Philippine Competitiveness Ranking Plunges! How the Crowding Out Strains Economic Competitiveness: The Construction Industry

Free competition is worth more to society than it costs—Oliver Wendell Holmes Jr., American jurist and Associate Justice of the Supreme Court of the United States 

In this issue

Philippine Competitiveness Ranking Plunges! How the Crowding Out Strains Economic Competitiveness: The Construction Industry

-How the Crowding Out Strains Economic Competitiveness

-How "Build, Build and Build" Crowds out the Domestic Construction Industry

-How Raging Construction Prices Increase the Risk of Accidents

-The Cantillon Effect: Eroding Competitiveness form a Massive Shift of Economic Factors to the Government

-The Cantillon Effect: Hasn’t Sustained Price Instability Been a Source of Loss of Competitiveness?

Philippine Competitiveness Ranking Plunges! How the Crowding Out Strains Economic Competitiveness: The Construction Industry

How the Crowding Out Strains Economic Competitiveness

According to the World Competitiveness Ranking Report in 2018, published by the Switzerland-based business school International Institute for Management Development, the Philippine economy experienced the most significant decline in the region.

The report indicated that the Philippines slipped to 13th place from its 11th ranking in 2017 among 14 Asia-Pacific nations. Even worse, the country’s ranking tumbled by a shocking 9 notches to the 50th spot from the 41st place in 2017 out of 63 economies tracked, as reported by Philstar (May 24, 2018)

Reasons cited were the “worsening” tourism, employment and public finances, as well as concerns about the country’s education system.

Competitiveness represents the third order of priority in the Duterte’s 10-point social agenda: “Increasing competitiveness and the ease of doing business, drawing upon successful models used to attract business to local cities such as Davao, as well as pursuing the relaxation of the Constitutional restrictions on foreign ownership, except with regards to land ownership, in order to attract foreign direct investments”

The report has excluded a critical factor behind the administration’s failure to meet their goal of improved competitiveness.

More precisely, the crowding out syndrome diminishes competitiveness.    

The crowding out dynamic exhibits that when the government draws resources, labor, and finances away from the private sector,such distorts the allocation of capital goods from a higher to lower value uses. Or more precisely, economic activities shifts from production to consumption. 

And there’s more.

The crowding out syndrome translates to the burgeoning share of the economic pie by the government. And when the government becomes the dominant economic force, the overshadowed private sector won’t just have to deal with reduced availability of higher-priced resources but suffers from a loss of productivity as well.

Thus, the loss of competitiveness signifies a natural outcome of a government growing bigger and faster than the private sector. Plainly put, the crowding out dynamic equals a LARGER government and a SMALLER private sector

How "Build, Build and Build" Crowds out the Domestic Construction Industry

The crowding out is not just a theory

This anecdote from a January Bloomberg report wonderfully demonstrates the crowding out dynamic in motion (bold mine)

The labor gap has already caused some project delays in the private construction industry, leading to an increase in home and office prices, said Joey Bondoc, research manager at Colliers International Philippines in Manila. Of the 16,200 additional residential units that Colliers expected in Manila last year, only about 7,400 units were completed in the first three quarters.

The result will be a bidding war for construction workers, says Budget Secretary Benjamin Diokno. “Companies should be willing to adjust their wage rates,’’ he said.

To ease the shortage, the state agency Technical Education and Skills Development Authority is training more building workers and engineers.

“Tesda in the past six years failed to train construction workers and zeroed in on the service industry such as hotels, food and business process outsourcing,” said Ibarra Paulino, executive director at the Philippine Constructors Association Inc., a group of about 130 large building contractors.

But the Philippines isn’t the only place that needs more builders. In Japan, where wages are much higher, Tokyo is in the middle of preparations for the 2020 Olympic Games. Singapore is doubling the size of its mass transit system, while Indonesia, India and Malaysia are all on infrastructure drives to boost growth.

To fill vacancies, some Philippine developers are retraining employees or hiring more laborers from the countryside. Others, like 8990 Holdings Inc. are setting up their own training facilities for masonry, carpentry, welding and crane operation.

