Our Lady Of Fatima University

Our Lady of Fatima University
Hilltop, Lagro Quezon City

College of Arts and Sciences
Social Sciences and Philosophy Department
2nd semester A.Y 2014-2015

RESEARCH PAPER IN HEALTH ECONOMICS W/ LRT

"The Determinants of Economic Growth in the
Philippines: A New Look."

Prof. Risil C. Galanga, MPA

BY:

JAMILAH G. DUGAN

MT2A2-4
COURSE/SECTIONTABLE OF CONTENTS
I. Introduction .....................................................................................................................3
II. A Bird’s Eye View of the Philippines and the Region Over the Last Decades (BACKGROUND) ......................................................................................................................4
III. Potential Determinants of Slower Growth ......................................................................................................................7 A. The Role of Fiscal Policy ......................................................................................................................7 B. External Developments .....................................................................................................................8 C. The Agricultural Sector ....................................................................................................................10 D. Political Stability and Reform Indicators ....................................................................................................................10
IV. Definition of Terms............................................................................12
V. Construction of a Growth Index ....................................................................................................................13
VI. Concluding Remarks ........................................................................15
Figures
1. Cumulative Real GDP Per Capita Growth of Select Emerging Markets ......................5 2. Change in Central Government Debt in Percent of GDP ..............................................7 3. Change in Interest Payments in Percent of Total Revenue ...........................................7 4. Gross Fixed Capital Formation in Percent of GDP .......................................................7 5. Government Expenditures in Percent of GDP .......................................................... ...8 6. Remittances in Percent of GDP ....................................................................................8
Text Tables 1. Sectoral Value Added and Growth ...................................................................................17 2. Regression Results on Determinants of Real Per Capita GDP Growth ...........................17 3. Regression Results on Determinants of Real Per Capita GDP Growth, by Group...........18 4. Regression Results on Determinants of Real Per Capita GDP Growth, Five-year averages ............................................................................................................18
Appendix Tables A.1 Government Finances ..................................................................................................19 A.2 Capital Formation ........................................................................................................19 A.3 Government Expenditure in Education ........................................................................19 A.4 Other Government Expenditures for Development .....................................................20 A.5 External Indicators .......................................................................................................20 A.6 Working Abroad, Emigration, and Tourism ................................................................20 A.7 Output/Input in Agriculture .........................................................................................20 A.8 Employment in Agriculture .........................................................................................21 A.9 Income and Inequality .................................................................................................21 A.10 Economic Freedom and its Sub-Indices .....................................................................21 A.11 Doing Business Sub-Indices .......................................................................................21 A.12 Population, Crisis Episodes, Coups and Colonial Rule ..............................................22 A.13 Education, Research and Development ......................................................................22 A.14 Patent Applications .....................................................................................................22 A.15 Competitiveness, Technology and Innovation ............................................................22 A.16 Real GDP Per Capita Indices of Select Emerging Markets ........................................23-24
I. INTRODUCTION

The world is witnessing Asia’s transformation that is anticipated to change the face of the global economic landscape. With the advancement of Asia in terms of economy, influence and living conditions over the past half a century, much of the recent literature have recognized its potential to be an economic stronghold.2 Relative to the surging growth in Asia, the picture on Philippine growth has been mixed. However, the expected contribution of—as well as impact on—the Philippines from this promising Asian outlook is less than ideal. In the 1950s, the Philippines had the second highest per capita GDP in Asia. What used to be considered as the Philippines’ counterparts in Southeast Asia: Malaysia, Indonesia, Thailand and Vietnam are now described as high performing economies and are targeting first world statuses, while the Philippines is operating in a low-growth trajectory (Alba, 2007).
The objective of this paper is twofold. First, to identify the factors behind the Philippines’ slower growth by contrasting its track record with other emerging markets in Asia and from other regions. Second, to recommend possible policy measures to address these factors. As far as we know, this is the first attempt to empirically estimate the determinants of slower growth in the Philippines, which include more recent macroeconomic data, novel methods such as index construction, and the use of patent applications to capture research and development. The paper proceeds as follows. Section II gives an overview of the Philippine economy during the last half a century relative to other emerging markets. Section III describes the data, while Section IV presents the model and regression results. Section V proposes the construction of a growth index, to validate the identified variables from the panel in a country-level setting. Finally, Section VI gives the conclusion and policy implications.

