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Investment Grade Philippines: Bouts of Irrational Exuberance?

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After my previous bearish piece, highlighting the structural imbalances within the Philippines economy, I came under criticism for allegedly magnifying the dark underbellies of the recent boom. Some took issue with my characterization of the mid-March stock markets' decline as a "crash," while others dismissively brushed aside my core arguments on the lack of inclusive and sustainable growth.

The Philippine Stock Exchange (PSE), after sustaining a 6 percent cumulative drop between March 6 and 20, managed to recover in late-March, breaching the 7,000 mark and beyond in recent weeks. Then came the sovereign credit ratings upgrade from Fitch and Standard and Poor's, giving the Philippines its first "investment grade" rating. At this point, it was easy for some to downplay more skeptical commentaries on the country's economic uptick, focusing rather on the "good news" and the ongoing bonanza in the stock markets, real estate, gambling and outsourcing sectors.

In recent weeks, two important studies, however, vindicated my analysis, which, beginning in 2011, underscored how -- despite the Aquino administration impressive macroeconomic performance -- the Philippines is overlooking more fundamental economic challenges in need of sustained, policy-oriented remedy. What the government must understand is that macroeconomic stability is not an end in itself; it is only a means to more lofty, urgent, and ultimately democratic goals of poverty-alleviation, employment generation, and sustainable growth.

Macroeconomic Consolidation

Today, the Philippines is abuzz with economic optimism. It is no longer the proverbial "Sick Man of Asia," but instead a much-celebrated growth pole amid a shaky global economic environment. Armed with an "investment grade" sovereign credit rating, the country is poised to benefit from (i) deeper access to high-end global investment pool and (ii) lower borrowing costs in international capital markets. Two key drivers of the recent economic uptick, notably the Business Process Outsourcing (BPO) sector and multi-billion remittances from Filipino Overseas Workers (OFW), are expected to score robust growth in the foreseeable future.

Meanwhile, a combination of (i) growing bilateral strategic cooperation -- amid rising geopolitical tensions in the Western Pacific -- and (ii) Tokyo's necessity to expand its overseas manufacturing hubs, primarily to revamp the domestic economy, is facilitating deeper Japanese investments in and economic aid to the Philippines.

After posting an impressive 6.6 percent GDP growth in 2012, among the fastest in the world, the Philippines, according to the World Bank and United Nations Economic and Social Survey of Asia and the Pacific (UNESCAP), is poised to grow as much as 6.2 percent in 2013 -- well within the government's 6-7 percent growth target.

No wonder, the Aquino administration is basking in an unprecedented sense of hope, relishing its record-high satisfaction ratings. The incumbent's senatorial bets, unsurprisingly, are expected to dominate the current by-elections.

Against such backdrop, I will go as far as arguing that Benigno Aquino III is perhaps the best president that the country had had in recent decades. I tend to agree with the likes of Ruchir Sharma, author of Breakout Nations, and Acemoglu and Robinson, authors of Why Nations Fail, on the argument that Aquino's "good governance" initiatives have restored some element of stability and predictability in the system -- portending the transformation of a cacique democracy into a modern nation-state, anchored by rule of law and entrepreneurial spirit. And as many distinguished experts have pointed out, sometimes what relatively poor and under-developed countries need is basically decent leadership, unmolested by delusions of grandeur and/or inconsistent policies.

Aquino, in some ways, has provided such leadership, allowing the Filipino electorate to no longer be confined to the notorious binary opposition between choosing smart but corrupt candidates, on one hand, or well-intentioned but inexperienced candidates, on the other. Although generally unknown for commanding technocratic depth, and criticized for his supposed laid-back style, Aquino combines a basic grasp of macroeconomics, political pragmatism, and decorous leadership. Much unnoticed by global watchers is the fact that Aquino has, despite his seemingly mainstream, libertarian views, integrated progressive forces into his government, from the presidential cabinet to bureaucracies in charge of, among other things, poverty alleviation and human rights. In a telling sign of his decisive leadership, he has, despite strong opposition, managed to push for controversial measures, notably the Reproductive Health (RH) and sin tax bills.

A Call for Sobriety

But the country's rising fortunes is precisely the reason for concern. The Philippines is no stranger to economic take-off. In Democracy and Development (2000), Przeworski et al. points out how, back in the 1950s, the Philippines -- along Costa Rica, Turkey, and West Germany -- was among the world's wunderkinds. Costa Rica, despite losing its strong economic momentum, will go on to become a bastion of peace, democracy, and welfare in Latin America and beyond. West Germany will evolve into a global industrial powerhouse. Turkey, after decades of military coups and instability, will join the elite group of trillion-dollar economies, already knocking at the door of the BRICs privilege club of giant emerging economies.

