Busy-ness Does Not Equal Business:
The Fatal Flaw in The Philippines' Small Business Initiatives

by Ben Kritz
18 May 2008



It is part of the national personality of the Philippines to be more than a little thin-skinned when faced with criticism, so it is difficult to find a willing audience for a frank assessment of the country's economy. From the top of the Administration's ivory tower to the wet floors of the smallest market stalls, anyone who is actually doing business is happily confident they are doing the right thing, and any discussion that tends to question their childlike belief in the simple formula that reward is directly proportional to effort is met with some degree of hostility. When they fail to meet, or even comprehend, global standards Filipinos prefer to be judged by their own. Thus, where outsiders see a third-world subsistence-level economy based on extralegal survival strategies, they declare that SMEs are the backbone of the economy, and that "a strong and viable small and medium enterprise sector is important for a successful export-oriented industrialization." (PIDS, 1997:1)

Extralegality plays an integral role in the world's developing economies, accounting for up to one- half to two-thirds of a country's economy. (Bird, 2007) As far back as 1970, author Keith Hart described this large, but largely invisible, sector as "informal" in an article about small businesses in Ghana. The International Labour Organization (1972, 1973) characterized the survival strategies used by poor migrants flooding into third-world cities -- of which the constant flow of provincianos seeking work in Manila is a perfect example -- as not a marginal but an integral economic activity. But the ILO also recognized that this "informality" is limited; it meets, sometimes very successfully, the subsistence needs of its actors, but because of the extralegal nature of the business activity, the individual enterprises are incapable of growing into larger ones in the traditional sense. At the time, The ILO cited excess labor supply, undercapitalization, and a lack of skills and technology as the root causes for developing nations' informal economies, and their paradoxical results of continuing high unemployment and inflation despite the increasing levels of economic activity. Providing financial, technological, and educational resources, the ILO reasoned, would stimulate growth, causing unemployment and inflation to drop.

So why hasn't that worked in the Philippines? The problem the Philippines faces is typical of other third-world economies: most of the necessary resources already exist, but the government and legal systems are incapable of defining and guaranteeing the surprisingly large amount of resources the poor in the informal sector of the economy actually possess. In The Mystery of Capital (2000) Hernando de Soto asserts that the poor already have enough capital; the challenge is to incorporate it and the people into the "formal" economic system by introducing legal reforms that encourage contract enforcement, statutory and tax legalization of businesses, and strong protections of property rights. In simple terms, putting additional resources into a faulty system does not correct the system's faults, but only makes the system larger and more difficulty to correct.


Click for larger picture Philippine transport "busy-ness" in a nutshell



Manila's migrants, faced with these conditions, create their own system that meets their employment, housing, transportation, and consumption demands, and the pattern is repeated in other areas across the country. The biggest reason extralegality has emerged is because of prohibitively high transaction and formalization costs. In order to properly legalize a business, an Filipino entrepreneur must wade through an alphabet soup of regulatory agencies -- DTI, BIR, SEC, SSS, PHIC -- and deal with three levels of government. Since enforcement is lax at best, the high costs of formalization generally outweigh the costs of staying informal, particularly at the nascent level of most entrepreneurs.

The result of this is an economy which is based, to a large extent, on millions of individual- or family-level businesses, the vast majority of which operate extralegally. The nation's political and commercial leadership sees the visible activity but not the invisible framework, and draws the inadequately-informed conclusion that the microlevel of SMEs is actually the most productive level of the economy as a whole. Microfinance programs and support incentives are promoted by the government and institutions such as ADB in mantra-like fashion that "owning your own business" is the path out of poverty, and congruently, the best course for development of the national economy. The reason this initiative is failing and will continue to do so is the lack of understanding of the extralegal sector. Because it is so widespread, the extralegal sector defines the business atmosphere in the Philippines; there are not separate markets for registered and unregistered businesses. Thus, certain characteristics of extralegal business practices have become institutionalized: a heavy reliance on cash transactions, a forced reduction in wage scales which lead to businesses becoming more labor than capital intensive, lack of incentives for reinvestment, and a preference for oral agreements because of poor contract enforcement.

Underlying this atmosphere is the promotion of "ownership," a deeply-ingrained philosophy that has been unintentionally perpetuated by the government's championing of SMEs. Driven by poverty, Filipinos are more than capable of doing something for themselves. A few hundred pesos borrowed from family or friends and a lot of determination and willingness to work hard is enough to start something, anything, be it selling barbecue off the front porch or signing up for one of the ubiquitous direct-selling businesses. The ones who are successful understand the holy trinity of capital -- work, save, reinvest -- but only to the point where the barbecue turns into a sari-sari store or the direct-selling business develops from hawking the wares of one catalog to several. Once the immediate needs of the home and family are met, there is no incentive to grow. Employees, if there are any, cannot be paid enough to retain them as human capital, and their loyalty is further disincentivized by the comparative attractiveness of striking out on their own. Business formalization is complicated at best, and because corruption is so widespread throughout government and business activities, is based on an adversarial process wherein the business owner is regarded with suspicion of trying to circumvent procedures and regulations. Business owners, on the other hand, are mistrustful of institutions, presuming they will be cheated and forced to pay bribes in order to make transactions go smoothly.

The sari-sari store or two hectares of rice will feed, clothe, house, and educate a family; that is unquestionably demonstrated in millions of places everyday in the Philippines. But for the government and other concerned institutions to equate this activity with the basis of a sound, global economy is a grave error. If the objective is to simply feed and employ the population, then the current programs promoting SMEs are indeed valid, because they can do that. Without incentives for business growth and labor stability, however, that will be the limit of the achievements the current programs can expect, and the Philippines' place in the third world will remain secure.


References

Bird, Matthew. (2007) 'Traveling Down the Other Path: Learning to See Extralegality as an Investment Opportunity'. University of Chicago, unpublished.

De Soto, Hernando. (2000) The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. New York: Basic Books.

Hart, Keith J. (1970) 'Small-Scale Entrepreneurs in Ghana and Development Planning'. Journal of Development Studies (104)6: 20.

Philippine Institute for Development Strategies (PIDS). (1997) 'Improving Institutional Support to Small and Medium Enterprises'. Policy Notes 97(06): 1-5.

Seers, Dudley, et al.(1973) 'Towards Full Employment: A Programme for Colombia'. Geneva: International Labor Office (ILO).

Singer, Hans and Jolly, Richard. (1972) 'Employment, Incomes and Equality: a strategy for increasing productive employment in Kenya'. Geneva: International Labor Office (ILO).


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NOTES: This is a highly-expurgated version of a report I did some time ago for a well-known major investment bank here. The original was close to 70 pages long, with lots of really cool charts and a five-page bibliography and all that sort of thing, and said in so many words: "The government's and your institution's microfinance programs are a bunch of crap. All you're doing is perpetuating the Stone Age economy this country lives on." Which is not exactly what they were expecting to hear, I think, but it's true. One of the Malacanang high-hats who was at the presentation tried to stand up for Gloria's baby, good soldier that he is, and actually said to me, "Well, you know our President is a Georgetown-educated economist..." (COOL! I've reached the Everest of Pinoy credentialism now, I thought) And I said, "Yes sir, that's what I've heard. I'm a Wharton-educated economist, as far as that goes, maybe she and I could get together and compare notes. Of course, maybe what I've covered here is not so much from my economic studies, but more from my MBA work."

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