PHILIPP I NE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas
Vol. XXV No. 1
DEVEL O PMENT RESEARCH NEWS January - February 2007
Editor's Notes Breakthrough (n.) - 1. a significant advance, as in scientific knowledge. 2. an act of surmounting an obstruction or restriction. (Source: Random House Webster's Dictionary, third edition) In this year's outlook, Dr. Josef Yap, PIDS' president and economic seer, poses an important question that many Filipinos are undoubtedly curious to know: Is a breakthrough in the horizon? Looking at the two definitions of the word "breakthrough" given above, Dr. Josef Yap is obviously referring to the second. In this outlook, he clearly points out not just a single obstruction but a myriad of issues that impede the economy from enjoying a continuous robust growth and that it should persistently struggle to surmount. Foremost of these is the decelerating performance of the manufacturing sector—a critical factor that will keep a breakthrough in the economy at bay. Dr. Yap attributes this to the sector's narrow base. He thus prescribes the expansion of the manufacturing base and goes further by emphasizing the primacy of manufacturing as an engine of growth and why it should not be abandoned in favor of the more prolific services sector. For an economy like the Philippines whose manufacturing sector continues to shrink, amid a bouncing and growing services sector which is also well supported by government and the private sector alike, Dr. Yap's piece is a reminder of the urgency for more immediate steps to revitalize the
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What's Inside 10 Firm characteristics dictate the Philippines' export peformance
ISSN 0115-9097
The Philippine economy in 2007: Is a breakthrough in the horizon? Josef T. Yap*
R
eal GDP growth of the Philippines rose to 5.4 percent last year after falling to 5 percent in 2005. This outcome surpassed the initial forecasts of many prominent analysts.1 What underpinned the higher growth rate were the rebound in the agriculture sector, the solid manufacturing growth, the steady performance of the services sector, and the favorable fiscal conditions. Additionally, the economy was able to withstand the adverse effects of three strong typhoons in the last quarter of 2006 and the higher-than-expected fuel prices—both of which were partially offset by the more benign political conditions in 2006. The crucial issue, however, is whether these gains can be consolidated to push the economy into a high-growth path in 2007.2
* President, Philippine Institute for Development Studies. Ms. Fatima Lourdes E. del Prado contributed to the box on the role of the services sector and also provided excellent research assistance. The assistance of Ms. Merle G. Galvan is also gratefully acknowledged. The usual disclaimer applies. 1 But not this writer. Many prominent analysts forecast a 5-percent-or-less real GDP growth for 2006. These same analysts adjusted their forecasts upward as the year progressed. Meanwhile, the NEDA set a revised target of 5.5 to 6.2 percent. This writer, however, forecast 5.4 percent in January 2006 (DRN, January-February 2006). The forecast growth rates of the various GDP components of this writer are also quite close to the actual figures. 2 Technically speaking, a high-growth path refers to a 7 to 10-percent GDP growth sustained over a number of years. The Philippines, however, will not likely cross even the 6-percent threshold.
DEVELOPMENT RESEARCH NEWS
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Government spending for large infrastructure projects is expected to provide a big boost this year based on the State of the Nation Address of President Gloria Macapagal-Arroyo on July 24, 2006. But still, there is the slowdown of the manufacturing sector to consider. The sector posted a 6.3-percent growth rate in the first quarter of 2006 but decelerated afterwards. With its sluggish performance, this trend will likely continue through the first half of 2007. And while the services sector is expected to post a higher growth in 2007, the intrinsic structure of this sector prevents it from being the