Our manufacturing handicap

After selling its product in our domestic market for over six decades, a major local manufacturer recently decided to cease production operations, and shift entirely to importing the product. It wasn’t an easy decision to make, but economic and business realities simply left the company no better option. Facing intense market price competition in the local market, it was costing the company significantly more to produce it here than simply importing it, even after import tariffs. I asked the company leaders if there’s really no way they could raise productivity and cut costs enough to match that of imports. Their negative answer boiled down to one word: scale.

Their overseas source produces the same product in facilities with a capacity several times that of their own plant here. Hence, they benefit from economies of scale, the phenomenon one might describe as “bigger is cheaper.” It’s the same reason why a small bakery producing 100 “pandesal” a day spends more to make one pandesal than a large one that produces 1,000. Why? The large firm can buy materials in bulk, hence more cheaply. Specialization of tasks can make its workers more productive. And fixed costs on building and equipment are spread out over more of the product (the shop and oven cost the same whether 100 or 1,000 pandesal are produced daily).

This is not an uncommon story in Philippine manufacturing. In 2020, Pilipinas Shell Petroleum Corp. shut down its oil refinery in Tabangao, Batangas, after nearly six decades of operation. Since 1962, Shell had been refining imported crude oil into gasoline, diesel, and other distillates there, but eventually found that it made more sense to simply import the finished products, rendering the refinery economically unviable. Shell’s much larger refinery in Singapore has a rated capacity five times that of the Batangas facility, and all things equal (and they are not!), economies of scale make it much cheaper to produce the fuels there than here. The pandemic finally triggered the decision to switch to importation, and its Batangas facility was converted into an import hub.

Such cases suggest to me that the only way a domestic manufacturer can hope to thrive and be price competitive is to produce at a scale comparable to its foreign counterparts, and that means well beyond what it could sell domestically. This is barring any other unique factors that might give a substantial cost advantage to being located here, such as cheaper or better labor, superior infrastructure, reliable governance, unusually generous incentives, or better access to raw materials/inputs. But we all know we’re in no position to credibly offer any of those except possibly the last, and that depends on the product (i.e., products made from primary goods like farm or mineral products we are abundant in). All told, a manufacturer must be export-oriented to warrant the scale it needs, if it is to compete and survive at all.

Herein lies the problematic situation that our peculiar economic history brought us to. Our country’s postwar industrial focus was import substitution, which was common among developing economies at the time. That entailed an inward-looking protectionist trade policy regime that makes imports more expensive via import tariffs, trade restrictions, or even government control. But the dynamic “Asian tigers” Hong Kong, Singapore, South Korea, and Taiwan as the “Gang of Four” in the first wave, then the second wave with Thailand, Malaysia, and Indonesia, soon felt the need to shift to export orientation. It became evident that import substitution could only take them so far, given limited domestic markets, and the only way to grow further and create even more jobs was to target the world market.

The first wave group began the shift in the 1960s to 70s, with the others following in the 1970s to 80s, intensifying it onward. “Shifting” involved a policy turnaround to initially, gradual, then more aggressive trade liberalization to face the competition and impel increased productivity and international competitiveness in their firms and farms. Key was ample corresponding support through public investments in needed infrastructure, and in research and development. They also directed credit to target export industries, and welcomed foreign investments in export enterprises via special economic zones and fiscal incentives. By the 1990s, our neighbors in the second wave had earned their place among the “NICs”—newly industrialized countries—to join the first four.

But we did not keep in step. We belatedly began the shift only by 1991, and only after seeing the others gain a significant head start. Still, inward-lookingness persisted into the 1990s and beyond. The boat had left us behind, earning us the unflattering appellation of “sick man of Asia” at worst, and “tiger cub” at best.