THE BLOG
01/12/2014 02:10 pm ET | Updated Mar 14, 2014

Upgrading the Philippine Economy: Why Emerging Markets Need a New Governance Model

With much of the developed world hobbling under the burden of massive public debt, The Economist couldn't resist the opportunity to encourage a global, multi-trillion-dollar "new wave of privatizations, this time centered on property." Unsatisfied with earlier waves of privatization, which focused on the banking sector, transport, telecoms, and utilities. It raised the specter of 21st century Thatcherism, where privatization allows governments to "cut their debts and improve their credit ratings," and, in the process, enhance "the economy's efficiency by boosting competition and by applying private-sector capital and skills to newly privatized assets."

Nevermind that the magazine's unflinching support for deeper pro-market reforms tends to contradict a vast body of economic literature, which points at how the state's precipitous withdrawal from the markets paved the way for the 2007-08 Great Recession -- and how this brought the world to the brink of another Great Depression. After all, even France's Socialist president, François Hollande, seems to be following in the footsteps of Britain's Tony Blair and Germany's Gerhard Schröder by abandoning the basic tenets of economic socialism in favor of lower taxes, more market flexibility, and welfare-reform.

But even The Economist couldn't resist to counsel governments to "learn from mistakes made in past waves of privatization", for in the absence of "robust regulation, sell-offs enrich insiders and lead to backlashes." While regulatory capture undermined the privatization of the rail and utilities sectors in Britain, the emerging markets, in turn, suffered a similar fate when they tried to deregulate, among others, their telecom and banking sectors.

In places such as Egypt, the privatization of the banking sector allowed cronies to transform the financial markets into a bottomless source of private fund, with the Mubarak regime -- intent on preserving its network of political patronage -- bailing out major banks whenever they went bust. Similar patterns of crony capitalism emerged all across the developing world, with rent-seeking and insider manipulation bedeviling quasi-market economies, which undertook large-scale privatization schemes in recent decades. And as I have previously argued, the Philippines' current electricity crisis, which is hammering the economy and undermining the welfare of millions of consumers, is largely a function of mindless privatization in absence of a credible regulatory oversight.

Economic globalization has served as a powerful force behind the crumbling of state-led economic models. But among developing countries we have not necessarily seen the emergence of optimal modes of governance, which previously allowed Newly Industrialized Countries (NICs) such South Korea and Taiwan to leapfrog to developed world status. More than ever, what we need is a new model of governance, which could allow emerging economies to progressively climb up the ladder of development. And this requires also a shift in the mindset of the political leadership.

Economic globalization has allowed us to discover the paucity of state-led development under weak, corrupt regimes, but also detect the deleterious impact of simplistic pro-market reforms.

The Perils of Privatization

Initially, privatization allows governments to decouple from an unsustainable state-led economic model, which reduces fiscal pressures and provides space for entrepreneurial experimentation. But, from India to Brazil and Turkey, we have seen how several years of impressive economic expansion, under the guidance of market-oriented governments, has been followed by an explosion in public discontent over endemic corruption, macroeconomic uncertainty, and slowing growth -- signifying a major gap in the relationship between the state and markets.

Among newly-emerging economies such as the Philippines, recent economic gains have largely failed to trickle down to the masses. In absence of real political parties, reforms have been more a function of the personal whims of the political leadership rather than a reflection of carefully-considered programmatic action. There has been hardly any policy consistency, with cyclical leadership change ushering in new policy directions -- undermining the positive legacy of the previous administration.

True, the Aquino administration has managed to restore a measure of confidence in the economy, with more global investors taking notice of the country's massive economic potentials. And a legion of hard-working Filipinos around the world will continue to boost their national economy through tens of billions in annual remittances. Nevertheless, the long-term trajectory of the Philippine economy and many other emerging markets will primarily depend on how the political classes negotiate a new model of governance, which allows for the simultaneous empowerment of its state institutions as well as the dynamic entrepreneurial classes. And public pressure and democratic participation will be extremely important to reviving as well as sustaining reformist impulses within the ruling establishment.

