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Can the Services Sector Be an Engine of Economic Growth for the Philippines?

By Josef T. Yap and Fatima Lourdes E. del Prado
Philippine Institute for Development Studies

The services sector in the Philippines has been experiencing a robust growth in recent years, prompting proposals for the country to “abandon” the manufacturing sector and shift its policy in support of the services sector. The rationale is that such a shift would lead to high and sustained economic growth defined as 7 to 10 percent GDP growth for an extended period which is usually 10 years. An earlier article (1) on the country’s annual economic outlook argued that while the services sector was expected to post a higher growth in 2007, its intrinsic structure prevents it from being the major source of high and sustained economic growth rates. This Notes highlights the arguments against a policy shift supporting the services sector.

“Deindustrialization”

The phenomenon characterized by the massive transition of labor and output share from manufacturing to the services sector is widely referred to as “deindustrialization.” This follows the traditional development models of human societies’ sequential pattern of economic development—from agricultural to industrial and to services-oriented economies.

Industrialized countries and the so-called newly industrialized countries have generally followed this pattern. If the Philippines were to leapfrog the conventional sequence and instead focus its policies on supporting the services sector, this would entail conscious shifts in education policy, infrastructure projects, trade and industrial policy, budget allocation, and other important areas.

Performance of the Philippine manufacturing and services sectors Growth in the manufacturing sector was 5.4 percent in 2006. Among the larger subsectors, however, only food manufactures and products of petroleum and coal recorded significant growth rates, both at 6.7 percent. This only implies that the base of the manufacturing sector is still narrow. In addition, the performance of the manufacturing sector decelerated after the first quarter of 2006 and was expected to continue doing so in 2007.

On the other hand, the share of the services sector to total GDP in the Philippines has increased steadily in the past three decades. As of 2006, it stood at 48.3 percent compared to 32.8 percent for industry and 18.8 percent for agriculture. The strong performers in the services sector in 2006 were finance and private services. The boom in the stock market aided the 9.5 percent growth in finance while the expansion of the business process outsourcing (BPO) sector underpinned the 6.8 percent growth of private services

Furthermore, the services sector experienced the highest growth rate after the 1997 financial crisis, averaging 6 percent during the period 2001–2006 compared to 3.8 percent for agriculture and only 3.3 percent for industry. The figures for the manufacturing sector, meanwhile, are 24.2 percent in terms of its share to total GDP and 4.4 percent in terms of its average growth in 2001–2006. Unlike the experience of its neighbors at roughly the same stage of economic development, the manufacturing sector of the Philippines stagnated during the past 25 years.

Given these trends, should the Philippines reallocate its resources away from the manufacturing sector to the services sector where the country has a more distinct comparative advantage? The answer lies in both economic theory and the historical experience of countries. Theory explains the need for economic surpluses to fuel rapid output growth and the required economic transforma- tion needed to generate these surpluses.