GROWTH AND PRODUCTIVITY IN THE PHILIPPINES WINNING THE FUTURE © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 3 Table of Acknowledgments 5 Contents Executive Summary 7 Chapter 01. Drivers of Philippine Growth Since 23 the Early 1980s Chapter 02. Patterns and Drivers of 41 Aggregate Productivity Chapter 03. Patterns and Drivers of Productivity 59 at Industry and Firm Level Chapter 04. Policy Options for Increasing Productivity 71 and Economic Growth in the Philippines Chapter 05. The Stakes: Reforms to Achieve the 105 AmBisyon Natin 2040 Conclusion 117 Appendices 119 References 133 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 5 Acknowledgments The report was prepared by a World Bank team led by Rong Qian (GMTP2) under the guidance of Mara K. Warwick (Country Director, EACPF), Ndiame Diop (Practice Manager, GMTP2), and Birgit Hansl (Program Leader and Lead Economist, EACPF). Kevin Cruz (GMTP2) was the main author of chapter 1 with inputs from a background paper produced by Markus Bruckner (STC). Kevin Chua (GMTP2) was the main author of chapter 2. Rong Qian was the author of chapter 3 with inputs from Ha Nguyen (DECMG) and research assistance from Karen Lazaro (STC). Chapter 4 was produced by Rong Qian with research assistance from Kevin Cruz and Kevin Chua, inputs from Roberto Galang, Andres Garcia, Graciela Miralles, and Mariana Iootty, and discussion with HD team. Kevin Chua was the main author of chapter 5 under the guidance of Rong Qian and technical assistance from Kevin Cruz, Steven Pennings (DECMG), Jorge Guzman (DECMG), Young Eun Kim (DECMG), and Sharmilla Devadas (DECMG). Administrative assistance was provided by Maria Consuelo Sy (EACPF) and Reinaluz Ona (EACPF). Editing support was provided by Oscar Parlback (STC). Vice President: Victoria Kwakwa Country Director: Mara K. Warwick Practice Director: John Panzer Practice Manager: Ndiame Diop Task Team Leader: Rong Qian 7 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 7 Executive Summary 8 EXECUTIVE SUMMARY This report shows that sustaining high growth can only be achieved if the Philippines succeeds in sustaining high Total Factor Productivity (TFP) growth while accelerating capital accumulation. To achieve the AmBisyon Natin 2040, the Philippines needs to triple its income per capita in the next two decades. The AmBisyon Natin 2040 is the government’s plan to transform the country into a prosperous middle-class society free of poverty by 2040.1 This implies that the Philippine economy needs to grow at an annual average of 6.5 percent in the next 22 years, faster than the average growth of 5.3 percent since 2000—a challenge that only the Asian Tigers2 and China have managed to accomplish in the past. Faster economic growth will also need to be shared more broadly to eradicate poverty and improve the living standard of the average Filipino. This report shows that sustaining high growth can only be achieved if the Philippines succeeds in sustaining high Total Factor Productivity (TFP) growth while accelerating capital accumulation. To achieve the GDP per capita target by 2040, numerous scenarios regarding the potential mix of growth drivers were evaluated. The first key finding is that sustaining high TFP growth will be crucial to achieve the target. Specifically, the Philippines needs to sustain an average annual TFP growth rate of 1.5 percent or higher The top three policy reform areas for sustaining high in the next 22 years, more than double the world average growth and productivity, prerequisites for achieving since 2000. Such a high rate of TFP growth will require deep Ambisyon Natin 2040: structural reforms to remove constraints and distortions faced by the private sector. The second key finding is that Improve market competition through regulatory reforms. accelerating capital accumulation in the medium term will Evidence shows that restrictive market regulations and high be essential to reduce current infrastructure and capital costs of doing business are hindering competition in the constraints to growth. The Philippines can meet the capital Philippine economy. Poor domestic competition protects accumulation requirement by doubling the growth rate in the unproductive firms at the expense of more productive physical investment-to-GDP ratio over the next five years ones. It also reduces incentives for firms to innovate and through higher private and public investment, which would become more productive. Moreover, limited competition require the implementation of important reforms that are in key sectors has sizeable consequences for the economy highlighted in this report. beyond the direct effects on individual sectors. For instance, lack of competition and incomplete reforms in the telecommunications industry has led to a lack of investment in backbone infrastructure that undermines the productivity of firms in all service sectors. 1 The plan represents the collective long-term vision and aspirations of the Filipino people and the government in the next 25 years. It envisions a strongly rooted (matatag), comfortable (maginhawa), and secure life (panatag na buhay) for all Filipinos. According to the government, reaching this long-term goal can be judged on concrete changes in household consumption and asset-ownership, including “owning a house and a car and having the ability to send children to college while maintaining a middle-class lifestyle.” 2 The Asian Tigers (or Asian Dragons) are made up of Hong Kong, Singapore, South Korea, and Taiwan. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 9 Improve trade and investment climate policies and iii. Streamline burdensome administrative procedures to regulations. High logistic costs and non-tariff barriers in the start new businesses and pay taxes Philippines limit competition and reduce competitiveness. iv. Reduce restrictions on foreign investors (e.g., allow Firm-level evidence shows that although less than 10 foreign competition in sectors and reduce equity limits) percent of Filipino firms export, exporting firms are on v. Minimize the use of controlled prices to reduce market average more productive than firms that only focus on the distortions domestic market. In addition, the presence of restrictive vi. Reduce trade costs by improving port and regulations and policies on foreign investment have logistics infrastructure prevented faster growth in foreign direct investment (FDI), vii. Lower non-tariff barriers, procedural obstacles limiting knowledge spillover. Although firms with foreign in particular ownership are more productive on average than fully viii. Pursuing more balanced regulations between employees domestically owned firms, the share of Philippine firms with and employers by lowering the costs and simplifying foreign capital is less than 10 percent and declining. procedures for hiring and firing workers ix. Align the minimum wage with workers’ productivity by Reduce labor market rigidities and costs. considering the wage level of the informal sector Restrictive labor regulations, including high firing costs, x. Make regular employment contracts more flexible have led to high informality and an increase in temporary employment in the Philippines. Over 75 percent of total By creating competitive and flexible markets, poverty employment is informal across sectors, age, and education alleviation is likely to accelerate through more jobs, higher levels. The incidence of non-regular employment contracts labor productivity, and lower consumer prices. An equal reached about 40 percent of all wage employment in 2013. playing field and a regulatory environment that makes it Informal and non-regular employment contracts imply not easy to do business encourage firms to enter the market, only high job turnover but also less on-the-job training and invest, grow, create jobs, and innovate, leading to higher learning, which is a crucial element for productivity growth. productivity. Market competition coupled with flexible a labor market and abundant labor supply allows higher Top 10 policy actions: productivity to reduce product prices, which increases i. Continue to increase competition in the workers’ real income. As a result of more and higher paid telecommunications, electricity, and transport sectors jobs, more people will move out of poverty, helping achieve the AmBisyon Natin 2040 vision of a society free of poverty. ii. Strengthen the independence and authority of sector regulators (in the telecommunications, energy, and water sectors in particular) 10 EXECUTIVE SUMMARY GROWTH DRIVERS IN THE PHILIPPINES SINCE THE EARLY 1980S — KEY LESSONS LEARNED The Critical Role of Structural Reforms The Philippines’ long-term growth experience confirms the importance of structural reforms. The reforms initiated in the late 1980s and the 1990s played a key role in the country’s growth recovery and subsequent acceleration two decades later. They also highlight the existence of a time lag between the implementation and payoff of reforms, as reforms started to have an impact only in the second half of the 2000s. The growth recovery in the late 1990s was driven by trade openness, gradual financial sector opening and deepening, and infrastructure development that boosted the country’s external competitiveness. The cumulative effect of past reforms coupled with prudent fiscal and macroeconomic policies resulted in an impressive acceleration of economic growth in 2010-16. Importance of Macroeconomic Stability for Growth Another key lesson from the Philippines’ historical growth experience is that macroeconomic stability is a necessary (albeit not sufficient) condition for sustained growth. In the 1980s, the country experienced a debt crisis (1983) Large Scope to Boost Growth through and multiple coup d’état attempts (1986-1990), leading to Capital Accumulation growth contracting by 7.6 percent in 1984-85 and a “lost decade” in terms of economic growth. As a result, GDP per There are untapped opportunities to increase growth capita fell from US$1,687 in 1980 to US$1,5723 in 1999. through higher capital accumulation. The contribution By contrast, the economic recovery of the 2000s was of capital accumulation to economic growth increased preceded by a restoration of fiscal discipline and a reduction substantially in the Philippines when growth accelerated of inflation. Moreover, growth acceleration in 2010-16 in 2011-16, contributing more than one-third of growth. coincided with the continuation of macroeconomic stability Yet, capital accumulation is relatively low in the Philippines and favorable external conditions. Greater macroeconomic compared to peers due to low levels of public investment stability coupled with the implementation of structural and FDI. The country’s capital per worker is also low, less reforms in 2000-16 led to a near-doubling of the than half of that of Indonesia and Malaysia. Therefore, there Philippines’ GDP per capita, from US$1,607 in 2000 to are opportunities for the government to accelerate growth US$2,753 in 2016. by increasing capital accumulation. 3 GDP per capita (constant 2010 US$), WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 11 Important Role of Productivity in Total Factor Productivity’s contribution to growth has increased since 2010... Accelerating Growth Real GDP Growth and Contributions (Percentage Points) Sustaining high economic growth in the long term hinges 20 10.0 on maintaining high productivity growth through structural reforms. The contribution of total factor productivity (TFP) to economic growth has increased since 2000, mirroring 10 5.0 the evolution of the Philippine economy over the last two decades. TFP consistently contributed to growth during the economic recovery and acceleration of the 2000s 0 0.0 and 2010s, contributing one-third of growth on average during this period. Furthermore, the contribution of TFP to growth was higher in the Philippines than in regional peers -10 -5.0 between 1995 and 2010, with the only exception of China. 1986-1991 1996-2001 2001-2006 2006-2011 2011-2016 1981-1986 1991-1996 The growth in TFP reflects the implementation of a wide range of structural reforms since the 1990s. While these reforms brought economic growth, they also increased the Total Factor Productivity Capital Real GDP (RHS) contribution of TFP to growth. Human Capital per Labor Labor Although labor productivity growth has accelerated in Source: Staff calculations based on PSA data. the Philippines, it remains low compared to that of peers, suggesting an opportunity to increase growth by closing productivity gaps. Labor productivity growth has been consistent with the evolution of the country’s TFP growth. …outperforming many regional peers It accelerated substantially from an average annual rate Contribution to Growth in the Philippines and Regional Peers, 1995-2010 of 1.6 percent in 1998-2004 to 3.6 percent per year in (Percent) 2010-16. However, productivity growth was still lower 120 in the Philippines than in regional peers. For instance, 100 China and Vietnam’s labor productivity growth reached 7.6 80 percent and 4.2 percent, respectively, in 2010-16. As a 60 result, the labor productivity gap remains wide between the 40 Philippines and many regional peers. The country’s low labor productivity has been partly caused by historic low levels 20 of capital accumulation, resulting in low capital per worker, 0 which limits labor productivity growth despite higher TFP -20 Philippines China Malaysia Thailand Indonesia Vietnam growth. This represents an opportunity for the Philippines to increase labor productivity growth through higher capital accumulation and sustaining high TFP growth. Total Factor Productivity Capital Human Capital per Labor Labor Source: Staff calculations based on PSA data. 12 EXECUTIVE SUMMARY PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY — KEY FINDINGS AND MESSAGES The rationale for focusing on productivity is threefold. Aggregate labor productivity has grown significantly over First, productivity growth entails a more sustainable way to the past 20 years. This growth mainly reflects a rise in increase long-term economic growth compared to capital and within-sector productivity growth in manufacturing and labor accumulation, which face diminishing returns to scale. services and a small contribution of structural change (i.e., Second, labor productivity has remained the Philippines’ movement of resources from agriculture to other sectors). main driver of economic growth since 1998, representing 87 The contribution of structural change has remained small percent of per capita value-added growth. Finally, policies because most of the labor that moved out of agriculture aimed at enhancing productivity are also likely to increase went to low-end services—a sector with higher average investment growth and capital accumulation. This report uses productivity than agriculture but lower average productivity firm-level data to study productivity growth in the Philippines than manufacturing or formal services. The relatively small and sheds light on policy directions that could sustain and contribution of structural change to productivity growth accelerate productivity growth. in the Philippines makes the country an outlier among regional peers, as structural change played a central role in driving labor productivity growth in countries such as China, Indonesia, Malaysia, and Thailand. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 13 Since within-sector productivity growth has been the main driver of labor productivity in the Philippines, a microeconomic analysis of within-sector productivity dynamics can inform policies that could help the country close the productivity gap with peers. Manufacturing was the sector with the highest labor performer in the region. This was in sharp contrast to Visayas productivity growth in the Philippines over the past 20 years, where labor productivity decelerated to near zero in the outpacing some regional peers. Labor productivity growth same period. Moreover, Mindanao, the country’s largest increased from an average of 1.7 percent per year in 1998- agricultural region, has experienced only an intermediate 2009 to 4.9 percent in 2010-16. This acceleration reflected level of labor productivity growth. While annual labor a transition from textiles, apparel, and paper products to productivity growth in manufacturing was an impressive more skill-intensive products such as electronic components 8.5 percent and 4.9 percent on average in Luzon and and transport equipment. As a result, manufacturing output Mindanao, respectively, in 2011-15, it declined in Visayas in grew at an impressive average rate of 7.5 percent per year the same period. Labor productivity growth in Visayas only in 2010-16. improved in the service sector, where it tripled in 2006-10 at an annual average rate of 4.8 percent. Labor productivity There was also a near doubling of labor productivity growth growth in services also accelerated in Mindanao and Luzon in the service sector in 2011-16. This growth acceleration in 2011-15 at an annual average of 3.4 percent and was led by a rapid rise of labor productivity in formal services 3.2 percent, respectively. such as business process outsourcing and finance. Informal services, while having a lower level of labor productivity While labor productivity growth has gradually increased than formal services and employing most of the country’s in the Philippines since 1998 and accelerated since 2011, unskilled workers (in industries such as wholesale and retail labor productivity remains low compared to that of regional trade) also experienced rapid growth. peers. In 2016, the Philippines’ aggregate labor productivity was higher than that of Vietnam but less than one-third of In sharp contrast, labor productivity growth in the country’s Malaysia’s, two-third of Thailand’s, 69 percent of China’s, agriculture sector has been low relative to other sectors and and 74 percent of Indonesia’s. As a result, the country’s regional peers. Between 1998 and 2016, agricultural labor productivity gap relative to regional peers increased over productivity growth averaged 2.1 percent per year in the the past 20 years. While China’s level of productivity growth Philippines, half that of China and Malaysia during the same was only slightly higher than that of the Philippines in 1998, period. The low productivity in agriculture reflects a host of China has managed to quadruple its labor productivity, factors, including a focus of agricultural policy on rice self- surpassing Indonesia and currently performs almost at par sufficiency (which undermines diversification toward higher with Thailand. Part of the reason for its labor productivity value-added crops), frequent natural disasters, weakness growth is the Philippines’ lower capital per worker relative of institutions that support agriculture, and uncertainties to regional peers. generated by a lengthy and costly agrarian reform that has stymied investment. Since within-sector productivity growth has been the main driver of labor productivity in the Philippines, a There are large regional disparities in labor productivity microeconomic analysis of within-sector productivity growth in the Philippines. For example, Luzon’s average dynamics can inform policies that could help the country agricultural labor productivity growth of 4 percent per year close the productivity gap with peers. in 2011-15 was comparable to that of China—the best 14 EXECUTIVE SUMMARY PATTERNS AND DRIVERS OF INDUSTRY — AND FIRM-LEVEL PRODUCTIVITY: KEY FINDINGS AND MESSAGES There is evidence that policies that provide a conducive growth in the Philippines. However, the level of misallocation environment for firms to grow or export and which welcome of resources in the manufacturing sector declined in 2010- foreign equity increase productivity indirectly. Most 2016, as the government implemented various market Philippine firms are small (two-thirds of manufacturing firms reforms, including a gradual liberalization of the banking and over 80 percent of services firms employ less than 20 sector and continuous efforts to improve trade. This workers), not engaged in export activities (less than 10 contributed to a rapid increase in productivity and value- percent of firms export), and have little access to foreign addition in manufacturing during this period, bringing the equity (less than 10 percent of firms have foreign capital). country’s manufacturing productivity more in line with that This profile of firms has a bearing on productivity in the of regional peers. Philippines since productivity, whether measured as labor productivity or TFP, is positively correlated with firm size, the In contrast to the manufacturing sector, factor allocation share of firm production exported, and foreign capital. explains only a small part of the productivity in non- manufacturing industries and services. Specifically, factor Manufacturing has faced a sizeable but declining allocation represents only 12-13 percent of productivity in misallocation of resources. Productive manufacturing non-manufacturing sectors and services. Most productivity is firms face more distortions than less productive firms, determined by within-firm productivity, which is influenced resulting in a misallocation of resources that induces a large by managerial quality, technology, and innovation. To put this shortfall of productivity at the industry level. If resources into perspective, the factor allocation explains were reallocated efficiently, it is estimated that TFP in 51 percent of firm productivity in the United States, manufacturing could be almost double the actual level. which means that most productive firms have larger Therefore, market reforms aimed at levelling the playing market shares. field for firms could have a significant impact on productivity GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 15 POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Government policies that affect how resources are allocated Restrictive market regulations may be hindering competition across firms (e.g., allocation of labor and capital) and in the Philippine economy. Newly available product market the efficiency with which firms use resources determine regulation data suggest that regulatory restrictions may be productivity growth. Preferential policy treatment of limiting competition in key sectors. As a result, competition is unproductive firms allows them to remain in operation (or perceived to be weak in the Philippines, particularly regarding even thrive) and deny market shares to more productive the extent of market dominance where the country ranks firms that could use the resources more efficiently. below regional peers. Meanwhile, policies that encourage firms to improve their managerial quality, access technology, and innovate, Limited competition in key sectors of the economy has contribute to higher within-firm productivity. sizeable implications on output. The effect of regulatory barriers in key service sectors on manufacturing has led to Government policies can therefore be divided into reduced factor allocation efficiency. Results from simulations measures that affect the external environment of firms and show that removing restrictions in key service sectors those that influence firms’ internal operations. External could generate an additional 0.2 percent of GDP per year factors are mainly related to government policies and market by increasing the competitiveness of industries that use conditions that are outside of the control of individual firms these services. This is consistent with other findings that and include: demonstrate that restrictions on competition in service • the policy environment for competition and private- sectors have a detrimental effect on productivity across sector investment; sectors. For example, a duopolistic market structure in • trade integration; the Philippines’ telecommunications industry has led to a • spillover from FDI; lack of investment in backbone infrastructure that may be • access to finance and capital allocation; and undermining the productivity of firms in all service sectors. • education quality and labor market regulations. Competition is further undermined by barriers to entry such Within-firm determinants are factors that are firm-specific as the high cost of doing business and limitations for foreign and usually under the control of individual firms, notably investment in key sectors. The Philippines ranked 171st out innovation and managerial quality. of 190 economies on the ease of starting a business in the World Bank’s 2017 Doing Business report. Incumbent firms Improve market competition through are especially protected by high entry barriers in network regulatory reforms sectors. Moreover, investment restrictions for foreign firms limit market contestability, especially in capital-intensive Strengthening competition is expected to drive productivity sectors such as infrastructure, and reduce the inflow of FDI. growth. Competition can increase productivity by: As a result of high entry costs and barriers, unproductive • forcing firms to become more efficient to avoid exiting firms do not exit the market, which leads to lower aggregate the market; productivity growth. • ensuring that more productive firms increase their market share at the expense of less productive Priority policy recommendations in this area include: firms; and • continuing to increase competition in the • driving firms to innovate, to develop new products and telecommunications, electricity, and processes that can lead to improved efficiency. transport sectors; • strengthening the independence and authority of sector Market competition is largely determined by regulations that regulators (in the telecommunications, energy, and water enable or restrict competition. sectors in particular); 16 EXECUTIVE SUMMARY • streamlining burdensome administrative procedures to This was partly due to high trade costs and the presence start new businesses and pay taxes; of non-tariff measures. Trade costs include the burden of • reducing restrictions on foreign investors (e.g., allow government regulations, the quality of infrastructure, and foreign competition in sectors and reduce equity the burden of customs procedures. Non-tariff measures are limits); and mostly related to administrative procedures imposed by the • minimizing the use of controlled prices to reduce government, which have become an increasingly important market distortions. obstacle to trade in the Philippines. Improve trade and investment climate policies Although the share of exporting firms remains small across and regulations sectors, they are on average more productive than firms that focus on the domestic market. Firm-level data show that less While the Philippines has lowered its tariffs, its non-tariff than 10 percent of firms in the Philippines are engaged in barriers and trade costs remain higher than that of regional export activities, and this share has been declining in recent peers. The country has a liberalized trade regime, reflected years. Yet, firms that export at least part of their sales abroad in its low most-favored-nation tariff of 6.3 percent in 2016, are on average more productive than firms that sell only to the lowest among peers. However, the Philippines’ trade the domestic market. This is likely because firms that export openness, measured as the share of total trade to GDP, face more competition in the global market, which likely declined from 98.7 percent in 1998 to 64.9 percent in 2016. forces them to become more productive. The share of firms that export declined in the Philippines in 2010-14. Firms that export are on average more productive than firms that focus on the domestic market. Share of Firms by Export Status (Percent) Productivity and Export Status (Economy-wide Log of VA per Worker) 100 12 10 80 8 60 6 40 4 20 2 0 0 2010 2014 2010 2014 2010 2014 Agriculture Industry Services 2012 2013 2014 Firms with non-zero export sales Firms with zero export sales Firms with non-zero export sales Firms with zero export sales Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 17 While net FDI in the Philippines has been increasing since economy have some foreign ownership, with most foreign 2000, it remains low relative to peers. FDI averaged 1.7 owners in industry, although their share has declined in percent of GDP each year in 2011-16, lower than both the recent years. Regardless of the sector, firms with foreign structural peer average of 2.2 percent and the regional peer capital are more productive than firms with only domestic average of 3.2 percent. Moreover, direct equity investment capital. In addition, firm productivity tends to increase with represents less than half of total FDI in the Philippines, and more foreign ownership. its share has not increased in recent years (0.8 percent of GDP in 2005 and 0.7 percent of GDP in 2016), limiting Priority policy recommendations in this area include: knowledge spillovers. • minimizing restrictions on foreign investors; • reducing trade costs by improving port and logistics Philippine firms with foreign ownership are on average infrastructure; and more productive than domestically owned firms. Firm-level • continuing to lower non-tariff barriers, procedural evidence shows that less than 10 percent of all firms in the obstacles in particular. Share of firms with foreign ownership remains small. Foreign ownership is correlated with higher productivity. Composition of Firm Ownership by Sector (Percent) Productivity by Degree of Foreign Ownership and Sector (Log of VA Per Worker, 2014) 100 16.0 90 14.0 80 12.0 70 10.0 60 8.0 50 6.0 40 4.0 30 2.0 20 0.0 10 Agriculture Industry Services Manufacturing Total excluding 0 Manufacturing 2010 2014 2010 2014 2010 2014 Agriculture Industry Services 0% >0% & <25% >=25% & <50% Firms with foreign ownership 100% domestic >=50% & <75% >=75% Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. 18 EXECUTIVE SUMMARY Create an enabling environment for innovation • enhancing government support for innovation; and • increasing awareness among firms about existing The country’s innovation infrastructure is of poor quality. government programs that support innovation. In 2017, the World Economic Forum ranked the Philippines 74th out of 137 countries on the availability of scientists Reduce labor market rigidities and cost and engineers and 75th on the availability and quality of research capital, lower than most peers. Similarly, the A flexible labor market supports productivity growth by availability of information technology infrastructure, such allowing factors of production to move freely across firms as mobile subscriptions and internet access, was lower in and sectors. In an environment without distortions, firms the Philippines than in many regional peers while its cost with high productivity growth would be absorbing labor was higher. Market dominance and business regulations are and capital from firms that are less productive. Evidence also not conducive to creating an enabling environment for shows that the Philippines has more restrictive labor market innovation, as uncontested markets with high profit margins regulations, and these have likely impeded the efficient provide little incentives for innovation and productivity allocation of labor to the most productive firms. growth. Finally, the country’s low level of trade openness and FDI limits knowledge spillover. Restrictive labor regulations have led to high informality in the Philippines. The Doing Business’ ease of hiring and firing As a result, Philippine firms underperform their foreign peers index ranks the Philippines as 77th out of 137 countries, in adopting existing technologies. The Philippines ranked which makes the country’s labor market more restrictive 73rd out of 128 countries on the 2017 Global Innovation than that of most peers. In addition, minimum-wage and Index, behind all regional peers. Philippine firms are less redundancy costs are very high in the Philippines relative to likely to adopt existing technologies than firms in peers. peers. As a result, informal employment represents over 76 For instance, only 8.8 percent of firms in the Philippines percent of the country’s total employment. High informality have internationally recognized quality certifications and is present across the age, level of education, and sector of only 11.2 percent of firms use technology licensed from workers. Informal employment does not provide protection foreign companies, lower than in most peers. In addition, the to workers and tends to provide less training. As a result, country only spends 0.1 percent of GDP on research and on-the-job training and learning is limited, preventing faster development, compared to an average of 0.9 percent and productivity growth. 0.4 percent of GDP among regional and structural peers, respectively. Moreover, high dismissal costs have led to an increase in temporary employment. The dismissal of an employee with a High costs, lack of funds, and market dominance are the top regular employment contract involves a long administrative factors that prevent firms from innovating in the Philippines. process in the Philippines. This has led to an increase in Firms point to the high cost of innovation as the primary non-regular employment, which reached about 40 percent factor that prevents them from engaging in innovative of all wage employment in 2013. Workers under non-regular activities in the country, followed by a lack of funds from contracts have less employment security, receive lower both within firms and external sources. Market dominance wages, and their turnover is expected to be higher. and the lack of qualified personnel are also important factors that hamper innovation, especially among smaller firms. Priority policy recommendations in this area include: Priority policy recommendations in this area include: • lowering the cost of firing by simplifying dismissal • increasing human capital suitable for innovation; procedures and lowering redundancy costs; • improving the quality and reducing the cost of the • aligning the minimum wage with workers’ productivity country’s information technology infrastructure; by considering the wage level of the informal sector; and • increasing market competition; • making regular employment contracts more flexible by • reducing barriers to FDI; linking severance pay with tenure. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 19 THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 The current administration has adopted a long-term Philippines manages to sustain a TFP growth rate of 1.8 growth vision called AmBisyon Natin 2040. It represents the percent per year for decades to come, which is lower than collective long-term vision and aspirations of the Filipino the annual average of 2.2 percent in 2011-16. However, people and envisions the country as a prosperous middle- this will be a challenge, as experiences from other countries, class society free of poverty by 2040. The government’s such as the fast-growing Asian Tigers and China, show that goals are based on a set of household consumption and sustaining high TFP growth for a long period is possible asset-ownership targets. For a family of four, this level of but requires continuous efforts to remove constraints and consumption translates into an estimated gross monthly distortions in the markets. income of Php120,000 by 2040. The second key finding is that accelerating capital Central to this long-term vision is high, sustainable, and accumulation in the medium term will also be critical for inclusive economic growth that will depend on sustained achieving the GDP per capita target. This will require the productivity growth. The Philippines will need to reach a per investment-to-GDP ratio to grow by 3.0 percent per year capita GDP of about US$9,350 by 2040 to meet the goals until 2022 (through public and/or private investment) set out in the AmBisyon Natin 2040, which is more than three followed by the historical annual rate of 0.8 percent until times the current level of US$2,892. This implies that the 2040. This will result in an investment-to-GDP ratio of 33.6 Philippine economy needs to grow at an annual average of percent of GDP in 2040, higher than the average of many 6.5 percent in the next 22 years—a challenge that only the peers. This level of capital accumulation will require a TFP Asian Tigers4 and China have managed to accomplish in growth rate of 1.5 percent per year to achieve the GDP per the past. capita target by 2040. To evaluate and assess ways to achieve the growth target This report highlights a number of policies that are essential by 2040, a long-term growth model is used. The model to sustaining high TFP growth in the Philippines. Primarily, assesses various growth scenarios and the potential mix of the government needs to improve innovation, market growth drivers needed to reach the government’s goals. A efficiency, education, infrastructure, and governance.5 In baseline scenario was created based on the premise that particular, improving the country’s ranking on the innovation key growth drivers such as labor, human capital, investment, index to the level of China would have the largest positive and technology sustain their historical growth rates. Various impact on TFP growth, as it would lead to an annual average scenarios were then created relative to this baseline, and TFP growth rate of 2.1 percent in 2017-40. Moreover, an growth rates of select variables were adjusted to assess the improvement on the market-efficiency index to the level most realistic combination that will help the country achieve of Malaysia would result in an average annual TFP growth the AmBisyon Natin 2040. rate of 2.0 percent. Finally, improvements on the education, infrastructure, and governance indexes to the level of the The first key finding is that sustaining high TFP growth will be best performers in the region would increase TFP growth by crucial to achieve the GDP per capita target by 2040. Results an average of 1.8-2.0 percent per year for each determinant show that the GDP per capita target can be reached if the (given the rest are held constant). 4 Asian Tigers (or Asian Dragons) are made up of Hong Kong, Singapore, South Korea, and Taiwan. 5 Voice and accountability, corruption control, government effectiveness, political stability, regulatory quality, and rule of law. 20 EXECUTIVE SUMMARY IMPLICATIONS FOR POVERTY REDUCTION Productivity growth will help to accelerate poverty reduction same period. Except for public workers, this pattern of by creating more well-paying jobs. The poverty reduction stagnant real wages and increase productivity growth is that occurred in the Philippines between 2006 and 2016 was consistent across employees’ level of education, work driven by an increase in wage income, a movement of labor status (permanent or short-term contracts), and class of out of agriculture, and a rise in government transfers and work (private household, private establishment, or family remittances.6 An increase in productivity would raise wages operated). It also holds true across sectors (agriculture, and create new jobs, contributing to poverty reduction. industry, or services). Therefore, the government’s poverty Productivity growth in sectors that have low productivity alleviation policies need to achieve an increase in real wages such as agriculture will play a larger role in poverty reduction, as a result of increases in labor productivity. as it will primarily benefit the poor and vulnerable population. Furthermore, accelerating structural change (i.e., movement A lack of product market competition is likely contributing of labor out of agriculture) will also contribute to faster to real wage stagnation in the Philippines. There is an poverty reduction because productivity (and thus wages) are abundant labor supply in the country, and the labor market on average higher in non-agriculture sectors. is de-facto flexible due to high informality. However, product markets are not competitive in many sectors, and many Improving the link between labor productivity and real markets suffer from high entry costs. As a result, productivity wage growth will also be critical to reduce poverty. Real gains are not reflected in the real wage but rather in profit, wages have been stagnant in the Philippines despite labor which is consistent with the increasing share of capital in productivity improvements. Aggregate real wages remained national income. In addition, there is little incentive for flat in 2001-16, with real wages falling in 7 out of 15 years. firms to innovate (which would lead to better paying jobs) in Meanwhile, labor productivity increased by 57 percent in the uncontested markets with high profit margins. 6 World Bank (2018). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 21 An inability to create well-paying jobs and lift real wages is or higher degrees. This human capital flight features a likely to further encourage emigration, limiting productivity vicious cycle of high emigration due to limited domestic job growth. Productivity growth requires a process of efficiently opportunities, which leads to an insufficient supply of skilled combining human and physical capital. However, over workers for firms to expand and grow. It is therefore crucial 15 percent of the Philippines’ total labor force emigrates for authorities to increase both productivity and real wage each year, higher than in many peers. More than half of growth by encouraging greater market competition. all emigrants are under the age of thirty and hold college Real wages have remained flat despite rising GDP and productivity growth. Growth Trends (Year 2001 = 100) 240 220 200 180 160 140 100 80 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013 2014 2015 Real GDP (constant 2000 prices) Labor Productivity (constant 2000 prices) Real Wage Source: PSA data A large share of Philippine migrants is highly educated. Share of Registered Filipino Emigrants by Educational Attaninment prior to Migration (Percent) 100 50 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 College or above High school and vocational graduate Elementary or below Source: PSA data 22 EXECUTIVE SUMMARY SUMMARY OF KEY POLICY OPTIONS FOR BOOSTING PRODUCTIVITY AND GROWTH7 Reforms area Suggested policy Improve market competition Continue to increase competition in the telecommunications, electricity, and through regulatory reforms transport sectors Strengthen the independence and authority of sector regulators (in the telecommunications, energy, and water sectors in particular) Streamline burdensome administrative procedures to start new businesses and pay taxes Reduce restrictions on foreign investors (e.g., allow foreign competition in sectors and reduce equity limits) Minimize the use of controlled prices to reduce market distortions Further improve trade and Minimize restrictions on foreign investors investment policies and regulations Reduce trade costs by improving port and logistics infrastructure Reduce non-tariff barriers, procedural obstacles in particular Create an enabling environment Increase human capital suitable for innovation for innovation Improve the country’s information technology infrastructure and reduce its cost Increase market competition Reduce barriers to FDI Enhance government support for innovation Increase awareness among firms about existing government programs that support innovation Reduce labor market rigidities Pursuing more balanced regulations between employees and employers by and costs lowering the costs and simplifying procedures for hiring and firing workers Align the minimum wage with workers’ productivity by considering the wage level of the informal sector Make regular employment contracts more flexible 7 These policy options focus on reforms to boost industry-level and within-firm productivity. These should be complemented by agriculture reforms to boost agriculture productivity and reforms to accelerate structural change. 23 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 23 01 Drivers of Philippine Growth Since the Early 1980s 24 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S This chapter provides a historical perspective of the capital or labor and/or when these inputs are used Philippines’ growth performance, reviews past growth- more efficiently. Although countries often experience enhancing reforms, and identifies the drivers of economic growth through factor accumulation at an early stage of growth. The country has recently emerged as one of the top development, it is an unsustainable source of economic growth performers in the dynamic East Asia region (Figure growth in the long run since capital and labor face 1). To identify and understand the underlying sources of diminishing returns. Therefore, TFP is considered important growth in the Philippines, this chapter will perform a growth for long-term growth, and it is associated with how well a diagnosis that will quantify the role of structural reforms, country harnesses its physical and human capital through stabilization policies, external conditions, and persistence in technology adoption, product innovation, the sharing of the country’s growth performance. know-how between firms and sectors, and the mobility of workers. A growth-accounting exercise is also performed to This chapter also assesses the role of factor accumulations quantify the relative contribution of factor accumulations and total factor productivity (TFP) in economic growth. and TFP to economic growth. Growth occurs when there is an accumulation of either PROGRESS ON ECONOMIC GROWTH AND POVERTY REDUCTION The Philippines has become a strong growth performer While impressive economic growth over the past decades since 2010, as the government implemented business- has reduced poverty, progress in poverty alleviation has been friendly reforms and the external environment improved. slower in the Philippines than in peers. Past economic growth The country’s volatile macroeconomic and political has benefited low-income households more than the average environment in the 1980s resulted in low and highly volatile household in the Philippines, as the income of the bottom 40 growth rates that averaged 2.5 percent per year in 1980- percent of the population grew by an average of 2.9 percent 1997,8 much lower than the average of 4.6 percent among each year in 2006-16, faster than the annual average of structural peers and 7.6 percent among regional peers in 1.6 percent for the entire population (Figure 3). As a result, the same period.9,10,11 However, the Philippines experienced poverty incidence in the Philippines fell from 41.7 percent relatively high economic growth between 1998 and 2009, in 2006 to 33.7 percent in 2015. However, the country’s as the government implemented trade, investment, and rate of poverty reduction was lower than that of most privatization reforms in the late 1980s and the 1990s. regional and structural peers (Figure 2. Poverty reduction Moreover, economic growth benefited from a commitment has been slower in the Philippines than in peer countries.). by the government to strengthen macroeconomic stability. For example, Vietnam lifted 59.2 percent of its population Favorable domestic and external conditions allowed out of poverty in 2002-14, compared to only 9.5 percent in economic growth to accelerate to an average annual rate of the Philippines in 2000-15. In addition, income inequality 6.3 percent in 2010-2016, surpassing the average of both has remained stubbornly high in the Philippines, as its GINI structural and regional peers. coefficient remained at 0.4 in 2015, one of the highest among peers. Nevertheless, the Philippines was one of the most successful countries in reducing income inequality among peers in the last twenty years (Figure 4). 8 The Philippines experienced a debt crisis in 1983 that led to an economic contraction of 7.6 percent in 1984-85; multiple coup d’état attempts in 1986- 90 that led to the 1991 recession; and the Asian financial crisis in 1997 that resulted in a 0.6 percent contraction in economic growth in 1998. 9 Bangladesh, Kenya, Morocco, Pakistan, Sri Lanka, and Vietnam are defined as the Philippines’ structural peers based on the following criteria: a) they are lower-middle-income countries; b) their natural resource exports are lower than 20 percent of total exports; c) they score above average on the Natural Disaster Risk Index; d) each country’s population is above 20 million; e) they are all oil importers; f) their exports are not concentrated according to the Herfindahl index; and g) they are not landlocked countries, small states, or fragile states. China, Indonesia, Malaysia, Thailand, and Vietnam are identified as regional peers. 10 The regional peer average, with the exception of China, was 5.0 percent over the same period. 11 The Philippines’ growth volatility in the 1980s was five times the average of structural and regional peers, while growth volatility was around the average of structural peers but higher than the average of regional peers in subsequent decades (Figure A1 and A2 in Appendix 1). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 25 Figure 1. While the Philippines’ GDP growth has lagged behind that of Figure 2. Poverty reduction has been slower in the Philippines than in peers, it has improved over the past two decades. peer countries. Real GDP Average Annual Growth (Percent) Percent of Population Lifted Out of Poverty 8.0 70 Structural Peers Regional Peers 7.0 6.8 60 6.0 6.0 50 5.2 5.1 5.0 4.7 40 4.0 30 3.0 2.9 2.9 20 2.4 2.0 10 1.0 0 0 -10 Philippines Structural Regional World Philippines Structural Regional World -20 Vietnam Pakistan Sri Lanka Bangladesh Morocco Philippines Kenya Vietnam China Indonesia Thailand Philippines Malaysia Peers Peers Peers Peers 1980 - 1999 2000 -2016 Source: World Development Indicators (WDI). Source: WDI. Note: Period coverage varies by country.12 Figure 3. While low-income households gained more growth than the Figure 4. However, the Philippines wassuccessful in reducing inequality average household, income growth of low-income households was faster compared to peers… in peers. Income Growth (Percent) Change in GINI Structural Peers Regional Peers China 12 (2008-2012) 10 Malaysia 8 (2007-2012) 6 Thailand 4 (2008-2013) 2 Indonesia 0 (2011-2014) -2 Vietnam -4 (2010-2014) -6 Philippines (2006-2015) Philippines Vietnam Morocco Kenya Philippines Sri Lanka Bangladesh Pakistan Thailand Malaysia Vietnam Indonesia 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% Bottom 40 Total population Source: Staff calculations using the EAPPOV database. Source: WDI. Note: Period coverage varies by country. 12 Vietnam (2002-14), Pakistan (2001-13), Sri Lanka (2002-12), Bangladesh (2000-10), Morocco (2000-06), Philippines (2000-15), Kenya (1997-05), China (1999-2013), Indonesia (2000-13), Thailand (2000-13), and Malaysia (1997-2009). 26 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S GROWTH DETERMINANTS: REFORMS AND EXTERNAL FACTORS Understanding the drivers of economic growth in the country’s growth was due to transitional convergence (i.e., Philippines is crucial for the country to continue to pursue the economy’s reversion to its own steady state), structural policies aimed at improving long-term growth and shared reforms (i.e., outcomes from public policies aimed at prosperity. Over the past decade, during a period of changing the structure of the economy), stabilization policies relative political and macroeconomic stability, the country (i.e., outcomes from public policies aimed at stabilizing prices successfully pursued policies and reforms that accelerated and combating crises), and/or external conditions (i.e., factors economic growth and achieved more inclusive growth. To outside the domestic economy that impact its performance understand the factors that drove economic growth in the in both the short and the long run). Box 1 describes the Philippines, a regression analysis on a standard neoclassical variables used for each determinant of growth in the growth model for a sample of 126 countries covering econometric model. the period 1970-2015 was performed. It examined if a Box 1. Estimation Method The econometric model builds on the previous work of Loayza et al. (2005) and • Political institutions: Polity2 score, which measures the degree of political Araujo et al. (2014), in which the key econometric equation estimates the change constraints, political competition, and executive recruitment in the in the natural logarithm of real GDP per capita between two periods related to country. Higher values denote more democratic institutions. the lagged level of the natural logarithm of GDP per capita and a set of growth determinants. The set of growth determinants and the variable used as proxy are Stabilization Policies: the following: • Real exchange rate: the natural logarithm of the GDP price level divided by the nominal exchange rate. Transitional Convergence: • Inflation: consumer price inflation rate. • Real purchasing power parity (PPP) GDP per capita in the previous year. • Financial crisis: an indicator of systemic banking crises. Structural Reforms External Conditions: • Schooling: secondary enrolment. • Terms of trade growth: the changes in the net barter terms of trade index. • Financial development: ratio of domestic credit to the private sector as a • Commodity export growth index: the change in the International percent of GDP.13 Commodity Export Price Index. • Trade openness: ratio of exports plus imports over GDP adjusted for a country’s population size.14 • Government burden: ratio of government consumption to GDP. • Telecommunications infrastructure: number of telephone lines per capita. 13 Using the ratio of domestic credit to the private sector as percent of GDP as proxy for financial development has certain caveats, as the ratio may increase or decrease due to not just structural changes in the economy but also due to fluctuations in the business cycle. To avoid account- ing for business cycle fluctuations, 5-year averages are used in the model for all variables. 14 Using the ratio of total trade over GDP as a proxy for trade openness comes with the caveat that total trade is impacted by several exter- nal factors, such as global growth and terms of trade, and other exogenous events which cannot be attributed to a country’s policy reforms. To avoid accounting for business cycle fluctuations, 5-year averages are used in the model for all variables. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 27 The Lost Decade: The 1980s In fact, overall structural reform policies in the 1980s had a negative impact on growth, as the reduction in government The Philippines experienced subpar economic growth in the burden and the improvement in infrastructure and trade 1980s. This was primarily due to the country’s long history openness had a limited impact on growth while financial of macroeconomic mismanagement and political instability development contributed negatively to growth (Figure 8). that culminated in the 1983 external debt crisis (Figure 5 This was primarily a result of a weak reform effort and lack and Figure 6). The crisis resulted in the Philippines’ worst of progress in implementing key structural reforms. As the post-war recession, with the economy contracting by 7.3 1980s was a period of severe political and macroeconomic percent year-on-year in 1984 and 1985. During the 1980s, instability, Philippine authorities focused less on structural economic growth in the Philippines averaged 2.0 percent reform policies (Box 2). annually, significantly less than the average of 6.6 percent for regional peers and 4.7 percent for structural peers.15 As a result, the Philippines benefited the least from By contrast, the 1980s was a period of significant structural reforms to increase economic growth during the progress and economic growth for the countries that were 1980s relative to peers. The country’s structural reforms part of the “East Asian Miracle”16 resulting in the Philippines had the lowest impact on growth compared to regional being left behind in terms of economic growth and peers and the second lowest compared to structural poverty alleviation. peers (Figure 9). For example, the growth contribution of structural reforms in Malaysia exceeded that of the In the 1980s, neither structural reforms nor macroeconomic Philippines by nearly 3 percentage points per year during stabilization policies played a role in driving economic the 1980s, while structural reforms in the Philippines growth in the Philippines (Figure 7). During this period, contributed negative 0.1 percentage points per year in the growth was primarily driven by transitional convergence, as same period. Moreover, the Philippines’ stabilization policies the Philippines failed to successfully implement structural had no impact on growth, whereas some peers did benefit reforms and macroeconomic stabilization policies.17 from their stabilization policies (Figure 10). 15 Using WDI for real GDP growth. 16 “East Asia Miracles” refers to Hong Kong, Singapore, South Korea and Taiwan. 17 The Philippines’ attempts at adopting structural reform policies in the late 1970s and the early 1980s were largely unsuccessful. For example, the Philippine government’s initiatives under the International Monetary Fund’s Extended Fund Facility was largely unsuccessful in the late 1970s. Further reforms were initiated in the 1980s that targeted trade policy through the Philippines’ three-phased Tariff Reform Program (TRP), but it was suspended in 1983. 28 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S Figure 5. The Philippines’ volatile growth patterns were a product of numerous economic crises... Philippine Real GDP Growth (in percent), Poverty Incidence (in percent), Economic Crises External Debt Crisis Coup Attempts & Power Crisis Asian Financial Crisis Global Financial Crisis 1983- 1985 1989-1991 1997-1998 2008 - 2009 10 70 8 60 6 4 50 2 40 0 30 -2 -4 20 -6 10 -8 -10 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 GDP US$ 3.2/day poverty headcount ratio (RHS) Source: Philippine Statistics Authority (PSA) and WDI. Figure 6. …as well as political uncertainty. Philippine Real GDP Growth Rate and Presidential Regimes (Percent) Quirino Magsaysay Garcia Macapagal Marcos C. Aquino Ramos Estrada Arroyo B. Aquino III Duterte Dictatorship (1965-1986) Coup attempts Impeachment Coup attempt (1986-1990) (2001) (2003) 12 10 8 6 4 2 0 -2 -4 -6 -8 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: PSA. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 29 Figure 7. Structural reforms contributed negatively to growth in the 1980s. Figure 8. Reduction in government burden, improved infrastructure, and trade openness were the most important reforms in the 1980s. Contribution of Growth Drivers in the Philippines in the 1980s Contribution of Growth Drivers in the Philippines in the 1980s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.2 0.2 0.15 0.15 0 .1 0 .1 0.05 0.05 0 0 -0.05 -0.05 Transitional Structural Stabilization External Government Infrastructure Trade Schooling Financial convergence reforms policies conditions Burden Openness Development Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). Figure 9. The Philippines lagged behind peers in terms of the contribution Figure 10. ...as well as in terms of the contribution of stabilization policies of structural reforms to growth in the 1980s… to growth. Growth Contribution of Structural Reforms in the 1980s Growth Contribution of Stabilization Policies in the 1980s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.30 0.30 0.25 0.25 0.20 0.20 0.15 0.15 0.10 0.10 0.05 0.05 0.00 0.00 -0.05 -0.05 Malaysia Thailand Indonesia China Vietnam Philippines Bangladesh Kenya Morocco Sri Lanka Vietnam Philippines Pakistan China Indonesia Thailand Malaysia Philippines Thailand Pakistan Morocco Bangladesh Sri Lanka Philippines Kenya Vietnam Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). 30 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S Improving Macroeconomic Stability and Initiating economy, the government pursued policies that liberalized Structural Reforms: The 1990s foreign direct investment (FDI) in some sectors and opened up several industries to increase competition (e.g., the Growth started to recover in the 1990s. Economic growth financial, air transport, oil, power, and telecommunications in the Philippines accelerated slightly in the 1990s, industries). This led to improvements in infrastructure, averaging 2.8 percent per year, compared to an average financial development, and trade openness (Figure 12). annual rate of 2.0 percent in the previous decade. Yet, Meanwhile, stabilization policies, transitional convergence, growth was still subpar compared to the average of and external conditions had a limited impact on growth both structural (4.5 percent) and regional (6.8 percent) during the decade. peers. The growth acceleration was primarily the result of structural reforms, as the government pursued policies The impact of structural reforms on economic growth was aimed at improving the Philippines’ trade and investment smaller in the Philippines than in regional peers, although openness, domestic competition environment, and financial they had a bigger impact relative to structural peers (Figure development (Box 2). 13). While structural reforms had a larger impact on growth in the Philippines during the 1990s compared to Structural reforms played a key role in the growth recovery the previous decade, growth-enhancing structural reforms of the 1990s, establishing the underpinnings for strong benefitted the country less than they did regional peers. growth in the succeeding decades (Figure 11). During the Stabilization policies had a negative contribution to growth late 1980s and into the 1990s, the Philippine government in both the Philippines and most regional peers, partly pursued reforms aimed at liberalizing the trade regime because of the Asian financial crisis in 1997, which caused through the continuation of the country’s unilateral tariff a sharp decline in currency valuations and stock and asset reform program (TRP), the TRP II in 1991-95, and the TRP prices, a steep rise in interest rates, and a contraction in the III in 1996-2001. To increase competition in the domestic real sector. Figure 11. Structural reforms boosted growth in the 1990s… Figure 12. …especially in terms of infrastructure and financial development. Contribution of Growth Drivers in the Philippines in the 1990s Growth Contribution of Structural Reforms in the 1990s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.3 0.2 0.18 0.25 0.16 0.2 0.14 0.12 0.15 0.1 0.08 0 .1 0.06 0.05 0.04 0.02 0 0 Infrastructure Financial Trade Schooling Government -0.05 Development Openness Burden Transitional Structural Stabilization External convergence reforms policies conditions Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 31 Box 2. Key Structural Reforms Since the 1980s The 1980s • A number of sectors were opened up to competition such as the financial sector, air transport, power generation, inter-island shipping, • In the mid-1980s to the late 1990s, the Philippines pursued a series of and telecommunications industries. Growth and job creation followed trade liberalization policies through the government’s TRP I and Import the liberalization efforts, demonstrating the economic potential that Liberalization Program18 that included lowering tariffs and removing import monopolies and oligopolies had previously suppressed. quantitative restrictions to phase out excessive tariff-protection policies. The 2000s • The 1987 Constitution established the underpinnings to promote increased competition in the Philippines, declaring that the state shall regulate • Gradual liberalization of the banking sector with the enactment of the or prohibit monopolies when the public interest so requires. It was in General Banking Law and Republic Act 10641, which allowed the full entry the 1990s that a number of key industries were opened up to increase of foreign banks in the Philippines. competition. • Trade policy reform continued into the early 2000s through the TRP IV. The 1990s • The retail trade sector was partially liberalized in 2000 through Republic • The liberalization of FDI through Republic Act 7042 (Foreign investment Act 8762 (the Retail Trade Liberalization Act). Act of 1991) allowed foreign equity participation of up to 100 percent for sectors not specified in the country’s foreign investment negative list • In 2001, the Electric Power Industry Reform Act (Republic Act 9136) was (FINL).19,20 signed into law, which aimed to remove monopolies in the power industry through the privatization of the National Power Corporation’s assets. • The implementation of trade policy reforms continued under TRP II and III, which lowered the effective rates of tariffs. To affirm the government’s • In 2015, the Philippine Competition Commission was established through commitment to trade liberalization, the Philippines also signed agreements Republic Act 10667 (the Philippine Competition Act), which was a first to join the Association of Southeast Asian Nations Free Trade Agreement step in establishing a comprehensive competition policy framework in the and the General Agreement on Tariffs and Trade. Philippines. Source: World Bank (2013). “Philippine Development Report: Creating More and Better Jobs,” de Dios (2000). “Philippine Economic Growth: Can it Last?” and Aldaba (2013). “Twenty years after Philippine Trade Liberalization and Industrialization: What has happened and where do we go from here” Menrado, A. (2004). 18 The Marcos Administration first attempted to initiate the trade liberalization program in the early 1980s, but the full implementation of trade policy reforms was suspended due to the 1983 crisis. Upon election in 1986, the Corazon Aquino administration resumed the trade liberaliza- tion program. 19 Republic Act 7042 introduced a foreign investment negative list that explicitly states which areas of the Philippine economy are closed to foreign investment. 20 The contents of the FINL is updated every two years through an executive order. The latest FINL (Executive Order 184 series of 2015) includes mass media, the practice of professions, and small-scale mining as areas that do not allow foreign equity. 32 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S Figure 13. Structural reforms contributed less to growth in the Philippines Figure 14. Stabilization policies contributed less to growth in the than in regional peers during the 1990s. Philippines than in peers during the 1990s. Growth Contribution of Structural Reforms in the 1990s Growth Contribution of Stabilization Policies in the 1990s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.50 0.50 0.40 0.40 0.30 0.30 0.20 0.20 0.10 0.10 0.00 0.00 -0.10 -0.10 China Vietnam Indonesia Thailand Malaysia Philippines Vietnam Philippines Sri Lanka Morocco Pakistan Bangladesh Kenya Vietnam China Malaysia Thailand Indonesia Philippines Vietnam Kenya Sri Lanka Bangladesh Morocco Pakistan Philippines Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). Strong Growth Recovery: The 2000s The 2000s represented a period of strong growth recovery in the Philippines. Economic growth accelerated to an annual average of 4.5 percent in 2000-10, significantly higher than in the past two decades. During this decade, the Philippines was closing the gap with its structural peers, which grew by an average of 5.0 percent per year. However, the country’s rate of growth was still notably lower than the regional peer average of 6.3 percent per year. The improvement in the Philippines’ growth rate was partly due to the government’s commitment to improve macroeconomic and fiscal stability, including the adoption of tax policies that raised revenue collection and avoided a near fiscal crisis in 2004. In addition, structural reforms initiated in the previous two decades started to have an effect on economic activity, and the continuation of the TRP IV and the liberalization of the banking sector also contributed positively to economic growth. Structural reforms and transitional convergence were the main drivers of economic growth in the 2000s (Figure 15). growth, followed by the reduction in government burden Structural reforms accounted for around two-fifths of the (Figure 16). In addition, the government’s commitment economic growth during this decade, which was similar to to fiscal sustainability and the pursuit of an independent the growth contribution of transitional convergence. Among monetary policy led to a stable exchange rate and a structural reforms, the improvement in infrastructure was relatively low annual inflation rate of 5.2 percent on average the most significant in terms of raising GDP per capita in 2000-10.21 21 This is compared to the 9.3 average inflation rate between 1990 and 2000, using 2000 base prices. Source: BSP. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 33 Figure 15. Both transitional convergence and structural reforms drove Figure 16. Improvements in infrastructure and reduced government growth in the 2000s. burden were the main drivers of structural reforms Contribution of Growth Drivers in the Philippines in the 2000s Growth Contribution of Structural Reforms in the Philipines in the 2000s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.12 0.12 0.1 0.1 0.08 0.08 0.06 0.06 0.04 0.04 0.02 0.02 0 0 -0.02 -0.02 Transitional Structural Stabilization External convergence reforms policies conditions -0.04 Infrastructure Government Schooling Trade Financial Burden Openness Development Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). Figure 17. The contribution of structural reforms to growth in the Figure 18. Stabilization policies contributed more to growth in the Philippines was in line with the average of peers in the 2000s. Philippines than in peers, although their impact was relatively small. Growth Contribution of Structural Reforms Growth Contribution of Stabilization Policies in the 2000s (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.50 0.50 0.40 0.40 0.30 0.30 0.20 0.20 0.10 0.10 0.00 0.00 -0.10 -0.10 -0.20 Vietnam China Indonesia Philippines Thailand Malaysia Vietnam Sri Lanka Bangladesh Morocco Philippines Kenya Pakistan Philippines Malaysia Thailand Indonesia Vietnam China Philippines Bangladesh Morocco Kenya Pakistan Sri Lanka Vietnam Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). 