Capitalism and Inclusion Under Weak Institutions 2018 Online

Capitalism and Inclusion Under Weak Institutions 1
Capitalism
and Inclusion
Under
Weak Institutions
Capitalism
and Inclusion
Under
Weak Institutions
RAUL V. FABELLA
University of the Philippines

CENTER FOR INTEGRATIVE AND DEVELOPMENT STUDIES
6
Published by the
UNIVERSITY OF THE PHILIPPINES
CENTER FOR INTEGRATIVE AND DEVELOPMENT STUDIES
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Magsaysay Avenue, University of the Philippines
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Copyright 2018 by UP Center for Integrative and Development Studies

and Raul V. Fabella
No copies may be made in part or in whole without prior written permission

from the author and the publisher.
The National Library of the Philippines CIP Data
Recommended entry:
Fabella, Raul V.
Capitalism and inclusion under weak institutions / Raul V.
Fabella.. — Quezon City : University of the Philippines, CENTER FOR
INTEGRATIVE AND DEVELOPMENT STUDIES, [2018], c2018. pages ; cm
ISBN 978-971-742-116-2
1. Capitalism – Philippines. 2. Conglomerate corporations.

3. Economic development – Philippines. 4. Deng Xiaoping.
5. Public goods. 6. Infrastructure (Economics) I. Title.
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COVER AND BOOK DESIGN: Ariel G. Manuel
Printed in the Philippines

To Teena and Vigile

CONTENTS
Introduction ................................................................................................................ 1
Part I CAPITALISM AND INCLUSION
1 Inclusion and the Role of the State in

Orthodox Economics and Beyond................................................................. 17
2 Deng Xiaoping vs. Mao Zedong: PRC as Natural Experiment ................. 24
3 Low-Income Countries and Collective Action ............................................ 31
4 Social Incoherence and the Poverty of Public Goods ................................ 38
5 Credible Commitment Devices and Public Goods
in Weak States ................................................................................................... 51
6 Economic Stagnation, Development Progeria
and Inclusion ..................................................................................................... 57
7 Decompressing Investment in the Philippines ............................................. 68
Part II CONGLOMERACY AND INCLUSION
8 Conglomerates and Conglopolistic Competition ........................................ 77

9 Conglomerates, Consumer Welfare and Collective Action ........................ 84
10 Where Do We Go From Here and How? ..................................................... 93
11 Recapitulation .................................................................................................... 99
Appendix .................................................................................................................. 106

References ................................................................................................................ 108
Index ......................................................................................................................... 114
10
ACKNOWLEDGMENT
THE AUTHOR THANKS the Ayala Corporation-University of the Philippines

School of Economics (AC-UPSE) Economic Forum for its financial support
of this work. This volume could not have come to life without the unstinting
moral and editing support of Dr. Ma. Cristina “Teena” B. Fabella. Dr.
Emmanuel “Noel” de Dios, Dr. Joseph “Dockoy” Capuno, Dr. Geoffrey “Jeff ”
Ducanes, Dr. Sarah Daway-Ducanes and Mr. Romeo “Romy” Bernardo
provided wellsprings of continuing stimuli and interrogation for which the
author is deeply grateful. All errors are the author’s alone.
INTRODUCTION
The Crisis of Inclusion in Capitalism

CAPITALISM is under siege. It is embroiled in the crisis of inclusion (Rodrik,
2017; Smith, 2017). Capitalism is an ugly duckling difficult to be enamored
with except if you’re fitted with Ayn Rand (1964) lenses. A regime that thrives
on ‘creative destruction’ and whose popular image is linked with Gordon
Gecko’s “Greed is good” is likely to be more hated than loved. Since 1848,
when Marx and Engels issued the Communist Manifesto, the end of Capitalism
has been periodically announced, especially in the aftermath of economic
crises. But news of Capitalism’s demise has invariably proven premature.
Capitalism has a resilience that provokes curiosity. It continues to evolve
new varieties which survive and thrive after every crisis, while its detractors
and loud pretenders have eaten its dust. The overlaying phenotypes change,
but the underlying genome remains.
The very first sentence in the great Joseph Schumpeter’s (1976)
Capitalism, Socialism and Democracy written in the wake of the Great
Depression was: “Can Capitalism survive?” The very next sentence was his
answer—an emphatic “No.” Was he dead wrong as history seems to suggest?
No. Rather he was both right and wrong. Right because the Capitalism of his
day (Laissez-faire Capitalism or the Robber Baron Capitalism) no longer exists
today in the West; wrong because although sporting differentiated traits, the
offspring of Capitalism abound today: the social market economy (Germany),
the welfare state Capitalism (Sweden and Denmark), Chinese characteristic
Capitalism (PRC), the Wall-Street-driven Capitalism (USA). Wrong as well
because both the Entrepreneurial Capitalism with which he was enamored
and its nemesis, Bureaucratic Capitalism, which he disdained, are still with
us today. Mega corporations, such as Walmart, coexist with—and are under
threat from—start-ups that are spawned in carports and emerge as Amazons.
1
212 Introduction
Be that as it may, the twentieth century cannot be completely understood

if divorced from the protracted struggle between the Wealth of Nations-
inspired efficiency first ethic and Das Kapital-inspired equity first ethic. This,
as everyone now knows, culminated in the collapse of the flag carrier and
armada of the latter in 1989. Capitalism’s triumph over the Socialist challenge
points to one very important feature of the Capitalist genome: it allows
experimentation with Darwinian selection among the different phenotypes.
These phenotypes survive side by side because economic, socio-cultural and
physical environments abound and economic efficiency cannot be divorced
from—and must adapt to—these environments. For example, the oil crisis
in the 1970s raised the competitiveness of the energy-scarce Japanese
economy and its energy-economizing small car industry.
In contrast, Socialism—as we saw it practiced over the twentieth
century—was always overshadowed by the imperative of ideological purity;
it always trembled at the prospect of economic innovation undermining the
Socialist order. This should not have been a surprise as the logical corollary
of the Marxist doctrine of Economics as foundational to society. True, there
were experiments with varieties of Socialism, but these were quickly
suppressed by tanks and bullets; the Prague Spring was crushed by Soviet
tanks; the innovating Deng Xiaoping in China in the 1960s was labeled a
‘capitalist roader’ and silenced. This fear of variety was crucial to the collapse
in 1989 of the Socialist challenge; it became the great burden that finally broke,
as it were, the camel’s back. Why this same fate failed to befall the People’s
Republic of China (PRC), long in the phalanx of the Socialist challenge to
Capitalism, is a compelling story which will concern us in chapter 2.
Although the events of 1989 in the minds of many put finis to Socialism
as praxis, the inclusion imperative did not fold its tent and slink away.
Capitalism was never allowed to forget its soft underbelly.
Varieties of Inclusion:
Poverty Incidence vs. Income Inequality
That income inequality came—and remains— to be the dominant arena
of the failure of inclusion in the high-income and developed West is logical;
abject poverty in the West even in the 1970s has largely been routed. But
abject poverty is the face of the failure of inclusion in low-income countries.
This acute disparity in abject poverty incidence between the high-income
West and low-income countries finds expression in the immigration crisis

now plaguing Europe and the USA and rending its political fabric.
That the face of inclusion failure in low-income countries is abject poverty
is the judgment as well of the United Nation’s MDGs from 1990 to 2015 and
its successor SDGs to end in 2030. The MDGs managed to attain its target
of halving global poverty incidence (at $1.25 cutoff) by 2015. But three-fourths
(3/4) of this gain was made in the People’s Republic of China (PRC), which
achieved a poverty incidence reduction of from 64% in 1990 down to 4% in
2015. Roughly 600 million Chinese have crossed the poverty threshold since
the 1980s. The Philippines is one of the few that failed to hit the target of 17%
or half the poverty incidence of 34% in 1990, attaining instead only 26% in
2015. The SDGs now target zero poverty incidence by 2030.
The UN MDGs and SDGs have set no target for income inequality, which
reflects the fact that the relationship between income inequality and other
MDGs is unclear at best. Although admittedly flirting with the extreme and
employed here only for rhetorical effect, the Tagalog term that may apply to
the role of income inequality in low-income countries seems to be saling-pusa1.
The Kuznets Inverted U Hypothesis, or what’s left of it, says that income
inequality should first rise with higher per capita income, reach a peak and
then start to fall in later stages as per capita advances further (tracing as it were
a curve that looks like an inverted U) and thus need not worry us; higher
income inequality is a by-product of income growth. Berg and Ostry (2011)
gave evidence to the effect that longer duration economic growth tends to
associate with jurisdictions exhibiting more equitable income distribution. It
is not clear from Berg and Ostry whether longer-duration growth spells bring
about better income equality, or the other way around. Berg and Ostry lean
towards the latter view when they argue that higher income inequality may
trigger social unrest and/or bar the poor from human capital accumulation,
either of which can shorten the growth spells. I tend to believe that there is
a feedback loop at work, and that sustained growth leading to less income
inequality is the more compelling. It is generally given that the relation between
income inequality and economic growth is poorly understood. But deliberate
redistribution (redistribution by fiat) is another matter again. Forbes (2000)
and Banerjee and Duflo (2003) interpret their evidence as showing that
redistribution hurts income growth. It is best to adopt policies that both reduce
1 The saling-pusa flits around like everyone else in the game, but the score is unaffected.
414 Introduction
poverty incidence and reduce income inequality. But many policies, especially
redistribution by fiat, may actually hamper economic growth and poverty
reduction. In this volume, we will zero in on a policy regime that serves both
poverty reduction and better income distribution.
In the case of PRC in the era when poverty incidence tumbled by leaps
and bounds, income inequality (measured by the Gini ratio) rose from 31%
to 42%. This same era saw Chinese dollar billionaires (the ‘Jack Ma
phenomenon’) emerge and hit the world stage. Could this phenomenon
render the China miracle fragile? We don’t know, but neither is anyone
wagering good money on that possible vulnerability. So far, it has proven
robust. The tempest will come howling as it always does in Capitalist
economies, but by that time, PRC shall have attained a level that allows it
to ride the storm. Instead, the ‘Jack Ma phenomenon’ may be argued to have
helped rather than impede poverty reduction in China. If so, I call it a fair
exchange! Not only that, it echoes as well the idea that some social distinctions
possibly advance ‘common utility’ found in the US Constitution (1779):
Social distinctions can be based only on common utility.

- Declaration of Human Rights and the Citizen, 1779
This is not an endorsement of De Mandeville’s The Fable of the Bees where

inequality always manages to be inclusive while equality equates with social
misery. That not all social distinctions advance the common utility is implied
by the statement. As in China (PRC), the Robber Barons emerged during the
Gilded Age of the USA when it caught up and even overtook Old Europe; the
robber barons and their fabulous wealth may be argued to be in the service
of common utility opening up opportunities for struggling immigrants like
Andrew Carnegie. If fabulous wealth were a sin in each of these cases, it would
be, in the book of St. Thomas of Aquinas, a sin whose complete suppression
prevents a lot of good! (“…multae utilitates impedirentur si omnia peccata
districte prohiberentur”: also quoted in Hayek, 1988). If you had doubts about
Aquinas being a genius, this line should put that uncertainty to rest.
There is of course a genre of inclusion that is interesting as a warning
for policymakers, that is, inclusive poverty. This seems to have been the
outcome of many a socialist regime, including that of Mao Zedong’s China.
Deng Xiaoping is said to have quipped referring to Mao’s China with his
usual playful venom, “I do not want to redistribute poverty.” But the allure
of romantic Socialism did not expire in the momentous year of 1989 when
the Berlin Wall crumbled. It persists today under various guises, say, in the
so-called Bolivarian Revolution of Hugo Chavez and now of Nicolas Maduro
in Venezuela. In a smaller way, the Comprehensive Agrarian Reform Program
(CARP) in the Philippines since 1988 which created a new class of rural
people, the ‘landed poor’ (Fabella, 2017a) echoes this romantic Socialism. If
there is a thread common to all these, it is the belief that forcing wealth and
income equalization will lead to poverty reduction. False, and tragically so.
Inclusive poverty is the unerring progeny of such programs. Different
approaches to wealth and income equalization had very different effects on
the welfare of poor households, as shown by India (Besley and Burgess, 2000;
Fabella, 2017a). The best result came from legally changing the sharing rules
on distribution of the land’s product in favor of the tenant but keeping share
tenancy system itself, and the worst result came from the redistribution of
land to the tenants precisely as in CARP.
The takeaway here is that for low-income countries, poverty reduction
should be the obsession of policymakers. And revisiting the natural
experiment that was Deng’s China is the first step. As observed, the greatest
gain in poverty reduction in the MDG era occurred in the PRC. This
deserves ruminating over even if only to whet one’s curiosity. What PRC
has to teach us regarding the tradeoff between income inequality and
poverty reduction is valuable. That is what we tackle in chapter 2.
A Bird’s Eye View for the Time-Challenged

Time is a precious commodity and some of us do not have the luxury
of leisurely perusal. This section of the Introduction is designed for time-
challenged readers.
This enquiry proposes to tackle an ambitious project without being
lengthy: to imagine Capitalism in third world countries (market economy)
that is at once efficient and inclusive. Along the way, the central problem of
weak institutions has to be faced squarely. In Part I, we start with
contemporary Capitalism facing an inclusion crisis in the affluent first world;
the whys and wherefores being hot issues. Piketty (2013) fired the most
significant recent shots at contemporary western Capitalism as a natural ally
of exclusion and a rampantly growing one at that. Piketty’s broadside is about
inclusion as growing income inequality especially in mature high-income
616 Introduction
economies of Europe and the USA. Marx and Engels’s condemnation against
Capitalism (they called it bourgeois economy), by contrast, is about progressive
impoverishment of the masses or abject or absolute poverty. The former does
necessarily imply the latter. Marx and Engels saw no hope except in the
complete rejection of Capitalism and its replacement with Communism
following the revolt of the masses. Piketty sees hope in state intervention
in the form of more aggressive wealth and income taxation.
Chapter 1 touches on Neo-Classical Economics, the workhorse of
textbook economics, which has long struggled with the problem of reconciling
efficiency and equity. Socialists have accused the Economics orthodoxy and
rightly so of celebrating economic efficiency to the neglect of equity; they
proposed the state ownership of the means of production and central planning
as the friendlier route to equity. How? The debate raged with the Lange-Lerner
theory proposed by Oskar Lange in 1936 and elaborated by Abba Lerner and
others which states that if the state controlled capital allocation, then central
planning can replicate all that an efficient market can deliver but without
growing inequity, since all profits are socialized. Orthodox Economics
countered with the Second Fundamental Theorem of Welfare (SFTW). SFTW
states that a proper reallocation of initial assets (preferably with lump sum
taxes that it assumed did not alter preferences), then any feasible Pareto efficient
allocation can be reached by the market exchange including those that satisfy
the social norms of equity. This mathematically beautiful result stood on a
very strong set of—and empirically implausible—assumptions that include
homo economicus and no market failures. Nonetheless, orthodox economics
had succeeded with the SFTW in creating a firewall to the satisfaction of acolytes
between equity and efficiency. Equity was the concern of Politics and
Philosophy; efficiency was the interest of Economics.
This divide is exemplified by the political philosopher John Rawls’s (1971)
attempt to ground equity on the democratic voting under the veil of ignorance.
With the SFTW, orthodox academic economists can now indulge their fancy
at erecting the formal economic edifice unfettered by the awkwardness of
possible unfairness that is rooted in the politics of power and influence. When
the Visible Hand had to be resorted to, as was evidently required in the public
goods market failure, the state acting as P. Samuelson’s ‘benevolent central
planner’ (“benevolent, omniscient, omnipotent,” as A. Dixit characterized it)
was the only politics allowed. It was of course delusional. The emerging Neo-
Classical edifice became the Economics of what reality should be, not the
Economics of the reality as it is. The Public Choice revolution starting in 1960
with R. Coase’s (1960) The Problem of Social Cost was an attempt to break out
of this mental straitjacket, but it took another fifty years to really make its
mark. Finally, with North, Williamson, Acemoglu and Robinson leading the
charge, came the reluctant recognition that ‘institutions matter’ by mainstream
economics and practitioners in multi-lateral institutions.
We discuss here the reliance of orthodox economics on strong
institutions to clinch its central tenets, such as the fundamental theorems
of welfare and how it implicitly banished the idea of the state from the market.
With any incompleteness of markets, however, the state automatically enters
as part of the efficiency equation. The Greenwald-Stiglitz theorem
demonstrates that whenever there is any incompleteness or any missing
market, the state can use taxes to improve social welfare. And incompleteness,
especially information-based incompleteness, is ubiquitous. Stiglitz even
views it as the norm. With the persistent empirical broadsides and powerful
imaging tools from Cognitive Science and from Evolutionary Biology,
Economics can no longer ignore the reality that economic agents are
possessed of many behavioral types rather than just one (homo economicus)
and the optimizing axiom extends to the choice of types by agents to deploy
for different socio-economic environments.
While chapter 2 is all about the China (PRC) poverty reduction miracle
and the role of Deng Xiaoping, it is China in broad strokes; not a detailed
exegesis of the China Miracle. China (PRC) is especially interesting because
it went through, as it were, a natural experiment in transitioning from the
Mao Zedong era (1949–1976) to the Deng Xiaoping era (1976–1989). The
same people, the same underlying politics, but a markedly different set of
economic policies in that transition produced a massively different outcome
in terms of inclusion! Deng Xiaoping moved China from the stranglehold
of Mao’s Socialism to the embrace of structures we only recognize as genomic
Capitalism: free enterprise, profit-seeking, market determination of many
prices, foreign investment and, finally in 2004, private property. Deng
recognized that the state was doing too many things that other spheres of
provision, e.g., the market, could do better and he gave those spheres space.
To do these, Deng force-marched the Chinese state into a strategic retreat
from domains that other spheres could do better.
True, China still held on to many state corporations such as in banking,
railroads, steel, oil, etc., echoing, if not modeled after, the ‘commanding heights’
818 Introduction
Capitalism of the post-World War II Western Europe. Its catch-up strategy to

complement greater space for the market was an infrastructure build-up not
before seen in history, through a meteorically high and sustained investment
rate and a mercantilist posture in its currency. This was meant to attract foreign
investment and to sidestep the initially demand-challenged domestic market.
This does not mean that Mao did nothing; but the reforms of Mao (such as
strong usufruct right for farmers and township decentralization) failed to deliver
people out of poverty. What may have mattered most as precursor to the
subsequent Dengist revolution is Mao’s delivery of what we call a ‘restricted
preference’ polity in PRC: the scarcification in the Chinese populace of
preferences that are likely to oppose the authority of the Communist party.
This made decision making easier for the central authority. This may have
seeded a coherent polity which made the state strong.
We follow up further on the lesson from Deng Xiaoping—
recognizing spheres of provision other than the state and operating within
one’s domain of competence. The domain of competence of a sphere is
that subset of activities or services that the sphere can provide at less
cost than other spheres. We state the Efficient Assignment Rule thus: an
activity or service x is efficiently assigned when it is supplied or delivered
by a sphere of provision to whose domain of competence includes x. If
the market can provide the good or service at the lowest cost for the
same quality, the market must provide it. It does not mean the state quits
the market altogether; it should provide regulation and/or competition
enhancement where there is danger of abuse of market power. Weak states
tend to overreach—to operate beyond its domain of competence. We
discuss as one factor for overreach Hayek’s ‘fatal conceit’—the idea that
state actors are unable to recognize the limits of their powers and feel
especially compelled to intervene in organizations that evolved and
emerged over time via the interaction of people (such being ‘language’
and ‘the market’) and were not explicitly engineered by man. Hayek
characterized this tendency as ‘fatal’ because the outcome can be deadly
if slow burning.
In chapter 3 we ask whether Deng’s China is a template for low-income
countries aspiring to hop on to the rapid growth investment-led trajectory
traversed by the Asian economic miracles. Here we need to stop and pause.
That China (PRC) is a hard act to follow is an understatement. The reason
is that Deng’s China had a strong state, strong institutions and a coherent polity.
Few LDC states are possessed of such vast room to maneuver. The Long March
and the triumph of the revolution in 1949 gave the communist state and party
enormous political capital. Furthermore, Mao had effectively ideologically
cleansed China either by death in the millions as in the Great Leap Forward
(the Tiananmen Square Massacre in 1988 was a reminder of that strategy),
or by exile of actual and potential dissidents. The result was a Chinese Han
polity with a ‘restricted preference domain’ (as opposed to Arrow’s ‘universal
preference domain’). But political capital, however large at the start, rapidly
erodes unless continuously justified by tangible improvements in the welfare
of the polity. This was the lesson the now discredited Zimbabwean revolutionary
leader Robert Mugabe never learned. This was what the pragmatic Deng sorely
feared for China and the communist party. His moves were calculated to avert
this grim Robert Mugabe outcome. Deng’s was an instance of power deployed
for the common good if for reasons of self-preservation.
Most third world countries do not have the luxury of a strong state at the
helm nor have they the history that conduces towards a shared identity and
vision. The ‘imagined community’ remains a constructible ideal. In the parlance
of political science, they are still in the various stages of ‘nation-building’—of
forging a shared identity and a shared vision for the diverse groups constituting
its polity. At its center is a tenuous political settlement emanative of unstable
rules, unstable enforcement, the truck-and-barter of these rules and operational
overreach (operating in domains that other spheres can do better). Note that
we identify strong states with the quality of rules and enforcement rather than
with a capacity to sow fear. Trust in the central authority among weak state polities
is a very scarce resource and for good reason.
Buried under these drawbacks or perhaps foremost among them, weak
states exhibit a particular defect—feeble capacity for collective action. Since
public goods are quintessentially collective action problems, the common
feature among these states is poverty of public goods. Public goods are of
two kinds: soft infrastructure in the form of ‘rules of the game’ and hard
infrastructure such as the Three Gorges Dam and low power cost. Hard
infrastructure alone without the proper rules of the game will fall short. If
provided adequately together, they will lower the cost of doing business and
spur investment. If not, economic stagnation and abject poverty lurk nearby.
A closely related salient feature of weak states is its inability to reject the
importunings for special privileges and transfers by vested and tribal interests.
Thus, most weak states indulge in an orgiastic overreach—doing far too many
20
10 Introduction
things outside of its core competence with tragic consequences for fiscal
integrity and sustainability.
In chapter 4 we double down on the problem of collective action, as
well as why and how institutions matter. The role of weak institutions, many
times glossed over, is made explicit when connected to the pursuit of solutions
to collective action problems. A collective action problem is explicitly
modeled as a social dilemma game, the Fishing Game, where the pursuit of
individual advantage by the players results in inferior social outcomes. There
are two social environments of interest: a coherent society and an incoherent
society. In a coherent society, members are each driven to put the collective
interest ahead of the personal interests. In this society, the dilemma in the
Fishing Game does not arise. Extreme examples of this are the social insects,
where coherence is enforced by pheromones working on extremely restricted
preference. Ants and bees are genetically wired to align behavior with the
collective interest. Coherent societies always attain the first-best outcomes
in collective action problems.
Where agents have a choice between personal and collective interest,
alignment with the collective interest must be induced. Inducement is effected
via ‘institutions’—firstly, by an internally evolved system of governance as
in the Ostrom communities (relatively small communities that manage to
avoid the tragedy of the commons through rules enforced by the stakeholders
themselves and what D. North calls second party enforcement) can engender
and sustain this coherence through ‘norms’; alternatively, the collective can
enlist a third party, an outside factor, that issues ‘statutes’ that enforce
alignment with the collective interest. The famous Japanese movie The Seven
Samurai comes to mind. An isolated community—defenseless and victimized
by brigands—raises funds and enlists a group of samurai to rid it of the
scourge. The norm or statute consists of rules, associated penalties, quality
of enforcement on the part of governance authority, and the resource
contribution of stakeholders. Both norm and statute attempt to align behavior
towards the common good, and if successful, solve the collective action
problem. But the norm or statute may be misguided or weak, that is, either
it redirects behavior to wrong ends or does not change member behavior
at all. The relation between institutions and the performance of collectives
and societies is thus rendered explicit and formal.
In chapter 5, we relate the weak state’s capacity for collective action with
its incapacity to give credible commitments. The difficulty for the weak state
11
is that public goods are collective action problems whose address requires a
contract involving investment by stakeholders today in exchange for future
returns; and stakeholders may want their pie today, not in uncertain tomorrow
(see, e.g., Fabella, 2013). If the state is to coordinate this contract of forgone
present consumption for expanded future consumption, the state must be able
to make credible commitments about its own behavior. In the phraseology
made salient by Acemoglu and Robinson (2012), it must assure stakeholders
that it can ‘enforce contracts’ and ‘protect the property rights’. Governments
buffeted by demands from constituencies may find it difficult to abide by the
contracts it has entered into. Poverty of public goods is rooted in the incapacity
of the state to make commitments credible enough for its publics.
Not everything is lost. Fortuitous alignment of events sometimes brings
to power some well-meaning leadership. The chance configuration usually
brings with it a conferment of considerable political capital. The sitting
executive will be hamstrung at the outset by a poor reputation not of its own
making. It is not enough that it be honest. It must begin to change the facts
on the ground that will undermine the entrenched nexus of alliances that
tie its hands. If so, what are its options? The new dispensation so hampered
may overcome by offering credible commitment devices still within its power
to dispense as the chief executive. We saw this when water service was
privatized under President Fidel V. Ramos. His presidency, empowered by
his conquest of the crippling ‘power crisis’, sent credible signals of departure
from ‘business as usual’, such as de-hiring state water agency employees and
raising the tariff. Furthermore, through the implicit concession in the contract
that disputes will be subject to international oversight, it was able to attract
private business to come to the party.
Weak institutions and the poverty of public goods exact long-term toll
on the economy. In chapter 6, we focus on a long-term economic malady called
Development Progeria—a phenomenon in low-income countries where the
share of the Non-traded goods sector (Services) in GDP surges forward at the
expense of share of the Traded goods sector (e.g., Manufacturing). This share
dynamics is normal for high-income mature economies but is an anomaly for
low-income countries. Development progeriacs exhibit slow growth, low
investment rate and slow poverty reduction. The cross-country evidence is
that poverty incidence associates significantly and positively with higher share
of Services, but negatively and significantly with higher share of the
Manufacturing sector. While the cross-country evidence offered here does not
22
12 Introduction
necessarily mean the relationship holds for the Philippines, the suggestion is
strong that it does. We illustrate this with the comparative trajectories of
Manufacturing growth and poverty reduction in China (PRC), Vietnam and
the Philippines. We argue that development progeria becomes engendered by
market and institutional imperfections (the Rodrik Hypothesis) and by the
unwarranted strength of the domestic currency.
In chapter 7, we explore the correlates of investment in an effort to
decompress investment in low-income economies. We show evidence that
the investment rate in low-income countries co-varies positively and
significantly with the share in GDP of Manufacturing, but negatively and
significantly with the share of Services in GDP. Good governance and an
outward-biased exchange rate in combination with strong governance
correlate positively and significantly with the investment rate.
Part II begins with chapter 8 where we turn our attention to the
phenomenon of conglomerates and the positive role that they can play in low-
income countries with weak capacity for collective action. We first note that
there is a natural vent for size in Capitalist economies which is fostered by
competition and Darwinian selection. Size in many markets is, as in the animal
kingdom, a trait that is selected for survival. In Biology, this vent for size goes
by the name Cope’s rule: the tendency among vertebrates to acquire size over
time. Large business groups stand a better chance of weathering volatility and
changing fortunes; they have the financial wherewithal to internally bankroll
new projects rather than rely on imperfect capital markets; they can afford the
adoption of emerging technologies or engender new ones. The survival value
of size is even more pronounced in low-income countries where institutions
are weak and legal and/or extra-legal predation may be endemic.
In weak institutions environments, business groups are forced to vertically
integrate into what O. Williamson calls private ordering to deter state and non-
state predation and secure property rights. While simple vertical integration
into the upstream activities was the original target for Williamson’s private
ordering, it can easily be extended to the imperative for security that is severely
underprovided. In the Philippines, the ‘blue guard’ industry developed because
people and businesses feel they need protection in addition to that provided
by the state. And for good reason: the Philippine National Police (PNP)
sometimes spawns criminal syndicates (the so-called bantay-salakay). Large
businesses can acquire self-protection either by proprietary enforcement muscle
or by co-opting public enforcement to protect their assets; this can come by
13
capturing or influencing centers of political or statal decision making. While