lynchpin of high and sustained economic growth rates (see Box). The elections scheduled in May 2007 will definitely impact on the economy. Election spending normally fuels consumption expenditure. However, many investment decisions may be pushed back until the second half of the year because many investors would likely wait for a clear assessment of the political landscape. Public infrastructure projects may also be delayed because of the election ban. In the medium term, economic growth still largely depends on structural factors, which have been a subject of past outlooks presented here and many other relevant studies. A quick assessment is that there has been no major change in the institutional and governance framework driving the economy during the past decade. Clear evidence of this is the lethargic investment performance during this period, particularly in the private sector. The overall outlook, therefore, is a higher economic growth in 2007 but without a significant breakthrough for the economy. Economic highlights in 2006 Investment continued to be sluggish last year, expanding by mere 2.1 percent (Table 1 presents standard macroeconomic data for the Philippines). The reasons for this phenomenon have been discussed extensively in past outlooks. One factor that was featured last year was the term structure of interest rates, which reflected too low shortterm interest rates and too high long-term
January - February 2007
interest rates. A factor that emerged in 2006 is the exchange rate, with the peso being overvalued at the current rate of 48.30 pesos to one US dollar (as of February 9, 2007). An overvalued currency discourages investments in the tradable goods sector. Meanwhile, many other East Asian economies experienced low investment growth prior to 2006, with China a notable exception. One possible explanation for this trend is that surpluses generated by many East Asian economies have been diverted to finance the growing trans-Pacific macroeconomic imbalance. Personal consumption expenditure grew by 5.5 percent owing mainly to the surge in remittances from overseas Filipino workers. The dependence on consumption to fuel economic growth—reflected also in the low investment rate in the past decade—does not augur well for the expansion of potential output. This is consistent with the earlier assessment that no significant breakthrough will likely occur in 2007. On the production side, services continued to be the fastest growing sector. The downward trend in oil prices in the second half of 2006 led to a rebound in the transport and storage sector, which grew by 9.9 percent in the fourth quarter. However, the communication sector failed to post double-digit growth last year after a rapid expansion for an extended period. While this sector recorded 9.1-percent growth in 2006, there was a marked slowdown in the last quarter—perhaps an indication of digital fatigue. The strong performers in the services sector in 2006 were finance and private services. The boom in the stock market aided the 9.5-percent growth in finance while the expansion of the business process outsourcing (BPO) sector underpinned the 6.8-percent growth of private services. The robust growth experienced by the services sector in recent years has prompted proposals to “abandon” the manufacturing sector and instead allocate resources to exploit the comparative advantage of the Philippines in services. The Box in this out-
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DEVELOPMENT RESEARCH NEWS
January - February 2007
Table 1. Selected macroeconomic indicators, Philippines Annual growth rates and share to GDP At constant 1985 prices, in percent unless otherwise stated 2002
2003
2004
2 .2 6 2 .9 6
4 .3 1 3 .1 2
5 .8 2 5 .0 4
6 .7 2 6 .1 8
5 .6 4 4 .9 7
6 .2 1 5 .3 7
6 .5 0 5 .8 0
3 .6 9 1 9 .9 2
3 .8 0 2 0 .0 5
3 .9 2 1 9 .8 4
5 .2 7 1 9 .6 7
1 .8 3 1 9 .0 8
4 .0 7 1 8 .8 4
3 .5 0
3 .9 2 1 9 .8 2
3 .9 7 1 9 .9 9
3 .8 5 1 9 .7 6
5 .0 7 1 9 .5 5
2 .0 3 1 9 .0 0
3 .8 5 1 8 .7 3
F o r e s tr y
( 2 7 .2 6 ) 0 .1 0
( 3 0 .1 6 ) 0 .0 7
2 4 .1 0 0 .0 8
5 3 .2 9 0 .1 2
(3 1 .3 7 ) 0 .0 8
5 9 .7 8 0 .1 1
In d u s t r y S e c t o r (s h a re to G D P )
