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Wednesday, November 22, 2017 | MANILA, PHILIPPINES
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Date posted: Friday, December 11, 2015 | Manila, Philippines

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Philippine competitiveness in the age of AEC (Ready or not)

This is the question facing Filipino businessmen as the start of the ASEAN (Association of Southeast Asian Nations) Economic Community (AEC) nears.

A project eight years in the making, the AEC will transform the 10-member ASEAN into a single market and production hub where products, services, capital and skilled labor can freely cross borders. This experiment starts by the end of this year.

AEC broadens any ASEAN-headquartered company’s market to more than 600 million in what has been the fastest-growing region in the world.

To be sure, tariffs across the ASEAN have already gone down to zero on a wide swathe of products, while restrictions on cross-border trade in at least 80 services have been eased. Mutual recognition agreements covering eight professions have been signed, allowing a national from any of the ASEAN countries to work anywhere within the region.

For the Filipino businessman, this means a larger pool of rivals, which is a problem since domestic competition is already tight. Among the business constraints cited in a quarterly survey of the Bangko Sentral ng Pilipinas, competition has been the biggest concern raised by the majority of respondents. So, imagine how local businesses would feel if companies from other ASEAN countries join the fray.

Asian Institute of Management (AIM) professor Jamil Paolo S. Francisco captures pretty much the state of unreadiness among many Philippine businesses.

“If you ask ASEAN companies as to who among them has an ASEAN strategy, it most probably will be a Thai company since the typical Thai company is on a going-out strategy,” Mr. Francisco said. “There might be, give or take, one or two Philippine or Indonesian companies, but mostly they are on wait-and-see. And this was six months ago.”

Mr. Francisco teaches economics and is in the thick of AIM’s ASEAN integration studies. His pilot study is a book co-authored with two others on 58 top performing ASEAN-headquartered firms, including eight from the Philippines. The study, the results of which come out early next year, aims to identify peculiar ways of doing business in ASEAN in the last 12 years, discuss the companies’ strategies, including their plans for ASEAN integration.

According to Mr. Francisco, most if not all of the Philippine companies in the study are old. His researcher, while doing the rounds of interviews across Southeast Asia, wondered why they were talking to companies in Thailand, Malaysia or Indonesia that were much younger than those in the Philippines.

“That seems to be a peculiarity about us,” Mr. Francisco said. “A lot of these old Philippine companies took advantage of institutional voids. They tried to address these institutional voids, which is a euphemism for lack of infrastructure, lack of laws and regulations or even government.”

Mr. Francisco cites Ayala Land, Inc., which is an inspiration for companies in other ASEAN countries, since the Philippine firm introduced masterplanning ahead of government.

“I’ve talked to Indonesian companies, and they say they get their inspiration from this place in Makati where there’s al fresco dining, which is Greenbelt,” Mr. Francisco said.

With competition soon to come from every corner of ASEAN by yearend, the question now turns to whether the government has prepared the rest of Philippines, Inc.

For competitiveness is no longer a concern solely of the individual company seeking to maintain, if not widen its market share and earn a profit to boot. Since Harvard Business School professor Michael Porter’s seminal work on the subject came out in a 1990 book titled Competitive Advantage of Nations, a growing number of governments have assumed part of the burden of creating and sustaining corporate champions that can conquer markets abroad.

According to Mr. Porter, national competitiveness hinges on four things -- factor conditions, demand conditions, related and supporting industries, and firm strategy, structure and rivalry -- and in all four, the government has a role to play.

The concept of national competitiveness underlies international rankings like the World Economic Forum’s (WEF) Global Competitiveness Report and the Institute for Management Development’s World Competitiveness Yearbook. In these league tables, nations are ranked using a number of metrics that capture their level of productivity.

The government’s role in ensuring national competitiveness is summarized in what has come to be called “industrial policy,” which in the case of the Philippines over the past several decades, has swung between two extremes -- protection and trade liberalization (see “Quo Vadis Industrial Policy?” on page 45).

Under the Aquino administration, industrial policy is contained in the Philippine Development Plan 2011-2016, and has three objectives: improve the business environment, increase productivity and efficiency, and enhance consumer welfare. These will be attained through a combination of cutting red tape, strengthening the Philippine brand, providing assistance to small and medium enterprises, broadening market access of Philippine goods and services, picking sectoral winners, industrial clustering, promoting product standards and improving access to basic commodities.

Besides an improvement in the country’s ranking in international surveys of competitiveness, success will be gauged in terms of higher exports, more foreign direct investments (FDIs) and increasing employment, particularly in manufacturing.

With less than a year before President Benigno S. C. Aquino III’s term ends, how has the Philippines fared?

Looking at several international measures of competitiveness, we cannot deny the gains the country has made. The most dramatic advance can be seen in the WEF’s Global Competitiveness Report, where the Philippines rose from 85th spot in 2010 to 47th this year, allowing the country to meet its goal of joining the top third of economies in the annual ranking. In the Ease of Doing Business Report, the Philippines up until last year, had climbed 45 places since 2010.

