Import Substitution and Trade Liberalization Strategies
In its quest for industrialization, the postwar Philippine economy adopted a complex array of protective policies through high tariffs, quantitative restrictions and regulatory controls on prices, domestic supply, and market entry. However, after more than three decades of protectionism and import substitution, the policies failed to provide an efficient mechanism for allocating domestic resources in the economy.
Beginning in the 1980s, the Philippine government was prompted to implement policy reforms consistent with the requirements of a competitive market environment. Manufacturing was liberalized by removing tariff and non-tariff barriers. Foreign investment rules were relaxed and a new Omnibus Investment Code was legislated to simplify the investment incentive system. To promote export-oriented investment, the Philippine Economic Zone Authority (PEZA) was created, along with development of the Clark and Subic military reservations into special economic zones.
Since 2004, no major unilateral tariff changes have been made; mostly the tariff reductions carried out were those covered by the ASEAN Free Trade Area-Common Effective Preferential Tariff (AFTA-CEPT) scheme along with other free trade agreements (FTAs) of the Philippines such as the Japan-Philippines, ASEAN-Korea, and the ASEAN-China.
Lack of Structural Transformation and Diversification
Despite the breadth and depth of market-oriented reforms, the impact on the growth, employment, investment, and productivity of the manufacturing industry has been limited as the performance of the overall manufacturing industry has been weak. There has been no structural transformation of the economy from agriculture to manufacturing, no rapid industrial growth led by manufacturing. Instead, as Fabella and Fabella (2012) highlighted, development progeria (premature aging) characterized the Philippine economy. This is manifested by the rise in the share of services and fall in the share of industry and manufacturing sectors.
From the 1980s up to the early 2000s, manufacturing growth was slow, with an average of 0.9 percent in the 1980s and 2.5 percent in the 1990s. Modest growth was posted in the 2000s, averaging 4.1 percent. The share of manufacturing to total industrial output remained unchanged during the same periods accounting for 28 percent of total output in the 1970s, 26 percent in the 1980s, and 24 percent in the 1990s and 2000s. In terms of employment generation, the manufacturing industry failed in creating enough employment to absorb new entrants to the labor force as its share in total employment dropped from 11 percent in the mid-1970s to 9 percent in the 2000s. The industry’s total factor productivity growth was negative from 1996 to 2006.
Table 1: Manufacturing Performance
|Indicator (average in%)|
|Value added contribution|
The Philippine export base has become less diversified as the country’s exports are largely concentrated in three product groups: electronics and other electronics, garments and textile, and machinery and transport equipment. Within these major product groups, exports are highly concentrated in low value-added and labor-intensive products sectors. These goods are considerably dependent on imported inputs and have weak backward and/or upward linkages with the rest of the manufacturing sectors.
The industrial structure has remained “hollow” or “missing” in the middle and medium enterprises have never seriously challenged the large entrenched incumbents. The linkages between small and medium enterprises (SMEs) and large enterprises have also remained weak. SMEs have continued to face competitiveness problems along with difficulties in finance and market access.
While our neighboring countries registered substantial increases in the share of industry, in the Philippines, the share of industry declined and remained stagnant in the past two decades. Due to its lackluster growth, it was services that absorbed workers moving out from agriculture and new entrants to the labor force. On the average, unemployment rate was about 7.6% during the 2005–2010 period, while underemployment remained high at 20.14% during the same period.
Lessons from the Past
After more that two decades, the growth impact of trade liberalization has been less than expected. The Asian Development Bank (2007) and the World Bank (2007) cited factors that have undermined the positive impacts of trade liberalization. These are macroeconomic instability, inadequate property rights, presence of distortions in the credit markets, and weaknesses in the larger regulatory environment and investment climate. The prolonged peso appreciation and the failure of government measures to address this inhibited much of the potential growth from a more open economy. Tight fiscal condition due to huge fiscal deficits, lack of infrastructure, and weak investor confidence arising from governance issues like corruption and political instability have constrained growth, investment, and employment generation in the country. As a result, trade liberalization did not succeed in realizing efficient reallocation of resources and helping firms and workers move to higher productivity activities and jobs.
Our experience shows that trade liberalization does not automatically lead to growth or to a competitive domestic market economy. Though imports are effective in disciplining domestic manufacturing firms, the government has an important role to play particularly in creating and maintaining a competitive environment. It needs to coordinate policies to implement trade liberalization in tandem with the necessary support measures that will address the obstacles to the entry, exit and growth of domestic firms.
Currently, firms continue to face major constraints such as poor infrastructure and logistics; lack of domestic raw material suppliers, parts and components; bureaucracy, red tape, and policy inconsistency, and lack of highly skilled workers and lengthy and non-transparent process in dealing with labor issues. To maximize gains from liberalization and economic integration, certain conditions must be present: sound investment climate, sufficiently large human capital, and absence of domestic distortions like credit constraints.
The government must substantially increase infrastructure investment spending and strengthen the institutional and regulatory environment. Supply chain gaps must also be addressed along with the development of our parts and components industries. Adjustment measures like temporary industry support measures and training and job search assistance for displaced workers are also necessary to enable firms to cope with the new operating environment.
The author is Senior Research Fellow and Acting Vice-President, Philippine Institute for Development Studies (PIDS), 106 NEDA sa Makati Building, Legaspi Village, Makati City. Email: email@example.com.