0 .9 1 3 4 .7 6
0 .1 5 3 3 .7 5
4 .2 5 3 3 .5 0
4 .6 9 3 3 .0 3
4 .8 7 3 3 .0 0
4 .7 9 3 2 .8 2
5 0 .9 6 1 .4 8
1 6 .8 2 1 .6 5
2 .6 2 1 .5 9
9 .3 2 1 .6 6
3 .4 7 2 4 .4 5
4 .2 4 2 4 .2 6
5 .1 3 2 4 .0 2
5 .6 0 2 4 .1 6
5 .3 7 2 4 .1 6
4 .8 0
0 .9 6 4 .3 4
3 .4 1 4 .2 3
0 .8 7 4 .0 6
4 .5 6 4 .0 3
8 .0 0
G r o s s N a t io n a l P r o d u c t G r o s s D o m e s t ic P r o d u c t A g r ic u lt u r e , F is h e r y a n d F o re s try (s h a re to G D P ) A g r ic u lt u r e a n d f is h e r y
M in in g a n d q u a r r y in g
M a n u f a c t u r in g
C o n s t r u c t io n
E le c t r ic it y , G a s a n d W a t e r
( 6 .5 4 ) 1 .0 1 2 .8 7 2 4 .3 7 ( 4 .9 6 ) 6 .1 1
( 2 3 .7 2 ) 4 .5 2
2005
2006
F o re c a s t 2007
2001
(5 .9 8 ) 1 .4 8
5 .6 3
1 2 .0 0
0 .6 7 3 .2 7
4 .2 6 3 .3 1
3 .1 9 3 .2 5
4 .2 3 3 .1 9
2 .4 8 3 .1 1
6 .3 6 3 .1 4
6 .0 0
4 .2 5 4 5 .3 2
5 .1 0 4 6 .1 9
6 .1 1 4 6 .6 6
7 .6 4 4 7 .3 0
6 .3 5 4 7 .9 2
6 .2 8 4 8 .3 4
6 .8 2
8 .8 1 7 .4 1
8 .9 3 7 .8 2
8 .5 9 8 .0 9
1 1 .2 3 8 .4 7
7 .2 2 8 .6 5
6 .7 2 8 .7 6
7 .5 0
5 .6 1 1 6 .1 2
5 .7 6 1 6 .5 3
5 .6 6 1 6 .6 3
6 .7 8 1 6 .7 2
5 .6 4 1 6 .8 3
5 .5 0 1 6 .8 5
5 .5 0
1 .2 3 4 .7 2
3 .4 4 4 .7 4
5 .8 8 4 .7 7
9 .8 8 4 .9 4
1 3 .6 1 5 .3 5
9 .5 0 5 .5 6
1 0 .0 0
( 0 .4 5 ) 4 .8 0
1 .7 2 4 .7 4
4 .1 0 4 .7 0
5 .3 0 4 .6 6
5 .3 6 4 .6 7
5 .7 9 4 .6 9
6 .0 0
P r iv a t e s e r v ic e s
4 .4 0 7 .3 8
5 .4 9 7 .5 5
8 .1 2 7 .7 8
1 0 .1 3 8 .0 6
5 .5 2 8 .1 1
6 .8 5 8 .2 2
7 .0 0
G o v e r n m e n t s e r v ic e s
0 .9 4 4 .8 8
1 .4 6 4 .8 1
2 .7 0 4 .7 0
0 .4 9 4 .4 5
1 .8 8 4 .3 2
3 .9 4 4 .2 6
7 .0 0
3 .5 8 7 7 .7 7
4 .0 7 7 8 .4 9
5 .2 8 7 8 .6 7
5 .8 0 7 8 .3 8
4 .9 4 7 8 .3 6
5 .4 7 7 8 .4 3
5 .6 0
4 .0 2 6 .4 9
5 .7 0 6 .5 1
8 .5 0
(6 .0 4 ) 1 8 .1 8
2 .1 2 1 7 .6 2
7 .0 0
1 3 .9 9 8 .6 5 *
1 0 .0 0 1 2 .0 0
S e r v ic e S e c t o r (s h a re to G D P ) T r a n s p o r t , c o m m u n ic a t io n a n d s to r a g e T ra d e
F in a n c e
O w n e r s h ip o f d w e llin g s a n d r e a l e s ta te
P e rs o n a l C o n s u m p tio n E x p e n d itu re (s h a re to G D P ) G o v e rn m e n t C o n s u m p tio n (s h a re to G D P )
( 5 .3 2 ) 7 .5 3
( 3 .7 2 ) 7 .0 3
2 .4 9 6 .8 6
1 .3 9 6 .5 5
C a p it a l F o r m a t io n (s h a re to G D P )
( 7 .2 9 ) 2 2 .1 2
( 5 .0 2 ) 2 0 .3 8
3 .7 7 2 0 .1 3
7 .1 7 2 0 .3 2
E x p o r t s ( n o m in a l $ ) I m p o r t s ( n o m in a l $ )
( 1 5 .5 7 ) ( 4 .1 6 )
9 .5 1 1 8 .6 9
2 .9 1 3 .1 5
9 .5 2 8 .8 2
3 .9 7 7 .6 7 7 .6
I n f la t io n ( 2 0 0 0 = 1 0 0 ) ( a v e r a g e )
6 .8
3 .0
3 .5
6 .0
9 1 - D a y T r e a s u r y B ill R a t e ( a v e r a g e )
9 .8 6
5 .4 3
6 .0 3
7 .3 4
5 0 .9 9
5 1 .6
5 4 .2
5 6 .0 4
N o m in a l E x c h a n g e R a t e ( P / $ a v e r a g e )
6 .3 6 5 5 .0 9
N o te : * D a ta r e fe r to J a n u a r y to D e c e m b e r 2 0 0 6 . S o u r c e s : N a t io n a l A c c o u n t s o f t h e P h ilip p in e s , N a t io n a l S t a t is t ic a l C o o r d in a t io n B o a r d ; S e le c t e d P h ilip p in e E c o n o m ic I n d ic a t o r s , B a n g k o S e n t r a l n g P ilip in a s ; N a t io n a l S t a t is t ic s O f f ic e ;
6 .2
3 .8 - 4 .3
5 .3 5
4 .5 -5
5 2 .0 1
4 8 .4 -4 8 .7
DEVELOPMENT RESEARCH NEWS
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look explains why this policy prescription is, at best, premature. Growth in the manufacturing sector was a respectable 5.4 percent in 2006. However, among the larger subsectors, only food manufactures and products of petroleum and coal recorded significant growth rates, both at 6.7 percent. This only implies that the base of the manufacturing sector is still narrow. Policymakers should thus consider measures to expand the manufacturing base since recent studies have shown that diversification of the economy, particularly the manufacturing sector, is a necessary condition for rapid economic development.
As of January 2007, the 13th Congress filed more than 5,000 bills but only 37 were enacted into law. Of these, only five have a distinct economic nature and were passed in 2006 or early 2007. None of these bills, except the 2007 budget, is expected to make a significant economic impact in the short term.
