Toward a National Competition Policy for the Philippines · PDF fileAn Overview of the Philippine Cement Industry ... Figure 1. Assets of the Philippine Financial System, by Type of

Toward aNational Competition Policy

for the Philippines

Philippine APEC Study Center Network

PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES

Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas

edited byErlinda M. Medalla

Copyright 2002by the Philippine APEC Study Center Network (PASCN)and the Philippine Institute for Development Studies (PIDS)

Printed in the Philippines. All rights reserved.

The findings, interpretations and conclusions in this volume are thoseof the authors and do not necessarily reflect those of PASCN and PIDSand other institutions associated with the PASCN project on competition policy.The publication of this volume was funded by PASCN and PIDS. The membersof 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 Agencyand 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 SECRETARIATPHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIESNEDA sa Makati Building106 Amorsolo St., Legaspi Village1229 Makati City, PhilippinesTel. no.: PASCN (63-2) 8939588, 8925817; PIDS (63-2) 8935705, 8924059Fax no.: PASCN (63-2) 8939588; PIDS (63-2) 8939589, 8161091E-mail: [email protected]; [email protected]: http://pascn.pids.gov.ph; http://www.pids.gov.ph

ISBN 971-564-052-4RP 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.

FOREWORD ............................................................................................................xvii

CHAPTER 1Overview and Integrative ReportErlinda M. Medalla

Introduction ....................................................................................................... 1Objectives and Role of Competition Policy ...................................................... 4Implications and Findings from the Sector Studies ......................................... 9Elements of a Rational Competition Policy for the Philippines

and Recommendations for an Antitrust Legislation ............................... 16Concluding Remarks: Issues in Competition Policy

and Other Considerations ....................................................................... 24Bibliography .................................................................................................... 30

CHAPTER 2The State of Competition in the Philippine Manufacturing IndustryRafaelita A. Mercado-Aldaba

Abstract ........................................................................................................... 33Introduction ..................................................................................................... 34Theoretical Underpinnings of Competition Policy ........................................ 35Review of Literature ........................................................................................ 40Assessment of the Overall Performance of the Manufacturing Sector

Before and After Trade Policy Reforms .................................................. 44Analysis of Industry Structure and Competition

in the Manufacturing Sector ................................................................... 49Conclusions and Policy Recommendations .................................................... 59Bibliography .................................................................................................... 61

CHAPTER 3Of Cartels and Collusion: An Analysis of the Philippine Cement IndustryRafaelita A. Mercado-Aldaba

Abstract ........................................................................................................... 65Introduction ..................................................................................................... 66Basic Concepts and Theories .......................................................................... 67An Overview of the Philippine Cement Industry ........................................... 71Competition Analysis ..................................................................................... 73Conclusions and Policy Recommendations .................................................... 94Bibliography .................................................................................................... 97

TABLE OF CONTENTS

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CHAPTER 4Competition Policy and the Philippine Downstream Oil IndustryPeter Lee U

Abstract ........................................................................................................... 99Introduction ................................................................................................... 100RA 8180 and Tatad vs. Viray ....................................................................... 111Price Setting in Philippine Gasoline:

Law of One Price or Collusion? ............................................................ 121To Exchange or Not To: A National Oil Exchange? .................................... 131Deregulation Experiences and Lessons from Other Countries .................... 139Summary and Conclusions ........................................................................... 149Bibliography .................................................................................................. 150Appendices .................................................................................................... 152

CHAPTER 5Competition in Philippine Telecommunications: A Survey of the Critical IssuesRamonette B. Serafica

Abstract ......................................................................................................... 157Introduction ................................................................................................... 158The Role of Competition Policy

in Philippine Telecommunications ....................................................... 158The Market Environment of Philippine Telecommunications ..................... 160The Nature of Competition at the Local Level: Three (3) Cases ................. 167Postliberalization: Issues and Concerns ....................................................... 172Threats to Competition ................................................................................. 176Recommendations ......................................................................................... 181Bibliography .................................................................................................. 183Appendices .................................................................................................... 184

CHAPTER 6The State of Competition and Market Structure of the Philippine Air TransportIndustryMyrna S. Austria

Abstract ......................................................................................................... 189Introduction ................................................................................................... 190Contestability of Markets: Its Applicability

to the Air Transport Industry ................................................................ 191Regulatory Framework for International Air Services ................................. 193Policy and Regulatory Regimes

of the Philippine Air Transport Industry .............................................. 201

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Regulatory and Policy Regimes: Their Effects on theState of Competition and Market Structure .......................................... 206

The Role of CAB in a Deregulated Environment ........................................ 231Implementing Guidelines for EO 219 .......................................................... 231Areas for Competition Policy ....................................................................... 236Summary and Conclusions ........................................................................... 240Bibliography .................................................................................................. 241Appendices .................................................................................................... 242

CHAPTER 7Analysis of the State of Competition and Market Structure of the Bankingand Insurance SectorsMelanie S. Milo

Abstract ......................................................................................................... 253Introduction ................................................................................................... 254Regulatory Framework ................................................................................. 255Trends in Market Structure and Performance .............................................. 276Competition Policy Issues in the Financial Sector ....................................... 291Some Conclusions ......................................................................................... 302Bibliography .................................................................................................. 303

CHAPTER 8Government Policies and Regulations: Interface with Competition PolicyErlinda M. Medalla

Abstract ......................................................................................................... 307Introduction ................................................................................................... 308Philippine Trade Policy and Competition .................................................... 309Government Policies and Regulations and Competition Policy .................. 311Other Government Policies and Their Interface

with Competition Policy Objectives ...................................................... 320Summary and Conclusions ........................................................................... 324Bibliography .................................................................................................. 325Appendices .................................................................................................... 327

CHAPTER 9Recommendations for Philippine Antitrust Policy and RegulationAnthony R. A. Abad

Abstract ......................................................................................................... 339Introduction ................................................................................................... 340Survey of Existing Antitrust Laws and Regulations in the Philippines ...... 342

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Assessment of Antitrust Regulation in the Philippines ..................................357Recommendations for a New Legal and Regulatory Framework .....................362Bibliography ...................................................................................................382Appendices ....................................................................................................386

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

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

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

CHAPTER 4Figure 1. Flowchart of Petroleum Industry Production ............................. 104Figure 2. Schematic Diagram of Oil Recovery .......................................... 105Figure 3. Market Share of Oil Companies ................................................. 109Figure 4. Historical Prices of Oil ............................................................... 110Figure 5. Simple Product Flow of the Philippine Petroleum Industry

(downstream only and for retail) ........................................ 122Figure 6. Positive Price Shock Case .......................................................... 126Figure 7. Game Matrix .............................................................................. 126Figure 8. Game Matrix for Positive Crude Oil Price Shock ..................... 127Figure 9. Downward Price Shock Case ..................................................... 129Figure 10. Game Matrix for Negative Crude Oil Price Shock .................... 129Figure 11. Game Matrix for Positive Crude Oil Price Shock ..................... 129Figure 12. Unleaded Gasoline and Diesel Price Buildup, August 2000,

MOPS Based (in peso per liter) .......................................... 134Figure 13. Welfare Analysis (of lower marginal cost) with NOEC ............ 137Figure 14. A Bilateral Monopoly ................................................................. 139Figure 15. US Gasoline Distribution Structure ........................................... 143Figure 16. Share of US Gasoline Retail Establishments ............................. 144

CHAPTER 5Figure 1. Fixed Lines Market Shares ........................................................ 164Figure 2. Cellular Mobile Market Shares, 1998 ........................................ 165Figure 3. Interconnecting Carriers and Services ....................................... 173

LIST OF FIGURES

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CHAPTER 6Figure 1. Average Fare by Airline per Sector, 1997-1999 (P) .................. 219Figure 2. Market Share in Total Revenues of Airlines, 1995-1998 (%) ... 221Figure 3. Domestic Passenger Traffic

and Its Annual Growth Rate, 1990-1999 (%) .................... 223Figure 4. Used Entitlements as a Percentage of Negotiated Entitlements,

Philippines and Foreign Countries, 1996 (%) .................... 225Figure 5. Distribution of International Passenger Traffic,

to and from the Philippines, 1990-1999 (%) ...................... 229Figure 6. International Passenger Traffic, Philippines, 1990-1999 (%) ... 236Figure 7. Tourist Arrivals, Philippines, 1990-1999 (%) ........................... 237Figure 8. Tourist Receipts, Philippines, 1990-1999 (%) ........................... 238

CHAPTER 7Figure 1. Assets of the Philippine Financial System,

by Type of Institution, 1970-1999 (in billion P) ................. 277Figure 2. Distribution of Commercial Bank Assets,

by Type of Bank, 1980-2000Q1 (%) ................................... 281Figure 3. Measures of Commercial Bank Asset Concentration,

1980-2000Q1 ....................................................................... 282Figure 4. Measures of Asset Concentration in the Insurance Industry,

1970-1998 ............................................................................ 290

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CHAPTER 2Table 1. Empirical Evidence on Existing Barriers

to Competition in Manufacturing ......................................... 43Table 2. Effective Protection of Philippine Manufacturing Industries:

1983, 1988 and 1994 ............................................................. 46Table 3. Structure of Value Added (1985=100) ........................................ 47Table 4. Structure of Employment ............................................................. 48Table 5. Sector Shares and Growth Rates: Philippines, Indonesia,

Malaysia and Thailand .......................................................... 49Table 6. Distribution of Manufacturing Value Added ............................... 50Table 7. Average Annual Growth Rates of Selected

Economic Indicators in the Manufacturing Sector ............... 51Table 8. Capital Intensity, Capital Productivity and Labor Productivity

in the Manufacturing Sector ................................................. 53Table 9. Firm Size Distribution in Philippine Manufacturing:

1972, 1983, 1988, 1994 and 1995 (%) ................................. 55Table 10.1.Concentration Ratios and Performance Indicators

Manufacturing Sector: 1988, 1994 and 1995 ....................... 56Table 10.2. Correlations Between Concentration and Industry Profitability ..... 57Table 10.3. Estimates of the Concentration-Profits Relationship ................... 57

CHAPTER 3Table 1. Industry Ownership Structure Prior to the Asian Crisis ............. 74Table 2. Ownership Structure After the Asian Crisis ................................ 76Table 3. Market Shares ............................................................................... 78Table 4. Four-Firm Concentration (CR4) Levels and HHI ........................ 80Table 5a. Industry Price-Cost Margin .......................................................... 81Table 5b. Price-Cost Margin (PCM) by Firm .............................................. 82Table 6. Cement Imports (in 40 kg bags) ................................................... 83Table 7. Average Prices, Excess Supply and Industry Capacity,

1990-1999 (In ‘000 40 kg bags) ........................................... 86Table 8. Monthly Changes in Average Ex-Plant Prices (Jan-May 2000) ..... 88Table 9. Average Production Cost per Bag ................................................ 90Table 10. Economic Performance of the Cement Industry, 1996-2000 ....... 93

LIST OF TABLES

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CHAPTER 4Table 1. Oil Production (in barrels) – Philippines ................................... 102Table 2. Industry Retail Outlets ............................................................... 103Table 3. Players in the Downstream Oil Industry .................................... 106Table 4. Total Number of Gasoline Stations ............................................ 107Table 5 New Player Gasoline Stations (as of December 31, 2001) ........ 108Table 6. Market Share by Sector (%) ....................................................... 109Table 7. Thailand Service Station Growth ............................................... 142Table 8. Oil Industry Service Station by Contractual Arrangement

(as of May 2000) ................................................................. 148

CHAPTER 5Table 1. Number of Authorized Carriers ................................................. 161Table 2. Scope of Services ........................................................................ 162Table 3. Service Areas .............................................................................. 163Table 4. Comparison of WTO Reference Paper vs. Philippine

Commitment: Section on Competitive Safeguards ............. 177Table 5. Comparison of WTO Reference Paper vs. Philippine

Commitment: Section on Interconnection .......................... 177

CHAPTER 6Table 1. Size of Fleet, Type of Aircraft and Destinations Served,

by Airline, 1999-2000. ........................................................ 207Table 2. Domestic Passenger Traffic, by Airline, 1994-1999 .................. 208Table 3. Seat Capacity per Airline, 1990, 1994-1999 ............................. 209Table 4. Measure of the Degree of Effective Competition,

Domestic Air Industry, 1996-1999 ..................................... 210Table 5. Measure of the Degree of Domestic Competition, per Route,

1995-1999. ........................................................................... 211Table 6. Number of Domestic Flights, per Route, per Week, per Airline,

1999-2000 ............................................................................ 213Table 7. Market Share per Sector, per Airline, 1995-1999 (%) .............. 214Table 8. Growth Rate of Domestic Passenger Traffic, per Airline,

1994-1999(%) ...................................................................... 217Table 9. Percentage Difference of Fares in Domestic Flights,

1997-1999 (%) .................................................................... 220Table 10. Real Growth Rate of Fares per Airline,

by Major Sector, 1997-1999 (1990 prices) (%) .................. 220Table 11. Revenue and Income, by Airline, 1995-1998 (P Million) ......... 222Table 12. Measure of Degree of Competition, by Country, 1990-1999 ..... 227

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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 Trafficper 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 Countryof Residence, Philippines,1991-1999(%) ........................... 235

CHAPTER 7Table 1. Authorized Activities According to Type of Bank..................... 263Table 2. Limits on Equity Investments of Commercial

and Universal Banks ........................................................... 265Table 3. Minimum Capital Requirements for New

and Existing Insurance Companies .................................... 275Table 4. Number of Financial Institutions, 1980-June 1999 ................... 279Table 5. Number of Commercial Banks by Type of Bank,

1980-2000 Q1 ...................................................................... 279Table 6. Mergers and Acquisitions in the Commercial

Banking Sector, 1998-2000 ................................................. 280Table 7. Ownership Structure of Private Domestic Banks:

Percentage Share to Total Subscribed Capital, 1997/98 ..... 281Table 8. Commercial Banks’ Average Spread

and Rates of Return (%) ...................................................... 287Table 9. Share of the Insurance Sector in Total Financial

and NBFIs Assets, 1980-1998 (%) ..................................... 287Table 10. Distribution of Total Assets of the Insurance Sector,

1980-1998 ............................................................................ 288Table 11. Number of Insurance Companies by Type of Insurer,

1980-1998 ............................................................................ 289

xiii

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

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

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

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

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

LIST OF BOXES

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CHAPTER 4Appendix 1. Undercutting Price Increases Profits in the

Absence of Capacity Constraints ............................. 152Appendix 2. Best Price Response in the Absence of Capacity

Constraints ................................................................ 153Appendix 3. Selected Relevant Provisions of HB 8710

and HB 12052 ........................................................... 154

CHAPTER 5Appendix 1. Dominant Firm per Province ................................... 184Appendix 2. Relevant Provisions on Interconnection and

Implementing Rules and Regulations of RA 7925 .. 187

CHAPTER 6Appendix Table 1. List of Domestic Airports, by Type .......................... 242Appendix Table 2. Passenger Load Factor per Airline,

by Sector, 1995-2000 (%) ......................................... 243Appendix Table 3. Percentage Distribution of Seat Capacity,

by Major Routes, by Airline, 1995-1999 (%) .......... 246Appendix Table 4. Growth Rate of Passenger Traffic per Sector,

per Airline, 1995-1999 (%) ....................................... 247Appendix Table 5. Measure of Degree of Competition,

per Points Served, 1990-1999 .................................. 249Appendix Table 6. PAL’s Major Destination Points,1990,1995,1999 .... 250Appendix Table 7. Spearman Rank Correlation Test for

Herfindahl-Hirschman Index and Market Shareto Tourists Arrival, 1995 .......................................... 251

Appendix Table 8. Spearman Rank Correlation Test forHerfindahl-Hirschman Index and Market Shareto Tourists Arrival, 1999 .......................................... 251

CHAPTER 8Appendix Table 1. Antidumping Cases, 1985-1995 .............................. 327Appendix Table 2. Industry-Specific Policies and Regulation

with Direct Impact on Competition ......................... 328Appendix Table 3. List of Some Government Corporations .................. 330Appendix Table 4. Special Laws and Agencies Affecting Competition 331Appendix Table 5. Doing Business in the Philippines: A Checklist ...... 333

LIST OF APPENDICES

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Appendix Table 6.Requirements and Supporting Documentsfor Business Name Registration .................................335

Appendix Table 7.Major Policies with Competition Policy Interface ..............336

CHAPTER 9Appendix 1. Philippine Laws and Regulations

Affecting Competition .............................................. 386Appendix 2. Draft Bills in Congress ............................................. 392Appendix 3. Draft Bill for Discussion Purposes ........................... 393

xvii

FOREWORD

Competition policy is increasingly becoming an integral part of economic reformprograms of developing economies like the Philippines. After more than three de-cades of protectionism and highly concentrated industries, the shift toward a moreopen economy through liberalization, deregulation and privatization has highlightedthe role of competition policy in our economy. As we rely more on market mecha-nisms and less on government intervention to achieve economic progress, we needsound competition policy to ensure that the market works effectively and produceseconomic efficiency.

Much of the world is already striving to deal with the impact of globalizationwhere the integration of economies has broken down barriers to trade and openedwide the marketplace. But before we can even think about globalization, we need tocraft our own domestic competition policy. In so doing, we will be able to enhance thecompetitive behavior and technical efficiency of our industries and make them betterto compete with foreign firms. These will eventually make our economy more attrac-tive to foreign investment.

Moreover, since the Philippines has no established competition policy to date andits antitrust law is hardly implemented nor effective, the need for a national competi-tion policy acquires even greater urgency. In this light, we hope that the invaluablewealth of information contained in this book will be useful to and considered by ournational leaders, policymakers and industry players. Conducted by authorities in theirfields of research, the studies in this Volume aim to give us a mold by which to shapean effective Philippine competition policy.

On behalf of the PASCN, I would therefore like to thank and congratulate theauthors of this book for their diligence and commitment in coming up with thesestudies 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, PIDSand Lead Convenor, PASCN

1C H A P T E R

Overview and Integrative Report

Erlinda M. Medalla

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

– Adam Smith

INTRODUCTION

During the past decade, economic literature and policy discussions around theglobe have been increasingly focused on competition policies. It is not thatradically new concepts are being formulated. Rather, a growing need for newapproaches in competition policies is being felt because of its significance to

international trade, which have become highlighted with the reduction of trade barri-ers worldwide.

Although justification for competition policies is well founded in economic lit-erature, there is a need to understand their implications more fully, brought about notjust by what is happening in the global arena but even more importantly by variouscomprehensive policy reforms that have been undertaken by the government duringthe past decade or so.

2 TOWARD A NATIONAL COMPETITION POLICY FOR THE PHILIPPINES

The series of competition policy studies undertaken under the Philippine APECStudy Center Network (PASCN) recognizes the need for a new perspective, a new wayof understanding the issues and hopefully, a better approach to reforming economicpolicies. The reforms starting in the mid-1980s have done much to move the economytoward a more market-friendly policy environment. Trade reforms, banking reforms,foreign investment policy reforms, deregulation, privatization and the policy thrustsin 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 examinethe state of competition in the Philippine economy and determine how competitionpolicies that would help sustain and maximize benefits from the reforms could beformulated.

The studies presented in this volume are envisioned to be just the first stagetoward achieving a workable competition policy for the Philippines. Given the de-cades of protectionism and regulation prior to reforms, a culture of competition in thecountry has not fully evolved. And while there may be a general consensus that “com-petition is good,” there is vagueness in the minds of many and uncertainty about theneed for competition policy and how competition should be enforced. As the govern-ment becomes more involved in the development process in general and markets inparticular, such a need would become more acute. It is ironic that for a developingcountry with usually less perfect markets, there is a greater need for an effective com-petition policy to encourage better use of scarce resources but there is less recognitionof this need. It is thus timely for policymakers to pause and consider how competitionpolicy has affected, promoted, or hindered competition and to look more closely atwhat role it could play.

It is not that the government has done nothing to foster competition. As earliernoted, the reforms the government has implemented starting in the mid-1980s havedone 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 moreapparent. 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 lackof consistent, comprehensive, and rational competition policy.

In short, the Philippines has undertaken major reforms in what could be consid-ered the first layer of competition policy: trade reforms. It has also implementedsteps in what could be considered the second layer of competition policy—deregula-tion—but a lot more needs to be done with respect to how to move it a step furtherand develop more rational “competition rules.” Finally, the government, must,sooner or later, decide to what extent it wishes to implement what could be consid-ered the third layer of competition policy, the core competition policy that dealsdirectly 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 donefurther.

OVERVIEW AND INTEGRATIVE REPORT 3

This volume contains nine chapters. The next six chapters present the respectivestudies on the state of competition for six selected sectors. Chapter 2 provides anoverview of the manufacturing sector; Chapters 3 and 4, respectively, cover two spe-cific manufacturing industries—cement and oil; Chapters 5 and 6, two utilities sec-tors—the telecommunications and air transport industries; and Chapter 7, thefinancial sector. The choice of industries has been guided mainly by where competi-tion policy appears to be most crucial. The main objective of these studies is to assessthe state of competition in the specific sector. In this regard, the studies attempt toprovide some measures on how much competition exists. For most of the studies, thismeans looking at certain measures of concentration and profitability, and examiningprice movements to support the findings. For others, it was enough to look at thenumber of players involved, especially how this has changed over the years. Thesector studies also attempt to examine the regulatory framework, if any is involvedand how, the reforms undertaken, and some indication of the impact of these re-forms.

Knowing how government policy itself could affect competition, Chapter 8 ex-amines the major government policies and the interface with competition policy. Thechapter aims to clarify what important trade-offs may exist and how and possiblywhen conflicts between government policies and competition policy objectives arise.Finally, Chapter 9 reviews the existing antitrust laws, how effective and adequatethese have been and examine the bills that have been proposed.

This particular chapter provides the overview and integration and would alsoserve as the summary and conclusion of these various studies. The ideas and conceptsset forth in this paper are not meant to be novel, as indeed, the economic basis forcompetition policies has long been well established. The main objective is to clarifythe issues and formulate the framework for a workable competition policy for thePhilippines.

To set the framework for discussion, the next section briefly reviews what de-fines a competitive market, the benefits from competition, and the role and objec-tives of competition policy. The following section attempts to assess the state ofcompetition in the Philippines to have a better understanding of what needs to bedone further. To do this, it first looks briefly at the factors affecting the state ofcompetition and then discusses the major findings from the sector studies. Thecompleted sector studies include an overview of the manufacturing sector, cementand the downstream oil industries, two utilities sectors—telecommunications andair transport industries, and the financial sector. The paper then infers in the nextsection what the important elements are of competition policy for the Philippinesand proposes recommendations for an antitrust legislation. A brief assessment ofexisting laws and proposed bills is also provided. Finally, in the conclusion, theissues that confront competition policy and other important considerations in for-mulating and implementing a workable competition policy for the Philippines areaddressed.


OBJECTIVES AND ROLE OF COMPETITION POLICY

Almost everyone has a concept of what is competition. When one thinks of com-petition, one envisions a number of sellers/producers competing among each other tosell 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 patronageof buyers in order to achieve a particular business objective, e. g., profits, sales and/ormarket share. Competition in this context is often equated with rivalry. Competitiverivalry between firms can occur when there are two firms or many firms. This rivalrymay take place in terms of price, quality, service or combinations of these and otherfactors which customers may value,” or

“the process by which economic agents, acting independently in a market, limit eachother’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 themarket 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 toprovide competition. Monopolists and oligopolists would behave like “perfect”competitors when faced with threat of new entrants into the market (Baumol andWillig 1981).

What does such a competitive setting accomplish? Why is competition de-sirable? Or, conversely, what is objectionable about a noncompetitive marketsetting?

If there is competition, whether coming from existing rival firms or from thethreat of new entrants into the market, the seller must make sure that he produces thebest quality products at the least cost and sell his product at the price dictated by themarket. Otherwise, he loses his clientele and his market share to some other sellerwho 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 formerTariff Commissioner Abad puts it), he “profits with honor.” The end result is opti-mized welfare for all.

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1 This is the ability of the firm to dictate prices and the quantity supplied. In the case of amonopoly, the firm’s market power, or how much it can actually increase prices, depends onhow inelastic the demand is for the product. In quantitative terms, this market power is mea-sured by the inverse of the elasticity of demand. In a competitive situation, individual firmsface perfectly elastic demand. That is, demand elasticity approaches infinity, and individualfirms would have no market power.


In contrast, the absence of competition (or market contestability) gives the pro-ducer/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 ofconsumers. He would then have maximized his profits while consumers would beenjoying lower consumer surplus. The end result, this time, is sub-optimal output (athigher prices) and lower overall welfare.

There is perhaps some simplification involved here. For example, some wouldargue that there are cases/industries where excess profits are necessary to encouragereinvestments 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 ofcompetition, firms can become complacent and resistant to new and better ways ofdoing 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 termsof producing more with less (technical efficiency) but also in terms of inducing betterresource allocation (allocative efficiency). Allocative efficiency in a competitive set-ting is encouraged because producers and investors receive the correct market pricesignals that induce them to invest where there are highest returns. In this sense, thepresence of competition is almost synonymous with an efficient functioning of mar-kets. Competition acts as an efficient market regulator that induces production andconsumption at optimal levels and at least costs. As such, the highest overall welfareis made possible as reflected in wider consumer choices, lower prices, and better qual-ity of products.3 But perhaps even more important are the dynamic gains from inno-vation that competition fosters and the flexibility that it develops, on the wholeenabling the economy to cope better with the ever-changing environment.

Aside from these direct benefits, another important and positive implicationof competition is on equity. Competition, by reducing, if not eliminating, the eco-nomic power of certain sectors and providing the best product for the best price, in-trinsically advances equity objectives.

The problem is that, a firm, if it could, would rather avoid competition. In otherwords, consistent with its profit-maximizing objective, a firm has an incentive to tryto gain some market power and exercise some control on how much and at what priceto sell. Such behavior is still consistent with the competitive process if it does so byconstantly 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 inthe enforcement of a competition policy. This may complicate its administration, but if clearefficiency gains can be demonstrated, then such cases could be accommodated by a competitionpolicy, 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 optimumwelfare…that in certain cases, the market would, left to itself, result in loss in efficiency. Thisis elaborated on in the subsequent discussions.


attempt to somehow erect barriers to entry, collude with other firms by enteringinto some form of agreement or engaging in other anticompetitive activities. Inaddition, aside from such tendency of a firm to skirt competition, there are otherfactors that could limit competition, such as the presence of structural barriers toentry of firms.

The point is, in reality, most industries may not entirely possess the characteris-tics of a perfectly competitive model.4 Thankfully, in practice, there need not be acompletely perfect competition for the benefits to be realized. There need only be“effective” competition. Nonetheless, something even less than effective competitioncould tend to occur. Hence, the government may still need to implement policythat would encourage effective competition, or at least make the market morecontestable.

Of course, increasing competition may not always be enough to ensure that themarket would be able to perform its role of allocating resources efficiently. There areinstances of genuine market failures that may require some limitation in competi-tion—when more competition could even cause inefficiencies. In addition, some“rules” or regulation of the market (competition rules) may be needed to mimic thecompetitive process that the market fails to bring about. To illustrate, the most notableof these cases of market failures is the so-called natural monopoly. In such a case, themarket 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 scarceresources. 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 procompetitiveeffects (efficiency gains), e.g., where are there are economies of scope, synergies, andtransaction cost economies. These are discussed more fully in the next chapter.

In short, competition is not the end in itself. Instead, competition policy shouldbe one that promotes competition as long as it encourages efficiency and growth. Inaddition, whenever possible, competition policy should also be made consistent withsocial objectives. These principles are, of course, easier said than actually practiced.Different objectives could lead to conflicts and the resulting trade-offs are often diffi-cult to resolve.

These considerations suggest what the primary role of competition policy shouldbe—to safeguard, protect and promote competition and the competitive processand ensure that the market is able to function effectively and bring about eco-nomic efficiency. While in many instances, this would simply entail making the mar-ket contestable by easing entry of new firms, there would be cases where the market

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4 The main characteristic is the existence of many firms and/or open entry and exit of firms.


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 bringingabout the highest welfare. Hence, competition policy is not necessarily a laissez fairepolicy. It is about ensuring that the market works properly.

In sum, the primary task of competition policy is two-fold: (1) to make sure thatno entity would have market power it can abuse and (2) where necessary, to imple-ment competition rules that would emulate the competitive process and make up forthe market’s lack. As such, competition policy would, first of all, attempt to make themarket as contestable as possible. At the same time, it should be able to disallownaked restraints of trade and discipline firms when such acts are committed. Wheremarket power is inherent (in the structure), enforcement of competition policy shouldeffectively strip the owner of such market power the ability to use (abuse) it. In thisregard, this may require punishing anticompetitive acts with appropriate sanctionsand/or enforcing competition rules to guide the market.

There are several steps involved that are implied in carrying out this task. Thefirst is determining whether or not there is any firm (or concerted group of firms) inthe market that has market power. If yes, the next step is to find out how it has cometo possess such market power. Has it done so by becoming more efficient? Then, thiswould not pose a problem and is intrinsically part of the competitive process. If thefirm gained that market power by deliberately setting out to prevent other firms fromentering the market other than by becoming more efficient (behavioral barriers toentry), then it is committing exclusionary abuse which competition policy (throughan antitrust law) should disallow. If market power arises from structural factors, isthis due to government policy or is it due to the inherent structure of the industry?5 Ifthe former, are there defensible reasons for the government policy or should reformsbe made? If the problem is structural, is government regulation required to enforcecompetition rules? Are these “rules” appropriate? Then, the next step is to determinewhether or not the firm “abuses” that market power and how (exploitative abuse).(The same goes for those who have successfully and consciously erected barriers toentry.) And the final step is to determine the best way to prevent the firm from com-mitting exploitative abuse of such market power. (See Figure 1 for the diagrammaticalpresentation of these steps.)

Two general types of anticompetitive behavior are distinguished here. The first isthe act of the firm itself (or group of firms) to exclude potential firms from enteringthe market by means other than becoming more efficient. This is referred to as exclu-sionary abuse. Examples of such exclusionary abuse include: predatory pricing, ar-rangement to divide the market, unjustly raising rival’s costs, and unjustified refusalto deal with other firms. The second type of anticompetitive behavior mentionedabove is exploitative abuse. This refers to actual abuse of market power, mani-

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5 The different types of barriers to entry are discussed further in the next section.


Figure 1. Decision Tree: Role of Competition Policy

fested in setting prices above competitive levels and limiting supply. A primeexample of exploitative abuse is a cartel agreement to fix prices and/or to limitlevels of outputs.

As always, the primary objective of competition policy is increased efficiency andoverall welfare. Where increased competition could, in certain cases, lead to de-creased efficiency (as in the cases of genuine market failure described above and in thenext chapter), exceptions should clearly be made and limitations in competition al-lowed. Also, there could be instances where competition could give way to a moreurgent social objective if necessary. For example, certain social goods could be pro-vided to disadvantaged groups at less than competitive prices. In other words, compe-tition policy should give allowance for seemingly anticompetitive actions if there areclear public welfare grounds. Hence, although competition policies may not be explic-itly aimed at promoting other social objectives, the overriding and underlying goalremains 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 andobjectives of competition policy. Before proceeding further with the discussion, it istime to construct a more formal definition of competition policy to be clear on what itspecifically refers to. Competition, competition policy and antitrust policy are the keyterms used in the paper. For the purposes of this paper, we use antitrust policy andantitrust law interchangeably to refer to the policy and legal framework that dealsdirectly with anticompetitive behavior of firms. Competition law is also consideredalmost synonymous with antitrust law. What could make it different from antitrustlaw is if the law also provides a wider mandate for the tasked government agency to


carry out competition policy over and above disciplining anticompetitive firm behav-ior. What this could be would be made clearer when the elements of competitionpolicy is discussed later on in this paper.

Finally, we come to competition policy. In its “Concept Paper on CompetitionLaw 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, aswell as redressing anti-competitive results, of public and private restrictive practices.”

The Australia’s Hilmer Report as well as Patalinghug (1997) narrows down thebasic 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 studyaims to look into.

The problem with either definition is that it only describes what competitionpolicy could refer to. As such, neither can pin down what it is. But this is understand-able. For one, competition policy is not always as explicit as, for example, invest-ment policy, agricultural policy, housing policy, etc. and there is no distinct bodywhose main mandate is to promote competition. Second is the applicability of com-petition policy in almost any economic endeavor. As long as there are markets tospeak 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 hasno institutionalized national competition policy. Competition policy may be inherentin 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 andinoperative.

IMPLICATIONS AND FINDINGS FROM THE SECTORSTUDIES

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

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6 Planning and Project Coordination Division (April 7, 1999).


relevant chapters in this volume for more details: Chapter 2 on overview of the manu-facturing sector by Ms. Rafaelita Aldaba, Chapter 3 on the cement industry also byMs. 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 airtransport 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 stud-ies, it would help to look again at these factors. As pointed out earlier in the stepsinvolved in implementing the task of competition policy, it is necessary to identifywhere the market power (if it exists) is coming from.

The first factor to consider is the existence of trade barriers. There is no questionthat 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, andthe market becomes more contestable. Hence, with its widespread impact on thewhole economy, trade policy could act as a major competition policy tool. Indeed, thisis deemed the first layer of competition policy to be implemented.

The barriers to entry of new firms constitute the second major factor affectingthe state of competition. These barriers could be either behavioral or structural (seeBox 1). The former includes attempts of firms to shut out new players. If the firmdoes this by increasing its efficiency, then this is still consistent with the competitiveprocess. However, if exclusion is done through the use of naked restraints oftrade, then this represents anticompetitive behavior that competition policyshould prevent. Structural barriers are those barriers inherent in the nature of theindustry. Whether the implied market power is actually abused or not is whatmatters, and the question is how competition policy is able to deal with potentialabuse of market power.

There are other market failures and rigidities that may lead to limitations oncompetition. Again, this may not be necessarily bad for the economy if there areefficiency 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 naturalmonopolies, where huge capital requirements make duplication unviable and sociallywasteful.

These different factors have different impacts, and hence, have different implica-tions on what kind of competition policy action is needed. Anticompetitive behav-ioral barriers require sanctions from competition policy. Others require allowinganticompetitive setups if there are efficiency gains involved. Still others require evenmore, e.g., the need to enforce competition rules to make up for the failure of themarket to perform its price allocation function properly. Such cases of market fail-ures are those that have been considered as the justification for government regula-tion of an industry. This leads us to the last type of factors affecting the state ofcompetition—those that arise from government policy.


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.

Box 1. Examples of Structural and Behavioral Barriers to Entry


One set of such government policies is entwined with structural factors and mar-ket failure: industry regulations. These industry regulations are essentially a responseto a lack of competitive forces. The question is whether, indeed, the government regu-lation is doing what it is supposed to do, that is, make up for the market’s failure inperforming its proper role of determining the optimum levels of production and con-sumption. Are the right competition rules being applied?

The other government policies, on the other hand, may have other social objec-tives that may nonetheless impact negatively on competition. Such could cover a widearray of government policies. Nonetheless, no matter how essential the stated objec-tives of the policy are, if it seriously conflicts with competition policy, there is enoughreason to question if the policy indeed serves national welfare. This does not presumethat competition policy objectives are superior. Rather, it is always wise to weigh thepossible trade-offs arising from any policy: the losses, if there are, from limited com-petition and the foreseen benefits from the policy (see Medalla, this volume, on theinterface between competition policy and other government policies.)

As such, the PASCN conducted studies on the major utility sectors: telecommuni-cations, air transport, power, and shipping. The other industry studies hopefullywould provide a better understanding of the other sectors of the economy, covering anoverview of the manufacturing sector, the cement industry, and the downstream oilindustry in particular, and the special case of the financial sector.

Past studies on the manufacturing sector have consistently characterized themanufacturing sector as highly concentrated. Most notably, the Barriers to EntryStudy conducted by Lamberte et al. (1992) confirmed the presence of high concentra-tion in Philippine industries, which they attributed to uncontestable markets in theseindustries. Aldaba (this volume) looks at what has happened to the level of concentra-tion in the manufacturing sector during the more recent years, where substantial tradereforms have been implemented. At first glance, the results look alarming. The esti-mates show that the manufacturing sector is still indeed highly concentrated withroughly two-thirds of the manufacturing industry having concentration ratios rangingfrom 70 to 100 percent. On the average, 73.6 percent of value-added were from the topfour firms in each manufacturing subsector.

Subsectors with high level of concentration are mostly intermediate and capitalgoods such as petroleum refineries, glass and glass products, industrial chemicals,pottery, china and earthenware, petroleum and coal products, rubber products, othernonmetallic mineral, paper and paper products, professional and scientific equip-ment, nonferrous metal products, transport equipment, iron and steel, machinery ex-cept electrical, textiles, other chemicals (a borderline case), and fabricated metalproducts. Consumer goods like tobacco, food manufacturing, and food processingalso belong to the high concentration group.

Price-cost margins were estimated as a rough measure of profitability. On theaverage, 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


price-cost margins and high concentration ratios tend to suggest that some monopolyrents are being incurred.

A positive correlation between concentration and profitability in Philippinemanufacturing is noted by Aldaba. She finds two different possible interpretations ofthe results. First, she argues that it is possible that industrial concentration wouldfoster collusion and hence, monopoly pricing (structuralist view). On the other hand,following the efficiency market hypothesis, it could also very well be the case thatsuperior firms in an industry that make a product or cost breakthrough will gainmarket share, causing industry concentration to increase. Broadly interpreted, theefficient market hypothesis states that markets are workably competitive and that themarket structure reflects differential efficiency, not strategic behavior. Dominantfirms owe their position to superior performance, not to strategic behavior or thehistory of entry into the industry, and profits are simply the rents that accrue to supe-rior technology (Stigler 1968 and Demsetz 1973 as cited in Gilbert 1990).

In view of the ongoing structural reforms arising mainly from trade liberaliza-tion at the time, the efficiency market hypothesis appears the more likely explanationin many cases. This is supported by the findings of the various PIDS studies on theimpact of trade reforms (e.g., Medalla et al. 1996; Pineda 1997; Medalla 1998),which noted not only the improved competitiveness of the manufacturing sector asindicated by the reduction in the domestic resource cost ratio but also the generallyincreasing share in the value-added of those firms that had improved competitive-ness.

Not that the structuralist view would not apply in some cases. There would besectors where high concentration would allow and even encourage collusion, exploit-ative and exclusionary abuses.

Nonetheless, what this means is that the high concentration ratios, in the pres-ence of trade liberalization, is not as alarming as it appears. Indeed, this could be thelogical result of restructuring arising from trade reforms, where inefficient firms con-tract and efficient firms expand. What is more important is that markets are mademore contestable under a more liberal trade regime.

Still, even in a liberalized environment, the efficiency of markets is not alwaysguaranteed (World Bank and OECD 1998). While trade liberalization promotes com-petition in domestic markets, there exist various impediments that can dilute theprocompetitive effects of import competition. For example, if the local distributionchannels are somehow tied up with local producers (e.g., through vertical integrationor some vertical agreement like exclusive dealing), then the impact of trade liberaliza-tion may be limited (especially if substantial sunk costs are involved in putting upanother distribution channel). Furthermore, there could be huge transport costs in-volved that could make certain commodities almost nontradable and the reduction intrade policy barrier would not be important.

Finally, there might still be other nontariff barriers involved, which could endowthe domestic firm some market power. This applies, for example, to commodities


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 wewish to maximize the benefits from structural reforms already undertaken. More de-tails are found in the Aldaba study in this volume.

While the discussion provides an overview of the state of competition in manu-facturing, a lot of variation that is important to examine is hidden by simply lookingat manufacturing at such aggregated level. Thus, more specific cases need to be stud-ied. Two such manufacturing studies look separately at the cement industry and thedownstream oil industry.

Cement and oil industries are aptly suitable for comparison. Both produce homo-geneous products. Both are relatively more capital intensive, dominated by a few largefirms, and are popular suspects for cartel behavior. Nonetheless, despite these strongsimilarities, the findings differ. There is evidence of collusion, whether tacit or not, inthe case of cement but no definite findings for the oil industry. The former is based onthe finding of widely differing manufacturing costs in the presence of harmoniousmovements in prices and very low capacity utilization. Aldaba concludes that suchobserved behavior is inconsistent with competitive behavior and could only be ex-plained within a framework of some coordination, tacit or otherwise. Peter Lee U (thisvolume), on the other hand, offers explanation for the apparently synchronized pric-ing behavior of oil companies that does not imply collusion. Rather, the behavior hadto 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 provisionrequires heavy burden of proof that is almost impossible to obtain under the presentadministrative constraints. Meanwhile, what happens is a lot of lobbying from differ-ent sides, making the issues more political than it should be. If there were an effectivecompetition 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 industryregulation. The sectors covered all involved essential (bottleneck) facilities, whichjustify the need for the industry regulation. In general, the studies show that signifi-cant reforms have been implemented (or will be implemented in the case of the powersector) in terms of liberalization and deregulation, which have led to the introductionof greater competition and resulted in substantial benefits. At the same time, a num-ber of questions remain and new challenges and issues are created requiring newapproaches to sustaining these benefits. Unbundling the services to separate segmentsthat should be subject to greater competition is among the important parts of thereforms that should be sustained. Another key area for improvement is formulating aclear 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


utilities is the rate of return to base regulation that limits returns to 12 percent. Inaddition, some product (service) price setting is enforced. For example, in telecom-munications, 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 itseems reasonable that this is where the regulator takes over. Price fixing is also verypolitically appealing. However, as often experienced in many countries, governmentprice fixing often creates more problems than it solves. A major reason is informationproblem. It is difficult to predict demand and supply. Data on costs are difficult tocome by.

Sometimes, the problem is the point of price of intervention. Take the case oftelecommunications. End-user price (price paid by consumers) is set by NTC butinterconnecting carriers are allowed to negotiate access charges between them (inter-mediate price). A firm (the one enjoying network externalities) can effect a pricesqueeze in its effort to gain market power before the regulator can step in. One canthus question if it would be better for the regulator to intervene at the intermediatelevel and deregulate end-user price where enough competition exists. This wouldalso lower the cost of negotiation. Just imagine the costs involved with N carriersnegotiating bilaterally per product (service) for M types of products. Another ex-ample is the rate of return cap. This is where the rationale is more difficult to com-prehend. Presumably, the rate of return regulation is an alternative to user pricefixing and is much easier to manage and determine. However, if government wantsinvestments 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 noteven enough to cover interest costs. It creates, for prospective investors, “regulatoryrisks” on top of the commercial risks they already have to face. (If the firm makesmoney, it runs the risk of losing it because of the regulation.) Moreover, to a largeextent, the regulation only encourages cheating and effectively forces out of the mar-ket honest new players.

A related issue to price regulation that needs to be reviewed is the policy of crosssubsidization that complicates the process even more. There is a need to reevaluatethe costs and benefits of cross-subsidization. This has been used as a reason for limit-ing entry (to prevent new entrants from “skimming off the top”). In the first place, itis 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 morein-depth analysis). The case of financial regulation is perhaps of most unique impor-tance because of the nature of the financial sector and its vital link to the rest of theeconomy. The financial sector regulation can be justified on two grounds, two casesof market failures: (1) the presence of asymmetric information and (2) the presence


of systemic risks. Perhaps the more compelling of the two is the second. The risk to onebank is a risk to all. The failure of one bank can cause the failure of others, if not of thewhole 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 ofthe banks and the payment system. This means prudential regulations. It does notmean, however, limiting the number of firms per se. This means disallowing entryonly if the entrant could not prove its soundness and stability. The financial sector hasmade some strides in this area and these appear to have resulted in benefits mani-fested in the better and wider array of services available.

Finally, an emerging problem common to all is the recent trend toward mergersand acquisition. This could very quickly worsen the state of competition in thesemarkets. Again, this highlights the need for competition policy, especially for an ef-fective antitrust law dealing with mergers and acquisitions. More importantly, thedistortions in some of the regulations are increasingly recognized (e. g., access chargefor universal application that has created asymmetry between firms, especially be-tween 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 stateof competition, and as to what would be the ideal “competition rules” where they areneeded to compensate for the failure of the market to bring about a competitive process.

ELEMENTS OF A RATIONAL COMPETITION POLICY FORTHE PHILIPPINES AND RECOMMENDATIONS FOR ANANTITRUST LEGISLATION

In the previous sections, several key points emerge from the discussion and mustbe highlighted. These are summarized as follows:

• In general, there are clear benefits from competition. These arise mainlyfrom greater efficiency (technical and allocative) that ultimately translatesinto increased welfare.

• It is the contestability of the market that matters more than the actual num-ber of existing firms in creating a competitive environment. Moreover, whilein reality, perfectly “perfect” competition may not be present, an “effective”competition in actual cases may be enough for the benefits from competitionto be realized.

• The primary objective of competition policy is increased efficiency and over-all welfare. Its role is to safeguard, protect, and promote competition andthe competitive process and ensure that the market is able to functioneffectively.

• A firm has a tendency to try to gain some market power. It could do so byconstantly trying to become more efficient; in which case, there is no prob-


lem as this is consistent with the competitive process. But given enoughlatitude, it can also attempt to do more by somehow erecting barriers to entry(behavioral barriers). Such exclusionary abuse is something the antitrust lawshould address.

• For certain products, there could be structural barriers to entry that couldmake the market uncontestable and would naturally lead to monopolisticmarket structure (or concentration). Such monopolistic setups could allowfirms to abuse its market power (exploitative abuses). The antitrust lawshould be designed to effectively prevent such abuses.

• The primary task of competition policy is twofold: (1) to make sure that noentity would have market power it can abuse and (2) to implement, wherenecessary, competition rules that would emulate the competitive process.

• There could be efficiency gains for certain noncompetitive setups; that is, notall exclusionary actions and market concentrations are indications of abuseof market power. There could be noncompetitive setups that are beneficial un-der certain circumstances, e.g., presence of externalities of scope and synergies.

• Finally and to some, the most important, there is a need to reexamine gov-ernment policies and regulations in the light of its impact on competition.The studies on utilities show the complexities of industry regulation. Thesectors covered all involve essential (bottleneck) facilities that justify theneed for the industry regulation. In general, the studies show that significantreforms have been implemented (or will be implemented in the case of thepower sector) in terms of liberalization and deregulation, which have led tothe introduction of greater competition and resulted in substantial benefits.However, much more needs to be done.

ELEMENTS OF A RATIONAL COMPETITION POLICYThese 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 aserious need to reexamine and reevaluate government policies that impact on compe-tition. Such tasks, however, would not be complete, and in many cases, would bedifficult to carry out without the necessary information and education campaign aswell as adequate advocacy work. There are thus four major elements of an ideal com-petition policy for the Philippines.

