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Country Partnership Strategy: Philippines, 2011–2016

ECONOMIC ANALYSIS (SUMMARY)1

A. Recent Development and Long–term Growth Trends

1. Long-term growth performance. The Philippines had one of the highest per capita
incomes in East and Southeast Asia in the 1950s and 1960s with an advanced manufacturing
sector compared with its neighbors and well-developed human capital. From 1960 to 2008,
however, real gross domestic product (GDP) grew at an average annual rate of 4.0%. With rapid
population growth of 2.5%, per capita GDP increased by only 1.5%. Over the same period,
neighboring economies such as Indonesia, Malaysia, and Thailand grew about 4% per capita.
Although reforms in the past two decades (1990–2008) made the Philippine economy one of the
most open to trade and capital inflows, its growth continued to lag. By the end of the 1990s, the
Philippines’ per capita GDP had dropped below Indonesia, Malaysia, and Thailand (Figure 1).

Figure 1: Real GDP per Capita 1950–2008 Figure 2: Unemployment Rate, 1980–2008
(constant 2005 $) (% of total labor force)
18,000 14
Indonesia
16,000 12
Malaysia
10
14,000 Philippines
Thailand 8
12,000
Viet Nam 6
10,000
PRC 4
8,000
2
6,000
0
4,000

2002

2006
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000

2004

2008
2,000

0 Indonesia Malaysia Philippines


1960

1970
1950
1955

1965

1975
1980
1985
1990
1995
2000
2005

Thailand Viet Nam PRC

GDP = gross domestic product, PRC = People’s Republic PRC = People’s Republic of China.
of China. Source: World Bank, World Development Indicators.
Source: Penn World Table (PWT 6.3).

2. Strong economic growth in the past decade. During 2000–2010, real economic
growth averaged 4.8%, which was higher than in the previous decade (2.8%). Growth during this
period was accompanied by low inflation, strengthening external accounts, and a healthier and
better capitalized domestic banking sector. GDP growth slowed to 3.8% in 2008 and 1.1% in
2009 when the economy was hit by global food and fuel price hikes, the subsequent financial
crisis, and typhoons that caused massive floods in the capital region. Since late 2009, the
economy has recovered rapidly because of a sharp rebound in exports, especially in the
electronics industry and emergence of strong growth in business process outsourcing, a real

1
This summary is based on: ADB. 2007. Philippines: Critical Development Constraints. Manila; ADB. 2010.
Diagnosing the Philippine Economy: Toward Inclusive Growth. Manila; N. Usui. 2011. Transforming the Philippine
Economy: ―Walking on Two Legs‖. ADB Economics Working Paper Series. No. 252. Manila: Asian Development
Bank; and ADB. 2010. Tax Reforms towards Fiscal Consolidation: Policy Options to the New Administration.
Philippine Country Office Policy Note (July). Manila. The national income accounts have been recently revised and
the base year shifted from 1985 to 2000. The figures in this report are still based on the unrevised figures (for
constant prices).
2

estate construction boom, and solid private consumption backed by remittance inflows. While the
restocking of inventories led the early recovery, private investment has become another growth
engine. The GDP growth rate reached 7.3% in 2010, the highest since the mid-1980s.

3. Unemployment, underemployment, and poverty. 2 Since the mid-1980s, the


unemployment rate in the Philippines has fluctuated between 6% and 11%, compared with about
2%–3% for Viet Nam and about 1%–6% in Thailand (Figure 2). Even during the recent rapid
economic growth period (5.5% average in 2002–2007), unemployment averaged 9.8% and
underemployment averaged 19.2%. In 2010, despite the strong economic recovery, the
unemployment rate remained high at 7.3%, only slightly improved from 7.5% in 2009.

4. Vulnerable and overseas employment. The deployment of large numbers of workers


abroad (more than 1.4 million in 2009) and the high rate of so-called vulnerable employment
further mask the extent of domestic unemployment. The proportion of workers classified as
vulnerable3 remained high at 41.7% of all employed in 2010 (although this share had fallen from
45.2% in 2001). The average hourly wage of workers in the bottom 20% of the income
distribution is only 14% of the average hourly wage of workers in the top 20%, pointing to huge
differences in educational attainment. 4 Reflecting the limited job opportunities, the pace of
poverty reduction has been slower than in neighboring countries.5

5. Dynamic structural transformation in Asian economies. The rapid growth of East


Asian countries started in the 1970s when they shifted their development strategy towards export
promotion and attracted foreign direct investment. This process was accelerated in the 1980s
when foreign firms relocated their production bases across the region. Structural transformation
in these countries had three dimensions: (i) output shifted from low-productivity goods into
high-productivity ones, particularly manufactured goods; (ii) the labor force moved from
traditional activities in the primary sector to modern industry; and (iii) the export basket diversified
toward more sophisticated products. The industry sector has continually raised its productivity
through product diversification and sophistication, and has absorbed the labor force from
low-productivity sectors. The dynamic structural transformation has sustained growth and
reduced poverty by creating more affluent jobs.

