philippine industrialization

7/27/2019 Philippine Industrialization

1/22

INDUSTRIALIZATION, POLICY, AND GROWTH:

The Philippines versus East Asia*

Jamil Paolo S. Francisco

Department of EconomicsSchool of Social Sciences

Ateneo de Manila University

March 2008

*Draft only. Not for citation.


2/22

The story of Philippine industrialization started well. Rich in both natural and human resources, with then

arguably one of the highest educational standards in the developing world, and with privileged access to the U.S.

economy, the Philippines seemed well-equipped to meet the challenges of development as a newly-independent

nation in the late 1940s. As the story progressed however, it became mostly disappointing. Both the country and its

industrial sector were early leaders in East Asia, but neither has lived up to expectations.

Figure 1.1Growth of GDP and Industrial Output

This is in stark contrast with most of the countrys neighbors whose starting positions were less favorable

but now enjoy per capita income levels much higher than that of the Philippines. The economies of Korea, Thailand,

Malaysia, Taiwan and Singapore are notable examples. For instance, from being one of the poorest countries in the

region, South Korea has become an industrialized OECD-member country in a little more than three decades.

Objectives

This paper reviews the path of Philippine economic history and the direction of government industrial policy

from the 1960s to the present. A host of determinants are examined in an attempt to identify factors, from the

traditional to the controversial, to which the countrys poor performance can be attributed. Towards the end of the

paper, an empirical study is used to support the hypotheses offered. The papers research objectives are as follows:

To review the path of Philippine industrialization and examine industrial policies in comparison with selected

developing and newly-developed economies including but not limited to South Korea, Malaysia, and Taiwan.

To identify specific growth determinants that have contributed to the miracles of East Asia and assess the

Philippine performance with reference to these factors.

To provide an empirical analysis in support of the growth determinants hypothesized in the discussions.


3/22

Trends in Industrial Output and Growth

A sizeable manufacturing sector had formed in the 1950s and 60s, partly due to protectionist, import-

substituting policies, supported by a well-developed human capital base (Hill, 2003). In the late 60s, a policy shift

towards export-orientation began to realize but the poor performance during the last 30 years seems to indicate that,

since then, industrial policy has been either misguided, ineffective or lacking. Since the late 1960s, the growth of the

manufacturing sector has been slow and its GDP share has persistently remained below 30%. Domestic

manufactures continue to be mostly low-tech; and exports, although recently rising, have become increasingly

concentrated in one particular product group (electronics) where the sectors value-added is low.

Figure 1.1 reveals how an erratic growth path at comparatively low levels may have kept the country

from reaching its full potential. The 1980s, for example, had essentially been a lost decade for the Philippines.

The massive inflows of FDI during the period that led to rapid industrialization in the countrys neighbors such as

Thailand and Malaysia had skipped the Philippines, which then faced huge political and economic challenges. It was

during this decade that the country experienced its worse recession, with GDP shrinking by almost 10% for two

consecutive years. The debt-driven pump-priming strategy adopted in the previous decade proved to be

unsustainable as signs of trouble began to show in the early 1980s a growing balance-of-payments deficit,rising inflation, worrying budget deficits, and deteriorating market confidence . In 1983, the assassination of

Benigno Aquino in late August precipitated economic collapse, and the rest is history so to speak.

Industrialization has been characterized by a similar persistent boom-bust cycle, reflecting the overall

economys performance. The fact that movement in industrial output seem to have closely followed fluctuations in

total output can be attributed to the local manufacturing sectors predominantly inward orientation, which has made it

mostly dependent on domestic demand. It is also worth noting how swings in industrial output growth have been

more pronounced in every fluctuation of GDP growth a sign of stickiness between output trends.

Reflecting its comparatively high initial income per capita and early push for industrialization, the Philippines

had a relatively high share of manufacturing in the 1960s. Figure 1.2 reveals, however, that Philippine manufacturing

share in output had remained almost unchanged in the last 30 years; whereas that of Korea and Malaysia had

steadily increased until leveling off in the late 1980s and early 2000s respectively. Taiwans manufacturing share of

output, on the other hand, has been declining after reaching its peak in the late 1980s.

Figure 1.2Manufacturing Share in Total Output for Selected Asian Countries


4/22

Korea, Malaysia, and most especially, Taiwan appear to be classic examples of Chenerys model of

structural transformation from agricultural production to manufacturing and finally on to services as a

country progresses. On the other hand, a closer inspection of Philippine data seems to test the possibility of

leapfrogging from agriculture to services despite incomplete industrialization.

