Philippines
Selected Issues Paper
Author: International Monetary Fund
Publication Date:
01 Mar 2011
eISBN:
9781455219971
Language:
English
Keywords:
ISCR; CR; revenue; production function approach; affect growth; labor market; inflation expectation; revenue effort; expenditure shock; shock crowd; unemployment rate; employment growth; Total factor productivity; Fiscal consolidation; Fiscal stance; Inflation; Private investment; Global; Asia and Pacific; value chain; improvements in TFP; TFP to output growth; drivers of TFP; Employment; Public investment spending; Labor markets
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1. This paper estimates potential growth in the Philippines using different methodologies and discusses growth prospects for the medium term. Potential growth is a key input for assessing the supply capacity of the economy, which in turn has implications for assessments of macroeconomic policy. The production function approach highlights the scope for further increases in investment, employment, and total factor productivity (TFP). International comparisons and economic analysis, based on cross-country panel data, are used to shed light on the determinants of these growth pillars. The analysis highlights some areas in which measures may be particularly helpful for raising potential growth toward the authorities’ 7-8 percent target over the medium term.

Abstract

1. This paper estimates potential growth in the Philippines using different methodologies and discusses growth prospects for the medium term. Potential growth is a key input for assessing the supply capacity of the economy, which in turn has implications for assessments of macroeconomic policy. The production function approach highlights the scope for further increases in investment, employment, and total factor productivity (TFP). International comparisons and economic analysis, based on cross-country panel data, are used to shed light on the determinants of these growth pillars. The analysis highlights some areas in which measures may be particularly helpful for raising potential growth toward the authorities’ 7-8 percent target over the medium term.

I. Potential Growth and Prospects 1

A. Introduction

1. This paper estimates potential growth in the Philippines using different methodologies and discusses growth prospects for the medium term. Potential growth is a key input for assessing the supply capacity of the economy, which in turn has implications for assessments of macroeconomic policy. The production function approach highlights the scope for further increases in investment, employment, and total factor productivity (TFP). International comparisons and economic analysis, based on cross-country panel data, are used to shed light on the determinants of these growth pillars. The analysis highlights some areas in which measures may be particularly helpful for raising potential growth toward the authorities’ 7-8 percent target over the medium term.

B. Estimating Potential Growth

2. Several approaches can be used to estimate potential growth. Some methodologies rely on statistical techniques, while others are based on economic theory. In this paper for estimating potential growth in the Philippines, the following three approaches are used. A similar picture emerges from all three approaches, namely that potential growth in the Philippines has increased since the late 1990s. Potential growth was around 3-4 percent in the 1990s, but it increased in the 2000s and is now estimated to be around 5 percent.

A01ufig01

Potential Growth: Philippines

(In percent)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: IMF staff estimates.

  • Simple filtering approach. The Hodrick-Prescott (HP) approach is used as it is a common methodology that tries to decompose output into cycle and trend components. This approach is simple, as it requires only GDP as an input, but it suffers from the well-known “end-of-sample” problem and it also relies on a smoothing parameter that is chosen arbitrarily.

  • Production function approach. A simple growth accounting framework based on a production function is used to decompose potential output into its components (labor, capital, and TFP). In this approach, potential growth is estimated as the weighted sum of growth in potential labor and capital inputs combined with trend growth in TFP, specified as follows:
    ΔY*=αΔL*+(1−α)ΔK*+ΔTFP(trend)
    where Y* is potential output, L* is potential labor input, K* is potential capital input, and α is labor’s share of income.2 Although the approach also suffers from the same filtering problem as the HP approach, it has several strengths. One of the strengths is that it focuses explicitly on the supply capacity of the economy by using various data such as capital stock and employment. In addition, it allows analysts to identify the contributions of each of the sources of growth: labor, capital, and TFP.

  • Multivariate time-series model approach. A bivariate vector autoregression (VAR) that includes quarterly data on output growth and unemployment rate is estimated by following the approach of Blanchard and Quah (1989). This approach allows the economic variables to determine the strengths of the relationship among them (Congressional Budget Office, 2004).

C. Determinants of TFP: Empirical Investigation

3. The production function approach indicates that the sources of growth have changed somewhat in the Philippines in line with other ASEAN economies. While the contribution of labor has been relatively stable, the contribution of TFP growth has increased since the 1990s and the contribution of capital has declined. The rising contribution of TFP and falling contribution of capital are features that the Philippines shares with its regional peers.

