A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012

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The Charter Change Issue: Looking at the Evidence

Reforming the 1987 Constitution has been a long-standing issue, with previous attempts ranging from a proposed shift in

the type of government to the liberalization of the economic provisions of the Constitution. The Constitutional Correction

for Development (CONCORD) under former President Joseph Estrada, especially, zeroed in on the latter, particularly the

need to free up key sectors of the economy to foreign ownership. Today, the call for constitutional reforms has been taken

up once more by the leadership of both Houses of Congress with the proposal of amending restrictive economic provisions.

During Estrada’s CONCORD as in the present, the rationale for liberalizing the economic provisions of the Const itution has

been to help the domestic economy become more conducive to investments and, in the process, increase competition

towards ultimately improving social welfare. Today, the rationale remains a compelling premise. The current economic

environment, which has been weakened by the recent global financial and economic crises, presents an opportune time for

the Philippines to implement reforms and finally make it a very attractive point in the investment radar.

And there is so much potential in that field. The investment rate in the Philippines, which averages to 20.3 percent in 2000

to 2010, can be further bolstered by foreign capital. Data from the World Bank shows that the Philippines has been a

laggard in attracting FDI inflows among major Southeast Asian economies alone, pulling in an average of $1.6 billion a year

from 2000-2010. This pales in comparison with Singapore ($19.6 billion), Thailand ($6.8 billion), Malaysia ($4.7 billion),

Indonesia ($3.8 billion) and even Vietnam ($3.9 billion). The Philippines has some of the most restrictive regimes in terms of

foreign ownership in the region. In natural resources, for instance, the country has the lowest allowable share of foreign

equity ownership.

Just imagine how much the economy can gain from reforms that will allow foreign capital to supplement our own domestic

investments in capacitating production.

Why place so much importance on foreign capital?

Foreign direct investments (FDIs) represent long-term asset acquisitions that result in increased production capacity and

have been regarded as one of the key ingredients supporting the growth of developing economies. The theoretical

underpinnings of the economic impact of FDIs are well-developed in the literature, with the Solow-Swan growth model

emphasizing the importance of savings and capital accumulation in shifting the economy to a higher long-term growth path.

FDIs supplement domestic savings, which is characteristically low in the case of the Philippines, and create spillovers in

technology and management know-how.

Various empirical studies have built up the evidence regarding the efficiency gains from FDIs, as well as their spillovers. A

review of the literature reveals conflicting results from empirical works arising from differences in research design,

methodology, and data sources. Results notwithstanding, material evidence on the benefits of FDIs is well-documented.

Why amend the Constitution?

The constitution frames the body of fundamental laws and political constitutions that are critical in setting the way

economic agents behave. By extension, one could say that a nation’s economic performance is affected by the way the

basic law of the land is written. A paper written by Gerardo Sicat and Loretta Makasiar-Sicat in 2004 finds that

A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012

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constitutional construction is generally an important factor in economic development, although economic competitiveness

is the more powerful force in determining economic performance.

In another study, the same authors maintain that Constitutions should be simply written based on general principles rather

than specific rules, allowing greater freedom in the movement of factors of production in pursuing economic activity. Citing

the Philippines as an example, they assert the 1987 Constitution’s restrictive provisions as an impediment to the efficient

movement of factors of production and ultimately to investment promotion. The difficulty of removing this impediment lies

in the Constitution being “maintained by an alliance of the ruling classes and many nationalistic elements that favor

restrictions.” Gerardo Sicat further discussed the arguments for opening up the Constitution in a subsequent paper in 2005.

As a general rule in the country, foreign participation in Philippine enterprises can only go as high as 40 percent save for

cases allowed by Republic Act No. 7042 or the Foreign Investment Act. But for certain sectors expressly indicated in the

Constitution, e.g. natural resources, public utilities, and media, the rule is inflexible as embodied in Article XII (National

Economy and Patrimony) and Article XVI (General Provisions).

