Philippines - Current economic position and prospects (Vol. 2 of 3) : Special annexes

_ ,;,_ _ _,,,_ . - - -----_----------- 4 - PI2LF.SSD FOR r'WJEE.CtSI S F - FILE COP C DOCUMENT OF INTERNATIONAL BANK FOR RECON tJCTION Al D DR IM f TO INTERNATIONAL DEVELOPMENT ASSOCIATION R EPORTS IrD 5 Not For Public Use WITH4IN ONE WEEK Report No. 78a-PH CURRENT ECONOMIC POSITION AND PROSPECTS OF THE PHILIPPINES (in three volumes) VOLUME II SPECIAL ANNEXES ANNEX 1 - A SURVEY OF INDUSTRIAL DEVELOPMENT ANNEX 2 - THE TRANSPORTATION SECTOR July 25, 1973 'East Asia and Pacific Department Asia Region This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1.00 = Pesos 6.73i Pesos 1,000 = US$147,49 Pesos 1 million = US$147,493 FISCAL YEAR In the Philippines tlhe Fiscal Year covers the period July 1 to June 30.  This report is based on the findings of an Economic Mission which visited the Philippines from January 8 to February 3, 1973. Its members were: Russel J. Cheetham Chief of Mission Kevin Young General Economist Madhusudan S. Joshi General Economist Shakil A. Faruqi General Economist Michael Sapir Transport Economist Geoffrey Shepherd Industrial Economist Assistance in preparing statistical materials was provided by Mrs. F. Ledesma.   CURRENT ECONOMIC POSITION AND PROSPECTS OF THE PHILIPPINES VOLUME II SPECIAL ANNEXES TABLE OF CONTENTS Page No. ANNEX 1 A SURVEY OF INDUSTRIAL DEVELOPMENT I Introduction and Summary ..... .............. 1 II The Major Features of Growth in the 1960s .. 3 III The Policy Environment in the 1960s .... .... 15 IV Recent Developments ...... .................. 21 V The Outlook for Manufacturing .... .......... 37 VI Note on the Statistical Sources for Manufactur'ng ........ ...................... 46 VII Statistical Tables ...... ................... 51 ANNEX 2 THE TRANSPORTATION SECTOR I Background .......... ....................... 1 II The Highway System and Road Transport ...... 2 III Railways ......................................... 11 IV Ports, Harbors and Merchant Shipping ....... 15 V Airports and Civil Aviation ..... ........... 20 VI Reorganization and Overall Coordination of the Transport Sector ..... ............... 21 VII The Proposed Investment Program .... ........ 23 VIII Statistical Tables .................... 25   ANNEX 1 Page 1 PHILIPPINES CURRENT ECONOMIC POSITION AND PROSPECTS A SURVEY OF INDUSTRIAL DEVELOPMENT I. INTRODUJCTION AND SUMMIRY- 1. Under the shelter of direct import controls instituted in 1949 the Philippines saw the rapid development in the 1950s of a manufactu-ing sector based largely on import substitution in finished consumer goods. Industrialization, which became a major element of national economic policy, was further encouraged by the relatively easy access to capital and generous tax and import duty concessions enjoyed by a dynamic new entrepreneurial class which had been mostly recruited from traditional elites. Thus manu- facturing became the leading sector in the 1950s, with real output growing at about 10 percent per annum. The next decade saw similar policies, the major change being the replacement of direct controls by tariffs accompanied by a substantial devaluation in the early 1960's. However, by the 1960s the easier import substitution opportunities, mostly in consumer items, had been exhausted and the growth of the domestic market was also markedly slower than in the 1950s. Intermediate goods industries did not become leading in- dustries in spite of some Government emphasis on them, while export indus- tries failed to develop significantly. "Organized" industry grew by around 7 percent per annum and its employment by around 5-1/2 percent but, with relative stagnation in the substantial "unorganized" sector, overall output and employment growth was not in excess of 5-1/2 and 2-1/2 percent, respec- tively. 2- A substantial cost was attached to this growth, both in terms of investment and the balance of payments. Industrialists apparently found the import of capital goods increasingly attractive because of liberal credit and incentive policies and the concomitant opportunity for export of private capital through the over-invoicing of imports. As a result there was an increasingly inefficient use of capital, not in the strict sense of the term so much as in growing levels of idle capacity. The pattern of inward- looking industrial development was in many ways typical of other developing countries at similar stages of industrialization. However, the Philippines' case was arguably worse than the average, not only because in some respects the distortions look more extreme but also because of the country's high potential, given the diversity of manufacturing activity and the often high quality of management. While Government policies subsidized in one way or another many of the inputs into manufacturing, they neglected broader, macro- economic policies which might have assured a better growth in demand. 1/ This Annex also draws extensively on the work of the Economic Mission of October/November 1971.  AME 1 Page 2 3. In the late 1960s and early 1970s, there were vigorous government efforts to change the direction of industrial policy. These included the legislation of a new and comprehensive set of incentives for investments and exports, the substantial Peso devaluation, a tariff reform and various efforts to plan and control the development of specific sectors, in partic- ular some engineering goods and components. These did not succeed in removing all the various biases tending to reduce the cost of capital to the organized sector, nor have they so far been entirely successful in providing a new stimulus to industry, basically because the doiiestic market for manufactures has remained sluggish in recent years. However, they do provide a promising basis for future developments, in particular in the areas of non-traditional manufactured exports and the engineering industry. 4. A major issue for the future is the role that manufacturing can play in emplo3ifent creation. Even with healthy growth in domestic demand and in nontraditional exports, it is unlikely that output and employment growth will exceed 7 percent and 3 percent respectively in the medium-term. Manufacturing would thus do little more than maintain its share in overall employment creation in the medium-term unless expbrts growth can be sig- nificantly stepped up. In the longer-term, a higher growth rate will depend largely on sustained export growth -.the role of processed domestic raw materials is potentially impdrtant here - and the accelerated growth in the domestic market that could accompany significant growth in rural incolues. The latter could have an important-effect in stimulating small-scale industry, and thereby the rate of employment creat-ion. To pursue these possibilities, the government would need to ldok more closely at the viability of small-scale production and devise appropriate policies in the field of financial, technical and organizational assistance.  ANNEX 1 Page 3 II. THE MAJOR FEATURES OF GROWTH IN THE 1960S Growth in Output and Employment 5. This Annex is to concentrate on developments in the "organized" or "factory" sector, although some attention is given to the "unorganized" sector, inasmuch as the data permit, since it accounts for an estimated 15-25 percent and 65-70 percent of the sector's output and employment respectively. 1/ Even for the organized sector, the statistical base is poor and gives uncertain coverage. 2/ However, the evidence is fairly strong that the decade was characterized by poor overall growth in manufac- turing employment and output. Estimates of Major Growth Magnitudes in Manufacturing in the 1960s (percent) Organized Unorganized Total Annual average growth: Output 6-1/2-7 1-2 5-5-1/2 Employment 5-5-1/2 1-2 2-2-1/2 3 Productivity 1-1/2 0 3 Share in total NDP: 1960 11-13 6-8 19 1970 14-16 3-5 19 Share in total employment: 1960 3 9 12 1970 3-1/2 8-8-1/2 11-12 6. Growth in total manufacturing output (NDP) around 8-9 percent per annum in the second half of the 1950s gave way to an average of little more than 5 percent in the 1960s. Within this the organized sector grew at about 6-1/2 - 7 percent per annum according to the Annual Survey of Manufactures (ASM). 3/ The sector's contribution to net domestic product rose from about 1/ The organized sector is arbitrarily defined as those establishments employing five or more workers which are covered in the Annual Survey of Manufactures. The unorganized constitutes the residual. 2/ The statistical problems are discussed in the Note on the Statistical Sources for Manufacturing. Detailed statistical tables appear at the end of this Annex while reference is also made to tables in the Statis- tical Appendix to the main report (Volume III of this report). 3/ The ASM is thought to provide a better estimate of growth than the index of physical production because of the latter's inadequate coverage of the sector. None of the series, however, seems to provide reliable indicators of the growth of output in recent years. Both the NDP and production index estimates of an output increase around 20 percent in the period 1969-72 would seem far too high. See Note on the Statistical Sources for Maniufacturing'.  ANNE I Page 4 13 percent in 1950 to almost 19 percent in 1960, but grew no further during the decade. Growth of Real Output in Manufacturing, 1960-72 (Percent per annum) Total Output Organized Output Manufacturing NDP Deflated Value Index of Physical (1967 prices) Added (ASM) Production 1 2 3 1960-61 4.2 7.5 6.6 1961-62 5.2 6.2 5.7 1962-63 8.2 12.7 6.4 1963-64 1.8 0.3 8.3 1964-65 0.9 -3.3 2.8 1965-66 7.7 4.2 6.7 1966-67 4.9 n.a. 8.4 1967-68 6.9 n.a. 5.0 1968-69 5.3 6.7 3.0 1969-70 7.4 7.2 1.5 1970-71 8.5 n.a. 10.6/ 1971-72 5.9 n.a. 5.9< 1960-1970 5.2 7.2 5.4 /a January-September. Source: Column 1: Table 2.4 of Statistical Appendix. (Volume III of this Report). Column 2: Table 9 (value added) deflated by Manila wholesale price index for domestic products in Table 7.2 of Statistical Appendix (Volume III of this Report). Column 3: Central Bank, Statistical Bulletin up to 1965 (old series), Table 11.1 of Statistical Appendix (Volume III of this Report) from 1965 (new series). 7. Organized manufacturing saw little change in the pattern of output during the 1960s. Some decline in the share of the food industry, still accounting for almost one-quarter of total output in 1968, was largely the result of poor output growth in export-oriented sugar refining (there was some improvement in exports after 1968). Intermediate goods achieved a small rise, notably in chemicals. Growth in the share of durable and capital goods was halted in the 1960s by the relative stagnation of non- electrical machinery. 1/ There was little growth in completely new indus- tries or product lines in this period. 1/ This may fail to reflect some growth in various unorganized engineering !stivities. In particular, the "Jeepney" industry has grown up to help meet the need for small vehicles in public transport. This industry rebuilds army surplus jeep engines and manufactures many of the compo- nents that go into jeepney assembly.  ANNEX 1 Page 5 Share of Major Industry Groups in Organized Output (Percent) 1956 1962 1968 Consumer Goods 59.2 54.2 50.6 Intermediate Goods 36.5 37.1 40.8 Durable Consumer and Capital Goods 4.3 8.7 8.6 Total 100.0 100.0 100.0 Source: Table 2 (see also Table 3). 8. Growth in manufacturing employment averaged, according to Mission estimates, around 2-1/2 percent per annum in the 1960s while the sector main- tained a share of 11-12 percent in total employment. As a result, manufacturing accounted for only about 10 percent for the additional jobs created in the economy during the decade. Employment in the organized sector grew com- paratively rapidly at 5 - 5-1/2 percent but, because of its small size, its impact on employment creation in the economy was limited. The best indica- tions are that employment in the unorganized sector grew at no more than 1-2 percent per annum. This relative decline is also reflected in the falling shares in total manufacturing employment of self-employed and un- paid family workers, clearly associated with the unorganized sector for the most part, in favor of paid employees. Estimates of Employment in Manufacturing (000) Mission Published Data Estimate 1956 1960 1962 1968 1970 1960 1. Organized (ASK) 206 249 278 394 404 249 2. Unorganized (3 - 1) 809 787 774 840 998/a 875 3. Total (Labor Survey) 1,105 1,036 1,052 1,234 1,4021 - 1,124 /a Population census data. The large growth over 1968 is probably the result of discontinuity in the data. Source: Published data: Table 6. For Mission method of estimating total employment in 1960 see Technfical Note on Employment Statistics in Statistical Appendix (Volume III of this report). 9. The 1960s have seen no change in the high concentration of manu- facturing employment in Greater Manila and the rest of Southern Luzon. There was, however, a slight improvement in Mindanao's share of the total at the expense of other regions.  ANNEX 1 Page 6 Regional Share of Employment in Manufacturing Establishments with 20 -or more Workers, 1962 and 1968 (percent) 1962 1968 Southern Luzon: Manila and Suburbs 49.2 48.3 Other 21.1 19.4 Mindanao 8.0 11.5 Visayas 14.7 12.0 Other 7.0 8.8 Source: Annual Survey of Manufactures, 1962 and 1968. The Size Structure of Manufacturing 10. The size structure and relative capital labor and output ratios between firms of different sizes have changed little in the 1960s and there is a continuing strong concentration of manufacturing activity in larger firms. Many sub-industries, such as fertilizers, brewing, soap and cos- metics, and rubber tires are dominated by a small number of relatively large firms. In spite of this concentration, many activities, particularly intermediate, have failed to achieve economies of scale that are sufficiently large by international standards. The Size Structure of Manufacturing, 1968 Percentage Distribution of: Selected Ratios Value Fixed Fixed Added Assets Assets/ No. of Workers per Employ- Value Fixed per per Value Establishment ment Added Assets Employee Employee Added (P 000) (P 000) 5-19 18 6 8 3.7 5.2 1.4 20-49 9 5 5 7.0 6.6 0.9 50-99 9 7 7 8.5 8.4. 1.0 100-199 10 12 13 13.7 15.3 1.1 200-499 17 25 26 16.2 16.6 1.0 More than 500 37 45 41 13.8 11.7 0.8 Total 100 100 100 11.3 10.9 1.0 Source: Tables 9 and 10 (see also Tables 1 and 8). 11. The degree of concentration of production in larger establishments is high by the standards of other developing countries as the following comparisons show:  ANN'EX 1 Page 7 Distribution of Value Added in Selected Developing Countries Philippines West Malaysia Korea Brazil Colombia Size of Establishment 1968 1968 1968 1958 1967 5-19 workers 6 10 12 1/a 8/ 20-99 workers 12 28 16 22 21 More than 100 82 62 72 68 53 Total 100 100 100 100 100 /a Establishments with 6-19 workers. lb Establishments with 1-19 workers. Source: Bank Reports. 12. The size structure of employment is more normal in international comparison but the complement to this is the comparatively large differences in levels of labor productivity and capital-intensity between different sizes of establishment in Philippine manufacturing. In 1962, the ratio of value added per employee in smaller establishments (5-19 workers) to that of larger establishments (20 or more workers) was approximately 1 to 4 while the ratio of assets per employee was about 1 to 3 (Table 9). By 1968 these had fallen, respectively, to 3.4 and 2.5 but the differential still remained larger than in other countries. The ratio of value added per employee in smaller establishments to larger establishments was 1 to 2.1 in Korea (1968), 1 to 2.0 in West Malaysia (1968), and I to 1.3 in Brazil (1958). 13. Comparatively high capital-output ratios in the smallest establish- ments are not unknown in other countries but seem to be extreme in the Philippines' case and possibly denote greater inefficiencies in the use of capital in the smaller firms. The seeming underdevelopment of small- and medium-scale organized manufacturing, both in terms of its output and levels of investment, reflects in part the tendency of large firms to supply some of their own inputs through the process of vertically integrated activi- ties rather than through domestic sub-contracting. The Small-Scale and Unorganized Sectors 14. While small-scale organized establishments (defined here as establishments in the ASM employing 5-20 workers) have played a compara- tively small role in employment, the admittedly poor data suggest that the unorganized sector has played a more significant, if declining, role. This role, moreover, also seems large according to comparisons with the employ- ment structure of manufacturing in neighboring countries.  ANNEX 1 Page 8 Share of Unorganized Sector in Total Manufacturing Employment (percent) Philippines 1968 68 Indonesia 1963 50 West Malaysia 1963 38 Singapore 1966 40 Thailand 1963 52 Source: Appendix III of Economics Department Working Paper No. 78. The Indonesian and Thai figures are given with some reservations on their accuracy. 15. While small-scale factory activity is concentrated mainly in basic consumer goods, it is also represented in the machinery, transport, non- metallic mineral and chemical industries (see Table 8). According to a comparison of ASM and population census employment data for 1960 (see Table 7), most unorganized activity was confined to the food, textile and apparel industries. Other consumer goods and non-metallic minerals were also important. The unorganized sector is estimated to be about two-thirds rural and accounts for about approaching one-third of total rural non-agri- cultural employment. The apparent relative stagnation of output in the unorganized sector during the 1960s may reflect, in addition to poor growth of rural purchasing power, some substitution of production in favor of the organized sector. While no aggregate data are available, several instances of this, such as the production of footwear and garments, embroidery of fabrics, the weaving of fishing nets and production of domestic utensils, can be cited. The Sources of Growth -/ 16. Of expansion in the domestic market, import substitution and ex- ports, the first was by far the most important source of growth in output in the 1960s. The share of imports in the market for manufactures hardly declined while the small share of domestic production for export fell. 1/ The discussion is in terms of organized manufacturing only.  