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Deconstructing the Philippine Investment Puzzle: The Role of Collective Action Failures

Twelve Talking Points Raul V. Fabella

UP School of Economics and NAST

[I would like to thank the PEJA-UP Fellowship Program for this unique fellowship grant. This program is

innovative and unprecedented in its support for an expanded thinkspace which academics value more

than fat bankbooks. My mandate as I understood it is to think, as it were, outside the box, on an

emerging or enduring issue confronting the nation. In this I have benefited immensely from listening to

many of you in the audience. Errors are mine alone]

1. Our strategy is to put old wines in new wineskins. New combinations of vintage brews from

Economics, Political Science and Biology may shed new light on reality. Recombination of old ideas

sometimes renders the formidable doable. The reality in question is the Philippine Disease and the

Philippine Investment Puzzle. The Philippine Disease (PD) is the label we use for the long-term

retreat of the Philippine economy front the top to the bottom of the Asian League table. It echoes

the retreat of the British economy form front runner to also-ran in the aftermath of WWII attributed

to the pervasive state control of the economy and the veto of economic policy by the labor unions.

Many explanations have been put forward to explain the PD. We think we can start to unpack the

PD if we can unpack a puzzle, the Philippine Investment Puzzle (PIP).

2. The Philippine Investment Puzzle (de Dios, Medalla, Fabella, 2008; de Dios, 2011; Usui, 2010): Why

has the Philippine investment rate remained so low absolutely and relative to its neighbors? Both

public investment and private investment are dismally low. The appalling state of public

infrastructure in the Philippines compared to East Asia neighbors is testimony to the former. The

retreat of the Manufacturing testifies to the latter. Development Progeria (DP), a phenomenon

where a low income economy exhibits the industry share dynamics of a mature high income

economy and is the face of PIP. In DP, the Service sector becomes progressively dominant while the

industry and manufacturing sectors progressively retreat. The growth rate is much slower than

income-comparable catch-up economies. DP has a lot to do with perverse exchange rate policies

and weak institutions. Standard explanations abound: chronic fiscal imbalance, the high cost of

doing business, poor infrastructure, regulatory uncertainty, weak formal and informal institutions,

corruption, political instability, damaged culture, rapacious elites, flawed democracy, high discount

rate, etc. The explanations belong to either of four genres: resource-deficit, policy-deficit,

institution-deficit and culture-deficit. Some may be expressions of our genotype, which we can't

hope to change. Most of these deficits are phenotypic expressions, ultimately rooted in how

members of the Philippine collective make their choices (vote; allocate resources between present

and future; pay taxes, etc.) and craft political settlements (EPIRA, CARP, NFA, PDAF) in pursuit of

ends which are either aligned and re-enforcing, or conflicting and mutually undermining within a

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given environment. Phenotypes are adaptations to the environment. Dr Jose Rizal in The Indolence

of the Filipinos vehemently argued that indolence among Filipinos is strategic, thus, phenotypic. This

is the view that I embrace in this enquiry.

3. Is there a common thread running through many of these explanations? In pursuit of this thread, I

explore another layer of the proverbial onion: collective action failure (CAF). If a unified social

science is to happen, it will begin in the study of collective action: how members of a collective work

together to achieve ends that benefit all. And its language is Game Theory. We owe the collective

action concept to political scientist M. Olson (1965). CAF is the result of the incapacity of a collective

to transform collective action challengeses into collective surplus. The annals of underdevelopment

is painted on the canvass of wasted opportunities, not on the canvass of the paucity of resources.

Contrast two outcomes: one, a resounding collective achievement, the Three Gorges Dam; and the

other, a resounding CAF, the NAIA Terminal 3.

4. Collective action challenges (also social dilemma games) are social situations where the pursuit of

immediate individual gains by members of the collective leads to social outcomes that are inferior

for the collective as a whole. All public goods are collective action challenges: resources have to be

mobilized from members and public goods procured through a maze of principal-agent contracts

and over time. Without adequate public goods, A Smith’s Invisible Hand is chained. As K Arrow

observed, a vigorous market economy requires a “modicum of morality.” The Three Gorges Dam is

the embodiment of actualized opportunity and superior economic outcome. Think of the NAIA

Terminal 3 completed in 2002 but remains largely idle and decaying today. Think of the San Roque

Multi-Purpose Dam generating electricity but unable to irrigate 70 thousand hectares of agricultural

land for which it was also designed. Think of the LRT and MRT ─ still un-integrated and wasting

immense network externalities. Wasted opportunities all. Why in China and not here?

