Philippines Discussion Notes

Eric Le Borgne, Rosa Alonso I Terme, Karl Chua and Ulrich Lächler (EASPR)

The World Bank

February 10, 2010

1. 
   The Philippines exhibits important gaps in development outcomes vis-à-vis other countries in East Asia. Its economic performance improved markedly during 2000-08 relative to previous decades and in comparison to average world growth, but even so economic growth remained modest in comparison to the rates achieved elsewhere in the region (Table 1). Furthermore, while the rest of East Asia recorded strong progress in poverty reduction over the last decade, poverty indicators improved much more modestly in the Philippines. Meanwhile, income and consumption inequality continue to be among the highest in the region, and appear to be increasing.¹
   

2. 
   Regional comparisons on the evolution of social indicators show similar gaps, with the Philippines generally exhibiting positive, but more modest, advances than those recorded in neighboring countries. For example, the incidence of tuberculosis and the under-5 child mortality rate are both much higher in the Philippines than in the other large countries in the region with similar per capita income levels (Table 2). The key education indicators exhibit less variation than in health, but even here the Philippines tends to fall short compared to the sample mean.
   

3. 
   These performance gaps may be due, at least in part, to shortcomings in public spending. That is, the Philippines is either not spending enough or not spending efficiently enough in priority areas that are closely associated with growth and poverty reduction. Two generally recognized determinants of growth and poverty reduction during the developmental stage are the rates of physical and human capital accumulation. These rates typically depend on the amount of total spending on public infrastructure and on health and education services, as well as on the quality of such spending. Public spending has an important role to play in these three areas, which generally comprise the lion’s share of the total public sector primary budget.
   

4. 
   While large investment programs do not guarantee faster growth, inadequate investment is frequently identified as a bottleneck that prevents sustained economic growth. This appears to be a problem in the Philippines, which stands out vis-à-vis the other countries in East Asia, both in terms of exhibiting slower economic growth as well as a much lower level of total investment. While the comparator East Asian economies exhibited an average annual rate of capital formation of 26.2 percent of GDP during 2002-2008, the Philippines has only been investing around 16 percent of GDP (Table 3). Moreover, the total level of investment in the Philippines appears to have been declining since the end of the 1990s, raising questions about the sustainability of growth.
   

5. 
   The large gap between total investment levels in the Philippines and the amounts invested in the rest of the region is attributable to differences in both public and private investment spending. Table 4 shows that the average GDP-share of general government investment spending in the Philippines during 2002-08 (2.7 percent) was less than half the share in the other comparator East Asian economies (6.6 percent). A large gap has also developed on the side of private investment, which amounted to an average of only 12.5 percent of GDP in the Philippines during 2002-08, compared to 20 percent in the comparator East Asian economies.
   

6. 
   The declining trend in total investment spending exhibited by the Philippines is mostly due to declines in private investment,² though public investment also shows a decline (Table 3). Private investment also appears to have declined in the other comparator countries in East Asia, but to a lesser extent. This trend may be reflecting a less attractive investment climate in the aftermath of the East Asian financial crisis of 1997-98. In contrast to the Philippines, however, most of the other comparator countries have resisted declines in public investment spending.
   

7. 
   The Philippines exhibits similar public spending gaps vis-à-vis its East Asian neighbors in key social sectors. It devoted an average of 2.5 percent of GDP on public spending in education during 2002-07, and another 1.3 percent on public health in 2006, for a total of 3.8 percent of GDP (Table 5). In contrast, the countries in East Asia on average have been spending around 6.1 percent of GDP on both sectors. That is, they spend between 2 and 3 percent of GDP more on health and education than the Philippines.
   

8. 
   Another worrisome aspect of social spending in the Philippines is that it has been declining since the 1990s. In particular, between 1997 and 2008, total government spending (central plus local government, on an obligation basis) as a share of GDP declined by 50 percent in the health sector and by 36 percent in the education sector. This pattern is contrary to that observed elsewhere in the region and does not bode well for closing the gap in human capital accumulation that separates the Philippines from the other countries.
   