ANNEX 1 Page 9 Analysis of Change in Output and Markets, 1962-1969 (percent) Market Value Share in Growth 1962 1969 1962-1969 Domestic Production (Share in Domestic Market) 69 72 75 Imports ( " " " " ) 31 28 25 Total ( " " " ) 100 100 100 Expor's (Share in Domestic Production) 18 14 10 Source: Table 12 (see also Table 13). 17. The limited progress in import substitution in major industry groups, in spite of government attempts to pursue a policy of backward integration, is illustrated in the figures below. 1/ There were some gains in intermediate - most significantly in chemicals - and, to a lesser extent, consumer goods industries but these were offset by losses in machinery and equipment. Share of Output in the Domestic Market (percent) 1962 1969 Food Industry 87 92 Other Consumer Goods 90 94 Intermediate Goods 70 76 Durable Consumer and Capital Goods 32 28 Total 69 72 Source: Table 12. 18. The slow progress of import substitution stood in contrast to the growth pattern of earlier periods. In the period 1948-56 import substitu- tion, across a broad range of consumer and lighter intermediate goods, accounted for 21 percent of growth, in 1956-62, 10 percent but in 1962-69 only 2.5 percent. While this decline in share is marked, it is significant that, according to these figures, import substitution did not account for a 1/ There is some overstatement of (i) the level of import substitution achieved since the ratios are calculated on the basis of output at protected domestic prices and imports at world (cif) prices, and (ii) the gains in import substitution achieved since imports were cut back in 1969 due to growing balance-of-payments difficulties.  ANEX 1 Page 10 very large share in growth, even in the early 1950s. The rapid 1950s growth of the domestic market for manufactures of about 8 percent per annum was an important factor in industrial growth. In the 1960s, manufacturing growth became even more closely linked to growth in the domestic market. With the stagnation in real wages and low levels of public investment that characterized the 1960s, manufacturing NDP was unable to exceed the growth rate of total NDP. Import Dependence and Export Earnings 19. According to data from the 1965 Philippines' Input-Output Table, intermediate inputs into manufacturing accounted for 30 percent of all imports of goods and services while manufactured products accounted for 39 percent of total exports. Thus manufacturing was a leading spender and earner of foreign exchange. About 80 percent of its import requirements were accounted for by inputs into the textile, apparel, petroleum, chemicals, metal and transport industrles while about 90 percent of its export earnings came from traditional resource-based exports, canned pineapple, refined sugar, lumb,er, plywood and veneer, desiccated coconut and coconut oil (Table 14). 20. While many branches of organized manufacturing were characterized by a high dependence on imported inputs in the early 1960s9 this was more or less offset for the sector as a whole by the processing activities involved in resource-based exports. Mission estimates suggest that industry made no progress in lessening its dependence on imported inputs during the 1960s. Between 1962 and 1970, according to these calculations, such imports fluctuated between 17 and 20 percent of the value of organized (gross) output (equivalent to about 40 percent of value added). 1/ Imports of industrial capital goods were equivalent to another 6-7 percent of the value of output. On the other hand, there was some decline in the share of exports in output, largely on account of a stagnation in the export earnings of sugar up to 1970 and the failure of non-traditional exports to develop sufficiently to offset this. The share of exports in output, around 17 percent in the period 1962-65, fell to about 12 percent by 1969 (but recovered substantially by 1970). Sources of Industrial Financing 21. Table 15 presents some estimates by the Development Bank of the Philippines (DBP) of sources of financing of industrial investments in 1963 to 1970. When manufacturing was in its infancy in the 195,0s, large landowners 1/ Table 14 presents detailed data on 1965 imports and exports in terms of their share in domestic output. Since both imports and exports are, by and large, directly used and produced by larger enterprises, share in output is presented both in terms of the total output of the input/ output table and the organized output of the ASM.  ANNEX 1 Page 11 and primary product exports were major sources of industrial finance. In the 1960s, however, the role of equity investment from all sources was con- siderably diminished. The growing element of borrowing, reflected in Table 15 in an incremental debt-equity ratio of about 4 to 1, led to an estimated average debt-equity ratio of at least 3 to 1 for the latter part of the 1960s. 1/ A significant industrial securities market has failed to develop: though some 90 percent of manufacturing output in the organized sector comes from corporations, these remain overwhelmingly closed family businesses. 22. The DBP was the major source of long-term loans to industry, accounting for an average 10-15 percent of annual financing of capital formation. Japanese war reparations, which were channelled to industry up to the end of the 1970s, provided a source of long-term credit estimated to be 15-20 percent of the volume of DBP loans. In the later 1960s the Private Development Corporation of the Philippines became the only other significant source of long-term funds. A large amount of capital formation - approaching 30 percent on average - was financed by the "rolling over" of short-term loans from commercial banks. This was partly facilitated by the often close ties, through ownership, of commercial banks and groups of corporations. In the second half of the 1960s the DBP turned to substantial guaranteeing of foreign suppliers' credit (indirect foreign investment in Table 15) to sup- plement its cwn lending. These suppliers' credits, which accounted for almost half of industry financing in 1969, played a significant role in the balance of payments problems encountered by the Philippines since many of them were of a shorter-term nature. 23. Direct foreign investtent in the 1950s consisted largely of fairly heavy U.S. investments which were allowed easy access to the Philippines under various bilateral agreements in spite of growing feelings of economic nationalism. These investments were mostly aimed at establishing import- substituting manufacturing activities as a response to the effect of import controls on U.S. exports. As import substitution opportunities declined in the 1960s, so did foreign investments, indeed there was a net outflow towards the end of the decade. At the end of the decade, however, foreign partici- pation in manufacturing was still important: in 1970 foreign-controlled corporations accounted for around one-fifth of manufacturing NDP. 2/ 1/ The height of the incremental debt-equity ratio in Table 15 is sup- ported by evidence of a similar high ratio in the new investments regis- tered with the Board of Investments in 1969-73. As a result published data - giving average debt-equity ratios for the largest manufacturing corporations that are little more than 1 to 1 - would seem inaccurate. 2/ The Inter-Agency Working Group on Foreign Investments, Study of Private Foreign Investments in the Philippines: Interim Report, 1972. Among the major findings of this report were: the concentration of foreign investment in industry; the securing of a base to exploit the domestic market as the dominant motive for foreign investors in the Philippines; and the comparatively low ranking of the Filipino investment climate in South-East Asian comparison, as perceived by foreign investors.  ANNEX 1 Page 12 Efficiency in the Use of Capital 1/ 24. While there were no dramatic changes in overall investment patterns in the 1960s (see Table below and Table 16), the decade was dominated, more so than the 1950s, by substantial "lumpy" investments in intermediate goods, for instance, petroleum refining in 1961-62 and steel rolling in 1969-70. Share in Gross Fixed Capital Formation (percent) 1956 1962 1965 1968 1969 Consumer goods 56.3 38.1 53.0 41.7 31.4 Intermediate goods 35.3 56.1 41.6 52.6 64.6 Durable and capital goods 8.4 5.8 5.4 5.7 4.0 Total 100.0 100.0 100.0 100.0 100.0 Source: Table 16. 25. Three related measures of the use of factors of production strongly suggest that the productivity of capital has been declining in the 1960s. As the table below shows, the 1960s witnessed rising levels of capital-intensity in organized manufacturing in terms of capital-output (Column 1) and capital- labor (Column 3) ratios. 2/ If a substantially slower rise in the price of capital goods than in the price of other production inputs is taken into account, the rate of increase in the capital-output ratio in real terms becomes larger (Column 2). If levels of efficiency in the application of labor and capital remain constant, commensurate rises in labor productivity should be expected but the latter in fact rose very slowly in the 1960s 1/ Only the organized sector is treated in this section. There are apparently grave underestimates, by anything from 50 to 100 percent, in ASM fixed capital formation and, also, to a lesser extent, in ASM fixed assets. These are discussed in the Note on Statistical Sources for Manufacturing. The analysis in this section proceeds on the assumption that the degree of error has some consistency over time and across industries. 2/ See Table 19 for capital-output ratios by industry. The substantial rise in the capital-output ratio in current prices was common to about two-thirds of manufacturing. Prominent among industries experiencing the highest ratios were chemicals and non-metallic minerals. The textile paper and wood industries notably had falling ratios. The average is by no means high, even in 1969. In 1968, for instance, West Malaysia had a ratio of 1.02 and Korea of 1.38. The lowness of the Philippine ratio is probably a result of assets underestimation mentioned earlier.  ANNEX 1 Page 13 (Column 4). Normally a growth in output of around 6 - 7 percent per annum would be expected to be accompanied by a more pronounced rise in productivity. The evidence then, is that organized manufacturing used increasing amounts of capital during the 1960s without a clear positive effect on the produc- tivity of either factor of production. 2/ Capital-Labor Substitution and Productivity 1 2 3 4 Assets/Value Added Assets/Employees Value Added/Employees Current 1962 Prices 1962 Pesos 1962 Pesos 1962 0.79 0.79 6,254 7,900 1968 0.97 1.16 9,636 8,341 Annual Average) Growth (%) ) 3.4 6.5 7.5 0.9 1962-1968 ) Source: Data from Table 1, deflated by: Home Consumption Wholesale Price Index in Manila for machinery and transport equipment (assets) and Wholesale Price Index of Domestic Products in Manila for all items (value added). 26. The most tangible manifestation of inefficiency seems to have been poor rates of capacity utilization in many industries. Table 18 gives rates of capacity utilization in the second half of the 1960s for major industries for which the information is available. By 1968 these industries accounted for almost half of total assets and one third of total output in organized manufacturing. There was a variety of reasons for the growth of excess capacity, many of which reflected several government policies which made capital equipment available to industry on comparatively cheap terms (see Chapter II). Among these were: (i) government requirements, in some cases, that vertically-integrated plants be set up (i.e. pulp and paper); (ii) a domestic market too small to sustain several plants of a minimum economic size; (iii) over-optimistic market forecasts and investment decisions made by several large firms simultaneously (e.g. cement); (iv) competition from imports and (v) long periods required of some heavy investments to come on full stream. The attempted thrust in intermediate goods investments in the 1960s came up in particular against the problem of a small number of com- paratively large plants attempting to operate in a market of limited size. It is significant that, whilst the capital-output ratio for consumer goods decreased from 0.82 to 0.76 in 1962-68, it increased from 0.91 to 1.05 for intermediate goods. 1/ For the organized and unorganized sectors together, productivity in- creases probably averaged about 2-3 percent per annum in the 1960s because of the effect of substitution of factory for cottage-type production. 2/ From the available evidence this stands in marked contrast to the trends of the 1950s.  ANNEX 1 Page 14 27. According to the profits data from recent years contained in Table 17, many of the excess capacity industries of Table 18 were tending to earn below average returns on equity. Even the average profits situation in this table, however, seems extremely low. Part of this may result from the concealment or erosion of profits by manufacturing corporations, for instance by illegal expatriation of profits, generous fringe benefits to management or the hiving-off of profits to separate marketing companies. The indications are that, instead of published rates of return on equity of around 11 percent, Filipino entrepreneurs require a return of at least 20 percent. No satisfactory data exist to chart changes in profits over time. A best estimate would be that industrial profits remained steady or possibly declined by a small amount in the 1960s. 1/ 1/ The use of ASM data to calculate the return of gross profits (value added less wages and material inputs) on fixed assets gives a figure of around 100 percent for the early 1960s falling to around 80 percent for the late 1960s. However, given the increasing role played by debt in the structure of assets, it is unlikely that returns to equity declined by that amount.  ANNEX 1 Page 15 III. THE POLICY ENVIRONMENT IN THE 1960s 1/ 28. The promotion of industry continued to be at the center of the Government's economic strategy in the 1960s, as in the 1950s. The policy instruments to this end also continued to resemble those of the 1950s. Exchange rates, protection, tax incentives and credit policies combined to provide a heavy stimulus to industrialization, particularly in the area of import substitution in intermediate goods industries. The Government further set the tone for the pattern of industrialization with its emphasis on backward integration within firms on the one hand and on competition, albeit limited, rather than monopoly, on the other. It should, however, be stressed that the very strength of the private sector vis-a-vis government helped prevent the latter from pursuing consistent long-term strategies that might have proven effective in stimulating a more efficient pattern of industrialization. Exchange Rate and Protection Policy 2/ 29. The major changes in the industrial policy framework of the 1950s and 1960s were effected in the period 1960-62 when the system of protection was changed from one of import controls to an almost total reliance on ad valorem tariffs. 3/ This move was accompanied by a substantial Peso devaluation. As the balance of trade progressively deteriorated in the second half of the 1960s, the Peso became progressively overvalued up till the de facto devaluation of 1970. The overvalued Peso, combined with a tariff system that tended to discriminate strongly in favor of capital goods, raw material and some intermediate goods imports, allowed manufacturers to acquire cheap foreign inputs whilst penalizing actual or potential domestic producers of these goods. The widespread practice of unofficial private export of capital through the over-invoicing of imports, particularly capital goods facing low tariffs, provided a further stimulus to the import of industrial inputs. In addition, the Peso overvaluation provided a major barrier to the 1/ The development of industrial policies up to the Peso devaluation and the re-legislation of incentives at the end of the 1960s, which is the subject of this Chapter, has been extensively treated elsewhere, notably in J.H. Power and G.P. Sicat, The Philippines: Industrialization and Trade Policies, OUP, 1971; and V.B. Valdepenas, Jr., The Protection and Development of Philippine Manufacturing, Manila, Ateneo UnIversity Press, 1970. 2/ See J.H. Power, "The Structure of Protection in the Philippines", in Balassa and Associates, The Structure of Protection in Developing Countries, Baltimore, Johns Hopkins University Press, 1971. 3/ There were a few specific rates. An important complement to the tariff is provided by the levying of rates of sales taxes on imports that average 10-20 percent as compared to the nominal level of 7 per- cent for domestic products.  ANNEX 1 Page 16 development of manufactured exports outside traditional natural resource- based areas. 30. Tne most important changes in nominal levels of protection in the 1960s came from upward movements in the early 1960s in the average tariff on consumer and intermediate, - but not capital - goods as a result of strong private pressures for the offsetting of the effects of decontrol. Average Nominal Tariff Rates for Manufactures (weighted by the pattern of domestic consumption) 1961 1965 (percent) Consumer goods 64.1 70.1 Intermediate goods: Construction inputs 49.0 55.1 Other 24.6 27.4 Capital goods 16.2 16.2 All manufactures 46.2 50.8 Source: Power and Sicat, op. cit., Table 4.5 31. Estimates of effective protection in manufacturing for 1965 (see table below) indicate a substantially broader dispersal of rates according to the vertical stages of production. 