Report No. 2513-PH Industrial Development Strategy and Policies in the Philippines Volume 1: The Summary Report October 29, 1979 Country Programs Department East Asia and Pacific Regional Office Industrial Development and Finance Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRFNCY EQUIVALENTS US$1.0 P 7.40 p 1.00 US$0.135 P 1 million = TS$135,135 P 1 billion US$135 million ABBREVIATIONS ADB - Asian Development Bank AIIA - Agricultural Investment Incentives Act (R.A.) ASE - Annual Survey of Establishments BFAR - Bureau of Fisheries and Aquatic Resources BOI - Board of Investment CB - Central Bank of the Philippines COE - Census of Establishments CSMI - Commission on Small and Medium Industries DAP - Development Academy of the Philippines DBP - Development Bank of the Philippines DCP - Design Center of the Philippines DLC - Department of Loans and Credit (of CB) ECA - Economic Cooperation Administration (of the US) EPZA - Export Processing Zone Authority PCDU - Foreign Currency Deposit Units FDA - Food and Drug Administration, Ministry of Health FNRI - Food and Nutrition Research Institute PORPRODICOM - Forest Products Research and Industry Development Commission FRR - Financial Rate of Return FTI - Food Terminal Incorporated IDRC - International Development Research Center IED - Institute of Export Development (of BOI) IGF - Invention Guarantee Fund IGLF - Industrial Guarantee and Loan Fund IPP - Investment Priorities Plan IPPP - Industrial Promotion Policy Project at the University of the Philippines IRRI - International Rice Research Institute ISEC - International Services Executive Corporation MASICAP - Medium and Small Industry Coordinated Action Program MOA - Ministry of Agriculture MNA - Maritime Industry Authority MIRDC - Metals Industry Research and Development Center MOI - Ministry of Industry MSI - Medium-Scale Industries NACIDA - National Cottage Industry Development Authority NBFI - Von-Bank Financial Intermediaries NCSO - National Census and Statistics Office NEDA - National Economic and Development Authority NFFA - National Federation of Fishing Association NIST - National Institution of Science and Technology NPCC - National Pollution Control Commission NSC - National Steel Corporation NSDB - National Science Development Board OBU - Offshore Banking Unit -i -FOR OFFICIAL USE ONLY OIA - Office of the Internal Audit (of CB) PCMP - Progressive Car Manufacturing Program PD - Presidential Decree PDB - Private Development Banks PDCP - Private Development Corporation of the Philippines PCFM - Philippine Chamber of Food Manufacturers, Inc. PCHI - Philippine Chamber of Handicraft Industries PEC - Philippine Export Council PFFPI - Philippine Federation of Food Processing Industries PFCA - Philippine Fish Farmers Association PFPA - Philippine Fruit Processors Association PISO - Philippine Investments Systems Organization PNB - Philippine National Bank PSTC - Philippine Shoe Trading Corporation PSC - Price Stabilization Council PTMP - Progressive Truck Manufacturing Program PTPEA - Philippine Tuna Producers and Exporters Association PTRI - Philippine Textile Research Institute RA 5186 - Republic Act 5186: Investment Incentives Act RA 6135 - Republic Act 6135: Export Incentives Act RC - Review Committee (of IGLF) SBAC - Small Business Advisory Centers SMI - Small and Medium Industries STD - Special Time Deposits TAC - Trade Advisory Councils TCNAP - Tin Can Manufacturers Association of the Philippines, Inc. TDC - Technology Development Center TRC - Technology Resources Center UNIDO - United Nations Industrial Development Organization UP - University of the Philippines UPISSI - University of the Philippines Institute for Small-Scale Industries USAID - United States Agency for International Development FISCAL YEARS July 1-June 30 (up to June 30, 1975) July 1-December 31, 1975 (interim) January 1-December 31 (from January 1, 1976) IThis document has a restricted distribution and may be used by recipients only in the performance | of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. - lii - Page I MANUFACTURING: BASIC DATA Annual Rate of Growth (%) 1970 1977 1970-76 GDP (billion pesos, 1972 prices) 51.0 78.0 6.2 ManufacturinR Gross Value Added 11.8 18.6 6.7 (billion pesos, 1972 prices) Foodstuffs, beverages, tobacco 4.9 7.4 6.1 Textiles, clothing and footwear 1.1 1.8 7.3 Wood and furniture 0.5 0.8 7.0 Chemicals, rubber, oil & coal products 2.0 4.1 10.8 Nonmetallic mineral products 0.5 0.6 2.6 Basic and metal products, mechanical & electrical machinery, transport equipment 1.9 2.8 5.7 Other 0.9 1.1 2.9 Investment as Z of GDP (1975) 1970 1975 ManufacturinR Investment 2.4 2.1 4.71 2.86 (billion pesos, 1972 prices) Labor Force Total (in thousands) 10,729 14,663 5.3 Manufacturing (in thousands) 1,323 1,680 3.1 x of labor force 12.3% 11.0% Factory (in thousands) 404 .630 7.6 Z of manufacturing 30.5% 37.5% (1974) Shares in Factory Labor Force Foodstuffs, beverages, tobacco 13.2 17.0 Textiles, clothing and footwear 55.0 38.4 Wood and furniture 9.8 8.7 Chemicals, rubber, oil & coal products 2.2 5.2 Nonmetallic mineral products 1.8 2.7 Basic and metal products, mechanical & electrical machinery, transport equipment 13.8 16.8 Other 4.2 11.2 - iv - Page 2 Annual Rate of Growth (%) (Current prices) Exports (Million US$, 1973 1975 1977 1973-77 current prices) Total Exports 1,886.3 2,294.5 3,150.9 13.7 Traditional Exports 1,543.9 1,769.4 2,085.1 7.8 Sugar 293.6 614.6 532.2 16.0 Coconut 373.6 466.4 761.0 19.4 Minerals 334.3 255.8 302.3 -2.5 Forest products 416.5 225.2 261.5 -11.0 Fruits & vegetables 25.1 45.2 74.8 31.6 Other 100.8 162.2 153.3 10.9 Nontraditional Manu- factured Exports 226.8 374.3 717.0 33.3 Garments 58.0 107.0 250.2 44.3 Handicrafts 27.4 78.2 84.1 32.6 Electrical & electronic equipment & components 11.3 47.3 124.3 82.0 Non-metallic mineral manufactures, particu- larly cement 25.2 32.2 38.7 11.4 Chemicals 10.6 22.1 54.6 50.9 Wood manufactures, excl. plywood, veneer & lumber 17.2 16.9 35.6 20.0 Food products & beverages 15.0 14.7 30.7 19.5 Machinery & transport equipment 3.4 9.5 27.3 68.2 Textile yarn, fabrics & other related products 17.3 8.7 12.5 -22.1 Cordage, cable, ropes & twines 4.6 7.6 12.5 28.4 Other 36.8 30.1 46.5 6.1 Nontraditional Products (Unmanufactured) 55.4 135.5 323.7 55.5 Special Transactions & Re-Exports 60.2 15.3 25.1 -19.6 - v- Page 3 1977 Direction of Exports US$ million % of total World 3,150.9 100.0 United States 1,102.6 35.0 Japan 726.9 23.1 Netherlands 281.8 8.9 Germany 137.6 4.4 Union of Soviet Socialist Republics 130.1 4.1 People's Republic of China 108.0 3.4 United Kingdom 70.7 2.3 Singapore 64.5 2.1 Australia 60.4 1.9 Other 468.3 14.8 - vi - PREFACE This report presents the findings of an Industrial Sector Mission which visited the Philippines in February 1979 to review industrial strategy and policies, including rehabilitation and other programs toward further development and greater efficiency in a number of specific industries. The Report is in three volumes: One, The Summary Report; Two, the Main Report; and Three, the Statistical Appendix and Annexes with more detailed data. The scope of the Mission has been sketched in Chapter 1 of the Main Report. From the very start the work of the Mission was conceived as a joint Philippine-World Bank effort. Without the close cooperation and assistance of Philippine officials, the Mission could not have undertaken its task. After a preparatory visit by the Mission Chief in November 1978, the Minister of Industry arranged for several industry studies which were made available to the Mission on its arrival. The Minister also appointed a Coordinating Committee chaired by Rafael A. Sison, Deputy Minister and Conrado Sanchez, Jr., Supervising Governor, Board of Investments. The Mission members conducted all their field work with the help of Philippine counterparts. Further, in areas outside the purview of the Ministry of Industry and the Board of Investment, the Mission was guided by an inter- agency committee composed of representatives of NEDA and the Tariff Commis- sion, the Ministry of Finance, the Ministry of Natural Resources, the Central Bank, the Development Bank of the Philippines and the Metals Industry Research and Development Center. The Philippine counterpart committees and working groups are listed in Annex I-1. The Mission has benefitted from several earlier studies of Philippine trade, industry and employment problems, notably Vicente B. Valdepenas, Jr., "The Protection and Development of Philippine Manufacturing" (1970); John H. Power and Gerardo P. Sicat, "The Philippines: Industrializa- tion and Trade Policies" (1971); "Sharing in Development, a Program of Employment, Equity and Growth for the Philippines" (ILO, 1974);) and Robert E. Baldwin, "Foreign Trade Regimes and Economic Development in the Philippines" (1975). The Mission has also drawn frequently on the Working Papers of the Industrial Promotion Policies Project conducted in 1978 at the University of the Philippines under the direction of Romeo M. Bautista and John H. Power, and the NEDA/UNDP Export Promotion Project. Several World Bank reports have aided the Mission's analysis: "The Philippines: Priorities and Prospects for Development" (1976); "Staff Appraisal Report on the Second Small and Medium Industries Development Project" (Report No. 2417-PH, March 30, 1979); "Staff Appraisal Report on the Development Bank of the Philippines" (Report No. 1972-PH, April 21, 1978); "A Development Strategy and Investment Priorities for the Central Visayas (Region VII)" (Report No. 2264-PH, January 4, 1979); "An Overview of the Small and Medium Industry in the Philippines," a draft consultant report; and preliminary papers from the Bank's research project on small enterprises (RPO 67-159). - vii - The Mission was composed as follows: Barend A. de Vries - Chief of Mission Christiaan J. Poortman - Economist (Export and Employment Policies) William G. Tyler (Consultant) - Economist (Incentives) Maurice J. Joyce - Industrial Economist (Regional Dispersion, Garment and Cement Industries) Jacob Levitsky - Operations Adviser (Small Industry, Footwear and Furniture Industries) William P. O'Neil - Industry Expert (Steel Industry) Yung Whee Rhee - Economist (Mechanical Engineering Industry) Harry Y.H. Choi (Consultant) - Industry Expert (Mechanical Engi- neering Industry) Harold Catling (Consultant) - Industry Expert (Textile Industry) John P. Allchin (Consultant) - Industry Expert (Food Processing Industry) Kerry B. Busteed (Consultant) - Statistician Carlos F. Singer - Research Assistant The Mission report was discussed with the Government in August 1979 by a World Bank team composed of Messrs. Stanley Please, Barend A. de Vries, Hedayat Amin-Arsala, Lawrence E. Hinkle and Khalid Siraj. INDUSTRIAL DEVELOPMENT STRATEGY AND POLICIES IN THE PHILIPPINES SUMMARY REPORT PART I: ISSUES. RECOMMENDATIONS AND PRIORITIES 1. The Industrial Sector Mission which visited the Philippines in February 1979 dealt primarily with industrial policies and incentives, with a view to exploring ways in which the country can better achieve its objec- tives of broader and more rapid industrial growth, employment creation, export development, regional dispersion and stronger technological capacity. The Mission reviewed the various elements of the incentives system and has sought to determine how they might be adapted to facilitate achieving the Government's objectives'. In undertaking this task, the Mission studied in detail several industries where rehabilitation, new investment and technical assistance are needed to broaden and deepen industrial growth, increase the linkage with other sectors and are required to complement the necessary changes in the incentive system. It also reviewed policies for the develop- ment of small and labor-intensive industries. Specific industries reviewed included steel, mechanical engineering, textile and food processing, and in less detail, cement, garments, footwear and furniture. 2. Part I of this Summary briefly sets forth the principal issues in Philippine industrial development (Section A), discusses the manner in which major objectives might be realized and the policies which might be adopted to that end (Section B)'. Section C deals with industrial investment priori- ties. Part II summarizes the findings on individual industries. A. Issues and Oblectives Current Situation 3. The manufacturing sector has grown to the point that it has become a major factor in the development of the Philippines. It now makes up one- fourth of GDP and compares well in relative size with other countries in a similar stage of development. Besides achieving import substitution of a wide range of consumer products, policies have also stressed primary processing of domestic raw materials for export. Government policies have worked hand-in- hand with private initiative. Several industries are already relatively well established (e.g., food processing, chemical, garments and some consumer durables). More recently, there has been rapid growth of manufactured exports and increasing attention has been given to small industries. 4. Since 1970, policies affecting Philippine industry have undergone several significant changes - including a steep devaluation, measures to help small labor-intensive industries, and the introduction of various export incentives. As a result of these new measures, industry may well -have reached a turning point in the second half of this decade in that, for an increasing part of the sector, both growth and employment creation improved signifi- cantly. However, little change has occurred in the composition of invest- ment, which continued to stress capital-intensive industries; and the export industries enjoying special incentives were in many ways an enclave in an otherwise overprotected domestic economy. 5. The principal issues confronting the Government in shaping indus- trial policy stem from- the poor performance of the sector in terms of capital efficiency and cost competitiveness, as a leader in growth, provider of new employment and as a factor in regional diversification. Overall, manufactur- ing employment has fallen behind the growth of the work force, especially because of the slack in the informal sector. Industrial growth has generally bypassed the small firm, and the very large and important cottage sector - much less concentrated in Metro Manila than organized industry - was virtually stagnant. Further, industrialization has tended to favor production for the home market, and incentives - including the allocation of credit, import protection and investment incentives - favored relatively capital-intensive import substitution industries. The industrialization pattern may have reinforced regional and income disparities as its effect in raising employment and income of the poorest strata was small. In some industries (e.g., food processing), growth was accompanied by increased concentration. 