port No. 11061-PH The Philippines An Opening for Sustained Growth (In Three Volumes) Volume II: Part II: The Real Economy arnd Part IIl: The Lorrelates and Determinants of Poverty AprI 1, 1993 Country Operations Division Country Departnent i East Asia and Pacific Region FOR OFFICIAL USE ONLY Douent of the Wod Bank This docmn has a restricted distribution and may be wed by recipiens only in the pefomance of their official duies. Us coten may no otherwise be disckosed withut WorW Bank aurzation. FOR OMCIJAL USE ONLY BASIC ECNOM= REPORT TH PHRMMES: AN OPENING- FOR SUSTAINED GROWTH Table of Coent Volwne n PART n The Ra Economy: Performance, Polces, and the Busins Envromen Emf VI. STAGNATION IN THE 1980s: A STORY OF FLAGGING COMPEITITVENESS .. 122 A. Paens in Phippie Economic Performance .................... 123 B. Recommendaions: Fosteing an Export Culture .................... 131 VIi. THE PAST ROLE AND FUTURE POTENTIAL OF THE AGRICULTURAL SECTOR .................... 134 A. Overview .............................................. 134 B. Demand and Supply Prospec ............. 1e .................... 138 C. The Supporting Environment for Agriculture .................... 156 D. Agriculte Sector Sategy .................... 170 IX. THE COMPEMTIVENESS OF PHLIPPINE INDUSMY ................. 174 A. Historical Performance of the Maufri .ector .................... 177 B. Domesdc Competiton: Industial Strucure and the Missing Middle ........... ............................. 182 C. Compedtion from without: Impor Competiton, Export Rivalty, and the Beefits of Foreignrtovmm ..................... 206 D. A Stategy to Improve Ihdustrial Sr r id Performance .... .......... 233 X. POUCY INTERVENTIONS AND COMPETMTVENESS .................. 238 A. Macoeonomi Policy .... ... .................. 238 B. duiaPolicy: Incentives, Ruion and tCosof Doing Busines ............ ............................. 239 C. Policies for Sma and Medium Businees .......................... 255 D. Trade Policy . .......................................... 264 E. Govement Corpotiomns and Privadtton .......................... 273 This document has a tticted distibution and may be used by recpients only in the performtace of ther offlcial duties Its contents may not otherwise be disclosd without World Sank authoriztion. X1. INFRASTRUCTURE AND SUPPORTnNG SERVICES ................... 283 A. Infrastructure Power, Telecommunications, Tranport, and Water Supply ........... .............................. 283 B. Supportg Sevices: Fuianci Markets and the Industial LaborMAut ............ ............................. 305 C. A Strategy forte ..................................nastrcu. 317 PART m Tbe Correlat and De s of Povety XI]. THE MEASUREMENT AND CHARACTERISTICS OF POVERTY AND INCOME DISTRIBUlTON .................................. 323 A. The Masurement and Dimensions of Poverty ....................... 323 B. A Prfile of Phlippine Povety .............................. 344 XIII. THE PATTERN OF GROWTH AND INCOMES OF ThB POOR .... .......... 361 A. Macroeconomic Correlates of Povrty ............................ 361 B. The Labor Market in Perspective ............................... 372 XIV. IMPROVING ECONOMIC CAPABILITIES OF THE POOR . .390 A. Access to Land and Naural Resources .390 B. Delivering Social Services .398 XV. THE COMBINED INCIDENCE OF TAXES AND PUBUC EXPENDITURES IN THE PHILIPPINES 445 A. Ta.s ..446 B. Public Exenditures 456 C. Net Tax4Bendeit Incience.474 LISTOFPTABLES,.FIGURES.-AND BOXES CHAffK VI TABLES 7.1 Growth ad Composidon of GDP, 1946-91 ........................... 124 7.2 Growth of Output, Employment, and Productivity by Sector, 1980-90 .... ...... 126 7.3 Idicato of Policy Reform ..................................... 128 7.4 Ditribuon of Exporters and Value of Exports in the 1980s .130 EagE EGUES 7.1 M i g Share and Income Growth across Courties ................. 125 - QZ~~~~~~~~~BPTER vm 8.1 Stnru e ant Performance of the Agricultural Sector . 137 8.2 Regional and Subsectora Contibution to Growth in Agricultural Value Added, 1985-90. .................... 138 8.3 Divesification in Agiculta al Produion and Expors, 1980 and 1990 .151 8.4 Relative hmportuae of Top Agribusiness Groups .153 8.5 Con tr Ratios in Selected business Sectors .154 8.6 Stnucue and Perfornance of Agro-Industry, 1980-90 .................... 156 8.7 Evolution of Trade Protection in Agriculture and Aro-Indutry, 19888....................................... 158 8.8 Effective Protectdon Under E.O. 470, 1990-95 ......................... 159 8.9 Evolution of Govenam Expenditure in Agriculture, 1970-90 ............... 161 8.10 Co iti of Govement Expediu in Agriciture ...... ............. 162 8.11 Agricultural Poducdon Loans Gnted, 1983-90. 165 FIGURES 8.1 Agriculture in the Economo ................134 8.2 National Food Autrity Expenditures on Rice and Co Subsidies. 143 8.3 Agricultul Tem of Trade, 1980-90. 157 8.4 Projected Impa of Trade Liberalizaion. 160 8.5 aionl PiDe Ratios of RicelUrea and Maizd Urea, 1970 to 2000 .171 BOXES' 8.1 Agriclu Sector StrtagyM x ................................ 172 ,CHAPIXRIX TABLES 9.1 Distrldon of Value Added across M Subsctoru,1967-91 . ....................................... 180 9.2 Chanes in Employme SStucmt u reg119 ................ 183 9.3 Mnfaturing Esblishmes, Employment, and Vahe Added bystshmnSz, 1988 . ................. ;18 9.4 Coeration in Mufactrig scro Countris ....................... 187 9.5 Ditibution of Con at in maaufting acoss Countries ............... 188 9.6 Wap Dfferens by MnufuingEs ashmntSe across Countris ............................................... 189 Pae 9.7 Value Added in Manufacturing by Region. 1975-90 ...................... 192 9.8 Regional Distribution of Equity investment, 1981-90 ..................... 193 9.9 Decomposition of Manufacturing Output Growth between Census Years ............................................. 195 9.11 Shifts in Manufacturing Employment by Size Orientation of Subsectors and Size of Establishment: 1983-88 ....................... 196 9.12 Concentration in Manufacturing by Subsector, 1983 and 1988 ................ 198 9.13 Financial Performance of the Manufactua-ing Sector, 1979-90 ........................................... 202 9.14 Index of Country Openmess across Cournries, 1977-88 .................... 209 9.15 Nominal Tariff Rates across Countries, 1985 .......................... 210 9.16 Philippine Export Price Reladve to Competitor Countries .................. 216 9.17 Philippine Manufacturing Wage Relative to Competitor Countries .... ......... 217 9.18 Composition of Philippine Manufactured Exports ....................... 220 9.19 Concentration of Exports across Countries, 1980-88 ...................... 221 9.20 Investment across Countries, 1980489 ............................... 225 9.21 Rates of Investment by Size of Firms and Subsector ...................... 226 9.22 Foreign Direct Investment Flows from Japan .......................... 228 9.23 Foreign Direct Investment Fiows from the US. ........................ 229 9.24 Foreign Direct Investment Flows from Korea and Taiwan (China) .... ......... 230 9.25 Country Risk Indicator, 1977489 .................................. 231 9.26 Foreign Investnent as a Share of Total and Private Investment ............... 233 FIGURE 9.1 Manu rin in the Economy ................................... 174 9.2 Annual Growth Rates of Manufacturing Value Added and M Value Added Share in GDP, 1950-91 .............................. 178 9.3 Man cr Size Stucnure of the Philippines, Developing Countries, and Developed Counties .............................. 186 9.4 Value Added per Worker and Capital-Labor Ratio by M4anuacturing Establishment Size, 1988 .189 9.5 Establishment Size Distribution of Manuftrin Employment., 1983 and 1988 ............................................ 196 9.6 Changes in M ri Value Added by Subsector and Establishment Size, 1983-88 ................................... 199 9.7A Efficiency in Rsource Use by Small Manufa Estabishments, 1988 ....2.............................. 00 9.7B Effiiciey in Resource Use by Medium Manufacturing ESablidsh ns, 1988 ................200.... 2 9.7C Efficiency in Rsurce Use by LageManactr Establisments, 1988 ........................................ 201 9.8A Share in World Market for Manufactures of the Philippines, Korea, and Taiwan (China) .................................... 212 9.8B Share in World Market for Mandfactum of te Phitpinwes, Thaland, Indonesia, and Malaysia ................................ 213 9.8C Share in World Market for Manufactures of the Philippis, Chfle, Mexico, Turkey, di ...................................I. 213 Page 9.9 Exchange Rate, Unit Value, and Wage Rate Changes ..................... 215 9.10 Import Content of Exports, 1977-91 .......... ...................... 218 9.11 Investment and Export Performance in the Philippines and Thailand ............................................. 225 BOXES 9.1 1989 Survey of Household Subcontrctng Activities ..................... 206 9.2 Specialization and Diversification in Chile, Malaysia, and India .... .......... 222 9.3 India's Export Marketing Fund ............. ...................... 236 9.4 Marketing Clinics in the Philippines .......... ...................... 237 CHATER X TABLES 10.1 Comparison of Investment Incentive Policies in ASEAN Countries .......... ... 242 10.2 Revenue Foregone from BOI Incentives .243 10.3 Marginal Effective Tax Rate on Investment under the Omnibus Investment Code ............. ...................... . 244 10.4 Estimated Revenue Effects of Changes in Tax Incentives . 245 10.5 Regional Distribution of CBBEs Registred under Kalakalan 20.259 10.6 Quantitative Restrictions on Imports, 1980-91 .......................... 268 10.7 Weighted Average Effective Protection Rates by Major Groups for Each Phase of E.O. 470 ....................................... 270 10.8 Trade Protection in East Asia in the 1980s ............................ 272 BQXES 10.1 Chronology of Philippine Incentive Legislaion .240 10.2 Chonology of Philippine Trade Policy .266 10.3 Costs of BOI Program for Motor Vecs ............................ 273 10.A Financing Progrms for Micro, Cotage, ad Smal an Medium Enotprises (MCSME) 7............. n 2 CHlA&FMa TABLES 11.1 Co aaiveCosts of Industri Infrastructure and Services, 991 .285 11.2 Infrastructure Expansion: Some Interational Comparisons. 26 11.3 Chage in Ifrasrnu Services. .287 11.4 Outage Statistics for the Luzon Grid .288 11.5 AcOsuPublic lvesnmnt in nfa i Uturby Sector, 1978-90 .290 11.6 Private Sector Infrastrucmt hesment in the 1980s ....... .............. 