the popular perception of private ordering is derogatory—usually associated
with ‘private armies’ used to terrorize innocent people and ‘rent seeking’—in
certain underdeveloped jurisdictions, it may be the only way to get market
exchange started and sustained. There is no question that private ordering
capacity, once acquired, can itself be deployed for predation on others in society;
such risk must be weighed against no-exchange at all. Thus, weak institutions
reinforce the already considerable efficiency-rooted vent for size.
In the Philippines, business size expresses itself as horizontal
conglomeracy—large business groups being present in many markets at once.
This is because markets in the Philippines are small and, in order to grow,
businesses must enter those not traditionally associated with them; in turn,
they must suffer their own original niche to be invaded by others. This inter-
conglomerate competition is what we call ‘conglopolistic competition’.
Conglopolistic competition reduces market power of incumbents and raise
consumer welfare in those markets. Horizontal conglomerates in the Philippines
are mostly in Non-traded goods sector, a legacy of the same historical factors
that drove development progeria, which is how these two phenomena are
related. Note, however, that while these conglomerates are large relative to the
domestic rivals, they are mostly small when compared to global counterparts.
In a weak state, the capacity for collective action is diffused among many
sub-national entities. It is not concentrated in the political center as in a
strong state. Sub-national entities may have effective capacity for enforcement
and rule-making in their limited jurisdictions. The Ampatuan clan was one
such in Maguindanao politics; so is the Iglesia ni Kristo in the domain of
religion. Conglomerates are such sub-national entities in the business and
economic sphere. Conglomerates are repositories of substantial financial,
organizational and human capital resources and have command over
considerable capacity for collective action in the pursuit of profit and market
share. If properly enlisted and rechanneled, they could boost the weak state’s
capacity for collective action, especially in public goods provision. We
illustrate this by examples such as the privatization of water distribution
services in Metro Manila, TPLEX, NAIAX and the soon-to-be completed
Connector Road projects and the Clark International Air Terminal.
The privatization of the operation and management of water services
in Metro Manila in 1997, the signal achievement of the Ramos administration,
could not have come about without the enlistment and participation of
24
14 Introduction
domestic conglomerates (see chapter 9). We are seeing this unfold in TPLEX
and NAIAX, both delivered under Public-Private Partnership (PPP) by San
Miguel Corporation. The Connector Road Projects also under PPP will soon
greatly ease traffic in Metro Manila and, together with CALAX, will reduce
logistics cost in Luzon. The case of CALAX shows how the public may gain
from conglopolistic competition in infrastructure development. These
landmark achievements re-channeled conglomerate capacity towards solving
collective action problems. Nobody claims that PPP can solve every public
works failure. The Philippines is on the right track with its deployment.
In chapter 10 we ask how we can overcome the relative stagnation of
the past forty years. Most low-income countries are mired in ‘overreach’—
doing so much more than their competence warrants; concealing failed
programs under even more ambitious programs. Learning from Deng
Xiaoping, they should embrace ‘strategic retreat’: this means moving from
ownership and operation to regulation and safeguard of market completion.
Strategic retreat does not mean complete non-presence by the state. Note
that the Philippines has already successfully navigated this route partway:
in water distribution, petroleum products and power. Stepping back from
ownership and operation towards regulation and safeguard of competition
was not easy and took political courage. More can be done. Government can,
for example, deregulate property rights in land in Philippine agriculture by
lifting the land ownership limit. The privatization of the endless government
headache, the Metro Rail Transit or MRT, should be prioritized.
To break out of development progeria, we should embrace, rather than
fear, a weaker peso. We should encourage local firms and conglomerates to
enter the slipstream of large global players in the Traded goods sectors, a
tack which we call ‘slipstream industrialization’. Together with that is the lifting
of constitutional limits on foreign ownership. The presumption that
stewardship of national patrimony by locals is superior to its stewardship
by foreigners is grossly overrated. The upgrade of our public goods by
BUILDx3 and so the proper and responsible use of TRAIN revenues is
encouraged. Foreign borrowing is never a sustainable strategy for an
investment-led growth of decadal durations.
Now for the warp and weft of the sweeping tapestry.
PART I
Capitalism and Inclusion
26
1
Inclusion and the Role of the State
in Orthodox Economics and Beyond
Piketty and the Role of the State

THOMAS PIKETTY’S celebrated Capital in the 21st Century (2013)
demonstrated with as much panache as is possible in the social sciences that
income inequality in mature Capitalist economies grows without limit in
normal times as income rises. The share in income and wealth of the top
1% of the population grows indefinitely. This flies in the face of the canonical
wisdom we owe to Simon Kuznets (1955), the Inverted U Hypothesis, which
was no doubt one of the major anchors of the award of the Nobel Memorial
Prize on his person. The Inverted U Hypothesis says that income inequality—
couched in the terms of the Gini ratio—first rises, reaches a peak, and then
starts to decline as per capita income rises (Figures 1.1a and 1.1b).
That Piketty dares to call this Kuznetsian canon a ‘fairy tale’ tells one
that something monumental is in store. Such chutzpah is bound to attract
intense curiosity and even more intense scrutiny. It is not a step taken for
the uncertain. The interrogation has been withering. But thus far, the empirical
evidence has stood the test of time. Piketty’s own growth theoretic explanation
of the phenomenon cryptically succinctly expressed as r > g (r being the
interest rate that capital commands, while g is the growth rate of the economy)
is, however, still and will continue to be hotly disputed. Whatever the
explanation or explanations, Piketty foresees a grim future for Capitalism
and democracy if such a state of affairs is left unchecked.
17
28
18 Inclusion and the Role of the State
There are, though, some very salient differences between Piketty and
Marx and Engels. Piketty’s grim forecast was based on ever increasing income
inequality; Marx and Engels dwelt on absolute and abject poverty. The bridge
between abject poverty and revolution requires little elaboration. Peasant
revolts in the past followed episodes of extreme deprivation. Piketty is not
clear on how increasing inequality by itself will bring about the collapse of
Capitalism and democracy. Increasing inequality is ethically distasteful, but
all boats large and small can conceivably rise even with an unequally rising
tide. He leaves it to our imagination.
Share of
top decile
in national
income
Figure 1.1a
Income Inequality in the United States, 1910-2010.
Share of
top decile
in national
income
Figure 1.1b
Income Inequality in the United States, 1910-2010,
with notional Kuznets Inverted U Hypothesis (gray line).
19
There is another massive implication. Piketty was adamant in his claim

that this is not due to some garden variety market failure. This was happening
in well-behaved mature market economies which latecomers in the
development game consider aspirational models. Rather it suggests that at
the heart of mature well-behaved market economies exists another failure,
a meta-market failure, which emerges when the Pareto efficient distribution
of goods and services delivered by the well-behaved market departs from
the distribution favored by the norms of society. Piketty has revived an old
and venerable conundrum at the heart of Neo-Classical Economics—it is
possible that Pareto efficiency attained by voluntary contracting locates at
junctures that violate extant social norms of fairness and equity. One thus
needs to actively square market efficiency with equity. Benign neglect will
not do.
A. Smith, it appears, never imagined that the Invisible Hand would create
a problem that would require a Visible Hand to cure—meta-market failure
in the form of a crisis of inclusion. Piketty’s suggested rampart against
Armageddon, additional wealth and income taxation, was a battleground in
the 1970s between the Neo-conservatives inspired by R. Nozick (1973) who
viewed income and wealth taxes as theft and a violation of sacrosanct
individual rights, and the utilitarian liberals inspired by, among others, J.
Rawls, who demonstrated the idea that behind the ‘veil of ignorance’, risk-
averse citizens would voluntarily enshrine equitable distribution as an ethical
imperative. With the Thatcher and Reagan Revolutions in the 1980s leaning
explicitly towards the Nozickian worldview of freeing ‘the animal spirits’ of
Capitalism, income inequality started to rise. The timing of the post-1970
income inequality trajectory estimated by Piketty seems to suggest as much.
The Marxist Critique and the Lange-Lerner Paradigm

The Piketty conundrum was already posed by Marxists against the
emerging orthodox economics in the 1930s and into the 1950s. Even if a
Pareto efficient allocation will be attained by the hardly convincing
assumption of no-market failure (as, for example, in the First Fundamental
Theorem of Welfare), it may still violate the norm of equity. They argued
that free enterprise is condemned to wallow in the meta-market failure trap
and the only way around it is Socialism, that is, central planning and the
30
state ownership of all forces of production; in other words, the rejection of

the free enterprise system. The state, granting gratuitously that it is benign
and always pursues the common good, will ensure, guided by a central plan,
that the distribution of goods and services will be efficient while at once in
accord with the norms of fairness and justice. The most titillating rendition
of that fairness and justice was Marxist and Communist: “From each
according to his capacity, to each according to his need.”
The role of the state in inclusion brings us back to The Communist
Manifesto of Karl Marx and Friedrich Engels (1848) and Das Kapital of Karl
Marx (1867). Marx and Engels also predicted the eventual and inevitable
collapse of Capitalism. Internal contradictions leading to progressive
impoverishment of the masses and falling wages allow no other conclusion.
But the extant state being itself a tool of capitalist exploitation cannot be part
of the solution. The answer was instead a class war where the masses—who
have nothing to lose but their chains—seize state power and impose the
‘dictatorship of the proletariat’. The new dispensation will then enforce equity
and heretofore ride the attained technological efficiency to worker’s Nirvana.
This beguiling logic was bought by many peoples and movements. That it
did not happen quite the way they saw it is now a fact. Nonetheless, the history
of the twentieth century cannot be adequately told without reference to these
two thinkers and these two works. Piketty, by contrast, recommends explicit
state intervention—such as more aggressive income and wealth taxation—
to push back on inequality Armageddon. Unlike Marx’s, Piketty’s view of the
state is Lockean—the state is a commonwealth constituted by a social contract
among free individuals to pursue the common good that individually cannot
be attained. While wisdom is not always the state’s virtue, the state can be
a force for the good.
Some economists in the 1930s and 1940s, Oskar Lange (1936) and Abba
Lerner (1944) and collaborators, argued compellingly that central planning
with state ownership of capital using mathematical programming (really a
trial-and-error process along the lines of Vilfredo Pareto and Leon Walras)
can replicate everything that a decentralized market economy can generate,
particularly Pareto efficient outcomes, and then some—it can avoid the meta-
market failure dreaded by the socialists (Hodgson, 1998; Bator, 1958).
The Lange-Lerner theory was parlayed to respond to Friedrich Hayek’s
and Friedrich Von Mises’s withering criticisms during the Socialist
21
Calculation Debate of central planning as infeasible on the grounds that the

central authority will never have the access to the information decentrally
dispersed among economic agents to make the requisite calculation for
efficiency given by the condition: Price = Marginal Cost. Economic agents
will not reveal their true preference unless there are incentives to do so. Such
a problem spawned the modern discipline called Mechanism Design with
a view towards incentivizing truthful revelation of preferences. (The latter
earned Leonid Hurwicz, Eric Maskin and Roger Myerson the 2007 Nobel
Memorial Prize in Economics Science.) Though rooted in the socialist
calculation debate, Mechanism Design has transcended its origins.
Meanwhile, the Lange-Lerner vs. Hayek-Von Mises controversy was never
quite resolved. Neither was the Lange-Lerner model ever implemented in
any real economy. The Lange-Lerner model—or ‘market socialism’ as it was
then also called—never passed muster among praxis socialists who thought
that market socialism, which was free enterprise minus only the capital
market, was playing footsie with Capitalism. Ranged against ideological
purists, it never had a chance at application. Strangely, when an affine and
more market-friendly system was finally adopted in China (PRC), it became
a world-beater.
The Neo-Classical Empire Strikes Back

In the 1950s, Neo-Classical economics found a comfortable sanctuary
from the persistent efficiency vs. equity question in what came to be known
as the Second Fundamental Theorem of Welfare (SFTW) in the general
equilibrium framework of Arrow-Debreu. It states that every feasible Pareto
efficient allocation can be reached as a market allocation following a proper
redistribution of initial assets. Provided that the very strong assumptions
among which were homo economicus and no-market failure assumption held.
Provided, further, that the redistribution using preferably lump-sum taxes
leaves preferences intact. Though the invariance of preferences under
redistribution condition will hardly ever be realized in reality and many
objections to the effect surfaced, the elegant mathematics sold the result to
and ensured its acceptance among the realism-agnostic and formalism-drunk
economic crowd. This became a virtual rule in the discipline: elegant
mathematics always trumped empirical regularity. What it provided was a
32
firewall, however artificial, between efficiency and equity theoretically (Blaug,

2007). Equity was the realm of Political Science and Philosophy; efficiency
was the realm of Economics.
The liberal tradition that made equitable income distribution as a social
desideratum and which should get the state behind it, got a boost in the 1971
with John Rawls’s A Theory of Justice that became US graduate school required
reading in subsequent decades. Rawls argued that if we let our better and
risk-averse selves speak, we would vote for a more equitable distribution of
income. Our better self is one stripped of our current interests, capacities,
social standing and genetic inheritance; one, in other words, deciding behind
the ‘veil of ignorance’. This veil of ignorance process puts the norm of equity
on a more beguiling conceptual footing. Rawls approved of government
policies such as incomes policy to alleviate poverty and inequality. Although
we do not know how it impacted Rawls, it is interesting that the contest
between the efficiency-leaning Capitalist market economies and the equity-
leaning Socialist bloc was at the same decade at its most virulent with the
sides threatening Mutually Assured Destruction (MAD) on the other. Robert
Nozick, one of the gurus of radical Libertarianism, published his magnum
opus Anarchy, State and Utopia in 1973 as a response to J. Rawls. Nozick and
followers opposed the expanded role of government, especially its tendency
to extract resources through taxation from private individuals. This was also
the time when the Kuznets’s Inverted U hypothesis was still considered
canonical and thus economic growth would, without direct state intervention,
solve the income inequality problem. This was, however, a largely high-income
country issue.
Another of the crucial assumptions in SFTW that exorcised the state
from the pursuit of efficiency is that of ‘complete markets’. Every good or
service, extant or imagined, must have a market which determines price
through supply and demand. For example, to each contingent good, different
for every state of the world, corresponds a properly functioning market.
Stripped of this improbable condition, the state re-emerges as a compelling
player for efficiency as demonstrated by the Greenwald-Stiglitz Theorem
(1986): the state can improve welfare by proper taxation. The nature of the
state has to be addressed because ‘missing markets’ are everywhere.
As engaging as the inclusion debate in the affluent First World prompted
by the Piketty’s magnum opus is, it may distract us from the more basic
23
inclusion problem in third world economies. This involves poverty incidence

and, thus, poverty reduction. While there are circumstances or policy thrusts
where poverty reduction and more equitable income distribution are served
at the same time, there may be many others where serving one may hamper
the other. This conflict may be especially true of redistribution by fiat. Forbes
(2000) and Banerjee and Duflo (2003) give evidence that shows that
redistribution hurts income growth. And by so doing hurt poverty reduction.
One where they were both served by the same set of policy thrusts was the
export-oriented (thus tradable goods) labor-intensive industrialization
policies of the Asian economic miracles in their catch-up periods in the
second half of the twentieth century. But many times, emphasizing equitable
income distribution may hamper poverty reduction.
In the next chapter, we leave behind the realm of theory to explore the
ambit of reality in the form of the People’s Republic of China where, as we
observed, the greatest poverty reduction gain in history happened.
34
2
Deng Xiaoping vs. Mao Zedong:
PRC as Natural Experiment
HOW POVERTY REDUCTION of a scale unparalleled in history was attained

in PRC deserves much dwelling upon. Mao Zedong enshrined Socialism in
PRC in 1949 after routing and driving into exile General Chiang Kai Shek
and the Kuomintang. Mao’s Socialism was genomic: central planning, state
ownership of all forces of production, no free enterprise, no private property,
and no profit seeking. It brooked no revision. One of its first economic
programs in the 1950s was ‘The Great Leap Forward’ intended to propel PRC
to first world status under the Socialist banner. Ideological purity
encompasses both instruments and outcomes as encapsulated by the Mao
saying, “It doesn’t matter that the train is late as long as it is socialist.”
Thus, for example, the Lysenko system of farm cultivation was imposed
because it came from the Soviet Union rather than being science-based. The
Soviet kolkhoz (collective farming) system was also aped. Sharing of the
collective’s output was egalitarian. It proved to be a great debacle: upwards
of 30 million Chinese died in the process. Deng Xiaoping, sent by Mao to
limit the damage of The Great Leap Forward, had an epiphany—the
realization that the state was doing too many things that other spheres could
do better. In particular, the state should not tell farmers what to plant, when
to plant, when to harvest, who to sell to, and at what price!
Letting the farmers play the market was Deng’s recommendation. And
the farmers obliged, partly dissociating from the collective farms and trying
their hand at business and risk-taking. With one drawback: business sense
24
25
and risk-taking were not for everyone; playing the market meant some
farmers became huge gainers and enriched themselves, while others failed
and grew poor. This was too anti-egalitarian for the keepers of the faith in
Beijing and the Politburo. As a result, despite the tangible prosperity among
the farmers, Deng was hounded as a ‘capitalist roader’, stripped of power and
banished into exile. Had he not been a prominent cadre of the venerated
Long March, his life would surely have been snuffed, as was the life of dissident
Leon Trotsky. This was how orthodox Socialism dealt with dissent,
experimentation and innovation. Fortunately for PRC and the world, Deng
survived and took the helm after Mao’s death in 1976. The Deng Xiaoping
revolution had begun.
First, he launched the program called the ‘Household Responsibility
System’ which followed through what he started in the wake of ‘The Great
Leap Forward’. Chinese farmers were once more allowed to play the market
and again they obliged with alacrity and farmer incomes grew impressively.
This highly successful farm program was then leveraged to extend the market
to nonfarm sectors.
Dengist China turned its back on Maoist Socialism after a monumental
struggle with followers of the Gang of Four; as part of his ‘Socialism with
Chinese Characteristics’, it embraced free enterprise, foreign investment,
profit-seeking, an export platform status and, in 2004, it reinstituted private
property, scrapping the Marxist dogma that ‘property is theft’. Lost to nobody
was that these embraces were precisely the genome of Capitalism that Marx
and Engels despised. PRC still owns a good deal of state corporations and
state financial institutions and, thus, capital allocation is directly or indirectly
controlled. Deng’s Socialism with Chinese Characteristics thus seems affine
to the ‘market socialism’ of the earlier Lange-Lerner theory; it echoes as well
the ‘Commanding Heights Economy’ which characterized the British post-
World War II economy (Yergin and Stanislaw, 1998).
Deng’s departures really sprang from two major heresies: one, that
Socialism is about outcomes and not about instruments encapsulated in the
most famous of Dengist sayings: “It doesn’t matter what color the cat as long
as it catches the mouse”; and two, that there exist spheres of provision besides
the state which can outdo the state in efficiency in certain domains. One
such sphere is the market where individual industry and risk-taking are
rewarded. Was Deng thinking of poverty reduction as an end in itself? Was
36
26 PRC as Experiment
it compassion? Most likely, no. More likely he was thinking ‘survival’ as did
Machiavelli in The Prince:
A ruler must also show that he admires achievement in others,

giving work to men of ability and rewarding people who excel in
this or that craft. What’s more, he should reassure his subjects that
they can go calmly about their business as merchants or farmers,
or whatever other trade they practice, without worrying that if they
increase their wealth they’ll be in danger of having it taken away
from them, or that if they start up a business they’ll be punitively
taxed. On the contrary, a ruler should offer incentives to people
who want to do this kind of thing and to whoever plans to bring
prosperity to his city or state.
- Niccolo Machiavelli in The Prince, Chapter 21
This is the often overlooked message of The Prince. A state wallowing

in poverty, as was Mao’s China, has no wherewithal with which to defend
its sovereignty. And the survival of the state was the overarching good for
which “the end justifies the means.” This early, Machiavelli recognized that
good governance, credible rules, and letting citizens be their best are the
roots of survival and prosperity. Deng was not outdone in wisdom.
The other chapters of the Deng program are well known and
consistent. To nudge the market and investors to even greater heights, public
infrastructure must be upgraded to equal—or exceed—world standards;
and to do that meant an investment rate that saw no parallel in history—
45% to 50% of GDP for decades. Evidence of this infrastructure building
frenzy in the Deng era are the numerous breathtaking infrastructure
wonders of the world—the Three Gorges Dam, the Lhasa-Beijing Railroad,
the Hongkong-Zhuhai-Macao bridge, the longest high speed train system
in the world, the 10,000 kilometers of railroad each year—and the list goes
on. The Three Gorges Dam, with its 400-mile long reservoir, was, in
particular, described by the dam construction’s photographic chronicler,
Clark Everett in 2007 as “…to Western eyes, is almost inconceivable change.”
‘Western eyes’ spectacled by affluence and the diversity of visions and values
that it affords, cannot conceive of how one nation can, in peacetime,
27
mobilize to tackle such massive collective challenge. The Three Gorges

Dam promise became fully functional reality in July 2012. Yet another
reason why future projects of PRC will have the support of its people.
Figure 2.1 shows the comparative investment rates of Asian countries
from 2010 to 2015. Note that as late as the last five years, the investment rate
(GDCF/GDP) of China (PRC) was as high as 45%. The investment rates
among Asian countries were between 25–35% of GDP. The Philippines was
a clear cellar dweller at around 20% of GDP. This is what we call investment
compression. It was only since 2014 that the investment rate in the Philippines
started to inch upwards to 24%. The economic cluster of the Duterte
administration has rightly decided to raise government capital outlay to 8%
by 2022 which would boost the investment rate to 25–28% of GDP.
Source: Fabella (2017b)2
FIGURE 2.1
Comparative investment rates of Asian countries from 2010 to 2015
PRC’s investment rate was not only meteorically high, it was also
sustained. The latter is even more compelling than the former. How did
it manage to be investment-led for 30 straight years? To sustain such high-
octane investment-led growth, an economy must turn to the world for
2 “Who’s afraid of a weak peso?” BusinessWorld, 25 September 2017. http://

bworldonline.com/whos-afraid-weak-peso/
38
markets. If it produces only for the domestic market, it quickly runs into
production gluts—what the classical thinkers (Heckscher, 1935; see also
chapter 21 of J.M. Keynes’s (1936) General Theory of Employment, Interest
and Money) already knew well as ‘under-consumption theory’. The resulting
economic busts quickly put finis to high investment rates. This was clear
even in the post-Civil War high growth era of the United States called the
Gilded Age (1870–1900). Rapid growth led first by railroads and then steel
and oil was punctuated by depressions—first in the Panic of 1873, the Panic
of 1883, and the Panic of 1893—which caused much dislocations and forced
a pause in the economic activity. The USA then was largely inward-looking.
The boom-bust cycle very prominent in inward-looking economies was
thus avoided by PRC, as well indeed by the Asian economic miracles. In
other words, Deng’s PRC became export-oriented by the internal economic
logic of an investment-led trajectory. His fascination with the East Asian
Miracle economies (Singapore was a favorite) taught him some object
lessons.
Two other policy innovations rounded up and ensured the
sustainability of this program: the export processing zones to host export
platform foreign investment and an aggressively weak yuan starting in 1994.
The latter was vigorously opposed by developed trade partners, but which
PRC repeatedly rebuffed showing an uncommon mettle. These policies
made PRC ‘the workshop to the world’. And the rest is history.
Lessons from Deng Xiaoping: Taming Overreach

