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PHILIPPINES COMPONENTS 2 0 1 7

STEPS TO REGAIN COMPETITIVENESS

Adnan Awan Lucky Nurrahmat Shijir Ochirbat Alex Pham 2 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Contents

1. Executive Summary 3

2. Country Overview 4 - 7

3. Electronics Cluster 8 - 11

4. Cluster Competitiveness 12 - 17

5. Recommendations 18 - 19

6. Sources 20 GLOBAL COMPETITIVENESS REPORT | 3

Photo : ILFS Clusters 1. Executive Summary

ELECTRONIC COMPONENTS CLUSTER CLUSTER COMPETITIVENESS Electronics manufacturing is the most important While electronics manufacturing is one of the Philippines’ of the Philippines. Electronics exports from the Philippines most competitive sectors, its global competitiveness has totaled US$28.6 billion in 2016, accounting for more than 50% declined between 2000 and 2010, which is a cause of concern of the country’s exports. The industry has been an important for the country. One of the major reasons for this decline is the source of jobs and foreign direct investment, attracting multi- focus of the cluster on producing low value added interme- national companies like Intel, Acer, Texas Instruments, and diate components as opposed to high value added finished Toshiba to invest in the Philippines. products. Labor productivity has also not improved signifi- cantly, and continues to lag the level of other regional econo- PHILIPPINES OVERVIEW mies like Malaysia, Thailand, or Singapore. The Philippines has been categorized as a lower middle income country by the World with a GDP per capita of RECOMMENDATIONS US$2,904 in 2015. This Southeast Asian nation has a young The Philippines government is aware of the challenges facing population, advantageous location, and open economy the electronics cluster and plans to help it transition from low favorable for trade, but fragmented geography, natural disas- value added components to high value added products. To ters, political instability and weak institutions have hampered move up the ladder, we recommend that the government development. should attract highly skilled Filipino engineers and techni- cians from abroad through a special scheme and try to retain CLUSTER PERFORMANCE them in the country. It should also promote a R&D The economy of the country has transitioned from by increasing R&D investment and attracting leading multi- to manufacturing and now to services. In the 1980s, agricul- nationals to perform R&D in the Philippines. The cluster ture formed 1/4 of the economy. Agriculture now accounts for players, in coordination with the government, should focus only for 10.3% of GDP, while industry and services account for on improving the perception of the Philippines’ electronics 30.7% and 59% respectively. The electronics cluster, which is products which are currently perceived to be low quality. one of the most important industries, started developing in Finally, more can be done to help the Philippines be promoted the 1970s when electronics manufacturers from developed as a high quality global “brand” . countries began locating their operations in the Philippines to take advantage of cheap labor and favorable location. Histori- cally, the cluster has been dominated by foreign multinational corporations with very little contribution of local firms. 4 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Photo Credit: Wikipedia Commons 2. Country Overview

GEOGRAPHY The Philippines is an archipelago of 7,000 islands with a total area of 300,000 square kilometers between the Pacific Ocean and the South China Sea (World Bank, 2017).

The country has a long coastline with natural harbors like Manila Bay. Its land is fertile and suitable for crops like rice, corn, sugarcane and tobacco. Therefore, agriculture was the main source of livelihoods until the 1970s. There are extensive deposits in the country, including metals like nickel and and non-metals like clay, guano, , feldspar, , talc, , phosphate, and .

POLITICAL STRUCTURE Politically, the Philippines is a republic with a presidential form of government. Powers are divided among the execu- tive, legislature and judiciary. Executive comprises of the presi- dent, vice president and cabinet. The legislature is divided into Senate and House of Representatives, and is responsible for making laws. The judiciary comprises the Supreme Court and lower courts. The Supreme Court also has the power of judicial review and to declare any law, agreement or treaty unconstitutional.

Figure 1. Population density of the Philippines (Wikipedia) GLOBAL COMPETITIVENESS REPORT | 5

ECONOMIC OVERVIEW in large trade deficits that forced the to increase and agricultural During World War II, Japanese occupa- government to impose capital controls, exports. The efforts of liberalization by tion destroyed much of the Philippines’ restrict imports, and follow a policy of the government, however, were met economy and infrastructure. Since import substitution during the . with stiff resistance from industrialists independence, the country has had and the government re-imposed tariffs a checkered economic performance This policy worked for some time in 1968 to give a boost to domestic and developed economically by fits and growth in manufacturing sector manufacturing. and starts. The economy suffered from averaged 12% growth in the first half many problems common to other of 1950s and contributed 7.7% to GNP. The 20 year rule of Ferdinand Marcos developing countries, such as political However, manufacturing declined in (1965-1986) had deleterious effects instability, corruption, poor macroeco- on the economy of the nomic , external debt, over Philippines, especially reliance on aid, inequality and crony after the imposition capitalism. of martial law in 1972. Marcos promoted crony capitalism, which under- mined healthy competi- 100 million tion in business. population While the economy grew on an average of 6.4% in the 1970s, mostly on the back of increased In 2015, the Philippines had a total prices, this population of 100 million with a life growth came at a great expectancy of 68.4 years, which is price for the Philippines. below average for the region. However, The total international the Philippines, unlike China, Japan and debt of the country rose Thailand, has a young population which from US$2.3 billion in speaks good English. This has proven 1970 to US$24.4 billion to be an asset for business process in 1983. Debt servicing like call centers, software became increasingly diffi- development and back- services. cult, forcing the govern- Furthermore, 8 million Filipinos ment to renegotiate abroad and revenue from remittances and restructure its debt was US$30 billion in 2015. several times.