II. A BIRD’S EYE VIEW OF THE PHILIPPINES AND THE REGION OVER THE LAST DECADES
Although a singular formula has not been credited as the reason behind Asia’s rise in recent years, a laundry list of the features of the so-called miracle stories are in the literature. The Asian Development Bank (1997) gave the following reasons for the emergence of East Asia: export promotion, private sector-led development, agricultural transformation, high savings rates, skill accumulation and economic flexibility. These miracle economies have all become large-scale exporters of manufactured goods of increasing sophistication, have become highly urbanized and increasingly well-educated (Lucas, 1993). Perhaps the greatest achievement of this sustained, rapid growth is significant poverty reduction and the commensurate improvements in the quality of life. Indonesia, Malaysia, and Thailand have reduced their poverty levels substantially compared to their mid-1970s levels. This is evident in the improvement of social indicators such as life expectancy, infant mortality, and adult literacy (Asian Development Bank, 2002).
Several studies have likewise focused on Philippine growth and provided possible explanations why the Philippines did not become the economic powerhouse it was expected to be. Many observers have attributed the Philippines’ low growth to its weak institutions. Despite the Philippines being an open and growing economy, investment is relatively low compared to the rest of emerging Asia. Fiscal pressures due to weak revenue performance, weighty debt service, and high input costs put a strain on government spending, while the presence of conglomerates serves as a disincentive for the private sector to invest (Bocchi, 2008). While other Asian countries have their share of similar institutional deficiencies, corruption and political instability are unique in the Philippines in its unpredictability and extent (Nelson, 2007). Another factor that has been identified is the detrimental effects to competitiveness of the economic protectionism and the import-substitution policies that were followed after World War II to the 1970s (Yap, et al., 2009).
The Asian Development Bank (2007), using the growth diagnostics approach, identified the following critical constraints to Philippine growth and development: a tight fiscal situation, inadequate infrastructure, weak investor confidence, a small and narrow industrial base, lack and slow growth of employment, inequitable access to development opportunities, and inadequate social protection and safety nets. According to the World Bank (2010), although economic growth picked up sufficiently in the past decade, its sustainability is in question. The Philippines’ high dependency on the external environment and its long-standing constraints to growth—lack of adequate infrastructure, low investment, high unemployment and emigration rates, and government weakness—may still constrain growth. For a recent study on comparing total factor productivity (TFP) growth in the Philippines with other emerging markets, see Ide (2011). To better visualize these differences in growth, the Philippines is compared to three sets of emerging markets, grouped by their cumulative GDP growth rates. Twenty-two other emerging markets, eight of which are in Asia, are used for comparison. The countries are ranked according to their cumulative growth rates during 1984–2008:
 Top performing (Chile, China, India, Indonesia, Malaysia, Sri Lanka, Thailand, and Vietnam);
 Moderately growing (Egypt, Mongolia, Morocco, Pakistan, Tunisia, Turkey, and Uruguay); and
 Slower growing (Argentina, Brazil, Colombia, Jordan, Mexico, Peru, and South Africa).

The ‘top-performing’ group consists mostly of Asian economies. The group is completed by Chile, which ranked fifth. Almost all other Latin American economies belong to the third or ‘slower-growing’ group together with the Philippines, which is ranked 20th. Growth on average accelerated in the period 1984–2008 compared to 1965–1983, but not in the Philippines where it declined (see Figure 1).

