Protectionist clauses in the Philippine Constitution restrict foreign direct investment

Journal of Political Risk, Vol. 1, No. 1, May 2013.

Asia Foreign Direct Investment, 2003-2012.

Asia Foreign Direct Investment, 2003-2012.

Author: Priscilla Tacujan, Ph.D.

With the investment-grade credit rating granted by Fitch Ratings in March, an improved international business reputation, and sound fiscal management, the Philippines is poised to become the next foreign direct investment (FDI) destination of Asia.  Other conditions for a robust investment climate are in place: a large market, skilled human capital, youthful population, and strategic location that connects population centers across Asia. Also, the Philippines is increasingly open to international trade. By 2015, Southeast Asia will have the advantage of a single market through the Association of Southeast Asian Nations Economic Community (ASEAN).  According to data provided in the World Economic Forum’s Global Enabling Trade Report 2012, the country’s macroeconomic fundamentals are strong, making it attractive to at least a fraction of the foreign investors concerned over the Euro crisis.

Despite the improvement in the Philippine investment climate, the Philippine Constitution (1987) still has an antiquated article that supports laws restricting foreign ownership of property to 40% (Article XII), with minor adjustments and deviations by subsequent legislation. Removing the clause, and improving access and protections of foreign-owned business, would lead to a quantum leap in FDI and Philippine economic growth. Small changes to legislation are not enough. The Constitution needs to be changed in order to fully welcome foreign investors to the Philippines.

Foreign Direct Investment and Economic Growth

The emergence of Asian economic growth and globalization was propelled by, among other factors, the inflow of FDI from abroad.  Globally in the 1990s, multinational firms had contributed about 10 percent of world output and 30 percent of world exports, not to mention the technology transfer that had been taking place from host countries to recipient countries (Research Institute of Industrial Economics (RIIE)). FDI had a direct and positive impact on economic growth in Asia. Numerous theoretical and statistical studies clearly demonstrate that foreign direct investment increases economic growth.[1]  Countries seek to attract FDI because of the potential benefits it brings: financial resources, technology transfer, employment creation, and increased competition. These factors lead to improved  goods and services, export markets, and networks for sales, procurement, and information.  In short, FDI promotes economic growth by increasing the volume of investment and the efficiency of recipient countries.

In Asia, studies show that FDI was a major factor in the rapid economic growth of the 1970s (RIIE).  The norm then was to pursue the Japanese business model of imposing restrictions on foreign-controlled firms.  But Singapore, newly expelled from Malaya, pursued a different strategy of opening its doors to multinational firms.  Its subsequent success inspired other Asian countries to liberalize their economic policies.[2]

While Singapore, Malaysia, Thailand, Indonesia, and Vietnam have adopted liberal policies and opened to international investments, the Philippines and India still embrace protectionism in many areas of investment.  While HSBC recognizes that the Philippine economy is robust and youthful, it affirms in its latest analysis that multinationals “are reluctant to enter sectors with strict ownership limits” and that while FDI is increasing in the Philippines, “its restrictive policy on foreign ownership and an uncompetitive business environment make it one of the least attractive places for investors.”

Asia: 2013 Ease of Doing Business Index

 

Economy

Ease of Doing Business Rank

Singapore

1

Hong Kong SAR, China

2

Malaysia

12

Taiwan, China

16

Thailand

18

China

91

Vietnam

99

Indonesia

128

Cambodia

133

Philippines

138

Chart 1: Index of Economic Environment (Source: World Bank)

 

Aside from openness, other factors will need to be addressed in the Philippines to fully profit from international investment.  The World Bank, in its 2013 Ease of Doing Business study, provides a business index guide, using a set of 10 measurable indicators: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency.  In the chart above, Asian countries that have liberalized economic policies rank high while those who continue to cling to protectionism rank low. The range of the ranking is from 1 (the best) to 185 (the worst). The Philippines is ranked 138th.  Clearly the Philippines needs to address these issues to encourage not only FDI, but internal investment as well.

Philippine Opportunities

If the Philippines is to achieve its goal of 6 to 7% economic growth, it needs to increase the flow of FDI.  According to the Joint Foreign Chambers (JFC) of the Philippines, developing key areas of investment in the country could generate $75 billion in FDI, and 10 million jobs over the next ten years (Sun Star). The country’s biggest investment opportunities are in manufacturing, real estate, agriculture, mining, infrastructure, retail, and tourism – areas of investment that are largely untapped given the quantity of FDI seeking attractive international opportunities.  Manufacturing in the Philippines is especially attractive to Japanese and Korean firms.  Retail is booming, given the rise in domestic consumption.  With Robinsons Retail Group’s initial public offering planned for $800 million this year, the Philippine stock market is becoming more attractive to both foreign and domestic investors; to date, it is up 27%, “stronger than any other market in Southeast Asia” (WSJ).  Mining is another area that promises to yield high investment returns, given that the Philippines is considered “to be the 5th most mineral-rich country in the world for gold, nickel, copper and chromite worth over $840 billion.”  Unlocking this potential will depend on mining law reform, and a subsequent flow of FDI to the mining industry (Rappler).

