 40% from 1985. In 1985, the Gini coefficient was 41.04 and it increased to 43.04% in 2012. This increase indicates a growing level of inequality in the Philippines.
Table4: Gini Coefficient
Source: World Bank
Policy in the Philippines
Philippines economic policies can broadly be categorized into two sections, policies before 1986, and policies after 1986. This paper is mainly interested in policies after 1986. In order to get a clear understanding of why the country developed various economic policies after 1986, it is essential to understand the country’s economic, social, and political orientation before 1986. In the 1950s the country’s economic policies were mainly geared towards industrialization. This policy enabled the country’s GDP to grow at an average of 6.4% until 1960. Between 1960 and 1970, the industrialization policy lost its economic impact and the country’s economy grew at 4.9% annually. In 1970 till 1980, the country engaged in protectionist policies through import substitution.
On overall, these protectionist policies led to a difficulty in the balance of payments and resulted in smuggling, and corruption. The country also used a fixed exchange rate policy. These policies resulted in the country having huge deficits which made it borrow credit from the International Monetary Fund (IMF). Philippines central bank was also not independent, which resulted in it making policies that were contrary to the economic circumstances in the country. As a result, inflation rates rose sharply and foreign reserved were eroded. In effect, Philippines undertook various austerity measures including implementing a moratorium on foreign debt serving.
The policies that were implemented after 1986 were Medium-Term Philippine Development Plans (MTPDPs) that aimed at enabling economic recovery in the country through the use of monetary and fiscal policies. In particular, the government implemented policies on trade liberalization, fiscal consolidation and tax reform, terrific reduction to avoid protecting local industries, accession to the WTO, development of an independent central bank, and privatization of state-owned enterprises. In addition, the government also implemented policies on devolution, reformation of the banking sector, development of the capital market, and reformation of the country’s agriculture system. The impacts of these policies have been positive on the country’s economic performance. For example, the country was able to post robust economic growth after the Asian Financial crisis of 1997. In the 2001 to 2006 period, the country had an annual GDP growth rate of 4.6%. In the first nine months of 2007, the country had a growth rate of 7%. At the same time, the country’s inflation rate was at its lowest level that the country had experienced in the last 25 years (Yap, Celia, and Janet, 2009).
One of the causes of the slowdown in the growth of Philippines is a slow rate of gross domestic investments in the GDP. Nonetheless, despite the weak investment rate, the growth in GDP picked up from 2005. One of the possible explanations is that despite the slowdown in the rate of investment, the country has been experiencing a growing share of the service sector total output in GDP, which is shown in table 3 (ADB, 2007).This increase is because most service industries require fewer investments. Nevertheless, some investments such as those in transport and communication require substantial capital, which in effect leads to doubts on the increase in the service sector as the cause for the increase in growth.
In yet another case, the Philippines over capacity is cited to be the reason for the growth in GDP while the rate of investment has remained stationary. According to NSO (2004), 50% of large establishments were operating at less than their capacity in 2004. Among small businesses, 20% of them were also operating below capacity. In 2003, Philippines manufacturing businesses had an average utilization level of 74% while in 2007, it had 81% utilization levels. In conclusion, it is evident that an increase in capacity utilization decreased the rate of growth in investments (NSO, 2007). In light of this, it is essential to look at the factors that may be affecting the rate of investments in the Philippines such as low social return to investments, low private appropriability, and the high cost of finance, or any possible combination of the three.
Cost of Finance
On overall, the low domestic savings rate had the negative effect of pushing the real interest rates up. In addition, the inappropriate financial intermediation plans in the country made the cost of accessing finance to increase. The aforementioned factors had the overall effect of resulting in high cost of funds in a domestic financial market. Since the country savings rate was low, it deprived banks the necessary deposits need to offer credit to investors. Until 2006, the savings rate in the Philippines were the lowest for ASEAN countries and were similar to those of countries in Latin America. From 2003, the country’s trade account has been positive, which has led to a net positive transfer of resources into the country.