• Creation and enforcement of antitrust legislation aimed at preventing re-strictive business practices that significantly lessen competition and resultin abuse of dominant position, inefficiency, and reduction in welfare;

• Review of government regulations and policies with respect to its impact oncompetition and competition policy objectives;

• Advocacy for competition policy to facilitate and implement the required re-forms in government policy with welfare-reducing anticompetitive effects; and

• Information and education campaign.


In all these elements, the role of competition policy and the relevant competitionpolicy authority should be both reactive and proactive. These elements fit quite wellwith 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 competi-tion policy. Such a framework for competition policy would be able to address themajor concerns and primary tasks of competition policy noted above. Another impor-tant point to emphasize is that although the chart appears to indicate a central compe-tition policy body, this need not be necessarily the case. The linkages in the fourelements could be as close as to what is feasible, or as loose as what it could actuallybe. For example, the task of reviewing government policies and regulations could beundertaken by the government agency involved, although this may not be the ideal. Insum, the final form the organizational setup takes should ultimately depend on whatis most administratively feasible and efficient.

Figure 2. Decision Tree: Framework for Competition Policy

Creation and enforcement of an effective antitrust lawAn effective antitrust law is necessary to implement competition policy. This

antitrust legislation is aimed primarily at preventing restrictive business practices andabuse of dominant position. At the same time, it should allow for limitation in compe-tition on grounds of efficiency (arising from market failures discussed earlier) or clearpublic interests. Hence, it should include in its findings whether, for example, thedominant position resulted from exclusionary abuse or increased efficiency. It should


be specific on what are the prohibitions per se (that is, what anticompetitive acts areprohibited outright) and what should be subject to a “rules of reason” competition test.It should have provisions for dealing with mergers and acquisition, provisions onagreements, and provisions for dealing with cartels, monopolies, and abuse of domi-nant position.

Considering the encompassing nature of competition and the interrelationshipsand linkages between sectors, it should also be general in application—that is, appli-cable to all sectors, regardless of ownership. Thus, even firms under certain regula-tory boards should be subject to the discipline of the antitrust law. The objectives ofthe regulatory board would not be violated, as the law would have enough allowancesfor efficiency and public interest justification. Indeed it should benefit from the disci-pline it enforces.

More detailed discussion of what would constitute an effective antitrust law isdone later in the chapter, with the analysis of the present legal framework and recom-mendations for an antitrust legislation.

Review of government regulations and policiesPerhaps even more crucial to undertake is the review of government policies and

regulations. If the objective is to improve the competitive environment, what is prob-ably most worthwhile to tackle would be to reform government policies and regula-tions that directly interfere in the market. As earlier pointed out, this is mainly forthree reasons: (1) their impact on the state of competition is most direct and morevisible; (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 furtheroff before the crafting of a more effective antitrust legislation.

In particular, the major tasks involved in the review of government regulationsand 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 in-

dustry where more competition may be introduced• And introduce competitive neutrality in government businesses.

From these review activities would result more definite competition rules, par-ticularly on access to essential (bottleneck) facilities and price regulations. Further-more, the review would cover ways to improve the administration of the antitrustlegislation and build up the administrative capability of its enforcement.

In addition, but possibly with less priority, competition policy should also ideallybe able to review and reexamine major government policies, including industrial andagricultural policies, in the light of competition policy objectives.


Competition policy advocacyIf the required policy reforms made consistent with competition policy objective

are to be implemented, vigorous advocacy is required. The competition policy author-ity, 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 bedone without inputs from a rigorous and careful review of the relevant policies inquestion. Review should cover identifying gainers and losers. They should be able toidentify problems, trade-offs and possibly weigh benefits and costs of policy. In par-ticular, studies on the impact of competition policy reforms that could support itsadvocacy would be needed.

Studies, however, are not enough. Organizations should also be present to carryout the actual advocacy work. A networking system would need to be developed. Waysand means to mobilize consumer and other advocacy groups should be institutional-ized. This is related to the next element discussed below.

Education and information campaignFinally, education and information campaign on competition policy and laws

should be an integral part of the process. After more than three decades of tradeprotection and before trade reforms were implemented, in addition to having beenunder two decades of martial rule, it is not surprising that there is a lack of publicawareness about what competition really means and what it entails. What could becartel behavior such as collusion and other anticompetitive actions are viewed as partof 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 politicallysensitive commodities (e. g., oil). The fact that certain businesses are big is enough todraw conclusions of “unfair” competition. These perceptions are well ingrained andwould be difficult to change. A lot of education and information campaign is neededfor competition policy to be successfully implemented. And this should be a clear andmajor function of the competition policy body.

To perform this task, it would be necessary to mobilize the relevant groups in thecommunity, particularly those who understand and support competition in the varioussectors—consumers, politicians, and in the business community itself. Enlisting thehelp and mobilizing consumer groups, in particular, would help build awarenessabout competition and build constituency for needed reforms.

Figure 3 illustrates, in sum, the potential outputs envisioned from such a workingcompetition policy.

RECOMMENDATIONS FOR AN ANTITRUST LEGISLATIONThe core of the competition policy is the antitrust legislation aimed at pre-

venting restrictive business practices that significantly lessen competition and resultin abuse of dominant position, inefficiency, and reduction in welfare. What should bethe provisions and framework for an effective antitrust policy and law?


Assessment of existing antitrust legislationDespite 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, norhas existing competition in other sectors of the market been enhanced. Present lawsfor promoting competition in the Philippines have proven inadequate or ineffective tostave 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 implementedas may be seen in the lack of cases litigated in court. The same laws have even workedto discourage competition.

Several reasons have been forwarded to explain the lack of enforcement of com-petition 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 enforce-

ment agencies, responsibility is too diffused and accountability for implementation ofthe laws is difficult to fix.

Figure 3. Potential Outputs of a Working Competition Policy


Some regulators are unable to relate all the different existing laws and regu-lations. (Khemani 1996) Moreover, there is a lack of expertise in the apprecia-tion and implementation of competition laws that rely heavily on economicthought, techniques of analysis and value preferences as tools of enforcement(Khemani 1996).

The identification of a single specialized agency, under a specific competitionlaw, with the necessary expertise and authority to oversee the enforcement of compe-tition 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 regulatesthe 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 lawsthat established them. The objectives behind each of these laws are unquestionablynoble. However, inasmuch as each law is meant to address specific situations, thereruns 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 sothat the case may prosper—proof beyond reasonable doubt—is difficult to obtain. Inaddition, the witnesses and/or aggrieved parties, because of the long tedious legalprocesses involved, are themselves not interested in putting the perpetrators behindbars; rather they are more interested in obtaining an injunction or cease-and-desistorders. Moreover, fines are inadequate to deter would-be criminals (Khemani 1996).An administrative enforcement mechanism that can be implemented faster with heftyfines as penalties for unfair competition would be more effective.

• Lack of Jurisprudence on CompetitionThe judiciary has scarcely had the opportunity to pass upon the proper applica-

tion of the various laws on competition, partly due to lack of enforcement. The silenceor ambiguities in these laws have thus remained. The lack of guidance has discour-aged full implementation.

Suggested provisions and framework for the antitrust lawThe 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 willdepend on the design of a simple and enforceable model and a careful consideration ofthe political economy realities of this country.

As previously noted, considering the encompassing nature of competition and theinterrelationships and linkages between sectors, the antitrust law should be general in


application. Bearing in mind the factors affecting the state of competition and whatshould be the objectives of competition policy discussed in earlier sections, it shouldcontain rules governing monopolies and cartels, restrictive agreements, mergers andacquisitions, and provisions identifying outright prohibitions of clearly unfair compe-tition practices, all aimed at preventing exploitative and exclusionary abuses. Theserules, 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 “competitiontests,” should allow for limitation in competition where found to be so justified. Theantitrust law should endow investigative powers to whichever agency is tasked toimplement it. However, there should be transparency in the procedures, ideally withsome guidelines published. Finally, there should be clear possible course of actions, interms of remedies and/or penalties, for those found to be in violation of the antitrustlaw. To elaborate a little further, as suggested in the World Bank/OECD Frameworkfor the Design and Implementation of Competition Law and Policy, these cover thefollowing 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., preda-

tory pricing)– Set guidelines for rule of reason regarding what anticompetitive, exclu-

sionary actions could be allowed. There should be a competition test todetermine if the obstacle to entry is solely created by increasing effi-ciency of the firm. This competition test allows for limiting competitionon 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 agree-ments are cartel agreements. Similar considerations apply as in the case forrules governing concentrations (below)– Identify per se prohibitions. These would include clear cartel agree-

ments (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


• 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 competitiontest 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 mayinclude:– Distribution of false or misleading information that could harm compet-

ing firm– Distribution of false or misleading information (including information lack-

ing 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 andadditional mandate to incorporate the other elements of competition policy in thelegislation and if a central competition authority should be created. This is because ofthe huge implications of creating such a body. This is discussed later on in the con-cluding chapter as one of the issues that would need to be resolved. As yet, it is tooearly to tell what is the most feasible and effective way to implement competitionpolicy. 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 ishow to craft a competition law that would allow for the possibility of creating a centralauthority that would one day evolve into what it should ideally become.

CONCLUDING REMARKS: ISSUES IN COMPETITIONPOLICY AND OTHER CONSIDERATIONS

The elements of competition policy outlined above require a lot of technical exper-tise. The competition authority should have very competent and knowledgeable man-power to define markets, identify anticompetitive actions, and judiciously construct andadminister “competition tests” on issues of concentration, agreements, mergers and ac-quisitions. Being new in the area of implementing competition policy, there would be anexpected lack in expertise and a need for institution and capability building. The questionis what would be the best way to develop such expertise and institutions?


At present, there is no single body that oversees and coordinates all the activitiesthat seek to promote competition in the country. Instead, competition policy is morean implicit policy in different sectors of the government, which need not be rigorouslyadhered to. Furthermore, it is disjointedly implemented by a number of governmentoffices and interagency bodies so that at best, any isolated attempt to foster competi-tion would produce limited benefits. For sure, the past deregulation episodes, e.g., intelecommunications and domestic aviation, have led to noteworthy benefits, espe-cially during the early stages. But much more could have probably been done. Thesame could be said with respect to trade policy reforms.

Government institutions performing functions related to competition may beclassified into “core” or “primary” institutions and “outer ring” or “secondary” agen-cies. “Core” or “primary” competition institutions are those whose functions cutacross sectors or in which the promotion of competition or regulation of monopolisticbehavior 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 arelimited to a sector or where the aforementioned functions are secondary or incidentalto the main function(s) of promoting competition, but impinge on or affect competi-tion in very important ways.

Considering the broad scope of competition policy, it is not surprising that manyinstitutions are involved in the implementation of the various laws related to compe-tition. An oversight body responsible for coordinating and integrating the variousprograms and activities of these institutions could make for greater impact as well asmore 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 formi-dable tasks implied by the comprehensive nature of the elements of a rational compe-tition policy outlined above, a central body is indeed necessary. However, therequirements in terms of capable manpower and institution building could be verydaunting. Apprehensions about what it could become if not properly handled are quitevalid.

The question is what can be done. What is the most feasible way to implement amore explicit and effective competition policy? What is the best way to develop thecompetent 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 beginwith the creation of a coordinating body, and an austere law, which can be augmentedover time and which could emphasize the establishment of implementing institutionsand promotion of competition advocacy. Another approach is to transform an existingbody that is performing some of the functions of competition policy. A third approachwould be to create a new central body (such as the Fair Trade Commission) that couldbe designed to develop and evolve into what it should ideally become.


It is difficult to decide the best approach at the moment. The problem with thefirst approach is that coordinating bodies are usually not very effective as they lack thenecessary mandate, budgetary requirements, and authority. The problem with the lat-ter two approaches is that the requisite foundation may not be there. The bureaucracymay not be ready to perform such a function, even with enough mandate, budget, andauthority, and might even cause more harm than good at its current state of develop-ment.

Whatever the approach, initial efforts should already focus on the development ofphysical and human capital, training of judges, education of consumers, businesscommunity and government officials on the rationale for and content of an antitruststatute. We should allow the institutional foundations for the competition policy sys-tem to be established first and the enforcement of a comprehensive set of commands tobe introduced and this could take some time. The drafting of the law and creation ofsuch a commission should follow efforts to study the major sources of market failureand to identify distinctive institutional conditions that affect the choice of strategiesfor 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 ofanticompetitive behavior of firms, or simply antitrust legislation, but rather for thebroader area of competition policy and law including review of existing governmentpolicies and regulations from the point of view of competition policy, supported withcompetition advocacy and information and education campaign.

DESIGN CONSIDERATIONSThe following are some of the factors or criteria to be considered in the design of

administrative arrangements for the implementation of such a comprehensive compe-tition policy. To carry out due process of the core element of competition policy, spe-cifically the judicious enforcement of the antitrust law,

• The competition authority should be independent and insulated from politi-cal interference;

• The investigation, prosecution and adjudication functions in the enforce-ment of competition law should be separate;

• A system of checks and balances should be in place with appropriate rightsof appeal and review of decisions and facts on legal and economic grounds;

• The proceedings should be transparent while safeguarding sensitive businessinformation 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) arrange-

ments should consider financial autonomy and independence from outsidepressures.


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 alternativebest practices of competition in the market; and

• The competition authority should also be accorded a wider role in govern-ment economic policy decisionmaking.

A third criterion may be added, which is that the competition authority should haveenough clout or be located high enough in the government hierarchy to be able to en-force its decisions; if possible, it should (like the Presidential Economic Staff and itssuccessor the Presidential Management Staff) carry or be seen to carry the weight ofPresidential power and authority. Of course, political will or support is important for thecompetition authority regardless of its actual place in the governmental hierarchy.

The goal is to develop a competition authority that is credible, respected, andbased on public support. The basic characteristics and features of such a competitionpolicy body should include:

• Limited discretion – an important element here is setting the time frame forcoming out with decisions,

• Enough flexibility to deal with complex issues sure to arise in competitioncases,

• 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 notonly the careful design and the construction of an effective competition body, butwould also entail improvements in other institutions such as courts and the judicialsystem. Sadly, the institutional ingredients that make ambitious competition systemfeasible in developed countries rarely exist in developing settings and which will takelong years (decades) to build. This leads to the second major issue.

WHAT SHOULD BE THE PRIORITY AND FOCUS IN THESHORT-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 competitionpolicy environment—those covering government policies with anticompetition ef-fects, especially those with direct impact on the state of competition. Specifically, thismeans reviewing the performance of the regulatory boards. There is a clear need toreevaluate 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. Andfinally, this is where the greatest impact of implementing competition policy could befelt.


While priority and focus should be given reforms of government regulations, itdoes 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 AUTHORITYAnother 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, theantitrust law should have universal application. That is, anticompetitive acts in vio-lation of the antitrust law committed by any firm, whether private or public, under aregulatory body or not, should be subject to the discipline of the antitrust law. Eventhis would have an implication on what should be the relationship between the regu-latory 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 competitionpolicy functions at all levels7)? In any case, there should be very close coordinationbetween the competition policy body (or the authority enforcing the antitrust law)and the regulatory body. What form the coordination, relationship, or linkage be-tween the two bodies should take would depend on what is most feasible and effi-cient. The delineation of function would be such that primary responsibility shouldlie on the competition authority as far as anticompetitive behavior of the firm isinvolved. However, (especially during the capacity-building years of the competitionpolicy 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, shouldcarry a lot of weight. On the other hand, enforcing competition rules (part of theregulatory framework for the industry) should be the responsibility of the regula-tory body. However, the central competition authority, should one be created,would be responsible for reviewing the regulatory framework and policies of theregulatory body.

Such interrelationship between the regulatory body and the competitionpolicy body is among the major issues in moving towards a formalized and work-able competition policy for the Philippines. There might even come a time whenthe regulatory body has served its purpose and should be subsumed under thecompetition authority. Or it may continue to exist albeit with revised and im-proved functions.

In the long run, whether or not the regulatory bodies will be subsumed into thecentral competition authority (should one be created) would depend on what is mostadministratively effective. Whatever the final form the relationship takes, effortsshould 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 theparticular industry in question.


policy operational and workable, even though this may only be a long-term goal. Thepoint should not be lost to policymakers that perhaps the creation of such a centralbody, or even just an antitrust law which has universal application, is one of thereforms that are needed in instilling market discipline in industries covered by theregulation.

However, due to the comprehensive scope of the antitrust law, its implementationor application should probably be focused initially on one provision of the law to gainexperience, jurisprudence, expertise, and capability upon which to build on. Focusand priority could, for example, be placed on antitrust rules on mergers and acquisi-tion. This is probably be a good way to start, as the burden of proof lies on the part ofthe firm and hence, data and information gathering demands for analysis would begreatly reduced. It could also focus its initial efforts on one particular industry wellknown for anticompetitive practices. The demonstration effect that could arise wouldgo a long way in its advocacy for necessary reforms and in its education and informa-tion campaign. What is crucial is that there should be a solid legal framework to startwith, which the envisioned competition policy would build on.

LACK OF APPRECIATION OF THE PROBLEMThis 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 ofcompetition in the sector and a need to incorporate competition policy to discipline themarket. Nonetheless, the private sector does not seem thoroughly convinced of the needfor competition policy in general. Benefits from deregulations in the transport and tele-communication sectors are well understood. However, there appears to be a lack ofappreciation about the gravity of the problem—specifically with regard to limited com-petition in many industries in the manufacturing sector— and its adverse effects (seeAldaba, this volume). More research on the state of competition and more empiricalstudies on the impact of competition policy or lack of it appear to be necessary. Equallyimportant, intensive advocacy work to bring the results to the public would need to bedone.

Possibly one of the reasons for this lack of appreciation of the problem (especiallywith respect to the manufacturing sector) is the relative novelty of the idea after threedecades of protectionism and two decades of martial law. A culture of competition hasnot been cultivated in the country. Another is that trade reforms have been a relativelyrecent experience—only during the past decade or so. The Philippines is a smallcountry, where the average size of firms is relatively small. Even the larger establish-ments are small compared to medium-sized firms in the developed countries. Thereare doubts that existing firms have enough resources to erect barriers to entry, exceptpossibly for large or capital intensive industries.

Also, there is apprehension about a more general application of competitionpolicy—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


with enough provisions that would ensure due process and at the same time allow it toevolve into a competent and independent body, with officials who, like Caesar’s wife,would be above suspicion. Equally important, more education and information cam-paign is needed about the state of competition, the anticompetition elements present,and the benefits from competition policy. As noted above, some demonstration ofthese benefits is necessary. What is needed to make this happen?

The paper suggests focusing initial efforts on tasks within the capability of what-ever agency or coordinating body is initially designated, with the long-run view of de-veloping a competent body, out of this initial body or an entirely new competitionauthority. 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 asthat outlined in the paper could probably only be effectively administered by a centralcompetition authority. If developed, it could have an immense potential as a mechanismfor reviewing and reforming policies. What a boon it could be. What possibilities therecould be in reforming even recalcitrant government policies? But the requirements inboth human and capital resources would be large. Nonetheless, given the huge benefitsthat could be derived from a working competition policy, the government should ac-tively seek ways to bring it about. And a prerequisite to this would be the drafting of acarefully crafted antitrust law that adequately provides for due process and, at the sametime, forms the legal basis for the development and evolution of an ideal competitionpolicy body.

BIBLIOGRAPHY

Baumol, W. and Willig, R. 1981. Fixed Cost, Sunk Cost, Entry Barriers and Sustainability ofMonopoly. Quarterly Journal of Economics 95.

Gilbert, R.J. 1990. The Role of Potential competition in Industrial Organization. Journal ofEconomic Perspective 4:2.

IRIC (Institute for Research into International Competitiveness). 1999. A Framework forCompetition Policy in the Philippines. A Study undertaken for Philippines TariffCommission 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 ASEANRegion. 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. Barriersto 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 byJosef T. Yap. Makati City: Philippine Institute for Development Studies.


Medalla, E.M., Tecson, G.R., R.M. Bautista, J.H. Power and Associates. 1996. Catching Upwith Asia’s Tiger, Vol. II. Makati City: Philippine Institute for Development Studies.

Patalinghug, E.E. 1997. Competition Policy, Technology Policy and Philippine IndustrialCompetitiveness. 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. DiscussionPaper 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 andProject 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

2C H A P T E R

The State of Competitionin the Philippine Manufacturing Industry

Rafaelita A. Mercado-Aldaba*

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* The author is thankful to Dr. Gwen Tecson for her insightful comments and suggestions on anearlier draft. The research assistance of Ms. Cora Pisano in the preparation of this paper is alsogratefully acknowledged.

ABSTRACT

Competition policy is integral to the process of international trade liberalizationand to deregulation in domestic markets. This paper shows that even if tradebarriers are removed, there are other factors that can impede theprocompetitive effects of trade liberalization. These include the presence of

nontradables, absence of effective competition due to the ability of domestic firms toincrease prices and to prevent imports from entering the market, and the presence ofcartels that may divide the markets through price-fixing or geographic market-sharingagreements.

These barriers inhibit domestic and international prices from converging, thus mut-ing the gains from trade liberalization. While liberalization may be a precondition for thegrowth of a free market, it does not, by itself, guarantee effective competition. In theabsence of competition laws, there is a risk that liberalization may not be sufficient tofoster effective competition and it would also be difficult to control possible abuses ofdominant positions by large-scale firms including multinationals. If effective competi-tion has to emerge, trade reforms have to be accompanied by the creation of competitivemarket and industry structures.


INTRODUCTIONAs in most developing countries, the Philippines adopted the then predominant

import substitution model in its quest for industrialization during the postwar years. Acomplex array of protective policies, investment incentive measures to promote selectedindustries, and regulatory controls emerged. While these instruments of protection,promotion, and regulation promoted and stimulated investments in the early stages ofindustrialization, they came to impose over time barriers to resource mobility and com-petition. They became associated with the protection of entrenched incumbents andstimulated rent-seeking behavior.

Being the darling of policymakers, domestic manufacturers in the country havereceived heavy protection through high tariffs, quantitative restrictions and administra-tive allocations. These policies, however, failed to provide an efficient mechanism forallocating domestic resources among manufacturing subsectors (Bautista et al. 1979).Instead, they led to concentration of the manufacturing industry and sheltered domes-tic markets. In this environment, small groups of entrenched oligopolists were able toextract monopoly power in the market. Not surprisingly, these groups tend to wieldsignificant economic and political influence in the country.

With the demise of the import substitution model, the government was prompted toinstitute policy reforms consistent with the requirements of a competitive market envi-ronment. The government responded to the regulatory constraints that the complexregulatory maze imposed through deregulation and liberalization. It liberalized the traderegime by removing tariffs and nontariff barriers, reducing the antiexport bias, andincreasing import competition. It also deregulated the economy by changing the set ofrules that governed economic activities. All these reforms were aimed at removingbarriers to competition, factor mobility, and firm growth.

Yet even in a liberalized environment, the efficiency of markets is not always guar-anteed (World Bank and OECD 1998). While trade liberalization promotes competition indomestic markets, there exist various impediments that can dilute the procompetitiveeffects of import competition. The ability of economic agents to exercise monopolypower is derived from the presence of barriers to competition. These barriers may benatural (as a function for example of economies of scale), strategic (due to the presenceof few agents in markets), or policy generated (erected by anticompetitive instrumentsof regulation, promotion, and protection of economic activity).

In the last 20 or so years, there has been real progress in the liberalization of tariffand nontariff barriers. One important issue that needs to be addressed is whether or notthis trade liberalization has resulted in increased market contestability in the manufac-turing sector. The current study attempts to assess the general market conditions andthe current state of competition in the manufacturing industry. It will also address theissue of whether or not trade liberalization has led to greater competition and marketentry opportunities.

The next section briefly describes the basic concepts underlying competitionpolicy. The third section reviews existing literature on the state of competition in Philip-


pine manufacturing industries. The fourth section assesses the overall performance ofthe manufacturing sector before and after trade liberalization. The fifth section presentsan analysis of industry structure, price-cost margins and concentration in the manufac-turing sector. The sixth and final section presents the policy implications and recom-mendations of the paper.

THEORETICAL UNDERPINNINGSOF COMPETITION POLICY

COMPETITION, MARKET POWER AND BARRIERS TO ENTRYIn 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 satisfyconsumer demands. As competition is often equated with rivalry, it pressures firms tobecome efficient and to offer a wider choice of products and services to consumers at lowerprices. Competitive rivalry may take place in terms of price, quantity, service, or combina-tions 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 andservices at lower prices. A competitive economy enables individuals to exercise eco-nomic freedom, meaning freedom for consumers to choose what they value most andfor entrepreneurs to choose where they want to invest. The competition process willallow 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 ofdistortions and create incentives for firms to reallocate resources from lower to highervalued uses. Decentralized decisionmaking by firms promotes efficient allocation ofsociety’s resources, increases consumer welfare, and gives rise to dynamic efficiency inthe form of innovation, technological change, and economic progress.

It is important to recognize that high levels of market concentration as well as thepresence 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 tocompetition. Large firms may achieve a dominant position in the market through legiti-mate ways like innovation, superior production or distribution methods, or greater en-trepreneurial skills. For as long as markets remain contestable (when entry into a marketis easy), we would expect large firms in an oligopolistic environment to act indepen-dently 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 fewfirms in the market? If entry is easy and costless, the potential threat from imports orfrom domestic competitors will make incumbent firms behave competitively. As soon asone firm or a group of firms attempts to increase prices or lower quality from competitivelevels, a new firm can come in to serve the market and this will drive prices back down tocompetitive levels.


Competition can be lessened significantly by (a) government regulatory policies,(b) behavioral restraints, and (c) structural characteristics of the market that can act asbarriers to entry (Box 1). Regulatory barriers include investment licensing, tariff andnontariff measures, antidumping and countervailing duties. Behavioral barriers repre-sent abuse of dominant position where “relatively large” firms engage inanticompetitive conduct by preventing entry or forcing exit of competitors throughvarious kinds of monopolistic conduct including predatory pricing and market foreclo-sure. 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, cartelbehavior, or collusion. Examples are price fixing, bid rigging and allocation of territoriesor customers, and output restriction agreements. Vertical restraints are contractualagreements between supplier and purchasers/retailers in both upstream and down-stream markets. Examples include:

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

Box 1. Structural, Behavioral and Regulatory Barriers to Entry

Source: World Bank and OECD (1998).


• Resale price maintenance agreements: retail price is fixed by the producer orprice floors or ceilings are imposed.

• Exclusive distribution agreements: distributors are assigned exclusivity withina geographic area or over particular types of clients, or over specific products.

• Exclusive dealing agreements: downstream firms are prohibited from dealingwith competing producers or distributors.

• Tie-in sale agreements: downstream firms are required to purchase a certainrange of products before being allowed to purchase a particular product.

• Quantity forcing: downstream firms are required to purchase a minimum quan-tity 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 attainif they are to have average cost as low as possible. If the minimum efficient scale is so largethat only one firm of that size can serve the entire market, there will be a monopoly. Thissituation often occurs with public utilities such as distribution of water, electricity, andpiped 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 otheranticompetitive business practices. The presence of barriers to entry impedes competitionand allows firms to acquire and exercise market power. Market power enables firms, unilat-erally (monopoly) or in collusion with others (cartel), to profitably raise prices and maintainthese over a significant period of time without competitive response from other existing orpotential firms. Barriers to entry are necessary for market power. Market power can becreated through mergers or agreements between competitors not to compete or throughrestrictive vertical arrangements and predatory pricing which is an abuse of preexistingmarket power. A firm’s exercise of market power can harm consumers and other producersthrough higher prices (rather than competitive prices), reduced output, and poorer qualityproducts. In general, market power results in inefficient allocation of resources and nega-tively affects industry performance and economic welfare.

Large firms may take advantage of their market power by abusing their dominantposition or monopolization. This entails the suppression of competition by restricting orforeclosing the entry of smaller rivals, for example, by increasing competitors’ costs ofentering a market or charging predatory prices which harms the competitive process.

Theories on industrial organization and competitionThere are a number of theories in industrial organization economics explaining the

need to preserve competition. The two major opposing schools of thought can bebroadly 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.


While both schools share the same objective, i.e., to promote the efficient use ofresources, the debate stems from the choice and application of different policy instru-ments.

The structural theory of market performance states that firms respond to entry butare able to earn persistent profits when the structural characteristics of markets makeentry difficult. Bain identified the conditions of entry as technological features ofmarkets that affect the exercise of market power. Economies of scale, absolute costadvantages, and product differentiation were the primary determinants identified asentry barriers that enable a firm to maintain price above average cost (Gilbert 1990).

The structuralist school emphasizes the interaction between market structure andcollusive and exclusionary business practices by firms that enable them to exercisemarket power and persistently earn excess profits (Khemani and Dutz 1995). The struc-turalist school is rooted on the traditional structure-conduct-performance (SCP) para-digm of industrial concentration which states that a concentrated industry (structure)will facilitate collusion (conduct) and hence monopoly pricing (performance). Firmsoperating in oligopolistic industries with large market shares are more likely to coordi-nate 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 marketstructure, but today, the focus is more on pricing and output policies affecting marketstructure while aiming at the exclusion of competition such as advertising, research anddevelopment, contractual arrangements, and preemption of input sources and distribu-tion channels.

The Chicago school was developed in reaction to the structuralist viewpoint thatindustrial concentration fosters collusion and hence, monopoly pricing. Demsetz (1973)argued that superior low cost firms would have higher profits and would grow to domi-nate their industries. Low costs lead to competition, which in turn lead to concentrationof industry (Leach 1997). Advocates of the Chicago school say that a policy of indus-trial deconcentration would destroy efficiency with no benefit of lower prices to con-sumers.

Economists associated with the Chicago school maintain that markets are workablycompetitive and the market structure reflects differential efficiency, not strategic behav-ior. They argue that collusion is difficult to practice profitably in all but the most highlyconcentrated industries and is therefore not a serious problem (Stigler 1968). Wherecompetition is limited, collusion is primarily due to barriers to entry that the governmentcreates. They advocate the pursuit of economic efficiency as the unequivocal goal forcompetition policy. Failure to consider economic efficiency distorts the basic intent ofcompetition policy. As a result, they favor a minimalist approach toward the implemen-tation of competition policy. Competition law, in particular, should be restricted to pre-venting collusion, especially price fixing agreements (Posner 1969 and Bork 1978 ascited in Khemani and Dutz 1995).

The two schools of thought also differ with respect to the interpretation of thepositive relationship between concentration and profits found in empirical studies. The


structuralist school maintains that the positive relationship between concentration andprofits indicates monopolistic pricing. High levels of concentration are due toanticompetitive business practices that lead to resource misallocation. The Chicagoschool argues that the positive relationship reflects superior competitive performanceby leading firms (with large market shares), independent of any ability to collude (Leach1997). In the absence of government-erected barriers to entry, high levels of concentra-tion and profits can be maintained only if the leading firms constantly strive to beinnovative and efficient (see Khemani and Dutz 1995).

MEASURES OF CONCENTRATION AND PROFITABILITYLeach (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. thesum of the leading four firms’ market shares.

n2) The Herfindahl-Hirschman index (HHI) = Σ msi

2

i=1where msi is the market share of the ith firm and n the number of firms, i.e., it is thesum of the squared market shares of all firms in an industry. HHI ranges from aminimum of 1/n for n firms of equal size to a maximum of 1 when there is only onefirm.

The HHI is the most common measure used to assess concentration ofshares of industry participants. In the US, the following thresholds are used asguidelines:

0 –1000 unconcentrated1000 – 1800 moderately concentratedabove 1800 highly concentrated.

n3) The Horvath index (HI) = msi + Σ msj

2 [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

2Σ (i – msi) – 1i=1

where n is the number of firms in an industry, i is firm rank, and msi is market share. Likethe HHI, the Rosenbluth index ranges from a minimum of 1/n for n firms of equal size toa maximum of 1 when there is only one firm.


Price-cost margins are commonly applied as measures of profitability in most con-centration profits studies. In diagnosing market dominance, the price-cost margin orLerner 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. Marketpower implies that a firm is able to charge prices substantially above its marginalcost while a firm without market power must charge a price that approximates itsmarginal cost.

REVIEW OF LITERATURE

Previous studies on the state of competition in the manufacturing industry high-lighted the high degree of industrial concentration in the country. Lindsey (1977) ana-lyzed the level of concentration in the manufacturing industry, its determinants and itsrelationship to industry profitability. He characterized the manufacturing sector as mo-nopolistic and identified capital intensity and degree of fabrication as barriers to compe-tition. He concluded that the high levels of concentration led to monopoly power. DeDios (1986) examined the effects of tariffs on industrial structure. His results showedthat tariff protection led to concentration. This suggested that firm concentration al-lowed the earning of monopolistic profits. He identified degree of capital intensity,minimum efficient scale and working capital requirement as barriers to entry that led toconcentration.

The 1993 World Bank report on the Philippines indicated that the country’s manu-facturing sector was highly concentrated and this contributed to the reduction of com-petition 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 concentrationeased substantially. Its estimates revealed that the degree of concentration declinedfrom 70 percent to 63 percent between 1983 and 1988. The report concluded that, al-though oligopoly and rent-seeking behavior remained rife in the Philippines, there wasevidence that the economy became more competitive and efficient in resource usetoward the end of the 1980s.

At the aggregate level, evidence of improvement included numerous smaller newentrants to many industrial sectors and the increased labor intensity in production. Ata disaggregated level, concentration ratios were declining in export-oriented industrieswhile smaller firms were increasing their share of production in sub-sectors largelygeared to exports. Concentration eased for 19 out of 31 three-digit subsectors, led by thefootwear and furniture sectors and followed by wearing apparel, leather, and food (PSIC311), all of which were export-oriented. The leaders in heightened concentration werenonelectrical machinery and nonferrous metals, followed by food (PSIC 312), beveragesand chemicals (generally domestic-oriented, except for nonferrous metals and chemi-


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 75percent. For sectors with above average concentration in 1983, only nonferrous metalsand glass experienced increases in concentration, but a number of highly concentratedsectors experienced virtually no change, which reflected the incumbents’ utter domi-nance 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 indus-trial organization economics type of study and to date, the most comprehensive in termsof scope and analysis. The study was based on six case studies covering telecommuni-cations, glass, man-made fibers, cement, iron and steel, and passenger cars and wassupplemented by a review of existing industry studies conducted in the country at thattime. The study confirmed the presence of high concentration in Philippine industriesthat gave rise to uncontestable markets in these industries. The study found that gen-erally, government policy induced the entry barriers in several industries and at times,these government policy-induced barriers even reinforced the existing structural barri-ers to entry such as excess capacity, absolute advantages (through franchises, creditsubsidies and fiscal incentives) and limit pricing (via price and rate regulation). More-over, the presence of barriers to entry undermined the effectiveness of the structuralreforms implemented during that time.

The microlevel findings of the study are:• Concentration in the following sectors may have resulted from deliberate gov-

ernment policy of protection and promotion:– Traditional natural monopolies such as telecommunications, power distri-

bution, interisland shipping and banking– Favored industries under the government’s progressive manufacturing

programs which include cars, trucks, motorcycles, integrated steel milland synthetic fiber

– Special “modernization” programs for distressed industries like textilesand cement

• A cartel-like behavior was observed in flour milling, cement and interislandshipping. The government was seen as having a hand in tolerating or abettingcollusionary arrangements in these industries.

• Entry barriers negatively affect users as indicated by the price comparisonsbetween domestic and border prices. Domestic prices were higher than borderprices over long periods in car assembly, flat glass, synthetic fibers, and cement.

• Entry barriers served to keep inefficient firms operating or if these firms wereefficient, allowed them to generate monopoly rents. This was apparent in ce-ment, 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


Philippine manufacturing industries to the trade policy reform of the 1980s. Using con-centration ratios estimated by the World Bank, Tecson (1996) noted that trade liberaliza-tion was accompanied by a deconcentration of manufacturing industries as indicatedby 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 to63 percent in 1988. Quantitative restrictions and import licensing, particularly of im-ported intermediate and capital goods, constituted powerful entry barriers in the indus-try. The whole postwar history of industrialization was characterized by a series ofspecial programs and laws that granted privileges and incentives to selected firms andindustries. While some of these policies remained in force, the trade policy reformprovided firms with relatively greater access to supply and lower import prices of capitalequipment and other production inputs. This lowered some of the formidable barriersinto industries. Furthermore, given the profitability of protected industries, new en-trants were attracted to challenge the incumbents. Out of the 31 sectors, only eightshowed an increase in concentration. These were beverages, tobacco, wood and corkproducts, 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, syn-thetic resin and plastic, agricultural machinery, and shipbuilding and repair. One impor-tant contribution of these studies (except for textile and garments and motorcycle andparts) was the inclusion of industrial organization issues in their trade policy analysis.Concentration ratios and price-cost-margins were estimated and existing barriers tocompetition were identified.

The other industry studies included in the review were carried out by Tolentino andPhilexport (1998 and 1999) on sugar, Mercado-Aldaba (1996) on passenger cars, and theDevelopment Bank of the Philippines (1992) on cement and pulp and paper.

Table 1 presents the different manufacturing industry studies conducted in thecountry during the nineties. A classification of the existing barriers to competitionidentified in the literature was made following the categories listed in Box 1. Barriers toentry can either be structural or behavioral. In the former, regulatory barriers are sepa-rated from other structural barriers. Regulatory barriers arise from the governmentpolicy of protection, regulation and promotion.

Previous studies show that Philippine manufacturing was characterized not onlyby protectionism and heavy regulation but also by high concentration, notably inslaughtering, dairy processing, appliance, flat glass, pulp and paper, cement, sugar,synthetic fiber, textile and in local car manufacture and assembly sector as well as inmotorcycles and parts where the government deliberately limited the number of indus-try participants. Government involvement in the economy also directly impeded compe-tition through the creation of state-controlled monopoly in the iron and steel industry.The government-owned National Steel Corporation was the only producer of flatproducts.


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


All of the industries reviewed were found to be heavily regulated by the govern-ment. The structural barriers identified in the literature included economies of scale andhuge capital requirement. These barriers affected the following industries: syntheticfiber, passenger cars, motorcycle and parts, dairy processing, appliance, flat glass,synthetic resin, shipbuilding and repair, cement, and pulp and paper. The behavioralbarriers included excess capacity and horizontal price fixing and were found in thefollowing industries: synthetic fiber, hot and cold milling and tinning, flat glass, cement,and sugar. Clearly, the government policy of regulation, promotion, and protectionencouraged greater concentration as a way to compete against imports and achieveeconomies of scale.

This policy of high trade barriers combined with generous long-term invest-ment incentives to domestic industries deterred competition from abroad and con-tributed to the oligopolistic structure of the Philippine manufacturing industry.With agreements to fix prices (in sugar and cement, for instance), prices are nolonger the product of competition among rival producers but more an outcome ofnegotiations between the government and a small number of producers. Price con-trols thus result not only in simply limiting the potential for price competitionamong producers but also in preventing the development of a culture of competi-tion in the country.

ASSESSMENT OF THE OVERALL PERFORMANCEOF THE MANUFACTURING SECTOR BEFORE AND AFTERTRADE POLICY REFORMS

AN OVERVIEW OF TRADE POLICY REFORMS AND PROTECTION STRUCTUREFROM THE 80s TO THE 90s

Over the last two decades, there have been three major liberalization episodes in thecountry. The first major trade policy reform was implemented in 1981 as part of theconditionalities 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 zeroto 50 percent tariff range. This led to a significant reduction of both the average tariffand 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 theyear 1995. The third most important tariff reform was pursued during the Ramos admin-istration. Executive Order 264 further reduced the tariff range to within three to 10percent by the year 2000 (Medalla et al. 1995).

Simultaneous with the implementation of the tariff reduction policy, quantitativerestrictions have also been eliminated. The number of import restrictions fell fromaround 32 percent of the total number of PSCC lines in 1985 to only about 3 percentin 1996.


This series of trade policy reforms have significantly reduced the average level ofeffective 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 47percent in 1995, it was still well above the –1.4 percent EPR on exportables. Thisindicated that a strong bias still remained toward the production of protectedimportables.

While the three major liberalization episodes in the country reduced the averageeffective protection rate in manufacturing from a high level of 43 percent in 1983 to 19percent in 1994, protection rate for sectors such as food manufacturing, beverages,tobacco, other chemicals, and fabricated metal products remained relatively high rang-ing from 29 to 53 percent (Table 2). For some sectors such as transport equipment andfood manufacturing, protection even increased from 49 to 57 percent and from 21 to 50percent, respectively, between 1988 and 1994.

Using domestic resource cost (DRC)2 as measure, empirical studies showed thattrade reforms led to improvements in competitiveness. The DRC/SER (domestic re-source cost/shadow exchange rate) ratio fell from 1.7 in 1983 to 1.5 in 1988 and to 1.18 in1994. This indicated that as trade liberalization policies were implemented, firms tendedto become more efficient.

DID THE PAST TRADE REFORMS RESULT IN DESIRED STRUCTURALCHANGES?

With the introduction of trade reforms, we expected profound changes in in-dustry structure involving both substantial shifts of resources between economicsectors and restructuring within industries. Trade liberalization was expected todrive the process of restructuring and reallocation of resources within and acrosssectors of the economy such that unprofitable activities contracted while profit-able ones expanded.

____________________

1 The EPR concept is used to measure protection while the DRC framework is employed todetermine economic efficiency. The EPR takes into consideration the protection given to theoutput and inputs of a specific activity. The net effect of protection on output and inputs isindicated by the protection of the activity’s value added. Thus, the EPR is computed as theproportionate 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 exchangeearned by the activity through export, or saved through import substitution. The DRC is com-pared with the social exchange rate (SER), which represents the opportunity cost of domesticresources used in all activities producing tradable goods. A DRC/SER greater (less) than oneindicates 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 notproduced, resources could be used in other activities that yield maximum benefits to society (seeMedalla et al. 1996).


Source: Medalla (1998)

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

Table 2. Effective Protection of Philippine Manufacturing Industries:

1983, 1988 and 1994


Table 3 reveals that there has been very little systematic movement of resources inindustry and manufacturing. It is the services sector which has been experiencing amajor increase in size. The share of services has been increasing since 1980 from about36 percent to 43.4 percent in 1997. At the outset of the trade reforms, industry had thelargest 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 addedslightly increased its share between 1980 and 1985 but dropped from 24.6 percent to 20.7percent between 1985 and 1997.

In terms of changes in employment, Table 4 reveals that there has been no substan-tial change in terms of the industry’s contribution to total employment. The manufactur-ing sector failed in creating enough employment to absorb new entrants to the laborforce as well as those who move out of the agricultural sector. As Table 4 shows, priorto the trade reforms, employment distribution was biased against industry and manufac-turing. The labor force was highly concentrated in agriculture with a share of 51.4percent 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 pacewhile the share of services increased as it continously absorbed the labor force, thusbecoming the largest employer from 1997 to 1999.

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

Table 3. Structure of Value Added (1985=100)

Source: National Statistical Coordination Board, National Income Accounts.

Sources: Pante and Medalla, PIDS Working Paper 90-18; Yearbook of Labor Statistics (OctoberRounds); Reyes, de Guzman, Manasan and Orbeta, Social Impact of the Regional Financial Crisisin the Philippines (Preliminary Report).

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

Table 4. Structure of Employment


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

Note that there are two caveats here. First, the real appreciation of the peso hasoften been cited as the main reason for the manufacturing sector’s apparent failure toexpand and create employment after liberalization. Second, the current state of datacollection in the country still leaves much to be desired. Better measurement of newfirms and industries created after liberalization as well as improved estimation of theexpanding services sector, which is difficult, is critical to the above analysis.

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 theNational Statistical Coordination Board. For Indonesia, Malaysia, and Thailand, the estimates weretaken from Sachs et al. Promotion of Broad-Based Economic Growth in the Philippines, 1998.


ANALYSIS OF INDUSTRY STRUCTURE AND COMPETITIONIN THE MANUFACTURING SECTOR

INDUSTRIAL COMPOSITION AND PERFORMANCETable 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 bulkof manufacturing value added with its unchanged share of 45 percent in both 1972 and1983. Consumer goods followed with a share of 40 percent in 1972 and 34 percent in1983. Capital goods registered a share which increased from 16 percent in 1972 to 20percent 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. Althoughit fell to 40 percent in 1994, the sector still represented the bulk of manufacturing valueadded. The share of intermediate goods dropped to 39 percent in 1988 and to 37 percentin 1994. Due to the growing importance of electrical machinery (whose share steadilyincreased from 3 percent in 1972 to 7 percent in 1983 and 1988 and to almost 10 percent in1994), the capital goods sector has slowly inched its way from a share of 16 percent in 1988to 22 percent in 1994.

In the consumer goods sector, food processing, food manufacturing, and bever-ages were the most important subsectors in 1994 as they comprised 67 percent of thesector’s value added. In the intermediate goods sector, other chemicals and petroleumrefineries represented almost 50 percent of the sector’s value added while in the capitalgoods sector, electrical machinery together with iron and steel were the topsubsectors with their combined shares of about 65 percent of the sector’s valueadded.

A comparison of the economic performance of the manufacturing sector and itscomponents 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 capturethe posttariff reform years. Overall, manufacturing census value added grew at an an-nual average growth of 3.6 percent during the pretrade reform period 1972-1983. Thisdeclined to 0.9 percent during the period 1983-1988, but recovered to 6.6 percent in theperiod 1988-1994.

The average growth of employment continuously dropped from 5 percent prior tothe trade reforms to 4 percent in 1983-1988 and to only one percent in 1988-94. Duringthis period, pottery, china and earthenware, electrical machinery, professional and sci-entific equipment, leather footwear, and transport equipment registered the highestannual average employment growth rates, which ranged from 10 to 13 percent. Thenumber of establishments grew from 2.4 percent before the trade reforms to 10.3 percentin 1983-1988, but this fell to 3 percent in the period 1988-1994. In this period, the glassand glass products, pottery, china and earthenware, industrial chemicals, and iron andsteel subsectors posted the highest average annual growth rates in terms of number ofestablishments, which ranged from 8 to 11 percent.


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

Table 6. Distribution of Manufacturing Value Added


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

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


Value added growth at the subsector level was highly variable. Eight manufacturingsubsectors 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 an-nual growth rate of 17 percent during the 1988-1994 period.

Other manufacturing subsectors that were growing during the 1972-1983 periodregistered negative average annual growth rates immediately after the implementationof trade reforms, i.e., 1983-1988, but recovered in the succeeding period, 1988-1994.These subsectors covered food manufacturing, leather and leather products, leatherfootwear, petroleum refineries, iron and steel, fabricated metal products, cement, ma-chinery except electrical and transport equipment, which posted the highest averageannual growth rate of 18 percent during the 1988-94 period.