A01ufig02

Potential Growth Contribution: Capital, Labor, and TFP

(In percent)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: IMF staff estimates.
A01ufig03

Contribution of TFP to Output Growth: ASEAN-4

(In percent)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: IMF staff estimates.

4. Understanding the drivers of TFP is important for analyzing economic growth as TFP plays an important role in sustaining long-term growth. Unlike the contributions of factor inputs, such as population growth and capital accumulation, that are subject to diminishing returns, improvements in TFP can persist over the long term and can make a lasting contribution to growth.

5. Economic analysis based on cross-country panel regressions is employed to examine the determinants of TFP growth. The empirical literature on the determinants of TFP growth emphasizes the importance of trade openness, human capital, and institutional quality (Asian Development Bank, 2010). Jaumotte and Spatafora (2007) argue that initial employment in agriculture also can have a strong impact on TFP growth. In addition to these variables, the analysis in this section considers countries’ initial level of per capita GDP and inflation, which are standard in the growth literature to capture the effects of convergence and macroeconomic stability (Barro, 1996, and Bosworth and Collins, 2003). Foreign direct investment is also included as an independent variable to capture the impact of technology diffusion. Accordingly, the regression equation is the following:

TFPit=ci+β*Iniit+σ*Infit+γ*Openit+δ*G0vit+ρ*Schit+Φ*FDIit+η*Secit+uit

where Ini is real per capita GDP in the initial year of each period, Inf is inflation, Open is trade openness, Gov is institutional quality, Sch is average secondary schooling years, FDI is the ratio of FDI to GDP, Sec is the share of agriculture to GDP, c is a constant term for each country, and u is the error term.3 A panel dataset of 52 countries over the period 1981-2005 is used, and cross-country fixed effects panel regressions are employed.4

6. The results suggest that higher institutional quality, better human capital, and a lower share of agriculture are correlated with TFP growth.5

  • Institutional quality: an improvement in the governance rating by 10 points is associated with a 0.3 percentage point increase in TFP growth.

  • Human capital: a one year increase in average secondary schooling years is associated with a 0.8 percentage point increase in TFP growth.

  • Share of agriculture in GDP: a reduction in this share by 5 percentage points (comparable to change during 1996-2005 in the Philippines) is associated with a 0.7 percentage point increase in TFP growth.

TFP Growth, Fixed Effects, Panel Regressions

article image
Note: T-statistics are in parenthesis: ***, **, and * indicate significance at 1, 5 and 10 percent.Source: IMF staff estimates.

D. Investment and Employment: International Comparisons

7. International comparisons regarding investment suggest that addressing the low level of investment in the Philippines would be critical for raising potential growth over the medium term. Both public and private investments have been anemic in the Philippines compared with other Asian economies. The ratio of public and private investment to GDP declined from 5 percent in the 1990s to 3 percent in the 2000s and from 17 percent to 13 percent during the same period, respectively. Although it is difficult to estimate individual countries’ optimal level of investment, given differences in economic structure, the capital-to-output and investment-to-output ratios in the Philippines are low relative to steady-state levels in 2008 (IMF, 2010a).

A01ufig04

Investment

(In percent of GDP, 2000-09 average)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: WEO database.
A01ufig05

Capital-to-Output and Investment-to-Output Ratio

(Relative to steady-state level in 2008)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Sources: Penn World Tables; World Economic Outlook; and IMF staff calculations.

8. Fiscal slippages and difficulties in the business climate in the past may have contributed to the relatively low level of investment. Cross-country comparisons suggest that there is a clear link between the revenue-to-GDP ratio and the public investment rate. The level of public investment has been low in the Philippines, owing to low public revenue, and the debt service burden has been high relative to other Asian economies. In this context, reversing revenue slippages would be critical to raise public investment over the medium term. Another important reason for low investment seems to be the business environment.6 The World Bank Doing Business 2010 suggests that the business environment in the Philippines continues to lag behind those in other Asian economies, particularly in terms of starting a business and protecting investors. Reducing the costs of doing business by streamlining business procedures and improving governance by tackling corruption and strengthening the legal system would be helpful to raise private investment.

A01ufig06

Link between Government Revenue and Public Investment

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: World Economic Outlook.
A01ufig07

Ease of Doing Business

(Ranking out of 183 countries by category)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: World Bank, Doing Business Survery (2010).

