WHITHER THE PHILIPPINE MANUFACTURING SECTOR: LOOKING BACK, WAY FORWARD

WHITHER THE PHILIPPINE MANUFACTURING SECTOR: LOOKING BACK, WAY FORWARD Ponciano S. Intal Jr. and Edward See I. INTRODUCTION The Philippine manufacturing sector is at the crossroads. On the one hand, the sector has experienced a particularly difficult adjustment period in the 1980s and especially in the 1990s. On the other hand, there is a growing realization in the business community of the need for a more concerted effort by both the government and the industrial sector to better manage the challenges of globalization and increased economic integration in the region. This paper examines the performance of the Philippine manufacturing sector: highlighting key factors behind the failure of the country s industrial deepening; and discussing key elements of the way forward for the sector in the face of increased domestic economic openness, regional economic integration, and globalization. II. THE PHILIPPINE MANUFACTURING PERFORMANCE IN REGIONAL PERSPECTIVE The Philippine manufacturing sector has the lowest share to total employment and one of the lowest shares to total output among comparator countries in the region. As Table 1 shows, the 9.0 percent share to total employment in 2003 pales in comparison to Thailand s 14.7 percent, Singapore s 17.9 percent and Malaysia s 21.6 percent. Even Vietnam and Indonesia have higher share to total employment than the Philippines. In terms of the manufacturing share to total output (gross domestic product), the Philippines ranked second to Vietnam as the lowest among the comparator countries in 2003. The Philippines ranked lowest in terms of the share of the industry sector (i.e., manufacturing plus mining plus construction) to total output in 2003. The country s share is marginally lower than Singapore, which has virtually no mining industry. Vietnam, which has the lowest manufacturing share to output, has large mining and construction industries to raise the share of the total industrial sector to twice that of the manufacturing sector. Note that China, which has a relatively low share of manufacturing employment to total employment, has in fact the highest share of manufacturing and industry to total output among the comparator countries in the region in 2003. Table 1 further highlights the relatively poor performance of the Philippine manufacturing sector in the region. In comparing the 2003 figures with the 1990 figures, the Philippines stands out as the only Southeast Asian middle income developing country whose share of manufacturing to total employment and total output declined. The rise in the share of

manufacturing to total output was particularly large for Vietnam, Thailand and Malaysia. China, which also experienced a reduction in the share of manufacturing to total employment in the 1990 to 2003 period like the Philippines, registered an 8.3 percentage points increase in the share of manufacturing to total output, which is just slightly slower than Vietnam s 8.5 percentage increase, the largest among the comparator countries in the region. Percent Share of Manufacturing Manufacturing to total employment Table 1: Key Indicators Percent Share of Manufacturing to GDP Percent Share of Industry Industry to GDP (All) Country 1990 2000 2003 1990 2000 2003 1990 2000 2003 China 13.3 11.2 12.1 37.0 43.6 45.3 41.6 50.2 52.3 South Korea 27.2 20.3 19.0 28.8 26.1 23.4 43.1 36.2 34.6 Indonesia 10.1 13.1 12.0 20.7 24.9 24.7 39.1 46.1 43.6 Malaysia 19.9 23.5 21.6 24.2 32.7 31.2 42.2 50.8 48.6 Philippines 9.7 10.1 9.0 24.8 22.2 23.1 34.5 32.3 32.6 Singapore 29.0 20.8 17.9 25.8 26.4 26.1 33.0 34.1 32.7 Thailand 10.2 14.5 14.7 27.2 33.6 35.2 37.2 42.0 44.0 Viet Nam 7.8 8.7 11.2 12.3 18.6 20.8 22.7 36.7 40.0 Source: ADB Key Indicators In addition to the Philippines and China, South Korea and Singapore also experienced declines in the share of manufacturing to total employment during the 1990 to 2003 period. The declines for Singapore and South Korea are not surprising as both countries have matured industrially with comparatively high wages and per capita income and are moving inexorably into service economies. Nonetheless, the share of manufacturing to total employment in 1990 for both Singapore and South Korea was more than 25 percent, which none of the other Southeast Asian developing countries and China have reached so far. That is, manufacturing was central to job creation in Singapore and South Korea during the early part of their industrialization drive. Note that even in 2003, the share of manufacturing to total employment in both countries remained nearly twice that of the Philippines. The decline in the share of manufacturing to total employment in China is likely the result of the ongoing streamlining of the state owned enterprises as part of the industrial restructuring being undertaken in the country in the face of the increased openness and greater concern for global competitiveness in China. It is likely that this reduction is only temporary; as the more efficient non state owned firms gain further headway and importance in the country s manufacturing sector, total manufacturing employment would likely rise given China s growing global competitiveness in manufacturing. Notice that China presents the largest gap between the share of manufacturing to total employment and the share to total output, suggesting that labor productivity in manufacturing is relatively high in the country Sharp contrast to China (and Singapore), there is both a reduction in the share of manufacturing to total employment and total output in the case of the Philippines. This reflects 2

the difficult adjustment of the sector during the period, resulting in very mixed sub industry performances and the overall failure of the sector to be a significant driver of growth and employment for the whole economy. The comparatively poor performance of the manufacturing sector in generating employment and growth for the Philippine economy contrasts sharply with the comparatively huge importance of manufactured exports to total Philippine exports. Table 2 presents the share of manufactured goods to total (goods) exports in selected comparator countries in the region. As Table 2 shows, the Philippines is one of the most dependent on manufactures for its exports, comparable to the more industrialized South Korea and Singapore which have substantially higher share of manufacturing employment to total employment than the Philippines. China has comparable degree of dependence on manufactured exports for its overall export performance as the Philippines. Yet as noted before, manufacturing accounts for a much higher share, as well as a sharply rising share to total output in China as compared to the smaller and declining share in the Philippines. Table 2: Share of Manufactured Goods to Total Exports: Cross Country Comparison Country 1986 1990 2000 2003 China 63.9 74.7 89.8 92.1 South Korea 92.4 94.1 92 96.6 Indonesia 29.5 45 65.8 Malaysia 78.6 88.6 87.7 Philippines 69.3 77.2 94.2 93 Singapore 81.4 91.3 90.4 Thailand 46.2 64.8 79.2 78.5 Vietnam 31.3 30.5 44.7 Source: ADB Key Indicators Thus the Philippine manufacturing sector appears to be a puzzle in the region. Despite having one of the highest, and rising, contributions to total exports, the Philippine manufacturing sector has one of the lowest, and declining, employment and output shares in the region during the 1990s and early 2000s. Moreover, the share of total exports to total output in the Philippines rose substantially during the period, comparable to the experience of the other countries in the region. In short, manufactured exports did not provide as much employment and growth kick in the Philippines as it did in other middle income developing countries in the region. An important clue to understanding the apparent puzzle is that Philippine manufactured exports is heavily dependent on a few products, primarily semiconductors and integrated circuits, which have a very high import content. Malaysia also has a heavy dependence on electronics exports as in the Philippines. However, Malaysia has a wider range of electronics products as major exports with overall higher local content. As a result, 3