1/ High effective protection for manufacturing, well in excess of the protection afforded other sectors, contributed to a sectoral bias in the allocation of resources in favor of industry. Effective protection on finished consumer goods, especially those with a high import content (for instance durables), was sufficient to make imports uncompetitive across a broad range of products (c.f. the gap between realized and potential rates in consumer goods in the table below). This was also true of many intermediate goods though protection on intermediates at earlier stages of production (Intermediate Products I), for instance pulp and some basic chemicals, tended to be significantly lower than at later stages (Intermediate Products II), for instance paper, paints, cosmetics and fertilizers, with the result that some of the former were hardly competitive with imports. Low nominal tariffs on output and com- paratively high tariffs on metal inputs made effective protection lowest in the area of many metal and engineering goods. 1/ Potential rates estimate the maximum degree of protection afforded by the tariff (and sales tax) structure while realized rates estimate, on the basis of price comparisons, the degree of protection actually availed of.  ANNEX 1 Page 17 Nominal and Effective Protective Rates for Manufactures, 1965 Nominal Effective Potential Realized Potential Realized Consumer Goods: processed foods 24 15 77 47 beverages & tobacco 115 10 183 15 other non-durables 107 22 287 55 durables 150 68 -232 1,355 Construction materials 59 25 102 50 Intermediate Products I 14 13 15 16 Intermediate Products II 57 33 175 88 Machinery 27 27 103 112 Transport Equipment 29 29 75 77 All Manufactures 52 24 128 49 Source: J. H. Power, 2p. cit., Table 11.11. Estimates of effective protection are based on domestic coefficients and are calculated using the Balassa method. Note: Intermediate Products I are yarn, lumber, pulp, leather, synthetic materials, other chemical materials, petroleum products, glass pig iron, steel ingots and non-ferrous metals; Intermediate Products II are fabrics, wood products, paper products, rubber products, plastic goods, chemical products, rolled steel products, metal castings and metal manufactures. 32. The above estimates fail to reflect important inconsistencies in the structure of protection which resulted from widespread actual and technical smuggling and tariff exemptions.1/ Actual smuggling, particularly important in the 1960s in textiles, electronics and cigarettes, was partly the result of the difficulties of policing the extended coastline of 7,000 islands. Substantial technical smuggling was to a very large extent made possible by many catch-all sub-categories for items not elsewhere specified (designated "other) which were subject to far lover duties. In FY 1969-70, 12 percent of the import bill was imported duty-free under provisions of the tariff code (2 percent) and 73 different Congressional Acts (10 percent), whilst another 3 percent was imported under similar provisions at reduced rates of duty. These exemptions resulted, for instance, from legislation on general investment incentives, specific measures for textiles and mining, and imports under reparations, by the Government and by regional development authorities. The most important consequence of exemptions, from the point of view of protection, was in the 1/ In recent years the government has intensified anti-smuggling measures. A recent tariff reform (see paras. 69 to 73) has removed major loopholes and simplied customs administration.  ANNEX 1 Page 18 area of capital goods which, as a result probably realized rates of pro- tection, well below the average quoted in the above tables. The exemptions also affected inputs; a well-known example of this was the privelege formerly enjoyed by cooperatives, largely sugar-producing, to import fertilizers duty-free and which contributed to excess capacity in the domestic fertilizer industry. The Incentives System 1/ 33. Following on tax exemption schemes in the 1950s designed to encourage certain broadly defined "new and necessary industries," strong pressure built up within industry to have them continued. As a result, the Basic Industries Act passed in 1961 and in effect, until 1970, exempted imports of machinery, equipment and spare parts by firms engaged in "basic" activities from import duties and the special import and foreign exchange taxes. 2/ Ultimately, 20 industries became designated as "basic", the list was broad enough to include again most of the industries which had benefited in the past and offered much latitude in designating additional activities as "basic". It is likely that some of this expansion would have been effected without any fiscal sacrifices. Although the aim of the Act was to develop a bias against the purely finishing types of activities, the in- centives offered were often excessive contributing to the creation of idle capacity in some industries, for instance, in confectioneries and bakeries; and redundant in others due to the persistence of a sellers' market, for instance, sugar mills, cement, industrial chemicals, and inadequate in other lines such as processing of minerals. Furthermore, a number of specialized tax incentives was also instituted for chemicals, fertilizers, and textiles, and involving partial and temporary exemptions from customs duties and revenue taxes on intermediate inputs for periods from 4-6 years. Cottage industries were also exempted for five years after their registration with the National Cottage Industries Development Authority (NACIDA) from all taxes, including customs duties, except income taxes. 34. As virtually the only incentive for manufactured exports, the internal revenue and customs codes offered excise tax exemptions and draw- backs on customs duties. These provisions remained virtually inoperative because of the maze of procedures involved in claiming drawbacks. 35. From February 1963 to June 1970, out of a total investment in capital equipment of r 1.2 billion under the Basic Industries Act f 182 million, or 16 percent, was given in tax exemptions. These were largely concentrated in mining, plywood and veneer, textiles, chemicals and pulp and paper. 3/ For the period 1965-69, tax exemptions on intermediate textile 1/ See V.B. Valdepenas, op. cit., Chapter III and Joint Legislative Executive Tax commission, 13th Annual Report, 1971, Chapter VIII. 2/ The 1967 Investment Incentives Act, which established a new set of incentives, is discussed in Chapter III. 3/ See Tax Commission, op. cit.. According to Mission estimates, investments receiving incentives accounted, for 15-25 percent or total industrial investment in this period.  ANNEX 1 Page 19 imports were valued at ? 124 million, or an estimated 7-8 percent of the value of textile output. Deductions under industrial incentive arrangements also represented a substantial claim upon the fiscal resources of the country, accounting for an estimated 3 percent of Central Government revenues in the period 1965-69. A government review, in 1970, of fiscal incentives on selected Asian countries, concluded that of seven countries compared, the Philippines emerged on the whole as the most liberal. 1/ Credit and Interest Rate Policies 36. The general environment for private industry's borrowing was set by the Government's past policy of generally low interest rates on the one hand, and a system of preferential rates on the other. The low interest rate policy was underpinned by the 1916 Anti-Usury Law limiting interest on secured loans to a 12 percent ceiling and on unsecured loans to 14 percent. This law contributed to a rigid and inefficient interest rate structure which became characterized in the later 1960s by a substantial divergence between recorded and effective rates, a bias against the develop- ment of long-term lending instruments, high effective rates in unregulated markets, and a consequent tendency to misallocate resources. In the first half of the 1960s, the commercial banks typically set rates of interest between 7 and 10 percent on short-term loans. Since then, these rates have risen to their ceilings. It was estimated in 1970 that additional charges on these led to effective rates of interest up to 7 percentage points higher, whilst rates in unregulated markets were a good deal higher. 2/ Longer-term instruments were prevented from developing partly because high rates of interest could be earned on short-term funds from government securities and, more recently, money market operations. The resulting "rolling-over" of short term money to finance much industrial investment created some uncertainty for entrepreneurs but, more important, helped maintain a "closed" aspect to the financing system since the functioning of a "rolling-over" system relied on close personal bank-customer contacts. 37. Meanwhile selected industries profited from lower rates obtainable through government institutions. Long-term loans in the 1960s from DBP were typically 7 to 10 percent. Interest on Japanese war reparations was set by law at 3 percent. Moreover, the large default on reparation repayments, largely the result of technical difficulties in the Government's pursuance of defaulters, would certainly make the effective rate of interest negative. DBP has had in several cases to preempt default by re-lending to distressed industries. It did this after 1962. It also had to institute a special program in 1966 to help out several "temporarily distressed industries", including pulp and paper, steel and textiles. These four industry branches, together with three others (cement, radio and television), and certain metal products, represented by far the most important single customers of the DBP, accounting for 59 percent of total DBP loans to manufacturing up to the end of FY70. 1/ Tax Commission, op. cit. 2/ National Economic Council, Report of the Inter-Agency Committee on the Study of Interest Rates, February, 1972.  ANNEX I Page 20 38. There were specific attempts to establsh lines of credit for smaller-scale industries, but the credit and interest rate policy framework acted against their success. Since collateral, rather than project viability, has remained the dominant criterion of public and private lending, this was of necessity biased to larger (and better known) customers. The totality of DBP loans to cottage and small-scale industries (defined by the size of the loan, rather than of the firm) up to the end of FY70 constituted only one percent of total loans. The enabling Act of NACIDA which was established in 1962 to foster the development of cottage industries, also stipulated that r 50 million should be provided both by the DBP and the Phlippine National Bark to be loaned to cottage industries at a 4 percent rate of interest. Hardly any loans were made under this scheme, because the two banks could earn higher returns elsewhere. Moreover, an effort by NACIDA a few years later to create its own banking arm failed before any loans had been made. Small-scale industry participation in reparation funds, on the other hand, proved more successful. Up to the end of January 1970, they had received about 6 percent of funds that went to manufacturing. Other Policies 39. It has been claimed that biases applied to the cost of labor played an additional important part in the factor price distortions. A minimum wage law was enacted in the 1950s and the minimum wage was further raised in 1965 and 1970. However, it covers only about 4 percent of the total Philippine labor force, including most of organized manufacturing. Smaller manufacturing enterprises practice considerable evasion which partially offsets other disadvantages they face in competition with large- scale industry. The evidence suggests that neither the 1965 nor the 1970 new wage minimum had a significant effect in raising wage costs. Real wages, in terms of the cost to employers, failed to rise significantly in the years following 1965 and continued to fall after 1970. 1/ Meanwhile the share of wages in output tended to decline over the 1960s (Table 11). Minimum wage legislation might also be expected to bring about, as it seems for instance to have done in India, a narrowing in the wage spread -- that is, the premium on skill differential -- between industries. This has not been the case. According to some manufacturers, there is often a preference for machines over labor because of labor relations problems. This preference may provide a more important bias in favor of capital than money wage levels. At the same time, however, as minimum wages have been the same for metropolis and regions, they have helped maintain the bias against regional dispersal. 40. A combination of a sometimes over-valued exchange rate with a tariff structure affording rates of protection that tended to escalate sharply with the degree of fabrication provided the cornerstone of the policy environment for industry in the 1960s. As a result industry was able to obtaia waity of its inLputs, particularly capital, at a low cost whilst its output was often able to command high prices in a sheltered market. In addition the incidence of tax incentives and preferentjal 1/ See Table 17.4 oL the Statistical Appendix, Vol. III of this report.  ANNEX 1 Page 21 credit policies was concentrated on a small group of largely intermediate industries, textiles, pulp and paper, steel, sugar, cement, and some industrial chemicals in particular and had the effect of further raising the effective protection they enjoyed. As a result, many industries could afford to produce with suboptimal scale, excess capacity or both. Indeed government credit and incentive policies clearly played more than a passive role in the development of excess capacity during the decade. This high- cost pattern of industrialization, which did not succeed in reducing the import dependence of the manufacturing sector, clearly raised the cost of inputs to other sectors, in particular agriculture and construction, and the cost of finished goods for consumers. 41. The effects of some aspects of industrial policy on the pattern of growth within the manufacturing sector need some mention. Firstly, the over- valued Peso combined with the high cost of protected intermediate inputs (and the absence of a mechanism to offset the high cost of domestic or imported inputs), meant that industrial exports were unable to develop. Secondly, the structure of protection inhibited the development of some of the simpler engineering and metal-using industries that might have taken place, given the size of the Philippines' market and its level of development. 1/ Thirdly, the areas of concentration of government incentive and credit policies and the emphasis of some of these policies on vertical integration, provide part of the explanation of the apparently high share of large firms in output and the inability of smaller firms to compete. Not only did these policies make manufacturing less likely to exploit any existing possibilities for the more labor-intensive tecqhniques associated with smaller scale, but they also meant that the entrepreneurial base of the modern sector was not broadened. 2/ IV. RECENT DEVELOPMENTS 42. Several important developments since the late 1960s reflect government attempts to change the direction of industrial policy. In 1967, a new set of investment incentives was introduced and the Board of Investments (BOI) was created to administer them. The floating of the Peso in 1970 was a critical catalyst of change. It was accompanied by the introduction of some controls on investment and improved cooperation among various government agencies in industrial policy areas. In the same year, substantial export incentives were introduced. Since then, there has been a gradual process of narrowing of investment priorities and experimentation in industrial planning and control. 1/ However, heavy protection and subsidization would have only served to create a capital-intensive, high-cost engineering industry producing goods inappropriate for the Philippines and to have inhibited the important, though comparatively small, developments in labor-intensive engineering and machine shops that did in fact take place. 2/ The seeming existence noted in Cnapter I, of a comparatively large unorganized sector alongside a comparatively underdeveloped small- and medium-scale factory sector, could thus reflect the lack of those very conditions enabling workshops to become factories.  ANNEX 1 Page 22 The Peso Devaluation and the Introduction of Investment Control 43. The de facto devaluation of the Peso in February, 1970, a sub- sequent slight further devaluation and major international currency re- alignments meant that, between 1969 and the end of 1972, the Peso had devalued by more than 72 percent against the U.S. dollar and around 100 percent against the Yen and the Deutschmark. 1/ Some of the cost advantages of devaluation were eroded by a 20 percent rise in the price of domestic industrial goods in 1970 but the rise tailed off to about 10 percent in both 1971 and 1972. 