As mentioned earlier, the manufacturing sector experienced a deceleration after the first quarter of 2006. This can be explained by the high fuel prices, the rapid appreciation of the peso, and the slowdown in the global electronics market. Lack of production capacity due to low investment rates in the past has also contributed to this downtrend. There was a surprising contraction of the mining sector in 2006. The National Statistical Coordination Board (NSCB) attributed this mainly to the sharp decline in the demand for coal. Crude oil, natural gas, and condensate production also declined. Meanwhile, the sector of electricity, gas, and water expanded by 6.4 percent. The NSCB ascribed this to the sustained demand for electricity in the commercial sector as a result of the construction of new shopping malls. Meanwhile, adjusted figures show that activity in the construction sector was expanding at a slower pace in the past several years. The 4.6-percent growth in 2006 was in fact the highest since 2001. The data show that private construction has been declining since the fourth quarter of 2005. This is related to the moribund investment climate. The slack was picked up by public construction as the fiscal space created by tax reforms allowed government to play a more substantial role. The 13.3-percent growth in public construction in 2006 materialized despite the re-enacted budget.
January - February 2007
As expected, the agriculture sector rebounded from the effects of the El Niño in 2005, although the momentum was disrupted by typhoons in the last quarter of 2006. As a result, agriculture growth slipped to 4.1 percent last year after averaging 5.1 percent in the first three quarters. Inflation moderated last year after the oil price-related surge in 2005. Interest rates— represented by the 91-day Treasury Bill rate— followed this trend, averaging 5.4 percent for the whole year. Meanwhile, the exchange rate averaged 52.01 pesos to a US dollar. This represents a 5.6-percent currency appreciation that occurred due to the faster growth in exports, the inflow of portfolio capital, the hefty increase in OFW remittances, and the renewed confidence in the economy following a successful fiscal consolidation. As of January 2007, the 13th Congress filed more than 5,000 bills but only 37 were enacted into law. Of these, only five—RA 9343, which extends the Special Purpose Vehicle Act; RA 9358, which allowed a special budget allocation; RA 9361, which amends Section 110 (B) of the National Internal Revenue Code; RA 9367 or the Bioethanol Fuel Act of 2005; and the newly approved House Bill 5794, otherwise known as the national budget of 2007—have a distinct economic nature and were passed in 2006 or early 2007. None of these five bills, except the 2007 budget, is expected to make a significant economic impact in the short term. Key global developments and issues Global economic activity in 2006 was higher compared in 2005 despite the higher fuel prices, the rise in short-term interest rates, and the suspension of talks on the Doha round (Table 2). To a large degree, the higher world GDP growth can be attributed to the rapid expansion of developing economies. This, in turn, was fueled by the relatively low interest rates and the abundant global liquidity. An encouraging sign from the point of view of global macroeconomic stability was the ascendance of domestic demand in developing countries last year.
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DEVELOPMENT RESEARCH NEWS
January - February 2007
Table 2. GDP growth of major industrialized countries and regions
World US Japan Euro Zone
2004
2005
2006e
4.1 4.2 2.3 1.7
3.5 3.2 2.6 1.4
3.9 3.4 2.8 2.4
2007f 3.2 1.9 2.4 1.9
e - estimate; f - forecast Source: World Bank East Asia Update, November 2006, Asian Development Outlook 2006 Update.
The shift in the center of gravity of global economic growth is partly reflected in the surge in stock prices in emerging markets. Some analysts have drawn an analogy between the current economic developments in India and China and the rapid economic growth of Western Europe and Japan in the 1950s and 1960s. This implies that global economic growth is becoming less reliant on the performance of the US economy. The economic growth in the US was expected to slow down in 2006 due to the weakness in the automobile sector and the collapse of the housing market following the tightening of monetary policy. The latter triggered a fall in residential investments and a drop in housing prices, which, in turn, moderated consumer demand. The slower growth in domestic demand, however, was offset by a sharp rise in export growth and lower import growth. The rise in demand for US exports last year is attributed primarily to the rapid growth of domestic demand in emerging markets. The result was an estimated GDP growth of 3.4 percent in 2006, which is even higher than the 2005 figure. A slower economic growth for the US is still expected for this year as the fallout from the downturn in the housing market has yet to run its full course. The economy will also experience some consolidation to address nagging concerns with regard to the twin deficits. Moreover, the high output growth in key developing countries will likely taper off in 2007 and lead to lower demand for US exports. On the other hand, the resurgence in economic activity in Japan continued in 2006. The successful restructuring in the bank-
