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• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T00590R000300530001-4
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• Document Creation Date: January 12, 2017
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• Sequence Number: 1
• Publication Date: November 1, 1985
• Content Type: REPORT

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Directorate of
Intelligence
1986-87 Elections
The Philippine Economy:
Marcos's Options for the
n-a-cseCTCf
EA 85-10187
November 1985
Copy 438
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Directorate of Secret
Intelligence 25X1
The Philippine Economy:
Marcos's Options for the
1986-87 Elections
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This paper was prepared byl Iand
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Office of East Asian Analysis, with a
Comments and queries are welcome and may be
directed to the Chief, Southeast Asia Division, OEA,
on
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Secret
EA 85-10187
November 1985
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The Philippine Economy:
Marcos's Options for the
1986-87 Elections F_
Secret
Key Judgments The economic instability that has characterized the Philippines since the
Information available foreign debt moratorium declared in October 1983-instability manifested
as of 21 October 1985 in high inflation, capital flight, and bank failures-has been brought under
was used in this report. control in recent months. President Marcos's government now faces the
difficult task of moving a depressed economy off dead center as elections
approach for local officials in May 1986 and for the presidency in June
1987.F_~
We believe Marcos has three basic options for the economy as elections
near:
? Spending To Win. A budget-busting spending spree aimed at gaining
votes for the ruling party is a time-honored tradition in Philippine
politics. Our econometric simulations show that real output could rise by
6 percent next year with such policies, but the drawbacks include
renewed inflation, suspension of loan disbursements from foreign credi-
tors, and fostering an appearance of political desperation.
? Adopting Foreign Creditors' Prescriptions. Marcos could attempt to
broaden his political support with promises of a "new beginning,"
including institutions serving the needs of the working poor and an end to
the business favors granted to political allies. Although such policies
could raise national output by nearly 5 percent next year, wide-ranging
policy reforms would threaten the source of much of the ruling party's fi-
nancial support.
? Staying the Course. The path of least resistance for Marcos is intermit-
tent compliance with the IMF's adjustment program, which to him
means continued economic privileges for allies of the ruling party and
deferring reforms that would threaten them. F_~
We believe Marcos will conclude that the political and economic risks
associated with either a preelection spending spree or sweeping policy
reforms are too high. In our judgment, Marcos will choose to "stay the
course" on economic policy while hoping for a rebound in exports to
stimulate the economy. Our econometric simulations suggest that such an
approach would permit a modest economic recovery through 1987:
? With favorable economic conditions abroad, GNP would grow by
3.4 percent in 1986 and nearly 6 percent in 1987, after declining by
approximately 4 percent this year.
Secret
EA 85-10187
November 1985
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? Consumer price inflation would decline to a 10-percent annual rate by
1987, while private consumption would be 10 percent higher than 1984
levels. 7-1
The electoral payoff to Marcos of such an outcome would increase as the
economy picked up steam, while avoiding the inflationary side effects of a
budget-busting spending spree. Few gains would be visible by the May
1986 elections, even if the economy resumed growth early next year. But, if
an economic recovery carried into 1987, the ruling party's presidential slate
probably would benefit from increased employment, low inflation, and
voter perceptions that an economic rebound was under way. F_~
Middle-of-the-road economic policies, however, would fail to set the stage
for a sustainable, long-term recovery and would do little to reduce friction
between Manila and its largest creditors-particularly the United States-
over economic policy reform. Measures necessary to boost exports-such as
dramatic exchange rate liberalization-probably would be postponed,
making the post-1987 election adjustment more painful both economically
and politically. In any event, prospects for lasting economic recovery also
would be undermined if businessmen remained uncertain about the
country's political future, felt threatened by economic privileges granted to
Marcos's political associates, and concluded that Manila was losing the
battle against the Communist-led insurgency.F_~
In our judgment, Marcos almost certainly is concerned that confrontations
over economic policy are likely as US economic assistance is increasingly
tied to policy reform, especially in such politically sensitive areas as
agricultural monopolies. Moreover, as local elections approach, we believe
Marcos will become more sensitive to US efforts to push reform in any
area-economic, political, or military. F_
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Secret
Key Judgments
Moving Toward Elections
? Economic Policy Options
Spending To Win 4
Adopting Foreign Creditors' Prescriptions 4
Staying the Course 4
For the Philippines 8
For the Economy in the Longer Term 9
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Figure 1
The Philippines: Economic
Indicators, 1980-87
Real GNP Growth
Percent
Consumer Price
Inflation
Percent
Current Account
Billion US $
13.1 10.2 10.0
101 FEW nn
9.8
1.2
1980 81 82 83 84 85a 86a 87a
a Stay-the-course projections. See text for a description of assumptions underlying
this approach.