Figure 1.3Relative Shares of Agriculture, Industry, and Services

Theories on development, such as Lewis two-sector model predict the structural shift away from the

agricultural sector and towards the modern industrial sector. The Philippine case seems to be an exception however,

since the share of industry has remained at more or less the same level, in spite of the decline in agriculture (Figure1.3). Meanwhile, services now account for more than half of total production. The absence of a rapid and sizeable

structural shift to the industrial sector is unique to the Philippines in the context of its South East Asian peers (Hill,

2003). It is also rather troubling, given the correlation between manufacturing share and GDP growth. Rodrik (2006),

in a comparison of trends in manufacturing shares across five regions (East Asia, South Asia, Latin America, the

Middle East and North Africa, and Sub-Saharan Africa) shows that the countries that have been growing most rapidly

were those with large manufacturing sectors. Data from recent years reveal the continuing high-growth trend in the


5/22

industrial sector of most of the countrys neighbors and the Philippines relatively poor performance. Figure 1.4

shows growth rates of industry for selected countries between 1999 and 2004.

Figure 1.4Growth Rates of Industry for Selected Asian Countries

De-industrialization and the shift to services is expected in high per capita income countries like Korea,

Taiwan, and Singapore but not in low per capita income countries like the Philippines. Figure 1.5 places Philippine

per capita income in its regional context.

Figure 1.5Real GDP Per capita of Selected Asian Countries

Hill (2003) offers three explanations for the industrial sectors stagnation . First, he argues that trade

liberalization in the 1980s through the 1990s provided average nominal protection rates to agriculture that exceeded

those in manufacturing, creating a resource allocation bias against manufacturing. Following these reforms, the

industrial sector had become increasingly labor-intensive, contributing to a fall in value-added. A second factor,

according to Hill was the real appreciation of the peso through the 1990s up until the Asian financial crisis. This real


6/22

appreciation was due to small nominal appreciations of the local currency plus higher inflation in the countrys major

trading partners. The overvalued peso reduced the competitiveness of Philippine manufactures. Finally,tightened

labor market regulations pushed wages upward in the formal sector so that relative wage levels in the Philippines are

now considered high compared to those of its neighbors, again also affecting competitiveness.

Export Structure and Growth

In 1960, the value of Philippine exports was a third more than that of Malaysias, four times that of

Thailands, and about twenty times that of Koreas. By 1990, however, it was clear that the countrys exports had

lagged far behind the late-bloomers. In 2005, the value of Korean exports was more than 6 times as much as the

Philippines, Malaysias exports nearly three times as much, and Thailands exports twice as much. As a result of

slow export growth, the level of Philippine exports has remained below that of many of its neighbors since the early

1990s (figure 1.6). Figure 1.7 shows export growth among Korea, Malaysia, and the Philippines. The trend line for

the Philippines reveals a flat trend at low average growth at around 6 to 7% for the period 1960 to 2006.

Figure 1.6Export Levels of Selected Asian Countries

Figure 1.7Export Growth of Selected Asian Countries


7/22

Although export growth has generally been slow and erratic in the last 40 years, the early to mid-1990s saw

seven consecutive years of positive growth, growing above 10% for four years. This significant acceleration has been

mainly attributed to the infusion of foreign-owned electronics investments in export zones. Total value of exports in

real terms more than doubled between 1990 and 1997. So tremendously successful has the electronics export sector

become that it now dominates Philippine exports (merchandise), with electronics and machinery accounting for close

to 70% of total export value in 2005. Although Malaysia and Korea are also heavily dependent on electronics exports,

neither compares to the Philippine case.

Figure 1.7Export Dependence on Electronics and Machinery of Selected Countries (2005)

Over the period 1990-2000, total exports increased nominally by US$30.3 billion, manufactured exports rose

by US$28.2 billion, while electronics and machinery increase by US$28.5 billion, meaning export growth was mainly

led by manufactured exports, and among manufactured exports non-electronics exports actually declined slightly. It is


8/22

sometimes argued that high concentration on a narrow product group, particularly electronics is an inherently risky

activity that does not provide the basis for sustainable, broad-based industrialization. For one, the electronics sector

is said to be characterized by shallow linkages with the rest of the economy and is therefore prone to migration as

soon as real labor costs begin to rise or fiscal incentives expire. Although the electronics industry covers a broad

spectrum from labor-intensive, low value-added activities to high-skill, research-intensive ones, Philippine

manufacturing activities have remained at the labor-intensive, low-value added end of such spectrum.Semiconductors are by far the largest item among the countrys electronics exports. Unfortunately, semiconductor

manufacturing in the country is essentially an import-export operation, where local value-added is thin, backward

linkages are not fully developed, and R&D contribution is negligible (Hill, 2003). A second, perhaps more

fundamental concern is that such high export dependence on a narrow product group is contrary to the common

pattern of outward-oriented industrialization in East Asia.

