Toward a National Competition Policy for the Philippines Edited by Erlinda M

Toward a National Competition Policy for the Philippines edited by Erlinda M. Medalla

Philippine APEC Study Center Network

PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas Copyright 2002 by the Philippine APEC Study Center Network (PASCN) and the Philippine Institute for Development Studies (PIDS)

The findings, interpretations and conclusions in this volume are those of the authors and do not necessarily reflect those of PASCN and PIDS and other institutions associated with the PASCN project on competition policy. The publication of this volume was funded by PASCN and PIDS. The members of PASCN include: Asian Institute of Management, Ateneo de Manila University, Central Luzon State University, De La Salle University, Foreign Service Institute, Mindanao State University, Philippine Institute for Development Studies (Lead Agency and Secretariat), Silliman University, University of Asia and the Pacific, University of San Carlos, University of the Philippines, and Xavier University.

Please address all inquiries to: PHILIPPINE APEC STUDY CENTER NETWORK SECRETARIAT PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES NEDA sa Makati Building 106 Amorsolo St., Legaspi Village 1229 Makati City, Philippines Tel. no.: PASCN (63-2) 8939588, 8925817; PIDS (63-2) 8935705, 8924059 Fax no.: PASCN (63-2) 8939588; PIDS (63-2) 8939589, 8161091 E-mail: [email protected]; [email protected] URL: http://pascn.pids.gov.ph; http://www.pids.gov.ph

ISBN 971-564-052-4 RP 09-02-500

Cover and book design by Joel C. Lozare for Graphico Media, Inc. Typesetting and Layout by Mandy F. Javillonar for Graphico Media, Inc. TABLE OF CONTENTS

FOREWORD ...... xvii

CHAPTER 1 Overview and Integrative Report Erlinda M. Medalla Introduction...... 1 Objectives and Role of Competition Policy ...... 4 Implications and Findings from the Sector Studies ...... 9 Elements of a Rational Competition Policy for the Philippines and Recommendations for an Antitrust Legislation ...... 16 Concluding Remarks: Issues in Competition Policy and Other Considerations ...... 24 Bibliography...... 30

CHAPTER 2 The State of Competition in the Philippine Manufacturing Industry Rafaelita A. Mercado-Aldaba Abstract ...... 33 Introduction...... 34 Theoretical Underpinnings of Competition Policy ...... 35 Review of Literature...... 40 Assessment of the Overall Performance of the Manufacturing Sector Before and After Trade Policy Reforms ...... 44 Analysis of Industry Structure and Competition in the Manufacturing Sector ...... 49 Conclusions and Policy Recommendations ...... 59 Bibliography...... 61

CHAPTER 3 Of Cartels and Collusion: An Analysis of the Philippine Cement Industry Rafaelita A. Mercado-Aldaba Abstract ...... 65 Introduction...... 66 Basic Concepts and Theories ...... 67 An Overview of the Philippine Cement Industry ...... 71 Competition Analysis ...... 73 Conclusions and Policy Recommendations ...... 94 Bibliography...... 97 v CHAPTER 4 Competition Policy and the Philippine Downstream Oil Industry Peter Lee U Abstract ...... 99 Introduction...... 100 RA 8180 and Tatad vs. Viray ...... 111 Price Setting in Philippine Gasoline: Law of One Price or Collusion? ...... 121 To Exchange or Not To: A National Oil Exchange?...... 131 Deregulation Experiences and Lessons from Other Countries ...... 139 Summary and Conclusions ...... 149 Bibliography...... 150 Appendices ...... 152

CHAPTER 5 Competition in Philippine Telecommunications: A Survey of the Critical Issues Ramonette B. Serafica Abstract ...... 157 Introduction...... 158 The Role of Competition Policy in Philippine Telecommunications ...... 158 The Market Environment of Philippine Telecommunications...... 160 The Nature of Competition at the Local Level: Three (3) Cases ...... 167 Postliberalization: Issues and Concerns ...... 172 Threats to Competition ...... 176 Recommendations ...... 181 Bibliography...... 183 Appendices ...... 184

CHAPTER 6 The State of Competition and Market Structure of the Philippine Air Transport Industry Myrna S. Austria Abstract ...... 189 Introduction...... 190 Contestability of Markets: Its Applicability to the Air Transport Industry ...... 191 Regulatory Framework for International Air Services ...... 193 Policy and Regulatory Regimes of the Philippine Air Transport Industry ...... 201 vi Regulatory and Policy Regimes: Their Effects on the State of Competition and Market Structure ...... 206 The Role of CAB in a Deregulated Environment ...... 231 Implementing Guidelines for EO 219 ...... 231 Areas for Competition Policy ...... 236 Summary and Conclusions ...... 240 Bibliography...... 241 Appendices ...... 242

CHAPTER 7 Analysis of the State of Competition and Market Structure of the Banking and Insurance Sectors Melanie S. Milo Abstract ...... 253 Introduction...... 254 Regulatory Framework ...... 255 Trends in Market Structure and Performance ...... 276 Competition Policy Issues in the Financial Sector ...... 291 Some Conclusions ...... 302 Bibliography...... 303

CHAPTER 8 Government Policies and Regulations: Interface with Competition Policy Erlinda M. Medalla Abstract ...... 307 Introduction...... 308 Philippine Trade Policy and Competition ...... 309 Government Policies and Regulations and Competition Policy ...... 311 Other Government Policies and Their Interface with Competition Policy Objectives ...... 320 Summary and Conclusions ...... 324 Bibliography...... 325 Appendices ...... 327

CHAPTER 9 Recommendations for Philippine Antitrust Policy and Regulation Anthony R. A. Abad Abstract ...... 339 Introduction...... 340 Survey of Existing Antitrust Laws and Regulations in the Philippines ...... 342 vii Assessment of Antitrust Regulation in the Philippines ...... 357 Recommendations for a New Legal and Regulatory Framework ...... 362 Bibliography ...... 382 Appendices ...... 386

ABOUT THE AUTHORS ...... 403 ABOUT THE PUBLISHERS ...... 405

viii LIST OF FIGURES

CHAPTER 1 Figure 1. Decision Tree: Role of Competition Policy ...... 8 Figure 2. Decision Tree: Framework for Competition Policy ...... 18 Figure 3. Potential Outputs of a Working Competition Policy ...... 21

CHAPTER 3 Figure 1. Geographic Markets in the Philippine Cement Industry ...... 77 Figure 2. Average Market Shares ...... 79 Figure 3. Average Ex-Plant Prices ...... 87

CHAPTER 4 Figure 1. Flowchart of Petroleum Industry Production ...... 104 Figure 2. Schematic Diagram of Oil Recovery ...... 105 Figure 3. Market Share of Oil Companies...... 109 Figure 4. Historical Prices of Oil ...... 110 Figure 5. Simple Product Flow of the Philippine Petroleum Industry (downstream only and for retail) ...... 122 Figure 6. Positive Price Shock Case ...... 126 Figure 7. Game Matrix ...... 126 Figure 8. Game Matrix for Positive Crude Oil Price Shock ...... 127 Figure 9. Downward Price Shock Case ...... 129 Figure 10. Game Matrix for Negative Crude Oil Price Shock ...... 129 Figure 11. Game Matrix for Positive Crude Oil Price Shock ...... 129 Figure 12. Unleaded Gasoline and Diesel Price Buildup, August 2000, MOPS Based (in peso per liter) ...... 134 Figure 13. Welfare Analysis (of lower marginal cost) with NOEC ...... 137 Figure 14. A Bilateral Monopoly ...... 139 Figure 15. US Gasoline Distribution Structure ...... 143 Figure 16. Share of US Gasoline Retail Establishments ...... 144

CHAPTER 5 Figure 1. Fixed Lines Market Shares ...... 164 Figure 2. Cellular Mobile Market Shares, 1998 ...... 165 Figure 3. Interconnecting Carriers and Services ...... 173 ix CHAPTER 6 Figure 1. Average Fare by Airline per Sector, 1997-1999 (P) ...... 219 Figure 2. Market Share in Total Revenues of Airlines, 1995-1998 (%) ... 221 Figure 3. Domestic Passenger Traffic and Its Annual Growth Rate, 1990-1999 (%) ...... 223 Figure 4. Used Entitlements as a Percentage of Negotiated Entitlements, Philippines and Foreign Countries, 1996 (%) ...... 225 Figure 5. Distribution of International Passenger Traffic, to and from the Philippines, 1990-1999 (%) ...... 229 Figure 6. International Passenger Traffic, Philippines, 1990-1999 (%) ... 236 Figure 7. Tourist Arrivals, Philippines, 1990-1999 (%) ...... 237 Figure 8. Tourist Receipts, Philippines, 1990-1999 (%) ...... 238

CHAPTER 7 Figure 1. Assets of the Philippine Financial System, by Type of Institution, 1970-1999 (in billion P) ...... 277 Figure 2. Distribution of Commercial Bank Assets, by Type of Bank, 1980-2000Q1 (%) ...... 281 Figure 3. Measures of Commercial Bank Asset Concentration, 1980-2000Q1 ...... 282 Figure 4. Measures of Asset Concentration in the Insurance Industry, 1970-1998...... 290

x LIST OF TABLES

CHAPTER 2 Table 1. Empirical Evidence on Existing Barriers to Competition in Manufacturing ...... 43 Table 2. Effective Protection of Philippine Manufacturing Industries: 1983, 1988 and 1994 ...... 46 Table 3. Structure of Value Added (1985=100) ...... 47 Table 4. Structure of Employment ...... 48 Table 5. Sector Shares and Growth Rates: Philippines, Indonesia, Malaysia and Thailand ...... 49 Table 6. Distribution of Manufacturing Value Added ...... 50 Table 7. Average Annual Growth Rates of Selected Economic Indicators in the Manufacturing Sector ...... 51 Table 8. Capital Intensity, Capital Productivity and Labor Productivity in the Manufacturing Sector ...... 53 Table 9. Firm Size Distribution in Philippine Manufacturing: 1972, 1983, 1988, 1994 and 1995 (%) ...... 55 Table 10.1.Concentration Ratios and Performance Indicators Manufacturing Sector: 1988, 1994 and 1995 ...... 56 Table 10.2. Correlations Between Concentration and Industry Profitability ..... 57 Table 10.3. Estimates of the Concentration-Profits Relationship...... 57

CHAPTER 3 Table 1. Industry Ownership Structure Prior to the Asian Crisis ...... 74 Table 2. Ownership Structure After the Asian Crisis ...... 76 Table 3. Market Shares ...... 78 Table 4. Four-Firm Concentration (CR4) Levels and HHI ...... 80 Table 5a. Industry Price-Cost Margin ...... 81 Table 5b. Price-Cost Margin (PCM) by Firm ...... 82 Table 6. Cement Imports (in 40 kg bags)...... 83 Table 7. Average Prices, Excess Supply and Industry Capacity, 1990-1999 (In ‘000 40 kg bags) ...... 86 Table 8. Monthly Changes in Average Ex-Plant Prices (Jan-May 2000) ..... 88 Table 9. Average Production Cost per Bag ...... 90 Table 10. Economic Performance of the Cement Industry, 1996-2000 ...... 93 xi CHAPTER 4 Table 1. Oil Production (in barrels) – Philippines ...... 102 Table 2. Industry Retail Outlets ...... 103 Table 3. Players in the Downstream Oil Industry ...... 106 Table 4. Total Number of Gasoline Stations ...... 107 Table 5 New Player Gasoline Stations (as of December 31, 2001) ...... 108 Table 6. Market Share by Sector (%) ...... 109 Table 7. Thailand Service Station Growth ...... 142 Table 8. Oil Industry Service Station by Contractual Arrangement (as of May 2000) ...... 148

CHAPTER 5 Table 1. Number of Authorized Carriers ...... 161 Table 2. Scope of Services ...... 162 Table 3. Service Areas ...... 163 Table 4. Comparison of WTO Reference Paper vs. Philippine Commitment: Section on Competitive Safeguards ...... 177 Table 5. Comparison of WTO Reference Paper vs. Philippine Commitment: Section on Interconnection ...... 177

CHAPTER 6 Table 1. Size of Fleet, Type of Aircraft and Destinations Served, by Airline, 1999-2000...... 207 Table 2. Domestic Passenger Traffic, by Airline, 1994-1999 ...... 208 Table 3. Seat Capacity per Airline, 1990, 1994-1999 ...... 209 Table 4. Measure of the Degree of Effective Competition, Domestic Air Industry, 1996-1999 ...... 210 Table 5. Measure of the Degree of Domestic Competition, per Route, 1995-1999...... 211 Table 6. Number of Domestic Flights, per Route, per Week, per Airline, 1999-2000...... 213 Table 7. Market Share per Sector, per Airline, 1995-1999 (%) ...... 214 Table 8. Growth Rate of Domestic Passenger Traffic, per Airline, 1994-1999(%)...... 217 Table 9. Percentage Difference of Fares in Domestic Flights, 1997-1999 (%) ...... 220 Table 10. Real Growth Rate of Fares per Airline, by Major Sector, 1997-1999 (1990 prices) (%) ...... 220 Table 11. Revenue and Income, by Airline, 1995-1998 (P Million) ...... 222 Table 12. Measure of Degree of Competition, by Country, 1990-1999 ..... 227 xii Table 13. Market Concentration, Australia and Philippines (based on the Herfindahl-Hirschman index) ...... 228 Table 14. Market Share of Philippine Airlines (PAL) in International Passenger Traffic per Country of Destination, 1990-1999 (%) ...... 230 Table 15. International Passenger Traffic to and from the Philippines, by Airline, 1990-1999 ...... 232 Table 16. Top 30 Countries and Scheduled Air Carriers, 1988, 1996-1997 ...... 234 Table 17. Distribution of Tourists, by Major Country of Residence, Philippines,1991-1999(%) ...... 235

CHAPTER 7 Table 1. Authorized Activities According to Type of Bank...... 263 Table 2. Limits on Equity Investments of Commercial and Universal Banks ...... 265 Table 3. Minimum Capital Requirements for New and Existing Insurance Companies ...... 275 Table 4. Number of Financial Institutions, 1980-June 1999 ...... 279 Table 5. Number of Commercial Banks by Type of Bank, 1980-2000 Q1 ...... 279 Table 6. Mergers and Acquisitions in the Commercial Banking Sector, 1998-2000...... 280 Table 7. Ownership Structure of Private Domestic Banks: Percentage Share to Total Subscribed Capital, 1997/98..... 281 Table 8. Commercial Banks’ Average Spread and Rates of Return (%) ...... 287 Table 9. Share of the Insurance Sector in Total Financial and NBFIs Assets, 1980-1998 (%) ...... 287 Table 10. Distribution of Total Assets of the Insurance Sector, 1980-1998...... 288 Table 11. Number of Insurance Companies by Type of Insurer, 1980-1998...... 289

xiii LIST OF BOXES

CHAPTER 1 Box 1. Examples of Structural and Behavioral Barriers to Entry ...... 11

CHAPTER 2 Box 1. Structural, Behavioral and Regulatory Barriers to Entry ...... 36

CHAPTER 3 Box 1. Cases of Cement Cartels: Other Countries’ Experience ...... 85

CHAPTER 5 Box 1. How Regulatory Lag Can Be Anticompetitive...... 167 Box 2. Alternative Calling Plans Under Digitel ...... 168 Box 3. Example of Unreasonable Long Distance Charges...... 174

CHAPTER 6 Box 1. Freedoms of the Air ...... 194

xiv LIST OF APPENDICES

CHAPTER 4 Appendix 1. Undercutting Price Increases Profits in the Absence of Capacity Constraints ...... 152 Appendix 2. Best Price Response in the Absence of Capacity Constraints...... 153 Appendix 3. Selected Relevant Provisions of HB 8710 and HB 12052 ...... 154

CHAPTER 5 Appendix 1. Dominant Firm per Province ...... 184 Appendix 2. Relevant Provisions on Interconnection and Implementing Rules and Regulations of RA 7925 .. 187

CHAPTER 6 Appendix Table 1. List of Domestic Airports, by Type ...... 242 Appendix Table 2. Passenger Load Factor per Airline, by Sector, 1995-2000 (%) ...... 243 Appendix Table 3. Percentage Distribution of Seat Capacity, by Major Routes, by Airline, 1995-1999 (%) ...... 246 Appendix Table 4. Growth Rate of Passenger Traffic per Sector, per Airline, 1995-1999 (%) ...... 247 Appendix Table 5. Measure of Degree of Competition, per Points Served, 1990-1999 ...... 249 Appendix Table 6. PAL’s Major Destination Points,1990,1995,1999 .... 250 Appendix Table 7. Spearman Rank Correlation Test for Herfindahl-Hirschman Index and Market Share to Tourists Arrival, 1995 ...... 251 Appendix Table 8. Spearman Rank Correlation Test for Herfindahl-Hirschman Index and Market Share to Tourists Arrival, 1999 ...... 251

CHAPTER 8 Appendix Table 1. Antidumping Cases, 1985-1995 ...... 327 Appendix Table 2. Industry-Specific Policies and Regulation with Direct Impact on Competition ...... 328 Appendix Table 3. List of Some Government Corporations ...... 330 Appendix Table 4. Special Laws and Agencies Affecting Competition 331 Appendix Table 5. Doing Business in the Philippines: A Checklist ...... 333 xv Appendix Table 6.Requirements and Supporting Documents for Business Name Registration ...... 335 Appendix Table 7.Major Policies with Competition Policy Interface ...... 336

CHAPTER 9 Appendix 1. Philippine Laws and Regulations Affecting Competition ...... 386 Appendix 2. Draft Bills in Congress ...... 392 Appendix 3. Draft Bill for Discussion Purposes ...... 393

xvi FOREWORD

Competition policy is increasingly becoming an integral part of economic reform programs of developing economies like the Philippines. After more than three decades of protectionism and highly concentrated industries, the shift toward a more open economy through liberalization, deregulation and privatization has highlighted the role of competition policy in our economy. As we rely more on market mechanisms and less on government intervention to achieve economic progress, we need sound competition policy to ensure that the market works effectively and produces economic efficiency. Much of the world is already striving to deal with the impact of globalization where the integration of economies has broken down barriers to trade and opened wide the marketplace. But before we can even think about globalization, we need to craft our own domestic competition policy. In so doing, we will be able to enhance the competitive behavior and technical efficiency of our industries and make them better to compete with foreign firms. These will eventually make our economy more attractive to foreign investment. Moreover, since the Philippines has no established competition policy to date and its antitrust law is hardly implemented nor effective, the need for a national competition policy acquires even greater urgency. In this light, we hope that the invaluable wealth of information contained in this book will be useful to and considered by our national leaders, policymakers and industry players. Conducted by authorities in their fields of research, the studies in this Volume aim to give us a mold by which to shape an effective Philippine competition policy. On behalf of the PASCN, I would therefore like to thank and congratulate the authors of this book for their diligence and commitment in coming up with these studies that are not only highly instructive but timely. Finally, I also wish to acknowl- edge all those who made possible the publication of this book.

Mario B. Lamberte, Ph.D. President, PIDS and Lead Convenor, PASCN

xvii 1 CHAPTER

Overview and Integrative Report

Erlinda M. Medalla

“The natural effort of every individual to better his own condition ... is so powerful, that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of sur- mounting a hundred impertinent obstructions with which the folly of human laws too often encumbers its operation.” – Adam Smith

INTRODUCTION

uring the past decade, economic literature and policy discussions around the globe have been increasingly focused on competition policies. It is not that radically new concepts are being formulated. Rather, a growing need for new Dapproaches in competition policies is being felt because of its significance to international trade, which have become highlighted with the reduction of trade barriers worldwide. Although justification for competition policies is well founded in economic literature, there is a need to understand their implications more fully, brought about not just by what is happening in the global arena but even more importantly by various comprehensive policy reforms that have been undertaken by the government during the past decade or so. 2 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The series of competition policy studies undertaken under the Philippine APEC Study Center Network (PASCN) recognizes the need for a new perspective, a new way of understanding the issues and hopefully, a better approach to reforming economic policies. The reforms starting in the mid-1980s have done much to move the economy toward a more market-friendly policy environment. Trade reforms, banking reforms, foreign investment policy reforms, deregulation, privatization and the policy thrusts in general have explicitly and implicitly recognized the benefits from competition. However, it is time to consider what more should be done. The next step is to examine the state of competition in the Philippine economy and determine how competition policies that would help sustain and maximize benefits from the reforms could be formulated. The studies presented in this volume are envisioned to be just the first stage toward achieving a workable competition policy for the Philippines. Given the decades of protectionism and regulation prior to reforms, a culture of competition in the country has not fully evolved. And while there may be a general consensus that “competition is good,” there is vagueness in the minds of many and uncertainty about the need for competition policy and how competition should be enforced. As the government becomes more involved in the development process in general and markets in particular, such a need would become more acute. It is ironic that for a developing country with usually less perfect markets, there is a greater need for an effective competition policy to encourage better use of scarce resources but there is less recognition of this need. It is thus timely for policymakers to pause and consider how competition policy has affected, promoted, or hindered competition and to look more closely at what role it could play. It is not that the government has done nothing to foster competition. As earlier noted, the reforms the government has implemented starting in the mid-1980s have done much to enhance the state of competition in the different sectors of the economy, particularly in the liberalization and deregulation efforts. In the process, however, new problems emerge and the need for clearer “competition rules” becomes more apparent. This is especially true in the case of specific industry regulations. Moreover, while there is a proliferation of laws governing competition, there appears to be a lack of consistent, comprehensive, and rational competition policy. In short, the Philippines has undertaken major reforms in what could be considered the first layer of competition policy: trade reforms. It has also implemented steps in what could be considered the second layer of competition policy—deregulation—but a lot more needs to be done with respect to how to move it a step further and develop more rational “competition rules.” Finally, the government, must, sooner or later, decide to what extent it wishes to implement what could be considered the third layer of competition policy, the core competition policy that deals directly with the anticompetitive behavior of firms—a working antitrust law. Hope- fully, the studies in this volume would help shed some light on what needs to be done further. OVERVIEW AND INTEGRATIVE REPORT 3

This volume contains nine chapters. The next six chapters present the respective studies on the state of competition for six selected sectors. Chapter 2 provides an overview of the manufacturing sector; Chapters 3 and 4, respectively, cover two specific manufacturing industries—cement and oil; Chapters 5 and 6, two utilities sectors—the telecommunications and air transport industries; and Chapter 7, the financial sector. The choice of industries has been guided mainly by where competition policy appears to be most crucial. The main objective of these studies is to assess the state of competition in the specific sector. In this regard, the studies attempt to provide some measures on how much competition exists. For most of the studies, this means looking at certain measures of concentration and profitability, and examining price movements to support the findings. For others, it was enough to look at the number of players involved, especially how this has changed over the years. The sector studies also attempt to examine the regulatory framework, if any is involved and how, the reforms undertaken, and some indication of the impact of these reforms. Knowing how government policy itself could affect competition, Chapter 8 examines the major government policies and the interface with competition policy. The chapter aims to clarify what important trade-offs may exist and how and possibly when conflicts between government policies and competition policy objectives arise. Finally, Chapter 9 reviews the existing antitrust laws, how effective and adequate these have been and examine the bills that have been proposed. This particular chapter provides the overview and integration and would also serve as the summary and conclusion of these various studies. The ideas and concepts set forth in this paper are not meant to be novel, as indeed, the economic basis for competition policies has long been well established. The main objective is to clarify the issues and formulate the framework for a workable competition policy for the Philippines. To set the framework for discussion, the next section briefly reviews what defines a competitive market, the benefits from competition, and the role and objectives of competition policy. The following section attempts to assess the state of competition in the Philippines to have a better understanding of what needs to be done further. To do this, it first looks briefly at the factors affecting the state of competition and then discusses the major findings from the sector studies. The completed sector studies include an overview of the manufacturing sector, cement and the downstream oil industries, two utilities sectors—telecommunications and air transport industries, and the financial sector. The paper then infers in the next section what the important elements are of competition policy for the Philippines and proposes recommendations for an antitrust legislation. A brief assessment of existing laws and proposed bills is also provided. Finally, in the conclusion, the issues that confront competition policy and other important considerations in formulating and implementing a workable competition policy for the Philippines are addressed. 4 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

OBJECTIVES AND ROLE OF COMPETITION POLICY

Almost everyone has a concept of what is competition. When one thinks of competition, one envisions a number of sellers/producers competing among each other to sell the most products to the most number of consumers. Quoting from the World Bank/OECD glossary, competition is: “a situation in a market in which firms or sellers independently strive for the patronage of buyers in order to achieve a particular business objective, e. g., profits, sales and/or market share. Competition in this context is often equated with rivalry. Competitive rivalry between firms can occur when there are two firms or many firms. This rivalry may take place in terms of price, quality, service or combinations of these and other factors which customers may value,” or

“the process by which economic agents, acting independently in a market, limit each other’s ability to control the conditions prevailing in the market.”

Such a competitive situation may also be effected by “market contestability.” That is, competition comes not only from actual firms or sellers already in the market but also from firms or sellers that could enter and “contest” the market. In other words, when the market is contestable, the threat of entry is enough to provide competition. Monopolists and oligopolists would behave like “perfect” competitors when faced with threat of new entrants into the market (Baumol and Willig 1981). What does such a competitive setting accomplish? Why is competition desirable? Or, conversely, what is objectionable about a noncompetitive market setting? If there is competition, whether coming from existing rival firms or from the threat of new entrants into the market, the seller must make sure that he produces the best quality products at the least cost and sell his product at the price dictated by the market. Otherwise, he loses his clientele and his market share to some other seller who could do better. In other words, the producer/supplier has no “market power.”1 That is, he cannot manipulate prices and extract excess profits (rents). And (as former Tariff Commissioner Abad puts it), he “profits with honor.” The end result is optimized welfare for all.

______

1 This is the ability of the firm to dictate prices and the quantity supplied. In the case of a monopoly, the firm’s market power, or how much it can actually increase prices, depends on how inelastic the demand is for the product. In quantitative terms, this market power is measured by the inverse of the elasticity of demand. In a competitive situation, individual firms face perfectly elastic demand. That is, demand elasticity approaches infinity, and individual firms would have no market power. OVERVIEW AND INTEGRATIVE REPORT 5

In contrast, the absence of competition (or market contestability) gives the producer/supplier some market power. He can limit the quantity supplied and set prices (at more than competitive level) that would allow him to enjoy rents, at the expense of consumers. He would then have maximized his profits while consumers would be enjoying lower consumer surplus. The end result, this time, is sub-optimal output (at higher prices) and lower overall welfare. There is perhaps some simplification involved here. For example, some would argue that there are cases/industries where excess profits are necessary to encourage reinvestments and innovation. The question is how real and prevalent these may be.2 In practice, quite the opposite is more likely to happen. Without the pressures of competition, firms can become complacent and resistant to new and better ways of doing things because there is enough uncontested profit to go around. In any case, the benefits from competition are easy to comprehend. In the sim- plest terms, competition promotes efficiency. It promotes efficiency not only in terms of producing more with less (technical efficiency) but also in terms of inducing better resource allocation (allocative efficiency). Allocative efficiency in a competitive setting is encouraged because producers and investors receive the correct market price signals that induce them to invest where there are highest returns. In this sense, the presence of competition is almost synonymous with an efficient functioning of markets. Competition acts as an efficient market regulator that induces production and consumption at optimal levels and at least costs. As such, the highest overall welfare is made possible as reflected in wider consumer choices, lower prices, and better quality of products.3 But perhaps even more important are the dynamic gains from innovation that competition fosters and the flexibility that it develops, on the whole enabling the economy to cope better with the ever-changing environment. Aside from these direct benefits, another important and positive implication of competition is on equity. Competition, by reducing, if not eliminating, the economic power of certain sectors and providing the best product for the best price, intrinsically advances equity objectives. The problem is that, a firm, if it could, would rather avoid competition. In other words, consistent with its profit-maximizing objective, a firm has an incentive to try to gain some market power and exercise some control on how much and at what price to sell. Such behavior is still consistent with the competitive process if it does so by constantly trying to become more efficient. But given enough latitude, it may also ______

2 If there are indeed such cases, then these should be given due allowance and consideration in the enforcement of a competition policy. This may complicate its administration, but if clear efficiency gains can be demonstrated, then such cases could be accommodated by a competition policy, whose main objective is efficiency. This is expounded on later in the paper. 3 Of course, there are cases where “unregulated” competition may not yield optimum welfare…that in certain cases, the market would, left to itself, result in loss in efficiency. This is elaborated on in the subsequent discussions. 6 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES attempt to somehow erect barriers to entry, collude with other firms by entering into some form of agreement or engaging in other anticompetitive activities. In addition, aside from such tendency of a firm to skirt competition, there are other factors that could limit competition, such as the presence of structural barriers to entry of firms. The point is, in reality, most industries may not entirely possess the characteristics of a perfectly competitive model.4 Thankfully, in practice, there need not be a completely perfect competition for the benefits to be realized. There need only be “effective” competition. Nonetheless, something even less than effective competition could tend to occur. Hence, the government may still need to implement policy that would encourage effective competition, or at least make the market more contestable. Of course, increasing competition may not always be enough to ensure that the market would be able to perform its role of allocating resources efficiently. There are instances of genuine market failures that may require some limitation in competition—when more competition could even cause inefficiencies. In addition, some “rules” or regulation of the market (competition rules) may be needed to mimic the competitive process that the market fails to bring about. To illustrate, the most notable of these cases of market failures is the so-called natural monopoly. In such a case, the market may be too small for more than one firm to viably service the entire market. Allowing another firm to be established only implies duplication and waste of scarce resources. At the same time, such monopoly may be an “essential facility” that is “essential” for the survival of rival firms using the facility. Hence, “competition rules” on access are necessary to assist the market and make up for its lack. There are also cases when seemingly anticompetitive setups (high concentration, mergers and acquisitions leading to few firms in the market) have procompetitive effects (efficiency gains), e.g., where are there are economies of scope, synergies, and transaction cost economies. These are discussed more fully in the next chapter. In short, competition is not the end in itself. Instead, competition policy should be one that promotes competition as long as it encourages efficiency and growth. In addition, whenever possible, competition policy should also be made consistent with social objectives. These principles are, of course, easier said than actually practiced. Different objectives could lead to conflicts and the resulting trade-offs are often difficult to resolve. These considerations suggest what the primary role of competition policy should be—to safeguard, protect and promote competition and the competitive process and ensure that the market is able to function effectively and bring about economic efficiency. While in many instances, this would simply entail making the market contestable by easing entry of new firms, there would be cases where the market ______

4 The main characteristic is the existence of many firms and/or open entry and exit of firms. OVERVIEW AND INTEGRATIVE REPORT 7 completely fails and more would be required from competition policy. Specifically, this may mean a need for additional competition rules to assist the market in bringing about the highest welfare. Hence, competition policy is not necessarily a laissez faire policy. It is about ensuring that the market works properly. In sum, the primary task of competition policy is two-fold: (1) to make sure that no entity would have market power it can abuse and (2) where necessary, to implement competition rules that would emulate the competitive process and make up for the market’s lack. As such, competition policy would, first of all, attempt to make the market as contestable as possible. At the same time, it should be able to disallow naked restraints of trade and discipline firms when such acts are committed. Where market power is inherent (in the structure), enforcement of competition policy should effectively strip the owner of such market power the ability to use (abuse) it. In this regard, this may require punishing anticompetitive acts with appropriate sanctions and/or enforcing competition rules to guide the market. There are several steps involved that are implied in carrying out this task. The first is determining whether or not there is any firm (or concerted group of firms) in the market that has market power. If yes, the next step is to find out how it has come to possess such market power. Has it done so by becoming more efficient? Then, this would not pose a problem and is intrinsically part of the competitive process. If the firm gained that market power by deliberately setting out to prevent other firms from entering the market other than by becoming more efficient (behavioral barriers to entry), then it is committing exclusionary abuse which competition policy (through an antitrust law) should disallow. If market power arises from structural factors, is this due to government policy or is it due to the inherent structure of the industry?5 If the former, are there defensible reasons for the government policy or should reforms be made? If the problem is structural, is government regulation required to enforce competition rules? Are these “rules” appropriate? Then, the next step is to determine whether or not the firm “abuses” that market power and how (exploitative abuse). (The same goes for those who have successfully and consciously erected barriers to entry.) And the final step is to determine the best way to prevent the firm from committing exploitative abuse of such market power. (See Figure 1 for the diagrammatical presentation of these steps.) Two general types of anticompetitive behavior are distinguished here. The first is the act of the firm itself (or group of firms) to exclude potential firms from entering the market by means other than becoming more efficient. This is referred to as exclusionary abuse. Examples of such exclusionary abuse include: predatory pricing, arrangement to divide the market, unjustly raising rival’s costs, and unjustified refusal to deal with other firms. The second type of anticompetitive behavior mentioned above is exploitative abuse. This refers to actual abuse of market power, mani- ______

5 The different types of barriers to entry are discussed further in the next section. 8 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Figure 1. Decision Tree: Role of Competition Policy

fested in setting prices above competitive levels and limiting supply. A prime example of exploitative abuse is a cartel agreement to fix prices and/or to limit levels of outputs. As always, the primary objective of competition policy is increased efficiency and overall welfare. Where increased competition could, in certain cases, lead to decreased efficiency (as in the cases of genuine market failure described above and in the next chapter), exceptions should clearly be made and limitations in competition allowed. Also, there could be instances where competition could give way to a more urgent social objective if necessary. For example, certain social goods could be provided to disadvantaged groups at less than competitive prices. In other words, competition policy should give allowance for seemingly anticompetitive actions if there are clear public welfare grounds. Hence, although competition policies may not be explicitly aimed at promoting other social objectives, the overriding and underlying goal remains to be national welfare. And to avoid some of the complications involved, what constitutes “public interests” should be made clear beforehand. The above discussion elaborated on the concept of competition and the role and objectives of competition policy. Before proceeding further with the discussion, it is time to construct a more formal definition of competition policy to be clear on what it specifically refers to. Competition, competition policy and antitrust policy are the key terms used in the paper. For the purposes of this paper, we use antitrust policy and antitrust law interchangeably to refer to the policy and legal framework that deals directly with anticompetitive behavior of firms. Competition law is also considered almost synonymous with antitrust law. What could make it different from antitrust law is if the law also provides a wider mandate for the tasked government agency to OVERVIEW AND INTEGRATIVE REPORT 9 carry out competition policy over and above disciplining anticompetitive firm behavior. What this could be would be made clearer when the elements of competition policy is discussed later on in this paper. Finally, we come to competition policy. In its “Concept Paper on Competition Law and Policy,” the Tariff Commission6 defines competition policy as pertaining to “all laws, government policies and regulations aimed at establishing competition and, having done so, maintaining the same. It includes measures aimed at promoting, advancing and ensuring competitive market conditions by the removal of control, as well as redressing anti-competitive results, of public and private restrictive practices.” The Australia’s Hilmer Report as well as Patalinghug (1997) narrows down the basic elements of an effective competition policy to six: (a) policy toward a monopoly, (b) policy toward mergers, (c) policy toward restrictive and anticompetitive practice, (d) policy toward state entry barriers, and (e) policy toward consumer protection. This, however, would prematurely limit the scope of competition policy that this study aims to look into. The problem with either definition is that it only describes what competition policy could refer to. As such, neither can pin down what it is. But this is understandable. For one, competition policy is not always as explicit as, for example, investment policy, agricultural policy, housing policy, etc. and there is no distinct body whose main mandate is to promote competition. Second is the applicability of competition policy in almost any economic endeavor. As long as there are markets to speak of, there is a role for competition policy (albeit, in many cases, a noninterven- tionist one). What is important to make clear at this point is that the Philippines presently has no institutionalized national competition policy. Competition policy may be inherent in so many of the country’s policy thrust, but it has no formalized competition policy. And this is in spite of having an antitrust law for the simple reason that is lame and inoperative.

IMPLICATIONS AND FINDINGS FROM THE SECTOR STUDIES

While the Philippines may have no institutionalized national competition policy as earlier suggested, there have been important reforms that have contributed to the enhancement of the state of competition in the Philippines. To have a better understanding of what needs to be done further, it is important to examine where we are and the state of competition in the various sectors of the economy. Toward this end, this section examines and summarizes the findings from the sector studies (refer to the ______

6 Planning and Project Coordination Division (April 7, 1999). 10 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES relevant chapters in this volume for more details: Chapter 2 on overview of the manufacturing sector by Ms. Rafaelita Aldaba, Chapter 3 on the cement industry also by Ms. Aldaba, Chapter 4 on the Philippine downstream oil industry by Dr. Peter Lee U, Chapter 5 on telecommunications by Dr. Ramonette Serafica, Chapter 6 on the air transport industry by Dr. Myrna Austria, and Chapter 7 on the financial sector by Dr. Melanie Milo). There are many factors that could affect the state of competition in any industry. As such, before proceeding with the discussion of relevant findings from these studies, it would help to look again at these factors. As pointed out earlier in the steps involved in implementing the task of competition policy, it is necessary to identify where the market power (if it exists) is coming from. The first factor to consider is the existence of trade barriers. There is no question that the kind of trade regime adopted by the country affects the state of competition. By simply allowing imports to come in, some barriers to entry are broken down, and the market becomes more contestable. Hence, with its widespread impact on the whole economy, trade policy could act as a major competition policy tool. Indeed, this is deemed the first layer of competition policy to be implemented. The barriers to entry of new firms constitute the second major factor affecting the state of competition. These barriers could be either behavioral or structural (see Box 1). The former includes attempts of firms to shut out new players. If the firm does this by increasing its efficiency, then this is still consistent with the competitive process. However, if exclusion is done through the use of naked restraints of trade, then this represents anticompetitive behavior that competition policy should prevent. Structural barriers are those barriers inherent in the nature of the industry. Whether the implied market power is actually abused or not is what matters, and the question is how competition policy is able to deal with potential abuse of market power. There are other market failures and rigidities that may lead to limitations on competition. Again, this may not be necessarily bad for the economy if there are efficiency gains entailed. Examples include cases where there are economies of scope, synergies, and transactions cost economies. In a class of its own is the case of natural monopolies, where huge capital requirements make duplication unviable and socially wasteful. These different factors have different impacts, and hence, have different implications on what kind of competition policy action is needed. Anticompetitive behavioral barriers require sanctions from competition policy. Others require allowing anticompetitive setups if there are efficiency gains involved. Still others require even more, e.g., the need to enforce competition rules to make up for the failure of the market to perform its price allocation function properly. Such cases of market failures are those that have been considered as the justification for government regulation of an industry. This leads us to the last type of factors affecting the state of competition—those that arise from government policy. OVERVIEW AND INTEGRATIVE REPORT 11

Box 1. Examples of Structural and Behavioral Barriers to Entry

A. MAJOR SOURCES OF STRUCTURAL BARRIERS TO ENTRY 1. Sunk costs These are investments into the market that would not have any use or value if withdrawn from it. Thus new firms would think twice before entering the market if such costs are high relative to the expected returns. Sunk costs could come from large fixed costs, startup losses, physical and human investments that are specific to the market, “soft” assets such as huge advertising costs to establish brand names and others. 2. Absolute cost advantage Incumbent firms could have absolute cost advantage, e.g., arising from steep learning curb, prior access to a natural resource, some government policy like direct subsidies, etc. 3. Large capital requirements This could also be due to sunk costs or imperfection in the capital market that limit the ability of new entrants to come up with the required capital at similar costs to the incumbent. 4. Network industries These are where competing firms share the same critical facilities. Incumbent firms may be able to deny new entrants access to the common facility.

B. BEHAVIORAL BARRIERS TO ENTRY 1. Predatory pricing This is where the incumbent firm temporarily sells at a price below cost to drive out new entrants. There is some debate about how effective this is in discouraging new entrants since it may be unsustainable and not a very rational behavior (McGee 1958). 2. Excess capacity This is an attempt to demonstrate that the incumbent can maintain the pre-entry level of output. 3. Product differentiation and advertising This is when “first-mover” advantage is perceived. This is possible with established brand loyalty and some “inertia” in consumer tastes. (The result, however, could be procompetitive when demand actually expands. The incumbent might itself try to fill in the differentiated products and maintain it even if it is unprofitable to hold on to some market power, but as in predatory and limit pricing, this could be unsustainable). 4. Horizontal restraints Horizontal relationships, whether through mergers and acquisitions or some horizontal agreements, would increase the market share and market power of the firm/s involved. Some horizontal restraints or agreements could benefit the firms because of efficiency gains from the arrangement and would therefore have procompetitive effects. However, there could be horizontal agreements with anticompetitive effects. Examples include a. Cartel agreements to fix prices above competitive levels and/or to limit levels of outputs b. Bid-rigging or collusion-setting prices at auctions c. Arrangements to divide the market (by territory, size, customer, etc.). 5. Vertical restraints Vertical relationship between firms may be able to discourage entry into one or some stage of production. This could take the following forms: a. Foreclosure and exclusion b. Raising rival’s costs Contracts such as exclusive dealing, tie-ins (sale of one product on condition of purchase of another), etc. 12 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

One set of such government policies is entwined with structural factors and market failure: industry regulations. These industry regulations are essentially a response to a lack of competitive forces. The question is whether, indeed, the government regulation is doing what it is supposed to do, that is, make up for the market’s failure in performing its proper role of determining the optimum levels of production and consumption. Are the right competition rules being applied? The other government policies, on the other hand, may have other social objectives that may nonetheless impact negatively on competition. Such could cover a wide array of government policies. Nonetheless, no matter how essential the stated objectives of the policy are, if it seriously conflicts with competition policy, there is enough reason to question if the policy indeed serves national welfare. This does not presume that competition policy objectives are superior. Rather, it is always wise to weigh the possible trade-offs arising from any policy: the losses, if there are, from limited competition and the foreseen benefits from the policy (see Medalla, this volume, on the interface between competition policy and other government policies.) As such, the PASCN conducted studies on the major utility sectors: telecommunications, air transport, power, and shipping. The other industry studies hopefully would provide a better understanding of the other sectors of the economy, covering an overview of the manufacturing sector, the cement industry, and the downstream oil industry in particular, and the special case of the financial sector. Past studies on the manufacturing sector have consistently characterized the manufacturing sector as highly concentrated. Most notably, the Barriers to Entry Study conducted by Lamberte et al. (1992) confirmed the presence of high concentration in Philippine industries, which they attributed to uncontestable markets in these industries. Aldaba (this volume) looks at what has happened to the level of concentration in the manufacturing sector during the more recent years, where substantial trade reforms have been implemented. At first glance, the results look alarming. The estimates show that the manufacturing sector is still indeed highly concentrated with roughly two-thirds of the manufacturing industry having concentration ratios ranging from 70 to 100 percent. On the average, 73.6 percent of value-added were from the top four firms in each manufacturing subsector. Subsectors with high level of concentration are mostly intermediate and capital goods such as petroleum refineries, glass and glass products, industrial chemicals, pottery, china and earthenware, petroleum and coal products, rubber products, other nonmetallic mineral, paper and paper products, professional and scientific equipment, nonferrous metal products, transport equipment, iron and steel, machinery except electrical, textiles, other chemicals (a borderline case), and fabricated metal products. Consumer goods like tobacco, food manufacturing, and food processing also belong to the high concentration group. Price-cost margins were estimated as a rough measure of profitability. On the average, the manufacturing industry posted a price-cost margin of 30 percent in 1988. This increased to 34 percent in 1994 and to 36 percent in 1995. A combination of high OVERVIEW AND INTEGRATIVE REPORT 13 price-cost margins and high concentration ratios tend to suggest that some monopoly rents are being incurred. A positive correlation between concentration and profitability in Philippine manufacturing is noted by Aldaba. She finds two different possible interpretations of the results. First, she argues that it is possible that industrial concentration would foster collusion and hence, monopoly pricing (structuralist view). On the other hand, following the efficiency market hypothesis, it could also very well be the case that superior firms in an industry that make a product or cost breakthrough will gain market share, causing industry concentration to increase. Broadly interpreted, the efficient market hypothesis states that markets are workably competitive and that the market structure reflects differential efficiency, not strategic behavior. Dominant firms owe their position to superior performance, not to strategic behavior or the history of entry into the industry, and profits are simply the rents that accrue to superior technology (Stigler 1968 and Demsetz 1973 as cited in Gilbert 1990). In view of the ongoing structural reforms arising mainly from trade liberalization at the time, the efficiency market hypothesis appears the more likely explanation in many cases. This is supported by the findings of the various PIDS studies on the impact of trade reforms (e.g., Medalla et al. 1996; Pineda 1997; Medalla 1998), which noted not only the improved competitiveness of the manufacturing sector as indicated by the reduction in the domestic resource cost ratio but also the generally increasing share in the value-added of those firms that had improved competitiveness. Not that the structuralist view would not apply in some cases. There would be sectors where high concentration would allow and even encourage collusion, exploitative and exclusionary abuses. Nonetheless, what this means is that the high concentration ratios, in the presence of trade liberalization, is not as alarming as it appears. Indeed, this could be the logical result of restructuring arising from trade reforms, where inefficient firms contract and efficient firms expand. What is more important is that markets are made more contestable under a more liberal trade regime. Still, even in a liberalized environment, the efficiency of markets is not always guaranteed (World Bank and OECD 1998). While trade liberalization promotes competition in domestic markets, there exist various impediments that can dilute the procompetitive effects of import competition. For example, if the local distribution channels are somehow tied up with local producers (e.g., through vertical integration or some vertical agreement like exclusive dealing), then the impact of trade liberalization may be limited (especially if substantial sunk costs are involved in putting up another distribution channel). Furthermore, there could be huge transport costs involved that could make certain commodities almost nontradable and the reduction in trade policy barrier would not be important. Finally, there might still be other nontariff barriers involved, which could endow the domestic firm some market power. This applies, for example, to commodities 14 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES covered by local manufacturing programs that still receive higher tariff protection. The antidumping threat could also pose significant barriers in certain cases. The results highlight the need for a working competition policy, especially if we wish to maximize the benefits from structural reforms already undertaken. More details are found in the Aldaba study in this volume. While the discussion provides an overview of the state of competition in manufacturing, a lot of variation that is important to examine is hidden by simply looking at manufacturing at such aggregated level. Thus, more specific cases need to be studied. Two such manufacturing studies look separately at the cement industry and the downstream oil industry. Cement and oil industries are aptly suitable for comparison. Both produce homogeneous products. Both are relatively more capital intensive, dominated by a few large firms, and are popular suspects for cartel behavior. Nonetheless, despite these strong similarities, the findings differ. There is evidence of collusion, whether tacit or not, in the case of cement but no definite findings for the oil industry. The former is based on the finding of widely differing manufacturing costs in the presence of harmonious movements in prices and very low capacity utilization. Aldaba concludes that such observed behavior is inconsistent with competitive behavior and could only be explained within a framework of some coordination, tacit or otherwise. Peter Lee U (this volume), on the other hand, offers explanation for the apparently synchronized pricing behavior of oil companies that does not imply collusion. Rather, the behavior had to do more with maximizing profits in the short run due to changes in crude oil prices. The thing is, whether or not collusion could be proven in any of these cases, nothing can really be done under the existing antitrust law whose penal provision requires heavy burden of proof that is almost impossible to obtain under the present administrative constraints. Meanwhile, what happens is a lot of lobbying from different sides, making the issues more political than it should be. If there were an effective competition law, the issues would have been more objectively analyzed and resolved. There would be no need to even think about a national oil exchange. The studies on utilities, on the other hand, show the complexities of industry regulation. The sectors covered all involved essential (bottleneck) facilities, which justify the need for the industry regulation. In general, the studies show that significant reforms have been implemented (or will be implemented in the case of the power sector) in terms of liberalization and deregulation, which have led to the introduction of greater competition and resulted in substantial benefits. At the same time, a number of questions remain and new challenges and issues are created requiring new approaches to sustaining these benefits. Unbundling the services to separate segments that should be subject to greater competition is among the important parts of the reforms that should be sustained. Another key area for improvement is formulating a clear policy on access. Another important question that should further be looked into is the use of price/ rate fixing itself as part of the regulatory framework. A general rule applicable to OVERVIEW AND INTEGRATIVE REPORT 15 utilities is the rate of return to base regulation that limits returns to 12 percent. In addition, some product (service) price setting is enforced. For example, in telecommunications, end-user rates are set by the National Telecommunications Commission (NTC). Price setting is also enforced in the power and transportation sectors. At the outset, price fixing appears to be a logical policy handle of the regulator, especially since there is presumption of market failure in the industry being regulated. Where competition as market regulator fails, the ultimate impact is in prices and it seems reasonable that this is where the regulator takes over. Price fixing is also very politically appealing. However, as often experienced in many countries, government price fixing often creates more problems than it solves. A major reason is information problem. It is difficult to predict demand and supply. Data on costs are difficult to come by. Sometimes, the problem is the point of price of intervention. Take the case of telecommunications. End-user price (price paid by consumers) is set by NTC but interconnecting carriers are allowed to negotiate access charges between them (intermediate price). A firm (the one enjoying network externalities) can effect a price squeeze in its effort to gain market power before the regulator can step in. One can thus question if it would be better for the regulator to intervene at the intermediate level and deregulate end-user price where enough competition exists. This would also lower the cost of negotiation. Just imagine the costs involved with N carriers negotiating bilaterally per product (service) for M types of products. Another example is the rate of return cap. This is where the rationale is more difficult to comprehend. Presumably, the rate of return regulation is an alternative to user price fixing and is much easier to manage and determine. However, if government wants investments to happen, it should not put limits on how much the firm can earn, certainly not at an unreasonably low nominal rate of return of 12 percent that is not even enough to cover interest costs. It creates, for prospective investors, “regulatory risks” on top of the commercial risks they already have to face. (If the firm makes money, it runs the risk of losing it because of the regulation.) Moreover, to a large extent, the regulation only encourages cheating and effectively forces out of the market honest new players. A related issue to price regulation that needs to be reviewed is the policy of cross subsidization that complicates the process even more. There is a need to reevaluate the costs and benefits of cross-subsidization. This has been used as a reason for limiting entry (to prevent new entrants from “skimming off the top”). In the first place, it is very difficult to set the right prices and the cost of making a mistake could be high. In the second place, are there other alternatives to attaining the objective? We come to the banking and insurance sectors (see Milo, this volume, for a more in-depth analysis). The case of financial regulation is perhaps of most unique importance because of the nature of the financial sector and its vital link to the rest of the economy. The financial sector regulation can be justified on two grounds, two cases of market failures: (1) the presence of asymmetric information and (2) the presence 16 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES of systemic risks. Perhaps the more compelling of the two is the second. The risk to one bank is a risk to all. The failure of one bank can cause the failure of others, if not of the whole system. Thus, regulation of the financial regulation is indeed well founded. Ideally, the regulation should address only the particular market failure. Hence, in the case of the financial sector, this means ensuring the stability and soundness of the banks and the payment system. This means prudential regulations. It does not mean, however, limiting the number of firms per se. This means disallowing entry only if the entrant could not prove its soundness and stability. The financial sector has made some strides in this area and these appear to have resulted in benefits manifested in the better and wider array of services available. Finally, an emerging problem common to all is the recent trend toward mergers and acquisition. This could very quickly worsen the state of competition in these markets. Again, this highlights the need for competition policy, especially for an effective antitrust law dealing with mergers and acquisitions. More importantly, the distortions in some of the regulations are increasingly recognized (e. g., access charge for universal application that has created asymmetry between firms, especially between old and newer firms). This again points to the need for a closer review and reex- amination of government policies and regulations, especially as they impact on the state of competition, and as to what would be the ideal “competition rules” where they are needed to compensate for the failure of the market to bring about a competitive process.

ELEMENTS OF A RATIONAL COMPETITION POLICY FOR THE PHILIPPINES AND RECOMMENDATIONS FOR AN ANTITRUST LEGISLATION

In the previous sections, several key points emerge from the discussion and must be highlighted. These are summarized as follows: • In general, there are clear benefits from competition. These arise mainly from greater efficiency (technical and allocative) that ultimately translates into increased welfare. • It is the contestability of the market that matters more than the actual number of existing firms in creating a competitive environment. Moreover, while in reality, perfectly “perfect” competition may not be present, an “effective” competition in actual cases may be enough for the benefits from competition to be realized. • The primary objective of competition policy is increased efficiency and overall welfare. Its role is to safeguard, protect, and promote competition and the competitive process and ensure that the market is able to function effectively. • A firm has a tendency to try to gain some market power. It could do so by constantly trying to become more efficient; in which case, there is no prob- OVERVIEW AND INTEGRATIVE REPORT 17

lem as this is consistent with the competitive process. But given enough latitude, it can also attempt to do more by somehow erecting barriers to entry (behavioral barriers). Such exclusionary abuse is something the antitrust law should address. • For certain products, there could be structural barriers to entry that could make the market uncontestable and would naturally lead to monopolistic market structure (or concentration). Such monopolistic setups could allow firms to abuse its market power (exploitative abuses). The antitrust law should be designed to effectively prevent such abuses. • The primary task of competition policy is twofold: (1) to make sure that no entity would have market power it can abuse and (2) to implement, where necessary, competition rules that would emulate the competitive process. • There could be efficiency gains for certain noncompetitive setups; that is, not all exclusionary actions and market concentrations are indications of abuse of market power. There could be noncompetitive setups that are beneficial under certain circumstances, e.g., presence of externalities of scope and synergies. • Finally and to some, the most important, there is a need to reexamine government policies and regulations in the light of its impact on competition. The studies on utilities show the complexities of industry regulation. The sectors covered all involve essential (bottleneck) facilities that justify the need for the industry regulation. In general, the studies show that significant reforms have been implemented (or will be implemented in the case of the power sector) in terms of liberalization and deregulation, which have led to the introduction of greater competition and resulted in substantial benefits. However, much more needs to be done.

ELEMENTS OF A RATIONAL COMPETITION POLICY These key points imply two major requirements for an effective competition policy. First, there is a need for an effective antitrust law. And second, there is a serious need to reexamine and reevaluate government policies that impact on competition. Such tasks, however, would not be complete, and in many cases, would be difficult to carry out without the necessary information and education campaign as well as adequate advocacy work. There are thus four major elements of an ideal competition policy for the Philippines. • Creation and enforcement of antitrust legislation aimed at preventing restrictive business practices that significantly lessen competition and result in abuse of dominant position, inefficiency, and reduction in welfare; • Review of government regulations and policies with respect to its impact on competition and competition policy objectives; • Advocacy for competition policy to facilitate and implement the required reforms in government policy with welfare-reducing anticompetitive effects; and • Information and education campaign. 18 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

In all these elements, the role of competition policy and the relevant competition policy authority should be both reactive and proactive. These elements fit quite well with the suggested framework for competition policy, presented in an earlier section. This is presented again in Figure 2, with the inclusion of these elements of competition policy. Such a framework for competition policy would be able to address the major concerns and primary tasks of competition policy noted above. Another important point to emphasize is that although the chart appears to indicate a central competition policy body, this need not be necessarily the case. The linkages in the four elements could be as close as to what is feasible, or as loose as what it could actually be. For example, the task of reviewing government policies and regulations could be undertaken by the government agency involved, although this may not be the ideal. In sum, the final form the organizational setup takes should ultimately depend on what is most administratively feasible and efficient.

Figure 2. Decision Tree: Framework for Competition Policy

Creation and enforcement of an effective antitrust law An effective antitrust law is necessary to implement competition policy. This antitrust legislation is aimed primarily at preventing restrictive business practices and abuse of dominant position. At the same time, it should allow for limitation in competition on grounds of efficiency (arising from market failures discussed earlier) or clear public interests. Hence, it should include in its findings whether, for example, the dominant position resulted from exclusionary abuse or increased efficiency. It should OVERVIEW AND INTEGRATIVE REPORT 19 be specific on what are the prohibitions per se (that is, what anticompetitive acts are prohibited outright) and what should be subject to a “rules of reason” competition test. It should have provisions for dealing with mergers and acquisition, provisions on agreements, and provisions for dealing with cartels, monopolies, and abuse of dominant position. Considering the encompassing nature of competition and the interrelationships and linkages between sectors, it should also be general in application—that is, applicable to all sectors, regardless of ownership. Thus, even firms under certain regulatory boards should be subject to the discipline of the antitrust law. The objectives of the regulatory board would not be violated, as the law would have enough allowances for efficiency and public interest justification. Indeed it should benefit from the discipline it enforces. More detailed discussion of what would constitute an effective antitrust law is done later in the chapter, with the analysis of the present legal framework and recommendations for an antitrust legislation.

Review of government regulations and policies Perhaps even more crucial to undertake is the review of government policies and regulations. If the objective is to improve the competitive environment, what is probably most worthwhile to tackle would be to reform government policies and regulations that directly interfere in the market. As earlier pointed out, this is mainly for three reasons: (1) their impact on the state of competition is most direct and more visible; (2) because much has already been done with respect to trade reforms; and (3) there is still a long way to go before the antitrust law is used successfully, even further off before the crafting of a more effective antitrust legislation. In particular, the major tasks involved in the review of government regulations and policies would cover the following: • Formulate regulations on public and private monopolies • Review the regulatory framework covering natural monopolies and access to essential facilities • Recommend more rationale “competition rules” to apply • Look into the possibility of deregulating further certain segments of the industry where more competition may be introduced • And introduce competitive neutrality in government businesses.

From these review activities would result more definite competition rules, particularly on access to essential (bottleneck) facilities and price regulations. Further- more, the review would cover ways to improve the administration of the antitrust legislation and build up the administrative capability of its enforcement. In addition, but possibly with less priority, competition policy should also ideally be able to review and reexamine major government policies, including industrial and agricultural policies, in the light of competition policy objectives. 20 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Competition policy advocacy If the required policy reforms made consistent with competition policy objective are to be implemented, vigorous advocacy is required. The competition policy authority, whatever form it finally takes, should ultimately be based on public support. Ad- vocacy is thus a crucial element of competition policy. Advocacy, in turn, cannot be done without inputs from a rigorous and careful review of the relevant policies in question. Review should cover identifying gainers and losers. They should be able to identify problems, trade-offs and possibly weigh benefits and costs of policy. In particular, studies on the impact of competition policy reforms that could support its advocacy would be needed. Studies, however, are not enough. Organizations should also be present to carry out the actual advocacy work. A networking system would need to be developed. Ways and means to mobilize consumer and other advocacy groups should be institutionalized. This is related to the next element discussed below.

Education and information campaign Finally, education and information campaign on competition policy and laws should be an integral part of the process. After more than three decades of trade protection and before trade reforms were implemented, in addition to having been under two decades of martial rule, it is not surprising that there is a lack of public awareness about what competition really means and what it entails. What could be cartel behavior such as collusion and other anticompetitive actions are viewed as part of the ordinary course of doing business and benign firm behavior. On the other hand, there is some paranoia about big businesses involved in the production of politically sensitive commodities (e. g., oil). The fact that certain businesses are big is enough to draw conclusions of “unfair” competition. These perceptions are well ingrained and would be difficult to change. A lot of education and information campaign is needed for competition policy to be successfully implemented. And this should be a clear and major function of the competition policy body. To perform this task, it would be necessary to mobilize the relevant groups in the community, particularly those who understand and support competition in the various sectors—consumers, politicians, and in the business community itself. Enlisting the help and mobilizing consumer groups, in particular, would help build awareness about competition and build constituency for needed reforms. Figure 3 illustrates, in sum, the potential outputs envisioned from such a working competition policy.

RECOMMENDATIONS FOR AN ANTITRUST LEGISLATION The core of the competition policy is the antitrust legislation aimed at preventing restrictive business practices that significantly lessen competition and result in abuse of dominant position, inefficiency, and reduction in welfare. What should be the provisions and framework for an effective antitrust policy and law? OVERVIEW AND INTEGRATIVE REPORT 21

Figure 3. Potential Outputs of a Working Competition Policy

Assessment of existing antitrust legislation Despite the considerable number of laws and their varied nature (see Abad, this volume), competition has not been fully established in all sectors of the economy, nor has existing competition in other sectors of the market been enhanced. Present laws for promoting competition in the Philippines have proven inadequate or ineffective to stave off the ill effects of anticompetitive structures and behavior in the market, mainly due to lack of enforcement. These laws have been hardly used or implemented as may be seen in the lack of cases litigated in court. The same laws have even worked to discourage competition. Several reasons have been forwarded to explain the lack of enforcement of competition laws (Lazatin 1994) in the Philippines. These are summarized from Abad (this volume) as follows:

• “Too Many Cooks.” There is a saying that, “Too many cooks spoil the broth.” With so many enforcement agencies, responsibility is too diffused and accountability for implementation of the laws is difficult to fix. 22 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Some regulators are unable to relate all the different existing laws and regulations. (Khemani 1996) Moreover, there is a lack of expertise in the appreciation and implementation of competition laws that rely heavily on economic thought, techniques of analysis and value preferences as tools of enforcement (Khemani 1996). The identification of a single specialized agency, under a specific competition law, with the necessary expertise and authority to oversee the enforcement of competition laws is therefore critical.

• “Regulatory Capture” With a specific agency regulating each industry, the danger of regulatory capture is inevitable. In time and with familiarity, it is the industry that ultimately regulates the regulator.

• Lack of a Comprehensive Competition Law and a “User-Friendly” Enforce- ment Mechanism Of course, the number of enforcement agencies is a direct result of the many laws that established them. The objectives behind each of these laws are unquestionably noble. However, inasmuch as each law is meant to address specific situations, there runs the risk of one law negating the positive effects of another. Since some of these laws are penal in nature, the quantum of evidence required so that the case may prosper—proof beyond reasonable doubt—is difficult to obtain. In addition, the witnesses and/or aggrieved parties, because of the long tedious legal processes involved, are themselves not interested in putting the perpetrators behind bars; rather they are more interested in obtaining an injunction or cease-and-desist orders. Moreover, fines are inadequate to deter would-be criminals (Khemani 1996). An administrative enforcement mechanism that can be implemented faster with hefty fines as penalties for unfair competition would be more effective.

• Lack of Jurisprudence on Competition The judiciary has scarcely had the opportunity to pass upon the proper application of the various laws on competition, partly due to lack of enforcement. The silence or ambiguities in these laws have thus remained. The lack of guidance has discour- aged full implementation.

Suggested provisions and framework for the antitrust law The Philippines has yet to craft a truly effective legal and regulatory framework for enforcing competition in the economy. How such a framework is to shape up will depend on the design of a simple and enforceable model and a careful consideration of the political economy realities of this country. As previously noted, considering the encompassing nature of competition and the interrelationships and linkages between sectors, the antitrust law should be general in OVERVIEW AND INTEGRATIVE REPORT 23 application. Bearing in mind the factors affecting the state of competition and what should be the objectives of competition policy discussed in earlier sections, it should contain rules governing monopolies and cartels, restrictive agreements, mergers and acquisitions, and provisions identifying outright prohibitions of clearly unfair competition practices, all aimed at preventing exploitative and exclusionary abuses. These rules, where possible, should identify per se prohibition to simplify some of the tasks. For other cases, rule of reason, e.g., by judiciously applying crafted “competition tests,” should allow for limitation in competition where found to be so justified. The antitrust law should endow investigative powers to whichever agency is tasked to implement it. However, there should be transparency in the procedures, ideally with some guidelines published. Finally, there should be clear possible course of actions, in terms of remedies and/or penalties, for those found to be in violation of the antitrust law. To elaborate a little further, as suggested in the World Bank/OECD Framework for the Design and Implementation of Competition Law and Policy, these cover the following provisions: • Rules governing monopolies and cartels and abuse of dominant position. – Establish if firm has dominant position – Examine entry barrier condition – Identify anticompetitive actions (creating obstacles to entry, e.g., predatory pricing) – Set guidelines for rule of reason regarding what anticompetitive, exclusionary actions could be allowed. There should be a competition test to determine if the obstacle to entry is solely created by increasing efficiency of the firm. This competition test allows for limiting competition on efficiency grounds – Provide burden of proof – firm – Provide for possible remedies (e.g., reorganize, divest)

• Rules governing restrictive agreements. The premise is that not all agreements are cartel agreements. Similar considerations apply as in the case for rules governing concentrations (below) – Identify per se prohibitions. These would include clear cartel agreements (naked restraints of trade) such as: - Price fixing or setting - Output fixing or setting - Bid rigging - Division of markets – Examine entry barrier conditions – Identify other forms of anticompetitive (exclusionary) conduct where rule of reason could apply – Set competition test guidelines – Provide burden of proof – firm 24 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• Rules governing mergers and acquisitions – Examine entry barrier conditions – Set and define threshold for mergers that are small enough and where prior notification is not required. – Set rule of reason guidelines for permitted mergers and acquisition even for those above the threshold. For these, there should be a competition test which show that there would on balance be efficiency gains. – Burden of proof – firm

• Provisions for prohibited unfair competition practices: List specific actions considered as prohibited unfair competition practices. Examples of such unfair competition practices that should be prohibited may include: – Distribution of false or misleading information that could harm competing firm – Distribution of false or misleading information (including information lacking basis) to consumers, e.g., related to price, quality, characteristics, etc. – Unauthorized use, receipt, or dissemination of confidential scientific, technical, production, business, or trade information

Thus far, the recommendation is silent on whether or not there should be and additional mandate to incorporate the other elements of competition policy in the legislation and if a central competition authority should be created. This is because of the huge implications of creating such a body. This is discussed later on in the concluding chapter as one of the issues that would need to be resolved. As yet, it is too early to tell what is the most feasible and effective way to implement competition policy. For sure, a “good” central authority is best able to accomplish the task. Whether it is feasible to create one, however, is another question. The challenge is how to craft a competition law that would allow for the possibility of creating a central authority that would one day evolve into what it should ideally become.

CONCLUDING REMARKS: ISSUES IN COMPETITION POLICY AND OTHER CONSIDERATIONS

The elements of competition policy outlined above require a lot of technical expertise. The competition authority should have very competent and knowledgeable manpower to define markets, identify anticompetitive actions, and judiciously construct and administer “competition tests” on issues of concentration, agreements, mergers and acquisitions. Being new in the area of implementing competition policy, there would be an expected lack in expertise and a need for institution and capability building. The question is what would be the best way to develop such expertise and institutions? OVERVIEW AND INTEGRATIVE REPORT 25

At present, there is no single body that oversees and coordinates all the activities that seek to promote competition in the country. Instead, competition policy is more an implicit policy in different sectors of the government, which need not be rigorously adhered to. Furthermore, it is disjointedly implemented by a number of government offices and interagency bodies so that at best, any isolated attempt to foster competition would produce limited benefits. For sure, the past deregulation episodes, e.g., in telecommunications and domestic aviation, have led to noteworthy benefits, especially during the early stages. But much more could have probably been done. The same could be said with respect to trade policy reforms. Government institutions performing functions related to competition may be classified into “core” or “primary” institutions and “outer ring” or “secondary” agencies. “Core” or “primary” competition institutions are those whose functions cut across sectors or in which the promotion of competition or regulation of monopolistic behavior and/or the protection of consumers are the primary if not the sole functions. Those in the outer ring, on the other hand, are those in which the said functions are limited to a sector or where the aforementioned functions are secondary or incidental to the main function(s) of promoting competition, but impinge on or affect competition in very important ways. Considering the broad scope of competition policy, it is not surprising that many institutions are involved in the implementation of the various laws related to competition. An oversight body responsible for coordinating and integrating the various programs and activities of these institutions could make for greater impact as well as more effective enforcement of competition.

SHOULD A CENTRAL BODY BE CREATED? Herein lies the first major issue in competition policy for the Philippines: whether or not to create a central body responsible for competition policy. Given the formidable tasks implied by the comprehensive nature of the elements of a rational competition policy outlined above, a central body is indeed necessary. However, the requirements in terms of capable manpower and institution building could be very daunting. Apprehensions about what it could become if not properly handled are quite valid. The question is what can be done. What is the most feasible way to implement a more explicit and effective competition policy? What is the best way to develop the competent body to implement competition policy—if not now, then in the long run? One approach is to do this gradually, possibly on a piecemeal basis. We can begin with the creation of a coordinating body, and an austere law, which can be augmented over time and which could emphasize the establishment of implementing institutions and promotion of competition advocacy. Another approach is to transform an existing body that is performing some of the functions of competition policy. A third approach would be to create a new central body (such as the Fair Trade Commission) that could be designed to develop and evolve into what it should ideally become. 26 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

It is difficult to decide the best approach at the moment. The problem with the first approach is that coordinating bodies are usually not very effective as they lack the necessary mandate, budgetary requirements, and authority. The problem with the latter two approaches is that the requisite foundation may not be there. The bureaucracy may not be ready to perform such a function, even with enough mandate, budget, and authority, and might even cause more harm than good at its current state of development. Whatever the approach, initial efforts should already focus on the development of physical and human capital, training of judges, education of consumers, business community and government officials on the rationale for and content of an antitrust statute. We should allow the institutional foundations for the competition policy system to be established first and the enforcement of a comprehensive set of commands to be introduced and this could take some time. The drafting of the law and creation of such a commission should follow efforts to study the major sources of market failure and to identify distinctive institutional conditions that affect the choice of strategies for correcting such failures. In the long run, the government should work toward creating such a commission. Ideally, this commission would be responsible not just for the prevention of anticompetitive behavior of firms, or simply antitrust legislation, but rather for the broader area of competition policy and law including review of existing government policies and regulations from the point of view of competition policy, supported with competition advocacy and information and education campaign.

DESIGN CONSIDERATIONS The following are some of the factors or criteria to be considered in the design of administrative arrangements for the implementation of such a comprehensive competition policy. To carry out due process of the core element of competition policy, specifically the judicious enforcement of the antitrust law, • The competition authority should be independent and insulated from political interference; • The investigation, prosecution and adjudication functions in the enforcement of competition law should be separate; • A system of checks and balances should be in place with appropriate rights of appeal and review of decisions and facts on legal and economic grounds; • The proceedings should be transparent while safeguarding sensitive business information of a competitive nature; • Cases and related matters must be resolved expeditiously; • The proceedings should be accessible to all affected parties with provisions for introducing expert testimony and evidence; and • The design of institutional (as distinguished from administrative) arrangements should consider financial autonomy and independence from outside pressures. OVERVIEW AND INTEGRATIVE REPORT 27

With respect to the other elements of competition policy, • The competition authority should have an advocacy function, particularly as it relates to the formulation of economic regulatory policies to put alternative best practices of competition in the market; and • The competition authority should also be accorded a wider role in government economic policy decisionmaking.

A third criterion may be added, which is that the competition authority should have enough clout or be located high enough in the government hierarchy to be able to enforce its decisions; if possible, it should (like the Presidential Economic Staff and its successor the Presidential Management Staff) carry or be seen to carry the weight of Presidential power and authority. Of course, political will or support is important for the competition authority regardless of its actual place in the governmental hierarchy. The goal is to develop a competition authority that is credible, respected, and based on public support. The basic characteristics and features of such a competition policy body should include: • Limited discretion – an important element here is setting the time frame for coming out with decisions, • Enough flexibility to deal with complex issues sure to arise in competition cases, • Independence – subject to review only by the Supreme Court.

Obviously, details of implementation would need to be meticulously worked out. Equally important, the successful implementation of competition policy requires not only the careful design and the construction of an effective competition body, but would also entail improvements in other institutions such as courts and the judicial system. Sadly, the institutional ingredients that make ambitious competition system feasible in developed countries rarely exist in developing settings and which will take long years (decades) to build. This leads to the second major issue.

WHAT SHOULD BE THE PRIORITY AND FOCUS IN THE SHORT-TO-MEDIUM RUN? This issue is related to the priority and focus of competition policy in the short-to- medium run. While competition issues regarding the conduct of firms are important, perhaps the more crucial and urgent concern is the second layer of the competition policy environment—those covering government policies with anticompetition effects, especially those with direct impact on the state of competition. Specifically, this means reviewing the performance of the regulatory boards. There is a clear need to reevaluate policies and review whether such policies and regulations could pass a “competition” test or, if not, if they could be justified on public welfare grounds. And finally, this is where the greatest impact of implementing competition policy could be felt. 28 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

While priority and focus should be given reforms of government regulations, it does not imply that creation and/or implementation of a more effective antitrust policy (the third layer of the competition policy environment—the core competition policy) should be neglected.

THE REGULATORY BODIES AND THE COMPETITION AUTHORITY Another issue is what happens to the regulatory bodies that might presently exist? At the very least, even if a central competition authority is not created, the antitrust law should have universal application. That is, anticompetitive acts in violation of the antitrust law committed by any firm, whether private or public, under a regulatory body or not, should be subject to the discipline of the antitrust law. Even this would have an implication on what should be the relationship between the regulatory body and the antitrust law enforcer. What more if a central authority is created (which does not mean that the central authority should perform all the competition policy functions at all levels7)? In any case, there should be very close coordination between the competition policy body (or the authority enforcing the antitrust law) and the regulatory body. What form the coordination, relationship, or linkage between the two bodies should take would depend on what is most feasible and efficient. The delineation of function would be such that primary responsibility should lie on the competition authority as far as anticompetitive behavior of the firm is involved. However, (especially during the capacity-building years of the competition policy body if such a body is created), the recommendations of the regulatory body, having more resources and greater expertise in examining the firms it covers, should carry a lot of weight. On the other hand, enforcing competition rules (part of the regulatory framework for the industry) should be the responsibility of the regulatory body. However, the central competition authority, should one be created, would be responsible for reviewing the regulatory framework and policies of the regulatory body. Such interrelationship between the regulatory body and the competition policy body is among the major issues in moving towards a formalized and workable competition policy for the Philippines. There might even come a time when the regulatory body has served its purpose and should be subsumed under the competition authority. Or it may continue to exist albeit with revised and improved functions. In the long run, whether or not the regulatory bodies will be subsumed into the central competition authority (should one be created) would depend on what is most administratively effective. Whatever the final form the relationship takes, efforts should begin soonest toward making a more comprehensive and central competition ______

7 Indeed, it should leave the more technical aspects to the particular agency specializing in the particular industry in question. OVERVIEW AND INTEGRATIVE REPORT 29 policy operational and workable, even though this may only be a long-term goal. The point should not be lost to policymakers that perhaps the creation of such a central body, or even just an antitrust law which has universal application, is one of the reforms that are needed in instilling market discipline in industries covered by the regulation. However, due to the comprehensive scope of the antitrust law, its implementation or application should probably be focused initially on one provision of the law to gain experience, jurisprudence, expertise, and capability upon which to build on. Focus and priority could, for example, be placed on antitrust rules on mergers and acquisition. This is probably be a good way to start, as the burden of proof lies on the part of the firm and hence, data and information gathering demands for analysis would be greatly reduced. It could also focus its initial efforts on one particular industry well known for anticompetitive practices. The demonstration effect that could arise would go a long way in its advocacy for necessary reforms and in its education and information campaign. What is crucial is that there should be a solid legal framework to start with, which the envisioned competition policy would build on.

LACK OF APPRECIATION OF THE PROBLEM This brings us to the next issue. How great is the need for competition policy and law? Initial findings from the various sector studies show a need to improve the state of competition in the sector and a need to incorporate competition policy to discipline the market. Nonetheless, the private sector does not seem thoroughly convinced of the need for competition policy in general. Benefits from deregulations in the transport and telecommunication sectors are well understood. However, there appears to be a lack of appreciation about the gravity of the problem—specifically with regard to limited competition in many industries in the manufacturing sector— and its adverse effects (see Aldaba, this volume). More research on the state of competition and more empirical studies on the impact of competition policy or lack of it appear to be necessary. Equally important, intensive advocacy work to bring the results to the public would need to be done. Possibly one of the reasons for this lack of appreciation of the problem (especially with respect to the manufacturing sector) is the relative novelty of the idea after three decades of protectionism and two decades of martial law. A culture of competition has not been cultivated in the country. Another is that trade reforms have been a relatively recent experience—only during the past decade or so. The Philippines is a small country, where the average size of firms is relatively small. Even the larger establishments are small compared to medium-sized firms in the developed countries. There are doubts that existing firms have enough resources to erect barriers to entry, except possibly for large or capital intensive industries. Also, there is apprehension about a more general application of competition policy—that it could lead to indiscriminate use of power of competition authority. This is a valid concern. It is thus critical that the competition law is carefully crafted 30 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES with enough provisions that would ensure due process and at the same time allow it to evolve into a competent and independent body, with officials who, like Caesar’s wife, would be above suspicion. Equally important, more education and information campaign is needed about the state of competition, the anticompetition elements present, and the benefits from competition policy. As noted above, some demonstration of these benefits is necessary. What is needed to make this happen? The paper suggests focusing initial efforts on tasks within the capability of whatever agency or coordinating body is initially designated, with the long-run view of developing a competent body, out of this initial body or an entirely new competition authority. We are thus back to the original question: should a central body be created, even at the start? As earlier pointed out, a comprehensive competition policy such as that outlined in the paper could probably only be effectively administered by a central competition authority. If developed, it could have an immense potential as a mechanism for reviewing and reforming policies. What a boon it could be. What possibilities there could be in reforming even recalcitrant government policies? But the requirements in both human and capital resources would be large. Nonetheless, given the huge benefits that could be derived from a working competition policy, the government should actively seek ways to bring it about. And a prerequisite to this would be the drafting of a carefully crafted antitrust law that adequately provides for due process and, at the same time, forms the legal basis for the development and evolution of an ideal competition policy body.

BIBLIOGRAPHY

Baumol, W. and Willig, R. 1981. Fixed Cost, Sunk Cost, Entry Barriers and Sustainability of Monopoly. Quarterly Journal of Economics 95. Gilbert, R.J. 1990. The Role of Potential competition in Industrial Organization. Journal of Economic Perspective 4:2. IRIC (Institute for Research into International Competitiveness). 1999. A Framework for Competition Policy in the Philippines. A Study undertaken for Philippines Tariff Commission Funded by the United Nations Office for Projects Services (UNOPS). Khemani, R.S. 1996. The Role and Importance of Competition Law and Policy in the ASEAN Region. Paper presented at a conference organized by the World Bank, March 1996, Jakarta, Indonesia Lamberte, M.B., E.S. de Dios, D.A. Flores, J.F. Tabbada and M.E.C. Ramiro. 1992. Barriers to Entry Study. Final Report, Volume I. United States Agency for International Devel- opment (USAID). Lazatin, V. 1994. Outline of Competition Law Enforcement in the Philippines. McGee, John. 1958. Predatory Price Cutting: The Standard Oil (N.J.) Case. Journal of Law and Economics 1:137-169. Medalla, E.M. 1998. Trade and Industrial Policy Beyond 2000: An Assessment of the Philip- pine Economy. In The Philippine Beyond 2000: An Economic Assessment, edited by Josef T. Yap. Makati City: Philippine Institute for Development Studies. OVERVIEW AND INTEGRATIVE REPORT 31

Medalla, E.M., Tecson, G.R., R.M. Bautista, J.H. Power and Associates. 1996. Catching Up with Asia’s Tiger, Vol. II. Makati City: Philippine Institute for Development Studies. Patalinghug, E.E. 1997. Competition Policy, Technology Policy and Philippine Industrial Competitiveness. A Professorial Chair Paper for the College of Business Administra- tion, University of the Philippine, Diliman, Q.C. Pineda, V.S. 1997. Effects of the Uniform Five Percent Tariff on Manufacturing. Discussion Paper No. 97-16. Makati City: Philippine Institute for Development Studies. Stigler, G. 1968. A Theory of Obligation. In The Organization of Industry, Edited by G.J. Stigler. Housewood, III. Richard Dd. Irwin. Tariff Commission. 1999. Concept Paper on Competition Law and Policy. Planning and Project Division. World Bank. 1998. Competition Policy and Economic Reform: An Interpretive Summary. Washington. —————. 1990. Glossary of Industrial Organisation Economics and Competition Law. Washington. World Bank and Organization for Economic Co-operation and Development (OECD). 1999. A Framework for the Design and Implementation of Competition Law and Policy. Washington. MANUFACTURING INDUSTRY 33

2 CHAPTER

The State of Competition in the Philippine Manufacturing Industry

Rafaelita A. Mercado-Aldaba*

ABSTRACT

ompetition policy is integral to the process of international trade liberalization and to deregulation in domestic markets. This paper shows that even if trade barriers are removed, there are other factors that can impede the Cprocompetitive effects of trade liberalization. These include the presence of nontradables, absence of effective competition due to the ability of domestic firms to increase prices and to prevent imports from entering the market, and the presence of cartels that may divide the markets through price-fixing or geographic market-sharing agreements. These barriers inhibit domestic and international prices from converging, thus muting the gains from trade liberalization. While liberalization may be a precondition for the growth of a free market, it does not, by itself, guarantee effective competition. In the absence of competition laws, there is a risk that liberalization may not be sufficient to foster effective competition and it would also be difficult to control possible abuses of dominant positions by large-scale firms including multinationals. If effective competition has to emerge, trade reforms have to be accompanied by the creation of competitive market and industry structures. ______

* The author is thankful to Dr. Gwen Tecson for her insightful comments and suggestions on an earlier draft. The research assistance of Ms. Cora Pisano in the preparation of this paper is also gratefully acknowledged. 34 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

INTRODUCTION As in most developing countries, the Philippines adopted the then predominant import substitution model in its quest for industrialization during the postwar years. A complex array of protective policies, investment incentive measures to promote selected industries, and regulatory controls emerged. While these instruments of protection, promotion, and regulation promoted and stimulated investments in the early stages of industrialization, they came to impose over time barriers to resource mobility and competition. They became associated with the protection of entrenched incumbents and stimulated rent-seeking behavior. Being the darling of policymakers, domestic manufacturers in the country have received heavy protection through high tariffs, quantitative restrictions and administrative allocations. These policies, however, failed to provide an efficient mechanism for allocating domestic resources among manufacturing subsectors (Bautista et al. 1979). Instead, they led to concentration of the manufacturing industry and sheltered domestic markets. In this environment, small groups of entrenched oligopolists were able to extract monopoly power in the market. Not surprisingly, these groups tend to wield significant economic and political influence in the country. With the demise of the import substitution model, the government was prompted to institute policy reforms consistent with the requirements of a competitive market environment. The government responded to the regulatory constraints that the complex regulatory maze imposed through deregulation and liberalization. It liberalized the trade regime by removing tariffs and nontariff barriers, reducing the antiexport bias, and increasing import competition. It also deregulated the economy by changing the set of rules that governed economic activities. All these reforms were aimed at removing barriers to competition, factor mobility, and firm growth. Yet even in a liberalized environment, the efficiency of markets is not always guaranteed (World Bank and OECD 1998). While trade liberalization promotes competition in domestic markets, there exist various impediments that can dilute the procompetitive effects of import competition. The ability of economic agents to exercise monopoly power is derived from the presence of barriers to competition. These barriers may be natural (as a function for example of economies of scale), strategic (due to the presence of few agents in markets), or policy generated (erected by anticompetitive instruments of regulation, promotion, and protection of economic activity). In the last 20 or so years, there has been real progress in the liberalization of tariff and nontariff barriers. One important issue that needs to be addressed is whether or not this trade liberalization has resulted in increased market contestability in the manufacturing sector. The current study attempts to assess the general market conditions and the current state of competition in the manufacturing industry. It will also address the issue of whether or not trade liberalization has led to greater competition and market entry opportunities. The next section briefly describes the basic concepts underlying competition policy. The third section reviews existing literature on the state of competition in Philip- MANUFACTURING INDUSTRY 35 pine manufacturing industries. The fourth section assesses the overall performance of the manufacturing sector before and after trade liberalization. The fifth section presents an analysis of industry structure, price-cost margins and concentration in the manufacturing sector. The sixth and final section presents the policy implications and recommendations of the paper.

THEORETICAL UNDERPINNINGS OF COMPETITION POLICY

COMPETITION, MARKET POWER AND BARRIERS TO ENTRY In economics, competition is seen as a process that allows a sufficient number of producers in the same market or industry to independently offer different ways to satisfy consumer demands. As competition is often equated with rivalry, it pressures firms to become efficient and to offer a wider choice of products and services to consumers at lower prices. Competitive rivalry may take place in terms of price, quantity, service, or combinations of these and other factors that customers may value (World Bank and OECD 1998). Competition forces firms to become efficient and to sell a wider range of goods and services at lower prices. A competitive economy enables individuals to exercise economic freedom, meaning freedom for consumers to choose what they value most and for entrepreneurs to choose where they want to invest. The competition process will allow consumers and producers to exercise their freedom of choice free of any price- fixing conspiracies and monopolistic bullying. As the World Bank and OECD study (1998) noted, in a competitive economy, price and profit signals tend to be free of distortions and create incentives for firms to reallocate resources from lower to higher valued uses. Decentralized decisionmaking by firms promotes efficient allocation of society’s resources, increases consumer welfare, and gives rise to dynamic efficiency in the form of innovation, technological change, and economic progress. It is important to recognize that high levels of market concentration as well as the presence of monopolies (a type of industrial structure where there is only one large firm) or oligopolies (where there are a few large firms) are not necessarily detrimental to competition. Large firms may achieve a dominant position in the market through legitimate ways like innovation, superior production or distribution methods, or greater entrepreneurial skills. For as long as markets remain contestable (when entry into a market is easy), we would expect large firms in an oligopolistic environment to act independently or monopolies to behave in a competitive manner. How can we have competitive prices if there is only one firm or if there are only a few firms in the market? If entry is easy and costless, the potential threat from imports or from domestic competitors will make incumbent firms behave competitively. As soon as one firm or a group of firms attempts to increase prices or lower quality from competitive levels, a new firm can come in to serve the market and this will drive prices back down to competitive levels. 36 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Competition can be lessened significantly by (a) government regulatory policies, (b) behavioral restraints, and (c) structural characteristics of the market that can act as barriers to entry (Box 1). Regulatory barriers include investment licensing, tariff and nontariff measures, antidumping and countervailing duties. Behavioral barriers represent abuse of dominant position where “relatively large” firms engage in anticompetitive conduct by preventing entry or forcing exit of competitors through various kinds of monopolistic conduct including predatory pricing and market foreclosure. Behavioral restraints are often classified into two: horizontal and vertical. Horizon- tal restraints refer to agreements that are referred to as “naked” restraints of trade, cartel behavior, or collusion. Examples are price fixing, bid rigging and allocation of territories or customers, and output restriction agreements. Vertical restraints are contractual agreements between supplier and purchasers/retailers in both upstream and downstream markets. Examples include:

Box 1. Structural, Behavioral and Regulatory Barriers to Entry

Structural: barriers due solely to conditions outside the control of market participants • Sunk costs: costs that a firm cannot avoid by withdrawing from the market; sort of entry fee • Absolute cost advantage: access to natural resource or human resources • Economies of scale: unit cost of production fall with increasing output • Large capital requirements • Network industries: firms that are competitors share some critical facility like transportation and telecommunications

Behavioral: represent abuse of dominant position where “relatively large” firms engage in anticompetitive conduct or restrictive business practices by preventing entry or forcing exit of competitors through various kinds of monopolistic conduct • Excess capacity • Product differentiation and advertising • Horizontal restraints: cartels or collusion (price-fixing agreements, market-sharing territorial arrangements, bid rigging), price discrimination • Vertical restraints: resale price maintenance, exclusive dealing • Foreclosure and exclusion • Tactics to increase rivals’ costs

Regulatory: barriers imposed by government policies • Special permits, license to operate • Regulations influencing the use of some inputs • Tariffs, quotas, and other nontariff barriers • Antidumping and countervailing duties • Discriminatory export practices • Exclusionary lists • Ownership restrictions

Source: World Bank and OECD (1998). MANUFACTURING INDUSTRY 37

• Resale price maintenance agreements: retail price is fixed by the producer or price floors or ceilings are imposed. • Exclusive distribution agreements: distributors are assigned exclusivity within a geographic area or over particular types of clients, or over specific products. • Exclusive dealing agreements: downstream firms are prohibited from dealing with competing producers or distributors. • Tie-in sale agreements: downstream firms are required to purchase a certain range of products before being allowed to purchase a particular product. • Quantity forcing: downstream firms are required to purchase a minimum quantity of a product.

Economies of scale (increasing returns to scale) is an example of a structural barrier. When there are increasing returns to scale, there is a minimum size that firms have to attain if they are to have average cost as low as possible. If the minimum efficient scale is so large that only one firm of that size can serve the entire market, there will be a monopoly. This situation often occurs with public utilities such as distribution of water, electricity, and piped gas. Firms may gain market power by limiting competition, i.e., by erecting barriers to trade, entering into collusive arrangements to restrict prices and output, and engaging in other anticompetitive business practices. The presence of barriers to entry impedes competition and allows firms to acquire and exercise market power. Market power enables firms, unilaterally (monopoly) or in collusion with others (cartel), to profitably raise prices and maintain these over a significant period of time without competitive response from other existing or potential firms. Barriers to entry are necessary for market power. Market power can be created through mergers or agreements between competitors not to compete or through restrictive vertical arrangements and predatory pricing which is an abuse of preexisting market power. A firm’s exercise of market power can harm consumers and other producers through higher prices (rather than competitive prices), reduced output, and poorer quality products. In general, market power results in inefficient allocation of resources and negatively affects industry performance and economic welfare. Large firms may take advantage of their market power by abusing their dominant position or monopolization. This entails the suppression of competition by restricting or foreclosing the entry of smaller rivals, for example, by increasing competitors’ costs of entering a market or charging predatory prices which harms the competitive process.

Theories on industrial organization and competition There are a number of theories in industrial organization economics explaining the need to preserve competition. The two major opposing schools of thought can be broadly classified into two: • structuralist school as developed by Joe Bain and contemporaries • market efficiency model or Chicago school which is attributed to Stigler and Demsetz. 38 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

While both schools share the same objective, i.e., to promote the efficient use of resources, the debate stems from the choice and application of different policy instruments. The structural theory of market performance states that firms respond to entry but are able to earn persistent profits when the structural characteristics of markets make entry difficult. Bain identified the conditions of entry as technological features of markets that affect the exercise of market power. Economies of scale, absolute cost advantages, and product differentiation were the primary determinants identified as entry barriers that enable a firm to maintain price above average cost (Gilbert 1990). The structuralist school emphasizes the interaction between market structure and collusive and exclusionary business practices by firms that enable them to exercise market power and persistently earn excess profits (Khemani and Dutz 1995). The structuralist school is rooted on the traditional structure-conduct-performance (SCP) paradigm of industrial concentration which states that a concentrated industry (structure) will facilitate collusion (conduct) and hence monopoly pricing (performance). Firms operating in oligopolistic industries with large market shares are more likely to coordinate their pricing and output or to unilaterally engage in anticompetitive behavior. Khemani and Dutz noted that in the past, the emphasis was on the role of market structure, but today, the focus is more on pricing and output policies affecting market structure while aiming at the exclusion of competition such as advertising, research and development, contractual arrangements, and preemption of input sources and distribution channels. The Chicago school was developed in reaction to the structuralist viewpoint that industrial concentration fosters collusion and hence, monopoly pricing. Demsetz (1973) argued that superior low cost firms would have higher profits and would grow to dominate their industries. Low costs lead to competition, which in turn lead to concentration of industry (Leach 1997). Advocates of the Chicago school say that a policy of industrial deconcentration would destroy efficiency with no benefit of lower prices to consumers. Economists associated with the Chicago school maintain that markets are workably competitive and the market structure reflects differential efficiency, not strategic behavior. They argue that collusion is difficult to practice profitably in all but the most highly concentrated industries and is therefore not a serious problem (Stigler 1968). Where competition is limited, collusion is primarily due to barriers to entry that the government creates. They advocate the pursuit of economic efficiency as the unequivocal goal for competition policy. Failure to consider economic efficiency distorts the basic intent of competition policy. As a result, they favor a minimalist approach toward the implementation of competition policy. Competition law, in particular, should be restricted to preventing collusion, especially price fixing agreements (Posner 1969 and Bork 1978 as cited in Khemani and Dutz 1995). The two schools of thought also differ with respect to the interpretation of the positive relationship between concentration and profits found in empirical studies. The MANUFACTURING INDUSTRY 39 structuralist school maintains that the positive relationship between concentration and profits indicates monopolistic pricing. High levels of concentration are due to anticompetitive business practices that lead to resource misallocation. The Chicago school argues that the positive relationship reflects superior competitive performance by leading firms (with large market shares), independent of any ability to collude (Leach 1997). In the absence of government-erected barriers to entry, high levels of concentration and profits can be maintained only if the leading firms constantly strive to be innovative and efficient (see Khemani and Dutz 1995).

MEASURES OF CONCENTRATION AND PROFITABILITY Leach (1997) identified four measures of concentration using gross output as the size variable: 1) The four-firm concentration ratio (CR4) which is the proportion of an industry’s gross output accounted for by the four leading firms in the industry, i.e. the sum of the leading four firms’ market shares. n Σ 2 2) The Herfindahl-Hirschman index (HHI) = msi i=1 where msi is the market share of the ith firm and n the number of firms, i.e., it is the sum of the squared market shares of all firms in an industry. HHI ranges from a minimum of 1/n for n firms of equal size to a maximum of 1 when there is only one firm. The HHI is the most common measure used to assess concentration of shares of industry participants. In the US, the following thresholds are used as guidelines: 0 –1000 unconcentrated 1000 – 1800 moderately concentrated above 1800 highly concentrated. n Σ 2 3) The Horvath index (HI) = msi + msj [1 + (1-msi)] j=2 i.e., it is the sum of the market share of the leading and a HHI of the remaining firms “reinforced by a multiplier reflecting the proportional size of the rest of the industry”.

The HI has a maximum of 1 and a minimum approaching msi.

4) The Rosenbluth index (RI) = ____1____ n Σ 2 (i – msi) – 1 i=1 where n is the number of firms in an industry, i is firm rank, and msi is market share. Like the HHI, the Rosenbluth index ranges from a minimum of 1/n for n firms of equal size to a maximum of 1 when there is only one firm. 40 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Price-cost margins are commonly applied as measures of profitability in most concentration profits studies. In diagnosing market dominance, the price-cost margin or Lerner index L, defined in terms of marginal costs, is given by L = (price-marginal cost)/price. The price cost margin is used as a direct measure of market power. It is also true that the price cost margin is inversely related to the elasticity of demand. Market power implies that a firm is able to charge prices substantially above its marginal cost while a firm without market power must charge a price that approximates its marginal cost.

REVIEW OF LITERATURE

Previous studies on the state of competition in the manufacturing industry highlighted the high degree of industrial concentration in the country. Lindsey (1977) analyzed the level of concentration in the manufacturing industry, its determinants and its relationship to industry profitability. He characterized the manufacturing sector as monopolistic and identified capital intensity and degree of fabrication as barriers to competition. He concluded that the high levels of concentration led to monopoly power. De Dios (1986) examined the effects of tariffs on industrial structure. His results showed that tariff protection led to concentration. This suggested that firm concentration allowed the earning of monopolistic profits. He identified degree of capital intensity, minimum efficient scale and working capital requirement as barriers to entry that led to concentration. The 1993 World Bank report on the Philippines indicated that the country’s manufacturing sector was highly concentrated and this contributed to the reduction of competition in the affected subsectors that hampered efficiency gains in structural reform. The report, however, noted that by the end of the 1980s, the degree of concentration eased substantially. Its estimates revealed that the degree of concentration declined from 70 percent to 63 percent between 1983 and 1988. The report concluded that, although oligopoly and rent-seeking behavior remained rife in the Philippines, there was evidence that the economy became more competitive and efficient in resource use toward the end of the 1980s. At the aggregate level, evidence of improvement included numerous smaller new entrants to many industrial sectors and the increased labor intensity in production. At a disaggregated level, concentration ratios were declining in export-oriented industries while smaller firms were increasing their share of production in sub-sectors largely geared to exports. Concentration eased for 19 out of 31 three-digit subsectors, led by the footwear and furniture sectors and followed by wearing apparel, leather, and food (PSIC 311), all of which were export-oriented. The leaders in heightened concentration were nonelectrical machinery and nonferrous metals, followed by food (PSIC 312), beverages and chemicals (generally domestic-oriented, except for nonferrous metals and chemi- MANUFACTURING INDUSTRY 41 cals). The most dramatic decline among sectors highly concentrated in 1983 was in food (PSIC 311), from 82 percent to 59 percent, and in pottery and china, from 97 percent to 75 percent. For sectors with above average concentration in 1983, only nonferrous metals and glass experienced increases in concentration, but a number of highly concentrated sectors experienced virtually no change, which reflected the incumbents’ utter dominance of the market (as in tobacco) or the presence of a government-controlled market (as in petroleum or transport equipment). The barriers to entry study conducted by Lamberte et al. (1992) was the first industrial organization economics type of study and to date, the most comprehensive in terms of scope and analysis. The study was based on six case studies covering telecommunications, glass, man-made fibers, cement, iron and steel, and passenger cars and was supplemented by a review of existing industry studies conducted in the country at that time. The study confirmed the presence of high concentration in Philippine industries that gave rise to uncontestable markets in these industries. The study found that generally, government policy induced the entry barriers in several industries and at times, these government policy-induced barriers even reinforced the existing structural barriers to entry such as excess capacity, absolute advantages (through franchises, credit subsidies and fiscal incentives) and limit pricing (via price and rate regulation). More- over, the presence of barriers to entry undermined the effectiveness of the structural reforms implemented during that time. The microlevel findings of the study are: • Concentration in the following sectors may have resulted from deliberate government policy of protection and promotion: – Traditional natural monopolies such as telecommunications, power distribution, interisland shipping and banking – Favored industries under the government’s progressive manufacturing programs which include cars, trucks, motorcycles, integrated steel mill and synthetic fiber – Special “modernization” programs for distressed industries like textiles and cement • A cartel-like behavior was observed in flour milling, cement and interisland shipping. The government was seen as having a hand in tolerating or abetting collusionary arrangements in these industries. • Entry barriers negatively affect users as indicated by the price comparisons between domestic and border prices. Domestic prices were higher than border prices over long periods in car assembly, flat glass, synthetic fibers, and cement. • Entry barriers served to keep inefficient firms operating or if these firms were efficient, allowed them to generate monopoly rents. This was apparent in cement, glass manufacturing, shipping, and pulp and paper.

In 1993, the PIDS carried out a project on Development Incentives Assessment (DIA) that had an industry studies component designed to analyze the response of 42 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Philippine manufacturing industries to the trade policy reform of the 1980s. Using concentration ratios estimated by the World Bank, Tecson (1996) noted that trade liberalization was accompanied by a deconcentration of manufacturing industries as indicated by a general pattern of decline in four-plant concentration ratios between 1983 and 1988. The average concentration ratio for manufacturing decreased from 70 percent in 1983 to 63 percent in 1988. Quantitative restrictions and import licensing, particularly of imported intermediate and capital goods, constituted powerful entry barriers in the industry. The whole postwar history of industrialization was characterized by a series of special programs and laws that granted privileges and incentives to selected firms and industries. While some of these policies remained in force, the trade policy reform provided firms with relatively greater access to supply and lower import prices of capital equipment and other production inputs. This lowered some of the formidable barriers into industries. Furthermore, given the profitability of protected industries, new entrants were attracted to challenge the incumbents. Out of the 31 sectors, only eight showed an increase in concentration. These were beverages, tobacco, wood and cork products, industrial chemicals, glass and glass products, nonferrous metal products, electrical machinery, and professional and scientific equipment. The DIA project carried out the following industry studies: textile and garments, motorcycle and parts industry, meat and dairy processing, appliance, packaging, synthetic resin and plastic, agricultural machinery, and shipbuilding and repair. One important contribution of these studies (except for textile and garments and motorcycle and parts) was the inclusion of industrial organization issues in their trade policy analysis. Concentration ratios and price-cost-margins were estimated and existing barriers to competition were identified. The other industry studies included in the review were carried out by Tolentino and Philexport (1998 and 1999) on sugar, Mercado-Aldaba (1996) on passenger cars, and the Development Bank of the Philippines (1992) on cement and pulp and paper. Table 1 presents the different manufacturing industry studies conducted in the country during the nineties. A classification of the existing barriers to competition identified in the literature was made following the categories listed in Box 1. Barriers to entry can either be structural or behavioral. In the former, regulatory barriers are separated from other structural barriers. Regulatory barriers arise from the government policy of protection, regulation and promotion. Previous studies show that Philippine manufacturing was characterized not only by protectionism and heavy regulation but also by high concentration, notably in slaughtering, dairy processing, appliance, flat glass, pulp and paper, cement, sugar, synthetic fiber, textile and in local car manufacture and assembly sector as well as in motorcycles and parts where the government deliberately limited the number of industry participants. Government involvement in the economy also directly impeded competition through the creation of state-controlled monopoly in the iron and steel industry. The government-owned National Steel Corporation was the only producer of flat products. MANUFACTURING INDUSTRY 43

Table 1. Empirical Evidence on Existing Barriers to Competition in Manufacturing Manufacturing Market Regulatory Structural Behavioral Sector Structure Barriers Barriers Barriers Synthetic Fiber (Lamberte Monopoly Import restrictions Huge capital Excess capacity et al. 1992) High tariffs investment Hot and Cold Milling Government- Import restrictions Excess capacity and Tinning (Lamberte owned Monopoly (quotas) et al. 1992) Passenger Cars Oligopoly Local Content Huge capital investment (Lamberte et al. 1992; Program Mercado-Aldaba 1996) Import ban on CBUs Economies of scale Tariffs and taxes Motorcycle and parts, Oligopoly Local Content Economies of scale (Pineda 1994) Program Slaughtering Oligopoly Import restrictions (de Dios 1994) Large-scale Oligopoly Import restrictions Product differentiation Meat Processing (de Dios 1994) Advertising Dairy Processing Oligopoly High tariffs Sunk costs (de Dios 1994) Import restrictions Economies of scale Product perishability Appliance (Lapid 1994) Oligopoly Government protection Economies of scale Product Access to distribution differentiation channels Capital requirements Technology acquisition Flat Glass (Lamberte Monopoly Import restriction Huge capital Excess capacity et al. 1992; Medilo 1994) High tariffs investment Synthetic Resin: thermo- Oligopoly Tariff protection Huge capital requirement plastic (Banzon 1994) Import restrictions Shipbuilding and Oligopoly Tariff protection Huge capital requirements Repair (Mendoza 1994) Import restrictions Technology acquisition Boatbuilding and Oligopoly Tariff protection Repair (Mendoza 1994) Import restrictions Cement (Lamberte et Oligopoly Bureaucratic procedures Huge capital investment Horizontal price al. 1992; DBP 1992) Import controls Economies of scale fixing High tariffs PCIA approval to establish a new firm or expand an existing one Pulp and Paper (DBP 1992) Oligopoly High tariffs Huge capital requirement Sugar Oligopoly High tariffs Price fixing (Tolentino 1998,1999; SRA intervention in Philexport) the supply and price of sugar 44 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

All of the industries reviewed were found to be heavily regulated by the government. The structural barriers identified in the literature included economies of scale and huge capital requirement. These barriers affected the following industries: synthetic fiber, passenger cars, motorcycle and parts, dairy processing, appliance, flat glass, synthetic resin, shipbuilding and repair, cement, and pulp and paper. The behavioral barriers included excess capacity and horizontal price fixing and were found in the following industries: synthetic fiber, hot and cold milling and tinning, flat glass, cement, and sugar. Clearly, the government policy of regulation, promotion, and protection encouraged greater concentration as a way to compete against imports and achieve economies of scale. This policy of high trade barriers combined with generous long-term investment incentives to domestic industries deterred competition from abroad and contributed to the oligopolistic structure of the Philippine manufacturing industry. With agreements to fix prices (in sugar and cement, for instance), prices are no longer the product of competition among rival producers but more an outcome of negotiations between the government and a small number of producers. Price controls thus result not only in simply limiting the potential for price competition among producers but also in preventing the development of a culture of competition in the country.

ASSESSMENT OF THE OVERALL PERFORMANCE OF THE MANUFACTURING SECTOR BEFORE AND AFTER TRADE POLICY REFORMS

AN OVERVIEW OF TRADE POLICY REFORMS AND PROTECTION STRUCTURE FROM THE 80s TO THE 90s Over the last two decades, there have been three major liberalization episodes in the country. The first major trade policy reform was implemented in 1981 as part of the conditionalities associated with a series of World Bank structural adjustment loans. Between 1981 and 1985, peak tariff rates of 70 to 100 percent were reduced to within zero to 50 percent tariff range. This led to a significant reduction of both the average tariff and the variation in tariff protection across industries. The second episode was legislated during the Aquino administration through Ex- ecutive Order 470. This narrowed down the tariff range to within 3 to 30 percent by the year 1995. The third most important tariff reform was pursued during the Ramos administration. Executive Order 264 further reduced the tariff range to within three to 10 percent by the year 2000 (Medalla et al. 1995). Simultaneous with the implementation of the tariff reduction policy, quantitative restrictions have also been eliminated. The number of import restrictions fell from around 32 percent of the total number of PSCC lines in 1985 to only about 3 percent in 1996. MANUFACTURING INDUSTRY 45

This series of trade policy reforms have significantly reduced the average level of effective protection from 44 percent in 1983 to 24 percent in 1995. For importables, although the effective protection rate (EPR)1 declined from 87 percent in 1983 to 47 percent in 1995, it was still well above the –1.4 percent EPR on exportables. This indicated that a strong bias still remained toward the production of protected importables. While the three major liberalization episodes in the country reduced the average effective protection rate in manufacturing from a high level of 43 percent in 1983 to 19 percent in 1994, protection rate for sectors such as food manufacturing, beverages, tobacco, other chemicals, and fabricated metal products remained relatively high ranging from 29 to 53 percent (Table 2). For some sectors such as transport equipment and food manufacturing, protection even increased from 49 to 57 percent and from 21 to 50 percent, respectively, between 1988 and 1994. Using domestic resource cost (DRC)2 as measure, empirical studies showed that trade reforms led to improvements in competitiveness. The DRC/SER (domestic resource cost/shadow exchange rate) ratio fell from 1.7 in 1983 to 1.5 in 1988 and to 1.18 in 1994. This indicated that as trade liberalization policies were implemented, firms tended to become more efficient.

DID THE PAST TRADE REFORMS RESULT IN DESIRED STRUCTURAL CHANGES? With the introduction of trade reforms, we expected profound changes in industry structure involving both substantial shifts of resources between economic sectors and restructuring within industries. Trade liberalization was expected to drive the process of restructuring and reallocation of resources within and across sectors of the economy such that unprofitable activities contracted while profitable ones expanded.

