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12th National Convention on Statistics (NCS) EDSA Shangri-La Hotel

October 1-2, 2013

EXAMINING THE APPROPRIATE MEASURE OF INVESTMENTS THAT SUPPORT ECONOMIC GROWTH:

by:

Marites B. Oliva, Richard Emerson D. Ballester, Melanie Grace A. Quintos, Jessie Ruth G. Granadillos, Marphil A. dela Cruz, Generose Y. Ballesteros, and

Ma. Josephine Therese Emily G. Teves

For additional information, please contact: Author’s name Marites B. Oliva Designation OIC- Assistant Director Affiliation National Policy and Planning Staff National Economic and Development Authority Address 12 St. J. Escriva Drive, OrtigasCenter, Pasig City Tel. No. +632 - 6336012 Email MBOliva@neda.gov.ph Co-authors’ names/ Richard Emerson D. Ballester (OIC- Division Chief) Designations Melanie Grace A. Quintos (Senior Economic Development Specialist) Jessie Ruth G. Granadillos (Senior Economic Development Specialist) Marphil A. dela Cruz (Economic Development Specialist I) Generose Y. Ballesteros (Economic Development Specialist II) Ma. Josephine Therese Emily G. Teves (Economic Development Specialist II) Affiliation National Policy and Planning Staff National Economic and Development Authority Address 12 St. J. Escriva Drive, OrtigasCenter, Pasig City Tel. No. +632 - 6336012 Email addresses RDBallester@neda.gov.ph, MAQuintos@neda.gov.ph,

JGGranadillos@neda.gov.ph,MAdelaCruz@neda.gov.ph, GYBallesteros@neda.gov.ph, MGTeves@neda.gov.ph

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Working Paper:

EXAMINING THE APPROPRIATE MEASURE OF INVESTMENTS THAT SUPPORT ECONOMIC GROWTH

ABSTRACT

The weak role of investment in the Philippine economy has been considered one of the main reasons for the country’s low and volatile growth in the last 30 years. Determined to achieve an inclusive growth in the medium term, the Aquino administration set an investment to GDP ratio target of 22 percent by 2016 to ensure that there will be a structural transformation in the Philippine economy: from being consumption driven to one that is increasingly led by investments. This will be primarily done through massive investment in physical infrastructure to make up for the country’s massive infrastructure backlog and to improve the country’s competitiveness. Considering the significant role of investment in the country’s economic development, this working paper aims to determine the appropriate investment indicators that should be used by the Philippine government in setting the medium term target and in monitoring and assessing the country’s performance towards achieving inclusive growth. This was determined by analyzing the different investment indicators and their relationship with economic growth. The paper looked into the various definitions and measurements of investment, including the evolution of investment indicators. The aim is to understand investment data, particularly for economic and policy analysis, distinguishing indicators from the system of national accounts and those that are based on changes in stocks in the production function. The study also explored the appropriateness of comparing investment performance across countries, exploring further other relevant and useful indicators in doing investment analysis. Based on our results, it is better to use the ratio to GDP of fixed capital formation (FCF) rather than gross capital formation (GCF) to avoid counting in the very irregular and volatile behaviour of changes in stocks. Moreover, merely monitoring the ratio to GDP of FCF is not sufficient since there is also a need to look into the efficiency of investments. In investments, both quantity and quality matter. The availability of official data on fixed capital formation disaggregated to public and private as well as capital stock is also very useful in policy analysis. The result of this study will provide relevant information that will be useful in policy formulation and analysis on improving the economic structure of the Philippine economy towards achieving inclusive growth. This could also be useful for improving the country’s statistics on investments, from a user’s point of view.