292 11.7 Completion Time of World Bank Infrastructure Projects ................... 293 11.8 Average Tariffs of the ASEAN Utilities ...... ....................... 300 11.9 The Competitiveness of Philippine Labor ............................ 309 11.10 Labor Ratings in Selected Asian Countries ............................ 310 11.11 Secondary School Enrollment Ratio ................................ 312 11.12 Labor Force Skills across Countries: T echology Education and R&D Employment ................... 313 FIGURES 11.1 Public Investment by National Government and GOCCs .289 11.2 Private Infrastructure Investment 292 11.3 Expenditure on Road Maintenance .296 11.4 Comparison of Expenditures for Road Maintace and Investment ........ .... 296 CHA-ER NU TABLES 12.1 Individuals and Families in Poverty, 1971-88 .324 12.2 Official Poverty Line Characteristics .329 12.3 Philippine Poverty Lines as Percentages of Poverty Lines in Indonesia and Thailand, 1976 and 1986 .330 12.4 Poverty Thresholds and Incidence . ................................. 331 12.5 Alternative Indices of Poverty InciJence for Families, 1971-88 .334 12.6 Health and Fertility Indicators by Year, 1965-90 .341 12.7 Basic Nutrition Indicators: Inteiountry Comparison .342 12.8 Malnourished Children 0-6 Years Old ................................ 342 12.9 Malnourished Children 0-6 Years Old, by Age Group .................... 343 12.10 Charactstics of the Poor, 1988 ................................. 345 12.11 Average Shares of Income Source for Families in Bottom 30 Percen of Income Distribution, Rural and Urban Areas, 1965 and 1988 ............... 346 12.12 Family Income Shares by Pre-Transfer Income Quintile, 158 .349 12.13 Income Distribution, 1961-88 .351 12.14 Shares in Income Distribution in Lower-Middle-Income Counti .... ......... 352 12.15 Total, Urb.n. and Rural Poverty and Susitence for Famflies in 1985, 1988 and Change between l985 and 1988. 353 12.16 Share of Rural and Agricultual Families in Total and among Families in Bottom 30 Percent of Income Distibutdon, 1985 and 1988. 353 12.17 Urban and Rural Income Distibution, 1961-88 .354 12.18 Regional Total Povery and Subsistence Nmbers and Rates for Families in 1985, 1988, and Change btween 1985 and 1988. 355 12.19 Poverty Incidence by Family Size, 1988. 357 12.20 Dependency Ratios by Deciles, 1988. 357 12.21 Age CohortsbyDeciles, 1988 ................................... 358 PREs ~ ~ ~ ~ ~ ~ ~~E 12.1 niviuas and Families in Poverty and bdow Subsistece ................. 327 12.2 (a) Cross Country Regression for Female Expected Schooling in 1965 with Selected Asian Counties -Indicated . ,...... 336 (b) Cross Country Regression for Male Expected Schoolng in 1965 with Selected Asian Counties Indicated . .336 (c) Cross Coutry Rgrssion for Female Expected Schooling in 1987 with Selected Asian Counries dicated ..................... 337 (d) Cross Country Regression for Male Expected Schooling in 1987 with Selected Asian Counties Indicaed . .337 12.3 (a) Cross Coutry Regression for Female Life Expancy at Birth in 1965 with Selected Asian Countries Idicaed . ............... 339 (b) Cross Country Regression for Male Life Expecy at Birth in 1965 with Selected Asian Countries Indicated . ............... 339 (c) Cross Country Regression for Female Lfe Expectancy at Birth in 1988 with Selected Asian Countries Indicated . ........... 340 (d) Cross Country Regression for Male Life Expectancy at Birth in 1988 with Sdected Asin Countries Indicated ................ 340 12.4 (a) Reltionship between Trandsers and Ineme, Uban Households ......... .. 350 (b) Relationship between Transfs and Income, Rural Households ..... ....... 350 BOD= 12.1 How Reliable is the Family Inome and Expenditure Survey? . .325 12.2 Distributionally Sensitive Poverty Indicators ..... .................... 333 12.3 Ifat Mortity Staistics in the Philippines .................... 338 12.4 Welfare Services .................... 348 CHAPTER ThBLES 13.1 Averg Rea Family Iome Grwth by De s beween FIESs, 1961-8 ........ ............ 363 13.2 Average Anua Rates of Growth of Per Capita Aggregas .. . 364 13.3 The Transformation of Phlipine Employment ..367 13.4 Rate of Unemployment ad Undeemployment .. 373 13.5 Ptivale,. Nonagricultural Employment by Economic Sector, ouinold vesus Estbh Data. 1983 ..376 13.6 Unsied WWages i ntMpolitanManlla. 19M.91 . .378 13.7 Compaison of Idustrl Wage Trends-Unskled Industri Labor versus nfcturing Averag ..379 13.8 Averap Daily Wages of Farm Workers (without meals) . .................. 380 13.9 Employment, Iom, and Wa eCha cesisof CEDP Workers . .387 FIGURES 13.1 Gross Domestic Per Capita Income Index ............................ 362 13.2 Real Net National Disposable Income Growth .365 13.3 Average Annual Growth in Export Share in GDP for 1965 to 1989 vs. Average Annual Growth Rate in Headcount Measure of Rural Poverty .369 13.4 Agriculture-Industry Terms of Trade .370 13.5 Local Wholesale Prices Rice/Urea and Maize/Urea .370 13.6 Irtenational Prices, Actual and Projected, Rice/Urea and Maize/Urea .371 13.7 Real Daily Wages and Productivity for Agriculture and Industry .375 13.8 Comparison of the Legislated Minimum Wage to the Market Wage .384 BOXES 13.1 Mininum Wages in Puerto Rico .385 aFrE DVy TABLES 14.1 Basic Indicators of Overall Education Development, 1989 .400 14.2 Cohort Survival Rates in Elementary Schooling by Socioeconomic Groups .402 14.3 Regression Results on Transition Rates, Dependent variable: Transition rates: Prinary to Secondary, 1990 .404 14.4 Rates of Return to Education .405 14.5 Mean Earnings by Education Level, Philippines, 1988 .407 14.6 Basic Indicators of Overall Health Development, 1989 .415 14.7 Total Health Care Exper..itue .418 14.8 Regression Results: Dependent Variable: Infant Mortality Rate .425 14.9 Uses of National Health Expenditure .427 14.10 Labor Input Mixes by Region, 1990 .428 FIGURE 14.1 CARP Targets and Fulfillment .392 14.2 Agrarian Reform Refund Expendiures .392 14.3 Secondary Level: Expenditr and Outceme 1990 ....................... 402 14.4 Relationshp between Transition Rate (Prtmary to Secondary) and Education Epenitur by Province, 1990 ........................... 403 14.5 Public versus Private Financing by Region, 1989 ..... . .................. 407 14.6 Infant Mortality Rates and Per Capita GNP in Fourteen Asian Counties, 1989 ........................................... 416 14.7 Average Life Expectancy at Birth and Per Capita GNP in Fourteen Asian Countries, 1989 ........................................... 416 14.8 Per Capita Health Expenditure, 1990 ............................... 419 14.9 Per Capita Health Expenditure and IMR, 1990 ......................... 419 14.10 (a) Infant Morality and Health Expenditure .......................... 420 bas 14.10 (b) Infant Mortality Rate . ....................... , 421 14.11 (a) Proportion of Households with Safewater. 422 (b) Coverage of Sanitation. 422 (c) Percen Immunized with DPT 3 .423 (d) Population per Physician .423 '4.12 Deaths Attended and Population-Bed Ratio, 1988 . . .424 14.13 Air Emissions (896,680T/Year), Stationary and Mobile, 1990 .439 lOXB 14.1 Sustainable Development throgh Community-based Resource Management .398 14.2 Targeting for Health Services .......................,,,.... 414 14.3 Volunteers for Health? .429 14.4 Does Air Pollution Affect Health? ................................. 441 ,CHATRS XV TIL15 15.1 Individuel Compensation Tax . 447 15.2 Effective Tax Rates by Income Clss .448 15.3 Incidence of Income Taxes ..................................... 449 15.4 Expenditure Shaes by Income Class .453 15.5A Effective Excise Tax Rates ....... ............. ................ 454 15.5B Effective Excise Tax Rates by Decile . 454 15.6 Import Tariffs ............................................. 455 15.7 Distribution of Tax Burdens . 457 15.8 Enrollment Rates by Age and Income Quintle, 1982 . 461 15.9 Enrollment Rates by Income Quitile in Higher Education, 1982 . 461 15.10 Per Capita Education Expendiure by Quintile of Income Distribution, 1988 .463 15.11 Utilization Rates of Health Facilities by Dreile of Household Per Capita Income .463. 15.12 Utilization Rates of Health Facilities 1987, by RRegion. Raniedfrom Poor to Rich ............ ........................ 465 15.13 Public Expdiures by Region .................................. 466 15.14 Percentag of Households within Income Ranges ........................ 467 15.15 IncWence of Pubic Expenditures ................................. 468 15.16 Incdenc of Education and Health Expendiures in Indoesia, 1987 .469 15.17 Gross Enrollwm Ratios, 1960-90 .470 15.18 Paterns of Public Spending by Levels of Eduaton .471 15.19 Per Capita Houseold Expenditure on Health Care by Per Capita Income Quintile, 1988 .................................... 472 15.20 Regional Allocations from Local Goverment Code ....... ............... 473 15.21 Cbange in Benefit I ence wh Loal Govemment Code .................. 474 15.22 Net Incidence of Taxes and Public Expenditures ........................ 476 15.1 Philippies: In au tu eEm dire Exp i............................. 460 15.2 Per Sudnt Expenditure ....................................... 464 15.3 DistributionofCwmulativeSpedingonEducation ....................... 471 BO1 ES lS.l I TeInidenceof Rurd Dodiuo .................................. 459 AN OPING FOR SXUAID GROWTH PART th TM Re-l Eesmor.a 1* ?dk6u Mi de U.inin laylrinmu * 122 - VII. STAGNATION IN THE 1980s: A STORY OF FLAGGING COMPETITIVENESS 7.1 Unsatisfactory private sector growth in the Philippines is a problem that emerged clearly by the late 1970s, closely linked to the flagging international competitiveness of an economy weighed down by policy distortions. Many performance indicators-total factor productivity growth in manufacturing, economy wide incremental capital output ratios, and the rate of employment generation- illustrate the economy's lack of dynamism over two decades. However, the country's export performance through the 1970s and until the mid-1980s was solid, and the agricultural sector (except for forestry) showed many improvements until the 1980s. The more recent story is simihrly a mixed one. The poor growth perfonnance of the Philippine econon,' in 1990 and 1991. following directly the strong upswing of 1986 to 1989, has created doubts about "hether any supply response has followed the structural reforms of the 1980s. It has lent credence to the view that the Philippines tends to perform below potential. Although supply response to strucnWal reforms has been muted overall, in some subsectors and by sor= measures, the response of producers has been apparent. Thus, this part of the report, in describing performance, policies, and prospects of the real economy, concludes that with a few additional but important policy initiatives by the government, the economy will be well placed for growth and a recovery of international competitiveness. 