______

1 The EPR concept is used to measure protection while the DRC framework is employed to determine economic efficiency. The EPR takes into consideration the protection given to the output and inputs of a specific activity. The net effect of protection on output and inputs is indicated by the protection of the activity’s value added. Thus, the EPR is computed as the proportionate increase in domestic value added over free trade value added. 2 The DRC measures the social cost of domestic resources used per unit of net foreign exchange earned by the activity through export, or saved through import substitution. The DRC is compared with the social exchange rate (SER), which represents the opportunity cost of domestic resources used in all activities producing tradable goods. A DRC/SER greater (less) than one indicates comparative disadvantage (advantage) in the production of the tradable good. A DRC/ SER greater than one also implies allocative inefficiency because if the tradable good is not produced, resources could be used in other activities that yield maximum benefits to society (see Medalla et al. 1996). 46 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 2. Effective Protection of Philippine Manufacturing Industries: 1983, 1988 and 1994 PSIC Industry 1983 1988 1994 Total Manufacturing 42.8 28.3 19.17 CONSUMER GOODS 311 Food Processing 32.9 22.3 14.45 312 Food Manufacturing 11 21.3 50.26 313 Beverages 83.7 52 43.96 314 Tobacco 147 60.6 53.39 322 Wearing apparel except footwear 3.1 3.9 4.69 324 Leather footwear -6.5 -5.3 0.22 332 Furniture except metal -2.6 1.9 -0.07 386 Metal furniture 182.7 75.9 -4.51 INTERMEDIATE GOODS 321 Textiles 92.8 30.6 1.93 323 Leather and leather products -13.9 1.7 7.95 331 Wood and cork products 2.1 4.5 7.53 341 Paper and paper products 65.0 29.2 19.86 342 Printing and publishing 68.3 72.4 13.64 351 Industrial Chemicals 53.2 8.5 3.04 352 Other Chemical Products 37.7 44.8 29.14 353 Petroleum refineries 56.6 59.6 20.07 354 Petroleum and coal products 74.5 -5.5 -10.06 355 Rubber products 129.3 18.9 17.31 356 Plastic products 119.7 20.9 17.88 361 Pottery, china, and earthenware 224.1 4.7 3.56 362 Glass and glass products 67.1 37.4 20.21 363 Cement 79.2 42.4 19.49 369 Other nonmetallic mineral products 280.3 17.4 18.40 CAPITAL GOODS 371 Iron and steel 38.3 80.5 9.12 372 Nonferrous metal products -9.7 -11.3 -1.15 381 Fabricated metal products 82.3 66.3 28.74 382 Machinery except electrical 28.1 11.7 0.36 383 Electrical machinery 4.5 30.9 4.72 384 Transport equipment 50.6 48.8 57.32 385 Professional and scientific equipment -13.2 21.0 1.09 OTHERS 390 Miscellaneous manufacture 8.1 4.65 -0.83 Source: Medalla (1998) MANUFACTURING INDUSTRY 47

Table 3 reveals that there has been very little systematic movement of resources in industry and manufacturing. It is the services sector which has been experiencing a major increase in size. The share of services has been increasing since 1980 from about 36 percent to 43.4 percent in 1997. At the outset of the trade reforms, industry had the largest share at 40.5 percent. Its share declined between 1980 and 1985 and since then, there has been no major change in terms of shifts in resources. Agriculture value added slightly increased its share between 1980 and 1985 but dropped from 24.6 percent to 20.7 percent between 1985 and 1997.

Table 3. Structure of Value Added (1985=100) Sector Pre-trade Policy Reforms Post-trade Policy Reform 1980 1985 1988 1994 1997 Agriculture 23.50 24.58 23.58 22.36 20.68 Industry 40.52 35.07 35.24 34.71 35.91 Manufacturing 27.60 25.15 25.71 24.84 25.05 Services 35.98 40.35 41.19 42.93 43.41 Total 100.0 100.0 100.0 100.0 100.0 Source: National Statistical Coordination Board, National Income Accounts.

In terms of changes in employment, Table 4 reveals that there has been no substantial change in terms of the industry’s contribution to total employment. The manufacturing sector failed in creating enough employment to absorb new entrants to the labor force as well as those who move out of the agricultural sector. As Table 4 shows, prior to the trade reforms, employment distribution was biased against industry and manufacturing. The labor force was highly concentrated in agriculture with a share of 51.4 percent while industry had a share of only 15.5 percent. After the trade reforms, agriculture’s share has continuously dropped although apparently at a moderate pace while the share of services increased as it continously absorbed the labor force, thus becoming the largest employer from 1997 to 1999.

Table 4. Structure of Employment Pre-trade Post-trade Sector Policy Reforms Policy Reform 1980 1985 1988 1994 1997 1998 1999 Agriculture 51.4 49.0 47.0 44.7 40.4 39.9 39.1 Industry 15.5 14.2 15.4 15.8 16.7 15.7 15.6 Manufacturing 11.0 9.7 10.3 10.3 9.9 9.5 9.6 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Sources: Pante and Medalla, PIDS Working Paper 90-18; Yearbook of Labor Statistics (October Rounds); Reyes, de Guzman, Manasan and Orbeta, Social Impact of the Regional Financial Crisis in the Philippines (Preliminary Report). 48 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 5 compares the Philippines’ performance in terms of value added distribution and average annual growth rates with other Southeast Asian developing countries. It is evident from the data that our neighboring countries registered significant reductions in the share of agriculture and substantial increases in the size of industry during the period 1986 to 1996. For the years 1993-1996, the average annual share of Philippine agriculture remained at about 22 percent while industry was only 6.3 percent. In contrast, the average annual share of agriculture in Indonesia dropped to 17.5 percent, 14.5 percent in Malaysia, and 10.6 percent in Thailand while the average annual industry share increased to 40.6 percent in Indonesia, 43 percent in Malaysia, and 39.4 percent in Thailand. In these countries, manufacturing has played a leading role with high average annual growth rates of 11.7 percent in Indonesia, 14.1 percent in Malaysia, and 11.8 percent in Thailand. On the other hand, the Philippines only managed to grow at an average rate of 5.8 percent during the years 1993-1996. Indeed, the Philippines needs a significant amount of adjustment before there is complete convergence of sectoral shares with those of our neighbors.

Table 5. Sector Shares and Growth Rates: Philippines, Indonesia, Malaysia and Thailand PHILIPPINES INDONESIA MALAYSIA THAILAND 1986- 1993- 1986- 1983- 1986- 1993- 1986- 1993- 1992 1996 1992 1995 1992 1995 1992 1995 VALUE ADDED Agriculture 23.32 21.95 21.2 17.5 18.5 14.5 14.3 10.6 Industry 34.96 34.98 37.8 40.6 37.9 43.0 35.9 39.4 Manufacturing 25.32 25.04 19.6 23.4 22.6 31.5 26.2 28.7 Services 41.72 43.07 41.0 41.9 43.6 42.5 49.8 50.0 GROWTH RATES GDP 3.31 4.97 7.4 7.6 7.2 9.0 9.8 8.6 Agriculture 1.94 2.42 3.8 2.1 4.0 2.5 4.1 1.9 Industry 3.17 6.31 8.9 10.5 9.9 12.1 13.4 11.0 Manufacturing 3.49 5.79 10.8 11.7 13.3 14.1 14.1 11.8 Services 4.21 5.21 8.0 7.3 6.2 8.3 9.1 8.3 Source: For the Philippines, estimates were based on National Income Accounts data from the National Statistical Coordination Board. For Indonesia, Malaysia, and Thailand, the estimates were taken from Sachs et al. Promotion of Broad-Based Economic Growth in the Philippines, 1998.

Note that there are two caveats here. First, the real appreciation of the peso has often been cited as the main reason for the manufacturing sector’s apparent failure to expand and create employment after liberalization. Second, the current state of data collection in the country still leaves much to be desired. Better measurement of new firms and industries created after liberalization as well as improved estimation of the expanding services sector, which is difficult, is critical to the above analysis. MANUFACTURING INDUSTRY 49

ANALYSIS OF INDUSTRY STRUCTURE AND COMPETITION IN THE MANUFACTURING SECTOR

INDUSTRIAL COMPOSITION AND PERFORMANCE Table 6 presents the distribution of manufacturing value added for the years 1972, 1983, 1988, and 1994. Prior to the trade reforms, intermediate goods comprised the bulk of manufacturing value added with its unchanged share of 45 percent in both 1972 and 1983. Consumer goods followed with a share of 40 percent in 1972 and 34 percent in 1983. Capital goods registered a share which increased from 16 percent in 1972 to 20 percent in 1983. After the trade reforms, the share of consumer goods rose to 44 percent in 1988, which made it the most important sector in terms of value added contribution. Although it fell to 40 percent in 1994, the sector still represented the bulk of manufacturing value added. The share of intermediate goods dropped to 39 percent in 1988 and to 37 percent in 1994. Due to the growing importance of electrical machinery (whose share steadily increased from 3 percent in 1972 to 7 percent in 1983 and 1988 and to almost 10 percent in 1994), the capital goods sector has slowly inched its way from a share of 16 percent in 1988 to 22 percent in 1994. In the consumer goods sector, food processing, food manufacturing, and beverages were the most important subsectors in 1994 as they comprised 67 percent of the sector’s value added. In the intermediate goods sector, other chemicals and petroleum refineries represented almost 50 percent of the sector’s value added while in the capital goods sector, electrical machinery together with iron and steel were the top subsectors with their combined shares of about 65 percent of the sector’s value added. A comparison of the economic performance of the manufacturing sector and its components for the periods 1972-1983, 1983-1988, and 1988-94 is presented in Table 7. The period 1972-83 represents the pretariff reform years while the next periods capture the posttariff reform years. Overall, manufacturing census value added grew at an annual average growth of 3.6 percent during the pretrade reform period 1972-1983. This declined to 0.9 percent during the period 1983-1988, but recovered to 6.6 percent in the period 1988-1994. The average growth of employment continuously dropped from 5 percent prior to the trade reforms to 4 percent in 1983-1988 and to only one percent in 1988-94. During this period, pottery, china and earthenware, electrical machinery, professional and scientific equipment, leather footwear, and transport equipment registered the highest annual average employment growth rates, which ranged from 10 to 13 percent. The number of establishments grew from 2.4 percent before the trade reforms to 10.3 percent in 1983-1988, but this fell to 3 percent in the period 1988-1994. In this period, the glass and glass products, pottery, china and earthenware, industrial chemicals, and iron and steel subsectors posted the highest average annual growth rates in terms of number of establishments, which ranged from 8 to 11 percent. 50 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 6. Distribution of Manufacturing Value Added PSIC Manufacturing Sector 1972 1983 1988 1994 Consumer Goods 40 34 44 40 311 Food Processing 57 29 21 22 312 Food Manufacturing 10 26 22 23 313 Beverages 13 23 27 22 314 Tobacco 16 11 15 14 322 Wearing Apparel except Footwear 2 8 12 16 324 Leather Footwear 0 1 0 1 332 Furniture except Metal 2 2 3 2 386 Metal Furniture 0 0 0 Subtotal 100 100 100 100 Intermediate Goods 44.82 45.45 38.90 36.93 321 Textiles 16.31 12.83 11.74 8.39 323 Leather and Leather Products 0.26 0.35 0.40 0.42 331 Wood and Cork Products 16.60 8.82 7.26 2.70 341 Paper and Paper Products 7.59 5.58 6.95 5.55 342 Printing and Publishing 4.36 2.95 3.21 4.00 351 Industrial Chemicals 5.02 7.64 10.37 7.11 352 Other Chemicals 18.20 16.87 23.87 28.17 353 Petroleum Refineries 12.11 29.99 15.64 21.86 354 Petroleum and Coal Products 0.07 0.12 0.27 0.14 355 Rubber Products 4.83 3.84 6.04 3.74 356 Plastic Products 2.85 3.53 4.35 5.35 361 Pottery, China and Earthenware 0.28 0.55 0.89 1.27 362 Glass and Glass Products 3.02 1.58 3.45 2.85 363 Cement 0.00 3.54 3.72 5.84 369 Other Nonmetallic Mineral Prods 8.50 1.83 1.85 2.61 Subtotal 100.00 100.00 100.00 100.00 Capital Goods 14.95 20.12 16.06 22.42 371 Iron and Steel 16.12 38.72 23.98 20.42 372 Nonferrous Metal Products 0.53 2.86 14.21 4.77 381 Fabricated Metal Products 25.05 9.04 8.86 8.26 382 Machinery except Electrical 10.65 4.48 4.68 5.09 383 Electrical Machinery 19.84 29.51 35.46 44.24 384 Transport Equipment 27.27 15.12 11.74 15.89 385 Professional and Scientific Eqpt 0.53 0.26 1.07 1.33 Subtotal 100.00 100.00 100.00 100.00 390 Miscellaneous Manufacture 0.31 0.54 0.95 1.00 Total 100.00 100.00 100.00 100.00 MANUFACTURING INDUSTRY 51

Table 7. Average Annual Growth Rates of Selected Economic Indicators in the Manufacturing Sector PSIC Manufacturing No. of Establishments Employment Census Value Added Sector 1972-1983 1983-1988 1988-1994 1972-1983 1983-1988 1988-1994 1972-1983 1983-1988 1988-1994 311 Food Processing -6.39 10.02 2.49 -4.56 9.34 2.10 -2.46 -3.95 3.90 312 Food Manufacturing 21.61 6.58 4.79 15.13 0.30 -0.25 13.19 -1.49 3.59 313 Beverages 0.52 1.90 -2.48 5.82 1.65 -3.07 8.61 11.71 1.25 314 Tobacco -3.72 1.34 -6.28 -0.89 -4.47 -3.29 -4.19 6.98 7.37 321 Textiles 2.21 8.78 1.47 3.62 0.78 -5.41 -0.17 -2.44 -0.03 322 Wearing Apparel except Footwr 3.33 25.14 3.68 13.78 13.29 0.61 14.60 14.17 9.62 323 Leather and Leather Products 2.99 14.13 -1.33 10.83 6.76 3.89 8.18 -0.73 11.07 324 Leather Footwear 4.87 18.35 2.82 12.57 0.59 9.89 15.26 -17.61 19.13 331 Wood and Cork Products -2.26 10.92 -5.86 0.65 -1.30 -12.98 -3.30 -4.58 -9.51 332 Furniture except Metal 3.79 13.79 -1.88 8.73 16.11 -8.21 2.12 -3.30 -13.51 341 Paper and Paper Products -0.46 10.76 5.05 -2.10 2.78 2.67 -0.91 6.82 5.72 342 Printing and Publishing 2.20 8.97 3.21 1.76 5.45 2.18 4.30 0.25 10.22 351 Industrial Chemicals 3.41 3.01 7.79 3.81 0.95 1.22 10.99 1.74 -1.92 352 Other Chemicals 2.80 7.87 0.53 2.47 3.88 0.82 6.09 2.59 7.36 353 Petroleum Refineries 0.00 0.00 0.00 6.09 4.23 1.62 4.12 -3.22 15.09 354 Petroleum and Coal Products 9.33 14.87 -2.20 14.41 4.03 5.52 -0.10 30.14 -2.26 355 Rubber Products 2.27 8.24 3.07 5.59 8.31 -1.48 4.95 5.47 -0.84 356 Plastic Products 1.84 13.47 5.79 6.69 0.76 6.83 6.11 5.13 5.29 361 Pottery, China and Earthenware 9.50 16.63 8.80 9.06 16.93 12.92 10.61 11.25 7.81 362 Glass and Glass Products -1.25 1.44 10.57 0.67 -4.59 -1.67 -1.85 17.80 -1.48 363 Cement 0.00 0.96 -4.15 3.17 1.83 9.66 369 Other Nonmetallic Mineral Prods 0.26 8.69 2.19 0.00 -2.39 4.43 -9.49 1.04 7.75 371 Iron and Steel 4.81 0.50 7.76 6.51 -2.30 5.66 18.27 -12.94 7.22 372 Nonferrous Metal Products 6.22 -1.89 2.11 19.67 -6.52 5.64 31.95 30.79 -5.55 381 Fabricated Metal Products 0.49 6.33 6.24 1.65 1.87 5.56 3.23 -5.45 11.97 382 Machinery except Electrical 4.84 6.61 0.97 4.74 1.60 3.35 2.94 -5.36 14.84 383 Electrical Machinery 3.75 6.34 4.85 13.04 0.68 12.12 17.04 4.18 17.18 384 Transport Equipment -1.52 1.99 5.45 3.08 -9.02 9.67 6.35 -10.45 18.19 385 Professional and Scientific Eqpt -1.64 1.92 2.82 2.64 31.39 10.27 -0.41 23.72 14.29 386 Metal Furniture 0.68 2.11 1.22 9.42 -3.21 9.88 390 Miscellaneous Manufacture 3.58 19.33 -0.26 6.72 23.15 1.82 9.02 9.06 4.98 Total 2.36 10.32 2.70 4.56 3.80 1.01 3.61 0.59 6.63 52 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Value added growth at the subsector level was highly variable. Eight manufacturing subsectors posted positive annual growth rates for the three periods under review. These included beverages, wearing apparel except footwear, printing and publishing, other chemicals, plastic products, pottery, china and earthenware, electrical machinery, and miscellaneous manufactures. Electrical machinery posted the highest average annual growth rate of 17 percent during the 1988-1994 period. Other manufacturing subsectors that were growing during the 1972-1983 period registered negative average annual growth rates immediately after the implementation of trade reforms, i.e., 1983-1988, but recovered in the succeeding period, 1988-1994. These subsectors covered food manufacturing, leather and leather products, leather footwear, petroleum refineries, iron and steel, fabricated metal products, cement, machinery except electrical and transport equipment, which posted the highest average annual growth rate of 18 percent during the 1988-94 period. Some manufacturing subsectors that posted negative annual average growth rates prior to the trade reforms experienced improvements in terms of economic performance as suggested by their positive average value added growth rates for the periods after the trade reforms. These included tobacco, paper and paper products, other nonmetallic mineral products, metal furniture and professional and scientific equipment, which posted an average annual growth rate of 14 percent in the 1988-1994 period. Printing and publishing steadily grew from 14.4 percent to 17.5 percent and to 19.4 percent during the three periods under review. Other nonmetallic mineral products grew from a low 3 percent to 15.7 percent between the periods 1972-1983 and 1983-1988. Its growth rate further increased to 21.9 percent during the period 1988-1994. Fabricated metal products increased from 10.9 percent to 13.4 percent and to 21 percent while machinery except electrical rose from 12.5 percent to 14.5 percent and to 24.5 percent in all three periods under study. Except for fabricated metal products, the increasing trend in the growth of the subsectors’ value added is not accompanied by corresponding increases in the growth of the subsectors’ number of establishments and employment. Textiles and wood and cork products performed poorly for all three periods under review. These subsectors experienced substantial reduction in their value added as suggested by their negative average annual growth rates prior and after the trade reforms. Food processing posted negative growth rates for the two succeeding periods under study, but was able to bounce back in the third period. Glass and glass products and petroleum and coal both had negative average annual growth rates prior to the trade reforms; although their performance improved immediately after the implementation of trade reforms, this was not sustained as they again posted negative growth rates in the third period. Other subsectors like industrial chemicals, nonferrous metal products and rubber products, which were characterized by positive value added growth rates before and immediately after the trade reforms, performed poorly in the last period (1988-1994). Manufacturing has become more capital intensive from P65,600 per worker in 1983 to P110,610 per worker in 1988 (Table 8). In 1994, the ratio increased to P135,306 per worker. Almost all subsectors followed the same rising trend except for nonferrous metal MANUFACTURING INDUSTRY 53

Table 8. Capital Intensity, Capital Productivity and Labor Productivity in the Manufacturing Sector K/L ratio CVA/K ratio CVA/L ratio PSIC Manufacturing Sector (in 000 pesos) (in 000 pesos) 1983 1988 1994 1983 1988 1994 1983 1988 1994 311 Food Processing 94.9 93.3 310.3 1.4 2.1 1.3 131.5 196.0 400.8 312 Food Manufacturing 75.6 97.9 234.2 0.7 1.4 1.4 53.9 140.4 324.3 313 Beverages 117.3 169.0 758.9 1.3 3.1 1.5 153.6 516.3 1150.2 314 Tobacco 73.4 44.5 134.5 1.6 13.4 11.4 114.6 595.2 1532.4 321 Textiles 69.4 94.4 212.6 0.5 0.7 0.7 37.7 68.0 157.6 322 Wearing Apparel except Footwr 7.8 9.9 31.1 2.6 5.2 4.5 20.4 51.2 139.4 323 Leather and Leather Products 14.3 22.3 44.0 1.7 1.8 1.8 24.6 41.0 79.1 324 Leather Footwear 11.0 10.4 32.2 2.8 2.6 2.2 30.7 27.3 72.1 331 Wood and Cork Products 34.4 31.6 103.9 1.1 2.1 1.3 37.3 67.1 133.6 332 Furniture except Metal 9.0 14.3 44.4 2.4 2.8 2.2 21.6 40.6 98.9 341 Paper and Paper Products 196.1 148.3 452.7 0.5 1.6 0.8 105.2 234.1 371.1 342 Printing and Publishing 32.0 39.8 124.6 1.6 2.1 1.7 49.4 84.7 215.3 351 Industrial Chemicals 231.9 1288.0 1096.0 0.8 0.4 0.7 186.2 493.7 732.3 352 Other Chemicals 51.0 119.5 376.4 3.4 3.5 2.9 174.0 417.0 1089.3 353 Petroleum Refineries 460.5 1498.911546.1 8.3 2.2 0.9 3825.0 3321.7 9802.5 354 Petroleum and Coal Products 59.7 78.0 173.5 1.1 3.2 1.3 65.2 251.3 221.8 355 Rubber Products 23.0 65.6 103.3 2.4 1.8 1.8 55.3 119.6 188.4 356 Plastic Products 37.3 59.3 162.0 1.4 2.2 1.5 53.0 128.9 240.3 361 Pottery, China and Earthenware 59.2 58.4 121.1 1.0 1.6 1.2 60.6 93.0 147.8 362 Glass and Glass Products 117.0 136.2 957.7 0.5 2.3 0.7 55.0 310.8 659.8 363 Cement 270.1 642.6 2192.7 0.5 0.5 0.5 122.4 326.0 986.4 369 Other Nonmetallic Mineral Prods 51.9 57.7 200.8 0.7 1.5 1.1 38.1 89.1 225.5 371 Iron and Steel 205.6 559.9 1344.5 1.2 0.6 0.5 248.5 330.3 690.9 372 Nonferrous Metal Products 191.9 3966.0 2866.4 0.5 0.3 0.3 88.3 1172.4 968.4 381 Fabricated Metal Products 35.0 48.5 133.7 1.5 1.8 1.5 52.2 89.2 205.2 382 Machinery except Electrical 21.4 33.1 142.5 1.4 1.7 1.2 30.3 55.9 170.5 383 Electrical Machinery 32.5 89.4 227.3 1.9 1.6 1.3 62.7 139.1 298.8 384 Transport Equipment 98.0 137.6 6.0 0.8 1.3 1.8 75.9 180.8 10.7 385 Professional and Scientific Eqpt 23.6 34.5 63.7 1.3 1.8 2.3 31.1 62.5 148.7 386 Metal Furniture 77.0 68.8 113.1 0.4 0.7 0.8 28.0 44.6 94.5 390 Miscellaneous Manufacture 18.9 12.8 65.8 1.9 4.1 1.8 35.4 52.4 120.9 Total 65.6 110.6 135.3 1.2 1.4 1.2 79.3 157.5 166.6 Notes: CVA : Census value added K/L ratio: Capital/Labor Sources: 1972-1988 Census data were from the World Bank, The Philippines. An Opening for Sustained Growth, April 1993. 1994 Census data from the National Statistics Office. 54 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES products and transport equipment whose capital/labor ratios dropped between 1988 and 1994. Petroleum refineries had the highest capital/labor ratio followed by nonferrous metal products, cement, iron and steel and industrial chemicals. Capital productivity in manufacturing slightly increased from 1.2 in 1983 to 1.4 in 1988. However, this dropped back to its pretariff reform ratio of 1.2 in 1994. Three subsectors experienced rising capital productivity over the three years under study. These included transport equipment, professional and scientific equipment, and metal furniture. Tobacco had the highest capital productivity in 1994 while wearing apparel except footwear was a far second. Labor productivity rose from P79,280 per worker in 1983 to P157,510 in 1988 and to P166,580 in 1994. Petroleum refineries had the highest labor productivity followed by beverages and other chemicals. While almost all subsectors had rising labor productivity for all three years under study, petroleum and coal products, nonferrous products and transport equipment witnessed reductions in their labor productivity between 1988 and 1994. Table 9 presents the size structure of the manufacturing industry. Philippine manufacturing has often been characterized as having a dualistic size structure since the import substitution phase of the 1950s (World Bank 1993). The table indicates that the industry is still dominated by a small number of very large firms. In 1995, large-scale establishments accounted for 76 percent of manufacturing value added and 67 percent of employment, although they represented only 10 percent of all firms. On the other hand, small establishments, which represented 82 percent of all firms, accounted for a 21 percent share of employment and only 11 percent of manufacturing value added. Me- dium-scale establishments, which numbered 8 percent of all establishments, accounted for 12 percent of employment and 13 percent of manufacturing value added.

Table 9. Firm Size Distribution in Philippine Manufacturing: 1972, 1983, 1988, 1994 and 1995 (%) Number of Firms 1972 1983 1988 1994 1995 Small 83 78 84 72 82 Medium 7 9 7 12 8 Large 10 13 9 16 10 Employment 1972 1983 1988 1994 1995 Small 22 18 24 21 21 Medium 10 10 12 13 12 Large 68 72 64 66 67 Census Value Added 1972 1983 1988 1994 1995 Small 15 11 12 11 11 Medium 12 8 11 12 13 Large 74 81 77 77 76 Note: Small-sized establishments employ 10 to 99 employees, medium-sized establishments have 100 to 199 employees while large establishments have 200 or more workers. Sources: National Statistics Office, 1972, 1983, 1988, and 1994 Census of Establishments. MANUFACTURING INDUSTRY 55

DOMESTIC COMPETITION AND CONCENTRATION

Concentration and profitability Table 10.1 presents the estimates of four-firm concentration ratios in the manufacturing sector for the years 1988, 1994, and 1995. After trade liberalization, the average four-firm concentration ratio in manufacturing remained high for all three years under review. It even went up slightly from 70.88 in 1988 to 73.63 in 1994 and remained at the same level in 1995. The estimates show that the manufacturing sector is highly concentrated with roughly two-thirds of the manufacturing industry having concentration ratios ranging from 70 to 100 percent. The estimates also imply that on the average, 73.6 percent of value added were from the top four firms in each manufacturing subsector. Subsectors with high level of concentration are mostly intermediate and capital goods such as petroleum refineries, glass and glass products, industrial chemicals, pottery, china and earthenware, petroleum and coal products, rubber products, other nonmetallic mineral, paper and paper products, professional and scientific equipment, nonferrous metal products, transport equipment, iron and steel, machinery except electrical, textiles, other chemicals (a borderline case), and fabricated metal products. Con- sumer goods like tobacco, food manufacturing and food processing also belong to the high concentration group. The moderate concentration group consists of subsectors with ratios ranging from 40 to 69 percent. In 1995, this group included beverages, electrical machinery, metal furniture, wood and cork products, cement, printing and publishing, leather footwear, furniture except metal, plastic products, and leather and leather products. Only wearing apparel except footwear fell under the low concentration group. Price-cost margins were estimated as a rough measure of market power. On the average, the manufacturing industry posted a price cost margin of 30 percent in 1988. This increased to 34 percent in 1994 and to 36 percent in 1995. The table shows that in 1995, price cost margins remained high particularly for tobacco (57 percent), other chemicals (46 percent), other nonmetallic minerals (40 percent), food manufacturing (41 percent), and glass and glass products (52 percent). These manufacturing industries were among the subsectors with very high degrees of concentration. Even subsectors classified under medium and low degrees of concentration have relatively high price- cost margins. For instance, moderately concentrated subsectors like beverages had a price-cost margin of 57 percent in 1995, cement with 42 percent while a nonconcentrated subsector such as wearing apparel registered a price-cost margin of 32 percent. A combination of high price-cost margins and high concentration ratios tend to suggest that firms are able to exercise market power and that some monopoly rents are being incurred. Table 10.2 confirms the positive correlation between concentration and industry profitability for the Philippine manufacturing sector. The table shows a positive and highly significant correlation between profitability and concentration for all three years: 1988, 1994, and 1995. 56 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 10.1. Concentration Ratios and Performance Indicators Manufacturing Sector: 1988, 1994 and 1995 Sectors Concentration Number of Price-Cost Ratios Establishments Margins 1988 1994 1995 1988 1994 1995 1988 1994 1995 HIGH Petroleum Refineries 100.00 100.00 100.00 4 4 4 0.18 0.22 0.32 Professional and Scientific 100.00 100.00 99.97 14 13 20 0.32 0.23 0.24 Tobacco 96.64 99.56 99.41 25 21 22 0.48 0.56 0.57 Nonferrous Metal Products 99.67 99.28 98.57 35 34 40 0.24 0.18 0.24 Glass and Glass Products 96.33 90.58 92.05 35 53 46 0.46 0.5 0.52 Industrial Chemicals 90.14 87.52 84.65 112 171 197 0.37 0.34 0.31 Transport Equipment 80.98 86.20 84.40 230 264 265 0.28 0.23 0.23 Pottery, China and Earthenware 92.82 86.05 93.74 59 68 61 0.34 0.34 0.35 Food Processing 79.51 81.37 81.74 915 751 717 0.3 0.3 0.32 Iron and Steel 84.18 80.64 70.55 128 191 201 0.23 0.43 0.24 Machinery except Electrical 63.59 77.47 79.43 556 464 460 0.28 0.32 0.28 Petroleum and Coal Products 81.10 77.00 87.40 16 14 16 0.24 0.14 0.26 Fabricated Metal Products 73.45 74.48 74.32 469 555 550 0.28 0.32 0.28 Other Chemicals 66.37 75.64 69.09 300 288 295 0.4 0.46 0.46 Rubber Products 79.15 73.50 73.66 137 187 181 0.24 0.28 0.37 Other Nonmetallic Mineral 68.92 71.31 74.54 353 304 253 0.34 0.37 0.4 Paper and Paper Products 78.97 71.23 70.40 167 215 206 0.32 0.3 0.29 Miscellaneous Manufacture 70.87 70.62 76.76 342 312 309 0.27 0.23 0.31 Textiles 64.12 64.14 72.37 549 537 508 0.28 0.24 0.3 Food Manufacturing 63.48 69.74 77.92 2003 1879 1798 0.32 0.33 0.41 MODERATE Beverages 48.19 70.08 63.43 91 86 88 0.31 0.56 0.57 Electrical Machinery 64.80 69.36 63.73 217 271 310 0.21 0.22 0.28 Metal Furniture 80.88 79.49 62.67 36 34 35 0.3 0.1 0.21 Leather and Leather Products 57.70 63.89 64.02 120 84 85 0.17 0.16 0.23 Wood and Cork Products 40.50 55.47 65.35 683 401 354 0.22 0.24 0.23 Cement 45.30 48.30 45.37 17 18 18 0.28 0.37 0.42 Printing and Publishing 42.13 47.26 51.08 636 637 636 0.25 0.28 0.32 Leather Footwear 30.33 41.70 55.00 425 384 373 0.19 0.14 0.2 Furniture except Metal 19.51 40.91 41.64 678 497 439 0.22 0.24 0.25 Plastic Products 49.41 40.75 50.87 300 377 365 0.27 0.29 0.29 LOW Wearing Apparel except Footwear 34.70 31.69 26.52 1556 1512 1521 0.25 0.13 0.32 Total Manufacturing 70.88 73.63 73.64 11208 10726 10373 0.30 0.34 0.36

Note: The concentration ratios refer to the ratio of census value added by the four largest firms to the total in each five-digit PSIC sector. The concentration ratios given above are weighted averages for three-digit PSIC. The price-cost margin (PCM) was estimated as follows: PCM = [(Value of Output - Cost of Raw Materials – Total Compensation )/Value of Output]. The price cost margins given above are weighted averages for three-digit PSIC. Source of basic data: 1988 and 1994 Census of Establishments and 1995 Annual Survey of Establishments, National Statistics Office. MANUFACTURING INDUSTRY 57

Table 10.2. Correlations Between Concentration and Industry Profitability Price-Cost Margin 1988 1994 1995 Four-firm Concentration Ratio 0.00306 0.00298 0.00338

Table 10.3 presents the results using a conventional regression specification of the concentration-profits relationship including capital intensity. This variable is added to control the result that a positive relationship between concentration and profitability could wrongly reflect the firms’ large capital costs per unit of output. In future price regressions, it is also important to include variables representing barriers to entry like product differentiation, economies of scale, and absolute cost advantages. The absence of reliable data has prevented the present analysis from taking these into account. Except for 1995, the results show that concentration is highly significant for the Philippine manufacturing industry. The coefficient for capital intensity had the expected positive sign but was significant only for 1995 and for the pooled data. Although it was negative in 1988 (implying that capital-intensive industries performed badly in 1988), this was statistically insignificant.

Table 10.3. Estimates of the Concentration-Profits Relationship Dependent Variable: Price Cost Margin 1988 Constant 0.19008** Concentration Ratio 0.00094** Capital Intensity -0.01133 R2 0.025 1994 Constant 0.17405** Concentration Ratio 0.00098** Capital Intensity 0.01355 R2 0.030 1995 Constant 0.24560** Concentration Ratio 0.0005 Capital Intensity 0.02867* R2 0.024 Pooled Data Constant 0.19450** Concentration Ratio 0.00089** Capital Intensity 0.01707* R2 0.03 **Significant at the 1 percent level. * Significant at the 5 percent level. 58 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The positive correlation/relationship between concentration and profitability in Philippine manufacturing is consistent with both the structuralist school and the efficiency hypothesis or Chicago school. According to the structuralist line, industrial concentration fosters collusion and hence, monopoly pricing. A positive coefficient can be taken as an indication that any further increase in market concentration due to a merger, for example, would increase market power and therefore, the price that consumers of the product have to pay. On the other hand, the efficiency hypothesis points out that superior firms in an industry that make a product or cost breakthrough will gain market share, causing industry concentration to increase. Broadly interpreted, the efficient markets hypothesis states that markets are workably competitive and that the market structure reflects differential efficiency, not strategic behavior. Domi- nant firms owe their position to superior performance, not to strategic behavior, or the history of entry into the industry and the profits are simply the rents that accrue to superior technology (Stigler 1968 and Demsetz 1973 as cited in Gilbert 1990). The Chicago school would interpret a positive relationship between concentration and profitability as due to higher efficiency and not to the presence of market power. Note that firms may achieve a dominant position in a market through methods that are perfectly legitimate, for example, through the adoption of efficient business practices like innovation, adoption of superior production/distribution methods, or simply greater entrepreneurial efforts. In the Philippine context, empirical analysis indicated that after the implementation of trade liberalization, manufacturing firms tended to become more efficient as shown by the reduction in their average domestic resource costs between 1988 to 1994. It is important to recognize that the Philippine is characterized by limited R&D and S&T activities particularly private sector underinvestment in R&D. Cororaton (2000) noted that the estimated gap in R&D investment is about 0.58 of GNP or approximately P14 billion in current prices. Underinvestment is prevalent in almost all sectors notably in agriculture and manufacturing. The Philippines is also characterized by a high concentration of wealth and resources in a few families representing the country’s elite group. For instance, the top 5.5 percent of all land-holding families own 44 percent of all tillable land. The richest 15 percent of all families account for 52.5 percent of total national income. Only a few family-owned conglomerates control the bulk of industry sales, employment and assets (Foundation for Economic Freedom, Economic Policy Agenda Series No.5). The concentration of economic wealth among a small number of families and groups combined with high levels of industrial concentration may raise competition problems. Interlocking directorates are common in the country and this may encourage the sharing of information and coordination of anticompetitive behavior. There is always the danger that with high price-cost margins, high concentration ratios, and high concentration of ownership around family-based conglomerates, large firms may take advantage of their market power and abuse their dominant position. MANUFACTURING INDUSTRY 59

CONCLUSIONS AND POLICY RECOMMENDATIONS

The Philippine manufacturing industry developed under a complex policy package of protection, promotion, and regulation. The policies resulted in an inefficient allocation of resources and encouraged greater concentration as a way to compete against imports and achieve economies of scale. The industry studies reviewed indicated the presence of regulatory barriers, which included import restrictions and high tariffs, as well as behavioral barriers like cartels and structural barriers such as economies of scale and huge capital requirement. With the presence of high trade barriers, competition from abroad was impeded. Cartel-like practices, which were sanctioned by the government, as well as government involvement in the economy through state-controlled monopolies, limited the potential for price competition among producers, thus failing to nurture the culture of competition in the country. Since the 1980s, the Philippines has witnessed substantial trade reforms that included tariff reduction and removal of quantitative import restrictions. These policy changes intended to expose industries to international competition and emphasized the need to improve quality, cost and innovation. After more than a decade of implementation, these reforms have not resulted in a major increase in the size of industry and systematic movement of resources toward the manufacturing sector. Despite real progress in implementing trade liberalization, the real growth of the manufacturing sector has been slow. One possible reason for this slow growth is that barriers to competition continue to exist and are preventing industries from maximizing the gains from trade liberalization. As liberalization progresses, private enterprises may continue to engage in restrictive business practices to offset the effect of liberalization. Mergers and acquisitions especially those between large scale firms may result in an increase in market concentration and a reduction in competition. An economy may remain sluggish for a long time, trapped in a cycle of weak competition, low productivity, and slow growth if large incumbent firms with monopoly power are able to prevent new entrants into existing markets; if government intervenes to distort foreign or domestic trade; and if access to credit, land, infrastructure, or distribution outlets inhibits new firms from competing vigorously. The situation becomes particularly risky for those firms engaged in the manufacture of inputs into other production processes. The output of such sectors may be essential to the ability of downstream firms to compete effectively on international markets, and weak competition or low productivity in these sectors may have social costs significantly higher than calculations of private costs (Fingleton et al. 1995). Estimates showed that for the manufacturing industry as a whole, concentration in most sectors remained high from the late 1980s to the mid-1990s. The four-firm concentration level for the whole manufacturing industry increased from 70.88 in 1988 to about 74 in 1994 to 1995. Around two-thirds of the manufacturing subsectors had very high concentration levels that ranged from 70 to 100 percent. 60 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Available data also indicated that price-cost margins (PCM) moved in the same direction as concentration levels. The PCM increased from 30 percent in 1988 to 34 percent in 1994 and to 36 percent in 1995. Some highly concentrated subsectors were found to have very high PCMs such as tobacco (PCM: 57 percent), glass and glass products (PCM: 52 percent), food manufacturing (PCM: 41 percent), and other nonmetallic mineral products (PCM: 40 percent). The relationship between concentration and profitability is estimated using regression techniques. The results confirmed the positive correlation/relationship between concentration and profitability in Philippine manufacturing. This positive relationship is consistent with both the structuralist school and efficiency hypothesis or Chicago school. However, given the limited R&D and S&T activities in the country, particularly the underinvestment by the private sector in manufacturing and agriculture R&D/S&T activities, one is inclined to believe that the structuralist school may be more applicable to us. The high concentration of industries in a few family-owned conglomerates coupled with high levels of concentration and profitability may also indicate the presence of market power which may raise competition problems. Future studies should take a more in-depth analysis of this issue. The current paper only gives a general sense of the extent of competition in the manufacturing industry owing to the broad nature of the sector and the absence of reliable data. Industry cases are needed not only to extend the variety of industries studied but also to delve into details. Hence, there is a need to collect detailed price data, to monitor the behavior of individual firms, and to identify restrictive business practices and other barriers to competition. These are the only means through which conclusive evidence on the state of competition in manufacturing could be reached. To sum up, liberalizing the trade regime—removing tariff and nontariff barriers, removing anti-export bias, and increasing import competition—constitutes the basic agenda for the deregulation of the international trade regime and complements deregulation efforts in the domestic markets. Even if trade barriers are removed, there are other factors that can impede the procompetitive effects of trade liberalization. These include (1) the presence of nontradables as well as high weight-to-value products with high transport costs, perishables, and legal, financial and other services; and (2) the absence of effective competition due to the presence of regulatory, structural, and behavioral barriers to entry. The presence of these barriers prevents domestic and international prices from converging, thus muting the gains from trade liberalization. While liberalization may be a precondition for the growth of a free market, it does not, by itself, guarantee effective competition. In the absence of competition laws, there is a risk that liberalization may not be sufficient to foster effective competition and it would also be difficult to control possible abuses of dominant positions by large scale firms including multinationals. If effective competition has to emerge, trade reforms have to be accompanied by the creation of competitive market and industry structures. MANUFACTURING INDUSTRY 61

It is, thus, necessary to design safeguards that would ensure market contestability and regulate anticompetitive business conduct which can damage emerging competition. A well-drafted competition law is an important policy measure that the government should undertake. The adoption of a sound competition policy and establishment of an effective competition agency will buttress measures such as trade liberalization and deregulation with more domestic market competition. It is also essential to remove the remaining barriers to competition and enforce a competition policy that would foster the efficient use of resources and promote consumer welfare while protecting the freedom of economic action of various economic agents. Markets and their development require rules to orient the behavior of agents and institutions. For instance, cartels have been an accepted practice in the past. Given this environment, a competition agency has a critical role in changing the mindset of enterprise managers and the code of conduct of firms. Finally, in this age of globalization, deregulation, and liberalization, the idea of having competition law becomes a fashionable one. While it is easy to jump into this, policymakers need to remain cautious. They should be aware that the problems faced by developing countries in creating an effective competition law system are far different from those faced by developed countries. Our country needs a competition law to complement previous and ongoing market-oriented reforms. It should be emphasized that any attempt to make the implementation of competition law as a source of intervention in the market, corruption, misuse of bureaucratic power, or cause of market distortions must be rejected. The competition institutions to be created must possess accountability, transparency, checks and balances, and clear rules and procedures. While there is a need to revise our existing inefficient competition laws and pass new ones, proper care should be exercised in formulating the country’s competition laws taking into consideration our country’s institutional endowments, technical capacity, and financial capability.

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Of Cartels and Collusion: An Analysis of the Philippine Cement Industry

Rafaelita A. Mercado-Aldaba*

“Businessmen’s meetings, even for merriment and diversion usually end up in connivance to restrict competition. It is impossible indeed to prevent such meetings, by any law, which either could be executed, or would be consistent with liberty and justice.” — Adam Smith

ABSTRACT

his paper shows that the average market shares of cement firms in the last 13 years have remained high and stable. The industry has maintained a highly concentrated structure and entry is not easy because of the large capital re Tquirements necessary to operate a cement plant. The natural characteristics of cement—high transportation costs and relatively short shelf life—provide natural protection against competition from imports. The demand for cement is inelastic (estimated at about 0.29), providing substantial market power to firms. ______

* The author benefited from the insightful comments and suggestions of Dr. Gwen Tecson, Dr. Corinna Bautista, Dr. Linda Medalla and Dr. Mario Lamberte. The research assistance of Ms. Cora Pisano in the preparation of this paper is gratefully acknowledged. 66 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Market power is the ability of firms to raise and maintain prices above the level that would prevail under competition. The cement industry illustrates a clear case of market failure due to the existence of market power. The Lerner index (price-cost margin) estimates show that the cement firms are able to increase prices substantially above marginal costs. The price-cost margins ranged from 0.5 to 1.68 in Northern Luzon, 0.15 to 0.89 in the National Capital Region (NCR), 1.21 to 1.26 in Visayas, 0.24 to 1.36 in Mindanao, and 3.45 in Southern Luzon where only one firm operated. These high Lerner index estimates indicate that the cement firms have tremendous market power, which they do not hesitate to exercise collectively in order to earn higher profits and prevent effective competition from taking place. This results in higher prices and loss of economic welfare. The situation calls for the formulation of comprehensive competition law and policy that will address cartels and collusion. Without antitrust or competition laws, a small developing country like ours would have very little recourse against cartels, collusion, and other anticompetitive behavior.

INTRODUCTION

The cement industry in the Philippines developed under a complex array of regulatory controls, protective policies, and investment incentives designed to promote the industry. With the demise of the import substitution model, the government was prompted to institute reforms consistent with the demands of a competitive market. Starting in the late 1980s, the government deregulated the cement industry, removed import restrictions, and gradually reduced tariffs. Yet the more than 15 years of regulation, protection, and promotion have left a highly concentrated industry that was controlled by a small group of families who wielded economic and political influence in the country. It was not surprising that their owners were able to extract monopoly rents in the market. The mergers and acquisitions following the entry of large multinational cement firms in the late 1990s only highlighted the market concentration and absence of competition in the industry as the firms continued to collude and exercise their collective market power. Despite some real progress in implementing reforms in the industry, competition has remained limited. The ability of cement firms to engage in restrictive business practices has offset the effects of deregulation and liberalization. The firms’ anticompetitive practice became evident when their prices went up in an orchestrated fashion in the wake of the 1997 Asian financial crisis. This occurred at a time characterized by excess supply, overcapacity, and weak demand. The main objective of this paper is to assess the current state of competition in the cement industry focusing on firm behavior and industry structure. The paper is divided into five sections. The second section discusses the underlying theories on the need for competition and describes basic economic concepts such as cartels and collu- CEMENT INDUSTRY 67 sion and how they operate. The third section provides a brief history of the cement industry and the economic policies affecting its development. The fourth section is the heart of the paper as it evaluates competition and market power in the cement industry. The competition analysis entails three stages: market definition, market structure, and price analysis. The fifth and final section summarizes the major findings of the paper and presents the policy implications drawn from the competition analysis.

BASIC CONCEPTS AND THEORIES

COMPETITION AND MARKET POWER Competition refers to the process of rivalry among firms that forces them to become efficient and sell a wider range of goods and services at lower prices. The World Bank and the Organization for Economic Cooperation and Development (1998) noted that in a competitive economy, price and profit signals tend to be free of distortions and create incentives for firms to reallocate resources from lower to higher valued uses. Decentralized decisionmaking by firms promotes efficient allocation of society’s resources, increases consumer welfare, and gives rise to dynamic efficiency in the form of innovation, technological change, and economic progress. Firms, however, can have the incentive to obtain market power, i.e., the discretionary control over prices and other related factors determining business transactions. Market power refers to the ability of a firm, unilaterally or in collusion with others, to profitably raise price and maintain it over a significant period of time without competitive response by other existing and/or potential firms. Firms have market power individually or collectively when buyers do not have enough choice of alternative independent sellers. In a competitive market economy, consumers may buy from any firm and firms, in general, can enter any market. There can never be market power when entry is easy. As soon as one firm or a group of firms attempts to increase prices or lower quality from competitive levels, a new firm can come in to serve the market. The price-cost margin or Lerner index (L = [(price-marginal cost)/price]) is used as a direct measure of market power. Market power implies that a firm is able to charge prices substantially above marginal cost. A firm without market power must charge a price that approximates marginal cost. Under perfect competition, firms selling homogeneous products cannot affect market prices. Free entry of new firms ensures that the price, equated with marginal cost, just covers average cost. Firms that attempt to raise price above marginal cost will lose all customers.1 In contrast, market

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1 Assuming that economies of scale do not prevail over the whole range of output and that the minimum efficient scale of production is small relative to the overall market demand (see Neven 1993). 68 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES power is exercised as soon as firms have the ability to increase their own price above marginal cost without losing all customers. Market power arises when a firm produces a differentiated product such that customers do not switch easily to competitors as the price increases. Market power also arises when there is coordination of behavior or collusion between firms such that a price increase is accommodated by competitors (Neven 1993). Market power is expressed by the extent to which firms would be able to raise price profitably. Hence, market power is concerned with the own-price elasticity of demand. The own-price elasticity of demand measures the proportionate decline in sales following an increase in price (assuming that the prices of other products are held constant). The more elastic the demand curve, the more sales will be lost for any given level of price increase. Under these circumstances, firms will not possess market power. The power to control price requires a low own-price elasticity of demand. If the own-price elasticity is low, firms will have significant ability to raise prices profitably since price increases will not result in a significant reduction in sales. The own- price elasticity determines the extent of market power and can be used to directly assess market power issue.

Following Tirole (1988), the Lerner index Li is given by: α ε Li = / where α is firm i’s market share and ε is the elasticity of demand.

The Lerner index is proportional to the firm’s market share and inversely proportional to the elasticity of demand. Most concentration profits studies apply price-cost margins (PCMs) as measures of profitability. Leach (1997) estimated PCM based on the following formula: (Gross Output – Cost of Materials – Salaries and Wages)/Gross Output. Leach noted that the PCM is a crude measure of profitability because many important costs remained in the measure such as cost of capital, depreciation, income taxes, and head office expenses like advertising and R&D expenditures.

CARTELS, COLLUSION AND OLIGOPOLY Collusion describes a type of conduct or form of behavior where firms agree to coordinate their actions. Instead of competing against each other in terms of price, quality, or service, firms jointly agree to set prices and quantities that would maximize total industry profits. In a competitive environment, firms act independently and rivalry is present among competing firms in the market. In a cartel, firms get together and attempt to fix prices or levels of outputs, rig bids in auctions or procurements and divide markets by allocating customers, territories, relevant products or supplies in order to maximize total industry profits. Cartels and collusion are anticompetition because they create market power and suppress CEMENT INDUSTRY 69 rival and consumer activities. Cartels are worse than monopolies because they make it appear that there is competition in the market, when in reality there is none. They make consumers believe that what they see are independent offers while potential investors or rivals are made to believe that the market is sufficiently supplied. By raising prices and restricting supply, artificial shortages are deliberately created. As a result, goods and services become completely unavailable to some buyers and unnecessarily expensive for others. These output restrictions cause inefficiency, reduce productivity, and result in economic and social harm. Collusion is a cooperative game and involves two elements: (1) a process of communication/discussion and (2) an exchange of information with the aim of reaching an agreement and the imposition of punishment in case of deviations. It is important to differentiate between hard and soft cartels. Hard-core cartels or explicit collusion refers to explicit agreements to fix prices or share markets between producers and sellers of substitute products. Soft cartels or tacit collusion refers to collusive agreements that are merely implicit. Implicit coordination may be achieved without any communication or negotiation between firms. There will be no evidence of firms having met or having discussed coordination of market behavior. The only evidence that will be available relates to firms’ market behavior. The operation of both implicit and explicit mechanisms will require information. To be sustainable, information on other firms’ costs, outputs, prices, and discounts are necessary. The greater the number of firms and the more product heterogeneity, the greater these information requirements expand. It is not easy to detect cartels and to uncover them; it is necessary to understand how they work. A cartel needs to convince all significant competitors to increase their prices above competitive level and keep them there long enough to earn monopoly profits. It is difficult to agree on the price because different firms may prefer different prices. A firm with higher cost would prefer higher cartel price while a firm with lower cost would prefer lower cartel price that would still generate monopoly profits. Assuming a price has been agreed upon, the cartel must make sure that no member would cheat by lowering prices. There is always a temptation to produce more than is agreed and hence, make higher profits assuming that the rest of the industry will produce at a constant level and will not respond. To be successful, a cartel must have a punishment strategy to police members’ behavior usually in the form of a price war. This requires that firms must be able to keep track of the prices and production levels of the other firms in the cartel. Oligopoly theory tells us that there are several ways in which firms behave in an oligopolistic environment. The leading models are summarized in Rees (1993). Cournot Model: firms independently choose outputs on the assumption that their rivals make no response to their choices and market equilibrium is achieved through a sequence of alternating output choices, which converge over time. 70 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Stackelberg Model: a leader makes a choice of output, the other firms act as followers and make their profit-maximizing response to this output. The leader takes account of these responses in choosing its output and is able to do better than it would under Cournot reactions. Kinked Demand Curve Model: each firm believes that an increase in its output (reduction in its price) will be matched by its rivals, while a reduction in output (increase in price) will not be followed. This creates a kink in the firm’s perceived demand curve at its current price-output pair, which then tends to remain the same despite changes in marginal cost because of a discontinuity in the firm’s marginal revenue at the kink. Bertrand Model: firms independently choose prices, on the assumption that their rivals make no response to their choices. When firms produce identical outputs and have identical constant marginal costs equilibrium, price ends up equal to this common cost. Edgeworth Model: firms choose prices as in the Bertrand model, with identical constant marginal costs, but with fixed output capacities. There is a range of possible types of outcome and the possibility of price cycles. There is a range of prices the upper and lower limits of which are determined by demand, cost, and capacity param- eters. As firms set prices alternately over consecutive periods, price falls by small steps from the upper limit of the interval until it reaches the lower limit and then jumps back to the upper limit and the cycle begins again. All these oligopoly models are examples of noncooperative games. It is important to recognize that oligopolies are not necessarily detrimental to competition. Large firms may achieve a dominant position in the market through legitimate ways like innovation, superior production or distribution methods, or greater entrepreneurial skills. These firms may act on their own and do not come to an agreement governing their behavior. In general, collusion results in the smallest industry output and the highest price. Bertrand equilibrium, the competitive equilibrium, gives the highest output and the lowest price. The other models provide results that are in between these two extremes. Many theorists see the above models as giving analytical precision to the idea of tacit collusion (Rees). This would not involve explicit agreement but simply the unspoken acceptance by the firms that it is in their best interests to produce the monopoly output on the understanding that failure to do so would provoke a price war. In the real world, there are many facilitating devices that have been developed to help firms achieve successful tacit collusion. These include: • Trade associations: In many industries, associations are usually organized to handle public relations, organize conventions, trade fairs, etc. However, they may also act as facilitating devices as in collecting and disseminating information on costs, outputs, prices, and policing both tacit and explicit agreements: CEMENT INDUSTRY 71

• Price leadership: In this practice, the dominant firm first announces price changes and the other firms follow within a short period of time. It is also possible for a non-dominant firm, which is considered the best at judging market conditions to play this role. This practice of price leadership is a way of addressing the problem of choosing one price agreement in the set of possible agreements. If the leader is good in selecting mutually acceptable prices, the agreement can be entirely tacit. • Basing point price: this is a pricing system where transport costs are high, relative to production costs, and buyers and sellers are spatially dispersed. It is common in industries like steel and cement. Delivered prices are computed according to base prices and transport charges. This arrangement often results in delivered prices to any buyer that is always uniform across sellers and there is no price competition. Sellers must exchange information on base prices and transport charges, but no explicit agreement to collude on prices is made. • There are also many opportunities for company officials to make their views known to each other on the state of the market and the direction prices should take. Examples of these include newspaper interviews, articles in trade publications, or speeches.

The prospect that firms may rely on tacit collusion or implicit coordination enforcement mechanisms to exercise collective market power raises an important issue for competition policy. In the US, collusion is in most instances per se illegal. In the European Community, hard-core cartel agreements are prohibited. In the UK, the policy is directed more at evaluating the results of collusive behavior. Whether firms ‘really’ colluded is not a central issue. What matters is the appraisal of the outcomes of their behavior from the point of view of economic efficiency. In the enforcement of competition policy, the current trend is now moving away from “per se” rule toward the use of the “rule of reason” approach.

AN OVERVIEW OF THE PHILIPPINE CEMENT INDUSTRY

Cement, like other homogeneous products such as sugar and flour, is often cited as a market likely to have a cartel. Historically, the Philippine cement industry thrived under a powerful government-sanctioned cartel that captured Filipino consumers and industry users including the government. Many of the cement firms had direct government participation through guarantees, loans, and equity. The economic slump in the early 1970s resulted in large losses and chronic oversupply prompting cement firms to push for government regulation of the industry. They believed that by government regulation, the industry could prevent cutthroat competition. As the government also had financial interests in the sector, it immediately responded by creating the 72 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Philippine Cement Industry Authority (PCIA) as an attached agency of the Depart- ment of Trade and Industry under Presidential Decree 94 in 1973. The PCIA was tasked to allocate supply, control prices and regulate entry in the industry. In the absence of information, the PCIA had to coordinate closely with the industry association, which is currently known as Philippine Cement Manufacturers Corporation (Philcemcor). The PCIA and the Philcemcor worked closely together in regulating the industry to the point where PCIA delegated the setting of production quotas to Philcemcor. Aside from regulation, the government heavily protected and promoted the industry through high tariffs and import restrictions as well as fiscal incentives under the Board of Investment’s (BOI) rehabilitation, modernization and rationalization program. Collusion in the industry took place through the firms’ informal agreement to set production quotas and to assign geographic markets among themselves (Lamberte et al. 1992). Philcemcor held regular monthly meetings to set production quotas. It also arranged the geographical division of the markets that restricted Luzon plants to sell only in the Luzon area and the Visayas/Mindanao plants to confine their sales in those locations (SGV Consulting 1992). This practice divided the country into regional markets served by a dominant player, thus, eliminating competition from taking place in the industry. By regulating prices and outputs, prices were no longer the product of competition among rival producers but more of the outcome of negotiations between the government and a small number of producers. In 1987, the PCIA was abolished through Executive Order 133, but the price control function was transferred to the Department of Trade and Industry. The price control was momentarily lifted in February 1989 and reemployed in July 1989. Prices were finally deregulated in November 1991 through DTI Administrative Order 10. Moreover, reforms to end territorial arrangements of cement companies and lift DTI approval for establishing or expanding cement plants were carried out through DTI Administrative Order 5 issued in 1990. Simultaneous with the abolition of the PCIA in 1987, the Development Bank of the Philippines (DBP) transferred cement industry financial assets to the Asset Privatization Trust (APT). Most of the firms negotiated the settlement of their debts under the “direct debt buy out” scheme with the APT. APT also bidded out all the cement companies foreclosed by DBP (OECC 1991). Central Bank Circular 1195 lifted the import restrictions on cement in 31 March 1989. At about the same time, the tariff on cement was reduced from 50 percent in 1979 to 40 percent in 1988 and was further cut to 20 percent in 1989. From January 1990 to mid-1991, the tariffs on portland cement and clinker were suspended to address the problem of cement shortage following the expansion of construction activities in the country. In July 1991, the 20 percent tariff on cement imports was restored. This was reduced to 5 percent in 1993-1994 and to 3 percent in 1995-1997. The rate, however, was increased to 10 percent during 1997-1998. In 1999, this was reduced to 7 percent and currently its rate stands at 5 percent. CEMENT INDUSTRY 73

The past three years witnessed the acquisitions of local cement companies by four large foreign firms: Lafarge, Holderbank, Cemex, and Blue Circle. These firms (together with Heidelberger) account for about 60 percent of the annual 100 million metric tons (mt) of the global cement trade. Following the entry of foreign players, consumer groups and industry observers raised concerns on their possible domination of the market and the creation of a cartel. The cement price increases since 1999 baffled many, considering that these price hikes were carried out amid excess supply and weak demand due to the slowdown in construction activity. These price increases immediately following the entry of foreign players prompted industry analysts to believe that a cement cartel was at work. Philcemcor defended the companies by saying that the price increases were inevitable due to the high production costs and finance charges. The financial crisis struck at a time when cement companies were expanding in anticipation of increased economic growth. This resulted in dramatic increases in their foreign-denominated loans and high interest rates on local loans. Congress immediately initiated investigations on the reemergence of a cement cartel. The DTI also conducted preliminary investigation on the possible collusion among members of the suspected cartel to keep cement prices above normal levels. So far, there is still no official announcement on the findings of these cartel investigations.

COMPETITION ANALYSIS

Three major steps were adopted in assessing competition in the cement industry: • Market definition: What are the products and geographic areas that form part of the relevant market? • Market structure issues: What are the market shares, concentration, and entry conditions in the industry? Does the industry possess market power? • Price analysis: Are movements in prices consistent with competition or with collusion? Are there significant price differences among geographic markets? Do we see prices in one geographic market that are substantially higher than in others? Are price-cost relationships consistent with competition or with collusion?

MARKET DEFINITION A market has two components, its product and its geographic reach. The product market describes the good or service that is bought and sold while the geographic market describes the location of the producers or sellers of the product.

Product market The cement industry covers the manufacture of hydraulic cements including portland, aluminous slag and superphosphate, whether or not in the form of clinker 74 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

(1994 Philippine Standard Industrial Classification). Cement is a superior bonding agent used as a raw material in concrete construction. Its main components are limestone, clayey materials, and ferrous materials, which are processed into clinker. The latter is ground and mixed with gypsum to produce cement. Cement manufacturing is basically capital intensive. Capital costs accounted for about 20 percent of total manufacturing costs (SGV Consulting 1992). The industry is also a heavy user of energy with costs ranging from 30 to 43 percent of manufacturing costs depending on the type of manufacturing process applied. There are currently three types of cement produced in the country: Ordinary Portland cement (Type 1): regarded as the most important type of cement and is manufactured from limestone, clayey materials, siliceous materials, ferrous materials, and gypsum. It is hydraulic and cementitious in the presence of water. Portland Cement (Type 1) accounts for the bulk of total demand in the industry. Portland Pozzolan Cement (Type P): a type of blended cement composed of a finely ground mixture of 70 to 80 percent clinker and 20 to 30 percent pozzolan materials. Portland-Pozzolan Cement (Type 1-P): a cement product with a shorter curing period than Type P Portland Pozzolan and compares favorably with ordinary portland cement in terms of compressive strength and setting time.

Industry players While there are many individual cement firms operating in the industry, in terms of ownership, only a few groups control the industry’s operations. In the early 1990s, there were only three ownership groupings in the industry with the Phinma group controlling six plants accounting for 42 percent of the industry’s total rated capacity (Table 1). The Zobel-Araneta-Montinola group accounted for 18 percent of the industry’s rated capacity while the Alcantara group had 14 percent. The rest of the firms were independent from the three groups and together comprised roughly 27 percent of industry capacity.

Table 1. Industry Ownership Structure Prior to the Asian Crisis Geographic Market Phinma Zobel-Araneta- Alcantara Independent Group Montinola Group Group Firms Luzon North Bacnotan Northern NCR Solid FR Republic Hi-Cement Titan Continental Rizal Central Luzon South Fortune Visayas Apo Mindanao Davao Union Alsons Pacific Iligan Mindanao CEMENT INDUSTRY 75

Following the 1997 Asian financial crisis, an industry reorganization started to unfold as foreign cement companies entered and forged partnerships with local firms. The peso depreciation following the crisis boosted the debt costs of cement firms (particularly those with foreign-denominated loans). As the recession caused the construction industry to contract, foreign firms were able to buy into the local cement industry. Most local firms have taken in foreign companies as partners to generate fresh capital, strengthen their balance sheet, and improve their technology to bring operations at par with world standards. Mergers and acquisitions started to intensify in 1997. Central merged with Bacnotan; during the same year, Cemex S.A. of Mexico (the world’s third largest cement maker) bought Rizal and Solid. In 1999, Cemex also acquired Apo Cement from JG Summit Holdings of taipan John Gokongwei Jr. In 1998, the French firm Lafarge (the world’s second largest cement manufacturer) bought into Southeast Asian Cement, Republic Cement, and Continental Ce- ment while UK-based Blue Circle Ltd. also bought into Republic Cement and Fortune Cement (which are partly owned by retail magnate Henry Sy Sr.) as well as in Mindanao Portland and Iligan. Heidelberger bought into Limay while Swiss cement manufacturer Holderbank (the world’s largest cement maker) bought into Bacnotan Cement, Davao Union Cement, and Hi-Cement in mid-1998 and into Alsons and Iligan in early 1999 (Table 2). With the presence of the world’s largest cement companies, the industry which used to be dominated by one big group and several family-owned companies is now divided into five groups with cross-ownership: Phinma, Holderbank, Lafarge, Blue Circle, and Cemex. Four firms remain independent and have not linked up with a foreign partner: Northern (Eduardo Cojuangco), Grand (Benedictos), Pacific, and Titan (Aranetas). Industry restructuring continues, as the market remains sluggish due to the decline in construction activities. Currently, industry restructuring has taken the form of mergers and consolidations with the objective of improving commercial and operational efficiency. The Securities and Exchange Commission approved the merger of Bacnotan Ce- ment, Davao Union Cement, and Hi-Cement in early 2001. Phinma and Holderbank control the umbrella company known as Union Cement Corporation (UCC). UCC has a total capacity of 5.7 million metric tons and is expected to be the country’s biggest cement company. Industry analysts also expect Holderbank to merge Union Cement with Alsons Cement where it owns a 50 percent stake. Toward the end of 1999, Blue Circle announced its plan to consolidate the operations of Fortune Cement, Republic Cement, Zeus Holdings, and Iligan Cement. Blue Circle will own 64.5 percent of the merged entity. The other partners are the SM Group of Henry Sy and the Montinola family. The combined entity will be the second largest cement company (with a market share of almost 20 percent) in the country with full national coverage and a total clinker capacity of 4.4 million tons. The integration is expected to incur cost savings amounting to P750 million. 76 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 2. Ownership Structure After the Asian Crisis Geographic Market Phinma Holder- Lafarge Blue Cemex Others Group bank Circle A.Luzon North Bacnotan 60% 40% Northern Independent Limay Heidelberger B.NCR Solid 100% Hi-Cement 60% 40% Republic 13% 54% FR 69% Rizal 100% Continental 100% Titan Independent C.Luzon South Fortune 20% D.Visayas Lloyds 69% Grand Independent Apo 100% E.Mindanao Davao 60% 40% Union Alsons 50% Iligan 37% Pacific Independent Mindanao 73%

Geographic market Cement has a limited shelf life (three to six months) and is characterized by high transport and handling costs. Cement manufacturing in the Philippines is basically resource-based with cement plants located in or near limestone quarry areas. Cement is distributed by land within Luzon and by both land and water within Visayas and Mindanao. CEMENT INDUSTRY 77

There are two major natural markets in the country: Luzon (except Bicol) and the South (Bicol with Visayas and Mindanao). A more detailed geographic market breakdown divides the country into five large regional groups: Northern and Central Luzon, National Capital Region, Southern Luzon, Visayas, and Mindanao. Figure 1 shows the five geographic markets in the country.

Figure 1. Geographic Markets in the Philippine Cement Industry

LIMAY GRINDING MILL BACNOTAN Limay, Bataan Bacnotan, La Union REPUBLIC NORTHERN Norzagaray, Bulacan Sison, Pangasinan CONTINENTAL HI CEMENT Norzagaray, Bulacan Norzagaray, Bulacan RIZAL BACNOTAN Binangonan, Rizal San Ildefonso, Bulacan TITAN F-R Tanay, Rizal LLOYDS RICHFIELD Pasig City / Teresa Rizal Danao City, Cebu SOLID APO Antipolo City Naga, Cebu FORTUNE GRAND Taysan, Batangas San Fernando, Cebu

PACIFIC Surigao City, Surigao del Sur ALSONS Lugait, Misamis Oriental

MINDANAO Kiwalan, Iligan City

ILIGAN DAVAO UNION Kiwalan, Iligan City Ilang, Davao City

MARKET STRUCTURE AND MARKET POWER

Market shares Table 3 and Figure 2 present the individual and average market shares of the cement firms based on their sales data. In the Northern and Central Luzon area, there are three firms operating, namely, Bacnotan, Northern, and Limay. The first two cement companies dominate the market, although Limay, which entered the market only in 1997, registered increasing shares between 1997 and 1999. 78 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 3. Market Shares 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 NORTHERN LUZON Bacnotan 43.80 36.48 41.77 45.37 48.89 55.34 56.55 55.83 47.67 37.34 Northern 56.20 63.52 58.23 54.63 51.11 44.66 43.45 29.21 39.54 45.53 Limay 0.00 0.00 0.00 0.00 0.00 0.00 0.00 14.96 12.78 17.13 Subtotal 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 NATIONAL CAPITAL REGION Solid 23.03 23.59 27.10 29.66 28.75 30.06 27.88 23.07 22.53 22.00 Hi-Cement 15.06 15.07 18.01 21.35 21.07 19.49 22.57 31.86 33.00 29.65 Republic 13.43 12.94 14.03 12.03 13.53 13.11 12.81 15.44 17.01 19.19 FR 17.07 16.29 10.10 11.01 11.02 10.24 8.22 8.33 14.55 20.59 Rizal 15.11 15.86 12.85 9.41 10.23 9.68 9.20 7.22 3.20 0.33 Central 7.63 7.14 6.86 6.32 6.14 5.81 5.41 Merged w/Bacnotan 0.00 Continental 4.23 4.86 6.09 5.59 5.02 6.76 7.21 8.20 7.00 7.47 Titan 4.44 4.25 4.97 4.62 4.25 4.87 6.69 5.89 2.70 0.77 Subtotal 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 SOUTHERN LUZON Fortune 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 VISAYAS Lloyds 25.39 61.16 45.75 39.51 37.13 37.66 14.83 18.86 Grand 41.91 47.41 49.16 50.19 28.18 19.36 Apo 74.61 38.84 12.34 13.08 13.71 12.15 56.99 61.78 Subtotal 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 MINDANAO Davao Union 37.58 37.38 40.95 37.60 35.65 34.07 47.17 45.18 44.78 33.08 Alsons 26.30 24.92 20.19 25.00 27.46 26.23 21.19 26.54 22.25 38.81 Iligan 22.33 23.58 21.30 24.56 24.65 23.36 19.02 16.76 19.61 11.90 Pacific 5.45 5.81 10.48 8.01 7.68 9.19 7.01 6.07 4.65 7.26 Mindanao 8.35 8.31 7.08 4.83 4.56 7.15 5.61 5.45 8.71 8.95 Subtotal 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 Source: Philcemcor. CEMENT INDUSTRY 79

Figure 2. Average Market Shares

The National Capital Region has the most number of competing firms. There used to be eight firms before Central merged with Bacnotan in 1997. Hi-Cement, Solid, Republic, and FR are currently the leaders in the NCR market. In Southern Luzon, there is only one firm, Fortune Cement. In the Visayas, there used to be only one firm, Apo Cement, up to 1991. Lloyds entered the market in 1992 followed by Grand in 1994. The incumbent, Apo Cement, lost substantial market share to the new entrants, but regained its position in the last two years, 1998 and 1999. In Mindanao, five firms are operating with the bulk of the market controlled by Davao Union, Alsons, and Iligan.

Concentration measures and price-cost margin One needs to be careful in defining the cement market. Product market definition is relatively easy as cement is a homogeneous good. Geographic market definition is very important as the firms’ individual shares would change depending on the extent of the geographic market defined. Correctly defining the product and geographic markets is necessary to accurately assess the level of concentration in the industry. After the deregulation of cement prices, removal of import restrictions as well as substantial tariff reductions, the estimates show that in all five geographic markets, the cement industry has remained highly concentrated for the 13-year period, 1987- 1999 (Table 4). Both the four-firm concentration ratios and the Herfindahl- Hirschman Index (HHI) estimates confirm this finding. 80 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 4. Four-Firm Concentration (CR4) Levels and HHI

CR4 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 N.Luzon 100 100 100 100 100 100 100 100 100 100 100 100 100

NCR 100 84 86 91 81 72 74 74 73 81 87 88 99 S. Luzon 100 100 100 100 100 100 100 100 100 100 100 100 100 Visayas 100 100 100 100 100 100 100 100 100 100 100 100 100

Mindanao 100 93 94 94 94 92 96 96 93 94 100 95 93 HHI 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 N.Luzon 5370 5193 5169 5081 5360 5123 5115 5001 5085 5087 4293 3962 3768

NCR 2676 1578 1623 1547 1523 1649 1791 1774 1755 1727 2008 2213 2163 S. Luzon 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000 4353 Visayas 10000 10000 10000 10000 10000 10000 5118 4312 3998 3977 4086 4318 3587

Mindanao 3199 2653 2634 2701 2689 2755 2794 2740 2589 3120 3174 3011 2617

Except in NCR, the four-firm concentration ratios have remained high and hardly changed in the last 13 years. In NCR, the concentration ratio remained high and fluctuated between 1987 and 1999 with slight movements downward in 1992 and 1995 and steady increases thereafter. Going by the US guidelines (where 1000 and below is considered unconcentrated, between 1000 to 1800 is moderately concentrated, and above 1800 is highly concentrated), the HHI estimates indicate that between 1988 and 1996, NCR was only moderately concentrated and started to be highly concentrated only in 1997. The HHI estimates indicate that the concentration levels in Northern Luzon and the Visayas are declining but still remained at high levels. Except in 1999, there was no change in the level of concentration in Southern Luzon, which has been controlled by only one firm as indicated by its HHI of 10000 ( the maximum in the range of HHI outcomes). In Mindanao, the concentration level stayed high and was almost constant between 1988 and 1999. PCMs were estimated using firm-level data from the 1988 and 1994 Census of Establishments and the 1995 Annual Survey of Establishments of the National Statis- tics Office. The PCM was estimated as follows: PCM = [(Value of Output - Cost of Raw Materials – Total Compensation )/Value of Output]. As earlier indicated, a firm with market power is able to charge a price significantly above marginal cost while a firm without market power must charge a price closer to marginal cost. It is evident from Table 5A that the estimated average PCMs are high and have been increasing. These figures are higher than the average PCMs estimated for the whole manufacturing industry. In 1995, the cement industry posted a PCM of 42 percent compared to 36 percent in manufacturing. CEMENT INDUSTRY 81

Table 5A. Industry Price-Cost Margin Year 1988 1994 1995 Cement 0.28 0.37 0.42 Manufacturing 0.30 0.34 0.36

To assess the degree of market power of cement firms, the own price elasticity of demand was measured. The demand curve was estimated using Philcemcor and Na- tional Statistics Office monthly data from 1993 to 1999 and computed according to the following: Q = 32117 – 11638P + 2492D (11.68) (-3.24) (2.41) t-statistic 0.000 0.002 0.018 p value R2 = 0.15 F-statistic 7.3 where Q: cement demand (domestic sales + imports) P: real price per bag (ex-plant price/CPI) D: seasonal dummy

Both constant and coefficient of real price were found to be highly significant while seasonal dummy was insignificant. To enable us to estimate own-price elasticity, the demand equation is expressed in logarithmic form: ln Q = 16.86 – 0.29lnP + 0.095D (391.61) (-2.9) (2.12) t-statistic 0.000 0.0043 0.0367 p value R2 = 0.13 F-statistic 5.92

The estimated relationship shows that the own-price elasticity is very small (0.29) indicating that demand for cement is inelastic. The constant and the coeffi- cients of real price and seasonal dummy are all statistically significant. Table 5B shows the estimates of PCM derived using the estimated own price elasticity. These estimates allow us to directly compare prices and marginal costs. Evidently, the estimates confirm the substantial market power wielded by the domestic firms. Fortune Cement, being the only cement firm operating in Southern Luzon, registered the highest PCM at 3.5. Bacnotan, Northern, Davao Union, Grand, Lloyds, and Apo followed with their greater than 1 PCMs ranging from 1.2 to 1.6. PCMs of less than one were registered in the National Capital Region with leaders Solid and Hi-Cement posting the highest (almost equal to 1) at 0.9 and 0.8, respectively. The rest of the firms operating in the NCR had PCMs ranging from 0.15 to 0.5. 82 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 5B. Price Cost Margin (PCM) by Firm GEOGRAPHIC MARKET PCM GEOGRAPHIC MARKET PCM N. LUZON VISAYAS Bacnotan 1.62 Lloyds 1.21 Northern 1.68 Grand 1.36 Limay 0.52 Apo 1.22 NCR MINDANAO Solid 0.89 Davao Union 1.36 Hi-Cement 0.78 Alsons 0.89 Republic 0.49 Iligan 0.71 FR 0.44 Pacific 0.25 Rizal 0.32 Mindanao Portland 0.24 Continental 0.22 S. LUZON Titan 0.15 Fortune 3.45

Market entry conditions Cement manufacturing is a highly capital-intensive activity. Heavy capital requirements are needed to obtain the necessary facilities, technology, and raw materials (mainly limestone). Lumber being relatively more expensive, there are no viable substitute for cement. Cement is characterized by a low price elasticity of demand (as earlier shown). A firm’s power to control price requires a low own-price elasticity of demand. If elasticity of demand is high, producers will have no significant ability to raise prices since any price increases will lead to substantial reduction in sales. Cement is a type of high weight-to-value product with high transport and handling costs and, as such, it is often classified as a nontradable good. Potential competition from imports is important as a mechanism to control market power. In the cement industry, however, this is of little practical value because of the substantial costs of entry. Cement can be imported in bulk, but this will require a bulk handling facility, which is quite expensive. For instance, a 300,000 mt silo will cost around P500 million in investment. On the other hand, shipping cement in bags will entail extra handling costs, which can easily increase the price. These factors limit the procompetitive effects of imports on the industry, providing natural protection for established firms. Table 6 presents cement imports from 1990 to 2000. Except for the years 1990, 1992, and 2000, imports represented a small portion of total consumption. Given the characteristics of cement, foreign firms may have found it more profitable to become parties to the domestic industry rather than to compete via imports. While the sharp increases in imports in the early 1990s were due to shortages in the domestic market, CEMENT INDUSTRY 83 the import surge in 2000 may be attributed to the global over supply of cement and depressed demand due to the generally unfavorable world economic conditions after the 1997 Asian financial crisis.

Table 6. Cement Imports (in 40 kg bags) Year Bagged Bulk Total Total As Percentage of Imports Consumption Total Consumption 1990 23,097,831 - 23,097,831 183,722,831 12.57 1991 250,000 - 250,000 173,252,916 0.14 1992 13,769,275 3,271,400 17,040,675 182,149,782 9.36 1993 - - - 200,081,411 - 1994 241,723 - 241,723 240,152,950 0.10 1995 5,104,175 6,906,250 12,010,425 277,237,624 4.33 1996 10,885,250 6,105,050 16,990,300 323,821,577 5.25 1997 8,794,475 - 8,794,475 372,209,958 2.36 1998 1,821,775 2,682,500 4,504,275 322,362,183 1.40 1999 - 11,860,750 11,860,750 308,594,848 3.84 2000 39,475,000 301,425,000 13.10 Source: PHILCEMCOR

The domestic cement industry strongly resisted the entry of cheaper imports which were sold about P5-10 lower than domestic cement. Philcemcor immediately filed a dumping suit against Taiwan Cement Corporation and Japan’s Taiheiyo for allegedly dumping cement at US$36 and US$20 per ton ex-terminal import price, respectively. Eventually, Japan’s Taiheiyo succumbed and increased its prices in line with the prevailing domestic cement prices. Refusing to do the same, Taiwan Cement Corporation was made the main respondent of Philcemcor’s antidumping case. Tai- wan Cement Corporation has at present discontinued its operations in the Philip- pines. Alsons and several other domestic firms moved by diverting their cement exports to Taiwan in retaliation to the alleged dumping. Alsons stated that it would sell its cement at a significantly lower price than the prevailing domestic price in Taiwan to send a message that Philippine cement companies could play their game. Note that in 1997, the average spot price for cement in India was US$40/mt and this dropped further to between $25 and $27/mt in 1998. In Thailand, prices ranged from US$16 to US$18/mt in late November 19982 . These are more or less consistent with the ex-terminal import prices of Taiwan and Japan in the Philippines. Apart from Taiwan and Japan, Indonesia also exports cement to the country. ______

2 Indian Express Newspapers. 84 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Since 2000, the local cement companies have been asking the government for more stringent measures to regulate the entry of cement imports, which were allegedly being sold at dumped prices. The Tariff Commission, however, failed to find sufficient evidence to prove that the domestic cement industry indeed suffered serious injury arising from imports. Subsequently, Philcemcor sought refuge through Repub- lic Act 8800, which allows industries affected by import surges to request for either general or special safeguards. In November 2001, the Department of Trade and Indus- try imposed a temporary additional duty of P20.60 per bag of imported cement for duration of 200 days. In turn, the industry promised that the firms would not increase their prices during this period and committed to sell cement within the price range P125 to P135. In March 2002, the Tariff Commission completely reversed this decision and instead, recommended against the granting of a 50 percent tariff and an import quota requested by Philcemcor.

PRICE ANALYSIS AND ANTICOMPETITIVE BEHAVIOR The foregoing sections indicate that firms in the industry have high and stable market shares. Demand for cement is inelastic, thus providing firms power to control prices. Their ability to price substantially above marginal cost indicates the high degree of market power that they can collectively exert. The industry has remained highly concentrated and entry by new firms is not easy due to the large capital requirements as well as the natural characteristics of cement, which limit import competition. All these factors indicate that the cement firms have tremendous market power. With their ability to collude, the firms are able to restrict competition, raise and fix prices in order to increase profits. Since it is difficult to find material evidence of coordination such as a written document or agreement governing the cement industry’s behavior, the analysis in this section focuses on associated firm behavior and practices that are indicative of a common policy being pursued by the industry. Cement is a homogeneous product and is often regarded as an industry likely to engage in collusion. Box 1 contains cement cartel cases in the Slovak Republic, an economy in transition, the European Community, and in Norway. In the Philippines, there are only three major groups (Phinma/Holderbank, Cemex, and LaFarge/Blue Circle)3 in the industry, which make coordination easier. The industry has a very active association, the Philcemcor, that aggregates industry statistics and may facilitate the exchange of individual price and quantity between competitors. The history of coordination in the industry is also a very significant factor to establish the presumption that the firms are not acting on their own. Table 7 presents a picture of the economic operation of the industry from 1990 up to 1999. Total supply (domestic production + imports + inventory - exports) and total demand (domestic sales+imports) were estimated alongside with excess supply (total ______

3 LaFarge acquired Blue Circle in July 2001. CEMENT INDUSTRY 85

Box 1. Cases of Cement Cartels: Other Countries’ Experience

Case 1: Slovak Republic In the Slovak Republic, the Antimonopoly Office (AMO) successfully prosecuted a cement cartel, which was found engaging in unlawful agreements. Starting in 1992, the AMO had been receiving complaints from cement users alleging illegal practices between cement producers. The AMO made a breakthrough after an investigator found a letter from an official of the Cement Association of the Slovak Republic suggesting a nationwide division of markets. This prompted the AMO to collect data on prices, production, exports, and inventories of the domestic cement producers. In their analysis of the pattern of price changes, they could not explain the observed trend objectively. This gave rise to strong suspicions that cement prices were artificially set. The AMO started interviewing witnesses at the offices of the cement association. Their interviews confirmed their suspicions that indeed cement producers entered into agreements restricting competition for at least two years. The cement producers agreed to a regular exchange of basic economic data about their firms (output, costs, exports, inventories, profits, number of employees, and average wages and salaries). They reported this information monthly to a consulting firm, which compiled and distributed it to the producers. The consulting firm also prepared documents establishing a geographic division of markets among the producers and suggesting production quotas for each producer. One of the documents contained the following: “The particular region shall be supplied exclusively by the producer located therein. If there is no producer in a region, a principal supplier shall be designated.” In 1994, the AMO issued an order prohibiting all cement producers from engaging in market division, setting sales quotas or exchanging information that could facilitate the coordination of such illegal agreements. The office imposed fines totaling SK19.96 million (US$0.7 million) on the entrepreneurs who had participated in the agreements. The firms appealed the decision to the Supreme Court of the Slovak Republic, which upheld the same.

Case 2: European Community In the European Community, the European Commission found 42 cement producers throughout Europe to have prevented parallel imports, to have systematically exchanged detailed information and to have occasionally fixed prices. The Commission relied mostly on material evidence of coordination between firms as it imposed fines ranging from 100,000 to 32 million Ecus.

Case 3: Norway Steen and Sorgard (1996) showed that the Norwegian cement market was characterized by semi collusion where firms competed on capacities and colluded on prices. Their results indicated that the rapid increase in capacity and thereby exports in the period 1956 to 1967 – the late phase of the price cartel could be best explained by the market sharing agreement in which each firm over invested in capacity to receive a large quota in the domestic market.

Sources: Steen and Sorgard (1996); Neven et al. (1998); World Bank–OECD (1998). 86 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 7. Average Prices, Excess Supply and Industry Capacity, 1990-1999 (In ‘000 40 kg bags) Indicators 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Production 164060 172324 166536 201268 236623 263842 310725 367019 322196 313937 Exports 0 0 0 125 0 0 0 0 2150 17284 Imports 23098 250 17041 0 242 12010 16990 8794 4504 11861 Beginning Inventory 3435 2757 4184 5246 1958 573 4467 8070 10258 Total Domestic Supply 187158 176009 186334 205327 242111 277810 328288 380280 332620 318772 Sales 160625 173002 165109 200081 239911 265227 306831 363416 317858 296733 Imports 23098 250 17041 242 12010 16990 8794 4504 11861 Total Domestic Demand 183723 173252 182150 200081 240153 277237 323821 372210 322362 308594 Excess Supply 3435 2757 4184 5246 1958 573 4467 8070 10258 10178 Ave. Ex-plant Price (in pesos per 40 kg bag) 78.58 84.50 92.33 100.97 94.92 72.75 85.17 Capacity Utilization Rate (In %) 97.41 93.55 77.89 87.51 86.44 93.44 88.15 80.05 50.26 48.97 Percentage Changes 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Production 5.04 -3.36 20.86 17.57 11.50 17.77 18.12 -12.21 -2.56 Sales 7.71 -4.56 21.18 19.91 10.55 15.69 18.44 -12.54 -6.65 Ave. Ex-plant Price 7.53 9.27 9.36 -5.99 -23.36 17.07 Total Supply -5.96 5.87 10.19 17.91 14.75 18.17 15.84 -12.53 -4.16 Total Demand -5.70 5.14 9.84 20.03 15.44 16.80 14.94 -13.39 -4.27 Source of basic data: Philcemcor. supply-total demand). The table also shows average ex-plant prices, capacity utilization rates, and annual percentage changes in sales, production, total demand, and total supply. The data indicate strong industry growth between 1993 and 1996. In anticipation of continuous future growth, cement firms expanded their capacity from 282 million (40 kg bags) in 1995 to 641 million (40 kg bags) in 1998. Most of them financed their expansion through foreign debts. Prior to the crisis, the industry’s average excess supply stood at about 3 million (40 kg bags). From 1997 to 1999, this increased to about 9.5 million (40 kg bags). Capacity utilization rate was around 50 percent in 1998 and 1999. With the financial crisis in 1997, the demand for cement dropped by 13 percent in 1998 and by 4 percent in 1999. The slowdown in the construction and property sector resulted in an oversup- CEMENT INDUSTRY 87 ply of cement in the market forcing cement firms to cut prices. As firms engaged in a price war average ex-plant prices were reduced by 6 percent in 1997 and by 23 percent in 1998. The cement industry is highly dependent on construction demand. Between 1998 and 1999, gross value-added in construction declined by 8.4 percent and 2.8 percent, respectively. This reduction was mostly due to the decrease in private construction by around 13.5 percent in 1998 and by 14.5 percent in 1999. Analysts believe that pros- pects for the sector’s recovery in the short term would remain bleak. A Phinma report indicated that the overcapacity of the industry would remain until at least the year 2007. Nonetheless, despite the overcapacity of the industry, excess supply, and weak demand, average ex-plant prices increased by around 17 percent beginning in 1999 (Table 7). These price increases continued up to the year 2000. A closer scrutiny would reveal uniformity in pricing behavior and identical price changes that closely followed each other. Figure 3 presents the pricing behavior of firms in the industry over the last seven years from January 1993 to May 2000. In general, the demand for cement is seasonal; it peaks during the dry months and falls thereafter. As evident from the figure, there is a fairly stable pattern in the movement of average ex-plant prices between 1993 and 1996. Chaotic movements in the average ex-plant prices started to be felt in April 1997. During this time, the demand for cement was still rising with growth estimated at about 14 percent. Average ex-plant prices declined steadily from P104 in March 1997 to P 88 in September of the same year. While it slightly moved up to P90 in October to November, it again fell to P87 by the end of the year. The same declining trend was observed during the whole period of 1998. It only stopped after industry leader Phinma announced that it would no longer engage in any price reduction. As expected, everybody in the industry followed. Cement prices

Figure 3. Average Ex-Plant Prices 88 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES then began to go up consistently from January 1999 to May 2000. This continued even with the entry of imports, which started to build up in March 1999. Table 8 presents the percentage changes in the monthly average ex-plant prices from February to May 2000 as well as the simultaneous price increases among the

Table 8. Monthly Changes in Average Ex-Plant Prices (Jan-May 2000) Geographic Area January February March April May Average Average Percent Average Percent Average Percent Average Percent Price Price Change Price Change Price Change Price Change Luzon North Northern 96 96 - 103 7.29 103 - 103 - Bacnotan 98 105 7.14 105 - 108 2.86 108 - Limay 98 102 4.08 105 2.94 110 4.76 110 - Ave Price (in P) 101.00 104.33 107.00 107.00 Standard Deviation 1.15 4.58 1.15 3.61 NCR Hi-Cement 97 105 8.25 105 - 108 2.86 108 - Continental 96.25 97.25 1.04 105.25 8.23 107.25 1.90 107.25 - Republic 98.25 98.25 - 104.25 6.11 104.25 - 107.25 - FR(Pasig) 98.25 98.25 - 106.25 8.14 108.25 0.02 108.25 - FR(Teresa) 97.50 97.25 (0.26) 104.25 7.20 106.25 1.92 106.25 - Solid 99 99 - 107 8.08 108 0.93 108 - Ave Price (in P) 99.17 105.33 107.00 107.5 Standard Deviation 1.04 2.94 1.1 1.53 Luzon South Fortune 98.38 98.38 - 98.63 - 107.25 8.75 107.25 - Visayas Lloyds 104.25 104.25 - 114.25 9.59 114.25 - 115.75 1.31 Grand 104.25 104.25 - 114.25 9.59 114.25 - 114.25 - Apo 105 105 - 117 11.43 117 - 117 - Ave Price (in P) 104.50 115.17 115.17 115.67 Standard Deviation 0.43 0.43 1.59 1.59 Mindanao Mindanao 98 100 2.04 107 7.00 107 - 107 - Davao Union 97 97 - 105 8.25 107 1.90 107 - Alsons 98 100 2.04 107 7.00 107 - 107 - Iligan 98 100 2.04 107 7.00 107 - 107 - Pacific 100 103 3.00 108 4.85 110 1.85 110 - Ave Price (in P) 100.00 106.80 107.60 107.60 Standard Deviation 1.10 2.12 1.10 1.34 Source of basic data: Philcemcor. CEMENT INDUSTRY 89 firms during the period. Beginning in February 2000, the largest price increases were initiated by Phinma firms Bacnotan and Hi Cement whose prices went up by 7.14 percent and 8.25 percent, respectively. In March, the rest of the firms followed and increased their prices by roughly the same amount. Northern increased its price by 7.3 percent; Continental: 8.23 percent; Republic: 6.11 percent; FR Pasig: 8.14 percent; FR Teresa: 7.2 percent; and Solid: 8.08 percent. In the Visayas, Lloyds and Grand increased their prices by 9.59 percent, and Apo: 11.43 percent. In Mindanao, Mindanao Portland increased its price by 7 percent; Davao (Phinma firm): 8.25 percent; Alsons and Iligan: 7 percent; and Pa- cific: 5 percent. These simultaneous price increases by the cement firms take place in the face of excess supply and weak demand as a result of construction slowdown in the country. Imports continue to come in as their share to total consumption more than doubled from 1.4 percent in 1998 to 3.84 percent in 1999. The variability in ex-plant prices among the firms within each geographic market in the industry is very small as indicated by the standard deviation figures. In February and April 2000, the standard deviation was 1.15 in Northern Luzon, 1.04 and 1.1, respectively, in NCR, and 1.1 in Mindanao. In May, it was 1.59 in the Visayas, 1.53 in NCR, and 1.34 in Mindanao. There is also not much variation in the average prices across the three major geographic markets in the country. In February 2000, the average price in Northern Luzon was P101 per bag, P99.17 in NCR, and P100 in Mindanao. The average price of P104.50 in the Visayas is slightly different. In March, the average price in North- ern Luzon was P104.33, P105.33 in NCR, P106.80 in Mindanao, and P115.17 in the Visayas. In April and May, the average price in Northern Luzon was P107, P107 and P107.50, respectively, in NCR, P107.60 in Mindanao, and P115.67 in the Visayas. Under competitive conditions, the only explanation for this low variation in prices is that firms have more or less similar cost structure. This does not seem to be the case based on current cost estimates provided by various sources. For instance, the Department of Trade and Industry (DTI) noted that, based on the production costs submitted by cement firms to DTI, power costs alone fluctuated widely among the firms. The power cost of one firm was found to be 10 times more than the others. According to Philcemcor, the production and debt servicing costs of the firms amount to much more than P90 per bag. Southeast Asia Cement Holdings, Inc. (FR and Lloyds) estimated the average cost of cement including depreciation and interest payments at about P80 per bag. Cost information based on the cement firms’ financial statements submitted to the Securities and Exchange Commission are presented in Table 9. The table reveals that the variation in average production cost per bag is high and notably increasing steadily in 1998 and 1999 when the standard deviation in the firms’ production costs substantially widened (except in Northern Luzon where the standard deviation remained almost constant). 90 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 9. Average Production Cost per Bag 1996 1997 1998 1999 Northern Luzon Bacnotan 97.71 87.46 Northern 57.31 67.83 58.47 Standard Deviation 21.13 20.50 NCR Solid 65.48 70.65 69.01 76.11 Republic 64.24 60.01 68.29 79.94 FR 67.79 61.89 53.76 76.22 Rizal 58.44 64.96 91.86 193.79 Continental 70.58 56.20 58.15 130.63 Titan 56.00 78.50 126.73 Standard Deviation 4.50 5.59 13.84 46.54 Southern Luzon Fortune 42.27 41.04 53.02 74.55 Visayas Lloyds 52.99 60.75 66.34 68.39 Grand 45.71 53.55 63.74 Apo 42.89 56.23 53.55 98.61 Standard Deviation 7.14 7.72 7.39 18.93 Mindanao Davao Union 64.22 78.91 Alsons 43.84 47.90 45.24 112.55 Iligan 44.46 52.43 59.23 121.56 Mindanao 57.36 59.56 58.29 56.08 Standard Deviation 7.69 5.88 8.10 30.30 Standard Deviation Philippines 10.79 8.10 12.04 37.02 Sources of basic data: Securities and Exchange Commission and Formal Investigation Report of the Tariff Commission, March 2002.

The table also shows wide gaps in the average production cost of firms. In 1999, Bacnotan produced a bag of cement at a cost of P87.50 while Northern had a cost of only P58.50. In NCR, Solid and FR had almost equal production cost of about P76 per bag, Republic had an average cost of P80 while Titan had P127 and Rizal incurred almost P194. In Southern Luzon, Fortune’s production cost was roughly P75 while Davao Union located in Mindanao had P79. Other firms like Alsons had P113; Iligan had P122 while Mindanao Portland had the lowest at P56. In the Visayas, Apo Cement’s production cost was P99 while Grand and Lloyds had P68 and P64, respectively. CEMENT INDUSTRY 91

The above cost information does not explain the low variation in prices earlier discussed. This similar prices-different cost relationship only makes sense if cement firms are engaged in collusive arrangements. It also tends to confirm the previous finding that the industry has market power and is exercising it to coordinate prices. Note that a firm with market power will price substantially higher than marginal cost while a firm without market power will price closer to marginal cost. Under competitive conditions, firms with different cost structures should be quoting different prices and equilibrium is achieved at the level where price equals marginal cost. If competition is effective, it should weed out the inefficient firms and allow the market share of efficient firms to increase. This results in price uniformity in the market. Competition forces firms to become efficient and offer a wider choice of products at lower prices. It gives rise to increased consumer welfare and allocative efficiency. What is preventing efficient cement firms from undercutting their inefficient rivals? The only logical explanation is the presence of collusive behavior or cartel to fix prices in the industry. The threat of a price war and the fear that departure from such behavior may lead to costly price cutting, lower profits and market instability create incentives for firms to maintain such an implicit arrangement among themselves. Moreover, inefficient firms are able to survive under the price umbrella provided by the cartel. Thus, this setup is acceptable because it allows efficient firms to make excess profits and inefficient ones to continue their operations. The president of La Farge Philippines, Philip Roseburg, aptly described the behavior of cement firms such as his as follows, “In any industry you can fight for a bigger market share but someone has to give up that market share… But obviously this wouldn’t work with our competitors here…they will fight and then we get into a bloody battle where everyone ends up bruised. Given the opportunity, yes we can try and improve our market share. But I don’t want to lose out in the end and trigger another price war. What you can do is offer better products… LaFarge has no plans of rocking the boat. We wouldn’t make a run on market share, we want to keep it as stable as possible” (Philippine Star, 24 February 2001). In another interview, Tomas Clough of Alsons boldly stated4: “People take positions that demonstrate to other people that they are going to behave in a rational manner. By closing Calaca (Alson Cement’s bulk terminal in Batangas Prov- ince, south of Manila), I am indicating that that I’m prepared not to compete in Luzon. And what do I expect in return? I expect people to allow me to reasonably clear market in Mindanao and the Visayas. And if they come and wreck my market (in those areas), I’ll open up Calaca again. It’s as simple as that.” ______

4 Interview with Tomas Clough, Asian Cement Magazine as presented by CHARGE during the House of Representatives’ hearing on cement. 92 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Prior to the 2000 price increases, the Philcemcor president indicated that “cement prices must be such that they would allow cement firms to recover their costs of debt servicing and production and get a fair and reasonable return on their investments in order for the industry to remain viable and eventually achieve stability” (Manila Bulle- tin, 29 November 1999). The cement firms rationalized their price increases by noting that their operating costs, including those for energy and labor, have gotten higher than in the past. They argued that due to the depreciation of the peso, the costs of servicing the huge foreign debts incurred by the cement firms when they expanded their capacities have also risen. They noted that production and debt servicing costs amount to much more than P90 per bag, hence cement firms, individually and for their own self-interests, have had to increase their prices to avoid incurring heavy losses, which could lead to closure. The Philippine Constructors Association (PCA) together with other construction groups, the National Confederation of Contractors Associations of the Philippines (NACCAP) and the Association of Concrete and Aggregate Producers of the Philip- pines (ACAPP), have strongly opposed the “unwarranted and concerted increase of cement prices” by the domestic cement industry (Business World, 31 March 2000). The groups said that the abrupt price increases in March 2000 were not related to any major production cost or market forces but are meant to recoup past investment losses (Manila Bulletin, 30 March 2000). With respect to their increasing energy costs, the National Economic and De- velopment Authority (NEDA) indicated that fuel and power costs in cement manufacturing accounted for 25 and 14 percent, respectively, of total production costs. Most cement plants have already shifted from bunker to coal fuel since the 1970s. Between 1997 and 1999, the price of imported fuel dropped from an average of US$40/MT to about US$34/MT, indicating that the fuel cost of the industry has been declining. Industrial power rates did not change substantially from 1998 to 1999 either, with average rates at about P2.38/kwh and P2.50/kwh, respectively. With regard to their rising interest payments, are all cement firms paying exactly the same amount to warrant the uniform price increases that they have been engaged in? Table 10 summarizes the economic performance of the cement industry from 1996 to 2000. The table shows that import share surged from 4 percent in 1999 to 13 percent in 2000, domestic production declined by about 5 percent in 2000 while capacity utilization improved from 62 percent to 73 percent in 2000. Labor productivity increased from 2,517 mt/worker to 3,037 mt/worker as employment dropped by 21 percent. Despite the import surge and production decline in 2000, the industry’s sales revenues jumped by almost 29 percent. The industry also registered income from operations amounting to P2.4 billion and a return on sales of 12.4 percent. Curiously, while non-cartel members5 were able to post net income from 1999 to 2000, the cartel ______

5 Northern Cement Corporation, Goodfound Cement Corporation, Grand Cement Manufacturing Corporation, Limay Grinding Mill Corporation, and Titan Cement Manufacturing Corporation. CEMENT INDUSTRY 93 members reported net losses during the same years. These net losses were mainly attributed to other expenses consisting of huge interest expenditures, foreign exchange losses and other expenses such as write down of fixed assets and deferred charges, decline in value of investments, costs of plant shutdown/voluntary separation, provision for inventory obsolescence, net losses in equity of subsidiaries, and cumulative effect of a change in accounting policy6.

Table 10. Economic Performance of the Cement Industry, 1996-2000 Economic Indicator 1996 1997 1998 1999 2000 Production (in MT) 12429101 14680757 12887858 12557524 11959015 % Change 18.12 -12.21 -2.56 -4.77 Sales (in MT) 12273000 14536000 12714000 11869000 10478000 % Change 18.44 -12.53 -6.65 -11.72 Capacity Utilization* 78.95 69.39 69.1 61.77 73.15 % Change -12.11 -0.42 -10.61 18.42 Revenues (‘000) 22766230 29344305 Alleged Cartel 21071482 24127422 18097931 20202884 25967633 % Change 14.50 -24.99 11.63 28.53 Non-Cartel 2563346 3376672 % Change 31.73 Return on Sales Alleged Cartel 26.90 20.96 0.52 -12.97 7.62 Non-Cartel -3.31 11.76 Income/Loss from Operations (‘000) Alleged Cartel 5668433 5056613 93466 -2619647 1978009 Non-Cartel -84835 396996 Net Income/Loss (‘000) Alleged Cartel 5508559 4062074 -3388603 -7708552 -5558671 Non-Cartel 80263 137349 Imports (in MT) 679612 351779 180171 474430 1579027 As % of Domestic Consumption 5.25 2.36 1.40 3.84 13.10 Employment Alleged Cartel 3276 3550 3116 4282 3400 * Operating Kilns Source: Formal Investigation Report, Tariff Commission, 13 March 2002.

______

6 Formal Investigation Report, Tariff Commission, 13 March 2002. 94 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Altogether, it is far from clear that the sequence of observed price increases oc- curring in the industry since January 1999 could be explained in terms of competitive interactions. The firms seem to have different cost structures and yet, the prices that they are quoting are almost similar. Their price behavior shows that they have increased their prices by almost the same amount in what seems to be a harmonious fashion. This is not surprising if it is considered that the firms have tremendous market power and they are collectively exercising it. As such, the only way to explain why the observed price behavior is inconsistent with competitive behavior would be because the firms are engaged in price coordination. This also explains why their sales revenues went up despite the 5 percent reduction in production and the 13 percent increase in import share. Under competitive conditions, the simultaneous price increases that the firms have been undertaking are quite unbelievable considering that demand for cement is still low and imports are able to come in. Given excess supply under perfect competition, markets would clear by reducing prices until demand and supply are equal. Moreover, under competitive conditions, firms will react to a negative demand shock by output reduction or even firm exit to minimize their losses. In contrast, firms involved in price or output coordination react by expanding output or engaging in a price war (Green and Porter 1984 as cited in Neven et al. 1998). This is exactly what happened in the industry in 1998. In the face of the Asian crisis, a price war erupted and some firms (FR, Apo, and Mindanao) engaged in output expansion rather than reduction. But after the lowest price of P45 per bag was hit in December 1998, price coordination again resumed beginning in January 1999. Excess supply in 1998 and 1999 remained at very high levels. From about 4.5 million bags in 1996, excess supply almost doubled to 8 million bags in 1997 and reached 10 million bags in 1998 and 1999. However, while prices dropped in 1998, they started to go up in 1999. Average prices declined by 23 percent in 1998 but increased by 17 percent in 1999.

CONCLUSIONS AND POLICY RECOMMENDATIONS

SUMMARY Prior to the implementation of deregulation and trade liberalization, the industry was engaged in collusion facilitated by market sharing agreements. Sanctioned by government regulations, these were accepted practices in the past. Although cement prices were deregulated, import restrictions lifted and tariffs set at a low rate of 5 percent, the ability of the firms to engage in collusive behavior has effectively inhib- ited competition from taking place. This allowed firms to manipulate prices to the detriment of consumers, other industry users including the government, and society as a whole. Despite these reforms, the industry has remained highly concentrated. The cement firms have tremendous market power, which they do not hesitate to collectively CEMENT INDUSTRY 95 exercise. The presence of implicit coordination or conscious parallel behavior in the industry has become glaring as prices rose substantially and continuously since 1999 in a simultaneous manner at a time characterized by excess supply, overcapacity, and weak demand. The cement industry clearly illustrates the presence of market failure. The existence of market power and the absence of competition leads to higher prices and loss of economic welfare. One important lesson that could be drawn from the analysis is that while deregulation and trade liberalization are necessary, they are not sufficient to ensure that markets perform efficiently and that their outcomes are reasonably equitable. In the presence of restrictive business practices like cartels, these reforms alone cannot guarantee competition as observed in the behavior of the cement firms. Trade reforms need to be accompanied by competition policy in order to strengthen market forces and ensure that their benefits flow to consumers. Given our weak institutions, firms can successfully organize to influence government policy. Rather than compete, firms will always lobby for government protection and hide from the challenges of market competition by invoking policies like antidumping and safeguard measures or engaging in cartel activities. It is no wonder that cartel behavior persists in the country; the government allows it through its use of regulatory measures, through its failure to legislate the correct laws against anti-competitive behavior; and simply ignoring that such behavior exists. The cement case shows that our previous experience of regulation, promotion, and protection encouraged greater concentration, limited the potential for competition, and prevented the development of a culture of competition in the country.

ALTERNATIVE POLICY OPTIONS The cement firms have attempted to rationalize their price-fixing activities by indicating that their past investments in the industry have not yet yielded any profits due to the Asian financial crisis and the political instability in the country. Demand has continued to drop and as such, the firms have been incurring losses. Adding to their woes, they complain, is the availability of cheaper imports. To survive, domestic firms have adopted a strategy of avoiding competition by fixing prices. What can a small developing country like the Philippines do to address the issue of anticompetitive behavior being justified by the industry as a necessary tactic for survival given the prolonged reduction in demand? There are different courses of action that may be adopted by the government:

(1) Maintain a business-as-usual attitude, let the firms continue with their tacit collusion but allow imports to come in. Given the lack of material evidence and our ineffective antitrust laws, imports are the only means to provide competitive discipline to the industry characterized by limited competition and one that is prone to collusive behavior. Once economic re- 96 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES covery sets in and businesses return to their normal conditions, this may no longer be a feasible option given the high transportation and handling costs of imported cement.

(2) Protect the industry against imports by increasing tariffs and imposing antidumping duties. As import tariffs are liberalized, the pressure on governments to invoke instruments like antidumping and countervailing duties (measures that limit import competition) increases. The government must avoid the imposition of antidumping measures for reasons other than predatory dumping. Safeguard measures must not be provided to industries and firms that are able to exert collective market power and are engaged in collusive and other anticompetitive activities. Safeguard measures could easily be abused and become protectionist tools; hence, the government must be circumspect and carefully weigh the welfare gains and losses of increasing tariffs to the industry. As our previous experience showed, increasing tariffs and protection would only provide an incentive to encourage smuggling. It is only with competition that consumers will obtain the best possible goods at the lowest possible prices.

(3) Formulate competition laws/policy that will address both implicit and explicit cartels. This is the best solution because without competition laws, a small developing country like us would have very little recourse against cartels and collusion and other anticompetitive behavior. The outcome of cartel behavior is against public interest and is highly distortive of economic efficiency. Cartels limit competition and allow firms to manipulate prices to the detriment of consumers and other industry users including the government. Competition law will eliminate abusive monopoly conduct, price fixing and other cartels. It will prohibit mergers and acquisitions that limit competition. Com- petition law is primarily meant to protect consumers, both individual consumers and firms that buy intermediate goods and capital assets including governments that build infrastructures like roads, bridges, schoolbuildings, etc. Competition law is meant to protect the competition process, which will allow efficient firms that respond to consumer demand to succeed over the inefficient firms. The competition process will allow consumers and producers to exercise their freedom of choice free of any price-fixing conspiracies and monopolistic bullying. With competition, consumers will obtain the best possible goods at the lowest possible prices. Monopo- lies and cartels are not the key to the survival of domestic industries, effective competition is. From the seventies to the eighties, the cement industry thrived under a powerful, government-sanctioned cartel. Local manufacturers cannot forever hide from import competition by invoking protection against dumping and engaging in cartel activities. With the increased globalization of markets, efficiency is the key to survival. In other countries with strong enforcement institutions, cartels are illegal and are CEMENT INDUSTRY 97 treated toughly. Rather than engaging in price fixing and wasting scarce resources by rent seeking, the cement industry should instead redirect its efforts toward enhancing its efficiency and competitiveness.

