Zero sum or Win-win? The Philippines and the ASEAN Economic Community

(Published in the ECCP Business Review, 2013)

WILL THE PHILIPPINES be a winner or a loser with the advent of the ASEAN Economic Community (AEC) in 2015?

Clues that might yield a final answer to this key question can be found in two Scorecards published over the last three years by the ASEAN Secretariat based in Jakarta, Indonesia. The scorecards track the Philippines' readiness for the AEC, and those of the nine other Association of Southeast Asian Nations member states. There will be four scorecards until 2015.

So far, the Philippines did its part to ensure the free trade that underpins the AEC. It performed quite well by ASEAN integration standards in the second scorecard, this for the period 2010 to 2011.

Of the 19 categories that grade progress in this monitoring mechanism, the Philippines implemented all its targeted measures in nine categories and implemented half of the targeted measures in a further nine.

The Philippines, however, “failed” in one category—food, agriculture and forestry—where it implemented less than half of all targeted measures. Ominously, this sector has been identified by Filipino experts as one of two key problem areas (the other being manufacturing) that might suffer gravely because of ASEAN integration.

Food, agriculture and forestry includes food security; the free flow of safe and qualified products; improving competitiveness in international markets and the development of national good agriculture practices.

The Philippines’ scorecard saw it “pass” in the free flows of capital, skilled labor, and priority integration sectors; competition policy; intellectual property rights; minerals; ICT; taxation and e-commerce.

She did half of what was expected in the free flow of goods, investment and capital; consumer protection; transport; energy; SME development; initiative for ASEAN integration and external economic relations.

But these achievements fell short of those from 2008 to 2009 when the Philippines implemented all but two of the 19 targeted measures.  The laggards were the free flow of services and transport.

For 2008 to 2009, which is also described as Phase 1, the Philippines’s implementation rate stood at 94.55% as against the regional implementation rate of 86.7%. The Philippines met 91 of the 105 measures it set out to accomplish.

For 2010 to 2011 or Phase 2, the Philippines, implementation rate was 65.92% versus the ASEAN implementation rate of 56.4%.

The checkered performance for 2010 to 2011 reflects the increasingly difficult nature of the remaining integration challenges faced by the Philippines as it approaches December 2015.

ASEAN has announced an AEC Blueprint achievement rate of 80% for this period and admitted difficulty implementing the remaining 20%.

This April, President Benigno Aquino III said ASEAN’s efforts to create the single market are now in their hardest phase owing to protectionist muscle-flexing by sensitive sectors such as agriculture.

"They have finished with the easy parts but the accomplishments will not be as fast as in discussing the hard parts. When you reach that point, there can be some protectionist measures taken by each economy," Aquino said.

Among the key challenges within ASEAN identified by Aquino were creating a framework to open up the services sector, which includes banking, telecommunications, retail and insurance.

To do list

Unimplemented measures for both the Philippines and ASEAN are in trade facilitation and customs regulations; standards and conformance; services and investment liberalization; agriculture and forestry cooperation and consumer protection and transport.

The Philippines also needs to implement six measures that affect increased foreign equity and improve market-access in services and transport. A South Korean study submitted to the ASEAN Secretariat showed that the Philippines’ restrictive cabotage rule remains a major stumbling block to achieving ASEAN integration of shipping services.

The Cabotage Law of the Philippines prohibits foreign carriers from engaging in domestic coastwise trade and reserves coastwise trade for national flag carriers.

Also known as the Jones Act of 1920, the law was enacted to protect the interests of local ship owners against foreign ships. Almost a century of protection, however, has resulted in a domestic shipping industry that is effectively a cartel consisting of five shipping companies that control 90% of domestic shipping.

Critics blame the law for stunting interisland trade; contributing to the dearth of safe and well-maintained vessels; impeding the growth of local economies by fueling expensive consumer prices, undermining inclusive growth and discouraging investments that could make domestic shipping more efficient.

The National Economic Development Authority (NEDA) believes a cartel consisting of domestic shipping companies is contributing to the exorbitant cargo fees pummeling domestic shippers. NEDA also noted that domestic shipping lines have not been very efficient.