Malaysia s electronics related industries have a larger share of total manufacturing output and employment than in the Philippines. As will be discussed later, the Philippine electrical machinery and electronics industry saw a substantial rise in output and employment shares in the 1990s, although the share is still low compared to that in Malaysia. What this suggests is that the dynamism in the electrical and electronics industry in the Philippines was combined with apparent stagnation or decline in the other manufacturing industries so much so that the overall manufacturing sector was sluggish relative to the rest of the economy in terms of output and employment growth. The mixed performance of the manufacturing industries indicates a difficult adjustment process for the Philippine manufacturing sector during the 1990s and early 2000s. In order to understand why the adjustment process was difficult, it is useful to have a long view of the manufacturing sector and examine key factors that shaped the sector s performance, and thereby point toward the way forward for the sector in the face of increased domestic economic openness, regional integration and globalization. III. THE PHILIPPINE MANUFACTURING SECTOR: A LONG VIEW The decline in the share of manufacturing to total employment and output is not just a recent phenomenon. In fact the declining share of manufacturing to total employment occurred since the 1960s. Table 3 shows that the share of manufacturing to total employment secularly declined from 12.1 percent in 1960 to 11.9 percent in 1970 to 10.6 percent in 1980 to 9.7 percent in 1990 and 9.0 in 2003. Similarly, the share of manufacturing to the Gross Domestic Product, after rising during the 1970s, has been declining since the early 1980s, from 26.3 percent in the early 1980s to about 25 percent in the early 1990s and about 23 percent in the early 2000s. The decline in shares has not been monotonic every year; nonetheless, the secular trend of decline is apparent. Table 3: Share of Sector to Total Employment, by sector Sector 1960 1965 1970 1975 1980 1985 1990 1995 Agriculture 61.2 56.7 53.7 53.5 51.4 49 45.2 43.5 Industry 12.6 11.3 12.6 12.1 11.6 10.7 10.7 16.1 Manufacturing 12.1 10.9 11.9 11.4 10.6 9.7 9.7 10.2 Services 26.2 31.5 32.1 34.1 36.5 40.2 44 40.5 Source: Cororaton et al. (1999) The overall performance of the manufacturing sector since the 1970s has been stop go, which mirrors the whole economy (See Figure 1). There was robust growth of the whole manufacturing sector during the 1970s, similar to that of the whole economy which grew on the average by 3.86 percent. The growth performance of manufacturing sharply deteriorated in the early 1980s, as the economy slid towards the economic crisis of 1983 to 1986. The fastest average growth rate of the manufacturing sector occurred during the heyday of the Aquino administration, as the economy was recovering from the economic crisis. The years 1990 to 1992 saw the negative effects of the December 1989 coup attempt, the oil price increase from the Gulf 4

War, the energy crisis and the devastating 1990 earthquake and the eruption of Mt. Pinatubo in 1991 on the Philippine economy. The economy then went into a mild recession and the manufacturing sector barely grew. The manufacturing sector grew during the growth phase of the whole economy during 1993 to 1996, in tandem with the booming East Asia region. Note however that the pace of manufacturing growth was not as fast as that of the whole economy, reflecting to some extent the problems of industrial adjustment in the sector. The East Asian Crisis of 1997 ultimately dampened the growth of the whole economy and the manufacturing sector, followed by a mild resumption of growth since 2000. A more detailed presentation of the growth rate of the manufacturing sector by industry is shown in Table 4. As Table 4 shows, the 1970s was a particularly good period for the manufacturing sector in terms of output growth. All the industries grew robustly, with a wide range of industries growing particularly fast; i.e., highly labor intensive industries like footwear and wearing apparel, capital intensive industries like chemical and chemical products as well as basic metal industries, and more skilled labor intensive industries like electrical machinery and transport equipment. Even resource based industries like wood and cork products as well as paper and paper products grew fast. Chart 1: Growth Rates of GVA in Manufacturing and GDP 20 15 10 5 0 5 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 10 15 GVA gr GDP gr 5