BIBLIOGRAPHY

Anon. 1999. Cement Price Key to Viability. Manila Bulletin, 29 November. ––––––. 2000. Construction Industry Groups Object to Cement Pricing. Manila Bulletin, 30 March. ––––––. 2000. Constructors Warn Cement Price May Hit P140 per Bag. Business World, 31 March. Boner, R.A. 1995. Competition Policy and Instruments in Reforming Economies, Chapter 3. In Regulatory Policies and Reform: A Comparative Perspective, edited by Claudio R. Frischtak. Ferriols, D. 2001. Why Cement Prices Remain High Despite Influx of Cheap Imports. Philip- pine Star, 24 February. Fingleton, J., E. Fox, D. Neven and P. Seabright. 1995. Competition Policy and the Transfor- mation of Central Europe, European Communities. Frischtak, C.R. 1995. The Changed Role of the State: Regulatory Policies and Reform in a Comparative Perspective, Chapter 1. In Regulatory Policies and Reform: A Compara- tive Perspective, edited by Claudio R. Frischtak. Gilbert, R.J. 1990. The Role of Potential Competition in Industrial Organization. Journal of Economic Perspectives 4:2. Khemani, R.S. and M.A. Dutz. 1995. The Instruments of Competition Policy and Their Rel- evance for Economic Development. In Regulatory Policies and Reform: A Compara- tive Perspective, edited by Claudio R. Frischtak. Lamberte, M., E. de Dios, D.A. Flores, J.F. Tabbada and E. Ramiro. 1992. Barriers to Entry Study, Volumes I and II. United States Agency for International Development. Leach, D. 1997. Concentration-Profits Monopoly Vs. Efficiency Debate: South African Evi- dence. Contemporary Economic Policy 15. Neven, D., P. Papandropolous and P. Seabright. 1998. Hard and Soft Cartels. In Trawling for Minnows European Competition Policy and Agreements Between Firms. London: Centre for Economic Policy Research. OECC (Onada Engineering and Consulting Co.) 1991. Industrial Restructuring Studies: Ce- ment. Makati City: Development Bank of the Philippines. Rees, R. 1993. Tacit Collusion. Oxford Review and Economic Policy 9(2):27-40 Shapiro, C. 1989. Theories of Oligopoly Behavior. In Handbook of Industrial Organization, Vol. I, edited by R. Schlamensee and R.D. Willig. Elsevier Science Publishers B.V. Steen, F. and L. Sorgard. 1996. A Model of Semi Collusion in the Norwegian Cement Mar- ket. Tariff Commission. 2002. Cement Industry: Safeguard Action Against Imports Formal Inves- tigation Report. Tirole, J. 1988. The Theory of Industrial Organization. London, England: MIT Press. World Bank and the Organisation for Economic Cooperation and Development (OECD). 1998. A Framework for the Design and Implementation of Competition Law and Policy. 4 CHAPTER

Competition Policy and the Philippine Downstream Oil Industry

Peter Lee U*

ABSTRACT

he Philippine downstream petroleum industry underwent monumental change with the passage of Republic Act 8180, the original Downstream Oil Industry Deregulation Act. The first section of the paper surveys the industry T developments before and after deregulation. However, the original deregulation law was struck down by the Supreme Court on November 5, 1997 because it “encouraged” anticompetitive behavior. Specifically, three provisions were cited: (1) the four-percent tariff differential between crude oil and refined products, (2) minimum inventory requirement, and (3) prohibition of predatory pricing. It is not clear that these provisions were actually anticompetitive from an economics point of view. ______

* The author wishes to thank the following offices and resource persons who shared their knowledge of the industry: Ms. Zenaida Monsada and Ms. Cory Mendoza-Boaquina, Depart- ment of Energy; Mr. Juan Armando J. Patag, Chemoil Asia, Inc.; Mr. Fernando L. Martinez, Eastern Petroleum Corporation; Mr. Joey Campos, Mr. Elino Crisostomo, Mr. Noel Ventigan and Mr. Raffy Ledesma, Petron Corporation; Mr. Rey G. Marquez and Mr. Ted Reyes, Philip- pine Institute of Petroleum, Inc.; Mr. Benito A. Bernardo, Jr. and Mr. Sebastian C. Quiniones, Pilipinas Shell Petroleum Corporation; and Mr. Rick Reyes, Subic Bay Distribution (Coastal Corp. and PTT). Lastly, the author is grateful for the comments of the participants of the workshops organized by the PASCN, PIDS and UA&P and the UP-Manchester International Confer- ence on Competition Policy. The author remains solely responsible for all remaining errors. 100 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The second section analyzes the consistency of the Supreme Court decision with economic theory. The report argues that tariff differentials are currently built into the country’s tariff code as a matter of policy, even in the context of the tariff reform program. Thus, it is not unreasonable for the deregulation law to incorporate a tariff differential. The report also disagrees with the Supreme Court reasoning on minimum inventory requirements. As with the tariff differential issue, the report points out whether or not this constitutes significant barriers to entry is an empirical question. The analysis of the decision, in contrast, treats it as if it were a “yes or no” type of question. Moreover, the paper argues that inventory decisions are best left to individual firm discretion. Thus, the high court decision arguably effected the right thing (removal of the inventory requirement) for the wrong reason. Finally, the paper argues that the decision on predatory pricing does not follow the court’s premise. In any case, if the court believed that the tariff differential and inventory requirements posed significant barriers to entry, then a predatory pricing provision could be favorable to competition. The oil companies are also often accused of price fixing because of their similar prices and their timing of price hikes and price cuts. The third section uses a theoretical model (a simple extension of the Bertrand price-fixing game) to analyze this question. It shows that similar prices and the timing of price changes can be consistent with competition. Moreover, the model predicts an asymmetry in the timing of price changes i.e., prices increase faster when crude oil price increases than they do when there is a decrease in crude oil price. The fourth section looks at the proposed national oil exchange. As put forward by Congressman Enrique Garcia, representative of Bataan, such an oil exchange would in effect be a monopoly. As such, it would be susceptible to graft and corruption and would be inefficient as well. Furthermore, a simple welfare analysis is used to show that the oil exchange would be economically inefficient as a measure to subsidize consumers. The fifth and final section examines the experience of other countries’ regulation of the downstream petroleum industry. Thailand and New Zealand both deregulated their downstream oil industries fairly recently. In the case of Thailand, which deregulated before the Philippines, the major oil companies still control a significant share of the market. However, the new players are starting to eat into the market. On the other hand, the United States is a mature market but has experimented with various policies like divestiture and divorcement in its bid to equalize market power.

INTRODUCTION

The Philippine oil industry has not always been regulated. At one point, it was a fairly competitive industry with as much as four refiners (Bataan Refining, Filoil, Caltex and Shell) and six marketing companies (Esso, Filoil, Caltex, Getty, Mobil, OIL INDUSTRY 101 and Shell). This was before the 1970s and before the first world oil crisis. The government responded to the onset of the first oil crisis with the passage of Republic Act (RA) No. 6173 or the Oil Industry Commission Act in April 1971. This law created the Oil Industry Commission (OIC) that regulated most activities of the industry. Most importantly, price regulation was introduced. Prior to this, industry players freely set their own prices but now the OIC would fix prices. In 1973, government created the Philippine National Oil Company (PNOC). It acquired Esso and Filoil. A further realignment in the industry occurred in 1983 with the acquisition by Caltex of Mobil while Shell acquired Basic Landoil (Getty). PNOC later acquired Bataan Refining and thus, by 1985, the industry was reduced to just three companies: Caltex, Shell, and PNOC (later Petron). In 1984, then President Ferdinand Marcos created the Oil Price Stabilization Fund (OPSF) as a buffer fund to stabilize oil prices. When world oil prices were lower than the corresponding fixed pump prices, the firms contributed to the fund. When the opposite happens, the firms drew from the fund. When Corazon Aquino took over as President, she created the Energy Regulatory Board (ERB) through Executive Order (EO) 172. The ERB basically took over the functions of the OPSF. Most importantly, the ERB was tasked with setting the prices of petroleum products. It was also during her term that the Department of Energy (DOE) was created through RA 7638. The Act was important for mandating the DOE to provide for an environment of free market and to institute, with the President’s approval, the deregulation of the oil industry. As part of its general thrust of opening the Philippine economy to market forces, the Ramos administration passed into law on March 28, 1996, RA 8180, “An Act Deregulating the Downstream Oil Industry.” It took effect on April 16, 1996. The major effect of this Act was allowing oil firms to set their own prices. Unfortunately, the Asian crisis caused the peso to depreciate from P28:US$1 to P40:US$1. Naturally, the oil companies increased their pump prices, since the Philippines imports practi- cally all of its crude oil requirements. However, as the peso kept depreciating and the oil companies kept adjusting, public clamor broke out. This attracted the attention of a few lawmakers who pro- ceeded to file a suit with the Supreme Court1 . Subsequently the Supreme Court decided in favor of the petitioners and it nullified RA 8180 on November 5, 1997. This decision is very important. Competition policy and antitrust laws are still at a very nascent stage in the Philippines. Thus, this decision may fortunately or unfortunately set a precedent and shape future policy. Ma. Lourdes Sereno, a leading Philippine legal scholar, has termed it a “landmark” case in local antitrust for it discusses the economic concepts of monopolization and cartelization, predatory pricing and barriers to entry among others (Sereno 1999). ______

1 We shall henceforth refer to the Supreme Court as SC. 102 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Congress quickly sought to “repair” RA 8180. The result was RA 8479 which was approved on February 10, 1998. After two years and with a new oil deregulation act replacing RA8180, we can perhaps look back on the events. This research paper seeks precisely to examine the reasonableness of the SC’s decision.

PHILIPPINE OIL INDUSTRY STRUCTURE The petroleum industry is usually classified into two sectors: the upstream and the downstream portion. The upstream portion refers to the exploration and drilling of oil, whether such oil deposits are found under land surfaces or off-shore, e.g., under water. The downstream portion of the industry begins with the transportation of the output of the upstream portion, the crude oil, to refineries. Thus, the downstream portion will generally include the following activities: importation and exportation of crude oil and petroleum products, refining, transportation (also referred to as transhipment and hauling), and marketing and retailing. The Philippines is involved in both the upstream and downstream aspects. The Nido field was the first significant petroleum deposit discovered in 1976. Commercial production from Nido commenced in 1979. This was followed in the 1990s by the Malampaya and West Linapacan fields in Palawan. However, Philippine crude oil production is generally minimal and insignificant in relation to its energy requirements (Table 1) and especially when compared to crude oil production of some of our neighbors.

Table 1. Oil Production (in barrels) – Philippines 1996 1997 Nido 174,821 124,450 Matinloc 91,490 123,280 Total 266,311 247,730 Statistics Philippines India Malaysia Thailand Proven Oil Reserves (Billion Barrels) 1/1/99 0.23 3.97 3.90 0.30 Oil Production (1000 B/D) 0.85 764.00 797.00 123.00 Oil Consumption (1000 B/D) 350.00 1800.00 450.00 740.00 Production/Consumption (%) 0.24 42 177 17 Crude Refining Capacity (1000 B/D) 1/1/99 389.00 1141.51 474.40 712.75 Note: B/D = barrels per day

Sources: Oil production data for the Philippines were sourced from the Department of Energy; comparative statistics from the U.S. Dept of Energy, URL http://www.eia.doe.gov/emeu/ phdex/contents.html. OIL INDUSTRY 103

Caltex established the first oil refinery in Bauan, Batangas, in July 1954. Stanvac and Shell followed. At one point, there were even six refineries. Today, only the Big Three have refineries. Stanvac Refinery became the Bataan Refinery and its Limay, Bataan plant was completed in January 1961. The Shell Refinery started operations in July 1962 while a local player, Filoil Refinery, began operations in September 1962. Meanwhile, retail of petroleum products seemed to have been a vibrant business in the pre-martial law era. Total number of retail outlets in the industry grew to as much as 4,860 in 1972, but the number has suffered a decline since then (Table 2). Even as of 2001, the number of stations is only 3,658, which is much less than the 1972 figure.

Table 2. Industry Retail Outlets Company 1969 1972 1977 1981 Esso 802 771 0 0 Filoil 336 382 0 0 Caltex 995 1079 1103 1048 Getty 493 1086 582 433 Mobil 628 675 661 517 Shell 839 867 804 733 Petron 0 0 1058 1067 Total 4093 4860 4208 3798 Source: Paderanga and Paderanga (1988).

Petroleum products are transported by a fleet of interisland tankers, barges, tank trucks and the Batangas-Manila pipeline.

BASIC TECHNICAL BACKGROUND Petroleum is a hydrocarbon containing hundreds of compounds. However, only compounds containing carbon and hydrogen are the predominant ones (for example, octane). Other compounds containing some oxygen, sulfur, and nitrogen are less abundant. Compositions of crude oils are usually in the following range: 83-87 percent carbon; 11-16 percent hydrogen; 0-7 percent oxygen plus nitrogen; and 0-4 percent sulfur. Petroleum Hydrocarbons are desirable because they are responsible for the high heating value of petroleum. (Keep in mind that petroleum’s primary use involves the conversion of its chemical energy to heat, with carbon and hydrogen in the various compounds being converted during combustion to carbon dioxide and water.) At the other extreme, compounds containing sulfur and nitrogen are undesirable because during combustion they are converted to sulfur dioxide and nitrogen oxides—precur- sors to acid rain. 104 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The vast majority of petroleum is refined into various fuel products such as gasoline, kerosene, diesel fuel, and fuel oils (Figure 1). A very small remaining fraction is used to produce chemicals which are the basis for the so-called petrochemical industry. They include products that are synonymous with modern society, pharmaceuti- cals, cosmetics, plastics, detergents, and textiles, to name just a few. Most of the petroleum seems to be concentrated in the Middle East. Millions of years ago, as it was formed from decaying plant and animal material, particularly rich deposits were accumulated in the Persian Gulf area.

Figure 1. Flowchart of Petroleum Industry Production

Source: Petroleum and Crude Oil downloadable at www.ems.psu.edu/~radovic/petroleum.htm

In primary recovery of oil, which relies on the natural reservoir pressure to squeeze out the oil from the porous rock, approximately 30 percent of the oil in the reservoir is brought to the surface (Figure 2). Enhanced recovery methods must be used to recover more than that. Water or gas injection (secondary recovery) is used to increase the reservoir pressure. Steam injection (tertiary recovery) is typically used to reduce the viscosity of the remaining oil and thus, further increase the amount that can be pumped out of the reservoir. These methods are not used routinely because they are expensive. When the price of oil increases, there is greater incentive to use them and thus increase, to some degree, the proven reserves of oil. OIL INDUSTRY 105

Figure 2. Schematic Diagram of Oil Recovery

Source: Petroleum and Crude Oil downloadable at www.ems.psu.edu/~radovic/petroleum.htm

PROGRESS REPORT ON THE EFFECTS OF DEREGULATION International crude oil prices have continued to rise in recent months as the Or- ganization of Petroleum Exporting Countries or OPEC members implemented production cutbacks. Inevitably, domestic pump prices for gasoline and diesel had to be adjusted upwards. This has raised protests among the various oil product-consuming sectors as well as among the opponents of oil deregulation. The latter have used this occasion to ask for a repeal of oil deregulation. Congressman Enrique Garcia, representative of Bataan, who had been one of those who successfully petitioned for the repeal of the first oil deregulation law, filed yet another motion to dismiss this second oil deregulation law.2 The media, particularly some newspaper editorials, have been railing once again against the oil companies, and consequently, against the idea of deregulation as well. Not suprisingly, most of those pushing for a repeal or at least a review of the law rest their arguments on the following price issues: • fuel prices have not dropped but have conversely been rising • alleged evidence of price fixing, i.e., cartelization and collusion on price • overpricing by oil firms

Essentially, their opinion is that the oil deregulation law failed to establish an environment of competition in the industry. But is it fair to expect the law to bring intense competition in a span of merely two years? Or to expect it to bring lower prices? Deregulation of an industry sometimes does bring with it lower prices. However, in this case, international crude oil prices have been rising in recent months and therefore, it is not surprising that gasoline

2 The Supreme Court recently rejected that motion in a ruling last December 1999. 106 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES prices also had to be raised. From the low teens in the first quarter of 1999, international prices have since doubled to mid-$20s per barrel. We must remember that the Philippines has very limited crude oil production. Since the products that we use, e.g., gasoline, diesel, etc. are refined from crude oil, we must practi- cally import all of it. Price reduction per se is not the objective of deregulation. The rationale for deregulating in this case is to open the market and subject it more closely to market forces and let in more competitors. The increased competition in turn should serve as an incentive to firms to be more efficient, which may lead to lower prices in some cases. Attracting more investments is another objective of deregulation. Decontrol- ling prices also did away with the government’s (specifically the ERB’s) function of computing and setting prices, thus, freeing government resources for other functions, regulatory or otherwise. These objectives remain valid. The deregulation has so far brought in quite a number of new players, as statistics from the Department of Energy show (Table 3). Even allowing for double-counting (because some of the firms may be engaged in more than one activity), the numbers are not insignificant, considering the industry has been deregulated barely four years. For example, there are now over 80 firms in the various subsectors in contrast to mainly the three majors prior to deregulation.

Table 3. Players in the Downstream Oil Industry Number of Players Activity Dec 1998 Mar 1999 Aug 2000 Fuels Bulk Marketing 25 28 31 Retail Marketing 8 11 19 LPG Bulk Marketing 8 9 14 Storage/Transhipment 4 4 13 Bunkering 5 8 9 Refining 3 3 3 Total 53 63 89 Source: Department of Energy.

The charge of collusion on price misses the point on the oil industry’s deregulation. It is unfair to blame RA 8479 (the Oil Industry Deregulation Act) for the price fixing and/or coercive practices of the oil companies. The Act precisely outlaws such activities. What should be decried, is not the industry’s deregulation, but the slow prosecution of anticompetitive practices, if in fact, they exist. If Shell, Caltex, or Petron are in fact colluding and talking with each other on what prices to set, then by all means let us gather the evidence and prosecute them. But often, it seems that the only “evidence” put forth on the alleged collision of the OIL INDUSTRY 107 majors on prices is that they have similar or identical prices and that they change prices at roughly the same time. As this paper will argue later3 , this is not conclusive proof of collusion. Similar or even identical prices and coincident price changes are consistent with either collusion or competition. RA 8479 does not condone price fixing. Neither was it the intended result. Unfor- tunately, price fixing can occur in any free market, and perhaps they do occur in many markets in our country except that they go unnoticed. The act of colluding on prices or coercing other sellers to follow, is in fact a violation of RA 8479. Sec. 11a of the Act specifically prohibits acts of cartelization, which the Act defines as “…any agreement, combination or concerted action by refiners, importers and/or dealers, or their representatives, to fix prices… in restraint of trade or free competition.”

SPATIAL COMPETITION AND RETAIL GASOLINE MARKETS A common observation of many motorists is that there seems to be more serious competition along Sucat Road south of Metro Manila, where some new players have stations competing with those of the majors. Prices have reportedly been lower here in the past by as much as 60 to 70 cents as compared with other gasoline stations in Metro Manila. This actually argues for deregulation and a free market. We must remember that spatial (i.e., location) competition is the key in retail gasoline marketing. A gasoline station’s market is essentially geographic, i.e., its market is determined by its location because it determines who and how many motorists are normally in the area. In this aspect, the gap between the Big Three and the new players is truly huge. At last count, there is a total of 3,652 gasoline stations in the country. As of June 30, 2001, the new players account for only 362 of these. (See Tables 4 and 5 for a breakdown by region and by new player.) Moreover, putting up a new gasoline station requires substantial investment. (Estimates range from about P5 million to P10 million for a modest size station.) That it would be difficult for the new players to catch up overnight is therefore an understatement. We will certainly have to be patient.

Table 4. Total Number of Gasoline Stations 1996 1997 1998 1999 2000 2001* Luzon 1909 1739 1843 2019 2303 2424 Visayas 614 538 563 584 597 633 Mindanao 537 516 545 577 588 601 Total 3060 2793 2951 3180 3488 3658 *As of December 31, 2001 Source: Energy Information Administration Bureau, Department of Energy. ______

3 See section entitled “Price Setting in Philippine Gasoline: Law of One Price or Collusion.” 108 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 5 New Player Gasoline Stations (as of December 31, 2001) New Players Number Flying V 69 Seaoil 53 Total 48 Energex 28 Jetti 27 Eastern 23 Unioil 22 PTT 13 Gas Asia 3 Others 125 Total 411 Source: Energy Information Administration Bureau, Department of Energy.

Furthermore, since location is critical for a gasoline station’s success and given all the years when entry into the industry was regulated and there were only the three majors, they had their run of the field and the choice of the best locations, especially in the urban areas. Until fairly recently, Sucat was not as densely populated and we surmise, the area was left relatively uncontested. It will therefore be in relatively, newly populated areas where the new players can find locations more easily. Unfortu- nately for Metro Manilans, this means the benefit of increased competition may be slower for them. This suggests the importance of not discouraging new entrants into the industry. We have seen what benefits they bring when they can come in, e.g., the Sucat Road example. But to do an about-face on oil deregulation and either nullify it or impose price controls would precisely scare away potential future competitors of the three oil majors. Not surprisingly, the new players have yet to make a significant dent in market share on the retail side. Nevertheless, the new players have a market share of 8 percent out of the total oil products market (Figure 3). This is quite an improvement from their 0.7 percent share in 1996. (As of the first semester, Shell has overtaken Petron in market share.) One area where the new players have made inroads faster is in bulk sales (Table 6). Perhaps this is understandable, given our observations on retail marketing. Unlike retail marketing, bulk selling does not require the huge investment needed to have a network of gasoline stations. A new player only needs hauling and storage facilities, both of which would be needed anyway for retail marketing. OIL INDUSTRY 109

Figure 3. Market Share of Oil Companies

Source: Department of Energy.

Table 6. Market Share by Sector (%) Majors Others FY 1998 FY 1999 2000 Q1 FY 1998 FY 1999 2000 Q1 Reseller 97.7 96.1 94.7 2.3 3.9 5.3 Industrial 93.4 84.2 86.9 6.6 15.8 13.1 Sales to NPC 98.4 94.5 99.1 1.6 5.5 0.9 LPG 90.1 81.1 76.1 9.9 18.9 23.9 Source: Department of Energy.

RECENT OIL PRICE BEHAVIOR Let us investigate the issue of overpricing. Figure 4 presents the price and cost movements of international crude oil prices and a few select refined products (unleaded and premium gasoline, and diesel) based on DOE data. For ease of compara- bility, the original data4 have been transformed into indices with the first data point, January 1998, as the base, i.e., all the indices equal 100 at this point. Thus, for example, a crude oil index of 120 would signify that costs were 20 percent higher than in January 1998. January 1998 is a convenient starting point because oil prices were under ERB control then. ______

4 The Crude Oil Cost Index is a peso cost index obtained by indexing the product of the foreign exchange rate (PhP/$) and the Dubai cost of crude oil ($/bbl). The price indexes of premium and unleaded gasoline and diesel are indexes of the average pump prices at selected gasoline stations (PhP/liter). 110 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Figure 4. Historical Prices of Oil

Legend: PG = Premium gasoline; UG = Unleaded gasoline; D = Diesel Source of raw data: Department of Energy.

A casual visual inspection reveals that prices dipped slightly after RA 8479 was passed in February 1998 and the industry was “re-deregulated”. (Recall that the SC struck down RA 8180, the original oil deregulation law, in November of 1997 and the industry briefly went back to price control.) One may, of course, argue that it was the oil companies’ interest to lower prices after RA 8479 took effect, if only to appease the public and to link deregulation to lower prices in their minds. Intention is very difficult to prove, however, and we will not waste time attempting to do so. Nevertheless, the timing of RA 8479 was very propitious as the peso cost of oil was dropping in the first quarter of 1998. (Although the peso depreciated during that time, international dollar prices of crude oil dropped faster.) Figure 4 also shows that by around the third quarter of 1999, the peso cost of crude oil was up more than that of fuel prices (of premium, unleaded and diesel) relative to January 1998 levels. In fact, the growth rate of imported peso crude cost continued to outstrip growth in pump prices. In other words, while gasoline and diesel prices were higher on the average in January 1998, they had not risen as fast as the oil companies’ cost of imported crude. This suggests that the oil companies’ margins on the three products have actually narrowed. Third, in between January 1998 and the first quarter of 1999, gasoline and diesel prices relatively did not go down by as much as the crude oil cost index did. Crude oil is not the only cost of production of course, but if the other costs of production have been constant, then Figure 4 suggests that the full benefits of lower crude oil costs were not passed on. However, before we jump on the oil companies’ case for this, we must remember that our analysis depends much on the state of things in the base period. If prices in January 1998 corresponded to a fair rate of return, and if the other OIL INDUSTRY 111 costs of production remained fairly constant, then Figure 2 does suggest that profit margins did widen. In any case, we must also remember that the oil companies incurred sizable losses in 1997 as a result of the SC’s TRO that prevented them from adjusting prices to match the peso depreciation. If the profit margins widened in 1998, it may only have reflected an attempt to recoup the losses suffered in 1997. In any case, Figure 4 suggests that those margins have shrunk further since then and may even be negative by now. Presently, the country is once again having second thoughts about oil deregulation. Perhaps we forget too easily that the oil industry was not always regulated. The problem is, most of the population is not old enough to recall that. Most have lived all their adult lives in a regulated oil industry environment. So, for them, deregulation has the added psychological barrier of being a step into the unknown. Unfortunately, recent indication from OPEC members are that the production restraints will remain and worldwide inventories of oil will stay tight. This suggests that we should not expect a respite from rising crude oil prices anytime soon. The same holds true for domestic pump prices. Certainly, this would further fuel the present clamor to abandon oil deregulation. As we have argued, this is an inevitable result over which we have little control. With or without price control, prices simply have to rise if crude oil prices continue to rise. It would be a pity to consider for naught the achievements that the oil deregulation has achieved so far.

RA 8180 AND TATAD VS. VIRAY

There were actually two petitions filed before the SC that led to the high court’s decision to overturn RA 8180 in 1997. One of the petitions was filed by then Sen. Francisco Tatad, with the Secretaries of the Department of Energy and the Depart- ment of Finance as respondents. The other petition involved Congressmen Joker Ar- royo, Edcel Lagman, Wigberto Tanada, and Enrique Garcia, with the Free Legal Assistance Group (FLAG), Human Rights Foundation Inc., Freedom from Debt Coa- lition, and Sanlakas as copetitioners, and then Executive Secretary Ruben Torres, Energy Secretary Francisco Viray, and the oil companies Caltex, Shell, and Petron as respondents. The decision has come to be known as the Tatad vs. Sec. Viray case. We will refer to it as the Tatad case. The SC decision on the Tatad case is a landmark one in the Philippine antitrust scene. In perhaps no other decision has economic concepts played such a central role. In this section, we will examine the decision to see how economic theory (or the lack of or misinterpretation of it) contributed to the said decision. It should be stressed that the SC itself was not against deregulation. This was amply repeated in the decision to a subsequent petition that Congressman Garcia filed questioning the timing of deregulation and seeking the declaration of Section 19 of 112 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

RA 8479 as unconstitutional.5 For example, in the decision on this case written by Associate Justice Consuelo Ynares-Santiago: “Be that as it may, we are not concerned with whether or not there should be deregulation. This is outside our jurisdiction. The Court respects the legislative finding that deregulation is the policy answer to the problems. It bears stressing that R.A. 8180 was declared invalid not because deregulation is unconstitutional. The law was struck down because, as crafted, three key provisions plainly encouraged the continued existence if not the proliferation of the constitutionally proscribed evils of monopoly and restraint of trade.”

While Justice Ynares-Santiago was not a member of the 1997 SC that overturned RA 8180, those who concurred with her decision included Justice Puno (who penned the majority decision in Tatad vs. Viray), Chief Justice Davide and Justices Belosillo, Kapunan, Panganiban, Mendoza, and Vitug. Justice Melo also concurred in this decision but dissented in the original Tatad vs. Viray decision. Neither is the Court antifree market nor skeptical of the power of the market to serve consumers: “Our ruling in Tatad is categorical that the Constitution’s Article XII, Section 19, is anti-trust in history and spirit. It espouses competition. We have stated that only competition which is fair can release the creative forces of the market.”

At this juncture, Judge Ynares-Santiago quotes the following from the Tatad decision: “Section 19, Article XII of our Constitution is antitrust in history and in spirit. It espouses competition. The desirability of competition is the reason for the prohibition against restraint of trade, the reason for the interdiction of unfair competition, and the reason for regulation on unmitigated monopolies. Competition is thus the underlying principle of section 19, Article XII of our Constitution which cannot be violated by RA No. 8180. We subscribe to the observation of Prof. Gellhorn that the objective of antitrust law is “to assure a competitive economy, based upon the belief that through competition producers will strive to satisfy consumer wants at the lowest price with the sacrifice of the fewest resources. Competition among producers allows consumers to bid for goods and services, and thus matches their desires with society’s opportunity costs.” He adds with appropriateness that there is a reliance upon “the operation of the ‘market’ system (free enterprise) to decide what shall be produced, how resources shall be allocated in the production process, and to whom the various products will be distributed. The market system relies on the consumer to decide what and how much shall be produced, and on competition, among producers to determine who will manufacture it.” ______

5 The case referred to is that of G.R. 132451 Rep. Enrique T. Garcia v. Hon. Renato C. Corona, et al. OIL INDUSTRY 113

Again, we underline in scarlet that the fundamental principle espoused by section 19, Article XII of the Constitution is competition for it alone can release the creative forces of the market.6 This section is important for it underscores the high court’s recognition of competition’s role in achieving consumer welfare in a market economy. It is quite clear that we did not have an SC that was socialist or liberal (in the sense of favoring big government and government intervention) in attitude, and even if it were, it was a court cognizant of its limits. More than one Justice have stressed that it is not their role to second-guess the wisdom of legislators’ choice of deregulation as to what would be the best course of action toward improving consumer welfare. Once again, in the above-cited decision (Garcia vs. Corona) authored by Judge Ynares-Santiago:

“It bears reiterating at the outset that the deregulation of the oil industry is a policy determination of the highest order. It is unquestionably a priority program of Govern- ment.… Be that as it may, we are not concerned with whether or not there should be deregulation. This is outside our jurisdiction. The judgment on the issue is a settled matter and only Congress can reverse it.”

In a separate concurring opinion, Justice Quisumbing states and cites another precedent: “….As the Court said in Tanada v. Tuvera, “[T]his Court is not called upon to rule upon the wisdom of the law or to repeal it or modify it if we find it impractical. That is not our function. That function belongs to the legislator. Our task is merely to interpret and apply the law as conceived and approved by the political departments of the government in accordance with the prescribed procedure.”

Why then did the Court strike down RA 8180? We can find a succinct summary yet again in the above-cited decision of Judge Ynares-Santiago: “…the High Court found that certain provision of R.A. No. 8180 were violative of Section 19 of Article XII of the Constitution which states that “the State shall regulate or prohibit monopolies when the public interest so requires. No combinations in restraint of trade or unfair competition shall be allowed.” In particular, the provision of R.S. No. 8180 on (1) tariff differential, (2) minimum inventory and (3) predatory pricing were found to “inhibit fair competition, encourage monopolistic power and interfere with the free interaction of market forces.” RA No. 8180 was declared unconstitutional in its entirety since “the three (3) offending provisions,” the Court noted, “so permeated the law that they were so intimately the esse of the law.” ______

6 Supreme Court, Tatad vs. Viray et al. 1997 citing Gellhorn, Anti Trust Law and Economics in a Nutshell, 1986 ed., p. 45. 114 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Let us now examine the reasoning of the Court on each of these three points in the Tatad decision overturning RA 8180.

THE TARIFF DIFFERENTIAL ISSUE RA 8180 provided for tariff rates of 7 percent on imports of refined petroleum products as compared with 3 percent tariff on crude oil. The section dealing with this is Section 5(b) which states: “Any law to the contrary notwithstanding and starting with the effectivity of this Act, tariff duty shall be imposed and collected on imported crude oil at the rate of three percent (3%) and imported refined petroleum products at the rate of seven percent (7%) except fuel oil and LPG, the rate for which shall be the same as that for imported crude oil. Provided, that beginning on January 1, 2004 the tariff rate on imported crude oil and refined petroleum products shall be the same. Provided, further, that this provision may be amended only by an Act of Congress.”

With regards to this particular provision, Justice Puno contends that it is anticompetitive because: “In the cases at bar, it cannot be denied that our downstream oil industry is operated and controlled by an oligopoly, a foreign oligopoly at that. As the dominant players, Petron, Shell, and Caltex boast of existing refineries of various capacities. The tariff differential of 4% therefore works to their immense benefit. Yet, this is only one edge of the tariff differential. The other edge cuts and cuts deep in the heart of their competitors. It erects a high barrier to the entry of new players. New players that intend to equalize the market power of Petron, Shell, and Caltex by building refineries of their own will have to spend billions of pesos. Those who will not build refineries but compete with them will suffer the huge disadvantage on increasing their product cost by 4%. They will be competing on an uneven field. The argument that the 4% tariff differential is desirable because it will induce prospective players to invest in refineries puts the cart before the horse. The first need is to attract new players and they cannot be attracted by burdening them with heavy disincentives. Without new players belonging to the league of Petron, Shell, and Caltex, competition in our downstream oil industry is an idle dream.”

It may be stretching things a bit to characterize the 4 percent differential as a “significant” barrier that works to the “immense benefit” of the oil companies. After all, the tariff differential was even more substantial at 10 percent (tariff rates of 10 percent for crude oil and 20 percent for refined products) before RA 8180. In general, for industrial products, the tariff structure builds a 7 percent tariff differential; 3 percent for raw materials and 10 percent for finished products. It would seem incongru- ent for the SC to find Sec 5(b) of RA 8180 unconstitutional because of a 4 percent differential but remain silent about the Tariff Reform Program that builds in a 7 percent tariff differential by design. OIL INDUSTRY 115

Nonetheless, trade theory suggests that a uniform tariff structure is ideal. Tariff differentials introduce market distortions that would penalize some sectors and re- ward others. Such distortions could lead to serious misallocation of resources. In the meantime, however, uneven structure remains until trade policy reforms could be implemented toward a more uniform tariff. In sum, while there is economic rationale for equalization of tariffs, competing refined products can now be imported at lower cost. What is being questioned is the economic soundness of the argument that the tariff differential provision is anticompetitive and constitutes a barrier to entry.

INVENTORY REQUIREMENTS With regards to inventory, Section 6 of RA 8180 required the following: Sec. 6. Security of Supply -To ensure the security and continuity of petroleum crude and products supply, the DOE shall require the refiners and importers to maintain a minimum inventory equivalent to ten percent (10%) of their respective annual sales volume or forty (40) days of supply, whichever is lower. Clearly, the intention of the legislators behind the inventory requirement seems to have been the deterrence of “fly-by-night” operations and assurance of supply. From an economist’s viewpoint though, it is market forces, rather than legislation, which best provides such deterrence. First of all, any business establishment has to make provisions for inventory. Businessmen naturally want to avoid running out of inventory because it means foregone revenue and possibly, lost customer goodwill. The larger the inventory, the less likely this will happen. However, carrying inventory entails carrying costs, not just storage costs but also the cost of goods tied up in the inventory (unless suppliers are particularly generous with their terms). The larger the inventory, the larger also will be the carrying costs. The standard inventory models in economics would have firms weighing the tradeoffs between the cost of lost customer goodwill and revenue in the event of a stockout situation with the carrying cost of inventory. Among other variables, interest rates, exchange rate, sales volume, forecasts of market size, etc. could be determinants of the optimum level of inventory to maintain. Since these factors may change over time, the optimal level of inventory can too. The author has been unable to determine the source or rationale of the rule-of-thumb of 10 percent or 40 days that has been decided on by the legislators who crafted RA 8180. In any case, the upshot is that this provision is arguably unnecessary and possibly obtrusive. Nevertheless, the question that confronts us is why did the high court rule this provision as being anticompetitive, and therefore, unconstitutional? The reason seems basically the belief that this stipulation will be more onerous to the new entrants than to the Big Three, and will thus discourage the entry of new players. In other words, the Court seems to view it as erecting another barrier to entry. To cite once again from Justice Puno’s decision: 116 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

“The provision on inventory widens the balance of advantage of Petron, Shell, and Caltex against prospective new players. Petron, Shell and Caltex can easily comply with the inventory requirement of RA No. 8180 in view of their existing compliance with this requirement difficult as it will entail a prohibitive cost. The construction of storage facilities and the cost of inventory can thus scare prospective players. Their net effect is to further occlude the entry points of new players, dampen competition and enhance the control of the market by the three (3) existing oil companies.”

Once again there arises the question, to what degree does this represent a barrier to entry? True, the Big Three will require no new action to comply with this requirement while the new players will. However, as it has been explained above, the new players will presumably want to install some storage capacity and maintain some inventory as part of normal business practice anyway. The question is whether or not the 10 percent or 40-day equivalent is unreasonably above this level or not. It may even be the case that the new players would have voluntarily maintained more than the minimum specified in Sec. 6 of RA 8180 anyway. Furthermore, even before RA 8180 was repealed, around 30 new players had already expressed their intent to do business here. Many like Coastal, PTT, Total, SeaOil, and Flying V had even gone ahead and started operations already. This would seem to belie the claim that the overall effect of the 4-percent tariff differential and the minimum inventory requirement is to be a significant barrier to entry. Admittedly, one could speculate that perhaps, in the absence of these alleged anticompetitive provisions, there would have been more new players. But 30 hardly seems an insignificant number of new entrants (certainly when compared to three: Shell, Caltex, and Petron) and would seem to cast some doubt on the barriers to entry that these alleged offending provisions erected. Justice Francisco makes precisely this point in his dissenting opinion: “…Whether or not the requirement is advantageous, disadvantageous or conducive for new oil companies hinges on presumptions and speculations which is not within the realm of judicial adjudication. It may not be amiss to mention here that according to the Office of the Solicitor General “ there are about thirty (30) new entrants in the downstream activities x x x , fourteen (14) of which have started operation x x x, eight (8) having commenced operation last March 1997, and the rest to operate between the second quarter of 1997 and the year 2000.” Petitioners did not controvert this aver- ment, which thereby cast serious doubt over their claim of “hostile” environment.

PREDATORY PRICING From inventory requirements, we now move to the issue of predatory pricing. Predatory pricing has had a long history in the annals of antitrust literature. The most famous antitrust case involving predatory pricing is perhaps that of Nelson Rockefeller’s Standard Oil case of 1911. This is the very same Standard Oil that arguably inspired the Sherman Act, the grandfather of American antitrust law. OIL INDUSTRY 117

On the surface, the concept of predatory pricing sounds plausible and even obvious. The idea is that a firm might “prey” on a competitor (or many competitors) by setting very low prices to capture as much of the market as possible and drive the competitor(s) out of business. In extreme arguments, it is argued that the predator might even be willing to incur temporary losses in the process. Thus, as the usual story goes, the predator is normally characterized as a firm with deep pockets, since it must be able to suffer losses initially in its bid to drive the competition out of business. Once the competition has been put out of commission, the “predator” is now a monopoly and can set monopoly price and enjoy monopoly profits. McGee (1958), however, argued that Standard Oil did not practice predatory pricing and presented evidence for his view. More importantly, he advanced sound economic arguments for his belief that predatory pricing is a rare occurrence. The gist of his argument is that predatory pricing is irrational and that it is cheaper for a predator to buy out the prey than to engage in a price cutting war: “Assume that Standard has an absolute monopoly in some important markets, and was earning substantial profits there. Assume that in another market there are several competitors, all of whom Standard wants to get out of the way. Standard cuts the price below cost. Everyone suffers losses. Standard would, of course, suffer losses even though it has other profitable markets: it could have been earning at least competitive returns and is not. The war could go on until after average variable costs are not covered and are not expected to be covered; and the competitors drop out. In the meanwhile, the predator would have been pouring money in to crush them. If, instead of fighting, the would-be monopolist bought out his competitors directly, he could afford to pay them up to the discounted value of the expected monopoly profits to be gotten as a result of their extinction. Anything above the competitive value of their firms should be enough to buy them. In the purchase case, monopoly profits could begin at once; in the predatory case, large losses would first have to be incurred. Losses would have to be set off against the prospective monopoly profits, discounted appropriately. Even supposing that the competitors would not sell for competitive value, it is difficult to see why the predator would be unwilling to take the amount that he would otherwise spend in price wars and pay it as a bonus.”

Let us try to illustrate the issues involved in McGee’s argument below with the following simple diagram comparing the two income flows: 118 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

π We will let m denote the monopoly profits per period that would accrue to the π predator once the competition is out of the way. The symbol c will be the competition profit that the predator earns when it has to compete with the prey. Let L represent the lost profits per period to the predator from predatory pricing. Finally, let I represent the “investment” or purchase price the predator pays for the prey in the case of a merger/acquisition. The first line then represents the incremental income or profit flow to the predator if it were to buy out or merge with the prey at the starting point, 0. In this case, monopoly profits begin at once. If we assume that barriers to entry are high enough to rule out future new entrants, then the discounted value of the flow of π monopoly profits would be given by m /r , where r is the discount rate. On the other π hand, c/r is the discounted value of the flow of income to the prey, and this is also the minimum price it would require to sell out. Here we have assumed that both predator π and prey earn the same amount of profit c if both are in the market. Normally, the story in predatory pricing has the predator being much larger than the prey and so this minimum price will be smaller in that case. The second line represents the flow of profits under the scenario that the predator chooses to cut prices to drive the prey out of business. In this case, the predator will forgo some profits and perhaps even incur actual losses, L, in order to convince the prey to leave. The predator will presumably prefer the course of action that yields the highest net present value (NPV). For the above two strategies, the difference between the two NPVs would be: π π n ( m - c + L) NPV of merger minus NPV of Predation = ∑ −−−−−−−− − Ι i=1 (1+r)i where n is the number of years losses L have to be sustained by the predator. Predation is viable if the difference is negative while merger/acquisition is better if the difference is positive. In general, predation is more viable the larger the acquisition price I, the smaller the losses L to be incurred, and the shorter the period they must be incurred. The simple comparison above assumes that the monopoly profits can be enjoyed forever. A further problem with predatory pricing surfaces when we consider barriers to entry, or rather, the lack of it. If entry barriers are low, i.e., then it is easy for new players to enter the industry. Consequently then, even if a predator could drive a prey out of the market, it could be easily confounded by the entry of other new firms. This would bring the predator back to square one, and worse, after having squandered foregone profits. At the very least, this brief survey of the literature on predatory pricing suggests that we might not have to worry about it. If we accept this premise, the implication is that a provision on predatory pricing is not needed in the oil deregulation law. How- ever, the debate on whether or not predatory pricing is rational behavior and can possibly be observed in real market behavior is not a settled one in economics. One OIL INDUSTRY 119 could say that legislators were at least prudent in incorporating such a provision. At the very least, it would be a type of regulatory insurance. If predatory pricing never happens, then the provision is harmless. If it does occur, then we are covered. However, for the sake of argument, let us allow that predatory pricing could occur and that it is prudent to provide against it. RA 8180 has a very general definition of predatory pricing, one that allows quite a bit of freedom in interpretation: RA 8180 Sec. 9. Prohibited Acts b) Predatory pricing which means selling or offering to sell any product at a price unreasonably below the industry average cost so as to attract customers to the detriment of competitors.

It is quite silent on what industry average cost means. This is perhaps intentional because even the literature is not unanimous on what should be the benchmark for a ‘predatory’ price. Perhaps the most famous is the so-called Areeda-Turner test. Areeda and Turner originally proposed that marginal cost should be the boundary below which a price is judged predatory. After all, economic theory claims that in a competitive market, prices would tend toward marginal cost (see Hovenkamp 1986:115-188 for an explanation of the test). The problem, however, with using marginal cost is that it is difficult to measure. Thus, Areeda-Turner proposed that average variable costs (AVC) could also be used as a proxy for marginal cost. Variable costs (and hence, average variable costs) are arguably easier to measure. Moreover, the minimum average variable cost has a special place in the firm’s economic theory. It is known as the ‘shutdown point’ because when prices fall below this level, it is argued that a firm is better off shutting down because it cannot even recover variable costs, let alone fixed costs. If it were to shut down, then at least it loses only the fixed costs and is therefore, better off. Thus, it would not make sense to set a price below this. Indeed, Areeda and Turner propose that a price lower than average variable should conclusively be presumed to be predatory. In contrast, RA8479 seems to have been written to define predatory pricing much more precise: RA 8479 Sec. 11 b) Predatory pricing which means selling or offering to sell any oil product at a price below the seller’s or offeror’s average variable cost for the purpose of destroying competition, eliminating a competitor or discouraging a potential competitor from entering the market: Provided, however, That pricing below average variable cost in order to match the lower price of the competitor and not for the purpose of destroying competition shall not be deemed predatory pricing. For purposes of this prohibition, “variable cost” as distinguished from “fixed cost”, refers to costs such as utilities or raw materials, which vary as the output increases or decreases and “average variable cost” refers to the sum of all variable costs divided by the number of units of outputs. 120 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

What is curious about the Tatad decision however, is that it did not call for a more precise redefinition of predatory pricing.7 Why then did Justice Puno rule that the original provision also tended to “inhibit fair competition, encourage monopolistic power and interfere with the free interaction of market forces,” and is therefore unconstitutional? He correctly saw the earlier point made above that predatory pricing is futile without significant barriers to entry.8 “…The ban on predatory pricing cannot be analyzed in isolation. Its validity is interlocked with the barriers imposed by R.A. No. 8180 on the entry of new players. The inquiry should be to determine whether predatory pricing on the part of the dominant oil companies is encouraged by the provisions in the law blocking the entry of new players.”

However, his analysis of the implication drawn from this economic point seems faulty. “As aforediscussed, the 4% tariff differential and the inventory requirement are significant barriers which discourage new players to enter the market. Considering these significant barriers established by R.A. No. 8180 and the lack of players with the comparable clout of PETRON, SHELL and CALTEX, the temptation for a dominant player to engage in predatory pricing and succeed is a chilling reality. Petitioners’ charge that this provision on predatory pricing is anti-competitive is not without reason.”

If in fact the barriers to entry are high, then the immediate preceding discussion on barriers to entry and predatory pricing implies that if predation is to be rational behavior at all, it would precisely be under a regime of high barriers to entry. There- fore, a provision banning predatory pricing, in the interest of promoting competition, should precisely be welcomed rather than removed, as Justice Puno would seem to have it.

______

7 Although it seems the petitioners had apparently complained about the imprecision in the definition of predatory pricing. Justice Francisco mentions this in his separate dissenting opinion: “…On predatory pricing: What petitioners bewail the most in Section 9(b) is “the definition of ‘predatory pricing’ [which] is too broad in scope and indefinite in meaning…” 8 In fact, Justice Puno cites an American legal author, Hovenkamp, on this point: “The rationale for predatory pricing is the sustaining of losses today that will give a firm monopoly profits in the future. The monopoly profits will never materialize, however, for the market is flooded with new entrants as soon as the successful predator attempts to raise its price. Predatory pricing will be profitable only if the market contains significant barriers to new entry.” (Hovenkamp, Economics and Federal Anti-Trust Law, Hornbook Series, Student ed., 1985 ed., p. 181.) OIL INDUSTRY 121

PRICE SETTING IN PHILIPPINE GASOLINE: LAW OF ONE PRICE OR COLLUSION?

Rising international crude oil prices in recent months have forced local oil firms to raise prices anew. This has provoked another round of accusations of cartelization and price collusion. The most common ‘evidence’ put forward is that the oil companies have very similar prices (differing only by a few centavos in the case of the Big Three) and that they change prices in quick succession of each other. The following is a list of quotes from legislators and even from SC justices that illustrate this bias.

SOME QUOTES: “There seems to be a tacit agreement between the firms on oil pricing. What is happening now is that when one (firm) raises its price, the two other companies would only match the price” (Aquino 1997). “I can’t see how logic would support the view that stiff competition is the reason the firms’ prices are identical” (Aquino 1997). “Do you mean to say, even if there were 40 oil firms in the market now, prices would still be the same?” (Aquino 1997). “The fact that they have identical prices indicates that there is collusion, connivance and conspiracy amounting to cartelization among Petron, Caltex, and Shell” (Aquino et al. 1997). A Philippine Senator was quoted as saying “… that in many instances, the three oil companies had the same price for the same product, and whenever there was a change, that change will take place almost simultaneously. Now these three oil companies do not have the same buying prices for crude. They do not have the same production costs (or) the same marketing costs, so how come they have the same selling prices? This is something” (Yamsuan and Batino 1999). “These oil companies have inventories that would last up to three months so they should not immediately raise prices even if prices in the international market go up. BIR says 8 oil firms…” (Yamsuan 1999).

Is this the law of one price working? Because gasoline is gasoline, i.e., a homogenous product, one company’s price cannot diverge too much from another one’s or else everyone will just purchase the lower priced gasoline. Or is the pricing behavior of the Big Three oil firms actually the outcome of collusion? These are good questions and their answer is not altogether obvious. The man on the street cannot be faulted if his natural intuition is that because the costs of production have not changed yet, there is no justification for raising prices. This section will present a theoretical model that attempts to explain the uniformity of prices as well as the timing of price changes. We will refer to the products of the oil firms collectively as gasoline even though they refine and sell other types of fuel as well, e.g., diesel, kerosene, aviation fuel, etc. The basic production flow of fuel is simplified as follows: Crude oil is imported and 122 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES then passed through a refinery, where it is processed into the various types of fuel (Figure 5). In the case of the Philippines, crude oil production is negligible so the country imports all its crude oil requirements.

Figure 5. Simple Product Flow of the Philippine Petroleum Industry (downstream only and for retail)

Refinery Gasoline Station

Crude Oil Imports Refining Distribution

THE MODEL We start with a review of the standard Bertrand duopoly model. Assume that there are two firms in a market. The common assumption in such models is that the lower priced firm gets as much customers as it can supply. If both firms charge the same price, they split the market evenly. Let us also assume that each firm is identical and so they have the same costs. For further simplification, we will assume that marginal costs, c, are constant. Let us assume a linear demand function: P = a - bQ Under these assumptions there are two classical duopoly models of competitive behavior, Cournot and Bertrand. Specifically, there are two Nash equilibria, the Cournot equilibrium in quantity and the Bertrand equilibrium in prices. Since we are investigating price setting behavior, we will concentrate on duopoly equilibria in prices and briefly review the Bertrand model. Given identical marginal costs, the Bertrand equilibrium has both firms pricing at the same level P = c, and each earning zero economic profit.9 Each firm will have an output of q = (a-c)/2b. In the standard Bertrand model, each firm is assumed to be able to meet the entire market demand, i.e., no capacity constraints. Furthermore, the story in the Bertrand model is that buyers are perfectly informed of prices so that a firm that charges a higher price will not sell anything. All the buyers simply purchase from the other lower priced firm. In the event that both firms charge the same price, it is assumed that they split the market equally. It is easy to see that we cannot have different prices in a Nash equilibrium. If prices were different, then the high priced firm sells nothing and thus, will lower prices. If both firms charge a common price above c, it can be shown that either firm can always increase profits by undercutting the rival’s price by just a bit in order to ______

9 Students of economics are often thrown off by the idea of zero profits in equilibrium because of their confusion with the common (accounting) sense of the word profit. The economics usage of economic profit includes all opportunity costs. Thus a ‘normal’ return on capital is already included as a cost when computing for economic profit and therefore zero economic profits is not as bad as it sounds. OIL INDUSTRY 123 gain the entire market.10 Finally, no firm will price below c, because even if they gain the entire market as a result, they will lose (c – p) on each unit and will therefore be better off not selling anything. Thus, the only Nash equilibrium possible in prices is to have p1 = p2 = c. One drawback of this standard Bertrand model is that it is a static model. How- ever, it is easy to extend it to a repeated setting. Obviously, in an infinite repeated setting, one Nash equilibrium is for each firm to set pi = c in each stage, just like the static case. The same reasons establishing a common price equal to marginal cost as Nash equilibrium in the static case apply as well in establishing a similar equilibrium in each stage. Thus, the Bertrand duopoly model is often cited as an example of a market with a small number of firms, yet achieves the competitive result, price equals marginal cost, in equilibrium. What drives this result? Intuitively, it is the assumption that switching is costless, a buyer can just as well consume either firm’s product, i.e., the good is a homogenous one. If a buyer does not prefer one firm’s product over the other and when one firm charges a higher price, the buyer simply does not buy from that seller and switches to the other. This is arguably the case with gasoline. Thus, the Bertrand model in fact predicts that similar prices are an equilibrium outcome. It is not the outcome of collusive activity but of competition. This is often referred to as the law of one price.

A Simple Model of Asymmetric Price Behavior This suggests that it is not surprising for firms to have the same price. However, the standard Bertrand story ignores considerations of inventory. It is as if everything sold is produced in that same period. In reality that is not often the case. Specifically, one firm may still have stock of cheaper gasoline produced in an earlier period when crude oil prices were lower. Moreover, even if firms had the same inventory capacities, it is likely that, for whatever reason, their purchases of crude oil stock are not synchronized. In practice, this may occur for various reasons: different rates of sale, production delays, etc. Thus, when there is a crude oil price shock, one firm may run out of cheaper inventory sooner. The quotes previously cited seem to be premised on the above. Why should a firm that still has inventory of cheaper oil raise prices? As cited above, some questions have been raised (even by lawmakers) as to why the Big Three change prices at about the same time when they purchase oil stocks at different times and presumably at different prices. Their implicit assumption seemed to be that only those who had run out of the cheaper oil and had to purchase more expensive oil (in case of rising crude oil prices) should raise their price, while the others that still had inventory of cheaper crude would not. It seemed to them that some oil firms might be taking advantage of ______

10 See Appendix 1. 124 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the situation by raising prices even though they had not run out of their cheaper inventory. To the average man on the street, it smacks of opportunism. While this issue was raised in the context of oil prices, it is an issue that applies to any commodity experiencing a price shock, or a sudden unexpected movement of the exchange rate. Indeed, in the past when the peso depreciated sharply for example, consumers have been heard to make the same complaints about traders of other goods that had been imported under a lower exchange rate. Moreover, some have “noticed”11 that upward price adjustments seem to occur faster than downward adjustments. In fairness to our policymakers, they are not alone in their questioning. Even US politicians have fallen to the same line of thinking, and not without basis (Karrenbrock 1991). There has been work done (Karrenbrock 1991 and Borenstein et al. 1997 for the US; Reilly and Witt 1998 for the UK) to investigate asymmetric price behavior, but no similar work has yet been done for the Philippine case. All three studies cited above have, in fact, found evidence for asymmetric price behavior. However, these studies tend to approach the phenomenon from the empirical side. In general, their objective is measurement of the price asymmetry. Borenstein et al. propose three hypotheses to explain the price asymmetry (see Borenstein et al. 1997:324) based on inventory adjustment costs, production lags, search cost theory and focal pricing points. For our purposes, their first hypothesis is perhaps the closest in spirit to the model we will present shortly: Prices are sticky downward when input prices fall because the old prices act as a focal point for pricing. We offer a theoretical explanation of price asymmetry that is based on the simple Bertrand price setting game. It can serve as one analytical explication of the above hypothesis. The model will consider two cases: a one time positive shock (increase), and a one time negative shock (decrease) in crude oil prices.

First Scenario: Positive crude oil price shock First, let us lay down the time line of the “game”. For simplicity, we assume that the demand for gasoline is perfectly inelastic, i.e., fixed in each period. At the start of the period, firms set their respective price and the distribution of the market results afterwards. The total amount of gasoline available for sale or supply in a particular period is the sum of the finished goods inventory and gasoline refined in the period. We assume that we have a simultaneous game. However, the results do not change if the game were a sequential one instead since the game matrices remain unchanged. In keeping with our identical firms world, both firms are assumed to have the same inventory capacity. This makes it more plausible to assume that they both have the same reorder point or minimum inventory level to be maintained. Each firm is assumed to have the same fixed costs, F, and that each can supply the entire market. ______

11 This hypothesis seems to be inspired more by casual observation than empirical investigation in the Philippine case. I have not been able to find a study that investigates this question with Philippine data. OIL INDUSTRY 125

Consider the case of a positive shock in crude oil prices. Let us consider that point in time when one firm (say firm B) has “run out” of the cheaper gasoline and must now sell gasoline refined from the more expensive crude oil. Suppose firm A still has inventory of gasoline refined from cheaper crude. Let ch denote the marginal cost of the higher priced gasoline, and cl the lower cost gasoline, both of which we will assume to be constant within the same time period. The question that the firms now confront is whether or not to raise price and to what level. We assume that there is complete information, i.e., both firms are aware of their and each other’s inventory situation as well as the costs of imported crude. We are interested in the Nash equilibria, if any. To solve for these, we will construct the two firms’ reaction functions in price space. Before we do this, let us rule out some price ranges where obviously there will not be Nash equilibria. Clearly, prices at or greater than ch will not allow Nash equilibria. If either firm sets a price in this region, the other firm can undercut and gain the entire market and therefore be better off. Since marginal costs are constant, marginal cost equals variable cost. Therefore, a firm will keep producing and selling so long as price is above the marginal cost, i.e., there is positive contribution margin, in order to partly or entirely cover the fixed cost. Another technical detail that we must take care of is that with infinitely divisible prices, i.e., continuous, then Nash equilibria may not exist since the lower-cost firm can always increase profits slightly by approaching the higher-cost firm’s price infini- tesimally from below. We get around that by assuming that prices and costs can only be set at integral values, e.g., one cent, two cents, etc., i.e., no fractions of cents possible. We will let ε here represent one cent. In general, it is easy to see that for a perfectly inelastic market demand quantity of Q, a firm can increase profits by undercutting its rival as long as prices are at least three cents above marginal cost. A slight complication arises when prices are just one or two cents above marginal cost. In this case it can be easily shown that both c + ε and c + 2ε are equally good responses to a price of c + 2ε set by the competitor (see Appendix 2). We start with firm A’s reaction function (Figure 6). Firm A does best by always undercutting whatever Firm B’s price is, down to its marginal cost cl. Below cl, A does not recover even the variable (marginal) cost so it makes no sense to price lower than cl even if B does. B has a similar strategy. Whenever possible, it will prefer to undercut except when prices are below ch, since B will not cover even variable costs below that point. One should also keep in mind that the reaction functions are really discrete and hence, discontinuous. They have been drawn as continuous lines however, to facilitate visual reading. The intersection of the reaction curves represents a Nash equilibrium.

In this case, we have a unique solution where B sets a price of ch and A undercuts ε at ch - . We may also represent the above game in the normal form using a game matrix (Figure 7). Having analyzed the reaction functions allows us to pinpoint the key 126 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Figure 6. Positive Price Shock Case

Figure 7. Game Matrix Firm B

ch cl ci

Firm A cl

prices. The following game matrix presents payoffs in terms of income before fixed costs, i.e., revenues less variable costs only. Since we assume a common fixed cost F, incorporating fixed costs would merely add a minus F to every element of the matrix and not change the analysis of a Nash equilibrium. The total market volume Q has also been normalized to equal one. The normal form also allows us to gain an additional intuitive understanding of the competing strategies. It allows us to see that B actually has a weakly dominant strategy, which is to raise its price immediately. If a firm elects to raise its price, there are three possible price levels in a Nash equilibrium: ch , cl, or some intermediate price ci where ch > ci > cl. At the risk of δ δ complicating the notation, let us define another parameter = ch – ci. Thus represents the amount by which a firm undercuts ch . Note that we can rule out the possibility of prices above ch and below cl in a Nash equilibrium. First, if prices are above ch, then the higher priced firm can do better by undercutting a little the low price to gain the entire market. Second, if prices are below cl, then losses are incurred and either or both firms are better off not selling anything. OIL INDUSTRY 127

Without loss of generality, let us normalize units so that ch – cl = 1 and the market volume, Q, is also 1. This makes reading the game matrix easier. Then the above game matrix becomes Figure 8.

Figure 8. Game Matrix for Positive Crude Oil Price Shock Firm B

ch cl ci

Firm A cl

An inspection of the game matrix reveals that not raising price for firm B (stay- ing at p = cl ) is strictly dominated by raising price to either ch or ci. Furthermore, among the strategies involving raising price, raising the price to ch weakly dominates raising to an intermediate level ci. Intuitively, with the higher cost gasoline, if firm B continues selling at any price below the new higher cost, then it loses some amount per unit. It would have been better off not to sell anything. Thus, firm B is better off raising prices regardless of what its rival does. If A maintains its old (and lower) price then, B simply sells nothing but suffers no loss. If A matches B’s new higher price, then they split the market and firm B will make zero economic profits (and subsequently, some amount of accounting profit) at least. If A undercuts B by just a little (say e) to gain the entire market, then B sells nothing but at least will not lose any money. Firm A, on the other hand, sees the same game matrix and if it believes B is rational, can rule out the possibility that B will not raise prices since it is a dominated strategy. In other words, it can safely assume B will play its weakly dominant strategy and raise prices to ch. But given that Firm B will raise its price, then the best strategy δ for A now is to raise prices also to an intermediate price ci = 1 - . If firm A can actually supply the entire market, then it sets δ as small as possible, e.g., one cent, so that it gets the entire market. However, if A cannot supply the entire market, then there is some critical fraction of the market it can supply below which it does best by simply setting p = ch. Setting δ p = ch - would merely forgo some revenue. This critical fraction is where: (1 – δ) f ≥ ½ δ The left hand side is the economic profit from selling at ch - to a fraction f of the market (recall that the market size has been normalized to one) while the right hand side is the profit from matching the price but selling to only half the market (ch-cl)*1/2. 128 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Thus, the critical fraction of the market that can be supplied such that A prefers to undercut is:

1 f ≥ −−−−−−−−−− 2(1– δ) As δ approaches zero, this fraction approaches ½. In other words, if A cannot supply at least half of the market, then it is better off matching prices and splitting the market.

In either case, the equilibrium suggests price will either be at ch immediately and δ both firms split the market, or at some price ch - that is close to it. Here, firm A enjoys a temporary windfall—temporary because ultimately A will also run out of the cheaper inventory. Of course, consumers in an actual market are not likely to discriminate between prices that differ only by a few cents12 and the firms may nevertheless end up splitting the market. In other words, the higher priced firm (as long as it is not too much in the perception of buyers) may not necessarily sell nothing. Even theoretically though, one can offer a plausible explanation why firm A may simply match prices and not attempt to undercut B. If both firms are in this business for the long haul, and neither one is likelier to anticipate a positive price shock, then either firm is just as likely as the other to find itself in firm B’s situation. In the long run, this could naturally give rise to a ‘you scratch my back and I’ll scratch yours’ kind of strategy. That is, A will not play hardball too much and will just match B’s price with the tacit assumption that when A finds itself in a similar disadvantaged situation, B will return the favor. Indeed, some studies in game theory have found that in a repeated setting, even the prisoners’ dilemma could start to yield cooperative outcomes.

SECOND SCENARIO: NEGATIVE CRUDE OIL PRICE SHOCK Let us consider the second case where there is an unexpected drop in crude oil prices. Suppose firm B is now the first to run out of the old inventory of more expensive gasoline. We maintain the same market allocation rule as above: low-priced firm gets all the market and it splits the market in the event of identical prices. Following the same notation as above, we obtain the following corresponding reaction curves in Figure 9 (analogous to Figure 6) game matrices, Figure 10 (analogous to Figure 7), and Figure 11 (analogous to Figure 8). The corresponding game matrices show a remarkable asymmetry in the off diagonal elements (although with reversed payoffs). Meanwhile, the payoffs are reversed on the main diagonal.

______

12 The industrial organization literature offers various explanations for this: search costs, transportation costs, etc. OIL INDUSTRY 129

Figure 9. Downward Price Shock Case

Figure 10. Game Matrix for Negative Crude Oil Price Shock Firm B

ch cl ci

Firm A cl

Figure 11. Game Matrix for Positive Crude Oil Price Shock Firm B

ch cl ci

Firm A cl

Now, continuing to charge the old high price of ch is the weakly dominant strategy for firm A. Recognizing this, firm B will therefore choose the intermediate price, δ ch - . A similar discussion as above regarding the fraction of the market that B can supply thus ensues. But whatever the case (whether or not B can supply at least a critical fraction of the market), the Nash equilibrium has B either simply matching δ the old price of ch, or getting as close as possible to it with ch - . The important point here though, is that B does not immediately go to the lower price dictated by the lower cost, but rather waits for A to finish off its old inventory. In the meantime, B enjoys a temporary “windfall”. Thus there is an asymmetry in the price change in response to a negative crude oil price shock as compared to a positive one. 130 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

There is, however, a theoretical quirk that arises and needs to be addressed in this second scenario in order for the model to be logically consistent. Technically, if B undercuts A, then A sells nothing and will forever have the costlier inventory. Mean- while, B will then enjoy positive economic profits period after period. One could imagine that A might then be willing to match any price just to get rid of the costly inventory and move on to new cheaper inventory that would put it on equal footing with B. This could be the case especially if there are fixed costs for A. (This is the explanation for the alternative dashed line branch of A’s reaction function, collinear with the 45-degree ray in figure 5.) If the loss from selling the inventory below cost during this period is less than the discounted stream of fixed costs in the future, then this will be the case. There are two ways how a real market may depart from the above extreme theoretical result. Both have already been mentioned in the first scenario. The first is that in real markets, buyers may ignore price differences of a few cents. Second is that in a repeated setting, B may think it wiser to ‘cooperate’ and not lower prices until later when A is ‘ready’; with the unspoken understanding that A will return the favor in the future when the shoe is on the other foot. Obviously, once A has also consumed its old higher cost inventory and has the same lower cost cl as B, both can go back to a Bertrand equilibrium with price cl. In an ideal unchanging world with identical duopolists and a fixed market with perfectly inelastic demand, it is reasonable to argue that in the long run, the market would evolve in such a way that both firms invest enough capacity to split the market. In this case, we expect the classic Bertrand result of identical prices and price equals marginal cost (occasionally, at least of the higher cost firm) still holds. We implicitly assumed a simultaneous move game here but it is easy to see that even if the firms moved alternately, the same outcome would result for so long as both firms have the same information and costs because the game matrices remain the same. In a sequential setting, the firm that runs out of old inventory presumably (firm B) will move first, since the other firm will still be in a status quo situation. This suggests that even without explicit collusion, the two firms would change prices anyway and do so at about the same time, because it is a Nash equilibrium for both of them to do so. (This is not to suggest that Nash equilibria must necessarily be played. Game theory implies no such thing. Nevertheless, if an outcome is Nash equilibrium, then that fact can help explain why that outcome is plausible.) Here, some firm (A in the first case and B in the second) enjoys a temporary “windfall”. This windfall is akin to what some retailers enjoy when the foreign exchange rate depreciates/appreciates and/or they have old stock bought at the old and cheaper price/exchange rate. It may precisely be this intuition that the average man on the street has about the oil companies that leads him to feel he is being taken advantage of and consequently, marches in protest in front of these oil companies’ offices. Again, this is not to exonerate the oil companies of collusion. It may well be that their executives actually get together and agree on what price to charge next and when OIL INDUSTRY 131 to change prices. The results merely point out that similar prices and simultaneous price changes are consistent with independent competitive price setting behavior. In other words, simply having the same prices and changing prices at the same time are not sufficient conditions for the existence of collusion. Therefore, they are not sufficient evidence for regulators to conclude that there is collusion. In this regard, it would be a pity to abrogate or amend the oil deregulation law based on reasoning that rests solely on this misconception.

TO EXCHANGE OR NOT TO: A NATIONAL OIL EXCHANGE?

In recent months, the idea of a national oil exchange has been much discussed in the media and among the general public. Congressman Enrique Garcia (the same congressman who had been one of the petitioners in Tatad vs. Viray) originally proposed this idea. He authored House Bill (HB) No. 871013 , which describes his proposed exchange system. Apparently, an almost identical version was filed in the Senate by Sen. Juan Ponce Enrile, Senate Bill (SB) No. 1855. In essence, the original idea has been to nationalize all oil storage facilities14 in the country and have the resulting government corporation (to be called National Oil Exchange Corporation or NOEC) trade in the world oil market. The proposed NOEC will buy, store and distribute refined petroleum products. The rationale was basically that such a ‘big’ national entity could obtain better prices for the refined products. Oil companies, the new players and the Big Three, will now purchase their refined products from the NOEC and will be allowed to distribute them through their usual channels, e.g., their gasoline stations. This almost certainly implies that the local refineries will be shut down since these refineries need storage facilities for their raw materials (crude oil). One can also ask what happens to Coastal Petroleum, which currently leases the storage depots left behind by the Americans in their former bases. Needless to say, this will scare away foreign investors. For if the investments of the foreign oil companies in their refineries can be nationalized just like that, then what guarantee would a foreign investor in any industry have that once their investments are sunk in the Philippines, the government will not take policy actions that render those investments useless?15 ______

13 See Appendix 3 for selected provisions of HB 8710 and HB 12052. 14 Including those owned by the Big Three as well as the Subic-Clark facilities that are currently being leased by Coastal Petroleum. 15 Presumably, the government will purchase or lease whatever private storage facilities the NOEC will take over. This, of course, raises the practical question of whether or not the government can afford to spend that much money to get into the oil business. 132 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Second, plainly and simply, it erects a government monopoly. Once again, it would put government in business and in direct competition with private business. In this case, it makes government an importer of refined petroleum products. Too easily, we forget that even though these oil companies may be foreign-owned (one of them is partly Philippine-owned, i.e., the Philippine government owns 40 percent of Petron), we are still talking of local jobs here. In principle, one may ask, why not do the same to other industries as well, that is, just have the government import cheaper goods and close down the local manufacturers? Third, assuming that the Big Three are allowed to name a price or rental rate for their facilities, what guarantee is there that the price or rent will not negate whatever scale economies the NOEC could gain from the purchase of the refined products? Then there is always the “x” factor: the tendency for publicly run corporations to be less efficient. Witness NASUTRA and other government monopolies of the past. When a monopoly is created, there is always the temptation to extract rent from such a situation. The government is not an exception to such temptations. A Philippine Star columnist, Federico Pascual, has advanced a compromise measure. He proposes that the NOEC merely take over the Subic and Clark storage facilities the Americans left. Under his scheme, all other private facilities will be left in private hands. The oil companies can then go ahead refining and/or importing as usual. Of course, they may also purchase from the NOEC if they so desire. Essentially, the NOEC would simply be supplanting Coastal Petroleum in this revised compromise formula. He rationalizes that the Subic and Clark facilities would be equivalent to 25 percent of total storage capacity, thereby giving the NOEC a sufficient initial market share to compete with the Big Three. This “Pascual” formula is certainly less extreme than the original Garcia proposal.16 However, there remain some problems with it. First, this still requires taking over the Clark-Subic facilities currently leased under contract to Coastal Petroleum. To rescind this contractual arrangement would again cast grave doubts in the minds of foreign investors on the stability of Philippine laws, and more importantly, whether or not a contract in the Philippines means anything at all. Second, is there any reason to believe that a government entity can do much better than Coastal, a private firm following the profit motive, in sourcing refined products? Coastal presumably attempts to source the same volume of products at the lowest possible price in order to maximize its profits. Moreover, Coastal is a company already with much experience in the business. It is their expertise or comparative advantage. Should we believe that the government can do better at trading in world oil markets when that is not their expertise? Of course, some might say

______

16 In the latest version of his oil exchange idea, House Bill No. 12052, Congressman Garcia has also toned down his original proposal by reducing the scope of control from industry-wide facilities to just those at Subic and Clark. See Appendix 3. OIL INDUSTRY 133 that the government ran Petron for many years and that experience will be helpful. Certainly that experience counts, but that experience has presumably been left behind with Petron. Then there are other logistical problems. The Subic-Clark facilities will accommodate only about a fourth, or 25 percent, of the total Philippine market demand. Moreover, it has no LPG storage facilities. Thus an oil exchange would still have to build storage for the remainder, a very costly proposition, or lease from the current private companies. Also, refining is a continuous process. It cannot be shut down and started up again as easily as a light bulb. The oil exchange would create a high-risk business environment for refineries. If a refining company cannot be assured that it will win next month’s, or even the next few months’ bidding for that matter, what would it do with its output? The incentives would be stacked heavily in favor of simply trading and abandoning refining. This would not bade well for our security of supply. Finally, both the Garcia and the Pascual formulas fail to take into consideration the spatial nature of retail gasoline competition. As has been pointed out in the first section, the market of a retail gasoline station is a geographic one. Given that the Big Three still hold a huge lead over the new players in terms of gasoline stations (about 3,000 vs. 165), that still represents an overwhelming market share dominance. More importantly, that market dominance still translates into price-setting power. You can have 25 percent of the storage capacity, but if you do not have the gasoline stations to sell them, the inventory will just sit in storage.

WILL A NATIONAL OIL EXCHANGE REDUCE OIL PRICES? The concept of a national oil exchange seems to make sense intuitively. Anyone who has haggled in a palengke has experienced getting a discount when he buys in bulk or in greater volume. But this is precisely what makes it a dangerous idea. The mistake is to extrapolate from this experience and conclude that the same thing will happen with the oil exchange. The mistake lies in forgetting the relative sizes of the Philippine market and the total international market for oil. Oftentimes, our day-today haggling experience is limited to encounters with small individual merchants in the market or tiangge. Imagine, however, what sort of results you could expect from haggling over the price of a couple of shirts with say, Shoemart. You would probably be asked to take it or leave it. The total Philippine consumption for oil is estimated at 350,000 barrels per day. In contrast, the world market is estimated to be more than 70 million barrels a day. It is very difficult to imagine that we could get any significant price discount, given our very small demand relative to the total market, and even with the volumes that major oil traders transact. At the root of the exchange idea seems to be the belief that the major oil companies abuse the practice of transfer pricing. The mother companies of the Big Three have been accused of selling overpriced inputs (in this case, crude oil) to their local subsidiary which would inflate the mother company profits while reducing the subsidiary’s. 134 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

However, actual practices between mother company and subsidiary vary. For example, Petron has a non-exclusive supply agreement with its parent ARAMCO, since the former also buys from other sources. Shell reports that it sources most of its crude oil from non-Shell crude oil fields like those of the National Iran Oil Company (NIOC), which is owned by the Iranian government. The global Royal Dutch Shell conglomerate actually has a separate subsidiary that purchases and delivers crude oil to the various Shell refineries around the world, including the Philippines. This arrangement arguably reduces costs by exploiting economies of scale in global distribution. But if transfer pricing is really excessive, it should show up in the bottomline— the price. The case should then be that final refined products from a major oil trading market like Singapore could be imported at significant savings. The DOE has estimated a cost “build-up” based on the August 2000 Mean of Platt’s Singapore (MOPS) price for refined unleaded and diesel final products (Figure 12). This is the average price for those products prevailing in Singapore, a free and unfettered market that the prices should be competitive. Their computations, in fact, show that the completely builtup price would have been higher than the then prevailing local prices: P17.23 vs. P16.85 per liter for unleaded and P14.09 vs. P13.03 per liter for diesel. This suggests that whatever transfer prices were charged the local refiners by their respective mother companies were reasonable. In other words, an oil exchange would not succeed in reducing prices and may even result, ironically, in higher prices.

Figure 12. Unleaded Gasoline and Diesel Price Buildup, August 2000, MOPS Based (in peso per liter)

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12 12 12 12 12 12

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Source: Department of Energy. OIL INDUSTRY 135

Moreover, economists recognize that transfer pricing is a valid management practice to optimize resource allocation among a firm’s various divisions. When the transfer prices are set at their proper levels, they reflect the opportunity costs of the transferred resources. Transfer prices allow the various divisions of a conglomerate to balance the flow of resources among themselves to optimize conglomerate-wide profits. If a transfer price was set too high, then the “buying” subsidiary would get the signal that its operations are costlier and less profitable than it actually is and thus, curtail its output. Moreover, it would have a more difficult time competing because of its “inflated” internal costs. In the context of this paper, an oil major could not maintain excessively “high” transfer prices in the long run because the other majors’ subsidiaries with the correct transfer price built in would be able to undercut its subsidiary in price. On the other hand, an excessive transfer price would mislead the “selling” division into thinking its operations were more profitable than it actually is and overpro- duce its output. Then when it tries to sell the excess outside the conglomerate, it discovers that it cannot sell any because the market price is lower than the transfer price. Overall profits of the conglomerate might suffer in the end. Thus, the conglomerate has an incentive to transfer price among its subsidiaries at the economically “proper” transfer prices. But the most important objection to the oil exchange is perhaps the fact that it would be a monopoly. All distributors would have to purchase their stocks from it. This raises the question of whether the oil exchange will operate as a nonprofit, or a profit-making enterprise. If it operates for profit, then it will lead to what economists call “double marginalization”. It will charge a margin for profit and then on top of that, the distributors will also charge another margin for themselves. Thus, prices may even end up higher than without an oil exchange. Suppose it operates as a nonprofit and simply passes on to the distributors whatever savings in purchase discounts it enjoys.17 What guarantee is there that the distributors will pass on the savings to the consumers? In fact, if the distributors are a cartel or a monopoly themselves, they will tend to keep some of this saving for themselves. Thus, it would be an economically inefficient way of helping the consumer. This possibility is analyzed and dealt with more extensively in the next subsection. Monopolies also tend to be inefficient precisely because they have no competition. The government has not had a particularly good track record in operating monopolies. While the oil exchange will not engage in manufacturing, it may be inefficient in administering the exchange, e.g., purchasing, allocation and distribution of the refined products. Problems of graft and corruption also loom large in the bidding and allocation of the product, as well as the bidding out of ancillary contrac- ______

17 This seems to be what HB No. 12052 Sec. 8 contemplates. See appendix of this chapter. 136 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES tual functions like hauling, shipping etc. A government-run oil exchange would also probably be susceptible to political pressure to subsidize prices of products to keep them artificially low. This is why the Oil Price Stabilization Fund (OPSF) ended up in a deficit when the industry was regulated and why the National Power Corporation (NAPOCOR) is not profitable. Lastly, if the Big Three are, in fact, a monopolistic cartel and collude to overprice their products, they are able to do so because they control most of the retail outlets. The oil exchange does nothing to address this. In fact, the oil exchange would simply deliver cheaper goods for this cartel to sell, on the assumption that the latter is able to obtain the refined products at a substantial discount. Besides, if the Big Three really were colluding, could they not also collude and rig the submission of bids to the oil exchange? If this were the case, the solution is really enforcement of antitrust laws and empowerment of the concerned government agencies with the resources to detect, prevent and prosecute such anticompetitive behavior.

THEORETICAL WELFARE ANALYSIS Presumably, the objective in setting up the NOEC is to lower the pump price of gasoline. Reading through the NOEC proposal as embodied in HB 8710 and SB 1858, it seems the assumption is that the NOEC can buy refined products abroad from the lowest bidders at the lowest prices and then count on the oil companies to pass these savings to the consumers. As was argued above, however, the Big Three still have substantial market power on the retail end. Let us, in order to give the greatest justification for an NOEC, assume that the Big Three act as a monopolistic cartel18. Let us assume further that the NOEC is, in fact, able to source finished products at lower costs abroad than from the refineries here. Suppose the NOEC simply elects to pass on the savings. Then we might consider modeling this situation as a reduction in the marginal cost of the Big Three monopoly (Figure 13). In this case, it can be shown that if the Big Three monopoly maximize profits and set MR = MC, then the increase in their producer surplus will be greater than the increase in consumer surplus. In this simple model, we assume the total market demand by consumers for gasoline is linear and given by P = a – bQ . Let P1 and Q1 represent an initial condition where the marginal cost is c1. Then suppose the NOEC is able to reduce prices to distributors (including the Big Three) from c1 to c2, then a profit-maximizing distributing monopoly will set marginal revenue equal to the lower marginal cost c2 and charge P2 and supply Q2. Evidently, both consumer and producer surplus will increase as a result. However, we will now show that the increase in producer surplus will be greater than the increase in consumer surplus in this simple model. ______

18 Otherwise, if the Big Three are competing vigorously with each other, one may question the need for an NOEC. OIL INDUSTRY 137

Figure 13. Welfare Analysis (of lower marginal costs) with NOEC

Fact: ΔProducer Surplus > ΔConsumer Surplus

Proof: The change in consumer surplus is given by:

Δ CS = (P1 – P2) Q1 + ½ (Q2 – Q1)(P1 – P2)

= (P1 – P2) Q1 + ½ (Q2 – Q1) = (P1 – P2) ½ (Q2 – Q1)

= ½ [P1Q2 – P2Q2 + P1Q1 – P2Q1]

The change in producer surplus is given by:

Δ PS = (P2 – c2) Q2 – (P1 – c1) Q1

= (P2 – a + 2bQ2) Q2 – (P1 – a + 2b Q1) Q1 2 2 = Q2a + Q1a + P2Q2 + 2b Q2 – P1Q1 + 2b Q1 2 2 = a (Q2 + Q1) + P2Q2 – P1Q1 + 2b (Q2 – Q1 ) Then Δ Δ 1 3 3 2 2 PS – CS = Q2 (a – P1) = a Q1 + /2 P2Q1 + /2 P2Q2 – /2 P1Q1 + 2b (Q2 – Q1 ) > 0 138 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

To establish that the difference is positive in this case, we simply need to note the following:

• Since a is the intercept of the demand case, evidently a > P1 • A monopolist will always set price in the elastic range of the demand curve.

This implies that: P2Q2 > P1Q1

This, in fact, implies that the NOEC, if successful in reducing costs, would actually increase the producer surplus of the Big Three as distributors more than it would increase the consumer surplus. Keep in mind that there will definitely be an increase in consumer surplus. The result merely suggests that a monopolistic distributor or a cartel, will benefit more from a successful NOEC, than will consumers. Graphically, this is represented by the relatively smaller drop in prices than the drop in marginal costs. Of course, since the Big Three may not refine crude oil under Garcia’s proposal, they will forgo some producer surplus from refining. This simple model is unable to tell us, however, whether on balance the monopolistic distributor/cartel will have higher or lower total surplus. It seems ironic, however, that even if the NOEC proposal was to succeed, its primary beneficiary would be the distributor. If the consumer is the target of the benefit, it might be more efficient to effect a direct transfer of gasoline to consumers, e.g., a subsidy, rather than through this roundabout way. But what if NOEC were to operate as a profit-maximizing monopoly? Then we could have a case of a bilateral monopoly: a monopoly in the form of the oil companies’ distribution (if they collude), and a monopoly in the supply of products to the oil companies in the form of NOEC. Intuition suggests that the final product price will be higher and Figure 14 shows why. In Figure 14, we will make the simplifying assumptions of linearity and constant marginal costs. Let D represent the final demand curve by consumers for the product. This is also the demand curve faced by the distributors. Consequently, the marginal revenue curve for the distributors is also linear and twice as steep with the same intercept, a. Note that if marginal costs are constant, then this marginal revenue curve

MRDistributor is also the demand curve facing the NOEC monopoly. This is because the distributors would set their constant marginal costs equal to their marginal revenue to determine the quantity they would sell. In turn, the marginal revenue curve for

NOEC, MRNOEC, is linear and twice as steep as MRDistributor with the same intercept, a. Suppose first that the NOEC did not exist and the distribution cartel had constant marginal costs of MC. Then profit maximization would require them to set this MC equal to their marginal revenue and sell Q0 at a price of P0. Now if NOEC existed and suppose, hypothetically, that the best bid it receives for refined product also happens to be the MC (for example the local oil companies won the bid), then NOEC maxi- mizes profits by equating its marginal cost (MC) with its marginal revenue. In this case, NOEC would sell Q1 and charge a price of P0 to the distribution cartel. In turn, OIL INDUSTRY 139

Figure 14. A Bilateral Monopoly

the marginal cost of the distribution cartel would now be P0 and to maximize profits it would sell the quantity Q1 at P1. Obviously, P1 is higher than P0 and the final consumers will be worse off. How- ever, an interesting result in this case is that the resulting loss of consumer surplus is less than the surplus obtained by NOEC. The loss of consumer surplus (compared to the hypothetical case of no NOEC) is represented by the area (P1 – P0)* Q1 + ½(Q0-Q1) (P1 – P0). NOEC surplus is represented by (P0 – MC)*Q1. It can be shown that the NOEC surplus will, in this case, be greater than the loss of consumer surplus. In other words, NOEC could theoretically distribute its surplus back to the consumers and more than compensate the latter. In practice, of course, this could be difficult to do as it may be virtually impossible to identify who paid more for the product. An unin- tended transfer of wealth may thus result. Note, however, that overall, there will be a deadweight loss to society, coming at the expense of the distribution cartel. This deadweight loss will be represented by the area (P0 – MC)(Q0 - Q1) + ½(Q0-Q1) (P1 – P0). Thus, while it might effect a transfer from the distributors to the final consumers, it does so inefficiently.

DEREGULATION EXPERIENCES AND LESSONS FROM OTHER COUNTRIES

The Philippines is not the first to deregulate its oil industry. Other countries have done so ahead of us. Among these have been some neighbors like Thailand and New Zealand. Other countries like the United States have experimented with policies to remedy perceived undesirable features of a deregulated or free oil market. This section surveys the experiences of some of these countries with the objective of drawing some lessons from their experiences. 140 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

NEW ZEALAND New Zealand deregulated its oil market in May 1988 with the passing of its Pe- troleum Sector Reform Act. Prior to this, its oil industry was regulated for 50 years, much longer than the Philippine experience. New Zealand’s regulation of its oil market consisted of: • price and margin control • entry exit regulation (licensing of retailers and wholesalers) • divorcement – Its Motor Spirits Distribution Act required a licence to operate either at the wholesale or retail level. In general, the Act proscribed vertical integration from either level to the other.

New Zealand’s Commerce Act is its main antitrust legislation. Accompanying it are the Fair Trading Act and the Consumer Guarantees Act. Both of these are consumer protection legislation. Most of the refined products come from the Marsden Point Refinery. Four companies dominate the wholesaling with the following approximate market shares as given by Clough et al. (1989). An interesting setup in New Zealand is that these four companies together hold 69 percent of the shares in the New Zealand Refining Company. BP/ Europa ...... 32% Shell ...... 24% Mobil ...... 28% Caltex...... 16% After deregulation, Clough et al. (1989) reports the following experience: • The pace of structural change seemed fastest in the first six months, slowing down thereafter. • With the repeal of divorcement, oil wholesalers and the oil companies quickly moved to acquire retail sites and stations. Clough estimates that the wholesalers may have acquired or secured long term supply contracts with around 15 to 20 percent of all outlets. British Petroleum (BP), an oil major, acquired in August the largest independent multiple outlet chain of stations. Not long afterwards, it also signed up the second largest chain on a long term contract. • Intense competition for some sites in some areas led to some stations changing brand. Oil companies reputedly dangled very generous offers to induce some retailers to sign long-term contracts or to purchase sites. • Oil companies formalized the nature of supply contracts. Retailers that previously supplied on verbal agreements were asked to enter into formal written contracts. And where written contract was already being used, the oil companies sought to have new contracts with longer terms, e.g., on an annual to three or five year basis. • Among the oil companies, there is a split in their approach toward management of stations. Two have opted for a more “hands-on” approach, with manager-operation of a substantial number of their outlets, with the remaining franchised out. The other two companies seemed to favor franchising, preferring to franchise or lease out their sites. OIL INDUSTRY 141

• Majority of retail stations remain independent businesses although now are likelier to be “tied” by a contract to a particular supplier than was the case prior to deregulation. • Retail prices did fall after deregulation. A Ministry of Energy survey suggests that prices may have fallen by about 2.02 to 3.35 cents/liter for super grade and 1.39 to 2.44 for unleaded regular grade. Interestingly, the Minister of Energy dropped both retail and wholesale prices by 6 cents/liter four days before the industry was deregulated. Their reason was to prevent the prices in the regulated regime from becoming a “benchmark” for deregulated price setting. Subsequent deregulation prices did move up but did not return to the previous high controlled levels.

THAILAND Fortuitously (or perhaps by design), Thailand took advantage of the fall in world oil prices after the end of the Iraq-Kuwait war to start its deregulation. Thailand implemented its deregulation in a staggered manner. “Semi deregulation” was implemented at the end of May 1991 while “full deregulation” was implemented less than three months later on August 19. Prior to deregulation, the industry was subject to price control in a system very much similar to the way prices were set here in the prederegulation Philippines. The government determined ex-refinery and import prices based on Singapore posting and spot prices. Excise and municipal taxes on a specific basis (baht/liter) were yet another layer. The government also set the marketing margin and this rarely changed. Retail prices were set by the government and were basically built on top of the preceding components. The resulting retail prices were rarely changed. Since prices of international crude fluctuated frequently, this implied that the Thais also had a buffer oil fund levy/subsidy analogous to our OPSF. Conceptually, the retail price was basically arrived thus, Retail Price = Ex-Refinery/Import Price + Oil fund + Taxes + Marketing Margin At the time of the deregulation, there were two state-owned oil companies (PTT and Bangchak) and four major private oil companies, namely, Shell, ESSO, Caltex, and Thaioil. Unlike the Philippines, there were a few independent oil companies involved in wholesale trade. Oil imports were controlled with a quota system. Entry into the oil business was closed by government policy (no license issued for article 6 oil trader) Semi deregulation meant the following: • Service stations were required to display visible prices of their products. • Government reduced wholesale prices by reducing the oil fund levy. • When actual retail price was lower than the maximum price, it abolished the maximum retail price. • However, the government still fixed ex-refinery and import prices on a weekly basis. 142 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• The oil fund levy was fixed at a constant level and wholesale prices were allowed to change each week in line with ex-refinery prices. • The oil companies were responsible for setting prices at their service stations and closely monitoring them. • Oil companies were required to inform the National Energy Policy Office (NEPO) of changes in retail prices. • Service stations were required to report their pump prices every month.

Even after four years, Thailand’s retail market was still dominated by four companies with a combined market share of over 80 percent (as of September 1995). Perhaps the lesson here is that we need to be more patient in reaping the benefits. We should not expect a more competitive environment to spring up overnight. The Thais were not without post deregulation problems either. There was consumer perception that the marketing margin was too high and indeed, estimates of the average marketing margin rose from a little above 50 satang/liter at the start of 1991 (before deregulation) to above 120 satang/liter in October 1995. Not unlike our experience, there was public perception that the oil companies engaged in price collusion and that retail prices moved upwards faster than they did downward. In stark contrast to the Philippines, the number of service stations grew quite rapidly after deregulation as shown in Table 7. There were quite a few new entrants and while their number of service stations is still far behind the prederegulation majors, their growth is remarkable, however.

Table 7. Thailand Service Station Growth TRADE 1992Q4 % 1995Q2 % % growth PTT 1025 27 1352 22 32 Shell 915 24 1008 16 10 ESSO 757 20 811 13 7 Caltex 547 15 585 10 7 BCP 41 1 777 13 1795 SUSCO 95 3 126 2 33 Mobil 50 1 68 1 36 BP 25 1 39 1 56 Q8 23 1 63 1 174 PT - 0 167 3 - Jet - 0 24 0 - Cosmo - 0 93 2 - Sukhothai - 0 45 1 - MP - 0 68 1 - Independents 286 8 930 15 225 Total 3764 100 6156 100 64 OIL INDUSTRY 143

UNITED STATES Easily the biggest oil market in the world is the US market, also arguably the most competitive. This is because the huge market size easily makes possible the existence of a multitude of firms at all stages of the downstream oil industry. The structure of the US market offers many lessons for the Philippines. In addition, the various forms of regulation that have been tried like divorcement and divestiture are worth studying because they may be proposed here in the Philippines in the future, too. Over 100 refineries refine gasoline and together with imported fuel, constitutes the supply of gasoline in the US market. Retail distribution takes place through various channels (Figure 15). Refiners often sell generic gasoline in bulk directly from the refinery to distributors or even to other refiners. “Branded” refiners also haul their product to a distribution terminal in a city to be sold either as branded gasoline (that is, with company-specific additives and with the right to use the refiner’s name at resale) or as generic gasoline (not permitted to carry the refiner’s name).

Figure 15. US Gasoline Distribution Structure

Source: Borenstein and Gilbert (1993).

At the city terminal, the refiners can either supply service stations directly or work through middlemen known as “jobbers.” A typical jobber supplies many branded stations and often owns many of the stations it services. For instance, a jobber could supply two Exxon, three Chevron, and five “unbranded” stations some of which may be owned and operated by the jobber himself. The branded stations must get their products from their own terminals while the unbranded ones may source theirs from any terminal. Thus, the gasoline bought at a generic or unbranded station may actually be Shell, Exxon, Chevron, other gasoline (generally without the company-specific additives), or gasoline from an unbranded or lesser known refiner. 144 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The jobbers function as intermediaries. They can provide the refiner with information on local market conditions, as well as contacts with dealers and other business people. Such information and contacts may be more costly for the refiner to acquire on its own under certain circumstances, for instance, if it is operating in a small town. As of 1993, there were about 200,000 retail establishments selling gasoline in the United States. About 120,000 or 60 percent of them are major-brand stations (Figure 16). The 15 largest refiners are integrated down to the retail level. Of all the service stations, though, only about 16.4 percent is owned by oil companies. This proportion is low when compared with some of our local players. Shell Philippines estimates that about half of their stations are company-owned. Petron owns 395 stations compared to 496 dealer owned stations.

Figure 16. Share of US Gasoline Retail Establishments Share of US Gasoline Retail Establishments

Bulk and Company-Operated Other 7% Stations 16%

Jobber-Supplied Direct-Supplied Stations 46% Stations 31% Source: Borenstein and Gilbert (1993).

Gasoline retailing in the US may thus be characterized as a mixed distribution system. Many major firms are vertically integrated: they operate a refinery as well as their own service depots. Some companies even franchise out the operation of some stations to third parties. Most companies practice both. Then there are jobbers or wholesalers who do not have a refinery but maintain a network of retail service stations under a common brand name. There is even one refinery, Tosco Corp., which has no stations bearing its name and instead sells all its output to jobbers. The oil industry’s activities involve a three-step process: refining, transporting and dispensing. The first step refers to the transformation of crude oil into the final product, such as gasoline. The product is then transported from the refinery to the city terminals and on to the retail outlets. Finally, it is dispensed to the fuel tanks of auto- mobiles. OIL INDUSTRY 145

Although many firms are vertically integrated from the refinery all the way down to the retailer, they need not be so, as evident in the case of many US companies. Each stage could be considered a different sub-industry altogether. Thus, there is no reason why competition should not prosper at each stage. As of 1993, more than 100 refining companies were operating in the US, supplying about 95 percent of the total volume of gasoline consumed. The remaining 5 percent was imported. Although the 15 biggest companies account for 82 percent of domestic production, no single company has a market share over 9 percent. Nine firms have market shares ranging from 5 to 9 percent. The 15 biggest refiners are vertically integrated all the way down to the retail level, but none of them operate even half of their brand name stations directly—proof that the US oil refining industry is fairly competitive and by no means highly concentrated. Theoretically, the transport stage can be subjected to competition as well. At this stage, barriers to entry are relatively lower since capital and technology requirements are not as critical. Since the US is a contiguous land mass, most gasoline is transported by truck, railway and pipeline. Of these, trucking would probably have the lowest barriers to entry. Except in the smallest town or in the most isolated place, there seems to be a fair amount of competition at the dispensing stage. It would not cost a consumer too much to drive to the gas station around the corner if he does not like the price at the one near his house. The strength of the US structure is that it allows competition at two levels: interbrand and intrabrand. A dealer-owned Chevron station competes not only with the Exxon outlet across the street but with other dealer-owned Chevron stations and those that Chevron itself owns and operates. Price is not regulated (except under emergency situations such as the oil crises of the 1970s); thus, a consumer can witness vigorous price rivalry. In fact, it is even possible for two stations in the same city to charge different prices for the same brand of gasoline. The US market is so huge it can easily accommodate 100 refiners. Given economies of scale in refinery operation, however, a small market like the Philippines can only hold so much industry players. Too many refiners would cause some to fall by the wayside as they would not be operating at a capacity sufficient to bring down costs. (Still, entry and exit decisions of industry players are best left to market forces rather than to legislation.) The Philippine gasoline retail structure, in contrast, has several weak areas. First, there is not enough competition at the ex-refinery stage. Domestically, this is dominated by the Big Three. This has been remedied by the oil deregulation law by allowing imported petroleum products to compete with those of the Big Three. Second, the Philippines has not yet demonstrated much intrabrand rivalry at the retail stage. The three oil companies may charge different prices for the same type of gasoline or diesel, but most stations under the same firm, at least in Metro Manila, charge the same exact price—no wonder the Big Three are being accused of colluding 146 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES on prices. (Prices in the provinces are different from those here but, within the same city, they are the same for stations under the same oil company.)19 But perhaps, just as important as intrabrand rivalry could be the rivalry between branded and unbranded gasoline stations. This could be akin to the competition between branded and generic medicines. Chemically, gasoline is gasoline and the only difference in the product from one oil company to another is in their respective addi- tive. The network of unbranded stations is already quite developed in the US. Mean- while, unbranded stations have yet to take off here. In a sense, many of our new players are the analogue of the unbranded stations in the US. Most of the new players actually do not have the storage facilities to import and therefore, actually get their gasoline from the Big Three. But again, the number of their retail stations are too few compared to those of the Big Three to have an impact on prices and volumes.

IS THERE A CASE FOR DIVORCEMENT? It is not only in the Philippines that people complain about gasoline prices and suspect the big oil companies of keeping prices high by restricting competition. Even in the US, similar public sentiment has been vented against the oil companies. Oil companies there have been accused as well of cartelization and wielding too much market power that allows them to overcharge. Consequently, legislators there have been searching for “solutions” to increase the level of competition. One such measure is divorcement legislation. A divorcement bill requires refiners to “divorce” themselves from owning and running retail gasoline stations. They would be restricted to franchising stations and supplying independent dealer-owned stations. In other words, divorcement is concerned with prohibiting or restricting the extent that oil refining companies vertically integrate into distribution. Typically, an oil company-owned station would be operated by salaried employees of the oil company/refiner. The company sets prices and retains profits. By contrast, franchise dealers lease the station and equipment, set retail prices and keep the profits. In return, they may pay the oil company a rent, which may be fixed or tied to the amount of gasoline sold. Last year, as international crude oil prices started to climb, California legislators started entertaining the idea of introducing a divorcement bill. As early as 1974, the state of Maryland has already passed such a law. Barron and Umbeck (1983) examined the Maryland experience. Blass and Carlton (1999) report that divorcement has been legislated in six states: Connecticut, the District of Columbia, Delaware, Mary- land, Nevada, and Virginia. Very often, the proponents of such divorcement measures have been the franchised station operators. It should be noted that in the United States, there has been a trend since the 1970s toward increased (oil) company-owned stations and fewer fran- ______

19 This practice has started to change since this article was first written. OIL INDUSTRY 147 chised stations. Barron and Umbeck also note that prices at company-operated stations tend to be lower than those at the franchised stations. This has led the latter to accuse the oil companies of predatory pricing. There have been several studies that examined the economic consequences of divorcement legislation in the US. Most of them conclude that divorcement is actually an unadvisable policy decision as it leads to higher prices. Barron and Umbeck (1983,1984) argue that the trend toward more company-owned stations is actually an efficient response to market changes. In the US, there has been a shift away from full service stations, i.e., stations offering oil change, muffler replacement, tune-up, repair, etc., as consumers go elsewhere for these services. The rise of specialty shops that cater to these services, e.g., muffler shops, express oil change and lube shops, etc., has accentuated that trend. Following franchising theory, they argue that when the nature of an activity makes it difficult or costly to monitor, a principal would prefer to franchise out the operation. Since it is more difficult to monitor and manage those auxiliary services like repair, stations had in the past tended to be franchisees. However, as stations become more specialized, i.e., only dispensing fuel, which is easily monitored and measured, the oil companies have found it less necessary to franchise, opting instead to own and/or operate more stations. A study by Shepard (1993), in fact, finds evidence that stations with service bays tend to be lessee-dealers and those stations that mainly sell gasoline and convenience store products tend to be company operated. Both Barron and Umbeck and Shepard find evidence that prices may be lower at company-owned stations. A possible explanation of this is the so-called double marginalization problem. When a residual claimant such as a franchisee dealer sets price on top of the refiner’s wholesale price, the dealer may set a second, supercompetitive markup over the refiner’s wholesale price. This second markup would be absent in a company-operated station. Hastings (2000) takes advantage of a unique market event in California, the purchase by the Atlantic Richfield Company (ARCO) of the Thrifty chain of stations, to investigate this. Thrifty is an independent chain of gasoline stations while ARCO is an oil major. Thus, the long-term lease by ARCO of over 260 independent Thrifty stations converts what used to be independent dealers into company (ARCO)-operated stores of varying degrees of vertical integration. She finds that stations that competed with what used to be a Thrifty station enjoyed a significant increase in price after the latter was converted into an ARCO station. However, this increase was enjoyed regardless of the contractual arrangement of the ARCO station, i.e., whether it is company-operated or a franchise. She concludes that the loss of an independent unbranded station had an impact on prices (increase) but that the type of contraction at the branded station did not. In the Philippines, there seems to be a difference in the structure of retail distribution between the new players and the Big Three. Among the Big Three, the split between company-owned and dealer-owned stations is about half. New player stations, on the other hand, tend to be dealer-owned (Table 8). 148 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 8. Oil Industry Service Station by Contractual Arrangement (as of May 2000) Petron Shell Caltex Others No. of Stations CO DO Total CO DO Total CO DO Total CO DO Total Luzon359 352 711 332 350 682 313 288 601 37 159 196 Visayas & Mindanao 160 279 439 146 262 408 162 210 372 0 17 17 Total 519 631 1156 478 612 1090 475 498 973 37 176 213 Industry No. of Stations CO DO Total Luzon 1041 1149 2190 Visayas & Mindanao 468 768 1236 Total 1509 1917 3426 CO = Company operated DO = Dealer operated Source: Petron. The gross margin of the franchise retail stations average only about 60 cents per liter. Out of this gross margin, the station owner will still have to cover his other costs of labor, overhead, etc. When compared with the final selling prices that range from P12 to P17 for the various product lines, this constitutes only about 5 percent or less. Thus, even if competition among retailers could be increased, there would not be much scope for reduction of the margin. Divorcement does not guarantee lower prices if wholesale prices are unaffected. In the deregulated Philippine setting, this could be effected through import competition. With importation of refined products liberalized, the local refineries will have to compete with refineries abroad, especially Singapore for example, up to at least a margin for transportation costs. However, even this is muted at the moment due to the lack of storage facilities by independent importers. At the moment only Coastal, Unioil, and Total have import facilities that are operational or will be onstream soon. Industry sources would place their combined capacity at about 25 percent of market. Over time, however, this should grow and provide more competition for the Big Three.

DIVESTITURE It is well known that the Federal Trade Commission (FTC) and the Department of Justice (DOJ) in the US, their main government antitrust watchdogs, have rules-of- thumb on market concentration to which they subject proposed mergers. The recent Exxon-Mobil merger is a good example of one such case.20 Prior to the merger, Exxon and Mobil were the second and fourth largest private oil companies in the world, respectively. Together, their assets would reach $80 billion, possibly making it the largest in the world. Ironically, both were key parts of the ______

20 Most of the facts in the following section were obtained from FTC Docket No. C-3907 (Nov. 30, 1999). OIL INDUSTRY 149 old Standard Oil Trust that was broken up in the early part of the last century by antitrust legislation. In order for the merger to be allowed, the FTC ruled that assets in refining, terminal facilities, retail gas stations and pipeline interests totaling $2 billion of the merging companies had to be divested within nine months. The two companies competed head-to-head against each other in many states and the FTC ruled that in some markets, the merged Exxon-Mobil would wield too much market power. So meticulous was the FTC judgment, for example, that for retail gasoline stations it actually enumerated specific cities where a merged Exxon-Merger would have too many stations and prescribed how many stations should be divested in each city. Nevertheless, the FTC allowed the merger to push through on the following grounds: • Except for regions and markets where they directly competed, the FTC judged the merger not harmful to competition. • Exxon-Mobil would control only 1 percent of the world’s oil reserves and constitute less than 3 percent of world oil production. • Even after the merger, the top four firms would account for only 42 percent of refining capacity and gasoline sales, which does not normally warrant antitrust action.

In the Philippines, by contrast, the Big Three account for 100 percent of refining production and 90 percent of the total market. This is highly concentrated in any definition of market concentration. Even though no merger is forthcoming among or involving the Big Three, divestiture might be an option that could be studied. The huge lead of the Big Three in terms of stations might precisely be whittled down by such a policy. However, the margin of over 3000 to 165 is definitely too large to be overhauled by mere divestiture. Other measures to promote the growth of competitors will have to be pursued in tandem with divestiture.

SUMMARY AND CONCLUSIONS

The road to deregulation for the Philippines has not been a straight one. The original Oil Deregulation Law, RA 8180, was signed into law on March 28, 1996. Rising import costs due to the depreciating exchange rate brought on by the Asian crisis forced the oil companies to raise prices in 1997. This did not go unnoticed among some legislators who filed a case with the SC seeking to revoke the Oil De- regulation Law. In a very important decision for Philippine antitrust history, the SC ruled that certain provisions of RA 8180 are unconstitutional and struck it down. A new oil deregulation law, RA 8479, with the ‘offending’ provisions of the first either amended or omitted, was subsequently passed and implemented. Thus, the experience with oil deregulation is important because it represents perhaps the first major test of the country’s path down competition policy and antitrust 150 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES legislation. The SC should be commended for its well-meaning defense of consumer welfare and sincere desire for the true forces of market competition to bear fruit. It should be commended as well for its efforts to apply economics concepts such as competition and market behavior in its analysis of the case, the crux of which is really economic in nature. However, the economic reasoning that accompanied the decision was imperfect. Fortunately, the court erred (unconsciously) on the side of consumer welfare and the new players in the industry. The removal of the tariff differential benefits the new players, enabling them to bring in the products at a slightly lower cost. If they pass this saving on, then consumers will benefit. The potential benefits though, if any at all, arguably come at the expense of the local refining industry. On the other hand, the inventory requirement was unnecessary to begin with anyway, so doing away with the inventory requirement will probably have no meaningful effect. The public outcry may ultimately be a natural resistance to rising prices and to paying more, but it demonstrates the fact that competition policy is implicitly in the minds of the public. They are concerned that a few big firms may be manipulating the market to the detriment of the consuming public. For example, the public perceives the simultaneous price changing by the oil companies as a necessary manifestation of price collusion of some sort. There is certainly a healthy suspicion of the oil industry, which to be fair, is present also in other countries, even the United States. As an outgrowth of such concern and sentiment, we have certain measures being entertained, such as the proposal to set up a centralized National Oil Exchange. Oth- ers have pointed to the pricing pattern of the Big Three as proof of a cartel and have demanded for corresponding sanctions. However, closer scrutiny under the lens of economic analysis suggests that the economic grounds for these positions are weak. It is clear that a marriage of economics, especially the theory of industrial organization, with law is requisite to intelligent competition policy formulation and jurisprudence. Legislators and judges have the moral duty to implement the constitutional vision of competition and protect the public from monopolies. Oftentimes, however, the actual effects of laws or policies that are proposed in pursuit of this objective require economic tools and analysis for evaluation. Thus, it can only profit Philippine policymaking if more discussion between legal and economics scholars is promoted.