Imbz and Wacziarg (2003) examined patterns of sectoral concentration in a large cross-section of countries,

as well as within countries over time, and discovered that as incomes increase, economies become less

concentrated and more diversified in production. Only upon reaching relatively high levels of income does further

growth become associated with increased specialization. In other words, a graph of sectoral concentration versus

income per capita produces a U-shaped curve. From this point of view then, Philippine dependence on electronicsexports may be problematic. Rodrik (2006) puts it bluntly: diversification is a key correlate of economic

developmentpoor countries produce a relatively narrow range of goods, while richer countries are engaged in a

broad range of economic activities.

Unlike many of its better-endowed neighbors, the Philippines had lost its comparative advantage in most

resource-based industries (Hill, 2003). Figure 1.8 below illustrates how the countrys exports had shifted from

primarily unprocessed metal, sugar, and wood products towards electronics and machinery. However, the countrys

performance record in other labor-intensive industries, apart from electronics, has also been disappointing making

the success of the electronics sector an oddity. Hill offers a plausible explanation. The answer appears to lie in the

countrys export policy regime. Electronics has succeeded because of very liberal provisions applying to the export-

processing zones, where most foreign-owned electronics investments have poured in. Firms in these specialeconomic zones enjoy no foreign ownership restrictions, minimum bureaucratic hurdles, attractive fiscal incentives,

adequate utility services, and quick access to international markets. In other words, electronics firms are spared from

the constraints that have generally held back firms in the rest of the economy.

The success of the Philippine electronics sector is no doubt an example of successful industrial policy in

terms of picking winners at least in terms of providing incentives to export manufacturers that are allowed to

locate themselves in the particular export-processing zones. Picking winners has resulted in mixed outcomes for the

Philippines with a number of disappointing stories. In the late 1960s, the government sought to promote the countrys

automotive industry through a special program that offered heavy protection to up to five local assemblers that were

expected to steadily increase local content through subcontracting. As it turned out, anticipated technological

transfers did not occur and subcontracting networks failed to proliferate (Hill 1985), but vested interests thereafter

developed to maintain protection. In 1990, the cost of protection was equivalent to about 40% of the value of motor

vehicles sold to consumers (Takacs, 1994). Despite its early lead, the Philippines had lost the auto industry to

Thailand, which has become the regions leading automotive manufacturer.

Figure 1.8Shares of Selected Items in Total Philippine Exports


9/22

In the famed article by Hausmann, Hwang, and Rodrik (2005), an index of the income level of a countrys

exports is constructed, and is made to demonstrate how the mix of goods that a country produces has important

implications for economic growth. The index basically measures the quality of each countrys export basket. The

study concludes that countries that produce a set of goods that are placed high on the spectrum tend to perform

better than the ones that produce a lower quality of goods. Using an index of export productivity (EXPY)

developed by the author closely following Hausmann, Hwang, and Rodrik, the Philippines appears second on the list

in terms of export productivity among 12 selected countries in East Asia, and South and Central America. It may be

to the surprise of many to see the Philippines receive one of the highest scores, suggesting that the country must

then be one of the better performers.

Table 1.1Export Levels of Selected Asian Countries

Country EXPY Country EXPY

Korea 11,814.51 Brazil 8,660.06

Philippines 11,502.12 India 8,337.84

Malaysia 10,974.02 Indonesia 8,193.36

China 10,785.95 Argentina 7,619.88

Mexico 10,758.99 Chile 7,182.38

Thailand 10,613.77 Vietnam 6,836.39

A closer inspection of the export structure of countries provides valuable insight to the physical make-up of

exports. In the analysis that follows, items are categorized into four groups: group I being the lowest, composed of

low-income/low export productivity goods such as sugar, coffee, cereals, and beverages, and group IV being the

highest, including goods such as medical products, precision equipment, machinery, and electronics (for a complete

list of groupings, please refer toAppendix A). Since Philippine exports have been dominated by electronics and

machinery, it is no surprise that group-IV items now make up about 70% of the countrys total exports. Figure 1.9

shows the export structure of the Philippines (a), Korea (b), and Malaysia (c). These three countries have the highest


10/22

group-IV concentrations of exports among those studied. In plain words, these three countries have the most hi-

tech exports goods that have been mostly associated with high-income countries.

Figure 1.9Structure of Exports


11/22

Like the Philippines, the export sectors of Korea and Malaysia are dominated by group-IV items, mostly

electronics and machinery. But, there is no contention that unlike Korea and Malaysia, the Philippines is a low-

income country, and the countrys growth performance has been anything but remarkable. In 2006, Korean real GDP

per capita (US$13,865) was twelve times as much as Philippine per capita income (US$1,175); Malaysias was four

times as much (US$4,623). Per capita income growth from the period 1965-1995 averaged 7.2% in Korea, 4.8% in

Malaysia, but only 1.2% in the Philippines. Does the Philippine case then present a challenge to the correlation

between export mix and economic performance observed by Hausmann, Hwang, and Rodrik? An examination of the

structure of domestic manufacturing is presented in the discussion that follows.