ing and corporate sectors, along with high corporate profitability, has fueled business investments. Exports have also risen primarily because of greater access to China. The economy experienced mild inflation during the year and, as a result, the Bank of Japan lifted its “zero rate� policy by 25 basis points. Nevertheless, the high differential between domestic and international interest rates has led to a depreciation of the Japanese yen against major international currencies. GDP growth is expected to be slightly lower in 2007, though, due to further contraction of public spending that is in line with fiscal consolidation. The Eurozone economies rebounded strongly in 2006 as private consumption and investment spending strengthened. Improved labor market conditions provided a boost in consumer confidence while higher corporate profitability and a more favorable business climate led to higher investments. However, the European Central Bank is poised to raise interest rates to counter the residual inflationary pressure that resulted from higher oil prices. Many countries are undergoing fiscal consolidation, largely in response to their commitment to the stability pact. Net exports from the region will not be able to compensate for lower domestic demand due to the strength of the Euro. Moreover, there are still several structural impediments to growth, related mainly to labor market issues. The overall outcome will be lower growth in 2007. The foremost global economic risk remains to be the trans-Pacific macroeconomic imbalance. This issue was discussed extensively in two previous outlook papers. The shift toward greater reliance on domestic de-
DEVELOPMENT RESEARCH NEWS
The likely slowdown in
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January - February 2007
Table 3. Average prices of crude oil (in USD/barrel)
the manufacturing sector Brent Dubai
will put a cap on the growth prospects for the
2004
2005
2006
2007f
38.32 33.46
54.51 49.44
65.42 61.53
58-60 55-56.5
f - forecast Source: Bloomberg
Philippine economy this year. However, increased construction activity— particularly
large
infrastructure projects of the government—and the continued surge in the services sector will push GDP growth to 5.8 percent in 2007.
mand in developing economies and the slowing down of domestic demand in the US is a sign of an orderly adjustment of global imbalances. However, the current account surpluses generated by emerging markets have become a source of excessive global liquidity, prompting concerns of overheating in emerging markets.3 Developing-country policymakers will be preoccupied in 2007 with preventing abrupt changes in key macroeconomic variables. This is reflected in the recent attempt by the Thai monetary authority to limit hot money inflows. The concern about overheating economies is another reason behind the projected fall in global output growth.
Manufacturing is expected to expand by only 4.8 percent owing to the overvalued currency, the low investment rate in the past, and the slowdown in global demand. Nevertheless, the industry sector should grow by 5.6 percent following the anticipated sharp rise in value added from the construction sector. Meanwhile, the services sector is expected to receive solid contributions from all its subsectors. The expected drop in fuel prices will benefit the transport sector, and the aggregate transport, communication, and storage sector should expand by 7.5 percent. Finance and private services will be carried by past momentum. The entire services sector is forecast to grow by 6.8 percent in 2007.
Meanwhile, oil prices are expected to moderate in 2007 (Table 3). Apart from the slowing demand for oil that will accompany the deceleration of global economic growth, the price of oil will respond to a likely rise in non-OPEC supply and the high level of stocks in the US. However, geopolitical risks will prevent oil prices from dropping to their 2005 levels.
The agriculture sector should expand at a steady pace assuming there are no serious weather disturbances. This, along with the expected fall in oil prices, will contribute to lower inflation in 2007, early evidence of which is the 3.9-percent inflation recorded in January. The annual average is forecast to be between 3.7 and 4.2 percent.
Prospects for 2007 The likely slowdown in the manufacturing sector will put a cap on the growth prospects for the Philippine economy this year. However, increased construction activity— particularly large infrastructure projects of the government—and the continued surge in the services sector will push GDP growth to 5.8 percent in 2007. This is higher than the 2006 figure but lower than the government target of 6.1 to 6.7 percent.
Better macroeconomic conditions, particularly a lower fiscal deficit and a lower inflation rate, will boost domestic demand in the Philippines. Growth in consumption spending will be slightly higher in 2007, and investment expenditure will rise sharply in response to government pump-priming activities. Meanwhile, the adjustment in salaries of public servants will result in higher growth in government consumption and government services. DRN
3
This concern has been heightened by the sharp fall in the Shanghai Composite Index on February 27, 2007 and the subsequent sell-off in other stock markets. The Philippine Stock Exchange index fell by 7.9 percent the next day. As of press time, this has been considered by analysts as a correction and should not affect the economic outlook for 2007.
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January - February 2007
Box. Will a conscious policy shift in support of the services sector lead to high and sustained economic growth?