BIBLIOGRAPHY

Aquino, N. 1997. Almost Uniform Prices of Oil Firms Questioned. Business World, 1 Octo- ber. Aquino, N. et a1. 1997. Court Freezes Fuel Prices. Business World, 8 October. Barron, J. J. Umbeck. 1983. A Dubious Bill of Divorcemenrt. Regulation 29-33. ————–. 1984. The Effects of Different Contractual Arrangements: The Case of Retail Gasoline Markets. Journal of Law and Economics 313-328. OIL INDUSTRY 151

Blass, A.A. and D. Carlton. 1999. The Choice of Organizational Form in Gasoline Retailing and the Costs of Laws Limiting that Choice. National Bureau of Economic Research Working Paper No. 7435:1-26. Blinder, A.S. 1987. Hard Heads Soft Hearts: Tough-Minded Economics for a Just Society. New York: Addison Wesley. Borenstein S., A.C. Cameron, and R. Gilbert. 1997. Do Gasoline Prices Respond Asymmetri- cally to Crude Oil Price Changes?. Quarterly Journal of Economics 112(1): 305-339. Borenstein S. and R. Gilbert. 1993. Uncle Sam at the Gas Pump: Causes and Consequences of Regulating Gasoline Distribution. Regulation 63-75. Clough, P., A. Bollard, E. Assendelft and J. Cully. 1989. Issues in Oil Sector Deregulation. Research Monograph 43. Wellington: New Zealand Institute of Economic Research. Congress of the Philippines. 1996. An Act Deregulating the Downstream Oil Industry, and for Other Purposes (RA 8180). ————––. 1998. An Act Deregulating the Downstream Oil Industry, and for Other Pur- poses (RA 8479). Hastings, J. 2000. Vertical Relationships and Competition in Retail Gasoline Markets: An Empirical Study of the Divorcement Issue in Southern California. University of Cali- fornia-Berkeley Energy Institute Working Paper PWP-075 1-33. Hovenkamp, H. 1986. Antitrust. St. Paul: West Publishing. Karrenbrock, J.D. 1991. The Behavior of Retail Gasoline Prices: Symmetric or Not? Federal Reserve Bank of St. Louis. McGee, J. 1958. Predatory Price Cutting: The Standard Oil (N.J.) Case. Journal of Law and Economics 1:137-169. Paderanga, A. and C. Paderanga Jr. 1988. The Oil Industry in the Philippines. Philippine Economic Journal 27(1-2):89-107. Reilly, B. and R. Witt. 1998. Petrol Price Asymmetries Revisited. Energy Economics 20:297- 308. Sereno, M.L. 1999. Law and Economics for the Judge. In Perspectives on Law, Economics and Justice, p. 9. Supreme Court of the Philippines. Shepard, A. 1993. Contractual form, retail price, and asset characteristics in gasoline retailing. RAND Journal of Economics 24(1):58-77. Supreme Court of the Philippines. 1999. Rep. Enrique T. Garcia v. Hon. Renato C. Corona, et al. GR 132541. Manila. ————––. 1997. Sen. Francisco S. Tatad v. The Secretary of the Department of Energy and the Secretary of the Department of Finance. GR 124360. Manila. Yamsuan, C.Y. BIR Says 8 Oil Frims Duped Gov’t P4B. Philippine Daily Inquirer, 31 August. Yamsuan, C.Y. and C.S. Batino. 1999. Senate Committee Urges Return to Regulation. Phil- ippine Daily Inquirer, 28 August. 152 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

APPENDICES

Appendix 1. Undercutting Price Increases Profits in the Absence of Capacity Constraints Profit for firm if it splits the market:

a – P π = (P – MC) –––––– s 2b Profit for firm if it undercuts by ε and gains the entire market:

a – P + ε π = (P – MC – ε) –––––– u 2b Therefore, the change in profits is:

a – Pa – P + ε Δ π = π – π = (P – MC) –––––– – (P – MC – ε) –––––– s u 2b 2b

a – P It can be shown that as ε → 0 then Δπ → – (P – MC) –––– < 0; i.e., a firm can 2b increase profits by undercutting the rival’s price to obtain the entire market if P>MC. OIL INDUSTRY 153

Appendix 2. Best Price Response in the Absence of Capacity Constraints When the price of a firm’s competitor is c + 2ε, the firm is indifferent between undercutting to gain the entire market Q, and just matching price and splitting the market since total contribution to profits will be the same: (Note that ε and 2ε are the unit contribution margins.) ε Q = 2ε Q/2 However, if the competitor’s price is c + 3ε, then undercutting to gain the entire market will increase total contribution to profits since: 2Qε > 3εQ/2 It is easy to see that for as long as the competitor’s price p is such that p > c +2ε, where c is the firm’s constant marginal cost, then undercutting will increase total contribution to profits: p > c +2ε (p - 2ε) Q > cQ pQ - 2εQ > cQ

adding pQ – 2cQ to both sides, 2pQ -2εQ – 2cQ > p Q - cQ 2Q (p - ε - c) > (p – c) Q Q (p - ε - c) > ( p – c ) Q/2 The last equation states that the total contribution margin serving the entire market at price p - ε is greater than when splitting the market at price p. 154 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix 3. Selected Relevant Provisions of HB 8710 and HB 12052

HB 8710 An Act Restructuring the Oil Industry By Establishing a National Oil Ex- change, And For Other Purposes Sec. 3 Coverage – This Act shall apply to all persons or entities engaged in any and all activities of the oil industry in the Philippines. Sec. 4 Creation of National Oil Exchange Corporation (NOEC) – Within three (3) months from the effectivity of this Act, a government-owned and controlled corporation to be named as the National Oil Exchange Corporation (NOEC) shall be established. The NOEC shall determine the country’s total monthly requirements for refined petroleum products, and shall exclusively handle all the purchases, storages and distributions thereof to distributors, wholesalers, retailers and big bulk consumers throughout the country. Sec. 5 Bidding – On a monthly basis, the NOEC shall bid out, to all interested oil refineries and trading companies in the world, the total monthly requirements for all refined petroleum products, in order to obtain the lowest price for said products. Only the products of the lowest complying and winning bidder/s may and shall be placed in commerce in the Philippines. Sec. 6 Storage Facilities – The NOEC shall take over and operate all the commercial ocean receiving terminals and storage depots for refined petroleum products all over the country. For this purpose, the NOEC shall take control of the operation of said facilities by way of compulsory purchase or lease, at its option, subject to the requirements of the Constitution and existing laws. Such facilities shall be used exclusively by the NOEC for the storage and distribution of the products of the lowest complying and winning monthly bidder/s. HB 12052 An Act Restructuring the Oil Industry By Establishing a National Oil Exchange, And For Other Purposes Sec. 3 Coverage – This Act shall provide a framework for the following: (a) Establishment and operation of a National Oil Exchange which will exclusively handle the original acquisition/purchase of the country’s total requirement for each and every refined petroleum product: gasoline, diesel, kerosene, fuel oil, liquified petroleum gas and other oil products; and (b) Definition of the participation and responsibility of the various government agencies and private entities. Sec. 4 Creation of National Oil Exchange Corporation – Within three (3) months from the effectivity of this Act, a government-owned and controlled corporation to be named as the National Oil Exchange Corporation, hereinafter referred to as “OILEX”, shall be established. The OILEX shall determine the country’s total monthly requirements for refined petroleum products, and shall exclusively handle their original acquisition/purchase, storage and eventual distribution to distributors and wholesalers, both the Big Three (3) oil companies and the new players alike. OIL INDUSTRY 155

Appendix 3 (continued)

Sec. 6 Bidding and Negotiation – The OILEX shall acquire/purchase the country’s requirement of each and every refined petroleum through bidding and term contract negotiation open to all oil refineries and traders in the world, in order to obtain the lowest price for said products. Only the refined petroleum products of the lowest complying winning bidder/s and term contractor/s may and shall be placed in commerce in the Philippines. Sec.7 Storage Facilities – The OILEX shall take over and operate the government-owned ocean receiving terminals and storage depots at Subic and Clark to receive and store all refined petroleum products. For this purpose, the OILEX shall take control of the operation of said facilities subject to the requirements of the Constitu- tion and existing laws. Such facilities shall be used exclusively by the OILEX for the storage and distribution of the products of the lowest complying and winning bidder/ s and term contractor/s. The refined petroleum products coming from the winning local oil refineries may be maintained in their respective storage facilities, subject to the exclusive control and disposition of the OILEX. Sec. 8 Selling and Oil Pricing Mechanism – The OILEX shall sell, ex-plant and at cost, to all distributors and wholesalers all the refined petroleum products it will acquire. The cost, aside from the acquisition price, shall include recovery of expenses of the OILEX, etc. 5 CHAPTER

Competition in Philippine Telecommunications: A Survey of the Critical Issues

Ramonette B. Serafica*

“It would be a truism to say that the most effective forms of competition we have, or can have, are imperfect forms, since there are no others. But it will mean something if we can find, after due examination, that some of these forms do their jobs well enough to be an adequate working reliance-more serviceable, on the whole, than those substitutes which involve abandoning reliance on competition. And it would be useful if we can learn something about the kinds and degrees of “imperfection” which are positively serviceable under particular situations.” – Clark 1940

ABSTRACT

elecommunications liberalization in the Philippines has produced a number of benefits such as higher teledensity, greater variety of services and to some extent, lower prices. However, simply relaxing market entry restrictions has Tbeen proven insufficient in creating a truly competitive environment. This paper looks at the state of competition in the Philippine telecommunications market and discusses the various threats to the competitive process in the industry. The paper also suggests areas for intervention from the standpoint of competition policy.

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* The author acknowledges the research assistance of Ms. Jovie Importante. All errors are the sole responsibility of the author. 158 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

INTRODUCTION

The demonopolization of Philippine telecommunications can be considered as one of the best legacies of the Ramos administration. It is hard to imagine that any other policy move could have elicited the same supply response from industry, particularly from the dominant operator. This study seeks to improve on the achievements of liberalization by carefully analyzing the critical issues affecting competition in Philippine telecommunications. In particular, the objectives of the study are: • To provide a clear and workable definition of competition policy especially as it applies to the telecommunications industry. • To evaluate the state of competition in the Philippine telecommunications industry. • To identify threats to the competitive provisioning of telecommunications services. • To suggest policy and regulatory measures to ensure a contestable telecommunications market.

To begin, some basic concepts and principles are presented to better understand competition policy and its role in telecommunications. Next, we will carefully review the state of competition in Philippine telecommunications by looking at the industry structure and the relevant regulation affecting firm conduct particularly with respect to pricing. Then, the experiences of local communities after the introduction of liberalization will be discussed followed by an analysis of the critical issues undermining the competitive environment. Specific recommendations to create a more competitive and efficient telecommunications market are presented last.

THE ROLE OF COMPETITION POLICY IN PHILIPPINE TELECOMMUNICATIONS

The virtues of competition are well known. Several efficiencies are attained in markets where there are many buyers and sellers none of which has market power, where consumers perceive no product differentiation, where information is costless, and where barriers to entry and exit do not exist. Productive efficiency is achieved because firms are forced to produce goods and services at minimum cost. Allocative efficiency is attained because only the right amount and mix of goods and services are produced at prices that reflect the opportunity cost of all resources utilized. X-inefficiency is avoided because the discipline of a competitive market will punish managerial slack or excesses. Equally important, consumer welfare is also maximized under a perfectly competitive market structure. TELECOMMUNICATIONS 159

In reality, most industries do not possess all of the standard characteristics of a perfectly competitive model from which such efficiencies are supposed to emanate. In the case of telecommunications, massive capital requirements imply high barriers to entry and exit especially since a significant portion of fixed cost incurred is sunk. Telecommunications is also characterized by a network of switches, transmission links, and terminal or distribution points that give rise to economies of scale and scope. However, this does not mean that telecommunications is necessarily a natural monopoly. Being multiproduct in nature, different portions of the telecommunications network can be opened to varying degrees of competition, although still not to the extent described in a perfectly competitive model. Another important characteristic of telecommunications is that it enjoys network externalities (also referred to as consumption scale economies), which means that the benefits from telecommunications increase with the number of users that one is able to reach. These economic properties of telecommunications have at least two important implications for policymaking and regulation. First, since the industry is not perfectly competitive, then unfettered market activity cannot be expected to produce outcomes that are always efficient or that promote consumer welfare. Traditionally, countervailing market power in industries such as telecommunications was simply called regulation (or monopoly regulation). Given that technological and market conditions have now allowed feasible and desirable entry of competition in some subsectors of the industry, a more general set of rules under “competition policy” (which subsumes monopoly regulation) must be put in place. A proactive set of rules promoting competition is necessary to assist entry and ensure that fair competition is maintained particularly since an incumbent can use its position to undermine competition. An incumbent not only enjoys certain advantages from being the first mover in the market but it also controls certain facilities that an entrant needs for the delivery of its service. Without rules that explicitly deal with the potential for abuse of the dominant position, then efforts to approximate the desirable results of a perfectly competitive market by simply relaxing market entry will not be effective. In other countries particularly the US, antitrust laws govern the ways in which firms are allowed to compete with each other. Agreements among competitors (e.g., price fixing arrangements) and actions by a single firm that hurt rivals (e.g., denial of access to bottleneck facilities) are the main areas covered by antitrust policy. When no additional inquiry is required to determine whether or not a certain firm behavior violates antitrust laws, then such conduct is said to be per se illegal. An example of this would be an agreement whose sole purpose is to fix price or restrict output. However, not all cooperative agreements are considered illegal especially when such arrangements are necessary to achieve procompetitive purposes (e.g., the reduction in transactions costs). In such cases, the courts apply a rule of reason analysis whereby the reasonableness of the agreement is determined. To be sure, antitrust is not antimonopoly. The intent of the antitrust laws is primarily to prevent business practices that would harm society through the exercise of market power (Carlton and Perloff 1994). 160 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The second equally important point that needs to be recognized is that even as competition policy attempts to mimic the competitive market, tradeoffs among the desirable efficiencies will have to be made. For example, since fixed costs are involved, then a policy of promoting entry will lead to lower x-inefficiency within the incumbent firm but will also result in a duplication of facilities in the industry. A merger, which exploits synergies and generates efficiencies, may have to be challenged if this creates a significant increase in market power (or the ability to set the terms of the market with respect to price or supply). If one of the government’s objectives is to encourage dynamic efficiency (i.e., innovation), then firms should be allowed to earn above-normal profits or engage in tie-in arrangements to recoup investments in R&D. Note, too, that the competitive model is silent on the issue of equity. Thus, prices may have to be distorted resulting in allocative inefficiency in the short term if this will translate to more people being able to access the telecommunications network thereby increasing the benefits for everyone in the long run. Competition policy, just like regulation, will have to balance the conflicting interests of the various stakeholders—at times, even requiring intertemporal comparisons of welfare effects. Thus, the critical decision will have to be made in terms of choosing which among the different interests and objectives are more equal than others. Given these considerations, what specific elements of competition policy are most relevant to Philippine telecommunications? The next few sections will discuss the state of the industry and its regulatory environment to aid us in identifying the rules that must be put in place to create a healthy competitive market.

THE MARKET ENVIRONMENT OF PHILIPPINE TELECOMMUNICATIONS

As declared in the Public Telecommunications Policy Act of the Philippines (RA 7925), “A healthy and competitive environment shall be fostered, one in which telecommunications carriers are free to make business decisions and to interact with one another in providing telecommunications services, with the end view of encouraging their financial viability while maintaining affordable rates” [Article II. Sec 4f]. Tele- communications is defined as “any process which enables a telecommunications entity to relay and receive voice, data, electronic messages, written or printed matter, fixed or moving pictures, words, music or visible or audible signals or any control signals or any design and for any purpose by wire, radio or other electromagnetic, spectral, optical or technological means.” Accordingly, the Act specifies the following categories of telecommunications services: local exchange service, interexchange carrier service, international carrier service, value-added service, mobile radio service, and radio paging service. The National Telecommunications Commission (NTC) is the agency that exercises jurisdiction over the supervision, adjudication, and control over all telecommuni- TELECOMMUNICATIONS 161 cations services. Although it is an independent regulatory body, the NTC remains under the administrative supervision of the Department of Transportation and Commu- nication (DOTC) as an attached agency. However, in terms of its quasi-judicial functions, the decisions of the NTC can be appealed only to the Supreme Court. According to RA 7925, it is the responsibility of the NTC to “Foster fair and efficient market conduct, through, but not limited to, the protection of telecommunications entities from unfair trade practices of other carriers” [Art. III Sec. 5d].

THE STRUCTURE OF THE INDUSTRY Table 1 shows the growth of the industry following liberalization. Although Philip- pine telecommunications has always been multioperator in character, it was only until the issuance of the Executive Order 109 (and subsequently with the enactment of RA 7925) that the industry was effectively demonopolized. That there are no longer monopolies in the industry does not mean that no single operator today is able to exercise considerable market power but rather, that there are now at least two operators allowed to compete in the same geographic market for each of the service categories identified in RA 7925.1

Table 1. Number of Authorized Carriers TELECOM SERVICE 1992 1993 1994 1995 1996 1997 1998 Local Exchange Carrier (LEC) 45 49 60 67 74 76 76 Cellular Mobile Telephone Service (CMTS) 2 5 5 5 5 5 5 Paging Service 6 6 10 11 14 15 15 Public Trunk Repeater Service 7 8 8 10 10 10 10 International Gateway Facility 3 5 9 9 9 11 11 Satellite Service 3 3 3 3 3 3 3 International Record Carrier 4 4 5 5 5 5 5 Domestic Record Carrier 6 6 6 6 6 6 6 Very Small Aperture Terminal 4 4 3 3 3 4 4 Public Coastal Station 13 13 13 12 12 12 12 Radiotelephone 4 6 6 5 5 5 5 Value-Added Service - - - 1 27 47 70 Source: National Telecommunications Commission Annual Report (1997, 1998).

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1 Thus, this is the simple “single seller” definition of a monopoly. Whether or not certain firms control essential facilities and are thus able to behave like a monopolist will be discussed in a later section. 162 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Of these service categories, only value-added service has been deregulated such that even registration with the NTC is not being strictly enforced. Entry into the regulated segments of the industry occurs in two stages. The first step requires a congres- sional franchise to operate a telecommunications service in all or some parts of the country. The second phase involves applying for a Certificate of Public Convenience and Necessity (CPCN) or a Provisional Authority (PA) that the NTC grants and which requires carriers to demonstrate that they are technically and financially able to carry out the service and that sufficient demand exists. A description of the service, the specific rate or a general rate structure that may be charged for the service and the regulations under which that service can be provided are all contained in the PA. EO 109 forced the creation of several vertically integrated multiservice firms. In addition to the Philippine Long Distance Telephone Company, Inc. (PLDT), there are now nine other firms engaged in various telecommunications services. Moreover, most of these firms have positioned themselves further downstream in value-added service, either through an affiliate, subsidiary, or sister company (Table 2).

Table 2. Scope of Services

Service Bayantel Capwire Digitel Etpi Globe Islacom Philcom Piltel Pldt Smart

IGF X X X X X X X X X

LEC X X X X X X X X X X

CMTS X X X X

VAS X X X X X X

Although all carriers were given a national franchise, PLDT is the only carrier that operates local exchange service (including Public Calling Offices) all over the country while the rest are restricted by their PAs to serve only specific geographic areas (Table 3). In addition to these vertically integrated firms, there are about 66 other licensed provincial operators who have been providing LEC service on a limited scale. Four of these pure LEC operators are government-owned and should be privatized soon as mandated by RA 7925. At the aggregate level, PLDT accounts for about 60 percent of the total subscribed lines (Figure 1) and remains the dominant operator in the most lucrative service area, Metro Manila. In Luzon, DIGITEL is emerging as the dominant operator while for the rest of the country, no single firm consistently enjoys the dominant position for competition in the so-called “last mile connection.” Appendix 1 identifies the dominant and fringe operators in each of the provinces. TELECOMMUNICATIONS 163

Table 3. Service Areas Service Bayantel Capwire Digitel Etpi Globe Islacom Philcom Piltel Pldt Smart NCR A X X NCR B X X NCR C X X NCR D X X CAR A X / X X CAR B X X X IX XX II X X X III X / X X IV A X X / X IV B X X / X VX X /X VI X X VII X X VIII X X IX X X X XXXX XI X X X XII X X CARAGA X X X ARMM A X X ARMM B X X X Note: 1. Coverage:

National Capital Region (NCR) A – Manila, Navotas, Caloocan City B – Quezon City, Valenzuela, Malabon C – Makati, San Juan, Mandaluyong, Marikina, Pasig D – Pasay City, Las Pinas, Paranaque, Pateros, Taguig, Muntinlupa Cordillera Administrative Region (CAR) A – Abra, Benguet, Mountain Province B – Apayao, Ifugao, Kalinga Region I (Ilocos Region) – Ilocos Norte, Ilocos Sur, La Union, Pangasinan Region II (Cagayan Valley) – Batanes, Cagayan, Isabela, Quirino, Nueva Vizcaya Region III (Central Luzon) – Bataan, Bulacan, Nueva Ecija, Pamapanga, Tarlac, Zambales Region IV (Southern Tagalog) A – Aurora, Laguna, Marinduque, Quezon, Rizal, Romblon B – Batangas, Cavite, Occidental Mindoro, Oriental Mindoro, Palawan Region V (Bicol Region) – Albay, Camarines Norte, Camarines Sur, Catanduanes, Masbate, Sorsogon Region VI (Western Visayas) – Aklan, Antique, Capiz, Guimaras, Iloilo, Negros Occidental Region VII (Central Visayas) – Bohol, Cebu, Negros Oriental 164 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Region VIII (Eastern Visayas) – Biliran, Eastern Samar, Leyte, Northern Samar, Southern Leyte, Western Samar Region IX (Western Mindanao) – Basilan, Zamboanga del Norte, Zamboanga del Sur Region X (Northern Mindanao) – Bukidnon, Camiguin, Misamis Occidental, Misamis Oriental Region XI (Southern Mindanao) – Davao, Davao Oriental, Davao del Sur, South Cotabato, Sarangani, Compostela Valley Region XII (Central Mindanao) – Lanao del Norte, North Cotabato, Sultan Kudarat, Cotabato City, Marawi City Region XIII (CARAGA) – Agusan del Norte, Agusan del Sur, Surigao del Sur, Surigao del Norte Autonomous Region in Muslim Mindanao (ARMM) A – Lanao del Sur, Maguindanao B – Sulu, Tawi-Tawi

2. / - Select areas only: Baguio (CAR); Olongapo and Subic (Region III); Puerto Princesa and Boac (Region IV); Masbate (Region V)

Figure 1. Fixed Lines Market Shares

PLDT remains the dominant firm in the fixed line business and its market share at the national level is still larger than all competition combined. For 1998, the leader in the mobile market was SMART (Figure 2).

THE ECONOMIC REGULATION OF THE INDUSTRY

Determination of end-user price Traditionally, the industry adhered to a return on rate base (RORB) regulation that set the maximum allowable return of 12 percent based on the net book value of property, plant, and equipment plus working capital covering two months average operating expenses. Another principle, which guided rate setting, was the policy objective to maintain the affordability of basic telephone service especially for residential use. With TELECOMMUNICATIONS 165

Figure 2. Cellular Mobile Market Shares, 1998

these two constraints, price regulation for a multiservice, vertically integrated firm such as PLDT resulted in cross subsidization whereby the rates of some services were set above cost (i.e., international long distance) in order to cross-subsidize LEC service that was presumably priced below cost. The collection rate, or the price charged to consumers for international long distance calls, are partly influenced by the international accounting rate system whereby carriers, for example, PLDT and American Telephone & Telegraph (AT&T), would agree on the price (the accounting rate) of a call between the Philippines and the US such that the originating telco would remit half of the accounting rate (the settlement rate) to the terminating telco. The collection rate was set higher than the accounting rate so that local service could be made affordable and still enable PLDT to earn the allowable rate of return. In recent years however, the NTC has allowed collection rates to decrease as a result of international pressures, spearheaded by the US Federal Communications Com- mission (FCC), to reform the accounting rate system in favor of lower rates that reflect actual costs and to maintain a balance between outgoing and incoming international toll traffic. The need to cross-subsidize local telephone service (i.e., prevent increases in basic rates) and encourage network expansion has prevented the NTC from deregulating the prices of international calls altogether. In the case of local service, the price that subscribers pay consists primarily of two parts: the base rate and the foreign currency adjustment (FCA). The base rate is generally set low and does not change frequently. The monthly rates charged to consumers, however, move with changes in the peso-dollar exchange rate. For example, prior to PLDT’s implementation of rate rebalancing in December of 1997, the base rates for Metro Manila were fixed at P110 for residential subscribers and P232 for business subscribers, which were set way back in 1983. Since then, the final prices charged to subscribers have increased as a result of the foreign currency adjustment, which allows utilities such as PLDT to automatically adjust the rates by 1 percent for every P0.10 increase/decrease in the peso-dollar exchange rate. The adjustment factor, which is 166 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES based on a moving reference exchange rate, is then multiplied by the base rate to determine the FCA. The FCA is added/subtracted to the previous rate to arrive at the new monthly rate.2 Thus, by October 31, 1997, the prevailing rates were P326.41 and P728.30 for residential and business subscribers, respectively. An additional 10 percent tax is added to the final price. Base rate increases are not automatic and still have to be reviewed by the Commis- sion. RA 7925 eliminated the 12 percent ceiling (NTC 1997) but provided no basis for the determination of “fair and reasonable” rates. The industry has been pushing for rate rebalancing3 and metering. In the absence of a set of principles and concrete guidelines for rate setting, the resolution of these issues remains contentious.

Determination of access price Although end-user rates are regulated and set by the NTC, the price of intermediate goods (i.e., access charge) is negotiated between interconnecting carriers. As specified in the RA 7925, the access charge is supposed to “make provision for the cross subsidy to unprofitable local exchange service areas” [Article III Sec. 5 c]. More generally, the rates of interconnection must take the following into consideration [Article III Sec. 18]: • The costs of the facilities needed to complete the interconnection, • The need to provide the cross subsidy to local exchange carriers to enable them to fulfill the primary national objective of increasing telephone density in the country, and • Assure a rate of return on the total local exchange network investment that is at parity with those earned by other segments of the telecommunications industry.

The actual level and the structure of the access charge differ depending on the type of interconnecting service. PLDT adopts the following commercial arrangements, which is the de facto industry practice: “IGF interconnection involves payment of access charges, whereas toll calls for IXCs and LECs are settled based on revenue sharing. CMTS interconnection settlement for local calls is also based on access charges; for toll calls, the basis is revenue sharing. LEC to LEC interconnection with hauling from one service area to another service area is settled based on trunk charges, while overlay LEC to LEC interconnection in a given service area has no charges. Pag- –––––––––––––––––––– 2 Other carriers compute the FCA using a fixed reference exchange rate as specified in their PA. As such, the FCA is added to the original base rate and not to the previous rate to arrive at the new monthly rate. 3 To date, only the applications of PLDT, BAYANTEL, and GLOBE for increases in basic rates (as part of rate rebalancing) have been approved although almost all carriers filed in 1997 to early 1998. TELECOMMUNICATIONS 167

ing and trunk radio interconnection settlements are based on fixed charges“ (PLDT 1998).

Obviously, a firm can deliberately effect a price squeeze on a competitor under a setup where the price of an intermediate good is negotiated while that of the final good is set by the regulator. What is not obvious is that regulatory lag can cause the same as what GLOBE experienced (Box 1).

Box 1. How Regulatory Lag Can Be Anticompetitive

As mentioned, access charges on national long distance calls are typically in the form of revenue sharing, which in turn is based on the approved collection rate. In the past, GLOBE had suffered a price squeeze when PLDT increased its access charge as a result of its approved rate rebalancing while GLOBE could not pass on the higher access charge to its subscribers since its petition for rate rebalancing had not been approved.

THE NATURE OF COMPETITION AT THE LOCAL LEVEL: THREE (3) CASES

The liberalization of the telecommunications sector has been beneficial to the country. The single most important achievement of liberalization is that it has expanded consumer choice. Although it was technology that enabled more access options to become available (e.g., cellular and landline), it was the deliberate policy of expanding supply via the entry of new players that has produced the gains for consumers. Carriers strive to be the first to provide advanced features that current technology makes possible (e.g., caller ID, three-way calling). Moreover, in today’s market, carriers actively seek out customers—a scenario that was un- imaginable before. In this section, we present the experiences of three communities with regard to the introduction of competition at the local exchange level. These cities were selected because of the unique competitive environment that can be found in each market.

DAGUPAN CITY Telecommunications services available in Dagupan City consist DAGUPAN CITY of telegraph, telex, fax, cellular Population : 128,499 (1998) phone, fixed line, paging, and other Land Area : 43.6 sq. km Population Density : 2,945 / sq. km auxiliary facilities such as public Classification : Component City payphones and public calling sta- Income Class : 1st tions. For their basic telephone 168 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES needs, the city has three full service telecommunications firms to choose from: PLDT, DIGITEL, and SMART. It is not uncommon for establishments or even some households to subscribe to more than one carrier. But although the first suspect for this kind of behavior is interconnection, which both carriers and subscribers say has been resolved, the main explanation for patronizing more than one carrier appears to be product differentiation. Subscribers prefer PLDT because of its flat rate and the fact that it is still easier to call Metro Manila using a PLDT line. Being first in the area also helps in that long-time customers would rather acquire a second line than give up his or her PLDT connection or phone number. DIGITEL’s appeal is the wider calling area for local calls (i.e., no long distance charges for DIGITEL-TO-DIGITEL calls within the province). The fact that it is metered does not seem to deter subscribers, as DIGITEL has designed three calling plans which they can choose from: Choice 150, 300, and 750. Each plan provides an allowance for both local and long distance calls. Interestingly, when the company introduced the usage-based monthly plans for telephone service in June 1997, it took efforts to assist subscribers in selecting the calling plan that best suits their needs by coming up with some guidelines based on their calling habits and budget. For example, Plan 150 was being marketed as appropriate for the following subscriber type: use of telephone is limited, average monthly charges on long distance calls is less than P100 or the average monthly bill is less than P376, and customer wants to limit phone expenses to P150 only. For the other types of subscribers, DIGITEL designed alternative calling plans so that subscribers can self-select (Box 2). Box 2. Alternative Calling Plans Under Digitel

To introduce (and sell) the idea of metered service to its subscribers, DIGITEL inserted a letter in the monthly billing statement entitled “The Freedom of Choice,” which reads:

THE FREEDOM OF CHOICE

Dear Digitel Subscriber, Starting June 25, 1997, we bring you CHOICE. CHOICE allows you to choose your own monthly telephone charging plan. CHOICE also reduces calling rates by as much as 90%. This new usage-based monthly plan for telephone service was recently approved by the National Telecommunications Commission. It provides great value to frequent users by giving more talk- time at less expense. This unique charging scheme is exclusive to Digitel susbcribers. CHOICE has three plans especially designed to suit your varying calling needs and budget. No longer will you be classified as a residential or a business subscriber. With Choice, pay a fixed-monthly rate of either P150, P300 and P750 and you get corresponding built-in call allowances. As your need changes, you can shift from one CHOICE plan to another, as often as you like, for a minimal fee. CHOICE is your “customized” telephone pricing plan only from Digitel. TELECOMMUNICATIONS 169

SMART is the latest carrier to enter the local exchange market in Dagupan City. It still has to establish its distinguishing brand of service so it is not yet considered as the first choice. Some subscribers avail of SMART only when they are unable to get a line or are still waiting for one from their preferred carrier.

NAGA CITY Communication now is relatively easy in Naga City with the NAGA CITY availability of three telegraph of- Population : 126,972 (1998) Land Area : 77 sq. km fices, eight courier services, two lo- Population Density : 1,649 / sq. km cal telephone operators, long Classification : Independent distance telephone operators, two Component City cellular phone operators, one pager Income Class : 1st operator, four cable television stations, six television stations, 20 radio stations, and 12 local weeklies. The government’s National Telephone Program Bicol switching station, a major mode of the Luzon-Mindanao communication backbone, is located in Naga City. Since 1997, there have been two landline operators in Naga City—BAYANTEL and DIGITEL. Prior to the duopoly situation, only one company, Naga Telephone Company (NATELCO), provided local service in the area for more than twenty years. NATELCO was eventually bought by BAYANTEL, which is now operating under the franchise granted to NATELCO in 1978 under Resolution Number 5 of the city council granting it a 35-year franchise. Initially, BAYANTEL operated in the Province of Albay, Camarines Norte, Camarines Sur, and Sorsogon in the Bicol Region. It has an estimated subscriber base of 14,000 in Naga. DIGITEL’s entry into Naga City is not through a buy-out of a local company. In- stead, it bought the operating rights from DOTC that had an existing telephone project in Naga. At present, DIGITEL has an estimated 5,000 subscribers. As mentioned previously, DIGITEL adopts metered service although it offers several calling plans so subscribers can choose depending on their own needs. An applicant pays an installation fee, depending on the plan chosen. The installation fee includes installation charges, service activation fee, advance monthly fee, 10 percent VAT, instrument deposits, and city electrician inspection fee. The installation fees for residential and business applicants are of the same amount. Unlike DIGITEL, BAYANTEL does not apply metering. It collects a monthly charge of P472.88 from its residential subscribers. This rate includes the local charge, FCA, and 10 percent VAT. For business subscribers, the monthly charge is P979.75 covering the same charges as the residential. Each carrier has its own set of advantages that subscribers take into account. In fact, there are those, businesses especially, that subscribe to both. A cursory survey of these establishments reveal that the advantages of having a DIGITEL phone is that it 170 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES has clearer transmissions and connects easily especially when making long distance calls. However, they use their BAYANTEL phones when making lengthy calls. Both operators offer similar telephone features, which include caller ID, security pin, and call waiting. The two also offers “Instant Connection” or “Same Day Installation.” BAYANTEL offers “Oplan Kabit Agad” granting 50 percent discount on the installation fee. Aside from the special telephone features and the instant connection it offers, BAYANTEL also conducts house calls and sends letters to potential subscribers. For the convenience of customers, BAYANTEL employs agents who collect payments directly from the subscribers instead of having them travel to its office. DIGITEL’s version is called “Katok-Kabit,” connecting the telephone the same day that the installation fee is paid. In general, DIGITEL has a lower installation fee than BAYANTEL. Recently, it also lowered its long distance rate to 3.00 per minute known as the “Pakikisama” rate. In addition to providing telephone service, DIGITEL now offers Internet service to its subscribers. Within Naga City, there is no interconnection problem between the two telephone companies. Subscribers of both companies can call each other without having to worry about incurring long distance charges.

CAGAYAN DE ORO CITY Of the 82 cities in the Philippines, Cagayan de Oro has the most number CAGAYAN DE ORO CITY of telephone operators. Currently, Population : 487,282 (1998) Land Area : 488 sq. km there are four landline carriers operat- Population Density : 998 / sq. km ing in the city. These are Misamis Ori- Classification : Highly ental Provincial Telephone System Urbanized City (MISORTEL), Cruz Telephone Com- Income Class : 1st pany (CRUZTELCO), National Tele- phone Program Tranch 1-3, and PHILCOM. It is quite common in Cagayan de Oro, especially in commercial areas, to subscribe to two telephone companies. Unfortunately, the reason is quite different from that in Dagupan City. MISORTEL is the oldest operating telephone company in Cagayan de Oro, operating for a few decades now. It is owned by the Misamis Oriental Provincial Government. As the first and the oldest, MISORTEL claims to enjoy the biggest market share in the city estimated at around 70 percent while the remaining 30 percent subscribers are shared by the other three telephone carriers. An applicant is charged P6,600.00 by MISORTEL. The amount is broken down as: P5,000.00 for refundable deposit; P1,500.00 for the telephone unit; and P100.00 for installation. Commercial subscribers are charged P450.00 monthly plus EVAT. Residential subscribers pay a monthly rate of P220.00, which includes the EVAT. Supposedly, installation takes one to two weeks. TELECOMMUNICATIONS 171

Becoming aware of the stiff competition they are facing, the management has started introducing marketing innovations. A customer care department was set up in the early part of 1999. Research was done on target clients especially on corporations and commercial establishments. Calls and visits to potential clients were made. Special attention was given to customer complaints. MISORTEL became active in sponsoring shows and special events. Phone booths offering “free calls” were put up in the MISORTEL office, city hall, and other strategic public places. The management wants to change the public perception that because MISORTEL is a government-owned company, it will be run as the “usual” government office. A slogan and logo contest was launched, changing the MISORTEL logo from the provincial government seal into a more corporate-looking one. Among the four telephone carriers, CRUZTELCO is the newest addition having started operations in the city only in March 1998. It took four years before it got its permit to operate from the city government. Its service covers the Province of Misamis Oriental and within the city limits of Cagayan De Oro. The installation rates of CRUZTELCO is relatively cheaper amounting to P2,558.00. This amount covers P300.00 installation fee, P558.00 installation materials, and P1,700.00 for the telephone set. Monthly rate for residential line is P242.00 including EVAT. Com- mercial subscribers are charged P423.50, which also includes EVAT. CRUZTELCO’s subscribers are typically those not served by other landline carriers. Usually, CRUZTELCO does a survey and its services are offered to those who do not have existing telephone lines. Mostly, service provision is concentrated in areas outside the city proper. Based on customers’ feedback, they avail of CRUZTELCO’s services because of the cheaper cash outlay when applying for installation. The National Telephone Program Tranch 1-3 is a DOTC project offering landline telephone service to areas in Cagayan de Oro which are outside the city proper. Focus is on providing telephone service to barangays in the city peripheries. The contractor for the project is ITALTEL. Monthly rate for residential subscribers is P249.85 and P419.40 for commercial subscribers. It has been its policy not to encroach on the other carriers’ subscribers and instead concentrate on the unserved. PHILCOM’s entry into the city is by virtue of the previous administration’s basic telephone program. As an international gateway facilities operator, it was required to install 300,000 landlines in its service area—the Mindanao region. Because of this requirement, PHILCOM is said to have the most number of available lines, although MISORTEL remains as having the highest number of subscribers. Direct interconnection is only possible between MISORTEL and NTP. For the rest, in order to make calls between two different carriers, a long distance rate is charged. This poses a financial burden to subscribers especially to those who are frequent business callers. Burdened by the interconnection problem and seeing no immediate action from the service providers, subscribers have employed strategies to make the situation bearable. Most subscribers, especially those engaged in business have at least two service carri- 172 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES ers. Choice of carrier is based on the number of subscribers of the carrier and one’s calling circle, typically MISORTEL and PHILCOM. In this manner, they can make as many calls as needed without incurring long distance charges. Another strategy is to acquire a cellular phone. This allows subscribers to call any subscriber of the different LEC service operators. In an effort to alleviate the situation, City Council Resolution No. 4027-98 has requested the Office of the President to include local government units (LGUs) as a negotiating party in solving the interconnection problem of service providers. The council feels that with the LGU being authorized and directly involved in the situation, they can make telephone companies sign an interconnection agreement.

POSTLIBERALIZATION: ISSUES AND CONCERNS

Although liberalization has addressed many consumer woes from poor quality of service to absolute lack of service, some problems have been created as well, thereby diminishing the potential gains that could be derived from a competitive environment. In addition, certain developments in both the technology and regulatory fronts pose new challenges to the competitive model.

INTERCONNECTION The most critical issue that has emerged from the liberalization of telecommunications is interconnection, which is required to enable subscribers of different carriers to communicate with one another or enjoy the services of other carriers. Figure 3 depicts the different types of multiservice telecommunications firms operating in the Philippines. In Metro Manila, there at least five carriers, with PLDT controlling the bulk of the subscribed lines. The other operators provide the same services as PLDT or are licensed CMTS carriers as well. In the provinces, the type of carriers can range from simple LECs to full service operators. In general, interconnecting n carriers would require [n(n-1)]/2 agreements. How- ever, interconnection agreements are not made for interconnecting carriers per se but for each of its service (e.g., CMTS, LEC, IGF, etc.), thereby increasing the theoretically maximum number of interconnection contracts that must be specified, negotiated, and enforced. Both the technical and the commercial aspects of interconnection contracts are negotiated on a bilateral basis and the role of the regulator is merely to mediate, through moral suasion, whenever parties fail to reach an agreement. As mentioned in the previous section, the price of interconnection, which can take the form of an access charge or a share of the revenues, is not regulated. RA 7925 and its Implementing Rules and Regulations provide some guidelines (see Ap- pendix 2) but these have proven to be inadequate in resolving interconnection issues. Being bilateral in nature, settlement of the terms of interconnection is determined by the relative bargaining strengths of the carriers. Access payments usually make up a TELECOMMUNICATIONS 173

Figure 3. Interconnecting Carriers and Services

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significant portion of the operating costs of a new entrant (e.g., 30-40 percent). For incumbents, however, access payments are a source of revenues particularly in the beginning when the direction of calls is from subscribers of the new carriers to the subscribers of incumbents. Thus, the access charge is very important to business survival. New operators have complained in the past of unfair conduct by the dominant firm, PLDT. These include, among others, insufficient interconnection, unequal access settlements or revenue-sharing arrangements, as well as the use of interconnection as a lever in other commercial negotiations. To be sure, alleged unfair or uncooperative behavior is not limited to PLDT, as other incumbent operators (e.g., Cagayan de Oro case) have also been reluctant to interconnect or grant favorable terms of interconnection to competition. From the subscribers’ end, the interconnection problem is felt in terms of unsuc- cessful call attempts and irrational calling charges. Although no official figures are publicly reported, call failure rates as a result of poor interconnection are believed to be well above the 2.5 percent to 1 percent prescribed under the NTC regulations. Subscrib- ers have also complained of unreasonable long distance charges for calls to nearby telephones, even to neighbors (Box 3). 174 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Box 3. Example of Unreasonable Long Distance Charges

In the office of Meycauayan Mayor Eduardo Alarilla, there are two telephones that are separated by a divider. One is a Digitel phone while the other is from Racitelcom. In order to talk to someone on the other side of the divider, one has to dial the Bulacan area code and incur a PhP4 per minute charge because it is considered a long distance call.

Source: Mauricio, Orlan L. “Probe of Phone Firms Ordered,” Manila Standard, September 23, 1999.

MERGERS AND VERTICAL INTEGRATION Industry consolidation has been expected ever since the onset of liberalization. The number of firms that entered the market was seen as more than the Philippine market could handle and only two to three multiservice telecommunications firms were expected to survive. New operators would eventually merge with each other to gain significant market share vis-à-vis PLDT, which would remain as the leading firm within the short to medium term. In November 24, 1998, the long-anticipated industry consolidation was officially set in motion with the acquisition by First Pacific of 17.2 economic interest in PLDT paving the way for the eventual merger of PLDT, PILTEL, and SMART. The integration of their respective fixed, mobile, and internet/multimedia lines of business is expected to generate efficiencies in terms of infrastructure use, network operations, network development and planning, customer care, billing, and other support services. Despite the obvious benefits, not everyone greeted this development with enthu- siasm. The trepidation was understandable because the merger that was taking place was not between fringe operators but between the dominant firms in the fixed and mobile markets. Immediately, fears of the return of monopoly abuse were raised. A reading of the events that transpired in the second part of 1999 indicates that there is a real danger of abuse of market dominance with the merger. Although SMART is the industry leader in the mobile market, GLOBE is the recognized leader in digital technology, which is largely propelled by the popularity of its short messaging service. By the time SMART had launched its digital cellular service that could offer the same feature, subscribers were already hooked on GLOBE’s text messaging, which was possible only among GLOBE subscribers. This made it difficult for SMART to entice subscribers to switch. Around the same time that SMART was negotiating forinterconnection with GLOBE’s text messaging, which it obviously found difficult to obtain, PLDT accused GLOBE of misrepresenting calls to avoid paying correct access charges and subsequently, restricted GLOBE’s interconnection with PLDT’s landlines. The motive behind the action taken against GLOBE would not have been suspect were it not for its timing and the fact that the issue waned right after GLOBE agreed to interconnect its short messaging services. TELECOMMUNICATIONS 175

Another development, which has both efficiency and possible anticompetitive implications, is the integration of Internet service into fixed line. Initiated in the country by DIGITEL with its DIGITEL ONE, GLOBE has also introduced Globelines Net Express allowing subscribers to access the Internet and send and receive e-mail without sub- scribing to any independent Internet service provider (ISP). As an example of what convergence offers, the benefits to consumers include convenience (e.g., single billing) and cost savings from not having to pay the flat fees that subscription to independent ISPs usually entail. The implication for competing independent ISPs is that their survival is conditioned on being able to obtain adequate capacity or leased lines, which is in the interest of telcos offering Internet service to deny, restrict or delay. Under RA 7925, telcos are allowed to offer value-added service provided that that no cross subsidization from its utility operations take place and that other value-added providers are not discriminated against in rates or are denied equitable access to its facilities.

CONVERGENCE Indeed, the horizontal and vertical mergers we are witnessing are being driven by technology convergence. In general, technology convergence implies an increasing overlap between the two primary components of the communication process that have traditionally been separated, namely: common carrier “conduit” systems and networks that transmit signals anonymously and “content”-based information sources and technologies. Various forms of convergence between traditionally separated industry segments include wireless delivery of telephone signals, wireline delivery of television signals, cable television technology, multichannel wireless and satellite video distribution, digital data transmission, and the Internet. Because of technology convergence, market convergence is emerging from both the supply and demand side. On the supply side, the longstanding organizational divisions between technologies, services, and companies are eroding as industry providers across market segments and national boundaries merge while on the demand side, the market responds via increasing interest in and purchase of multimedia services and technologies (Townsend 1997). For the Philippine market setting, the immediate concern is whether or not firms are enabled by the current policy environment to respond to the market demands that technology convergence creates. For example, under Sec. 4a of RA 7925, “no single franchise shall authorize an entity to engage in both telecommunications and broad- casting, either through the airwaves or by cable.” In response, proposals have been filed in Congress (so-called “convergence bills”) that seek, among other things, to remove cross-sector ownership restrictions. From the standpoint of competition policy, given the inevitability of supply-side convergence, will the industry be less competitive as a result of the mergers? How will consumers, current and future, be affected and protected? Since mergers are supposed to create efficiencies, then such efficiencies must outweigh the potential harmful effects of increased market power for the mergers to be allowed, even encouraged. In turn, whether or not any detrimental effects can be mitigated will depend on the existence of competitive safeguards. 176 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

REGULATORY COMMITMENTS BY THE PHILIPPINES UNDER WTO The General Agreement on Trade and Services Reference Paper on Basic Telecom- munications prescribes a set of regulatory principles to govern the sector. Specifically, it includes key regulatory requirements to ensure nondiscriminatory market access, including competitive safeguards, nondiscriminatory interconnection, competitively neutral universal service obligations, independent regulators, and nondiscriminatory procedures for the allocation and use of scarce resources. The Reference Paper defined key terms pertaining to competitive safeguards as follows: Users - service consumers and suppliers Essential facilities - facilities of a public telecommunications transport network or service • are exclusively or predominantly provided by a single or limited number of suppliers; and • cannot feasibly be economical or technically substituted in order to provide a service.

A major supplier - a supplier that has the ability to materially affect the terms of participation (having regard to price and supply) in the relevant market for basic telecommunications as a result of • control over essential facilities; or • use of its position in the market.

As shown in Table 4, the Philippines’ commitment based on its revised draft offer does not adopt the specific regulatory principles on competitive safeguards suggested in the Reference Paper. Instead, the Philippine version adopts a general and more flexible language. That the Philippines opted to state its commitment to the principles of competition in such broad terms, suggests that either a) specific rules governing market behavior are already in place or b) such specific rules, if they do not yet exist, shall be established. With regard to interconnection, the primary difference between the Philippine commitment and the Reference Paper is that the former applies its interconnection guidelines to all suppliers while the latter prescribes the interconnection guidelines specifically with respect to a major supplier (Table 5).

THREATS TO COMPETITION

As the experiences of local communities show, despite some problems, consumers are already clear winners as a result of liberalization. Given such gains, is there still a need for a competition policy to govern the sector? The answer stems from two main concerns. Firstly, we want to make sure that such benefits are not temporary. Secondly, we want to be able to enjoy the benefits of competition to its fullest. As long as threats TELECOMMUNICATIONS 177

Table 4. Comparison of WTO Reference Paper vs. Philippine Commitment: Section on Competitive Safeguards

WTO REFERENCE PAPER SPECIFYING REGULATORY PRINCIPLES 1. Competitive safeguards 1.1. Prevention of anticompetitive practices in telecommunications Appropriate measures shall be maintained for the purpose of preventing suppliers who, alone or together, are a major supplier from engaging in or continuing anticompetitive practices.

1.2. Safeguards The anticompetitive practices referred to above shall include in particular • engaging in anticompetitive cross subsidization; • using information obtained from competitors with anticompetitive results; and • not making available to other services suppliers on a timely basis technical information about essential facilities and commercially relevant information which are necessary for them to provide the services.

THE PHILIPPINES COMMITMENT ON BASIC TELECOMMUNICATIONS (FEBRUARY 10, 1997) 1. Competitive safeguard Appropriate measures shall be maintained for the purpose of preventing suppliers from engaging in or continuing anticompetitive practices

Table 5. Comparison of WTO Reference Paper vs. Philippine Commitment: Section on Interconnection

WTO REFERENCE PAPER SPECIFYING REGULATORY PRINCIPLES 2. Interconnection 2.1. This section applies to linking with suppliers providing telecommunication transport networks or services in order to allow the users of one supplier to communications with users of another supplier and to access services provided by another supplier, where specific commitments are undertaken. 2.2 Interconnection to be ensured Interconnection with a major supplier will be ensured at any technically feasible point in the network. Such interconnection is provided • under nondiscriminatory terms, conditions(including technical standards and specifications), and rates and of quality no less favorable than that provided for its own like services or for like services of nonaffiliated service suppliers or for its subsidiaries or other affiliates; • in a timely fashion, on terms, conditions (including technical standards and specifications) and cost-oriented rates that are transparent, reasonable, having regard to economic feasibility, and sufficiently unbundled so that the supplier need not pay for network components or facilities that it does not require for the service to be provided; and • upon request, at points in addition to the network termination points offered to the majority of users, subject to charges that reflect the cost of construction of necessary additional facilities. 178 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 5. (continued)

2.3. Public availability of the procedures for interconnection negotiations The procedures applicable for interconnection to a major supplier will be made publicly available 2.4. Transparency of interconnection arrangements It is ensured that a major supplier will make publicly available either its interconnection agreements of a reference interconnection offer. 2.5. Interconnection: dispute settlement A service supplier requesting interconnection with a major supplier will have recourse, either • at any time or • after a reasonable period of time which has been made public known to an independent domestic body, which may be a regulatory body as referred to in paragraph 5 below, to resolve disputes regarding appropriate terms, conditions, and rates for interconnection within a reasonable period of time, to the extent that these have not been established previously.

THE PHILIPPINES COMMITMENT ON BASIC TELECOMMUNICATIONS (FEBRUARY 10, 1997) 2. Interconnection In order to achieve viable, efficient, reliable and universal telecommunications services, a fair and reasonable interconnection of facilities of authorized public network operators and other providers of telecommunications services shall be provided. Interconnection shall be at any technically feasible point in the network, under non-discriminatory terms and conditions, in a timely fashion, and on terms and conditions that are fair, transparent and reasonable. A service supplier requesting interconnection with another supplier will have recourse after a reasonable period of time which has been made publicly known to an independent domestic body, which may be a regulatory body referred to in paragraph 5 below, to resolve disputes regarding appropriate terms, conditions and rates for interconnection within a reasonable period of time, to the extent that these have not been established previously. to competition exist and as long as opportunities for increasing consumer welfare exists, then there must be continuous efforts to improve the competitive environment and to guard the competitive process. Before identifying the threats to competition, we must first establish what it is about competition that we want to promote and preserve. From the experience at the local level, what appears to be the most important gain from liberalization is the expansion of consumer choice. And because the consumer has a choice, then firms do their best to influence consumer preference through improved service, wider product offer- ings and, to some extent, lower prices. Promoting consumer choice does not depend on the number of players per se. Indeed, in a network industry such as telecommunications, too many operators may even diminish the quality of the choices available to the public. From the standpoint of competition policy, what will promote and preserve genuine consumer choice is the existence of firms that are credible threats to each other. TELECOMMUNICATIONS 179

Based on our discussions on the industry structure, the regulatory environment and general market environment, the threat to the attainment of credible competition can be stated simply as follows: There are not enough specific rules to govern the conduct of firms. Whatever rules exist only help to preserve the market power of a dominant operator. Because of the lack of explicit rules and the incidence of asymmetric regulation, then a firm can engage in exclusionary actions that harm rivals, which, if unabated, will induce the exit of competition.

LACK OF EXPLICIT RULES It is a common expression that the devil is in the details but in this case it is really the lack of details that undermines the essence of competition. In particular, there are two elements of competition policy that we need to define for the Philippine telecommunications sector right now.

1. What is our policy on access? One important element of competition policy is access to essential facilities (also known as bottleneck facilities). An essential facility is considered such because it is necessary to a competitor’s survival. It is deemed important for effective competition in telecommunications because it is not easy and also not efficient to duplicate certain facilities within a reasonable timeframe. Supposing that an IGF operator wishes to deliver an international call and in order to deliver and complete the service, it would be better to use the existing access line of the subscriber than to install a second line to transport the message. The WTO reference paper prescribes interconnection guidelines specifically for essential facilities and for major suppliers in recognition of the size to which their networks have grown as a consequence of the monopoly position that they have enjoyed for decades. Unless other operators obtain timely access to the networks of incumbents under nondiscriminatory terms and conditions and at cost-oriented rates then they will not be able to receive the benefits of liberalization as advocated in the WTO. However, to the extent that new entrants can feasibly and efficiently duplicate the facilities, then such are no longer considered essential (AT & T 1998). Thus, such guidelines are really intended to facilitate the entry of competition and to support them at the early stages of market entry. Same obligations for access are not imposed on carriers other than a major supplier because to do so would limit the flexibility of new competitors. In addition to not providing new entrants in basic telephone service with the support needed to accommodate their entry, our lack of explicit policy on access for the rest of the sector also leads us to apply interconnection indiscriminately thereby hurting the spirit of competition. A case in point is the GLOBE-SMART interconnection of short messaging service. Whereas interconnection is required (i.e., essential) for vertically related services in order for the full service to be completed, to require the same or on the same terms for parallel services is anticompetitive. Such decision robs an innovator or 180 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES first mover of the rewards from risk-taking. In the end, it is the consumer that is adversely affected because consumer choice is constrained in a market environment that does not provide incentives for firms to innovate or initiate.

2. What is our policy on vertical and horizontal mergers? A policy on mergers entails the setting of guidelines that would trigger an inquiry on whether or not a proposed merger will reduce competition after the merger takes place. For example, pre- and postmerger market shares or industry concentration are compared to determine if a proposed merger would go unchallenged or not. If challenged, further inquiries would need to be undertaken to determine if the merger should be allowed. As mentioned earlier, mergers create efficiencies particularly for the firm. However, efficiencies alone do not provide justification for a merger and specific benefits accruing to society must be identified and weighed against other effects to determine the merits of a merger. For example, what may be required is to demonstrate that the merger will result in lower prices or at least not lead to an increase. In the case of vertical integration, anticompetitive behavior can take the form of foreclosure (i.e., when a competitor is denied access to a monopoly segment controlled by the vertically integrated firm), a price squeeze (i.e., access charges are so high as to reduce a competitor’s margins) or price discrimination (i.e., monopoly rents from the utility operations are used to subsidize to lower prices in the competitive lines of business). All these actions are considered exclusionary or even predatory because they harm rivals and facilitate exit. Once exit takes place, then the surviving firm can exercise absolute market power. Again, consumers end up as the real losers because their choices are narrowed down. To be sure, provisions with regard to such anticompetitive behavior are already spelled out in RA 7925 (e.g., VAS). RA 7925’s Implementing Rules and Regulations (IRR), however, do not touch on these issues.

ASYMMETRY IN REGULATION IN FAVOR OF DOMINANT OPERATOR There are a couple of regulations that work against the creation of genuine competition in the sector. The first imposes an additional cost to entrants but not to the dominant operator. The second deprives competition of opportunities to exploit economies of scale and scope. It also deprives competition of the opportunity to generate network externalities.

1. Universal access strategies New entrants were required to install a fixed number of lines as a condition for entry. CMTS operators had to install 400,000 lines while IGF operators were required to put up 300,000 lines in underserved and unserved areas. In contrast, the incumbent dominant operator PLDT was never subjected to any such requirement. Clearly, such rule constitutes a barrier to entry. That firms still entered the market despite the existence of such barrier does not reduce its detrimental effect on competition and consumers. TELECOMMUNICATIONS 181

How are consumers hurt by such an unequal cost burden? The imposition of additional cost to entrants can help mask any inefficiency on the part the dominant operator. Also, a particular firm may be an efficient CMTS operator only or an efficient IGF operator only. Forcing firms to provide another service deprives consumers of the benefits of specialization. Although most carriers have already satisfied this requirement, universal service obligations is still relevant to the issue of competition because of the use of the access charge as a tool for subsidizing local exchange service. As discussed earlier, the access charge must not only reflect the actual cost of interconnection but is also supposed to contain a subsidy component. That the access charge is used as an instrument for the universal access goals of the government exacerbates the asymmetry between firms. PLDT, despite not having to install a line in an unserved or underserved area, imputes a subsidy component into the access charge for its local exchange.

2. Assignment of service areas Another factor that works against the creation of a credible threat to the dominant operator is that fringe operators are constrained by the regulator to operate only within certain jurisdictions. As a result, their ability to develop economies from both the supply and demand side is constrained. Supply side economies imply that a firm can take advantage of common inputs so that costs per line are reduced. Therefore, one firm providing the service in areas A and B can be more efficient than two firms operating in each area. Demand side economies mean that one’s subscribers can easily access a wider network of subscribers (i.e., from different parts of the country), which attracts even more subscribers to join. Naturally, a firm that enjoys both such economies can have a better bargaining position vis-à-vis the dominant firm. In summary, the current market environment neither bodes well for competition nor for consumer welfare. There is a false sense of fairness in the lack of explicit rules to govern how firms, particularly a dominant firm, are supposed to compete because it ignores the inherent asymmetry between incumbents and new entrants. That certain regulations handicap new entrants even further only serve to impede the creation of genuine competition in the Philippine telecommunications sector.

RECOMMENDATIONS

What can be done to ensure a contestable4 Philippines telecommunications sector? Our recommendations are based on the following assumptions: ––––––––––––––––––––

4 Strictly speaking, the requirements of contestability (e.g., zero sunk cost) do not apply here. We use the term loosely to mean that firms behave as if credible competition, actual or potential, exists. 182 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• The regulator alone cannot provide the necessary countervailing power against market power (Gavino 1992; Serafica 1998). • We have to work within the policy framework of RA 7925, which specifies that: - Access charges are to be negotiated (Article VI Sec. 18), - The access charge is supposed to make provision for the cross subsidy to unprofitable local exchange service areas (and not to local exchange per se) (Article III. Sec. 5 c), and - The NTC can exempt any specific telecommunications service from its rate or tariff regulation if the service has sufficient competition to ensure fair and reasonable rates or tariffs (Article VI Sec. 17). • Most entrants have already complied with the mandate to install lines.

With the aforementioned as givens, it is recommended that steps be taken to distribute market power and create an environment that prevents the exercise of monopolistic behavior. Concretely, this would entail the following: First, we should establish specific rules to govern firm behavior. In particular, policies on access to essential facilities and mergers discussed earlier must be defined. Second, a second national license (i.e., the LEC can operate anywhere in the Philippines just like PLDT) must be granted to facilitate consolidation and the formation of a second carrier that can pose a credible threat to the current dominant operator. Third, we must improve regulation by privatizing certain functions such as auditing performance of operators, preparing public consultation documents or implementing alternative dispute resolution mechanisms (Smith 1997). This would make important information readily available to consumers, firms, and even the regulator. It also enhances the process of regulation. Of course, rule making (i.e., regulatory authority) would still rest with the NTC. The first three suggestions stem from our concern that the regulator alone cannot be expected to perform the role of a “countervailing power.” Therefore, this function must be shifted to the market itself, distributing power not only among firms but also between the two sides of the market—the suppliers and the consumers. Fourth, the access charge must only serve one objective and that is to accommodate competition. The implication in terms of the level and structure of the access charge is that the rates must reflect only the cost of interconnection with no provision for universal access goals. Given the requirement in RA 7925, subsidy should go only to unprofitable areas. The argument that access charges based on the incremental cost of interconnection will not encourage network buildout is not relevant for the Philippine case because of the forced rollout earlier implemented. Therefore the more appropriate access-pricing regime for the country at this point (i.e., post-SAS) is one that facilitates competition rather than network buildout. Finally, end-user price setting by the regulator must eventually be removed. There is no way that the regulator can determine the “right” price in an increasingly conver- gent environment. Firms must be accorded greater flexibility in structuring their prices. TELECOMMUNICATIONS 183

Fear of cartel-like behavior can be addressed as long as procompetitive policies are expanded and strengthened. Therefore, although the initial focus is on curtailing market power by a single firm, rules to prevent collusion must be established before price regulation is completely relaxed.

BIBLIOGRAPHY

AT&T. 1998. The Requirements of the GATS Reference Paper. Unpublished. Carlton, D.W. and J.M. Perloff. 1994. Antitrust Laws and Policy. In Modern Industrial Orga- nization. New York: Harper Collins College Publishers. Clark, J.M. 1940. Toward a Concept of Workable Competition. American Economic Review 30(2): 242. Gavino, J. Jr. 1992. A Critical Study of the Regulation of the Telephone Utility: Some Options for Policy Development. Ph.D. dissertation, University of the Philippines. NTC (National Telecommunications Commission). Annual Report. various years PLDT (Philippine Long Distance Company). 1998. Annual Reports:33 Serafica, R.B. 2002. Beyond 2000: An Assessment of Infrastructure Policies. In The Philippine Beyond 2000: An Economic Assessment, edited by Josef T. Yap. Makati City: Philip- pine Institute for Development Studies. Smith, P. 1997. What the Transformation of Telecom Markets Means for Regulation. Public Policy for the Private Sector Note No. 121. Townsend, D.N. 1997. Regulatory Implications of Telecommunications Convergence. ITU Regulatory Colloquium No. 6. 184 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix 1. Dominant Firm per Province DOMINANT MARKET SHARE REGION PROVINCE FIRM OF DOMINANT OTHER OPERATORS FIRM CAR A Abra DIGITEL 54% SMART Benguet PILTEL 74% SMART, PLDT, DIGITEL Mt. Province SMART 78% DIGITEL CAR B Kalinga-Apayao DIGITEL 100% None Ifugao DIGITEL 100% None Region 1 Ilocos Norte PLDT 49% SMART, DIGITEL Ilocos Sur DIGITEL 86% SMART La Union PLDT 51% Northern Tel. Co., SMART, DIGITEL Pangasinan DIGITEL 80% Nortelco, SMART, San Carlos Tel. Co., PLDT Region 2 Batanes None 0 None Cagayan PLDT 76% DIGITEL Isabela DIGITEL 100% None Quirino DIGITEL 100% None Nueva Vizcaya DIGITEL 100% None Region 3 Bataan PLDT 58% Battlex, DIGITEL, OWNI, SMART Bulacan DIGITEL 56% SMART, PLDT, Datelcom Corp. Nueva Ecija PLDT 46% SMART, DIGITEL Pampanga DIGITEL 34% Datelcom, SMART, PLDT, Pampanga Tel. Co. Tarlac PLDT 90% SMART Zambales DIGITEL 73% SMART, PLDT Region 4 A Aurora None 0 None Laguna PLDT 49% DIGITEL, Banahaw Tel. Co., PT&T, Intelco, CTSI Marinduque DIGITEL 100% None Quezon Gen. Tel. Sys. 38% Lukban Tel. Sys, PLDT, Santos Tel. Sys, Cruztelco., DIGITEL Rizal PLDT 45% PT&T, DIGITEL Romblon Romblon T. C. 100% None Region 4 B Batangas PLDT 44% CTSI, GLOBE, West. Bat. Tel. Sys., DIGITEL Cavite PLDT 44% GLOBE, DIGITEL Occidental Mindoro DIGITEL 100% None Oriental Mindoro Calapan Tel. Sys. 76% GLOBE, RMC Tel Con. Inc. Palawan None None None TELECOMMUNICATIONS 185

Appendix 1 (continued) DOMINANT MARKET SHARE REGION PROVINCE FIRM OF DOMINANT OTHER OPERATORS FIRM

Region 5 Albay BAYANTEL 71% BICOL TP. & TG., INC., DIGITEL Camarines Norte DIGITEL 50% BAYANTEL, Santos Tel. Sys, Labo Tel System Camarines Sur BAYANTEL 55% Iriga Tel. Co., LM United TCI, Bicol Rural Tel, DIGITEL Catanduanes DIGITEL 100% None Masbate None None None Sorsogon DIGITEL 82% BTTI Region 6 Aklan Panay Tel. Co. 62% PLDT, Cruztelco Antique ISLACOM 100% None Capiz PLDT 88% ISLACOM Guimaras None 0 None Iloilo ISLACOM 65% PLDT, S. Iloilo Tel. Co., Pantelco Negros Occidental ISLACOM 50% PLDT, SN Carlos Tel. Sys., Victorias Tel. Sys. Region 7 Bohol PLDT 51% ISLACOM, Cruztelco. Cebu PLDT 63% TMSI, ISLACOM, Danao Tel. Co. Negros Oriental ISLACOM 49% Cruztelco, PLDT Siquijor ISLACOM 76% TMSI Region 8 Eastern Samar None 0 None Leyte ISLACOM 100% None Northern Samar None 0 None Samar None 0 None Southern Leyte ISLACOM 100% None Biliran None None None Region 9 Basilan None None None Zamboanga del Norte Cruztelco 100% None Zamboanga del Sur PLDT 71% Ipil Tel. Sys., Cruztelco Region 10 Bukidnon Southern Tel. Co. 52% PHILCOM Camiguin Camiguin Tel. Coop. 80% Camteco Misamis Occidental PLDT 81% TMSI, Cruztelco Misamis Oriental PHILCOM 56% Italtel, Sotelco, Misortel, Cruztelco Region 11 Davao PHILCOM 43% Cruztelco, Datelco Global CI, PLDT Davao del Sur PLDT 100% None Davao Oriental PHILCOM 63% Mati Tel. Co. South Cotabato Marbel 100% None 186 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix 1 (continued) DOMINANT MARKET SHARE REGION PROVINCE FIRM OF DOMINANT OTHER OPERATORS FIRM Sarangani None 0 None Compostela Valley None 0 None Region 12 Lanao del Norte Maranao Tel. Co. 87% TMSI, GLOBE Cotabato M. Kidapawan Tel. 60% GLOBE, Midsayap Com. Sys. Sultan Kudarat Sultan Kudarat TS 100% None Region 13 Agusan del Norte Cruztelco 55% PHILCOM Agusan del Sur PHILCOM 62% Cruztelco Surigao del Norte Cruztelco 55% PHILCOM Surigao del Sur PHILCOM 84% PLDT ARMM Lanao del Sur None 0 None Marawi City None 0 None Maguindanao PLDT 95% GLOBE Sulu Jolo TS 100% None Jolo None 0 None Tawi-tawi None 0 None Bongao None 0 None NCR A Manila PLDT 100% ETPI, BAYANTEL Caloocan PLDT 100% ETPI NCR B Quezon City PLDT 57% BAYANTEL Valenzuela PLDT 51% BAYANTEL Malabon PLDT 64% BAYANTEL NCR C Makati PLDT 84% GLOBE San Juan PLDT 94% GLOBE Mandaluyong PLDT 72% GLOBE Marikina PLDT 84% GLOBE Pasig PLDT 83% GLOBE NCR D Las Pinas PLDT 100% SMART Paranaque PLDT 68% SMART Pasay PLDT 56% SMART Taguig SMART 100% None Muntinlupa PLDT 55% SMART

Note: Computation of market share based on reported 1998 subscribed lines only. Source: National Telecommunications Commission. TELECOMMUNICATIONS 187

Appendix 2. Relevant Provisions on Interconnection and Implementing Rules and Regulations of RA 7925

RA 7925 : Relevant Provisions on Interconnection Article III. Sec. 5 c (the Commission shall) mandate a fair and reasonable interconnection of facilities of authorized public network operators and other providers of telecommunications services through appropriate modalities of interconnection and at a reasonable and fair level of charges, which make provision for the cross subsidy to unprofitable local exchange service areas so as to promote telephone density and provide the most extensive access to basic telecommunications services available at affordable rates to the public; Article VI Sec. 18 Access Charge/Revenue Sharing – The access charge/revenue sharing arrangements between all interconnecting carriers shall be negotiated between the parties and the agreement between the parties shall be submitted to the Commission. In the event the parties fail to agree thereon within a reasonable period of time, the dispute shall be submitted to the Commission for resolution. In adopting or approving an access charge formula or revenue sharing agreement between two or more carriers, particularly, but not limited to a local exchange, interconnecting with a mobile radio, inter-exchange long distance carrier, or international carrier, the Commission shall ensure equity, reciprocity and fairness among the parties concerned. In so approving the rates for interconnection between the telecommunications carriers, the Commission shall take into consideration the costs of the facilities needed to complete the interconnection, the need to provide the cross-subsidy to local exchange carriers to enable them to fulfill the primary national objective of increasing telephone density in the country and assure a rate of return on the total local exchange network investment that is at parity with those earned by other segments of the telecommunications industry: Provided, That international carriers and mobile radio operators which are mandated to provide local exchange services, shall not be exempt from the requirement to provide the cross-subsidy, when they interconnect with the local exchanges of other carriers: Provided, further, That the local exchanges which they will additionally operate, shall equally be entitled to the cross-subsidy from other international carriers, mobile radio operators, or interexchange carriers interconnecting with them.

RA 7925 Implementing Rules and Regulations: Relevant Provisions on Interconnection RULE 520 ACCESS CHARGES

GENERAL • Until the local exchange service is priced reflecting actual costs, the local exchange service shall be cross-subsidized by other telecommunications services. • The allocation of the local exchange carrier costs to all interconnect services including those offered by the same company operating the LE service shall be based on actual cost of interconnection. • The subsidy needed by the LE service operator to earn a rate of return at parity with the other segments of telecommunications industry shall be charged against the international and domestic toll and CMTS interconnect services • The Cost Manual shall follow the accounting structure based on the applicable provision of US Federal Communications Commission (FCC) Part 36 as modified to confirm with the provisions of this Circular. • Provision for doubtful accounts (as used in general accounting) shall not be included in the costs. • Only taxes actually incurred shall be included in the costs. • The access charge shall be negotiated by the interconnecting parties. In the event the parties cannot arrive at an agreement, either or both parties can bring the matter before the Commission for final action pursuant to NTC MC 9-7-93 • Interconnecting parties shall strictly adhere to the herein prescribed guidelines. • The cost manual shall be submitted to the Commission not later than 31st of July of each year for approval. In approving the cost manual, the Commission shall consider efficiency and the “Philippine Best Practice”. 188 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix 2 (continued)

• The interconnection between CMTS and local exchange network for purposes of calculating the access charge shall be considered domestic toll interconnect. • Reappraisal of plant and facilities in service shall be duly approved by the Commission after due notice and hearing. • Actual costs and all accounting charges for provisioning of services and interconnection shall be nondiscriminatory, transparent, de-averaged by time of day and unbundled, and subject to review by the Commission. • Interconnection charges shall be composed of the access charge and the subsidy. For the purpose of calculating the subsidy, the local exchange networks shall be classified into three (3), to wit: Metro Manila, Highly Urbanized Cities defined by law and Others • Interconnection charges shall accrue only on completed calls.

COST SEPARATION • A LE service provider operating other telecommunications services shall separate the cost at discrete and recognizable point(s) of demarcation for each of the services it offers to determine the cost of the local exchange service. • Direct assignment of costs to each services category when possible will be made. • Actual costs basis of separation which gives consideration to relative usage/circuit occupancy of services for traffic related costs shall be used. • Costs of customer billing of toll services shall be allocated fully to the local exchange service. • Cost of marketing and advertising shall not be allocated to the local exchange service.

ALLOCATION OF COSTS • The local exchange service costs shall be shared by the interconnect services as follows: - The cost allocated/charged to the local exchange service shall be equivalent to the local exchange service gross revenue plus the revenues derived from the interconnection services other than international and domestic toll and CMTS - The cost allocated/charged to the interconnection services other than domestic and international toll and CMTS shall be based on the actual cost of interconnection - The cost allocated/charged to the international and domestic toll and CMTS interconnection services shall be divided into two components, to wit: access charge and subsidy. The access charge shall be based on the actual costs of interconnection while the subsidy shall be equal to the revenue required by the LE operator to earn a rate of return at parity with those earned by other segments of the telecommunications industry. - Interconnection services shall also include all telecommunications services offered by the PTE interconnected to the local exchange network, operated by the same PTE.

INTERCONNECTION OF LOCAL EXCHANGE NETWORKS • There shall be no access charges to be paid by either party in the interconnection of local exchange networks operating in a given local exchange service area if the monthly local exchange service rate is fixed and that the local exchange service operators do not discriminate applicants for local exchange service. • In the event that in any given local exchange service area there are a mixture of fixed and measured rates, the local exchange service operators thereat shall negotiate for the access charges. In the event the parties cannot agree, the matter may be brought to the Commission for final action pursuant to the MC 9-7-93. • In the negotiation between the LE service operators, the cost of investment shall be considered. 6 CHAPTER

The State of Competition and Market Structure of the Philippine Air Transport Industry

Myrna S. Austria*

ABSTRACT

his paper examined the regulatory and policy regimes and their effects on the state of competition and market structure of the Philippine air transport industry. There is no doubt that liberalization and deregulation have brought Tgenuine competition in the domestic air transport industry resulting in lower airfare, improvement in the quality of service, and efficiency in the industry in general. The deregulation, however, resulted in the establishment of niche markets, with the big players concentrating on the major routes where traffic demand is heavier while the smaller airlines are flying the secondary and tertiary routes where traffic demand is lighter.

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*The author wishes to thank Mr. Joselito P. Supangco for his comments and suggestions on an earlier draft of the paper. The excellent research assistance provided by Ms Dorothea C. Lazaro is also gratefully acknowledged. 190 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

While the country has a policy pronouncement, through Executive Order (EO) 219, of liberalizing its international air transport industry, the EO has yet to be implemented given the absence of its implementing guidelines. But EO 219 alone is not enough. The government needs to deepen its liberalization efforts by adopting a more liberal approach to its bilateral air agreements. While other countries are taking on more flexible approaches to liberalization and regulation to meet the increasing demand for international air services brought about by the increasing integration of economies, the country is keeping to its old restrictive practices and policies. The effect of such restrictive policies is a high degree of concentration in the country’s international aviation industry. The government needs to act quickly to promote competition in the industry. As the experiences of other countries have shown, convenient and efficient air services brought about by greater competition are critical to attracting foreign investment, trade, and tourism. To this end, the paper has identified areas where competition policy should be defined to introduce competition where there is none and to ensure that competition where it exists is effective.

INTRODUCTION

Until the late 1970s, domestic and international air transport throughout the world was a highly regulated industry. There are several reasons advanced for government regulation. The widely held view is that governments traditionally considered air transport as a quasi-public utility since industry returns are not limited to those accruing directly to the industry itself, but includes external benefits to the wider economy (Hanlon 1996). The industry is regarded as (i) an instrument to promote national interests like trade, investment and tourism; (ii) a source of foreign exchange; or simply (iii) a source of prestige and symbol. To avoid the conflict that may arise from the differing objectives of the government (national interests) and the airlines (commercial), governments conferred monopolies to their national airlines. This is the reason why all countries, with the exception of the US, had one flag carrier before deregulation. The airlines were then protected from competition through regulations. Over the years, however, the merits of regulating the industry have been put into question. The absence of competition resulted in inefficiency, higher cost of travel, and the inability of the industry to meet the increasing demand for air services, as a result of the growing interdependence of global markets and communities. All these have increasingly put pressure for reform in the industry. In the Philippines, reforms in the industry were slowly introduced in 1995. Nevertheless, there is a growing perception that the country’s air transport services, particularly the international air transport services, have not improved. This paper examines the country’s regulatory and policy regimes and their effects on the state of competition and market structure of the industry. The scope AIR TRANSPORT INDUSTRY 191 of the study, however, is limited only to scheduled air services, i.e., freight and chartered flights are excluded. The paper is organized as follows: The next section looks into the applicability of the contestability of markets to the air transport industry. It is followed by a discussion of the regulatory framework that governs the operation of the global air transport, including the reforms that are being made in the industry. The policy and regulatory regimes of the Philippines are discussed next, followed by their effects on the state of competition and market structure of the industry, both domestic and international. The implications of the deregulation on the role of the Civil Aviation Board (CAB) are briefly examined in the succeeding section. Following it is a discussion of the areas that need to be addressed in the implementing guidelines of Executive Order (EO) 219. The penultimate section identifies areas where competition policy and regulations should be defined to introduce competition where there is none and to ensure that competition where it exists is effective. The last section presents the summary and conclusions.

CONTESTABILITY OF MARKETS: ITS APPLICABILITY TO THE AIR TRANSPORT INDUSTRY

The literature on contestability of markets points to the importance of the threat of competition, as distinct from actual competition, in enforcing good behavior and conduct among firms in an industry (Hanlon 1996). This kind of market is characterized by the following: (i) there are no barriers to entry, i.e., new entrants bear no extra cost that are not borne by the incumbents; (ii) there are no sunk costs, i.e., costs that cannot be recouped when a firm withdraws from the industry; and (iii) the time for incumbents to change their prices in response to the entry is longer than the time for the new entrant to make profits. According to this theory, firms in oligopolistic industries will still price at the same level as they would in a perfectly competitive market so long as the threat of competition exists. In other words, under this market, the incumbents can protect themselves from new competition only by behaving well. A contestable market offers consumers and the society similar benefits from a perfectly competitive market (Baumol and Lee 1991). Because of the threat of competition, firms cannot charge higher-than-competitive prices or earn excessive profits; any attempt to do so would invite new entrants to undercut the incumbents’ prices to a level that could still give them attractive return. Waste and inefficiency beyond that which are allowed by the current state of technology and level of knowledge are also avoided as these would be reflected in higher costs and prices, the presence of which would invite the entry of efficient firms. Likewise, predatory pricing and cross-subsidy pricing are prevented. Predation becomes unattractive since it can only be done if there is a prospect for making future profits large enough to recoup losses made when prices or profits were kept low to drive competitors or new entrants away; but then, 192 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES excessive profits would invite entry. Cross subsidy occurs when a firm charges a price below cost to a particular group of customers and the loss is made up for by charging excessive prices to other customers. This is not feasible under a contestable market as the excessive price would invite new entrants who can sell at a lower price level. In effect, the new entrants are capturing from the incumbents the earnings that were previously used for cross subsidy. Several studies, however, have shown that the air transport industry does not possess the characteristics of a contestable market (Hanlon 1996) or at least, the industry is less contestable than had been thought at the time of its deregulation in the US (Baumol and Lee 1991). As will be discussed in the next section, entry to the industry is not costless as there are barriers to entry, some of which are inherent to the incumbents being the first movers in the industry. Also, while expenditures on aircraft is not a sunk cost in the same way that a fixed plant in manufacturing is, since aircrafts can now be leased or disposed of in second-hand markets, costs in advertising and promotion cannot be recouped once the airline withdraws from the industry. Because of deregulation, greater importance is now given to advertising especially if an airline wants to establish an extensive network and become competitive in a deregulated environment. Finally, in a deregulated environment, airfares can change anytime; and with the advent of information technology, the change is automatically communicated to travel agencies through the computer reservation system. Despite this, however, the recent literature also shows that the contestability framework can be used to design policies and regulations that would enforce competitive behavior among firms when markets cannot do the job. As Baumol and Lee (1991:7) clearly pointed out, “Note, however, that the analytical power of the theory does not depend on the ubiquity of contestability; indeed, its policy lessons apply primarily to industries that are not contestable, whose regulation can be aided by contestability theory, which provides norms of behavior to which the regulated firms can reasonably be held.” What is described above is especially applicable when the industry’s cost structure is such that efficiency can only be attained if there are only a few large firms in the industry. The air transport industry, for one, is naturally oligopolistic, as there are important advantages in a large firm size in the industry. For example, there are economies of scope when airlines configure their networks in the hub-and-spoke pattern or when airlines make large-scale marketing campaigns of their network, a strategy that is more efficient than promoting individual routes. It could also be that where traffic is low, a single carrier with multiple frequencies per week is more commercially viable and efficient than multiple carriers who operate one frequency each per week. Hence, given the nature and structure of the industry, competition policies and regulations can be designed to allow airlines to reap the benefits of their size advan- AIR TRANSPORT INDUSTRY 193 tages while at the same time protecting the consumers and smaller airlines from the threat of market power and oligopolistic behavior of large airlines.

REGULATORY FRAMEWORK FOR INTERNATIONAL AIR SERVICES

Trade in international air services is unlike trade in goods. Trade in goods is done at all levels (bilateral, regional, and multilateral) and where the World Trade Organi- zation (WTO) principle of most favored nation (MFN) is applied, every trading partner is treated equally. In contrast, trade in air services traditionally takes place under a common regulatory framework of bilateral air services agreements (ASAs) between pairs of countries. As will be discussed later, it was only recently that regional regulatory practices evolved. The International Conference on Aviation held in Chicago in 1944 (or simply the Chicago Convention of 1944) provided the foundation for the ASAs by establishing what is commonly referred to as freedoms of the air (Box 1) after it failed to establish a multilateral system in the provision of international air services. The framework of the bilateral system of ASAs is based on the principle that a country has the complete and exclusive sovereignty over its air space (Article 6 of the Convention). As WTO (1998:19) explained, “This means that a state has the right to control regular air traffic flying over its territory: no regular international air service can take place above the territory of a state, or within its territory, without the permission or authorization of that state, and in confor- mity with the conditions attached to the authorization.”

To this day, this framework is the basis for the global air transport industry. Ex- change of air service rights between countries is negotiated bilaterally based on the principle of reciprocity or ‘equality of opportunity’. This means that two countries agree to exchange air rights that would give their respective carriers equal access to each other’s markets. ASAs set out the terms and conditions under which airlines of the contracting countries can fly. It is a ‘positive list’ of activities that an airline is allowed. Since a country has the exclusive sovereignty over its air space, anything for which there is no specific provision in the ASA is not allowed. Again, this is unlike agreements in trade in goods where traders are able to do anything that is not constrained by a ‘negative list’ of specific restrictions (Productivity Commission 1998). A standard ASA has the following provisions: • Freedoms of air granted for the conduct of international air services; descrip- tions of the routes, including capacity (number of seats supplied) and frequency (number of flights), and type of aircraft to be used are usually contained in an annex to the ASA; 194 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Box 1. Freedoms of the Air First freedom the right of an airline of one country to fly over the territory of another country without landing. Second freedom the right of an airline of one country to land in another country for purposes of refuelling and maintenance while en route to another country, but not to pick up or disembark traffic (passenger, cargo or mail). Third freedom the right of an airline of one country to carry traffic from its country of registration to another country. Fourth freedom the right of an airline of one country to carry traffic from another country to its own country of registration. Fifth freedom the right of an airline of one country to carry traffic between two countries outside of its own country of registration as long as the flight originates or terminates in its own country of registration. Sixth freedom the right of an airline of one country to carry traffic between two foreign countries via its own country of registration (i.e., combination of third and fourth freedoms). Seventh freedom the right of an airline of one country to operate flights between two other countries without the flight originating or terminating in its own country of registration. Eighth freedom the right of an airline of one country to carry traffic between two points within the territory of another country (or cabotage rights).

Note: Sixth to eighth freedoms are supplementary freedoms although not officially recognized by the International Civil Aviation Organization (ICAO). Source: WTO (998).

• Designation of carrier/s by each party and authorization by the other party of carrier/s to operate the agreed air services on the specified routes; • Conditions of revocation or suspension of operating authorization, one of which is that designated carriers should be substantially owned and effectively controlled by the state or nationals of the contracting parties; • Principles governing operation of agreed services, one of which is the guarantee of fair and equal opportunity for the designated airlines to operate the agreed services; • Principles for regulating capacity and tariffs/fares; • Commercial rights or “soft rights” which include the following: - Exemption from custom duties, excise tax, and similar fees or charges by both parties for aircraft fuel, lubricants, spare parts, and supplies used by the other airline of the other party; - Obligation of contracting parties to extend to each other aviation security; - Agreement to observe the laws and regulations of each party relating entry, clearance, immigration, passports, customs, and quarantine; - Rights for conversion and remittance of revenues; - Rights for airline representation and sales; and - Rights to establish offices and entry and residence of non-national personnel. AIR TRANSPORT INDUSTRY 195

• Principles/procedures for disputes settlement; • Right of each party to consult the other party for any modification/amendment to the agreement; and • Right to terminate the agreement and the procedures for terminating the agreement.

ASAS: ITS EFFECTS ON COMPETITION AND EFFICIENCY The bilateral framework has turned the international air transport industry into one of the most regulated industries in the world. Some features of the ASAs have restricted competition by limiting entry and constraining capacity thereby affecting the efficiency of airlines.

Capacity and frequency constraints Capacity and frequency constraints have the potential to suppress competition in a route since designated carriers cannot operate additional services beyond that which is specified in the ASAs, even if there is unsatisfied demand. This unsatisfied demand could be the result of: (i) the inefficiency of designated carrier/s in the route that cause them to operate below capacity; or (ii) an increase in traffic demand. A situation like this would enable airlines to charge airfares at a level higher than in a competitive market. Furthermore, to the extent that the frequency, capacity, and type of aircraft for a particular route are predetermined in the ASAs, the airlines are prevented from making the least cost combination of these in providing services in that route. Hence, the cost of providing services may be higher (technical inefficiency) than if airlines are allowed to make their own decision based on market conditions, like any producer in all other industries (Productivity Commission 1998). Likewise, to the extent that the choice of routes is limited by the ASAs, airlines are prevented from configuring or developing an efficient network (allocative inefficiency). Nevertheless, the recent reforms in the ASAs have given designated airlines some flexibility to change aircraft size and capacity depending on the estimated demand for a particular period or day.

Ownership and control restriction The bilateral system requires that countries designate their carriers to fly the international routes. This designation of airlines already limits the set of carriers that could compete in individual routes, as carriers would not be granted access rights unless they are designated in the ASAs. In other words, the system has be- stowed complete market power to designated airlines of bilateral partners while completely excluding from the market nondesignated airlines and third-country carriers. However, designation of airlines is vital for technical and safety regulations because the bilateral system requires that countries are accountable for maintaining the 196 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES safety of their carriers. Given this, what really hinders competition is the requirement for designation. The bilateral system requires that designated airlines should be substantially owned and effectively controlled by the state or nationals of the bilateral partners. This restriction hinders the entry of foreigners from establishing airlines in countries other than their own. Traditionally, most countries have a single “flag” carrier which is traditionally, state-owned. Single designation would have, at most, two carriers (one for each bilateral partner) operating in the routes and this creates potential for duopolistic pricing. However, with the recent trends on privatization of airlines and domestic deregulation, more and more countries are having a multiple designation system. Although multiple designation has increased competition in the individual routes, the bilateral framework still limits competition to designated carriers of the bilateral partners. Where fifth or sixth freedom is granted, third-country carriers provide an important source of competitive pressure to the routes. In terms of efficiency, the local ownership requirement has a distorting effect on the domestic capital market, especially in developing countries where the capital market is small. Since the airline industry is capital intensive, the capital market maybe too small to provide sufficient equity capital for the development of the airline industry. The insufficiency of capital may retard the development of the airline industry. It could also raise the cost of capital not only for the airline industry but also for other industries as well. In the absence of equity capital, airlines would most likely resort to debt financing. In this sense, the restriction on local ownership limits the flexibility of airlines in their choice between equity and debt capital.

Cabotage Foreign carriers are not allowed cabotage rights and hence, this limits competition in the domestic market to domestic airlines.

STRUCTURAL BARRIERS TO ENTRY Apart from the regulatory barriers arising from the bilateral system, there are structural barriers inherent to the characteristic of the international aviation industry (but which also apply to the domestic air industry). These structural barriers arise from first-mover advantages that give incumbent carriers substantial market power. Unless these are addressed by the appropriate competition policies, they can result to anticompetitive practices (Warren et al. 1998).

Economies of traffic density This refers to the fall in average unit cost as the number of passengers traveling on a particular route increases. This is achieved if an airline adds flights in a route or seats on existing flights. If the incumbent airline is realizing economies of density in a route, potential entrants are deterred from entry by the choices available to them. AIR TRANSPORT INDUSTRY 197

That is, entry can be made either on a small scale but with a significant cost disadvantage or on a large scale that is likely to depress airfares significantly (Warren et al. 1998). Incumbent airlines possess some advantages that would prevent potential entrants from achieving economies of density. One, incumbent airlines generally have established interlining agreements1 with other airlines that could feed connecting traffic into the route at issue. There are significant reductions in transfer costs available for passengers who prefer interline travel. Potential entrants would therefore have difficulty attracting this kind of passengers without interlining arrangements. But making interlining arrangements could also prove difficult and could put the potential entrants at a cost disadvantage. This would require potential entrants to either duplicate the incumbent’s existing arrangement or hire existing airlines who can provide feeder services. Most likely, those who can provide feeder services are already committed to the incumbent airline and hence, would only be willing to shift loyalty if offered a higher price (Warren et al. 1998). Two, for the business and first class passengers, who are price insensitive and considered high yield2 for airlines, while there are several factors influencing their choice of an airline, what is more important is greater seat availability and greater options of flights, both of which an airline could only realize with increased frequency. Potential entrants cannot attract these passengers unless they can offer flights as frequent as the incumbent carriers. Three, frequent flyer programs3 (FFP) of incumbent carriers also act as entry barrier to potential entrants as these programs build passengers’ loyalty to the carriers offering them. Business travelers in particular are heavily influenced by their FFP membership in choosing the flights of a particular airline. A survey done in the US among travel agents shows that more than half of the respondents reported that travelers always or almost always chose their flights in order to build FFP mileage points (Hanlon 1996). Hence, potential entrants would have difficulty attracting passengers who are already members of the incumbent carrier’s FFP.

Access to essential inputs Potential entrants could also be deterred from entry in international routes because of the ability of the incumbent carrier to forestall a competitor’s access to auxil- ______

1 Interlining arrangement allows one airline to carry passengers on behalf of another airline. This type of arrangement becomes particularly important and strategic if an airline has extensive domestic network or if one of the points in the route is an international hub. 2 Yield refers to revenue per unit of traffic. 3 Frequent flyer program is a purchase incentive plan that rewards the traveler for repeat patronage of the services of a particular airline. For each ticket bought, a traveler accumulates mileage points according to the distance traveled and class of ticket bought. The traveler can then exchange the mileage points for rewards in the form of free or discount tickets, upgrades from one class of travel to another and other benefits (Hanlon 1996). 198 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES iary services essential in the provision of air services. In many countries, the incumbent airline is also the incumbent supplier of ground handling and aircraft repair and maintenance services. Hence, the incumbent airline can discriminate against new entrants in terms of pricing and quality of service. Some airports, however, have multiple purveyors of groundhandling services that compete with each other for airline customers. Likewise, incumbent carriers can prevent potential entrants’ access to landing slots or airport gates since as incumbents, they have the advantage of possessing (as assigned by airport authorities) the peak landing slots4 or best-positioned gates in most airports. The commercial value of slots varies considerably. Slots at the beginning and end of the day are convenient for business, for which business and first class seats are much in demand. As traffic increases and with airports being unable to expand their operations for physical reasons, slots become a valuable physical resource. Without access to the priority slots or gates, new entrants would have difficulty attracting business class passengers and perishable freights, both of which are time-sensitive. Since there is often only one airport in most destinations, potential entrants are left with no alternative. Hence, this enhances the power of the incumbent airline to foreclose potential entrants’ access to these inputs. The use of the computer reservation system5 (CRS) has the potential to foreclose potential entrants from the market for ticket sales. When they were first developed in the 1960s and 1970s, CRSs were considered simply as a device to save on time and labor in handling the growing number of flight reservations (Hanlon 1996). Because airfares and entry to routes were still highly regulated then, airlines did not see any market power advantages in developing their own CRS and even made their system available to travel agencies. However, with the deregulation in the 1980s, passengers have been presented many alternatives in terms of airlines, flights and fares in a particular route, which any travel agency hooked to a CRS, can screen through. About 75 percent of flights made through CRS are made from its first screen page (Hanlon 1996). Hence, access to the first screen page became an important source of competition among airlines. Airlines owning or controlling CRS can therefore program the computer in such a way that their flights appear on the first page of the screen while a competitor’s flights appear on a later screen page. Potential entrants wishing to sell its tickets through the CRS are placed at a cost advantage since they have to spend to be able to include their flights in the CRS affiliated with the incumbent carriers; and since CRS usually give priority screen ______4 Landing slots refer to the specific time allocated for an aircraft to land and take off. These are assigned on a first-come, first-serve basis. 5 Computer reservation system contains information about carriers’ schedules, availability, fares and fare rules, for which reservations can be made or tickets may be issued. AIR TRANSPORT INDUSTRY 199 listing to their developers’ own-flights or incumbent carrier’s flights, potential entrants have to give travel agencies incentives big enough for them to scroll through the flights of incumbent carriers or owners of CRSs (Hanlon 1996; Warren et al. 1998).

REFORMS IN THE AIR TRANSPORT INDUSTRY The inflexibility of the bilateral regulatory system to market conditions, together with the structural barriers to entry, has rendered the international air industry inefficient. The inefficiency of the system and the growing density of air traffic, as a result of the increasing integration of economies leading to the expansion of business-related travel within and among countries, have created intense pressure for liberalization and deregulation. The main goal of the reforms was to reduce the restrictions on competition in order to increase the efficiency of the industry. The reform process has occurred at all levels: unilateral, bilateral, regional, and multilateral. Nonetheless, the reforms are still in their limited form. They have focused more on removing the regulatory barriers and less on the structural barriers. And for the regulatory reforms, most are limited to the removal of restrictions on market access and frequency, i.e., all other restrictions are retained; and they discriminate against third countries in bilateral agreements or against nonmembers in regional/multilateral agreements. The unilateral reforms were directed only to the domestic airline industry. The reforms came in the form of deregulation and privatization of government-owned airlines. Domestic deregulation first occurred in the United States in 1978 (USATA 1999), followed by Europe in the late 1980s and Australia and New Zealand in the early 1990s (Productivity Commission 1998). In the 1990s, there was an increased trend toward liberalizing bilateral agreements. The most common of these is the bilateral “open skies agreement” of the United States with 35 countries that include Brunei, South Korea, Singapore, Malay- sia, and Taiwan in Asia (Findlay and Nikomborirak 1999). Under the agreement, the US and its bilateral partners can fly the third, fourth, and fifth freedoms without restrictions, although the latter is subject to the approval of the third country. There is also the Single Aviation Market for Australia and New Zealand where carriers of both countries have unrestricted rights to fly third, fourth, and eighth freedoms. The agreement also allows for greater flexibility in foreign ownership as carriers of both countries could be majority-owned and effectively controlled by nationals of either Australia or New Zealand or both (Productivity Commission 1998). At the regional level, the EU Common Aviation Market is the most significant (UNCTAD 1999). Under the arrangement, the EU member states have, over a period of three phases (1988, 1990, and 1992), established a single market for intra-Europe air services. The reform is more comprehensive as it covers both regulatory and structural barriers. Carriers of member states can fly without restrictions anywhere within the single market. Restrictions on local ownership were also dismantled as any na- 200 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES tional of EU can establish an airline anywhere within the single market. Common rules on access on ground handling, airport slots and computer reservations system were also established. But traffic rights between EU members and third countries continue to be governed by bilateral agreements. Still at the regional level, the Andean Pact of 1991 is also prominent (UNCTAD 1999). This covers the open skies agreement among Bolivia, Colombia, Ecuador, Peru, and Venezuela where airlines of member states could fly without restrictions on intrazone traffic. In 1997, the APEC Transportation Working Group identified areas for possible liberalization: air carrier ownership and control, fares/tariffs, air freight, multiple airline designation, charter services, airline cooperative arrangements, and market access. In 1999, APEC Leaders committed to identify steps to liberalize air services in the above areas in accordance with the Bogor goals (APEC Leaders Statement 1999). However, no progress has been achieved so far. At the multilateral level, reforms are set out in the Annex on the Air Transport Services in the WTO-General Agreement on Trade in Services (GATS). The reforms cover some aspects of the structural barriers to entry, such as aircraft repair and maintenance, selling and marketing of air transport services, and computer reservation system (WTO 1998). The Annex requires that access to these areas be granted to carriers of WTO members following the principles of national treatment and most favored nation (MFN). The Annex, however, has stayed away from market access, i.e., the agreement does not cover traffic rights, however granted; or services directly related to the exercise of traffic rights.6 Nonetheless, the Annex has yet to generate an impact as most WTO members have been granted exemptions from implementing them. It was up for review in 2000. The results of studies on the effects of the reform have been mixed, however. For Australia, the domestic deregulation reduced the average price of air travel by 1 percent and improved the quality of service (in terms of increased flight frequency, expansion of frequent flyer programs, and airport club lounges) as a result of the entry of more airlines in the domestic industry. The effects of introducing one more Australian airline in the Asian routes show an increase in net economic welfare (measured by changes in consumer surplus and airline profits) in Australia and in all affected routes (Productivity Commission 1998). The US experience in domestic deregulation also shows that airfares have fallen in real terms (USATA 1999) but it was less clear that this have been the result of the deregulation (Hanlon 1996). However, after five years of deregulation, fierce competition pushed a number of airlines into bankruptcy or merger, making the industry marginally more oligopolistic than it was before deregulation. ______

6 The Annex does not contain a definition of “services directly related to the exercise of traffic rights”. AIR TRANSPORT INDUSTRY 201

POLICY AND REGULATORY REGIMES OF THE PHILIPPINE AIR TRANSPORT INDUSTRY

Policymaking for the Philippine civil aviation industry started with Republic Act (RA) No. 776, known as the Civil Aeronautics Act of the Philippines passed in 1952. The Act established the policies and laws governing the economic and technical regulation of civil aeronautics in the country. It laid down the guidelines for the operation of two regulatory organizations, the Civil Aeronautics Board (CAB) for economic regulation and the Civil Aeronautics Administration7 (CAA) for technical regulation. The powers and functions of the two bodies were premised on the policies set out for the industry in the Act, two of which dealt in the area of competition as follows: • Promotion of adequate, economical and efficient service by air carriers at reasonable charges, without unjust discriminations, undue preferences or advantages, or unfair or destructive competitive practices (Section 4d); and • Competition between air carriers to the extent necessary to assure the sound development of an air transportation system properly adapted to the needs of the foreign and domestic commerce of the Philippines, of the Postal Service, and of the National Defense (Section 4e).

In 1959, the government recognized as vital for its security and defense and for the enhancement of its international commerce, the need to maintain its own international air operations. However, the attainment of this objective required a national carrier. Hence, RA 2232 was passed in June 1959 designating the Philippine Airlines (PAL) as the country’s national flag carrier. Prior to this, the conduct of trade in air services between the Philippines and other countries was exclusively provided by foreign airlines.

One-airline policy, 1973-1987 A major shift in policy came with the passage of Letter of Instructions (LOI) No. 151 and 151A in December 1973 establishing a one-airline policy in both the international and domestic operations. The two LOIs, in effect, repealed Section 4 (e) of RA 776. Two airlines (Filipinas Orient Airlines and Air Manila Inc.) were subsequently closed, and PAL, being the flag carrier, had a virtual monopoly of the country’s air transport industry. PAL’s monopoly was exposed to the possibility of competition when, in June 1978, it was given a new franchise for its operations under Presidential Decree (PD) No. 1590. PD 1590 had a provision that the franchise was not to be interpreted as an exclusive grant of privileges to PAL. Despite this provision, however, no other airline joined the industry. Furthermore, another presidential decree (PD 1466), also implemented in June 1978, reserved certain categories of traffic to PAL. This includes the ______

7 Presently known as the Air Transportation Office (ATO) of the Department of Transportation and Communication. 202 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES transport of persons or cargoes that use government funds or loans and credits that are guaranteed by the government. Hence, even if new players had entered the industry, PAL would have retained its monopoly over this category of air traffic.

Accreditation system, 1988-1994 The first attempt at reform came during the Aquino administration that adhered to the policy of allowing a healthy and regulated competition among the airlines in the country. Executive Order (EO) No. 333 was issued in August 1988 revoking the one-airline policy. With the change in policy, a number of companies/individuals applied for permits for scheduled domestic combination of passenger and cargo services. Hence in 1989, CAB introduced an accreditation system defining the guidelines for the grant of permits. To a very large extent, the guidelines under the accreditation system defined the country’s domestic air transportation policy as follows: • Domestic air services are classified into three: (i) rural service–air transportation to and from rural airports and other ATO-rated airports; (ii) secondary service–air transportation between secondary airports, or between secondary and trunkline airports; and (iii) trunkline service–air transportation between trunkline airports (See Appendix 1 for the list of airports falling under the three classifications); • The route structure of an airline shall be that at least 5 percent and 25 percent of the total monthly available seat kilometer of the proposed base operations shall be allotted for rural and secondary services, respectively; • Each operator shall provide at least three scheduled services a week on each trunkline, secondary and rural route; and • Only two operators shall be allowed to operate on a base initially. However, more operators are allowed if deemed necessary based on traffic demand.

While the above accreditation system for domestic air services was definitely more liberal than the one-airline policy, the guidelines were still very restrictive. Air- line operators were not given full freedom in determining the routes and frequencies they want to fly, both of which depend on traffic demand and profitability. Also, fares are still regulated by CAB. The accreditation system, however, did not succeed in bringing in new players into the industry. The failure was not necessarily due to the system’s restrictive character but to the legislative issue as to the constitutionality of the CAB in issuing a permit to an individual or entity to engage in air commerce without Congress’ prior granting of a legislative franchise to the person or entity concerned. This issue created uncertainty among the domestic operators who do not have a franchise and a hesita- tion on those wanting to join the industry knowing that the grant of a franchise by the Congress is a lengthy and time-consuming process plus the fact that one cannot be certain that a franchise can be granted (DOTC 1992). In the end, the legislative issue restricted the growth of the industry. AIR TRANSPORT INDUSTRY 203

The issue, however, has now been settled by the Court of Appeals, which finally decided that a legislative franchise is not a prerequisite for the issuance of a permit by CAB. On the surface, this Court of Appeals ruling looks good as it facilitates the entry of new players in the industry. However, the possession of a legislative franchise by an airline would entitle it to enjoy certain tax concessions. This court ruling, therefore, does not level the playing field in the industry.

Liberalization and deregulation, 1995-present For 22 long years, PAL was flying solo. But at the same time, the pressure for the deregulation of the industry was also building up. Many sources contributed to the pressure but the inefficiencies of PAL’s service and its financial losses intensified the pressure and brought the issue to a head. Hence, the supremacy of PAL was finally challenged with the passing of EO 219 in 1995 under the Ramos administration. The EO established the domestic and international civil aviation liberalization policy of the country. The change in policy came in response to the government’s “thrust to expand investment and trade, and increase access for Filipino as well as foreign passengers” and hence the “need for the Philippines to improve air service availability, quality and efficiency through exposure to foreign markets and competition” (EO 219, paragraph 3). The policy is also in line with the 1987 constitutional mandate prohibiting monopolies when the public interest requires.

For domestic air transportation: Restrictions on domestic routes and frequencies were eliminated and so were government controls on rates and charges: • A minimum of two operators in each route/link shall be encouraged. Routes/ links presently serviced by one operator shall be open for entry for additional operators (Section 2.1). Operators are also free to leave unprofitable/uneco- nomical routes. • Airfares shall be deregulated for routes/links operated by more than one carrier. However, for routes/links serviced by a single operator, airfares will continue to be regulated (Section 2.2).

EO 219 signaled the entry of new airlines in the industry. As will be seen in the next section of the paper, the above provisions of EO 219 make the domestic air industry a market-driven industry, with customer demand determining the levels of service and price.

For international air transportation: Areas where there was a significant change in policy include the number of carriers that can be designated as the country’s flag carriers and the basis for the negotiation of traffic rights and routes. 204 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• At least two international carriers shall be designated official carrier(s) for the Philippines. If the designated carrier(s) do not service the total frequency entitlement of the Philippines under existing Air Services Agreements, additional carrier(s) may be designated to operate the unused frequencies (Sec- tion 1.1); • Exchange of traffic rights and routes with other countries shall be based on national interest and reciprocity between the Philippines and other countries (Section 1.2); • Exchange of third and fourth freedoms will be based on reciprocity and value for the Philippines. Fifth freedom is secondary and supplemental to third and fourth freedom traffic, except that the CAB may grant fifth freedom rights to promote the development of routes and destinations. Special flights may be authorized if the designated carriers fail to accommodate a route/link traffic demand (Section 1.3).