7.2 This part of the report auempts to set the performance of the real economy in context by comparing performance in the 1980s to that of the 1970s and earlier periods and by comparing policy reform and the supply response to those of the Philippines' competitors in East Asia and elsewhere. It concludes that structural reform of agriculture and idustry has been extensive. The weakening of the supply response is seen to have a fourfold explanation: the stop-and-go nature of policy reform, especisi;W of the trade regime, due mosdy to the necessities imposed by repeated stabilization episodes; the slo%- iess in completion of the major elements of structural reform, which are just now falling into place; the ability of an oligopolistic economy to resist change; and repeated macroeconomic shocks, particularly the balance of payments crises of 1983 and 1990 (see Chapter M). The report finds that an appropriate enabling environment for economic growth is now essentially in place in the Philippines, although it remains to be seen whether the economy will respond to these incentives or whether a more proactive stance on the part of the government will be needed as has been the experience in other East Asian countries. Two policy areas that require some furither attention are financial markets and labor regulations, in particular, the minimum wage. However, as is clear for every sector of the real economy, the most problematic yet crucial area for govemment action is infrastructure. 7.3 The real economy is looked at by sector in this part: agriculture (Chapter VIll), industry (Chapter D), and inastructure (Chapter XI), intrrupted by Chatter IX which summarizes the policy framework. This chapter presents the broad tmes that emerge from the examiations of sectors and the policy framework that follow in Chapters Vm through XI and then sumnarizes the overall recommendations from those chapters. - 123 - A. Patterns in Philippine Economic Performance Interruoted Structural Tiansformation 7.4 The economy of the Philippines has performed poorly along many dimensions over the past twenty years. It has failed to provide sufficient numbers of wage-paying jobs in the modem sector for its growing labor force, and the steady climb in welfare that comes out of rising productivity has not materialized. The comnpetitivetess of its products on world aarkets has faded in the 1980s, leaving export performance lagging ever funher below the high stndards of the East Asia region. Despite the breadth and depth of policy reforns, structural transformation has not progressed in the past decade, partly due to the severe ups and downs of the economy in the 1980s, multiple external shocks, and repeated episodes of macroeconomic stabilization efforts. Instead, the Philippines possesses the characteristics of a stagmnt economy: low output growth, low employment growth, and low productivity growth. Yet few glaring imbalances in the structure of the Philippine economy are apparent-the government has had limited involvement in private sector activides; the distribution of employmet and output across sectors is balanced; exports are reasonably diversified. Why then has the supply response of the economy to policy reforms in the 1980s been so muted? 7.5 During the 1980s, the government implemented a broad spectrum of policy reforms to create a more neutral and stable incentive system and a more outward-oriented policy regime. After a three-year collapse in economic activity between 1984 and 1986, led by industrial production declines, the Philippine economy experienced a significant recovery in the late 1980s. However, with a dip in performance in 1990 and 1991, doubts have resurfaced about the strength of economic growth over the medium term and whether policy reforms during the 1980s have improved the prospects for higher, long-term growth rates. 7.6 The stagnation of the 1980s has left the Philippines an outsider in its region, surrounded by a set of formidable competitors. The pattem of successful development in most of the rest of East Asia is well known: high growth is driven by manuactured exports. This route to high growth requires competitiveness in selling products on the world market and competitiveness in attracing foreign investment to provide the capital, technology, and know-how to mount a successful export drive. The dilemma for the Philippines and the focus of this part of the report is to undmtand the Philippines' failure to perform and to identify policies that can help shift the eonomy onto an export-oriented high- growth path. 7.7 IndustrialiMion. The rise in the share of manuf in output and employment as per capita income increases is a well-documented stage of modern econonic growth. This transformation in the structure of production contributes to accelerated growth rates as resources are shifted to sectors with higher producivity. The period from 1946 to the end of the 1960s was a positive transformation for the Philippines. M fin more than doubled its share of GDP, and its high growth in the 1950s sparked strong GDP growth. By many mues, the Philippine economy as a whole registered its best performance in the 1950s and 1960s and has suffered from widespread stagnation ever since. Its basic structure has changed little since the 1960s: the share of maufari in value added has not grown since 1970. The failure to conrAiue to shift production toward the industrial sector after 1970 is interwoven with the economy's failure to achieve satsfactory growth rates of outt (Table 7.1). -124 - Tabh 7.1 Grow& nd CQeso of GOP, 19461 (i 1985 prices) Se of GOP Oin pee) Sector 194649 19359 1960-69 197049 19)85 19861 Agrackue. Fisheries. and Foruy 36.8 32.5 29.7 25.9 23.2 23.4 bndusy 26.7 30.0 32.1 37. 39.4 35.3 Mining and Quarryi 0.5 1.1 1.1 1.4 1.6 1.7 M _mnuauna 11.9 21.3 25.1 28.0 26.3 25.3 con_ucin 12.7 6.4 4.9 6.5 9.0 5.3 Ekctrity, Gas & War 1.6 1.1 1.0 1.6 2.5 3 0 Services 36.3 37.6 38.2 36.7 37.4 4.3 Totl GDP 100.0 100.0 100.0 100.0 100.0 100.0 Av groi* raes (a percen) Sector 194649 19359 1969 1970-79 19U.85 198"-91 Aglure, F1::s. and Fsousy 14.6 5.8 4.2 3.7 OA 2A Inusuy 28.0 8.2 5.1 8.0 .2.3 3.7 Mmuig Nd Quaryin 44.1 13A 5.6 6.8 6.9 -1.5 Mafacuring 46.0 11.6 5.3 6.6 .1.8 3.9 Consuttuio 18.0 0.4 4.6 14.2 .6.9 4.3 Eecicily. Gas a war 3.3 4A 4.8 13.7 6.1 4.6 Services 13.6 7.3 4.7 5.2 2.0 4.4 ToWl GDP 15.7 7.1 4.7 .8 40.1 3.6 Sowe: Natdl twcom Aco. NSCB. 7.8 Te role of the mnufaci seet in long-m gowth has boe examined at lenzthY Observatons across countries for the pas three decades lvae revealed a gaenIl pat for suctura anfomaion with regard to the dsre of mnaing in GDP and GDP per capita Fgie 7.1 diplays a distic upward dope th is quite sep at lower incom levels. Counies such as Japan, Sout Korea, Indonesa, and Tha_and that be moved the fat inm GDP per capia av ao moved fathest in developing their ssector. The Phlippines fits dth geal pattern; unfrunatelY, it has moved little in the pst thre decade, re blig Colombia and Peru aher than is Eas Asian neighbors. Thu, ft I not th init conditios wee bad (the Philippines is not an oudier) bt th absence of change in economic sm ue is cause for concer 1' C.f. Holis Chenery and Moshe Syruin (1975), atr of DWveopat. l901970 (ondon: Oxford University Press). Also, Hollis Chbnery, Sheman Robin and Moske Syrquin (1986) Industialintion and Growth: A Compative Sudy (New Yord Oxfrd Univest Pre). -12S- F%r 7.1: _mo_ *auft Sw ad GIc _ asain Couawi.s GlOP pw eF pht (1987$) 0.0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Nw Dopm we uw" eubofw ft Pbfpp_ _Fmo rb d. Kf Smpf. Mexico. Combw Pa. b_ USd dw Unod S_; fo die IMO I 170s , uld 180. S==: Wor Bk oeac 7.9 .tnwtmgtzg. Sbe wo ie tamuin itsearlystages byin the mn of i in labor _r pouldo 1 etds (da7) it can be absorbed into the high productvity sectors, ing an elatic suply of unamilled labor in asicure and services. Hower, this pbImmn h pesised inhe YPhpines. Only small sifts il the disbuti of eqloym a oorred m the put two docad,; ad they have been fm informal agricultu to info_m urban sevies. Iy compris it is the successu absortdon of labor into the forma seor that is noommy for risn prduiqv nd i_r nus. Tht is, ue sign of a sucessu ecomy is the creation of wapayn jobs Sor its gowin work fcet Y Anoher si is the shift of emplloyuin ino hihr prodctivi sectors over dme. Iatead, in the Philbpines, the strongest employmnt owh in he 1980 ha be by the swvies sector, a low-produvity area (Table 7.2). Hower, Table 7.2 aso display s the ilure of t nf rin sector in the 1980s: ha as yet un d potena to be a hbhprodut and bhgw rwth sector. See Appei Table E.3. 3' Thb isisisdiscusdW atl mng Put M. - 126 - Tabk 7.2: Growth of Output, Employm_t, and ProductlvIty by Sector, 1980X90 (in percent except as noted) 1980-85 1985-90 1980-90 Employmnent Growth Agriculture 3.1 0.3 1.6 Industry 2.9 5.0 3.4 Services 4.2 4.2 5.0 LAbor Productvity Growth Agriulre -3.8 2.7 -0.5 Industry .6.5 0.5 4.3 Services -2.9 1.2 -2.3 GDP Growth .0.7 4.8 0.9 Agriculture .0.7 3.0 1.0 Industry -3.6 5.5 -0.9 Services 1.3 5.4 2.7 1980 1985 1990 Labor Productivity Level Agricultute 17.0 14.5 15.8 Industy 96.7 71.3 75.6 Service 40.4 31.7 33.3 Note: Labor ProductvW Lcvel is defined as constant value added per worker in thousands of 1985 pesos. Source. Philippine Statist Yeatbook 1991. 