Low-investment risks cited

BusinessMirror, February 7, 2008

THE low level of investments despite high economic growth in the Philippines should be a cause of concern for the country as this could result in longer-term risks, according to an economist of the World Bank (WB).
In a policy research working paper titled "Rising Growth, Declining Investment: The Puzzle of the Philippines Breaking the 'Low-Capital-Stock’ Equilibrium," WB East Asia and Pacific Region senior economist Alessandro Magnoli Bocchi said that in the long run, export-led services might “cannibalize" remittances-fueled consumption.

“As the service sector grows and creates employment opportunities, the present labor outflows might get absorbed by the domestic economy. Also, when first-generation emigrants diminish in volume, remittances inevitably  decline: in those countries where emigrants are allowed to settle-when the first generation comes to the end of its working life, and the ties between the following generations and the country of origin weaken-the second-and third-generation emigrants tend to remit a lower proportion of their income,” Bocchi said.

He said that while the present growth path of the country is stable and could hold in the short and medium term, the growth is “curtailing” faster and inclusive growth. He said this also leaves the country’s true growth potential untapped.


To help investments, grow at the pace of GDP, Bocchi said the government must adopt at three-pronged strategy of improving economic zones while pursuing competitive  exchange rates that promote new exports; increasing revenues to finance infrastructure and education spending; implementing gradual reforms to tackle the rent seeking conglomerate economy; and opening oligopolistic markets.

“To reach its growth potential and sustain it in the long term, the economy needs to take better advantage of its geographical location and – by offering appealing opportunities within the regional context – attract more domestic and foreign investment of its core sectors. But to deliver faster growth, the country needs to address its lack of competitiveness,” he said.

Bocchi said greater competition in ports and shipping, civil air transport, wholesale electricity and cement-production markets should be encouraged. This would reduce costs, spur investments and create jobs.

The government, Bocchi said, should also reduce protection for agriculture products, particularly rice, to benefit food processing and livestock industries. However, Bocchi stressed that political reforms are needed to trigger and sustain these economic gains.

“The economy needs to reach an equilibrium that is more conducive to sustainable growth. In conclusion, moving to a ‘high-capital-stock’ equilibrium – attainable through fewer elite capturing regulations, more public-private risk-sharing and greater government revenues – is needed to sustain speedier and more inclusive growth, and to reduce unemployment and poverty more rapidly,” Bocchi said.

The WB economist said lack of investments in the country is due to low public-sector investments and the dampened interest and inability of the private sector to invest.

Of the overall investment decline, domestic investment fell by 80 percent while foreign investments decreased by 15 percent. Adding an element of rigidity to the downturn, 40 percent of the overall decline was due to lower construction, he said.


“Three reasons explain this puzzle: in the Philippines, investment does not grow at the pace of GDP [gross domestic product] because the public sector cannot afford it, the capital-intensive private sector does not want to expand that fast, and the rest of the private sector does not need it,” Bocchi said.

He said the government’s low investments have become a bottleneck for private investment, compared with its Asian neighbors. Bocchi said the country ranks low in transport comparisons and educational achievement.

The serious fiscal pressures of the public sector, due to decades of weak revenue performance, prevent the government from keeping public investments growing at the pace of GDP growth. “The declining quantity and quality of public investment, especially in infrastructure and education, provide little incentives for private investment and constitutes a bottle-neck to long-term economic growth,” Bocchi said.

The high cost of inputs and weighty debt service, he added, exacerbate the fiscal position of the government and prevent it from increasing its investments.

While the government is now trying to resolve its fiscal problems with reforms such as the value-added tax (VAT), this is insufficient, Bocchi said. The collection of corporate and personal income taxes and excise taxes remain insufficient.

“The public-debt-to-GDP ratio remains high at about 77 percent, the fiscal position is till fragile and significant interest payments still expose the economy to swings in financial-market sentiment. Hence, containing the risk premium with further tax efforts and steady progress on reforms is crucial. Concerns about the long history of macroeconomic volatility, the unsettled political climate and [the unpredictability in the incidence of] corruption add to risks for investors,” the paper stated.


Another reason Bocchi cited for the low investment levels was the expectation by the capital-intensive private sector of low returns – preventing it from expanding its investments at the pace of GDP growth.

By not investing enough to provide incentives for private investments, the public sector must share blame for the low interest in the private sector to invest.

He said the high cost of inputs also makes expansion – particularly in agriculture, sea and air transport, power, cement, mining and banking – unattractive to the private sector.

“Inputs are expensive because of elite-capture in the traditional sectors of the economy [such as] agriculture, sea and air transport, power, cement, mining and banking. There, the politically connected corporate conglomerates, protected by favorable rules and regulations, enjoy barriers to entry and market power, and hence sell at a high price their products which are critical inputs for both upstream and downstream sectors,” Bocchi said.

According to him, low productivity in traditional sectors also prevents investors from expanding or increasing investments.

Bocchi said because of this, “rent-seeking corporate conglomerates, controlled by the local elite,” use political connections to hinder tax collection that dampens public spending and limit economic entry that drives potential investors out and discourages smaller firms to expand.