OF SUBSTANCE AND SPIRIT
In one of the episodes of Karen Davila’s ANC talk show about three weeks ago, former NEDA Director General and Socio-Economic Planning Secretary “Mareng” Winnie Monsod clarified a few important points critical to the issue of Charter Change. First, she questioned whether the remaining economic sectors of educational institutions, mass media and advertising sectors, if liberalized, could truly herd foreign direct investments (FDI) into the Philippines in a big way. Second, while she agreed that the 1987 Philippine Constitution could stand some amendments, the timing could be more appropriate. This is not the time to do it because in the first place, she argued, no hard evidence or research has been presented that liberalizing a few remaining economic sectors could spark enormous interest in the country’s investment prospects.
To support her arguments, she cited in particular the work of Bangko Sentral ng Pilipinas’ (BSP) Hazel Parcon-Santos to show that there are essential ingredients to the positive decision of foreign direct investors to invest here other than allowing full foreign ownership of business and liberalizing the terms of engagement. We know Hazel because she worked with us on various research projects that she handled with excellence at the BSP’s Center for Monetary and Financial Policy.
She has two major publications, both of which dwelt on the issue of foreign direct investment. The first one was published in 2014, “Trade and Investment in the Philippines.” This paper is basically a review of the literature. She discussed the evolution of the country’s trade policy and its impact on the various sectors of the economy, stressing the positive impact of trade liberalization on productivity, economic growth, and on the environment and efficiency but with mixed results on income distribution and poverty as well as on the labor market.
On foreign direct investment, Hazel recognized that developing countries in general are short of both capital and access to international financial markets. Such countries attract foreign capital by offering various types of incentives in order to achieve capital accumulation. She pointed out the constitutional restrictions in certain industries in the Philippines — mass media, small-scale mining, private security agencies and the manufacture of firecrackers and pyrotechnic devices, among others, including domestic air transport, public utilities and pawnshop operation. Of course, with the reforms after the 1990s, in many of these sectors foreign participation has been mostly decontrolled.
What is more interesting is the one whole section she devoted on the determinants of FDI. Tracing through the literature, she identified the various factors that attracted FDI: general policy of openness, strong macroeconomic fundamentals, economic recovery and political stability.
There are also negative factors including militant labor unions, inadequate technical and vocational skills, high cost of unskilled labor compared to Indonesia, Vietnam and China, weak labor productivity, poor infrastructure and lack of competitive support industries.
She also cited various works that found that there are three categories of government policies that affect FDI in general. The first category includes investments in infrastructure and industrial power supply, as well as wage and productivity. The second category includes tax structure and administration as well as fiscal incentives and FDI restrictions and limitations. And the third category includes membership in bilateral investment treaties and economic partnerships. All these promote FDIs.
An early study by the Asian Development Bank (2005) in four manufacturing sectors, Hazel quoted, showed that macroeconomic stability, corruption, electricity, tax rates and economic policy uncertainty are the top five concerns of FDI proponents. Another study found that fiscal incentives are not significant and that public resources should instead be deployed in productivity-enhancing goods like education and infrastructure.
The second paper of Hazel was done in 2021 and resurrected on Sept. 26, 2023 in the form of a research blog in collaboration with other BSP staff namely, Maria Rica Amador and Marie Edelweiss Romarate. The 2021 paper casts its query in a competitive mould, that the five members of the Association of Southeast Asian Nations (ASEAN) Indonesia, Malaysia, the Philippines, Thailand and Vietnam would have to compete for FDIs by improving their investment environment as they aspire to recover from the health pandemic. Using Nikolaas Tinbergen’s gravity model (1962), they found that FDIs respond to various factors, both economic and non-economic: sovereign credit ratings, corporate tax rates and FDI restrictions, quality of human capital, and public governance.
One important aspect of the paper is captured by a chart in the study showing that the Philippines in 1997 was the third most restrictive among the ASEAN 5, after Vietnam and Malaysia. In 2019, Vietnam was the most open of the five, with the Philippines coming in last. But all ASEAN five between 1997 and 2019 brought down many of their regulatory restrictions on FDIs.
In their review of the empirical literature, the BSP research staff extracted the various factors driving FDIs such as locational advantages of host countries, market size, cost and quality of labor, economic openness, and quality of governance and business regulations.
Focusing on the ASEAN-5, the initial observation was that “as of end-2019, Thailand has the highest inward FDI stock from the 15 source countries, while the Philippines has the lowest.” At various desirable levels of FDI determinants, the Philippines was particularly characterized as the economy with the highest corporate tax rate and FDI equity restrictiveness index; highest perception of corruption, the lowest rule of law index, overall ease of doing business and road quality index.
One key empirical result in the ASEAN-5 shows that “the overall FDI restrictiveness index is statistically insignificant for all investors when macroeconomic stability, governance, ease of doing business, and quality of infrastructure are accounted for.” The BSP researchers also concluded that FDIs have different sensitivities to different FDI restrictions, they cannot be generalized as if liberalizing one aspect could produce wholesale migration of foreign capital. For instance, Asian FDIs do not seem to be prevented from investing in the ASEAN-5 by restrictions on employment and approval mechanisms.
To strengthen their finding on FDIs restrictions, they used instead alternative specifications of economic openness, like capital account openness, instead of FDI restrictiveness index. Based on the so-called Chinn-Ito index, this proved statistically insignificant, too. However, joining bilateral trade treaties and economic partnership is positive for FDIs and statistically significant.
The concluding paragraph of Parcon, Amador and Romarate should not be surprising: “…there is no factor that can single-handedly attract FDIs.” Both economic and non-economic factors are important, that breaking the barriers in tax and FDI restrictions will not be sufficient if the investment climate is rather weak. Critical, holistic policies have to be constantly enhanced on efficient business regulations, quality of public governance and infrastructure and the availability of appropriate human capital.