An Assessment of the Philippine Economy Germelino M. Bautista This report discusses the cyclical and unsustainable pattern of Philippine economic growth, the factors precipitating the economy’s cyclical downswings, the contribution of the various sectors and implicit growth strategy, the effect on employment by gender, and the state of the country’s natural resources and environment. It argues that the cyclical pattern of growth and movement in income are related not only to the pattern of spending at the macro level, the nature of electoral politics, and developments at the sectoral and regional level. They are also affected by the unsustainability of the implicit growth strategy prior to the 1980s, limitations of the current liberalization strategy, and the state of the country’s natural resources and environment. The implications of the growth pattern for the poverty situation of the country and the state of its environment in the last twenty years are also explored in the report. More particularly, it asserts that cyclical growth with very short spurts or upward swings, given a severely degraded environment and high population growth rate, make poverty alleviation extremely challenging. After identifying the various core poverty groups that have emerged out of the country’s growth experience, the report provides a brief evaluation of government capacity and effort to alleviate poverty. It concludes with a preliminary discussion of selected strategic interventions to address the persistent problems of unsustainable growth, poverty, and environmental degradation and the implications of these interventions for economic governance. All tables and figures can be read at: http://www.cseas.kyoto-u.ac.jp/krsea/4/bautista/image What Has Been the Nature and Pattern of Growth? Postwar Cycles, Employment, and Per Capita Income Levels Few and short periods of growth spurts, long-term cycles of upswings and downswings, and a marked difference between the cyclical growth patterns before and after 1983 characterize the post-WWII growth of the Philippine economy. Using per capita GDP growth, Figure 1 shows the various cycles of the Philippine economy from the 1960s to 2002, their fluctuations, and length. Rather than a linear or a progressive pattern of growth, the figure reveals instead a series of limited and brief periods of growth spurts. From the 1960s to 2002, the economy has gone through six cycles – 1962-1965, 1966-1969, 1970-1973, 1974-1983, 1985-1991, and 1992-1998. Each cycle starts off with several years of growth that eventually decelerates. The economy peaked, for instance, in 1962/63, 1972/1973, 1976/ 77, 1988/ 89, and 1996/ 97, dipping downwards in subsequent years to complete the cycle and start anew. Except for the longer stretch between 1975 and 1982, each cycle in the last four decades have extended over a 4 to 5 year period of positive growth before ending with low or negative growth rates in per capita real GDP (1990-93, 1998). At present, the economy is on its seventh cycle. Across the various cycles, a chasm represented by the crisis period (1983-1985) divides and differentiates the cycles in the 1960 to 1982 period from those in the period from 1986 to the present. These crisis years came with the assassination of Senator Benigno Aquino which saw the end of Ferdinand Marcos’ authoritarian rule. With the crisis period as a watershed of sorts for cyclical growth, the period before it, the 1950s to 1982, registered positive GDP and per capita GDP growth rates that were not punctuated with negative growth rates. Interestingly, the number and volatility of growth cycles are higher when investment growth rather than GDP or GDP per capita growth is used to define them. With investment growth as a cyclical measure, there were years of negative growth rates and crisis years before the 1983-1985 crisis (de Dios 2000). The following years with negative growth in investment of more than one percent were defined as periods of economic crisis: 1956 (-1.8), 1960 (-10.7), 1970 (-4.0), and 1980 (-2.8). The chasm that divides these two periods also differentiates the movement of per capita real income. Despite cyclical downswings from the 1970s to the early 1980s, real per capita income managed to move continuously upwards during the period, peaking in 1982 (Figure 2). In contrast, cyclical growth with negative rates after the 1983-1985 crisis prevented income from moving steadily upward. As a result, it took two decades to recover peak 1982 real per capita GDP. Were it not for various internal and external destabilizing factors, such as the 1990 coup attempts and the 1991 elections and power shortages, the 1990 GDP growth rate of 3%, if maintained, would have been able to recover the peak 1983 real income in 1993. With the long recovery period, the absence of any increase in real GDP per capita from 1983 to 2002 suggests that the average Filipino did not experience any material progress within the period. It is interesting to note that in comparison to GDP per capita, the recovery of the peak GNP per capita was achieved two years earlier, in 2000, largely because of the contribution of overseas remittances. Illustrating the movement of real GDP and GNP per capita in 1985 prices from 1970 to 2002, Figure 2 shows the divergence between the two series, specifically after 1991, that reflects the increasing role of overseas remittances. Apparently providing a two-year advantage in additional income, overseas employment and remittances provided a way out of domestic political instabilities and economic difficulties. Since the 1970s, overseas Filipino workers have been deployed to foreign countries. Figure 3A shows the number of deployed overseas Filipino workers and their remittances from 1984 to 2000. Accounting initially for 1.4% of total employment in 1980, they grew in numbers and eventually constituted 3.1% of total employment in 2000. Increased rates of deployment and transfers of overseas remittances were also apparent during slump or crisis years, such as 1985, 1991, and 1997-1999. Given the increasing numbers of Filipino overseas workers, a plethora of studies have been conducted to assess their impact on families, communities, and the economy as a whole. The current literature presents ambivalent narratives. On the one hand, overseas labor employment in varied occupations and destinations have generally improved the living conditions of the families left behind, although such improvements seem to have been premised on longer overseas stints or contract renewals. At the level of individual migrants, their worlds have broadened considerably as they discovered personal autonomy and individuality in foreign cultures. The new tastes they have acquired have been transmitted to their homeland, resulting in an expansion of Philippine culinary tastes and architectural designs, among others. On the other hand, the negative psychological effects of the Filipino diaspora on families, especially in the wake of the increasing feminization of labor since the mid-1980s and the exploitation of Filipino contract workers abroad, balance the overall picture. What is clear, however, is that working for overseas markets has benefited the economy by reducing unemployment at the aggregate level and by skill category. Going abroad has also increased returns to investment in education and skills (Philippine Human Development Report 2002). But a major reason why a provisional labor export policy in the 1970s has been institutionalized despite negative consequences is its contribution to the country’s foreign exchange earnings, averaging 22% in 1995-2000. Except for 3 years within the 1984-2000 period, the level of remittances has steadily grown, thereby accounting for the increasing difference between GNP and GDP per capita (Figure 3B). Remittances as a portion of GNP increased from 0.07% of GNP in 1980 to 7.7% in 2000. With regard to domestic employment, the boom-and-bust cycles have directly impinged on the level and quality of employment of both male and female labor. As a representation of Okun’s law, Figure 4 shows that rising GDP growth rates in 1973-1975, 1992-1994, and 1998-1999 were accompanied by declining unemployment rates, while declining growth rates went hand in hand with higher unemployment rates in the downswing or crisis years of 1963-1964, 1967-1969, the early 1980s, 1997, 1999, and 2000. Male unemployment rates correlated significantly with growth but not so female unemployment. There were more years, especially in the 1960s and early 1970s when female unemployment rates did not move inversely with growth compared to male unemployment. The increasing participation of women in the growing service sector (to be discussed in a later section) may partly explain the non-application of Okun’s Law to female labor. Figure 4 also shows the presence of gender differentiation in employment opportunities. In the 1960s, early 1970s and 80s, and from 1988 to the late 1990s, women had higher unemployment rates compared to their male counterparts. Moreover, even if the growth episodes in the 1980s and 1990s opened up opportunities for female labor – as reflected in the higher increase of female labor force participation rates (from 44% in 1981 to 50% in 1999) compared to male labor force participation (remaining at 79% to 82%) within the same period (Figure 5) – the increase in the number of women joining the labor force did not catch up with the historically much higher labor force participation rates of males. Rates of underemployment for males, however, were higher than those for females. And improvements in GDP growth were associated with lower underemployment rates for males and females in the early 1970s and early 1990s. Why Has the Country’s Economy Grown Poorly and Unevenly? Accounting for Cyclical and Unsustainable Growth Since the 1970s, the Philippines has not experienced sustained and rapid growth like some of its neighbors. At the macro level, the downswings are related to fluctuations in private investments and government deficit spending. Apart from these variables and other sources of macroeconomic and political instability, the economic growth of the country has been cyclical and unstable because of the low and erratic growth pattern of particular sectors, the unsustainability of the implicit postwar growth strategy prior to the 1980s, and the limitations of the current liberalization and export-oriented industrialization strategy. At the macro level, the downturn in investments has been attributed to a decrease in past GNP growth, higher real interest rates, lower domestic credit, and a depreciating currency (Fabella 1994). Reduced investment activity is also deemed to be significantly associated with the year before a presidential election and with expectations of lower GDP (de Dios 2000). Fabella’s real-structural hypothesis suggests that fluctuations are self-induced and that government expansionary fiscal policies actively precipitate crises. Building on his view of the relationship between government spending and crisis, de Dios argues given the crisis-prone structure of the economy – its high import dependence, its limited export earning capacity, low savings ratio, and overvalued currency policy - that the onset of a crisis cycle commences with government spending to drive the economy out of recession and stimulate growth. This results in higher interest rates and rising prices that worsens competitiveness and enlarges the current account deficits. These deficits, in turn, are financed by foreign borrowings or by drawing from international reserves. Under the circumstances, prolonged investment booms would occur when there are export windfalls or external loans. As current accounts continue to worsen and foreign borrowings fail to keep up, de Dios further argues, the currency becomes vulnerable to speculative attacks and a drastic depreciation or devaluation takes place. An atmosphere of macroeconomic instability, measured by wide fluctuations in exchange rates, ensues. Resulting from cost-push inflation, high-interest rates, and a tight money policy regime, this unstable environment has a profound, negative impact on private investment. Although they are not significant statistically in de Dios’s regression model, the variables that create such an atmosphere, exacerbated by expansionary government spending prior to elections, negatively affect private investment. However the cycles are defined – in terms of per capita GDP or investment growth – drastically declining rates have occurred within the year before or after the start of a new presidential administration. The country’s postwar history thus shows the crucial role of political regimes in promoting both growth and cyclical generation, as well as determining through their policies and actions the length of a cycle or its peak income level. Empirically, the direction of the relationship between private investments (I) and government spending (G) is not as clear-cut. During the 1983-1985, 1990-1991, and 1997-98 crisis years, government consumption and capital formation decreased, instead of the hypothesized inverse relationship (Figure 6). Only in 