6. Stagnant industry sector performance. The Philippines has not seen significant
structural transformation as experienced in other Southeast Asian countries. The industry
sector’s share of GDP decreased from 39% in 1980 to 32% in 2007. The labor force employed in
the industry remained stagnant at about 15% over the same period. Trade liberalization in the
1990s, and even during the recent rapid growth period, did not trigger a rising share of industry.
As of 2007, the manufacturing sector accounted for only 22% of GDP and less than 10% of
employment (Table 1). This is in marked contrast to neighboring economies, where the share of
manufacturing has steadily increased in both output and employment. In the Philippines, the
decline in agriculture’s share of employment has been offset by the growing services sector,
which accounted for more than 54% of GDP and employed 49% of total workers as of 2007. The
country’s export base remains narrow: two industries—electronics and garments—account for
about 70% of exports. Both of these industries are essentially import–export operations, mainly
in the form of assembly labor, with a thin layer of local value added.

2
The long-term trends in poverty reduction are provided in the Poverty Analysis Summary (accessible from the list of
linked documents in Appendix 2).
3
Self-employed and unpaid family workers who are less likely to have formal work arrangements, access to benefits
or social protection, and are more at risk in recessions.
4
ADB. 2007. Key Indicators 2007: Inequality in Asia. Manila.
5
Poverty Analysis Summary (accessible from the list of linked documents in Appendix 2).
3

Table 1: Structural Change, 1980–2007


Output (% of GDP) Employment (% of total employment)
Indonesia Malaysia Indonesia Malaysia
Sector Sector
1980 2007 Change 1980 2007 Change 1980 2007 Change 1980 2007 Change
Agriculture 24.0 13.7 (10.3) 22.6 10.2 (12.4) Agriculture 56.4 41.2 (15.2) 37.2 14.8 (22.4)
Industry 41.7 46.8 5.1 41.0 47.7 6.7 Industry 13.1 18.8 5.7 24.1 28.5 4.4
Manufacturing 13.0 27.1 14.1 21.6 28.0 6.4 Manufacturing 9.0 12.4 3.4 16.1 18.8 2.7
Services 34.3 39.5 5.1 36.3 42.0 5.7 Services 30.5 40.0 9.5 38.7 56.7 18.0
Philippines Thailand Philippines Thailand
1980 2007 Change 1980 2007 Change 1980 2007 Change 1980 2007 Change
Agriculture 25.1 14.2 (10.9) 23.2 10.7 (12.6) Agriculture 51.8 36.1 (15.7) 70.8 41.7 (29.1)
Industry 38.8 31.6 (7.2) 28.7 44.7 16.0 Industry 15.4 15.1 (0.3) 10.3 20.7 10.4
Manufacturing 25.7 22.0 (3.8) 21.5 35.6 14.1 Manufacturing 10.8 9.1 (1.7) 7.9 15.1 7.1
Services 36.1 54.2 18.1 48.1 44.6 (3.4) Services 32.8 48.8 16.0 18.9 37.6 18.7
( ) = negative, GDP = gross domestic product.
Sources: World Bank, World Development Indicators, and International Labor Organization, LABORSTA.

Figure 3: Labor Productivity, 1980–2007


(constant 2000 $)
Economy-Wide Labor Productivity Labor Productivity by Sector
14,000 12,000
12,000 10,000
10,000
8,000
8,000
6,000
6,000
4,000
4,000
2,000
2,000
0 0
1986
1980

1983

1989

1992

1995

1998

2001

2004

2007
1998
1980

1983

1986

1989

1992

1995

2001

2004

2007

Indonesia Malaysia Agriculture Industry


Philippines Thailand Services Manufacturing
Source: ADB. 2010. Transforming the Philippine Economy. Philippine Country Office Policy Note (October). Manila.