You see the cost of government taking resources away from the private sector?

The government is driven by political objectives. In contrast, profits and losses spur most of the private sector activities. The differences in incentives reveal that there is no contest for the private sector when confronted with an institutionalized monopoly.  The flow of labor and resources will represent a lopsided activity in favor of the government. Thus a bidding war is a mirage.

Proof?

Figure 1

The Bloomberg report has not just been an account signifying the current economic backdrop if government statistics is to be believed, that January narrative has been transposed to 1Q 2018 GDP.

Real GDP (RGDP) for the construction sector grew by 9.3% which was led by the public construction at 25.1%. Private construction accounted for a 6.8% RGDP. (Figure 1 Lower window) It is unclear whether the reported private construction GDP represents purely private sector undertaking or if it includes Public-Private Partnerships (PPP) projects. I suspect the latter. Nevertheless, public sector growth has outpaced the private sector by 269%.

Competition for resources has been heavily skewed in favor of the government. Based on the Philippine Statistics Authority’s Construction Material prices, wholesale prices, which represent government prices spent on its projects, has rocketed to 7.51% in April whereas reported the private sector retail prices grew by only 2.55%. That government prices have clocked in a whopping 194% increase more than the private sector validates the Bloomberg’s chronicle.

And if I am not mistaken, rising private sector construction material retail prices have hardly been about actual construction activities but about the spillover effects from shortages created by the massive boom in public construction.

And if my suspicion is accurate, higher prices will not only suppress private construction activities, ballooning cost overruns will force marginal players out of the playing field due to accruing losses.

The crowding out syndrome reveals the process of centralization of economic activities as the private sector becomes marginalized in favor of the government and government-sponsored activities.

With a smaller, less productive private sector, how can the economy be competitive?

How Raging Construction Prices Increase the Risk of Accidents

For the public sector, two potential consequences from higher prices:  If the projected costs of the construction projects are variable, higher prices mean higher project costs which also extrapolates to larger public expenditures. And expanded public spending entails more debt and or more BSP liquidity infusions.

However, if the project costs are fixed, then costs overruns may translate to a scrimping of costs through the use of inferior materials for construction. The result would be the emergent accounts of accidents, such as the collapse of concrete beams in the ongoing construction of a flyover in Imus City in the third week of May.

Last February, the Indonesian government suspended some infrastructure projects due to a string of accidents. One of the key reasons for such accidents has been due to the omission of standard procedures “to lower the costs”.

The higher the prices, the greater the odds that public projects will be built on inferior quality, thus heightening risks of mishaps.

Of course, the more the government expands, the greater the odds of corruption.

The Cantillon Effect: Eroding Competitiveness form a Massive Shift of Economic Factors to the Government

And that’s not all. 

Skyrocketing of wholesale construction material prices showcases the Cantillon Effect. The great Irish French economist Richard Cantillon theorized of the relative effects of money on the economy.

As Austrian economist Mark Thornton observed*

Cantillon showed that changes in the quantity of money could have several different types of real effects on production, investment, consumption, and trade depending on who first received the money; effects now labeled Cantillon effects, injection effects, or first-round effects.

*Mark Thornton CANTILLON ON THE CAUSE OF THE BUSINESS CYCLE THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 9, NO. 3 (FALL 2006) p.49

The first recipients of new money benefit from current prices, thereby enjoying higher standards of living that come at the expense of later recipients, who signify the later chain of spending thus pays for higher prices – hence the lower standard of living.

Applied to the current setting, the government IS the first recipient of the new money.

It uses money raised mostly from debt and from the BSP to finance its massive construction projects, by bidding up construction material prices (and labor) way above the ability of the private sectors to match them. Deficit spending says tax revenues account for the last chain of the government finance.

Whereas Cantillon posited that the chain of spending from first to the later recipients would cause the later to acquire at higher prices, when the government accounts for the original recipients this may lead to a different scenario

Because governments are not driven by profits and losses but by political imperatives, they are less sensitive to prices.

