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

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 Constitution 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


                                                              1
A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom
                                                                                                    August 2012
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.




                                                              2
A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom
                                                                                                      August 2012
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
                                                                                                                        1
restrictive. Some of our neighbors like Malaysia and Vietnam have already been included in the ongoing negotiations , 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                                         th
 Latest updates have reported that the 13 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

                                                                   3

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FEF- A synopsis on the policy paper concerning the charter change issue

  • 1. A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012 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 Constitution 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 1
  • 2. A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012 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. 2
  • 3. A synopsis on the preliminary policy paper prepared by the Foundation for Economic Freedom August 2012 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 1 restrictive. Some of our neighbors like Malaysia and Vietnam have already been included in the ongoing negotiations , 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 th Latest updates have reported that the 13 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 3