Retail Trade Policy and the Philippine Economy

Submitted to:

Trade and Investment Policy Analysis and Advocacy Support (TAPS) -Philippine Exporters Confederation

A Project of: Policy and Development Foundation, Inc.

1999

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Part I

An Integrative Report

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Retail Trade and Liberalization: Towards Retailing and Distribution Services for the 21st Century

The project was commissioned by PHILEXPORT-TAPS to examine further the

policy issue of retail trade liberalization. The contributions of the project to the ongoing

discussion on the liberalization issue as well as to future discussions on the development

of the retail trade sector are as follows:

• The project provides more detailed information about the state of the

Philippine retail and wholesale trade sector than earlier studies.

• The project emphasizes the importance of addressing the entire

distribution sector rather than just the retail trade industry.

• The project examines, and draws insights for the issue of retail trade

liberalization in the country from, the experiences on retail trade

regulation in OECD countries, retail trade deregulation in Japan, and the

liberalization of selected service industries in the OECD countries and the

Philippines.

The study team was headed by Dr. Ponciano S. Intal,Jr., Executive Director of the

DLSU Angelo King Institute for Economic and Business Studies, De La Salle University

and former President of the Philippine Institute for Development Studies (PIDS). The

members of the study team were: Dr. Myrna Austria, Research Fellow, PIDS; Dr. Cesar

Cororaton, Research Fellow, PIDS; Ms. Melanie Milo, Research Associate, PIDS; and

Ms. Rafaelita Aldaba, Research Associate, PIDS. Research support was provided by Mr.

Ronald Yacat (programmer) and Ms. Leilanie Basilio, Mr. Euben Paracuelles and Ms.

Janet Cuenca (research assistants). The study team benefited a lot from the support and

understanding of Ms. Pilipinas Quising of PHILEXPORT-TAPS as well as the

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administrative support of Ms. Corazon Marquez and Mr. Oscar Laspunia of Policy and

Development Foundation, Inc. (PDFI).

The Project Report consists of three parts. Part One is the integrative report. It is

composed of three chapters; namely, Chapter One, on the structure and development of

the Philippine distribution industry and on the competitive pressure and efficiency of the

distribution sector and the retail trade industry; Chapter Two, on regulation and

regulatory changes in retail trade and selected service industries in OECD countries and

the Philippines; and Chapter Three, on retail trade nationalization and liberalization:

towards retailing and distribution services for the 21st century. Part Two consists of four

supporting and related studies on the liberalization of the banking, insurance and

telecommunications industries, the issue of franchising and technology transfer and the

simulations on the impact of foreign direct investment in retailing on the rest of the

economy. Part Three consists of Appendix tables.

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Chapter I

Structure and Development of the Philippine Distribution

Industry

I. Contribution of the distribution sector to the economy

Output and Employment. The distribution sector; i.e., wholesale and

retail trade, is an important and rising sector of the Philippine economy. The sector

accounted for 15.6 percent of GDP in 1998, up from 14.5 percent in 1985 (see Table 1).

The bulk of the value added in the sector is contributed by the retail trade sub-sector,

accounting for about four-fifths in 1985 and three-fourths in 1998. The decline in the

share of retail trade to the total value added in the distribution sector stems from the faster

growth of the wholesale sub-sector during the period. Indeed, the share of wholesale

trade to the national output increased significantly while that of retail trade actually

declined marginally during the past decade or so.

The contribution of the distribution sector to total output varies

considerably among the regions in the country. The top four regions in terms of the share

of the distribution sector to the regional gross domestic product are Central Visayas,

Western Visayas, Northern Mindanao and Southern Mindanao. Their trade shares are

much higher than the national average, with Central Visayas being the most trade

dependent at 29 percent of regional output (see Table 1). The four regions with the

lowest shares are CAR, ARMM, Eastern Visayas and Central Mindanao. These four

regions are among the poorer regions in the country. Metro Manila, which dominates

much of the country’s wholesale and retail trade, is actually less trade dependent than the

national average. Nevertheless, Metro Manila accounts for more than a quarter of the

national value added in retail and wholesale trade. Similarly, Southern Tagalog and

Central Visayas together account for another quarter. A trio of regions -Western Visayas,

Southern Mindanao and Central Luzon - contribute another quarter. Thus, trading activity

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in the country is largely concentrated in 6 or 7 regions (including Northern Mindanao)

that tend to be the “richer” regions in the country.

The distribution sector is also a major and rising source of employment in

the country. The sector accounted for 13.8 and 15.1 percent of total employment in 1991

and 1997, respectively. The sector is even more important for female employment as it

accounts for a quarter of total female employment in the country. Indeed, the sector

depends overwhelmingly on female employment: females account for nearly two-thirds

of total employment in the sector. Finally, employment in the sector is primarily

concentrated in the informal sector, accounting for nearly three-fourths of total

employment in 1995. Nonetheless, the underemployment rate (i.e., the percentage of

underemployed to total employed) in the sector is less than the national average for all

the sectors. (See Table 2.)

The shares of the distribution sector to total output and employment,

respectively, in selected countries are shown in Table 3. The Philippine output share is

comparable to those of Italy and the United States, higher than those of Malaysia, Korea,

Japan, France and Germany but lower than those of Indonesia, Australia, Singapore and

Hong Kong. There is no discernible relationship between the output share and per capita

income. Nonetheless, in most of the countries, the distribution sector contributes a

substantial share to national output. The importance of the distribution sector is even

more pronounced with respect to employment. The figures for the OECD countries in

Table 3 show substantially higher employment shares compared with output shares.

Notice that the employment share of the distribution sector in the Philippines is lower

than many OECD countries. This suggests that, given the still low per capita income of

the Philippines vis-à-vis the OECD countries, the distribution sector in the Philippines

can be expected to be a major generator of employment in the country in the future.

Number of establishments and retail density. There were about 208,732

wholesale and retail establishments in the country in 1995, up by 15 percent from the

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181,576 wholesale and retail establishments in 1991. Out of the 208,730 in 1995, 185,968

were retail establishments (6,628 large and 179,340 small) and 22,762 were wholesale

establishments (2,778 large and 19,984 small). These establishments are those included in

the annual surveys of wholesale and retail establishments for 1991 and 1995. The annual

surveys and census of establishments include only sari-sari stores with at least one

regular employee. They do not include “…pseudo-establishments found in stalls, booths,

or stands that could easily transfer or disappear, e.g., open market stalls, movable

magazine and book stands, etc.” (NSO). In short, the census and annual surveys cover

mainly the formal retail sub-sector and do not include the large informal retail segment in

the country. 1

As a comparison, there were about 96,703 manufacturing establishments

in 1995 in the country. Thus, wholesale and retail trade establishments are far more

numerous than manufacturing establishments. The big gap in the number of

establishments can be explained in part by the small size of a typical retail establishment

compared to a typical manufacturing concern. Nonetheless, what the numbers indicate is

that wholesaling and retailing contribute significantly to business activity in the country.

Pilat (1997) states that in a typical OECD country the wholesale and retail

trade sector accounts for between 25 percent to 30 percent of all enterprises, which is

substantially higher than the sector’s contribution to national output. The Philippine case

follows the OECD case; indeed, perhaps more so, similar to the poorer OECD countries

like Greece and Portugal where wholesale and retail establishments account for about 40

percent of all enterprises because of the comparatively small size of the retail

establishments.

Table 4 presents the retail density as well as the retail and wholesale

density in the Philippines by region in 1991 and 1995. Retail density in the Philippines

inched up from 25 establishments per 10,000 population in 1991 to 27 establishments in

1 For the issue of opening up the retail trade industry to foreign investment, it is the formal retail trade sub-sector which is most relevant.

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1995. The national average of the combined retail and wholesale density hovered

between 29 to 30 establishments per 10,000 population during the period. The national

average for retail density masks a wide range of retail densities among the country’s

regions. The highest retail densities are in Metro Manila and, surprisingly, Western

Mindanao; the lowest retail densities are in the Autonomous Region of Muslim Mindanao

(ARMM) and Eastern Visayas. There is no clear cut relationship between the level of

economic development of a region and its retail density, although Table 4 indicates that

the poorest regions in the country (i.e., ARMM, Eastern Visayas and Bicol) have the

lowest retail densities.1 Nevertheless, Table 4 also indicates that the retail densities of

most of the regions inched up during the early 1990s.

The retail density in the OECD countries is shown in Table 5. What is

most striking from the table is that the retail density in the OECD countries is

substantially higher than the retail density in the Philippines; indeed, in a number of

OECD countries, it is several times higher than that of the Philippines. Table 5 also

shows that the retail density of the poorer OECD countries (e.g., Greece, Portugal, Spain)

increased significantly during the 1955-1990 period, while the retail density of the richer

and more densely populated OECD countries declined during the period (e.g., Japan,

Germany, France, United Kingdom, Belgium, Denmark, Netherlands).

The OECD experience suggests that there seems to be an “inverted U”

relationship between retail density and per capita income. That is, as a low middle

income country develops, its retail density increases; however, after reaching some

“turning point” per capita level (range), its retail density secularly declines. This

“inverted U” relationship is similar to the Kuznets curve relating the degree of income

inequality and per capita income. Drawing from Table 5, it appears that the level of per

capita income for the turning point in retail trade density appears to be significantly

1 As noted earlier, the census and annual survey data do not include the “pseudo-establishments” and sari-sari stores without any regular employee. It is likely that the poorer the region is, the higher would be its reliance on the informal retail trade sector. Thus, the very low retail density in the poorest regions of the country may reflect in part the larger importance of the informal sector in these regions.

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higher than the generally accepted turning point per capita level (range) in the

distribution of income.

The historical experience of the OECD countries is instructive for the

likely future path of Philippine retailing. Given the far lower retail density and per capita

income of the Philippines relative to the OECD countries, Table 5 suggests that there

remains a huge scope for the growth in the number of retail establishments in the

Philippines as the country grows over time. (Notice that Korea, one of the new members

of OECD, had a retail density of 166 establishments per 10,000 population in 1990.) It

must be noted that the retail density estimate for the Philippines does not include much of

the informal retail sector. It is likely that the OECD countries do not also include the

informal sector although it is probable that the share of the informal sector in the

Philippines is higher than in the OECD countries. Nevertheless, the vast gap in the retail

densities between the Philippines and the OECD countries indicates the vast scope for

growth of the country’s formal retail trade sector in consonance with the growth of the

economy and the rise in per capita income. The expansion of the formal retail trade sector

may arise either from the “graduation” of hitherto informal establishments into formal

retail establishments (as per the definition in the annual surveys and censuses) or from the

establishment of altogether new stores and shops.

Industry classification of the distribution sector. In the censuses and

annual surveys, the National Statistics Office (NSO) defines wholesale trade as the

“resale or sale without transformation of new and used goods to retailers, to industrial,

commercial, institution or professional users, to other wholesalers, and to government,

wholesale merchant, industrial distributors, exporters and importers”. Likewise, retail

trade is defined by NSO as the “resale or sale without transformation of new and used

goods for personal or household consumption” (NSO). The wholesale trade sub-sector

and the retail trade sub-sector are decomposed further according to the kinds of products

resold and the nature of outlets. Thus, the industry classification at the 3-digit PSIC is as

follows:

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Wholesale Trade:

• Farm, forest and marine products

• Processed food, beverages and tobacco products

• Dry goods, textiles and wearing apparel

• Construction materials and supplies

• Office and household furniture, furnishings, and appliances and

wares

• Machinery equipment, including transport equipment

• Minerals, metals, and industrial chemicals

• Petroleum and petroleum products

• Wholesale trade, n.e.c.

Retail Trade:

• Books, office, school supplies, including newspapers and

magazines

• Food, beverages and tobacco

• Dry goods, textiles and wearing apparel

• Construction materials and supplies

• Office and household furniture, furnishings, and appliances and

wares

• Transportation, machinery and equipment, accessories and supplies

• Medical supplies and equipment stores

• Petroleum and other fuel products

• Retail trade, n.e.c.

Notice the similarity in the industry disaggregation of wholesale and retail

trade at the 3-digit PSIC level. Table 6 presents the industry disaggregation at the 5-digit

level. For retail trade, the more familiar retailing institutions listed in Table 6 are

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groceries (PSIC no. 62211), supermarkets (62212), sari-sari stores (62213), department

stores and bazaars (62301), hardware stores (62401), drug stores (62701) and gasoline

stations (62801). What Table 6 brings out with respect to retail trade is the great diversity

of retail activities and retailing institutions. This reflects the market and institutional

responses to the varied consumer wants as well as the apparently growing specialization

and changes in retailing formats in the provision of retailing services.

Industry composition. There is a preponderance of retailers and

wholesalers in the food, beverages and tobacco classification, followed by retailers and

wholesalers in dry goods, textile and wearing apparel. The third most numerous retail and

wholesale establishments are in the wholesaling and retailing of construction materials

and supplies (see Table 7). The preponderance of retailers and wholesalers in food,

clothing and housing is not surprising because they constitute the bulk of expenditures of

a Filipino consumer. In 1991, 48.5 percent of total family expenditures was spent on

food, 13.5 percent on housing1, 3.7 percent on clothing, footwear and other wear, and 2.7

percent on beverages and tobacco. In 1997, 43.9 percent of total family expenditures was

on food, 15.4 percent on housing, 3.3 percent on clothing, footwear and other wear, and

2.1 percent on beverages and tobacco. Thus, expenditures on food, clothing, housing,

beverages and tobacco as a share of total family expenditures was 68.4 percent in 1991

and 64.7 percent in 1997, respectively (NSCB).

There is a significant difference in the industry composition of large

wholesalers and retailers from the small wholesalers and retailers. (A “ large” wholesaler

or retailer is an establishment with average total employment of 10 or more people; a “

small” wholesaler or retailer has less than 10 people average employment.) (See Table

7.) The biggest number of large wholesale establishments is in the dealership of

machinery and equipment (especially the dealership of commercial and industrial

1 Housing expenditures is composed primarily of rentals and house maintenance expenditures. Much of construction expenditures is on house construction, which is an investment expenditure. Much of wholesaling and retailing of construction materials and supplies cover both investment and consumption expenditures of households, apart from investment expenditures of firms and the government.

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machinery and equipment), followed closely by wholesale trade not elsewhere classified

(which is dominated by merchandise brokers, general merchants, importers and

exporters), followed by wholesalers of paper and paper products. Small wholesalers are

concentrated in the wholesaling of farm, forest and marine products (which are primarily

wholesalers of grains such as rice and corn and wholesalers of coconut and coconut

products), followed by the dealing of minerals, metals and industrial chemicals except

petroleum (the most numerous of which are in scrap metal). In retailing, the top three

sub-industries in terms of number of establishments are the same for both the large and

small establishments, although there is a slight difference in ranking. The top three are

the retailing of food, beverages and tobacco, retailing of dry goods, textiles and wearing

apparel, and finally, retailing of construction materials and supplies. The most numerous

of the retail establishments in food, beverages and tobacco are sari-sari stores, groceries

and retailers of cereals (e.g., rice, corn) and pulses. Retailers of dry goods, textiles and

wearing apparel are concentrated in the retailing of wearing apparel and footwear.

Hardware stores, retailers of construction materials and lumber retailers account for the

bulk of retail establishments in construction materials and supplies.

There is no detailed information on wholesale and retail trade establishments

after 1995. Nevertheless, it is likely that the same general features of the early 1990s

remain. Drawing from the survey data, there may be a possible reduction in the share of

small retailers in food, beverage and tobacco as well as of small retailers in dry goods,

textiles and wearing apparel. The decline would probably be due to the graduation of

some of the establishments into the “large” category. Another possible reason is the

secular decline in the share of food expenditures to total family expenditures during the

period.

The industry composition of total sales, value added and employment for

small and large establishments in wholesale and retail trade are shown in Table 8, Table

9 and Table 10. Wholesale trade is largely the province of large establishments because

they account for the bulk of sales, value added and even employment. In contrast, retail

trade is largely small scale, with small establishments dominant in employment

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generation and accounting for more than half of retail value added despite the much

larger gross sales of large retail establishments than the gross sales of small retail

establishments.

Large establishments accounted for 84 percent of total sales and 91

percent of gross value added in wholesale trade in 1991. The corresponding shares in

1995 were 74 percent and 79 percent, respectively. There is thus a significant shift in

composition towards the small establishments in wholesaling during the period. Notice

that the total value of gross value added of large establishments in wholesaling declined

in absolute terms during 1991-1995 while that of small wholesale establishments more

than doubled. In contrast, the composition of gross sales and value added shifted in favor

of large establishments in retailing during the period. The share of large establishments in

gross sales and gross value added in retail trade rose from 53 percent and 38 percent,

respectively, in 1991 to 55 percent and 46 percent respectively in 1995. In terms of

employment, the share of large establishments declined in wholesaling from 58.6 percent

in 1991 to 54.6 percent in 1995 but increased in retailing from 20.8 percent to 22.1

percent during the same period. The level of employment of large wholesalers declined in

absolute terms during the period, accounting for the significant drop in the share of large

wholesalers to the total employment in wholesaling during the early 1990s.

A more detailed disaggregation of gross sales, gross value added and

employment in wholesaling and retailing at the 5-digit PSIC level is shown for 1994 in

Appendix Table A.1. Among the large wholesale establishments, wholesaling of

petroleum and petroleum products dominated in terms of gross sales and gross value

added, accounting for 24.1 percent and 20 percent respectively of total gross sales and

gross value added of large wholesale firms. The next five industries were wholesaling of

medicinal and pharmaceutical products, wholesaling of processed food, wholesaling of

beverages, dealing of land motor vehicles and parts, and merchandise brokers, general

merchants, importers and exporters. Notice that the top six industries are also the major

employers among the large wholesalers, with the sole exception of petroleum and

petroleum products wholesaling which is in fact one of the lowest employment

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generators. Among the small wholesalers, wholesaling of petroleum and petroleum

products is also the most important in terms of gross sales and gross value added, while

contributing only a few to employment. The other major contributors to gross sales are

wholesaling of grains, wholesaling of cement and masonry products, beverage and

processed food wholesaling, and wholesaling of coconut and coconut by-products. The

most important employment generators among small wholesalers are the wholesalers of

grains and coconut and coconut by-products.

In retailing, department stores and bazaars contributed the largest to gross

sales, gross value added, and employment of large retailers accounting for 22.9 percent,

36 percent and 22 percent, respectively in 1994. The other major contributors to gross

sales, gross value added, and employment are retailing of motor vehicles, supermarkets,

groceries, gasoline stations, and retailing of household appliances. Retailing is dominated

by small establishments when it comes to employment and gross value added. The most

important employment generators are sari-sari stores, department stores and bazaars,

groceries, retailers of rice, corn and other grains and pulses, hardware stores, drug stores

and retailers of automotive parts. The major contributors to gross value added were food

and beverages retailing, department stores and bazaars, retailing of household appliances,

groceries and sari-sari stores. Department stores and bazaars accounted for the largest

share to total sales among small retailers, followed by gasoline stations, food and

beverage retailers, n.e.c., groceries, hardware stores, and retailers of household

appliances.

Regional Distribution. The regional distribution of the number of

establishments in wholesaling and retailing for 1991 and 1995 is shown in Table 12. The

regional distribution of gross sales, gross value added and total employment in wholesale

and retail is presented in Table 13. Not surprisingly, Metro Manila houses the majority

of large wholesale firms, and even to some extent, retail firms. In 1991, Metro Manila

accounted for 60 percent of the country’s large wholesale firms and 47 percent of all the

large retail establishments. In 1995, Metro Manila accounted for 56.7 percent of the

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country’s large wholesale establishments and 45.2 percent of the large retailers. The

dominance of Metro Manila in large wholesale and retail establishments is even more

evident in terms of gross sales and gross value added. Metro Manila’s large wholesale

and retail establishments accounted for 69 percent of gross sales and 75 percent of gross

value added of all large wholesale and retail establishments in 1991, although the shares

declined to 64 percent and 67 percent, respectively, in 1995. For the whole distribution

sector, Metro Manila accounted for 63 percent of total sales and 68 percent of gross value

added of both wholesale and retail trade in 1991, although the corresponding shares in

1995 declined significantly to 50 percent for both gross sales and gross value added.

The share of Metro Manila to gross sales, gross value added and

employment by industry in 1995 is shown in Table 14. The table shows that Metro

Manila virtually monopolizes the large establishment segment in a number of industries,

particularly wholesaling of office and household furniture, furnishings and appliances

(615), wholesale trade not elsewhere classified; i.e., merchandise brokering, import and

export (619), dealing of machinery and equipment (616), retailing of books, office and

school supplies (621) and retailing of dry goods, textiles and wearing apparel (623).

Notice in Table 14 that the share of Metro Manila in gross value added is generally

higher than its share in gross sales for large wholesale enterprises, suggesting that much

of the returns of wholesaling in the country accrues to the Metro Manila large

wholesalers. Metro Manila is not as dominant in retailing as in wholesaling, especially

for small retail establishments. Nevertheless, the region is still an important presence

especially in the retailing of office and household furniture, furnishings and appliances

(625), retailing of books and office and school supplies (621), retailing of transport

machinery and equipment, accessories and supplies (626), and retailing of construction

materials and supplies (624). The large presence of Metro Manila even in retailing stems

from the fact that the region is the premier retail market in the country given its large

population and higher per capita income.

In comparing the total sales by region by industry in 1991 and 1995, the

share of Metro Manila declined in a number of industries but increased in a few others

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during the early 1990s. Specifically, Metro Manila’s share in gross sales declined in the

wholesaling of farm, forest and marine products (611), wholesaling of processed food,

beverages and tobacco (612), dealing of petroleum and petroleum products (618) and

retailing of food, beverages and tobacco (622). On the other hand, Metro Manila

increased its share to total gross sales in industries such as the wholesaling of office and

household furniture, furnishings and appliances and supplies (615), retailing of transport

machinery and equipment, accessories and supplies (626) and retailing of construction

materials and supplies (624). The changes in shares appear to indicate that Metro Manila

is losing share in favor of other regions in the wholesale and retail trade of “basic

commodities” (e.g., farm and processed food, dry goods, textiles and wearing apparel)

but it is gaining market shares in the commodities with higher income elasticity of

demand, e.g., office and household furniture and appliances, transport equipment.

In summary, the retail trade sub-sector consists primarily of small

establishments but the small number of large retail establishments (mainly Metro Manila

based) account for nearly one half of total retail sales in the country. Wholesale trade

sales is dominated by large establishments in most wholesale trade lines, and Metro

Manila’s large wholesalers dominate wholesaling in a number of wholesale lines. Metro

Manila’s large wholesalers also captured much of the returns from wholesaling among all

large establishments in the country. The dominance (and virtual monopoly in a few

wholesale lines) of Metro Manila, although not at all unexpected, has significant bearing

on the efficiency and cost of the country’s distribution system. It is likely that

transportation bottlenecks and the price margins between Metro Manila and the rest of

the country can be explained in part by the concentration of wholesaling in Metro Manila.

It may also suggest low competitive pressure (and possibly even cartel in certain lines)

which can have possible negative impact on the entire distribution sector in the country.

The findings on gross margins bring out the issue of competitive pressure in wholesale

trade as much as in retail trade.

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II. Efficiency and Competitive Pressure in the Distribution Sector

and the Retail Trade Industry

Gross Margins. In the public hearing of the Senate Committee on Trade and

Commerce on October 9, 1998, Mr. Roberto Claudio of the Philippine Retailers

Association stated that Philippine retailers are operating on a 20 to 25 percent gross

margin. This compares well with other Asian retailers which are operating on 40 to 50

percent gross margin and North American retailers at 60 to 80 percent gross margin.

Gross margins are widely used as indicators of the competitive pressure and/or

efficiency in the distribution sector. Specifically, the lower the margin is, the keener

price competition is likely to be (and firms would have to be more efficient to survive

the competition).

This section presents estimates of gross margins by industry based on the

results of the 1988 and 1994 Census of Establishments. The estimates are compared with

some estimates for a few OECD countries in the 1970s and 1980s, industry–level

estimates for the UK in the 1950s and Japan in the 1980s, and estimates for a few retail

chains in the UK and France in the 1990s. The estimates and comparisons help clarify

Mr. Claudio’s statement and point to the need to widen the policy concern towards the

whole distribution sector and not just the retailing sub-sector.

Estimates of the gross margin (as a ratio of gross sales) in both the

wholesale and retail trade sub-sectors by industries for large and small establishments in

1988 and 1994 are presented in Table 15. The average gross margin for all wholesale

establishments was 20 percent in 1988 and 29 percent in 1994; the average gross margin

for all retail establishments was 19 percent for both 1988 and 1994. The average gross

margin of large retail establishments was 16 percent in 1988 and 15 percent in 1994; the

corresponding gross margin for small retail establishments was 24 percent in 1988 and 25

percent in 1994. The average gross margin of large wholesale establishments was 19

percent in 1988 and 22 percent in 1994; the average gross margin of small wholesale

establishments was 30 percent in 1988 and 21 percent in 1994. Thus, on the average,

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wholesale trade posted higher gross margin compared to retail trade in 1988 and

especially in 1994. The gap is particularly evident among large establishments.

There is a wide variation in gross margins among industries and by

establishment size around the mean values in both wholesale and retail trade. Drawing

from the 1994 Census data, industries that registered low gross margin (i.e., 12 percent or

below) include the following:

All establishments:

• Gasoline stations

• Groceries

• Supermarkets

• Land motor vehicles and parts, dealing

• Lumber and planing mill products, wholesaling

• Tobacco products, wholesaling

Large establishments:

• Gasoline stations;

• Liquefied petroleum gas retailing

• Drug stores

• Supermarkets

• Fish and other seafoods retailing

• Rice, corn and other grains and pulses retailing

• Motor vehicles, including used vehicles, dealing

• Textile fabrics, retailing

• Cement and masonry materials wholesaling

• Lumber and planing mill products, retailing

• Tobacco products wholesaling

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Small establishments:

• Gasoline stations

• Petroleum and petroleum products, wholesaling

• Fish and other seafoods, wholesaling

• Tobacco leaf, wholesaling

• Cement and masonry materials, wholesaling

Industries which had very high gross margin (i.e., 36 percent and up) include the

following:

All establishments:

• Electrical materials wholesaling

• Footwear, all kinds of materials, wholesaling

• Nonmetallic minerals wholesaling

• Handicraft products wholesaling

• Scraps, except metal, wholesaling

• Art goods, marble products, paintings, and artists supplies,

retailing

• Optical goods and supplies, retailing

• Toys and gifts retailing

Large establishments:

• Wearing apparel, wholesaling

• Electrical materials, wholesaling

• Agricultural machinery, equipment and accessories, dealing

• Flowers and plants, wholesaling and retailing

• Handicraft products, wholesaling and retailing

• Musical instruments, amusement goods and toys, wholesaling

• Radio and TV parts and accessories, retailing

• Art goods, marble products, paintings and artists supplies

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• Medical, surgical and dental equipment and supplies, retailing

• Optical goods and supplies, retailing

• Toys and gifts retailing

Small establishments:

• Beverage wholesaling

• Footwear wholesaling

• Cordage, rope and twine

• Electrical materials, wholesaling

• Agricultural machinery, equipment and accessories, dealing

• Nonmetallic minerals, wholesaling

• Industrial chemicals, dealing

• Medical and pharmaceutical products, wholesaling

• Handicraft products, wholesaling

• Scraps, except metal, wholesaling

• Paper and paper products, wholesaling

• Books, office and school supplies, retailing

• Bakery products, retailing

• Leather goods, retailing

• Nipa, bamboo and rattan, retailing

• Art goods, marble products, paintings and artists supplies

• Office machines and equipment, retailing

• Optical goods and supplies, retailing

• Fresh and artificial flowers, retailing

• Photographic equipment and supplies, retailing

The wide variation of gross margins among sub-industries is not surprising

given the wide variety of products and shop types. It appears that stores that rely on

volume tend to have low gross margins (e.g., drug stores, gasoline stations,

supermarkets), although administered pricing and government-mandated price guidelines

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may have also contributed to the low margins for automobile dealers and gasoline

stations, respectively. It also appears that gross margins tend to be higher for

commodities that are more perishable or breakable (e.g., fruits and vegetables) and for

commodities with high unit value but low traffic and therefore with high inventory costs.

Nevertheless, only detailed industry or commodity analyses can unravel the reasons

behind the high gross margins; this is beyond the scope of the paper and the study report.

Gross margin by establishment size. The discussion above highlights that

on the average small establishments tend to have higher gross margins. Table 11

elaborates on this by decomposing further the gross margin by establishment size at the

3-digit PSIC level and in a few cases at the 5-digit level. The table indicates that for the

most part, the pattern of the gross margin follows somewhat a U-curve, in that sense that

the gross margin starts relatively high for very small establishments, declines as the

establishment size increases and then turns up at a higher level of employment.