Figure 2
The Philippines: Economic Indicators
per Capita, 1980-87
i
0 1980 81 82 83 84 85a 86a 87a
a Stay-the-course projections. See text for a description of assumptions underlying
this approach.
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Secret
The Philippine Economy:
Marcos's Options for the
1986-87 Elections F_
Two Years Into the Debt Crisis
The Philippines has made substantial progress con-
taining its economic crisis and stabilizing the
$26 billion debt-ridden economy.' Runaway inflation,
record high interest rates, and aftershocks of two
successive devaluations following the moratorium on
debt repayments in October 1983 have been largely
brought under control:
? Tight monetary policy has slowed inflation from an
annual rate of 100 percent last summer to an
adjusted annual rate of only 8 percent in recent
months.
? Interest rates, which peaked at 40 percent late last
year, have fallen to less than 20 percent.
? Weak local demand for imports and disbursements
from the nearly $10 billion financial rescue package
negotiated with foreign creditors have eased pres-
sures on the peso so dramatically that the difference
between the official exchange rate and the black-
market rate-as high as 50 percent in early 1984-
is now negligible. As a result, the exchange rate has
remained stable for most of this year at about 18.5
pesos per US dollar.
Manila's economic policy makers are now shifting
attention to stimulating the lackluster economy. By
any standard, the damage produced by the debt crisis
has been extensive, and local businessmen remain
discouraged. Philippine economists estimate that na-
tional output fell by 4.6 percent in first half 1985,
following a 5.3-percent decline last year. Bankruptcies
and business closings have been widespread-during
the first quarter of 1985, 800 of the country's top
2,000 corporations ceased operations at least tempo-
rarily. According to the US Embassy, the unemploy-
ment rate remains at nearly 15 percent-representing
about 3 million people. At the same time, less than
half of those employed hold full-time jobs.
Moving Toward Elections
Further deterioration of the economy over the next
two years would be a major political handicap for
President Marcos and the ruling New Society Party
(KBL). Local elections are scheduled in May 1986
throughout the country for governors, mayors, and
local leaders-a total of over 16,000 offices. Elected
officials will exercise considerable political influence
at the provincial level, according to US Embassy
reports. As a result, most Philippine politicians believe
that KBL election victories in 1986 are a vital build-
ing block for a successful bid by Marcos in the
presidential elections scheduled for June 1987.
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The ruling party faces an uphill battle if its own
public surveys are any guide.2 25X1
the prospect of significant KBL losses in 25X1
1986-reflecting the concern of rural voters not only
with the economy, but also with declining security,
military abuses, corrupt local officials, and Manila's
apparent indifference to their problems. The govern-
ment's own internal reports estimate that in one
region the opposition will win 90 percent of the
election contests and more than half the contests in
most of the other regions. We believe that this
underscores the importance to the ruling party of
achieving the appearance of progress in setting the
economy on the road to recovery-which, in our
judgment, will require continued progress in the fight
against inflation, reasonably low interest rates, posi-
tive economic growth, falling unemployment, and an
improving trade balance.
Although Marcos's political fortunes have suffered
because of the economic crisis and the widespread
perception of economic mismanagement, we believe
he has to some degree been protected by the ability of
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Table 1
The Philippines: Economic Policy Options
Policy
Option
Staying the
Course
A business-as-usual approach to
balancing political and economic
objectives ... lack of dramatic eco-
nomic reforms maintains tradition-
al political alliances ... Manila's
most likely policy option.
Adopting Foreign
Creditors' Prescriptions
Policies that pave the way for long-
term economic growth ... but
would constrain Marcos's ability to
finance election spending ... re-
quire dismantling structure of eco-
nomic privileges ... least likely op-
tion.
Expenditures stay well within IMF
guidelines and are focused on pro-
ductive services. New taxes are im-
posed on incomes to expand the tax
base. Spending increases 12 per-
cent in 1986 and 15 to 20 percent
in 1987.
Fiscal policy Government expenditure limited by
IMF guidelines, but some election
spending likely. Spending increases
15 to 20 percent annually in 1986
and. 1987.
