Philippine Industrialization

The Philippines and its industrial sector had much potential before; they were considered as early leaders in East Asia. However, neither has lived up to initial expectations. A sophisticated manufacturing sector and a prospect of export-oriented industrialization started to bloom in the 1950’s and 1960’s. But for the past thirty years, Philippine performance has been unsatisfactory. Manufacturing output has grown at a very slow rate, little structural change took place, export has concentrated on one product group (electronics), and export growth has been poor.

Although poor performance can be attributed to factors outside the sector, an analysis of the manufacturing sector reveals the flaws of the Philippine economy. These include:

·         Misguided and costly interventions

·         Infrequently developed international orientation

·         A tendency to focus on rents rather than efficiency on poor support facilities

·         An uncompetitive cost structure

Trends in Output, Employment, and Productivity

The ‘boom bust” pattern characterizes Philippine industrialization and the economy as a whole. The manufacturing sector had been inward looking and it relies on domestic demand for its growth. The cyclical pattern continued until the 1970’s with a sharp decline in 1971-72 followed by strong growth. The economy slowed down after that and eventually crashed in 1983-86. During the Aquino administration, a short recovery followed. Positive growth continued until the Ramos regime and the Asian crisis broke out. Growth resumed by 1999.

The Philippines had one of the highest shares of manufacturing in Asia in the 1960’s; this is reflected by high initial income per capita and an early push for industrialization. Manufacturing share remained constant from 1970-1990. But after that, it declined steadily.

Two unusual features describe the country’s industrialization experience starting 1970, relative to the East Asian comparative context. First, there has been a rapid structural change. Second, there has been a process “de-industrialization” occurring at a low per capita income.

Three relevant explanations for this include:

·         The trade liberalization during the 1980’s, which accelerated in the next decade. The agricultural sector received higher protection rates than the manufacturing sector and the industrial sector became labor-intensive.

·         The real appreciation of the peso through the 1990’s until the Asian crisis, which reduced the competitiveness of tradable goods activities.

·         Tightened labor market regulations in the post-Marcos period increased wages in the formal sector. Relative wage levels became higher compared to that from neighbouring countries, which affected competitiveness in tradable goods industries.

Although the liberalization reforms produced a more efficient manufacturing sector, the growth in manufacturing productivity has been unsatisfactory. The sector accounted for little more than 20% of GDP, and less than 20% of employment. Because of this, it seemed like the country has a stronger comparative advantage in services production as compared to manufacturing. Total factor productivity (TFP) growth estimates reflect sluggish growth.

Philippine industries are ranked using four standard measures:

·         Value added per worker – a measure of capital intensity

·         Wages per worker and the proportion of skilled workers – indicators of skill intensity

·         Fixed capital per worker – a measure of physical capital intensity

·         R&D as a percentage of total expenditure – measures R&D intensity

Food-processing industries are close to industry averages, while beverages are more capital and skill-intensive. Meanwhile, tobacco products have high figures for value added due to product differentiation.

Compared to its Asian neighbours, Indonesia, Malaysia, and Taiwan, the Philippine industrial sector is quite small. Its growth has been much slower and its output and employment shares are below those of the other countries. Capital intensities are quite similar across countries. Philippine industrial exports exceed those of Indonesia, but are smaller than those of Malaysia and Thailand. Philippine foreign investment is of intermediate ranking.

Industry Structure and Major Sectors

There has been a lack of structural modification within manufacturing. Food processing, beverages, and tobacco dominate the sector, with 50% of value added and 22-25% of employment. The output shares of labor-intensive and heavy industry are similar. The share of labor-intensive industries did not rise in spite of liberalizing reforms in the 1980’s. Almost all of the incremental expansion in the output share of labor-intensive industries since the 1980’s is accounted for by electronics – it has been performing well and is now the third largest employer. Garments, footwear, and a diverse range of export-oriented labor-intensive industries have performed well. This is in contrast to the declining output and employment of the industries of textile, wood products, metal goods, and machinery. Meanwhile, the heavy industries sector has been unable to adjust to the new, less protected environment.

The electronics sector has been very successful. Electronics exports have grown rapidly; in fact, its share is the highest among East Asian countries and the country now registers on international markets as it supplies 2% of global exports. This is a case of regulatory reform that released the Philippines’ comparative advantage in skilled and semi-skilled labor. This is an import-export operation where local value added is slim, backward linkages are not yet fully developed, the local R&D base is insignificant, the industry is weakly connected to consumer electronics, and infrastructure challenges also exists. Linkages need to improve by reducing barriers between the export zones and the rest of the economy. The zones’ fiscal incentives may also not be sustainable in the long run.