The deleterious effects of the Cabotage Law on trade can be seen in the irony that it is cheaper to ship to Hong Kong from Davao than to ship from Davao to Manila.

Arangkada, a project of the Joint Foreign Chambers of the Philippines, also noted it is cheaper to transship a container from Manila to Cagayan de Oro via Hong Kong or Kaohsiung than to ship directly from Manila to Cagayan de Oro.

It pointed out that the Philippines’ domestic shipping industry is not competitive due to the predominant use of small ships (200-300 TEU container ships compared to the more efficient 5,000 TEU foreign container ships).

The government does, however, recognize the law’s ill-effect and in 2008 formed an Anti-Cabotage Task Force (ACTF). ACTF said a massive reform or overhaul of the cabotage system will definitely benefit consumers, farmers, traders, buyers, investors, tourism operators and exporters. It noted the domestic shipping industry will also benefit since reforms will encourage more trade and business, resulting in more volume shipments.

Sen. Edgardo Angara said allowing foreign shipping firms to compete with domestic shipping can reduce the cost of transporting goods by 30%.

“This has been a long-standing issue. If we allow the foreign shipping firms to ship to different (local) ports, it will bring down or lower shipping costs by 30%.”

Angara’s views are not shared by Maritime Industry Authority (Marina) that claims local shipping is not strong enough to compete with international rivals. Administrator Vicente Suazo, Jr. said lifting the cabotage law may kill small- and medium-scale shipping operators.

"Instead, the country should continue to look for additional incentives to be given to local operators to acquire new vessels for them to be at par with their foreign counterparts," he said.

This, of course, does not make sense as it protects a few families that own shipping lines at the expense of inclusive growth, job generation and making the country more competitive. “Juan de la Cruz” continues to suffer because of the protection of a few rich families enjoying quasi monopolies. Given the Aquino Administration’s majority in both Houses of Congress, these reforms should be possible.

But there are other options: the Customs Commissioner has the power to declare more harbors as “international harbors’” that will allow international competition or international cooperation to lower shipping costs.

New and more modern vessels will be needed to facilitate the free flow of goods and investments that ASEAN has said is necessary to lower transportation and logistics costs between and within member countries.

The Philippines’ ranked 59^th in the World Bank’s 2012 Logistics Performance Index. In comparison, Singapore placed 1^st; Malaysia, 29^th, Thailand, 38^th and Indonesia 52^nd.

The index reflects assessments of a country's logistics based on efficiency of the customs clearance process, quality of trade- and transport-related infrastructure, ease of arranging competitively priced shipments and quality of logistics services, among others.

The Philippine Chamber of Commerce and Industry (PCCI) laments the constraints that lead to the high cost of logistics. Among the leading constraints is the Philippines’ inadequate infrastructure.

Opposition to ending cabotage, however, is fading. A report showing that Philippine cabotage is blocking ASEAN shipping integration could be the nail that finally shuts the coffin containing cabotage.

The report, “Formulating an ASEAN Single Shipping Market Implementing Strategy,” has identified cabotage as one of the major barriers to the Philippines’ accession to the ASEAN Single Shipping Market. It was transmitted to the ASEAN Transport Ministers meeting this June.

ASEAN this year targets the liberalization in logistics services such as maritime cargo handling services, storage and warehousing services, freight transport agency services, courier services, packaging services and customs clearance services.

The report said foreign ships calling in Philippine ports are needed in order for the Philippines to achieve sustainable growth and, more important, achieve a single ASEAN market bolstered by regional shipping integration. It also cited the lack of direct shipping services to Europe and the United States.

 “The insufficient cargo base and insufficient berth depth are some of the underlying factors for this lack of direct shipment between the Philippines and US or Europe,” it said.

Instead, shipping lines use Singapore, Malaysia, Hong Kong and Taiwan as transshipment hubs. This reliance on transshipments has led to unnecessarily longer shipping times and higher costs than under direct shipments.

Henry Schumacher, Vice President of the European Chamber of Commerce of the Philippines, noted that the European Union’s logistics industry urges ASEAN member states to liberalize the maritime transport sector by allowing international shipping companies to carry out international relays and transport international cargo.

“The industry encourages ASEAN to relax cabotage laws and allow international shipping companies to operate within domestic maritime to the benefit of local and ASEAN business,” he pointed out.