6. Looking ahead, what is needed in Philippine industrial policy is a two-pronged approach. On the one hand, the nontraditional manufactured export drive should continue with increased participation by industries, firms and regions. On the other hand, policies for the home industries should be reoriented toward better utilization of capital and domestic resources and more employment creation. By becoming more competitive and concentrating on branches where the Philippines has comparative advantage, home industries should also be able to export an increasing share of their output, either directly or indirectly. Prospects and Strategy 7. The Philippines is in a strong position to continue expanding its nontraditional exports. They exceeded $1 billion in 1978, and mainly con- sisted of labor-intensive items. Philippine wages have declined significantly relative to those in competing and customer countries; at present, wages are one-half to one-third of those in Korea and Hong Kong, while productivity in many export firms compares favorably with that in these countries. Based on a product-byproduct review, and taking into account market access and prospects, the Mission finds that, assuming continued export policy improvements and no major setbacks in major markets, nontraditional exports can continue to grow by some 18% per year, reaching $3 billion (in 1977 prices) by the mid- eighties. The projection of 18% compares with a Bank projection of 12% for manufactured export growth for all LDCs. In order to realize or exceed this potential, the Government will have to broaden export incentives - as recommended in paras. 24-26 - by putting all export industries, both direct and indirect, on a free-trade basis and increasing availability of credits, especially for raw material procurement and for new investment by smaller firms. As part of its export po'licy, the Government will have to continue simplifying administrative procedures and provide infrastructure facilities INDUSTRIAL DEVELOPMENT STRATEGY AND POLICIES IN THE PHILIPPINES SUMMARY REPORT PART I: ISSUES, RECOMMENDATIONS AND PRIORITIES 1. The Industrial Sector Mission which visited the Philippines ln February 1979 dealt primarily with industrial policies and incentives, with a view to exploring ways in which the country can better achieve its objec- tives of broader and more rapid industrial growth, employment creation, export development, regional dispersion and stronger technological capacity. The Mission reviewed the various elements of the incentives system and has sought to determine how they might be adapted to facilitate achieving the Government's objectives. In undertaking this task, the Mission studied in detail several industries where rehabilitatipn, new investment and technical assistance are needed to broaden and deepen Industrial growth, increase the linkage with other sectors and are required to complement the necessary changes in the incentive system. It also reviewed policies for the develop- ment of small and labor-intensive industries. Specific industrles reviewed included steel, mechanical engineering, textile and food processing, and in less detail, cement, garments, footwear and furniture. 2. Part I of this Summary briefly sets forth the principal issues in Philippine industrial development (Section A), discusses the manner in which major objectives might be realized and the policies which might be adopted to that end (Section B). Section C deals with industrial investment priori- ties. Part II summarizes the findings on individual industries. A. Issues and Objectives Current Situation 3. The manufacturing sector has grown to the point that it has become a major factor in the development of the Philippines. It now makes up one- fourth of GDP and compares well in relative size with other countries in a similar stage of development. Besides achieving import substitution of a wide range of consumer products, policies have also stressed primary processing of domestic raw materials for export. Government policies have worked hand-in- hand with private initiative. Several industries are already relatively well established (e.g., food processing, chemical, garments and some consumer durables). More recently, there has been rapid growth of manufactured exports and increasing attention has been given to small industries. 4. Since 1970, policies affecting Philippine industry have undergone several significant changes - including a steep devaluation, measures to help small labor-intensive industries, and the introduction of various export incentives. As a result of these new measures, industry may well have reached a turning point in the second half of this decade in that, for an increasing part of the sector, both growth and employment creation improved signifi- cantly. However, little change has occurred in the composition of invest- ment, which continued to stress capital-intensive industries; and the export industries enjoying special incentives were in many ways an enclave in an otherwise overprotected domestic economy. 5. The principal issues confronting the Government in shaping indus- trial policy stem from- the poor performance of the sector in terms of capital efficiency and cost competitiveness, as a leader in growth, provider of new employment and as a factor in regional diversification. Overall, manufactur- ing employment has fallen behind the growth of the work force, especially because of the slack in the informal sector. Industrial growth has generally bypassed the small firm, and the very large and important cottage sector - much less concentrated in Metro Manila than organized industry - was virtually stagnant. Further, industrialization has tended to favor production for the home market, and incentives - including the allocation of credit, import protection and investment incentives - favored relatively capital-intensive import substitution industries. The industrialization pattern may have reinforced regional and income disparities as its effect in raising employment and income of the poorest strata was small. In some industries (e.g., food processing), growth was accompanied by increased concentration. 6. Looking ahead, what is needed in Philippine industrial policy is a two-pronged approach. On the one hand, the nontraditional manufactured export drive should continue with increased participation by industries, firms and regions. On the other hand, policies for the home industries should be reoriented toward better utilization of capital and domestic resources and more employment creation. By becoming more competitive and concentrating on branches where the Philippines has comparative advantage, home industries should also be able to export an increasing share of their output, either directly or indirectly. Prospects and Strategy 7. The Philippines is in a strong position to continue expanding its nontraditional exports. They exceeded $1 billion in 1978, and mainly con- sisted of labor-intensive items. Philippine wages have declined significantly relative to those in competing and customer countries; at present, wages are one-half to one-third of those in Korea and Hong Kong, while productivity in many export firms compares favorably with that in these countries. Based on a product-byproduct review, and taking into account market access and prospects, the Mission finds that, assuming continued export policy improvements and no major setbacks in major markets, nontraditional exports can continue to grow by some 18% per year, reaching $3 billion (in 1977 prices) by the mid- eighties. The projection of 18% compares with a Bank projection of 12% for manufactured export growth for all LDCs. In order to realize or exceed this potential, the Government will have to broaden export incentives - as recommended in paras. 24-26 - by putting all export industries, both direct and indirect, on a free-trade basis and increasing availability of credits, especially for raw material procurement and for new investment by smaller firms. As part of its export policy, the Government will have to continue simplifying administrative procedures and provide infrastructure facilities where needed. Private industry, in turn, must respond by developing new products and higher quality markets. 8. The measures recommended below in Section B would make possible a broader participation in export growth in several respects: more and smaller firms, greater regional dispersal of export production, new product and market development, increased skill component, and a greater share of inputs to be procured at home. They should also help in increasing the proportion of value added in nontraditional manufactured exports and the net foreign exchange earnings from them. 9. The 18% export growth projection is illustrative and, in fact, could well be exceeded. On the other hand, if export incentives are not improved as recommended, the growth rate could easily fall below the illustrations given, coming closer to the average 12% foreseen for all LDCs, and the export growth would have a narrower base and benefit fewer workers, regions and industries. The cost of not broadening and simplifying the export incentives could be heavy in terms of scarce foreign exchange earnings (close to $1 billion per year by 1985) and employment creation foregone (some 160,000 jobs by 1985 if the growth rate were 12% instead of 18%). 10. The Home industries make up 85% of manufacturing output and employ- ment. If manufacturing as a whole is to make a sufficiently dynamic contri- bution to Philippine development, improvements in capital efficiency, labor intensity, and cost levels must be achieved by home industries in order to accelerate the growth in their employment and output and to enable them to make an indirect contribution to export expansion. A number of policy innova- tions are needed, as discussed below, to accelerate growth of production for the home market in line with the Government's development plan and to increase its contribution to employment and equity among population groups and regions. There are at present several subsectors which can greatly improve their capital utilization and efficiency. Well focussed rehabilitation would produce high investment returns and make possible cost reduction and more rapid output growth; industries in this category dealt with by the Mission include textiles, cement and steel rolling. Investment decisions (and incentives) should give greater weight to employment creation and be more cautious on the expansion or initiation of large-scale capital-intensive projects. A shift toward more labor-intensive investment would be in line with Philippine comparative advantage and the overriding need for providing productive jobs. This will involve, inter alia, greater stress on promising small and labor-intensive industries and the development of the mechanical engineering industry. Greater competitiveness of the industrial economy would also enable a larger part of the industry sector to participate in export growth, either directly or through domestic production of inputs for the export industries (e.g., textiles and steel products). Greater participation of domestic industries in supplying the export industries will tend to raise the capital labor ratios of the export sector as a whole, but direct export production will continue to be a labor-intensive operation. - 4 - 11. In the absence of policy reform along the lines discussed in Section B and greater emphasis on rehabilitation and capital efficiency, new investment in home industries would be more capital-intensive than projected, new outlays would have lower economic returns, and output growth would not accelerate over past levels. Home industry would not be able to lower costs and prices, with resulting adverse effects on prices of consumer goods and on indirect participation in export expansion. Under these circumstances, employment growth in home industries would be less than 2% (compared with more than 4% under the more favorable policies). The cost of not undertaking needed policy reforms would thus be that home industry would generate 300,000 fewer jobs by 1985 and that its output growth might be closer to 6% than 8%. 12. Achievement of the projected growth in nontraditional manufactured exports and of greater capital efficiency and labor intensity in home indus- tries could accelerate the overall growth of manufacturing value added from the 6% annual rate of 1970-77 to 8% in 1978-1985, while simultaneously doubl- ing the growth rate of employment from 3% to 6%. The projected increase in manufacturing employment implies a considerable increase in the employment elasticity of manufacturing output. This would be achieved through a combin- ation of continued rapid expansion of labor-intensive exports and, in the home industries, the restructuring of tariff and investment incentives leading to more efficient use of capital and reducing the capital intensity of new investment somewhat. Because of its much higher labor intensity than in the home industry, employment in nontraditional manufactured exports would rise by 17% per year and provide 40% of new employment opportunity in manufacturing. Even assuming slightly higher capital intensity than in the recent past, nontraditional export industries would account for only 10% of total investment. Home industry which is much larger than the export sector, would still provide 54% of the new jobs created in the manufacturing sector, with the remaining 6% being accounted for by the traditional export industries. Home industry would also absorb the major share of investment (81%), and hence it is on home industry that efforts to improve capital efficiency must focus. 13. The above growth pattern would bring about a dynamic change in the composition of manufacturing output and employment. Overall manufacturing employment would rise by an average of 120,000 jobs per year in 1977-85, accounting for about one-fifth of the new jobs required in the economy as a whole. However, within this total, factory employment, the growth rate of which would accelerate from 7% to 10% annually, would double, while employ- ment in the cottage sector would grow relatively slowly (1.5%). Hence, by the mid-eighties the factory sector would replace the cottage industry as the principal source of employment in manufacturing as its share of the total would rise from 40% to 55%. Although it is vital for long-term development that this transformation take place, Government programs would need to pay special attention to the productivity of cottage workers lest their incomes fall too far behind those in the organized sector. -5- B. Policies Effects of the Present Incentive System 14. The major elements of the incentive system are the customs tariff, import licensing, credit arrangements, investment and export incentives, and technical and technological assistance for specific industrial branches or small industry. The combined effect of the present incentive measures and import restrictions is to build a bias in favor of production for the home market and impose a penalty on the export industries, except for those with access to duty-free imports. Philippine incentives also have had the effect of lowering the price of capital goods relative to consumer goods. Customs tariffs have favored relatively more capital-intensive import substitution, while the tariff on capital goods has itself been low. In addition, investment incentives have the effect of reducing the cost of capital equipment. It is the larger, usually more capital-intensive, firms which have benefitted most from these incentives. 