External shocks, adjustment policies, and investment : illustrations from a forward-looking CGE model of the Philippines

This paper presents a model that integrates intertemporal and forward-looking behavior in investment and consumption decisions in a multisectoral general equilibrium framework applicable to developing countries. It formulates and uses an infinite-horizon growth model to examine the adjustment, growth, and debt problems of a middle-income country, which the author illustrates using data for the Philippines. The author concludes that the expectation is a key factor. Contrary to the common suggestion that an economy should adjust and contract in response to a permanent import price shock, the behavior suggested in a model with rational expectations in investment decisions is that the opposite can be true. Combined with other policies, tariff reform could rechannel investment and resources toward the more tradable sectors and exports can be emphasized and increased. If domestic resources are also mobilized through increased tax collection, the combined effect will be to reduce or slow the accumulation of foreign debt. In other words, middle-income countries like the Philippines missed a golden opportunity for policy reform in the 1970s and found it harder to implement adjustment policies under less favorable circumstances in the 1980s.