Domestic Manufacturing and Industrial Policy

Closer examination of domestic manufacturing reveals how the structure of Philippine exports is nothing like

that of the manufacturing sector that comprises it. In contrast to how group-IV manufactures dominate the export

sector, group-IV manufactures account for only 20% of the total value of domestic manufacturing. Meanwhile, group-Imanufactures constitute more than half. Food, Beverage, and Tobacco has continued to dominate domestic

manufacturing since the 1960s, accounting for 45% of domestic manufactures in 2006.

Figure 1.10Structure of Philippine Manufacturing Sector


12/22

The dissimilarity between the countrys export sector and its manufacturing industry is a peculiar case

indeed. In Korea, Malaysia, and Taiwan, the structure of domestic manufacturing is similar to that of the export

sector; with group-IV items dominating domestic manufacturing (refer toAppendix B). The inconsistency of the

Philippine case raises a number of questions. How can the export sector thrive in high tech manufacturing while the

rest of local industry continues to be dominated by low tech production? Why has the share of domestic industry

languished while export manufactures (electronics) have led the growth of export share in total output in the last twodecades? What is behind the success of electronics exports? What is behind the failure of domestic manufacturing?

What role has industrial policy played?

Johnson, Ostry, and Subramanian (2006) examined cases of growth acceleration and found that nearly all

cases took place in the midst of a rapid increase in the share of manufactures in total exports. Jones and Olken

(2005) found that accelerations were associated with increased manufacturing share of total employment.

Neoclassical explanations of rapid growth in East Asia emphasize the role of sound fundamentals capital

accumulation, macroeconomic stability, and outward-orientation with few price distortions. The World Banks report

on the East Asian Miracle (1993) acknowledged the important role played by governments in Japan, Korea, Taiwan,

and other Asian economies in getting the basics rights, along with interventions that promoted exports and

encouraged savings and investment. Governments were said to have intervened heavily but in a market friendlyway. One of the supposed secretes of success of the Asian tigers was the willingness and ability to adjust policy to

meet the changing needs of their growing economies.

Most of the debate about industrial policy in East Asia has centered on the seemingly unique ability of

governments to identify strategic industries and allocate scarce resources towards them (Hernandez, 2004). These

industries are usually those considered to have high export potential or high learning spillovers. The promotion of

specific sectors changed the industrial structures of Japan, Korea, and later on, Taiwan. For example, the success of

steel, shipbuilding, automobiles, and electronics in Korea has been attributed to successful government industrial

policy. Nevertheless, there also have been disappointments such as the automotive industries in Malaysia and the

Philippines. The soundness of picking winners certainly has been a point of contention but most economists agree

that efforts to promote specific industries are unlikely to be successful without first getting the basics right. With fewexceptions, East Asian economies have been successful whether because of or in spite of government intervention

largely because of their fundamentals macroeconomic stability, investments in human capital, and adequate

infrastructure. Hernandez (2004) cites the Philippines as an example of how picking winners could be unsuccessful

without the right fundamentals in place.

Determinants of East Asian Growth

Capital accumulation is the primary key to growth in the neoclassical perspective. It is no surprise that most

of the growth in East Asia during its miracle years has been attributed to this. Figure 1.11 shows how Philippine

capital formation as a percentage of real GDP has seriously lagged behind that of its neighbors. The average in thelast 20 years has been less than 23%, and in 2005, capital formation share of total output was as low as 16%.

Figure 1.11Capital Formation as Percentage of GDP for Selected Asian Countries


13/22

It comes as no surprise though that capital formation in the Philippines has been weak, given that the

countrys savings rates have been anemic, well below East Asian standards (figure 1.12). Much of the countrys

economic activity has for many years been mostly consumption-driven. Investor confidence has generally been low,

especially plagued by corruption concerns and bureaucratic red tape. Partly to blame as well may be the countrys

chronic fiscal deficits. Unlike the governments of most of its high-growth neighbors, successive Philippine

governments have almost always been net borrowers.

Also to blame may be the fact that the Philippines had not experienced long periods of sustained growth

similar to that experienced by each of East Asias best performers. Political instability in almost every decade since

independence has exacerbated the cyclical nature of the countrys economic performance. In a study by Harrigan

(1998), high savings rates were seen to invariably follow periods of sustained growth. Figure 1.1 at the beginning of

this report illustrates how growth has been erratic since 1980, with boom-bust cycles occurring every 4 to 5 years.

