MANILA, Philippines—A casual glance at the Philippine dailies suggests that the country is a pit of institutional dysfunction. The economy is growing but the growth is still largely externally driven by the overseas workers industry, which grew fortunately behind the government’s back and beyond its grasp. In fact the most dynamic local sector, the BPO, grows precisely because it avoids government-provided services (ports and transport) and funnels its business into cyberspace courtesy of private telcos.
The anomaly-ridden Naia 3 Terminal is still gathering dust four years after it was delivered for operation, resulting in billions of pesos going down the drain. The government is building additional international airports while its foremost gateway is being downgraded. The litany of past state telephony contracts (Municipal Telephone Program and Telepono Sa Barangay) is still costing the taxpayer upwards of $20 million in debt amortization a year despite zero or almost zero service from nonexistent, disrepaired or dust-gathering equipment.
The current NBN-ZTE crisis resulted from greed abetted by defective and rent-inviting procurement rules. Its unmistakable subtext is the unresolved “Hello Garci tapes” crisis stemming from election counts being put for sale to the highest bidder. A full-page ad in a national daily decrying the state of the Philippines and of its institutions as “dysfunctional” was right on the money. Yes, we are still growing but our march to the bottom of the Asian league continues.
The relevant subtext to the current crisis is the crisis of institutions. Thanks to the tragedy of the Eden’s Apple, man will always carry the seed of deviltry. Which is why we have rules and institutions in society to moderate the worst expressions of human frailty. In the case of the Philippines, these institutions have progressively shown signs of systemic failure. The restoration of these institutions is of paramount importance. Which is why Nobel Laureate and “Oracle of Institutions” Douglass North’s visit is very timely.
[North, winner of the 1993 Nobel for economics, visited the country on March 12-16. He is a member of the Ronald Coase Institute, which runs workshops for young social scientists all over the world. He gave a talk at UP Los Bańos on Thursday, at the Manila Pen in Makati on Friday and at the UP School of Economics in Quezon City yesterday.]
When North started dropping hints that “institutions matter” in economic development in the 1970s, the economics of development was dominated by mechanical models of growth (e.g., the Harrod-Domar models of growth) and neo-classical economics was basking in the lofty peaks of the Arrow-Debreu model in which governance was irrelevant, human frailty did not matter and the transaction cost of exchange was taboo.
Among these strangely Platonic constructs, institutions did not matter because institutions were precisely about governance, human frailty and transaction cost. North and his coworkers were flirting with heresy.
The 1970s was at the same time cradling other heresies. Oliver Williamson’s revival of Ronald Coase’s master insight, transactions cost, was heroic but lonely. Alchian and Demsetz’s 1973 seminal article showed that there was more to the firm than dessicated engineering relations: it was pregnant with asymmetric information, free riding and incentives to reduce their toll. And then there was the Northian tidbits painstakingly constructed from the records of European history. The latter, however, was also at that time in the wane among leading economics departments.
Convinced that “facts” would eventually erode the profession’s disdain, North and coworkers restudied European economic history and noticed a startling regularity: Institutions that enabled markets, underpinned economic success stories; institutions that stifled markets accompanied stagnation. While it reaffirmed Adam Smith’s faith in the market and private initiative as the engine of growth, North and co-workers revealed the shafts and cylinders of that market engine.
The evidence began to mount in favor and a quarter of a century later, the mantra “institutions matter” is overarching. The buy-in by multilateral institutions and by the economics profession is well nigh complete.
Institutions are of two kinds:
Institutions that affect the cost of doing business: those that reduce the cost of market exchange (contract laws, contract enforcement, bankruptcy work-out rules, commercial codes and dispute resolution mechanisms).
Institutions that protect property rights: those that reduce the likelihood of expropriation without compensation by the state (constitutions, separation of powers, electoral accountability, etc.) and those that penalize unlawful expropriation by private persons (police, courts of law, penal and commercial codes, etc.). How do these enable the market?
Market exchange is always mediated by some form of contract. Contracts are a covenant of mutually agreed exchange of obligations or deliverables by the contractors. When parties can violate the contract provisions with impunity, the market exchange will fail to happen. For example, when it is unclear that the next mayor will honor debts incurred by his predecessor, no investor will purchase the municipal bond issuance. If a “third party,” who is more credible guarantees the issuance obligations, only then will the issuance fly with investors.
The international panel of adjudicators in the case of the water distribution privatization in Metro Manila gave a lot of investor mileage to the initiative. If “third parties” are there instead to extort and plunder, the market will run out of investments that create value.
By far, the most important provider of third party services in the economy is the government. The state or government issues the rules (say government procurement rules or commercial code) and guarantees the integrity of contracts through its organs (the courts and the sheriff’s office). The important dimensions are (1) the nature of the rules (good if they enable the market exchange; bad if they stifle it). (2) the quality of enforcement (good if it is unbiased and timely; bad if it is selective and delayed).
The 18th amendment to the US Constitution prohibited the market of alcohol and eroded the quality of local government in the ’20s. The anti-jueteng law in the Philippines led to the capture by gambling operators of local and national government enforcement organs.
Dire consequences such as the crisis of presidential legitimacy in 2001 are natural offshoots of bad rules of the game. The telecoms deregulation in 1995 in the Philippines, by contrast, resulted in the flowering of the telecoms market with prices in steep descent and service quality in steep ascent. But the overall Philippine picture remains institutions-wise dismal.
The Northian viewpoint is extremely pregnant in the Philippine setting today. If there is a useful undercurrent in the war between “good” and “evil,” it’s the tug-of-war between “good institutions” and “evil” ones, the latter being open invitations to the ugliest footprints of human frailty. It would be a shame if we fail to harness the current crisis in pushing the envelope toward the good.
(Raul V. Fabella is a professor at the School of Economics, University of the Philippines.)
