Powering the manufacturing sector

Weslene Uy, Senior Economic Research Analyst of the Stratbase ADR Institute

During the first quarter of 2018, the industry sector was the fastest expanding supply-side growth driver, improving by 7.9% year on year. Manufacturing, in particular, expanded by 8%, higher than the 7.7% growth recorded in the same period in 2017. Nikkei’s Purchasing Managers’ Index also reveals that the country continues to have among the fastest-growing manufacturing sectors in the region — alongside Vietnam — recovering in April after a slow start this year as manufacturers were adjusting to higher input prices.

In another piece of good news, foreign direct investment (FDI) inflows rose by 52.6% to $1.5 billion for the first two months of 2018, continuing the sustained investment inflows. FDI reached a record-high $10 billion in 2017 during Duterte’s first full-year in office, signifying a vote of confidence on the country’s prospects. From being a laggard in the region in terms of FDI inflows, the country has already overtaken Thailand and Malaysia last year. Of these investment inflows, a third goes into the manufacturing sector.

This is a promising turnaround — after several government efforts to revive the sector — from when manufacturing has languished in the 1990s and 2000s. Manufacturing’s spillover effects are well recognized, with its potential to create jobs and generate investments in other sectors.

The government has come up with a Comprehensive National Industrial Strategy in 2012 and upgraded it to the Inclusive Innovation Industrial Strategy (i3s) in 2017, to boost the sector and strengthen linkages in the global and domestic value chains.

By 2020, the sector is expected to increase its contribution to 30% of the Philippines’ GDP by 2020 from the current 23.6% and is set to increase its share of employment by 6.4 percentage points to 15%.

With the exodus of foreign firms from China due to rising labor costs, and as the latter is transitioning towards higher-value manufacturing, the Philippines must take advantage of this window of opportunity.

Although the manufacturing sector is expected to sustain growth for the year, deeply entrenched issues which have deterred foreign investors from coming in, such as high power costs, poor infrastructure, and restrictive foreign ownership rules, must be addressed.

LOWERING ENERGY PRICES

Recently, Meralco announced that it has lowered power rates by P0.5436 per kilowatt-hour (kwh) in May due to lower generation and transmission costs (the former makes up around half of Meralco’s tariff).

This means that customers consuming 200 kwh will see a P108.72 decrease in their electricity bills. This is, of course, a welcome but unexpected development, since the increased demand during the summer months typically push electricity prices upwards. Consumers, who have been burdened with higher commodity prices in the last few months, can breathe a temporary sigh of relief.

Over the long term, however, lower power prices have to be sustained.

If the Philippines is to maintain its strong growth momentum and shift towards its goal of becoming a high-income country by 2040, electricity consumption is expected to grow by 4.3% annually. The installed capacity may also have to double to service the increased demand in the next 25 years.

Unfortunately, the current capacity is inadequate for the projected growth in electricity demand. One of the culprits behind this is the red tape in approving new projects — an issue which also beleaguers players in other industries and cuts across all sectors.

Starting a new power plant, for example, requires over 150 permits, hurdling through at least 12 government agencies, and takes around three to five years for a facility to become operational. A study by Dr. Ramon Clarete finds that cutting down red tape can reduce power prices by as much as 7%. Lowering power costs will undoubtedly be a big boost for a country with the highest electricity prices in the region, after Singapore.

REVERSING PREMATURE DEINDUSTRIALIZATION

The Philippines is suffering from premature deindustrialization, a phenomenon documented by Harvard economist Dani Rodrik, that is typically exhibited in developing countries which become service-oriented economies without being properly immersed in industrialization. The Philippines is deindustrializing at lower levels of per capita income compared to developed countries. This means that the country’s opportunities in the sector are running out earlier and at much lower income levels.

In a study by the Energy Policy and Development Program (EPDP), the authors find that higher power prices speed up deindustrialization. The study finds that higher power prices are associated with a downward shift in the share of manufacturing gross value added (GVA) and with manufacturing employment shares peaking at substantially lower levels of per capita income and declining at faster rates, which indicates that power prices are linked with structural transformation.

High power prices also skew the industry towards less power-intensive manufacturing and more labor-intensive operations.

In contrast, Indonesia, which has lower and more stable power costs as a result of heavy subsidy by the government, has a higher manufacturing GVA driven by more power-intensive industries.

The government’s ambitious target to turn our manufacturing sector into an important growth driver might be difficult without lowering the cost of electricity.

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