2 Lessons on Regulatory Reform: The Philippines’ Experience

Laura Wallace
Published Date:
January 1999
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Florian Alburo

What I would like to do today is discuss what I consider to be the preconditions for successful regulatory reform, review some illustrative cases, and touch on some of the potential directions that would improve regulatory reform and the regulatory environment in developing countries.

Preconditions for Reform

There are a number of macroeconomic preconditions for a good regulatory environment. These include:

  • a more open economic stance,
  • trade liberalization,
  • privatization of state-owned enterprises, and
  • deregulation of markets.

It is easy to say, in rhetorical terms, that these are important but, in practical terms, what we have to understand is that each of these four preconditions themselves require preconditions, and that policymakers will have to devise appropriate mixes among them.

Going back to our list of preconditions then, in practical terms, this means that for a movement toward a more open economic stance, there must be a critical political constituency. Of course, that is not an easy task, and fortunately for economists and professors, that is not what we do, so I will not dwell on that.

For trade liberalization, it is not just a question of reducing tariffs or liberalizing imports, but also of what should be liberalized first, inputs or outputs? Which industries should be liberalized first, export-oriented or import-oriented? Theoretically, one can always say let us liberalize across-the-board, but that is easier said than done. Also, what should be the timing and sequencing? Should it be the capital account or the current account first? These are issues that are not only germane to academic discussions but also to political economy debates.

For privatization, preconditions include developing local capital markets and the pricing of initial public offerings of state-operated enterprises prior to their sale. For deregulation, preconditions might include ruling out extreme concentration of ownership or extreme concentration in markets, which then raises the issue of associated trade liberalization.

So each of the macroeconomic preconditions have preconditions themselves. That is already a tough agenda. Moreover, each implementation experience should lead to what I call cumulative lessons and more successful reforms. Then, too, the regulatory environment may require complementary discretion on the part of the bureaucracy, either in terms of facilitation or mandates from higher authorities.

Sample Cases

Let us take a look at what I consider to be three illustrative cases.

The first one involves the Philippines. It illustrates what I consider to be a cumulatively refined foreign investment law. The Philippines first passed a foreign investment law in 1946, and then continuously revised it—the result of cumulative lessons learned—all the way up until 1991 (see Box 1). The first law was targeted at promoting specific industries but by the time the final revision was made in 1991, the Philippines decided, instead, to use a negative foreign investment list. As long as an industry was not on the negative list, foreign investments could be made up to 100 percent. Fortunately, for political reasons, although that list could be used to protect industries, to date, none have been listed.

Box 1.Cumulatively Refined Foreign Investment Law in the Philippines

  • The 1946 Incentives Act (Republic Act or R.A. 35) provided for preferred allocation of foreign exchange resources while controlling profit remittances. The incentives were for “new and necessary industries,” which eventually became importsubstituting industries.
  • The 1967 law (R.A. 5186) created the Board of Investments and instituted an investments priorities plan for pioneer and nonpioneer industries.
  • The 1970 Export Incentives Act (R.A. 6135) provided separate incentives for nontraditional exports and an export-priorities plan.
  • The 1981 Omnibus Incentives Code (Presidential Decree or P.D. 1789) consolidated all previous incentives laws and harmonized provisions, that were eventually incorporated into a new investment incentives policy.
  • The 1987 Omnibus Incentives Code (Executive Order No. 226) further consolidated the incentives administered by other regulatory agencies (export processing zone authorities, tourism development incentives act, agricultural development incentives act).
  • The 1991 Foreign Investments Act created a foreign investment negative list allowing for 100 percent equity in areas not on the list, and requiring only a single registration with the Securities and Exchange Commission unless incentives are sought, in which case, registration with the Board of Investments is essential. To date, that list has remained empty.
  • The cumulative experience with investment laws finally led to a regulation in 1991 that is characterized by greater transparency and consistency.

In the 1991 law, the Philippines also altered the bureaucratic regulations. Previously, foreign investors had to register with both the Board of Investments and the Securities and Exchange Commission. In 1991 this was simplified so that foreign investors only had to register with the Securities and Exchange Commission and were notified that if they wanted investment incentives, they would have to contact another institution—the Board of Investments.

The second case highlights policy choices in trade liberalization and deregulation. Before developing countries embark on trade liberalization and deregulation, many industries and products are typically subject to a range of trade barriers, such as high tariffs, local content rules, quantitative restrictions, and licensing. A commitment to trade liberalization would ideally be neutral, but in practical terms, there are difficult choices to be made.

For example, should final products, intermediate products, or raw materials be liberalized first? What criteria should be used in determining sequencing, revenue generation and value-added, or employment? Which industries should be targeted, export-oriented or domestic-oriented industries?

It is very easy to find examples where these choices are important, and here I would like to cite the case of liberalizing the import of newsprint in the Philippines. Liberalization of newsprint in many countries requires choices because many of the inputs may be subject to restrictions. One problem arises from the fact that caustic soda, in many developing countries, is under some form of quantitative restriction and caustic soda is needed to whiten newsprint. That is why in developing countries, the newspapers are brownish, whereas in developed countries, they are normally white, quite white. Thus it is very difficult for newsprint industries—and downstream industries, such as publishing—to compete if the inputs are subject to restrictions.