Working Paper:

EXAMINING THE APPROPRIATE MEASURE OF INVESTMENTS THAT SUPPORT ECONOMIC GROWTH

I. Introduction

Since 1946, the Philippine economy has been driven by household final consumption expenditure (HFCE). While this has always been followed by capital formation (CF), the share to gross domestic product (GDP) of HFCE averaged at around 68 percent while that of CF was only 22 percent. The ratio to GDP of HFCE increased from 66 percent in 1946 to 70 percent in 2012 while that of CF was reduced from 25 percent to 19 percent during the same period. Moreover, the growth of CF has been volatile throughout the years and there were periods that its contraction has been considered in many analyses as one of the main reasons for the

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recorded overall decline in the country’s economic growth. The weak role of investment in the Philippine economy has been considered one of the primary reasons for the country’s low and volatile growth in the past 30 years.

Determined to achieve an inclusive growth in the medium term, the Aquino

administration set an investment to GDP ratio target of 22 percent by 2016 to ensure that the country will have a higher growth trajectory through higher contribution of physical capital to growth, in addition to increases in total factor productivity (PDP, 2011-2016). While the country recognizes that the source of its economic resilience is its domestic economy that is driven primarily by strong household consumption, the intention is to increase the role of investment in economic development to ensure that the present high economic growth will be sustained in later years. The Philippine Development Plan, 2011-2016 indicated that this will be done through massive investments in transport, water, energy, and other infrastructure, accompanied by good governance. The massive investment in physical infrastructure will make up for the country’s infrastructure backlog while helping improve the country’s competitiveness. Since PDP targets are the primary gauge as to which the actual performance of the Philippine economy will be compared and assessed, and from which corresponding policies, strategies and programs will be formulated to ensure the achievement of medium term economic goal, the use of appropriate data and indicators in this regard is crucial. Hence, this paper aims to determine the correct investment indicators for setting up the target and for monitoring and assessing the economic performance of the country, which serve as bases in formulating policies and determining the appropriate government actions.

To determine the appropriate indicator, this working paper started with what investment

is based on economic theories, followed by how this is measured and how this measurement has evolved in the System of National Accounts. Then, the relationship of different investment indicators with economic growth is analysed using simple correlation and cointegration tests. The paper also looked into other useful indicators for investment, particularly for cross-country analysis. II. Investment and Economic Growth Theories

The amount of output that can be produced in an economy, given the factors of

production, depends on the production technology that is usually expressed in terms of production function. The basic production function can be written in mathematical form as:

Q=f (L, K)

where Q is the quantity of output, L is the quantity of labor used, and K is the quantity of capital employed.

The theory of capital fundamentalism, which accentuates the role of capital to achieve

economic growth started to gain dominance in the post-World War II era of economic thoughts. In 1934, Simon Kuznets pioneered the concept of capital formation which he defined as the portion of the nation’s output which is not used for immediate consumption but is maintained and added to the nation’s wealth stock. Kuznets measured gross capital formation in terms of the flow of finished durable commodities to households and enterprises, total construction, net change in business inventories, and the nation’s exports less imports, which were evaluated at current and 1929 prices.

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Harrod (1939) and Domar (1946) have been the classical advocates of the direct relationship between the size of capital stock and the GDP, in which the change in capital stock is equated to the net national savings. Capital stock, in this sense, refers to physical assets.

Meanwhile, the Solow neoclassical growth model attempts to explain long run economic

growth in terms of capital accumulation and technological progress, along with productivity and population growth. By factoring in labor and technology, the Solow growth model offers an extension to the classic Harrod-Domar model. One significant attribute of the Solow growth model is its distinction between vintages of capital which assumes that older capital is less dynamic than its newer counterparts.

In the early part of the 20th century, economic growth models which focus on human

development to achieve growth started to emerge. The O-ring Theory of Economic Development developed by Kremer (1993) advocates that high skilled workers who are working proficiently together will bring high valued output. It emphasizes on the strong complementarity of quality inputs to production, in which high skilled workers are more desirable due to less susceptibility of making mistakes.

Given the role of capital in determining the amount of output that can be produced in an

economy, more investment, which is defined as the creation of new capital consisting of goods purchased for future use (Mankiw,2007), can lead to economic growth since high investment rate is equivalent to accumulation of more capital, hence more output. There are a number of models and theories in economic literature that discuss about the contribution of investment to output growth and most of them have shown the growth rate of the economy is an increasing function of investment rate.

