What is driving the economy?

It is remarkable that the Philippine economy has been showing dynamism this year so far, even with a sluggish world economy. This implies that the energy driving our economic growth lately is coming from within. Indeed it is internal demand—that is, we Filipinos ourselves purchasing our goods and services—that has provided the current impetus for heightened economic activity, thereby providing increased jobs and incomes for Filipinos. I will explain some of the evidence on this below.

In basic economics, we are taught that the products and services produced in the economy are bought by four major sectors: private consumers for their consumption needs; businesses and firms for their real investment requirements such as structures, equipment and materials; government for public infrastructure and services, and for its own consumption requirements like office supplies and equipment; and foreigners who buy our products and services as we export them abroad, or buy them here as tourists.  Growth in spending by any or all of these would propel growth in the economy as a whole, as increased demand for goods and services would certainly draw a response of greater production on the part of the economy’s producers.

What’s more, any rise in spending by any of these four sectors of the economy provokes a multiplier effect that leads to even more growth in economic activity. This is because any new spending leads to a chain reaction of new incomes and consequent new spending. If a company spends P100 million on a new factory, this turns into P100 million in total incomes received by contractors, engineers, construction workers, suppliers of equipment and construction materials and others. But that’s not the end of it. Those various people now have more money to spend or save as they choose. If people save P20 out of every additional P100 income they receive on the average, then the original P100 million of investment spending turns into a new round of P80 million in spending on various things such as food, clothing, appliances, etc. that those construction people normally spend their incomes on. And since anyone’s spending turns into someone else’s income, that second-round P80 million in incomes turns into a third round of spending amounting to P64 million. This becomes yet another round of incomes spurring yet another round of spending, and so on down the line.

Ultimately, the P100 million originally spent by the investing firm will actually create five times as much (P500 million) total production and incomes. The mathematically inclined can figure out that if the saving rate is 20 percent or 0.2, the multiplier works out to be one divided by that, or five. So if people tend to save less, say 10 percent, every spending gets multiplied by even more (that is, 10) and generates 10 times more production and incomes in the economy. And even more so if those savings are kept within the country, so that the banks receiving them could further put that money to work within our domestic economy, say by lending the savings to a company that would invest it in a new factory—thereby repeating the same story above.

Official data suggest that there is indeed more domestic spending by consumers, investors and government lately, even as foreign purchases of our products (especially in Europe) had slowed down due to their own homegrown difficulties. In particular, government spending for both its consumption requirements and for public construction has dramatically swung around from a negative performance last year. In the first half of the year, government consumption spending grew 12.3 percent, a dramatic turnaround against the 4.6-percent drop in the same period last year. Government construction spending jumped 55.4 percent after falling 51.1 percent last year. The government, stung by criticisms that it directly dragged down the economy last year with reduced spending as it worked to plug corruption loopholes, has now come back with a vengeance. And this time, having done what it did last year, it has greater confidence that the money it spends goes (mostly?) to the intended purposes, rather than be siphoned off to bank accounts abroad and killing the usual multiplier effect. (Remember the question on why a neighboring country that appears to have as much corruption as we do manages to have its economy grow faster than ours? The explanation offered has been that their corrupt officials keep the money at home, while ours stash the money abroad.)

The data show that firms’ investment spending on durable equipment, breeding stock and orchard development and on intellectual property products have likewise sped up significantly from last year’s pace. Private consumption growth is similarly brisk at 5.7 percent. Interestingly, among the strongest sources of growth in people’s spending are communication (with our continuing fascination for ever more sophisticated smart phones), restaurants and hotels, and recreation and culture. These suggest to me that domestic tourism has been a particularly important driver of our growth. One only needs to experience the now common flight delays and overcrowded airports to be convinced that Filipinos are traveling a lot more—and perking up the economy in the process.

The good news is that spending by foreigners on our products—i.e., our exports—has lately resumed growth after contracting last year. Even then, the latest figures suggest that the export turnaround may be tentative. But I wouldn’t lose sleep over this one. After all, our economy is now speeding along on its own steam, through the Filipinos’ own spending, multiplier effect and all.

E-mail: cielito.habito@gmail.com