7.10 Iotrnational Co eti veness. "'International competitiveness" summaries an economy's success in world markets, generally as an exporter of mafactured goods. It is determined by the ability of the enterprises located in tbat couny to produce goods and services that are more attractive than those of competors and the ability to take advantage of cagng opportuies in the international marketplace to sustain that atraivens. Competitiveness has an importance far beyond the easing of the balance of payments constraint through plenti export roeeipts. Success in export markets opens the door to exportdriven growth, and it indicates the acdevement of efficiency by the economy. Thus, it is the market test of an economy's performance. While resoume endowmens do confer inA advantages, a country's strting point is far less imporant than its ability to improve cotiually, especially if world markets have a high degree of flux. 7.11 lhe easiest ssessment of compdtiveness is a country's export performance over time. On this first count, as on so many others, the Philippines possesses an eroding or completely eroded advantage. The growth of Philippine mafard exports comed favorably with Thailand, Malaysia, Singapore, Hong Kong, and South Korea in the 1970s and in the first half of the 1980s. It is the second half of the decade, when these competitors doubled or tripled their growth rate of the 1980-85 period, that the Philippines fell behind with only 13 percent growth from 1985-89. (See Figures 9.8A-C). Three years of dismal performance followed by three years of un recovery has left the Philippines with a substantial and growing ga to be closed. In addition, the pattern of a country's export growth - 127 - should stimulate the transformation of industrial structure. For example, in Thailand, South Korea, and Taiwan (China), the high growth of manufactured exports has led output growth in the m facturi sector. The competition that comes from opemness to world markets also should drive up efficiency in factor use. Dynamic economies experience rising levels of productivity of labor and capital. In the Philippines, in contrast, manufacurng suffered a productivity slowdown in the 1970s, with labor productivity growth collapsing from its 4 percent rate through the 1960s to -2 percent for the following decade. The 1980s witnessed labor productivity growth close to zero. Thus, contacts with the world nurket in the 1980s failed to bump the Philippine economy onto a sustainable high-growth path. 7.12 The success of a country's products on world markets of course depends on the internal efficiency of its enterprises, but the national environment-the interaction of government policies, human and physical capital, and natural resource endowments-plays a cnrcial role in enhancig or impairing competidveness. A growing body of case studies supports the view that competition, especially in the industial sector, is the most effective way to encourage efficiency and modenization, charactristics that are crucial for the economy to be competWive in world markets. This competition can be generated 'from within (through domestic rivals) or 'from without' (through openmess to trade and foreign investment). The Pace and m of Polic 7.13 The pace and scope of policy reform is not the issue for the Philippines. Slow but substaive economic policy reforms have been achieved in the 1980s, especially since 1986. Current and ongoing reforms have targeted the reduction of distortons in trade, exchange rate, investment, regional, and financial policies. Today, the Philippine economy appears afflicted primarily by a lack of confidence. Both domestc and foreign investors seem to share misgivings about the prospects of the economy. While not surprising in view of the recent record, it is unforunate because the economy has potentl elements of stegth, which in the 1970s did indeed help it gain greater presene in the world economy. Foremost among these advantages is a well-educated labor force. Foreign iflueces (through trade, investmen and ideas) continue to be a major strength underpning recent growth, wh improved prospects from recent reforms in the foreign trade and investme regimes. Also, innovative and potentially significant moves have been made toward greater private involvement in infrsucture management and financing. which may break the logjam of inastructure needs. 7.14 Policy reforms in the Philippines in the 1980s, in the areas of trade, foreig inestmen. regulation, tax, and privatization, generally match the achivements of other counties considered successful refomers (Table 7.3). But dhese refoms have not yet borne fuit in tetms of output employment, and export growth However, it may be that the Philippines' supply response is not so far from that of other reforming comies. For example, Mexico has not yet exhibited strng growth, and labor-tsive idusties are shrinkg in output and employment. This respome tas occurred despit the country's stellar intenational reputn and high flows of direct vesm from the United Stas in anticipaton of the North Ameican Free Tradt Agreement. Mexico's expeience suggests that since the composiion of output d employment must shift !eore aggregate indicors show improvement, growth rates will not jump immdiately. New sectots may be grownmg quickly, but old firms require time to shed labor. The difficulty for the Philippines has been that the 'germination' period for stuctur adjustment to take root has been inupted by merous physical, economic, and political upheavals. - 128 - Table 7.3: Indicators of Polcky Reform SPhilipDfines Indonesia Mexico Chile Policy Area 1980 1985 1991 1995 1982 1985 1991 1982 1985 1991 1973 1980 1989 Fiscal Expenditure 10 10 16 - 11 12 11 22 20 22 28 25 21 (percent of GDP) External Debt 30 57 56 - 15 36 47 34 50 33 33 35 60 (percem of GDP) Average Tariff Rate (percent) Unweighted 43 28 27 21 37 27 20 27 23 13 105 10 10 Import-weighted n.a. 18 19 15 22 13 10 n.a. 12 n.a. 94 10 10 Import Licensing (percent coverage) Unweighted 52 35 5 I n.a. 32' 10 100 12 n.a. S0o o0 o0 Lmport-weighted 33' 33 13b 1 n.a. 43' 13 100 35 14 n.a. n.a. n.a. Public Enterprises n.a. 7Q0 304 79 208 214 211 1155 920 285 498 43 27 (number) FDI from United States and Japan (Million $) Total 283 188 355 - 2586 1306 1752 834 778 769 n.a. 118 265 In manufacturing 127 117 215 - 203 195 208 647 627 632 n.a. 29 147 a. For 1981. b. For 1990. c. For 1986. d. Approximate. e. For 1987. Note: Fiscal expenditures is current government expenditure as percentage of GDP; extenal debt is external medium and long-term public debt as percent of GDP; foreign direct investment (FDI) for 1980 is average 1981-84. 1985 is average 1985-88. 1991 is actual 1989. Source: Philippine Tariff Commission; NEDA; Depament of Finance; World Bank staff reports; GA1T (1991). Trad Policy Reform: Chile; Rolf J. Luders (1990), 'thile's Massive SOE Divestiture Program: 1975-1990. Falumes and Successes.' paper presented to Conference on Privatization ad Ownership Changes in East and Cental Euope. World Bank. June 13-14. 7.15 One lesson of the Philippine experience in the past decade is that the stalling of economic reform in the mid- 1980s has cost it dearly. The country had been successful in encouraging the growth of exports in a few labor-intensive sectors in the 1970s. Then, in the eatly 1980s, when a second and stronger push toward an outward orientation was needed, policy reforms were insttuted to open up the economy and enhance its international competitiveness. It was poised for further flows of foreign investment and rapid growth of export ir-austries. Instead, crisis followed upon crisis, and short-term - 129- difficulties dominated policymakers' agendas. The confusion that resulted damaged perceptions of the Philippines' policy environment far more than the slowly diminishing policy distortions themselves. :C$exibiliqy of Organizational Structures: The Missing Middle 7.16 The Philippine economy suffers from segmentation along many dimensions. Industry and agriculture are not well integrated, with a significant wedge remaining between the rural agricultural and urban manufacturing wage. As a result, the Philippines continues to be a labor surplus economy. Large and small firms inhabit separate worlds, with little subcontracting to connect them through input or product markets. This segmentation of labor markets is both a result of and a continuing cause of a failure of wages, profitability, and productivity to converge. Perhaps most importantly, the export sector has few linkages with the rest of the economy. Supporting this fragmentation is a set of organizational structures that have arisen from the policy distortions of the past and that now strive to preserve the status quo. 7.17 The often cited "missing middle' in the size distribution of firms is an important cause of the inflexibility of the industrial sector. Mamnfacuring production is concemrated in large firms, while small manufacturing firms provide the majority of employment. In between is the missing middle of medium-scale firns that fail to make substantial contributions to employment and output. Only a smatl amount of subcontracting exists, and workers in large fitms continue to earn wages far above the manufacturing norm. This dualism and the resulting lack of domestic competition have been lasting features of the economy. The policy bias toward large-scale manufacturing, a result of the postwar idustrialization process, has been substanially dismantled through significant policy reform to counter the inward orientation of the economy. Against the backdrop of recent trade, investm; and forteign exchange liberalization, the filling out of this "nmissing middle" in the manufacturing sector would likely provide an extra boost to domestic competition, dynamic efficiency, and resource allocation. 7.18 The isolaton of the export sector and its connection to the policy regime are of central interest. The lack of interaction with rest of the economy prevents efficiency gains arising fromn successful international competition from spreading to domestically oriented firms. Until the 198Qs, the Philippines' policy incentives for exports were ones that encouraged enclave development. Export Processing Zones, bonded warebouses that were required to be separate from domestic production, and tax and duty incentives applicable for new projects only, encouraged an export sector with few linkages. As a result, there are few mixed-sales firms. In 1988, of the top 200 exporters (who provided more than two-thirds of export sales), vhtally all were 100 percent for export. In addition, of the top 50 exporters, 20 were majority foreip-owned. As a result, even though expor grew well undt 1984, this new sector provided no benefits to the domestic market in terms of improving efficiency through greater competition or economies of scale. This policy bias explains why the Philippines got stuck after the first phase of developing lb ssembly export industries. It also explains why backward linkages and perhaps subcontcn ve not ari. Instead, the country needs a simple and effective system of duty drawbacks -so that existing domestc producers can begin to operate in the export market. 