44. Under the new control on capital goods imports, the Central Bank has to approve all payments on such imports made on a deferred basis (i.e. not within 360 days). Tne criteria for approval are that industries should be, in order of priority, export-oriented, BOI-approved or others not certified as oyercrowded. Imports on a cash basis by agricultural, export- oriented and BOI-registered industries require no prior permission while residual non-overcrowded industries can apply for (and usually obtain) Central Bank approval. The latter can, however, import plant and spares valued at less than $50,000 per month without permission. The only capital goods imports allowed overcrowded industries are imports of plant and spares, valued at less than $50,000 per month, which replace but do not expand existing capacity. All imports on this less than $50,000 per month basis made by "residual" and overcrowded industries require certification from BOI. 45. A list of overcrowded industries was drawn up, and has been periodically revised, by the Financial and Fiscal Policy Committee (FFPC), a body providing for the coordination between government agencies of such policies as investment and exchange availability. About 40 product lines, all in manufacturing industry and representing nearly half of its total output and assets were originally listed as overcrowded. Prominent among those still listed are flour milling, sugar, brewing, many domestic electric appliances, cement, fertilizers, motor vehicle assembly, and some basic steel products. The New Incentives Framework 46. The Investment Incentives Act (RA 5186) of September 1967, introduced a comprehensive incentives system covering agro-industries, mining and manufacturing. The Export Incentives Act (RA 6135) of August 1970, further extended incentives on exports of goods and services. Presidential Decree No. 92 of January 1973, made some important amendments to both Acts. Both Acts are administered by the BOI which came into ex- istence in November 1968. One of its main tasks under RA 5186 is to draw up an annual Investment Priorities Plan (IPP) - the current IPP is the sixth - listing those activities which qualify for incentives. The IPP also presents a broad range of data on market size, input requirements, levels of protection needed, and costs and benefits. Qualifying activities 1/ See Table in para 8 of Vol I of this report.  ANNEX 1 Page 23 are divided into "preferred non-pioneer" and "preferred pioneer" categories. A necessary (but not always sufficient) condition of pioneer status is newness of product and process on a commercial scale in the Philippines. 47. To qualify for incentives under RA 5186, enterprises, which must be corporations, are required to submit detailed feasibility studies. These studies, together with private sector proposals, have so far, in practice, constituted the BOI's main source of information in constructing the IPP. The major fiscal incentives for registered projects (including amendments under Presidential Decree No. 92) are: duty and tax concessions on imported and domestic capital equipment; tax deductions for expansion reinvestment in some projects; accelerated depreciation of fixed assets; tax deductible carry-over of net operating losses; and additional deductions from taxable income for labor-training expenses (introduced in 1973). Pioneer enterprises receive additional incentives in the form of exemption from all taxes, except income tax (at the rate of 100 percent in the year of a product's initial inclusion in the IPP, gradually phasing out to zero by the sixteenth year); and tariff protection, at government discretion, of up to 50 percent. 48. The Investment Incentives Act also introduced concessions on the promotional, shipping and imported raw material costs of exporters. The Export Incentives Act offered an alternative set of incentives for export producers (single proprietorship and partnership, as well as corporations) and new incentives for export traders and service exporters. Presidential Decree No. 92 aligned export incentives in the Investment Incentives Act with those of the Export Incentives Act and included tourism as a service export in the latter. The major production incentives under the Export Incentives Act, as amended, are: tax credits on duties and taxes on material inputs in export production; 1/ deduction from a firm's total taxable income, in the first five years from registration, based on a formula encouraging use of labor and local raw materials. 2/ Incentives may also be offered on investments in new export capacity broadly similar to the major incentives offered under the Investment Incentives Act. 49. Product areas which qualify for export incentives according to criteria of competitiveness, foreign exchange contribution and profitability to the economy, are listed in an Export Priorities Plan (EPP). The current EPP is the fourth. The practice has been to present two lists of products. List A covers products which are exportable from existing capacity and would only receive concessions on investment when a capacity increase is needed to meet export orders and the cost of the imported machinery can be covered by export sales within five years. List B is a shorter list of non-pioneer and pioneer investment areas for export parallel to the investment areas of the IPP. 1/ A time limit of 10 years from registration was omitted in the amend- ment. 2/ In addition, registered exporters are exempted from export taxes and can make labor training expenses tax deductible.  ANNEX 1 Page 24 50. The incentives legislation, together with Republic Act RA 5455 of 1968, provides the framework for controls on foreign investment. RA 5455 allows foreign equity participation up to 30 percent in any activity as long as there are no other constitutional or legal limitations on foreign owner- ship. BOI has the authority to allow foreign equity in excess of 30 percent as long as it is in the interests of the economy. Under RAs 5186 and 6135 foreign equity is allowed up to 40 percent in non-pioneer areas and up to 100 percent in pioneer areas. 1/ Originally aliens had to divest themselves of their controlling share over a period beginning in the 10th and ending in the 20th year after registration. The most significant part of the 1973 amendment was to lengthen the period of divestment to 30 years or, in the case of corporations exporting at least 70 percent of their output, to 40 years. In addition, the amendment allowed foreign firms exporting at least 70 per- cent of output to qualify for export incentives. The Incentives,System and the Direction of New Investment -/ 51. The new set of incentives has made improvements in principle, including the introduction of economic criteria of evaluation, a simple planning mechanism to avoid over-investment in specific areas, an attempt to remove the bias of previous incentive schemes against domestic capital goods, and a comprehensive framework for foreign investment. The new plan- ning and evaluation elements have, however, proven somewhat disappointing. By and large both the investments and export priorities plans have constituted broad "shopping lists" without real quantitative investment targets or a time framework. "Measured capacity" - the additional capacity estimated to be required by projected growth in the domestic market or by the development of exports - has remained the dominant criterion whilst other economic criteria have tended to remain subsidiary. With the important exception of more ad- vanced engineering goods, a great deal of the leading categories of manufactured imports were originally listed in the IPP, together with certain traditional export products such as coconut, wood and mining products. 52. Almost one quarter of the total investments actually made by the almost 200 projects registered under the IPP (see Table 20) by the end of 1971 was incurred on projects where investment decisions had already been made and equipment installation had already begun before BOI registered them in an attempt to exercise some control over them. Most of the investments made prior to registration were accounted for by the hot- and cold-rolled steel investments of two firms. 53. Around 60 percent of actual and planned investments are in areas of import substitution, mostly in heavy industries, with the rest almost entirely in traditional processed exports and export-oriented mining. The most immediate foreign exchange impact has been in the export earnings of traditional processed products which, according to BOI calculations, have been 1/ If Filipino investments are smaller than the total projected demand- supply gap of a product, a non-pioneer area may be opened to 100 per- cent foreign ownership three years after it has been listed in the IPP. 2/ The effect of production incentives for non-traditional exports is examined in a subsequent section.  ANNEX 1 Page 25 in excess of $100 million per annum in recent years. The net foreign exchange savings of import substituting projects, according to broad Mission estimates, were probably under $10 million and $30 million in 1971 and 1972 respectively. If planned investments come on stream promptly and achieve good rates of capacity utilization, this figure could be from $60 to $80 million by the mid 1970s, or around 10 percent of the import bill for industrial inputs. 54. Most tax incentives were given through the expansion reinvestment allowance, accelerated depreciation, and taxes and duties on imported capital equipment and represent a substantial subsidy element in terms of the value of fixed capital investment (see below). 1/ Few tax credits for domestically produced capital equipment were used. There was a substantially uneven distribution in the incentives, with a particular bias in favor of tradit.onal export-oriented industries. These industries are not only well established but many of them are traditional high-profit earners, and incentives seem to have been largely superfluous. 2/ Actual Investments in Fixed Capital of BOI Registered Projects and Estimated Taxes Foregone 1969-1971 (Million Pesos) 1969 1970 1971 Fixed Capital Investment 740.5 658.3 524.6 Estimated taxes foregone 48.9 97.7 118.4 Taxes foregone as a percentage of investment 6.6 14.8 22.6 Source: BOI. Figures relate to reporting firms only. How- ever, these account for the bulk of investment. 55. One of the more disappointing aspects of registered investments so far is the concentration of total investments on a small number of highly capital-intensive projects. Thirteen projects in nickel, steel and paper accounted up to the end of 1971 for three-quarters of investment costs and one quarter of employment creation for manufacturing. When the projects are fully operative, less than 30,000 direct jobs will have been created in manufacturing, the equivalent of about one year's employment creation in the whole organized manufacturing sector. Clearly, however, some of the projects are justifiable on other grounds. The nickel project in particular will make large foreign exchange earnings. The regional spread of project employment, is also promising. 1/ The subsidy element of the Investment Incentives Act should prove heavier than that of the Basic Industries Act of 1961 (see para 33) because the range of incentives is broader. 2/ A 1973 amendment to the expansion reinvestment incentive was designed to help combat. this.  ANNEX 1 Page 26 56. The IPP is designed to promote investment across a broad range of industries whilst the overcrowded industries list is designed to inhibit investment across an equally broad range. Between them, these two lists appear to leave few intermediate areas where investment is freely sanctioned, yet not offered incentives. In spite of this, the figures below suggest that, by 1971 when large imports of steel-mill equipment were no longer being made, BOI registered investments accounted for a comparatively small part of total industrial investment.1/ Whilst some of the residual would be accounted for by replacement investment, its size probably indicates that some industries listed as overcrowded were still importing liberally. 2/ Imports of Durable Manufacturing and Mining Equipment 1969-1971 (Million Pesos) BOI Registered as a Total BOI Registered Percentage of Total 1969 687 353 51 1970 900 512 57 1971 1,046 243 23 Source: Total imports are f.o.b. from Central Bank Statistics and consist of "Metal working machinery 'plus' construction and other industrial machinery" less construction items. BOI- registered imports include cif and handling charges. Total imports are converted from Dollars to Pesos at I 3.9 for 1969, r 5.9 for 1970 and f 6.5 for 1971. Recent Approaches to Industrial Promotion 57. In the period since the initial legislation of incentives the Government, in trying to deal more effectively with problems of industrial planning and implementation, has gradually moved to more active forms of industrial promotion through the acquisition of a new rationalizing and plan- ning role in industry. This reflects not only the stature BOI had acquired but also the further improvement in inter-agency cooperation. BOI has also been vigorously promoting new exports (see following section). 58. Amongst the largest projects listed in the IPP in recent years have been steelmaking (reduction of iron ore) and petrochemicals. In both 1/ Capital equipment import figures are used as indicators of investment trends and some caution should be attached to interpreting this. In particular, figures for BOI imports and total imports may not cover ,?recisely the same time period. 2/ One industry listed in 1971 as overcrowded, textiles (spinning and weaving) alone imported $23 million of textile equipment in 1971. (This also, however, includes knitting equipment.) This could represent estimated additional capacity equivalent to 15 to 20 percent of existing capacity.  ANN0EX 1 Page 27 cases, investment costs are very high and the domestic market will not be large enough, probably for a decade at least, to support a plant that is economic by international standards. These projects, originally included in the IPP as a result of private pressures, have been retained in recent years; however, BOI has sought to forestall rather than actually promote these projects. Recently the BOI has begun to prune the IPP. In both the fifth and sixth IPP, for instance, approaching 20 items were excluded. 1/ In the sixth IPP these deletions were based on a new criterion, to encourage labor-intensity, that project areas should only be included if imported capital equipment per man-year of direct employment generated in each year of full operation does not exceed $4,000. Projects with export potential, such as a copper smelter or some automotive production, that fail to meet this criterion may, however, still be retained if their proponents can cover in the first five years of operation most of their foreign exchange ca?ital costs. A smaller number of projects, such as steel making, which meet aeither criterion are retained because of the potential importance that the Government attaches to them in the industrialization process. New project area additions to recent IPPs have consisted largely of engineering and automotive goods, many of them comparatively labor-intensive. 59. The BOI's role in the rationalization of certain industries arose from its partial responsibilities in the area of overcrowded industries and from requests by other government agencies. BOI decided that the spinning and weaving industry could be removed from overcrowded status in 1972 and new investments allowed only if existing mills in the Greater Manila area registered under the Export Incentiveg Act and covered the costs of equipment imports by export revenues within five years. Expansion outside this area had to be undertaken either under the IPP or the EPP. This policy could assure substantial exports, either in fabric or in garment form but it is regrettable that the price that the Government pays for some degree of control should be the subsidization of investment in an industry which has proven itself in the past more than willing to invest, and which would in any case receive incentives related to export sales. In the cement industry, which has been able to use some of its excess capacity to export in recent years, BOI has secured private cooperation in the creation of a Cement Authority in January, 1973. The task of this Authority is to rationalize the location of cement-production for the domestic market and for export, and to control and promote the export of cement, for instance, by negotiating bulk shipping contracts. In a similar move to rationalize the location of domestic production and to promote exports, the governments, through the Presidential Steel Committee, temporarily nationalized last October one of the two large firms rolling flat steel products and secured the cooperation of the other. 60. The most far reaching rationalization program to-date, also involving a substantial investment in new capacity, has come in the automobile industry. This development is important not only for the promotion of the automobile industry itself, but also because it represents a concerted effort 1/ This included a large rayon project in the Fifth IPP and, in the Sixth, the naptha cracker, the up-stream part of the petrochemicals project.  ANNEX 1 Page 28 to develop a domestic engineering capability. The lack of progress in engineering goods in general has reflected problems of low levels of effective protection, insufficient "know-how", an industrial structure which has not encouraged inter-firm sub-contracting, and a small domestic market. In vehicle assembly, in addition, domestic content programs have been hampered by the policies pursued by international automobile companies. In view of these problems, the BOI approach in its Progressive Car Manufacturing Program (PCMP) is to encourage import substitution in components that can be manufactured economically for the domestic market and exports in other components where scale is vital. As a partial rationalization of the assembly industry, the BOI selected five PCMP candidates from the 11 assembly firms operating in 1972. Only these five firms will be allowed to import passenger cars in completely-knocked-down (CKD) kits. The purely import substitution feature of the program is to be achieved largely by the assemblers sub-contracting production of simpler items like springs, radiators, glass parts, plastic products, and soft trim to existing engineer- ing firms who possess in aggregate a substantial amount of excess capacity. The assemblers in turn will each undertake a major investment in a component. As a result, substantial capacity in body shell, transmission, engine block and stamping and pressing production will come on stream in 1974-1975. The investing firms, all international companies or with strong international connections have undertaken to export the great majority of their production in the form of interplant transfers in the East and South Pacific Region. According to PCMP targets, the Program should save 20 percent of the import bill for CKD vehicles and earn the equivralent of 30 percent of this bill through exports by 1976-1977. 