5. The state is the most important human artifact for the address of collective action problems in large

polities (T. Hobbes, J. J. Rousseau, A. Smith, J. Locke, P. Samuelson, M. Olson, R. Nozick). Small

polities where interaction is face-to-face, repeated, and multidimensional do evolve coherent “trust

groups” that solve CACs such as common resource management. The extensive research of E

Ostrom and her group as well as laboratory experiments bear this out. We are concerned here with

large polities. P. Samuelson (as well as M. Olson and going all the way to A Smith) showed that

private voluntary contribution among self-centric individuals will fail to provide adequate public

goods in large polities. Thus, the idea of the state. When the state is perfect, as is Samuelson's

benevolent central planner, the public goods failure (or any market failure) is solved promptly.

When the state is imperfect (Buchanan, Coase, the Public Choice revolution), government

interventions can become government failures – purveyors of waste and venality. How to transform

Hobbes’ Leviathan into Locke’s Commonwealth, that is, actually pursuing inclusiveness is the biggest

collective action challenge of our time. In the literature, the challenge is variously labeled as the

“acquisition of good institutions" (Rodrik) or the move from "limited access order" to "open access

order" (North, Weingast and Wallis). The failure of the Philippine collective to tame its own

Leviathan is a CAF of the first order.

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6. A Leviathan is flawed due to either benevolence-deficit or competence-deficit or both on the part of

the state. When non-benevolent, the state may intervene even when there is no market failure

purely for private gains (recall the NBN-ZTE scandal) or if there is a market failure, the intervention

is crafted to maximize private gains (recall the Fertilizer Scam or the Diosdado Macapagal Avenue).

Competence-deficit may be due in part to information-deficit and/or organization- and

management-deficit (recall the Telepono sa Barangay). It is difficult to separate incompetence (not

punishable) from pure venality (punishable). And even when venality is evidenced prima facie, the

arm of the law may be short and/or vendible (by scoundrels in robes).

7. In particular, in the case of a true public goods failure, the state intervention has first to collect the

tax and then to procure the good. In the first, the state's action may be ineffective (non-payment of

taxes remains the dominant strategy because the enforcement is weak which includes widespread

venality; in the second, the state intervention may be inefficient: either procures the good but at

enormous cost (the Diosdado Macapagal Avenue) or procures its grotesque substitute (the

Helicopter scandal; Loboc Half-a-Bridge; ghost delivery). When massive procurement failures mar

the state's Visible Hand, it may be better for society if the Hand is bound by collection failure, that

is, tax evasion may at times become both "ethically chic" for citizens and out-rightly welfare-

improving! (an instance of the theory of the second best). There is a lesson here on sequencing of

reform: Procurement reform must precede tax administration reform.

8. For Max Weber, mature and dynamic Capitalism is rooted on a rational state that renders the

economic environment "calculable." Investors take calculated risks but shy away when the risk is

incalculable. Today, we say that regulatory environment that protects property rights and enforces

contracts hastens investment and growth (Acemoglu and Robinson, 2011). In particular, it solves the

Investor's Dilemma: investors will balk if the danger of ex-post opportunism or ex-propriation either

by his partner or by the state is considerable. When minority investors are not protected they will

shy away. When the regulatory regime is weak, private ordering (O Williamson) can sometimes

substitute for public ordering. Ironically, in an unpredictable environment, private firms may seek

comfort under the cover of regulatory and/or state capture in order to invest. In weak governance

environments capture (even elite capture) may be the only way to crowd in investment. It is no

mystery why at the start East Asian miracle countries actually nurtured large business

conglomerates (Chaebols, Zaibatzus, Taipans) with special dispensations to do the investing. An

example of private ordering is full ownership (shunning partnerships or arms-length contracting. Full

ownership by a foreign investor can reduce the risk of misbehavior by local partners. If such is also

prohibited to favor local stewardship, they may be forced to find a "dummy" which may also be

illegal. If they persist, they descend into the murky twilight world of un-enforceable because illegal

contracts. The NAIA terminal 3 fiasco has roots in the constitutional foreign ownership limit. More

likely, with such red flags as the NAIA Terminal 3, foreign investors go elsewhere.

9. Because of their inability to punish perpetrators, weak states tend to take the easier way out –

outlaw policy instruments: we outlawed integrated power companies (unbundled) before the

regulatory environment for arms-length contracting is secure; we outlawed take-or-pay due to the

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IPP morass and government provision of power generators through EPIRA; we outlawed larger than

5-hectare land ownership and the market for land through CARP. We indulge in the mutilation of the

policy instrument space. Mao Zedong mutilated the policy space ("A socialist train that comes late is

better than capitalist one that comes on time") in the name of ideological purity and produced the

disastrous Great Leap Forward. Deng Xiaoping de-mutilated the policy space ("It doesn't matter

what color the cat as long as it catches the mice") and produced the PRC miracle! Still Deng was

lucky because he was riding an already strong state. In the Philippines, the starting block is a weak

state.