III. Evolution of Investment Measurements in the National Accounts

The 1947 Measurement of National Income and the Construction of Social Accounts came about when the League of Nations Committee of Statistical Experts decided in April 1939 to formulate a guideline that could be used by countries to estimate their total aggregate income. This was in accordance with the 1928 recommendations of the Final Act of the International Conference relating to Economic Statistics held in Geneva. The report laid out the primary guidelines for computing net national expenditure at factor cost. In particular, the estimation for domestic capital formation is consisted of the following: “(a) Persons- restricted to land and buildings and equal to gross expenditures less sales and less sums needed to meet depreciation and obsolescence; (b) Public collective provider- net additions to the capital equipment of public authorities in their capacity as final consumers; and (c) Business enterprises which was further divided into (i) construction, works, and durable equipment- net additions to the fixed capital of all enterprises, (ii) inventories–physical change in inventories i.e. stocks and work in progress, valued at the prices ruling in the period, and (iii) gold and silver bullion and coin” (United Nations 1947). In 1953, the Statistical Office of the United Nations (UN)1 released an updated version of the national income guidelines entitled A System of National Accounts and Supporting Tables. Similar to the first report, it aimed to provide a standard basis of reporting national income statistics taking into account the experiences of the participating countries in the past five years. In comparison with the 1947 definition of capital formation, the 1953 report provided a more

1 The United Nations was founded in 1945 replacing the League of Nations after it failed to achieve its goal of maintaining peace

when the Second World Warstarted.

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detailed measurement of the components of capital formation. Gross domestic capital formation is defined as the “gross value of goods which are added to the domestic capital stock of the nation”. Expenditure accounts under gross capital formation were broken down into two major components: fixed capital and changes in inventories. Gross fixed capital includes the “value of purchases and own-account construction of fixed assets (land, construction and works, machinery and equipment) as well as the value of the change in work in progress on domestic account in dwellings and non-residential buildings. As a general rule, all durable producers' goods with an expected life-time of more than a year are included in capital formation, however, in practice, small items (i.e. hand tools, motor tires, office desk) are being charged to current expense instead”. On the other hand, the “value of the change in stocks represents the value of the physical change in (a) raw materials, (b) work in progress (except on dwellings and non-residential buildings which are included in fixed capital formation), and (c) finished goods which are held by enterprises and in government stockpiles” (United Nations 1953). The second edition of the System of National Accounts and Supporting Tables was released in 1960 reflecting minor revisions stemming from the comments and experiences of the countries. Referring to the measurement of capital formation alone, much of the components of gross capital formation remained the same except the addition of land as part of fixed capital. The 1960 report also provided clarifications on the treatments of different cases such as land purchased or rented for defence will be accounted under 'public administration and defence' while land meant for residential or recreational purposes will be considered under 'ownership of dwellings'. Also, in cases when it is hard to distinguish between the value of the land and the value of the building, the total value should be recorded either in 'dwellings' or 'non-residential buildings' (United Nations 1960). In 1964, the UN published the third edition of the report to incorporate the recommendations of the International Monetary Fund (IMF). However, no changes were noted in the definition of capital formation. In 1968, the Statistical Commission adopted the new manual entitled ‘System of National Accounts (SNA)’ wherein a noticeable change in the classifications and the definitions under Gross Capital Formation, particularly in Land as part of Fixed Capital, and Changes in Stock were observed. Land, by definition in the 1964 SNA, includes reclaimed areas only if it represents an addition to total land availability. Moreover, expenditures on land reclamation resulting from floods are considered under ‘other construction and works’. In the 1968 SNA, regardless of whether it represents an addition to total land availability or not, outlays on all land reclamation and land clearance irrespective; irrigation and flood control projects and dams and dikes; clearance and afforestation of timber tracts and forests; and transfer costs of transactions are included in the renamed line item ‘Land improvement and plantation and orchard development and breeding stock, draught animals, etc.’ Meanwhile, changes in stocks expanded beyond Goods producing industries such as ‘Work-in-progress’, and ‘Finished Goods’, to ‘Materials and supplies’, ‘Livestock except breeding stock, dairy cattle and the like’, ‘Wholesale and Retail Trade’, ‘Other industries’, and ‘Government services’ (United Nations 1968). In the mid- 1980s, five organizations, namely Commission of the European Communities – Eurostat, IMF, Organisation for Economic Co-operation and Development (OECD), UN, and World Bank (WB) have embarked on a process of reviewing the Systems of National Accounts which lasted for several years. In 1993, these five organizations were able to successfully publish a revised version of the SNA as approved by the Statistical Commission of the United Nations. Among the major changes in the 1993 SNA was the inclusion of literary-artistic outputs,

