THE PHILIPPINES AND THE MIDDLE INCOME TRAP

by Cesar Polvorosa Jr.

Published in Philippine Star 2022

Joining the ranks of high-income countries is the holy grail of developing economies. The World Bank (WB) defines high income countries as having Gross National Income (GNI) per capita of $12,696 or more.

This universal aspiration came into sharp focus recently as the NEDA announced that the Philippines will aim to be a high-income country in two decades. This came on the heels of a prior announcement that the country will attain upper middle-income status or a GNI per capita income of at least US$4,096 within the next few years from the 2021 est. of $3,640.

Thus, the grand plan is for the Philippines to graduate to the ranks of upper middle-income countries as an intermediate step and then achieving the be-all and end-all of development of officially becoming a rich country.

Economic development is an arduous undertaking over decades yet, the Philippine story is especially exhibit A as a frustrating exercise in futility. The Philippines was identified as a leading Asian light together with Japan in 1960. By the end of the 1960s Japan became the world’s 2nd biggest economy while the Philippines fell behind the rising East Asian powers.

However, the Philippines was considered a potential Newly Industrialized Country (NIC) in the late 1970s. Then, the toxic confluence of debilitating external debts and behest loans, economic mismanagement and repression erupted into the upheavals of the 1980s with the nation reeling from the economic fallout of more than a lost decade.

During the Ramos administration in the mid 1990s the beguiling NIC dream re-emerged but was disrupted by the 1997 Asian Financial Crisis and the 2008 Great Recession. The term of Ninoy Aquino during 2010 – 16 achieved the highest sustained growth in 40 years and the country was hailed as a rising Asian Tiger economy.

However, it was crucial that robust growth and reforms would be maintained for at least another term. Unfortunately, while the world was indeed devastated by the pandemic the Philippine economy plunge in 2020 of – 9.6% was globally one of the worst. Now, Vietnam whose civil war only ended in 1975 is finally catching up in per capita income. The rising sun of the Philippine economy is a narrative of false dawns.

The development record in fact shows that majority of countries failed to graduate to the ranks of high-income economies and remain mired in the middle-income status though the Philippines had a distinct head start in the region dating back to the early 1960s.

The WB referred to it as the “Middle Income Trap” or the development situation where a country gets stuck in that middle income stage. Only 15 out of 101 countries escaped the middle-income trap during the period 1960 to 2010.

In the Asian region, these countries that escaped said trap include Hong Kong, Japan, South Korea, Singapore and Taiwan. The failure to ascend to high income status is usually attributed to the loss of national economic competitiveness.

These Asian countries that made it are all renowned export machines. Development is achieved by overall consistency in economic performance and outcomes which has broader and deeper roots that transcend simplistic economic explanations.

Arrested development: Avoiding the middle-income trap

Majority of countries fail to ascend to high income status over a period of several decades. Economies of Malaysia, Brazil and South Africa appeared to have plateaued. Unless Thailand which was very promising in the past few decades can bridge the fault lines in its society it is also a candidate for the middle-income trap.

Countries get snared in the middle-income trap as their existing economic models had lost their competitive edge. These causes include governance issues, dearth of innovations, productivity slowdown and inability to compete in overseas markets and to cope with the transition from labor intensive to capital intensive industries.

The economist Walt Rostow observed that economies evolve through distinct stages of development. Economies exhibit robust growth lasting several years in the third stage that is appropriately the “take off” stage before it coasts along in stage 4 (drive to maturity) and stage 5 (high mass consumption). The concern is that countries lose steam in stage 3 and growth sputter even before they become rich resulting in the middle-income plateau.

The existing Philippine development model can likely take the country to above average growth for the next few years but sustaining vigorous increases beyond that demand creativity and bold initiatives. In turn, this will extend the country’s take-off stage consisting of a rapid, sustained expansion that enables the country to achieve high-income status. So how can the Philippines avoid the middle-income trap?

A need for a new economic model

Philippine economic performance in recent years revealed that the 6-7% GDP growth range seems to be the maximum growth trajectory. In comparison, East Asian countries expanded 8-10% to achieve developed status within a generation.

Internally, the Philippine advantages are bountiful natural resources and a substantial and young population base – the demographic dividend creates a huge labor pool on the input side and domestic market on the output side that is likewise a double-edged sword if growth falters and jobs become scarce in the economy of the future.

Externally, the advent of the Fourth Industrial Revolution or the collective term for the current automation, and manufacturing technologies will usher in transformative change in the competitive position of countries in the global economy.

In the coming years the advances in 3D Printers, robotics, drones, driver-less vehicles, fintech, internet of things, VR, lab-grown food, AI etc. will foster greater automation and labor displacement. If the West, plagued with labor shortages are concerned with rapid automation, how much more for a labor surplus country like the Philippines?

The role of institutions

The institutional approach to development emphasizes the dynamics of the interplay of formal institutions (laws, regulations) with informal institutions (culture, norms) in shaping the economic and social outcomes of a country. Major contributions to the institutional approach were made by prominent economists Douglass North, Oliver Williamson, Ronald Coase, etc. Thus, entrepreneurship is encouraged through enabling laws, infrastructure and financing support, upholding property rights and will eventually engender an entrepreneurial culture.

