Posted: January 11, 2011 in Uncategorized

The state and the four economies


Weber and other scholars, following Hobbes’ lead, valorized the state as the source of political order and stability given its legal monopoly over means of violence.  Charles Tilly teaches us that while there is technically no difference between a state and protection racket, the state’s monopoly of violence is considered necessary and legitimate.  North and Weingast meanwhile add that the state must be powerful enough to be able to protect and enforce property rights and contracts.  However, it must also have limited power so asset holders are not preyed upon.  Sovereigns need to assure asset holders so the consequent economic activity generated will yield tax revenues adequate for their purposes.  This is the so-called ‘commitment problem’ often cited in the literature.  The said problem concerns how sovereigns or governments can make credible commitments to assure the sanctity of citizen’s property rights.  Sovereigns must be powerful enough to protect and enforce property rights.  The state’s power is largely a function of its control over means of violence.  However, asset holders must be convinced that a powerful Leviathan will not use its power to prey on them.  Hence, a sovereign must be able to make a credible commitment to restrain itself from predation.  Thus the state itself is the key public good that provides derivative public goods.  In many developing countries like the Philippines, the demand for such a competent and limited state is quite apparent but its supply is not forthcoming.


In reality, however, as Bates, Greif, and Singh (2002) remind us, the state is not the only societal agent with assets for violence.  This is especially true in the developing world.  Consequently, it is also not the only agency that can protect and enforce property rights and contracts.  Therefore, security of life and property are not intrinsic public goods that only a state can provide.  They can also be private goods since they can be provided by private agents or non-state actors.  Like the state, private actors must have control over some means of violence to be able to secure life and property.  Absent the state, private agents will have the monopoly over means of violence and security is a pure private good.  When states and non-state actors have access (even if unequal) to means of violence, then they become rival suppliers of security to private actors without such assets.


The protection and enforcement of property rights is one of the single most important failures of the Philippine state.  The Spanish colonial state sought to impose property rights regimes that were alien to those instituted by the indigenous peoples of the archipelago, which included stewardship, usufruct, and communal assets.  In the process, massive asset theft typical of all colonial ventures occurred in the country.  The main object of theft and ownership was land (esp. arable land) as well as labor power.  Given the paucity of the colonial state bureaucracy, the Spanish colonialists sought to corral indigenous Filipinos in settlements so surpluses could be extracted through tributes, forced labor, and taxes in kind.  The American colonial state introduced the distinction between public and inalienable land and privately-owned and alienable real estate.  In the process, several indigenous minority peoples in the highlands were disenfranchised of their so-called ancestral domains.  The 1946-1972 post-colonial state continued these Western-originated property regimes even as the asset structure diversified over time.  In general, access to political power guaranteed security of property rights and elites at various levels consolidated their political and economic positions.


Up to the eve of the declaration of martial law in September 1972, the property rights of rival elite factions were generally secure regardless of the political cycle’s outcome.  Ownership rights were not extinguished by an electoral loss.  The elites were organized into two political parties that alternated in power at the national level.  The ability of an elite faction to regain power in the next election deterred the faction in power from erasing the property rights of the ‘outs.’  Elite factions, therefore, were prevented by the possibility of electoral defeat from disrespecting the property rights of their rivals.  The default behaviour was for the ‘ins’ to plunder the state treasury instead of confiscating the property of the ‘outs.’  Notwithstanding a constitutional provision for two presidential terms, no president has been able to win re-election until 1969 when Ferdinand Marcos won an unprecedented second term.


The balance of power between the rival elite factions shifted decisively in favour of his faction after Marcos’ unprecedented re-election in 1969.  Apart from Marcos’ own manoeuvres (including packing the military of officers from his region to ensure their personal loyalty), the Cold War interests of the United States afforded his government access to substantial foreign monies (in the form of US military aid, loans from multi-lateral financial institutions, and private commercial banks bulging with petro-dollar deposits).  External funding allowed Marcos to rely less on credible domestic property rights commitments to extract the necessary resources that he could use as patronage to consolidate his political position.  He monopolized political power through the declaration of martial law in September 1972 and proceeded to erase property rights of his political opponents (Kushida 2003).


The demise of the dictatorship in February 1986 saw the post-Marcos elites attempting a restoration of pre-martial arrangements with respect to property rights and access to political power.  The properties of the anti-Marcos elites (such as the Lopez, Lopa, and Jacinto families) were returned to their former owners while a new constitution adopted in 1987 provided the ground rules for political contestation and all but forestalled the possibility of new dictatorships.  After an initial lock-out period, even the Marcoses were allowed back into the country and managed to win electoral posts or stand for elections.  Despite the formation of a presidential commission mandated to recover the so-called ill-gotten wealth of the Marcoses and their cronies, these properties got entangled in a quagmire of unresolved law suits filed within and without the country.


The violation of elite property rights by Marcos during the dictatorship’s heyday is like a genie let out of the bottle.  Despite all efforts to date, the mess created by the initial massive cancellation of property rights has not been sorted out to everybody’s satisfaction.  The ownership of substantial portions of the equities of major Philippine corporations (including the top-ranked San Miguel Corporation and the Philippine Long Distance Telephone Company) remains contested.  The fall of the dictatorship also led to the recognition of new asset claimants—the thousands of human rights victims who were tortured or murdered by Marcos’ security forces and the coconut farmers disenfranchised by the so-called coconut levy.  The claims of the human rights victims against the Marcos estate had been repeatedly recognized by US courts while the Philippine Supreme Court had repeatedly ruled that the coconut levy was a public fund and must be taken from the control of businessman Eduardo Cojuangco, who used the money to wrest control of the country’s premier business firm—the San Miguel Corporation (SMC).  To date, however, none of these judicial decisions have been enforced since rival claimants have managed to secure restraining orders against them.