34 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S The contribution of structural reforms to growth in the government efforts to improve macroeconomic and fiscal Philippines was in line with the average of peers during fundamentals. Economic growth averaged 5.9 percent per the 2000s (Figure 17). Structural reforms lifted economic year in 2011-15, faster than both structural (5.3 percent) growth in all regional peers, except for Malaysia. The and regional (5.4 percent) peers. Growth during this growth contribution of structural reforms in the Philippines period was supported by the cumulative effects of past was close to the median of structural peers but lower than structural reforms, improved macro-fiscal fundamentals that of regional peers. For example, structural reforms through prudent fiscal deficit and debt management, an contributed 2.5 percentage points of GDP per capita independent monetary policy, and favorable external growth each year in China, nearly three times that of the conditions. Among the key growth drivers, transitional Philippines. However, macroeconomic stabilization policies convergence was the main driver of growth during this contributed more to growth in the Philippines than in both period (Figure 19). This implies that the country benefited structural and regional peers, although their overall impact more from past reforms in the 2010s than in the previous was small (Figure 18). decade. During this period, structural reforms led to improvements in infrastructure and financial development Growth Acceleration: 2011-15 and a reduction in government burden, contributing around one-third of economic growth (Figure 20). Economic growth in the Philippines accelerated in the 2010s, driven by past structural reforms and sustained Figure 19. Transitional convergence and structural reforms drove Figure 20. ...driven by improvements in infrastructure, financial development, economic growth in 2011-15… and reduced government burden Contribution of Growth Drivers in the Philippines in the 2010s Contribution of Structural Reforms in 2011-15 (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.14 0.04 0.12 0.03 0.1 0.02 0.08 0.01 0.06 0 0.04 -0.01 0.02 -0.02 Infrastructure Financial Government Schooling Trade 0 Development Burden Openness -0.02 Transitional Structural Stabilization External convergence reforms policies conditions Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 35 During the 2010s, the contribution of structural reforms to growth was close to the average of peer countries (Figure 21). The growth contribution of structural reforms exceeded that of stabilization policies in both the Philippines and the majority of peers between 2011 and 2015. The contribution of structural reforms to economic growth in the Philippines was close to the median of both regional and structural peers, while the growth contribution of stabilization policies was higher in the Philippines than in the median peer country (Figure 22). Besides transitional convergence, structural reforms were the main drivers of economic growth in the Philippines over the past four decades. Stabilization policies have also contributed positively to growth since 2000, as the country’s macroeconomic and fiscal fundamentals continued to improve, although their contribution to growth was smaller compared to that of structural reforms. The outcomes of both structural reforms and stabilization policies were reflected in the country’s productivity growth, which is discussed in the next section. Figure 21. The growth contribution of structural reforms in the Philippines Figure 22. …but the impact of the country’s stabilization policies was high was in line with the peers in 2011-2015… relative to peers. Growth Contribution of Structural Reforms in 2011-15 Growth Contribution of Stabilization Policies in 2011-15 (Change in Log GDP per Capita) (Change in Log GDP per Capita) 0.16 0.16 0.14 0.14 0.12 0.12 0.10 0.10 0.08 0.08 0.06 0.06 0.04 0.04 0.02 0.02 0 0 -0.02 -0.02 -0.04 -0.04 Indonesia China Philippines Thailand Malaysia Vietnam Sri Lanka Bangladesh Philippines Kenya Vietnam Morocco Bangladesh Malaysia Vietnam Philippines Indonesia Thailand China Vietnam Philippines Sri Lanka Bangladesh Morocco Pakistan Kenya Source: Background paper prepared for this report by Brueckner (2017). Source: Background paper prepared for this report by Brueckner (2017). 36 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S ROLE OF FACTOR ACCUMULATION AND TFP An analysis of the role of factor accumulation and TFP Capital accumulation has been relatively limited in the in economic growth constitutes another method to Philippines due to low levels of domestic savings and understand the Philippines’ recent economic success. The public investment. Gross domestic savings increased only previous section provided a historical view of the country’s slightly from 14.3 percent of GDP in 1998 to 15.3 percent past growth performance by assessing the role of structural of GDP in 2016, which is low relative to both regional reforms, stabilization policies, and external factors. Another and structural peers. Similarly, the Philippines had the way to analyze the country’s growth drivers is to quantify lowest level of capital accumulation among peers (Figure the relative contribution of factor accumulation and TFP 23 and Figure 24), which was exacerbated by the equally to growth through a growth-accounting exercise. This is low inflows of FDI, averaging a mere 1.5 percent of GDP complemented by a benchmarking analysis that compares per year in 1998-2015. The low investment rate is mainly the Philippines to its structural and regional peers. These driven by the low level of public investment, averaging only two analyses combined will not only provide an idea of 2.5 percent of GDP each year in 1998-2015, compared what factors drove past economic growth but also shed with an average of 8.6 percent and 3.8 percent per year light on potential future growth that will be generated from among regional and structural peers, respectively (Figure 25 capital, labor, and TFP. In Chapter 2, TFP growth will be and Figure 26). While private investment in the Philippines further decomposed to identify if efficiency gains within was similar to the average of peers, it was not enough to sectors or better allocation of production factors across compensate for the country’s low level of public investment sectors have been driving productivity growth. (Figure 27 and Figure 28). Figure 23. Capital accumulation in the Philippines, as a share of GDP, Figure 24. …and the inflow of net FDI is also low relative to peers. is the lowest among peers… Gross Capital Formation: the Philippines and Regional Peers Gross Capital Formation: the Philippines and Structural Peers (percent of GDP, 1998-2005 average) (percent of GDP, 1998-2005 average) 50 50 40 40 30 30 20 20 10 10 0 0 Philippines Malaysia Thailand Indonesia Vietnam China Pakistan Kenya Philippines Bangladesh Sri Lanka Morocco Vietnam Gross capital formation net FDI Gross capital formation net FDI Source: WDI. Source: WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 37 Figure 25. The level of public investment in the Philippines is among the Figure 26. …and significantly low relative to structural peers. lowest in the region… Public Investment in the Philippines and Regional Peers Public Investment in the Philippines and Structural Peers (percent of GDP) (percent of GDP) 25 15 20 10 15 10 5 5 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines China Indonesia Philippines Vietnam Kenya Sri Lanka Malaysia Thailand Vietnam Bangladesh Morocco Pakistan Source: WDI. Source: WDI. Figure 27. However, the level of private investment in the Philippines Figure 28. …and structural peers. ranks among the average of regional peers… Private Investment in the Philippines and Regional Peers (percent of GDP) Private Investment in the Philippines and Structural Peers (percent of GDP) 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines China Indonesia Philippines Vietnam Kenya Sri Lanka Malaysia Thailand Vietnam Bangladesh Morocco Pakistan Source: WDI. Source: WDI. 38 CHAPTER 01. DRIVERS OF PHILIPPINE GROWTH SINCE THE EARLY 1980S Yet, capital accumulation has been the main driver of growth in the same period, and its contribution to growth economic growth in the Philippines since the 1980s. A has steadily declined in the past three decades. While the decomposition of real GDP growth shows that capital contribution of TFP to growth was negative on average accumulation has consistently been the main driver of between 1981 and 2000, it has consistently contributed economic growth in the country, contributing about three- positively to growth since 2002, with the exception of fifths of the growth between 1981 and 2016. By contrast, 2009 at the height of the global recession (Figure 29 and labor accumulation, defined as the increased labor Figure 30). employed in the economy, contributed 31.3 percent of the Figure 29. TFP’s contribution to growth has increased since 2010… Figure 30. …after it declined temporarily in 2009 at the height of the global recession. Real GDP Growth and Contributions (Percentage Points) Real GDP Growth and Contributions (Percentage Points) 15 10.0 15 10 8 10 10 6 5.0 5 4 5 2 0 0 0.0 0 -2 -5 -5 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total Factor Productivity Capital Real GDP (RHS) -5.0 -10 Human Capital per Labor Labor 1981-1986 1986-1991 1991-1996 1996-2001 2001-2006 2006-2011 2011-2016 Source: Staff calculations based on PSA data. Total Factor Productivity Capital Real GDP (RHS) Human Capital per Labor Labor Source: Staff calculations based on PSA data. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 39 The contribution of TFP to economic growth increased (Figure 29 and Figure 30). Since 2002, however, TFP has in 2000s, mirroring the path of overall economic growth. consistently contributed positively to growth, averaging a The country’s sharp economic contraction in 1981-86 third of growth in 2001-16. Furthermore, the contribution coincided with not only the historic tail-end of the Marcos of TFP to growth was higher in the Philippines than in dictatorship and a national debt crisis in 1983 but also regional (except for China) and structural (except for Sri a significant negative contribution of TFP to economic Lanka) peers between 1995 and 2010 (Figure 31 and growth. TFP’s contribution to growth quickly rebounded Figure 32). in 1986-91 but again turned negative the decade after Figure 31. The contribution of TFP to economic growth was higher in the Figure 32. …and many structural peers. Philippines than in many regional peers… Contribution to growth in the Philippines and Regional Peers, 1995-2010 Contribution to Growth in the Philippines and Structural Peers, 1995-2010 (Percent) (Percent) 120 120 100 100 80 80 60 60 40 40 20 20 0 0 -20 -20 Philippines China Malaysia Thailand Indonesia Vietnam Philippines Bangladesh Kenya Morocco Pakistan Sri Lanka Vietnam Total Factor Productivity Capital Total Factor Productivity Capital Human Capital per Labor Labor Human Capital per Labor Labor Source: Staff calculations based on PSA data and WDI. Source: Staff calculations based on PSA data and WDI. 41 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 41 02 Patterns and Drivers of Aggregate Productivity 42 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY This chapter analyzes the drivers of aggregate productivity performed. The goal of the exercise is to explain the drivers growth in the Philippines. It begins with an assessment of aggregate productivity growth based on changes in of the production and productivity performance of the demographics, level of employment, labor force participation, country’s three main sectors: agriculture, manufacturing, and movement of labor across sectors, and within-sector services.22 To understand the performance of these sectors, a productivity growth. Chapter 3 will then focus on within- decomposition of per capita value-added (VA) growth is sector productivity dynamics at the firm level. DOMESTIC CONSTRAINTS SLOW PRODUCTIVITY GROWTH IN AGRICULTURE Despite the Philippines’ recent economic performance, its structural peer average of US$1,093 but less than half of agricultural sector has underperformed that of regional the regional peer average of US$2780. Between 1998 and peers in terms of production and productivity growth. The 2016, agricultural labor productivity growth averaged 2.1 agriculture sector’s contribution to GDP declined in the percent per year in the Philippines, much lower than the Philippines from 14.8 percent of GDP in 1998 to 9.7 percent regional peer average of 3.3 percent per year (Figure 33). of GDP in 2016. While gross agriculture output increased by As a result, labor productivity in the country’s agriculture 73 percent between 1990 and 2013, this was considerably sector remains much lower than the regional peer average. lower than in Vietnam and China whose agriculture The Philippines’ past agrarian reforms, its vulnerability to production more than tripled and doubled, respectively, natural disasters, and the multitude of institutions involved in during this period (Figure 34). In 1998, the Philippines’ providing support to farmers are some of the reasons for the agricultural labor productivity, measured as VA per worker, country’s poor agricultural performance (Box 3). was US$1,320 (in 2000 constant prices), higher than the Figure 33. Agricultural labor productivity growth was lower in the Figure 34. Agricultural output was also lower in the Philippines than in Philippines than in regional peers. regional peers. Agricultural Labor Productivity Growth: the Philippines vs. peers, 1999-2016 Agriculture VA Growth (1998=100) (Average, Percent) 200 6 180 5 4 160 3 2 140 1 120 0 Philippines Vietnam Thailand Indonesia Malaysia China Pakistan Kenya Vietnam Sri Lanka Bangladesh Morocco 100 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Philippines China Indonesia Source: Staff calculations based on PSA data. Malaysia Thailand Vietnam Source: Organization for Economic Co-operation and Development (OECD) (2017). 22 Instead of analyzing the industry sector, this chapter focuses on manufacturing, which is the main driver of industry in the Philippines, representing about two-third of the industry’s output between 2010 and 2017. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 43 Agricultural labor productivity growth varies widely across Between 1998 and 2016, the share of employment in regions. Luzon has the highest labor productivity growth, agriculture declined from 37.9 percent in 1998 to 26.9 which accelerated from around 1.0 percent per year in 2001- percent in 2016. Since 2012, agricultural employment has 10 to 4.1 percent per year in 2011-15. During the same declined in absolute numbers, averaging a decline of 2.0 period Visayas’ labor productivity growth, the lowest among percent per year between 2012 and 2016. Although this the three main regions, decelerated from an annual average structural shift from low-productivity agriculture to more of 2.5 percent in 2001-05 to 0 percent in 2011-15 (Figure productive sectors was sizeable, it was less pronounced than 35). There is also a large disparity in labor productivity within in most other countries in the region.23 In the Philippines, regions, especially in Luzon. For instance, agriculture labor all the employment moving out of agriculture went to the productivity in the National Capital Region (NCR) was almost service sector, informal services in particular. While labor three times the average labor productivity in Luzon in 2015 productivity is higher in the service sector than in agriculture, (Figure 36). it is still low relative to peer countries, which limits the positive contribution of the structural shift to economy-wide The movement of labor out of agriculture has contributed to productivity growth. overall productivity growth in the Philippines, although the shift has been less prominent than in regional peers. Figure 35. Agricultural labor productivity varies across regions… Figure 36. Agricultural output was also lower in the Philippines than in regional peers. Agriculture: VA per Worker by Region, 2000-15 (in Php, Constant 2000 Prices) Agriculture: VA per Worker by Region, 2015 (in Php, Constant 2000 Prices) 80000 250000 75000 200000 70000 65000 150000 60000 100000 55000 50000 50000 45000 0 40000 MIMAROPA CARAGA Cagayan Valley NCR Central Luzon CALABARZON Northern Mindanao Ilocos Region Central Mindanao Southern Mindanao Western Visayas Western Mindanao Eatern Visayas Bicol Region CAR ARMM Central Visayas 35000 30000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines Luzon Source: OECD (2017). Visayas Mindanao Source: Staff calculations based on PSA data. 23 OECD (2017). 44 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Box 3. Reasons for the Philippines’ Low Agricultural Output and Productivity The Philippines’ main agricultural policy focused on rice self-sufficiency has cyclones in recent years, resulting in annual damages equivalent to 3 percent prevented the country from diversifying away from crops such as rice and corn. of total agriculture output in the late 2000s due to typhoons, droughts, and The objectives of its agricultural policy over the past few decades have focused floods. The risk of natural disasters is aggravated by the incidence of poverty, on food security and poverty alleviation through ensuring a stable supply of food, as it hampers the ability of farmers to make decisions and investments that can especially rice, at affordable prices. As a result of the government’s support to mitigate the effects of disasters. rice producers, agricultural production only increased from 16 percent in 1991 to 22 percent in 2013. During this period, other Asian countries diversified to and A large share of agriculture land is in conflict areas, resulting in lower agriculture increased the production of higher-value crops, resulting in higher agricultural output and less investment. Conflict not only result in damages to the capital output and productivity. base and infrastructure as well as causalities, it also redirects resources for reconstruction that could have been used to improve rural infrastructure and The country’s lengthy and costly agrarian reform has brought uncertainty to support farmers. Moreover, farmers in conflict areas face the possibility of being beneficiaries and undermined investment. The agrarian reform program started displaced, losing their crops, having their land destroyed, and even losing their in 1988 and aimed to support social justice and development in rural areas by lives. Therefore, farmers have little incentive to invest in new technology or crops, regulating tenancy, establishing a maximum limit on farm sizes, and supporting or even expand their current production. Conflict also causes a reallocation of family farms. The land-tenure reform distributed more than 6.9 million hectares resources, which entails deadweight and unrecoverable losses. to small-scale farmers, and about 50 percent of beneficiaries received assistance to improve farm productivity. However, the overall distribution process is The complex system of institutions involved in the design and implementation incomplete, inter-generational land-transfer arrangements are unresolved, and of agriculture policy limits the effectiveness and efficiency of support provided there is a lack of demand-driven support services, including the timely issuance to farmers. Although the Agriculture and Fisheries Modernization Act of 1997 of collective and individual titles. As a result, there has been limited investment integrated all agriculture support into one framework, implementation is divided in the agriculture sector, as small farmers lack access to credit and expertise, and between four departments, with their sub-units, agencies, and councils as well there is less incentive for large farms to invest due to uncertainties. as numerous government-owned and controlled corporations that were created to implement policies in strategic areas. A fragmented institutional setup results in The Philippines’ high vulnerability to natural disasters partially accounts for its weak coordination, increases the risk of corruption, reduces the clarity of policy poor agriculture performance. The El Niño weather phenomenon contributed to direction and agency roles, and restricts the reach and depth of support provided an agricultural output loss of 6.8 percent in 1998 and 0.4 percent in 2009-10. In to the sector. addition, there has been an increase in the severity and intensity of tropical Source: OECD’s Agricultural Policies in the Philippines (2017); Philippines Rising Transition Notes, World Bank (2016); Impacts of Natural Disasters on Agriculture, Food Security, and Natural Resources and Environment in the Philippines, PIDS (2012); and The Mindanao Conflict in the Philippines, World Bank (2005). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 45 A RESURGENCE IN MANUFACTURING RAISES LABOR PRODUCTIVITY Growth in the Philippine manufacturing sector accelerated in year in 2003-09 (Figure 37). The growth in manufacturing 2010-16 and outpaced the growth of some regional peers. VA was accompanied by slower employment growth in Between 1998 and 2016, the country’s manufacturing manufacturing at 1.4 percent annually between 1998 and VA (constant 2010 US$) grew at an annual average of 4.8 2016 (Figure 41). As a result, labor productivity in the percent, outpacing the growth of regional peers such as Philippine manufacturing sector grew at an annual average of Thailand and Indonesia. Much of the faster growth happened 2.9 percent between 1998 and 2016, higher than the annual after the 2009 global recession, with the manufacturing average of 2.5 percent and 2.3 percent for regional and sector growing at an average annual rate of 7.5 percent in structural peers, respectively, in the same period (Figure 38). 2010-16, much higher than the average of 3.0 percent per Figure 37. Growth in manufacturing VA was higher in the Philippines than Figure 38. Labor productivity in the country’s manufacturing sector is peers after 2010 above the average of peers. Manufacturing VA Growth: the Phlippines vs. Regional Peers Manufacturing Labor Productivity Growth Rates: the Philippines vs. peers, (Average Annual Growth, %) 1998-2016 (Average, %) 12 4.0 10 3.5 3.0 8 2.5 2.0 6 1.5 1.0 4 0.5 2 0 Philippines Indonesia Thailand Malaysia Vietnam Kenya Pakistan Morocco Bangladesh Sri Lanka Vietnam 0 Philippines Vietnam Thailand Indonesia Malaysia 1998 - 2002 2003 - 2009 2019 - 2016 Source: WDI, ILO, and staff calculations. Source: WDI. 46 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Labor productivity growth in the manufacturing sector has High productivity growth in the manufacturing sector accelerated across all regions in the Philippines, except in was due to a transition to more skill-intensive products. Visayas (Figure 39). Mindanao has benefitted from strong Between 1998 and 2016, there was a gradual decline in growth in the manufacturing sector, with labor productivity the share of textiles, wearing apparel, and paper products growth accelerating from an annual average of 3.4 percent in in total manufacturing output, and an increase in the share 2006-10 to an average of 8.5 percent per year in 2011-15 of telecommunications and transport equipment (Figure (Figure 40). By contrast, manufacturing labor productivity 42). In 1998, food manufacture; radio, television, and growth fell slightly in Visayas. Labor productivity growth communication equipment and apparatus; and chemical in manufacturing in Luzon, which accounts for nearly 80 products represented about half of all manufacturing percent of the country’s manufacturing output, accelerated output in the Philippines. In 2016, the share of these three to an annual average of 4.9 percent in 2011-15, up from an product lines increased to about two-thirds of the country’s average of 2.1 percent in the previous five years. As a result, manufacturing activities. This resulted in an average of 3.5 the gap in labor productivity between Luzon and Mindanao percent annual contraction in the exports of articles of narrowed over the past fifteen years, although at a much apparels in 1998-16, resulting in their share of total exports slower pace than between Luzon and Visayas. shrinking from 8.8 percent in 1998 to 1.5 percent in 2016. Meanwhile, the export of electronic components grew by an average of 5.5 percent annually in the same period. Box 4. The Industry Success of Business Process Outsourcing The Philippines is a market leader in the global information technology-business The liberalization of the telecommunications industry in the 1990s helped process outsourcing (IT-BPO) industry, staying at the forefront of voice-related the Philippines nurture a nascent IT-BPO industry. Telecommunications were services. The IT-BPO industry is one of the country’s fastest growing sectors, deregulated with the break-up of the existing monopoly in the market in 1993, experiencing rapid growth in both revenue and employment generation. Total which resulted in more investments and new players in the industry. The IT-BPO revenue grew at an annual average of 17.0 percent in 2010-16, reaching liberalization effectively increased competition, resulting not only in improved US$22.9 billion (7.5 percent of GDP) in 2016, up from US$8.9 billion (4.5 percent of service delivery but also greater network availability and connectivity. GDP) in 2010. This growth momentum is expected to be sustained with revenues Telecommunications costs went down substantially, including for international estimated to reach US$38.9 billion by 2022. There has also been a rapid growth direct dialing and internet connections. For example, international direct dialing in employment in the sector, increasing from 0.5 million workers (1.4 percent of from the Philippines to the United States decreased from US$0.50 per minute in total employment) in 2010 to 1.2 million (2.9 percent) in 2016, and the industry 2000 to around US$0.32 per minute in 2007 and as low as US$0.05 per minute in is projected to employ 1.8 million workers by 2022. The Philippines is the top 2017. These early market developments supported the emergence of the IT-BPO destination for voice-support services, supplanting India in 2011 by garnering industry in the Philippines. more operations and people employed in call centers. The country has the potential to climb up the IT-BPO value chain, competing in higher value-added products and services such as in back-office systems, accounting, animation, and healthcare information management. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 47 Figure 39. Labor productivity growth in manufacturing differs across Figure 40. Labor productivity growth in Mindanao accelerated in regions in the Philippines. recent years. Manufacturing: VA Per Worker by Region (in Php, Constant 2000 Prices) Manufacturing: VA Per Worker Growth by Region (Percent) 700000 10 600000 8 500000 6 400000 4 300000 2 200000 100000 0 Philippines Luzon Visayas Mindanao 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines Luzon 2001 - 2005 2006 -2010 2011 -2015 Visayas Mindanao Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. Figure 41. The share of manufacturing in GDP has recovered from an earlier decline. Contribution of Manufacturing to Output and Employment (Percent) 25 11 20 10 15 9 10 8 5 7 0 6 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Share to Real GDP Share to total employment (RHS) Source: Staff calculations based on PSA data. 48 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Figure 42. The country’s manufacturing sector is transitioning to more skill-intensive production. Share of Sub-sectors in Total Manufacturing Output (Percent) 40 Food manufactures 35 30 Radio, television and communication 25 equipment and apparatus 2016 20 Chemical & 15 chemical products Petroleum and other fuel products 10 Furniture and fixtures Beverage Textile manufactures 5 industries Wearing apparel 0 0 10 20 30 40 1998 Source: Staff calculations based on PSA data. RAPID LABOR PRODUCTIVITY GROWTH IN THE SERVICE SECTOR DESPITE ITS DUAL NATURE The Philippines’ service sector has experienced rapid growth, employs half of all workers in the economy and includes and labor productivity in the sector has continued to rise. finance, real-estate, and other business, including the fast- The contribution of services to total output increased from growing BPO industry (Box 4). Meanwhile, the informal 50.8 percent of GDP in 1998 to 59.5 percent of GDP service sector has served as a catch-basin for excess in 2016. Moreover, the service sector grew at an annual agricultural workers who could not find employment in urban average rate of 5.7 percent in the same period, more than manufacturing or in the formal service sector.24 Between the agriculture and industry sectors. This rapid growth was 1998 and 2016, labor productivity in informal services grew driven by both formal and informal services. Formal service at an average annual rate of 2.6 percent, faster than the sector output growth accelerated from 5.9 percent in 2005- average annual 1.7 percent in formal services. As result, 09 to 7.1 percent in 2010-16, while output growth in the the ratio of labor productivity between formal and informal informal service sector accelerated from 4.7 percent to 6.3 services narrowed, from 1.5 times in 1998 to 1.3 times percent over the same period. in 2016. The labor productivity gap between formal and informal services has also been declining. The formal service sector 24 The formal service sector includes the following subsectors: finance, real-estate and other business activities (including BPO), public administration, and other personal services. The informal service sector is operationally defined to include the following subsectors: i) wholesale and retail trade and ii) transportation, communication, and storage (TCS). Around 85 percent of TCS workers work in the informal TCS sector, which excludes the whole communications sub-sector, corpo- rate executives, general managers who finished at least high school, supervisors, physicists, engineers, and other professionals. The informal services sector accounts for over half of services sector employment. The report uses this operational definition as a proxy for informality, as the Labor Force Survey does not include variables which are necessary to define the level of informality of employment. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 49 However, there are still large disparities in labor productivity growth in services also accelerated in Mindanao and Luzon, across regions. Labor productivity growth in the Philippines’ reaching an annual average of 3.4 percent and 3.2 percent, service sector nearly doubled from an average of 1.8 percent respectively, in 2011-15. Yet, large disparities still exist per year in 2006-10 to an average of 3.4 percent in 2011- across regions (Figure 44). For example, VA per service 15. Labor productivity growth was the highest in Visayas, worker in the NCR was Php 203,550 in 2015, compared to averaging 4.8 percent per year in 2011-15, more than a mere average Php 76,243 in the country’s other regions three times the growth rate in 2006-10. Labor productivity (Figure 45). 38+23+2217E Figure 43. Employment in the formal and informal services sectors grew in 1998-2016 17.1 37.9 Industry Agriculture Share of Total Employment by Sector, 1998 (Percent) 22.4 Informal Services 22.6 27+28+2718E Formal Services 17.5 26.9 Industry Agriculture Share of Total Employment by Sector, 2016 (Percent) 27.3 Informal Services 28.4 Formal Services Source: Staff calculations based on PSA data. 50 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Figure 44. Labor productivity growth in manufacturing differs across Figure 45. … particularly between the NCR and other regions. regions in the Philippines. Services: VA per Worker by Region, 2000-15 (in Php, Constant 2000 prices) Services: VA per Worker by Region, 2015 (in Php, Constant 2000 Prices) 300000 700000 600000 250000 500000 400000 200000 300000 150000 200000 100000 100000 0 MIMAROPA CARAGA Cagayan Valley Cagayan Valley NCR Central Luzon Central Visayas Southern Mindanao CALABARZON Northern Mindanao Central Luzon Western Mindanao Western Visayas Central Mindanao Eastern Visyas Bicol Region ARMM 50000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines Luzon Visayas Mindanao Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. LABOR PRODUCTIVITY IS DRIVEN BY SECTOR PRODUCTIVITY GROWTH Per capita income growth comes from changes in The movement of labor from one sector to another can demographics, employment levels, labor force participation, be further divided into “between-static” and “between- sector-level productivity growth, and movement of labor dynamic” components. The between-static component across sectors (Box 5). Changes in sector-level productivity measures whether workers move to sectors with above- are often cited as the “within” component, and changes average productivity. For instance, if labor transitioned from a reallocation of labor between sectors are often out of agriculture to the financial service sector, which has referred to as the “across” component. The latter measures higher productivity than the economy-wide average, the the extent of structural change in the economy (Figure 46). between-static component would be positive. The between- For instance, aggregate productivity can arise from either dynamic component measures whether productivity growth efficiency improvements within agriculture (i.e., the “within” is higher in sectors with an increase in employment. For component), such as the adoption of a new fertilizer, or the example, this component would be positive if manufacturing, movement of labor from agriculture to more productive which is growing faster than the economy-wide average, is sectors (i.e., the “across” component), such as manufacturing. absorbing more labor. Both the between-static and -dynamic components measure the aggregate level of allocative efficiency in the economy. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 51 Figure 46. GDP Growth Decomposition Per capita VA growth Change in employment rate Change in output per worker Change in demographic Change in participation rate (Labor productivity) structure Changes “within” sectors Changes “across” sectors (Structural change) Change between-dynamic Change between-static The analysis of per capita VA growth covers the following percent on average in 1998-2016. Increases in the employed three periods: 1998 to 2004, 2005 to 2009, and 2010 labor force (due to demographic growth in employment and to 2016. Economic growth in the Philippines started to labor force participation) played a minor role throughout recover in late 1990s, growing at an average annual rate the period, contributing an average of 11 percent each year of 3.6 percent between 1998 and 2004. TFP contributed in 1998-2004, 15 percent in 2005-09, and 12 percent in an average of 1.5 percentage points to growth each year 2010-16. during this period. The country quickly recovered after the near-fiscal crisis in 2005, growing by 4.4 percent on average However, labor productivity growth was lower in the each year in 2005-09. In this period, TFP contributed an Philippines than in regional peers in the past two decades. average of 1.3 percentage points to growth each year. Using constant 2011 US$ in PPP terms, VA per worker in After the global financial crisis in 2009, economic growth the Philippines reached US$11,093 in 1998, lower than in the Philippines accelerated to an average annual rate of the regional peer average of US$15,452 but higher than 6.1 percent in 2010-16, with TFP growth averaging 2.2 the structural peer average of US$9,346 (Figure 47 and percentage points year-on-year. An understanding of the Figure 48).25 Labor productivity growth in the Philippines drivers of TFP growth in each of these periods can provide accelerated from 1.6 percent in 1998-04 to 3.6 percent in insight into the growth dynamics of TFP. 2010-16. Despite recent acceleration, the country’s labor productivity growth has been lower than that of many Labor productivity growth was the main driver of per peers, widening the gap in labor productivity between the capita VA growth between 1998 and 2016 (Figure 51). Philippines and regional peers (Figure 49 and Figure 50). Per capita VA growth accelerated from an annual average This was partly because capital per worker has been much of 2.1 percent in 1998-2004 to 2.5 percent in 2005-09 lower in the Philippines than in peer countries. Considering and 4.7 percent in 2010-16. A decomposition of per capita the Philippines’ high TFP growth rate in recent years, labor VA growth between labor productivity and the employed productivity would have likely been higher if capital per labor force reveals that changes in labor productivity were worker had been higher. the main drivers of per capita VA growth, contributing 87 25 To compare productivity growth between two countries, labor productivity growth is often used, as it is comparable across countries. 52 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Figure 47. Labor productivity in the Philippines is below the average of regional peers… Box 5. Understanding and Measuring Productivity VA per Worker: the Philippines vs. Regional Peers (Constant 2011 PPP $) Productivity is defined as the efficiency with which inputs (such as labor and 60000 capital) are used in the production process. Two measures are often used in the empirical analysis: (i) labor productivity, expressed as output (or VA) per 50000 worker; and (ii) TFP, which measures the efficiency of all inputs used in the production process. TFP is usually derived as a residual once the impact of all inputs on output is considered. 