EconomyEditor's PickWhy are investments low and how can the country increase investments to generate jobs and recover from the pandemic?

November 1, 2021

(First of two parts)

IN THE FIRST PLACE, how is the country faring with respect to investments? Very poorly. Not just in foreign direct investments, but in domestic investments as well. Both in absolute numbers and in growth rates, the amount of investments (and the portion going into investment spending) is low. FDI was only $4.5 billion in 2019, compared to Vietnam’s $8 billion and Indonesia’s $13 billion. Investment spending as a percentage of GDP is the second lowest in Asia. We rank near the bottom with Cambodia. As a percentage of GDP, the country’s ratio for the years 2010 to 2019 was only about 22%, just ahead of Cambodia and well-behind Vietnam (26%) and Indonesia (31%).

This means that domestic investors also don’t have confidence in the Philippine economy. The question is why? Aside from the restrictive laws that discourage foreign investments (the 3rd most restrictive in the world, according to the OECD or the Organization for Economic Cooperation and Development), which could account for the paltry foreign investments, why are even domestic investors timid and afraid? Here are my answers:

1. The dominance of monopolies in key industries. This is the answer given by Alexander Bocchi, an Italian economist, who did a study for the World Bank in 2008. He noticed that investments were concentrated in capital-light industries such as Business Process Outsourcing and not much in capital-intensive industries, such as steel and chemicals manufacturing. Bocchi said the explanation lies in the fact that politically connected local conglomerates control key industries. These industries make the economy uncompetitive overall. Not only do investors have to deal with the high costs and bad service from these monopolists, they also would have to deal with the uncertainty of the rules as these conglomerates are politically connected.

Indeed, the Philippines is the most concentrated economy in Asia, tying with Bangladesh, i.e., monopolies and duopolies control many industries. Aspiring competitors would find it hard to compete with these existing monopolies and legal and non-legal barriers to entry.

The dominance of monopolies, especially in regulated non-tradable service industries, has many other negative effects, not just in discouraging investments and making the economy uncompetitive.

For example, the high cost of labor in the Philippines could be accounted for by the monopolists’ tolerance for higher legal minimum wages and other labor costs. They could very well afford to part a pittance of their monopoly rent as it has a negligible effect on their monopoly profits. An increase in legal minimum wages would hardly dent the profits of the telecom companies, for example, but would, and is, gravely hurting MSMEs (Micro, Small and Medium Enterprises).

2. Lack of public goods. Public goods — the stuff that the government is expected to provide — from roads to education — are lacking or are of poor quality. An MSME investor, for example, will find that he/she must internalize the cost of traffic or bad roads. His transportation vehicle will break down easily and be limited in its turnaround time due to congestion and other problems.

The poor quality of graduates is another cost that businesses must internalize. Instead of new employees being able to become productive off the bat, they need to be trained and retrained, at the cost to the employer.

The lack and poor quality of public goods, therefore, is a significant deterrent to investment.

3. Bad governance. Corruption, rigged rules, incompetence, and inefficiency scare away investors. For example, say you are a garments manufacturer. You can repurpose your factory and even buy new machinery to produce masks that the public desperately needs. However, will you even bother when a winner has been pre-determined?

This is just one example. There are millions of other examples. Investors experience bad governance up and down the different levels of government, from securing licenses from City Hall to getting permits from national regulatory agencies.

Investors hate uncertainty. They thrive best when there are rules and predictability. Unfortunately, in this country, the “rules themselves are for sale,” as National Scientist Dr. Raul Fabella so aptly put it. If the rules themselves are for sale, the game becomes chaotic. The risks become unmanageable.

However, the root of bad governance lies in our political economy. Our oligarchy is in regulated non-tradable services, where the incentive is to “capture the regulator” or “penetrate the state” to earn extraordinary profits.

Unlike in other countries, where the economy is outward-looking and their oligarchy is subjected to the discipline of competing globally, the Philippine economy remains inward-looking and a weak, incompetent state serves the interests of the local oligarchy.

Furthermore, lack of competition exacerbates the bad governance. At least when there’s healthy competition, companies try to extract value by innovation and satisfying the customer. Where the situation is monopolistic, the companies try to gain an edge by getting favors or “rents” from the government. In other words, corruption and monopoly go hand in hand.

In an outward-looking economy, companies will have a difficult time competing in the global market if the government is corrupt, inefficient, and incompetent. Samsung can’t compete in manufacturing and selling chips worldwide if South Korea’s infrastructure is creaky or their public education produces incompetent graduates. Look at all the outward-looking economies — China, Japan, South Korea, Singapore, Taiwan, and Vietnam, and they all have relatively strong, competent bureaucracies, good educational systems, and effective governments.

Not so in the Philippines where exports remain a tiny 30% of GDP, compared to say, Vietnam, which can boast of 100% of exports to GDP.

4. Uncertain property rights and over-regulation. Fundamental to investment is well-defined and secure property rights, according to Law and Economics. Indeed, if you can’t reap what you plant, and if your right is made insecure by government regulation, why invest at all?

Uncertain property rights and over-regulation, for example, explain the denudation of the forests, the decline of the forestry industry, and why the country hasn’t been able to realize its forestry potential.