Traditional development models maintain that human societies follow a sequential pattern of economic development—from agricultural to industrial and later on, to servicesoriented economies. Each stage is accompanied by a shift in labor structure that gravitates toward a more progressive and sophisticated center of production and economic activity. For over three decades, the massive transition of labor and output share from manufacturing to the services sector—a phenomenon widely referred to as ‘deindustrialization’—has caused many to seriously consider its causes and likely implications. Industrialized countries and the so-called newly industrialized countries have generally followed this pattern. In the case of the Philippines, the share of the services sector to total GDP in the Philippines increased steadily during the past three decades. As of 2006, it stood at 48.3 percent compared to 32.8 percent for industry and 18.8 percent for agriculture (see Table on page 3). More importantly, the services sector experienced the highest growth rate after the 1997 financial crisis, averaging 6 percent during the period 2001-2006 compared to 3.8 percent for agriculture and only 3.3 percent for industry. The figures for the manufacturing sector are 24.2 percent and 4.4 percent, respectively. Unlike the experience of its neighbors at roughly the same stage of economic development, the manufacturing sector of the Philippines stagnated during the past 25 years (see Table on page 9). These trends have prompted many analysts to advocate “abandoning” the manufacturing sector and reallocating resources to the services sector instead where the Philippines has a more distinct comparative advantage. The recommendation is for the country to leapfrog the conventional sequence and instead gear its policies toward supporting the services sector. This would entail conscious
shifts in education policy, infrastructure projects, trade and industrial policy, budget allocation, and other important areas. The crucial issue is whether the services sector can be the main source of high and sustained economic growth defined as 7 to 10percent GDP growth for an extended period, usually 10 years. The answer lies in both economic theory and the historical experience of countries. The latter delves into the reasons of “deindustrialization” in advanced economies and the recent experience of India. Meanwhile, theory explains the need for economic surpluses to fuel rapid output growth and the required economic transformation needed to generate these surpluses. A study on the deindustrialization process in England lists the following factors for this phenomenon:a . 1) Consumption. Deindustrialization reflects a rapid fall in the relative price of manufactures. Rising imports from lowwage countries, together with rising productivity at home, mean that manufactured goods in the advanced economies are now so cheap that consumers can buy a lot more of these goods while spending a smaller fraction of their income on them. 2) Productivity. Because of improvements in investments and technology, the labor productivity growth rate of manufacturing is faster than that of the services industry. Hence, to maintain its share of real output, the manufacturing sector has required a decreasing share of total employment while to achieve the same result, the services sector has required an increasing share of employment. To keep up with the more dynamic manufacturing sector, the sera
Lifted from Rowthorn and Coutts (2004).
DEVELOPMENT RESEARCH NEWS
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vices sector has absorbed an ever-increasing share of total employment, which it has acquired at the expense of manufacturing. 3) International trade. International trade affects manufacturing employment in a variety of ways. It may increase productivity in this sector by stimulating competition and encouraging domestic firms to produce more efficiently. Competition from imports may also increase productivity by eliminating low value-added activities or inefficient firms. To pay for imports, a country may export goods and services to foreigners, may use its income from investments abroad, or may borrow. 4) Specialization. Deindustrialization could be the result of increasing specialization. Certain activities that were previously performed in-house by manufacturing firms are now outsourced. This represents a reclassification rather than a genuine shrinkage in the manufacturing sector. The experience of India may be a case of overspecialization and does not necessarily mirror the experience of industrialized countries. From 1991 to 2005, the share of the services sector in India grew from 40 percent to 52 percent of GDP, accounting for 63 percent of cumulative increase in GDP during this period. A large portion of this growth was attributed to India’s IT and IT-enabled services (ITES) sectors, which were able to capture the increased demand from the US and other developed countries for this type of services. But while their double-digit GDP contribution may have been nothing short of astonishing, for a huge fraction of the Indian population, the glass is viewed as ‘half-empty’. The reason is that only a small proportion of the working population is absorbed by these sectors. The ITES sectors cater only to the very few educated and young upwardly mobile professionals, and offer lim-
January - February 2007
ited opportunities for low-skilled and semiskilled workers that constitute a huge bulk of India’s poverty-stricken regions. Furthermore, the nature of jobs outsourced to India “create little or no intellectual property for Indian firms. With few barriers to enter or to exit, these jobs will shift to other countries for the same reasons they moved to India” (Konana (2006). Hence, fears about this growth being unsustainable may not be unfounded. The Philippines seems to be emulating the example of India as demonstrated by the growing number of call centers throughout the country. However, as noted by ADB in a 2005 report, only a small proportion (about 4 percent) of the total labor force in the Philippines, just like in India, is absorbed by the ITES sectors simply because majority of the applicants have failed to meet the skills that the positions demand. Hence, one of the proposals is to consciously shift government policies toward support of the services sector (for example, through retraining programs that emphasize English language skills). The same report reiterated the relationship between economic development and industry growth. Two major reasons were given to justify why the manufacturing sector came to be referred to as ‘the engine of growth’: “The first is that there are increasing returns to scale in industry, which are of two types: (i) those derived from large-scale production, which induce lower average costs; and (ii) those derived from the fact that output growth has an effect on capital accumulation and the embodiment of new technological progress in capital. Labor productivity also increases as output grows through “learning by doing." ”The second main reason is that if activities outside industry are subject to diminishing returns (with the marginal
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DEVELOPMENT RESEARCH NEWS
January - February 2007
Share of manufacturing to total output (in percent) Indonesia 1980 2005
Malaysia
15.2 28.1
Average GDP growth (in percent) 1981-1988 5.0* 1988-2005 4.9
Philippines
Thailand
19.6 29.4
27.6 23.4
23.1 34.7
4.8 6.5
0.6 3.6
7.0 5.4
Source: ADB key indicators and various national statistical websites. Note: Reason for break in computation of growth rates is availability of data using a single base year. * - indicates 1983-1987.