The genius and heresy of Deng Xiaoping was in recognizing that there
are spheres of provision other than the state and that these can do better
than the state in many domains; that the state, however strong, may be
overreaching, that is, operating beyond its domain of competence. His
statesmanship consisted in forcing the state to a strategic retreat from those
domains that other spheres can do better. In many low-income countries,
the status quo is state overreach many times massive—the state unable to
refuse the demand of vested interests for sources of rent does too many things
and badly. China’s overreach under Mao, however, was not due to the same
incapacity of the weak center, but due to the Socialist dogma of state
ownership of forces of production.
29
Consider the economy as an exhaustive collection of activities each

producing a good or service. Each activity is assigned to one of three spheres
of provision: the State, the Market, and Hybrid (PPP). Each sphere has a
respective domain of competence: the subset of goods and services that it
can produce at less cost than all other spheres for the same quality. We define
the Efficient Assignment Rule (EAR) as the situation where every sphere
provides goods or services included in its domain of competence.
Thus, a good or service is efficiently assigned if it is in the domain of
competence of the sphere providing it. Efficient assignment means zero
opportunity cost, at least in the dimension of provision. Overreach means
that a sphere provides goods or services that other spheres could provide
at a lower cost for the same quality.
Staying within one’s domain of competence is not easy. Retreating back
to proper confines once exceeded is even harder. Nobel Memorial Prize
winner Friedrich Hayek (1988) called the inability of state actors to recognize
their own limits to improve on markets a ‘fatal conceit’. With political victory
comes a sense of invulnerability. Reinforcing this is the political asymmetry
in the pressure to act—the pressure on politicians to act or to appear to act
is overwhelming; when the programs and projects fail, the sponsoring
politician can always find some force majeure, such as the weather or dolts
in the implementation bureaucracy, to blame. The most common fallback
excuse is ‘lack of funds’ and the insider-favored remedy is ‘higher budget
allocation’. Or wherever there is term limit, the problem anyway is passed
on as burden to the incoming administration. Inaction, on the other hand,
spells political death.
Governments, however well-meaning, many times embrace even
sensible ideas only to despoil them with over-ambition. Government honchos,
following logics other than that of economic efficiency, tend to go for too
big a bite. Massive social asphyxia follows mindless overreach. Surely, most
markets are imperfect but perfecting them calls most times for ‘nudges’, not
for lobotomy. Nudges may come in the form of regulations and the safeguard
of competition.
The domain of competence of a sphere is not fixed; it can change with
technological advances, with education, and even with better motivation due
to better pay. Power companies used to be state-owned and integrated, but
the improved capacity of the state to regulate monopolies and enforce long-
40
term contracts allowed the power sector to be unbundled and power to be

efficiently provided by private firms. This is not to say that unbundled power
sector is always better. But under weak institutions where government
corporations are used as gravy trains, it may indeed prove a productive shift
to a nudge regime.
The domain of competence of the state can shrink when the state loses
competence, as when the state adds more and more activities to its already
overfull agenda, thus resulting in inadequate budgets, low paid manpower,
and a drop in the focus of decision makers. The weaker the state the smaller
is its domain of competence, as observed above. The fact that government-
owned railway companies are efficiently run in Berlin does not mean that
railway companies should be state-owned in Djibouti or Manila. As we will
see in chapter 6 below, the lack of competence of the state makes for failed
interventions or state failures. The marked superiority in the service of
privately run LRT over that of the state-owned MRT in Metro Manila serves
as evidence that the Philippine state’s domain of competence does not at the
moment include train service provision.
Though Deng’s China had lessons to teach, other countries may fail to
learn. There may be hurdles to that learning or, armed with the learning,
they may fail to follow through. What is the most significant obstacle to
following in China’s footsteps? We deal with this in the next chapter.
3
Low-Income Countries and
Collective Action
DOES Deng’s PRC provide the template for other low-income countries to
follow? There are valuable lessons to learn, notably, (1) the recognition by
Deng that there are other spheres of provision aside from the state, namely,
the market, that can do better in some activities, and (2) the retreat of the
state to core competence that Deng engineered. The emphasis on public
infrastructure and outward orientation to sustain the investment-led growth,
at least during the take-off stage of development, are valuable lessons.
But one must remember that Deng’s PRC was a strong state with strong
institutions and a coherent polity. Its overreach was ideological rather than
political. Whether one likes it or not, Mao’s legacy to Deng was a coherent
polity bound together by a strong sense of identity and mission. The Chinese
state was strongly supported by a fairly coherent polity enabled by a process
which may be called preference restriction—where actual and potential
opponents of the regime subscribing to alternative worldviews were exiled
either to foreign shores or to the afterlife. China went through the era of
ideological cleansing. The Arrow Impossibility Theorem, which we owe to
Kenneth Arrow, states that satisfying a group of seemingly innocuous liberal
axioms, first among them being universal domain, rendered rational social
decision making impossible. Universal domain in turn meant that members
of the polity are allowed to choose any and every well-behaved preference
ordering. In short, the Arrow Impossibility Theorem states what is quite
obvious: social decision making is harder the more varied the preferences
that have to be given voice to. For example, the USA cannot seem to upgrade
31
32
42 Low-Income Countries and Collective Action
its aging infrastructure because advocates of spending for an infrastructure

upgrade cannot strike a deal with supporters of smaller government and
deficits. The restriction of preference thus makes it so much easier to
formulate rules and implement policies. The construction of the massive
Three Gorges Dam entailed relocating 13 cities, 140 towns and 1.3 million
people to complete, yet went smoothly and on time. “Incomprehensible” to
Western eyes. With a capacity of 22.5 gigawatts of power, it can supply the
whole power needs of the Philippines twice over. Many Westerners wondered
why there was not more social unrest and rancor among those negatively
impacted. They interpret widespread assent with the project as elicited by
fear. “This could never have happened in the West,” was the shared conclusion
by Western observers. One possibility that Westerners can never come to
terms with is that the Chinese polity may have had more trust and identity
with the leadership in Beijing than is conceivable in the West. Beijing had
delivered on promises in the past and that is sufficient to elicit assent. And
from all indications, the leadership in the case of The Three Gorges Dam
has once more fulfilled its part in the quid pro quo. This is quite a contrast
with governance in many low-income countries where a simple bridge
construction takes eons to plan and construct, if at all, and often what is
finally delivered is only half a bridge.
State Capacity and Market Failures

Straying from its domain of competence is many times rooted in familiar
triggers for intervention by the state, viz., market failures. We subscribe to
the belief that this frequently adduced reason for state intervention should
be redefined to account for the capacity of the state for crafting and
implementing the intervention. Better it is to re-label the technical market
failure as proto-failure. A proto-failure, like the orthodox market failure
concept, is an engineering concept that is invariant to changes in time and
space (see, Fabella and Fabella, 2016). A proto-failure is a failure whether
one is in Berlin or in Djibouti.
The label market failure should refer to those proto-failures that the
extant state can actually improve upon. Thus a market failure depending as
it does on state capacity can vary across time and place. A market failure
in Berlin may not be a market failure in Djibouti if Berlin has the capacity
33
to improve on the market failure while Djibouti has not. Proto-failures that
the extant state cannot improve upon should be called the Williamson proto-
failures (O. Williamson, 2010). Society is better off if forbearance with the
Williamson proto-failures becomes the state’s attitude. A Williamson proto-
failure in Djibouti today may become a market failure a decade hence when
technology has improved the capacity of the Djibouti government. Clearly,
the lack of clarity between these two failures reinforces the already marked
penchant for intervention among government bureaucrats. The question that
should continually be asked of overzealous politicians and bureaucrats is,
“Will your proposed intervention really improve on the status quo given the
weak capacity of institutions?”
Most low-income countries are presided over by a weak state. The
features of weak states are well known: unstable and inconsistent rules and
enforcement, the truck-and-barter of rules by unscrupulous bureaucrats, the
capture of state junctures of decision by private interests for private gain,
and extension of the state to domains and activities where it has no
comparative advantage. Most pronounced among the weak state’s frailties
is the inability to forge a coherent polity poised to solve collective action
problems. The latter is very salient because adequate public goods require
coherence among the polity to act as one. Since the provision of public goods
requires a modicum of social coherence, the poverty of public goods is the
usual flip side of social incoherence.
The poverty of public goods is the first spectacle greeting every visitor
and balikbayan to the Philippines transiting in Singapore or Hong Kong and
deplaning in NAIA Metro Manila. NAIA Terminal 1 is a relic from the dark
ages and belongs in a museum. Until very recently, its toilets and transport
amenities with its masses of hangers-on were, to put it mildly, a nightmare
to navigate. NAIA Terminal 3 is better appointed, but for more than a decade
after its turnover in 2002, it was idly gathering dust and decaying, its use
blocked by a legal Gordian knot which the Philippine state was unable to
undo. Congestion and poor air control equipment meant a 30-minute to
one-hour delay for incoming or outgoing planes, hiking up fuel prices which
air travelers ultimately defray, and courting air disaster over Metro Manila.
And you can feel the cost of doing business in the country rising.
When you had finally cleared the Customs maze to leave the NAIA
premises you faced a creaky, grid-prone road system that could take many
44
hours of your life to negotiate and shatter your equanimity. The new NAIAX
eases this somewhat, but the nightmare is postponed only a few minutes.
The legal gridlock that stood in the way of NAIA Terminal 3’s early use is
repeated in every sphere of public goods provision. Truly, when viewed from
its public goods endowment, the Philippines is prima facie evidence of the
ravages of weak collective action capacity. The relation of weak capacity for
collective action and the poverty of public goods is our next concern.
Dampeners of Internal Conflict

In the past, political jurisdictions that had weak institutions were simply
swallowed up by jurisdictions with stronger institutions. There was always
an imminent threat of invasion from the outside when a state looked weak.
This imminent threat galvanized internal coherence. That was the landscape
when Niccolo Machiavelli wrote The Prince, where the strong monarch was
equated with a strong state. But as we observed above, Machiavelli also
instinctively knew that a strong state has to be well-endowed, one that has
the wherewithal to resist encroachments by hostile neighbors. To survive,
the aspiring state, the entity still having to establish its credentials as it were
among the league of states, must grow up quickly; it should attain social
coherence by suppressing internal conflicts and manage the rest through
economic prosperity so that it can present a more formidable rampart against
invaders. This is how the various peoples of Europe solidified into separate
nation-states. Each gave neighbors the impression that the cost of territorial
encroachment to intruders would be very high due to either or both internal
coherence and the nascent state’s alliances with other states. It is as if it is
proclaiming to the rest: “Mess with me and it will cost you.” The plot echoes
the storyline from evolutionary biology, specifically multi-level selection of
Wilson and Sober (1994)—inter-group competition leads to norms and laws
that dampen intra-group competition, thus, engendering greater fitness at
the group level; this, in turn, redounds to added fitness for members of the
group.
Imminent threat is no doubt part of the story of South Korea, Taiwan
and Singapore, the triad of East Asian success stories. South Korea
experienced the Korean War and, with only a ‘truce’ between the warring
parties more than half a century after, remains virtually at war with its neighbor
35
North Korea. We hope for better times in the post-2018 Winter Olympics
era and the subsequent cordial and historic Moon-Kim meeting in the DMZ.
But the virtual state of war over half a century left no room for errors for
South Korea. It was shape up or ship out. Taiwan had only the Taiwan Strait
separating it from the hostile giant, the PRC, and the occasional cannonade
between the armies in the 1950s and 1960s would cause blood pressure to
fluctuate. Singapore has preached to its populace that its size will always
pose a temptation for neighbors to encroach. No doubt, imminent threat has
played a part in dampening non-conformist beliefs and tendencies. The
resulting coherence has underpinned phenomenal economic success.
In the age of the post-World War II United Nations, occasional territorial
grab—though decidedly rarer—still rears its head. A case in point seems to
be strong China’s (PRC) encroachment into the Scarborough Shoal and other
maritime territories also claimed by weaker neighbors. Russia’s grab of Crimea
from Ukraine is another. The same logic motivates North Korea to
fanatically—and to the exclusion of other social goals—acquire a nuclear
arsenal: again, “Mess with me and I will bloody your nose.” That North Korea
also brutally suppresses internal dissent is inevitable. But unless genocide,
the use of chemical weapons or ethnic cleansing is being perpetrated, the
threat of armed intervention by the global community seems to have waned.
Zimbabwe under Mugabe was heavily mismanaged to the immense suffering
of Zimbabweans without the world and its neighbors raising a threatening
finger.
Engendering social coherence can be effected through the restriction
of preference among the populace. This is done either via ideological cleansing
(and its more familiar and abhorred relative ‘ethnic cleansing’), by ‘fission’
or by the Gulag strategy.
Both modern China and Vietnam had episodes of ideological cleansing
in their histories, driving into exile those who would or could foment
ideological discord. Cuba is another country that has this feature, having
driven all actual or potential dissenters to Florida, USA. The remaining
populace is more likely to be contented and would readily agree with the
ruling ideology and party, making decision-making less contentious. Cuba
is interesting in that if the current post-Fidel Castro leadership discovers
and embraces Dengism, Cuba’s future may, like Vietnam’s, prove miraculous.
The Rohingya Crisis in Myanmar is an attempt by the Myanmar Buddhist
46
majority to eliminate real or imagined internal conflicts coming from the

Muslim minority. Ethnic cleansing in the wake of the collapse of Josef Broz
Tito’s Yugoslavia is of the genre. Though in our colonial past, episodes of
ethnic cleansing were perpetrated especially against the Chinese (sangleys
as they were derogatorily referred to), such cleansing seems remote and
thankfully so in the Philippines of the twenty-first century.
Fission is another way towards a restricted preference outcome. The
Union of Soviet Socialist Republics (USSR) splintered into many states now
each marching to a different tune. The centrifugal tendency among these
disparate tribes of the USSR was formerly suppressed by the deafening
anthem of world and Soviet Socialism. The erstwhile ‘Yugoslavia’ fissured
in a bloody fashion into the constituent tribes that were previously forced
to coalesce under the iron-fisted Josef Broz Tito. Homogeneous if smaller
populations result from such fission—Serbia is Orthodox Christian, Croatia
is Catholic, Herzegovina is Islamic. ‘Czechoslovakia’ fissured into the Czech
Republic and the Slovak Republic peacefully by mutual consent. Both
experiments seem to have left separate polities now pursuing separate futures;
Yugoslavia’s offshoots were by contrast somewhat traumatized by the
unleashed and hitherto latent inter-tribal barbarism. Belgium, Spain and Great
Britain are in danger of following suit. Brexit or the exit of Great Britain
from the European Union has been electorally decided and its form is being
negotiated. This is partly because the real or imagined external threats to
common survival that in the past pushed internal tribal differences below
the surface have slowly folded their tents. Instead of the famous United States
slogan, E pluribus unum, the direction in our time seems to be Ex uno, plures
(Many from one).
The fission viewpoint argues that the Filipino race may be better served
by making three or four states out of the one Philippine state (say, Luzon,
Visayas, Christian Mindanao and Bangsamoro Republic) with three or four
votes in the UN. Each can then pursue a different course of economic and
political management and who knows may do better in time. Singapore
separated from the Malaysia Federation and both did very well indeed. This
is not to be scoffed at in the Philippines simply because the tendency is
emotionally deep-rooted. The Muslim restiveness in Mindanao, let’s face it,
is aimed ultimately at independence, not coexistence. The Visayan-speaking
Filipinos have long chafed under the yoke of Imperialist Manila and the
37
Tagalogs in the same way that the Catalans of Spain resent the hegemony
of Madrid and the Castilians. The vote for Duterte by the largely Visayan-
speaking South was partly to spite the largely Tagalog-dominated North.
Duterte’s continued popularity rides on this undercurrent of resentment.
Most familiar, the most often resorted to dampener of internal conflicts,
is autocratic rule. Its fellow traveler is the police state. This strategy sends
behavioral tendencies and beliefs that contest the primacy of the dominant
ideology or threaten the integrity of the social fabric into exile. Those who
cannot or refuse to keep alternative worldviews buried and out of sight are
sent to reform and/or work camps known as gulags. Deng Xiaoping himself
was forced into internal exile. North Korea’s gulag prison camps, the most
well-known modern example, follow the Stalinist model made famous by
A. Solzhenitsyn’s The Gulag Archipelago. At the extreme the exile of misfits
is to the afterlife which has materialized as extra-judicial killings (EJK) in
the Philippines. The temptation to capacitate the state through autocratic
rule is the easiest to sell to the public and no doubt will continue to enjoy
widespread vocal advocates.
In the absence of terror, violence, and imminent threats, finding
dampeners of internal conflict, as it were organically, is a huge challenge.
Competition in the twenty-first century has become less expressed in armed
conflict and tends to be benignly waged in various social and economic world
league tables. Even so, those without appreciable levels of social coherence
will persist at the basement of these league tables.
Coherence is attained with the alignment of behavior of members. We
deal with how alignment of behavior is attained in the next chapter.
48
4
Social Incoherence and the
Poverty of Public Goods
THIS CHAPTER is intended primarily for students of formal social

sciences, but curious bystanders are more than welcome to pick up a few
ideas. To bring the relation between social coherence and public goods
provision into sharper relief, we detour into the world of small number
dilemma games which I seriously believe should become major equipment
in every social scientist’s toolkit. We aim to bring the discourse to a level
that transcends simple storytelling and anecdotes. This methodological
tour de force is useful for establishing the formal relationship between
economic success (or failure) and quality of ‘institutions’ made explicit
through norms and statutes. In this chapter, the reader will not be spared
the rod, as it were. We start by studying a collective action problem called
The Fishing Game.
38
39
The Fishing Game as Collective Action Problem

We present the Fishing game as an iconic collective action problem. Its
payoff table is given in Table 4.1 below.
Table 4.1. The Fishing Game and Tragedy of the Commons: Cases
• Two fisher folk, Ambo (A) and Berto (B) fish in the
same lake.
• Their strategies consist of either: Fish with Net (N)
or Fish with Dynamite (D)
• Case 1: A and B are total strangers: cannot cooperate/
coordinate their actions
• Case 2: A and B are brothers in trustful terms
The payoff matrix of the Fishing game is in Table 4.2:
TABLE 4.2. Payoff Matrix of the Fishing Game: Invisible Hand
Berto
N D
Ambo N 10, 10 2, 15
D 15, 2 3, 3
Note 1: Those with some exposure to elementary Game Theory will

recognize that the Fishing Game is of the Prisoner’s Dilemma Game genre
and may omit the immediately following discussion. It is also called a
collective action problem or a social dilemma game because the pursuit
of selfish interest by players leads to a bad outcome for the society.
The payoff pair (x, y) says that Ambo gets x (the left number) while
Berto gets y (the right number). For example, the payoff pair (2, 15) means
that Ambo gets 2 and Berto gets 15. The payoff pair (10, 10) results when
Ambo plays strategy N and Berto plays strategy N—both fishermen behave
(do the right thing); the payoff pair (2, 15) results when Ambo plays N
(behaves) and Berto plays D (misbehaves). When both fishermen play D
(misbehave), (3, 3) results and each gets 3.
40
50 Social Incoherence and Public Goods
CASE 1: Ambo and Berto are total strangers (homo economicus in

textbook Economics)
Each will only look after his payoff regardless of the payoff for the
whole group. Suppose that both fishermen play D (misbehave), that is, the
action pair is (D, D), the payoff pair is (3, 3) and each gets 3. If both behave,
the action pair is (N, N) and the payoff pair is (10, 10), each getting 10.
Now getting 10 is much better than getting 3. But The Fishing Game will
tend towards (D, D) giving (3, 3) as payoff. Why? (N, N) gives (10, 10) but
Berto will realize 15 if he switches to D; so will Ambo, since at N he does
not care what Berto gets. So both will switch and they end up at (D, D)
giving each (3, 3). We say that (N, N) is not stable and won’t last. (N, N)
is vulnerable to betrayal when both look only after his own payoff. Now
they are at (D, D). Will (D, D) last? Suppose Berto switches to N (behaves)
from D, Berto gets 2 which is less than 3 if he stays at D. So Berto will not
switch; similarly Ambo. There is no incentive to switch, so (D, D) is stable.
No other action pair has this property of stability. The stable feature of
action pair (D, D) has a name in Game Theory; it is called the Nash
equilibrium of the game. But (D, D) gives Ambo and Berto 3 each while
(N, N) would have given each 10. The Nash equilibrium of this game is
a bad outcome because there is a payoff pair (10, 10) which gives each
higher! But because each looks only after his own selfish benefit (payoff),
the Fishing Game ends up badly. In Economics, the Fishing Game
exemplifies the popular label market failure. With many (more than two)
fisherfolk, this result is called familiarly ‘The Tragedy of the Commons’
after Hardin (1968)—where the fish stock of the lake is degraded or
destroyed and everyone is left in misery. ‘The Tragedy of the Commons’
is a collective action failure often associated with overexploitation and
depletion of a common resource. A common resource is an asset owned
by the collective and accessible for use to all members. It may be a body
of water that sustains fishing, a forest that provides timber and game or
the atmosphere that soaks up carbon emission.
41
CASE 2: Ambo and Berto are part of a coherent group whose

members care for and look after each other (homo reciprocus or
socialis in Behavioral Economics).
Now each will prioritize what is good for the community, in this case
consisting of Ambo and Berto and their families. Since (N, N) gives each
10 and 20 together and no other action combination gives higher [say (N,
D) gives (2, 15), which together gives 17 < 20], both will choose N and (N,
N) is the solution of the Fishing Game for members playing this game.
Choosing N is still vulnerable to betrayal but the players are reasonably
confident that the other player will not exploit his vulnerability. In other
words, there are considerations beyond the immediate payoffs that the players
are paying attention to. Ambo and Berto in Case 2 have avoided the ‘Tragedy
of the Commons’—the fish stock in the lake remains high to sustain a bright
future.
We have the following definition: A coherent group is one whose
members always choose the strategy that maximizes group welfare
when playing a social dilemma game with other members of the same
group.
Ambo and Berto in Case 2 belong to a coherent group. By contrast, Ambo
and Berto in Case 1 belong to an incoherent group. The coherent group
realizes the opportunity (the best outcome for the group) locked up in every
collective action problem, while an incoherent group will fail. Groups that
are coherent will thus tend to be more successful (in this case, harvesting
greater returns from the common resource) than groups that are incoherent.
Over time the difference in the success of both groups will be considerable.
It will rival the remarkable difference in the success of the East Asian Miracle
economies and the other less developed economies.
The provision of public goods is an iconic collective action problem.
A public good, like a decent bridge across a river, makes life easier for everyone
living in the vicinity—everyone can use it for free. But to construct a bridge
requires financing which the potential beneficiaries must raise—those who
will benefit must contribute to bring it about.
Suppose citizens are acting like Ambo and Berto of Case 1:
looking out only for immediate personal interest and contribution is
52
voluntary. Potential beneficiaries will either refuse to contribute or will

contribute much less than required for a decent bridge and its ample social
benefit—that is, they will reason that they can anyway use the bridge once
completed from the contributions of others. In other words, they will ‘free
ride’ on other people’s contribution. Since others similarly motivated will
reason the same way, either no bridge is built [the Mancur Olson (1965)
‘zero contribution hypothesis’], or only half a bridge is built. P. Samuelson’s
(1954, 1955) ‘under-provision theorem’ says that when members of a polity
contribute voluntarily towards the building of a bridge, the contribution
will fall short of the ideal—the size and quality of the bridge that maximizes
the collective’s welfare.
Suppose the citizens constitute a coherent group whose members look
after and care for each other. Then their behavior will be governed by norms
of cooperation that consider ‘free riding’ a grave social transgression; they
will each contribute enough or more than enough resources so an ideal
bridge is completed. And the community is all the better for it. How much
easier it is for community welfare to be advanced in societies where
coherence has been pre-established.
The takeaway from this section is that every collective action
challenge contains a social opportunity. Coherent communities realize
this opportunity; incoherent communities squander this opportunity.
Over time, the performance of these communities will diverge in a big
way.
Ferromagnets
Coherence, when attained, is very productive in nature. Consider an
iron bar. An iron bar consists of trillions of electrons. Now each electron has
a magnetic moment called the electron spin. The electrons of a regular iron
bar have electron spins pointing randomly in all directions. The magnetic
moments cancel. Now put the iron bar in the field of a strong magnet and
the spins start to align. When all the electron spins are pointed in only one
direction you get an emergent phenomenon called ferromagnetism. Its
electrons are said to be in a coherent state (Figure 4.1).
43
• Coherence and Civilization: Electrons

iron bar ferromagnet
• Coherent communities readily solve

collective action problems
FIGURE 4.1
Social coherence and public goods
The humble iron bar has become a ferromagnet—now has a magnetic

field and starts to act on other metals coming within its field. It now acquires
the capacity for work. As children, we excitedly caused iron filings to dance
on the surface of a sheet of paper with a magnet. Rotate a coil of copper wire
around a ferromagnet and, lo, electricity begins to flow. Magnetism is the
very touchstone of modern civilization. You get the Three Gorges Dam and
the wonders of electric power like the Beijing-Lhasa Railway Line of PRC!
Similarly, communities characterized by social coherence are able to
provide massive public goods. By contrast, incoherent polities are
characterized by a ‘poverty of public goods’, low incomes, and low station
in the world league tables.
Social Coherence
Social coherence is the capacity of the community to act as one to
advance collective welfare. Faced with a collective action challenge, they will
attain the first best outcome. Social coherence is either autonomic or induced.
Autonomic coherence comes from forms of affinities: family, clan, religion,
or shared life experience like victories in war. In this case, the imperative
to act for the group comes from the inside of—and hardwired in—the cerebral
cortex of members. The action potential towards cooperation is triggered
in the limbic system of the brain and requires no deliberation. One does it
like one seeks food when hungry.
54
The radius of members to which this autonomic impulse holds sway

we call the radius of coherence. This is a circle of members with whom
cooperation (behaving properly) is autonomic rather than deliberate. This
radius differs for different groups. The radius for a particular group can fall
by repeated betrayals or free rides by other members. In particular, this
centripetal force degrades as the group becomes large, ceteris paribus, slowly
in some groups and precipitously in others. The Japanese society is perhaps
one example where the radius of coherence extends to the whole nihon-jin
nation and degradation is slow. The smaller and largely homogeneous polities
known as Scandinavian countries are also noted for being coherent. Rules
such as traffic red lights are respected even at three o’clock in the morning
because they are viewed as embodiments of the social family. They are as
much “mine” as of the community. Since incidentally they also mostly lead
the World Happiness Index, one is led to wonder whether there is a
connection.
Some states, by contrast, consist of subgroups or tribes the radii of
coherence of which do not extend beyond their immediate families or clans;
these are known as ‘tribal societies’. In this case, the state presides over a
polity that is a nation de jure but not one de facto. A de facto nation is what
political scientists call ‘an imagined community’, one whose members owe
an autonomic allegiance to the whole. National Artist F. Sionil Jose’s (1999)
observation regarding the Philippines is suggestive: “We became a state before
we became a nation.” In other words, F. Sionil Jose posed the question: Is
the Filipino polity today a nation de jure only or is it also de facto?
There is no presumption that social coherence will always be employed
for the good. In the case of Japan, it was deployed to whip up frenzy for and
wage World War II to disastrous effect. It was deployed by Adolf Hitler to
embark on a war of expansion and self-destruction. But if it happens to be
deployed for the good, such as the construction of public infrastructure, it
can produce miracles. China under Deng comes to mind.
Induced Social Coherence

Social coherence, like everything else in the universe, is, however
attained, subject to the Second Law of Thermodynamics—disorder always
grows globally. Social coherence always degrades in time unless continuously
45
replenished. When un-replenished, as was the case of the fourth-century

Roman Empire wracked by frequent bloody internecine rivalries, the fall is
just a matter of time. As in nature, disorder can be kept at bay by capturing
and transforming natural energy flow to push back the growth of local
entropy. When coherence is being renewed or grown, we say that it is induced.
We assume here that the players are not themselves disposed to cohere from
the start.
There are two paths to induction: first is by internally evolved
governance within and by the community itself and based on norms and
associated penalties; second is by governance based on laws enacted and
enforced by a party outside the immediate community which we call the
state or government. We next detail the way this works to induce coherence
in the game theoretic framework applied to a fishing community.
Statutes, Penalties and Coherence

Let S be a statute consisting of (i) a rule: dynamite fishing is a
punishable transgression; (ii) a penalty: its users, if apprehended with
probability f, 0 ≤ f ≤ 1, will be punished to the tune of p > 0; and (iii) a
head tax: that fisherfolk will each be charged c > 0 to help defray the expense
of the system. Thus, we write the statute S = (c, p, f) ). Let us see how this
changes the Fishing Game. The payoff function of the new game with statute
S is in Table 4.3.
TABLE 4.3. The S-Modified Fishing Game
B
N D
A N 10 – c, 10 – c 2 – c, 15 – c – pf
D 15 – c – pf, 2 – c 3 – c – pf, 3 – c –pf
Note that the head tax is paid, anyway, however the game ends. If Ambo
plays N and Berto plays D, Ambo gets (2 – c) while Berto gets (15 – c – pf),
where pf is the expected penalty for using dynamite. Let us first suppose that
the governance is strong, that is, f = 1 or every transgression, if caught, is
56
meted a punishment p. So the payoff of Berto using dynamite is (15 – c –

p). The game changes, depending upon S. Let us consider a specific (p, c)
= (6, 2), as in Table 4.4 below.
TABLE 4.4. The S= (7, 2, 1)-modified Fishing Game
B
N D
A N 10 – 2, 10 – 2 = (8, 8) 2 – 2, 15 – 2 – 7 = (0, 6)
D 15 – 2 – 7, 2 – 2 = (6, 0) 3 – 2 – 7, 3 – 2 – 7 = (-6, -6)
The payoff matrix of the S = (2, 7, 1)-modified game has (8, 8) for playing
(N, N), it is (0, 6) for action pair (N, D) (D, D), the previous Nash equilibrium
which delivered payoff (3, 3) ceases to be so and (-6, -6) for action pair (D,
D). Now the unique Nash equilibrium of the game is (N, N) giving payoff
(8, 8). (D, D), the previous Nash equilibrium which delivered payoff (3, 3)
ceases to be.
The statute S has changed the behavior of Ambo and Berto; more
important, it has successfully aligned behavior towards the collective
optimum (N, N). It has netted the community an aggregate payoff of 10 [(8
+ 8) – (3 + 3)]. The group (Ambo and Berto) has achieved coherence, if an
induced one. The energy that was employed to induce social coherence was
the tax c (rechanneled from consumption to an investment in governance).
This contribution is easily afforded in the first best outcome because the
individual income from the first best outcome (8) was more than sufficient
to cover the individual cost (3). The intervention in the form of statute S
has created value for the community—it is a government success. The
occasion for government success is a market failure. No amount of
government intervention will create value for the community if there is no
market failure. Thus we say: The first question of any proposed government
intervention is, “What is the market failure?”
47
Whence is the Statute S?