During 1965–1983, the Philippine economy performed broadly in line with the average, but was hit by political unrest,3 a string of natural disasters,4 and economic turmoil in 1984. The GNP contracted by -6.8 percent in 1984, followed by a further -3.8 contraction in 1985. Investment, both domestic and foreign, declined dramatically and capital outflows reached as high as US$2 million a day.5 While the natural disasters and economic turmoil that happened in 1984 can be seen as temporary shocks, the political instability in 1984 seems to be the key factor for the rapid growth deceleration given its long run impact on the economy.
Hausmann, et al. (2005) defines economic turning points as rapid acceleration in economic growth sustained for at least eight years. For the Philippines, 1984 was such a turning point marked by a rapid deceleration in per capita GDP growth.
In general, sustained development in East Asia can be attributed to a significant rise in agricultural output and income, followed by the growth of export-oriented, labor-intensive manufacturing (Intal and See, 2008). East Asian governments (with the exception of Hong Kong SAR and Singapore) invested sufficiently in agricultural research, local extension services and rural infrastructure that significantly increased their agricultural productivity (ADB, 1997). However, the Philippines was unable to develop its agriculture and industry sectors (particularly manufacturing) to be at par with its Asian neighbors even after some of the turmoil from 1984 dissipated. In fact, growth in the agriculture and industry sectors, as well as the manufacturing sub-sector, were lower than the ‘slower-growing’ group average for 1984–2008. The literature on economic growth has identified a number of factors that might explain growth. These determinants are discussed in the following section where the Philippines is contrasted with the three other sets of emerging markets.

III. POTENTIAL DETERMINANTS OF SLOWER GROWTH

A. The Role of Fiscal Policy

Indicators of fiscal policy in the Philippines are broadly comparable with other emerging markets, except for the increase in debt (Table A.1). The deficit and tax revenue, both in percentages of GDP, are comparable to the other emerging markets despite showing no signs of improving. Central government debt in percent of GDP increased steadily, a reversal from the overall decreasing trend (see Figure 2). However, interest payments in percent of revenues have consistently been above the emerging market averages, which may be reflective of the stagnant revenue growth (Figure 3).
The Philippines is characterized by slower and declining public and private investment (Table A.2). Capital investments in percent of GDP has declined, compared to the increasing trends of other emerging markets (see Figure 4). Government investment in percent of tax revenue has also declined since 1997, suggesting that this component was compressed during the fiscal adjustment in this period. Notably, governments of the top-performing group invest almost thrice as much as the Philippine ratio. The Philippines stands out as having very low public spending on education (Table A.3). Government spending in education in percent of GDP has increased, albeit lower than the group averages. Data on per capita spending per student show that averages across countries have declined. However, the deficiency in the Philippine educational spending is most pronounced in the tertiary level when compared to other emerging markets.
The Philippines has meager government spending on research and development and transportation, but has substantial expenditure in information and communications technology (Table A.4). Government expenditure in research and development in percent of GDP as well as paved roads in percent of total roads continue to be below the group averages and has declined further recently. However, the ICT expenditures in percent of GDP is one of the highest among emerging markets in 2003 and 2006. This is evident in the upsurge of cellular technology and high-technology exports (i.e., semiconductors) in the Philippines in recent years.
B. External Developments

The Philippines’ external position is relatively strong, as evidenced by its low spreads, but has a larger trade deficit and smaller foreign direct investment inflows. The trade deficit has been substantial; however, it must be noted that the Philippines has been operating a current account surplus since 2003, on account of strong remittance inflows. Net FDI inflows in percent of GDP is below the averages of other countries. The Emerging Markets Bond Index (EMBI) sovereign spreads, or the standard market measure of sovereign default risk, has declined substantially and is now comparable to other emerging markets. The share of remittances in GDP has tripled, while the emigration rate of college graduates continues to increase (Table A.6). Averaging 7.3 percent of GDP in 1984–2008, remittances in the Philippines are the second highest among the emerging markets. The trend in emigration of college graduates in the Philippines is increasing, compared to the generally decreasing trends in other emerging markets.
The performance of Philippine tourism has been below the comparators, but is catching up (Table A.6). The number of tourist arrivals is significantly lower in 1995 and 2007 than in its emerging market counterparts. However, tourism receipts are becoming an increasingly important part of exports, having doubled from 1995 to 2007, while those of other emerging markets remained generally the same.