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large databases, all expenditures on mineral exploration, construction of fixed assets by military personnel for the use of the civilians, computer software and entertainment, among others as part of gross fixed capital formation. Fixed assets with long period of production shall only be classified under gross fixed capital formation upon the transfer of ownership to the end user of the product. Otherwise, it will be counted under work-in-progress which is part of changes in inventories. Meanwhile, the growth of cultivated assets such as livestock and fish stock, vineyards, orchards, plantations and timber tracts, agricultural products, and the like before harvest or use of products is to be considered as part of changes in inventories. In addition, services output which takes a long time to produce such as architectural design, software development, etc. as well as all goods held by the government will also be recorded under inventories. Moreover, the 1993 SNA also added a third category under the capital formation called “acquisitions less disposals of valuables”. This includes produced assets or output from production processes which are primarily used as a store of value rather than for production or consumption. Examples of valuables are precious metals, stones, antiques, and art objects (United Nations 1993). The 1993 SNA was later revised in 2008 by the Inter-Secretariat Working Group on National Accounts (ISWGNA) composed of the same five organizations who prepared the previous SNA. The 2008 SNA was published in response to the changing economic environment, advancement in research methodologies, and growing needs of the users. Unlike in the 1993 SNA, the output of research and development (R&D) is now considered as part of capital formation, treated as “intellectual property products”. However, if it does not entail any economic benefit to the owner, then it is regarded only as intermediate consumption. Furthermore, in the 1993 SNA, only expenditures by the military on fixed assets that could be used by civilians for production are considered as part of capital formation while offensive military weapons are excluded regardless of the length of their life. In the latest SNA, military weapons such as vehicles and other equipment will now be counted as fixed asset. In addition, all databases with a useful life of more than one year will be treated as fixed asset compared to the previous SNA where only ‘large’ databases were regarded as assets. The 2008 SNA also provides a distinction between originals and copies of intellectual products. A copy maybe considered as fixed asset if it could be used in production for more than a year (United Nations 2008).

IV. Investment Indicators

Under the national income accounts (NIA), there are two measures of investments:

capital formation (CF) and fixed capital formation. The only feature that separates the two measures is the changes in inventories. The CF is comprised of the FCF, changes in inventories, net of disposal of valuables.

The FCF is the total producer’s acquisition of fixed assets within the accounting period,

less disposals. Aside from durable goods, this also includes assets such as those for breeding stocks and orchards development as well as intellectual property products so long as they are used in production. The fixed assets, goods or services, must be repeatedly our continuously used in production for more than a year, as defined by the asset boundary which classifies between those that are for consumption and those used for capital formation. However, not all those that fall under the asset boundary are considered. For instance, goods that are relatively small in value compared to other machineries, but used repetitively, such as hand tools, are considered to be expenses in supplies used for intermediate consumption, hence they are not included as part of fixed capital. Some durable goods may be classified as household consumption or capital goods, depending on their intended use. For instance, if the vehicle was

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purchased by an enterprise, then it will be part of capital formation. Intellectual property products such as software or artistic originals are also considered fixed capital because they are used in production.

An improvement on the asset is separately calculated as an increase in asset value. On

the other hand, improvements in land in its natural state are recorded as new fixed asset since it does not increase the value of the natural resource itself. Other considerations are discussed in detail in the SNA 2008 for the time of recording, ownership of assets, and valuation.

