Dutch Disease and the OFW

Michael Alan Hamlin

Posted on April 21, 2008

Exploitation of natural — and human — resources can’t last forever…

Depending on who is doing the counting, around eight million overseas Filipino workers (OFWs) sent $14 billion dollars – or about $160 per citizen – home to the Philippines last year. Although often hailed as economic heroes for their contribution to the Philippines’ “SM economy,” University of the Philippines (UP) professor Felipe Medalla said last week in Washington D.C. that the OFW remittances demonstrate just how sick the Philippine economy really is.

Medalla was speaking at a two-day symposium on the Philippines hosted by the John Hopkins’ Paul H. Nitze School of Advanced International Studies (SAIS). Medalla’s presentation, coauthored by UP colleagues Raul V. Fabella and Emmanuel S. de Dios, was made available to me by Brett M. Decker, senior vice president of the Export-Import Bank of the United States. Decker and Medalla composed a panel on the topic, “The Philippine Economy: How Can the Philippines Sustain Economic Growth and Development?”

The answer to that question, according to Medalla, is that it can’t. Not unless significant reform and restructuring take place. The reason, Medalla says, is that the high level of OFW remittances has contributed to a severe Dutch Disease situation that will eventually cause the Philippine economy to implode despite the promise of some key, emerging sectors such as offshoring and outsourcing (O&O), medical tourism and tourism, and mining.

Economists define Dutch Disease as circumstances in which the exploitation of natural resources – in this case, OFWs – causes a decline in other sectors because of rising exchange rates, making them less competitive globally. As we all know, high volumes of remittances in recent years have contributed to a dramatic appreciation of the Philippine peso and declining competitiveness of traditional export sectors.

Although many analysts have praised the Philippine government for imposing fiscal reforms which contributed to last year’s reported 6.5 percent expansion, Medalla and his colleagues argue that macroeconomic indicators are in fact symptomatic of a barely growing economy. They point to 1) persistently weak or negative growth in capital spending; 2) low inflation; 3) a strengthening peso; 4) low domestic interest rates; 5) sluggish bank lending; and, 6) a declining share of imports.

These indicators point to other fundamental problems. Because the appreciating peso makes exports uncompetitive, investment in traditional export-oriented sectors decreases. Medalla notes that investment declined from 24 percent of gross domestic product (GDP) in 2000 to less than 18 percent in 2006. This is strategically alarming because the SM economy does not produce new knowledge, skills, or expertise. It merely provides short-term and unsustainable gratification in the form of such things as low value-added service jobs, a highly competitive retail sector and speculative consumer real estate investment.

As a result, investments in education and infrastructure slump, since they are not required. Weak educational infrastructure results in a labor pool that lacks the skills required to qualify workers for jobs in growth sectors, explaining why O&O companies have very low hiring rates despite investors’ enthusiasm for the Philippines and Filipinos. Even jobs available to OFWs for the most part are limited to entry-level work, decreasing their “remittance power” as well as their general employability.

Ultimately, poor educational infrastructure will cause the “SM economy” to collapse, because it simply won’t be able to produce highly productive workers. Although Medalla and his coauthors can’t predict when it will begin to falter, they say that, “The only certainty is that the process is self-undermining and cannot last indefinitely. At some point, the forces for a slow implosion can result in a situation where the increasing outward exodus of workers creates only as many jobs and incomes abroad as it destroys at home.”

One thing is clear: “The country is living off stocks of previously-educated manpower,” Medalla warned, and the buffer between growth of remittances and decline in remittances is narrowing.

Unfortunately, conditions don’t exist that will enable, or force, government to effectively address this insidious disease. Foremost among the hurdles, according to Decker, is the “twin problems of corruption and cronyism.” “Too much of the economy is siphoned away to graft,” rather than invested for the future, he told participants at the conference, which included influential policy makers and analysts from around the world.

While this is a depressing reality, the fact that it is being discussed in the influential SAIS forum and other venues is an acknowledgment that the inherent weaknesses that characterize the “SM economy” must be urgently addressed. And, that the world is watching.

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