In the current environment, spending on infrastructure to account for 5% of the GDP represents the fourth priority of the Duterte regime’s 10-point agenda. In the relentless pursuit of such goal, the national government has signified the PRIMARY factor in powering inflation furiously in the construction sector. The gaping gulf in construction wholesale and retail price inflation underscores this dynamic.

The government’s response to vacillating political priorities exquisitely highlighted by the Bloomberg report: “Tesda in the past six years failed to train construction workers and zeroed in on the service industry such as hotels, food and business process outsourcing,” said Ibarra Paulino, executive director at the Philippine Constructors Association Inc., a group of about 130 large building contractors.

Nonetheless, Cantillon showed that the injections of money would have real effects on production, investment, consumption, and trade and on relative prices.

The Bloomberg narrative exhibits how domestic labor has been evolving to meet with such political goal.

The public construction industry has been absorbing private sector construction labor, as well as laborers from the countryside. Part of the migration to the construction industry includes sugar farmers as discussed in March. [See Bullseye! Crowding Out Effect in Motion: Sugar Farmers Move to the Construction Industry! Excise Taxes: Will Sardine Manufacturing Be the Next Coca-Cola? March 5, 2018]

Labor movements can be indicative of changes in production, investment, consumption, and trade patterns.

The absorption of laborers to the “build, build and build” industries translates to labor shortages elsewhere. Wouldn’t labor strains percolate eventually to output and investments as well?

Have escalating imbalances been worsened by the NG’s Spend Spend and Spend programs not limited to the “Golden Age of Infrastructure”?

Hasn’t the massive change in the nation’s economic structure been a critical source of the loss of economic competitiveness?

The Cantillon Effect: Hasn’t Sustained Price Instability Been a Source of Loss of Competitiveness?

As for the relative prices, here is Murray Rothbard on Cantillon’s theory, [Murray N Rothbard Richard Cantillon: The Founding Father of Modern Economics Mises.org]

“relative prices will be changed in the course of the general price rise, because the increased spending is "directed more or less to certain kinds of products or merchandise according to the idea of those who acquire the money, [and] market prices will rise more for certain things than for others." Moreover, the overall price rise will not necessarily be proportionate to the increase in the supply of money. Specifically, because those who receive new money will scarcely do so in the same proportion as their previous cash balances, their demands, and hence prices, will not all rise to the same degree.

The point of the above is that prices will not rise at the same time. Where new money has been spent is where price pressures will occur

And because of the NG’s programs, the most significant price spikes have emerged primarily in the construction and its ancillary industries

Figure 2

But other sectors with the government’s fingerprints on it have also seen an infusion of new funds.

Aside from construction loans which vaulted +30.02% in April, bank lending to the education +41.23%, public administration and defense +29.61% and transport and storage sectors +30.93% outperformed substantially in April. (figure 2, upper window)

Recall that the NG has instituted free college education in and a Php 2.2 billion Public Utility Vehicle Modernization program in 2017. These sectors have seen credit growth ramped up significantly.

Curiously, banking loans to the hotel and food industry growth plunged to +1.16% in April. Has this reflected “worsening” tourism from the war on Boracay which became a drag on the nation’s competitiveness? 

Shall we see negative numbers in the coming months for this sector?

Loans to the trade industry +22.71% rocketed in April. Curiously, consumer borrowing (+19.05%) continues to soften with all subsectors slowing. Even the once-hot credit card growth (+21.03%) appears to have peaked out. Has rising rates begun to bite?

So while the consumer demand side loans have been moderating, the consumer supply side or retail loans continue to fly.

So what gives? Income tax cut will juice up spending? Really? With “spend, spend and spend” financed by the BSP and by banking system raising prices, whatever benefits those tax cuts has provided would have a very short window.

Besides, with the NG siphoning away resources from the private sector, what would be the means left for consumers to spend?

With economic calculation muddled by pervasive political intrusions, how will entrepreneurs profit and increase productivity from such a landscape?

And hasn’t sustained price instability been a way to lose competitiveness?

In socialist societies, competitiveness in the economic front is hardly a concern. However, competition for power signifies the paramount agenda.