Table 4: Growth Rate of Gross Value Added (in percent) All industries 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Food 0.3 0.9 2.0 0.0 1.5 2.9 1.6 5.5 2.8 6.6 0.8 3.2 5.5 1.9 4.3 7.2 Beverage and Tobacco 1.1 8.0 2.2 2.0 0.1 0.8 5.4 5.1 3.2 7.9 7.5 1.4 0.2 3.3 0.7 2.8 Textile 3.8 12.7 10.4 11.0 2.9 12.0 0.7 7.4 6.3 2.0 3.2 4.4 8.4 11.4 8.5 11.2 Footwear and wearing apparel 33.3 10.1 16.8 5.5 7.0 0.6 7.1 5.5 8.1 8.8 2.7 2.8 14.9 14.1 3.8 6.9 Leather and leather products 4.5 12.4 14.4 9.6 6.8 5.7 2.7 1.4 15.0 13.0 12.6 4.2 0.9 3.2 10.9 4.7 Wood and wood products 13.3 8.6 9.0 7.0 3.6 17.9 6.7 19.4 2.5 3.7 6.7 6.7 11.5 9.4 7.2 2.1 Furniture and fixtures 14.8 8.8 14.8 7.6 5.2 11.2 3.8 6.9 11.3 2.0 11.8 2.1 1.0 11.2 1.9 7.4 Paper and printing 8.1 25.4 15.5 3.9 0.3 5.2 7.1 4.5 11.4 0.3 0.0 0.9 2.6 9.9 6.5 0.6 Chemicals 1.2 9.4 7.0 4.4 5.8 8.3 3.3 1.3 8.1 5.8 7.3 0.7 2.1 2.5 8.3 2.4 Petroleum and coal 17.0 27.4 0.0 14.4 3.8 11.5 0.7 4.7 7.8 8.8 1.2 5.7 0.9 7.4 2.4 12.3 Rubber products 21.4 9.6 8.8 5.0 0.5 5.4 13.7 4.2 11.8 8.2 8.2 11.4 11.7 2.4 17.6 5.2 Non metallic mineral products 11.7 25.3 31.6 9.2 9.9 5.7 9.8 10.7 14.1 7.5 12.6 16.5 11.8 3.6 7.3 9.7 Basic metal 11.6 19.7 1.6 10.2 0.9 20.8 7.2 3.9 26.8 3.9 1.5 9.2 11.4 14.4 7.0 1.2 Metal products 5.1 14.1 21.1 3.4 7.4 5.0 1.6 1.1 5.0 10.8 4.3 12.6 1.0 8.7 13.2 19.2 Machinery 6.3 13.7 20.8 2.7 0.1 5.0 4.0 7.0 17.3 15.3 13.5 5.8 0.4 18.7 26.2 18.4 Electrical machinery 3.8 10.1 10.8 7.0 3.4 3.0 14.9 22.7 13.5 14.7 31.1 6.1 15.5 24.2 4.8 18.9 Transport equipment 18.9 18.9 32.5 5.0 7.9 15.2 21.8 7.8 16.6 1.4 11.1 34.0 9.6 7.1 9.4 4.1 Miscellaneous manufactures 9.1 19.6 18.7 1.1 6.2 19.2 8.9 13.3 2.2 6.4 13.2 8.1 9.5 13.1 11.1 2.7 Source: Philippine Statistical Yearbook Note: GVA is in constant 1985 prices If the 1970s were a good period for the manufacturing sector, the years 1983 to 1986 were particularly difficult for the sector as the whole economy went into a serious economic crisis. The industries hardest hit appear to be the import dependent domestic oriented industries (e.g., transport equipment, rubber products) as well as industries linked to construction and investment expenditures which collapsed during the period (e.g., nonmetallic mineral products, machinery except electrical). Many of the same industries were also the ones hard hit during the East Asian crisis period of 1997 to 1999. Note that in both the 1983 to 1986 and 1997 to 1999 episodes, the peso registered drastic devaluation/depreciation and domestic interest rates shot up considerably as domestic credit market clamped up. Perhaps the major difference between the two episodes is that there was greater political uncertainty during the early 1980s, which could have adversely affected the smaller export firms as foreign buyers shifted part of their sourcing to other countries. Nonetheless, the two crisis periods tend to indicate the greater vulnerability of domestic oriented industries to business cycles. This is to a large extent not at all surprising since the home market is the key market of the domestic industries by definition. At the same time, the electrical machinery industry indicates that the export market can provide a significant buffer from domestic crises (See Table 4). This suggests that the manufacturing sector would have done better, and would likely do better, if it is more export oriented. 6

Table 4 shows that it is only the electrical machinery industry that has consistently registered positive growth rates from 1971 to 2002. This is because the industry is increasingly dominated by the export oriented electronics and semiconductor firms, most of which are multinational firms, and much of their output is for the foreign market. Moreover, because most of them are multinationals, the firms located in the Philippines have the wherewithal to insulate themselves from the vagaries of business cycles in the country. Precisely because it is the only industry that has been consistently growing in the 1990s and it is largely export oriented, the share of the industry in the country s exports became dominant and in the whole manufacturing sector rising to the top three in employment and output. The industry s share to total manufacturing output increased dramatically from 3.6 percent in 1986 to 13.7 percent in 2002 and is now the second most important manufacturing industry in terms of value added after food processing. Similarly, the industry became the third most important employer in manufacturing by 1995, its share in 1995 more than double the 6.3 percent share in 1986. The period since the latter 1980s is when the country undertook trade liberalization measures especially on manufactured imports, through the virtual elimination of non tariff barriers and the substantial reduction in tariffs. The performance of the industries during the 1990s provides some indication of which industries found it difficult to compete vis à vis imports. Textile manufactures stand out as one of those that got hit hard by the import liberalization (and some say, also textile smuggling), as indicated by the continuous reduction in output since 1991. This output reduction translates into firm closures and sharp employment cutbacks in the early 1990s. Another industry that registered continuous output declines in the 1990s is the wood and cork products. This is the result of the sharp deterioration in the domestic supply of wood products from years of deforestation. Thus, the country had to increasingly rely on imports of wood products, not only for construction but also for its furniture industry. Another resource based industry that also registered significant output declines is the rubber products industry. Not only was the industry hurt by the more competitive Southeast Asian countries (e.g., Malaysia) but also by agrarian reform and by the unsettled peace and order situation in Mindanao where the country s rubber plantations are located. The other loser is the basic metal industry which ultimately saw the closure of the country s major integrated steel plant in Iligan City in the late 1990s. The other industries that also saw significant drops in output especially in the latter 1990s are the two that have been vulnerable to business slowdowns; i.e., transport equipment (from declines in domestic consumer demand) and nonmetallic mineral products (from the decline in the construction sector). There are a few winners among the manufacturing industries in the Philippines since the early 1990s. Apart from electrical machinery industry, which accelerated in the 1990s and early 2000s, the other winners are miscellaneous manufactures, machinery except electrical, leather and leather products, and to a less extent furniture and fixtures industry. Notice that most of these industries tend to rely more on semi skilled or highly skilled labor combined with large capital (engineering goods industries like electrical machinery) or product innovation (furniture and fixtures, leather and leather products). It is apparent that this is increasingly the area of comparative advantage for the Philippines. 7