7.19 A quick look at the size distribution of exporters in the Philippines illustrates the interaction of domestc and export competition (Table 7.4). Not only is industrial production dominated by a small number of large firms, but exporting too is dominated by large firms, with 46 percent of total exporm in 1984 sold by the largest 0.4 percent exporting companies. The smallest 90 percent of exporters totaled less than 10 percent of exports in that year. Such a skewed distribution must reflect the underlying size - 130- distribution of producers, which itself is the outcome of the history of domestic and foreign competition policy in the Philippines. By 1990, the distribution had flattened out somewhat. The top 0.4 percent of exporters conunanded only 33 percent of total expon sales, with significant gains by middle-size exporters. The analysis in this report tentatively concludes that policy refonms have finally started to bite, and many of the inflexible and seemingly permanent structures of the Philippine economy are indeed beginning to evolve. Table 7.4: Dstrbutla of Exporters uW Vae of Exports in the 19I (perce) Sie of An"uaEert Shipments Exon os Total Valu of E&mOmS (in S) 1984 1988 1990 1984 1988 1990 1.000,000 and less 88.5 87.1 85.4 8.1 9.3 8.9 1.000.001 - 10,000,000 9.7 10.7 12.4 23.1 27.0 29.7 10.000,001 - 50.000,000 1.4 1.8 1.7 22.8 31.1 28.9 over 50.000.000 0.4 0.4 OA 46.0 32.6 32.5 Total 100.0 100.0 100.0 100.0 100.0 100.0 Note: nickds all export prodcs. Source: NSO; World Bank staff reports. LAW Oornities in the190s 7.20 Through the 1970s, the policy regime generally subsidized capital an encouraged larger fim. The discretionary nature of many of these policies (for example, import restrictions and project- by-project approval for tax incentives) nurured rentseeking; th, these incentives were most anable by large firms. in addition, large fims petitioned for contimued incetives to favor them. The oil shocks of 1973 and 1979 squeezed the profits of these fims, even though real wages fell. Large firms responded by icasing their size. Public investment in sectors prone to larger firms, such as chemicals, aggravated this tendency in the late 1970s. It is true that some export products, such as footwear and garments, had a technological bias to large firm (to reap economies of scale for high-volume low-qualit products). However, it seems that by the early 1980s, firms had grown too large for efficient exportig. They becme uable to respond to markt changes and unable to shift up the qualty acrve, as new cheaper entrants frm other developing counties began to grab market sbare in the 1980s. 7.21 In the 1980s. when adjusent to major economic shocs-ext.nal and domestic-was key, the Philippines lacked the flexibiliq to adjust and compete because of low c ti and market dominadon by large firms; us, the 1980s was a period of major decline. A series of shocks in the 1980. pushed the Philippines off track, while its competitors soared ahead. During the mid-1980s, a new group of compettors gathred expence and strength. The mid-1980s was a particlarly mnportan ^ 131 - period becaue South Korea and Taiwan (China) experienced rising wage and exchange rates, forcing a shift ito higherquality products within their traditional area of competence and a move into new products. leaving open the door for emerging comptitors to move in behind them. Exchange rate movements and financil liberalization in Japan spurred a large outflow of Japanese investment funds. and Korea and Taiwan (China) also became sources of substanial foreign investment into low-wage economies. This created a window of opporuity, which was exploited within Asia by China, Thailand, Malaysia, and Indonesia to produce and sell in world markets a range of labor-intensive products. The Philippines largely missed this unique window. Now it has been left significanuly behind, with much ground to make up. B. Recommendaions: Egsgin an Eaport Culture 7.22 A major danger for the Philipines now is that the lack of confidence that has been suppressmg domestic and foreign investment projects can be sefping. Low confidence holds back investmt; but low levels of investment reinforce the lack of confidence in the economy. An example of such a pervse cycle is the feedback between infastructure and foreign investmet. Governments with tight fiscal consains are rght to doubt tbat building ifanstue ahead of demand will automatically induce investment. Yet if basic services are lacking, investors will hesitate, confirming the lack of confidence shown by the govermen. The main challenge before the Philippines is to renew the positive link between confidence and investment, a task tdat will require amplifying pockets of strength in the ecomy to create a demonstration of succss, while at the same time investing for the long run in much-needed infasc. Unformately, the task ahead is not made any easier by the world econoic environment. The start of the 1990s has been slow, with the iustslued economies facing difficult economic and financial conditions. Competition for ruces and markets is intense. Yet, the urgency of engaging in international trade and attracting foreign investment is greater than ever. Such international transactions are the prime source of new information and changig technologies, which, in tum, are essential for sustainig long-term growth. 7.23 These int ned issues are diswssed in the rest of Part n. Some cross-cutting themes for the real economy emerge. First, problemis with product quality and standards reach across all sectors, reducing export possibilities and domestic efficiency. For example, the inability to control aflatoxin in copra may exclude from the European mare coconbase exports. Second, after years of custcks in capital expenditures, inffrtutu problems are acute. Infrastucr requires new investnent and gratly increased mainte e .xpdu. Power and transpot are the two parts of infrastic most important for growth. Third, limited competition is yet anodher common tbeme. Solutions concentre on export and investm promoton and institutional development. Some positive moves have already been made in truly adopting an export culture. For exmple, Presidet Ramos has agreed to head the Export and uween Development Council, which held its inaugural meeting in Febrary 1992, during which it condered the present and future needs of exporters. The president's peroa involvement is an important symbolic action, signifyig the country's new enthusiasm for genuine outward orientation. 7.24 1ncjves. Broadly speaking, the sutr r of tax incentives in the Philippines is in line with those of its major competitors. It is tue that a variety of possibilities exist that would improve the incentives framework in compaison with other countries, by allowing acceeated depreciation and net loss carryover for corporations, by exempting all imports of capital equipment from duties, and by reducing tariffs below the levels set by E.O. 470. All seem desirable from the point of view of business, but the analysis of this report argues that such extension of fiscal incentives would be very expensive and would itensify pressures on the budget. Busins would be better served by the allocation of scarce - 132 - budget funds to key bottleneck areas such as infrastructure, rather than by further tax exemptions and credits. 7.25 Qualitv. Improvements in the ability to deliver quality goods will be the key to better perfornance of exports, both manufacturing and agricultural. Access to imported equipment may bt. important in this process of absorbing t^-hnological advances from abroad. Of more concern for government, the setting and enforceme.: f standards could conserve design skills and resolve the problem of the poor reputation of Philippine goods. Better defined standards and measures will increase specialization in the domestic market, while quality control for exports will improve unit prices. The development of institutions. rather than policy changes to shift relative prices or channel subsidies and tax breaks to certain sectors, needs to be the focus of government attention. 7.26 Institutional support is part of the export culture that Philippines needs to develop. Policymakers adopted the rhetoric of export development beginning in 1967, but it has been largely ceremonial and hence ineffective. For example, the central bank monitors imports that have been liberalized (watching for "import surges"), rather than export sales. Recently, positive steps, including the establishment of the Export and Investment Development Council and the new One-Stop-Shop (for availment of tax credits) have emerged, but a real litmus test will be the effective restructuring of the Board of Investment into a promotional body. The central bank has eliminated the credit subsidy to exporters, indicating the goverment's agreement that subsidies are not the right approach to foster exports, and has reduced exporters' transactions costs through foreign exchange liberalization. One area in which extensive discussion has not led to policy action is the extension of duty drawbacks to indirect exporters, a move that carries with it the danger of leakages from value added tax collections. An alternative, of course, is to make the implicit tax on exporting lower by acceleating the tariff reductiop planned in E.O. 470, again with careful consideration of revenue costs. 7.27 The sorts of actions that would strengthen standards, for example, would include publicly funded research centers establishing closer and better links with private industry, perhaps through private sector participation on boards of directors of these institutes and dtrough fee-for-service arrangements. The laboratory and testing facilities of the institutes could then be geared toward performing the basic services required by industry, especially product testing against nationally developed standards. Such product testing is crucial for the productive sector to increase productivity and quality to enter and thrive in export markets. 