Some manufacturing subsectors that posted negative annual average growth ratesprior to the trade reforms experienced improvements in terms of economic performanceas suggested by their positive average value added growth rates for the periods afterthe trade reforms. These included tobacco, paper and paper products, other nonmetallicmineral products, metal furniture and professional and scientific equipment, whichposted 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 19.4percent during the three periods under review. Other nonmetallic mineral products grewfrom a low 3 percent to 15.7 percent between the periods 1972-1983 and 1983-1988. Itsgrowth rate further increased to 21.9 percent during the period 1988-1994. Fabricatedmetal products increased from 10.9 percent to 13.4 percent and to 21 percent whilemachinery except electrical rose from 12.5 percent to 14.5 percent and to 24.5 percent inall three periods under study. Except for fabricated metal products, the increasing trendin the growth of the subsectors’ value added is not accompanied by correspondingincreases in the growth of the subsectors’ number of establishments and employment.

Textiles and wood and cork products performed poorly for all three periods underreview. These subsectors experienced substantial reduction in their value added assuggested by their negative average annual growth rates prior and after the trade re-forms. Food processing posted negative growth rates for the two succeeding periodsunder study, but was able to bounce back in the third period. Glass and glass productsand petroleum and coal both had negative average annual growth rates prior to the tradereforms; although their performance improved immediately after the implementation oftrade reforms, this was not sustained as they again posted negative growth rates in thethird period. Other subsectors like industrial chemicals, nonferrous metal products andrubber products, which were characterized by positive value added growth rates beforeand 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 1983to P110,610 per worker in 1988 (Table 8). In 1994, the ratio increased to P135,306 perworker. Almost all subsectors followed the same rising trend except for nonferrous metal


Notes:CVA : Census value addedK/L ratio: Capital/LaborSources: 1972-1988 Census data were from the World Bank, The Philippines. An Opening forSustained Growth, April 1993. 1994 Census data from the National Statistics Office.

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

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


Note: Small-sized establishments employ 10 to 99 employees, medium-sized establishmentshave 100 to 199 employees while large establishments have 200 or more workers.Sources: National Statistics Office, 1972, 1983, 1988, and 1994 Census of Establishments.

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

products and transport equipment whose capital/labor ratios dropped between 1988and 1994. Petroleum refineries had the highest capital/labor ratio followed by nonfer-rous metal products, cement, iron and steel and industrial chemicals. Capital productiv-ity in manufacturing slightly increased from 1.2 in 1983 to 1.4 in 1988. However, thisdropped back to its pretariff reform ratio of 1.2 in 1994. Three subsectors experiencedrising capital productivity over the three years under study. These included transportequipment, professional and scientific equipment, and metal furniture. Tobacco had thehighest 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 P166,580in 1994. Petroleum refineries had the highest labor productivity followed by beverages andother chemicals. While almost all subsectors had rising labor productivity for all three yearsunder study, petroleum and coal products, nonferrous products and transport equipmentwitnessed reductions in their labor productivity between 1988 and 1994.

Table 9 presents the size structure of the manufacturing industry. Philippine manu-facturing has often been characterized as having a dualistic size structure since theimport substitution phase of the 1950s (World Bank 1993). The table indicates that theindustry is still dominated by a small number of very large firms. In 1995, large-scaleestablishments accounted for 76 percent of manufacturing value added and 67 percentof employment, although they represented only 10 percent of all firms. On the otherhand, small establishments, which represented 82 percent of all firms, accounted for a 21percent share of employment and only 11 percent of manufacturing value added. Me-dium-scale establishments, which numbered 8 percent of all establishments, accountedfor 12 percent of employment and 13 percent of manufacturing value added.


DOMESTIC COMPETITION AND CONCENTRATION

Concentration and profitabilityTable 10.1 presents the estimates of four-firm concentration ratios in the manufac-

turing sector for the years 1988, 1994, and 1995. After trade liberalization, the averagefour-firm concentration ratio in manufacturing remained high for all three years underreview. It even went up slightly from 70.88 in 1988 to 73.63 in 1994 and remained at thesame level in 1995. The estimates show that the manufacturing sector is highly concen-trated with roughly two-thirds of the manufacturing industry having concentrationratios ranging from 70 to 100 percent. The estimates also imply that on the average, 73.6percent of value added were from the top four firms in each manufacturing subsector.

Subsectors with high level of concentration are mostly intermediate and capitalgoods such as petroleum refineries, glass and glass products, industrial chemicals,pottery, china and earthenware, petroleum and coal products, rubber products, othernonmetallic mineral, paper and paper products, professional and scientific equipment,nonferrous metal products, transport equipment, iron and steel, machinery except elec-trical, textiles, other chemicals (a borderline case), and fabricated metal products. Con-sumer goods like tobacco, food manufacturing and food processing also belong to thehigh concentration group.

The moderate concentration group consists of subsectors with ratios ranging from40 to 69 percent. In 1995, this group included beverages, electrical machinery, metalfurniture, wood and cork products, cement, printing and publishing, leather footwear,furniture except metal, plastic products, and leather and leather products. Only wearingapparel except footwear fell under the low concentration group.

Price-cost margins were estimated as a rough measure of market power. On theaverage, 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 in1995, price cost margins remained high particularly for tobacco (57 percent), otherchemicals (46 percent), other nonmetallic minerals (40 percent), food manufacturing (41percent), and glass and glass products (52 percent). These manufacturing industrieswere among the subsectors with very high degrees of concentration. Even subsectorsclassified under medium and low degrees of concentration have relatively high price-cost margins. For instance, moderately concentrated subsectors like beverages had aprice-cost margin of 57 percent in 1995, cement with 42 percent while a nonconcentratedsubsector such as wearing apparel registered a price-cost margin of 32 percent. Acombination of high price-cost margins and high concentration ratios tend to suggestthat firms are able to exercise market power and that some monopoly rents are beingincurred.

Table 10.2 confirms the positive correlation between concentration and industryprofitability for the Philippine manufacturing sector. The table shows a positive andhighly significant correlation between profitability and concentration for all three years:1988, 1994, and 1995.


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

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


Table 10.3 presents the results using a conventional regression specification of theconcentration-profits relationship including capital intensity. This variable is added tocontrol the result that a positive relationship between concentration and profitabilitycould wrongly reflect the firms’ large capital costs per unit of output. In future priceregressions, it is also important to include variables representing barriers to entry likeproduct differentiation, economies of scale, and absolute cost advantages. The ab-sence 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 thePhilippine manufacturing industry. The coefficient for capital intensity had the expectedpositive sign but was significant only for 1995 and for the pooled data. Although it wasnegative in 1988 (implying that capital-intensive industries performed badly in 1988),this was statistically insignificant.

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. Estimates of the Concentration-Profits Relationship

**Significant at the 1 percent level.* Significant at the 5 percent level.

Dependent Variable: Price Cost Margin

1988

Constant 0.19008**

Concentration Ratio 0.00094**

Capital Intensity -0.01133

R2 0.025

1994

Constant 0.17405**


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**


Capital Intensity 0.01707*

R2 0.03


The positive correlation/relationship between concentration and profitability inPhilippine manufacturing is consistent with both the structuralist school and the effi-ciency hypothesis or Chicago school. According to the structuralist line, industrialconcentration fosters collusion and hence, monopoly pricing. A positive coefficientcan be taken as an indication that any further increase in market concentration due toa merger, for example, would increase market power and therefore, the price that con-sumers of the product have to pay. On the other hand, the efficiency hypothesis pointsout that superior firms in an industry that make a product or cost breakthrough will gainmarket share, causing industry concentration to increase. Broadly interpreted, theefficient markets hypothesis states that markets are workably competitive and thatthe market structure reflects differential efficiency, not strategic behavior. Domi-nant firms owe their position to superior performance, not to strategic behavior, orthe history of entry into the industry and the profits are simply the rents thataccrue to superior technology (Stigler 1968 and Demsetz 1973 as cited in Gilbert1990). The Chicago school would interpret a positive relationship between concen-tration and profitability as due to higher efficiency and not to the presence ofmarket power.

Note that firms may achieve a dominant position in a market through methods thatare perfectly legitimate, for example, through the adoption of efficient business prac-tices like innovation, adoption of superior production/distribution methods, or simplygreater entrepreneurial efforts. In the Philippine context, empirical analysis indicatedthat after the implementation of trade liberalization, manufacturing firms tended tobecome more efficient as shown by the reduction in their average domestic resourcecosts between 1988 to 1994. It is important to recognize that the Philippine is character-ized by limited R&D and S&T activities particularly private sector underinvestment inR&D. Cororaton (2000) noted that the estimated gap in R&D investment is about 0.58of GNP or approximately P14 billion in current prices. Underinvestment is prevalent inalmost all sectors notably in agriculture and manufacturing.

The Philippines is also characterized by a high concentration of wealth and re-sources in a few families representing the country’s elite group. For instance, the top5.5 percent of all land-holding families own 44 percent of all tillable land. The richest 15percent of all families account for 52.5 percent of total national income. Only a fewfamily-owned conglomerates control the bulk of industry sales, employment and as-sets (Foundation for Economic Freedom, Economic Policy Agenda Series No.5).The concentration of economic wealth among a small number of families andgroups combined with high levels of industrial concentration may raise competi-tion problems. Interlocking directorates are common in the country and this mayencourage the sharing of information and coordination of anticompetitive behav-ior. There is always the danger that with high price-cost margins, high concentra-tion ratios, and high concentration of ownership around family-basedconglomerates, large firms may take advantage of their market power and abusetheir dominant position.


CONCLUSIONS AND POLICY RECOMMENDATIONS

The Philippine manufacturing industry developed under a complex policy packageof protection, promotion, and regulation. The policies resulted in an inefficient alloca-tion of resources and encouraged greater concentration as a way to compete againstimports and achieve economies of scale. The industry studies reviewed indicated thepresence of regulatory barriers, which included import restrictions and high tariffs, aswell as behavioral barriers like cartels and structural barriers such as economies of scaleand huge capital requirement. With the presence of high trade barriers, competition fromabroad was impeded. Cartel-like practices, which were sanctioned by the government,as well as government involvement in the economy through state-controlled monopo-lies, limited the potential for price competition among producers, thus failing to nurturethe culture of competition in the country.

Since the 1980s, the Philippines has witnessed substantial trade reforms that in-cluded tariff reduction and removal of quantitative import restrictions. These policychanges intended to expose industries to international competition and emphasized theneed to improve quality, cost and innovation. After more than a decade of implementa-tion, these reforms have not resulted in a major increase in the size of industry andsystematic movement of resources toward the manufacturing sector. Despite realprogress in implementing trade liberalization, the real growth of the manufacturing sec-tor has been slow.

One possible reason for this slow growth is that barriers to competition continue toexist and are preventing industries from maximizing the gains from trade liberalization.As liberalization progresses, private enterprises may continue to engage in restrictivebusiness practices to offset the effect of liberalization. Mergers and acquisitions espe-cially those between large scale firms may result in an increase in market concentrationand a reduction in competition.

An economy may remain sluggish for a long time, trapped in a cycle of weakcompetition, low productivity, and slow growth if large incumbent firms with monopolypower are able to prevent new entrants into existing markets; if government intervenesto distort foreign or domestic trade; and if access to credit, land, infrastructure, ordistribution outlets inhibits new firms from competing vigorously. The situation be-comes particularly risky for those firms engaged in the manufacture of inputs into otherproduction processes. The output of such sectors may be essential to the ability ofdownstream firms to compete effectively on international markets, and weak competi-tion or low productivity in these sectors may have social costs significantly higher thancalculations of private costs (Fingleton et al. 1995).

Estimates showed that for the manufacturing industry as a whole, concentration inmost sectors remained high from the late 1980s to the mid-1990s. The four-firm concen-tration level for the whole manufacturing industry increased from 70.88 in 1988 to about74 in 1994 to 1995. Around two-thirds of the manufacturing subsectors had very highconcentration levels that ranged from 70 to 100 percent.


Available data also indicated that price-cost margins (PCM) moved in the samedirection as concentration levels. The PCM increased from 30 percent in 1988 to 34percent in 1994 and to 36 percent in 1995. Some highly concentrated subsectors werefound to have very high PCMs such as tobacco (PCM: 57 percent), glass and glassproducts (PCM: 52 percent), food manufacturing (PCM: 41 percent), and other nonme-tallic mineral products (PCM: 40 percent).

The relationship between concentration and profitability is estimated using regres-sion techniques. The results confirmed the positive correlation/relationship betweenconcentration and profitability in Philippine manufacturing. This positive relationship isconsistent with both the structuralist school and efficiency hypothesis or Chicagoschool. However, given the limited R&D and S&T activities in the country, particularlythe underinvestment by the private sector in manufacturing and agriculture R&D/S&Tactivities, one is inclined to believe that the structuralist school may be more applicableto us. The high concentration of industries in a few family-owned conglomeratescoupled with high levels of concentration and profitability may also indicate the pres-ence of market power which may raise competition problems. Future studies should takea more in-depth analysis of this issue.

The current paper only gives a general sense of the extent of competition in themanufacturing industry owing to the broad nature of the sector and the absence ofreliable data. Industry cases are needed not only to extend the variety of industriesstudied but also to delve into details. Hence, there is a need to collect detailed pricedata, to monitor the behavior of individual firms, and to identify restrictive businesspractices and other barriers to competition. These are the only means through whichconclusive evidence on the state of competition in manufacturing could bereached.

To sum up, liberalizing the trade regime—removing tariff and nontariff barriers,removing anti-export bias, and increasing import competition—constitutes the basicagenda for the deregulation of the international trade regime and complements deregu-lation efforts in the domestic markets. Even if trade barriers are removed, there are otherfactors 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 hightransport costs, perishables, and legal, financial and other services; and (2) the absenceof effective competition due to the presence of regulatory, structural, and behavioralbarriers to entry.

The presence of these barriers prevents domestic and international prices fromconverging, thus muting the gains from trade liberalization. While liberalization may bea precondition for the growth of a free market, it does not, by itself, guarantee effectivecompetition. In the absence of competition laws, there is a risk that liberalization may notbe sufficient to foster effective competition and it would also be difficult to controlpossible abuses of dominant positions by large scale firms including multinationals. Ifeffective competition has to emerge, trade reforms have to be accompanied by thecreation of competitive market and industry structures.


It is, thus, necessary to design safeguards that would ensure market contestabilityand regulate anticompetitive business conduct which can damage emerging competi-tion. A well-drafted competition law is an important policy measure that the governmentshould undertake. The adoption of a sound competition policy and establishment of aneffective competition agency will buttress measures such as trade liberalization andderegulation with more domestic market competition. It is also essential to remove theremaining barriers to competition and enforce a competition policy that would foster theefficient use of resources and promote consumer welfare while protecting the freedomof economic action of various economic agents. Markets and their development requirerules to orient the behavior of agents and institutions. For instance, cartels have been anaccepted practice in the past. Given this environment, a competition agency has a criticalrole 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 ofhaving 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 bydeveloping countries in creating an effective competition law system are far differentfrom those faced by developed countries. Our country needs a competition law tocomplement previous and ongoing market-oriented reforms. It should be emphasizedthat any attempt to make the implementation of competition law as a source of interventionin the market, corruption, misuse of bureaucratic power, or cause of market distortionsmust be rejected. The competition institutions to be created must possess accountability,transparency, checks and balances, and clear rules and procedures. While there is a needto revise our existing inefficient competition laws and pass new ones, proper care shouldbe exercised in formulating the country’s competition laws taking into consideration ourcountry’s institutional endowments, technical capacity, and financial capability.

BIBLIOGRAPHY

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Boner, R.A. 1995. Competition Policy and Instruments in Reforming Economies. In RegulatoryPolicies and Reform: A Comparative Perspective, edited by C.R. Frischtak.

Cororaton, C. 2000. S&T/R&D - Medium Terms National Action Agenda for Productivity.Discussions Paper Series No. 2000-21. Makati City, Philippines: Philippine Institutefor Development Studies.

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Demsetz, H. 1973. Industry Structure, Market Rivalry and Public Policy. Journal of Law andEconomics. April 1973.

Dutz, M. and S. Suthiwart-Narueput. 1995. Competition Issues Beyond Trade Liberalization:Distribution and Domestic Market Access. In Regulatory Policies and Reform: A Com-parative Perspective, edited by C.R. Frischtak.

Fingleton, J., E. Fox, D. Neven and P. Seabright. 1996. Competition Policy and the Transforma-tion of Central Europe. London: Centre for Economic Policy Research.

Frischtak, C.R. 1995. The Changed Role of the State: Regulatory Policies and Reform in aComparative Perspective. In Regulatory Policies and Reform: A Comparative Perspec-tive, edited by Claudio R. Frischtak.

Gilbert, R.J. 1990. The Role of Potential Competition in Industrial Organization. Journal ofEconomic 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 ComparativePerspective, edited by Claudio R. Frischtak.

Lamberte, E. D., E. de Dios, D. A. Flores, J.F. Tabbada and E. Ramiro. 1992. Barriers to EntryStudy, Volumes I and II. United States Agency for International Development.

Lapid, D. 1994. Appliance Industry: Impact of Trade Policy Reforms on Performance, Com-petitiveness and Structure. Research Paper Series No. 94-05. Makati City: PhilippineInstitute for Development Studies.

Leach, D. 1997. Concentration-Profits Monopoly vs. Efficiency Debate: South African Evi-dence. Contemporary Economic Policy 15 (April).

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Medalla, F. 1998. Trade and Industrial Policy Beyond 2000: An Assessment of the PhilippineEconomy. PIDS Discussion Paper Series No. 98-05. Makati City: Philippine Institutefor Development Studies

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Neven, D.J. 1993. Merger in Daylight. In The Economics and Politics of European MergerControl. London: Centre for Economic Policy Research.

Neven, D., P. Papandropolous and P. Seabright. 1998. Hard and Soft Cartels. In Trawling forMinnows European Competition Policy and Agreements Between Firms. London: Centrefor Economic Policy Research.

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––––––. 1993 The Philippines: An Opening for Sustained Growth.

3C H A P T E R

Of Cartels and Collusion:An Analysis of the

Philippine Cement Industry

Rafaelita A. Mercado-Aldaba*

“Businessmen’s meetings, even for merriment and diversion usuallyend up in connivance to restrict competition. It is impossible indeed toprevent such meetings, by any law, which either could be executed, orwould be consistent with liberty and justice.”

— Adam Smith

ABSTRACT

This paper shows that the average market shares of cement firms in the last 13years have remained high and stable. The industry has maintained a highlyconcentrated structure and entry is not easy because of the large capital requirements necessary to operate a cement plant. The natural characteristics

of cement—high transportation costs and relatively short shelf life—provide naturalprotection against competition from imports. The demand for cement is inelastic (es-timated at about 0.29), providing substantial market power to firms.

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* 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.


Market power is the ability of firms to raise and maintain prices above the levelthat would prevail under competition. The cement industry illustrates a clear case ofmarket failure due to the existence of market power. The Lerner index (price-costmargin) estimates show that the cement firms are able to increase prices substantiallyabove marginal costs. The price-cost margins ranged from 0.5 to 1.68 in NorthernLuzon, 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 tremendousmarket power, which they do not hesitate to exercise collectively in order to earnhigher profits and prevent effective competition from taking place. This results inhigher prices and loss of economic welfare.

The situation calls for the formulation of comprehensive competition law andpolicy that will address cartels and collusion. Without antitrust or competition laws, asmall 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 regu-latory controls, protective policies, and investment incentives designed to promote theindustry. With the demise of the import substitution model, the government wasprompted to institute reforms consistent with the demands of a competitive market.Starting in the late 1980s, the government deregulated the cement industry, removedimport restrictions, and gradually reduced tariffs.

Yet the more than 15 years of regulation, protection, and promotion have left ahighly concentrated industry that was controlled by a small group of families whowielded economic and political influence in the country. It was not surprising thattheir owners were able to extract monopoly rents in the market. The mergers andacquisitions following the entry of large multinational cement firms in the late 1990sonly highlighted the market concentration and absence of competition in the industryas the firms continued to collude and exercise their collective market power.

Despite some real progress in implementing reforms in the industry, competitionhas remained limited. The ability of cement firms to engage in restrictive businesspractices has offset the effects of deregulation and liberalization. The firms’anticompetitive practice became evident when their prices went up in an orchestratedfashion in the wake of the 1997 Asian financial crisis. This occurred at a time charac-terized by excess supply, overcapacity, and weak demand.

The main objective of this paper is to assess the current state of competition in thecement industry focusing on firm behavior and industry structure. The paper is di-vided into five sections. The second section discusses the underlying theories on theneed 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 cementindustry and the economic policies affecting its development. The fourth section is theheart of the paper as it evaluates competition and market power in the cement indus-try. The competition analysis entails three stages: market definition, market structure,and price analysis. The fifth and final section summarizes the major findings of thepaper and presents the policy implications drawn from the competition analysis.

BASIC CONCEPTS AND THEORIES

COMPETITION AND MARKET POWERCompetition refers to the process of rivalry among firms that forces them to be-

come efficient and sell a wider range of goods and services at lower prices. The WorldBank and the Organization for Economic Cooperation and Development (1998) notedthat in a competitive economy, price and profit signals tend to be free of distortionsand create incentives for firms to reallocate resources from lower to higher valueduses. Decentralized decisionmaking by firms promotes efficient allocation of society’sresources, increases consumer welfare, and gives rise to dynamic efficiency in theform of innovation, technological change, and economic progress.

Firms, however, can have the incentive to obtain market power, i.e., the discre-tionary control over prices and other related factors determining business transac-tions. Market power refers to the ability of a firm, unilaterally or in collusion withothers, to profitably raise price and maintain it over a significant period of time with-out competitive response by other existing and/or potential firms. Firms have marketpower individually or collectively when buyers do not have enough choice of alterna-tive independent sellers. In a competitive market economy, consumers may buy fromany firm and firms, in general, can enter any market. There can never be marketpower when entry is easy. As soon as one firm or a group of firms attempts to increaseprices or lower quality from competitive levels, a new firm can come in to serve themarket.

The price-cost margin or Lerner index (L = [(price-marginal cost)/price]) is usedas a direct measure of market power. Market power implies that a firm is able tocharge prices substantially above marginal cost. A firm without market power mustcharge a price that approximates marginal cost. Under perfect competition, firms sell-ing homogeneous products cannot affect market prices. Free entry of new firms en-sures that the price, equated with marginal cost, just covers average cost. Firms thatattempt 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 theminimum efficient scale of production is small relative to the overall market demand (seeNeven 1993).


power is exercised as soon as firms have the ability to increase their own price abovemarginal cost without losing all customers. Market power arises when a firm pro-duces a differentiated product such that customers do not switch easily to competitorsas the price increases. Market power also arises when there is coordination of behav-ior or collusion between firms such that a price increase is accommodated by competi-tors (Neven 1993).

Market power is expressed by the extent to which firms would be able to raiseprice profitably. Hence, market power is concerned with the own-price elasticity ofdemand. The own-price elasticity of demand measures the proportionate decline insales following an increase in price (assuming that the prices of other products areheld constant). The more elastic the demand curve, the more sales will be lost for anygiven level of price increase. Under these circumstances, firms will not possess mar-ket power. The power to control price requires a low own-price elasticity of demand. Ifthe own-price elasticity is low, firms will have significant ability to raise prices prof-itably 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 directlyassess market power issue.

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

The Lerner index is proportional to the firm’s market share and inversely propor-tional to the elasticity of demand.

Most concentration profits studies apply price-cost margins (PCMs) as measuresof profitability. Leach (1997) estimated PCM based on the following formula: (GrossOutput – Cost of Materials – Salaries and Wages)/Gross Output. Leach noted that thePCM is a crude measure of profitability because many important costs remained in themeasure such as cost of capital, depreciation, income taxes, and head office expenseslike advertising and R&D expenditures.

CARTELS, COLLUSION AND OLIGOPOLYCollusion 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 maximizetotal industry profits. In a competitive environment, firms act independently and ri-valry is present among competing firms in the market.

In a cartel, firms get together and attempt to fix prices or levels of outputs, rigbids in auctions or procurements and divide markets by allocating customers, territo-ries, relevant products or supplies in order to maximize total industry profits. Cartelsand 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 itappear that there is competition in the market, when in reality there is none. Theymake consumers believe that what they see are independent offers while potentialinvestors or rivals are made to believe that the market is sufficiently supplied. Byraising prices and restricting supply, artificial shortages are deliberately created. As aresult, goods and services become completely unavailable to some buyers and unnec-essarily expensive for others. These output restrictions cause inefficiency, reduce pro-ductivity, and result in economic and social harm.

Collusion is a cooperative game and involves two elements: (1) a process of com-munication/discussion and (2) an exchange of information with the aim of reachingan agreement and the imposition of punishment in case of deviations. It is importantto differentiate between hard and soft cartels. Hard-core cartels or explicit collusionrefers to explicit agreements to fix prices or share markets between producers andsellers of substitute products. Soft cartels or tacit collusion refers to collusive agree-ments that are merely implicit. Implicit coordination may be achieved without anycommunication or negotiation between firms. There will be no evidence of firms hav-ing met or having discussed coordination of market behavior. The only evidence thatwill be available relates to firms’ market behavior. The operation of both implicit andexplicit mechanisms will require information. To be sustainable, information on otherfirms’ costs, outputs, prices, and discounts are necessary. The greater the number offirms and the more product heterogeneity, the greater these information requirementsexpand.

It is not easy to detect cartels and to uncover them; it is necessary to understandhow they work. A cartel needs to convince all significant competitors to increase theirprices above competitive level and keep them there long enough to earn monopolyprofits. It is difficult to agree on the price because different firms may prefer differentprices. A firm with higher cost would prefer higher cartel price while a firm withlower 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 memberwould cheat by lowering prices.

There is always a temptation to produce more than is agreed and hence, makehigher profits assuming that the rest of the industry will produce at a constant leveland will not respond. To be successful, a cartel must have a punishment strategy topolice members’ behavior usually in the form of a price war. This requires that firmsmust be able to keep track of the prices and production levels of the other firms in thecartel.

Oligopoly theory tells us that there are several ways in which firms behave inan oligopolistic environment. The leading models are summarized in Rees(1993).

Cournot Model: firms independently choose outputs on the assumption thattheir rivals make no response to their choices and market equilibrium is achievedthrough a sequence of alternating output choices, which converge over time.


Stackelberg Model: a leader makes a choice of output, the other firms act asfollowers and make their profit-maximizing response to this output. The leader takesaccount of these responses in choosing its output and is able to do better than it wouldunder 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 (in-crease in price) will not be followed. This creates a kink in the firm’s perceived de-mand curve at its current price-output pair, which then tends to remain the samedespite changes in marginal cost because of a discontinuity in the firm’s marginalrevenue at the kink.

Bertrand Model: firms independently choose prices, on the assumption thattheir rivals make no response to their choices. When firms produce identical outputsand have identical constant marginal costs equilibrium, price ends up equal to thiscommon cost.

Edgeworth Model: firms choose prices as in the Bertrand model, with identicalconstant marginal costs, but with fixed output capacities. There is a range of possibletypes of outcome and the possibility of price cycles. There is a range of prices theupper 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 smallsteps from the upper limit of the interval until it reaches the lower limit and thenjumps back to the upper limit and the cycle begins again.

All these oligopoly models are examples of noncooperative games. It is importantto recognize that oligopolies are not necessarily detrimental to competition. Largefirms may achieve a dominant position in the market through legitimate ways likeinnovation, superior production or distribution methods, or greater entrepreneurialskills. These firms may act on their own and do not come to an agreement governingtheir behavior.

In general, collusion results in the smallest industry output and the highestprice. Bertrand equilibrium, the competitive equilibrium, gives the highest outputand the lowest price. The other models provide results that are in between these twoextremes. Many theorists see the above models as giving analytical precision to theidea of tacit collusion (Rees). This would not involve explicit agreement but sim-ply the unspoken acceptance by the firms that it is in their best interests to pro-duce the monopoly output on the understanding that failure to do so wouldprovoke a price war.

In the real world, there are many facilitating devices that have been developed tohelp firms achieve successful tacit collusion. These include:

• Trade associations: In many industries, associations are usually organizedto handle public relations, organize conventions, trade fairs, etc. However,they may also act as facilitating devices as in collecting and disseminatinginformation on costs, outputs, prices, and policing both tacit and explicitagreements:

CEMENT INDUSTRY 71

• Price leadership: In this practice, the dominant firm first announces pricechanges and the other firms follow within a short period of time. It is alsopossible for a non-dominant firm, which is considered the best at judgingmarket conditions to play this role. This practice of price leadership is a wayof addressing the problem of choosing one price agreement in the set ofpossible agreements. If the leader is good in selecting mutually acceptableprices, 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. Itis common in industries like steel and cement. Delivered prices are com-puted according to base prices and transport charges. This arrangement of-ten results in delivered prices to any buyer that is always uniform acrosssellers and there is no price competition. Sellers must exchange informationon base prices and transport charges, but no explicit agreement to colludeon prices is made.

• There are also many opportunities for company officials to make their viewsknown to each other on the state of the market and the direction pricesshould take. Examples of these include newspaper interviews, articles intrade publications, or speeches.

The prospect that firms may rely on tacit collusion or implicit coordination en-forcement mechanisms to exercise collective market power raises an important issuefor competition policy. In the US, collusion is in most instances per se illegal. In theEuropean Community, hard-core cartel agreements are prohibited. In the UK, thepolicy 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 outcomesof their behavior from the point of view of economic efficiency. In the enforcement ofcompetition policy, the current trend is now moving away from “per se” rule towardthe 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 citedas a market likely to have a cartel. Historically, the Philippine cement industry thrivedunder a powerful government-sanctioned cartel that captured Filipino consumers andindustry users including the government. Many of the cement firms had direct gov-ernment participation through guarantees, loans, and equity. The economic slump inthe early 1970s resulted in large losses and chronic oversupply prompting cementfirms to push for government regulation of the industry. They believed that by govern-ment regulation, the industry could prevent cutthroat competition. As the governmentalso had financial interests in the sector, it immediately responded by creating the


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 theindustry. In the absence of information, the PCIA had to coordinate closely with theindustry association, which is currently known as Philippine Cement ManufacturersCorporation (Philcemcor). The PCIA and the Philcemcor worked closely together inregulating the industry to the point where PCIA delegated the setting of productionquotas to Philcemcor. Aside from regulation, the government heavily protected andpromoted the industry through high tariffs and import restrictions as well as fiscalincentives under the Board of Investment’s (BOI) rehabilitation, modernization andrationalization program.

Collusion in the industry took place through the firms’ informal agreement to setproduction quotas and to assign geographic markets among themselves (Lamberte etal. 1992). Philcemcor held regular monthly meetings to set production quotas. It alsoarranged the geographical division of the markets that restricted Luzon plants to sellonly in the Luzon area and the Visayas/Mindanao plants to confine their sales in thoselocations (SGV Consulting 1992). This practice divided the country into regionalmarkets served by a dominant player, thus, eliminating competition from taking placein the industry. By regulating prices and outputs, prices were no longer the product ofcompetition among rival producers but more of the outcome of negotiations betweenthe government and a small number of producers.

In 1987, the PCIA was abolished through Executive Order 133, but the pricecontrol function was transferred to the Department of Trade and Industry. The pricecontrol was momentarily lifted in February 1989 and reemployed in July 1989. Priceswere finally deregulated in November 1991 through DTI Administrative Order 10.Moreover, reforms to end territorial arrangements of cement companies and lift DTIapproval for establishing or expanding cement plants were carried out through DTIAdministrative Order 5 issued in 1990.

Simultaneous with the abolition of the PCIA in 1987, the Development Bank ofthe Philippines (DBP) transferred cement industry financial assets to the AssetPrivatization Trust (APT). Most of the firms negotiated the settlement of their debtsunder the “direct debt buy out” scheme with the APT. APT also bidded out all thecement companies foreclosed by DBP (OECC 1991).

Central Bank Circular 1195 lifted the import restrictions on cement in 31 March1989. At about the same time, the tariff on cement was reduced from 50 percent in1979 to 40 percent in 1988 and was further cut to 20 percent in 1989. From January1990 to mid-1991, the tariffs on portland cement and clinker were suspended to ad-dress the problem of cement shortage following the expansion of construction activi-ties 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 to7 percent and currently its rate stands at 5 percent.

CEMENT INDUSTRY 73

The past three years witnessed the acquisitions of local cement companies by fourlarge foreign firms: Lafarge, Holderbank, Cemex, and Blue Circle. These firms (to-gether with Heidelberger) account for about 60 percent of the annual 100 millionmetric tons (mt) of the global cement trade. Following the entry of foreign players,consumer groups and industry observers raised concerns on their possible dominationof the market and the creation of a cartel. The cement price increases since 1999baffled many, considering that these price hikes were carried out amid excess supplyand weak demand due to the slowdown in construction activity. These price increasesimmediately following the entry of foreign players prompted industry analysts to be-lieve that a cement cartel was at work.

Philcemcor defended the companies by saying that the price increases were inevi-table due to the high production costs and finance charges. The financial crisis struckat a time when cement companies were expanding in anticipation of increased eco-nomic growth. This resulted in dramatic increases in their foreign-denominated loansand high interest rates on local loans. Congress immediately initiated investigationson the reemergence of a cement cartel. The DTI also conducted preliminary investiga-tion on the possible collusion among members of the suspected cartel to keep cementprices above normal levels. So far, there is still no official announcement on the find-ings 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 en-

try 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 mar-kets? Do we see prices in one geographic market that are substantially higherthan in others? Are price-cost relationships consistent with competition orwith collusion?

MARKET DEFINITIONA 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 geographicmarket describes the location of the producers or sellers of the product.

Product marketThe cement industry covers the manufacture of hydraulic cements including

portland, aluminous slag and superphosphate, whether or not in the form of clinker


(1994 Philippine Standard Industrial Classification). Cement is a superior bondingagent used as a raw material in concrete construction. Its main components are lime-stone, clayey materials, and ferrous materials, which are processed into clinker. Thelatter is ground and mixed with gypsum to produce cement.

Cement manufacturing is basically capital intensive. Capital costs accounted forabout 20 percent of total manufacturing costs (SGV Consulting 1992). The industry isalso a heavy user of energy with costs ranging from 30 to 43 percent of manufacturingcosts 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 ce-

ment and is manufactured from limestone, clayey materials, siliceous materials, fer-rous 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 afinely ground mixture of 70 to 80 percent clinker and 20 to 30 percent pozzolanmaterials.

Portland-Pozzolan Cement (Type 1-P): a cement product with a shorter curingperiod than Type P Portland Pozzolan and compares favorably with ordinary portlandcement in terms of compressive strength and setting time.

Industry playersWhile 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 groupcontrolling 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 theindustry’s rated capacity while the Alcantara group had 14 percent. The rest of thefirms were independent from the three groups and together comprised roughly 27percent of industry capacity.

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

Table 1. Industry Ownership Structure Prior to the Asian Crisis

CEMENT INDUSTRY 75

Following the 1997 Asian financial crisis, an industry reorganization started tounfold 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 con-struction industry to contract, foreign firms were able to buy into the local cementindustry. Most local firms have taken in foreign companies as partners to generatefresh capital, strengthen their balance sheet, and improve their technology to bringoperations at par with world standards.

Mergers and acquisitions started to intensify in 1997. Central merged withBacnotan; during the same year, Cemex S.A. of Mexico (the world’s third largestcement maker) bought Rizal and Solid. In 1999, Cemex also acquired Apo Cementfrom JG Summit Holdings of taipan John Gokongwei Jr.

In 1998, the French firm Lafarge (the world’s second largest cement manufac-turer) bought into Southeast Asian Cement, Republic Cement, and Continental Ce-ment while UK-based Blue Circle Ltd. also bought into Republic Cement and FortuneCement (which are partly owned by retail magnate Henry Sy Sr.) as well as inMindanao Portland and Iligan. Heidelberger bought into Limay while Swiss cementmanufacturer Holderbank (the world’s largest cement maker) bought into BacnotanCement, Davao Union Cement, and Hi-Cement in mid-1998 and into Alsons andIligan in early 1999 (Table 2).

With the presence of the world’s largest cement companies, the industry whichused to be dominated by one big group and several family-owned companies is nowdivided into five groups with cross-ownership: Phinma, Holderbank, Lafarge, BlueCircle, and Cemex. Four firms remain independent and have not linked up with aforeign partner: Northern (Eduardo Cojuangco), Grand (Benedictos), Pacific, andTitan (Aranetas). Industry restructuring continues, as the market remains sluggishdue to the decline in construction activities. Currently, industry restructuring hastaken the form of mergers and consolidations with the objective of improving com-mercial 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 Holderbankcontrol the umbrella company known as Union Cement Corporation (UCC). UCC hasa total capacity of 5.7 million metric tons and is expected to be the country’s biggestcement company. Industry analysts also expect Holderbank to merge Union Cementwith Alsons Cement where it owns a 50 percent stake.

Toward the end of 1999, Blue Circle announced its plan to consolidate the opera-tions of Fortune Cement, Republic Cement, Zeus Holdings, and Iligan Cement. BlueCircle will own 64.5 percent of the merged entity. The other partners are the SMGroup of Henry Sy and the Montinola family. The combined entity will be the secondlargest cement company (with a market share of almost 20 percent) in the countrywith full national coverage and a total clinker capacity of 4.4 million tons. The inte-gration is expected to incur cost savings amounting to P750 million.


Geographic marketCement has a limited shelf life (three to six months) and is characterized by high

transport and handling costs. Cement manufacturing in the Philippines is basicallyresource-based with cement plants located in or near limestone quarry areas. Cementis distributed by land within Luzon and by both land and water within Visayas andMindanao.

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%

Table 2. Ownership Structure After the Asian Crisis

CEMENT INDUSTRY 77

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

MARKET STRUCTURE AND MARKET POWER

Market sharesTable 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, thereare three firms operating, namely, Bacnotan, Northern, and Limay. The first two ce-ment companies dominate the market, although Limay, which entered the marketonly in 1997, registered increasing shares between 1997 and 1999.

Figure 1. Geographic Markets in the Philippine Cement Industry

BACNOTAN

Bacnotan, La Union

NORTHERN

Sison, Pangasinan

HI CEMENT

Norzagaray, Bulacan

BACNOTAN

San Ildefonso, Bulacan

F-R

Pasig City / Teresa Rizal

SOLID

Antipolo City

FORTUNE

Taysan, Batangas

LIMAY GRINDING MILL

Limay, Bataan

REPUBLIC

Norzagaray, Bulacan

CONTINENTAL

Norzagaray, Bulacan

RIZAL

Binangonan, Rizal

TITAN

Tanay, Rizal LLOYDS RICHFIELD

Danao City, Cebu

APO

Naga, Cebu

GRAND

San Fernando, Cebu

PACIFIC

Surigao City, Surigao del Sur

ALSONS

Lugait, Misamis Oriental

MINDANAO

Kiwalan, Iligan City

ILIGAN

Kiwalan, Iligan CityDAVAO UNION

Ilang, Davao City


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

Table 3. Market Shares

Source: Philcemcor.

CEMENT INDUSTRY 79

The National Capital Region has the most number of competing firms. Thereused 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 SouthernLuzon, there is only one firm, Fortune Cement.

In the Visayas, there used to be only one firm, Apo Cement, up to 1991. Lloydsentered 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 lasttwo years, 1998 and 1999. In Mindanao, five firms are operating with the bulk of themarket controlled by Davao Union, Alsons, and Iligan.

Concentration measures and price-cost marginOne needs to be careful in defining the cement market. Product market definition

is relatively easy as cement is a homogeneous good. Geographic market definition isvery important as the firms’ individual shares would change depending on the extentof the geographic market defined. Correctly defining the product and geographicmarkets is necessary to accurately assess the level of concentration in the industry.

After the deregulation of cement prices, removal of import restrictions as well assubstantial 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.

Figure 2. Average Market Shares


Except in NCR, the four-firm concentration ratios have remained high andhardly changed in the last 13 years. In NCR, the concentration ratio remained highand fluctuated between 1987 and 1999 with slight movements downward in 1992 and1995 and steady increases thereafter.

Going by the US guidelines (where 1000 and below is consideredunconcentrated, between 1000 to 1800 is moderately concentrated, and above 1800 ishighly concentrated), the HHI estimates indicate that between 1988 and 1996, NCRwas only moderately concentrated and started to be highly concentrated only in 1997.The HHI estimates indicate that the concentration levels in Northern Luzon and theVisayas are declining but still remained at high levels. Except in 1999, there was nochange in the level of concentration in Southern Luzon, which has been controlled byonly one firm as indicated by its HHI of 10000 ( the maximum in the range of HHIoutcomes). In Mindanao, the concentration level stayed high and was almost constantbetween 1988 and 1999.

PCMs were estimated using firm-level data from the 1988 and 1994 Census ofEstablishments and the 1995 Annual Survey of Establishments of the National Statis-tics Office. The PCM was estimated as follows: PCM = [(Value of Output - Cost ofRaw Materials – Total Compensation )/Value of Output]. As earlier indicated, a firmwith market power is able to charge a price significantly above marginal cost while afirm 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 havebeen increasing. These figures are higher than the average PCMs estimated for thewhole manufacturing industry. In 1995, the cement industry posted a PCM of 42percent compared to 36 percent in manufacturing.

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

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

CEMENT INDUSTRY 81

To assess the degree of market power of cement firms, the own price elasticity ofdemand was measured. The demand curve was estimated using Philcemcor and Na-tional Statistics Office monthly data from 1993 to 1999 and computed according tothe following:

Q = 32117 – 11638P + 2492D(11.68) (-3.24) (2.41) t-statistic0.000 0.002 0.018 p value

R2 = 0.15F-statistic 7.3whereQ: 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 significantwhile seasonal dummy was insignificant.

To enable us to estimate own-price elasticity, the demand equation is expressed inlogarithmic form:

ln Q = 16.86 – 0.29lnP + 0.095D(391.61) (-2.9) (2.12) t-statistic0.000 0.0043 0.0367 p value

R2 = 0.13F-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 priceelasticity. These estimates allow us to directly compare prices and marginal costs.Evidently, the estimates confirm the substantial market power wielded by the domes-tic 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 ofless than one were registered in the National Capital Region with leaders Solid andHi-Cement posting the highest (almost equal to 1) at 0.9 and 0.8, respectively. Therest of the firms operating in the NCR had PCMs ranging from 0.15 to 0.5.

Table 5A. Industry Price-Cost Margin

Year 1988 1994 1995

Cement 0.28 0.37 0.42

Manufacturing 0.30 0.34 0.36


Market entry conditionsCement manufacturing is a highly capital-intensive activity. Heavy capital re-

quirements are needed to obtain the necessary facilities, technology, and raw materi-als (mainly limestone). Lumber being relatively more expensive, there are no viablesubstitute for cement. Cement is characterized by a low price elasticity of demand (asearlier shown). A firm’s power to control price requires a low own-price elasticity ofdemand. If elasticity of demand is high, producers will have no significant ability toraise 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 han-dling costs and, as such, it is often classified as a nontradable good. Potential compe-tition from imports is important as a mechanism to control market power. In thecement industry, however, this is of little practical value because of the substantialcosts of entry. Cement can be imported in bulk, but this will require a bulk handlingfacility, which is quite expensive. For instance, a 300,000 mt silo will cost aroundP500 million in investment. On the other hand, shipping cement in bags will entailextra handling costs, which can easily increase the price. These factors limit theprocompetitive effects of imports on the industry, providing natural protection forestablished 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 thecharacteristics of cement, foreign firms may have found it more profitable to becomeparties to the domestic industry rather than to compete via imports. While the sharpincreases in imports in the early 1990s were due to shortages in the domestic market,

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

Table 5B. Price Cost Margin (PCM) by Firm

CEMENT INDUSTRY 83

the import surge in 2000 may be attributed to the global over supply of cement anddepressed demand due to the generally unfavorable world economic conditions afterthe 1997 Asian financial crisis.

The domestic cement industry strongly resisted the entry of cheaper importswhich were sold about P5-10 lower than domestic cement. Philcemcor immediatelyfiled a dumping suit against Taiwan Cement Corporation and Japan’s Taiheiyo forallegedly 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 linewith the prevailing domestic cement prices. Refusing to do the same, Taiwan CementCorporation 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 cementexports to Taiwan in retaliation to the alleged dumping. Alsons stated that it wouldsell its cement at a significantly lower price than the prevailing domestic price inTaiwan 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 andthis dropped further to between $25 and $27/mt in 1998. In Thailand, prices rangedfrom US$16 to US$18/mt in late November 19982 . These are more or less consistentwith the ex-terminal import prices of Taiwan and Japan in the Philippines. Apartfrom Taiwan and Japan, Indonesia also exports cement to the country.

___________________

2 Indian Express Newspapers.

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

Table 6. Cement Imports (in 40 kg bags)

Source: PHILCEMCOR


Since 2000, the local cement companies have been asking the government formore stringent measures to regulate the entry of cement imports, which were alleg-edly being sold at dumped prices. The Tariff Commission, however, failed to findsufficient evidence to prove that the domestic cement industry indeed suffered seriousinjury arising from imports. Subsequently, Philcemcor sought refuge through Repub-lic Act 8800, which allows industries affected by import surges to request for eithergeneral 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 forduration of 200 days. In turn, the industry promised that the firms would not increasetheir prices during this period and committed to sell cement within the price rangeP125 to P135. In March 2002, the Tariff Commission completely reversed this deci-sion and instead, recommended against the granting of a 50 percent tariff and animport quota requested by Philcemcor.

PRICE ANALYSIS AND ANTICOMPETITIVE BEHAVIORThe foregoing sections indicate that firms in the industry have high and stable

market shares. Demand for cement is inelastic, thus providing firms power to controlprices. Their ability to price substantially above marginal cost indicates the high de-gree of market power that they can collectively exert. The industry has remainedhighly concentrated and entry by new firms is not easy due to the large capital require-ments as well as the natural characteristics of cement, which limit import competi-tion. 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 fixprices in order to increase profits. Since it is difficult to find material evidence ofcoordination such as a written document or agreement governing the cementindustry’s behavior, the analysis in this section focuses on associated firm behaviorand 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 toengage in collusion. Box 1 contains cement cartel cases in the Slovak Republic, aneconomy in transition, the European Community, and in Norway. In the Philippines,there are only three major groups (Phinma/Holderbank, Cemex, and LaFarge/BlueCircle)3 in the industry, which make coordination easier. The industry has a very ac-tive association, the Philcemcor, that aggregates industry statistics and may facilitatethe exchange of individual price and quantity between competitors. The history ofcoordination in the industry is also a very significant factor to establish the presump-tion that the firms are not acting on their own.

Table 7 presents a picture of the economic operation of the industry from 1990 upto 1999. Total supply (domestic production + imports + inventory - exports) and totaldemand (domestic sales+imports) were estimated alongside with excess supply (total

___________________

3 LaFarge acquired Blue Circle in July 2001.

CEMENT INDUSTRY 85

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.

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

Sources: Steen and Sorgard (1996); Neven et al. (1998); World Bank–OECD (1998).


supply-total demand). The table also shows average ex-plant prices, capacity utiliza-tion rates, and annual percentage changes in sales, production, total demand, andtotal supply.

