Philippines - Managing global integration (Vol. 2 of 2) : Background Papers

Report No. 17024-PH Philippines Managing Global Integration (In Two Volumes) Volurne I11i Background Ppeir,,rs November 17, 1997 Povertv ReduCtion arld Ecotnormyii: Management .(( tor Ufnit East Asia- anm Ilacifi( Regionnal ()ftie Document of the World Bank  CURRENCY EQUIVALENTS (As of November 17, 1997) Currency Unit Peso $1.00 = 34.05 pesos 1.00 peso = $0.029 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System Vice President Jean-Michel Severino, EAP Country Director Vinay K. Bhargava, EACPF Sector Manager (Acting) Pieter Bottelier, EASPR Staff Member Sanjay Dhar, Principal Economist, EASPR  CONTENTS Acronyms and Abbreviations ...................................................... vii 1. ISSUES IN GLOBAL INTEGRATION AND COMPETITIVENESS ..................1 A. Introduction .......................................................1 B. The Dynamics of Global Integration-A Comparative Perspective ...................2 C. The Competitiveness of the Philippines as a Location for FDI ..........................8 D. The Labor Market and Export Competitiveness ............................................... 11 2. ISSUES IN MANUFACTURED EXPORT DEVELOPMENT .. 23 A. Introduction ...................................................... 23 B. Export Patterns ...................................................... 24 C. Major Export Products ...................................................... 34 D. Main Deterrninants of Competitiveness ...................................................... 41 E. Institutional Framework for Export Development ............................................ 55 F. Policy Implications ...................................................... 57 3. ROLE OF ECONOMIC ZONES IN THE PHIILIPPINES' EXPORT COMPETITIVENESS ....................................................... 61 A. Introduction ...................................................... 61 B. International Economic Zone Concepts and Trends ......................................... 62 C. Comparative Analysis of Economic Performance ............................................ 68 D. Future Role of Economic Zones ...................................................... 97 Annex 1: The Long-Termn Evolution of the Philippine Economy . ........................ 105 Annex 2: Export Prospects of Key Sectors: Semiconductors and Garments . .11............... I References ......................................................1 119 TABLES Table 1.1: Macroeconomic Trends, 1985-90 and 1990-95 .6 Table 1.2: Macroeconomic Performance, 1985-90 and 1990-95 .7 Table 1.3: Weighted Average MFN Tariff Rates for Large Developing Countries .8 Table 1.4: Prevailing Wage Levels, 1996 .9 Table 1.5: Relative Infrastructure Costs, 1996 .10 Table 1.6: Relative Transport and Communication Costs, 1996 .10 Table 1.7: Philippine Labor Market-Aggregate Characteristics .13 Table 1.8: Philippine Labor Market-Sectoral Characteristics .15  iv Contents Table 1.9: Unit Labor Cost Indexes in Manufacturing in Selected Countries, 1986-95 .......................................................... 17 Table 1.10: Unit Labor Costs in the Philippines, 1991-95 ............................................... 18 Table 1.11: Unit Labor Cost Indexes for Selected Tradable Subsectors ......................... 19 Table 1.12: Nonagricultural Index of Compensation ....................................................... 20 Table 1.13: Productivity Index ........................................................... 21 Table 2.1: Comparative Export Performance, 1980-95 .24 Table 2.2: Philippines' Manufactured Export Performance, 1991-96 .25 Table 2.3: Top 30 Manufactured Exports from the Philippines .27 Table 2.4: Technological Basis of Competitive Advantage .28 Table 2.5: Fastest Growing 50 Manufactures in World Trade .29 Table 2.6: Distribution of Manufactured Exports by Technological Categories (%) .30 Table 2.7: Market Positioning Classification .32 Table 2.8: Market Positioning of Manufactured Exports, 1990-95 .32 Table 2.9: Philippine Revealed Comparative Advantage in Manufactured Exports .33 Table 2.10: Values and Growth of Textile and Garment Exports, 1990-95 .34 Table 2.11: Top 25 Exporters of Garments to OECD .35 Table 2.12: Annual FDI Inflows .......................................................... 41 Table 2.13: Structure and Effectiveness of Selected Investment Promotion Bodies ....... 43 Table 2.14: Educational Enrollments (Latest Available Year) ........................................ 47 Table 2.15: R&D Employment and Expenditures .......................................................... 50 Table 3.1: Growth in Export Processing Zone Activity Worldwide .63 Table 3.2: EPZ Regulatory Bodies .67 Table 3.3: Economic Performance of the Philippine Ecozones, 1986-96 .69 Table 3.4: Economic Impact of Various Zone Programs, 1996 .70 Table 3.5: Labor Intensity of Ecozone Operations .73 Table 3.6: Comparative Export Performance Indicators .74 Table 3.7: Composition of Net Present Value of the Philippine EPZs .77 Table 3.8: Comparison of Philippine Ecozone Regime and Other East Asian EPZ Programs .80 Table 3.9: Comparison of Incentives Available Under Various Programs in the Philippines .88 Table 3.10: Powers and Functions of Selected EPZ Regulatory Bodies ......................... 