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The Philippines: The Prospect for Manufacturing Relocation

Stronger emphasis on infrastructure improves the appeal as a manufacturing base

With soaring wages and operating costs in China, many manufacturers are looking for alternative production bases in Southeast Asia to relocate or diversify their production. Unlike Vietnam and Myanmar, the alternative production bases in Southeast Asia that can boast cheap labour, the Philippines’ comparative advantages and opportunities lie in its burgeoning local sales market, English-speaking skilled labour and management efficacy. This article examines the manufacturing opportunities in the Philippines, following HKTDC Research’s recent field trip to the country.

Economic Optimism Sustained Under the Duterte Government

The Philippines registered strong economic growth of 6.8% in 2016, ranking it among the fastest-growing economies in the world. This momentum is expected to continue, with projected annual growth of more than 6.8% over the next five years. For many years, economic growth has been driven by robust manufacturing and business processing operation (BPO) services, and strong investment and consumption, buttressed by hefty overseas remittances. Fast income growth and a surge in purchasing power have combined to transform this archipelago state of more than 100 million people into a burgeoning modern consumer market. Foreign manufacturers can find local sales opportunities while also serving the export market.

President Rodrigo Duterte remains popular after almost a year in office, despite a clear realignment of Philippine foreign policy. As far as economic policy is concerned, President Duterte continues the reforms initiated by the previous Aquino administration, including the promotion of foreign direct investment (FDI). Under the Philippine Development Plan released in February 2017, Duterte’s government is keen to enhance the global exposure of the Philippines via trade and inward investment promotion. The government is working to reduce red tape and streamline the bureaucracy to improve the ease of doing business. Notably, the diplomatic shift towards closer economic co-operation with China is seen as opening a new window for foreign investment and trade.

During a recent market research trip in Manila, HKTDC Research found that businesses were optimistic about the future development of the Philippines. They were generally supportive of the government’s economic policy and believed a strong government under President Duterte could better tackle the long-standing problems of red tape and bureaucracy that remain major hurdles for anyone doing business in the Philippines. Filipino-Chinese business communities in the country are particularly enthusiastic about the opportunities brought about by potential Chinese investment. They expressed a keen interest in co-operating with Chinese partners.

Manufacturing Development in the Philippines

Manufacturing makes up almost a quarter of Philippine GDP. The sector recorded strong growth of more than 6% in 2016 and was the top contributor to the country’s GDP growth last year. Important manufacturing sectors in the Philippines include semiconductors, electronic components, refined petroleum products, computers, peripheral equipment and accessories, and processed food. The Philippines lies in the mid-range among ASEAN countries in terms of manufacturing gross value added, or GVA (see the figure below), surpassing Malaysia and way ahead of Vietnam, despite the fact that Vietnam has been industrialising fast lately, thanks to substantial FDI-led manufacturing or assembly of electronic products.

Chart: Manufacturing GVA of Selected ASEAN Countries
Chart: Manufacturing GVA of Selected ASEAN Countries

Manufacturing is also an FDI magnet in the Philippines, compared to most other sectors. The Department of Trade and Industry (DTI), along with related investment promotion agencies, devises the policies for attracting manufacturing investment. Priorities are given to export manufacturing and low-pollution light industries that can generate local employment, such as semiconductors and consumer electronics.

Chart: Approved FDI by Industry 2016
Chart: Approved FDI by Industry 2016

As seen from the figure above, almost half of the approved FDI went to the manufacturing sector, which is also an import-export revenue raiser for the Philippines. Among all manufacturing products, electronics products are the country’s most important export sector, accounting for about 50% of total exports.

Chart: Major Export Items of the Philippines 2016
Chart: Major Export Items of the Philippines 2016

Japan, the US, Hong Kong, the Chinese mainland and Singapore are the Philippines’ major export markets. The Philippines actually exported more to Hong Kong than to the Chinese mainland in 2016, according to Philippine statistics. This is rare for an ASEAN country trading with both the Chinese mainland and Hong Kong.

Table: Top 5 Export Markets of the Philippines 2016
Table: Top 5 Export Markets of the Philippines 2016

More than 70% of Philippine exports to Hong Kong in 2016 were re-exported to the Chinese mainland, however, indicating the important role for Hong Kong in bridging trade between the Philippines and China. More than 70% of Philippine exports to Hong Kong in 2016 consisted of semiconductors and electronics products, while Hong Kong’s exports of similar items to the Philippines were less than 10% of total exports from the city to the country. This not only led to trade deficits on those tariff lines, but also contributed significantly to Hong Kong’s overall trade deficit of about US$4.4 billion with the Philippines in 2016.