The data indicate strong industry growth between 1993 and 1996. In anticipationof 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 theirexpansion 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 financialcrisis in 1997, the demand for cement dropped by 13 percent in 1998 and by 4 percentin 1999. The slowdown in the construction and property sector resulted in an oversup-

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

Table 7. Average Prices, Excess Supply and Industry Capacity, 1990-1999

(In ‘000 40 kg bags)

Source of basic data: Philcemcor.

CEMENT INDUSTRY 87

ply of cement in the market forcing cement firms to cut prices. As firms engaged in aprice war average ex-plant prices were reduced by 6 percent in 1997 and by 23 percentin 1998.

The cement industry is highly dependent on construction demand. Between 1998and 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 byaround 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 reportindicated that the overcapacity of the industry would remain until at least the year2007. Nonetheless, despite the overcapacity of the industry, excess supply, and weakdemand, 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 pricechanges that closely followed each other. Figure 3 presents the pricing behavior offirms in the industry over the last seven years from January 1993 to May 2000. Ingeneral, the demand for cement is seasonal; it peaks during the dry months and fallsthereafter. As evident from the figure, there is a fairly stable pattern in the movementof average ex-plant prices between 1993 and 1996. Chaotic movements in the averageex-plant prices started to be felt in April 1997. During this time, the demand forcement was still rising with growth estimated at about 14 percent. Average ex-plantprices declined steadily from P104 in March 1997 to P 88 in September of the sameyear. While it slightly moved up to P90 in October to November, it again fell to P87 bythe end of the year.

The same declining trend was observed during the whole period of 1998. It onlystopped after industry leader Phinma announced that it would no longer engage inany price reduction. As expected, everybody in the industry followed. Cement prices

Figure 3. Average Ex-Plant Prices


then began to go up consistently from January 1999 to May 2000. This continued evenwith the entry of imports, which started to build up in March 1999.

Table 8 presents the percentage changes in the monthly average ex-plant pricesfrom February to May 2000 as well as the simultaneous price increases among the

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


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


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


Table 8. Monthly Changes in Average Ex-Plant Prices (Jan-May 2000)

Source of basic data: Philcemcor.

CEMENT INDUSTRY 89

firms during the period. Beginning in February 2000, the largest price increases wereinitiated by Phinma firms Bacnotan and Hi Cement whose prices went up by 7.14percent and 8.25 percent, respectively.

In March, the rest of the firms followed and increased their prices by roughly thesame 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 7percent; 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 inthe face of excess supply and weak demand as a result of construction slowdown in thecountry. Imports continue to come in as their share to total consumption more thandoubled from 1.4 percent in 1998 to 3.84 percent in 1999.

The variability in ex-plant prices among the firms within each geographic mar-ket in the industry is very small as indicated by the standard deviation figures. InFebruary and April 2000, the standard deviation was 1.15 in Northern Luzon, 1.04and 1.1, respectively, in NCR, and 1.1 in Mindanao. In May, it was 1.59 in theVisayas, 1.53 in NCR, and 1.34 in Mindanao.

There is also not much variation in the average prices across the three majorgeographic markets in the country. In February 2000, the average price in NorthernLuzon was P101 per bag, P99.17 in NCR, and P100 in Mindanao. The average priceof 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 theVisayas. In April and May, the average price in Northern Luzon was P107, P107and P107.50, respectively, in NCR, P107.60 in Mindanao, and P115.67 in theVisayas.

Under competitive conditions, the only explanation for this low variation inprices is that firms have more or less similar cost structure. This does not seem to bethe case based on current cost estimates provided by various sources. For instance, theDepartment of Trade and Industry (DTI) noted that, based on the production costssubmitted by cement firms to DTI, power costs alone fluctuated widely among thefirms. 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 amountto much more than P90 per bag. Southeast Asia Cement Holdings, Inc. (FR andLloyds) estimated the average cost of cement including depreciation and interest pay-ments at about P80 per bag.

Cost information based on the cement firms’ financial statements submitted tothe Securities and Exchange Commission are presented in Table 9. The table revealsthat the variation in average production cost per bag is high and notably increasingsteadily in 1998 and 1999 when the standard deviation in the firms’ production costssubstantially widened (except in Northern Luzon where the standard deviation re-mained almost constant).


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 ofonly P58.50. In NCR, Solid and FR had almost equal production cost of about P76per bag, Republic had an average cost of P80 while Titan had P127 and Rizal in-curred almost P194. In Southern Luzon, Fortune’s production cost was roughly P75while 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, ApoCement’s production cost was P99 while Grand and Lloyds had P68 and P64,respectively.

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


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


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 Philippines 10.79 8.10 12.04 37.02

Table 9. Average Production Cost per Bag

Sources of basic data: Securities and Exchange Commission and Formal Investigation Reportof the Tariff Commission, March 2002.

CEMENT INDUSTRY 91

The above cost information does not explain the low variation in prices earlierdiscussed. This similar prices-different cost relationship only makes sense if cementfirms are engaged in collusive arrangements. It also tends to confirm the previousfinding 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 costwhile a firm without market power will price closer to marginal cost.

Under competitive conditions, firms with different cost structures should be quot-ing different prices and equilibrium is achieved at the level where price equals mar-ginal cost. If competition is effective, it should weed out the inefficient firms andallow the market share of efficient firms to increase. This results in price uniformityin the market. Competition forces firms to become efficient and offer a wider choice ofproducts at lower prices. It gives rise to increased consumer welfare and allocativeefficiency.

What is preventing efficient cement firms from undercutting their inefficient ri-vals? The only logical explanation is the presence of collusive behavior or cartel to fixprices in the industry. The threat of a price war and the fear that departure from suchbehavior may lead to costly price cutting, lower profits and market instability createincentives for firms to maintain such an implicit arrangement among themselves.Moreover, inefficient firms are able to survive under the price umbrella provided bythe cartel. Thus, this setup is acceptable because it allows efficient firms to makeexcess profits and inefficient ones to continue their operations. The president of LaFarge Philippines, Philip Roseburg, aptly described the behavior of cement firms suchas his as follows,

“In any industry you can fight for a bigger market share but someone has to give up thatmarket share… But obviously this wouldn’t work with our competitors here…theywill fight and then we get into a bloody battle where everyone ends up bruised. Giventhe opportunity, yes we can try and improve our market share. But I don’t want to loseout 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, wewant 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 ina 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 marketin 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 theHouse of Representatives’ hearing on cement.


Prior to the 2000 price increases, the Philcemcor president indicated that “cementprices must be such that they would allow cement firms to recover their costs of debtservicing and production and get a fair and reasonable return on their investments inorder for the industry to remain viable and eventually achieve stability” (Manila Bulle-tin, 29 November 1999). The cement firms rationalized their price increases by notingthat their operating costs, including those for energy and labor, have gotten higher thanin the past. They argued that due to the depreciation of the peso, the costs of servicingthe huge foreign debts incurred by the cement firms when they expanded their capacitieshave also risen. They noted that production and debt servicing costs amount to much morethan P90 per bag, hence cement firms, individually and for their own self-interests, havehad to increase their prices to avoid incurring heavy losses, which could lead to closure.

The Philippine Constructors Association (PCA) together with other constructiongroups, 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 ofcement 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 anymajor 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 manu-facturing 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 ofUS$40/MT to about US$34/MT, indicating that the fuel cost of the industry hasbeen declining. Industrial power rates did not change substantially from 1998 to1999 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 thesame amount to warrant the uniform price increases that they have been engaged in?

Table 10 summarizes the economic performance of the cement industry from1996 to 2000. The table shows that import share surged from 4 percent in 1999 to 13percent in 2000, domestic production declined by about 5 percent in 2000 while ca-pacity utilization improved from 62 percent to 73 percent in 2000. Labor productivityincreased from 2,517 mt/worker to 3,037 mt/worker as employment dropped by 21percent. Despite the import surge and production decline in 2000, the industry’s salesrevenues jumped by almost 29 percent. The industry also registered income fromoperations 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 ManufacturingCorporation, Limay Grinding Mill Corporation, and Titan Cement Manufacturing Corporation.

CEMENT INDUSTRY 93

members reported net losses during the same years. These net losses were mainlyattributed to other expenses consisting of huge interest expenditures, foreign ex-change losses and other expenses such as write down of fixed assets and deferredcharges, decline in value of investments, costs of plant shutdown/voluntary separa-tion, provision for inventory obsolescence, net losses in equity of subsidiaries, andcumulative effect of a change in accounting policy6.

___________________

6 Formal Investigation Report, Tariff Commission, 13 March 2002.

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 KilnsSource: Formal Investigation Report, Tariff Commission, 13 March 2002.

Table 10. Economic Performance of the Cement Industry, 1996-2000


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 competitiveinteractions. The firms seem to have different cost structures and yet, the prices thatthey are quoting are almost similar. Their price behavior shows that they have in-creased their prices by almost the same amount in what seems to be a harmoniousfashion. This is not surprising if it is considered that the firms have tremendous mar-ket power and they are collectively exercising it. As such, the only way to explain whythe observed price behavior is inconsistent with competitive behavior would be be-cause the firms are engaged in price coordination. This also explains why their salesrevenues went up despite the 5 percent reduction in production and the 13 percentincrease in import share.

Under competitive conditions, the simultaneous price increases that the firmshave been undertaking are quite unbelievable considering that demand for cement isstill low and imports are able to come in. Given excess supply under perfect competi-tion, markets would clear by reducing prices until demand and supply are equal.Moreover, under competitive conditions, firms will react to a negative demand shockby output reduction or even firm exit to minimize their losses. In contrast, firms in-volved in price or output coordination react by expanding output or engaging in aprice war (Green and Porter 1984 as cited in Neven et al. 1998). This is exactly whathappened in the industry in 1998. In the face of the Asian crisis, a price war eruptedand some firms (FR, Apo, and Mindanao) engaged in output expansion rather thanreduction. But after the lowest price of P45 per bag was hit in December 1998, pricecoordination again resumed beginning in January 1999. Excess supply in 1998 and1999 remained at very high levels. From about 4.5 million bags in 1996, excess sup-ply almost doubled to 8 million bags in 1997 and reached 10 million bags in 1998 and1999. However, while prices dropped in 1998, they started to go up in 1999. Averageprices declined by 23 percent in 1998 but increased by 17 percent in 1999.

CONCLUSIONS AND POLICY RECOMMENDATIONS

SUMMARYPrior to the implementation of deregulation and trade liberalization, the industry

was engaged in collusion facilitated by market sharing agreements. Sanctioned bygovernment regulations, these were accepted practices in the past. Although cementprices were deregulated, import restrictions lifted and tariffs set at a low rate of 5percent, 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 thedetriment of consumers, other industry users including the government, and societyas a whole.

Despite these reforms, the industry has remained highly concentrated. The ce-ment 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 theindustry has become glaring as prices rose substantially and continuously since 1999in a simultaneous manner at a time characterized by excess supply, overcapacity, andweak demand.

The cement industry clearly illustrates the presence of market failure. The exist-ence of market power and the absence of competition leads to higher prices and loss ofeconomic welfare. One important lesson that could be drawn from the analysis is thatwhile deregulation and trade liberalization are necessary, they are not sufficient toensure that markets perform efficiently and that their outcomes are reasonably equi-table. In the presence of restrictive business practices like cartels, these reforms alonecannot guarantee competition as observed in the behavior of the cement firms. Tradereforms need to be accompanied by competition policy in order to strengthen marketforces and ensure that their benefits flow to consumers.

Given our weak institutions, firms can successfully organize to influence govern-ment policy. Rather than compete, firms will always lobby for government protectionand hide from the challenges of market competition by invoking policies like anti-dumping and safeguard measures or engaging in cartel activities. It is no wonder thatcartel behavior persists in the country; the government allows it through its use ofregulatory measures, through its failure to legislate the correct laws against anti-com-petitive behavior; and simply ignoring that such behavior exists. The cement caseshows that our previous experience of regulation, promotion, and protection encour-aged greater concentration, limited the potential for competition, and prevented thedevelopment of a culture of competition in the country.

ALTERNATIVE POLICY OPTIONSThe cement firms have attempted to rationalize their price-fixing activities

by indicating that their past investments in the industry have not yet yielded anyprofits due to the Asian financial crisis and the political instability in the coun-try. Demand has continued to drop and as such, the firms have been incurringlosses. Adding to their woes, they complain, is the availability of cheaper im-ports. To survive, domestic firms have adopted a strategy of avoiding competi-tion by fixing prices.

What can a small developing country like the Philippines do to address the issueof anticompetitive behavior being justified by the industry as a necessary tactic forsurvival given the prolonged reduction in demand? There are different courses ofaction that may be adopted by the government:

(1) Maintain a business-as-usual attitude, let the firms continue with their tacitcollusion but allow imports to come in.

Given the lack of material evidence and our ineffective antitrust laws, importsare the only means to provide competitive discipline to the industry characterized bylimited competition and one that is prone to collusive behavior. Once economic re-


covery sets in and businesses return to their normal conditions, this may no longerbe a feasible option given the high transportation and handling costs of importedcement.

(2) Protect the industry against imports by increasing tariffs and imposing anti-dumping duties.

As import tariffs are liberalized, the pressure on governments to invoke instru-ments like antidumping and countervailing duties (measures that limit import com-petition) increases. The government must avoid the imposition of antidumpingmeasures for reasons other than predatory dumping. Safeguard measures must not beprovided to industries and firms that are able to exert collective market power andare engaged in collusive and other anticompetitive activities. Safeguard measurescould easily be abused and become protectionist tools; hence, the government mustbe circumspect and carefully weigh the welfare gains and losses of increasing tariffsto the industry. As our previous experience showed, increasing tariffs and protectionwould only provide an incentive to encourage smuggling. It is only with competitionthat consumers will obtain the best possible goods at the lowest possible prices.

(3) Formulate competition laws/policy that will address both implicit and ex-plicit cartels. This is the best solution because without competition laws, asmall developing country like us would have very little recourse againstcartels and collusion and other anticompetitive behavior.

The outcome of cartel behavior is against public interest and is highly distortiveof economic efficiency. Cartels limit competition and allow firms to manipulateprices to the detriment of consumers and other industry users including the govern-ment. Competition law will eliminate abusive monopoly conduct, price fixing andother cartels. It will prohibit mergers and acquisitions that limit competition. Com-petition law is primarily meant to protect consumers, both individual consumers andfirms that buy intermediate goods and capital assets including governments thatbuild infrastructures like roads, bridges, schoolbuildings, etc. Competition law ismeant to protect the competition process, which will allow efficient firms that re-spond to consumer demand to succeed over the inefficient firms. The competitionprocess will allow consumers and producers to exercise their freedom of choice freeof any price-fixing conspiracies and monopolistic bullying. With competition, con-sumers 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, effectivecompetition is.

From the seventies to the eighties, the cement industry thrived under a powerful,government-sanctioned cartel. Local manufacturers cannot forever hide from importcompetition by invoking protection against dumping and engaging in cartel activi-ties. With the increased globalization of markets, efficiency is the key to survival. Inother 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 byrent seeking, the cement industry should instead redirect its efforts toward enhanc-ing 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 aComparative 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 ofEconomic 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 EntryStudy, 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 forMinnows 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):27-40Shapiro, 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 andPolicy.

4C H A P T E R

Competition Policy and thePhilippine Downstream Oil Industry

Peter Lee U*

ABSTRACT

The Philippine downstream petroleum industry underwent monumentalchange with the passage of Republic Act 8180, the original Downstream OilIndustry Deregulation Act. The first section of the paper surveys the industrydevelopments before and after deregulation. However, the original deregula-

tion 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) mini-mum inventory requirement, and (3) prohibition of predatory pricing. It is not clearthat these provisions were actually anticompetitive from an economics point of view.

____________________

* The author wishes to thank the following offices and resource persons who shared theirknowledge 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 Ventiganand 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 (CoastalCorp. and PTT). Lastly, the author is grateful for the comments of the participants of the work-shops 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.


The second section analyzes the consistency of the Supreme Court decision witheconomic theory. The report argues that tariff differentials are currently built into thecountry’s tariff code as a matter of policy, even in the context of the tariff reformprogram. Thus, it is not unreasonable for the deregulation law to incorporate a tariffdifferential. The report also disagrees with the Supreme Court reasoning on minimuminventory requirements. As with the tariff differential issue, the report points outwhether 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 ofquestion. Moreover, the paper argues that inventory decisions are best left to indi-vidual firm discretion. Thus, the high court decision arguably effected the right thing(removal of the inventory requirement) for the wrong reason. Finally, the paper ar-gues that the decision on predatory pricing does not follow the court’s premise. In anycase, if the court believed that the tariff differential and inventory requirements posedsignificant barriers to entry, then a predatory pricing provision could be favorable tocompetition.

The oil companies are also often accused of price fixing because of their similarprices and their timing of price hikes and price cuts. The third section uses a theoreti-cal model (a simple extension of the Bertrand price-fixing game) to analyze this ques-tion. It shows that similar prices and the timing of price changes can be consistentwith competition. Moreover, the model predicts an asymmetry in the timing of pricechanges i.e., prices increase faster when crude oil price increases than they do whenthere is a decrease in crude oil price.

The fourth section looks at the proposed national oil exchange. As put forward byCongressman Enrique Garcia, representative of Bataan, such an oil exchange wouldin effect be a monopoly. As such, it would be susceptible to graft and corruption andwould be inefficient as well. Furthermore, a simple welfare analysis is used to showthat the oil exchange would be economically inefficient as a measure to subsidizeconsumers.

The fifth and final section examines the experience of other countries’ regulationof the downstream petroleum industry. Thailand and New Zealand both deregulatedtheir downstream oil industries fairly recently. In the case of Thailand, which deregu-lated before the Philippines, the major oil companies still control a significant shareof the market. However, the new players are starting to eat into the market. On theother hand, the United States is a mature market but has experimented with variouspolicies 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 afairly 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 govern-ment 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 createdthe Oil Industry Commission (OIC) that regulated most activities of the industry.Most importantly, price regulation was introduced. Prior to this, industry playersfreely set their own prices but now the OIC would fix prices.

In 1973, government created the Philippine National Oil Company (PNOC). Itacquired Esso and Filoil. A further realignment in the industry occurred in 1983 withthe acquisition by Caltex of Mobil while Shell acquired Basic Landoil (Getty). PNOClater acquired Bataan Refining and thus, by 1985, the industry was reduced to justthree companies: Caltex, Shell, and PNOC (later Petron).

In 1984, then President Ferdinand Marcos created the Oil Price StabilizationFund (OPSF) as a buffer fund to stabilize oil prices. When world oil prices were lowerthan the corresponding fixed pump prices, the firms contributed to the fund. Whenthe opposite happens, the firms drew from the fund.

When Corazon Aquino took over as President, she created the Energy RegulatoryBoard (ERB) through Executive Order (EO) 172. The ERB basically took over thefunctions of the OPSF. Most importantly, the ERB was tasked with setting the pricesof 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 DOEto provide for an environment of free market and to institute, with the President’sapproval, 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 ActDeregulating the Downstream Oil Industry.” It took effect on April 16, 1996. Themajor 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 de-cided in favor of the petitioners and it nullified RA 8180 on November 5, 1997. Thisdecision is very important. Competition policy and antitrust laws are still at a verynascent stage in the Philippines. Thus, this decision may fortunately or unfortunatelyset a precedent and shape future policy. Ma. Lourdes Sereno, a leading Philippinelegal scholar, has termed it a “landmark” case in local antitrust for it discusses theeconomic concepts of monopolization and cartelization, predatory pricing and barri-ers to entry among others (Sereno 1999).

___________________

1 We shall henceforth refer to the Supreme Court as SC.


Congress quickly sought to “repair” RA 8180. The result was RA 8479 whichwas approved on February 10, 1998.

After two years and with a new oil deregulation act replacing RA8180, we canperhaps look back on the events. This research paper seeks precisely to examine thereasonableness of the SC’s decision.

PHILIPPINE OIL INDUSTRY STRUCTUREThe petroleum industry is usually classified into two sectors: the upstream and

the downstream portion. The upstream portion refers to the exploration and drillingof oil, whether such oil deposits are found under land surfaces or off-shore, e.g., underwater. The downstream portion of the industry begins with the transportation of theoutput of the upstream portion, the crude oil, to refineries. Thus, the downstreamportion will generally include the following activities: importation and exportation ofcrude oil and petroleum products, refining, transportation (also referred to as tran-shipment and hauling), and marketing and retailing.

The Philippines is involved in both the upstream and downstream aspects. TheNido field was the first significant petroleum deposit discovered in 1976. Commercialproduction from Nido commenced in 1979. This was followed in the 1990s by theMalampaya and West Linapacan fields in Palawan. However, Philippine crude oil pro-duction 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.

1996 1997

Nido 174,821 124,450

Matinloc 91,490 123,280

Total 266,311 247,730

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.

Table 1. Oil Production (in barrels) – Philippines

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

OIL INDUSTRY 103

Caltex established the first oil refinery in Bauan, Batangas, in July 1954. Stanvacand Shell followed. At one point, there were even six refineries. Today, only the BigThree have refineries. Stanvac Refinery became the Bataan Refinery and its Limay,Bataan plant was completed in January 1961. The Shell Refinery started operations inJuly 1962 while a local player, Filoil Refinery, began operations in September 1962.

Meanwhile, retail of petroleum products seemed to have been a vibrant businessin the pre-martial law era. Total number of retail outlets in the industry grew to asmuch 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 the1972 figure.

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

BASIC TECHNICAL BACKGROUNDPetroleum 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 lessabundant. Compositions of crude oils are usually in the following range: 83-87 per-cent carbon; 11-16 percent hydrogen; 0-7 percent oxygen plus nitrogen; and 0-4 per-cent sulfur.

Petroleum Hydrocarbons are desirable because they are responsible for the highheating value of petroleum. (Keep in mind that petroleum’s primary use involves theconversion of its chemical energy to heat, with carbon and hydrogen in the variouscompounds being converted during combustion to carbon dioxide and water.) At theother extreme, compounds containing sulfur and nitrogen are undesirable becauseduring combustion they are converted to sulfur dioxide and nitrogen oxides—precur-sors to acid rain.

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).

Table 2. Industry Retail Outlets


The vast majority of petroleum is refined into various fuel products such as gaso-line, kerosene, diesel fuel, and fuel oils (Figure 1). A very small remaining fraction isused to produce chemicals which are the basis for the so-called petrochemical indus-try. 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 ofyears ago, as it was formed from decaying plant and animal material, particularly richdeposits were accumulated in the Persian Gulf area.

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

Figure 1. Flowchart of Petroleum Industry Production

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

OIL INDUSTRY 105

PROGRESS REPORT ON THE EFFECTS OF DEREGULATIONInternational crude oil prices have continued to rise in recent months as the Or-

ganization of Petroleum Exporting Countries or OPEC members implemented pro-duction cutbacks. Inevitably, domestic pump prices for gasoline and diesel had to beadjusted upwards. This has raised protests among the various oil product-consumingsectors as well as among the opponents of oil deregulation. The latter have used thisoccasion to ask for a repeal of oil deregulation. Congressman Enrique Garcia, repre-sentative of Bataan, who had been one of those who successfully petitioned for therepeal of the first oil deregulation law, filed yet another motion to dismiss this secondoil deregulation law.2 The media, particularly some newspaper editorials, have beenrailing once again against the oil companies, and consequently, against the idea ofderegulation as well.

Not suprisingly, most of those pushing for a repeal or at least a review of the lawrest 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 anenvironment of competition in the industry.

But is it fair to expect the law to bring intense competition in a span of merely twoyears? Or to expect it to bring lower prices? Deregulation of an industry sometimesdoes bring with it lower prices. However, in this case, international crude oil priceshave 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.

Figure 2. Schematic Diagram of Oil Recovery

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


prices also had to be raised. From the low teens in the first quarter of 1999, inter-national prices have since doubled to mid-$20s per barrel. We must rememberthat the Philippines has very limited crude oil production. Since the productsthat 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 forderegulating in this case is to open the market and subject it more closely to marketforces and let in more competitors. The increased competition in turn should serve asan incentive to firms to be more efficient, which may lead to lower prices in somecases. Attracting more investments is another objective of deregulation. Decontrol-ling prices also did away with the government’s (specifically the ERB’s) function ofcomputing 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 statisticsfrom 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 numbersare 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 tomainly the three majors prior to deregulation.

The charge of collusion on price misses the point on the oil industry’s deregula-tion. It is unfair to blame RA 8479 (the Oil Industry Deregulation Act) for the pricefixing and/or coercive practices of the oil companies. The Act precisely outlaws suchactivities. What should be decried, is not the industry’s deregulation, but the slowprosecution of anticompetitive practices, if in fact, they exist.

If Shell, Caltex, or Petron are in fact colluding and talking with each other onwhat 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

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.

Table 3. Players in the Downstream Oil Industry

OIL INDUSTRY 107

majors on prices is that they have similar or identical prices and that they changeprices at roughly the same time. As this paper will argue later3 , this is not conclusiveproof of collusion. Similar or even identical prices and coincident price changes areconsistent 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 manymarkets in our country except that they go unnoticed. The act of colluding on prices orcoercing other sellers to follow, is in fact a violation of RA 8479. Sec. 11a of the Actspecifically prohibits acts of cartelization, which the Act defines as “…any agree-ment, combination or concerted action by refiners, importers and/or dealers, or theirrepresentatives, to fix prices… in restraint of trade or free competition.”

SPATIAL COMPETITION AND RETAIL GASOLINE MARKETSA 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 havestations competing with those of the majors. Prices have reportedly been lower here inthe past by as much as 60 to 70 cents as compared with other gasoline stations inMetro Manila. This actually argues for deregulation and a free market.

We must remember that spatial (i.e., location) competition is the key in retailgasoline marketing. A gasoline station’s market is essentially geographic, i.e., itsmarket is determined by its location because it determines who and how many motor-ists are normally in the area. In this aspect, the gap between the Big Three and thenew players is truly huge. At last count, there is a total of 3,652 gasoline stations inthe country. As of June 30, 2001, the new players account for only 362 of these. (SeeTables 4 and 5 for a breakdown by region and by new player.) Moreover, putting up anew gasoline station requires substantial investment. (Estimates range from about P5million to P10 million for a modest size station.) That it would be difficult for the newplayers to catch up overnight is therefore an understatement. We will certainly have tobe patient.

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3 See section entitled “Price Setting in Philippine Gasoline: Law of One Price or Collusion.”

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, 2001Source: Energy Information Administration Bureau, Department of Energy.

Table 4. Total Number of Gasoline Stations


Furthermore, since location is critical for a gasoline station’s success and givenall the years when entry into the industry was regulated and there were only the threemajors, they had their run of the field and the choice of the best locations, especially inthe urban areas. Until fairly recently, Sucat was not as densely populated and wesurmise, 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 beslower 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 Roadexample. But to do an about-face on oil deregulation and either nullify it or imposeprice controls would precisely scare away potential future competitors of the three oilmajors.

Not surprisingly, the new players have yet to make a significant dent in marketshare on the retail side. Nevertheless, the new players have a market share of 8 per-cent out of the total oil products market (Figure 3). This is quite an improvement fromtheir 0.7 percent share in 1996. (As of the first semester, Shell has overtaken Petron inmarket share.)

One area where the new players have made inroads faster is in bulk sales (Table6). Perhaps this is understandable, given our observations on retail marketing. Unlikeretail marketing, bulk selling does not require the huge investment needed to have anetwork of gasoline stations. A new player only needs hauling and storage facilities,both of which would be needed anyway for retail marketing.

Source: Energy Information Administration Bureau, Department of Energy.

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

Table 5 New Player Gasoline Stations (as of December 31, 2001)

OIL INDUSTRY 109

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4 The Crude Oil Cost Index is a peso cost index obtained by indexing the product of the foreignexchange rate (PhP/$) and the Dubai cost of crude oil ($/bbl). The price indexes of premiumand unleaded gasoline and diesel are indexes of the average pump prices at selected gasolinestations (PhP/liter).

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


Table 6. Market Share by Sector (%)

RECENT OIL PRICE BEHAVIOR

Let us investigate the issue of overpricing. Figure 4 presents the price and costmovements of international crude oil prices and a few select refined products (un-leaded 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 ex-ample, a crude oil index of 120 would signify that costs were 20 percent higher than inJanuary 1998. January 1998 is a convenient starting point because oil prices wereunder ERB control then.


Figure 3. Market Share of Oil Companies


A casual visual inspection reveals that prices dipped slightly after RA 8479 waspassed in February 1998 and the industry was “re-deregulated”. (Recall that the SCstruck down RA 8180, the original oil deregulation law, in November of 1997 and theindustry briefly went back to price control.) One may, of course, argue that it was theoil companies’ interest to lower prices after RA 8479 took effect, if only to appease thepublic and to link deregulation to lower prices in their minds. Intention is very diffi-cult 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 thefirst quarter of 1998. (Although the peso depreciated during that time, internationaldollar prices of crude oil dropped faster.)

Figure 4 also shows that by around the third quarter of 1999, the peso cost ofcrude 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 costcontinued to outstrip growth in pump prices. In other words, while gasoline and dieselprices were higher on the average in January 1998, they had not risen as fast as the oilcompanies’ cost of imported crude. This suggests that the oil companies’ margins onthe three products have actually narrowed.

Third, in between January 1998 and the first quarter of 1999, gasoline and dieselprices relatively did not go down by as much as the crude oil cost index did. Crude oilis not the only cost of production of course, but if the other costs of production havebeen constant, then Figure 4 suggests that the full benefits of lower crude oil costswere not passed on. However, before we jump on the oil companies’ case for this, wemust remember that our analysis depends much on the state of things in the baseperiod. If prices in January 1998 corresponded to a fair rate of return, and if the other

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

Figure 4. Historical Prices of Oil

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costs of production remained fairly constant, then Figure 2 does suggest that profitmargins did widen. In any case, we must also remember that the oil companies in-curred sizable losses in 1997 as a result of the SC’s TRO that prevented them fromadjusting prices to match the peso depreciation. If the profit margins widened in1998, it may only have reflected an attempt to recoup the losses suffered in 1997. Inany case, Figure 4 suggests that those margins have shrunk further since then andmay even be negative by now.

Presently, the country is once again having second thoughts about oil de-regulation. Perhaps we forget too easily that the oil industry was not always regu-lated. 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 intothe unknown.

Unfortunately, recent indication from OPEC members are that the productionrestraints will remain and worldwide inventories of oil will stay tight. This suggeststhat we should not expect a respite from rising crude oil prices anytime soon. Thesame holds true for domestic pump prices. Certainly, this would further fuel thepresent clamor to abandon oil deregulation. As we have argued, this is an inevitableresult over which we have little control. With or without price control, prices simplyhave to rise if crude oil prices continue to rise. It would be a pity to consider for naughtthe 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’sdecision 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 LegalAssistance 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 asrespondents. The decision has come to be known as the Tatad vs. Sec. Viray case. Wewill refer to it as the Tatad case.

The SC decision on the Tatad case is a landmark one in the Philippine antitrustscene. 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 lackof or misinterpretation of it) contributed to the said decision.

It should be stressed that the SC itself was not against deregulation. This wasamply repeated in the decision to a subsequent petition that Congressman Garcia filedquestioning the timing of deregulation and seeking the declaration of Section 19 of


RA 8479 as unconstitutional.5 For example, in the decision on this case written byAssociate Justice Consuelo Ynares-Santiago:

“Be that as it may, we are not concerned with whether or not there should be deregula-tion. This is outside our jurisdiction.The Court respects the legislative finding that deregulation is the policy answer to theproblems. It bears stressing that R.A. 8180 was declared invalid not because deregula-tion is unconstitutional. The law was struck down because, as crafted, three key provi-sions plainly encouraged the continued existence if not the proliferation of theconstitutionally proscribed evils of monopoly and restraint of trade.”

While Justice Ynares-Santiago was not a member of the 1997 SC that overturnedRA 8180, those who concurred with her decision included Justice Puno (who pennedthe majority decision in Tatad vs. Viray), Chief Justice Davide and Justices Belosillo,Kapunan, Panganiban, Mendoza, and Vitug. Justice Melo also concurred in this deci-sion but dissented in the original Tatad vs. Viray decision.

Neither is the Court antifree market nor skeptical of the power of the market toserve consumers:

“Our ruling in Tatad is categorical that the Constitution’s Article XII, Section 19, isanti-trust in history and spirit. It espouses competition. We have stated that only com-petition 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 es-pouses competition. The desirability of competition is the reason for the prohibitionagainst restraint of trade, the reason for the interdiction of unfair competition, and thereason for regulation on unmitigated monopolies. Competition is thus the underlyingprinciple of section 19, Article XII of our Constitution which cannot be violated by RANo. 8180. We subscribe to the observation of Prof. Gellhorn that the objective of anti-trust law is “to assure a competitive economy, based upon the belief that through com-petition producers will strive to satisfy consumer wants at the lowest price with thesacrifice of the fewest resources. Competition among producers allows consumers tobid for goods and services, and thus matches their desires with society’s opportunitycosts.” 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 shallbe allocated in the production process, and to whom the various products will be dis-tributed. The market system relies on the consumer to decide what and how muchshall be produced, and on competition, among producers to determine who willmanufacture it.”

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

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Again, we underline in scarlet that the fundamental principle espoused by section19, Article XII of the Constitution is competition for it alone can release the creativeforces of the market.6

This section is important for it underscores the high court’s recognition ofcompetition’s role in achieving consumer welfare in a market economy. It is quiteclear that we did not have an SC that was socialist or liberal (in the sense of favoringbig government and government intervention) in attitude, and even if it were, it was acourt cognizant of its limits. More than one Justice have stressed that it is not theirrole to second-guess the wisdom of legislators’ choice of deregulation as to whatwould 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 policydetermination 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 deregula-tion. This is outside our jurisdiction. The judgment on the issue is a settled matter andonly Congress can reverse it.”

In a separate concurring opinion, Justice Quisumbing states and cites anotherprecedent:

“….As the Court said in Tanada v. Tuvera, “[T]his Court is not called upon to rule uponthe wisdom of the law or to repeal it or modify it if we find it impractical. That is not ourfunction. That function belongs to the legislator. Our task is merely to interpret andapply the law as conceived and approved by the political departments of the govern-ment in accordance with the prescribed procedure.”

Why then did the Court strike down RA 8180? We can find a succinct summaryyet again in the above-cited decision of Judge Ynares-Santiago:

“…the High Court found that certain provision of R.A. No. 8180 were violative ofSection 19 of Article XII of the Constitution which states that “the State shall regulateor prohibit monopolies when the public interest so requires. No combinations in re-straint of trade or unfair competition shall be allowed.” In particular, the provision ofR.S. No. 8180 on (1) tariff differential, (2) minimum inventory and (3) predatory pric-ing were found to “inhibit fair competition, encourage monopolistic power and inter-fere with the free interaction of market forces.” RA No. 8180 was declaredunconstitutional in its entirety since “the three (3) offending provisions,” the Courtnoted, “so permeated the law that they were so intimately the esse of the law.”

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6 Supreme Court, Tatad vs. Viray et al. 1997 citing Gellhorn, Anti Trust Law and Economics ina Nutshell, 1986 ed., p. 45.


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

THE TARIFF DIFFERENTIAL ISSUERA 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 thisis 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 threepercent (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 crudeoil. Provided, that beginning on January 1, 2004 the tariff rate on imported crude oiland refined petroleum products shall be the same. Provided, further, that this provisionmay be amended only by an Act of Congress.”

With regards to this particular provision, Justice Puno contends that it isanticompetitive because:

“In the cases at bar, it cannot be denied that our downstream oil industry is operatedand 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 tariffdifferential of 4% therefore works to their immense benefit. Yet, this is only one edge ofthe tariff differential. The other edge cuts and cuts deep in the heart of their competi-tors. It erects a high barrier to the entry of new players. New players that intend toequalize the market power of Petron, Shell, and Caltex by building refineries of theirown will have to spend billions of pesos. Those who will not build refineries but com-pete with them will suffer the huge disadvantage on increasing their product cost by4%. They will be competing on an uneven field. The argument that the 4% tariff differ-ential is desirable because it will induce prospective players to invest in refineries putsthe cart before the horse. The first need is to attract new players and they cannot beattracted by burdening them with heavy disincentives. Without new players belongingto the league of Petron, Shell, and Caltex, competition in our downstream oil industryis 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. Afterall, the tariff differential was even more substantial at 10 percent (tariff rates of 10percent 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 per-cent 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 percentdifferential but remain silent about the Tariff Reform Program that builds in a 7 per-cent tariff differential by design.

OIL INDUSTRY 115

Nonetheless, trade theory suggests that a uniform tariff structure is ideal. Tariffdifferentials introduce market distortions that would penalize some sectors and re-ward others. Such distortions could lead to serious misallocation of resources. In themeantime, however, uneven structure remains until trade policy reforms could beimplemented toward a more uniform tariff.

In sum, while there is economic rationale for equalization of tariffs, competingrefined products can now be imported at lower cost. What is being questioned is theeconomic soundness of the argument that the tariff differential provision isanticompetitive and constitutes a barrier to entry.

INVENTORY REQUIREMENTSWith 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 main-tain a minimum inventory equivalent to ten percent (10%) of their respective annualsales volume or forty (40) days of supply, whichever is lower.

Clearly, the intention of the legislators behind the inventory requirement seemsto 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 fore-gone revenue and possibly, lost customer goodwill. The larger the inventory, the lesslikely this will happen. However, carrying inventory entails carrying costs, not juststorage costs but also the cost of goods tied up in the inventory (unless suppliers areparticularly generous with their terms). The larger the inventory, the larger also willbe the carrying costs.

The standard inventory models in economics would have firms weighing thetradeoffs between the cost of lost customer goodwill and revenue in the event of astockout situation with the carrying cost of inventory. Among other variables, interestrates, exchange rate, sales volume, forecasts of market size, etc. could be determinantsof the optimum level of inventory to maintain. Since these factors may change overtime, the optimal level of inventory can too. The author has been unable to determinethe source or rationale of the rule-of-thumb of 10 percent or 40 days that has beendecided on by the legislators who crafted RA 8180. In any case, the upshot is that thisprovision is arguably unnecessary and possibly obtrusive.

Nevertheless, the question that confronts us is why did the high court rule thisprovision as being anticompetitive, and therefore, unconstitutional?

The reason seems basically the belief that this stipulation will be more onerous tothe new entrants than to the Big Three, and will thus discourage the entry of newplayers. In other words, the Court seems to view it as erecting another barrier to entry.To cite once again from Justice Puno’s decision:


“The provision on inventory widens the balance of advantage of Petron, Shell, andCaltex against prospective new players. Petron, Shell and Caltex can easily complywith the inventory requirement of RA No. 8180 in view of their existing compliancewith this requirement difficult as it will entail a prohibitive cost. The construction ofstorage facilities and the cost of inventory can thus scare prospective players. Their neteffect is to further occlude the entry points of new players, dampen competition andenhance 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 barrierto entry? True, the Big Three will require no new action to comply with this require-ment while the new players will. However, as it has been explained above, the newplayers will presumably want to install some storage capacity and maintain someinventory as part of normal business practice anyway. The question is whether or notthe 10 percent or 40-day equivalent is unreasonably above this level or not. It mayeven be the case that the new players would have voluntarily maintained more thanthe minimum specified in Sec. 6 of RA 8180 anyway.

Furthermore, even before RA 8180 was repealed, around 30 new players hadalready 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 wouldseem to belie the claim that the overall effect of the 4-percent tariff differential and theminimum inventory requirement is to be a significant barrier to entry. Admittedly,one could speculate that perhaps, in the absence of these alleged anticompetitive pro-visions, there would have been more new players. But 30 hardly seems an insignifi-cant number of new entrants (certainly when compared to three: Shell, Caltex, andPetron) and would seem to cast some doubt on the barriers to entry that these allegedoffending provisions erected. Justice Francisco makes precisely this point in his dis-senting opinion:

“…Whether or not the requirement is advantageous, disadvantageous or conducive fornew oil companies hinges on presumptions and speculations which is not within therealm of judicial adjudication. It may not be amiss to mention here that according to theOffice of the Solicitor General “ there are about thirty (30) new entrants in the down-stream 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 thesecond 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 PRICINGFrom 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 mostfamous antitrust case involving predatory pricing is perhaps that of NelsonRockefeller’s Standard Oil case of 1911. This is the very same Standard Oil thatarguably inspired the Sherman Act, the grandfather of American antitrust law.

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On the surface, the concept of predatory pricing sounds plausible and even obvi-ous. The idea is that a firm might “prey” on a competitor (or many competitors) bysetting very low prices to capture as much of the market as possible and drive thecompetitor(s) out of business. In extreme arguments, it is argued that the predatormight even be willing to incur temporary losses in the process. Thus, as the usualstory goes, the predator is normally characterized as a firm with deep pockets, since itmust 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 mo-nopoly and can set monopoly price and enjoy monopoly profits.

McGee (1958), however, argued that Standard Oil did not practice predatorypricing and presented evidence for his view. More importantly, he advanced soundeconomic arguments for his belief that predatory pricing is a rare occurrence. The gistof his argument is that predatory pricing is irrational and that it is cheaper for apredator 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 wasearning substantial profits there. Assume that in another market there are several competi-tors, 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 otherprofitable markets: it could have been earning at least competitive returns and is not. Thewar could go on until after average variable costs are not covered and are not expected tobe covered; and the competitors drop out. In the meanwhile, the predator would have beenpouring money in to crush them. If, instead of fighting, the would-be monopolist boughtout his competitors directly, he could afford to pay them up to the discounted value of theexpected monopoly profits to be gotten as a result of their extinction. Anything above thecompetitive 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 haveto 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 competi-tive value, it is difficult to see why the predator would be unwilling to take the amount thathe 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 thefollowing simple diagram comparing the two income flows:


We will let πm denote the monopoly profits per period that would accrue to thepredator once the competition is out of the way. The symbol πc will be the competitionprofit that the predator earns when it has to compete with the prey. Let L represent thelost profits per period to the predator from predatory pricing. Finally, let I representthe “investment” or purchase price the predator pays for the prey in the case of amerger/acquisition. The first line then represents the incremental income or profitflow 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 arehigh enough to rule out future new entrants, then the discounted value of the flow ofmonopoly profits would be given by πm /r , where r is the discount rate. On the otherhand, πc/r is the discounted value of the flow of income to the prey, and this is also theminimum price it would require to sell out. Here we have assumed that both predatorand prey earn the same amount of profit πc if both are in the market. Normally, thestory in predatory pricing has the predator being much larger than the prey and so thisminimum price will be smaller in that case.

The second line represents the flow of profits under the scenario that the predatorchooses to cut prices to drive the prey out of business. In this case, the predator willforgo some profits and perhaps even incur actual losses, L, in order to convince theprey to leave.

The predator will presumably prefer the course of action that yields the highestnet present value (NPV). For the above two strategies, the difference between the twoNPVs would be:

n (πm - πc + 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 acquisi-tion price I, the smaller the losses L to be incurred, and the shorter the period theymust be incurred.

The simple comparison above assumes that the monopoly profits can be enjoyedforever. A further problem with predatory pricing surfaces when we consider barriersto entry, or rather, the lack of it. If entry barriers are low, i.e., then it is easy for newplayers to enter the industry. Consequently then, even if a predator could drive a preyout of the market, it could be easily confounded by the entry of other new firms. Thiswould bring the predator back to square one, and worse, after having squanderedforegone profits.

At the very least, this brief survey of the literature on predatory pricing suggeststhat we might not have to worry about it. If we accept this premise, the implication isthat 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 canpossibly 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 pricingnever happens, then the provision is harmless. If it does occur, then we are cov-ered.

However, for the sake of argument, let us allow that predatory pricing could occurand that it is prudent to provide against it. RA 8180 has a very general definition ofpredatory pricing, one that allows quite a bit of freedom in interpretation:

RA 8180 Sec. 9. Prohibited Actsb) Predatory pricing which means selling or offering to sell any product at a priceunreasonably below the industry average cost so as to attract customers to the detri-ment of competitors.

It is quite silent on what industry average cost means. This is perhaps intentionalbecause 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 boundarybelow which a price is judged predatory. After all, economic theory claims that in acompetitive market, prices would tend toward marginal cost (see Hovenkamp1986:115-188 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 usedas a proxy for marginal cost. Variable costs (and hence, average variable costs) arearguably easier to measure. Moreover, the minimum average variable cost has a spe-cial place in the firm’s economic theory. It is known as the ‘shutdown point’ becausewhen prices fall below this level, it is argued that a firm is better off shutting downbecause it cannot even recover variable costs, let alone fixed costs. If it were to shutdown, then at least it loses only the fixed costs and is therefore, better off. Thus, itwould not make sense to set a price below this. Indeed, Areeda and Turner proposethat a price lower than average variable should conclusively be presumed to bepredatory.

In contrast, RA8479 seems to have been written to define predatory pricing muchmore precise:

RA 8479 Sec. 11 b) Predatory pricing which means selling or offering to sell any oilproduct at a price below the seller’s or offeror’s average variable cost for the purpose ofdestroying competition, eliminating a competitor or discouraging a potential competi-tor from entering the market: Provided, however, That pricing below average variablecost in order to match the lower price of the competitor and not for the purpose ofdestroying competition shall not be deemed predatory pricing. For purposes of thisprohibition, “variable cost” as distinguished from “fixed cost”, refers to costs such asutilities or raw materials, which vary as the output increases or decreases and “averagevariable cost” refers to the sum of all variable costs divided by the number of units ofoutputs.


What is curious about the Tatad decision however, is that it did not call for a moreprecise redefinition of predatory pricing.7 Why then did Justice Puno rule that theoriginal provision also tended to “inhibit fair competition, encourage monopolisticpower and interfere with the free interaction of market forces,” and is therefore un-constitutional? He correctly saw the earlier point made above that predatory pricing isfutile without significant barriers to entry.8

“…The ban on predatory pricing cannot be analyzed in isolation. Its validity is inter-locked with the barriers imposed by R.A. No. 8180 on the entry of new players. Theinquiry should be to determine whether predatory pricing on the part of the dominantoil companies is encouraged by the provisions in the law blocking the entry of newplayers.”

However, his analysis of the implication drawn from this economic point seemsfaulty.

“As aforediscussed, the 4% tariff differential and the inventory requirement are signifi-cant barriers which discourage new players to enter the market. Considering thesesignificant barriers established by R.A. No. 8180 and the lack of players with thecomparable clout of PETRON, SHELL and CALTEX, the temptation for a dominantplayer 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 rea-son.”

If in fact the barriers to entry are high, then the immediate preceding discussionon barriers to entry and predatory pricing implies that if predation is to be rationalbehavior 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 competi-tion, should precisely be welcomed rather than removed, as Justice Puno would seemto have it.

