Policy Reversals, Lobby Groups, and Economic Distortions

The author is Research Associate Philippine Institute for Development Studies and candidate UP School of Economics writing a dissertation on this topic. This piece was published in the Yellow Pad column of Business World, 31 May 2004 edition.

Except during the Ramos administration, the various liberalization
episodes in the country have always been marred by reversals. The
inability of the government to sustain trade reforms can be attributed
not only to the crises that have plagued the country but also to
intense lobbying by interest groups. The Marcos administration
suspended the first Tariff Reform Program (TRP) because of the 1983
crises. The Aquino administration signed Executive Order (EO) 413 in
1990 to simplify the tariff structure but it was never implemented
because of the vehement protests from domestic manufacturers. It even
led to the formation of the protectionist advocate Federation of
Philippine Industries. In 1998, the Estrada administration passed a
comprehensive tariff reform through EO 486. Barely six months after,
the opposition by local manufacturers resulted in the issuance of EO 63
to increase the tariffs on textiles, garments, and petrochemicals. The
same pattern emerged under the Arroyo administration; TRP IV,
legislated under Estrada, never really took off the ground due to
intense lobbying pressures. Consequently, tariffs were frozen from 2000
to 2001 and the twin EOs 241 and 264 were issued in 2003 to increase
tariffs on selected agricultural and manufactured products.

The Philippine Institute for Development Studies (PIDS) is currently
reestimating effective protection rates (EPRs) resulting from the
recent changes in tariffs. EPRs are more meaningful than actual tariff
rates, for they measure the net protection of value added received by
domestic producers from the protection of their outputs and the penalty
from the protection of their inputs. Preliminary results indicate that
the twin EOs did not lead to any substantial increases in both average
tariff and effective protection. However, since many of the tariff
increases were made selectively to favor particular interest groups,
the twin EOs hardly made a significant contribution in reducing our
highly dispersed tariffs. The results also indicated that the structure
of protection has remained biased for manufacturing importables as they
continue to receive higher levels of protection than exportables. The
estimates also showed that the bias for agriculture has remained as the
sector enjoys the highest average level of protection from 1998 onwards.

Though our average legal tariffs are already low, it should be noted
that economic and trade distortions associated with a tariff schedule
depend not only on the size of the tariffs but also on the dispersion
of these tariffs across all products. The more dispersion in a
country’s tariff schedule, the greater the distortions caused by
tariffs on production and consumption patterns. Firms will tend to
increase the production of those commodities protected by high tariffs
while consumers will tend to shift their consumption from products with
high tariffs to competing products with lower costs. Given the tariff
distortions, inefficient resource allocation arises that tends to favor
highly protected importables at the expense of exportables as well as
highly protected final goods at the expense of intermediate goods. The
latter encourages the production of final goods but discourages the
production of intermediate goods. This partly explains the lack of
backward linkages in our economy.

A large dispersion of tariff structure also encourages lobbying for
high protection by industry groups . Our long history of protection
shows how policy reversals are driven by vested interest groups
especially those with political clout that lobby for protection to the
goods that they produce and duty-free access to their inputs. It is not
surprising that tariffs on the products of lobby groups have remained
high while tariffs on products where there is no or small domestic
industry have been low.

The PIDS results indicated that highly protected manufacturing sectors
like food manufactures, transport equipment, and textiles performed
poorly from 1981 to 2002. Their growth remained sluggish and their
contribution to total value added even declined (see table below). On
the other hand, sectors with very little protection like machinery and
parts, electrical machinery and appliances, beverages and paper &
paper products registered faster growth and increasing contribution to
total value added. Their growth rates were also consistently higher,
even posting respectable rates during and after the Asian crisis.
Beverages and paper used to be highly protected in the past. Their
experience shows how liberalized sectors were able to survive the
transition from a protected market to a freer one.

Economic Performance of Manufacturing Sectors by Level of Protection (in percent)

Manufacturing Group
by Level of Protection
1981-85 1986-90 1991-95 1996-97 1998-02
High EPR group
Value Added average real growth rate -11.71 8.08 2.24 -0.20 0.06
Total Share in Manufacturing Value Added 57.3 43.6 48.2 45.3 45.8
Moderate EPR group
Value Added average real growth rate -4.30 5.43 0.94 3.60 -1.79
Total Share in Manufacturing Value Added 31.4 34.8 37.1 37.4 32.7
Low EPR group
Value Added average real growth rate -1.36 9.20 3.36 8.23 3.69
Total Share in Manufacturing Value Added 11.2 12.4 14.8 17.3 21.7
Manufacturing Value Added real growth rate -3.14 4.92 2.00 4.78 2.43

The above analysis strongly suggests that there is little economic
justification in providing diverse tariff protection. Engaging in
tariff reforms that do not reduce the level of dispersion of the tariff
structure will convey relatively small benefits. The government should
therefore give priority to reducing the highest tariffs. This requires
strong political will as this would involve a lot of agricultural
products. It should also raise the low rates, although this might be
more controversial particularly for intermediate and capital goods. For
revenue generation, tariffs on sin products may be raised but these
must be accompanied by equivalent taxes on domestic production.
Finally, it should simplify the tariff structure by limiting the number
of tariffs and reducing both tariff levels and dispersion. A tariff
structure that is low and has a small variance will be beneficial
especially in discouraging lobbying activities and incentives for
corruption.

If the next administration finds it inevitable for political or other
reasons to reverse its tariff policy, then it should avoid a
sector-by-sector approach as this lends itself most easily to lobbying
and selective requests for protection. Instead, a broader approach say,
an across the board increase should be adopted rather than selective
increases to individual sectors.

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