15. Import protection is relatively high and uneven. Based on 1974 estimates, the average effective tariff is about 54% for the economy as a whole. For manufacturing, the effective protection was even higher - 125% - while certain industries (notably intermediate and capital goods) received relatively less protection (18-23%). In the period 1965-74, effective protection rates for manufacturing increased from 51% to 125%; a major cause was the increase in effective protection rates for consumption goods which reached an average of 274% in 1974. On the other hand, since 1974, a number of individual tariffs have been reduced on a case-by-case basis, and the importance of export production under free-trade arrangements has increased. 16. Import protection has had an adverse impact on manufacturing in several aspects: (a) It has tended to channel resources into industries, usually capital-intensive, where the Philippines has relatively less comparative advantage, and has penalized relatively labor- intensive products (e.g.,simple producer goods in the mechanical engineering industry). (b) It has encouraged high costs, inefficient use of capital and excess capacity. Examples treated by the Mission in detail are the tex- tile and steel rolling industries. (c) It has penalized exports by taxing imported inputs or permitting domestic inputs to be produced at-high costs and low quality. The penalty imposed on those export industries subject to tariffs on their inputs averaged 16% in 1974. Examples covered by the Mission are: textiles, steel products and cans (for the food processing industry). 17. The tariff and tax disincentives for export industries have, since the early seventies, been partly offset by putting approved export producers on a free-trade basis. Bonded (manufacturing) warehouses and other arrange- ments free exporters from paying duty on imported inputs, which would other- wise represent a sizable penalty on export production (e.g., equivalent to 150% of value added in the garment industry). As is evident from the dynamic growth of nontraditional manufactured exports, industries under this selective free-trade regime have benefitted greatly, and the profit opportunities provided by free-trade arrangements for serving large export markets have been sufficient to draw some resources away from the relatively more profitable but limited domestic market. H1owever, as a group, potential direct and indirect export industries that are subject to tariffs still pay a significant penalty on export sales. Achievement of projected export growth - which would rely in part on achieving both a more diversified product mix and higher net foreign exchange earnings through indirect export of domestically-produced inputs will require elimination of this penalty. Improvements in the Incentive System 18. The measures recommended by the Mission fall into three major cate- gories. First, a lowering of protection and simplification of investment incentives are needed to improve the performance of the home industries by increasing their competitiveness, capital efficiency and employment effects. Secondly, improvements in the various elements of the export incentive system are needed to solidify and broaden the manufactured export drive. Thirdly, the improvements in the various incentive measures need to be supported by credit policy, subsector planning, vocational training, technological assistance and special measures in the regional dispersal and small industry programs. Reduction in Protection 19. Import protection should generally be lowered - to an average nom- inal level of 20-30% - and the structure of protection be made more even. Two major courses of action are envisaged: one consists of certain across-the-board measures which can be taken rather quickly. The other remaining tariff changes are those for selected branches where the Government plans specific industry programs linked to changes in protection; these may require 2-3 years to be fully implemented. 20. Across-the-board tariff action would include: (a) The lowering of peak rates (those between 70-100%, e.g., shoes and cotton fabrics); (b) Lowering tariffs with the aim of removing redundancy (e.g., the tariffs on clothes, pineapple, furniture); and (c) Substituting sales taxes for high tariffs on luxury items. -7- 21. In some selected industries, changes in import protection will have to go hand-in-hand with programs to improve the efficiency and competitiveness of the industry. The textile and steel industries are examples discussed by the Mission, but there may be other industries where the Government needs to link tariff reform with new investment and rehabilitation. The rehabilitation and/or investment programs for the textile and steel rolling industries, sum- marized in Section C and Part II, would enable these industries to lower their costs and expand output. Reduction in tariffs in these industries would induce them to become more competitive and in fact assure that the new invest- ments would result in improved capital efficiency and utilization. On the other hand, in selected simple producer goods, where the Philippines' dynamic comparative advantage is currently underutilized, protection should be increased selectively as new projects are identified and executed; thus, the present low tariff in these industries would be brought closer in line with the revised levels for the rest of the manufacturing sector. In other cases, higher levels of effective protection might be permitted to continue on cer- tain conditions worked out as part of an industry-wide program. For example, selected industries might continue receiving high effective protection on condition that they export part of their output (e.g., refrigerators). 22. The reduction in tariff protection should be accompanied by the immediate removal of licensing by the Central Bank, lest the benefits of lower tariffs will be offset by continued licensing. The Mission found that Central Bank licensing for a number of industries is an obstacle toward product improvement, greater competition, and the provision of supplies to export industries. The restriction of competition from imports has enabled a number of firms (e.g., in the textile and steel rolling industries) to operate at uneconomic levels of capacity utilization and costs. Investment Incentives 23. Investment incentives are currently administered by the Board of Investment. The present system is complex and difficult to administer. As the manufacturing sector grows, it will be important that the Board have a manageable task and be able to deal with the many dynamic issues of indus- trial growth. Simplification would lessen administrative discretion and help small industry and regional dispersion. In order to implement the strategy recommended above, in revising and administering the incentive system, care- ful attention needs to be given to comparative advantage, efficient use of capital, employment creation and regional dispersal, in particular: (a) Certain general investment incentives could be applied to all indus- try through the fiscal system. The Mission has not made a study of particular measures, but extra tax credits for labor and local raw material costs would be worth consideration. A move in this direc- tion, moreover, would make possible a simplification in the present range of discretionary incentives and the remaining special incen- tives would become easier to administer. Certain industries currently receiving incentives no longer need special encouragement in other than exceptional circumstances, since they are already relatively well established (e.g., food processing and garments). -8- (b) The Board of Investment might best identify selected industries worthy of special incentives. For this purpose, it would have to draw on strategy plans to be prepared for selected industries. Within the industries to be selected all registered firms should be eligible to receive incentives. The nature and level of the incentives should, to the extent possible, be set by prior guide- lines for each industry. Contrary to the present practice (which tends to penalize relatively more efficient firms) of considering each proposal in detail, firms should be eligible regardless of how profitable they are and, at a later stage, should also be permitted to proceed with expansion, as long as the industry has priority status. In selected cases, incentives may be provided on certain performance conditions, e.g., that a portion of new output be exported. (c) For carrying out (b) above, detailed economic appraisal will need to be applied in granting selected incentives for particular industries, including determination of the likely economic rate of return and the level of protection required. Such appraisal should be applied to large projects as well as in the (prior) determination of the eligibility of an industry for special incentives. (d) The Board should encourage projects with economic justification in the outer regions, by direct negotiation and/or tolerance of slightly lower rates of return (to make up for the initial dis- economies of location outside the central regions). 24. The work of the BOI in administering investment incentives should be supported by the preparation of strategy plans for selected industries. The Mission has identified the need for such plans in the mechanical engi- neering and food processing industries. These plans should help determine promising new projects and give guidance to the BOI decision making process. Decisions in other selected industries eligible for investment incentives should likewise be guided by strategy plans. Export Incentives and Promotion Measures 25. Some serious deficiencies still exist in the special arrangements under which manufactured export industries operate. First, the various methods through which duty-free importation currently takes place (drawback, bonded warehouses, marginal deposit requirements) tend to be either time consuming, burdensome and thus tying up working capital, or too restrictive in terms of eligibility requirements (bonded manufacturing warehouse system). Costly paperwork and procedures required by various Government agencies create overhead expenses and delays, acting as a disincentive for exporters. Furthermore, the cost of the short-term export financing facilities of the Central Bank are high compared with the rates charged for export financing in countries with which the Philippines competes. Many of the smaller or newly - 9 - established exporters are not aware of the existence of this export credit facility or are discouraged by its procedural requirements. Their access is also limited because of the bias of the commercial banking system against high-risk export financing for industries without an established track record. 26. All manufactured export industries should be placed on a free-trade regime to the maximum extent feasible. This involves: (a) duty-free importa- tion of raw material and components; and (b) providing additional assistance where necessary. The present system is restricted to selected firms in direct export manufacturing. It tends to place the smaller firms at a disadvantage, as well as "indirect exporters," i.e., domestic suppliers to export firms. A broader approach would permit all procurement for export production to be free of duty and would need to be accompanied by improved financing facilities for raw material and semi-finished inputs. Credit Policy and Other Supporting Measures 27. The recommended improvements in the incentive system discussed so far should be supported by the necessary adaptations in credit policy, tech- nical assistance, training, subsector planning and the small industry and regional development programs. 28. Credit measures will have to go hand in hand with the application of other incentive measures. The full impact of changes in industrial policies in favor of technological development, labor-intensive production, small industry and regional dispersion will only be realized as they are matched by corresponding expansion by private commercial credit and the allocation of investment credit. The provision of long-term credit should be more cautious in avoiding excess capacity in major industry branches (such as has arisen in the past 10 years in the steel rolling and cement industries). The Mission has given special attention to the provision of short- and long-term credit to small industry (para. 31c), regional dispersion (para. 32), and export indus- tries. The credit measures envisaged would, of course, have to be part of the country's general financial policies which have been analyzed by the Bank's Financial Sector Mission. 29. In support of export promotion policies, a special credit facility for financing raw material procurement by export firms is especially worthy of consideration. Further, the commercial banks could very significantly increase their support for regional dispersion and export expansion by expand- ing their operations (now overwkellningly concentrated in the Center) to the outer regions and by giving greater assistance to export firms (particularly small and growing firms). Both exporters and their bankers would benefit from a simplification of export documentation. Action:should also be taken to establish an export credit guarantee and insurance scheme. 30. Technical and technological assistance should be supplied more effectively in a way that individual firms or plants can benefit. The Main Report discusses several of the specialized institutes, e.g., those operating - 10 - in mechanical engineering, forest products, textiles and food and nutrition. Most of these should maintain closer contacts with plant operations and focus more sharply on actual industrial practices. Their operations should also feed into the assistance rendered under the small industry program. 31. In addition, the technical institutes may be instrumental in improv- ing vocational training in selected industries. The Mission is keenly aware of a shortage of skilled technical workers in several industries, caused in part by poor training and inadequate pay scales. It would seem best that the Ministry of Industry take the lead in a strengthened vocational training program. Small Industry Program 32. Government policy might best aim at an increased integration of the cottage and small-scale sectors with more organized larger-scale manufactur- ing. The process of integration should be enhanced and supported by more effective technical assistance and enlarged credit facilities. MASICAP and SBACs can effectively use larger Government support for improved and more permanent staffing. 