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

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,, 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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