“Member countries should exercise non-discriminatory procedures in maritime trade and services with ASEAN countries.”

Schumacher said the EU’s logistic industry urges ASEAN to implement a common de minimis baseline of US$100, moving towards US$200 and the EU to implement a commercially viable de minimis baseline exempting shipments from import duties and taxes such as VAT, and any customs declarations.

“European business strongly supports the objectives of the ASEAN Logistics Roadmap and the Master Plan on ASEAN Connectivity in contributing to the ASEAN Economic Community by 2015 through liberalization and facilitation measures in logistics services and the creation of the integrated ASEAN logistics environment that includes maritime services.”

The bottom line is that to facilitate the free flow of goods and investments, AEC needs to lower transportation and logistics costs between and within member countries. Cabotage has no place in this.

The upcoming Roll-on/Roll-off (RoRo) ferry service between Davao City and Bitung, Indonesia has the potential to cut transportation costs between both ports by 5% to 10% compared to regular shipments, said the Philippine Exporters Confederation, Inc. The service is expected to begin in the third quarter of this year.

The Davao-Bitung RoRo will promote easier trade between Mindanao’s producers and markets in Indonesia. Bitung or Kota Bitung is a city on the northern coast of the island of Sulawesi. It lies some 350 nautical miles to the south of Davao City.

The direct route to Indonesia will correct absurd shipping situations such as that faced by one major food company that transports its cereals produced in Mindanao to Indonesia by first shipping these cereals to Manila, and from Manila to Singapore and from Singapore to Indonesia.

Ready or not

Cabotage is part of a larger, ongoing conversation about the Philippines’ preparedness for the AEC.  Judging from published comments by pundits, the Philippines will not be ready for the AEC by 2015.

There is near unanimous opinion that agribusiness and manufacturing—because of their uncompetitiveness—will suffer the most from the AEC’s more liberalized markets.  

The Philippines’ inability to develop or articulate a “strategic positioning goal” for itself has also come under scrutiny. Malaysia has said it wants to dominate “green technology” in the AEC; Indonesia wants more investments. And the Philippines?

But what causes the most anxiety among those fearful the Philippines will let slip the advantages offered by the AEC is a nagging perception the country remains unprepared for integration despite laudable progress to the contrary.

Rafael Alunan, former Secretary, Department of Interior and Local Government, believes “. . . the prevailing sense is that the country somehow seems unprepared to meet the competitive challenges when trade barriers are lifted to allow for the free flow of goods and services in the region.”

He noted that the business sector needs a carefully constructed environment to steel itself for the onslaught of liberalization while giving foreign competition a serious run for their money.

“Whenever ASEAN integration is taken up, the lack of preparedness and synchronicity of the government and private sector and weak state of competitiveness dominate the conversation,” he said.

Alunan sees agricultural and manufacturing sectors as the most vulnerable to ASEAN integration’s risks while BPO and tourism stand to benefit.

“Exploiting opportunities arising from ASEAN integration requires that we lessen our vulnerabilities to foreign competition and exposure to market risks.

“I’m not aware of contingency plans that aim to mitigate the risks posed by cheap products and services, and to strengthen our competitive advantage where we shine or could eventually shine.”

Romulo Virola, Secretary-General of the National Statistical Coordination Board until his retirement in 2012, said the Philippines is not yet ready to benefit from economic integration in 2015 given that we still have to focus on economic problems.

The PCCI’s leadership feels that policies need to be in place before the Philippines can truly integrate with ASEAN. Donald Dee, Vice-Chairman for Multilateral Trade, said these policies include a national single window and customs certification; mutual reciprocity agreements on export standards and a dispute settlement agency. The Philippines has to do this immediately “. . . or we will be left behind.”

The government, however, says the AEC is nothing to be scared of. Secretary of Trade Gregory Domingo told local business leaders to develop the confidence to seize opportunities.

“There are only two and half years before AEC. Do we have to panic? No,” he told PCCI members.

He reminded businessmen that integration will no longer have a significant impact on trade in commodities. Tariffs on over 99% of products traded within ASEAN were removed on January 1, 2010.