33. It would be most effective to concentrate on those industry branches which have the best potential for productive job creation and more efficient capital utilization. MOI staff analysis should continuously seek to identify the more promising branches and firm sizes which deserve priority support under SMI programs. In this manner, the small enterprise policy would concen- trate on selected industry branches (e.g., shoes, furniture, and mechanical engineering, handicrafts and garments). For these selected industries, special support would take the form of: (a) A more comprehensive field service and direct assistance program of the specialized institutes (e.g., those operating in mechanical engineering, forest products, textiles and food and nutrition). In the industrializing outer regions the work of the institutes and that of MASICAP and the SBACs could be coordinated by Regional Directors of the MOI. (b) Increased Government support for subcontracting by large firms of products for small firms. (c) Expanded access to and increased allocation of credit to SMI by development and commercial banks, with emphasis on credit to the more rapidly growing firms in the industry; and, more efforts to provide support for SMI through the provision of equity capital and leasing facilities. The activities of financing institutions should be closely linked with the extension of technical assistance. (d) Special trading companies for export development. SMIs are often unable themselves to establish links with overseas buyers, nor to process the documentation presently necessary for exporting. If the smaller industries are to participate more effectively in export growth, there is a need for grouping potential small industry exporters together. Trading companies could help in handling pro- duct promotion, marketing, packaging, shipping, short-term financ- ing, documentation, etc., for potential SMI exporters. Regional Development 34. Steps to make the small industry program mDre effective will also be instrumental in furthering regional dispersal since these are relatively more dispersed than the manufacturing sector as a whole. Except for the pro- cessing of traditional commodity exports and production of selected handi- crafts, the outlying regions have not yet benefited directly from either the general industrialization process nor from the expansion of manufactured exports. The recommended changes in export and investment incentives would place firms in the outlying regions on a more equal footing with those in the Center. The BOI should encourage location in the outer regions of economically-justified projects. Additional steps to further dispersal of industrialization are: (a) Emphasis on infrastructure improvement, and industrial estates in selected areas of the country with high potential for industrial growth; (i.e., Central and Western Visayas and Northern and Southern Mindanao); (b) Improved planning of industrial location and infrastructure in Metro Manila and the satellite cities of Southern Tagalog and Central Luzon; (c) Increased commercial bank financing of industry in the outer regions; (d) Increased investment finance through existing institutions, and expansion of the private development banks in the outer regions; and (e) Strengthening of industrial support services in the outer regions and decentralization of administration as this is done. Need for Concerted Action 35. The adaptations and reforms in the incentive system discussed above will require concerted actions by the agencies directly concerned, in particular, the Ministry of Industry, the Board of Investment, NEDA, the Tariff Commission, and the Central Bank. Where tariff changes are geared to specific industry conditions, they must be contingent on the preparation and execution of programs for the industries to be guided by the MOI and BOI. These programs must, in turn, be given priority in the allocation of investment finance. Central Bank licensing will need to be relaxed for those items which will receive lower duties lest continued licensing make the - 12 - tariff reduction ineffective. Export promotion efforts will need to be backed up by credit policies. The Board of Investment would usually not grant benefits for new investments if they were in need of effective protection above the 30% level achieved as a general objective and would, in selected cases, also encourage exportation of part of the output from these new investments. C. Industrial Investment Priorities 36. In assessing industrial priorities, the Mission was necessarily selective in its more detailed review of specific industries. These indus- tries were selected with these criteria in mind: (a) their importance in the drive to make industry more export-oriented an4 labor-intensive; (b) their potential greater importance in the small industry program and regional dis- persal; (c) their need for rehabilitation and renewal, in recognition of the fact that significant pockets of industry are wasteful users of capital and high cost suppliers of inputs which require corrective action if they are not to be a drag on the economy; (d) their potential for making a greater con- tribution to growth, the country's comparative advantage and technological development; (e) their potential of increasing utilization of domestic resources; and (f) the country is facing major decisions on very substantial investment outlays which require careful technical and operational attention and assistance. Among the more important industries not reviewed in detail are several capital-intensive industries such as chemicals and petrochemicals and raw material processing for exports (metals, minerals, coconut and sugar products). 37. The following paragraphs summarize the major groups of industries reviewed by the Mission in a roughly declining order of priority (details are given in Part II and the Industry Chapters of Volume II): (a) Nontraditional manufactured export industries (e.g., garments, electronics); (b) Selected labor-intensive industries which could be assisted as part of the small industry and regional dispersion programs (furniture, footwear and small-scale power loom weaving); (c) Selected branches of the food processing industry which could make greater utilization of domestic raw materials and provide low- cost foods; (d) Industries requiring new investment and rehabilitation with the aim of improving capital efficiency, labor utilization and production costs (mechanical engineering, steel rolling, textiles cement rehabilitation); (e) A program of phased expansion of the cement industry; and (f) Integrated steel production. - 13 - 38. Top prlority should be assigned to continued expansion of labor- intensive manufactured export Industries. The very large potentials in terms of export earnings and employment creation and the policy requirements have already been discussed. Action should be taken to make possible a broader participation in the export drive. At present, with the notable exception of cottage industry handicrafts, export industries are heavily concentrated in the Center. Further, at present, value added in manufactured export indus- tries is a mere 25%. 39. The- greater part of raw material lnputs of most export industrles is imported. Net foreign earnings from manufactured exports are at best only 40% of gross. Only the wood, handlcraft and food processing Industrles rely on domestic raw materials, and these industries should be put in a position to expand relatively more rapidly than others. Domestic Industries should increasingly be put in a position to supply a larger share of the requirements of export industries. If backward linkages are to be successfully developed, the capital efficiency and cost levels of input-produclng home industries will have to be improved through measures discussed previously. This is true particularly for the textile and the steel rolling industries, but it would be wrong to limit the strategy to these two industries. In addition, export expansion has thus far relied heavily on a narrow range of products (garments, electronics, and handicrafts). If exports are to continue to expand rapidly from a now much larger base, new product lines will have to be introduced as the growth of older ones slows. Technological deepening of manufactured exports with the help of the specialized institutes and foreign investors (joint ventures) and greatly improved vocational training will, over the medium-and longer-term, be instrumental ln both increasing the proportion of value added and the skill component and diversifying the product mix. 40. Of equal prlority as the present major export industries are special industry programs for the footwear and furniture industries envlsaged as a component of the small industry program and small-scale weavlng. The footwear and furniture industries are labor-intensive and potentially export-oriented, and the furniture industry utilizes domestlc raw materials. The smaller enterprises in both industries require more technical and marketing assist- ance, moderate improvement in equipment, help in improving domestic raw material supplies, and are suitable for more extensive regional dispersal. 41. Small-Scale Power Loom Weaving. While the textile industry is relatively capital-intensive, with modern spinning or weaving mills requirlng $30-50,000 Investment per job created, there is some scope for addltional job creation in weaving. Using smaller looms, the cost per job can be reduced to $1,500. A system of unlts, organized as a cooperative with from 10-40 looms, could employ from 15-60 people and could produce reasonable quality cloth. Such a system might be suited to regions outside Manila and could be tested on a pilot basis to ascertain whether possible organlzational or supply problems could be overcome. - 14 - 42. Next in priority, the food processing industry - the largest single industry in terms of output and employment - has a significant role to play in improving utilization of rich domestic resources for home consumption, greater production of nutritious low-cost foods, exports and regional (resource- oriented) development. Industrial investments identified by the Mission are moderate - some $30 million in the next few years - but substantial additional effort is needed to improve raw material supplies. The employment generating effect of increased supplies of agricultural materials is several times larger than that of the processing industry itself. Export potential assuming adequate resource development (fruits and fisheries) is large: rising from $100 million at present to $500 million in the mid-eighties. Since it is already well established, the industry needs no longer special tax incentives except to encourage new processes or location in the outer regions. Caution is needed to avoid excessive concentration in the industry and permit a satisfactory role to small growers and processors. A subsector strategy plan, identifying suitable investment opportunities, should be drawn up. The Government should designate the appropriate agency which will take the lead in sector planning and the coordination between raw material supply and processing. The most appropriate agencies would be the Ministry of Agriculture for raw material coordination and the MOI for investment planning. The DBP could play an essential role in project identification and promotion. 43. Next in priority is a group of industries where the necessary new investment or rehabilitation deserves high priority because of their impact on output, capital efficiency and/or employment creation. From the view point of a unified and sensible strategy, they have several characteristics in common: (a) First, while not all are as labor-intensive as the nontraditional manufactured export industries discussed before, they are mostly in the middle ranges of capital intensity (with the exception of the cement industry). Thus, while their employment effect is smaller than the export industries, it is larger than what it would be for the steel and chemical industries. (b) Second, individually and as a group, they require fairly large investment outlays. Given the competing claims from other sectors as well as the even more capital-intensive industries, a degree of rationing and allocation will be called forth which will make it essential that the Government make at least a notional allocation of investment over a period of 3-4 years as justifiable programs are carried out. The combined investments which the Mission has tentatively identified are on the order of magnitude of more than $500 million as against a total investment projection of about $150 million annually in the nontraditional manufactured export industries, at least $1.3 billion in an integrated steel project and over $1 billion in new cement plants. (c) Thirdly, there is strong evidence that investment in these indus- tries will have high economic returns because they will make possible considerably lower costs and increased capital efficiency, - .5 - and enable the industries to supply at least part of their output to export industries (textiles and steel rolling), or enable the Philippines to exploit a comparative advantage (e.g., selected projects in the mechanical engineering industry including the foundry industry). (d) Fourthly, the investments and rehabilitation of the industries are designed to correct conditions which at least in part have been caused by excessive (or unduly prolonged) protection and/or exces- sive finance (textiles and steel rolling, suffering from high cost, and poor facility planning) or relative neglect by the incentive system (i.e., comparatively low protection, financing and technical help: the producer goods industry). 