Monetary policy Limited by IMF guidelines, but
occasional lack of compliance pos-
sible. Reserve money increases 10
percent annually in 1986 and 1987.
Reserve money remains within
IMF guidelines, increasing 10 per-
cent annually in both 1986 and
1987.
Some depreciation of peso, reach- Complete float of the peso, requir-
ing 21 pesos to the dollar by the ing significant institutional and
end of 1985 and 24 pesos to the policy reforms. Exchange rate de-
dollar by the end of 1986. preciates to 22 pesos to the dollar
by the end of 1985 and to over 25
pesos to the dollar by the end of
1986.
Policies designed to boost KBL's
election prospects by maximizing
short-term economic gains-
... would put Manila on collision
course with the IMF, World Bank,
and commercial creditors ... an
outside possibility.
Expenditures rise significantly
above IMF guidelines, with empha-
sis on construction and public
works. Spending increases 50 per-
cent in 1986 and 15 percent in
1987.
Also heavily expansionary-reserve
money growth above IMF targets is
necessary to finance increases in
government spending. Reserve
money increases 10 percent by the
end of this year and by a 17-
percent average rate in 1986 and
1987.
Exchange rate is maintained at the
current level of 18.6 pesos to the
dollar.
Reforms Only minimal reforms undertaken Aggressive reforms in both agricul- Reforms in agriculture and finance
in agriculture and financial sector. ture and finance. Dismantle agri- are not undertaken.
Implemented only when pressed cultural marketing monopolies,
hard by the United States and in- particularly in coconuts and sugar.
ternational financial institutions. Rationalize and merge failing pri-
vate and public banks.
the populace to adjust to hard times. Despite a 16-
percent drop in real income, for example, per capita
consumption has fallen only 4 percent since 1981-
offsetting the initial impact of the economic crisis for
many Filipinos. Consumption has been sustained by
sharply reducing savings, and, in some cases, actually
drawing down holdings of financial assets. For exam-
ple, the stock of personal savings fell by $250 million
last year and has fallen further this year, according to
government data. F__1
There is, nevertheless, no doubt that the economy's
troubles have had an impact at the polls. In our
judgment, depressed urban areas-which have suf-
fered the brunt of the economic decline since the debt
crisis-contributed to the opposition's 16-to-5 sweep
of Manila's seats in the National Assembly during
parliamentary elections in May 1984. Unemployment
and wage cuts have swelled the ranks of Manila's
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Table 1
The Philippines: Economic Policy Options (continued)
Key economic out-
comes
Consumer price
inflation
Implications ? Politically acceptable for Marcos in
view of mild inflation and healthy
growth in 1987. However, "status
quo" does not set the stage for a
sustainable recovery. Necessary
policy changes are postponed, mak-
ing the eventual adjustment more
painful.
Adopting Foreign
Creditors' Prescriptions
Drawbacks include higher short-
term inflation and significantly less
"pork barreling." Nevertheless, ag-
ricultural reforms lead to improved
distribution of income and thus in-
creased spending. Financial re-
forms lower banking costs and in-
terest rates, improving investment.
Overall, this policy sets the stage
for long-term sustainable growth.
poor, with one-third of Metro Manila's population of
6.8 million now residing in squatter colonies and slum
areas, according to press reports. A lack of trade
financing because of the debt moratorium and tight
credit policies precipitated a shortage of imported
capital goods and raw materials, forcing manufactur-
ing firms to delay or cancel production schedules.
Manufacturing output-which is heavily concentrat-
ed in Manila and accounts for one-third of GNP-fell
by nearly 20 percent over the last 18 months. Produc-
tion by key manufacturing firms is now 35 percent
below 1981 levels, and real wages in manufacturing
have fallen by one-third. F_-]
The rural economy-which supports nearly two-thirds
of the populace-has been spared the full impact of
the economy's slide, and it is no accident that the
KBL won nearly two-thirds of the National Assembly
Among the three options, this poli-
cy achieves maximum growth by
1986, but at the cost of severe
inflation and lower growth in 1987.