The GDP per capita of the Phlippines Figure 2. GDP per Capita (World Bank) This debt crisis increased has quadrupled to US$2,904 in 2015 the influence of the World from only US$715 in 1990. However, it the second half of the 1950s, imports Bank and International Monetary Fund still lags behind other countries in the increased, and there was corruption in in the country, both of which encour- region like China ($8,069), Indonesia foreign exchange allocation. aged foreign direct investment in the ($3,346), Malaysia ($9,768), Thailand country. Declining prices for the Philip- ($5,814) and Singapore ($52,888). This The government was forced to reverse pines’ exports in the world market in laggard status is particularly poignant the policy, devalue the Peso, and reduce the early 1980s, coupled with financial considering that the Philippines was tariffs in 1962 to spur exports, helping scandals and reckless borrowing of richer than these countries in the 1970s. government owned financial institu- tions exasperated the situation. ECONOMIC HISTORY After independence, the Philippines $2,640 This gave rise to an economic crisis in became dependent on the United 1983. The murder of Senator Benigno States, its former colonizer, for recon- GDP per Aquino, the chief rival of the presi- struction and the revival of its economy. dent, also resulted in political crisis. As a consequence, the country had to capita Marco’s government never recovered open its borders to American from these crises and he ultimately fled in order to receive aid. This resulted from the country in 1986, giving way to 6 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Corazon Aquino. (1997-98) affected the Philippines but after briefly slowing down in 2009, the it was able to recover more quickly in economy grew at an average of 6.2% Under President Aquino, the economy comparison to neighboring economies. annually between 2010 and 2015 under briefly recovered in 1986 but again ran Benigno Aquino III. into difficulties in 1988 due to power President Joseph Estrada (1998-2001) shortages, trade and fiscal deficits revived corruption and cronyism. and natural disasters like drought and However, under President Arroyo (2001- BUSINESS ENVIRONMENT earthquake. In the 1980s, the economy 2010), the economy improved. It was in According to the World Economic performed poorly and real GNP grew this period that exports of electronics Forum’s Global Competitiveness Report, at an average annual rate of only 1.8%, equipment from the Philippines picked the Philippines is ranked 57th out of 138 while population growth rate was up. Companies like Texas Instruments countries for competitiveness. These 2.5%. In 1990, the per capita GDP was only US$715 and unemployment 8.3%. Aquino tried to revive the economy, but soon came under the influence of inter- national creditors and a strong business community.

Aquino had to deal with two conten- tious issues. First was the servicing of an onerous $28 billion debt. Some economists suggested repudiating the debt, as it may not have been possible to both the debt and revive the economy. However, repudiation was rejected by the President due to the influence of powerful business interests and creditors. The second issue was land reforms. Economists believed that distri- bution of land through reforms was necessary to give a boost to domestic Figure 3. Philippines rankings on competitiveness (World Economic Forum) demand. However, the government failed to institute meaningful land and Toshiba located operations in the findings reinforce the constraints that reforms as Congress was dominated by Philippines, preferring it over China. our team has identified within our large landowners. The country started exporting disks, Porter Diamond analysis. parts, and microchips. However, her successor President Fidel Institutions Ramos (1992-98) successfully addressed GDP grew by more than 5% for three Institutions are considered weak in the many challenges faced by the economy. consecutive years before the Global Philippines, as corruption is a major The power shortage was overcome Financial Crisis hit the Philippines’ problem, public trust in politicians is and infrastructure was improved. The economy in 2008. At that time, two low, and the legal system is inefficient. banking system was reformed and thirds of overseas from the country Investors are poorly protected and police services are unreliable. Terrorism, crime, and violence also impose consid- The Philippines is ranked 57th erable costs on business. out of 138 countries for global Infrastructure The quality of , railroads, and air competitiveness is poor. were broken. It was during was comprised of electronics compo- Macroeconomic Environment this time that electronics companies like nents. The Crisis resulted in reduced The Philippines has a stable macroeco- Acer and Intel invested in the Philip- demand for microchips and electronics nomic environment, as inflation and the pines. GDP growth averaged 5% and components, and the Philippines’ budget deficit are under control, and inflation came down from 25% to single economy suffered badly along with the country’s credit rating is good. digits. The East Asian Financial Crisis other East Asian economies. However, GLOBAL COMPETITIVENESS REPORT | 7

Agriculture In 1980, agriculture comprised 1/4 of the Philippines’ GDP, with rice, sugar- cane, bananas, pineapple, coconuts, corn, fish, eggs, pork and beef being the main agricultural products. Over the years agriculture has lost its promi- nence to services and industry and now accounts only for 10.3% of GDP (Prableen Bajpai, 2017). However, agriculture still employs around 30% of the labor force.