Industries that tend to follow the U-curve pattern include the following:

• department stores and bazaars (62301),

• groceries (62211),

• farm, forest and marine products wholesaling (611),

• office and household furniture, furnishings and appliances

wholesaling (615),

• construction materials and supplies retailing (624),

• office and household furniture and furnishings, fixtures, and

appliances and wares retailing (625).

• supermarkets

Another discernible pattern of the gross margin by establishment size is

the initial high gross margin at the very low establishment sizes followed by reduction to

a low level as the establishment size increases; the gross margins tend to hover near the

22

low level as the establishment size increases further. This pattern is akin to an L-shape.

Industries that tend to follow this pattern include:

• transport machinery and equipment, accessories and supplies

retailing

• petroleum and other fuel products retailing, and

• medical supplies and equipment stores

The “L-shape” pattern merits attention because it suggests that there are

constant returns to scale beyond the small scale of operations. The petroleum and other

fuel products retailing industry appears to exemplify the L-shape pattern. This implies

that petroleum distribution can accommodate an appreciable number of large distributors.

However, it is the “U-shape” pattern that seems to be dominant in the Philippine

distribution sector, especially the retailing industry.

The U-shaped pattern of the gross margin is not unique to the Philippines.

Hughes and Pollard (1957) found that the U-shaped pattern characterized the majority of

the retail industries in Great Britain in the 1950s. Hughes and Pollard explained the U-

shaped pattern as arising from the large establishments not passing all the benefits of bulk

purchase to their consumers while the small stores, buying at unfavorable rates, had to

charge higher prices to recoup their investments or had to limit their stocks to high-

margin goods. It was the middle-sized stores, the bulk with working proprietors which

had the lowest margins (Hughes and Pollard, 1957). The explanation of Hughes and

Pollard for the case of Great Britain in the 1950s seems to be relevant also for the

Philippines in the 1990s. That is, it is likely that the high gross margin of small

establishments has much to do with unfavorable purchase rates. It may also reflect the

willingness of customers to pay for the convenience and small lots that neighborhood

stores provide. Similarly, the gross margin of large establishments may reflect the

decision not to pass to consumers the benefits of bulk purchases. It may also reflect the

possible turning up of the average cost of operations arising from diseconomies of scale.

23

The U-shaped pattern of gross margin implies that there are limits to the expansion of an

organization.

Gross margins by location. Gross margins differ widely among provinces

just as there is a wide variation in gross margins among industries. Gross margin ratios

at the provincial level at the three digit level are shown in Table 17. The gross margin

ratios in selected wholesale and retail industries (at the 5-digit level) in Metro Manila,

Cebu and Zamboanga del Sur are shown in Table 18. The gross margin results seem to

be idiosyncratic; that is, the gross margin in each industry of each province is

determined uniquely by the circumstances affecting such industry in the given province.

Nonetheless, the tables seem to bring out the following:

• Gross margins tend to be higher in the provinces than in Metro Manila,

except especially in the wholesaling of farm, forest and marine products.

There is an even number of higher and lower gross margin ratios (than

Metro Manila’s) in the retailing of construction materials and supplies as

well as of petroleum products. It appears that gross margins in the

provinces tend to be lower or as low as Metro Manila in industries where

the source of supply is largely outside of Metro Manila (e.g., farm, forest

and marine products; construction materials) or where there may be an

industry practice of low margin (e.g., petroleum retailing industry).

• In a number of difficult-to-reach provinces such as the mountainous

provinces of Mt. Province, Lanao del Sur and Bukidnon, gross margins

tend to be high, especially for goods that are mainly sourced from the

Metro Manila area and environs (e.g., processed foods, dry goods). In

addition, retailing in these provinces is largely undertaken by small

establishments which tend to have higher margins.

24

• Cebu and (to a lesser extent) Iloilo tend to have comparatively lower gross

margins than Metro Manila in a number of industries; this may be due to

their being at the cross-roads of inter-island shipping in the country.

• In many instances, the high gross margins in the provinces is linked to the

preponderance of small retail establishments which, on the average for the

country, have higher gross margins than large establishments.

Gross margins of other countries. Gross margins in a few developed

countries are presented in Table 19 and Table 20 as points of comparison for the

Philippines. Table 19 presents the average gross margin for wholesale trade, retail trade

and the entire distribution sector. The table highlights two major differences between the

Philippines and the developed countries. The first one is that whereas in the Philippines

the gross margin in wholesale trade is higher than the gross margin in retail trade, in

developed countries the gross margin in wholesale trade is lower than the gross margin in

retail trade.

The second major difference is that the gross margin of the entire

distribution sector in the Philippines is lower than the gross margins of the developed

countries. The lower gross margin of the entire distribution sector in the Philippines

stems primarily from a much lower retail trade margin despite a much higher wholesale

trade margin. Notice also that in comparing the 1988 and 1994 estimates for the

Philippines, the gross margin of the entire distribution sector declined despite a sharply

higher wholesale trade margin because of the decline in the retail trade margin. In effect,

it has been the squeeze in the retail trade margin that contributed to the comparatively

low and declining gross margin in the entire distribution network.

The comparatively higher wholesale trade gross margin in the face of the

comparatively low retail trade margin suggests that the overriding policy concern for the

further reduction in the gross margin of the distribution sector is not so much the retail

trade sector but the high margin in the wholesaling sector and further improvements in

25

the distribution network including such ancillary services as transportation and handling

services. In the ongoing debate on the liberalization of the retail trade subsector, what

the above finding indicates is that an important but overlooked issue is whether or not

retail trade liberalization can be used as an indirect means of inducing greater

competitive pressure in the wholesale trade sector. In this regard, an important

development in retailing in the developed countries during the past two decades has

been the integration of wholesaling and retailing operations by major retail chains.

Retail chains have shifted toward central distribution systems as merchandise goes

through consolidation warehouses and distribution services. As a result, retail chains

have provided competitive pressure on wholesale trade and indeed have led toward the

demise of traditional merchant wholesalers (Sternquist and Kacker, 1994, p.36). Thus, in

the ongoing debate in the country on the liberalization of the retail trade industry, it is

important to take into account the possible impact of foreign retailers on the structure of

gross margins in the entire distribution sector. Larger foreign retailers which have used

the integration of wholesale and retail operations as a source of their competitive

advantage have the greater potentials for instituting innovative processes and

mechanisms into the country’s distribution sector. This points to a policy bias in favor of

a more liberal policy stance toward large foreign retailers.

Table 20 compares the Philippine gross margins in a few retailing

industries with those of Japan and the United Kingdom. The table shows that retail gross

margins in the Philippines are lower than in Japan. The comparison with the UK

estimates in 1950, when perhaps there is greater similarity between the Philippines now

and the UK then, also indicates that Philippine retail margins are either comparable or

lower. Thus, the comparisons echo the earlier finding based on Table 19; that is, gross

margin in retailing in the Philippines is comparatively lower than in developed countries.

26

Corstjens, Cortsjens and Lal (1995) present the following estimates of

gross margins of selected major French and UK (grocery) retail chains in the early 1990s:

• Carrefour (Fr.): 12 % Sainsbury (UK) 21 %

• Promodes (Fr.) 11 Tesco (UK) 21

• Casino (Fr.) 16 Argyll (UK) 20

The UK chains have higher gross margins than the French chains because the

former generate a much higher share of private label sales to total sales than the French

chains (Corstjens, Corstjens and Lal, 1995). The gross margin of large establishment

groceries in the Philippines in 1994 (see Table 15) is lower than the gross margins of the

French chains and especially of the UK chains

In summary, retail margins in the Philippines are generally lower than those

in a number of OECD countries which are the likely sources of retail investments into the

country. The gross margins of the more popular retail types are in general very low

except for department stores. However, the wholesale gross margins in the Philippines

are substantially higher than the wholesale margins in OECD countries. This brings to the

fore that the important policy concern for the government is how to improve the

efficiency of, and reduce margins in, the entire distribution sector (and especially the

wholesale trade industry) and not just the retail industry.

Concentration ratio and competition. The financial profile of the Top 2,000

corporations in the Philippines was used to estimate concentration ratios in selected

wholesale and retail trade industries for 1991-1995. The data for the gross sales for all

establishments were taken from the annual survey of wholesale and retail establishments,

except for 1994 which used the 1994 Census results. The concentration ratios at the 3-

digit PSIC level for 1991, 1992, 1993 and 1995 are shown in Table 21 while the

concentration ratios at the 5-digit level for 1994 are shown in Table 22. Table 21

indicates that there has been an increase in the average concentration ratio for wholesale

27

trade and retail trade during the first half of the 1990s. Moreover, it appears that retail

trade is increasingly more concentrated than wholesale trade. However, aggregate data

hide a wide variation in concentration ratios. More importantly, it is likely that it is at the

more disaggregated level where monopoly power and contestability are more relevant

because of greater commonality of markets. Thus, the concentration ratios at the 5-digit

PSIC level are likely to be more insightful (see Table 22). Two observations stand out

from Table 21; namely,

(a) A few wholesale and retail industries are highly concentrated,

e.g.,dealing of livestock and poultry and unprocessed animal products

(61107), wholesaling of wearing apparel, except footwear (61302),

wholesaling of construction materials and supplies (61409),

wholesaling of commercial machinery and equipment (61602),

wholesaling of musical instruments, amusement goods and toys

(61905), retailing of passenger motor vehicles (62601), retailing of

drugs and pharmaceutical goods (62701) and retailing of

photographic equipment and supplies (62907).

(b) There are more wholesale trade industries that are relatively more

concentrated than retail trade industries. From the table, there are 11

wholesale trade industries with concentration ratios of at least 0.40

as compared to 5 retail trade industries. This is not very surprising

because wholesalers consolidate supplies from various producers

(both foreign and local) and distribute them to a large number of

retailers, thereby allowing wholesalers to reap the benefits of possible

economies of scale or scope.

Nonetheless, the high concentration ratios in wholesale trade bring out the

issue of monopoly power of a few large wholesalers vis-à-vis thousands of retailers. It is

likely that one reason behind the comparatively high gross margin in wholesaling in the

Philippines is the high concentration ratio in a number of wholesale trade industries.

28

Thus, an important policy issue concerning the overall efficiency of the entire distribution

network is the encouragement of greater competition in wholesale trade. As noted earlier,

the greater competitive pressure in wholesale trade in developed countries arose from the

expansion and integration of wholesaling functions by large retail chains. For the

Philippines, a number of options are in principle available, including entry of new firms

(either locally owned or foreign owned) in wholesaling, integration of large retail stores

into wholesaling operations (i.e., bypassing wholesalers), and amalgamation of small

retail establishments into large buying groups. The experience in other countries with

respect to buying groups is a mixed one except where it is an endogenous response to

tightening labor markets and growing competition from large retail chains. Thus, it is

primarily through investments either directly into wholesaling or indirectly through

integrated wholesale-retail operations that greater contestability and competition in

wholesale trade can be effected in the country.

29

Chapter II

Regulation and Regulatory Changes in Retail Trade and Other

Selected Service Industries

Retail trade regulation in OECD countries.1

Retail trade is regulated in a number of OECD countries. The regulations

center on restrictions on the establishment of large scale retail enterprises, regulations of

shop opening hours, zoning regulations, restrictions on vertical restraints, pricing and

promotion, and restrictions or public monopoly in the sale of pharmaceutical products,

liquor and tobacco products.

The most important regulation in retail trade in OECD countries is the

restriction on the establishment of large-scale retail establishments. A number of OECD

countries have enacted laws for this purpose; for example, Japan’s Large Scale Retail

Store law (enacted in 1974), France’s Loi Royer (1973), Begium’s Second Padlock Law

(1975) and Italy’s No. 426/71 (1971). Large scale retail establishments have been

restricted in order to protect the small scale, “mom and pop” stores, to protect the

downtown (or city center) stores (from competition from suburban retail centers), and to

manage land use at the local level. The regulations on large-scale retail stores have

become more restrictive in recent years in these countries, with the major exception of

Japan, which has embarked on a path of liberalization.

Studies have shown that the restrictions on large-scale retail stores have

had significant impact on the retail landscape. In Japan, the high retail density and the

preponderance of small neighborhood “mom and pop” stores have been attributed in part

to the Large Scale Retail Store law. In addition, fundamental and structural factors like

the lack of storage space in most Japanese homes, limited car ownership and high

1 This section draws heavily on Pilat (1997).

30

population density (which encourage frequent purchases from stores within short walking

distance) are also important determinants of Japan’s retail landscape (Flath 1996). In

Belgium, the enactment of the Second Padlock Law drastically curtailed the growth of

hypermarts but encouraged the growth of large supermarkets (but smaller than

hypermarts) and franchising (which was used by the large retailers to circumvent the law

to increase their sales). Also, it contributed to the significantly lower average size of retail

outlets in Belgium relative to those in neighboring countries. Finally, it contributed to the

international expansion of major retailers in Belgium because their domestic expansions

were constrained by the Padlock Law. In Italy, Law 426/71 slowed the diffusion of large

stores especially in Southern Italy, favored co-operative chains based on local stores over

retailers with multiple outlets and led to large retailers forced to live with stores of sub-

optimal size. In France, the Loi Royer limited the growth of supermarkets in the 1970s.

However, the growth of hypermarts was not as much affected because the law was

circumvented through (1) the filing of a larger number of applications for new

hypermarts than really planned to take into account the percentage of rejection, (2) the

splitting up of adjoining retail units to be consistent with the size limitations, and (3)

expansion in the size of existing hypermarts when the implementation of the law became

more stringent in the later years. Ironically, the Loi Royer, which was enacted partly

because of pressures from municipalities worried about the adverse impact of large out-

of-town retailers on local shopping centers, also slowed down the growth of city center

shopping areas, which require large stores as anchors for a large number of small retail

establishments. (See Pilat 1997.)

The policy stance on large-scale retail establishments has seesawed over

the years in a number of OECD countries. Belgium abolished the First Padlock Law in

1961. The ensuing growth of large stores put increasing pressure on small stores, so much

so that the latter succeeded in the enactment of the Second Padlock Law in 1975 which

restricts the establishment and expansion of large stores. Similarly, Italy tightened the

implementation of its 426/71 law during the 1970s when there was high level of

unemployment and social unrest and relaxed its implementation in the 1980s when the

country’s economic growth improved. Spain, after a period of liberal stance on the

31

establishment of large stores, introduced a law in 1996 restricting large retail

establishments. Likewise, France has increasingly tightened the implementation of its

legal restrictions on large stores in the 1990s with the introduction of new laws

strengthening Loi Royer.

Large stores have been adversely affected not only by the laws that

explicitly restrict their growth but also by other regulations in retail trade. In particular,

zoning regulations have been used to discourage the growth of large retail stores in the

suburbs in order to protect the stores in the city center in addition to the objective of

rationalizing land use consistent with local infrastructure constraints and environmental

considerations. Similarly, restrictions on shopping hours (which have been most

stringent in Germany) are biased against large stores which, in contrast to small

neighborhood stores, have the flexibility and economies of scale to hire appropriate

numbers of personnel to accommodate more flexible and longer shopping hours.

In OECD countries, there is a tendency for the average size of retail

establishments to increase as per capita income increases. Nevertheless, Hoj et.al. (1995)

find in their regression analyses that zoning laws and restrictions on large scale

establishments slowed down the growth of the average size of establishments in OECD

countries. Similarly, an OECD study cited in Hoj et.al. (1995) indicates that the density

of food outlets in Japan and Italy would have been lower were it not for the laws in Italy

and Japan explicitly restricting the growth of large establishments.

The restrictions on large retailers have meant that large retailers have a

much smaller share of total retail sales, and correspondingly, a higher share by small

establishments, in the more restrictive countries compared to countries with more

liberalized retail environments. For example, small stores with employment of less than

10 accounted for 48.9 percent of Japan’s retail sales and 36 percent of France’s retail

sales in the late 1980s, in sharp contrast to the 13.7 percent share of small stores in the

United States. Correspondingly, large retail establishments with employment of more

than 100 accounted for 15 percent of Japan’s retail sales while large establishments with

32

employees numbering more than 200 accounted for 34 percent in France. In sharp

contrast, 65.2 percent of US retail sales and 63.6 percent of UK retail sales come from

large retail establishments with employment of more than 200 (Baily 1993, p.124).

The preponderance of small retailers in countries with more restrictive

policies on large retail enterprises appears to have also contributed to lower labor

productivity in retailing in these countries compared to that of the United States. Baily

(1993) estimates that labor productivity in general merchandise retailing in Japan and

France was only 44 percent and 69 percent respectively of the US level in 1987. Pilat

(1997) finds that the productivity growth appears to have slowed down in Japan, France,

Italy and Belgium following the introduction of legislation restricting the establishment

of large retail establishments. Large retailers tend to be more efficient; they have also

been the source of innovation and new technologies in the sector. Hoj, et.al. (1995) find

that higher average size of retail establishments is associated with lower average price

levels, suggesting that large enterprises increase the efficiency of the distribution system.

Large retailers like Wal-mart have been in the vanguard in the use of information

technology in retailing and distribution activities which have contributed to lower-than-

average share of distribution costs to total sales (Pilat 1997). Other potential gains from

the rise in the average size of retail outlets include the reduction in consumer prices and

increased output of distribution services (Hoj, et.al. 1995).

In summary, large stores have been a politically sensitive issue in a

number of OECD countries. Concerns about employment and the management of

structural changes in the sector are at the heart of the issue as liberalization can be

expected to generate structural changes in the sector. In a number of European countries

(e.g., France, Spain, Belgium, Italy), this has led to the tightening of their regulations on

the establishment of large retail establishments in recent years. Japan stands as a notable

exception among the OECD countries with restrictive policies in retailing because it has

embarked on a path of deregulation in the 1990s. The impact of the retail trade

liberalization in Japan is discussed in the succeeding section.

33

An important concern is whether or not the liberalization of the retailing

industry leads to significant losses in overall employment. The experience in Japan after

the liberalization of the Large Scale Retail Stores Law did not result in significant losses

in employment. The United States, which arguably has the most modern retailing

industry among OECD countries, has seen growing employment in retailing over the past

two decades. Moreover, the US experience indicates that small shops still play an

important part in the whole retailing system in developed countries despite their much

reduced share to total retail sales. Small shops have become more specialized and

customer-oriented. In addition, small shops have been finding ways to improve efficiency

in operations, reduce costs and gain economies of scale through, for example,

franchising. Thus, in the end, addressing the issue of whether or not, or at what phase, to

liberalize restrictions on large stores involves judgements on the trade-off, at least in the

short run, between social stability and efficiency. And the efficiency “opportunity cost”

of social stability is the lower labor productivity in retailing in the countries with more

restrictive policy environments in retail trade.

Retail trade liberalization in Japan

Japan successively liberalized the Large-Scale Retail Store Law during

the 1990s. The more recent revisions include the streamlining of procedures for opening

up large retail establishments, abolition of regulations on store space for stores with less

than 1,000 square meters, and allowing longer and more frequent opening hours of large

stores. As a result, there was a significant rise in the number of applications to open large

stores (up to 6,000 square meters in the largest cities). The rise in the number of large

stores coincided with the decline in the number of “mom and pop” neighborhood stores,

increased integration of neighborhood stores into larger convenience store chains such as

7-Eleven, decline in unincorporated enterprises and rise in incorporated businesses. In

spite of these developments, however, the losses in employment arising from the easing

of restrictions on large retailers in Japan have not been significant. (See Pilat 1997.).

34

The liberalization of the implementation of the Large-Scale Retail Store

Law occurred at the same that there were significant changes in the retail industry, arising

in part from the increased motorisation of Japan and more importantly from the

appreciation of the Japanese yen in the late 1980s and early 1990s. The changes were not

only in terms of the structure of the industry but also in terms of the business

relationships and practices in the distribution sector.

Up until the 1970s, the degree of motorisation in Japan was only about

half that of Germany, United Kingdom and France (and was still lower than had been in

the United States in 1930). This meant that shopping was on foot or by public

transportation (near railway stations), with limited choice as to the size and location of

stores. With very high land costs in such store locations, stores were mainly small stores

as they had to have high space efficiency in order to survive. The sharp rise in cars

encouraged the growth of suburban type-large scale retail chain stores; nevertheless, poor

roads for suburban shopping, traffic jams and high land cost slowed down the growth of

large suburban stores. (See Itoh 1996.)

But the more important factor behind the changes in structure and business

relationships in the Japanese distribution industry was the appreciation of the Japanese

yen which led to the growth of the large retail chains and discount stores. The

appreciation of the yen led to the surge of imports of such products as Asian-made

apparel products, foreign processed foods and home electronic appliances supported

primarily by the importation of large retail stores and chains. This meant a significant

change in the traditional keiretsu-type relationships between manufacturers and retailers

(and wholesalers). For example, apparel is traditionally distributed by the large

manufacturing firms through the large department stores on a consignment basis wherein

the firms send their sales clerks to the stores, set their retail prices and all unsold products

are returned to them. Department stores merely provided space and did not take risk on

the products. Thus, apparel firms engaged heavily in retail activities while department

stores depended heavily on apparel firms. The appreciation of the Japanese yen changed

the importance of this relationship significantly. Specifically, it encouraged the sharp

35

growth in the so-called "roadside chain stores” where the stores sell same types of

apparel (usually their own brand) allowing for economies of scale and do not rely on

consignment arrangements. Because they take risks on the products they sell, the roadside

store chains (which can have more than 300 outlets) relied a lot on low wage countries

like China for sewing. The sharp growth of roadside store chains can be surmised from

the fact that they accounted for about one half of the volume of men’s suit sold in Japan

by the mid 1990s compared to almost nothing in the mid-1970s. (See Itoh 1996.)

The impact of the growth of large stores on the vertical relationships

between manufacturers and retailers (and wholesalers) is also exemplified by the retailing

of home medicine ( Itoh 1996). Because of government regulations, retail drug stores in

Japan were traditionally dominated by mom and pop shops heavily dependent on

wholesalers for such services as store display arrangement, transportation of products,

choice of products sold and setting of retail prices. Manufacturers used rebate system

with wholesalers and retailers in order to promote their products. Because manufacturers

were allowed to control the prices of most medicines, manufacturers (especially those

selling directly to retailers) kept high retail margins in order to give the retailers strong

incentives to sell their products. Such high retail margins were largely maintained

because discounts were discouraged and the stores were small and spread apart resulting

in low price elasticity of demand. The rapid expansion of retail chain drugstores in recent

years has led to more common use of discounting and has made it more difficult for

manufacturers to maintain high retail margins. (See Itoh 1996.)

There were economy-wide gains from the liberalization of the Large Scale

Retail Stores law. The price of the distribution sector relative to the overall price level

(i.e., GDP deflator) declined by about 2 percent per year during 1992 and 1993. Estimates

of consumer welfare gains and increased demand arising from the retail trade

liberalization in Japan ranged between ¾ to 1 percent of GDP (Pilat 1997).

36

Deregulation and liberalization in other service industries in the OECD

countries1.

There has been a marked shift towards deregulation and liberalization of

service industries in many countries including OECD countries. The experiences indicate

that the regulatory changes have been on the whole welfare- and efficiency- enhancing.

Where the performance is mixed, complementary competition policy measures were

needed but not implemented. To wit:

• Road transport. Road freight and passenger transport was once one of the

most regulated in the OECD countries. However, it has been increasingly liberalized

during the past three decades. Freight transport was deregulated in the 1960s in

Australia, Sweden and the United Kingdom and in the 1980s in France, New Zealand,

Norway and the United States. The deregulation of the passenger transport industry

occurred in the 1980s in the OECD countries. The impact of the deregulation has

been largely positive. In all of the OECD countries that deregulated, the entry of new

firms into the road transport industry increased. For example, the number of carriers

and intermediaries in road freight doubled between 1979 and 1985, although most of

the new entrants were small firms such that the overall industry concentration

increased only slightly during the period. Similarly, the number of transport

authorisations in France doubled during 1974 and 1987. In addition, the quality of

service (in terms of routes served, safety, and facilities and equipment) improved. In

most cases, rates and fares dropped arising from the liberalization. For example,

transport fares fell by 6.4 percent for short-zone traffic and by 3.4 percent for long-

zone traffic in France after the 1986 deregulation. Other effects worth noting were the

following:

(a) increased concentration in freight transport in Australia and the United

States,

(b) reduction in industry profits in Canada

1 This section draws heavily on Hoj, et. al., 1995.

37

(c) increase in employment in New Zealand

(d) the use of market niching in terms of routes and quality of service as a

survival and/or growth strategy, especially in the United Kingdom

(e) reduction in the procurement costs for scheduled bus services in

Sweden.

• Telecommunications. There has been a significant change in the

state of competition and policy regime in the telecommunications industry in

many OECD countries. Where once the industry was viewed a natural monopoly

requiring government ownership or at least substantial government equity

participation as well as strict government regulation, technological developments

have created new avenues for contestability and allowed new participants in the

industry. As a result, there has been a shift towards privatization and

liberalization of the telecommunications industry. Nevertheless, only the United

States, Canada and the United Kingdom have completely private

telecommunication services industries. As of 1994, the rest of the OECD

countries are either still publicly owned (e.g., France, Germany, Norway,

Belgium, Austria, Greece, Switzerland, Ireland and Turkey) or have a mix of

public and private ownership (e.g., Japan, Australia, New Zealand, Italy, the

Netherlands, Spain, Portugal, Sweden and Finland). Similarly the degree of

competition differs among the various telecommunication services and countries.

Voice telephony (local, trunk and international) is still a monopoly in most OECD

countries, except for Japan, New Zealand, United Kingdom, Sweden, Finland, the

United States (for trunk and international) and Canada (for international). Where

there has been a greater degree of competition is in mobile communications

(especially paging and to a lesser extent digital) and data transmission services.

The greatest degree of competition is in the market for telecommunication

equipment and the provision of value added services.

38

The differences in the ownership structure and degree of competition in

the various telecommunication services among the OECD countries allow for

comparative analysis on the impact of regulation and liberalization in the industry. Baily

(1993) compared the productivity in telecommunications in the United States, France,

Germany, Japan and the United Kingdom. He found that productivity in

telecommunications in Germany and France was about half that of the United States, that

of Japan was between two-thirds to three-fourths of the United States and that of the

United Kingdom about two-fifths to one-half of the United States. Although there may be

many reasons for the significant gap in productivity among the sample countries, it is

likely that a significant reason is the competition environment. In both Germany and

France, up until the early 1990s, telecommunications was largely a government

monopoly with the German industry stuck with mechanical switching devices and the

French telecommunications firms overstaffed at the same time that the French

government subsidized an aggressive and expensive technology upgrading program. The

United Kingdom privatized its telecommunications; however, British Telecom (BT) was

a virtual monopoly in local phone service and did not reduce employment substantially.

The comparatively higher productivity in Japan relative to the European countries

stemmed in part from the streamlining and restructuring of NKK with the significant rise

in the number of players in the various telecommunications fields.

Privatization and regulatory reform in telecommunications in OECD

countries has led to more efficient pricing. There has been a shift towards fixed charges

in line with the high fixed cost and very low marginal costs in the industry. Cross

subsidization of local calls by long distance calls has been reduced. This has resulted in

lower long distance rates and higher local call rates. The decline in long distance rates

and the corresponding rise in local call rates has been particularly pronounced in the

countries with the more competitive telecommunications industry as compared to those

with more restrictive policy regimes. Thus, in countries with competitive

telecommunications industries, long distance call rates dropped by between 18 and 35

percent, business charges by about 9 percent and total residential charges by 3 percent

while local calls increased by 15 percent during 1990-1994. In countries with non-

39

competitive industries, long distance call rates declined by between 12 and 16 percent

and business charges by 3 percent while local calls increased by 20 percent and total

residential charges by about 9 percent during the same period (Hoj, et.al., 1995).

Output and productivity in the telecommunications industry improved

because of the developments in technology and increased outsourcing. New products and

services were developed as the demand for telecommunication services increased.

Drawing from the privatization experiences of Japan and Finland, employment did not

suffer despite the trimming down of personnel of the privatized former public utilities

because the reduction in personnel of privatized firms was at least offset (or even more

than offset) by increased employment from new entrants into the liberalized industry.

Privatization was more welfare enhancing when complementary competition policy rules

were enacted that ensured entry of new entrants and “… level playing field in terms of

competition, technical standards and fair access between different operators’ networks.”

Privatization that does not lead to competition and improvements in efficiency is best

exemplified by the privatization experience in the United Kingdom in the 1980s when

British Telecom virtually dominated the industry; it was only in the 1990s that there has

been greater competitive pressures because of the influx of many new investors ( Hoj,

et.al., 1995).

• Airline industry. The airline industry is largely a regulated industry in the

OECD countries with the principal exceptions of the United States and Canada.