61. Though modest by the standards of some other domestic content programs in developing countries, the PCMP incurs several critical problems. That part of the program encouraging local sub-contracting is well conceived to develop local engineering and entrepreneurial capabilities. However, since the practice of firms exporting CKD packs, when a component is deleted from them, is to reduce the price of the pack by less than the average price of that component, there will obviously be some cost attached to foreign exchange savings. 1/ Perhaps more problematic, however, is the exporting aspect of the PCMP. Though new investments have been made in plant of reasonable scale, a good rate of utilization of this capacity depends entirely on exporting, mainly in the form of inter-plant transfers but the commitment 1/ An upper level is set to this cost by BOI's stipulation that the size of the deletion allowance must exceed the foreign exchange cost of the domestic manufacture of a component.  ANNEX 1 Page 29 to, and ability to reach, these export targets of the international firms involved is uncertain. 1/ 62. The PCMP became operative in July, 1972. A program for trucks and buses is expected to follow in two or three years. The BOI is currently studying the inter-island shipping fleet requirements of the Philippines with a view to establishing a similar Horizontal "components" approach to the development of a domestic shipbuilding industry. A further important development has been based on the International Rice Research Institute's adaptation of the design of imported handpower tillers from Japan to take account of local engineering and maintenance conditions. BOI is in turn promoting the manufacture of these tillers using an imported engine. Two firms have so far been registered to produce hand tillers and the BOI is experimenting in selected provinces with cooperative ventures between already existing small machine shops which would each manufacture specified parts. 63. In response to its new leading role and to its experience of sector rationalization, the BOI has begun to evolve in recent months a more formal approach to planning based on specific industry sub-sectors. Sector planning, as BOI calls this, represents a realization that a broader planning exercise is unrealistic in view of the government's poor general knowledge, as yet, of industry and the underdevelopment of its tools of implementation. It is not yet clear precisely what will be the content of sector plans. They are intended as five year rolling plans to be appended to the IPP. Currently under preparation are sector plans for textiles and garmets, agricultural machinery, livestock, and poultry processing, and feed grains. These will be followed in 1973, inter alia, by electronics, plastics, and shipbuilding. There has also been a noticeable evolution in BOI's concept of regional planning. On the one hand BOI is laying more stress, partly through the IPP, on the regional dispersal of the factory sector. This is assuming the aspect of a "growth poles" approach. On the other hand it is currently beginning to be involved in the promotion of small-scale rurally based simple agricultural processing industries (see para 76). Exports of Manufactures 64. Exports of non-traditional manufactures 2/ grew substantially in recent years across a broad range of products, from a share of 6 percent 1/ Participants agreed to export largely as the price to be paid for continuing assembly operations in the Philippines. These operations, however, constitute a very small part of the global interests of these firms. They apparently intend to direct most of their exports to Australia and New Zealand although, for instance, the growth market in these countries is in automatic transmissions rather than the manual transmissions that two participants are planning to export. The fact that two of the five participants have been allowed to invest in transmissions worsens the situation if exports do not materialize. In the case of body-stamping, a more intensive exploitation of the domestic market could result in production losses for the more labor-intensive, smaller-scale production of jeepney bodies by existing, smaller firms. 2/ All manufactures except coconut, sugar, wood (except furniture), pineapple, abaca and tobacco products (see Table 21).  ANNEX 1 Page 30 of total exports in 1969 to 9 percent by 1971. In 1972, however, this growth was severely checked, largely due to the poor performance of the leading items of 1971, petroleum products, cement (non-metallic minerals) and tinplate (metal manufactures). If these items are excluded from non- traditional exports, the residual is seen to have grown by around 30 per- cent per annum each year since 1969. This impressive growth was largely the result of the Peso devaluation, excess capacity in the domestic market and the new export incentives. Most of the growth was concentrated in BOI- registered exports, some of it from the growth in exports of individual firms - only about 30 exporting firms were registered in 1970 - and some of it from new firms - there were over 150 registered firms in 1972. Most BOI exports were from industries with excess capacity. The most important BOI product areas have been garmets, cement (this item with very variable export success), textiles and handicrafts. Thirty two other product groups accounted for the remaining 40 percent of BOI exports in 1972. Of these electronics and fish preparations achieved impressive growth. There has, however, so far been little stability in the pattern of export growth, either for product areas or for firms. Exports of Non-Traditional Manufactures ($ mi'llion) 1968 1969 1970 1971 1972 Mineral Fuels and Lubricants 15 13 17 24 19 Non-Metallic Mineral Products 1 1 3 14 8 Manufactures of Metal 1 8 17 13 1 Other 26 28 37 50 65 Total 43 50 74 101 93 of which BOI-registered exports($ m.) - 5 14 36 40 Rate of growth of total (%) n.a. 16 48 36 -8 Share of BOI in total (%) - 10 19 36 43 Share of total in all merchandise exports (%) 5 6 7 9 8 Source: Table 21 and BOI figures of reporting firms (excludes abaca products, bananas and services). 65. The most important use of export incentives has come from the tax credit and reduced income tax provisions in RA 6135. The tax credit is potentially most important in offsetting the effects of protection on imported input prices and could represent as much as 20-30 percent of the value of export sales. 1/ In fact, preliminary estimates suggest that it has averaged well under 5 percent. This reflects in part the cumbersome operation of tax crediting - though improvements have recently been made - especially for smaller firms which cannot afford the necessary accounting 1/ For instance, about 20 percent in the case of man-made fiber fabric or 30 percent in the case of some electronics assembly.  ANNEX 1 Page 31 overhead for the claiming of credits. Thus the most successful export products so far, for instance shrimps, handicrafts, cement and garmets using domestic fabrics, have tended to have a fairly low import content. The reduced income tax formula represents a subsidy to the use of labor and domestic raw materials. It is estimated to have averaged 5 percent of the value of export sales. An amendment to the formula in 1973 was designed not to alter this average but it is extremely useful in reducing the variability in the value of this incentive to no more than 9 percent of export sales under the present rate of corporation tax. 1/ 66. For some products, such as petroleum products and cement, instability in export growth has reflected market characteristics such as temporary supply deficits in the region. More important in the larger number of cases, such as textiles, this instability reflects that exporting from spare capacity, while it represents an opportunity to experiment in new markets, cannot assure long term export growth. As domestic market growth improves capacity utilization, the level of export incentives may prove in- sufficient, in the case of many industries, to counter the attractiveness of the protected domestic market. Export-specific capacity may also be required in those cases where export markets require different product qualities. There has in fact recently been some increase in emphasis on investment in new export areas. The BOI is paying particular attention to capacity expansion in those industries, such as electronics and garments, where export prospects seem best. In several cases, principally textiles and certain automobile components, investments will only be allowed on condition that a substantial part of output is exported. The growing emphasis on promoting export-oriented foreign investments, particularly in labor-intensive areas, found expression in the liberalization of conditions governing foreign investments in Presidential Decree No. 92. 67. The export processing zone at Mariveles near Manila, now in an advanced stage of construction, could prove an important initiative in export 1/ The new formula allows deduction from a firm's total taxable income of an amount equivalent to the sum of direct labor and total raw material costs in export production, but not in excess of 25 percent of export revenue. If pre-tax income on export sales is at least as high as this 25 percent ceiling, tax saved is 35 percent (present rate of corporation tax) x 25 percent = 8.8 percent of sales value. Clearly, the reduced income tax formula requires close scrutiny by BOI of regis- tered firms' accounting practices and of export values.  ANNEX 1 Page 32 promotion. Its development has, however, been haphazard. Costs and benefits and economic levels of rents and utility rates have been insufficiently appraised and long term development plans remain somewhat hazy. 1/ 68. The marketing of new products remains a major constraint on export growth and the Government has as yet no coordinated policies in this area. The BOI provides general export information and studies on export markets. It is also encouraging, through incentives, the development of export trading firms. The Department of Trade and Tourism plans to establish government-run display centers (Trading Houses) in major foreign cities. A UNDP/UNCTAD technical assistance study on export promotion is currently getting under way. This will hopefully succeed in defining the Government's role more precisely, as well as providing the basis for better coordination and a clearer allocation of responsibilities between the agencies involved. Tariff Reform 69. The tariff reform of Presidential Decree No. 34 became effective on January 1, 1973. The new tariff replaces almost 40 rates, ranging from 0 percent to 250 percent ad valorem, and various specific, alternative and compound rates, by 6 ad valorem rates raging from 10 percent to 100 percent with virtually no specific or compound rates. The introduction of a basic revenue tariff of 10 percent upward movements in many other rates, the reduction in the availability of exemptions 2/ and the removal of anomalies allowing technical smuggling 3/ will raise the average ad valorem value of tariffs collected. According to Mission estimates, the new tariff would, in the absence of significant changes in the pattern of imports, raise the average ad valorem tariff from its present level of about 13-15 percent to at least 20 percent. 70. This rise in the average tariff level is based on a more or less across-the-board rise in tariff rates ranging between 5 and 10 percent in most cases. Firstly, all items previously dutied at less than 10 percent now face a 10 percent tariff. Secondly, tariffs previously levied at rates that no longer exist, are almost all rounded up rather than down. The notable exception is about 130 rates previously in excess of 100 percent. T'hirdly, there are many small import items, often of a non-essential nature, where already high tariffs rise significantly. Finally, there is a number 'If The subsidy element that the present zone will provide for exporters, in addition to the incentives to which they are entitled under the Export Incentives Act, will prove excessive. 2/ Exemptions, including government exemptions, are to be suspended with exception of those offered under incentives legislation. Other exemptions would become allowable on a discretionary basis. 3/ In fact some progress in raising tariffs in "other" sub-categories (see para 32) had been made prior to this reform.  ANNEX 1 Page 33 of cases where a larger tariff rise is presumably aimed at a protective, rather than a revenue effect. For instance, of almost 150 items with current import levels in excess of ) 10 miUlion, there are about 27 items with tariff rises in the area of 8-15 percentage points and a further 20 with rises above 15 percentage points. 71. The reform has a clear impact on import-dependent industries which face new revenue tariffs on raw cotton, all metals in primary form and some semi-processed steel products. In many of these cases there is a corresponding rise in protection of the final product (e.g. pipes and fittings) or else the protection on value added is maintained by a tariff that is high enough to be redundant (e.g. cotton textiles). In some intermediate steel products (e.g. cold rolled steel), however, effective protection is likely to be lessened. Moreover, metal-using industries such as components manufacture and engineering will also be faced with higher input costs. There has been some selective protection of such industries, for instance power tillers, industrial sewing machines, printing machinery and automobile parts, but the bulk of tariffs on capital goods and metal products was not significantly changed. Thus for certain products potentially suited to production in the Philippines (e.g. taps and valves, typewriters, parts for machinery and cycles) tariff reform may inhibit further development. 72. Certain import-competing, or potentially-competing, industries have acquired new levels of protection, some of which may in turn raise the cost of inputs to other industries. A large tariff rise from 20-25 percent to 50 percent on certain petrochemical products, presumably anticipating the needs of an eventual domestic petrochemicals industry, will immediately raise prices for plastics-using industries. Tariff rises from 30 to 50 percent are also evident across a broad range of electrical equipment and components. In addition protective rates have been estab- lished for miscellaneous industries such as ceramic tableware and sanitary fixtures. 73. Although the various aspects of the Tariff reform make generaliza- tion difficult, the overall indications are that the pattern of effective protection generated by the tariff code has not changed significantly and, consequently, that levels of protection afforded to final-stage products remain excessive in many cases.1/ This view, however, requires some quali- fication since the reform represents a fundamental administrative rationaliza- tion of tariff rates, grouping them into broad bands and removing many of the inconsistencies of the old schedule. On balance, therefore, the reform does represent a beginning to the task of structural change. It would, in any 1/ Whilst higher levels of protection on some nonessentials should discourage, at the margin at least, consumption of imported luxuries, these will only further encourage domestic production of such items unless the reform is supported by higher rates of taxation on the consumption of such items. There is therefore little in the reform to suggest that it will re-allocate investments from non-essential to exportable goods.  ANNEX 1 Page 34 case, have been unrealistic to expect sweeping reforms at this time. The industrial structure which has developed under the present high levels of protection would become unviable over large areas under a system that suddenly became more uniform. Medium- and Small-Scale Industry 74. While there seems to have been an increasing realization in recent years of the economic, and particularly employment, potential of small- and medium-scale industry, this has not resulted in the formulation of a coherent set of objectives or policies in spite of the efforts made in recent years to reorganize the public effort in this area. 75. Various small schemes have been established, both publicly and privately, since 1970 to extend credit to small firms. A small credit line of f 10 million was made available by the Social Security System for small loans to be channelled, on a supervised basis, through the University of the Philippines - Institute for Small-Scale Industry (UP-ISSI). Although the UP-ISSI is one of the most competent institutions operating in the areas of small industries it had only approved less than 0 2 million of loans under the scheme by the end of 1972. PDCP and two commercial Banks also have small financing programs for small-scale industries. Since 1970 DBP has increased the number of loans made through its industrial branches and its pattern of lernding is reported to have moved in favor of smaller projects. The disappointing response to some of these programs reflects the familiar problems of collateral, the inability of small entrepreneurs to fulfill the requirements of feasibility studies and their reluctance to approach large banks or public institutions, particularly if these have no regional branches. As a result of its experience with the supervised credit scheme, the UP-ISSI plans to move away from loan processing towards a more purely technical assistance role in project preparation and supervision. Meanwhile, the financing schemes of private institutions are unlikely to grow significantly since the processing and supervision costs of small industry loans mean that such schemes have to be subsidized from other activities. Currently the Investment Coordination Committee of NEDA is trying to formulate a coherent government policy towards financing of small industries. 