40000 To understand the drivers of changes in productivity growth, changes in 30000 productivity is decomposed into its sources or components, both at the aggregate/sectoral and firm levels: 20000 1. The sources of changes in aggregate productivity can be decomposed as follows: • Between-sector change or structural: measures the contribution 10000 of changes in sectoral employment shares between sectors to aggregate productivity growth. It contributes positively (negatively) 0 if high-productivity sectors increase (decrease) their market share. Vietnam Philippines Indonesia China Thailand Malaysia • Within-sector: measures the average contribution of productivity growth that occurs within each sector. It contributes positively (negatively) to aggregate productivity if productivity increases 1998 2016 (decreases) within a sector. Source: WDI. 2. Productivity changes within sectors can be decomposed into five subcomponents: • Within-firm: measures the contribution of productivity growth Figure 48. … particularly between the NCR and other regions. within surviving firms. It contributes positively (negatively) to sector-level productivity if productivity of surviving firms increases Services: VA per Worker by Region, 2015 (in Php, Constant 2000 Prices) (decreases). 35000 • Between-firm: measures the contribution of labor reallocation across sectors, which is positive (negative) when labor moves 30000 from less (more) to more (less) productive sectors. Specifically, it measures whether workers move to sectors with above-average 25000 productivity (static reallocation effect). • Cross: measures the joint effect of changes in employment shares and sectoral productivity growth. It is positive (negative) if workers are 20000 moving to sectors that are experiencing positive (negative) productivity growth. This measures whether productivity growth is higher in sectors that 15000 expand in terms of employment shares (dynamic reallocation effect). • Entry: measures the average difference between entering firms’ productivity 10000 and initial productivity at the sector level. It contributes positively (negatively) to sector-level productivity if entering firms have higher (lower) 5000 productivity than the initial sector average. • Exit: measures the average difference between initial productivity at the sector level and exiting firms’ productivity. It contributes positively 0 Bangladesh Kenya Vietnam Pakistan Philippines Morocco Sri Lanka (negatively) to sector-level productivity if exiting firms have lower (higher) productivity than the initial sector average. 1998 2016 Note: Given data limitations, this report will not study entry and exit dynamics. Source: WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 53 The recent improvement in labor productivity in the were the sectors with the highest annual growth in labor Philippines mainly reflects a rise in within-sector productivity productivity. By contrast, real estate, renting and other growth. Sector-level productivity growth was the main driver business activities, and construction experienced negative of labor productivity growth in the Philippines between productivity growth in the same period (Figure 53).26,27,28 1998 and 2016 (Figure 52). This is reflected in the increased The Philippines relies more heavily on within-sector contribution of many individual sectors to aggregate productivity growth than other countries in East Asia, productivity over time. In 1998-2016, mining, transport, including China, Indonesia, Malaysia, and Thailand.29 communication and storage, utilities, and manufacturing Figure 49. The Philippines’ labor productivity growth was low relative to Figure 50. …widening the gap between the Philippines and its peers in the past two decades… regional peers. VA per Worker Growth: the Philippines vs. Regional Peers (1998=100) VA per Worker Growth: the Philippines vs. Structural Peers (1998=100) 500 500 400 400 300 300 200 200 100 100 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Philippines China Indonesia Philippines Vietnam Kenya Sri Lanka Malaysia Thailand Vietnam Bangladesh Morocco Pakistan Source: WDI. Source: WDI. Note: GDP per person employed (constant 2011 PPP$). Note: GDP per person employed (constant 2011 PPP$). 26 National income accounts data are based on the 1994 Philippine Standard Industrial Classification (PSIC). However, labor force survey data from the PSA was reclassified in 2009 with the revision of the 2009 PSIC. In the 2009 PSIC, the “real estate, renting and business activities” was split into three sections. “Real estate” is now represented as a stand-alone section under the 2009 PSIC. The remaining activities were separated into “professional, scientific, and technical activities” and “administrative and support service activities.” “Computer and related activities” were previously classified in Division 72 in the 1994 PSIC but are no longer included in this section. Computer repair activities were grouped with repair of household goods in “other service activities,” while software publishing and IT activities have been grouped in the new “Information and Communication” category. As a result of these changes, employment data for the real estate, renting, and other business activities subsector from 2012 - 2016 are estimates based on the 2-digit PSIC codes available through the labor force survey. The PSA is currently in the process of updating national income accounts based on the 2012 base year, which will reflect latest industry classifications under the 2009 PSIC. 27 Based on the 1994 PSIC, real estate activities include buying, selling, renting, and operating self-owned or leased real estate such as apartment buildings and dwellings and non-residential buildings; developing and subdividing real estate into lots, etc; development and sale of land and cemetery lots; and operation of apartelles. 28 Based on the 1994 PSIC, renting activities include renting of machinery and equipment without operators and personal and household goods. Other business activities include: i) computer and related activities; ii) research and development; iii) and other miscellaneous business activities such as legal activities, accounting, auditing, market research, etc. 29 EAP April 2017. 54 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Structural changes in the Philippine economy also to sectors with increasing productivity growth) contributed contributed to labor productivity growth, although at a negatively to labor productivity in the same period (Figure smaller scale than within-sector productivity growth. The 52). This was because although the share of employment between-static component’s (i.e., movement of labor to increased in real estate and renting and other business more productive sectors) contribution to overall labor activities, productivity in these sectors declined. By contrast, productivity growth was 46.3 percent in 1998-2004, 18.4 productivity increased in manufacturing while its share in percent in 2005-09, and 30.1 percent in 2010-16. However, total employment declined from 10.2 percent in 1998 to 8.3 the between-dynamic component (i.e., movement of labor percent in 2016. Figure 51. Per capita VA growth came primarily from Figure 52. Within-sector productivity growth contributed the increased productivity. most to labor productivity growth. Decomposition of Growth in per Capita VA (Percent) Decomposition of Annual Growth of Labor Productivity (Percentage Points) 5 5 3 3 1 1 0 0 -1 -1 1998-2004 2005-2009 2010-2016 1998-2004 2005-2009 2010-2016 Change in Share of Working Age Population between-dynamic Change in Participation Rate between-static Change in Employment Rate within Change in Productivity average annual labor productivity growth Annual Growth per capita Value Added Source: Staff calculations based on PSA and WDI. Source: Staff calculations based on PSA and WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 55 Figure 53. Most sectors experienced labor productivity growth in 2010-16 Annualized Labor Productivity Growth by Sector (Percent) 10 8 6 4 2 0 -2 -4 -6 -8 Utility Real Estate, Renting, and Business Government Services Mining and Agriculture Other Services Finance Wholesale and Retail Trade Transport, Communication and Storage Total Activities Construction Quarrying Manufacturing 1998-2004 2005-2009 2010-2016 Source: Staff calculations based on PSA data. The steady shift in employment from agriculture to services percentage points to aggregate productivity growth in 1998- underpins the productivity gains from structural change. 2014. Structural gains occur when (i) labor move to relatively Figure 54 shows changes in employment shares and the high-productivity sectors or (ii) when labor move out of relative productivity of sectors, measured as log of the ratio relatively low-productivity sectors. Productivity in utilities, between sectoral productivity and economy-wide average finance, and real estate, renting, and other business activities productivity between 1998 and 2016. For positive gains is high relative to the economy-wide average productivity. to occur through structural change, sectors need to be in These sectors also gained labor share (example of labor either the top-right corner (e.g., services) where labor shifts moving to more productive sectors). Moreover, labor moved into relatively high-productivity sectors, or in the third out of the less productive agriculture sector, increasing quadrant (e.g., agriculture) where labor shifts out of low- aggregate productivity (example of labor moving from less productivity sectors. Structural change (i.e., the “across” productive sectors). The combined effect of the movement component) contributed around 0.3 percentage points and of labor across sectors contributed 13 percent to labor 1.1 percentage points per year to labor productivity growth productivity growth in 1998-2014 (Figure 55). The structural in 1998-2009 and 2010-16, respectively. change will continue to contribute to aggregate labor productivity growth in the Philippines, as the agriculture The sectoral shift in employment from agriculture to services, sector still employs more than a quarter of all workers in the and to a lesser extent manufacturing, contributed around 13 country (Figure 56). 56 CHAPTER 02. PATTERNS AND DRIVERS OF AGGREGATE PRODUCTIVITY Figure 54. Labor is transitioning from agriculture to more productive sectors. Contribution of Manufacturing to Output and Employment (Percent) 1.2 1 Electricity, Gas and Water 0.8 Finance Log (sector prod/average prod) Real Estate, Renting and 0.6 Business Activities Manufacturing 0.4 Mining 0.2 Construction Government services 0 Trade Transport, Communication and Storage Other services -0.2 -0.4 Agriculture -0.6 -0.8 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 Change in employment share (1998-2016) Source: Staff calculations based on PSA and WDI. Note: The figure plots the logarithm of sectoral VA per worker (relative to the average across all sectors) and the change in the employment share for 11 economic sectors in 1998-2016. The size of the circle reflects the employment share in 2016. On the vertical axis, sectors above zero are more productive than the average sector in the economy. On the horizontal axis, sectors to the right of zero have had increases in their employment shares. The service sector has contributed the most to per capita Figure 55. Labor movement across sectors increased labor VA growth among the three main sectors in the Philippines, productivity by 13 percent compared to no labor movement. and the reallocation of labor to more productive sectors improved after 2010. The contribution of the service sector Labor Productivity: Actual vs Counterfactual (in Php, Constant 2000 Prices) to per capita VA growth increased from 0.5 percentage 200000 points in 1998-2004 to 1.5 percentage points and 2.0 percentage points in 2005-09 and 2010-16, respectively (Figure 57). The intersectoral reallocation (i.e., the 180000 “across” component) of labor productivity accelerated and started to contribute more to per capita VA growth 160000 after 2010. In terms of within-sector productivity growth, manufacturing, wholesale and retail trade, transportation, 140000 and communication and storage have contributed the most to per capita VA growth, while the real estate sector has consistently been the worst performer since 1998 120000 (Figure 58). 100000 Within-sector productivity growth drove aggregate labor 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 productivity growth in the Philippines between 1998 and 2016. Yet, there was substantial variation in labor Aggregate productivity productivity growth across sectors, with manufacturing and counter factual some formal service sectors experiencing the highest levels of labor productivity growth. The next chapter will examine Source: Staff calculations based on PSA and WDI. firm-level evidence to assess the role of factor allocation in within-sector productivity dynamics. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 57 Figure 56. The share of employment in agriculture has been declining since 1998. 1+10671524E 27+ 38+36+ 1+958192414E 1+819517E Employment by Sector (Percent) 1998 37.9 2006 35.8 2016 26.9 Agriculture Transport, Communication and Storage Other Services Mining and Quarrying Wholesale and Retail Trade Manufacturing Finance Construction Real Estate, Renting and Business Activities Utilities Government Services Source: Staff calculations based on PSA and WDI. Figure 57. Among the main three sectors, services contributed the Figure 58. The manufacturing sector experienced significant most to per capita VA growth. productivity growth… Decomposition of per Capita VA Growth Decomposition of per Capita VA Growth (Change in Productivity (Change in Productivity by Sector, Percentage Points) by Sector, Percentage Points) 4 6 4 5 3 3 4 4 2 2 3 1 1 2 2 0 0 1 -1 0 -1 0 1998-2004 2005-2009 2010-2016 1998-2004 2005-2009 2010-2016 Services Manufacturing Other Services Industry Utilities Transport, Communication and Storage Agriculture Agriculture Wholesale and Retail Trade Annual Growth per capita Value Added Mining, Quarrying and Construction Finance Annual Growth per capita Value Added Real Estate, Renting and Business Activties Annual Growth per capita Value Added (RHS) Intersectoral Reallocation Effect Source: Staff calculations based on PSA and WDI. Source: Staff calculations based on PSA and WDI. 59 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 59 03 Patterns and Drivers of Productivity at Industry and Firm Level 60 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL Productivity growth in the Philippines has been mainly driven activities and firms, while technical efficiency occurs when by within-sector productivity growth. To better understand firms produce more output from the same level of inputs. what drives sector-level productivity dynamics, this chapter To improve overall productivity through a better allocation assess the role of allocative and technical efficiencies in of resources, resources from firms with low returns on sector productivity growth. Firm performance contributes to production factors need to flow to firms with high returns aggregate productivity growth through two channels: i) the in the same or different sectors. While allocative efficiency capacity of markets to efficiently allocate resources across across sector was analyzed in Chapter 2, this chapter firms (i.e., allocative efficiency) and ii) the evolution of firm will focus on allocative efficiency between firms within a productivity (i.e., technical efficiency). Allocative efficiency narrowly defined sector. involves the allocation of resources to the most productive FIRM CHARACTERISTICS AND PRODUCTIVITY The Philippine economy is dominated by small firms that and services (Figure 61 and Figure 62). This is also common are less productive than medium or large firms.30 In 2014, in other countries, as larger firms tend to have better access two-thirds of the country’s manufacturing firms and over to credit and technology, benefit from economies of scale, 80 percent of services firms employed less than 20 workers and are more resilient to shocks than smaller firms. However, (Figure 59 and Figure 60). Yet, small firms are on average less a large share of small firms in an economy can be an productive than medium or large firms in both manufacturing indication that firms are suffering from stunted growth. Figure 59. Most firms are small in the manufacturing sector… Figure 60. …as well as in the service sector. Manufacturing Firms by Size Services Firms by Size 18000 180000 16000 160000 14000 140000 12000 120000 10000 100000 8000 80000 6000 60000 4000 40000 2000 20000 0 0 2001 2009 2014 2001 2009 2014 100 and above 20-99 workers 1-19 workers 100 and above 20-99 workers 1-19 workers Source: PSA. Source: PSA. 30 Details of the dataset can be found in Annex 3.1. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 61 The relationship between the age and size of firms differs differences across sectors. In manufacturing, for example, across sectors in the Philippines. When product and factor old textile firms are on average smaller than younger firms, markets work efficiently, unproductive firms exit the market while old firms in the motor vehicles industry are 21 times while more efficient firms remain and expand. This pattern larger than younger firms (Table 1). In services, old financial is observed in the United States where old firms (i.e., firms firms are 13 times larger than younger firms, while firms in 40 or more years old) are about eight times larger than firms administrative and supporting services do not seem to grow with less than five years in the market. In the Philippines, the over time (Table 2). The distinct growth patterns of firms in economy-wide ratio of average employment to young firms different sectors could be caused by differences in sectors’ shows a similar pattern, as old firms are about seven times product and/or factor market efficiencies. larger than young firms (Figure 63). However, there are vast Figure 61. Large firms are more productive than small or medium firms in Figure 62. …as well as in services. manufacturing… Productivity by Firm Size in Manufacturing (Log of VA per Worker) Productivity by Firm Size in Services (Log of VA per Worker) 14 12 12 11.5 10 11 8 6 10.5 4 10 2 0 9.5 2012 2013 2014 2001 2009 2014 100 and above 20-99 workers 1-19 workers 100 and above 20-99 workers 1-19 workers Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. Figure 63. Firms in the Philippines are growing at a healthy rate. Average Employment by Age Relative to Employment of Young Firms (All Firms) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 2014 Manufacturing 2014 Economy-wide 1.0 2014 Service 0 <5 5-9 10-14 15-19 20-24 25-29 30-34 35-39 >=40 Source: Staff calculations based on PSA data. 62 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL Table 1. Ratio of Average Employment Relative to Young Firms, Manufacturing, 2014 1994 PSIC 2-Digit Industries <5 5-9 10-14 15-19 20-24 25-29 30-34 35-39 >=40 Food products and beverages 1 1.8 1.7 5.1 5.2 5.6 7.2 8.4 9.3 Textiles 1 0.4 1 0.8 0.9 0.8 0.7 1 0.9 Wearing apparel 1 1.9 2.2 3.9 3.2 5.5 8.3 1.3 3.7 Tanning and dressing of leather; manufacture 1 0.7 1.2 1.1 0.9 1.2 1.1 0.8 1 of luggage, handbags and footwear Wood, wood products and cork, except 1 1.1 1.5 2.7 3.2 1.2 4.6 2.2 1.9 furniture; manufacture of articles of bamboo, cane, rattan and the like; manufacture of plaiting materials Paper and paper products 1 1.1 0.9 1.2 1.1 1.5 1 0.7 0.7 Publishing, printing and reproduction of 1 1 1.9 1.6 4.1 8.2 3.9 7.5 7.5 recorded media* Coke, refined petroleum and other fuel products Chemical and chemical products 1 1.3 1.2 1.8 2 1.2 4.1 3.3 4.4 Rubber and paper products 1 1.9 2.1 1.7 3 1 19.3 Paper and paper products 1 0.6 6 3.1 5.5 5.8 3.6 1.2 5.7 Basic metals 1 1.3 1.5 1.5 3.1 1.7 1.3 2.1 3.1 Fabricated metal products, except machinery 1 1.4 1.5 3.7 4.7 3 1.7 4.1 3.9 and equipment Machinery and equipmeny, n.e.c. 1 1.9 5.5 4.4 1.5 7.2 1.2 1.9 3.5 Office, accounting and computing machinery 1 1.1 1.6 1.2 2.6 Electrical machinery and apparatus, n.e.c. 1 0.9 1.8 2.5 2.4 3.4 0.2 0.5 1.1 Radio, television and communication 1 1.5 1.6 2.5 2.8 15.2 9.7 4.2 equipment and apparatus Medical, precision and optical instruments, 1 0.1 0.3 0.6 0.6 1.3 2.2 0.3 0.1 watches and clocks Motor vehicles, trailers and semi-trailers 1 4.3 28.6 19.5 27.7 17.6 4.5 3.2 21.1 Other transport equipment 1 3.4 3.5 33.5 37.1 Manufacture and repair of furniture** 1 2.3 1.5 1.6 4.1 4.4 5.5 1 2.9 Manufacturing, n.e.c. 1 1.6 1.8 2.2 1.1 2.5 0.4 1.4 2.3 Manufacturing Sector 1 1.3 1.5 3.2 3.9 5.8 4.2 2.6 4.1 Source: Staff calculations based on PSA data. Table 2. Ratio of Average Employment Relative to Young Firms, Services, 2014 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 63 Table 2. Ratio of Average Employment Relative to Young Firms, Services, 2014 2009 PSIC Services Sectors <5 5-9 10-14 15-19 20-24 25-29 30-34 35-39 >=40 Wholesale and retail trade; repair of motor 1 1 2 2 2 3 2 3 4 vehicles and motorcycles Transportation and storage 1 1 1 1 2 4 2 3 8 Accommodation and food service activities 1 1 1 2 2 1 2 2 2 Information and communication 1 1 2 3 3 3 2 1 6 Financial and insurance activities 1 1 1 2 2 4 6 2 13 Real state activities 1 1 1 2 2 1 2 1 1 Professional, scientific and technical activities 1 1 1 1 2 4 2 1 3 Administrative and support service activities 1 2 1 1 1 1 1 2 1 Education 1 1 1 1 2 3 3 6 7 Human health and social work activities 1 1 1 2 2 1 4 3 12 Arts, entertainment and recreation 1 1 1 1 4 7 2 9 3 Other service activities 1 1 1 2 2 2 3 3 3 Services Sector 1 1 2 2 2 2 3 3 6 Source: Staff calculations based on PSA data. The share of firms with foreign capital remains small in the Firms with foreign ownership are on average more overall economy, although the degree of foreign ownership productive than fully domestically owned firms. is relatively high in some services and manufacturing sectors. Between 2010 and 2014, firms with foreign capital were Less than 10 percent of all firms in the Philippines have some more productive than firms with 100 percent domestic degree of foreign ownership, with most foreign owners in capital (Figure 66). In addition, firm productivity tends industry (their share has, however, declined in recent years) to increase with more foreign ownership (Figure 67). For (Figure 64). Across sectors, firms in manufacturing and instance, firms in agriculture with between 50 percent and services, such as in information communication technologies 75 percent foreign capital were substantially more productive and professional services that have foreign ownership, than firms with only domestic capital during the same receive on average more than 50 percent of their capital period. This finding is consistent with evidence from other from foreign sources (Figure 65). developing countries. 64 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL Figure 64. The share of Philippine firms with foreign ownership remains small. Composition of Firm Ownership by Sector (Percent) 100 90 80 70 60 50 40 30 20 10 0 2010 2014 2010 2014 2010 2014 Agriculture Industry Services 100% domestic Firms with foreign ownership Source: Staff calculations based on PSA data. Figure 65. Foreign ownership is high in some services and manufacturing sectors. Average Foreign Onwership by Sector (Percent) 80 70 60 50 40 30 20 10 0 conditioning Supply Information and communication Eelectricity, gas, and air- Manufacturing Professional, scientific and technical services Transportation and storage Water supply, sewerage, waste management, and remediation services Wholesale and retail rrade Accommodation and food services Education Construction Financial and insurance Arts, entertainment and recreation Other services Agriculture, forestry and activities fishing Mining and quarrying Administrative and support service activities Human health and social work activities Real estate activities 2010 2014 Source: Staff calculations based on PSA data. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 65 Figure 66. Firms with foreign ownership are on average more Figure 67. Foreign ownership is correlated with higher productivity. productive than fully domestically owned firms. Productivity and Firm Ownership Productivity by Degree of Foreign Ownership by Sector (Economy-wide Log of VA per Worker) (Log of VA per Worker, 2014) 15 12 12 10 8 9 6 6 4 3 2 0 0 2012 2013 2014 Agriculture Industry Services Manufacturing Total excluding manufacturing 100% Filipino Firms Firms with Foreign Ownership 0% >0% & <25% >25% & <50% >50% & <75% >=75% Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. While the number of exporting firms remains small across sectors, they are on average more productive than firms that only focus on the domestic market. Consistent with aggregate data, firm-level data show that the share of firms that export remains small in the Philippines (Figure 68). In agriculture, a mere 5 percent of sampled firms exported in 2014, down from less than 10 percent in 2010. A similar trend can be observed in industry: the share of exporting firms declined from 10 percent in 2010 to 7 percent in 2014. The share of export service firms also remains small, declining from 2 percent in 2010 to 1 percent in 2014. Yet, firms that export are on average more productive than firms that focus on the domestic market (Figure 69). This is likely because firms that export face more competition in global markets, which likely forces them to be more productive, a stylized fact presented in many countries. 66 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL Figure 68. The share of firms that export declined in the Philippines in Figure 69. Firms that export are on average more productive than firms 2010-14. that focus on the domestic market. Share of Firms by Export Status (Percent) Productivity and Export Status (Economy-wide Log of VA per Worker) 100 12 10 80 8 60 6 40 4 20 2 0 0 2010 2014 2010 2014 2010 2014 Agriculture Industry Services 2012 2013 2014 Firms with zero export sales Firms with non-zero export sales Firms with zero export sales Firms with non-zero export sales Source: Staff calculations based on PSA data. Source: Staff calculations based on PSA data. A better allocation of resources could help expand more productive firms and sectors. While firms that are large, export, and have foreign ownership are more productive than firms that are small, domestically owned, and only focus on domestic market, they represent a very small share of firms in the Philippines. While this is not likely the result of a lack of policies to support specific industries, it might be explained by an inefficient allocation of resources. By removing market distortions, resources for the production of goods and services (i.e., capital and labor) are likely to flow from less productive firms to firms that have a high productivity potential. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 67 FACTOR ALLOCATION IN MANUFACTURING IS IMPROVING A misallocation of resources hampers growth and creates There are greater differences in the productivity of inefficient firm dynamics. Resource misallocation is caused manufacturing firms in the Philippines than in many by three categories of factors: (i) statutory provisions, other countries. While differences in productivity among including the tax code that varies with firm characteristics, firms producing the same products are common around tariffs that only apply to certain categories of goods, and the world,33 they are particularly high in the Philippines. labor and product market regulations that restrict the size of Philippine firms in the 90th percentile of the productivity firms or limit their market access; (ii) discretionary provisions distribution were 5.5 times more productive than firms in granted by the government that favor or penalize specific the 10th percentile in 2014 (Figure 70). This was higher than firms;31 and (iii) market imperfections such as the presence of in both Malaysia (2.2 times in 2010) and China (3.5 times in monopolies, market frictions, and the uneven enforcement 2005) (Figure 71).34 This high level of disparity means that of property rights. A misallocation of resources can prevent some firms can produce much more with the same inputs the expansion of productive firms and promote the survival within the same industry. The disparity could be caused of unproductive ones. It can also discourage firms from by differences in technology, processes, human capital, or investing, growing, and increasing productivity.32 managerial skills. However, this is also a sign of significant disparities in the allocation of production factors (i.e., a misallocation of production factors). Figure 70. There are large differences in productivity levels across Figure 71. ...and manufacturing firm productivity dispersion is higher in manufacturing firms in the Philippines… the Philippines than in many other countries. Ratio of Productivity between the 90th and 10th percentile of the Ratio of Producitivty between the 90th and 10th percentile of the Productivity Distribution Productivity Distribution 7 Philippines (2014) 6 Mexico (2004) 5 Malaysia (2010) 4 Chile (2006) 3 2 China (2005) 1 US (1997) 0 0 1 2 3 4 5 6 2001 2003 2005 2006 2008 2009 2010 2012 2013 2014 Source: Staff calculations based on PSA data. Source: Philippine data from a background paper prepared for this report using PSA data. Data for other countries are from the Inter-American Development Bank (2010), Hsieh and Klenow (2009), Ha et al. (2017). Note: The TFPR from the framework of Hsieh and Klenow (2009) is used as a productivity measure. 31 Discretionary provisions are often referred to as crony capitalism or even government corruption. Examples include subsidies, tax breaks, low interest rate loans granted to specific firms, an unfair bidding process, preferential market access, or selective enforcement of taxes and regulations 32 Hsieh and Klenow (2014), Restuccia and Rogerson (2017). 33 Syverson (2011). 34 Magnitudes differences could be partly due to different period covered in comparing countries. 68 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL An improvement in factor allocation could lead to higher productivity growth at the sector level (discussed in Chapter TFP growth. An industry’s overall TFP growth depends not 2). This also confirms that within-sector productivity growth only on the TFP of individual firms but also on the allocation was driven by both improvements in within-firm productivity of resources across firms. The difference between TFP in growth and improvements in factor allocation across firms in an environment without distortions, where resources are the same sector, which reduced misallocation. The declining allocated perfectly, and the observed level of TFP is called trend of misallocation in manufacturing that started in 2010 misallocation.35 This means that if firms in an industry have was consistent across manufacturing subsectors, suggesting more productive use of labor than other firms in the same that macroeconomic factors such as macroeconomic stability industry, the firms with higher productivity should absorb and the gradual and continuous implementation of structural labor from the less productive firms. However, misallocation reforms have been driving the improvement rather than could occur if labor market friction prevents this labor shift factors in individual subsectors. A comparison with peer though an increase in labor costs. Moreover, misallocation countries shows that misallocation in the Philippines is in could also take place if unproductive firms receives tax line with that of China in 2005 and Malaysia in 2010 but incentives, as these firms would have an advantage over lower than that of Kenya in 2010 (Figure 73). However, more productive firms that are not benefiting from the the country’s misallocation is relatively high compared with incentives. As result, the unproductive firms would attract countries in Latin America, as the average misallocation in capital and labor that could have had higher Latin America was around 60 percent. productivity returns. Still, productive manufacturing firms face more distortions in Public policies that address the problem of misallocation the Philippines than less productive firms, preventing faster could yield large productivity dividends in the Philippines. economic growth. Evidence suggests that productive firms Policy actions that remove distortions in factor (i.e., capital face larger idiosyncratic distortions than less productive firms and labor), product, and intermediate goods and services in manufacturing,37 which means that productive firms are markets could boost overall productivity by increasing the “taxed” at a higher rate in term of distortions. As a result, productivity of lagging industries and firms to national productive firms could have expanded their production more average levels. Since the size of misallocation in the country’s if they had acquired more resources. Examples of distortion manufacturing sector was 98 percent in 2014, TFP in include preferential market access and preferential tax manufacturing could be almost double the current level if incentives to certain firms, which lead productive firms to resources were perfectly allocated.36 produce below their optimal levels. This could also, however, mean that unproductive firms continue to operate and use Nevertheless, factor allocation in Philippine manufacturing resources in the economy, as their output is possibly being has improved in recent years. Misallocation in the sector subsidized. The constraints faced by productive firms will declined from 180 percent in 2009 to 98 percent in ultimately worsen the economy’s overall productivity growth. 2014 (Figure 72), which is consistent with positive labor 35 Hsieh and Klenow (2009). Details of the framework can be found in annex 3.2. 36 For a robustness check, the framework of Bils, Kleneo, and Ruane (2017) was used. Results can be found in Annex 3.3. 37 There is a statistically significant positive relationship between firm productivity and firm distortion. Restuccia and Rogerson (2008) argue that productivi- ty losses due to misallocation would be even more significant if distortions are correlated positively with firm productivity. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 69 Figure 72. Misallocation has declined in the Philippines since 2009… Figure 73. … and is in line with selected regional peers. Hypothetical Productivity Gains (Percent) Hypothetical Productivity Gains (Percent) 200 200 150 150 100 100 50 50 0 0 2006 2008 2009 2010 2012 2013 2014 US China Malaysia Philippines Kenya 1997 2005 2010 2014 2010 Source: Staff calculations based on PSA data. Source: Data for the Philippines are based on staff calculations Note: Data only include formal firms and sectors with larger than using PSA data, Shieh and Klenow (2009), Nguyen, H., T. Taskin, 10 firms. Sectors with less than 10 firms have been removed to and A. Yilmaz (2016), Chuah et al (2018). results driven by outliers. ROLE OF FACTOR ALLOCATION IN PRODUCTIVITY REMAINS SMALL IN NON-MANUFACTURING SECTORS The role of factor allocation in firm productivity is small and between-firm productivity is positive, more productive has been declining in non-manufacturing industries and firms have higher market shares than less productive firms, services. The economy-wide census in 2012, 2013, and resulting in an improvement in factor allocation.39 In the 2014 were used to assess the role of factor allocation in firm Philippines, factor allocation explained, on average, 12.5 productivity in non-manufacturing industries and services in percent of firm productivity in non-manufacturing industries the Philippines.38 Sectoral productivity is decomposed into and 13 percent of firm productivity in services in 2012-14 within-firm productivity and between-firm productivity. The (Figure 74 and Figure 75). Moreover, the size of the factor latter captures the role of factor allocation and the allocation allocation component declined between 2012 and 2014, of resources across firms in the same narrowly defined suggesting factor allocation has slightly worsened in non- sectors (unlike the “between” component in Chapter 2 that manufacturing industries and services. captures allocation of resources across sectors). When 38 The reason for adopting a different methodology for services is that Hsieh and Klenow (2009) requires the use of labor shares of corresponding United States’ narrowly defined industries. While Unites States labor shares are available for manufacturing industries, they are not available for services. 