9. 
   The relatively low level of public spending on public infrastructure, education and health in the Philippines does not just reflect an allocational choice that discriminates against these priority sectors. It mainly reflects the relatively small size of primary public spending compared to that found in the other countries in East Asia (Table 6).³ The share of the non-interest central government budget devoted to the priority sectors is only moderately lower in the Philippines, even though the absolute share of GDP devoted to those sectors is significantly lower.⁴
   

10. 
    It is not readily apparent that the efficiency of public spending is significantly different in the Philippines from the rest of the region. This contrasts with the findings from the preceding section, which indicated that the Philippines devotes a significantly smaller share of GDP on public spending on infrastructure, education and health than other countries in the region. A traditional way of assessing the efficiency of total investment spending is by way of calculating Incremental Capital-Output Ratios (ICORs).⁵ Table 7 indicates that the ICORs observed in the Philippines over the last decade are not substantially different from the averages observed in the rest of the region or across lower middle-income countries worldwide. This measure does not permit us to isolate the efficiency of public versus private investment, but it does suggest that there are no major differences in the relation between capital spending and growth in the Philippines and in the rest of the region. That is, there is no apparent efficiency gap in investment spending.
    

11. 
    The Philippines also does not seem to exhibit notable gaps vis-à-vis its regional neighbors in the efficiency of public spending on health and education. Annex 2 compares the average efficiency scores for public spending on education and health in countries in East Asia based on data from 1996-2002.⁶ With respect to the education performance indicators, the Philippines exhibits an average efficiency rating of 0.59 using the input-oriented measures and of 0.71 using the output-oriented measures. These ratings are comparable to the overall EAP ratings of 0.60 and 0.66. A similar picture emerges on the health side, where the Philippines exhibits average ratings of 0.75 and 0.88 compared to the EAP averages of 0.73 and 0.91. Although there are a number of important caveats to keep in mind when dealing with these figures,⁷ the main outcome of these comparisons is that on average they do not yield significant differences between the efficiency of public social spending in the Philippines and in the other countries in the region.⁸
    

12. 
    Insofar as the shortfall in the Philippines’ development outcomes vis-à-vis the outcomes observed in the rest of the East Asia region are due to gaps in the size and efficiency of public spending, policymakers could expect to remove the shortfall by closing these public spending gaps. The broad-brush comparisons carried out above could not identify significant efficiency gaps separating public spending in the Philippines from spending in the other countries. However, they did identify some very large gaps in the size of public spending. In particular, Table 4 points toward a public investment gap on the order of 3 to 4 percent of GDP, while Table 5 points to a gap in public spending on education and health of between 2 and 3 percent of GDP.⁹ This yields a total public spending gap in these three priority sectors of between 5 and 7 percent of GDP. Closing this public spending gap will not be enough, however, to place the Philippines on a comparable footing with the other countries in East Asia, as Tables 3 and 4 also show a gap in private investment spending of 7 to 8 percent of GDP between the Philippines and the other comparator countries in East Asia. Closing the total investment gap, therefore, will also depend on significant increases in private investment that will in turn require substantial improvements in the investment climate.
    

13. 
    If policymakers hope to raise the development outcomes of the Philippines toward the levels attained elsewhere in East Asia, they will need to consider stepping up public spending by 5 to 7 percent of GDP, while introducing measures to improve the investment climate for the private sector.¹⁰ This is a very tall order for at least two reasons: first, because it would require an increase in public revenues by the same order of magnitude. The public sector debt in the Philippines is already quite high (over 60 percent of GDP at end-2009), which leaves little room for deficit financing, and especially not for deficits of these orders of magnitude. However, the government has been struggling hard just to prevent the total tax intake from falling below 14 percent of GDP, so raising the tax intake by the amounts being contemplated will not be an easy task.¹¹ The good news is that there are several important opportunities for improving tax policies and strengthening tax administration to raise tax revenues significantly, while rendering the tax system more efficient and equitable (see Philippines Discussion Note No. 3 (Tax Policy and Administration). The other important constraint that needs to be overcome in order to raise total public spending by the indicated amount are the current shortcomings in public expenditure and financial management. This is particularly important in view of the public sector’s chronic under-execution of the budget and lack of budget transparency. Here too, there are several measures that the government can take to improve its public financial management in order to accommodate a significant increase in public spending; see Philippines Discussion Note No 23 (Public Financial Management).
    