Notice that the performance of the furniture and fixture industry slowed down dramatically during 2000 to 2002 while that of footwear and wearing apparel turned very robust during the same period. These growth performances are indicative of significant changes ongoing in these industries in the face of greater competition from abroad. In the case of the furniture and fixture industry, it is increasingly under siege from the growing competition from countries like China and Vietnam which lower unit labor costs and which have been increasingly able to produce higher quality furniture products. The country s furniture industry successfully shifted its product focus towards the higher end furniture market in the 1990s as competition in the lower end market from lower cost exporters (Indonesia, China, Vietnam) intensified (see Zosa, 2005). However, by the 2000s, China and Vietnam have increasingly succeeded to move up the product ladder, thereby threatening the country s niche in the furniture market. The country s furniture industry now faces the challenge of defining and following through its industrial upgrading and competitiveness strategy in the face of growing competition from other exporters in the region. As in the case of the footwear and wearing apparel industry, the garments industry has been in the throes of adjustment during the whole 1990s decade. The industry has increasingly shifted towards the medium to higher end garments for exports, resulting in higher unit value of garment exports. The end of the Multi fiber Agreement (MFA) and the elimination of garment quotas in 2005 has been a major worry for the country s garment export industry. The garment industry is highly sensitive to labor cost increases, and the Philippines has relatively high wages compared to countries like Vietnam and China. Nonetheless, a number of the industry leaders are cautiously optimistic that the country s garment industry can hold its own, although robust growth remains very uncertain. Industry leaders have been particularly active in defining the strategy of industrial upgrading and developing programs that are meant to help the garment industry to improve its efficiency and productivity. Much remains to be done however in the implementation and refinement of the industry upgrading program for the garment industry. The recent reimposition of quotas on Chinese exports to the U.S. and E.U. merely provides a temporary breather for the industry. Among the manufacturing industries, it is the food manufacturing industry that has been relatively steady in terms of performance during the 1990s and early 2000s. A large and growing domestic market primarily because of rising population is the backbone of the industry. At the same time, the improved output performance of the agricultural sector in the 1990s compared with the 1980s contributed to the improved output performance of the food manufacturing industry in the 1990s compared to the 1980s. Tables 5 and 6 present the percentage share of the industries to the total manufacturing gross value added and employment respectively. As Table 5 indicates, the most remarkable shift in production is the sharp rise in the output share of the electrical machinery industry from 3.6 percent in 1986 to 13.7 percent in 2002. Other industries that registered share increases albeit very modestly are miscellaneous manufactures, machinery other than electric, and metal 8

products. These industries tend to be more reliant on skilled labor and this is where the country seems to have a growing comparative advantage. This is in view of its relatively high cost unskilled labor vis à vis other countries in the region. Three industries, which showed substantial fluctuations in output share during the late 1980s and the 1990s but which nonetheless registered some minor increases over time are transport equipment, non metallic mineral products, and the footwear and wearing apparel industries. These industries have large domestic markets and are therefore vulnerable to domestic business cycles. At the same time, the wearing apparel industry and to a much less extent, the transport equipment industry, have export oriented sub sectors that are in the process of adjusting to the challenges and opportunities of globalization. Table 5: Share to Total Gross Value Added (in percent) All Industries 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Food 46.1 43.7 40.3 38.9 37.9 37.4 37.0 36.2 36.3 35.0 35.3 34.1 35.6 37.0 35.7 36.1 37.5 Beverage and Tobacco 7.7 7.2 7.1 6.8 6.8 6.8 6.9 6.5 6.5 6.3 6.4 6.6 6.6 6.5 6.3 6.1 6.1 Textile 4.0 3.9 4.0 4.2 3.7 3.6 3.2 3.1 2.8 2.8 2.6 2.4 2.3 2.1 1.7 1.5 1.7 Footwear and wearing apparel 3.8 4.8 4.8 5.3 5.5 5.9 6.0 6.4 6.4 6.5 5.6 5.5 5.7 4.8 5.2 5.2 5.4 Leather and leather products 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Wood and wood products 2.0 2.1 2.1 2.2 2.3 2.2 1.8 1.9 1.5 1.4 1.3 1.3 1.3 1.1 0.9 0.8 0.8 Furniture and fixtures 1.1 1.2 1.2 1.3 1.4 1.3 1.2 1.1 1.2 1.2 1.2 1.3 1.3 1.3 1.3 1.3 1.2 Paper and printing 2.2 2.2 2.5 2.8 2.8 2.8 2.7 2.5 2.5 2.6 2.5 2.4 2.4 2.3 2.4 2.1 2.1 Chemicals 6.3 6.1 6.1 6.1 6.2 6.6 6.2 6.3 6.1 6.2 6.2 6.4 6.4 6.2 5.7 6.0 5.7 Petroleum and coal 12.0 13.3 15.5 14.6 16.3 15.8 17.9 17.7 17.6 17.8 18.3 17.8 16.9 16.5 16.8 15.9 13.5 Rubber products 1.3 1.5 1.5 1.5 1.5 1.5 1.5 1.3 1.2 1.2 1.1 0.9 0.8 0.9 0.9 0.7 0.7 Non metallic mineral products 1.9 2.0 2.3 2.8 2.5 2.7 2.6 2.9 3.0 3.2 3.3 3.5 3.0 2.6 2.4 2.1 2.3 Basic metal 2.8 3.0 3.3 3.0 2.7 2.7 2.2 2.3 2.3 2.7 2.5 2.3 2.1 1.9 1.5 1.6 1.5 Metal products 2.0 2.0 2.1 2.4 2.4 2.3 2.4 2.4 2.3 2.2 2.4 2.2 1.9 1.9 2.0 2.2 2.5 Machinery 1.0 1.0 1.0 1.1 1.1 1.1 1.2 1.3 1.3 1.4 1.5 1.7 1.6 1.6 1.8 2.2 1.7 Electrical machinery 3.6 3.5 3.5 3.7 3.9 4.0 4.2 4.8 5.6 5.9 6.5 8.1 8.7 9.9 11.7 11.9 13.7 Transport equipment 0.7 0.7 0.8 1.0 1.0 0.9 1.1 1.3 1.4 1.5 1.4 1.2 0.8 0.9 0.9 1.0 1.0 Miscellaneous manufactures 1.6 1.7 1.8 2.1 2.0 2.2 1.8 1.9 2.1 2.0 2.0 2.2 2.4 2.6 2.8 3.0 2.8 Source: Philippine Statistical Yearbook Note: GVA is in constant 1985 prices 9