10. A weak state is a tenuous political settlement among diverse and mutually suspecting groups. The

reward for support is the award of virtual sovereignty over a state agency or a region (the

Ampatuans in Maguindanao). Since power has been abused in the past, groups are comfortable

with and nurture a weak center. Since a weak center cannot make credible commitments, it cannot

mediate inter-temporal and inter-group conflicts of interest. Thus small economically insignificant

projects celebrating the “Divide-by-N” allocation rule (PDAF, barangay roads, Salary

Standardization). Healing of the weak state is the great challenge of our time. In most LDCs, the

state weakness comes the rising tide of widespread mistrust coming from many past episodes of

betrayal. A strong state is capable of making credible commitments and, thus, can mediate inter-

temporal, inter-class and inter-regional conflicts of interests. It is able to lengthen investment

planning horizons.

Fukuyama uses the label "low trust society." I prefer the label "fragmented trust societies." The fund

of trust is conserved (not low); it is however highly fragmented having retreated to smaller and

smaller trust groups which people rightly think can nurture their aspirations. Thus, the Ampatuan

clan; thus, the Iglesia ni Cristo; thus, the Greek letter fraternities). Small groups in fragmented trust

societies can very coherent. They are also mostly exclusivist. The state, the embodiment of society

at large, is distrusted. Competing groups want their share "now" because the state cannot

guarantee a fair redistribution later.

In the paper, we introduce the Ostrom-Kabayanihan Space (OKS): that circle of people with whom

an agent's dominant strategy in a collective action game is always "cooperate" (versus “defect”

against non-members). The radius of the OKS is defined by the trust/belief that among the included

members, betrayal is highly unlikely. We normally call them “clans.” In other words, the OKS defines

the boundary of the agent's trust group. Japan and Denmark are examples of polities where the OKS

of citizens may be said to encompass most of the nation. They are like "ferromagnets" (all electron

spins are aligned) poised for action. The Philippines is not in that league. When trust is fragmented,

society becomes incoherent. It cannot be trained towards large projects. It is all the more important

in incoherent societies that the state becomes credible so it can enforce formal contracts among

members of different trust groups.

11. Where do we start arresting the feckless state? Weak states are as a rule overloaded with too

many commitments (NFA, CARP, OPSF in the past, etc.) far in excess of the number it has financial

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and/or expertise/integrity resources to implement well. It thus becomes for its people the purveyor

of waste, white elephants and venality. The first step towards a more effective state is a strategic

retreat from the most egregious failures (NFA today and OPSF in the past). The state must do fewer,

more fundamental things better based on competitive advantage. It is not from Hayek and Nozick

(state size ideology) that my vote goes to a limited state but from Deng Xiaoping (pragmatism). The

size of the state does not matter as long as it is efficient! The second step is adopting simpler

modalities to pursue the same ends (low uniform income tax to reduce discretion). CCT is the

simpler safety net modality (with emphasis on "Conditional"). A replacement for CARP to attract

private capital to agriculture and enhance farm productivity is urgent. The third step is enlisting the

market to do things it can do better (PPP is correct). We have done that in water distribution in

Metro-Manila and retreated from OPSF to great benefit. With a pared down agenda, each

commitment will be done better what with larger budgets, higher salaries and more focused

attention. The Deng Xiaoping-inspired rule is: Render unto the state everything that the state can do

better by virtue of comparative competence; outsource everything else! But doing these goes against

the grain of all traditional politics. We badly need a state capable of swimming against the tide. We

need to recapture the commanding heights of politics for trust.

12. We need to re-consolidate trust. Trust will return to the political center when the state ceases to be

seen as the breeder of betrayal and becomes instead its nemesis. Prosecuting and jailing

perpetrators of procurement betrayals is sine qua non first step of this arduous journey. Which is

why returning the judiciary to its original mandate of enforcing accountability is task one.

Institutionalizing accountability and transparency is the close second. The removal of Renato Corona

as CJ was an immense "conjuncture" we have no right under heaven to waste. Events of the last

few months (rising global credit and governance ratings, “the next big thing”) suggest we are

witnessing the birthing of a positive perception cascade when the flapping of butterfly wings can

become a gale. This has the making of a singular collective opportunity. Would that we all join in

the flapping of the wings!