Industry The industrial sector has been a major contributor to the Philippines’ economy. From 1980 to 2014, it averaged 34% of GDP. In 2015, it accounted for 30.7% of the GDP and employs 16% of the workforce. The electronics industry, which is the country’s major source of exports, started in the 1970s and attracted investment from developed countries due to the benefit of low cost production offered by the Philippines.

Services Services have overtaken the indus- trial sector in the Philippines, now accounting for 59% of the GDP and employing 54% of labor. Within services there are three major segments: business process outsourcing, , and export work services.

Figure 4. Porter Diamond for Philippines (Team Analysis) Business process outsourcing thrived in the Philippines due to the English in terms of financial markets develop- and technical skills possessed by its ment. workforce. However, Tourism has not While the Philippines has a large been able to tap its full potential, and English-speaking population, the Technological lags Singapore, Thailand and Malaysia overall quality of education is low and The country is ranked at 83 and 62 for due to the poorer quality of services the country has no higher education technological readiness and innovation to tourists. Export work services has that are globally ranked. respectively. For technological readi- become an important segment, as ness, it is better than Indonesia and the remittances from Filipinos in other Goods Market Efficiency India, but lags behind China, Malaysia, countries comprise 10% of GDP. Many markets are inefficient in the Singapore and Thailand. It is behind all Philippines and anti- policies these countries in innovation. PRODUCTIVITY are not effective. It takes 29 days to start According to the International Labor a business due to excessive procedures , labor productivity in the and customs clearance is difficult. COMPOSITION OF ECONOMY Philippines is low compared to China, According to the World Bank, agricul- Malaysia, Indonesia, Singapore, and Financial Market Development ture accounts for 10% of the Philippines’ Thailand (ILO, 2017). The Philippines’ The Philippines lags behind Singapore, economy, while industry and services productivity has increased by only 22% Thailand, India, Indonesia, and Malaysia account for 31% and 59% respectively. over the past 7 years. 8 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Photo Credit: Singapore Business Times 3. Electronics Cluster

CLUSTER PROFILE chain, the sector receives inputs such as raw materials or more Electronics and (E&E) is a huge global upstream electronic components, and produces components market, encompassing a range of different products in indus- that serve either large electronics players downstream (Apple, tries such as automotive, medical, aerospace, defense, indus- , , etc) that own the , and distri- trial equipment, as well as , communica- bution of final products, or original equipment manufacturers tion, storage and office equipment, and consumer appliances. such as . According to UN Comtrade, total world exports of electronic and electrical equipment was approximately US$2.3 trillion CLUSTER TIMELINE in 2015. The industry is highly driven by foreign direct investment, starting in the early 1970s with investment from Intel. After The industry is heavily standardized both in terms of product the initial wave of investment led by American and European and process by bodies such as Institute of companies, Japanese companies began their investment in Electrical and Electronics Engineers, or industry standardiza- the mid-1980s, while Korean investments began in the 2000s. tion body such as Electronic Industry Alliance. Such standards Today, foreign investment in the E&E components account for allow for the fragmentation of the manufacturing process, so almost 72% of the industry. that different electronics and electrical components can be manufactured in different locations. Our report will focus on Foreign companies that invested in the E&E industry mostly the electronics and electrical components sub-sector in the stayed for the long term, with many operations dating back to Philippines. the 1970s or 1980s. However, the 2008-2009 global financial crisis led to lower demand for electronics components. The The type of products in E&E components include passive lower demand, coupled with the exit of Intel in 2009, impacted electronic components (capacitors and resistors), semiconduc- industry growth negatively. However, 110 new investments tors (wafers, integrated circuits), printed circuit boards, and were made during 2010-2015, a sign that the industry has transmission and devices (, switch- started to recover again. gear, storage component). Residing in the middle in the value GLOBAL COMPETITIVENESS REPORT | 9