7.28 Infrastructure. Although the current state of infrstructure, with the exception of power, is tolerable, the country has been living off past investment; water supply, urban transport, and the road network, in particular, have been seriously neglected. Two strategies are promising here. First, the moves to use Build-Operate-Transfer arrangements in infrastructure, especially in power, promise to draw in greater private sector participation. Second, the plans to economize on industrial infrastmcture by focusing on carefully located Export Processing Zones and Industrial Pstates should both draw in foreign investors and encourage domestic firms to export. Establishment of Regional Industrial Centers to extend the existing industrial corridor around Manila (as with CALABARZON) promises to improve the distribution of industry (and resolve overconcentration in Manila itself). In the past, the government has not treated these zones properly to achieve the agg-'-meration effects of areas such as Penang in Malaysia, where a concentration of similar firms has led to many economies of scale such as skills training. The clustering of similar sector firms should be encouraged to assist in the specialization of exports. In other words, having a strategy pays dividends. Furthermore, promotion of foreign investment must be coordinated with the available sites and overall strategy either by cental or local governments. 133 - 7.29 Foreign and DoMestic Comnetition. The oligopolistic nature of the Philippine economy is well known. It is the inflexibility that this structure creates, especially in the industrial sector--the risk- averse behavior of mnarket leaders and the focus on rent-sharing rather than profit maximnization-that parly explains the economy's slow and hesitant supply response to policy reform. Trade and investment liberalization, efforts that must be sustained and, in the case of nontariff rest.ictions on imports. completed. have begun to have an impact on the efficiency of domestic industry, by providing new sources of competitin. For foreign competition to drive up domestic efficiency significantly, foreign direct investment needs to be allowed to expand into new areas such as banks and transport, and foreign investors require strengthened land use rights. Further direct action is also necessary, in the form of an overhaul and strengthening of antimonopoly regulations and the institutions that implement them. Only then will small and medium firms be given a fair chance in the Philippine market. 7.30 The Industrial Labor Market. If the rate of increase in the minimum wage of the past few years continues and the govermet's commitment to enforcement is maintained, the Philippines could easily price itself out of the competitive arena of unskilled, labor-intensive manufactures. Recent policy initiatives, specifically the 1989 regionalization of wage detemiiation, have allowed the local labor market situation to influence local wages. This step moves in the right direction but is insufficient. Wage detemunation remains a negotiated agreement amongst unions, employers, and govermnent. Other mechanisms must be studied to develop market-oriented procedures that reflect conditions of abundant supply of unskilled labor. 7.31 In contrast to the high price of fomWal sector unskilled labor, it appears that pay levels for skilled Philippine workers are relatively low. The aggressive minimum wage policy of the Aquino administration has been assocated with a general compression in the education/occupation wage structure. Without a wage structure that reflects underlying economic needs, higher education is more geared toward providing credentials to allow recipients access to fonnal sector jobs than to providing the skills required by a dynamic industrial secor, especially in engineering and the sciences. Thus, as labor market reforms are implemented, complememary changes in the management of higher education must also be carried out. 7.32 Buildint Exnort Compnetiveness. The key to export competitiveness is a competitive domestic sector. The recommendations above work to build competitiveness from within the domestic market and from without, by opeing the economy to import and export competition. While it must be acknowledged that macroeconomic policies play an important role, particularly insofar as the exchange rate and interest rates are affected, the exchange rate does not seem to be the crucial boteneck for exports, because overall labot costs (including skilled labor) remami competitive. This said. it is variability of the extange rate that taknslates to damaging uncertity about profitability for business. For example, the recent appreciation of the peso has unquestionably hurt exporters because it was unanticipated. hefore, the goal for the exchange rate should be a stable market-determined price, to be achieved by the broadening snd deepening of the foreign exchange market. Export competitiveness is to be sought,Athen, not through mic policy or fiscal incentives, but rather, through quality improvements, access to effective provision of supportig services and infrstructure, foreign investmt flows to provide marketng and technical expertise, and a well-trained labor force. -134 - Vm. THE PAST ROLE AND FUTUE POTENTIAL QF THE AGRICULTURAL SECTOR A. Q,rview fgriculture in the Ecnomy 8.1 Contribution to GDP. Agriculture continues to play a significant role in the economy, both in tenns of its direct contribution to production and employment and as a basis for activities in the manufacuring and the services sector. In 1990, agriculture accounted for 22 percent of GDP and employed more dtan 45 percent of the work force. Agriculture-based industry accounted for another 13 percent of GDP, and it has been estimated that at least one-third of the services sector is also linked to agriculture. Although agriculture's share in national ouput and employment has dropped continuously over the past two decades, the pace of change has been remarkably slow. Value added in the agricultural sector accounted for 28 percent in 1970, for 25 percent in 1980, and for 22 percent in 1990 (Figure 8.1). In comparison, the share of Thailand's agriculture in GDP dropped from about 28 percent to 15 percent over the same tme penod. This slow structural shift in the Philippine economy is a reflection both of agriculture's comparatively strong performance and Philippine industry's failure to become the main engine of growth and the principal source of labor absorption over the past two decades. Figwue .1: Agrukur In the Ecwmm 100- 90 MOP 40-~ ~ ~ ~ ~ ~~~4 30- \~~~~~~~~ 70 -of 196 t1970 t9I75 I 1 lip1990 Sare: Phippin Stis Yerok, Mw. - 135- 8.2 The agricultural sector was negatively affected by the economic crisis of 1983-85, but less so than other scaors. Agricultural GDP fell by 6 percen between 1982 and 1985, compared with 12 percent for GDP as a whole. During the second half of the 1980s, the agricultural sector recovered to grow at an average annual rate of 3 percent, contributing about 16 percent to domestic growth between 1985 and 1990. Although respectable, the sectoral growth rate during the period of economic recovery was below both growth in the rest of the economy and the sector's strong growth rate of more than 5 percent a year during the 1970s. Several factors account for this slowdown, in_luding the fact that the fruits of the green revolution had largely been exploited by the early 1980s, an overall downward trend in inerational conunodity prices affecting the Philippines' traditional exports crops, a series of natural calanities, and continued macronomic and sector-specific impediments that have led to serious underinvesunent in the sector. Among these impediments have figured an overvalued exchange rate, high interest rates, continuous deterioration of intersectoral terms of trade, weak infstucture (especially an inefficient, higly regulated and oligopolistic transport system), feeble agricultural support services, and slow implementation of the agrarian reform program. 8.3 AVgrjctualg&a4. Agriculural expt earnings ontinued to deline the during 1980s, both in absolute terms and as a share of total export eauings. While agricultural products accounted for 70 percent of total export eamnings in the early 1970s, this share had fallen to about 43 percent in 1980 and to only 21 percent in 1990. The decline in agrifcutural exports is the result of marked declines in the price and producton of traditional sugar and cocout exports, stagnaton in banana production, and limited growth of most no onal agricultWal exorts. This declining trend notwithstanding, official trade data utderestimate the relative imporance of agncultural products as a soure of foreign excage generation: the import content of agricultural exports is significaty lower than that of most manufactured exports, particularly in the garment and electronics industry. 8.4 Agricultural imports have remained relatively stable as a share of total imports but increased markedly in absolute terms during the late 1980s. The increase in imports is largely associated with increas in demand for relatively income-elastic products (livestock, feed and meat, wheat. milk and dairy products) in response to rising incomes, at least in urbn areas, during the period of economic recovery. The continued decline in agricultural export earnings and the sharp increase in agricultural imports during recent year have led to a marked deterioration of the agricultural trade ba!ance, which for the first time turned negative in 1990. but recovered again in 1991 thanks to depressed imports. 