Meanwhile, according to Lequiller and Blades (2006), the components of inventories are as follows: (a) stocks of inputs intended to be used later as intermediate consumption in a production process; (b) stocks of finished goods that have not yet been sold; (c) those present in wholesale or retail distribution sites specifically purchased for resale; (d) strategic stocks (food, oil, stocks for intervention on agricultural markets) managed by government authorities; and (e) “work in progress”, which consists of goods being processed but which cannot yet be delivered to the user at the end of the accounting period

V. Method for Testing the Relationship between Investment and Economic Growth

In order to determine the more appropriate investment indicator that can be used by the Philippine government in setting up the medium term target and for monitoring and assessing the economic performance of the country, this paper tried to apply various methods of determining the relationship of economic growth (GDP) and various investment indicators (CF, FCF).

One of the simplest method of determining the relationship between economic growth

and various investment indicators is correlation analysis. Correlation analysis is observing the interaction of variables. It is a statistical tool that measures the strength of the linear relationship between variables and determines the extent to which changes in the value of one variable are associated with changes in another variable. The strength of the relationship refers to the degree to which one variable predicts the other, the stronger the relationship between variables the more accurate the prediction can be done. The relationship between the variables is known as correlation of coefficient, which is represented by a value within a range of -1 to +1. A positive coefficient indicates that the variables are moving in the same direction, while a negative coefficient indicates otherwise. A coefficient of 0 indicates no relationship between the variables (Palmliden, 2012).

Another method that will be applied to determine the relationship between investment indicators and economic growth is the cointegration test. Variables are considered cointegrated if the trend in one variable can be expressed as a linear combination of the trend in another variable or a linear combination of these integrated variables is stationary (Enders, 2010 and

Wooldridge, 2006). As illustrated by Wooldridge (2006), if { : 0,1,...}ty t and { : 0,1,...}tx t are

two I(1) processes, then if there exists a ( 0) such that t ty x is an I(0) process2, then y

and x are cointegrated and is the cointegration parameter. If the two variables are

cointegrated, there is a tendency for these variables to move together. A scatter plot of these variables seems to indicate that the variables rise and fall in tandem. Even if each variable is

2 According to Wooldridge (2006), I(0) process “has constant mean, constant variance,

autocorrelations that depend only on the time distance between any two variables in the series, and asymptotically uncorrelated.”

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-20

-10

0

10

20

30

40

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

GR_RGDP00

GR_FIXCAP00

GR_CAPFORM00

-40

-20

0

20

40

60

80

100

50 55 60 65 70 75 80 85 90 95 00 05 10

GR_RGDP85

GR_FIXCAP85

GR_CAPFORM85

nonstationary, they are considered to have a long run relationship. If they trend together, their long run movement follow each other. Meanwhile, if two variables are not cointegrated, these variables meander, without any tendency to return to a long run level. Their difference could become very large, that there is no tendency for them to come back together. These variables are expected to have no long run equilibrium that they wander arbitrarily far from each other (Enders, 2010 and Wooldridge, 2006). Hence, with these definitions and concepts, a test of cointegration between economic growth indicators of investments will be conducted to see which indicator has greater long run relationship and could be more appropriate in targeting and doing analysis. VI. Results

To choose a more appropriate measure of investment when setting the medium term Plan target and conducting policy analysis, three sets of annual NIA data were utilized: (a) the 1985-based series which runs from 1946 until 2010; (b) the 2000-based series which runs from 1998 to 2012, and (c) the World Bank (WB) series, consistent with the official 2000-based NIA of the Philippines, which runs from 1960 to 2012.