The policy is definitely more liberal than before where there was only one designated flag carrier (PAL); and the interests of the flag carrier, not the interests of the country, were the primary consideration in the negotiation of traffic rights with other countries. However, the implementing rules and regulations (IRR) of EO 219 have not yet been formulated five years since its issuance. In 1999, the Estrada administration, through Civil Aviation Consultative Coun- cil Resolution No. 001-98, launched a policy on progressive liberalization of bilateral air services agreements. But what “progressive liberalization” means has not been defined. The guidelines by which this new policy should be fleshed out have not been defined as well. Progressive liberalization would reinforce EO 219 if defined as the gradual reduction of regulations within a set time frame, e.g., programmed increase of seat capacity, routes or frequency. The absence of the implementing guidelines of EO 219 and of a clear definition of what progressive liberalization means creates a gap between policy pronouncement and policy implementation. This is evident in the perception in the industry that the renegotiation of existing Philippine ASAs does not reflect the change in policy. Worse yet, there is a growing perception that the government has reverted to the old days of protectionist policies. This was best illustrated with the dispute over the RP-Taiwan ASAs in 1999 and 2000 where the government’s stance on the issue gave the impression that the country’s aviation policy still predominantly aims to ensure the viability of PAL.8 It appeared as though the interests of PAL continue to

______

8 This is based on the 20 January 2000 letter of the Manila Economic and Cultural Office (MECO) to the Taipei Economic Cultural Office (TECO) where the former requested the latter to “kindly consider the difficulties facing Philippine Airlines and self-restrain the capacity on the route between Taipei and Manila.” AIR TRANSPORT INDUSTRY 205 take precedence over the more important elements of national interest. Hence, unless the gap in policy pronouncement and implementation is addressed, the development of the country’s international air transport industry is left with no clear direction to follow.

Privatization, 1992-1999 Although originally owned by private entrepreneurs since its establishment in 1941, PAL was under government control from 1977 to 1991. The move to privatize PAL first came in 1992 in line with the Aquino administration’s policy of privatizing state-owned companies. PR Holdings won the bidding for 67 percent share of the company in that year. By 1999, Lucio Tan held 90 percent ownership of PAL. Nonetheless, privatization, without regard for effective competition, will only lead to the privatization of monopoly rents.

WHAT REMAINS REGULATED? There is really not much liberalization going under EO 219. Several areas have remained restricted or regulated.

Capacity and frequency The country’s ASAs put limits to the capacity and frequency that the designated carriers of both contracting countries can use. The limits are specified in terms of the number of flights and seats that the designated carriers can operate each week. Since capacities and frequencies are predetermined, any change in market conditions that require changes in the needed capacities and frequencies would be subject to renegotiation. Under EO 219, the grant of frequencies or increase in existing frequencies is the sole prerogative of CAB, subject to the confirmation of the Office of the President.

Tariffs and fares CAB still regulates the fares, rates and other charges. The country’s ASAs adopt dual approval, i.e., fares are approved by the aviation authorities of the bilateral partners.

Freedom of rights granted Only the first four freedoms are granted, with limitations on capacity and frequency on the third and fourth freedoms. Fifth freedom is granted but this is also limited in terms of the third countries to which the freedom applies. The sixth and seventh freedoms are not allowed.

Ownership and effective control Designated carriers are required to be substantially owned and effectively controlled by the state or nationals of the contracting countries. The constitution requires 60 percent domestic equity. 206 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Cabotage Foreign airlines are not allowed to fly the country’s domestic routes.

City/point designation Since 1995, CAB has introduced open points in the route schedule, unless a separate route capacity to points outside Manila is specified in the ASA. For the latter, however, unused entitlements in a particular route cannot be used in another route even if the entitlements in the latter are not enough to meet the traffic demand.

In summary, the above regulations have remained, not because the government is restricted by the bilateral system, but because the government has not made any reform in its bilateral ASAs. The developments over the past 30 years in other countries point to the reduction of government control in each of the above areas (WTO 1998). For capacity determination, the move has been away from predetermination to free determination where bilateral partners agree not to impose unilateral restrictions on the volume of traffic, frequency of service or type of aircraft. For airfares, the move has been away from dual approval to dual disapproval where the airfares are enforced unless disapproved by the aviation authorities of the bilateral partners. The development of open skies agreements is a move toward suppression of capacity and tariff clauses in the ASAs. In place of regulations, these countries use competition policy instruments to counter predatory practices, abuse of dominant position and other unfair competitive behavior of airlines.

REGULATORY AND POLICY REGIMES: THEIR EFFECTS ON THE STATE OF COMPETITION AND MARKET STRUCTURE

DOMESTIC AIR SERVICES For 22 long years, PAL was flying solo in the country’s domestic airways. The monopoly created so much inefficiency that the quality of service was not tailored to the demand. In other words, the airline did not endeavor to maintain certain service standards to keep its customers (and attract even more) since it knows that the latter had no alternative. Hence, delays and troubles in PAL flights were more of the rule than the exception. This image created another meaning for the company’s acronym, “Plane Always Late”. Left with no choice, travelers had to contend themselves with whatever PAL can offer. Furthermore, PAL was beset with financial woes; and being a government-run corporation, the company continuously relied on government subsidies for its operations. The mismanagement of PAL and the inefficiency in the provision of air services were a clear waste of resources that could have been used productively elsewhere in the economy. The riding public and the industries that rely on air services for the transport of their products also suffered. AIR TRANSPORT INDUSTRY 207

Today’s domestic air transport industry is radically different from what it was prior to the deregulation in 1995. EO 219 made possible the entry of five new players in the industry (Table 1). Each company adopted specific marketing strategies that were geared toward making a difference in the market. For example, Cebu Pacific Air is known for its “low fare, great value” and GrandAir for its “hot meals and on time service”.

Table 1. Size of Fleet, Type of Aircraft and Destinations Served, by Airline, 1999-2000 Year Aircrafts in fleet Airline of Type Seat No. of Destinations served Entry Capacity Aircraft Philippine Airlines 1941 Boeing 747-400 439 4 Manila, Tuguegarao, Puerto Princesa, Boeing 747-200 372 2 Zamboanga, Kalibo, Dipolog, Ilo-ilo, Roxas, Airbus 340-300 264 2 Bacolod, Cebu, Naga, Legaspi, Tacloban, Airbus 330-300 278 8* Cagayan de Oro, General Santos, Butuan, Airbus 320-200 150 3* Cebu–Cotabato, Davao Boeing 737-300 114 9* Cebu Pacific Air 1996 DC 9 115 12 Manila, Cebu, Davao, Cagayan de Oro, Tacloban, Iloilo, Bacolod, Zamboanga, Roxas, Dumaguete, Kalibo Air Philippines 1996 MD 88 165 2 Manila–Bacolod, Cagayan de Oro, Cebu, Boeing 737-200 109 11 Cotabato, Davao, Dumaguete, General Santos City, Iloilo, Kalibo, Legaspi, Puerto Princesa, San Jose, Subic, Tacloban, Zamboanga Grand Airways** 1995 Boeing 737 114 Manila, Cebu, Davao, Cagayan de Oro Airbus 300 264 Asian Spirit 1996 De Havilland DHC-7 48 2 Manila–Baguio, Busuanga, Calbayog YS 11-A 60 7 (Samar), Catarman, Caticlan (Boracay), LET-410 19 1 Cauayan (Isabela), Marinduque, Masbate, Naga, San Jose (Or. Mindoro), Tablas (Romblon), Tagbilaran (Bohol), Virac (Catanduanes), Cebu- Cagayan de Oro, Pagadian, Tandag, Tacloban, Zamboanga- Jolo, Tawi- tawi Mindanao Express 1996 Beechcraft C1900 19 2 Cagayan de Oro, Cebu, Davao, Kalibo, Pagadian, Zamboanga, Cotabato, Tawi- tawi, Camiguin, Tandag, Dipolog, Gen. Santos, Tacloban, Butuan, Jolo, Surigao *3,2,4 aircrafts of type A330, A320, and B737 are for domestic operations, respectively. The rest of PAL’s fleet is for international operations. ** Information on number of aircraft not available. Grand Airways ceased operations in early 1999. Source: Airlines. 208 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The airlines are free to choose routes to service. Price setting was also left to the airlines to decide, along with the level of capacity they wanted to offer in the market. The entry of new airlines resulted in unprecedented competition in the industry. Pas- sengers now have several choices not only of airlines but of flight schedules as well. The latter is made possible by the increase in the frequency of flights in the different routes.

Market structure In general, PAL remains the dominant carrier in the domestic air transport industry, with an average market share of 63 percent of the total passenger traffic (Table 2)

Table 2. Domestic Passenger Traffic, by Airline, 1994-1999 Airline 1994 1995 1996 1997 1998 1999 1. Passenger traffic Philippine Airlines 4,495,444 4,735,674 4,448,740 4,602,558 2,968,950 2,980,169 Cebu Pacific Air 360,574 1,006,820 1,183,431 1,474,649 Air Philippines 256,569 677,967 892,625 1,307,002 Grand Airways 212,866 480,463 364,446 179,826 Asian Spirit 57,531 179,640 148,409 292,144 Mindanao Express 8,864 10,327 25,918 Total 4,495,444 4,948,540 5,603,877 6,840,295 5,383,568 6,079,882 2. Market Share (%) Philippine Airlines 100.0 95.7 79.4 67.3 55.1 49.0 Cebu Pacific Air 6.4 14.7 22.0 24.3 Air Philippines 4.6 9.9 16.6 21.5 Grand Airways 4.3 8.6 5.3 3.3 Asian Spirit 1.0 2.6 2.8 4.8 Mindanao Express 0.1 0.2 0.4 Total 100.0 100.0 100.0 100.0 100.0 100.0 3. Passenger Load Factor (%) Philippine Airlines 79.3 69.9 73.6 72.8 * 84.6 Cebu Pacific Air 64.2 74.7 80.9 64.0 Air Philippines 51.9 66.4 59.7 59.0 Grand Airways 47.1 58.0 55.4 57.8 Asian Spirit 51.1 63.0 66.8 65.3 Mindanao Express 39.8 36.1 51.6 Overall 79.3 68.5 69.7 70.8 71.2 *No data on seats available for PAL. Note: Passenger load factor per sector are found in Appendix Table 2. Sources: Civil Aeronautics Board and Airlines. AIR TRANSPORT INDUSTRY 209 for the period 1996-1999. Since PAL has the largest fleet and the bigger aircrafts, it offers the largest seat capacity in the industry (Table 3). Nonetheless, PAL suffered a significant decline in market share as the new airlines slowly inched their way in the industry and provided competition to PAL. The financial and labor problems of PAL in 1998 and the consequent downsizing of the airline’s fleet from 54 to 24 aircrafts contributed to the airline’s loss of market share. At the same time, the situation provided the new airlines the opportunity to enlarge their fleet and increase their seat capacity and hence, their share in the market. For example, in 1999, Cebu Pacific and Air Philippines had a combined share of 53 percent of the total seats (Table 3) and have captured almost 46 percent of the passenger traffic (Table 2).

Table 3. Seat Capacity per Airline, 1990, 1994-1999 AIRLINE 1990 1994 1995 1996 1997 1998 1999 Seat Capacity Philippine Airlines 5,543,213 5,670,362 6,773,007 6,044,489 6,323,605 - 3,523,047 Cebu Pacific Air - - - 561,240 1,348,527 1,462,137 2,303,751 Air Philippines - - - 494,764 1,021,565 1,494,297 2,217,060 Grand Airways - - 452,400 828,072 657,817 311,030 - Asian Spirit - - - 112,524 285,051 222,100 447,730 Mindanao Express - 22,273 28,588 50,187 Total 5,543,213 5,670,362 7,225,407 8,041,089 9,658,838 3,518,152 8,541,775 % Distribution Philippine Airlines 100.0 100.0 93.7 75.2 65.5 41.2 Cebu Pacific Air 7.0 14.0 41.6 27.0 Air Philippines 6.2 10.6 42.5 26.0 Grand Airways 6.3 10.3 6.8 8.8 Asian Spirit 1.4 3.0 6.3 5.2 Mindanao Express 0.2 0.8 0.6 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Notes: (1) There are no available data for PAL for 1998; 1999 data for PAL include up to 3rd quarter only. (2) Percentage distribution of seat capacity per airline, by major route are found in Appendix Table 3. Sources: Civil Aeronautics Board and Airlines. 210 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

While the number of players has remained the same since the industry was deregulated, the degree of competition has increasingly intensified. The inverse of the Herfindahl-Hirschman Index9 (HHI), which is used as a measure of effective competition, shows that the number of effective competitors has been increasing since 1996 (Table 4).

Table 4. Measure of the Degree of Effective Competition, Domestic Air Industry, 1996-1999 Year Herfindahl-Hirschman Index (HHI) 1/HHI 1995 0.9177 1.09 1996 0.6439 1.55 1997 0.4878 2.05 1998 0.3818 2.62 1999 0.3476 2.88 Note: Index is based on market share.

The deregulation of the industry resulted in the establishment of niche markets. The bigger players, as defined by the size of their fleet and aircrafts (Grand Interna- tional Airways, Cebu Pacific Air, and Air Philippines), are concentrating on the major trunklines where traffic demand is heavier while the smaller airlines (Asian Spirit and Mindanao Express) are flying the secondary and tertiary/rural routes where traffic demand is lighter (Table 1). PAL was flying all three types of routes until 1998 when it abandoned most of its secondary/tertiary routes because of the downsizing of its fleet and as will be discussed later, cross subsidization, which used to characterize PAL’s operation of the different types of routes, was no longer feasible under a deregulated environment. An examination of the Herfindahl-Hirschman Index of the different routes or sectors shows that only the major trunklines are being fiercely contested, i.e., the number of effective competitors is increasing (Table 5). Except for Grand Airways, the players in these markets have relatively the same frequency of flights per week (Table 6). This implies that no airline dominates the flight frequency and the airlines can fly the said routes as much as traffic demands, although of course, their seat capacity determines the amount of the traffic they can accommodate. ______

9 The index is measured as the sum of the squares of the market shares. It is compared with the ratio 1/n where n is the number of players in the industry. The higher the index relative to 1/n, the less competitive the industry is. The inverse of the index gives the number of equal sized competitors that would provide a degree of competition equivalent to that actually observed in the market share data. Hence, it is used as a measure of the number of effective competitors. AIR TRANSPORT INDUSTRY 211

Table 5. Measure of the Degree of Domestic Competition, per Route, 1995-1999 Sector 1995 1996 1997 1998 1999 HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI A. Major Trunkline Manila-Cebu-Manila 0.80 1.25 0.53 1.88 0.46 2.19 0.41 2.43 0.44 2.26 Manila-Davao-Manila 0.66 1.52 0.41 2.45 0.32 3.09 0.34 2.98 0.38 2.65 Manila-Zamboanga-Manila 1.00 1.00 0.72 1.39 0.57 1.74 0.50 2.00 0.35 2.83 Manila-Bacolod-Manila 1.00 1.00 0.97 1.04 0.55 1.82 0.40 2.52 0.37 2.70 Manila-Iloilo-Manila 1.00 1.00 0.47 2.12 0.41 2.44 0.35 2.84 0.34 2.98 Manila-Legaspi-Manila 1.00 1.00 0.86 1.16 0.71 1.40 0.64 1.56 0.58 1.72 Manila-Tacloban-Manila 1.00 1.00 0.74 1.35 0.43 2.30 0.46 2.17 0.42 2.40 Manila-Puerto Prinsesa-Manila 1.00 1.00 0.69 1.44 0.55 1.83 0.54 1.84 0.50 2.00 Manila-Cagayan de Oro-Manila 1.00 1.00 0.65 1.54 0.45 2.21 0.42 2.40 0.36 2.75 Manila- Cotabato-Manila 1.00 1.00 0.67 1.50 0.50 1.99 0.58 1.73 0.54 1.84 Manila-Dumaguete-Manila 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.92 1.09 Manila-San Jose-Manila 1.00 1.00 0.75 1.33 0.54 1.86 0.39 2.54 0.51 1.98 Manila-Roxas-Manila 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.55 1.83 B. Secondary/Rural Route Manila-Baguio-Manila 1.00 1.00 0.98 1.02 0.79 1.27 1.00 1.00 0.55 1.83 Manila-Kalibo-Manila 1.00 1.00 0.81 1.23 0.57 1.76 0.52 1.91 0.40 2.52 Manila-Calbayog-Manila 1.00 1.00 1.00 1.00 1.00 1.00 0.67 1.50 1.00 1.00 Manila-Catarman-Manila 1.00 1.00 0.96 1.05 0.52 1.91 0.75 1.34 1.00 1.00 Manila-Daet-Manila 1.00 1.00 0.86 1.16 0.83 1.21 1.00 1.00 Manila-General Santos- Manila 1.00 1.00 1.00 1.00 0.52 1.91 0.56 1.78 Manila-Laoag-Manila 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Manila-Marinduque-Manila 1.00 1.00 1.00 1.00 1.00 1.00 0.82 1.21 1.00 1.00 Manila-Masbate-Manila 1.00 1.00 0.60 1.66 0.55 1.82 0.64 1.55 1.00 1.00 Manila-Naga-Manila 1.00 1.00 0.61 1.65 0.51 1.95 0.51 1.94 0.39 2.57 Manila-Tablas-Manila 1.00 1.00 0.61 1.63 1.00 1.00 1.00 1.00 1.00 1.00 Manila-Tagbilaran-Manila 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.61 1.64 Manila-Virac-Manila 1.00 1.00 0.67 1.50 0.58 1.74 0.50 1.99 0.57 1.76 Cagayan-Davao-Cagayan 1.00 1.00 1.00 1.00 0.90 1.11 0.59 1.70 0.76 1.32 Cagayan-Zamboanga-Cagayan 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-Bacolod-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 0.93 1.07 0.51 1.98 Cebu-Butuan-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-Cagayan-Cebu 1.00 1.00 1.00 1.00 0.94 1.06 0.81 1.24 0.56 1.77 212 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 5 (continued) Sector 1995 1996 1997 1998 1999 HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI Cebu-Cotabato-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-Davao-Cebu 1.00 1.00 1.00 1.00 0.62 1.63 0.50 2.02 0.51 1.98 Cebu-Dipolog-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-General Santos- Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-Iloilo-Cebu 1.00 1.00 1.00 1.00 0.82 1.22 0.58 1.74 0.55 1.82 Cebu-Kalibo-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.63 1.60 Cebu-Pagadian-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.61 1.63 Cebu-Puerto Princesa-Cebu 1.00 1.00 1.00 1.00 Cebu-Surigao-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 0.97 1.03 1.00 1.00 Cebu-Tagbilaran-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Cebu-Tandag-Cebu 1.00 1.00 1.00 1.00 0.94 1.07 0.84 1.20 0.59 1.69 Cebu-Zamboanga-Cebu 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.93 1.08 Cotabato-Zamboanga-Cotabato 1.00 1.00 1.00 1.00 0.89 1.12 1.00 1.00 Davao-Zamboanga-Davao 1.00 1.00 1.00 1.00 1.00 1.00 0.95 1.05 0.88 1.13 Dipolog-Zamboanga-Dipolog 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Iloilo-Puerto-Princesa-Iloilo 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Pagadian-Zamboanga-Pagadian 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Tacloban-Cebu-Tacloban 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Tawi-Tawi-Zamboanga-Tawi-tawi 1.00 1.00 1.00 1.00 0.96 1.05 0.87 1.15 1.00 1.00 Note: Herfindahl-Hirschman index is based on market share.

Air Philippines and Cebu Pacific Air are providing PAL stiff competition in the major trunklines as shown by the annual increases in their market shares since joining the industry in 1996 (Table 2 and Table 7). Passenger traffic for these two airlines grew by 72 percent and 60 percent, respectively, for the past four years (Table 8). Cebu Pacific has succeeded in increasing its share in 1998 despite the crash of one of its aircrafts during the year, which was dubbed as the country’s biggest air disaster in the 1990s. Grand Airways, on the other hand, failed to improve its share of the market since joining the industry until it ceased operation in early 1999. In contrast, except for a number of sectors, much of the secondary and tertiary routes were still monopolized by PAL until 1998 (Table 7). Due to PAL’s downsizing, the airline gave up some of these routes in 1999. While Asian Spirit and Mindanao Express got the markets abandoned by PAL, the two airlines have their own niche markets (as shown by their 100 percent shares), with Mindanao Express concentrating its service in the Mindanao area, particularly Davao, Cagayan de Oro, and Zamboanga. Likewise, while Cebu Pacific and Air Philippines are concentrating their operations in the major trunklines, they also have their own niches in some of the secondary/tertiary routes. AIR TRANSPORT INDUSTRY 213

Table 6. Number of Domestic Flights, per Route, per Week, per Airline, 1999-2000 Sector Philippine Cebu Air Grand Asian Mindanao Total Airlines Pacific Air Phils. Airways Spirit Express A. Major Trunkline Manila- Cebu 47 49 35 18 149 Manila- Davao 20 28 14 11 73 Manila- Zamboanga 12 11 7 30 Manila- Bacolod 21 21 14 56 Manila- Iloilo 28 21 28 77 Manila- Legaspi 10 7 17 Manila- Tacloban 14 21 14 49 Manila-Puerto Prinsesa 7 7 14 Manila-Cagayan de Oro 21 21 14 10 66 Manila- Cotabato 7 7 14 Manila-Dumaguete 7 14 21 Manila-San Jose 3 3 Manila-Roxas 7 7 14 B. Secondary/Rural Route Manila- Baguio 4 4 Manila- Kalibo 14 14 14 42 Manila-Calbayog 3 3 Manila-Catarman 4 4 Manila-Daet 0 Manila-General Santos 7 7 14 Manila-Laoag 0 Manila-Marinduque 4 4 Manila-Masbate 7 7 Manila-Naga 10 7 17 Manila-Tablas 0 Manila-Tagbilaran 4 4 Manila-Virac 7 7 Cagayan-Davao 3 5 8 Cebu-Bacolod 4 4 8 Cebu-Davao 10 11 4 5 30 Cebu-General Santos 7 1 8 Cebu-Iloilo 5 7 12 Cebu-Kalibo 3 2 5 Cebu-Tagbilaran 4 4 Cebu-Zamboanga 4 4 8 Davao-Zamboanga 3 1 4

Notes: (1) Number of flights per airline is equal to the sum of flights/aircraft/day x frequency/ week; (2) Flights are one way only. Source: Airlines, as of March 2000. 214 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 7. Market Share per Sector, per Airline, 1995-1999 (%)

Sector Philippine Airlines Cebu Pacific Air 1995 1996 1997 1998 1999* 1996 1997 1998 1999 A. Major Trunkline Manila- Cebu- Manila 88.6 69.3 63.7 58.3 59.9 10.9 17.4 23.1 24.6 Manila- Davao- Manila 78.1 54.2 47.5 47.4 50.0 13.3 23.4 24.9 28.4 Manila- Zamboanga- Manila 100.0 83.1 69.2 57.3 40.0 1.2 21.8 Manila- Bacolod- Manila 100.0 98.2 69.9 52.0 39.8 1.8 23.9 31.2 42.5 Manila- Iloilo- Manila 100.0 63.7 56.0 44.6 35.5 16.6 22.0 26.7 29.9 Manila- Legaspi- Manila 100.0 92.3 82.7 76.7 70.0 Manila- Tacloban- Manila 100.0 85.6 53.9 38.5 26.0 7.1 36.7 55.6 56.5 Manila-Puerto Prinsesa- Manila 100.0 81.5 66.4 64.9 48.1 Manila-Cagayan de Oro-Manila 100.0 79.0 58.3 52.1 43.6 15.0 32.2 37.1 36.6 Manila- Cotabato-Manila 100.0 78.9 53.3 30.2 35.1 Manila-Dumaguete-Manila 100.0 100.0 100.0 100.0 4.3 Manila-San Jose-Manila 100.0 85.6 63.9 53.4 Manila-Roxas-Manila 100.0 100.0 100.0 100.0 65.1 34.9 B. Secondary/Rural Route Manila- Baguio- Manila 100.0 98.8 87.9 100.0 Manila- Kalibo- Manila 100.0 89.4 72.9 68.6 53.6 12.8 11.7 20.2 Manila-Calbayog-Manila 100.0 100.0 78.8 Manila-Catarman-Manila 100.0 97.8 60.7 85.1 Manila-Daet-Manila 100.0 92.5 90.4 100.0 Manila-General Santos- Manila 100.0 100.0 61.1 67.5 Manila-Laoag-Manila 100.0 100.0 100.0 100.0 Manila-Marinduque-Manila 100.0 100.0 100.0 90.3 Manila-Masbate-Manila 100.0 72.6 34.1 23.2 Manila-Naga-Manila 100.0 73.1 65.8 62.3 44.7 Manila-Tablas-Manila 100.0 73.6 Manila-Tagbilaran-Manila 100.0 100.0 100.0 100.0 26.7 Manila-Virac-Manila 100.0 78.9 69.4 59.6 Cagayan-Davao-Cagayan 100.0 100.0 95.0 76.7 Cagayan-Zamboanga-Cagayan 100.0 100.0 Cebu-Bacolod-Cebu 100.0 100.0 100.0 96.5 44.3 3.5 55.7 Cebu-Butuan-Cebu 100.0 100.0 100.0 100.0 Cebu-Cagayan-Cebu 100.0 100.0 97.1 89.8 Cebu-Cotabato-Cebu 100.0 100.0 100.0 100.0 Cebu-Davao-Cebu 100.0 100.0 74.0 44.1 44.4 26.0 54.9 55.6 Cebu-Dipolog-Cebu 100.0 100.0 100.0 100.0 Cebu-General Santos- Cebu 100.0 100.0 100.0 100.0 Cebu-Iloilo-Cebu 100.0 100.0 90.0 69.4 34.5 30.6 65.5 Cebu-Kalibo-Cebu 100.0 100.0 100.0 100.0 75.2 Cebu-Pagadian-Cebu 100.0 100.0 100.0 100.0 Cebu-Puerto Princesa-Cebu 100.0 Cebu-Surigao-Cebu 100.0 100.0 100.0 98.6 Cebu-Tagbilaran-Cebu 100.0 100.0 100.0 100.0 Cebu-Tandag-Cebu 100.0 100.0 96.8 91.4 Cebu-Zamboanga-Cebu 100.0 100.0 100.0 100.0 3.6 Cotabato-Zamboanga-Cotabato 100.0 100.0 94.5 Davao-Zamboanga-Davao 100.0 100.0 100.0 97.5 Dipolog-Zamboanga-Dipolog 100.0 100.0 100.0 100.0 Iloilo-Puerto-Princesa-Iloilo 100.0 100.0 100.0 100.0 Pagadian-Zamboanga-Pagadian 100.0 100.0 100.0 100.0 Tacloban-Cebu-Tacloban 100.0 100.0 100.0 100.0 Tawi-Tawi-Zamboanga-Tawi-tawi 100.0 100.0 97.8 93.3 Note: PAL data for 1999 includes first to third quarters only. Sources: Civil Aeronautics Board and Airlines. AIR TRANSPORT INDUSTRY 215

Table 7 (continued)

Sector Air Philippines Grand Airways 1996 1997 1998 1999 1995 1996 1997 1998 A. Major Trunkline Manila- Cebu- Manila 5.5 11.9 15.5 11.4 19.8 13.4 6.7 Manila- Davao- Manila 1.5 17.0 21.2 21.6 21.9 31.0 12.1 6.6 Manila- Zamboanga- Manila 16.9 30.8 41.6 38.2 Manila- Bacolod- Manila 6.3 16.7 17.7 Manila- Iloilo- Manila 19.4 21.7 28.7 34.6 0.3 0.3 Manila- Legaspi- Manila 7.7 17.3 23.3 30.0 Manila- Tacloban- Manila 0.5 17.5 7.3 9.4 5.5 Manila-Puerto Prinsesa- Manila 17.7 32.7 35.1 51.9 0.9 0.9 Manila-Cagayan de Oro-Manila 2.3 19.8 6.0 9.5 8.4 Manila- Cotabato-Manila 21.1 46.7 69.8 64.9 Manila-Dumaguete-Manila 95.7 Manila-San Jose-Manila 25.1 55.6 Manila-Roxas-Manila B. Secondary/Rural Route Manila- Baguio- Manila 0.0 34.8 Manila- Kalibo- Manila 10.6 14.4 19.8 26.2 Manila-Calbayog-Manila Manila-Catarman-Manila Manila-Daet-Manila Manila-General Santos- Manila 38.9 32.5 Manila-Laoag-Manila 100.0 Manila-Marinduque-Manila Manila-Masbate-Manila Manila-Naga-Manila 26.9 27.4 2.2 14.2 Manila-Tablas-Manila Manila-Tagbilaran-Manila Manila-Virac-Manila 2.2 31.4 Cagayan-Davao-Cagayan 14.3 Cagayan-Zamboanga-Cagayan Cebu-Bacolod-Cebu Cebu-Butuan-Cebu Cebu-Cagayan-Cebu Cebu-Cotabato-Cebu Cebu-Davao-Cebu 1.0 Cebu-Dipolog-Cebu Cebu-General Santos- Cebu 100.0 Cebu-Iloilo-Cebu 10.0 Cebu-Kalibo-Cebu Cebu-Pagadian-Cebu Cebu-Puerto Princesa-Cebu Cebu-Surigao-Cebu Cebu-Tagbilaran-Cebu Cebu-Tandag-Cebu Cebu-Zamboanga-Cebu 96.4 Cotabato-Zamboanga-Cotabato Davao-Zamboanga-Davao 93.8 Dipolog-Zamboanga-Dipolog Iloilo-Puerto-Princesa-Iloilo Pagadian-Zamboanga-Pagadian Tacloban-Cebu-Tacloban Tawi-Tawi-Zamboanga-Tawi-tawi Note: PAL data for 1999 includes first to third quarters only. Sources: Civil Aeronautics Board and Airlines. 216 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 7 (continued) Sector Asian Spirit Mindanao Express 1996 1997 1998 1999 1996 1997 1998 1999 A. Major Trunkline Manila- Cebu- Manila Manila- Davao- Manila Manila- Zamboanga- Manila Manila- Bacolod- Manila Manila- Iloilo- Manila Manila- Legaspi- Manila Manila- Tacloban- Manila Manila-Puerto Prinsesa- Manila Manila-Cagayan de Oro-Manila Manila- Cotabato-Manila Manila-Dumaguete-Manila Manila-San Jose-Manila 14.4 36.1 21.5 44.4 Manila-Roxas-Manila B. Secondary/Rural Route Manila- Baguio- Manila 1.2 12.1 65.2 Manila- Kalibo- Manila Manila-Calbayog-Manila 100.0 21.2 100.0 Manila-Catarman-Manila 2.2 39.3 14.9 100.0 Manila-Daet-Manila 7.5 9.6 Manila-General Santos- Manila Manila-Laoag-Manila Manila-Marinduque-Manila 9.7 100.0 Manila-Masbate-Manila 27.4 65.9 76.8 100.0 Manila-Naga-Manila 6.9 35.6 41.0 Manila-Tablas-Manila 26.4 100.0 100.0 100.0 Manila-Tagbilaran-Manila 73.3 Manila-Virac-Manila 21.1 30.6 38.1 68.6 Cagayan-Davao-Cagayan 85.7 Cagayan-Zamboanga-Cagayan 5.0 23.3 100.0 Cebu-Bacolod-Cebu 0.1 Cebu-Butuan-Cebu 100.0 Cebu-Cagayan-Cebu 68.0 32.0 Cebu-Cotabato-Cebu 2.9 10.2 100.0 Cebu-Davao-Cebu Cebu-Dipolog-Cebu 100.0 Cebu-General Santos- Cebu Cebu-Iloilo-Cebu Cebu-Kalibo-Cebu 24.8 Cebu-Pagadian-Cebu 74.0 26.0 Cebu-Puerto Princesa-Cebu 100.0 Cebu-Surigao-Cebu 100.0 Cebu-Tagbilaran-Cebu 100.0 1.4 Cebu-Tandag-Cebu 71.5 28.5 Cebu-Zamboanga-Cebu 3.2 8.6 Cotabato-Zamboanga-Cotabato 100.0 Davao-Zamboanga-Davao 5.5 100.0 6.2 Dipolog-Zamboanga-Dipolog 100.0 100.0 100.0 Iloilo-Puerto-Princesa-Iloilo 2.5 100.0 Pagadian-Zamboanga-Pagadian 100.0 Tacloban-Cebu-Tacloban 100.0 Tawi-Tawi-Zamboanga-Tawi-tawi 100.0 Note: PAL data for 1999 includes first to third quarters only. Sources: Civil Aeronautics Board and Airlines. AIR TRANSPORT INDUSTRY 217

Table 8. Growth Rate of Domestic Passenger Traffic per Airline, 1994-1999(%)

Airline 1995 1996 1997 1998 1999 1996-1999 Philippine Airlines 5.3 -6.1 3.5 -35.5 0.4 -12.5 Cebu Pacific Air 179.2 17.5 24.6 59.9 Air Philippines 164.2 31.7 46.4 72.1 Grand Airways 125.7 -24.1 -50.7 Asian Spirit 212.2 -17.4 96.9 71.9 Mindanao Express 16.5 151.0 43.0 Overall 10.1 13.2 22.1 -21.3 12.9 02.8 Note: Growth rate per sector are found in Appendix Table 4. Sources: Civil Aeronautics Board and Airlines.

An examination of the inverse of the Herfindahl-Hirschman Index for the secondary and tertiary routes shows that the deregulation has yet to create an impact on competition in these routes (Table 5). As will be discussed below, the smaller airlines are able to charge higher fares, sometimes equivalent to business class fare in bigger airlines, because of the absence of competition. Nonetheless, what is important is that these routes are contestable, i.e., airlines are free to provide service to any of the routes once they recognized some profits. The emerging picture in the industry shows that the presence of big carriers in the secondary and tertiary routes could kill the small carriers flying the said routes. The experience of the smaller airlines would attest to this as they experienced losing out their markets to the bigger airlines once the latter discover the profitability of the routes. Competition comes in terms of the comfort that a passenger gets by flying a bigger airline and in terms of lower fare. Because their cost spread is higher, the bigger airlines could charge lower airfare than smaller airlines. An example would be the case of the Cebu-Bacolod route of Mindanao Express. The airline developed the route and for sometime, was flying the route alone. Cebu Pacific Air later joined the route when the airline saw its profitability. Due to the small size of the market and its bigger planes, Cebu Pacific Air eventually ate up the market of Mindanao Express.

Intermodal competition The source of competition in the secondary and tertiary routes comes not only from the industry itself but also from the alternative modes of travel, that is, water and land. This is particularly true for those traveling between the country’s islands in the south. The introduction of comfortable high-speed ferries, which resulted from the deregulation of the interisland shipping industry, opened up an alternative mode of travel to a market that would previously only consider travel by air. At the same time, however, the lower airfare offered by the new entrants in the industry enabled passengers who used to take the boats to travel by plane. 218 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Likewise, the improvement of roads in Mindanao has significantly reduced travel time by land. Since land travel is a lot cheaper than air travel, this development has become a source of competition for the air transport industry. An example of this is the Davao-General Santos route of Mindanao Express, whose load factor was significantly reduced from 90 percent to 20-30 percent when travel time by land in this route was reduced from 6 hours to 2 hours as a result of the road improvement in the area. This intermodal competition will likely intensify with the continued improvement in the interisland shipping industry and road transport and hence, will have some bearing on the future structure of the air transport industry, at least in the secondary/tertiary routes.

Tariffs or airfares It is common knowledge that air travel remains a luxury few Filipinos can afford. In fact, this is the biggest hindrance to the promotion of domestic tourism among the local populace. The increased competition in the domestic air industry, however, provided travelers with lower airfares, and from the traveler’s perspective, the lower fares are the most important result of the deregulation. The airlines are free to set their airfares based on traffic demand and cost. Before the deregulation, PAL cross-subsidized the otherwise unprofitable missionary (tertiary) routes that the government required the airline to fly by charging higher airfare than what the market dictates in the major trunklines. Cross subsidization therefore enabled PAL to maintain its flights in the tertiary routes. With the new environment, however, cross subsidization is no longer feasible. PAL had to lower its airfare in the major routes to remain competitive, and consequently, had to abandon most of its tertiary routes. After the deregulation10, PAL still charged the highest fare (Figure 1), even after withdrawing from the missionary routes. Its cost base and leverage is very high relative to the other airlines because of its financial obligations arising from the loans that financed its fleet modernization program. Likewise, PAL’s crew training is more stringent, given the state-of-the-art of equipment that it operates and hence, the cost of training is higher than other airlines. But the airline is able to compete and capture a large size of the market because its bigger and newer aircrafts connote better safety to the travelers’ psyche. Admittedly, the airline’s greatest marketing advantage over the others is its good safety record. On the other hand, the fleet of the new airlines is composed mostly of aircrafts (some of which are already old) leased from other companies. This makes their operational cost lower than PAL and hence, they are able to charge lower airfares. In 1997, PAL’s fares in the major routes are 11 percent to 34 percent higher than Cebu Pacific and 30 percent to as high as 184 percent than Air Philippines (Table 9).

10 For sometime, after the deregulation, the government still required PAL to fly the missionary routes until it subsequently abandoned these routes. AIR TRANSPORT INDUSTRY 219

Caution should be exercised in interpreting these numbers, however. It could be that the new airlines were pricing below cost during the initial years of their operations and accounting for initial losses as investment costs used in building up goodwill. As Figure 1 shows, the price difference narrowed down in 1999. Furthermore, PAL charged the lowest fare increase, in real terms, during the period 1997-1999 in most of the major routes (Table 10).

Figure 1. Average Fare by Airline per Sector, 1997-1999 ( P )

Source: Airlines. 220 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 9. Percentage Difference of Fares in Domestic Flights, 1997-1999 (%) Sector 1997 1998 1999 Phil. Phil. Cebu Phil. Phil. Cebu Phil. Phil. Cebu Airlines- Airlines- Pacific- Airlines- Airlines- Pacific- Airlines- Airlines- Pacific- Cebu Air Air Cebu Air Air Cebu Air Air Pacific Phils. Phils. Pacific Phils. Phils. Pacific Phils. Phils. Manila- Cebu 33.7 77.2 32.5 30.5 12.5 -13.8 14.1 14.1 0.0 Manila- Davao 19.8 184.0 137.0 26.8 14.8 -9.4 15.0 14.9 0.0 Manila-Iloilo 16.7 30.0 11.4 27.1 5.4 -17.1 14.7 15.0 0.3 Manila- Cagayan 11.0 0.0 -9.9 50.3 20.8 -19.6 21.2 24.5 2.7 Manila- Tacloban 21.9 54.3 19.6 -22.5 28.1 27.9 -0.1 Manila-Bacolod 14.9 31.8 14.7 41.0 13.5 -19.6 15.8 15.6 -0.1 Manila- Kalibo 27.5 51.0 18.4 17.3 2.0 -13.0 27.0 15.2 -9.3 Manila-Zamboanga 37.4 13.0 4.6 -7.4 25.2 17.6 -6.1 Source: Airlines.

Table 10. Real Growth Rate of Fares per Airline, by Major Sector, 1997-1999 (1990 Prices) (%) Sector Philippine Airlines Cebu Pacific Air Air Philippines Manila- Cebu 3.7 12.2 29.2 Manila- Davao 5.5 7.8 65.9 Manila-Iloilo 13.6 14.6 20.8 Manila- Cagayan 15.8 10.9 3.8 Manila- Tacloban 15.1 12.3 Manila-Bacolod 14.0 13.6 21.7 Manila- Kalibo 11.6 11.8 27.8 Manila-Zamboanga 17.5 27.0 Average for all major sectors 12.1 11.9 28.0 Source: Airlines.

There is some sort of a convergence in the fares being charged by Cebu Pacific and Air Philippines (Figure 1). In 1997, Cebu Pacific fares were higher than Air Philippines but the picture was reversed in 1998. By 1999, the difference between the two is very minimal. Nonetheless, this does not indicate any price collusion between the two airlines. While the two airlines compete with PAL, they cannot collude as Air Philippines and PAL, although they are different companies, are substantially owned by the same person. The situation in the secondary and tertiary routes is different, however. Airlines flying these routes are able to charge a higher fare than what the market demands because of the absence of competition as pointed out earlier. For example, Mindanao Express fare is equivalent to the business class fare charged by PAL for the same route AIR TRANSPORT INDUSTRY 221 before the latter abandoned these routes11. Paying a higher price for a lower class of service left the travelers worse off. It would be unprofitable for smaller airlines to charge a lower fare because their cost spread is small, i.e., small aircraft would only have a small number of passengers to share the flight cost. Hence, as long as the airlines in the secondary and tertiary routes do not see a threat of competition or the entry of a new airline in the routes, they will set their fares at a higher level than they would in a more competitive environment.

Revenues Since PAL dominates the passenger traffic, it would naturally capture the bulk of the industry’s total revenue (Figure 2). Nonetheless, PAL has been registering a net loss that is becoming bigger every year (Table 11) despite its bigger passenger load as compared to the other airlines (Table 2 and Appendix Table 2). The losses are a manifestation of PAL’s inefficiency brought about by years of government interference and by its monopoly status. PAL could have easily reduced its operating costs when it had financial and labor problems but the government did not allow its restructuring and reengineering. Hence, compared to other foreign and local airlines, PAL has more employees per aircraft, a sure sign of inefficiency, low productivity and higher labor cost. Furthermore, the debt burden of the airline, which was magni- fied by the depreciation of the peso during the financial crisis in 1997, is also contributing to its losses.

Figure 2. Market Share in Total Revenues of Airlines, 1995-1998 (%)

Sources: Civil Aeronautics Board and Airlines. ______

11 This information is based on an interview with one of the senior staff of Mindanao Express. 222 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 11. Revenue and Income, by Airline, 1995-1998 (P million) 1995 1996 1997 1998 1999 Scheduled Net Net Net Net Net Operators Revenues Income Revenues Income Revenues Income Revenues Income Revenues Income (Net Loss) (Net Loss) (Net loss) (Net Loss) (Net Loss) Philippine Airlines 5,282 (227) 27,639 (2,182) 31,031 (2,502) 7,992 (1,639) 4,748 (2,854) Cebu Pacific Air 440 (15) 1,297 6 1,705 66 Air Philippines 286 (250) 853 8 1,467 3 Grand Airways 402 (92) 970 (91) 917 (150) Asian Spirit 202 (22) 168 (13) Mindanao Express 6 (1) 39 (2) 81 (12) 131 (11) Total 5,690 (320) 29,374 (2,541) 34,381 (2,671) 11,464 (1,594) 4,748 (2,854)

Notes: (1) Data exclude revenue from cargo; (2) 1996-1997 data for PAL include both international and domestic revenue. Sources: Civil Aeronautics Board and Airlines.

In contrast, PAL’s major competitors (Air Philippines and Cebu Pacific) suffered losses during the initial year of operation but were able to recover and have registered favorable financial performance thereafter. The emerging picture here shows that competition in the industry enables the more efficient, low-cost airlines to operate at fares lower than precompetition days and still remain profitable. Asian Spirit and Mindanao Express are also incurring losses. Such financial standing of the different airlines could affect the future structure of the industry. The financial problem besetting the industry is an indication that only a few large efficient airlines may, in the long run, survive. The continued losses of the unprofitable airlines could drive them to withdraw or exit from the industry or merge with the profitable ones.

Growth in Domestic Air Travel With greater competition on the major routes, lower airfares, and more available flights, domestic travel has grown rapidly after the deregulation (Figure 3). Competi- tion arising from promotional and discount fares continues to open the air industry to travelers who previously could not afford to travel by air. The growth of passenger traffic was highest at almost 22 percent during the period 1996-1997. The downsizing of PAL’s operation in 1998, coupled with the Asian financial crisis that affected the inflow of foreign tourists to the country, however, resulted to a decline in passenger traffic of almost equal magnitude as the increase in 1997 (Figure 3). This shows that potential demand for domestic air travel is high, a demand that could only be met if the airlines have enough capacity to provide the required air services. AIR TRANSPORT INDUSTRY 223

INTERNATIONAL AIR SERVICES Five years after the liberalization of the country’s international air services, PAL remained uncontested as the country’s flag carrier flying the international routes. International air services to and from the country are provided by PAL and 39 other foreign airlines. Because these foreign airlines are operating by virtue of their countries’ air services agreements with the Philippines, competition in a particular route is limited between PAL and the designated carrier/s of the country’s bilateral partner in that route, except for the routes where fifth freedom is allowed and in which case, a third-country carrier provides competition to those routes. As will be shown later, however, there are not many of this kind of route.

Designation of carriers While CAB has designated other airlines (apart from the incumbent PAL) to fly some of the international routes, these Philippine-based carriers have yet to provide PAL the much-needed competition. Mindanao Express has been designated second carrier for the BIMP-EAGA in 1998 but the airline has never operated its international routes until it ceased operation toward the end of 2000. Grand Air was designated second flag carrier to Hong Kong and Taipei in 1996 and the airline was servicing these routes until its closure in early 1999. But during its operation, Grand Air’s negligible market share did not create an impact on competition, as will be shown later. In 1999, Cebu Pacific Air was issued a temporary operating permit (TOP) to fly Indonesia, Singapore, Bangkok, Guam, and Kuala Lumpur, but the airline has yet to be designated as second flag carrier to these countries. The new airlines already foresee a structural barrier to their entry in the international routes, that is, the difficulty of securing airport slots. The available slots have already been allocated to PAL. Request for additional slots is a long process and this

Figure 3. Domestic Passenger Traffic and Its Annual Growth Rate, 1990-1999 (%)

Source: National Statistics Office and Civil Aeronautics Board 224 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES could curtail the plans of other airlines to fly international. Being designated a carrier, therefore, does not guarantee market access. Lack of airport slots can render the right to access meaningless in practice. In other countries, some airlines resort to buying the slots of other airlines just to get over this barrier, but the cost is very high.

Absence of measures to counteract PAL’s downsizing The immediate effect of PAL’s downsizing is shortage of seat capacity, which in turn, limits the airline’s ability to serve the country’s international seat entitlements. Considering that there are no other designated carriers, CAB should have played a proactive role by installing measures to offset the effects that PAL’s downsizing have on the industry. As Section 1.3 of EO 219 provides, to wit: “All grants of frequencies or capacity to, any increase of existing frequencies or capacities of and/or grant of new routes or traffic points to any foreign carrier (even if on a provisional basis) shall be the sole prerogative of CAB subject to the confirmation of the Office of the President.” Given this, the least that CAB could do is to renegotiate the ASAs and grant additional frequency or seat capacity to foreign airlines, even on a selective basis, covering only those with heavy traffic, in order to meet the demand. On the contrary, CAB renegotiated for a lower seat capacity to the level of PAL, as in the case of the RP-Taiwan air disputes. Clearly, this move does not serve well the nation’s interests. If the country would like to attract foreign investment, trade, and tourism, convenient air services that have a wide range of flight and schedule options are critical. As discussed earlier, business travelers give greater value to flexibility in flights and frequency. Companies also prefer to locate in areas that are easily connected to destinations around the world. Likewise, tourists prefer to travel to destinations that are easy to reach. Because PAL’s rehabilitation plan prohibits the airline from acquiring new aircrafts during its rehabilitation period (1999-2003), the situation will likely worsen unless CAB takes the appropriate action.

Use of the country’s seat entitlements The absence of competition has resulted in poor performance and growth. PAL is unable to use all the entitlements in the country’s ASAs. In 1996, foreign airlines performed better in using their country’s entitlements than PAL, i.e., PAL used only 61 percent of the country’s traffic rights per week compared to 81 percent for the foreign airlines. PAL was able to use all its entitlements only in five countries (Aus- tralia, China, Japan, London, and Hong Kong) while 12 countries were able to use all their entitlements (Figure 4). Worse yet, PAL was not able to use any of the country’s entitlements in nine countries. The performance for 1999 and 2000 could be worse considering that there were no new designated airlines when PAL abandoned some of its international flights. Figure 4. Used Entitlements as a Percentage of Negotiated Entitlements, Philippines and Foreign Countries, 1996 (%) Philippine Airlines Foreign Airlines Australia Brunei China Egypt France Germany Gulf States Italy Indonesia route 1 route 2 Japan South Korea Kuwait Malaysia route 1 route 2 Netherlands Pakistan Saudi Arabia Singapore route 1 route 2 Switzerland Thailand UK London Hong Kong USA Vietnam

100 80 60 40 20 0 0 20 40 60 80 100 Percentage Percentage

Source: DOTC (1997, Table 8.2). 226 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The nonutilization of the country’s entitlements could be due to the following factors.12 One, PAL may not be competitive in some routes given its higher operating costs and poor image. Passengers want a dependable carrier and not one that may close operations at any moment and strand them in a foreign land. Two, PAL may actually be operating in a “revenue-sharing pool” with the other designated carrier. It may or may not fly a certain route but would share in the revenues that the two designated carriers may generate in such a route. Or, the two carriers may opt to have only one operate on the route with revenues put in the “pool”. This is difficult to prove but has been recognized to occur. The result of such practice is the generation of monopoly profits in the route. Nonetheless, the unused entitlements is an indication that under the existing ASAs there are opportunities for PAL and other Philippine-based carriers to operate additional international services without the government requesting for greater capacity.

Market structure The effects on competition of the restrictive aviation policies of the country is shown by the high degree of concentration in the country’s international aviation industry in the 1990s (Table 12). Only the markets for Japan, South Korea, Taiwan, Hong Kong, and the U.S. show a relatively lower concentration and this is due to competition from fifth freedom. Incidentally, Tokyo (Japan), Taiwan, Hong Kong, and Seoul (Korea) are the Asian hubs of airlines flying to and from North America and Europe. A comparison of the country’s market concentration with other countries, like Australia for which data are available, clearly shows that the country’s air policies are not as liberal as that of Australia to promote competition (Table 13). Australia is one of the countries known for its efficient airline industry. The degree of concentration worsened in the latter half of the 1990s, an evidence that the liberalization policies of 1995 did not have any impact. Between 1990 and 1995, 25 percent of the country’s markets registered an increase in concentration; this rose to 48 percent between 1995 and 1999 (Table 12). In almost all the country-pairs, it is the airline of the country’s bilateral partners that dominates, especially in 1999 when PAL abandoned most of its international routes (Table 14). In general, foreign airlines together accounted for the bulk of the traffic, which was almost twice the share of PAL during the period 1990-1999 (Figure 5). PAL has an average annual market share of 37.4 percent, with Hong Kong, Tokyo, Los Ange- les, Singapore, and San Francisco as its top destination points (Appendix Table 6). Although Grand Air was able to fly the Manila-Hong Kong route in 1996 until 1998, its market share was negligible (Table 15). Among the foreign airlines, the top per- ______

12 This paragraph was taken from the written comments of Mr. Joselito P. Supangco on an earlier draft of the paper. AIR TRANSPORT INDUSTRY 227

Table 12. Measure of Degree of Competition, by Country, 1990-1999 Herfindahl-Hirschman Country Points Index (HHI) 1/HHI 1990 1995 1999 1990 1995 1999 Australia Brisbane, Melbourne, Sydney 0.63 0.56 1.00 1.58 1.78 1.00 Bahrain Bahrain 1.00 1.00 1.00 1.00 1.00 1.00 Brunei Brunei 0.64 0.61 1.00 1.57 1.64 1.00 Canada Canada 1.00 1.00 China Macau, Peking, Xiamen 1.00 0.50 1.00 1.99 Egypt Cairo 1.00 1.00 1.00 1.00 1.00 1.00 Fed. States of Micronesia Pohnpei 1.00 1.00 France Paris 1.00 0.60 1.00 1.00 1.67 1.00 Germany Frankfurt 0.50 0.53 1.99 1.87 Guam Guam 1.00 0.98 0.87 1.00 1.02 1.15 Hong Kong Hong Kong 0.44 0.41 0.47 2.27 2.43 2.12 India New Delhi 1.00 1.00 Indonesia Jakarta, Menado 1.00 0.50 1.00 1.00 2.00 1.00 Italy Rome 1.00 1.00 1.00 1.00 Japan Fukuoka, Nagoya, Okinawa, Osaka, Tokyo 0.23 0.28 0.28 4.30 3.53 3.62 South Korea Seoul 0.37 0.26 0.41 2.72 3.78 2.43 Kuwait Kuwait 1.00 1.00 1.00 1.00 1.00 1.00 Malaysia Kota Kinabalu, Kuala Lumpur, Kuching 0.57 0.57 0.86 1.75 1.76 1.17 Nauru Republic Nauru 1.00 1.00 1.00 1.00 1.00 1.00 Netherlands Amsterdam 0.59 0.99 1.00 1.70 1.01 1.00 Oman Muscat 1.00 1.00 1.00 1.00 Pakistan Karachi 0.88 1.00 1.14 1.00 Papua New Guinea Port Moresby 1.00 1.00 1.00 1.00 Qatar Doha 1.00 1.00 1.00 1.00 Saudi Arabia Dharan, Jeddah, Riyadh 0.50 0.58 0.71 2.00 1.73 1.40 Singapore Singapore 0.51 0.52 0.52 1.97 1.94 1.94 Switzerland Geneva, Zurich 1.00 1.00 1.00 1.00 1.00 1.00 Taiwan Kaohsiung, Taipei 0.47 0.32 0.42 2.15 3.12 2.39 Thailand Bangkok 0.31 0.27 0.83 3.23 3.71 1.21 United Arab Emirates Abu Dhabi, Dubai 0.39 0.49 0.71 2.57 2.03 1.41 United Kingdom London 0.50 0.50 1.00 1.98 1.99 1.00 United States of America Chicago, Los Angeles, San Francisco, Honolulu 0.35 0.48 0.51 2.88 2.10 1.96 Vietnam Hanoi, Saigon 1.00 1.00 1.00 1.00 Notes: (1) Herfindahl-Hirschman Index is based on market share. (2) Measure of the degree of competition by points served is in Appendix Table 5. 228 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 13. Market Concentration, Australia and Philippines (based on the Herfindahl-Hirschman index) Country Australia Philippines April 1997-April 1998 1995 1999 Australia 0.56 1.00 Canada 0.33 1.00 China 0.18 1.00 0.50 France 0.17 0.60 1.00 Germany 0.19 0.53 Hong Kong 0.31 0.41 0.47 Indonesia 0.28 0.50 1.00 Italy 0.23 1.00 Japan 0.29 0.28 0.28 Malaysia 0.30 0.57 0.86 Netherlands 0.16 0.99 1.00 Philippines 0.37 Singapore 0.28 0.52 0.52 South Korea 0.22 0.26 0.41 Taiwan 0.17 0.32 0.42 Thailand 0.26 0.27 0.83 United Kingdom 0.16 0.50 1.00 United States of America 0.32 0.48 0.51 Sources: Australian Productivity Commission (1998), Table 6.1; Table 12 of this paper. formers in terms of share in overall passenger traffic include Cathay Pacific (before its closure in 1999), China Airlines, Northwest Airlines, Saudi Arabian Airlines, and Singapore Airlines (Table 15).

Growth of international passenger traffic The country has remained a small player in the international air transport industry. Compared to other countries in the region, the Philippines was very much below the ranking in terms of passenger-kilometers performed (Table 16). Worse yet, the country was demoted in its ranking between 1988 and 1997. This is in contrast to Malaysia and South Korea, which have managed to improve on their ranking in the international air industry. The rapid economic growth of these countries played a major factor in the growth of their passenger traffic. The volume of international traffic doubled between 1990 and 1997 (Figure 6). However, the financial crisis in 1997 and 1998 severely affected air travel in the region thereby reducing passenger traffic not only in the Philippines but in other Asian countries as well. The restrictive air transport policies of the country were, however, manifested during the past two years as the industry suffered a major setback. Being AIR TRANSPORT INDUSTRY 229 the country’s lone designated carrier, PAL’s financial and labor problems in 1998 adversely affected the industry’s total seat capacity. The absence of measures to avert the impact of PAL’s situation is shown by the 17 percent and 57 percent drop in passenger traffic in 1998 and 1999, respectively. Had there been other Philippine- based designated carriers or had the frequency and seat capacity of the bilateral partners been increased, either of which could have taken PAL’s entitlements, the decline in traffic could not have been as bad.

Figure 5. Distribution of International Passenger Traffic, to and from the Philippines, 1990-1999 (%)

Note: 1996-1998 only for Grand Airways

Source: Civil Aeronautics Board.

Effects on tourism The development of the country’s air transport is correlated with that of the tourism industry as 98 percent of tourists visiting the country travel by air. These two industries have contributed to each other’s expansion or contraction. A comparison of Table 12 and Table 17 shows that the markets with relatively lower concentration are the same markets that generated the most tourists (top five) for the country. This is further confirmed by a significant negative Spearman rank correlation coefficient between the two variables, i.e., the less concentrated a market is, the greater is the number of tourists coming from that market. This implies that the greater airline competition in these markets gives tourists greater options for seats, flights, and airfare, thereby making the Philippines easy to reach and air travel more convenient. Aviation policies that restrict competition limit the potential of growth of tourism. While the number of tourist arrivals has doubled between 1990 and 1998, the annual growth rate has been on a declining trend (Figure 7) and so has the foreign exchange earnings of the industry (Figure 8). The combined effects of reduced de- Table 14. Market Share of Philippine Airlines (PAL) in International Passenger Traffic per Country of Destination, 1990-1999 (%) 1990 1995 1999 PAL Foreign PAL’s share PAL Foreign PAL’s share PAL Foreign PAL’s share Country Points served Carriers (%) Carriers (%) Carriers (%) Australia Brisbane, Melbourne, Sydney 93,712 30,060 75.7 134,413 63,945 67.8 120,532 0.0 Bahrain Bahrain 53,504 0.0 35,381 0.0 23,861 0.0 Brunei Brunei 7,327 23,383 23.9 17,777 49,070 26.6 34,716 0.0 Canada Canada 20,450 0.0 China Macau, Peking, Xiamen 37,868 100.0 17,586 15,377 53.4 Egypt Cairo 14,802 0.0 8,670 0.0 8,403 0.0 Fed. States of Micronesia Pohnpei 573 0.0 France Paris 7,386 0.0 9,680 25,403 27.6 24,191 0.0 Germany Frankfurt 38,100 42,359 47.4 58,144 99,094 37.0 Guam Guam 108,244 0.0 146,133 0.0 155,688 0.0 Hong Kong Hong Kong 354,787 50,256 87.6 519,085 966,114 35.0 388,483 194,338 66.7 India New Delhi 3,008 0.0 Indonesia Jakarta, Menado 31,475 0.0 44,406 24,285 64.6 5,212 0.0 Italy Rome 14,087 100.0 7 21,394 0.0 Japan Fukuoka, Nagoya, Okinawa, Osaka, Tokyo 217,502 382,714 36.2 331,312 496,992 40.0 271,849 320,995 45.9 Korea Seoul 144,122 0.0 91,416 350,897 20.7 63,964 361,368 15.0 Kuwait Kuwait 30,386 0.0 33,639 0.0 61,671 0.0 Malaysia Kota Kinabalu, Kuala Lumpur, Kuching 24,218 67,473 26.4 50,543 105,682 32.4 160,899 0.0 Nauru Republic Nauru 2,492 0.0 3,144 0.0 6,359 0.0 Netherlands Amsterdam 6,698 16,306 29.1 94 27,854 0.3 46,551 0.0 Oman Muscat 30,728 0.0 21,119 0.0 Pakistan Karachi 8,452 574 93.6 19,475 0.0 Papua New Guinea Port Moresby 5,050 0.0 101 11,816 0.8 11,860 0.0 Qatar Doha 33,844 0.0 21,289 0.0 Saudi Arabia Dharan, Jeddah, Riyadh 121,538 123,651 49.6 130,173 299,932 30.3 47,913 234,752 17.0 Singapore Singapore 126,388 161,963 43.8 118,567 275,298 30.1 80,283 414,758 16.2 Switzerland Geneva, Zurich 8,240 0.0 12,095 0.0 17,329 0.0 Taiwan Kaohsiung, Taipei 126,054 127,514 49.7 204,483 444,925 31.5 72,300 376,919 16.1 Thailand Bangkok 71,401 167,190 29.9 69,160 183,719 27.3 147,123 0.0 United Arab Emirates Abu Dhabi, Dubai 27,564 24,548 52.9 40,418 45,827 46.9 131,405 0.0 United Kingdom London 23,682 19,798 54.5 38,638 44,144 46.7 64,351 0.0 United States of America Chicago, Los Angeles, San Francisco, Honolulu 295,302 327,341 47.4 468,374 323,251 59.2 302,491 230,456 56.8 Vietnam Hanoi, Saigon 938 100.0 30,028 100.0 15,475 0.0 Source: Civil Aeronautics Board. AIR TRANSPORT INDUSTRY 231 mand for air travel due to the Asian crisis and the industry’s problem with PAL in 1998 are reflected in the negative growth rate of tourist arrivals and tourist receipts during the year. Likewise, tourist arrivals from Taiwan alone were reduced by more than 50 percent, as a result of the abrogation of the RP-Taiwan ASA last year (Rodolfo 2000).

THE ROLE OF CAB IN A DEREGULATED ENVIRONMENT

Economic regulation for the country’s air transport industry is the responsibility of the Civil Aeronautics Board (CAB) by virtue of RA 776. Among other things, the CAB issues certificate of public convenience and necessity or operating permits, ap- proves flight schedules, and determines the routes an air carrier may fly and the fares and charges that an air carrier may collect. The Board is also a member of the panel that negotiates the country’s ASAs. Under a deregulated environment, however, the role of CAB is greatly diminished. Its role of determining capacities, frequencies and airfares is now limited to international air transport. With diminished functions, its continued existence would depend on the regulations that would remain under the new environment. In other countries, like the US, the remaining functions of the economic regulator were absorbed by the transportation department while the economic regulating body itself was abolished (USATA 1999).

IMPLEMENTING GUIDELINES FOR EO 219

Given the industry’s poor performance and the growing demands for international travel, there is an urgent need to formulate the implementing rules and guidelines of EO 219. Some of the areas that are critical to promoting greater competition and efficiency in the industry and that need to be addressed by the implementing rules and regulations include the following:

National interest The EO is rather vague on what constitutes national interest. National interest should include that which provides the maximum benefit to the nation and the public such as: (i) promotion of tourism, trade and investment; (ii) maximization of consumer benefits; and (iii) promotion of competition itself.

Designation of carriers and allocation of entitlements Multiple designation under the bilateral system facilitates entry into the market of new airlines and hence, provides potential for greater competition. However, multiple designation needs to be accompanied with sufficient capacity for it to yield com- Table 15. International Passenger Traffic to and from the Philippines, by Airline, 1990-1999 Airline 1990 % Share 1991 % Share 1992 % Share 1993 % Share 1994 % Share 1995 % Share 1996 % Share 1997 % Share 1998 % Share 1999 % Share Air France 27,695 0.7 40,447 0.9 50,588 1.0 64,770 1.1 76,304 1.2 89,777 1.4 78,079 1.1 84,820 1.1 84,736 1.3 24,808 0.9 Air Macau 4,817 0.2 Air Micronesia 108,009 2.7 117,190 2.7 Air Nauru 2,727 0.1 2,958 0.1 2,768 0.1 3,033 0.1 5,075 0.1 4,437 0.1 8,203 0.1 10,482 0.1 13,989 0.2 8,669 0.3 Air Nuigini 5,050 0.1 8,627 0.2 9,276 0.2 9,526 0.2 11,871 0.2 11,816 0.2 11,986 0.2 13,200 0.2 12,639 0.2 5,504 0.2 Alitalia 17,774 0.3 36,200 0.6 41,463 0.7 39,682 0.6 39,992 0.5 53,230 0.7 27,941 0.4 Asiana Airways 25,826 0.4 77,838 1.2 115,180 1.6 119,631 1.5 139,639 2.1 66,246 2.3 British Airways 49,296 1.2 50,274 1.1 69,838 1.4 63,791 1.1 78,092 1.2 97,574 1.5 110,294 1.5 102,669 1.3 92,709 1.4 51,772 1.8 Canadian Airlines 64,703 0.8 65,004 1.0 31,526 1.1 Cathay Pacific Airways 385,584 9.8 519,879 11.8 538,221 10.5 641,174 11.3 711,548 11.4 794,515 12.0 803,557 10.9 770,510 9.9 920,178 14.0 China Airlines 128,072 3.2 130,070 2.9 179,274 3.5 220,713 3.9 232,398 3.7 268,177 4.1 264,666 3.6 288,616 3.7 438,499 6.7 171,601 5.9 China Southern Airlines CAAC 6,799 0.1 4,839 0.1 Continental Airlines 44,726 1.1 40,573 0.9 Continental Micronesia 119,621 2.3 121,584 2.1 148,234 2.4 144,840 2.2 140,485 1.9 136,750 1.8 139,056 2.1 75,728 2.6 Egyptair 45,159 1.1 57,920 1.3 43,531 0.8 44,452 0.8 45,776 0.7 30,808 0.5 23,472 0.3 14,364 0.2 34,966 0.5 23,866 0.8 Emirates Air 13,455 0.3 58,348 1.3 80,950 1.6 82,454 1.4 80,679 1.3 78,859 1.2 80,037 1.1 84,943 1.1 140,140 2.1 63,698 2.2 Eva Air 24,680 0.5 108,909 1.9 145,320 2.3 141,981 2.2 158,247 2.1 149,797 1.9 185,628 2.8 51,680 1.8 Garuda Indonesian Airlines 31,475 0.8 19,534 0.4 18,111 0.4 19,581 0.3 17,665 0.3 19,019 0.3 14,847 0.2 12,239 0.2 Gulf Air 53,504 1.4 62,954 1.4 91,427 1.8 89,995 1.6 101,506 1.6 100,735 1.5 93,176 1.3 88,849 1.1 94,532 1.4 48,089 1.7 Hong Kong Vietnam Japan Airlines 150,566 3.8 149,573 3.4 165,207 3.2 178,639 3.1 201,076 3.2 246,741 3.7 280,831 3.8 284,587 3.6 219,816 3.3 50,492 1.7 KLM Royal Dutch Airlines 16,968 0.4 16,390 0.4 22,053 0.4 26,267 0.5 27,697 0.4 27,938 0.4 36,790 0.5 64,880 0.8 70,838 1.1 27,865 1.0 Korean Airways 61,420 1.6 62,421 1.4 65,193 1.3 80,385 1.4 95,441 1.5 134,676 2.0 153,880 2.1 215,474 2.8 229,621 3.5 120,677 4.2 Kuwait Airways 30,386 0.8 15,577 0.4 38,989 0.8 47,234 0.8 41,728 0.7 33,639 0.5 44,883 0.6 46,125 0.6 62,264 0.9 28,478 1.0 Lufthansa German Airlines 61,653 1.6 67,153 1.5 74,237 1.4 84,243 1.5 121,373 1.9 151,835 2.3 167,838 2.3 164,373 2.1 160,821 2.5 Table 15 (continued) Airline 1990 % Share 1991 % Share 1992 % Share 1993 % Share 1994 % Share 1995 % Share 1996 % Share 1997 % Share 1998 % Share 1999 % Share Malaysian Airlines 64,852 1.6 67,449 1.5 66,811 1.3 76,392 1.3 97,239 1.6 144,295 2.2 147,423 2.0 137,116 1.8 118,497 1.8 70,240 2.4 Northwest Airlines 323,637 8.2 343,487 7.8 396,752 7.7 333,032 5.8 379,762 6.1 408,679 6.2 447,338 6.1 478,803 6.1 484,457 7.4 160,334 5.5 P.T. Bouraq Airlines 1,598 0.0 4,668 0.1 5,266 0.1 6,635 0.1 1,370 0.0 8,265 0.1 2,431 0.1 Pakistan International Airlines 61,462 1.6 60,799 1.4 73,128 1.4 64,878 1.1 65,791 1.1 58,893 0.9 57,104 0.8 58,053 0.7 51,075 0.8 61,746 2.1 Qantas Airways 30,060 0.8 32,722 0.7 37,886 0.7 45,679 0.8 59,208 0.9 63,945 1.0 69,172 0.9 79,618 1.0 95,286 1.5 61,746 2.1 Qatar Airways 18,340 0.2 19,377 0.2 3,254 0.0 Royal Brunei Airlines 23,383 0.6 29,683 0.7 38,737 0.8 48,116 0.8 54,480 0.9 49,070 0.7 55,509 0.8 52,861 0.7 57,971 0.9 18,193 0.6 Saudi Arabian Airlines 123,651 3.1 236,936 5.4 312,581 6.1 318,168 5.6 285,793 4.6 299,932 4.5 286,603 3.9 265,104 3.4 131,831 2.0 118,169 4.1 Silkair (Singapore) Ltd. 9,686 0.2 20,528 0.4 25,087 0.4 24,748 0.4 35,942 0.5 55,973 0.7 47,519 0.7 38,280 1.3 Singapore Airlines 161,963 4.1 161,421 3.7 187,860 3.6 221,676 3.9 267,092 4.3 275,298 4.2 345,943 4.7 382,767 4.9 429,461 6.5 168,573 5.8 Swissair 11,260 0.3 9,465 0.2 10,318 0.2 9,922 0.2 12,703 0.2 16,714 0.3 19,175 0.3 21,683 0.3 25,040 0.4 11,341 0.4 Thai International Airways 184,853 4.7 180,540 4.1 186,541 3.6 188,966 3.3 188,297 3.0 166,188 2.5 192,931 2.6 233,786 3.0 259,211 3.9 7,777 0.3 United Airlines 158,632 4.0 142,645 3.2 170,151 3.3 251,376 4.4 213,715 3.4 184,229 2.8 182,815 2.5 212,260 2.7 24,862 0.4 Vietnam Airlines 9,495 0.1 4,096 0.1 5,279 0.1 Grand International Airways 45,454 0.6 108,721 1.4 14,014 0.2 Philippine Airlines 1,585,772 40.2 1,724,475 39.1 1,998,730 38.8 2,117,252 37.2 2,294,501 36.6 2,409,641 36.5 2,835,019 38.4 2,914,262 37.3 1,591,592 24.3 1,233,758 42.7 Total 3,945,270 100 4,409,510 100 5,147,768 100 5,696,654 100 6,264,816 100 6,601,785 100 7,381,341 100 7,802,891 100 6,562,909 100 2,892,585 100 Source: Civil Aeronautics Board. 234 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 16. Top 30 Countries and Scheduled Air Carriers, 1988, 1996-1997

PASSENGER-KILOMETERS PERFORMED Country or Estimated Ranking Carrier Estimated Ranking Group of countries 1997 (million) 1997 1996 1988 1997 (million) 1997 1996 1988 United States 267,753 1 1 1 British Airways 99,086 1 1 1 United Kingdom 151,052 2 2 2 United 76,228 2 2 11 Japan 84,098 3 3 3 Lufhansa 66,385 3 4 4 Germany 82,258 4 4 5 JAL 62,030 4 3 2 Netherlands 70,465 5 5 9 Air France 60,751 5 9 6 Singapore 55,459 6 7 6 American 55,878 6 5 13 France 53,781 7 6 4 KLM 55,595 7 8 9 Republic of Korea 51,954 8 8 15 SIA 55,459 8 6 5 Australia 48,554 9 9 7 Northwest 52,370 9 7 8 Canada 40,928 10 10 8 Qantas 44,137 10 10 7 Italy 29,285 11 11 14 Cathay Pacific 38,942 11 11 12 Thailand 27,747 12 12 10 Delta 36,907 12 13 23 Switzerland 26,160 13 15 13 Korean Air 34,206 13 12 20 Brazil 25,537 14 14 18 Alitalia 28,720 14 14 19 Malaysia 24,029 15 13 25 Thai Airways 27,747 15 15 14 Spain 23,235 16 16 11 Swissair 24,901 16 17 17 Gulf States 21,576 17 17 24 Air Canada 24,147 17 18 21 New Zealand 19,970 18 18 19 Malaysian Airlines 24,004 18 16 32 Russian Federation 18,135 19 19 - Iberia 21,539 19 19 15 Scandinavia 16,609 20 21 16 Virgin Atlantic 19,158 20 22 53 Indonesia 16,182 21 22 21 Air New Zealand 18,340 21 20 27 China 15,781 22 20 30 All Nippon Airways 18,306 22 24 46 Hong Kong 19,341 - - - Continental 17,376 23 33 18 Philippines 14,431 23 24 22 Canadian 16,781 24 21 25 Saudi Arabia 13,061 24 23 17 Varig 16,717 25 25 26 India 12,877 25 25 20 SAS 16,157 26 23 22 South Africa 11,940 26 27 33 Garuda 15,592 27 26 28 Israel 11,492 27 26 26 PAL 14,431 28 29 29 Belgium 11,277 28 28 28 Saudia 13,061 29 27 24 Mexico 10,983 29 29 23 Asiana 12,527 30 31 - Austria 9,940 30 30 53

Source: UNCTAD (1999), Table 1 and Table 2. AIR TRANSPORT INDUSTRY 235

Table 17. Distribution of Tourists, by Major Country of Residence, Philippines, 1991-1999 (%)

Country 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 USA 22.8 22.7 21.2 21.7 21.9 21.3 19.6 20.5 23.7 23.5 JAPAN 22.6 23.3 21.2 19.5 6.6 6.7 18.4 18.0 18.3 19.7 HONGKONG 7.9 6.6 6.3 6.1 19.6 20.1 7.8 7.6 8.2 8.1 TAIWAN 6.3 6.2 11.7 13.6 11.1 11.8 10.8 11.8 9.4 7.3 SOUTH KOREA 4.1 4.8 5.2 5.6 6.9 7.5 9.1 8.1 4.2 6.8 UNITED KINGDOM 3.7 4.2 3.7 4.1 4.3 4.4 4.4 4.6 4.9 4.5 AUSTRALIA 5.3 5.2 4.9 4.8 4.9 4.7 4.6 4.5 4.3 3.9 CANADA 2.3 2.6 2.8 2.9 2.8 2.8 3.0 3.1 3.4 3.3 GERMANY 3.0 3.3 3.5 3.4 3.3 3.2 3.2 3.0 3.3 3.1 SINGAPORE 2.2 1.8 2.0 1.9 2.0 1.7 2.3 2.4 2.4 2.6 MALAYSIA 1.3 1.6 1.4 1.7 2.0 2.2 2.7 2.9 2.5 2.5 FRANCE 1.1 1.2 1.3 1.1 1.0 1.1 1.1 1.2 1.3 1.2 CHINA 0.5 0.6 0.6 0.6 0.7 0.5 0.8 0.9 1.2 1.1 INDIA 0.8 0.8 0.8 0.7 0.8 0.8 0.8 0.8 1.1 0.9 NETHERLANDS 0.7 0.9 0.7 0.7 0.7 0.8 0.8 0.7 0.9 0.9 SWITZERLAND 1.2 1.3 1.2 1.1 1.0 0.9 0.9 0.8 0.9 0.8 INDONESIA 0.7 0.9 0.8 0.8 0.8 0.8 1.0 1.0 0.8 0.8 THAILAND 1.0 1.2 1.0 0.9 0.9 0.9 0.9 0.8 0.8 0.8 ITALY 1.0 0.9 0.9 0.9 0.9 0.8 0.7 0.7 0.7 0.7 DENMARK 0.3 0.4 0.4 0.4 0.4 0.3 0.4 0.4 0.6 0.6 SAUDI ARABIA 1.5 1.5 1.4 1.0 0.9 0.8 0.7 0.5 0.6 0.6 SWEDEN 0.8 0.8 0.6 0.6 0.5 0.5 0.5 0.5 0.6 0.5 NEW ZEALAND 0.4 0.5 0.4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 Sub-total 91.4 93.1 94.0 94.5 94.7 94.9 95.1 95.3 94.5 94.9 Others 8.6 6.9 6.0 5.5 5.3 5.1 4.9 4.7 5.5 5.1 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Sources: National Statistics Office and Department of Tourism. 236 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Figure 6. International Passenger Traffic, Philippines, 1990-1999 (%)

Source: Civil Aeronautics Board. petition benefits. But given the capacity constraint under the bilateral system, the number of airlines that will make a route commercially viable depends largely on the size of the market (i.e., capacity available) in question. Hence, it is important to first establish the number of airlines required by the market before any designation of carriers is done. But the process and criteria for designating airlines should be established in the guidelines. Other countries have established an approach for allocating capacity to carriers on contested routes.13 They have also established a body whose function is solely to allocate capacity14; this body is separate from the body that sits in the negotiation of ASAs.

AREAS FOR COMPETITION POLICY

This section of the paper identifies areas where competition policy and regulations have remained undefined. Ideally, where effective competition exists, the need for regulation is reduced principally because the strong competition itself constitutes a self-regulating mechanism whereby excess profits and anticompetitive behavior are ______

13 South Korea uses a rule-based approach that involves a predetermined formula; Canada uses a geographic allocation system; Australia, U.S. and the United Kingdom use public interest approach that involves an adjudicative process using some form of public interest test based on defined policies and criteria (Productivity Commission 1998). 14 Allocation of capacity in Australia is done by the International Air Services Commission (IASC). AIR TRANSPORT INDUSTRY 237

Figure 7. Tourist Arrivals, Philippines, 1990-1999 (%)

Sources: National Statistics Office and Department of Tourism. eliminated (Stewart-Smith 1999). The role of policies and regulations under a liberalized and deregulated environment is therefore to ensure that competition is effective. This becomes more important in an oligopolistic structure where the failure of any one player would have a dramatic impact on the market power of competitors. One important area for competition policy is on merger and acquisition. The fierce competition that resulted from deregulation in other countries has pushed a number of airlines into bankruptcy, merger or consolidation. Merger or consolidation has both positive and negative effects. On the positive side, efficiency is enhanced as it allows airlines to achieve economies of scale and scope by consolidating airline functions such as ground handling, repair and maintenance, marketing, etc. On the negative side, there is the fear that the end result will be a large airline becoming so dominant that it can exert considerable market power. The potential of seeing merger or consolidation happening in the country should not be taken lightly for the following reasons. First, domestic traffic in the country is relatively small and this by itself limits the number of airlines that would make an efficient domestic air transport industry. Second, only two of the airlines are currently profitable. Third, two of the existing airlines are substantially owned by the same person. Fourth, the new entrants will need substantial capital to be able to fly the international routes. Given the local ownership requirement, merger or consolidation could be an easy way out to the huge capital requirement of the industry. Thus, a policy or regulation should be defined in such a way that a merger or consolidation would not result in reduced service and less competition. The government should weigh the efficiency-enhancing effects against the market power effects. In short, a merger or consolidation should be in the interest of the traveling public. 238 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Figure 8. Tourist Receipts, Philippines, 1990-1999 (%) Value in US$ (million) Value

Source: Sources: Department of Tourism.

Below are areas for competition policy specific to the domestic and international air transport industry.

DOMESTIC AIR TRANSPORT INDUSTRY

Essential air service Cross subsidization is no longer feasible under a deregulated environment. How- ever, considering the country’s archipelagic setting, there are remote areas where air services are not commercially viable but which are deemed necessary on social grounds or for developmental reasons. The government should set up a system that would give airlines incentive to provide air services that otherwise would be money losers. Other countries have adopted several approaches in addressing this issue. One approach would be a competitive bidding for government subsidy, i.e., giving the subsidy to the airline that values it the most.

Intermodal competition The shipping industry has become an important source of competition for the air transport industry in providing transport services in the country’s islands in the south. The system for providing government subsidy to air services in missionary routes or remote areas should therefore be designed in such a way that the efficiency arising from the intermodal competition will not be distorted. AIR TRANSPORT INDUSTRY 239

Tariffs/Fares Airfares should continue to be regulated in routes where air services are provided by only one airline.

INTERNATIONAL AIR TRANSPORT INDUSTRY Given the bilateral framework in the provision of air services, there is only a limited scope for the country’s unilateral reform that would enhance efficiency. Any liberalization effort should therefore be done in the context of the bilateral negotiating process and at the multilateral or regional level for some areas.

Market access Multiple designation under EO 219 is incompatible with capacity constraints, as entry will be limited if capacity is not sufficient for each carrier to be commercially viable. Hence, multiple designation should be accompanied by the removal of capacity constraints. The country should pursue liberal bilateral agreements aiming for the gradual removal, within a set timeframe, of constraints in capacity, frequency, and type of aircrafts so as to allow airlines greater flexibility in determining the least cost of providing air services in the routes. This, in effect, will deepen the country’s liberalization efforts. However, a balance has to be struck in setting the time period. If competition is introduced too slowly, the incumbent airline (PAL) has little incentive to eliminate monopoly rents. Allowing competition too rapidly, on the other hand, may result in lost opportunity for the new players to gain organizational efficiencies, as they have yet to establish a credible presence in international routes, and may fail altogether.

Access to inputs A liberal market access, if not accompanied by a freer access to inputs for the provision of air services, will not produce any effect. This is where regional and multilateral actions are needed. Of immediate importance under this area is the regulatory reform on how to facilitate the access of new airlines to airport landing slots that are often hard to contest, particularly the peak landing slots, as these have already been allocated to the incumbent(s).

Alliances The motivation for the formation of alliances is the need to offer a global service with connections around the world while restraining costs. Indirectly, however, alliances are formed to overcome constraints in the bilateral agreements, particularly foreign equity restriction. Alliances may come in several forms, one of which is code sharing, where one airline uses the seats of another airline but employs its own airline designator code. Code sharing has anticompetitive effects as it reduces consumer’s choice of airlines. 240 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

SUMMARY AND CONCLUSIONS

There is no doubt that liberalization and deregulation have brought genuine competition in the domestic air transport industry. Although the number of players has remained the same since the industry was deregulated, this paper has shown that the degree of competition has been increasingly intensified, particularly in the major routes, resulting in lower airfare, improvement in the quality of service and efficiency in the industry in general. On the other hand, while other countries are adopting more flexible approaches to liberalization and regulation to meet the increasing demand for international air services brought about by the increasing integration of economies, the Philippines is keeping to its old restrictive policies and practices. In particular, the government’s stance on issues concerning its air services agreements is not compatible with its pronouncement of a progressive liberalization policy. The effect of such restrictive policies is reflected in the high degree of concentration in the country’s international aviation industry. The outcome is a decline in passenger traffic, tourists, and tourist receipts. EO 219 should be implemented quickly for the liberalization of the country’s international air transport industry. But EO 219 alone is not enough. The government needs to deepen its liberalization efforts by adopting a more flexible approach to its liberalization efforts. The government needs to act quickly to promote competition in the industry. As the experiences of other countries have shown, convenient and efficient air services brought about by greater competition are critical to attracting foreign investment, trade, and tourism. To this end, this paper has identified areas where competition policy and new regulations should be defined and pursued to ensure that airlines are able to reap the benefits of their oligopolistic structure while at the same time consumers are protected from the abuse of market power.

BIBLIOGRAPHY

Ambidji Group Pty Ltd 1997. Civil Aviation Master Plan. Department of Transportation and Communications, Philippines. APEC. 1999. APEC Economic Leaders’ Declaration. Singapore. Baumol, W. and K.S. Lee. 1991. Contestable Markets, Trade and Development. The World Bank Research Observer, 6(1). DOTC (Department of Transportation And Communication). 1992. Civil Aviation Masterplan Report 1. Findlay, C. and D. Nikomborirak. 1999. Air Transport, Paper prepared for the East Asia Conference on Options for the WTO 2000 Negotiations, Manila. Hanlon, P. 1996. Global Airlines, Competition in a Transnational Industry. Great Britain: Butterworth-Heinemann. PAL (Philippine Airlines). 1999. Amended and Restated Rehabilitation Plan. Makati. AIR TRANSPORT INDUSTRY 241

Productivity Commission. 1998. International Air Services, Report No. 2. AusInfo, Canberra. Rodolfo, C.L.S. 2000. For Whom Shall We Fly, Challenges to the Philippine Aviation. Pasig City.: University of Asia and the Pacific. Schwalbach, J. 1991. Entry, Exit, Concentration, and Market Contestability. In Entry and Market Contestability, An International Comparison, edited by P. Geroski and J. Schwalbach. USA. Stewart-Smith, M. 1999. Industry Structure and Regulation. World Bank. UNCTAD (United Nations Conference on Trade and Development). 1999. Air Transport Services: The Positive Agenda for Developing Countries, Report by the UNCTAD Secretariat. USATA (US Air Transport Association). 1999. Airline Handbook. Available from the World Wide Web: (http://www.air-transport.org.). Warren,T., V. Tamms and C. Findlay. 1998. Beyond the Bilateral System: Competition Policy and Trade in International Aviation Service. Auckland: PECC Trade Policy Forum. WTO (World Trade Organization) 1998. Air Transport Services. Background Note by the Secretariat, Council for Trade in Services. APPENDICES

Appendix Table 1. List of Domestic Airports, by Type Trunkline Secondary Rural 1. Manila 1. Jolo 1. Allah Valley 2. Cebu 2. Kalibo 2. Caticlan 3. Davao 3. Butuan 3. Bislig 4. Iloilo 4. Tagbilaran 4. Cauayan 5. Zamboanga 5. Dipolog 5. Lubang 6. Bacolod 6. Pagadian 6. Busuanga 7. Cagayan de Oro 7. Iligan 7. Bagabag 8. Tacloban 8. Gen. Santos 8. Cati 9. Legaspi 9. Marinduque 9. Cuyo 10. Cotabato 10. Mamburao 10. San Fernando 11. Puerto Princesa 11. Romblon 11. Plaridel 12. Dumaguete 12. Naga 12. Palanan 13. San Jose 13. Masbate 13. Daet 14. Roxas 14. Virac 14. Siocon 15. Baguio 15. Ipil 16. Tuguegarao 16. Castillejos 17. Surigao 17. Hilongos 18. Tawi-tawi 18. Calaoan 19. Ozamis 19. Linayen 20. Catarman 20. Ormoc 21. Calbayog 21. Antique 22. Tandag 22. Lucena 23. Laoag 23. Iba 24. Malabang 24. Cagayan de Sulu 25. Basco 25. Vigan 26. Guiuan 27. Catbalogan 28. Baler 29. Aparri 30. Camiguin 31. Jomalig 32. Ubay 33. Liloy 34. Siquijor 35. Malaybalay 36. Wasig 37. Rosales 38. Sorsogon 39. Dolores 40. Biliran 41. Alabat 42. Lahug 43. Bulan 44. Itbayat 45. Maasiao 46. Siargao Source: Civil Aeronautics Board. Appendix Table 2. Passenger Load Factor per Airline, by Sector, 1995-2000 (%) SECTOR PHILIPPINE AIRLINES CEBU PACIFIC AIR 1995 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000 A. Major Trunkline Manila- Cebu- Manila 65.4 60.7 69.9 66.7 62.8 76.0 84.0 67.4 64.4 Manila- Davao- Manila 59.2 55.9 64.7 70.0 65.6 77.9 78.0 71.5 69.3 Manila- Zamboanga- Manila 71.1 60.6 70.8 59.2 31.0 50.4 45.5 Manila- Bacolod- Manila 77.0 77.0 73.3 61.7 48.8 67.0 78.0 64.6 64.8 Manila- Iloilo- Manila 85.0 71.5 77.3 61.5 64.0 74.0 76.0 60.0 64.2 Manila- Legaspi- Manila 84.3 82.6 84.7 66.0 65.3 Manila- Tacloban- Manila 84.7 77.4 78.7 59.0 61.8 76.0 83.0 68.5 Manila-Puerto Prinsesa- Manila 75.5 69.0 73.4 63.5 Manila-Cagayan de Oro-Manila 84.8 76.0 80.2 72.0 70.2 77.0 79.0 67.0 63.8 Manila- Cotabato-Manila 73.2 61.1 62.2 55.3 Manila-Dumaguete-Manila 76.8 61.1 73.3 32.0 44.6 Manila-San Jose-Manila 63.6 70.3 82.7 Manila-Roxas-Manila 74.0 70.3 74.5 65.4 39.7 44.6 B. Secondary/Rural Route Manila- Baguio- Manila 81.6 76.8 83.4 Manila- Kalibo- Manila 82.6 81.9 78.2 61.6 61.0 78.0 52.0 45.6 Manila-Calbayog-Manila 87.7 84.4 Manila-Catarman-Manila 88.3 82.6 73.9 Manila-Daet-Manila 77.4 72.1 68.8 Manila-General Santos- Manila 59.1 63.0 61.4 Manila-Laoag-Manila 66.9 68.5 65.2 Manila-Marinduque-Manila 84.3 81.5 87.0 Manila-Masbate-Manila 82.5 74.8 84.8 Manila-Naga-Manila 91.6 89.9 89.6 53.6 Manila-Tablas-Manila 75.2 69.0 Manila-Tagbilaran-Manila 87.5 77.5 74.5 88.1 Manila-Virac-Manila 85.6 61.5 79.0 Cagayan-Davao-Cagayan 76.7 78.2 78.4 48.3 Cagayan-Zamboanga-Cagayan 66.6 100.0 Cebu-Bacolod-Cebu 80.7 84.2 81.8 44.1 43.0 55.0 65.5 Cebu-Butuan-Cebu 84.5 81.4 83.3 Cebu-Cagayan-Cebu 57.6 54.0 57.0 35.7 Cebu-Cotabato-Cebu 71.8 49.9 81.5 Cebu-Davao-Cebu 76.4 59.1 61.9 53.7 78.0 88.0 62.0 59.6 Cebu-Dipolog-Cebu 82.3 76.6 68.6 Cebu-General Santos- Cebu 89.2 83.8 79.5 Cebu-Iloilo-Cebu 73.8 78.8 82.5 46.6 75.0 67.0 55.7 Cebu-Kalibo-Cebu 76.7 77.7 80.6 52.0 43.9 Cebu-Pagadian-Cebu 66.2 75.1 77.9 Cebu-Puerto Princesa-Cebu Cebu-Surigao-Cebu 77.2 73.5 71.6 Cebu-Tagbilaran-Cebu 66.0 42.8 43.5 Cebu-Tandag-Cebu 83.4 78.6 83.1 Cebu-Zamboanga-Cebu 69.0 60.7 68.1 34.7 48.9 Cotabato-Zamboanga-Cotabato 67.5 43.2 78.3 Davao- Gen San- Davao Davao-Zamboanga-Davao 75.9 77.5 72.9 51.1 Dipolog-Zamboanga-Dipolog 72.0 59.2 70.1 Iloilo-Puerto-Princesa-Iloilo 74.3 71.3 69.7 Pagadian-Zamboanga-Pagadian 79.1 72.5 75.7 Tacloban-Cebu-Tacloban 61.7 51.0 80.3 Tawi-Tawi-Zamboanga-Tawi-tawi 81.6 71.2 73.6 Note: No data for 1998 and 2000 for PAL. Sources: Civil Aeronautics Board and Airlines. Appendix Table 2 (continued) SECTOR AIR PHILIPPINES GRAND AIRWAYS 1995 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000 A. Major Trunkline Manila- Cebu- Manila 57.0 57.0 55.0 55.0 43.3 57.3 61.0 64.0 Manila- Davao- Manila 42.0 75.0 67.0 68.4 68.0 52.6 57.7 50.0 57.0 Manila- Zamboanga- Manila 59.0 75.0 53.0 62.0 59.0 Manila- Bacolod- Manila 63.0 60.0 50.9 52.7 Manila- Iloilo- Manila 66.0 75.0 75.0 66.0 64.0 46.1 42.0 Manila- Legaspi- Manila 57.0 64.0 60.0 42.9 30.0 Manila- Tacloban- Manila 64.0 50.4 42.0 56.0 46.0 53.0 Manila-Puerto Prinsesa- Manila 58.2 74.0 66.0 73.8 66.0 39.2 43.0 Manila-Cagayan de Oro-Manila 55.0 54.4 59.0 62.4 52.0 47.0 Manila- Cotabato-Manila 44.0 77.0 69.0 64.0 58.0 Manila-Dumaguete-Manila 72.0 60.0 Manila-San Jose-Manila 52.0 56.0 58.0 Manila-Roxas-Manila B. Secondary/Rural Route Manila- Baguio- Manila Manila- Kalibo- Manila 34.5 Manila-Calbayog-Manila 58.2 61.0 66.1 48.7 47.0 Manila-Catarman-Manila Manila-Daet-Manila Manila-General Santos- Manila Manila-Laoag-Manila 54.0 63.0 62.0 Manila-Marinduque-Manila 41.0 30.0 Manila-Masbate-Manila Manila-Naga-Manila Manila-Tablas-Manila 51.0 64.0 39.0 35.0 Manila-Tagbilaran-Manila Manila-Virac-Manila Cagayan-Davao-Cagayan 47.0 45.0 26.0 Cagayan-Zamboanga-Cagayan 25.0 Cebu-Bacolod-Cebu Cebu-Butuan-Cebu Cebu-Cagayan-Cebu Cebu-Cotabato-Cebu Cebu-Davao-Cebu Cebu-Dipolog-Cebu 23.0 Cebu-General Santos- Cebu Cebu-Iloilo-Cebu 49.0 Cebu-Kalibo-Cebu 38.0 Cebu-Pagadian-Cebu Cebu-Puerto Princesa-Cebu Cebu-Surigao-Cebu Cebu-Tagbilaran-Cebu Cebu-Tandag-Cebu Cebu-Zamboanga-Cebu Cotabato-Zamboanga-Cotabato 57.0 47.0 Davao- Gen San- Davao Davao-Zamboanga-Davao Dipolog-Zamboanga-Dipolog 66.0 50.0 Iloilo-Puerto-Princesa-Iloilo Pagadian-Zamboanga-Pagadian Tacloban-Cebu-Tacloban Tawi-Tawi-Zamboanga-Tawi-tawi

Note: No data for 1998 and 2000 for PAL. Sources: Civil Aeronautics Board and Airlines. Appendix Table 2 (continued) SECTOR ASIAN SPIRIT MINDANAO EXPRESS 1995 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000 A. Major Trunkline Manila- Cebu- Manila Manila- Davao- Manila Manila- Zamboanga- Manila Manila- Bacolod- Manila Manila- Iloilo- Manila Manila- Legaspi- Manila Manila- Tacloban- Manila Manila-Puerto Prinsesa- Manila Manila-Cagayan de Oro-Manila Manila- Cotabato-Manila Manila-Dumaguete-Manila Manila-San Jose-Manila 51.6 50.2 49.0 62.0 68.5 Manila-Roxas-Manila B. Secondary/Rural Route Manila- Baguio- Manila 30.6 39.0 52.0 60.1 Manila- Kalibo- Manila Manila-Calbayog-Manila 42.7 63.1 66.0 Manila-Catarman-Manila 61.6 46.8 64.3 73.0 67.3 Manila-Daet-Manila 33.6 40.7 Manila-General Santos- Manila Manila-Laoag-Manila Manila-Marinduque-Manila 63.7 62.0 55.1 Manila-Masbate-Manila 45.6 81.3 75.8 82.0 74.6 Manila-Naga-Manila 41.5 56.4 49.0 43.9 Manila-Tablas-Manila 47.3 59.7 57.0 66.0 58.7 Manila-Tagbilaran-Manila 62.0 78.6 Manila-Virac-Manila 46.3 48.0 65.0 67.0 74.2 Cagayan-Davao-Cagayan 60.7 48.9 72.6 Cagayan-Zamboanga-Cagayan 21.0 Cebu-Bacolod-Cebu 21.0 Cebu-Butuan-Cebu 32.3 Cebu-Cagayan-Cebu 53.0 44.8 25.0 19.4 50.0 Cebu-Cotabato-Cebu 17.9 39.8 Cebu-Davao-Cebu Cebu-Dipolog-Cebu 36.5 Cebu-General Santos- Cebu Cebu-Iloilo-Cebu Cebu-Kalibo-Cebu 56.0 Cebu-Pagadian-Cebu 35.0 42.0 35.0 Cebu-Puerto Princesa-Cebu 21.0 Cebu-Surigao-Cebu 14.8 23.7 Cebu-Tagbilaran-Cebu 34.0 21.2 Cebu-Tandag-Cebu 44.0 39.5 39.0 37.7 55.1 Cebu-Zamboanga-Cebu 5.0 Cotabato-Zamboanga-Cotabato 52.2 48.7 51.0 Davao- Gen San- Davao 42.8 35.0 Davao-Zamboanga-Davao 48.0 48.3 Dipolog-Zamboanga-Dipolog 38.8 Iloilo-Puerto-Princesa-Iloilo 17.6 Pagadian-Zamboanga-Pagadian 24.7 Tacloban-Cebu-Tacloban 36.2 7.0 Tawi-Tawi-Zamboanga-Tawi-tawi 43.1 50.3 45.3 60.2

Note: No data for 1998 and 2000 for PAL. Sources: Civil Aeronautics Board and Airlines. Appendix Table 3. Percentage Distribution of Seat Capacity, by Major Routes, by Airline, 1995-1999 (%)

SECTOR Philippine Airlines Cebu Pacific Air Air Philippines Grand Airways Asian Spirit 1995 1996 1997 1998* 1999** 1996 1997 1998 1999 1996 1997 1998 1999 1995 1996 1997 1998 1996 1997 1998 1999

Manila- Cebu- Manila 83.7 68.7 62.9 50.2 10.5 15.8 44.0 27.9 6.2 39.3 21.9 16.3 20.8 15.1 16.8

Manila- Davao- Manila 76.0 55.8 48.9 41.8 11.6 20.0 39.9 32.4 1.8 15.0 45.6 25.8 24.0 30.9 16.1 14.4

Manila- Zamboanga- Manila 100.0 84.0 71.3 49.6 45.1 31.7 16.0 28.7 54.9 18.7

Manila- Bacolod- Manila 100.0 97.2 67.9 39.1 2.8 25.2 56.5 39.8 6.9 43.5 21.1

Manila- Iloilo- Manila 100.0 64.3 55.3 36.0 18.7 22.7 46.7 31.2 16.6 21.4 53.3 32.7 0.5 0.6

Manila- Legaspi- Manila 100.0 94.5 77.7 60.2 5.5 22.3 100.0 39.8

Manila- Tacloban- Manila 100.0 81.8 49.9 27.3 8.5 35.3 85.2 51.1 1.6 21.6 9.7 14.8 13.2

Manila-Puerto Prinsesa- Manila 100.0 80.0 67.8 51.8 18.5 30.6 100.0 48.2 1.5 1.6

Manila-Cagayan de Oro-Manila 100.0 77.0 54.7 39.9 15.8 31.5 66.5 36.1 8.2 24.0 7.2 13.8 25.3

Manila- Cotabato-Manila 100.0 77.6 55.8 38.3 22.4 44.2 100.0 61.7

Manila-Dumaguete-Manila 100.0 100.0 100.0 36.0 5.9 100.0 58.2

Manila-San Jose-Manila 100.0 81.4 51.8 52.0 81.8 18.6 48.2 48.0 18.2

Manila-Roxas-Manila 100.0 100.0 100.0 100.0

For major routes 90.3 72.5 60.5 42.1 9.4 17.7 46.6 30.4 4.1 11.6 17.1 27.3 9.7 13.8 9.6 11.1 0.2 0.6 0.5 0.2

*1998 No data for 1998 for PAL. **1999 is up to 3rd quarter only for PAL. Source: Civil Aeronautics Board. Appendix Table 4. Growth Rate of Passenger Traffic per Sector, per Airline, 1995-1999 (%) Sector Philippine Airlines Cebu Pacific Air Air Philippines Grand Airways Asian Spirit Mindanao Express 1996 1997 1998 1999* 1997 1998 1999 1997 1998 1999 1996 1997 1998 1997 1998 1999 1997 1998 1999 A. Major Trunkline 86.58 43.45 112.91 -17.84 -56.43 Manila- Cebu- Manila -3.76 11.31 -20.48 12.78 92.38 15.93 16.83 1228.70 9.14 14.15 95.95 -53.14 -52.23 Manila- Davao- Manila -3.70 5.53 -12.50 17.86 112.84 -6.79 27.57 157.05 5.79 0.53 Manila- Zamboanga- Manila -12.63 17.68 -35.15 -23.62 1946.60 159.44 1.59 Manila- Bacolod- Manila 0.14 -6.43 -27.78 -26.74 1673.93 26.99 30.26 40.14 21.09 12.46 31.24 -100.00 Manila- Iloilo- Manila -17.02 10.07 -27.24 -25.73 65.05 11.32 4.48 152.60 -1.32 6.50 Manila- Legaspi- Manila 2.07 0.37 -32.19 -24.59 3328.53 76.14 -41.92 Manila- Tacloban- Manila -15.98 -13.54 -28.55 -34.97 611.06 51.56 -2.12 146.69 -20.02 50.23 43.45 -100.00 Manila-Puerto Prinsesa- Manila 2.23 8.68 -27.19 -24.80 782.54 118.22 -18.77 Manila-Cagayan de Oro-Manila -10.50 2.50 -18.20 -12.60 199.21 5.18 3.07 233.47 -18.79 -7.80 Manila- Cotabato-Manila -18.49 1.93 -69.27 15.45 235.02 -69.16 248.15 Manila-Dumaguete-Manila -0.99 -6.83 -57.30 -100.00 273.09 Manila-San Jose-Manila 6.86 -0.23 -56.81 -100.00 Manila-Roxas-Manila -4.85 5.96 -12.80 -29.55 B. Secondary/Rural Route Manila- Baguio- Manila -34.09 66.42 -58.37 -100.00 Manila- Kalibo- Manila 3.17 -6.00 -32.56 -27.98 -34.47 59.64 57.04 -1.57 22.41 -73.02 514.44 Manila-Calbayog-Manila -2.22 -100.00 -100.00 3179.55 -89.40 986.83 Manila-Catarman-Manila 3.16 13.97 -60.85 -100.00 25.82 -100.00 Manila-Daet-Manila -13.21 -3.65 -57.46 -100.00 Manila-General Santos- Manila 201.71 3.67 -1.23 -25.38 Manila-Laoag-Manila -4.78 18.69 -44.70 -100.00 696.12 Manila-Marinduque-Manila -6.82 -34.19 -63.05 -100.00 213.14 -23.37 28.57 Manila-Masbate-Manila -20.09 -38.74 -55.27 -100.00 260.49 0.84 Manila-Naga-Manila 4.75 27.83 -34.18 -37.23 44.58 -94.51 475.31 317.77 -50.25 18.62 Manila-Tablas-Manila -40.43 -100.00 Appendix Table 4 (continued) Sector Philippine Airlines Cebu Pacific Air Air Philippines Grand Airways Asian Spirit Mindanao Express 1996 1997 1998 1999* 1997 1998 1999 1997 1998 1999 1996 1997 1998 1997 1998 1999 1997 1998 1999 Manila-Tagbilaran-Manila -3.03 35.42 -20.35 -87.72 99.17 -39.29 171.50 Manila-Virac-Manila -18.39 20.42 -58.09 -100.00 2018.58 Cagayan-Davao-Cagayan -6.89 7.15 -82.06 -100.00 3.94 278.10 Cagayan-Zamboanga-Cagayan -100.00 -100.00 Cebu-Bacolod-Cebu 7.26 8.77 -58.41 -29.63 2343.16 Cebu-Butuan-Cebu -18.72 0.48 -66.82 -100.00 Cebu-Cagayan-Cebu -10.36 8.33 -79.60 -100.00 -23.42 715.56 Cebu-Cotabato-Cebu -25.13 6.65 -64.83 -100.00 Cebu-Davao-Cebu 24.81 3.85 -57.58 0.97 50.23 1.39 -100.00 Cebu-Dipolog-Cebu -4.62 -12.59 -60.43 -100.00 Cebu-General Santos- Cebu -11.67 -43.16 -62.69 -100.00 Cebu-Iloilo-Cebu 6.02 -5.55 -63.91 -32.78 189.78 -100.00 Cebu-Kalibo-Cebu 1.68 5.10 -57.51 -100.00 Cebu-Pagadian-Cebu -8.38 -21.87 -58.08 -100.00 Cebu-Puerto Princesa-Cebu -100.00 Cebu-Surigao-Cebu -24.39 -9.29 -63.52 -100.00 -1.37 Cebu-Tagbilaran-Cebu -45.06 -74.44 -98.62 -100.00 Cebu-Tandag-Cebu -2.60 4.36 -60.71 -100.00 9.87 45.71 Cebu-Zamboanga-Cebu -36.20 3.13 -51.54 -93.37 Cotabato-Zamboanga-Cotabato -30.90 17.33 -100.00 159.57 19.86 Davao-Zamboanga-Davao 6.37 37.61 -61.75 -100.00 -20.15 -100.00 Dipolog-Zamboanga-Dipolog -0.51 -8.37 -62.08 -100.00 193.13 Iloilo-Puerto-Princesa-Iloilo -3.86 -2.10 -68.90 -100.00 Pagadian-Zamboanga-Pagadian -13.03 -20.78 -66.55 -100.00 Tacloban-Cebu-Tacloban -23.16 -12.96 -68.04 -100.00 Tawi-Tawi-Zamboanga-Tawi-tawi -17.25 -18.92 -66.25 -100.00 *1999 data for PAL is up to 3rd quarter only, except Davao and Cebu . Sources: Civil Aeronautics Board and Airlines. AIR TRANSPORT INDUSTRY 249

Appendix Table 5. Measure of Degree of Competition, per Points Served, 1990-1999 Herfindahl-Hirschman Country Points Index (HHI) 1/HHI 1990 1995 1999 1990 1995 1999 Australia Brisbane 1.00 1.00 1.00 1.00 Melbourne 1.00 1.00 1.00 1.00 Sydney 0.53 0.50 1.00 1.90 2.00 1.00 Bahrain Bahrain 1.00 1.00 1.00 1.00 1.00 1.00 Brunei Brunei 0.64 0.61 1.00 1.57 1.64 1.00 Canada Canada 1.00 1.00 China Macau 1.00 1.00 Peking 1.00 1.00 Xiamen 1.00 1.00 1.00 1.00 Egypt Cairo 1.00 1.00 1.00 1.00 1.00 1.00 Federated States of Micronesia Pohnpei 1.00 1.00 France Paris 1.00 0.60 1.00 1.00 1.67 1.00 Germany Frankfurt 0.50 0.53 1.99 1.87 Guam Guam 1.00 0.98 0.87 1.00 1.02 1.15 Hong Kong Hong Kong 0.44 0.40 0.47 2.27 2.48 2.12 Hong Kong/ Cebu 0.54 1.00 1.86 1.00 India New Delhi 1.00 1.00 Indonesia Jakarta 1.00 0.58 1.00 1.72 Menado 1.00 1.00 1.00 1.00 Italy Rome 1.00 1.00 1.00 1.00 Japan Fukuoka 1.00 1.00 1.00 1.00 Nagoya 1.00 1.00 Okinawa 1.00 1.00 Osaka 1.00 0.39 0.59 1.00 2.54 1.71 Osaka/Cebu 1.00 1.00 1.00 1.00 Tokyo 0.28 0.33 0.30 3.56 3.05 3.33 Tokyo/ Cebu 1.00 1.00 1.00 1.00 Korea Seoul 0.37 0.26 0.41 2.72 3.78 2.43 Kuwait Kuwait 1.00 1.00 1.00 1.00 1.00 1.00 Malaysia Kota Kinabalu 0.68 0.53 1.00 1.46 1.88 1.00 Kuala Lumpur 0.49 0.56 0.81 2.06 1.78 1.23 Kuching 1.00 1.00 1.00 1.00 Nauru Republic Nauru 1.00 1.00 1.00 1.00 1.00 1.00 Netherlands Amsterdam 0.59 0.99 1.00 1.70 1.01 1.00 Oman Muscat 1.00 1.00 1.00 1.00 Pakistan Karachi 0.88 1.00 1.14 1.00 Papua New Guinea Port Moresby 1.00 1.00 1.00 1.00 Qatar Doha 1.00 1.00 1.00 1.00 Note: Herfindahl index is based on market share. source: Civil Aeronautics Board. 250 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix Table 5 (continued) Herfindahl-Hirschman Country Points Index (HHI) 1/HHI 1990 1995 1999 1990 1995 1999 Saudi Arabia Dharan 1.00 0.64 0.52 1.00 1.57 1.92 Jeddah 0.94 0.58 1.00 1.07 1.72 1.00 Riyadh 0.50 0.52 0.71 2.00 1.91 1.41 Singapore Singapore 0.51 0.52 0.52 1.97 1.94 1.94 Switzerland Geneva 1.00 1.00 1.00 1.00 Zurich 1.00 1.00 1.00 1.00 1.00 1.00 Taiwan Kaohsiung 0.55 1.00 1.82 1.00 Taipei 0.47 0.30 0.38 2.15 3.31 2.65 Thailand Bangkok 0.31 0.27 0.83 3.23 3.71 1.21 United Arab Emirates Abu Dhabi 1.00 0.90 1.00 1.00 1.11 1.00 Dubai 0.59 0.54 1.00 1.69 1.86 1.00 United Kingdom London 0.50 0.50 1.00 1.98 1.99 1.00 United States of America Chicago 1.00 1.00 1.00 1.00 Los Angeles 1.00 1.00 1.00 1.00 1.00 1.00 San Francisco 0.32 0.46 0.53 3.10 2.18 1.87 Honolulu 0.99 1.00 1.01 1.00 Vietnam Hanoi 1.00 1.00 Saigon 1.00 1.00 1.00 1.00 Note: Herfindahl index is based on market share. source: Civil Aeronautics Board.

