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Review of Raul Fabella, Capitalism and Inclusion under Weak Institutions

published by the University of the Philippines, Center for Integrative and Development Studies, 2018. pdf download

The lackluster development performance of the Philippines over the span of many decades is routinely blamed on "weak institutions" by Filipinos. In this thought-provoking book, University of the Philippines economics professor and Philippine National Scientist Raul Fabella advises on how to overcome the curse of weak institutions to achieve robust growth with poverty reduction.

As an American living in the Philippines the last 5+ years, I have puzzled over what is meant by "weak institutions". Fabella grounds the notion in a lack of social coherence. He makes much of the contrast with China which "has attained the fullness of an 'imagined community'"(p.100), its "coherent polity bound together by a strong sense of identity and mission." (p.31) Lacking such coherence, the Philippines suffers from a "feeble capacity for collective action". (p.9) This is manifested in a weak state characterized by "unstable and inconsistent rules and enforcement, the truck-and-barter of rules by unscrupulous bureaucrats, the capture of state junctures of decision by private interests for private gain, and extension of the state to domains and activities where it has no comparative advantage." (p.33) A spate of problems follows from this to the detriment of inclusive economic development.

The trouble begins with an inability to provide critical infrastructure, both the soft variety of norms and rules and the hard variety of transportation networks and public utilities. Fabella points to the international airport that serves the nation's capital as "Exhibit A of a weak state" (p.33), certainly a vivid image for those who have transited through.

Inadequate infrastructure results in high logistics costs and a general lack of global competitiveness to stunt the growth of tradable manufactures. For its income level, the Philippines has an exceptionally large services share in the economy. This "development progeria" – a sectoral composition of GDP in line with that of higher income countries – has been amplified by "an enduring romance with the strong peso with roots in our colonial past ... codified in our consciousness as defining the good life."  (p.61)

The big drawback of services oriented development is that it has left so much of the populace behind, mired in poverty. By contrast, countries such as China and Vietnam that have relied on export-led manufacturing to drive growth have succeeded in lifting broad masses of their people out of poverty. These countries were the "star performers of the MDG [Millennium Development Goal] program" (p.65), whereas the Philippines was one of the few countries that failed to meet its targets.

So, how is the Philippines to escape the trap of weak institutions and development progeria to accelerate its growth and lift its people out of poverty? Fabella proposes a multi-faceted strategy. Infrastructure is at the foundation, with some notable successes achieved already by involving the private sector. These include the privatization of water and sewer services in Metro Manila in 1997, public private partnerships in the construction and operation of tollways, and a private commuter rail line that greatly outclasses its sorry public counterpart. 

In the Philippines, involving the private sector means enlisting the talents of the country's "conglopolistic" behemoths. These conglomerates operate across domestic services of retail, finance, and property development. From origins in different niches, they have expanded into each other's turf to compete with a "healthy mutual suspicion", abetted by the diverse ethnicities of their owners: Filipinos of Spanish descent; ethnic Filipinos; and Filipinos of Chinese extraction. (p.85) The substantial size of these conglomerates allows them to mobilize funds at scale and, in a weak state environment, command "an edge in dealing with predatory tax collectors and regulators." (p.79) Importantly, they have the managerial know-how to undertake major infrastructure projects. It remains for the state to ensure competition among them to win the opportunities.

A second facet of Fabella's proposed strategy is to raise the Philippines' low national investment rate. A tax reform initiative passed in 2017 has boosted government resources, with revenues meant in part to support President Duterte's signature "Build Build Build" infrastructure program. Infrastructure improvement should in turn incentivize increased private investment. Fabella warns, however, of the danger of public funds being diverted to entitlement creation as with free tuition at public universities and salary increases for public employees unmatched by any productivity gains.

Finally, a third facet of the strategy is to expand manufacturing, which Fabella equates with traded goods. This is the linchpin, as he sees it, for reducing poverty. Infrastructure investment will go some distance toward spurring manufacturing growth. Beyond that, Fabella advocates a lower value for the peso citing Rodrik (2008) for the argument that against the crippling effects of weak institutions, an undervalued currency can "level the playing field". He points to China as an exemplar of this approach. How in the Philippine case a lower currency value is to be achieved is left sketchy, with mention only of "monetary and exchange rate policy ... rhetorically if not yet factually." (p.94)

Fabella's core argument that with weak state capacity to provide collective goods, the Philippines should seek recourse in what may be regarded as the strong institution of its conglomerate firms makes sense, I believe. Indeed the strategy is already being realized to good effect. The latest example is granting of a franchise for a new international airport to San Miguel Corporation. (BusinessWorld) Fabella is to be congratulated for bringing intellectual heft to such endeavors. Yet at the same time, it seems to me the weakness of the state need not be taken as immutable. President Duterte came to power with a mandate to root out corruption and laments his failure to do so, offering to resign as recently as 28 September (CNN Philippines), and not for the first time (GMA News). Tackling corruption should remain high on the agenda. But it will take more than lip service. 

Throughout the book, China is invoked as a model. This applies to its strong institutions, its fashioning of an appropriate role for the state, its emphasis on infrastructure, its high investment rate, its reliance on export-led manufacturing, its exchange rate policy, and, most laudably, its success in alleviating poverty. Just how much the China experience is worthy of emulation or admiration is debatable, I would submit. Further thoughts follow in a subsequent post: On China as a Model for the Philippines (Fabella Review Addendum).

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