1959-1960 and 1969-1970 did a slump (not a negative growth) accompany an increase in G and a decrease in I. On the other hand, in 1991-92, both G and I increased. So far, the increase in G and decrease in I in 2001-2003 has not been associated with negative growth, a situation that may end up similar to 1979-1980 when GDP grew by 5.1%. Whether the relationship between G and I in crisis periods is direct or inverse, a common observation during the slump or crisis years 1959-60, 1969-70, 1983-85, 1990-91, 1991-92, and 1997-98 is an increase in the current account deficit and deterioration in the balance of payments position (Figure 7). Apart from declining international reserves, crisis years have also been periods of high or increasing public sector deficits associated with declining or negative growth, such as in 1984-85, 1990-91, and 1998 (Figure 8). On the other hand, the relatively long or favorable cycles of 1970-1983 and 1992-1996 were marked by high growths in industry and agriculture production and exports, in addition to growing investments and government spending and small fiscal deficits. The duration of a growth cycle or the onset of negative growth thus seem to depend on the relationship between private capital and political regime, the availability of external accommodation such as loans or IMF assistance, and the growth conditions of the different sectors. It is unfortunate that the country’s post-war political administrations have reproduced unstable and unsustainable economic growth. Unlike some of its neighbors, the Philippines has not experienced a period of sustained and rapid growth since the 1970s. For various reasons, it has been unable to build on and sustain the upward trend in per capita income seen from the 1960s to 1982. For one, the sources of postwar growth have reached their limits. Moreover, the transition from one political regime to another, as well as from one growth strategy to another, has been conflict-ridden and highly politicized, proceeding without the necessary institutional arrangements to resolve conflicts, establish secure expectations, and mobilize the required human and social capital and financial resources to build resilience against shocks and maintain productive dynamism (Rodrik 2003) Prior to the 1980s, natural resource and agricultural exports – together with an overvalued currency policy, tariff protection, and government spending that supported import substitution industrialization – provided the impetus to growth. By the 1980s, however, this implicit growth strategy had worked itself out. The depletion of forest and fishery stocks and the inability of a relatively underdeveloped agricultural sector to provide cheap food and new exports made it difficult for agriculture and the natural resource sector (except for minerals) to supply resources for industrial growth. Moreover, the propensity of governments to rely on deficit spending and external borrowings to finance infrastructure investment and prop up growth, in combination with an overvalued currency, eventually became inflationary and socially costly. Thus by the early 1980s, a new growth strategy had become imperative. The economic and political crisis in the 1983-1985 period and the depletion of the country’s natural resources coincided with the increasing prominence of liberalization as the economic policy framework for both the developed and the developing world. The adoption by the Philippine government of this framework to facilitate the entry of foreign capital and the subsequent establishment of export-oriented industries constitutes a major policy shift distinguishing the deregulatory perspective of post-1986 economic policy makers and managers from the protectionist bent of pre-1980s legislators and managers. Since 1986, successive government administrations have promulgated legislation and adopted programs that hewed more closely to the principles of deregulation, liberalization, and decentralization. The Tariff Reform Program and the Import Liberalization Program were integral components of the structural adjustment loan program extended by the World Bank in the early 1980s, with phases implemented beyond 1986. They were precursors of subsequent policies and programs that proponents in government, regardless of administration (Aquino, Ramos, Estrada, Macapagal), justified by their contribution to the enhancement of the country’s global competitiveness. The liberal policies and programs included: ratification of the 1986 Uruguay Round Agreement of the GATT and membership in the Asia-Pacific Economic Cooperation and the ASEAN Free Trade Area (1993-96), the latter two expressly pursued for accession to various multilateral trade agreements; liberalization of telecommunications in 1993, banking and insurance services in 1994, and air transport services and domestic shipping in 1995; deregulation of international satellite communications and securities and banking regulation reform in 2000; promulgation of RA 8366 (1997) and RA 8556 (1998), amending the 1991 Foreign Investment Act to grant greater foreign equity participation in investment houses and financial companies, and the Retail Trade Liberalization Act of 2000, giving foreign investors open access to particular areas of the retail trade; passage of the Agricultural Tariffication Act of 1996, lifting quantitative restrictions and providing Minimum Access Volume to enable producers to import agricultural products at lower tariff rates. Within the framework of these policies, economic directions would increasingly be influenced by global movements of capital, investments and shifts in nontraditional exports, access to cheap food abroad, and the extent of government’s deficit spending activities. The following sections explore developments in the different sectors of the economy in order to cull the sources of growth at levels lower than the macro level and link these to the poverty of people and communities and the degraded state of the Philippine environment. Profile and Prospects of the Various Sectors The growth condition of the different sectors suggests probable effects on the overall cyclical growth of the macro-economy or the length of a cycle. From 1967 to 2002, the service sector has been the most stable. Only in 3 years out of 35 (1984, 1985, 1991) did it have negative growth rates (Figure 9). Since the 1960s, it has sustained higher growth rates than both the GDP or GNP rate and the manufacturing sector and has continued to lead the economy’s growth up to the present (Table 1). Also, its various subsectors provided impetus even when the rest of the economy was on a decline. For instance, in the 1980s, when growth rates dropped relative to the 1970s, two service subsectors – occupied dwellings and real estate, and private services – raised the overall sector average. The use of overseas workers’ remittances for housing and real estate purchases may have accounted for this growth. In the 1990s, transportation, communication and storage, trade, finance, and government services also contributed to service sector growth. While the service sector raised its growth performance, especially before the early 1980s, the economy’s potential growth was constrained by the erratic and declining growth of the forestry and manufacturing sectors and by the low growth performance of the crop agriculture and fishery sectors. In the natural resource sector, forestry was the most erratic subsector with the highest number of negative growth years (Figure 10), although its cycles before the period of negative growth corresponded to the cyclical GDP growth pattern. It is notable that forestry registered negative rates for 25 years in a 35-year period (1967-2002). In comparison, the manufacturing sector had only 6 years of negative growth, with cycles of growth coinciding with those of the macro-economy (Figure 11). Nevertheless, manufacturing growth had fallen below the GDP growth rate by the 1990s. And agriculture’s low and stagnating growth has adversely affected overall economic performance despite its relative stability, with only two years of negative growth (Figure 12). Fisheries growth declined in the 1990s, reaching a zero level by 1998 (Figure 13). Like the natural resource sector, agriculture was unable to sustain its earlier growth. After growing at 6.3% in the 1960s, crop agriculture fell behind and grew at a much lower rate in the 1980s and 1990s (Table 2). Its growth decelerated to 1.3% in the 1990s, far below the GDP and population growth of the country. Only livestock managed to grow above the GDP growth rate in the 1990s. With fewer growth peaks, agriculture grew cyclically with rates generally lower than those of manufacturing and the service sectors. As a consequence, the combined share of agriculture, fishery, and forestry in GDP declined from 25.8% in 1980 to 16.5% in 2000, while their share in employment declined from 51.3% to 38.6% (Table 3a, b). Like agriculture, the manufacturing sector grew below the GDP growth rate in the 1990s, with industry’s share dropping from 38.5% in 1980 to 30.9% in 2000. Growth of the Service Sector Given the stable growth of the service sector and its higher output contribution relative to agriculture and industry through most of the 1990s, the sector was able to provide greater employment opportunities for both males and females compared to the other two sectors. In contrast to the pictures constructed from Figure 14, that would show the generally declining proportion of employed males and females in agriculture, fishery, and forestry in the late 1980s and the 1990s, the proportion of employed males and females in the different services subsectors grew. Female employment in particular rose and dominated the community, social, and personal services and the wholesale and retail trade (Figure 15). These subsectors accounted for about 50% of the female labor force. Males were in community, social, and personal services at a lower level and were increasingly absorbed in transportation, storage, and communication (Figure 16). After the crisis in the early 1990s, male employment also grew in the wholesale and retail trade. While male employment also increased in construction, the 1997 crisis affected it adversely. Although the economic crises of 1991-92 and 1997-98 and the El Niño drought of 1997 affected employment opportunities negatively in industry and agriculture, they did not reduce employment opportunities in the services sector (Table 4). Based on the Annual Survey of Establishments, employment in services from 1990 to 1998 increased an annual average of 21% per year (Table 5). Table 5 also shows that a greater proportion of those employed were in micro units or small- sized establishments, i.e. having less than 10 employees. Employment over the period in larger establishments (10 or more workers) increased at a slightly higher rate, though not enough to overtake the predominance of micro units. Males comprised the majority only in the transport, storage, and communication subsector. In the other subsectors, the proportion of females either grew or they constituted the majority. It is notable that while females accounted for 53% of those employed in the small retail trade business, male involvement in small-scale trade grew significantly during the period. Employment growth in the service sector occurred even though the number of employees per establishment declined for both micro enterprises and those with 10 and more workers. (Only in wholesale and retail establishments with 10 or more workers was there no downsizing.) The decrease in the number of employees in micro enterprises from 5 or 6 to 3 could have been due to the relative ease of entry for small units like families or self-employed kin. Interestingly, employment particularly grew in micro enterprises despite the meager wage per worker. Low levels of compensation – ranging from 52 to 220 pesos per day and increasing at 0.25 to 6%, a rate below the inflation rate – imply that the workers concerned would accept any amount rather than remain unemployed or underemployed, especially in periods of crisis. Upon reflection, it would seem that the availability of more employment opportunities in micro enterprises and the increased involvement of females across the different services and of males in the small trade outfits might reflect adjustments workers made to unemployment or underemployment difficulties during the 1990/92-1998 cycle period. Other processes underpinned the growth of female and male employment in the services sector. Men and women withdrew or were pushed out of their role in agriculture as self-employed producers and unpaid family workers, respectively. Their transfer into the non-agricultural sector either as wage/salary workers or as own account workers (self-employed or employer) in the period from 1985 to 1990, for instance, entailed migration from Regions 5, 6, 7, 8, CAR, 2, and 1, and settlement in urban areas like NCR, Cebu, and Regions 4, 10, 11 or their urban centers (Table 6). Women constituted a larger proportion (53.3%) of these migrants. Three out of 4 (74.7%) of them moved to Metro Manila and other urban centers (Villamil 