8.5 La[. The agrcultural sector contied to absorb a significant share of the entering labor force particularly during the first half of the 1980s. During the years of economic recovery, however, agricultural labor as a share of totl employment drpped markedly for the first time since the late 1960s. As a result, average output, and thus average incme per workar grew significantly faster (2.6 percent) than average ouput of workers in the other sectors. Over the decade as a whole, however, labor absopion in the sector outpaced sectoral outu growth, resulting in a real labor productivity decline of almost 6 percen. Although this decline compares fably to that in other sectors of the economy, the drop in average productivi of agrculural wori;es is of particular concern because value added per agricultural laborer remains well below that in industry or services (22 percent of average industri value added per worker, 48 percent of service value added) and poverty is most widespread among households deriving their income from agricultural activities. Over the past three decades, moreover, the real wage - 136- of agricultural wage laborers has shown no upward trend whatsoeverY The Philippines still seems mired in the first stage of development of a dual economy, in which the presence of substantial rural surplus labor is the dominant characteristic of the labor market. Sectoral Structire and Performance 8.6 Crop production continues to be the most important subsector, accounting for 55 percer.t to 60 percent of sectoral value added during the 1980s. This share has remained relatively stable since the mid 1970s. While the country's main staples, rice and corn, remain the most important crops in terms of value added and in hectarage, the traditional export crops-coconut, sugar, and, to a lesser extent, bananas-have continued to lose their importance. Rice and corn were the only major crops that averaged positive growth rates during the first half of the 1980s. However, growth in rice production slowed down considerably during the decade, as the benefits of the green revolution had largely been exploited by the early 1980s and irrigated area expanded much slower than during the 1970s. Growth in the corn sector, on the other hand, accelerated throughout the decade as a result of the expansion (albeit slow) of high yield varieties (HYVs) and shift of some upland rice area to corn. 8.7 The coconut indusay was faced with falling international prices, declining yields because of aging trees and more recenly, acteage reduction as result of the cuting of older trees. Value added in coconut growing dropped at an average annual rate of almost 10 percent during the second half of the 1980s. Sugar cane production also lost ground contnuously during the 1980s, chiefly due to loss of quotas in the lucrative U.S. sugar market, the drop of world prices to a level at which Philippine production could no longer compete, and the deterioration of peace-and-order conditions in the country's main sugar producing area. Sugar production recovered somewhat between 1987 and 1989, thanks to improved world prices and the temporary increase in access to the U.S. export market. 8.8 Despite the continued preponderance of food grains and traditonal export crops, other crops have gained in importance and as a group have shown the strongest growth rate and made the most important contribution to overall sectoral growth during the second half of the 1980s, at least according to official GDP statistics (Table 8.1). Lack of consistent yearly data prevens a detailed analysis of the relative importance and the evolution of these crops. Data for 1989 and 1990 suggests that pineapples, coffee, mangoes, cassava, and tobacco are the most important other crops in terms of value added (jointly accounting for about 7 percent of sectoral value added). Volume production of pineapples and tnangoes grew steadily through 1987, but has dropped since then. Tobacco, casava, and other rootcrops performed well throughout the decade, the latter two mostly as a result of increasing demand for animal feed. Producton of a variety of other crops including rubber, cocoa, peanuts, citrus, and a variety of vegetables grew during the latter half of the 1980s, but their reladve share in sectoral value added remains too small to substantially influence overall sectoral performance. The positive growth of vanous minor crops notwihstanding, it is surprising that their share in GDP has not improved in the wake of the declines in the traditional export crops. This is presumably attributable to lack of improvement in prices as well as other obstacles that agricultuwal producers continue to face. C.f. Chapter XIII for a discussion of wages. - 137 - Table 8.1: Structre and Perfornance of the Agricultural Sector (percent) Share of Sectoral Value Added Accumulaed Growth of Value Added 1970 1975 1980 1985 1990 198085 1985-90 Agricultural Crops 53.1 62.3 59.6 60.0 57.1 -0 7 Palay 18.9 17.0 11.7 16.7 15.9 16 7 Corn 6.1 6.2 5.1 7.1 8.0 21 22 Coconut 5.3 8.5 8.2 8.4 5.5 -S .37 Sugarcane 6.6 7.9 4.4 2.8 3.1 -27 -4 Banana 1.7 5.7 2.5 2.6 2.5 -10 -21 Other Crops 14.5 17.0 27.7 22.4 22.1 -8 24 Livestock 11.8 8.3 7.5 8.2 13.1 13 59 Poultry 4.1 3.9 5.3 5.0 7.2 -2 80 Fisheries 17.5 16.9 16.9 20.1 18.2 26 14 Forestry 13.4 8.6 10.7 6.7 4.4 -51 -14 Total Agriculture 1C{.0 100.0 100.0 100.0 100.0 -2 16 Note: Shares of value added are based on curent price value added. Growth rates are based on constant price value added. Source: Philippine Stadsdcal Yearbook, 1991. 8.9 While the crop cultivation subsector as a whole has thus retained its relative Wportance in terms of sectoral value added, intersectoral shifts have occunred among the three other subsectors. Livestock and poultry productien have appaently gained considerable importance, while value added in the forestry sector continued to decline. Mainly n response to income-induced increases m demand, recorded production in the livestock and poultry sectors has grown at more than 11 percent a year since 1985, accounting for almost 60 percent of overall sectoral growth during this period. As a result, 20 percent of value added in agriculture was attributed to the livestock and poultry sectors in 1990, compared with 13 percent a decade earlier. Similarly, fisheries-at least conmnercial fisheries and aquaculture appear to have performed well throughout the decade, contributing significantly to overail sectoral growth.Y 8.10 Regional Performance and Contribution to National Sectoral Growlt. Southern Tagalog, Central Luzon. and Northem Mindanao were the most important sectoral growth centers during 1980-90, when these tdwe regions accounted for more than half of the growth in total value added (Table 8.2). These were also regions with reLatively important non-agricultural sectors and good overall econromic performance, which in turn permitted demand-led growth for relatively income-elastic products such as fruits and vegebles or livestock and poultry products. Production boosts in the livestock and poultry sectors were the main source of growth in Southern Tagalog and Central Luzon, which together ' The tends in the total catch of small-scale municipal capture fisheries are not reliably recorded in natonal statistics, and some part of the growth in commercial catch could have come at the expense of the municipal fisheres sector, contrary to the impression created by official stauistcs. - 138 - accounted for 42 percent and 68 pere of nationat growth in the livestock and poultry sectors respectively. Growth in Northern Mindanao was fiuelted by marked incres in corn production as a major input to the booming livestock sector and a shift away from coconut toward the production of fruit and tree crops. The agricultural sectors of the best performing regions are marked by stronger diversification than those in other regions. Central Luzon and Southern Tagalog also benefit from better rural inftastructure than most other regions and from proximity to Manila. Tabl 8.1: Regiona mad Subeector Ceaumiudm. to Growth toi Agneuluo Vale Add, 19S.9 uN- Aedc- Ag,d- GOiW uo* laa nero Vau of Regiou Cros ?oakiy Fhu Fory SA rotaw Added GDP AU Rgi< 26 54 18 46 7 100 16 25 I Docos 4 3 2 40 0 9 21 19 n csgayan Valley 2 2 0 40 0 4 14 13 m CenualLuzAn 4 9 4 4 0 1 17 32 29 IV Soudxemraalog 1 21 1 0 1 24 21 27 V Bicol Re.IO -2 2 40 4 1 0 1 12 VI wenm visayas 4 4 4 0 1 9 13 17 VII CenlV iayes 2 4 0 4 0 6 22 31 Vm EAsrnViysa -2 2 1 40 0 1 3 11 Ix West Mndmo 0 1 2 40 1 4 9 13 X Norhm MiWlamno 11 3 1 -1 1 14 25 18 )aI SouXm mMeaz 0 4 3 -2 1 5 6 IS XII Cdnts Mbadmo 6 2 4 4 1 8 17 15 Suosector wdt Raw 7 67 14 -14 27 16 Now: Growth rtes an acmulated ovaer 198590 d bd ono constapnti vae added Source: R1ional Ndonal laone Accons NSO. B. Demndand So&DDhr Pro food Grains 8.11 D Factor. Cereals remain the most important soc of caloric intake hi the Philippines. Rice and cor are the doninat domstcally produced gSains, while wheat is entirely imported. Rice consmption per capita is three times higher than that of other grains combined. Com is consumed as a main staple or supplement to rice by about 20 percent of the popuation, mainly in Cagayan Valley, Eastem and Central Visay, and Mindao. Coin. however, is viewed by consumers as an inferior good, and consequntly per capita corn consption has been decreasing since the mid- 1970s. Rice consumption per capita, on the other hand, condties to grow, as does wheat consumption, albeit at a slower pace than rice. The deand for com as animal feed grew markedly (4.6 percent a year) during the past decade, zaising the share of feed com in total com consunption to about 70 percent. -139- 8.12 Asing positive income grwth over the comng years, ftue gwth in dmnd for corn will derive almost entirely from demand for feod com. The rawe at which this occurs will depend not only on populaden and ime growth, but also on the evolution of dometc corn prices. Com prices have been kept significany above border parity prices (on avrage about 35 percen above parity over the past three years) through a combinaton of import tariffs and quantitative restrictions. This has kept livestock production costs and consequenty te price of meat products high, thus dampening the demand for livestock products. Gradual liberalization of the corn and livestock markets would result in reduced prices for both feed and livestock products, thus spurring demand. 8.13 As long as rice rmain a norml good in the Philippines. future increases in demand will be driven by income and, particularly, popution growthY A recent study by the World Bank projects that rice consumptioncould grow by as nmuch as 30 percent or by 1.74 M tons by the year 2000, if future growth rates of 4.0 percent in per capita income and 2.2 percent in popuation occur. Consumption of wheat, which has a relavely high incom elasticity, c also be expected to grow as incomes rise and some substitution of wheat for rce may take place. 8.14 Rice Production lssu. During the past two decades gmwth i nce production has mainly come from yield increases, as plant area has largey remained the same since the late 1960s. Three faors have accounted for these incrases: the widespread adoption of high yielding vanetes, increased use of fertilizer, and the reladively rapid expansion of irrigaed area. The share of irrigated area in total harvested area rose from 33 prent in the mid-1960s to nearly 60 percent at the tum of the 1990s. production from iTigted are now accots for about 70 percent of total produion. Producon owth in the 1990s will have to come fom yield gains, as total harvested area seems, if anything, likely to decline due to loss of cultivable land and the possible shift to higher-value crops on dry season irgtdland. 