C. The Agricultural Sector
The Philippines has the lowest agricultural exports in the region (Table A.7). This indicator is an approximate measure of the degree to which an economy 's exports are dependent on agricultural raw materials. A look at the agricultural component of merchandise exports shows a big drop for the Philippines in 1984–2005 relative to 1965–1983. However, the Philippines’ other agricultural statistics are comparable with the top-performing emerging markets (Table A.8).
D. Political Stability and Reform Indicators
Income inequality has increased relatively more in the Philippines compared to other emerging markets (Table A.9). The GINI coefficient has worsened in the Philippines, while being broadly stable for the other emerging markets. The top 10 percent income earners have increased their share of the economic pie, while the bottom 10 percent and the middle income groups saw their decline. The reverse is true for the top performers, which pertains to a more equitable distribution of income. The Philippines has relatively more trade freedom, but also more corruption and barriers to doing business (Table A.10). Generally, the Philippines’ economic freedom index is consistent with the other emerging markets. The Philippines’ trade freedom index increased dramatically between 1995 and 2010, reflecting strong trade liberalization. Indices of corruption and the ease of doing business in the Philippines are consistently lower compared to other emerging markets. In terms of taxes, the Philippines is similar to the emerging market average (Table A.11). Indicators of tax efficiency remained almost the same from 2006 to 2010, while other emerging markets were able to improve theirs. Slower-growing economies in general and the Philippines in particular have faster population growth and a greater number of crisis episodes, coups and years under colonial rule (Table A.12). Population growth in the Philippines has consistently been above the average of other emerging markets and has decelerated at a slower pace. The Philippines has also experienced a greater number of financial crises (banking, currency and debt crises in 1983, aside from the regional crisis of 1997/1998) than other emerging countries. The number of coups (successful as well as attempts) in 1984–2010 has been triple the average in other emerging markets, reflecting greater political uncertainty. Looking back at history, the Philippines experienced the longest colonial rule (333 years under Spain) compared to the averages of the emerging market groups, with potential implications for the quality of institutions and sense of national identity. The Philippines has relatively high literacy, but is weak in research and development (Tables A.13 and A.14). The percentage of literate individuals is higher in the Philippines compared to other developing countries. However, the number of researchers, scientific and technical journal articles as well as patent applications has lagged other emerging markets substantially.
Index scores in competitiveness, technology, and innovation are among the lowest in emerging markets (Table A.15). Different ranking and reform indices show that the Philippines has fallen behind emerging market norms.
The Philippines’ mediocre performance in a number of indicators—particularly relative to its Asian counterparts—illuminates some of the existing pieces of the Philippine growth puzzle. Although broadly speaking, the Philippines does not seem to be an outlier in the context of most indicators presented, a few interesting variables emerge, which will be the focus in the empirical section: i) weak agricultural productivity, ii) high government debt, iii) low public, private, and foreign investment, iv) weak research and development spending, v) low spending on education, vi) lackluster tourism sector, vii) relatively high income inequality, viii) high corruption, ix) strong population growth, x) more episodes of financial crisis, and xi) political uncertainty.

IV. Definition of terms.

Fiscal- of or relating to the public treasury or revenues
Detrimental-causing detriment, as loss or injury; damaging; harmful.
Cumulative- increasing or growing by accumulation or successive additions:
Deceleration- to slow the rate of increase of
Determinants- a determining agent or factor.
Meager- deficient in quantity or quality; lacking fullness or richness; scanty; inadequate:
Expenditure-the act of expending something, especially funds; disbursement; consumption.
Remittances- the sending of money, checks, etc., to a recipient at a distance.
Merchandise- the manufactured goods bought and sold in any business.
Coups- a highly successful, unexpected stroke, act, or move; a clever action or accomplishment.
Mediocre- not satisfactory; poor; inferior:
Counterpart- a person or thing closely resembling another, especially in function:
Regressions- the act of going back to a previous place or state; return or reversion.
Correlation- mutual relation of two or more things, parts, etc.:
Turmoil-a state of great commotion, confusion, or disturbance; tumult; agitation; disquiet
Crisis-a condition of instability or danger, as in social, economic, or political, leading to a decisive change.
Debt- something that is owed or that one is bound to pay to or perform for another:

V. CONSTRUCTION OF A GROWTH INDEX

To explore the importance of these determinants at the country level, a growth index is constructed. Unfortunately, an equation such as the one in Table 2 cannot be estimated for individual countries as the degrees of freedom would be too low. However, an analysis of whether the information from the regressions provides a good fit for individual countries can be made by constructing either a relative index or a weighted index. For both indices, the nine variables from specification 3 in Table 2 and the corresponding signs of its coefficients are used. The relative index assigns scores based on rankings. For indicators with a positive (negative) effect on real per capita GDP, the countries are ranked in ascending (descending) order by their indicator values for a given year. The country score for a particular indicator per year is equivalent to its rank. Hence, the highest possible country score for a particular indicator per year is equivalent to the number of countries with available data. Consequently, countries with no available data for a given year are given a score of “0.” The overall relative index of a country for a given year is then computed as the total scores (or rankings) for each of the nine variables.

The relative index captures well the dynamics of Philippine growth. Table A.16 below shows the cumulative five-year averages of real GDP per capita rankings as well as the computed rankings based on the relative index of the sample. The estimated relative index is consistent with the Philippine growth performance. While the Philippine economic growth has picked up considerably in the last decade, per capita GDP for the most part of the estimation period (early 1980s to the 1990s) was far below the average for East Asia.
It should be noted though that the index value is affected—for some countries—by data limitations. For example, China only has data for the current account balance and the number of patent applications beginning 1981 and 1985, respectively. This automatically gives China a score of “0” for these two indicators for the years without data. Similarly, Vietnam and
Mongolia have no data available for the fiscal balance and other countries also have missing data for some indicators in various years. Given the shortcomings of the relative index, a weighted index is constructed, which uses correlation coefficients as weights and standardized values of the data set. For the variables in specification 3 in Table 2, the values are standardized across countries and across time using the mean and standard deviation of the entire sample.9 The correlation of each variable with real GDP per capita is then computed for the 23 countries.10 The weighted index of a country for a given year is computed as the linear combination of the variables using the correlation coefficients as weights. To account for data gaps, the weighted index is divided by the number of available data for that given year.

In general, the weighted index provides a good fit and suggests that the Philippines did not have sustained periods of above-average improvements in economic fundamentals compared to its counterparts in the region. For the Philippines, the correlation between the real per capita growth rankings and the rankings based on the weighted index is 49 percent, which is above the 47 percent average of all countries (see Table A.16). However, it is still not an ideal index for all countries. For example, Malaysia scored relatively low especially in the last decade. An explanation for this could be that certain country-specific variables that are important to growth, although to some extent captured in the regression by the initial GDP per capita variable, are not included in the weighted index. Furthermore, the importance of such country-specific factors could change over time, which would not be captured in the regression specification. In the context of the indicators identified, the Philippines has experienced a gradual relative decline, which is in stark contrast with its Asian counterparts that have high rankings that coincide with the recent resurgence in the region. The rankings of the relative and weighted indices appear to capture that 1984 was indeed a turning point for the Philippines, which is not clear from the actual real GDP per capita rankings. Note that taking the cumulative real GDP growth rates instead (as in Figure 1) shows that the Philippine growth rate declined further starting 1984.

VI. CONCLUDING REMARKS
Novel methods are applied to identify which factors have caused the Philippines’ growth rate to lag behind its neighbors. Key determinants of per capita GDP growth are investigated in a panel of 23 emerging markets for the period 1965–2008. Splitting the sample into top performing, moderately growing, and slower-growing countries reveals that the Philippines is an outlier in terms of agricultural exports, investment, research and development, population growth and political uncertainty. Panel regressions reveal that these factors, along with the deficit, inflation, trade openness, the current account balance, and the frequency of crisis episodes are significant determinants of growth. Separate regressions show considerable heterogeneity among the growth determinants in a group of top-performing countries relative to moderately growing and slower-growing countries. A growth index is constructed that confirms that the determinants found in the panel regressions are also key for both the absolute and relative performance of each emerging market over time. The construction of a growth index focuses on the usefulness of the identified determinants at the country level. The index underscores that the regression is a good fit for the Philippines both in terms of its absolute and relative performance over time. In addition, it accurately dates the turning point when the Philippines started to lag behind. Finally, it also suggests that the Philippines lacked sustained periods of improvement in the key growth determinants, indicative that a strong and persistent period of economic reforms has been absent. The analysis suggests that to catch up with its East Asian counterparts, the Philippines will need to i) maintain macroeconomic stability, ii) expand its fiscal space, and iii) redirect public spending to agriculture, infrastructure, and research and development. Expansion of the fiscal space and thus scaling up spending on public investment requires raising tax revenue through both administrative and selective tax policy measures. This would include strengthening tax administration, reform in excise taxes, rationalization of fiscal incentives, and addressing exemptions in value-added taxation. Better irrigation, access to fertilizers, farm-to-market roads, and storage facilities could support development in the agricultural sector. The government’s focus on public-private partnerships (PPP) for traditional and nontraditional infrastructure investments is also beneficial for maximizing the returns to development. Strengthening the focus of education on the sciences in all levels would encourage future researchers and scientists who would be instrumental in nation building.