39 The OP method is used for the decomposition. This decomposes sectoral productivity into an unweighted average of firm-level labor productivity in the sector and a covariance term capturing the joint distribution of a firm’s productivity and its output share. The extent of resource misallocation is inferred by the covariance term, where a positive value indicates that more productive firms have higher market shares. Increases in the covariance term would therefore capture improvements in the allocation of productive inputs (i.e., workers). This is because a larger share of the industry output is correctly concentrated among to the most productive firms. 70 CHAPTER 03. PATTERNS AND DRIVERS OF PRODUCTIVITY AT INDUSTRY AND FIRM LEVEL Figure 74. Factor allocation explains only a small part of firm productivity in Figure 75. …as well as in services. non-manufacturing industries… Firm Productivity: Within vs Factor Allocation, Firm Productivity: Within vs Factor Allocation, Services Non-manufacturing Industry (Log of VA per Worker) (Log of VA per Worker) 15.0 15.0 12.0 12.0 9.0 9.0 6.0 6.0 3.0 3.0 0.0 0.0 2012 2013 2014 2012 2013 2014 Within-firm Factor allocation Within-firm Factor allocation Source: Staff calculations based on PSA data following Olley and Pakes (1996). Source: Staff calculations based on PSA data following Olley and Pakes (1996). Although these methodologies have limitations, evidence productivity growth through a better allocation of resources suggests that the Philippines can increase productivity across firms. The two methodologies used to infer the degree growth through better factor allocation. Chapter 1 of misallocation of resources among firms made strong demonstrated that the contribution of productivity to assumptions and are therefore limited. The first method can economic growth has accelerated in recent years. Chapter only calculate the size of the misallocation but not its source, 2 confirmed that within-sector productivity improvements while the second model does not consider the entry and have been driving aggregate productivity growth. This exit of firms. Yet, these are frontier methods for calculating chapter provided evidence that factor allocation across productivity and widely used. The next chapter will discuss firms is improving in manufacturing but worsening slightly ways to further improve allocative efficiency. Moreover, the in non-manufacturing industries and services. Furthermore, size of the factor allocation component declined between there is a large potential to reduce misallocation in the 2012 and 2014, suggesting factor allocation has slightly Philippines, suggesting opportunities to further increase worsened in non-manufacturing industries and services. 71 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 71 04 Policy Options for Increasing Productivity and Economic Growth in the Philippines 72 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES This chapter explores ways to boost productivity growth THE REGULATORY ENVIRONMENT by closing gaps in technical and allocative efficiencies. External and within-firm determinants of productivity growth LIMITS MARKET COMPETITION are separated following the methodology developed by Syverson.40 External factors are mainly related to government Within-firm determinants are factors that are firm-specific policies and market conditions that are outside of the control and usually under the control of individual firms, notably of individual firms and include: innovation and managerial quality. While this categorization has its limitations, as many within-firm factors are also • the policy environment for competition and private- affected by the external environment, it provides a sector investment; useful tool to gain insights into the main determinants of • trade integration; productivity growth. This chapter analyzes factors that affect • spillover from FDI; firms’ productivity dynamics, and it identifies opportunities • access to finance and capital allocation; and to improve factor allocation as well as innovation systems to • education quality and labor market regulations. unleash the growth potential of the Philippines. Chapter 5 will use a simulation model to quantify the productivity and growth impacts of these factors. Market regulations affect productivity growth because they are among the most significant determinants of competition in the economy. Market competition is largely determined by regulations that can either enable or restrict competition. The presence of a regulatory framework that strengthens competition within each industry or in the market as a whole is expected to drive productivity growth through three main channels. First, competition pressures firms to become more efficient to avoid exiting the market.41 Second, it ensures that more productive firms increase their market share at the expense of less productive firms. As high-productivity firms capture resources and expand, low-productivity firms are forced to exit when they cannot attract or retain factors of production.42 Finally, competition drives firms to innovate, to develop new products and processes, which can improve their efficiency. However, the relationship between innovation and competition is not linear.43 Market rules and regulations, however, may be hindering competition in the Philippines. In manufacturing, Philippine markets are more concentrated than those of regional peers, with a higher proportion of monopoly, duopoly or oligopoly markets, which are typically more prone to collusion and abuse of market power (Figure 76). Furthermore, there has been a recent increase in the number of monopolies and 40 Syverson, 2011. 41 Bloom and Van Reenen (2010) examined the links between product market competition and quality of management and found evidence that competi- tion is robustly and positively associated with higher management practice scores. 42 Syverson (2004), Arnold et al (2011). 43 Aghion (2005) found an inverted U shape relationship between innovation and productivity. On the one hand, firms aim to innovate to gain a cost advantage, differentiate their products, or bring new products to the market in the presence of competition. On the other hand, the financial incentives for firms to innovate stems from the ability to generate positive returns from innovation, which suggests a need for ex post market power. In this case, intellectual property rights and patents play an important role. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 73 duopolies in the country’s manufacturing industry (Figure measure the trickle-down impacts of regulatory barriers 77). As a result, market competition is perceived to be weak to competition in the service sector on manufacturing, in the Philippines. The country ranked 114th out of 138 input-output linkages were analyzed.45 Results suggest that economies on market dominance in the World Economic downstream manufacturing sectors, for which the incidence Forum’s 2016-17 Global Competitiveness Report, which of anti-competitive restrictions in services is higher, tend to was below the average of the countries in the sample and have productivity distributions that are more dispersed and lowest among regional peers (Figure 78). Limited competition skewed to the left, an indication of a potential misallocation affects business risks, especially related to vested interests of resources (explored in Chapter 3).46 This suggests that and unfair competitive practices (Figure 79).44 anticompetitive regulations in service sectors may prevent the allocation of resources to more productive firms, The effect of anticompetitive restrictions in the service hampering productivity performance at both the firm and sector not only distorts services but also sectors that use aggregate level. services as production inputs, such as manufacturing. To Figure 76. Philippine markets are more concentrated than peers’… Figure 77. …and they have become more concentrated in recent years. Market Concentration in Manufacturing in the Philippines and selected EAP Evolution of Market Concentration in Manufacturing in the Philippines (Percent) Countries (Percent) 100 20 80 15 60 10 40 5 20 0 0 Philippines Indonesia Malaysia Cambodia Monopoly Duopoly Oligarchy (3-6) Monopoly Duopoly Oligopoly (3-6) Many Philippines 2009 Philippines 2015 Source: Fostering Competition in the Philippines, 2018. Source: Fostering Competition in the Philippines, 2018. Note: Regional peers were selected among countries with available information from the World Bank’s Enterprise Survey. 44 Interpreting concentration measures as an indicator of competition and the extent of dominance demands a complementary analysis of market character- istics, including economies of scale and barriers to entry and rivalry. World Bank (2017a) 45 These knock-on effects capture one channel through which the market environment affects decisions made by firms on resource allocation, and how such decisions affect the share of production and sales of each firm in the market as well as their productivity performance. 46 Details of the method can be found in Appendix 3.4. 74 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES In addition to sector-specific restrictions, the cost of Although the Philippines’ Competition Act applies to all firms doing business is high in the Philippines. High entry costs across sectors, the existence of a forbearance clause that discourage firms from entering markets, dampening the enables the Philippine Competition Commission to exempt productivity-enhancing effect of creative destruction. In the specific practices or even sectors from the scope of the World Bank’s 2017 Doing Business report, the Philippines law may increase the risk of anticompetitive behavior and ranked 171st out of 190 economies on the ease of starting economic distortions. Furthermore, high barriers to FDI a business. According to PMR indicators, the absence of due to constitutional and legislative limitations for foreign simplifying tools in the system of licenses and permits raises participation in selected sectors and economic activities the complexity of regulatory procedures. Also, barriers in have led to low levels of FDI in the country. These barriers service sectors contribute to the high administrative burden to entry limit competition and could raise input costs for on firms operating in the country.47 In addition, incumbent Philippine firms. firms are protected by high barriers in network sectors. Figure 78. Perceived competition is low in the Philippines… Figure 79. …and it is related to vested interests and unfair competitive practices. Market dominance (1= dominated by a few business groups; 7 = spread among 12 many firms) 5 10 4 8 3 6 2 4 1 2 0 Bangladesh Philippines Indonesia Sri Lanka Morocco Malaysia Thailand Vietnam Pakistan Kenya China 0 Bangladesh Philippines Indonesia Sri Lanka Morocco Malaysia Thailand Vietnam Pakistan Kenya China Source: WEF, 2017-2018. Vested interests/cronyism Unfair competitive practices Discrimination against Price controls foreign companies Source: Fostering Competition in the Philippines, 2018 Note: The index is constructed by adding the individual values of each indicator in a 0-4 scale. 47 These include entry and behavioral restrictions on regulated services (i.e., accountants, lawyers, architects, and engineers). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 75 Philippine authorities can accelerate GDP growth by removing Figure 80. The Philippines has a liberalized trade regime reflected in its restrictions in key service sectors. According to IMF estimates, low average most-favored-nation rates among structural peers… an improvement in sector-wide PMR indicators of 10 percent could increase TFP by at least 1.3 percentage points.48 The Simple Average Tariff Rates: the Philippines vs. Structural Peers (Percent) World Bank performed a simulation of the Philippine economy 15 and the regulatory environment in the service sector in 2017. It demonstrated that the country could transition from the fourth to the second quartile in terms of PMR indicators if the government 12 lifted 86 restrictions mapped by the PMR indicators.49 Moreover, the simulation results showed that a reduction of PMRs in key 9 service sectors (i.e., energy, professional services, transportation, and communications) could add US$0.6 billion (0.2 percent of GDP) to the annual GDP by boosting competitiveness in 6 downstream industries that use these services. 3 HIGH TRADE COSTS LIMIT EXTERNAL COMPETITION AND 0 Philippines Sri Lanka Vietnam Morocco Kenya Bangladesh TECHNOLOGY TRANSFER Source: World Integrated Trade Solution (WITS). Note: Latest data available. International trade contributes to productivity growth by increasing competition and facilitating technology adoption. Figure 81. …as well as among regional peers. While foreign trade introduces competition in the local market Simple Average Tariff Rates: the Philippines vs. Regional Peers (Percent) by integrating industries into global value chains, it also provides opportunities for domestic firms to access larger markets, 12 specialize, and achieve economies of scale. Faced with a higher degree of competition, inefficient firms are forced to 10 exit, resulting in a more efficient allocation of resources. The access to foreign markets and global expertise can also increase 8 domestic productivity by allowing domestic firms to access frontier technologies, modern practices, new processes, and 6 management capabilities. 4 However, the Philippines’ level of trade openness has been declining over the past two decades despite its relatively low tariff 2 rates. The country has a liberalized trade regime reflected in its low most-favored-nation tariff of 6.3 percent in 2016, the lowest 0 among structural peers and only slightly higher than Malaysia’s Malaysia Philippines Indonesia Vietnam China Thailand among regional peers (Figure 80 and Figure 81). By contrast, its Source: World Integrated Trade Solution (WITS). trade openness, measured as the share of total trade to GDP, Note: Latest data available. declined from 98.7 percent in 1998 to 64.9 percent in 2016 (Figure 82 and Figure 83). From being considered a pioneer of trade openness in the late 1990s, the Philippines currently ranks below both Vietnam and Morocco and in line with the average of structural peers. Moreover, it ranks below the average of regional peers. 48 IMF et. al (2014) 49 World Bank (2017a) 76 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 82. The Philippines’ level of trade openness has been declining… Trade as Share of GDP, the Philippines vs. Structural Peers (Percent) 200 150 100 50 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Philippines Bangladesh Kenya Vietnam Morocco Pakistan Sri Lanka Source: WDI. Figure 83. …to well below regional peers. Trade as Share of GDP, the Philippines vs. Regional Peers (Percent) 250 200 150 100 50 0 2006 1998 1999 2000 2001 2002 2003 2004 2005 2007 2008 2009 2011 2010 2012 2013 2014 2015 2016 Philippines China Indonesia Malaysia Thailand Vietnam Source: WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 77 The country’s export competitiveness is impeded by high that 60.7 percent of Philippine exporters and 69.6 percent trade costs. Trade costs in the Philippines are among the of importers reported obstacles due to NTMs, relatively highest in the Association of Southeast Asian Nations, high among peers (Figure 84). Furthermore, almost all NTMs according to the 2016 Doing Business report. Investors faced by Philippine importers are obstacles within the home in the Philippines pay twice as much to export or import country, the highest among peers (Figure 85). a shipping container as investors in Thailand. In addition, the Philippines ranks lowest among peer countries on the Most NTMs are related to administrative obstacles imposed World Bank’s Logistics Performance Index,50 and it scores by the Philippine government. Procedural obstacles especially low on connectivity to international markets. The (POs) refer to practical challenges directly related to the Global Competitiveness Index shows that trade is affected by implementation of NTMs, which means that the challenge the country’s government regulations, overall infrastructure posed by POs is in the implementation of regulations rather quality, and customs procedures. than the regulations themselves. A separation of NTMs into “difficult regulations” and “obstacles related to POs” reveals Non-tariff measures (NTMs) are also high in the Philippines. that 93.5 percent of Philippine exporters and 98.2 percent Besides tariffs, importing and exporting firms need to comply of importers report POs as the main barriers to trade, the with NTMs, which encompass a wide range of requirements, highest rates among peer countries. An “informal or usual including technical regulations, product standards, and high payment” accounted for 44 percent of the complaints custom procedures. NTMs have become an increasingly among exporters, and “administrative burdens” were the important obstacle to trade in the Philippines. A survey most troublesome for 38 percent of importers. conducted by the International Trade Center in 2015 shows Figure 84. More Philippine trade companies face NTM-related obstacles Figure 85. Philippine importers face more domestic NTMs than importers compared with companies in peers. in peers.peers. Share of Companies Affected by NTM-related Obstacles (Percent) Share of NTM Obstacles Experienced at Home by Importers (Percent) 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Philippines Morocco Indonesia Thailand Sri Lanka Kenya Bangladesh Philippines Indonesia Kenya Sri Lanka Thailand Bangladesh Morocco Exporters Importers Source: ITC NTM Survey. Note: Sri Lanka (2010), Kenya (2011), Morocco (2011), Indonesia (2013), Thailand (2014), Bangladesh (2015), and the Philippines (2016). Source: ITC NTM Survey. Note: Sri Lanka (2010), Kenya (2011), Morocco (2011), Indonesia (2013), Thailand (2014), Bangladesh (2015), and the Philippines (2016). 50 The index measures the timeliness of deliveries, the quality of infrastructure assets, logistics quality and competence, and the ability to track and trace shipments. 78 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES LOW LEVELS OF FDI LIMIT KNOWLEDGE SPILLOVER FDI brings not only capital, new technologies, marketing While the inflow of FDI into the Philippines increased during techniques, and management skills to a country but can also the last two decades, it remains low relative to many peers. increase domestic industries’ productivity through knowledge Net FDI in the Philippines increased by 74 percent between spillover and increased competition. Foreign investors 1999 and 2016, the largest increase among structural contribute to productivity growth when there is a technology peers, with the exception of Morocco (Figure 86). However, transfer beyond the original scope of the FDI and when the level of FDI in the country is still low relative to many there are knowledge spillovers to domestic firms. Knowledge regional peers (Figure 87). For instance, net FDI in the spillovers can take place when local firms improve their Philippines reached 2.6 percent of GDP in 2016, up from efficiency by adopting the technology of foreign firms 1.5 percent in 1999, while it represented around 4.3 percent operating in the local market. Another kind of spillover occurs of GDP in Malaysia. Moreover, a decomposition of net FDI when the entry of foreign firms leads to more competition into direct-equity and inter-company borrowing reveals that in the domestic economy, forcing local firms to use their direct-equity investment in the Philippines’ economic sectors existing resources more efficiently and/or leverage new fell from 0.8 percent of GDP in 2005 to 0.7 percent of GDP technologies to stay competitive. in 2016 (Figure 88). Most of the increase in net FDI was due to an increase in inter-company investment through debt instruments, which increased from 0.3 percent of GDP in 2005 to 1.7 percent of GDP in 2016.51 Figure 86. The net inflow of FDI into the Philippines has been increasing… Figure 87. …but is still low relative to regional peers. Net FDI Inflow: the Philippines vs. Structural Peers (% of GDP) Net FDI Inflow: the Philippines vs. Regional Peers (% of GDP) 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 -1 Philippines Bangladesh Kenya Pakistan Sri Lanka Morocco Vietnam Philippines Bangladesh Kenya Pakistan Sri Lanka Morocco 1999 - 2014 2005 - 2010 2011 - 2016 1999 - 2014 2005 - 2010 2011 - 2016 Source: WDI. Source: WDI. 51 Debt instruments include the borrowing and lending of funds— including debt securities and suppliers’ credits—between direct investors and subsidiaries, branches, and associates. Debt instruments include loans, debt securities, financial leases, and suppliers’ credit (trade credit and advances). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 79 Figure 88. The level of FDI in the country’s sectors remains small… Figure 89. …and most investment was concentrated in the service sector in recent years. Decomposition of Net FDI (% of GDP) Net FDI to Sectors (3 Year Average, % of GDP) 3.0 0.8 0.7 2.5 0.6 2.0 0.5 1.5 0.4 0.3 1.0 0.2 0.5 0.1 0.0 0.0 2005-2007 2008-2010 2011-2013 2014-2016 -0.5 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Agricultural sector Non-agricultural sector Services sector Investment into sectors Debt instrument Source: PSA. Reinvestment of earnings Others, not elsewhere classified Source: PSA. 80 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Nevertheless, sectors that received FDI experienced the highest productivity growth. Sectors that received FDI in the form of direct-equity investment had either high productivity growth (manufacturing, financial and insurance activities) or high productivity levels (real estate, financial and insurance activities) (Figure 89, Figure 90, and Figure 91). Moreover, firms with foreign ownership were in general more productive than firms with only domestic capital (Chapter 3), suggesting that FDI contributes to productivity growth. Figure 90. The manufacturing sector received most FDI in industry… Figure 91. …and financial services received most FDI in services. Net FDI in Industry (3 Year Average, % of GDP) Net FDI in Services (3 Year Average, % of GDP) 0.8 0.5 0.7 0.4 0.6 0.5 0.3 0.4 0.2 0.3 0.2 0.1 0.1 0.0 0.0 -0.1 2005-2007 2008-2010 2011-2013 2014-2016 -0.1 2005-2007 2008-2010 2011-2013 2014-2016 Construction Manufacturing Arts, entertainment and recreation Trade Utilities Mining Real estate Transport, storage, and communication Source: Bangko Sentral ng Pilipinas. Financial and insurance Other services Accomodation and food services Source: Bangko Sentral ng Pilipinas. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 81 CREDIT FLOWS TO THE MOST PRODUCTIVE SECTORS A well-functioning financial sector that efficiently allocates productivity and profit, that are capital intensive, and with credit is paramount for productivity growth. There is a clear contained risk. positive correlation between an economy’s capital per worker and TFP (Figure 92). A country’s financial sector affects The allocation of credit to the private sector in the economic growth through (i) its impact on both human Philippines seems adequate given the country’s income level and physical capital accumulation and (ii) its impact on but relatively low compared to regional peers. As a percent of productivity. As intermediaries, financial institutions mobilize GDP, credit to the private sector is at the level predicted by savings for investment, facilitate inflows of foreign capital— its income level (Figure 93). This indicates that the financial including FDI, portfolio investment, and remittances—and sector is efficient in intermediating funds between savers efficiently allocate resources to the most productive firms and borrowers. At 45 percent of GDP, credit to private and sectors. The financial sector also reduces risk associated sector in the Philippines is slightly higher than the average with individual projects, which increases capital accumulation of structural peers (41 percent of GDP) (Figure 94) but and leads to higher long-term economic growth. However, substantially lower than the average of regional peers (114 credit does not necessarily go to sectors with the highest percent of GDP) (Figure 95). productivity growth, but rather to sectors with high Figure 92. Capital accumulation is positively correlated with TFP. Figure 93. The level of domestic credit to the private sector is adequate relative to the country’s income level. TFP Proportion (US TFP=1) Domestic Credit to the Private Sector, 2016 (% of GDP) 2.5 250 2.0 200 1.5 150 1.0 100 PHL 0.5 50 PHL 0.0 0 0 100,000 200,000 300,000 400,000 500,000 600,000 0 100,000 200,000 300,000 400,000 500,000 600,000 Capital per worker (2005 US$) GNI per capita PPP (international currency) Source: Penn World Table 9.0. Source: WDI. 82 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Philippine firms rely less on external funds for investment than firms in peers. Although many firms in developing countries rely heavily on internal funds for investment spending, the level of domestic credit is especially high in the Philippines relative to peers. Less than 7 percent of working capital of the country’s firms is financed by banks, which is half of the share of firms in structural peers and much lower than the 18 percent among firms in regional peers. Even for the country’s large firms, only 11.6 percent of funds used for investment originates from banks, much lower than the structural peer average of 21.6 percent. However, most Philippine firms that apply for a loan through the banking system are approved. Based on enterprise survey data from 2015, over 70 percent of small enterprises had their loan applications approved, and this increased to more than 90 percent for medium-sized firms. Rather than access, this heavy reliance on internal funds seems to be the result of either high costs in the formal banking system or the preference of firms. Figure 94. The level of domestic credit in the Philippines is relatively high Figure 95. …but relatively low compared with regional peers. compared with structural peers… Domestic Credit: the Philippines vs. Structural Peers, 2016 (% of GDP) Domestic Credit: the Philippines vs. Regional Peers, 2016 (% of GDP) 0.8 200 0.7 0.6 150 0.5 0.4 100 0.3 0.2 50 0.1 0.0 0 Pakistan Kenya Bangladesh Philippines Sri Lanka Morocco Indonesia Philippines Malaysia Thailand China Source: WDI. Source: WDI. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 83 22+18+1710954E Figure 96. Credit was not allocated to sectors with high productivity growth in 2017… Share of Credit Allocation, 2017 Industry 11% Construction 4% 22% Real Estate Actvities Transportation and Storage 5% Information and Communication 5% Wholesale and Retail Trade, Financial and 18% Repair of Motor Vehicles, Insurance Activities 9% Motorcycles Manufacturing 10% Electricity, Gas, Steam and 17% Air-Conditioning Supply Source: Bangko Sentral ng Pilipinas. Note: The allocation of credit was calculated as change of outstanding loans between 2016 and 2017. Figure 97. …as credit growth expanded at a faster rate in sectors with relatively low labor productivity growth. Average Annual Growth Rate of Loans, 2007-16 (Percent) Utilities Construction Real Estate Activities Wholesale and Retail Trade, Repair of Motor Vehicles, Motorcycles Agriculture, Forestry And Fishing Others Manufacturing Financial And Insurance Activities 0 5 10 15 20 25 30 Source: Bangko Sentral ng Pilipinas. 84 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES While private-sector credit was allocated to the most productivity remained above the economy-wide average productive sectors in 2017, it was not allocated to the (Figure 98). The manufacturing sector received 10 percent of sectors with the highest productivity growth. The largest total credit in the same year, and its labor productivity was share of outstanding loans—22 percent—was in the real also above the economy-wide average. By contrast, credit estate sector in the same year (Figure 96). This was the result to finance agricultural activities declined in 2017, which was of an average 16.7 percent annual growth in credit to finance consistent with the below-average productivity performance real estate activities in 2007-16 (Figure 97). However, labor of the agriculture sector. Overall, a large share of credit in productivity in the real estate sector declined by an average the Philippines is flowing to the most productive sectors in of 2.2 percent per year in the same period. Still, the sector’s the economy. Figure 98. Credit was allocated to sectors with high productivity in 2017. Credit Allocation and Deviation from Average VA per Worker, Ratios 1.2 1 Electricity, Gas and Water 0.8 Log (sector prod/average prod) Finance 0.6 Real Estate, Renting and Business Activities Manufacturing 0.4 Mining 0.2 Construction 0 Government services Trade Transport, Other services -0.2 Communication and Storage -0.4 Agriculture -0.6 -0.8 -10 -5 0 5 10 15 20 25 30 Share of credit (2017) Source: Bangko Sentral ng Pilipinas. Note: The allocation of credit was calculated as change of outstanding loans between 2016 and 2017. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 85 LABOR MARKET RIGIDITIES AND HIGH COSTS LEAD TO HIGH INFORMALITY A flexible labor market is important to support economic restrictive than in peers (Figure 99). Specifically, the country growth and productivity, as it allows factors of production suffers from long administrative processes for regular to move freely across firms and sectors. Firms with high employment. In addition, the Philippines ranked 86th out productivity growth, in an environment without distortions, of 137 countries on wage determination, which makes it would be absorbing more labor and capital from firms that less flexible than the average of both structural and regional are less productive. However, evidence shows that restrictive peers (Figure 100). Moreover, the country’s minimum wage is labor market regulations impede the efficient allocation of considered high by several measures, both relative to Filipino labor to the most productive firms in the Philippines. worker productivity and to the minimum wage of other countries with similar income levels.52 Finally, redundancy Employers find labor regulations in the Philippines costs are very high in the Philippines, 27 weeks of salary, more restrictive than in peer countries. On the Global resulting in a rank of 118th out of 136 countries. Of all Competitiveness Index, the Philippines ranked 77th out of the indicators in the index, the ease of hiring and firing has 137 countries on the ease of hiring and firing, more progressed the least in the Philippines since 2007. Figure 99. Labor regulations in the Philippines are more restrictive than Figure 100. Wage determination is also more restrictive in the Philippines in peers. compared with peers. Ease of Hiring and Firing (7=best) Flexibility of Wage Determination (7=best) 5 6 4 5 3 4 2 3 1 2 0 1 Malaysia China Indonesia Thailand Kenya Bangladesh Vietnam Pakistan Philippines Sri Lanka Morocco 0 Malaysia Morocco Bangladesh Kenya Sri Lanka Vietnam Philippines China Indonesia Thailand Pakistan Source: World Economic Forum. Source: World Economic Forum. 52 World Bank (2013); Betcherman (2014). 86 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES However, labor regulations apply only to a small portion with a regular employment contract involves a long of the economy. Labor regulations in the Philippines apply administrative process that includes notices to the employee, only to wage workers, which account for 60 percent of hearings, and payment of separation benefits. Furthermore, all employed workers in the country. Therefore, de jure an employee has the right to contest the validity of the coverage of worker protection is limited given the high share dismissal through a dispute resolution mechanism, which of non-wage employment in the economy. Additionally, many could be lengthy and costly and whose decision often favors wage workers are not subject to labor regulations as they are the employee. As result of high dismissal costs, the incidence either employed by informal firms or employed informally by of non-regular employment is increasing and reached about formal firms. As result, only about 24 percent of all employed 40 percent of all wage employment in 2013. However, workers and 40 percent of all wage employees benefit from workers under non-regular contracts have less employment worker protection in the Philippines (Figure 101).53 security and receive lower wages.54 Their turnover is also expected to be higher, and there is less job-training and High dismissal costs have led to an increase in temporary learning, limiting their contribution to productivity growth. employment, which discourages on-the-job training and learning. The dismissal of an employee Figure 101. Informality and non-compliance limit the coverage of worker protection in the Philippines. ALL EMPLOYED WORKERS (100%) De jure coverage 60% of total employment WAGE WORKERS 60%) NON-WAGE WORKERS (40%) WORKERS IN FORMAL FIRMS (50%) WORKERS IN INFORMAL FIRMS (50%) FORMAL WAGE WORKERS (80%) INFORMAL WAGE WORKERS (20%) De facto coverage 24% of total employment, 40% of wage workers Source: World Bank (2016). Note: “Workers in informal firms” are defined as workers who reported that their employers are private households or private establishments whose businesses are not registered or do not have fixed locations. Workers are considered as “informal wage workers” if any two of the following conditions are met: employment can be terminated without notice, employers do not pay social insurance contributions, or employment is not based on a written contract. 53 World Bank (2016). 54 World Bank (2016). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 87 Figure 102. Informal employment is high in the Philippines… Figure 103. …regardless of age level. Informal Employment: Share of Non-Agricultural Employment Informality by Age Group (Percent) (Percent) 100 80 70 80 60 60 50 40 40 30 20 20 10 0 0 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-60 61-64 65 and up China Sri Lanka Vietnam Philippines Indonesia Pakistan Informal employment: Informal sector Formal Informal employment: Outside informal sector Informal Source: Informal Sector Survey (ISS) 2008. Source: Informal Sector Survey (ISS) 2008. The Philippines’ restrictive labor regulations and high labor across age and education groups: around 30.8 percent costs have contributed to the growth of the country’s large and 63.2 percent of employed college graduates and informal sector. High minimum wages and dismissal costs undergraduates, respectively, have informal employment discourage the formalization of jobs. Informal employment (Figure 103 and Figure 104). However, it is especially high represents 76.3 percent of total employment in the among non-college graduates. The country’s agriculture country.55 Even excluding the agriculture sector, 66.8 percent sector has the largest share of informal employment at 93.4 of total employment is informal, which is relatively high percent, followed by industry (67.5 percent) and services among peers (Figure 102). Moreover, informality occurs (66.6 percent) (Figure 105). 