The Philippine business climate is generally peaceful, with very few labor strikes, due to alternative dispute-resolution mechanisms (such as conciliation-mediation) made available by the Department of Labor. The Philippine government touts industrial peace as its comparative advantage against other countries in the region, pointing to only three labor strikes in 2012, compared to Vietnam’s 857 strikes the year before (FT).  In Bangladesh, about 500,000 workers went on strike during the summer of 2012, causing 300 factories to close (Institute for Global Labour and Human Rights).

Despite the advantages of the Philippines, it attracted a measly $2.8 billion in FDI, according to the Bangko Sentral ng Pilipinas (BSP). Even excluding China, which had FDI of USD $254 billion in 2012, this performance is abysmal compared to other Asian nations. As shown in the graph above, most Asian nations had less than USD $10 billion in 2004. Three countries rose clearly above the rest by 2012 – Singapore, India, and Indonesia.  The Philippines stagnated at the bottom of FDI over nearly the entire period.

The 60-40 Foreign Ownership Clause in the Constitution

Why is FDI and economic growth in the Philippines a constitutional issue? The Philippines is lagging in FDI relative to its competitors because of economic strictures in the Philippine Constitution (Article XII), as well as corollary protectionist laws that have emerged since 1987.  Specifically, foreign ownership of property is restricted to a 40% baseline share in the Constitution, with minor deviations and adjustments in subsequent legislation.  By imposing restrictions on foreign ownership, Philippine lawmakers believed they protected the country’s sovereignty from foreign encroachments. The thought was that by imposing barriers on foreign trade and investments, and prohibiting controlling property rights by foreign nationals, domestic economic strength and independence would be achieved.

However, these economic restrictions repelled investors and mostly benefitted small interest groups in the Philippines. They are provisions that work against the provision of economic growth and greater employment opportunities. The interest groups that benefited support protectionism in the Philippines and do not want any form of competition, domestic or foreign, to threaten their almost monopolistic access to market shares and government influence.  Kenneth Akintewe, portfolio manager at Aberdeen Asset Management in Singapore, observes that large family-controlled businesses in the Philippines dictate terms: “There is a real hesitancy to allow foreigners to come in and have a major say in how businesses are run. Until that dynamic changes, it is difficult to see foreigners being particularly enthusiastic” about investing in the Philippines.

Citing a study by Stephen Thomsen of the IFRI Center for Asian Studies, Mr. Ramon del Rosario, Chairman of the Makati Business Club, pointed to restrictive foreign-ownership rules as one of the three major impediments to Philippine economic growth (identifying the other two as perceived high levels of corruption and labor costs), adding that “protectionist policies are not doing us any good in terms of improving the quality of our industries and services” (Philippine Daily Inquirer). He said that it is imperative to amend the restrictive economic provisions of the Philippine Constitution, and endorsed the movement towards charter change (locally known as cha-cha).

If there is an inherent flaw in the 1987 Philippine Constitution, it is in the integration of economic policies into its provisions.  While a constitution embodies the fundamental law of the land and provides principles and general guidelines, economic policy must be more specific, changeable, and consist of programs that cater to the changing needs and challenges of market fluctuations.  The constitutionalization of social and economic policies within the Philippine Constitution has diminished the stature of the Constitution as the fundamental law of the land.  These policy provisions have reduced the Constitution to a mere policy instrument of past historical and political circumstances, now irrelevant and causing an impedance to the economy.

A Filipino congressman, Misamis Occidental Representative Loreto Leo Ocampos, understood the economic dynamics of the restrictions when, during an introduction of his resolution for a constitutional amendment in 2011, said: “All our economic policies should not be in the Constitution because changing them is difficult. They should be dynamic and refinements should be just a subject of legislation.”  In order to attract foreign direct investment, he continued, a constitutional amendment should include the revisions of the following provisions:

Remove the 60-40 percent equity limitations; remove control and management exclusively by Filipinos in companies with foreign equity; expand the role of foreign investors in the exploration, development, and utilization of natural resources; allow foreign ownership of industrial lands; liberalize media by allowing foreign investment in media; liberalize the practice of profession by allowing foreigners to practice their profession in accordance with the principle of reciprocity; liberalize investments in educational institutions by allowing foreign investment in tertiary education; among others (SunStar).

The economic provision on public utilities is equally problematic. Article XII Section 11 states:

No franchise, certificate, or any other form of authorization for the operation of a public utility shall be granted except to citizens of the Philippines or to corporations or associations organized under the laws of the Philippines, at least sixty per centum of whose capital is owned by such citizens; nor shall such franchise, certificate, or authorization be exclusive in character or for a longer period than fifty years. Neither shall any such franchise or right be granted except under the condition that it shall be subject to amendment, alteration, or repeal by the Congress when the common good so requires. The State shall encourage equity participation in public utilities by the general public. The participation of foreign investors in the governing body of any public utility enterprise shall be limited to their proportionate share in its capital, and all the executive and managing officers of such corporation or association must be citizens of the Philippines.”

