Business World
Introspective
Sometime after the midterm test, students of microeconomics are introduced to a topic called externalities, an inelegant term that simply refers to spillover effects of a particular action. First impressions of externalities are typically negative - how self-interested decisions of farmers to put as many cows as possible on public pasture grounds result in the tragedy of the overgrazed commons, overgrazing being the negative externality.
Much less prominent but equally important is the concept of positive externality, where actions can generate unintended benefits for third parties.
While externality is associated with market failure that requires government intervention to correct - taxes for negative externalities and subsidies for positive externalities - government action itself can generate positive or negative externalities, something that governments need to consciously be mindful of when making decisions to act.
The significance of positive externalities stuck with us in the course of doing work for the World Bank Growth Commission that tried to study the political economy of reform during the Ramos period (a copy of the working paper may be downloaded from http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf). We picked three successful reform cases - water privatization, telecommunications de-monopolization, and oil deregulation - that we thought best illustrated the process of reform, the elements that made reform succeed, and the resulting increase in sectoral competition and improvement in service delivery.
However, more than the sectoral efficiencies or macroeconomic stability gained, what we thought notable were the positive externalities generated by achieving a critical mass of reforms (starting with the resolution of the power crisis) within a short period of time. This helped to win public confidence, attract investor attention, and catalyze responses of a broader nature that expanded the economy's growth potential.
For instance, when Singaporean leader Lee Kuan Yew chided the Philippines in 1992 as a country where 98% of the residents are waiting for a telephone and the other two percent are waiting for a dial tone, nobody at the time realized that reforming the sector would spawn a new growth sector - business process outsourcing - for the country more than a decade later.
Similarly, the considerable positive externalities of the reform of the water sector in Manila dawned on me during a lecture of World Bank Vice President for research Danny Leipziger. His question to the audience was, "What is the single thing that explains best the quality of health in children, including infant mortality?" Answers from the audience included expenditures in public health, the number of doctors, education of mothers and their incomes, all of which were wrong. The simple answer was availability of drinking water.
Unfortunately, political instability, including what analysts consider a crisis in leadership, since the Ramos Administration has not allowed the extension of the reform to other sectors, e.g., rural water, air transport, the cement industry, agricultural commodities, ports and shipping. Pressures of the political environment have not only seen minimal follow-through in reforms but have led to government decisions that carried negative externalities in terms of their impact on long-term business investments.
An example is the non-adjustment of power rates during the Estrada administration through the Arroyo administration's first term. While this was corrected after the 2004 elections, we are now seeing something similar in the water sector with the non-implementation of agreed tariff adjustments based on the last rate rebasing exercise, a mechanism that has worked well in the past. Such actions not only expose government to the costs of potential contract disputes, but send very harmful signals that do not help reverse the decline in governance indicators since the Asian crisis.
Our case studies revealed how much leadership matters in influencing the timing of reform by clearly articulating the problems, pointing to the solutions, and rallying the people to push for change. Likewise, a maturing civil society that has a wider appreciation of the externalities generated by particular government actions seems to be more engaged now in supporting reform moves. As seen in the 2005 EVAT reform, though businesses and taxpayers realized that they would end up paying higher taxes, there was an appreciation that the reform being pushed by government would reap wide benefits to the economy and the country.
Romeo L. Bernardo is a board member of the Institute for Development and Econometric Analysis (IDEA), Inc.