44. Some of the points of particular interests in the industry programs in this category of priority may be mentioned briefly here: (a) The textile industry rehabilitation program (approximately $250 million, the precise amount to be determined after more detailed review of the studies now being completed). About half of the industry is efficient, but the rest suffers from obsolescent machinery and can at present only survive as a result of high protection (50-70% nominal, over 100% effective protection). Rehabilitation would be combined with increased product speciali- zation and would result in cost reduction and improved utilization of capacity. Some of the new output could be exported - in fact some export could be a condition of the receipt of investment incentives and finance. The program would go hand in hand with (and in fact be conditional upon) a lowering of protection (to uniform levels of 20-30% to be determined as the program is pre- pared). Implementation must be based on criteria for selecting eligible private firms, depending on inter alia quality of manage- ment, ability to grow and export, and rate of return. The amount of capacity to be rehabilitated would depend on the prospects for direct and/or indirect exports and domestic sales at the lower level of prices foreseen. Applying these criteria would imply phasing out some plants which even after additional capital expenditures could not become competitive at the proposed lower protection levels. (b) The steel rolling industry. A number of rolling mills, particularly the larger and newer ones, can be operated economically. Some mills require modernization and rounding out. National Steel's cold rolling mill, for example, has an ultimate potential to produce about 700,000 to 800,000 tons/year (tpy) but at present has a capacity of only 300,000 tons. Expansion at a cost of about $70 to $100 million should enable its capacity to be increased to about 700,000 to 800,000 tpy. This investment would permit the company to increase productivity, lower costs of production, and ultimately to lower prices - hence, make possible lower protection - and still obtain an economic return, possibly in the range of 12-15%, on the new investment. - 16 - to lower prices - hence, make possible lower protection - and still obtain an economic return, possibly in the range of 12-15%, on the new investment. (c) The mechanical enRineering industry. In the interest of efficient longer-run development, producer goods should receive greater incentives from the Government, including more technical assistance and long-term investment finance. New investments or expansion in the producer goods subsector could amount to $100 million in the next few years. Areas of immediate opportunities could be mining and material handling equipment. Foundries, fabrication shops and machine shops require new tooling. One large or two complementary smaller projects might be considered possibly as joint ventures with established foreign makers. These actions should be guided by specific product planning within a comprehensive strategy for the subsector. Active support is warranted for MIRDC's effort to initiate such a planning exercise. (d) A rehabilitation program for the cement industry is needed to restore run-down facilities. It would also include improvements in pollution control and have a coal conversion component. The program could require an outlay of some $130 million, of which $60 million is for plant rehabilitation, $30 million for anti-pollution equipment and $30-50 million for coal conversion (depending on whether or not old plants are converted). 45. At the lower end of the priority scale are the programs for the relatively capital-intensive industries of which cement expansion and the proposed integrated steel project are taken up in the Mission Report. The proposed steel project would ensure a more reliable supply of steel to Philippine industry over a period when steel using branches will gain importance. Both of these programs are important for longer-run development, but in view of their high capital cost and low employment effects the Government should proceed cautiously on the basis of sector-wide planning and utilizing apropriate technical assistance. In the case of the cement program, it may be possible to proceed step-wise in stages within an overall industry program, so that it may be possible to proceed more easily within the confines of overall financial constraint. However, it may be economically and tech- nically justifiable to postpone the steel project until a larger project would be called for. 46. A program to build new cement plants would follow an initial rehabilitation project. See para. 41 (d). Over the next ten years, invest- ment in new plants might total $1,000 million (at 1979 prices). Such expenditures require careful consideration, and an official joint body should be set up to administer the program with qualified, full-time staff and technical advisors. The returns on such an effort could be high through increased efficiency and lower costs of a material basic to the construction industry. 47. The Mission has made only a very preliminary review of the proposed integrated steel project in Northern Mindanao. The market would justify a project of 1.5 million tons per year, at a cost of at least $1.3 billion, by - 17 - the mid-eighties. The proposed plant could produce steel at competitive prices, but show only a moderate return on investment and moderate foreign exchange savings. 48. The large investment in steel should be compared with other high priority claims in infrastructure, agriculture and other branches of manufac- turing. Investment in these other areas would not necessarily come at the expense of steel, and vice versa, but a balance must be struck among compet- ing priority claims lest the efforts of continued manufactured export growth and necessary industrial rehabilitation fail. The steel investment would require over a period of years an outlay about equal to the total annual capital expenditure of the Government (P 10 billion in FY78). Within the industrial sector, the steel investment can be compared with the total investment in nontraditional manufactured exports of some P 9 billion in the eight years (1977-85) which are projected to create new employment for 360,000 workers and net additional foreign exchange earnings of at least $1 billion per year by 1985. The steel investment is more than three times as large as the combined outlays required for the rehabilitation of the textile and cement industries. 49. The Government should consider the trade-off between proceeding with the present proposal and a somewhat larger project in 5-7 years. As against the present proposal, it may be appropriate to consider a larger steel plant which would start operations after 1990. A moderately higher return would be obtained on a larger integrated plant project - of say about 2.5-3.0 million tons - particularly since it could be combined with a more economically-sized hot strip mill (e.g., 1.5-2.0 million tpy). Postponement would, however, entail risks and may create difficulties should shortages recur on world steel markets. On the other hand, a delay in incurring substantial new debts could be beneficial in view of the current tight balance of payments and fiscal situation. 50. In any case, further work on an integrated steel project should include additional effective technical assistance to assure improvement in National Steel's operating practices, especially maintenance planning and practices, in order to achieve better overall utilization of plant capacity. 51. The time requirements for these various components of the industry programs run roughly parallel with their relative priority. The more urgent projects and proposals can also be caried out within a relatively short period, while those with lower priority can be planned and executed over a longer period of years. Thus, the measures to improve export incentives, the small industry programs and subsector planning in the mechanical engi- neering and food processing industries can be initiated immediately. The ,priority textile and 2cement rehabilitation and steel rolling projects will require 2-3 years. Improvements in producer goods industries and the cement and steel programs fall in a longer time span. Several of the institutional improvements also require a longer and persistent effort, in particular vocational training and the improved effectiveness of the specialized technical institutes (and setting up new ones), both under the aegis of the Ministry of Industry. - 18 - PART II: REVIEW OF INDUSTRIES 52. This part summarizes the Mission's findlngs on the industries which were reviewed in detail. It starts with a review of small industry and regional dispersion of industry and then proceeds to the individual industries covered. A. Small and Medium Industries 53. Small- and medium-sized industries (SMIs) employ, together with the cottage sector, close to 80% of the work force in manufacturing and produce only 25% of value added. While these data are highly tentative, they do illustrate the low output per worker, particularly in the smaller-sized firms. The low labor productivity is in part caused by limited use of capital equipment - in many cases perhaps even more limited than is justified by the low level of wages. 54. Small-scale enterprises are concentrated in those industries which have been reviewed in Chapters VI and IX of the Main Report: mechanical engineering, garments, footwear and furniture. SSI account for more than half of value added or employment in these industries. The role of SSI in food processing is also large, but it has been declining (see Chapter VIII). Like large-scale manufacturing (enterprises with 200 workers or more), SMIs are heavily concentrated in Metro Manila and the surrounding central regions. However, the cottage industries, which often require less infra- structure, are less concentrated. 55. Since the early 1970s the Government has been giving increasing attention to the role of SMIs in Philippine development. As part of this effort, the sector has been receiving larger amounts of technical assistance and finance. NEDA correctly identifies the SMI sector as of strategic importance in employment creation and regional dispersion. 56. The Philippines has proportionally one of the largest cottage indus- try sectors in the world. It consists mainly of very small labor-intensive establishments producing low quality, cheap consumer items and making handi- crafts and souvenir items for export and sale to tourists. The organized sector - usually designated as enterprises with more than 20 workers but which includes many in the 5-9 category - has been growing rapidly over the past 10 years, and the Mission projects this trend to continue. Despite several measures in the form of special credit lines and technical assis- tance programs in support of cottage and SSEs, they still receive relatively less favorable treatment in comparison with large-scale enterprises. The small size of enterprises and their dispersion puts them at a disadvantage vis-a-vis the large-scale enterprises. With the exception of programs specially designed to deal with SMIs, the Government's general programs for - 19 - industrial development, e.g., those embodied in the incentives administered by the BOI, are mostly geared to the larger enterprises. Total budget outlays of MOI for SSE technical assistance, project preparation, and business improvement were only P 7.9 million in 1977.1L 57. One reason why the cottage sector has remained large, while grow- ing only slowly, is that workers have not had sufficient opportunity to move to the organized sector. While the latter has grown much more rapidly, it has still been unable to provide sufficient numbers of new jobs, and it has paid relatively low wages (usually the minimum wage). Agriculture has been able to absorb few additional workers. As labor-intensive, manufactured exports continue to expand, remuneration and working conditions in the organized sector may also improve, hence these industries may start drawing larger numbers from the cottage sector. This process should also help some cottage industries to mechanize and be transformed into more modern small industries. 58. It is difficult to generalize about the capital intensity of Philippine manufacturing. The Mission has not made a comprehensive review of factor intensity in manufacturing. However, in its plant visits, it encountered few, if any, cases of excessively capital-intensive technology. In fact, the Mission recommends capital improvements in several branches (e.g., food processing, mechanical engineering, textiles, and selected branches of other small industries). Available statistics, while often incomplete, also suggest that a large part of manufacturing is relatively labor-intensive and this is particularly true for SMI. The capital labor ratio for all manufacturing was P 80,000 (1974) or US$11,000, about P 13,400 (or less than US$2,000) for SSI (1974) and less than US$125 per worker in the cottage sector. 59. It is even more difficult to arrive at a general conclusion about capital efficiency in small industry. It seems clear that in the interest of a sound manufacturing structure, more should be done to improve labor and capital efficiency in selected branches (e.g., wood, furniture and leather) where small industry is markedly less efficient than large industry. Increased mechanization and training could redress the balance. In several branches, small-scale industry is more efficient than large industry (e.g., rubber shoes, foundries, fabricated metal products) and these would be a sound bet for increasing their contribution to the development of the sector. B. Regional Dispersal 60. Manufacturing industry in the Philippines historically has been concentrated in-Manila. In 1975, some 7.3Z'.'of manufacturing value added and LI This includes all budgets for MASICAP, SBACs, studies and UNDP- supported programs. - 20 - 65% of employment was located In Manila and the surroundlng provinces. If the resource-based food and wood industries are excluded, the share of manu- facturing value added In Manila and environs rlses to 87%. This means that until recently virtually all manufacturing industry is based in Manila, except for some resource-based raw material processing and some small industry serving local markets. The industry outside Manila is, in turn, located mainly in the industrializing regions of the Western Visayas, Central Visayas and Northern and Southern Mindanao. 61. The heavy concentration of industry in Manila has come about for a number of reasons: political, social and economic. The major consumer market and center of Government has always been in Manila. The policies followed during the import substitution drive of the 1950s and 1960s depended on the availability of imported materials and intermediate goods, and thus the natural location of industry was near the major port of Manila. These pressures were reinforced by the lack of infrastructure in the regions. Without adequate telephones, power, roads and water supply, modern Industry will not develop. Further constraints to the development of industry in the regions have arisen through the concentration of Government decision-making in Manila. 62. Government Strategies and Policies. The Government is keenly aware of the regional disparities in industrial growth and investment and has sought to divert industry to the regions. The main concern has been the desire to ease the overcrowding in Manila with its consequent economic and social costs and to alleviate the problems of unemployment and outmigration in the regions. The Government has devoted much effort to regional planning and has drawn up a separate development plan for each region for 1978-82. A detailed program of project packages to translate into action the objectives and strategies of the regional five-year plans is under preparation. 