____________________

7 Although it seems the petitioners had apparently complained about the imprecision in thedefinition of predatory pricing. Justice Francisco mentions this in his separate dissenting opin-ion: “…On predatory pricing: What petitioners bewail the most in Section 9(b) is “the defini-tion 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 mo-nopoly profits in the future. The monopoly profits will never materialize, however, for themarket is flooded with new entrants as soon as the successful predator attempts to raise itsprice. Predatory pricing will be profitable only if the market contains significant barriers tonew entry.” (Hovenkamp, Economics and Federal Anti-Trust Law, Hornbook Series, Studented., 1985 ed., p. 181.)

OIL INDUSTRY 121

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

Rising international crude oil prices in recent months have forced local oil firmsto raise prices anew. This has provoked another round of accusations of cartelizationand price collusion. The most common ‘evidence’ put forward is that the oil compa-nies have very similar prices (differing only by a few centavos in the case of the BigThree) and that they change prices in quick succession of each other. The following isa 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 wouldonly match the price” (Aquino 1997).

“I can’t see how logic would support the view that stiff competition is the reasonthe firms’ prices are identical” (Aquino 1997).

“Do you mean to say, even if there were 40 oil firms in the market now, priceswould still be the same?” (Aquino 1997).

“The fact that they have identical prices indicates that there is collusion, conniv-ance 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 threeoil companies had the same price for the same product, and whenever there was achange, that change will take place almost simultaneously. Now these three oil compa-nies do not have the same buying prices for crude. They do not have the same produc-tion costs (or) the same marketing costs, so how come they have the same sellingprices? This is something” (Yamsuan and Batino 1999).

“These oil companies have inventories that would last up to three months so theyshould 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 homog-enous product, one company’s price cannot diverge too much from another one’s orelse everyone will just purchase the lower priced gasoline. Or is the pricing behaviorof the Big Three oil firms actually the outcome of collusion? These are good questionsand their answer is not altogether obvious. The man on the street cannot be faulted if hisnatural intuition is that because the costs of production have not changed yet, there is nojustification for raising prices. This section will present a theoretical model that attemptsto 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 thoughthey 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


____________________

9 Students of economics are often thrown off by the idea of zero profits in equilibrium becauseof their confusion with the common (accounting) sense of the word profit. The economics usageof economic profit includes all opportunity costs. Thus a ‘normal’ return on capital is alreadyincluded as a cost when computing for economic profit and therefore zero economic profits isnot as bad as it sounds.

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 thecountry imports all its crude oil requirements.

THE MODELWe 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 thelower priced firm gets as much customers as it can supply. If both firms charge thesame price, they split the market evenly. Let us also assume that each firm is identicaland so they have the same costs. For further simplification, we will assume that mar-ginal costs, c, are constant. Let us assume a linear demand function: P = a - bQ

Under these assumptions there are two classical duopoly models of competitivebehavior, Cournot and Bertrand. Specifically, there are two Nash equilibria, theCournot equilibrium in quantity and the Bertrand equilibrium in prices.

Since we are investigating price setting behavior, we will concentrate on duopolyequilibria in prices and briefly review the Bertrand model. Given identical marginalcosts, the Bertrand equilibrium has both firms pricing at the same level P = c, andeach earning zero economic profit.9 Each firm will have an output of q = (a-c)/2b. Inthe standard Bertrand model, each firm is assumed to be able to meet the entire mar-ket demand, i.e., no capacity constraints.

Furthermore, the story in the Bertrand model is that buyers are perfectly in-formed of prices so that a firm that charges a higher price will not sell anything. Allthe buyers simply purchase from the other lower priced firm. In the event that bothfirms 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. Ifprices were different, then the high priced firm sells nothing and thus, will lowerprices. If both firms charge a common price above c, it can be shown that either firmcan always increase profits by undercutting the rival’s price by just a bit in order to

Figure 5. Simple Product Flow of the Philippine Petroleum Industry

(downstream only and for retail)

Crude Oil Imports Refining Distribution

Refinery Gasoline Station

� �

OIL INDUSTRY 123

gain the entire market.10 Finally, no firm will price below c, because even if they gainthe entire market as a result, they will lose (c – p) on each unit and will therefore bebetter off not selling anything. Thus, the only Nash equilibrium possible in prices is tohave 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 repeatedsetting, one Nash equilibrium is for each firm to set pi = c in each stage, just like thestatic case. The same reasons establishing a common price equal to marginal cost asNash equilibrium in the static case apply as well in establishing a similar equilibriumin each stage.

Thus, the Bertrand duopoly model is often cited as an example of a market with asmall 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 homogenousone. If a buyer does not prefer one firm’s product over the other and when one firmcharges a higher price, the buyer simply does not buy from that seller and switches tothe other. This is arguably the case with gasoline. Thus, the Bertrand model in factpredicts that similar prices are an equilibrium outcome. It is not the outcome of collu-sive activity but of competition. This is often referred to as the law of one price.

A Simple Model of Asymmetric Price BehaviorThis 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 everythingsold 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 whencrude oil prices were lower. Moreover, even if firms had the same inventory capaci-ties, it is likely that, for whatever reason, their purchases of crude oil stock are notsynchronized. 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 runout of cheaper inventory sooner.

The quotes previously cited seem to be premised on the above. Why should a firmthat still has inventory of cheaper oil raise prices? As cited above, some questionshave been raised (even by lawmakers) as to why the Big Three change prices at aboutthe same time when they purchase oil stocks at different times and presumably atdifferent prices. Their implicit assumption seemed to be that only those who had runout of the cheaper oil and had to purchase more expensive oil (in case of rising crudeoil prices) should raise their price, while the others that still had inventory of cheapercrude would not. It seemed to them that some oil firms might be taking advantage of

____________________

10 See Appendix 1.


the situation by raising prices even though they had not run out of their cheaperinventory. To the average man on the street, it smacks of opportunism. While thisissue was raised in the context of oil prices, it is an issue that applies to any commod-ity experiencing a price shock, or a sudden unexpected movement of the exchangerate. Indeed, in the past when the peso depreciated sharply for example, consumershave been heard to make the same complaints about traders of other goods that hadbeen imported under a lower exchange rate.

Moreover, some have “noticed”11 that upward price adjustments seem to occurfaster than downward adjustments. In fairness to our policymakers, they are not alonein their questioning. Even US politicians have fallen to the same line of thinking, andnot without basis (Karrenbrock 1991). There has been work done (Karrenbrock 1991and Borenstein et al. 1997 for the US; Reilly and Witt 1998 for the UK) to investigateasymmetric 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 empiricalside. In general, their objective is measurement of the price asymmetry. Borenstein etal. propose three hypotheses to explain the price asymmetry (see Borenstein et al.1997:324) based on inventory adjustment costs, production lags, search cost theoryand focal pricing points. For our purposes, their first hypothesis is perhaps the closestin spirit to the model we will present shortly: Prices are sticky downward when inputprices 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 simpleBertrand price setting game. It can serve as one analytical explication of the abovehypothesis. 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 shockFirst, 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 ofthe period, firms set their respective price and the distribution of the market resultsafterwards. The total amount of gasoline available for sale or supply in a particularperiod 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 notchange if the game were a sequential one instead since the game matrices remainunchanged. In keeping with our identical firms world, both firms are assumed to havethe same inventory capacity. This makes it more plausible to assume that they bothhave the same reorder point or minimum inventory level to be maintained. Each firmis 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 investigationin the Philippine case. I have not been able to find a study that investigates this question withPhilippine data.

OIL INDUSTRY 125

Consider the case of a positive shock in crude oil prices. Let us consider that pointin time when one firm (say firm B) has “run out” of the cheaper gasoline and mustnow sell gasoline refined from the more expensive crude oil. Suppose firm A still hasinventory of gasoline refined from cheaper crude. Let ch denote the marginal cost ofthe higher priced gasoline, and cl the lower cost gasoline, both of which we willassume to be constant within the same time period.

The question that the firms now confront is whether or not to raise price and towhat level. We assume that there is complete information, i.e., both firms are aware oftheir and each other’s inventory situation as well as the costs of imported crude. Weare interested in the Nash equilibria, if any. To solve for these, we will construct thetwo firms’ reaction functions in price space. Before we do this, let us rule out someprice ranges where obviously there will not be Nash equilibria. Clearly, prices at orgreater 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, afirm 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 divisibleprices, i.e., continuous, then Nash equilibria may not exist since the lower-cost firmcan 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 onlybe set at integral values, e.g., one cent, two cents, etc., i.e., no fractions of centspossible. We will let ε here represent one cent.

In general, it is easy to see that for a perfectly inelastic market demand quantity ofQ, a firm can increase profits by undercutting its rival as long as prices are at leastthree cents above marginal cost. A slight complication arises when prices are just oneor two cents above marginal cost. In this case it can be easily shown that both c + εand c + 2ε are equally good responses to a price of c + 2ε set by the competitor (seeAppendix 2).

We start with firm A’s reaction function (Figure 6). Firm A does best by alwaysundercutting whatever Firm B’s price is, down to its marginal cost cl. Below cl, A doesnot recover even the variable (marginal) cost so it makes no sense to price lower thancl even if B does. B has a similar strategy. Whenever possible, it will prefer to under-cut except when prices are below ch, since B will not cover even variable costs belowthat point.

One should also keep in mind that the reaction functions are really discrete andhence, discontinuous. They have been drawn as continuous lines however, to facilitatevisual 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 undercutsat ch - ε.

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


Figure 7. Game Matrix

Firm B

prices. The following game matrix presents payoffs in terms of income before fixedcosts, 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 matrixand not change the analysis of a Nash equilibrium. The total market volume Q hasalso been normalized to equal one.

The normal form also allows us to gain an additional intuitive understanding ofthe competing strategies. It allows us to see that B actually has a weakly dominantstrategy, which is to raise its price immediately.

If a firm elects to raise its price, there are three possible price levels in a Nashequilibrium: ch , cl, or some intermediate price ci where ch > ci > cl. At the risk ofcomplicating the notation, let us define another parameter δ = ch – ci. Thus δ repre-sents the amount by which a firm undercuts ch . Note that we can rule out the possibil-ity 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 gainthe entire market. Second, if prices are below cl, then losses are incurred and either orboth firms are better off not selling anything.

Figure 6. Positive Price Shock Case

ch

cl

ci

ch

cl

ci

Firm A

OIL INDUSTRY 127

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

Figure 8. Game Matrix for Positive Crude Oil Price Shock

Firm B

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 dominatesraising to an intermediate level ci. Intuitively, with the higher cost gasoline, if firm Bcontinues selling at any price below the new higher cost, then it loses some amountper unit. It would have been better off not to sell anything. Thus, firm B is better offraising prices regardless of what its rival does. If A maintains its old (and lower) pricethen, 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 subse-quently, some amount of accounting profit) at least. If A undercuts B by just a little (saye) 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 isrational, can rule out the possibility that B will not raise prices since it is a dominatedstrategy. In other words, it can safely assume B will play its weakly dominant strategyand raise prices to ch. But given that Firm B will raise its price, then the best strategyfor A now is to raise prices also to an intermediate price ci = 1 - δ. If firm A canactually supply the entire market, then it sets δ as small as possible, e.g., one cent, sothat it gets the entire market.

However, if A cannot supply the entire market, then there is some critical fractionof the market it can supply below which it does best by simply setting p = ch. Settingp = ch - δ would merely forgo some revenue. This critical fraction is where:

(1 – δ) f ≥ ½The left hand side is the economic profit from selling at ch - δ to a fraction f

of the market (recall that the market size has been normalized to one) while theright hand side is the profit from matching the price but selling to only half themarket (ch-cl)*1/2.

ch

cl

ci

Firm A

ch

cl

ci


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

1f ≥ −−−−−−−−−−

2(1– δ)

As δ approaches zero, this fraction approaches ½. In other words, if A cannotsupply at least half of the market, then it is better off matching prices and splitting themarket.

In either case, the equilibrium suggests price will either be at ch immediately andboth firms split the market, or at some price ch - δ that is close to it. Here, firm Aenjoys a temporary windfall—temporary because ultimately A will also run out of thecheaper inventory.

Of course, consumers in an actual market are not likely to discriminate betweenprices that differ only by a few cents12 and the firms may nevertheless end up splittingthe market. In other words, the higher priced firm (as long as it is not too much in theperception of buyers) may not necessarily sell nothing.

Even theoretically though, one can offer a plausible explanation why firm A maysimply match prices and not attempt to undercut B. If both firms are in this businessfor the long haul, and neither one is likelier to anticipate a positive price shock, theneither firm is just as likely as the other to find itself in firm B’s situation. In the longrun, 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’sprice with the tacit assumption that when A finds itself in a similar disadvantagedsituation, B will return the favor. Indeed, some studies in game theory have found thatin a repeated setting, even the prisoners’ dilemma could start to yield cooperativeoutcomes.

SECOND SCENARIO: NEGATIVE CRUDE OIL PRICE SHOCKLet 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 expen-sive gasoline. We maintain the same market allocation rule as above: low-priced firmgets all the market and it splits the market in the event of identical prices. Followingthe same notation as above, we obtain the following corresponding reaction curves inFigure 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 aremarkable 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, trans-portation costs, etc.

OIL INDUSTRY 129

Figure 9. Downward Price Shock Case

Figure 10. Game Matrix for Negative Crude Oil Price Shock

Figure 11. Game Matrix for Positive Crude Oil Price Shock

Firm B

ch

cl

ci

Firm A

ch

cl

ci

Firm B

ch

cl

ci

Firm A

ch

cl

ci

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


There is, however, a theoretical quirk that arises and needs to be addressed in thissecond scenario in order for the model to be logically consistent. Technically, if Bundercuts 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 couldimagine that A might then be willing to match any price just to get rid of the costlyinventory and move on to new cheaper inventory that would put it on equal footingwith B. This could be the case especially if there are fixed costs for A. (This is theexplanation for the alternative dashed line branch of A’s reaction function, collinearwith the 45-degree ray in figure 5.) If the loss from selling the inventory below costduring this period is less than the discounted stream of fixed costs in the future, thenthis will be the case.

There are two ways how a real market may depart from the above extreme theo-retical result. Both have already been mentioned in the first scenario. The first is thatin real markets, buyers may ignore price differences of a few cents. Second is that in arepeated setting, B may think it wiser to ‘cooperate’ and not lower prices until laterwhen A is ‘ready’; with the unspoken understanding that A will return the favor inthe future when the shoe is on the other foot.

Obviously, once A has also consumed its old higher cost inventory and has thesame 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 withperfectly inelastic demand, it is reasonable to argue that in the long run, the marketwould 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 equalsmarginal 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 thateven if the firms moved alternately, the same outcome would result for so long as bothfirms have the same information and costs because the game matrices remain thesame. In a sequential setting, the firm that runs out of old inventory presumably (firmB) 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 changeprices anyway and do so at about the same time, because it is a Nash equilibrium forboth of them to do so. (This is not to suggest that Nash equilibria must necessarily beplayed. Game theory implies no such thing. Nevertheless, if an outcome is Nash equi-librium, 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 ex-change rate depreciates/appreciates and/or they have old stock bought at the old andcheaper price/exchange rate. It may precisely be this intuition that the average man onthe street has about the oil companies that leads him to feel he is being taken advan-tage 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 thattheir executives actually get together and agree on what price to charge next and when

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to change prices. The results merely point out that similar prices and simultaneousprice changes are consistent with independent competitive price setting behavior. Inother words, simply having the same prices and changing prices at the same time arenot sufficient conditions for the existence of collusion. Therefore, they are not suffi-cient evidence for regulators to conclude that there is collusion. In this regard, itwould be a pity to abrogate or amend the oil deregulation law based on reasoning thatrests solely on this misconception.

TO EXCHANGE OR NOT TO: A NATIONAL OILEXCHANGE?

In recent months, the idea of a national oil exchange has been much discussed inthe media and among the general public. Congressman Enrique Garcia (the samecongressman who had been one of the petitioners in Tatad vs. Viray) originally pro-posed this idea. He authored House Bill (HB) No. 871013 , which describes his pro-posed exchange system. Apparently, an almost identical version was filed in theSenate by Sen. Juan Ponce Enrile, Senate Bill (SB) No. 1855. In essence, the originalidea has been to nationalize all oil storage facilities14 in the country and have theresulting government corporation (to be called National Oil Exchange Corporation orNOEC) trade in the world oil market. The proposed NOEC will buy, store and distrib-ute refined petroleum products. The rationale was basically that such a ‘big’ nationalentity could obtain better prices for the refined products.

Oil companies, the new players and the Big Three, will now purchase their re-fined products from the NOEC and will be allowed to distribute them through theirusual channels, e.g., their gasoline stations.

This almost certainly implies that the local refineries will be shut down sincethese refineries need storage facilities for their raw materials (crude oil). One can alsoask what happens to Coastal Petroleum, which currently leases the storage depots leftbehind by the Americans in their former bases.

Needless to say, this will scare away foreign investors. For if the investments ofthe foreign oil companies in their refineries can be nationalized just like that, thenwhat guarantee would a foreign investor in any industry have that once their invest-ments are sunk in the Philippines, the government will not take policy actions thatrender those investments useless?15

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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 cur-rently being leased by Coastal Petroleum.15 Presumably, the government will purchase or lease whatever private storage facilities theNOEC will take over. This, of course, raises the practical question of whether or not the gov-ernment can afford to spend that much money to get into the oil business.


Second, plainly and simply, it erects a government monopoly. Once again, itwould put government in business and in direct competition with private business. Inthis 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 40percent 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 governmentimport cheaper goods and close down the local manufacturers?

Third, assuming that the Big Three are allowed to name a price or rental rate fortheir facilities, what guarantee is there that the price or rent will not negate whateverscale 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 tobe 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 sucha situation. The government is not an exception to such temptations.

A Philippine Star columnist, Federico Pascual, has advanced a compromise mea-sure. He proposes that the NOEC merely take over the Subic and Clark storage facili-ties the Americans left. Under his scheme, all other private facilities will be left inprivate hands. The oil companies can then go ahead refining and/or importing asusual. 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 compro-mise formula. He rationalizes that the Subic and Clark facilities would be equivalentto 25 percent of total storage capacity, thereby giving the NOEC a sufficient initialmarket share to compete with the Big Three.

This “Pascual” formula is certainly less extreme than the original Garcia pro-posal.16 However, there remain some problems with it.

First, this still requires taking over the Clark-Subic facilities currently leased undercontract to Coastal Petroleum. To rescind this contractual arrangement would again castgrave doubts in the minds of foreign investors on the stability of Philippine laws, andmore 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 muchbetter than Coastal, a private firm following the profit motive, in sourcing refinedproducts? Coastal presumably attempts to source the same volume of products at thelowest possible price in order to maximize its profits. Moreover, Coastal is a companyalready with much experience in the business. It is their expertise or comparativeadvantage. Should we believe that the government can do better at trading inworld oil markets when that is not their expertise? Of course, some might say

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16 In the latest version of his oil exchange idea, House Bill No. 12052, Congressman Garcia hasalso toned down his original proposal by reducing the scope of control from industry-widefacilities 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 help-ful. Certainly that experience counts, but that experience has presumably beenleft behind with Petron.

Then there are other logistical problems. The Subic-Clark facilities will accom-modate 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 tobuild storage for the remainder, a very costly proposition, or lease from the currentprivate companies. Also, refining is a continuous process. It cannot be shut down andstarted up again as easily as a light bulb. The oil exchange would create a high-riskbusiness environment for refineries. If a refining company cannot be assured that itwill win next month’s, or even the next few months’ bidding for that matter, whatwould it do with its output? The incentives would be stacked heavily in favor of simplytrading 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 considerationthe spatial nature of retail gasoline competition. As has been pointed out in the firstsection, the market of a retail gasoline station is a geographic one. Given that the BigThree still hold a huge lead over the new players in terms of gasoline stations (about3,000 vs. 165), that still represents an overwhelming market share dominance. Moreimportantly, that market dominance still translates into price-setting power. You canhave 25 percent of the storage capacity, but if you do not have the gasoline stations tosell 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 inbulk or in greater volume. But this is precisely what makes it a dangerous idea. Themistake is to extrapolate from this experience and conclude that the same thing willhappen with the oil exchange. The mistake lies in forgetting the relative sizes of thePhilippine market and the total international market for oil. Oftentimes, our day-to-day haggling experience is limited to encounters with small individual merchants inthe market or tiangge. Imagine, however, what sort of results you could expect fromhaggling over the price of a couple of shirts with say, Shoemart. You would probablybe asked to take it or leave it. The total Philippine consumption for oil is estimated at350,000 barrels per day. In contrast, the world market is estimated to be more than 70million barrels a day. It is very difficult to imagine that we could get any significantprice discount, given our very small demand relative to the total market, and evenwith the volumes that major oil traders transact.

At the root of the exchange idea seems to be the belief that the major oil compa-nies abuse the practice of transfer pricing. The mother companies of the Big Threehave been accused of selling overpriced inputs (in this case, crude oil) to their localsubsidiary which would inflate the mother company profits while reducing thesubsidiary’s.


However, actual practices between mother company and subsidiary vary. For ex-ample, Petron has a non-exclusive supply agreement with its parent ARAMCO, sincethe former also buys from other sources. Shell reports that it sources most of its crudeoil 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 Shellconglomerate actually has a separate subsidiary that purchases and delivers crude oilto the various Shell refineries around the world, including the Philippines. This ar-rangement 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 tradingmarket like Singapore could be imported at significant savings. The DOE has esti-mated 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 averageprice for those products prevailing in Singapore, a free and unfettered market that theprices should be competitive. Their computations, in fact, show that the com-pletely builtup price would have been higher than the then prevailing localprices: P17.23 vs. P16.85 per liter for unleaded and P14.09 vs. P13.03 per literfor diesel. This suggests that whatever transfer prices were charged the localrefiners by their respective mother companies were reasonable. In other words,an oil exchange would not succeed in reducing prices and may even result, ironi-cally, in higher prices.

Figure 12. Unleaded Gasoline and Diesel Price Buildup, August 2000, MOPS Based

(in peso per liter)


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Moreover, economists recognize that transfer pricing is a valid managementpractice to optimize resource allocation among a firm’s various divisions. When thetransfer prices are set at their proper levels, they reflect the opportunity costs of thetransferred resources. Transfer prices allow the various divisions of a conglomerate tobalance the flow of resources among themselves to optimize conglomerate-wide prof-its. If a transfer price was set too high, then the “buying” subsidiary would get thesignal 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 be-cause of its “inflated” internal costs. In the context of this paper, an oil majorcould not maintain excessively “high” transfer prices in the long run because theother majors’ subsidiaries with the correct transfer price built in would be able toundercut its subsidiary in price.

On the other hand, an excessive transfer price would mislead the “selling” divi-sion 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, itdiscovers that it cannot sell any because the market price is lower than the transferprice. Overall profits of the conglomerate might suffer in the end. Thus, the conglom-erate 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 itwould 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 aprofit-making enterprise. If it operates for profit, then it will lead to what economistscall “double marginalization”. It will charge a margin for profit and then on top ofthat, the distributors will also charge another margin for themselves. Thus, pricesmay even end up higher than without an oil exchange.

Suppose it operates as a nonprofit and simply passes on to the distributors what-ever savings in purchase discounts it enjoys.17 What guarantee is there that the dis-tributors will pass on the savings to the consumers? In fact, if the distributors are acartel or a monopoly themselves, they will tend to keep some of this saving forthemselves. Thus, it would be an economically inefficient way of helping theconsumer. This possibility is analyzed and dealt with more extensively in thenext subsection.

Monopolies also tend to be inefficient precisely because they have no competi-tion. The government has not had a particularly good track record in operating mo-nopolies. While the oil exchange will not engage in manufacturing, it may beinefficient in administering the exchange, e.g., purchasing, allocation and distribu-tion of the refined products. Problems of graft and corruption also loom large in thebidding and allocation of the product, as well as the bidding out of ancillary contrac-

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17 This seems to be what HB No. 12052 Sec. 8 contemplates. See appendix of this chapter.


tual functions like hauling, shipping etc. A government-run oil exchange would alsoprobably be susceptible to political pressure to subsidize prices of products to keepthem artificially low. This is why the Oil Price Stabilization Fund (OPSF) ended up ina 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 overpricetheir 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 simplydeliver cheaper goods for this cartel to sell, on the assumption that the latter is able toobtain the refined products at a substantial discount. Besides, if the Big Three reallywere colluding, could they not also collude and rig the submission of bids to the oilexchange? If this were the case, the solution is really enforcement of antitrust lawsand empowerment of the concerned government agencies with the resources to detect,prevent and prosecute such anticompetitive behavior.

THEORETICAL WELFARE ANALYSISPresumably, 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 thelowest bidders at the lowest prices and then count on the oil companies to pass thesesavings to the consumers.

As was argued above, however, the Big Three still have substantial market poweron 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 thatthe NOEC is, in fact, able to source finished products at lower costs abroad than fromthe refineries here. Suppose the NOEC simply elects to pass on the savings. Then wemight consider modeling this situation as a reduction in the marginal cost of the BigThree monopoly (Figure 13). In this case, it can be shown that if the Big Three mo-nopoly maximize profits and set MR = MC, then the increase in their producer sur-plus will be greater than the increase in consumer surplus.

In this simple model, we assume the total market demand by consumers for gaso-line is linear and given by P = a – bQ . Let P1 and Q1 represent an initial conditionwhere the marginal cost is c1. Then suppose the NOEC is able to reduce prices todistributors (including the Big Three) from c1 to c2, then a profit-maximizing distrib-uting monopoly will set marginal revenue equal to the lower marginal cost c2 andcharge P2 and supply Q2. Evidently, both consumer and producer surplus will increaseas a result. However, we will now show that the increase in producer surplus will begreater than the increase in consumer surplus in this simple model.

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

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Fact: ΔProducer Surplus > ΔConsumer Surplus

Proof:The change in consumer surplus is given by:

ΔCS = (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:

ΔPS = (P2 – c2) Q2 – (P1 – c1) Q1

= (P2 – a + 2bQ2) Q2 – (P1 – a + 2b Q1) Q1

= Q2a + Q1a + P2Q2 + 2b Q22 – P1Q1 + 2b Q1

2

= a (Q2 + Q1) + P2Q2 – P1Q1 + 2b (Q22 – Q1

2)

Then

ΔPS – ΔCS = Q2 (a – P1) = a Q1 + 1/2 P2Q1 + 3/2 P2Q2 – 3/2 P1Q1 + 2b (Q22 – Q1

2) > 0

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


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

• 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 actu-ally increase the producer surplus of the Big Three as distributors more than it wouldincrease the consumer surplus. Keep in mind that there will definitely be an increasein consumer surplus. The result merely suggests that a monopolistic distributor or acartel, 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 marginalcosts.

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 totell us, however, whether on balance the monopolistic distributor/cartel will havehigher or lower total surplus.

It seems ironic, however, that even if the NOEC proposal was to succeed, itsprimary beneficiary would be the distributor. If the consumer is the target of the ben-efit, 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 wecould have a case of a bilateral monopoly: a monopoly in the form of the oil compa-nies’ distribution (if they collude), and a monopoly in the supply of products to the oilcompanies in the form of NOEC. Intuition suggests that the final product price will behigher and Figure 14 shows why.

In Figure 14, we will make the simplifying assumptions of linearity and constantmarginal 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 marginalrevenue curve for the distributors is also linear and twice as steep with the sameintercept, a. Note that if marginal costs are constant, then this marginal revenue curveMRDistributor is also the demand curve facing the NOEC monopoly. This is because thedistributors would set their constant marginal costs equal to their marginal revenue todetermine the quantity they would sell. In turn, the marginal revenue curve forNOEC, 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 constantmarginal costs of MC. Then profit maximization would require them to set this MCequal to their marginal revenue and sell Q0 at a price of P0. Now if NOEC existed andsuppose, hypothetically, that the best bid it receives for refined product also happensto 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 thiscase, NOEC would sell Q1 and charge a price of P0 to the distribution cartel. In turn,

OIL INDUSTRY 139

the marginal cost of the distribution cartel would now be P0 and to maximize profits itwould 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 isless than the surplus obtained by NOEC. The loss of consumer surplus (compared tothe 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 theNOEC surplus will, in this case, be greater than the loss of consumer surplus. In otherwords, NOEC could theoretically distribute its surplus back to the consumers andmore than compensate the latter. In practice, of course, this could be difficult to do asit 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 atthe expense of the distribution cartel. This deadweight loss will be represented by thearea (P0 – MC)(Q0 - Q1) + ½(Q0-Q1) (P1 – P0). Thus, while it might effect a transferfrom the distributors to the final consumers, it does so inefficiently.

DEREGULATION EXPERIENCES AND LESSONS FROMOTHER COUNTRIES

The Philippines is not the first to deregulate its oil industry. Other countries havedone so ahead of us. Among these have been some neighbors like Thailand and NewZealand. Other countries like the United States have experimented with policies toremedy perceived undesirable features of a deregulated or free oil market. This sectionsurveys the experiences of some of these countries with the objective of drawing somelessons from their experiences.

Figure 14. A Bilateral Monopoly


NEW ZEALANDNew 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 oper-

ate either at the wholesale or retail level. In general, the Act proscribed ver-tical integration from either level to the other.

New Zealand’s Commerce Act is its main antitrust legislation. Accompanying itare the Fair Trading Act and the Consumer Guarantees Act. Both of these are con-sumer protection legislation.

Most of the refined products come from the Marsden Point Refinery. Four compa-nies dominate the wholesaling with the following approximate market shares as givenby Clough et al. (1989). An interesting setup in New Zealand is that these four compa-nies 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 wholesalersmay have acquired or secured long term supply contracts with around 15 to 20percent of all outlets. British Petroleum (BP), an oil major, acquired in Augustthe largest independent multiple outlet chain of stations. Not long afterwards, italso signed up the second largest chain on a long term contract.

• Intense competition for some sites in some areas led to some stations chang-ing brand. Oil companies reputedly dangled very generous offers to inducesome retailers to sign long-term contracts or to purchase sites.

• Oil companies formalized the nature of supply contracts. Retailers that pre-viously supplied on verbal agreements were asked to enter into formal writ-ten contracts. And where written contract was already being used, the oilcompanies sought to have new contracts with longer terms, e.g., on an an-nual to three or five year basis.

• Among the oil companies, there is a split in their approach toward manage-ment of stations. Two have opted for a more “hands-on” approach, withmanager-operation of a substantial number of their outlets, with the remain-ing 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 arelikelier to be “tied” by a contract to a particular supplier than was the caseprior to deregulation.

• Retail prices did fall after deregulation. A Ministry of Energy survey sug-gests that prices may have fallen by about 2.02 to 3.35 cents/liter for supergrade and 1.39 to 2.44 for unleaded regular grade. Interestingly, the Ministerof Energy dropped both retail and wholesale prices by 6 cents/liter four daysbefore the industry was deregulated. Their reason was to prevent the pricesin the regulated regime from becoming a “benchmark” for deregulated pricesetting. Subsequent deregulation prices did move up but did not return to theprevious high controlled levels.

THAILANDFortuitously (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. Thailandimplemented its deregulation in a staggered manner. “Semi deregulation” was imple-mented at the end of May 1991 while “full deregulation” was implemented less thanthree months later on August 19.

Prior to deregulation, the industry was subject to price control in a system verymuch similar to the way prices were set here in the prederegulation Philippines. Thegovernment determined ex-refinery and import prices based on Singapore postingand spot prices. Excise and municipal taxes on a specific basis (baht/liter) were yetanother 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 preced-ing components. The resulting retail prices were rarely changed. Since prices of inter-national crude fluctuated frequently, this implied that the Thais also had a buffer oilfund levy/subsidy analogous to our OPSF. Conceptually, the retail price was basicallyarrived thus,

Retail Price = Ex-Refinery/Import Price + Oil fund + Taxes + Marketing MarginAt 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 inwholesale trade. Oil imports were controlled with a quota system. Entry into the oilbusiness 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.


• The oil fund levy was fixed at a constant level and wholesale prices wereallowed to change each week in line with ex-refinery prices.

• The oil companies were responsible for setting prices at their service stationsand 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 com-panies 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. Weshould not expect a more competitive environment to spring up overnight.

The Thais were not without post deregulation problems either. There was con-sumer perception that the marketing margin was too high and indeed, estimates of theaverage 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 expe-rience, there was public perception that the oil companies engaged in price collusionand that retail prices moved upwards faster than they did downward.

In stark contrast to the Philippines, the number of service stations grew quiterapidly after deregulation as shown in Table 7.

There were quite a few new entrants and while their number of service stations isstill far behind the prederegulation majors, their growth is remarkable, however.

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

Table 7. Thailand Service Station Growth

OIL INDUSTRY 143

UNITED STATES

Easily the biggest oil market in the world is the US market, also arguably themost competitive. This is because the huge market size easily makes possible theexistence of a multitude of firms at all stages of the downstream oil industry. Thestructure of the US market offers many lessons for the Philippines. In addition, thevarious forms of regulation that have been tried like divorcement and divestiture areworth studying because they may be proposed here in the Philippines in the future, too.

Over 100 refineries refine gasoline and together with imported fuel, constitutesthe supply of gasoline in the US market. Retail distribution takes place through vari-ous channels (Figure 15). Refiners often sell generic gasoline in bulk directly from therefinery to distributors or even to other refiners. “Branded” refiners also haul theirproduct to a distribution terminal in a city to be sold either as branded gasoline (thatis, with company-specific additives and with the right to use the refiner’s name atresale) 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 orwork through middlemen known as “jobbers.” A typical jobber supplies manybranded stations and often owns many of the stations it services. For instance, a jobbercould supply two Exxon, three Chevron, and five “unbranded” stations some of whichmay be owned and operated by the jobber himself. The branded stations must get theirproducts from their own terminals while the unbranded ones may source theirs fromany terminal. Thus, the gasoline bought at a generic or unbranded station may actu-ally be Shell, Exxon, Chevron, other gasoline (generally without the company-spe-cific additives), or gasoline from an unbranded or lesser known refiner.


The jobbers function as intermediaries. They can provide the refiner with infor-mation on local market conditions, as well as contacts with dealers and other businesspeople. Such information and contacts may be more costly for the refiner to acquire onits 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 theUnited States. About 120,000 or 60 percent of them are major-brand stations (Figure16). The 15 largest refiners are integrated down to the retail level. Of all the servicestations, though, only about 16.4 percent is owned by oil companies. This proportionis low when compared with some of our local players. Shell Philippines estimates thatabout half of their stations are company-owned. Petron owns 395 stations compared to496 dealer owned stations.

Gasoline retailing in the US may thus be characterized as a mixed distributionsystem. Many major firms are vertically integrated: they operate a refinery as well astheir own service depots. Some companies even franchise out the operation of somestations to third parties. Most companies practice both. Then there are jobbers orwholesalers who do not have a refinery but maintain a network of retail service sta-tions under a common brand name. There is even one refinery, Tosco Corp., whichhas no stations bearing its name and instead sells all its output to jobbers.

The oil industry’s activities involve a three-step process: refining, transportingand dispensing. The first step refers to the transformation of crude oil into the finalproduct, such as gasoline. The product is then transported from the refinery to the cityterminals and on to the retail outlets. Finally, it is dispensed to the fuel tanks of auto-mobiles.

Figure 16. Share of US Gasoline Retail Establishments

Source: Borenstein and Gilbert (1993).

Share of US Gasoline Retail Establishments

Bulk and

Other 7%

Company-Operated

Stations 16%

Jobber-Supplied

Stations 46%

Direct-Supplied

Stations 31%

OIL INDUSTRY 145

Although many firms are vertically integrated from the refinery all the way downto the retailer, they need not be so, as evident in the case of many US companies. Eachstage could be considered a different sub-industry altogether. Thus, there is no reasonwhy competition should not prosper at each stage.

As of 1993, more than 100 refining companies were operating in the US, supply-ing about 95 percent of the total volume of gasoline consumed. The remaining 5percent was imported. Although the 15 biggest companies account for 82 percent ofdomestic production, no single company has a market share over 9 percent. Ninefirms have market shares ranging from 5 to 9 percent. The 15 biggest refiners arevertically integrated all the way down to the retail level, but none of them operate evenhalf of their brand name stations directly—proof that the US oil refining industry isfairly competitive and by no means highly concentrated.

Theoretically, the transport stage can be subjected to competition as well. At thisstage, barriers to entry are relatively lower since capital and technology requirementsare not as critical. Since the US is a contiguous land mass, most gasoline is trans-ported by truck, railway and pipeline. Of these, trucking would probably have thelowest barriers to entry.

Except in the smallest town or in the most isolated place, there seems to be a fairamount of competition at the dispensing stage. It would not cost a consumer too muchto drive to the gas station around the corner if he does not like the price at the one nearhis 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 withthe Exxon outlet across the street but with other dealer-owned Chevron stations andthose that Chevron itself owns and operates. Price is not regulated (except underemergency situations such as the oil crises of the 1970s); thus, a consumer can witnessvigorous price rivalry. In fact, it is even possible for two stations in the same city tocharge different prices for the same brand of gasoline.

The US market is so huge it can easily accommodate 100 refiners. Given econo-mies of scale in refinery operation, however, a small market like the Philippines canonly hold so much industry players. Too many refiners would cause some to fall by thewayside 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 ratherthan 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 byallowing imported petroleum products to compete with those of the Big Three.

Second, the Philippines has not yet demonstrated much intrabrand rivalry at theretail stage. The three oil companies may charge different prices for the same type ofgasoline 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


on prices. (Prices in the provinces are different from those here but, within the samecity, they are the same for stations under the same oil company.)19

But perhaps, just as important as intrabrand rivalry could be the rivalry betweenbranded and unbranded gasoline stations. This could be akin to the competition be-tween branded and generic medicines. Chemically, gasoline is gasoline and the onlydifference 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 newplayers are the analogue of the unbranded stations in the US. Most of the new playersactually do not have the storage facilities to import and therefore, actually get theirgasoline from the Big Three. But again, the number of their retail stations are too fewcompared 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. Evenin the US, similar public sentiment has been vented against the oil companies. Oilcompanies there have been accused as well of cartelization and wielding too muchmarket power that allows them to overcharge. Consequently, legislators there havebeen searching for “solutions” to increase the level of competition.

One such measure is divorcement legislation. A divorcement bill requires refin-ers to “divorce” themselves from owning and running retail gasoline stations. Theywould be restricted to franchising stations and supplying independent dealer-ownedstations. In other words, divorcement is concerned with prohibiting or restricting theextent that oil refining companies vertically integrate into distribution. Typically, anoil company-owned station would be operated by salaried employees of the oil com-pany/refiner. The company sets prices and retains profits. By contrast, franchise deal-ers 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 ofgasoline sold.

Last year, as international crude oil prices started to climb, California legislatorsstarted entertaining the idea of introducing a divorcement bill. As early as 1974, thestate of Maryland has already passed such a law. Barron and Umbeck (1983) exam-ined the Maryland experience. Blass and Carlton (1999) report that divorcement hasbeen 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 fran-chised station operators. It should be noted that in the United States, there has been atrend 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 sta-tions tend to be lower than those at the franchised stations. This has led the latter toaccuse the oil companies of predatory pricing.

There have been several studies that examined the economic consequences ofdivorcement legislation in the US. Most of them conclude that divorcement is actuallyan 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 anefficient response to market changes. In the US, there has been a shift away from fullservice stations, i.e., stations offering oil change, muffler replacement, tune-up, re-pair, etc., as consumers go elsewhere for these services. The rise of specialty shops thatcater to these services, e.g., muffler shops, express oil change and lube shops, etc., hasaccentuated that trend. Following franchising theory, they argue that when the nature ofan activity makes it difficult or costly to monitor, a principal would prefer to franchise outthe operation. Since it is more difficult to monitor and manage those auxiliary serviceslike repair, stations had in the past tended to be franchisees. However, as stations becomemore specialized, i.e., only dispensing fuel, which is easily monitored and measured, theoil companies have found it less necessary to franchise, opting instead to own and/oroperate more stations. A study by Shepard (1993), in fact, finds evidence that stationswith service bays tend to be lessee-dealers and those stations that mainly sell gasoline andconvenience store products tend to be company operated.

Both Barron and Umbeck and Shepard find evidence that prices may be lower atcompany-owned stations. A possible explanation of this is the so-called doublemarginalization problem. When a residual claimant such as a franchisee dealer setsprice on top of the refiner’s wholesale price, the dealer may set a second,supercompetitive markup over the refiner’s wholesale price. This second markupwould be absent in a company-operated station.

Hastings (2000) takes advantage of a unique market event in California, the pur-chase by the Atlantic Richfield Company (ARCO) of the Thrifty chain of stations, toinvestigate this. Thrifty is an independent chain of gasoline stations while ARCO isan oil major. Thus, the long-term lease by ARCO of over 260 independent Thriftystations converts what used to be independent dealers into company (ARCO)-oper-ated stores of varying degrees of vertical integration. She finds that stations that com-peted with what used to be a Thrifty station enjoyed a significant increase in priceafter the latter was converted into an ARCO station. However, this increase was en-joyed regardless of the contractual arrangement of the ARCO station, i.e., whether itis company-operated or a franchise. She concludes that the loss of an independentunbranded station had an impact on prices (increase) but that the type of contractionat the branded station did not.

In the Philippines, there seems to be a difference in the structure of retail distribu-tion between the new players and the Big Three. Among the Big Three, the splitbetween company-owned and dealer-owned stations is about half. New player sta-tions, on the other hand, tend to be dealer-owned (Table 8).


____________________

20 Most of the facts in the following section were obtained from FTC Docket No. C-3907 (Nov.30, 1999).

The gross margin of the franchise retail stations average only about 60 cents perliter. Out of this gross margin, the station owner will still have to cover his other costsof labor, overhead, etc. When compared with the final selling prices that range fromP12 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 bemuch 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 competi-tion. With importation of refined products liberalized, the local refineries will have tocompete with refineries abroad, especially Singapore for example, up to at least amargin for transportation costs. However, even this is muted at the moment due to thelack 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. Overtime, however, this should grow and provide more competition for the Big Three.

DIVESTITUREIt 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 recentExxon-Mobil merger is a good example of one such case.20

Prior to the merger, Exxon and Mobil were the second and fourth largest privateoil companies in the world, respectively. Together, their assets would reach $80 bil-lion, possibly making it the largest in the world. Ironically, both were key parts of the

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

Table 8. Oil Industry Service Station by Contractual Arrangement (as of May 2000)

CO = Company operatedDO = Dealer operatedSource: Petron.

OIL INDUSTRY 149

old Standard Oil Trust that was broken up in the early part of the last century byantitrust legislation. In order for the merger to be allowed, the FTC ruled that assets inrefining, terminal facilities, retail gas stations and pipeline interests totaling $2 bil-lion of the merging companies had to be divested within nine months. The two com-panies competed head-to-head against each other in many states and the FTC ruledthat 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 itactually enumerated specific cities where a merged Exxon-Merger would have toomany stations and prescribed how many stations should be divested in each city.

Nevertheless, the FTC allowed the merger to push through on the followinggrounds:

• Except for regions and markets where they directly competed, the FTCjudged the merger not harmful to competition.

• Exxon-Mobil would control only 1 percent of the world’s oil reserves andconstitute less than 3 percent of world oil production.

• Even after the merger, the top four firms would account for only 42 percentof refining capacity and gasoline sales, which does not normally warrantantitrust action.

In the Philippines, by contrast, the Big Three account for 100 percent of refiningproduction and 90 percent of the total market. This is highly concentrated in anydefinition of market concentration. Even though no merger is forthcoming among orinvolving the Big Three, divestiture might be an option that could be studied. Thehuge lead of the Big Three in terms of stations might precisely be whittled down bysuch a policy. However, the margin of over 3000 to 165 is definitely too large to beoverhauled by mere divestiture. Other measures to promote the growth of competitorswill have to be pursued in tandem with divestiture.

SUMMARY AND CONCLUSIONS

The road to deregulation for the Philippines has not been a straight one. Theoriginal 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 Asiancrisis forced the oil companies to raise prices in 1997. This did not go unnoticedamong 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 SCruled that certain provisions of RA 8180 are unconstitutional and struck it down. Anew oil deregulation law, RA 8479, with the ‘offending’ provisions of the first eitheramended or omitted, was subsequently passed and implemented.

Thus, the experience with oil deregulation is important because it represents per-haps the first major test of the country’s path down competition policy and antitrust


legislation. The SC should be commended for its well-meaning defense of consumerwelfare and sincere desire for the true forces of market competition to bear fruit. Itshould be commended as well for its efforts to apply economics concepts such ascompetition and market behavior in its analysis of the case, the crux of which is reallyeconomic in nature.

However, the economic reasoning that accompanied the decision was imperfect.Fortunately, the court erred (unconsciously) on the side of consumer welfare and thenew players in the industry. The removal of the tariff differential benefits the newplayers, enabling them to bring in the products at a slightly lower cost. If they passthis saving on, then consumers will benefit. The potential benefits though, if any atall, arguably come at the expense of the local refining industry. On the other hand, theinventory requirement was unnecessary to begin with anyway, so doing away with theinventory requirement will probably have no meaningful effect.

The public outcry may ultimately be a natural resistance to rising prices and topaying more, but it demonstrates the fact that competition policy is implicitly in theminds of the public. They are concerned that a few big firms may be manipulating themarket to the detriment of the consuming public. For example, the public perceivesthe simultaneous price changing by the oil companies as a necessary manifestation ofprice 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 beingentertained, 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 havedemanded for corresponding sanctions. However, closer scrutiny under the lens ofeconomic analysis suggests that the economic grounds for these positions are weak.

It is clear that a marriage of economics, especially the theory of industrial organi-zation, with law is requisite to intelligent competition policy formulation and juris-prudence. Legislators and judges have the moral duty to implement the constitutionalvision of competition and protect the public from monopolies. Oftentimes, however,the actual effects of laws or policies that are proposed in pursuit of this objectiverequire economic tools and analysis for evaluation. Thus, it can only profit Philippinepolicymaking 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 Retailingand the Costs of Laws Limiting that Choice. National Bureau of Economic ResearchWorking 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 retail-

ing. 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.


APPENDICES

Appendix 1. Undercutting Price Increases Profits in the Absence

of Capacity Constraints

Profit for firm if it splits the market:

a – Pπs = (P – MC) ––––––2b

Profit for firm if it undercuts by ε and gains the entire market:

a – P + επu = (P – MC – ε) ––––––2b

Therefore, the change in profits is:

a – P a – P + εΔ π = πs – πu = (P – MC) –––––– – (P – MC – ε) ––––––2b 2b

a – PIt 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 marketif 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 betweenundercutting to gain the entire market Q, and just matching price and splitting themarket since total contribution to profits will be the same: (Note that ε and 2ε are theunit contribution margins.)