Tables

Appendix tables

REFERENCES
Alba, Michael M., 2007, “Why has the Philippines Remained a Poor Country? Some
Perspectives from Growth Economics,” Discussion Paper No. 2007–01, (Quezon
City: University of the Philippines School of Economics).
Aristovnik, Aleksander, 2006, “The Determinants and Excessiveness of Current Account
Deficits in Eastern Europe and the Former Soviet Union,” MPRA Paper 483,
(Germany: University Library of Munich).
Arora, Vivek and Athanasios Vamvakidis, 2004, “How Much Do Trading Partners Matter for
Economic Growth?,” IMF Working Paper 04/26 (Washington: International
Monetary Fund).
Asian Development Bank, 1997, “Emerging Asia Changes and Challenges,” (Mandaluyong
City: Philippines).
––––––, 2011, “Asia 2010: Realizing the Asian Century,” (Mandaluyong City, Philippines).
––––––, 2002, “Growth and Poverty: Lessons from the East Asian Miracle Revisited,” ADB
Research Paper (Mandaluyong City, Philippines).
––––––, 2007, “Philippines: Critical Development Constraints,” Country Diagnostics
Studies, Economics and Research Department (Mandaluyong City, Philippines).
Asmann, Christian, 2008, “Assessing the Effect of Current Account and Currency Crises on
Economic Growth,” (Germany: Department of Economics, Christian-Albrechts-
Universitat Kiel).

http://www.academia.edu/405141/The_determinants_of_economic_growth_in_emerging_economies_a_comparative_analysis https://ideas.repec.org/p/imf/imfwpa/11-288.html http://www.adb.org/publications/economic-growth-asia-determinants-and-prospects http://dirp3.pids.gov.ph/ris/dps/pidsdps1211.pdf www.nscb.gov.ph/ncs/9thncs/papers/poverty_profile.pd mpra.ub.uni-muenchen.de/19449/ www.adbi.org/discussion.../institutions.and.economic.development/

www.eaber.org/sites/default/files/.../PIDS_Duenas-Caparas_2006.pdf

References: Alba, Michael M., 2007, “Why has the Philippines Remained a Poor Country? Some Perspectives from Growth Economics,” Discussion Paper No Aristovnik, Aleksander, 2006, “The Determinants and Excessiveness of Current Account Deficits in Eastern Europe and the Former Soviet Union,” MPRA Paper 483, Arora, Vivek and Athanasios Vamvakidis, 2004, “How Much Do Trading Partners Matter for Economic Growth?,” IMF Working Paper 04/26 (Washington: International Asian Development Bank, 1997, “Emerging Asia Changes and Challenges,” (Mandaluyong City: Philippines). ––––––, 2011, “Asia 2010: Realizing the Asian Century,” (Mandaluyong City, Philippines). ––––––, 2002, “Growth and Poverty: Lessons from the East Asian Miracle Revisited,” ADB Research Paper (Mandaluyong City, Philippines). ––––––, 2007, “Philippines: Critical Development Constraints,” Country Diagnostics Studies, Economics and Research Department (Mandaluyong City, Philippines). Asmann, Christian, 2008, “Assessing the Effect of Current Account and Currency Crises on Economic Growth,” (Germany: Department of Economics, Christian-Albrechts-