Table 5: Savings Rate
|Year||Percentage Savings Rate of GDP||China: Percentage Savings Rate of GDP||Malaysia: Percentage Savings Rate of GDP||Thailand: Percentage savings Rate of GDP||Brazil: Percentage savings rate of GDP|
Source: World Bank
Table 5: Current Account Balance
|Year||Current Account Balance, BoP current US $|
Source: World Bank
Social Returns to Investments
The social returns of investments are dependent on the investments made on complementary factors of production. Investments in complementary factors normally have positive externalities that in turn improve the overall economic performance of a country. Investments in human capital, for example, augment labor due to increased efficiency. It also leads to innovation, which improves the level of productivity of all factors and in turn acts as an essential component in the long run growth of an economy. Infrastructure development and social overhead capital improve private production by improving transport and communication as well as integrating markets (Kakwani, Neri, and Son, 2007).
Human Capital Development in the Philippines
Philippines has been having a high unemployment rate, which indicates that the lack of human resources is not a cause for its weak economic performance. According to de la Cruz (2007), there were 447,000 graduates from colleges and universities in 2006. Of this population, just 26,000 were employed as technicians, there was an increase by 31,000 for employed professionals, and the number of sales workers increased by 135,000. The number of unskilled laborers increased by 382, 000 during this period. The earnings of skilled labor in emerging industries, such as information technology, finance, and real estate, indicate that the salaries of skilled labor are between 3 and 4 times those of unskilled labor. In more established sectors such as education and healthcare, the salaries are between 2 and 2.5 those of unskilled labor (NSO, n.d.). On overall, this differences in wage levels indicate that skilled human capital may be a constraint in some industries, especially the emerging ones that require high levels of research and skill (Sto. Domingo & Rubio, 2007).
Table 7: Percentage of Unemployment
|Year||Percentage of Unemployment|
Investment in infrastructure is essential for economic growth. The Philippines has continued to lag behind in its investment in infrastructure, which has led to its weak economic performance. After the country experienced an economic crisis in the mid-1980s, Philippines retained its investment at below 0.5% of GDP till 1990. The investment in infrastructure then rose to between 2 and 4%, before dipping to 1% in 2002. The percentage of the country’s paved road is only 22%, while those of its neighbors are much higher. Thailand, for example, has 99% of its roads as paved while in Malaysia, the rate is 31%. In particular, the lack of appropriate infrastructure has led to a high cost of doing business in the Philippines when compared to nearby Southeast Asia countries.
The poor state of infrastructure, which has increased the cost of doing business in the country, has also led to a decrease in foreign direct investments. The small inflows of foreign direct investments in the Philippines have led to a constraint in the resources available for growth at national and subnational levels (Llanto, 2004). According to Basilio and Gundaya (1997), the differences in economic growth in Philippines is due to differences in the level of infrastructural developments in various regions. In 2005, the Asian Development Bank in union with the World Bank noted that inadequate infrastructure and expensive and unreliable electricity were the leading causes of Philippines competitiveness.
Appropriability of returns to investments
Private parties only invest if they expect to earn sufficient returns from their investments. Any issue that risk or limits their ability to earn the desired amount of income discourages them from undertaking a given activity. Since government activities have a direct macro and micro-economic environment, the actions of Philippines government have played an essential role in influencing the rate of investments in the country
The Philippines has experienced economic instabilities due to macroeconomic factors in the form of fiscal policies and current account deficits, exposure to short-term external debt, over lending, and over borrowing. These macroeconomic factors have the impact of discouraging investors, which leads to capital flight, economic recessions, and capital flight. The sharp monetary contraction aggravates the economic recession. Some period of recessions have been observed in the Philippines such as in the 1982-1985 period, 1991-1993, 1998, and 2001. In most of the 1980’s to 2000, Philippines posted a trade deficit in its activities mainly due to difficulties in accessing foreign credit, downgrades in sovereign credit, and weak revenue generation especially in tax collection.
