The Philippines' economy performed well before, during and since the 2009 global financial crisis.
Faster GDP growth has been both a cause and an effect of lower economic risk, especially on the fiscal and external accounts.
The Philippines has been a historical underachiever because of its poor governance and weak institutions.
Further improvements to institutions could ensure that economic growth continues and accelerates.
The Philippines has been one of the star performers of the world economy during and since the global financial crisis. It was one of just a handful of economies to avoid recession in 2009 and has continued to outperform in the aftermath, growing 7.2% in 2013. That puts it behind only China (7.7% GDP growth in 2013) in the Asia-Pacific region.
An extended boom
Among the 56 major economies that we cover in detail, the Philippines has been the eighth fastest growing since 2006; its compound annual growth rate of 5.3% puts it behind only China, India, Indonesia, and a couple of Latin American countries. GDP per capita has doubled over this period to $2,800.
And unlike those of some high-performing peers in Latin America, the Philippine growth engine shows no signs of slowing. GDP growth is expected near 6% again this year, which is around its potential growth rate.
Risks recede
This outperformance has come as both a cause and an effect of falling economic risk. The current account balance sits in healthy surplus; the peso is stable, trending slowly but surely higher since 2005; inflation is low at 4.1% y/y according to the latest CPI data; and the government has balanced the budget and lowered public debt to 38% of GDP in 2013 from 66% in 2004. Moody’s Investors Service upgraded the Philippine government bond rating to Baa3 or investment grade in October.
Most of this improvement has happened despite a weak global economy, with many countries struggling to grow or scrambling to avoid another downturn in the financial crisis. The growth and risk profile of the Philippines' economy have been in a virtuous cycle for most of the past decade.
A welcome break from the past
The relatively recent outperformance of the Philippines' economy followed decades of disappointment. In 1960 the Philippines had a GDP per capita of around $700 in constant 2000 U.S. dollar terms, compared with $1,500 in Korea. It took the Philippines 52 years to reach Korea’s 1960 level of income; over the same period average incomes in Korea grew 14 times higher, propelling it into the club of rich economies.
It needn’t have played out like this. The Philippines has many advantages—plenty of natural resources, a prime position in Asia’s shipping lanes, a large pool of educated English speakers, and historical links to the U.S. and its booming economy. The Philippines' economy has been the region’s perennial underachiever.
Until recently, that is. Now, with the economy booming, the question arises: Is the current growth trajectory sustainable? In the near term, there are few signs of stress or overheating and we and most other analysts see only a modest chance of a downside scenario. But what about the longer term? Has the Philippines finally shaken off its label as the “sick man of Asia” and lifted itself onto a higher growth trajectory?
Drivers are partially known
The drivers of economic development are only partially known. Yet we can provide some insight from history, the development literature, and an econometric model.
A lot of the development literature centres on the role of institutions within an economy. The long-term outlook for the Philippines depends in large part on whether its governance and institutions have changed permanently and for the better, or whether the current period of good governance proves to be a passing phase.
The government is dominated by the country’s wealthiest families, which are believed to control 80% of the seats in the upper and lower houses of parliament, as well as countless more in local politics. Political parties have weak ideologies and elections are won on personality and money. President Benigno Aquino, who has done a good job in attracting private investment and taken steps to reduce corruption, is the son of an ex-president and a senator. The economy is dominated by conglomerates in agriculture, maritime and air transport, energy, cement, and banking.
If the country’s institutions—courts, government, the bureaucracy, the education system, physical infrastructure, and so on—do not evolve to be more inclusive and transparent, the economy will revert to underperformance. The economy should facilitate upward (and downward) mobility and equal access to credit, and industries should be protected only if they provide ancillary benefits such as exporters, which provide foreign currency.
World Bank indicators
The World Bank Development Indicators offer some guidance to the Philippines' recent progress from an institutional perspective. The Philippines has generally improved in recent years, but still ranks low compared with its near neighbours such as Malaysia.
On the World Bank’s Governance Indicators, the Philippines fares poorly with only modest signs of improvement over the past decade. On its best score, government effectiveness, the Philippines ranks just above the global average, but this shouldn’t be interpreted as a good or even acceptable result. It sits six places behind Thailand, for example, where the military has just taken over the government. The rest of the indicators reaffirm the Philippines’ weak institutions and poor governance. On the Control of Corruption gauge, the Philippines sits between Liberia and Mozambique and well behind its neighbours Thailand and Malaysia, though above Indonesia.
Other indicators suggest that the Philippines’ institutions are weak but improving. The World Bank’s World Development database contains information on the private sector, including the oft-quoted Ease of Doing Business Index.
The Philippines fares reasonably well on the cost of starting a business. It is relatively high at 19% of gross national income, but that’s partly because of the country’s low GNI. In current U.S. dollar terms this works out to around $50 to start a business in the Philippines, which is comparable with Thailand ($26) though well behind Hong Kong ($2.50). The Philippines ranks poorly on the Ease of Doing Business index. Even with the recent improvement it ranks at 108 out of 189. Malaysia, by contrast, ranks 7th, with Thailand 18th and Indonesia 120th.
What can a model tell us?
To help us analyse these links we built an econometric model. We used a panel of Asia-Pacific economies (13 in total, but only six countries shown below) to test the relationship between real GDP per capita and the cost of starting a business and governance quality.
We ran three shocks through the model. The first involves halving a country’s cost of doing business. The second shock lifts a country’s government effectiveness reading by 10 points. For the Philippines it lifts its reading to 67; Malaysia, by contrast, already sits at 80. The third scenario combines the two shocks.
Australia (along with Korea, Japan, Hong Kong and New Zealand—not shown) already has good institutions in place and sees little improvement. But poorer countries with inferior institutions stand to benefit substantially from an improvement in their governance. India, where governance is ineffective and business costs are relatively high, stands to benefit the most. The Philippines could benefit from lower business costs and more effective governance, with both shocks of roughly equal importance. Growth in Philippine GDP per capita is expected to be around 3.7% this year. This could lift to 5% with lower business costs or more effective governance, or 6.4% with both. The latter would translate into overall GDP growth of around 8%.
Glenn Levine is a Senior Economist at Moody's Analytics.