ε Q = 2ε Q/2However, if the competitor’s price is c + 3ε, then undercutting to gain the entire

market will increase total contribution to profits since:2Qε > 3εQ/2It 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 totalcontribution to profits:

p > c +2ε(p - 2ε) Q > cQpQ - 2εQ > cQ

adding pQ – 2cQ to both sides,2pQ -2εQ – 2cQ > p Q - cQ2Q (p - ε - c) > (p – c) QQ (p - ε - c) > ( p – c ) Q/2

The last equation states that the total contribution margin serving the entire mar-ket at price p - ε is greater than when splitting the market at price p.


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 anyand 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 corpo-ration to be named as the National Oil Exchange Corporation (NOEC) shall be estab-lished. The NOEC shall determine the country’s total monthly requirements forrefined petroleum products, and shall exclusively handle all the purchases, storagesand distributions thereof to distributors, wholesalers, retailers and big bulk consumersthroughout the country.

Sec. 5 Bidding – On a monthly basis, the NOEC shall bid out, to all interested oilrefineries and trading companies in the world, the total monthly requirements for allrefined petroleum products, in order to obtain the lowest price for said products. Onlythe products of the lowest complying and winning bidder/s may and shall be placed incommerce in the Philippines.

Sec. 6 Storage Facilities – The NOEC shall take over and operate all the com-mercial ocean receiving terminals and storage depots for refined petroleum productsall over the country. For this purpose, the NOEC shall take control of the operation ofsaid facilities by way of compulsory purchase or lease, at its option, subject to therequirements of the Constitution and existing laws. Such facilities shall be used ex-clusively by the NOEC for the storage and distribution of the products of the lowestcomplying and winning monthly bidder/s.HB 12052 An Act Restructuring the Oil Industry By Establishing a National OilExchange, 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 exclu-

sively handle the original acquisition/purchase of the country’s total require-ment 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 governmentagencies 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 corpora-tion to be named as the National Oil Exchange Corporation, hereinafter referred toas “OILEX”, shall be established. The OILEX shall determine the country’s totalmonthly requirements for refined petroleum products, and shall exclusivelyhandle their original acquisition/purchase, storage and eventual distribution todistributors and wholesalers, both the Big Three (3) oil companies and the newplayers alike.

OIL INDUSTRY 155

Sec. 6 Bidding and Negotiation – The OILEX shall acquire/purchase thecountry’s requirement of each and every refined petroleum through bidding and termcontract negotiation open to all oil refineries and traders in the world, in order toobtain the lowest price for said products. Only the refined petroleum products of thelowest complying winning bidder/s and term contractor/s may and shall be placed incommerce in the Philippines.

Sec.7 Storage Facilities – The OILEX shall take over and operate the govern-ment-owned ocean receiving terminals and storage depots at Subic and Clark to re-ceive and store all refined petroleum products. For this purpose, the OILEX shall takecontrol 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 thestorage and distribution of the products of the lowest complying and winning bidder/s and term contractor/s. The refined petroleum products coming from the winninglocal oil refineries may be maintained in their respective storage facilities, subject tothe exclusive control and disposition of the OILEX.

Sec. 8 Selling and Oil Pricing Mechanism – The OILEX shall sell, ex-plant andat cost, to all distributors and wholesalers all the refined petroleum products it willacquire. The cost, aside from the acquisition price, shall include recovery of expensesof the OILEX, etc.

Appendix 3 (continued)

“It would be a truism to say that the most effective forms of competi-tion we have, or can have, are imperfect forms, since there are noothers. But it will mean something if we can find, after due examina-tion, that some of these forms do their jobs well enough to be anadequate working reliance-more serviceable, on the whole, thanthose substitutes which involve abandoning reliance on competi-tion. And it would be useful if we can learn something about thekinds and degrees of “imperfection” which are positively service-able under particular situations.”

– Clark 1940

ABSTRACT

Telecommunications liberalization in the Philippines has produced a number ofbenefits such as higher teledensity, greater variety of services and to someextent, lower prices. However, simply relaxing market entry restrictions hasbeen proven insufficient in creating a truly competitive environment. This pa-

per looks at the state of competition in the Philippine telecommunications market anddiscusses the various threats to the competitive process in the industry. The paper alsosuggests areas for intervention from the standpoint of competition policy.

5C H A P T E R

Competition inPhilippine Telecommunications:A Survey of the Critical Issues

Ramonette B. Serafica*

––––––––––––––––––––

* The author acknowledges the research assistance of Ms. Jovie Importante. All errors are thesole responsibility of the author.


INTRODUCTION

The demonopolization of Philippine telecommunications can be considered asone of the best legacies of the Ramos administration. It is hard to imagine that anyother policy move could have elicited the same supply response from industry, par-ticularly from the dominant operator.

This study seeks to improve on the achievements of liberalization by carefullyanalyzing 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 especiallyas it applies to the telecommunications industry.

• To evaluate the state of competition in the Philippine telecommunicationsindustry.

• To identify threats to the competitive provisioning of telecommunicationsservices.

• To suggest policy and regulatory measures to ensure a contestable telecom-munications market.

To begin, some basic concepts and principles are presented to better under-stand competition policy and its role in telecommunications. Next, we will carefullyreview the state of competition in Philippine telecommunications by looking at theindustry structure and the relevant regulation affecting firm conduct particularlywith respect to pricing. Then, the experiences of local communities after the intro-duction of liberalization will be discussed followed by an analysis of the criticalissues undermining the competitive environment. Specific recommendations tocreate a more competitive and efficient telecommunications market are presentedlast.

THE ROLE OF COMPETITION POLICY IN PHILIPPINETELECOMMUNICATIONS

The virtues of competition are well known. Several efficiencies are attained inmarkets 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 achievedbecause firms are forced to produce goods and services at minimum cost. Allocativeefficiency is attained because only the right amount and mix of goods and services areproduced at prices that reflect the opportunity cost of all resources utilized. X-ineffi-ciency is avoided because the discipline of a competitive market will punish managerialslack or excesses. Equally important, consumer welfare is also maximized under a per-fectly competitive market structure.

TELECOMMUNICATIONS 159

In reality, most industries do not possess all of the standard characteristics of aperfectly competitive model from which such efficiencies are supposed to emanate. Inthe case of telecommunications, massive capital requirements imply high barriers toentry and exit especially since a significant portion of fixed cost incurred is sunk.Telecommunications is also characterized by a network of switches, transmissionlinks, and terminal or distribution points that give rise to economies of scale andscope. However, this does not mean that telecommunications is necessarily a naturalmonopoly. Being multiproduct in nature, different portions of the telecommunica-tions network can be opened to varying degrees of competition, although still not tothe extent described in a perfectly competitive model. Another important characteris-tic of telecommunications is that it enjoys network externalities (also referred to asconsumption scale economies), which means that the benefits from telecommunica-tions increase with the number of users that one is able to reach. These economicproperties of telecommunications have at least two important implications forpolicymaking and regulation.

First, since the industry is not perfectly competitive, then unfettered market activ-ity cannot be expected to produce outcomes that are always efficient or that promoteconsumer welfare. Traditionally, countervailing market power in industries such astelecommunications was simply called regulation (or monopoly regulation). Giventhat technological and market conditions have now allowed feasible and desirableentry of competition in some subsectors of the industry, a more general set of rulesunder “competition policy” (which subsumes monopoly regulation) must be put inplace. A proactive set of rules promoting competition is necessary to assist entry andensure that fair competition is maintained particularly since an incumbent can use itsposition to undermine competition. An incumbent not only enjoys certain advantagesfrom being the first mover in the market but it also controls certain facilities that an entrantneeds for the delivery of its service. Without rules that explicitly deal with the potential forabuse of the dominant position, then efforts to approximate the desirable results of aperfectly competitive market by simply relaxing market entry will not be effective.

In other countries particularly the US, antitrust laws govern the ways in which firmsare allowed to compete with each other. Agreements among competitors (e.g., pricefixing arrangements) and actions by a single firm that hurt rivals (e.g., denial of access tobottleneck facilities) are the main areas covered by antitrust policy. When no additionalinquiry is required to determine whether or not a certain firm behavior violates antitrustlaws, then such conduct is said to be per se illegal. An example of this would be anagreement whose sole purpose is to fix price or restrict output. However, not all coopera-tive agreements are considered illegal especially when such arrangements are neces-sary to achieve procompetitive purposes (e.g., the reduction in transactions costs). Insuch cases, the courts apply a rule of reason analysis whereby the reasonableness ofthe agreement is determined. To be sure, antitrust is not antimonopoly. The intent of theantitrust laws is primarily to prevent business practices that would harm societythrough the exercise of market power (Carlton and Perloff 1994).


The second equally important point that needs to be recognized is that even ascompetition policy attempts to mimic the competitive market, tradeoffs among the desir-able efficiencies will have to be made. For example, since fixed costs are involved, thena policy of promoting entry will lead to lower x-inefficiency within the incumbent firm butwill also result in a duplication of facilities in the industry. A merger, which exploitssynergies and generates efficiencies, may have to be challenged if this creates a signifi-cant increase in market power (or the ability to set the terms of the market with respect toprice or supply). If one of the government’s objectives is to encourage dynamic effi-ciency (i.e., innovation), then firms should be allowed to earn above-normal profits orengage in tie-in arrangements to recoup investments in R&D. Note, too, that the com-petitive model is silent on the issue of equity. Thus, prices may have to be distortedresulting in allocative inefficiency in the short term if this will translate to more peoplebeing able to access the telecommunications network thereby increasing the benefitsfor everyone in the long run.

Competition policy, just like regulation, will have to balance the conflicting in-terests of the various stakeholders—at times, even requiring intertemporal compari-sons of welfare effects. Thus, the critical decision will have to be made in terms ofchoosing which among the different interests and objectives are more equal than others.

Given these considerations, what specific elements of competition policy aremost relevant to Philippine telecommunications? The next few sections will discussthe state of the industry and its regulatory environment to aid us in identifying therules that must be put in place to create a healthy competitive market.

THE MARKET ENVIRONMENT OF PHILIPPINETELECOMMUNICATIONS

As declared in the Public Telecommunications Policy Act of the Philippines (RA7925), “A healthy and competitive environment shall be fostered, one in which tele-communications carriers are free to make business decisions and to interact with oneanother in providing telecommunications services, with the end view of encouragingtheir financial viability while maintaining affordable rates” [Article II. Sec 4f]. Tele-communications is defined as “any process which enables a telecommunications en-tity 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 controlsignals or any design and for any purpose by wire, radio or other electromagnetic,spectral, optical or technological means.” Accordingly, the Act specifies the followingcategories of telecommunications services: local exchange service, interexchange car-rier service, international carrier service, value-added service, mobile radio service, andradio paging service.

The National Telecommunications Commission (NTC) is the agency that exer-cises jurisdiction over the supervision, adjudication, and control over all telecommuni-


cations services. Although it is an independent regulatory body, the NTC remainsunder the administrative supervision of the Department of Transportation and Commu-nication (DOTC) as an attached agency. However, in terms of its quasi-judicial func-tions, the decisions of the NTC can be appealed only to the Supreme Court. Accordingto RA 7925, it is the responsibility of the NTC to “Foster fair and efficient marketconduct, through, but not limited to, the protection of telecommunications entities fromunfair trade practices of other carriers” [Art. III Sec. 5d].

THE STRUCTURE OF THE INDUSTRYTable 1 shows the growth of the industry following liberalization. Although Philip-

pine telecommunications has always been multioperator in character, it was only untilthe issuance of the Executive Order 109 (and subsequently with the enactment of RA7925) that the industry was effectively demonopolized. That there are no longer mo-nopolies in the industry does not mean that no single operator today is able to exerciseconsiderable market power but rather, that there are now at least two operators allowedto compete in the same geographic market for each of the service categories identified inRA 7925.1

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

Table 1. Number of Authorized Carriers

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 firmscontrol essential facilities and are thus able to behave like a monopolist will be discussed in alater section.


Of these service categories, only value-added service has been deregulated suchthat even registration with the NTC is not being strictly enforced. Entry into the regu-lated 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 thecountry. The second phase involves applying for a Certificate of Public Convenienceand Necessity (CPCN) or a Provisional Authority (PA) that the NTC grants and whichrequires carriers to demonstrate that they are technically and financially able to carryout the service and that sufficient demand exists. A description of the service, thespecific rate or a general rate structure that may be charged for the service and theregulations under which that service can be provided are all contained in the PA.

EO 109 forced the creation of several vertically integrated multiservice firms. Inaddition to the Philippine Long Distance Telephone Company, Inc. (PLDT), there arenow nine other firms engaged in various telecommunications services. Moreover, mostof these firms have positioned themselves further downstream in value-added service,either through an affiliate, subsidiary, or sister company (Table 2).

Although all carriers were given a national franchise, PLDT is the only carrier thatoperates local exchange service (including Public Calling Offices) all over the countrywhile the rest are restricted by their PAs to serve only specific geographic areas (Table3). In addition to these vertically integrated firms, there are about 66 other licensedprovincial operators who have been providing LEC service on a limited scale. Four ofthese pure LEC operators are government-owned and should be privatized soon asmandated by RA 7925. At the aggregate level, PLDT accounts for about 60 percent ofthe total subscribed lines (Figure 1) and remains the dominant operator in the mostlucrative service area, Metro Manila. In Luzon, DIGITEL is emerging as the dominantoperator while for the rest of the country, no single firm consistently enjoys the domi-nant position for competition in the so-called “last mile connection.” Appendix 1 iden-tifies the dominant and fringe operators in each of the provinces.

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

Table 2. Scope of Services


Note:1. Coverage:

National Capital Region (NCR)A – Manila, Navotas, Caloocan CityB – Quezon City, Valenzuela, MalabonC – Makati, San Juan, Mandaluyong, Marikina, PasigD – Pasay City, Las Pinas, Paranaque, Pateros, Taguig, Muntinlupa

Cordillera Administrative Region (CAR)A – Abra, Benguet, Mountain ProvinceB – Apayao, Ifugao, Kalinga

Region I (Ilocos Region) – Ilocos Norte, Ilocos Sur, La Union, PangasinanRegion II (Cagayan Valley) – Batanes, Cagayan, Isabela, Quirino, Nueva VizcayaRegion III (Central Luzon) – Bataan, Bulacan, Nueva Ecija, Pamapanga, Tarlac, ZambalesRegion IV (Southern Tagalog)

A – Aurora, Laguna, Marinduque, Quezon, Rizal, RomblonB – 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 OccidentalRegion VII (Central Visayas) – Bohol, Cebu, Negros Oriental

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

I X X X

II X X X

III X / X X

IV A X X / X

IV B X X / X

V X X / X

VI X X

VII X X

VIII X X

IX X X X

X X X X

XI X X X

XII X X

CARAGA X X X

ARMM A X X

ARMM B X X X

Table 3. Service Areas


Region VIII (Eastern Visayas) – Biliran, Eastern Samar, Leyte, Northern Samar,Southern Leyte, Western Samar

Region IX (Western Mindanao) – Basilan, Zamboanga del Norte, Zamboanga del SurRegion X (Northern Mindanao) – Bukidnon, Camiguin, Misamis Occidental,

Misamis OrientalRegion XI (Southern Mindanao) – Davao, Davao Oriental, Davao del Sur, South Cotabato,

Sarangani, Compostela ValleyRegion XII (Central Mindanao) – Lanao del Norte, North Cotabato, Sultan Kudarat,

Cotabato City, Marawi CityRegion XIII (CARAGA) – Agusan del Norte, Agusan del Sur, Surigao del Sur,

Surigao del NorteAutonomous Region in Muslim Mindanao (ARMM)

A – Lanao del Sur, MaguindanaoB – Sulu, Tawi-Tawi

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

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

THE ECONOMIC REGULATION OF THE INDUSTRY

Determination of end-user priceTraditionally, 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 operatingexpenses. Another principle, which guided rate setting, was the policy objective tomaintain the affordability of basic telephone service especially for residential use. With

Figure 1. Fixed Lines Market Shares


these two constraints, price regulation for a multiservice, vertically integrated firm suchas PLDT resulted in cross subsidization whereby the rates of some services were setabove cost (i.e., international long distance) in order to cross-subsidize LEC service thatwas presumably priced below cost.

The collection rate, or the price charged to consumers for international long dis-tance calls, are partly influenced by the international accounting rate system wherebycarriers, for example, PLDT and American Telephone & Telegraph (AT&T), would agreeon the price (the accounting rate) of a call between the Philippines and the US such thatthe originating telco would remit half of the accounting rate (the settlement rate) to theterminating telco. The collection rate was set higher than the accounting rate so thatlocal service could be made affordable and still enable PLDT to earn the allowable rate ofreturn. In recent years however, the NTC has allowed collection rates to decrease as aresult of international pressures, spearheaded by the US Federal Communications Com-mission (FCC), to reform the accounting rate system in favor of lower rates that reflectactual costs and to maintain a balance between outgoing and incoming international tolltraffic. The need to cross-subsidize local telephone service (i.e., prevent increases inbasic rates) and encourage network expansion has prevented the NTC fromderegulating the prices of international calls altogether.

In the case of local service, the price that subscribers pay consists primarily of twoparts: the base rate and the foreign currency adjustment (FCA). The base rate is gener-ally 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 toPLDT’s implementation of rate rebalancing in December of 1997, the base rates forMetro Manila were fixed at P110 for residential subscribers and P232 for business sub-scribers, which were set way back in 1983. Since then, the final prices charged to sub-scribers have increased as a result of the foreign currency adjustment, which allowsutilities such as PLDT to automatically adjust the rates by 1 percent for every P0.10increase/decrease in the peso-dollar exchange rate. The adjustment factor, which is

Figure 2. Cellular Mobile Market Shares, 1998


based on a moving reference exchange rate, is then multiplied by the base rate todetermine the FCA. The FCA is added/subtracted to the previous rate to arrive at thenew monthly rate.2 Thus, by October 31, 1997, the prevailing rates were P326.41 andP728.30 for residential and business subscribers, respectively. An additional 10 percenttax 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 thedetermination of “fair and reasonable” rates. The industry has been pushing for raterebalancing3 and metering. In the absence of a set of principles and concrete guidelinesfor rate setting, the resolution of these issues remains contentious.

Determination of access priceAlthough 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 specifiedin the RA 7925, the access charge is supposed to “make provision for the cross subsidyto unprofitable local exchange service areas” [Article III Sec. 5 c]. More generally, therates 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 inthe country, and

• Assure a rate of return on the total local exchange network investment that isat parity with those earned by other segments of the telecommunications in-dustry.

The actual level and the structure of the access charge differ depending on the typeof interconnecting service. PLDT adopts the following commercial arrangements, whichis the de facto industry practice:

“IGF interconnection involves payment of access charges, whereastoll calls for IXCs and LECs are settled based on revenue sharing.CMTS interconnection settlement for local calls is also based onaccess charges; for toll calls, the basis is revenue sharing. LEC toLEC interconnection with hauling from one service area to anotherservice area is settled based on trunk charges, while overlay LEC toLEC 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. Assuch, the FCA is added to the original base rate and not to the previous rate to arrive at the newmonthly 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 toearly 1998.

––––––––––––––––––––


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

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

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

The liberalization of the telecommunications sector has been beneficial to thecountry. The single most important achievement of liberalization is that it has ex-panded consumer choice. Although it was technology that enabled more accessoptions to become available (e.g., cellular and landline), it was the deliberate policyof expanding supply via the entry of new players that has produced the gains forconsumers. Carriers strive to be the first to provide advanced features that currenttechnology makes possible (e.g., caller ID, three-way calling). Moreover, intoday’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 theintroduction of competition at the local exchange level. These cities were selected be-cause of the unique competitive environment that can be found in each market.

DAGUPAN CITYTelecommunications services

available in Dagupan City consistof telegraph, telex, fax, cellularphone, fixed line, paging, and otherauxiliary facilities such as publicpayphones and public calling sta-tions. For their basic telephone

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.

DAGUPAN CITYPopulation : 128,499 (1998)Land Area : 43.6 sq. kmPopulation Density : 2,945 / sq. kmClassification : Component CityIncome Class : 1st


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 tomore than one carrier. But although the first suspect for this kind of behavior is intercon-nection, which both carriers and subscribers say has been resolved, the main explana-tion 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 tocall Metro Manila using a PLDT line. Being first in the area also helps in that long-timecustomers would rather acquire a second line than give up his or her PLDT connectionor phone number.

DIGITEL’s appeal is the wider calling area for local calls (i.e., no long distancecharges for DIGITEL-TO-DIGITEL calls within the province). The fact that it is metereddoes not seem to deter subscribers, as DIGITEL has designed three calling plans whichthey can choose from: Choice 150, 300, and 750. Each plan provides an allowance forboth local and long distance calls. Interestingly, when the company introduced theusage-based monthly plans for telephone service in June 1997, it took efforts to assistsubscribers in selecting the calling plan that best suits their needs by coming up withsome guidelines based on their calling habits and budget. For example, Plan 150 wasbeing marketed as appropriate for the following subscriber type: use of telephone islimited, average monthly charges on long distance calls is less than P100 or the averagemonthly 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 thatsubscribers 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.


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

NAGA CITYCommunication now is rela-

tively easy in Naga City with theavailability of three telegraph of-fices, eight courier services, two lo-cal telephone operators, longdistance telephone operators, twocellular phone operators, one pageroperator, four cable television sta-tions, six television stations, 20 ra-dio stations, and 12 local weeklies. The government’s National Telephone ProgramBicol switching station, a major mode of the Luzon-Mindanao communicationbackbone, is located in Naga City.

Since 1997, there have been two landline operators in Naga City—BAYANTEL andDIGITEL. 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 underthe franchise granted to NATELCO in 1978 under Resolution Number 5 of the citycouncil granting it a 35-year franchise. Initially, BAYANTEL operated in the Province ofAlbay, Camarines Norte, Camarines Sur, and Sorsogon in the Bicol Region. It has anestimated 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 projectin Naga. At present, DIGITEL has an estimated 5,000 subscribers. As mentioned previ-ously, DIGITEL adopts metered service although it offers several calling plans so sub-scribers can choose depending on their own needs. An applicant pays an installationfee, depending on the plan chosen. The installation fee includes installation charges,service activation fee, advance monthly fee, 10 percent VAT, instrument deposits, andcity electrician inspection fee. The installation fees for residential and business appli-cants are of the same amount.

Unlike DIGITEL, BAYANTEL does not apply metering. It collects a monthlycharge 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 P979.75covering the same charges as the residential.

Each carrier has its own set of advantages that subscribers take into account. Infact, there are those, businesses especially, that subscribe to both. A cursory survey ofthese establishments reveal that the advantages of having a DIGITEL phone is that it

NAGA CITYPopulation : 126,972 (1998)Land Area : 77 sq. kmPopulation Density : 1,649 / sq. kmClassification : Independent

Component CityIncome Class : 1st


has clearer transmissions and connects easily especially when making long distancecalls. However, they use their BAYANTEL phones when making lengthy calls.

Both operators offer similar telephone features, which include caller ID, secu-rity pin, and call waiting. The two also offers “Instant Connection” or “Same DayInstallation.”

BAYANTEL offers “Oplan Kabit Agad” granting 50 percent discount on the instal-lation fee. Aside from the special telephone features and the instant connection it offers,BAYANTEL also conducts house calls and sends letters to potential subscribers. Forthe convenience of customers, BAYANTEL employs agents who collect payments di-rectly from the subscribers instead of having them travel to its office.

DIGITEL’s version is called “Katok-Kabit,” connecting the telephone the sameday that the installation fee is paid. In general, DIGITEL has a lower installation feethan BAYANTEL. Recently, it also lowered its long distance rate to 3.00 per minuteknown 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 telephonecompanies. Subscribers of both companies can call each other without having toworry about incurring long distance charges.

CAGAYAN DE ORO CITYOf the 82 cities in the Philippines,

Cagayan de Oro has the most numberof telephone operators. Currently,there are four landline carriers operat-ing in the city. These are Misamis Ori-ental Provincial Telephone System(MISORTEL), Cruz Telephone Com-pany (CRUZTELCO), National Tele-phone Program Tranch 1-3, andPHILCOM. It is quite common in Cagayan de Oro, especially in commercial areas, tosubscribe to two telephone companies. Unfortunately, the reason is quite different fromthat in Dagupan City.

MISORTEL is the oldest operating telephone company in Cagayan de Oro, operat-ing 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 thecity estimated at around 70 percent while the remaining 30 percent subscribers areshared by the other three telephone carriers.

An applicant is charged P6,600.00 by MISORTEL. The amount is broken downas: P5,000.00 for refundable deposit; P1,500.00 for the telephone unit; and P100.00for 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.

CAGAYAN DE ORO CITYPopulation : 487,282 (1998)Land Area : 488 sq. kmPopulation Density : 998 / sq. kmClassification : Highly

Urbanized CityIncome Class : 1st


Becoming aware of the stiff competition they are facing, the management hasstarted introducing marketing innovations. A customer care department was set up inthe early part of 1999. Research was done on target clients especially on corporationsand commercial establishments. Calls and visits to potential clients were made. Specialattention was given to customer complaints. MISORTEL became active in sponsoringshows and special events. Phone booths offering “free calls” were put up in theMISORTEL office, city hall, and other strategic public places.

The management wants to change the public perception that because MISORTELis a government-owned company, it will be run as the “usual” government office. Aslogan and logo contest was launched, changing the MISORTEL logo from the provin-cial government seal into a more corporate-looking one.

Among the four telephone carriers, CRUZTELCO is the newest addition havingstarted operations in the city only in March 1998. It took four years before it got itspermit to operate from the city government. Its service covers the Province of MisamisOriental 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 P1,700.00for 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 carri-ers. Usually, CRUZTELCO does a survey and its services are offered to those who donot have existing telephone lines. Mostly, service provision is concentrated in areasoutside the city proper. Based on customers’ feedback, they avail of CRUZTELCO’sservices because of the cheaper cash outlay when applying for installation.

The National Telephone Program Tranch 1-3 is a DOTC project offering landlinetelephone service to areas in Cagayan de Oro which are outside the city proper. Focusis on providing telephone service to barangays in the city peripheries. The contractorfor the project is ITALTEL. Monthly rate for residential subscribers is P249.85 andP419.40 for commercial subscribers. It has been its policy not to encroach on the othercarriers’ subscribers and instead concentrate on the unserved.

PHILCOM’s entry into the city is by virtue of the previous administration’s basictelephone program. As an international gateway facilities operator, it was required toinstall 300,000 landlines in its service area—the Mindanao region. Because of thisrequirement, PHILCOM is said to have the most number of available lines, althoughMISORTEL remains as having the highest number of subscribers.

Direct interconnection is only possible between MISORTEL and NTP. For therest, in order to make calls between two different carriers, a long distance rate ischarged. This poses a financial burden to subscribers especially to those who are fre-quent business callers.

Burdened by the interconnection problem and seeing no immediate action from theservice providers, subscribers have employed strategies to make the situation bearable.Most subscribers, especially those engaged in business have at least two service carri-


ers. Choice of carrier is based on the number of subscribers of the carrier and one’scalling circle, typically MISORTEL and PHILCOM. In this manner, they can make asmany calls as needed without incurring long distance charges. Another strategy is toacquire a cellular phone. This allows subscribers to call any subscriber of the differentLEC service operators.

In an effort to alleviate the situation, City Council Resolution No. 4027-98 hasrequested the Office of the President to include local government units (LGUs) as anegotiating party in solving the interconnection problem of service providers. Thecouncil 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 ofservice to absolute lack of service, some problems have been created as well, therebydiminishing the potential gains that could be derived from a competitive environ-ment. In addition, certain developments in both the technology and regulatory frontspose new challenges to the competitive model.

INTERCONNECTIONThe most critical issue that has emerged from the liberalization of telecommuni-

cations is interconnection, which is required to enable subscribers of different carriersto communicate with one another or enjoy the services of other carriers.

Figure 3 depicts the different types of multiservice telecommunications firms op-erating in the Philippines. In Metro Manila, there at least five carriers, with PLDTcontrolling the bulk of the subscribed lines. The other operators provide the sameservices as PLDT or are licensed CMTS carriers as well. In the provinces, the type ofcarriers 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 butfor each of its service (e.g., CMTS, LEC, IGF, etc.), thereby increasing the theoreti-cally maximum number of interconnection contracts that must be specified, negoti-ated, and enforced. Both the technical and the commercial aspects of interconnectioncontracts are negotiated on a bilateral basis and the role of the regulator is merely tomediate, through moral suasion, whenever parties fail to reach an agreement.

As mentioned in the previous section, the price of interconnection, which cantake the form of an access charge or a share of the revenues, is not regulated. RA7925 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 bythe relative bargaining strengths of the carriers. Access payments usually make up a


significant portion of the operating costs of a new entrant (e.g., 30-40 percent). Forincumbents, however, access payments are a source of revenues particularly in thebeginning when the direction of calls is from subscribers of the new carriers to thesubscribers of incumbents. Thus, the access charge is very important to businesssurvival.

New operators have complained in the past of unfair conduct by the dominant firm,PLDT. These include, among others, insufficient interconnection, unequal accesssettlements or revenue-sharing arrangements, as well as the use of interconnection as alever in other commercial negotiations. To be sure, alleged unfair or uncooperativebehavior is not limited to PLDT, as other incumbent operators (e.g., Cagayan de Orocase) have also been reluctant to interconnect or grant favorable terms of interconnec-tion 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 arepublicly reported, call failure rates as a result of poor interconnection are believed to bewell 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 nearbytelephones, even to neighbors (Box 3).

Figure 3. Interconnecting Carriers and Services

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IGF

LEC

IXC

IGF

LEC

IXC

IGF

LEC

CMTS

IXC

IXC

CMTS

LEC

(METERED)

IXC

CMTS

LEC

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(METERED)

IGF

PURE

LEC

Metro Manila

Outside Metro Manila


MERGERS AND VERTICAL INTEGRATIONIndustry 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 marketcould handle and only two to three multiservice telecommunications firms were ex-pected to survive. New operators would eventually merge with each other to gainsignificant market share vis-à-vis PLDT, which would remain as the leading firm withinthe short to medium term.

In November 24, 1998, the long-anticipated industry consolidation was officiallyset in motion with the acquisition by First Pacific of 17.2 economic interest in PLDTpaving the way for the eventual merger of PLDT, PILTEL, and SMART. The integrationof their respective fixed, mobile, and internet/multimedia lines of business is expectedto generate efficiencies in terms of infrastructure use, network operations, networkdevelopment 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 placewas not between fringe operators but between the dominant firms in the fixed andmobile 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 thatthere is a real danger of abuse of market dominance with the merger. Although SMARTis the industry leader in the mobile market, GLOBE is the recognized leader in digitaltechnology, 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 samefeature, subscribers were already hooked on GLOBE’s text messaging, which was pos-sible only among GLOBE subscribers. This made it difficult for SMART to entice sub-scribers to switch. Around the same time that SMART was negotiatingforinterconnection with GLOBE’s text messaging, which it obviously found difficult toobtain, PLDT accused GLOBE of misrepresenting calls to avoid paying correct accesscharges and subsequently, restricted GLOBE’s interconnection with PLDT’s landlines.The motive behind the action taken against GLOBE would not have been suspect wereit not for its timing and the fact that the issue waned right after GLOBE agreed tointerconnect its short messaging services.

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.


Another development, which has both efficiency and possible anticompetitiveimplications, is the integration of Internet service into fixed line. Initiated in the countryby DIGITEL with its DIGITEL ONE, GLOBE has also introduced Globelines Net Expressallowing 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 whatconvergence 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 independentISPs usually entail. The implication for competing independent ISPs is that their sur-vival is conditioned on being able to obtain adequate capacity or leased lines, which isin the interest of telcos offering Internet service to deny, restrict or delay. Under RA7925, telcos are allowed to offer value-added service provided that that no cross subsi-dization from its utility operations take place and that other value-added providers arenot discriminated against in rates or are denied equitable access to its facilities.

CONVERGENCEIndeed, the horizontal and vertical mergers we are witnessing are being driven by

technology convergence. In general, technology convergence implies an increasingoverlap between the two primary components of the communication process that havetraditionally been separated, namely: common carrier “conduit” systems and networksthat transmit signals anonymously and “content”-based information sources and tech-nologies. Various forms of convergence between traditionally separated industry seg-ments include wireless delivery of telephone signals, wireline delivery of televisionsignals, cable television technology, multichannel wireless and satellite video distribu-tion, digital data transmission, and the Internet. Because of technology convergence,market convergence is emerging from both the supply and demand side. On the supplyside, the longstanding organizational divisions between technologies, services, and com-panies are eroding as industry providers across market segments and national boundariesmerge while on the demand side, the market responds via increasing interest in and pur-chase of multimedia services and technologies (Townsend 1997).

For the Philippine market setting, the immediate concern is whether or not firms areenabled by the current policy environment to respond to the market demands thattechnology convergence creates. For example, under Sec. 4a of RA 7925, “no singlefranchise shall authorize an entity to engage in both telecommunications and broad-casting, either through the airwaves or by cable.” In response, proposals have beenfiled in Congress (so-called “convergence bills”) that seek, among other things, toremove cross-sector ownership restrictions.

From the standpoint of competition policy, given the inevitability of supply-side con-vergence, will the industry be less competitive as a result of the mergers? How will consum-ers, current and future, be affected and protected? Since mergers are supposed to createefficiencies, then such efficiencies must outweigh the potential harmful effects of increasedmarket power for the mergers to be allowed, even encouraged. In turn, whether or not anydetrimental effects can be mitigated will depend on the existence of competitive safeguards.


REGULATORY COMMITMENTS BY THE PHILIPPINES UNDER WTOThe 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, competitivelyneutral universal service obligations, independent regulators, and nondiscriminatoryprocedures for the allocation and use of scarce resources. The Reference Paper definedkey terms pertaining to competitive safeguards as follows:

Users - service consumers and suppliersEssential 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 ofparticipation (having regard to price and supply) in the relevant market for basic tele-communications 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 offerdoes not adopt the specific regulatory principles on competitive safeguards suggestedin the Reference Paper. Instead, the Philippine version adopts a general and more flexiblelanguage.

That the Philippines opted to state its commitment to the principles of competitionin such broad terms, suggests that either a) specific rules governing market behavior arealready 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 com-mitment and the Reference Paper is that the former applies its interconnection guide-lines to all suppliers while the latter prescribes the interconnection guidelinesspecifically with respect to a major supplier (Table 5).

THREATS TO COMPETITION

As the experiences of local communities show, despite some problems, consumersare already clear winners as a result of liberalization. Given such gains, is there still aneed for a competition policy to govern the sector? The answer stems from two mainconcerns. 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


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 prac-

tices.

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 4. Comparison of WTO Reference Paper vs. Philippine Commitment:

Section on Competitive Safeguards

WTO REFERENCE PAPER SPECIFYING REGULATORY PRINCIPLES

2. Interconnection

2.1. This section applies to linking with suppliers providing telecommunication transport networks or ser-

vices 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.

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

Section on Interconnection


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 agree-

ments 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 toguard the competitive process.

Before identifying the threats to competition, we must first establish what it isabout competition that we want to promote and preserve. From the experience at thelocal level, what appears to be the most important gain from liberalization is the expan-sion of consumer choice. And because the consumer has a choice, then firms do theirbest 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 mayeven diminish the quality of the choices available to the public. From the standpoint ofcompetition policy, what will promote and preserve genuine consumer choice is theexistence of firms that are credible threats to each other.


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

LACK OF EXPLICIT RULESIt 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 twoelements of competition policy that we need to define for the Philippine telecommunica-tions 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 isnecessary to a competitor’s survival.

It is deemed important for effective competition in telecommunications because it isnot easy and also not efficient to duplicate certain facilities within a reasonabletimeframe. Supposing that an IGF operator wishes to deliver an international call and inorder to deliver and complete the service, it would be better to use the existing accessline of the subscriber than to install a second line to transport the message.

The WTO reference paper prescribes interconnection guidelines specifically foressential facilities and for major suppliers in recognition of the size to which theirnetworks have grown as a consequence of the monopoly position that they have en-joyed for decades. Unless other operators obtain timely access to the networks ofincumbents under nondiscriminatory terms and conditions and at cost-oriented ratesthen they will not be able to receive the benefits of liberalization as advocated in theWTO. However, to the extent that new entrants can feasibly and efficiently duplicate thefacilities, then such are no longer considered essential (AT & T 1998). Thus, suchguidelines are really intended to facilitate the entry of competition and to support themat the early stages of market entry. Same obligations for access are not imposed oncarriers other than a major supplier because to do so would limit the flexibility of newcompetitors.

In addition to not providing new entrants in basic telephone service with the sup-port needed to accommodate their entry, our lack of explicit policy on access for the restof the sector also leads us to apply interconnection indiscriminately thereby hurting thespirit of competition. A case in point is the GLOBE-SMART interconnection of shortmessaging service. Whereas interconnection is required (i.e., essential) for verticallyrelated services in order for the full service to be completed, to require the same or on thesame terms for parallel services is anticompetitive. Such decision robs an innovator or


first mover of the rewards from risk-taking. In the end, it is the consumer that is ad-versely affected because consumer choice is constrained in a market environment thatdoes 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 takesplace. For example, pre- and postmerger market shares or industry concentration arecompared to determine if a proposed merger would go unchallenged or not. If chal-lenged, further inquiries would need to be undertaken to determine if the merger shouldbe allowed. As mentioned earlier, mergers create efficiencies particularly for the firm.However, efficiencies alone do not provide justification for a merger and specific ben-efits accruing to society must be identified and weighed against other effects to deter-mine the merits of a merger. For example, what may be required is to demonstrate that themerger 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 offoreclosure (i.e., when a competitor is denied access to a monopoly segment controlledby the vertically integrated firm), a price squeeze (i.e., access charges are so high as toreduce a competitor’s margins) or price discrimination (i.e., monopoly rents from theutility operations are used to subsidize to lower prices in the competitive lines of busi-ness). All these actions are considered exclusionary or even predatory because theyharm rivals and facilitate exit. Once exit takes place, then the surviving firm can exerciseabsolute market power. Again, consumers end up as the real losers because theirchoices are narrowed down.

To be sure, provisions with regard to such anticompetitive behavior are alreadyspelled 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 OPERATORThere are a couple of regulations that work against the creation of genuine compe-

tition in the sector. The first imposes an additional cost to entrants but not to thedominant operator. The second deprives competition of opportunities to exploit econo-mies of scale and scope. It also deprives competition of the opportunity to generatenetwork externalities.

1. Universal access strategiesNew 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 up300,000 lines in underserved and unserved areas. In contrast, the incumbent dominantoperator PLDT was never subjected to any such requirement. Clearly, such rule consti-tutes a barrier to entry. That firms still entered the market despite the existence of suchbarrier does not reduce its detrimental effect on competition and consumers.


How are consumers hurt by such an unequal cost burden? The imposition ofadditional cost to entrants can help mask any inefficiency on the part the dominantoperator. Also, a particular firm may be an efficient CMTS operator only or an efficientIGF operator only. Forcing firms to provide another service deprives consumers of thebenefits of specialization.

Although most carriers have already satisfied this requirement, universal serviceobligations is still relevant to the issue of competition because of the use of the accesscharge as a tool for subsidizing local exchange service. As discussed earlier, the accesscharge must not only reflect the actual cost of interconnection but is also supposed tocontain a subsidy component. That the access charge is used as an instrument for theuniversal 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 asubsidy component into the access charge for its local exchange.

2. Assignment of service areasAnother 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 withincertain jurisdictions. As a result, their ability to develop economies from both the sup-ply and demand side is constrained. Supply side economies imply that a firm can takeadvantage of common inputs so that costs per line are reduced. Therefore, one firmproviding the service in areas A and B can be more efficient than two firms operating ineach area. Demand side economies mean that one’s subscribers can easily access awider network of subscribers (i.e., from different parts of the country), which attractseven more subscribers to join. Naturally, a firm that enjoys both such economies canhave a better bargaining position vis-à-vis the dominant firm.

In summary, the current market environment neither bodes well for competition norfor consumer welfare. There is a false sense of fairness in the lack of explicit rules togovern how firms, particularly a dominant firm, are supposed to compete because itignores the inherent asymmetry between incumbents and new entrants. That certainregulations handicap new entrants even further only serve to impede the creation ofgenuine competition in the Philippine telecommunications sector.

RECOMMENDATIONS

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

––––––––––––––––––––

4 Strictly speaking, the requirements of contestability (e.g., zero sunk cost) do not apply here. Weuse the term loosely to mean that firms behave as if credible competition, actual or potential,exists.


• The regulator alone cannot provide the necessary countervailing poweragainst 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 perse) (Article III. Sec. 5 c), and

- The NTC can exempt any specific telecommunications service from its rateor tariff regulation if the service has sufficient competition to ensure fairand 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 dis-tribute market power and create an environment that prevents the exercise of monopo-listic behavior. Concretely, this would entail the following:

First, we should establish specific rules to govern firm behavior. In particular, poli-cies 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 thePhilippines just like PLDT) must be granted to facilitate consolidation and the forma-tion 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 auditingperformance of operators, preparing public consultation documents or implementingalternative dispute resolution mechanisms (Smith 1997). This would make importantinformation readily available to consumers, firms, and even the regulator. It also en-hances 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 cannotbe expected to perform the role of a “countervailing power.” Therefore, this functionmust be shifted to the market itself, distributing power not only among firms but alsobetween the two sides of the market—the suppliers and the consumers.

Fourth, the access charge must only serve one objective and that is to accommo-date competition. The implication in terms of the level and structure of the access chargeis that the rates must reflect only the cost of interconnection with no provision foruniversal access goals. Given the requirement in RA 7925, subsidy should go only tounprofitable areas. The argument that access charges based on the incremental cost ofinterconnection will not encourage network buildout is not relevant for the Philippinecase because of the forced rollout earlier implemented. Therefore the more appropriateaccess-pricing regime for the country at this point (i.e., post-SAS) is one that facilitatescompetition rather than network buildout.

Finally, end-user price setting by the regulator must eventually be removed. Thereis 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.


Fear of cartel-like behavior can be addressed as long as procompetitive policies areexpanded and strengthened. Therefore, although the initial focus is on curtailing marketpower by a single firm, rules to prevent collusion must be established before priceregulation 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 yearsPLDT (Philippine Long Distance Company). 1998. Annual Reports:33Serafica, 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. PublicPolicy for the Private Sector Note No. 121.

Townsend, D.N. 1997. Regulatory Implications of Telecommunications Convergence. ITURegulatory Colloquium No. 6.


DOMINANT MARKET SHARE

REGION PROVINCE FIRM OF DOMINANT OTHER OPERATORS

FIRM

Appendix 1. Dominant Firm per Province

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





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 NorteCruztelco 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





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.


RA 7925 : Relevant Provisions on InterconnectionArticle 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 inter-

exchange 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”.

Appendix 2. Relevant Provisions on Interconnection and Implementing

Rules and Regulations of RA 7925


• 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 non-

discriminatory, 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.


6C H A P T E R

The State of Competitionand Market Structure of the

Philippine Air Transport Industry

Myrna S. Austria*

ABSTRACT

This paper examined the regulatory and policy regimes and their effects on thestate of competition and market structure of the Philippine air transport in-dustry. There is no doubt that liberalization and deregulation have broughtgenuine competition in the domestic air transport industry resulting in lower

airfare, improvement in the quality of service, and efficiency in the industry in gen-eral. The deregulation, however, resulted in the establishment of niche markets, withthe big players concentrating on the major routes where traffic demand is heavierwhile the smaller airlines are flying the secondary and tertiary routes where trafficdemand is lighter.

____________________

*The author wishes to thank Mr. Joselito P. Supangco for his comments and suggestions on anearlier draft of the paper. The excellent research assistance provided by Ms Dorothea C. Lazarois also gratefully acknowledged.


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 imple-mented given the absence of its implementing guidelines. But EO 219 alone is notenough. The government needs to deepen its liberalization efforts by adopting a moreliberal approach to its bilateral air agreements. While other countries are taking onmore flexible approaches to liberalization and regulation to meet the increasing de-mand for international air services brought about by the increasing integration ofeconomies, the country is keeping to its old restrictive practices and policies. Theeffect of such restrictive policies is a high degree of concentration in the country’sinternational aviation industry.

The government needs to act quickly to promote competition in the industry. Asthe experiences of other countries have shown, convenient and efficient air servicesbrought about by greater competition are critical to attracting foreign investment,trade, and tourism. To this end, the paper has identified areas where competitionpolicy should be defined to introduce competition where there is none and to ensurethat competition where it exists is effective.

INTRODUCTION

Until the late 1970s, domestic and international air transport throughout theworld was a highly regulated industry. There are several reasons advanced for govern-ment regulation. The widely held view is that governments traditionally consideredair transport as a quasi-public utility since industry returns are not limited to thoseaccruing directly to the industry itself, but includes external benefits to the widereconomy (Hanlon 1996). The industry is regarded as (i) an instrument to promotenational interests like trade, investment and tourism; (ii) a source of foreign ex-change; or simply (iii) a source of prestige and symbol. To avoid the conflict that mayarise from the differing objectives of the government (national interests) and the airlines(commercial), governments conferred monopolies to their national airlines. This is thereason why all countries, with the exception of the US, had one flag carrier before deregu-lation. The airlines were then protected from competition through regulations.

Over the years, however, the merits of regulating the industry have been put intoquestion. 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 aresult of the growing interdependence of global markets and communities. All thesehave 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 ser-vices, particularly the international air transport services, have not improved.This paper examines the country’s regulatory and policy regimes and their ef-fects 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 andchartered flights are excluded.

The paper is organized as follows: The next section looks into the applicability ofthe contestability of markets to the air transport industry. It is followed by a discussionof 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 regulatoryregimes of the Philippines are discussed next, followed by their effects on the state ofcompetition 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 theareas that need to be addressed in the implementing guidelines of Executive Order(EO) 219. The penultimate section identifies areas where competition policy andregulations should be defined to introduce competition where there is none and toensure that competition where it exists is effective. The last section presents the sum-mary and conclusions.

CONTESTABILITY OF MARKETS: ITS APPLICABILITY TOTHE AIR TRANSPORT INDUSTRY

The literature on contestability of markets points to the importance of the threatof competition, as distinct from actual competition, in enforcing good behavior andconduct among firms in an industry (Hanlon 1996). This kind of market is character-ized by the following: (i) there are no barriers to entry, i.e., new entrants bear no extracost that are not borne by the incumbents; (ii) there are no sunk costs, i.e., costs thatcannot be recouped when a firm withdraws from the industry; and (iii) the time forincumbents to change their prices in response to the entry is longer than the time forthe new entrant to make profits. According to this theory, firms in oligopolistic indus-tries will still price at the same level as they would in a perfectly competitive marketso long as the threat of competition exists. In other words, under this market, theincumbents can protect themselves from new competition only by behaving well.