Domestic services tend to be monopolies or duopolies; international services are

regulated through bilateral agreements. A comparison of the deregulated airline

industry in the U.S. and the more regulated airline industries in Europe provides some

insights on the effects of competition and deregulation of the industry. The

comparison indicates that the U.S. airlines have been able to optimize operations and

maximize economies of scope from their hub-and-spoke operations that allow for

easy interconnection. (Airline operations offer little economies of scale except in off-

flight services like ground handling but more of economies of scope through hub and

spoke operations, code sharing and the operation of computer reservation systems.)

40

With greater reliance on international flight operations, European airlines have also

been hampered by bilateral agreements that control international flight frequencies as

well as more ponderous immigration arrangements compared to domestic operations

in continent-wide U.S.A.. European airlines are also hampered by less efficient air-

control systems, higher fuel prices and less competition in ground handling in Europe

than in the United States. As a result, the productivity of European airlines lag

behind the U.S. airlines in virtually all aspects of European operations (Baily 1993.)

Estimates of the productivity gap of European airlines relative to US airlines range

from 20 percent to 40 percent. Not surprisingly, the unit price and cost of European

airlines increased faster than those of U.S. airlines. There is a wide variation in costs

among European airlines reflecting the fact that some airlines find it difficult to

restructure and be cost efficient. In addition, airline pricing in the U.S. has become

more uniform in contrast to the wide variation in pricing among European airlines.

(Hoj, et.al., 1995).

The sectoral liberalization initiatives do not only have sectoral effects;

there are also economy wide effects. Although the quantification of the economy wide

effects is more difficult to do and has been much more limited, the prevailing view is that

the economy wide effects can exceed the sectoral effects. There are three reasons for this;

namely,(a) increased efficiency in one sector frees up resources to other sectors and

thereby improves overall resource allocation (the “static” effect), (b) increased capacity

for product innovation and growth by expanding the range of goods and services

provided as exemplified in the cases of the distribution and telecommunication industries

(the “dynamic” effect), and (c) improved flexibility and competitiveness of the whole

economy because the higher productivity or lower prices in the liberalized sectors

reverberate into the industries that use the outputs of the liberalized industries. Estimates

of the effects of the regulatory reforms in the United States in airlines, trucking,

telecommunications, among others, suggest increased social welfare amounting to

between 0.65 and 0.85 percent of GNP. Moreover, such gains were shared by both the

consumers and the workers and producers, who generally also benefited from the

liberalization programs. Estimates on the effects of the deregulation arising from the

41

European internal market suggest that the gains from the economies of scale, lower profit

margins, and the dismantling of technical and customs barriers range from 1.5 percent to

as high as 7 percent of GDP. Similar analysis for Australia on the “Hilmer” reform

package of enhancing competition in the whole Australian economy including the utility

sector, road transport and ports show large welfare gains that is widely distributed among

the various sectors of the economy. Country studies in the United Kingdom, the

Netherlands and Germany also point to contributions to international competitiveness,

rise in employment and GDP, and reduction in the inflation rate. Even in the case of New

Zealand, the wide ranging reforms in the country which had initial negative effects

eventually resulted in the rebound of productivity and improvement in the international

orientation and competitiveness of the country. (See Hoj, et.al. 1995.)

Deregulation and liberalization in selected service industries in the

Philippines

The Philippines has been liberalizing much of the Philippine economy. In the

service sector, the country has allowed more foreign banks to enter the banking industry,

liberalized the insurance industry allowing 100 percent foreign ownership, and

significantly deregulated the telecommunications industry. The impact of the

liberalization and deregulation initiatives in these industries on the country has largely

been positive. To wit:

• Telecommunications industry. Up until the 1980s, the Philippine

telecommunications industry was characterized by a virtual private monopoly in the

most important segment, the telephone sub-sector. Teledensity was low, the queue for

a telephone line was inordinately long measured in years, the quality of service left

much to be desired. Starting in the late 1980s but more importantly beginning in

1993, the Philippine government implemented a series of policy reforms that

deregulated and encouraged greater competition in the various segments of the

telecommunication industry. Among these policy reforms were the mandating of

42

compulsory interconnection among authorized public telecommunications carriers,

mandating the provision of more telephone exchanges and developed the service area

scheme requiring international gateway facility operators and other service providers

to subsidize the provision of local exchange carrier service in unserved or

underserved areas of the country, promoted an open and competitive environment for

services such as cellular mobile telephone system, and reduced barriers to entry into

the telecommunication industry.

The impact of the reforms on the industry and the economy has been

significant. The number of operators in the various segments of the industry increased

tremendously during the 1990s, with the attendant increase of competition in the industry.

Thus, for example, there are now 74 private and 4 government telephone operators in the

country (as compared to 45 companies in 1992), with PLDT accounting for 32 percent of

the total number of installed lines in 1998 as compared to 94 percent before the

liberalization. Similarly, from being the sole operator of the country’s international

switching center, PLDT is now only one of the 11 such IGF operators. By 1997, there

were 15 paging companies, 5 cellular mobile telephone system companies, and 130

internet service providers as compared to 6 paging companies, 2 cellular mobile

telephone system companies and no internet service provider in 1992. The expansion in

the number of operators gave rise to the expansion in services offered. Thus, for example,

the 1990s has seen the sharp expansion in the subscriber base of cellular mobile phones

and pagers. To a large extent, the expansion of the industry has been propelled by the

inflow of foreign investments in the sector as a number of major American, European and

Asian companies formed joint ventures with local firms. The total foreign direct

investment in telecommunications for the period 1990-1998 was 25 times higher than the

total for the period 1973-1989. As a result of the increased investments, the country’s

teledensity has increased, from 1.2 in 1992 to 8.1 in 1997, although the regional

distribution remains highly uneven from 0.9 in Cagayan Valley to 28.6 in Metro Manila.

43

The consumers benefited from the liberalization and deregulation in the

telecommunications industry. The waiting time for a telephone line has dropped

tremendously. The prices for international calls, cellular mobile phone and paging

services have declined. There has been an expansion in the services provided by

telephone firms and other telecommunications companies to their customers, as perhaps

best exemplified by the “texting” phenomenon.

The expansion of the industry in the face of increased competition and foreign

as well as local investment has led to the increase in the share of the industry to the

country’s national output (GDP) from 1.4 percent in 1990 to 2.0 percent in 1997. The

impact on the economy is likely much more. The emerging reputation of the Philippines

as a good site for backroom operations of large multinational firms abroad is partly

attributable to the improvement of the country’s telecommunications facilities. Similarly,

for the rising professional service exports of the country, best exemplified by computer

software but also include such services as film animation and magazine and book

editorial services.

Study One of the Report provides a detailed discussion on the opening up of

the Philippine telecommunications industry to competition and foreign investment.

• Banking and Insurance industries. In both the banking and insurance

industries, foreign companies had a major presence in the Philippines during the

colonial period beginning in the 1870s. However, the post World War II period

has been restrictions on the establishment of foreign institutions, either

specifically stated as in the 1948 General Banking Act or as part of an overall ban

on the entry of new insurance companies under the 1966 Insurance Act. In recent

decades, there was a stop-go nature to the further opening up of the banking

industry to foreign participation until the passage of RA 7721which allowed the

entry of up to 10 new fully-owned foreign banks (up to 6 branches for each bank)

into the country. Other foreign banks have since come in by buying into existing

banks. In the case of the insurance industry, foreign participation in non-life

44

insurance companies was allowed up to 40 percent under the Omnibus Investment

Code; foreign equity in life insurance companies apart from those operating

already before the passage of the Code was not allowed because the sector was

deemed by the Insurance Commission to be adequately capitalized. It was in 1994

that the entry of new insurance companies was allowed, including 100 percent

foreign ownership, in both the life and non-life segments of the industry.

The liberalization of entry of foreign investments into the banking and

insurance industries had the expected impact of foreign direct investment into the

industries and the attendant increase in the share of foreign-owned banks or insurance

companies to total assets in the industry. The share of foreign banks to the industry’s

total assets rose from 11.4 percent in 1990 to 16.5 percent in 1997. The share of foreign

banks to the industry’s total loans increased slightly from 10.4 percent in 1990 to 11.7

percent in 1997. The share of foreign banks to the industry’s total deposits declined

however from 7.5 percent in 1990 to only 7.2 percent in 1997. In the case of the

insurance industry, the number of foreign insurance companies rose from 18 in 1993 to

24 in 1997 with the new entrants concentrated mainly in the life insurance business. The

share of foreign companies to the industry’s total assets increased marginally from 41

percent in 1993 to 43 percent in 1997.

There are no thorough analyses yet of the impact of the liberalization of the

banking and insurance industries on the Philippine economy. In contrast to the

telecommunications industry, the impact on the consumer is not as clear cut. There is no

perceptible narrowing of the interest rate spread between the average lending rate and the

average deposit rate following the bank entry liberalization. The non-life insurance

industry, which is generally viewed to be undercapitalized, has not yet generated much

foreign investment. Nevertheless, there are indications that the entry of foreign banks and

insurance companies has raised the competitive pressure in the banking and insurance

industries. Mergers, bank niching and branching, and increases in bank capitalization of

the larger domestic banks sharpened up in recent years, most likely partly in response to

the entry of the new banks. Similarly, there appears to be increased competition in terms

45

of insurance products being offered to consumers. To some extent, the liberalization

initiatives are still very recent and the changes are likely to be slow and more subtle in

the two industries (including possible changes in operational strategies and streamlining

of operations), in contrast to the telecommunications industry which responded to a huge

unmet demand. Nevertheless, it can be expected that over time the larger capitalization of

the banks and insurance firms as well as the more transparent corporate governance

environments of the foreign firms would contribute to the strengthening of the

foundations of the country’s financial system as long as the overall macroeconomic

policy regime remains prudent.

Study Two of the Report presents a more detailed discussion of the

liberalization of the banking and insurance industries in the country.

The experiences presented above bring out that on the whole the increased

competitive environment arising from deregulation, privatization and regulatory reform

has been beneficial. Productivity is higher and costs have been contained. Behind this has

been the ability of firms to enter and exit freely, lay off workers and restructure industries

(Baily 1993). In the Philippines, the inflow of foreign investments has been important

and allowed to help address an important unmet demand at least with respect to

telecommunications services. Nonetheless, while in the aggregate there are net positive

results, there are also individual disruptions at the micro-level as firms may die or

restructure and workers are laid off at least temporarily. Or, as in the US experience,

stores in downtown business districts closed shop with the rise of retail centers in the

suburbs. It is clear that part of the challenge is how to manage the reform process in order

to minimize such disruptions and maximize the opportunities brought about by the

liberalization and regulatory reform initiatives.

46

Chapter III

Retail Trade Nationalization and Liberalization: Towards

Retailing and Distribution Services for the 21st Century

I. Retail trade nationalization, retail trade liberalization

The Philippines nationalized retail trade in 1954 with the enactment of

R.A. 1180, popularly known as the “Retail Trade Nationalization Law.” It was, as

Agpalo (1962) put it, “..the culmination of a social movement” (p.20). The law was the

result of decades of agitation since the start of the century by many of the country’s

prominent leaders to Filipinize retailing and put Filipino faces behind a ubiquitous social

institution. In fact the earliest attempt to exclude the Chinese from retail trade was

initiated by the Spaniards in the 1580s because the latter felt they could not compete with

the Chinese and deserved to be given the opportunity to profit from the trade themselves.

The royal decree in 1589 forbidding the Chinese to engage in retail trade was not

implemented though. 1

The impulse for the movement to Filipinize retail trade in the country

during the 20th century started with the William Taft’s “The Philippines for the Filipinos”

slogan that inspired the agitation for the nationalization of the country’s retail trade by

1905. The administrative route to the Filipinization of retail trade was given impetus with

the establishment of the Bureau of Commerce in 1918. The legislative route started with

the adoption by the Philippine Legislature of a Bookkeeping Act in 1921, requiring

merchants to keep their accounts in English, Spanish or a local dialect and thus was

aimed primarily against the Chinese shopkeepers. However, the Chinese succeeded in

convincing the United States Supreme Court to render the Act null and void. It was

beginning 1930, with the establishment of the Ang Bagong Katipunan organized by the

1 The paragreph and the succeeding two paragraphs draw very heavily on Agpalo (1962).

47

then Speaker Manuel Roxas, that the movement for the nationalization of retail trade

gathered momentum. Ang Bagong Katipunan espoused economic protectionism, which

became fully developed in the National Economic Protectionism Association (NEPA)

organized in 1934. One of the founders of NEPA, Salvador Araneta, was instrumental in

pushing the nationalization of the retail trade (i.e., ownership of at least 75 percent by

citizens of the Philippine Islands and the United States) in the 1934-1935 Constitutional

Convention. Although the Convention eventually defeated the Araneta proposal

primarily out of fear of adverse foreign repercussions, the Convention delegates

nevertheless passed the “Cuenco Resolution.” The Cuenco Resolution indicated that the

Convention delegates were in favor of the nationalization of retail trade but that it did not

approve the Araneta proposal because the National Assembly (the Legislature during the

Commonwealth period) was empowered to enact such law. Thus, the Constitutional

Convention through the Cuenco Resolution set the stage for the legislative route in

wresting the control of the retail trade industry from the Chinese in the succeeding years

into the early 1950s.

There were proposals for retail trade nationalization brought to the

National 4th Assembly during the Commonwealth period but they did not prosper because

the government was worried about possible intervention by Japan (which was a rising

military power then) in Philippine affairs ostensibly to protect Japanese nationals in the

country. A bill nationalizing the retail trade industry was passed by Congress in 1945 but

was vetoed by President Osmena because of concerns about international repercussions.

The political salience of retail trade nationalization at that time could be discerned by the

fact that three bills nationalizing retail trade were introduced on the first session in 1946

of the First Congress (1946-1949). Several more bills of similar nature were introduced

during 1947-1953. The series of bills nationalizing the retail trade industry had one

important constant: the movement to nationalize the retail trade was the wellspring of

ideas and eventually the utilization of the techniques of lobbying and organizing in

support of the bills. Indeed, the leaders of the movement would become critical in

monitoring and keeping vigil of the legislative process until the eventual passage of

Republic Act 1180, otherwise known as the Retail Trade Nationalization Law, in 1954.

48

The nationalization of retail trade was an embodiment of the economic

nationalism at that time born during the colonial period when much of the nation’s

business and most of the corporations were foreign owned. It was consistent with the

industrial protection policy at that time, where protection of domestic enterprises against

competition from imports was viewed as a mechanism not only to build the country’s

manufacturing sector but also to nurture Filipino industrialists and businessmen. The

1950s culminated with President Garcia’s Filipino First Policy. Agpalo’s (1962) account

of the movement for, and the legislative debate on, the nationalization of retail trade

amply shows that the process was not an easy one, punctuated by pressures from foreign

countries (especially China) as well as fears by Filipino top political leaders during the

late 1930s that retail trade nationalization could become a pretext for Japan to intervene

in the Philippines to protect Japanese nationals in the country. The drive to have more

Filipino participation in the nation’s retail trade even spawned nongovernment initiatives

like the Pera-Pera Movement organized in 1938 (Agpalo 1962, p.32). In short, the

nationalization of the retail trade industry was a product of its times; it was principally a

social policy-cum-political measure rather than an economic policy measure.

Overall, the law succeeded in putting the retail trade industry into the

hands of the Filipinos. There is no longer any need for what one of the earliest agitators

for the nationalization of the retail trade did in 1905, when Dr. Bonifacio Arevalo urged

Filipinos to establish retail stores and appealed to the consumers to patronize Filipino

stores (Agpalo 1962, p.23).

Times have changed drastically since the 1950s, however. The economic

policy of protectionism and Filipino First has given way to competition, liberalization

and outwardness. The Philippine government has progressively liberalized and opened

the Philippine economy through a series of reforms for about a decade and a half now.

Foreign investors can now have 100 percent ownership of enterprises in many economic

sectors in the economy. Thus, the Retail Trade Nationalization Law has become an

anachronism, especially when foreigners can invest in sectors that can be considered

49

more “sensitive” and “strategic” (e.g., banking) than retailing. Moreover, the social

context under which the nationalization law was enacted (i.e., foreign control of retailing)

is no longer as politically salient today as during the colonial period. Not surprisingly, it

is the government that has been spearheading the move to amend the Retail Trade

Nationalization Law. (Government officials during the Commonwealth period did not

support the retail trade nationalization bills at that time not because they did not support

the economic ideology behind the nationalization bills but because they were afraid that

foreign governments could use the retail trade nationalization as a pretext to intervene in

Philippine afffairs.)

At the same time, however, it is important to take into account the social

context of retail trade. Especially during the colonial period and in the early post WWII

period, the retail store is a social institution that every Filipino interacts with from birth to

adulthood. Thus, the alien control of the retail industry during the colonial period and

well into the Philippine republic rankled the Filipino nationalist such that nationalism was

equated with Filipinization at that time. The Filipino-Chinese crisis of 1923, when a

quarrel between a Filipino customer and a Chinese shopkeeper led to a near riot among

Filipinos and Chinese aiding their fellow countrymen as well as the momentary closure

of Chinese shops in Manila (Agpalo 1962, p.26), exemplifies a social stress arising from

the perceived inequitable alien control of the retail trade sector. Moreover, retail trade

remains an important training ground for new entrepreneurs especially in the light of the

substantial unemployment and underemployment in the country. As Agpalo (1962, p.

56) puts it: “…a retailer someday can become a wholesaler and later as importer and

exporter. The retailer, too, may become a chain-store owner…” This perspective, that

retailing is a breeding ground for new Filipino entrepreneurs, remains a key rallying point

of the Filipino retailers today in their objection to the opening of the retail trade industry

to foreign investment.

Given that the Retail Trade Nationalization Law is already inconsistent

with the economic policy and realities at present, the issue therefore is no longer

whether or not to liberalize the industry but rather the degree and pace of the

50

liberalization process. In the light of the lingering concerns about the fate of Filipino

retailers in case the industry is opened up to foreign investment, it is important to

address perhaps the most important concern, which is whether or not Filipino retailers

would be swamped by foreign retailers when the industry is opened up to them. Related

to this is the fear that the entry of big foreign retailers would hasten the demise of small

retailers in the country.

Retail trade liberalization: the demise of the Filipino retailer?

The estimates of gross margins in Table 15 are instructive in this regard.

The estimates indicate that on the average the margins among large establishments are

low in many of the more popular retail formats. This is especially the case in Metro

Manila and Cebu, the two major retail markets in the country. The margins are

significantly lower than the retail margins in the OECD countries which are the likely

sources of foreign investments in retailing in the country. This means that domestic stores

can compete with foreign stores, in terms of price competition. Given the low margins

and likely higher set up costs, foreign firms would have to have unique advantages, either

in terms of more efficient systems, product niches or service quality, to be able to

compete effectively vis-à-vis domestic retailers. If the gross margin data in the Annual

Surveys and Census of Establishments are a fair representation of the true industry

situation; i.e., firms give correct data to the National Statistical Office, then it is highly

unlikely that domestic retailers would be swamped by foreign retailers after the

liberalization of the industry. Moreover, the retail density in the country is still low and

offers a huge scope for the expansion of the number of establishments in the retail trade

industry as the economy grows over time.

The retail margins among small establishments are higher than among large

establishments. This may suggest that there are opportunities to exploit in small scale

retailing. There are two probable sources of foreign competition here. The first one would

be direct competition from potential immigrants from low- income Asian countries (e.g.,

51

India, Pakistan) with strong trading tradition. However, it is unlikely that Philippine

immigration laws would be relaxed to allow such flow of immigrants. The second one is

where large foreign retailers use their market power and economies of scale to kill off

local small retailers. While there is some likelihood of this, there are economic conditions

in the country that would minimize such occurrence. The more likely impact is greater

competitive pressure on medium and large retailers especially in the supermarket and

grocery segment as well as, importantly, on wholesaling operations. This is discussed

further below. On the whole, it is likely that the opening up of the retail trade industry to

foreign investment would not appreciably hurt the small retailers in the country.

Moreover, the experience in other countries indicates that there are no

guarantees for success for foreign retailers. For example, US retailers like Federated,

Sears and Woolworth failed in their attempts to gain market share in Spain and left

(Sternquist and Kacker 1994, p.117). Walmart apears to have failed in Indonesia. A Hong

Kong retail institution failed in Singapore. Foreign retailers seem to have been on the

retreat in East Asia during the past two years in view of the East Asian crisis.

Nevertheless, foreign retailers can be expected to become aggressive in

their expansion into Asia as East Asia recovers from the crisis and resumes growth. There

are already a number of big retailers making their presence felt in Asia. Thus, Carrefour

(France) is already in Taiwan, China, Thailand, Korea, Malaysia, Hong Kong, Singapore

and Indonesia. Ahold (the Netherlands) is in Malaysia, Shanghai, Thailand, Singapore

and Indonesia. Dairy Farm, a regional food and drugstore operator, is in Hong Kong (its

home base), Singapore, Australia, Taiwan, Indonesia, New Zealand, Malaysia and China.

Makro (Netherlands), focusing on wholesaling, is in Thailand, Indonesia, Taiwan,

Malaysia, China and the Philippines. AS Watson is in Hong Kong, Singapore, China,

Taiwan, Thailand and Malaysia. Other multinational retailers with so far more limited

country coverage in Asia include: Walmart (US; in China, Korea), Promodes (France; in

Taiwan, Indonesia and Korea), Delhaize (Belgium; in Thailand, Indonesia, Singapore),

Tesco (UK; in Thailand, Korea), Metro (Germany; in China), Auchan (France; in

Thailand), Casino (France; in Taiwan and Thailand), Boots (UK; in Thailand) and Jusco

52

(Japan; in Hong Kong, Malaysia and Thailand). (See Banzon 1999). It is interesting to

note that despite its vaunted financial resources and technological prowess, Walmart is

not yet a major presence in Asia; indeed, it retreated from Indonesia.

It may noted that the above mentioned retailers are mainly into

supermarkets, drugstores, grocery and convenience stores, where there are economies of

scale and therefore are likely focus of concerns of domestic retailers. Foreign retailers

that are more into non-food items like Marks and Spencer may not be a major concern to

domestic retailers because there is greater avenue for product differentiation and market

niching as well as less scope for economies of scale in non-food retailing.

The experience in developed countries is that there are economies of scale

in food retailing, such that a small number of big chains control much of the food

retailing industry. Thus, for example, the UK grocery giants (Tesco, Sainsbury and

Safeway) control 40 percent of UK’s food market and, together with Asda, Kwik Save

and Isoceles, dominate UK’s grocery retailing business. Similarly, the top ten leading

companies control 52 percent of France’s food retail sector, with Intermarche, Leclerc

and Carrefour controlling 25 percent of the total. Food distribution in Germany is also

highly concentrated, with 0.3 percent of all distributors headed by giants like Aldi and

Tengleman controlling 64 percent of total sales by the late 1980s. Behind the economies

of scale in food distribution is the highly integrated nature of operations of the large

players that allow them to coordinate their purchases without the need for wholesalers,

use specialized skills and new technology in purchasing and inventory management, and

gain negotiations leverage with manufacturers. (See Sternquist and Kacker 1994.) Some

store chains also adapt their store formats depending on the market and location, ranging

from a superstore which offers the widest range of products down to an express or

convenience store stocking a much more limited range of products. There is also

potential for bringing economies of scale to small establishments located in residential

neighborhoods by operating them around a centrally located large anchor store (Banzon

1999). Large food distributors, especially in the United Kingdom, have also developed

53

private labels manufactured to their specifications that allow them higher margins and

rate of profit (Sternquist and Kacker 1994).

The economies of scale in food distribution suggest that small independent

grocery stores and supermarkets are the ones most vulnerable to foreign competition. The

1994 Census results indicate that smaller grocery stores and supermarkets (i.e., those

establishments with employees less than 10) have higher gross margin than the bigger

grocery stores and supermarkets. Thus, there may be potentials for well-coordinated

chains of food stores to gain market share. Nonetheless, the success of large food

distributors in developed countries stems in part from the developed infrastructure

facilities and systems in these countries that allow food distributors the opportunities to

coordinate purchases, warehousing and distribution efficiently and reduce costs. The poor

infrastructure facilities and the archipelagic nature of the Philippines are likely important

constraints for foreign retailers in being able to replicate their systems effortlessly into

the country. In short, it is unlikely that big foreign retailers would be able to dominate

food distribution and shut out domestic retailers in the country in the same way that big

domestic retailers have so far failed to do so.

Big foreign retailers could gain significant market presence domestically if

they succeed in reducing wholesale margins which, as indicated in Table 19, are

comparatively higher in the Philippines than in the developed countries. Indeed, this is

likely an important source of competitiveness of the big foreign retailers because of their

systems, processes and technology that integrate wholesaling and retailing functions. Part

of the success of the big chains is precisely the ability to negotiate directly with

manufacturers and manage the distribution process to meet the demands of consumers in

a more timely and efficient manner than competitor establishments. Foreign firms relying

on economies of scale as their source of competitiveness in the Philippines would have to

be big in order to generate the needed scale of operations where the investments in

backward integration and logistics (e.g., distribution centers) become profitable. This

means that the foreign firms would have to have multiple stores domestically. Thus, for

example, Ahold has 47 stores in Malaysia, 44 stores in Shanghai and 38 stores in

54

Thailand. Similarly, Dairy Farm has 261 supermarkets in Australia, 220 supermarkets in

Hong Kong, 86 supermarkets in Indonesia and 77 supermarkets in New Zealand (Banzon

1999). This suggests that if foreign retailers were to come in a big way, they would locate

their chain of stores in very few urban markets in the country in order that the logistics

economies are maximized.

There are economic factors in the Philippines at present that will prevent

the demise of small retailers despite the entry of big foreign retailers. The first are the

high unemployment and underemployment rates in the country compared to developed

countries. The second is the low entry cost into retailing. The two together explain the

huge informal retail sector in the country. The reason for the decline in the small

independent retailers, especially in food retailing, in the developed countries is because of

the comparatively tight labor market and much higher wage rates in these countries

which make labor-saving but capital intensive large integrated purchasing, distribution

and retailing operations cost-effective. It may be noted that the enactment of laws

imposing restrictions on large scale retail enterprises in Europe occurred only in the

1970s and not much earlier (except in Belgium which had such a law passed before the

Second World War) because the tightening labor market and rising labor cost have made

small scale retailing increasingly vulnerable to competition from new and bigger retail

formats like hypermarts in Europe.

Another important consideration for the success of large stores like

Walmart in the United States is the availability of private transportation. The Walmart

strategy in the U.S. is to set up a store at a site within driving distance of several small

communities and to use lower prices (from its lower land costs and efficiencies in

integrating its distribution system by bypassing wholesalers) to undercut the small local

stores and drive them out of business (Baily 1993, p.87). In the Philippines, however, the

low level of private car ownership, the lack of appropriate storage space at home and the

low purchasing power of an average Filipino would likely prevent the optimal use of

economies of scale a-la Walmart and would likely mean the continued growth of small

neighborhood stores at least in the near future.

55

Nonetheless, the entry of foreign retailers into the country may likely

influence the way retailing is done in the country. For example, Walmart is known not

just for its technological prowess (it has one of the best information systems in the world)

but also for its heavy investment in consumer research and large investments in the

training of its employees (Banzon 1999), two areas that Philippine retailers appear to be

negligent of. Similarly, the increased competitive pressure from the entry of big foreign

supermarket and grocery chains into the country could encourage domestic operators to

integrate, cooperate and/or streamline operations. The introduction of distribution

systems by big foreign retailers will increase competitive pressure in wholesaling that

could lead to improvements in the services of wholesalers to the small retailers, and/or to

the reduction of wholesale margins and/or to changes in the channels of distribution in

the country away from wholesalers and towards self-distributing retailers (i.e, where

distribution and retailing are under the same firm). It may be recalled that there are more

wholesale industries than retail industries that are highly concentrated in the Philippines.

Finally, the entry of big foreign retailers that rely on technology-based systems and

processes could accelerate the domestic retailers’ investment into efficient consumer

response (ECR) initiatives that ultimately benefit consumers. The ECR initiative is

discussed further in the next section.

In summary, while it will not result in the demise of the Filipino retailer,

the entry of foreign retailers in the country would accelerate changes in the Philippine

retailing industry that most likely would prepare the industry better for the challenges of

the 21st century.

II. Towards Retailing and Distribution Services for the 21st Century

The changing shape of retailing. Retailing is changing significantly, especially

in developed countries. First, there is a growing internationalization of retailing. Where

once retailing is viewed as an essential service in a community around a specific location,

retail services and retailing concepts have become increasingly globalized. Innovative

56

retail ideas have spread around the world in varying degrees despite the vast difference in

per capita incomes. Retail ideas get exported to the rest of the world through various

channels such as foreign branches, foreign acquisitions, joint ventures, management

contracts, licensing and franchising. A successful retailer with a unique business and

product innovation or merchandise mix or cost advantage from vertically integrated

facilities of food processing and packaging may be motivated to expand operations

internationally (Sternquist and Kacker 1994, pp.1-3). Thus, retail service is increasingly

becoming exportable.

