The Philippine Mystery: Why Must ASEAN’s Growth Leader Struggle for FDI?

Despite a strong growth performance, the Philippines does not attract enough FDI. What is needed is greater competitiveness, improved business environment, legislative changes, and less corruption. The bad news is that time is running out.

Usually, strong growth translates to increasing FDI attractiveness. In this view, the Philippines, as the leading growth performer in Southeast Asia, should be the region’s FDI engine as well. And yet, that’s not the case.

The question is why? And what could be done about it?

Falling behind

In the mid-1990s – amidst the Fidel Ramos years – the role of FDI as a percentage of GDP was still 8.2 percent in the Philippines. This performance was not that different from Indonesia (9.3%) or Thailand (10.5%), but significantly below the Southeast Asian average (21.3%).

In the next decade and a half, the FDI share in the Philippines increased slowly, but more than doubled in Indonesia and almost quadrupled in Thailand. In 2008/9, the global recession put an end to soaring FDI.

By 2010-2012, the share of FDI as a percentage of GDP actually declined in the Philippines to 12.4 percent (13% in 2010). This was only half of that in Indonesia, barely a fourth of its counterpart in Thailand and just a fifth of the regional average.

FDI stocks illustrate past history, whereas FDI flows tell us more about the current status quo. In this regard, the situation is somewhat better.

In the pre-2008 crisis era, FDI in the Philippines as a percentage of gross fixed capital formation (GFCF) was about 10.3 percent, higher than in Indonesia, significantly lower than in Thailand, and less than half of the regional average.

In 2012, the share of FDI flows in the Philippines shrank to 5.6 percent, which was less than in Indonesia or Thailand, and barely a third of the regional average.

If the growth potential of the Philippines is to be realized, the current levels of FDI in the country are inadequate and unacceptable. While recent net inflows indicate rapid relative growth, the starting point remains low.

High unemployment figures will not be overcome without FDI that generates jobs. Further, as long as legislation works against FDI (e.g., the 60/40 foreign ownership law), bureaucratic labyrinths are bound to dampen foreign investor interest, given the abundance of alternatives in South, Southeast Asia and elsewhere.

Competitiveness, Environment, Corruption

Since the early 1990s – the Chinese reforms, the collapse of Soviet Union and India’s financial crisis – the size of FDI has increased significantly worldwide. Today, FDI is an integral part of the globalization of competition and particularly the global specialization of value chains of multinational corporations.

Typically, investors use global indicators to review FDI opportunities, focusing on business environment, corruption, and competitiveness.

In the new Global Competitiveness Index (World Economic Forum), the Philippines is ranked 65th. While it has advanced 22 places since reaching its lowest mark in 2009, the perception is that corruption (108th) and red tape (108th) are now being addressed, even though they remain pervasive. The country’s infrastructure is still in a dire state, particularly with respect to sea (120th) and air transport (112th). Further, various market rigidities continue, most notably in the labor market (103rd).

In the Corruption Perceptions (Transparency International), the Philippines is ranked 106th, far behind China (80), Thailand (88), and India (94).

Further, the Philippines is ranked only 138th in the Doing Business indicators (World Bank). What’s worse, this ranking has not improved, but got worse – particularly in such areas, as starting a business, paying taxes, and resolving insolvencies.

How should the Philippines seek to attract FDI? The short answer is: enhance business environment, fight corruption, and foster competitiveness.

Use FDI to enhance competitiveness

Take the case of competitiveness. Not all FDI is beneficial, but the kind of FDI that strengthens competitiveness certainly is. However, the objective should be to attract investors primarily with higher productivity.

A simple example: subsidizing electricity rates may offer private gains for the investor, but improving the efficiency and quality of the electricity grid will enhance the productivity of the business environment in the country.

Second, the goal should be to improve the quality of the location in ways that benefit many companies and industries, not just one or two companies. Specific tariff exemptions generate market distortions, whereas improved customs procedures enhance national competitiveness.

Also, the point should be to develop ‘sticky’ incentives that are tied to the location rather than the investor. Granting corporate tax breaks boosts the ‘race to the bottom.’ In contrast, broad improvements in the business environment contribute to increasing country attractiveness.

Moreover, the focus should be on sustained investment rather than transient one-time deals. If incentives are tied to the total size of the investment, including follow-on investments, they will be more beneficial to the country.

The time for the FDI debates is about to run out, however.

Global FDI stagnation

Global FDI has not been unaffected by the gloomy and uncertain environment. In 2012, it plunged by a whopping 18 percent. In particular, FDI flows to developed economies plunged by 32 percent, to a level last seen almost a decade ago. Europe alone accounted for two thirds of the global FDI decline.

Since the bulk of FDI in the Philippines comes from a few traditional sources – the UK, Singapore, Hong Kong and the US – all of which cope with stagnation or lingering recovery, it is time to consider alternative sources, especially those that have longer-term growth potential, including China.

In addition to old risks, new ones include the potentially longer growth slowdown in several emerging economies – especially if the anticipated unwinding of monetary policy stimulus in the U.S. leads to sustained capital flow reversals.

Rivalry for FDI is about to become a lot tougher. In this merciless operating environment, communicating growth records is not enough. It is time to tackle the inconvenient realities.

A version of this commentary was released by Asia Times on Oct 4, 2013