Appendix Table 6. PAL’s Major Destination Points,1990,1995,1999 Points served 1990 Points served 1995 Points served 1999 Passenger% Share Passenger % Share Passenger % Share Hong Kong 354,787 22.4 Hong Kong 519,330 21.6 Hong Kong 388,483 29.5 Tokyo 217,338 13.7 Los Angeles 249,710 10.4 Tokyo 185,026 14.0 Los Angeles 140,187 8.8 Tokyo 249,108 10.3 Los Angeles 168,376 12.8 Singapore 126,388 8.0 Taipei 179,980 7.5 San Francisco 134,115 10.2 Taipei 126,054 7.9 San Francisco 155,292 6.4 Singapore 80,283 6.1 San Francisco 116,797 7.4 Singapore 118,567 4.9 Taipei 72,300 5.5 Riyadh 76,159 4.8 Seoul 91,416 3.8 Seoul 64,236 4.9 Bangkok 71,401 4.5 Sydney 71,908 3.0 Osaka 38,170 2.9 Sydney 48,235 3.0 Bangkok 69,160 2.9 Fukuoka 34,194 2.6 Dharan 43,571 2.7 Honululu 63,372 2.6 Dharan 24,526 1.9 Others 264,855 16.7 Others 641,798 26.6 Others 128,530 9.8 Total 1,585,772 100.0 Total 2,409,641 100.0 Total 1,318,239 100.0

Source: Civil Aeronautics Board. AIR TRANSPORT INDUSTRY 251

Appendix Table 7. Spearman Rank Correlation Test for Herfindahl-Hirschman Index and Market Share to Tourists Arrival, 1995 Country Herfindahl-HirschmanIndex (HHI) Share to Visitors Arrival (%) d2 HHI Rank% Share Rank United States of America 0.476 13 21.251 1 144 Hong Kong 0.412 14 20.071 2 144 Taiwan 0.320 15 11.826 3 144 South Korea 0.264 18 7.549 4 196 Japan 0.283 16 6.654 5 121 Australia 0.563 8 4.713 6 4 United Kingdom 0.502 11 4.384 7 16 Germany 0.534 9 3.153 8 1 Malaysia 0.568 7 2.171 9 4 Singapore 0.516 10 1.697 10 0 France 0.600 5 1.121 11 36 Switzerland 1.000 1.5 0.915 12 110 Thailand 0.270 17 0.881 13 16 Italy 0.999 3 0.791 14 121 Indonesia 0.500 12 0.790 15 9 Netherlands 0.993 4 0.758 16 144 Saudi Arabia 0.578 6 0.752 17 121 China 1.000 1.5 0.534 18 272.3 Sources: Table 12 and 17. Σ 2 2 Spearman rank correlation test: Rs = 1 - [(6 di ) / n(n -1)] = -0.6548 α where di = difference between the ranks; n= number of samples. The test was significant at = 0.05.

Appendix Table 8. Spearman Rank Correlation Test for Herfindahl-Hirschman Index and Market Share to Tourists Arrival, 1999 Country Herfindahl-HirschmanIndex (HHI) Share to Visitors Arrival (%) d2 HHI Rank% Share Rank United States of America 0.509 12 23.518 1 121 Japan 0.276 17 19.658 2 225 Hong Kong 0.472 14 8.124 3 121 Taiwan 0.419 15 7.295 4 121 South Korea 0.411 16 6.751 5 121 United Kingdom 1.000 4 4.511 6 4 Australia 1.000 4 3.943 7 9 Canada 1.000 4 3.297 8 16 Singapore 0.515 11 2.600 9 4 Malaysia 0.855 8 2.520 10 4 France 1.000 4 1.241 11 49 China 0.503 13 1.076 12 1 Netherlands 1.000 4 0.872 13 81 Switzerland 1.000 4 0.841 14 100 Indonesia 1.000 4 0.834 15 121 Thailand 0.825 9 0.817 16 49 Saudi Arabia 0.714 10 0.580 17 49.0 Sources: Table 12 and 17. Σ 2 2 Spearman rank correlation test: Rs = 1 - [(6 di ) / n(n -1)] = - 0.4657 α where di = difference between the ranks; n = number of samples. The test was significant at = 0.05. 7 CHAPTER

Analysis of the State of Competition and Market Structure of the Banking and Insurance Sectors

Melanie S. Milo

ABSTRACT

his paper looks at how competition and efficiency in the financial services sector, particularly the banking and insurance industries, have been affected by the regulatory regime and market structure. To begin, an overview of how Tfinancial policy in the Philippines evolved over time is given. The interaction between regulation and competition is also shown through a description of the principal statutory regulations that affect the banking and insurance industries to date. Then, the discussion of the changes in financial policy is augmented by looking at their impact on the structure of the financial system in the third section. The monitoring of structural change in the financial system is done through the use of indicators of changes in competitive structure and indicators of gains in competitive efficiency implicit in financial market performance. In the fourth section, financial sector regulations and their impact on market structure are assessed in the context of competition policy elements and principles that have been identified in the literature. Some emerging competition policy issues that need to be analyzed further are also presented. Finally, some conclusions are presented in the last section. 254 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

INTRODUCTION

A successful financial market is characterized as being simultaneously sound and competitive. On the one hand, a competitive but unsound financial system is unsustainable because its lack of soundness will ultimately cause the system to break down. On the other hand, a sound but uncompetitive financial system will lead to inefficiencies in both the financial system and the entire economy. Both cases will have delete- rious effects on the economy’s growth performance and society’s welfare. The major issue confronting financial regulation then is how to balance the need for both soundness and competitiveness. In most markets, simply removing state-imposed barriers would improve competition. But in financial markets, some form of regulation is necessary to protect the competitive process and the reputation and soundness of the financial system (Grimes 1999). The regulation of the Philippine financial services sector, particularly the banking sector, has undergone considerable change in the last two decades. On the one hand, there has been the removal of certain regulations such as direct controls on interest rates and there has also been a substantial relaxation in other regulations such as restrictions on entry, lines of business, and portfolios. The overall objective of such deregulatory reforms was to promote competitive conditions to foster greater efficiency in the financial sector. On the other hand, there has also been a strengthening of prudential regulation, which was justified as necessary to protect depositors and to preserve the stability of the payments system. The design, implementation, and enforcement of regulatory rules have expectedly affected the structure and nature of the Philippine financial services sector, especially since they continue to impose important constraints on the ownership and business powers of financial institutions. This, in turn, has important implications for the competitive process in the financial services sector and ultimately the type, quality, and price of the products offered to consumers and business users. This chapter looks at how competition and efficiency in the financial services sector, particularly in the banking and insurance industries, have been affected by the regulatory regime and market structure. The regulatory framework itself is an important determinant of the structure of the financial system. The following section gives an overview of public policy toward the financial system, with particular focus on the role of competition policy as an instrument for improving the efficiency and functioning of the financial system beginning in the 1980s. The section then shows the interaction between regulation and competition through a description of what is regulated and what is left to the market. In particular, it describes the current principal statutory regulations that affect the banking and insurance industries. Because the application of competition policy is significantly more advanced in the commercial banking sector, it can give important lessons and insights on how to develop competition policy for the other sectors of the financial system, as well as an overall competition policy for the Philippines. The insurance sector is important because of the potential role that it can play in the development of the Philippine capital markets. BANKING AND INSURANCE 255

It is useful to monitor the evolution of deregulatory policies in order to identify areas that inhibit the working of market forces in financial markets. However, monitoring steps already taken in relation to remaining regulations does not give a clear/ full picture of the extent to which playing fields are being leveled in practice. Thus, policy changes need to be considered in parallel with changes in the competitive structure of the financial sector. This is the focus of the third section. In particular, structural change in the banking and insurance sectors is monitored through the use of various indicators of changes in competitive structures and gains in competitive efficiency implicit in financial market performance. While the application of competition policy in the banking sector has been fairly extensive and intensive, it is not yet complete and some competition policy issues remain. In contrast, reform of the private insurance industry occurred only in the mid- 1990s and regulation remains highly restrictive. Thus, there are also continuing competition policy issues in the insurance sector that need to be addressed to further enhance competitiveness and efficiency in the sector. Finally, an efficient financial system also requires an efficient regulatory structure. Two aspects that need to be considered are the appropriate regulatory framework for the financial sector as a whole, and the application of a national competition policy framework to the financial sector. These competition policy issues are the focus of the fourth section. Some conclusions and policy implications are then presented in the fifth and final section.

REGULATORY FRAMEWORK

POLICIES TOWARD AN EFFICIENT FINANCIAL SYSTEM: WIDENING THE SCOPE FOR COMPETITION Following more than 30 years of repressionist financial policies from the time the Central Bank of the Philippines (CBP) began operations in 1949, the Philippines formally embarked on a financial liberalization program in the early 1980s as part of an overall structural adjustment program.1 It included the gradual liberalization of interest rates from 1981 to 1983; the easing of restrictions on the range of operations financial institutions were allowed to conduct in the domestic markets, including the introduction of universal banking in 1980; and rationalization of financial market regulations, including higher capital requirements for banks and nonbank quasi- banks (NBQBs) (Remolona and Lamberte 1986). ______

1 In its original sense, financial liberalization refers to the substantial reduction of government intervention in setting interest rates and allocating credit. In the subsequent discussions, financial liberalization, financial deregulation and financial reform are used interchangeably to refer to all measures that are designed to encourage and to provide more scope for the working of market forces and competition in the financial sector. For a fuller discussion of the evolution of financial policy in the Philippines from the 1950s to the 1990s, see Milo (2000). 256 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

But soon after the start of financial liberalization, the financial system underwent a crisis of confidence, which was triggered by the defaults of a prominent business- man who fled the country in 1981, and compounded by a series of investment frauds and stockbroker failures (Laya 1982). The financial crisis deepened as a result of the political and economic crises in 1983-1985, which led to significant financial shallowing (World Bank 1986). An important lesson that emerged from the experience, which also proved true in other developing countries that undertook financial liberalization, was that there were prerequisites to a successful financial liberalization. The two most commonly cited factors were macroeconomic stability and adequate prudential regulation/supervision (Cho and Khatkhate 1989). As a result, subsequent financial reforms in the Philippines began to incorporate the imposition and/or tightening of regulations for prudential reasons, simultaneously with deregulatory reforms. Financial reforms were resumed in 1986, which specifically addressed problems endemic to the system since the 1960s, and further highlighted by the earlier reform effort and financial crisis. These included the interlinked problems of fraud or insider abuse by bank owners or officers and inadequate/ineffective prudential supervision and regulation of banks. Thus, policy reforms effecting prudential bank management included increased minimum capitalization requirements; compliance with minimum risk asset ratios; single borrower’s limit; limit on loans to directors, officers, stockholders, and related interests (DOSRI); limits on allowable interlocking directorships and officerships; provisions for loan loss or doubtful accounts; audit and reporting requirements; and stricter bail-out policy of problematic banks (Bautista 1992). The government also rehabilitated ailing financial institutions, notably the government-owned banks and rural banks. However, the problem was not just the lack of prudential rules, but a weakened CBP—both financially and politically. And a strong central bank, which effectively carries out its role of supervising financial institutions, is a prerequisite for a stable financial system (World Bank 1988). Thus, the CBP was likewise rehabilitated in 1993, with the creation of a new, independent Central Monetary Authority called the Bangko Sentral ng Pilipinas (BSP). Other banking reforms implemented in the 1990s included the deregulation of entry of new domestic banks and of domestic bank branching in 1993, which were further rationalized in 1995, and the easing of restriction on the entry of foreign banks in 1994. The government also moved to reduce its direct participation in the banking system by privatizing five of the six banks that it took over during the crises in the 1980s. The Philippine National Bank (PNB) also passed into majority private ownership in 1995. Deregulation of entry was an especially important reform because it was a necessary complement to the removal of interest rate ceilings. As noted by Blundell- Wignall and Ishida (1990), the impact of removing interest rate ceilings is dependent on the degree of competitive pressure. Competition for deposits may not improve if BANKING AND INSURANCE 257 there is no serious threat of entry into the banking system, or if other regulations, such as those concerning branching, become binding constraints. Particularly noteworthy was the continued fixity of the interest rate on savings deposits after interest rates liberalized, which had been attributed to some monopoly power of the large commercial banks (Tan 1989). Thus, a review of the Philippine financial sector following the reforms in the 1980s still identified the lack of competitive behavior among banks as an important feature needing reform (World Bank 1988). There was also an effort to expand the coverage of financial sector reforms in the second half of the 1990s. It was recognized that the predominance of bank loans in corporate financing was one of the factors that complicated the Philippines’ financial liberalization program in the early 1980s. The East Asian crisis also highlighted the dangers of a bank-dominated financial system. Thus, there was a need to improve the competitiveness of other financial institutions to provide savers and borrowers with alternatives to banks. It was also recognized that the country’s sustained growth performance required substantial mobilization of domestic resources from nonbanking sources. A more robust capital market that can efficiently mobilize and allocate long- term resources would greatly contribute to this (World Bank 1992). Reforms in the other sectors of the Philippine financial system included the liberalization of entry into the private insurance industry in 1996, and efforts to develop the equity markets such as the unification of the Manila and Makati Stock Exchanges to form the Philippine Stock Exchange in 1994. In particular, the liberalization of foreign investments and foreign exchange transactions in the 1990s had a significant impact on the development of the capital markets (Lamberte 1995). Republic Act (RA) 8366, or the Investment Houses Law, was enacted in October 1997, which increased the maximum foreign equity participation in investment houses from 40 to 60 percent and raised the minimum capital requirement. The Financing Act of 1998 (RA 8556) also raised the maximum foreign equity participation in financing companies to 60 percent and the minimum capital requirement. Adjustments in the right direction were taking place in the financial sector. Unfortunately, the 1997 Asian financial crisis disrupted the process of reform and adjustment. The 1997 Asian financial crisis again emphasized the importance of an efficient and well-developed financial system, as well as adequate prudential regulation and supervision of financial intermediaries, in the context of increasing deregulation and globalization of capital markets. Two important bills that were passed in the aftermath of the Asian crisis were the General Banking Law of 2000 (RA 8791) and the Securities Regulation Code (RA 8799) enacted two months after in July 2000. Both aimed to address some weaknesses, particularly in the regulatory frameworks governing banks and the securities market. The rationale behind the various financial sector reforms that have been implemented in the Philippines was precisely to improve the workings of the financial system. In particular, a move away from interventionist and repressionist policies toward freeing up the system from various restrictions was seen as growth promoting. Policies to reform the financial sector evolved gradually over time, with reforms 258 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES building on earlier reforms. However, the reform process was far from smooth and was fraught with difficulties. But despite some frictions in its operation, a deregulated (albeit also properly supervised) financial sector is still superior to a publicly managed one. For instance, the relative resilience of the Philippines to the ill effects of the Asian crisis was partly attributed to the financial sector reforms that had already been implemented, particularly the consecutive increases in the minimum capital requirements of banks and tighter prudential regulation. Financial liberalization is a process and not a one-off episode, and it necessarily takes time for governments to implement reforms and for institutions to adjust to these reforms. The key is to deepen the reforms in order for the expected benefits of financial liberalization to be fully realized, even as the government works to promote macroeconomic stability.

CURRENT REGULATIONS AND RESTRICTION The previous section briefly discussed public policy toward the Philippine financial system, particularly the role of competition policy in enhancing the efficiency and functioning of financial institutions and markets. It included a wide range of domestic deregulation as well as external liberalization measures, such as the abolition of interest rate and other price controls, and the easing of restrictions on the range of operations that financial institutions are allowed to conduct in the domestic and international markets, new entry restrictions, and other obstacles to the functioning of financial markets. The overall disposition of authorities toward the development of markets and intensifying competition also forms part of such policies (Broker 1989). Thus, most of the current regulations in the Philippine banking sector are justified for prudential reasons, that is, to protect the stability and soundness of the financial system. While it is recognized that prudential regulations can be anticompetitive, some limited level of prudential regulation can also promote competitive forces (Grimes 1999). The 1990s experience again emphasized the importance of adequate prudential regulation and supervision of financial intermediaries, especially given the increasingly global nature of capital markets. Current banking regulation also aims to address longstanding weaknesses in the sector, particularly the presence of many small banks, and concentration of ownership and the related issue of insider abuse. The following subsections review the current principal statutory regulations in the banking and insurance sectors. Specifically, they highlight the interaction between regulation and competition by describing what areas/activities are regulated and what are left to the market.

Banking sector RA 337 or the General Banking Act of 1948, as amended, used to be the primary governing law for the commercial banking sector. A recent amendment to this Act was RA 7721, which partially liberalized the entry and scope of operations of foreign banks in the Philippines and which was enacted in 1994. It was only in May 2000 that BANKING AND INSURANCE 259 a new general banking law, RA 8791 or the General Banking Law of 2000, was enacted. The new general banking law was deemed necessary and overdue given the significant changes both in the domestic and international environments. Its goal was to “promote and maintain a stable and efficient banking and financial system that is globally competitive, dynamic, and responsive to the demands of a developing economy” (Sec. 2). An important element of this Law was the adoption and incorporation of internationally accepted standards and practices into the BSP’s supervisory processes. In addition, RA 7653 or the New Central Bank Act of 1993 defined the BSP’s general functions, operations and powers relating to the banking sector and other financial institutions. Finally, there are also specific legislations that govern the lending activities of banks. The major regulations and restrictions currently in operation in the commercial banking sector are as follows2:

1. Restrictions on branching and new entry (including the entry of foreign banks)3 Restrictions on branching and entry of new domestic and foreign banks were significantly eased only from 1993 to 1995. New domestic banks, satisfying the laws of incorporation as approved by the Monetary Board, could be established as long as they meet minimum capital and other prudential requirements. Geographical restrictions on domestic bank branching were lifted in 1993, and branches could be established anywhere subject to certain prudential requirements, such as those on capital adequacy, liquidity, profitability, and soundness of management (Paderanga 1996). However, licensing of domestic bank branches still needed the prior approval of the Monetary Board, which continued to retain discretionary powers (Lamberte and Llanto 1993). RA 7721, which was enacted in May 1994, partially liberalized the entry and scope of operations of foreign banks in the Philippines. In particular, foreign banks were authorized to operate in the Philippines through any one of the following modes of entry: (i) acquire, purchase or own up to 60 percent of an existing domestic bank; (ii) invest in up to 60 percent of the voting stock of a new banking subsidiary incorporated in the Philippines; or (iii) establish a branch with full banking authority. The third mode of entry was operative for only five years from the date of effectivity of the Act, and was limited to only 10 foreign banks. Each of the 10 foreign banks was entitled to six branches—three in locations of its choice and three in locations to be designated by the Monetary Board. The four foreign banks operating through branches in the Philippines upon the effectivity of the Act were also accorded the same branching privilege. ______

2 This section also draws on the BSP’s Manual of Regulations for Banks (1996) and on more recent circulars and resolutions. 3 For a fuller discussion of bank entry and branching regulations and their impact on competition, see Milo (2001). 260 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

For a foreign bank to be able to establish a branch or a subsidiary, it had to be among the top 150 banks in the world or the top five banks in its country of origin. Furthermore, it had to be widely owned and publicly listed in its country of origin, or the government of its country of origin must own more than 50 percent of its capital stock. At least 50 stockholders, none of whom owns more than 15 percent of the capital stock, are required for a foreign bank to be considered as widely owned. However, in August 1999, the BSP again declared an indefinite moratorium on the establishment of new domestic banks, and the branch expansion of existing banks but excluding microfinance-oriented banks.4 The foreign banks were exempted from the moratorium on local branch expansion, although the limit of six new branches remained. This policy, together with mandated consecutive increases in minimum capital requirements of banks, reflected the BSP’s preference for and strategy of forcing more mergers and acquisitions to reduce the number and increase the average size of banks in the Philippines. Consolidation is in turn expected to result in a stronger and more stable banking system. Thus, prospective investors were encouraged to acquire existing banks instead of applying for new operating licenses, while banks wishing to expand could do so by taking over smaller banks. The BSP Governor had expressed concern over the large number of banks in the Philippines, and noted that a few strong banks would be good for the industry, the economy, and eventually, the consumers. He put forward a five-year scenario wherein four to six local banks, together with the 14 existing foreign banks, would dominate 80 percent of the industry’s resources. The remaining smaller banks, on the other hand, could either develop into niche players or be weeded out of the system. In accordance with RA 7721, the Philippines last granted licenses to 10 new foreign bank branches in 1995, which brought the total number of foreign bank branches in the country to 14.5 There have also been seven new locally incorporated foreign bank subsidiaries. With the reimposed moratorium on the entry of new banks, the only alternative for foreign banks to enter the domestic industry is to buy into existing domestic banks. Again, this fitted in with the BSP’s push for more mergers and acquisitions in the banking system. The BSP has designated a critical role for foreign banks in its effort to consolidate the banking sector, that is, foreign buy-ins were especially encouraged. More consolidation and more openness to foreign banks were seen as positive factors for the Philippine banking system. In particular, a strong foreign banking presence—with credibility and capital—would result in improved efficiency and help stabilize the system during times of stress.

______

4 Monetary Board Resolution No. 1224 dated 27 August 1999. 5 Bank of China was granted a license in 2000, replacing Development Bank of Singapore which surrendered its license to buy 60 percent of Philippine-based Bank of Southeast Asia in 1998. BANKING AND INSURANCE 261

While the drafters of RA 7721, as well as the BSP, recognized the role of foreign banks in creating a more competitive environment, the intention was not for them to dominate the local banks. RA 7721 also expressly stated that, “In allowing increased foreign participation in the financial system, it shall be the policy of the State that the financial system remain effectively controlled by Fili- pinos” (Sec. 1 para. 3). In fact, the Act required that control of at least 70 percent of the resources or assets of the entire banking system be held by domestic banks that are majority owned by Filipinos. In that sense, RA 7721 was even more restrictive than RA 337, which did not contain such a provision although it also intended to keep foreign participation in the domestic banking sector to a minority. Both past and incumbent BSP Governors, while amenable to the idea of another round of banking sector liberalization, also made the point that it should be legislated such that some “macroeconomic” protection would be retained for the local banks, such as imposing a time period for allowing 100 percent foreign ownership of existing domestic banks. RA 8791, or the General Banking Law of 2000, formalized the moratorium on new bank entry by stipulating that “no new commercial bank shall be established within three years from the effectivity of this Act” (Sec. 8.3). It also tightened the licensing requirement by including an assessment of the bank’s ownership structure, directors and senior management in the licensing process (Sec. 8.3). RA 8791 also expanded the coverage of RA 7721 by allowing a foreign bank to acquire up to 100 percent of the voting stock of (only) one bank, but only within seven years from the effectivity of RA 8791. This included foreign banks that have acquired 60 percent of the voting stock of a bank under RA 7721. Furthermore, RA 8791 contained the same provision as RA 7721, requiring the Monetary Board to ensure that banks which are majority owned by Filipinos control 70 percent of the resources or assets of the entire banking system. The rationale for this restriction is not explicitly stated in both Acts. Even if it is imposed for nationalistic reasons, its merit in the context of competition and efficiency needs to be established. It is not clear how such a restriction addresses the primary concerns of efficiency and soundness of the banking sector. Overall, government barriers to entry are typically imposed to limit and reduce the number, as well as increase the average size of banks in the Philippines. Bigger and fewer banks, in turn, are seen to promote the safety and soundness of the financial system. But it is also recognized that their removal would enhance market contestability and the competitive process. A balance needs to be struck between the potential costs and potential benefits of allowing greater competition. In particular, the potential adverse effects of enhancing competition through a lowering of barriers to entry can be addressed by properly applying prudential regulations and restrictions such as those currently in place, especially the fitness and properness criteria for bank owners and managers. The focus should not just be the size of banks per se, but whether they are sound, competitive, and efficient. 262 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

2. Restrictions on pricing (interest rate controls and other controls on prices or fees) There are currently no statutory or regulatory controls that affect the behavior of banks in this area. Interest rates on all deposits and loans have been liberalized since 1983, and are now essentially market determined. The rediscount rate was also re- aligned to reflect prevailing market rates. The BSP influences interest rates through indirect mechanisms, such as its overnight rates. However, as a result of the Asian financial crisis, the BSP entered into an informal arrangement or “gentleman’s agreement” with the Bankers Association of the Philippines (BAP) to bring down interest rates to support the government’s efforts in stimulating investments and growth: banks agreed to keep lending rates 1.5-6 percentage points above the 91-day Treasury bill rate, which the BSP supported by reducing reserve requirements in order to help bring down banks’ intermediation costs, although the BSP was also prepared to impose sanctions on banks that violated the spread. This course of action clearly went beyond moral suasion and represented direct intervention in normal market mechanisms. Instead, the BSP should seek to develop other instruments and build up its technical capacity to maintain monetary control in an increasingly sophisticated financial world, as well as to induce the domestic financial system to intermediate more efficiently. RA 8791 also contained a general provision that allows the Monetary Board to prescribe the terms and conditions for various types of bank loans and other credit accommodations, “taking into account the requirements of the economy for the effective utilization of long-term funds” (Sec. 43). Thus, this aspect has once again become potentially subject to regulation.

3. Line-of-business restrictions and regulations on ownership linkages among financial institutions Table 1 presents the activities and functions that the different types of banks are authorized to undertake. Reforms in the early 1980s to reduce the enforced specialization of financial institutions and to broaden the range of their services significantly streamlined the different types and functions of banks. The result was a more flexible and dynamic institutional structure. Ownership ceilings are currently still in place, which were originally aimed to widen the ownership base of commercial banks in particular, and hence, mitigate the problem of insider abuse. Compared to RA 337 as amended, however, the ceilings set by RA 8791 are less restrictive but have stricter disclosure requirements. Previously, under the old General Banking Act, a Filipino individual and/or family group (individuals related up to the 3rd degree of consanguinity or affinity) could not own more than 20 percent of a domestic bank, while the ceiling for domestic corporations (not wholly or majority owned by an individual or family group) was set at 30 percent. RA 7721 then accorded Philippine corporations, banks and nonbanks that are listed in the stock exchange, or are of good standing for at least ten years, the same right as foreign banks to own up to 60 percent of the voting stock of a domestic bank, although they BANKING AND INSURANCE 263

Table 1. Authorized Activities According to Type of Bank Activities Universal Commercial Thrift Rural Banks Banks Banks Banks A. Commercial banking services 1. Accept deposits A A A A 2. Issue LCs and accept drafts A A A1 C2 3. Discounting of promissory notes and commercial papers A A C C 4. Foreign exchange transactions A A A P 5. Lend money against security A A A C B. Equity investments in allied undertakings A A C C C. Equity investments in non-allied undertakings A P P P D. Trust operations C C C C E. Issue real estate and chattel mortgage bonds, buy and sell these for its own account, accept/receive in payment or as amortization on loans A A C P F. Activities of investment houses 1. Securities underwriting A S P P 2. Syndication activities A A C C 3. Business development and project implementation A A C P 4. Financial consultancy and investment A A C P 5. Lease real and/or personal properties A S P P G. Money market operations A A C C3 Note: A - Authorized activites C - Conditional/Authorized but subject to BSP approval P - Prohibited S - Through a subsidiary 1 Limited only to domestic Letters of Credit and drafts. 2 Limited to domestic drafts. 3 Limited to money market placements. Sources: Lamberte and Llanto (1993); Bangko Sentral ng Pilipinas. could do so for only one domestic bank in both cases. With respect to foreign equity held by an individual, a nonfinancial entity, or a nonbank financial entity not owned or controlled by the bank, its subsidiary or holding company, the ceiling on total foreign equity participation in a domestic bank was 30 percent. This was upgradeable to 40 percent subject to the President’s approval. Under the new General Banking Law, the ownership ceilings were simplified and unified. Filipinos and domestic nonbank corporations are now subject to the same rule as foreign individuals and nonbank corporations, that is, they may own or control up to 40 percent of the voting stock of a domestic bank. RA 8791 explicitly defines family groups and related interests, whose stockholdings must be fully disclosed in all their 264 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES transactions with the bank. Individuals related to each other within the fourth degree of consanguinity or affinity, legitimate or common law, are considered as a family group or related interests, while two or more corporations owned or controlled by the same family group or same group of persons are considered as related interests. The citizenship of a corporation is now determined based on the citizenship of the controlling stockholders of the corporation, regardless of the place of incorporation (Secs. 11-13). The simplified, more uniform, and even higher ownership ceilings make for easier monitoring because of greater transparency, especially since it is very difficult to uncover indirect ownership through individuals or companies where no visible connection is evident. On the other hand, tighter disclosure requirements shift the burden of regulation to the banks themselves. Recent developments, particularly Lucio Tan’s announcement that he had gained ownership or control of 46 percent of PNB through direct ownership and proxies, which was more than double the ceiling at that time, validate the necessity of tightening disclosure requirements for family and corporation ownership of bank shares. One loophole that the BSP recently addressed was the disclosure of ownership of shares of stock lodged with the Philippine Central Depository (PCD), the country’s securities storehouse. Previously, such shares were just recorded as being held by a “PCD nominee,” since the PCD was supposed to hold such accounts for brokers for only a few days. It was the brokers who knew the ownership details. The BSP now requires all bank corporate secretaries to disclose the ultimate beneficial owners of their respective banks’ shares in their consolidated list of stockholders which is reported quarterly. There are also current restrictions on interlocking directorships and/or officerships within the Philippine financial system. Interlocking facilitates collusion and the lobbying process (Tan 1991). Thus, such restrictions were also deemed necessary to safeguard against the exercise of undue influence over the operation and management of similar financial institutions by the same person or group of persons, which could have an adverse effect on competition or result in conflicts of interest situations. However, there are no restrictions on interlocking directorates among banks and nonfinancial corporations. It is the latter that has implications on resource allocation (Tan 1991).

4. Restrictions on the portfolio of assets that banks can hold (such as requirements to hold certain types of securities or requirements not to hold other securities, including requirements not to hold the control of nonfinancial companies) Table 2 presents the ceilings on equity investments of universal and commercial banks under the new General Banking Law. Universal banks may invest in the equities of both allied and nonallied enterprises, while commercial banks are limited only to allied enterprises. Both are subject to the prior approval of the Monetary Board. Overall, the ceilings have been relaxed under the new law. BANKING AND INSURANCE 265

Table 2. Limits on Equity Investments of Commercial and Universal Banks Activities Commercial Banks Universal Banks Allied enterprises Financial allied undertakings1 100% 100% Commercial/Universal Banks 100%2 100%2 Thrift banks 100% 100% Rural banks 100% 100% Investment houses 100% 100% Others (leasing, credit card venture companies, etc.) 40% 100% Insurance companies 0 51% Nonfinancial allied undertakings 100% 100% Nonallied undertakings Agriculture 0 35% Manufacturing 0 35% Public Utilities 0 35% Other ceilings Equity investment in any single Enterprise 25% of net worth 25% of net worth Max. amount of equity investments 35% of net worth 50% of net worth Notes: 1 To promote competitive conditions, the Monetary Board may further limit equity investments of universal and commercial banks in quasi-banks to 40 percent. 2 For publicly listed universal or commercial banks; limited to only one other universal or commercial bank. Otherwise, the equity investment of a commercial bank in other financial allied enterprises, including another commercial bank, is limited to a minority holding. Source: Bangko Sentral ng Pilipinas.

Limits on loans, credit accommodations and guarantees continue to be imposed on banks for prudential reasons, such as to avoid the concentration of credit in favor of a few individuals or groups. In this area, RA 8791 is stricter and affords the Monetary Board greater authority to govern such loans. The single borrower limit stipulates that the total credit commitment of a bank to any person, partnership, association, corporation, or other entity shall not exceed 20 percent of the bank’s net worth. Previously, the limit was 25 percent. This could be increased by an additional 10 percent subject to certain conditions, such as the additional liabilities being adequately secured. The limits on loans to DOSRI were also tightened to make insider abuse more difficult. In particular, RA 8791 requires loans to a director or officer of a bank to be approved by the majority of the directors of the bank, excluding the director concerned, and reported to the supervising and examining department of the BSP. The 266 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES new General Banking Law’s inclusion of two independent directors in a bank’s board of directors, who are not officers or employees of the bank, its subsidiaries or affiliates, or related interests, was meant to further minimize the risks associated with DOSRI loans. The total outstanding credit accommodation should not exceed the unencumbered portion of a DOSRI’s outstanding deposits plus the book value of his paid-in capital contribution in the lending bank. The definition of a DOSRI loan was also expanded to include investments of the bank in enterprises owned or controlled by the respective DOSRI. DOSRI borrowers are also required to waive the secrecy of their deposits in all banks in the Philippines. In addition, loans and other credit accommodations against real estate should not exceed 75 percent of the appraised value of the real estate security, plus 60 percent of the appraised value of the insured improvements. Previously, the ceiling was 60 percent. There is also an aggregate limit on real estate loans of commercial banks, which is 20 percent of their respective total loan portfolio. These two provisions were imposed in May 1997, just before the outbreak of the Asian financial crisis. As noted earlier, the policy of despecialization by widening the range of permissible activities and products of financial institutions aimed to enhance competition and efficiency in the financial sector. Financial institutions were thus accorded greater flexibility in responding to new business opportunities under changing demand and supply conditions. However, the separation of some securities-related activities from commercial banking has also been justified based on perceived conflict of interest reasons and concerns relating to the concentration of power in the financial sector (Broker 1989). In fact Yap et al. (1990) found that the interlocking of commercial banks with investment institutions increased the relative importance of some banks and made the money market less diversified. The restrictions on ownership, and interlocking directorships and officerships were meant to address these concerns. Furthermore, RA 8791 accorded the BSP authority to examine an enterprise that is wholly or majority owned or controlled by the bank (Sec. 7). The corresponding provision in RA 7653 is more defined and restrictive, in that it also allows the BSP to supervise and examine banks and quasi-banks’ subsidiaries (i.e., corporations where a bank or quasi-bank owns more than 50 percent of the voting stock) and affiliates (i.e., corporations where a bank or quasi-bank owns 50 percent or less of the voting stock, or is related or linked through common stockholders or other such factors as may be determined by the Monetary Board) engaged in allied activities (Sec. 25). These restrictions and provisions, together with the limits on loans and credit accommodations, are intended to mitigate insider abuse, which is still the primary cause of bank failure in the Philippines. This issue is particularly relevant with the failure of Urban Bank, which was attributed to problems in its investment house subsidiary, Urbancorp Investments, Inc. Urban Bank was one of the smallest commercial banks before it was downgraded to a thrift bank last March 2000 because it was unable to meet the new capitalization requirement. Urbancorp operated as an investment house without quasi-banking BANKING AND INSURANCE 267 functions and engaged in trust operations. The latter, which had significant real estate exposure, suffered liquidity problems when its investors preterminated their holdings due partly to the failure of another investment house. Urban Bank, in turn, suffered heavy withdrawals due both to the pretermination of placements by its subsidiary’s investors and to the loss of public confidence following its downgrade. The simultaneous weakening of these two financial institutions was clearly interlinked. They are both currently under receivership. Failure to detect problems in Urbancorp has been attributed to some lapse in supervision/regulatory oversight, which in turn arose from confusion in the proper assignment of regulatory function over investment houses between the BSP and the Securities and Exchange Commission (SEC). RA 7653 also provided for the transfer of regulatory powers over finance companies without quasi- banking functions and other institutions performing similar functions from the BSP to the SEC, within five years from the effectivity of the Act (Sec. 130). However, the implementing rules and guidelines had not been drawn up at the time. Abuses of conflicts of interest situations have significant implications on efficiency, investor protection, financial safety nets and stability of the financial system. But given the competition and efficiency gains associated with despecialization, re- verting to an institutional separation of functions in the financial sector is also not the solution. Thus, the emphasis is once again on prudential regulation. Some tightening in the trust operations of banks may be warranted, but ultimately the issue is not just the lack of some detailed code of conduct but also the proper implementation of existing regulations. Also in this context, the provision in RA 8791 which states that “a bank may, subject to prior approval of the Monetary Board, use any or all of its branches as outlets for the presentation and/or sale of the financial products of its allied undertakings or of its investment house units” (Sec. 20) needs to be carefully evaluated and prudently applied because it could lead to conflicts of interest situations and unduly expand the coverage of the financial safety net.

5. Compulsory deposit insurance The deposit liabilities of any bank or banking institution must be insured with the Philippine Deposit Insurance Corporation (PDIC). The PDIC offers partial coverage, with insured deposits equivalent to the net amount due to any depositor for deposits in an insured bank (after deducting offsets) but not to exceed P100,000. The assessment rate is a flat rate and not related to the risk of a bank, that is, the same rate applies to all banks and banking categories. It also has a ceiling of 1/5 of 1 percent per annum, and currently stands at 1/2 of 1/5 of 1 percent. A bank’s semiannual assessment is equal to the amount of the rate times the assessment base or the total deposit liabilities of the bank, but shall not be less than P250. The semiannual assessment base is defined as the average of total deposits at the close of each quarter. Overall, the current level of deposit insurance does not seem excessive. But the more relevant issue may be implicit insurance, particularly the BSP’s explicit policy of not allowing big banks to fail. 268 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The PDIC is also seeking amendments to its charter, which include higher deposit insurance coverage and more powers to improve its regulatory functions (e.g., improved access to BSP records; authority to assume receivership of a bank that has declared a bank holiday).

6. Restrictions on capital adequacy The minimum capital requirement is differentiated according to type of bank, and increases significantly the more functions or activities a bank is allowed to undertake. Over time, minimum capital requirements have been progressively increased because authorities believed that bigger banks would lead to a more stable banking system. For expanded commercial banks or universal banks, the increase was from P500 million in 1980 to P1 billion in 1990, P2.5 billion in 1995, and P4.95 billion in 1999. For commercial banks, the corresponding amounts are P100 million, P500 million, P1.25 billion, and P 2.4 billion, respectively. Still, Philippine banks are fairly small compared to banks in other countries in the region. Increases in banks’ minimum capital requirements have typically been used as a barrier to entry. Also, mergers and acquisitions are especially preferred as a means of meeting higher capitalization requirements to reduce the number and increase the size of banks in the Philippines. Thus, the BSP grants various incentives for bank consolidations, including temporary exemptions from some restrictions. The final stage of the mandatory capital build-up program was supposed to raise minimum capital requirements by the end of 2000 to P5.4 billion and P2.8 billion for universal and commercial banks, respectively. The BSP decided to cancel this final stage in line with its adoption of the Basle risk-based capital adequacy standard, which is one of the major provisions of the new General Banking Law. The decision to shift to this new framework for measuring capital adequacy was actually made by the Monetary Board in June 19936 , but its implementation was subject to the amendment of the old General Banking Act. The BSP is also set to allow Tier 2 capitalization. Under this scheme, banks can issue convertible notes with a given yield for a prescribed time period. Investors will then have the option to convert the Tier 2 notes into bank equity, although they have no voting rights and their shares are subordinate to common shares.

7. Reserve requirements Reserve requirements are imposed on all peso deposit liabilities, deposit substitutes and common trust funds of banks and nonbank quasi-banks. They take two forms—regular reserve requirements and liquidity reserves. Of the former, at least 25 percent but not to exceed 40 percent must be held as deposits at the BSP, and the balance in the form of cash in vault and government securities. Deposits maintained ______

6 Resolution No. 544 dated 25 June 1993. BANKING AND INSURANCE 269 with the BSP are paid an interest rate of 4 percent per annum based on the average daily balance and are credited quarterly, while eligible government securities must bear an interest rate of not more than 4 percent per annum, be nonnegotiable and carry BSP support. On top of the regular reserve requirements, liquidity reserves, which may be maintained in the form of short-term, market yielding government securities, were imposed beginning in May 1995 accompanied by reductions in the regular reserve requirements to allow banks to earn higher remuneration on their required reserves. Regular reserve requirements for commercial banks currently range from 7 to 9 percent, while liquidity reserves are set at 3 percent for all peso deposits and deposit substitutes and 6 percent for common trust funds. The current reserve requirements are significantly lower compared to previous levels. This, together with higher interest rates paid on reserves, served to reduce banks’ cost of intermediation, which in turn should have a positive impact on the level of intermediation activity. Foreign exchange deposit liabilities of commercial banks authorized to operate an FCDU require a 100 percent asset cover, which may take the form of foreign currency notes and coins on hand; foreign currency deposits with the BSP, foreign banks abroad, OBUs and other FCDUs; foreign currency loans authorized by the BSP; investments in foreign-currency-denominated debt instruments; and other assets as may be determined by the BSP.

8. Requirements to direct credit to favored sectors The government continues to direct credit to certain sectors of the economy through both regulatory and statutory restrictions. The loan-to-deposit ratio or deposit retention scheme requires that at least 75 percent of total deposit liabilities, net of required reserves and cash in vault, accumulated by branches and other banking offices in a particular geographical grouping outside of Metro Manila, be invested there. This is to help develop that particular area, for instance, by ensuring that funds do not flow from branches in the rural areas to head offices in the urban areas. Ac- cording to Relampagos and Lamberte (1988), this regulation impinged on banks’ capacity to intermediate more efficiently. The reduction of the geographical groupings from 13 to three (Luzon, Visayas, Mindanao) in 1990 has presumably reduced such adverse effects. A longstanding statutory restriction on bank’s credit allocation is the 1975 Presidential Decree No. 717, or the Agri-Agra law, that requires all banks to allocate 25 percent of their loanable funds to agriculture, with at least 10 percent earmarked for agrarian reform credit. Because of banks’ frequent inability to meet this requirement, they were allowed to hold alternative investments. In particular, unused funds earmarked for agrarian reform credit can be invested temporarily in government securities that the BSP has expressly declared eligible for the purpose. But such securities: (a) must be monetized, encashed, or repurchased whenever funds are needed by the bank for lending to the beneficiaries of agrarian reform; and (b) cannot 270 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES be hypothecated or encumbered in any way or earmarked for any other purpose. The unused funds set aside for agricultural credit in general may also be invested in commercial papers issued by entities engaged in agricultural production, processing, storage, marketing, or exportation of agricultural products; and importation, manufacture, distribution of farm machineries and equipment, fertilizers, etc. used for agricultural production. All unused Agri-Agra allocation funds in the preceding year shall also be invested in socialized and low-cost housing provided the utilized portion was solely devoted to agricultural and agrarian reform credit. Finally, loans extended by banks to finance educational institutions, cooperatives, hospitals and other medical services, low-cost housing, and those extended to local government units without national government guarantee are included in determining compliance with the provisions of PD 717. In 1991, RA 6977, or the Magna Carta for Small Enterprises, was signed into law mandating all banks to allocate a certain portion of their total loan portfolio to small enterprises. The effectivity of this law had a time period and set the mandated credit allocation at 5 percent in 1991, 10 percent in 1992-95, 5 percent in 1996, and possibly lifted by the end of 1997. In 1996, RA 6977 was amended by Republic Act No. 8289, An Act to Strengthen the Promotion and Development of, and Assistance to Small and Medium Scale Enterprises. This law required all lending institutions, for a period of 10 years from August 1997 to August 2007, to set aside at least 6 and 2 percent of their total loan portfolio for small and medium enterprises, respectively. Banks could report compliance on a groupwide basis, provided that the subsidiary banks are at least 75 percent owned or controlled by the parent bank. Such loans are also eligible for guarantee coverage to be issued by the Small Business Guarantee and Finance Corporation (SBGFC), which was also established under RA 8289. For government corporations that perform banking or credit functions, credits to the economic activities falling under Priority II (real estate loans, consumption and other non-productive, speculative activities) of the Schedule of Credit Priorities must be limited to 50 percent of their outstanding loans at any time. Banks have long been calling for the removal of mandated credit requirements. The International Monetary Fund (IMF) and the World Bank have also recommended that the government abandon its mandatory lending policies because they only bring up the cost of lending in the country. Even the BSP shares the same sentiment. In fact, one of the priority legislative agenda identified under the Medium Term Philippine Development Plan for 1999-2004 was the amendment of the Agri-Agra Law to lift the 25 percent quota of loanable funds to agriculture. It should also be noted that both the New Central Bank Act and the General Banking Law have done away with the developmental objective. Such requirements posed distortions in the banking system, and ran counter to the government’s thrust of making the system more market oriented. Also, the government already had in place various credit programs that target these sectors, although the general consensus was that they were not very effective or successful (Magno 1988; Llanto et al. 1990; RIDA 1995). Strict compliance has been BANKING AND INSURANCE 271 fairly low. Efforts to make the requirements more flexible by allowing other means to comply with the provisions (e.g., subscription to Erap bonds, bonds for socialized housing) clearly defeat the purpose of such policies to direct credit to priority sectors and magnify their overall ineffectiveness.

9. Special rules concerning liquidation, winding up, insolvency, composition or analogous proceedings in the banking sector The exit procedure in the banking sector is fairly well defined under the New Central Bank Act. A bank or quasi-bank that is found to be unable or unwilling to maintain a condition of liquidity deemed adequate to protect its depositors and creditors may be placed under the authority of a conservator by the Monetary Board. The conservator is empowered to overrule or revoke the actions of the previous management and board of directors of the bank or quasi-bank, as well as exercise all powers to be vested by the Monetary Board as it deems necessary. The Monetary Board can terminate the conservatorship when it is satisfied that the institution can continue to operate on its own. If a bank is found to be insolvent, the Monetary Board may summarily and without need for prior hearing forbid the bank from doing business, and designate the PDIC as its receiver. If the PDIC finds that the bank cannot be rehabilitated, the Monetary Board shall notify the board of directors and direct the receiver with the liquidation. The bank’s assets will be converted to money for the purpose of paying its creditors and other parties, in accordance with the rules on concurrence and preference of credit under the Civil Code of the Philippines. Technically, the PDIC has 90 days to decide whether to rehabilitate or liquidate a bank. The decision to close small banks, such as rural banks, is fairly quick and straightforward. When it comes to bigger banks, however, there is an implicit policy of preventing their closure because of potential contagion effects on the entire banking sector. Thus, the BSP, PDIC and the SEC have been heavily involved in the rehabilitation of some failed banks such as Orient Bank, which failed in 1998, and more recently, Urban Bank and Prime Savings Bank. Charges of fraud and engaging in unsafe and unsound banking practices have also been filed against the officials of these banks, as well as against a number of rural banks. Although similar cases have previously been filed, regulators have yet to successfully prosecute a banker accused of fraud.

10. Industry regulator The BSP is the banking sector’s principal regulatory and supervisory authority, as provided for under RA 7653 or the New Central Bank Act. Two specific departments help to carry out this function—the Supervision and Examination Sector (SES), which is the operating department, and the Supervisory Reports and Special Studies Office (SRSO), which receives the regular financial reports, generates the statistical reports for the use of the operating departments, and reviews systems and 272 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES procedures related to supervision. The PDIC also monitors the activities of banks, although it primarily relies on information gathered by the BSP. The PDIC especially oversees rural banks, since RA 7653 (New Central Bank Act of 1993) transferred the receivership and liquidation of rural banks from the BSP to the PDIC. Finally, the SEC registers the banks’ articles of incorporation, but only if they are accompanied by a certificate of authority to operate issued by the Monetary Board (Lamberte and Llanto 1993; Intal and Llanto 1998). The BSP’s supervisory powers over the operations and activities of banks include the issuance of rules of conduct or the establishment of standards of operation; the conduct of examination to determine compliance with laws and regulations; regular annual investigation to determine whether an institution is conducting its business on a safe or sound basis; inquiring into the solvency and liquidity of the institution; and enforcing prompt corrective action. RA 8791 also granted the BSP supervisory and regulatory powers over quasi-banks, trust entities, and other financial institutions, which under special laws are subject to BSP supervision. That the initial CBP was given the task of supervising the overall financial system, covering both banks and nonbank financial institutions (NBFIs), in the early 1970s proved auspicious with the broadening of the range of services and activities that banks, particularly commercial banks, were allowed to undertake in the early 1980s. In particular, the cross-ownership and/or interlocking directorships of banks and NBFIs have resulted in overlapping regulatory and supervisory functions. For instance, the SEC, which acts as the registrar for all companies, also regulates and supervises the securities market. Insurance firms, excluding government-owned insurance corporations that are governed by their respective charters, are regulated and supervised by the Insurance Commission of the Philippines. Given such overlaps, well-delineated roles for and coordination among all regulatory/supervisory bodies in any capacity are vital to properly regulate or supervise the financial sector, particularly the banking sector. This would help ensure that all risks are accounted for, and that regulatory avoidance or arbitrage does not become a problem. In this context, the off-loading of supervisory and regulatory functions over some financial institutions from the BSP to the SEC, for instance, needs to be evaluated even though, as was noted earlier, there are provisions in the New Central Bank Act and General Banking Law that allow the BSP to examine banks’ subsidiaries and affiliates, and thus ascertain the overall or consolidated condition of banks. The issue then is how to put these provisions into operation. As this review of current regulations shows, the BSP continues to have pervasive powers over banks from their entry to their exit. The new General Banking Law served to reinforce this by increasing both the depth and width of regulation. In particular, it allows the BSP to potentially regulate areas that are not currently subject to regulation, including those that had been deregulated in the past. Thus, the BSP can strongly influence the behavior of banks and the overall status and structure of the banking sector. BANKING AND INSURANCE 273

Insurance sector7 The regulation and supervision of the insurance industry is the responsibility of the Insurance Commission, which was set up as an autonomous body in 1949 when it was split from the Central Bank of the Philippines. It falls under the jurisdiction of the Department of Finance (DOF), although the latter’s role is not well defined and is weak especially with respect to its oversight functions. The Insurance Commission is a powerful government agency with licensing, regulatory, and adjudicatory functions. The Insurance Code of 1978 is the overall regulatory framework of the industry. Changes to the 1978 Code have been very few. Historically, conservatism and risk aversion marked the regulatory framework governing the insurance industry. Although this resulted in overall financial soundness, it was also deemed as overly cautious and thus constrained the industry’s growth and development. The Philippine insurance industry was deemed as lagging behind in terms of product development and innovation. An even more adverse effect of this stance was that it prevented the industry from playing a more active role in the development of the Philippine capital market. Unlike the mismatch between the maturities of banks’ assets and liabilities, for instance, life insurance companies can lend their funds on a long-term basis since the policies they sell are also long term. As in the commercial banking sector, one of the provisions of the Insurance Act of 1966 was to ban the entry of new insurance companies. The restriction on entry was also retained under the 1978 Insurance Code, although it did not provide specific conditions for approval to engage in insurance business and was not particularly restrictive. The rationale was also similar: there was a rapid growth in the number of insurance companies in the 1950s and 1960s, many of which were found to be inad- equately capitalized, as well as engaged in fraudulent activities (Emery 1976). The industry was also deemed as overcrowded, hence the restriction on new entry. With respect to foreign participation in the industry, the Insurance Commission was also stricter relative to the general restriction on foreign investments in the country. The Foreign Investment Act allowed foreign equity participation of up to 30 percent in certain industries including insurance. This limit was raised to 40 percent in 1987. But in the insurance industry, the Insurance Commission further restricted foreign equity participation by limiting them to the nonlife insurance sector. In contrast, no foreign equity participation was allowed in the life insurance sector other than the foreign companies that were already in operation. This dichotomy in policy was due to the difference in the structure of the nonlife relative to the life insurance sector. The former was characterized by a large number of weakly capitalized companies, while the latter was judged to be overcrowded but adequately capitalized. Thus, foreign investment was encouraged in the nonlife sector to strengthen its capitalization. There was also the perception that it would be better for Filipinos to own life insur- ______

7 The historical discussion of regulation of the insurance sector draws on World Bank (1992). 274 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES ance companies because they mobilized domestic savings. This could also be the rationale for the policy of limiting foreign banks to a minority position. In contrast to the banking sector, the nature of regulation in the insurance industry did not evolve over time. However, the reform particularly of entry restrictions was fairly quick when it occured in the 1990s. In March 1992, the Department of Finance issued an order that opened the insurance industry to new entrants.8 The restriction on foreign equity in the life insurance sector was also removed. In particular, foreigner equity participation of up to 40 percent in both existing and new life insurance companies was allowed. However, significantly higher minimum paid-up capital requirements were set for the new companies. In October 1994, the Department of Finance issued another set of guidelines on the entry of new foreign insurance or reinsurance companies or intermediaries.9 In particular, a foreign insurance or reinsurance company or intermediary was allowed entry under (only) one of the following modes: (i) ownership of the voting stock of an existing domestic insurance or reinsurance incorporated in the Philippines; (ii) investment in new insurance or reinsurance company or intermediary incorporated in the Philippines; or (iii) establishment of a branch, but not for an intermediary. To qualify for entry, the companies have to belong to the top 200 foreign insurance or reinsurance or intermediaries in the world or among the top 10 in their country of origin, and have been in business for at least 10 years. To qualify as a branch or as a new company incorporated in the Philippines, a company also has to be widely owned and publicly listed in its country of origin, unless it was majority owned by the government. To be considered as “widely owned,” no single stockholder of the applicant must own more than 20 percent of its voting stock. A foreign insurance or reinsurance company that would operate as a branch, or where foreign equity in the company or intermediary was more than 40 percent, was allowed entry only within two years from the effectivity of the Order. During this period, the number of foreign insurance or reinsurance companies or intermediaries that would be allowed entry was five each, although this could be increased to 10 upon the recommendation of the Department of Finance and the approval of the President. No composite license was to be issued to an insurance applicant under these guidelines. Full liberalization of entry came with the enactment of RA 8179 in March 1996, which deleted the Negative “C” List from the Foreign Investment Act and allowed up to 100 percent foreign equity in the insurance sector. To obtain a Certificate of Au- thority from the Insurance Commission to transact any insurance business, an insur- ______

8 Department Order No. 27-92 issued on 17 May 1992. 9 Department Order No. 100-94 issued on 24 October 1994. The Insurance Code classifies a company as either domestic or foreign, depending on its place of incorporation. Domestic companies are those formed, organized, or existing under Philippine laws. That is, the Insurance Code considers foreign registration and not foreign ownership as the deciding factor. BANKING AND INSURANCE 275 ance company must satisfy capital, asset, and other requirements, such as qualifications of executive officers and key officials of the company. The Certificate of Author- ity is renewed annually, which makes it possible for the Insurance Commission to maintain tight control over the industry. Authorization is also needed before an insurance company can transact both life and nonlife insurance business. There are also pricing restrictions, lines of business restrictions, and restrictions on interlocking directorships and officerships. Other requirements under the Insurance Code include minimum paid-up capital and contributed surplus, which are adjusted from time to time. The Code also contained specific provisions concerning capital and required reserves. The 1994 guidelines, for instance, raised minimum capital requirements for new companies, with the amount increasing significantly as the foreign equity in the company increased (Table 3). Aside from paid-up capital, stockholders are also required to pay a contributed surplus in cash to the company. In addition, foreign insurance companies have to deposit with the Insurance Commission eligible securities equivalent to the actual market value of not less than the minimum paid-up capital required of domestic insurance companies. At least 50 percent of such securities have to consist of bonds or other evidences of debt of the Philippine government and government-owned or controlled corporations (GOCCs), including the Philippine central bank. In the case of domestic companies, they have to deposit 25 percent of minimum paid-up capital with the Insurance Commission, also in the form of government or associated securities. Foreign insurance or reinsurance companies seeking to establish branches are further required to deposit with the Insurance Commission allowable securities to the market value of not less than P300 million or P500 million, respectively.

Table 3. Minimum Capital Requirements for New and Existing Insurance Companies Paid-up Capital Contributed Surplus New Entrants Foreign equity is less than 40 percent P 75 million P 25 million Foreign equity is between 40 and 60 percent P 150 million P 50 million Foreign equity is 60 percent or more P 250 million P 50 million Existing P 50 million P 25 million Source: Insurance Commission.

In contrast to the policy on entry, the Insurance Code’s requirements on investment policies and practices are quite restrictive, which resulted in insurance companies’ very conservative investment choices. The Insurance Commission defined its role in regulating investments as follows: “By the very nature of insurance business, insurance companies need investments which are safe and free from excessive market 276 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES price fluctuations since a relatively small shrinkage in asset values could endanger their solvency” (World Bank 1992:126). Restrictions on the portfolio of assets that insurance companies could hold include limits on investments in stocks, bonds and other certificates of indebtedness, real estate investments, investment in a single enterprise, and investments in foreign currency. These restrictions, coupled with the required security deposits, led to a relatively high proportion of the industry’s portfolio in short term assets and government paper. Another important effect of the tight and conservative regulation of the insurance industry was the emergence of the pre-need industry, over which the Insurance Com- mission had no jurisdiction. Instead, the SEC is responsible for the overall regulation and supervision of the pre-need industry, which is fairly liberal compared to the Insur- ance Commission. In recognition of this disparity in regulation, the SEC recently issued a circular10 that set limits on the investment portfolio of pre-need companies. The circular restricted pre-need companies’ trust fund investments to fixed income instruments, mutual funds, blue chip equities and real estate in first-class cities and municipalities. There is also a pending bill in Congress, the Pre-need Plans Security Code, which seeks to strengthen the protection offered to pre-need plan holders by placing this industry under the authority of the Insurance Commission. Considering the similar nature of their business, such a move would serve to harmonize the regulation of the pre-need industry with that of the insurance industry, and hence dissipate any undue advantage of the former over the latter. Overall, the reform process in the insurance sector is just beginning and more needs to be done. The Insurance Commission is in the process of revising the Insur- ance Code to address significant changes brought about by financial liberalization and globalization of financial markets. It would do well to learn from the experience of the banking sector in this regard. While it is important to monitor the evolution of financial policies, the broader process of structural change in the financial system needs to be assessed as well. In particular, the use of indicators, which help to monitor the broader process of structural change in the financial system, would provide a more critical and thorough assessment of financial reforms. The government would then be better guided in its reform efforts. This is the focus of the next section.

TRENDS IN MARKET STRUCTURE AND PERFORMANCE

It is useful to monitor the evolution of deregulatory policies in order to identify areas that continue to inhibit the working of market forces in financial markets. How- ever, monitoring steps already taken in relation to remaining regulations does not ______

10 Memorandum Circular No. 1, which took effect on 21 June 2000. BANKING AND INSURANCE 277 give a clear/full picture of the extent to which playing fields are being leveled in practice. Thus, policy changes need to be considered along with changes in the competitive structure of the financial sector. The monitoring of structural change in the banking and insurance sectors can be done through the use of some indicators of changes in competitive structure and indicators of gains in competitive efficiency implicit in financial market performance.

BANKING SECTOR

Financial structure The Philippine financial system consists of banks and nonbank financial institutions (NBFIs). RA 8791 classifies banks into commercial banks, universal banks (expanded commercial banks), thrift banks (savings and mortgage banks, stock savings and loan associations, and private development banks), rural banks, cooperative banks, and Islamic banks. NBFIs include, among others, insurance companies, investment houses, financing companies, securities dealers and brokers, fund managers, lending investors, pension funds, pawnshops and nonstock savings and loan associations. Figure 1 shows the total assets of the Philippine financial system from 1970 to 1999. Total assets of the financial system as percentage of gross domestic product (GDP) rose from 63 percent in 1970 to 117 percent in 1983, then fell to 66 percent in 1988 as a result of the financial and economic crises in the mid-1980s. The ratio rose to around 140 percent in 1997, and again declined to 124 percent in the aftermath of

Figure 1. Assets of the Philippine Financial System, by Type of Institution, 1970-1999 (in billion P)

Sources of basic data: Bangko Sentral ng Pilipinas; National Statistical Coordination Board. 278 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the Asian crisis. The total assets of commercial banks, in particular, grew significantly in the 1990s due to the successive increases in minimum capital requirements, the upgrading of the specialized government banks and the entry of new local and foreign banks. The Philippine financial system has consistently been dominated by commercial banks. In fact, the importance of commercial banks even increased over time. The banking system accounted for 81 percent of total financial assets in 1999, compared to around 76 percent in 1970. The asset share of commercial banks also increased from around 57 percent in 1970 to 73 percent in 1999. In contrast, the asset share of rural banks fell from around 3 percent in the 1970s to less than 2 percent in 1999, while the asset share of thrift banks only slightly rose to 6 percent in 1999 from 4 percent in 1970. On the other hand, the share of NBFIs in total financial assets fell from a high of 28 percent in 1975 to 19 percent in 1999. Thus, there has been no significant structural change in the Philippine financial sector. A bank-dominated financial system is not necessarily bad. The issue is whether such a structure is a market-outcome, or the result of government regulation. In the case of the Philippines, it was clearly the latter. The banking sector has historically been the focus of financial sector policy, development and reform. In contrast, efforts to reform and develop the other sectors of the financial system began only in the mid-1990s. A theory on the relationship between financial development and economic development in a market-oriented economy posits that the banking system, which initially leads financial development, declines in importance as real growth and financial development continue (Goldsmith 1969). One observed characteristic of the process of economic development over time in a market-oriented economy is an expansion and elaboration of the financial structure (institutions, instruments, and activities). On the other hand, economic development is retarded if financial intermediaries do not evolve (Patrick 1966). This was also borne out by more recent empirical literature (e.g., King and Levine 1996; Lee 1991). Table 4 shows the number of offices of financial institutions operating in the Philippines from 1980 to 1999. The easing of restrictions on bank branching was very evident in the rapid growth of banking offices. Compared to just 0.5 percent in the 1980s, the number of banking offices in the 1990s grew at an average annual rate of 8.7 percent, with all bank categories posting significant growth. In particular, double- digit growth rates were recorded in the number of branches of rural banks beginning in 1990 and in commercial and thrift banks beginning in 1992. The period after the deregulation of foreign bank entry but before the Asian crisis was also marked by a dramatic increase in the number of commercial and thrift bank branches. The increase in the number of head offices of commercial banks was largely due to the entry of foreign banks in 1995. However, foreign banks were at a serious disadvantage in terms of number of branches. For instance, private domestic commercial banks had a total of over 4,000 branches in 1999. In contrast, foreign bank branches and subsidiaries had only around 219 branches. BANKING AND INSURANCE 279

Table 4. Number of Financial Institutions, 1980-June 1999 1980 1985 1990 1991 1992 1993 1994 1995 1996 1997 1998 Jun-99 Phil. Financial System 4,894 5,554 7,258 7,732 8,668 9,692 10,826 12,144 15,238 17,025 18,242 19,023 Head Offices 2,387 2,676 3,915 4,096 4,413 4,914 5,428 6,007 7,234 7,790 8,139 8,379 Branches/Agencies 2,507 2,878 3,343 3,636 4,255 4,778 5,398 6,137 8,004 9,235 10,103 10,644 I. Banking Institutions 3,327 3,532 3,511 3,649 4,112 4,452 4,871 5,318 6,335 7,182 7,646 7,689 Head offices 1,206 1,052 937 916 917 909 917 935 961 1,003 996 976 Branches/Agencies 2,121 2,480 2,574 2,733 3,195 3,573 3,954 4,383 5,374 6,179 6,650 6,713 A. Commercial Banks 1,501 1,744 1,813 1,923 2,254 2,477 2,776 3,047 3,650 4,078 4,230 4,326 Head offices 32 30 30 31 32 32 33 46 49 54 53 52 Branches/Agencies 1,469 1,714 1,783 1,892 2,222 2,445 2,743 3,001 3,601 4,024 4,177 4,274 B. Thrift Banks 671 671 653 663 718 780 821 925 1,171 1,389 1,474 1,478 Head offices 144 118 103 101 98 97 100 99 108 117 117 118 Branches/Agencies 527 553 550 562 620 683 721 826 1,063 1,272 1,357 1,360 C. Rural Banks 1,155 1,117 1,045 1,063 1,140 1,195 1,274 1,346 1,514 1,715 1,942 1,885 Head offices 1,030 904 804 784 787 780 784 790 804 832 826 806 Branches/Agencies 125 213 241 279 353 415 490 556 710 883 1,116 1,079 II. NBFIs 1,475 1,922 3,620 3,941 4,372 5,035 5,730 6,575 8,903 9,843 10,596 11,334 Head offices 1,178 1,621 2,975 3,177 3,493 4,002 4,508 5,069 6,273 6,787 7,143 7,403 Branches/Agencies 297 301 645 764 879 1,033 1,222 1,506 2,630 3,056 3,453 3,931 Source of basic data: Bangko Sentral ng Pilipinas.

Overall, the Philippine banking system continued to be characterized by the presence of a few large commercial banks and a lot of very small thrift and rural banks. The continued dominance of a few, large commercial banks raises the issue of market power. Table 5 shows the number of commercial banks by ownership. In contrast to previous decades, the period after 1995 was characterized by significant movement in

Table 5. Number of Commercial Banks by Type of Bank, 1980-2000 Q1 Type of bank 1980 1985 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Q1 TOTAL 32 30 30 31 32 32 33 46 49 54 53 52 47 Private domestic banks 27 25 25 26 27 27 28 30 31 33 32 30 25 Foreign bank branches 4 4 4 4 4 4 4 14 14 14 13 13 13 Foreign bank subsidiaries 4 5 6 6 Government banks 1 1 1 1 1 1124333 3

Note: Data for the first quarter of 2000 incorporate the mergers and acquisitions reported in Table 6. Source of basic data: Bangko Sentral ng Pilipinas. 280 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the commercial banking sector in terms of new entries and consolidations. The number of foreign bank branches and subsidiaries increased as a result of deregulation. On the other hand, the number of domestic private banks initially increased in the first half of the 1990s as a result of deregulation of entry, then decreased toward the latter half due to mergers and acquisitions. Although the BSP encouraged mergers and acquisitions to meet the higher capital requirements, the latter primarily took place among the biggest banks (Table 6). Thus, the motivation would seem to be to protect market share.

Table 6. Mergers and Acquisitions in the Commercial Banking Sector, 1998-2000

Year Consolidating banks Surviving entity Effectivity1

1998 Bank of Southeast Asia / DBS Bank (Philippines), Inc. 9/9/98 DBS Bank of Singapore 1999 Equitable / PCI Bank Equitable PCI Bank 9/28/99

2000 Global Bank / Asian Bank Global Bank 2/9/2000

Global Bank / Philbank Global Bank 3/24/20002

BPI / Far East Bank & Trust Co. BPI - Far East 4/7/2000

Prudential Bank / Pilipinas Bank Prudential Bank 5/2/2000

Metrobank / Solidbank MetroBank 6/30/2000

Note: 1 Refers to dates of effectivity as stated in the Circular Letter, unless otherwise stated. 2 Date of Monetary Board approval. Source: Espenilla (2000).

Figure 2 shows the distribution of commercial bank assets according to ownership of banks. Private domestic banks consistently accounted for over 60 percent of total commercial bank assets. Private domestic banks’ share rose to as high as 77 percent in 1994, before subsequently falling to around 67 percent in 1999, with the entry of the 10 foreign banks in 1995. If the share of the Philippine National Bank (PNB), which passed into majority private ownership in 1995, is included, the share rises to around 76 percent in 1999. On the other hand, the asset share of foreign bank branches and subsidiaries rose from around 9 percent in 1995 to 17.5 percent in 1997. Finally, the share of government owned commercial banks declined from less than 27 percent in 1980 (accounted for by PNB) to 12.6 percent in 1999. BANKING AND INSURANCE 281

Figure 2. Distribution of Commercial Bank Assets, by Type of Bank, 1980-2000Q1 (%)

Source of basic data: Bangko Sentral ng Pilipinas. Note: 1Includes branches and subsidiaries of foreign banks.

With respect to the ownership of private domestic commercial banks, Table 7 shows that very few remained purely Filipino owned, which indicates the impact of liberalizing foreign equity participation in the domestic banking industry.

Table 7. Ownership Structure of Private Domestic Banks: Percentage Share to Total Subscribed Capital, 1997/98 Filipino Foreign Filipino Foreign Allied Banking Corp. 100 0 Phil Bank of Communications2 86 14 Asia United Bank 70 30 Philippine Banking Corp. 2 76 24 AsianBank Corp.1 87 13 Philippine Comm’l Int’l. Bank2 72 28 Banco de Oro 100 0 Philippine Trust Co. 2 100 0 Bank of Commerce1 100 0 Philippine Veterans Bank 84 16 Bank of the Philippine Islands 78 22 Pilipinas Bank 70 30 China Banking Corp.2 87 13 Prudential Bank2 84 16 Bank of Southeast Asia 100 0 Rizal Comm’l Banking Corp. 2 100 0 East West Bank 100 0 Security Bank Corp. 2 84 16 Equitable Banking Corp. 2 87 13 Solidbank Corp. 60 40 Export and Industry Bank 70 30 TA Bank of the Philippines, Inc. 52 48 Far East Bank and Trust Co. 2 58 42 Traders Royal Bank 93 7 Global Business Bank 60 40 Union Bank of the Philippines3 98 2 International Exchange Bank 100 0 United Coconut Planters Bank 100 0 MetroBank and Trust Co. 82 18 Urban Bank2 98 2 Panasia Banking, Inc. 70 30 Westmont Bank na na Notes: 1 Percent share in total common stocks issued. 2 Percent share in top 20 stockholders. 3 Percent share in top 20 stockholders, as of 30 June 1999. 4 Na means not available. Source of basic data: Securities and Exchange Commission. 282 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Measures of concentration Figure 3 presents some asset concentration measures of the Philippine commercial banking system. Although the actual value of the Herfindahl index (HI)11 may not be indicative of undue concentration, given its very low values, it would also be useful to look at the trend. The HI was fairly stable from 1990 to 1994. It began to decline in 1995 with the entry of the new foreign banks, indicating that the system was becoming less concentrated. However, this trend was reversed beginning in 1998, which means that the mergers and acquisitions also resulted in increasing concentration.

Figure 3. Measures of Commercial Bank Asset Concentration, 1980-2000Q1

Source of basic data: Published balance sheet statements of commercial banks.

Similar trends are also evident when one looks at the asset share of the three and five largest commercial banks, which are all domestic banks. Before the restriction on new bank entry was eased in 1995, the five largest commercial banks consistently accounted for around half of the sector’s total assets. Their share declined to around 37 percent in 1997, but this trend has since been reversed. Also, the wide gap between the five biggest and five smallest commercial banks is stark. The concern with excessive concentration is that it is a potential source of monopoly power. Tan (1989) further argued that the institutional setting 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 be- longed to a loosely knit and geographically proximate social group. And in a number of cases, their business interdependence extended beyond banking and included bank-

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11 The Herfindahl index, which is a commonly used measure of industrial concentration, is calculated by squaring and summing the share of industry size accounted for by every firm in the industry, with a maximum value of 1 (or 10,000 where the market share is measured in percentage terms) indicating a monopoly. BANKING AND INSURANCE 283 ing conglomeration in production and trade. Thus, there is a need to monitor the concentration process even in a deregulated environment to detect any further strengthening of the oligopolistic group and to ensure that it does not lead to misuse of market power.

Operational efficiency Operational efficiency is a microeconomic concept, but it is also used to characterize a financial system. In particular, the market structure could be reflected in the spread between the cost of funds and the lending rate: a financial system is considered operationally efficient if the interest spread is low. The latter, in turn, arises from two factors. On a microeconomic level, the more cost efficient banks are, the lower the spread will be under reasonably competitive conditions. On a macroeconomic level, systemic risks also affect the spread. A more stable and confident environment will lead to a lower risk premium over lending, thus leading to a lower spread (Ersel and Kandil 2000). A high intermediation margin would imply a smaller intermediation activity (Tan 1989). One of the structural weaknesses identified in the past in the Philippine banking sector was the large spread between commercial bank deposit and lending rates, which in turn was attributed to high intermediation costs mainly in the form of taxes and reserve requirements, as well as high profit margins (World Bank 1986). Tan (1989) also pointed out that the interest rate differential might not just be due to taxes, but to some monopoly power of the large commercial banks as well. More recently, the World Bank (1998) noted that high intermediation costs continued to be a feature of the Philippine banking system, especially when compared to other Asian economies.12 Average net interest margin as a ratio of total assets from 1988 to 1995 was 4.2 percent. Figures for comparable countries like Indonesia and Thailand were 3.5 and 3.1 percent, respectively (Demirguc-Kunt and Huizinga 1997; Claessens and Glaessner 1998). In addition to high reserve requirements and the mandated credit requirements discussed earlier, other contributing factors to the Philippines’ high intermediation costs were high operating costs and insufficient competition (World Bank 1998). Op- erating costs of banks were found to be significantly higher in the Philippines compared to other Asian economies. In particular, average overhead costs as a ratio of total assets in 1988 to 1995 was around 4.4 percent, compared to 2.9 percent and 2.0 percent for Indonesia and Thailand, respectively. Despite the higher operating costs, Philippine banks were also found to be more profitable. The ratio of net profit to total

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12 The interest spread is often used for international comparisons of financial sector efficiency. But as Claessens and Glaessner (1998) noted, cross-country comparisons should be done with care because a number of country-specific regulatory, tax, macroeconomic and microeconomic factors affect the costs of financial intermediation. 284 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES assets was around 2 percent for Philippine banks during the same period, against 0.9 and 1.1 for Indonesia and Thailand respectively (Demirguc-Kunt and Huizinga 1997; Claessens and Glaessner 1998). Thus, the World Bank (1998) noted that the “high profits despite high costs indicate lack of competition, which is also evidenced by the fact that there is high concentration in the banking sector…” (p. 23). Tan (1989) has previously argued that the ultimate effect of the policy of restricted entry into the banking sector has been to shield both the big and small banks from competition which allowed the big banks to earn abnormal profits and the small banks to operate at high costs. Thus, it is important for the banking industry to be sufficiently competitive if financial intermediation is to be carried out efficiently. The partial liberalization of foreign bank entry in 1994 precisely aimed to increase competition and improve efficiency in the domestic banking sector. By increasing competition, it was expected that market forces would reduce bank spreads. Al- though the entry of more foreign banks led to some changes in the banking structure, particularly the decline in concentration ratios, there has been no significant impact on bank spreads. Table 8 shows domestic commercial banks’ average spread and rates of return both prior to and after the restriction on foreign bank entry was eased in 1995. Both only slightly declined during the post-liberalization years prior to the Asian crisis.

Table 8. Commercial Banks’ Average Spread and Rates of Return (%)

Average Spread1 Average Rate of Return on Assets on Equity Pre-liberalization: 1991-942 4.733 2.51 25.66

Post-liberalization: 1995-97 4.345 2.23 18.83 Notes: 1 Difference between lending and deposit rates adjusted for the gross receipts tax and changes in required reserves; 2 1987-94 for Average rate of return. Source: Lamberte (1999).

Recent studies have examined the impact of the entry of more foreign banks on domestic banks’ interest rate spreads and efficiency (e.g., Manzano and Neri 2001; Montinola and Moreno 2001; Unite and Sullivan 2001). Overall, their results indicate that foreign bank entry has had limited impact. Manzano and Neri (2001) noted that the effects on competition might not have been felt immediately because of a period of adjustment for the foreign banks, and/or because liberalization did not go far enough. But ultimately, they attributed the persistence of high bank spreads to the government’s macroeconomic policy mix. In particular, the overvalued exchange rate before the crisis encouraged foreign borrowing and dollar intermediation by BANKING AND INSURANCE 285 banks, which dampened the competition for peso deposits and upward movements in the deposit rate. On the other hand, the government’s high interest rate policy to defend the exchange rate caused banks’ lending rate to remain high. Thus, the impact of macroeconomic factors could have masked the impact of foreign bank entry on domestic banks’ interest spread. According to Montinola and Moreno (2001), the scope of liberalization was limited, hence its modest effects on competitiveness and efficiency. A more in-depth study of the determinants of bank net interest margins would be useful to establish the impact of the change in the structure of bank competition. Apart from the market structure component, regulatory components in the form of reserve requirements and capital to asset ratios, and a risk premium component to account for uncertainty in the macroeconomic environment facing banks would have significant effects on bank net interest margins (Saunders and Schumacher 2000). With respect to the regulatory components, it has also been argued that part of the reason for the high bank spreads is that Philippine banks are heavily capitalized and less leveraged. In the years prior to the 1997 Asian crisis, Philippine banks’ capital adequacy ratio, defined as the ratio of net worth to risk assets, was between 17 and 20 percent compared to the Bank for International Settlement’s requirement of 8 percent. Holding equity capital is relatively costly when compared to debt, and so banks that have relatively high capital ratios can be expected to try to cover some of this cost by imposing an extra spread (Saunders and Schumacher 2000). On the other hand, reserve requirements in the 1990s were significantly lower compared to previous periods. This, together with higher interest rates paid on reserves, should have served to reduce banks’ cost of intermediation. Finally, the mandatory credit requirements continued to act as a tax on banks that gets translated into a higher spread. While the entry of more foreign banks in 1995 has not had a visible impact in terms of reducing domestic banks’ interest spread, this does not mean that foreign banks have had no impact whatsoever on domestic banks’ operations and on the level of competition in the banking sector. Focusing on price or interest competition does not take into account the dynamic aspect of competition and efficiency. The latter refers to the structural response of banks to deregulation as reflected for instance in their balance sheets, that is, the changes in the structure of their assets and liabilities. Audretsch et al. (2001) noted that competition and antitrust policies in the developed economies such as the European Union have been based on traditional static models and analyses of industrial organization, wherein technology and consumer demand are given and price (output) is the firm’s main, if not its only, choice variable. In contrast to the static models’ focus on price competition, more recent dynamic models of industrial organization argue that firms in reality are “engaged in a continuing dynamic competitive process, constantly creating and adopting new products and processes in order to gain advantage over their rivals” (p. 618). And in a dynamic economy, the latter may have a more significant effect on welfare than the former in 286 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the long run. The issue is especially relevant to financial markets as they operate in more deregulated and globalized environments and become increasingly characterized by technological advancements and product innovations. This emphasizes the need to augment traditional analyses of industrial organization, such as Bain’s (1956) Structure-Conduct-Performance paradigm, with more dynamic analyses of markets and institutions in order to come up with a fuller depiction of competition (Audretsch et al. 2001). In the Philippines, foreign banks traditionally competed with local banks primarily in corporate lending and nonbranch-based financial services. A survey of selected local banks on their reactions to the entry of more foreign banks in 1995 indicated that the latter has led to a more competitive environment particularly in wholesale banking (Hapitan 2001). The entry of more foreign banks further reduced the already thinning spreads from servicing corporate accounts because of the entry of more local banks in the early 1990s. This induced local banks to tap other segments of the market that would generate higher returns. Thus, local banks shifted their focus toward developing products and services for the middle and retail consumer markets, and, to some extent, the previously neglected small- and medium-sized enterprises. Local banks also sought to improve existing product lines and services, especially by introducing technology- based enhancements such as phone banking, bills payment, point- of-sale transactions, and Internet banking (AAC 1998). But as Hapitan (2001) also noted, re-engineering was undertaken by the domestic banks as a strategy in itself, and not because of the entry of more foreign banks per se. Local banks’ greater focus on retail operations could also account for the persistence of high bank spreads, both from the cost and profit aspects. Banks whose services are directed more toward retail operations normally have higher operating costs compared to banks that are more oriented toward wholesale markets. This is due to the former’s need for more branches, equipment and personnel to serve retail customers. Higher operating costs then translate into a higher spread (Brock and Suarez 2000). Branches of domestic commercial banks expanded rapidly especially in 1995- 1997, which accounts for the increasing trend in their operating costs during that period. The shift toward more profitable retail lending could have also allowed banks to maintain their profit margins. The New General Banking Law has allowed foreign banks to fully own an existing local bank, thus relaxing the restriction on branching by foreign banks. In December 2000, Hong Kong Shanghai Banking Corporation (HSBC) acquired a local thrift bank, which could further enhance competition in the middle and retail consumer markets.

INSURANCE SECTOR It was noted earlier that the share of NBFIs in total financial assets fell from a high of 28 percent in 1975 to 19 percent in 1999. A major sector under NBFIs is the insurance sector. In fact, the share of the insurance sector in total NBFI assets steadily increased over the past two decades, from 47 percent in 1980 to 71 percent in 1998 BANKING AND INSURANCE 287

(Table 9). Over half of the insurance sector’s assets were, in turn, accounted for by two government insurance corporations. However, the share of the insurance sector in total financial assets fell in the 1990s with the rapid expansion of the banking sector.

Table 9. Share of the Insurance Sector in Total Financial and NBFIs Assets, 1980-1998 (%) 1980 1985 1990 1995 1996 1997 1998 Assets (billion pesos) Total financial 249.67 492.80 802.98 2,080.57 2,680.81 3,429.98 3,473.39 NBFIs 58.36 104.17 194.13 443.11 507.86 582.40 622.88 Insurance 27.54 59.40 132.87 286.86 334.34 388.74 439.84 Distribution of insurance (%) Government1 64 66 66 65 64 64 64 Private 36 34 34 35 36 36 36 Share in total financial (%) Insurance 11 12 17 14 12 11 13 Government 7 8 11 9 8 7 8 Private 4 4 6 5 4 4 5 Share in NBFIs (%) Insurance 47 57 68 65 66 67 70 Government 30 38 45 42 42 43 45 Private 17 19 23 23 24 24 25 Note: 1 SSS and GSIS. Sources of basic data: Social Security System; Government Service Insurance System; Bangko Sentral ng Pilipinas.

There are two broad categories in the insurance industry: life and nonlife. These two categories not only offer entirely different products, but also have different structures, modes of operation, constituent characteristics and regulatory requirements. Although the industry is largely private owned, it also includes five government insurance corporations: the Government Service Insurance System (GSIS), Social Secu- rity System (SSS), Philippine Crop Insurance Corporation (PCIC), Philippine Deposit Insurance Corporation (PDIC) and the Home Mortgage and Guarantee Fund (HMGF). These government corporations are governed by their respective charters and do not fall under the authority of the Insurance Commission. The government sector has consistently been twice as big as the private insurance industry in terms of assets. Another important sector is the pre-need industry, which also operated outside of the purview of the Insurance Commission. Thus, the pre-need industry grew significantly since it operated under a less restrictive regulatory environment relative to the life and nonlife insurance sectors. 288 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Table 10 shows the total assets of the private insurance industry. Total assets in real terms grew very fast in the 1990s compared to the 1980—8.5 percent per annum from 1991 to 1998 as opposed to just 2 percent from 1980 to 1990. The real growth rates of total assets by sector (life and nonlife) and ownership (domestic and foreign) also showed a similar trend over the same periods. As a percentage of GDP, though, there was only a slight increase in total assets from around 4 percent in 1980 to less than 6 percent in 1998. The life insurance sector grew at a faster rate of 10 percent per annum in the 1990s, while the nonlife insurance sector grew by around 6 percent. In terms of percentage distribution, life insurance accounted for over half of total assets, with its share significantly growing in the 1990s.

Table 10. Distribution of Total Assets of the Insurance Sector, 1980-1998 1980 1985 1990 1995 1996 1997 1998 Total assets (million pesos) 9,997 20,284 45,151 100,269 120,234 140,203 157,546 Total assets (% of GDP) 4.1 3.6 4.2 5.3 5.5 5.8 5.9 Domestic (% of Total) 64.2 59.9 58.2 58.4 58.5 56.9 54.4 Foreign (% of Total) 35.8 40.1 41.8 41.6 41.5 43.1 45.6 Life (% of Total) 51.1 51.8 56.5 66.6 68.9 66.3 67.7 Domestic (% of Life) 51.3 47.4 46.3 44.7 46.3 44.6 41.7 Foreign (% of Life) 48.7 52.6 53.7 55.3 53.7 55.4 58.3 Nonlife (% of Total) 43.8 43.5 40.6 31.6 29.2 31.7 30.3 Domestic (% of Nonlife) 75.8 71.0 72.4 85.6 85.6 80.7 80.4 Foreign (% of Nonlife) 24.2 29.0 27.6 14.4 14.4 19.3 19.6 Prof’l reinsurer (% of Total) 5.1 4.8 2.9 1.8 1.9 2.0 2.0 Domestic (% of Prof’l) 93.0 93.9 90.5 86.6 87.0 87.8 88.3 Foreign (% of Prof’l) 7.0 6.1 9.5 13.4 13.0 12.2 11.7 Note: Domestic and foreign are defined according to ownership, not place of incorporation. Thus, foreign companies include branches and domestically incorporated but foreign-owned companies. Source of basic: Insurance Commission.

In contrast to the banking sector, there was significant foreign participation in the insurance industry even prior to deregulation of entry. In particular, total assets of the life insurance sector were roughly equally divided between domestic and foreign- owned companies. Also, total assets of foreign-owned insurance companies in real terms grew at an average annual rate of 11 percent in the 1990s, which was double that of domestic companies. This was due to the deregulation of foreign entry. Most of the new foreign entrants were life insurance companies, which also accounted for their increasing share in this sector. In contrast, there was a decline both in the overall BANKING AND INSURANCE 289 asset share of the nonlife sector and the share of foreign-owned nonlife companies. This indicates that the objective of increasing the industry’s capitalization by allowing greater foreign participation was being achieved only in the life insurance sector. The deregulation of entry led to an increase in both domestic and foreign private insurance companies (Table 11). There were around 148 private insurance companies in 1998 compared to 129 in 1995, around 70-80 percent of which are domestic nonlife insurance companies. As noted earlier, most of the new foreign entrants were life insurance companies that increased their number and asset share from 1995 to 1998. Although there were also more domestic life insurance companies, their asset share declined to around 42 percent in 1998. In contrast, the number of foreign nonlife

Table 11. Number of Insurance Companies by Type of Insurer, 1980-1998 1980 1985 1990 1995 1996 1997 1998 TOTAL 135 130 130 129 134 145 148 Domestic 111 103 108 112 114 121 122 Foreign 24 25 20 16 18 22 23 Composite - 2 2 1 2 2 3 Life 23 22 23 26 29 34 35 Domestic 19 18 19 21 22 24 23 Foreign 4 4 4 5 7 10 12 Domestically incorporated 2 2 2 3 5 8 10 Branch 2 2 2 2 2 2 2 Nonlife 107 101 101 98 99 105 106 Domestic 88 81 86 88 89 94 96 Foreign 19 20 15 10 10 11 10 Domestically incorporated 6 6 5 4 4 5 4 Branch 13 14 10 6 6 6 6 Source: Insurance Commission.

insurance companies was relatively unchanged over the same period, while the number of domestic companies increased further to 96 in 1998. Taking into account the decline in the asset share of the domestic nonlife insurance companies over this period, this suggests that their problem of weak capitalization may have even worsened. With respect to concentration of ownership of assets, the Herfindahl index (HI) does not indicate undue concentration in the nonlife insurance sector, but it does indicate that the life insurance sector is significantly more concentrated (Figure 4). The latter becomes even more evident when one looks at the asset share of the five 290 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES largest life insurance companies which consistently accounted for at least 80 percent of total assets of this sector. In contrast, the asset share of the five largest nonlife insurance companies was less than 40 percent. However, the latter also signifies a high degree of concentration given the greater number of nonlife insurance companies. The World Bank (1992) noted that these small, weak companies are one of the principal causes of inefficiencies and even abuses in the nonlife sector. In contrast, concentration in the life insurance sector was not deemed a problem, and was noted to be common in other countries as well. There was also a slight downward trend in the HI for the life insurance sector with the entry of more foreign companies. But as in the banking sector, the oligopolistic structure in both life and nonlife insurance is very evident.

Figure 4. Measures of Asset Concentration in the Insurance Industry, 1970-1998

Note: The Herfindahl index is plotted on the left hand scale, while the asset share of the five largest companies is plotted on the right hand scale. Source of basic data: Insurance Commission.

The rapid growth of the insurance industry in recent years augurs well for the development of the country’s capital markets and overall economic growth. Life insurance is far more likely to add to long-term capital growth than nonlife insurance, or banks. Since the policies they sell are typically long-term, life insurance firms can also lend their funds on a long-term basis. It should also be noted that the industry grew under a still restrictive regulatory framework. Again, as in the banking sector, the danger inherent in a policy of closed markets should also be underscored and competition encouraged in the insurance industry. In particular, the presence of subsidiaries or branches of foreign insurers, as well as BANKING AND INSURANCE 291 foreign companies’ acquisition of minority or majority interests, contributes to the development of the domestic insurance sector. Foreign presence brings with it innovation and transfers of know-how, while at the same time giving access to additional financial resources, improving insurance rules, fostering greater diversification of business, expanding capacity, broadening the scope of products offered, and increasing financial security (OECD 1997). But clearly, further reforms are needed to complement the deregulation of foreign entry into the Philippine market. Overly conservative and restrictive investment policies and practices led to rather perverse results in that they encouraged investments in short-term assets, especially government securities. This created an unfortunate mismatch between the maturities of the industry’s assets and liabilities, especially given the country’s serious need for long- term capital (World Bank 1992). Needless to say, some prudential regulation of investment would still be necessary to balance profitability with soundness. While both the banking and insurance sectors started off as highly regulated, even repressed industries, only the regulatory framework in the former evolved over time. It was only very recently that deregulatory reforms in the insurance sector were initiated. Overall, the results indicate that one recent policy reform had an especially significant positive impact on the competitive structure of the commercial banking sector—the liberalization of entry of new banks. This led to less concentration and presumably, less market power of the domestic banks as well as greater competition. Why this has been so, despite the fact that the process of financial liberalization has been on going for more than a decade, is explored further in the next section, which looks at the regulation of the financial sector in the overall context of competition policy.

COMPETITION POLICY ISSUES IN THE FINANCIAL SECTOR

This section seeks to identify some relevant issues pertaining to competition policy in the financial sector that need to be examined further.

BANKING SECTOR Overall, the banking sector in the Philippines is still subject to extensive government regulation. This is not surprising since even banks in developed economies are typically subject to substantial public regulation. While most of the current regulations are justified for prudential reasons, particularly to protect the stability and soundness of the financial system, some longstanding restrictions are clearly meant to achieve some social objective. Furthermore, some regulations may no longer be necessary for prudential reasons, thereby restricting competition unnecessarily. Thus, an appraisal of existing regulations to ascertain their impact on competition and efficiency, and their overall effectiveness in the rapidly changing financial environment is always instructive. 292 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

It has been repeatedly pointed out in the literature that better prudential regulation and supervision are of paramount importance in dealing with the consequences of liberalization and globalization of financial markets. However, better regulation does not necessarily call for the institution of more or stronger rules, but a different kind of regulation. New approaches to the supervision of financial institutions have been characterized by a shift in focus away from formulaic capital standards and mandated portfolio structures, toward improvements in transparency and in the supervision of risk management systems (Hendricks and Hirtle 1997). Prudential supervision is designed for balance sheet regulation and the rise in off-balance-sheet activities of banks diminish the importance and effectiveness of such regulation. Thus, there is also a need to strengthen disclosure, transparency, and bankruptcy rules. Reporting requirements seem to be comprehensive and adequate for supervisory needs in the Philippines. What needs to be ensured is that all data and information are effectively utilized. In the case of the Philippines, the need for stronger prudential regulation and supervision is partly due to the explicit, and more importantly, the implicit guarantees in the financial system. Ultimately, the way to reduce the former would be to minimize the latter. Prudential regulation in effect substitutes the judgment of regulators for that of regulated financial institutions and their customers. Thus, the former ab- sorbs risks that would otherwise be borne by the latter. And in order to minimize its own risk exposure, regulators have an incentive to further limit the behavior of regulated institutions. But prudential regulation lessens competitive pressure and carries efficiency costs (Wallis et al. 1997). It should be pointed out that regulators also have the potential to engage in moral hazard, that is, regulators may cover up problems in the financial system, whether to hide their mistakes or because of political pressure (Aoki 1997). Overregulation is costly, cumbersome, and counterproductive. The issue then becomes, what constitutes appropriate prudential regulation? One area of public policy that has had a significant impact on the structure and performance of the Philippine banking sector is on entry and branching. In particular, restrictions on entry and branching led to an uncompetitive and inefficient banking system. On the other hand, their deregulation enhanced the contestability and competitiveness of the market and facilitated changes in banking trends, such as the introduction of new products, services, and technologies. Entry into the banking sector is one area that continues to be regulated even in the most liberalized or deregulated financial system. For instance, even the OECD countries continue to regulate the entry of new domestic banks, although none out- rightly ban new entry—that is, new entry requires a license but is otherwise free. Controls on entry in the form of authorization criteria include minimum capital requirements, and more importantly, fitness and properness criteria for controllers and managers of banks. On the other hand, the entry of foreign banks is relatively more restricted (OECD 1998a). Thus, regulation of entry to the banking industry is primarily a tool of prudential regulation. “Free banking,” or the removal of entry and other BANKING AND INSURANCE 293 restrictions without accompanying prudential regulations, is not deemed as tenable because it could lead to overcompetition and excessive risk taking, thus compromis- ing the stability and soundness of the banking system. In contrast, current entry regulations in the Philippines contain similar prudential requirements, as well as an outright ban on new entry of commercial banks. Overall, government barriers to entry are typically imposed to limit and reduce the number, as well as increase the average size of banks in the Philippines. Bigger and fewer banks, in turn, are seen to promote the safety and soundness of the financial system. But it is also recognized that their removal would enhance market contestability and the competitive process. A balance needs to be struck between the potential costs and potential benefits of allowing greater competition. In particular, the potential adverse effects of enhancing competition through a lowering of barriers to entry can be addressed by properly applying prudential regulations and restrictions such as those currently in place, especially the fitness and properness criteria for bank owners and managers. The focus should not just be the size of banks per se, but whether they are sound, competitive and efficient. Although in the Philippines, one merit of having direct entry restrictions is that it frees monetary authorities from political interventions in the licensing process. On the other hand, the policy bias has shifted in favor of foreign banks. The literature on foreign banking typically asserts that foreign bank entry can render national banking markets more competitive, thereby forcing domestic banks to operate more efficiently. For instance, Claessens et al. (1998) provide empirical evidence that significant foreign ownership share of banks does reduce the profitability and overall expenses of domestically owned banks. The results demonstrate how foreign bank entry can improve the functioning of national banking markets, with positive overall welfare implications for banking customers and the economy, even as it reduces domestic banking profits. An interesting finding of their study is that the number of entrants, rather than their market share, is the critical factor. That is, the impact of foreign banks on competition is immediately upon entry rather than after they have gained substantial market share. Papi and Revoltella (1999) likewise concluded that foreign direct investment in the banking sectors of transitional economies also provided valuable opportunities for the development of the host banking sector and the host economy as a whole. In this context, the recent move to further liberalize foreign bank entry in the Philippines is a step in the right direction. Also, it would seem that the aggregate 30 percent asset share limit on foreign majority-owned banks is not that potentially restrictive. Another potential positive impact of greater foreign participation in the Philip- pine banking sector is on the ownership structure of domestic banks. As noted earlier, very few domestic banks have remained purely Filipino owned, and foreign stakes could increase further. To date, the asset share of foreign bank branches and subsidiaries is around 15 percent of total banking assets. With the higher limit on total foreign equity participation of individuals and nonbanks in domestic banks, there is still con- 294 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES siderable room for increased foreign participation in the banking sector. This could serve not just to widen the ownership base of domestic banks, but also change the nature of ownership and hence, banking in the Philippines. Concentration of ownership continues to be a concern essentially because of its adverse implications on allocation of credit, the worst case being DOSRI abuses. A related issue here is interlocking ownership among financial and nonfinancial firms. The overall experience of developing countries has been that when industrial conglomerates control financial institutions, this led to a worsening in resource allocation, decreased competition, conflicts of interest, and problems of financial inflexibility and instability. These problems are particularly serious in developing countries with weak prudential regulation and supervision as well as tight restrictions on entry into the banking industry (Fry 1988). Ironically, such linkages could have contributed to the stability of the Philippine financial system, for instance, by helping to avert massive loan defaults during the crisis in the early 1980s. Banks typically restructured loans to allied firms to avoid provisioning and write-offs for bad loans, and thus protected both nonfinancial and financial firms from bankruptcy. More recently, the Bankers Association of the Philippines spearheaded efforts to assist other ailing investment houses in the aftermath of the Asian crisis. This should thwart further contagion effects on the banking sector and avoid the Urban Bank experience. But while such linkages may contribute to the stability of the commercial banking sector in the short run, any resulting adverse efficiency effects would eventually backfire on the banks themselves. The cases of Japan and South Korea clearly demonstrated this, with grave consequences for the entire economy. As long as scarce loanable funds are not channeled to borrowers who can use them most productively, the level and quality of investments and consequently, the rate of economic growth, will be severely affected. Thus, a change in the nature of Philippine banking is warranted. In particular, a move away from a relationship-based system of financial intermediation to one of explicit market based transactions would enhance competition and efficiency. In addition to the policy on entry and branching, other key policy issues with respect to competition in the commercial banking sector that need to be addressed include: • Anticompetitive agreements: The question of collusion and cartelization is a longstanding one in the commercial banking sector. Another issue is the potential misuse of market power with the continued dominance of a few large commercial banks. One way to deal with both these issues is to make the threat of potential entry available at all times. Two main areas of concern with respect to market concentration and collusion are overpricing of financial products and underprovision of services essential to economic growth and welfare. For instance, it has been observed among OECD countries that anticompetitive practices, such as nonitemized charges and financial penal- BANKING AND INSURANCE 295

ties for account closure, occurred more frequently with the deregulation of financial services. Also, as banks enter into more cooperative arrangements (e.g., the interconnection of networks such as ATMs; operation of international credit card systems or national debit transfer systems), these give rise to competition concerns. Finally, it should be noted that anticompetitive agreements could transpire not just between banks, but between banks and regulators as well. • Competitive neutrality: Although the government’s share in total assets of commercial banks has declined, it is still quite substantial. The two government-owned banks were the fifth and seventh largest banks as of the first quarter of 2000, and together, accounted for almost 13 percent of total commercial bank assets. The strong presence of government banks in the industry could lead to distortions in competition, especially since they have shifted from development financing to commercial and industrial lending to directly compete with private banks. More importantly, they are very prone to “be- hest loans,” which was the cause of the collapse of government banks in the early 1980s. Land Bank of the Philippines (LBP), together with the Philip- pine National Bank (PNB), again experienced financial difficulties and sought assistance from the BSP in 2000. The LBP even considered transfer- ring its losses to the national government, but the latter’s growing deficit did not allow it. The government is also making moves to regain control over PNB. Clearly, undue advantages because of their direct link to the government served to compromise their competitiveness and efficiency. • Unjustified regulatory restrictions on competition: In addition to market entry restrictions, restrictions on competitive behavior, such as portfolio restrictions (e.g., mandatory credit requirements), also need to be assessed. But a distinction needs to be made here between credit restrictions designed to channel funds to specific sectors to achieve some social objective, and those imposed for prudential reasons. Obliging banks to subsidize and/or service certain activities compromise their efficiency and may not be sustainable in a competitive environment. That is not to say that the credit needs of the targeted sectors are not valid, but the issue is the effectiveness of directed credit. Their credit needs can be more efficiently dealt with through other means, such as direct government funding, transfer payments or provision of services. For instance, it has been suggested that the government banks, which have become increasingly involved in commercial lending, revert to their original mandate of development financing. It is also important to have an effective treatment of the “exit problem.” This is influenced by policies toward exit, downsizing, bankruptcy and public bailout commitments. It is desirable, from the viewpoint of efficiency, that inefficient and noncompetitive institutions discontinue their operations. But 296 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

if a series of banking failures is not handled well, it could trigger a crisis of confidence and thus threaten the stability of the entire financial system. In general, insolvent banks should be allowed to fail. Competition is distorted by policies that prevent banks from exiting from the marketplace in the normal manner. Policies that seek to prevent bank failures may also deter entry into the industry. Competition is further distorted when the statutory powers of the state is used to assist a failing bank, which may constitute a form of “state aid” (OECD 1998a). Thus, the IMF has been pushing for greater powers for the BSP and the PDIC in dealing with problematic banks. It should also be noted that losses due to its bail-out of troubled banks in the 1980s partly caused the collapse of the Central Bank of the Philippines, which required its rehabilitation in 1993. • Mergers and acquisitions: In addition to their potential impact on market power, potential effects on competition and efficiency need to be clearly identified and considered. It needs to be pointed out that not all mergers and acquisitions are healthy for the economy. They could also lead to some problems especially if they are regulation driven, such as using capitalization requirements to drive consolidation. For instance, one problem of increasing capital through mergers and acquisitions is the potential additional risks in credit. Combining banking with nontraditional activities, such as insurance,13 may also extend the financial safety net. There should be a thorough evaluation of the potential effects of consolidation. This would include both direct effects (e.g., increased market power and/or improved firm efficiency) and indirect effects (e.g., reduction in the availability of financial services to small customers). There are also potential systemic consequences, such as changes in the efficiency of the payments system and the safety and soundness of the financial system (Berger et al. 1998). On the other hand, the Philippine commercial banking sector has been found to still exhibit economies of scale in the 1990s (Okuda 1999). Thus, it stands to benefit from more consolidation, particularly among the smaller banks.

INSURANCE SECTOR It was noted earlier that the reform and deregulatory process in the insurance industry is still in the initial stages and more needs to be done. As such, it can learn a lot from the way competition policy has been implemented in the banking sector. One key lesson is the importance of policy consistency. An essential policy reform in the banking sector, which occurred rather belatedly, was the deregulation of entry. In contrast, this was the first major reform in the insurance industry. However, it should ______

13 That is, “bancassurance”. Milo (2002) discusses financial services integration and its regulatory implications more fully. BANKING AND INSURANCE 297 be noted that the easing of entry restrictions in the banking sector was also preceded by other deregulatory measures, such as those on pricing and range of operations. In addition, proper safeguards were instituted, including the buildup of regulatory capacity. Given the complementary nature of these reforms, the full benefits of financial liberalization could have been realized sooner had their implementation been properly or even simultaneously paced. But one benefit of the delay in liberalization of entry was that it gave the regulatory and supervisory body ample time to also evolve. Thus, as in the banking sector, adequate prudential and regulatory provisions should be established to ensure the soundness of the insurance industry as well as the protection of consumers. Simultaneous with this, a regulatory and supervisory body that is capable of carrying out these tasks must be put in place. The strengthening of the regulatory and supervisory framework should be in parallel with other market-oriented reforms, particularly with competition and liberalization measures, to improve the efficiency of the insurance industry (Kawai 1997). Another important issue that needs to be addressed with respect to the regulatory and supervisory framework is the lack of consistent regulation. In particular, the regulation of the pre-need industry should be harmonized with the regulation of the private insurance industry (World Bank 1992). Furthermore, regulatory and supervisory authorities need to ensure that state-owned companies and private firms are treated equally. Regulations should ensure fair treatment among the different insurers operating in the same areas (competitive neutrality). At the same time, the importance of having different regulations applying to different sectors (e.g., life and nonlife insurance) must also be recognized. Each of these sectors operates under its own constraints and requires specific management and regulatory structures (OECD 1997). Other fundamental aspects of insurance regulation and supervision that need to be addressed to enhance competition and efficiency include: • Investments: Regulations governing the management of assets are typically based on a list of admissible investments. Governing principles include those on diversification, spread and liquidity; localization; currency matching; and maturity matching. Over regulation should be avoided. The insurance regulatory framework must encourage stability, while maintaining the necessary flexibility to meet developments in the market (OECD 1997). • Liberalization and competition: A program of removing monopolies and privatizing state-owned companies should be considered. Considering the size of the public sector relative to the private insurance industry, efforts to improve the competitiveness and efficiency of the latter could be hindered unless similar efforts are undertaken by government-owned insurance corporations. • Distribution and management of insurance products: The emergence of new insurance companies and products necessitates the development of modern distribution networks, with the possibility of an adequate combination of several types of intermediaries (insurance company staff, agents, brokers, 298 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

direct sales, etc.) (OECD 1997). In the Philippines, life insurance is almost exclusively sold through agents, while a mixture of agents and brokers sells nonlife insurance. Thus, the focus is on the licensing of agents, while little attention is given to the effectiveness of the agency management processes within the industry. But the structural inefficiencies of such a distribution network hamper the industry’s potential for growth and unduly involves the regulatory body in the network’s management. Thus, the development of more effective networks is necessary. In other countries, agents are a less important channel of distribution while other channels, such as banks, are relatively well developed (World Bank 1992). The current limit on a universal bank’s equity investment in an insurance company is 51 percent. Increasing bank ownership of insurance companies may help to improve the capitalization of the insurance industry and thus improve the capacity to grow without further reliance on overseas capital. But the issue then becomes the effective supervision of both the banking and insurance sectors and the requisite coordination and cooperation between their respective regulatory bodies. • Taxation: This is a key issue in any discussion of the insurance industry’s growth and development. Taxes imposed on the insurance industry have been described as onerous. They are also not uniformly applied (World Bank 1992). There are current proposals to amend the tax structure by simplifying it, lowering the rates and leveling the playing field.