The fundamental point to be made with the above digression is the fragility of property rights in the Philippines.  If the properties of elites are not even sacrosanct, could we expect the assets of non-elites and less-powerful to be more secure?  Nonetheless, legal advances in property reform since 1986—including the Comprehensive Agrarian Reform Law (CARL), Urban Development and Housing Act (UDHA), Indigenous Peoples Rights Act (IPRA)—have created new property rights for the under-classes.  While these property rights for the poor are still limited and imperfect (largely due to the opposition of adversely-affected parties and state agency capture), the rights-based instruments generated by these reforms have generated a new set of informal commercial transactions over these assets.  For example, an agrarian reform beneficiary is prohibited by CARL from transferring or conveying the acquired for a period of 10 years or until the land is fully paid.  This legal prohibition has not stopped needy farmers from selling or from using the asset to obtain informal credit.  In other cases, the weakness of state agencies and legal empowerment due to these new property reform laws have enabled informal transactions among the under-classes even in the absence of official documents such as titles, patents, and leases.  These informal transactions cover housing ‘rights’ in key urban poor areas in the country.[1]


In sum, the strength of the state and the competence of its institutions are the most important factors behind the existence of a four-sector political economy.  The ideal is an economy that is wholly, or at least predominantly, formal.  While the informal economy is not expected to disappear even with the growth of the formal economy, the status of informal entrepreneurs should be legally recognized, their incomes should be adequate, and their working conditions should be decent.  The smallest sector should be the criminal sector.  The war economy should not even exist since the ideal situation is one where the state enjoys unrivalled authority.  While the Venn diagrams in Figures 1a and 1b seemed to imply equal-sized economic sectors (because of the convention of using equally-sized circles), these sectors are actually unequal in size.[2]


What determines the size of these different economic sectors?  The size of a nation’s population is directly related to the size of the formal, informal, and household and subsistence economies.  But population size is not the key variable of interest.  As shown in Figure 2, the strength of the state is a major determinant of the size of the various economies.  Where the state is weak and is unable to enforce its own laws, criminal activity flourishes.  Formals and informals will also be tempted to participate in lucrative crimes.  Where the state is incoherent and incompetent, you will also have a large informal sector.  Informals, like all economic actors, are rational.  When the costs of complying with state regulations exceed the benefits of compliance, informal activity is rational even if it is technically illegal.  This means that laws that foster informal activity



could be considered as irrational or inefficient.  Expressed in another way, informals find that the benefits of illegality exceed its costs.  Notwithstanding the technically-illegal nature of informal activity, informals never look at themselves as criminal.  Street vendors swept off the sidewalks by mulcting cops often complain: Bakit kami ang hinuhuli ninyo?  Ang daming mga kriminal diyan? (Why are you arresting us?  There so many criminals around?  Why not them?)


But state strength is a large umbrella variable that needs to be disaggregated.  One dimension of state strength may be its capacity to extract resources from society.  And this capacity may be measured either by the average tax rate or average annual tax collections.  And these variables may exhibit a reverse relationship compared to overall state strength, that is, the higher the tax rate or annual tax intake, then most likely, the formal economy would be smaller and the informal and criminal economies would be larger.  But the relationship between taxes and sizes of the economies is not straightforward as it may apparently seem.  Even at a high level of average annual tax take, the size of the formal economy may still be substantial if the ratio of public goods expenditure to total tax revenues would be high.  In other words, if there is a high rate of conversion of tax revenues into public goods, then the formal economy would be similarly large compared to a situation where tax revenues are dissipated by state officials.  Another manifestation of state strength is its coordinative and integrative capacity; the higher this capacity is, the bigger the formal economy and the smaller the other economies will be.  Further work will have to be done so the impact of other variables such as level of corruption, quality of bureaucracy, costs of property rights enforcement on the size of the various economies could be studied.


Schneider (2002) reports the size of informal economies of some 110 countries as a percentage of the 1999/2000 gross national product (GNP).  The following table (Table 2) summarizes the statistics for the informal economies of selected South and Southeast Asian countries including the Philippines.  As a percentage share of GNP, the Philippine informal economy trails those of Thailand and Sri Lanka.  In terms of absolute value (in US dollars), the Philippine informal economy is second to Thailand within Southeast Asia.


Table 2:  Size of informal and formal economies of selected Asian countries

Country GNP at market prices (current US$, billion) 2000 Informal economy in % of GNP, 1999/2000 Informal economy (current US$, billion)


Informal economy

GNP per capita

(in US$)

Indonesia 1426.6 19.4 276.8 110.6
Malaysia 823.9 31.1 256.2 1051.2
Philippines 793.2 43.4 344.2 451.4
Singapore 983.7 13.1 128.9 3240.9
Thailand 1205.4 52.6 634.1 1052.0
Vietnam 313.5 15.6 48.9 60.8
Bangladesh 468.9 35.6 166.9 131.7
India 4531.8 23.1 1046.8 104.0
Pakistan 596.0 36.8 219.3 161.9
Sri Lanka 160.0 44.6 71.4 379.1

Source: Schneider (2002)

[1] These points are fully developed in Mendoza (2007).

[2] The size of an economic sector can be measured as the monetary value of all economic activities at a point in time.




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