Constant exchange rate requires
that imports be constrained by tar-
iffs, quotas, or through the black
market. The long-term implications
of this policy are the most serious-
a sharp recession would be neces-
sary, probably by 1988, to stabilize
the economy again.
seats outside of Manila in the 1984 elections. Despite
a host of problems, including increasingly costly
inputs-such as fertilizer and credit-and a growing
insurgency, agricultural production increased by 1
percent last year and by 1 percent in the first half of
this year, according to US Embassy reports-a
marked contrast with the 10-percent decline in manu-
facturing. Rice and corn production, for example, are
at near-record levels because of government credit
programs, the cultivation of more land, and favorable
weather. FI
Economic Policy Options
Given constraints imposed on Marcos by his foreign
creditors, we have identified three policy approaches
that incorporate trade-offs between short-run political
considerations and longer term economic growth to
approximate the mix of economic policies that Marcos
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is likely to have available as the country moves toward
elections.'
Spending To Win. A massive spending program
aimed at winning votes for the ruling party-without
regard for the budgetary consequences-is a time-
honored tradition in Philippine politics, and in the
short term it can be effective. We believe that with a
20-percent jump in public spending Marcos could
point to visible increases in social services and public
works by the 1986 elections. Additionally, increased
funding for military supplies and soldiers' salaries
could improve morale, and-we believe-security, in
the countryside. We estimate that real output could
rise by more than 6 percent next year, accompanied
by higher levels of.income and employment. Under
this scenario, Marcos: would also defer -any economic
reforms that threaten his political allies-whose
wealth and influence are critical factors for the ruling
party during elections.F__1
The policy's short-term appeal is largely offset by its
medium-term costs. Despite the initial gains generat-
ed by massive government spending, our simulation
shows budget-busting measures would rekindle infla-
tion to rates exceeding 30 percent by 1987-the
presidential election year-and trigger concern that
another recession would be needed to correct for the
overspending. Furthermore, without economic re-
forms to address the grievances bolstering Communist
Party recruitment in the countryside, this policy
package, in our judgment, would do little to stem the
rising insurgency. F__1 .
This policy approach also would take Manila out of
compliance with the IMF program, resulting in cut-
ting off new funds from foreign creditors. Such a
development would jeopardize Manila's relations with
foreign creditors and complicate negotiations to re-
schedule foreign debt payments falling due in 1987.
In our judgment, this second round-of rescheduling
'The IMF is providing Manila with a $615 million balance-of-
payments loan-with disbursements running through May 1986-
in return for Manila's compliance with economic targets designed
to improve the balance of payments, trim inflation, and improve the
structure of public finances and agricultural marketing arrange-
ments. Compliance with the IMF program has permitted Manila to
reschedule $5.5 billion in amortization payments to foreign credi-
tors due between October 1983 and December 1986 and obtain $3
billion in short-term trade credits and $925 million in medium-term
loans.
may be necessary because export earnings and new
foreign credits will probably be insufficient to finance
principal repayments to foreign creditors, which will
reach $2.3 billion in 1987-a $1 billion increase over
1986 levels-if Manila is to avoid curtailing imports
or depleting foreign exchange reserves. F_~
Adopting Foreign Creditors' Prescriptions. Although
we do not believe Marcos will reverse himself after 20
years and wholeheartedly adopt the economic reforms
currently recommended by the IMF and World Bank,
such an approach would allow him to broaden his
support base by promoting a "new beginning." In
such an event, Marcos could promise to make eco-
nomic institutions more equitable-including reorga-
nizing agricultural marketing monopolies, which cur-
rently generate. enormous profits for a small group of
businessmen who are political associates of Marcos.
The economic benefits of policy reforms-illustrating
the best case outcome from following IMF and World
Bank recommendations-are considerable. We esti-
mate that the combination of economic reforms and
responsible fiscal and monetary policies-all of which
build confidence in the economy among domestic and
foreign investors-would raise national output by
nearly 5 percent next year and by over 8 percent in
1987. These policies, moreover, would pave the way
for long-term sustainable economic growth and in-
clude economic reforms, such as those in agriculture,
essential to an effective counterinsurgency strategy.
These achievements would be offset by some short-
term dislocations if the country's financial system,
agricultural marketing, and trade and tariff proce-
dures are reorganized. For one thing, a sharp devalua-
tion of the peso would temporarily accelerate infla-
tion. More important, Manila's ability to engage in
pork-barrel politics would be sharply curtailed. The
US Embassy reports that Marcos is already impatient
with the IMF, concerned. that the high political cost of
the Fund's austerity program-resulting, from succes-
sive devaluations, cutbacks in government spending,
and restrictive lending policies-may not-justify the
program's long-term benefits. F_~
Staying the Course. We believe that Marcos is most
likely-to stick with his time-tested approach to deci-
sionmaking-seeking the path of least resistance. In
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Secret
Along with the level of world trade and the demand
for Philippine exports, Manila's economic policies
will largely determine the performance of the Philip-
pine economy during the politically critical next 18
months. In analyzing Marcos's policy options, we
have calculated the impact on the economy of the
individual policy instruments at Manila's disposal.
