Philippines Electricity Crisis: How Regulatory Capture Undermines Emerging Markets

The Philippines is paying the price for decades of mindless privatization, which has done more to reinforce the oligarchic hold on the Philippine economy rather than unleash the dynamic energies of the private sector.
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In its latest issue, Foreign Affairs magazine, which identified the Philippines as among the six up-and-coming countries in the 21st century, will certainly help enhance the Aquino administration's self-confidence in its macroeconomic policy -- and somehow discredit the naysayers, who have (mistakenly) dismissed the Philippine economy as a bubble in disguise. Decoupling from the whimpering BRICS (Brazil, Russia, India, China and South Africa) economies, Foreign Affairs editors Gideon Rose and Jonathan Tepperman have focused on emerging markets such as the Philippines, for its "combination of size, recent performance and economic potential" as well as emergence as an "outsourcing powerhouse" under the "the clean and committed stewardship" of a new administration. In a separate essay, Karen Brooks, who looked at the economic potentials of Indonesia and the Philippines as the next tiger economies, praised the Aquino administration for its "bold leadership", which unlike Indonesia's wavering government "has taken real steps to address some of its challenges." She identified two key factors, which have supposedly made the Philippines a leading contender among emerging markets; first, improvements in transparency and efficiency in fiscal spending and tax administration, and second, the Aquino administration's huge reservoir of political capital, which could be translated into swift and decisive reforms in the coming years.

While Brooks thoughtfully surveys a wide range of challenges bedeviling the Philippine economy, the above analysis, however, overlooks the extent to which recent reforms have not cut deep enough. And there is a failure to even mention the combined impact of the recent corruption scandals and the aftermath of the Haiyan crisis on the Aquino administration's popularity, which has taken a hit in recent months.

What we see today in the Philippines is more a country that has come to confront its internal demons than an emerging market firmly placed on an inexorable tiger road. Nothing underscores this complex picture more than the latest uproar over an alleged collusion among power-generating companies to introduce a further hike in electricity prices. To put things into perspective, the Philippines already has Asia's most expensive electricity rates, even higher than post-Fukushima Japan. Such prohibitive rates have not only hurt ordinary consumers, but have also served as among the strongest disincentives against manufacturing investments in the country.

But there is a deeper lesson to draw from the Philippines' power-generation predicament. Contrary to the conventional analysis forwarded by most analysts, including Karen Brooks, what the Philippines needs the most is not more privatization and economic liberalization per se -- which have actually exacerbated rather than ameliorated the country's structural economic weaknesses since the 1990s -- but instead a stronger state that (a) can bust oligarchic collusion, and (b) protect the interest of the consumers and productive sectors of the economy. And we won't have a dramatic turnabout in the Philippines' economic fortunes unless the Aquino administration and its successors fully internalize the indispensable role of the state, which ranges from ensuring the rule of law to protecting strategic sectors of the economy against special interest, even in an era of economic globalization.

Privatization and Regulatory Capture

Ironically, the power crisis in the Philippines, which promises to retard the country's growth trajectory and its aspirations for industrial development, is not a product of excessive state intervention and public mismanagement. Instead, it is a classic example of how economic liberalization -- under the auspices of a corrupt political system and in the absence of a competitive private sector -- has handed the key sectors of the economy to a handful of oligarchs, which have prioritized profits over capacity-building and accessibility. And yet, we are still waiting for a commensurate response by the Aquino administration to such brazen strangulation of Philippines' manufacturing potentials, which ultimately rely on, among other things, the affordable availability of power and energy resources.

In essence, there is nothing wrong with having a competitive economy where dynamic entrepreneurs are allowed to engage in and spur a "creative destruction" of innovation to increase economic productivity for the benefit of the consumers and the overall economy. And John Maynard Keynes, who is widely recognized as the brains behind post-war, state-led capitalism in the Western world, would have never supported the monstrosity of ineffectual and corrupt state-controlled enterprises, which dominated large portions of the developing world for much of the post-colonial era. But what followers of Joseph Schumpeter, Friedrich Hayek, and Milton Friedman have overlooked are the perils of privatization in under-developed markets, where you have a tiny, oligarchic private sector, which lacks capital, expertise, and -- above all -- appreciation for collective interest, but has unshakable grip on the the political economy.

Moreover, as I argue in my forthcoming book How Capitalism Failed the Arab World, the key problem with the privatization process in the developing world is its inherent vulnerability to regulatory capture -- the process by which major businesses and special interests co-opt a weak, post-transition state in order to control profitable, strategic enterprises, which were previously held by the government.

Similar to most other developing countries, the Philippines engaged in a wide-ranging process of economic liberalization in the 1990s, which saw the massive expansion in the private ownership as well as operation of key economic sectors such as water, infrastructure and electricity. It was hailed as a natural remedy to decades-long crony capitalism under the former Marcos regime. As far as power-generation is concerned, the transition to a market-economy culminated in the passage of Republic Act 9136, or the Electric Power Industry Reform Act, better known as EPIRA, in 2001.

This was landmark legislation, which promised to lower electricity costs, expand the country's capacity for energy production, and enhance the efficiency of its transmission by supplanting the Rate of Return on Base (RORB) system with a Performance-Based Regulation (PBR) regime. In reality, however, the increasingly privatized electricity sector would be dominated by the country's leading business families, which turned electricity production into one of the most profitable businesses in the country -- at the expense of the overall economy and public welfare.

Public Outrage

Recent months have seen increasing mobilization by the Phillippine middle classes against corruption in state institutions. So when they learned that Manila Electric Company (Meralco) was going to introduce an unprecedented electricity rate hike in three trenches beginning in 2014, there was an immediate expression of outrage, prompting the Aquino administration to launch an investigation on the matter.

When the Energy Regulatory Commission's (ERC) chief Zenaida Cruz-Ducut, who oversaw the approval of Meralco's request for rate increases, resigned, suspicions of bureaucratic capture intensified. After all, Ducat, a former member of the Philippine Congress, is implicated in the alleged embezzlement of Priority Development Assistance Fund (PDAF), and was appointed to the ERC by the previous Arroyo administration, which is also facing charges of corruption and public mismanagement.

Soon, progressive legislators such as Walden Bello and Ibarra Gutierrez asked the Department of Justice (DOJ) to investigate not only Meralco, but also a whole host of power companies over "possible violations of laws prohibiting cartelization, monopolies and combinations in restraint of trade as defined in competition laws." Specifically, the power producers are being accused of "staging" production shortages, which in turn prompted expensive purchases of emergency supply, to justify a sharp price hike. The Department of Energy (DOE), which has also expressed its suspicions of a possible collusion, is undertaking a separate investigation on the issue.

So far, public pressure seems to have partially succeeded: The ERC has been forced to ask Meralco to hold-off any price hike by January 2014. Still, it is far from clear whether there will be any definitive resolution of this particular crisis, namely the revision or abrogation of the EPIRA law, given how a stream of corruption-related investigations has inundated the Aquino administration.

Overall, what is clear is that the Philippines is paying the price for decades of mindless privatization, which has done more to reinforce the oligarchic hold on the Philippine economy rather than unleash the dynamic energies of the private sector. Perhaps what the Philippines needs more than ever is a simultaneous empowerment of its state institutions as well as the new emerging entrepreneurial class, which has been hammered by oligopolistic businesses and lack of an independent, enabling regulatory regime. In short, what the Philippines yearns for is a more "effective" state and more "competitive" market at the same time.

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