55 Informal employment refers to the total number of persons with informal main jobs. A job is informal when it lacks basic social or legal protections or em- ployment benefits and may be found in the formal sector, informal sector, or households. Persons in informal employment include the following types: wage workers, self-employed workers, and unpaid family members. First, wage workers are categorized as formal if they meet at least two of the following three criteria: (1) have a written employment contract, (2) have employer-provided social insurance, or (3) are protected from arbitrary dismissal. Otherwise, they are categorized as informal. Second, self-employed workers are formal if they maintain a proper bookkeeping system. If not, they are classified as informal. Finally, unpaid family members are informal by definition. This definition is based on the World Bank’s Philippine Labor Market Review (2016). 88 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 104. Informal employment is also high among Figure 105. …and even in industry and services. non-college graduates… Informality by Education Level (Percent) Informality by Sector (Percent) 100 100 80 80 60 60 40 40 20 20 0 0 No grade Elementrary High school College Agriculture Industry Services completed Formal Formal Informal Informal Source: Informal Sector Survey (ISS) 2008. Source: Informal Sector Survey (ISS) 2008. A POTENTIAL SKILLS MISMATCH IN SERVICES COULD LIMIT PRODUCTIVITY GROWTH A well-educated workforce is critical to support productivity (Figure 106 and Figure 107). Moreover, more than half of growth. Since a middle-income country such as the all employed workers in the country’s formal labor market Philippines is more likely to accelerate productivity growth have some tertiary education (Figure 109). In the aggregate, through technology adoption, creating and maintaining a the share of the labor force with tertiary education in the skilled workforce is necessary to increase the economy’s Philippines is high relative to its income level (Figure 108). productivity. However, creating a workforce with skilled workers requires not only adequate formal training but also However, progress on improving learning outcomes has been attractive job opportunities to avoid workers leaving slow. An analysis by the World Bank in 2018 found that the country. many students do not retain valuable skills at the country’s schools. The Philippines’ learning outcomes are the weakest Access to education has been expanding steadily in the among major countries in East Asia based on international Philippines. Primary education reached almost universal test data from 2013. Although it is likely that education enrollment in 2015, and improvement in access to secondary performance has improved since then, results from national education has been robust. Tertiary enrollment has also achievement tests suggest that there has only been a risen steadily and reached a gross enrollment rate of 34 modest improvement at the primary level and no measurable percent in 2013, comparatively better than other middle- improvement at the secondary level. While average scores income countries and regional peers. As a result, average at the primary level have increased modestly over time, years of schooling in the Philippines reached 9.3 years in they remained almost flat at the secondary education level 2014, higher than the structural peer average of 6.8 years between 2004 and 2015. and only behind Malaysia (10.1 years) among regional peers GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 89 Figure 106. Average years of education in the Philippines is comparable to structural peers… Trade as Share of GDP, the Philippines vs. Structural Peers (Percent) 12 10 8 6 4 2 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines Bangladesh Kenya Vietnam Morocco Pakistan Sri Lanka Source: Human Development Data. Figure 107. …and regional peers. Average Years of Schooling: the Philippines vs Regional Peers 12 10 8 6 4 2 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Philippines China Indonesia Malaysia Thailand Vietnam Source: Human Development Data. 90 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 108. Tertiary enrollment is high relative to the country’s Figure 109. with more than half of all workers with formal employment income level… possessing a tertiary education. Labor Force with Advanced Education, 2016 (Percent) Employment by Education Level (Percent) 70 120 60 100 50 80 40 60 30 20 40 10 20 0 7 8 9 10 11 12 0 Log GDP per capita Formarlly employed Informarlly employed Incomplete primary Complete secondary Source: WD. Primary Incomplete tertiary Incomplete secondary Complete tertiary Source: ISS survey 2009. While workforce skills are not reported as the main obstacle Moreover, new types of jobs may require different sets of to doing business in the country, a growing skills mismatch skills, as technologies such as automation become more in services may be limiting faster productivity growth. Firms affordable and easily accessible. The digital and computing did not consider the skills of the country’s workforce the revolution made it possible for machines to perform tasks main obstacle to doing business in 2015: inadequately that were previously reserved for humans, including the educated workers ranked 12th out of 16 obstacles on the application of logic and information to provide a wide-array World Bank’s 2015 Enterprise Survey (Figure 110). Instead, of goods and services, from automated manufacturing and firms reported that corruption, the tax rates, and competition transportation to accounting and bookkeeping. While neither from the informal sector were the main challenges to doing the current skills mismatch nor the threat of automation is business. Furthermore, Philippine firms were less likely currently a pressing issue in the Philippines, it may become to report workforce skills as the main obstacle to doing one in the future. Therefore, the country needs to emphasize business than firms in other countries in the region (Figure scientific, mathematical, and communication abilities as well 111). However, there has been an increase in firms that as soft skills, such as perseverance, flexibility, creativity, and reported workforce skills as inadequate, from 7.8 percent in team work, to develop the complementary skills needed 2009 to 10.1 percent in 2015, mainly in services. Since the to derive benefit from future technologies and keep the Philippines’ service sector has been expanding over time, the population employed. Access to the right skills can turn skills gap, although currently small, is likely to widen and may “replacing” technologies into “enabling” technologies prevent faster productivity growth in the future.56 for workers.57 56 World Bank, 2017a. 57 Norman et. Al (2018) forthcoming “The Future of Work: Race with, not against, the Machine” GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 91 There is also evidence of a shortage of skilled jobs in the In addition, more than a third of the country’s unskilled country’s labor market. The World Bank has found evidence manual workers have at least a secondary education degree. of a shortage of skilled jobs in the Philippines.58 About 30 This suggests that the scarcity of quality jobs is not caused percent of workers with secondary education are often by an insufficient supply of middle-skilled workers but an forced to take unskilled jobs and work as laborers. insufficient supply of high quality jobs. Figure 110. Workforce skills are not reported as the main obstacle by firms in the Philippines... Major Obstacles to Doing Business Identified by Firms (Percent) Corruption Tax rates Practices of competition in the informal sector Transport Electricity Tax administration Telecommunications Political instability Crime, theft and disorder Business licensing and permits Access to finance Inadequately educated workforce Courts Customs and trade regulations Access to land Labor regulations 0 5 10 15 20 25 30 Source: Enterprise Survey 2015. 58 World Bank, 2017a. 92 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 111. …even relative to other countries in the region. Firms in most countries in East Asia identify inadequate skills as a major obstacle to doing business (Percent) Cambodia (2013) Mongolia (2013) Lao PDR (2012) Myanmar (2014) Malaysia (2015) Indonesia (2015) Philippines (2015) Vietnam (2015) China (2012) 0 5 10 15 20 25 30 Source: Enterprise Survey 2015. STAGNANT REAL WAGES AND INSUFFICIENT QUALITY JOBS LEAD TO HIGH EMIGRATION Real wages have been stagnant in the Philippines despite labor productivity growth. To retain skilled workers in the country, real wage increases need to reflect labor productivity growth. However, this has not happened in the Philippines.59 Between 2001 and 2016, the country’s real GDP more than doubled, growing by an average of 5.4 percent per year. Labor productivity also increased significantly during this period, with an average annual growth rate of 3.1 percent in 2001-16. By contrast, real wages remained flat in 2001-16, with 7 out of 15 years registering negative growth rates (Figure 112). Except for public workers, this pattern holds across employees’ level of education, nature of work (i.e., permanent, short term, or different employer), and class of work (i.e., private household, private establishment, public sector, or family operated). 59 The World Bank (2016) has found similar results. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 93 Figure 112. Real wages have remained flat despite rising GDP and Figure 113. Agriculture experienced minor real wage growth despite its productivity growth. low productivity. Growth Trends (Year 2001 = 100) Agriculture Growth Trends (2001 = 100) 250 150 200 150 120 100 50 90 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Real GDP (constant 2000 prices) Employment Real Agri VA (constant 2000 prices) Employment (Agriculture) Labor Productivity (constant 2000 prices) Real Wage Agri Labor Productivity (constant 2000 prices) Real Wage (Agriculture) Source: PSA. Source: PSA. Figure 114. Real wage growth in industry remained flat despite rising Figure 115. …and a similar pattern held true in the service sector. productivity… Industry Growth Trends (2001 = 100) Services Growth Trends (2001 = 100) 250 250 200 200 150 150 100 100 50 50 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Real Industry VA (constant 2000 prices) Employment (Industry) Real Services VA (constant 2000 prices) Employment (Services) Industry Productivity (constant 2000 prices) Real Wage (Industry) Services Productivity (constant 2000 prices) Real Wage (Services) Source: PSA. Source: PSA. 94 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES The de-linked growth between real wage and labor an environment of competitive labor and product markets. productivity is consistent across sectors. Surprisingly, This is because competition should result in lower output agriculture, the sector with the lowest labor productivity prices. However, there can be an observed correlation growth, was the only sector that experienced minor real between sectoral productivity gains and real wages or profit wage growth in 2001-16 (Figure 113). While real wages when either labor or product markets are not perfectly grew by barely 6 percent in the agriculture sector during this competitive (Box 5). While the Philippines’ labor supply is period, they declined by 5 percent in industry and remained abundant, and its labor market is somewhat competitive flat in services. Within industry, real wages declined in all considering its informal sector, product markets are not subsectors (i.e., mining, manufacturing, construction, and competitive in many sectors. Market dominance, the utilities) while labor productivity increased, especially in presence of monopolies and duopolies, and high entry costs manufacturing and mining. In services, there was a large contribute to a lack of competition in many sectors. As result, disparity among subsectors. For instance, real wages in productivity gains are not always reflected in real wages but transport, government services, and renting of non-real rather in profit, consistent with the increasing share of capital estate and other business activities increased along with in the Philippines’ national income. labor productivity. However, trade and finance experienced positive labor productivity growth while real wages declined. An example of how lack of market competition contributes to In real estate, labor productivity experienced its biggest real wage stagnation. Assuming that labor productivity in the decline in the services sector while real wages experienced trucking industry doubles because of an increase in the size their biggest increase. of trucks. If an increase in labor productivity in the industry lead to higher wages for truck drivers, there would be an Low and stagnant real wages discourage capital investment, expected increase in the supply of drivers. With perfectly preventing faster productivity growth. Capital per worker competitive labor markets and excess labor supply, the wages is positively correlated with higher TFP. However, capital of truck drivers would in fact remain unchanged, as the per worker is low in the Philippines compared to regional inflow of new workers would be driving down wages before and structural peers—less than half of that of Indonesia and the effects of the increase in productivity could materialize in Malaysia and only higher than that of Kenya in 2011. To wages. Only if product markets were not competitive would sustain and accelerate TFP growth, the Philippines needs to an increase in industry productivity, with industry wages increase capital investment, which may be a challenge in an unchanged, lead to an increase in profits. If product markets environment of low labor costs. were competitive, excess profit would attract new firms to enter the market, driving down output prices until excess Lack of product market competition may be contributing profits were depleted. In this scenario, firms could expand to real wage stagnation. There is a positive relationship output with the same costs and sell products at lower prices, between labor productivity growth and real wage growth in which would increase the real wage of workers. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 95 Box 6. A Framework to Analyze Real Wage Stagnation with Rising Labor Productivity In the long run, labor productivity affects living standards through real wages. Labor share. The declining labor share can be caused by: In a simple economic model, the relationship between labor productivity growth and the growth of real consumption wages is mediated by changes in the share • Lack of market competition. In the presence of competitive labor and of national income going to labor and changes in the relative prices of output and product markets, there should be no direct relationship between labor consumption goods, which is the labor’s term of trade. productivity growth and the growth in real consumption wages at the sector level. Wages are determined at the level of the total economy, and Δ Real wage = Δ labor productivity + Δ labor’s share + labor market and labor productivity gains are reflected in lower output Δ labor’s term of trade prices rather than higher wages in sectors with above-average labor productivity growth. Lower prices benefit all workers rather than only Therefore, the gap between real wages and labor productivity growth could be workers in the sector experiencing above-average labor productivity explained by declining labor shares, falling labor’s terms of trade, rising earning growth. inequalities, and measurement errors of labor productivity and earnings. • Weak institutional setting for wage bargaining. In markets with Earning inequalities. If the gap between labor productivity and the median real perfect competition and constant returns to scale, wage bargaining has no wage is small while the gap between labor productivity and average real wage is effect on the labor share. In these markets, there is no excess profit to be large, there is likely a presence of high earning inequalities. Specifically, large shared and labor requests for higher wages will remain either unanswered earning inequalities contribute to the rising gap between labor productivity and or will drive the targeted business out of the market. In reality, however, real wages. few firms operate in a perfectly competitive market, opening the door to excess profits. This excess profit can, in turn, be shared between the Labor’s terms of trade. Labor’s terms of trade measures how shifts in the relative owners of the firm and labor. This is where wage bargaining can play an prices of consumption goods and output affect the consumption wages of important role in affecting the labor share. workers. Declining terms of trade means that the price of goods that workers produce is increasing at a slower rate than the price of goods that workers • Capital-biased technological change. Technological change can shift consume. All else being equal, declines in labor’s term of trade are bad for labor and capital shares if the technology is biased in favor of either factor workers because they result in lower consumption wages. of production. If a new technology is capital biased, it means that the technology allows the use of less labor and more capital at given factor Measurement errors. An inaccurate measurement of labor productivity and real prices, decreasing the marginal productivity of labor at a given ratio of wages could happen if: (i) labor productivity is better measured in hours, not labor to capital. workers. (ii) total labor compensation (including non-wage benefits) is not used to calculate nominal wages; and/or (iii) there is a divergence over time between • Large labor supply. A large labor supply reduces the bargaining power the series used to deflate nominal output (i.e., the GDP deflator) and the series of workers. used to deflate nominal wages (i.e., the consumer price index). Source: Sharpe et al. (2008). Stagnant real wages and a lack of quality jobs have migrants as share of the country’s labor force increased by contributed to a high rate of emigration from the Philippines. 50 percent between 1998 and 2015, from 10 percent to 15 The Philippines has a larger share of emigrants than country percent (Figure 118). Also, the share of emigrants below the peers (Figure 116 and Figure 117). The number of emigrants age of thirty has increased over time and is now more than as share of the total population increased from 3.5 percent in half of all emigrants (Figure 119). If these trends continue, 1995 to 5.3 percent in 2015. This is substantially higher than it will be difficult for the Philippines to generate economic the regional peer average of 2.4 percent and slightly higher growth from its labor force. than the structural peer average of 5 percent. Moreover, 96 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 116. More workers in the Philippines emigrate compared with Figure 117. …and its regional peers. structural peers… Migrant Stock as Share of the Population: the Philippines vs. Structural Peers Migrant Stock as Share of the Population: the Philippines vs. Regional Peers (Percent) (Percent) 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Bangladesh Kenya Morocco Pakistan Philippines Sri Lanka Vietnam China Indonesia Malaysia Philippines Thailand Vietnam 1995 2005 2015 1995 2005 2015 Source: United Nations. Source: United Nations. Figure 118. The share of migrants in the labor force has been increasing… Figure 119. …especially among the youth. Migrants as Share of the Population and Labor Force (Percent) Share of Filipino Emigrants by Age Group (Percent) 0.20 100 80 0.15 60 0.10 40 0.05 20 0.00 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Migrants as % of total population 19 - below 30 - 39 50 - 69 Migrants, ages 15-64 as % of total labor force 20 - 29 40 - 49 60 - above Source: Commission on Filipinos Overseas (CFO). Source: CFO. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 97 The high emigration rate slows the country’s productivity Since productivity growth requires both human and physical growth. The education profile of emigrants affects a country’s capital, the emigration of skilled workers negatively affects human capital stock. The relative high level of education, firms’ ability to find skilled labor in the economy, preventing including language skills, of Filipino workers increases their them from expanding and innovating. As a result, the employment opportunities outside of the country (Figure Philippines’ human capital flight slows productivity growth, as 120). A survey conducted by the Organization for Economic the country perpetuates in a vicious cycle of emigration due Co-operation and Development (OECD) on public policies, to lack of domestic opportunities, which in turn shrinks the migration, and development found that the intention to pool of skilled labor in the economy. emigrate increases with the level of education (Figure 121).60 Figure 120. A large share of Philippine migrants is highly educated… Figure 121. …and those planning to emigrate have the highest levels of educational attainment. Share of Registered Filipino Emigrants by Educational Attaninment Prior to Share of Individuals Planning to Emigrate by Education Level (Percent) Migration (Percent) 30 100 25 20 50 15 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 5 College or above High school and vocational graduate 0 No formal Primary education Lower secondary Higher secondary Post secondary Elementary or below education education education education Source: CFO. Source: CFO. 60 The OECD survey found a positive correlation between education and migration intentions after controlling for other relevant individual and household characteristics. 98 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES WEAK CAPACITY TO INNOVATE LIMITS PRODUCTIVITY GROWTH Productivity growth is largely influenced by the capabilities and incentives of firms to innovate. Innovation refers to activities that either expand the technology frontier or absorb and adapt existing technology. The development of new technologies requires access to relevant human capital, continuous investment in research and development (R&D), and well-defined and enforceable property rights. However, innovation in developing countries, including in the Philippines, is mostly done by adopting and diffusing existing knowledge and technologies through international transfers and spillovers.61 A country’s innovation capacity is determined by its innovation infrastructure, the micro-environment, and the than most peers (Figure 122). Also, the cost of information quality of linkages between the two. Innovation capacity, technology services is higher in the Philippines than in many defined as an economy’s potential to innovate, depends on regional peers (Figure 124 and Figure 125). Moreover, the level of technological sophistication in the economy, the there is weak international competition in the Philippines’ quality of the country’s labor force, the rate of investment, innovation sector, as the country suffers from limited trade and both public- and private-sector policies that affect openness and low levels of FDI. the incentives for and the productivity of R&D activities. There are three main elements of a country’s innovation The country could improve its micro-environment and capacity: (the common innovation infrastructure, (2) the the quality of linkages between common innovation microeconomic environment, and (3) the quality of linkages infrastructure. The high level of market dominance and the between the two. First, an innovation infrastructure includes presence of inefficient business regulations in the Philippines a country’s accumulated knowledge stock and talent pool; are not conducive for innovation. In addition, the country national investment and policy priorities, such as higher underperforms many regional peers in the ability to diffuse education spending and intellectual property protection; technology through collaboration between universities and the availability of information technology infrastructure; industry (Figure 123). and openness to competition, which will exert a cross- As a result, Philippine firms lag behind peers in adopting cutting impact on innovation across sectors.62 Second, the existing technologies. On the 2017 Global Innovation microeconomic environment includes the presence of high- Index, the Philippines ranked 73rd out of 128 countries, quality inputs such as scientists; structures that encourage behind regional peers such as Thailand (51st), Vietnam investment and intense local rivalry, which implies an equal (47th), Malaysia (37th), and China (22nd). The country’s playing field; and pressure and insight from sophisticated underperformance in innovation can be partly explained local demand. Finally, the absence of strong linkages by low spending on R&D, merely 0.1 percent of GDP, between the country’s innovation infrastructure and the compared with an average of 0.9 percent of GDP among microeconomic environment may cause upstream scientific regional peers and an average of 0.4 percent of GDP among and technical activities to spill over to other countries instead structural peers (Figure 126). In addition, Philippine firms are of domestic industries. less likely to adopt existing technologies than firms in peer The Philippines’ common innovation infrastructure is of poor countries (Figure 127). For instance, only 8.8 percent of firms quality. In 2017, the Philippines ranked 75th out of 137 in the Philippines have internationally recognized quality countries on the availability and quality of research capital certifications and only 11.2 percent of firms use technology and 74th on the availability of scientists and engineers, lower licensed from foreign companies, lower than in most peers. 61 Freeman (1987), Lundvall (1992), Nelson and Rosenberg (1993), Metcalfe (1995). 62 Furman and Hayes (2004), Nelson (1993). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 99 Figure 122. The availability and quality of research capital in the Figure 123. More collaboration between universities and industry could Philippines is low. yield better technology diffusion. Availability and Quality of Research Capital (7=best) University-industry Collaboration in R&D (7=best) 6 6 5 5 4 4 3 3 2 2 1 1 0 0 Indonesia Sri Lanka Philippines Vietnam Indonesia Thailand Vietnam Bangladesh Malaysia China Kenya Thailand Pakistan Bangladesh Malaysia China Kenya Sri Lanka Philippines Pakistan Availability of scientists and engineers Quality of scientific research institutions Source: World Economic Forum. Source: World Economic Forum. Figure 124. The Philippines lags behind regional peers in the availability Figure 125. …and the cost telecommunications services. of information technology... Mobile Subscription and Internet Access, 2015 Price of telecommunciations Services as Share of GNI per Capita, 2015 150 150 120 120 90 90 60 60 30 30 0 0 China Philippines Thailand Vietnam Indonesia Malaysia Malaysia China Thailand Indonesia Vietnam Philippines Mobile subscription Internet access Mobile Fixed broadband Source: Access to telecommunications, International Communication Union Source: Price of telecommunications, International Telecommunication Union. (2015). Measuring the Information Society Report 2016. 100 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Most firms involved in innovation are large firms in the Information and Communication Technologies (ICT) industry. While young and small firms are usually more innovative, large firms dedicate more resources to innovation in the Philippines (Figure 128). The prominent position of large firms in innovation may even be underestimated considering that most micro and small firms in the Philippines are in the informal sector, and many of them are unregistered. ICT is the country’s most innovative industry, with more than half of all firms involved in innovation (Figure 129). Figure 126. The Philippines allocates little resources to R&D… Figure 127. …and its firms lag behind peers in technology adoption. Research and Development Expenditure (% of GDP) 2.5 60 Percent of firms with Percent of firms an internationally- using technology recognized quality licensed from foreign 50 certification companies* 2.0 40 1.5 30 1.0 20 0.5 10 0 0 Philippines Indonesia Thailand Sri Lanka Vietnam Malaysia Bangladesh Morocco Kenya Pakistan China Philippines Thailand Sri Lanka Vietnam Bangladesh China Morocco Kenya Pakistan Malaysia Indonesia Malaysia China Kenya Morocco Thailand Vietnam Pakistan Philippines Sri Lanka Indonesia Source: World Bank. Source: Enterprise Survey, World Bank. Note: Morocco (2010), Kenya (2010), Indonesia (2013), Philippines (2013), Sri Note: Sri Lanka (2011) China (2012), Bangladesh (2013), Kenya (2013), Morocco (2013), Pakistan (2013), Indonesia (2015), Malaysia (2015), Lanka (2013), Vietnam (2013), China (2015), Malaysia (2015), Pakistan (2015), Philippines (2015), Vietnam (2015), Thailand (2016). Thailand (2015). *Only for manufacturing firms. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 101 High costs, insufficient resources, market dominance, and country’s firms receive public financial support for innovation lack of skills are the most prominent factors that prevent (Figure 131). Small and large firms are the main target groups firms from innovating in the Philippines (Figure 130). Firms for government support: 4.9 percent of small firms and point to the high cost of innovation as the primary factor 3.7 percent of large firms receive some kind of innovation that prevent them from engaging in innovation activities in support from the government. Moreover, less than 20 the country, followed by lack of funds from within firms and percent of firms are aware of public policies to support external sources. Moreover, market dominance and lack of innovation (Figure 133). Large firms and firms in the ICT qualified personnel are also important factors that discourage industry are more aware of government support than small innovation, especially among micro, small, and medium firms in the BPO industry (Figure 134). Apart from financial enterprises (MSMEs). support, the public procurement of advanced technology products, an effective method to foster and support The government provides limited support for innovation innovation, is at a lower level in the Philippines than in all activities in the private sector, contributing to the low level peers (Figure 132). of innovation in the economy. Merely 3.1 percent of the Figure 128. Large firms are more likely to engage innovation activities. Figure 129. ICT is the most innovative industry while the BPO is the least. Firms Active in Innovation by Size (Percent) Firms Active in Innovation by Industry (Percent) 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 All firms Micro Medium Small Large All BPO Food Mfg Other Mfg ICT industries Source: 2015 Survey of Innovation Activities, Philippine Institute for Source: 2015 Survey of Innovation Activities, Philippine Institute for Development Studies. Development Studies. 102 CHAPTER 04. POLICY OPTIONS FOR INCREASING PRODUCTIVITY AND ECONOMIC GROWTH IN THE PHILIPPINES Figure 130. High costs and lack of funds are the most prominent factors hampering innovation. Factors Hampering Innovation Activities (Percent) Lack of information on markets Difficulty in finding cooperation partners for innovation Lack of information on technology Uncertain demand for innovative goods or services Lack of qualified personnel Market dominated by established enterprises Lack of finance from sources outside enterprise Lack of funds within establishment or enterprise Innovation costs too high 0 10 20 30 40 50 MSMEs Large firms Source: 2015 Survey of Innovation Activities, Philippine Institute for Development Studies. Figure 131. Few firms receive public financial support for innovation. Figure 132. The level of government procurement of advanced technology products is low. Firms Receiving Public Financial Support for Innovation (Percent) Government Procurement of Advanced Technology Products (7=best) 5 5 4 4 3 3 2 2 1 1 0 0 Philippines Bangladesh Morocco Sri Lanka Thailand Vietnam Pakistan Kenya Indonesia China Malaysia All firms Medium Micro Large Small Source: 2015 Survey of Innovation Activities, Philippine Institute Source: Source: 2017 Global Competitiveness Index Report. for Development Studies. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 103 Figure 133. Few MSMEs are aware of the government’s Figure 134. ICT firms are the most aware of the government’s innovation innovation policy. policies while BPO firms are the least. Firms Aware of Any Government Innovation Policy or Intervention by Firm Firms Aware of Any Government Innovation Policy or Intervention by Size (Percent) Industry (Percent) 30 30 25 25 20 20 15 15 10 10 5 5 0 0 All firms Micro Small Medium Large All BPO Food Mfg Other Mfg ICT industries Source: 2015 Survey of Innovation Activities, Philippine Institute for Source: 2015 Survey of Innovation Activities, Philippine Institute for Development Studies. Development Studies. Lack of competition hinders productivity growth in the Philippines. While the Philippines’ labor market is competitive, and there are abundant skilled workers, real wages have been stagnant. This may be related to a lack of competition in product markets. Stagnant real wages hamper productivity growth by lowering capital intensity, depressing innovation, and encouraging the emigration of skilled workers. Therefore, increasing competition would boost productivity growth in the Philippines. 105 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 105 05 The Stakes: Reforms to Achieve the AmBisyon Natin 2040 106 CHAPTER 05. THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 The current administration has adopted a long-term growth increasing opportunities for the poor in order to eradicate vision for the Philippines called AmBisyon Natin 2040. poverty by 2040, if not earlier. The vision represents the collective long-term vision and aspirations of the Filipino people and the country in the The Philippines will need to reach a per capita real GDP of next 25 years.63 It envisions a strongly rooted (matatag), about US$9,350 by 2040 to meet the goals set out in the comfortable (maginhawa), and secure life (panatag na buhay) AmBisyon Natin 2040.64 This is a rough target that is aligned for all Filipinos, and that families live together in a high-trust with the government’s target of tripling per capita income society with a strong sense of community. Also, there is from its current level. Assuming that net factor income from access to high-quality education, decent jobs, sustainable abroad represents 15 percent of gross national income, the incomes, opportunities for entrepreneurship, and an efficient per capita GDP of US$9,350 corresponds to a per capita transportation system. The AmBisyon Natin 2040 also GNI of US$11,000, which is nearly the threshold for a high- envisions Filipino families living in comfortable homes, with income country.65 desired amenities and secure ownership, and individuals enjoying work-life balance, financial security, comfortable Sustaining TFP growth and accelerating capital accumulation retirement, and long and healthy lives. will be crucial for reaching the GDP per capita target needed to realize the government’s vision. A long-term Sustainable and inclusive economic growth is central to the growth model was used to evaluate the feasibility of the government’s long-term vision. Sustaining robust economic government’s vision and ways to achieve the GDP target growth is a necessary condition for the Philippines to become by 2040. The model assesses various growth scenarios and a prosperous middle-class society free of poverty by 2040. the potential mix of growth drivers needed to reach the The government’s goal is based on a set of household government’s goals. A baseline scenario was created based consumption and asset-ownership targets, including owning on the premise that key growth drivers such as labor, human a house and a car and having enough money to send children capital, investment, and technology sustain their historical to college while maintaining a middle-class lifestyle. For a growth rates. Various scenarios were then created relative family of four, this level of consumption translates into an to this baseline, and growth rates of select variables were estimated gross monthly income of Php120,000 by 2040, adjusted to assess the most realistic combination that will meaning that the Philippines’ per capita income needs to realize the AmBisyon Natin 2040. The most realistic scenario triple over the next 25 years. Moreover, the government’s shows that accelerating capital accumulation in the medium strategy calls for growth to be inclusive and distributed across term while sustaining relatively high TFP growth will help the sectors, regions, and income groups. It especially focuses on government achieve its long-term vision. 