A new industrial policy for the Philippines -- 1

Yellow Pad

Rafaelita M. Aldaba

Posted on January 07, 2013

IMPORT SUBSTITUTION and trade liberalization strategies

In its quest for industrialization, the postwar Philippine economy adopted a complex array of
protective policies through high tariffs, quantitative restrictions and regulatory controls on prices,
domestic supply, and market entry. However, after more than three decades of protectionism and
import substitution, the policies failed to provide an efficient mechanism for allocating domestic
resources in the economy.

Beginning in the 1980s, the Philippine government was prompted to implement policy reforms
consistent with the requirements of a competitive market environment. Manufacturing was
liberalized by removing tariff and non-tariff barriers. Foreign investment rules were relaxed and a
new Omnibus Investment Code was legislated to simplify the investment incentive system. To
promote export-oriented investment, the Philippine Economic Zone Authority (PEZA) was created,
along with development of the Clark and Subic military reservations into special economic zones.

Since 2004, no major unilateral tariff changes have been made; mostly the tariff reductions carried
out were those covered by the ASEAN Free Trade Area-Common Effective Preferential Tariff (AFTA-
CEPT) scheme along with other free trade agreements (FTAs) of the Philippines such as the Japan-
Philippines, ASEAN-Korea, and the ASEAN-China.

LACK OF STRUCTURAL TRANSFORMATION AND DIVERSIFICATION

Despite the breadth and depth of market-oriented reforms, the impact on the growth, employment,
investment, and productivity of the manufacturing industry has been limited as the performance of
the overall manufacturing industry has been weak. There has been no structural transformation of
the economy from agriculture to manufacturing, no rapid industrial growth led by manufacturing.
Instead, as Fabella and Fabella (2012) highlighted, development progeria (premature aging)
characterized the Philippine economy. This is manifested by the rise in the share of services and fall
in the share of industry and manufacturing sectors.

From the 1980s up to the early 2000s, manufacturing growth was slow, with an average of 0.9% in
the 1980s and 2.5% in the 1990s. Modest growth was posted in the 2000s, averaging 4.1%. The
share of manufacturing to total industrial output remained unchanged during the same periods
accounting for 28% of total output in the 1970s, 26% in the 1980s, and 24% in the 1990s and 2000s.
In terms of employment generation, the manufacturing industry failed in creating enough
employment to absorb new entrants to the labor force as its share in total employment dropped
from 11% in the mid-1970s to 9% in the 2000s. The industrys total factor productivity growth was
negative from 1996 to 2006. (See table)

The Philippine export base has become less diversified as the countrys exports are largely
concentrated in three product groups: electronics and other electronics, garments and textile, and
machinery and transport equipment. Within these major product groups, exports are highly
concentrated in low value-added and labor-intensive products sectors. These goods are considerably
dependent on imported inputs and have weak backward and/or upward linkages with the rest of the
manufacturing sectors.

The industrial structure has remained hollow or missing in the middle and medium enterprises
have never seriously challenged the large entrenched incumbents. The linkages between small and
medium enterprises (SMEs) and large enterprises have also remained weak. SMEs have continued to
face competitiveness problems along with difficulties in finance and market access.

While our neighboring countries registered substantial increases in the share of industry, in the
Philippines, the share of industry declined and remained stagnant in the past two decades. Due to its
lackluster growth, it was services that absorbed workers moving out from agriculture and new
entrants to the labor force. On the average, unemployment rate was about 7.6% during the 2005-
2010 period, while underemployment remained high at 20.14% during the same period.

LESSONS FROM THE PAST

After more that two decades, the growth impact of trade liberalization has been less than expected.
The Asian Development Bank (2007) and the World Bank (2007) cited factors that have undermined
the positive impacts of trade liberalization. These are macroeconomic instability, inadequate
property rights, presence of distortions in the credit markets, and weaknesses in the larger
regulatory environment and investment climate. The prolonged peso appreciation and the failure of
government measures to address this inhibited much of the potential growth from a more open
economy. Tight fiscal condition due to huge fiscal deficits, lack of infrastructure, and weak investor
confidence arising from governance issues like corruption and political instability have constrained
growth, investment, and employment generation in the country. As a result, trade liberalization did
not succeed in realizing efficient reallocation of resources and helping firms and workers move to
higher productivity activities and jobs.