1998). Given the proportion of women migrants in urban areas relative to men, more of them would have been recruited into the informal urban labor market. Table 7 presents various economic activities identified in a 1995 survey of the urban informal sector in the National Capital Region (NCR). About 80.5% of these activities fall within the service sector (National Statistics Office n.d.). Most of them – tending sari-sari (small variety) stores, food retailing, other trade, providing services in rented buildings, personal and household services, and assisting in eating, drinking, or lodging places – employ women. The survey also estimated approximately 291,000 informal sector operators who employ about 539,000 persons. Such operators and employees comprise about 18.6% of total employment in NCR. It is quite possible that most workers in the informal sector reside in slums or belong to E households (according to the 1993 classification scheme of the Marketing and Opinion Research Society of the Philippines), which different survey organizations estimate to constitute about 32%-40% of households in 1995 (Bautista 2001). Comprising a greater proportion of unpaid family workers in both the agricultural and nonagricultural sectors, females have been a significant source of surplus labor for the urban economy. They have in effect served as a reserve army, drawn into and mobilized not in factories but in the formal and informal service sectors. Since women made up 64.4% of the poor working population in 2001 (Philippine Human Development Report 2002), the likelihood that they are drawn in greater numbers into the informal vis-à-vis the formal sector is high indeed. The dualistic structure of the larger economy, segmented into a formal/organized and informal/unorganized sector is being reproduced in the urban service sector. With its varied activities and accompanying size reduction of service units, the informal sector seems to be undergoing a Geertz-like involution process of absorbing unemployed, underemployed, or displaced labor from the larger community, thereby complementing the limited opportunities in the other sectors or parts of the country. Is this part of the restructuring of the Philippine non-agricultural sectors resulting from cyclical growth and the process of liberalization? The Limits of Service-led Growth The expansion of the informal service sector and the higher growth rate of the formal service sector relative to the GDP rate, however, could not pull up the rest of the economy. Its growth did not spread to most regions and corners of the country, as reflected in the Gross Regional Domestic Product (GRDP) growth rate from 1987 to 1999. Table 8 reveals that service sector growth was confined mainly to the National Capital Region, Cordillera Autonomous Region, Southern Tagalog, and Central Visayas, where the sector grew faster than the national average (Manasan 2002). Since the expansion of the service sector is part and parcel of urbanization, growth in these regions occurred in the cities, where financial, commercial, educational, and governmental centers are located and physically coexist with the growing slum population and informal service sector. The cultural and recreational attractions of these cities to domestic and foreign tourists have fostered the development of the formal service sector (e.g. the expansion of airline and hotel facilities with the influx of tourists to Cebu). However, the absence of growth in agriculture and manufacturing in the countryside also increased the number of lower middle class and poor rural migrants to urban centers, but they were too numerous to be absorbed by the formal service sector. Thus urban in-migration has resulted in both the market expansion of the informal sector and growing slum populations Service-led growth in the absence of environmental management responses and facilities is also constrained by the carrying capacity of its urban environment. Because booming urban centers attract more people and promote economic activities, the process of urbanization and population and economic growth entails greater consumption of energy and water resources and the generation and accumulation of wastes. Hence, cities without adequate foresight and safeguards face problems of groundwater depletion, improperly disposed garbage, air and aquifer pollution, coastal land subsidence, and the accompanying health hazards. These problems are already apparent in Metro Manila, Cebu, Baguio, Batangas City, Cagayan de Oro, and other cities. Table 9 illustrates the extent of groundwater depletion due to greater withdrawal than recharge in Manila, Cebu, and Cagayan de Oro, while Figure 17 shows that the actual average total suspended particulate (TSP) in most cities exceeds the TSP guideline, indicating the extent of air pollution (World Bank 2002). The Manufacturing Sector Shifts and restructuring within the sector. Tables 3A and 3B show that as a sector, industry maintained its GDP share of 31-35% and its employment share of 14-16% in the 1990s. However, manufacturing, a major industry subsector in the 1970s with a 25% GDP share, declined steadily in the next two decades, resulting in a 22% share in the late 1990s and early 2000. While not exactly dramatic, the 3 percentage-point drop in the Philippines contrasts sharply with the increase in the GDP share of this subsector in Thailand, Malaysia, and Indonesia. Philippine value added in manufacturing was only 32% of Thailand’s, 57% of Indonesia’s, and 59% of Malaysia’s in 1998 (Table 10). Furthermore, the country’s 3.6% industrial growth in the 1990s was much slower than that of Thailand (9.0%), Indonesia (9.9%), and Malaysia (10.8%). Although its industrial exports in 1998 exceeded those of Indonesia, they were much smaller than those of Malaysia and Thailand (Hill 2002). The shift from industrial protection to a liberalized structure, the domestic currency policy and external financial environment, and the accompanying flow of foreign investments have had an effect on the level and composition of manufacturing output, the size distribution of firms, and the level and sources of employment. Since the 1980s, investments, particularly foreign direct equity investments, have risen, growing at an average 3.75% annually from 1981 to 1990 (Table 11C) and reaching their highest volume in 1994. While undeterred by the 1983-84 economic crisis, their marked decline from 1995 to 1998 partly reflects the effects of the 1997 Asian financial crisis. Where was foreign investment directed? Across the broad sectors, very little went to agriculture, fishery, and forestry. Instead, industry and services (banks and financial institutions) received the bulk of investment, with industry having the greater share. Within industry, investments in manufacturing grew consistently from the 1980s to 1994. Investments in mining also grew, but declined from 1991. Among the different manufacturing industries, a significant portion of foreign investments went to chemicals and chemical products and food in the early 1990s (Figure 18). By 1996, machine, apparatus, appliances and supplies, and nonmetallic mineral products became significant. What were the major changes in the manufacturing sector? Table 12 shows the share of the various manufacturing industries in gross value added. Food processing continues to be the dominant industry, having regained its 44% share of 1985 by 2002. While foreign investments may have infused greater capacity in the food processing industry, it is not clear whether such investments contributed to greater export production or production for the local urban market. The proportion of processed food output exported in 1995 was 27.5% of PSIC category 311 (canned fruits, vegetables, fish, seafood, and coconut, vegetable, and animal oil) and only 4.9% of PSIC 312 (grains, bakery, milled sugar, confectionery, desiccated coconut, coffee, and animal feed). Apparently, there has been no improvement in the production efficiency or export capability of PSIC 312. What is apparent in Table 12 is the impressive increase in the share of electronics, which grew from 3.7% in 1990 to 13% in 2002. This contrasts with the decline in the shares of particular industries such as petroleum products, garments and footwear, and wood and rubber products. Other changes have transpired within the manufacturing sector. With its relatively constant share (14-16%) of total employment over time, the common impression is that the size distribution of firms has not changed. Large firms are believed to continue to dominate the sector and small firms largely account for residual employment and value added. Micro enterprises with less than 10 workers accounted for about a quarter (23-24%) of manufacturing employment in 1990 and 1998, while small, medium, and large establishments accounted for the greater portion (Table 13). However, since the late 1970s, the distribution of firms and employment by firm size has changed. Specifically, there has been an apparent shift in the number of firms, percentage of employment, and percentage of value added from the large enterprises (200+ workers) and the medium (100-200) to the small enterprises (10-99 workers), as shown in Table 14. Based on manufacturing survey data from 1982 to 1998, the shift from large and medium industries to small industries has been accompanied by contraction in operations and labor displacement, specifically in textile, rubber, glass, wood products, and pottery. Because of investment inflows, there was a net increase in employment over the period, specifically in large industries, like electronics and professional and scientific equipment production, and in a few small industries, like leather, plastic, nonmetallic, fabricated metal, machinery, and others. More employment opportunities were also available in food processing and wearing apparel. But the net increase in employment over a 16-year period was not significant. On average, only 30,511 additional jobs per year were generated (or only 3 percent of the 1.013 million labor force entrants in 1998), thereby failing to improve the sector’s share of employment opportunities (Table 15). The effect of foreign investment inflows is more apparent in the trade accounts. For instance, foreign investment in machinery, apparatus, and appliances, a large-scale industry, contributed to the growth of exports (particularly electronic products) as well as imports. Since the early 1990s, electronics exports have been a major source of growth, increasing in value from $1 billion in 1985 to $7 billion in 1995 and $20 billion in 1999. Together with smaller, related items such as machine goods, electronics accounted for the entire merchandise trade expansion in the 1990s, or almost 70% of the merchandise exports of the country. And more imports have become available due to trade liberalization, resulting in higher ratios of imports to GNP. It is notable that the manufacturing sector’s gross value added did not sufficiently expand with the growth of electronics exports. One reason could be that the manufacture of semi-conductors, one of the country’s biggest export products, is essentially an import-export operation where local value added is thin and backward linkages are absent. The industry is also weakly connected to consumer electronics. Hence, with its very low value added, the growth of electronics product exports was not able to substantively expand the export sector and transform the manufacturing sector. Similarly, the expectation that employment opportunities would grow with the increase in labor- intensive export production did not materialize. The earlier growing demand for labor in the export-oriented wearing apparel or garments industry was not sustained in the late 1980s. When it collapsed, the electronics industry became the second biggest employer in 1998, next to food manufacturing. The ability of the industry to absorb a substantial portion (39%) of the work force, however, meant that there were very few industries that could significantly provide employment opportunities. As a result, its growth was not enough to raise the proportion of labor employed in the manufacturing sector. In sum, the new exports have come mainly from the electronics industry, and their production has not contributed substantively to value-added or net trade surplus. Engaged in enclave production, they have hardly been linked to the larger economy and contribute meagerly to growth. As a consequence, little structural change has occurred with this form of export-oriented industrialization. Manufactured exports and capital flight in the new global order. A number of concerns had arisen by the 1990s regarding the transition to a new export-oriented industrialization strategy with foreign capital involvement. Apart from limited value added, employment creation, and net trade, multinational involvement in export production might also have entailed capital flight through export under-invoicing. While it was common knowledge for Filipino log exporters and sugar barons to underreport their earnings in earlier decades, it is surprising to imagine global capital engaging in