63. The BOI incentive system has indirectly discouraged regional dis- persal through favoring capital-intensive industries which, by and large, are located near Manila. Those industries outside Manila that have been assisted are mainly larger resource-based capital-intensive industries, such as sugar or coconut oil mills, or cement plants. Small industries, which are the ones most likely to grow in the regions, often fall outside the reach of BOI incentives. 64. The explicit location policy with the most impact on industrial location is the ban on new nonexport projects within a 50 km radius of Manila. This ban, however, has meant simply that industry has grouped just outside this limit. While this has eased the congestion in the heart of Manila, it has not helped the more remote regions. The 50 km ban has recentl,y-been relaxed following complaints about the difficulties it caused. The BOI, when considering project applications, has followed the practice of encouraging location in the provinces. - 21 - 65. Future Steps: Infrastructure. A crucial bottleneck inhibiting industrial growth outside Manila is lack of infrastructure. To develop their individual potential the major regional cities need primary infrastructure such as water, power, telephones and efficient road and water transport. The Government's plans for providing such infrastructure should continue to have high priority. An efficient way to package infrastructure for industry at reasonable costs is through industrial estates to deliver all the necessary infrastructure to industry at one site. The Government's plans should con- centrate on estates in the major growth areas, such as Cebu, Davao, Cagayan de Oro and perhaps Iloilo or Bacolod. While NEDA has drawn up the plans for the industrial estate program, the responsibility for its coordination should be with the MOI. At the same time, actual project implementation should be carried out at the regional level, either by public or private groups. The estates should help smaller exporters by providing bonded ware- houses to serve groups of smaller enterpreneurs. Export processing zones in selected areas may also help to increase export activity in the regions. 66. In addition, Central Luzon and Southern Tagalog must necessarily be developed as major industrial centers and as such, action should be taken to locate suitable industries in designated parts of these regions. Such action would help provide an alternative pattern of industrial location, supplementing'any restrictions on industrial development in Metro Manila as discussed below. A satellite city strategy would cover infrastructure, industry and planning for other sectors as well. 67. Incentives. The present incentives system is not designed to enhance industrial dispersal. It is clear that it could play a greater role in assisting regional decentralization. A positive incentives policy would encourage regional dispersal by: (a) discouraging industry in Metro Manila; (b) giving neutral treatment to investment in the growth regions surrounding Manila; and (c) encouraging the outlying regions by giving them some pref- erence in the administration of a simplified incentives system. If, as recommended in para. 34, all export industries were put on a free-trade basis, and investment incentives were simplified, firms in the outer regions would obtain more equal treatment than at present. 68. Regional Industrial Promotion. While there is some decentraliza- tion in Government services to industry, for example, the MASICAP and SBAC programs, key policy decisions are made in Manila. Businessmen in the regions are handicapped by having to deal all the time with Manila in the complex process of obtaining BOI registration and incentives. A simplifica- tion of the incentives system would be of great help to provincial entrepreneurs. 69. An appropriate incentives policy, allied with infrastructure deve- lopment, is vital to increasing industrial growth outside Manila. A more efficient way than the 50 km ban to discourage industry in Manila would be to impose an increased industrial property tax in Metro Manila. In addition, the BOI, as a matter of policy, should not extend investment incentives in Manila, - 22 - except in cases that did not add to congestion or that fitted in with an overall zoning plan for Manila. These steps would ensure accelerated growth outside Manila, particularly in the central region surrounding the Capital. To encourage industry to go away from the central region, incentives favoring labor, such as tax credits or subsidies for labor training, extra deductions of labor costs from taxable income, and tax credits for necessary infra- structure development, will be important. Furthermore, the BOI could permit a lower rate of return on projects in the outer regions. 70. Regional industrial development would also be helped substantially through a strengthening of existing regional administration, in the cities and provinces and in the main line agencies. Proposals to strengthen regional administration should receive the wholehearted support of the Government. 71. The MASICAP and SBAC programs and continued efforts on labor training and industrial extension services are also essential to dispersal. Project promotion should be assisted through the current phase of the Regional Planning Project. Projects covered by the Mission with regional impact include the furniture and leather industries, food processing near the source of raw materials, and the suggested small power loom weaving project. 72. Finance and Credit Policy. The outer regions are currently served by branches of most major Philippine banks; development finance for industry is provided mainly through branches of DBP and through private development banks; IGLF funds are available for SMI in the regions. Long-term finance is available in the regions through DBP and IGLF, with 30% of IGLF and 49% of DBP industrial loans over the past three years going outside Manila and the surrounding provinces. However, loan processing is perceived by businessmen as taking excessive time, and corrective steps would seem to be justified particularly for investment financing in the outer regions. Further, over the longer term the private development banks could become an expanded and more efficient channel for industrial finance in the regions. 73. Working capital outside Manila is scarce. The commercial banks, the prime suppliers of working capital, direct most of their operations to Metro Manila, and on March 31, 1978, 92% of total private commercial bank credits outstanding in manufacturing were in Metro Manila. The commercial banks should make a much greater effort to diversify their portfolios regionally. Clearly, Government action in infrastructure and industrial incentives should be supplemented by greater private financial support. Without more financial cooperation, regional industrial development will continue to suffer. C. Steel 74. The Philippines now has a substantial steel industry, consisting of about 50 individual firms. The industry is characterized by a rather large indicated capacity for rolling and finishing (well over 2 million tons/yr) and relatively small indicated capacity for steelmaking (about - 23 - 400,000 tons/yr). These figures are in relation to a present market for finished steel products, which is slightly in excess of one million tons/yr. The country is dependent on imports of slabs and billets for most of its steel industry. Hence, a proposal to evaluate an integrated steel operation to supply these basic products has been under consideration by the Government. Further, the Philippines imports many finished products (e.g., plates, hot and cold rolled sheets, tinplate, etc.) due, in part, to under- utilization of existing capacity. 75. Steel rolling is an "overcrowded" industry. There are 39 rolling mills, and 11 plants for coated products. Utilization of installed capacity is frequently 50% or less, and overall was only 37% in 1977-1978. There are many reasons for this performance beyond the control of individual plants, but poor maintenance and operating practices, limited availability of spare parts, and management problems are also responsible. Excess capacity makes for low profits, especially in the steel industry where utilization rates of 60-65% or higher are usually required to break even. Many of these plants operate with periodic losses, but they seldom go out of business. 76. Protection in the steel industry has a strong "cascading" effect. Effective protection in steel bars and galvanized sheets is over 100%. The high effective protection levels result from a 10% tariff on major inputs and 50% nominal protection on finished outputs (rods, bars, tinplate and galvanized iron sheets). In practice, the price effect of protection is moderated by price control on finished products, which, however, may introduce supply shortages. High levels of protection have provided financial incentives conducive to premature investment in facilities (mostly in rolling mills). They have also relieved necessary pressure on many important parts of the industry to improve its basic performance, reduce excess capacity, and achieve reasonable levels of cost. Lower levels of protection would have been conducive to more rational facility planning (new plants/expansion) in tune with realistic market estimates and to higher standards of operating performance than have actually been achieved. 77. A realignment of tariffs on various steel products would help the industry in improving its performance, while increasing competitive pressure for modernization and better planning of facilities. Protection levels for individual branches (and products) must be determined after detailed review. The present protection structure will need to be made more even, with fully finished products (tinplates, galvanized sheets) receiving protection below the present 50% (probably closer to 30%). Reduction in actual tariff rates would have to be accompanied by relaxation of restrictions (import licensing) if it is to have a full effect on industry operations and prices. 78. Some of the rolling mills and steelmaking facilities are small and outdated and may not be economical to operate except in special cir- cumstances, such as small/specialized local markets, economical scrap supply, etc. A lowering of the cost of steel to consumers associated with some re- duction in the tariff on finished products - say to a 30% maximum - would - 24 - have several beneficial effects: (a) it could make price control unneces- sary for some selective items and hence improve supply conditions, (b) more generally - for a wider range of products - it could increase competition and reduce the number of inefficient firms; and (c) it should, in the end, reduce the cost of steel products. Lower steel prices would help in reducing construction costs and costs of fabricated metal products; it would also improve the possibilities for export of metal products. 79. The Philippines has for some years been considering the establish- ment of an integrated steel plant in Northern Mindanao. The proposal being prepared now envisages an investment of at least $1.3 billion in a plant of about 1.5 million ton capacity, which could be operative in the mid-1980s.Ll Prefeasibility studies of the plant are still under way. They deserve very careful analysis because of the large amount of financing required, the possibilities of alternative timing, product mix, and facilities for an integrated operation, and the benefits and costs to the economy. The Mission has made only a tentative and preliminary analysis of available information and, at the present, can only present some general considerations to be taken into account in the broader context of Philippine industrial development. 80. The $1.3 billion (or higher) investment in an integrated steel operation may make possible production of slabs, billets (and possibly hot rolled sheets) at competitive price levels in the mid-eighties, assuming effective steps are taken to improve operating practices and efficiency in the industry. The market in the mid-eighties would probably justify a plant with about 1.5 million tpy raw steel capacity. It would most likely produce a low economic return - say in the range of 7 to 9% - and moderate savings of foreign exchange (around $100 million per year), and the creation of only 4,100 new jobs. The benefit to the economy would be a more secure supply of steel at reasonable and stable prices. Security of supply would be especially important in times of scarcity on world markets, when imported steel prices might become more volatile than prices of main inputs (iron ore and coal). Development of the industry would also contribute to the growth and diversifi- cation of the Northern Mindanao economy, including related industries such as refractories, rolls, castings, transport, other supplies and services; and provide other indirect benefits, such as technology transfer, improved management techniques and practices, advanced training in fields of mechanical/electrical/hydraulic equipment operation and maintenance. All of the above could contribute significantly to indirect employment in the long-term future. 81. The indicated foreign exchange savings would increase rapidly with increases in steel product selling prices, which could occur during periods of world steel shortages - as in 1974. During such shortages, selling prices could increase the equivalent of 20% or more over the full year. Annual /1 This supersedes a proposal for a 1.0 million ton plant, which had been considered up to the time of the Mission. - 25 - foreign exchange savings associated with the operation of the integrated steel plant could then easily reach about $140 million per year. 82. In view of the substantial investment involved, a decision on an integrated steel project should be considered in the broader framework of industrial priorities (see para. 48). It may be appropriate to consider a plant which would start operations after 1990. The Philippine domestic steel market is projected to grow at 7-8% p.a., from the present 1.3 million tons to around 2.1 million tons in 1985, of which 1.5-1.6 million tons could logically be provided by an integrated plant. A moderately higher return would, however, be obtained on a larger integrated plant project - say about 2.5-3.0 million tons - particularly since it could be combined with a more economically-sized hot strip mill (e.g., 1.5-2.0 million tpy). The Philippines already has,a hot strip mill (National Steel) of about 0.5 million ton capacity (a steckel mill, with some marginal technical characteristics). Unless the existing mill were to be closed, additional hot strip capacity of only about 0.5 million tons would be required by the mid-1980s if included on the same schedule as the integrated steel operations. The larger, better balanced capacities (2.5-3.0 million ton raw steel capacity and 1.5-2.0 million ton hot strip mill) could be accommodated by the home market by about 1991 and should produce a somewhat higher rate of return on total investment required. 