According to our analysis, the three most important
Qf these instruments are exchange rate, fiscal, and
monetary policiesF_~
To capture the effects of permanent changes in these
policies on the current account deficit and the foreign
debt, and politically sensitive variables such as eco-
nomic growth and inflation, we have simulated the
economic outcome of a 10 percent change in the
exchange rate, a 10 percent change in government
spending, and a 10 percent change in the money
supply. F_~
Among these three policy instruments, our analysis
indicates that a 10 percent increase in government
spending generates the largest and most rapid in-
crease in economic activity-adding an extra 3 per-
cent to total national output. By raising the demand
for imports, however, this policy leads to a significant
deterioration in the balance of trade and the highest
level offoreign debt of the three policies. On the other
hand, a 10 percent devaluation improves the trade
balance-by increasing import prices and making
Philippine products more competitive on world mar-
kets-and reduces the country's dependence on for-
eign capital. This policy, however, leads to signifi-
cantly higher rates of inflation-and thus higher
interest rates-which initially reduce national output
by 1 percent. Although the impact on national output
of a 10 percent increase in the money supply is not, as
dramatic as that achieved with the other two policy
instruments, the effect is less destabilizing and longer
lasting. F_~
In practice, Marcos will choose a combination-4f
these and other policy instruments that best serve his
political needs. There are limits, however, on his
ability to manipulate individual policies. The IMF-
imposed austerity program, for example, limits Man-
ila's ability to increase government spending, cut
taxes, and raise the money supply-traditional op-
tions for boosting the economy. The Fund program
calls on the government to cut its budget deficit from
over $775 million in 1982 to about $400 million in
1985, while raising tax revenues from $2 billion in
1982 to over $4 billion this year. Poor revenue
performance this year will force Manila to introduce
new taxes-a move that would depress domestic
demand further. In addition, Manila must reduce
government lending to public-sector corporations by
one-third and limit wage increases to government
workers.F---]
Other factors that influence the economy in the short
term will remain beyond Marcos's control. Private-
and public-investment spending-historically, an im-
portant engine of growth-is constrained by high
interest rates and uncertainty about the economy, the
country's political future, and the rapidly growing
Communist insurgency, according to US Embassy
reporting. Investment spending fell by 25 percent last
year and is falling sharply again this year.
the success of the insurgency is
plans, especially in rural areas.
Ifor example, companies are pulling out of
areas in Mindanao that are falling under the control
of the insurgents.
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Figure 3
The Phillipines: Impact of Economic Policy Instruments a
Increase in GNP
Growth
Percent
Increase in Consumer
Price Inflation
Percent
Change in the
Current Account
Million US $
Change in the
Total Foreign Debt
Million US $
0 0 0
IIIIIIIIIIIII IIIIIIIIIIIII
-80
-80
-200 0 1 2 3 4 5 6 7 8 9 1 0 1 1 12 -200 0 1 2 3 4 5 6 7 8 9 1 0 1 1 12 -200 0 1 2 3 4 5 6 7 8 9 10 11 12
Quarters from policy change
a Difference from baseline case.
b 10 Percent Peso Devaluation. Most often talked about policy change ...
discourages imports by raising import prices ... effect on the trade balance
and the foreign debt are clearly beneficial ... political reasons for Marcos
to resist devaluation are easy to understand, however, because inflation
jumps immediately due to higher import costs and remains significantly
higher for a year ... effect on growth is initially negative and only becomes
positive after five quarters ... model, however; may not capture complete
supply response of exporters ... such a devaluation would move the
exchange rate from 18.6 pesos per dollar to 20.5 pesos per dollar.
c 10 Percent Increase in Government Spending. Policy most likely to be used
before an election ... spending on construction projects, higher salaries,
and increased government employment give immediate and significant
boost to growth ... effect tails off quickly however ... overheated economy
raises imports and prices . . . erodes the current account, adding to foreign
debt levels . . . this policy change would increase operating expenses from
34.0 billion pesos per year to 37.4 billion pesos per year ... such an
increase would leave the budget deficit marginally above IMF guidelines.
d 10 Percent Increase in Money Supply. Approach used to increase domestic
credit and lower interest rates ... increases both consumer spending and
private investment ... quick impact on GNP growth, which peaks four
quarters after policy change ... effect on the current account and foreign
debt are clearly negative ... policy often used to finance government
spending ... at present, such a policy would increase reserve money from
32.0 billion pesos to 35.2 billion ... a level within IMF guidelines.
