The structural weaknesses of the Philippine economy

Introspective By Calixto V. Chikiamco | September 9, 2018 – 9:34 pm

Recent economic data show the structural weaknesses of the Philippine economy.

In August, inflation accelerated to 6.4% pa from 5.7% pa in July, the highest inflation rate in nine years.

The tighter monetary stance of the Bangko Sentral and higher inflation will slow growth even as GDP posted a disappointing 6% pa growth in the second quarter, far below the government’s target of 7 to 9% pa.

Trade and current account deficits continue to widen. More alarmingly, exports have continued to slide despite the weakness of the Philippine peso and strong global growth, which is supposed to lift the demand for exports.

Government economic managers have dismissed these recent economic data as mere hiccups. On the contrary, the higher inflation rate, the widening current account, balance of trade and balance of payments deficits, reveal the structural weaknesses of the economy, which remain unaddressed. This means that the economy is very much vulnerable to shocks of the sort we are seeing now. It also shows that the economy is performing far below its potential and that the economy is just cruising along on the back of OFW remittances. Therefore, the government can take little credit for economic growth.

These structural weaknesses are related to the four binding constraints I keep writing about: 1) Monopolies in strategic industries, namely, shipping, ports, and telecommunications. 2) The National Food Authority (NFA) monopoly in rice importation and the Department of Agriculture’s obsession with rice self-sufficiency. 3) Labor rigidities, in the form of high minimum or entry-level wages and highly restrictive labor security regulations and 4) The restricted rural land market due to CARP laws and overregulation by the Department of Agrarian Reform.

Take, for example, the recent inflation. If you take away oil price increases, much of the inflation is the result of food inflation. Rice prices continue to surge because of the NFA’s mismanagement of the rice supply situation. The lack of rice supply from importation can be strictly traced to NFA since it has the sole authority under the law to import.

In other words, the culprit is the NFA and its legal monopoly is to blame. However, the buck stops with President Duterte because he favored the NFA’s head Jason Aquino in a policy dispute with Cabsec Jun Evasco, who was pushing for the private sector to import rice. We must ask President Duterte why he favored Aquino and hold him accountable.

The NFA’s monopoly on rice importation has many negative effects on the economy: 1) It saddles the government with large fiscal losses since it imports rice and sells them below cost, ostensibly for the poorer rice consumers. Actually, there’s a lot of diversion going on, probably by the NFA in collusion with unscrupulous rice traders. 2) It makes our manufacturing uncompetitive because rice represents the biggest source of calories for the Philippine worker. High rice prices mean higher wages and lower competitiveness. (This also relates to the uncompetitiveness of our labor-intensive export manufacturing, which has shown significant weakness in this year’s economic figures.) and 3) The NFA and the Department of Agriculture’s unrealistic rice self-sufficiency program consumes at least 60% of the budget for agriculture. There’s not enough budget for higher value crops, the cultivation of which would benefit the economy more.

The ideal situation is this: Let the private sector import rice with the lowest tariff rates possible (higher tariffs will only encourage smuggling.) Rice prices should then fall. More than 100 million rice consumers will benefit. Workers will see an increase in their real disposable incomes, enabling them to buy wage goods that should benefit local manufacturing. The budget that’s now going to rice can then be used to increase production of higher value crops, which would mean more income for rice farmers. As a bonus, the majority of rice farmers, who consume their own production during the harvest season and buy from the market during the lean season, will benefit from lower rice prices as well.

However, it’s not only rice but the entire agricultural sector as well that’s the culprit in the disappointing inflation, GDP and export numbers. Agricultural growth was flat in the second quarter. Copra prices have also collapsed, contributing to the poor export and agricultural production numbers.

With agricultural production growing much less than population growth, food prices will always be under pressure. Again, manufacturing gets impacted because workers have to spend much more of their pay on food. Workers then have to demand higher wages to keep up with food inflation.

What is the cause of our low agricultural productivity and anemic agricultural growth? The three binding constraints of monopolies in strategic industries, the NFA rice monopoly, and CARP laws and regulations come into play. Monopolies in ports and shipping make transport of agricultural goods expensive. The NFA rice import monopoly and the DA’s rice self-sufficiency program mean government’s budget for agriculture goes mainly for rice, a low value-added commodity for which we have no competitive advantage. CARP laws and regulations discourage private investments in agriculture, hinder loans to the agricultural sector (there are many restrictions on rural land that prevent banks from lending against farmlands, particularly those with Certificate of Land Ownership Awards), and cause the fragmentation of farmlands.

The weakness of our export sector despite strong global growth and the weakness of the peso should similarly be a cause for concern. It has resulted in growing current account, balance of trade and balance of payments deficits and decline in international reserves. While import-intensive electronics exports have remained steady, agricultural exports have declined while other manufacturing exports also fell. The former is due to low agricultural productivity in primary agricultural exports, such as copra, and the latter is most probably due to the uncompetitiveness of our exports caused by labor rigidities (high minimum wages and security of tenure provisions in the Labor Code).

We have not been able to diversify our exports beyond import-intensive electronics. Labor-intensive export industries, such as garments and light manufacturing, have fled to countries such as Cambodia, Bangladesh and Vietnam. Our high entry level wages, the most number of official holidays, increased SSS pension contributions, security of tenure provisions in the Labor Code, and threats such as ending ENDO and giving 14^th month pay proposed by the Secretary of Labor, have caused labor-intensive manufacturing investors to flee.

On the other hand, while Vietnam has become the biggest coffee exporter in the world, our Department of Agriculture is obsessed with rice self-sufficiency. Our farms are also fragmented, with an average size of one hectare because of CARP (Comprehensive Agrarian Reform) restrictions. Due to restrictions on farmland ownership, efficient farmers are prohibited from buying out inefficient ones. Even leasing of rural land is difficult due to overregulation of the rural land market by the Department of Agrarian Reform. Finally, credit doesn’t flow to agriculture because of restrictions on agricultural land that make them unbankable.

The inflation surge is but the tip of an iceberg. More fundamentally, our rising current account, trade and balance of payments deficits are causes for concern. “You ain’t seen nothing yet,” as the Americans say. The balance of trade has widened when BBB or the government’s infrastructure program hasn’t yet taken off in earnest. Imagine a jump in the level of capital imports and the trade deficit once the infrastructure program gets going.

The prescient purchase of dollars by the BSP on the watch of Governor Say Tetangco is the only thing keeping us from being another Indonesia, where the rupiah has fallen steeply amidst rising current account deficits. But maybe not for long because the deficits are rising and depleting our international reserves while our structural problems remain unaddressed.

In my next column, I will discuss what the government should do. However, I will say now what the government should NOT do. It should not spend its political capital on Charter change toward a flawed federalism and on prosecuting the opposition. President Duterte should not keep Jason Aquino, Manny Piñol, Art Tugade, and Silvestre Bello III, who are responsible for the failures in governance we see today.

I repeat: The unwelcome rise in inflation is but the tip of an iceberg. Other shocks, from a speculative attack on the peso to double-digit interest rates, await the economy if the structural weaknesses of the economy remain unaddressed. Time for the administration to go off its high horses, remove its air of arrogance and hubris, and buckle down to work. Otherwise, it will keep breaking records in terms of inflation rate, decline in the peso, and loss of business confidence.

Source: http://www.bworldonline.com/the-structural-weaknesses-of-the-philippine-economy/