Philippine Trade Liberalization: Faith Damns, Losers can Only Weep

Jan 14, 2012

Philippine Trade Liberalization: Faith Damns, Losers can Only Weep

By Nepomuceno Malaluan

Context

Through successive tariff reform programs, the Philippines pursued a trade policy anchored on unilateral and deepening liberalization across all products.

In 1981, as part of the country’s structural adjustment program, the country commenced a tariff reform program that called for the narrowing of the tariff band from its 10% to 100% to a 10% to 50% range.  This brought down average nominal tariff rate from 42% in 1980 to about 20% by 1985.

The next comprehensive tariff reduction came in 1991. It involved phased adjustment from 1991-995 towards final rates clustered around 3%, 10%, 20% and 30% covering 95% of all tariff lines. This brought average nominal tariff from 28% down to 20% at the end of the period.

In 1995, the Philippines acceded to the World Trade Organization. Under this agreement, the Philippines bound 63% of the tariff lines to tariff ceilings generally 10 percentage points above the 1995 applied rates. It also committed to replace quantitative restrictions with tariffs.

Still, the government pursued its unilateral march towards even deeper liberalization. Its new tariff reform program initiated in 1995 aimed to achieve a uniform level of tariff of 5% by 2004. By 1997, average nominal tariff was down to 13%. In 2001, the tariff reduction schedule was modified to achieve a tariff band of 0 to 5% instead of a uniform 5%, excepting only a very limited number of sensitive agricultural products. The completion of this final target was only interrupted by a deceleration of implementation in 2002, owing to the large government deficit and pressure for protection from a number of producers.

In 2010, average nominal tariff stood at 7.02%. In terms of sectoral distribution, agriculture has average nominal tariff of 11.94%, mining has 2.28%, and manufacturing has 6.18%.

The Impact of Trade Liberalization
The initial push for trade liberalization was the assessment that the import substitution strategy failed to usher industrialization and development. The protection bias in favor of finished manufactures over raw materials, intermediate goods and capital goods was seen to have penalized exports, particularly agriculture. It also encouraged production of consumer goods over intermediate goods and capital goods.

Thus, the 1981 tariff reform program sought to rationalize protection towards a narrowed band to reduce tariff-induced price distortions and enhance the allocation of resources according to the country’s “comparative advantage”. This narrowing of tariff dispersion was intensified after the fall of Marcos, with ambitions toward a uniform tariff.

In addition to removing protection biases, the liberalizers also wanted to unilaterally and deeply cut tariffs. This will move domestic prices ever closer to world price, subjecting local production to competition and forcing them to improve their efficiency.

The resulting efficient allocation of resources, improved competitiveness of our products, and the gains by domestic consumers, are the country’s ticket to sustained growth and development.

In terms of concrete prediction, one example was a study done by Habito and Cororaton (2000), as summarized by Clarete (2005). The prediction was that the tariff reforms from 1995 to 2000 would result in a small decline in the number of jobs in agriculture and services, but new jobs created in manufacturing would more than compensate for such job loss.  Real GDP will increase and income distribution will improve, with the “poorest quintile income group receiving the largest share of the GDP growth”.

Clarete (2005), a leading exponent of trade liberalization, himself notes the divergence between what was predicted and actual outcomes, which we quote in relevant parts:

§  For most of the period covered by the analysis, imports exceeded exports, which meant that the country experienced a trade deficit as a result of trade liberalization. Secondly, rather than revealing a fairly diverse basket of exports from a large number of industries, as the simulation-based analysis indicated, the ex-post assessment indicates a concentration of exports in only a few industries.

§  The services sector is leading in creating jobs for the Philippine labor force. Contrary to the results obtained from simulating the effects of trade reforms using models of the Philippine economy, industry rather than making up for the observed reduction of jobs in agriculture and services in the ex-ante analysis, has turned out in this ex-post assessment of the effects of these reforms to be part of the problem. According to the results from the simulations, trade liberalization should have resulted in resources of industries rendered uncompetitive moving into those that were given a boost by lower import restrictions. However, the shares of the various manufacturing sectors to total manufacturing production barely changed, indicating that resources hardly moved.

§  In terms of per capita income, the country is not better off, as this has remained more or less unchanged, even falling slightly from $1,173 (at 1995 prices) in 1980 to $1,165 in 2001 (table 1 and figure 4). There were years when the average Filipino was worse off than in 1980, but relative to that year, when trade reforms began, the average Filipino’s standard of living has remained roughly the same.

Even the determined efforts of unilateral liberalizers to show the brighter side of the strategy cannot escape the ugly side. For instance, Cororaton and Cockburn (2005), using an integrated CGE-micro-simulation, concludes that the tariff cuts implemented between 1994 and 2000 were generally poverty-reducing. However, this is primarily through the “substantial reduction in consumer prices they engendered.” But elsewhere in their study, we also see the following:

§  Domestic producers experience reduced volume and prices for local sales

§  Volume of exports increase, but so does volume of imports

§  Total output in almost all sub-sectors decline, except for non-food manufacturing which marginally pulls up overall output.