Figure 1.12Savings Rates across Selected Asian Countries


14/22

Investments in skills and infrastructure explain a great deal of how Japan, Korea, Taiwan, China and

Singapore moved up the technology ladder (Hernandez, 2004). . The governments of these economies pursued

policies to promote the development of high-tech sectors such as electronics and semiconductors. Along with these

investments of course, came new technologies and learning opportunities. Japan and Korea especially relied on

licensing and reverse engineering to access foreign technology. Large industrial conglomerates like the chaebol in

Korea were given subsidized credit, protection from imported goods, and fiscal incentives. Discipline, however, was

attached to the protection afforded them by government. Firms were required to report their performance regularly,

so the government had up-to-date information of the developments in each sector. Government support often

depended on export performance. Individual firms that met export targets were given more favorable treatment

(Hernandez, 2004). In Taiwan, on the other hand, public research institutions played a larger role in promoting new

technologies and coordinating industry-specific R&D. Singapore, meanwhile, relied heavily on FDI to bring in bothforeign capital and foreign technology. However, it was not enough for Singapore to simply attract FDI; it also sought

to increase the ability of local firms and workers to absorb new technology through domestic linkages and on-the-job

training. Soon, the agency in charge of attracting foreign investments began to focus on increasingly more

sophisticated technologies.

As local economies progressed, research and development began to provide the key to sustained growth in

East Asia. The flying geese hypothesis postulates how countries shift from labor-intensive to capital-intensive

industries as real wages begin to rise and developing countries begin to lose their comparative advantage in cheap

labor. This was seen in Korea and Taiwan following Japan, and then in Malaysia and Singapore following Taiwan

and Korea. By the time developing economies reach the turning point, simply borrowing technology from developed

countries becomes inadequate. R&D then begins to play an important role in developing new home-growntechnologies. Figure 1.12 below shows estimates from various sources of R&D expenditure as a share of total output

for selected countries in different years between 2002 and 2004.

Figure 1.12R&D Share of Total Expenditures for Selected Countries


15/22

Source: Nationmaster.com

Philippine R&D expenditure is estimated at a mere 0.11% as of 2002. It is argued, however, that since the

Philippines has yet to reach its turning point, it still has the luxury of being a technology borrower (Hill, 2003).

According to Hill, more than worrying about research and development spending, the government should focus on

removing barriers to the inflow of technology, and on ensuring sufficient absorptive capacity for these new

technologies to be utilized by local economic agents.

Whether growth in East Asia can be attributed to factor accumulation or to advances total factor productivity

(TFP) has been the subject of much debate. A number of these found the contribution of TFP growth to output growth

in the region to be negligible (Kim and Lau 1994, Young 1992, 1995), suggesting that the secret behind the East

Asian miracle was nothing particularly extraordinary. Table 1.2 below summarizes the findings of a number of

studies as compiled by Wong and Ng (2001). In contrast, high and sustained rates of investment in the region have

no parallel among developing countries.

Table 1.2TFP Growth Estimates across Selected Asian Countries


16/22

Inclusive Years Korea Taiwan HongKong

Singapore Malaysia Thailand

Kim and Lau (1966-1990) 1.2 1.2 2.4 1.9 - -

Young (1966-1990) 1.7 2.6 2.3 0.2 - -

Lindaur and Roemer (1965-1990) 4.9 4.9 3.6 3.6 1.1 3.2

World Bank, Miracle (1980-1989) 3.1 3.8 3.6 1.2 1.1 2.5

Thomas and Wong (1960-1990) 2.1 3.6 4.0 2.8 2.2 -

Hsieh (1966-1990) 1.7 3.8 2.8 2.2 - -

Manti (1970-1990) 1.4 2.1 2.4 1.4 0.4 1.6

Collins and Bosworth

(1960-1984) 1.5 2.0 - 1.5 0.9 1.8

(1984-1995) 2.1 3.8 - 3.1 1.4 3.3

Source: Wong and Ng (2001)

Whether gains in TFP or factor accumulation (or both) are behind the miracle of East Asia, Philippine

performance has been poor compared to its peers in either criterion. It should therefore not come as a surprise that

the country had failed to achieve the levels of development enjoyed by its neighbors.

The role of trade policies in East Asia has also been the subject of debate, particularly on how these policies

may have supported industrial policy. In contrast to Latin and South American countries, export shares in East Asia

have been large (Figure 1.13). In the early 2000s, for example, Malaysian exports were valued at about 120% of

GDP, Thai exports at around 70%, and Vietnamese exports at around 60%. During the same period, Chilean exports

were only at around 35%, Mexican exports at around 30%, and Argentine exports at around 25%.

Trade regimes in East Asia have been largely described as export-oriented, while those in Latin and South

America have been considered rather inward-looking characterized by protectionist trade regimes and import-

substitution. It is important to note however, that many East Asian economies, with Hong Kong and Singapore as

notable exceptions, had also used high tariffs and quantitative restrictions to protect local industries. These policieshowever were offset by incentives regimes and exchange rate policies meant to promote exports (Hernandez, 2004).