I I I I I I I I I J I I
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Secret
Table 2
Political Implications of Marcos's
Economic Policy Options
Policy
Options
Net
Appeal
Political
Cost of
Implementing
Policy
Economy's
Contribution
to Vote
Political
Cost of
Implementing
Policy
Economy's
Contribution
to Policy
to Marcos a
Adopting foreign
creditors' prescriptions
Highest
Moderate
a We assume the net appeal to Marcos.of each policy option is an
estimate of the economy's contribution to the vote for the ruling
party minus the political costs of implementing the policy. The
political costs, in our judgment, are the fallout arising from policy
reforms directed against the economic privileges of powerful KBL
allies, such as coconut industry king Eduardo Cojuangco and sugar
magnate Roberto Benedicto, and the reaction of two key groups of
foreign creditors-international financial institutions, such as the
IMF and World Bank, and commercial banks, particularly in the
United States.
this case, few new economic reforms would be imple-
mented, but the economy would also be spared unset-
tling policy changes. Although we expect that.Marcos
would attempt to create the illusion of reform by
carrying out some of. the measures recommended by
the IMF, he would leave intact the economic privi-
leges of powerful and supportive interest groups. In
addition, while Marcos would boost government
spending for activities appealing to voters-such as
constructing schools, health centers, and roads-the
spending could be financed largely by redirecting
funds already in the government's budget, rather than
embarking on a budget-busting spree. Funding for the
ruling party's campaign would be directed through
such government agencies as the Ministry of Human
Settlements, after being generated by reductions in
outlays for other ministries.F-7
If Marcos follows this course, a modest but politically
acceptable economic recovery is likely in 1986. We
estimate GNP would grow by 3.4 percent next year
and nearly 6 percent in 1987. Significant gains are
also projected in trimming inflation-in 1987 con-
sumer prices will rise by only 10 percent-and private
consumption in 1987 would be 10 percent above 1984
levels. We believe that the economic turnaround
would follow modest improvements in various sectors
of the economy-such as finance, housing, and ser-
vices-that are already under way but are overshad-
owed economically by the unexpectedly large decline
in exports this year-down by 14 percent during the
first 8 months of this year. In addition, the IMF is
loosening its restrictions on the supply of reserve
money at Manila's request, raising the ceiling from 31
billion pesos in March 1985 to 38 billion pesos for
December. As a result, domestic credit is more readily
available at lower interest rates, a development that
facilitates inventory restocking by businesses and
stimulates domestic borrowing. F_~
Marcos is also likely to "stay the course" because
such policies are beginning to show modest positive
results. For example, stable exchange rates and lower
inflation rates have largely put an end to panic
hoarding of consumer goods and currency speculation
by businessmen and bankers, leading to a resumption
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of financing for more normal business purposes. Fur-
thermore, the agricultural sector is rebounding, and
even depressed coconut exports are showing signs of
picking up, according to industry data. Finally, we
estimate that the cumulative effect of past devalua-
tions, the availability of trade credits, and some
modest improvement in the world markets for Philip-
pine products could raise export earnings by 20
Figure 4
The Philippines: Exports by
Commodity, 1984
Total exports for 1984:
Million US $ 5,391
percent next year.`
Some Caveats. However Marcos proceeds, the econo-
my's outcome will be particularly sensitive to the
performance of exports. Exports represent over 20
percent of GNP and generate another 20 percent of
national output as they flow through the economy.
Our analysis-based largely on our econometric mod-
el of the Philippine economy-indicates that a 10-
percent increase in export earnings raises the GNP
growth rate by 4 percentage points. The model also
shows, however, that, if export growth is flat next
year, GNP will decline by more than 5 percent-
25X1 rather than show the 3.4-percent growth we project.
