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Action for Economic Reforms

LIBERALIZATION, CURRENCY APPRECIATION AND INDUSTRIAL ADJUSTMENT

The author is a professor of economics at the Department of Economics, College of Business and Economics, and the executive director of the Angelo King Institute for Economic and Business Studies, De La Salle University.


One of the major policy developments in the Philippines during the

latter 1980s and early 1990s was the dismantling of trade barriers and

reduction of tariffs. The percentage of total import commodity lines

that were regulated dropped from 32% in 1980 and 1985 to 14.7% in 1986,

8.2% in 1990 and 2.9% in 1999 (De Dios 1997). The book tariff rates,

which had 17.5% and 9.1% of all HS (harmonized system) tariff lines in

tariff levels of 100% and 70%, respectively, in the late 1970s,


narrowed down significantly towards the 0%-50% range by the late 1980s.

Most of the tariff lines converged within the 3%-30% range by 1995 and

within the 3%-10% range by 2000. The effective rate of protection in

manufacturing using book tariff rates and inclusive of the impact of

duty drawback declined from 64.7% in 1983 to 45.5% in 1990 and 37.3% in

1995 (Medalla, 1998). The weighted effective rate of protection in

manufacturing declined from 24.3% in 1988 to 18.2% in 1995 and 15.7% in

2000; the decline for the import substituting manufacturing industries

was more drastic, from 38.4% in 1988 to 23.9% in 2000 (Medalla 1998).


The sharp drop in the incidence of non-tariff barriers and the tariff

rates especially in manufacturing has transformed the Philippines from

one of the more protectionist countries in the 1970s to one of the more

open economies by the mid-1990s among all the East Asian countries.

Trade liberalization in the Philippines occurred in tandem with the

real appreciation of the Philippine peso. Among the Southeast Asian

currencies, the peso experienced the largest appreciation during the

early 1990s. In terms of the real effective exchange rate, the peso

appreciated by 42.8% during 1991-96; in contrast, the rates of

appreciation of the baht, rupiah and ringgit were only 9.9%, 8.4% and

12%, respectively, during the same period (Hicklin, Robinson and Singh

1997).


The trade liberalization program of the Philippines during the 1980s

and the 1990s has had efficiency effects. Studies by Medalla and her

colleagues at the Philippine Institute for Development Studies (e.g.,

Medalla 1998) show that the overall efficiency of the Philippine

manufacturing sector has improved during the period. The ratio of

domestic resource cost (DRC) to the shadow exchange rate (SER)

decreased from 1.72 in 1983 to 1.54 in 1988 and 1.18 in 1994 (A DRC to

SER ratio of less than unity is indicative of economic efficiency.) The

share of efficient industries; i.e., those industries with DRC to SER

of less than unity, in terms of output increased from 18.8% in 1983 to

41.6% in 1994. (However, in terms of the number of establishments the

share of efficient firms increased only from 19.6% in 1983 to 22.4% in

1994.) The interindustry variation in effective rates of protection

narrowed; similarly, the protection incentives to capital intensive

import substituting industries were reduced. In short, the trade reform

program improved the incentive structure towards greater allocative

efficiency in the country, especially in manufacturing. (See e.g.,

Medalla 1998; Medalla, et.al., 1996.)


However, the reduction in protection meant greater vulnerability of the

manufacturing sector to a significant currency appreciation. Notice

that the share of efficient establishments was less than one-fourth of

all establishments in 1994. This implies that three- fourths of all the

establishments were vulnerable to an inconsistent policy of trade

liberalization cum currency appreciation. Perhaps, the most vulnerable

were those firms that have DRC to SER ratios of greater than 2; i.e.,

very inefficient ones. Thus, these firms and industries needed to

substantially improve their productivity in order to effectively

compete in a more open economic environment. Moreover, even the

(socially) efficient industries were also negatively impacted by the

emergence of China, Indonesia and other low-cost countries as exporters

of labor intensive light manufactures. Thus, for example, the

Philippine garment industry, particularly the domestic-oriented

subsector, reeled from increased competition from cheaper and/or better

quality imports. Even the more famous local brands for the local market

increasingly had their products manufactured abroad, especially China.


Finally, it may be noted that one of the effects of long years of

industrial protection is that, at least for the firms of multinational

firms in the country, part of the economic rent from protection was

captured by their workers through higher wages and salaries. The

general opening up of East Asian countries, as exemplified by the ASEAN

trade preferential agreement (ASEAN CEPT) and eventual AFTA, led MNCs

to rationalize their production centers in the region. That is, they

realigned their production such that certain plants manufactured

products for the whole region (or subregion) rather than for one

country only. Because of this, a number of MNCs relocated their

production from the Philippines to other countries which have more

recent, and hence more modern, plants and/or cheaper labor costs.


The reduction in tariffs together with currency appreciation could have

been offset by sharper rise in labor productivity in the country

relative to competitor countries. However, manufacturing labor

productivity barely increased during the 1980s and early 1990s in sharp

contrast to Indonesia, China, Thailand, Singapore and Malaysia. In

addition, both the rupiah and the yuan depreciated in real terms

relative to the peso during the period. In contrast, wage increases in

the Philippines in the late 1980s and early 1990s were greater than

labor productivity growth.


The changed internal and external environment facing Philippine

manufacturing required the restructuring of the sector. For the most

part, this involved the shift toward the more skilled labor intensive

(but capital intensive) industries such as electronics or niches in the

industries. Thus, the virtual creation of a new industry centering

around primarily assembly of semiconductors and computer parts

propelled by MNC investments in the country’s export zones or

industrial estates. Similarly, the Philippine furniture industry has

increasingly relied on design strengths rather than cheap price for its

export drive. It is apparent that, in view of the comparatively high

wages and skill composition of Philippine labor, it is in semi-skilled

labor intensive goods and services where the Philippines has emerging

comparative advantage.


Statistical data on average growth rates of the various manufacturing

industries highlights the contrasting output effect of industrial

restructuring in the face of trade liberalization and currency

appreciation. Thus, for example, textile manufacturing registered

substantial output declines during the 1990s. The decline of the

Philippine textile industry may have increased the vulnerability of the

country’s (footwear and) wearing apparel industry to cutthroat

competition in the domestic market in periods of recession: the level

of output of the footwear and wearing apparel industry in 1999 was

virtually the same as in 1990. Both the rubber products industry and

the wood and cork industry – two industries where domestic resource

constraints make the Philippines less competitive vis-a-vis Malaysia

and Indonesia – suffered significant output declines during the period.


The industry that registered sharp output increase during the period

was electrical machinery industry primarily because of the

semiconductor and computer parts investments of mostly MNCs into the

country. Three other industries registered relatively robust growth

that further hint at the ongoing industrial restructuring process in

the country; i.e., food manufacturing (which can be expected in view of

the still large share of agriculture in the Philippine economy and the

high population growth rate), non-electrical machinery and

miscellaneous manufacturing.


In short, the overriding picture of Philippine manufacturing during the

latter 1980s and the 1990s was one of an extremely mixed performance of

the manufacturing industry. This appears to indicate a difficult

industrial restructuring process in the country against a backdrop of a

volatile macroeconomy. The net result is that manufacturing employment

as a share of total employment declined secularly during the 1990s,

from 10.65% in 1992 to 9.58% in 1999. Indeed, manufacturing contributed

only 4.6% to the increase in the total number of employed persons

during 1992-1999.

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