So much to gain from the AEC

Categories: JFC News

Date: 18 Jun 2014

Posted on June 17, 2014 08:16:25 PM

Shanaka Jay Peiris

LAST month’s column discussed the opportunities and challenges posed by ASEAN Economic Community (AEC) 2015 to the region in the run-up to the World Economic Forum (WEF) East Asia meetings in Manila. Now I will focus on AEC and the Philippines.

ASEAN’s potential is huge. If its 10 members were a single country, it would be the world’s third most populous (625 million), with a GDP of $2.4 trillion, trade of $2.5 trillion, and a high share of youth in its population. It would be the largest recipient of foreign direct investments, and among the top exporters of electronics, manufacturing products, palm oil, rubber, and one of the largest tourist destinations. ASEAN economic performance has been strong — annual growth has averaged 5% to 6% in the last 30 years — and its location and rapidly growing middle class can help turn the region into a trade hub for Asia.

The AEC can facilitate the Philippines’s further integration into the global economy and create conditions to foster economic development and inclusion. With 99% of goods of ASEAN origin having zero tariff, growing intra-ASEAN trade is already benefitting the Philippines. Tariffs on sensitive agricultural products (such as rice and sugar) remain elevated, however, and that will need to be phased out and entail some adjustment costs. In addition, non-tariff barriers remain elevated, including high logistics costs (due to inadequate infrastructure and regulatory issues), red tape, and lack of automation and modernization of customs procedures. On the other hand, some neighboring countries subsidize electricity, and this adversely affects the Philippines’ competitiveness, although that is changing with the gradual reduction in energy subsidies in the region.

Deeper regional integration can provide the impetus for reform and embed a “culture of competition.” The AEC, as well as other regional trade agreements, aim to reduce behind-the-border barriers to trade and investment. This can bring new transport infrastructure, transfer advanced technologies, and create new employment in traditional and new sectors.

But to partake in these gains, the Philippines will need to relax its restrictive limits on foreign ownership of equity — one of the most restrictive regimes in the region, according to the World Bank’s Investing Across Borders. The Philippines moved up 11 places in the WEF’s Global Competitiveness Index between 2011 and 2013, but it still ranks 59th out of 148 countries, well below Indonesia, due to substandard infrastructure. The Philippines also needs to improve its “soft” infrastructure, including regulatory reforms reducing red tape. Several large Filipino companies already operate within ASEAN and further afield, attesting to their ability to survive — even thrive — in a competitive marketplace.

Many of the benefits of closer integration depend on improved efficiency from economies of scale and greater inclusiveness. Micro-enterprises and small- and medium-size firms are important sources of Philippine GDP and employment, accounting for 30% and 70% of the total, respectively. Many of these informal service firms are prevented from expanding by the burden of red tape and excessive bureaucracy, which act as significant fixed costs for small firms. While the Philippines jumped 30 places in the World Bank’s 2014 Doing Business survey, starting a business and paying taxes remain particularly time consuming. Moreover, small firms generally do not receive the generous tax incentives granted to many larger firms. Expansion is also constrained by labor market rigidities, such as high firing costs and a prohibition on any firm ever signing a short-term contract with a worker with whom it has previously contracted, leading to high labor turnover and training costs. As a result of these high costs of operating in the formal sector, firms may opt to stay small to remain “below the radar” of the official sector and often rely on financial services provided by the informal sector, which tend to be costly.

Agri-business in rural areas where most of the poor are could cater to the growing regional market, particularly with the onset of peace in Mindanao. In addition to law and order issues of the past, the incomplete assignment of property rights has stunted investment, productivity and employment because land cannot be monetized. Granting individual — rather than collective — land ownership for small land parcels and rationalizing land use plans would allow land to be used as collateral for loans. In addition, improving supply chain links through farm-to-market roads and liberalizing inter-island shipping would reduce logistics costs, thereby opening up new markets and increasing the rate of return on farming.

China is in the process of rebalancing its growth drivers from external demand and related investment, toward a more consumption-based economy that could benefit ASEAN countries. Specifically, many ASEAN countries produce a wide variety of consumer goods. The tightening of the Chinese labor market can be expected to lead to outward investments as Chinese firms and multinationals establish new production bases abroad, especially in those ASEAN countries like the Philippines with rapidly growing work forces. Also, demand for ASEAN services, such as tourism and education, can be expected to increase. The Philippines can hope to benefit from these trends by further opening up to foreign direct investments and reducing the costs of doing business.



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