The Danger of Complacency

In his latest essay, Ruchir Sharma, arguably the world's leading emerging markets expert, has once again placed his trust in previously under-rated economies such as Mexico, Philippines, Peru, and Thailand, which have been among the more dynamic growth poles in the developing world. While many experts have expressed legitimate reservations with countries such as Mexico (think of the drug cartels and criminal gangs), Thailand (think of the ongoing anti-government protests), and the Philippines (think of the unchanged poverty and unemployment figures), Sharma makes two important points.

First, Sharma criticizes many observers for simplistically focusing on single variables (think of demographics or location) to draw long-term projections about emerging economies. After all, a minimal familiarity with development economics easily reveals the paucity of mono-causal or single-factor theories. It takes an auspicious convergence of several factors to give birth to an economic miracle.

Second, Sharma looks at the fragile nature of economic take-off, and its close relationship with the ability of the political leadership to progressively introduce new productivity-enhancing strategies as the country climbs up the development ladder.

"What [emerging markets'] experiences underscore is that political cycles are as important to a nation's prospects as economic ones. Crises and downturns often lead to a period of reform, which can flower into a revival or a boom," Sharma argues, cautioning against complacency among the political leadership. "But such success can then lead to arrogance and complacency -- and the next downturn. The boom of the last decade seemed to revise that script, as nearly all the emerging nations rose in unison and downturns all but disappeared."

As he correctly points out, the challenge for many emerging economies is to continuously introduce calibrated economic reforms even when the economy has picked up. Economic growth will inevitably depend on the health and dynamism of not only the market forces, but also the state. And this is why empowering state institutions -- through, among other things, providing better compensation for state employees and hiring a competent bureaucratic legion -- is extremely important. A competent state means that even a change in the political leadership will not necessarily disrupt a positive momentum towards change.

The problem, however, is the tendency of the reformist leadership to fall into a cycle of complacency, and stubbornly use recent economic gains to defend its own legacy. Instead of focusing on the state institutions, the governing administration will spend more time defending itself, and its core members, while criticizing the previous administration and current opponents for any mishap.

For some critics, this is already happening across many emerging markets, from Turkey (think of protests against the AKP) to India (think of the end of Congress party's hegemony) as well as Indonesia (think of the popular hunger for a "Jokowi" bid for presidency) and the Philippines, where President Benigno Aquino is facing declining popularity and grappling with widespread corruption scandals testing his administration's mettle.

Reforms 2.0

In fact, historically, sustained periods of economic growth tend to magnify the insecurities and challenges to the reformist leadership -- and create new uncertainty traps. For instance, a rise in expectations among the aspirational middle classes, now increasingly intolerant of any indication of bad governance and macroeconomic downturn, could lead to more incidents of protests and a decline in confidence in state institutions. The result is a beleaguered political leadership, which lacks enough latitude to engage in much-needed policy experimentations.

Moreover, opponents of reform could instrumentalize renewed political uncertainty by engaging in legislative filibustering, stepping up black propaganda against the government, and provoking chaos by feeding popular frustrations with the government.

This is precisely why the Aquino administration urgently needs to demonstrate its ability to push with its reformist agenda while the economy is still posting impressive growth rates. Among the economic sectors in need of urgent upgrade are the electricity sector (vulnerable to oligarchic collusion), agriculture (no meaningful land reform in effect), manufacturing (hammered by cheap imports, high water and electricity cost), and infrastructure (low spending-GDP ratio, with major projects not expected before 2015).

Overall, instead of investing its political capital in taking credit for recent macroeconomic gains, the Aquino administration and its successors should instead focus on how to upgrade the economy and institute an effective governance model, which enhances the potentials of both state institutions as well as markets. And yes, this only shows how 21st century policy-making has become even more complicated.