§  Labor and capital income from agriculture declines

§  While labor and capital income from non-agriculture increases, this was pulled up by the large increase in the rate of return to capital in capital-intensive non-food manufacturing

§  Income inequality worsens

Too Aggressive for Our Own Good

To be sure, a case can be made for rationalizing differential tariff protection levels, and reducing tariffs to improve resource allocation and competitiveness. But the Philippine trade liberalization strategy and its outcomes show that such approach will not necessarily lead to the predicted results.

One error of Philippine trade liberalization is that the tariff reduction has been far too aggressive.

A look at the Philippine tariff profile in comparison to its neighboring developing countries in 2009 will show that the Philippines has made far deeper tariff reduction, especially in agriculture, with the exception of Indonesia. (See Table 1: Trade and Tariff Profiles, Select Asian Countries) To the extent that the Philippines was an early starter in unilateral liberalization, one could surmise that the difference would have even been wider in earlier years.

The trade results are also apparent. Philippines and Indonesia with their deep liberalization had far inferior trade outcomes than Thailand, Malaysia, Vietnam, and China. In terms of trade ranking, the Philippines fares the worst, not only by being the lowest ranked exporter, but also by registering an importation rank much higher than its exports ranking. The other countries show closer rankings for both exports and imports, signifying a more balanced trade.

Both the Clarete and Cororaton findings above indicate that agriculture and industry have been run to the ground by competition. Instead of industry taking off from an improving allocation of resources, resources (both capital and labor) trooped to the non-tradable services sector. Between 1985 to 2010, services has proved robust in terms of share in output, while agriculture and industry have dropped. Services is now our biggest employer, accounting for 52% of total employed in 2010. Agriculture employs 33% while industry accounts for a very low 15% of employment. (See Table 2: Percentage Distribution of GNP by Industrial Origin and Table 3: GDP and Employment, by Industrial Origin)

But another stark labor response has been to leave the country for work overseas. This was the direct outcome of jobs being destroyed and income depressed in both agriculture and industry. The contribution of Net Factor Income from Abroad in the structure of the Philippine economy from 1985 to 2010 is unmistakable. (See Table 2)         The exodus of capital and labor from agriculture and industry to services and overseas work shows that inefficiencies were not entirely induced by price distortions; other sources of inefficiencies were beyond the control of producers. These include infrastructure bottlenecks and market and government failures.

While movement in the exchange rate (peso depreciation) would have provided a price-correcting mechanism, the other unintended result of trade liberalization — labor going overseas — has prevented the price correction. On the contrary, the ever increasing remittances of overseas workers pushed the overvaluation of the peso, squeezing the tradable sectors even more.

Most Vulnerable Sectors Lose
In the thirty years of trade liberalization Philippine style, the economy has settled into its new structure.

Big capital has adjusted. If we look at the country’s 40 richest, they have all diversified away from agriculture and manufacturing into services and nontradables, particularly utilities, property, retail trade, and infrastructure.

Our overseas work force, despite challenges such as the middle-east conflict, has proven strong and has been shoring our economy and giving it resilience in the face of global crises.

Both overseas labor and gainfully employed local labor have benefited from low prices of traded goods, although they have to pay high prices for certain services, such as utilities.

But what about the losers in the process?

These are the poorest and most vulnerable segments of the population that no one bothers to look at. They are the segment of labor unable to find jobs with decent pay in the harsh conditions of competition under trade liberalization. They are the growing number of informal settlers in the cities, trying to escape non-paying agriculture. They are the large number of informal workers crowding city streets at any time of the day in search of odd jobs.

One key characteristic of this vulnerable, immobile labor segment is lack of education. By occupation, they belong to the 5.7 million farmers, forestry workers and fishermen and 11.6 million laborers and unskilled workers, in all comprising 48% of the 36 million employed. Of these, 8.6 million have education from zero to at most grade 6. (See Table 4: Employed Persons by Major Occupation by Highest Grade Completed)

These are the victims of Philippine trade liberalization.

Give Relief to Domestic Production through Tariff Adjustment
The present very low levels of tariff must be adjusted upwards to provide immediate relief to domestic production, employment and income. An across the board modest increase in tariff will recover some protection for domestic production, lift income and employment, and improve the prospects of our countrysides.

Unfortunately, the adjustment will not be without transition costs for sections of the same vulnerable sectors. The increase in prices of commodities arising from the tariff adjustment will adversely impact particularly those employed in the low-paying segment of services.

But this is where programs like the conditional cash transfers can serve as safety net, and assume greater meaning insofar as it is linked to restructuring the economy towards a more sustainable path. Also, the improvement in government revenue from the tariff increase must be used wisely by government to address the many sources of production inefficiencies, and assist in the transition.

Beyond this immediate adjustment, we must also now begin to look more favorably to a strategic and integrated industrial policy.

The Philippines need not be damned forever; there are things we can do other than weep.