7. Slow growth of labor productivity. Compared with ASEAN-4 economies, progress in


economy-wide labor productivity in the Philippines has been weak. During 1980–2007,
aggregate labor productivity increased by only 10% (the annual average growth rate was 0.4%),
while labor productivity in Indonesia, Malaysia, and Thailand more than doubled (Figure 3). In the
Philippines, productivity for all sectors (agriculture, industry, and services) has stagnated over 3
decades. Industry and agriculture contributed negatively to aggregate productivity growth, and
only a minor contribution was made by services. The country’s overall productivity grew only
slightly through a labor shift from agriculture to services. Workers have continued to move into
the services sector, where self-employment is common and wages are more flexible. As a result,
4

more jobs were created in the low-skill, low-wage category.6

8. Remittance-based consumption and weak investment. Supported by remittance


inflows, consumption has been the main driver of aggregate demand in the Philippines. Private
consumption, accounting for about three-fourths of GDP, has been financed in part by soaring
remittances from Filipino workers abroad (10% of GDP in 2010). Reflecting the structural
changes in favor of services, which are less capital-intensive and more labor-intensive, the
country’s share of fixed investment in GDP decreased from a high of 25% in 1997 to 14%–15%
in 2005–2009, contrasting with the recovery in investments in its neighboring countries after the
Asian financial crisis (Figure 4).

9. Revisiting the growth strategy. Figure 4: Gross Fixed Capital Formation,


To attain more inclusive economic growth, 1980–2008 (% of GDP)
the Philippines may have to revisit its 50
strategies in lagging areas of the
economy. 7 The chronic problems of the 40
economy—high unemployment, slow
poverty reduction, and stagnant 30
investment— reflect the slow
industrialization process. The economy's 20
real growth potential remains untapped
and the slow pace of employment 10
generation despite growth hinders
inclusiveness. The Philippines’ biggest
0
need is to create domestic jobs for the

1998
1980
1982
1984
1986
1988
1990
1992
1994
1996

2000
2002
2004
2006
2008
growing working-age population.
PRC Republic of Korea
Indonesia Malaysia
Philippines Thailand
Viet Nam
GDP = gross domestic product, PRC = People’s Republic of
China.
Source: World Bank, World Development Indicators.

B. Key Constraints to Inclusive Growth

10. Weak revenue generation and public expenditure management. Persistent fiscal
imbalances and a lack of sustainable fiscal management have severely constrained growth for a
long period. Fiscal deficits result from weaknesses in tax revenue mobilization and poor public
expenditure and financial management. After reaching a peak of 17% of GDP in 1997, total tax
revenues declined steadily to below 13% in 2002 and 2003, contributing to a fiscal deficit of 5.3%
of GDP in 2003. Fiscal measures introduced in 2005, supported by development partners,
including ADB, broadened the value-added tax (VAT) base and increased the VAT rate from

6
H. H. Son. 2010. Growth, Inequality, and the Labor Market: The Philippines. In J. Zhuang, ed. Poverty, Inequality,
and Inclusive Growth in Asia: Measurement, Policy Issues, and Country Studies. Manila: Asian Development Bank.
7
N. Usui. 2011. Transforming the Philippine Economy: ―Walking on Two Legs‖. ADB Economics Working Paper
Series. No. 252. Manila: Asian Development Bank; A. M. Bocchi. 2008. Rising Growth, Declining Investment: The
Puzzle of the Philippines. Breaking the "Low-Capital Stock" Equilibrium. Washington, D.C; and World Bank. 2011.
Philippine Discussion Notes: Challenges and Options for 2010 and Beyond. Washington, D.C.
5

10% to 12% and the corporate income tax rate from 32% to 35%.8 As a result, the tax-to-GDP
ratio increased to 14.3% in 2006, with the budget deficit declining to 1.1% of GDP. However,
fiscal pressure has been growing since 2009. While stimulus spending and post-calamity
restructuring costs contributed to the larger deficit, the country's weak revenue mobilization
capacity has exacerbated the problem. The combination of accelerating spending and weak
revenue collection drove the fiscal deficit to 3.9% of GDP and the debt-to-GDP ratio to 57.3% in
2009. Tax revenues fell to 12.8% of GDP in 2009 (Figure 5), the lowest since the 2005 and 2006
tax reforms. It was also the lowest among neighboring members of the Association of Southeast
Asian Nations.