But the constant in all of this -- and the reason for the Philippines’ dominance in the voice segment of business process outsourcing (BPO) -- is the country’s high quality of human capital -- a strength highlighted in the government’s branding campaign, “Your business, our people” (see “From ‘Asia’s sick man’ to ‘Manila standard’: Repositioning Brand Philippines” on page 42).

Suraj Moraje, who is managing partner of McKinsey & Co. in Manila, admits that the BPO industry has given the Philippines a leg up on the global stage.

“In the last 15 years, the Philippines has built its brand globally with the success of its BPO industry. The industry has grown to around 10% of GDP (gross domestic product) and has put the Philippines on the map as the largest voice-based BPO provider in the world,” he said.

But “beyond BPO, it is unclear which ‘space’ the country would like to occupy on the international stage,” Mr. Moraje said.

Department of Trade and Industry (DTI) Secretary Gregory L. Domingo agrees that building competitiveness remains a work in progress. The DTI chief chairs the National Competitiveness Council, a public-private body created by Presidential fiat.

“We cannot claim that we’re competitive in all, but we’re competitive in some, such as those sectors that don’t require a lot of power… those sectors that require a lot of intricate work in terms of machines, whether it be embroidery or large-scale steel infrastructure,” Mr. Domingo said.

He cites local shipbuilding yards run by foreign firms like Hanjin, Tsuneishi and Keppel, all of which prefer Filipino welders. Then there’s AG&P, which builds large-scale modular steel infrastructure, such as oil and gas platforms and petrochemical plants.

“These are mega-structures. Each module is like a seven-storey building, similar to what you see on National Geographic,” said Mr. Domingo. “They have special ships that can take two to three modules and transport it to the US, where they assemble it like LEGO blocks.”

These are some of the businesses that have helped manufacturing grow close to 9% in recent years, bringing up its share in GDP to 24%, or on target. Investments also have risen more than sixfold between 2010 and 2014, while the country’s exports base has broadened, with electronics, previously 70% of the total, down to under 50%.

But McKinsey’s Mr. Moraje said the country’s share of global flow of goods, services and capital trails its ASEAN neighbors. He cited the manufacturing sector, which can lay claim to no industry that has attracted more than 20% of FDI.

“On the one hand, this could indicate a broad-based economy with deep resilience,” Mr. Moraje said. “However, it could also imply that we have not successfully established a deep-enough brand for the country in other sectors. This is possibly one of the reasons why our total FDI in manufacturing between 2009 and 2013 was less than half that of other large ASEAN countries.”

In McKinsey Global Institute’s Connectivity Index, the Philippines ranks “far lower than some other ASEAN countries such as Singapore, Malaysia and Thailand,” Mr. Moraje said.

The index measures the inflows and outflows of goods, services, finance, people, and data and communication relative to the size of the economy.

“The Philippines has a unique opportunity to capture even greater benefits from global flows… To do this, the country could establish its brand firmly in specific sectors aside from BPO,” Mr. Moraje said.

Greater integration, such as that aimed for under the AEC, can lower costs by up to 20% in many sectors, according to McKinsey Global Institute’s calculations.

“The Philippines could drive productivity gains in its work force,” Mr. Moraje said. “For example, despite its lower wage rates, the average output per daily wage in the Philippines is $5.50, compared to $8.70 in China. Our research estimates that the Philippines will need to increase the pace of productivity increases by around 60%, just to sustain its 5% GDP growth rate going forward, raise income levels and increase the country’s competitiveness.”

“In the face of increased globalization and the AEC, the time is ripe for the Philippines to understand its other true sources of competitive strength and engage more confidently on the global stage,” he said.

As to which sectors outside of BPO where the Philippines can claim competitiveness is a function of, again, institutional voids. The DTI is already drawing up road maps for 29 potential industries under its Manufacturing Resurgence Program, trying to identify gaps that need to be addressed. One such gap is infrastructure.

According to McKinsey Global Institute’s forecasts, the GDP of Metro Manila by 2040 will equal that of the entire Malaysia today, while the economic output of the next three cities will approximate that of Myanmar.

“With a higher level of GDP per capita, citizens should be able to expect more globally compatible and livable cities. The Philippines can start planning and building such cities of the future today,” Mr. Moraje said.

Some infrastructure gaps will surely prove more daunting.

“We’re an archipelagic nation, so cost of logistics -- if you have to rely on domestic materials -- is high,” said DTI’s Mr. Domingo. “So we’re very strong in areas where supplies are coming from overseas.”

Early this year, the legislature relaxed the Cabotage Law, allowing foreign ships to make calls on select Philippine ports outside of Manila; a reform that can introduce competition and hopefully bring down the cost of transporting products.

“But we only have few international cargo ports,” Mr. Domingo said. “It will still not allow international ships to call on other Philippine ports. So it’s limited. This is a big step in the sense that we’ve liberalized a significant part of the shipping industry, but it’s not 100%. It’s like the open skies policy -- open skies only outside NAIA (Ninoy Aquino International Airport).”