The automotive industry has not been as successful as the electronics sector. Even with the 1973 Progressive Car Manufacturing Plan Production, runs were still uneconomic, the foreign parties did not supply the appropriate technology, subcontracting networks did not flourish, and vested interests developed. Even if liberalization started in the early 1990’s, the investment climate remains unfavourable to attract foreign capital. Auto production was just one-third that of Indonesia and one-quarter that of Thailand; exports were insignificant.

The Philippine textile and garments industry was overtaken by that of its neighbours in spite of its potential comparative advantage, competitive exchange rate, and remarkable design skills. The textile industry failed to adjust from a protected to an outward-looking environment. The industry is burdened with uneconomic production runs and scale, poor quality control, undeveloped facilities, high costs, and poor export performance.

Export Structure and Performance

The total value of exports rose five times from $7.8 billion to $38.1 million in the 1990’s. Growth momentum was maintained during the succeeding years, allowing the country to survive the Asian economic crisis more successfully than any other crisis-affected economy.

Three quarters of Philippine merchandise exports was accounted by the electronics and related machinery products sectors. From 1990-2000, total exports increased by $30.3 billion, manufactured exports rose by $28.2 billion, while electronics and manufacturing rose by $28.5 billion. Non-manufacturing exports were constant and non-electronics manufacturing exports declined. The 1990’s export growth was driven by foreign-owned electronics firms in the export-processing zones. The Philippine Export Zone Authority (PEZA) pointed out that during 1995-1999, electronics accounted for more than half of total PEZA investments, while machinery and equipment accounted for more than one-third of investments. Majority of the exports originated form multinational corporations (85%), where 46% were from Japanese firms.

Export intensity varied across manufacturing industries. It has been observed that the country’s comparative advantage lies in labor-intensive industries, and its former advantage in resource-based activities has almost disappeared. Because of this, a high correlation between the percentage of output and labor intensity is foreseen. In addition, export shares and foreign ownership is expected since foreign firms are important for successful export orientation.

Data from 1985-2000 show the dominance of electronics; local value added constitutes just a small share in this sector. One of the hurdles of the Philippine industry is the need to diversify away from its dependence on labor-intensive electronic exports. It has sought to shift away from relying on a small range of exports; however, the structure became even more concentrated in a narrow range of products.

The success in electronics showed that the country is competitive in a large and expanding industry in which international trade barriers are small. It also established the country’s reputation among international market groups. It has been argued that heavy reliance on the electronics sector poses risk because it has shallow linkages with the economy and it is prone to international migration when labor costs rise or when fiscal incentives expire. These statements are, however, overstated because the nature of the industry also evolves as industrialization progresses. It was also observed that linkages do not introduce limitation. Local suppliers meet the specifications of multinational corporations over time as these corporations induce supplier firms to relocate and as local firms become more competent.

If the country is exposed to the performance of just one industry, high export concentration becomes risky. This becomes a major concern. Analysts have been puzzled that there are just a few strong export performers in Philippine manufacturing.

Countries in East Asia have undergone outward-oriented industrialization; the Philippines, however, has gone the opposite direction. The country has lost its comparative advantage in resource-based industries; it has recorded poor performance from labor-intensive industries. The reason why the electronics sector stands out lies on the dualistic nature of the export policy regime. Liberal provisions were applied to export-processing zones. Firms in these zones are protected from the constraints in the rest of the economy: there are no ownership restrictions; bureaucratic hurdles are insignificant; fiscal incentives are available; there are ample utility supplies; and there is unhindered access to the international markets. Firms in the zones can tap into the country’s best comparative advantage. Through regulatory reform, the success in the zones can be replicated elsewhere.

Governments need to make sure that trade restrictions or regulations do not prohibit backward integration. Also, as labor-intensive activities are left, proactive measures must be enacted to ensure that the necessary skill base is in place. The base of the operations of PEZA must be broadened, and in effect create a nationwide PEZA.

Ownership Patterns and Concentration

Foreign investment in the Philippines was modest by East Asian norms. Shares were low because of reluctance to invest in the country and domestic political opposition to a large foreign presence. Until the 1980’s restrictions were placed on foreign equity shares and sectors of activity. A complex regulatory regime and foreign exchange licensing also deterred foreign investment. The country missed out on Asia’s foreign investment boom in the early 1980’s to the mid-1990’s because political instability, economic crisis, and disputes with international creditors.

Since there are only a few entry barriers for foreign firms in the country, interindustry variations in foreign ownership are likely to follow the pattern specified by standard industrial organization theory: foreign ownership would be above average in industries characterized by intense R&D, product differentiation, high export orientation, and large absolute capital requirements[1]. This is exactly why foreign firms are dominant in petroleum refining, non-ferrous metals, and electronics.

