Crossroads (Toward Philippine economic and social progress)
Philippine Star, 17 December 2014


Last week, I wrote about PEZA’s success in attracting foreign direct investments (FDIs). This is the agency that enabled the country to induce companies to manufacture for exports, diversify our export trade and create steady employment of labor in jobs of good quality.

Yet, relative decline of industry to total output. The success of PEZA, though, is not enough to pull the industrial sector substantially forward. PEZA firms, however plentiful, are in general dwarfed by the total size of the national economy and by the sum of all industrial firms serving only the domestic market.

The BOI law – successor to the industrial incentives programs of short term periods (first, the law promoting “new and necessary industries” and later that on “basic industries” of the 1940s and the 1950s-early 60s) – was full of industrial guidance.

It was still the product of a regime of beliefs, that of an age of industrial planning, economic nationalism, import substitution and high protection. On top of this, too, were the important considerations stemming from the Constitutional provisions on restricting FDIs in three sectors of the economy – land ownership, public utilities, and natural resources.

Nationalistic exclusivism as the mindset of BOI incentives. The law that established the BOI in 1967 and the export incentives in 1968 was crafted with all the above principles or objectives in mind. It was basically the handiwork of Sen. Jose W. Diokno, the inheritor of the mantle of nationalism that Claro M. Recto held.

Diokno’s thoughts were more specific. They had a certain bearing on the fate of industries in the country once they got put to work. He essentially set up the legal framework for the investment and export incentives law through the BOI before the country decided to adopt more open policies for encouraging foreign investors through the export manufacturing channel.

Diokno wanted to preserve industrial development in the domestic market for domestic businessmen. He did not want foreign capital to dominate domestic industries. He would therefore introduce provisions of law that made it difficult for foreign direct investments, except when they were put in a minority position no higher than 40 percent of total capital, to receive investment incentives.

In cases of pioneer investment projects, he could allow full foreign ownership but only with a long term plan of divesting their capital contribution. The same kind of preferential treatment was put in place to favor firms even in the export incentives law.

By pushing too hard on the proscription for joint ventures, by following essentially the formula used in defining them, the BOI investment incentives made it more difficult for FDIs to want to come and make investments in the country.

In other countries in Southeast Asia, fully owned FDIs were welcome. Even when the joint venture vehicle became the preferred mechanism for particular types of industrial projects, they allowed more generous proportions of contribution, certainly above the 40 percent that was required.

Economic consequences of inward industrial policies. A major consequence of the BOI law was that it attracted mainly domestic investment ventures designed to serve the local market.

Another was the resistance of foreign capital to venture into the country despite the premise that it was as much welcome in pioneer industries as fully owned as they were, provided they were minority joint ventures with domestic partners.

The domestic firms that applied for incentives – even those proposed by well-to-do proponents – often lacked sufficient capital to leverage on. As a result, the projects tended to be small when they should normally be of bigger scale. The budget constraint often certainly reduced their penetration of the market.

Such firms were also largely prone to borrowing for the finance of new capital equipment and for the purchase of supplies. Many firms were heavy borrowers from the state financial institutions. In contrast, most foreign investments had their own foreign equity capital to rely on and access to world capital markets for working capital.

Such heavy dependence made inevitable the close relationships linking investment proponents with their political patrons in the financing of the projects. This type of cronyism was not a unique aftermath of the BOI incentive system but a common feature of economic policies that involved a lot of state guidance, high protectionism and other forms of subsidy.

Moreover, as the firms promoted were mainly designed to serve the domestic market and earned no foreign exchange revenues, they contributed to the country’s dwindling reserves of foreign exchange and the deterioration of the balance of payments.

A further implication of this situation concerned the credit resources of the state financial institutions from which they borrowed. When they could not effectively service their loans, they also reduced the financial strength of the state financial institutions that extended them credit.

All these conditions conspired to bring about the relative decline of industrial output especially when the country opened to more import competition. This happened especially after the country’s accession to the new World Trade Organization and as the country adopted, as a consequence, a more open trading system.

The firms promoted under these policies of exclusion of foreign capital in the domestic market could not survive the onslaught of a tougher economic environment. Since none of them could earn export income, they became more vulnerable to fluctuations of the peso exchange rate too.

Major basic industries did not advance in scale. Those that were established at one time or other suffered the fate of economic inefficiency marked by high costs. The low state of public resources could not finance the growth of these industries, and neither could the government support them.

Hence, a hollow industrial structure resulted from these earlier failures. At a time when PEZA was succeeding in inviting new companies engaged in the manufacture of goods for exports, the domestic industrial sector was weak and unable to produce and supply growing requirements of export manufacturing locators for some of their needs.

This meant that the growth of export manufacturing industries under PEZA would have less domestic impact except in the form of incomes of workers hired. The firms would have to buy their inputs mainly from abroad.

BOI guidance and PEZA more open policy. BOI guidance of industrial growth – what is often known as “industrial policy” should include a big role for foreign capital. Without that inclusive component for scarce resources, any roadmap for industrial policy is likely to encounter a difficult if not a dead-end.