1/ 76. In the areas of BOI involvement in small- and medium-scale in- dustry, its emphasis has been on finding markets and removing institutional, rather than financial barriers. In particular its recent emphasis on the development of domestic sub-contracting and of more labor-intensive in- dustries has given new emphasis to medium-scale firms. BOI envisages the promotion of the smallest-scale firms best achieved through strong regional development authorities. As an initial support to such a development, it is currently considering the establishment of a small number of pilot demonstration projects in Northern Mindanao, including feed milling, poultry raising, fishmeal and wood products. 1/ Tha, Committee is taking steps to establish an effective role for the already existing Industrial Guarantee and Loan Fund.  ANNEX 1 Page 35 Other Developments 77. There has recently been a series of Presidential Decrees aimed at a basic reform of the credit system which, given the legal ceiling imposed on interest rates and rapid rates of inflation of recent years has increas- ingly favored speculatory money-market transactions at the expense of production credits. 1/ The reforms give the Central Bank greater discretion and control over the entire credit system. Presidential Decree No. 116 is important in amending the Usury Law to allow greater flexibility in the setting of interest rates on loans and deposits and in maintaining a reason- able relationship between the returns on long- and short-term funds. The Government has not as yet acted under this Decree. 78. With the inflationary effect of devaluation and rising domestic food prices the minimum wage was increased in 1970 from V 6 to V 8 per day. However, this rise has been more than offset for wage earners by rapidly rising consumer goods prices, especially rice. Recently the newly created Wage Commission has begun to award new minima to selected industries. So far coconut and sugar processing are the only manufacturing industries con- cerned and it is not clear how far, or on what criteria, wage awards are to develop. 2/ After the disruptive floods of July, 1972, extensive price controls were imposed on a broad range of commodities. These are now being replaced by a system of so-called socialized pricing where price controls are applied in respect only of a small number of essentials consumed by low- income families. Recent Performance of the Manufacturing Sector 79. The indications are that the performance of industry since 1969 in terms of output growth - and probably, in consequence of employment creation - has been poor. 3/ The immediate effect of the 1970 devaluation was dis- ruptive as many manufacturers were faced with a large jump in their foreign debts in Peso terms. There was a noted recovery in 1971 but further stagnation in 1972, partly as a result of the severe flooding of August, 1972. Underlying this poor performance were stagnant levels of domestic demand resulting from three poor years in agriculture, a severe decline, until the end of 1972, in real wages (in terms of purchasing power) and stagnant levels of investment. At the same time, however, new policies, particularly the exchange rate adjustment and the new incentives did succeed in contributing to output growth through a modest amount of import substitu- tion and new exports. 1/ See paras 117-119 of Main Report for a lengthier discussion of recent developments. 2/ The award of new minima to industries based in regions with lower costs of living than Manila might set a dangerous precedent. 3/ See footnote to para 6 on the unreliability of published statistics on recent growth in output.  ANNEX 1 Page 36 80. The level of industrial investment has remained stagnant in real terms since 1968. I/ This may in part be the result of poor expectations of entrepreneurs in a period of stagnant output and also of profits that have probably declined since 1969. At the same time, the devaluation and the control on capital goods imports instituted in 1970 have also probably contributed. There are indications that, as a result, capacity utilization has improved in some industries, such as textiles and some consumer electronics, to a point where new investments appear to be needed. In other industries, such as cement, steel and some chemicals, however, substantial excess capacity persists in spite of recent improvements. 81. In spite of the important contribution to structural rationalization of the Peso devaluation and the various reforms or partial reforms in other areas, tariffs and incentives policies have continued to maintain part of the bias in favor of cheap capital in recent years. Tax incentives, though given somewhat more judiciously, may prove on the whole heavier than in the 1960s whilst the recent tariff reform probably led to some increase in average levels of potential effective protection. At the same time, it is important to recognize the progress that has been made, in particular in the development of BOI capabilities, in the emergence of more realistic planning mechanisms, in export promotion 2/ and in experiments in new, "organizational" techniques of promotion. The full force of these new efforts should be seen within the next few years. 1/ The latest national accounts estimates (February 1973) give estimates of gross domestic capital formation in durable equipment which allow the isolation of gross domestic capital formation in non-electrical machinery (except power-generating, agricultural, construction, mining, air-conditioning and refrigerating machinery) as follows (in constant 1967 prices): 1967: P 765 m. 1968: P 934 m. 1969: P 897 m. 1970: P 980 m. 1971: P 985 m. 1972: P 871 m. 2/ The introduction of incentives encouraging use of labor and domestic raw materials is noteworthy.  ANNEX 1 Page 37 V. THE OUTLOOK FOR MANUFACTURING 82. The point has already been made in the main part of this report that the industrial growth rate will need to rise substantially in the next decade if industry is to play its part in providing employment opportunities at a time when agriculture's absorptive ability will be declining. 1/ To achieve this, the problem of demand for manufactures, which has continued to prove the crucial constraint to growth since the early 1960s, must be tackled. The elements of industrial strategy that are suggested by current developments within the Philippine economy in general and manufacturing in particular have been outlined in the main report (paras 38 to 45 of Vol I). This chapter discusses some of the important development and policy issues which this strategy raises. The Pattern of Growth 83. Exports of non-traditional manufactures offer considerable promise of providing a source of growth exogeneous to the economy; they will be important in contributing to the foreign exchange requirements of overall industrial growth and in offsetting the expected slow growth of traditional processed exports. 2/ The contribution of newer exports may prove to be limited in the next decade, not only because of their present low share in output (less than 5 percent), but also because of the problems of entry into world markets and protectionism in importing countries. Nonetheless, exports markets hold great promise for the Philippines, particularly as the 1970 Peso devaluation and recent comparative wage movements in South-East Asia have left the Philippines in a strong competitive position on labor costs. 84. For the next decade, at least, the domestic market is likely to remain crucial to the rate and pattern of growth. Here, rising levels of public investment could create substantial demand for construction materials in the coming years. A more vigorous agricultural sector, could lead, within a few years, to increased demand for agricultural inputs. A recovery in industrial investment, essential within the next two years if manufacturing is to achieve good rates of growth, would also create demand for domestic investment goods, mostly construction materials. Most of the growth in production of these investment goods would be achievable on the basis of ample existing capacity for the next few years. 85. The hoped for recovery in the level of agricultural production will be vital to industrial recovery in the short term. In the longer term, sustained growth in agriculture around 5 percent per annum, together with the hoped-for productivity increases associated with agrarian reform, could lead to a sustained growth in consumer, particularly rural, demand which would be central to the attainment of high rates of growth of industrial output. 1/ Volume 1, para 39. 2/ Mineral (nickel and copper) processing should lead to some recovery in growth of traditional exports in the second half of the 1970s.  ANNEX 1 Page 38 86. A number of BOI-related projects, presently coming on stream or in the "pipeline", should make significant foreign exchange savings if good rates of capacity utilization are achieved and start-up time is prompt. These are mostly in the category of heavy-industry intermediate goods, for instance, paper, lubricating oil and synthetic fibers. The range of remain- ing potential import substitution projects in this category is severely limited by the size of the domestic market. Petrochemicals and steel, for instance, would be import-substitutable only at the price of high costs for customer industries. However expansion in the domestic market could, by the late 1970s, be sufficient for the reconsideration of some heavier import-substituting investments. 1/ Import substitution in engineering goods is significant for its potential long-term role in industrial development, rather than the effect on the import bill in the medium-term that is likely if import substitution in this area remains on its present selective basis. This area of government priority development, which aims to capitalize on abundant existing skills, may eventually lead to a domestic capital goods industry capable of adapting technologies in some areas of production that are appropriate to the skills and requirements of the Philippines. 2/ 87. The recent government emphasis on labor-intensity, manufactured exports and the engineering industry, together with BOI's policy to encourage a more horizontal industrial structure through sub-contracting, should have the effect of fostering the medium-scale, and possibly the small-scale sectors of industry in the next decade. Its most important consequence should be in broadening the present narrow entrepreneurial base of organized industries from the ranks of the numerous existing entrepreneurs in the small-scale and unorganized sectors. In addition, the increasing emphasis on regional dispersal should foster regional growth poles. In the longer term, the growth of rural demand for manufactures could lead to a growth in small-scale, rurally- based industries. 3/ Very little is at present known about this sector but it is feasible that, with the protection element of transport costs from major industrial centers, it could produce some goods such as apparel, furniture, some housing materials and household items at competitive levels. 4/ 88. The table below represents broad Mission estimates of the growth of output for the rest of the 1970s that could arise from the broad industrial 1/ Such investments could even be made viable before this period if the Association of South East Asian Nations (ASEAN) makes sufficient progress in industrial cooperation. 2/ Several examples of such adaptations already exist. For instance, many textile firms in recent years, unable to import all their machinery requirements, widened their looms with the help of local engineering firms. 3/ The BOI is also engaged i., promoting agro-processing activities (to serve urban, as well as rural, consumers) in such enterprises. 4/ The development of a domestic engineering industry could be important providing such industry with appropriately cheap and simple machinery.  ANNEX 1 Page 39 strategy outlined in the main report and discussed in the preceding para- graphs. It does not aim to provide an accurate forecast, rather to identify the relative importance of major sectors. It is unlikely that real growth in manufacturing NDP could exceed 7 percent per annum over the rest of the 1970s without a substantial increase in the rate of growth either in domestic consumption or in exports. By way of illustration, the raising of the growth rate by one percentage point could be achieved, pari passu by an almost 7 per- cent annual growth in consumer goods production alone, or an annual growth of just over 30 percent non-traditional manufactured exports alone.1/ For the 1980s these two elements will continue to be crucial to high rates or growrn. Possible Elements of Real Growth in Manufacturing NDP, 1972-1980 (percent) Share in Share Incremer.t Growth Rate 1972 1980 1972-80 per annum Exports: traditional 9 6 2 2 non-traditional 3 7 13 20 Consumer goods /a 76 68 55 5 Investment goods /b 12 15 20 11 Import substitution /c - 4 10 - Total/average 100 100 100 7 /a Includes estimate of unorganized sector production. /b Agricultural inputs, construction materials in public and industrial investment and capital equipment. /c The value of net import savings from new import-substituting projects coming on stream after 1972. (Table 20, setting out major BOI investment areas, gives some indication of the main areas of import substitution). 89. It is likely that any structural change towards smaller, more labor-intensive industries will have at best a marginal affect on the rate of employment creation during the remainder of the 1970s. If output grows at 7 percent, it is difficult therefore, to expect employment growth to surpass 3 percent per annum. Even with a policy environment more conducive to productivity increases than in the 1960s, organized sector employment could grow by 5-1/2 percent per annum. However, as the estimated magnitudes below suggest, based on output estimates in the previous table, this would be offset by far slower growth in unorganized employment. Manufacturing would be unlikely to play a much larger role in employment creation than it did in the 1960s unless the development of rural incomes in the later 1/ Of course non-traditional exports start from such a lcw base that high growth rates are not unrealistic.  ANNEX 1 Page 40 1970s were to sustain some growth in local industries. If a greater con- tribution to employment creation is to be made in the 1980s, higher output growth is essential. However, even this will lead only to a limited improve- ment in contribution if changes in the structure of output do not come about. For example, 9 percent per annum growth in manufacturing output in the 1980s might create little more than two-thirds of a million jobs - or just over one-tenth of the expected increment in the labor force during the decade - if growth continues to be monopolized by a capital-intensive modern sector. For this reason, the ability of rural income growth to create rural off-farm jobs could be crucial, not only in creating employment, but also in mitigating the iacreased rural-urban migration that could accompany a decline in agriculture's ability to create jobs. Possible Elements in Manufacturing Employment Growth, 1972-80 Share (%) Increment Share in Growth 1972 1980 1972-80 (000) Increase (%) p-a Organized 30 35-40 175-225 60-75 4.5-5.5 Unorganized 70 60-65 70-130 25-40 0.8-1.5 Total 100 100 250-350 100 2.2-2.8 The Policy Issues 90. Since the Government remains firmly committed to private enter- prise for industrial development, its ability to plan and control the flow of resources in industry will be vital to the pursuit of a coherent strategy. The BOI's new sectoral planning concept should provide a more realistic approach than has so far existed in industrial planning and should lend to a better understanding of the constraints. The content of these sector plans is not yet clear. To make such plans more than studies of market demand, a formal framework could usefully be established to cover, for example, industry structure, prices, required levels of protection and technology profile (e.g. excess capacity, obsolescence, scope for engineer- ing improvements) and to subject identifiable projects to calculation of economic rates of return. The present method of selection of areas for sector planning is seemingly based on "rule-of-thumb" perceptions of priorities.  ANNEX I Page 41 91. The Government's ability to implement plans may still be compromised by the prevailing system of tariff, tax, and interest rate incentives. In spite of the Peso devaluation, these still apparently result in a situation where, since the overcrowded industry control remains in force, the government still fears over-investment in many areas. If this control is to be temporarily continued, its effectiveness could be improved. Firstly, closer government supervision of investment outside of BOI review could help determine whether this control is being abused. Secondly, a more flexible approach to the control may prove necessary if industrial investment is to recover in the next two years: at present an industry may be deemed "overcrowded" even though domestic demand might be sufficient to provide for a better level of capacity utilization. 1/ Thirdly, the control could be supplemented by a more active Government role in determining the extent to which presently idle plant is capable, with or without major engineering alterations, of being put back into viable use and in providing programs which could then assure the resuscitation of viable equipment. 2/ 92. In general, however, the Government wishes to move in the direction of greater guidance of industry, rather than of direct controls. A more fundamental solution to problems of excessive or uneconomic investments is related to reform in tariffs, incentives and the cost of capital. The recent tariff reform did little to change the problem of generally high, but ex- tremely disparate levels of protection. However, future reforms are not ruled out. Sector planning may well provide the initial framework for considering the long-term problems that basic reforms might involve. Over- night abolition of all the higher levels of protection would clearly disrupt the present industrial structure. Therefore, a meaningful reform would probably have to proceed according to a pre-announced timetable which would move in time the process of obsolescence and replacement of installed equip- ment and give adequate notice to entrepreneurs. 