(i) The statute S may emanate from evolved local governance worked
out and enforced by the stakeholders—the fisherfolk themselves.
The statute in this case is called a norm, the penalty p is informal,
such as pariahdom (transgressors do not get invited to parties,
expected mutual help may be denied, etc.). This was the pathway
taken by the fisherfolk of the famous APO Island marine
protected area (MPA) and the Sumilon Island MPA which
captured world attention due to the heroic effort of the Silliman
University team under the leadership of Professor Angel Alcala
(2017). (Professor Alcala is also a National Scientist and a
Magsaysay Award winner.) The virtue of governance by local
stakeholders is that its transactions cost is low and it is more
likely to be sustainable. In the typology attributed to Douglass
North, governance by local stakeholders is second-party
enforcement.
(ii) The statute S may emanate from outside the immediate group,
say, the state or government which enacts rules that bind this
and other groups. This is a third-party enforcement in North’s
typology.
Howsoever S is emanated, it is productive of social benefit only if there

is a failure in the first place. That is why economists worthy of the name
always ask of every proposed government intervention: What is the market
failure? And if so, can the intervention improve on the status quo?
Government Failures
Third-party intervention does not always succeed. There are several
drawbacks associated with this type of imported governance. One is simply
that the statute crafted away from the venue may not be suitable for the local
condition. It could backfire in many locales. The level of enforcement by
paid outsiders may be lukewarm or indifferent, outsiders being themselves
exempt from the cost of failure.
58
Suppose S =(c, p, f) = (4, 7, 4/7). That is, the system is more costly (4
> 2) and the enforcement is lukewarm; that is, probability of punishment
for transgression is f = (4/7), meaning, that enforcement is weak as only 4
of 7 transgressions are punished. Thus effective average penalty is only 4
instead of 7. The modified payoff matrix of S = (4, 7, 4/7) is now:
TABLE 4.5. The S = (4, 7, 4/7)-modified payoff matrix
B
N D
A N 10 – 4, 10 – 4 = (6, 6) 2 – 4, 15 – 4 – 4 = (-2,7)
D 15 – 4 – 4, 2 – 4 = (6, -2) 3 – 4 – 4, 3 – 4 – 4 = (-5,-5)
Pay attention only to the number pairs in parenthesis. Note that (N, N)
giving (6, 6) is no longer a Nash equilibrium because either player can do
better if he switches to D to realize 7 > 6. Once at (N, D) or (D, N), there
is no incentive for players to switch because that would mean getting (-5)
instead of (-2). Thus both (N, D) and (D, N) are Nash equilibrium. The game
has been transformed into an anti-coordination game with two Nash
equilibria (D, N) and (N, D). It is also more familiarly known as a Game of
Chicken. But note that either of these equilibria is inferior welfare-wise for
the group—they each give an aggregate of 5 (7 – 2) but the original game
gave an aggregate of 6 (3 + 3) > 5. Additionally, either equilibrium delivers
a boon for one (7) and a disaster for the other (-2). It is, in other words, non-
inclusive. Society is not only poorer; it is also nasty.
Society is clearly better off without the intervention S = (4, 7, 4/7).
The intervention S fails because, first, it is more costly (4 > 2) and, second,
its enforcement f is weak ((4/7) < 1). Governance imported from the
outside which is (a) weak and costly, and (b) does not fit local conditions
can make things worse! Note that there may be fishing jurisdictions in
which S = (4, 7, 4/7) succeeds in aligning behavior for the best. But not
here. This is the bane of third party enforcement—statutes may be a
mismatch with local conditions and/or too costly to implement. Weak
institutions do this.
49
The outcome with S = (4, 7, 4/7) is what is known as a government or

state failure (also a Visible Hand failure)! State failures make things worse
than the laissez-faire status quo, the state of affairs prior to intervention. If
S = (4, 7, 4/7) is as much as it can offer, it is better that the state refrain from
intervening at all. When the status quo is a government failure, it is a valid
reason for further government action. For example, a subsequent statute S
=(7, 2, 1) to replace S = (4, 7, 4/7) will produce the government success in
Table 4.4 above. Thus, the more complete query for a government intervention
is: What is the market failure or the government failure that it addresses?
And how sure is it that the intervention will produce the identified benefit
for society given the weak capacity of the state?
A government failure actually happened when the government took
over the governance of the above-cited APO Island and Sumilon Island
marine protected area from local stakeholders! Things quickly became dire
and the harvest of fish dwindled. The situation improved only with the return
of governance to local fisherfolk.
We saw above how influential a high expected penalty (pf) is in the
attainment of the best outcome. So why not just raise the expected penalty
pf or the statutory penalty p? It is not so simple since to raise pf you will
have to finance it, and that entails a rise in the budget for enforcement and
a rise in tax contribution c. This rise in c could make the final outcome
undesirable (10 - c < 3). Furthermore, a rise in the statutory penalty p may
reduce f as more enforcers succumb to higher bribe offers from
apprehended violators. Mere increase in statutory penalty will not guarantee
high pf jurisdictions of weak institutions. This is the bane of weak
institutions.
Refraining from intervention or disengaging from failed programs by
themselves require much wisdom and political courage, virtues which are
in short supply in governments of low-income countries. F. Hayek in The
Fatal Conceit (1988) claimed that government actors are possessed of the
belief that they can always improve on the status quo, usually an autonomously
evolved system of provisioning such as the market. There is, as it were, a
hardwired pathology to intervene regardless of evidence. The result is not
always pretty and may be very costly if not fatal.
By contrast, the superior capacity of the state made manifest by statute
S = (2, 7, 1) can induce social coherence which, in turn, engenders decent
60
public goods. S = (4, 7, 3/4), on the other hand, fails to engender social
coherence and consequently fails to unlock the opportunities hidden in the
collective action problems. The poverty of public goods is the tangible
expression of societal incoherence or the failure of its institutions to induce
social coherence.
When S = (4, 7, 3/4) is endemic in state interventions, state failures
become the expectation of even well-meaning interventions. The state
develops a reputation as the wellspring of failed programs. This reputation,
having been acquired, is very difficult to shake off. Even when the top
positions of government suddenly fall on the laps of a well-meaning
benevolent leadership (which sometimes happens), it is still unclear that he/
she would be able to make a difference. He/she would be holding de jure
but perhaps not de facto power.
One makes a distinction here between the state of the institutions and
the intent of the occupants of de jure positions of authority. This comes from
the distinction between de jure and de facto power. From time to time, as
if by Poisson process, the position of authority may fall on the shoulders of
a well-meaning leader, one for whom the welfare of the whole polity is top
priority. This leader we call ‘benevolent’. Benevolence in this case may not
be matched by de facto power to whip inherited weak institutions into shape.
The new occupant will exercise de jure power only and will be hampered
by the dismal reputation not of its own making. It will be like a careful and
prudent driver at the steering wheel of, as it were, a ‘moving casket’ of a vehicle.
The conventional wisdom is that the upright leader will be boxed into utter
futility. With weak institutions as backdrop how can a well-meaning authority
in weak institutions environment effect change? The answer is through
‘credible commitments’ which we will tackle next.
5
Credible Commitment Devices and
Public Goods in Weak States
THE STATE’S CAPACITY to provide public goods relates very closely to how
much confidence its commitments elicit from its public. This is the dimension
of ‘credible commitments’. A public good, say a bridge, is essentially foregone
present gratification for larger future consumption. The state must convince
the polity that ample future gains are forthcoming from the bridge to be
financed through their taxes. A public good is always an implicit contract
between the state and the polity. If the political center is viewed by its publics
as unable to credibly commit to its part of the contract, that is, to safeguard
and properly use the resources collected as taxes, the polity may opt to withhold
the required tax contribution from the state either latently or patently and
instead use it for private consumption. No bridge! From casual evidence,
especially evident in the construction of The Three Gorges Dam, it appears
that its public believes that the current leadership in China (PRC) delivers
its part of the social contract. The Chinese leadership paid for that confidence
with deliveries on past promises.
In The Fishing Game, the capacity to credibly commit emerges
as a very high probability (f = 1) of punishment for malfeasance
(dy namite f i shing ) as wel l as t he low t r ans a c t ions co st of
implementation. A miserably low probability (f = 4/7) of punishment
for misbehavior and/or a very high cost of implementation reverses the
prospect for positive social dividend. Stakeholders may vote (if that is
granted them as a prerogative) in the first instance against the enactment
S (also sometimes manifested as tax revolt). That prerogative is seldom
51
52
62 Credible Commitment and Public Goods
accorded. Again, either no bridge or half a bridge is delivered. The

result is a government failure.
How does a government with a reputation for non-delivery and
wastage improve its prospects as a partner in development moving forward?
One way to do that is to offer a commitment device that makes it very
painful to renege or to give a credible signal that business-as-usual is past
history. The first is frequently resorted to: bank tellers are obliged to submit
a ‘bond’ which is forfeited if the teller absconds with the money in her
trust. This is modeled as ‘hostage’ by O. Williamson (1983). Japanese daimyo
of old were obliged to leave behind their families in the capital Edo when
they visited their far-off fiefdoms as insurance against subversive or anti-
shogun activity.
The state struggling under a tarnished reputation can signal its departure
from business-as-usual by doing something which, because of its actual or
potential political cost to the state actors, could not be done under business-
as-usual.
One way is to tether the state’s commitments to international treaties
which will make such obligations costly to renege on. Many of these treaties
are entered into by states to make their respective jurisdictions friendlier
to foreign investment. The global community has standards of behavior that
infuse harmony and fruition to common endeavors. The local community
despite its own contrary tendencies tries to appear to subscribe to these
standards in return for foreign investment flows. The enactment of a
competition law is viewed as such a commitment device which subsequently
raises foreign investment inflow into the country (Clarke, 2011). This is also
what happened in the run-up to the privatization of water distribution and
sewerage services in Metro Manila.
Signaling a New Regime: The MWSS Privatization

Water distribution and sewerage in Metro Manila prior to 1997 was
provided by the government entity, Manila Water and Sewerage System
(MWSS). In view of the many problems of service interruption, water quality
and fiscal drain, then President Fidel V. Ramos decided to privatize the system.
The first hurdle to the MWSS privatization was getting enough private players
to participate to avert an auction failure. The second was to get them to bid
53
aggressively enough to generate consumer surplus for the hitherto skeptical

public. This was to happen with the backdrop being a state with a very bad
record in its dealings with the private sector. For example, the Philippine
Supreme Court among others decided in the 1990 “Garcia versus DTI” case
that a projected petro-chemical plant could not be located in the investor’s
preferred site in the province of Batangas, thus, effectively wresting from
private investors the prerogative of siting their plant. The foreign investor
promptly packed its bags. To improve the outlook for MWSS privatization,
the roll-out of credible signals and commitment devices on the part of the
government was required.
Credible Commitment Devices

The state under then President Fidel V. Ramos implemented a number
of drastic changes in the run-up to privatization:
(i) It engineered the passage of the National Water Crisis Act which
gave the President targeted and time-bound emergency powers
to negotiate and close contracts in the address of the water crisis
and privatize MWSS; this reduced the likelihood of obstruction
by other branches of government.
(ii) It raised water tariff substantially from Php5 per cubic meter to
Php8.70; since inability to adjust the tariff was one cause of the
MWSS burden, the move signaled the grim determination of
the Ramos dispensation.
(iii) It reduced the state water system workforce by 30% (about 4,000
employees) by offering a generous retirement package for state
employees. This was viewed as highly improbable in the old
regime. There was a new political reality.
(iv) The involvement of the International Finance Corporation (IFC)
as advisor in the drawing up of the contract (concession
agreement, CA) was a signal that the parameters of the game
will comply with best practices in the world where concession
templates have proven successful. The CA was crafted jointly by
the possible bidders and the state to ensure transparency and
understanding of the provisions.
64
(v) The creation of an international Appeals Panel which required

as chairperson an international dispute resolution practitioner
guaranteed that global standards in dispute resolution will apply.
Thus, disputes will be adjudicated at first instance not by local
courts, which are viewed as weak. But when a local court does
intervene, its judgment can be challenged in an international
court outside the country.
The first three signaled a resolute benevolent leadership willing to take

difficult steps for the common good. The next two instanced a case of
tethering to global standards and effectively pole vaulting the weakness of
local institutions. These were not easy steps and required a fortuitous
alignment of events: a determined and open-to-experiment leadership of
President Fidel Ramos who was previously empowered as the conqueror of
the power crisis; the obvious failure of the state as water distribution services
provider; and the ferment in the private global capital movement revived
by the 1989 collapse of the Socialist challenge. The latter was frozen in the
debt crisis decade of the 1980s. The role of Lady Luck cannot be denied, but
one has to be ready to cash in when she smiles.
The Result
These devices suggested a radical change in the government as counter
party in water procurement contracting. The success of the assurance exercise
was made manifest by the number of parties that expressed interest, of which
four were pre-qualified: Ayala Corporation with United Utilities, Metro
Pacific Corporation with Anglian Water, Benpres Holdings Corporation with
Lyonnaise de Eux, and Aboitiz Holdings with Campagnie Generale de Eux.
The local sponsors were all conglomerates engaged in many other activities
except water services which hitherto were largely a state preserve. The
international partners were all global players in water and sanitation services
and thus had the requisite expertise. These were either French or British.
Each bidder submitted a tariff bid (i.e., per cubic meter of water). Whoever
submits the lowest tariff (or the highest discount) wins. The aggressiveness
of the bids surprised even the architects.
55
The bid results were as follows:
TABLE 5.1. Bids Tendered by Participating Consortia by Service Area
East Percent Discount Peso Bids
Ayala-United 73.61 Php 2.31

Aboitiz-CGE 37.12 Php 5.20
Metro Pacific-Anglian 35.49 Php 5.66
Benpres-Lyonnaise 30.21 Php 6.12
West Percent Discount Peso Bids
Ayala-United 71.36 Php 2.51

Benpres-Lyonnaise 43.41 Php 4.96
Aboitiz-CGE 43.12 Php 4.99
Metro Pacific-Anglian 33.10 Php 5.87
Tariff Prior to Bid 100.00 Php 8.78
Adapted from Dumol, 2000
The Ayala-United consortium won both the East and the West Zones
at Php2.32 per cubic meter of water and Php2.51 per cubic meter, respectively.
Ayala-United was awarded the East Zone, by virtue of a predetermined lower
average formula. Thus, Benpres-Lyonnaise, with the second highest bid of
Php4.96 per cubic meter for the West Zone, got the West Zone. Ayala-United’s
bid for the East was only 26.38% of current water tariff of Php8.70 per cubic
meter. That of Benpres-Lyonnaise was only 56.57% of existing tariff. The
feeling of total vindication by advocates was well placed and euphoria seemed
in order. One broadsheet columnist summarized the reaction of the day as
the “sweetness of privatization.” Such an outcome would not have come about
if the players did not get sufficient reassurance that the state would honor
its part of the CA.
Two decades after, the privatization of MWSS remains a signal
achievement of the Ramos administration. It represented a retreat by the
state from a domain that the market can do better. It has been used as a
template for reform in water by other countries in the world. Effectively, the
66
state retreated from state ownership to regulation of Metro Manila water

service provision. What this shows is that poor reputation of the state can
be overcome by offering credible commitment devices of future good
behavior. Since these devices have to be by themselves costly to be credible,
the reforming authority must itself be possessed of tremendous resolve. This
is courage deployed for the common good; courage wedded to common
sense! That itself is very rare. But, if and when such an authority emerges,
a bad past need not completely condemn the future.
Such instances of success are encouraging and point the way for the
future although by themselves they may be too few and far between to propel
the escape from the tyranny of backward infrastructure. Left to fester, the
poverty of public goods both soft and hard will take its toll on long-run
economic performance. This is the issue we tackle in the next chapter.
6
Economic Stagnation,
Development Progeria
and Inclusion
WHAT IS development progeria? Development progeria is a phenomenon

where, over the long term, the growth of Manufacturing lags behind that of
Services in a ‘low-income economy’. Manufacturing here proxies for the
‘traded goods sector’ and Services proxies for the ‘non-traded goods sector’.
This trajectory of the industrial shares is normal for mature high-income
economies, but problematic for low-income countries. It is analogous to the
medical condition called progeria, a genetic malfunction where a child of
six years has the physical features and the life prospects of a 60-year-old.
We will show how problematic development progeria is for the low-
income countries with special emphasis on inclusion defined as poverty
incidence. First of all, in a fast-growing low-income economy on the
convergence trajectory (meaning on the path to closing the gap between
itself and the high-income OECD countries), Manufacturing (the traded
goods sector) grows faster than Services (non-traded goods sector) and as
a result Manufacturing share in GDP gains while the Services share loses.
As shown in Figure 6.1, the Services sector has been gaining industrial
shares over the last 30 years while those of Manufacturing and Industry shares
have trended downwards. Services sector now contributes about 58% of
Philippine GDP.
57
68
58 Stagnation and Inclusion
Data Source: World Bank Development Indicators
60.0
50.0
40.0
Shares
(%) 30.0
20.0
10.0
0.0
‘86 ‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09
FIGURE 6.1
Trajectory of Philippine Value-Added by Industry
as % Shares of GDP, 1986-2009
The contrast with countries on the convergent path is interesting and

we think dramatic. The following shows the trajectories of industrial shares
of select countries in the decade 1986–1996.
FIGURE 6.2
Change in % Industry Shares, 1986-1996
59
Columns above the ‘0.0’ line means that the sector has gained shares in
GDP in the decade 1986–1996; columns below the ‘0.0’ line means that the sector
has lost shares in GDP in the same decade. Focus on the Philippines for the
moment. The Service sector gained during the decade while Industry and
Manufacturing lost shares. Then consider the last two countries, Germany and
USA, both representing the high-income mature economies. For these two
countries, the Service sector gained shares in the decade while Industry and
Manufacturing lost shares. The trajectory of industrial shares in the Philippines
mimicked the trajectories of high-income mature economies, even though per
capita income of the Philippines was very low. Now turn to the industrial shares
trajectories for fast-growing but low per capita-income economies, Thailand and
Indonesia. Through the decade 1986–1996, the Service sector lost shares while
the shares of the Industry and Manufacturing gained shares. So their industrial
shares trajectory is very different from that of the Philippines, Germany and
USA. South Korea’s trajectory reflects an economy in transition—the Services
sector gained while Manufacturing barely earned even as Industry lost. China’s
trajectory shows gains for the three sectors led by a long shot by Industry and
Manufacturing. Malaysia’s trajectory also shows an economy in the middle income
category where all sectors gained at the expense of Agriculture (not shown).
Figure 6.3 below shows the comparative per capita incomes of the select
countries for two periods 1991 and 2002.
Per Capita
Income ($)
FIGURE 6.3
Per capita income (US$), 1991 and 2002
70
We see that USA and Germany are clearly mature economies with per
capita incomes in excess of US$10 thousand throughout the periods. South
Korea crossed the threshold in the second half of the period; the rest of the
countries had a ways to go, although Malaysia is quickly closing the gap. We
repeated the industrial share exercise for the period 1996–2009. The result
is given below (Figure 6.4).
Change in
% Shares
FIGURE 6.4
Change in % Industry Shares 1996-2009
A similar pattern emerges for the period 1996–2009. The Philippines’

trajectory still mimics that of Germany and the USA. Thailand still
presents a stark contrast to this pattern while Indonesia’s Service sector
still lost shares as did Manufacturing, while the Industry sector gained.
We submit that this is partly why Thailand and Indonesia have left the
Philippines behind in per capita income. But more important, how does
it affect inclusion?
Development Progeria and the Strong Peso

Two factors, notably, weak institutions leading to poverty of public goods
and the Philippines’ pursuit of a strong peso, were mainly contributive to
61
the long-term retreat in the Philippines of Tradables, in general, and

Manufacturing, in particular.
Rodrik (2008) broke new ground by giving evidence that market and
institutional distortions tend to ‘tax’ tradables more than non-tradables.
This deserves elaboration and reiteration. Tradables tend to be more
complex and roundabout, need the cooperation of many agents, and thus
more contract-intensive. Tradables move across borders and are subject
to physical hijack and predation in weak states. Tradables also produce
more positive externalities, technological spillovers and learning-by-doing
(Korinek and Serven, 2010) than non-tradables and may exhibit more scale
economies due to the Baumol Effect (barber shops will never exhibit
economies of scale). What this means is that the poverty of soft and hard
public goods tends to favor the non-traded goods sector (Services) which
does not have to compete with foreign counterparts. Rodrik (2008) claimed
that currency undervaluation levels the playing field for the traded goods
sector and makes for a better long-term growth prospect. We will revisit
this in the next chapter.
In the Philippines our policy response was the exact opposite. We
maintained an enduring romance with the strong peso with roots in our
colonial past. The Philippines’ relatively high standard of living was confirmed
by hordes of immigrants from neighboring countries wanting entry in the
early post-war period; the peso-dollar exchange rate was then two pesos per
US dollar (Php2/1US$). This was codified in our consciousness as defining
the good life—enjoying access to imported US products. The ideal to be
pursued became associated with a strong peso. That the Php2/1US$ was
economically wrong was brought home by the BOP Crisis of 1949. But the
authorities decided to defy economic logic and maintain the overvalued peso
at Php2/1US$, exactly the opposite of exchange rate decisions in Taiwan and
Japan in the immediate post-war era. In Japan, the exchange rate chosen was
Y360/US$ in 1949 from Y3/US$ in the pre-WW II era; in the Philippines,
it was Php2/US$ in the 1930s and exactly the same in early 1950s. No wonder
that the Philippines became the favorite export destination of Japanese
products. The subsequent Import Substitution regime was thought up to
support the level of the peso by administratively—through tariffs and
quotas—reducing the demand for imports. It only sowed the seeds of the
boom-bust economy.
72
Two policy episodes in our history, one in the second half of the 1980s
and another in the mid-1990s, illustrate this. In the wake of the BOP crisis—
occasioned by heavy foreign borrowing plus wanton wastage and corruption
under President Marcos—banker Jose ‘Jobo’ Fernandez was appointed Central
Bank governor. The peso was rapidly depreciating and forex was fast flowing
out of the country. The central bank under Governor Fernandez resolved
to snatch the sacred peso from the jaws of devaluation in mid-1980s through
the ‘interest rate cure’: it deployed the infamous “Jobo bills” with prohibitively
high interest rate. This shrank the real economy to fit the massively mis-
aligned Philippine peso. Banks snatched the Jobo bills realizing indecent
returns even as the Philippine economy collapsed. The interest rate cure and
the strong peso effectively aborted the prospect for a tradables-driven
recovery under President Corazon Aquino. In this environment, given other
entrenched institutional drawbacks, there was no room for new investments
in Tradables and Manufacturing. While it is true that the political instability
and coup attempts caused the Philippines to miss the Japanese foreign
investment tsunami, the heightened overvaluation of the peso, thanks to the
interest rate cure, left foreign and domestic investors without a prospect in
the foreign markets and killed off any hope for an export- and Manufacturing-
driven recovery. The twin curse of the Jobo bills and the coup plotters bent
the arc of Philippine history towards a Service sector-led economy.
The second episode also involved the central bank, now rechristened
the Bangko Sentral ng Pilipinas (BSP). In about the mid-1990s, in the waning
days of the power crisis, strong portfolio investment flows attracted by still
high interest rates put pressure on the peso to appreciate. When local business
complained about the high cost of money, the central bank—instead of easing
up on the high interest rate—encouraged them to borrow in dollars abroad.
The BSP feared that a benign monetary policy would deprive the artificially
strong peso of the support of a high interest rate. This surge in private foreign
borrowing resulted in heavy dollar exposures of banks and private
corporations. The heavy commitments of these dollar borrowings in the
Service sectors, notably real estate, resulted in currency mismatches. It created
stock market and real estate bubbles which made for an artificial and shaky
prosperity. It failed to create a capacity to service the debt which would have
materialized had the borrowings been invested in tradable goods and
Manufacturing, had there been a more favorable exchange rate. The Asian
63
financial crisis starting in 1998 exposed the unsustainable and dangerous

nature of the strong peso-high interest rate strategy which, in turn, effectively
aborted the highly promising—if still domestic-oriented—Ramos recovery.
In early 1994, a group of us (Emmanuel de Dios, Benjamin Diokno,
Cayetano Paderanga, Calixto Chikiamko and myself ) together with
PHILEXPORT called for the deliberate weakening of the peso. China had just
devalued the yuan heavily and it (China) was threatening to ‘eat our lunch’.
This was a cause endorsed in a speech by then Senate President Edgardo
Angara at the first plenary session of the 1994 National Economic Summit.
Instead, we were treated worse than lepers. One mouthpiece of the then central
bank governor labelled us the ‘jukebox economists’—singing any tune the
moneybags call. The implied moneybags, IMF and the World Bank, did not
even know they were calling our tune; they were, in fact, calling the CB’s
tune. These moneybags had a catatonic fixation for floating the exchange
rate which, at that point of considerable dollar inflow, pointed to appreciation.
But even labor unions whose jobs we were trying to save called for our heads.
One did not need rocket science to see that PRC’s move would devastate
Philippine manufacturing and employment. But our plea for economic
survival fell on deaf ears. When the summit resolutions were read at the end
of the day, there was not a pip on the exchange rate. Chikiamco’s lament was
classic: “We lost our balls!” This time it was Jobo bills in another guise that
forced the appreciation. They were called the Special Deposit Account (SDAs)
offering very high rates to the wealthy who had the cash to spare. This BSP
instrument became the pet peeve of Foundation for Economic Freedom (FEF)
stalwart Ernest Leung. He considered it a way to indecently transfer resources
from the poor to the rich, since it would incur losses for the BSP which the
taxpayers will then have to make good.
Inclusion and Development Progeria:

The Average Tendency for Low-Income Economies
Our interest in this short volume is inclusion, defined as poverty
reduction. Daway-Ducanes, Ducanes and Fabella (2017) (see also Fabella,
2017b) hypothesized that low-income countries showing symptoms of
development progeria would also exhibit higher incidence of poverty; that
is, the higher the share of the Service sector, the higher poverty incidence
74
is; contrariwise, the higher the share of the Manufacturing sector, the lower
poverty incidence is. The authors tested this by running cross-country
correlation regressions of these variables against measures of poverty for
low-income countries (<$10,000 per capita). Their results are as follows
(Table 6.1):
TABLE 6.1. Correlates of Poverty Gap and Poverty Head Count

Ratio: The Role of Manufacturing
System-GMM
Poverty gap Poverty headcount ratio
$1.9/day $3.1/day $1.9/day $3.1/day
1 2 3 4
Poverty measure (-1) 0.528 0.685 0.724 0.872

[0.010]*** [0.011]*** [0.012]*** [0.010]***
Manufacturing size -0.063 -0.077 -0.155 -0.059
[0.022]*** [0.029]** [0.036]*** [0.035]*
Services size 0.106 0.145 0.192 0.262
[0.009]*** [0.013]*** [0.033]*** [0.025]***
ICRG -0.042 -0.096 -0.106 -0.258
[0.008]*** [0.006]*** [0.012]*** [0.013]***
Real GNI per capita -0.001 -0.001 -0.001 -0.001
[0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of observations 195 195 195 195
Number of countries 65 65 65 65
AR(2) Arellano-Bond test 0.753 0.715 0.419 0.423
Hansen p-test 0.477 0.54 0.54 0.582
Number of instruments 64 64 64 64
Robust standard errors in brackets

* significant at 10%; ** significant at 5%; *** significant at 1%
Note: The set of regressors included Period 2 to Period 6 (dummies) which are not shown.
65
Note that higher Manufacturing share in GDP on average associates

significantly with lower poverty gap and lower poverty headcount. By
contrast, higher Services sector share in GDP associates significantly with
higher poverty gap and higher poverty headcount. Governance quality
(ICRG) and per capita income serve as controls. It seems clear that, on average,
development progeria associates with higher poverty incidence for these types
of countries. These regressions do not establish that development progeria
causes poverty incidence to rise; we only have a strong suggestion that on
average across low-income countries, high Services share in GDP
(development progeria) and higher poverty seem to strongly co-vary. When
you see one you are likely see the other. In contrast, when you see high
Manufacturing sector share, you are likely to see low poverty incidence. They
are, as it were, good buddies. Applying results from a cross-country (ensemble)
analysis to individual countries, however, runs into the problem of
non-ergodicity—that is, the ensemble (cross country) average may not
equal the time average for that particular country. There is no claim here
that this central tendency applies to a particular country like the Philippines
or China (PRC). So we need to look at individual country experiences.
China, Vietnam and the Philippines:

Manufacturing and Poverty Reduction
To bring the above results in sharp relief, we present a visual comparison
of three low-income countries, namely, China, Vietnam, and the Philippines
(less than US$10,000 per capita) on the issue of Manufacturing share and
poverty reduction in the first 20 years of the MDG (1990–2010). Figure 6.5
gives the poverty reduction experience of the three countries for the 1990–
2010 period.
As observed above, the Philippines was one of the countries that failed
to meet the MDG target of cutting by half poverty incidence (MDG1) between
1990 and 2015. By contrast, China (PRC) and Vietnam were two star
performers of the MDG program as shown above. China went from 64%
down to 10% while Vietnam went from 50% down to about 5% in 2010. In
Figure 6.6 below, we juxtapose the average growth of Manufacturing and the
average growth of Services between 1990 and 2010.
66
FIGURE 6.5
Poverty reduction (%): Philippines, PRC, Vietnam, 1990 and 2010
FIGURE 6.6
Manufacturing vs. Services average growth (%), 1990-2010
67
Note that for China and Vietnam, Manufacturing average growth

outstripped that of the Service sector. By contrast, in the Philippines, the
average growth of Manufacturing fell well below that of the Service sector.
The contrast with poverty reduction is marked, suggesting a positive
correlation between development progeria and poverty incidence.
No account of mediocre economic performance can be complete
without a detour to the investment experience of these countries in the last
two decades. The issues we elucidated on above (exchange rate bias against
tradables, development progeria, weak institutions and infrastructural
deficits) had to have impacted investment in these countries. We will turn
to this in the next chapter.
78
7
Decompressing Investment
in the Philippines
THAT CAPITALISM in the country has thus far failed to be inclusive deserves
serious scrutiny. It is not the failure of Capitalism as genome, but of a phenome
of Capitalism, a particular manifestation of the genome in a particular policy
and governance setting. In the last chapter we identified a particular phenome
called development progeria which appears to particularly like the company
of poverty. Bad environments will produce backward Capitalist phenotype.
But it is not Capitalism’s fault; rather, the environment’s. Under the right
ecology, as was shown above, Capitalism has done wonders for inclusion,
say, in China and Vietnam. There are enumerable interesting sound bites
advanced to take the measure of non-inclusion in the Philippines. Some of
these are ‘bad elites’, ‘elite capture’, ‘crony capitalism’, ‘political instability’, and
‘rent-seeking’, etc. This inquiry tries to provide the economic pathway which
serves as reduced form of these sound bites to social outcomes. The economic
pathway to economic outcomes, whether growth or inclusion, seems to us
to traverse the quantity and the quality of investment. As far as I know only
Dr. Emmanuel de Dios (2011) has investigated the econometric association
between investment and an important sound bite, political instability, in the
Philippines. His evidence points to the fact that political instability depresses
investment. Political instability is clearly an institutional deficit.
Why have China and Vietnam forged an inclusive Capitalism? The secret
ingredient seems to be that they have avoided contracting development
progeria. How have they managed to do that?
68
69
As we observed, the investment rate (quantity of investment) of China

has been meteoric at around the 45% level, while that of Vietnam has hovered
in the 30% range for the longest time. At the paltry rate of 20% of GDP, the
case of the Philippines may be called ‘investment compression’. But even
more important than the quantity of investment is the quality of investment
as reflected by its allocation between the Tradable goods and Non-tradable
goods sectors.
Market and Institutional Imperfections

As already alluded to above, Dani Rodrik (2008) has demonstrated that
markets, as well as institutional imperfections, tend to herd investment away
from the Traded goods sector towards the Non-traded goods sector. These
imperfections add significantly to the transaction cost of Tradables which
they cannot pass on to consumers in the competitive global economy. Non-
tradables, in contrast, compete largely among themselves in the local economy,
face the same market and institutional imperfections, and thus are not
competitively disadvantaged. There is then coming from these failures a
natural bias against the Tradable sector. Left to itself, investment will find
comfort in the Non-traded goods sector and away from the Traded goods
sector. The story Rodrik wanted to tell was that an economy can partly offset
this local bias against the Tradable sector by maintaining a weak currency,
a strategy he calls ‘levelling the playing field’. He then showed that, indeed,
those economies that had the courage to level the playing field by maintaining
a weak (i.e., undervalued) currency have done better in terms of economic
growth. China, of course, beckons as the modern exemplar; Japan and Taiwan
led the way in the post-World War II era. The prospect of the Tradable goods
sector worsens when the domestic currency is instead deliberately kept strong
(i.e., overvalued) for other goals such as to fight domestic inflation and/or
keep domestic food prices low by importation. The overall bias against
Tradables is thus ‘doubly skewed’, resulting in a stampede out of Tradables.
The market and institutional deficits in Rodrik (2008) correspond to
and manifest themselves as the poverty of public goods in this present work.
Poverty of public goods translates into higher logistics cost which
disadvantages the Traded goods sector against foreign rivals. As an instance,
the president of IBM Philippines once made a visit to the UP School of
70
80 Decompressing Investment
Economics. He was brought in by two vehicles—one of which ferried four

bodyguards. This was at the height of kidnapping-for-ransom and, as
president of IBM, he was ‘kidnap quality’. That extra cost would not have
been incurred by his competitors in Shenzen or Singapore. It was a real cost
in the Philippines. The lack of social coherence, itself an institutional
weakness, underpins the failure of the polity to adequately address these
imperfections.
When investment flocks to the Non-traded goods sector, the problem
of sustainability rears its head. The attempt to steeply ramp up investment
by, say, cheaper credit, quickly creates ‘price bubbles’ in the Non-traded goods
sector. These are invariably followed by ‘price busts’ which empties the gas
tank of investment. Likewise, the ramping up of investment in an inward-
looking economy runs up into what classical economists call the ‘under-
consumption crisis’ as domestic market demand falls short of rampaging
supply. When this happens, investment loses steam.
The investment-driven economies of East Asia and now China needed
outward orientation to sustain the investment drive over long periods. South
Korea sustained an 8% GDP growth for two and a half decades running
from 1960 to 1984. This would not have been possible had S. Korea been
selling only in the domestic market. An inward-looking economy cannot
sustain such protracted high-speed growth. Overheating follows quickly in
an inward-looking economy. Even the USA during the Gilded Age (1870–
1900), a vast inward-looking economy, suffered such overheating and
investment collapse, as happened in 1883 and 1893.
A weak currency helps not only outward orientation, but also the
sustainability of such high levels of investment. But to work its magic, peso
weakening must be sustained. It cannot be only episodal. We have had peso
weakenings in the past that were promptly reversed (the exchange rate was
once at Php50/$ and readily brought back to Php40/$). Those do not work
at all. Unless the long-entrenched import bias in the currency is finally
exorcized with incontrovertible signals, investors assume reversion to the
status quo and act accordingly. They may even lobby for that reversion. The
reason is hysteresis, a physical phenomenon familiar to engineers and exact
scientists. Hysteresis in this case means that when an import bias (alias
overvaluation of the currency) of x percent has built up an import orientation
in the economy, it takes more than x percent depreciation (alias
71
undervaluation) of the currency and one sustained for a long period to reverse
the orientation. Nonlinearity is of the essence; nonlinearity is at the heart
of hysteresis; history matters.
Movements of the exchange rate, even within a band, always display
short-run volatility. Investors expect the movements to be mean-revert and
thus do not change investment plans. When an import bias is embedded for
a long time in the currency, it shapes the investment trajectory of the economy.
Short-run movements of the exchange rate have little or no effect on this
trajectory. They have to be convinced that there is a regime change that looks
and feels permanent before they would budge. Because their investment
commitments are tied to the old regime, they may even be staunch advocates
of the old regime. Such are most moguls of the Service industry. The signals
of a regime change are the size of the change and its staying power, but
preferably both. A change in the exchange rate in a weak governance
environment will be interpreted as reflecting the weakness of the economy
(as, say, reflecting macroeconomic instability) and thus as unwanted volatility;
as such, it will only reduce the investment rate. But the exact same change
in the exchange rate in a strong governance environment (and more likely
also a strong economy which is not forced to devalue) will be seen as strategic
and thus interpreted as sustainable. This will raise the investment rate.
If the Philippines is to shift to an investment-led growth, as seems to
be the Duterte government rhetoric, insights into the behavior of the
investment rate (GDCF/GDP) in low-income developing countries is of
utmost importance. Daway-Ducanes, Ducanes and Fabella (2017) ran
regressions of the correlates of the Investment Rate for low-income countries
(<$10,000 per capita income), the same data set as above regressions on
poverty incidence. The explanatory variables of interest are: the industry
share of Manufacturing (manu-gdp) and the industry share of Services (serv-
gdp), the proxy for governance and (soft and hard) infrastructure quality
(ICRG), (log rer) which reflect movements in the exchange rate, interaction
between exchange rate movement and the quality of governance (lrer-ICRG),
and the inflow of foreign investment (fdi-inflow). For controls they have as
starting point per capita income (lgnicapita-cons), the real interest rate (real-
interest), lagged investment rates (1-fixed k, 12-fixed k) period dummies, and
dummy for tropical location (Tropicar). The dynamic panel data estimates
are given in Table 7.1:
82
Dynamic panel-data estimation, two-step system GMM
Group variable: countryid Number of obs = 365

Time variable : periodid Number of groups = 102
Number of instruments = 88 Obs per group: min = 1
F(16, 102) = 207735.62 avg = 3.58
Prob > F = 0.000 max = 5
fixedk Coef. Std. Err. t P>|t| [95% Conf. Interval]
l_fixedk .6069841 .0097029 62.56 0.000 .5877384 .6262298

l2_fixedk -.1486858 .0127669 -11.65 0.000 -.1740089 -.1233628
lrer -2.442404 .2426952 -10.06 0.000 -2.923789 -1.961019
lrer_icrg .0375798 .0037033 10.15 0.000 .0302344 .0449253
icrg .0712697 .026818 2.66 0.009 .0180763 .1244632
fdi_inflow .1540616 .0189124 8.15 0.000 .1165489 .1915744
tropicar -.4429408 .2583699 -1.71 0.089 -.9554164 .0695348
manuf_gdp .1035651 .0137019 7.56 0.000 .0763874 .1307428
serv_gdp -.0527951 .0177249 -2.98 0.004 -.0879523 -.0176378
lgnicapita_cons -.4941392 .2165501 -2.28 0.025 -.9236652 -.0646131
real_interest .0264208 .0026133 10.11 0.000 .0212374 .0316042
period3 12.12158 1.757852 6.90 0.000 8.634893 15.60827
period4 11.15781 1.838909 6.07 0.000 7.510342 14.80528
period5 11.49781 1.798024 6.39 0.000 7.931436 15.06418
period6 13.30241 1.776806 7.49 0.000 9.778119 16.82669
period7 12.69041 1.776799 7.14 0.000 9.166134 16.21468
TABLE 7.1. Investment rate for low-income countries

(<$10,000 per capita income)
The share of Manufacturing in GDP associates positively and

significantly with the investment rate, while that of the Service sector
associates negatively and significantly—again the footprint of development
progeria in this sample of low-income countries. Good infrastructure proxied
by ICRG and inflow of foreign direct investment also associate significantly
and positively with the investment rate. The direction and significance of
these relations are as we expect them.
The role of the exchange rate is interesting: movements in the exchange
rate (lrer) by itself alone associates negatively and significantly with the
investment rate consistent with the interpretation that such movements reflect
macroeconomic instability and interpreted as unwanted volatility. But the
interaction between the real exchange rate and quality of governance
73
(lrer_ICRG) associates positively and significantly with the investment rate.

When movements of the exchange rate interact with strong governance, it
is interpreted as invested with aforethought and resolve rather than as a result
of weakness and, because sustainable, raises the investment rate.
The lesson is that investment compression associates strongly and
negatively with development progeria, with good soft and hard infrastructure,
and with a sustained and pro-export posture in the exchange rate.
Furthermore, a healthy foreign investment inflow correlates with high
investment.
The economic cluster of the Duterte administration in the Philippines
is committed to a much higher investment rate and a more rapid job creation.
It also wants to bring Manufacturing to the regions. All correct directions.
An investment rate raised to between 25–35% of GDP is only part of the
story; for an investment-led growth, the high investment rate must become
sustainable over decades. This can be attained by becoming even more
outward-oriented so as to escape the limited confines of the domestic
economy. Thus, the contribution of Manufacturing to GDP must rise; the
contribution of Manufacturing to regional GDP must rise. To attract more—
and especially the right—foreign investment, it does not harm to signal
outward orientation by a willingness (at least rhetorically, if not factually)
to maintain a weaker peso. Weakening of the peso that only tracks global
weakening against the dollar is of little help. We need to end our romance
with the strong peso in order to attain a sustained rapid growth that will
finally break the back of poverty in the Philippines (see Fabella, 2017c).
This march to an investment-led growth and rapid job creation can,
however, be slowed down or even aborted by inconsistent policy steps. One
such step is acronymed ‘endo’, short for ‘end of contractualization’.
Contractualization has been demonized as a strategy of business in the
Philippines to exploit surplus labor by employing labor on contractual basis
to avoid the substantial additional cost associated with permanent hires. But
contractualization can also be viewed as ‘labor sharing’: scarce employment
slots are being shared by more workers; permanent workers are paid less
than they could be without contractual labor; contractual labor have some
income, sporadic maybe but some, instead of none at all. The decay rate of
work attitude and work aptitude is so much more rapid among the long-
term unemployed than among those with only sporadic spells of
84
unemployment. If contractualization is ended and all employment mandated

by law to be permanent, this will precipitate a substantial rise in labor cost
and a substantial reduction in hired labor. Fewer workers will be employed
and many workers now currently listed as underemployed will join the ranks
of the openly unemployed. Job creation will also slow down as investors,
foreign and domestic, think twice about locating in the Philippines. Businesses
that are trapped and cannot relocate will invest more in machines that displace
labor. More smart machines will prematurely replace workers. New
organizations will be invented to eliminate jobs. The impact on the industrial
structure will be considerable. The long-term unintended consequence on
labor welfare may be the opposite of the intended.
In this volume, we argue for a determined pushback on development
progeria by reducing the bias against the Tradable goods sector and
Manufacturing. Endo will worsen that bias. Already, the cost of power has
increased due to the lifting by TRAIN 1 of the VAT exemption on power
transmission, a development that further raises the bias against
Manufacturing. The Services sector will just pass on the added cost of labor
due to Endo and added cost of power to domestic consumers; Manufacturing
cannot do the same so Manufacturing is bound to lose out further. Thus,
Endo is inconsistent with the Duterte administration’s resolve to raise the
investment rate, increase the contribution of Manufacturing, and speed up
the rate of job creation.
In Part II of this volume, we will dwell on another phenomenon related
to weak institutions, inward orientation and small markets. This is the
phenomenon of vertical conglomerates and the game they play called
conglopolistic competition in the non-traded goods space. Since
conglomerates are ubiquitous in the Philippines, how should we view them?
Should they be feared and pushed back or should they be rechanneled and
enlisted towards greater welfare contribution?
PART II
Conglomeracy and Inclusion
86
8
Conglomerates and
Conglopolistic Competition
ONE VERY salient feature of current Philippine economy is the unmistakable

presence of conglomerates competing in many markets. Philippine
conglomerates are horizontally integrated large corporations. Though
originally emanating from different core businesses, their footprints in many
disparate markets are very large.
The Vent for Size3

Coase’s (1937) seminal observation—that market transactions are not
without cost and the higher the cost of market transactions the larger the
firms—started ‘the boundary of the firm’ sub-discipline in Economics. But
the idea went into eclipse for 30 years before Oliver Williamson (1975), the
2009 Nobel Memorial Prize winner, resurrected the idea in the 1970s and
put ‘transactions cost economics’ and firm-market boundary back on the
disciplinal agenda. The crucial decision problem for the firm in this arena
is whether to ‘make or buy’ a service or an input, an issue alien to the black
box of the Arrow-Debreu firm. In underdeveloped economies, market
transactions and exchange costs tend to be prohibitive; the pioneering
3 This section owes a great deal to Fabella (2016), “Conglopolistic Competition in Small
Emerging Economies: When Large and Diversified is Beautiful.” http://
www.econ.upd.edu.ph/dp/index.php/dp/article/view/1492/975. Accessed November 2017.
See also Fabella (2015), “N-Poly Viability and Conglopolistic Competition of Emerging
Markets.”
77
88
78 Conglomerates and Competition
entrepreneur—having no one to buy from or organized entities to sell to—

faces the entire attendant forward and backward linkage risks. The main
reason is the underdevelopment of the factor markets (Khanna and Palepu,
1999). The primus inter pares among these factor markets is the capital market.
Firms need capital to grow their businesses, but in LDCs the financial markets
may not be able to meet their capital requirements at reasonable rates. The
capital market failure is usually the motivation for state financial intervention
in favor of certain companies and partly underlies the emergence of state-
sponsored conglomerates. Where the financial market is weak, firms outside
the orbit of the state largesse need to raise capital internally (Williamson,
1975; Stein, 1997; Klein, 2002). Economic size is the private sector’s way of
compensating for the capital market deficit through internal capital
generation. Large companies also tend to be sought after and favored with
lower interest rate by the banking sector which, following the Stiglitz-Weiss
logic (that banks require warranties, collateral or reputational, to lend under
asymmetric information) use size as a proxy for capacity to pay and for quality.
They are also sought after as partners by foreign investors and serve as
conduits of foreign capital by direct borrowing. In Biology, there is even a
rule for analogous reason governing the tendency towards large size among
vertebrates called the Cope’s rule (McMahon and Bonner, 1983).
The ‘make’ decisions taking the form of vertical integration to reduce those
risks lead to the emergence of large vertically integrated firms in large markets.
The ‘vent for size’ going through vertical integration comes in this case from
profit-seeking through efficient provision and control of the value chain.
Predation, Uncertainty and the Impulse for Size

The vent for size is also more urgent in weak governance environments.
Less developed economies are backward for many reasons, but the most
encompassing reason is weak governance due to weak institutions (Shirley,
2005). Weak governance starts with a hobbled state whose many organs of
rule-making and enforcement intended in theory to advance the common
weal are either too feeble to resist or too susceptible to capture and used as
instruments of predation on weaker players. This is analogous to the famous
risk associated with the emergence of the state itself: it can be an instrument
of protection or an instrument of expropriation (Acemoglu, 2002; North,
79
2005). Unfortunately, the political economy of governance in LDCs not only

does not guarantee state benevolence, but may indeed invite predatory
behavior. Where ‘weak public ordering’, the term favored by O. Williamson,
is an integral part of the politico-economic landscape, the private firm must
also vertically integrate into defensive private ordering in order to survive.
A weak governance environment begets the proverbial predation table
where rents are divvied up. It is popularly observed that having a seat in the
predation table means you do not end up on the menu. The seats at the table
are, however, allocated according to political power. Economic size, insofar
as it gets translated into political power, can procure for its holder a seat at
that table. While size is a magnet for predators, it is also a rampart against
predation. Small firms are vulnerable to predation because the cost of
protection can be prohibitive and not affordable. Large firms in weak public
ordering environments are those that have managed to survive the predatory
jungle by acquiring defensive ramparts or that have used the predatory
landscape to their advantage. Having a hand in the election of the president
of the republic means having a say at who becomes the minister of finance
or the commissioner of the tax bureau. Being able to afford the highest-paid,
judiciary-savvy and high-profile lawyers gives the firm an edge in dealing
with predatory tax collectors and regulators. Such are out of reach for small-
and medium-scale enterprises. Their only survival strategy is to pay off the
corrupt tax man.
This foray into the political economy arena is, in the O. Williamson’s
(1985) sense, a ‘make’ decision in order to render property rights and contract
uncertainty manageable where the wielding of state power is unpredictable
and sometimes predatory. In the Philippines, the most convincing reminder
of weak public ordering is the ubiquitous ‘blue guards’, now a big industry.
As in Biology, large size allows cell complexity and diversity which makes
for flexibility (McMahon and Bonner, 1983). The human brain’s enormous
capacity derives both from its size relative to human body mass and from
the complexity of its neuronal connections. Not without reason did Adam
Smith (1776) hail division of labor as the lodestone for progress.
Thus, where governance is weak, firm size—in the language of
evolutionary biology—plays the role of a trait selected for survival. They are
like the bright colors announcing the lethal toxicity of highly poisonous
salamanders or of coral snakes. Predators learn quickly to avoid a frontal
90
tussle with such firms and turn their attention to more vulnerable smaller
ones. The grapevine story has it that when Robina Gokongwei, scion to
conglomerate magnate John Gokongwei, was kidnapped by a crime syndicate,
John Gokongwei bankrolled another syndicate to hunt down and eliminate
every member of the kidnap syndicate. Once a self-protection capability is
acquired, the marginal cost of its further use is negligible. Like sunk capital,
it is attended with economies of scale. Further acquisition of size lowers its
average cost. It is no different from a political machinery: once set up, electing
yet another member of the political clan costs very little. Concentration or
political dynasty seems dictated by the dynamics of the political market. It
thus serves as an entry barrier to the political market.
Too Big to Behave

The danger of size in weak public ordering environment goes beyond
just the usual too-big-to-fail; it includes too-big-to-behave. Having acquired
a political or physical firepower to repel predators, the temptation to use
the same capacity to, in turn, prey on weaker rivals is strong. Large
conglomerates may succumb not only to the temptation of abuse of market
power, but to the employment of acquired political leverage for rent-seeking.
This prompted many observers to mystify Schumacher’s (1973) ‘small is
beautiful’ view. Not representative but suggestive nonetheless of
romanticism was the Schumacher statement: “Man is small, and, therefore,
small is beautiful.” Reminds one of the role of powerlessness in the
attainment of efficiency in the First Fundamental Theorem of Welfare. Man
is small relative to the cosmos, yes, but since he is also enormous relative
to the amoebas, may we say that “enormous is beautiful”? And with more
reason: our humanity, our capacity to reflect, depends upon the neuronal
complexity and specialization of the human brain which are supported by
our brain size. Schumacher had a dim view of Capitalism, but had high
hopes for socialists who he thought should use nationalized industries “not
simply to out-capitalize the capitalists… but to evolve a more democratic
and dignified system of industrial administration…” Large, it appeared,
can evolve if socialist, but not if Capitalist, into the “more humane”. While
there are areas where Schumacher’s romantic view applies, we have
exaggerated the utility of that view.
81
True, many large business groups may develop and maintain

clandestine and privately mutually beneficial relations with political actors.
This murky matrix of relationships and connected dealings became the
favorite whipping boy of sanctimonious Western observers in the wake of
the Asian financial crisis of 1998 which, for many, signaled the end of the
proverbial East Asian Model.4 As the financial crisis of 2008 revealed,
however, the West is not immune from such financial self-dealing-based
sinkholes despite its vaunted regulatory ramparts. The announcement of
the death of the East Asian model proved grossly premature. PRC is its
flag bearer in the twenty-first century.
We do not underestimate this risk. Our view is: rather than condemn
size at the outset because of the risk, we consider size as a necessary investment
in efficiency and sustainability. In the language more familiar to modern
competition policy, market or economic dominance is not a crime per se;
its abuse is. But abuse has to be clearly demonstrated according to the
standards of the law and preferably the rule of reason. We recognize this
danger, but neither should it blind us to the reality that in the world of market
survival and competition, small is synonymous with fragile.
Horizontal Conglomeracy
The spread of large business groups across many disparate unrelated
markets through horizontal integration is also motivated in the literature by
underdevelopment in the capital and insurance markets. The need to raise
capital internally may also be addressed by size through diversification. But
the pronounced motive for conglomeracy is the mitigation of risk and returns
volatility. With developed capital markets, investors can reduce volatility by
owning diversified equity holdings. Where the capital and insurance markets
are underdeveloped, implicit portfolio diversification can be achieved by
owning shares of a diversified conglomerate. Diversified holdings by firms
can reduce returns volatility, lower bankruptcy risk and earn better credit
rating. This should make conglomerate shares enjoy a premium in such
markets. Other reasons for the premium have been proposed: lower interest
borrowing, lower tax burden due to intra-firm transactions, and leveraging
4 “In Praise of Rules,” The Economist, 2001.http://www.economist.com/node/559389.