This is why the DTI chief is not so keen about the near-term prospects of the government’s clustering program when it comes to heavy industries. According to him, poor infrastructure makes it more advantageous to source overseas than to create backward linkages.

“Clustering is more of a challenge, but it’s a really good idea, especially if you talk about the rural areas where they have very little resources. It makes sense to cluster,” Mr. Domingo said.

The DTI makes clustering work through its Shared Services Facilities Program, in which community-based businesses are provided tools and equipment to boost productivity and ensure product quality. The government has established more than 1,000 of these shared service facilities since 2013.

An example is vegetable noodle-making in San Nicolas town, near Laoag City in the Ilocos Region. The DTI provided a mixer, cutters, blenders and other equipment to a cooperative, which buys its raw materials from a nearby market and sells its product in the same area.

“But these are not for export, since they have yet to satisfy strong domestic demand,” Mr. Domingo said. To help establish economies of scale, DTI already asked the Department of Social Welfare and Development to tap these veggie noodle makers for the government’s disaster relief operations, so the program hits two birds with one stone.

A more capital-intensive industry that the DTI plans to include in its Manufacturing Resurgence Program is copper production.

The ore is mined in the Philippines and partially processed by Philippine Associated Smelting and Refining Corp. (PASAR), a remnant of the country’s failed drive to industrialize in the 1970s but which has since been acquired by Swiss mining giant Glencore. PASAR ships its copper cathodes abroad, where they are further processed into wire and sold back to Philippine makers of wiring harness, one of the country’s exports.

“So it’s not an integrated industry,” Mr. Domingo said. “It goes back and forth many times. We’re a very big user of copper wires because we have the wiring harness industry and also for construction requirements. But we import all of that stuff even though the raw materials come from here.”

But there are limits to what industrial clustering can do by way of forging forward or backward linkages, thereby capturing a greater part of the value chain, according to AIM’s Mr. Francisco.

“Twenty years ago, it would have been better to capture a big part of the value chain. But now when we’re in a globalized or regionalized economy, the value chain is already in place, and it would not make any sense to reestablish something somewhere else,” he said. “So, it cannot be the same brand of clustering we talked about 15-20 years ago.”

Take the case of the Comprehensive Automotive Resurgence Strategy (CARS), an ambitious program aimed at establishing the Philippines as a production hub. The program is ambitious since the Philippines has gone down this road more than once in the past. Add to that, Thailand has long established its position as Southeast Asia’s Detroit, with Malaysia a runner-up and Indonesia playing catch up.

Despite initial excitement, local assemblers, mostly belonging to Japan’s big car makers, have toned down their expectations about CARS. The government set what they described as high entry barriers, with no existing player able to meet the minimum production volume to qualify for the program.

Mr. Francisco said services may be a more promising area where the Philippines can latch on to existing regional or global value chains, and claim a bigger share of that value.

“We’re in a situation where we’re already in services,” he said. “How can we join that value chain in manufacturing? Why not go into the services component of that value chain, such as design? We just have to find those niches, add a little more value to it, then we’re great.”

In fact, all eight Philippine companies featured in his upcoming study on ASEAN champions belong to the services sector, such as construction, transport, real estate, utilities and food service.

“Some of them may be monopolies, but there is an impetus on their part to improve service. Because if you do good here, then you start thinking about exporting your service abroad… The strategy of going out is clearer in their vision,” Mr. Francisco said.

McKinsey’s Mr. Moraje cites the Philippines’ supposed edge in the BPO sector, where the non-voice segment already accounts of 40% of the total receipts.

“Digital technologies will revolutionize business processing over the coming decade, and the skills required to succeed will dramatically change as could the volume of jobs needed,” he said. “To continue to grow in the face of this change, the Philippines will need to rapidly grow digital capabilities and talent, while also looking to invent new offshoring models in specific verticals, such as medical tourism, shipping.”

In this regard, “picking winners” -- provided they don’t end up as rent-seekers that cling to state support in the face of repeated failure -- may yet hold promise.

“There’s that part of the development story of any economy where we really have to try it out. If it doesn’t work, then shift our focus to something else. That’s how the Koreans did it, the Taiwanese did it. Because if you don’t pick winners, it takes too long,” Mr. Francisco said.

The key here is to give those industries a chance to come up with linkages and add value. And by linkage, the most important one, he said, is with ASEAN.

“If it’s a potluck, then what are we bringing to the table? BPO? Marketing? Branding? Design? Textbook economics will say manufacturing. But as an opportunity for growth and latching up the value chain, we shouldn’t throw away services. It’s the greatest employer and revenue source,” Mr. Francisco said. “We have the talent, yes. But we need to export not just the people; we need to export the consulting service.”

*Send e-mail to Mr. Tenorio at astenorio@bworldonline.com or follow him on Twitter @arnoldtenorio.

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