3/ Reform could eventually obviate many investment and export incentives. In the absence of reform, one possibility of mitigating the cheap capital problem would consist in a moderate rise in the tariff on capital goods from the present typical level of 10 percent, say to 20 percent. This could at the margin at least, provide incentives for fuller capacity utilization, increase the relative attractive- ness of labor intensive industries and techniques, and lengthen the economic 1/ This was recently found by the Government to be the case in the "overcrowded" meat processing industry where the largest firm was inactive for financial reasons. 2/ For instance, such equipment might be leased to existing producers. 3/ A draft congressional tariff bill of February, 1972, with which the 1973 reform has many similarities, in fact designated many high rates (typically for consumer goods) as protective and stipulated that they last for no more than 10 years.  ANNEX 1 Page 42 life of existing machinery. 1/ In addition, the existing tariff structure would be more effective if the often prohibitive levels of protection against luxury imports were complemented with high sales taxes that would discourage protected domestic production. 2/ 93. Investment incentives continue to be amongst the strongest in Southeast Asia. They have proven excessive in some cases. They have led to subsidized uneconomic investments in others and they continue to exercise a bias in favor of capital-intensive industries and techniques. Particularly in the case of foreign investors, incentives may well be redundant. 3/ There would seem to be a case for a continuing review, not only of the general level of all investment incentives, but also of the number of industries qualifying. Tt may become increasingly the case that D,OI, acting within the constraints of present legislation, would extend incentives to industries, as has been the case with textiles, simply as a means of exercising some control over investments, rather than to encourage investment which might not otherwise have been forthcoming. In such cases there might be room for an intermediate stage of control where investment is sanctioned but given no or few incentives. 4/ 94. Reforms in the area of credit and interest-rate policy could contribute not only to a more correct pricing of capital but also to the spread of the industrial base among a broader circle of entrepreneurs. Some of the recent steps taken in credit policy have laid the groundwork for such a reform. 95. Apart from general problems of incentive and tariff levels that have already been touched on, the export drive raises several important issues. The medium term can be seen, broadly, as a period of experimentation to which inevitable mistakes and costs will be attached. The later 1970s 1/ In this case, it would be imperative to reduce the level of incentives in order not to increase their relative incidence. A moderate rise in the capital goods tariff would also provide a not-excessive level of protection that could foster some capital goods production-in areas that have not necessarily been designated for BOI priority. 2/ The Government could also usefully reconsider the tariff protection of up to 50 percent it can allow pioneer projects. It is probable that most projects requiring anything more than temporary - say five-year - protection of th-s nature do not make an efficient use of resources. 3/ A growing body of literature contends that tax concessions play little part in foreign companies' decisions to invest in a given country. 4/ In the case of the automobile industry, control over investment levels (and new entrants) is indeed exercised indirectly by the Central Bank's allocation of quotas for import of CKD packs for assembly.  A2NEX 1 Page 43 should provide a useful point, once exports have developed more stable patterns and the competitive strength of various products becomes more obvious, at which the level and coverage of incentives can be reconsidered. Meanwhile, it is not too early to attempt to focus, as the BOI is indeed doing, on specific areas promising the highest returns. In particular, recent experience suggests that sustained growth in exports will depend heavily on export-specific investments in the next few years in products, such as garmets and electronics, showing the greatest potential. The Export Processing Zone will be instrumental in this. It might, however, prove inadvisable to proceed in the construction of further such zones until the costs and benefits of this one are properly evaluated. Export marketing will remain a problem in the medium term that must be met with experimentation. A significant public effort in this domain should await the outcome of the UNDP/UNCTAD study. If ASEAN is to produce any results in terms of intra-regional trade agreements, this front needs to be tackled immediately before the industrialization efforts of its member countries are too far advanced to accommodate any significant intra-regional specialization. It is probably true that the quickest returns in foreign marketing are still to be made through foreign investments, joint ventures and sub-contracting. 96. A.basic issue in export promotion is the role that exports of mis- cellaneous products, which have so far been at the center of the export drive, should play relative to exports of processed domestic raw materials. The comparative advantage of the latter, based on a combination of domestic raw materials and low wages, may prove more durable than that from low wages alone. Hence more urgent attention might usefully be given, for instance, to upgrading more wood products (into pulp, plywood and construction materials), 1/ copper products 2/ and processed foods. To pursue this, the Government would need not only to become more active in project identifica- tion, but also in removing some of the constraints to production in the primary sector. 3/ 97. The initial issue in the development of the engineering industry is that of feasibility. As the Government is well aware, the promotion of engineering needs to be highly selective, given the complexity and scale requirements of engineering production. The economic cost of both import substitution and exporting needs to be established far more rigorously than 1/ Higher rates of utilization of wood wastes could make wood exports more competitive. 2/ A copper smelter, due on stream in 1977, will represent an initial stage of upgrading which could in turn lead to production of copper metal products such as pipes. 3/ Infrastructure is a major constraint. The major constraint in processed goods is availability and price fluctuations.  ANNEX 1 Page 44 was the case with the PCMP. 1/ Again, the sector plan would provide an appropriate framework within which to study costs. BOI's chosen horizontal, sub-contracting approach to engineering development will also require evaluation in the light of the experience of the automobile components and agricultural machinery programs. There is a limit to the viable areas in which small- and medium-scale industries can produce, given the lLmita- tions imposed by small-scale and by the lower engineering tolerance asso- ciated with smaller equipment. 2/ 98. The conflicting claims of intermediate metal products on the one hand and finished metal and engineering products on the other for high levels of protection will continue to provide problems in the development of the latter. A partial solution was provided by the protective tariffs imposed on selected engineering goods in the recent tariff reform (see para 70). However, this could mean that potential areas of competitive domestic production, such as spare parts for industrial machines, valves and caps and typewriters, are unlikely to develop until they become government priority areas. Viability will also depend on the domestic industry's ability to offer comparable credit terms with imports. Particularly in the case of shipbuilding, a financing program, run for instance by DBP, could prove critical to the industry's development. 99. In general terms much of the development of small- and medium- scale industry will depend on an appropriate framework of industrial incentives that tends to work less thani it has in the past in favor of larger firms. For the small- and medium-scale factory sector, which has some prospects of development in the coming Years, the provision of markets through the development of inter-firm linkages is perhaps most important whilst the provision of credit also has a role to play. 3/ In the unorganized se:tor the development of appropriate - typically low-income and rural - markets will take a longer time. The most relevant area of government action for the present would be to improve its very deficient knowledge of the sector and its potential. 4/ A knowledge of what the unorganized sector is producing, what it might be able to produce at competitive or near-competitive levels with the organized sector, and the economic cost, in terms of higher 1/ Higher costs seem a priori likely in areas where multinational enter- prises are active, given their transfer-pricing practices. 2/ There may be an argument for the development of competent public technical agencies to play an advisory role in this and other general problems such as quality control and technological adaptation. IRRI's Agricultural Engineering Department may provide a model in this respect. 3/ The problem is not merely one of credit availability but also of the capacity of small entrepreneurs to prepare projects and establish adequate accounting systems. 4/ when they become available, detailed results from the 1970 population census and 1967 and 1972 economic ensuses could provide a useful start- ing point.  ANNEX 1 Page 45 prices, that the country might be prepared to pay for the social gain of employment creation would be vital determinants of the viability of small- industry development. In the event that a potential role were envisaged for small industry, certain conflicts with other policies would need to be taken into account. For instance, in the face of the development of regional growth poles of organized industry, unorganized industry might not be able to remain competitive. Similarly, the comparatively large-scale production techniques that will be encouraged by export development in areas such as textiles and footwear may also encroach on potential areas of small- industry competitiveness. 100. A priority, in the event that the Government intends to promote the unorganized sector more vigorously, would be to consolidate the present many-sided and often conflicting efforts of public agencies in this area. At the same time it could usefully consider general policies to offset the advantages that the organized sector might continue to enjoy in terms of the cost of factor inputs. One such policy might consist in broad minimum wage exemptions. 1/ 101. There would be an additional important role for public agencies of direct involvement in the small industry sector. The most obvious task would be to encourage the flow of funds to this sector. A government guarantee fund might prove useful in mitigating the "collateral conscious- ness" of public and private lending institutions, as well, possibly, as in offsetting the high unit costs of processing small loans (but actual sub- sidized rates would not be desirable). In addition government agencies could play the role of an organizational catalyst in, for instance, fostering subcontracting arrangements, cooperatives and demonstration projects; they could provide substantial technical assistance (project preparation, credit supervision, general technical advice) and appropriate infrastructure (for instance small-scale industry estates). 1/ This is already enjoyed by NACIDA-registered enterprises.  ANNEX 1 Page 46 VI. Note on the Statistical Sonrces for Manufacturing 1. Manufacturing statistics are collected by two principal agencies. The Central Bank establishes indices of physical production, sales, employ- ment and prices. 1/ Recently these series were revised from a 1955 to a 1965 basis and, in the case of the production index, the weights were updated. The Bureau of the Census and Statistics (BCS) carried out Economic Censuses in 1961, 1967 and 1972 though results are as yet available only for 1961. 2/ In all other years since 1956, it has conducted Annual Surveys of Manufactures (ASM), covering establishments with 20 or more employees on a complete enumeration basis and those with 5 to 19 on a 1-in-10 sample basis. ASMs provide for establishments employing five or more workers series on produc- tion values, employment, investment and assets. 3/ The BCS has additionally provided ior most years sample survey estimates of total manufacturing employment in all activities, organized and unorganized in its Survey of Households (BCSSH). 4/ In addition to the BCS, the Office of Statistical Coordination and Standards (OSCAS), the arm of the National Council 5/ which prepares the national accounts, has provided separate estimates for recent years of investment in manufacturing. 6/ Inconsistencies and discontinuities in some of the series mentioned above strongly affect the interpretation of manufacturing performance in the 1960s. Output 2. There was a growing recognition by the Central Bank and by some users of its 1955-based index of physical production that the latter provided an increasingly inaccurate measure of growth in output. Recorded rates of growth were on average lower than those provided by suitably 1/ The sales index appears in the Central Bank's Annual Report, while the others appear in its Statistical Bulletin. 2! Bureau of the Cenasus and Statistics, Economic Census of the ?hilippines 1961: Manufacturing, Vol. !II, Manila, 1965. _if The most recent publication of finalized ASM data, giving detailed pro- duction data at the PSIC 4-digit level, as well as regional breakdowns, was for 1968: BCS, Annual Survey of Manufactures: 1968, Vol. VII, Manila, 1972. Since the appearance of the previous volume, TTol. VI, cove7-ing 1962, additional data on size structure and form of ownership has remained in unpublished form. _I These statistics appear in Bureau of the Census and Statistics, The BCS Survey of Households Bulletin (formerly The Philippine Statistical larveys of Households Bulletin). S/ Now the National Economic and Development Authority. -/ Unpublished.  ANNEX 1 Page 47 deflated value of output figures. Individual industries tended to exhibit annual fluctuations which seem unrealistically large. In acknowledgment of some of the problems associated with an outdated sample and weights, the Central Bank recently introduced a new 1965-based index. However, this too is associated with several problems. Firstly, a stratified sample of only 134 firms is being used and little confidence can be placed in index results at disaggregated industry levels. Some industries at the PSIC 3-digit level, such as the shoe industry are completely excluded. Secondly, whilst the sample is drawn from corporations ("organized" sector), the weights, instead of being based on the "organized" output of the ASM, are drawn from the 1965 BCS Input-Output Table which covers both organized and unorganized sectors. The index is quite sensitive to these weightings. The provisional results that have so far been obtained from the new index bear little relation to the year-by-year pattern of growth as measured either by the old index or deflated production values. Given the problems associated with both the old and new series, the index of physical production has hardly been used in assessing manufacturing performance. 3. The principal problem affecting output - and, even more, employ- ment - measurements in the ASMs relates to the degree of coverage of estab- lishments achieved and the consistency in this over time. 1/ The ASM series on total number of establishments, employment and value added reflects clear jumps, way above average rates of change, in immediate post-census years. The following table gives the growth in number of establishments and employment in the two-year periods straddling the 1961 and 1967 censuses. Growth of Establishments and Employment Around Census Years (percent) Establishments Employment 1962/1960 1968/1966 1962/1960 1968/1966 Small Establishments 18 39 -3 44 Large Establishments 16 16 16 19 All Establishments 17 33 12 23 Source: Table 1 of Annex 2. 4. The 1961 census, for which only establishment figures are available on a comparable basis, clearly suggests a significant increase in coverage over 1960. Not all this increase, especially in small firms (less than 20 employees) was maintained in the 1962 ASM. Moreover a declining tendency in the number of both small and large establishments in 1/ This problem is also met in the census. The census defines a manufacturing establishment, broadly, as a single manufacturing unit under single control "able to furnish data on its activities". Firms may wish to avoid the census or ASM to avoid disclosures which they may perceive to be harmful to their tax situation or general business operation.  ANNEX 1 Page 48 1962-66 suggests that the ASM was less than fully covering the growth of new establishments. The comparative thoroughness of the inquiries undertaken in the 1967 Census was responsible for a very large rise in the 1968 establish- ment count, especially among small firms. Since the large establishments have a greater weight in employment, and an even greater weight in output, much of the increased coverage effect becomes diluted when aggregate levels of output are considered. Given this, 1962 and 1968 provide reasonably similar years in terms of ASM coverage and, therefore, these have been taken, along with 1956, the first ASM year, as comparable reference years for the purpose of illustrating some aspects of the growth of manufacturing. 