Philippines - International Economic Relations

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International economic relations

At independence in 1946, the Philippines was an agricultural nation tied closely to its erstwhile colonizer, the United States. This was most clearly observed in trade relations between the two countries. In 1950 the value of the Philippines' ten principal exports--all but one being agricultural or mineral products in raw or minimally processed form--added up to 85 percent of the country's exports. For the first twenty-five years of independence, the structure of export trade remained relatively constant.

The direction of trade, however, did not remain constant. In 1949, 80 percent of total Philippine trade was with the United States. Thereafter, the United States portion declined as that of Japan rose. In 1970 the two countries' share was approximately 40 percent each, the United States slightly more, and Japan slightly less. The pattern of import trade was similar, if not as concentrated. The United States share of Philippine imports declined more rapidly than Japan's share rose, so that by 1970 the two countries accounted for about 60 percent of total Philippine imports. After 1970 Philippine exporters began to find new markets, and on the import side the dramatic increases in petroleum prices shifted shares in value terms, if not in volume. In 1988 the United States accounted for 27 percent of total Philippine trade, Japan for 19 percent.

At the time of independence and as a requirement for receiving war reconstruction assistance from the United States, the Philippine government agreed to a number of items that, in effect, kept the Philippines closely linked to the United States economy and protected American business interests in the Philippines. Manila promised not to change its (overvalued) exchange rate from the prewar parity of P2 to the dollar, or to impose tariffs on imports from the United States without the consent of the president of the United States. By 1949 the situation had become untenable. Imports greatly surpassed the sum of exports and the inflow of dollar aid, and a regime of import and foreign-exchange controls was initiated, which remained in place until the early 1960s.

The controls initially reduced the inflow of goods dramatically. Between 1949 and 1950, imports fell by almost 40 percent to US$342 million and surpassed the 1949 level in only one year during the 1950s. Being constrained, imports of goods and nonfactor services as a proportion of GNP declined during the 1950s, ending the decade at 10.6 percent, about the same percentage as that of exports. By the late 1950s, however, exchange controls had begun to lose their effectiveness as most available foreign exchange was committed for required imports. A tariff law was passed in 1957, and, from 1960 to early 1962, import and exchange controls were phased out. Exports and imports increased rapidly. By 1965 the import to GNP ratio was more than 17 percent. Another acceleration of imports occurred in the early 1970s, this time raising the import to GNP ratio to around 25 percent, the level at which it remained into the 1990s. Imports in the 1970s were increasingly being financed by external debt rather than by exports.

The composition of imports evolved after independence as industrial development occurred and commercial policy was modified. In 1949, about 37 percent of imports were consumer goods. This proportion declined to around 20 percent during the exchange-and-import control period of the 1950s. By the late 1960s, consumer imports had been largely replaced by domestic production. Imports of machinery and equipment increased, however, as the country engaged in industrialization, from around 10 percent in the early 1950s to double that by the mid-1960s. As a result of the surge in petroleum prices in the 1970s, the import share of both consumer and capital goods fell somewhat, but their relative magnitudes remained the same.

No matter the trade regime, the Philippines had difficulty in generating sufficient exports to pay for its imports. In the forty years from 1950 through 1990, the trade balance was positive in only two years: 1963 and 1973. For a few years after major devaluations in 1962 and 1970, the current account was in surplus, but then it too turned negative. Excessive imports remained a problem in the late 1980s. Between 1986 and 1989, the negative trade balance increased tenfold from US$202 million to US$2.6 billion.

In 1990 weaker world prices for Philippine exports, higher production costs, and a slowdown in the economies of the Philippines' major trading partners restrained export growth to only slightly more than 4 percent. Increasing petroleum prices and heavy importation of capital goods, including power-generating equipment, helped push imports up almost 17 percent, resulting in a 50 percent jump in the trade deficit to more than US$4 billion. Reducing the drain on foreign exchange has became a major government priority.

A number of factors contributed to the rather dismal trade history of the Philippines. The country's terms of trade have fallen for most of the period since 1950, so that in the late 1980s, a given quantity of exports could buy only 55 percent of the volume of imports that it could buy in the early 1950s. A second factor was the persistent overvaluation of the exchange rate. The peso was devalued a number of times falling from a pre-independence value of P2 to the dollar to P28 in May 1990. The adjustments, however, had not stimulated exports or curtailed imports sufficiently to bring the two in line with one another.

A third consideration was the country's trade and industrial policies, including tariff protection and investment incentives. Many economists have argued that these policies favorably affected import-substitution industries to the detriment of export industries. In the 1970s, the implementation of an export- incentives program and the opening of an export-processing zone at Mariveles on the Bataan Peninsula reduced the biases somewhat. The export of manufactures (e.g., electronic components, garments, handicrafts, chemicals, furniture, and footwear) increased rapidly. Additional export-processing zones were constructed in Baguio City and on Mactan Island near Cebu City. During the 1970s and early 1980s, nontraditional exports (i.e., commodities not among the ten largest traditional exports) grew at a rate twice that of total exports. Their share of total exports increased from 8.3 percent in 1970 to 61.7 percent in 1985. At the same time that nontraditional exports were booming, falling raw material prices adversely affected the value of traditional exports.

In 1988 the value of nontraditional exports was US$5.4 billion, 75 percent of the total. The most important, electrical and electronic equipment and garments, earned US$1.5 billion and US$1.3 billion, respectively. Both of these product groups, however, had high import content. Domestic value added was no more than 20 percent of the export value of electronic components and probably no more than twice that in the garment industry. Another rapidly growing export item was seafood, particularly shrimps and prawns, which earned US$307 million in 1988.

The World Bank and the IMF as well as many Philippine economists had long advocated reduction of the level of tariff protection and elimination of import controls. Those in the business community who were engaged in import-substitution manufacturing activities, however, opposed reductions. They feared that they could not successfully compete if tariff barriers were lowered.

In the early 1980s, the Philippine government reached agreement with the World Bank to reduce tariffs by about one-third and to lift import restrictions on some 3,000 items over a five- to six-year period. The bank, in turn, provided the Philippines with a financial sector loan of US$150 million and a structural adjustment loan for US$200 million, to provide balance-of-payments relief while the tariff wall was reduced. Approximately two-thirds of the changes had been enacted when the program ground to a halt in the wake of the economic and political crisis that followed the August 1983 assassination of former Senator Benigno Aquino.

In an October 1986 accord with the IMF, the Aquino government agreed to liberalize import controls and to eliminate quantitative barriers on 1,232 products by the end of 1986. The target was accomplished for all but 303 products, of which 180 were intermediate and capital goods. Agreement was reached to extend the deadline until May 1988 on those products. The liberalizing impact was reduced in some cases, however, by tariffs being erected as quantitative controls came down.

A tariff revision scheme was put forth again in June 1990 by Secretary of Finance Jesus Estanislao. After an intracabinet struggle, Aquino signed Executive Order 413 on July 19, 1990, implementing the policy. The tariff structure was to be simplified by reducing the number of rates to four, ranging from 3 percent to 30 percent. However, in August 1990, business groups successfully persuaded Aquino to delay the tariff reform package for six months.

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