Due to the country’s huge public debt, the Philippines government is vulnerable to increases in interest rates. In 2006, the country public debt was 64% of its GDP and its interest payment was 5.5% of the country’s GDP. The debt payment was so high as it amounted to 31.1% of the country’s budget. Given that defaulting foreign debt always has the risk of denting the appropriability of investments return, the country is always vulnerable to currency risks. Moreover, this tight fiscal position limits the ability of the government to finance essential infrastructural services. The strategies implemented after the Asian crisis have reduced the chances of risks of defaulting foreign debt. In 2007 for example, the inflation rates were 2.7%, which was below the target inflation rate that was between 4 and 5%. Similarly, efforts to broaden and deepen the country’s financial and capital market will enhance savings and attract more capital. The appreciation of the peso is one of the challenges facing the country. A high rate of appreciation may reduce the rate of returns that investors make in the Philippines, which may dent the appropriability of returns from investments in the country. On the other hand, most open market operations to sterilize the dollar inflows in the country may increase the rate of inflation (Lim, 2007).
Poor governance affects the appropriability of private investors in the Philippines and it is a critical constraint to investment growth in the country. According to Kaufmann, Kray, and Mastruzzi (2006), formal guarantees of civil liberties are essential in creating assurance to investors that their interests are safeguarded in the country. In order to achieve this objective, a country has the duty of ensuring that there is zero tolerance to corruption, follow up of the democratic process, and there is adequate legal infrastructure that guarantees individuals of their rights and freedoms. In the 1980s for example, Philippines had political instability, corruption, and a weak rule of law, which had negative effects on the country’s economy. Political instability was manifested in the country in 2000, 2005-2006, and in 2007. Generally, the perception of worsening corruption also explains to some extent the reason for the decline in investments in recent years.
In a survey conducted in 2005 on investment climate survey, 32% of the investors considered high tax rate to be the main constraint for businesses in Philippines (ADB-WB, 2005). Similarly, in terms of corporate tax rate, Philippines also has the highest tax levels when compared to other ASEAN countries. In terms of global competitiveness, the country was the 97th out of 102 countries in the Global Competitiveness Report (WEF, 2004). In particular, Philippines was noted for having cumbersome procedures and red tapes in setting up business. For example, it only took 8 days to register a business in Singapore, and 11 days in Hong Kong. On the contrary, it took 59 days in the Philippines.
Markey failure is observed in the Philippines in the context of information and learning externalities. Moreover, coordination failures have also played a role in limiting the growth of the country’s market. Generally, these externalities can be observed by the lack of growth in exports and diversification of the country’s exports (Huasman and Rodrik, 2006). Simply, a positive externality is observed when a new product has spillover effects to other non-related industries without giving due remuneration to the original component. There are various occurrences that indicate that the Philippines has market failures that have undermined its performance.
To begin with, the country has been unable to increase its market base and to diversify its products. In particular, only two industries; the electrical machinery and appliances and the nonelectrical appliances and machinery contribute more than 60% of its exports. Moreover, these industries mainly focus in semiconductors and have low-value addition to the final product. In addition, the country’s domestic manufacturing uses low technological process. It is also characterized by low quality and slow upgrading of the final product. Mainly, the country focuses on low productivity commodities such as footwear, clothing, beverage, and food products. Despite the country’s well-established education system, Philippines ranks low in research and technology. According to ADB-WB (2005), most businesses noted that technological improvements in the Philippines were mainly driven by technologies in new products and not from the countries skilled personnel. In order to ensure that there is a spread of positive externalities into the country, Philippines must give incentives to first-time investors who are willing to undertake investments and innovations that have positive externalities and spillover effects to other areas of the economy.
After implementing economic reforms in 1986, Philippines economy has an overall improvement in its performance. In pursuit of even greater economic growth and development, the country should implement policies that cut across economic and social reforms. From 1986 till 2010, the country’s real GDP more than doubled. Nonetheless, this rate of growth is slow when compared to its neighbors. Generally, the country’s private investments are still weak and about 25% of families live in poverty in the country. Going forward, the country should implement strategies that aim at increasing its ability to engage in various fiscal policies. To achieve this goal, the country will have to decrease its share of foreign debt and increase its foreign reserves. It will also have to improve its infrastructure, especially in the transport and electricity sector. In addition, it will have to build investors’ confidence in order to attract both local and foreign direct investments into the country. Finally, it will have to solve issues that lead to market failure, which in effect results in a small and narrow industrial base.
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