the similar practice of accumulating stores of earnings outside the site of country production. Edsel Beja’s preliminary data suggest that from the mid 1980s, about $1 billion a year may have been under-reported. By 1996 and 1999, annual capital flight through export under-invoicing increased to $2 billion, reaching about $4.8 billion by 2000 (Figure 19A). Apart from under-invoicing export earnings, the same exporter-importers could have understated import receipts, possibly to reduce import tax payments and other customs exactions that are suppose to be based on the value of the merchandise (Figure 19B). Transfer pricing could be another possible motive. Because the unreported import purchases are certainly received by a supplier belonging to the same conglomerate, under-invoicing may be a means to transfer revenues. The involvement of foreign investor-exporters in this contemporary form of capital flight raises the issue of global corporate governance, unless the policy framework of liberalization and deregulation considers capital flight from developing societies a natural consequence of the free flow of capital. The Natural Resource Sector: Depletion of Forestry Resources The country’s natural capital (forests, fisheries, minerals, soil, and water) has conventionally been viewed as free, inexhaustible instruments for economic use and wealth creation. Accordingly, the postcolonial state allocated most public forestlands for resource extraction rather than conservation. All political administrations (some more than others) liberally granted permits for logging, mining, livestock grazing, and tree plantations. Since the 1950s, an increasing portion of forestlands were released for commercial logging purposes; by 1990 the government had granted a total of 10.2 million hectares or about 68 percent of classified forestlands to timber license agreement holders (DENR 1992). The allocation of forestlands for commercial logging or mining purposes suggests that extractive companies and their work force (rather than landless aspiring peasants) pioneered the opening of frontier forest lands and paved the rough trails and roads that linked their logging concession areas to town centers. Judging from current observations and interviews in settled logged-over lands in Mindanao, they were left in an unproductive state for landless lowland migrants to cultivate later for subsistence. Some logging workers also settled in the area and opened up residual forest for cultivation (Seki 2003). State incentives also bolstered the production and export of natural resources and the establishment of resource-processing industries. In the forestry sector, these incentives included liberal annual allowable cuts, zero export taxes, low forest charges, and high protective tariffs to shelter the local processing industry. In the other resource sectors, low permit fees or taxes on commercial fisheries and mining, respectively, or subsidies in the form of state infrastructure, price support, stabilization funds, and tax amnesty encouraged resource extraction and export. Ironically, incentives in the forestry and other sectors also came in the form of state inaction or the non-enforcement of existing policies and penalties. Given these incentives, high economic rents available in the sector, and the failure of the state to require reinvestment in the resource stock, the production of forestry, fishery, and mineral commodities grew at an unsustainable rate during the postwar decades, eventually depleting the resources. In the forestry sector, about 172,000 ha of primary growth forest was lost annually from the 1950s to the early 1970s. The much-reduced stock henceforth prevented timber production and export from proceeding at the same rate. It contracted by 4.4% in the 1970s, by 7% in the 1980s, and by 21.7% in the 1990s. In the early 1960s, the average contribution of forestry to the economy was a significant 15% of gross value added (Bautista 1990). Had forest utilization for wood production been planned with a sustainable resource management system in place, the sector could have continued contributing positive value added. Unplanned and excessive logging initiated a historical process of forestland conversion and the eventual loss of the country’s forest cover. Comprising about 70% of the country’s 30 million ha, the estimated forestland of 19.5 to 20.9 million ha in 1901 was reduced to 5.39 million ha by 1997 (Table 16A). This process of deforestation involved the degradation or conversion of old- growth forests and even residual forests, contributing to the expansion of unproductive reproduction brush, grasslands, and farms. Table 16B provides estimates of forest area conversion to other types of forestlands and farmlands. The changed landscape, vegetation, and use of forestlands are significant because they have also altered local climate, precipitation, soil conditions, slope stability, and stream flow. These, in turn, have had consequences for lowland and downstream communities and facilities. Figure 20 shows the cumulative build up of sediments originating from the degraded types of forestlands based on soil erosion rates on different types of land. Much of the soil erosion resulted from the conversion and loss of old-growth forests to other types of land. The history of logging in the Philippines, limited replanting activities of timber licensees, and absence of new tenure and management systems in the cancelled logged-over concession areas have rendered most forestlands open-access resources vulnerable to illegal cutting, lowland migration, swidden farming, forest fires, and other soil depleting activities. These conditions have further contributed to forestland degradation, the formation of deep gullies, soil erosion, excavations, landslides, and sedimentation that have in turn expanded flood plains and damaged farms on both sides of rivers (Umehara 2002). Other off-site impacts include the siltation and sedimentation of irrigation canals, reservoirs, and dams and the consequent decline in water delivery and hydroelectric power production. Hence, apart from local external effects such as local climate change, slope instability, soil erosion, and reduced or erratic stream flows, deforestation has also negatively affected the off-site/downstream productive potential of irrigation systems and hydroelectric power facilities, the recharge capacity of aquifers, and lowland soil quality. These have constrained farm yields and income, as well as the overall growth capacity of the economy. Deteriorating environmental conditions are significantly related to poverty and migration. Table 17 shows that provinces with greater forest loss, larger proportions of farmlands, and smaller proportions of irrigated farms have had a higher share of households living below the poverty threshold. High poverty incidence or lack of growth or employment opportunities in the non- farm and non-forest sectors of these provinces has also been associated with out-migration. Other studies have shown uplands, as well as coastal and urban centers, to be destinations of rural migrants. Fishery Depletion and the Sector’s Growth Potential The degradation of Philippine forests is paralleled in the coastal areas and seas by the depletion of fish stock. Because of population growth and the increase in local and external demand, the number of fisher folk and carrier vessels of different tonnage and fishing gears in the municipal and commercial fishery sector, respectively, have increased since the late 1940s (Dalzell et al. 1987). With the use of fleet horsepower as numeraire, the fishing power or equivalent horsepower of a fisher folk and his vessel, as well as the horsepower equivalent of a commercial vessel with its respective gear and tonnage, is now measurable (Israel and Banzon 1998; Padilla and de Guzman 1994). As an indicator of fishing power or effort from the late 1940s to 2000, the combined horsepower of municipal and commercial fishery for small pelagics in the country – sardines, herring, mackerels, anchovies – is shown in Figure 21. The figure reveals the acceleration of fishing efforts in the 1970s and early 1980s. National statistics show, however, that the 4.5% growth rate of fisheries’ gross value added in the 1970s declined to 2.4% by the 1980s and 1.4% in the 1990s. An increase in fishing effort is therefore not necessarily associated with greater catch per unit effort (CPUE). A decline in CPUE signals the onset of an “overfished” situation that the market might not reveal. By measuring CPEU, Figure 22 shows, for instance, that the stock of small pelagics in the country was already being over-fished in the late 1970s or early 1980s. In an “overfished” situation, municipal fisher folks and those in the commercial sector have different capacities to provide the required greater effort to harvest a given catch. They could be differentiated by the gear and tonnage of their vessel. Figure 23 shows that the disparity between municipal and commercial fisheries in capacity to catch fish had grown by the 1980s. Since then, the CPUE of municipal fisheries has diminished more than the CPUE of commercial fisheries. Even as non-government organizations working with fisher folk bewailed the loss of fish as a result of the destruction of corral reefs, commercial fishers led by catchers of tuna for export experienced modest and steady growth by going farther out into the sea. Reduced stocks and competition from commercial fisheries caused the value added of municipal fisheries to decline from half the subsector’s share of gross value added in the 1960s to only one- third in the 1990s. Nevertheless, while commercial fishery also experienced declining CPUE, the fishery sector continued to grow. Interestingly, its growth from 2000 to 2002 did not result from the revival of municipal and commercial fishery but from the expansion of aquaculture and mariculture. The continued expansion of these two sectors, however, is threatened by various environmental factors. The siltation of coastal areas and pollution of rivers, for instance, have reduced the supply of milkfish fries. The pollution of coastal waters and the outbreak of red tide episodes, on the other hand, have constrained the growth of mariculture. On the whole, resource depletion caused by overfishing, destructive fishing practices, the degradation of mangroves, and the pollution of major rivers and lakes contributed to the weakening performance of the fisheries sector in the last two decades. The impact of deforestation and the unintended effects of lowland agriculture (e.g. seepage of chemicals from fertilizers and pesticides) and the constraints these impose on its more promising growth areas (aquaculture and mariculture) do not augur well for fisher folk who have traditionally relied on fishing, as well as those who have recently fallen into the sector’s “safety net.” It is worth noting that the very high annual growth rates of the population engaged in full-time (3.7 to 9%) or part- time fishing (1.5 to 12%) from the 1950s to the mid-1980s – rates far above the national population growth rate (2.35 to 3%), suggest that displaced workers or residents in upstream and lowland areas have taken refuge in coastal villages (Table 18). The increasing congestion in many such areas explains why Philippine coastal villages of late conjure images of urban slums. Agriculture Table 19 shows how the relatively high growth rates of gross value added (GVA) by commodity in the 1960s and 1970s declined overtime (David 2002). Unfortunately, the high rates for crop agriculture could not be sustained in the succeeding decades. Specifically, palay and corn experienced declining, albeit positive rates in the 1980s and 1990s. On the other hand, coconut registered negative growth in the two decades, while sugar and bananas’negative growth in the 1980s improved in the 1990s, but were still far from their growth levels of the 1970s. Only piggery and poultry grew steadily over time. Since the 1980s, the Philippines has had one of the lowest GVA average growth rates in the Asian region (Balisacan 2002). There were no new export cash crops in the 1980s. New high- value crops, like potato, vegetables, and cut flowers, were introduced at this time but have had limited effect on sector production. By the 1990s, Philippine agricultural exports’ share of world exports had declined, especially for banana and pineapple, while agricultural imports surpassed exports. The slow and stagnating growth of crop agriculture in the past two decades contrasts with the situation that prevailed from the 1950s to the 1970s. At least three developments contributed to the sector’s remarkable growth three decades ago: the establishment of a national irrigation system (NIS) in the 1950s and 1960s over an area that covered about 70% of the current system; peso devaluation in the 1960s, the boom in world prices in the early 1970s, and preferential access to the American market for sugar; the introduction of the new high yielding seed-fertilizer technology in rice coupled with subsidized government credit. What has happened since then? Why did the country’s head-start