92
of managerial resources. I recall talking to a taipan who revealed a desire

to enter markets that are less susceptible to the vagaries of macroeconomic
instability. He has since added to his considerable holdings hospital and
infrastructure assets in keeping with this resolve.
Because markets are small and/or fragmented in small emerging
economies, the vent for size among firms manifests itself as horizontal
conglomeracy—playing and competing in many markets at once. Note,
however, that horizontal conglomeracy is quintessentially a Non-traded goods
sector phenomenon in the Philippines. The vent for size in small economies
need not manifest itself as horizontal conglomeracy among firms in the
Tradable goods sector which sells to the vast global market; these thus grow
largely untroubled by quick market saturation. They can acquire heft while
staying within their core market and associated vertical integrates. The best
example is Foxconn in the People’s Republic of China, a Taiwanese foreign
investment which grew to enormous size as an original equipment
manufacturer (OEM) for global digital equipment brands and has stayed as
such even as it moved much of its operations globally. Yet another is
Convergys of India which has stayed with business process outsourcing
(BPO), which is a Tradable service. Furthermore, as observed in chapter 7,
institutional and market distortions which abound in low-income economies
tend to weigh down the Traded goods sector more than the Non-traded
goods sector and draws investment decisions away from Traded goods
(Rodrik, 2008).
The Philippines: A Case in Point

In emerging markets, casual empiricism suggests that the dominance
of conglomeracy in the Non-Traded goods sector is not abating. Contemporary
Philippines, where most newsworthy economic projects involving large
capital outlays are linked to one or more of the very visible conglomerates,
seems emblematic of this trend.
In the Philippines, the following Non-traded goods sectors host the
following players: banking—Ayala group, Aboitiz group, SM Prime group,
Lucio Tan group, Gokongwei group; property development—Ayala group,
SM Prime group, Lucio Tan group, Gokongwei group, DMCI group,
Megaworld, Phinma; retail merchandising—Ayala group, SM Prime,
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Gokongwei group, Rustan’s; telecoms—Metro-Pacific group, Ayala group, San

Miguel group; power generation and distribution—Ayala group, Aboitiz
group, San Miguel group, DMCI, Benpres group, Metro-Pacific group;
infrastructure construction and operation—Ayala group, Metro Pacific group,
DMCI group, San Miguel group, Megaworld group; and tertiary education—
SM Prime group, Yuchengco group, PHINMA group, Lucio Tan group, and
Ayala group, to name a few.
Contrast this to the large players in the vast US market that have stayed
largely within their original core markets including their vertical integrates,
e.g., Walmart in merchandising; Bank of America, Citigroup and JP Morgan
in banking; Trump in property development; Intel in microchips; GE in
industrial machinery; GM and Ford in vehicle manufacturing and assembly;
Apple in Digital Devices; Google in search devices; and Facebook in social
media.
Large horizontally diversified firms abound because their kind is selected
for survival in uncertain environments. They may indeed be the most efficient
path to progress for small emerging economies. In relatively more volatile
environments, their depth and breadth allow them to survive the vagaries of
politics and nature where small undiversified companies will fail. Their size
enables them to afford new technologies mostly piggybacked on new fixed
capital equipment. For example, a super critical steam generator could produce
more electricity per unit of input than a subcritical steam generator because
of the new technologies embodied in it that allow it to operate at super critical
levels. But this also comes with a high initial price tag.
The points made here are not new, but are reiterated to counter a
perceived bias against large firms and conglomerates in many LDCs. Many
an economist, brandishing a PhD from the West, steeped in the grand
tradition of the Arrow-Debreu world where powerlessness is the principal
anchor of market efficiency, and exposed to industrial organization and
competition studies in jurisdictions with strong public ordering, will rattle
off Herfindahl and other indices showing concentration. Without proper
grounding in the vicissitudes of business in small markets and in jurisdictions
with weak public ordering, facile pronouncements about possible abuse of
market power frequently don’t make any sense. They often put the carabao
before the cart.
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9
Conglomerates, Consumer Welfare
and Collective Action
WHILE THERE are many interesting issues associated with Conglopolistic

Competition, there are two issues of immediate concern, viz., how they serve
consumer welfare and how they boost the state’s capacity for collective action.
Consumer Welfare and Conglopolistic Competition

That the more firms competing in the market (in this case more
conglomerates) the larger is the consumer surplus, is a standard result in
the Theory of Industrial Organization. This is shown formally in the
Appendix for the interested reader.
The fact alone that conglomerates compete in the same market improves
welfare, no matter that their entry into these markets is profit-motivated.
The welfare gain is the harvest of Adam Smith’s ‘Invisible Hand’. The
government’s only role is to safeguard free entry and prevent collusion. In
the Philippines, the enabling law for this is already enshrined (The Philippine
Competition Act). The generally accepted exception to this is when the market
is a natural monopoly, that is, when the fixed capital requirement is large
and two or more firms producing for the same market will end up losing
money due to economies of scale, and being unsustainable, will in time
consolidate into one firm. The power transmission franchise granted the
National Grid Corporation of the Philippines (NGCP) reflects the natural
monopoly feature of power transmission. So do all the franchises to
distribution utilities. The franchises granted to the two water service
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85
concessionaires, Manila Water Company Inc. and Maynilad Water Services

Inc. in Metro Manila reflect the natural monopoly in water distribution. By
contrast, power generation (in the Philippines) has been declared by EPIRA
as competitive, meaning that power generation not being invested with scale
economies is a free entry sector.
Conglopolistic competition is especially pro-consumer welfare in
jurisdictions where institutions are unable or unwilling to monitor and
punish abuse of market power. SM North used to be the only source of
‘malling service’ in the West Triangle area until the Trinoma Complex was
built by the Ayala group. Now, mallers have options; they can just cross
the footbridge linking both malls. Likewise, the power of mall owners over
retail locators is reduced since the locators could now play one mall against
the other.
There is logic to why, in small emerging markets, these large firms will
begin to invade each other’s markets in the pursuit of overall size. In other
words, one can show that mutual invasion of each other’s market is a sub-
game perfect equilibrium solution to the entry game when there are no
barriers to entry (see Fabella, 2016). They tend to outgrow their original
market niche and would seek to build size by mutual invasion. Thus, there
is a natural tendency for conglopolistic competition to reduce market power
and its abuse.
What is the role of competition policy in such environments? It is
important that the competition watchdog ensures that these conglomerates
stay at each other’s throats and not collude in the Non-traded goods sector.
The conglomerate ownership profile in the Philippines has an interesting
ethnic feature—some are owned or controlled by Filipinos of Spanish descent,
others are by ethnic Filipinos and still others, the majority, are by Filipinos
of Chinese extraction. There is a healthy mutual suspicion among these ethnic
groups which is a bar against collusive behavior. Of course they will not
hesitate and should not be deterred from occasionally working together to
raise the financing and share the risk in certain large projects. Although there
is an established belief that competition and profit-seeking will eventually
blur these ethnic lines, ethnic identity can still exert strong pressure to
compete rather than collude. For one, ethnic identity makes it more unlikely
for their offspring to inter-marry—an informal pathway often taken by
consolidation.
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86 Consumer Welfare and Collective Action
It is different in the Traded goods sector where forbearance by the

competition watchdog for collusion and consolidation by local conglomerates
is in order as long as the economy is fairly open in those sectors. As banking
becomes increasingly cross-border and banking services become increasingly
cross-border-competitive, it may be wise for local banks to merge and for
the banking regulator, BSP, to encourage it as indeed it now does.
Boosting the Nation’s Collective Action Capacity

Weak public ordering in LDCs as we discussed earlier manifests itself
principally in weak capacity for collective action. This is crucial because the
most important task of every state is the provision of public goods which,
first and foremost, is a collective action problem. The provision of arterial
public infrastructure requires sizeable resources which must first be collected
in sufficient volume and, second, allocated to large arterial infrastructure
amidst myriads of competing claims for its use and which, in turn, require
careful implementation. States afflicted by weak public ordering find it
difficult to negotiate all or some of these steps adequately; thus, bad
infrastructure and bad economic outcomes. Even when resources are raised,
state implementation of large projects frequently end up mired in corruption
and waste.
Large conglomerates—with their command of sizeable financial
resources, considerable reputational capital and, more important, efficient
and motivated management resources—can be harnessed to boost the
collective action capacity of the state. They, of course, look for adequate
bottom line before committing. The now prominent Public-Private
Partnership (PPP) follows this idea. The very successful privatization of water
service in Metro Manila, for example, could not have come about without
these large conglomerates and conglopolistic competition (Fabella, 2011).
While social incoherence stands in the way of adequate public goods
provision, sometimes the state can boost its collective action capacity by
enlisting economic entities that possess and/or have demonstrated strong
collective action capacity in their own endeavors. The conglomerates existing
in its jurisdiction are candidates. Conglomerates possess the resources, the
strong organization, and skilled, well-paid and highly motivated manpower
to undertake large projects. As observed earlier, weak public ordering prompts
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private entities to acquire private ordering capacity. Thus, weak public

institutions are compatible with and even prompts the growth of capacitated
private sub-national institutions. At this stage in its history, the Philippines
already has a clutch of such conglomerates which, with proper incentives,
can be launched towards large undertakings of greater public interest. Because
of the anti-Manufacturing bias of our incentives structure, most of these
conglomerates, in the interest of their bottomline, have stayed clear of
Manufacturing. They are mostly rooted and compete in banking, power, retail
trade and real estate development.
Rather than fear these conglomerates and impede their progress, the
Philippine state will do well to embrace and redirect these conglomerates
towards the provision of public goods and towards partnering with global
players in the Manufacturing sector. The government’s role requires itself
to become a reliable counterparty in large projects, that is, to credibly commit
to long-term and market-driven contracts and enforce them religiously. Weak
states are especially vulnerable to clamors for short-term relief at the expense
of long-term viability and prosperity.
Public-Private Partnership (PPP), perhaps the most popular method
of enlistment for large infrastructure projects, is possible only if there are
large financially well-endowed players willing to undertake the risks
associated with being counterparty to the government. They must have the
wherewithal to fight protracted legal battles when the sitting government
reneges on contracts. The cost of litigating their claims against the government
as in the case, say, of the income tax holiday written in the concession contract
of water service concessionaires in Metro Manila, but contested and denied
by the water regulator, is prohibitive for smaller firms. Moreover, where
auction is the preferred market testing modality, there should be enough
financially capacitated bidders to constitute a successful bid. Box 9.1 below
details a successful collective action initiative which became a reality only
because there were large conglomerates which had the financial heft and the
reputational capital to attract foreign partners with the specific expertise on
water service delivery to allow them to play the role of minority partners
(see, e.g., Fabella, 2011). The latter is important especially because none of
the domestic players had previous experience and expertise in water service
provision and there is a perception that minority owners are treated badly
in LDCs.
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Box 9.1
Water Services Privatization: Firm Size as Catalytic
Water services procurement in Metro Manila was privatized

in 1997 and is now globally regarded very highly as a PPP success.
Pre-privatization, water and sewerage service in Metro Manila was
provided by a state-owned and -operated agency, the Manila Water
and Sewerage System (MWSS). Water service quality was very poor
(up to eight-hour water interruptions) though water tariff was very
low since upward water tariff adjustment was considered anathema
politically. It thus had to be subsidized by the state and was a fiscal
drain. Privatization would transfer the burden of financing capital
requirement of water infrastructure spending to the winning
bidders and ultimately to the water buyers. But the size of the project
was immense and only very deep pockets would qualify. The
reimbursement modality of the contract meant that only very large
players can qualify. Likewise, the constitutional requirement of
control by Filipinos of public utilities meant that foreign capital
with water service expertise can be attracted to become minority
partners only if the domestic partners could be found with
reputation for upright dealings and with some financial heft. The
players that responded were all huge conglomerates: Metro Pacific
Corporation; Ayala Corporation; Benpres Holdings Corporation;
and Aboitiz Holdings Corp. The intense competition among these
conglomerates allowed a hefty discount to be passed on to the
consumers of water. The aggressive behavior of the winner of the
East wing, Ayala Corporation, was interpreted as due partly to the
conglomerate nature of the bidder (being primarily in property
development). The quality of water service has approached global
standards since privatization. Without these large domestic players,
this momentous privatization would not have happened.
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Conglopolistic Competition in Infrastructure: CALAX

Yet another important PPP contract was signed in 2015. The Cavite
Laguna Expressway (CALAX) is a 47-km eight-lane interchange tollway
project to link the South Luzon Expressway and the Cavite Expressway.
CALAX was to be procured under the Philippine government’s PPP Program.
The auction parameter was the amount of money the bidders were willing
to pay (premium) the government for the right to construct and operate the
project on a user fee basis. The first CALAX auction in June 2014—won by
the Team Orion with a bid of Php11.66 billion in premium payment—was
scrapped by the government when a technicality-disqualified contender, San
Miguel Corporation-affiliated Optimal Infrastructure, opened its bid
document to the public, revealing a Php20.1billion bid. Then President
Aquino—responding to the revelation—ordered a rebid with bid floor being
Php20.1billion. This act by the government produced a spirited howl because
the government seemed to have reneged on an implicit promise to honor
an above board auction. The government’s response was that the
disqualification was too harsh for too flimsy an infraction over bid security
and it cannot, in conscience, leave Php8 billion on the table. In the rebid held
on May 26, 2015, Metro Pacific Investments Corporation won with a bid of
Php 27.3 billion. The project is now being implemented. Whichever side the
rule of law falls on this controversy, the fact is, intense competition among
conglomerates meant that the government realized an additional Php27.3
billion for infrastructure projects in other jurisdictions. Yet again showing
that collective action capacity so lacking in most LDC governments can be
boosted by proper channeling of large conglomerates. Other large
infrastructure projects have already been completed (e.g., the Tarlac-
Pangasinan-La Union Expressway/( TPLEX and the Ninoy Aquino
International Airport Expressway/NAIAX by San Miguel Corporation) or have
been awarded and construction started (e.g., the ongoing Connector Road
Projects, one branch to San Miguel and the other to Metro Pacific) after
intense competition between conglomerates.
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Conglomerates and Inclusion

Do conglomerates contribute in a positive way to inclusion in its normal
profit-motivated way? The answer is “Yes”. One way is through empowerment.
One ubiquitous example is the tingi-tingi and ‘unli’ prepaid SMS contracts
which empower the lowest income classes. Kasambahay (househelp) now
can follow the progress of their children’s education in the provinces and
can combat homesickness with frequent voice calls. Conglomerates can and
do turn pursuit of the bottomline into empowerment of the poor.
Ariel G. Manuel
FIGURE 9.1
Big business meets sari-sari store.
In pursuit of lower non-revenue water which represents lost revenue

to the firm, the water concessionaires in Metro Manila started programs to
connect informal settlers by working out an arrangement with the local
barangay councils, which then becomes the legal counterparty in the ensuing
contracts. Piped water gives the informal settlers at least two benefits:
substantial monetary savings, since water-carrier provided water is very
costly; and health benefits from higher quality piped water. It also improves
the bottomline of the concessionaires. Manila Water’s Tubig para sa Barangay
has improved the lives of 1.8 million informal settlers.
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Ariel G. Manuel
FIGURE 9.2
Tubig para sa Barangay: Manila Water provided piped water
connection to 1.8 million informal settlers, reduced its NRW
and boosted its bottom line. Ditto Maynilad.
Conglopolistic competition is alive as well in non-elite tertiary

education where they have upgraded facilities and faculties. Mapua Institute
of Technology (MIT) has now become Mapua University after it was
acquired by the Yuchengco group. The University of the East now is under
the Lucio Tan group; and National University is owned by SM Investments
Corporation. Ayala Corp. has acquired the University of Nueva Caceres
and the National Teachers College. All it took was for government to
deregulate the tuition fees in tertiary education and conglomerate resources
began to flow in.
Conglomerate CSRs (Corporate Social Responsibility) are also making
headway in education, making available scholarships to thousands of indigent
students (e.g., PLDT Gabay Guro Foundation) and in the upgrade of teaching
and pedagogy in the country (Metrobank Foundation’s Outstanding Teachers
and Filipinos Awards). The SM group also gifted the University of the
Philippines with the UP-BGC building and facility for UP graduate studies
in the BGC, Taguig. Smart-PLDT Foundation’s sponsorship and advocacy
of the revolutionary Dynamic Learning Program (DLP) pioneered by Drs.
Christopher Bernido and Maria Victoria Carpio-Bernido at the Central
Visayas Institute Foundation (CVIF) in Jagna, Bohol, has touched the lives
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and improved the learning opportunities of thousands of high school students

in more than 200 secondary schools nationwide. Other examples exist and
inspire.
There is, of course, the contentious issue that firms do CSR to reduce
their tax obligation and thus as it were steal from public coffers and subtract
from public weal. In strong institution jurisdictions where tax revenue does
truly bankroll public infrastructure, this concern seems a given. That
resources concentrated in the hands of the state get better social returns
than when the same resources are left in private hands and privately deployed
is on firmer ground under strong institutions. It may be less compelling in
jurisdictions where ghostly public goods are rampant and state resources
leak into innumerable private black holes. Nonetheless, it is always prudent
to watch out for and minimize such eventualities.
The main message here is simple: when the state has a weak capacity
for collective action, the presence of large conglomerates can boost the
state’s—and the nation’s—capacity to solve collective action problems, of
which the most important is in the provision of arterial public infrastructure.
What is required is a credible and enabling regulatory environment and the
nurture of healthy competition among private players. The Philippine
Competition Commission is there for that. Rather than frustrate
conglomerates for fear of size and abuse of dominance, we should re-channel
them into competing among themselves in socially productive endeavors
and competing against their counterparts in the world.
In the next chapter, we tackle the question of where we go from here,
and how we may engender a greater coherence as a nation in order to tackle
the poverty of public goods and the shortfall in inclusion.
10
Where Do We Go
From Here and How?
THE INVESTMENT rate in the Philippines has been dismally low at around
20% over the last quarter century, a situation we described as investment
compression. We need to raise the investment rate to between 25–35% of
GDP where it stands among our neighbors. Internal consumption-led growth
will not do; that is too prone to bubbles and busts. But it is normal for a
polity that distrusts its leadership to prefer to consume in the present rather
than seed the soil for a better future that may not be forthcoming. Nor do
spasmodic spikes in the investment rate make for an investment-led growth.
Rather than episodes of high investment rate we should aim for a high
investment rate sustained for at least two decades running.
We do this by first raising our government capital outlay to 8% of GDP
which will, in turn, crowd in private investment. This will support the
present government’s BUILDx3 program and ease up the severe poverty of
public goods that is plain to see. The BUILDx3 program has to be financed,
preferably internally, which is the goal of the enacted TRAIN 1. The
Department of Finance version of TRAIN was at once future-enabling in its
revenue target, compassionate in handling the impact on the very poorest,
and courageous in its bid to plug revenue leakages. TRAIN 1 ran the gauntlet
of, at least in this case, a backward-looking political process that endangered
its integrity. Fortunately, despite the negative add-ons, such as the coal tax
and the lifting of exemption of transmission VAT, the enacted TRAIN has
sufficiently positive features to be contributive to rebuilding. The danger
is that given the false generosity that holds both the legislative and indeed
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104 Where and How to Go from Here
the executive branches in thrall, after funding of freebies and entitlements,

there may not be enough left for BUILDx3. To repeat, the enacted TRAIN 1
is positive despite the frailties tacked on for political expediency. The inflation
uptick post-TRAIN 1 has become in early 2018 a cause celebre by the press
even though TRAIN’s actual contribution to the price uptick is minute. As
with true reforms, the contribution from TRAIN to the inflation is immediate
while the harvest is still to materialize. In truth, this inflationary uptick is
a small price to pay for the contemplated economic transformation and future
resiliency.
We say ‘preferably internally’ financed infrastructure build-up because
external financing—either by foreign borrowing or aid—is never sustainable
and the intended investment-led growth soon founders. We can run into a
payments deficit as we were wont to do in the past. While it is better that
the investment-led growth be anchored on internally mobilized resources,
its flipside is the need to pair the investment-led growth with greater external
market orientation. If we rely only on the domestic market to prop the supply
side build-up, we soon run into the problem of under-consumption. A
sustained investment-led growth is almost by necessity forced to hop on the
global market for sustained demand. Thus, the Philippines must, for durable
growth, shift its center of gravity much more towards the tradable goods
(Manufacturing and Agriculture). What this entails is not only a quantitative,
but also a qualitative change in our investment profile—not just higher
investment rate, but also an investment that tilts towards tradables and
Manufacturing.
We have shown how Manufacturing seems so much more in tune with
poverty reduction in low-income countries. With so much market and
institutional deficits in the Philippines which, on balance, favors investment
in Non-traded goods (Services), it would help to have a pro-Tradable goods
sector slant in the monetary and exchange rate policy—a slant towards weaker
peso, rhetorically if not yet factually, to level the playing field as Rodrik would
have it. This has at least three benefits: it will serve to attract domestic
investment into the Tradable goods sector; it will attract export-platform
foreign investment; and it will reduce profits from and incentives to
smuggling. Export platform foreign investment was what started China (PRC)
and the East Asian Miracles on the trail of global market success. By contrast,
the tack taken by the Department of Industry seems backward; to revive the
95
ghost of import substitution manufacturing in, say, the car industry, via
selective direct or indirect incentive, is futile and will end up the same way
as the Import Substitution fiasco in the 1950s.
For the public to allow so much resources to be transferred from their
pockets to the pocket of—and be deployed by—the government, the public
must be reasonably assured that the waste and venality in the past government
spending shall not have a reprise over the new resources. The government
has to show itself capable of employing tax resources in socially productive
endeavors and not frittering it away in palliatives and populist entitlements.
In other words, government has to earn public trust. At the moment the signs
do not inspire confidence; entitlement creation has so far trumped productive
deployment, e.g., free tuition in state universities and colleges; increase in
salaries of public servants without mechanisms for corresponding increase
in efficiency. As regards the free tuition fee policy, it is deplorable that the
very effective Socialized Tuition Fee Program (STFP) of the University of
the Philippines became a victim and was phased out, very likely never to
be revived. This program evolved over many years as a bargained settlement
among stakeholders and made a distinction between rich and poor students,
the former paying higher tuition fees to help subsidize the latter. In at least
this case, generosity to the rich is the unintended consequence of generosity
to the poor. It may not be unique.
This is where ‘strategic retreat’ by government is called for. The dismal
record of government, that is, at making a ‘muck’ of most everything it touches,
such as the daily breakdowns of state-run MRT and the still to be used
imported rail cars, inspires only skepticism. The Philippine government must
cede activities and services to spheres that can provide them better so more
resources can be deployed for activities where it has comparative competence
such as regulation, enforcing contracts and protecting private property.
Moving away from owning and operating businesses towards regulation and
the safeguard of competition is the preferred pathway in weak institutions
environment.
The decision of the NEDA Board in January 2018 to privatize Clark
International Airport (CIA) operations is eminently correct. In December
2017, the state authorities decided to make CIA in Pampanga as the second
major gateway. Spot on! It would greatly declog both NAIA and Metro Manila
especially EDSA by serving Central and Northern Luzon and not to say North
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Metro Manila passengers. It now takes only between 1.30 to 2 hours by P2P
bus from Trinoma in Quezon City to CIA. NAIA will now better serve South
Manila, Calabarzon and the Bicol region passengers. NAIA 1, 3 and 4 should
be next in the privatization pipeline.
The shift from ownership and operation to greater arm’s-length
regulation is not easy. It requires both wisdom and courage. But it is a direction
that the Philippines has already traversed with some success. It no longer
is hypothetical for the country. We do not have to re-invent the wheel here.
It has worked to our benefit in the past (MWSS privatization, OPSF
jettisoning, the EPIRA). As with all true reforms, teething pains cannot be
avoided. Indeed, those teething pains signify that the reform is meaningful.
Meaningless reforms are painless and non-contentious. We need to continue,
not slacken, the pace of the state-ceding activities to other spheres of
provision. Thus, for example, MRT should be privatized soonest (Santiago,
2017). Property rights and ownership in the agricultural sector should be
unshackled by embracing tradable property rights and leaving the market
to determine farm cultivation sizes. The five-hectare ownership limit in CARP
(and CARPER) hamstrings farm modernization and productivity.
Rather than threaten to shackle the conglomerates in our midst, we
should re-channel them to the Tradable goods sector, such as food production
or towards that segment of the Non-traded goods that is ancillary to the
Traded goods sector—power generation. We have already managed through
PPP to re-channel them towards infrastructure development, a non-tradable
service that is ancillary to traded goods sector. With trimmed down state
agenda, the remaining programs will have more adequate budgets, manned
by people who are more motivated because they are better paid and show
overall better performance. Better performance of government programs will
re-motivate trust in government. With increased trust and stronger fiscal
position, the government can now entertain more ambitious programs. The
polity can be induced to relent from its ‘eat, drink and be merry for tomorrow
we die’ outlook because the government can be trusted to transform today’s
foregone consumption into tomorrow’s bumper harvest. That is the real secret
behind the Three Gorges Dam achievement. EPIRA is an instance where the
plugging of fiscal drain from the state’s ownership and operation of power
supply and delivery allowed the government the wherewithal to bankroll
and scale-up a CCT (also 4Ps) program.
97
Whatever resources it realizes from TRAIN 1 must be used to bankroll