The pace of US economic growth, in turn, will be a
primary determinant of Philippine export levels. Sales
to the United States account for nearly 40 percent of
Philippine exports, and sales to this country have been
responsible for nearly 90 percent of the increase in
Philippine exports since 1979. Our econometric model
shows, moreover, that a 1-percent increase in the US
economy leads to a nearly 1-percentage-point increase
in Philippine GNP growth. In addition, our analysis
concludes that US economic growth has twice the
25X1 impact on Philippine -export levels that Japanese
growth has. F__1
Even if all went well under our "staying the course"
scenario, per capita incomes in 1987 would still be 12
percent below the 1981 peak of $775 per person, and
the economic recovery would remain vulnerable to
disruptive political events in the Philippines. A half-
hearted commitment to the IMF, moreover, would
result in on-again, off-again compliance with the
Fund program and continuous haggling over specific
Forest products
Sugar products
a Includes fruits and vegetables, copper, handicrafts, chemicals, food products,
machinery, furniture, and textiles.
program targets; and, more important, it would delay
disbursements by the IMF and trade financing pro-
vided by foreign commercial creditors. This has al-
ready occurred because of Manila's recent failure to
implement reforms in the sugar and coconut indus-
tries and to enact new taxes requested by the IMF.
Points To Ponder
For the Philippines. Although a modest economic
recovery would enhance political and social stability,
we believe that the KBL's prospects in the local
elections remain clouded. Few economic gains will be
visible by mid-1986, and Marcos and his ruling party
have little time to make up for the hardships voters
have endured during two years of economic crisis. In
addition, Marcos must overcome the public's growing
resentment over the corruption and wealth of the
political elite-heightened by recent widely circulated
press cxposes-and end lingering doubts about his
' Protectionist measures by Manila's trading partners will make this
target more difficult to achieve, but it is in line with the IMF's
projections. In any case, a 20-percent increase in 1986 brings
exports earnings to a level only 2 percent above 1981 earnings.
Secret
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ability to manage the economy. Under these condi-
tions, we believe that Marcos's likely choice of eco-
nomic policies will, at best, have a limited influence
on boosting his party's fortunes in the 1986 elections.
For the United States. Manila's business-as-usual
approach to the economy assures continued friction
with the United States over economic policy reforms
necessary to ensure long-term economic growth, a
viable resolution to the debt crisis, and a more
equitable distribution of income. According to US
Embassy reports, the United States is already identi-
fied by many senior officials in Manila as the prime
mover behind efforts by the IMF and World Bank to
reform economic policies and institutions. In addition,
the Philippine press has suggested that recent disclo-
sures in the US media of the First Family's overseas
wealth were instigated by US Government agencies to
By 1987, however, an economic recovery-well into
its second year and gaining momentum-could bene-
fit the ruling party and woo some of the middle class
back into the KBL fold. In addition, we believe voters'
resentment toward the ruling party will abate if
employment rises and inflation continues to decline.
Although voters in Philippine elections tend to mark
their ballots on the basis of the personality and
patronage of each candidate, an improving economy
25X1 would be an important factor in determining the
election outcome, as would issues such as the state of
the insurgency and political reform. F-7
lies.
Outside the realm of electoral politics, benefits of
"staying the course" would be far more modest.
Because such an approach fails to rectify economic
grievances that feed the Communist insurgents' popu-
lar appeal, a modest economic recovery might do no
more than slow the insurgents' momentum.' Although
we believe a rebounding economy would undermine
the Communists' success in mounting large-scale
demonstrations by peasant organizations and ease
many of the economic hardships that sustain the
increasingly militant labor movement, in our judg-
ment, Manila also needs to vigorously pursue equita-
ble rural development. Measures include focusing on
increased public works projects and social services and
fundamental reforms in rural institutions such as land
tenancy, agricultural credit, and marketing monopo-
' These economic grievances center around disputes over land titles,
land tenure systems, equal access to government economic institu-
tions and services-such as rural banks and agricultural extension
agents-and inadequate and declining social services. F_
embarrass Marcos.