There is a growing globalization of retailing. A number of major retailers

in the developed countries have been expanding internationally, primarily into the rest of

Europe and the United States but increasingly into Asia and Latin America. The

motivations for expansion beyond the home market were both “pull” and “push” factors.

Among the “push” factors were the market saturation of the home market and the policy

constraint to the expansion of large establishments. For example, French hypermarket

chains expanded into southern Europe, Germany, United Kingdom, Brazil and Argentina

after the enactment and implementation of the 1973 Loi Royer Act (Sternquist and

Kacker 1994, pp. 152-153). Among the “pull” factors, especially with respect to the

European investments in the United States included compatibility in culture, language,

level of economic growth and climate, a much more business-friendly policy

environment in the US compared to Europe, the opportunity to understand the US

market, and the exchange of retailing knowhow with partner US retailers (Sternquist and

Kacker 1994, pp.154-161). The results of foreign investments in US retailing or of US

retailers investments have been very uneven: many foreign investments in major US

retailers (e.g., Sach’s Fifth, Marshall Field, Bonwit Teller) did not prove sustainable just

as major US retailers (e.g., J.C. Penney, Sears Roebuck, Safeway, Woolworth and

Federated Department Stores) sold off some or all of their foreign investments by the

1980s (Hollander and Keep 1992). The expansion of the big retailers into the rest of the

world, especially Asia and Latin America, appears linked not only to the growth

potentials in selected countries in the two emerging regions but also to the perception that

there would only be extremely few retailers with dominant global presence, Thus, there

57

is to some extent a race for global expansion among the major retailers in the developed

countries (Banzon 1999).

Second, retail operation is increasingly becoming an automated system of

managing consumer needs (Sternquist and Kacker 1994, pp.1). Food distribution is

increasingly consumer-driven, rather than producer-driven, as the system is being

designed increasingly to respond to consumer demand as quickly and as cheaply as

possible. Scanners are not only being used to speed up checkout and verify prices but also

to facilitate a variety of consumer loyalty programs and the targetting of products to

consumers based on their consumer patterns and demographic characteristics (Kinsey,

et.al., 1996, pp.13-14). This leads, for example, away from market segmentation into

relationship marketing by treating customers individually (Achabal and McIntyre 1992).

Indeed, technology is reshaping retailing. The most recent example is the explosion of e-

commerce especially in the developed countries. The effect is increasingly retailing

without borders.

And third, processes, systems and relationships in the entire distribution

sector are changing in order to gear the whole supply chain better to consumer needs.

This is best exemplified by the ECR (Efficient Consumer Response) initiative of the US

grocery industry. This is an industry-wide collaborative effort among food manufacturers,

distributors, brokers and retailers in order to improve intra- and inter-firm efficiencies

through new forms of collaboration primarily based on the more effective use of

information technology. By redesigning their own value chain and their linkages with the

value chain of their trading partners, firms can improve their competitive advantage. The

ECR initiative supports such reengineering efforts by facilitating improvements in

category management towards efficient product assortment, reengineering of warehouse

and logistics operations and redesign of processes that link separate firms. The

improvements in physical distribution and faster and a more accurate transmission of

orders, billing and product information allow faster and less costly movement of products

through the supply chain and reduce product inventories throughout the system. (See

King and Phumpiu 1996.)

58

There are significant benefits to manufacturers, retailers and consumers

from the adoption of ECR technologies. For the manufacturer, ECR strategies reduce out-

of-stock problems, improve relationship with trading partner and better image of the

manufacturer’s brand. For the retailer, ECR strategies improves customer loyalty and

allows more efficient store assortment and efficient replenishment of goods. For the

consumer, ECR strategies increase choice, fresher products, reduced out-of-stock and

increased shopping convenience. (See Banzon 1999.)

It may be noted that there are three major channels of distribution in the

grocery industry; namely, wholesaler supplied (where manufacturing, distribution and

retailing are performed by separate firms), self-distributing retailer (where distribution

and retailing are under the control of the same firm) and manufacturer direct store

delivery (where manufacturing and distribution are under the control of the same firm).

New competitors in the industry emerged as new technologies, business practices and

market conditions offered new opportunities for profit. For instance, large self-

distributing general merchandisers such as Wal-mart entered the grocery retail business

armed with new information technologies, sophisticated retail information and logistics

systems designed to maximize the use of such technologies. Similarly, “category killers”

specialize in a single line of products sold in supermarkets, replicate standardized formats

and business practices in a large number of stores and exercise volume buying power

with a narrow set of manufacturers or vendors. (See King and Phumpiu 1996.) Thus,

innovation and competition in retailing has emerged in part through the deft use of new

technologies, business practices, product mix and linkages within the supply chain.

The Philippine retail industry has been influenced to some extent by the

changes in the world retailing market. New retail formats such as warehouse or discount

stores have been established. Specialty stores, primarily boutiques and under franchise

arrangements, have taken root. Nonetheless, it is likely that the Philippine retail industry

and the Philippine economy can benefit from the systems and business practices of

59

foreign retailers that have succeeded in taking advantage of potentials for efficiencies in

effectively managing the firms’ supply and value added chains.

In addition, there remains the challenge of improving the systems and

procedures facing the country’s retail industry. Banzon (1999) enumerates many issues

that face the retail industry, including high costs of processing invoices in the country

that is at least twice the world average, high rate of out-of-stock that can go up to 20

percent of the time, long retail inventory time and unpaid balances that can go up to 6

months. Thus, Banzon brings out the importance of ECR for a more efficient retail trade

sector in the country.

Franchising, FDI and technology transfer. Franchising is growing fast

in the country. The number of franchises in the country nearly tripled during 1995-1998.

The share of foreign franchises increased from 42 percent in 1995 to 57 percent in 1998.

Most of the franchises were in the food business until the mid-1990s but by 1998, 57

percent of the total franchises were in the non-food business, especially for the local

franchises. Franchising started in the US with product franchising in the 1840s but there

is an increasing trend towards the business format franchise. In the US, among the more

important product franchises are automobile and gasoline retailing and softdrink bottling;

among the more important business format franchises are restaurants, hotels and motels,

and convenience stores.

Franchising is acknowledged as an important means to small business

growth. Indeed, around 40 percent of the total retail sales in the United States is

accounted by franchise establishments. Franchising is still new in Asia. For example,

franchise sales accounted for only 5 percent of Singapore of GNP in the early 1990s

(Robinson 1994) Franchising combines “…the advantages of entrepreneurial small

business with the large-scale marketing and buying power of a great corporation” (Katz

1996, p.1).

60

The franchise route is one means toward increasing productivity and

meeting the challenges of a changing retail and service sector. For a up-front fee and a

royalty (usually between 3 to 8 percent of gross sales), franchisees capitalize on the

franchisor’s brand name, well-developed concept and business system as well as

supporting business expertise such as management expertise, training, economies of scale

and advertising and promotions support. On the other hand, franchising allows

franchisors the opportunity to expand, albeit with less management control, without much

capital as compared to a chain.

In interviews with a small group of Filipino franchisees, franchising

allowed the franchisees to gain access to the technology they need to run the business.

Most of them felt that the technology could not be acquired from other sources. The

major areas of technology transfer are in operations (primarily in processing, physical

lay-outing and quality control), human resource development or training for both the

management and operations personnel, and marketing support (pricing, raw material

sourcing). Nevertheless, the most important for the franchisees is the brand name. To the

franchisees, the brand name and the proven system of running the business are enough

assurance that a franchise is more likely to succeed than starting an independent business.

Study Three discusses franchising and technology transfer in the

Philippines.

Franchising is one means of technology transfer from abroad. It is a

possible alternative to opening up the retail trade sector to foreign investment. However,

at the macroeconomic level, franchising involves capital outflows from the country while

opening the retail trade industry to foreign direct investment results in capital inflow in

addition to technology transfer. This is an important consideration at the macroeconomic

level for a country like the Philippines that is perennially short of capital for investments.

Nonetheless, franchising and opening up retail trade to foreign investment are not likely

to be substitutes. Some foreign retailers would prefer the franchising route; others the

foreign direct investment route. Even in Hong Kong, with a more welcoming

61

environment to foreign direct investment in retailing than the Philippines, franchising

remains profitable to foreign franchisors.

FDI in retail trade and the macroeconomy. Foreign investments in retail

trade have impacts not only on the retail trade industry but also on other sectors of the

economy. A simple simulation of the impact of foreign investments in retail trade by

Cororaton and Cuenca (1999) using an input-output framework indicates that the sectors

that will be significantly benefited from the foreign investments, apart from the retail

trade industry, are the finance, utilities and transportation industries. Foreign investments

in retail trade also contribute to macroeconomic stability and improved balance of

payments position as well as, directly or indirectly, increased employment.

Study Four presents Cororaton and Cuenca’s simulations.

Cororaton and Cuenca’s simulations are a simple one; they do not capture

the efficiency effects of technology transfer nor the benefits from greater competition in

the entire distribution sector arising from the inflow of foreign direct investment in

retailing. Another macroeconomic impact of foreign direct investment in retailing that is

not captured in Cororaton and Cuenca is that foreign direct investment eases the

constraint on capital for investment in retailing. Given the limited capital in the country,

domestic investments and loans (both local and foreign) for the retail sector are

opportunities lost in the other sectors of the economy. The recent East Asian crisis shows

that too much capital spent on the nontradable sector of the economy such as retail and

real estate property can lead to a deterioration in the international competitiveness of the

economy and a likely balance of payments crisis. Given that there will be a growing

demand for retail trade services as the economy grows and in the light of the limited

capital resources of the country, it would be better to open up the retail trade industry to

foreign investment.

62

As a final note, it is sometimes argued that the opening up of retail trade to

foreign retailers would encourage the latter to dump their goods in the country thereby

hurting the Filipino retailers and unnecessarily raising imports. While the risk of dumping

remains, the country has anti-dumping regulations that can be imposed. In addition,

foreign retailers need to pay tariffs on their imports while at present Filipino

viajeros/viajeras buy goods during sale seasons abroad and bring them over to the

country with likely nary a duty. Thus, the dumping issue may not likely be an important

concern with respect to the opening up of the retail trade industry to foreign investment.

III. Policy Implications

The discussion in the paper leads to a number of policy implications, to wit:

• Allow foreign investments in the retail trade industry. On the whole, the

returns to the country of opening up the industry to foreign investments are higher than

possible costs. The benefits stem from the increased competitive pressure in the entire

distribution network especially in wholesale trade, technology transfer including human

resource development, and the macroeconomic benefits of foreign direct investment. The

possible adjustment costs appear to be manageable considering that the retail margins in

the country are on the average lower than in the OECD countries. Thus, Filipino retailers

on the whole can compete with foreign retailers price-wise. Moreover, the retail density

of the country is still low; thus, there is a large scope for the expansion of the number of

retail establishments over time. It may be noted that virtually all the major East Asian

countries except the Philippines now host foreign retailers, either fully-owned or in joint

ventures, in their countries.

• Favor large- scale foreign retailers over small- scale retailers. It is the

large-scale retailers that have developed the systems and processes that improve the

efficiency of distribution services. They are also the ones that can provide the competitive

pressure in wholesale trade. The bias for large-scale foreign retailers can be implemented

63

through a higher allowable foreign equity participation for large-scale investments or, a

higher cut-off investment level if a uniform foreign equity participation for both large-

and small-scale foreign retailers is preferred. (The extent of the foreign equity

participation beyond a simple majority of 51 percent is fundamentally a political

question.)

• Controlled opening up to large-scale foreign retailers may be preferable

While Filipino retailers can on the whole compete price-wise vis-à-vis foreign retailers,

there are some vulnerable sectors especially medium-sized supermarkets and grocery

stores. A policy bias for joint ventures may be called for in order to maximize the

benefits of technology transfer. Similarly, a policy bias for a mix of chain stores and

franchise stores is preferable to a sole emphasis on chain stores in order to encourage the

growth, rather than displacement, of small Filipino retailers.

• Encourage domestic franchising. Franchising is one means of instituting

greater efficiencies in retailing through streamlined business systems, human resource

development, continuous quality control and product development, and market

development. Franchising is one means by which Filipino retailers can adjust to an open

retail trade industry. In Singapore, the government has launched several initiatives to

encourage franchising in Singapore. The initiatives include the setting up of a Franchise

Development Centre tasked to help in upgrading the local retail sector by fostering

economic groupings among retailers and assist them establish franchises and

cooperatives, the Management of Economic Group Assistance (MEGA) Scheme which

provides grants to the more established local firms for study missions, consultancy work

and training to encourage them to initiate franchises, and the Franchise Development

Assistance Scheme (FRANDAS) which absorbs part of the cost of developing the

franchise programs of local firms planning to expand abroad through franchising (e.g.,

feasibility studies, hiring of consultants and lawyers) (Robinson 1994). Like in

Singapore, it is important for the Philippines to provide government support to the

development of local franchises and possibly even the expansion of local franchises

abroad.

64

• Strengthen the Domestic Trade Development Council. It is clear from

the discussion above that beyond the liberalization of the retail trade industry, the policy

challenge for the Philippine government is the improvement of the entire distribution

sector. The liberalization of the retail trade industry can be a catalyst for possible

innovations and changes in the distribution sector. Nevertheless, it is important for the

government to give more attention to the sector. The Domestic Trade Development

Council can be tasked to develop a Distribution Sector Development Plan for both the

wholesale and retail trade sector. The Council can also be a policy advocate for the

improvements in the policy regime and infrastructure in shipping, transportation, credit

and storage.

65

References: Achabal, D. and S. McIntyre (1992), “Emerging Technology in Retailing:

Challenges and Opportunities for the 1990s” in R. Peterson (ed.) The

Future of U.S. Retailing: An Agenda for the 21st Century. New York:

Quorum Books.

Agpalo, R. (1962). The Political Process and the Nationalization of the Retail

Industry. Quezon City: University of the Philippines.

Arceo-Dumlao, T (1999). “Franchising may not immediately turn your firm into

a Jollibee, but it could the first step” Philippine Daily Inquirer, April 23

issue.

Baily, M.N. (1993), “Competition, Regulation and Efficiency in Service Industries” Brookings Papers on Economic Activity: Microeconomics, Vol 2.

Banzon, G. (1999)’ “Emerging Global Retailing Trends” Paper presented at the

1st Cebu Retail Expo and Convention, SM Conference Hall, Cebu City,

October.

Cortsjens, J,, M. Cortsjens, and R. Lal (1995). Retail Competition in the Fast- Moving Consumer Goods Industry: The Case of France and the U.K.. INSEAD Working Paper, INSEAD (France), March.

Flath, D. (1996), “Is Japan’s Retail Sector Truly Distinctive?” Journal of

Comparative Economics, Vol. 23, pp.181-191.

Hall, M. and J. Knapp (1955), “Gross Margins and Efficiency Measurement in

Retail Trade” Oxford Economic Papers, Vol 7. Reprinted in K. Tucker

and B. Yamey (eds.) Economics of Retailing. Penguin Education, 1973.

66

Hoj, J., T. Kato and D. Pilat (1995), “Deregulation and Privatization in the Service Sector” OECD Economic Studies, No. 5.

Hughes, J.D. and S. Pollard (1957), “Gross Margins in Retail Distribution”

Oxford Economic Papers, Vol. 9. Reprinted in K. Tucker and B. Yamey

(eds.) Economics of Retailing. Penguin Education, 1973.

Itoh, M. (1996), “Regulatory Reform: An Experience of the Japanese Distribution

System” in OECD, Regulatory Reform and International Market

Openness. Paris: OECD.

Jefferys, J. and D. Knee (1962). Retailing in Europe: Present Structure and

FutureTrends. London: MacMillan and Co.

Katz, J. (1996), “Franchise Nation” Regional Review, Federal Reserve Bank of

Boston.

Maruyama, M. (1993). A Study of the Distribution System of Japan. OECD

Working Paper No. 12. Paris: OECD.

Pilat, D. (1997) Regulation and Performance in the Distribution Sector. OECD

Economic Department Working Paper No. 180. Paris: OECD.

Robinson. J. (1994), The Franchising Business in Singapore DBS Bank-

Singapore Briefing, Economic Research Department, DBS Bank,

Singapore.

Sternquist, B. and M. Kacker (1994). European Retailing’s Vanishing Borders.

Westport, Conn. U.S.A.: Quorum Books.

Yoshino, M. Y.(1971). The Japanese Marketing System: Adaptations and

Innovations. Massachusetts Institute of Technology.

67

Part II

Supporting Studies

68

Study I

Opening Up the Philippine Telecommunications

Industry To Competition and Foreign Investment

By: Rafaelita A. Mercado- Aldaba

69

Opening Up The Philippine Telecommunications Industry To Competition and

Foreign Investment

Rafaelita A. Mercado-Aldaba I. Introduction

Historically, the provision of telecommunications services has been a prime

example of natural monopoly owing to the high cost of fixed investment in building a

telecommunications network. The traditional assumption was that the market could not

efficiently support more than one firm and allowing firms to pursue profit-maximizing

strategies in a market that was not structurally competitive would not maximize consumer

welfare. Economic regulation was seen as the best policy to correct this market failure

and serve public interest. State-run telecommunications organizations (which maintained

monopoly control of access to the network) have, thus, become the norm.

Technological change, however, has challenged the traditional notions of natural

monopolies. This has been especially evident in telecommunications where rapid

technological change in the sector has considerably reduced costs and expanded the range

of networks and the types of services offered. As the traditional market structure that was

suitable for voice telephony was no longer appropriate for new network services known

as “value added services or value added network services (VANS)”1, many countries

decided to liberalize. The 1980s witnessed the introduction of competition, deregulation

on long distance services, and privatization in the UK, USA, and Japan. And soon, many

countries followed suit by privatizing their state-owned telecommunications providers.

Apparently, the natural monopoly model and economies of scale arguments were no

longer true for the telecommunications sector. Technological change with some growth

in market size has increased the technical feasibility of competition (Janow, 1998).

In the Philippines, the government allowed a private monopoly to provide

telecommunications services. For more than half a century, the telecommunications 1 These include data banks, electronic mail, and electronic data interchange.

70

industry was a regulated monopoly which was subject to significant regulatory barriers to

entry. Congressional franchises, which were difficult to acquire, were required prior to

entry into telecommunications services and facilities. For almost 65 years, the Philippine

Long Distance and Telephone Company (PLDT) dominated the industry and controlled

both domestic and overseas toll services.

Amidst the wave of deregulation and liberalization that swept the world economy,

the Philippines implemented a series of substantial policy reforms in 1993 aimed towards

universal access to basic telephone services. The policy changes were also meant to

address the dismal state of the telecommunications sector as indicated by the long waiting

time to own a telephone and the huge telephone backlog. Service was generally not

available and where it was, quality of service was unreliable (World Bank, 1993). These

problems were attributed to the failure of a private monopoly to develop the

telecommunications industry and by the weak policy and regulatory framework of the

government resulting in its inability to discipline PLDT effectively (Gavino, 1992 as cited

in Serafica, 1998).

Opportunities for foreign investment in the past had been limited by the fact that

many countries had state- or private-owned monopoly carriers. Telecommunications had,

traditionally, been an industry requiring large-scale and lumpy investments. Domestic

investors could not provide that level of investment in contrast to foreign firms which had

the capital, managerial expertise and technology. Market liberalization has offered the

potential benefits of additional investment, new and improved products as well as lower

prices. Nevertheless, many developing countries fear that by opening up their market to

competition and foreign investment, they will lose control of a strategic industry.

The Philippines restricts foreign equity participation up to 40 percent. The

liberalization and deregulation of the telecommunications sector saw the entry of nine new

firms, all of which were joint ventures, in a market which was previously controlled by a

monopoly. The main objective of this paper is to determine the impact of foreign

71

investment on the Philippine telecommunications industry. An attempt is also made to

draw lessons from the experience of the sector as these may be useful to the on-going

debate on the retail trade liberalization bill.

The next section discusses recent government policy on telecommunications and

the existing regulatory framework, after which, the current structure of the industry is

presented. The paper then looks at the effects of foreign investment on the performance

of the industry. The final section provides some insights and lessons based on the

experience of the telecommunications sector and contribute to the ongoing discussions on

the retail trade liberalization law.

I. Regulatory Framework and Government Policy Towards the

Liberalization of Telecommunications

Regulatory and Administrative Framework

The telecommunications industry operates under close government regulation.

The Philippine Constitution allows foreign equity participation in the industry up to a

maximum ownership of forty percent. Entry into the industry requires a congressional

franchise which is issued for a maximum period of fifty years. After the franchise is

acquired, another authorization requirement is the Certificate of Public Convenience and

Necessity (CPCN) which is issued by the National Telecommunications Office (NTC).

The operations of telecommunications operators including operating facilities, services

provided, and rates charged are regulated by the NTC. In procuring telecommunications

equipment, buyers are required to secure a permit to purchase and permit to import from

the NTC. The enactment of RA in 1995 introduced some regulatory changes in the

industry. For instance, radio paging is no longer regulated by the NTC, except only with

respect to the norms on radio frequency use while value added service is no longer

required to secure a franchise and is allowed to competitively offer its services, provided

that it does not put up its own network.

72

The Department of Transportation and Communications (DOTC) is the primary

government office responsible for formulating telecommunications policy in the

country. Its functions include the following:

• Formulate and recommend national policies and guidelines for the

preparation and implementation of integrated and comprehensive

communications systems at the national, regional, and local levels;

• Establish and administer comprehensive and integrated programs for

communications;

• Assess, review and provide direction to communications research and

development programs of the government; Administer and enforce all

laws, rules and regulations in the telecommunications sector.

The National Telecommunications Office (NTC) is a quasi-judicial body acting as

the regulatory arm of the telecommunications industry. The DOTC provides the overall

policy guidance to the NTC. It issues Certificate of Public Convenience and Necessity

(CPCN) to telecommunications carriers and regulates the operations of

telecommunications carriers and radio and television broadcasters. Its functions include

the following:

• Establish, prescribe and regulate areas of operation of particular operators

of public service communications;

• Determine and prescribe charges or rates pertinent to the operation of such

public utility and services with some exception;

• Grant permits for the use of radio frequencies and sub-allocate frequencies

allocated at the international level by the International

Telecommunications Union;

73

• Register radio transmitters and receivers.

The Telecommunications Office (TELOF) and the Municipal Telephone Project

Office (MTPO) are operating arms of the government providing limited telephone and

telegraph services in rural areas. The TELOF provides the following services to the

general public particularly in areas where the private sector has not ventured:

telegraphic transfer, telegraph messages, and telephone lines/units. The MTPO

implements the government’s municipal telephone program which was established

under the Municipal Telephone Act (RA 6849) to implement a nationwide plan and

install telephones in every unserved municipality. RA 6849 gave qualified private

telecommunications operators the first option to provide, install, and operate public

calling stations in all unserved municipalities.

Recent Policy Changes

After the change of administration in 1986, telecommunications was identified as

one of the most serious constraints to a strategy of private-sector-led growth. In 1987,

following discussions with various stakeholders, the DOTC announced a broad package

of policy statements including the deregulation of the telecommunications sector and

the definition of the government’s role as creating a business environment in which the

private sector could compete profitably. Shortly thereafter, the NTC granted

Certificates of Convenience and Necessity to two international record carriers, Eastern

Telecommunications Philippines, Inc (ETPI) and Philippine Global Communications

(Philcom). The two firms were expected to provide competition to PLDT in the

provision of international telephone traffic. This was, however, delayed as PLDT

reacted by waging legal battles to protect its market share against new entrants.

The reform process was accelerated only in recent years with the issuance of

substantial policy changes in 1993 which were aimed at increasing private sector

investment in the telecommunications sector and fostering competition between the

74

heavily protected monopoly, PLDT, and companies that were willing to invest in the

sector. These policy reforms which were intended to deregulate and liberalize the

industry are briefly described below:

Executive Order 59 (February 1993): mandated the compulsory interconnection

of authorized public telecommunications carriers in order to create a universally

accessible and fully integrated nationwide telecommunications networks.

Executive Order 109 (July 1993): mandated the provision of more local telephone

exchanges and required international gateway facility (IGF) operators and providers of

services which were possible sources of subsidy to provide local exchange carrier service

in unserved or underserved areas. To facilitate the implementation of EO 109, the NTC

developed the service area scheme (SAS) under which the country was divided into

eleven equally viable local exchange carrier (LEC) areas which were assigned to IGF and

CMTS licensees. Each area has a mix of urban and less profitable rural markets to

prevent concentrating telephone services in lucrative areas.

In return for the authorizations granted them to operate the highly profitable

cellular phone and international gateway operations, IGF and CMTS franchise holders

were each required to provide at least 300,000 and 400,000 local exchange lines,

respectively, within five years. A telecommunications operator with both CMTS and

IGF franchises must install 700,000 land lines within its designated area. There are

three carriers with both IGF and CMTS permits: Globe Telecom, Isla Communications,

and Smart Communications.

Republic Act 7925 (1995): reduced barriers to entry in the telecommunications

industry.

• The use of radio frequency shall be subject to reasonable spectrum

user fees. Where the demand for specific frequencies exceeds availability, the

NTC shall hold open tenders for the same.

75

• Protection of the local exchange operator from uncompensated

bypass or overlapping of operations of other telecommunications entities in

need of physical links or connection to its customers in the areas.

• Rates shall no longer be governed by the 12 percent ceiling.

• Radio paging is no longer regulated by the NTC, except only with

respect to the norms on radio frequency use.

• Value added service is no longer required to secure a franchise and

is allowed to competitively offer its services, provided that it does not put up

its own network.

• The required period for international gateway facility (IGF) and

CMTS operators to provide local exchange service is reduced from five years

(under EO 109) to three years.

Department Circular Number 91-260: minimize or eliminate situations where

multiple operators are providing local exchange service in a given area.

Department Circular Number 92-269: promote an open and competitive

environment for services such as cellular mobile telephone system (CMTS) subject to

availability of radio spectrum.

Department Circular Number 93-273: promote and develop a robust domestic

satellite services industry through a dynamic, healthy, and competitive environment.

Department Circular Number 94-277: broaden access to international satellite

systems in order to permit the public to experience the benefits to be derived from greater

competition and new technologies.

76

I. Structure of the Industry

Based on the 1994 Census of Establishments, the telecommunications industry

generated a total value added of P 26.4 billion which represented a contribution of about

1.6 percent of the country’s gross domestic product (see Table 1). The telephone sub-

sector contributed the bulk of the total with its share of about 81 percent of total

telecommunications value added. The industry employed about 393,360 workers. The

sector was heavily dominated by large firms. Although small firms represented 51

percent of total telecommunications establishments, they accounted for a very small

percentage, almost negligible, of total value added and roughly one percent of total

average employment.

In 1995 (based on the Annual Survey of Establishments), the telecommunications

industry registered an increase of about 17 percent in its total value added. Its

contribution to the economy as measured by its ratio to GDP remained unchanged at 1.6

percent. The provision of telephone services still dominated the industry as its share to

total value added rose to 86 percent. The total number of telecommunications companies

increased by 38 percent between 1994 and 1995, with small firms posting the highest

increase. The total number of workers increased by about 17 percent, or 461,688 workers

(refer to Table 1).

77

Table 1: Economic Contribution of the Telecommunications Industry, 1994 and 1995

Value Added

In P million As % of GDP Average Total Employment

Number of Establish-ments

Telecommunications Sub-sector

1994 1995 1994 1995 1994 1995 1994 1995 Telephone Service With 10 or more employees With less than 10 employees Sub total

21438.5

16.1

21454.6

26440.1

37.8

26477.9

1.3

1.4

22933

193

23126

27989

377

28366

39

56

95

60

86

146 Telegraph Services With 10 or more employees With less than 10 employees Sub total

3025.0

0.4

3025.4

2424.4

1.4

2425.8

0.2

0.1

7569

15

7584

8067

21

8088

14 5

19

12 6

18 Communications Services, nec With 10 or more employees With less than 10 employees Sub total

1931.6

1.7 1933.3

1847.8

49.7

1897.5

0.1

0.1

2011

59

2070

1914

106

2020

21

15

36

23

20

43 With 10 or more employees With less than 10 employees Total

26395.1

18.2

26413.3

30712.0

88.9

30800.9

1.6

1.6

32513

267

32780

37970

504

38474

74

76

150

95

112

207 Source: 1994 Census of Establishments and 1995 Annual Survey of Establishments

In terms of profitability, the telecommunications sector posted a total net

income of P 8.1 billion in 1995, more than half of which (about 71 percent) was

accounted for by the telecommunications giant, PLDT (see Table 2). Total net income

increased by about 22 percent in 1996 as the share of PLDT dropped to 64 percent. In

1995, a total of fourteen telecommunications companies landed in the top 1000

corporations in terms of gross revenues. In 1996, this went up to sixteen companies. As

78

expected, telephone service was the most profitable segment of the industry with a share

of 83 percent of the total in 1995, although this dropped to 74 percent in 1996. Aside

from PLDT, the other top earners were Piltel (a PLDT subsidiary) and Smart. The

telegraph service sub-sector posted losses of about P183 million in 1995 and P879

million in 1996. Other communication services registered net income of P1.6 billion with

the top earners composed of Philippine Telecom Investment, Eastern

Telecommunications Philippines, Philippine Communications Satellite, and Philippine

Overseas Telecom. The net income of this sub-sector more than doubled in 1996 as

gateway operators Digital and Islacom increased their shares to 25 and 20 percent,

respectively. The other companies’ share of the sub-sector’s total net income declined

substantially from their 1995 levels. The share of Philippine Telecom dropped from 62 to

36 percent while ETPI’s share decreased from 34 to 13 percent. Philcomsat experienced

the same as its share slid from 20 to only five percent in the years under review.