63 AmBisyon Natin 2040: A Long-term Vision for the Philippines, Available Online: http://2040.neda.gov.ph/. May 3, 2018. 64 The base year corresponds to the per capita GDP of US$2,892 in 2017. 65 NFIA totaled about 18.4 percent of GNI in 2000-16. A lower ratio 15.0 percent is assumed in the long term considering the declining trend of remittance growth, coupled with the outlook of fewer Filipinos seeking employment abroad as the domestic economy strengthens. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 107 ACHIEVING THE LONG-TERM GROWTH TARGET The World Bank’s Long-Term Growth Model (LTGM) is used economies such as human capital, demographics, and the to simulate different growth scenarios. The LTGM is based difference in labor market participation between men and on the Solow-Swan model, which is a long-term model set women. Moreover, the baseline LTGM allows for an analysis within the framework of neo-classical economics (Box 6). of the effects of economic growth on poverty alleviation. The As with the Solow-Swan model, investment, savings, and World Bank’s LTGM has been used for growth simulations productivity remain the key growth drivers in the LTGM. and country economy diagnostics in more than twenty However, the World Bank’s model is extended to include developing countries, including in peers such as Malaysia, other factors that are important for developing and emerging Bangladesh, and Sri Lanka. Box 7. A Description of the Long-term Growth Model The Long-term Growth Model is based on the Solow-Swan model. The economy (e) I t St FDI t Dt D t—1 /Y t—1 = + + — consists of a single sector that produces output using physical capital Kt and Yt Yt Yt Yt (1+g pc y, t )(1+g N, t ) effective labor ht Lt. At denotes TFP, which determines the aggregate efficiency of the economy. The relationship between inputs and output is governed by the Cobb-Douglas production function given by: By combining these, the model can calculate growth that comes from an investment or savings constraint, or it can calculate the required level of (a) Yt=At Kt1-β (ht Lt)β investment to meet a growth ztarget. It also calculates changes in the poverty rate, as growth in GDP per capita shifts the income distribution to the right. where β is the aggregate labor share of income, and effective labor is decomposed into human capital per worker ht and the number of workers Lt. The (f) total number of workers can be written as: 1-β I t gy,t+1 ≈ gAt+1 + β(gh,t+1 + gω,t+1 + gN,t+1 +gρ,t+1) +[ ] — (1-β)δ K t /Y t Y t (b) Lt=ρt ωt Nt Headline GDP growth (gy,t+1) can be decomposed using a log-linear where ρt is the participation rate, ωt is the working age to total population ratio, approximation into different growth fundamentals (Equation A6). Here gx,t+1 is and Nt is the total population. the growth rate of factor x from t to t+1. Equation (g) is the equivalent formulation for per capita GDP growth, gpcy,t+1 = gy,t+1 — gN,t+1, with the key difference Physical capital next period (Kt+1) is formed by undepreciated capital (1-δ) being that population growth adds to headline GDP growth, but subtracts from Kt and new investment It: GDP per capita growth. (c) Kt+1=(1-δ) Kt+It (g) 1-β I t gpcy,t+1 ≈ gAt+1 + β(gh,t+1 + gω,t+1 +gρ,t+1) + [ ] — (1-β)δ+ g Investment is funded by either domestic savings St or foreign savings via a K t /Y t Y t N,t+1 current account deficit CADt: (1-β)/(Kt/Yt) is the marginal product of capital (MPK), or the inverse of the (d) It /Yt =St /Yt +CADt /Yt marginal ICOR (mICOR), which determines the effectiveness of investment in boosting growth. An increase in Kt/Yt, for example from excessive investment, One can further decompose changes in foreign savings into inbound FDI and will decrease the MPK and increase the ICOR. changes in total external debt (Dt): Source: Based on Loayza and Pennings (2018), accessible at www.worldbank.org/LTGM. The LTGM builds on earlier work by Hevia and Loayza (2012). 108 CHAPTER 05. THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 The growth analysis uses data that span a four-decade and human capital growth is an additional 50.0 percent period, ranging from 2000 to 2040. Historical averages (compared to the 10.0 percent of scenario 4). between 2000 and 2016 are used as data inputs for key parameters (e.g., initial GDP per capita, labor share of income, Determining the feasibility of the growth paths depends depreciation rate, and initial capital-output ratio) and growth on how attainable the growth of key variables is (Table 3). rates or ratios of key variables (e.g., initial TFP growth, Reasonable growth thresholds can be determined based on initial human capital growth, labor market participation rate, the historical growth experiences of select economies and demographics, and poverty growth). The growth-simulation comparative peers. For example, TFP growth did not exceed exercises begin in 2017 and extend to 2040. Growth targets 2.0 percent for the 95th percentile across 168 countries in generally use conservative estimates based on the country’s the past two decades. The world TFP growth average was historical averages, and they are compared with peer 0.7 percent in 2000-14, and the average TFP growth among averages and stylized facts. the Four Asian Tigers66 was 1.8 percent in 1960-90. While there are exceptions, such as China’s annual average TFP A baseline scenario that assumes no reforms and five growth of 2.1 percent in 1980-2010, it is safe to assume scenarios with varying key growth drivers were simulated. that a conservative estimate of the Philippines’ average The baseline scenario assumes that no reforms are instituted, TFP growth rate will not exceed 2.0 percent in the next and the economy continues its current growth path. The two decades. In terms of investment-output ratios, China’s factors of production—labor, physical capital, human capital, 45.0 percent of GDP in 2010 was the highest ratio ever and TFP—grow at their historical average between 2000 and recorded. However, the annual average for structural peers 2016. This is followed by five different growth scenarios. was 23.7 percent of GDP in 2000-2016, while the average Scenario 1 simulates a successful case of the public “Build, of regional peers was 29.8 percent during the same period. Build, Build” program. Scenarios 2 and 3 simulate the growth The Philippines’ investment-output ratio was 24.5 percent needed for human capital and TFP separately to reach the of GDP in 2016, implying ample room for higher growth. target GDP per capita. Scenario 4 simulates a moderate case Finally, the average years of schooling varies from an average where both physical and human capital growth accelerates of 6.5 years among structural peers and 12 years among the by an additional 10 percent on top of their historical growth Four Asian Tigers. Meanwhile, the average years of schooling rates. The scenario then finds the corresponding TFP growth internationally is 8.3 years. rate needed to reach the target per capita GDP. Finally, scenario 5 is a progressive case of Scenario 4 where physical 66 The Four Asian Tigers are Hong Kong, Singapore, South Korea, and Taiwan. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 109 Table 3. Historical Growth Averages of Key Growth Drivers TFP Growth (2000- Investment-Output ratio Years of schooling 2014) in percent (2016) in percent World 0.7 23.2 8.3 East Asia Pacific countries (All) 1.0 31.4 9.3 Structural Peers 1.0 23.7 6.5 Regional Peers 1.5 29.8 8.4 East Asian Tigers 1.8 (1960-1990) 31.9 (1990) 12.0 China 2.1 (1980-2010) 45 (2010) 7.6 Philippines 1.8 24.5 8.5 Source: WDI. PATHS FOR FUTURE GROWTH GDP per capita will reach US$8,615 by 2040 if the economy expected to fall from 27.0 percent in 2015 to 3.2 percent in continues on its current growth path. This is the baseline 2040, using the poverty line of US$3.20 a day.68 scenario, which assumes that key economic parameters and growth variables grow at their historical rates since 2000 The administration’s infrastructure investment program (Table 4). In this scenario, the investment-to-GDP ratio is provides momentum for strong medium-term growth. projected to grow at an annual rate of 0.8 percent, from 24.5 Scenario 1 simulates the successful delivery of the percent of GDP in 2016 to 30.1 percent of GDP in 2040. administration’s “Build, Build, Build” program in which the The human capital index is estimated to grow by 0.5 percent investment-to-GDP ratio grows by 3.0 percent each year per year, resulting in an increase in the average years of to reach 29.2 percent of GDP in 2022.69 Assuming that the schooling from 8.5 years in 2017 to 9.4 years in 2040. The investment ratio then grows at the historical average of 0.8 TFP growth rate is conservatively set at 1.5 percent annually, percent per year until 2040, the investment-to-GDP ratio which is lower than the rate of 1.8 percent in 2000-16.67 will reach 33.6 percent of GDP in 2040, higher than the However, this TFP growth is higher than the world average average of many peers. Under this scenario, real GDP per of 0.7 percent since 2000 and the East Asia Pacific average capita will reach US$9,237 by 2040, slightly lower than the of 1.0 percent in 2000-14. Given these assumptions, real government’s target, implying an annual average real GDP GDP is projected to grow at an average rate of 6.2 percent growth rate of 6.5 percent in 2017-40. This scenario requires per year between 2017 and 2040. With the relatively high that TFP grows at 1.5 percent per year, same as the baseline, growth rate, real GDP per capita reaches US$8,615 by 2040, rather high based on world experience. lower than the GDP per capita target. Poverty headcount is 67 World Bank, East Asia and Pacific Update April 2017. 68 The poverty headcount rate assumes a log-normal distribution of income per capita with a constant Gini coefficient. GDP growth shifts the income distri- bution, resulting in people crossing the poverty line. The growth elasticity of poverty (GEP) is computed as the percentage fall in the headcount poverty rate from a 1 percent increase in per capita income. In this simulation, the Philippines’ GEP rises from 1.4 in 2017 to 2.6 by 2040, which explains the low poverty rate in 2040. 69 This was the average investment-to-GDP growth rate between 2011 and 2016. 110 CHAPTER 05. THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 ACHIEVING THE LONG-TERM GROWTH TARGET Growth in human capital would need to accelerate grow by an annual average of 1.1 percent between 2017 and dramatically if other factors maintain their current growth 2040 (scenario 2). This is around twice the historical average rates. Scenario 2 assumes that all variables in the baseline of 0.5 percent in 2000-16 This implies the average years of scenario are maintained except the human capital index. schooling in the Philippines would be around 10.4 years by Human capital is measured as an index directly related to 2040. This is a rather ambitious target since the East Asia a country’s average years of schooling and its returns on Pacific average was 9.1 years in 2016 and the highest record education. For the country to reach the US$9,350 per capita is held by South Korea with 13 years of education. real GDP target, the human capital index would need to Table 4. Historical Growth Averages of Key Growth Drivers Parameters Data Source Depreciation rate 3.6% PWT 8.1 Labor share 0.5 Conservative estimate, PWT 8.1 (41.1%) Initial capital-output (2017) 2.2 Conservative estimate, PWT 8.1 (2.7) Initial GDP/capita (2017) 2892 World Bank staff estimate Assumptions Initial labor market participation rate 67.2% Labor Force Survey Initial male participation rate 81.3% Labor Force Survey Initial female participation rate 52.8% Labor Force Survey Initial population growth rate (2017) 1.6% PSA estimate Population growth rate by 2050 0.7% Staff estimate Initial headcount poverty rate (as of 2015) 27.0% WDI poverty line of US$3.20 Gini coefficient (as of 2017) 46.5% PovcalNet The Philippines would need to sustain its current high TFP TFP growth, however, could be a challenge, considering the growth rate if both physical and human capital maintain world average was below 1 percent in 2000-14. Countries their current growth rates. Scenario 3 assumes that all that have managed to sustain high TFP growth include the variables in the baseline scenario are maintained except Four Asian Tigers during their growth expansion years (annual for the TFP growth rate. To reach the target per capita real average of 1.8 percent in 1960-90) and China between GDP of US$9,350 in 2040, TFP would need to grow at an 1980 and 2010 (average of 2.1 percent). Under Scenario 3, average annual rate of 1.8 percent between 2017 and 2040 the Philippines’ real GDP growth rate reaches 6.5 percent (Scenario 3). TFP growth in the Philippines accelerated from annually in 2017-40, which is about the average of 6-7 an annual average of 1.4 percent in 2006-11 to an average percent among the Four Asian Tiger economies for two and a of 2.2 percent in 2011-16. Sustaining the 1.8 percent of half decades since the1960s.70 70 Young (1995) GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 111 Table 5. Alternative Growth Scenarios Scenario Baseline 1 2 3 4 5 Objective To reach US$9,350 per capita GDP in 2040 Description Build, Build, Increasing Increasing 10% growth 50% growth Build human capital TFP growth acceleration acceleration growth Human Capital Initial human capital index growth 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% Target human capital growth by 2040 0.5% 0.5% 1.6% 0.5% 0.6% 0.8% Average years of schooling by 2040 9.4 9.4 10.4 9.4 9.5 9.8 Total Factor Productivity Initial TFP growth 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% Target TFP growth rate by 2040 1.5% 1.5% 1.5% 2.0% 1.9% 1.5% Investment Initial investment to GDP ratio 0.25 0.25 0.25 0.25 0.25 0.25 Target Investment ratio by 2040 0.30 0.34 0.30 0.30 0.31 0.33 Results Real GDP growth (2017-2040) 6.2% 6.5% 6.5% 6.5% 6.5% 6.5% Real GDP per capita in 2040 8,615 9,237 9,352 9,353 9,351 9,350 Poverty headcount rate in 2040 3.2% 2.6% 2.6% 2.6% 2.6% 2.6% 112 CHAPTER 05. THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 An acceleration of both physical and human capital growth only US$7,116 in 2040. This assumes that the investment- along with sustained TFP growth could achieve the per capita to-GDP ratio and the human capital index grow at historical GDP target by 2040. Given that sustaining a high TFP growth averages. Therefore, it is important that the Philippines rate would be challenging, an increase in both physical and maintains or increases its TFP growth rate to reach the human capital growth would lower the required TFP growth. GDP target. To reach the per capita GDP target, Scenario 4 illustrates that a 10 percent increase in the historical growth rates for Growth volatility can also have a large impact on the physical and human capital would lower the required TFP likelihood of achieving the growth target. Volatility in growth rate to 1.7 percent per year. Under this scenario, the economic growth introduces uncertainty into the economy average years of schooling would reach 9.5 years and the by affecting investment, trade, and asset levels. It also investment-to-GDP ratio would reach 30.6 percent by 2040. discourages continuity in economic planning, which can Moreover, Scenario 5 simulates a 50 percent increase in the even dampen the impact of high average growth of the historical growth levels for both human and physical capital, factors of production. In addition, volatility creates periods which would result in an investment-to-GDP ratio of 32.9 of overinvestment and underinvestment than can lower the and an average of 9.8 years of schooling by 2040. Under average return on capital investment.71 However, volatility Scenario 5, TFP growth would need to grow by 1.5 percent needs to be sizeable to have a long-term impact on growth, per year to reach the per capita GDP target by 2040. as business fluctuations do not affect long-term growth. For instance, when a slight volatility shock is introduced Sustaining high TFP growth will be crucial for the government into the LTGM while the baseline average growth rates are to achieve its per capita GDP target. Scenarios 1 through maintained, GDP per capita reaches close to the baseline 5 shows that the government can reach its per capita GDP level by 2040. Conversely, if volatility becomes excessive, target if the country can sustain TFP growth of 1.5 percent per capita GDP reduces to US$7,418 in 2040,72 which per year until 2040. Otherwise, if the TFP growth rate falls to corresponds to an average annual real GDP growth rate of 0.9 percent per year (the historical average in 1990-2016), 5.5 percent in 2017-40, compared to 6.2 percent in the per capita GDP growth would slow to an average of 5.3 baseline scenario. percent per year in 2017-40, resulting in a per capita GDP of 71 This is due to the concavity of the production function with respect to capital, which implies that the marginal product of capital is lower in periods of high capital stock than in periods of lower capital stock. 72 To introduce a volatility shock to the LTGM, the standard deviation of the growth rates for each of the factors of production is obtained, which is simu- lated in the model (TFP growth, human capital index growth, and investment-to-GDP ratio growth) and the standard deviation of each variable is multiplied by 3 (the so-called standard deviation factor). The standard deviation factor of TFP growth, HC index, and I/Y are then divided by the average growth rate of each variable. This value is then added and subtracted from the average growth rate of each variable to determine a range of values that will be randomly generated and introduced into the simulation. This provides a non-smooth growth path for the factors of production that simulates an introduction of volatility into the model that is not present in the baseline simulations. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 113 DRIVERS OF TOTAL FACTOR PRODUCTIVITY GROWTH The importance of TFP as a growth driver highlights the need contribution of these factors to TFP growth. The model to understand its determinants. TFP is generally regarded as identifies five categories of TFP determinants: innovation, a residual component of growth that represents economic education, market efficiency, infrastructure, and institutions, efficiency and technological improvement. This loose and along with their corresponding indicators. Subcomponent broad definition, however, impedes a precise understanding indexes are constructed to represent each of these five of how to improve TFP growth. While Chapter 4 discussed categories, and an overall index is set up to represent the five the main factors affecting TFP growth, this section uses a categories combined (Box 7). model developed by the World Bank to quantify the relative Box 8. A TFP Module for the Extended Long-Term Growth Model A TFP module is set up to predict the TFP growth rate based on TFP determinants. Based on an extensive literature review, the determinants of TFP are identified and classified into five categories: innovation, education, market efficiency, physical infrastructure, and institutions (governance). For each category, a set of subcomponent indexes are constructed based on the most relevant and available empirical indicators using the factor analysis (Table 6). These subcomponent indexes are combined into an overall TFP index using the principal component analysis. Table 6. TFP Determinants and Related Indicators Innovation R&D expenditure, public and private (percent of GDP) Number of patents, residents, and nonresidents (per 100 people) Number of scientific journal articles (per 100 people) Education Government expenditure on education (percent of GDP) Proxy for primary education: secondary enrollment rate (gross percentage) Proxy for secondary education: PISA score Proxy for tertiary education: completed tertiary education (percent of population 25+) Market Efficiency Goods market: Doing Business index Financial market: IMF Financial development index Labor market: Minimum wage (percent of VA per worker), severance pay for redundancy dismissal (weeks of salary), and share of women in wage employment in non-agricultural sectors Infrastructure Fixed telephone and mobile subscription (per capita) Length of paved roads (kilometer per capita) Electricity production (kilowatt per capita) Access to improved water source (percent of population) Access to improved sanitation facilities (percent of population) Governance Voice and accountability, corruption control, government effectiveness, political stability, regulatory quality, and rule of law To measure the relative contribution of the five main determinants of TFP growth, the variation of the TFP growth rate is decomposed to that explained by each determinant across countries over the period 1985−2014. Finally, a model is built to quantify the relationship between the overall determinant index and the change in the growth rate of TFP. The model is as follows: GDP TFP growth c,t=β 0+β 1Index c,t-5+β 2Index c,t-5*OECD c+β 3ln( wo ) +θ c+δ t+ε c,t rker c,t-5 TFP growth c,t : annualized TFP growth over t-5 and t Index c,t-5 : overall determinant index at t-5 OECD c : 1 if a country has been a member of OECD for more than 40 years; otherwise 0 GDP c,t-5 : total real GDP (constant 2010 US$) at t-5 worker c,t-5 : total number of employed population at t-5 θ c : country effect δ t : time effect Source: Based on the work of Kim and Loayza (2017). 114 CHAPTER 05. THE STAKES: REFORMS TO ACHIEVE THE AMBISYON NATIN 2040 The determinants of TFP perform better in the Philippines Moreover, a convergence to regional best practices leads than in structural peers. The country performs better than to higher TFP growth. If the Philippines reaches the overall most structural peers on market efficiency, education, and TFP determinant index of Malaysia, its average TFP growth governance. In the World Bank’s 2017 Doing Business rate will reach 2.8 percent in 2017-40. Although this is an report, the Philippines ranked higher than most peers on unrealistically high TFP growth, it illustrates that TFP growth market efficiency, outranked only by Morocco, while it shared can accelerate substantially by improving TFP fundamentals. the top rank with Morocco in the Financial Development Among the five determinants, raising the innovation index index. The country is also in the lead in the participation of to the level of China will have the largest positive impact women in wage employment in non-agricultural sectors. on TFP growth, as it leads to the annual TFP growth rate of Moreover, the country fares well compared to peers on both 2.1 percent on average over 2017-40. Also, improving the secondary and tertiary education enrollment and the Progress market-efficiency index to the level of Malaysia’s will result for International Student Assessment (PISA), whereas its in an average annual growth of 2.0 percent in TFP in 2017- share of public spending on education is somewhat lower 40. Raising the level of the education, infrastructure, and than in some peers. While the Philippines does not score governance indexes to the best practices in the region will exceptionally well on governance indicators, it still performs lead to an average annual 1.8-2.0 percent growth in TFP for better in voice and accountability, government effectiveness, each determinant if the rest are held constant. and regulatory quality than many structural peers. The country underperforms structural peers in innovation, but it The Philippines needs to sustain its high TFP growth to reach is in line with the average of structural peers in terms of the targets set out in the AmBisyon Natin 2040. Although infrastructure quality. the country has experienced high TFP growth in the past decades, sustaining these levels for two more decades could However, the Philippines underperforms regional peers be challenging. Experiences from other countries, such as the in term of TFP fundamentals. The country underperforms fast-growing Asian Tigers and China, show that sustaining regional peers in all categories of TFP determinants, except high TFP growth for a long period is possible but requires for governance.73 The infrastructure gap is especially wide, continuous reforms to remove constraints and distortions in as the country performs worse than all regional peers on the markets. Given that the Philippines’ TFP fundamentals infrastructure quality. The country also does poorly in terms of could be further improved, closing the gap with regional peers innovation, as its R&D expenditures rank the lowest together will be important to sustain high TFP growth. However, it will with Indonesia’s. Furthermore, its PISA score and share of require substantial efforts to remove market imperfections to public expenditure on education are below the average of improve market competition, infrastructure, and human capital countries in the region. The country also performs below the as well as to create an enabling environment for innovation. average of regional peers on market efficiency in both the Doing Business report and the Financial Development index. Global technological progress could also change the Philippines’ growth path by affecting the country’s growth The Philippines can accelerate TFP growth by raising the model. The technology revolution is inevitable and includes performance of the TFP determinants to the average of advancements in big data and analytics, automatization, regional peers (Table 7). The model simulates a one-time system integration, etc. Countries, including the Philippines, shock to the overall TFP determinant index, the underlying will have to adapt to new technologies and work methods. subcomponent indexes, or the underlying indicators one at Whether these will enhance or deter economic growth a time. It then compares the results to the baseline scenario where TFP grows at 1.5 percent per year. If the Philippines will depend on how a country reacts to the opportunities reaches the regional average of the overall TFP determinant and challenges posed by them. For a successful transition, index, TFP will grow at 2.0 percent annually in 2017-40. the Philippines needs to first address pending issues in its Among the five determinants, an improvement in the business environment, infrastructure, and institutions to innovation index will lead to the fastest TFP growth. The rest improve competitiveness. It also needs to lower trade and of the determinants have an equal impact on TFP growth. If logistics costs to improve connections with the rest of world. the indexes for education, efficiency, and infrastructure reach The Philippines will then need to support the creation of new their regional averages, each will push TFP growth to roughly business models in the economy and new skills for the digital 1.6 percent on average per year in 2017-40 if the rest are economy, especially in the export service sector since it is held constant. particularly susceptible to automation. 73 The regional average of the governance index was pulled down by China and Vietnam. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 115 Table 7. Impact of TFP Determinants on Average TFP Growth in the Philippines Average TFP Growth if indicator reaches TFP Determinants Indicators Best Practice among Regional Average Regional Peers (%) (%) Innovation R&D Expenditure 1.9 1.6 Number of patents (Per 100) 1.6 1.5 Number of scientific and technical journals published 1.6 1.5 (/100 people) Education Government expenditure on education (% of GDP) 1.6 1.5 Secondary enrolment rate (% of relevant population) 1.6 NA Tertiary completion rate (% of population aged 25 1.6 NA and above) PISA score, average across math, science, and reading 1.8 1.6 Efficiency World Bank Doing Business scores 1.6 1.5 IMF Financial Development Index 1.7 1.6 Women in wage employment in the nonagricultural 1.5 NA sector Infrastructure Fixed telephone (per 100 persons) 1.6 1.5 Mobile subscription (per 100 persons) 1.5 1.5 Electricity production (kw per 100 persons) 1.6 1.5 Paved road (km per 100 persons) 1.6 1.5 Access to improved sanitation facilities (% of 1.6 1.5 population) Access to improved water source (% of population) 1.5 1.5 Institutions Control of corruption 1.6 1.5 Government effectiveness 1.6 1.5 Political stability 1.6 1.5 Regulatory quality 1.6 1.5 Rule of law 1.6 1.5 Source: NA means that the Philippines performs better than the regional average. 117 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 117 Conclusion 118 CONCLUSION The Philippines has experienced impressive economic growth This report highlighted a number of key policies that are in the last two decades. Since the early 2000s, the country’s crucial to sustaining high TFP growth in the Philippines. per capita GDP growth accelerated partly as a result of These policies include: i) improving market competition past structural reforms and the government’s commitment by eliminating restrictions on foreign vis-à-vis domestic to macroeconomic and fiscal stability. Continuing efforts investors; ii) streamlining burdensome administrative to strengthen macroeconomic fundamentals along with procedures for existing and new businesses, starting a new favorable external conditions and the cumulative effects of business, and paying taxes; iii) shortening the FDI negative structural reforms have positioned the Philippines as one of list; iv) reducing limits on foreign equity; v) easing non-tariff the strongest growth performers in the East Asia barriers (especially POs); vi) lowering labor market rigidities Pacific region. through reducing the cost firing by simplifying dismissal procedures and lowering severance pay; vii) making regular The country aims to continue its growth success by tripling employment contracts more flexible by linking severance its income per capita by 2040 through the government’s pay with tenure; viii) and aligning the minimum wage with growth plan AmBisyon Natin 2040. The plan represents the productivity by considering the wage level of the informal collective long-term vision and aspirations of the Filipino sector. Moreover, the government needs to remove distorting people and envisions the Philippines as a prosperous policies (i.e., rice subsidies) and invest in human capital if it middle-class society free of poverty by 2040. Central to this is to increase labor productivity of the agriculture sector. long-term vision is high, sustainable, and inclusive economic Removing these policies will likely boost agriculture output growth that will depend on sustained productivity growth. by diversifying away from rice to higher output crops. Also, This implies that the Philippine economy needs to grow at investing in human capital will encourage more movement of an annual average of 6.5 percent in the next 22 years—a labor out of agriculture, accelerating structural change. challenge that only the Asian Tigers and China have managed to accomplish in the past. Poverty alleviation is likely to accelerate with more competitive and flexible markets. Creating an equal playing Accelerating capital accumulation and sustaining high TFP field and simplifying business regulations encourage firms to growth are essential to achieve the government’s goals. enter the market and invest, grow, and innovate, leading to Simulations show that given the Philippines’ current low level higher labor productivity. Market competition coupled with a of capital accumulation, increasing capital accumulation in flexible labor market and abundant labor supply allows higher the medium term will greatly contribute to economic growth. productivity to reduce product prices, which raises the real However, a faster pace of capital accumulation will need to incomes of workers. As result of more and higher paid jobs, be accompanied by sustaining high TFP growth rates. Yet, more people will be able to move out of poverty, helping the sustaining high TFP growth for a long period is only possible government achieve the AmBisyon Natin 2040 and realize its with continuous efforts to remove constraints and distortions vision of a society free of poverty. in the markets. 