So Near Yet So Far: The Philippines’ Lower-Middle-Income Country Trap

If you listen only to the Philippines’ economic managers, you’d think the country is one of ASEAN’s bright spots.

On 8 August, Arsenio Balisacan, the country’s socioeconomic planner, proudly exclaimed that the 6.4 per cent GDP growth in the second quarter of the year meant that the Philippines kept its rank as “one of Asia’s best-performing major emerging economies”. He added, “For East Asia’s economies that have released their second quarter 2024 GDP growth, we follow behind Vietnam at 6.9 per cent while leading Malaysia at 5.8 per cent, Indonesia at 5.0 per cent, and China at 4.7 per cent.”

But in fact, a disturbing number of indicators point to the Philippines lagging behind the region.

First, we need to go back to the start of the pandemic. In 2020, the Philippine GDP dropped by nearly 10 per cent, the worst recession among all ten ASEAN countries (Figure 1). This is hardly surprising, given the mismanagement of the previous administration of Rodrigo Duterte, which led to one of the world’s longest pandemic lockdowns.

Because of this, the pandemic scars on the Philippine economy are now permanent. The Philippines needs GDP growth in excess of 10 per cent yearly to return to its pre-pandemic GDP trend. This puts the perceived “high” growth of 6.4 per cent into proper perspective.

Figure 1. Knocked off the pre-pandemic trajectory

Second, Vietnam officially overtook the Philippines in per-capita income during the pandemic. This is a remarkable development because just a few decades ago, Vietnam was economically worse off than the Philippines. Even Laos, Cambodia, and Myanmar have made significant strides. When we contrast all 10 ASEAN countries, the Philippines’ trend of GDP per capita sticks out as a sore thumb: the country’s trend line is distinctly flatter compared to the rest of the region (Figure 2).

Figure 2. The Philippines’ national income: Stuck in the lower middle, overtaken by Vietnam

The Philippines’ slow progress is underscored by a frustrating failure to transition into an “upper-middle-income country”. The economy has been stuck in the “lower-middle-income” category since 1989 when the World Bank first developed its country classification by income.

To be sure, growth in recent decades means that the Philippines has been inching closer to the upper-middle-income status. Most recently, Balisacan said the Philippines will be upper-middle income “towards the latter part of 2025 or early 2026”. However, the Philippine government has been promising this status change every year since at least 2017. Every year, too, this promise has been broken.

The Philippines is by no means unique in being a perennial middle-income country. But its case is special because the Philippines has been stuck in lower-middle-income status for at least 35 years. This long period allowed several ASEAN countries to overtake the country economically.

When we contrast all 10 ASEAN countries, the Philippines’ trend of GDP per person sticks out as a sore thumb: the trend line is distinctly flatter compared to the rest of the region.

What gives? How can the Philippines escape this lower-middle-income trap?

Sound macroeconomic fundamentals would be key, and in this regard, the Philippines has no major problem. It has come a long way since the gross economic mismanagement during the Marcos dictatorship (1972-1986), which culminated in the country’s worst post-war recession from 1984 to 1985. Growth is steady, overall inflation has been in single digits for decades, and unemployment recently reached a historic low.  

The bigger sticking point lies in the economy’s structure and how it is transforming. Figure 3 shows a spurt of industrialisation in the 1960s and 1970s, peaking in 1981. But since then, the share of industry in GDP has gradually declined and stagnated.

Figure 3. De-industrialising since 1981… too early

By contrast, the Philippines is now a service-driven economy, with services accounting for 62.3 per cent of its GDP in 2023. The predominance of services in the Philippines is part and parcel of a growing trend in many developing countries called “premature deindustrialisation”. More and more countries have leapfrogged from agriculture to services, bypassing industry — and this is not necessarily bad.

Yet the Philippines seems to have largely missed out on the promise of industrialisation, insofar as industry — especially if export-oriented — holds out great potential technological progress and positive spillovers.

Indeed, export-oriented industrialisation has brought many Asian economies on a path towards prosperity. Vietnam, for instance, is now a manufacturing hub for many prominent tech companies such as Samsung, Intel, Apple, and LG. It is also leading in electric vehicle exports. Leaning into this export-oriented strategy has resulted in massive dividends for Vietnam, whose electronics exports amount to US$11.5 billion monthly. By contrast, the Philippines’ exports remain stuck in low-value-added semiconductors and other electronic components. Its total exports are a little over US$6 billion monthly.

A recent World Bank study showed that Vietnam’s booming exports have made ripples across its economy so that even workers in non-export-oriented industries have benefitted. The export boom has lifted wages and promoted employment across Vietnam, especially among lower-income groups. The export boom also tended to reduce the premium on college degrees while fostering wage growth for non-degree-holding workers, allowing better chances for economic mobility for those with lesser education. Women, too, benefitted a lot more in terms of wages.

Vietnam’s experience offers hope for countries like the Philippines, which are stuck in a rut. Some economists have argued that the Philippines has lost its chance at industrialisation. But Vietnam’s case suggests it may not be too late for the Philippines.

The first step is to address the dearth of investments, especially in export manufacturing. As early as 2007, South Korean investments flocked to Vietnam, attracted by cheap labour, good infrastructure, and a host of incentives. By contrast, the Philippines’ foreign direct investments of late have declined steadily since 2021, precisely because of opposite factors: expensive labour, bad infrastructure, and insufficient incentives.

It is not too late for the Philippines, but its leaders must step up and not be lulled into complacency by the sparkly growth figures.

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