Correlation analyses were done for real growth rates of GDP (GR_RGDP), CF (GR_CAPFORM), and FCF (GR_FIXCAP) in each dataset. Based on the results, the growth rate of FCF appears to have a higher degree of association with GDP compared to CF. The corresponding plots for each correlation matrix graphically illustrate the closer affinity of FCF. Since the difference between CF and FCF is changes in inventories, this seems to imply that changes in inventories, due to its volatility, tend to mute the capacity of CF to have a greater degree of association with real GDP. Table 1. Correlation Matrix Using 1985-series Figure 1. Graph of Variables Using the 1985- series

Correlation Real GDP gr CF gr FCF gr

Real GDP gr 1.000000 CF gr 0.779076 1.000000 FCF gr 0.793885 0.946314 1.000000

Table 2. Correlation Matrix Using 2000-series Figure 2. Graph of Variables Using the 2000- series

Correlation Real GDP gr CF gr FCF gr

Real GDP gr 1.000000 CF gr 0.149339 1.000000 FCF gr 0.733311 0.336821 1.000000

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-40

-20

0

20

40

60

80

60 65 70 75 80 85 90 95 00 05 10

GR_RGDPWB

GR_FIXCAPWB

GR_CAPFORMWB

Table 3. Correlation Matrix Using WB Data Figure 3. Graph of Variables Using the WB 2000- series

The second method is the conduct of cointegration tests to explore the existence of a long run relationship between CF and real GDP and between FCF and real GDP. Before proceeding to this approach, there is a need first to know the order of integration of the variables. The order of integration of a variable shows the minimum number of times that the series must be differenced to make it stationary. Taking into consideration the definition of cointegration, it is necessary that the variables are integrated of the same order. While based on the graphs above, it appears that all the variables are stationary, this needs to be confirmed empirically and this will be conducted through the Phillips-Perron (PP) test.

The PP test is a nonparametric unit root test. It modifies the Dicker-Fuller (DF) test equation, making the asymptotic distribution of the test statistic unaffected by serial correlation. As applied to our data, all of them exhibit rejection of the null hypothesis that there is a unit root at 1 percent level of significance. Hence, we can safely conclude that all the variables are stationary as they are all I(0).

Table 4. Phillips-Perron Test of Growth Rates of Real GDP, Fixed Capital Formation

and Capital Formation

Period Dataset With Intercept Without Intercept and Trend

1985-series Real GDP -9.599*** -

Capital Formation - -7.730***

Fixed Capital Formation - -8.150***

2000-series Real GDP -4.280*** -

Capital Formation - -3.687***

Fixed Capital Formation - -3.926***

WB series Real GDP -4.140*** -

Capital Formation - -3.320***

Fixed Capital Formation - -4.585*** Note: Triple asterisks (***) denote 1 percent level of significance

Since the real growth rates of GDP, CF, and FCF are stationary, proceeding to cointegraton test is no longer necessary (Note: The authors also conducted cointegration tests using the approaches of Johansen and Breitung but since the variables are already stationary, these are not presented in the paper). Based on the results of the first statistical method used, which is the correlation test, it appears that FCF is a more appropriate indicator for setting the investment target and assessing actual performance that will serve as a basis for formulating

Correlation Real GDP gr CF gr FCF gr

Real GDP gr 1.000000 CF gr 0.426189 1.000000 FCF gr 0.747855 0.622110 1.000000

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policies. The said indicator is deemed to have a higher degree of relation and stronger long-run relationship with economic growth. With the operational method of measuring changes in inventories as discussed above, it is quite clear that CF is not the best indicator to determine long run growth.

Meanwhile, it should be noted that the authors of this paper are conscious of the

possible limitations of the approaches used in the study as well as data availability. There are other unit root tests which could be of use for further research such as the augmented Dickey-Fuller test suggested by Engle and Granger (1987) and that of Phillips and Ouliaris (1990) and other quantitative techniques which could be used to meet the objective of this paper. These are possible topics/methods for future research. Also, another topic of interest in this working paper is doing correlation analyses and cointegration tests for various components of fixed capital data, and between changes in inventory and CF. However, this can only be considered in the future due to data limitation. VI. Another Investment Indicator: The Incremental Capital Output Ratio