“If you’re thinking of lower tariffs because of the AEC, don’t worry. You’re already competing with other ASEAN countries.”

The downside facing the Philippine business community as regards the AEC, however, is that Filipinos have not been aggressive in taking advantage of the opportunities presented by lower tariffs, a failure Domingo said was caused by the absence of a local AEC information campaign.

The problems with agribusiness

The worst case scenario for the Philippines’ agriculture sector is a slow and painful decline at the hands of the AEC. This vulnerable sector accounts for over 10% of the Philippines’ GDP and 35% of the country’s workforce.

It’s also the chief source of the poverty bedeviling the Philippines, which has a poverty incidence of 40%. The World Bank estimates that about half of the rural population in the Philippines is poor.

A report by the University of Asia and the Pacific in 2010 identified agriculture as the main source of livelihood and income among the poor. It pointed out that developing agriculture by increasing incomes from land and non-farm jobs will have a tremendous impact on reducing poverty.

It recommended crafting a blueprint for the agriculture sector and pushed for increasing non-farm and off-farm jobs by increasing investments in food processing.

Arsenio Balisacan, NEDA Director General, said solving the huge underemployment problem in agriculture is crucial to reducing poverty and achieving “inclusive growth.”

He urged the private sector to help farmers and other agriculture workers increase demand for their products.

“Linking agricultural workers to the supply chain will increase effective demand for agricultural output and, hopefully, increase returns to their labor. However, we are aware that the agriculture sector will need to improve the quality and increase the quantity of its output,” he said.

Balisacan “. . . hopes the business sector can take on a huge role in this, perhaps through technology, additional training, equipment or others.”

Hence, the need to develop agribusiness, both as a means of making Philippine agricultural produce more competitive in the AEC and in mitigating poverty among farmers.

A turnover of PhP 123 quadrillion

ASEAN agribusiness carries massive potential economic power and the EU is proof of this. Businesses in the EU agri-food chain generate a turnover of PhP123 quadrillion (Euro 2.2 trillion) and provide direct employment to over 33 million Europeans. Taken together, the European food and drink industry is the largest manufacturing sector in the EU in terms of turnover, value added and employment.

Schumacher noted that Philippine agribusiness has a great future if built on successful models like Nestle Philippines and La Frutera, Inc.

Nestle has a long-running program that develops rural areas and communities by aiding coffee farmers and facilitates indirect and direct employment. Its 20-year old agronomy program provides access to farming technological advances; trains farmers and promotes sustainable practices.

Based in Maguindanao province, La Frutera is the Philippines' largest banana exporter. Its employees are practically all Muslim Filipinos, many of whom formerly fought against the government. La Frutera is proving that providing jobs, especially in rural areas, is the direct and sustainable way of alleviating poverty.

In ASEAN, outstanding regulatory issues are hindering development and growth. Further ASEAN agribusiness growth can be nurtured by solving issues in the regulatory arena that constrain development.

Schumacher identified some of the regulatory issues affecting ASEAN and the Philippines as tariff, taxes and non-tariff barriers; sanitary and phyto-sanitary standards and technical standards and product classification rules.

Among vital recommendations for solving these market access issues include phasing out import tariffs and non-tariff barriers over time; ensuring that ASEAN member states develop taxes and regulations that are simple, transparent and fully compliant with rules of the World Trade Organization and basing technical standards and product definitions on internationally recognized standards.

In the Philippines, agribusiness is being held in check by a dearth of locally made mechanized implements to speed-up production; limited irrigation; expensive fertilizer and the inability to combine small farms into larger farms to attain economies of scale through mechanized farming.

Manufacturing needs to resurrect

The debilitated state of Philippine manufacturing can be traced to a skewed “industrialization” over the past century that favored import substitution and exports of agricultural and forestry products having limited value-added. Coupled with high tariffs protecting factories that sold mostly to the domestic market, this “industrialization” rendered Philippine manufacturing unfit to compete in today’s globalized world.

The Philippines also didn’t develop its potential to be a major exporter and instead became dependent on remittances for much of its economic growth. Robust exports usually generate quality jobs in manufacturing and increase direct revenue for the government that overseas jobs cannot.