truly socially productive public goods. In other words, the visibility and
tangibility of TRAIN 1-enabled infrastructure must be ensured. One of these
must connect Mindanao to the Luzon-Visayas power grid by a submarine
cable to finally create a One-Philippine Power Grid. In line with this is the
upgrade of the still limited Luzon-Visayas and inter-Visayas power highways.
The Mindanao-Visayas segment, once completed, can be turned over to
NGCP for operation and management. Integration of power markets always
leads to lower-priced and more stable power.
In regard to the greater outward-looking stance for sustainability, the
lifting of the constitutional limits on foreign ownership, the easing of
administrative hurdles to actual investment—whether local or foreign—and
the maintenance of an export-friendly peso will help create a cascade of
favorable news required to push the Philippines higher in the radar screen
of investors. An export-friendly peso will attract the right foreign investment
into the Tradable goods sector.
The role of foreign investment cannot be overemphasized. The
history of the East Asian Miracles including now China (PRC) shows the
pivotal roles of direct foreign investment. Foreign investment represents
‘smart capital’—that which has the global network, the supply chain, the
market savvy, and the track record to navigate the global traded goods
market. Needless to add we have to be much more assiduous in our efforts
to attract them. A new/old industrialization path with a twist can be
considered.
Slipstream industrialization is a way for our conglomerates, now still
mostly rooted in the Non-traded goods sector, to enter rapidly into the Traded
goods space. Slipstream is that space directly behind a fast moving leader
where air resistance is much reduced for a follower—it takes less effort for
the follower to move forward. Much of development in the past has taken
this route—less developed economies getting on the slipstream of mature
economies via labor-intensive manufactures. In the modern era, it is now
third world firms with designs on Manufacturing that should endeavor to
enter the slipstream of global firms. As observed, Foxconn (Hon Hai) became
a global giant as an OEM manufacturer in PRC in the slipstream of Apple,
Samsung, Sony, etc. You don’t see a Foxconn cellphone, but almost every
upscale smartphone has an invisible Foxconn footprint. Foxconn is a Taiwan-
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owned foreign investment company in PRC and now elsewhere in East Asia.
The Philippines needs to facilitate the slipstream partnerships for our
conglomerates.
In the next and last chapter, we recapitulate the lessons we learned
to craft an overall vision that parts ways with the trajectory of wasted
opportunities and blaze a path toward a new and more inclusive future.
11
Recapitulation
CAPITALISM faces an inclusion crisis the world over. This is true in the
affluent OECD countries where the inclusion crisis is about income inequality.
Income inequality in high-income mature economies has been shown to
exacerbate with per capita income by Thomas Piketty’s 2014 masterpiece.
Inclusion in low-income countries with weak institutions is, however, more
about the reduction of abject poverty than about income inequality. While
there are policy regimes that promote both poverty reduction and more
equitable income distribution, our position is that, when there is a conflict
between these two facets of inclusion, abject poverty reduction should take
priority. PRC reduced its poverty incidence massively while allowing income
Gini to rise. It is arguable that the rise in income Gini in China actually
helped along rather than impeded its poverty reduction. The ‘Jack Ma
phenomenon’ is one of the unmistakable promontories of present-day China.
As we observed earlier about the US Constitution, the ‘Jack Ma phenomenon’
may have been a case of ‘social distinction’ advancing the ‘common utility’
or collective welfare in modern parlance. The UN MDG and the subsequent
UN SDG has targets for poverty incidence, but not for income inequality.
Piketty argued that Capitalism can no longer depend on the Kuznets
Inverted U hypothesis to automatically push back income inequality. Instead,
Capitalism should and could be made more inclusive by a more determined
regime of progressive income and wealth taxation. We argue that Capitalism
or its alter ego, the market economy, can be a vehicle for inclusion in low-
income countries especially in the sense of poverty reduction. This can be
pursued by raising government capital outlay to say 6–8% with which to
scale up infrastructure spending, which will in turn draw in local and foreign
99
110
100 Recapitulation
investment towards an investment rate of 25–35%. But the government must

collect taxes with which to bankroll the increase in capital outlay. That is
the reason behind the recently enacted TRAIN 1. TRAIN 1 is a good forward-
looking program for job creation and poverty reduction despite the
immediate cost in inflation.
As observed, the People’s Republic of China (PRC) is the real superstar
not just in economic growth, but more so in poverty reduction—three-fourths
of all poverty reduction gains in the world during the MDG era (1990–2015)
happened in China where 600 million people graduated out of poverty. In this,
Deng Xiaoping was the real hero. Under Deng, PRC effectively adopted the
genome we associate with Capitalism—free enterprise, profit seeking, foreign
investment and world trade, and finally, private property in 2004—effectively
scorning the Socialism of Marx and Engels and Mao Zedong, but repudiating
as well the politics of the West. Along the way, Deng’s PRC allowed the market
to provide goods and services, previously the sole prerogative of the state. It
went into overdrive in the upgrade of its infrastructure, built economic zones
which welcomed the hitherto disdained foreign investment, allowed farmers
to determine their own fates and, lately, allowed tradable usufruct rights on
land (the Liuzhuan System; see, e.g., Fabella, 2014).
While we know more or less what Deng’s China did, Deng’s China remains
a hard act to follow. The reason is plain enough: Deng inherited from Mao
Zedong a China that was strong with a coherent polity and hard institutions.
Those who opposed or were naturally disposed to oppose the political authority
were rendered scarce by a process we call ideological cleansing. This strategy
is hardly open to many low-income countries. That the Chinese polity and
the central authority are in broad agreement is evidenced by the largely trouble-
free construction of the Three Gorges Dam, a massive project that many
Western observers opined could not be done in the West. The People’s Republic
of China has, as it were, attained the fullness of an ‘imagined community’. Most
low-income country governments, by contrast, are fragile political settlements
that exhibit weak institutions and characterized by unstable rules, unstable
enforcement, the truck-and-barter of rules and the capture of state organs by
private interest for private gains. In other words, these polities are still in the
process of what political scientists call ‘state building’. Distrust of the central
authority is the norm. Gridlock is endemic. In the Philippines, the San Roque
Dam’s capacity to irrigate 70,000 hectares of rice land was continuously
101
sidelined by conflicting claims that the Philippine state could not or would
not resolve. The NAIA Terminal 3 was unused and decaying for a decade after
its delivery in 2002 because it was bogged down by festering legal dispute that,
in China, would have been ironed out with dispatch. Weak states and institutions
manifest themselves as weak capacity for collective action; weak collective action
capacity results in the poverty of public goods. The poverty of public goods,
stunted economic growth and high poverty incidence are fellow travelers in
the development highway.
Mounting game-changing projects run into intractable headwinds when
public trust is low and the polity is fragmented. The state is often mired in
the quagmire of ‘overreach’—that is, it spreads itself too thin in too many
puny projects and programs that reflect the fragility of its underlying
settlement. Distrust is the currency of the land in many third world countries
and with good reason. Most of its programs result in a harvest of waste and
venality which becomes the signature of the state among its own polity. When
a competition law was contemplated for the Philippines in the first decade
of the twenty-first century under a compromised chief executive, the most
powerful opposing argument was: “It will be another livelihood project for
government bureaucrats!” A more crass, perhaps, but no less valid version
of the biblical adage: “The spirit is willing, but the flesh is weak”! The
oppositors won that fight. The Philippine Competition Act (RA 10667) finally
became law in 2015 under President Benigno Aquino III.
Citizens, keenly cognizant of the very weak capacity of institutions in
the Philippines, must constantly press upon advocates of the government
intervention the question: What is the market or government failure that the
state intervention or program addresses? Has the government the capacity
to see through the intervention to the benefit of society? Unless adequate
answers are supplied by advocates who should bear the burden of proof,
opposition must be imperative.
We have seen how important trust is for institutions and how costly
is the lack of trust. How do we restore trust in our institutions? The first
step to restoration of trust is a strategic pause to new state programs only
distantly related if not completely alien to its core competence and a strategic
retreat from many extant but failed programs of the state. That is not easy.
If Deng Xiaoping found it hard going outflanking the old guards and old
ideas, ideas which the present-day National Democratic Front (NDF) still
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102 Recapitulation
champions, it is several orders of magnitude harder for many low-income

countries. As this clearly goes against the grain of political wisdom in these
countries, it takes a rare alignment of circumstances to pull off. Even with
the most favorable of conditions, one can only hope for a slow evolutionary
process of healing rather than radical Dengist turnaround.
Such alignments, if extremely rare, do occur. It starts with the fortuitous
accession of a new well-meaning leadership. Deng Xiaoping is an example.
He was a forlorn discredited outsider who had a heretical vision. As luck
would have it he managed to wrest power after Mao’s death in 1976. He
exploited the emerging global forces outside PRC to outflank the opposition.
In Deng’s case, the cross-border movement of private capital and the Chinese
diaspora served as lynchpin. The new economic zones established under
Deng quickly became magnets for global export platform DFIs. Foxconn
(Hon Hai), then a fledgling Taiwanese OEM company and three decades
later the second largest private employer in the world after retailer Walmart
in the USA, located in PRC in 1988. It was one of those facts on the ground
and their harvest that could no longer be gainsaid. And the Deng Xiaoping
era got its lasting lease on life.
The Philippines has, despite its weak institutions and poor reputation
in contract compliance, has mounted a few successful strategic retreats by
the state: the abandoning the OPSF and the privatization of downstream oil
industry in 1998 and the privatization of water and sewerage services in
Metro Manila in 1997 and the privatization of the electricity industry via
the 2001 EPIRA. The first two occurred under President Fidel Ramos who,
like Deng Xiaoping, enlisted a convergence of factors, namely, the presence
of a crisis and global capital movement to support his reforms. President
Ramos created a splash as the conqueror of the crippling ‘power crisis’ of
the early 1990s. This he accomplished by drawing in independent power
producers with a generous market risk-free ‘take or pay’ contract; this
guaranteed independent power producers a high rate of return regardless
of market conditions. Capital responded with 22 IPP contracts signed between
1991 and 1993 for 2.6 gigawatts (Abrenica, 2004). The power crisis was
conquered (although at a high price, it turned out, when the domestic market
collapsed in the wake of the Asian financial crisis). This conquest, nonetheless,
gave President Ramos the political wherewithal to launch and see through
other reforms. The privatization of water and sewerage service in Metro
103
Manila could not have proceeded without the well-publicized water crisis
showing the failure of government provision of water distribution and the
partnership between foreign capital and local conglomerates. Being acutely
sensitive to, and seizing opportunities that emerge in the global economy,
provided anchors for tilting the domestic balance of power towards game-
changing reforms.
These precious few episodes of strategic retreat experienced growing
pains at the start, but in time proved themselves beneficial. The
considerable difficulty is the flipside of meaningful reforms. When
painless, the reform will likely be meaningless. Which is why TRAIN 1 has
a shot at meaningfulness.
Had our public infrastructure been adequate and our monetary and
exchange rate policy more traded goods-friendly, the Philippine investment
rate would have been higher while tilted more towards the Traded goods
sector and Manufacturing; the economy would not have become mired in
the malady of development progeria—when a low-income economy has the
industry share dynamics of a rich mature economy—that is, its Service sector
grows faster than its Manufacturing. Development progeria in low-income
economies associates with economic stagnation, low investment and high
poverty incidence. The roots of development progeria are market and
institutional failures, such as poverty of public goods, compounded by a
penchant—in low-income economies—to maintain an overvalued currency
to cheapen imports and/or fight inflation. Together they hamstring
Manufacturing in favor of Services. In the Philippines, it was literally a
romance with the strong peso partly helped along by Dutch disease pressure
from OFW remittance that cleared the way for a flourishing development
progeria. These features are not genetic; they can be reversed.
The Philippines at this stage in its history has in its midst a number
of large private conglomerates which are repositories of considerable
financial, organizational and human capital resources. Because of the
entrenched bias that drove investment away from the Traded goods sector
(say, Manufacturing), these conglomerates are mostly in the Non-traded
goods sector. These conglomerates tend to be horizontal (not in the sense
of geographic but in the sense of activities) because markets in the Philippines
tend to be small. To acquire size, which we observed is a trait selected for
survival in environments characterized by weak institutions and predation,
114
104 Recapitulation
these conglomerates grow horizontally. By doing so they invade each other’s

markets and enhance consumer sovereignty in these markets. This
phenomenon we call ‘conglopolistic competition’. Conglopolisitc competition
tends to empower and benefit the consumers. This is true, for example, in
banking which the retail trade giant, Shoe Mart Corp. (SM) entered after
acquiring Banco de Oro and now gives the traditional banking community
a run for its money. In turn, the Ayala group deeply entrenched in banking
and property development has invaded the retail and malling services space
long the preserve of SM.
Even more interesting, these conglomerates compete in the
infrastructure development space as private partners in PPP projects of the
government. We have seen the flowers of this competition. Metro Manila
water distribution privatization could not have happened without these large
conglomerates. Conglomerate competition figured in the Ninoy Aquino
International Airport Expressway (NAIAX), the Tarlac-Pangasinan-La Union
Expressway (TPLEX), the soon-to-be Cavite-Laguna Expressway (CALAX)
and the sorely needed Connector Road projects. We saw how the government
of President Benigno Aquino III realized Php28-billion in givebacks for the
right to build and operate (the CALAX). This giveback can now be used to
bankroll infrastructure projects in less viable regions. Thus the government’s
weak capacity for public goods provision has been increasingly boosted by
the enlistment of these conglomerates via the PPP modality. The game
changer here was the abandonment in the early 1990s of the deeply rooted
view that transport and other infrastructure was the sole preserve of state
provision. It would be foolhardy to abandon PPP now. It would be foolhardy
for any government with designs on a bright future to keep breaking contracts
its predecessor has signed on to, such as the income tax holiday in the water
concession contracts, and thus show itself as an unreliable contract
counterparty. It is a simple rule of law imperative that when a government
sets aside a contract or a contract provision, it must adequately compensate
the aggrieved private counterparty to the contract. And adequate
compensation must be negotiated and cannot be arbitrarily imposed.
Development progeria—unlike its medical counterpart—is only
phenotypic. As phenotypic, it is curable. Change the operating environment
and the phenotype will adapt. The bottom line is that we can break out of
development progeria by upgrading our infrastructure by leaps and bounds.
105
Raising the government capital outlay to 8% of GDP will go a long way

towards decompressing investment, that is, raising the investment rate to
25–35% of GDP. Better infrastructure lowers the cost of doing business—
for example, lower power cost always reduces the bias against the Tradable
sector (Manufacturing and Agriculture) since these have to compete in the
domestic and global market with Tradables from foreign jurisdictions with
better public goods endowment and lower power cost. Rodrik (2008) has
shown that the bias against the Traded goods sector can be reduced (the
playing field can be leveled) by maintaining a weaker peso. Rodrik and others
have demonstrated that higher economic growth and undervalued currencies
are strong correlates in the development landscape.
Since at this stage in our history, we already have a clutch of
conglopolistic competitors, our strategy should be to enlist and re-channel
them towards boosting the state’s weak capacity for collective action, that
is, towards more public goods activities such as infrastructure development.
The Duterte administration armed with considerable mandate (30% plurality
is high in the Philippines) has a rare opportunity to swing the arc of history
in favor of a more respectable future.
But vigilance against incoherence in policy and vision cannot be
overemphasized. Adequate infrastructure through “BUILDx3” is designed to
make us an attractive investment destination. But then we also impose higher
power cost and we effectively mandate higher labor cost through ‘endo’. The
massive Hanjin shipbuilding investment in 2010 that would have employed
4,000 workers both directly and indirectly, in Northern Mindanao was
aborted by local government interference which the central government could
not or would not resolve (Sicat, 2015). This and like instances send very bad
signals to foreign investors. Now we are embarking on giving more powers
to local and regional governments through the federalism project. Investors
especially in the Tradable goods sectors such as Manufacturing and
Agriculture are very averse to incalculable risks emanating from the political
projects. We may be calling a party from which investors shy away.
Fully aware that ‘wasted opportunities’ may well have been the middle
name of the Philippines in the last forty years, we cannot stay on the shores
of business as usual. Would that the future not be another showcase of
squandered opportunities. The annals of failed development are painted on
the canvas of squandered opportunities, not on the canvas of scarce resources!
116
APPENDIX
Welfare Gains from Conglopolistic Competition

WE CONSIDER a market with inverse demand function P = a – bX, a, b >
0, where the number of firms n > 0 and X = Σxi is the sum of the outputs
of n individual firms. In the following we will consider the inverse demand
intercept ‘a’ as a proxy for market size (also called vertical growth by Hegji,
2001; Neumann et al., 2001). Each firm faces a fixed capital investment of
K > 0 to be amortized at fixed rate r > 0. The size of K has scale economic
implication. We thus assume the total cost function facing firm i as
Ci= cixi + rK, ci > 0.
The variable cost of firm i is [cixi] and fixed cost is rK. The average cost
(Ci/xi) = [ci + (rk/xi)] is decreasing at a decreasing rate as is customary with
scale economies. The firms play a Cournot market game. We assume that
(a – ci) > 0 for all i. This characterization of the oligopoly market with fixed
K is common (Dasgupta and Stiglitz, 1980; Neumann et al., 2001; see Hegji,
2001 for a case with endogenous K). The symmetric Cournot market
equilibrium production is
xo = (a – c)/[b(n + 1)],
and the total production is
nxo = {n(a – c)/[b(n + 1)]},
106
107
while the Cournot equilibrium price is
po =[a + nc]/[( n + 1)].
Using xo, nxo and po, we find the welfare level using the consumer’s
surplus at Cournot competitive equilibrium with n firms, CS(n), to be:
CS(n) = (n/(n + 1)2(a – c)2/2b.
Note that CS(∞) is maximum for any n = 1, 2,…, ∞. This is the Nirvana
of competition viewpoint although it really has little practical value. The
corresponding consumer’s surplus at Cournot competitive equilibrium with
(n + 1) firms and under the same K is:
CS(n + 1) = ((n + 1)/(n + 2))2(a – c)2/2b.
Now it is clear that CS(n) < CS(n + 1). Thus, more firms competing
in the market will deliver higher consumer welfare. The welfare dividend
of greater competition is
[CS(n + 1) – CS(n)] > 0.
This is obvious, for example, if the initial market has n = 1 (a monopoly)

and the subsequent market has n = 2 (a duopoly). Note that the consumer
surplus is monotonic increasing with respect to the number of firms. This
is independent of the fixed cost or the size of K. The size of K, however,
limits the number of firms that can make money in the x market. If the
number of firms is such that all of them are losing money, then a consolidation
will follow that whittles down the number of firms. As the number drops
due to consolidation, consumer’s surplus falls. Thus, the monotonicity relation
holds whatever the size of K.
118
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124
INDEX
A retail and malling services space, 82, 104

telecoms, 83
Aboitiz Holdings Corp, 54, 88 Box 9.1:
tertiary education, 83
banking, 82
power generation and distribution, 83
Agriculture: property rights and B
ownership, 96 Bangko Sentral ng Pilipinas (BSP):
Alcala, Angel, 47 portfolio investment, 62
Ampatuan clan,13 Bank of America: banking, 83
Angara, Edgardo, 63 Baumol Effect, 61
APO Island marine protected area (MPA), Beijing-Lhasa Railway Line, 43
47, 49 Belgium, 36
Appeals Panel: creation of, 54 Benevolent leadership, 50, 54
Apple: digital devices, 83 Benpres Holdings Corporation, 54, 88
Aquino, Benigno III, 101, 104 Box 9.1: power generation and
Aquino, Corazon: tradables-driven distribution, 83
recovery, 62 Berlin Wall, 5
Armed intervention, 35 Bernido, Christopher, 91
Arrow, Kenneth. Arrow Impossibility Boom-bust cycle, 28, 61
Theorem, 31 BOP Crisis, 61, 62
Arrow-Debreu firm, 77: equilibrium Bourgeois economy, 6
framework, 21; market efficiency, 83 Brexit, 36
Asian countries: comparative investment BUILDx3 program, 14, 93–94, 105
rates, 27 fig. 2.1 Bureaucratic capitalism, 1
Asian economic miracles, 8, 28: export- Business, Big: meets sari-sari store, 90 fig.
oriented labor-intensive 9.1
industrialization, 23
Asian financial crisis (1998), 62–63, 81
C
Ayala Corporation, 54, 55, 88 Box 9.1:
acquired National Teachers College, 91 Calculation debate: of central planning, 21
acquired the University of Nueva Capital: allocation, 6, 25; markets, 78, 81;
Caceres, 91 political, 9
banking, 82 Capitalism, 19–20, 21, 68, 80, 99:
infrastructure construction and Chinese characteristic Capitalism
operation, 83 (PRC), 1
power generation and distribution, 83 and democracy, 17, 18
property development, 82 Genomic, 7, 25, 100
114
115
inclusion, 1–2, 99 Conglomerates, 12, 13, 74, 80, 86:

and Socialist challenge, 2 anti-Manufacturing bias, 87
Carnegie, Andrew, 4 and foreign partners, 87
Carpio-Bernido, Maria Victoria, 91 and inclusion, 90–92
Cavite-Laguna Expressway (CALAX), 14, market competition and welfare, 84
89, 104 re-channel to tradable goods, 96
Central Visayas Institute Foundation slipstream industrialization, 97
(CVIF), 91 Conglopolistic competition, 13, 74, 84–86,
Chavez, Hugo: Bolivarian Revolution, 5 89, 104, 105
Chemical weapons, Use of, 35 Connector Road Projects, 13–14, 89, 104
Chiang Kai Shek, 24 Consortia by service area, 55 table 5.1
Chikiamko, Calixto, 63 Consumer welfare: and conglopolistic
Chinese Han polity, 9, competition, 84–86
Chinese polity, 32 Contractualization: labor sharing, 73–74
Chinese sangleys: ethnic cleansing, 36 Convergys of India: business process
Citigroup: banking, 83 outsourcing (BPO), 82
Clark International Airport (CIA), 13: Cope’s rule, 12, 78
privatization, 95–96 Corporate Social Responsibility (CSR), 91,
Class war, 20 92
Coase, R. The Problem of Social Cost, 7: Credible commitments, 10, 11, 50, 51
‘the boundary of the firm’, 77 Croatia: Catholic, 36
Cognitive Science, 7 Crony capitalism, 68
Coherence, social, 10, 34, 35, 37, 42, 43– Cross-country evidence of poverty
45, 92 incidence, 11–12
Collective action capacity, 10, 39n 1, 40, Cuba: dissenters, 35
86–87, 89 Currency devaluation, 61, 62: overvaluing,
‘Commanding Heights Economy’, 25 103; weak: outward orientation, 70
Commitment devices, 11, 53–54, 56 Czech Republic, 36
Common utility, 4, 99
Communism, 6 D
Competence, Domain of, 8, 28–30, 32
Competition policy, 84, 85 de Dios, Emmanuel, 63, 68
Comprehensive Agrarian Reform de facto nation: ‘imagined community’, 44
Program (CARP), 5, 96 de facto power, 50
Conditional Cash Transfer (CCT) (also de jure nation, 44
4Ps) program, 96 de jure power, 50
Comprehensive Agrarian Reform De Mandeville’s The Fable of the Bees, 4
Program Extension with Reforms Deng Xiaoping (1976–1989), 2, 4, 7–8, 9,
(CARPER), 96 100:
Conglomeracy, Horizontal, 13, 81–82 farmers play the market, 24–26
outflanking the old guards, 101
126
116 Index
taming overreach, 28–30 ‘Endo’ (end of contractualization), 73, 74,

cross-border movement of private 105. Search also under
capital, 102 Contractualization
internal exile, 37 Engels, Friedrich:
spheres of provision, 31 collapse of Capitalism, 20
strategic retreat, 14 Communist Manifesto, 1
Department of Industry: import Socialism, 100
substitution manufacturing, 94–95 Entrepreneurial Capitalism, 1
Development progeria, 11, 14, 57, 60–63, Electric Power Industry Reform Act
68, 74, 103, 104 (EPIRA), 85, 96
‘Dictatorship, of the proletariat’, 20 Equitable income distribution, 3, 22, 23,
Diokno, Benjamin, 63 99
DMCI group: Equity, 2, 6, 19–22
infrastructure construction and Europe: cost of territorial encroachment,
operation, 83 34
power generation and distribution, 83 Everett, Clark, 26
property development, 82 Exchange rate, 12, 62–63, 67, 71–73, 94,
Domestic food prices: low by 103
importation, 69 Export platform, 25, 28, 94, 102
Domestic inflation, 69 Export processing zones, 28
Domestic investment: into tradable goods
sector, 94 F
Domestic market, 8, 28, 70, 94
Dutch disease pressure: from OFW Fabella, Raul, 63
remittance, 103 Facebook: Social Media, 83
Duterte administration, 105: investment Farm cultivation: Lysenko system, 24
rate, 27, 73, 74 Farmers: business and risk-taking, 24–25
Fernandez, Jose “Jobo”: interest rate cure,
62
E
Ferromagnets, 42–43
East Asian Miracle economies, 28, 41: Filipino race: fission viewpoint, 36
export platform foreign investment, Firms. Search under Business;
94, 97 Conglomerates
East Asian Model, 70, 81 First Fundamental Theorem of Welfare,
Economic agents, 7, 21 19, 80
Economic growth, 3, 4, 22, 100, 101, 105 Fishing Game, 10, 51:
Economic size, 78, 79 collective action problem, 39–42
Economic success, 35, 38 payoff matrix, 39 table 4.2
Economics orthodoxy, 6 tragedy of the commons, 39 table 4.1
Efficiency, 6, 13, 19–22, 25, 29, 80, 81, 83, 95 Ford: vehicle manufacturing and
Efficient Assignment Rule (EAR), 8, 29 assembly, 83
‘Elite capture’, 68 Foreign direct investment, 72
117
Foreign investment, 7, 8, 25, 100: inflow, Great Leap Forward, 9, 24, 25