Industrial organization theory also explains why there are interindustry variations in seller concentration. High seller concentration is predicted in industries characterized by considerable barriers to entry (scale economies, product differentiation, capital requirements). Studies have shown that industry profitability is positively associated with concentration, capital intensity, and foreign ownership, but negatively associated with imports, it is possible that high profitability reflects “Schumpterian efficiency”. However, the persistence of these econometric results suggest otherwise. Seller concentration has been declining for major industry groups since the early 1980’s. This suggests that Philippine manufacturers face stronger competitive pressures than was the case in the 1980’s.

A competition policy must be set. Provided that import and domestic distribution channels operate competitively, the most effective anti-monopoly policy is an open trade regime. The Philippines has made progress over the past decade, but it also has several unfinished agenda. The country’s capacity to implement a sophisticated and complex institutional structure is in question though. Given the poor regulatory record of its stock exchange and its powerful legal industry, such an institution might be captured by vested interests and could just be an additional layer of bureaucracy that with which firms have to negotiate.

Small and Medium-Sized Enterprises (SMEs) and Size Distribution

Industrialization calls for a strong SME sector because it provides base for major industries; it is a source of industrial resiliency and flexibility; and it contributes to broader development objectives and equity inclusion.

Data from 1978 and 1995 suggest that the size distribution of the Philippine manufacturing industry has not drastically changed. Large firms dominate the manufacturing sector – with three-quarters of value added and two-thirds of employment. Middle-sized firms are insignificant, while small firms make up about one-quarter of employment and one-eighth of value added.

As expected, there is interindustry variation in the size distribution of firms. As suggested by industrial organization theory, small firms are more important in labor-intensive industries, in which economies of scale in the production or marketing processes are less significant. On the other hand, large-scale firms dominate in the technology and capital-intensive sectors.

There is little evidence on the presence of SME exports. It is probable that size is not the key determinant of outcomes, but factors like: export orientation, degree of foreign ownership, exposure to unhedged foreign currency borrowings, and industry location. Because of these factors (the lack of them), smaller industries fared worse than the larger ones.

Since the manufacturing sector has not been growing quickly, a lack of SME dynamism is perceived. Also, the size structure of Philippine firms is characterized by extensive segmentation and a “missing middle” is evident. These two suggest that Philippine manufacturing has a bimodal size distribution, signifying a lack of mobility and an unintegrated industrial sector. Evidence from the Philippines indicates that large firms are many times more capital intensive than small firms, relative to other countries.

Explanations for this phenomenon include:

·         The historical policy regime (government intervention) and segmented factor markets

·         The interconnected influences of factor markets and government regulations. These consist of incentives for small firms not to grow and access to the formal financial sector

·         Infrastructure constraints

Spatial Patterns of Industrialization

Due to significant interregional diversity in relative resource endowments and extensive intersectoral policy intervention, the extent and nature of industrialization in the Philippines is expected to be regionally diverse. However, there are no differences in factor endowments across Luzon, Visayas, and Mindanao. This suggests, in aggregate, an absence of highly capital-intensive enclave manufacturing.

A distinct industrialization pattern emerges, where the greater Manila region, including Central Luzon and Southern Tagalog is dominant (78.5% of value added and 77.4% of employment). Value added and employment seem to increase over time. A combination of regulatory pressures and lower production costs likely explains the spillover from the national capital. The rise of export zones beyond the southeastern boundaries of Manila accelerated the trend in recent years.

Beyond Manila, there is trivial modern-sector industrial activity. The country’s rural industrialization has stagnated. In Central Visayas, the major industrial zone is centered on Cebu. The share of Western Visayas has fallen since the 1970’s, reflecting the declining performance of the sugar industry. Industrial clusters in Mindanao are found in large cities in Southern and Northern Mindanao, such as Davao.

The regional manufacturing profiles verify the a priori expectations of spatial patterns of comparative advantage. The more industrialized regions have a more diversified industrial structure with both footloose and export-oriented activities. On the other hand, less industrialized regions rely on resource-based processing industries and simple consumer goods and have little industrial diversity. The largest industry in Central Luzon and Southern Tagalog is petroleum refining, while in Manila it is chemicals. The largest industry in Cebu is electronics, while food processing and beverages dominate most of the remaining 12 regions.

The spatial concentration patterns are likely to continue into the future. It is possible for Manila’s share for manufacturing to decline due to decentralization initiatives and urban costs; however, it will still be the most attractive location for manufacturing investments because of its economies of scale and scope. Industries that require technical and scientific labor will also be attracted to the city’s pool of skilled labor. The manufacturing base may expand as transport networks and utilities become more available. Cebu, on the other hand, can secure its position as the second largest manufacturing center, with a diverse range of export and domestic market industries. Mindanao can become a major producer of resource-based manufacturing if peace and order are established.