Arangkada gave this sober assessment on the state of manufacturing in a recent report:

“Domestic manufacturing has never faced more challenges to survival than today, such as high business costs, low import duties and extensive technical smuggling. As long as smuggling provides better profits than manufacturers, the economy will be one of traders and smugglers.”

Compounding these drawbacks is the absence of a national policy identifying manufacturing as a key component of economic development. There is also no national industrial master plan while funding for overseas trade and investment promotions remains puny.

More than a year ago, the Department of Trade and Industry asked industry sectors to prepare roadmaps to growth. Almost 40 were submitted, according to sources. These roadmaps, however, have not been made public and the Philippine Institute of Development Studies (PIDS), the government think tank, is said to be still drafting a strategy on the basis of these roadmaps.

The “Arangkada” team recently held focus group discussions on manufacturing, trying to zero in on five industries with the potential of employing a large number of people and five issues per industry that need to be addressed to make the selected industries grow.

The identified industries are garments/footwear; food/ agriculture; shipbuilding; electronics and automotive/aviation. Some of the issues hindering the growth of these industries are the inflexible Labor Code; unrealistic minimum wages; the need for domestic-market oriented industrial zones (managed by the Philippine Export Zone Authority); inadequate infrastructure and the excessively high cost of power and domestic transportation.

Despite manufacturing’s weakness, Balisacan said that the country must continue planting the seeds of a structural transformation of the economy to make it more industry and investment-led.

Infrastructure is the key

Former Budget Secretary Benjamin Diokno is pushing for more spending in public infrastructure to revive the manufacturing sector, which plays a key role in job creation.

"The message is clear. The best way to prepare for ASEAN integration is by making the Philippines stronger domestically. We have to ramp-up public infrastructure spending," Diokno said.

Diokno emphasized that the cost of financing is at historic lows. If projects are rolled out now, the Philippines can build more for cheaper.

"We will be stronger and ready to march forward with the rest of the world. That’s when we will benefit fully from ASEAN integration.”

To the Philippines’ advantage, public spending on infrastructure by the Aquino Administration is now robust, overturning a contraction in 2011. Spending surged in the first four months of this year to P75.2 billion, up a huge 45% from P52 billion year-on-year.

Infrastructure spending from January to April went mostly to covered road projects of the Department of Public Works and Highways; the construction of irrigation systems, classrooms and other educational facilities and hospitals and health centers.

“Through our budget reforms and, consequently, the improved quality of public spending, we were able to fill out crucial resource-and-supply gaps that may have affected the country’s fast-growing industries,” said Budget Secretary Florencio Abad.

The higher spending is closing the Philippines’ gap with other AEC member states. The Philippines last year invested 3% of its gross domestic product in infrastructure compared to the previous 2%. Average government spending on infrastructure in Southeast Asia, however, stands at 5%.

The aggressive infrastructure investments could help eliminate the poor infrastructure that remains one of the major causes of the Philippines’ inability to draw more foreign direct investments of FDIs.

The Philippines received a trickle of FDIs from 2001 to 2011. In these 11 years, only US$16.7 billion in FDIs flowed into the Philippines. In contrast, Thailand took in US$77.8 billion; Indonesia, US$64.7 billion; Malaysia, US$58.2 billion and Vietnam, US$49.4 billion.

In 2011 alone, the first full year of the Aquino administration, total FDI inflows were a miniscule US$1.3 billion. In this same year, Indonesia attracted US$18.2 billion; Malaysia, US$16.6 billion; Thailand, US$9.6 billion and Vietnam, US$7.4 billion.

The Asian Development Bank said the Philippines needs to target infrastructure spending equivalent to 7% or 8% of GDP to compete head-to-head against its neighbors in cornering FDIs. The World Bank suggested the Philippines increase its public infrastructure spending gradually, to reach 5% of GDP by 2016.

Like the European Economic Community on which it’s modeled, the ASEAN Economic Community is facing a win-win game—and so is the Philippines. It’s now a matter of the Aquino administration seeing through the remaining tough economic and political reforms that will ensure the Philippines win-wins in the face of entrenched monopolies; misguided nationalism and political meddling.

The only other alternative to the Win-win game now being played is the more lethal Zero sum game—and this is a game the Philippines can’t win, and shouldn’t be playing.