14. 
    To the extent that the government can generate additional fiscal savings through, say, a reduction in non-priority public expenditures, it would reduce the adjustment burden placed on the tax system. Identifying such potential savings is best done through comprehensive program analyses and the application of monitoring and evaluation mechanisms that still remain to be developed for most government programs in the Philippines. However, there are a few large expenditure items that merit attention as potential candidates for generating fiscal savings. One of these is the rice subsidy provided by the government through the National Food Authority (NFA). Another source of potential fiscal savings is the budget transfers to the other Government Owned and Controlled Corporations (GOCCs), other than the NFA.¹²
    

15. 
    The rice subsidies provided by the Philippine government through the NFA are fiscally expensive and very inefficient in reaching their intended beneficiaries (Annex 1). The total fiscal cost of these subsidies is projected to lie between 0.6 and 1.0 percent of GDP per annum in 2008-10, but only around 50 percent of these subsidies reach the poor. This means that the cost of the fiscal transfer reaching the poor is between 0.3 and 0.5 percent of GDP. Replacing the NFA by a well targeted, conditional cash transfer program that reaches the same sub-group of poor beneficiaries should therefore be able to generate fiscal savings of around 0.4 percent of GDP.
    

16. 
    The GOCCs represent another burden on the government budget. The actual budget transfers to the country’s 767 GOCCs turn out to be consistently higher than the amounts budgeted, and they have significantly increased over the past 10 years, to reach almost 1.3 percent of GDP in 2008 (Figure 1). The welfare rationale for these budget transfers is not clear, so the government might consider phasing out these transfers to the GOCCs, which could potentially yield fiscal savings of another 0.3 to 0.7 percent of GDP, in addition to any one-time privatization revenues.¹³
    

17. 
    Replacing NFA rice subsidies by a well-targeted social protection system and the elimination of budget transfers and other non-budget support to the GOCCs could yield potential savings of around 1 percent of GDP. That would reduce the additional fiscal revenue effort required to close the public spending gap in priority areas to about 4 to 6 percent of GDP.
    

18. 
    There is also room for reducing the required fiscal revenue effort even further through improvements in the efficiency of public spending, although the potential fiscal savings from this source are more difficult to quantify. While the earlier analysis concluded that the Philippines is not very different from other countries in the region in regard to the efficiency of public expenditures, there are opportunities for raising its spending efficiency beyond the regional comparators. That would help to close the development outcome gap vis-à-vis the other countries in East Asia by raising the development impact of public expenditures without having to raise their total amount. A good starting point for considering such efficiency-raising measures is by reviewing and correcting the shortcomings in public financial management identified in the recently concluded Public Expenditure and Financial Accountability (PEFA) assessment. One key area that warrants a close review in this context is the role of Special Purpose Funds, which have grown from under 20 percent of total budget in the late 1990s to 32 percent in 2009. These funds allow for significant discretion in public resource allocation and are not easily monitored, which seriously impairs the transparency of the fiscal budget.
    

19. 
    The preceding benchmarking exercise found that the Philippines exhibits a significant gap in development outcomes vis-à-vis other countries in East Asia. It also identified a total public expenditure gap of 5 to 7 percent of GDP in priority areas (public infrastructure, education and health spending), which the Philippines may have to close if it hopes to have a chance of raising its development performance to regional standards. Closing this expenditure gap would require increasing the public revenue effort by the same order of magnitude, except for possible fiscal savings that might be achieved through the elimination of non-priority expenditures or improvements in the efficiency of public spending. Two potential sources of fiscal savings are the rice subsidies granted through the NFA and the budget transfers made to other GOCCs. Replacing the rice subsidy with better targeted transfers and eliminating the transfers to GOCCs could reduce the total revenue gap to between 4 and 6 percent of GDP. These fiscal expenditure and revenue measures are summarized in Table 8.
    

20. 
    In closing, it is useful to keep in mind that every development experience has its unique aspects, so there would be no reason to expect the pattern of development in the Philippines to be the same as that of any other country in the region. For example, the development spurt experienced by Thailand and Malaysia during the 1980s and 1990s depended largely on the expansion of their export manufacturing sectors. The Philippines, in contrast, may exhibit more promising development prospects in the service sectors, building on its English-speaking population, rapid growth of Business Process Outsourcing activities and untapped tourism potential. If this turns out to be the preferred growth model for the Philippines, the most appropriate combination of public infrastructure and social spending is likely to vary from that observed in the other countries. It could, for example, warrant relatively more investment in education and telecommunications capacity, instead of public infrastructure investment in roads or energy generation. What stands out in the preceding benchmarking analysis, however, is that public spending in the Philippines has fallen short in all the priority areas. This suggests that there is an overall public spending gap to be mended, even as the precise composition of that spending gap remains a matter for further discussion.
    

with inputs from Eric Le Borgne, Yasuhiko Matsuda and Sheryll Namingit

EASPR

The World Bank

PHILIPPINES Discussion Note No. 5