CLUSTER MAP Below is the description of each compo- nent in the cluster map

Figure 5. Timeline of cluster development (Duke ; Team Analysis)

short training programs (~2 months), engineering programs in the Philippines Electronic and electrical compo- often conducted by the company or the established the Engineering Research nent manufacturers industry association (SEIPI). and Development for At the center of the cluster are the (ERDT). The ERDT is a consortium of manufacturers Other than the production workers, the eight universities that provide graduate themselves. The and industry also attracts graduates from level engineering education, focused on Electronics Industries in the Philip- local universities, both engineering . pines Foundation (SEIPI) records and non-engineering. Several univer- membership of 261 companies from sities with engineering and manage- Key members of this consortium an approximately total number of ment program, such as Batangas State include Ateneo de Manila University firms of 926, which mostly resides in University, Ateneo de Manila University, (ADMU), Central Luzon State University north western area of Philippines. The Central Luzon State University, Mapua (CLSU), De La Salle University (DLSU), industry employs approximately 2.2 Institute of , and De La Salle Mapua Institute of Technology (MIT), million workers. University serve as talent pools for the Mindanao State University – Iligan Insti- industry. tute of Technology (MSU-IIT), University Supporting institutions of the Philippines (U.P.) Diliman, and U.P. At the bottom of the map are 4 key SEIPI estimates that there are approxi- Los Baños and University of San Carlos groups of institutions that support the mately 500,000 graduates every year (USC). cluster. that are readily employable in the industry. They are competitive, train- 3. Industry groups 1. Educational institutions able and usually English proficient The Semiconductor and Electronics (universities and technical high workers[8]. The workers in the industry Industries in the Philippines Founda- schools) enjoy approximately 17% higher tion (SEIPI) was established in 1984 Production workers account for 77% compensation than their peers in other to promote business interests of of total employment (Philippines NSO, industries (Philippines NSO, 2013). its members, to act as the industry 2013). Typically, production workers are representative to coordinate with graduates from technical/vocational 2. Research institutions the Philippines government, and to high schools that specialize in training In 2007, concerned about the lack enable sharing of knowledge and best for the electronic and electrical field. of engineering and research talent practices among its members. It is now Newly hired workers then undergo among Filipinos, seven deans of the top the largest organization for foreign 10 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Figure 6. Map of the Philippines’ electronics components manufacturing cluster (Team Analysis) and local electronics companies in the and Engineering (COMSTE), a bicameral manufacturing. Philippines, and is considered the most committee created by a joint resolution organized industry association in the of the 13th Congress (starting on July Young (2010) notes that below country. 2004), advance innovative programs companies are presence in Philippines: and legislation to improve Philip- The organization boasts a total member- pines’ competitiveness in science and design: Applica- ship of 264 companies, including large technology. One of the special panels tion Specific Integrated Circuits (ASIC) multinationals as well as local Filipino in the COMSTE is the electronics and and Field Programmable Gate Arrays companies. It provides services in semiconductor panel. The Philippines (FPGA) design, VHDL (VHSIC Hardware the areas of Training, Research and Economic Zone Authority (PEZA), Description Language) verification, Development, Advocacy, Information, part of the Department of Trade and conducted by companies such as Intel, Networking and Services (T.R.A.I.N.S.) Industry, promotes and administers Sanyo Semiconductor, Eazix, Symphony, [13]. It provides industry publications, the country’s Special Economic Zones, BItmicro industry events, and training program where many of the electronics manufac- such as Teen for Work Scholarship turers are located. Integrated Circuit Packaging design, Program (TWSP), which grant schol- operated by TI Phils, and Fairchild arships and training for high school Design and Firmware Semiconductor graduates to undergo two weeks of Although still nascent, there is a training before being deployed to growing silicon design and develop- Module and product design, with electronic companies. ment industry in the Philippines (at companies such as Lexmark, Eazix, Blue the left of the cluster map). The sector Chip 4. Government institutions sits higher up in the value chain, Various government institutions typically requires more technical and Firmware: embedded system both support the industry. Congressional engineering backgrounds, and has a hardware and software, such as Canon Commission on Science, Technology higher value added than components IT and Tsukiden. GLOBAL COMPETITIVENESS REPORT | 11

Enabling Institutions cluster is able to take advantage of cluster and the electronic products Three type of institutions at the top of 27 major shipping ports operated cluster. The electronics component the cluster map serve as enabling insti- under the Philippines Port Authority, a cluster supplies components such as tutions for the electronic cluster. Special government-owned enterprise under navigation , automotive wire Economic Zones (SEZ), operated by the Department of Transportation and and cables, and electric motors to the private sector and/or the govern- . Private port compa- the automotive cluster in the Philip- ment, allow manufacturers to start and nies, such as Harbour Centre Port pines. Although the size of automotive operate operations more smoothly. Terminal, often also jointly operate industry is still relatively small compared a Special Economic Zone and port, to peers, with an annual capacity of only Most of the factories are located in the providing smooth supply chain from 250,000 units compared to 1.5 million SEZ, and benefits from incentives such raw materials importing to manufac- units in Thailand, the industry still as income tax holidays, tax and duty turing to export/shipping. enjoyed double digit growth in 2015