over other Southeast Asian countries in the Green Revolution not translate into sustainable agricultural growth? The opening of forestlands for migrant farms and the deterioration of irrigation and water supply. Several factors undermined the growth of the sector. While farms were generally located in the lowlands in the 1950s and 1960s, they began to expand to the upland public forests from the 1970s. The migration of landless settlers and the claims of lowlanders over portions of forestland dramatically increased population and farming activity in the uplands. Estimated at 2 to 4 million people (Cruz 1989) – about the size of the indigenous peoples or from a third to a half of rural-urban migrants – the magnitude of upland migration from 1970 to 1990 had profound implications. Given the farm technology and consumption requirements of lowland migrants relative to indigenous peoples, the presence of the new settlers more than doubled the pressure on forest and upland resources. The migrants, who could not subsist on food gathering and hunting unlike their indigenous counterparts, cleared the existing vegetation and diverted natural springs for domestic and farm use. Since the encroachment and settlement of the uplands by subsistence peasants coincided with or followed the onslaught of commercial logging, their shifting farm practices and upland expansion exacerbated the effects of deforestation. As a result, downstream areas, irrigation facilities, and farms were adversely affected by cumulative soil erosion and reduced stream flows. Against this backdrop, the decline in the growth of agriculture after the 1970s is traceable to the following factors: the intensification of commercial logging and upland farming activities from the 1950s to the 1970s; the effects of logging and upland farming on the volume and distribution of stream flow from headwater forests to lowland farms; the consequences of excessive surface runoffs during the rainy season on soil stability or erosion; the accumulation of silt and sediments in irrigation canals and reservoirs. The degradation of the watershed in the logged-over and upland farm areas has thus impaired the delivery of irrigation services, if not damaged some existing facilities. These in turn resulted in deteriorated land quality. At the start of the 1970s, when 70% of the existing NIS system had already been established, the system began to supply less and less water. There were fewer facilities operating while some of the operational ones could not fully cover their respective service areas. This decline in performance reflected the extent to which upland vegetation and soil stability had changed, as well as the volume and distribution of stream flow from headwater forests to farms. Under these conditions, the building of additional irrigation systems became unviable by the 1970s, while deterioration appeared to continue. More than twenty years later (1995), 83 of the 171 NIS were in critical condition and could service only 16.6% of the total critical watershed area of 3.13 million ha (Bautista and Tan 2001). Ferguson’s (1987) review of the performance of publicly funded national and communal irrigation developments in the country revealed that their performance had been less favorable than projected, that water distribution was inefficient and inequitable, and that the system by the latter 1980s had rapidly deteriorated. Ferguson further observed that the portion of the service area supplied by these facilities had declined rapidly and that the systems built after 1972 could reach only 56% of their designed area, unlike the broader reach of irrigation systems constructed earlier. The weak performance of post-1972 irrigation facilities compared to those built earlier might have been due to the combined effects of accumulated environmental degradation or deforestation, the availability of social capital, or corruption in the construction of these facilities. Failure to contain unabated logging operations in the 1960s and 1980s and to rehabilitate logged-over forest lands, for instance, could have eroded watershed quality. This in turn would have made it more difficult to clear the much higher amount of accumulated silt from upstream deforestation and to obtain adequate water for the new high-yielding crop varieties in the areas covered by the new NIS. The heavier workload and the need for greater vigilance in maintaining an NIS (new or old), underlie de los Reyes and Jopillo’s (1989) finding that facilities maintained by irrigation associations using a participatory model – therefore reflecting a higher level of social capital – had higher service ratios (74% as opposed to 64%). Farmers’ informal complaints about cracks and leaks in newer irrigation canals have aggravated the situation further. Corruption in the form of inferior construction materials or short cuts in the fulfillment of government contracts is widely suspected and discussed in local rumor mills, but there are no empirical case studies of corruption in the construction of irrigation systems known to this researcher. A more common view in the literature is that the low performance of existing irrigation systems is a function of the design and operation of gravity irrigation systems (David and Roumaset 2002). While the design could have been at faulty for not considering the reduced water discharge resulting from deforestation or the degraded state of watersheds, the literature, with its engineering bent, has been generally silent on the environmental impact or externalities of past and ongoing upland activities. However, recent case studies in lowland areas closer to the uplands are beginning to document these (Umehara 2002). The decline in NIS performance over time may not simply be due to the engineering design of the system or the lack of social capital among farmers whose interest is to have enough water to meet the needs of their high-yielding seed varieties. There has also been a failure to conceptually and programmatically link the lowland farm demand for water with its sources. Most studies of irrigation facilities and water supply issues, as well as of agricultural productivity, gloss over the effects of deforestation and its environmental correlates – local climate change, slope instability, soil erosion, and reduced or erratic stream flows – on the productive potential of irrigation systems and hydroelectric power facilities, the recharge capacity of aquifers, and lowland soil quality. The literature also fails to consider the limitations of existing policies, such as the absence of a headwater forest protection policy, and the segmented policy and organizational framework for the management of forests, watersheds, and farmlands. Neither do most existing studies consider that the lack of coordination among various government agencies (DENR-FMB, MGB, DPWH, NWRB, NIA, and DA) is problematic. Theoretical or methodological considerations could possibly constrain researchers from taking into account the dynamics of different ecosystems and the need to maintain their harmony. For instance, the adoption of an analytical framework or policy perspective that assumes an extractive growth strategy and focuses on specific commodities or services (e.g. timber, export crop, high-yielding varieties, roads) would tend to be insensitive to their externalities and the requirements of the environment and the larger community. As to concrete programs of action, major initiatives have not been undertaken to address the simultaneous demands for forest rehabilitation, soil/land stability, improved water yields, river protection, and irrigation management. Neither has a comprehensive and integrated program to mitigate the adverse social and environmental impacts of logging, mining, road construction, and other upstream activities been formulated to arrest the cumulative effects of watershed and forest destruction on the supply and quality of water sources and consequent levels of agricultural productivity. National agencies and local governments seem to have responded more to the immediate needs of their constituencies. Given the poor state of irrigation and the increasing demand for water, they have funded rehabilitation projects and the establishment of small-scale irrigation projects (SWIPs), diversion dams, shallow tubewells, and spring boxes. While these redistributive measures are useful in light of short-term water needs, they have been too localized. They are not designed from a broader watershed or river basin management perspective that would account for available surface and groundwater resources to meet competing current and future uses and assess the social and environmental impacts of tapping into them. Natural disasters. The share of agriculture in GVA has also declined because of natural disasters, including the El Niño phenomenon. The records of the Philippine Atmospheric, Geophysical, Astronomical Services Administration (PAGASA) show that the El Niño has recurred at least every 3 to 5 years from the late 1960s to the 1980s. During this period five drought events (1968-69, 1972-73, 1976-77, 1982-83, and 1986-87) were recorded. While earlier drought periods had intervals of 3 to 5 years, the frequency of these events intensified in the late 1980s, with the interval trimmed to one or two years (1989, 1990-95, 1997-98). The longest and worst drought happened in the 1990-95 period. It was also during this time (1993) that the country had the greatest number of tropical cyclones – 33 in comparison to the annual average of 20. The El Niño phenomenon in 1997 was so severe that many rainfed and irrigated lands were not planted that year. With the water level in Angat Dam, Bulacan, dropping by 26.4 meters from its normal level and the Pantabangan Dam dropping 39.3 meters, there was much less irrigation water available (Berja 2003). Aside from El Niño, the local experience of climate change has become more frequent and intense, including floods, drought, soil erosion, and the collapse of sloping lands that have adversely affected the agricultural sector in particular regions. The effects of these disasters on agricultural production have been more pronounced in about half of the country’s regions (Regions 5, 6, 8, 10, 11, 12), where agriculture constitutes 35-50% of the regional economy (Manasan 2002). Region 5 has been particularly prone to typhoons and flashfloods. Except for Region 7, severe droughts and typhoons have affected crop production in the Visayan and Mindanao regions. As cases in point, the drought in 1990 destroyed palay, coconut, sugarcane, corn, banana, and mango in Region 6, while the 1993 typhoon affected its agricultural production. The dry spell in 1990 and devastating typhoons in 1994 and 1996 resulted in the poor performance of the agricultural sector in Region 8, while excessive rainfall in Region 11, particularly in Sarangani province, and flashfloods in South Cotobato that affected standing crop contributed to the 23% decline in the region’s corn production. Adverse natural conditions made worse by degraded watersheds and poorly performing irrigation systems have made agricultural production more risky and threatening for subsistence farm households. In the absence of crop insurance, subsidized government credit or safety nets, the threats and uncertainties posed by uncontrollable natural events may have further fostered dependence on local creditors who also serve as local farm input suppliers or product buyers. Research is needed, however, to determine whether the risks and needs for financial assistance, which have intensified with the greater frequency and severity of natural disasters, have resulted in new terms within the informal credit or product markets or whether the risks have simply been absorbed by households that may have moved downwards on the social ladder. Trade liberalization and low world prices. Finally, low world prices for farm products in the context of trade liberalization have buffeted the agricultural sector. While historically agriculture has been a net foreign exchange earner, accounting for 66% of exports and 20% of total imports (including manufactured agricultural inputs), by the early 1990s it ceased to be a net earner. Agricultural import share rose from 30% of agricultural exports in the 1960s and 1970s to more than 150% by the late 1990s because of the sharp drop in world commodity prices in 1980 and their inability to recover previous levels. In the context of trade liberalization, low world prices have both been beneficial for consumers and detrimental to small rice farmers. The drop in world rice prices, in particular, has eroded the country’s comparative advantage in rice. The seeming bright spot in agriculture is the livestock and poultry subsector, the only one that grew above the population growth rate (in the 1960s, 1980s, and 1990s for livestock and throughout the period for poultry). The growth rate of this subsector accelerated after 1980 and its contribution to GVA rose from 13% to nearly 25% within two decades. The subsector further grew in 2000-2002 at 7%. David et al. (2002) assert that its growth and export potential could have been