83. Such a postponement would, however, pose certain risks for the Philippine economy if serious world steel shortages were to develop by the mid-eighties, and such shortages would raise steel prices even above the cost level at which a 1.5 million ton plant can operate. In such a shortage situation, the price of semi-finished products (on which the Philippines would be dependent) could be particularly volatile, and supply conditions for those products could be tight. D. Mechanical Engineering 84. The ME industry is heavily concentrated on consumer products and has at present little capacity in capital goods production. About half of the output of ME industries consists of motor vehicles, home appliances, mining and construction machinery spares. Another 40% constitutes manufacture of various small metal products. The growth of this industry has fallen behind that of manufacturing generally and, as a result, the country has become relatively more dependent on imports and has had less opportunity to build technological capacity in metal working. Philippine comparative advantage lies more in simple producer goods than in production of more sophisticated consumer durables -- this is evident from the Mission's plant observations, differences in labor-intensity and from computation of domestic resource costs. While consumer goods industries are relatively less efficient, they have received higher levels of protection than producer goods industries. - 26 - 85. Strengthening of the ME sector will require new investment and improved tooling, design and production technology. It will be necessary to determine more carefully in whlch product lines, especially producer goods, the Philippines has a comparative advantage and what type of assistance is most called for to help them get established. The most urgent problem areas in the industry are: (a) raw material supply (e.g., scrap, tinplate and steel sheets); (b) many obsolete plants; (c) a shortage of experienced shop supervisory personnel and skilled workers; and (d) technology. Deficiencies in product design and enforcement of standards limit production largely to low-value items, and technical servlces by organizations such as MIRDC are severely constrained by lack of funds. 86. Emphasis will initially have to be on economic import substitution particularly in simple producer goods. In exports, electronic products and auto parts have been the most important items. Main opportunities to develop new exports should lie in: (a) relatively simple and labor-intensive items such as hand tools, cutlery, foundry products, auto parts and machinery repla- cement parts (for mining machinery); and (b) metal products that are linked to other export sectors such as overseas construction and food processing. Further, it may be possible that, under present levels of protection, the producers of consumer durables and participants in the PCMP can be encouraged to increase their exports of finished products and/or parts. The foundry industry also merits priority attention. A basic need is selective moderniza- tion and upgrading of foundries to achieve production specialization by type and weight of castings. 87. The Progressive Car Manufacturing Program (PCMP) was a key initia- tive avoiding the establishment of many additional automotive producers and encouraging both domestic production and exports of key components. The program has received protection of close to 100% on final products (through tariffs and tax exemption), resulting in effective protection of over 300%. The incentive scheme has encouraged in-house production of components by PCMP particlpants rather than subcontracting. Increased production of automotive components might involve larger sales abroad and/or more procurement from domestic ancillary firms for consumption at home. Either form may require changes in the incentive system. For the further development of the ancillary industries, they should receive the same incentive treatment as the PCMP participants. Further study is required to identify the products which could be manufactured at reasonable cost. Increases in the domestic content requirement could easily lead to an excessive rise in automotive production cost. With rules for incentives for ancillary production established, the specification of domestic procurement content would need no longer play the same regulatory role as at present. Instead, it would be better to consider the domestic resource cost of net foreign exchange savings or earnings under the PCMP program and consider appropriate incentives to achieve them. 88. At present producer goods industries tend to receive less incentives than other lndustries. It is desirable that the Government establish a more - 27 - even level of incentives: narrowing the present disparity between effective incentives in the ME sector and manufacturing in general, and, within the ME sector itself, between underprotected producer goods and overprotected consumer items. Increases in tariffs may best be put into effect as groups of new projects are approved. For this purpose, the development banks should allocate larger amounts of long-term finance for projects in the ME sector. Further, the development of machinery production will require loans on terms competitive with those available on imported machinery. 89. In the administration of incentives, improved capability of small- and medium-sized producers deserves primary emphasis. They need assistance in raw material supply, layout and tooling, production problems, product testing and training of shop personnel. Organizations like MIRDC will require substantially increased resources to render broader and mwre effective service to the industry. E. Textiles 90. The textile industry has grown from a negligible size in the mid- 1950s to an industry employing around 64,000 with a value added of 980 million pesos in 1974. The industry does not meet domestic demand and some 25% of local consumption of yarn is imported. It is organized mainly on a vertical pattern, with little specialization in the major subprocesses of yarn manufacture, cloth production and finishing. On the scale practiced in the Philippines, this form of organization is generally uneconomic and can thrive only in a protected home market. Greater efficiency from speciali- zation could be expected to result in higher profits for specialist production. 91. The quality and performance of general management in the industry is good, given the conditions prevailing in the Philippines. The quality of technical management, on the other hand, is variable. At its best, it is good by world standards, with efficiently run mills showing a commendable record of innovation in regard to equipment, operating procedures and production control techniques. Regrettably, other companies operate old, worn out machinery in a desultory fashion under deplorable working conditions, with little effort put into maintenance and renewals. This is generally a reflection of the quality of technical management in those companies arising from a serious shortage of adequately trained Philippine technologists. The number of technologists needed is very small and suitable training may best be obtained by awarding fellowships each year to enable four of five qualified Filipinos to study abroad for up to three years. This would fairly quickly reduce the current dependence on expatriate technologists. The Textile Research Institute should also play a greater role than at present in keeping the industry up-to-date with technical developments. - 28 - 92. While the general quality of operator labor is adequate (at least around Manila), comparisons with other countries show that productivity could still be improved. The main labor problems lie in the shortage of skilled technicians. Modern textile machinery can only work well when in first-class condition, and technicians are vital to adequate maintenance. This appears to be a part of a general problem of insufficient attention being paid to training of technicians for industry. 93. Availability of Raw Materials. The Philippines has set up synthetic fiber plants with Japanese participation to supply the domestic textile indus- try. The present capacity of these plants is less than the requirements of the textile industry, and the balance, particularly polyester fiber, is imported. Further investment is being considered in synthetic fiber produc- tion to replace these imports. Unfortunately, there is a world-wide aver- supply of all synthetic fibers. Currently, it is cheaper to shop around, buying fibers exported at marginal cost rather than setting up new plants. It is, of course, difficult to say how long this situation will last, but it is clear that now is not the right time to invest further in so capital-intensive an industry. 94. Natural fiber prices, on the other hand, are high and will probably remain so. The Philippines has potential for expanding domestic production of ramie, which has many of the attributes in its finished form of linen. 95. Rehabilitation. Only about one-quarter of the existing equipment in the main line industry is less than ten years old, and much of the remainder is about twenty years old. This old machinery is in need of substantial renovation and, in many cases, renewal. The benefits would be a substantial reduction in operating costs and an increase in productive capacity by some 25%. There would also be some quality improvement. A strategy needs to be evolved to incorporate funds spent on rehabilitation with greater specialization. The Government's Textile Industry Inter-Agency Committee is currently studying the industry to decide on an approach to future rehabilitation. 96. Protection. The textile industry receives substantial protection against imports, with tariff rates varying from 10% on cotton up to 70% on woven fabrics. These tariffs have the effect of raising domestic prices with domestically-produced synthetic yarn priced about 50% higher than import prices, and fabrics some 40-80% more expensive than equivalent imports. This protection gives scope for very high profits for efficient firms, and permits inefficient firms to survive. While the present tariff levels may have been justified in the past to protect the infant textile industry, there is little case now for such high levels. The Mission recommends a phased reduction to levels that would give approximately equal effective protection to each stage in the production process. Indicative levels might be 10% for fiber, 20% for yarn, 25% for fabric and 30% for clothing. This would result in effective protection of 30-40% on staple fiber, yarn and fabric. Such tariff reduction should be tied to a rehabilitation program for the industry. - 29 - With appropriate rehabilitation and specialization most firms could cope successfully with such tariff changes. Any decisions to expand industry capacity for domestic or export production should be based on such reduced tariffs and not on the current levels. F. Food Processing 97. The food processing industry produces about one-fourth of all manufactured value added and employs one-fifth of the manufacturing work force. The Mission focussed on processing of fruits, vegetables, fish and meat products. In this subsector, some 50 large firms account for 80% of output and virtually all of the exports. The industry has shown rapid growth in the last ten years, particularly in fruits and fish products. 98. The major companies operating in this sector are well established and have significantly consolidated their position in the home market. The trend toward concentration has been reinforced by backward integration into raw material production. If left unchecked, this trend could endanger the position of the smaller growers and independent processors and would make new entry into the industry more difficult. 99. The processing industry is relatively well established. In food processing, the Philippines compares well with other countries in a similar stage of development. The Mission, moreover, found no evidence that the industry used excessively sophisticated equipment. In fact, as the larger firms expand and diversify their output, there is a case for increasing investment in machinery. Most of the larger companies have expansion plans, perhaps adding up to some $30 million, to be put into effect over the next three years or so. With the larger companies operating satisfactorily and with reasonable profits, investments in increasing output of existing products can be carried out without use of incentives currently provided by the Board of Investment. 100. Major bottlenecks for expanding output for domestic production and exports are the supply of raw materials (including fish) and other inputs (especially packaging material and cans) Improvement in raw material supplies will require a concerted effort by several agencies. 101. The Philippines' apparently rich marine resources and the avid export demand for the frozen and canned products are making for rapid expansion of the seafood processing industry. In the home market, a good prospect is identified for substituting the sizeable imports of canned sardines and mackerel with domestically-processed counterparts. Supportive measures for the industry's growth include: improved fishing facilities, both commercial and municipal operations; development of new fishing ports, collection centers, ice plants, etc.; training peasant fishermen and inculcating quality aspects; suitably priced cans of appropriate standard; and domestic production of tomato paste competitive with imports. - 30 - 102. The fruit and vegetable industry's output ranks foremost in the subsector. Several well-established firms operate efficiently, many having close connections with overseas sources of expertise. Pineapple products occupy the pre-eminent place in exports. Each of the two principal firms in pineapple processing, plus a third firm shortly to start operations, has its own plantation. In the domestic market, juices and nectars, from indigenous raw materials and imported concentrates, and low-priced items like beans in tomato sauce, enjoy increasing sales. Requirements for the industry's development are: consistent domestic raw material inputs and competitively priced packaging, especially as to cans and their quality. Product diversification could provide increased throughput and hence lower unit cost. The Ministry of Agriculture's collaboration with the industry and its extension services to producers could lessen the trend to backward integration being evidenced. 103. Given the favorable position of the export processing industry, present levels of protection appear unduly high. Board of Investment incentives would give special encouragement to raw material production, new products and processes and "newcomers" to the industry. 