Table 6: Share of Industry s Employment to Total Employment by Major Industry Group, 1986 1998 Group 1986 1987 1988 1989 1990 1991 1993 1994 1995 1996 1997 1998 Food manufactures 19.5 19.7 18.8 17.6 18.0 17.3 18.4 18.1 17.8 17.6 17.2 17.8 Beverage industries 4.2 4.0 3.5 3.3 3.5 3.5 2.9 2.8 2.7 2.7 2.7 2.6 Tobacco manufactures 2.0 1.9 1.7 1.4 1.4 1.4 1.4 1.3 1.2 1.1 1.0 0.7 Textile manufactures 11.2 11.4 10.4 10.6 10.5 8.9 7.4 7.1 6.1 5.0 4.9 4.6 Wearing Apparel 14.6 15.1 16.6 20.3 18.0 18.3 17.8 16.3 15.9 14.6 14.0 13.6 Leather and Leather Products 1.7 1.4 1.7 1.9 1.8 2.5 2.3 2.4 2.5 3.4 3.6 3.7 Wood and cork products 7.1 6.6 6.6 5.8 4.9 4.6 3.3 2.7 2.6 2.6 2.5 2.1 Furniture and fixtures 3.6 4.1 4.9 4.6 4.0 3.7 2.7 2.9 2.6 2.7 2.9 3.1 Paper and paper products 1.8 1.7 1.8 1.7 1.6 1.6 1.7 2.0 2.1 2.1 2.0 2.0 Publishing and printing 2.6 2.5 2.4 2.3 2.4 2.3 2.9 2.5 2.6 2.7 2.7 2.6 Chemical & chemical prod. 5.3 5.0 4.7 4.5 4.6 4.7 4.7 4.8 4.9 5.2 5.1 4.8 Products of petroleum & coal 0.4 0.4 0.3 0.3 0.3 0.3 0.4 0.4 0.4 0.3 0.3 0.2 Rubber products 2.9 3.4 3.1 2.8 3.1 2.8 2.5 2.7 2.2 0.9 0.9 0.9 Plastic Products 1.9 2.0 2.1 2.1 2.1 2.1 2.6 2.9 2.7 3.0 3.0 2.8 Non metallic mineral prod. 2.4 3.2 3.3 3.3 3.8 3.9 3.9 4.1 3.6 4.2 4.2 4.1 Basic metal industries 2.9 2.5 2.1 2.1 2.3 2.3 2.4 2.8 3.0 3.5 3.4 3.4 Metal industries 2.7 2.7 2.5 2.7 2.5 2.8 3.3 3.3 3.7 3.3 3.4 3.5 Machinery except electrical 2.0 1.9 2.2 2.1 2.1 2.1 2.2 2.4 3.2 2.9 2.9 3.2 Electrical machinery 6.4 6.4 6.3 6.1 8.1 9.5 10.9 12.1 13.9 12.9 13.4 14.8 Transport equipment 1.9 1.7 1.6 1.8 2.3 2.3 2.6 2.7 2.8 3.2 3.2 2.7 Office Equipments 0.5 0.5 0.4 0.3 0.3 0.3 0.8 0.7 0.8 1.1 1.3 2.0 Miscellaneous manufactures 2.3 1.9 2.9 2.3 2.5 2.8 2.9 3.0 2.8 5.1 5.4 4.9 Notes: Data are for establishments with average employment of 10 or more workers Source: Philippine Statistical Yearbook 1986 2004 The industries that lost ground in output share include the textile industry, wood and wood products industry, rubber products industry and the basic metal industry. These industries are generally resource based and, for the basic metal and textile industries, also power intensive. In a more open economic environment, the Philippines does not have a comparative advantage in wood and rubber products as compared to its neighboring countries like Indonesia and Malaysia. In addition, the country has one of the highest power rates in the region, thereby hurting the competitiveness of a power intensive (in the spinning process) and low skilled labor intensive industry like textiles. The country s basic metal industry is also burdened by the lack of domestic raw materials and by the high power cost, compounded by the use of old technology in its largest firm, the National Steel Corporation, which is less efficient for the output size demanded by the domestic market. The industry that registered the sharpest decline in output share is the food manufacturing industry. As the dominant subsector, the decline in the output share is not surprising in the face of faster growing industries like electrical machinery. Moreover, the industry is largely domestic oriented even if it is less vulnerable to domestic business fluctuations than say the transport equipment industry because it addresses a more basic and primordial need, (i.e., food). Because the industry is primarily 10

domestic oriented, its growth has been hemmed in by the overall low growth of the whole economy during the period compared to many of its neighboring countries in the region. Table 6 shows similar industry shifts in employment in the manufacturing sector. Within a decade between 1986 and 1995, the electrical machinery industry more than doubled its employment share from 6.4 percent to 14.8 percent, raising its ranking from the 6th most important employer in manufacturing to third most important. Considering that the industry has continued to grow in the late 1990s as compared to the garment industry, it is likely that the electrical industry has almost overtaken the garment industry as the second most important employer after food manufacturing. The footwear and apparel sector reached its height as employer in 1989, when its share rose to 20.3 percent, but has since secularly declined in employment as the footwear industry lost competitiveness vis à vis countries like Indonesia in the early 1990s and China in the latter 1990s and early 2000s. In addition to the electrical machinery industry, the other industries that registered increases in employment share albeit far more modestly are miscellaneous manufactures, transport equipment, machinery other than electric, metal products and leather and leather products. Note that with the exception of the leather and leather goods industry, the other industries that registered higher employment share in the 1990s are the ones that registered the significant increase in labor productivity during the period. They are also primarily more skill intensive industries with a number of them being engineering goods industries. As noted earlier, these are the industries where the Philippines is gaining comparative advantage. Conversely, the industries where the country is losing comparative advantage tend to be the losers in employment share in manufacturing (e.g., textile, wood and wood products). The drop in textile is particularly significant because the textile industry was in fact the second most important employer in manufacturing by 1975 until the early 1980s. The wood and wood products industry was also a major employer, ranking third after food processing and textile manufacturing in 1975. IV. PRODUCTIVITY AND COMPETITIVENESS At the heart of competitiveness in the long run is productivity growth. The higher the growth rate of labor productivity relative to competitor industries in other countries, the greater is the probability that the country remains internationally competitive as long as the increase in real wages does not exceed that of labor productivity growth. Where productivity growth is marginal or even negative, competitiveness is severely compromised especially if wages increase. At the same time, the reduction in unit labor cost (in the face of marginal or negative labor productivity growth) via a reduction in real wages would have substantial negative social and growth effects eventually and therefore not sustainable. Estimates of total factor productivity for the Philippines show poor productivity performance as compared to comparator countries in the region. For example, estimates of Collins and Bosworth (1997) show that the Philippines is the only major East Asian country that registered negative growth of total factor productivity during 1973 to 1994 (See Table 7). As Table 7 shows, total factor productivity growth was negative for the sub periods 1973 to 1984 11