REGULATORY FRAMEWORK Identifying the appropriate level and form of intervention is a serious challenge to government. Regulatory efficiency factors in overall economic performance. Ineffi- ciency results in costs to the community through higher taxes and charges, poor service, uncompetitive pricing, or slower economic growth. In order to control costs and ensure effectiveness, regulation has to be placed within a consistent framework. To do this, it is necessary to clearly establish what needs to be regulated and why, as well as to define the principles for effective and efficient regulation (Wallis et al. 1997). Cor- ollary to this would be the identification of the appropriate regulatory structure. The development of a national competition policy is a necessary and useful step in this direction, and enhancing the role of competition in regulation may be one guiding principle. In the financial sector, there are two aspects pertaining to regulatory framework that need to be considered. First is the appropriate regulatory framework for the whole financial sector. Second is how a national competition policy framework should apply to the financial sector. In addition to economies of scale, Philippine commercial banks have also been found to exhibit economies of scope (Okuda 1999). As such, they could achieve more efficient production if they broadened the scope of their operations. The current regulatory framework is supportive of such move toward diversification, given that line- BANKING AND INSURANCE 299 of-business restrictions have been eased under the new General Banking Law. Cross- sectoral ownership restrictions have likewise been relaxed. The interlocked structure of the Philippine financial sector could further diminish the effectiveness of such restrictions. Convergence or consolidation among financial institutions, overlapping of functions and blurring of product boundaries (e.g., between banks and insurance companies; cross-selling) would necessarily have an impact on the effectiveness and efficiency of regulation. Furthermore, new technology has allowed the unbundling and repackaging of individual products in a various ways. This makes it easier to circumvent regulations that prohibit an activity through product innovation to produce a close substitute (Herring and Santomero 1995). Thus, an important issue that needs to be considered is the competition effects of regulations affecting banks and insurance companies separately, for instance, within financial conglomerates. The different standards of regulation and supervision of financial institutions by the various government agencies have become more problematic recently. There have been some efforts to harmonize regulations, such as the SEC’s attempts to coordinate more with the Insurance Commission and the BSP to improve the regulation of pre- need firms and investment houses under its jurisdiction, respectively. But a more wholistic and formalized approach is warranted. The regulatory approach governing line-of-business restrictions in the Philippines is the “conglomerate” approach. The formation of cross-sector financial conglomerates (through the use of subsidiaries or holding companies) is allowed but there exist separate regulatory regimes for the traditional categories of financial sector institutions, including banks, securities firms and insurance companies. It is worth considering whether or not this approach needs to be supplanted by a “coordinated” approach.14 That is, the separate regulatory regimes for the parts of the conglomerate would still exist, but they are combined with regulatory and supervisory practices that explicitly take into account the conglomerate nature of the regulated institution (OECD 1998b). The latter would ensure consistency of regulation and prevent regulatory avoidance or arbitrage. Tan (2000) goes further and suggests that, for efficiency and streamlining of regulation, an Omnibus Act for all financial institutions may be the inevitable way forward. Consolidating existing supervisory roles, regulatory structures and financial services legislation is deemed to be more cost effective and efficient. Both accord with the view that the complexity of financial products and markets, their intrinsic risks and the detailed knowledge required to deliver efficient regulation in this sector argue strongly for continued specialized regulatory arrangements in the financial sector. In which case, a separate regulatory agency (or agencies) to conduct such specialized regulation is also still necessary (Wallis et al. 1997). ______

14 A third approach is the “pillars” approach, wherein separate regulatory regimes for the major traditional categories of financial sector institutions exist, and line-of-business and ownership restrictions prevent these “pillars” from competing in each others’ markets (OECD 1998b). 300 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Under the New Central Bank Act, the BSP has become, to some extent, the de facto “super-regulator” of the financial system with its authority to supervise and examine banks’ subsidiaries and affiliates engaged in allied activities (Sec. 25). The Act also gave the Monetary Board considerable leeway in defining a bank affiliate. Furthermore, the General Banking Law allowed the Monetary Board to examine any enterprise that is wholly or majority owned or controlled by a bank (Sec. 7), and to define the term “related interests” (Sec. 36). Finally, Section 38 of the New Central Bank Act allows the Monetary Board to “… determine and provide for such operating departments and other offices, including a public information office, of the Bangko Sentral as it deems convenient for the proper and efficient conduct of the operations and the accomplishments of the objectives of the Bangko Sentral.” This provision then allows the BSP to set up the necessary structure to put into operation the provisions relating to its supervision of banking groups. One advantage of the above option is that the BSP is a relatively more experienced regulator in the financial sector, especially in a deregulated environment. It could then set the standard for the other regulators in the sector. But the setup could also lead to duplication of functions which could result in conflicts with other regulatory agencies. Thus, complementary arrangements in the other regulatory agencies are also called for in order to minimize duplications as well as oversights, and to maximize coordination efforts. Such coordinated approach would entail institutional capacity building for all regulators, and not just the BSP. Otherwise, the BSP might become overstretched in fulfilling its supervisory functions over other financial institutions for which it does not have the expertise. A related point to consider here would be whether or not the BSP’s regulatory and supervisory functions need to be separated from its monetary functions. But one problem with this option is that it is limited to financial institutions linked to banks and it preserves the centrality of banks in the system. The requisite buildup of other regulatory agencies would presumably translate to better supervision and regulation of the other financial institutions under their separate jurisdictions. But ultimately, what is needed is a broader perspective in the supervision and regulation, as well as the strengthening and development of the different sectors of the Philippine financial system. The BSP alone is not equipped to efficiently and flexibly address these tasks because its primary operational relationships are with banks, and its operational skills and culture have long been focused on banking. The second aspect with regard to the regulatory framework is how a national competition policy framework should apply to the financial sector. Clearly, there are specific financial market characteristics and issues that may complicate the application of general competition principles to the financial sector, and which therefore need to be taken into consideration. But almost all OECD countries, for instance, apply their national competition law to the banking sector without exception. Most enforce the competition law through the competition authority, although a few do so through the banking regulator. Major structural changes in the banking sector, particularly mergers and acquisitions, also fall under the jurisdiction of both the banking BANKING AND INSURANCE 301 regulators and the competition authority, thus necessitating some mechanism for resolving possibly conflicting regulatory decisions (OECD 1998a). Grimes (1999) likewise argued that the general competition principles identified by the Pacific Economic Co-operation Council (PECC) to guide the development of an international competition policy framework, and that are intended to provide a framework for all industries as well as investment and cross-border transactions, should apply to financial institutions with just some clarifications. Similar to the regulation of all goods and services markets, financial system regulation may be classified into three: general market regulation, regulation for (financial) safety and regulation for social purposes (Wallis et al. 1997). General market regulation aims to ensure that markets work efficiently and competitively. It includes conduct and disclosure regulation to prevent fraud and prohibit anticompetitive behavior; ensure market integrity (i.e., that participants act with integrity to promote confidence in the efficiency and fairness of markets) and consumer protection (i.e., that retail consumers have adequate information to facilitate informed judgments, are treated fairly and have adequate avenues for redress); and promote the overall competitiveness of markets. Wallis et al. (1997) argued for specialized regulation in the areas of financial market integrity and consumer protection. But they also argued that the case for specialized arrangements in the area of competition regulation is relatively weak. Although financial products are complex and any assessment of competition would require detailed analyses of markets, the key features relevant to competition assessment in this sector are not unique. Thus, the application of an economy-wide competition regulation to the financial sector would ensure greater regulatory consistency and efficiency. However, it is also recognized that the market mechanism is restricted by the nature and structure of the market itself, which in turn would necessitate some regulatory intervention to achieve welfare-enhancing outcomes. Thus, there is also regulation for financial safety, particularly in the form of prudential regulations to ensure soundness and stability. But again, prudential regulation lessens competitive pressure and imposes efficiency costs. In the case of the Philippines, there has been a tendency toward increasing and tightening prudential regulation, which reflects the BSP’s bias for soundness and stability. Thus, a better balance between the twin objectives of soundness/stability and competitiveness/efficiency needs to be achieved. One benefit of having a national competition policy/law administered by a separate agency is that it could serve to complement, even check the BSP by specifically focusing on competitiveness and efficiency. Some mechanism for resolving any conflict in regulatory decisions would also be needed. With respect to regulation for social purposes, requiring banks to service certain activities or sectors compromises their efficiency. Even if it is deemed worthwhile to purposely restrict competition to pursue wider equity objectives, a national competition policy can then require the government to justify its interventions and restrictions in the market. That is, another aspect of competition policy would be to make such 302 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES government interventions and restrictions transparent and open to public scrutiny and assessment of their effectiveness at achieving distributional and other objectives (Cabalu et al. 1999).

SOME CONCLUSIONS Financial reforms implemented in the Philippines from the 1980s to the 1990s have been fairly extensive and intensive, particularly in the banking sector. But the reform process is not yet complete in the banking sector and more so in the other sectors of the Philippine financial system. Overall, despite the difficulties in its implementation, financial liberalization per se is still a valid concept for efficiency enhancement. It is in the implementation that the liberalization process is often compromised, particularly in the nonmarket approach and in ineffective supervision (Tan 2000). The East Asian crisis once again highlighted the dangers of a bank- dominated financial system. Thus, there is a need to improve the competitiveness of other financial institutions to provide savers and borrowers with alternatives. For instance, the insurance industry has a potentially more important role to play in this regard. Thus, the scope of competition policy must be widened to include the other sectors of the Philippine financial system. An appraisal of existing regulations in the other sectors would also be very instructive. The discussion especially highlighted the role of government in promoting a stable and efficient financial system in terms of the regulatory framework. But the most important contribution that the government can probably make to promote the development of the financial system is to provide a stable and consistent macroeconomic environment (Herring and Santomero 1995). Financial stability is simply not feasible without it. On the other hand, confidence in a country’s financial system is also critical to macroeconomic stability. But as the Asian crisis demonstrated, unan- ticipated shocks do occur even in a stable macroeconomic environment. Thus, it is also important for the government to nurture a resilient financial structure that is capable of withstanding financial market volatilities and does not amplify the shocks to the real economy. In the more deregulated and globalized environment, a static and dynamically efficient financial structure coupled with effective regulation becomes imperative to enable the real economy to succeed in the global marketplace (Herring and Santomero 1995). Some problems continue to exist and persist in the Philippine financial system. However, that does not mean that all of them are directly rooted in the financial system. Financial liberalization does not take place in a vacuum and it must be coordinated with real sector policies. Ultimately, the performance of the financial sector reflects that of the real sector, and even the best financial institutions will encounter problems if real sector distortions persist. As long as there are market imperfections in the real sector, financial deregulation is not likely to develop a competitive market structure in the financial system (Park 1991). This underscores the importance of developing a national competition policy for the Philippines. BANKING AND INSURANCE 303

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Government Policies and Regulations: Interface with Competition Policy

Erlinda M. Medalla

“To widen the market and to narrow the competition is always the interest of the dealers... The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted, till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both de- ceived and oppressed it.” — Adam Smith

ABSTRACT

he paper aims to examine the major government policies in terms of how they relate to the objectives of competition; clarify what important trade-offs may exist; and determine how and when conflicts between government policies Tand competition policy objectives arise. Three sets of government policies are discussed. The first is trade policy, in particular trade liberalization, where the impact on competition is most direct and apparent. The second group covers government policies and regulations that have direct impact on competition, namely: 1) government regulation of an industry, or a segment of it; 2) direct government equity partici- 308 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES pation; and 3) other regulatory restrictions. The third group of policies consists of other major government policies with other development objectives and their interface with competition policy objectives. These include industrial policies, agricultural policies and environmental policy and regulations. In general, the paper points out the need to bring in more closely the principles of competition policy into analyzing and evaluating government policies. Indeed, competition policy would provide a new and different perspective that could help formulate a more effective and dynamic development policy for the Philippines.

INTRODUCTION

Conceivably, almost anything (and everything) the government does, could affect competition. There may not be any conscious, coherent, or concerted policy on competition, but government policy interventions will always alter, in varying degrees, for good or bad, the state of competition. It is ironic that for a developing country with usually less perfect markets, there is a greater need for an effective competition policy to encourage better use of scarce resources. However, there is less recognition of this need. Not that the government has done nothing to foster competition. The reforms starting in the mid-1980s have done much to move the economy toward a more market-friendly policy environment. Since the mid-1980s, trade reforms, banking reforms, foreign investment policy reforms, deregulation, privatization, and the policy thrusts in general have explicitly and implicitly recognized the benefits of competition. But government has done so much more that may need to be reexamined in the light of competition policy.1 It is not that competition policy objectives are superior. Rather, it is because there are efficiency gains and improved consumer welfare usually expected from competition. And if some government policy conflicts with competition policy, there is enough reason to question whether or not this policy serves national welfare and its stated objective. This sums up the main objective of the paper—to examine the major government policies as they impact on competition. This paper is not meant to be an in-depth and comprehensive analysis but simply aims to at least make a general assessment of the major government policies as to how they possibly affect competition. As such, it hopes to give signals and insights on where more analysis or reform is needed in the various policy areas and how much could be gained from incorporating competition policy in the framework used in these policy areas. To organize the discussion, government policies are divided into three groups according to how direct their impact is on competition. The first singles out the trade ______

1 A background on competition policy, what it is, its objectives and rationale, is available in the integrative paper of this volume. GOVERNMENT POLICIES 309 policy regime, considered here as the first layer of competition policy, which has a widespread impact on the state of competition. This is discussed in the next section. The second group, covered in the third section, includes those government policies and regulations directly intervening in the market. They regulate entry into the market or some aspects of the operation of the industry itself, like prices and rates to apply. The second-to-the-last section deals with the third group of other major government policy areas as they relate to competition. This group would consist of government policies aimed at achieving various other objectives that are not explicitly related to competition but would nonetheless have significant, though less direct impact, on the state of competition. These include, for example, industrial, agricultural and environmental policies.

PHILIPPINE TRADE POLICY AND COMPETITION

There is no question that the kind of trade regime adopted by the country affects the state of competition. By simply allowing imports to come in, some barriers to entry are broken down and the market becomes more contestable. The world market is always a potential source of supply, so that in a relatively open economy, even a monopolistic or an oligopolistic domestic producer, faced with competition from imported goods, would act like “perfect” competitors. Hence, with its pervasive impact on the whole economy, trade policy could act as a major competition policy tool. The Philippine trade policy regime has changed substantially during the past two decades—from a highly restrictive and protectionist system to a relatively open trade regime. Tariffs went down across sectors from highs of 100 percent (or even more) before 1980 (i. e., before the first Tariff Reform Program) to a present range of 3 to 10 percent for the majority of products. Tariffs of more than 30 percent are found mainly in agricultural products (e. g., sugar, rice, corn, livestock not for breeding, etc.) and only in a few industrial products (e. g., completely builtup cars). Nontariff import restrictions, mainly in the form of import licensing requirements or outright import prohibitions have also been removed except for a few (less than 3 percent of commodities at the 6-digit level of classification). There are a few remaining import restrictions, again for some (basically the same) agricultural products and for reasons of health, sanitation and national security. Tariff rates are expected to fall to a range of 0 to 5 percent by 2004 (except for a limited number of products). These reforms in Philippine trade policy have been well chronicled and well studied and would not be further elaborated on in this paper. Suffice it to say that the series of trade reforms undertaken is largely due to the recognition of the huge costs of the three decades of protection and to expected benefits from competition. Trade liberalization could thus be considered the first major layer of competition policies to be implemented in the postwar era. Indeed, the major trade reforms implemented since 310 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the mid-1980s have contributed much to improving the state of competition in the Philippines. Although the impact of trade policy on competition cannot be underestimated, there are other factors to consider in assessing how much competition actually results. A World Bank/OECD 1998 study identifies the following factors: • The existence of crossborder distribution systems, • The amount of information that domestic buyers have on foreign firms, • Whether or not foreign suppliers have been placed on approved sourcing lists, • The existence of significant excess capacity held by foreign firms, • The similarity between the needs of domestic buyers and needs of foreign firms, • Exchange rate trends, and • The existence of technology-licensing agreements, strategic alliances, or other affiliations between domestic buyers and foreign firms.

However, advances in information technology and the declining transport costs across borders (especially relative to domestic transport costs) diminish the impact of these factors, with the exception perhaps of the third and the last factors. Indeed, if these concerns would have some impact on the ability of foreign products to compete with local supply, they may even enhance, not diminish, the competitive edge of foreign products over domestic supply because of some perceived (whether real or not) superiority of imported goods. What is more important to examine is the structure of the local distribution channels (the third and the last factors cited above are related to this). If the local distribution channels are somehow tied up with local producers (e.g., through vertical integration or some vertical agreement like exclusive dealing), then the impact of trade liberalization may be limited (especially if substantial sunk costs are involved in putting up another distribution channel).2 Perhaps another consideration is that local firms could (and would most likely) resort to product differentiation. However, this would only offer minimal market power as foreign competition could potentially offer so much more. And if product differentiation leads to overall increased supply of goods, the impact is procompetitive, resulting in a wider range of products and higher consumer welfare. Although trade reforms during the past decade or so have substantially removed or reduced tariffs and import controls, there are still some important barriers to trade that remain. Recently, newer forms of protectionism are becoming more important— antidumping measures and possibly to a lesser extent, the subsidies and countervailing duties.

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2 This is a problem, for example, in the case of the downstream oil industry. This is discussed in greater detail in a separate paper by Peter Lee U in this PASCN series of studies on competition policy. GOVERNMENT POLICIES 311

Theoretically, the antidumping act and the subsidies and countervailing act could be considered as competition policies being carried out at a global level. They are allowed under the GATT-WTO codes to deal with “unfair” trade practices, which cause trade distortions that hamper the efficient global allocation of resources. The intention is to prevent predatory pricing (dumping price) and unfair trade practices (subsidies giving exporting firm “unfair” competitive advantage) that go with these acts. The problem is how close to the spirit of the code would the cases filed be in most instances? How prone are these provisions to being used as simply protectionist tools? The General Agreement on Tariffs and Trade-World Trade Organization (GATT- WTO) codes on antidumping and countervailing duties have tried to make rules transparent and predictable as much as possible. However, the current national laws on antidumping and countervailing duties would have to be more effective. Thus, improvements in the Philippine national laws have been made to make them more consistent with WTO rules. In the end, however, even with the perfect rules, it is their actual implementation and administration that would matter. If cases could be easily filed and if authorities could easily find prima facie evidence, the mere threat of filing a case would be an effective barrier to entry, whether or not the case is real. Although the number of cases being filed is still few, it has been growing since the 1990s (see Appendix Table 1). The antidumping act could be an effective tool of protection and a real barrier to trade. Much depends on the orientation and objectives of the relevant authorities tasked to implement them.

GOVERNMENT POLICIES AND REGULATIONS AND COMPETITION POLICY

Recognizing the extent of trade policy reforms that have been implemented, it is perhaps more crucial to examine government policies and regulations that directly interfere in the market. These are direct government interventions that control either entry into the market or some aspects of operation in the market, or both. In general these include: • Government regulation of an industry, or a segment of it, • Direct government equity participation, and • Other regulatory restrictions.

INDUSTRY–SPECIFIC REGULATIONS No government measure and action could have a more direct impact on competition than government attempts to regulate an industry. Such a strong involvement should also require a strong rationale. In general, the government would have reason to intervene in cases of market failure. Among the most important and most recog- 312 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES nized of these are (1) the presence of economies of scale and (2) externalities.3 In such cases, the intent of these regulations could, in fact, be basically procompetitive—since the market would not be able to function efficiently4 if left to itself. Thus, a regulatory framework may be justified. What needs to be examined then is if the regulation is indeed intended and designed to perform its role of correcting market failures and how well it is able to do so. Or does the regulatory framework only distort the market further? If it is the latter, what reforms are needed? These are important questions to ask which only in-depth studies of the particular cases could answer. Hopefully, however, the following discussion could help shed some light on what could the issues be—particularly, how the regulatory framework limits competition and how, in certain cases, expected benefits may not compensate for such loss in competition.

Economies of scale and industry regulation Economies of scale can arise from efficiencies in production, which could only be realized upon the attainment of a certain plant size. Economies could also come from other stages or areas such as purchasing, marketing and R&D activities. Such gain in efficiency from economies of scale, however, is not by itself an argument for regulating the industry and limiting the number of firms in the market.

Where the good is tradable The above is especially true if the good is tradable. If such a good with economies of scale is tradable, then it could also possibly have export potential and the economies of scale need not be derived from serving the domestic market alone. If there are private initiatives to enter the market even without any promotion and incentive from government, they could have very well realized the potential gains pf that good and its entry into the market should not be restricted and should even be welcome. The problem is that the promise of economies of scale is a lure for governments to intervene, especially when the industry is also considered “strategic.” The reasoning is that an initial push is necessary for private sector to see and act on this potential. Indeed, this appears to have been the government’s strategy during its protectionist and import-substituting phase. This has been the main reason, for example, for the local content programs and for the promotion of certain heavy industries like steel and cement by the government during that time (and which remains in the present time in some cases). Generous incentives are granted to selected industries but at the same time, some regulations are also imposed. There have also been cases of direct government equity participation (e.g., National Steel Corporation).

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3 Even in these cases, direct government intervention is not automatically called for. See subsequent discussion. See also Stiglitz (2000) on the role of government in a digital economy 4 That is, match supply and demand at optimal levels. GOVERNMENT POLICIES 313

As experience has shown, however, such a strategy has been very costly and ineffective (Baustista et al. 1979) Their promotion only led to industrial concentrations and to a further need for government regulation. The supposed export potential and economies of scale of the selected industry are not realized and only served to penalize downstream industries (and ultimately limited the growth of the industry). The lesson here is that restricting entry is not the best option. Restricting entry is not enough to realize economies of scale and the export potential of the industry. The profits earned from the domestic market may already be enough because the incumbent firms are able to charge high enough prices, being protected as they are from threats of new entry. Without the discipline of competition, there is no urgency to export and the firms are more likely to be content in just serving the domestic market. Not only is restricting entry ineffective, it also creates additional costs and problems. The final outcome of restricting entry is an industrial concentration characterized by underutilized redundant capacity (one objective the restriction to entry is supposed to prevent). Hence, by the mid-1980s, the need for reforms has become urgently felt. Regulatory bodies such as the Iron and Steel Authority were abolished (and government assets sold). Nothing could be done with respect to the sunk costs of capital. The more pressing problem is presented by concentration—the possibility of abuse of dominant position. This is not remedied by continued restriction to entry (which would only preserve its market power). Quite the opposite, the solution is to make the market contestable. Indeed, in general, where the good is tradable and if concentration naturally results because of economies of scale, efforts should be made to make the market contestable. Then, the monopoly would not present a problem since it would not be able to earn excess profits because of the threat of entry. If there are sunk costs involved creating structural barriers to entry, the incumbent firm should be subject to the discipline of an antitrust law to prevent anticompetitive actions.

Where the good is a natural monopoly A problem arises, however, when the good is nontradable and the size of the market is too small for more than one producer to achieve economies of scale. The arguments above could also apply. This could result in duplication of investment, which could be a waste of resources if entry is not restricted. Nonetheless, wasteful as duplication of investments may be, the cost of duplication may still not be large enough to outweigh the cost of foregoing the competitive process. In a class of its own is the case of the so-called natural monopoly. It requires very large fixed capital and involves huge sunk costs such that duplication may indeed be socially and economically unviable. Moreover, this could often involve an essential facility (also referred to as bottleneck facility) where access is “essential” for the survival of the firms using it. Access problems could arise due to the market power held by the vertically integrated owner of the facility. Then, some regulation would be needed and justified. 314 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The foremost examples of such cases are said to be in electricity (transmission), interisland shipping (ports), civil aviation and telecommunications. Toward this end, the government created corresponding regulatory bodies to address the problem. These are the Energy Regulatory Board (ERB) for electricity, the National Tele- communications Commission (NTC) for the telecommunications industry, the Philippine Ports Authority (PPA) and the Maritime Industry Authority (MARINA) for the shipping industry, and the Civil Aeronautics Board (CAB) for civil aviation industry. (These are discussed in more detail in separate papers on telecommunications and civil aviation by Serafica and Austria, chapter 5 and 6, respectively, of this volume). The two main regulatory measures these bodies employ include, among other things: • The authority to issue, amend or revoke license/permit to operate in particular areas, and • Control or fixing of rates/price.

For example MARINA has the right to determine what should be the capacity in all routes and on this basis, issue, amend and revoke franchise/permit to operate a route. It also regulates the passenger fares, freight rates and other related charges. At the same time, it imposes a cap on the 12-percent rate of return. In the case of telecommunications, although the franchise is granted by act of congress, NTC grants a provisional authority (PA) for a carrier to be able to operate in a specific geographic area. It also sets and regulates the end-user price of the telecommunication service. There are other important measures the regulatory bodies use, depending on the nature of the industry. This could include standards and safety regulations, whose purpose may be unquestionable yet may impact unnecessarily on competition and efficiency. In general, the regulation is supposedly for the development and rationalization of the industry. Invariably, efficiency is an explicit objective, so is competition in some cases, e.g., in the NTC. Another supposed objective of regulation is to provide access to less privileged sectors. Usually, the provision of a minimum level of good or service to unserved or underserved areas at an affordable price is an additional objective. This social objective is particularly important in the case of electricity, transportation and telecommunications. Indeed, this provides one of the main guidelines for regulating the rates—to allow for some cross subsidization from more to less lucrative markets. All these are undoubtedly worthy objectives. Nonetheless, considering the power that the regulator has, and the (monopoly) rights given the firm in allowing its entry, a careful review is necessary with respect to the real impact of the regulation. This requires a separate in-depth study of each industry. This paper can only point out the relevant issues that need to be looked into. So much depends on how the regulation is actually applied and how necessary are the regulatory measures used. In this regard, there are issues that have to be addressed. GOVERNMENT POLICIES 315

First, there is a tendency for the regulation to cover a greater portion of the industry than what is necessary and for the regulator to “overregulate.” Is there a rationale for the regulation in the first place? And if there is, how much of the industry could be deregulated, and/or how much of the regulation could be relaxed? Are there elements/ activities in the industry covered by the regulation and which should be made subject to competition? If any of these possibilities is true, the cost of the regulation could be very high. Indeed, especially after the era of controls under the Marcos regime, there was increased realization of the costs of regulation, which spurred the policy thrust toward deregulation in the concerned industries. Deregulation has mainly been done by easing entry into the industry and allowing more players to come in. The benefits of deregulation are still being felt—in shipping, domestic air travel, and telecommunications, in particular. Nonetheless, much more could still be done. Specifically, there must be clearer delineation between segments (activities) in the industry, which are natural monopolies, and those which should be subject to more competition. Related to this is the second issue. Among the major reasons for regulating an industry is the case of an essential facility. How “essential” is the essential facility? Is there a clear policy on access? Is it essential enough to justify restricting entry of firms, i.e., disallowing other firms to put up its own facility? For example, if the facility is not too difficult and costly to duplicate, then entry should not be restricted. In other words, a stricter definition of what is “essential facility” is needed. This is a prerequisite to a clear policy on access. This would also help regulators identify and limit what segment of the industry could be considered a natural monopoly. Third, one should question the use of price/rate fixing as part of the regulatory framework. A general rule applicable to public utilities (including power, shipping and telecommunications) is the rate of return to base regulation, which limits returns to 12 percent. In addition, some product (service) price setting is enforced. For example, in telecommunications, end-user rates are set by the NTC. Price setting is also enforced in power and transportation. At the outset, price fixing appears to be a logical policy handle of the regulator, especially since there is presumption of market failure in the industry being regulated. Where competition as market regulator fails, the ultimate impact is on prices and it seems reasonable that this is where the regulator takes over. Price fixing is also very politically appealing. However, as often experienced in many countries, government price fixing often creates more problems than it solves. A major reason is information problem. It is difficult to predict demand and supply. Data on costs are difficult to come by. Sometimes, the problem is the point of price of intervention. Take the case of telecommunications. End-user price (price paid by consumers) is set by NTC but interconnecting carriers are allowed to negotiate access charges between them (intermediate price). A firm (the one enjoying network externalities) can effect a price squeeze in its effort to gain market power before the regulator can step in. One can thus question, if it would be better for the regulator to intervene at the intermediate level and 316 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES deregulate end-user price where enough competition exists. This would also lower the cost of negotiation. Just imagine the costs involved with N carriers negotiating bilaterally per product (service) for M types of products. Another example is the rate of return cap. This is where the rationale is more difficult to comprehend. Presumably, the rate of return regulation is an alternative to user price fixing and is much easier to manage and determine. However, if government wants investments to happen, it should not put limits on how much the firm can earn, certainly not at an unreasonably low nominal rate of return of 12 percent, which is not even enough to cover interest costs. It creates, for prospective investors, “regulatory risks” on top of the commercial risks they already have to face. (If the firm makes money, it runs the risk of losing it because of the regulation.) Moreover, to a large extent, the regulation only encourages cheating and also effectively forces the honest new players out of the market. What then are the other options available? The first option should be to seek ways to make the market as contestable as possible. This, of course, is easier said than done and there could be cases where the market cannot be made contestable. Another option, which could be developed in the longer run, is to craft and implement an antitrust law that would be applicable even to the firms in the regulated industry. Then, there would be less need for price regulation since there would be some check on the firm’s anticompetitive abusive behavior. (This includes both exclusionary abuse and exploitative abuse of market power. The first covers a firm’s efforts to shut out new players by means other than becoming more efficient. The second covers abuse of market power by setting prices and reducing output levels that endow the firm excess profits.) The fourth question is the policy of cross subsidization, which complicates even further the problem of price fixing. There is a need to reevaluate the costs and benefits of cross subsidization. This has been used as a reason for limiting entry (to prevent new entrants from “skimming off the top”). In the first place, it is very difficult to set the right prices and the cost of making a mistake could be high. In the second place, are there alternatives to attaining the objective? These considerations make the assessment of how well objectives are satisfied very difficult to do. Fifth, a problem common to all regulations is that the regulator could become subject to “capture” (Stigler 1968). The regulator could become beholden to the incumbent firm and would protect the “competitor” rather than the competitive process. A review of the regulation should determine if and to what extent there is a regulatory capture. Perhaps, the task of regulation could, in reality, be even in the hands of the monopolist. What safeguards are necessary to prevent such a situation? Finally, another problem that is also common to all regulations is the tendency for regulators to use complicated and cumbersome procedures, which could negate whatever procompetitive effects that may result. Regular reviews to update and streamline the procedures would go a long way in increasing the efficiency of the regulatory process and the industry itself. GOVERNMENT POLICIES 317

The case for financial sector regulation Of most unique importance perhaps is the case of financial regulation because of the nature of the financial sector and its vital link to the rest of the economy. The financial sector regulation can be justified on two grounds, i.e., two cases of market failures: (1) the presence of asymmetric information and (2) the presence of systemic risks (see Milo, this volume). Perhaps the more compelling of the two is the second. The risk to one bank is a risk to all. The failure of one bank can cause the failure of others, if not of the whole system. Thus, regulation of the financial sector is indeed well founded. However, there is regulation, and there is regulation. Ideally, the regulation should address only the particular market failure. Hence, in the case of the financial sector, this means ensuring the stability and soundness of the banks and of the payment system. This means prudential regulations. It does not mean limiting the number of firms per se. This means disallowing entry only if the entrant could not prove its soundness and stability. However, as in the other cases discussed above, the problem of regulation is the tendency to “overregulate.” Are the regulations really just for the soundness and stability of the system? Or is entry unnecessarily restricted, weakening the discipline from competition? 5 Incorporating competition policy could only enhance the efficiency of the sector. This suggests that the competition policy, at least as far as preventing abuses of market power is concerned, should also apply to the financial sector. Thus, another important issue is how to make the competition policy work for the financial sector. Of particular relevance to the sector would be the competition policy rules on mergers and acquisitions. It should ensure that mergers and acquisition would result in greater efficiency and/or increased welfare reflected in improved service and greater variety of products, especially where the merger or acquisition would lead to a substantial share of the market falling in the hands of a dominant player. While there should be a universal competition policy rule for all firms, there should be very close coordination between the competition policy body (or the authority enforcing the antitrust law) and the financial sector regulator. What form the coordination, relationship or linkage between the two bodies should take would depend on what is most feasible and efficient. However, (especially during the capacity building years of the competition policy body if such a body is created), the recommendations of the financial sector regulator, having more resources and greater expertise in examining the firms it covers, should carry a lot of weight. Such interrelationship between ______

5 This tendency has two basic dimensions—depth and breadth. On the former, the issues are clearer. On the latter, there are more questions. Can one really regulate only a section of the financial sector (e. g., just the banking system) and leave the rest unchecked? If not, how much should financial regulation cover? Should there be just one regulatory body? (e g., BSP regulating all, including investment houses) . A lot of the issues are really concerned with which is most administratively efficient. 318 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES the regulatory body and the competition policy body is among the major issues in moving toward a formalized and workable competition policy for the Philippines. This issue should be ironed out and resolved, not only for the financial sector but for the other sectors as well. The issues in competition policy for the financial sector are discussed in more detail in Milo (this volume).

Other industry-specific regulations There are other industry-specific regulatory bodies. Possibly among the most important is the Land Transportation Franchising and Regulatory Board (LTFRB). Its primary objective is the provision of service in all areas at affordable costs. There are also elements of public safety objectives. The same objective may also be important in other industry regulations. In most of the other cases, the objectives are social in nature that could be far removed from efficiency concerns. In general, granted that the stated objectives dictate the overriding guideline of the regulator, there is still the question of how best to do it. A different perspective from competition policy objectives may prove beneficial. It could very well be the case that incorporating competition policy in the framework of regulating bodies would clarify most of their problems and advance their objectives as well, since efficiency should always be a hallmark of any agency’s operation. Also, most of the issues raised in the previous section also apply, particularly: • the tendency to over regulate, • price setting as a regulatory measure, • regulatory capture, and • need to update and streamline procedures.

Appendix Table 2 provides a list of industry-specific regulations.

DIRECT GOVERNMENT EQUITY PARTICIPATION As could be implied from the preceding discussion, one reason for direct equity participation in the Philippine setting is the promotion of an industry. Such a strategy was widely used during the Marcos administration. The social profitability is considered high but due to some distortions (e.g., high private risks), the private sector is not interested in entering the market because it is not privately profitable. Thus, the government directly steps in by way of direct equity participation. (Of course, the government could simply provide fiscal and other incentives to make the activity privately profitable.) Another reason the government intervenes in the form of direct equity is to provide stability in the market. But perhaps the most justifiable reason for government equity participation is the production or provision of a public good. Appendix Table 3 provides a list of these existing public enterprises. Whatever the reasons are for government equity participation, it is always important to reexamine the objectives and to analyze its impact on the economy. With GOVERNMENT POLICIES 319 regards to the latter, it is important to consider in the analysis how government equity participation impacts on competition, as this would have direct bearing on efficiency and overall welfare. The public enterprise may be enjoying undeserved, unnecessary and unfair advantages, e.g., in terms of tax privileges, access to credit and loan guarantees. This could drive the more efficient private firms out of the market. Privatization has been part of the major reforms being implemented since the Aquino administration. For some years, asset privatization has been a source of badly needed revenues. However, although it has been an important source of revenue especially during the initial years, privatization is now viewed more as a tool to enhance efficiency and encourage competition. This is part of the effort of reforming public enterprises. Various research studies have shown that publicly-owned and run corporations are less efficient than private enterprises. This is due to a number of factors. First is the hiring and firing scheme, which is constrained by civil service regulations that make it extremely difficult to hire and fire employees. The second factor is the incentive and compensation structure. Third is lack of accountability. These factors, among others, deprive the public enterprise of the usual motivation for profit maximization as is present in private firms. However, transfer of ownership alone would not ensure (may only transfer rents) increased efficiency if the necessary conditions for a competitive market are not set forth beforehand. Indeed, the problem may not be whether or not to transfer ownership but rather, how the competition process and discipline could be introduced. If there would be transfer of ownership, all unnecessary advantages the firm previously enjoyed should be removed and competitive neutrality should be ensured. These issues need to be examined further in reforming public enterprises. But perhaps, the first step is to make antitrust policy universally applicable to firms, whether private or public.

OTHER REGULATORY RESTRICTIONS The other regulatory restrictions could range from explicit restraints to entry requiring firms to obtain permit or license to operate in a particular market, to stringent procedural and other requirements making entry to a market difficult. These include, among others: • Local Government Code provisions on licensing and zoning, • Lengthy and cumbersome bankruptcy and insolvency laws that create exit barriers, • Labor Code provisions that restrict flexibility of firms to downsize or shut down, which also create exit barriers, • Intellectual property rights protection, • Government procurement policy, and • Business registration requirements. 320 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The rationale for the restriction varies—from public safety to monitoring and other reasons. Appendix Table 4 provides a listing of some special laws and provisions creating regulatory restrictions. In the first, the local government is given leeway in its efforts to pursue its own strategy for development. While some autonomy should be exercised by the local government, it should be made aware if its actions could have serious detrimental impact on competition and efficiency, even if in the end, it has the final say on the matter. In the second, these exit provisions could create entry barriers as well. The government policy on intellectual property rights (IPR) is intended to encourage innovation, a necessary condition for dynamic efficiency. Though it could grant temporary monopoly rights to the IPR holder, this should be balanced against future dynamic gains from innovation. Government procurement policies are among the issues being examined in the international fora on trade. There is increasing concern about how these could violate the spirit of fair trade espoused by the WTO. The impact of government policies or fair trade should not only be an international concern; its impact on domestic competition should also be an immediate concern. How much are auctions studies considered? Finally the cumbersome process of registration procedures could also be an important source of barriers to entry. This is especially true for the small and medium scale industries. The checklists of requirements for doing business in the Philippines and for business registration in Appendix Tables 5 and 6 illustrate the long process and numerous requirements a prospective business needs to hurdle just to be registered. This could specially prove more difficult for small and medium enterprises. Regular review of these procedures should be done to simplify and modernize the process. To summarize, these regulations are supposed to serve some objectives, even those that are procompetitive. Nonetheless, just looking at the host of government regulations, it is not difficult to imagine how they could interfere in how the market functions and how they could limit the state of competition. There is a clear need to reevaluate these policies and review whether such policies and regulations could pass a “competition” test or, if not, if they could be justified on grounds of public welfare or of the objectives they are supposed to achieve.

OTHER GOVERNMENT POLICIES AND THEIR INTERFACE WITH COMPETITION POLICY OBJECTIVES

Finally, this section deals with the third group of government policies, which would include those aimed at achieving various other objectives that are not overtly related to competition policy but would nonetheless have significant, though less direct, impact on the state of competition. The list in this second group could be long but the major policies would include, among others, the following: GOVERNMENT POLICIES 321

• Industrial policies: investment policy, export promotion, foreign investment, and regional development policies, • Agricultural policies, and • Environmental policy and regulations. (Please refer to Appendix Table7).

The last could likewise have a direct impact on barriers to entry but is included here because of other social objectives paramount to it. Also, there is no doubt that there are other major policies not included that would have a significant interface with competition policy objectives. This, however, hopefully illustrates the importance of examining this interface and the lessons that could be obtained from it for the others. These policies are supposed to serve other explicit objectives—basically the development of the sector that will ultimately benefit the economy as a whole. The question is how much competition policy should be considered.

INDUSTRIAL POLICIES The first policy, which is a major tool for industrial development, is investment policy. This is largely embodied in the Omnibus Investment Code (OIC). The OIC is mainly administered by the Board of Investments (BOI) basically through the promotion of selected activities in its Investment Priorities Plan (IPP) and the granting of fiscal incentives. The OIC also has other provisions aimed at other specific objectives, of which the more important ones include: (a) regional development objectives specifically through the promotion of industrial estates and (b) promotion of foreign direct investment (FDI). For the investment policy as a whole, the objective is to aid in industrial growth and development. The rationale behind this is that there are market failures that prevent the industrial sector from developing naturally. Indeed, there is greater conscious consideration of this rationale in the role of investment policy. This is reflected when the list of industries in the IPP was shortened, and there was a move toward a more promotional body. The “measured capacity” concept in the OIC, which limits granting of incentives when a certain capacity (some optimum scale) is reached, is clearly anticompetition in nature and is not actually practiced. There is a move toward the “greening” of incentives with the realization of externalities involved. Export promotion remains in the list of priority. As noted above, regional dispersal of industries and promotion of regional investment are among the stated goals of the Philippine government. These are arguably desirable objectives. Nonetheless, the industrial strategy chosen has probably been too preoccupied with simply trying to overcome the failures of the market (real or merely perceived). Less (or no) explicit consideration has been taken about how the policies affect the state of competition. This is one area where more conscious efforts should be made and reforms implemented accordingly. More- over, industrial policy could even go one step beyond this assessment of how it im- 322 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES pacts on the state of competition. An obvious strategy, which has been overlooked, is to proactively support competition policy for industry, since competition and industry policy objectives largely merge. A major objective of industrial development policy is to enhance efficiency, which directly coincides with that of competition policy. So the question is, could competition policy actually serve as one of the policy tools for industrial development (together with trade, fiscal and monetary policies)? Is it even deliberately considered? Or, on the contrary, are there anticompetition effects that unintentionally go against the competition policy objective (defeating their purpose)? One that comes to mind is the inherent bias of an incentive granting system against the entry of small and medium scale industries. An industrial policy tool, which is particularly important with respect to its impact on competition, is the policy on FDI. Restrictions on foreign equity have a direct impact on entry of firms. Specifically, they represent (policy-induced) structural barriers to entry. Substantial liberalization was effected by the 1992 Foreign Investment Act that changed the regime from a highly regulatory system of positive list where foreign equity is fully or partially allowed, to a more liberal system of negative lists where only those in the list are not allowed 100 percent foreign equity participation. Recently, some liberalization was implemented in retail trade with the passing of the Retail Trade Act. This could have a big impact on competition. It would also complement well the effects of trade reforms. Foreign equity participation is still limited for many sectors and this is supposedly because of some other social objectives (national security, sovereignty, and others). Clearly, there is a need to reexamine the issues to evaluate whether or not the restriction, in fact, serves the stated objectives, and assess the benefits and costs of limiting competition with such restrictions.

AGRICULTURAL POLICIES With respect to agricultural policy, a basic rule should be for government to intervene only when market fails. However, for agricultural policies, there appears to be the additional and equally important (possibly more so in some cases) equity objective. This is where it could run counter to competition policy objectives. This is where the problems could become intractable. Often, the government hides behind the supposed interests of the farmer to justify interventionist policies in agriculture. Does protecting the agricultural sector necessarily imply foregoing the rules of competition? One might actually be surprised to find that the local farmer understands competition even better than big businessmen. For sure, there could be tradeoffs. Nonetheless, if such tradeoffs exist, it is even more important to be able to analyze clearly what they are. Are they justified? That is, would the benefits (from equity considerations for example) outweigh the costs (e. g., efficiency losses from foregoing competition objectives)? In particular, agricultural policy still relies much on tariff policy tools and other trade controls that are clearly anticompetition. This is supposed to protect the income GOVERNMENT POLICIES 323 of farmers (equity objective). Are the costs of protection commensurate to the benefits of increased income for the farmer? Is protection even reaching the farmer? Also very important to examine are the other policies that have anticompetition elements, especially those involving direct state intervention in marketing. These are the regulations implemented by the National Food Authority (NFA) and the Sugar Regulatory Administration (SRA). Numerous studies of the impact of these anticompetition policies on efficiency have been done but recommendations have always fallen short of implementation. They face political constraints that often prove insurmountable. This implies a need for intensive advocacy work. This implies a need for a (respected and credible) body more committed to implementing competition policy rules and whose functions and capability include advocacy and information and education campaign.

ENVIRONMENTAL POLICY AND REGULATIONS Perhaps the policy that has the most direct interface with competition policy is environmental policy and regulations. The environment is a public good characterized by externalities. To illustrate, our air and water system would have a limited absorptive capacity, beyond which environmental costs become acute. Thus, environmental standards need to be set and some regulations need to be put in place to efficiently manage the environment and promote sustainable development. Whenever feasible, market-based instruments should be used, which would allow the market to perform its function. However, the use of command-and-control measures may, in some cases, be unavoidable (whether due to administrative constraints or other reasons) and more intrusive environmental regulations may be necessary. Environmental regulations, for example, include preentry conditions such as the environmental impact analysis (EIA), the environmental clearance certificate (ECC) and some other permits or licenses. These clearly create barriers to entry. Hence, there is evident conflict between environmental and competition policy objectives. Should environmental concerns be the overriding objective? The ideal answer is that both should be considered—environmental benefits must be weighed against costs from loss in competition. This weighing of costs and benefits, however, need not be done directly. What is necessary is to implement measures that would lead to inter- nalization of external costs. If environmental costs were internalized properly, then overall welfare is optimized. That is, so long as good environmental policy is in place and adequately enforced, whatever economic policy adopted would not impose undue burden because there would be “correct” pricing of scarce environmental resources. Indeed, to optimize welfare, there should be both good environmental policy and good economic policy (including competition policy). Pricing economic resources below costs would lead to waste of resources. Pricing above costs, on the other hand, would impose undue burden on industry, unnecessarily raise costs and ultimately reduce overall welfare. The former comes from inad- 324 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES equate environmental policy and/or the lax enforcement of it. The latter arises from too stringent policy and administration. Environmental policy and regulations, however sound they may be, would be ineffective if not complemented by a transparent and efficient implementing agency. The problem is, difficult as it may be to formulate sound environmental policies, it is sometimes even more difficult to administer and implement them properly. Nonethe- less, the government must ever be reviewing the relevance and soundness of environmental policies, as well as the effectiveness of its administration, keeping in mind in both cases the possible impact on the competitive environment.

SUMMARY AND CONCLUSIONS

This paper looked at an array of government policies to examine its interface with competition policy. A running theme in the discussion is that, one way or another, whatever government does could affect the market and as such, affect the state of competition. This applies whether government intervention is direct through some regulatory restriction, or indirect by influencing the incentive structure no matter how essential the stated objectives of the policy are. If it seriously conflicts with competition policy, there is enough reason to question it if it indeed serves national welfare. This does not presume that competition policy objectives are superior. Rather, what the paper points out is that it is always wise to weigh the possible tradeoffs: the possible losses from limited competition and the foreseen benefits from the policy. More- over, the paper proposes that the review and analysis could go one step further and to examine if, on the contrary, incorporating competition policy rules and principles could even advance the major objectives of the policy. The paper also suggests that among the government policies, perhaps the more crucial to examine are government policies and regulations that directly interfere in the market. This is mainly for two reasons: (1) their impact on the state of competition is most direct and the needed competition policy reforms (removing un- wanted anticompetitive elements) are easier to isolate and will have greater and more visible impact, and (2) because much has already been done with respect to trade reforms. In this regard, the paper points out the relevant issues that need to be looked into. These are summarized below. First, there is a tendency for the regulation to cover a greater portion of the industry than what is necessary and for the regulator to “overregulate.” Are there elements/ activities in the industry covered by the regulation that should be made subject to competition? Related to this is the policy of access to an essential facility (bottleneck facility). Among the major reasons for regulating an industry is the case of an essential facility. A strict definition of what is “essential facility” is needed for a clear policy on access. GOVERNMENT POLICIES 325

This would also help regulators identify and limit what segment of the industry could be considered a natural monopoly. Third, one should question the use of price/rate fixing as part of the regulatory framework. Where competition as market regulator fails, the ultimate impact is in the prices and it seems reasonable that this is where the regulator takes over. However, government price fixing often creates more problems than it solves. A major reason is information problem. Sometimes, the problem is the point of price of intervention. Take the case of the rate of return to base regulation. Presumably, this is an alternative to user price fixing and is much easier to determine. However, if government wants investments to happen, it is not logical to put limits on how much the firm can earn, especially at unreasonably low nominal rate that is not even enough to cover interest costs. The fourth question is the policy of cross-subsidization, which complicates even further the problem of price fixing. There is a need to reevaluate the costs and benefits of cross subsidization. Fifth is the possibility of regulatory capture. The regulator could become beholden to the incumbent firm. There should be safeguards to prevent this. This is where the need for a separate body that will oversee the whole competitive setting becomes more apparent. Finally, another problem is the use of complicated and cumbersome procedures that could negate whatever procompetitive effects there could be. Regular review to update and streamline the procedures would go a long way to increasing the efficiency of the regulatory process and the industry itself. In summary, what all these imply is the need to closely reexamine government policies in the light of competition objectives. Such an exercise would surely bring new perspectives that would make for a more efficient administration of policies and the identification and implementation of needed reforms.

BIBLIOGRAPHY

Bautista, R.M., J.A. Power and Associates. 1979. Industrial Promotion Policies in the Philip- pines. Makati City: Philippine Institute for Development Studies. Medalla, E.M. 1996. New Instruments of Protection. In The Emerging World Trading Envi- ronment and Developing Asia: The Case of the Philippines by P.S. Intal et al. Mandaluyong City, Philippines: Asian Development Bank. ————. 1997. Philippine Industrial Policy and the Environment: Integrative Report. Un- published paper submitted to UNIDO. 1997. ————. 1998. Issues in Competition Policies and Elements of a Rational Competition Policy for the Philippines: An Overview Paper. PASCN Discussion Paper No. 2000- 08. Makati City: Philippine APEC Study Center Network. ————. 2000. Trade and Industrial Policy Beyond 2000: An Assessment of the Philippine Economy. In The Philippine Beyond 2000: An Economic Assessment. Makati City: Philippine Institute for Development Studies. 326 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Stigler, G.J. 1968. The Organization of Industry. Homewood, Illinois: Richard D. Erwin, Inc. Stiglitz, J.E. et al. 2000. The Role of Government in a Digital Age. Report commissioned by the Computer and Communications Industry Associations. Washington, D. C. Tabadda, J.P. and M.S. Baylon. 2000. Institutional Arrangements for the Implementation of Competition Policy in the Philippines. Draft paper submitted to the Philippine APEC Study Center Network. World Bank and the Organisation for Economic Cooperation and Development (OECD). 1998. A Framework for the Design and Implementation of Competition Law and Policy. Washington, D.C. GOVERNMENT POLICIES 327

APPENDICES

Appendix Table 1. Antidumping Cases, 1985-1995 Total No. of Year Cases No. of No. of Cases Articles Country Originally Cases Imposed Imposed of Filed Dismissed AD Duty AD Duty Origin

1985 2 2 0 ------

1986 3 3 0 ------

1987 6 6 a/ 0 ------

1988 5 5 0 ------

1989 1 1 0 ------

1990 4 3 1 Refraction Bricks Thailand

1991 6 4 2 Refraction Bricks Thailand Safety Matches Indonesia

1992 0 0 0 ------

1993 1 0 1 Galvanized Malleables PROC Coated Fittings

1994 9 b/ 5 2 Refraction Bricks Thailand PVC Resin Korea

1995 3 c/ 1 0 ------a/ includes 1 case withdrawn. b/ 2 cases pending with the Department of Finance (DOF). c/ 2 cases pending with DOF. Source: Medalla (1996). 328 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix Table 2. Industry-Specific Policies and Regulation with Direct Impact on Competition

Industry Regulatory Bodies/ Functions/Objectives Implementating Agencies Banks and financial Bangko Sentral ng Supervise and regulate financial institutions— restriction on the institutions Pilipinas (BSP) grant of commercial bank licenses; Conduct monetary policy through open market operations, Impose reserve requirements and rediscounting of transactions; Issue currency, lend to other banks and the government; Manage foreign currency reserves; Determine the exchange rate policy. Insurance Insurance Regulation—promulgate and implement rules and regulations companies Commission (IC) governing insurance institutions, license insurance firms, brokers and agents, and rehabilitate delinquent insurance companies; Supervision— examine the financial condition of insurance entities, review their premium rates, and evaluate their financial reports; Adjudication on the insurance industry. Power generation Department of Will develop and update the existing Philippine energy program and oil companies Energy (DOE) which shall provide for an integrated and comprehensive exploration, development, utilization, distribution, and conservation of energy resources, with preferential bias for environment-friendly indigenous, and low-cost sources of energy; Establish and administer programs for the exploration, transportation, marketing, distribution, utilization, conservation, stockpiling, and storage of energy resources of all forms, whether conventional or non-conventional; Regulate private sector activities relative to energy projects as provided for under existing laws. National Power Responsible for the strategic and rational development of the Corporation Philippine power grids and the construction of generating (NAPOCOR) facilities, in cooperation with the private sector. Energy Regulatory Ensure adequate and continuous supply of crude oil, electric Board (ERB) power, and other energy sources at reasonable and stable prices; Protect the oil industry, electric utilities and other entities and persons engaged in the importation, exportation, marketing and distribution of energy sources and products, and ensure that these entities and persons operate under the conditions of orderly and economic competition; Responsible for fixing and regulating the rate of schedule of prices of piped gas to be charged by duly franchised gas companies (implementation of full deregulation). GOVERNMENT POLICIES 329

Appendix Table 2 (continued) Telecommuni- National Telecom- Independent regulatory body that exercises jurisdiction cations companies munications over the supervision, adjudication, and control over all Commission (NTC) telecommunications services; Responsible for the issuance of licenses to operate telecommunications systems facilities and monitoring of compliance to rules and regulations. Land vehicles Land Transportation Prescribe and regulate routes of service, economically Franchising and viable capacities, and zones or areas of operation; Regulatory Board Issue, amend, revise, and suspend or cancel certification (LTFRB) of Public Convenience or permits; Determine, prescribe, and approve reasonable fares and rates for public land transportation services, among others. Shipping industry Maritime Industry Regulate and supervise both domestic and overseas Authority shipping industries; (MARINA) Evaluate and process applications to increase/change passenger fares, freight rates, and other charges related to the operation of domestic public water transportation services. Air commerce Civil Aeronautics Responsible for the establishment and enforcement of companies Board (CAB) standard airline/airfreight rates, fees, and other charges based on studies of airline traffic and volume of passengers and cargo; Maintain an accounting system for all air carriers and conducts audits to determine whether or not air carriers have complied with bilateral agreements and local policies. Port operators and Philippine Ports Establish, develop, regulate, manage, and operate a rational arrastre services Authority (PPA) national port system in support of trade and national development; Regulate port services, select port operators, and collect fees for port-related services Toll Toll Regulatory Authorized to approve initial toll rates, review and Board approve toll rates. Water Local Water Undertake water supply development outside Metro Utilities Manila through the creation of Water Districts; Administration Establish minimum standards and regulations (e.g., construction (LWUA) materials and supplies, maintenance and operation) for local water utilities, as well as monitor and evaluate local water standards. Housing National Housing Provide affordable and adequate housing for homeless Authority (NHA) low-income families and afford them access to social services and economic development; Harness and promote private participation in housing ventures in terms of capital expenditures, land, expertise, financing, and facilities for the sustained growth of the housing industry. Sources: Abad (this volume); Tabbada and Baylon (2000); USAID (1992); Administrative Code of 1987, E.O. 292.

GOVERNMENT POLICIES 331

Appendix Table 4. Special Laws and Agencies Affecting Competition Laws Provision/Purpose Implementing Functions Agencies Local Licensing and Zoning or Local Government Grant franchises and permits or licenses Government Code Land Classification Units (LGUs) within the locality; (RA 7160, 1991) Taxation Grant of tax exemptions, incentives, or re- liefs to entities engaged in “community growth-inducing industries.”

Insolvency law Seeks to effect an eq- Private Conduct hearings in case the dissolution af- (Act No.1956) uitable distribution of Corporations - fects the rights of any creditor having claim the insolvent’s property Securities and against the corporation; among creditors Exchange Appoint a receiver to take charge of the liq- Commission (SEC) uidation of the corporation.

Bankruptcy Law Deals with suspension Banks and Financial Appoint a conservator to take charge of the of payments, the relief Institutions - assets and liabilities of the bank or nonbank of insolvent debtors, Bangko Sentral ng as well as assume management (if in a state the protection of credi- Pilipinas (BSP) of continuing inability to maintain a condi- tors and the punish- tion of solvency and liquidity); ment of fraudulent Designate a receiver to take charge of as- debtors sets and liabilities and administer to the benefit of creditors (if continuance in business would involve probable loss to depositors and creditors); Assign liquidator to take over the functions and shall convert the banks assets to money for the purpose of paying off its creditors (if insolvent and cannot resume business).

Corporation Code Rules regarding merg- Securities and Absolute jurisdiction, supervision and con- (BP 68, 1980) ers and consolidations Exchange trol over all corporations, partnerships and and the acquisition of Commission (SEC) associations in the Philippines; as a regula- all or substantially all tory agency, it has the exclusive jurisdiction the assets or shares of to hear and decide on cases involving fraud stocks of corporations and misrepresentation committed by corporate officers and their organizations.

Revised Securities Prohibits and penalizes Empowered to look into intra-corporate prob- Act (BP 178, 1982) the manipulation of se- lems of corporations, issue injunctive relief, curity prices and in- subpoena and subpoena duces tecum; im- sider trading pose fines and penalties; and even suspend or revoke the certificate of registration of any erring establishment after a proper hearing. 332 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix Table 4 (continued) Laws Provision/Purpose Implementing Functions Agencies Labor Code Provide adequate Bureau of Labor Provide orientation to workers on their rights (PD 442) protection to labor by Relations and privileges under existing laws and regu- stipulating the mini- lations. mum conditions of labor, labor relations, National Labor Develop schemes and projects for the im- formation of workers Relations provement of the standards of living of work- organizations and Commission ers and their families. unions, termination and retirement benefits of workers

Intellectual Protection of pat- Intellectual Examine applications for grant of letters, Property Code ents, trademarks and Property Office patent for inventions and register utility mod- (RA 8293, 1997) copyrights and the (IPO) els and industrial designs; register technol- corresponding penal- ogy transfer arrangements and settle dis- ties for infringement putes;

Promote the use of patent information as a tool for technology development;

Administratively adjudicate contested proceedings affecting intellectual property rights.

Budget Reform Protecting locally- State Accounting Develop and implement a comprehensive PD 1177 manufactured or pro- and Auditing audit program that shall encompass an ex- duced articles over Development amination of financial transactions, ac- foreign-made prod- Office, Commission counts, and reports, including evaluation of ucts of Audit (COA) compliance with applicable laws and regulations. Purchase of locally manufactured products

RA 5183 Reserving to Filipi- Institute control measures through the pro- nos and Filipino- mulgation of auditing rules and regulations owned corporations governing receipts, disbursements and uses the exclusive right to of funds and property consistent with the enter into contracts total economic development efforts of the with any GOCCs, government. company, agency or municipal corporation for the supply of materials, goods, and commodities Sources: Abad (this volume); USAID (1992); Administrative Code of 1987, E.O 292. GOVERNMENT POLICIES 333

Appendix Table 5. Doing Business in the Philippines: A Checklist This checklist is a general guide which investors may find helpful in preparing to do business in the Philippines. An investor needs only to undertake the applicable combination of activities. Some can be done simultaneously. It is advisable to seek the assistance and briefing of the Board of Investments One-Stop Action Center (BOI- OSAC), the Bureau of Trade Regulation and Consumer Protection (BTRCP), the Philippine Economic Zone Authority (PEZA), and the Securities and Exchange Commission (SEC). GETTING STARTED A. General Registration Requirements Investors setting up business in the country will have to comply with the following general requirements: • Registration of corporations and partnerships—Securities and Exchange Commission (SEC) • Registration of business name/single proprietorship—Bureau of Trade Regulations and Consumer Pro- tection (BTRCP) • Registration for incentives availment under Executive Order 226—Board of Investments (BOI) • Registration of export firms (for those locating in any of the country’s export processing zones and availing of incentives)—Philippine Economic Zone Authority (PEZA) • Registration of foreign investments for purposes of capital repatriation and profit remittances—Banko Sentral ng Pilipinas (BSP) • Securing Tax Identification Number (TIN) —Bureau of Internal Revenue (BIR) • Securing locational clearance/business permit for firms locating in Metro Manila—Metro Manila Au- thority (MMA) • Securing building permit and license to do business—City Halls/Municipal Offices in the localities where the business will be set up • Securing an employer’s SSS number—Social Security System (SSS) • Securing membership in the government health care benefits system—Medicare • Securing electric services connection—Manila Electric Co. (MERALCO) for business in MERALCO franchise area; local electric utility firms for companies locating in non-MERALCO franchise area • Securing Water services—Metropolitan Waterworks and Sewerage System (MW SS) for firms locating in Metro Manila and Local Water Utilities Administration (LWUA) for firms locating outside Metro Manila • Securing telephone services connection—Philippine Long Distance Telephone Co. (PLDT), Bayantel, Digitel, Smart and Globelines. B. Special Permits/Clearance/Registration • Permit to construct/operate pollution-control devices—Department of Environmental and Natural Re- sources (DENR) • Trademarks/patents registration—Bureau of Patents, Trademarks, and Technology Transfer (BPTTT) • Registration of power-generation projects—National Power Corporation (NAPOCOR) • Philippine Standard (PS) Quality Mark to ensure that locally-manufactured consumer products conform to Philippine standards—Bureau of Products Standards (BPS) • Import Commodity Clearance (ICC) Quality Mark to ensure that imported consumer products conform to Philippine standards—Bureau of Product Standard (BPS) • Clearance for projects which involve food, chemicals, and others—Bureau of Food and Drug (BFD) • Registration of tourism projects—Department of Tourism (DOT) • Franchise for mass transit operation—Land Transportation, Franchising and Regulatory Board (LTRFB) • Telecommunication projects—National Telecommunications Commission (NTC) • License/clearance for defense-related projects—Department of National Defense (DND)/ Philippine National Police (PNP) • Registration of advanced technology—Department of Science and Technology (DOST) • Clearance for health-related projects—Department of Health (DOH) • Clearance for oil exploration activities—Office of Energy Affairs (OEA) • Acquiring mining rights—Bureau of Mines and Geo-Sciences (BMG) 334 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix Table 5 (continued) C. Special Permits/Clearances for selected export businesses Export of products will need clearances and permits prior to every shipment • Clearance for export of animal and animal by-products—Bureau of Animal Industry (BAI) • Clearance for plant export—Bureau of Plant Industry (BPI) • Clearance for export of food, drugs, and chemicals—Bureau of Food and Drug (BFD) • Clearance/qouta for coffee exports—International Coffee Organization Certifying Agency (ICOCA) • Clearance for quota allocation of garment exports—Garments and Textile Export Board (GTEB) • Clearance for export of fisheries and other aquatic products—Bureau of Fisheries and Aquatic Re- sources (BFAR) • Special documentation certificate for preferential treatment of handicrafts export—Department of Trade & Industry-National Capital Region (DTI-NCR) • Export clearance for coconut products—Philippine Coconut Authority (PCA) • Commodity clearance for natural fibers export—Fiber Industry Development Authority (FillA) AVAILABLE FRONTLINES A. One-Stop Action Centers (OSAC) Designated One-Stop Action Centers provide facilities and services which enable the investor to obtain necessary investment information and documentation in one physical location. These OSAC are: • One-Stop Action Center for Investments - at the Board of Investments (BOI) • One-Stop Export Documentation Center - at the International Trade Center Complex • One-Stop Import Processing Center - at the Bureau of Import Services (BIS) • One-Stop Shop Tax Credit Center - at the Department of Finance (DOF) • One-Stop Action Garments Export Assistance Center - at the Garments and Textile Export Board B. Technical Services and Quality Control Agencies listed blow provide various quality control and technical services to investors: • Cottage Industry Technology Center (CITC) • Philippine Shippers Council (PSC) • Philippine Textile Research Institute (PTRI) • Product Development and Design Center of the Philippines (PDDCP) • National Manpower and Youth Council (NMYC), Department of Labor and Employment(DOLE) C. Export Marketing When in need of export marketing support, the investor can consult various government agencies for free assistance in: • Matchmaking between exports and buyers/raw material suppliers—Export Assistance Network (Exponet) • Market information, strategy, product research, and foreign trade assistance—Bureau of Export Trade Promotion (BETP) • Garments export assistance—Garments and Textile Export Board -One Stop Action Center (GTEB-OSAC) • Trading with Socialist countries—Philippine International Trading Corporation (PITC) • Trade fairs/exhibitions—Center for International Trade Exposition and Missions (CITEM) • Product development and improvement—Product Development and Design Center of the Philippines (PDDCP) • Subcontracting facilities between contractors and subcontractors—National Subcontractors Exchange (Subconex) Aside from these frontline assistance centers, the investors may also approach different industry association and business chambers.

Source: BOI website (http://www.boi.gov.ph/). GOVERNMENT POLICIES 335

Appendix Table 6. Requirements and Supporting Documents for Business Name Registration 1. Fill out completely the application form and submit to the Department of Trade & Industry Provincial Office where the business is located. 2. If Single Proprietorship. a. The applicant must be a Filipino Citizen, of majority age (18 years or over) and must attached two (2) passport size pictures taken not more than one (1) year preceding this filing. b. Natural-born Filipinos whose names are suggestive of an alien nationality (example: Chua, Tan, Taylor, etc.) attach proof of citizenship, e.g., PRC ID, birth certificate or voter’s ID. c. For Citizen of the Philippines by: NATURALIZATION - submit photocopy of naturalization certificate and oath of allegiance or identification card issued by the Commission on Immigration & Deportation and present original copies for comparison. ELECTION - submit photocopy of affidavit of election or identification card issued by the Commission on Immigration and Deportation and present original copies for comparison. 3. If Partnership / Corporation / Cooperatives / Other Judicial Entities, a. Submit photocopy of SEC certificates of registration, articles of incorporation / partnership and by- laws duly signed by authorized representative/ partner. b. Cooperative must be registered first with Cooperatives Development Authority (CDA) and submit copy of certificate thereof. 4. If Franchise Holders of Business Name - submit latest franchise agreement. 5. If Foreign Investor, he must submit the following: a. Alien certificate of registration. b. Accomplished DTI Form No. 17 under R.A. 7042 c. Written Appointment of Filipino Resident Agent d. Authority to verify bank accounts/bank certificate of deposit e. Proof of inward remittance of foreign currency for non-resident alien and Bank Certificate of Deposit for resident alien. f. Copy of valuation report from Central Bank if investment includes assets other than foreign exchange. g. Certification from resident alien not seeking remittance of profit or dividends. h. Clearance from other involved agencies such as Department of Science and Technology, Philippine National Police, Etc. i. In case of alien retailer, latest permit to engage in retail business per R.A. 1180 j. If corporation/partnership SEC certificate of registration and Certificate of Authority from SEC. 6. If the business name, together with business establishment was acquired thru sale, transfer or assignment, applicant must comply with the Bulk Sales Law, by submitting the following: a. Affidavit of vendor stating that at the time of sales, he had no creditors or if there were creditor/s, copy of notice to them. b. Deed of sales, assignment or transfer c. Inventory of properties sold, assigned or transferred d. Payment of fee as prescribed by the government e. Original certificate of business name registration of vendor for cancellation.

Additional requirements may be imposed on a case-to-case basis on actual examination and processing of the application.

Source: BTRCP, DTI. 336 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Appendix Table 7. Major Policies with Competition Policy Interface Policy Areas Regulatory Bodies/ Purpose/Functions/Objectives Implementating Agencies

Industry and Investments Department of Trade and Formulate and implement policies, plans, and Policy Industry (DTI) programs relative to the development, expansion, promotion, and regulation of trade, industry, and investments.

Export Board of Investments Coordinate the formulation and implementation of Promotion (BOI) short-, medium- and long-term industrial plans as well as promoting investments in the country in accordance with national policies and priorities; Register, monitor and grant investment incentives to Promotion of individual enterprises; Catalytic Industry Formulate policies and guidelines aimed at creating an environment conducive to the expansion of existing investments.

Regional Philippine Economic Zone Tasked with the establishment, operation, and Development Authority (PEZA) management of world-class economic zones or ecozones throughout the country.

Foreign Garments and Textile Formulate negotiation strategies and the actual Investment Policy Export Board (GTEB) negotiation of bilateral trade agreements with major importing countries such as the United States, European Union, Canada, and Norway; Overall administration and allocation of export quota, processing and issuance of garment and textile export clearances, bonded manufacturing warehouse licenses, and authority to import raw materials; Conduct promotional and developmental activities that aim to diversify and expand export markets and optimize quota utilization.

Bases Conversion and Administer and develop former military bases into other Development Authority productive uses. (BCDA)

Subic Bay Metropolitan Administer and develop the Subic Bay Freeport Authority (SBMA) (SBF) into a self-sustaining industrial, commercial, financial, and investment center to generate, among others, employment opportunities in and around the Zone; Establish and regulate the operation and maintenance of utilities, services, and infrastructure; Operate directly and indirectly tourism-related activities, and protect the freeport’s forests. GOVERNMENT POLICIES 337

Appendix Table 7 (continued) Policy Areas Regulatory Bodies/ Purpose/Functions/Objectives Implementating Agencies

Clark Development Manage and develop the Clark Special Economic Zone Corporation (CDC) into a premier economic center and model township promoting industrial, service, commercial, recreational, residential, and ecological development.

Agriculture Department Responsible for planning, formulation, execution, Policy of Agriculture (DA) regulation, and monitoring of programs and activities relating to agriculture, food production and supply.

National Food Authority Responsible for food security and stabilization of (NFA) supply and prices of rice, corn, wheat and other grains, and food stuffs; implements subsidized marketing strategy.

Sugar Regulatory Responsible for the regulation and development of the Administration (SRA) sugar industry including the allocation of sugar production and export quota.

Philippine Coconut Responsible for the regulation and development of the Authority (PCA) coconut industry.

Environment Policy Department of Administrative agency compelling compliance on Environment and Natural environmental laws and responsible for the issuance Establishment of Resources (DENR) of environmental compliance certificate (ECC) and Environment Impact environmental permits—authority to construct (AC) Assessment System and permit to operate (PO). (EIA) Pollution Adjudication Empowered to order the cessation of environmentally Board harmful activities through cease-and-desist orders. Establishment of ambient, effluent Environment Recommend possible legislation, policies, and and input standards Management Bureau programs for environmental management and pollution control; formulate environmental quality standards for water, air, land, noise, and radiations; formulate rules Comprehensive Air and regulations for proper disposition of solid waste, Pollution Control toxic and hazardous substances; recommend rules and Policy; regulations for environmental impact assessments; ODS Phaseout and provide technical assistance for their implementation and monitoring.

Sources: Administrative Code of 1987, E.O 292; Medalla (1997). 9 CHAPTER

Recommendations for Philippine Antitrust Policy and Regulation

Anthony R. A. Abad

ABSTRACT

his short study has been commissioned as a means to develop specific recommendations for new antitrust policies and regulations. The scope of work and objectives of this study are: (1) to review existing antitrust laws and regulations; (2) to examine the effectiveness and adequacy of these laws and regulations; (3) to examine how well these laws conform with international rules; and (4) to suggestT recommendations for reform. There have already been quite a number of studies conducted dealing with antitrust and/or competition issues from an economic analysis point of view, but there also have been some based on industry or sector. In contrast, this study will focus on antitrust issues from a legal and regulatory structure point of view and in a comprehensive manner rather than a sector-specific approach. This study will also analyze the proper administrative structures for effective policy enforcement, and necessarily include some insights on existing political economy conditions. 340 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

INTRODUCTION

BACKGROUND The recent introduction of economic reforms in the Philippines through substantial trade and investment liberalization, deregulation, and privatization has led to a slow realization that freer trade and open markets are good for Filipinos in general. This is due largely to the obvious efficiency and welfare gains brought about by increased competition from new products and services. Conversely, it can also be said of the Philippines that our long and sad history of underdevelopment can actually be traced to a lack of competition in our economy. With this important realization, the Philippine government has adopted a policy of introducing more competition-enhancing measures, such as the further lowering of trade and investment barriers and the reform of certain economic regulations. Unfortunately, government officials have not even mentioned the need for a new and comprehensive framework for antitrust policy and regulation, despite the central role it plays in economic reform measures for enhancing competition. There have been quite a number of draft bills for a proposed antitrust or competition law filed in Congress; however, they have yet to be fully appreciated by our political leaders and they have yet to be filed as part of introducing a truly comprehensive new framework for antitrust policy and regulation. The introduction of a new framework for antitrust policy and regulation will require much more than merely passing a new law. To avoid committing the mistakes of the past, a careful and in-depth analysis of the current approach of the Philippines to sustaining a market-oriented economy and regulating economic activity will be needed. Reviewing existing economic laws and regulations and testing their effectiveness as tools for promoting economic efficiency and public welfare through competition should also be done. This analysis can then form the basis for crafting a framework for antitrust policy and regulation.

RATIONALE AND SCOPE OF THE STUDY This study aims to develop specific recommendations for new antitrust laws and regulations. The conceptual portions of the study, as well as much of the initial research on laws and regulations in the Philippines, are drawn largely from the previous work of the author in studies prepared by FTAsia Consulting for the Asia Foundation and Philexport-TAPS. Since competition policy is a rather broad topic encompassing various aspects of functioning market economies, there is need to focus on specific key areas. The emphasis of this study is on the legal and regulatory aspects of competition policy, particularly the framework for effective enforcement of competition in all sectors of the Philippine economy. This is important because of its bearing on the actual implementation of competition policy in the country. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 341

The scope of work and objectives of this study are as follows: • To review existing antitrust laws and regulations; • To examine the effectiveness and adequacy of these laws and regulations; • To examine how well these laws conform with international rules; and • To suggest recommendations for reform.

There have already been quite a number of studies conducted dealing with antitrust and/or competition issues from an economic analysis point of view, but there also have been some based on industry or sector. In contrast, this study will be focusing on antitrust issues from a legal and regulatory structure point of view and in a comprehensive manner rather than a sector-specific approach. This study will also analyze the proper administrative structures for effective policy enforcement and will necessarily include some insights on existing political economy conditions. The study will have three major components: 1. Survey of Existing Antitrust Laws and Regulations in the Philippines – The concept of antitrust regulation is not exactly new to the Philippines. Appar- ently, old antitrust provisions of U.S. laws found their way into the Philip- pine Constitution, and Criminal and Civil Codes. Antitrust enforcement is also implicitly vested in various regulatory agencies and bodies. This section of the paper surveys these existing laws and regulations that are deemed as the existing antitrust and/or competition policy framework of the Philip- pines. This survey also covers draft bills on the proposed antitrust or competition law of the Philippines. Finally, this section also reviews a few “success stories” from other countries and regional groupings, both developed and developing, which implemented their own antitrust or competition laws and regulations. 2. Analysis of Existing Antitrust Regulation in the Philippines – Knowing the existing laws and regulations for antitrust enforcement at the disposal of the Philippine government, what is then the actual effectiveness of these laws and regulations in promoting competition in the Philippine economy? This section analyzes the state of antitrust regulation in this country and examines the government’s capability to implement its antitrust laws and regulations. It studies the general regulatory structure in place, and identifies a number of the regulators and institutions involved in the antitrust process. How have they managed to control the behavior of the players in various industries and sectors? How have they affected the structure of markets in the Philippine economy? What are the major problem areas? 3. Recommendations for a New Legal and Regulatory Framework for Antitrust Enforcement in the Philippines – This section recommends a new antitrust policy and regulatory framework for the Philippines. Given the Philippines’ long history of protectionism and over regulation, market distortions are rampant in the economy despite the existence of basic antitrust laws and 342 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

regulations. Therefore, there is still a need to propose a more effective framework for antitrust regulation in this country. Such a framework should first lay down the basic policy objectives and principles, as well as spell out the basic structure for regulation. This section also suggests certain basic provisions for new antitrust legislation and mechanisms for more effective enforcement.

SURVEY OF EXISTING ANTITRUST LAWS AND REGULATIONS IN THE PHILIPPINES

Antitrust regulation is not new to the Philippines. Apparently, old antitrust provisions of U.S. laws found their way into the Philippine Constitution, and Criminal and Civil Codes. Antitrust enforcement is also implicitly vested in various regulatory agencies and bodies. This section of the paper surveys these existing laws and regulations that are deemed as the existing antitrust and/or competition policy framework of the Philippines. This survey also covers draft bills on the proposed antitrust or competition law of the Philippines.

ANTITRUST LAW IN THE PHILIPPINES

THE CONSTITUTION Under the Constitution,1 the State is mandated to regulate or prohibit, for the sake of public interest, monopolies, combinations in restraint of trade and other unfair competition practices. These provisions were based on the U.S. Sherman Act. Note that the Constitution does not prohibit monopolies per se. Monopolies are not illegal in themselves, in contrast with combinations in restraint of trade and other unfair competition practices that are illegal per se. The latter are to be prohibited without exception. However, since the Constitution does not define what would constitute unlawful monopolies, or combinations in restraint of trade or unfair competition practices, separate legislation and/or case laws are the bases for making such definitions.

CRIMINAL LAW Act No. 3815 as amended, otherwise known as the Revised Penal Code, punishes anticompetitive behavior that is criminal in nature. Article 186 defines and penalizes monopolies and combinations in restraint of trade while Article 187 provides penalties. ______

1 Constitution, Article XII, Section 19. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 343

Combinations in restraint of trade are defined as: • Any agreement, whether in the form of a contract or conspiracy or combination in the form of trust or otherwise, resulting in the restraint of trade or commerce; or • Preventing by artificial means free competition in the market; or • Any manner of combination, conspiracy, or agreement between or among manufacturers, producers, processors, or importers of any merchandise or object of commerce, or with any other persons, for the purpose of making transactions prejudicial to lawful commerce, or increasing the market price of such merchandise or object of commerce or any other article in the manufacture, production, or processing, or importation of which such merchandise or object of commerce is used.

Illegal monopolies are defined as: • Monopolizing any merchandise or object of trade or commerce; or • Combining with any other person or persons to monopolize any merchandise or object of trade or commerce,

in order to alter the price thereof by spreading false rumors or making use of any other artifice to restrain free competition in the market. The Revised Penal Code also penalizes other frauds in commerce and industry such as falsely marking gold and silver articles and altering trademarks.2

CIVIL LAW Republic Act (RA) No. 386 (1949) as amended, otherwise known as the Civil Code of the Philippines, took effect in August 1950. It allows the collection of damages arising from unfair competition in agricultural, commercial, or industrial enterprises or in labor.3 It also allows the collection of damages arising from abuse in the exercise of rights and in the performance of duties,4 e.g., abuse of a dominant market position by a monopolist. Peculiarly enough, the Civil Code does not define unfair competition and merely lists the means by which unfair competition can be committed: force, intimidation, deceit, machination, or any other unjust, oppressive or highhanded method. Treble damages for civil liability arising from anticompetitive behavior is allowed under RA No. 165, otherwise known as An Act to Prohibit Monopolies and Combinations in Restraint of Trade.

______

2 Republic Act No. 166 (1947). 3 Article 28. 4 Article 19. 344 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

SPECIAL LAWS Special laws specifically address some unfair competition practices.

• RA 8293 (1997), otherwise known as the Intellectual Property Code of the Philippines This new law provides for the protection of patents,5 trademarks,6 and copyrights,7 and the corresponding penalties for infringement.

• Batas Pambansa Blg. 68 (1980), otherwise known as the Corporation Code of the Philippines This law provides for the rules regarding mergers and consolidations,8 and the acquisition of all or substantially all the assets or shares of stock of corporations.9 It must be noted, however, that the Corporation Code does not address the problem of the probable abuse of a dominant position when horizontal mergers occur, e.g. merger of three shipping lines – Aboitiz, William Lines, and Gothong Lines into the WGA Super Ferry, or in case of vertical acquisitions, e.g. Philippine Long Distance Telephone Company with respect to Sequel Net (an Internet service provider) and Home Cable.

• Batas Pambansa Blg. 178 (1982) as amended, otherwise known as the Re- vised Securities Act This law complements the Corporation Code. It prohibits and penalizes the manipulation of security prices and insider trading.10

• RA 7581 (1991), otherwise known as the Price Act, and RA 7394 (1932), otherwise known as the Consumer Act of the Philippines Consumer welfare and protection is also an important aspect of competition policy. In this area, the significant laws are the Price Act and the Consumer Act of the Philippines. The Price Act defines and identifies illegal acts of price manipulation such as, hoarding, profiteering and cartels. Through price controls and mandated ceiling mechanisms, the Price Act also seeks to stabilize the prices of basic commodities and prescribes measures against abusive price increases during emergencies and other critical situations. ______

5 Rep. Act No. 8293 (!997), at Part II. 6 Id., at Part III. 7 Id., at Part IV. 8 Title IX. 9 Title IV, Sections 40 and 42. 10 Id. at secs. 26 and 30. Sec. 15 also provides for the revocation of registration for engaging in fraudulent acts in connection with the sale of securities. Sec. 27 prohibits manipulative and deceptive devices, sec. 28 artificial measures of price control, and sec. 29 fraudulent transactions. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 345

The Consumer Act of the Philippines provides for consumer product quality and safety standards. It also covers deceptive, unfair, and unconscionable sales acts and practices (including weight and measures, product and service warranties), consumer credit transactions, and penalties for violations of the statute.

Agencies enforcing antitrust law in the Philippines Under these various special laws, there are certain agencies that should be enforcing competition:

General Agencies

• Department of Trade and Industry (DTI) and its attached agencies, including the Bureau of Trade Regulation and Consumer Protection (BTRCP), Bureau of Food and Drugs (BFAD), Intellectual Property Office (IPO), and Bureau of Product Stan- dards (BPS). The DTI, BTRCP, BFAD, and BPS look out for consumer welfare, while the IPO is in charge of the protection of intellectual property rights.

• Securities and Exchange Commission (SEC) The SEC supervises and monitors stock and nonstock corporations, and resolves intra-corporate disputes, and regulates all forms of securities, brokers and dealers, financing companies and investment houses.

• Philippine Economic Zone Authority (PEZA) The PEZA supervises ecozone developers and ecozone-registered enterprises.

• Bases Conversion and Development Authority (BCDA) The BCDA administers and develops former military bases, other than Subic and Clark, and BCDA-registered enterprises.

• Subic Bay Metropolitan Authority (SBMA) The SBMA administers and develops the former American Subic Naval Base and SBMA-registered enterprises.

• Clark Development Corporation (CDC) The CDC administers and develops the former U.S. Clark Air Base, and Clark- registered enterprises.

• National Library The National Library is in-charge of copyright registration. Together with the Supreme Court Library, it is also the depository of copyrighted materials and other items. 346 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Industry-Specific Agencies • Bangko Sentral ng Pilipinas (BSP), for banks and financial institutions • Insurance Commission (IC), for insurance companies • Philippine Tourism Authority (PTA), for the tourism industry • Housing and Land Use Regulatory Board (HLURB), for land use and real estate development • National Food Authority (NFA), for rice, corn, wheat and other grains and food stuffs • Sugar Regulatory Administration (SRA), for the sugar industry • Philippine Coconut Authority (PCA), for the coconut industry • Garments and Textile Export Board (GTEB), for garment manufacturers and exporters • Board of Investments (BOI), for pioneer or nonpioneer industries and those listed in the Investments Priorities Plan, availing of the incentives under the Omnibus Investments Code. • National Telecommunications Commission (NTC), for telecommunications companies • Land Transportation Franchising and Regulatory Board (LTFRB), for common carriers for land • Civil Aeronautics Board (CAB), for companies engaged in air commerce • Maritime Industry Authority (MARINA), for the shipping industry • Philippine Ports Authority (PPA), for port operators and arrastre services • Department of Energy (DOE), Energy Regulatory Board (ERB), and the Na- tional Power Corporation (NAPOCOR), for power generation companies and oil companies.

A more thorough listing of various laws and regulations affecting competition is given in Appendix 1. Although these various laws and regulations do not explicitly implement competition policy, all of them either directly or indirectly restrict or open market access or investment flows, and hence, affect competition.

INTERNATIONAL COMMITMENTS The World Trade Organization (WTO) agreements implicitly encourage international competition through trade liberalization. The agreements that are directly relevant to competition policy and restrictive business practices are: • Agreement on the Implementation of Article VI of GATT 1994 on antidumping • Agreement on Subsidies and Countervailing Measures • Agreement on Safeguards, particularly Article 11:2 on voluntary export restraints, orderly marketing arrangements, etc., maintained by the government, and Article 11:3 on equivalent nongovernmental measures RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 347

• General Agreement on Trade in Service (GATS), particularly Article VIII on supply of services by a monopolist in a member country, and required consultations with other member countries • Agreement on Trade-Related aspects of Intellectual Property Rights (TRIPs), including trade in counterfeit goods, particularly Article 8 on the abuse of intellectual property rights by right holders and Articles 31 and 40 on licensing practices and conditions on use • Agreement on Trade-Related Investment Measures (TRIMs), particularly Article 9 on amending TRIMs to be complemented with investment policy and competition policy.

JURISPRUDENCE Since the law itself is not clear, case law or judicial interpretation is particularly important in defining unlawful monopolies, combinations in restraint of trade and unfair competition practices. The Supreme Court has affirmed the need to “... recast our laws on trust, monopolies, oligopolies, cartels and combinations injurious to public welfare — to re- store competition where it has disappeared and to preserve it where it still exists. In a word, we need to perpetuate competition as a system to regulate the economy and achieve global product quality.”11 To date, there have been only two cases decided by the Supreme Court defining monopoly. In the case of Gokongwei, Jr. v Securities and Exchange Commission, et al.,12 the Supreme Court narrowly defined monopoly as “unified tactics with regard to price.” Further, the Supreme Court apparently considered a monopoly as undesirable in itself, and not the abuse of a monopoly or dominant position. “A ‘monopoly’ embraces any combination the tendency of which is to prevent competition in the broad and general sense, or to control prices to the detriment of the public. In short, it is the concentration of business in the hands of a few. The material consideration in determining its existence is not that prices are raised and competition actually excluded, but that power exists to raise prices or exclude competition when desired. Further, it must be understood that the idea of a monopoly is now understood to include a condition produced by the mere act of individuals. Its dominant thought is the notion of exclusivity or unity, or the suppression of competition by the unification of interest or management, or it may be through agreement and concert of action. It is, in brief, unified tactics with regard to price.” ______

11 Tatad v. The Secretary of the Department of Energy and The Secretary of the Department of Finance, etc, G.R. Nos. 14360 and 17867, Decision En Banc dated 03 December 1997 on the Motion for Reconsideration, citing the State of the Nation Address of President Fidel V. Ramos, 3rd Session of the Ninth Congress, 25 July 1994. 12 G.R. No. L-45911, 89 SCRA 339 (1979). 348 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

In the Gokongwei case, John Gokongwei, Jr. has acquired enough SMC shares of stock to get himself elected to the board of directors of San Miguel Beer Corporation (SMBC), a beer manufacturer. However, Mr. Gokongwei also controlled a rival beer manufacturing company, Asia Brewery, Inc. The Supreme Court held Mr. Gokongwei’s action as constituting unfair competition. In the Tatad case,13 the Supreme Court, in its original decision, held that: “A monopoly is a privilege or peculiar advantage vested in one or more persons or companies, consisting in the exclusive right or power to carry on a particular business or trade, manufacture a particular article, or control the sale or the whole supply of a particular commodity. It is a form of market structure in which one or a few firms dominate the total sales of a product or service.” (Citations omitted) In the Gokongwei case, it was likewise held that a monopoly can be achieved through the “suppression of competition by the unification of interest or management, or it may be thru agreement and concert of action.”14 Thus, even mergers and consolidations of companies, where these could lead to unfair competition, can be regulated. The Tatad case15 also defined combinations in restraint of trade and differentiated a combination from a monopoly: “On the other hand, a combination in restraint of trade is an agreement or understanding between two or more persons, in the form of a contract, trust, pool, holding company, or other form of association, for the purpose of unduly restricting competition, monopolizing trade and commerce in a certain commodity, controlling its production, distribution and price, or otherwise interfering with the freedom of trade without statutory authority. Combination in restrain of trade refers to the means while monopoly refers to the end.” (Citations omitted) Note that the Supreme Court emphasized that for unfair competition to exist, there need not be an actual injury. It is sufficient that the “power exists to raise prices or exclude competition when desired.” With its ruling that the Senate did not commit a grave abuse of discretion in ratifying the WTO Agreement and its three Annexes, the Supreme Court removed any judicial obstacle against the government’s adoption of a policy of trade liberalization by enlisting the Philippines in the WTO:16 “Moreover, GATT itself has provided built-in protection from unfair foreign competition and trade practices including antidumping measures, countervailing measures and

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13 G.R. Nos. 124360 and 127867, Decision En Banc dated 05 November 1997. 14 Id., at note 41. 15 Id, at note 42. 16 Wigberto E. Tañada, et al. v. Edgardo J. Angara, et al.., G.R. No. 118295, En Banc Decision dated 02 May 1997 (272 SCRA 18). RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 349

safeguards against import surges. Where local business are (sic) jeopardized by unfair foreign competition, the Philippines can avail of these measures. There is hardly therefore any basis for the statement that under the WTO, local industries and enterprises will all be wiped out and that Filipinos will be deprived of control of the economy. Quite the contrary, the weaker situations of developing nations like the Philippines have been taken into account; thus, there would be no basis to say that in joining the WTO, the respondents have gravely abused their discretion. True, they have made a bold decision to steer the ship of state into the yet uncharted sea of economic liberalization. But such decision cannot be set aside on the ground of grave abuse of discretion, simply because we disagree with it or simply because we believe only in other economic policies. As earlier stated, the Court in taking jurisdiction over this case will not pass upon the advantages and disadvantages of trade liberalization as an economic policy. It will only perform its constitutional duty of determining whether the Senate committed grave abuse of discretion.

x x x

The WTO reliance on ‘most favored nation,’ ‘national treatment,’ and ’trade without discrimination’ cannot be struck down as unconstitutional as in fact they are rules of equality and reciprocity that apply to all WTO members. Aside from envi- sioning a trade policy based on ‘equality and reciprocity,’ the fundamental law encourages industries that are ‘competitive in both domestic and foreign markets,’ thereby demonstrating a clear policy against a sheltered domestic trade environment, but one in favor of the gradual development of robust industries that can compete with the best in foreign markets. Indeed, Filipino managers and Filipino enterprises have shown capability and tenacity to compete internationally. And given a free trade environment, Filipino entrepreneurs and managers in Hong Kong have demonstrated the Filipino capacity to grow and to prosper against the best offered under a policy of laissez faire.” (Emphasis supplied)

PROPOSED ANTITRUST LEGISLATION Realizing the deficiencies of the existing legal and regulatory systems for enforcing competition, the Philippine government, through the legislature, has been attempting to pass new antitrust or competition legislation since the early 1980s. The numerous draft bills have been quite varied, having been adopted from various existing antitrust and competition laws around the world. Unfortunately, a lack of appreciation and political will have kept these proposed laws out of the government’s priority list. Consequently, quite a number of draft antitrust or competition laws have accumulated over the years, but none of these have actually been acted upon. Both Houses of the present 11th Congress already have a number of draft laws submitted. These latest proposed bills have been attached to this study as Appendix 2. 350 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

In the House of Representatives, there are four draft bills, namely: House Bill No. 271 – “An Act Providing for Antitrust Penalties.” - authored by Rep. Roilo Golez; House Bill No. 1373 - “An Act Penalizing Unfair Trade Practices, and Combina- tions in Restraint of Trade, Creating the Fair Trade Commission, Appropriating Funds Therefor and For Other Purposes.” - authored by Rep. Gerardo Espina; House Bill No. 3780 — “An Act Prohibiting Monopolies, Attempt to Monopolize an Industry or Line of Commerce, Manipulations of Prices of Commodities, Asset Acquisition and Interlocking Memberships in the Board of Directors of Competing Corporate Bodies and Price Discrimination among Customers, Providing Penalties Therefor and for Other Purposes,” - authored by Reps. Feliciano Belmonte Jr., Jack Enrile, and Oscar Moreno; and House Bill No. 4455 - “An Act Prescribing a Fair Competition Law, Its Enforce- ment, the Establishment of a Fair Trade Commission, Delineating its Powers and Functions and for Other Purposes,” – authored by Reps. Neptali Gonzales II and Manuel Roxas II. In the Senate, there are two draft bills, namely: Senate Bill No. 150 - “An Act Creating the Fair Trade Commission, Prescribing its Powers and Functions in Regulating Trade Competition and Monopolies, and For Other Purposes.” - authored by Sen. Sergio Osmena III; and Senate Bill No. 1792 - “An Act Prohibiting Monopolies, Attempt to Monopolize an Industry or Line of Commerce, Manipulations of Prices of Commodities, Asset Acquisition and Interlocking Memberships in the Board of Directors of Competing Corporate Bodies and Price Discrimination among Customers, Providing Penalties Therefor and for Other Purposes,” - authored by Sen. Juan Ponce Enrile. A comparative discussion of the bills is contained in the last chapter of this study. According to the Committee on Trade and Industry of the House with which the bills are pending, only one hearing on antitrust legislation has been conducted and so far, the measures have been put on hold. No committee report has yet been issued on the subject and it has not even been calendared in the order of business of the House. In the Senate, the Committee on Ways and Means has conducted only one hearing. In the meantime, Sen. Osmena is preparing for a set of Committee hearings. However, these have yet to be scheduled. Unfortunately, despite the obvious importance of the proposed measure in the economic development program of the government, it has not even been declared a priority measure by the executive branch.

ANTITRUST ENFORCEMENT IN OTHER COUNTRIES A cursory review (Meyerman and Cuevas 1998) of the developments in antitrust enforcement in other Asia Pacific economies may be useful to benchmark the progress of the Philippines, as well as to better appreciate the trends at the international and regional levels. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 351

Indonesia The Indonesian Competition Law was only recently enacted on 5 March 1999 after lengthy deliberations in Parliament and as part of economic restructuring efforts following the Asian financial crisis. The Law was to take full effect on 5 March 2000. The overall objectives of the Competition Law are to prohibit anticompetitive behavior in order to safeguard the public interest, to increase the efficiency of the national economy and to enhance social welfare. The Law is also designed to build a conducive business environment through fair competition that assures equal business opportunity for all business actors, to prevent monopoly practices and unfair business competition, and to create efficient and effective business activities. The Competition Law prohibits oligopoly, price-fixing, market division, boycott, cartels and trusts, vertical integration, tying-in agreements, and agreements with foreign parties that may lead to monopoly practices and unfair business competition. Mergers and acquisitions are also prohibited if they lead to monopoly and unfair competition. The Law includes the establishment of an independent enforcement agency called the Business Competition Oversight Commission, which reports to the Presi- dent. The Commission’s responsibilities include examining agreements that may lead to monopoly or unfair practices, investigating abuse of dominance, giving policy recommendations to the government, and issuing and compiling implementation guidelines. The Commission has the authority to conduct investigations and impose administrative and punitive sanctions. Administrative sanctions may be in the form of cancellation of business permit or prohibition of interlocking directorships. Punitive sanctions are in the form of fines and imprisonment. Parties to a case may appeal the Commission’s decisions to a District Court or the Supreme Court.

Malaysia Efforts to draft a competition law or trade practices law begun in 1993, but no law has yet been promulgated. Various consultations and information campaigns have been conducted in order to get a consensus from and educate the public. Existing laws do not prohibit restrictive trade practices or abuse of dominance. However, competition policy has been integrated in the process of deregulation and privatization. A regulatory body monitoring privatized public utilities promotes competition by allowing other firms to operate certain parts of privatized service through licensing arrangements. For example, eight firms have been licensed to operate telecommunications services in competition with the dominant privatized Telekom Ma- laysia, while several independent power producers have been allowed to generate and sell energy to the dominant Tenaga Nasional Berhad. As part of the WTO mandate of trade liberalization, tariffs and nontariff restrictions are being dismantled to encourage domestic and international trade. There are also approximately 30 laws which regulate enterprises and promote consumer protection, as well as administrative rules and regulations such as those 352 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES administered by the Foreign Investment Commission that governs the acquisition of assets, mergers, and takeovers.

Singapore Singapore does not have any formal competition laws. Its “competition policy framework” depends on a free and open market that, in turn, ensures a competitive environment in the domestic economy. For the services sector, in which the government has traditionally been the sole provider, Singapore has commenced a program of corporatization and privatization in order to subject such services to competition and market disciplines.

Japan Japan’s Anti-Monopoly Act (AMA) was passed in 1947. The Japan Fair Trade Commission (JFTC) is an independent regulatory commission created under the AMA. American laws exerted a strong influence on the AMA which had the following goals: • Promote free and fair competition • Stimulate the creative initiative of entrepreneurs • Encourage business activities • Increase employment levels and people’s real income • Promote the development of the economy while protecting the interests of consumers in general.

To achieve these goals, the AMA aims to eliminate any unreasonable constraint to business activities by prohibiting private monopolies, unreasonable restraints of trade and unfair trade practices, and preventing excessive concentration of market power. In 1977, the AMA was amended to impose tougher sanctions against cartel. In addition to regulating common anticompetitive conduct, the AMA also regulates mergers, acquisitions, shareholdings and interlocking directorates that are subject to filing requirements and scrutiny by the JFTC. The JFTC may direct the erring enterprises not to implement or to terminate or to take the necessary steps to lessen the possible anticompetitive impact of a transaction. Almost all enterprises contem- plating mergers with antitrust concerns consult the JFTC before they formally file for approval and registration of mergers. The JFTC regularly publishes its merger guidelines and actual merger consultation cases in order to ensure transparency. The JFTC also publishes recommendations for deregulation and exemption systems under the AMA. On the basis of these recommendations, the concerned government agencies modify or abolish economic regulations. Thereafter, the JFTC monitors the impact of these changes to determine if significant competition has come about. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 353

In the mid-1980s, the U.S. government alleged possible anticompetitive prac- tices17 of Japanese enterprises and associations. As a consequence, Japan improved its enforcement of competition policy through the following measures: increased the JFTC staff and budget allocation; acted on price-fixing cartels and bid rigging; disclosed detailed information on cases; increased the severity of penalties; and published JFTC guidelines on distribution and trade practices. In 1991, Japan raised the surcharge rate on cartels to 6 percent from 1.5 percent of sales. In 1992, the maximum fine for criminal anticompetitive conduct was raised by 2000 percent or up to ¥100 million or approximately P33 million.18

Korea Since 1966, government intervention helped in South Korea’s rapid economic development. However, such a strategy is no longer recognized as suitable in the current international economic context. In 1996, the Monopoly Regulation and Fair Trade Act (MRFTA) was amended to boost the effectiveness of competition law on a wider spectrum. Remedial measures were the earlier focus of competition law while preventive measures were neglected. Thus, some monopolistic and oligopolistic enterprises enjoyed the protection of “government supervision.” The Korean Fair Trade Commission (KFTC) has begun concentrating on markets where monopolists and oligopolists have become entrenched and has been identifying restraints on competition in these markets. The KFTC is also studying chaebols, that is large business groups engaged in group-based competition through mutual assistance. The fleet-like expansion and management of such groups are a disincentive to building individual competitiveness. Under the 1996 amendments to the MRFTA, the ceiling for debt guarantees among affiliates of large business groups has been decreased from 200 percent to 100 percent of the individual firm’s assets. Penalties for anticompetitive conduct have also become stiffer. For example, the KFTC imposed its highest fine, to date, on three paper producers the amount of 8.3 billion won (US$10 million or approximately P437.8 million19 ) for engaging in collusive activity. All anticompetitive mergers are now forbidden, regardless of the size of the enterprises. Previously, only mergers involving assets exceeding 20 billion won (US$25 million approximately P1.1 billion) were evaluated by the KFTC. Pre-merger notification to the KFTC is required for enterprises with a minimum size of 100 billion won (US$125 million or approximately P5.4 billion). ______

17 In Matsushita Electric Industrial Co. Ltd., et al. v. Zenith Radio Corporation, et al., 475 US 574 (1986), a U.S. television manufacturer claimed that a Japanese company was exporting television sets to the U.S. at dumped prices. The U.S. Supreme Court ruled that the actions of Japanese television makers were not demonstrably predatory, under the Sherman Act. The U.S. Supreme Court had stricter standards for predatory pricing. 18 P1.00 = ¥3.0194 (Bangko Sentral ng Pilipinas Exchange Rate as of 18 September 1998). 19 US$1.00 = P43.78 (Bangko Sentral ng Pilipinas Exchange Rate as of 18 September 1998). 354 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The elevation of the KFTC to a ministerial-level agency signaled the importance of competition policy. The KFTC chairman is now a Cabinet member. More significantly, the KFTC is specifically responsible for removing restraints to competition cause by government policy and initiating procedures to review anticompetitive regulation. These changes reflect the growing recognition that competition policy is extremely important in a globally-integrated economy and need to be coordinated with the other economic policies of a country.

China China’s first competition legislation was the Regulations on Development and Protection of Competition which the Chinese government promulgated in 1980 through the State Council. It still featured characteristics of the centrally-planned economy prevailing at the time. Nevertheless, the first Regulations had a significant impact since it shed new light on the theoretical research on competition in China. The Regulations were eventually modified on 1 December 1993, when the Law for Countering Unfair Competition became effective, after having been endorsed by the Standing Committee of the National People’s Congress on 2 September 1993. This was the result of the work of a unified task force formed in 1987, which consisted of several departments, such as the State Legislative Bureau (now known as the State Legislative Office) and the State Administration for Industry and Commerce (SAIC) and others, to draft a national law for competition. A new Antimonopoly Law is currently being drafted. In addition, competition law and policy are also embodied in other new laws such as the Law of the People’s Republic of China for Protecting Consumer’s Rights and Interests (promulgated in 1993), as well as the Regulations on Antidumping and Antisubsidization (promulgated by the State Council in 1997).

Taiwan After a decade of policy debate and deliberation, Taiwan’s Fair Trade Law was promulgated on 04 February 1991 and enforced a year later with the establishment of the Fair Trade Commission. The Fair Trade Law covers a wide range of antitrust and unfair competition concerns. The antitrust portion of the Law regulates monopolies, mergers, and concerted actions. In general, the Law permits the existence of monopolies, as long as they do not abuse their market power. Mergers involving parties reaching a certain sales volume or market share must apply with the Commission for approval. The Commission in principle forbids concerted actions but allows for exceptions which require the Commission’s prior approval. The unfair competition portion of the Law regulates practices such as resale price maintenance, various other types of vertical constraints, acts which are likely to impede fair competition, false and deceptive advertising, multi-level sales and other practices which are deceptive or grossly unfair. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 355

In order to keep pace with the current social and economic circumstances, as well as to anticipate future developments, the Fair Trade Law has been amended as of 05 February 1999. Salient points of the amendments include: increasing pecuniary penalties administrative and criminal fines directed at persons who and enterprises that violate the Fair Trade Law. This upgraded the Fair Trade Commission’s capability to regulate enterprises that do not comply with the Commission’s directives and to deal with cases through administrative means before resorting to the judicial system, except for those cases involving illegal multilevel sales schemes.

Australia Australia first enacted its competition law in 1906 with the passing of the Austra- lian Industries Preservation Act which prohibited monopoly and restraints of trade. Due to early strict judicial interpretation and constitutional limitations, this, and subsequent related legislation, was not entirely successful until the enactment of the Trade Practices Act of 1974 which contains Australia’s basic competition law providing for a comprehensive regime for business competition and regulation. The competition laws were greatly enhanced following the adoption of the 1993 Hilmer Committee recommendations and the development of the National Competi- tion Policy, agreed to in 1995 by the Federal, State and Territory governments. Key features of the new laws include the following: • An independent regulator, the Australian Competition and Consumer Com- mission (ACCC), now undertakes compliance and education activities and enforces the law by pursuing court action. • Universal application of the competitive conduct rules to all sectors of the Australian economy, including government business activities and the unin- corporated sectors (e.g., the professions). • Mechanisms that provide access to essential services through significant infrastructure facilities; and price oversight of State and Territory government businesses through the Price Surveillance Act of 1983.

Australia’s competition laws apply to all forms of business and to all industry sectors. They fit within a competition policy framework that involves many other initiatives such as review of anticompetitive regulation and the application of a competitive neutrality policy to government businesses.

New Zealand New Zealand has had a variety of competition laws since 1905. Between 1958 and 1986 the trade practices law was based primarily on United Kingdom legislation. This type of legislation was formalistic, consisting of lists of practices, which could be investigated, and generally only prevented those considered contrary to the public interest. A change of approach was made with the enactment of the Commerce Act in 1986. At the same time, a number of measures designed to increase the competitive- 356 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES ness and efficiency of the New Zealand economy was introduced such as reducing Government control and direct regulation of business activity. The Commerce Act was seen as a necessary accompaniment to the market reforms as it ensured that private firms did not replace the previous government regulation with anticompetitive behaviour. The Act was needed to: • Define the rules by which business are to operate in the newly deregulated, open economy. • Deter the possible spread of restrictive practices and mergers by firms wishing to reduce the new competition. • Provide a basis for the regulation of corporatized and privatized utilities.

In this environment, it was intended that the Commerce Act would promote competition through legislation which: • Prohibits the establishment or operation of business arrangements which reduce competition; • Prohibits firms from using market power for anticompetitive purposes; • Provides for the scrutiny of mergers and takeovers to prevent undesirable acquisitions of market power; and • Provides for price control in markets where there is an absence of competition.

The Act was largely modelled on the Australian Trade Practices Act. The enactment of the Act represented a shift in competition law approach in New Zealand, moving from an abuse control to a prohibition law modelled on the Australian Act. New Zealand’s approach, like Australia, is to focus on the behavior of industries rather than their structure, and recognizes that in some cases, an efficient industry structure may imply fewer competitors.

Mexico The Federal Law on Economic Competition (FLEC) was enacted on 23 June 1993 creating the Federal Competition Commission as the agency in charge of enforcing the law. The Federal Competition Commission was designed to function as an autonomous administrative body of the executive branch within the Mexican Secre- tariat of Commerce (Secretaria de Comercio y Fomento Industrial or SECOFI). The President appoints a panel of five commissioners, including the Commission president, to form a plenary session with decisions made by majority vote. The Commis- sion is empowered to: • Conduct investigations of competition violations initiated at the request of interested parties or by the Commission itself. • Issue administrative rulings and assess penalties for violations. • Render advisory opinions regarding, competition policy questions. • Participate in the negotiation of international agreements regarding competition policy. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 357

This antitrust statute consists of 39 articles that establish economic and legal regulations for all economic agents in Mexico. This includes all government agencies or entities, individuals, private companies, state-owned companies or companies with government participation, associations, professional organizations, trusts and the like.

ASSESSMENT OF ANTITRUST REGULATION IN THE PHILIPPINES

Historically, developed countries have used and are using antitrust regulation to foster and maintain competition that ensures an efficient, working market economy and modern democracy. Competition, through its allocative, distributive and incentive functions, can prevent undue concentration of economic power and the consequent concentration of political power in the economic elite who use their economic and political powers to have their inefficiencies subsidized by the majority of consumers and taxpayers. Knowing the existing laws and regulations for antitrust enforcement at the disposal of the Philippine government, what is then the actual effectiveness of these laws and regulations in promoting competition in the Philippine economy? This section analyzes the state of antitrust regulation in this country and examines the government’s capability to implement its antitrust laws and regulations. It studies the general regulatory structure in place and identifies a number of the regulators and institutions involved in the antitrust process. How have they managed to control the behavior of the players in various industries and sectors? How have they affected the structure of markets in the Philippine economy? What are the major problem areas?