The following are the main arguments why these restrictions should be removed:

1. Efficiency gains. The primary motivation in amending the restrictive economic provisions of the charter is that

these hinder the free flow of factors of production, most notable foreign capital and technology, and constrains

and alters the behavior of economic agents. Furthermore, these also represent additional costs of compliance (and

circumvention) or foregone opportunities. In other words, there is a case for efficiency gains to be had from

removing these economic restrictions.

2. Freeing the state from elite capture. The institutional set-up alters the behavior of economic agents that

eventually makes the State vulnerable, and thus captured by the elite and vested interest groups. This complicates

economic management and undermines the openness of the economy through protectionist and inward-looking

policies embodied in the 1987 charter. This emphasizes the need for liberalizing protected industries and allowing

competition that will redound to the increased welfare of consumers, through better quality and lower prices of

commodities – some of which are productivity-enhancing such as public utilities.

3. Correcting the corruptive effects. Constitutional restrictions result in adverse selection problems, where the

country effectively allows foreign investors who may not necessarily be the efficient ones, but those whose

tolerance for risk is high enough to go around the rules with the cooperation of state instrumentalities. This

ultimately leads to opportunities for rent-seeking behavior, reinforcing the elite capture and further constraining

competition that should be able to facilitate efficiency and increased consumer welfare.

4. Seizing the moment. The current administration has the advantage of a leader whose integrity is recognized by the

general public, having the image of a reformist free from political agenda. The window of opportunity to make

credible reforms without the taint of personal gains is here, supported by the fact that the current economic

environment augurs well for emerging economies like the Philippines. The competition is somewhat tense as

developing economies compete for the remaining wealth in the global economy. The Philippines must be able to

compete aggressively at this point and stridently banner its readiness to participate in the game; otherwise, it will

simply be left out again.

A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012

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One of the more forceful arguments against constitutional reforms is the demand for evidence-based decision-making,

implying that the assertions regarding the need to amend the constitution are not supported by empirical evidence.

Acknowledging the difficulty of directly quantifying the exact economic effects of constitutional provisions, we point out

that the so-called evidence-based arguments against amending the Constitution are also subject to the same limitation and

only support claims indirectly. We discuss these in detail with our corresponding counter-arguments.

Some say the fundamentals of the country are enough to propel the economy to greater heights, quoting the robust figures

of late, and the increasing infrastructure investment brought on by the government. Truth be told, the 6.4-percent growth

in the first quarter is unlikely to hold up because the source of growth is in itself unsustainable; public sector investment

cannot keep buttressing the economy because in the end, the measure of economic gains takes into account the private

sector and its ability to flourish. Returns from investments take time, too, with a gestation period and the time accounted

for by investors to see if the promises of these investments will be delivered. Not to mention, there is also the more

elementary problem associated with a not-so competitive game (extending to the public-private partnership) brought

about by the current institutional set-up. The country has always stuck close to the same formula as before but has never

really taken off despite the efforts. That is because structurally, we remain the same – restrictive, inflexible, and mired by

weak institutions.

Bottom-line is that the Constitution should be flexible in order to help the incumbent leadership adjust to and maximize

opportunities in the present times. And at present, the country is once again at the juncture of taking off; we can jump into

the bandwagon of increasing international ties through the Trans-Pacific Partnership – a break that can be lost if we remain

restrictive. Some of our neighbors like Malaysia and Vietnam have already been included in the ongoing negotiations1, and

their participation in this agreement is a sure deal given their relative flexibility. Without significant structural reforms

aimed at enhancing the country’s competitiveness, we will only reinforce our country’s standing as a laggard – the sick man

of Asia – in a robustly growing region.

1 Latest updates have reported that the 13

th round of TPP negotiations in San Diego, California have been geared towards inching closer

to the conclusion of the 20-plus chapters of the agreement covering the United States, Australia, Brunei, Chile, Malaysia, New Zealand,

Peru, Singapore and Vietnam. Updates accessed at http://www.ustr.gov/trade-agreements/free-trade-agreements/trans-pacific-

partnership/round-13-sandiego