and 1984 to 1994. In sharp contrast, competitor countries in the region had substantial positive growth of total factor productivity during the whole period, rising to 1.4 percent per year in Malaysia, 3.1 percent per year in Singapore, 3.3 percent per year in Thailand and 4.6 percent per year in China during the East Asian Miracle period of high output per worker growth during the latter 1980s and early 1990s. Note that, from Table 8, a negative growth of total factor productivity dampens the country s output per worker and is indicative of a misuse or underutilization of resources. This is especially the case for the period 1973 to 1984, where the contribution to growth of capital formation was substantially negated by declines in factor productivity, which suggests significant misuse or misallocation of capital in the country during the period. Note also that the Philippines experienced negative growth of output per worker during 1984 to 1994, arising from the negative growth of total factor productivity and also near stagnation in capital formation, reflecting the adverse impact the country s serious economic crisis of the mid 1980s and the utter failure of the country to encourage investments during the period relative to the growth of the population, and definitely relative to the performance of its neighboring countries. Table 7: Sources of Growth in East Asia (annual percentage), 1960 1994 Region/Period Output per Worker Physical Capital Contribution of Education Factor Productivity China 1960 94 4.5 1.5 0.4 2.6 1960 73 2.2 0.4 0.4 1.4 1973 94 6.0 2.2 0.4 3.3 1973 84 4.3 1.7 0.4 2.2 1984 94 8.0 2.9 0.3 4.6 Indonesia 1960 94 3.4 2.1 0.5 0.8 1960 73 2.5 0.9 0.5 1.1 1973 94 4.0 2.8 0.5 0.7 1973 84 4.3 3.3 0.5 0.5 1984 94 3.7 2.3 0.5 0.9 Korea 1960 94 5.7 3.3 0.8 1.5 1960 73 5.6 3.2 0.9 1.4 1973 94 5.8 3.4 0.7 1.6 1973 84 5.3 3.4 0.8 1.1 1984 94 6.2 3.3 0.6 2.1 Malaysia 1960 94 3.8 2.3 0.5 0.9 1960 73 4.0 2.4 0.5 1.0 1973 94 3.7 2.3 0.5 0.9 1973 84 3.6 2.7 0.5 0.4 1984 94 3.8 1.8 0.5 1.4 12

Table 7: Sources of Growth in East Asia (annual percentage), 1960 1994 (continued) Region/Period Output per Worker Physical Capital Contribution of Education Factor Productivity Philippines 1960 94 1.3 1.2 0.5 0.4 1960 73 2.5 1.3 0.6 0.7 1973 94 0.5 1.1 0.5 1.1 1973 84 1.2 2.0 0.6 1.3 1984 94 0.3 0.2 0.4 0.9 Singapore 1960 94 5.4 3.4 0.4 1.5 1960 73 5.9 4.6 0.4 0.9 1973 94 5.1 2.7 0.4 2.0 1973 84 4.3 3.1 0.2 1.0 1984 94 6.0 2.3 0.6 3.1 Thailand 1960 94 5.0 2.7 0.4 1.8 1960 73 4.8 3.2 0.1 1.4 1973 94 5.2 2.3 0.6 2.1 1973 84 3.6 2.0 0.5 1.1 1984 94 6.9 2.6 0.8 3.3 Taiwan 1960 94 5.8 3.1 0.6 2.0 1960 73 6.8 3.9 0.5 2.2 1973 94 5.2 2.7 0.7 1.8 1973 84 4.9 3.0 0.9 0.9 1984 94 5.6 2.3 0.5 2.8 Source: Collins and Bosworth (1997) 13

