Vietnam overtakes the Philippines. How did this happen?

by Andrew J. Masigan (The Philippine Star), 4 Nov 2020

Alas, Vietnam, a backwater communist country just 40 years ago, has overtaken us in terms of per capita income. The Philippines, once the star economy in the 50’s and 60’s, has fallen behind in the region’s development race and is now only wealthier than Cambodia, Laos and Myanmar.

The International Monetary Fund reported that Vietnam’s per capita income will rise to $3,500 by yearend, surpassing that of the Philippines which will remain stagnant at $3,380. Since Vietnam adopted its Doi Moi policies in 1986 (Doi Moi policies consist of reforms meant to transform Vietnam to a market driven, socialist economy), the Vietnamese economy has grown at an average rate of 6.5 percent over 33 years. The Philippines, whose economy was 12 percent larger than Vietnam 33 years ago, grew by an average of only 4.6 percent.

There is a universe of reasons why the Philippines has lagged behind. But if I were to put a finger on the main culprit, it boils down to the Philippines’ failure to industrialize.

See, Vietnam pursued industrialization by attracting foreign capital, by building its manufacturing competencies and by exporting its way to prosperity. Vietnam’s government was so astute that it created the right conditions for foreign investors to thrive. This included a competitive tax structure, less bureaucratic red tape, stable government policies, less corruption and the development of upstream and downstream supply chains. It was admittedly weak in infrastructure when it started, but lately has accelerated infrastructure spending to 8 percent of GDP.

In a span of three decades, Vietnam has become the preferred destination for multi-national corporations for its favorable investment climate, its manufacturing competence and relatively cheap production cost. Vietnamese exports grew by an average rate of 16 percent for decades, while that of the Philippines grew by half that rate. Vietnam bagged $112 billion worth of foreign direct investments from 2010 to 2019, while the Philippines attracted only $57 billion. No surprise, as of 2019, Vietnam’s merchandise exports topped $300 million while the Philippines’ was only at $70 million.

The Philippines, on the other hand, relied on its population to drive growth. Following the wave of sound economic reforms by FVR, the administrations of Erap and GMA did little to attract foreign capital and build the manufacturing sector. Instead, it relied on remittances from Filipinos working abroad. While exporting workers came with high social costs (e.g. separation of families and brain drain), it proved convenient as it eased the pressure on unemployment whilst providing the economy with valuable foreign exchange.

Exporting our people was easier than instituting reforms to make our environment more conducive to doing business. It was certainly easier than curbing corruption, streamlining the bureaucracy, opening industries to foreign competition and addressing expensive power cost, etc.

By the time GMA left office, OFW remittances constituted 9.35 percent of GDP, making it one of the principal sectors that kept the economy afloat. The economy grew by an anemic 2.5 percent during Erap’s watch and by a lackluster 4.9 percent during GMA’s time.

Still banking on our population, PNoy’s administration accelerated the development of the IT-BPO industry. IT-BPOs quickly developed into a strong leg of the economy, such that by the end of PNoy’s term, the industry generated some $26 billion in revenues and employed 1.4 million of the workforce. OFW remittances, coupled with the incomes derived from the IT-BPO industry, caused household incomes to rise and developed a new middle class.

PNoy’s greatest contribution, however, was fiscal discipline. On the back of a fastidious campaign to collect taxes coupled with belt tightening measures, the country’s fiscal position improved to a point where credit rating agencies classified our debts as investment grade. PNoy relied on private-public-partnerships (PPP) for infrastructure development.

Average GDP growth during PNoy’s time accelerated to 6.1 percent. And because the Aquino narrative of good governance resonated well abroad, foreign direct investments posted an uptick, as did the manufacturing sector. The uptick, however, was not significant enough to drive growth.

President Duterte’s economic managers built on the advancements of PNoy’s administration. With rising household incomes, consumer demand became an even more important driver of the economy. And because our debts were classified as investment grade, government could borrow at favorable interest rates. This allowed it to embark on its ambitious infrastructure program.

On the back of household consumption and government spending, the economy grew by 6.7 percent, 6.2 percent and 5.9 percent for the years 2017, 2018 and 2019, respectively. The declining pattern is indicative of an economy growing beyond its true capacity.

The unfortunate reality is that our economy is not structured in a way that allows 7 percent growth. Ours is an economy driven by consumer demand and government spending, not by production. Thus, government needs to spend more to squeeze more growth out of the economy – but doing so would mean acquiring more debt.

However, our economic managers are not inclined to increase the country’s debt stock, as doing so may compromise our investment grade status. The last the Duterte government wants is to end its term with a credit rating inferior to what it inherited from PNoy.

It therefore comes as no surprise that despite an anticipated economic contraction of 9 percent this year, government allotted the lowest stimulus package in the region amounting to just 5.83 percent of GDP. For context, Vietnam’s stimulus package amounts to 10.12 percent of GDP. This means the Philippines will be left further behind in 2021 and 2022.

Our hope is that the leaders elected in 2022 will make that long overdue shift in economic policy.

The new leadership must curate the conditions to allow the millions of low income workers in the agricultural, hospitality and retail sectors to migrate to more sophisticated jobs in the manufacturing or technical services sector. When this is done, the country will naturally shift from being an economy driven by consumption and government spending to one driven by production. A national program must be carried out to widen our industrial base and expand the range of products we can competently produce. We must then climb the value chain in technological complexity, uniqueness and quality.

In short, the next leader must foster an era of rapid industrialization and it must be made a national priority. It starts with fundamental reforms to make our environment more conducive for manufacturing. Unless we pivot to industrialization, we will soon find ourselves falling further behind the development race.