Look at this contradiction: The Philippines has a competitive advantage in forestry. It’s in the tropical zone, where trees mature faster. The country can produce 100 cubic meters of timber per hectare compared to a temperate country like Finland, which can produce at most, 15 cubic meters per hectare. It’s also a mountainous country, which has more than three million hectares suitable for tree plantation.

Moreover, there’s a growing global demand for forestry products, from pulp that can be made into paper, to furniture and construction materials. Because of the carbon credits that forest plantations generate and the “green” branding they project, investors are eager to invest in forest plantations.

And yet, the Philippines is a major importer of wood and wood products. Whereas before the Philippines was a major exporter of logs and timber, presently, it imports 75% of its wood requirements. Very few investors in tree plantation are left.

The answer to this conundrum is unsecure property rights and over-regulation. Forestry investors got whipsawed when the Benigno (Noynoy) Aquino administration issued a total log ban. The EO didn’t make a distinction between natural forests and man-made or planted forests. Over-regulation, in the form of 100% inventory of trees to permits to harvest and transport, increased the costs and uncertainty of doing business. Wood processing plants were given short-term permits contingent on many regulations of the Department of Environment and Natural Resources (DENR). Consequently, in the CARAGA region, a center of forest production, the number of wood processing plants shrank from 120 before the total log ban into a pitiful three plants. Because the demand for timber from wood processing plants evaporated, the tree farmers couldn’t find a market for their products. Government killed the industry.

Even now, although the DENR recently issued DAO 2008-12 to liberalize certain policies for tree plantation, there’s still hesitancy among investors. The reason is that there are a lot of overlapping claims on the forest, even if, under the Regalian doctrine, the state is the sole owner of forest lands. The National Commission of Indigenous Peoples has been issuing Certificates of Ancestral Domain (CAD) titles right and left, without clear surveys and even if IP titles are “qualified titles,” i.e., subject to prior rights. There’s also no central registry for IFMAs (Integrated Forest Management Agreements), CADTs, and similar rights over the forest. There’s just property rights mayhem and uncertainty facing investors.

The problem of property rights uncertainty and overregulation similarly affects agriculture. The rural land markets are overregulated, and therefore agricultural productivity is poor. Efficient farmers, for example, are prohibited from buying out inefficient ones due to the land retention limit of five hectares stipulated in the Comprehensive Agrarian Reform Law. In other words, a farmer making good money and making the land productive is prohibited from buying the land of a neighboring farmer who is much less efficient and unproductive.

Land consolidation through leasing is also prohibited or discouraged. Agrarian Reform Beneficiaries (ARBs) with outstanding debts to the Land Bank are prohibited from selling or leasing out the land. Most of these ARBs (about 75%) are unable to pay the amortizations so their farms, which are the most productive since they were the first ones targeted under CARP, are excluded from the leasing market.

The result of this over-regulation is land fragmentation, which, according to Canadian economists Tasso Adamopolous and Diego Restuccia in a paper published in the US National Bureau of Economic Research, has caused a drop in Philippine farm productivity by 17%. In other words, while peasants become landowning farmers, they became poorer. No wonder our agricultural growth can’t even match population growth and the country has become a big importer of food.

5. Labor rigidities and plight of labor-intensive industries. The country hasn’t industrialized. Services dominate the economy. The economy is suffering from development progeria, according to National Scientist Raul Fabella, or premature aging because it has bypassed the manufacturing stage to go immediately into a service economy.

The problem is that much of the services in our service economy consist of low-productivity, low wage work, such as selling fast food or delivering packages. Higher productivity, higher wage jobs are in manufacturing, but labor-intensive manufacturing fled the country and found more favorable environments in Vietnam, Bangladesh, and other countries, even though nearly a quarter (a third since the pandemic began) of the labor force are unemployed and underemployed.

Here again is a contradiction: the country has a large labor pool, much of which is young and idle, but investors aren’t coming in here to make use of our large English speaking labor force despite labor scarcity and ageing population in many countries. Why? The answer lies in labor rigidities: inflexible rules built into the labor code that discourage employment.

These labor rigidities consist of high minimum wages relative to productivity and strict rules guaranteeing labor security and permanency after a probationary period of a mere six months. The fact that entry level wages are close to average wages in the Philippines is an indication that entry level wages are too high for unskilled, low level wage work.

Investors in labor-intensive industries also must contend with costly and strict standards for labor permanency after a mere six months. Labor disputes can be costly, especially if the decisions are made many years after the alleged illegal dismissals.

Another rigidity that discourages investment in labor-intensive industries, and which mainly penalize MSMEs rather than monopolists is the sheer number of holidays in the country — the most in Asia. With holidays numbering not less than 26 a year, employers are effectively paying 14 months, compared to paying only 12 months in other countries.

(To be continued.)

Calixto V. Chikiamko is a business process outsourcing and internet entrepreneur, a book author, and a writer on political economy. He serves as a property rights consultant to The Asia Foundation and is currently president and co-founder of the Foundation for Economic Freedom. He is a board member of the Institute of Development and Econometric Analysis.

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