Table 8: Labor Productivity by Major and Minor Industry Group, 1998 2002 Major and Minor Industry Group 1998 1999 2000 2001 2002 All Industries 33,345 33,096 35,442 34,357 34,798 Agriculture, Fishery and Forestry 17,164 17,121 18,904 18,393 18,540 Agriculture 15,310 15,340 17,130 16,575 16,649 Agricultural Crops Production 10,567 10,874 11,996 11,819 12,128 Production of Livestock, Poultry and Other Animals 69,807 69,639 88,120 75,716 63,694 Agricultural Services 83,435 61,621 89,955 33,624 22,008 Fishery 33,822 32,795 33,444 34,610 36,041 Forestry/Hunting/Trapping and Game Propagation 13,451 21,300 16,732 9,784 3,102 Mining and Quarrying 93,193 100,371 100,306 98,301 135,265 Metallic Ore Mining 84,000 77,919 80,217 96,875 110,667 Non Metallic Ore Mining 106,298 140,143 135,846 100,000 157,780 Manufacturing 81,455 81,431 86,438 83,992 88,028 Manufacture of Food, Beverages, and Tobacco 149,256 154,716 161,771 151,290 160,822 Textile, Wearing Apparel and Leather Industries 23,087 18,628 20,125 21,918 23,547 Manufacture of Wood and Wood Products including Furniture and Fixtures 18,833 16,997 17,737 14,499 13,689 Manufacture of Paper and Paper Products, Printing and Publishing 49,762 50,376 56,475 42,828 42,228 Manufacture of Chemicals and Chemical, Petroleum, Coal, Rubber and Plastic Products 326,159 340,192 365,355 345,750 368,221 Manufacture of Non Metallic Mineral Products except Products of Petroleum and Coal 73,489 65,551 74,013 68,618 72,418 Basic Metal Industries 64,122 54,623 42,857 63,131 66,719 Manufacture of Fabricated Metal Products, Machinery and Equipment/ Other Manufacturing Industries 58,953 67,242 77,255 73,164 83,471 Electricity, Gas and Water 219,674 223,279 266,885 275,437 292,068 Electricity/Gas and Steam 265,868 283,196 336,382 357,702 407,526 Waterworks and Supply 66,656 62,447 77,118 80,294 62,763 Construction 32,883 33,567 43,527 38,600 37,066 Wholesale and Retail Trade 33,359 33,404 34,100 30,730 30,433 Wholesale Trade 110,561 116,549 112,736 90,406 100,174 Retail Trade 26,897 26,918 27,880 25,101 24,646 Transportation, Storage and Communications 32,344 32,368 34,327 35,024 37,375 Transportation Services/Storage and Warehousing 22,123 21,624 21,722 20,498 20,775 Communication 190,382 218,635 255,477 328,160 376,119 Financing, Insurance, Real Estate and Business Services 94,478 90,158 90,852 80,235 78,489 Banking Institutions 217,245 231,385 240,628 246,267 234,786 Financial Intermediaries (Non banks) 76,564 60,704 62,563 43,596 41,946 Insurance 142,881 112,823 119,346 179,491 188,500 Real Estate 99,610 105,505 110,329 94,146 89,075 Business Services 2 24,887 24,383 25,003 21,447 21,958 Source: Bureau of Labor and Employment Statistics 14

The same poor productivity performance of the Philippines is also echoed in terms of partial labor productivity measures. The average growth of GDP per employed person during 1980 to 2001 for the Philippines was a negative 0.6 percent per year as against, for the same period, a positive 3.9 percent per year for Thailand, 5.2 percent per year for China, 4.9 percent per year for Korea, 4.3 percent per year for Taiwan, 3.9 percent for Singapore, 3.3 percent per year for Hong Kong, 2.8 percent per year for Malaysia, 3.0 percent per year for Pakistan, 3.2 percent per year for India, 2.2 percent per year for Sri Lanka, 1.8 percent per year for Indonesia and 1.5 percent per year for Bangladesh. In short, the Philippines was the only major Asian developing country that registered labor productivity decline on the average for two decades during the 1980s and the 1990s. In manufacturing, estimates by Cororaton and Abdulla (1999) of total productivity growth show a remarkable pro cyclical pattern with the overall economy. According to the study, total factor productivity growth rate in manufacturing averaged negative 2.5 percent per year during 1958 to 1960, 3.8 percent per year during 1961 to 1965, 0.3 percent per year during 1966 to 1970, 1.5 percent per year during 1971 to 1975, negative 1.5 percent per year during 1976 to 1980, 4.1 percent per year during 1981 to 1983, negative 8.3 percent per year during 1984 to 1986 and 1.0 percent per year during 1987 to 1991. The large negative growth in total factor productivity in 1984 to 1986 is linked to the serious economic crisis that occurred. Similarly, the negative growth during 1958 to 1960 is linked to the deteriorating balance of payments problems which hampered the import dependent import substituting manufacturing sector at that time in view of the tight national supply of international reserves at that time. The marginal growth of total productivity during 1966 to 1970 also reflects the negative effects of the balance of payments problem and eventual currency crisis during 1969 to 1970. The only period of negative total productivity growth without an economic crisis in the country from the late 1950s to the late 1980s was the 1976 to 1980 period. This period was characterized by rising non tariff protection especially in capital intensive industries as well as rising capital intensity of industrial production. The periods of significant positive total productivity growth in manufacturing are primarily related to economic recovery or trade liberalization periods. The periods of 1961 to 1965 and 1987 to 1991 are both periods of economic recovery, policy deregulation and trade liberalization. In fact, the period of 1961 1965 is usually termed the import decontrol period in Philippine economic history. Similarly, the years 1987 to 1991 represent the resumption of economic and trade liberalization after the tight controls undertaken during the balance of payments crisis of 1983 to 1985. The years 1971 to 1975 are also characterized by economic recovery as well as increased efforts at export orientation primarily through the operation of export zones and bonded warehouses. The high rate of total factor productivity growth during 1981 to 1983 is more difficult to explain as the Philippine economy started to falter during this period. Nonetheless, the country s trade reform program towards lower protection and less non tariff barriers started during this period albeit only temporarily and in a limited way. This may have allowed more intensive use of the industrial capital stock that was built up in the late 1970s (It may be better to combine 1976 to 1980 and 1981 to 1983 so much so that the average 15