A contestable market offers consumers and the society similar benefits from aperfectly competitive market (Baumol and Lee 1991). Because of the threat of compe-tition, 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 toa level that could still give them attractive return. Waste and inefficiency beyond thatwhich are allowed by the current state of technology and level of knowledge are alsoavoided as these would be reflected in higher costs and prices, the presence of whichwould invite the entry of efficient firms. Likewise, predatory pricing and cross-sub-sidy pricing are prevented. Predation becomes unattractive since it can only be done ifthere is a prospect for making future profits large enough to recoup losses made whenprices or profits were kept low to drive competitors or new entrants away; but then,


excessive profits would invite entry. Cross subsidy occurs when a firm charges a pricebelow cost to a particular group of customers and the loss is made up for by chargingexcessive prices to other customers. This is not feasible under a contestable market asthe excessive price would invite new entrants who can sell at a lower price level. Ineffect, the new entrants are capturing from the incumbents the earnings that werepreviously used for cross subsidy.

Several studies, however, have shown that the air transport industry does notpossess the characteristics of a contestable market (Hanlon 1996) or at least, theindustry is less contestable than had been thought at the time of its deregulation inthe US (Baumol and Lee 1991). As will be discussed in the next section, entry to theindustry is not costless as there are barriers to entry, some of which are inherent tothe incumbents being the first movers in the industry. Also, while expenditures onaircraft 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 inadvertising and promotion cannot be recouped once the airline withdraws from theindustry. Because of deregulation, greater importance is now given to advertisingespecially if an airline wants to establish an extensive network and become competi-tive in a deregulated environment. Finally, in a deregulated environment, airfarescan change anytime; and with the advent of information technology, the change isautomatically communicated to travel agencies through the computer reservationsystem.

Despite this, however, the recent literature also shows that the contestabilityframework can be used to design policies and regulations that would enforce competi-tive 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 ubiquityof contestability; indeed, its policy lessons apply primarily to industries that are notcontestable, whose regulation can be aided by contestability theory, which providesnorms of behavior to which the regulated firms can reasonably be held.”

What is described above is especially applicable when the industry’s cost structure issuch that efficiency can only be attained if there are only a few large firms in theindustry. The air transport industry, for one, is naturally oligopolistic, as there areimportant advantages in a large firm size in the industry. For example, there areeconomies of scope when airlines configure their networks in the hub-and-spoke pat-tern or when airlines make large-scale marketing campaigns of their network, a strat-egy that is more efficient than promoting individual routes. It could also be that wheretraffic is low, a single carrier with multiple frequencies per week is more commer-cially viable and efficient than multiple carriers who operate one frequency each perweek.

Hence, given the nature and structure of the industry, competition policies andregulations can be designed to allow airlines to reap the benefits of their size advan-


tages while at the same time protecting the consumers and smaller airlines from thethreat of market power and oligopolistic behavior of large airlines.

REGULATORY FRAMEWORK FOR INTERNATIONAL AIRSERVICES

Trade in international air services is unlike trade in goods. Trade in goods is doneat all levels (bilateral, regional, and multilateral) and where the World Trade Organi-zation (WTO) principle of most favored nation (MFN) is applied, every trading part-ner is treated equally. In contrast, trade in air services traditionally takes place undera common regulatory framework of bilateral air services agreements (ASAs) betweenpairs of countries. As will be discussed later, it was only recently that regional regula-tory practices evolved.

The International Conference on Aviation held in Chicago in 1944 (or simply theChicago Convention of 1944) provided the foundation for the ASAs by establishingwhat is commonly referred to as freedoms of the air (Box 1) after it failed to establisha multilateral system in the provision of international air services. The framework ofthe bilateral system of ASAs is based on the principle that a country has the completeand 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 terri-tory: no regular international air service can take place above the territory of a state, orwithin 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 theprinciple of reciprocity or ‘equality of opportunity’. This means that two countriesagree to exchange air rights that would give their respective carriers equal access toeach other’s markets.

ASAs set out the terms and conditions under which airlines of the contractingcountries can fly. It is a ‘positive list’ of activities that an airline is allowed. Since acountry has the exclusive sovereignty over its air space, anything for which there is nospecific provision in the ASA is not allowed. Again, this is unlike agreements in tradein goods where traders are able to do anything that is not constrained by a ‘negativelist’ 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 fre-quency (number of flights), and type of aircraft to be used are usuallycontained in an annex to the ASA;


• Designation of carrier/s by each party and authorization by the other party ofcarrier/s to operate the agreed air services on the specified routes;

• Conditions of revocation or suspension of operating authorization, one ofwhich is that designated carriers should be substantially owned and effec-tively controlled by the state or nationals of the contracting parties;

• Principles governing operation of agreed services, one of which is the guar-antee of fair and equal opportunity for the designated airlines to operate theagreed 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 chargesby both parties for aircraft fuel, lubricants, spare parts, and suppliesused 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 per-

sonnel.

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 theInternational Civil Aviation Organization (ICAO).Source: WTO (998).


• Principles/procedures for disputes settlement;• Right of each party to consult the other party for any modification/amend-

ment to the agreement; and• Right to terminate the agreement and the procedures for terminating the

agreement.

ASAS: ITS EFFECTS ON COMPETITION AND EFFICIENCYThe bilateral framework has turned the international air transport industry into

one of the most regulated industries in the world. Some features of the ASAs haverestricted competition by limiting entry and constraining capacity thereby affectingthe efficiency of airlines.

Capacity and frequency constraintsCapacity and frequency constraints have the potential to suppress competition in

a route since designated carriers cannot operate additional services beyond that whichis specified in the ASAs, even if there is unsatisfied demand. This unsatisfied demandcould be the result of: (i) the inefficiency of designated carrier/s in the route that causethem to operate below capacity; or (ii) an increase in traffic demand. A situation likethis would enable airlines to charge airfares at a level higher than in a competitivemarket.

Furthermore, to the extent that the frequency, capacity, and type of aircraft for aparticular route are predetermined in the ASAs, the airlines are prevented from mak-ing the least cost combination of these in providing services in that route. Hence, thecost of providing services may be higher (technical inefficiency) than if airlines areallowed to make their own decision based on market conditions, like any producer inall other industries (Productivity Commission 1998). Likewise, to the extent that thechoice of routes is limited by the ASAs, airlines are prevented from configuring ordeveloping an efficient network (allocative inefficiency).

Nevertheless, the recent reforms in the ASAs have given designated airlinessome flexibility to change aircraft size and capacity depending on the estimated de-mand for a particular period or day.

Ownership and control restrictionThe bilateral system requires that countries designate their carriers to fly the

international routes. This designation of airlines already limits the set of carriersthat could compete in individual routes, as carriers would not be granted accessrights unless they are designated in the ASAs. In other words, the system has be-stowed complete market power to designated airlines of bilateral partners whilecompletely excluding from the market nondesignated airlines and third-countrycarriers.

However, designation of airlines is vital for technical and safety regulations be-cause the bilateral system requires that countries are accountable for maintaining the


safety of their carriers. Given this, what really hinders competition is the requirementfor designation. The bilateral system requires that designated airlines should be sub-stantially owned and effectively controlled by the state or nationals of the bilateralpartners. This restriction hinders the entry of foreigners from establishing airlines incountries 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 bilat-eral partner) operating in the routes and this creates potential for duopolistic pricing.However, with the recent trends on privatization of airlines and domestic deregula-tion, more and more countries are having a multiple designation system. Althoughmultiple designation has increased competition in the individual routes, the bilateralframework still limits competition to designated carriers of the bilateral partners.Where fifth or sixth freedom is granted, third-country carriers provide an importantsource of competitive pressure to the routes.

In terms of efficiency, the local ownership requirement has a distorting effect onthe domestic capital market, especially in developing countries where the capital mar-ket is small. Since the airline industry is capital intensive, the capital market maybetoo small to provide sufficient equity capital for the development of the airline indus-try. The insufficiency of capital may retard the development of the airline industry. Itcould also raise the cost of capital not only for the airline industry but also for otherindustries as well.

In the absence of equity capital, airlines would most likely resort to debt financ-ing. In this sense, the restriction on local ownership limits the flexibility of airlines intheir choice between equity and debt capital.

CabotageForeign carriers are not allowed cabotage rights and hence, this limits competi-

tion in the domestic market to domestic airlines.

STRUCTURAL BARRIERS TO ENTRYApart 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 arisefrom first-mover advantages that give incumbent carriers substantial market power.Unless these are addressed by the appropriate competition policies, they can result toanticompetitive practices (Warren et al. 1998).

Economies of traffic densityThis 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 orseats on existing flights. If the incumbent airline is realizing economies of density ina route, potential entrants are deterred from entry by the choices available to them.


That is, entry can be made either on a small scale but with a significant cost disadvantageor on a large scale that is likely to depress airfares significantly (Warren et al. 1998).

Incumbent airlines possess some advantages that would prevent potential en-trants from achieving economies of density. One, incumbent airlines generally haveestablished interlining agreements1 with other airlines that could feed connectingtraffic into the route at issue. There are significant reductions in transfer costs avail-able for passengers who prefer interline travel. Potential entrants would thereforehave difficulty attracting this kind of passengers without interlining arrangements.But making interlining arrangements could also prove difficult and could put thepotential entrants at a cost disadvantage. This would require potential entrants toeither duplicate the incumbent’s existing arrangement or hire existing airlines whocan provide feeder services. Most likely, those who can provide feeder services arealready committed to the incumbent airline and hence, would only be willing to shiftloyalty if offered a higher price (Warren et al. 1998).

Two, for the business and first class passengers, who are price insensitive andconsidered high yield2 for airlines, while there are several factors influencing theirchoice of an airline, what is more important is greater seat availability and greateroptions of flights, both of which an airline could only realize with increased fre-quency. Potential entrants cannot attract these passengers unless they can offer flightsas frequent as the incumbent carriers.

Three, frequent flyer programs3 (FFP) of incumbent carriers also act as entrybarrier to potential entrants as these programs build passengers’ loyalty to the carriersoffering them. Business travelers in particular are heavily influenced by their FFPmembership in choosing the flights of a particular airline. A survey done in the USamong travel agents shows that more than half of the respondents reported that trav-elers always or almost always chose their flights in order to build FFP mileage points(Hanlon 1996). Hence, potential entrants would have difficulty attracting passengerswho are already members of the incumbent carrier’s FFP.

Access to essential inputsPotential entrants could also be deterred from entry in international routes be-

cause 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 exten-sive 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 pa-tronage of the services of a particular airline. For each ticket bought, a traveler accumulatesmileage points according to the distance traveled and class of ticket bought. The traveler canthen exchange the mileage points for rewards in the form of free or discount tickets, upgradesfrom one class of travel to another and other benefits (Hanlon 1996).


iary services essential in the provision of air services. In many countries, the incum-bent airline is also the incumbent supplier of ground handling and aircraft repair andmaintenance services. Hence, the incumbent airline can discriminate against newentrants in terms of pricing and quality of service. Some airports, however, have mul-tiple purveyors of groundhandling services that compete with each other for airlinecustomers.

Likewise, incumbent carriers can prevent potential entrants’ access to landingslots or airport gates since as incumbents, they have the advantage of possessing(as assigned by airport authorities) the peak landing slots4 or best-positioned gatesin most airports. The commercial value of slots varies considerably. Slots at thebeginning and end of the day are convenient for business, for which business andfirst class seats are much in demand. As traffic increases and with airports beingunable to expand their operations for physical reasons, slots become a valuablephysical resource. Without access to the priority slots or gates, new entrantswould have difficulty attracting business class passengers and perishablefreights, both of which are time-sensitive. Since there is often only one airportin most destinations, potential entrants are left with no alternative. Hence, thisenhances 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 foreclosepotential entrants from the market for ticket sales. When they were first developed inthe 1960s and 1970s, CRSs were considered simply as a device to save on time andlabor in handling the growing number of flight reservations (Hanlon 1996). Becauseairfares and entry to routes were still highly regulated then, airlines did not see anymarket power advantages in developing their own CRS and even made their systemavailable to travel agencies.

However, with the deregulation in the 1980s, passengers have been presentedmany alternatives in terms of airlines, flights and fares in a particular route, whichany travel agency hooked to a CRS, can screen through. About 75 percent of flightsmade through CRS are made from its first screen page (Hanlon 1996). Hence, accessto the first screen page became an important source of competition among airlines.Airlines owning or controlling CRS can therefore program the computer in such away that their flights appear on the first page of the screen while a competitor’s flightsappear on a later screen page.

Potential entrants wishing to sell its tickets through the CRS are placed at a costadvantage since they have to spend to be able to include their flights in the CRSaffiliated 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 areassigned 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.


listing to their developers’ own-flights or incumbent carrier’s flights, potential en-trants have to give travel agencies incentives big enough for them to scroll throughthe flights of incumbent carriers or owners of CRSs (Hanlon 1996; Warren et al.1998).

REFORMS IN THE AIR TRANSPORT INDUSTRYThe inflexibility of the bilateral regulatory system to market conditions, together

with the structural barriers to entry, has rendered the international air industry ineffi-cient. The inefficiency of the system and the growing density of air traffic, as a resultof the increasing integration of economies leading to the expansion of business-re-lated travel within and among countries, have created intense pressure for liberaliza-tion and deregulation. The main goal of the reforms was to reduce the restrictions oncompetition in order to increase the efficiency of the industry.

The reform process has occurred at all levels: unilateral, bilateral, regional, andmultilateral. Nonetheless, the reforms are still in their limited form. They have fo-cused 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 onmarket access and frequency, i.e., all other restrictions are retained; and they dis-criminate against third countries in bilateral agreements or against nonmembers inregional/multilateral agreements.

The unilateral reforms were directed only to the domestic airline industry. Thereforms came in the form of deregulation and privatization of government-ownedairlines. Domestic deregulation first occurred in the United States in 1978 (USATA1999), followed by Europe in the late 1980s and Australia and New Zealand in theearly 1990s (Productivity Commission 1998).

In the 1990s, there was an increased trend toward liberalizing bilateral agree-ments. The most common of these is the bilateral “open skies agreement” of theUnited States with 35 countries that include Brunei, South Korea, Singapore, Malay-sia, and Taiwan in Asia (Findlay and Nikomborirak 1999). Under the agreement, theUS and its bilateral partners can fly the third, fourth, and fifth freedoms withoutrestrictions, although the latter is subject to the approval of the third country. There isalso the Single Aviation Market for Australia and New Zealand where carriers of bothcountries have unrestricted rights to fly third, fourth, and eighth freedoms. The agree-ment also allows for greater flexibility in foreign ownership as carriers of both coun-tries could be majority-owned and effectively controlled by nationals of eitherAustralia 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 periodof three phases (1988, 1990, and 1992), established a single market for intra-Europeair services. The reform is more comprehensive as it covers both regulatory and struc-tural barriers. Carriers of member states can fly without restrictions anywhere withinthe single market. Restrictions on local ownership were also dismantled as any na-


tional of EU can establish an airline anywhere within the single market. Commonrules on access on ground handling, airport slots and computer reservations systemwere also established. But traffic rights between EU members and third countriescontinue to be governed by bilateral agreements.

Still at the regional level, the Andean Pact of 1991 is also prominent (UNCTAD1999). This covers the open skies agreement among Bolivia, Colombia, Ecuador,Peru, and Venezuela where airlines of member states could fly without restrictions onintrazone traffic.

In 1997, the APEC Transportation Working Group identified areas for possibleliberalization: air carrier ownership and control, fares/tariffs, air freight, multipleairline designation, charter services, airline cooperative arrangements, and marketaccess. In 1999, APEC Leaders committed to identify steps to liberalize air services inthe 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 TransportServices in the WTO-General Agreement on Trade in Services (GATS). The reformscover some aspects of the structural barriers to entry, such as aircraft repair and main-tenance, selling and marketing of air transport services, and computer reservationsystem (WTO 1998). The Annex requires that access to these areas be granted tocarriers of WTO members following the principles of national treatment and mostfavored nation (MFN). The Annex, however, has stayed away from market access,i.e., the agreement does not cover traffic rights, however granted; or services directlyrelated to the exercise of traffic rights.6 Nonetheless, the Annex has yet to generate animpact as most WTO members have been granted exemptions from implementingthem. It was up for review in 2000.

The results of studies on the effects of the reform have been mixed, however. ForAustralia, the domestic deregulation reduced the average price of air travel by 1 per-cent and improved the quality of service (in terms of increased flight frequency, ex-pansion of frequent flyer programs, and airport club lounges) as a result of the entry ofmore airlines in the domestic industry. The effects of introducing one more Australianairline in the Asian routes show an increase in net economic welfare (measured bychanges in consumer surplus and airline profits) in Australia and in all affected routes(Productivity Commission 1998). The US experience in domestic deregulation alsoshows that airfares have fallen in real terms (USATA 1999) but it was less clearthat this have been the result of the deregulation (Hanlon 1996). However, afterfive years of deregulation, fierce competition pushed a number of airlines intobankruptcy or merger, making the industry marginally more oligopolistic than itwas before deregulation.

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6 The Annex does not contain a definition of “services directly related to the exercise of trafficrights”.


POLICY AND REGULATORY REGIMES OF THEPHILIPPINE 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 regu-lation of civil aeronautics in the country. It laid down the guidelines for the operationof two regulatory organizations, the Civil Aeronautics Board (CAB) for economicregulation and the Civil Aeronautics Administration7 (CAA) for technical regula-tion. The powers and functions of the two bodies were premised on the policies set outfor 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 atreasonable charges, without unjust discriminations, undue preferences or ad-vantages, or unfair or destructive competitive practices (Section 4d); and

• Competition between air carriers to the extent necessary to assure the sounddevelopment of an air transportation system properly adapted to the needs ofthe 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 forthe enhancement of its international commerce, the need to maintain its own interna-tional air operations. However, the attainment of this objective required a national car-rier. 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 servicesbetween the Philippines and other countries was exclusively provided by foreign airlines.

One-airline policy, 1973-1987A 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 internationaland domestic operations. The two LOIs, in effect, repealed Section 4 (e) of RA 776. Twoairlines (Filipinas Orient Airlines and Air Manila Inc.) were subsequently closed, andPAL, 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 June1978, 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 anexclusive grant of privileges to PAL. Despite this provision, however, no other airlinejoined the industry. Furthermore, another presidential decree (PD 1466), also imple-mented in June 1978, reserved certain categories of traffic to PAL. This includes the

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7 Presently known as the Air Transportation Office (ATO) of the Department of Transportationand Communication.


transport of persons or cargoes that use government funds or loans and credits that areguaranteed 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, 1988-1994The first attempt at reform came during the Aquino administration that adhered

to the policy of allowing a healthy and regulated competition among the airlines inthe country. Executive Order (EO) No. 333 was issued in August 1988 revoking theone-airline policy. With the change in policy, a number of companies/individuals ap-plied for permits for scheduled domestic combination of passenger and cargo services.Hence in 1989, CAB introduced an accreditation system defining the guidelines forthe grant of permits. To a very large extent, the guidelines under the accreditationsystem defined the country’s domestic air transportation policy as follows:

• Domestic air services are classified into three: (i) rural service–airtransportation to and from rural airports and other ATO-rated airports;(ii) secondary service–air transportation between secondary airports, orbetween secondary and trunkline airports; and (iii) trunkline service–airtransportation between trunkline airports (See Appendix 1 for the list ofairports falling under the three classifications);

• The route structure of an airline shall be that at least 5 percent and 25 percentof the total monthly available seat kilometer of the proposed base operationsshall be allotted for rural and secondary services, respectively;

• Each operator shall provide at least three scheduled services a week oneach 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 definitelymore 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 frequenciesthey want to fly, both of which depend on traffic demand and profitability. Also, faresare still regulated by CAB.

The accreditation system, however, did not succeed in bringing in new playersinto the industry. The failure was not necessarily due to the system’s restrictive char-acter but to the legislative issue as to the constitutionality of the CAB in issuing apermit to an individual or entity to engage in air commerce without Congress’ priorgranting of a legislative franchise to the person or entity concerned. This issue createduncertainty 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 theCongress is a lengthy and time-consuming process plus the fact that one cannot becertain that a franchise can be granted (DOTC 1992). In the end, the legislative issuerestricted the growth of the industry.


The issue, however, has now been settled by the Court of Appeals, which finallydecided that a legislative franchise is not a prerequisite for the issuance of a permit byCAB. On the surface, this Court of Appeals ruling looks good as it facilitates the entryof new players in the industry. However, the possession of a legislative franchise by anairline 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-presentFor 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 contributedto the pressure but the inefficiencies of PAL’s service and its financial lossesintensified the pressure and brought the issue to a head. Hence, the supremacy ofPAL was finally challenged with the passing of EO 219 in 1995 under the Ramosadministration.

The EO established the domestic and international civil aviation liberalizationpolicy 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 asforeign passengers” and hence the “need for the Philippines to improve air serviceavailability, quality and efficiency through exposure to foreign markets and competi-tion” (EO 219, paragraph 3). The policy is also in line with the 1987 constitutionalmandate 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 additionaloperators (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 car-rier. However, for routes/links serviced by a single operator, airfares willcontinue to be regulated (Section 2.2).

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

For international air transportation:Areas where there was a significant change in policy include the number of car-

riers that can be designated as the country’s flag carriers and the basis for the negotia-tion of traffic rights and routes.


• At least two international carriers shall be designated official carrier(s) forthe Philippines. If the designated carrier(s) do not service the total frequencyentitlement of the Philippines under existing Air Services Agreements, addi-tional 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 onnational interest and reciprocity between the Philippines and other countries(Section 1.2);

• Exchange of third and fourth freedoms will be based on reciprocity and valuefor the Philippines. Fifth freedom is secondary and supplemental to third andfourth freedom traffic, except that the CAB may grant fifth freedom rights topromote the development of routes and destinations. Special flights may beauthorized if the designated carriers fail to accommodate a route/link trafficdemand (Section 1.3).

The policy is definitely more liberal than before where there was only one desig-nated flag carrier (PAL); and the interests of the flag carrier, not the interests of thecountry, were the primary consideration in the negotiation of traffic rights with othercountries. However, the implementing rules and regulations (IRR) of EO 219 havenot 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 bilateralair services agreements. But what “progressive liberalization” means has not beendefined. The guidelines by which this new policy should be fleshed out have not beendefined as well. Progressive liberalization would reinforce EO 219 if defined as thegradual reduction of regulations within a set time frame, e.g., programmed increaseof seat capacity, routes or frequency.

The absence of the implementing guidelines of EO 219 and of a clear definitionof what progressive liberalization means creates a gap between policy pronounce-ment and policy implementation. This is evident in the perception in the industrythat the renegotiation of existing Philippine ASAs does not reflect the change inpolicy. Worse yet, there is a growing perception that the government has reverted tothe old days of protectionist policies. This was best illustrated with the dispute overthe RP-Taiwan ASAs in 1999 and 2000 where the government’s stance on the issuegave the impression that the country’s aviation policy still predominantly aims toensure the viability of PAL.8 It appeared as though the interests of PAL continue to

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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 latterto “kindly consider the difficulties facing Philippine Airlines and self-restrain the capacity onthe route between Taipei and Manila.”


take precedence over the more important elements of national interest. Hence, unlessthe gap in policy pronouncement and implementation is addressed, the development ofthe country’s international air transport industry is left with no clear direction to follow.

Privatization, 1992-1999Although originally owned by private entrepreneurs since its establishment in

1941, PAL was under government control from 1977 to 1991. The move to privatizePAL first came in 1992 in line with the Aquino administration’s policy of privatizingstate-owned companies. PR Holdings won the bidding for 67 percent share of thecompany in that year. By 1999, Lucio Tan held 90 percent ownership of PAL.

Nonetheless, privatization, without regard for effective competition, will onlylead 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 frequencyThe 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 thenumber of flights and seats that the designated carriers can operate each week. Sincecapacities and frequencies are predetermined, any change in market conditions thatrequire changes in the needed capacities and frequencies would be subject to renego-tiation. Under EO 219, the grant of frequencies or increase in existing frequen-cies is the sole prerogative of CAB, subject to the confirmation of the Office ofthe President.

Tariffs and faresCAB 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 thebilateral partners.

Freedom of rights grantedOnly the first four freedoms are granted, with limitations on capacity and fre-

quency on the third and fourth freedoms. Fifth freedom is granted but this is alsolimited in terms of the third countries to which the freedom applies. The sixth andseventh freedoms are not allowed.

Ownership and effective controlDesignated carriers are required to be substantially owned and effectively con-

trolled by the state or nationals of the contracting countries. The constitution requires60 percent domestic equity.


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

City/point designationSince 1995, CAB has introduced open points in the route schedule, unless a sepa-

rate 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 routeeven 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 isrestricted by the bilateral system, but because the government has not made any reform inits bilateral ASAs. The developments over the past 30 years in other countries point to thereduction of government control in each of the above areas (WTO 1998). For capacitydetermination, the move has been away from predetermination to free determinationwhere bilateral partners agree not to impose unilateral restrictions on the volume oftraffic, frequency of service or type of aircraft. For airfares, the move has been away fromdual approval to dual disapproval where the airfares are enforced unless disapproved bythe aviation authorities of the bilateral partners. The development of open skies agree-ments is a move toward suppression of capacity and tariff clauses in the ASAs. In place ofregulations, these countries use competition policy instruments to counter predatorypractices, abuse of dominant position and other unfair competitive behavior of airlines.

REGULATORY AND POLICY REGIMES: THEIR EFFECTSON THE STATE OF COMPETITION AND MARKETSTRUCTURE

DOMESTIC AIR SERVICESFor 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 tothe demand. In other words, the airline did not endeavor to maintain certain servicestandards to keep its customers (and attract even more) since it knows that the latterhad no alternative. Hence, delays and troubles in PAL flights were more of the rulethan the exception. This image created another meaning for the company’s acronym,“Plane Always Late”. Left with no choice, travelers had to contend themselves withwhatever PAL can offer.

Furthermore, PAL was beset with financial woes; and being a government-runcorporation, the company continuously relied on government subsidies for its opera-tions. The mismanagement of PAL and the inefficiency in the provision of air ser-vices were a clear waste of resources that could have been used productivelyelsewhere in the economy. The riding public and the industries that rely on air ser-vices for the transport of their products also suffered.


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

*3,2,4 aircrafts of type A330, A320, and B737 are for domestic operations, respectively. The rest ofPAL’s fleet is for international operations.** Information on number of aircraft not available. Grand Airways ceased operations in early 1999.Source: Airlines.

Philippine Airlines 1941 Boeing 747-400 439 4

Boeing 747-200 372 2

Airbus 340-300 264 2

Airbus 330-300 278 8*

Airbus 320-200 150 3*

Boeing 737-300 114 9*

Cebu Pacific Air 1996 DC 9 115 12

Air Philippines 1996 MD 88 165 2

Boeing 737-200 109 11

Grand Airways** 1995 Boeing 737 114

Airbus 300 264

Asian Spirit 1996 De Havilland DHC-7 48 2

YS 11-A 60 7

LET-410 19 1

Mindanao Express 1996 Beechcraft C1900 19 2

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 servedEntry Capacity Aircraft

Manila, Tuguegarao, Puerto Princesa,

Zamboanga, Kalibo, Dipolog, Ilo-ilo, Roxas,

Bacolod, Cebu, Naga, Legaspi, Tacloban,

Cagayan de Oro, General Santos, Butuan,

Cebu–Cotabato, Davao

Manila, Cebu, Davao, Cagayan de Oro,

Tacloban, Iloilo, Bacolod, Zamboanga,

Roxas, Dumaguete, Kalibo

Manila–Bacolod, Cagayan de Oro, Cebu,

Cotabato, Davao, Dumaguete, General Santos

City, Iloilo, Kalibo, Legaspi, Puerto Princesa,

San Jose, Subic, Tacloban, Zamboanga

Manila, Cebu, Davao, Cagayan de Oro

Manila–Baguio, Busuanga, Calbayog

(Samar), Catarman, Caticlan (Boracay),

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

Cagayan de Oro, Cebu, Davao, Kalibo,

Pagadian, Zamboanga, Cotabato, Tawi-

tawi, Camiguin, Tandag, Dipolog, Gen.

Santos, Tacloban, Butuan, Jolo, Surigao


The airlines are free to choose routes to service. Price setting was also left to theairlines 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 differentroutes.

Market structureIn general, PAL remains the dominant carrier in the domestic air transport indus-

try, with an average market share of 63 percent of the total passenger traffic (Table 2)

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


Grand Airways 47.1 58.0 55.4 57.8

Asian Spirit 51.1 63.0 66.8 65.3


Overall 79.3 68.5 69.7 70.8 71.2

Table 2. Domestic Passenger Traffic, by Airline, 1994-1999

*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.


for the period 1996-1999. Since PAL has the largest fleet and the bigger aircrafts, itoffers the largest seat capacity in the industry (Table 3).

Nonetheless, PAL suffered a significant decline in market share as the new airlinesslowly inched their way in the industry and provided competition to PAL. The financialand labor problems of PAL in 1998 and the consequent downsizing of the airline’s fleetfrom 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 increasetheir seat capacity and hence, their share in the market. For example, in 1999, CebuPacific 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).

AIRLINE 1990 1994 1995 1996 1997 1998 1999

Table 3. Seat Capacity per Airline, 1990, 1994-1999

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 AppendixTable 3.Sources: Civil Aeronautics Board and Airlines.

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


Grand Airways 6.3 10.3 6.8 8.8

Asian Spirit 1.4 3.0 6.3 5.2


Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0


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

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 ma-jor trunklines where traffic demand is heavier while the smaller airlines (Asian Spiritand Mindanao Express) are flying the secondary and tertiary/rural routes where traf-fic demand is lighter (Table 1). PAL was flying all three types of routes until 1998when it abandoned most of its secondary/tertiary routes because of the downsizing ofits fleet and as will be discussed later, cross subsidization, which used to characterizePAL’s operation of the different types of routes, was no longer feasible under a deregu-lated environment.

An examination of the Herfindahl-Hirschman Index of the different routes orsectors shows that only the major trunklines are being fiercely contested, i.e., thenumber 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 airlinescan fly the said routes as much as traffic demands, although of course, their seatcapacity determines the amount of the traffic they can accommodate.

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9 The index is measured as the sum of the squares of the market shares. It is compared with theratio 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 sizedcompetitors that would provide a degree of competition equivalent to that actually observed inthe market share data. Hence, it is used as a measure of the number of effective competitors.

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

Table 4. Measure of the Degree of Effective Competition, Domestic Air Industry,

1996-1999

Note: Index is based on market share.


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

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


Air Philippines and Cebu Pacific Air are providing PAL stiff competition in themajor trunklines as shown by the annual increases in their market shares since join-ing the industry in 1996 (Table 2 and Table 7). Passenger traffic for these two airlinesgrew by 72 percent and 60 percent, respectively, for the past four years (Table 8). CebuPacific has succeeded in increasing its share in 1998 despite the crash of one of itsaircrafts during the year, which was dubbed as the country’s biggest air disaster in the1990s. Grand Airways, on the other hand, failed to improve its share of the marketsince joining the industry until it ceased operation in early 1999.

In contrast, except for a number of sectors, much of the secondary and tertiaryroutes 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 MindanaoExpress got the markets abandoned by PAL, the two airlines have their own nichemarkets (as shown by their 100 percent shares), with Mindanao Express concentrat-ing its service in the Mindanao area, particularly Davao, Cagayan de Oro, andZamboanga. Likewise, while Cebu Pacific and Air Philippines are concentrating theiroperations in the major trunklines, they also have their own niches in some of thesecondary/tertiary routes.

Table 5 (continued)

Sector 1995 1996 1997 1998 1999

HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI HHI 1/HHI

Note: Herfindahl-Hirschman index is based on market share.

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


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


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

Table 6. Number of Domestic Flights, per Route, per Week, per Airline, 1999-2000

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.


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


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.

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


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


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


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


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

Table 7 (continued)



An examination of the inverse of the Herfindahl-Hirschman Index for the sec-ondary and tertiary routes shows that the deregulation has yet to create an impact oncompetition in these routes (Table 5). As will be discussed below, the smaller airlinesare able to charge higher fares, sometimes equivalent to business class fare in biggerairlines, because of the absence of competition.

Nonetheless, what is important is that these routes are contestable, i.e., airlinesare free to provide service to any of the routes once they recognized some profits. Theemerging picture in the industry shows that the presence of big carriers in the second-ary and tertiary routes could kill the small carriers flying the said routes. The experi-ence of the smaller airlines would attest to this as they experienced losing out theirmarkets 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 biggerairline and in terms of lower fare. Because their cost spread is higher, the biggerairlines could charge lower airfare than smaller airlines. An example would be thecase of the Cebu-Bacolod route of Mindanao Express. The airline developed the routeand for sometime, was flying the route alone. Cebu Pacific Air later joined the routewhen the airline saw its profitability. Due to the small size of the market and its biggerplanes, Cebu Pacific Air eventually ate up the market of Mindanao Express.

Intermodal competitionThe 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 andland. This is particularly true for those traveling between the country’s islands in thesouth. The introduction of comfortable high-speed ferries, which resulted from thederegulation of the interisland shipping industry, opened up an alternative mode oftravel 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 passen-gers who used to take the boats to travel by plane.

Airline 1995 1996 1997 1998 1999 1996-1999

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

Note: Growth rate per sector are found in Appendix Table 4.Sources: Civil Aeronautics Board and Airlines.

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


Overall 10.1 13.2 22.1 -21.3 12.9 02.8


Likewise, the improvement of roads in Mindanao has significantly reducedtravel time by land. Since land travel is a lot cheaper than air travel, this develop-ment has become a source of competition for the air transport industry. An exampleof this is the Davao-General Santos route of Mindanao Express, whose load factorwas significantly reduced from 90 percent to 20-30 percent when travel time by landin this route was reduced from 6 hours to 2 hours as a result of the road improvementin the area.

This intermodal competition will likely intensify with the continued improve-ment in the interisland shipping industry and road transport and hence, will havesome bearing on the future structure of the air transport industry, at least in the sec-ondary/tertiary routes.

Tariffs or airfaresIt 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 thelocal populace. The increased competition in the domestic air industry, however, pro-vided travelers with lower airfares, and from the traveler’s perspective, the lower faresare the most important result of the deregulation. The airlines are free to set theirairfares based on traffic demand and cost.

Before the deregulation, PAL cross-subsidized the otherwise unprofitable mis-sionary (tertiary) routes that the government required the airline to fly by charginghigher airfare than what the market dictates in the major trunklines. Cross subsidiza-tion therefore enabled PAL to maintain its flights in the tertiary routes. With the newenvironment, however, cross subsidization is no longer feasible. PAL had to lower itsairfare in the major routes to remain competitive, and consequently, had to abandonmost of its tertiary routes.

After the deregulation10, PAL still charged the highest fare (Figure 1), even afterwithdrawing from the missionary routes. Its cost base and leverage is very high relativeto the other airlines because of its financial obligations arising from the loans that fi-nanced 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 ishigher than other airlines. But the airline is able to compete and capture a large size of themarket 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 goodsafety record. On the other hand, the fleet of the new airlines is composed mostly ofaircrafts (some of which are already old) leased from other companies. This makes theiroperational 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 thanCebu 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 missionaryroutes until it subsequently abandoned these routes.


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

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

Source: Airlines.


There is some sort of a convergence in the fares being charged by Cebu Pacificand Air Philippines (Figure 1). In 1997, Cebu Pacific fares were higher than AirPhilippines but the picture was reversed in 1998. By 1999, the difference between thetwo is very minimal. Nonetheless, this does not indicate any price collusion betweenthe two airlines. While the two airlines compete with PAL, they cannot collude as AirPhilippines and PAL, although they are different companies, are substantially ownedby the same person.

The situation in the secondary and tertiary routes is different, however. Airlinesflying these routes are able to charge a higher fare than what the market demandsbecause of the absence of competition as pointed out earlier. For example, MindanaoExpress fare is equivalent to the business class fare charged by PAL for the same route

Table 9. Percentage Difference of Fares in Domestic Flights, 1997-1999 (%)

Source: Airlines.

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

Sector 1997 1998 1999Phil. 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 AirPacific Phils. Phils. Pacific Phils. Phils. Pacific Phils. Phils.

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

Table 10. Real Growth Rate of Fares per Airline, by Major Sector, 1997-1999

(1990 Prices) (%)

Source: Airlines.


before the latter abandoned these routes11. Paying a higher price for a lower class ofservice left the travelers worse off. It would be unprofitable for smaller airlines tocharge a lower fare because their cost spread is small, i.e., small aircraft would onlyhave a small number of passengers to share the flight cost. Hence, as long as theairlines in the secondary and tertiary routes do not see a threat of competition or theentry of a new airline in the routes, they will set their fares at a higher level than theywould in a more competitive environment.

RevenuesSince 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 netloss that is becoming bigger every year (Table 11) despite its bigger passenger load ascompared to the other airlines (Table 2 and Appendix Table 2). The losses are amanifestation of PAL’s inefficiency brought about by years of government interfer-ence and by its monopoly status. PAL could have easily reduced its operating costswhen it had financial and labor problems but the government did not allow its re-structuring and reengineering. Hence, compared to other foreign and local airlines,PAL has more employees per aircraft, a sure sign of inefficiency, low productivityand 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 con-tributing to its losses.

____________________

11 This information is based on an interview with one of the senior staff of Mindanao Express.

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

Sources: Civil Aeronautics Board and Airlines.


In contrast, PAL’s major competitors (Air Philippines and Cebu Pacific) sufferedlosses during the initial year of operation but were able to recover and have registeredfavorable financial performance thereafter. The emerging picture here shows thatcompetition in the industry enables the more efficient, low-cost airlines to operate atfares lower than precompetition days and still remain profitable.

Asian Spirit and Mindanao Express are also incurring losses. Such financialstanding of the different airlines could affect the future structure of the industry. Thefinancial problem besetting the industry is an indication that only a few large effi-cient airlines may, in the long run, survive. The continued losses of the unprofitableairlines could drive them to withdraw or exit from the industry or merge with theprofitable ones.

Growth in Domestic Air TravelWith 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 totravelers who previously could not afford to travel by air. The growth of passengertraffic was highest at almost 22 percent during the period 1996-1997. The downsizingof PAL’s operation in 1998, coupled with the Asian financial crisis that affected theinflow of foreign tourists to the country, however, resulted to a decline in passengertraffic of almost equal magnitude as the increase in 1997 (Figure 3). This shows thatpotential demand for domestic air travel is high, a demand that could only be met ifthe airlines have enough capacity to provide the required air services.

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)

1995 1996 1997 1998 1999

Scheduled

Operators

Net Net Net Net Net

Revenues Income Revenues Income Revenues Income Revenues Income Revenues Income

(Net Loss) (Net Loss) (Net loss) (Net Loss) (Net Loss)

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

Table 11. Revenue and Income, by Airline, 1995-1998 (P million)


INTERNATIONAL AIR SERVICESFive 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 otherforeign airlines. Because these foreign airlines are operating by virtue of their coun-tries’ air services agreements with the Philippines, competition in a particular route islimited between PAL and the designated carrier/s of the country’s bilateral partner inthat route, except for the routes where fifth freedom is allowed and in which case, athird-country carrier provides competition to those routes. As will be shown later,however, there are not many of this kind of route.

Designation of carriersWhile CAB has designated other airlines (apart from the incumbent PAL) to fly

some of the international routes, these Philippine-based carriers have yet to providePAL the much-needed competition. Mindanao Express has been designated secondcarrier for the BIMP-EAGA in 1998 but the airline has never operated its interna-tional routes until it ceased operation toward the end of 2000. Grand Air was desig-nated second flag carrier to Hong Kong and Taipei in 1996 and the airline was servicingthese routes until its closure in early 1999. But during its operation, Grand Air’s negli-gible 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 flyIndonesia, Singapore, Bangkok, Guam, and Kuala Lumpur, but the airline has yet tobe designated as second flag carrier to these countries.

The new airlines already foresee a structural barrier to their entry in the interna-tional routes, that is, the difficulty of securing airport slots. The available slots havealready been allocated to PAL. Request for additional slots is a long process and this

Source: National Statistics Office and Civil Aeronautics Board

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

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 rightto access meaningless in practice. In other countries, some airlines resort to buyingthe slots of other airlines just to get over this barrier, but the cost is very high.

Absence of measures to counteract PAL’s downsizingThe 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 aproactive role by installing measures to offset the effects that PAL’s downsizing haveon 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 capaci-ties of and/or grant of new routes or traffic points to any foreign carrier (even if on aprovisional basis) shall be the sole prerogative of CAB subject to the confirmation ofthe Office of the President.”

Given this, the least that CAB could do is to renegotiate the ASAs and grantadditional 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 theRP-Taiwan air disputes.

Clearly, this move does not serve well the nation’s interests. If the country wouldlike to attract foreign investment, trade, and tourism, convenient air services thathave a wide range of flight and schedule options are critical. As discussed earlier,business travelers give greater value to flexibility in flights and frequency. Companiesalso prefer to locate in areas that are easily connected to destinations around theworld. Likewise, tourists prefer to travel to destinations that are easy to reach.

Because PAL’s rehabilitation plan prohibits the airline from acquiring newaircrafts during its rehabilitation period (1999-2003), the situation will likely worsenunless CAB takes the appropriate action.

Use of the country’s seat entitlementsThe 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 airlinesperformed better in using their country’s entitlements than PAL, i.e., PAL used only61 percent of the country’s traffic rights per week compared to 81 percent for theforeign 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 alltheir entitlements (Figure 4). Worse yet, PAL was not able to use any of the country’sentitlements in nine countries. The performance for 1999 and 2000 could be worseconsidering that there were no new designated airlines when PAL abandoned some ofits international flights.


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The nonutilization of the country’s entitlements could be due to the followingfactors.12 One, PAL may not be competitive in some routes given its higher operatingcosts and poor image. Passengers want a dependable carrier and not one that mayclose operations at any moment and strand them in a foreign land. Two, PAL mayactually be operating in a “revenue-sharing pool” with the other designated carrier. Itmay or may not fly a certain route but would share in the revenues that the two desig-nated carriers may generate in such a route. Or, the two carriers may opt to have onlyone operate on the route with revenues put in the “pool”. This is difficult to prove buthas been recognized to occur. The result of such practice is the generation of mo-nopoly profits in the route.

Nonetheless, the unused entitlements is an indication that under the existingASAs there are opportunities for PAL and other Philippine-based carriers to operateadditional international services without the government requesting for greater ca-pacity.

Market structureThe effects on competition of the restrictive aviation policies of the country is

shown by the high degree of concentration in the country’s international aviationindustry 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 tocompetition from fifth freedom. Incidentally, Tokyo (Japan), Taiwan, Hong Kong,and Seoul (Korea) are the Asian hubs of airlines flying to and from North Americaand Europe. A comparison of the country’s market concentration with other coun-tries, like Australia for which data are available, clearly shows that the country’s airpolicies 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 evidencethat the liberalization policies of 1995 did not have any impact. Between 1990 and1995, 25 percent of the country’s markets registered an increase in concentration; thisrose 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 1999when PAL abandoned most of its international routes (Table 14).

In general, foreign airlines together accounted for the bulk of the traffic, whichwas almost twice the share of PAL during the period 1990-1999 (Figure 5). PAL hasan 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 anearlier draft of the paper.


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

Table 12. Measure of Degree of Competition, by Country, 1990-1999

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.


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

Table 13. Market Concentration, Australia and Philippines (based on the

Herfindahl-Hirschman index)

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 itsclosure in 1999), China Airlines, Northwest Airlines, Saudi Arabian Airlines, andSingapore Airlines (Table 15).

Growth of international passenger trafficThe country has remained a small player in the international air transport indus-

try. Compared to other countries in the region, the Philippines was very much belowthe ranking in terms of passenger-kilometers performed (Table 16). Worse yet, thecountry was demoted in its ranking between 1988 and 1997. This is in contrast toMalaysia and South Korea, which have managed to improve on their ranking in theinternational air industry. The rapid economic growth of these countries played amajor 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 re-gion thereby reducing passenger traffic not only in the Philippines but in other Asiancountries 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


the country’s lone designated carrier, PAL’s financial and labor problems in 1998adversely affected the industry’s total seat capacity. The absence of measures to avertthe impact of PAL’s situation is shown by the 17 percent and 57 percent drop inpassenger traffic in 1998 and 1999, respectively. Had there been other Philippine-based designated carriers or had the frequency and seat capacity of the bilateral part-ners been increased, either of which could have taken PAL’s entitlements, the declinein traffic could not have been as bad.

Effects on tourismThe development of the country’s air transport is correlated with that of the tour-

ism industry as 98 percent of tourists visiting the country travel by air. These twoindustries have contributed to each other’s expansion or contraction. A comparison ofTable 12 and Table 17 shows that the markets with relatively lower concentration arethe same markets that generated the most tourists (top five) for the country. This isfurther confirmed by a significant negative Spearman rank correlation coefficient be-tween the two variables, i.e., the less concentrated a market is, the greater is thenumber of tourists coming from that market. This implies that the greater airlinecompetition in these markets gives tourists greater options for seats, flights, and air-fare, thereby making the Philippines easy to reach and air travel more convenient.

Aviation policies that restrict competition limit the potential of growth of tour-ism. While the number of tourist arrivals has doubled between 1990 and 1998, theannual growth rate has been on a declining trend (Figure 7) and so has the foreignexchange earnings of the industry (Figure 8). The combined effects of reduced de-

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.