79

Table 2: Net Income Of Major Telecommunications Operators, 1995 and 1996

(in million pesos)

1995 1996Sub-

sector Net In- Com

Top Earners % Share

Rank Net In-come

Top Earners % Share

Rank

Tele-phone Service

6724 PLDT Piltel Smart

86 12 2

8 76 371

7365 PLDT Piltel Smart

87 10 3

8 72 182

Tele-graph Service

-183 GMCR Phil. Wireless PT&T

-85 41

-15

453 583 757

-879 GMCR Phil. Wireless PT&T Radio Commns

-85 10 -4 -29

228 560

754 919

CommunicationService, nec

1626 Phil.Telecom ETPI Philcomsat Phil. Overseas Digital Extelcom Phil. Global EasyCall

62 34 26 26

11 0.5 -35 -1

340 236 348 691

461 402 288 592

3505 Phil.Telecom ETPI Philcomsat Digital Extelcom Phil. Global EasyCall Interl Commns Islacom

36 13 5 20 -12 -0.2

2 -4 25

339 294 538 246 384 465 525 365 555

Total 8167 9991 Source: Business Profiles 1997-98: Top 7000 Corporations

The telecommunications industry is composed of the following operations: 1. Voice Carrier Service

The country has a total of 74 private and four government telephone operators

including the TELOF, the government’s nationwide telecommunications carrier. There

are currently 6,548,114 installed lines in the country (as of October 1998).

PLDT is the dominant carrier with a total percentage share of about 32 percent of

the total number of installed lines in 1998. Far second are Islacom with a share of 11

80

percent and Smart and Globe with equal shares of 10.8 percent. Bayantel follows with a

share of 7 percent (see Table 3).

Table 3: Number of Installed Lines by Carrier

Carrier Number of Installed Lines

% Share

PLDT 2114780 32.3 Digitel 374816 5.7 Globe 705288 10.8 Bayantel 462509 7.1 Islacom 727407 11.0 Philcom 71334 1.1 Piltel 379413 5.8 PT&T 172314 2.6 Smart 704073 10.8 ETPI/TTPI 71357 1.1 Other Operators 764823 11.7 Total 6548114 100.0

Source: NTC

Table 4: Telephone Distribution By Region, 1997

Region Installed

Lines Population Telephone

Density CAR 64814 1309811 4.95

I 242742 3931261 6.17 II 23630 2640554 0.89 III 427199 7218913 5.92 IV 734047 10463047 7.02 V 133363 4488068 2.97 VI 258204 5983675 4.32 VII 380290 5214527 7.29 VIII 89182 3511714 2.54 IX 44457 2930263 1.52 X 115943 4139703 2.80 XI 339941 5331644 6.38 XII 67468 2473078 2.73

ARMM 45319 2087362 2.17 NCR 2808957 9814977 28.62 Total 5775556 71538597 8.07

Source: NTC

81

Telephone density is about 9.6 for every 100 persons, an improvement from the

1997 figure of 8.07. The distribution of telephones across regions as shown in Table 4

reveals a highly uneven distribution. Most telephone lines are concentrated in Metro

Manila, the center of economic and political power in the country. Metro Manila had a

high telephone density of 28.62 in 1997 while the rest of the country had a telephone

density ranging from 0.89 (Region II) to 7.29 (Region VII). The table also shows that

coming far second after Metro Manila is Region VII followed by Regions IV, XI and I.

Telephone services are classified into two: local exchange services and long

distance telephone services. The latter is further divided into domestic or national long

distance and international long distance. Local exchange service in the country is

provided under the service area scheme wherein a single carrier (operator) is allowed

to serve only in its assigned area (refer to Table 5). The scheme requires each IGF

operator and CMTS operator to install 300,000 and 400,000 telephone lines,

respectively within three years. A telecommunications operator with both CMTS and

IGF franchises must install 700,000 telephone lines. PLDT is excluded from the

scheme as it is not obligated to fulfil the same requirement.

82

Table 5: Service Area Scheme

Assigned Carrier

SA Number

Region Province

Smartcom 1 3

I NCR D III

Abra, Ilocos Norte, Ilocos Sur, La Union, Pangasinan, Mt. Province, Benguet Pasay City, Las Pinas, Paranaque, Pateros, Taguig, Muntinlupa Tarlac, Pampanga, Zambales, Bataan, Bulacan, Nueva Ecija

Eastern 2 II NCR A

Batanes, Cagayan Valley, Isabela, Quirino, Nueva Viscaya, Ifugao, Kalinga-Apayao Manila, Navotas, Caloocan City

PT&T/Capwire

4 IVA Aurora, Laguna, Quezon, Marinduque, Rizal, Romblon

Globe GMCR

5 11

IVB XII NCR C

Cavite, Batangas, Occ. Mindoro, Or. Mindoro, Palawan Lanao del Norte, Lanao del Sur, Maguindanao, North Cotabato, Sultan Kudarat Makati, San Juan, Mandaluyong, Marikina, Pasig

ICC 6 V NCR B

Albay, Camarines Norte, Camarines Sur, Catanduanes, Masbate, Sorsogon Quezon City, Valenzuela, Malabon

Islacom 7 8

VI VII A VII B VIII

Aklan, Antique, Capiz, Iloilo, Negros Occidental, Guimaras Negros Oriental, Siquijor Bohol, Cebu Eastern Samar, Leyte, Northern Samar, Southern Leyte, Samar, Biliran

Piltel 9 IX A X

Zamboanga del Norte, Zamboanga del Sur Misamis Occidental

10

XI A IX B

Davao del Sur, South Cotabato, Sarangani Sulu, Tawi-Tawi

Philcom 9 10

X XI B XI A IXB

Agusan del Norte, Agusan del Sur, Bukidnon, Camiguin Misamis Oriental, Surigao del Norte Surigao del Sur, Davao Oriental Davao del Norte Basilan

Source: NTC

83

There are nine telephone firms currently operating under this scheme: Globe

Telecom, Islacom, Smart, Digitel, International Communications Corporation-Bayantel,

Philippine Global Communications/ Major Telecoms (Philcom), Piltel, PT&T/Capitol

Wireless, and ETPI (see Table 6). Under EO 109, the SAS participants are required to

install a total of four million telephone lines within three years. As these carriers began

their rollout programs in 1996, PLDT launched its Zero Backlog Program under which

it continued to install lines. Based on the revised rollout plans of the SAS participants,

main telephone lines are expected to reach 4,110,248 lines in 1998 while PLDT

committed to install an additional 1,254,372 lines.

The SAS carriers have been lagging in fulfilling the three-year deadline set by

Congress. According to the DOTC, these carriers have concentrated their installations

in profitable urban areas while the provision of telephone lines in rural areas has

remained sluggish. Based on the 1998 second quarter accomplishment ratings1 reported

by the NTC, five firms failed to comply with their EO 109 commitments: Islacom –

49.5%, Major/Philcom - 23.8%, Piltel – 94.9%, PT&T/Capwire - 57.4%, and ETPI -

23.8% (refer to Table 6). ETPI obtained its provisional authority to provide local

exchange carrier service only in September 1996 and extended its total rollout program

up to 1999. The NTC warned that penalties would be imposed on those telephone firms

that would not measure up by September 1999. It also plans to open up the areas where

assigned operators failed to supply the required lines to other carriers.

1 Ratio of a firm’s installed telephone lines to its total required lines under EO 109.

84

Table 6: Status of Service Area Scheme

Telecommuni-cations Carrier

Total Lines Required Under SAS

Total Lines Committed Under Revised Rollout Plans

Cumulative Lines Installed

Performance Rating

Digitel 300000 337932 374816 124.9 Globe Telecom 700000 705205 705288 100.8 ICC/Bayantel 300000 341410 462509 154.2

Islacom 700000 701330 346457 49.5 Major/Philcom 300000 305706 71334 23.8 Piltel 400000 417858 379413 94.9 PT&T/Capwire 300000 300000 172314 57.4 Smart 700000 700310 704073 100.6 ETPI 300000 300497 71357 23.8 Sub-total 4000000 4110248 3287561 PLDT - 1254372 1274282 - Total 4000000 5364620 4561843 - Source: NTC

Newcomers in the industry, however, are lobbying for the abolition of the service

area scheme as it tends to limit the smaller carriers’ growth capacity and ability to

compete with the dominant PLDT. Lamberte (1996) called for a review of the scheme

as it seemed to run counter to the policy of competition. What the scheme did was to

level the playing field for PLDT as new entrants were obligated to practice cross-

subsidization between the less lucrative areas with the very profitable ones. Lamberte

hinted that it may not be too late to abandon the scheme especially since many of the

participants were way behind their schedule.

Alonzo and San Pedro (1996) commented that there may be too many players

competing in a capital intensive sector where operating a network of 300,000 or

400,000 lines may not be profitable. Out of the eleven service areas designated by the

NTC, only four included parts of the profitable Metro Manila area where PLDT’s main

lines were already concentrated. Thus, the less populated areas would not be as

attractive to operators.

85

Serafica (1998) argued that in opening up previously monopolized markets,

competition may be hampered due to the presence of asymmetry (e.g. control of

essential facility by incumbent) between an established firm and new players. There is,

thus, a need to provide assistance to new players by limiting further entry, ensuring

favorable terms of interconnection or relieving entrants from obligations placed on the

incumbent. This is exactly the opposite of what the service area scheme seeks to

achieve. Serafica added that the experience of telecommunications worldwide showed

that effective competition took place only with some form of assistance to new players.

PLDT provides not only local telephone service but domestic and international

long distance services as well. It is the principal supplier of long distance telephone

service in the country as it owns and operates an extensive nationwide backbone

transmission network which is necessary for the processing of long distance telephone

calls. Smaller telecommunications companies must go through PLDT’s network to allow

them to process these calls. They have long complained that PLDT has been charging

them unreasonably higher fees. An alternative backbone facility is currently being

developed by the government, the National Telephone Digital Network, which was

initially pushed by Philippine Global Communications and Bayan Communications.

The issuance of EO 59 in February 1993 mandated compulsory interconnections

of all public telecommunications carriers. Many considered the pace of interconnection

to be very slow. As PLDT controls the public switch network, it has dictated the pace

of interconnection. New industry players and smaller firms complained that it was

difficult for them to negotiate favorable interconnection deals with PLDT as, being the

incumbent operator, it had a stronger bargaining position. After more than five years

since the issuance of EO 59, it was only recently that interconnections have been

almost fully completed. Early this year, PLDT reported that it is now fully connected

with other carriers including its international gateway facility for long distance calls,

except for ETPI, with which it is set to conclude an interconnection agreement within

the year (Manila Times, January 12, 1999).

86

PLDT used to be the only operator of an international switching center in the

Philippines. With the liberalization of the sector, there are now a total of eleven IGF

operators (including PLDT).

2. Record/Data Carrier Services

Record/data carrier services are classified into domestic and international record

carrier services. The services provided are telegraph, telex, facsimile, electronic mail

and data communications services. There are currently six domestic record carriers

consisting of GMCR (Globe Telecom), Oceanic Wireless Network (OWNI), Philippine

Telegraph and Telephone (PT&T), Radio Communications of the Philippines (RCPI),

Universal Telecommunications, and TELOF. There are five international record

carriers composed of Capwire, ETPI, Globe Telecom, Philcom, and PLDT.

The domestic record carrier services is dominated by telegraph with the

government’s TELOF providing the major telegraph service in the country. Telex is the

second largest domestic record service which is provided mainly by private domestic

record carriers.

3. Carrier’ s Carrier Service Prior to the liberalization of the sub-sector, there used to be only two satellite

carriers, PHILCOMSAT and DOMSAT providing leased circuits to the international

and domestic record carriers. With the issuance of DOTC Circular Number 93-273, any

qualified applicant may apply for a CPCN/Provisonal Authority (PA) to install, operate

and maintain any satellite related services. There are three companies which were

granted authority to provide various transmission services for other communications

carriers. These are: DOMSAT PHILCOMSAT, and CAPWIRE.

87

4. Other Services

Radio Paging Services

Prior to the liberalization of the radio paging services sub-sector, there was only

one provider of such services. As of December 1998, there were fifteen companies that

provided radio paging services in the country. The number of radio paging subscribers

has rapidly grown over the years. Given the limited supply of fixed telephone lines and

increasing demand, radio paging services provided an alternative. Between 1990 and

1995, the number of radio paging subscribers increased by 62 percent annually. As of

December 1998, the NTC reported that there were 704,138 radio paging subscribers

dominated by Easycall with its share of 39 percent of the market. Pocketbell closely

followed with a share of 28 percent of the market (see Table 7).

Trunked Repeater Radio System

Trunk radio services served as another alternative to address the deficiencies in

telephone services. There are, currently, ten trunk repeater radio system providers. The

number of trunk radio system subscribers increased substantially from 1,938 in 1991 to

45,859 in 1997.

88

Table 7: Radio Paging System by Company, 1998

Operator Number of Subscribers

% Share

Easycall Communications Philippines 275560 39.1 Philippine Wireless (Pocketbell) 195275 27.7 Infocom Communication (Infopage) 77750 11.0 Pilipino Telephone Corporation (Beeper) 40828 5.8 Radio Marine (Power Page) 30200 4.3 Island Country (Jaspage) 26000 3.7 Isla Communications (Icon) 22197 3.2 Multi-Media Telephone (Index) 17397 2.5 Ermita Electronics (Star Pager 2000) 11168 1.6 Message System (Recall 138) 4243 0.6 Teodoro Romasanta (Digipage) 3320 0.5 Worldwide Communications 200 0.0 AZ Communications - Smart Communications (Smartpage) - Corona International - Total 704138 100.0

Source: NTC

Cellular Mobile Telephone System

There are, currently, five CMTS companies in the country Express

Telecommunications (Digital), Piltel (Mobiline), Smart, Isla Communications, and

GMCR (Handyphone). In 1989, the government granted Piltel and Extelcom franchises

to operate cellular mobile telephone systems. Smartcom, Islacom, and Globe entered the

market in 1993.

Owing to the shortage of fixed telephone lines, the demand for cellular telephones

swelled as a result of a growing population and economic growth. In 1991, there were

only 34,600 cellular mobile telephone subscribers. This increased to 493,862 subscribers

in 1995. In 1997, there were 1,343,620 subscribers.

89

The cellular mobile telephone market is dominated by Smart with its share of 49

percent of the market (see Table 8). This is followed by Piltel with a share of 19

percent and by Extelcom and Globe with equal shares of about 13 percent each.

Table 8: Cellular Mobile Telephone System Subscribers by Company

Operator Number of Subscribers % Share Smart 762262 48.9 Piltel 293340 18.8 Globe 203819 13.1 Extelcom 200000 12.8 Islacom 100000 6.4 Total 1559421 100.0

Source: NTC

I. Impact of Foreign Investment in the Telecommunications Sector

Telecommunications play a paramount role in determining the competitiveness of

an economy in a modern society. Countries know full well that a modern

telecommunications network is strategic to their survival in a competitive global

economy. Access to an advanced telecommunications services at reasonable prices is

essential to their economic and industrial development.

To fast track the development of telecommunications infrastructure, there are two

courses of action open to governments. One way is to commit more public funds to the

sector and the other is to open the sector to private capital through privatization,

liberalization, and deregulation. The latter, which has been pursued in the Philippines,

is the favored policy direction as governments find it hard to provide much better

infrastructure with the latest technology given their limited funds and inadequacies in

managing a technology-driven industry like the telecommunications sector (Ure and

Vivorakij, 1998).

90

The telecommunications industry is a high technology industry requiring large-

scale investment. The entry of foreign companies is crucial to the sector as local investors

would not be able to provide the required scale of investment whereas foreign companies

have the capital, managerial expertise, and technology. Historically, opportunities for

foreign investment flows in the telecommunications industry have been hampered

because most countries had either state-owned or privated-owned monopoly carriers.

With the recent liberalization, privatization, and deregulation of the sector, this era is

about to come to an end.

However, as the sector is viewed as a security issue and a national asset that must

not be controlled by foreigners, many developing countries still impose restrictions on

foreign equity participation. The Philippine Constitution limits foreign ownership in the

sector to 40 percent. Other Asian countries that impose foreign ownership limitation

include Indonesia - 35% (except PCS), Malaysia - 30% in existing licensed PTOs, and

Thailand - 20% while Australia, New Zealand, Pakistan, and Hongkong have none (Basic

Telecoms Agreement, GATS).

Foreign Direct Investment (FDI) in Telecommunications

The increasingly liberalized environment together with political stability in the

country spurred confidence for both domestic and foreign investors. With the opening

up of the sector, foreign carriers entered the country in alliance with local companies.

Nine telephone companies entered the market immediately after liberalization and

currently, there are two more firms, Belltel and Philcomsat, which have been given

approval to operate by the NTC.

91

Table 9: Foreign Direct Equity Investment in Telecommunications

In million US$

Year

1990 1991 1992 1993 1994 1995 1996 1997 1998

FDI 0.89

0.58 3.13 34.29 35.31 16.9 57.7 292.26 1.85

Total Foreign Direct Investment 1990-98

442.9

Total Foreign Direct Investment 1973-98

460.5

Source: Bangko Sentral ng Pilipinas

As shown in Table 9, FDI flows to the sector increased dramatically from

US$0.89 million in 1990 to US$292.3 million in 1997. The bulk ( 96 percent) of the

stock of foreign direct investment in the sector was accumulated starting in 1992

following the liberalization of the sector to competition and foreign investment. Note

that Asian companies like Thailand’s Telecom Asia and Shinawatra, Hongkong’s First

Pacific, Australia’s Telia, Singapore Telecom, Japan’s NTT and South Korea’s

Retelcom have been making their presence felt in the Philippines alongside European

and American companies like Cable and Wireless, Deutsche Telekom, Millicom, AIG

and Comsat (see Table 10).

Late in November 1998, First Pacific acquired a 17.2 percent stake at PLDT in a

US$749 million deal. The stake could be a controlling block in the company which has a

widely dispersed ownership structure. To increase PLDT’s income, First Pacific

announced its plan to reduce the staff from 15,000 to 12,000 and to merge Smart

Communications, the country’s largest cellular phone operator, with PLDT’s Piltel

(Manila Times, 14 November 1998). Industry players believe that First Pacific’s buy-in

to the country’s biggest telecommunications company would reinforce PLDT’s hold in

the industry and set the stage for the merger of their cellular phone companies. The

combined share of Smart and Piltel accounts for 68 percent of the total number of CMTS

subscribers. The merger could create an industry giant with combined telephone and

cellular phone subscribers of 3,874,455 which accounts for about 48 percent of the

92

country’s total subscribers in a country of 73 million people where the telephone market

is far from saturated.

Table 10: Foreign Investors in the Telecommunications Sector

Wireline and Wireless Voice Company

Foreign Partner Equity

PLDT First Pacific (Hongkong) 17.20 Bayantel/ICC Nynex(US), Telecom Asia (Thailand) 32.24 Digital Telia (Australia) 15.00 Eastern Cable & Wireless (UK) 40.00 Extelcom Millicom (US) 40.00 Globe GMCR Singapore Telecom 37.00 Islacom Deutsche Telekom, Shinawatra (Thailand) 30.00 PT&T/Capwire Retelcom (South Korea) 20.00 Piltel AIG (US) - Smart First Pacific (Hongkong), NTT (Japan) 40.00 Philcom Comsat (US) 16.80

Sources: Ure and Vivorakij,1998 and Lamberte, 1996

Gains from Opening Up The Telecommunications Sector To

Competition and Foreign Investment

Prior to the introduction of regulatory reforms in the 1990s, there was no

competition in the telecommunications industry. There was very little foreign direct

investment in the sector as

93

Table 11: Number of Telecommunications Services Companies by Sub-sector, 1992-97

Telecommunications Sub-sector

1992 1993 1994 1995 1996 1997

Local Exchange Carrier Service

45 49 60 67 74 76

Cellular Mobile Telephone Service

2 5 5 5 5 5

Paging Service 6 6 10 11 14 15 Public Trunk Repeater Service

7 8 8 10 10 10

International Gateway Facility

3 5 9 9 9 11

Satellite Service 3 3 3 3 3 3 International Record Carrier

4 4 5 5 5 5

Domestic Record Carrier

6 6 6 6 6 6

Internet Service 0 - 1 - 113 130 Source: 1997 NTC Annual Report

shown in Table 9. After 1993, nine new firms entered the market. The range of

telecommunications services became diversified (see Table 11). Cellular phones and

pagers became a common sight and internet access became more widespread. Currently,

there are eleven IGF operators, five CMTS providers, 15 paging service companies, and

130 internet service providers.

Customers also benefited from the introduction of digital switching as well as the

availability of services such as call forwarding, call barring, call hold, and call waiting.

Customers have also experienced price reductions in international calls as well as CMTS

and paging services. With the operation of more international gateways, international toll

rates declined. Outgoing international calls increased from 136 million minutes in 1992

to 172 million minutes in 1995 while incoming traffic to the Philippines rose from 462

million minutes to 540 million minutes in 1995 (APEC, 1994 and ITU, 1997). In 1995,

94

this meant a net gain for the country which amounted to US$ 235 million in estimated net

settlement payments (ITU, 1997)1.

Table 12: Number of Main Lines and Subscribers in the

Telecommunications Industry

Year Number of Main Lines

Telephone Density

Number of CMTS Subscribers

Number of Paging Subscribers

Number of Trunk Radio Subscribers

1990 14652 - 1991 - 1938 1992 740033 1.17 56044 71758 - 1993 784719 1.21 102400 - - 1994 1109652 1.67 171903 228547 5982 1995 1409639 2.01 493862 324816 18799 1996 3352842 4.66 959024 491025 32998 1997 5775556 8.07 1343620 704138 45859 Source: 1997 NTC Annual Report

Moreover, following the opening of the market, teledensity (telephone mainlines

per 100 inhabitants) increased from 0.95 in 1984 to 1.68 in 1994 (see Table 12). In 1997,

the country had a teledensity of 8.07 and this was projected to reach 9.8 by 1998. With

competition and the entry of foreign investment, the number of CMTS subscribers and

paging services subscribers more than doubled between the years 1995 and 1997. The

same goes for trunk radio service subscribers.

In terms of the absolute growth in mainlines, the country posted an impressive

cumulative annual growth rate (CAGR), especially when one compares this with other

ASEAN countries. Table 13 shows that the Philippines’ CAGR rose from 3.2 percent

prior to liberalization (calculated for the period 1984 to 1990) to 18.2 percent after

liberalization (i.e, for the period 1990-1995). As a result of greater telephone penetration,

the long waiting time to own a telephone which took over a decade prior to liberalization,

has ceased. 1 By international agreement, the telephone company in the country where the call is billed should pay the

95

Table 13: Comparison of Selected ASEAN Countries’ Cumulative Annual Growth Rates

Country Mainlines

1984 (in 000s)

Mainlines 1990 (in 000s)

Mainlines 1995 (in 000s)

CAGR (%) 1984-90

CAGR (%) 1990-95

Philippines 505 610 1410 3.2 18.2 Thailand 519 1325 3482 16.9 21.3 Malaysia 849 1588 3332 11.0 16.0 Indonesia 536 1066 3290 12.1 25.3 Source: Ure and Vivorakij, 1998

It is evident from Table 14 that opening the sector to competition and foreign

investment has boosted the contribution of the telecommunications industry to the

economy. Value added and revenues from the telecommunications sector improved

substantially. Value added as percentage of GDP increased from 1 percent in 1988 to 1.6

percent in 1994 while revenues as percentage of GDP rose from 1.4 percent in 1988 to

2.1 percent in 1994. These increases could be attributed mainly to the growth in the

telephone sub-sector as well as in other telecommunications services which include

cellular mobile telephone and paging services. The contribution of the telegraph sub-

sector remained unchanged.

telephone company at the other end for terminating the call (ITU, 1997).

96

Table 14: Economic Contribution of the Telecommunications Sector Before and

After Liberalization

Prior to Liberalization, 1988 After Liberalization, 1994 Telecommunications Subsector Number of

Establish-ments

Value Added (in billion p)

Revenue/ Sales (in billion p)

Number of Establish- ments

Value Added (in billion p)

Revenue/ Sales (in billion p)

Telephone As % of GDP

30 6.1 0.8

8.1 1.0

95 21.5 1.3

27.0 1.6

Telegraph As % of GDP

14 1.8 0.2

2.6 0.3

19 3.0 0.2

5.0 0.3

Others As % of GDP

6 0.4 0.05

0.7 0.08

36 1.9 0.1

3.0 0.2

Total As % of GDP

50 8.3 1.0

11.4 1.4

150 26.4 1.6

35.0 2.1

Census of Establishments, 1988 and 1994

I. Conclusions and Lessons from the Liberalization of Telecommunications

Amidst the continuing worldwide trend in economic deregulation and regulatory

reform, the Philippines introduced substantial policy changes in the telecommunications

sector in 1993. Five years have elapsed since these policy reforms opened up the sector to

competition and foreign investment and, as shown in the preceding section, the results

produced have been positive. The telecommunications sector has indeed benefited from

increased foreign investment in a liberalized environment (see Table 15). At the same

time, however, there are still policy issues that remains to be settled to sustain these

regulatory reforms and create and maintain a competitive marketplace that would ensure

significant benefits in terms of new market opportunities, more level playing field,

greater choice and lower prices in the telecommunications sector. Competition is what

drives businesses to improve their efficiency, develop new products and assists economic

growth and create employment. While liberalization may be a precondition for the

growth of a free market, it does not, by itself, guarantee effective

97

Table 15: Opening Up The Telecommunications Industry To Competition

and Foreign Investment : Summary Of Benefits

Before After Foreign Direct Investment 1973-89: US$ 17.6 million 1973-98: US$460.5million Total Value Added As % of GDP

1988: P8.3 billion 1.0

1994: P26.4 billion 1.6

Revenue/Sales As % of GDP

1988: P11.3 billion 1.4

1994: P34.9 billion 2.1

Telephone Density 1984: 0.95 1997: 8.07 Fixed Telephones Lines 1984:505000 1998: 6548114 Mobile Telephone Subscribers 1997: 1559421 Paging Subscribers 1997: 704138 Number of Establishments Local Exchange Service Cellular Mobile Telephone Paging Public Trunk Repeater International Gateway Facility Satellite Service International Record Carrier Domestic Record Carrier Internet Service

1997 76 5 15 10 11 3 5 6 130

competition. It is only by creating a policy environment that encourages competition that

we can maximize the benefits from foreign direct investment. Thus, it is essential to

remove the remaining impediments to competition and enforce a competition policy that

would foster competitive market outcomes and competition in the sector. It must be noted

that the regulatory reform process becomes more complex as the telecommunications

industry is subject to significant technological and market-based changes (Janow, 1998).

Uncertainties increase as new and advance technologies emerge such that policies that

may work today may no longer be appropriate in the future. It is necessary that the

regulatory system is continually adjusted to take into consideration domestic or

international policy changes. Liberalization, deregulation, and the whole regulatory

reform process requires an institutional structure that is technically competent in handling

the complex issues that emerge in the telecommunications industry.

98

Policy Issues and Remaining Barriers to Competition

1. Need for Domestic Competition Policy in the Telecommunications

Industry

With the opening up of the market to competition and foreign investment, the

dominant position of the incumbent firm, PLDT, declined from 94 percent prior to 1993

to 87 percent in 1995. In 1998, while still holding the largest share, this was further

reduced to only 32.3 percent (see Table 16). As this developed, First Pacific bought

control of PLDT. The PLDT-First Pacific deal is expected to bolster PLDT’s control of

the industry. The PLDT takeover was described by Finance Asia as a strategic acquisition

made for commercial rather than political reasons that would allow First Pacific to

consolidate its position in the Philippine telecommunications industry by synthesizing the

operations of PLDT and Smart. Smart and Piltel have a combined share of 68 percent of

the total number of CMTS subscribers while PLDT and Smart together account for 43%

of the total number of installed lines. The merger would, thus, reinforce PLDT’s position

with its combined telephone and cellular phone subscribers of 3,874,455 which currently

accounts for about 48 percent of the total number of telephone and cellular phone

subscribers in the country.