8.15 The growth in yields leveled off significatly duing the 1980s (aveging 2.0 percent, but only 1.3 percent on irrigad land), s most farmers had adopted HWs (87 percent in 1988) and were on average achieving good yields elative to their potial. Expansion of imgated u and the shift of upland nce produces on mgimal lands to other crops were thus the main source of yield gains in the 1980s. Yields wihin water regimes (for example, on lowland irted paddy) bave lreY leveled off. nmprovements in input use effiiency and ber m mamsent ine futr are not exected to result in raes of yidd incr beyond those achieved aon igaed areas during the 1980s. Analysis of the ferlize respone fumctin based on aggegt daa sggess tt, by 1989, fme were on avenge already using as much chemicals mnuent as was conmically optmal, and the marginal response to increased feroizer use is prbably nilf' Recen rsearch on the orgins of yield gaps betwe fumers I Recent stuldie by the World Bank nd the International Food Policy Resarch Instite have found that rice rmans a norma good with ativdy low but posiive inoome dasticities. World Bank (1992). Iisated AgicU Sector Revic'. Report No. 9848-PH. Aprl 15; IFPRI. c Mi,i Coma/Livestoc Sector: 1ermae and Policy ImnicatiolSn, December 1991. 4' The fact that margina prodwivity of icased ferilizu use on nre appear to be nil strony suggests that prograM like the recent twoforone fertilz subsidy caagn will not succeed in raiig rice yieds. Indeed, the bneiol RIce Research lnmst (IMI) has found that use of ftzer on rice did not ire even in the areas subsidized. At the same time, re undbtedly rema opportunities to benefit from more apr at proportioan of mtritents aEd to addres mi ntient deficiencies In paricular areas; as wel as to improve effiency of nutrient uptae with be=er application - 140 - suggests that differentials are less due to varying access to technology or inputs than to differences in land quality, irrigation access, and farner technical knowledge." Substantial reduction of yield differentials is thus not likely to be easy. Furthermore, the general degradation in the paddy environment caused by pest pressure, rapid depletion of soil micronutrients, and changes in soil chemistry due to intensive cropping under flood irrigation puts downward pressure on yield potentials with currently available varieties. 8.16 This implies that most future growth in palay production will either have to come from considerable expansion of irrigated area or from new technological breakthroughs in the area of HYVs (although some gains may be had from increasing the use of certified seeds). The International Rice Research Institute (IRRI) expects the release of hybrid rice in the Philippines, with the potential for a 20 percent yield increase, to occur in the next five years, but the dissemination will likely require another five to ten yearsY' A further breeding breakthrough, based on current IRRI design strategy, is about a decade away. The inescapable time lags imply that widespread impact on production will not be felt for a decade or more. Therefore, in the medium term, rice production increases above and beyond the relatively small yield gains achievable through improved input and water management will depend largely on the rate at which rainfed land will be converted to irrigated land. The potential for expansion of irrigated area remains significant, as only about 50 percent of irrigable land is currently irrigated. However, past irrigation projects have often yielded rates of return below acceptable levels, and it is reasonable to assume that the economic retums from new projects will decline as favorable sites are exhausted. This suggests that caution should be exercised in the selection of future irrigation investnents and that scarce resources should not be allocated to irrigation development at all costs. 8.17 In view of government financial constraints and limits on project implementation capacity, it is not likely that surface irrigation will increase by substantially more than 275,000 hectares through the 1990s. (Further potential for tubewell irrigation exists, but is not economical for rice production.) Rice supply projections, based on this potential and taking into account the limited prospects for yield increases from other sources, suggest that the Philippines will not be able to meet the rapidly increasing demand for rice with domestic production alone over the next decade and will thus have to resort to increasing imports to cover the balance.!' This could best be redressed by a substitution of corn land to rice, induced by the correct adjustment of incentives. 8.18 Corn Production Issues. Since 1985 the harvested area of corn has surpassed that of rice and coconut, to reach a record high of 3.8 million hectares in 1990. The area devoted to corn now accounts for about 29 percent of total area, while rice and coconuts account for 25 percent and 24 percent respectively. The expansion in corn area came entirely from yellow corn, which is grown for feed. Area F C.f. P. Pingali and others, 'The Post-Green Revolution Blues in Asian Rice Production: The Diminished Gap between Experimnm Station and Farmer Yields," Social Sciences Division Paper, IRRI, 1990. V Although releases of hybrids are likely to come from PHILIUCE (a new domestic research facility), the production of hybrid seed must come from private sector seed companies, for which this is a new technology. 2' World Bank (1992), Irriated Aericulture Sector Review, Report No. 9848-PH. April 15. - 141 - expansion was paralleled by significam yield gains as a result of the more widespread adoption of improved varieties. The area under production of high yielding varieties (open pollinated or hybrid) increased from 0.5 million ha, or 15 percent of planted area, in 1980 to 1.3 million ha or 35 percent in 19901 Yields for yellow corn grew at an average annual rate of more than 6 percent between 1980-90, while yields for white corn grew at about 1.3 percent a year. These improvements notwithstanding. average corn yields (1.27 ha/t) remain low, even for areas planted with high yielding varieties. Low yields among farmers planting improved varieties are due to the frequently primitive cultivation practices and limited or inappropriate fertilizer application.2' Yield increases are likely to be the main source of growth in corn production in the future, as many upland rice and some sugar production areas have already come under com production and sigrificant conversion of lands under perennial crops is unlikely. 8.19 Two types of improved corn seeds are available in the Philippines, the improved open- pollinated (OP) white and yellow corn and the hybrid yellow corn. Hybrid seed is more responsive to fertilizer and can yield up to 50 percent more than open pollinated com, but new seeds have to be purchased each year and relatively high amounts of fertilizer have to be applied to assure high yields. In an upland cropping enviroment with high rainfall vanability, the capital requirements and high financial risks associated with hybrid corn production leave this technology beyond the reach of small and resourcoor farmers. Aside from the relatively high costs, the timing and availability of inputs remain a major issue. The market for hybrid seed is highly concentrated and claims of oligopolistic pricing prevail. After the recent merger of the two largest providers of hybnd seed (controUling close to 90 percent of the market), only two major competitors remain. Goverment policies encouraging increased competition in this market could thus help increase the availability of hybrid seed at a more advantageous price. 8.20 Given the difficulties associated with the adoption of hybrid varieties, additional research on genetic improvement of OP varieties and more aggressive dissemination of improved OP cultivars are recommended. More expanded use of improved OP seed has in the past also been constrained by a shortage of such seed. 8.21 Increased corn yields have created a second-generation problem of com shelling and drying (due to harvest-period labor constants). As corn is usually sundned on the farm, the problem is compounded by rain during the main harvest season. High moisture content results in lower grain quality (especially an aflatoxin problem), which often leads feed millers to prefer imported over domestcally produced com. Similar drying and storage problems afflict paddy rice, where processing losses also result from low-quality milling. Profit margins for grain processing and storage are too low and interest rates too high to induce private investment in drying or storage, at least as long as the market prices fail to give significant weight to quality differences (possibly attributable to price controls). Various studies I BAS data do not differentaue between the area under hybrid and the area under improved open pollinated corn. Estimates of the area planted to hybrid com vary from 7 percent in the mid 1980s to more recent estimates of 10 to 15 percent of total area, with the most important share being in Cagayan valley. 21 Fertilizer is applied to about 63 percent of total harvested area, but application ratios vary widely between regions as well as among idividual farmers. - 142- focusing on these issues in postharvest handling are under way, and the low economic returns at present do not provide justification for public sector investments. 8.22 Lack of adequate jnbatrtre, particularly good rural roads, ports, bulk handling equipment, and shipping facilities, constrain the development of the entire agricultural sector, but are of particular importance for high-bulk, low-value products like grains. About two-thirds of corn is produced in Mirnanao, but only 7 percent of the country's feedmilling capacity is in this region, while 82 percent is near Manila (NCR, Southen Tagalog, Central Luzon). As a result, most of the corn produced for feed is now shipped to Manila for processing. The rice trade is somewhat less affected by high transportation costs as about half of domestic production is consumed on or near the farm and the ratio of bulk to value is significantly lower than that of unmilled maize. 8.23 Transport costs typically account for about 35 to 50 percent of grain marketing costs!
World Bank Group · Pre-2003 Economic or Sector Report
Philippines - An opening for sustained growth (Vol. 2 of 3) : Parts II and III : the real economy and the correlates and determinants of poverty
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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