Figure 7. Geographic distribution of the cluster (PEZA) free importation of raw materials, VAT (27.6%) and 2016 (24.6%). zero-rating of local purchases, simpli- Although most of the investment in fied import-export procedures and the electronic components cluster is The finished electronic products special immigrant and non-immigrant Foreign Direct Investment, 28% of the cluster is also a big sector in the Philip- visa process. cluster is comprised of Filipino-owned pines. The sector, which is comprised enterprises that benefit from financing of consumer/ sector, The authority overseeing the SEZ, PEZA, provided by various Filipino computer/storage/office equipment, promises fast turnaround especially and financial institutions, such as BDO industrial equipment, consumer for electronics manufacturing of four Unibank, Metropolitan Bank and Trust appliances, and medical equipment, days to complete a production cycle, Company (Metrobank), Bank of the accounts for US$ 10.5 billion in 2014 consisting of one day of receiving and Philippines Island (BPI). export and consists of approximately custom processing of raw materials, two 320 firms. The sector provides local days for manufacturing, and one day for Other Clusters demand for the electronic component import process. The electronics component cluster also cluster, aside from final demand from benefits from the growing demand of final products manufacturers or OEM Being an archipelago, the electronics other clusters, such as the automotive plants abroad. 12 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Photo Credit: Wikipedia Commons 4. Cluster Competitiveness

HISTORICAL PERFORMANCE generates at least 0.12 cents in additional indirect taxes The electronics cluster has been the Philippines’ economic for the economy and 0.11 cents to 0.25 cents of additional backbone and icon of economic transformation since the mid household income in the economy. Its impact is also high on 1970’s. Before the growth of the electronics sector, the country employment, with every 1 billion peso increase in investments was sustained on exports of agricultural and products creating between 620 to 1,408 additional quality jobs in the with limited value-add such as coconut oil, copper metal, and economy. plywood for much of the last century. PERFORMANCE CHALLENGES Since then, the electronics industry has grown rapidly and has Despite a significant growth in share of electronics exports become the country’s top export with total receipts of $2.47 from 22% in 1991 to 42% in 2014, the Philippines’ cluster’s billion, accounting for 51.6% of the total exports revenue by growth has been unimpressive compared with the world rate. 2017. Among electronics products, constitute The cluster has shown a negative export CAGR of -2% since the largest share with 35.9% of total electronics production. 2007, compared to a world rate of 4%.

The electronics industry is also an important source of During this period, exports suffered from economic crisis of employment due to its labor-intensive operations. In 2014, the 2008, followed by Intel’s exit from the Philippines. According to sector directly employed 344,450 workers through 258 firms the Philippines Statistics Authority (PSA), the cluster’s export and contributes around 1.9 million indirect jobs. The industry earnings fell from a peak of $32.2bn, or 21.6% of GDP, in 2007 also is the largest source of FDI in the Philippines due to the to $26.6bn, or 9.8% of GDP, in 2013. However, an improving dominance of foreign multinational corporations. investment climate and strengthening global demand has helped the industry pick up again since 2014. ECONOMIC IMPACT The multiplier effect of the electronics cluster is also large, In addition, the cluser’s low value add focus is suppressing indicating its significant impact on the Philippines’ economy. the potential growth of the industry. According to the PSA, According to SEIPI, every 1 peso increase in export sales the sector produced just $8 billion of gross value added in GLOBAL COMPETITIVENESS REPORT | 13

2014, or 2.8% of GDP. That was up power costs, lack of technological and Asian Competition from $7.4billion, or 2.9% of GDP, in product innovation, lack of financing, Most competition for the cluster 2013 and $7.3 billion, or 3.1% of GDP, and limited SME product development comes from Asia. The world super star in 2012. Philippines is heavily focused initiatives. performers among electronics compo- on back-end testing and assembly, nents exporters are China/Hong Kong lacking the manufacturing capability RELATIVE COMPETITIVENESS and South Korea, while other exporters for semiconductor wafer fabrication, The Philippines’ share in global exports from Asia such as Malaysia and Thailand which is a major step in moving up the is being threatened by the high cost have performed significantly better value chain. of production, lack of infrastructure than the Philippines. With rising costs coupled, and absence of product diver- in the Philippines, threats may increase sification. from Vietnam or other countries that The country’s offer lower labor costs. electronics export accounts Furthermore, the structural shift away for just 1% of from PCs towards and global E&E tablets may explain why Taiwan and exports in 2014, South Korea are performing better than while the top Southeast Asian countries in electronic ten electronics exports. The poor performance of the producers Filipino and Singaporan electronics comprise 79% of clusters is driven by a greater focus on the global total. slower growing sectors such as hard disks, PCs, and semiconductor produc- SEIPI has identi- tion. According to Credit Suisse, tablets fied a deterio- and smartphones will continue to rating trade off be the drivers of growth in electronic Figure 8. Trends in electronics exports (Credit Suisse) between costs and shipments. This may be a negative sign productivity that for the future growth prospects of the Although SEIPI identifies several indus- provides a chance for new players, such Philippines’ electronic industry. tries such as Medical/Industrial Instru- as Vietnam, to enter the market. Among mentation, Automotive, Consumer the major constraints pressuring Value Add Electronics and Office Equipment that competitiveness, poor infrastructure, The Philippines has significantly lagged have high growth potential, no action especially the slow pace and high cost behind its Asian peers due to a relative has been taken by the government. In of moving goods, ranked as the highest lack of value added production. practice, most of the value add within concern among investors. the electronics sector derives from In particular, other Southeast Asian semiconductor research and chip design that does not exist in the Philippines.