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Table 16: Distribution of Working Lines by Carrier

After Liberalization Major Carrier Prior to Liberalization 1995 1998

PLDT 94.0 86.7 32.3 Digitel - 3.6 5.7 Globe - - 10.8 Bayantel - - 7.1 Islacom - - 11.0 Philcom - - 1.1 Piltel - 3.0 5.8 PT&T - - 2.6 Smart - - 10.8 ETPI/TTPI - - 1.1 Other Operators 6.0 6.7 11.7

It is important to distinguish between welfare enhancing mergers and welfare

diminishing mergers. In the former, mergers between firms can be an effective way of

developing competitive advantage, optimizing the benefits of complementary strengths

and taking advantage of economies of scale and scope. Mergers can also work as an

important discipline upon poorly performing management. Merger activity can thus

improve efficiency to the benefit of consumers and the community in general. On the

other hand, mergers can result in a decline in the number of players in an industry, at

least in the short run. In some cases, particularly where there are significant barriers to

entry, mergers can lead to increased industry concentration and increased market power

which may run counter to community interest .

To ensure that mergers and acquisitions do not create or enhance market power

which can damage emerging competition, it is necessary to design safeguards that would

ensure market contestability and regulate anti-competitive business conduct or practices.

For instance, in the US and Japan, mergers and acquisitions are controlled when they tend

to stifle competition substantially or to create a monopoly using important criteria which

include, among others, the threshold beyond which a merger or acquisition is subject to

scrutiny (in Japan, the market share of 25%), efficiency which will be created through the

100

merger or acquisition, competition from abroad, and acquisition of a failing company or

division ( Matsushita, 1996).

While liberalization is expected to provide increased foreign investment, access to

technology and opportunities for companies to improve efficiency, it may not be

sufficient to foster effective competition in a sector previously dominated by a monopoly.

If effective competition has to emerge, regulatory reforms have to be accompanied by the

creation of competitive market and industry structures. As competition laws were absent,

PLDT which owns the domestic backbone system, was able to influence not only the

speed but also the terms and conditions for interconnection as well as terms and

conditions for revenue-sharing arrangements. Industry experience has shown the slow

progress of interconnection, the difficulties of new entrants in getting interconnection

with PLDT’s domestic backbone and in drawing up satisfactory revenue sharing

arrangements. In contrast, in Australia, for instance, competition policy provides that the

new entrant be given access to the interconnection network at what is regarded as a

relatively inexpensive price to help offset the competitive advantages of the incumbent

(Hilmer Report, 1993).

The opening up of the telecommunications sector to foreign investment has

provided the economy with benefits, however, in the absence of competition laws, there

is a risk that liberalization may not be sufficient to foster effective competition in the

sector which used to be dominated by a private monopoly. Promoting competition is also

the single most effective way of maximizing the benefits that foreign investment offers.

Turning now to the liberalization of retail trade, the most important lesson that

can be drawn from this paper is the importance of well-designed and effectively

implemented competition law and policy to accompany regulatory reforms. Competition

rules play a very important role in ensuring the effectiveness of liberalization. As

liberalization progresses, private enterprises may engage in restrictive business practices

to offset the effect of liberalization. It becomes increasingly important to counteract these

practices through vigorous enforcement of competition laws. These would enable us to

101

control possible abuses of dominant positions by large scale firms including

multinationals. In small developing country markets, multinational companies are likely

to be dominant firms. Mergers and acquisitions would also be under the supervision of

competition laws, especially those between large scale firms which may result in an

increase in market concentration and a reduction in competition.

2. Reexamine the SAS

The SAS was drafted with the best of intentions. Unfortunately, good intentions

do not necessarily make good policy. The SAS has long been criticized as it seemed to

discourage the expansion of infrastructure and competition. The scheme ran counter to

competition policy and what it did was to level the playing field for PLDT as new

entrants were obligated to practice cross-subsidization between the less lucrative areas

with the very profitable ones (Lamberte, 1996).

To date, five out of the nine SAS carriers have been lagging in fulfilling their roll-

out targets. The NTC has given them up to September 1999 to install the required lines,

otherwise NTC warned that penalties would be imposed and their assigned areas would

be opened up to other carriers. Considering that most of the carriers failed to meet their

commitments, it is important for policy makers to review the merits of continuing the

scheme.

3. Bringing Telecom Services to Rural Areas

While increasingly open markets and competition in the telecommunications

industry can lead to economic gains, there is no assurance that outlying rural regions

can be linked to the network. The current policy of cross-subsidization in which the

cost of providing telephone lines in rural areas is subsidized by profits on heavy routes

and on long-distance calls may no longer be suitable in the light of declining cost of

long distance traffic. There is a need for the government together with the private sector

to design programs to help less-favored regions in order to achieve universal access.

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4. Towards a Cost-based Tariff Structure

In order for competition to work efficiently, there is a need to bring the tariff

structure closer to costs. The introduction of more rational tariff-based policy (cost-

based) would cause users to make more efficient decisions and would also reduce the

likelihood of cream skimming of the most profitable traffic by new entrants.

103

References:

Abrenica, Ma. Joy V., Technological Convergence and Competition: The

Telecommunications Industry, paper presented at the IDE-UPSE Symposium-

Workshop on Studies in Governance and Regulation, 16 December 1998.

Alonzo, Ruperto P. and W. San Pedro, The Philippine Telecommunications

Industry PIDS Development Research News, Vol. XIV No. 4, July-Aug 1996.

Barriers To Entry Study Volume I, paper prepared by SGV Consulting for US

Agency for International Development, April 1992.

Business Profiles 1997-98: Top 7000 Corporations

Janow, Merit E., Policy Approaches to Economic Deregulation and Regulatory

Reform in Business, Markets and Government in the Asia Pacific, edited

by Rong-I Wu and Yun-Peng Chu, 1998, New York and London

Lamberte, Mario L. Trade in Services, 1996.

Serafica, Ramonette B., Was PLDT a Natural Monopoly? Telecommunications

Policy, Vol. 22, No. 4/5, pp. 359-370, 1998.

_________________, Beyond 2000: An Assessment of Infrastructure Policies,

PIDS Discussion Paper No. 98-07, May 1998.

Matsushita, Mitsuo, The System of Competition, paper prepared for APEC

Partners For Progress-Seminar on Competition Policy, Bangkok, Thailand,

March 19, 1997.

National Competition Policy, Report by the Independent Committee of Inquiry for the

104

Heads of Australian Governments (Hilmer Report), Australia, August 1993 .

The Philippines: An Opening for Sustained Growth, World Bank document,

April 1, 1993.

Ure, John and Araya Vivorakij, Telecommunications and Privatization in Asia in

Business, Markets and Government in the Asia Pacific, edited by Rong-I

Wu and Yun-Peng Chu, 1998, New York and London

1997 NTC Annual Report

105

Study II

Retail Trade Policy and the Philippine Economy: Some

Insights from Liberalization of the Banking and Insurance

Sectors

By: Ma. Melanie R.S. Milo

106

Retail Trade Policy and the Philippine Economy: Some Insights from the

Liberalization of the Banking and Insurance Sectors1

Ma. Melanie R.S. Milo2

I. Policy changes in the banking and insurance industries, especially with

respect to foreign ownership

A. Banking sector3

Foreign banks in the Philippines have a long history. The first commercial bank

established in the Philippines was the Banco Español Filipino, later known as the Bank of

the Philippine Islands, which began operations in 1851. Two British banks, the Chartered

Bank of India, Australia and China (now the Standard Chartered Bank) and the

Hongkong and Shanghai Banking Corporation opened branches in the Philippines in the

1870s, and an American bank (First National City Bank of New York) in 1902. Other

foreign bank branches were established over the period 1900-45, but they were short-

lived or did not resume operations after the war. Only four foreign banks resumed

operations in 1945 – the First National City Bank, the Chartered Bank of India, Australia

and China, the Hongkong and Shanghai Banking Corporation, and the Nederlandsch

Indische Handlesbank. The latter was later absorbed by Bank of America, which was the

last foreign bank to establish a branch in the Philippines in 1947.

In 1948, the General Banking Act was enacted, which specifically restricted

foreigners from establishing full-fledged bank branches or locally incorporated

subsidiaries, although they were allowed a maximum equity participation of 30 (in some

cases 40) percent in newly established commercial banks. However, this provision was

significantly tightened in 1957 when the Monetary Board required all new banks to have

1 Draft report submitted to the Policy and Development Foundation, Inc. (PDFI) for the research project “Retail Trade Policy and the Philippine Economy”. 2 Research Associate, Philippine Institute for Development Studies. The usual caveat applies. 3 This section draws on Milo (1998).

107

100 percent Filipino ownership. Furthermore, ownership of banks was limited to natural-

born Filipino citizens. This regulation was eased in 1965, with naturalized Filipinos

allowed 20-30 percent ownership of new banks. Thus, no new foreign banks were

established in the Philippines since 1947 (Emery 1976). Foreign banks were also

prohibited to open new branches, barred from accepting government deposits, and rarely

able to rediscount with the CB. The bias against foreign banks was due to the perception

that foreign banks were not using their resources, derived in large measure from local

deposits, to promote the growth of the Philippine economy, but rather to serve the needs

of multinational firms. Thus, there was a shift in policy towards the development of

private domestic banks.

Following the change in regulation of foreign banks, there was a significant shift

in the composition of commercial banks. The share of foreign banks in the total assets of

the commercial banking system significantly fell from 70 percent in 1900 to 25 percent in

1925 (with the establishment of the largest and government-owned Philippine National

Bank in 1916), 30 percent in 1950, 15 percent in 1960, and just 9 percent in 1970 (Table

1), as the number of domestic banks rapidly increased. When the Central Bank of the

Philippines commenced operations in 1949, only one of the eleven commercial banks

was a privately-owned Filipino bank – the rest were either government-owned (one),

controlled by the Catholic church (two), branches of foreign banks (four), or Philippine-

chartered banks controlled by American or Chinese interests (three). By the end of the

1960s, there were 38 commercial banks, consisting of the largest and government-owned

PNB, 33 domestic banks, and the 4 foreign bank branches.

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Table 1. Total assets of the Philippine commercial banking system, 1900-95

Percent Distribution Year Total (mil pesos) Domestic Foreign Total domestic Government Private 1900 40 29.4 n.a. n.a. 70.6 1925 264 74.6 n.a. n.a. 25.4 1950 1,079 69.7 n.a. n.a. 30.3 1955 1,413 85.8 48.9 36.9 14.1 1960 2,337 85.1 36.0 49.1 14.9 1965 6,786 92.8 36.3 56.5 7.2 1970 13,541 91.1 34.0 57.1 8.9 1975 49,980 89.7 36.8 52.9 10.3 1980 146,026 87.2 28.4 58.8 12.8 1985 285,578 84.6 26.7 57.9 15.4 1990 497,488 87.1 13.6 73.5 12.9 1995 1,885,560 87.0 21.0 66.0 13.0 Source: Hutchcroft (1993); Bangko Sentral ng Pilipinas.

The mushrooming of banks led to a high degree of bank instability, with several

banks experiencing financial difficulties. In particular, there arose a two-pronged problem

in the banking sector: insider abuse by bank officers/owners and lack of prudential

supervision and regulation. Bank difficulties were primarily attributed to the rapid growth

of banks, which left most banks undercapitalized, lacking in managerial skills, and low

on deposits. Thus, the CB informally imposed a moratorium on the licensing of new

commercial banks in 1966. However, general malversation of funds was typically cited

as the underlying cause of bank difficulty and failure, in particular, fraud or insider abuse

by bank owners or officers (Emery 1976). Another problem that became evident during

this period was the lack of prudential supervision and regulation of banks, which in turn

worsened the problem of insider abuse.

In November 1971, the government authorized a review of the banking and

overall financial system of the country. The review was conducted by the Joint

International Monetary Fund-Central Bank of the Philippines Banking Survey

Commission to assess the performance and capacity of the country's financial sector. The

recommendations of the Commission were implemented in a package of financial

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reforms that began in November 1972. The reforms covered four areas - the CB itself, the

money market, the banking system, and interest rate determination.

Reforms in the banking sector specifically sought to address the twin issues of

weak, family-based private banks, and the CB’s inability to supervise them. To

encourage banks to improve their condition, the Commission proposed mergers among

banks and the diffusion of equity within each bank, while retaining the CB policy from

1957 of 100 percent Filipino equity in any new commercial bank. The actual banking

reforms embodied in Presidential Decree No. 72 went further than the Commission’s

recommendations. The minimum paid-in capital of commercial banks was raised from

P20 million to P100 million. To enable commercial banks to meet the new capital

requirement, mergers and consolidations were encouraged. In addition, foreign equity

participation of up to 40 percent was allowed, thus overturning the prohibition imposed in

1957. It was believed that foreign participation would be a stabilizing influence, and

“professionalize” the management of banks. To deal with the problem of insider abuse,

the CB reduced the maximum ownership share of an individual to 20 percent, and of a

corporation to 30 percent to disperse bank ownership. Finally, no new bank licenses were

to be issued, making the informal cap on new banks imposed in 1966 official (Lamberte

1989; Hutchcroft 1993).

The mandated increase in paid-in capital of commercial banks achieved its stated

objective of encouraging mergers. From 1974-76, thirteen banks consolidated into 6

banks, reducing the number of domestic commercial banks from 34 to 27. Also, ten local

banks received substantial capital infusion from 13 foreign banks. However, the ultimate

objective of strengthening the weak banks to stabilize the banking system proved to be

elusive. Mergers typically occurred among the weak banks, since the sounder banks had

no incentive to merge with those banks saddled with bad, often DOSRI-related, loans.

Five of the six banks suffered major difficulties in later years. Foreign participation was

generally workable in banks that were already more broadly held and professionally

managed. On the other hand, major disputes between the foreign investors and local

families/owners over the composition of loan portfolio typically arose with the “errant”

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banks. This resulted in five of the foreign banks divesting themselves of their stakes in

the local banks within the same period. Simply put, foreign equity participation was not a

successful deterrent to insider abuse of banks. With regards to the restriction on

ownership share of banks, while there was compliance on paper, this was easily

circumvented through the use of dummy stockholders, and was not strictly enforced. In

some cases, it was simply ignored, given the weakened position of bank supervisors

within the CB. The impetus of the reforms began to wane when it became obvious that

problems of bank instability had not been mitigated, but had even grown worse

(Lamberte 1989; Hutchcroft 1993).

Another financial sector review was conducted in 1979, this time by a joint IMF-

World Bank mission. The mission found the Philippine financial system to be relatively

well developed. However, the specialized nature of the various institutions had also led to

fragmentation and reduced competition, hampering the system’s ability to adjust to

changing needs and demands. Thus, measures that would foster active competition in the

system were deemed as central to any reform in the financial structure. Another major

concern raised by the mission was the underdeveloped state of the long term capital

market.

Following the financial sector review in 1979, the Philippines formally embarked

on a financial liberalization program in the early 1980s, after more than 30 years of

repressionist financial policies from the time the CB began operations in 1949. This was

part of an overall structural adjustment program of economic liberalization. The aims

were to: (i) promote competitive conditions to foster greater efficiency in the financial

system; and (ii) increase the availability of and access to longer term funds, which were

the major concerns raised by the 1979 mission (Remolona and Lamberte 1986).

The first objective of increased competition and efficiency was to be achieved by

lessening the enforced specialization of financial institutions, and broadening the range of

their services. These included: the introduction of extended commercial banks or

universal banks authorized to offer a wider range of services including those previously

111

reserved to investment houses, such as underwriting and securities dealing; the

elimination of all functional distinctions among thrift banks; reduction in differentiation

among categories of banks and non-bank financial intermediaries authorized to perform

quasi-banking functions (NBQBs); and increase in the powers and functions of NBQBs.

Minimum capital requirements for banks and NBQBs were also raised. However, entry

barriers were not relaxed. The second objective of increasing the availability of longer

term funds through term transformation was to be achieved through interest rate

deregulation.

Soon after the start of financial liberalization, the financial system went through a

crisis of confidence (Laya 1982). It was triggered by the defaults of a prominent

businessman, and compounded by a series of investment frauds and stockbroker failures

that exacerbated the fragility of the system. Before the financial system could fully

recover, it was hit by another, more severe crisis as a result of the unstable political

climate and the BOP crisis in 1983. The period from 1983-85 was marked by

considerable financial turbulence. Simply put, the timing of financial liberalization in the

Philippines was inauspicious, with the reforms overtaken by one crisis after another.

Whatever benefits were derived from the reforms were largely undermined by the

successive weakening of the financial system as a result of the crises. Overall, the

country’s initial attempt at financial liberalization was not deemed a success, and this was

attributed to the chaotic macroeconomic environment. However, there was also the

inadequate functioning of the market mechanism. What the crises also magnified were

the long standing structural weaknesses in the financial system, particularly its weak

structural base that consisted of too many weak, small banks, and a few strong, big banks.

And in contrast to the 1972 financial sector review, the 1979 review did not address the

issue of instability in the system and its inherent causes.

Policy changes to strengthen the CB’s supervision and regulation of the banking

system were implemented only in 1986. They covered the following areas: (a) policies on

prudential banking restrictions; (b) imposition of penalties and sanctions; (c) supervisory

procedures; and (d) policies on the establishment of new banks and branches. Policies

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effecting prudential bank management included, among others, minimum capitalization

requirements; compliance with the minimum risk asset ratio; the single borrower’s limit;

limit on loans to directors, stockholders and related interests (DOSRI); allowable

interlocking directorships and officerships; provisions for loan loss or doubtful accounts;

audit and reporting requirements; and a major policy shift away from the policy of

sustaining weak banks except in times of general financial emergency or when specific

banks face problems of liquidity rather than solvency (Bautista 1992).

While stronger prudential supervision would help to alleviate moral hazard

problems in the banking sector, there was still the issue of corporate governance. As Park

(1991) pointed out, in relation to the financial liberalization experience of the Southern

Cone countries in the late 1970s and early 1980s, '… it is debatable whether better

regulation of bank activities would have mitigated the problem (of moral hazard) as long

as the banks were controlled by a few industrial groups and conglomerates, in particular

when these groups believed that the government could not afford to let them go bankrupt'

(p. 351).

The primary objective of removing interest rate ceilings and legislated functional

specialization among the different financial institutions was to improve the efficiency of

intermediation by promoting competition. In fact inter-institutional competition remained

limited. A review of the Philippine financial sector by the World Bank in 1988 still

identified the lack of competitive behavior among the banks as an important feature

needing reform. Efforts to widen the ownership base of commercial banks were again

largely unsuccessful. While interest rate deregulation is a necessary condition for

fostering competition, there were other barriers to competition. In particular, the impact

of removing interest rate ceilings depend on the degree of competitive pressure.

Competition would not improve if there is no serious threat of entry into the banking

system, or if other regulations, such as those concerning branching, become binding

constraints. The moratorium on granting new bank licenses in the Philippines, which was

imposed in the 1970s, was lifted in 1989. However, the CB’s policy on bank entry

continued to be restrictive. In particular, although the CB issued guidelines for the

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establishment of banks, it retained a strictly discretionary policy on branching by locally

owned banks, and strict branching restrictions on the four foreign banks already in

operation. No commercial bank application was considered because the number of

commercial banks in the system was deemed too many already. And the limit on foreign

equity participation in domestic banks discouraged foreign banks from entering the

domestic market. The unfavorable outcome of joint ventures in the past made foreign

investors more aware of the need to have greater control over bank operations in order to

protect their investments (Lamberte and Llanto 1993).

In May 1992, President Ramos was elected into office, and he initiated a program

of policy reforms and deregulation in critical areas of the economy. The economic

reforms were aimed at leveling the playing field, and democratizing and liberalizing the

economy to make it more competitive. These included further tariff reforms aimed at a

more neutral tariff policy; a tax reform program, and reforms of the government’s

privatization and infrastructure programs; further liberalization of foreign investments;

liberalization of foreign exchange transactions; and liberalization of key industries such

as telecommunications, transport, banking, and other key commodities.

In the financial sector, regulations on the entry of new domestic banks and bank

branching were significantly relaxed in 1993, and further simplified and made uniform

across banks in 1995. And the moratorium on the entry of foreign banks, which had been

in place since 1948, was lifted in May 1994 with the passing of RA 7721. This law

allowed the entry of up to 10 foreign banks through the establishment of a branch within

the next 5 years, although they were not allowed to open more than six branches in the

country. As an alternative mode of entry, foreign banks can buy up to 60 percent of

existing banks or establish new bank subsidiaries with a local partner on a 60-40 basis.

Maximum foreign equity participation in an existing local bank or subsidiary was also

raised to 60 percent from the 40 percent set in the early 1970s. There were twenty two

applicants, and the ten chosen banks were announced in February 1995. Applicants had

to belong to the top 150 banks in the world, or the top 5 banks in their own country.

Minimum capitalization was set at P210 million.

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The liberalization of entry rules for foreign banks was intended to increase overall

efficiency in the banking sector, which was deemed as operating very much like a cartel.

By introducing greater competition from foreign banks, the expectation was that the wide

margin between savings and loans rates would be narrowed. Borrowing costs were

expected to fall, while interest rates on deposits were expected to increase, which would

in turn serve to encourage a rise in domestic savings. Competition, particularly in the area

of wholesale banking, was expected to heighten since most of the new foreign banks

indicated that they would commence their activity in that area. Better customer service

and the introduction of new financial products/instruments were the other expected

benefits of the entry of new foreign banks into the system. Furthermore, it was hoped that

the presence of more foreign banks in the system would help to lessen the vulnerability of

the banking system to outflows of foreign capital, as what happened in early 1995 in the

aftermath of the Mexican crisis.

Very recently, the Senate conducted a hearing on proposed amendments to the

General Banking Act. In particular, there is a Senate proposal to allow 100 percent

ownership of banks established in the Philippines. This policy direction is being

considered as a way of improving the delivery of banking services in the country, which

is deemed as continuing to be seriously inadequate. Although 60 percent already

represented majority control, this was not considered attractive enough for foreign banks.

The law has a bias for buyouts, but there is still the remaining 40 percent stake whose

holders the foreign banks might not know of. Clear lessons from the country’s experience

with financial liberalization to date need to be drawn in order to come up with an

informed, well-founded and definitive stance on the issue of further financial sector

liberalization.

B. Insurance sector1

As in the commercial banking sector, the first insurance enterprise operating

along modern principles was also foreign-owned. In 1829, Lloyd’s of London appointed

1 This section draws on World Bank (1992).

115

Stracham, Murray and Co., Inc., as its representative in the Philippines. Early companies

offered non-life insurance, and life insurance was not available locally until Sun Life

Assurance of Canada began to operate in the Philippines in 1898. The first domestic non-

life insurance company, Yek Tong Lin Fire and Marine Insurance Company, was

established in 1906; the first domestic life insurance company, Insular Life Assurance

Company, was organized in 1910. There was a substantial increase in the number of

insurance companies through the years. In 1915, they numbered 44; by 1957, their

number increased to 107; ten years later, there were 178 insurance companies in the

Philippines. Of these, 25 were life insurance companies, while 153 companies offered

non-life insurance. Domestic companies outnumbered foreign companies in both

categories: 19 of the former, and 113 of the latter. During 1965-67, there was a

mushrooming of insurance companies. This was followed by a wholesale suspension by

the authorities of a large number of the new companies, which were found to be

inadequately capitalized, as well as engaged in fraudulent activities. Thus, authorities

closed down 30 insurance companies towards the end of 1967 (Emery 1976).

Regulation of the insurance industry is the responsibility of the Office of the

Insurance Commissioner. The Commission was set up as an autonomous body in 1949

when it was split from the CB. As a result of the rather haphazard state of operation of

the industry, the Insurance Act, which embodied the overall regulatory framework of the

industry, was enacted in 1966. Because of the uncontrolled growth of the number of

insurance companies in the mid-1960s, one of the provisions of the Insurance Act was to

ban the entry of new insurance companies. Industry regulation was replaced by the

Insurance Code of 1978, which was modeled on earlier US legislation. The restriction on

entry was also retained. Changes to the 1978 Code had been very few, with none in

recent years.

The Commission itself falls under the jurisdiction of the Department of Finance

(DOF), although the latter’s role is not well-defined and weak, especially with respect to

its oversight functions. When it comes to the role and functions of the Commission vis-à-

vis the industry, the approach and emphasis seemed to be on conservatism and playing

116

safe. A positive result of this approach had been the overall financially sound status of the

industry.

But it could be argued that the approach was overly cautious and not sufficiently

development oriented, with the result that the growth of the industry was constrained.

With respect to entry, for instance, the Insurance Code did not provide specific conditions

for approval to engage business and the Code itself was not particularly restrictive. But

there was also a provision in the Code that granted the Commission the right to refuse a

Certificate of authority if this would best promote the nation’s interests. Thus, it was

possible to maintain a tight control on a continuing basis because the Certificate of

authority had to be renewed annually, subject to the insurance company’s compliance

with the provisions of the Code or the circulars, instructions, rulings or decisions of the

Commissioner.

The Omnibus Investment Code regulates foreign investment in the Philippines,

including in the insurance industry. Within this legal framework, the Commission’s

policy had been to allow foreign equity participation only in non-life insurance

companies up to the maximum allowed by the Omnibus Investment Code. This used to

be 30 percent and was raised to 40 percent in 1987, without the foreign investor having to

obtain prior authority from the Board of Investments. The Commission’s expressed

policy of allowing foreign investments only in non-life insurance was seen as a means to

increase the sector’s paid-up capital, which was deemed as highly inadequate. On the

other hand, foreign equity participation in life companies was disallowed because this

sector was seen as adequately capitalized. As in the banking sector, only foreign

insurance companies that were already operating before the law was set in place could

transact business in the Philippines. Also, domestic savings mobilization, which is one of

the activities that life insurance companies undertake, was preferred to be left entirely in

the hands of companies owned 100 percent by Filipinos. Furthermore, the Commission

deemed the life insurance industry to be overcrowded; thus, no new life insurance

company had been licensed to operate in the recent past. The dichotomy in the way life

and non-life insurance companies was regulated was stark.

117

The Commission’s conservative and restrictive management led to the Philippine

insurance industry lagging behind many other countries, for example, in terms of the

range of insurance products and investment portfolio composition. An important factor

was its tight restriction on foreign participation in the industry. Lack of expertise and

experience was a major issue, especially for the smaller locally owned companies.

Foreign investment and management input could go a long way in improving this

situation. Also, the government already controlled the level of foreign investment in the

Philippines through the Omnibus Investment Code. Thus, the Commission’s additional

level of restriction seemed unwarranted. The prudent and safe provision of insurance is

not constrained or endangered by foreign ownership of insurance companies as long as

this is done within the broader policies of the government. On the other hand,

encouraging foreign investment, without further restrictions on the level of foreign

ownership beyond what is already legally provided, would help increase the

capitalization and level of expertise of the industry, and assist in the reduction of the

volume of reinsurance premiums passing through the industry. A more pragmatic

viewpoint towards foreign investment was clearly called for.

Internationally, the insurance industry, especially life insurance, has changed

radically as a result of marketing innovation and advances. Laws and regulatory

frameworks have also been changed to keep pace with the industry. In the case of the

Philippines, the conclusion must be that the development of the market for insurance has

outstripped the capacity of regulations.

The entry of new insurance companies was finally deregulated in 1994.

Furthermore, liberalization of the sector also meant 100 percent ownership by foreign

investors, as opposed to the maximum 40 percent from 1987, giving the Philippines one

of the most liberal investment regimes in the region. The policy thrust, as in banking, is

to encourage companies with stronger capital bases so that more of the population may

avail of insurance services. Stronger companies can open more branches and the

Insurance Commission seeks to increase the percentage of insured people to 20 percent of

the population by 2000 from the current estimated 14-15 percent. Consequently, where

118

insurance companies could operate on only P10 million paid-up capital before, new

domestic companies now need P100 million, while foreign companies are required to

have P300 million. Domestic companies are encouraged to increase their capital base by

putting a limit on the amount of insurance they can write, up to P50 million. For example,

non-life companies with paid up capital of less than P50 million can only insure risks up

to a maximum 3-4 times their capital base. Life companies can write term insurances

only, and not permanent plans, if paid up capital is less than P50 million. As a result,

several foreign and domestic companies have been established since the deregulation

(Table 2).

Table 2. New insurance companies established since the deregulation Year Name of company Foreign capitalization Nationality 1995 Aetna Life Insurance Co. 99.99 American 1996 PCIB-Cigna Life Insurance Corp. 50.00 American Pru Life Corp of UK 99.99 British ING Life Insurance Co. (Phils.) Inc. 99.99 Dutch Aegon Life Insurance Co. (Phils.) Inc. 99.99 Dutch Petrogen Insurance Corp. 100.00 Filipino 1997 Ayala General Insurance Corp. 100.00 Filipino Zurich Life Insurance Phils., Inc. 99.99 Swiss Urbancorp Life Insurance Inc. 100.00 Filipino Capgen Insurance Corp. 100.00 Filipino Nippon Life Insurance Co. of the Phils. 50.00 Japanese Philippine General Insurance Corp. 100.00 Filipino John Hancock Life Insurance Corp. 99.78 American Corporate Guarantee & Insurance Corp. 100.00 Filipino Berkley International Life Insurance Inc. 58.00 American Zurich General Insurance Phils. 99.99 Swiss 1998 Pioneer Allianz Life Assurance Corp. 50.00 German

Source: Insurance Commission.