greater but for the protection of the local corn feed industry. Interestingly, as a growth industry, livestock and poultry farms in Mindanao (e.g. Bukidnon) have generally been established in mountain areas and near rivers to support the animals’ health and development and for easy wastewater disposal, respectively. This industry decision was made without explicit estimates of environmental costs. It would seem that while the hog and poultry industry is being penalized by quantitative restrictions or tariffs placed on corn imports, it is being subsidized by the environment. While import liberalization may be beneficial to consumers, government does acknowledge its potential negative impact on small farmers. Liberalization could result in unemployment or displacement, particularly in inefficient sectors, when efficiently produced imported commodities are cheaper than local products. Trade liberalization may also result in greater inequity in the agricultural sector. Unlike big producers, small farmers cannot achieve economies of scale. This limits their access to formal credit as well as to the product market and increases their dependence on trader-creditors for loans and linkages. Hence, small farmers are forced to sell their commodities to big traders at depressed prices. Acknowledging the small farmers’ need for safety nets, the Philippine government has assigned the revenues collected from Minimum Access Volume imports for this purpose, as well as to enhance agricultural productivity. Critics assert, however, that MAV allocations have benefited large traders more than their intended beneficiaries. They note that only a fraction (12 billion pesos) of the promised allocation (54.816 billion pesos) for safety net assistance has been made available. Moreover, the requirements are said to be so stringent that small farmers have not been able to avail of the safety net funds (de la Cruz et al. 2003). Sources of inequity within the agricultural sector that maintain, if not enhance, existing disparities are many. Farm producers differ in access to secure tenure or ownership rights, irrigation, credit, fertilizer subsidies, infrastructure investments, and MAV-generated funds. Belonging either to a subsector with low/declining growth rates or to one with good prospects also differentiates the agricultural population in terms of expected agricultural incomes. It is accurate to project, however, that while producers will differ in the benefits gained from trade liberalization, such benefits will generally bypass a large segment of the farm population. What are the Effects of Growth Cycles, Natural Resource Extraction, and Environmental Degradation on Poverty? In the second half of the postwar period, when the country’s growth cycles were punctuated by negative growth, statistics nevertheless disclosed a decline in poverty incidence from 44.2% in 1985 to 31.8% in 1997 and 33.7% in 2000 (Reyes 2003). The decline in poverty incidence, however, proceeded at a slow pace and was not sustained. Was growth pro-poor? An examination of the employment situation of the country suggests tentative answers. The employment status in 2002 shows that job creation continued to lag behind the growth of the labor force. More Filipinos were unemployed in 2002; unemployment rose from 11.1% in 2001 to 11.4% in 2002 (compare to 8% in 1980, 12.6% in 1985, and 10% in 1991). The service sector continued to be the principal source of additional jobs. In interpreting the positive change in poverty levels, three points are worth noting: First, a significant feature of poverty in a context of cyclical and erratic economic growth and high population growth rate is its intergenerational character. With exceptional cases of upward mobility, the children of the poor, who are malnourished and drop out of school on average by Grade 4, are probably fated to be like their parents. Or they will be worse off, especially if they cannot move out of the poverty trap through urban migration, participation in the informal economy, or overseas employment. The last escape valve is not open to the very poor, who can not afford the cost of obtaining labor contracts and initial departures. Second, the effects of cyclical crisis on the poor are gender-differentiated. Feminist studies on the effects of the debt crisis and structural adjustment on women (Angeles 2001; Eviota 1991; Freedom from Debt Coalition 1994; and Santos and Lee 1988, as summarized in C. Bautista 2002) argue that the poor generally serve as shock absorbers in times of crisis. Angeles (2001) concludes based on case studies that the Structural Adjustment Programs (SAP) of the mid- 1980s increased poverty and unemployment rates among the women documented by the research, widened male and female differentials, decreased formal sector employment for women, and increased their integration into the informal sector and overseas labor market. While pointing to similar documented effects of the Structural Adjustment Program on poor women, the literature on the impact of the 1997 Asian financial crisis portrays a more nuanced picture. Prior to the crisis, female labor force participation had been lower than men’s although it increased much faster than male rates in the 1985-1987 and 1994-1996 liberalization period. The 1987-1990 period of economic recovery also registered higher female unemployment rates and lower unemployment rates for men. This trend changed during the 1991 recession because the growth of the female-dominated service sector in 1992 and 1993 – particularly retail, trade, finance, and community, social, and personal services – led to faster reduction of unemployment rates among women than men. Lim (1998) noted a significant drop in female employment in the manufacturing sector and a general lower absorption rate of female labor during the growth period from 1995 to 1997 as female service employment increased. In contrast, male unemployment rates dropped in 1996 with the expansion of the industrial, transportation, and construction sectors in conjunction with the expanding real estate market. The 1997 financial crisis and coincidental occurrence of the El Niño phenomenon in the same year increased unemployment levels for both men and women in rural areas. The increase in female labor force participation in urban areas could have been the effect of migration from rural areas and the absorption of migrant women into the expanding service sector. Since the crisis hit the formal sector, men registered the highest unemployment rates as a result of the crisis. The 1997 Asian financial crisis affected poor women in ways other than employment. More than half the poor households in the panel data constructed by Balisacan and Edillon from the 1997 Family Income and Expenditure Survey and the 1998 Annual Poverty Income Survey coped by changing their eating habits and not accessing health services. The poorest 20% of the 21,602 households in the panel data also pulled out their children of school, with more female children withdrawn than men (Balisacan and Edillon 1999, as cited in Bautista 2002). Other qualitative effects of the 1997 crisis on women in various sectors, particularly their coping strategies as they absorbed its impact, are cogently summarized in J. Illo. and R. Pineda (1999). Third, while poverty (i.e. income threshold) levels may respond to growth, the number and proportion of poor people remain significant. Moreover, improvements in average living standards during growth spurts, as measured by the Family Income and Expenditure Survey, may not be reflected in the lives of the “core poor,” who hardly benefit from the growth of the formal sector and periods of declining prices, interest rates, and stable exchange rates. The poverty-generating processes discussed in the previous section have resulted in the creation or reproduction of this group. Historically affected by the displacement and exclusion that accompany growth, the decline of particular sectors or industries, and the failure of individuals and groups to obtain gainful employment in light of sectoral and macroeconomic changes, the country’s core poor can be found among the following: indigenous communities in the uplands who have been pushed into the interiors by loggers, miners and lowland migrants; former workers of logging concessions who have relocated or resettled in the uplands and engage in subsistence production; municipal fisher folk whose CPUE has declined or who have been displaced by commercial fisheries in their traditional fishing grounds in the absence of regulation on over-fishing, weak enforcement of rules against the use of destructive techniques, lack of protection against the encroachment of commercial fishing vessels in municipal waters, lack of policy on the use of mangroves, and non-existent enforcement of pollution laws; municipal fisher folk who cannot find or move to better fishing grounds; farm and non-farm workers displaced from an economically declining sector or industry (e.g., sugar, wood) who have migrated to upland or coastal areas; farm households in regions or areas where agriculture has lagged behind and been subjected to drought, natural calamities, or changes in climatic conditions, such as Cagayan Valley, Bicol, Eastern Visayas and Mindanao; farmers and farm laborers in areas without adequate water and properly performing irrigation systems or where farm production has declined; landless workers who have migrated to coastal areas, towns, or cities and are unemployed or underemployed in the informal sector; permanently laid-off workers. All told, most of these people live or originate in the rural areas. Many are self-employed in the forestry, fishery, agriculture, or urban informal sector, while some are seasonally or temporarily hired. Generally surviving at subsistence levels, they and their families seem to have no alternative but to survive and cope in a stagnating area or form of livelihood activity without prospect of improvement or growth. Their kin and children seem to be caught in the same cycle of poverty, and growth in other sectors or the larger economy have no significant effects on their prospects. Table 20 provides a preliminary estimate of the core poor who have historically been excluded or marginalized by development processes. The magnitude (26.7 million people) and distribution of the various groups was estimated using the number of people below the poverty income threshold in 1997, the known population estimate of particular groups in a given year, and the national population growth rate. The table shows that the proportion of core poor groups found in rural areas may be more than the 61% estimate because this figure does not include small farmers in unirrigated and vulnerable areas who are classified under the “unaccounted” group. Estimates of this residual category range from 1% to 12% depending on the proportion of urban slum dwellers (26% or 36%) used. It is also notable that the victims of cyclical growth in the formal sector among the core poor constitute only 1.3%. The direct relationship between poverty incidence levels and the upward swing in growth cycles, on the one hand, and the intergenerational and gender-differentiated character of poverty, on the other, suggest the need to stabilize the economy, lengthen its cycle, and prolong the upward trend, so that when a slump occurs, the next generation as well as the women who carry the brunt of crises would have enjoyed the benefits of proper education, labor force participation, nutrition, and health care. Without a prolonged cycle brought about by sustained growth, short upward swings will not make even a dent on the experiences of the poor in general and poor women and children in particular. Finally, the core poor, who have existed in the shadows of growth, need to be brought into the light through direct poverty alleviation policies and programs. Government Spending and Poverty Alleviation If the post-war cyclical growth process with few and brief upward swings hardly touched a significant segment of the poor population, then poverty reduction efforts could have only depended primarily on government action. What government efforts were expended to address poverty at the policy/institutional level and at the level of providing immediate relief to the poor? At the policy and institutional level, government response is reflected in the poverty reduction agenda articulated in the Medium Term Philippine Development Plan (MTPDP), which was formalized and implemented through a Poverty Reduction Partnership Agreement (PRPA) with the Asian Development Bank in October 2001. The Agreement specified a number of key indicators and targets based on the MTPDP as a basis for monitoring progress in the attainment of poverty reduction goals. Table 21 presents the indicators and targets for macroeconomic stability and equitable growth, agricultural modernization and social equity, comprehensive human development and governance. Unfortunately, several 2002 targets were not met. Performance fell short of the target in the follow areas: national government budget deficit; national government spending on social services; lands