total factor productivity growth rate is 0.6 percent per year for 1976 to 1983. The significant slowdown compared to 1971 to 1975 reflects the negative effect of increased industrial protection and capital intensity of industrial production at that time). Note that a negative total factor productivity growth means that increases in the usage of inputs like labor and capital did not generate corresponding increases in output, thereby indicating deterioration in the efficiency in the use of resources. It can be inferred that the negative total productivity growth during the crisis periods reflects the underutilization of capital and labor resources arising from both demand drop and constrained access to international reserves to finance raw material inputs. In contrast, the period of the latter 1970s reflect misallocation of capital resources such that the output effect of the increased investments was not commensurately high. Cororaton and Abdulla (1999) also estimated the total factor productivity growth by industry in the manufacturing sector. Data problems make the results less robust as compared to the estimate for the whole manufacturing sector. Nonetheless, the findings at the sub sectoral level tend to validate the sectoral result in that there are expectedly more industries registering declining total productivity during economic crises. Cororaton and Abdulla (1999) also show that performances at the industry level are very varied and even in periods of overall growth, there are still a number of industries which generate negative total productivity growth rates. It can be inferred from the discussion above that the nearly three decade long deterioration in the relative productivity performance of the Philippine economy may explain to a large extent the loss in international competitiveness of many of the Philippine industries visà vis competitors like Thailand, Malaysia and China. Partial labor productivity estimates by industry for the more recent period (1998 to 2002) also provide a very mixed productivity picture and poor performance overall (See Table 8). An increase of 4 percent over four years, or an average of 1 percent per year, of partial labor productivity is low. Indeed, if the growth in the capital stock during the same period were to be taken into consideration, it would mean virtual stagnation in total factor productivity. Labor productivity in the manufacturing sector grew at a slightly higher rate at an average of 2 percent per annum. Within the manufacturing sector there is a wide variation in productivity performance. Largely natural resource based industries registered substantial declines in labor productivity; e.g., manufacture of wood and wood products including furniture and fixtures, manufacture of paper and paper products, including printing and publishing. Labor productivity in textile, garments, leather, non metallic mineral products and basic metals industries largely stagnated during 1998 to 2002. The only group of manufacturing industries that registered significant labor productivity growth was the manufacture of fabricated metal products, machinery and equipment. This group includes electrical machinery, machinery other than electrical, and transport equipment manufacturing. This group registered an average of about 10 percent growth rate in labor productivity per year during the period. 16

Note that the manufacturing industries which registered negative labor productivity growth tend to have sluggish or negative output performance in the latter 1990s and early 2000s. Similarly, the industries which had the substantial rise in partial labor productivity are the industries that also experienced increase in the share to total manufacturing output and employment. Thus, on the whole the manufacturing sector had a spotty performance with respect to productivity during the late 1990s, with only the sector comprising machinery and equipment and fabricated metals that registered robust productivity growth. In view of the spotty productivity performance, decline in unit labor cost in manufacturing would have to rely on declining labor compensation, at least in the formal and larger enterprises of the manufacturing sector. Table 9 presents the index of unit labor cost estimate for the whole manufacturing sector during 1986 2002. Labor productivity in manufacturing was largely stagnant from the latter 1980s to the early 1990s with the exception of 1990, and then rose marginally from 1996 to 2002. Labor compensation index, after rising briefly in the late 1980s, declined secularly during the 1990s and early 2000s. As a result, the unit labor cost index declined monotonically from 1988 to 2002 to less than half the initial level by the end of the period. Table 9: Index of Unit Labor Cost Estimate in Philippine Manufacturing, 1986 2002 Year Compensation Index Labor Productivity Index Unit Labor Cost Index 1986 91.95 90.76 101 1987 98.64 88.69 111 1988 103.00 89.37 115 1989 100.72 92.17 109 1990 100.00 100.00 100 1991 83.25 91.10 91 1992 82.05 84.08 98 1993 76.57 87.85 87 1994 70.29 87.71 80 1995 65.46 94.05 70 1996 57.89 92.64 62 1997 57.33 96.58 59 1998 56.20 97.91 57 1999 54.11 95.60 57 2000 53.46 101.1 53 2001 51.53 100.4 51 2002 51.05 105.23 49 Source: Yearbook of Labor Statistics, DOLE BLES Index of Unit Labor Cost = (Compensation/Labor Productivity)*100 The unit labor cost indexes in manufacturing in selected Asian countries are presented in Table 10 for the period 1986 to 1995. Unit labor costs in Korea and Taiwan increased during 17

the period, which explains in part the continued flow of investments from Taiwan and South Korea primarily to China during the 1990s. The table indicates that the decline in unit labor cost during the 1990s is not unique to the Philippines. In fact, China had similar decline as the Philippines. Considering that China s real wages have been known to have increased during the period, the decline in the unit labor cost in China is largely the result of the sharp rise in labor productivity. Declines in unit labor cost appear to have been lower in Indonesia, Thailand and Singapore than in the Philippines. It is likely that the decline in the unit labor cost in Thailand and Singapore also stemmed from the faster rise in labor productivity as compared with the rise in real compensation of labor in the two countries. So, on the whole it appears that it is only the Philippines which experienced a decline in the unit labor cost primarily from reduction in the real compensation of labor rather than from the growth in labor productivity at a rate faster than the rise in the real compensation of labor. Table 10: Unit Labor Cost Index in Manufacturing in Selected Countries, 1986 1995 Country 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 China 100 97 95 91 91 87 82 77 74 Hong Kong 100 91 95 95 94 82 76 79 78 67 India 100 85 77 63 Indonesia 100 96 101 90 91 103 106 97 93 Korea 100 110 117 146 158 172 180 180 181 177 Philippines 100 115 120 127 134 140 157 145 Singapore 100 95 94 105 108 105 110 100 93 85 Sri Lanka 100 96 76 58 117 116 99 126 133 Taiwan 100 105 111 122 124 121 126 122 126 124 Thailand 100 106 87 83 88 99 104 100 90 Japan 100 97 97 100 100 102 106 110 114 117 United States 100 97 93 92 92 92 91 90 87 82 Source: World Bank (1997): Managing Global Integration: Philippines (from Godfrey, 1997) Entries are ratios of total annual compensation per employee to value added per employee at 1986 constant prices In the face of the increased openness of the Philippine economy and in the light of the emergence of low labor cost countries like Vietnam and China in the export market, the decline in the real compensation of labor in order to reduce the unit labor cost (given the stagnation of labor productivity) is probably a necessary recourse in order to prevent an even drastic deterioration in the economic and competitiveness performance of the Philippine manufacturing sector in the 1990s. Note that the cost of unskilled labor in the Philippines was about 3.1 to 4.7 times that of the unskilled labor wage in Vietnam in 1996 (World Bank, 1997). Similarly, skilled labor in the Philippines earned about 2.8 times that in Vietnam (Ibid.). Thus, despite the reduction in the compensation of labor during the 1990s, the wage gap between the Philippines and the low labor cost countries like Vietnam and China remains significant, suggesting that the country needs to adjust well to the realities of having large low labor cost countries as competitors. Clearly, this cannot be done through further reduction in the real wages of workers especially in view of the high level of income inequality in the country. What it means is that the Philippines has to be more pro active in seeking out the avenues for 18