Aside from fixed capital, another useful investment indicator is the incremental capital output ratio (ICOR). According to Perkins, et al. (2000), ICOR is considered as a measure of efficiency of the use of capital and it is one of the indicators being targeted to increase economic growth. In training developing country officials, the International Monetary Fund (IMF) defined ICOR as the ratio of investment to change in output. Perkins, et al. (2000) discussed that a smaller ICOR is usually interpreted as greater efficiency for it means less capital is used to create a certain amount of output or equivalently a given level of capital will create more output. They added that a lower ICOR is expected to lead to a higher economic growth rate since a low ICOR usually means the efficient use of technology or the use of capital-saving technology. They said that if an economy has scarce capital and abundant labor, it should have a low ICOR, otherwise, it will use more capital and employ less labor for more output. Zupi (2002) mentioned in his paper that a number of international organizations are using the concept of ICOR in advising the developing countries about the level of investment requirements given the target economic growth rates.

This working paper tried to use the concept of ICOR in assessing the investment

performance of selected countries of the Association of South East Asian Nations (ASEAN). Looking at the investment to GDP ratios (i.e., ratio of fixed capital formation to GDP in Table 5), one can see that among ASEAN-5 countries, the Philippines has the lowest ratio of investment to GDP since 1980s. Also, after reaching the peak in 1990s, the investment to GDP ratio of the Philippines is on a downward trend, unlike other ASEAN-5 countries. With this trend and level of investment to GDP ratio, one cannot expect a strong growth from the Philippines.

Table 5. Investment to GDP ratio of ASEAN-5 Countries, 1960-2012

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Note: GDP, GCF and GFCF in constant 2005 US$

Source of basic data: World Bank

http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=world-development-indicators#

However, using the ICOR indicator, one can see that while the Philippines has been

performing poorly in terms of share of investment to GDP, the country is becoming more efficient in its use of capital. From posting the lowest share of investment to total output and highest ICOR in the 1980s, the country has started to show improvement in terms of capital utilization in 2000, with its ICOR value recording second to the lowest in 2000-2009 and the lowest in 2010-2012. This could be attributed to the implementation of reforms (Figure 4), including those that started in the 1990s, which helped increase the country’s efficiency in using technology and the use of capital-saving technology. These could partly explain the respectable growth that the Philippines has been achieving recently. Hence, in doing investment analysis, it will be useful to complement the investment to GDP indicator with ICOR. However, due to various formula in estimating this indicator, it will be very useful that the country’s statistical agencies will release the official ICOR data.

Table 6. Incremental Capital Output Ratio of ASEAN-5 Countries, 1960-2012

Note: GDP, GCF and GFCF in constant 2005 US$

Source of basic data: World Bank

http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=world-development-indicators#

Figure 4. Historical Implementation of Reforms in the Philippines, 1993 to 2012

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Source: Bangko Sentral ng Pilipinas-Investor Relations Office’s presentation “Republic of the Philippines: Good Governance

is Good Economics” slides 4 and 5. Unpublished.

VII. Conclusion

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Based on the results of analyses and tests conducted, it appears that FCF is a better indicator for investment compared to GCF. The growth rate of FCF is more positively related to the growth rate of GDP and they seem to have stronger long-run relationship since both are stationary. Also, using this indicator would avoid the need to consider the very irregular and volatile behaviour of changes in inventories in doing performance assessment, analysis, and medium term targeting for development planning.

Moreover, since both quantity and quality matter in investments, the monitoring and targeting of the FCF indicator should be complemented with ICOR to consider the efficiency of the country in using capital. The ICOR indicator will help qualify investment performance and this will be useful in directing policies towards a more appropriate utilization of capital and labor resources. Based on recent performance, the Philippines should not only improve its level of investments but also maintain or better yet further increase its efficiency in using capital.

However, aside from the techniques, the tests and analyses conducted in this working

paper are limited by data availability. The timely release of historical and disaggregate data of investments, including the official ICOR data, is crucial to properly conduct analysis and formulate development plans and policies that would help direct the Philippine economy towards achieving the goal of inclusive growth.

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