104. Recommendations: Raw Materials. Consideration should be given to adopt a policy whereby, within a determined period of, say, five to ten years, all large processors procure not less than 30% by value of their domestic raw material inputs from independent suppliers with preference being given to small growers and fishermen, formed into associations or cooperatives with which the large processors would contract. 105. Cans. Steps should be taken to improve the domestic can supply. Domestic can fabricators should be helped to operate their facilities more economically by providing more adequate supplies of black plate. The Government would be well-advised to permit freer imports at low duties of black plate and tin plate until domestic production of these imports can be increased to meet domestic requirements. Export industries should be able to obtain their can requirements at international prices and quality. 106. Tariff System. Given the present performance of the industry, protection is generally only warranted where it is needed to compensate for input prices over international levels. Hence, a phased reduction of tariffs could be effected. Concomitantly, a mechanism might be considered for imposing a sales tax on those products destined for the luxury (high-income group) market. 107. Incentives. (i) It is proposed that a shift in emphasis be made so as to accord yet further importance to raw materials production and their effective marketing. (ii) To facilitate small producers' access to incen- tives, BOI and the Ministries and agencies directly concerned should set up arrangements so that intending applicants are assisted in formulating both their projects and applications. (iii) Since incentives are no longer a - 31 - determinant factor for existing large firms in expanding their present fa- cilities to augment current output, it is proposed that incentives should be preferentially available to encourage existing large firms to diversify into new products and to adopt innovative process technologies. Newly established firms should, however, be entitled to incentives. 108. Accredited Trade Entity. Many important issues - finance, tariffs, incentives, inputs, effects of FDA regulations, etc. - are of general con- cern to the food processing industry as a whole. With this in mind, the Ministry of Industry, in concert with the existing trade associations for food processors, might give the de facto recognition of one overall entity (perhaps PFFPI) accredited for dialogue and negotiation with the Government agencies concerned. 109. Although the Mission has focussed on the large firms, the identi- fication, work-up, promotion and realization of opportunities for smaller- scale processing projects deserve attention. Potential exists both to im- prove existing small-scale operations and to establish new processing acti- vities (especially of the "primary" type) adjacent to areas of production, such as might be developed through growers' associations and cooperatives. G. Cement 110. The cement industry in the Philippines currently consists of 18 plants, operated by 16 companies. Production is 4.2 million tons per annum, of which 800,000 mt were exported in 1978. The industry is located near markets and/or raw material sources throughout the country with 11 plants in Luzon, 2 in the Visayas and 5 in Mindanao. 111. A combination of overexpansion, a depressed market, increasing costs, large debt burden, and severe underutilization of capacity has led to large losses by most firms in the industry. Debts could not be repaid, even after they were refinanced by lending institutions, and most of the industry remains heavily in arrears. 112. As a result of operating losses, working capital for plant main- tenance was insufficient, and plant facilities were run down. Further technical problems have resulted from poor management and lack of spare parts; production is often interrupted by erratic electricity supply and extreme weather conditions; ancillary machines and instrumentation are inadequate or in poor condition; and operating staff are inexperienced and supervision is lacking. These difficulties have led to serious deterioration in the capabilities of many plants. The industry, as a whole, is producing as much as current facilities will permit, even though this is only 63% of rated capacity. Many cement plants are in urgent need of rehabilitation, while others have deteriorated to such an extent that they should be scrapped. - 32 - 113. Further action is also needed for pollution control and conversion of cement plants from oil to coal firing. The National Pollution Control Commission (NPCC) has set standards for dust emission, which the industry must meet. This will entail additional cost and add to the industry's current burdens. While coal conversion in selected plants is likely to prove economical, such conversion should take place only in efficient firms after careful technical study. Both the coal conversion and the installation of more anti-pollution equipment should be tied in with an overall plan for industry rationalization. 114. Under such a rationalization plan some obsolete plants will have to be phased out over the next few years. At the same time, new plants must be constructed to meet increasing demand projected at over 4 million tons over the next decade. A package program should be worked out for the indus- try to include finance, technical and management assistance, labor training, and other back-up facilities. Finance for rehabilitation, expansion or new plants should be provided only to firms with sound technical proposals, sufficient managerial expertise, and enough equity to put a project on sound footing. H. Garments 115. The clothing industry is the most dynamic industry in the Philippines. It has evolved since the 1950s from small tailoring and dress shops making clothing-to-order to a multimillion dollar business with exports of over US$300 million in 1978. In 1975, the industry employed some 106,000 people in 28,000 establishments in the organized sector, with many others undertaking part-time commission work in homes and small shops. Garment exports covered most types of clothing, with a heavy emphasis on embroidery and high volume lines, such as standard suits and trousers. Some 60% of the value of garment exports lies in imported fabric, but the export industry has generated an estimated 70,000 jobs, with associated spin-offs such as labor and management training. 116. The traditional export market has been the US, but the industry has been diversifying its markets over the past three years, and 24% of garment exports went to Europe in 1977. The quotas imposed on imports of Philippine garments by the US, Australia, the EEC and Canada will effect industry exports. In past years, such quotas have not been a severely limiting factor, but, as the exports expand, their pressure will become more severe. To minimize the effects of the quotas, the industry must be able to diversify and upgrade its product lines, so as to have the flexibility to shift production to lines unaffected by quotas. The industry needs to know the fashion and market situation in other countries, and facilities should be provided to help Filipino entrepreneurs to travel overseas on business and/or to retain agents in other countries to provide feedback on the latest trends in clothing markets and fashions. - 33 - 117. The garment industry relies almost entirely on imported raw materials, mostly fabric. In most cases, domestically-produced fabrics are considerably more expensive than imported fabrics, and in many cases their quality is inferior. The materials are imported for re-export duty-free through BOI-approved bonded warehouses or the Export Processing Zone at Bataan. This policy of free import has minimized the problems the garment industry would face if it had to rely on domestic fabrics under the present tariff system, and exporters have been able to take advantage of cheap labor costs to expand overseas markets. But, at the same time, a large potential market for domestic textile producers has not been exploited. 118. Steps toward greater efficiency in the textile industry are dis- cussed in Section F-3. -A reduction in tariffs on textiles would give greater incentive for exports. The Government could also help by applying the draw- back to inputs of textile firms producing for garment exports. Such indirect drawback should be available to all firms under simple administrative procedures (para. 25). 119. The main incentives assisting the domestic clothing industry are the tariffs and restrictions on clothing imports. The tariff on clothing is 100% which is higher than the 70% tariff on fabrics, resulting in an effective rate of protection of 175%. In practice, competition, coupled with the relatively low level of domestic purchasing power, means that domestic prices are not set as high above c.i.f. import prices as the tariff would allow. Nevertheless, domestic garment prices are still considerably higher than export prices, and unit profits are higher on the domestic market. A reduction in tariffs on both inputs and outputs would allow the domestic clothing industry to lower prices while still operating profitably. I. Furniture 120. Many small shops and relatively labor-intensive technology characterize the furniture industry. Exports have increased significantly and now exceed $25 million. Market and cost conditions are favorable for further substantial growth. More rapid development would benefit some of the outer regions, e.g., Cebu. 121. Problems facing the furniture industry are: availablllty of suitable raw materlals, wood seasonlng, lack of skills, finance, and design. "Narra" hardwood, an important and prized ingredient, has been hard to get. The Government has banned its export, but domestic supplles are still scarce and expensive. There is an overreliance on "narra" hardwood, and more effort needs to be made to use other species of timber. Technlcal assistance is needed but the Forest Products Research Institute, although working on this problem, is not providing sufficient help. The rattan industry is also facing serious constraints in obtalning rattan poles. 122. Seasoning of hardwoods is dlfficult to organize in an industry with many small units. Modern, centralized kiln-drying facilities are - 34 - needed, especially for the smaller factories. This might be facilitated by relocating small plants into specialized industrial estates. Further, more training of skilled workers and technicians for the industry is needed, as well as a wage structure that would encourage skill formation. 123. The following measures for the development of the furniture industry are recommended: (a) Expanding the availability of suitable woods, rattan poles, and other materials through a better controlled reforestation pro- gram, timber felling, and distribution coordinated with the manufacturers, together with liberalized imported inputs where needed to maintain supply and reasonable price levels; (b) More skill training programs, and the introduction of a wage structure to encourage skill development; (c) More finance for equipment, working capital, and export produc- tion. Possibly a special industry program should be set up within the Government's SMI financing schemes; (d) Establishing a Furniture Trade Exporters Corporation, partly with public capital, to help in export marketing, common materials procurement and seasoning, relocation, training programs, etc.; (e) Involving the Design Center in assistance in improving furniture design; and (f) Search for new export markets, e.g., in Europe, the Middle East and Asian countries, especially for wooden furniture made from timbers other than "narra". J. Leather and Footwear 124. The leather and footwear industry has expanded considerably in response to both domestic and export demand. Total output was over 30 million pairs of shoes, of which 7 million were leather and the rest rubber. Exports reached 12 million pairs in 1978, of which more than 8 million were leather, mostly cheaper models, made with imported leather, and of designs prescribed by foreign buyers. At present levels of wages and productivity, there is a large potential for further growth. Outstanding proposals for new production and export marketing would more than double production. 125. The industry is composed of many small cottage firms and a few larger ones.-;In 1978, there were over 2,700 leather shoe manufacturers with over 20,000 workers in total. In all, about 125 plants had over 50 workers in 1977, and only 7 had over 200 workers. - 35 - 126. Supply of local leather is poor. Most tanneries are primitive and produce low quality leather. The Philippines does not produce hides in sufficient quantity or quality. The tanning industry, therefore, relies to a great extent on imported hides - at least for production of better quality leather. Even with imported hides, the quality of finished leather from Philippine tanneries is low. A major long-term technical assistance program would be needed to bring locally-produced leather to quality standards. It would have to extend from cattle raising and the slaughtering of the animals to the treatment of hides, to the equipping of tanneries and the training of technicians and skilled workers. 127. Technical Assistance. There is as yet no technical institute to assist the shoe industry. Such an institute could be of assistance in improving the quality of indigenous materials as well as the use of plastics, rubber components, adhesives, and finishing materials. The Philippine Shoe Trading Corporation, set up in 1978 with mixed Government and private capital, has already undertaken some export orders. The Corporation can be instrumental in subcontracting, common procurement, financing and export marketing for small firms. 128. Recommendations. To achieve its full potential and sustain the present momentum of the industry, more comprehensive assistance is needed: (a) Expansion of the scope and activities of the Philippine Shoe Trading Corporation. All export firms, including small ones, should be permitted to import raw materials duty-free; (b) More finance must be made accessible to the smaller firms for working capital and equipment. The Government's SME financing program might benefit from a specific shoe industry component; (c) A Leather and Footwear Development Center, jointly operated by the industry and Government, should be set up; and (d) A long-term (10-year) program for developing a high-quality leather tanning industry is needed.
World Bank Group · Pre-2003 Economic or Sector Report
Philippines - Industrial development strategy and policies (Vol. 1 of 3) : Summary report
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World Bank Group
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Pre-2003 Economic or Sector Report
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Philippines
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World Bank