What about the Philippines? It will, similar to Turkey, fall into cycles of economic crisis, democratic reversals, and bureaucratic paralysis -- ending up as one of Asia's poorest and most unequal societies. Aquino has managed to bring the country back to the cusp of an economic miracle, but a dangerous trend -- potentially undermining the country's second chance at take-off -- might be set in motion: irrational exuberance.

The notion of irrational exuberance goes back to the speech (1996) and book (2000) of legendary ex-Chairman of the Federal Reserve (1987-2006), Alan Greenspan, who oversaw a remarkable era of "Great moderation" -- healthy growth and relatively low inflation in tandem -- in the U.S. and elsewhere. As we all know, that era gave way to the tumultuous Great Recession in 2008, which upended the foolish belief that monetary policy alone could eliminate business cycles, despite the "irrational exuberance" fueling a casino-like financial system, ignoring the fundamental physics of markets.

Renowned economist Hyman Minsky, for instance, is responsible for one of the most important studies on how economic crisis is preceded by an era of relative economic stability, in turn, encouraging reckless financial practices and innovations, especially in the absence of proper regulation. The basic lesson is that complacency and lack of vigilance could portend economic disaster: In a post-Keynesian era, the government -- whenever the markets seem to do "well" -- tends to rollback intervention/regulation in the name of laissez-faire -- precisely the opposite of what is needed.

The Perils of Complacency

Going back to the Philippines, there is, of course, no short- to medium-term risks of economic collapse, but one could sense a form of irrational exuberance in play: The dangerous tendency to overlook fundamental structural problems in favor of glorifying secondary, and much more shallow, economic trends.

While the pre-recession U.S. ignored growing structural imbalances in the real estate sector, financial markets, and external trade relations, the Philippine government is obsessed with emphasizing the boom in the stock markets, real estate (boosted by the BPO and gambling sector), and foreign exchange reserves.

While the U.S. ignored the demise of its manufacturing sector, the unsustainable trade and credit relations with export-oriented giants such as China (the so-called 'manipulative cycle'), and the explosion in the derivative markets, the Philippines, in turn, is somehow ignoring its flailing industrial and agricultural sector, losing focus on large-scale employment-generation, and addressing poverty and inequality -- among the worst in the developing world. Given the scale of the country's socio-economic problems, vigilance is supposedly the name of the game.

Pre-recession U.S. foolishly ignored the wisdom of regulation, and reviving the domestic manufacturing. The fixation with low inflation and dynamism of the financial markets blinded the government to the vulnerabilities of the real economy. The rising Philippines today, on the other hand, is desperately in need of re-tooling its development strategy, since recent growth trends, as authoritative studies indicate, is far from inclusive: it has neither addressed double-digit poverty rates nor unemployment. And this is precisely why Philippine experts and observers should be cautious in estimating the country's long-term trajectory.

The Great Disconnect

One of my most bizarre experiences in recent days was when I browsed the front-page (May 3) of the Philippine Daily Inquirer, just to see that while one portion was about Standard and Poor's awarding of the Philippines' second "investment grade" status, following in the footsteps of Fitch, the other main report was on a staggering 1 million people joining the ranks of unemployed in recent months. The latest survey by Social Weather Station (SWS), conducted in the March 19-22 period, shows that unemployment rates have risen up to 25.4 percent, or the equivalent of 11.1 million individuals within the working force -- compared to 24.6 percent, or 10.1 million jobless individuals, back in December 2012. The official unemployment rate, however, stands at 7.1 percent as of January, from 6.8 percent in October 2012, showing that 2.9 million individuals couldn't find a permanent job. Both nominally and proportionally, despite the government's announcement of the availability of 400,000 jobs, unemployment is on the rise .

What makes the situation even more curious is the fact that the previous weeks were also an interesting display of starkly contrasting reports. Amid the euphoria over the Philippines first investment grade sovereign credit rating achievement, the latest report by the National Statistics Coordination Board (NSC) suggested that in the 2006-12 period "poverty remained unchanged as the computed differences are not statistically significant." According to the NSCB data, poverty incidence in the first half of 2012 stood at 27.9 percent, compared to 28.8 percent in 2006 and 28.6 percent in 2009.

So far, critics claim that the response from the government has been a mixture of denial, downplaying, and distraction - including a proposal to merge bond and stock markets, supposedly to more efficiently raise more private capital, despite concerns with reconciling the underlying contradictory tendencies of the two markets.

To put it simply, the government has done an impressive work in consolidating macroeconomic stability, but, as the Asian Development Bank's (ADB) brilliant economist Norio Usui has repeatedly emphasized, the main problem is that growth continues to lack an inclusive dimension. Echoing the analysis of renowned economists such as Harvard University's Dani Rodrik, Usui has talked about the "manufacturing imperative" in order to ensure growth is inclusive and ultimately sustainable. Unless the Philippines revamps its manufacturing sector, the current mode of service-oriented growth will continue to fall short of creating enough, well-paying jobs for the majority of the working force, both highly-educated and semi-skilled.