Currently, IC design, wafer fabrication, and R&D in the upstream section are considered as the largest gap in electronics produc- tion value add. Lack of diver- sification in manufacturing in the downstream sector is also contributing to the lack of competitiveness in the electronics industry. Constraining the develop- ment of both upstream and downstream activi- ties are the lack of a highly skilled workforce, high Figure 9. Shifts in end-product demand (Credit Suisse) 14 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

Figure 10. Comparison Table of Electronics Manufacturing Clusters in Asia (Team Analysis) clusters have been helped by their them to win higher global market present in the Philippines. In addition, home governments dedicating signifi- shares than that of the Philippines. foreign investors may increasingly cant effort in policy and financing to shift their focus from the Philippines to support value add in local electronics The governments of Malaysia, Vietnam, Vietnam for labor-intensive electronics production. Taiwan and Thailand also concentrate manufacturing. heavily on localizing R&D for domestic Electronics clusters in Malaysia, Singa- producers, attracting investment in Therefore, the Philippines’ competitive pore, Taiwan and Thailand benefit high value add products via favorable advantage in its current product mix is from local semiconductor production, tax and regulatory incentives, and at risk from other competing clusters, functional upgrading to chip design, developing local talent by involving suggesting that the Philippines will and linkage of backwards production. domestic universities and schools. have to move up the value chain in As a result, product mixes are more order to preserve the viability of its diversified for these countries, allowing Such government policy has been less electronics manufacturing cluster.

Figure 11. Competitiveness assessment of selected cluster by product (Credit Suisse) GLOBAL COMPETITIVENESS REPORT | 15

The Philippines has also been able to pines wants to retain the high quality Finally, the Philippines needs to maintain a low cost position relative engineering and business management improve its macroeconomic and polit- to other major global electronics talent needed to move to higher value ical environment to increase its compet- producers. The Philippines’ hourly parts of the supply chain. itiveness. Given the ASEAN region has compensation costs within the similarities in product mix across the computer, electronic, and optical 2. Competence of the Philippine electronics sector, the macro environ- products sector is still one of the lowest Export Zone Authority (PEZA) ment of each country plays an impor- levels in the world, alongside China Most foreign investors have located tant role in shape their competitiveness and India. Moreover, this data masks their manufacturing plants in the in attracting companies and talent. the large rates of wage growth that has Philippines’ special economic zones occurred in China’s coastal areas, which (SEZs), due to the lower overall costs COMPETITIVENESS ASSESSMENT has historically been China’s hotbed of of manufacturing and greater ease The Philippines’ share of global electronics manufacturing. of doing business. These SEZs are electronics component exports was managed by the Philippine Export Zone stagnant between 2007 and 2014, while However, while this low cost position Authority (PEZA), which has been rated China was able to increase its share in has historically allowed the Philip- by foreign investors in a Duke Univer- the sector from 21% to 31% over the pines to attract foreign investment in sity survey as being responsive to their same time period. More worryingly, the the past, it may be not a sign of true needs and organizationally stable, a overall size of the Philippines’ compo- cluster competitiveness in the future. critical consideration for investors. This nents exports did not grow between This is particularly true if the Philip- has encouraged foreign companies to 2007 and 2014, matching only France in terms of poor performance and lagging behind other Asian countries that were able to grow their component exports between 3 and 5%.

This poor performance suggests that the Philippines’ electronics compo- nents manufacturing cluster will have to think carefully about how to redefine its global value proposition, particularly as the historical drivers of growth may be changing in the future given the high level of innovation and competitiveness in other competing clusters.

CLUSTER STRENGTHS 1. Low Cost, English-speaking Workforce The electronic components cluster began in the Philippines as foreign multinationals searched for low-cost production centers that could slot easily into their global supply chains. This low cost, ready supply of relatively produc- tive labor remains a key attraction for investors.