distributed under CARP (Comprehensive Agrarian Reform Program); participation rate in secondary education cohort survival rate in elementary; Bureau of Internal Revenue (BIR) collection; BIR tax effort; and tax revenues. The unmet budget deficit target reflects the revenue collection performance of the national government, its mandated expenditures, and the magnitude of losses incurred by state-owned enterprises. With regard to revenue collection, tax effort (the ratio of government revenue to GDP) declined to 11.7% from 2001 to 2002. This decline stood in contrast to government’s effort improvement of 9.6% in 1983-85 and 17% in 1997, levels that were nearly comparable to those of Indonesia and Thailand. Growing at a low rate of 0.6%, revenue collection in the last year was limited because of underpayments of value added and excise taxes and reduction in tariff revenues as a result of the Tariff Reform Program. Against the 0.6% revenue growth, expenditures rose by 9.4% in 2002 to meet government’s mandated expenditures. The growing debt service or interest payments (from 21% to 26%) and allocations for local government units accounted for 44% of the increase in the national government’s budget in 2002.A corresponding reduction in the budget share of total economic and social services accompanied the increase. Manasan (2002) noted that since 1997, defense and economic services registered the biggest increases in spending, with the bulk of the increment going to raising agricultural productivity and land acquisition in connection with agrarian reform. In comparison, social services’ share of the national budget has declined. Consisting of education, health, social services, housing, and community development, this cluster of social expenditures accounted for 22% of the national budget. Interestingly, allocation to the social services grew the least in 2002, with the government unable to sustain its 2001 level in per capita terms. Assessing the level of government deficits depends on how it is defined, that is, whether central government or consolidated government figures are used. Deficits in excess of 5% of GDP were the norm in the 1980s and the late 1990s. Applying this norm, deficit spending was maintained in 2002 at about the same level, with the government deficit standing at 5.0% of GDP. The picture changes, however, when the consolidated measure, which includes the income position of government-owned corporations (GOCC), is used. Losses by these enterprises, which were much smaller in the 1990s, were in excess of 5% of GDP. Financial institutions like the old Central Bank, the Philippine National Bank, and the Development Bank of the Philippines and problems in utilities and trade accounted for much of the sector’s losses. It is important to note that the country’s public sector financial position (Table 22) worsened in the late 1990s (1997-2000) because of government’s deficit spending, losses incurred by the monitored GOCCs, and borrowing for Central Bank restructuring. In 1998, the monitored GOCCs and CB restructuring accounted for 63.35 billion of the 111.8 billioin peso public sector borrowing requirements. Were it not for these borrowing requirements, the national government could have achieved a surplus between 1994 and 1997 instead of a deficit. Against the continuing challenges of unreformed GOCCs and unaddressed deficits, government’s declining allocation for economic and social services from 1998 to 2002 reflects its dwindling resources for anti-poverty measures. There has been very little room for new spending on economic growth, anti-poverty initiatives, or the much-needed restoration of the environment necessary for sustainable growth. Most social services per capita expenditures declined in the last five years except for social welfare, labor, and employment, which rose because of the 30% increase in the budget of the Department of Social Welfare and Development in the wake of the May 1, 2001, uprising, counter-insurgency measures, and natural calamities. It would seem from its budgetary allocations and expenditures that government’s commitment to address poverty through growth-inducing and human resource strategies – education, health, and housing – is not matched by corresponding resources. Its most recent focus on emergency expenditures, while understandable in a crisis-prone country like the Philippines, provide only palliatives for the immediately displaced and hardly respond to more persistent but longer-term imperatives of malnutrition, preventive health, and the education of children, especially in the degraded provinces. Nor does it address the structural conditions of the displaced in forestry, fishery, farming, and the informal sector. In the context of a witting or unwitting emphasis on short-term palliatives, it is not surprising that government’s performance in its fight against poverty relative to the goals it has set has been poor. Towards Possible Interventions: What Can Be Done to Address Unsustainable Growth, Environmental Degradation, and Poverty? Cyclical growth with very short upward swings, environmental degradation, and a high population growth rate that has not dropped significantly for more than three decades make poverty alleviation extremely challenging. It would require a relatively more stable economy and prolonged upward trends; only these would ensure that when the inevitable slumps come, the next generation would have the health, financial support, and education to escape the poverty trap and achieve social mobility. Based on the country’s pre-1983 experience, sustained 4-5 year cycles with positive growth rates over a 20-year period – not seen in the last ten years – would seem to be the minimum necessary to make the economy take off. Sound macroeconomic management, controlled government spending, and the privatization of deficit-prone state-operated enterprises, as well as the reform of political and judicial institutions are the necessary conditions for sustained growth. In macroeconomic management, the institutionalization of a liberalization framework to guide national economic plans and policies has been a major achievement of government policy makers since 1986. Nevertheless, certain issues emanating from the structure of the economy and the pattern of foreign investments must be managed to enhance the potentials of liberalization: inter- and intra-regional disparities and urban environmental degradation resulting from service-led growth without corresponding development of the agricultural and manufacturing sectors, which constitute the material base of an economy with a large agrarian sector; social dislocation and environmental damage resulting from the increasing penetration of foreign capital into the country’s only untapped mineral resources; the narrow base of the present form of export-oriented industrialization, which concentrates on one industry (electronics) with limited value added, backward linkages to the larger economy, heavy reliance on imports, and consequently lower net trade balance; capital flight accompanying the growth of international trade and capital mobility; the need for greater entrepreneurial spirit and sense of competition with foreign capital among local businesspeople; the need for institutional safeguards in bureaucratic and government operations to obviate destabilizing transitions from one regime to another and break the historical link between regime change and economic slumps or crises. The necessary conditions presuppose that the agricultural and the natural resource sectors are not fetters to the development of the economy. Since the country’s natural resource base is in a depleted state, a sufficient condition for economic growth is the restocking, rebuilding, and overall restoration of natural capital. These efforts will enable the economy to go beyond the current limits that prevent it from building on and sustaining upward trends. In this regard, the following issues ought to be examined and addressed: the lack of an inventory of depleted resources and the absence of market signals to indicate the onset of depletion; the country’s low level of scientific interest in assessing environmental conditions and altering them to mitigate or reduce the effects of droughts, floods, and global climate change at local levels; the absence of systematic links between natural resource users and providers, standards for the provision of services, and institutional arrangements/ resource management agreements on payments, compensation, and mediation. At least two other sufficient conditions should be satisfied to ensure sustainable growth. The first is proactive linkage between the natural resource base/agriculture and manufacturing through the development of small- and medium-scale industries oriented to export markets. The second condition is to break the cycle of poverty by investing in human capital – in other words, prevent poverty’s extended reproduction by educating poor youth. The fulfillment of the necessary and sufficient conditions for sustained economic growth in the Philippines requires the institutionalization of a liberalization framework and in tandem with a strong state that can make its underlying principles work. While seemingly contradictory, a strong, market-oriented state is needed to protect and restore the environment to achieve long- term economic sustainability even as it enables capital to flow freely. It is needed to mobilize resources for safety nets and human capital formation, to mediate conflict among competing interests, to set and enforce standards for sustainable resource use and environmental management, and to build the necessary physical/social infrastructure and institutions for long- term development. Strategic Interventions and Economic Governance Despite its many challenges, an economic policy framework that highlights fiscal discipline, trade and financial liberalization, competitive currencies, privatization, and deregulation is still a necessary goal. However, as Rodrik (2003) correctly argues, this framework does not correspond neatly to specific sets of policy packages that are universally applicable. Rather, there is a need to creatively operationalize and package these principles into “institutional designs that are sensitive to local opportunities and constraints.” Furthermore, sustaining economic growth requires institutional arrangements that would make the economy resilient to shocks. The design and construction of these institutional arrangements entail a strong, market-oriented state capable of mobilizing resources and potential collaborators. However, the Philippine state at this time is neither strong nor market oriented. It is beset by weak political institutions and a political culture that denounces corruption yet tolerates it as a way of life. De Dios and Ferrer (2001), citing O. D. Corpuz’s work in 1965, trace the disproportionate role of corruption in the Philippines to the structure of Philippine politics and economy. Corpuz cited patronage at both the local and national levels, lack of information among the majority of Filipinos due to poverty and ignorance, the manipulation of government by powerful vested interests, the entrenchment of a stratum of political opportunists and big money politics, and a political system used as means of wealth accumulation through the manipulation of electoral politics. The costs of corruption to the economy are many. For instance, the granting of government concessions or unfair contracts denies the government fair market value for the resources under its control and the positive use of potential earnings for public purposes (Virtucio and Lalunio 2001). Corruption thrives not only because of willful collusion between government agents and contracting parties, but also because of the weak regulatory capacity of the state, which allows scams to proceed unchecked (Pascual and Lim 2001). The high ranking of the Philippines on the international corruption scale highlights the need to strengthen state institutions. The consequences of the weak state are seen in a lagging economy and a degraded environment that precludes sustainable development. A strong state is needed both to establish infrastructure for the market to operate and to preserve the nation’s natural resources from further degradation by vested interests. But even more than creating infrastructures and regulating natural resource extraction, the state must assume responsibility for economic governance – the creative balancing of market operations and social conditions, including the promotion of civil society and its participation in the country’s economic life. As a form of co-management or participatory decision-making, economic governance implies the collective management of economic resources ranging from natural and environmental to generated resources (tax revenues, state enterprise revenues, and public borrowings) and distribution of their benefits. All stakeholders collectively – not government alone – must face the tremendous challenges of achieving economic sustainability amidst environmental degradation, of improving the present and future welfare of the people