After brief experimentation with import-substitution, Taiwan moved to export-orientation in 1958, introducing

duty exemption schemes and export processing zones to promote foreign investment in the export sector. Korea

followed in the mid-1960s, but kept restriction on foreign investment. Indonesia, Thailand, and Malaysia abandoned

import-substitution and began promoting exports in the 1980s. By then, Taiwan and Korea had significantly

liberalized their economies, while China began to reduce tariffs and started to welcome foreign investments

(Hernandez, 2004). As discussed in the earlier section on exports, a remarkable trend in East Asia during this period

is the increase in the share of manufactured goods in total exports, replacing agricultural products as the primary

export of the region. This is true for the Philippines, as electrical and non-electrical machinery began to surpass

wood, sugar, and metal ore exports by the late 1980s. Similar shifts are observed in Malaysia (Figure 1.14) andIndonesia. In contrast, no similar shifts have occurred in Latin and South American countries like Argentina and

Brazil, with the exception of Mexico (refer toAppendix C).

Figure 1.13Exports as Percentage of GDP across Selected Countries


17/22

Figure 1.14Shares of Selected Items in Total Exports

Figure 1.14Shares of Selected Items in Total Exports


18/22

The rise of manufactures in total exports, along with the growth of exports in general, is associated with

higher economy-wide productivity growth. Westphal (2001) proposes that the existence of export-related knowledge-

transfer mechanisms may be higher for new export products rather than continuing exports. This means that the shift

from traditional exports to new exports of electronics and machinery may have been instrumental in helping East

Asian economies access foreign technologies. It may not be surprising then that the periods during which group-IV

export shares in Korea and Malaysia began to rise, have also been periods of high GDP growth.

In this light, a possible explanation to the disappointing development record of the Philippines in spite of its

remarkable performance in group-IV export growth is the economys inability to absorb new technologies from the hi-

tech export sectors and to develop domestic linkages through backward integration. Hill (2003) proposes that the

enclave nature of export processing zones may be partly to blame. Unfortunately, technology transfer to the rest of

the economy and backward integration may not be automatic. For this reason, the countrys share of group-IV

manufactures in total domestic output remains small in spite of the very high share of group-IV goods in total exports.

In summary, three factors appear to be the most important determinants of growth in East Asia. These are:

capital formation, the adoption (rather than invention) of new technologies, and export-orientation.

Determinants of Group-IV Manufacturing Share

An empirical analysis of the shares of group-IV items in domestic manufacturing and its possible

determinants is performed on pooled data from four Asian economies Korea, Malaysia, Taiwan, and the Philippines

from the period 1989-2005. A cross-weighted panel regression with fixed effects is chosen among several models.

Using cross-sectional weights helps correct heteroskedasticity, common in cross-sectional data from multiple

heterogeneous sample sources as in the case of the four economies under study. Assigning fixed effects estimates

different intercepts for each cross-section. The general specifications for each cross-section are as follows:

grp4percap = + 1pcapform + 2 rgdppercap + 3 reer + 4 mfgshare + 5 ar(1) + (1)

Group-IV domestic manufacturing output per capita (grp4percap) is regressed on capital formation as a

percentage of GDP (pcapform), real GDP per capita (rgdppercap), real effective exchange rate (reer), share of


19/22

manufacturing in total output (mfgshare), and an auto-regressive term. Capital formation is expected to be positively

related to the dependent variable, as group-IV manufacturing usually demands heavy investment in physical capital

and public infrastructure. Capital formation can also be an implicit indicator of new technology absorption.

Investment in physical capital generally requires adoption of foreign technologies to put the new capital to use. Real

per capita output is also expected to be positively related to group-IV manufacturing as rich countries tend to produce

mostly hi-tech, high-level manufactured goods. The real effective exchange rate, on the other hand, may be eitherpositively or negatively related to the dependent variable. A high REER makes imported capital equipment more

affordable to domestic manufacturers, while a low REER makes a countrys exports cheaper abroad. Recall that

several studies have suggested that export-orientation may have been one of the keys of East Asian success.

Meanwhile, total manufacturing share in GDP is expected to be positively related to group-IV manufacturing. A

positive relationship will confirm the notion that as an economy develops, its manufacturing sector thrives and

diversifies, which results in an increase in per capita income. Finally, an auto-regressive term is added mainly to

reduce serial auto-correlation.

Regression results are highly satisfactory. All coefficients are found to be statistically significant (at 90%

confidence forpcapform and 99% for all other variables), and signs are as expected.

Table 1.2Regression Output*

Dependent Variable: GRP4RPERCAPMethod: GLS (Cross Section Weights)

Variable Coefficient Std. Error t-Statistic Prob.