For front-line production workers, foreign companies surveyed by Duke University cite English language skills, stability and availability of supply, low cost, loyalty (low turnover rates), and openness to training as being core advantages of hiring Filipino workers. Figure 12. Labor cost comparison by country (US Bureau of Labor Statistics) 16 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

continue expanding their operations standards and wage levels continue to in the Philippines, which has led to rise, particularly within the lower value High turnover for skilled engineers sustained growth in both exports and added segments of the value chain that that have just gained enough experi- employment in the SEZs. Chinese firms may increasingly exit or ence to be truly productive hurts both outsource. individual companies and the cluster 3. Geographical concentration as a whole, as companies may become 90% of the electronics manufacturing The Philippines is potentially well reluctant to invest in training and cluster is located in just two geographi- placed to benefit from this trend, as 61% supporting their staff. cally close areas, Metro Manila and of its component are already exported Calabrazon. This geographical concen- regionally within East Asia. This vicious brain drain cycle also makes tration gives the Philippines cluster the it difficult for the country to retain its potential to gain from the benefits of Furthermore, integration can help most talented engineers and business agglomeration in diffusing knowledge generate major productivity gains in managers, potentially constraining the and experience. the cluster. The McKinsey Global Insti- country’s ability to increase manufac- tute estimates that manufacturing scale turing productivity, grow domestic benefits, inventory efficiencies, and businesses, and move up in the value logistics cost reductions from regional chain. trade integration can help drive cost 90% of firms savings and productivity gains between This cycle also tends to self-perpetuate 10-20% of the total cost base in the and reinforce itself, as a shortage of top located in electronics sector. talent hinders the ability of the Philip- pines to produce the high quality jobs just 2 areas CLUSTER WEAKNESSES that would keep these highly mobile 1. Brain drain of enginneering top performers in the country. and management talent Companies in the cluster surveyed by 2. Low tech, low productivity Duke University’s Center on Globaliza- Most manufacturing operations in the The highly foreign composition of the tion, Governance & Competitiveness cluster are focused on low produc- Philippines electronics cluster may also are particularly concerned about their tivity, labor-intensive manufac- generate unexpected agglomeration ability to retain engineers with 3+ years turing processes. There is significant benefits, since PEZA has also found that of experience, as once engineers gain scope to implement better manage- it is common for firms from the same experience, they are inclined to go ment practices, data analytics, and country to cluster in the same industrial abroad for higher wages. technology to increase the productivity park. of many Filipino electronics manufac- Highly skilled engineers typically turing plants. However, McKinsey notes 3. May benefit from ASEAN accounted for between 8-12% of that a key constraint on the Philippines’ regional integration and shift of the overall workforce in electronics ability to implement these productivity- electronics demand to Asia manufacturing. While this is a relatively enhancing business improvements There is an increasing shift towards small proportion of the total labor force, is the skills gap in areas such as data regional instead of global manufacturing chains as demand for finished electronics increases in Asia. Moreover, there continues to be progress towards harmonizing trade tariffs and removing barriers as part of the (albeit slow) efforts to create a common ASEAN economic community. Figure 13. Export Destinations for Philippines electronics This may create an oppor- components exports (Duke University) tunity for the Philippines to capture manufacturing share from engineers are key drivers for produc- analytics, management, and technology China in the future as Chinese living tivity and value added innovation. personnel that can think strategically. GLOBAL COMPETITIVENESS REPORT | 17