Figure 5: Tax Revenue Trends, 1997–2009 Figure 6: Tax Productivities


(% of GDP)
0.8
20 0.7 VAT CIT PIT
0.6
0.49
0.5
15
0.4
0.3
0.20
10 0.2 0.16 0.18
0.11
0.1 0.06

0.0
5

PRC (2006)
East Asia and the

Malaysia (2006)
Republic of Korea

Viet Nam (2007)


Philippines (2009)

Thailand (2007)
Pacific (2006)

(2007)
0
1997 1999 2001 2003 2005 2007 2009
CIT PIT VAT Excise tax Others
CIT = corporate income tax, GDP = gross domestic product, PIT = personal income tax, PRC = People’s Republic of
China, VAT = value-added tax.
Source: ADB. 2010. Tax Reforms towards Fiscal Consolidation. Philippine Country Office Policy Note (July). Manila.

11. Low tax productivity.9 The Philippines’ tax productivities, in particular for VAT and
corporate income tax, are far below the region's averages (Figure 6). The low productivities
signal the presence of significant tax loopholes and weak tax administration. From 1997 to 2008,
the tax collection fell about 2.9 percentage points, with about two-thirds accounted for by the
decline in excise tax revenues (on tobacco, alcoholic products, and gasoline), mainly because of
the lack of inflation adjustments. Personal income tax compliance is low and taxing
self-employed professionals is difficult. Tax incentives for investors distort economic activity by

8
The new tax legislation included a sunset clause whereby the corporate income tax rate would be cut to 30%
starting 1 January 2009. The rationalization of fiscal incentives that was meant to compensate for the revenue loss
did not take place. World Bank. 2011. Philippine Discussion Notes: Challenges and Options for 2010 and Beyond.
Washington, D.C.
9
Tax productivity is a conventional index to measure how effectively tax authorities produce revenues from available
tax bases. For each tax, the productivity is measured as the ratio of the tax revenue to GDP divided by the tax rate,
i.e., (tax revenue/GDP)/(tax rate). It can be regarded as a ratio of actual tax revenue to the hypothetical tax revenue
(GDP*tax rate), which reflects the extent to which existing revenue generating capacity has been exploited by tax
collection authorities. ADB. 2010. Tax Reforms towards Fiscal Consolidation: Policy Options to the New
Administration. Philippine Country Office Policy Note (July). Manila.
6

imposing high effective tax rates on companies that are not eligible to receive the incentives.10
The local governments’ lack of revenue generation capacity is also a concern.

12. Shortfall in provision of basic infrastructure and social services. The country’s
lagging outcomes both in physical and human capital accumulation can be explained mainly by
shortfalls in the size of public spending rather than shortfalls in the quality or efficiency of public
spending.11 Because of the tight fiscal position, the scope for increased physical and human
capital accumulation through public spending has been limited. As a result, the provision of these
services has been inadequate. Government capital expenditure was equivalent to 2.7% of GDP
(2002–2008 average), lower than in neighboring countries (Table 2).12 There are also public
spending gaps in key social sectors (Table 3). Public spending on education averaged 2.5% of
GDP compared with 4.0% of GDP in other Asian countries in 2002–2007. In 2006, overall
government spending for health was even lower at 1.3% of GDP. The impact of public
investments can get further reduced because of inefficient spending programs. 13 Low and
inefficient public spending on social services results in insufficient and unequal access to
opportunities.14

Table 2: Central Government Capital Expenditures and Net Lending


(average annual percent of GDP)
1996–2000 2002–2008
Philippines 3.6 2.7
Malaysia 6.0 7.3
Thailand 5.4 3.5
Viet Nam 6.9 9.2
Sample Mean 6.1 6.6
GDP = gross domestic product.
Source: World Bank. 2011. Philippine Discussion Notes: Challenges and
Options for 2010 and Beyond. Washington, D.C.

Table 3: Government Spending on Education and Health


(% of GDP)
Education Health
a a
Country 1990–1995 2002–2007 2000 2006
Philippines 3.0 2.5 1.6 1.3
Indonesia n.a. 3.5 1.7 1.9
Malaysia 4.4 4.6 1.9 2.3
Thailand 3.2 4.3 1.6 2.1
Viet Nam 2.9 n.a. 1.7 1.9
Sample Mean 3.5 4.1 1.7 2.0
GDP = gross domestic product, n.a. = not available.
Source: World Bank. 2011. Philippine Discussion Notes: Challenges and
a
Options for 2010 and Beyond. Washington, D.C. latest year in period