PCAPFORM 0.438240 0.238654 1.836299 0.0717RGDPPERCAP 0.154877 0.013060 11.85918 0.0000

REER -0.267339 0.082892 -3.225125 0.0021MFGSHARE 38.04589 2.045383 18.60086 0.0000

AR(1) 0.702689 0.089986 7.808901 0.0000

Fixed Effects_PHI--C -992.9149_KOR--C -1427.178_MAL--C -1020.057_TAI--C -1151.835

Weighted Statistics

R-squared 0.997872 Mean dependent var 1102.278Adjusted R-squared 0.997562 S.D. dependent var 862.1886S.E. of regression 42.56848 Sum squared resid 99664.13Log likelihood -299.9511 F-statistic 3223.693Durbin-Watson stat 1.649973 Prob(F-statistic) 0.000000

Unweighted Statistics

R-squared 0.996602 Mean dependent var 861.1021Adjusted R-squared 0.996107 S.D. dependent var 682.2814S.E. of regression 42.56849 Sum squared resid 99664.21Durbin-Watson stat 1.335705

*Output generated using Eviews 4.1

As expected, a higher proportion of GDP put into capital formation leads to greater group-IV manufacturing

per capita output. Also as expected, real per capital output is positively related to the dependent variable. The results

confirm the neoclassical view on the importance of capital accumulation. A country intent on producing hi-tech, high-


20/22

level manufactures must invest in physical capital and public infrastructure to succeed. Due to lack of time-series

data on research & development expenditures across the selected countries, the significance of investments in new

technology could not be tested directly. However, if capital formation were to be taken as an implicit indicator of the

adoption of new technology, the results also confirm the hypothesis on the importance of technology absorption. This

is clearly a problem for the Philippines where capital formation has remained weak for decades, due to both low

domestic savings rates and low FDI inflows, minimizing potential for technology adoption. Meanwhile, as earliermentioned, R&D spending is estimated at a dismal 0.11% of total output.

The negative relationship between REER and the dependent variable suggests the important role of exports

in domestic manufacturing. One obvious reason is that greater exports, particularly of items under group-IV, directly

translate to greater group-IV domestic output. Again, a low REER makes a countrys exports more affordable to

foreign consumers. A second, more interesting possibility is that greater exports may mean a greater need to be

globally competitive. For a countrys exports to be successful in world markets, firms must continually strive for cost-

efficiency, world-class quality, and product innovation. The larger the export sector is and the more integrated it is

with the rest of the economy, the better the quality of local firms. Technology transfer and backward integration allow

the local manufacturing sector to thrive. Weak export growth in the Philippines means the country has lagged behind

its Asian neighbors in taking advantage of world markets. As a result, the drive to be globally competitive among localfirms in the manufacturing industry is weak. The diminutive size of the Philippine export sector relative to its

neighbors (figure 1.6) may be directly related to the concentration of its small industrial base on low-tech group-I

manufactures.

The strong positive relationship between manufacturing share in total output and the dependent variable

suggests that the Philippine domestic manufacturing sectors heavy concentration (about 50%) on group-I items may,

in turn, be attributed to the small size of the countrys industrial base. It comes as no surprise that Korea, Malaysia

and Taiwan, economies with historically larger industrial sectors, produce more group-IV goods than the Philippines.

Conclusion and Policy Recommendations

It appears that most of the hypotheses quoted in this paper are supported by empirical evidence provided in

the preceding section. In conclusion, capital formation, the adoption of new technology, and export-orientation are

the most important determinants of growth in East Asia.

The model shows that capital formation, made possible through increased domestic savings and

investment, and augmented by FDI, is indeed imperative to growth. Most authors agree that the East Asian miracle

can be mostly attributed to simply getting the basics right. For the Philippines, the challenge is clearly to increase

the rate of investment, both private and public. Growth in recent years has been largely consumption-led, worrying

some economists about its sustainability. If the country is to finally follow the lead of its more prosperous neighbors,

it must seriously strive to make the big push out of its low and deteriorating investment-to-GDP ratio. Public

investment receives special attention here as inadequate infrastructure continues to hold back private investment.The argument that low savings rates simply follow low income levels is a convenient excuse, but Chinas recent

growth spurt attests to the possibility of high savings despite low levels of per capita income. Investments shortfalls

may hide deeper challenges. Here the unexplained factors like corruption, political stability, property rights,

enforceability of contracts, peace and order, and perhaps even culture play important implicit roles. Quantifying and

empirically testing the significance of these implicit variables remain a challenge, but most economists agree that

these make up a large part of the residuals of any decent regression of growth on its traditional determinants.

Whatever the direct role of these unexplained factors on development may be, the conclusion of this paper is that


21/22

capital formation is absolutely necessary for growth, and peace and order or political stability is the key to faster

capital accumulation then let the government prioritize these concerns. The country needs rapid capital formationat

all costs, so to speak.

