High Productivity Allows Growth and Equity at the Same Time 243.0

Paul Krugman, the 2008 winner of the Nobel Memorial Prize for Economics, says that in economies where trade is a small component of GDP as in the Philippines, the main determinant of competitiveness is domestic productivity.

And, in my view, addressing development policy via domestic productivity at the industry or firm level, and not with blunt macro-economic tools like foreign exchange manipulation as economist Calixto Chikiamco in a recent BusinessWorld column suggests, is the best way to achieve improvements without unintended consequences.

With public policies incentivizing productivity improvements at the industry or firm level, enterprises can contribute to social development in addition to primary economic objectives.

Note: This will become an important issue in the coming months as some experts forecast the peso to strengthen to 41.50 per US$1 mainly due to the weakness of the American economy.

Some economists will come out of the woodwork to suggest actions to weaken the peso at the macro level like Bangko Sentral intervention – that was resorted to in 2007 and lost the BSP P102.9B in retained earnings – and support exporters in transfer payments.

This would be fruitless approach as we will number have enough resources to affect the U.S. economy other than transfer payments to exporters. Better to give incentives to improve their productivity.

Competitiveness defined. To start with, Professor Krugman also notes that the most popular definition of competitiveness is that of Laura Tyson, Chairman of President Clinton’s Council of Economic Advisers, and I paraphrase:

“our ability to produce goods and services that meet the test of international competition while our citizens enjoy a standard of living that is both rising and sustainable.”

Please note that her qualifier of raising and sustaining the standard of living for Americans is similar to SYNTHESiST’s criteria for any innovation to be reported in this blog – the innovation must add to the total wealth of the Philippines and ought not be just that transfers payments to favored sectors or those that just makes individual entrepreneurs wealthy at the expense of others in society.

Productivity is key to Competitiveness.For an economy like the Philippines where net foreign trade is small – less than 5% of GDP – “‘competitiveness’ according to Tyson’s definition would be determined almost entirely by domestic factors, primary the rate of productivity growth.”

Professor Krugman’s main thesis is that competitiveness does not apply to countries as it does to firms for two reasons:

• Items that countries trade are not mutually exclusive of its other – they are not pure rivals; i.e. trade between countries is often a win-win game just as no trade can be bad for both; and,
• Many countries, like the Philippines and not city-states like Singapore or Hongkong or small countries like New Zealand or Netherlands, have trade as a small percentage of GDP at PPP – exports was roughly 11.5% while imports roughly 14.3% in 2009.

Note: Inward Filipino expatriate remittances (estimated at US$18.5B for 2010) account for 5.7% of GDP at PPP. Added to net trade above, the remittances reverses the foreign exchange position from negative to positive or higher net receipts with important policy development implications.

Another implication in Professor Krugman’s analysis, in my view, is that macroeconomic tools are too blunt instruments to use in attaining competitiveness when defined as productivity; better to use instruments that directly address the needs of industries or firms rather than the whole macro-economy.

Thus, due care must be made in policy development, for example in some competitiveness advocates proposing a weaker currency to improve exports, that what happens are merely transfer payments to favored and vocal sectors that may also impoverish other sectors or make less vocal once uncompetitive as what happened with agriculture in the Philippines.

Productivity or Value-Adding Potential. In another dimension of the competitiveness discussion, Professor Krugman criticizes other economists (Magaziner and Riech) for advocating industrial policy for the US by promoting “industries with high value added per worker” as desirable ones in his footnote on p. 37 of the article.

Value-Adding Potential (VAP). From this critique, SYNTHESiST likes to clarify our position promoting high value-adding industries as targets for development in emerging markets based on the definition below and not the economist’s typical definition of value-added in national income accounting.

Hereafter, SYNTHESiST will use value-adding potential to describe the target industries in terms of the actual scope for productivity improvement of the Philippine sector, industry or firm versus global benchmarks or rated engineering capacities.

The best illustration of value-adding potential are in SYNTHESiST’s previous posts on the social enterprises that are able to capture returns for the triple bottom lines of profits, equity and sustainability – Hapinoy and Rags2Riches:

• Hapinoy finds VAP as opportunity from the inefficiency of the national retail supply chain to serve the triple bottom lines; and,
• Rags2Riches finds VAP from creativity in fashion products for its shareholder, the Payatas nanays, and nature.

Final words. As I noted above, the Tyson definition of competitiveness is of two parts. We should not stop with the first part of just achieving product competitiveness with the rest of the world – as many vested interests would like us do – and not add the qualifier that the policy actions must, at the same time, raise and sustain the national standard of living.

With a policy response that covers the whole definition , social enterprises like Hapinoy and Rags2Riches that play a pivotal role in development will flower.

And, very well, social enterprise like Hapinoy and Rags2Riches could be the lead actors in springing the Philippines to developed world status.

Note: We first posted on Paul Krugman on March 7, 2009 on: Krugman Explains ASEAN Innovation and Total Factor Productivity.