total output and employment. Given the dominance of services in the economy, what are the implications of the service-led growth to the country’s long-term growth and development potential? Is there a connection between the decade-long growth pattern and the high unemployment, widespread poverty, and low investment? Can the new phenomenon of rapidly growing BPOs change the nature of such nexus, and help address those chronic problems of development and benefit the population?
To answer these critical questions, this paper analyzes structural change in production and employment patterns of the Philippine economy in the past decades, and examines its implications on the country’s long-term growth and development outcomes. The paper focuses on the impact of structural transformation on employment growth and economy-wide productivity growth, and assesses the process of product diversification and its implications on the growth performance by applying the concept of product space. The paper also proposes a new policy approach to revitalize public sector support for productive economic diversification.
Economy-wide labor productivity (real output per unit of labor input) growth is a key indicator of a country’s ability to continue improving its standards of living over time. Labor productivity growth in excess of wage increases is also a key strategy in retaining international export competitiveness. Successful Asian economies have continuously increased their economy-wide productivity (aggregate productivity) by improving sector productivity and shifting labor from sectors with low productivity to those with high productivity. Productivity growth within each sector and resource reallocation toward high productivity sectors are two engines of productivity growth throughout the economy. Over the last 3 decades, however, the Philippines’ aggregate labor productivity increased by only 10%. Neither sectoral productivity growth nor reallocation of labor across sectors contributed significantly to aggregate productivity growth. Labor productivity of services, which has been the key growth engine of the Philippine economy and absorbed labors from rural activities, has persistently been less than half of that of industry. In contrast, industry, which has indeed retained the highest productivity over the years, has neither raised its productivity level nor absorbed workers from the less productive sectors.
This lack of industrial dynamism in the Philippines, the low capacity of firms to expand or upgrade the range of industrial products being exported competitively is documented this report and argued to be inherently linked to the Philippines’ lagging performance. The evolution of the Philippine economy’s product space, which visualizes the process of economic diversification at the product level, shows that its regional neighbors continuously managed to shift their competitive industries’ products toward more diversified and sophisticated export baskets. Despite the increasing level of sophistication of its export basket, however, the process of industrial diversification in the Philippines has stagnated. The initial success in electronics did not translate into a deepening of other industrial capabilities across the economy. The Philippines has not fully utilized the accumulated capabilities in some electronics products into more sophisticated segments of electronics and other manufacturing products such as machinery, chemicals, and some metals. Arguably, private sector incentives to redeploy those productive capabilities into the production of new products have been weakened by several constraints such as underprovision of basic infrastructure and poor business and investment climate. Although progress was made, generous and passive public sector support provided through export promotion agencies have not achieved the expected outcomes in industrial development—at least compared with those in neighboring countries.
The Philippines’ growth has mainly been led by services. Productivity of the services labor, however, has persistently been well below that of industry. This suggests that although services have made the greatest contribution to economic growth and job creation, it was not necessarily associated with a rise in productive employment on the aggregate. The BPO industry entered the Philippine economy in the early 2000s, and the country has now become the third largest global BPO destination. However, the BPO industry employs only about 1% of the total labor force (2009), and its labor demand is biased toward relatively skilled workers. Given the large amount of under utilized labor with moderate skills and the prospect of further increasing the labor force in the near future, it is unlikely that development of services, even with the growing BPO industry, would be solely sufficient to address the development challenges of the country and bring the economy on the right track to inclusive growth.
To achieve inclusive growth, the Philippines needs to develop a stronger industrial sector to create productive job opportunities for the growing labor force. However, as the growing literature in industrial development illustrates, industrial upgrading and diversification are unlikely to take place without public intervention due to market failures in information, coordination, and externalities. Recent literature also emphasizes that market failures require public policy response or support specific to each product. The government needs to play an active role to help entrepreneurs take advantage of market opportunities.
The Philippines has a long tradition of public sector support for both domestic and foreign investors, mainly through investment promotion agencies (IPAs). IPAs have provided a variety of tax incentives for investment, export, job creation, and regional development. Registered firms enjoy income tax holidays, tax-exempted import of materials and capital goods, and deduction of wage bills from taxable income. While the IPAs have supported a wide range of priority industries in the Investment Priority Plans (IPP), the country has failed to attract investors, particularly foreign ones, and to spur local entrepreneurs in industry. Most investors have regarded past provision of fiscal incentives as redundant. The revenue loss due to the redundant incentives has likely reached over 1% of GDP. Impact assessments of the fiscal incentives have rarely been conducted.
Public sector support that can be implemented by the government usually falls in one of two broad categories: one is to improve general business and investment climate across sectors (broad-based or horizontal interventions), and another is to improve the efficiency of specific products and industries (targeted or vertical interventions).
A first step toward effective industrial development is to undertake broad-based reforms necessary to address the long-standing challenges such as tight fiscal position and weak business and investment climate. Fiscal consolidation is urgently needed to increase spending on infrastructure, since public investment has been constrained by weak revenue performance and poor expenditure management. The business community has been concerned about cumbersome business procedures and over-regulation, weak contract enforcement and property rights, and rigid labor market regulations. While significant progress has been made both in fiscal consolidation and business environment, experience in the country shows that broad-based public sector interventions are not enough to effectively develop the industry sector.
This paper stresses the critical importance of targeted interventions for industrial upgrading and diversification. Policymakers need to think of more focused ways to identify the needed interventions that would help promote new products that require very specific capabilities. Cross-cutting issues such as infrastructure have sector-or product-specific consequences. Installing roads instead of ports, for example, will have product-specific consequences. The high price of electricity can impede the development of manufacturing, but its impact varies significantly across products depending on the share of electricity costs in the total production cost in each product. Given limited resources and capacity, the government needs to choose target products to prioritize its interventions. Once policymakers recognize the need for targeted interventions, they face two policy challenges: first, identifying the right industries or products for public sector support, and second, helping the private sector exploit business opportunities in the targeted products. This paper proposes a two-step solution to these problems.
Selecting target products. This paper lists products that the Philippines can develop with relative ease (“nearby” products). These “nearby” products that the government can target are those where the accumulated capabilities for producing the current export basket are already being used. Thus, the available capabilities are mainly deployed to these new products, and no new capabilities are created. Policymakers can then develop the appropriate selection