GSP Features Heavily in Manufacturing Relocation Decisions

Electronics is identified as the industry sector with the best potential for manufacturing relocation. On the demand side, the sector is expected to benefit from continual economic growth and sturdy domestic consumption in the Philippines. First and foremost, urban development is a major demand driver for electronic equipment and products. Take, for example, the property boom in Metro Manila (as the National Capital Region, or NCR, is generally referred to). More than 12 million people live in Metro Manila, and there is strong demand for all sorts of household electronics. Other provincial areas are also seeing demand growing fast, especially for white goods, as these areas gradually develop.

The Philippines already possesses a good supply chain for electronics manufacturing, and a strong base of manufacturers of parts, components and machinery. This can reduce transportation costs and facilitate the management of the production cycle. As workers in the Philippines are better skilled but more expensive than many Southeast Asian production bases, the country is more suitable for producing higher value-added goods rather than basic items. 

Applicable GSP Benefits a Factor to Consider

The US has been an important trading partner of and investor in the Philippines, thanks to historical ties between the two. The Philippines ranks among top US beneficiaries of the Generalised System of Preference (GSP) system, alongside Brazil, Indonesia, Thailand and Turkey. Duty-free treatment is granted to about 5,000 lines of Philippines-originating products.

The Philippines was once a big supplier of ready-made garments (RMG) and apparel to US brands including Ralph Lauren and Coach. However this sector has been heavily hit by the exclusion of textiles, apparel and footwear (TCF) from the GSP list since 2015. The Philippines has since become a less attractive option for RMG and apparel manufacturing, after losing the competitive GSP advantage. This has narrowed the choices over the relocation of labour-intensive manufacturing industries to the country.

English-Speaking Skilled Labour Available

Labour costs in the Philippines are on the higher side among ASEAN production bases, as shown by the figure below comparing the minimum wage in selected ASEAN countries.  At a glance, wage levels in the Philippines are similar to those of Malaysia or Indonesia, while notably higher than wage levels in Vietnam and Myanmar.

Chart: Monthly Minimum Wages of Selected ASEAN Countries
Chart: Monthly Minimum Wages of Selected ASEAN Countries

The manufacturing minimum wage in the NCR, where the majority of foreign investors set up their operations, is about US$9 per day (within a range of PHP454-490). This translates into a monthly worker compensation including benefits of US$200-300 in the NCR. The country’s lowest minimum wage, applicable to the poorer regions, is about US$7 per day (around PHP265).

The Philippines promotes the trainability and skill levels of its labour over price. It is ranked 13th in the EF English Proficiency Index[1], behind only Singapore and Malaysia in Asia. Most Filipino workers are fluent in English, which makes it easier for management and training by foreign business owners. Compared with workers in other ASEAN countries, Filipino workers are considered more trainable and capable of conducting higher-level tasks.

As indicated by the figure below, the education level of the Philippines’ labour force is notably higher than many ASEAN countries. About 21% of the labour force in the Philippines is educated to tertiary level, even higher than in Singapore (16%). Almost six out of 10 (57%) of the Philippines’ population has attained secondary education. In the human capital study done by World Economic Forum, the Philippines scored well among ASEAN countries in ease of finding skilled employees, beaten only by Malaysia and Singapore[2].

Chart: Highest Level of Education Attained
Chart: Highest Level of Education Attained

Skilled middle management, which is always more difficult to hire and train locally in developing ASEAN countries, is plentiful in the Philippines. Tertiary-educated graduates stand ready to take up skilled roles. Hence the Philippines is more suitable for producing higher value-added items, such as semiconductors and electronics, and taking up higher-level roles in the supply chain.

Verte or locally known as Luenthai Philippines, a subsidiary of the Luen Thai Holdings producing fashion items and apparel, shared with HKTDC Research that the strength of their production line in the Philippines lies largely on its product development, design and advanced value added features in wash and print capability. It conceded that the group’s Vietnamese and Cambodian production lines have yet to acquire the skills and sophistication in handling those tasks, and Luenthai Philippines continues to provide the balance and the edge.