product of labor less than the average product) and if resources are drawn from these activities into industry as the latter expands, then the average product of labor will rise in non-industrial activities.� While the foregoing statements do not, in any way, attempt to discriminate against, or downplay, the significance of the services sector especially as it relates to both India’s and the Philippine’s development path, they nevertheless highlight the primacy of manufacturing in economic development. As shown in the Table above, compared to Indonesia, Malaysia, and Thailand, only the Philippines failed to increase the share of the manufacturing sector between 1980 and 2005. It is no coincidence that it had the lowest economic growth rate during this period. The employment shares of agriculture, industry, and services in the Philippines stood at 37, 15, and 48 percent, respectively, while manufacturing accounted for only 9 percent. These data indicate problems not only with the size of the manufacturing sector but also with its weak ability to absorb labor from the agriculture sector since the share of industry has been stagnant for at least 25 years. The preceding analysis begs the question of what kind of policies should be implemented to turn around the moribund manufacturing sector. Ideally, they should be those that promote diversification of pro-
duction activities into new areas, facilitate restructuring of existing activities, and foster coordination between public and private entities to make all of these happen. These policies form the core of ‘industrial policy’ although they need not be restricted to the industry sector. They also apply to the development of nontraditional activities in agriculture and services. Additionally, the use of industrial policies should not imply that governments will make the production and employment decisions. Instead, it requires that governments should play a ‘strategic and coordinating role’ in the development of nontraditional activities—activities where the underlying costs and opportunities are unknown to begin with and unfold only when such activities start (Rodrik 2004). Amid the controversy surrounding India’s services-driven growth today, Dasgupta and Singh (2005) suggest that India should "maximize and take advantage its strength in IT and use it extensively in all areas of the economy in order to upgrade manufacturing, agriculture as well as services." The study claims that for countries with low-levels of per capita income like India, where the demand for manufactures is going to remain high for a very long time, the contribution of manufacturing cannot be ignored or overly emphasized. In the Philippines, the newly created National Competitiveness Council can take the lead in crafting a more coherent industrial 12
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January - February 2007
Firm characteristics dictate the Philippines’ export performance wo-thirds of Philippine exports mainly come from semiconductors, garments, and electrical machinery and equipment. Despite their continued success in the world market, however, the country’s export performance on the whole is hindered by an alarming productivity gap where export growth is not translated to overall economic gains.
T
economic factors. For example, Pante and Medalla in 1990, and Medalla, Tecson, Bautista, and Power and Associates in 1996 highlighted the impact of trade policies in improving the efficiency and productivity of the manufacturing sector. Meanwhile, Yap in 1999 investigated the effects of macroeconomic stability and the structure of the financial sector.
Two major reasons for this productivity gap are the strong dependence of said goods on imported input supplies, and the weak backward and/or upward linkages with other players in the manufacturing sector.
In 2006, the study on export performance was conducted on a firm-level basis. Ma. Teresa S. Dueñas-Caparas, former research associate at PIDS, analyzed the performance of local firms in the world market using a firm-level survey carried out by the Asian Development Bank in collaboration with the World Bank and the Philippine National Statistics Office in 2002. Her study identified the different factors affecting the export performance of 726 local firms in four selected Philippine manufacturing industries (i.e., food and food processing, textiles, garments, and electronics and electrical machinery).