91 Table 3.11: Cost Competitiveness of the Philippine Ecozones, 1996 .96  Contents v BOXES Box 2.1: Singapore's Industrial Training System ............................................................ 49 Box 2.2: Technology Promotion by Korea ............................................................. 52 Box 2.3: Reforming the Indian Council of Scientific and Industrial Research ................. 54 Box 3.1: Changing EPZ Concept in Asia ............................................................ 64 Box 3.2: Prohibited and Actionable Subsidies Under the Uruguay Round ....................... 65 Box 3.3: Advantages of Using US Foreign Trade Zones .................................................. 99 Box 3.4: Examples of Perforrnance-Based Incentives ..................................................... 100 FIGURES Figure 1.1: Key Features of the Philippines' Economic Integration, 1985-96 .................. 3 Figure 1.2: Financial Market Developments ............................................................ 5 Figure 1.3: Real Minimum and Average Monthly Wages .............................................. 14 Figure 1.4: Unit Labor Cost Indexes ............................................................. 18 Figure 1.5: Unit Labor Cost Indexes-Export Sectors ................................................... 19 Figure 1.6: Unit Labor Cost Indexes for Selected Tradable Subsectors ......................... 20 Figure 1.7: Index of Compensation-Export Sectors ..................................................... 20 Figure 1.8: Productivity Index-Export Sectors ............................................................. 21 Figure 2.1: Shares of Technologically Complex and High-Technology Products in Total Manufactured Exports, 1995 ............................................................. 31 Figure 2.2: Value of Technologically Complex and High-Technology Exports, 1995 ..31 Figure 2.3: Hourly Labor Costs in the Apparel Industry ($) ........................................... 36 Figure 2.4: Share of Cumulative FDI in ASEAN, 1987-94 (%) ..................................... 42 Figure 3.1: Ecozone Exports and Investment Approvals, 1986-96 ................................. 69 Figure 3.2: Nunber of Ecozone Registered Firms (Annual Growth Rate) ..................... 71 Figure 3.3: Cumulative Investment by Product Group, 1996 ......................................... 72 Figure 3.4: Ecozone Employment Rates ............................................................ 72 Figure 3.5: Enclave Approach to EPZ Economic Analysis ............................................. 75   Acronyms andAbbreviations vii ACRONYMS AND ABBREVIATIONS BAP - Bankers' Association of the Philippines BCDA - Bases Conversion Development Authority BOI - Board of Investments BSP - Bangko Sentral Ng Pilipinas CARP - Comprehensive Agricultural Reform Program CPU - Central Processing Unit CTRP - Comprehensive Tax Reform Package DENR - Department of Environment and Natural Resources DOLE - Department of Labor and Employment DOST - Department of Science and Technology DRAM - Dynamic Random Access Memory EDC - Export Development Council EPZA - Export Processing Zone Authority FCDU - Foreign Currency Deposit Unit FDI - Foreign Direct Investment FIAS - Foreign Investment Advisory Service GDP - Gross Domestic Product GNP - Gross National Product GOCC - Government-Owned and Controlled Corporations GOP - Government of Philippines GTAP - Global Trade Analysis Project IC - Integrated Circuits IDC - Industry Development Council IRR - Implementing Rules and Regulations LGU - Local Government Unit MFA - Multifiber Agreement MFN - Most-Favored Nation MNC - Multinational Corporation NCR - National Capital Region NG - National Government NIE - Newly Industrialized Economy NPC - National Power Corporation NTB - Nontariff Barriers OBM - Own Brand Manufacture ODA - Official Development Assistance OEM - Original Equipment Manufacture PEDP - Philippine Export Development Plan  viii Acronyms andAbbreviations PEZA - Philippine Economic Zone Authority PHILEA - Philippine Industrial Estates Association QR - Quantitative Restriction RCA - Real Comparative Advantage R&D - Research and Development RDC - Regional Development Council SFB - Standard Factory Building SITC - Standard International Trade Classification SME - Small and Medium Enterprise STAND - Science and Technology Agenda for National Development TESDA - Technical Education and Skills Development Authority ULC - Unit Labor Cost UNCTAD - United Nations Conference on Trade and Development WTO - World Trade Organization  Chapter 1. Issues in Global Integration and Competitiveness I 1. ISSUES IN GLOBAL INTEGRATION AND COMPETITIVENESS A. INTRODUCTION 1.1 One of the key trends driving developing country growth in the 1990s has been the rapid pace of global integration. Declining costs of transport and communication and falling trade barriers are leading to increasing specialization and expanding trade, encouraging multinational companies (MNCs) to organize their production on a global basis through international production and subcontracting relationships. East Asia has been at the cutting edge of these changes. MNCs have invested heavily in the region, relocating component manufacturing and assembly operations to take advantage of lower labor costs and liberal trade regimes. Strong macroeconomic performance and relative creditworthiness have also attracted substantial investment flows, enabling these countries to tap global savings on attractive terms. And increased diversification of financial portfolios globally together with capital account liberalization in developing countries have combined to attract substantial financial investment. 