Some of these policy interventions to avoid the middle-income trap for the Philippines that can be comprehensively analyzed using the institutional approach and are inter-related and mutually reinforcing include:

National dream/vision

The articulation of a National Dream or Vision serves to create an achieving society by inspiring people toward concerted action to achieve a common goal by fostering the sense of a shared destiny. Thus, the Chinese Dream is the restoration of past national glory and the achievement of fully developed nation status for China by 2049, the centennial of the PROC.

Japan and South Korea were invigorated by the challenge of making their countries rise from the ashes of war and achieve national glory that transcend materialistic achievements. The American Dream is prosperity founded on individualism and equal opportunity. But what is the Filipino Dream/Vision? There is in fact AmBisyon Natin 2040. How many Filipinos actually know and can articulate this vision?

Good governance and economic reforms

The Philippines had been battered by governance crisis and scandals during the past decades that spooked investors and derailed economic growth. It’s imperative that the country maintains good governance reforms through continuing prudent macroeconomic management, transparency and minimization of corruption, constraining political dynasties and achieving peace.

One characteristic of countries that escaped the middle-income trap had been the turn to sustained good governance that translated to economic progress such as Singapore, Taiwan, Hong Kong, South Korea and Japan but also in Europe, the cases of Portugal and Spain. Most of these countries had eschewed strongman rule and made resolute strides towards good governance as the path to economic progress.

Infrastructure

Horrible traffic jams in Metro Manila are just the tip of the iceberg of the terrible state of infrastructure in the country. The Philippine infrastructure deficit is the worst in ASEAN (IMF). How important is infrastructure in the country’s future?

A February 2016 IMF Working Paper (WP/16/39) has concluded that significant infrastructure investments in the Philippines can potentially lead its GDP growing at 10-11% per annum for the next several years – which was the growth rate of top performing Asian countries.

Infrastructure enhancements can include focus on digital technologies and preparing for extreme conditions in the era of climate change. In the coming decades there should be greater emphasis on clean and renewable energy for transport, industry, and smart cities.

FDIs and SMEs

Dismantling the oligarchy dominated oligopolies is futile with coexisting constraints for foreign investments and community-based SMEs and organizations. An investment friendly, micro- and SME-centered as well as social enterprises and NGOs development strategy will spread the fruits of development across regions, help resolve inequality and broaden the ranks of the middle class to form the core of the anti-poverty program. Eventually, a broader and more prosperous middle class will be better educated and leads to good governance.

Quality education

The edge for the economies of the future will be based on science & technology, engineering and math (STEM) education. This is especially the strategy of Japan, South Korea, and Singapore. As widely reported in media during the past few years the education performance scores of Filipinos in the PISA are among the worst in the region.

In fact, it’s not just STEM but a renewed focus on History as properly taught can instill national pride and collectively inspire people to work harder with greater determination. In 1987 Fallows argued that a “Damaged Culture” manifested in a lack of nationalism hobbled Philippine progress.

A combined focus on SMEs and STEM Education especially geared for the digital era can make the country a hotbed of innovation and entrepreneurial culture through the enhancement of human capital. Good education will mean intelligent voters who will choose better qualified leaders. As Walter Cronkite observed, “we are not educated well enough to perform the necessary act of intelligently selecting our leaders.”

Rebalancing of the economy, food security and industrial policy/strategy

While the economy is being geared toward greater export competitiveness it would be a prudent strategy to achieve a balanced domestic market and export-driven economy. Future low growth and volatility are expected to adversely affect export dependent economies. The Philippines as a large nation can deviate from the export dependent strategy of small nations like Singapore and Netherlands.

Another rebalancing is to develop manufacturing, which has the greatest labor absorptive capacity even as the country continues to excel in BPO and service sectors, shipbuilding, and IT. Rapid tech development in AI can become the challenge to the Call Center dominance of the Philippines in the near future.

An industrial strategy is to develop the most promising industries of the future tailored for Philippine capabilities and strategize the climb up the technology ladder to generate higher valued added products. Developing the agri sector by maximizing efficiencies all through the supply chain can achieve food security and become the steppingstone for becoming a Newly Agro-Industrialized Country (NAIC). Consistent likewise with the Green approach in infrastructure projects, there should be a focus on environmentally friendly technologies.

Realizing the preconditions for take-off

These proposals comprise the Preconditions for Takeoff which is the 2nd stage of the Rostow Model. Choose the right leaders and good governance will ensue and the other preconditions of quality education, infrastructure development, proper economic planning and strategies will converge and usher in a prolonged and robust take off stage that should catapult the country into developed status.

Ultimately, economic achievements are engendered by the enabling structures of society as presided over by sustained and determined good governance of capable leadership – whose elusiveness is the enduring and formidable development challenge of the country.

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Author Cesar Polvorosa Jr. is a business school professor of economics, world geography, and international business management in Canada. He is also a published writer in economics, business, and literature. Major sections of the article are updates from his 2016 Interaksyon article on Philippines in the Next Thirty Years.