Monday, 29 October 2012

What is driving Philippines' economy?

Cielito F Habito
Philippine Daily Inquirer

It is remarkable that the Philippine economy has been showing dynamism this year, bucking the trend of a sluggish world economy. This implies that the energy driving our economic growth is coming from within. Indeed it is internal demand - that is, we Filipinos ourselves purchasing our goods and services - that has provided the current impetus for heightened economic activity, thereby providing increased jobs and incomes for Filipinos. I will explain some of the evidence on this below.

In basic economics, we are taught that the products and services produced in the economy are bought by four major sectors: private consumers for their consumption needs; businesses and firms for investment in structures, equipment and materials, etc; government for public infrastructure and services, and for its own day-to-day requirements; and foreigners who buy our products and services as exports abroad, or buy them here as tourists. Growth in spending by any or all of these propels growth in the economy as a whole, as increased demand stimulates greater production by the economy's producers.

What's more, any rise in spending by any of these four sectors provokes a multiplier effect that leads to even more growth in economic activity, via a chain reaction of new incomes and consequent new spending. If a company spends 100 million Philippine Pesos (Bt74.4 million) on a new factory, this turns into PP100 million in total incomes received by contractors, engineers, construction workers, suppliers of equipment and construction materials and others. But that's not the end of it. Those various people now have more money to spend or save as they choose. If people save PP20 out of every additional PP100 in income they receive, then the original PP100 million of investment spending turns into a new round of PP80 million in spending on various things such as food, clothing and appliances that those construction people normally spend their incomes on. And since anyone's spending turns into someone else's income, that second-round PP80 million in incomes turns into a third round of spending amounting to PP64 million. This becomes yet another round of incomes spurring yet another round of spending, and so on down the line.

Ultimately, the PP100 million originally spent by the investing firm will actually create five times as much (PP500 million) total production and incomes. The mathematically inclined can figure out that if the saving rate is 20 per cent, or 0.2, the multiplier works out to be one divided by that, or five. So if people tend to save less, say 10 per cent, every spending gets multiplied by even more (that is, 10) and generates 10 times more production and income in the economy. And even more so if those savings are kept within the country, so that the banks receiving it can plough it back into our domestic economy, say by lending the savings to a company that will invest it in a new factory - thereby repeating the same story above.

Official data suggest that there is indeed more domestic spending by consumers, investors and government lately, even as foreign purchases of our products (especially in Europe) have slowed. In particular, government spending has dramatically swung around from a 4.6-per-cent drop in the first six months last year to 12.3-per-cent growth in the same period this year. Government construction spending jumped 55.4 per cent after falling 51.1 per cent last year. Stung by criticism that it directly dragged down the economy last year with reduced spending, the government has now come back with a vengeance.

The data show that firms' investment spending on durable equipment, breeding stock and orchard development and on intellectual property products has likewise sped up significantly from last year's pace. Private consumption growth is similarly brisk at 5.7 per cent. Interestingly, among the strongest sources of growth in people's spending are communication (with our continuing fascination for ever more sophisticated smart phones), restaurants and hotels, and recreation and culture. These suggest that domestic tourism has been a particularly important driver of our growth. One only needs to experience the now common flight delays and overcrowded airports to be convinced that Filipinos are travelling a lot more - and perking up the economy in the process.

The good news is that spending by foreigners on our products - ie, our exports - has lately resumed growth after contracting last year. Even then, the latest figures suggest that the export turnaround may be tentative. But I wouldn't lose sleep over this one. After all, our economy is now speeding along on its own steam, through the Filipinos' own spending, multiplier effect and all.

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