71, 72; ‘smart capital’, 97 Greenwald-Stiglitz Theorem, 7: state
Foreign ownership: constitutional limits, welfare and proper taxation, 22
14, 97 Gross Domestic Product (GDP), 59, 69, 73:
Foundation for Economic Freedom investment rate, 27
(FEF), 63 Manufacturing, 58, 65, 72, 73
Foxconn (Hon Hai), 82, 97–98, 102 Non-traded goods sector (Services), 11,
Free enterprise system, 7, 19–20, 25,100 58, 65
Free tuition fee policy, 95 share of manufacturing, 72
Gulags, 37
G
H
Game of Chicken, 48
Game-changing projects, 101 Hayek, Friedrich, 20–21: The Fatal
GE: industrial machinery, 83 Conceit, 8, 29, 49
Gecko, Gordon: “Greed is good”, 1 Herfindahl, 83
Germany: Herzegovina: Islamic, 36
industry and manufacturing shares, 59 Hitler, Adolf: war of expansion, 44
service sector shares, 59; per capita Hongkong-Zhuhai-Macao bridge, 26
income, 59 fig.6.3–60 Human capital accumulation, 3
Gini ratio, 4, 17 Hybrid (PPP), 29
Global poverty incidence, 3 Hysteresis, 70–71
GM: vehicle manufacturing and assembly,
83 I
Gokongwei group:
banking, 82 Iglesia ni Kristo, 13
property development, 82 ‘Imagined community’, 9, 44, 100
retail merchandising, 83 Import Substitution fiasco (1950s), 61, 95
Gokongwei, John, 80 Inclusion: and development progeria, 57,
Gokongwei, Robina, 80 63–65
Goods, Distribution of, 19, 20 Inclusive poverty, 4, 5
Google: search devices, 83 Incoherent polities, 43
Governance quality (ICRG), 65 Income distribution, 3, 4, 22, 99
Governance: Income equalization: and poverty
from the outside, 48 reduction, 5
good, 12, 26 Income inequality, 2, 3, 5–6, 19, 22, 99
system of, 10 Individual industry, 25–26
Government: Indonesia: industry and manufacturing,
commitment device, 52 59; service sector, 59
failures, 47–50. Search also under Inducements, 10
State failures Induction: paths to, 45
Great Britain, 36 Industry share of select countries, 58 fig.
6.2, 60 fig. 6.4
128
118 Index
Inequality Armageddon, 19, 20 L

Infrastructure: conglopolistic
Laissez-faire Capitalism, 1, 49
competition, 89; hard, 9, 73; soft, 9, 73
Lange, Oskar, 6: state ownership of capital,
Institutions, Weak, 10, 11, 12
20
Instrument: of expropriation, 78; of
Lange-Lerner theory, 6, 20, 20–21, 25
protection, 78
Lange-Lerner vs. Hayek-Von Mises
Intel: microchips, 83
controversy, 21
Interconglomerate competition. Search
Lerner, Abba, 6: state ownership of capital,
under Conglopolistic competition.
20
Inter-group competition, 34
Less developed countries (LDCs):
Internal conflicts: dampeners, 34–37
benevolence, 79
International Finance Corporation, 53
large firms/conglomerates, 83
Inter-tribal barbarism, 36
weak governance, 78;
Intervention, 46, 49
weak public ordering, 86
Inter-Visayas power highway, 97
Leung, Ernest, 63
Intra-group competition, 34
Leveraging of managerial resources, 81–82
Inverted U Hypothesis, 17, 18 fig. 2.1b
Lhasa-Beijing Railroad, 26
Investment compression, 27, 69, 73, 93
Local governance, 47
Investment: correlates, 12
Lower interest borrowing, 81
Investment-led growth, 14, 27, 31, 71, 73,
Lower tax burden due to intra-firm
93, 94
transactions, 81
Inward-looking economy, 70
Low-income communities:
development progeria and poverty
J incidence, 63
‘Jack Ma phenomenon’, 4, 99 governance, 32
Japan: exchange rate, 61; ‘levelling the investment rate, 12, 71, 72 table 7.1
playing field’, 69 manufacturing and poverty reduction,
Japanese daimyo, 52 57, 94
Japanese society: radius of coherence, 44 ‘overreach’, 14, 28, 29
Job creation, 73, 74, 100 poverty reduction, 5, 99
Jobo bills, 62 weak institutions, 33, 100
Jose, F. Sionil: Filipino polity a nation de Lucio Tan group:
jure or de facto, 44 banking, 82
JP Morgan: banking, 83 property development, 82
tertiary education, 83
Luzon-Visayas power highway, 97
K
Kasambahay, 90 M
Keynes, J. M. General Theory of
Employment, Interest and Money, 28 Machiavelli, Niccolo. The Prince, 26, 34
Kuznets, Simon: Inverted U Hypothesis, Maduro, Nicolas: Venezuela, 5
3, 17, 22, 99 Magnetism, 43
119
Malaysia Federation, 36 Megaworld group:

industry and manufacturing, 59; infrastructure construction and
per capita income, 59 fig. 6.3–60 operation, 83
Mall owners: and retail locators, 85 property development, 82
Manila Water: Tubig para sa Barangay, Meta-market failure,19, 20
90–91 fig. 9.2 Metro Manila:
Manila Water and Sewerage System commitment devices, 53–54
(MWSS), 88 Box 9.1: privatization, privatization of water and sewerage
52–53, 55 service, 52, 86, 102–3
Manila Water Company Inc., 85 water distribution services, 13
Manufacturing sector, 57: water services procurement, 88 Box 9.1
industry share and exchange rate, 71 Metro Pacific Investments Corporation,
lower poverty incidence, 64 54, 89, 88 Box 9.1:
poverty gap and poverty head count infrastructure construction and
ratio, 64 table 6.1–65 operation, 83
Mao Zedong era (1949–1976), 4, 7: power generation and distribution, 83
‘restricted preference’ polity, 8 telecoms, 83
Socialism, 24, 100 Metro Rail Transit (MRT), 14, 95, 96
Mapua University: acquired by Metrobank Foundation:
Yuchengco group, 91 Outstanding Teachers and Filipinos
Market determination of many prices, 7 Awards, 91
Market dominance, 81 Mindanao: Muslim restiveness, 36
Market economy, 20, 99 Mindanao-Visayas power highway, 97
Market efficiency: with equity, 19 Moon-Kim meeting, 35
Market failure, 32–33, 40, 49 Mugabe, Robert, 9
‘Market socialism’, 21. Search also under Mutually Assured Destruction (MAD), 22
Lange-Lerner theory Myanmar: Rohingya Crisis, 35–36
Markets, 29, 31: and institutional
imperfections, 69 N
Market-driven contracts, 87
Marx, Karl: Nash equilibrium, 40, 46, 48
abject poverty, 18 ‘Nation-building’, 9
collapse of Capitalism, 20 National Democratic Front (NDF), 101–2
Communist Manifesto, 1 National Economic Development
critique, 19–21 Administration (NEDA), 95
Das Kapital, l, 20 National Grid Corporation of the
Socialism, 100 Philippines (NGCP), 84, 97
Maynilad Water Services Inc., 85 National University: owned by SM
Mechanism design, 21 Investments Corporation, 91
Mega corporations, 1. Search also under National Water Crisis Act, 53
Conglomerates Neo-Classical Economics, 6–7, 21: Pareto
efficiency, 19
130
120 Index
Ninoy Aquino International Airport export platform foreign investment,

(NAIA), 96: Terminal 3, 101 28, 94, 97
Ninoy Aquino International Airport Foxconn (Hon Hai), 82, 97–98, 102
Expressway (NAIAX), 13–14, 34, 89: Great Leap Forward, 9, 24, 25
conglomerate competition, 104 Household Responsibility System, 25
Non-tradable goods sector, 13, 61: ideological cleansing, 35
conglomerates, 85 ‘imagined community’, 100
investments, 69, 70; inclusive Capitalism, 68–69
‘price bubbles’, 70 income Gini, 99
North Korea, 35, 37 industry and manufacturing, 59
North, Douglass, 10, 47 investment-driven economies, 27, 70
Northern Mindanao: Hanjin shipbuilding ‘levelling the playing field’, 69
investment, 105 manufacturing share and poverty
Nozick, Robert. Anarchy, State and reduction, 12, 65–66 fig. 6.5
Utopia, 22; wealth and income manufacturing vs. services average
taxation, 19 growth, 66 fig. 6.6–67
market-friendly system, 21
O OEM manufacturer, 97, 102
poverty incidence reduction, 3–5, 7,
OECD countries: income inequality, 99 24, 99, 100;
Oil crisis, 2 Robber Barons, 4
Orthodox economics, 6–7, 19 state corporations 8, 25
Orthodox Socialism, 25 strong state, institutions and coherent
Ostrom communities, 10 polity, 8–9, 31, 100
Overreach, 8–9, 14, 28–30, 31, 101 Walmart, 102
Yuan: devaluation, 63; weak, 28
P Per capita income of select countries, 59
fig. 6.3
Paderanga, Cayetano, 63
Peso: export-friendly peso, 97;
Panic of 1873, 28
development progeria, 60–63;
Panic of 1883, 28
weakening, 63, 70, 73, 94
Panic of 1893, 28
PHILEXPORT, 63
Pareto efficient allocation, 19, 21
Philippine agriculture: deregulate
Pareto efficient distribution, 19
property rights, 14
Pareto efficient outcomes, 20
Philippine Competition Act, The, 84, 101
Pareto, Vilfredo, 20
Philippine Competition Commission, 92
Peasant revolts, 18
Philippine Long Distance Telephone
Penalties: and coherence, 45–46, 49
Company (PLDT): Gabay Guro
People’s Republic of China (PRC), 2:
Foundation, 91
East Asian model, 81
Philippine National Police (PNP):
encroachment into the Scarborough
criminal syndicates, 12
Shoal, 35
121
Philippine Value-Added by industry, 58 Tradables and Manufacturing, 62: to

fig. 6.1 the regions, 73
Philippines: ‘wasted opportunities’, 105
abandon OPSF, 102 weak institutions, 60, 101
‘blue guard industry’, 12 PHINMA group: property development,
Capitalism, 68; 82; tertiary education, 83
competition law, 101 Piketty, Thomas. Capital in the 21st
conglomerate ownership profile, 85 Century, 17:
conglomerates in Non-traded goods income inequality, 18, 99;
sector, 82 market failure, 19
domain of competence, 30, 95 state intervention, 20
end of contractualization, 73–74, 105 Piped water, 90
exchange rate, 61 Political dynasty, 80
extra-judicial killings (EJK), 37 Political instability, 68
government capital, 93, 105 Politics, of power and influence, 6
government has to earn public trust, Portfolio diversification, 81
95, 96, 101 Poverty incidence, 11, 23, 63–67, 101,
horizontal conglomeracy, 13 103: and income inequality, 2–5
industry and manufacturing, 59 Poverty of public goods, 11, 50, 69, 101:
investment: and non-traded goods sector, 61
compression, 69 Poverty reduction, 23, 67, 99, 100
in Non-traded goods (Services), 94: Poverty, Abject, 2–3, 18
towards traded goods sector Poverty, Absolute, 6, 18
and manufacturing, 103 Poverty, Inclusive, 4, 5
investment rate, 27, 71, 93 Power companies: state-owned, 29–30
‘landed poor’, 5 Power cost, 9, 74, 105
manufacturing and agriculture, 94 Power crisis, 62
Manufacturing vs. Services average Power generation, 96: competitive, 85
growth, 66 fig. 6.6–67 Power markets: integration, 97
non-inclusion, 68 Prague Spring, 2
peso, 60, 73, 105 Predation: and weak governance, 79
poverty incidence reduction, 3, 11, Preference restriction, 31, 32
65–66 fig. 6.5 Price=Marginal Cost, 21
poverty of public goods, 33–34 Prisoner’s Dilemma Game, 39n 1
privatization of the electricity industry Private foreign borrowing, 62
via EPIRA, 102 Private ordering, 12–13, 79, 86
privatization of water and sewerage Private property, 7, 25, 100
service, 52, 86, 102–3 Profit-seeking, 7, 25, 100
San Roque Dam, 100–1 Proto-failure, 32–33
Service sector-led economy, 59, 62 Public goods, 9, 11, 13, 14, 33, 34, 41,
slipstream partnerships, 98 104, 105: contract between state and
‘strategic retreat’ by government, 95 polity, 51
132
122 Index
Public infrastructure, 26, 31, 44, 86, 92, 103 Schumpeter, Joseph. Capitalism, Socialism
Public institutions, Weak, 87 and Democracy, 1; ‘small is beautiful’, 80
Public ordering, Weak, 80, 86–87 Second Fundamental Theorem of Welfare
Public-Private Partnership (PPP), 14, 86, (SFTW), 6, 21, 22
87, 96, 104 Second Law of Thermodynamics, 44
Second-party enforcement, 47
R Self-protection, 12, 80
Serbia: Orthodox Christian, 36
RA 10667. Search under Philippine Services sector, 57, 58, 59, 74:
Competition Act higher share and higher poverty
Radius of coherence, 44 incidence, 63–64
Ramos administration, 63: water services share in GDP, 65
privatization, 13–14 Share tenancy system, 5
Ramos, Fidel V.: Shoe Mart Corp. (SM). Search under SM
commitment devices, 53–54 Prime group
power crisis, 102 Silliman University team, 47
water distribution privatization, 11, 52, 55 Singapore: imminent threat, 34–35; and
Rawls, John. A Theory of Justice, 22; veil of Malaysia, 36
ignorance, 6, 19 Slipstream industrialization, 14, 97
Reagan Revolution, 19 Slovak Republic, 36
Real estate bubble, 62 SM North: malling service, 85
Real exchange rate: lagged investment SM Prime group:
rate, 71; and governance, 72–73 acquiring Banco de Oro, 104
Redistribution: by fiat, 3–4; using lump- banking, 82
sum taxes, 21 gifted the University of the
‘Rent-seeking’, 13, 68, 80 Philippines, 91
Risk-taking, 24–25, 81 property development, 82
Robber Baron Capitalism, 1 tertiary education, 83
Rodrik, Dani: markets and institutional retail merchandising, 82
imperfections, 69 Small emerging markets: large firms, 82, 85
Rustan’s: retail merchandising, 83 Smart-PLDT Foundation: Dynamic
Learning Program (DLP), 91
S Smith, Adam:
division of labor, 79
Saling-pusa, 3
Invisible Hand and crisis of inclusion,
Samuelson, P.: benevolent central planner,
19, 84
6; ‘under-provision theorem’, 42
The Wealth of Nations: efficiency first
San Miguel Corporations, 14, 89:
ethic, 2
infrastructure construction and
S-Modified Fishing Game, 45–46 table
operation, 83
4.3–4
power generation and distribution, 83
S-modified payoff matrix, 48 table 4.5
telecoms; 83
Smuggling: profits and incentives, 94
Scandinavian countries: coherent society, 44
Social asphyxia, 29
123
Social coherence, 34, 37, 42, 43–44, 70: Sub-national entities: enforcement and
and economic success, 35 rule-making, 13
induced, 44–45 Sumilon Island MPA, 47, 49
and public goods, 38, 43 fig. 4.1
Social dilemma game, 41 T
Social incoherence: state’s collective action
capacity, 86 Tagalogs, 37
Social market economy (Germany), 1 Taiwan:
Socialism, 2, 5, 19–20, 25 exchange rate, 61
Solzhenitsyn, A. The Gulag Archipelago, 37 imminent threat, 34–35
South Korea: levelling the playing field, 69
imminent threat, 34–35; Tarlac-Pangasinan-La Union Expressway
manufacturing sector, 59 (TPLEX), 13–14, 89: conglomerate
services sector, 59; per capita income, competition, 104
59 fig. 6.3–60 Tax revenue: bankroll public
Soviet kolkhoz (collective farming) system, infrastructure, 92, 100
24 ‘Tax’ tradables, 61
Soviet Socialism, 36 Team Orion, 89
Spain, 36 Tertiary education:
Special Deposit Account (SDAs), 63 conglopolistic competition, 91
State building, 100 tuition deregulation, 91
State capacity: and market failures, 32–34 Thailand: Industry and Manufacturing, 59;
State failures, 30, 49, 50 Service sector, 59
State ownership, 7, 20, 24, 28, 56 Thatcher Revolution: Capitalism, 19
State, 29 Theory of Industrial Organization, 84
capacity to provide public goods, 51 Third World countries: Capitalism, 5;
enforce contracts, 11 inclusion, 23; strong state, 9
international commitments, 52 Third-party enforcement, 47, 48
and markets, 7 Thomas Aquinas, St., 4
‘overreach’, 101 Three Gorges Dam, 9, 26–27, 32, 43, 51,
protect the property rights, 11 96, 100
retreat to core competence, 31 Tingi-tingi prepaid SMS contracts, 90
State, Strong: Tito, Josef Broz, 36
and quality of rules and enforcement, 9 Tradable/Traded goods sector, 11, 14, 61:
resist encroachments, 34 conglomerates, 86; investment quality,
State, Weak: 69; ‘levelling the playing field’, 69
collective action, 10–11, 13, 92, 101 Tragedy of the commons, 10, 40
poverty of public goods, 9 TRAIN 1, 14, 74, 93–94, 97, 100, 103
Statutes: and coherence, 45–47, 48 ‘Tribal societies’: nation de jure, 44
Stiglitz-Weiss logic, 78 Trinoma Complex: malling service, 85
Stock market bubble, 62 Trosky, Leon, 25
Strategic retreat, 7, 14, 28, 95, 101, 102, 103 Trump: property development, 83
Trust, in central authority, 9
134
124 Index
U W
Ukraine: Russia’s grab of Crimea, 35 Wall-Street-driven capitalism (USA), 1
‘Underconsumption crisis’, 70 Walmart, 1, 102: merchandising, 83
Underdeveloped economies: market Walras, Leon, 20
transactions and exchange costs, 77–78 Water concession contracts: income tax
Union of Soviet Socialist Republics holiday, 104
(USSR): fission, 36 Water distribution: monopoly, 85
United Nations. Millennium Development Water service privatization, 88 Box 9.1
Goals (MDGs), 3, 99: poverty reduction, 5 Water service quality, 88 Box 9.1
United Nation. Sustainable Development Water system workforce, 53
Goals (SDGs), 3, 99 Water tariff, 53
United States: Wealth: equalization, 5; and income
aging infrastructure, 31–32 taxation, 6
Gilded Age (1870–1900), 28, 70 Welfare: fundamental theorems, 7
income inequality with Inverted U Welfare state Capitalism (Sweden and
Hypothesis, 18 fig. 2.1b Denmark), 1
income inequality, 18 fig. 2.1a Western Europe: Capitalism, 8
Industry and Manufacturing shares, 59 Williamson, Oliver:
Service sector shares, 59; per capita ‘hostage’, 52
income, 59 fig. 6.3–60 private ordering, 12
University of the East: owned by Lucio Tan proto-failure, 33
group, 91 transactions cost economics, 77
University of the Philippines: Socialized ‘weak public ordering’, 79
Tuition Fee Program (STFP), 95 World Happiness Index, 44
‘Unli’ prepaid SMS contracts, 90 World trade, 100
V Y
‘Veil of ignorance’ process, 22 Yuchengco group: tertiary education, 83
Vent for size, 12, 13, 77–80, 82 Yugoslavia: ethnic cleansing, 36
Vietnam:
ideological cleansing, 35 Z
inclusive Capitalism, 68–69
manufacturing growth and poverty Zimbabwe, 35
reduction, 12, 65–66 fig.6.5
Manufacturing vs. Services average
growth, 66 fig. 6.6–67
Visayan-speaking Filipinos, 36
Volatility, 71–72: returns, 81
Von Mises, Friedrich, 20–21
For several decades Professor Raul Fabella has set the benchmark for academic
writing on economics and political economy on and in the Philippines. The
hallmarks of his works are academic rigor, clarity of exposition, logical reasoning,
and topicality, underpinned by a sense of urgency about pressing development
challenges that his country faces. His beautifully crafted writings are always a
pleasure to read, and this monograph on Capitalism and Inclusion under
Weak Institutions is no exception. Drawing on an eclectic group of authors,
including Schumpeter, Piketty, Marx and many others, the 11 chapters range far
and wide, from macroeconomics and international economic policy to
institutional change and social policy. Taken together, they persuasively set out
an agenda for a fairer and more prosperous Philippines. Professor Fabella’s book
is a must-read for anybody interested not only in the Philippines, but also the
developing world in general.
HAL HILL
H.W. Arndt Professor Emeritus of Southeast Asian Economies
Australian National University
DR. RAUL V. FABELLA is former Dean of the UP

School of Economics (1998-2007). He has a bachelor’s
degree in Philosophy from the Seminario Mayor-
Recoletos and earned his M.A. Economics at the UP
School of Economics (UPSE). He finished his Ph.D. in
Economics at Yale University as a Rockefeller scholar.
He has taught at UPSE since 1982 and published
numerous articles in local and international journals in
the fields of economic theory, trade, bargaining, public
choice, industrial organization, exchange rate policy, and
agrarian reform. In 1995, Dr. Fabella became the
youngest member of the National Academy of Science
and Technology. And in 2011, he was conferred the rank
of “National Scientist”, the highest distinction the
Philippine government gives to Filipino scientists.
For an adrenalin fix, he works the bike pedals and hits
tennis balls with wife Teena. Weaving ideas in coffee
shops is an integral part of his day.
ISBN 978-971-742-116-2

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Capitalism and Inclusion Under Weak Institutions 1

Capitalism and Inclusion Under Weak Institutions 3

University of the Philippines

Copyright 2018 by UP Center for Integrative and Development Studies

No copies may be made in part or in whole without prior written permission

The National Library of the Philippines CIP Data

1. Capitalism – Philippines. 2. Conglomerate corporations.

330.122 HB501 P820180123

COVER AND BOOK DESIGN: Ariel G. Manuel

Printed in the Philippines

To Teena and Vigile

Part I CAPITALISM AND INCLUSION

1 Inclusion and the Role of the State in

Part II CONGLOMERACY AND INCLUSION

8 Conglomerates and Conglopolistic Competition ........................................ 77

Appendix .................................................................................................................. 106

THE AUTHOR THANKS the Ayala Corporation-University of the Philippines

The Crisis of Inclusion in Capitalism

Be that as it may, the twentieth century cannot be completely understood

West and low-income countries finds expression in the immigration crisis

Social distinctions can be based only on common utility.

This is not an endorsement of De Mandeville’s The Fable of the Bees where

A Bird’s Eye View for the Time-Challenged

Capitalism of the post-World War II Western Europe. Its catch-up strategy to

capturing or influencing centers of political or statal decision making. While

Piketty and the Role of the State

There is another massive implication. Piketty was adamant in his claim

The Marxist Critique and the Lange-Lerner Paradigm

state ownership of all forces of production; in other words, the rejection of

Calculation Debate of central planning as infeasible on the grounds that the

The Neo-Classical Empire Strikes Back

firewall, however artificial, between efficiency and equity theoretically (Blaug,

inclusion problem in third world economies. This involves poverty incidence

HOW POVERTY REDUCTION of a scale unparalleled in history was attained

A ruler must also show that he admires achievement in others,

This is the often overlooked message of The Prince. A state wallowing

mobilize to tackle such massive collective challenge. The Three Gorges

Source: Fabella (2017b)2

2 “Who’s afraid of a weak peso?” BusinessWorld, 25 September 2017. http://

Lessons from Deng Xiaoping: Taming Overreach

Consider the economy as an exhaustive collection of activities each

term contracts allowed the power sector to be unbundled and power to be

its aging infrastructure because advocates of spending for an infrastructure

State Capacity and Market Failures

Dampeners of Internal Conflict

majority to eliminate real or imagined internal conflicts coming from the

THIS CHAPTER is intended primarily for students of formal social

The Fishing Game as Collective Action Problem

The payoff matrix of the Fishing game is in Table 4.2:

TABLE 4.2. Payoff Matrix of the Fishing Game: Invisible Hand

Note 1: Those with some exposure to elementary Game Theory will

CASE 1: Ambo and Berto are total strangers (homo economicus in

CASE 2: Ambo and Berto are part of a coherent group whose

voluntary. Potential beneficiaries will either refuse to contribute or will

• Coherence and Civilization: Electrons

• Coherent communities readily solve

The humble iron bar has become a ferromagnet—now has a magnetic

The radius of members to which this autonomic impulse holds sway

Induced Social Coherence