Our experience shows that trade liberalization does not automatically lead to growth or to a
competitive domestic market economy. Though imports are effective in disciplining domestic
manufacturing firms, the government has an important role to play particularly in creating and
maintaining a competitive environment. It needs to coordinate policies to implement trade
liberalization in tandem with the necessary support measures that will address the obstacles to the
entry, exit and growth of domestic firms.

Currently, firms continue to face major constraints such as poor infrastructure and logistics; lack of
domestic raw material suppliers, parts and components; bureaucracy, red tape, and policy
inconsistency, and lack of highly skilled workers and lengthy and non-transparent process in dealing
with labor issues. To maximize gains from liberalization and economic integration, certain conditions
must be present: sound investment climate, sufficiently large human capital, and absence of
domestic distortions like credit constraints.

The government must substantially increase infrastructure investment spending and strengthen the
institutional and regulatory environment. Supply chain gaps must also be addressed along with the
development of our parts and components industries. Adjustment measures like temporary industry
support measures and training and job search assistance for displaced workers are also necessary to
enable firms to cope with the new operating environment.

The author is senior research fellow and acting vice-president, Philippine Institute for Development
Studies. Email: raldaba@mail.pids.gov.ph

POLITICAL ECONOMY OF DEVELOPMENT

Philippines Table of Contents
Economic Development Until 1970

In the mid-nineteenth century, a Filipino landowning elite developed on the basis of the
export of abaca (Manila hemp), sugar, and other agricultural products. At the onset of the
United States power in the Philippines in 1898-99, this planter group was cultivated as part
of the United States military and political pacification program. The democratic process
imposed on the Philippines during the American colonial period remained under the
control of this elite. Access to political power required an economic basis, and in turn
provided the means for enhancing economic power. The landowning class was able to use
its privileged position directly to further its economic interests as well as to secure a flow
of resources to garner political support and ensure its position as the political elite.
Otherwise, the state played a minimal role in the economy, so that no powerful
bureaucratic group arose that could pursue a development program independent of the
wishes of the landowning class. This situation remained basically unchanged in the early
1990s.

At the time of independence in 1946, and in the aftermath of a destructive wartime

occupation by Japan, Philippine reliance on the United States was even more apparent. To
gain access to reconstruction assistance from the United States, the Philippines agreed to
maintain its prewar exchange rate with the United States dollar and not to restrict imports
from the United States. For a while the aid inflow from the United States offset the
negative balance of trade, but by 1949, the economy had entered a crisis. The Philippine
government responded by instituting import and foreign-exchange controls that lasted until
the early 1960s.

Import restrictions stimulated the manufacturing sector. Manufacturing net domestic

product (NDP) at first grew rapidly, averaging 12 percent growth per annum in real terms
during the first half of the 1950s, contributing to an average 7.7 percent growth in the
GNP, a higher rate than in any subsequent five-year period. The Philippines had entered an
import-substitution stage of industrialization, largely as the unintended consequence of a
policy response to balance-of-payments pressures. In the second half of the 1950s, the
growth rate of manufacturing fell by about a third to an average of 7.7 percent, and real
GNP growth was down to 4.9 percent. Import demand outpaced exports, and the allocation
of foreign exchange was subject to corruption. Pressure mounted for a change of policy.

In 1962 the government devalued the peso and abolished import controls and exchange
licensing. The peso fell by half to P3.90 to the dollar. Traditional exports of agricultural
and mineral products increased; however, the growth rate of manufacturing declined even
further. Substantial tariffs had been put in place in the late 1950s, but they apparently
provided insufficient protection. Pressure from industrialists, combined with renewed
balance of payments problems, resulted in the reimposition of exchange controls in 1968.
Manufacturing recovered slightly, growing an average of 6.1 percent per year in the second
half of the decade. However, the sector was no longer the engine of development that it
had been in the early 1950s. Overall real GNP growth was mediocre, averaging somewhat
under 5 percent in the second half of decade; growth of agriculture was more than a
percentage point lower. The limited impact of manufacturing also affected employment.
The sector's share of the employed labor force, which had risen rapidly during the 1950s to
over 12 percent, plateaued. Import substitution had run its course.
To stimulate industrialization, technocrats within the government worked to rationalize and
improve incentive structures, to move the country away from import substitution, and to
reduce tariffs. Movements to reduce tariffs, however, met stiff resistance from
industrialists, and government efforts to liberalize the economy and emphasize export-led
industrialization were largely unsuccessful.