Filipino economists argue that the constitutional limit on foreign ownership of companies that provide public utilities like airports, seaports, telecommunications, transportation, and infrastructure should be lifted in order to foster competition and improve performance.  They also argue that public utilities should be opened to foreign companies who have the technology and science to develop and build efficient transport facilities and infrastructure projects. These foreign companies need to be incentivized to compete, develop, and operate such projects by way of good investment returns and profits.   As Dr. Calixto Chikiamco, president of the Freedom for Economic Education, puts it:  “Right now, under the Constitution, [only] the Filipino firms are allowed to operate public utilities. So there is little competition in areas like airports, ports and telecommunications. And we need well-capitalized firms to be able to compete” (Interaksyon).

How were restrictive economic policies inserted into the Constitution, and by whom?  Suffice it to say that the 1987 Constitution, created to replace the 1973 Constitution that provided constitutional justification to the autocratic rule of former President Marcos, was drafted under a tense political atmosphere of transition. Marcos was seen to have been too close to foreign interests. Interest groups, including industry groups and leftist academics, took advantage of this public sentiment during the constitutional drafting process.

Constitutional Amendment Necessary

Amending the constitutional restrictions on foreign ownership would not be a complicated process.  According to the Constitution, any amendment or revision may be proposed by the Philippine Congress acting as a Constitutional Assembly, upon a vote of three-fourths of its Members, by a constitutional convention, or by people’s initiative.  To this end, re-elected Quezon City Representative Feliciano Belmonte Jr., expected to retain the speakership for the 16th Congress, is pushing for constitutional reforms.  Lawmakers sympathetic to charter change are confident that they have the numbers to convene a Constitutional Assembly, with the ruling Liberal Party’s 105 members, coalescing with members of the Nationalist People’s Coalition, National Unity Party, Nacionalista Party, and at least 16 senators from the Upper House (Asia News Network).

President Benigno Aquino and his advisers have expressed reluctance towards efforts to amend the Constitution. They say that for now they are reviewing archaic laws and introducing new economic legislation for the next Congress, to be installed in July.   The Budget Secretary, Florencio Abad Jr., would focus on minor modifications to the 22 year-old Foreign Investment Act (FIA) rather than amend the Constitution. Some have said that President Aquino is affected by personal bias, since the Constitution was produced under the leadership of his mother, Corazon Aquino.

In a recent Wall Street Journal article, President Aquino was characterized as unwilling to rewrite the Constitution. According to the author, “The document has a status almost approaching that of a sacred text.” (WSJ) If indeed the above is true — that President Aquino is reluctant to amend the Constitution for (sentimental) reasons ,the economic provisions of the Constitution will continue to enable an inefficient rent-seeking, monopolistic economy that benefits only a few entrenched interests rather than those who need new jobs from broad economic growth. The economic policies in the Constitution will continue to diminish the lofty nature of the Constitution, or of any constitution for that matter, as the fundamental law of the land.  Whatever prevents President Aquino and his advisers from addressing these issues certainly cannot withstand the scrutiny of reason, common sense, and fairness.

President Aquino owes it to the Filipino people, who elected him, to fulfill the duties and requirements of republicanism.  Republicanism puts in place a representative government that rules in the interest of the people that empower it precisely in order to promote their interests.  Rule by men does not have a place in genuine republicanism. Rather, republicanism gives the citizenry what it deserves: an enlightened representation of their interests, principled statesmanship, and effective leadership. Unless the Philippines embraces constitutional change and foreign direct investment, the growth of the Philippine economy will be crippled.  With everything else in place to attract FDI, namely, a large market, skilled human capital, a youthful population, a strategic location that connects population centers across Asia, and emerging market competitors that are soaking up the lion’s share of FDI flows — the stakes are indeed high.

Updated: 5/27/2013, 6/22/2013, 7/1/2013.
Republished: 6/3/2013 by the Philippine Star.
Peer-review status: 4/3 (Complete).

 


[1] See the following studies addressing the effect of restrictive policies and FDI on economic growth in Asian countries:

Trinh Nguyen, “The Great Migration: How FDI is Moving to ASEAN and India,HSBC Global Research (HSBC: Hong Kong), January 2013.

Japan on  National Committee for Pacific Economic Cooperation Council (JANCPEC), “An Assessment of Impediments to Foreign Direct Investment in APEC Member Economies,” The Pacific Economic Cooperation Council, 2002.

 Robert E. Lipsey and Fredrik Sjöholm, “FDI and Growth in East Asia: Lessons for Indonesia,” Research Institute of Industrial Economics, IFN Working Paper No. 852, 2010.

UNCTAD, “Measuring Restrictions on FDI in Services in Developing Countries and Transition Economies” (UN: NewYork), 2006.

[2] For a more thorough description of the business climate, including restrictions (or lack thereof) in each of these countries, see the US State Department’s Investment Climate Statement 2013.

Leave a Reply