The adoption of new technologies is a second key determinant. Developing countries during this age of

globalization have access to the best and latest technologies available. The flying geese hypothesis predicts the

transfer of industries, along with the essential technologies, from more developed to less developed economies with

relatively cheaper labor costs. Unfortunately, although the Philippine industrial sector remains far from being

completely developed, labor costs are no longer the cheapest in the region. FDI-led industrial and technological

development thus becomes more challenging. Nonetheless, success in the electronics sector (and more recently,

business process outsourcing in the services sector) prove that it is still possible to attract sizeable technological

transfers and capital inflows into the country, wherever comparative advantage or economies of scale exist.

However, as the story of the countrys electronics exports sector shows, attracting foreign investments and

technology transfer into particular sectors is one thing, establishing backward linkages is another. Inadequate

transport and energy infrastructure, inappropriate incentives, bureaucratic red tape, weak entrepreneurial spirit, and

lack of managerial skills are some of the concerns. Whether its the enclave nature of export processing zones or the

lack of infrastructure for backward integration and technological spread, government must address the obstacles thatkeep the Philippines from taking advantage of technologies already available in pocket sectors. The current

misalignment between the countrys hi-tech, group-IV dominated export sector and low-tech domestic manufacturing

industry is a clear indicator of failure in adopting new technologies.

In recent years, growth in services, particularly in the business process outsourcing (BPO) sector has been

remarkably high. However, although BPOs have provided much-needed employment, not-to-mention have spurred

the recent office-space development boom in the real estate market, an economy that leapfrogs into services

without having developed a sizeable industrial base might not be maximizing its full growth potential. The recently

published Asian Development Outlook summarizes: services alone cannot sustain growth. A sustainable growth path

can only be achieved by walking on two legs, so to speak a tandem of commercial services and industrial activity.

Finally, as East Asias miracle economies have demonstrated, export-orientation provides not only access to

foreign direct investments and technology transfer, it can also create incentives for firms to become globally

competitive thereby increasing efficiency among local producers. The promises of both the world economy and

increasingly integrated regional markets are too large to ignore. Intra-regional trade in East Asia for example has

been steadily increasing. It will be to the benefit of the Philippines to take advantage of the increased integration by

becoming part of the regional assembly line.

List of Works Cited

Asian Development Bank.Asian Development Outlook 2007: Growth Amid Change. ADB, 2007.


22/22

Hausmann, Ricardo, Jason Hwang, and Dank Rodrik. What You Export Matters. CID Working Paper No. 123.

Harvard University, December 2005.

Hausmann, Ricardo and Dani Rodrik. Doomed to Choose: Industrial Policy as Predicament. September 2006.

Hernandez, Zenaida. Industrial Policy in East Asia: In Search for Lessons. Background paper prepared for World

Development Report 2005: A Better Investment Climate for Everyone. World Bank, September 2004.

Hill, H. Subcontracting, Technological Diffusion, and the Development of Small Enterprise in Philippine

Manufacturing.Journal of Developing Areas.1985.

Jones, Benjamin F., and Benjamin A. Olken, The Anatomy of Start-Stop Growth, NBER Working Paper No. 11528(Cambridge, MA: National Bureau of Economic Research), 2005.

Johnson, Simon, Jonathan Ostry, and Arvind Subramanian, Africas Growth Prospects: Benchmarking theConstraints, IMF Working Paper (Washington: International Monetary Fund), 2006.

Kim, Jong-il, and Lawrence J. Lau. 1994. "The Sources of Economic Growth of the East Asian NewlyIndustrialized Countries." Journal of the Japanese and International Economies 8(3):235271.

Muprhy, Kevin, Adrei Shleifer, and Robert Vishny. Industrialization and the Big Push. Journal of PoliticalEconomyVol. 97 No. 5. October 1989.

Rodrik, Dani. Industrial Development: Stylized Facts and Policies. August 2006.

Rodrik, Dani. Industrial Policy for the Twenty-First Century. September 2004.

Romer, Paul. The Origins of Endogenous Growth.Journal of Economic Perspectives Vol. 8 No.1. 1994.

Takacs, W.E. Domestic Content and Compensatory Export Requirements: Protection of the Motor Vehicle Industry

in the Philippines. World Bank Economic Review. 1994.

Westphal, Larry E. 2001. "Technology Strategies for Economic Development in a Fast Changing Global Economy."

Economics of Innovation and New Technology 11:275320.

Wong, Poh-Kam, and Chee-Yueng Ng, eds. 2001. Industrial Policy, Innovation and Economic Growth: The

Experience of Japan and the Asian NIEs. Singapore: Singapore University Press.

Young, Alwyn. 1992. "A Tale of Two Cities: Factor Accumulation and Technical Change in Hong Kong and

Singapore." NBER Macroeconomics Annual. Cambridge, Mass.: MIT Press.

Young, Alwyn. 1995. "The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth

Experience." Quarterly Journal of Economics 110(3):64180.

philippine industrialization

Documents