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Institutional failures and economic growth

I will state here what is obvious: we are seeing governance and institutional failures that have impoverished Philippine society: Philhealth, the Department of Health, the Philippine National Police, the Bureau of Corrections and Jail Management, the National Telecommunications Commission, the Bureau of Immigration, the Task Force Bangon Marawi, not to mention the usual culprits, Customs, the Department of Public Works, Department of Transportation, etc.

However, these governance and institutional failures are not particular to the Duterte administration, but range across the different administrations. Moreover, the failure is present not only in the executive department but also throughout the bureaucracy and other institutions of government, from the legislative to the judiciary.

Governance and institutional failures are one of the reasons the Philippines still lags behind its ASEAN neighbors and why a country like Vietnam, devastated by years of war, can catch up and even overtake us.

Economic underdevelopment, therefore, is both a policy and institutional failure. I laugh at the stupidity of some “leftist” analysts whose knee-jerk reaction to anything that deviates from their Amado Guerrero thinking as “neo-liberal economics.” They imply that all non-socialist economists are market fundamentalists who see nothing but deregulation, privatization, free trade and globalization as the solution. The fact of the matter is that modern day economics has recognized the role of institutions (a matter that Marx himself recognized, albeit from a class standpoint), the rule of law, culture, and human behavior in economic development.

How important are institutions? China’s meteoric rise, for example, is wrongly attributed to economic reforms alone, according to Professor Yuen Yuen Ang of the University of Michigan. In reality, China, under Deng, undertook political and governance reforms that made possible its rapid economic development. These reforms included term limits on China’s rulers and performance ratings and competition in the bureaucracy. The result is that even Microsoft Founder Bill Gates marvelled at the excellence of China’s bureaucracy. The fact that China’s Xi Jinping is undoing these reforms is a different story altogether and may be a harbinger of weaker economic performance ahead. (Watch Prof. Ang’s excellent Youtube video lecture on China’s rise:

However, here in the Philippines, why are our institutions weak, inefficient, dysfunctional and corrupt?

First, there’s history. As I had repeatedly said, rent-seeking came early to the Philippines with the government allocating foreign exchange after independence in 1946 due to the loss of exchange rate sovereignty mandated by the Bell Trade Act. The politicization of economic decisions that came with foreign exchange control provided an incentive for weak and politicized institutions.

On top of these weakened and politicized institutions and rent-seeking in foreign exchange allocation, the country built a state guided by protectionism, economic nationalism, regulatory overreach, and statism that only worsened rent-seeking. (Did you know that the Philippine government went into the retail business itself in the 1950s with NAMARCO — the National Marketing Corporation? Or that Marcos authored a law that required permits for all imports?)

Furthermore, the US as the neo-colonial power, extracted through the Laurel-Langley agreement a privileged position versus other foreign nationals that its citizens be treated on equal footing with Filipino citizens, including the ownership of land; therefore, US interests became perfectly aligned with that of domestic rent-seekers and weak institutions.

This history of weak and politicized institutions continues to this very day. The present is a product of its past. Neither have our institutions been tempered in war, such as in Vietnam or South Korea, nor of a long history, as in Thailand.

Second, the political economy partially explains our weak institutions. Weak institutions are in the interest of our oligarchy, which derive much of their wealth in non-tradable, regulated service industries, such as shipping, ports, banking, telecommunications, infrastructure, real estate or in unsolicited PPP projects. “Regulatory capture” is in their interests, even if they deny it.

Third, a monopolistic economy, i.e. one dominated by monopolies and oligopolies, make for weak institutions. For so long as monopolies can extract rent, there’s little interest in innovation or for society to function well. Deteriorating peace and order, poor public education, corruption in Customs, etc. do little to reduce monopoly profit and therefore don’t spur a demand for better governance and public institutions.

Lastly, the Philippine economy is still inward-looking. It is the last among ASEAN nations in the ratio of exports to GDP (gross domestic product). Our export to GDP ratio is about 30% and declining, compared to Vietnam, whose exports are 100% of its GDP.

How does that affect our institutions? Export or outward looking economies, such as Taiwan, Japan, South Korea, and Vietnam have to have strong domestic institutions if their export champions are to compete in the world market. A country, for example, cannot hope to export pharmaceuticals if its drug authority is corrupt and allows substandard pharmaceutical drugs to proliferate. Its transport and port systems must be efficient for its export products to be cost competitive in the world market.

Here, unfortunately, our economic officials cheer a strong peso — a symptom of inward-lookingness — rather than fostering exports and an outward looking orientation. They reflect the elite view that exporting people, via OFWs, rather than goods will be the economy’s savoir and it’s better to do nothing but be a service-driven economy.

Can we strengthen our institutions by changing our form of government to parliamentary or federalist? No, because the root causes of the dysfunction of our bureaucracy is in our political economy. Until that is changed, democracy and good governance will just be formalisms without substance.

So, what do we do? First, we have to make rent-seeking less dominant in the economy. We need to introduce more competition into the economy by removing the foreign ownership restrictions in the Constitution, passing the Public Service Act Amendment, and dismantling all anti-competitive barriers in the economy. There are just too many barriers to competition in the economy, such as the requirement of franchises to offer satellite broadband, to the government being both regulator and operator at the same time, as in the Philippine Ports Authority.

Second, we have to depoliticize the bureaucracy. Presently, the President can appoint officials down to the assistant bureau level. Perhaps the President shouldn’t also be allowed to appoint more than two undersecretaries in a department. (In the Department of Natural Resources, for example, there are nine, of which only four are career.) The rest should be civil servants who must pass stringent regular performance ratings.

Presently, after every administration change, the bureaucracy has been used to reward political appointees and loyalist followers who have little or no competence.

Third, we have to demand more from our civil servants. Our populist politicians are fond of giving our teachers and men in uniform generous salary increases without demanding anything in return. The result is that the Philippines scores last in the PISA (Program for International Student Assessment) ratings in math and science while our PNP’s reputation is being corrupt, criminal, and functioning as mere tools of public officials despite salary increases.

Lastly, given the reality of the weakness of our bureaucracy, we should resort to solicited PPPs (Public-Private Partnerships) as much as possible. PPPs are a way to harness the private sector to cover for the weaknesses of our bureaucracy in delivering infrastructure or public services. However, unsolicited PPPs must be discouraged because they are another form of rent-seeking and we see unsolicited project proponents try to stifle competition.

We should also try to outsource governance where feasible, such as getting SGS or other internationally recognized bodies to do customs inspection or an international organization to certify mining companies in environmental compliance. I will even be more radical and urge the adoption of Nobel Prize winner Paul Romer’s chartered cities idea — outsource governance in a few export zones to other governments, such as islands north of Cagayan to the Taiwanese.

Political and governance reform — in short, institutional reform — are interlinked to economic reforms. Institutions matter in economic growth. However, the demand for institutional reforms will only rise if the political economy is right. The economy has got to be less dominated by monopolies and become more outward looking.

If nothing is done and the public sees failure after failure, the environment for authoritarianism and populist fascism — cutting democratic corners to produce results (as we are seeing now) — becomes even more favorable. The country could end up both being both poor and unfree.


Calixto V. Chikiamco is a board director of the Institute for Development and Econometric Analysis.

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