Marcos, in our judgment, almost certainly is con-
cerned that confrontations over economic policy are
likely as US economic assistance-totaling nearly
$250 million this year-is increasingly tied to policy
reforms in such politically sensitive areas as wheat
imports, fertilizer distribution, rural credit, and sugar
and coconut marketing. As local elections approach,
we believe that Marcos will become more sensitive to
US efforts to push reform in any area-economic,
political, or military. He has already reacted to moves
by the US Congress this summer to cut military
assistance and increase economic aid. Marcos created
a bipartisan commission in the National Assembly to
review US-Philippine relations-including the Mili-
tary Base Agreement and the $900 million in compen-
sation called for in the 1985-89 agreement. By form-
ing the commission, we believe Marcos has also
signaled the United States that various forms of
retaliation to further pressures are possible-ranging
from harassments over minor issues, such as visas for
US servicemen at the bases, to an abrogation of the
bases agreement, which we believe is unlikely. F_
For the Economy in the Longer Term. Even if the
Philippines enjoys a modest economic recovery during
the next two years, the long-term outlook remains
poor if Manila follows the approach to economic
policy we think it will. Inefficient economic institu-
tions and policies-especially in agriculture, banking,
and manufacturing-would continue to hobble the
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economy. A comprehensive package of agricultural
reforms, for example, would allow that sector to grow
by over 4 percent annually, according to our projec-
tions-compared with annual growth rates of 1 or 2
percent if current agricultural policies are retained.'
In addition, we believe flexible exchange rates-
unencumbered by foreign exchange controls and tariff
barriers-and further depreciation of the peso are
necessary to reverse the long-term decline in the
international competitiveness of Philippine export in-
dustries. Among other things, Manila's failure to
move more aggressively on exchange rate reform
discourages exports and encourages imports, and, as a
result, will continue to swell the trade deficit when the
economy resumes more traditional levels of growth.
Furthermore, reforms
in public finance and investment policies are needed
to raise domestic savings and reduce the country's
reliance on foreign capital.
A continuation of Marcos's policies beyond the presi-
dential election would bode ill for the economy even if
a modest rebound provided an aid to his reelection.
According to US Embassy reporting, a sustained and
vigorous recovery will be elusive as long as local
businessmen and foreign investors remain uncertain
about the country's political future and feel threat-
ened by government agencies and Marcos's political
associates. We believe that legislative or administra-
tive reforms will not be sufficient if they are circum-
vented.by Marcos through presidential decrees that he
uses to perpetuate systemic corruption and favors
granted his political associates. According to press
reports, many leading members of the Philippine
business community argue that the country's econom-
ic problems will not be resolved until political reforms
are undertaken. Moreover, if businessmen conclude
.that Manila is losing the battle against the
Communist-led insurgents, renewed capital flight
would undermine any economic resurgence.
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Appendix
Econometric Model
of the Philippines
To analyze Manila's ability to tailor the economic
environment to its political needs, we have extensively
overhauled our econometric simulation model in re-
cent months. The model consists of 76 equations; 23
describe economic behavior-such as consumer
spending patterns, investment decisions, and the level
of consumer prices-and 53 are accounting and other
economic identities describing relationships between
different variables. The model concentrates heavily on
the foreign-trade sector.
Recent improvements include:
? Refining the data base from updated National
Income Accounts through mid-1985 and improving
on the price deflators used to adjust for inflation.
? Refining the behavioral equations to markedly im-
prove the model's predictive ability.
? Reestimating all the behavioral equations using the
new data.
Even with these improvements, however, the model
contains several weaknesses, requiring additional
analysis outside the framework of the model to simu-
late outcomes:
? Although we have allowed for several supply con-
straints facing the economy-such as the foreign
debt repayment moratorium-the model is largely
influenced by trade flows and reflects the demand
for output rather than the suppliers' response. Thus,
it is possible that we have understated the exporters'
response to an exchange rate depreciation.
? The model does not explicitly track individual sec-
tors of the economy, such as agriculture, industry,
mining, or services. It does not, for example, simu-
late how the output of an agricultural crop would
respond to changes in agricultural prices or to the
dismantling of an agricultural marketing monopoly,
such as coconuts, sugar, or fertilizer.
? The model does not easily simulate the economic
effects of such factors as the insurgency or political
uncertainty.
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Figure 5
Econometric Model of the Philippines
Monetary Policy
Money supply
Fiscal Policy
Government expenditures
Trade Policy
Peso exchange rate
Debt Management
Debt rescheduling
O
Personal consumption Investment
GNP
Industrial production
Wages
l 1
Export
earnings
Current account
balance
Amortization
payments
Crude oil prices
World prices
Import
expenditures
J
US GNP
Japanese industrial production
Availability of trade financing
' Foreign debt i--
1
Overall balance
of payments
Foreign exchange reserves
Foreign investments
International interest rates
New loan disbursements
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Interest
payments
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Secret
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