9. Although basic infrastructure in the Philippines has improved somewhat over the years, it continues to lag behind regional comparators in several dimensions. For instance, the Philippines still lags with respect to electricity generation, telephone lines, and paved roads. The lags in infrastructure owe in part to low public investment. In this context, the authorities’ intentions to rely more on public private partnerships (PPPs) in order to develop infrastructure could be helpful. As several studies suggest, improvements in basic infrastructure can have a positive spillover effect on private investment (IMF, 2010b).

A01ufig08

Electricity Generation

(In kilowatt hours per capita)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: World Development Indicators.
A01ufig09

Phone Connections

(Telephone lines per 100 people)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: World Development Indicators.

10. The high level of unemployment remains a challenge in the Philippines. Employment in the Philippines grew by nearly 40 percent from 1995 to 2009, and the pace of growth has been faster than other ASEAN-4 economies with the exception of Malaysia. Employment growth has not, however, been strong enough to reduce the unemployment rate substantially, partly due to the rapid increase in the labor force. The unemployment rate has been around 7–8 percent in recent years and remains high in comparison with other ASEAN economies. The underemployment rate also remains high at around 18 percent. 7

A01ufig10

Employment

(1995=100)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: CEIC Data Company Ltd.
A01ufig11

Unemployment Rate 1/

(In percent)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: WEO database.1/ National definitions may vary.2/ The definition was revised in 2005.

11. The relationship between output growth and the unemployment rate appears relatively weak in the Philippines. Okun’s law captures the relationship between these two variables, and the correlation has been historically weaker in the Philippines than in Malaysia or Thailand. The weak relationship suggests that there may be some structural issues in the Philippine labor market. One such issue could be the high proportion of self-employed workers and unpaid family workers, who account for around 40 percent of total employment. In addition, redundancy costs in the Philippines are relatively high, and hiring and firing practices are relatively heavily regulated (World Economic Forum, Global Competitiveness Report 2010-11). In this context, promoting labor market flexibility would be helpful to improve labor market efficiency. In addition, active labor market measures such as job training and search assistance, remedial education, and job creation targeted at helping younger people may be helpful to reduce mismatches in the labor market as well as to increase employment and raise its quality (Asian Development Bank, 2008).

A01ufig12

Okun’s Law: Philippines

(Change in unemployment rate, percentage points)

Citation: IMF Staff Country Reports 2011, 058; 10.5089/9781455219971.002.A001

Source: IMF staff estimates.

Labor Market Efficiency

article image

1 = impeded by regulations, 7 = flexibly determined by employers.

Source: World Economic Forum.

E. Reform Scenario

12. All three pillars of growth need to be strengthened to raise potential growth over the medium term. An illustrative reform scenario that would see potential growth rise to the authorities’ target of 7-8 percent could include the following elements.

  • TFP. Continued investment in human capital, improving institutional quality by tackling corruption, and moving up the value chain from agriculture into industry and services would be important. Based on the regression results, an increase in average secondary schooling years by 0.3 years, an improvement in the governance index rating by 7 points, and a further transition of economic activity from agriculture to industry and services by 3 percentage points could raise the growth contribution of TFP from 2 percent historically to 3 percent by 2015.

  • Investment. Fiscal reforms and improvements in the business climate that raise the investment rate from its historical average of 15 percent of GDP to 19½ percent by 2015 could raise the growth contribution of capital from 1 percent historically to 2 percent by 2015.

  • Employment. Continued growth in the industrial and services sectors would be needed for creating jobs over the medium term. Improvements in labor market flexibility and active labor market measures such as job training and search assistance would also be helpful to increase employment and raise the contribution of labor from historical averages.

Growth Contribution Under a Reform Scenario

article image
Source: IMF staff estimates.

F. Conclusion

13. This chapter provides estimates of potential growth in the Philippines and highlights the scope for raising growth potential over the medium term. Estimations based on different methodologies show that potential growth has risen to around 5 percent in recent years. Going forward, potential growth could be raised further toward the authorities’ 7-8 percent target by strengthening all three pillars of growth. In particular, international comparisons suggest that rebalancing growth by relying more on investment will be critical. Addressing the low level of investment will require reversing revenue slippages and improving the business climate and basic infrastructure. Raising investment will also help to create more job opportunities and will keep step with structural reforms such as improving institutional quality and moving up the value chain from agriculture into industry and services in order to boost TFP growth further.