1.2 The purpose of this chapter is to illustrate how these global trends have influenced the growth performance of the economy and the key functions that have shaped its competitiveness. In the case of the Philippines, external finance has played a particularly important role in the process of integration. Private capital flows (together with substantial worker remittances) have contributed to the pool of savings available to the economy, and foreign investment has been the driving force behind much of the surge in the Philippines' manufactured exports in recent years. The recent turmoil in East Asian currency markets has underscored the volatility of private capital flows and the need to manage them carefully, particularly in the East Asian economies where private flows are so substantial in relation to GDP. This volatility has in turn highlighted the importance of an appropriate regulatory and incentive framework for the domestic financial sector. In addition, the realignment of exchange rates in the region may mean that the relative competitiveness of these countries could shift significantly relative to the situation that prevailed before the crisis, as reported in this chapter. In an environment of possibly increased uncertainty, countries that can maintain investor confidence in their capacity to enhance their competitiveness will tend to attract higher levels of foreign investment. 1.3 Section B of this chapter places the key elements of the Philippines' global integration in perspective, by comparing its evolution against that of other East Asian and developing countries. Section C evaluates the Philippines' relative position as a host for FDI, examining comparative infrastructure and labor costs within the region. The final  2 Chapter 1. Issues in Global Integration and Competitiveness topic of the chapter is an in-depth assessment of the Philippine labor market, focusing in particular on productivity, compensation and unit labor costs, and their impact on the competitiveness of tradable sectors. B. THE DYNAMics OF GLOBAL INTEGRATION-A COMPARATIVE PERSPECTIVE 1.4 One of the most important features of the pattern of economic development during the current decade has been the increasing integration of developing countries into the world economy. Developing country exports have risen more than three times faster than output growth, and net private capital flows have increased from an average of around 1 percent of developing country gross domestic product (GDP) in 1990 to around 4 percent of GDP in 1996. There has been a surge in FDI into developing countries, with MNCs building global networks of affiliates, subcontractors and other partners. As a share of gross domestic investment, FDI flows to developing countries climbed from less than 2 percent in the 1980s to over 5 percent in 1995. Similarly, the share of developing country output produced by MNCs has risen by more than half (from 3.9 percent of GDP in 1990 to 6.3 percent in 1996). Firms are taking advantage of falling trade and investment policy barriers-as well as declining transport and communication costs-to disaggregate production processes, especially in manufacturing. As a result, production processes are increasingly being organized on a global basis with MNCs increasingly oriented to worldwide export markets. 1.5 About half of net private flows to developing countries have taken the form of portfolio investment (bonds and equity finance) and commercial bank loans. This has substantially increased developing country access to foreign savings. The banking system in developing countries has played a major role in channeling these resources, as they are generally the primary intermediaries for these inflows. While the surge in investment has provided countries with new opportunities to tap global savings, high capital inflows have also presented new challenges to economic policymakers. Surges in capital inflows require careful macroeconomic management to contain consumption booms and upward pressure on real exchange rates that can undercut export competitiveness and lead to rising current account deficits. A related risk is that where financial systems are relatively weak or inadequately regulated and supervised, the increased availability of domestic credit may fuel risky investments in other financial assets or real estate. These types of investment are highly vulnerable to cyclical downturns and a correction in prices can trigger widespread losses for both the banking sector and the economy as a whole. 1.6 East Asia is at the leading edge of the increasing globalization of developing country economies (Figure 1.1). The ratio of trade to GDP in the region is nearly double the ratio for developing countries as a whole. The proportion of exports accounted for by manufactures is also higher than for developing countries as a group. But perhaps most striking is the significant impact of private capital flows on the East Asia region. Private  FIGURE 1.1: KEY FEATURES OF THE PHILIPPINES' ECONOMIC INTEGRATION, 1985-96 , Trade-to-GDP Ratio Manufactured Goods as a Ratio 5s % of Merchandise Exports 75 SE. Asia excl. Philipin 8- Philippines 70 55PhlpieG 45 - -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~5