amidst poverty and short growth spurts, and of addressing concrete imperatives. Such imperatives are numerous, including financial instability arising from short-term portfolio capital movement, the debt burden, lack of local entrepreneurship, and declining competitiveness. Economic governance is undoubtedly difficult to establish. It requires consensus on the nature and value of resources – the explicit economic and social objectives to be realized in resource allocation and use, as well as norms and decision-making mechanisms for the determination of priority and alternative uses. To illustrate: in the use of state resources, government revenues and savings, external funds, rents, and surplus, there might be a stated preference for the following: the use of external resources to finance investment rather than consumption, or long term investment growth rather than short-term investment and consumption growth; the promotion of steady export growth to exceed import growth; the avoidance of short term debt as a source of funds; improvement in the country’s ability to service external liabilities; the provision of benefits for a greater rather than a fewer number; programs and projects that address chronic and intergenerational poverty (education targeting the poor); the institution of tax reform to generate fiscal balance, encourage efforts to increase domestic savings, and reduce dependence on foreign debt; the provision to firms of long-term credits to sustain private investments through different cycles. With an orientation toward social goals, economic governance requires a monitoring system to verify whether immediate and strategic goals are being realized and a mechanism to provide incentives and induce movement towards their realization. Moreover, mechanisms for defining rights and duties of stakeholders and for resolving conflicts among them must also be in place. Economic governance is a relatively unexplored concept, so this economic assessment will conclude with an illustration in a concrete context. This allows not only the weaving together of the imperatives of market, environment, state, and democratization, but also allows the assessment to end on a hopeful note. Economic governance can be concretized at the micro-level in the management of watersheds, the restoration and natural functioning of which are critical to the achievement of sustained economic growth. The illustration is a way of mapping concrete ways in which government can proceed in addressing the country’s economic predicaments in collaboration with various groups. The Case of the Degraded Watershed and the Institution of User Fees A watershed performs many economic and environmental functions. Apart from the production of water, food, raw materials, and other resources, the watershed is a carrier and regulator. Under undisturbed or stable conditions, the regulation functions are benign, providing beneficial environmental services: determination of local climate conditions; prevention of runoffs or floods; maintenance of dry season flows; control of soil erosion and sedimentation; maintenance of water quality; topsoil formation and soil fertility maintenance; groundwater recharge; and regulation of the water table. Because these environmental services are free, the uncompensated benefits derived from them constitute Nature’s positive externalities. When watershed conditions deteriorate, however, the natural benign services they render become scarce, certain regulation functions cease to operate fully, and economic damage and loss is the result. The continued economic use of a degraded, unstable environment without mitigating measures exacerbates the situation, further diminishing environmental services and causing more negative externalities. The application of an environmental user fee (EUF) policy for watershed services has at least three different objectives, corresponding to particular modes of implementing user fees: The EUF is a means to discourage or penalize present and future activities that cause negative externalities. The EUF is an expression of the positive value of the watershed’s benign regulation functions. The payments made by watershed service users become, in effect, compensation for the use of currently free, beneficial environmental services. The EUF generates resources that may be used to encourage activities that enhance positive externalities. Alternately, the resources may be pooled and set aside as an environmental fund to finance the protection of the watershed. Or the environmental fund might be used for the restoration and improvement of the watershed’s capacity to provide services. A number of conditions, however, constrain the valuation, compensation, restoration, and sustainability of the beneficial services of the watershed (Bautista 2003). The enunciation of a user fee policy requires addressing these constraints. The following critical steps must be undertaken before a user fee system can be implemented. First, environmental education is fundamental to the promotion of an EUF system. It is imperative to disseminate information on the current state of environmental services and to heighten public awareness of the complex natural processes that generate concrete environmental services and the impact of particular human activities on the watershed’s regulation functions. People should know the importance of particular services to specific groups, the provisioning of particular inputs or desirable production conditions by the environment, the effect of the absence of these services on economic production and incomes, and the actions that need to be taken. Moreover, environmental education and economic literacy are necessary to address the “free rider” mentality – the unwillingness of resource users to pay for environmental services. Some farmers do not currently pay the irrigation service fee, while private commercial well owners resist payment for raw water extraction, partly because they have become accustomed to free environmental services. The object of environmental education and economic literacy is to create willingness among environmental service users to pay for the services they receive. Second, the environmental service in demand, as well as the groups demanding it, ought to be identified and the latter made to value the service. Table 23 provides a list of beneficiaries or demanders of particular environmental services, as well as their potential human agency suppliers. The value of these services – the result of complex, natural, environmental processes that may not be tangibly felt – is not immediately apparent. Demand itself seems only to be apparent when a particular service is in short supply, resulting in inadequate water or irrigation services, excess runoffs, unstable or declining soil quality, river pollution, or fishery depletion. In other words, the poor state of an environmental service underlies its demand. Methodologically, watershed services may be valued in terms of their future loss or the cost of damages due to their unavailability or degraded state. Third, the demand for environmental services can be made more apparent if they are represented as tangible products, such as regular stream flows, water reservoirs, erosion or flood controls, improved/unpolluted water quality conducive to fish growth, and soil moisture. For these potential commodities whose production must be ensured, potential suppliers must be identified. In the absence of a market or an immediately identifiable producer to ensure an adequate supply of particular environmental services, the supply side of the market can only be initially formed when potential suppliers have expressed willingness to become service providers. Moreover, it is necessary to specify the activities that are required in the production of environmental services. These activities must not only be conceptualized, but organized and implemented as an arrangement, technology, project, or contract. For instance, a watershed protection contract entails a combination of the best land resource use and management practices, while an arrangement for soil and water quality improvement consists of reforestation projects, upland farm practices, land techniques, river protection and monitoring, and waste disposal methods. The set of required activities guaranteeing the provision of environmental services are similar to command-and-control “standards.” They explicitly set allowable conditions or requirements for the provision of environmental services, the so-called positive externalities. Corollary to these requirements, the disallowable conditions – activities to be avoided or abated because they can damage the watershed’s regulation functions – may also be included in the arrangement or contract. The explicit enumeration of desirable requirement activities and those to be avoided serves as a basis to define the terms, rights, and responsibilities of the parties involved, as well as the mode of compensation. Upland or upstream providers are compensated or rewarded when they meet or exceed minimum standards for land use. If they do not meet the standards or provide the inputs for environmental service production, support must be given in the form of extension services, technical assistance, and perhaps subsidies under established priority conditions. Fourth, the state of the environment and the country’s level of knowledge regarding the generation of environmental services determine the required activities or standards to be established. Given the extent of environmental degradation in the Philippines, the arrangements and projects to be promoted must be inspired by a more developed science. Specifically, there is a need to develop the science and practice of improving local climate conditions, mitigating the damaging effects of natural disturbances, and restoring and enhancing nature’s productive capacity. Successful experiments in soil quality and water yield improvement and conservation, agro-forestry, local climate change through vegetation change, reforestation for land stability, water generation, flood and wind protection, and other measures must be replicated and improved. Fifth, in the absence of a market or other natural coordination between providers and demanders of environmental services, a third party is needed in the establishment of an EUF system for watershed services. The third party would be responsible for identifying, meeting, and securing commitments to pay from demanders of environmental services. As long as conditions of non- excludability and non-rivalry hold, there will be no incentive on the part of individual consumers to pay unless, as a group of beneficiaries, they willingly agree to pay for the environmental services they use. It is critical to obtain the commitment of key beneficiaries in the river basins, such as the National Irrigation Authority, the National Power Corporation, the Water District, the Bureau of Tourism, large plantations, and large city and municipal governments. Public enterprises and government departments are the single most important buyers of watershed services who have a clear interest in maintaining the quality and flow of water. The third party would also be responsible for identifying potential local suppliers of particular environmental services, drafting contracts and arrangements, and establishing consensus among demanders and suppliers on the proposed arrangement. It is in the proposed arrangement between environmental service consumers and providers that the user fee and the rights and duties of each party would be formalized. But before this stage is reached, the third party would act as a mediator of conflicts between demanders and suppliers, and among these groups. For instance, conflict between upland farmers and downstream irrigation associations and provincial water works, or among the irrigation association members, must be resolved through conflict mediation before any agreement can be formed. Another necessary condition is the provision of incentives and funds for investment in order to address the disincentive and under-investment problem that accompanies the free-rider mentality and absence of property rights. The crucial task of the third party here is to pool together the financial commitments of key public enterprises and government agencies as seed money for the establishment of an environmental fund. Who can undertake all the above functions? With its resources and influence at the local level, the provincial government is in the best position to organize prospective environmental service providers and demanders, serve as mediator, provide and guarantee property rights, solicit seed money for the environmental fund, and provide investment incentives. As the third party, the local government or state agency is, in effect, the instrument of co-management. Summarizing some of the above requirements, Table 23 identifies human providers, such as upstream communities, establishments, local government units or environmental agencies. Some of these local agencies may not yet be in operation or are currently ineffective. 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