10
An ADB study found that tax incentives are mostly "redundant", which means that firms that were granted the tax
incentives would have invested irrespective of receiving the incentives. ADB. 2010. Philippines: Strengthening
Investment Climate and Competitiveness. TA report prepared under ADB. 2007. Technical Assistance to the
Republic of the Philippines for Strengthening Investment Climate and Competitiveness. Manila.
11
A World Bank study examined the main causes of the country’s underperformance in education, health, and
transport. It found that, while spending efficiency is a problem in transport, shortfalls in the size of public spending is
the key cause of the underperformance in all these sectors. World Bank. 2010. Philippines: Public Expenditure
Review: Strengthening Public Finance for More Inclusive Growth. Unpublished.
12
Footnote 8, p. 5.
13
S. Jha and A. Mehta. 2010. Inclusiveness through Food Security: The Philippines' National Food Program. In J.
Zhuang, ed. Poverty, Inequality, and Inclusive Growth in Asia: Measurement, Policy Issues, and Country Studies.
Manila: Asian Development Bank.
14
Education Sector Assessment Summary, and Health and Social Protection Sector Assessment Summary
(accessible from the list of linked documents in Appendix 2).
7

13. Underinvestment in infrastructure. Private fixed investment in the Philippines, which


averaged only 12.5% of GDP during 2002–2008, compared with about 20% in the rest of the
region, has been insufficient to make up for the public spending gap in infrastructure investment,
undermining the investment climate.15

14. Limited competition. Enhancing competition has been an important policy objective.
After the political and debt crisis of the 1980s, the government implemented market-based
economic reforms, such as liberalizing trade, telecommunications, and domestic shipping, and
opening up to foreign direct investment. 16 However, the country has been unable to spur
domestic investments, and inflows of foreign direct investment have remained low compared
with its neighbors. Cartel behavior continues to exist in sectors such as maize, sugar, rice,
pharmaceutical drugs, water transport, cement, sea and air transport, energy, mining, and
banking.17 Some companies benefit from barriers to entry and dictate high prices for key inputs
for other sectors, such as transport, cement, and power. In many sectors, concentration ratios
and price–cost ratios have remained high, which suggests the presence of monopoly rents.18 An
explicit competition (antimonopoly) policy framework is needed to eliminate current
anticompetitive practices. Recent government initiatives in this area are worth noting.

15. Weak business and investment climate. Key constraints identified in business surveys
are provided in the private sector assessment summary (footnote 15). The number of procedures
required for starting a business is higher than in other countries in the region. 19 Further, the
weak bankruptcy law makes it difficult for unprofitable businesses to exit the market.
Shareholders’ rights are not effectively protected, and enforcement of legal rights through the
judicial system is still weak. Labor market rigidities, such as difficulties in hiring and firing labor,
also deter private investment.

16. Ineffective public support for industry. Despite a long history of using fiscal incentives,
the country’s public support for industrial development has been fragmented and ineffective at
achieving the primary goal of investment promotion.20 Several agencies, including the Board of
Investment and the Philippine Economic Zone Authority, have continued to provide fiscal
incentives, but a systematic and updated assessment of the effectiveness of the incentives may
need to be conducted. Although priority sectors are stipulated in the annual Investment Priority
Plan, its coverage is wide, and the priorities are defined only broadly at the aggregated sector
level.21 With only 0.11% of GDP going to research and development, the Philippines ranks 89th
of 103 countries and falls far behind other countries in the region.22 Links between universities
and research and development in industries are weak, and incentives to pursue higher education
in science and technology are low.

15
Private Sector Assessment Summary (accessible from the list of linked documents in Appendix 2).
16
R. M. Aldaba. 2008. Assessing Competition in the Philippines. Philippines Development Studies Discussion Paper
Series No. 2008–23. September. Manila.
17
A. M. Bocchi. 2008. Rising Growth, Declining Investment: The Puzzle of the Philippines. Breaking the "Low-Capital
Stock" Equilibrium. World Bank Policy Research Working Paper Series. No. 4472. Washington, D.C.: World Bank.
18
Footnote 8, page 4.
19
World Bank and International Finance Corporation. 2011. Doing Business 2011. Washington DC.
20
F. Medalla. 2006. On the Rationalization of Fiscal Incentives. Washington DC.: United States Agency for
International Development; and R. Reside. 2006. Fiscal Incentives and Investments in the Philippines. Washington
DC: United States Agency for International Development.
21
ADB is conducting a structural transformation study to identify target products for industrial diversification and
analyze the potential for public support for industrial development. ADB. 2010. Technical Assistance to Philippines
for a Structural Transformation Study of the Philippine Economy. Manila.
22
International Institute for Management Development. 2007. 2007 World Competitiveness Yearbook. Switzerland.