5. For national accounts purposes net value added in the "organized" sector is obtained by deducting from gross value added in the ASM an estimate for depreciation which is calculated on the basis of a ratio of depreciation to fixed assets established for each PSIC two-digit industry in connection with the 1961 census. 1/ The contribution of the "unorganized" sector is calculated by multiplying "unorganized" employment, a residual figure representing the difference between total manufacturing employment in the BCSSH and "organized" employment in the ASM, by a benchmark estimate of "unorganized" value added per employee obtained from the 1961 census. To express "unorganized" value added in current terms, a Central Bank index of wage earnings in manufacturing is used as an inflator. Given the limitations of the basic statistics, the overall method of obtaining net value added in current Pesos for organized and unorganized manufacturing is unexceptionable. However, the ASM's coverage problem may, on the one hand, distort "organized"' growth rates from year to year and, on the other, upset the calculation of the size of "unorganized" employment. 6. One problem in the national accounts resides in the method of deflating "organized" sector value added. The Index of Physical Produc- tion is the denominator and the Central Bank's Index of Sales the numerator used in the construction of a manufacturing price index. The index of sales does not underestimate output growth according to the ASM. Given this, the rate of growth of the denominator, will lead to an overstatement of the rate of price rise and ar. understatement of the growth in real output. For this reason, estimates of manufacturing growth according to the national accounts may be on the low side. 2/ For this reason the Central Bank's Wholesale Price Index of Domestic Products in Manila, which records slightly higher price rises than the national accounts deflator for the period 1962-68, has been used to deflate output in the organized sector. 1/ The methodology is set out in detail in OSCAS, Sources and Methods of Estimation for the National Accounts of the Philippines, 1971. 2/ In recent years, however, this does not seem to have been the case. The national accounts have recorded rates of growth in real output considerably higher than independent indicators, quantitative and non-quantitative, would suggest. The problem partly resides in the fact that, for recent years before the results of the ASM are tabulated, output trends can only be estimated by broad indicators such as indus- trial consumption of electricity.  ANNEX 1 Page 49 Employment 7. The problem of inconsistent coverage arises with both BCSSH and ASM employment statistics. In the period 1960-68 at least, adjusted Mission estimates (see para 4) suggest that the rate of growth of total manufacturing employment, according to the sample survey of the BCSSH, is fairly acceptable whilst the size of the labor force may be underestimated up to 10 percent. 1/ There is some concordance between ASM and BCSSH figures while the former gives the annual average growth rate for 1962-68 of paid employees as 5.4 percent, the latter, though admittedly covering a larger number of workers, gives a 5.5 percent rate for wage earners. 8. The Central Bank's employment index, which gives as detailed an industrial breakdown as the ASM, presents a radically different picture of employment growth, the average rate for 1962-68 being only 1.4 percent. Again, the outdated 1955 base must take the blame for this very low figure, although there is no weighting problem in this index. The size of the difference between Central Bank and ASM estimates is very large and requires further explanation. Meanwhile, the ASM series, corroborated as it is by the BCSSH, is to be preferred. Investment 9. The only detailed data on fixed capital formation in manufacturing come from censuses and ASMs. However, a separately derived figure for total fixed capital formation in manufacturing has been provided in national accounts estimates. ASM investment figures are far smaller as the following figures show. 2/ Investment in Manufacturing According to ASM and National Accounts (Million Pesos) National 1 as percent ASM Accounts of 2 1965 393 1,264 31 1966 572 1,277 45 1968 656 1,864 35 1969 770 1,865 41 1970 1,273 2,554 50 1/ Problems of coverage associated with the BCSSH are discussed in the technical note on employment in the statistical Appendix (Volume III of this report). 2/ ASM investment only covers "organized" industry but investment outside this sector is a very small part of the total.  ANNEX 1 Page 50 It is probable that the national accounts method overestimates fixed capital formation as a result of apparently high mark-ups applied to the value of imported capital equipment and some double-counting of imported components subsequently assembled into capital goods. 1/ However, the degree of overestimation is probably not such as to reduce the figure by more than 40 percent at the very most. Such a correction would still leave gross fixed capital formation in manufacturing, assuming the national accounts sectoral breakdown to be in the correct proportions, anything from 50 to 100 percent in excess of the ASM figure. 10. T'here are several independent indications that ASM figures for capital formation, as well as for total assets, are on the low side. A partial comparison can be made of ASM investment with investment of BOI- registered enterprises which suggests in certain cases gross under-statements by the ASM. In 1969 for instance, total recorded ASM investment in the paper industry stood at only 38 percent of BOI-recorded investment, while for the basic metal industry the figure was 65 percent. The inclusion in the ASM of the BOI investment figure for basic metals alone would have pushed up total manufacturing investment by 23 percent. ASM investment levels also seem low in the light of data on sources of financing of fixed capital formation (Table 15). Additionally, ASM investment shows some tendency towards being insufficient to account for growth in ASM-recorded fixed assets. In the case of 6 two-digit industries in the 1960s, this is abundantly clear since the increase in assets from the beginning of 1960 to the beginning of 1969 is larger than total investment in the 9-year period 1960-68. In the most important of these, the chemical industry, assets are recorded as increasing by 1 461 million (net) while investment totalled only I 408 million (gross). 1/ See Annex B of Volume I of Current Economic Position and Prospects of the Philippines (EAP 30a), May 10, 1972.  ANNEX 1 Page 51 VII. Statistical Tables Table No. 1. Selected Indicators for Manufacturing Establishments Employing Five or More Workers, 1956 and 1960-70. 2. Value added in Manufacturing Establishments Employing Five or More Workers, 1956 and 1960-70. 3. Changes in Value Added by Industry (Establishments Employing Five or More Workers), 1962-68 4. Employment in Manufacturing Establishments with Five or More Workers, 1960-70. 5. Changes in Employment by Industry (Establishments Employing Five or More Workers), 1962-68. 6. Manufacturing Employment by Type of Worker for Selected Years. 7. A Comparison of Manufacturing Employment in 1960 According to Population Census and Survey of Manufactures. 8. Employment Structure by Size of Establishment and Industry, 1968. 9. Size Distribution of Manufacturing Establishments Employing Five or More Workers, 1962 and 1968. 10. Selected Ratios by Size of Establishment, 1962 and 1968. 11. Share of Materials, Payrolls and Gross Profits in the Output of Manufacturing Establishments Employing Five or More Workers, 1956 and 1960-70. 12. Output, Trade and Domestic Availability by Industry, 1962 and 1969. 13. -Gtowth of Output, Trade and Availability by Major Industry Group 1962-69. 14. Import and Export Dependence of Major Industries, 1965. 15. Estimated Sources of Financing of Fixed Capital Formation in Mining and Manufacturing, 1963-1970. 16. Fixed Capital Formation in Manufacturing (Establishments Employing Five or More Workers), 1956 and 1960-70. 17. Sales and Returns to Equity of the Largest Manufacturing Corporations, 1969-71.  ANNEX 1 Page 52 Table No. (contd) 18. Rates of Capacity Utilization in Selected Industries, 1965-70. 19. Capital/Output Ratios in Manufacturing Establishments Employing Five or More Workers 1960-1962 and 1968-1969. 20. Fixed Capital Cost and Employment Creation of Investments Registered by BOI up to 1971. 21. Exports of Manufactures, 1968-72. Notes to Tables n.a.: not available .. : negligible The division of manufacturing into industries follows the Philippines Standard Industrial Classification in all Tables except Tables 17 and 20 (See Table 2 for 2-digit classification).  Tahle 1 Selected Indicators for Manufacturing Establishments Employing Five or More Workers, 1956 and 1960-70 Establishmrients Payroll (Mill. Pesos) Value Added (Mill. Pesos) Employment 5-19 20 or more 5-19 20 or more 5-19 20 or more 5-19 20 or more Workers Workers Total Workers Workers Total Workers Workers Total Workers Workers Total 1956 5,375 1,833 7,208 52.6 278.5 331.1 109.2 919.7 1,028.8 54,931 150,878 205,809 1960 5,337 1,884 7,221 48.4 422.7 471.1 131.2 1,631.7 1,762.9 49,687 199,094 2)48,781 1961 8,369 2,201 10,570 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 1962 6,289 2,180 8,469 42.0 506.8 548.8 100.3 2,099.6 2,199.9 48,Oo)4 230,1469 278,)473 1963 6,664 2,219 8,833 48.5 574.2 622.7 127.6 2,610.3 2,737.9 50,255 250,128 300,393 1964 5,8)48 2,196 8,04) 52.7 643.3 696.0 161.3 2,733.2 2,894.5 50,174 266,241 316, 415 1965 5,773 2,152 7,925 56.6 709.2 765.8 167.7 2,706.2 2,873.9 50,311 273,459 323,770 1966 5,961 2,075 8,036 59.5 787.8 847.3 172.4 2,970.5 3,142.9 51,375 275,354 327,354 1967 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 1968 7,673 2,385 10,058 92.5 983.5 1,076.0 274.2 )4,236.7 4,490.4 69,205 325,131 394,336 1969 8,338 2,176 10,514 86.8 1,067.1 1,153.9 249.1 4,594.7 4,843.8 70,12)4 333,226 403,390 1970 8,340 2,156 10,496 103.2 1,193.2 1,296.4 301.1 6,0)47.1 6,348.2 70,642 333,138 403,780 1 Fixed Capital Investment Gross Output (Rill. Pesos) Fixed Assets (Mill.Pesos) (Million Pesos) 5-19 20 or more 5-19 20 or more 5-19 20 or more Workers Workers Total Workers Workers Total Workers Workers Total 1956 351.3 1,994.2 2,345.5 96.9 737.5 834.4 6.3 84.9 91.2 1960 38b.7 3,547.6 3,934.3 80.9 1,182.1 1,263.0 8.0 223.3 231.3 1961 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 1962 294.7 5,10)4.2 5,398.9 109.7 1,631.8 1,741.5 8.9 390.3 399.2 1963 373.1 6,335.2 6,708.3 108.5 2,1U.l.4 2,252.9 12.1 302.4 314.5 1964 462.0 6,961.3 7,423.3 152.2 2,419.0 2,571.2 6.6 366.7 373.3 1965 4)46.7 7,020.3 7,467.0 188.6 2,747.6 2,936.2 15.1 378.2 393.3 1966 492.o 7,713.3 8,205.9 186.2 3,149.7 3,335.9 10.9 551.2 562.1 1967 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 1968 727.8 10,553.6 11,281.4 351.1 3,977.9 4,353.0 49.1 536.o 585.1 1969 727.0 11,179.2 11,906.? 33)4.7 4,186.6 4,521.3 13.1 757.2 770.3 1970 812.2 15,074-9 1'',887.1 313.5 5,342.5 5,656.0 26.0 1,246.6 1,272.6 Source: Bureo j of the Census and Statistics, Economic Census of the Philippine. 1961: Manufacturing, Vol. IIIj Annual Svrvey of Manufactures' 1968, Vol. VII, and Preliminary Report on the BCS Annual Survey of ManufacJ 9 and 1970.  Table 2 Value Added in Manufacturing Establishments &ployng Five or More Workers,-1956 and 1960-70 (PAl lion Pesos) 1956 1960 1961 b/ 1962 1963 1964 1965 1966 1968 1969 1970 C Consumer Goods 20 Food 257.5 487.2 512.1 583.6 762.8 824.6 659.2 710.2 1,055.2 1,136.8 1,599.7 21 Beverages 98.5 135.2 146.1 159.5 20i4.2 245.8 270.2 307.1 368.3 417.6 504.4 22 Tobacco 69.5 85.0 116.8 112.1 113.2 112.1 152.1 162.4 286.2 398.0 422.5 23 Textiles 43.2 102.1 103.6 136.9 183.0 169.7 181.3 184.3 315.0 297.4 332.9 24 Apparel 60.7 66.1 55.7 64.9 75.5 75.6 79.8 83.3 106.2 102.9 124.6 26 Furniture 12.3 15.7 12.7 16.1 21.7 26.6 23.2 29.3 27.7 27.8 26.9 28 Prirntirg 33.8 61.4 61.0 62.6 84.o 91.9 118.2 104.8 129.5 138.2 160.8 29 Leather 2.9 8.2 7.1 6.4 7.0 8.1 8.8 8.6 11.2 11.2 11.1 Intermcdiate Goods 25 Wood 50.1 75.0 123.2 103.6 138.8 156.5 154.5 177.7 244.7 222.6 262.0 27 Paper 18.8 46.1 40.2 48.4 62.2 55.9 68.7 79.6 122.3 122.8 201.0 30 Rubber 8.5 56.1 81.7 78.1 78.2 92.0 82.6 101.9 127.5 127.3 191.5 31 Chemicals 91.5 172.0 202.6 200.6 230.8 293.3 321.1 385.7 535.1 562.6 811.7 32 Petroleum d/ d/ 159.7 160.7 194.4 110.4 119.5 122.8 221.1 311.6 463.6 33 Non-Metallic Minerals 42:6 64-3 79.0 91.1 113.4 139.0 156.2 164.4 229.1 234.8 248.4 34 Basic Mietals 8.6 26.7 39.4 30.5 40.2 46.6 57.5 67.4 115.5 131.1 253.2 35 aetal Products 35.1 96.8 63.5 98.0 1C6.9 118.8 131.0 152.1 199.4 220.7 155.5 39 Miscellaneous 101.9 125.7 23.6 19.6 22.6 30.4 44.5 39.8 44.1 51.9 79.3 Duirable and Capital Goods 36 Machirery 13.1 32.7 57.6 39.5 25.2 18.8 18.6 22.7 41.8 39.7 56.1 37 Electrical Machinery 8.3 54.5 46.1 91.9 122.5 133.3 119.6 127.7 147.9 155.7 226.2 38 Transpcrt 22.0 52.1 55.1 95.8 149.1 144.8 107.3 111.0 162.8 151.2 216.7 Total 978.9 1,762.9 1,986.8 2,199.9 2,737.7 2,894.2 2,873.9 3,142.8 4,490.6 4,861.9 6,348.1 a/ /alue of gross output less the total cost of raw materials, containers and fuels consumed, purchased electric energy, contract work done by others, and resale goods soldl. b/ -stablishments with 10 or more workers. cl 1970: preliminary figures. d/ Included in miscellaneous. Source: Bureau of the Census and Statisttes, Economic Census of the Philippines, 1961: Manufacturmn', .o1. I,1, Annual Survey of Manufactures: 1968, Vol. VII, and Preliminary Report on the BCS Annual Survey of Manufact r ;; 1970.  ANNEX 1 Table 3 Changes in Value Added by Industry (Establishments Employing Five or More Workers), 1-962 - 1968 (Percent) Distribution Share Average Growth Qf Value Added in Growth Per Annum 1962 1968 1962 - 1968 1962 - 1968 Consumer Goods 54.2 51.2 50.5 12.4 Food 28.1 23.5 20.6 10.4 Beverages 7.7 8.2 9.1 15.0 Tobacco 5.2 6.4 7.6 16.9 Textiles 6.2 7.0 7.8 14.9 Apparel 3.0 2.4 1.8 8.6 Furniture 0.7 0.6 0.5 9.5 Printing 3.0 2.9 2.9 12.9 Leather 0.3 0.2 0.2 9.8 Intermediate Goods 37.1 40.9 44.1 14.2 Wood 4.6 5.4 6.2 15.4 Paper 2.2 2.7 3.2 16.8 Rubber 3.6 2.8 2.2 8.5 Chemicals 9.2 12.0 14.7 17.8 Petroleum 6.9 4.9 2.6 5.5 Non-metallic Minerals 4.3 5.1 6.0 16.6 Basic Metals 1.4 2.6 3.7 24.0 Metal Products 4.0 4.4 4.4 12.6 Miscellaneous 0.9 1.0 1.1 14.5 Durable and Capacity Goods 8.7 7.9 5.4 7.6 Machinery 1.8 1.0 0.1 1.0 Electricity Machinery 3.6 3.3 2T4 8.3 Transport 3.3 3.6 2.9 9.3 Total 100,0 100.0 100.0 12.7 Source: Table 2.  Table 14 Employment in Manufacturing Establishments With Five or More Workers, 1960-1970 bl Inidustry 1960 1961 1962 1963 1964 1965 1966 196U 1969 1970 2onsumer Goods Food 41,463 55,479 64,667 66,564 65,954 69,342 67,688 83,193 82,956 85,019 Beverages 9,226 10,337 11,392 11,730 12,389 12,134 13,591 12,880 15,027 15,081 Tobacco 13,218 13,000 12,784 13,063 13,971 13,982 15,023 18,756 20,828 22,617 Textiles 24,574 29,585 30,245 34,687 35,185 33,720 36,222 46,606 47,319 46,974 Apparel 30,022 24,495 28,301 29,133 30,863 29,037 27,563 37,848 39,083 40,178 Furniture 5,630 5,217 6,031 7,520 7,575 7,829 7,228 7,962 8,288 6,876 Printing 12,073 12,984 12,703 13,140 14,307 14,726 13,972 14,828 15,344 16,011 Leather 1,512 2,087 1,559 1,740) 2,343 2,206 2,214 2,274 2,517 1,760 rntermediate Goods Wood 19,371 29,728 23,649 26,942 30,125 32,851 34,124 39,195 38,512 38,855 Paper 4,635 5,266 5,426 6,575 6,927 6,500 7,227 7,742 7,880 8,928 Rubber 4,986 6,186 5,955 6,823 6,644 6,738 7,454 9,111 8,450 8,612 Chemicals 12,685 14,695 15,387 16,290 18,375 19,767 20,897 23,202 24,046 22,774 Petroleum a/ 996 1,219 1,344 1,198 1,054 1,043 1,136 1,886 1,523 Non-Metallic Minerals 8,164 10,038 9,531 11,386 11,904 13,635 13,243 16,337 17,598 18,622 Basic Metals 3,468 5,482 4,491 5,095 4,837 4,897 5,254 8,342 9,191 10,917 Metal Products 14,454 10,522 14,110 15,606 16,760 17,699 18,139 23,401 23,139 16,197 Miscellaneous 4,773/a 5,400 4,651 5,895 6,755 6,861 6,516 7,656 7,565 8,969 L)urable and Capital Equipment Machinery 3,841 8,607 4,658 4,007 3,974 4,016 3,985 5,808 6,107 6,714 Electrical 7,476 6,163 11,060 11,007 13,927 14,066 13,014 13,080 12,261 13,488 Transport 7,210 7,686 10,652 11,836 12,402 12,710 12,957 14,974 15,393 13,565 Total 248,781 263,053 278,473 300,383 316,415 323,770 327,354 394,336 403,390 403,780 a/ Petroleum is included in Miscellaneous. b/ Establishment employirg 10 or more workers. -w.urce: Bureau of the Census and Stat.istics, Economic CRnsus of the Philippixes, 1961: Manufacturirg, Vol. III, Annual Survey of Manufactures: 1968, Vol. VII, and Preliminary Report on the BCS Annual Survey of Manufactures, 1965and 1970.  ANNEX 1 Table 5 Changes in Lmployment by Industry (Establishments EmployingFive or ?&re Workers)? 1962 - 1968 Share in Employment Distribution Growth i2~2 1968 1962 1968 1962-1968 T percent (percentu' Consumer Goods 167,582 224,347 60.4 56.9 48.9 Food 64,667 83,193 23.2 21.1 16.0 Beverages 11,392 12,880 4.1 3.3 1.3 Tobacco 12,784 18,756 4.6 4.8 5.2 Textiles 30,245 46,606 10.9 11.8 14.1 Apparel 28,301 37,848 10.2 9.6 8.2 Furniture 6,031 7,962 2.2 2.0 1.7 Printing 12,703 14,828 4.6 3.7 1.8 Leather 1,559 2,274 0.6 0.6 0.6 Intermediate Goods 84,419 136.122 30.2 34.5 44.6 Wood 23,649 39,195 8.5 10.0 13.4 Paper 5,426 7,742 1.9 2.0 2.0 Rubber 5,955 9,111 2.1 2.3 2.9 Chemicals 15,387 23,202 5.5 5.9 6.7 Petroleum 1,219 1,136 0.4 0.3 - 0.1 Non-metallic Minerals 9,531 16,337 3.4 4.1 5.8 Basic Metals 4,491 8,342 1.6 2.1 3.3 Metal Products 14,110 23,401 5.1 5.9 8.0 Miscellaneous 4,651 7,656 1.7 1.9 2.6 Durable and Capital Goods 26,372 33,862 9.6 8.6 6.5 Machinery 4,658 5,808 1.7 1.5 1.0 Electrical Machinery 11,060 13,080 4.0 3.3 1.8 Transport 10,654 14,974 3.9 3.8 3.7 Total 278,473 394,336 100.2 100.0 100.0 Source: Table 4.  Table 6 Ylanufacturing s-nployment by Type of Worker for Selected Years Employment Distribution 19L6 1960 1962 1968 .1970 1956 1960 1962 196e 1970 ('000) (percent) Survey of Manufactures Employment