The government’s successful export zone strategy has reinforced the concentration of industrial activity in Luzon. Partial reforms of this type are desirable, over time the zones may reach other parts of the country. However, the zones have unintended spatial implications, and they have operated contrary to goal of spatial deconcentration.

Import Protection

By the end of 1990’s the Philippines had a clean and undistorted trade regime where: average tariff levels are reasonable; non-tariff barriers are few; and interindustry variations in effective rates of protection are sensible. Protection rates for agriculture now exceed manufacturing and the most serious non-tariff barriers are also located in the said sector. This highlights the importance of high-quality intellectual effort in exposing the costs of extensive trade policy intervention and the works of policy reformers. This has been a process driven by Philippine researchers and officials.

Interindustry differences in effective protection have not vanished. Previous protection for transport equipment, tobacco products, beverages, and chemical products still remain. Tan (1986) pointed out that there is a cascading structure of protection, where finished consumer goods receive higher assistance than inputs and capital goods. Because the most protected industries are above average in capital intensity and located disproportionately in urban areas, a bias employment and rural development arises.

If high variable protection coincides with foreign ownership, the possibility of immiserizing industrial growth arises: foreign firms extract rents from internationally inefficient industries, with little resultant benefit for the national economy. If protection coincides with concentration, a serious competition problem might occur because competitive pressures from both domestic and international sources are muted.

Most of the industries receiving protection have a sizable foreign presence. In addition, for major protected industries, foreign-owned firms produce at least one-third of industry output. However, there are also a few FDI-intensive industries receiving below average protection; so, the correlation between protection and foreign ownership is not overwhelming. The correlation between protection and concentration is also not pronounced as there are a few instances where the two coexist and there are those where the reverse is true.

Key Policy Changes

The record of industrialization reflects a bigger story of Philippine development. Slow economic and employment growth and the lack of dynamism in the SME sector have led to a continuing high poverty incidence. The mixed record of exports reflects the failure to embed a commitment to international orientation. Stagnation in rural industry has contributed to the unsatisfactory record of spatial development. The limited adoption of modern technology has held back the full utilization of human capital capabilities.

Rapid economic and industrial growth can be attained through a set of factors: good macroeconomic management, openness, sound and predictable institutions, an efficient financial sector, a reasonable measure of equity, good physical infrastructure, and a supportive external environment. In addition, the policies to promote rapid industrial expansion should be part of an overall strategy of accelerated, equitable growth.

Incentive Regime

Forward reform momentum must be maintained, but tariffs must be lowered and unified and non-tariff barriers must be removed. Structural adjustment must be applied to industries that are affected by exchange rate movements and workers must be provided although assistance must be time-bound and transparent. To ensure that manufacturers operate in a competitive environment, trade liberalization must be developed. Regulatory reform and bureaucratic simplification will complement such reforms. The fiscal incentives of export zones must also be reduced over time and integrated into a general fiscal reform package. The zones themselves will remain useful in encouraging government regulators to match the standards of PEZA. On the other hand, international market access does not pose a problem for manufacturers given the current structure of exports. Also, it will be beneficial for the country to immediately multilateralize its commitments to the ASEAN Free Trade Area (AFTA), as in the past.

Innovation and Diffusion Rates

To maximize innovation and diffusion capacities that are consistent with exploiting comparative advantage in unskilled and semi-skilled labor industries, the government’s science and technology policies should aim to remove barriers to inflows to technology and ensure that there is ample capacity for inflows to be utilized by local firms and workers. This can be achieved through:

·         An open policy toward the inflow of FDI and skilled labor

·         A commitment to high-quality public education system

·         Government support to R&D and reinforcement of domestic diffusion of public domain technologies. The government should develop the industrial extension services.

As for the limited backward linkages and relatively simple technological processes of the Philippine export zone activities, it will take time to develop them and government reforms are important to reduce the enclave nature of the zones.

Constraints to Industrial Growth

The government must ensure that the price, availability, and quality of requisite services are internationally competitive for firms to be able to compete with international producers. These include domestic and international telecommunications services, domestic and international shipping and civil aviation, airports and harbors, the domestic road network, financial services, the taxation regime, import-export procedures, and the general regulatory/licensing regime. There are departures with international norms of best practice for these services and they must be developed.

Source:
Hill, Hal, “Industry.” The Philippine Economy: Development, Policies, and Challenges, (Ateneo Press, 2003).

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[1] There are departures to theory, especially for small industries, where one or two large firms assume significant importance.