Another problem arises from the fact that bunker fuel, in many countries, is also restricted. Bunker fuel is needed to run the machines at integrated pulp and paper factories, which are fuel intensive, and it is these factories that produce newsprint. Instead, the bunker fuel tends to go to certain select oil refinery companies.

Yet another problem stems from the fact that resins tend to fall under some form of quantitative restriction, and these resins are needed for plywood, one of the by-products of an integrated pulp and paper factory. That is why in the Philippines, when the government liberalized the import of newsprint, many of our plywood shipments had to be returned. Why were they returned? Because they warped. Why did they warp? Because they needed a lot of glue. Why did they lack a lot of glue? Because an ingredient of glue is resin, and if resins are very expensive, then manufacturers try to economize on glue.

Let me now turn to the third case—telecommunications in China. For a long time, foreign investment in China has been heavily restricted, especially in the telecommunications sector, with foreigners forbidden to invest in the operation or management of telecommunication networks. Yet recent regulatory guides for foreign investment in telecoms in China and the legal framework indicate greater liberalization, although as should become clear shortly, this is more an exercise in innovation than anything else.

The creation of Liantong (or Unicom) in 1994, as a cooperative structure of the ministry of railways, the ministry of electronics industry, the ministry of power, and 13 major stockholders, allowed it to offer mobile services, initially in four Chinese cities. This is a fascinating twist, because, in theory, as a corporation of the ministry of railways, Liantong must focus on improving telecommunications in railways, but its mandate has been interpreted to be wider than that. What has happened, then, is that Liantong competes directly with the ministry of post and communications, the dominant state operator, and the third-largest telecom operator, Jitong, which is owned by 26 state institutions.

The way things work is foreign investors conclude their deals directly with Liantong. They also circumvent the foreign investment prohibition by forming equity joint ventures with local firms to construct telecom networks, ostensibly as part of railway improvement—as exemplified by the deal between Liantong and Nippon Telegraph and Telephone International of Japan. Foreign investment returns are in the form of “return for management consultancy and maintenance service contracts.”

So, foreign investment modalities used in China include consultancy contracts to run telecom networks and are not considered to be joint ventures, which would require approval by a higher level of government. In addition, because any project exceeding $30 million in value would require approval at the national level, projects are split up so that they do not exceed the limit. That way, they simply need provincial approval, which goes through Liantong.

These three cases, therefore, show that efforts are being made to be more transparent: in an evolving Philippines foreign investment law; to the extent that countries wish to liberalize and deregulate, policymakers will have difficult choices to make; and finally, that there are innovative ways to circumvent bureaucratic regulations.

Potential Directions

So, how is a good regulatory environment fostered, a point that we will keep returning to in our discussions?

Let me suggest one avenue. In a regime of open economies, differing regulations among trading partners tend to reduce trade volume, compared with a situation where regulatory environments are consistent. The example that I want to give here is, of course, APEC. The economies in APEC realize that consistency is an important way to foster a good regulatory environment. Thus, what has happened is that they have focused more on the informal barriers to entry and trade than on the formal ones, and for the informal ones, consolidated reform programs have taken place among all the countries. Let me mention a few of them:

  • adoption and alignment of product standards to conform with international standards;
  • mutual recognition arrangements, so that qualified individuals can more easily move from one country to another;
  • compatible technical infrastructure development, so that support from official development assistance can go toward consistent laboratory and product certification standards; and
  • transparency of the remaining regulations.

The APEC countries know that regulatory reforms are vital now, since it is estimated that over the next 10 years, some one trillion dollars will be needed for infrastructure investment in the region—far higher than what will be available from domestic resources. This means capital inflows will need to be higher, especially in the areas of telecommunications, power, and roads. One way to encourage that is through reforms that range from improving the business climate (e.g., removal of foreign exchange controls, and sale or lease of private lands to foreigners) to improving the financing environment (e.g., liberalization of foreign banking operations, unified stock exchanges, and franchising regulations).

Of course, key to improving the investment climate is eliminating corruption, and it is on this matter that I would like to make my final point. There is a notion out there that corruption is endemic in many developing countries. Indeed, on Transparency International’s Corruption Perceptions Index, many Asian and African countries fall way, way below the number that is acceptable.

Some observers argue that one important result of regulatory reform is the elimination of corruption. But I think we have to be a bit careful here. Certainly, a more transparent regulatory environment reduces corruption. But corruption is a byproduct of many factors: asymmetrical information access, weak legal frameworks, and cultural characteristics. From a development perspective, rapid economic growth amidst an evolving legal and institutional framework invites corruption. From a cultural perspective, personal relations often dictate the manner of economic transactions as they take place in emerging markets.

The APEC region is trying to tackle the corruption issue, in part, by promoting an infrastructure facilitation network. It begins with the assumption that information is not accessible to all interested parties—say, a bidding process for an infrastructure project. Thus, the goal is to ensure that information becomes a public good. The network is also trying to create what is called “good offices”—a coterie of people who know the network in each country. And to the extent that they are the vehicle by which information is generated and made available, that would reduce the costs of doing business in different countries, in the sense that information does not become a basis for the appropriation of rents by select groups or institutions.

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