These reasons are further aggravated by the observation that the country’s competitive base is narrow, as Lall in 2000 suggested in his study on Philippine competitiveness. It is dominated by semiconductors whose operations are susceptible to competitive forces and technology changes. The garment industry, on the other hand, suffers from poor utilization of cheap but skilled labor force. Lall further noted other significant factors that affect the garment industry, to wit: poor technological and design activities, weak technical support for domestic firms, poor research and development (R&D), and structural weaknesses in technology development (i.e., incompatibility between quality and relevance of education and industry needs). Technology development significantly stands out as a crucial factor. In the global setting, it is identified as one of the main reasons for the export success of countries like China, Malaysia, and Singapore, where their electronics, physics, and pharmaceutical sectors showed big improvements in world export shares. Past PIDS studies also delved on other causes but were highly focused on macro-
Foreign affiliation emerged as the strongest influence in improving a firm’s export performance. The study suggested that firms that have foreign interest and affiliation benefited more in the export trade as opposed to firms that have minimal or no foreign affiliation. Literature suggests that foreign affiliation is a primary source of knowledge and technology for local firms and helps to improve the quality of production, making goods more competitive in the world market. Firm age, firm size, R&D, and capital intensity are the other factors in the study found to influence export performance. Firm age is important in both the electronic and clothing industries, but most significant
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DEVELOPMENT RESEARCH NEWS
January - February 2007
Foreign affiliation emerged as the strongest influence in improving a firm's export performance. Firms that have foreign interest and affiliation benefited more in the export trade as opposed to firms that have minimal or no foreign affiliation. Literature suggests that foreign affiliation is a primary source of knowledge and technology for local firms and helps to improve the quality of production, making goods more competitive in the world market. Firm size, R&D, and capital intensity are the other factors in the study found to influence export performance. in the latter. Length of operation is indicative of deep knowledge of customer base that can result in economic gains in the clothing industry. However, for electronic firms, firm age is beneficial only at a certain point but beyond which, longevity of operation does not fully assure the export performance of local firms because rapid technological changes dictate the advancements in this sector. Firm size across all sectors exhibits a nonlinear relationship with export performance. The relationship between firm expansion, in terms of increased number of workers, and export performance, is positive in the initial stage but in the long run, any increases in firm size will not guarantee sustainability of export success. R&D activities are highly desirable for the electronics and food processing industries where the acquisition of the latest technological know-how is necessary to remain competitive in the export market. A higher capital per worker leads to better productivity of firms and higher propensity to export particularly for the electronics industry. The capital-intensive nature of the electronics industry facilitates the transfer of knowledge and technology embodied in machineries and equipment. However, higher capital intensity should be complemented by better trained workers. Based on these findings, DueĂąas-Caparas recommends certain policy initiatives that
are crucial for the Philippines in order to get a bigger share of and make a lasting presence in the global export market. First, local firms’ affiliations with foreign companies must be stressed either through joint ventures, direct investments, or foreign equity infusion. Second, investments in R&D activities and training of workers should be significantly improved. Foreign affiliations can be seen as channels for increased R&D resources, which can improve the technological capabilities of local manufacturing companies. Third, intensive acquisition of the latest machinery and equipment, complemented by the build up of technological capability, is a necessary ingredient for improving the productivity and efficiency of Filipino export firms. CSM References Lall, S. 2000. Export performance and competitiveness in the Philippines. Queen Elizabeth House Working Paper No. 49. University of Oxford. Medalla, L., G. Tecson, R. Bautista, J. Power and Associates. 1996. Philippine trade and industrial policies: catching up with Asia's tigers. Makati City: Philippine Institute for Development Studies. Pante, F. and E. Medalla. 1990. The Philippine industrial sector: policies, programs and performance. Working Paper Series No. 90-18. Makati City: Philippine Institute for Development Studies. Yap, J. 1999. Trade, competitiveness and finance in the Philippine manufacturing sector, 1980-95. Discussion Paper Series No. 99-12. Makati City: Philippine Institute for Development Studies.
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Editor's Notes...from page 1 ○
manufacturing sector, and the need for more in-depth analyses of the actual potential and sustainability prospects of the country's services sector. This issue also contains a brief article on a study by Ms. Teresa S. Dueñas-Caparas that delves into the determinants of the Philippines' export performance. Said study is a fitting companion to Dr. Yap's more macroeconomic insights on the sluggish performance of the manufacturing sector in that it takes a closer look at the reasons behind the weak export performance of the sector and provides more specific policy recommendations to help local firms penetrate and make a lasting presence in the global export market. DRN
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policy. However, the framework that has thus far been adopted is overly macro in nature and thus not very useful in this context. This topic can be addressed elsewhere. What this writeup wishes to emphasize, however, is that the services sector cannot be the major source of high and sustained economic growth in the Philippines. References Asian Development Bank. 2005. Labor markets in Asia: issues and perspectives. Manila. Dasgupta, S. and A. Signh. 2005.Will services be the new engine of economic growth in India? Working Paper No. 310. Centre for Business Research, University of Cambridge. Konana, P. and J. N. Doggett. 2004. Comparing India and China growth strate-
gies: chaotic or planned? [online] University of Texas Discussion Paper. http://www.mccombs.utexas.edu/facu l t y / p r a b h u d e v. k o n a n a / indiachina.pdf [Accessed January 24, 2007] Roach, S. 2005. Asian convergence. European Investment Perspectives [online]. http://www.basefinanciera.com/ finanzas/publico/club/ clubfundamental/a_externos/ Ideas_inversion051110.pdf [Accessed January 24, 2007] Rodrik, D. 2004. Industrial policy for the twenty-first century [online]. http:// ksghome.har vard.edu/~drodrik/ UNIDOSep.pdf. Rowthorn, R. and K. Coutts. 2004. Deindustrialization and the balance of payments in advanced economies. IMF Discussion Paper. DRN