Philippine economy: Headed for the middle-income trap?

Posted on Posted in 2018-2019, News

 

Illustrated by: Ivan Bueno

Article written by: Lorenzo G. Coloquio

 

The Philippines is considered to be one of the world’s fastest-growing economies in recent years. However, some worry that this growth will not last forever. Many institutions, the Asian Development Bank (ADB) among them, think that the Philippines may be headed to what some call the “middle-income trap”.

The “middle-income trap” is an economic term for a country whose GDP growth rates slow down substantially when it has a GDP per capita between USD 10,000 – 15,000. From the 101 middle-income countries during 1960, only 13 of those transitioned to  high-income economies by 2008. There are many factors that economists say lead to this middle-income trap. One factor is the lack of transition from factor-based to innovation-based growth. In other words, countries that are stuck in the middle-income trap are unable to transition from creating and exporting cheap goods to innovating and  producing high-quality products.

According to “Escaping the Middle-Income Trap : Innovate or Perish”, a paper by Eva Paus, the adoption of better technologies by high-income countries puts more pressure on middle-income countries to do the same in order to produce more and better goods. This, combined with policies that favored foreign producers, led to the middle-income trap affecting various countries in Latin America. This is because middle-income countries are losing their comparative advantage to high-income countries when it comes to producing goods, and therefore have no choice but to innovate. Therefore, science and technology investment is necessary for a country to escape the middle-income trap.

Corrupt and personality-based political institutions are another factor that many countries in the middle-income trap have in common. One example of a country currently in the middle-income trap is Brazil, which has been mired in political instability, income inequality, high cost of doing business, and low investment in creating new technologies. Countries that have made the transition from middle-income to high-income economies have seen their corruption levels decrease significantly before making that jump. These decreases in corruption levels were often brought by the introduction of new anti-corruption policies.  

Countries stuck in the middle-income trap, however, have not done the same switch. The decrease of corruption is usually attributed to the switch from the “rule of man”, where personality politics and patronage plague political and social institutions, to the “rule of law”, where political and social institutions are driven by rules rather than people.

Another factor that usually leads to a country being stuck in the middle-income trap is income inequality. Income inequality for middle-income countries usually means that access to education is limited to the elite, which, in turn, limits the growth of skilled human capital needed for innovation. Income inequality also hinders the adoption of pro-innovation policies if these policies threaten the position of the political and economic elites. Law-based institutions also lead to the creation of a competitive private sector which can compete internationally. Strengthening a country’s institutions involves removing vested interests in companies that promote patronage so that they are forced to compete in a more fair playing field.

Now, the Philippines has been a lower-middle income country for quite a while, and it is poised to become an upper-middle income country by 2019 according to the World Bank. In the field of innovation, it seems to lack the adoption of innovative policies and investment needed to escape the middle-income trap.

The Philippines’ investment on Research and Development has stagnated at 0.14% as of 2016. One example of a field that is affected by this underfunding is agriculture. Spending on agricultural R&D is at a measly 0.4% of the total agricultural budget, way below the 1% average in developing countries and 2-3% in developing countries. Agricultural research is also often limited to a few crops like corn and rice. This limited and underfunded research results in crops facing the same problems (floods, pests, etc) every year.

Former NEDA Chief Arsenio Balisacan says that in order for us to sustain long-term economic growth, our science and technology investment should be at least 2 percent of the national GDP, similar to other Southeast Asian countries. From this, it can be inferred that our lack of investment in innovation could lead us to the middle-income trap.

The Philippines also has a Gini index of 40.1 This is comparable to countries like Indonesia and China. This means that while the Philippines may be doing better than countries in Latin America and Africa in this respect, it still has a long way to go to curb economic inequality. Curbing this economic inequality will help create more skilled workers, thus making our economy more innovative.

Another sign that the Philippines might be headed to the middle-income trap is the Philippines’ corrupt political institutions. The Philippines is ranked 111 out of 180 in the Corruption index. This means that the Philippines’ political institutions are considered to be corrupt and plagued with vested interests and thus runs contrary to the principle of “rules-based” institutions common in many countries that escaped the middle-income trap. This can be seen in the 33,772 corruption cases from 1979 to 2016, or an average of 912 corruption cases a year.

While reports on the Philippine economy have lately been optimistic, with high GDP growth rates and more foreign investment coming in, it still has a long way to go before it can be on track to becoming a high-income country. Fixing its political and economical institutions as well as investing in technology for innovating the country are a few steps that are needed in order to put itself on the road to long-term growth. In these nation-building steps, we can create a better and more prosperous Philippines for a better tomorrow.

 

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