 

Luen Thai Holdings Ltd

Listed on the Hong Kong Stock Exchange with production bases in China and Southeast Asia, Luen Thai Holdings is one of the world’s largest garment manufacturers. In recent years, the group has taken up the manufacturing opportunities in ASEAN countries and further expanded its manufacturing and supply chain services operations in the region, spanning Vietnam, the Philippines, Cambodia and Indonesia.

 

Good Infrastructure and Connectivity in Freeport Zones

Geographically, the Philippines is situated close to the southern and eastern coast of China. The direct flight time from Hong Kong to Manila is slightly over two hours, actually shorter than to Ho Chi Minh City (HCMC) in Vietnam and comparable to travel times to Hanoi. However, there are more flights between Hong Kong and Manila than to either HCMC or Hanoi. The country can reach all ASEAN capitals, major cities along the coast of China and as far north as Seoul and Tokyo within five hours' flight time. Shipping from the Philippines can reach Hong Kong and Kaohsiung within one day.

Map: the Philippines and its Neighbours
Map: the Philippines and its Neighbours

Despite strong air connections with Hong Kong, the Philippines has been faulted for its under-developed infrastructure, which to an extent affects investor interest. The locational advantage of the Philippines is also offset by its being an archipelago state of 11 major islands and some seven thousand small ones. Despite the Philippine government placing stronger attention on enhancing the country’s infrastructure, it has been, statistically speaking, under-investing in infrastructure, at about 1.7 to 2% of GDP a year, with huge differences in infrastructure provision across the country.

In an attempt to tackle these infrastructure deficiencies, the Duterte administration has launched the “Build Build Build” initiative, with an ambitious target to raise infrastructure spending to 7% of GDP by 2018-2019 through increasing government spending and private-public partnership (PPP) schemes. The development of transport facilities, including railways, urban mass transit, airports and seaports, is a big part of the initiative. The manufacturing sector is expected to benefit from the Manila-Clark Railway, Clark International Airport extension and the Subic-Clark Cargo Railway project, which will improve freight movements between Metro Manila and the Clark and Subic freeport zones. Other economic zones in the peripheral areas will also benefit from the projects.

Luzon-based Manufacturing

Manufacturing facilities are mainly located in Central and Southern Luzon, the most developed part of the Philippines. Despite suffering from notorious traffic congestions in Metro Manila and over capacity at Manila port, Central and Southern Luzon offer the best infrastructure in the country and the best external connectivity. Fast-growing regions near Metro Manila such as Cavite and Pampanga are well-connected to the NCR by highways. Regional ports are also available.

Freeport zones converted from former military bases such as Clark and Subic possess comprehensive infrastructure for manufacturing, including well-paved four or even six-lane highways, ports and airports. At present, the Clark International Airport, Subic Bay International Airport and Port of Subic Bay are not fully utilised, with good room for expansion. The Clark International Airport has cargo flights to Taipei, Guangzhou and Shenzhen and runs direct passenger flights to Hong Kong. The Subic airport only serves passenger flights.

Comprehensive community facilities, such as residential units, entertainment and leisure facilities, resorts, clinics and international schools, are also available in these freeport zones, offering a good living environment for expat workers. Details of investment incentives and assessment of freeport zones and economic zones will be discussed in a separate, forthcoming article.

Photo: Resort under development in Clark Freezone.
Resort under development in Clark Freezone.
Photo: Resort under development in Clark Freezone.
Resort under development in Clark Freezone.
Photo: Wide and well-paved roads in economic zones.
Wide and well-paved roads in economic zones.
Photo: Wide and well-paved roads in economic zones.
Wide and well-paved roads in economic zones.

Summary

The Philippines contrasts well with other relocation hotspots in Southeast Asia in terms of human resources. With wages near the high end of the ASEAN manufacturing pay scale, however, it may not appear to be the best location for labour-intensive production, particularly RMG and apparel manufacturing. Yet the skilled and highly trainable English-speaking workforce may prove attractive to those foreign investors who want to avoid the managerial challenges and training impediments typically found in many alternative production bases in Southeast Asia. Infrastructure provision in the Philippines, while poor generally, is showing some encouraging signs of improvement in areas within and near Metro Manila.


[1]  EF English Proficiency Index 2016

[2]  Human Capital Outlook: ASEAN 2016, World Economic Forum

Content provided by Picture: Kenix Lee
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