This sentiment can be seen in a 2014 As lower value added “branch” plants, 3. Weak brand & perception McKinsey survey of foreign investors most of the foreign operations in the The low tech nature of the Philippines’ within major sectors on how different Philippines have their operational cluster also leads to a self-fulfilling cycle manufacturing clusters in South- direction set by managers in corporate in which firms regard the country as an east Asia rank on “Cost” and “Quality”. headquarters, who have little incentive ideal location for lower tier produc- Respondents consistently rated the to consider the future viability of the tion, but as unsuitable for higher value Philippines highly in terms of “Cost”, but Philippines cluster as a whole. added manufacturing. rarely in terms of “Quality”. This lack of local plant autonomy may Of the three main players in the This leads to a low weighted average in also make it difficult for the Filipino electronics value chain – lead firms, which other destinations within South- government to coax or incentivize contract manufacturers, and compo- east Asia appear more attractive than companies to move to higher value nent suppliers – more than 67% of the Philippines to investors looking to added sectors upstream or increase Filipino firms are in the less value added locate operations that will require more local productivity, as there are few clear component supply part of the chain capabilities than just low cost. cluster leaders to champion reform according to Duke University. efforts. 4. Weak supplier base and linkages to non-manufacturing 6. Government policies have segments been poorly implemented Philippines The local Filipino supporting industries The Philippines routinely ranks low that contribute to the components on global indicators for ease of doing regarded manufacturing cluster tend to be small, business and political institutional unproductive, and poorly managed. strength. has identified as Tier 3 While the foreign multinational compa- numerous areas in which the Philip- nies at the core of the cluster are large pines government can reduce corrup- producer and have global management practices, tion, and the World Bank’s Ease of Doing local Filipino suppliers tend to be Business report highlights how the predominately small and with have Philippines trails other Southeast Asian investment in technology, automation, countries on key criteria that foreign The contract and components manufac- or managerial talent. investors look at. turing space is divided into 3 main tiers in terms of value added complexity and This constrains the ability of the country Unfortunately, the Philippines’ govern- production capabilities, with competing to reap all the potential benefits from ment has made little progress in driving clusters in China being in Tier 1, and attracting so much foreign investment, improvement in many of these core Malaysia and Thailand occupying Tier 2. and hinders the ability of the cluster to problems. Over the past 5 years, the The Philippines is seen as participating move to more advanced manufacturing Philippines has made marginal progress in Tier 3, alongside other low value in the future. in improving the ability of companies added locations such as Indonesia, to get credit. However, there has been Vietnam, and Myanmar. almost no improvement in starting a business, getting electricity, getting permits, protecting minority investors, 67% of Filipino firms are in the less paying taxes, trading across borders, or enforcing contracts. value added component supply part The government’s lack of progress on of the chain improving the local business environ- ment is particularly poignant given the This weak country brand perception 5. Reliant on “branch” plants of increasing competitiveness of other may hinder the Philippines’ ability to foreign multinationals investment destinations in Southeast attract higher value added investment, It will be also difficult for the Philippines Asia. This inability to improve relative as foreign multinationals may only view to actively move towards a higher value to its peers may thus hinder the Philip- the country as a suitable investment add value chain position when 72% of pines’ ability to improve its electronics destination for low cost outsourcing, the industry is comprised of subsidiaries manufacturing cluster in the future. and not as a potential center for more of large multinational firms, which may value added business processes. have little strategic control. 18 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING

5. Recommendations

1. Improve value add by attracting through incentives, such as tax incentives for talent and smart investment opening new R&D centers in the Philippines The Philippines currently produces low and simplify administrative process for highly value added electronics components. The skilled engineers to work in the Philippines. electronics cluster needs to move to the next stage of higher value added products, which The govenrment should encourage the devel- will require a greater number of highly trained opment of local suppliers via incentives such engineers and technicians. as lower tax for companies with a certain percentage of local content, tax holidays for Additionally, market demands are shifting to local suppliers in the early years of opera- handheld electronics product such as cellular tion, and connecting local suppliers to other phones and tablets, while the Philippines advance suppliers via bilateral collaborations. electronic cluster is still producing compo- nents for desktop and appliances. For the cluster The cluster should make an active effort to The cluster should invest more in human shift to producing for faster growing end capital. This can be through providing training sectors. or exchange programs with partner compa- nies abroad. For the government The government should try to attract highly The cluster should invest more in R&D via skilled Filipino engineers and technicians collaboration with educational institutions working abroad, and provide incentives to such as the Engineering Research and Devel- retain them in the country. opment for Technologies (ERDT).

The government should focus on centers of The cluster should actively build a guiding excellence in local universities to promote coalition of 7-10 key players to spearhead the research and development. effort of moving up in the value chain and shifting to faster growing end products. The government should allocate a higher R&D budget for electronics. It can also provide tax 2. Improve perception of the cluster incentives for R&D. The Philippines’ electronic cluster consists mainly of Tier 3 suppliers, producing only The government should invite leading multi- components for other OEM and final product nationals to invest in R&D in the Philippines manufacturers with no brand recognition. As a GLOBAL COMPETITIVENESS REPORT | 19

result, they are easily replaceable. To address this issue, the cluster in collaboration with the government, should focus on changing the perception of the the Philippines “brand”.

For the government The government should actively support the clusters’ effort in brand by assisting in international trade shows and inter- national efforts to promote the Philippines’ brand

For the cluster The cluster should invest in brand building and marketing, poten- tially using funding from the government.

3. Improve business environment through better government delivery The Philippines’ poor business environment factors, such as its high corporate tax rate, inefficient bureaucracy, and underdevel- oped infrastructure, make the country less attractive to investors compared to its peeres in Southeast Asia. A key reason for this has been the government’s inability to deliver on its promises of improved service delivery for the cluster. Improving government service delivery can thus be a key way to help the cluster regain competitiveness.

For the government The government should reduce the amount of cluster initiatives it has proposed in order to focus and prioritize on key issues, particu- larly regarding talent retention and the ease of doing business.

The government should focus on improving service delivery by taking lessons from the UK Delivery Unit and Indonesia’s reform of its Investment Board on how to make the government delivery chain more effective.

The government should continue to pursue structural reforms over the medium term, such as shortening the processing time for permits, ensuring law enforcement, and reducing the burden of tax compliance.

Photo Credit: Wikipedia Commons 20 | PHILIPPINES ELECTRONIC COMPONENTS MANUFACTURING 6. Sources

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