119

II. The impact of foreign investments in the banking and insurance industries

A. Banking sector

As was noted earlier, there is a current Senate proposal to further amend the

General Banking Act in order to allow 100 percent ownership of banks established in the

Philippines. The merit of this proposal clearly depends on the country’s experience with

the partial liberalization of foreign bank entry in 1995. In particular, whether the

supposed benefits of increased competition and efficiency were actualized needs to be

assessed.

Table 1 shows the distribution of the total assets, deposits and loans of the

commercial banking system between domestic and foreign banks from 1990 to 1997.

Expectedly, the share of foreign banks in all three went up following the entry of the new

foreign banks in 1995, which would indicate a lessening dominance of domestic banks in

the system.

Table 3. Distribution of total assets, deposits and loans of commercial banks, 1990-

97

1990 1991 1992 1993 1994 1995 1996 1997 Total Assets (bil P) 488.9 562.1 630.0 775.9 959.3 1374.1 1885.6 2581.1 % Domestic KBs 88.6 88.6 90.2 90.2 91.2 91.1 87.3 83.5 % Foreign KBs 11.4 11.4 9.8 9.8 8.8 8.9 12.7 16.5

Total Deposits (bil P) 306.1 356.7 415.5 520.2 654.4 891.5 1238.3 1468.358 % Domestic KBs 92.5 93.4 93.3 93.7 93.5 95.1 95.1 92.8 % Foreign KBs 7.5 6.6 6.7 6.3 6.5 4.9 4.9 7.2

Total Loans (bil P) 141.0 221.8 297.6 406.2 514.9 810.0 1177.119 1507.086 % Domestic KBs 89.6 90.8 91.8 91.6 92.4 91.5 90.4 88.3 % Foreign KBs 10.4 9.2 8.2 8.4 7.6 8.5 9.6 11.7

Source of basic data: Bangko Sentral ng Pilipinas.

120

It is important that the banking industry be sufficiently competitive if financial

intermediation is to be carried out efficiently. Excessive concentration is a potential

source of monopoly power.

Notwithstanding the World Bank (1988) report's concern over the lack of

competitive behavior of banks, the report also took the position that there was no

evidence of undue concentration in the banking industry. The Herfindahl index1, which is

a commonly used measure of industrial concentration, was calculated. A value of 0.10

was obtained in 1986 and it was deemed as relatively low. Furthermore, the report also

noted that:

‘The size of individual commercial banks in the Philippines is much smaller than

that

in other Asian countries; the two largest Philippine banks, i.e., PNB and the

privately-owned Bank of the Philippine Islands, rank 82nd and 99th in a recent survey

(1987) of the 200 biggest banks in Asia. Thus, the largest banks in the Philippines are,

relatively, not very big; conversely, the smallest banks are very small indeed ... In sum,

the number of banks and the relatively small size of the biggest banks suggests that

concentration in the banking industry is not a problem.' (para.4, pp.ii)

Therein lies the weakness of the Herfindahl index (HI). While it is a good

measure of a monopoly, it does not adequately capture the existence of an oligopoly,

more specifically a cartel, because of the relatively greater weight it gives to very large

firms. For instance, if one firm has an industry share of 90 percent, then the HI will be

higher than 0.81. But if an industry is controlled by three firms with a 30 percent industry

share each, the HI will only be around than 0.27, thus belying the existence of a highly

concentrated industry.

1 The Herfindahl index is calculated by squaring and summing the share of industry size accounted for by every firm in the industry, with a maximum of one indicating a monopoly.

121

In another study cited by Tan (1989), the HI was calculated this time only for

private commercial banks. From 0.045 in 1982, the HI rose to 0.074 in 1988, or at an

annual average rate of around 9 percent, which was a rather fast rate of concentration.

Although these concentration indices appear small, Tan (1989) also noted that they do not

capture the institutional setting, which was likely to enhance the power of dominant

banks in the industry. First, all the head offices of commercial banks were located in

Metro Manila. Second, their owners/managers belonged to a loosely-knit and

geographically proximate social group. And in a number of cases, their business

interdependence extended beyond banking and included banking conglomeration in

production and trade. Interlocking directorates among financial and industrial

corporations in the Philippines is well documented (e.g., Doherty 1980; Hutchcroft 1991;

Tan 1991).

The question of collusion and cartelization is a key issue in the discussion of the

Philippine banking system. However, this is difficult to document, much more to

empirically test, although anecdotal evidence abounds (Hutchcroft 1993). But the

predictable results of such agreements are observable. Interest rates are likely to be

sticky, abnormal profits tend to persist, and in lieu of price or interest competition,

advertisement or product differentiation is used (Tan 1989).

Figure 1 presents some measures of asset concentration of the Philippine

commercial banking system. Although the actual value of the HI may not be indicative of

undue concentration, it would also be useful to look at the trend. From 1982-87, the HI

fell from 0.14 to 0.054, indicating that the system was becoming less concentrated.

However, this decline had to do with the rehabilitation of the government-owned

Philippine National Bank (PNB) in 1986, which led to a substantial reduction in its total

assets as its nonperforming assets were written off, as well as mandated increases in the

minimum capital requirements of banks. The PNB was the biggest commercial bank in

the Philippines, accounting for almost 20 percent of total commercial bank assets in

1980. The sorry state of the PNB, in turn, was due to its heavy involvement in the rescue

of both ailing financial and nonfinancial institutions during the crises years in the 1980s.

122

The period from 1987-94 again saw an increasing concentration of commercial bank

assets. And in 1995, the index began to decline, with the entry of the new foreign

commercial banks. On the other hand, the five-bank concentration ratio based on total

commercial bank assets was at least 50 percent from 1982-94, with the ratio reaching a

high of 66 percent in 1993. Again, the ratio began to decline with the entry of new

commercial banks, particularly foreign banks in 1995.

The reciprocal of the Herfindahl index gives the number of equally-sized banks

that would generate a degree of concentration equivalent to the actual concentration. For

1982, this was around 7 banks; for 1996, it was around 21. This means that the

distribution of resources among the 49 commercial banks existing at the end of 1997 was

equivalent in concentration terms to an industry of 21 equally-sized banks. Thus, there

could be some truth to the observation that there are too many small commercial banks in

the Philippines.

Figure 1. Measures of asset concentration in the commercial banking system,

1982-97

0.000.020.040.060.080.100.120.140.16

1982 1986 1990 1994010203040506070

Herfindahl index

Share of 5 largestbanks

Note: The Herfindahl index is plotted on the left scale, and the asset share (in percent) of the five largest commercial banks on the right scale. Source of basic data: Business Day's Top 1000 Corporations, 1981 to 1985; SEC's Top 1000 Corporations, 1986; CBP’s Fact Book of the Financial System, 1987 to 1990; PNB published financial reports, 1991 to 1995; published balance sheet statements of commercial banks, 1996-97.

123

Table 4 shows the five largest and five smallest domestic commercial banks in

terms of assets. The wide gap between the two groups is painfully obvious. Thus, the

Philippine financial system continued to consist of many small weak banks, a few big

strong banks, and a still fairly underdeveloped capital market, following more than 15

years of financial reforms. The ultimate effect of the monetary authorities’ policy of

restricted entry, especially of foreign banks, had been to shelter both the big and the small

banks from competition, allowing the former to earn abnormal profits, and the latter to

operate at high cost (Tan 1989). On the other hand, the entry of more local and foreign

banks did result in less concentration. Whether it would lead to further improvements in

financial intermediation still remains to be seen. Similar to the financial sector reforms of

the early 1980s, the deregulation of foreign bank entry in 1995 was followed by a

currency crisis in mid-1996, although the latter was primarily due to external factors.

Table 4. The five largest and five smallest commercial banks, 1990 and 1997a

(in million pesos)

1990 1997 Assets Deposits Loans Assets Deposits Loans

Largest Largest PNB 67590 44731 24551 MetroBank 247087 165283 164893 BPI 45174 34972 12430 PNB 242295 163021 149991 MetroBank 43598 13746 13746 BPI 166163 120356 88726 FarEast 42204 30590 10869 LBP 156179 112284 90778 PCIBank 33261 20436 8711 PCIBank 152300 94032 83900

Smallest Smallest AsianBank 2184 1054 474 Al-Amanah 569 486 86 Associated 2565 1984 678 AUBank 1368 85 775 Pilipinas 2814 1413 428 TA Bank 2954 578 1851 Producers 3255 1185 766 GBB 3908 1224 3541 Boston 3295 2123 563 Dev Bank of Singapore 4369 82 2108

Source: CBP’s Fact Book of the Financial System, 1990; published balance sheet

statements of commercial banks, 1997.

In terms of the impact of the entry of new foreign banks on the interest rate

spread, the result is less reassuring. Figure 2 graphs the average lending and deposit rates

124

of commercial banks from 1982-98. It shows that the interest rate differential between

average lending and savings deposit rates significantly widened in the years following the

liberalization of interest rates. This was due to a relatively constant savings deposit rate,

which has been attributed to some monopoly power of the commercial banks (Tan 1989).

It was only in the 1990s that the gap narrowed to around 7 percent. Overall, there has

been no perceptible narrowing of interest rate spreads, both following interest rate and

bank entry regulation.

Figure 2. Lending and deposit rates of commercial banks, 1982-98 (in percent)

0

5

10

15

20

25

30

1981 1984 1987 1990 1993 1996

Ave lending rateSavings deposit rateTime deposit rate (ave)

Source: Bangko Sentral ng Pilipinas.

B. Insurance sector

The insurance industry is mainly private sector owned and operated. But there are

also 3 public sector institutions – the GSIS, which also offers life insurance in addition to

providing social security for government employees and general insurance for

government; the Philippines Crop Insurance Corporation; and the Home Insurance and

Guarantee Corporation. Prior to deregulation, there were a total 127 private insurance

companies in the Philippines, of which 24 were life insurers and 97 non-life insurers

(Table 5). This number rose to 145 in 1997 following the deregulation of entry into the

insurance sector.

In classifying an insurance company as either a domestic or foreign company, the

Commission’s basis is its place of registration. Thus, domestic companies are those that

125

are formed, organized or existing under the laws of the Philippines, even if they are

foreign-owned. That is, the Code treats foreign registration, not foreign ownership, as the

deciding factor. For the purpose of this paper, however, the terms domestic and foreign

are used to refer to ownership. Thus, while only 10 of the 127 companies in 1994 are

classified as foreign (i.e., not registered in the Philippines), 6 others are fully foreign

owned but domestically incorporated.

Table 5. Market structure of the private insurance industry, 1990-97

1990a 1993 1994 1995 1996 1997

Total 130 127 127 129 134 145

Domestic 117 109 111 113 115 121

Foreign 13 18 16 16 19 24 Dom incorporated 6 6 7 10 15 Branch 13 12 10 9 9 9

Direct-writing 4 123 123 125 130 141

Composite 2 2 1 1 2 2

Domestic 2 2 1 1 1 0

Foreign 0 0 0 0 1 2 Dom. incorporated 0 0 0 1 2 Branch 0 0 0 0 0 0

Life 23 24 25 26 29 34

Domestic 21 20 21 21 22 24

Foreign 2 4 4 5 7 10 Dom. incorporated 2 2 3 5 8 Branch 2 2 2 2 2 2

Nonlife 101 97 98 98 99 105

Domestic 91 84 86 88 89 94

Foreign 10 13 11 10 10 11 Dom. incorporated 4 4 4 4 5 Branch 10 9 7 6 6 6

Professional Reinsurers 4 4 4 4 4 4

Domestic 3 3 3 3 3 3 Foreign branch 1 1 1 1 1 1

Note: For 1990, domestic insurance companies also included domestically incorporated foreign companies. Source: Insurance Commission.

126

Although domestic companies far outnumbered foreign companies in terms of

number, there was significant foreign ownership in the industry. Table 6 shows fairly

comparable asset shares of domestic and foreign insurance companies. The latter’s share

even exceeded the former share’s in the life insurance sector. The dominance of foreign

companies is more apparent when one looks at their market share based on premiums in

force (Figure 3). The difference in the average size of domestic versus foreign companies

is thus striking. Overall, the average asset size of the foreign firms was around four times

that of the domestic firms. When one distinguishes between life and nonlife, a different

picture emerges. The average size of foreign life insurance companies was around six

times that of domestic firms in 1993, while their average sizes were comparable for the

non-life sector. The growth of the life sector was also more rapid than the non-life sector.

Following the 1994 entry deregulation, the distribution of total assets between domestic

and foreign firms was basically unchanged. On average, however, the size of domestic

life insurance companies significantly increased. The average asset size of foreign life

insurance companies fell to just three times that of their domestic counterparts in 1997. In

contrast, the average size of foreign non-life insurance companies increased to around

twice that of their domestic counterparts.

127

Table 6. Asset structure of the private insurance industry, 1993-97 (in percent)

1993 1994 1995 1996 1997

Total assets (bil pesos) 75.807 83.933 100.269 120.234 140.204

Domestic 59 59 58 59 57

Foreign 41 41 42 41 43 Dom incorporated 28 27 27 27 28 Branch 14 14 14 15 15

Life 67 67 67 69 66

Domestic 31 31 30 32 30

Foreign 36 37 37 37 37 Dom. incorporated 24 24 24 24 23 Branch 12 12 13 13 13

Nonlife 31 31 32 29 32

Domestic 26 27 27 25 26

Foreign 5 4 5 4 6 Dom. incorporated 3 3 3 3 5 Branch 2 1 1 1 1

Professional Reinsurers 2 2 2 2 2

Domestic 2 2 2 2 2 Foreign branch 0 0 0 0 0

Figure 3. Premium income in insurance by ownership, 1993-97 (in million pesos)

0

5000

10000

15000

20000

1993 1994 1995 1996 1997

Foreign

Domest ic

Source: Insurance Commission.

128

In terms of concentration in the industry, Table 7 shows the market share of the

ten largest life and non-life insurance companies in 1989, based on premiums in force.

Concentration in the industry was not deemed as unusual nor did it pose problems, even

though the single largest life company (foreign) accounted for 35 percent of the market

and the 10 largest for 93 percent market share. This kind of market share distribution was

quite common in other countries also. The increase in the average size of domestic

insurance companies, and the entry of new foreign insurance companies most like

resulted in reduced concentration in the life insurance industry. Concentration would

seem to be less of a problem in the non-life sector. In fact, the major issue related to size

distribution of non-life companies was that there were too many very small domestic

companies. These companies were inadequately capitalized and operationally weak. Most

of them were family owned and, while unable to strengthen their capital, were also quite

unwilling to merge. These small weak companies had resulted in inefficiencies and even

abuses in the non-life sector in the past. The increasing participation of foreign insurance

companies should result in a stronger and sounder financial condition in the non-life

sector.

Table 7. Share of ten largest life and nonlife insurers in premium income,

1989

Life Premiums Share Nonlife Premiums Share Firm ranking (P mil) (%) Firm ranking (P mil) (%)

Philam 1,452 35.0 American Home 325 10.2 Insular 820 19.8 Ins.Co. of NA 261 8.2 Sun 596 14.4 Malayan 243 7.7 Filipinas 260 6.3 FGU 203 6.4 Unicoco 148 3.6 Philam 151 4.8 Manufacturers 141 3.4 Prudential 115 3.6 Manila Bankers 137 3.3 Pioneer 91 2.9 Great Pacific 126 3.1 Comm. Union 72 2.3 Lincoln Phil. 124 3.0 Oriental 70 2.2 Fortune 48 1.2 Perla Companie 65 2.0

Total 93.1 Total 50.3

Total no. of firms 23 Total no. of firms 101

Source: World Bank (1992).

129

II. Insights for the retail trade liberalization issue

Overall, the general objective for easing entry restrictions on foreign investors in

the banking and insurance industries was achieved. That is, the policy led to less industry

concentration and, presumably, to increased competition and efficiency. With respect to

the speed of the deregulation, the banking sector was more conservatively managed. This

may be warranted by the fact that it accounts for a large proportion of the Philippine

financial system, and any instability that may be brought about by deregulation will have

wide repercussions in the economy. On the other hand, the deregulation of entry

restrictions in the insurance industry was quite drastic. Furthermore, the deregulation of

entry restrictions was complemented by reforms in the banking sector’s regulatory

framework. In contrast, there were no corresponding changes in the regulatory

framework of the insurance industry. The latter could lead either to continued restricted

operations, if the Commission maintains its highly conservative regulatory stance, and/or

increased instability if the Commission is unable to cope with market innovation.

In the case of retail trade liberalization, the main lesson to be gained from

financial sector liberalization is the importance of having a well-defined competition

policy. The reform of policies dealing with restrictive business practices resulting from

concentration, dominant market positions or anti-competitive cooperation agreements, is

just one aspect of encouraging or providing more scope for competition. A generally

supportive policy attitude towards strengthening market elements and intensifying market

competition is also a crucial factor. Indeed, market developments have in recent years

had a major impact on policy, and authorities have often reacted to market forces rather

than taking a lead. Thus, in addition to the market structure, liberalization policy should

also take into account the overall regulatory regime and regulatory capacity because these

affect competition and efficiency as well.

130

References: Bautista, E.D., 1992. A Study of Philippine Monetary and Banking Policies, PIDS

Working Paper Series No. 9211, Philippine Institute for Development Studies,

Manila.

Doherty, J.F., 1980. A preliminary study of interlocking directorates among financial,

commercial, manufacturing and services enterprises in the Philippines,

Manila.

Emery, R.F., 1976. The Financial Institutions of Southeast Asia: A Country-by-

Country Study, Praeger Publishers, New York.

Hutchcroft, P.D., 1991. The politics of finance in the Philippines, Paper prepared for the

conference on Government, Financial Systems, and Economic Development:

A Comparative Study of Selected Asian and Latin American Countries, East-

West Center, Honolulu, 18-19 October.

________, 1993. Predatory oligarchy, patrimonial state: the politics of private domestic

commercial banking in the Philippines (in 2 volumes), unpublished dissertation,

Yale University, New Haven.

Lamberte, M.B., 1989. Assessment of the Problems of the Financial System: the

Philippine Case, PIDS Working Paper Series No. 89-18, Philippine Institute for

Development Studies, Manila.

131

________ and Llanto, G.M., 1993. A study of financial sector policies: the case of the

Philippines, Paper presented at the Conference on Financial Sector Development

in Asia, Asian Development Bank, Manila, 1-3 September.

Laya, J.C., 1982. A Crisis of Confidence and Other Papers, Central Bank of the

Philippines, Manila.

Milo, M.M.R.S., 1998. Dissertation submitted to the Australian National University,

Canberra for examination.

Park, Y.C., 1991. 'Financial repression and liberalization', in Krause, L.B. and Kihwan,

K. (eds)., Liberalization in the Process of Economic Development,University of

California Press, Ltd., Los Angeles: 332-65.

Remolona, E.M. and Lamberte, M.B., 1986. 'Financial reforms and balance-of-

payment crisis: the case of the Philippines', Philippine Review of Economics

and Business, 23(1&2): 101-41.

Tan, E.A., 1989. Bank Concentration and the Structure of Interest, UPSE Discussion

Paper No. 89-15, School of Economics, University of the Philippines, Diliman.

132

________, 1991. Interlocking Directorates, Commercial Banks, Other Financial

Institutions and Non-financial Corporations, UPSE Discussion Paper No. 91-10,

School of Economics, University of the Philippines, Diliman.

The World Bank, 1988. Philippines Financial Sector Study (In Three Volumes), The

World Bank, Washington, D.C.

________, 1992. Philippines Capital Market Study (in 2 volumes, Vol. 1: Main Report;

Vol. 2: Contractual Savings Sector), The World Bank, Washington, D.C.

133

Study III

Technology Transfer and Franchising: The Philippine

Case

By: Myrna S. Austria

134

Technology Transfer and Franchising: The Case of the Philippines

Myrna S. Austria* The on-going debate on the pending liberalization of the retail trade sector of

the Philippines open avenues for analyzing the possible benefits or threats that this may

bring to the economy. But doing this would entail dissecting the whole gamut of

concerns of the retail trade sector. This paper focuses on just one aspect of retail trade,

franchising. In almost all cases, franchising involves the retail of products or services.

In most discussion on franchising, the common cited benefits from

franchising are profits for business owners and investors, job creation for the country and

improved quality of products and services for the people. What is often neglected in the

literature, however, is a discussion on the impacts that franchising may have on

technology transfer, especially by foreign franchises. This paper addresses precisely this

issue, whether franchisees get the technology transfer they need from their foreign

franchisors and what kind of technologies are being transferred.

The next section of the paper is a discussion on the overview of the

Philippine franchising industry, including the recent trends and innovations in

franchising. This is followed by the results of the interview and survey conducted to

assess whether there is technology transfer in franchising. Also discussed under this

section are the perceptions of franchisees on the possible effects the retail trade

liberalization may have on franchising. The last section is conclusion.

Overview of the Philippine Franchising Industry

Franchising in the Philippines started as early as 1910 through the product

distribution scheme of the Singer Sewing Machine. The growth of the industry, however,

* Research Fellow, Philippine Institute for Development Studies. The research assistance provided by Euben Paracuelles is gratefully acknowledged.

135

has been more pronounced in the 1980s and more so in the 1990s. The number of

franchises grew from an average of 20 in the 1970s to 50 in the 1980s (Lim, 1998). By

1998, there are about 320 franchises operating in the country (Table 1). These enterprises

employ a total of around 300,000 employees. The increase in the number of franchises

amidst the economic crisis during the last two years has shown that franchising is one

investment area that is “recession proof”. The study by Lim (1998) in fact shows that the

success rate in the Philippine franchising industry is 95 percent, i.e. only 5 percent of the

franchises had ceased operation.

Foreign franchises have increased their share from 42 percent in 1995

to 57 percent in 1998 (Table 1). The enhanced competition posed by the successful

foreign franchises in the country has fueled local companies to become competitive and

expand their operations for them to keep their market shares in tact. This is shown by the

growth of local franchises for the past two years (Table 1). A very good example of this

is the Jollibee vs. McDonald’s competition. McDonald’s has faced tough competition

with Jollibee in the hamburger chain segment of the fastfood industry.

Up until the mid-1990s, most franchises in the country are in the food business

(Figure 1). The trend has been reversed, however, during the past 2-3 years. In 1998,

about 57 percent of the total franchise are in the non-food business like car rental,

printing, copying service, dry-cleaning and laundry, delivery courier service, educational

services, etc. The rise in the non-food franchise can be attributed to the increase in

income levels and increased preference for communication, educational and recreational

services during the past 2-3 years. Even among the foreign franchises, the non-food

business is growing much faster than the food sector (Figure 2).

136

Table 1. Number of franchises, local and foreign. Number % Distribution Annual Growth Rate (%)

Year Local Foreign Total Local Foreign Local Foreign Total

1970s ND ND 15-20 1980s ND ND 45-50 1995 64 47 111 57.6 42.4 1996 96 94 190 50.5 49.5 50.0 200.0 71.2 1997 115 136 251 45.8 54.2 19.8 44.7 32.1 1998 138 182 320 43.1 56.9 20.0 33.8 27.5

Source: Philippine Franchise Association.

Figure 1. Percent distribution of franchises, food and non-food, 1994 & 1998.

Figure 2. Number of foreign franchises, 1995-1998.

Source: Philippine Franchise Association.

30%

70%

Food

Nonfood

43%

57%

1994 1998

7 0 %

3 0 %

4 8 %

5 2 %

4 7 %

5 3 %

4 6 %

5 4 %

0

2 0

4 0

6 0

8 0

1 0 0

1 2 0

1 4 0

1 6 0

1 8 0

2 0 0

no. o

f fra

nchi

ses

1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8

N o n -F o o d

F o o d

4 7

9 4

1 3 6

1 8 2

137

The favorable trend in the franchising industry even during difficult times is

shown not only by the increase in the number of franchises operating in the country but

also by the expansion in the number of outlets of the franchises (Table 2). This could be

attributed to the increased urbanization of the different regions and provinces of the

country. Several franchises have expanded and moved into the country’s key cities like

Cebu, Davao and Baguio, and to the emerging urban centers where industrial and

economic zones have been expanding like in Cavite, Batangas, Laguna and Zambales.

The more successful franchises that have expanded in the regions are McDonald’s, Pizza

Hut, Kodak and 7-11 among foreign franchises; and Jollibee, Greenwich Pizza and

Chowking among local franchises.

Table 2. Number of outlets of selected franchises. No. of Outlets Growth Rate

Food 1997 1998* (%) Burger Machine 466 500 7.3 Jollibee 209 212 1.4 Chowking 114 120 5.3 Shakey's 108 109 0.9 Mc Donalds 108 172 59.3 Greenwich Pizza 70 128 82.9 Pizza Hut 61 74 21.3 Goldilocks 50 64 28.0 Texas Chicken 22 28 27.3 Non-Food Eastman Kodak 450 503 11.8 Mercury Drug 294 300 2.0 Agua Vida 120 253 110.8 Seven Eleven 107 144 34.6 Zenco Footsteps 116 120 3.4 Kameraworld 59 79 33.9 Electronic Realty Associates 27 44 63.0 Laundry Express 26 28 7.7

*As of March 1998 Source: Philippine Franchise Association.

138

Another indication of the favorable performance of the industry is the fact that 32

of the franchises belong to the top 1,000 corporations in the country (Table 3). These

franchises have a combined sales of P112.4 billion and P130.2 billion in 1996 and 1997,

respectively; and combined income of P6.2 billion and P1.3 billion, respectively, during

the same period. In real terms (1994 prices), this implies an 8.4 percent growth in sales

but a decline of 80 percent in income.

Franchising Arrangements

Franchising arrangements in the country take various forms. Most of the

franchises in the country are “company-owned” where the master licensee owns and

manages the different outlets of a franchise in the country.

Other franchises also allow owner-operator franchises where a particular

outlet of a franchise is owned and managed by a franchisee. This applies particularly to

outlets that are located outside of Metro Manila.

139

Table 3. Sales and income performance of selected franchise companies, 1996 & 1997. Company Rank Gross Sales (in Pm.) Income (in Pm.) Change in Change in

1997 1996 1997 1996 1997 1996 Sales (%) Income (%)

Caltex 5 6 38086 33820 -2360 740 12.6 -418.9 Coca-cola 12 11 25593 23948 2406 2947 6.9 -18.4 Mercury 19 18 18275 15830 284 246 15.4 15.4 Jollibee 62 59 7205 5772 442 602 24.8 -26.6 Pilipinas Makro 96 192 4667 2165 102 45 115.6 126.7 Avon 105 113 4216 3363 609 466 25.4 30.7 McDonald's 147 207 3102 2022 14 11 53.4 27.3 Phil. Seven Corp. 192 218 2467 1957 57 75 26.1 -24.0 Goodyear 209 140 2310 2695 -527 449 -14.3 -217.4 Monterey Farms Corp. 222 191 2190 2166 21 35 1.1 -40.0 Goldilocks 246 241 2026 1781 46 68 13.8 -32.4 Kodak 251 230 1978 1878 -47 148 5.3 -131.8 Tropical Hut 263 236 1873 1811 10 25 3.4 -60.0 Sara Lee 318 255 1533 1668 5 74 -8.1 -93.2 Pizza Hut 344 313 1415 1300 156 131 8.8 19.1 Zenco 368 346 1322 1172 -24 -53 12.8 -54.7 Chowking 422 460 1166 854 64 54 36.5 18.5 Levi's 425 368 1157 1074 113 161 7.7 -29.8 Greenwich 504 794 941 420 30 8 124.0 275.0 Wendy's 510 473 929 819 23 15 13.4 53.3 Cinderella 524 503 898 772 7 13 16.3 -46.2 Store Specialists 607 419 771 939 43 44 -17.9 -2.3 California Clothing 621 627 751 593 19 15 26.6 26.7 Rustan Mktg. Specialists 642 - 730 - 14 - - - Golden Arches Dev't Corp. 662 756 710 448 -58 28 58.5 -307.1 Singer 725 598 631 627 8 49 0.6 -83.7 Gift Gate 744 669 613 547 6 9 12.1 -33.3 Dunkin Donuts 771 658 584 558 16 27 4.7 -40.7 FedEx 773 861 584 360 -182 -263 62.2 -30.8 Waltermart Damarinas 887 777 502 429 3 3 17.0 0.0 Roasters 903 912 490 211 2 2 132.2 0.0 Shakey's 981 828 448 390 19 15 14.9 26.7

Source: Businessworld, 1998. “Top 1000 Corporations,” Vol. 12.