119 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 119 Appendices 120 EXECUTIVE SUMMARY APPENDIX 1. GROWTH VOLATILITY Figure A1 Figure A2 Growth volatility: Philippines vs structural peers Growth volatility: Philippines vs structural peers (coefficient of variaton) (coefficient of variaton) 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 1980s 1990s 2000s 2010s 1980s 1990s 2000s 2010s Philippines Bangladesh Kenya Philippines China Indonesia Morocco Pakistan Sri Lanka Malaysia Thailand Vietnam Vietnam Source: WDI Source: WDI APPENDIX 2. DATA FOR FIRMS’ PRODUCTIVITY DYNAMICS. Both the CPBI and ASPBI are confined to the formal sector and Fishing, Mining and Quarrying, Manufacturing, of the economy and as such excluded the informal sector. Electricity, Gas, Steam and Air Conditioning Supply, Water The CPBI and ASPBI describe the formal sector as comprised Supply; Sewerage, Waste Management and Remediation of the following: corporations and partnerships, cooperatives Activities, Construction, Wholesale and Retail Trade; Repair and foundations, single establishment with employment of of Motor Vehicles and Motorcycles, Transport and Storage, 10 or more, and single proprietorship with branches. Hence, Accommodation and Food Service Activities, Information the census and survey covered only the following economic and Communication, Financial and Insurance Activities, units: all establishments with total employment (TE) of 10 Real Estate Activities, Professional, Scientific and Technical or more, and; all establishments with TE of less than 10, Activities, Administrative and Support Service Activities, except those establishments which are single proprietorship Private Education, Human Health and Social Work Activities, in terms of legal organization, single establishment in terms Arts Entertainment, and Recreation, and Other Service of economic organization, and are engaged in economic Activities. activities classified per the 2009 Philippine Standard Industrial Classification (PSIC). In 2010, the ASPBI revealed a total of 148,266 firms in the formal sector while in 2012, CPBI registered a total There are 18 industrial sectors within the scope of CPBI of 219,184 firms. In 2013 and 2014, ASPBI recorded (2012) and ASPBI (2010, 2013, and 2014). These sectors, 225,244 and 226,682 establishments in the formal classified under the 2009 PSIC are: Agriculture, Forestry sector, respectively. PSA uses the annually updated List GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 121 of Establishments (LE) as the frame from which to draw and employment size as the second stratification variable. the sample establishments. According to the 2012 List Similarly, 2013 and 2014 ASPBI utilized stratified systematic of Establishments, there were 945,000 establishments in sampling with 5-digit PSIC serving as the industry strata and operation nationwide. Out of this number, 72 percent employment size as the second stratification variable. In or 680,400 establishments belong to the informal sector 2014, for establishments with Total Employment of 20 and and only 28 percent or 262,800 establishments made over, the 17 administrative regions serve as the geographic up he formal sector, which served as the frame for the domains while the 5-digit level (sub-class) of the 2009 PSIC 2012 CPBI. The ASPBI 2014 used the 2014 LE showing serves as the industry domain. a total of 944,500 registered establishments. About 266,257 establishments (28 percent) belong to the formal High response rates were recorded for 2012 CPBI and 2010, sector of which 231,000 (87 percent) comprised the 2013 and 2014 ASPBI. In 2010, 95.1 percent of sample establishment frame. This frame was used to draw the sample establishments responded, while 92.5 percent (54,869 out establishments for the 2014 survey. The 2013 LE estimated of 59,303 establishments) responded in the 2012 census. a total of 941,000 establishments, of this, about 28.0 percent In 2013 and 2014, the response rate for all establishments or 263,000 establishments belong to the formal sector of was 90.7 percent (27,752 out of 30,583 establishments) which 87.0 percent or 229,000 establishments comprised the and 87.48 percent (31,696 out of 36,231 establishments), establishment frame for the 2013 survey. respectively. Panel data on manufacturing is obtained from the Treatment of data manufacturing sector census and surveys in 2001, 2003, 2005, 2006, 2008, 2009, 2010, 2012, 2013 and 2014, Firms with zero capital stock, investment and compensation and economy-wide census (2012) and surveys (2013 and are removed from the sample with the assumption that firms 2014). The manufacturing sector data consist of individual cannot operate without any capital or labor. After the data firms belonging to 23 manufacturing industries classified cleaning and trimming process, the original manufacturing according to the 2-digit Philippine Standard Industrial sector dataset which consist of 485,813 observations Classification (PSIC) 1994. To standardize the classification will be trimmed to 152,925 observations, while the of firms by manufacturing industries across the ten waves, original economy-wide dataset which consists of 671,166 the census and survey data in 2010, 2012, 2013, and observations will be trimmed to 374,085. The main trimming 2014 which are based on PSIC 2009 codes are converted of the manufacturing sector dataset occurs at the dropping into PSIC 1994. The economy-wide panel data, which of informal sector firms especially during the earlier years of use PSIC 2009 to classify sectors, consist of individual the surveys, while in the economy-wide dataset, the main firms belonging to 18 large sections74 comprising the 3 trimming occurs during the cleaning process. After trimming economic sectors.75 The PSA survey years before 2006 and cleaning process and normalization of the distribution included firms that are classified as informal76, which are of firms, 332,888 of the observations in the manufacturing removed from the dataset for consistency. Hence, only sector dataset have been dropped out from the estimation formal sector firms are included in the analyses. Table A.1. process, while 297,081 observations have been dropped from shows the number of manufacturing firms and all firms.PSA the economy-wide dataset. uses stratified systematic sampling method to identify the sample establishment. Selection of sample establishment for the 2012 CPBI was done using stratified systematic sampling with 3-digit or 5-digit PSIC serving as industry strata 74 Section A Agriculture, Forestry, and Fishing, Section B Mining and Quarrying, Section C Manufacturing, Section D Electricity, Gas, Stream and Air Con- ditioning Supply, Section E Water Supply; Sewerage, Waste Management and Remediation Activities, Section F Construction, Section G Wholesale and Retail Trade; Repair of Motor Vehicles and Motorcycles, Section H Transportation and Storage, Section I Accommodation and Food Service Activities, Section J Information and Communication, Section K Financial and Insurance Activities, Section L Real Estate Activities, Section M Professional, Scientific, and Technical Activities, Section N Administrative and Support Service Activities, Section P Education, Section Q Human Health and Social Work Activities, Section R Arts, Entertainment, and Recreation, and Section S Other Service Activities. Note that Section O Public Services are not included in the available data provided by the Philippine Statistics Authority. 75 3 large economic sectors: Agriculture (Section A), Industry (Sections B to F), and Services (Sections G to S). See footnote 2 for details. 76 As per PSA, an informal sector firm is a single establishment and a single proprietor with less than 10 employees. A single establishment is an establishment which has neither branch nor main office. It may have ancillary unit/s other than main office, located elsewhere. (PSA CPBI/ASPBI Questionnaire) 122 APPENDICES Tables A.1, A.2, A.3 show the number of manufacturing firms and all firms in the original dataset, after dropping informal firms and cleaning. The firms in the census frame report data on gross output, value added, percentages of export sales, material expenditures, energy expenditures, salaries, employees’ benefits, number of employees, investments, book values, and ownership structure. Table A1. Number of firms before dropping informal firms Table A2. Number of firms after dropping informal firms, but before trimming and cleaning Number of Number of Number of Number of manufacturing firms economy-wide firms manufacturing firms economy-wide firms 2001 119,360 Not available 2001 114,332 Not available 2003 118,259 Not available 2003 18,250 Not available 2005 108,559 Not available 2005 16,527 Not available 2006 18,431 Not available 2006 16,136 Not available 2008 15,718 Not available 2008 13,582 Not available 2009 16,440 Not available 2009 14,959 Not available 2010 15,777 Not available 2010 13,990 Not available 2012 24,327 219,201 2012 22,640 207,215 2013 24,440 225,284 2013 24,423 220,525 2014 24,502 226,681 2014 24,154 222,083 Table A3. Number of firms after dropping informal firms, and trimming and cleaning Number of manufacturing firms Number of economy-wide firms 2001 6,589 Not available 2003 8,377 Not available 2005 9,237 Not available 2006 8,361 Not available 2008 6,874 Not available 2009 6,977 Not available 2010 7,109 Not available 2012 9,315 172,285 2013 10,410 101,487 2014 10,288 100,313 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 123 APPENDIX 3. HSIEH AND KLENOW (2009) FRAMEWORK The conceptual idea of allocation efficiency was translated Each establishment maximizes current profits: into an empirical framework by Hsieh and Klenow (2009). In their framework, they argue that the overall TFP of an π si = (1 —τ Ys i ) P si Ysi —w si L si —(1+τ Ksi ) RK si (4) industry depends not only on the TFP of individual firms, but also on how resources are being allocated across firms. where P si Ysi is the firm's value added (which is the firm's In their framework, in a frictionless environment, perfect revenue minus the cost of intermediate inputs); and w s i and allocation or rezsources implies that two firms within a R are the cost of one unit of labor and capital, respectively. narrowly defined industry should be able to employ resources The term τ Ys i denotes firm-specific output distortions that up to the point where they attain the same marginal revenue reduce firms' revenues. Many factors could contribute to products. Any dispersions in marginal revenue products output distortions, ranging from transportation costs to among firms operating within a narrowly defined industry discriminatory tax regimes to subsidies. These factors could will imply misallocation of resources in the industry. Note reduce output for a given set of inputs. The firm-specific that while the approach quantifies the overall extent of "capital" distortions, which raise the cost of capital (relative to misallocation, it is silent about which factors could be behind labor), are denoted as τ Ksi . Credit market imperfections such the misallocation. as preferential access to finance and labor market frictions could contribute to different "capital" distortions τ K s i across Consider an economy with many sectors, denoted s. Final firms. Therefore, an increase in usage of capital is indicative output Y is produced in each country using a Cobb-Douglas of relative distortions in the labor markets. production technology: Hsieh and Klenow (2009) differentiate the two productivity Y= Π s = 1 Ys s θ s (1) measures: TFPQ, which captures “physical productivity”; and TFPR, which captures “revenue productivity”: s where θ s is the value added share of sector s and Σ s= θ =1. 1 s Ysi TFPQ si = (5) L 1—α K α s s si si Each sector's output Ys is the aggregate of the individual P si Ysi firms’ output Ys i , using the CES technology: TFPR si = (6) α L si 1—α s K sis σ—1 σ—1 Ys =[ΣM sY i=1 si σ σ ] (2) In an absence of distortions, TFPR should not vary across firms within each sector. In other words, in the absence where Ys i is the differentiated product by firm i in sector s of distortions, more capital and labor should be allocated and σ is the elasticity of substitution across firms within the to firms with higher physical productivity (TFPQ) to the sectors. point where their higher output results in a lower price, P s i , which also results in the TFPR si equalizing across firms i . Each firm produces a differentiated product with the standard Any dispersions of TFPR across firms within a sector imply Cobb-Douglas production function: distortions. A firm with TFPR higher than the sector average suffers from the effects of distortions. On the contrary, it is Ys i = A s i L1— si α s K si (3 α s ) common for TFPQ to vary across firms because different firms may have different productivity levels. where A s i stands for firm-specific productivity; L si is the firm's labor; K si is the firm’s capital; and α s is the industry-specific From the revenue data, we can also derive capital share. Note that the assumption in this framework is that firms in the same narrowly defined sector—that is, TFPRQ si as: the 3-digit The Philippines Standard Industrial Classification ( P si Ysi ) σ—1 σ (PSIC)—have the same production function. TFPRQ si =As i =κ K αs (ω L si )1—α s (7) si 124 APPENDICES Equation (7) shows that TFPQ is calculated from P si , which Rewriting equation (12): contains elements of distortions, and κ is normalized to 1.77 σ R (1+τ ) ) ( ω ) αs 1—αs αs TFPR si = ( ksi (13) σ (1+τksi ) α R αs ω 1—αs σ—1 αs 1—αs 1—τysi P s i = σ—1 A ( ) ( 1—α ) (8) s si (1—τysi) αs s Equation (13) implies that in the absence of distortions (that Hsieh and Klenow (2009) choose the elasticity of is, τ Ksi = 0 and τ Ys i =0), TFPR will be the same for all firms “i " substitution, σ =3, and R =10, assuming a real interest rate within a sector “s .” Using this equation, we can deduce that of 5% and a depreciation rate of 5%. Capital share, α_s, a firm with higher τ Ksi and/or higher τ Ys i also has a higher and labor share, (1-α_s), are taken from the United States TFPR. manufacturing sectors, where firms are assumed to operate in an environment of minimal distortions. Therefore, the The industry level TFPR s is: shares of capital and labor of firms in the United States σ R αs ω represent an efficient utilization of resources. Any deviations TFPRs=( M 1—τ σ—1 α ∑ ( s Ysi )( PsiYsi ) ) ( M 1—α ∑ (τ s )( PsiYsi ) ) (14) s i=1 1+Ksi PsYs s i=1 Ys i PsYs of the U.S. capital-labor shares suggest distortions. When there are no distortions (that is, τ Ksi = 0 and τ Ys i =0) for Distortions represented by the output and capital wedges all i , the right-hand side of equation (14) equals the right- can be measured as follows: hand side of equation (13), which also means that TFPRs are equalized for all i . σ wsi Lsi 1—τ Ys i = σ—1 (1—α )P Y (9 ) s si si Rewriting equation (14):] αs wsi Lsi 1+τ Ks i = (10) 1— α RK σ M σ—1 σ lnTFP s = ln(∑ s TFPQ ) — 2 va r(lnTFPR si ) ( 15) s si σ—1 s= 1 si Firm i 's wage bill is represented by w si L si , and P si Ysi represents the firm's value added. Both values are taken from where M is the number of s sectors, and distortions the census data. Rewriting equation (10) to equation (11) in allocation show up in the var (variance) of revenue shows that the relative utilization of factors will be affected productivity TFPR across firms, while TFPQ is determined 1— α by distortions in the capital market and α , the labor- s by technology. s capital ratio in the less distorted (United States) environment. The estimation of firm i 's productivity or TFPQ si exploits the 1— αs wsi Lsi (1+ τ Ks i ) = (1 1 ) market structure based on the CES aggregator. It takes the αs RK form: si wsi Lsi If firm i 's actual labor-capital ratio RK is higher than the si (P si Ysi ) σ—1 σ less distorted labor-capital ratio, this implies that firm i may A si = (16) (L ) 1—α K α s s si si be facing difficulties in accessing capital (relative to hiring labor), and thus that firm i uses less than the optimal level The efficient industry's productivity level (when all marginal of capital. In other words, firm i has a positive capital wedge products are equalized) is: τ ks i . M σ—1 s Aσ—1) A si = (∑ i= 1 σ (17) s i Hsieh and Klenow (2009) show that without distortions, TF PR s i is proportional to the product of the marginal From equations (13), (14), (16), and (17), we can calculate the revenue product of labor and capital: ratio of the actual TFP in the economy to the efficient level of TFP as: 1—α TF PR s i ∝ ( MR PK si ) α ( M RP L si ) (1 2) s s Y M Asi TFPRs σ—1 θs S = ∏ s= s( [∑ i= 1 ) ] (18) σ-1 Yeff 1 Asi TFPRsi where MR PK s i is the marginal revenue product of capital for firm i in sector s and M RP L si is the marginal revenue product of labor for firm i in sector s . 77 See Hsieh and Klenow (2009) for a detailed explanation. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 125 APPENDIX 4. MEASURING DISTORTIONS WITH MEASUREMENT ERRORS This section provides a robustness check to the baseline argue that observed revenue ( R̂ i ) and inputs ( I ̂i ) could be Hsieh and Klenow framework. Hsieh and Klenow (2009) for subject to measurement errors: the first time provided an empirical framework to estimate misallocation. The framework relies on a few key assumptions. I ̂i = I i +f i The first key assumption is the use of CES aggregation of differentiated products in the same narrowly defined industry. R̂ i = R i + g i This assumption of the market structure allows among other things the derivation of quantity productivity (TFPQ) where f i and g i are measurement errors, and R i and I i in the absence of input and output quantity. In addition, are true revenue and inputs. Note that they assume the firms in the same industry have constant mark-up. Thus, any measurement errors take the additive form. variation of TFPR in this framework is attributable to resource misallocation. In practice, variation of TFPR in general could The growth rate of observed TFPR will reflect the growth be due to variation of mark-up (reflecting changes in demand rate of measurement error as well as the growth rate of true or quality), or measurement errors. Hsieh and Klenow (2009) distortions τ i : is our working framework in this chapter because of two R̂ i Î i ∆ TFPR i =∆ τ i +∆ ( ) —∆ ( ) reasons. The first reason is we do not observe input nor R i I i output prices and quantity to estimate quantity productivity Bils, Klenow and Ruane use the panel structure to estimate (TFPQ). The second reason is that since Hsieh and Klenow is the true distortion τ i . so widely used, we could contrast our finding to those in other studies. In this section, we provide the estimation of potential productivity gains after we correct for measurement errors. Bils, Klenow and Ruane (2017) propose a method that Column 3 of Table A4 reveals that after the correction of exploits the panel structure of the data to correct for measurement errors, the estimated misallocation (and hence potential measurement errors in revenue and inputs in the potential productivity gains from eliminating misallocation) in Hsieh and Klenow framework. Bils, Klenow and Ruane (2017) the Philippines is lower. Table A4. Potential productivity gains Potential productivity gains Potential productivity gains (Hsieh and Klenow, 2009) (Bils, Klenow and Ruane, 2017) 2006 94.1 82.16 2008 139.51 71.19 2009 180.04 74.41 2010 145.78 71.14 2012 133.88 88.74 2013 99.48 59.81 2014 98.35 63.30 126 APPENDICES APPENDIX 5. COMPETITION IN SERVICE SECTORS AND ITS IMPACT ON DOWNSTREAM USERS: AN INTRODUCTORY ANALYSIS FOR THE PHILIPPINES Focusing the analysis of competition-growth linkages within significant regulatory restrictions might be limiting industry level tends to underestimate the total effect of competition in key sectors of the Philippines economy. competition as a driver of firm or aggregate productivity A decomposition of the economy-wide PMR score enhancement. This is because the overall incentives to of the Philippines shows a similar influence from all improve productivity in a given sector are also affected by the level of competition in upstream sectors; those that three PMR sub-indicators (state control, barriers to sell intermediate inputs necessary to production. Conway entrepreneurship, and barriers to investment and and Nicoletti (2006) highlight that higher input prices raise trade) with a slightly heavier weight on state control the costs of entry for new firms in downstream sectors restrictions. While state control (37 percent) in the while influencing the cost structure of the incumbent Philippines contributes to restrictiveness more than firms, as well as the allocation of resources both within barriers to entrepreneurship (32 percent) and barriers to and across firms; all these factors affect the productivity trade and investment (31 percent). Overall, the three areas of firms. Bourles et al (2013) highlight two main channels where product market regulation in the Philippines seems through which competition in upstream sectors can to create the most significant restrictions to competition are influence productivity performance of downstream public ownership, administrative burdens to start up and users. Through the direct channel, fiercer competition in barriers to trade and investment. (Figure A3) services can generate downstream productivity gains, as final good producers get access to cheaper/higher quality The economy-wide PMR indicator is accompanied by a intermediate inputs. Through the indirect channel, stronger set of sectoral indicators in service sectors capturing the upstream competition can encourage downstream firms stringency of regulation in seven network sectors (electricity, to reallocate the resources they saved (with lower price gas, telecom, post and air, rail and rod transports) – grouped inputs) towards productivity-enhancing activities such in an indicator called ETCR - and professional services as innovation, technology adoption, workers’ training, (legal, accounting, engineering and architecture services).78 and managerial practices. The same authors estimate the impact of intermediate goods market imperfections Drawing from these PMR sectoral indicators, the current on downstream productivity for a panel of OECD note aims at shedding light on the status of competition in countries and find evidence that anticompetitive service sectors and its impacts on downstream users in the regulation have curbed productivity growth, and Philippines. It is structured in two main parts. The first part computes the regulatory impact indicator which is designed more strongly so for observations that are close to to capture the potential knock-on effects of anticompetitive the frontier. regulations in key upstream sectors on downstream users and brings first insights between these effects and firm The extent to which public policies promote or productivity distribution at sector level. The second part inhibit competition in several areas of product aims at quantifying the potential benefits of increased markets is captured by the economy-wide Product competition in services in the overall Philippine’s economy. Market Regulation (PMR) indicator. This indicator is constructed through a bottom-up approach and encompasses three key components: state control, barriers to entrepreneurship and barriers to trade and investment. New available PMR data suggests that 78 For further methodological details see the Koske et al (2015). GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 127 { Figure A3. Decomposition of PMR Score for the Philippines 3.00 3.00 2.50 2.50 37% 2.00 31% 2.00 24% 50% 1.50 1.50 32% 47% 1.00 1.00 63% 0.50 0.50 50% 37% 28% 0.00 0.00 Philippines State control Barriers to Barriers to trade entrepreneurship and investment State control Public ownership Complexity of Explicit barriers regulatory procedures Barriers to entrepreneurship Barriers to trade and investment Involvement in Administrative Other barriers business operation burdens or startups Regulatory protection of incumbents Source: The Philippines Product Market Regulations (PMR) questionnaire. Part 1. Computing the Regulatory Impact Indicator for where REGNMI is the degree of regulatory restrictiveness the Philippines. in the non-manufacturing sector j, wj,k denotes the total intermediate inputs of sector k from non-manufacturing Drawing from the methodology presented in Egert and sector j. The REGNMI indicators comprise the two sets Wanner (2016) and using PMR data collected for Philippines of PMR sectoral indicators already detailed: the Energy, in 2017, this section estimates the Regulatory Impact Transport and Communication Regulation (ETCR) indicators as indicator. This indicator measures the trickle-down impacts well as the regulatory indicators for professional services. The of regulatory barriers to competition in non-manufacturing input-output weights used for the Philippines is for 2012, the sectors on all Philippine’s manufacturing industries through latest year available. input-output linkages. It is worth clarifying here that the word impact in this case does not mean impact on performance of Figure A4 shows a comparison of two sets of REGIMPACT downstream users; it measures how important regulation in indicators: the narrow definition of the indicator – which services is for other sectors of the economy. includes only the ETCR – and the broader definition – which includes ETCR and professional services. The overall impact of these knock-on effects is a function of both the restrictiveness of regulations in key upstream non- Two results are noteworthy. First, the broad based manufacturing sectors and the extent to which the outputs REGIMPACT indicator is usually much higher than the of these sectors is used as inputs in other sectors. Following indicator using ETCR only, which reflects the importance this approach, the Regulatory Impact indicator for Philippine’s of professional services as suppliers of intermediate inputs downstream sector k in 2017 is computed as follows: for manufacturing sectors. Second, the “broad” knock-on n effect is the highest for Manufacturing of Pharmaceuticals, RegIMPACTk,2017=∑ REGNMIj,2017)*wj,k followed by Manufacture of other non-metallic mineral j=1 products and Manufacture of chemical products. At the other 128 APPENDICES extreme of the spectrum, the knock-on impact is the lowest In principle, these knock-on effects capture one channel in Manufacture of computer, electronic and optical products. through which the market environment affects decisions Overall, the cross-sector variation is considerable: the made by firms on resource allocation, and how such decisions incidence of anticompetitive regulation in energy, transport affect the share of production and sales of each firm in the and communications and professional services is almost market, as well as their productivity performances. As already 5 times higher for Manufacture of pharmaceuticals when mentioned, by affecting input factor dynamics, regulation compared with Manufacture of computer, electronic and in service sectors can impact the aggregate productivity optical products. performance of a downstream sector by influencing both the entry cost in the sector-user as well as the cost structure of its existing firms. Figure A4. Knock on effects of regulatory restrictiveness to competition in services across manufacturing users (using Philippines IO weights) Manufacture of computer, electronic and optical products Manufacture of coke and refined petroleum products Manufacture of machinery and equipment n.e.c. Manufacture of transport equipment Manufacture of wood products Manufacture of basic metals Manufacture of food products Manufacture of tobacco products Manufacture of furniture Manufacture of leather and related products Manufacture of wearing apparel Manufacture of beverages Manufacture of textiles Printing and reproduction of recorded media Other manufacturing Manufacture of paper products Manufacture of rubber and plastics products Manufacture of electrical equipment Manufacture of fabricated metal products Manufacture of chemical products Manufacture of other non-metallic mineral products Manufacture of pharmaceuticals 0.00 0.05 0.10 0.15 0.20 0.25 0.23 0.35 ETCR + Prof Serv. ETCR only GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 129 To assess how these knock-on effects, caused by and skewness measures of the firm productivity distribution anticompetitive regulations in service sectors, are associated are computed for each manufacturing sector in the ES. with productivity performance in downstream sectors, the Dispersion is measured by the inter-quartile range (defined 2015/16 Philippines Enterprise Survey (ES) is employed and as the difference between the 75th and 25th percentile) and two statistical moments of the firm productivity distribution, provides information on how stretched (or squeezed) the for each manufacturing-downstream sector, are analyzed: productivity distribution is, while the skewness measures dispersion and skewness. Firm-level productivity is defined how symmetric the distribution is. as revenue per employee79, while the dispersion Figure A5. Knock-on effects of regulatory restrictiveness Figure A6. Knock-on effects of regulatory restrictiveness to competition in key services sectors and productivity to competition in key services sectors and productivity dispersion of firms in downstream manufacturing sectors dispersion of firms in downstream manufacturing sectors 6 1 0.8 Inter-quartile range of (log) labor productivity Inter-quartile range of (log) labor productivity 5 0.6 4 0.4 3 0.2 0 2 -0.2 1 -0.4 0 -0.6 0 0.1 0.2 0.3 0.4 0 0.1 0.2 0.3 0.4 Regulatory impact (ETCR + Prof. services Regulatory impact (ETCR + Prof. services Note: IQR estimations of labor productivity distribution at sector level are Note: Skewness estimations of labor productivity distribution at sector adjusted by ES sampling weights level are adjusted by ES sampling weights 79 Because the ES data does not contain firm (product and inputs) prices, the measure of productivity used reflects more a proxy of market performance than true physical efficiency. Therefore, differences in revenue labor productivity across firms will not exclusively reflect differences in firm’s technical efficiency but also differences in terms of the market structure in which firms operate and differences in relative prices paid for inputs. 130 APPENDICES Figure A5 plots, for each downstream (manufacturing) Part 2. Quantifying the potential benefits of sector, the computed regulatory impact (on the x-axis) increased competition in services to the overall against the estimated dispersion of firm productivity Philippine’s economy distribution, adjusted by ES sampling weights. Only sectors with statistically significant estimated dispersions are The analysis presented at World Bank (2017) suggests that plotted. Results suggest that downstream sectors where just by concentrating on key reforms in service sectors, the incidence of anticompetitive regulations in services the Philippines could move from the fourth to the second are higher have greater productivity dispersion. It is worth quartile in terms of PMR overall restrictiveness among the stressing however that this correlation do not necessarily countries in the data set. A simulation based on enhancing imply causality. In fact, productivity dispersion is not the regulatory environment in the service sector would determined only by policy distortions; the recent literature imply lifting 86 restrictions mapped by the PMR indicators. on the underlying causes of productivity dispersion stresses In network industries, these would include limiting SOE that policy distortions are not necessarily the only factor presence (electricity generation, parcel and courier postal explaining productivity heterogeneity at firm level, even in services, railways and water transport of freight and narrowly defined sectors (see for instance, Foster et al (2016) passengers and operation of road, railways and maritime and Brown et al (2016)). Other factors like differences in infrastructure) and reducing barriers to entry (implementing mark-ups, adjustment costs, and product and factor price vertical separation and regulating third party access in distortions might be at play (De Loecker, 2011). electricity, and requiring unbundling of the local loop in telecom); eliminating price regulation for domestic air Figure 6 plots the same knock-on effects for each transport; developing efficient pricing mechanisms in the manufacturing sector against estimated skewness of telecom sector (regulating local loop unbundling prices and firm productivity distribution. Again, skewness values are international wholesale/retail roaming rates); and eliminating adjusted by ES sampling weights. A negative skewness FDI restrictions in utilities. In professional services, these value shows that the tail on the left side of the probability would focus on enabling a more dynamic environment by density function is longer than on the right-hand side, allowing inter-professional cooperation as well as which suggests that a large proportion of firms with low advertising; facilitating entry for domestic and foreign productivity levels survive in the market, compared to providers, reducing the number of exclusive tasks and the proportion of firms with high productivity. Results eliminating price regulation. for Philippines suggest that higher knock-on effects of anticompetitive regulations in services on downstream In this scenario, a significant share of the restrictions to be sectors are associated with lower and negative skewness, lifted constitute rules that discriminate and protect vested which suggests that less efficient firms are surviving in these interests as per the MCPAT effect-based categorization sectors. Again, this correlation result does not necessarily followed by rules that reinforce dominance or limit entry. imply causality. From the 86 restrictions identified, 42% belong to the state control pillar, 29% to the barriers to entrepreneurship and Overall, the results for the Philippines suggest that the other 29% to the barriers of trade and investment. downstream manufacturing sectors for which the incidence Taking into account the MCPAT classification, 42% of the of anticompetitive restrictions in services are higher tends lifted restrictions belong to the rules that discriminate and to have productivity distributions that are more dispersed protect vested interest, 35%, to the rules that reinforce and skewed to the left, which can be taken as an indication dominance or limit entry and 23%, to the rules that are of potential resource misallocation. This suggests that conducive to collusive outcomes or increase costs to anticompetitive regulations in service sectors might be in compete in the market. fact acting as a form of friction that prevents instantaneous allocation of resources to the firm with the highest productivity in downstream sectors, therefore hampering productivity performance at firm level and at aggregate level. GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 131 35+23+42E 42+29+E Figure A7. Share of 86 identified restrictions according to Figure A8. Share of 86 identified restrictions according to MCPAT classification PMR classification 35% 29% 42% 42% 29% 23% Rules that reinforce dominance or limit entry Pilar I: State Control Rules that are conducive to collusive outcomes or increase costs to Pilar II: Barriers to enterpreneurship compete in the market Pillar III: Barriers to trade & Invt Rules that discriminate and protect vested interests Source: OECD PMR database. By implementing this set of reforms in the service growth of the overall economy. The literature suggests sectors, the overall PMR score for the Philippines that a drop of 10% in the sector-wide PMR would would be reduced by 37.24% with the higher advance imply an increase in total factor productivity by at least within the barriers to trade and investment pillar. In 1.3 percentage points (IMF et al., 2014). For maximum fact, as shown in Figure A9, the score of barriers to effectiveness of the reform process, it is important entrepreneurship would be reduced by 39.42%, the to address competitive restrictions in the economy state control score would be reduced by 39.03%, and as a whole as proposed in the above simulations. the score of barriers to trade and investment would Concentrating on some specific areas (e.g. addressing decline by 32.83%. trade barriers without tackling the level of direct state participation in the economy) would prevent Lowering the PMR indicator along the lines of the the Philippines from obtaining the full benefits of the above simulation could have a positive impact in the envisaged measures. 132 APPENDICES Figure A9. PMR score (pre- and post-reform) 3 2.5 2 1.5 1 0.5 0 Product market State control Barriers to Barriers to trade regulation entrepreneurship and investment Philippines actual Philippines scenario Avg. of all countries Source: OECD-WBG PMR database. The full effect of the suggested reforms could increase the Philippines’ annual GDP growth rate by at least 0.2 percent (Table A5). Pro-competitive reforms in all the service sectors (energy, professional services, transportation, and telecommunications) could grow the country’s annual GDP by 0.2 percent and add US$0.6 billion to the annual GDP. Table A5. Expected Impact of reforms of key sectors on GDP Effect of reform on growth in downstream industries with above average service intensity Sector for reform Estimated impact on Expected impact on GDP measured Number of service annual value added 1/ at market prices 2015 2/ intensive markets (bill. PHP) (bill. USD) Across energy, professional 0.20% 26.8 0.6 91 services, transport, and telecommunications 3/ 1/ Calculations based on the Input-Output (I-O) table 2006, which includes information on 240 specific markets. Impact calculations are the additional value added as percentage of the GDP at current local prices of 2006, generated by improvements in a specific sector. 2/ We assume the structure of the economy remain constant, meaning that the estimated impact of changes in selected sectors on GDP 2006 were the same in 2015. The official exchange rate of 45.5 PHP/USD is used. 3/ Following the results of Barone and Cingano (2011), the estimate assumes a multiplier effect of 0.75pp in downstream sectors which have above average intensity across all named service sectors due to reforms across these selected sectors. Source: PSA (I-O table 2006), World Development Indicators, Barone and Cingano (2011) 133 GROWTH AND PRODUCTIVITY IN THE PHILIPPINES 133 References 134 REFERENCES Ackerberg, Daniel A., Kevin Caves, and Garth Frazer. 2015. “Identification Properties of Recent Production Function Estimators.” Econometrica 83 (6):2411–2451 Aghion, P., Bloom, N., Blundell, R., Griffith, R., and P. 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