Q2 Growth: Old or New Normal?

Introspective By Raul V. Fabella | August 26, 2018, 8:47 pm

The one bright spot for the Philippines in the second half of the 21^st century is its growth. The average growth rate of GDP in the last six years was 6.5%, which exceeded the 4.8% average growth under the Arroyo administration and thus was considered the “new normal.” The Duterte administration aimed to maintain or even exceed the new normal. The first full year of the Duterte administration managed a 6.7% GDP growth which exceeded the 6.5% norm. TRAIN 1, a feat of sorts, was signed in January 2018. One could, with reason, entertain the thought that the Duterte watch is poised to set a “new” normal of perhaps close to 7%. But the 6% GDP growth in Q2 is a three-year low and has renewed the conversation of revert to the old. Not because the 6% growth is to be sneezed at but because by mid-2018 the rainclouds are starting to gather. Inflation in July is 5.7%, and the BSP has responded with increases in the interest rate. The GDP growth for S1 is now 6.3%, which means that the economy has to grow at 7.1% in S2 to equal last year’s 6.7% or grow at 6.7% in S2 to reach the new normal level of 6.5%. Either 6.7% or 7.1% in S2 is now a tall order, given the contractionary pressure from the interest rate rise, the disruptions and floods due to inclement weather, the possible adverse fallout from TRAIN 2 on DFIs and ENDO and the looming headwinds from the tariff wars. Firms may prefer to batten their hatches and wait for sunnier days.

The 6% GDP growth itself owes to the no-growth in the Agriculture output (0.02%) despite no marked weather problem in Q2; a rising trade deficit due to slowing down of exports (13%) and a rising imports (19.7%) also mattered; the latter no doubt related to BUILDx3. There is no observable blip in consumption spending in S1, which could have been expected from TRAIN 1 personal income tax cut. The salient consumption blip came rather in the last quarter of 2017 (6.2%) which anticipated the TRAIN 1 vehicular tax increase. We hope that this dip is a one-off.

But the aspect that is worrying in the Q2 growth is the performance of the drivers: Manufacturing grew at 5.6% while Services grew at 6.6%. In other words, Services was driving the GDP! By contrast, in Q1 2018, Manufacturing grew at 8% while Services grew at 7%; likewise, in the first full year of Duterte’s watch, Manufacturing grew at 8.8% and services grew at 6.8 %. Manufacturing was the driver of GDP during the last six years.

Why is the change in the driver of interest? Because Services, not Manufacturing, was always the driver of GDP in Philippine growth of the old normal going all the way back to Marcos. It was the unique achievement of the Aquino administration that Manufacturing drove GDP (see Figure 1) below. This is the signature of the new normal.

The deeper reason is that this signature of the new normal makes for inclusive growth. It is now a canon in the annals of low-income country development that when Manufacturing drives growth, growth tends to be inclusive; when Services drives growth, it tends to be non-inclusive (see, e.g., Daway, Ducanes, and Fabella, 20161)! The relationship between growth drivers and inclusion is illustrated by the experience of the Philippines, China and Vietnam. Figure 2 gives the average growth of Manufacturing and Services from 1990 to 2010 for these countries.

Note that both in China and Vietnam Manufacturing led Services in growth; the opposite held in the Philippines. Now, contrast the poverty reduction performance of the same countries in the same period (Figure 3). The poverty reduction performance of both China and Vietnam dwarfs that of the Philippines for the same period.

This is consonant with the regression result of above-cited (Daway, Ducanes and Fabella, 2016). When Manufacturing drives GDP growth, growth tends to be inclusive. Thus, it is prudent to beware of Services being the engine of growth in low income countries! That is what happened in Q2 2018. Old habits die hard.

If the Duterte administration’s announced intention to renew Manufacturing especially in the regions sees fulfillment, it would leave inclusion as its legacy. The dip in Manufacturing in Q2 is a reminder that growth in the new normal is still fragile and its roots shallow. There are storm clouds in the global horizon which are beyond our control. The trepidation triggers in our own backyard are, however, our own making: the rising murkiness in the investment climate due to the CHA-CHA, especially the version issued by the Consultative Committee, the added uncertainty from TRAIN 2 and the ill-wind from ENDO. Q2 growth may be the first blush of this trepidation; investors may be deciding to stay on the sidelines and wait for more clarity and clemency.

The stakes are high. If we lose the investment battle, we lose the war. n

¹ “Quality of Growth and Poverty Incidence in Low Income Countries,” available at https://www.academia.edu/34094141/Quality_of_Growth_and_Poverty_Incidence_The_Role_of_Manufacturing

Source: http://www.bworldonline.com/q2-growth-old-or-new-normal/