References

  • Asian Development Bank, 2008, Asian Development Outlook 2008 (Manila).

  • Asian Development Bank, 2010, Asian Development Outlook 2010 Update (Manila).

  • Barro, Robert J., 1996, “Determinants of Economic Growth: A Cross-Country Empirical Study,” NBER Working Paper No. 5698 (Washington).

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  • Blanchard, O., and D. Quah, 1989, “The Dynamic Effects of Aggregate Demand and Supply Disturbances,” The American Economic Review, Vol. 79, No. 4, pp. 655–673.

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  • Bocchi, A., 2008, “Rising Growth, Declining Investment: The Puzzle of the Philippines,” World Bank Policy Research Working Paper No. 4472 (Washington).

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  • Bosworth, Barry, and Susan M. Collins, 2003, “The Empirics of Growth: An Update,” Brookings Papers on Economic Activity, Vol. 2003, No. 2.

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  • Congressional Budget Office, 2004, “A Summary of Alternative Methods for Estimating Potential GDP,” (Washington).

  • International Monetary Fund, 2010a, Regional Economic Outlook: Asia and Pacific, April 2010 (Washington).

  • International Monetary Fund, 2010b, Regional Economic Outlook: Asia and Pacific, October 2010 (Washington).

  • Jaumotte F., and N. Spatafora, 2007, “Asia Rising: A Sectoral Perspective,” IMF Working Paper No. 07/130 (Washington).

  • World Bank, 2010, “Doing Business 2010” (Washington).

  • World Economic Forum, 2010, “Global Competitiveness Report 2010-2011” (Geneva, Switzerland).

1

Prepared by Joji Ide (APD).

2

Capital stock is estimated by the perpetual inventory method, which defines capital stock in each period as Kt=(1−δ)*Kt−1+It where Kt is capital stock in period t, It is investment during t, and d is depreciate rate. Potential labor input is estimated by using data on population aged 15 years or over, labor force, employment, and mean hours worked.

3

The index of governance that reflects perceptions of corruption is used as a proxy to measure institutional quality. The index is compiled by the International Country Risk Guide. The share of agriculture value added to GDP from the World Development Indicators is used as a proxy to measure the transition of economic activity from agriculture to industry and services.

4

Non-overlapping five-year averages are used. The sample mainly consists of emerging and developing economies, but some advanced economies such as Korea are included. Time specific effects are not captured in this analysis. In terms of the individual country effects, the use of a fixed effects rather than a random effects model is justified by the Hausman test.

5

In addition, all variables have expected signs.

6

The relatively high share of the services sector may also explain the low level of investment in the Philippines. In fact, the share of the services sector has been higher than that in other ASEAN economies and increased from 47 percent in the 1990s to 54 percent in the 2000s. Bocchi (2008) points out that the growing businesses in the services sector such as the business process outsourcing (BPO) sector are less capital intensive than the industrial sector. However, the literature on the determinants on investment is inconclusive about the relationship between private investment and the shares of the industrial and services sectors (IMF, 2010b).

7

Employed persons who express the desire to have additional work in their present job, to have an additional job, or to have a new job with longer working hours are considered underemployed.

Same Series

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Cover IMF Staff Country Reports
Philippines: Selected Issues Paper
Author: International Monetary Fund
Volume/Issue:
Volume 2011: Issue 058
Publisher:
International Monetary Fund
ISBN:
9781455219971
ISSN:
1934-7685
Pages:
39
DOI:
https://doi.org/10.5089/9781455219971.002

Potential Growth: Philippines

(In percent)

Potential Growth Contribution: Capital, Labor, and TFP

(In percent)

Contribution of TFP to Output Growth: ASEAN-4

(In percent)

Investment

(In percent of GDP, 2000-09 average)

Capital-to-Output and Investment-to-Output Ratio

(Relative to steady-state level in 2008)

Link between Government Revenue and Public Investment

Ease of Doing Business

(Ranking out of 183 countries by category)

Electricity Generation

(In kilowatt hours per capita)

Phone Connections

(Telephone lines per 100 people)

Employment

(1995=100)

Unemployment Rate 1/

(In percent)

Okun’s Law: Philippines

(Change in unemployment rate, percentage points)