STRUCTURE OF MARKETS IN THE PHILIPPINE ECONOMY: A GENERAL ASSESSMENT The Philippine economy is characterized by a high concentration of wealth and resources in a few groups comprising the nation’s elite class. The top 5.5 percent of all land-holding families own 44 percent of all tillable land and the richest 15 percent of all families account for 52.5 percent of all the national income (Almonte 1993). Moreover, only 10 corporations in 1991 accounted for 26 percent of all revenues, 40 percent of all net income, and 34 percent of total assets of the top 1,000 corporations (SEC 1991). Studies confirm a high concentration ratio in ownership and production, i.e., the measure of the market share of the top three or four firms to total market size in certain key industries: petroleum, iron and steel manufacturing, fertilizer, pulp and paper, home appliance manufacturing, tobacco and cigarette, and tire manufacturing. This high concentration ratio is a direct result of the failed economic policies of the past, particularly from a surfeit of regulation and a dearth of competition. 358 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The Philippine government adopted a strategy of import substitution, protectionism and the allocation of resources through regulation. In the guise of “nationalism” predominant in the 1950s and 1960s, domestic enterprises, especially the so-called infant industries, were pampered and protected from foreign competition through the imposition of high tariffs or outright quota restrictions on imported products and similar measures. These measures, which persist up to the present, encouraged the rent-seeking, import-substituting, capital-intensive, and oligopolistic behavior of Philippine domestic enterprises. The requirement for franchises and licenses was also used as a device to protect incumbents by disqualifying competitors. The main purpose and effect of such requirement is to reserve (specific) areas to franchisee or licensee, and hence exclude others. Franchises are awarded by acts of Congress and are distinct from permits to operate, which are dispensed by agencies regulating public utilities. The fact makes the award of franchises potentially open to wider rent-seeking or political considerations. The high concentration ratio in various industries is also directly attributable to entry barriers that prevent new participants from entering and competing in the same industry. The Philippine economy, therefore, is largely captive to a small group of economic interests who have succeeded in maintaining market dominance by successfully excluding other firms from entering to participate and compete in the markets. With this concentration of economic power, political power was likewise concentrated in the hands of a small elite. Only 60 to 100 political clans control all elective positions at the national level. The Philippine Congress, on the basis of reported statements of assets and liabilities submitted by its members, is composed largely of multimillionaires. The marriage of economic and political power presents a formidable hindrance to any form of change that may, or threaten to, alter the existing status quo. The immediate past two government administrations saw the articulation of plans and programs to reform the economy and open up the markets to competition. From 1992 to 1998, significant executive and legislative reform measures promoted unexpected advances in economic growth and development for the Philip- pines. Annual growth rates experienced a dramatic increase from 0.5 percent in 1992 to 7.1 percent in 1996. There were also tangible improvements of consumer welfare in key sectors, such as telecommunications, air and water transport, consumer goods, and industrial inputs. The Philippines also joined various multilateral and regional trading and economic cooperation arrangements, such as the ASEAN Free Trade Area (AFTA), the Asia Pacific Economic Cooperation (APEC), and the World Trade Organization (WTO). All these arrangements sought to liberalize trade and investments, and provide the Philippines with the much-needed external pressure to introduce internal reforms. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 359

However, trade and investment liberalization and deregulation were not sufficient to make the Philippines globally competitive. Merely liberalizing trade and investments is not enough to achieve sustainable and stable competitiveness. One crucial lesson from the success of the recent economic reforms is that competition played a key role in improving capital accumulation, factor productivity, efficiency in resource allocation, technological advancement and innovation. It should be noted that throughout all these economic reform measures, the issue of maintaining competition and sustaining competitiveness has not been addressed. All these recent reform efforts may be actually be reversed and wasted unless the various measures are rationalized and embraced under well-articulated and comprehensive competition policy framework. After having enticed and invited investors to do business in the Philippines, measures must also be adopted to make them stay. These involve not only the removal of the barriers to entry but also the enforcement of existing laws and the introduction of new measures to foster and maintain fair competition in the Philippine economy.

INADEQUACY OF THE EXISTING ANTITRUST LAWS AND REGULATIONS Present laws for promoting competition in the Philippines have been proven inadequate or ineffective to stave off the ill effects of anticompetitive structures and behavior in the market, mainly due to lack of enforcement. Despite the considerable number of laws and their varied nature, competition has not been fully established in all sectors of the economy, nor has existing competition in other sectors of the market been enhanced. These laws have been hardly used or implemented as may been seen in the lack of cases litigated in court. The same laws have even worked to discourage competition. Several reasons have been forwarded to explain the lack of enforcement of competition laws in the Philippines (Lazatin 1994).

Too many cooks There is a saying that, “Too many cooks spoil the broth.” With so many enforcement agencies, responsibility is too diffused and accountability for implementation of the laws is difficult to fix. Some regulators are unable to relate all the different existing laws and regulations (Khemani 1996). Moreover, there is a lack of expertise in the appreciation and implementation of competition laws that rely heavily on economic thought, techniques of analysis, and value preferences as tools of enforcement (Khemani 1996). Identifying a single specialized agency under a specific competition law, with the necessary expertise and authority to oversee the enforcement of competition laws, is therefore critical. 360 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Regulatory capture With a specific agency regulating each industry, the danger of regulatory capture is inevitable. In time and with familiarity, it is the industry that ultimately regulates the regulator.

Lack of a comprehensive competition law and a user-friendly enforcement mechanism Of course, the number of enforcement agencies is a direct result of the many laws that established them. The objectives behind each of these laws are unquestionably noble. However, inasmuch as each law is meant to address specific situations, there runs the risk of one law negating the positive effects of another. Existing laws and regulations also need to be studied and their proper place in the scheme of competition policy determined. Since some of these laws are penal in nature, the quantum of evidence required so that the case may prosper–proof beyond reasonable doubt–is difficult to obtain. In addition, the witnesses and/or aggrieved parties, because of the long tedious legal processes involved, are themselves not interested in putting the perpetrators behind bars; rather they are more interested in obtaining an injunction or cease and desist orders. Moreover, fines are inadequate to deter would-be criminals (Khemani 1996). An administrative enforcement mechanism that can be implemented faster, with hefty fines as penalties for unfair competition, would be more effective. Although beyond the scope of this study, it must be pointed out that in addition to studying the laws that directly bear on competition and competition policy, it is indispensable to consider the other laws which bear on economic development as these also deal with the elements of competition policy.

Lack of jurisprudence on competition The judiciary has scarcely had the opportunity to pass upon the proper application of the various laws on competition, partly due to lack of enforcement. The silence or ambiguities in these laws have thus remained. The lack of guidance has discour- aged full implementation.

OTHER CONSIDERATIONS These are other considerations—a few problem areas that must be addressed so that this whole process of formulating a strategy for the introduction of a new regulatory system in the Philippines will not be a futile exercise.

Political capacity With major powerful economic interests involved and entrenched, the development of a comprehensive competition policy to guide future economic regulation in the Philippines will definitely run into serious political obstacles if such interests are opposed. The accumulation of rents through monopolies over resources, factors of RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 361 production, and channels for economic activity goes back centuries to the colonial periods. Political capacity is intricately entwined with financial capacity, public support, and relative autonomy from pressures and influence of vested interest groups.

Budgetary constraints Although government agencies may have relatively large budgets, the amount of these resources compared to those at the disposal of vested interests for the purpose of obstructing reform, appear quite meager. It is also important to note that the budget is essentially controlled by Congress and may be withheld from agencies involved in the reform effort.

Technical capacity Most officials in the bureaucracy, as well as politicians, nongovernment organization (NGO) members and consumers, still lack technical knowledge in competition policy. This is the same for bureaucrats involved in the enforcement of fair trade and those who could potentially be involved in competition regulation. A number of officials of the Tariff Commission, Department of Trade and Industry, and the National Economic Development Authority, have been attending various seminars and workshops on competition policy, but all still lack the practical experience.

Management constraints Strict rules on the management of government agencies and the allocation of agency resources severely limit the organizational capability of these agencies. This makes it difficult for an agency to institute innovations and reforms internally and react swiftly and flexibly to various external situations. Thus, government agencies are rendered ineffective and anticompetitive, especially when compared to private corporations.

Proper compensation Finally, low salary scales have a detrimental effect on morale in the bureaucracy. It explains why the agencies are unable to attract and maintain the best graduates from the best schools. It also explains the relatively poor performance of agencies vis- à-vis their private sector counterparts. Finally, low levels of compensation render government officials and employees highly vulnerable to corruption and undue influence by vested interests. The organizational capability assessment may put into question the feasibility of the initiative to develop and enforce antitrust measures. However, it is necessary at this point to take stock of the different obstacles and threats this endeavor faces, as well as of the actual capabilities of the key actors and decision makers. This can then pave the way for the formulation of a more realistic strategy for implementation. There may be a need to rethink the participation of the various key players in the process, as well as the timing and sequencing of measures. 362 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Ultimately, this initiative would still be the most logical next step in the struggle for the economic renewal of the Philippines. If the obstacles appear daunting, this should only strengthen the resolve to push this initiative forward in the most creative and strategic manner possible.

THE NEXT STEP The above assessment of antitrust regulation and competition promotion does yield disappointing results. Competition is undoubtedly an integral component of a functioning market economy. Indeed, for a society to reap the benefits of wealth creation, wealth distribution and the other major objectives of competition, the state must ensure that market forces are constantly at play within an economy. Over and over, the Philippine government has made pronouncements about its adherence to a modern capitalist market system. Our Constitution clearly declares that it is state policy to protect and promote competition. However, Philippine political and economic histories paint a totally different picture. Ever since the creation of the modern Philippine state, the rule has actually been to prevent and destroy competition in order to protect the dominant political and economic elite of the country. In key industries and services, monopolies and cartels have been the standard vehicles for wealth creation. Hence, laws and regulations were structured in such a way that competition could never flourish. There is an existing legal and regulatory system for promoting competition in this country. Unfortunately, it has proven to be completely ineffective in meeting its objectives. The Philippines has yet to craft a truly effective legal and regulatory framework for enforcing competition in the economy. How such a framework is to shape up, will depend on the design of a simple and enforceable model and a careful consideration of the political economy realities of this country.

RECOMMENDATIONS FOR A NEW LEGAL AND REGULATORY FRAMEWORK

In a world that is increasingly integrating economically and adhering to market- based rules and principles, a rational and well-articulated framework for competition- based economic regulation becomes an indispensable developmental tool for all countries. Recent international and regional developments indicate a pressing need for these new regulatory frameworks in developing and developed countries alike. The controversy and confusion surrounding the last WTO ministerial conference in Seattle highlight the urgency for WTO member countries to prepare their respective economic systems for competition in a so-called “Global Economy.” This adjustment process includes the introduction of new frameworks for economic regulation which prepare firms and industries for vigorous international competition. In fact, in RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 363 this last ministerial conference, a very important agenda item was the issue of trade and competition policy. Although this topic has been the subject of much controversy due largely to the differences of opinion between the United States and the European Union on the treatment of competition policy within the multilateral trading system, nevertheless, its inclusion as a topic for discussion in the WTO, as well as in other international institutions such as the OECD and the World Bank, underscores its crucial role in international economic relations and development. The “shocks” that the financial systems of the East Asian economies suffered illustrated the lack of responsiveness and relevance of existing regulatory frameworks to international economic realities. The Asian financial crisis was in fact a result of these fundamental conflict. Although certain countries, such as Malaysia and the Philippines, chose to impose restrictions on market-based flows of capital and goods, many countries across the region, such as Thailand, chose to review their antiquated economic regulations with the intention of amending and modernizing them. If a similar crisis is to be prevented in the future, then Asian economies would be better advised to choose the latter approach. The Philippines was certainly not spared the negative effects of the Asian financial crisis, despite claims to the contrary. Many firms and industries did suffer from the drastic fluctuations of an unstable currency. Unfortunately, rather than accepting the crisis as a result of market forces conflicting with anticompetitive economic regulations, these firms even cited the crisis as justification for imposing economic controls and trade barriers. For example, the Philippine government has made moves to increase trade protection for its textile, petrochemical, basic steel, and basic agricultural sectors. Such efforts only aggravate monopoly situations already prevailing in these sectors. What is most disturbing about this is it reveals a highly inconsistent approach in economic development policy and even a reversal of the Philippine government pronouncements about adhering to open markets, liberalization and competition. The problem is that the Philippines, despite the existence of numerous laws and regulations dealing with competition, really lacks a clear, coherent, comprehensive and enforceable legal and regulatory framework for antitrust enforcement and the protection of competition. Therefore, there is still a need to propose a more effective framework for antitrust regulation in this country. Such a framework should first lay down the basic policy objectives and principles, as well as spell out the basic structure for regulation.

REQUISITE FEATURES OF A COMPETITION LAW As explained earlier, Philippine laws and regulations bearing on competition are actually numerous and varied. However, there still remains a need to enact an overall law on competition, particularly a comprehensive antitrust legislation. In this regard, some authors have suggested the requisite features for such legislation: 364 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• Competition law should focus on the actual and, or potential business conduct of firms in a given market, and not on the absolute or relative size of firms. It should look at the business conduct of firms and on the business environment in which the firms operate. • Competition law must be effectively harmonized and linked with other government policies. Promoting competition in the business environment con- strains firms’ anticompetitive behavior and also inculcates sound business practices and ethics. • Competition law should be a law of general application, addressing all sectors of the economy. Exemptions from its application may be allowed if they do not limit competition, are based on sound economic principles and are aimed at facilitating legitimate economic activity. • Competition law should contain provisions explicitly prohibiting business practices that are clearly against economic efficiency and consumer welfare, such as price fixing, bid rigging, restriction of output and market shares and allocation of geographic markets and customers which should be deemed illegal per se and subject to criminal law and severe penalties. • Competition law should also provide for a “rule of reason” approach with respect to horizontal and vertical mergers, specialization agreements, joint ventures, vertical manufacturing and wholesale, retail distribution arrangements. Prior notification to and approval by the concerned agency of such business arrangements is recommended but only with respect to largest transactions, taking into consideration size thresholds in terms of market share, assets, sales and/or employment of parties involved (Khemani 1996). Ultimately, these measures should seek to establish a new national economic order with the private sector as the primary engine of growth and development, market forces as the determinants of prices and wages, competition as the principal means of economic, political and social control and discipline, consumer welfare, employment and income expansion, and economic efficiency as the main benchmark. Antitrust laws in the Philippines have been largely ineffective because their enforcement is vested in different agencies. This breeds confusion, noncoordination and conflicts. It is not uncommon for benefits from enforcement in one area to be negated by adverse effects from enforcement elsewhere. The effective implementation and enforcement of anticompetition laws should be vested in a centralized agency with sufficient powers to oversee and monitor the competitive climate in the different sectors of the economy, to formulate and recommend such measures as would ensure the maintenance of the competition in the Philippine domestic market and as would anticipate developments in the international market.

REALITY CHECK Given the central importance of competition in economic development, as well as the basic lack of capacity for enforcing competition in the Philippines, there is a need RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 365 to engage in a general overhaul of the legal and regulatory system. Ideally, therefore, the introduction of true competition policy in this country should be done in a centralized and comprehensive manner. This would necessitate the introduction of a new comprehensive law, that outlines the anticompetitive structures and behavior which need to be curtailed and the procedures for enforcing these, as well the creation of a new competition agency to implement the new law. The prime objective of this special reform effort is to institutionalize a “competition culture” in the Philippines. If society as a whole accepts and even promotes competition as an integral part of economic reality, then antitrust regulation can actually become self-sustaining. However, it will still require a legal and regulatory framework in which to operate. Furthermore, this framework will have to play that central role in an over-arching competition policy for the whole economy. This framework will have to be imbued with the level of importance that would command the respect of the highest leadership as official state policy.

FIRST OPTION: COMPREHENSIVE APPROACH Therefore, the first option in introducing an effective legal and regulatory framework for antitrust enforcement is the passage of a new law which is comprehensive in scope and central to economic policy. This new law will have to contain all the major provisions governing the conduct of antitrust enforcement and it will, in effect, modify the manner in which the government regulates the economic activities in the Philippines. The new law will centralize the different interventions of the government which relate to competition policy. The entity could be called the Philippine Trade Commission or the Philippine Competition Commission, composed of members with varied backgrounds in laws, economics, finance and various fields of industry and business. In determining the nature, powers, functions and duties of the Commission, it is proposed that the following guiding principles (Khemani 1996) be considered: • The Commission should be independent and insulated from political interference, or influence. • The investigation, prosecution and adjudication functions should be separate. • A system of checks and balances with appropriate rights of appeal and review of decisions and facts on legal and economic grounds should be provided. • The Commission should guarantee the expeditious resolutions of cases and related matter. • The proceedings should be transparent and acceptable to all affected parties. • The Commission should have a statutory role in participating, formulating and commenting on government economic and regulatory policies impact- ing on competition in the market place. • The Commission should consistently and fairly implement or apply all competition laws in addressing different types of restrictive business practices. 366 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Suggested scope and provisions for a competition law A recent report of the World Bank and the Organization for Economic Coopera- tion and Development (OECD) entitled, A Framework for the Design and Implemen- tation of Competition Law and Policy, suggests a structure for a competition law, including wording for its substantive provisions. Some of the suggested provisions are accompanied by a brief commentary. It must be emphasized that the statutory provisions are only suggestions. Competition laws must be drafted to fit the legal and economic context of each country.

Scope of competition law Competition Law is an essential part of the economic constitution of a free market country. It should, as much as possible, apply to all market transactions and to all entities engaged in commercial transactions irrespective of ownership or legal form. All exceptions to the application of the law should be explicitly identified in pertinent legislation. Suggested provisions: [Article ______] Purpose This Law is intended to maintain and enhance competition in order ultimately to enhance consumer welfare. [Article ______] Field of application 1. This Law shall be enforced on the whole territory of the Republic of ______and applies to all areas of commercial economic activity. The Law shall be applicable to all matters specified in [section(s) of the law containing the prohibitions of restrictive agreements, abuse of dominance, and merger review], having substantial effects in the Republic of ______, including those that result from acts done outside the Republic of ______. 2. This Law does not derogate from the direct enjoyment of the privileges and protections conferred by other laws protecting intellectual property, including inventions, industrial models, trademarks, and copyrights. It does apply to the use of such property in such a manner as to cause the anticompetitive effects prohibited herein. 3. This Law shall apply neither to the combinations or activities of workers or employees nor to agreements or arrangements between two or more employers when such combinations, activities, agreements, or arrangements are designed solely to facilitate collective bargaining in respect of conditions of employment.

Definitions The competition law should define common terms that are used in the law and that are needed to interpret its provisional consistency. Suggested provisions: “Competition”—the process by which economic agents, acting independently in a market, limit each other’s ability to control the conditions prevailing in that market. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 367

“Firm”—any natural or legal person, governmental body, partnership, or association in any form engaged directly or indirectly in economic activity. Two firms, one of which is controlled by the other, shall be treated as one firm. Two or more firms that are controlled by a single firm shall be treated as one firm. The competition office shall adopt a regulation setting out what constitutes control. “Good”—all property, tangible and intangible, and services.

“Market”—a collection of goods among which buyers are or would be willing to substitute, and a specific territory, which could extend beyond the borders of the Republic of ______, in which are located sellers among which buyers are or would be willing to substitute.

Abuse of dominant position Suggested provisions: [Article_]Abuse of a Dominant Position 1. “Dominant Position”—a firm has a dominant position if, acting on its own, it can profitably and materially restrain or reduce competition in a market for a significant period of time. The position of a firm is not dominant unless its share of the relevant market exceeds 35 percent. A firm having a market share exceeding 35 percent may or may not be found to be dominant depending on the economic situation in that market, including the firm’s market share, competing firms’ market shares and their abilities to expand those shares, and the potential for new entry into the market. 2. Actions of a dominant firm—including creating obstacles to the entry of competing firms or to the expansion of existing competitors or elimina- tion of competing firms from the market—that have or may probably have as their result a significant limitation of competition are prohibited. 3. Section 2 of this article does not prohibit actions by a firm that create obstacles to the entry of new firms or reduce the competitiveness of existing firms solely by increasing the efficiency of the firm taking those actions, or that pass the benefits of greater efficiency on to consumers.

[Article__] Power to break up a firm abusing its dominant position 1. When a firm has abused its dominant position and no other remedy under this law or under an applicable regulatory statute would be likely to rectify the situation or prevent recurrence of the abuse, the competition office may reorganize or divide the firm, provided there is a reasonable likeli- hood that the resulting entity or entities would be economically viable. 2. The power to reorganize or divide contained in this article shall be exercised in a manner designed to minimize any increases in costs of providing the good. 368 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The 35 percent “safe harbor” is found in the competition laws of several countries either expressly or in common law or practice. Although the 35 percent threshold is somewhat arbitrary, it is unlikely that a firm with a much smaller market share could successfully exercise market power unilaterally. There are some valid reasons for raising the threshold. In a small country that is relatively closed to international trade and investment, high concentration may be necessary so that firms can grow large enough to exhaust significant economies of scale and scope. In some countries’ law, a market share of 65 or 70 percent creates a presumption of dominance that the firm must rebut. But many think that the better practice is to place the burden of providing dominance on the competition agency. A high market share is a necessary but not sufficient condition. This provision employs a general legal standard: a “significant limitation of competition.” In economic terms, this standard typically refers to restrictions that would permit a price increase above what would prevail in a competitive market. However, It is not possible to legally define a “significant” limitation of competition, because the size of an anticompetitive price increase can vary across jurisdictions. It can even vary over time within the same country in response to changes in the resources available for antitrust enforcement and in the efficiency of the competitive agency. The laws of some countries also list specific types of conduct, such as predatory pricing, tying, or exclusive dealing that can constitute abuse of dominance. Such provisions are more common in countries that employ a civil code legal system, as opposed to a common law system. It is difficult to define such conduct accurately, however, or to be sufficiently inclusive of potentially abusive conduct. Also, it must always be remembered that the specific conduct is not always abusive or anticompetitive, even if carried through by a dominant firm.

Restrictive agreements Certain types of horizontal agreements, collectively described as cartel agreements, are subject to stricter control than other types. In many countries this distinction is not found in the law itself but in enforcement practice or regulations. Countries that are adopting competition laws for the first time, however, are better off making the distinction explicitly in the law. Doing so will help ensure that enterprises learn the seriousness of violating cartel prohibitions and will help business people understand that although some vertical agreements may hurt individual competitors, they are proscribed only if they harm competition industry wide. Not all horizontal agreements are cartel agreements. Competitors may integrate their operations to achieve greater efficiency, and the result may be procompetitive on balance. Agreements of this type include joint ventures, joint research and development, and the setting of common standards that benefit consumers. These agreements should be subject to a more lenient legal standard and distinguished from cartel agreements in the competition law. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 369

Finally, some horizontal and vertical agreements may be harmful to competition in some sense, but may generate efficiencies that make them beneficial on balance. (Cartel agreements, by definition, cannot generate such efficiencies.) It is helpful if the law sets forth the standards that govern this analysis. Suggested provisions: [Article___] Prohibited agreements between firms 1. An agreement, concluded in any form including by concerted practice, between competing firms (including firms that could easily become competitors) is prohibited if such an agreement has or would likely have as its principal effect: (a) Fixing or setting prices, tariffs, discounts, surcharges, or any other charges; (b) fixing or setting the quantity of output; (c) fixing or setting prices at auctions or in any other form of bidding,, except for joint bids so identified on their face to the party soliciting bids; (d) dividing the market, whether by territory, by volume of sales or purchases, by type of goods sold, by customers or sellers, or by other means; (e) eliminating from the market actual or potential sellers or purchasers; or (f) refusing to conclude contracts with actual or potential sellers or purchasers.

2. An agreement, other than those enumerated in section 1 of this article, concluded in any form including by concerted practice, is prohibited if it has or would likely have as its result, a significant limitation of competition. (a) An agreement among competing firms, including firms that could easily become competitors, other than those agreements enumerated in section 1 of this article, cannot be found to significantly limit competition unless the shares of the firms participating in the agreement collectively exceed 20 percent of a market affected by the agreement. (b) An agreement solely among noncompeting firms cannot be found to significantly limit competition unless: - At least one of the parties holds a dominant position in a market affected by the agreement; or - The limitation of competition results from the fact that similar agreements are widespread in a market affected by the agreement. (a) An agreement prohibited under section 2 of this article is nonetheless legal if it has brought about or is likely to bring about gains in real as opposed to merely pecuniary efficiencies that are greater than or that more than offset the effects of any limitation on competition that result or are likely to result from the agreement. (b) The burden of proof under this section lies with the parties seeking the exemption, and includes demonstrating that if the agreement were not implemented it is not likely that the relevant efficiency gains would be realized by means that would limit competition to a lesser degree than the agreement. 370 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Section 3(a)’s reference to “real, as opposed to merely pecuniary, gains in efficiency” is designed to exclude consideration of benefits such as reductions in income taxes or greater quantity discounts obtained solely through exercising greater purchasing leverage. Such pecuniary gains are transfers rather than increases in the economy’s ability to satisfy consumer needs. Section 3(b) does not require the parties to prove that the agreement is the only way to realize the claimed gains in efficiency, but that there are no practical, less anticompetitive means of doing so. Section 3(a), and an identical provision in section 9 of the article on concentrations, read together with article 1 (the purpose clause) implicitly applies a total welfare standard to the efficiencies defense or exemption. It does so by giving equal weight to both consumers and producers, thus ignoring any transformation of consumer surplus into producer surplus resulting from the agreement. Section 3(a) permits agreements in which the deadweight loss – that is, the surplus lost to consumers but not transformed into higher producer profits – from the fall in consumption due to a price increase is less than the value of resources saved in more efficiently producing the goods. Instead of a total welfare standard, some countries might prefer to focus exclusively on consumer welfare, and therefore allow an efficiency defense or exemption only in cases where efficiency gains are expected to be so large that consumers will not be harmed despite the anticipated increase in market power. To articulate such a standard, section 3(a) could be written as follows: 3. (a) An agreement prohibited under section 2 of this article is nonetheless legal if it has brought about or is likely to bring about gains in real as opposed to merely pecuniary efficiencies that are greater than or that more than offset the effects of any limitation on competition that result or are likely to result from the agreement.

Mergers and acquisitions A competition statute’s merger provisions should be permissive. In particular, there is no need for systematic review and approval of all mergers. Mergers should be allowed unless the competition authorities can show that they will significantly limit competition. Furthermore, requiring notification of all mergers would unduly burden the authorities and impose unreasonable costs and delays on the merging parties. Only large mergers, which are most likely to present a threat to competition, should be subject to premerger notification requirements. In countries with high inflation, it is advisable to measure the minimum-size threshold in terms that rise with inflation, for example as a multiple of a standard minimum wage. The same competition test should apply to all mergers, whether or not notification is required. The competition office should thus have the power to order the dissolution of smaller non-notified mergers. To eliminate the uncertainty created by possible dissolution, merging firms should be permitted to make voluntary notifications. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 371

Suggested provisions: [Article ___] Review of concentrations Definition 1. “Concentration”—concentration shall be deemed to arise when: – Two or more previously independent firms merge, amalgamate, or combine the whole or a part of their businesses; or – One or more natural or legal persons already controlling at least one firm acquire, whether by purchase or indirect control of the whole or parts of one or more other firms.

2. “Control”—for the purpose of this article, control is defined as the ability to materially influence a firm, in particular through: – Ownership or the right to use all or part of the assets of an undertaking; or – Rights or contracts that confer decisive influence on the composition, voting, or decisions of the organs of a firm.

Notification 3. When an agreement or public bid will produce a concentration larger than the minimum size as provided in regulations issued pursuant to section 7 of this article, the parties to the agreement or bid are prohibited from consummating such concentration until ___ days after providing notification to the competition office, in the form and containing the information specified in regulations issued pursuant to section 7. 4. Before the expiration of the __day period referred to in section 3 of this article, the competition office may issue a written request for further information. The issuance of such a request has the effect of extending the period within which the concentration may not be consummated for an additional __days, beginning on the day after substantially all of the requested information is supplied to the competition office. 5. Parties to an agreement or public bid not subject to the notification requirement in section 3 of this article may voluntarily notify and, if they do so, be subject to the same procedures, restrictions, and rights as are applied to cases of compulsory notification. 6. If, before consummation of a concentration, the competition office determines that such concentration is prohibited by section 8 of this article and does not qualify for exemption under section 9 of this article, the competition office may: (a) Prohibit consummation of the concentration; (b) Prohibit consummation of the concentration unless and until it is modified by changes specified by the competition office; (c) Prohibit consummation of the concentration unless and until the pertinent party or parties enter into legally enforceable agreements specified by the competition office. 372 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Regulations regarding concentrations 7. The competition office shall, from time to time, adopt and publish regulations stipulating: (a) The minimum size or sizes of concentrations subject to the notification requirement in section 3 of this article; (b) The information that must be supplied for notified concentrations; (c) Exceptions or exemptions from the notification requirement of section 3 for specified types of concentrations; (d) Other rules relating to the notification procedures in sections 3,4, and 5 of this article.

Permitted and prohibited concentrations 8. Concentrations that will probably lead to a significant limitation of competition are prohibited. 9. Concentrations prohibited under section 8 of this article shall nonetheless be free from prohibition by the competition office if the parties establish that either: (a) The concentration has brought about or is likely to bring about gains in real as opposed to merely pecuniary efficiencies that are greater than or that more than offset the effects of any limitation on competition that result or are likely to result from the concentration; or (b) One of the parties to the concentration is faced with actual or imminent financial failure, and the concentration represents the least anticompetitive among the known alternative uses for the failing firm’s assets.

The burden of proof under this section lies with the parties seeking the exemption. A party seeking to rely on the exemption specified in (a) must demonstrate that if the concentration were not consummated it is not likely that the relevant efficiency gains would be realized by means that would limit competition to a lesser degree than the concentration. A party seeking to rely on the exception specified in (b) must: i Demonstrate that reasonable steps have been taken within the recent past to identify alternative purchasers for the failing firm’s assets; ii fully describe the results of that search.

10. The competition office may determine, within three years after consummation, that either a non-notified concentration or a notified concentration in which the provisions of sections 3-5 of this article are not fully complied with, has led or will probably lead to a significant limitation of competition and does not qualify for either of the two exemptions set out in section 9 of this article. If it so determines, the competition office may: RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 373

(a) Undo the concentration by dissolving it into its constituent elements; (b) Require other modifications of the concentration, including sale of a portion of its operations or assets; (c) Require the surviving firm or firms to enter into legally enforceable agreements specified by the competition office and designed to reduce or eliminate the competition-limiting effects of the concentration.

11. Noticeable concentrations that the competition office determines are prohibited by section 8 of this article and do not qualify for exemption under section 9 may subsequently be authorized by a published decision of the Government of ______for overriding reasons of public policy involving a unique and significant contribution to the general welfare of the citizens of______.

Because delaying a merger can generate high costs for the parties involved and increase the risk that confidential business plans might become public knowledge, it is important to keep the delays mandated in sections 3 and 4 as short as possible. Although Sections 6 and 10 provide for both structural and behavioral remedies, the competition office should favor structural remedies. Behavioral remedies are generally ineffective unless they are easy to monitor and the competition office has effective means of ensuring compliance. The basis for the efficiencies defense or exemption in Section 9(a) is discussed in the commentary accompanying the article on restrictive agreements. If, as discussed there, it is decided that a consumer surplus standard is to be applied to this exemption, the alternative provision provided there may be used in this Article as well.

Unfair competition In enforcing this rubric of the law, the competition office could end up spending an inordinate amount of time arbitrating what are really private disputes and having little influence on the competitive process. To reduce that risk, the law should provide for enforcement through private actions. Every effort should also be made to ensure that the unfair competition provisions are as clear as possible. Note that countries could address this issue in their general consumer protection laws instead of in their competition statute.

Suggested provisions: [Article__] Prohibition of unfair competition Unfair competition is prohibited, including: 1. The distribution of false or misleading information that is capable of harming the business interests of another firm; 374 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

1. The distribution of false or misleading information to consumers, including the distribution of information lacking a reasonable basis, related to the price, character, method or place of production, properties, suitability for use, or quality of goods; 2. False or misleading comparison of goods in the process of advertising; 3. Fraudulent use of another’s trademark, firm name, or product labeling or packaging; 4. Unauthorized receipt, use, or dissemination of confidential scientific, technical, production, business, or trade information.

Organizational and enforcement matters

This section concerns a series of diverse provisions intended to improve the general effectiveness of a competition statute. Where applicable, comments will be followed by suggested statutory wording.

Specialized courts and rights of appeal In most countries the judiciary is involved with enforcing competition laws. The competition authority may be required to apply to the courts for orders that would implement its decisions. More commonly, parties involved may appeal the competition agency’s decisions to the courts. If private parties have the right to institute competition cases, these cases may be brought before the courts. Because the judiciaries in transition and developing economies are inexperienced in dealing with free market problems, it may be advisable to set up specialized courts to hear competition cases. Such courts could hear all commercial disputes or special- ize to hear only competition cases. Hearing these cases before specially-trained judges should speed up the acquisition of expertise and produce more consistent, predictable decisions. Specialized competition courts could adopt procedures and rules of evidence specifically suited to competition cases. The composition of the court could be tailored to the requirements of competition cases. For example, at least one economist could be included in each tribunal.

Private enforcement In some countries private actions for redress of injury by people harmed, resulting from violations of the competition law may be instituted before an appropriate court or tribunal. Such private actions have at least two benefits: they supplement and reinforce public enforcement of the competition law, and they free the competition authority from having to obtain such redress on behalf of private parties. To facilitate private rights of action, provisions could be added to the competition statute to: • Allow private plaintiffs to bring actions in courts for damages they can prove they sustained as a result of either a violation of the competition statute or a RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 375

party’s failure to comply with orders made under it, plus all reasonable costs they may have incurred investigating and prosecuting the case. • Allow private plaintiffs to bring actions for injunctive relief (for example, to prohibit mergers or to cease using certain anticompetitive contract terms). • Require the competition office to transfer to private plaintiffs all nonconfidential information gathered in the course of the office’s investigations. • Facilitate the use of court records in cases brought by the competition authority as evidence in private damage suits. • Allow group damage claims in competition cases.

Relationships between the competition office and other government bodies Independence from other parts of the government is important to the proper functioning of the competition office. Decisions of the office may affect the interests of entrenched businesses, which may have strong influence in one or more government ministries. The competition office should be free from the political influence of these interests. Suggested provisions: [Article__] Independence of the competition office 1. The competition office is under the authority of the [President of ______], and receives its budget directly from and reports directly to the [legislature of ______]. 2. The [head] of the competition office is appointed by the [President of ______], for a renewable term of [a minimum of three] years, and can only be removed by a [vote of the legislature] for patent inability to discharge his functions.

Though the competition office should be organizationally independent from other parts of the government, it should also have the power to participate in government decisions directly affecting competition. The competition office should thus have the power to make recommendations or presentations, and in some situations to intervene when government bodies are making decisions affecting competition policy. Suggested provision: [Article __] Representations and interventions by the competition office 1. The competition office shall have the right to make submissions to state administrative authorities engaged in designing or administering legislation or regulations that could affect competition in any market in [the Re- public of ______]. When hearings are held with regard to the adoption or administration of such laws or regulations, the competition office shall have the right to intervene in such proceedings. 2. The competition office shall have the right to publish the submissions and interventions referred to in Section 1 of this Article provided that confidential information is not divulged. 376 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Prohibition and remedial orders The appropriate remedy for many types of anticompetitive practices is to simply demand that the offending party stop engaging in the conduct or to take other actions to eliminate the effects of the unlawful practice. Punishment is also appropriate if the conduct is egregious. But some competitive harms are not readily apparent to business people, who may have initially engaged in the conduct in good faith. Such cases may include noncartel restrictive agreements, some abuses of a dominant position and some acts of unfair competition. The competition law should empower the competition agency to prohibit the conduct or redress the harm from it.

Suggested provision: [Article __] Prohibition and remedial orders The competition office [or appropriate court or tribunal] may issue orders prohibiting firms from carrying on the anticompetitive or unfair practices referred to in this Act and, if necessary, requiring such firms to take other specified actions to eliminate the harmful effects of such practices and to ensure against recurrence of such practices.

Fines and Penalties The competition office should have the authority to impose fines for cartel agreements, serious or repeated abuse of dominance, noncartel agreements, and unfair competition and to ensure compliance with merger notification requirements and competition office decisions. To deter cartel agreements, fines must be considerably larger than the extra profits that firms anticipate earning through their illegal behavior: for example, consider companies A and B that think they will be able to raise their profits by $500,000 by agreeing to increase prices. If they also believe that there is only a 10 percent probabil- ity of being punished for collusion, the anticipated fine must be approximately $5 million to effectively dissuade them. Some countries have found that the deterrent effect of penalties is enhanced considerably if the anticompetitive acts are characterized as criminal and if individuals as well as enterprises are made liable.

Interim injunctions The power to obtain interim injunctions, or temporary orders to stop a particular practice, is frequently necessary to preserve the status quo pending investigation. In- terim injunctions are particularly useful in merger cases, in which a merged entity is difficult to break apart, and in cases involving other types of conduct in which prohibition orders rather than fines, are relied on to eliminate or to prevent anticompetitive practices. Suggested provisions: [Article __] Interim injunctions 1. The head of the competition office may apply to [appropriate court of tribunal] for an order to suspend business practices under investigation by the competition office or the consummation of concentrations. Before making RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 377

the order, the [court or tribunal] shall be satisfied that the proposed measures are urgently required to avoid serious, imminent, and irreparable harm to the economic interests of the Republic of ______, as expressed in this Act. When the effectiveness of the order would not thereby be prejudiced, the [court or tribunal] shall permit the firms that would be subject to the order to present their views regarding the proposed order. 2. Within three days of the issuance of an order by the [court or tribunal] pursuant to this Article, the competition office shall deliver the order to the parties subject to it, together with reasons for the order and notice of the right to appeal. 3. All orders made under this Article lose effect twenty-one days after they are issued, unless renewed by express decision of the [court or tribunal]. 4. Orders issued under this section may be appealed to the [pertinent appeal court], but do not lose their effect pending the outcome of the appeal.

Enforcement guidelines and advance rulings Parties subject to the law should be helped to comply with it and to plan their activities accordingly. Much of this assistance could come through the publication of enforcement guidelines articulating how the competition office will interpret and apply the law. In addition, while protecting confidentiality, the competition office should be required to publish all prohibition orders and decisions imposing sanctions along with supporting reasons. There is also a need for a process whereby parties can obtain advance rulings from the competition office concerning planned courses of action. This information would be particularly helpful for exemptions given to horizontal or vertical agreements. Suggested provisions: [Article __] Advance rulings 1. Parties may apply to the competition office for advance rulings binding on that office, regarding eligibility for exemptions from the prohibitions of articles ______[relating to restrictive agreements and abuse of a dominant position]. If it chooses to grant an advance ruling, the competition office may include in it specified conditions and requirements. The advance ruling shall by its terms exist for a specified period of time. 2. Advance rulings may be renewed upon application by the parties. An advance ruling may be revoked or modified if: (a) A significant change in circumstances has occurred since the ruling; (b) The applicant infringed on a condition or a requirement specified in the ruling; (c) The decision to grant the ruling was materially influenced by inaccurate, fraudulent, or misleading evidence; or (d) The applicant abused the exemption granted to it. 378 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

3. The competition office shall arrange for publication of its advance rulings, omitting any confidential information. It may arrange similar publication of all other decisions taken under this act, again omitting any confidential information.

Investigative powers To ensure sufficient investigative capability, the competition office requires the production of information. The office should be able to require that parties under investigation, as well as third parties, produce documents (in paper or other form), written answers to question, and oral testimony. In addition, the competition office should have the power to search the premises of subjects of an investigation and to take away evidence discovered in the search. Such broad investigative powers should be subject to strict procedural safeguards. In most countries, searches can be conducted only after authorization of a court or tribunal—and the competition agency must show probable cause. The competition office should be required to permit any party submitting evidence to have reasonable access to that evidence, and it should be required to return the evidence after the investigation and subsequent enforcement proceedings. These powers should be reinforced with severe fines for willful destruction or withhold- ing of evidence or persistent refusal to supply requested information in a timely fashion. Protection of confidential information and avoidance of conflicts of interest If the competition office is to enjoy the confidence and cooperation of the business sector, it must protect the confidentiality of all nonpublic information that it acquires in the course of an investigation or proceeding. Also, it must ensure that its officials are not tempted to profit privately from knowledge acquired in the course of their duties. Suggested provisions: [Article __] Confidentiality and conflict of interest rules 1. Officials of the competition office, as well as their agents and consultants, shall maintain the confidentiality of all business, commercial, or official information of which they become aware during the course of their official activities, except that which is otherwise public. Disclosure of such confidential information may occur in the course of administrative or judicial proceedings arising under this Act, or otherwise as permitted by [the court or tribunal]. 2. All members of the competition office shall inform the head of the competition office of any position held or activity carried out in an economic field by the member, including all agents thereof. The head of the competition office shall take all necessary steps to ensure there is no conflict of interest arising from such positions or activities, including requiring that such positions be resigned or activities cease. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 379

To strengthen these provisions, fines and possible dismissal should be imposed if government employees willfully disclose confidential data or engage in conflicts of interest. Taking into consideration the suggested provisions above, a proposed antitrust/ competition law has been prepared and attached hereto as Annex C. Under the first option, the various draft bills, like the proposed version suggested above, take this comprehensive and centralized approach. However, these proposed laws take very different approaches to applying the basic provisions of an antitrust/ competition law outlined above. Among the House bills, the Espina bill is the strictest and most comprehensive. Specifically, it penalizes the spreading of false rumors and the setting of high prices. It likewise prohibits government officials from supporting monopolies or combinations in restraint of trade with concomitant penalties. Interestingly, it even has a di- vestment requirement for erring firms, forcing them to offer to public ownership certain percentages of their capital stock. The Belmonte bill covers the monopolization of trade both within and outside of the country, and contains more detailed provisions on various antitrust activities. However, both the Belmonte and Gonzales-Roxas bills contain more exception clauses than the Espina bill, with the Gonzales-Roxas bill providing the most exceptions. The Belmonte bill prohibits discriminatory pricing but allows two exceptions: differentials in the cost of manufacture, sale, or delivery, or when the Trade and In- dustry or Agriculture Secretary fix and establish quantity limits to prevent monopolies. The Gonzales-Roxas bill also prohibits price discrimination with five exceptions: socialized pricing, volume discounts, competitive pricing, bona fide selection of customers, and changing market conditions or prices of goods. Any and all of these exceptions may provide effective loopholes in the hands of creative law dodgers to circumvent the intent of the law. The Gonzales-Roxas bill affixes the adverb “knowingly” before the word “monopolize” to punish only an entity which “knowingly monopolizes” any kind of service or article of trade, but enumerates four broad exceptions: monopolies authorized by law, monopoly attained or maintained through superior skill, and intellectual property monopoly by reason of contractual rights. The Belmonte bill provides only for the exception of a patent or copyright holder. The Espina bill brooks for no exceptions. The Espina and Gonzales-Roxas bills both provide for the establishment of a Fair Trade Commission. However, the Espina bill provides for a more powerful Commis- sion compared to the Gonzales-Roxas version. The Espina Commission can administratively adjudicate violations of the Act as well as conduct formal investigations independent of civil and criminal action. As soon as a formal charge is filed, it may issue a preliminary order requiring a person to restrain from a particular act. Like- wise, it may issue writs of execution, cease and desist orders, and condemnation and seizure of products. The Gonzales-Roxas bill only enables the Commission to investi- 380 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES gate violations and prosecute these violations before the proper court. It has no adjudicatory powers to issue writs, cease and desist orders or condemnation and seizure of products. In terms of penalties, the Belmonte bill provides the stiffest fines, with P10 million for corporations and P1 million for individuals. However, in terms of administrative and criminal penalties, the Espina bill provides for imprisonment of not less than five years to not more than 20 years, including possible closure and dissolution of the erring firm. The Belmonte bill provides only for imprisonment not exceeding five years. As for the Gonzales-Roxas bill, it only contains provisions for fines. The two Senate bills also take very different approaches to antitrust enforcement. The Enrile version is the same as the Belmonte House bill, since Enrile’s son, Rep. Jack Enrile is also a co-author of that bill. This version is more of a penal law. It strengthens the existing penal provisions prohibiting monopolies and combinations in restraint of trade. It does not create an independent commission, but leaves antitrust enforcement to the Courts and the Departments of Justice, Agriculture, and Trade and Industry. The Osmeña version, on the other hand, is more of an administrative measure. It creates a Fair Trade Commission and outlines the various anticompetitive practices which the Commission is supposed to regulate. It includes definitions of monopolies, trusts, and relevant markets, and provides for price regulation and threshold values for notification, as well as fines, based on minimum wage levels. These different draft bills have certain similarities to the proposed law in this study. There are also certain significant differences. Many of these are actually combinations of provisions copied from the laws in other countries. The problem is that there is really no single model that will ensure success in the Philippines. That is why it is better to keep the proposed law as simple as possible to allow room for evolution within the unique context of the Philippine economy. The law proposed under this study is actually drawn from certain basic principles and provisions discussed above. This includes provisions on defining the relevant market, monopolies and abuse of dominant market position, horizontal agreements, mergers, other unfair trade practices, and the administrative mechanism for enforcement. One unique feature of this proposed law is that, instead of creating a new antitrust/competition agency from scratch, the existing Tariff Commission be converted into a Philippine Trade Commission or Fair Trade Commission. First of all, this will address the problem of the current government policy that no new agencies or bodies can be created unless it also involves the abolition of existing ones. Second, to a certain extent, the problem of capability may be partially addressed since the research and investigation personnel of the Tariff Commission are already involved in studying market access issues, defining relevant markets and analyzing industry structure. Finally, it will bring under one roof trade policy formulation and international fair trade enforcement (trade measures) and competition analysis and enforcement and consumer welfare promotion, which are all closely related. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 381

SECOND OPTION: PIECEMEAL APPROACH Unfortunately, the political economy realities, as well as the administrative and other problems outlined above make the passage of a comprehensive antitrust/competition law in the near future rather difficult. Although it is the more ideal approach, the comprehensiveness of the proposed new law may make it difficult to understand and appreciate, attract all kinds of political interventions, give rise to various obstacles to its timely passage, and render its actual implementation unwieldy. First of all, the proposed law may be difficult to understand and appreciate because of its more technical provisions. It may also be hard to absorb in its entirety. This means that potential supporters in the government, business sector, and civil society may not be able to rise in its defense against those who would oppose it. Secondly, a proposed law of this nature would attract much public attention, and those sectors opposed to its passage might conspire together to ensure its nonpassage or delay, or they may intervene to insert exceptions or other onerous provisions. Thirdly, such public attention and political interventions would only lead to other obstacles to the timely passage of the new law, such as endless public debates and media hype. Finally, a comprehensive approach to antitrust/competition law enforcement, especially if it involves the creation of a new agency or institution may run into significant implementation problems. As discussed above, the lack of capacity on the part of our bureaucracy will most probably present the important challenge. Therefore, even if the comprehensive approach may be the ideal option, it may not be the most practical. This means that we need to explore other possibilities if only to ensure that this country still introduces some form of improved legal and regulatory framework for antitrust enforcement. One other possibility is to approach the problem in a more “piecemeal” manner. For example, rather than introduce a single comprehensive law, this could be divided into components and introduced as separate draft bills. The portion outlining the list of antitrust violations may be separated from the list of remedies and the portion creating a new antitrust body. The technical details or implementing these laws could then be contained in rules and regulations. Also, rather than introducing completely new legislation, the government could instead introduce only amendatory legislation and revise various existing laws relating to antitrust/competition. The main objective would still be to operationalize the constitutional provisions promoting competition. The following existing laws could be amended for more effective antitrust enforcement:

• Revise Penal Code: shifting the burden of proof from “beyond reasonable doubt” to a less strict “preponderance of evidence,” increasing the penalties for violations, and providing the administrative mechanism for effective enforcement; • Civil Code: providing greater ease for an aggrieved party to file a civil case and collect damages from parties guilty of anticompetitive practices; 382 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

• Consumer Act: providing the legal mechanism for consumers to file cases for anticompetitive practices; and • Tariff and Customs Code: amending the charter of the Tariff Commission to convert it into a Philippine Trade Commission or some other antitrust body.

These are merely examples of existing laws which could be amended as part of a piecemeal introduction of an effective, improved legal and regulatory framework for antitrust enforcement. There are many other laws and also executive issuances which will have to be reviewed and amended. Special mention should also be made of the role of foreign investments in competition enforcement. Opening economic sectors to increased investment flows have the effect of creating more dynamic operating environments for businesses, wherein technology transfers and innovation are encouraged. Investment liberalization may also have the effect of providing local economic sectors with access to new and larger regional and global markets. Therefore, this piecemeal approach should also include the passage of laws and issuance of regulations which encourage the entry of more foreign investments. There may be many different approaches to achieving our main objectives. What this study attempts to present are the features of an effective legal and regulatory framework for antitrust enforcement. It should also be emphasized that there is indeed a need for such a framework for the Philippines. Competition policy is an essential element for economic reform in this country. The lack of competition is precisely one of the most significant reasons for our persistent underdevelopment. Therefore, one of the most important roles of government in promoting more equitable development is enforcing and preserving competition. The inadequacy of mere market-opening measures has been highlighted. In the end, the government will have to intervene to enforce competition, and this requires effective laws and regulations. The passage of new legislation, whether comprehensive or merely amendatory, will be a necessary first step in working towards our goal of institutionalizing that much needed “competition culture” in Philippine society.

BIBLIOGRAPHY

BOOKS, TREATISES, AND REPORTS Abrenica, M.J.V. 1996. 1995: A Tale of Two Semesters. A Policy Paper. Philippine Exporters Confederation, Inc. American Jurisprudence 2d, Vol 19. Campos, J.C. Jr. 1981. The Corporation Code: Comments, Notes and Selected Cases. Central Lawbook Publishing Co., Inc. Centesimus Annus (Text). Chamberlin, E.H. 1942. The Theory of Monopolistic Competition. Cambridge, Massachusetts: Harvard University Press. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 383

Cini, M. and L. McGowan. 1998. Competition Policy in the European Union. New York: St. Martin’s Press, Inc. Competition Policy in a Social Market Economy 51p. Dejillas, L.J. 1993. Christian Democracy & Social Market Economy: An Alternative Program of Government. Logos Publications, Inc. Friedman, J.W. 1993. Oligopoly Theory. Cambridge, Massachusetts: Cambridge University Press. Institute for Research into International Competitiveness (IRIC). 1999. A Policy Framework for Competition Policy in the Philippines. Perth, Australia: Curtin University of Tech- nology. Nicholson, W. 1995. Microeconomic Theory: Basic Principles and Extensions. 6th ed. Fort Worth, Texas: The Dryden Press. Pacific Economic Cooperation Council (PECC). 1995. Milestones in APEC Liberalization: A Map of Market Opening Measures by APEC Economies. Study for the Asia Pacific Economic Cooperation Secretariat: Singapore. Patalinghug, E.E. 1996. Setting the National Agenda for Consumer Protection Through Com- petition Policy. Paper presented at a forum on Protecting the Filipino Consumer Through Competition Policy, 18 March 1996. Patalinghug, E.E. Competition Policy: Some Suggested Ideas. Paper presented at the APEC Governors’ Workshop, 28 February 1996. Porter, M.E. 1990. The Competitive Advantage of Nations. New York: The Free Press. Price Waterhouse Coopers. 1999. APEC Competition Law Study. Prepared for the Asia Pacific Economic Cooperation Senior Officials (July 1999). 129p. Samuelson, P.A. and W.D. Nordhaus. 1995. Economics. 15th ed. New York: McGraw-Hill, Inc. SGV Consulting, Philippines. 1992. Barriers To Entry Study, Final Report 1. Study prepared for the United States Agency for International Development, April 1992, Philippines. Swann, D. 1979. Competition and Consumer Protection. London, England. The Pocket Oxford Dictionary of Current English. 8th ed. 1992. Oxford, England: Clarendon Press. Varian, Hal R. 1993 Intermediate Microeconomics: A Modern Approach (3rd edition). New York: W.W. Norton and Company, 1993. Whish, Richard, 1993 Competition Law (3rd edition). London: Butterworth & Co (Publishers) Ltd. World Bank (WB) and OECD. 1998. A Framework for the Design and Implementation of Competition Law and Policy. World Bank and OECD : Washington, D.C.

ARTICLES Baumol, Panzar and Willing. 1982. Contestable Markets and the Theory of Industry Structure. Bailey, 1981. Contestability and the Design of Regulatory and Anti-Trust Policy. 71 Am Ec Rev 178-183. Campos, R.A.O. and A.L. Arlegui. 1993. Toward A Pro-Competition And Pro-Consumer Anti- trust Policy. Economic Policy Paper 9 Center for Research and Communication, Phil- ippines. Clark, 1940. Toward a Concept of Workable Competition 30:241-256. Dejillas, L.J. 1996. Competition Policy and the Market Economy: The Philippine Experience. in Economic Policy and the Market Economy – The Philippine Setting. Leopoldo J. Dejillas, ed., 1996. (Institute for Development Research and Studies [IDRS] Konrad Adenauer Foundation [KAF], Makati City, Philippines) 190p. 384 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Janow, M.E. 1995. Public and Private Restraints that Limit Access to Markets. Jara, M.S. 1996. PLDT Commits 2 Interim Solutions to “link” Problems. Business World. 22 July 1996:8 Khemani, R.S. 1996. The Role and Importance of Competition Law and Policy in the ASEAN Region. Paper presented at a conference organized by the World Bank, March 1996, Jakarta, Indonesia. Lazatin, V. 1994. Outline of Competition Law Enforcement in the Philippines. Meyerman, G.E. and Cuevas, M.A. 1998. Competition Policy in a Global Economy - An Inter- pretive Summary. The International Bank for Reconstruction and Development/The World Bank, Washington, D.C., U.S.A. Sosmeña, G. Streamlining the Bureaucracy. 1994. Konrad Adenauer Stiftung (Philippines) Occasional Papers 55. Vol. II No. 2. Stockmann, K. 1991. The Function of Competition in a Social Market Economy. In Social Market Economy: An Economic System for Developing Countries 27, edited by Winfried Jung. Logos Publications, Inc. Vergara, B.F., Victor. Anti-Trust Legislation in the House of Representatives. Villanueva, O.J. 1996. PLDT to Address Voice Channel Problem of ICC. The Manila Chronicle. 22 July 1996:11. Watson, P. 1996. Practical Implications of the Post-GATT Order: Considerations for the Future Multilateral Agenda. In The World Trade Congress. Singapore.

CONSTITUTION AND STATUTES Philippine Constitution. Act No. 3815 (1930), Revised Penal Code. Republic Act No. 7394 (1932), Consumer Act of the Philippines. Republic Act No. 337 (1948), An Act Regulating Banks and Banking Institutions and for Other Purposes (General Banking Act). Republic Act No. 386 (1949), An Act to Ordain and Institute the Civil Code of the Philippines. Republic Act No. 1180 (1954), An Act to Regulate the Retail Business. Republic Act No. 3247 (1961), An Act to Prohibit Monopolies and Combinations in Restraint of Trade. Presidential Decree No. 442 (1974), Labor Code of the Philippines. Batas Pambansa Bilang 68 (1980), Corporation Code of the Philippines. Batas Pambansa Bilang 178 (1982), Revised Securities Act. Republic Act No. 6938 (1990), An Act to Ordain a Cooperative Code of the Philippines. Republic Act No. 7042 (1991), An Act to Promote Foreign Investments, Prescribe the Proce- dures for Registering Enterprises Doing Business in the Philippines, and for Other Purposes (Foreign Investments Act of 1991). Republic Act No. 7160 (1991), Local Government Code of 1991. Republic Act No. 7181 (1991), An Act Extending the Life of the Committee on Privatization and the Asset Privatization Trust. Republic Act No. 7581 (1991), An Act Providing Protection to Consumers by Stabilizing the Prices of Basic Necessities and Prime Commodities and by Prescribing Measures Against Undue Price Increases During Emergency Situations and Like Occasions (Price Act). Republic Act No. 7227 (1992), An Act Accelerating the Conversion of Military Reservations into other Productive Uses, Creating the Bases Conversion and Development Authority for this Purpose, Providing Funds Therefor, and for Other Purposes (Bases Conversion Act). RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 385

Republic Act No. 7661 (1992), An Act Amending Republic Act No. 7181entitled “An Act Extending the Life of the Committee on Privatization and Asset Privatization Trust.” Republic Act No. 7648 (1993), An Act Prescribing Urgent Related Measures Necessary and Proper to Effectively Address the Electric Power Crisis and for Other Purposes. Republic Act No. 7650 (1993), An Act Repealing Section 1404 and Amending Sections 1401 and 1403 of the Tariff and Customs Code of the Philippines, as amended, Relative to the Physical Examination of Imported Articles. Republic Act No. 7653 (1993), The New Central Bank Act. Republic Act No. 7721 (1994), An Act Liberalizing the Entry and Scope of Operations of Foreign Banks in the Philippines and for Other Purposes. Republic Act No. 7844 (1994), An Act to Develop Exports as a Key Towards the Achievement of the National Goals Towards the Year 2000 (Exports Development Act of 1994). Republic Act No. 7886 (1994), An Act Extending the Term of the Committee on Privatization and the Asset Privatization Trust Amending for the Purpose of Republic Act Numbered Seven Thousand Six Hundred Sixty-One. Republic Act No. 7888 (1995), An Act to Amend Article 7 (13) of Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987. Republic Act No. 7916 (1995), An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose the Philippine Economic Zone Authority (PEZA) and for Other Purposes (the Special Economic Zone Act of 1995). Republic Act No. 7918 (1995), An Act Amending Article 39, Title III of Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987, as amended. Republic Act No. 7922 (1995), An Act Establishing a Special Economic Zone and Free Port in the Municipality of Sta. Ana and Other Neighboring Islands in the Municipality of Aparri, Province of Cagayan, Providing Funds therefor, and for Other Purposes. Republic Act No. 7925 (1995), An Act to Promote and Govern the Development of Philippine Telecommunications and the Delivery of Public Telecommunication Services (Public Telecommunications Policy Act of the Philippines). Republic Act No. 8178 (1996), An Act Replacing Quantitative Imports Restrictions on Agricul- tural Products Except Rice, with Tariffs, Creating the Agricultural Competitiveness Enhancement Fund, and for Other Purposes. Republic Act No. 8179 (1996), An Act to Further Liberalize Foreign Investments, Amending for the Purpose Republic Act No. 7042, and for Other Purposes. Republic Act No. 8180 (1996), An Act Deregulating the Downstream Oil Industry, and for Other Purposes. Republic Act No. 8293 (1997), The Intellectual Property Code of the Philippines.

CASES G.R. Nos. 14360 and 127867, Decision En Banc dated 03 December 1997 on the Motion for Reconsideration, citing the State of the Nation Address of President Fidel V. Ramos, 3rd Session of the Ninth Congress, July 25, 1994. G.R. No. L-45911, 89 SCRA 339 (1979). G.R. Nos. 124360 and 127867, Decision En Banc dated 05 November 1997. G.R. No. 118295, En Banc Decision dated 02 May 1997 (272 SCRA 18). G.R. Nos. 124360 and 127867, Decision En Banc dated 05 November 1997. Case T-7/89Re Polypropylene Cartel SA Hercules (1991) ECR II-1711 Case 48/69 ICI vs Commission (Dyestuffs case 1972) ECR 619 386 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Case T-7/89Re Polypropylene Cartel SA Hercules (1991) ECR II-1711 Case T-11/89 Shell v. Commission [1992] ECR II-757. Case 107/82 AEG-Telefunken v. Commission [1983] ECR 3151. Case 26/75 General Motors Continental NV v Commission [1976] ECR 1367. G.R. Nos. 14360 and 127867, Decision En Banc dated 03 December 1997 on the Motion for Reconsideration. Matsushita Electric Industrial Co. Ltd., et al. v. Zenith Radio Corporation, et al.”, 475 US 574 (1986).

APPENDICES

Appendix 1. Philippine Laws And Regulations Affecting Competition

CONSTITUTION AND STATUTES Philippine Constitution. Act No. 3815 (1930), Revised Penal Code. Republic Act No. 7394 (1932), Consumer Act of the Philippines. Commonwealth Act No. 146 (1936), An Act to Reorganize the Public Service Commission, Prescribe its Powers, Duties, Define and Regulate Public Services, Provide and Fix the Rates and Quota of Expenses to be Paid by the Same, and for Other Purposes. Commonwealth Act No. 541 (1940), An Act to Regulate the Awarding of Contracts for the Construction or Repair of Public Works. Republic Act No. 337 (1948), An Act Regulating Banks and Banking Institutions and for Other Purposes (General Banking Act). Republic Act No. 386 (1949), An Act to Ordain and Institute the Civil Code of the Philippines. Republic Act No. 529 (1950), An Act to Assure Uniform Value to Philippine Coin and Cur- rency. Republic Act No. 3018 (1960), An Act Limiting the Right to Engage in the Rice and Corn Industry to Citizens of the Philippines, and for Other Purposes. Republic Act No. 3247 (1961), An Act to Prohibit Monopolies and Combinations in Restraint of Trade. Republic Act No. 4566 (1965), An Act Creating the Philippine Licensing Board for Contrac- tors, Prescribing its Powers, Duties and Functions, Providing Funds therefor, and for Other Purposes (Contractors’ License Law). Republic Act No. 5487 (1969), An Act to Regulate the Organization and Operation of Private Detective, Watchmen or Security Guard Agencies. Republic Act No. 5980 (1969), An Act Regulating the Organization and Operation of Financ- ing Companies. Presidential Decree No. 194 (1973), Authorizing Aliens, as well as Associations, Corporations or Partnerships Owned in Whole or in Part by Foreigners to Engage in the Rice and Corn Industry, and for Other Purposes. Presidential Decree No. 442 (1974), Labor Code of the Philippines. Batas Pambansa Bilang 68 (1980), Corporation Code of the Philippines. Batas Pambansa Bilang 178 (1982), Revised Securities Act. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 387

Presidential Decree No. 1853 (1982), Requiring Deposits of Duties at the Time of Opening of Letters of Credit Covering Imports and for Other Purposes. Republic Act No. 6938 (1990), An Act to Ordain a Cooperative Code of the Philippines. Republic Act No. 7042 (1991), An Act to Promote Foreign Investments, Prescribe the Proce- dures for Registering Enterprises Doing Business in the Philippines, and for Other Purposes (Foreign Investments Act of 1991). Republic Act No. 7076 (1991), An Act Creating a People’s Small-scale Mining Program and for Other Purposes (People’s Small-scale Mining Act of 1991). Republic Act No. 7160 (1991), Local Government Code of 1991. Republic Act No. 7181 (1991), An Act Extending the Life of the Committee on Privatization and the Asset Privatization Trust. Republic Act No. 7581 (1991), An Act Providing Protection to Consumers by Stabilizing the Prices of Basic Necessities and Prime Commodities and by Prescribing Measures Against Undue Price Increases During Emergency Situations and Like Occasions (Price Act). Republic Act No. 7227 (1992), An Act Accelerating the Conversion of Military Reservations into other Productive Uses, Creating the Bases Conversion and Development Authority for this Purpose, Providing Funds Therefor, and for Other Purposes (Bases Conversion Act). Republic Act No. 7642 (1992), An Act Increasing the Penalties for Tax Evasion, Amending for this Purpose the Pertinent Sections of the National Internal Revenue Code, as Amended. Republic Act No. 7661 (1992), An Act Amending Republic Act No. 7181entitled “An Act Extending the Life of the Committee on Privatization and Asset Privatization Trust.” Republic Act No. 7648 (1993), An Act Prescribing Urgent Related Measures Necessary and Proper to Effectively Address the Electric Power Crisis and for Other Purposes. Republic Act No. 7650 (1993), An Act Repealing Section 1404 and Amending Sections 1401 and 1403 of the Tariff and Customs Code of the Philippines, as amended, Relative to the Physical Examination of Imported Articles. Republic Act No. 7652 (1993), An Act allowing the long-term Lease of Private Lands by For- eign Investors (Investors’ Lease Act). Republic Act No. 7653 (1993), The New Central Bank Act. Republic Act No. 7660 (1993), An Act Rationalizing Further the Structure and Administration of the Documentary Stamp Tax, Amending for the Purpose Certain Provisions of the National Internal Revenue Code, as Amended, Allocating Funds for Specific Programs and for Other Purposes. Republic Act No. 7691 (1994), An Act expanding the jurisdiction of the Metropolitan Trial Courts, Municipal Trial Courts, and Municipal Circuit Trial Courts, Amending for this Purpose Batas Pambansa Blg. 129, Otherwise Known as the “Judiciary Reorganization Act of 1980.” Republic Act No. 7700 (1994), An Act Providing for Concurrent Jurisdiction Between and Among the First, Second and Third Divisions of the National Labor Relations Commis- sion to Further Ensure Speedy Disposition of Cases, Amending for this Purpose Article 213 of Presidential Decree No. 442, as Amended, and for Other Purposes. Republic Act No. 7717 (1994), An Act Imposing a Tax on the Sale, Barter or Exchange of Shares of Stock Listed and Traded Through the Local Stock Exchange or Through Ini- tial Public Offering, Amending for the Purpose of the National Internal Revenue Code, as Amended, by Inserting a New Section and Repealing Certain Sub-sections Thereof. 388 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Republic Act No. 7716 (1994), An Act Restructuring the Value-Added Tax (VAT) System, Widening its Tax Base and Enhancing its Administration, and for these Purposes Amending and Repealing the Relevant Provisions of the National Internal Revenue Code, as Amended, and for Other Purposes. Republic Act No. 7718 (1994), An Act Amending Certain Sections of Republic Act No. 6957, entitled “An Act Authorizing the Financing, Construction, Operation and Maintenance of Infrastructure Projects by Private Sector, and for Other Purposes. Republic Act No. 7721 (1994), An Act Liberalizing the Entry and Scope of Operations of Foreign Banks in the Philippines and for Other Purposes. Republic Act No. 7844 (1994), An Act to Develop Exports as a Key Towards the Achievement of the National Goals Towards the Year 2000 (Exports Development Act of 1994). Republic Act No. 7886 (1994), An Act Extending the Term of the Committee on Privatization and the Asset Privatization Trust Amending for the Purpose of Republic Act Numbered Seven Thousand Six Hundred Sixty-One. Republic Act No. 7888 (1995), An Act to Amend Article 7 (13) of Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987. Republic Act No. 7903 (1995), An Act Creating a Special Economic Zone and Free Port in the City of Zamboanga Creating for this Purpose the Zamboanga City Special Economic Zone Authority, Appropriating Funds therefor and for Other Purposes (Zamboanga City Special Economic Zone Act of 1995). Republic Act No. 7909 (1995), An Act Granting a Franchise to Pacific Airways Corporation to Establish and Maintain Rural Air Transport System and Allied Services in the Philippines. Republic Act No. 7916 (1995), An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose the Philippine Economic Zone Authority (PEZA) and for Other Purposes (the Special Economic Zone Act of 1995). Republic Act No. 7918 (1995), An Act Amending Article 39, Title III of Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987, as amended. Republic Act No. 7922 (1995), An Act Establishing a Special Economic Zone and Free Port in the Municipality of Sta. Ana and Other Neighboring Islands in the Municipality of Aparri, Province of Cagayan, Providing Funds therefor, and for Other Purposes. Republic Act No. 7925 (1995), An Act to Promote and Govern the Development of Philippine Telecommunications and the Delivery of Public Telecommunication Services (Public Telecommunications Policy Act of the Philippines). Republic Act 7942 (1995), An Act Instituting a New System of Mineral resources Exploration, Development, Utilization and Conservation (Philippine Mining Act of 1995). Republic Act No. 7902 (1995), An Act Expanding the Jurisdiction of the Court of Appeals, Amending for the Purpose of Section Nine of Batas Pambansa Blg. 129, as amended, known as the Judiciary Reorganization Act of 1980. Republic Act No. 7906 (1995), An Act Providing for the Regulation of the Organization and Operations of Thrift Banks, and for Other Purposes (Thrift Banks Act of 1995). Republic Act No. 7975 (1995), An Act to Strengthen the Functional and Structural Organiza- tion of the Sandiganbayan, amending for that purpose Presidential Decree No. 1606, as amended. Republic Act No. 8041 (1995), An Act to Address the National Water Crisis (Water Crisis Act). Republic Act No. 8047 (1995), An Act Providing for the Development of the Book Publishing Industry through the Formulation and Implementation of a National Book Policy and National Book Development Plan (Book Publishing Industry Development Act). RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 389

Republic Act No. 8103 (1995), An Act Granting a Franchise to All Asia Airlines Co., Inc. to Establish and Maintain Air Transportation Services Throughout the Philippines and/or Between the Philippines and Other Countries. Republic Act No. 8178 (1996), An Act Replacing Quantitative Imports Restrictions on Agricul- tural Products Except Rice, with Tariffs, Creating the Agricultural Competitiveness Enhancement Fund, and for Other Purposes. Republic Act No. 8179 (1996), An Act to Further Liberalize Foreign Investments, Amending for the Purpose Republic Act No. 7042, and for Other Purposes. Republic Act No. 8180 (1996), An Act Deregulating the Downstream Oil Industry, and for Other Purposes. Republic Act No. 8181 (1996), An Act Changing the Basis of Dutiable Value of Imported Articles Subject to an Ad Valorem Rate of Duty from Home Consumption Value (HCV) to Transaction Value (TV), Amending for the Purpose Section 201 Title 2, Part I of Presidential Decree No. 1464, otherwise known as the Tariff and Customs Code of the Philippines, as amended, and for Other Purposes. Republic Act No. 8293 (1997), The Intellectual Property Code of the Philippines. Republic Act No. 8424 (1997), The Tax Reform Act of 1997. Republic Act No. 8751 (1999), An Act Providing the Rules for the Imposition of an Countervailing Duty, Amending for the Purpose Section 302, Part 2, Title II, Book 1 of the Tariff and Customs Code of the Philippines, as amended, and for Other Purposes, (Countervailing Duty Act of 1999). Republic Act No. 8752 (1999), An Act Providing the Rules for the Imposition of an Anti- dumping Duty, Amending for the Purpose Section 301, Part 2, Title II, Book 1 of the Tariff and Customs Code of the Philippines, as amended by Republic Act No. 7843 and for Other Purposes, (Anti-Dumping Act of 1999). Republic Act No. 8762 (2000), An Act Liberalizing the Retail Trade, Repealing for the Purpose Republic Act No. 1180, as amended, and for Other Purposes, (Retail Trade Liberaliza- tion Act of 2000).

EXECUTIVE ORDERS Central Bank Circular No. 1389 (1983), Consolidated Foreign Exchange Rates and Regulations. Proclamation No. 50, Series of 1986, Proclaiming and Launching a Program for the Expeditious Disposition and Privatization of Certain Government Corporations and/or the Assets thereof, and Creating the Committee on Privatization and the Asset Privatization Trust. Proclamation No. 50-A, Series of 1986, Modifying Proclamation No. 50. Executive Order No. 215, Series of 1987, Amending Presidential Decree No. 40 and Allowing the Private Sector to Generate Electricity. Executive Order No. 226, Series of 1987, Omnibus Investment Code. Executive Order No. 309, Series of 1987, Reorganizing the Peace and Order Council. Department of Finance Order No. 100-94, Series of 1994, Guidelines on Entry of Foreign Insurance or Reinsurance Companies or Intermediaries. Executive Order No. 1, Series of 1992, Reducing the Rates of Import Duty on Electric Gener- ating Sets under Presidential Decree No. 1464, otherwise known as the Tariff and Cus- toms Code of 1978, as amended. Executive Order No. 2, Series of 1992, Extending the Effectivity of the Zero Rate of Import Duty on Cement and Cement Clinker under Section 104 of Presidential Decree No. 1464, Otherwise Known as the Tariff and Customs Code of 1978, as provided under Executive Order No. 387. 390 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Executive Order No. 3, Series of 1992, Creating a Presidential Anti-Crime Commission to identify and cause the investigation and prosecution of criminal elements in the country. Executive Order No. 8, Series of 1992, Restructuring the Rates of Import Duties and Amending the Classification of Certain Articles under Section 104 of the Tariff and Customs Code of 1978, as amended. Executive Order No. 59, Series of 1993, Prescribing the Policy Guidelines for Compulsory Interconnection of Authorized Public Telecommunications Carriers in order to Create a Universally Accessible and Fully Integrated Nationwide Telecommunications Network and thereby Encourage Greater Private Sector Investment in Telecommunications. Executive Order No. 79, Series of 1993, Modifying The Rates of Duty on Certain Imported Articles as provided under the Tariff and Customs Code of 1978, as amended, in order to implement the Minimum 50% Margin of Preference on Certain Products Included in the Brand-To-Brand Completion scheme in the Automotive Industry under the Basic Agreement on ASEAN Industrial Complementation. Executive Order No. 94, Series of 1993, Reducing the Import Duty on Cement Clinker under Section 104 of Presidential Decree No. 1464, otherwise known as the Tariff and Cus- toms Code of 1978. Executive Order No. 98, Series of 1993, Reorganizing the Export and Investment Development Council into the Export Development Council. Executive Order No. 106, Series of 1993, Lifting the Suspension of the Application of the Tariff Concessions Granted by the Philippines on Refractory Bricks under the ASEAN Preferential Trading Arrangements. Executive Order No. 109, Series of 1993, Policy to Improve the Provision of Local Exchange Carrier Service. Executive Order No. 110, Series of 1993, Strengthening the Export Development Council (EDC) amending for this purpose Executive Order No. 98 to Increase the Government and Private Sectors Members of the Council. Executive Order No. 115, Series of 1993, Increasing the Special Duties on Crude Oil and Oil Products under Section 104 of the Tariff and Customs Code of the Philippines, as amended. Executive Order No. 116, Series of 1993, Amending Section 1 of Executive Order No. 94, dated 01 June 1993. Executive Order No. 145, Series of 1993, Modifying The Rates of Duty on Certain Imported Articles as provided for under the Tariff and Customs Code of 1978, as amended, in order to Implement the 1994 Philippine Schedule of Tariff Reductions on Articles In- cluded in the Accelerated and Normal Programs of the Common Effective Preferential Tariff (CEPT) Scheme for the ASEAN Free Trade Area (AFTA). Executive Order No. 146, Series of 1993, amending Executive Order No. 43 of 1992, by modifying the margins of the preference and the applicable ASEAN preferential tariffs on certain items included in the coverage thereof. Executive Order No. 147, Series of 1993, Modifying The Rates of Duty on Certain Imported Articles as provided under the Tariff and Customs Code of 1978, as amended, in order to Implement the 10% Margin of Preference (MOP) Granted by the Philippines under the Agreement on the Global System of Trade Preferences among Developing Coun- tries as set forth in the Philippine Schedule of Concessions Annexed to the Agreement. Executive Order No. 148, Series of 1993, Modifying the Rates of Import Duty on Certain Imported Articles as provided under Presidential Decree No. 1464, as amended, otherwise known as the Tariff and Customs Code of the Philippines of 1978. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 391

Executive Order No. 153, Series of 1994, Modifying the Rates of Duty on Certain Imported Articles as provided for under the Tariff and Customs Code of 1978, as amended, in order to Implement the Ninety Per Centum Margin of Preference on Certain Products Included in the Nestle ASEAN Industrial Joint Venture (AIJV) Projects, as provided for in Article III, Paragraph 1 of the Revised Basic Agreement of AIJV. Executive Order No. 160, Series of 1994, Reducing the Special Duties on Crude Oil and Oil Products Prescribed in Executive Order No. 115, Series of 1993. Executive Order No. 172, Series of 1994, Increasing the Minimum Tariff Rate From Zero to Three Percent on Articles under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 173, Series of 1994, Amending Executive Order No. 153, Series of 1994 entitled Modifying the rates of duty on certain imported articles as provided under the tariff and customs code of 1978, as amended, in order to implement the minimum ninety per centum (90%) margin of preference on certain products included in the Nestle Asean Industrial Joint Venture (AIJV) Projects, as provided for in Article III, paragraph 1 of the Revised Basic Agreement on AIJV. Executive Order No. 180, Series of 1994, Strengthening the Export Development Council (EDC) amending for this purpose Executive Order (E.O.) No. 110, Further Amending E.O. No. 98. Executive Order No. 151, Series of 1994, Creating a Presidential Commission to Investigate Administrative Complaints Involving Graft and Corruption. Executive Order No. 185, Series of 1994, Opening the Domestic Water Transport Industry to New Operators and Investors. Executive Order No. 189, Series of 1994, Modifying the nomenclature and Rates of Import Duty on Certain Imported Articles under Section 104 of the Tariff and Customs Code of 1978, as amended. Executive Order No. 204, Series of 1994, Modifying the nomenclature and rates of import duty on certain articles under Section 104 of the Tariff and Customs Code of 1978. Executive Order No. 212, Series of 1994, Accelerating the Demonopolization and Privatization Program for Government Ports in the Country. Executive Order No. 213, Series of 1994, Deregulating Domestic Rate. Executive Order No. 219, Series of 1995, Establishing the Domestic and International Civil Aviation Liberalization Policy. Executive Order No. 227, Series of 1995, Reducing the Rates of Import Duty on Cement and Cement Clinker under Section of Presidential Decree 1464, otherwise known as the Tariff and Customs Code of 1978, as amended. Executive Order No. 237, Series of 1995, Modifying the Rates of Import Duty on Certain Imported Articles as amended, in order to Implement the Decision Taken by the 35th meeting of the Committee on Industry Minerals and Energy (COIM) to Constant Veloc- ity Joint Driveshafts Assembly and Parts Thereof Under the Agreement on Asean In- dustrial Joint Venture (AIJV). Executive Order No. 264, Series of 1995, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 287, Series of 1995, Modifying the Rates of Duty on Certain Imported Articles as Provided for Under the Tariff and Customs code of 1978, as amended, in order to implement the 1996 Philippine Schedule of Tariff Reduction Under the New Time Frame of the Accelerated Common Effective Preferential Tariff (CEPT) Scheme for the ASEAN Free Trade Area (AFTA). 392 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Executive Order No. 288, Series of 1995, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 298, Series of 1996, Providing for Alternative and/or Intermediate Modes of Privatization Pursuant to Proclamation No. 59 (s. 1986). Executive Order No. 311, Series of 1996, Encouraging Private Sector Participation in the Op- erations and Facilities of the Metropolitan Waterworks and Sewerage System. Executive Order No. 313, Series of 1996, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 328, Series of 1996, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 465, Series of 1998, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 486, Series of 1998, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 63, Series of 1999, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended. Executive Order No. 208, Series of 2000, Modifying the Nomenclature and the Rates of Import Duty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of 1978 (Presidential Decree No. 1464), as amended.

Appendix 2. Draft Bills in Congress

House Bill No. 1373. An Act Penalizing Unfair Trade Practices and Combinations in Restraint of Trade, Creating the Fair Trade Commission, Appropriating Funds Therefore and for Other Purposes. House Bill No. 3780. An Act Prohibiting Monopolies, Attempt to Monopolize an Industry or Line of Commerce, Manipulation or Prices Commodities, Asset Acquisition and Inter- locking Membership in the Board of Directors of Competing Corporate Bodies and Price Discrimination Among Customers, Providing Penalties Therefore and for Other Purposes. House Bill No. 271. An Act Providing for Antitrust Penalties House Bill No. 4455. An Act Prescribing A Fair Competition Law, Its Enforcement, the Estab- lishment of a Fair Trade Commission, Delineating its Powers and Functions, and for Other Purposes. Senate Bill No. 150. An Act Creating the Fair Trade Commission, Prescribing its Powers and Functions in Regulating Trade Competition and Monopolies and for Other Purposes. Senate Bill No. 1792. An Act Prohibiting Monopolies, Attempt to Monopolize an Industry or Line of Commerce, Manipulation of Prices or Commodities, Asset Acquisition and In- terlocking Membership in the Board of Directors of Competing Corporate Bodies and Price Discrimination Among Customers, Providing Penalties Therefore, and for Other Purposes. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 393

ARTICLE I - TITLE AND POLICY Section 1. Title – This Act shall be known as the “Philippine Fair Trade Act.” Section 2. Declaration of Policy – It is the policy of the State to maintain and enhance free and full competition in trade, industry and all commercial economic activity; penalize all forms of unfair trade, anti-competitive conduct and combinations in restraint of trade, in order to ultimately enhance consumer welfare.

Appendix 3. Draft Bill for Discussion Purposes

Republic of the Philippines SENATE/HOUSE OF REPRESENTATIVES Manila/ Quezon City

11th Congress

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– Introduced by ______

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AN ACT CREATING THE PHILIPPINE TRADE COMMISSION, REGULATING AND PENALIZING THE ABUSE OF DOMINANT POSITION, RESTRICTIVE AGREEMENTS, UNLAWFUL MERGERS, ACQUISITIONS AND COMBINATIONS IN RESTRAINT OF TRADE, UNFAIR COMPETITION AND OTHER ANTI-COMPETITIVE PRACTICES AND CONDUCT, AND APPROPRIATING FUNDS THEREFOR, AND FOR OTHER PURPOSES

Be it enacted by the Senate and the House of Representatives in Congress assembled: 394 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

ARTICLE 2 - SCOPE OF THE LAW AND DEFINITION OF TERMS Section 1. Applicability - This Act shall be enforceable in the whole territory of the Republic of the Philippines and applies to all areas of trade, industry and commercial economic activity. The Act shall be applicable to all matters specified in Articles 3, 4, 5 and 6, having substantial effects in the Republic of the Philippines, including those that result from acts done outside the Republic of the Philippines. Section 2. Limitations - This Act does not derogate from the direct enjoyment of the privileges and protections conferred by Republic Act No. 8293 (1997), otherwise known as the Intellectual Property Code, and other laws protecting intellectual property, including inventions, industrial models, trademarks and copyrights. It does, however, apply to the use of such property in such a manner as to cause the anti-competitive effects prohibited herein. This Law shall apply neither to the combinations or activities of workers or employees, nor to agreements or arrangements between two or more employers, when such combinations, activities, agreements or arrangements are designed solely to facilitate collective bargaining in respect of conditions of employment. Section 3. Definition of terms – Whenever used in this Act, the following terms shall be taken to mean as follows: (a) “Competition” - the process by which economic agents, acting independently in a market, limit each other’s ability to control the conditions prevailing in that market. (b) “Commission” – the Philippine Trade Commission created in Article 7 of this Act. (c) “Firm” - any natural or legal person, governmental body, partnership or association in any form, engaged directly or indirectly in economic activity. Two firms, one of which is controlled by the other, shall be treated as one firm. Two or more firms that are controlled by a single firm shall be treated as one firm. The Commis- sion shall, from time to time, adopt a regular setting of what constitutes control. (d) “Goods” - all property, tangible and intangible, and services. (e) “Market” - a collection of goods that are capable of being substituted for each other and that buyers are or would be willing to substitute, and a specific territory, which may extend beyond the borders of the Republic of the Philippines, in which are located sellers among whom buyers are or would be willing to substitute from whom they would buy.

ARTICLE 3 - ABUSE OF DOMINANT POSITION Section 1. Dominant Position — A firm shall be deemed to have a dominant position if, acting on its own, it can profitably and materially restrain or reduce competition in a market for a significant period of time. Section 2. Safe Harbor – A firm shall not be deemed to have a dominant position unless its share of the relevant market exceeds the percentage set by the Commission in its guidelines. A firm having a market share exceeding a percentage set by the Commission, may or may not be found to be dominant, depending on the economic situation in that marBIBLIOGRAPHY Section 3. Balancing Efficiencies - An agreement prohibited under Section 2 of this Article may nevertheless be permissible and allowed by the Commission if said agreement has brought about, or is likely to bring about, gains in real, as opposed to merely pecuniary, efficiencies that - (a) are greater than or more than offset the effects of any limitation on competition that result or are likely to result from the agreement; or RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 395

(b) consumer well being is expected to be enhanced as a result of the agreement. Section 4. Burden of proof - The burden of proof to show that the agreement is not prohibited lies with the parties seeking the exemption pursuant to Section 3. Such parties are required to, among others, demonstrate that if the agreement were not implemented, it is not likely that the relevant real efficiency gains would be realized by means that would limit competition to a lesser degree than the agreement.

ARTICLE 5 - MERGERS AND ACQUISITIONS Section 1. Review of Concentrations - A concentration shall be deemed to arise when: (a) two or more previously independent firms merge, amalgamate or combine the whole or a part of their business; or (b) one or more natural or legal persons already controlling at least one firm, acquire, whether by purchase of securities or assets, by contract or by other means, direct or indirect control of the whole or parts of one or more other firms. Section 2. Control - For the purpose of this Article, control is defined as the ability to materially influence a firm, in particular through: (a) ownership or the right to use all or part of the assets of an undertaking; or (b) rights or contracts which confer decisive influence on the composition, voting or decisions of the organs of a firm. Section 3. Compulsory Notification - Parties to an agreement that will produce a concentration larger than the minimum size as may be provided in regulations issued pursuant to Section 7 of this Article, are prohibited from consummating such concentration until thirty (30) days after providing notification to the Commission, in the form and containing the information specified in regulations issued pursuant to section 7. An agreement consummated in violation of this requirement shall be considered void and subject the parties to the corresponding penalties therefor. Section 4. Further Information – The Commission may, in writing, request the parties to the agreement, for further information, before the expiration of the thirty (30) day period referred to in section 3 of this Article. The issuance of such a request has the effect of extending the period within which the concentration may not be consummated for an additional thirty (30) days, beginning on the day after substantially all of the requested information is supplied to the Commission. Section 5. Voluntary Notification -- Parties to an agreement who are not subject to the notification requirement in Section 3 of this Article may voluntarily notify and, if they do so, be subject to the same procedures, restrictions and rights as are applied to cases of compulsory notification. Section 6. Effect of Notification - If, before consummation of a concentration, the Commission determines that such concentration is prohibited under Section 8, and does not qualify for exemption under Section 9, of this Article, the Commission may: (a) prohibit consummation of the concentration; (b) prohibit consummation of the concentration unless and until it is modified by changes specified by the Commission; or (c) prohibit consummation of the concentration unless and until the pertinent party or parties enter into legally enforceable agreements specified by the Commission. Section 7. Regulations of the Commission - The Commission shall from time to time adopt and publish regulations stipulating: (a) the minimum size or size of concentrations subject to the notification requirement of Section 3 of this Article; 396 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

(b) the information that must be supplied for notified concentrations; (c) exceptions or exemptions from the notification requirements of Section 3 for specified types of concentrations; and (d) other rules relating to the notification procedures in Sections 3, 4 and 5 of this Article. Section 8. Prohibited Concentrations - Concentrations that will significantly limit competition as may be determined by the Commission are prohibited. Section 9. Permissible Concentrations. Concentrations prohibited under Section 8 of this Ar- ticle shall, nonetheless, be free from prohibition by the Commission where the parties establish that either: (a) the concentration has brought about or is likely to bring about gains in real, as opposed to merely pecuniary, efficiencies that are greater than or more than offset the effects of any limitation on competition that result or are likely to result from the concentration; or (b) a party to the concentration is faced with actual or imminent financial failure, and the concentration represents the least anti-competitive arrangement among the known alternative uses for the failing firm’s assets. Section 10. Burden of Proof - The burden of proof under Section 9 lies with the parties seeking the exemption. A party seeking to rely on the exemption specified in Section 9 (a) must demonstrate that if the concentration were not consummated it is not likely that the relevant real efficiency gains would be realized by means that would limit competition to a lesser degree than the concentration. A party seeking to rely on the exceptions specified in Section 9 (b) must: (a) demonstrate that reasonable steps have been taken within the recent past to identify alternative purchasers for the failing firm’s assets; and (b) fully describe the results of that search. Section 11. Prescription - The Commission may determine, within three (3) years after consummation, that either: (a) a non-notified concentration; or (b) a notified concentration in which the provisions of Sections 3 to 5 of this Article are not fully complied with, has led or will probably lead to a significant limitation of competition and does not qualify for exemption set out in Section 9 of this Article. If it so determines, the Com- mission may: (a) undo the concentration by dissolving it into its constitutes elements; (b) require other modifications of the concentration, including sale of a portion of its operations or assets; or (c) require the surviving firm or firms to enter into legally enforceable agreements specified by the Commission and designed to reduce or eliminate the competition limiting effects of the concentration.

ARTICLE 6 - UNFAIR COMPETITION Section 1. Unfair Competition - Unfair competition is prohibited, including: (a) the distribution of false or misleading information which is capable of harming the business interests of another firm; (b) the distribution of false or misleading information to consumers, including the distribution of information lacking a reasonable basis, related to the price, character, method or place of production, properties, suitability for use, or quality of goods; RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 397

(c) false or misleading comparison of goods in the process of advertising; (d) fraudulent use of another’s trademark, firm name, or product labeling or packaging; or (e) unauthorized receipt, use, or dissemination of confidential scientific, technical, production, business or trade information.

ARTICLE 7 - THE COMMISSION Section 1. Philippine Trade Commission - There is hereby created (The existing Tariff Commission of the Philippines is hereby reconstituted into ) an independent col- legial body to be known as the Philippine Trade Commission. The Commission shall be composed of a Chairman and four (4) Associate Commissioners, all of whom shall be appointed by the President for a term of seven (7) years without reappointment. The Chairman and two (2) of the Associate Commissioners first appointed shall serve for a period of seven (7) years, while the other two (2) Asso- ciate Commissioners shall serve for five (5) years as shall be indicated in their respective appointments. Appointment to any vacancy shall only be for the unexpired term of the predecessor. In no case shall a member of the Commission be designated or appointed in a temporary or acting capacity. The Chairman of the Commission can only be removed for patent disability to discharge his/her functions. Section 2. Qualifications - The Chairman and the Associate Commissioners shall be citizens of the Philippines, at least forty (40) years of age, of recognized probity, integrity, and competence in the field of law, economics, finance banking, commerce, industry and/or consumer welfare, and must not have been a candidate for an elective national or local office in the immediately preceding election, whether regular or special. Section 3. Rank and Salary - The members of the Commission shall have the same rank, privileges, and salaries as the Chairman and members of a Constitutional Commission. Their salaries shall be set, and from time to time be adjusted by the President. In no case shall their salaries be decreased during their term of office. Section 4. Prohibitions and Disqualifications - The members of the Commission shall not, during their tenure, hold any other office or employment. They shall not during their tenure, directly or indirectly, practice any profession, participate in any business or financially interested in any contract or any franchise, or special privilege granted by the government of any subdivision, agency or instrumentality thereof, including government-owned and controlled corporations or their subsidiaries: Provided, however, that they may, with the prior permission of the President, teach part time in any institution of learning. They shall, at all times, strictly avoid conflict of interest situations in the conduct of their office. They shall not be qualified to run for any office in any public election, regular or special, immediately preceding their cessation from office. They shall not be allowed to appear or practice before the Commission for a period of one (1) year following their cessation from office. Section 5. Meetings, Notice, and Quorum - The Commission shall meet as often as may be necessary on such days as the Chairman, or in his/her absence, as a majority of the Commissioners may fix. The notice of meeting shall be given to all members at least one (1) day before the scheduled date of the meeting. The presence of at least three (3) Commissioners shall constitute a quorum. In the absence of the Chairman, one of the Associate Commissioner chosen by those present shall act as the presiding officer of the meeting. 398 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Section 6. Secretariat - The Commission shall have a Secretariat with a staff complement as may be determined by the Chairman in consultation with the Department of Budget and Management. The Secretariat shall be headed by an Executive Director who shall be appointed by the President. He/she shall act as the secretary of the Commission and shall be responsible for the effective implementation of the policies, rules and standards set by the Commission and oversee and coordinate the day-to-day activities of the different operating units of the Commission.

Article 8 - Powers and Functions of the Commission Section 1. Powers and Functions - To carry out the objectives of this Act, the Commission shall have and exercise the following powers and functions: (a) To enforce and effectively administer the provisions of this Act and other fair trade laws, subject to the powers vested in the courts and other administrative agencies under this Act; (b) undertake and prepare industry studies to determine industry structures, and the state of competition and competitiveness of Philippine industries, and collate, compile, distribute and disseminate resource materials on competition policy, with the end in view of creating a national database on competition; (c) conduct workshops and seminars, information campaigns for the public, and train or develop a pool of experts on competition; (d) extend technical assistance to the Philippine delegations to international bodies and meetings in regard to trade and competition law and policy; (e) draft and recommend proposed administrative and legislative measures for respective consideration and adoption/enactment by the Executive or Legislative Branch of government; (f) make submissions to the government authorities engaged in designing or administering legislation or regulations which could affect competition in any market in the Philippines, intervene in hearings and proceedings held with regard to the adoption or administration of such laws or regulations, and publish the submissions and interventions above referred to, provided that confidential information is not divulged; (g) administratively adjudicate violations of this Act and rules and regulations issued pursuant thereto, by conducting a formal investigation, independent of the corresponding criminal and civil action for said violation(s). The imposition of administrative penalties in the formal investigation is without prejudice to the imposition of penalties in the criminal action and/or judgment in the civil action and vice versa. As soon as a formal charge is filed with the Commission and even prior to the commencement of the formal investigation, the Commission may motu propio or upon verified application of any person, issue preliminary orders prohibiting firms from carrying on the anticompetitive or unfair practices referred to in this Act and, if necessary, requiring such firms to take other specified actions to eliminate the harmful effects of such practices and to ensure against recurrence of such practices. Before issuing any orders, the Commission shall be satisfied that the proposed measures are urgently required to avoid serious, imminent and irreparable harm to the economic interests of the Philippines, as expressed in this Act. Where the effectiveness of the order would not thereby be prejudiced, the Commission RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 399

may permit the firms that would be subject to the order to present their views regarding the proposed order. The Commission shall provide by rules and regulations the other procedures and restrictions for the issuance of such preliminary orders. All orders may, under this Section, lose effect twenty one (21) days after they are issued, unless renewed by express decision of the Commission. Upon its decision becoming final and executory, the Commission on its own initiative or upon motion of the winning party shall issue a writ of execution. The Commission shall deputize the Philippine National Police, National Bureau of Investigation or Armed Forces of the Philippines in the enforcement of any of its decisions and orders. Orders and decisions issued under this Section may be appealed to the pertinent appeal court, but do not lose their effect pending the outcome of the appeal; (h) conduct its own administrative investigations for the purpose of: (1) obtaining information relative to any activity that constitutes any past or present violation of this Act and other fair trade laws; and (2) gathering and compiling trade information relative to: (i) the nature, organization and resources of any person, firm, entity or association doing business in and/or with the Philippines or a Philip- pine firm; (ii) determining and evaluating the practices, acts methods, schemes, arrangements and other trade conditions prevailing in an industry. (i) the officials authorized to conduct the preliminary or administrative investigations, including formal investigations for purposes of administrative adjudication referred to in the Section 1 (g) of this Article, shall have the power to administer oaths, issue subpoena duces tecum to compel the attendance of witnesses and the production of necessary papers and documents, and to punish direct and indirect contempt as granted to superior courts under the Rules of Court; (j) initiate or institute the appropriate civil action or proceeding before the proper court or administrative agency in the implementation of the provisions of this Act and other fair trade laws or restrain any threatened violations thereof; (k) institute the appropriate information and prosecute criminal cases for any and all violations of this Act and other fair trade laws after conducting a preliminary investigation motu propio or upon complaint of any person, when there is sufficient ground to engender a well founded belief that the violation(s) complained of is/are being or has/have been committed, and in addition, and subject to the rules on prosecution of civil action under the Rules of Court, institute the appropriate action for the recovery of civil liability; (l) To recommend the amendment of existing franchises when, based on its own evaluation, the same has adversely affected the growth of the relevant market or industry; (m) To periodically conduct an inspection of any pertinent: (1) factory, shop, laboratory, establishment, store, warehouse, any means of transportation, and the like; (2) papers, documents, and records found in such factory, shop, laboratory, establishment, store, warehouse, means of transportation, and the like; (3) equipment, finished or unfinished products, raw materials, containers, labeling and other pertinent properties found in such factory, shop, laboratory, establishment, store, warehouse, means of transportation, and the like; 400 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

(4) activity being undertaken in such factory, shop, laboratory, establishment, store, warehouse, means of transportation and the like, which may be necessary to determine violations or which may aid in the enforcement of this Act, other fair trade laws, or rules and regulations issued pursuant thereto. The officials authorized to conduct said inspection may obtain a reasonable quantity of samples of the properties (except equipment) mentioned in Section 1 (m) (3) of this Article, to take pictures or video tapes of the places things mentioned in Section 1 (m) (1) and 3 of this Article, and secure copies of the papers mentioned in Section 1 (m) (2) of this Article. All acts authorized under this subsection shall be conducted at reasonable prompt- ness, in a professional manner and without undue disturbance to any legitimate work or activity being undertaken inside the premises of such places. Receipts shall be issued for samples which may thereafter be so obtained; (n) require any person, firm, entity or association to submit to it periodically or whenever necessary, such report, data, information, paper or document in such form as may be prescribed by the Commission; (o) request the different government agencies for assistance in obtaining information necessary for the proper discharge of its responsibilities under this Act, and examine, if necessary, the pertinent records and documents in the possession of such government agency; (p) promulgate such rules and regulations as may be necessary to implement the provisions and intent of this Act. Such rules shall be take effect fifteen (15) days following their publication in at least two (2) newspaper of general circulation or in the Official Gazette; and (q) To perform such other functions as it may deem appropriate for the proper enforcement of this Act. Section 2. Advance Rulings - Parties may apply to the competition office for advance rulings, binding on that office, regarding eligibility for exemptions. If it chooses to grant an advance ruling, the competition office may include in it specified conditions and requirements. The advance ruling shall by its terms exists for a specified period of time. Advance rulings may be renewed upon application by the parties. An advance ruling may be revoked or modified if: (a) a significant change in circumstances has occurred since the ruling; (b) the applicant infringed a condition or a requirement specified in the ruling; (c) the decision to grant the ruling was materially influenced by inaccurate, fraudulent or misleading data; or (d) the applicant abused the exemption granted to it. The competition office shall arrange for publication of its advance rulings, omitting any confidential information. It may arrange similar publication of all other decisions taken under this Act, again omitting any confidential information. Section 3. Rules on Confidentiality and Conflict of Interest - Officials of the Commission, as well as their agents and consultants, shall maintain the confidentiality of all business, commercial or official information of which they become aware during the course of their official activities, except that which is otherwise public. Disclosure of such confidential information may occur in the course of administrative or judicial proceedings arising under this Act, or otherwise as permitted by a court of competent jurisdiction. RECOMMENDATIONS FOR ANTITRUST POLICY AND REGULATION 401

All members of the Commission shall inform the Office of the Chairman of the Com- mission of any position held or activity carried out in an economic field by the member, including all agents thereof. The Chairman shall take all necessary steps to ensure there is no conflict of interest arising from such positions or activities, including requiring that such positions be resigned or activities cease.

ARTICLE 9 - PENALTIES Section 1. Administrative Penalties – After formal investigation, the Commission may impose one or more of the following administrative penalties: (a) censure of the erring firm(s); and/or (b) issuance of a Cease and Desist order which must specify the acts that the respondent shall cease and desist from and shall require him to submit a report of compliance therewith a reasonable time which shall be fixed in the order; and/or (c) condemnation or Seizure of Products or Property, in such manner as may be deemed appropriate by the Commission and in coordination with the proper authorities and remain in the custody of the Commission subject to the finality of the decision: Pro- vided, That perishable goods shall be disposed of and the proceeds of such disposition shall be subject to the final order or decision of the Commission in the case; and/or (d) other analogous penalties as may be deemed proper by the Commission. Section 2. Imposition of Administrative Fines - Administrative fines may be imposed in such an amount deemed reasonable by the Commission, which, in the case of an individual, shall not be less than Three Hundred Thousand Pesos (P300,000.00) nor more than One Million Pesos (P1,000,000.00), and in the case of a corporation or other judicial entity, not less than Three Million Pesos (P3,000,000.00) nor more than One Hundred Million Pesos (P100,000,000.00), and in both instances, an additional fine of Ten Thousand Pesos (P10,000.00) for each day of continuing violation: Provided, That in case of violations by corporations, associations, partnership or other juridical entities, individual fines may still be imposed on the officers directly or indirectly responsible for the implementation of the prohibited act. The fine imposed herein shall be regardless of the limit on the criminal fine in this Act and other fair trade laws violated. Section 3. Criminal Penalties - Any person who shall commit a prohibited act defined under Articles 3, 4, 5, and 6 or shall violate any provision of this Act shall be guilty of a felony and, upon conviction thereof, shall suffer the penalty of imprisonment of not less than five (5) years but not more than twenty (20) years and a fine of not less than Three Hundred Thousand Pesos (P300,000.00) in the case of an individual, and not less than Three Million Pesos (P3,000,000.00) in the case of a corporation or other juridical entity: Provided, That in case of violation by corporations, associations, partnerships or other juridical entities, the penalty of imprisonment shall be imposed on the officers directly or indirectly responsible for the implementation of the prohibited act. In addition to the foregoing penalties, the court may order the closure or dissolution of the establishment or firm where circumstances warrant and any property owned under any contract or by any combination, or pursuant to any conspiracy, and subject thereof as mentioned in the preceding sections, shall be forfeited in favor of the government. Section 4. Award Of Damages – Any person who shall be injured in his/its business or property by any other person or corporation shall recover the amount of damages sustained by reasoned of the act declared to be unlawful by this Act, including the costs of suit and reasonable attorney’s fees: Provided, That this Section shall be without prejudice to the filing of the appropriate criminal action against the offending party. 402 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

Section 5. Alien Violation — If the person committing the violation of this Act be an alien or a foreign firm, he/its foreign officers/representatives shall, in addition to the above penalties, be deported after paying his/its fine and/or serving his sentence without need of any further proceedings. Section 6. Public Officer as Offender – If the offender is a public officer, he shall, in addition, suffer the penalty of perpetual disqualification from holding a public office.

ARTICLE 10 - FINAL PROVISIONS Section 1. Appropriations - The amount necessary to carry out the provisions of this Act shall be included in the General Appropriations Act of the year following its enactment into law and thereafter. Section 2. Repealing Clause – All laws, decrees, orders, rules and regulations and all other issuance or parts thereof inconsistent with the provisions of this Act are hereby repealed or amended accordingly. Section 3. Separability Clause - If any part or provision of this Act is held unconstitutional or invalid, other parts or provisions hereof which are not affected thereby shall remain in full force and effect. Section 4. Effectivity Clause - This Act shall take effect immediately upon publication in the Official Gazette or at least two (2) newspapers of general circulation approved. ABOUT THE AUTHORS

Anthony R.A. Abad is Administrator of the National Food Authority (NFA) and Chairman of the Board and President of Food Terminal, Inc. Before his appointment at the NFA, he was a Commissioner of the Tariff Commission from 1995 to 2001. He earned his Law degree at the Ateneo de Manila University School of Law in 1991 and pursued further studies at the Harvard Institute for International Development as a Fellow in Public Policy and Management and Master in Public Administration at the Harvard University-John F. Kennedy School of Government in 1997. He attended several local and international conferences and seminars on trade, competition policy, and other economic development concerns. Aside from his work in government, he teaches international trade, competition policy and institutions of the European Union at the Ateneo de Manila University.

Rafaelita M. Aldaba is a Research Associate (on study leave) at PIDS and is currently pursuing her Ph.D. at the University of the Philippines School of Economics (UPSE) where she also received her Master of Arts in Economics degree in 1987. In 1989, she took the Advanced Studies Program in International Economic Policy Re- search at the Kiel Institute of World Economics in Kiel, Germany. She has written a number of papers on international trade, competition policy, and environmental economics.

Myrna S. Austria is a Senior Research Fellow at PIDS and Project Director of the Philippine APEC Study Center Network (PASCN) Secretariat, a regular component project of PIDS. She gained her Ph.D. from the Australian National University in 1993. She has been a member of various APEC organizations including the Philip- pine Technical Board for APEC Matters since 1996 and the APEC International As- sessment Network since 1999. Her research specializations include trade and investment policy, competition policy, and regional cooperation.

Erlinda M. Medalla is a Senior Research Fellow at PIDS. She obtained her Ph.D. in Economics from UPSE in 1979 and was a post-doctoral Fellow at Yale Uni- versity a year later. She has been a project director/project leader of various research projects handled by PIDS and other institutions since joining PIDS in 1981. Among her earlier positions were as a Senior Economic Development Specialist at the NEDA, Professorial Lecturer at the UPSE, and Consultant at the then Ministry of Trade and Industry. She conducts research on trade and industrial policy and has written a number of papers on trade and investment, shadow price estimation, tariffs and nontariff barriers to trade, and many others.

403 Melanie S. Milo is a Research Fellow at PIDS. She is a member of the Macroeco- nomics Group and conducts research on monetary policy and financial sector policy issues. She received her Ph.D. in Economics from the Australian National University in 2000.

Ramonette B. Serafica is an Associate Professor (on leave) at the De La Salle University-Manila. Before moving to the academe, she was an Industry Economist at Smart Communications, Inc. in 1998 and a Research Fellow at PIDS a year earlier. She received her doctoral degree from the University of Hawaii in 1996. Her research interests include telecommunications, competition policy, and infrastructure regulation.

Peter Lee U obtained his Ph.D. from Purdue University, U.S.A. in 1995 and presently teaches at the University of Asia and the Pacific (UA&P) School of Econom- ics where he is an Assistant Professor. While on leave from UA&P in 1999, he taught at the University of Texas at Dallas and North Lake College, Texas, U.S.A. He also did consultancy work for the Asian Development Bank in its project on Philippine power sector restructuring. His research interests are energy economics, industrial organization and regulation, antitrust, microeconomics, managerial economics, and public utility economics.

404 ABOUT THE PUBLISHERS

The Philippine APEC Study Center Network (PASCN) was established on November 23, 1996 by virtue of Administrative Order No. 303, as the Philippines’ response to the APEC Leaders’ Education Initiative. Among the goals of PASCN are to promote collaborative research on APEC-related issues; facilitate the exchange of information between or among government and nongovernment organizations, aca- demic or research institutions, business sector, and the public in general; encourage faculty and students of higher education to undertake studies, theses and dissertation on APEC issues; undertake capacity-building programs for government agencies on matters related to APEC; and provide technical assistance to government agencies and private organizations on APEC-related initiatives. The Network is composed of the Asian Institute of Management, Ateneo de Ma- nila University, Central Luzon State University, De La Salle University, Foreign Ser- vice Institute, Mindanao State University, Silliman University, University of Asia and the Pacific, University of the Philippines, University of San Carlos, Xavier University, and the Philippines Institute for Development Studies as Lead Agency and Secre- tariat. The Philippine Institute for Development Studies is a nonstock, nonprofit government research institution engaged in long-term, policy-oriented research. It was established on September 26, 1977 by virtue of Presidential Decree No. 1201. PIDS is envisioned to be a development policy “think tank” for planners, policy- and decisionmakers in government. Its activities are aimed at expanding research on social and economic development in order to assist policymakers and leaders in planning and policymaking. The Institute has three programs, namely, research, outreach, and dissemination and research utilization.

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