Other franchises operate on a product distributorship arrangement where the

franchisors market their products through the franchisees.

Franchising fee also varies. Some franchises involve a one-time franchising fee

plus a royalty fee, usually a fixed percentage of the monthly gross sales. The one-time

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franchising fee allows the franchisee to operate the business for as long as he wants.

Other forms of franchising fee take the form of a fixed amount of fee that allows the

franchise holder to operate for a particular number of years and is renewable, plus a

royalty fee. Product distributorship arrangements do not involve franchising fee nor

royalty fee; but the franchisee has the sole access to the products of the franchisor.

Trends and Innovations in the Franchising Industry

New trends and innovations have emerged in the Philippine franchising industry

as a result of the changes in lifestyle, tastes and preferences of Filipinos. For example,

franchise outlets have moved towards non-traditional locations like gasoline stations and

schools (Limjoco, 1998). Convenience stores are also increasingly becoming more and

more important to the growing middle class. This only shows the increase in profitable

market niches in the country.

Likewise, co-branding outlets where complementing franchises are housed under

one roof have become popular recently. A very good example of this is the Jollibee and

Greenwich Pizza co-branding stores.

The services sector has also shown strong potential for franchising. This could

include the areas in plumbing, electrical repair, carpentry and “lipat bahay” (Lim, 1998)

While there are no franchises in these areas yet, the potential for their development is

strong as Filipinos are becoming more and more concerned with guaranteed results and

reliable network.

International Franchising: The Next Generation Exports

Four of the country’s homegrown franchises have gone global in their operations

and they have done it successfully such that they have become a new source of foreign

141

exchange for the country. These franchises include Jollibee, Bench, Josephines’

Restaurant and Goldilock’s. These enterprises have capitalized on the proliferation of

Filipinos working and residing abroad. But more importantly, the more open global

environment has paved the way for the “internationalization” of these local franchises.

This development shows that the Filipino can be at par with the global standards of

franchising.

Other local franchises that have the potential to go global include Cinderella, STI

or AMA, Max’s Restaurant, Penshoppe and Mr. Quickie (Lim, 1998).

Government Policies and Regulations

Franchising in the country is governed by the following three laws: (i) Intellectual

Property Code of the Philippines; (ii) Civil Code of the Philippines; and (iii) Retail Trade

Law in relation to foreign franchisors.

Intellectual Property Code of the Philippines. To encourage more investments in

franchising in the country, the Intellectual Property Code of the Philippines or RA 8293

(or IP Code) took effect in January 1, 1998. The IP Code repealed the three major

intellectual property laws namely: (i) Copyright Law or PD 49; (ii) Patent Law or RA

165; and (iii) Trademark Law or RA 166.

The IP Code defines technology transfer arrangements as “contracts or

agreements involving the transfer of systematic knowledge for the manufacture of a

product, the application of a process, or rendering of a service including management

contracts; and the transfer, assignment or licensing of all forms of intellectual property

rights including the licensing of computer software except computer software developed

for mass market” (p.2 of RA 8293).

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Under the IP code, royalty arrangements are no longer regulated. Likewise,

franchisors are no longer mandated to register their franchises as long as their agreements

do not contain any of the prohibited clauses under Section 87 of the Code and contain all

the mandatory provisions under Section 88 of the Code (p.24 of RA 8293).

Civil Code of the Philippines. All franchise agreements, whether between

foreign franchisors and Philippine franchisees, or between Philippine franchisors and

Philippine franchisees are subject to Philippine laws including, among others, the Civil

Code provisions on obligations and contracts. Under the general principle on contracts

under the Civil Code, the franchisor and franchisee may agree on such terms and

conditions as they may deem convenient provided, however, that these are not contrary to

law, morals and public order.

Retail Trade Law or RA 1180. Franchises, in almost all instances, involve the

sale at retail of products; and hence the retail trade law applies. Under this law, a

franchisee which is not 100 percent Filipino-owned cannot operate an outlet which is

engaged in retailing defined as “any act, occupation or calling of habitually selling direct

to the general public merchandise, commodities of goods for consumption.

There is a bill pending in Congress that proposes to liberalize the retail trade law,

allowing foreign ownership in retail.

Technology Transfer and Franchising

This section of the paper discusses the results of the interview and survey made

on the major franchise holders in the country. The survey and interview were carried out

to determine whether there is technology transfer in franchising.

143

Thirteen major foreign franchise holders were interviewed for the

study, including one franchisee who is a holder/owner of 13 different franchises. Eight of

the franchisees are in the food business and the rest are either in car rental, RTW/retail or

film/photo services. Most of them started operation in the mid-1980s and early to mid-

1990s. Most of them employ less than 1,000 persons although one of them has a work

force of around 4,700.

Except for one, which is an owner-operator franchise, all of the franchises are

company-owned franchises. Two of the company-owned franchisees, however, sell

franchises outside of Metro Manila. Furthermore, two of them are involved in a product

distribution arrangement and hence, they do not pay any franchising fee or royalty fee.

Another two franchisees do not pay any franchising fee but they pay a royalty fee of 6-10

percent of monthly gross sales. For those that pay a franchising fee, the fee ranges from a

low of US$150,000 to a high of US$1 million, plus a royalty fee of 5-7 percent of

monthly gross sales.

Technology Transfer

All the franchisees acquired from their franchisors the technology they need for

their business. In fact, except for one, all of them considered that franchising is enough

for them to be able to acquire the technology that they need. Franchising provides a

proven system with track record in running the whole business and this is already enough

to enable them run their business.

Furthermore, 75 percent of them considered that without franchising, they

would not be able to acquire the same technology from other sources. The remaining 25

percent, however, thinks that they can acquire the same technology from other sources

but they opted for franchising because the brand name that goes with franchising is a sure

guarantee for greater sales and profits.

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Areas of technology transfer. Technology transfer in franchising is found in three

major areas namely, (i) operations, (ii) human resource development, and (iii)

management and administration (Table 4). For the food sector, the three most important

areas under operations where technology transfer occurs are in processing, physical lay-

outing and quality control, in that order. For the non-food sector, physical lay-outing was

ranked the most important; followed by other areas like access to fashion design. For

both sectors, foreign franchisors usually have a standard physical lay-outing that they

require their franchisees to follow. Likewise, not only is the quality of product or service

provided monitored by the foreign franchisors, but also the quality of equipment or

utensils used.

In terms of human resource development, training for operations personnel

was considered the most important benefit that non-food franchisees get from their

foreign franchisors. On the other hand, training for managerial staff was ranked first for

the food sector. For both sectors, training for operations personnel are usually done

locally but are conducted by the foreign franchisors. This occurs usually prior to the

opening of the franchise and occasionally after opening. Training for managerial staff is

usually done abroad, where the franchisor is located, before the start of operation.

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Table 4. Areas of technology transfer in franchising.

FOOD (F) NONFOOD (NF) F & NF Type of Technology Statistical Statistical Statistical

Points Rank Points Rank Points Rank

I. Operations

Processing 49 1 12 3.5 68 1 Physical Layouting 46 3 21 1 66 2 Quality Control 47 2 12 3.5 58 3 Equipment 37 4 8 5 45 4 Inventory 32 5 3 6 38 5 Packaging 30 6 30 6 Others* 16 2 23 7 Waste Disposal 20 7 20 8

II. HRD

Operations 20 3 16 1 40 1 Managerial 30 1 7 2 37 2 Supervisory 26 2 4 3 30 3 Others 0 0 0

III. Management & Administration

Marketing 31 1 22 1 48 1 Pricing 26 2.5 9 3 35 2 Accounting System 26 2.5 5 4 31 3 Raw Materials Sourcing 21 4 10 2 31 4 Others 0 0 0

* composed of Executive information systems & Fashion design for nonfood industry. Note: Ranking was made in their order of importance, with 1 as the most important, 2 as second, etc. Source: Results of interview/survey.

In the area of management and administration, technology transfer in marketing

was considered the most important for both sectors. The “brand name” is an important

marketing strategy in itself, especially that Filipinos are brand conscious. Marketing

materials (e.g. posters) are usually provided free. In terms of pricing, while there are no

standard mark-up, franchisors usually teach their franchisees how to price their products

or services. For accounting system, forms are usually provided for which franchisees only

need to fill up. Raw material sourcing was ranked second for the non-food sector. This

is especially true for those engaged in product distribution arrangement in retail since

146

only by being a franchise holder can they have access to the products of the franchisor.

However, raw material sourcing was ranked the least in the food sector since franchisees

are usually allowed to source their raw materials locally provided the quality is good.

Brand management vs. technology transfer. The profitability of a franchise was

ranked the most important reason for acquiring a franchise (Table 5). The proven system

of running the business is enough assurance that a franchise is more likely to succeed

than a starting-up and stand-alone business. However, while franchising is an enough

source of technology transfer, it appears that in the franchising relationship, brand

management is more important than technology transfer. This can be attributed to the

fact that the Filipino culture of being brand conscious (especially foreign brand) makes

franchising more profitable than any other type of doing business. Only four of the

franchisees interviewed considered technology transfer as more important than brand

management.

Other support from foreign franchisors. Franchisees also get support from their

foreign franchisors in terms of advertising, research and development and monitoring

system. R& D usually take the form of research on how to use local materials as inputs.

Table 5. Reasons for acquiring a franchise.

Statistical Points Rank

Profitable business 43 1 Brand management 35 2 Technology transfer 31 3 Others 0

Note: Same as Table 4. Source: Results of survey/interview.

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Likely Effects of Retail Trade Liberalization on Franchising

Except for one, all the franchisees interviewed considered that the

liberalization of the retail trade will not pose any threat to their business. Allowing

foreign franchisors to operate their own outlets here or allowing foreign investors to be

franchise holders here will all the more increase the competition that already exists in the

industry. The franchisees interviewed for the study considered this as good for the

industry. But nonetheless, they think that their foreign franchisors will not go the extent

of establishing their own outlets here. They think that one must know the tastes,

preferences, eating habits, expenditure pattern, culture, management and marketing

styles, etc. of Filipinos to be able to run a franchise/outlet successfully. Hence, foreign

franchisors will be better off it they just leave the franchising of their business to the

Filipinos. Even in Hong Kong, which is relatively an open economy, foreign franchisors

find franchising to the locals profitable.

Furthermore, for high-end products and services, the market is so small

that competitors or foreign franchisors would not find it profitable to come in and

compete. For those under the product distribution arrangement, the current set-up of

using franchising as a marketing strategy is already efficient and changing the system

might prove it costly for foreign franchisors.

Conclusion

Retail trade liberalization will not pose a threat to the local franchising industry as

local franchisees know where their competence and comparative advantage lie in this

kind of business. The increased competition that comes with liberalization is good for

the growth of the industry. But more importantly, if the opening of the country’s retail

trade sector will pressure other countries to liberalize theirs, then liberalization will pave

the way for the faster internationalization of the country’s home-grown franchises and

this would mean more foreign exchange for the country. As shown by the local industry

148

that have gone global in their franchise, the Filipino can be at par with the international

standard of franchising.

149

References:

Coopers & Lybrand. Assessment of Prospects for U.S.-Based Franchises in the

Philippines (Phase I). USAID. December 1992.

Lim, Samie. Philippine Franchise Study 1998. Philippine Franchise Association, 1998.

Minihane, Mike. “Best Practices in Successful Franchising.” Paper presented during the

6th Philippine International Franchise Conference and Expo. November 1998.

Republic Act No. 8293. An Act prescribing the intellectual property code and

establishing the intellectual property office, providing for its powers and

functions.

Sibal-Limjoco, Bing. “Philippine Franchising Trends.” Paper presented during the 6th

Philippine International Franchise Conference and Expo. November 1998.

Vevstad, Vegard. “Operation a Franchise System.” Paper presented during the 6th

Philippine International Franchise Conference and Expo. November 1998.

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Study IV

The Trade Sector in the Philippines

By: Caesar B. Cororaton and Janet Cuenca August 1999

151

The Trade Sector in the Philippines1

Caesar B. Cororaton and Janet Cuenca2

August 1999

I. Objective of the Paper

The objective of this paper is to analyze the link of the trade sector with the rest of

the economy. Also, it seeks to examine the impact on other major sectors of the economy

of increased activity as a result of higher foreign investment in the trade sector. The

paper uses input-output (IO) table analysis in determining the sector’s link with the rest

of the economy. In particular, forward and backward linkages were computed. Output,

income and employment multipliers were examined. Finally, simulation exercises

wherein different scenarios of foreign investment in the trade sector were conducted.

II. Definition of the Trade Sector

The trade sector discussed in the paper is composed of wholesale and retail trade

sectors. While finer breakdown into wholesale and retail is desirable for analysis because

of differences in characteristics, it may not be possible because of data unavailability.

The Philippine Statistical Industrial Classification (PSIC) defines wholesale trade

and retail trade as follows:

(1) Wholesale Trade. Wholesale trade is the resale or sale without transformation

of new and used goods to retailers, to industrial, commercial institution or professional

users, to other wholesalers; and to government, wholesale merchant, industrial

distributors, exporters and importers. It includes sales offices separately maintained by

1Part of the retail trade sector study. It is funded by Philexport. 2Research Fellow and Research Analyst, Philippine Institute for Development Studies.

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manufacturing enterprises and their agents, commodity exchanges, petroleum bulk

station, assemblers, buyers, and cooperative marketing associations for the selling of farm

products at wholesale price. Wholesalers who physically assemble, sort and grade goods

in large lots, break bulk, repack and bottle, (except in air tight containers) and redistribute

in smaller lots, store, refrigerate, deliver and install goods, and engage in sales promotion

for customers. Scrap metal waste and junk dealers and yards are included.

(2) Retail Trade. Retail trade is the resale or sale without transformation of new

and used goods for personal or household consumption. This includes regular retail stores

such as gasoline filling stations and retail motor vehicle dealers and consumer

cooperatives. Establishments engaged in selling to the general public, from displayed

merchandise products such as typewriters, stationery, lumber or petrol, are classified in

this group although these sales may not be for personal or household consumption or use.

However, establishments which sell such merchandise to institutional or industrial users

only are classified in wholesale trade. Also, classified in retail trade are establishments

primarily engaged in renting goods to the general public for personal or household use,

except amusement and recreational goods such as boats and canoes, motorcycles and

bicycles and saddle horses.

Contribution of the Sector

III.1 Sector's Contribution to GDP

The trade sector is one of the major sub-sectors in the overall service sector.

Table 1 shows that the share of the total service sector to the total gross domestic

product (GDP) is almost 42 percent. Although this share is an improvement relative to

the 38 percent share during the period 1980-1985, it is almost constant during the last

ten years. On the other hand, the trade sector is contributing almost 15 percent to GDP

over the past ten years. This share is an improvement though relative to the period 1980-

1985 of 13.6 percent.

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The trade sector is a major sub-sector in the overall service sector. Its share for

the last 15 years is about 35 percent.

III.2 Sector's Contribution to Employment

Table 2 shows the contribution of the service sector and the trade sector to the

total employment in the economy. The overall service sector has increasingly been a

major employer of Philippine labor. From 19 percent in 1993, its contribution to the total

employment increased to 21.4 percent in 1997. Similarly, the trade sector has

increasingly been contributing to employment. Its share increased from 14 percent in

1993 to 15.1 percent in 1997.

Indeed, within the service sector, the major employer is the trade sector with a

share of 71 percent in 1997. This, however, is a slight decline from 73.1 percent in 1993.

III.3 Trade Sector as Destination of FDI

There was a surge in capital inflow into the country before the 1997 regional

financial crisis. Foreign direct investment (FDI) alone reached high levels from about

US$3 billion in 1990 to about US$7.5 billion in 1996 (Figure 1).

Based on the trend, the service sector in general and the trade sector in particular

have not been as attractive as the other sectors as destination of FDI into the economy.

Figure 2 shows the historical share of the service sector and the trade sector to the total

FDI. In 1974, the share of the service sector was about 55 percent. The share dropped

significantly since then until it stabilized at about 22 percent in the second half of the

1980s and in the first half of the 1990s. However, the share increased slightly to about

28 percent in 1996.

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On the other hand, historical share of the trade sector has not been very

encouraging either. In 1974, its share to the total FDI inflows was about 5 percent.

Although the share improved to about 17 percent in 1980, it dropped consistently since

then to less than 10 percent of the total FDI in 1996.

III.4 Trade Sector's Link With Rest of Economy

Table 3 shows an indicator of the linkage of the trade sector with the rest of the

economy. The linkage is in terms of both forward and backward linkage based on the

different input-output (I-O) tables. The higher the level of the index (forward or

backward), the higher is the link of the sector with the rest of the economy.

Based on the results, the trade sector has stronger forward linkage than backward

linkage. For example, in 1988, it is the 4th in the ranking of forward linkages among the

different sectors of the economy. The sector that is at the top is the manufacturing. On the

other hand, in terms of backward linkage, it has one of the lowest, in particular the 10th

among 11 sectors. Manufacturing sector again has the highest forward linkage. The same

general ranking is seen in 1990.

IV. Multipliers

There are three multipliers discussed in this section: output, income, and

employment multipliers. Furthermore, there are two types of multipliers calculated in

the paper, simple and total multipliers. The former considers the household sector as

exogenous, while the latter as endogenous1. This section discusses the results of the

simple multipliers only. Appendix A presents the results of the total multipliers.

1The simple output multiplier is derived from an open input-output (IO) table where the household sector is exogenous. This means that the household sector is one of the columns under the final demand column. In a closed IO, the household sector is moved from the final demand column into the technologically

155

IV.1 Output Multiplier

An output multiplier for sector j is defined as the total value of production in all

sectors of the economy that is necessary in order to satisfy a peso's worth of final demand

for sector j's output. For the case of a simple output multiplier for sector j, the multiplier

can be written as,

(1) Oj = Σni=1 αij

where αij refers to the elements of the Leontief inverse, and i, j refer to sectors.

How is this multiplier analysis applied? If the government would like to investigate what

sector of the economy would generate the greatest output effect for every additional peso

of investment, then the sector with the highest output multiplier would indicate the

greatest impact in terms of total peso value of output generated throughout the economy.

Thus, the output multipliers can aid in ranking sectors in terms of their impact on total

output. We adopted the output multiplier analysis to 1995, 1988, and 1990 IO tables. The

results are shown in Table 4.

In 1985 the manufacturing sector is the 8th in the ranking while in 1988 and 1990,

it is at the top among the major sectors of the economy. The reason for this is that IO

analysis is sensitive to business cycle. Because of the deep recession in mid 1980s, it

generated a very low multiplier for the manufacturing sector. Thus, the case of the 1985

can be considered as an outlier with respect to the manufacturing multiplier. In both 1988

and 1990 it consistently has the highest multiplier value.

What is interesting is that the trade sector shows up as one of the sectors with the

lowest output multiplier; both during recession and “normal” years. These results are

generally consistent with its weak link (forward and backward) with the rest of the

economy as shown above.

interrelated table. This is known as endogenizing the household sector. The multiplier derived from this IO is called total output multiplier.

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IV.2 Income Multiplier

Income multiplier translates the impact of final demand changes into income

received by households (labor supply). The resulting change in income is the outcome of

direct and indirect effects of the final demand change. Income multiplier can be

interpreted as the new household income that will be generated by an additional peso

worth of final demand in a sector. In general, the simple household income multiplier, Hj,

for sector j is given by

(2) Hj = ∑ an+1,i αij

where an+1,i are the elements of the (n+1)th row, which is the household row, and

αij are the elements of the Leontief inverse(I-A)-1. This was used to calculate the simple

household income multiplier for the 1990 I-O model.

Also, total household income multiplier1, H′ j, was estimated using the equation

(3) H′ j = ∑ an+1,i α′ ij for i = 1,n + 1 sector

where an+1,i are the elements of the (n+1)th household row and α′ ij are the

elements of the Leontief inverse(I-A′)-1.

We applied the income multiplier analysis to the 1985, 1988 and 1990 IO tables.

The results are shown in Table 5.

The results are quite different from the results of output multiplier. The sector

with the highest income multiplier is the government sector in all three years.

Interestingly, its income multiplier value is way above the value of the other sectors.

Meanwhile, the manufacturing sector which is at the top during 1988 and 1990 in terms

of output multiplier has relatively low income multiplier, even lower than the income

1The household is endogenized in a closed IO model, see footnote 2.

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multiplier of the trade sector. In 1990, the trade sector ranks the 5th, but in terms of value

its not very far from the income multiplier of the manufacturing sector.

IV.3 Employment Multiplier

Employment multipliers can be used to analyze the job creation potential of

different sectors arising from additional final demand. It can also be used to depict the

relationships between the value of output of a sector and employment in that sector (in

physical, not monetary, terms). In general, for an n-sector IO model, the physical labor

input coefficient is

(4) Wn+1,i = ei/Xi

where ei is the number of employees in sector i, Xi is the value of output of the sector,

and Wn+1,i is one component of WR, i.e., the row vector [Wn+1,1,…,Wn+1,n], which

represents the peso value of labor inputs to each of the n sectors per peso’s worth of

sectoral output. Moreover, the simple employment multiplier is given by

(5) Ej = ∑ Wn+1,i αij for i = 1…n sector

We also applied the employment multiplier analysis to the 1985, 1988 and 1990

IO tables. The results are shown in Table 6.

The agricultural sector has the highest employment multiplier in all the three

years. In general, the service sector, including the trade sector, has relatively high

employment multiplier. These results are expected since these sectors are labor

intensive.

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V. Impact Analysis

Data from the Security and Exchange Commission (SEC) indicates that 21

percent of total investment in the trade sector is foreign investment, while 79 percent is

domestic investment. What would be the impact if, as a result of trade sector reforms, e.g.

retail trade liberalization, foreign investment into the sector improves? This section

presents a number of simulation results based IO multipliers concerning different shares

of foreign investment into the trade sector. In particular, the sector’s gross fixed capital

formation (GFCF) was adjusted to capture the following scenarios or cases: (1) the base

case, in which 79 percent share of the sector’s investment is domestic and 21 percent

foreign; (2) Case A, 70 percent domestic and 30 percent foreign; (3) Case B, 60 percent

domestic and 40 percent foreign; (4) Case C, 50 percent domestic and 50 percent foreign,

(5) Case D, 40 percent domestic and 60 percent (6) Case E, 30 percent domestic and 70

percent foreign. However, it must be noted that in all cases the level of the sector’s

domestic investment is held constant. Thus, changes in the sector’s foreign investment

result in changes in the total investment in the sector. The multiplier impact analysis was

applied to the 1990 IO table. A more detailed discussion of the method and the

calculations is shown in Appendix B.

Table 7 shows the simulation results. The upper panel of the table presents the

levels, while the second panel shows the percentage differences from the base scenario.

Note that in all scenarios, the level of domestic investment in the trade sector is held

fixed. Thus the increase in the share of foreign investment to the total automatically

translates into higher total investment in the sector.

Scenario with the biggest impact on the sector’s investment is Case E wherein

foreign investment is allowed to increase and to capture an investment share of 70

percent. On the other hand, Case B has the lowest impact. This is expected since it is the

case wherein the deviation from the base is the least.

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The impact on the rest of the sectors varies. The sector that benefits greatly from

the increased participation of foreign investment in the trade sector is the financial sector.

This is followed by utilities sector, and then transportation, communication and storage.

Agriculture and manufacturing sectors have small effects.

VI. Summary

The paper shows a number of IO-based analyses that attempt to examine the

impact of increased activity in the trade sector. The trade sector includes both wholesale

and retail sectors. While further decomposition into these sub-sectors is desirable because

they have differences in characters and behavior, it may not be possible because of data

unavailability.

Based on the results, it was observed that the sector’s link with the rest of the

economy is not very high. Compared to the sectors like manufacturing and agriculture, its

forward and backward linkages are relatively smaller. It follows therefore that its

multipliers are also relatively smaller.

Furthermore, based on the IO-based simulation exercises, it was observed that if

indeed trade reforms like the retail trade liberalization brings about increased foreign

participation, its impact on both agriculture and manufacturing is relatively small. It will

have bigger impact though on sectors like finance, utilities and transportation.

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APPENDIX A

Two further categories of multipliers were calculated: simple multiplier and total

multiplier. The first one is the multiplier that uses direct and indirect effects. In this case,

household is treated as exogenous. On the other hand, total multiplier uses direct,

indirect, and induced effects wherein household is assumed to be endogenous. This

appendix presents the results of the total multiplier calculations. The simple multipliers

are presented in the main text. Total output multipliers are shown in Table 1A. Table 2A

presents the total income multipliers, while Table 3A total employment multipliers.

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APPENDIX B

The general form for impact analysis using IO multiplier is:

(1A) X = (I-A)-1Y

where X is the column vector of total output, Y is the column vector of final

demand, I is the identity matrix, A is the matrix of “average propensities to spend” (aps),

and (I-A)-1 is the Leontief inverse matrix. It should be noted that Y vector incorporates

the assumed or projected behavior of one or more final-demand elements. Also, the

accuracy of the result, X, depends on the “correctness” of both Leontief inverse matrix

and Y-vector. For a Leontief inverse matrix to be correct, matrix A should be accurately

computed.

Considering that the column entries of the I-O model represent sectoral

expenditures on intermediate input or material input and factor input payments (sectoral

value added), A is just a matrix with elements aij where aij are the “average propensities

to spend”, i.e. the ratios between particular expenditures, xij and the total expenditure, xj

belonging to the same account.

(2A) A = xij /xj for i, j = 1,n sector

In the paper, (1A) was calculated for each of the six cases which resulted in

different X, which is “11 x 1”. All cases have common “11 x 11” matrix A but the

difference lies on the level of investments in Y, which is also “11 x 1”. Matrix A was

obtained using Equation (2A). Take for instance getting the “aps” for the first sector

with respect to trade. The entry for agriculture is 8,855,025 with respect to trade and the

total expenditure for agriculture is 397,260,699. Thus,

aps = 8,855,025/397,260,699 = 0.022290

162

Same formula was used to get other elements of A. Consequently, the Leontief

inverse was obtained by getting the inverse of the difference between the identity matrix

I, which is “11 x 11” and matrix A.

Part III

Appendix Tables

Table 1A Comparison of Total Output Multipliers for the Philippines

1985, 1988 & 1990

Sector Description 1985 1988 1990 Number Multiplier Rank Multiplier Rank Multiplier Rank

1 Agriculture_Fishery_and_Forestry 2.061 6 2.494 6 2.287 2 2 Mining_and_Quarrying 1.967 8 2.706 4 1.933 8 3 Manufacturing 1.772 10 2.992 2 2.154 5 4 Construction 2.426 2 2.892 3 2.229 3 5 Electricity_Gas_and_Water 2.007 7 2.377 8 1.921 9 6 Transport_Communication_and_Storage 2.284 3 2.481 7 2.084 6 7 Trade 1.937 9 2.226 9 1.939 7 8 Finance 2.182 5 2.226 9 1.861 10 9 Real_Estate 1.558 11 1.527 11 1.348 11 10 Private_Services 2.205 4 2.704 5 2.177 4 11 Government_Services 2.851 1 3.600 1 3.323 1

Table 2A

Comparison of Total Income Multipliers for the Philippines 1985, 1988 & 1990

Sector Description 1985 1988 1990 Number Multiplier Rank Multiplier Rank Multiplier Rank

1 Agriculture_Fishery_and_Forestry 0.493 3 0.532 2 0.361 2 2 Mining_and_Quarrying 0.351 8 0.446 6 0.189 6 3 Manufacturing 0.235 10 0.417 8 0.180 9 4 Construction 0.480 4 0.485 4 0.241 3 5 Electricity_Gas_and_Water 0.260 9 0.330 10 0.152 10 6 Transport_Communication_and_Storage 0.426 6 0.468 5 0.187 7 7 Trade 0.394 7 0.429 7 0.233 5 8 Finance 0.513 2 0.403 9 0.181 8 9 Real_Estate 0.189 11 0.126 11 0.048 11 10 Private_Services 0.455 5 0.487 3 0.235 4 11 Government_Services 0.936 1 1.072 1 0.792 1

Table 3A

Comparison of Total Employment Multipliers for the Philippines 1985 & 1988

Sector Description 1985 1988 Number Multiplier Rank Multiplier Rank

1 Agriculture_Fishery_and_Forestry 0.072 1 0.065 1 2 Mining_and_Quarrying 0.020 6 0.029 7 3 Manufacturing 0.016 7 0.036 4 4 Construction 0.030 5 0.036 4 5 Electricity_Gas_and_Water 0.015 9 0.022 8 6 Transport_Communication_and_Storage 0.031 4 0.038 3 7 Trade 0.033 3 0.036 4 8 Finance, Insurance, Real Estate 0.016 7 0.015 9 9 Private, Government Services 0.052 2 0.050 2

Figure 2

Trade Sector as Destination of Foreign Direct Investments (FDI) (In Percent)

Figure 1 Foreign Investments

(In dollars)