Business World, 20 August 2012


Like a terminal cancer patient grasping at quack cures in a desperate moment, the country’s elites at times suddenly and inexplicably seize upon some untried idea in the hope that it might be the magic bullet or fairy wand that fixes the country’s myriad problems. The list has thus far included uncritical embraces of authoritarianism, globalization, populist leadership, and moral rectitude. After the momentary flush, however, these precipitous enthusiasms typically subside and give way to the sober realization that development cannot be reduced to a magic formula — that is, until the next fad comes along.

The latest silver bullet to be polished is charter change to amend the “restrictive” economic provisions of the constitution. These refer primarily to the constitutional limits on foreign ownership in specific areas, namely: land and natural resources, the practice of the professions, public utilities, education, and the mass media.

The argument for changing these limits on nationality ownership often reads like an advocacy for the idea of foreign direct investment (FDI) itself: we need to change nationality requirement — allow 100% foreign ownership — because foreign investments are good. As proof, see what foreign investment has done in Thailand, Taiwan, Vietnam, China, and so on.

But these discussions are beside the point, a sad non-sequitur. For there is no question by now that foreign direct investment is beneficial and does play a crucial role in development. The real issue is the narrower one — whether limits on foreign ownership represent important hindrances to the massive entry of direct foreign investment in general, and into the Philippines in particular.

Both history and the academic literature suggest otherwise. To begin with, many other factors besides liberal ownership rules have been shown to determine FDI entry, among them: political stability, market size, trade-openness, exchange-rate rules, skill-levels, labor-market conditions, and infrastructure. Historically, the Philippines missed the massive flood of Japanese FDIs that lifted the boats of Thailand, Malaysia, and Indonesia in the 1980s and 1990s — not because its ownership rules were particularly stringent, but because the country was plunged in the chaos of the Marcos-created debt crisis and the subsequent coups d’état mounted by the country’s self-anointed saviors. China stands out as the antipode. It is today probably the largest developing-country recipient of foreign direct investment. Yet foreign ownership rules in China are even more restrictive: foreign ownership is simply disallowed in mining, steel, education, telecommunications and the internet (here, at least, we might allow up to 40% foreign ownership). What gives? Well, obviously other factors have proved more important than ownership restrictions.

Second, in terms of ownership or property rights themselves — except for truly prohibitive and autarkic regimes — it is less the allowable percentage ownership of investment that matters than the clarity and consistency of the rules themselves. In the first place, anyone since Berle and Means should know the difference between ownership and control; control is what really what matters, and this can be done with far less than 100% ownership. The tide of Japanese FDI in Southeast Asia after the Plaza-Louvre accords was hardly hindered by the fact that most of it had to take the form of joint-ventures.

But the extreme example is again proven by the much-admired China. There foreigners have actually been able to participate even in the “prohibited” industries through the creation of ingenious investment vehicles, notably the “variable interest entities” (VIEs). The Economist of 7 July 2011 describes it as follows (please note, Senator Sotto, here I am clearly quoting): “This entity, the VIE, must be run by a Chinese citizen. A series of contracts are then arranged, shifting the returns from the VIE first to a foreign-owned company registered in China and then to an offshore company, perhaps in the Cayman Islands.” Asset-ownership, in short, can be effectively replaced by contractual claims to securitized future returns. Brilliant.

In the Philippines, we have had our own creative solutions: besides control with minority ownership (think PLDT), service-contracts have also allowed foreigners to participate significantly in agriculture and resource-exploitation.

In short, one cannot underestimate the unbounded creativity of finance and capital to adjust to apparently difficult circumstances. Even Lenin realized this when he noted that nationalized land leased out to private capitalists may in fact be even more conducive to capitalism than peasant ownership.

But, some may argue, why make foreign investors go through these hoops rather than grant outright ownership itself?

The China lesson can actually be taken a bit further. The VIE arrangement has been going on for years but has recently taken some flak, since local authorities have taken it upon themselves arbitrarily to prohibit some of them. What this points to is the importance of consistency and reliability of the rules. In an important article, “Unbundling institutions” (2005), D. Acemoglu and S. Johnson underscore how “property-rights institutions” are of utmost importance in promoting long-run growth. The security of property rights, however, is really about “firms’ assessments of the extent of government corruption or the predictabilityof the legislature and the executive”. (See, Sen. Sotto, quotation marks are harmless!)

Now think of what advocates of charter change are proposing to do. They want congress to take a short cut — i.e., convene a constitutional assembly — in order to amend certain constitutional provisions.

On the one hand, this is an ostensible step towards creating a more liberal investment environment on paper. On the other hand, they would be demonstrating the practical ease by which the most basic rules can be changed, henceforth entrusting to congress the task of designing laxer or tighter rules on foreign participation in different economic sectors for the future. The current and foreseeable composition of congress gives no assurance that such a process will be smooth and non-contentious. At the very least, it is an invitation to future lobbying (yehey!).

The 1986 Constitution is not a beautiful document: it is verbose, pretentious, and overly detailed. But a good reason to accept it, defects notwithstanding, is that it ties the hands of would-be usurpers, limits lobbying, and provides predictable bounds and horizons for creative economic and financial improvisation.

Congress is quite free to spend the next four years arguing about the shape of constitutional provisions.

It should not delude itself into thinking, however, that it is thereby doing anything particularly urgent or relevant. Indeed, by demonstrating its ability for changing the rules on a dime, it may in fact discourage foreign investment rather than promote it.