Country Points served

Australia Brisbane, Melbourne, SydneyBahrain BahrainBrunei BruneiCanada CanadaChina Macau, Peking, XiamenEgypt CairoFed. States of Micronesia PohnpeiFrance ParisGermany FrankfurtGuam GuamHong Kong Hong KongIndia New DelhiIndonesia Jakarta, MenadoItaly RomeJapan Fukuoka, Nagoya, Okinawa, Osaka, TokyoKorea SeoulKuwait KuwaitMalaysia Kota Kinabalu, Kuala Lumpur, KuchingNauru Republic NauruNetherlands AmsterdamOman MuscatPakistan KarachiPapua New Guinea Port MoresbyQatar DohaSaudi Arabia Dharan, Jeddah, RiyadhSingapore SingaporeSwitzerland Geneva, ZurichTaiwan Kaohsiung, TaipeiThailand BangkokUnited Arab Emirates Abu Dhabi, DubaiUnited Kingdom LondonUnited States of America Chicago, Los Angeles, San Francisco, HonoluluVietnam Hanoi, Saigon

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

Carriers (%) Carriers (%) Carriers (%)

93,712 30,060 75.7 134,413 63,945 67.8 120,532 0.0

53,504 0.0 35,381 0.0 23,861 0.0 7,327 23,383 23.9 17,777 49,070 26.6 34,716 0.0

20,450 0.037,868 100.0 17,586 15,377 53.4

14,802 0.0 8,670 0.0 8,403 0.0573 0.0

7,386 0.0 9,680 25,403 27.6 24,191 0.038,100 42,359 47.4 58,144 99,094 37.0

108,244 0.0 146,133 0.0 155,688 0.0354,787 50,256 87.6 519,085 966,114 35.0 388,483 194,338 66.7

3,008 0.0 31,475 0.0 44,406 24,285 64.6 5,212 0.0

14,087 100.0 7 21,394 0.0217,502 382,714 36.2 331,312 496,992 40.0 271,849 320,995 45.9

144,122 0.0 91,416 350,897 20.7 63,964 361,368 15.0 30,386 0.0 33,639 0.0 61,671 0.0

24,218 67,473 26.4 50,543 105,682 32.4 160,899 0.0 2,492 0.0 3,144 0.0 6,359 0.0

6,698 16,306 29.1 94 27,854 0.3 46,551 0.030,728 0.0 21,119 0.0

8,452 574 93.6 19,475 0.0 5,050 0.0 101 11,816 0.8 11,860 0.0

33,844 0.0 21,289 0.0121,538 123,651 49.6 130,173 299,932 30.3 47,913 234,752 17.0126,388 161,963 43.8 118,567 275,298 30.1 80,283 414,758 16.2

8,240 0.0 12,095 0.0 17,329 0.0126,054 127,514 49.7 204,483 444,925 31.5 72,300 376,919 16.1

71,401 167,190 29.9 69,160 183,719 27.3 147,123 0.027,564 24,548 52.9 40,418 45,827 46.9 131,405 0.023,682 19,798 54.5 38,638 44,144 46.7 64,351 0.0

295,302 327,341 47.4 468,374 323,251 59.2 302,491 230,456 56.8938 100.0 30,028 100.0 15,475 0.0



mand for air travel due to the Asian crisis and the industry’s problem with PAL in1998 are reflected in the negative growth rate of tourist arrivals and tourist receiptsduring the year. Likewise, tourist arrivals from Taiwan alone were reduced by morethan 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 responsibilityof the Civil Aeronautics Board (CAB) by virtue of RA 776. Among other things, theCAB 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 faresand charges that an air carrier may collect. The Board is also a member of the panelthat negotiates the country’s ASAs.

Under a deregulated environment, however, the role of CAB is greatly dimin-ished. Its role of determining capacities, frequencies and airfares is now limited tointernational air transport. With diminished functions, its continued existence woulddepend on the regulations that would remain under the new environment. In othercountries, like the US, the remaining functions of the economic regulator were ab-sorbed by the transportation department while the economic regulating body itselfwas abolished (USATA 1999).

IMPLEMENTING GUIDELINES FOR EO 219

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

National interestThe EO is rather vague on what constitutes national interest. National interest

should include that which provides the maximum benefit to the nation and the publicsuch as: (i) promotion of tourism, trade and investment; (ii) maximization of con-sumer benefits; and (iii) promotion of competition itself.

Designation of carriers and allocation of entitlementsMultiple designation under the bilateral system facilitates entry into the market

of new airlines and hence, provides potential for greater competition. However, mul-tiple designation needs to be accompanied with sufficient capacity for it to yield com-

Airline 1990 % Share 1991 % Share 1992 % Share 1993 % Share

Air France 27,695 0.7 40,447 0.9 50,588 1.0 64,770 1.1

Air Macau

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

Air Nuigini 5,050 0.1 8,627 0.2 9,276 0.2 9,526 0.2

Alitalia 17,774 0.3 36,200 0.6

Asiana Airways

British Airways 49,296 1.2 50,274 1.1 69,838 1.4 63,791 1.1

Canadian Airlines

Cathay Pacific Airways 385,584 9.8 519,879 11.8 538,221 10.5 641,174 11.3

China Airlines 128,072 3.2 130,070 2.9 179,274 3.5 220,713 3.9

China Southern Airlines CAAC

Continental Airlines 44,726 1.1 40,573 0.9

Continental Micronesia 119,621 2.3 121,584 2.1

Egyptair 45,159 1.1 57,920 1.3 43,531 0.8 44,452 0.8

Emirates Air 13,455 0.3 58,348 1.3 80,950 1.6 82,454 1.4

Eva Air 24,680 0.5 108,909 1.9

Garuda Indonesian Airlines 31,475 0.8 19,534 0.4 18,111 0.4 19,581 0.3

Gulf Air 53,504 1.4 62,954 1.4 91,427 1.8 89,995 1.6

Hong Kong Vietnam

Japan Airlines 150,566 3.8 149,573 3.4 165,207 3.2 178,639 3.1

KLM Royal Dutch Airlines 16,968 0.4 16,390 0.4 22,053 0.4 26,267 0.5

Korean Airways 61,420 1.6 62,421 1.4 65,193 1.3 80,385 1.4

Kuwait Airways 30,386 0.8 15,577 0.4 38,989 0.8 47,234 0.8

Lufthansa German Airlines 61,653 1.6 67,153 1.5 74,237 1.4 84,243 1.5

1994 % Share 1995 % Share 1996 % Share 1997 % Share 1998 % Share 1999 % Share

76,304 1.2 89,777 1.4 78,079 1.1 84,820 1.1 84,736 1.3 24,808 0.9

4,817 0.2

5,075 0.1 4,437 0.1 8,203 0.1 10,482 0.1 13,989 0.2 8,669 0.3

11,871 0.2 11,816 0.2 11,986 0.2 13,200 0.2 12,639 0.2 5,504 0.2

41,463 0.7 39,682 0.6 39,992 0.5 53,230 0.7 27,941 0.4

25,826 0.4 77,838 1.2 115,180 1.6 119,631 1.5 139,639 2.1 66,246 2.3

78,092 1.2 97,574 1.5 110,294 1.5 102,669 1.3 92,709 1.4 51,772 1.8

64,703 0.8 65,004 1.0 31,526 1.1

711,548 11.4 794,515 12.0 803,557 10.9 770,510 9.9 920,178 14.0

232,398 3.7 268,177 4.1 264,666 3.6 288,616 3.7 438,499 6.7 171,601 5.9

6,799 0.1 4,839 0.1

148,234 2.4 144,840 2.2 140,485 1.9 136,750 1.8 139,056 2.1 75,728 2.6

45,776 0.7 30,808 0.5 23,472 0.3 14,364 0.2 34,966 0.5 23,866 0.8

80,679 1.3 78,859 1.2 80,037 1.1 84,943 1.1 140,140 2.1 63,698 2.2

145,320 2.3 141,981 2.2 158,247 2.1 149,797 1.9 185,628 2.8 51,680 1.8

17,665 0.3 19,019 0.3 14,847 0.2 12,239 0.2

101,506 1.6 100,735 1.5 93,176 1.3 88,849 1.1 94,532 1.4 48,089 1.7

201,076 3.2 246,741 3.7 280,831 3.8 284,587 3.6 219,816 3.3 50,492 1.7

27,697 0.4 27,938 0.4 36,790 0.5 64,880 0.8 70,838 1.1 27,865 1.0

95,441 1.5 134,676 2.0 153,880 2.1 215,474 2.8 229,621 3.5 120,677 4.2

41,728 0.7 33,639 0.5 44,883 0.6 46,125 0.6 62,264 0.9 28,478 1.0

121,373 1.9 151,835 2.3 167,838 2.3 164,373 2.1 160,821 2.5

Table 15. International Passenger Traffic to and from the Philippines, by Airline, 1990-1999

Airline 1990 % Share 1991 % Share 1992 % Share 1993 % Share

Malaysian Airlines 64,852 1.6 67,449 1.5 66,811 1.3 76,392 1.3

Northwest Airlines 323,637 8.2 343,487 7.8 396,752 7.7 333,032 5.8

P.T. Bouraq Airlines 1,598 0.0

Pakistan International Airlines 61,462 1.6 60,799 1.4 73,128 1.4 64,878 1.1

Qantas Airways 30,060 0.8 32,722 0.7 37,886 0.7 45,679 0.8

Qatar Airways

Royal Brunei Airlines 23,383 0.6 29,683 0.7 38,737 0.8 48,116 0.8

Saudi Arabian Airlines 123,651 3.1 236,936 5.4 312,581 6.1 318,168 5.6

Silkair (Singapore) Ltd. 9,686 0.2 20,528 0.4

Singapore Airlines 161,963 4.1 161,421 3.7 187,860 3.6 221,676 3.9

Swissair 11,260 0.3 9,465 0.2 10,318 0.2 9,922 0.2

Thai International Airways 184,853 4.7 180,540 4.1 186,541 3.6 188,966 3.3

United Airlines 158,632 4.0 142,645 3.2 170,151 3.3 251,376 4.4

Vietnam Airlines

Grand International Airways

Philippine Airlines 1,585,772 40.2 1,724,475 39.1 1,998,730 38.8 2,117,252 37.2

Total 3,945,270 100 4,409,510 100 5,147,768 100 5,696,654 100

1994 % Share 1995 % Share 1996 % Share 1997 % Share 1998 % Share 1999 % Share

97,239 1.6 144,295 2.2 147,423 2.0 137,116 1.8 118,497 1.8 70,240 2.4

379,762 6.1 408,679 6.2 447,338 6.1 478,803 6.1 484,457 7.4 160,334 5.5

4,668 0.1 5,266 0.1 6,635 0.1 1,370 0.0 8,265 0.1 2,431 0.1

65,791 1.1 58,893 0.9 57,104 0.8 58,053 0.7 51,075 0.8 61,746 2.1

59,208 0.9 63,945 1.0 69,172 0.9 79,618 1.0 95,286 1.5 61,746 2.1

18,340 0.2 19,377 0.2 3,254 0.0

54,480 0.9 49,070 0.7 55,509 0.8 52,861 0.7 57,971 0.9 18,193 0.6

285,793 4.6 299,932 4.5 286,603 3.9 265,104 3.4 131,831 2.0 118,169 4.1

25,087 0.4 24,748 0.4 35,942 0.5 55,973 0.7 47,519 0.7 38,280 1.3

267,092 4.3 275,298 4.2 345,943 4.7 382,767 4.9 429,461 6.5 168,573 5.8

12,703 0.2 16,714 0.3 19,175 0.3 21,683 0.3 25,040 0.4 11,341 0.4

188,297 3.0 166,188 2.5 192,931 2.6 233,786 3.0 259,211 3.9 7,777 0.3

213,715 3.4 184,229 2.8 182,815 2.5 212,260 2.7 24,862 0.4

9,495 0.1 4,096 0.1 5,279 0.1

45,454 0.6 108,721 1.4 14,014 0.2

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

6,264,816 100 6,601,785 100 7,381,341 100 7,802,891 100 6,562,909 100 2,892,585 100

Table 15 (continued)



PASSENGER-KILOMETERS PERFORMED

Country or Estimated Ranking Carrier Estimated Ranking

Group of countries 1997 (million) 1997 1996 1988 1997 (million) 1997 1996 1988

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

Source: UNCTAD (1999), Table 1 and Table 2.

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


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

Table 17. Distribution of Tourists, by Major Country of Residence, Philippines,

1991-1999 (%)

Sources: National Statistics Office and Department of Tourism.


____________________

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

petition benefits. But given the capacity constraint under the bilateral system, thenumber of airlines that will make a route commercially viable depends largely on thesize of the market (i.e., capacity available) in question.

Hence, it is important to first establish the number of airlines required by themarket before any designation of carriers is done. But the process and criteria fordesignating airlines should be established in the guidelines. Other countries haveestablished an approach for allocating capacity to carriers on contested routes.13 Theyhave also established a body whose function is solely to allocate capacity14; this bodyis 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 regula-tions have remained undefined. Ideally, where effective competition exists, the needfor regulation is reduced principally because the strong competition itself constitutes aself-regulating mechanism whereby excess profits and anticompetitive behavior are

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



eliminated (Stewart-Smith 1999). The role of policies and regulations under a liberal-ized and deregulated environment is therefore to ensure that competition is effective.This becomes more important in an oligopolistic structure where the failure of anyone player would have a dramatic impact on the market power of competitors.

One important area for competition policy is on merger and acquisition. Thefierce competition that resulted from deregulation in other countries has pushed anumber of airlines into bankruptcy, merger or consolidation. Merger or consolidationhas both positive and negative effects. On the positive side, efficiency is enhanced asit allows airlines to achieve economies of scale and scope by consolidating airlinefunctions such as ground handling, repair and maintenance, marketing, etc. On thenegative side, there is the fear that the end result will be a large airline becoming sodominant that it can exert considerable market power.

The potential of seeing merger or consolidation happening in the country shouldnot be taken lightly for the following reasons. First, domestic traffic in the country isrelatively small and this by itself limits the number of airlines that would make anefficient domestic air transport industry. Second, only two of the airlines are currentlyprofitable. Third, two of the existing airlines are substantially owned by the sameperson. Fourth, the new entrants will need substantial capital to be able to fly theinternational routes. Given the local ownership requirement, merger or consolidationcould 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 orconsolidation would not result in reduced service and less competition. The govern-ment should weigh the efficiency-enhancing effects against the market powereffects. In short, a merger or consolidation should be in the interest of the travel-ing public.

Sources: National Statistics Office and Department of Tourism.

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


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

DOMESTIC AIR TRANSPORT INDUSTRY

Essential air serviceCross subsidization is no longer feasible under a deregulated environment. How-

ever, considering the country’s archipelagic setting, there are remote areas where airservices are not commercially viable but which are deemed necessary on socialgrounds or for developmental reasons. The government should set up a system thatwould give airlines incentive to provide air services that otherwise would be moneylosers. Other countries have adopted several approaches in addressing this issue. Oneapproach would be a competitive bidding for government subsidy, i.e., giving thesubsidy to the airline that values it the most.

Intermodal competitionThe 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 orremote areas should therefore be designed in such a way that the efficiency arisingfrom the intermodal competition will not be distorted.

Figure 8. Tourist Receipts, Philippines, 1990-1999 (%)

Source: Sources: Department of Tourism.

Val

ue in

US$

(mill

ion)


Tariffs/FaresAirfares should continue to be regulated in routes where air services are provided

by only one airline.

INTERNATIONAL AIR TRANSPORT INDUSTRYGiven 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. Anyliberalization effort should therefore be done in the context of the bilateral negotiatingprocess and at the multilateral or regional level for some areas.

Market accessMultiple designation under EO 219 is incompatible with capacity constraints, as

entry will be limited if capacity is not sufficient for each carrier to be commerciallyviable. Hence, multiple designation should be accompanied by the removal of capac-ity constraints. The country should pursue liberal bilateral agreements aiming for thegradual removal, within a set timeframe, of constraints in capacity, frequency, andtype of aircrafts so as to allow airlines greater flexibility in determining the least costof providing air services in the routes. This, in effect, will deepen the country’s liber-alization efforts.

However, a balance has to be struck in setting the time period. If competitionis introduced too slowly, the incumbent airline (PAL) has little incentive toeliminate monopoly rents. Allowing competition too rapidly, on the other hand,may result in lost opportunity for the new players to gain organizational efficien-cies, as they have yet to establish a credible presence in international routes, andmay fail altogether.

Access to inputsA 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 mul-tilateral actions are needed. Of immediate importance under this area is the regulatoryreform on how to facilitate the access of new airlines to airport landing slots that areoften hard to contest, particularly the peak landing slots, as these have already beenallocated to the incumbent(s).

AlliancesThe motivation for the formation of alliances is the need to offer a global service

with connections around the world while restraining costs. Indirectly, however, alli-ances are formed to overcome constraints in the bilateral agreements, particularlyforeign equity restriction. Alliances may come in several forms, one of which is codesharing, where one airline uses the seats of another airline but employs its own airlinedesignator code. Code sharing has anticompetitive effects as it reduces consumer’schoice of airlines.



There is no doubt that liberalization and deregulation have brought genuine com-petition in the domestic air transport industry. Although the number of players hasremained the same since the industry was deregulated, this paper has shown that thedegree of competition has been increasingly intensified, particularly in the majorroutes, resulting in lower airfare, improvement in the quality of service and efficiencyin the industry in general.

On the other hand, while other countries are adopting more flexible approachesto liberalization and regulation to meet the increasing demand for international airservices brought about by the increasing integration of economies, the Philippines iskeeping to its old restrictive policies and practices. In particular, the government’sstance on issues concerning its air services agreements is not compatible with itspronouncement of a progressive liberalization policy. The effect of such restrictivepolicies is reflected in the high degree of concentration in the country’s internationalaviation industry. The outcome is a decline in passenger traffic, tourists, and touristreceipts.

EO 219 should be implemented quickly for the liberalization of the country’sinternational air transport industry. But EO 219 alone is not enough. The governmentneeds to deepen its liberalization efforts by adopting a more flexible approach to itsliberalization efforts.

The government needs to act quickly to promote competition in the industry. Asthe experiences of other countries have shown, convenient and efficient air servicesbrought about by greater competition are critical to attracting foreign investment,trade, and tourism. To this end, this paper has identified areas where competitionpolicy and new regulations should be defined and pursued to ensure that airlines areable to reap the benefits of their oligopolistic structure while at the same time consum-ers are protected from the abuse of market power.

BIBLIOGRAPHY

Ambidji Group Pty Ltd 1997. Civil Aviation Master Plan. Department of Transportation andCommunications, 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.


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. PasigCity.: University of Asia and the Pacific.

Schwalbach, J. 1991. Entry, Exit, Concentration, and Market Contestability. In Entry andMarket 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 UNCTADSecretariat.

USATA (US Air Transport Association). 1999. Airline Handbook. Available from the WorldWide Web: (http://www.air-transport.org.).

Warren,T., V. Tamms and C. Findlay. 1998. Beyond the Bilateral System: Competition Policyand Trade in International Aviation Service. Auckland: PECC Trade Policy Forum.

WTO (World Trade Organization) 1998. Air Transport Services. Background Note by theSecretariat, Council for Trade in Services.

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

Appendix Table 1. List of Domestic Airports, by Type


APPENDICES

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-San Jose-Manila 63.6 70.3 82.7

Manila-Roxas-Manila 74.0 70.3 74.5 65.4 39.7 44.6


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-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

Appendix Table 2. Passenger Load Factor per Airline, by Sector, 1995-2000 (%)

Note: No data for 1998 and 2000 for PAL. Sources: Civil Aeronautics Board and Airlines.

SECTOR AIR PHILIPPINES GRAND AIRWAYS

1995 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000

57.0 57.0 55.0 55.0 43.3 57.3 61.0 64.0

42.0 75.0 67.0 68.4 68.0 52.6 57.7 50.0 57.0

59.0 75.0 53.0 62.0 59.0

63.0 60.0 50.9 52.7

66.0 75.0 75.0 66.0 64.0 46.1 42.0

57.0 64.0 60.0 42.9 30.0

64.0 50.4 42.0 56.0 46.0 53.0

58.2 74.0 66.0 73.8 66.0 39.2 43.0

55.0 54.4 59.0 62.4 52.0 47.0

44.0 77.0 69.0 64.0 58.0

72.0 60.0

52.0 56.0 58.0

34.5

58.2 61.0 66.1 48.7 47.0

54.0 63.0 62.0

41.0 30.0

51.0 64.0 39.0 35.0

47.0 45.0 26.0

25.0

23.0

49.0

38.0

57.0 47.0

66.0 50.0


Appendix Table 2 (continued)

A. Major Trunkline












Manila-San Jose-Manila

Manila-Roxas-Manila


Manila- Baguio- Manila




Manila-Daet-Manila


Manila-Laoag-Manila



Manila-Naga-Manila



Manila-Virac-Manila

Cagayan-Davao-Cagayan


Cebu-Bacolod-Cebu

Cebu-Butuan-Cebu

Cebu-Cagayan-Cebu

Cebu-Cotabato-Cebu

Cebu-Davao-Cebu

Cebu-Dipolog-Cebu


Cebu-Iloilo-Cebu

Cebu-Kalibo-Cebu

Cebu-Pagadian-Cebu


Cebu-Surigao-Cebu


Cebu-Tandag-Cebu

Cebu-Zamboanga-Cebu



Davao-Zamboanga-Davao






SECTOR ASIAN SPIRIT MINDANAO EXPRESS

1995 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000

51.6 50.2 49.0 62.0 68.5

30.6 39.0 52.0 60.1

42.7 63.1 66.0

61.6 46.8 64.3 73.0 67.3

33.6 40.7

63.7 62.0 55.1

45.6 81.3 75.8 82.0 74.6

41.5 56.4 49.0 43.9

47.3 59.7 57.0 66.0 58.7

62.0 78.6

46.3 48.0 65.0 67.0 74.2

60.7 48.9 72.6

21.0

21.0

32.3

53.0 44.8 25.0 19.4 50.0

17.9 39.8

36.5

56.0

35.0 42.0 35.0

21.0

14.8 23.7

34.0 21.2

44.0 39.5 39.0 37.7 55.1

5.0

52.2 48.7 51.0

42.8 35.0

48.0 48.3

38.8

17.6

24.7

36.2 7.0

43.1 50.3 45.3 60.2



A. Major Trunkline












Manila-San Jose-Manila

Manila-Roxas-Manila


Manila- Baguio- Manila




Manila-Daet-Manila


Manila-Laoag-Manila



Manila-Naga-Manila



Manila-Virac-Manila

Cagayan-Davao-Cagayan


Cebu-Bacolod-Cebu

Cebu-Butuan-Cebu

Cebu-Cagayan-Cebu

Cebu-Cotabato-Cebu

Cebu-Davao-Cebu

Cebu-Dipolog-Cebu


Cebu-Iloilo-Cebu

Cebu-Kalibo-Cebu

Cebu-Pagadian-Cebu


Cebu-Surigao-Cebu


Cebu-Tandag-Cebu

Cebu-Zamboanga-Cebu



Davao-Zamboanga-Davao






SECTOR Philippine Airlines Cebu Pacific Air

1995 1996 1997 1998* 1999** 1996 1997 1998 1999

Manila- Cebu- Manila 83.7 68.7 62.9 50.2 10.5 15.8 44.0 27.9

Manila- Davao- Manila 76.0 55.8 48.9 41.8 11.6 20.0 39.9 32.4

Manila- Zamboanga- Manila 100.0 84.0 71.3 49.6 45.1 31.7

Manila- Bacolod- Manila 100.0 97.2 67.9 39.1 2.8 25.2 56.5 39.8

Manila- Iloilo- Manila 100.0 64.3 55.3 36.0 18.7 22.7 46.7 31.2

Manila- Legaspi- Manila 100.0 94.5 77.7 60.2

Manila- Tacloban- Manila 100.0 81.8 49.9 27.3 8.5 35.3 85.2 51.1

Manila-Puerto Prinsesa- Manila 100.0 80.0 67.8 51.8

Manila-Cagayan de Oro-Manila 100.0 77.0 54.7 39.9 15.8 31.5 66.5 36.1



Manila-San Jose-Manila 100.0 81.4 51.8

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

Air Philippines Grand Airways Asian Spirit

1996 1997 1998 1999 1995 1996 1997 1998 1996 1997 1998 1999

6.2 39.3 21.9 16.3 20.8 15.1 16.8

1.8 15.0 45.6 25.8 24.0 30.9 16.1 14.4

16.0 28.7 54.9 18.7

6.9 43.5 21.1

16.6 21.4 53.3 32.7 0.5 0.6

5.5 22.3 100.0 39.8

1.6 21.6 9.7 14.8 13.2

18.5 30.6 100.0 48.2 1.5 1.6

8.2 24.0 7.2 13.8 25.3

22.4 44.2 100.0 61.7

100.0 58.2

52.0 81.8 18.6 48.2 48.0 18.2

4.1 11.6 17.1 27.3 9.7 13.8 9.6 11.1 0.2 0.6 0.5 0.2

Appendix Table 3. Percentage Distribution of Seat Capacity, by Major Routes, by Airline, 1995-1999 (%)

*1998 No data for 1998 for PAL. **1999 is up to 3rd quarter only for PAL.Source: Civil Aeronautics Board.


1996 1997 1998 1999* 1997 1998 1999

A. Major Trunkline

Manila- Cebu- Manila -3.76 11.31 -20.48 12.78 92.38 15.93 16.83

Manila- Davao- Manila -3.70 5.53 -12.50 17.86 112.84 -6.79 27.57

Manila- Zamboanga- Manila -12.63 17.68 -35.15 -23.62 1946.60

Manila- Bacolod- Manila 0.14 -6.43 -27.78 -26.74 1673.93 26.99 30.26

Manila- Iloilo- Manila -17.02 10.07 -27.24 -25.73 65.05 11.32 4.48

Manila- Legaspi- Manila 2.07 0.37 -32.19 -24.59

Manila- Tacloban- Manila -15.98 -13.54 -28.55 -34.97 611.06 51.56 -2.12

Manila-Puerto Prinsesa- Manila 2.23 8.68 -27.19 -24.80

Manila-Cagayan de Oro-Manila -10.50 2.50 -18.20 -12.60 199.21 5.18 3.07

Manila- Cotabato-Manila -18.49 1.93 -69.27 15.45

Manila-Dumaguete-Manila -0.99 -6.83 -57.30 -100.00

Manila-San Jose-Manila 6.86 -0.23 -56.81 -100.00

Manila-Roxas-Manila -4.85 5.96 -12.80 -29.55


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

Manila-Calbayog-Manila -2.22 -100.00 -100.00

Manila-Catarman-Manila 3.16 13.97 -60.85 -100.00

Manila-Daet-Manila -13.21 -3.65 -57.46 -100.00

Manila-General Santos- Manila 201.71 3.67 -1.23

Manila-Laoag-Manila -4.78 18.69 -44.70 -100.00

Manila-Marinduque-Manila -6.82 -34.19 -63.05 -100.00

Manila-Masbate-Manila -20.09 -38.74 -55.27 -100.00

Manila-Naga-Manila 4.75 27.83 -34.18 -37.23

Manila-Tablas-Manila -40.43 -100.00

Air Philippines Grand Airways Asian Spirit Mindanao Express

1997 1998 1999 1996 1997 1998 1997 1998 1999 1997 1998 1999

86.58 43.45 112.91 -17.84 -56.43

1228.70 9.14 14.15 95.95 -53.14 -52.23

157.05 5.79 0.53

159.44 1.59

40.14 21.09 12.46 31.24 -100.00

152.60 -1.32 6.50

3328.53 76.14 -41.92

146.69 -20.02 50.23 43.45 -100.00

782.54 118.22 -18.77

233.47 -18.79 -7.80

235.02 -69.16 248.15

273.09

57.04 -1.57 22.41 -73.02 514.44

3179.55 -89.40 986.83

25.82 -100.00

-25.38

696.12

213.14 -23.37 28.57

260.49 0.84

44.58 -94.51 475.31 317.77 -50.25 18.62

Appendix Table 4. Growth Rate of Passenger Traffic per Sector, per Airline, 1995-1999 (%)


*1999 data for PAL is up to 3rd quarter only, except Davao and Cebu . Sources: Civil Aeronautics Board and Airlines.

Air Philippines Grand Airways Asian Spirit Mindanao Express

1997 1998 1999 1996 1997 1998 1997 1998 1999 1997 1998 1999

99.17 -39.29 171.50

2018.58

3.94 278.10

-23.42 715.56

-100.00

-100.00

-1.37

9.87 45.71

159.57 19.86

-20.15 -100.00

193.13


1996 1997 1998 1999* 1997 1998 1999

Manila-Tagbilaran-Manila -3.03 35.42 -20.35 -87.72

Manila-Virac-Manila -18.39 20.42 -58.09 -100.00

Cagayan-Davao-Cagayan -6.89 7.15 -82.06 -100.00

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

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

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

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

Cebu-Tagbilaran-Cebu -45.06 -74.44 -98.62 -100.00

Cebu-Tandag-Cebu -2.60 4.36 -60.71 -100.00

Cebu-Zamboanga-Cebu -36.20 3.13 -51.54 -93.37

Cotabato-Zamboanga-Cotabato -30.90 17.33 -100.00

Davao-Zamboanga-Davao 6.37 37.61 -61.75 -100.00

Dipolog-Zamboanga-Dipolog -0.51 -8.37 -62.08 -100.00

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

Appendix Table 5. Measure of Degree of Competition, per Points Served, 1990-1999



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.



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.



1990 1995 1999 1990 1995 1999

Appendix Table 6. PAL’s Major Destination Points,1990,1995,1999

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

Points served 1990 Points served 1995 Points served 1999

Passenger% Share Passenger % Share Passenger % Share



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

Appendix Table 7. Spearman Rank Correlation Test for Herfindahl-Hirschman Indexand Market Share to Tourists Arrival, 1995

Sources: Table 12 and 17.Spearman rank correlation test: Rs = 1 - [(6Σdi

2) / n(n2-1)]= -0.6548

where di = difference between the ranks; n= number of samples. The test was significant at α = 0.05.

CountryHerfindahl-HirschmanIndex (HHI) Share to Visitors Arrival (%)

d2

HHI Rank Rank% Share

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

Appendix Table 8. Spearman Rank Correlation Test for Herfindahl-Hirschman Indexand Market Share to Tourists Arrival, 1999

Sources: Table 12 and 17.Spearman rank correlation test: Rs = 1 - [(6Σdi

2) / n(n2-1)]= - 0.4657

where di = difference between the ranks; n = number of samples. The test was significant at α = 0.05.

CountryHerfindahl-HirschmanIndex (HHI) Share to Visitors Arrival (%)

d2

HHI Rank Rank% Share

7C H A P T E R

Analysis of the Stateof Competition and Market Structureof the Banking and Insurance Sectors

Melanie S. Milo

ABSTRACT

This paper looks at how competition and efficiency in the financial servicessector, particularly the banking and insurance industries, have been affectedby the regulatory regime and market structure. To begin, an overview of howfinancial policy in the Philippines evolved over time is given. The interaction

between regulation and competition is also shown through a description of the princi-pal statutory regulations that affect the banking and insurance industries to date.Then, the discussion of the changes in financial policy is augmented by looking attheir impact on the structure of the financial system in the third section. The monitor-ing of structural change in the financial system is done through the use of indicatorsof changes in competitive structure and indicators of gains in competitive efficiencyimplicit in financial market performance. In the fourth section, financial sector regu-lations and their impact on market structure are assessed in the context of competitionpolicy elements and principles that have been identified in the literature. Someemerging competition policy issues that need to be analyzed further are also pre-sented. Finally, some conclusions are presented in the last section.


INTRODUCTION

A successful financial market is characterized as being simultaneously sound andcompetitive. On the one hand, a competitive but unsound financial system is unsus-tainable 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 inefficien-cies 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 majorissue confronting financial regulation then is how to balance the need for both sound-ness and competitiveness. In most markets, simply removing state-imposed barrierswould improve competition. But in financial markets, some form of regulation isnecessary to protect the competitive process and the reputation and soundness of thefinancial system (Grimes 1999).

The regulation of the Philippine financial services sector, particularly the bank-ing sector, has undergone considerable change in the last two decades. On the onehand, there has been the removal of certain regulations such as direct controls oninterest rates and there has also been a substantial relaxation in other regulations suchas restrictions on entry, lines of business, and portfolios. The overall objective of suchderegulatory reforms was to promote competitive conditions to foster greater effi-ciency in the financial sector. On the other hand, there has also been a strengtheningof prudential regulation, which was justified as necessary to protect depositors and topreserve the stability of the payments system. The design, implementation, and en-forcement of regulatory rules have expectedly affected the structure and nature of thePhilippine financial services sector, especially since they continue to impose impor-tant constraints on the ownership and business powers of financial institutions. This,in turn, has important implications for the competitive process in the financial ser-vices sector and ultimately the type, quality, and price of the products offered to con-sumers and business users. This chapter looks at how competition and efficiency inthe 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 thefinancial system. The following section gives an overview of public policy toward thefinancial system, with particular focus on the role of competition policy as an instrumentfor improving the efficiency and functioning of the financial system beginning in the1980s. The section then shows the interaction between regulation and competitionthrough a description of what is regulated and what is left to the market. In particular, itdescribes the current principal statutory regulations that affect the banking and insuranceindustries. Because the application of competition policy is significantly more advanced inthe commercial banking sector, it can give important lessons and insights on how todevelop competition policy for the other sectors of the financial system, as well as anoverall competition policy for the Philippines. The insurance sector is important becauseof 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 identifyareas that inhibit the working of market forces in financial markets. However, moni-toring 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 competitivestructure 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 useof various indicators of changes in competitive structures and gains in competitiveefficiency implicit in financial market performance.

While the application of competition policy in the banking sector has been fairlyextensive and intensive, it is not yet complete and some competition policy issuesremain. In contrast, reform of the private insurance industry occurred only in the mid-1990s and regulation remains highly restrictive. Thus, there are also continuing com-petition policy issues in the insurance sector that need to be addressed to furtherenhance competitiveness and efficiency in the sector. Finally, an efficient financialsystem also requires an efficient regulatory structure. Two aspects that need to beconsidered are the appropriate regulatory framework for the financial sector as awhole, and the application of a national competition policy framework to the financialsector. These competition policy issues are the focus of the fourth section. Some con-clusions and policy implications are then presented in the fifth and final section.

REGULATORY FRAMEWORK

POLICIES TOWARD AN EFFICIENT FINANCIAL SYSTEM: WIDENING THESCOPE FOR COMPETITION

Following more than 30 years of repressionist financial policies from the time theCentral Bank of the Philippines (CBP) began operations in 1949, the Philippinesformally embarked on a financial liberalization program in the early 1980s as part ofan overall structural adjustment program.1 It included the gradual liberalization ofinterest rates from 1981 to 1983; the easing of restrictions on the range of operationsfinancial institutions were allowed to conduct in the domestic markets, including theintroduction of universal banking in 1980; and rationalization of financial marketregulations, 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 governmentintervention in setting interest rates and allocating credit. In the subsequent discussions, finan-cial liberalization, financial deregulation and financial reform are used interchangeably to referto all measures that are designed to encourage and to provide more scope for the working ofmarket forces and competition in the financial sector. For a fuller discussion of the evolution offinancial policy in the Philippines from the 1950s to the 1990s, see Milo (2000).


But soon after the start of financial liberalization, the financial system underwenta 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 fraudsand stockbroker failures (Laya 1982). The financial crisis deepened as a result of thepolitical and economic crises in 1983-1985, which led to significant financialshallowing (World Bank 1986). An important lesson that emerged from the experi-ence, which also proved true in other developing countries that undertook financialliberalization, was that there were prerequisites to a successful financial liberaliza-tion. The two most commonly cited factors were macroeconomic stability and ad-equate prudential regulation/supervision (Cho and Khatkhate 1989). As a result,subsequent financial reforms in the Philippines began to incorporate the impositionand/or tightening of regulations for prudential reasons, simultaneously withderegulatory reforms.

Financial reforms were resumed in 1986, which specifically addressed problemsendemic to the system since the 1960s, and further highlighted by the earlier reformeffort and financial crisis. These included the interlinked problems of fraud or in-sider abuse by bank owners or officers and inadequate/ineffective prudential supervi-sion and regulation of banks. Thus, policy reforms effecting prudential bankmanagement included increased minimum capitalization requirements; compliancewith minimum risk asset ratios; single borrower’s limit; limit on loans to directors,officers, stockholders, and related interests (DOSRI); limits on allowable interlock-ing directorships and officerships; provisions for loan loss or doubtful accounts; au-dit and reporting requirements; and stricter bail-out policy of problematic banks(Bautista 1992). The government also rehabilitated ailing financial institutions, no-tably the government-owned banks and rural banks. However, the problem was notjust the lack of prudential rules, but a weakened CBP—both financially and politi-cally. And a strong central bank, which effectively carries out its role of supervisingfinancial institutions, is a prerequisite for a stable financial system (World Bank1988). 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 ofentry of new domestic banks and of domestic bank branching in 1993, which werefurther rationalized in 1995, and the easing of restriction on the entry of foreign banksin 1994. The government also moved to reduce its direct participation in the bankingsystem by privatizing five of the six banks that it took over during the crises in the1980s. The Philippine National Bank (PNB) also passed into majority private owner-ship in 1995.

Deregulation of entry was an especially important reform because it was a neces-sary complement to the removal of interest rate ceilings. As noted by Blundell-Wignall and Ishida (1990), the impact of removing interest rate ceilings is dependenton the degree of competitive pressure. Competition for deposits may not improve if


there is no serious threat of entry into the banking system, or if other regulations, suchas those concerning branching, become binding constraints. Particularly noteworthywas the continued fixity of the interest rate on savings deposits after interest ratesliberalized, which had been attributed to some monopoly power of the large commer-cial banks (Tan 1989). Thus, a review of the Philippine financial sector following thereforms in the 1980s still identified the lack of competitive behavior among banks asan important feature needing reform (World Bank 1988).

There was also an effort to expand the coverage of financial sector reforms in thesecond half of the 1990s. It was recognized that the predominance of bank loans incorporate financing was one of the factors that complicated the Philippines’ financialliberalization program in the early 1980s. The East Asian crisis also highlighted thedangers of a bank-dominated financial system. Thus, there was a need to improve thecompetitiveness of other financial institutions to provide savers and borrowers withalternatives to banks. It was also recognized that the country’s sustained growth per-formance required substantial mobilization of domestic resources from nonbankingsources. 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 liber-alization of entry into the private insurance industry in 1996, and efforts to developthe equity markets such as the unification of the Manila and Makati Stock Exchangesto form the Philippine Stock Exchange in 1994. In particular, the liberalization offoreign investments and foreign exchange transactions in the 1990s had a significantimpact on the development of the capital markets (Lamberte 1995). Republic Act(RA) 8366, or the Investment Houses Law, was enacted in October 1997, which in-creased the maximum foreign equity participation in investment houses from 40 to 60percent and raised the minimum capital requirement. The Financing Act of 1998 (RA8556) also raised the maximum foreign equity participation in financing companiesto 60 percent and the minimum capital requirement. Adjustments in the right direc-tion were taking place in the financial sector. Unfortunately, the 1997 Asian financialcrisis disrupted the process of reform and adjustment. The 1997 Asian financial crisisagain 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. Twoimportant bills that were passed in the aftermath of the Asian crisis were the GeneralBanking Law of 2000 (RA 8791) and the Securities Regulation Code (RA 8799) enactedtwo months after in July 2000. Both aimed to address some weaknesses, particularly inthe regulatory frameworks governing banks and the securities market.

The rationale behind the various financial sector reforms that have been imple-mented in the Philippines was precisely to improve the workings of the financialsystem. In particular, a move away from interventionist and repressionist policiestoward freeing up the system from various restrictions was seen as growth promoting.Policies to reform the financial sector evolved gradually over time, with reforms


building on earlier reforms. However, the reform process was far from smooth andwas fraught with difficulties. But despite some frictions in its operation, a deregulated(albeit also properly supervised) financial sector is still superior to a publicly man-aged one. For instance, the relative resilience of the Philippines to the ill effects of theAsian crisis was partly attributed to the financial sector reforms that had already beenimplemented, particularly the consecutive increases in the minimum capital require-ments of banks and tighter prudential regulation. Financial liberalization is a processand not a one-off episode, and it necessarily takes time for governments to implementreforms and for institutions to adjust to these reforms. The key is to deepen the re-forms 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 RESTRICTIONThe previous section briefly discussed public policy toward the Philippine finan-

cial system, particularly the role of competition policy in enhancing the efficiencyand functioning of financial institutions and markets. It included a wide range ofdomestic deregulation as well as external liberalization measures, such as the aboli-tion of interest rate and other price controls, and the easing of restrictions on therange of operations that financial institutions are allowed to conduct in the domesticand international markets, new entry restrictions, and other obstacles to the func-tioning of financial markets. The overall disposition of authorities toward the devel-opment 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 justi-fied for prudential reasons, that is, to protect the stability and soundness of the finan-cial 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 adequateprudential regulation and supervision of financial intermediaries, especially given theincreasingly global nature of capital markets. Current banking regulation also aims toaddress longstanding weaknesses in the sector, particularly the presence of manysmall banks, and concentration of ownership and the related issue of insider abuse.The following subsections review the current principal statutory regulations in thebanking and insurance sectors. Specifically, they highlight the interaction betweenregulation and competition by describing what areas/activities are regulated and whatare left to the market.

Banking sectorRA 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 Actwas RA 7721, which partially liberalized the entry and scope of operations of foreignbanks in the Philippines and which was enacted in 1994. It was only in May 2000 that


a new general banking law, RA 8791 or the General Banking Law of 2000, was en-acted. The new general banking law was deemed necessary and overdue given thesignificant changes both in the domestic and international environments. Its goal wasto “promote and maintain a stable and efficient banking and financial system that isglobally competitive, dynamic, and responsive to the demands of a developingeconomy” (Sec. 2). An important element of this Law was the adoption and incorpo-ration of internationally accepted standards and practices into the BSP’s supervisoryprocesses. In addition, RA 7653 or the New Central Bank Act of 1993 defined theBSP’s general functions, operations and powers relating to the banking sector andother financial institutions. Finally, there are also specific legislations that govern thelending activities of banks.

The major regulations and restrictions currently in operation in the commercialbanking 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 weresignificantly eased only from 1993 to 1995. New domestic banks, satisfying the lawsof incorporation as approved by the Monetary Board, could be established as long asthey meet minimum capital and other prudential requirements. Geographical restric-tions on domestic bank branching were lifted in 1993, and branches could be estab-lished anywhere subject to certain prudential requirements, such as those on capitaladequacy, liquidity, profitability, and soundness of management (Paderanga 1996).However, licensing of domestic bank branches still needed the prior approval of theMonetary Board, which continued to retain discretionary powers (Lamberte andLlanto 1993).

RA 7721, which was enacted in May 1994, partially liberalized the entry andscope of operations of foreign banks in the Philippines. In particular, foreign bankswere authorized to operate in the Philippines through any one of the following modesof 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 incorpo-rated in the Philippines; or (iii) establish a branch with full banking authority. Thethird mode of entry was operative for only five years from the date of effectivity of theAct, and was limited to only 10 foreign banks. Each of the 10 foreign banks wasentitled to six branches—three in locations of its choice and three in locations to bedesignated by the Monetary Board. The four foreign banks operating throughbranches in the Philippines upon the effectivity of the Act were also accorded thesame branching privilege.____________________

2 This section also draws on the BSP’s Manual of Regulations for Banks (1996) and on morerecent circulars and resolutions.3 For a fuller discussion of bank entry and branching regulations and their impact on competi-tion, see Milo (2001).


For a foreign bank to be able to establish a branch or a subsidiary, it had to beamong 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, orthe government of its country of origin must own more than 50 percent of its capitalstock. At least 50 stockholders, none of whom owns more than 15 percent of thecapital stock, are required for a foreign bank to be considered as widely owned.

However, in August 1999, the BSP again declared an indefinite moratorium onthe establishment of new domestic banks, and the branch expansion of existing banksbut excluding microfinance-oriented banks.4 The foreign banks were exempted fromthe moratorium on local branch expansion, although the limit of six new branchesremained. This policy, together with mandated consecutive increases in minimumcapital requirements of banks, reflected the BSP’s preference for and strategy of forc-ing more mergers and acquisitions to reduce the number and increase the average sizeof banks in the Philippines. Consolidation is in turn expected to result in a strongerand more stable banking system. Thus, prospective investors were encouraged to ac-quire existing banks instead of applying for new operating licenses, while banks wish-ing to expand could do so by taking over smaller banks. The BSP Governor hadexpressed concern over the large number of banks in the Philippines, and noted that afew strong banks would be good for the industry, the economy, and eventually, theconsumers. He put forward a five-year scenario wherein four to six local banks, to-gether with the 14 existing foreign banks, would dominate 80 percent of theindustry’s resources. The remaining smaller banks, on the other hand, could eitherdevelop into niche players or be weeded out of the system.

In accordance with RA 7721, the Philippines last granted licenses to 10 newforeign bank branches in 1995, which brought the total number of foreign bankbranches in the country to 14.5 There have also been seven new locally incorporatedforeign 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 intoexisting domestic banks. Again, this fitted in with the BSP’s push for more mergersand acquisitions in the banking system. The BSP has designated a critical role forforeign banks in its effort to consolidate the banking sector, that is, foreign buy-inswere especially encouraged. More consolidation and more openness to foreign bankswere seen as positive factors for the Philippine banking system. In particular, a strongforeign banking presence—with credibility and capital—would result in improvedefficiency and help stabilize the system during times of stress.

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4 Monetary Board Resolution No. 1224 dated 27 August 1999.5 Bank of China was granted a license in 2000, replacing Development Bank of Singaporewhich surrendered its license to buy 60 percent of Philippine-based Bank of Southeast Asia in1998.


While the drafters of RA 7721, as well as the BSP, recognized the role offoreign banks in creating a more competitive environment, the intention was notfor them to dominate the local banks. RA 7721 also expressly stated that, “Inallowing increased foreign participation in the financial system, it shall be thepolicy 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 percentof the resources or assets of the entire banking system be held by domestic banksthat are majority owned by Filipinos. In that sense, RA 7721 was even morerestrictive than RA 337, which did not contain such a provision although it alsointended to keep foreign participation in the domestic banking sector to a minor-ity. Both past and incumbent BSP Governors, while amenable to the idea of an-other round of banking sector liberalization, also made the point that it should belegislated such that some “macroeconomic” protection would be retained for thelocal banks, such as imposing a time period for allowing 100 percent foreignownership of existing domestic banks.

RA 8791, or the General Banking Law of 2000, formalized the moratorium onnew bank entry by stipulating that “no new commercial bank shall be establishedwithin three years from the effectivity of this Act” (Sec. 8.3). It also tightened thelicensing 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 toacquire up to 100 percent of the voting stock of (only) one bank, but only within sevenyears from the effectivity of RA 8791. This included foreign banks that have acquired60 percent of the voting stock of a bank under RA 7721. Furthermore, RA 8791contained the same provision as RA 7721, requiring the Monetary Board to ensurethat banks which are majority owned by Filipinos control 70 percent of the resourcesor assets of the entire banking system. The rationale for this restriction is not explic-itly stated in both Acts. Even if it is imposed for nationalistic reasons, its merit in thecontext of competition and efficiency needs to be established. It is not clear how sucha restriction addresses the primary concerns of efficiency and soundness of the bank-ing sector.

Overall, government barriers to entry are typically imposed to limit and reducethe number, as well as increase the average size of banks in the Philippines. Biggerand fewer banks, in turn, are seen to promote the safety and soundness of the financialsystem. But it is also recognized that their removal would enhance marketcontestability and the competitive process. A balance needs to be struck between thepotential costs and potential benefits of allowing greater competition. In particular,the potential adverse effects of enhancing competition through a lowering of barriersto entry can be addressed by properly applying prudential regulations and restrictionssuch as those currently in place, especially the fitness and properness criteria for bankowners and managers. The focus should not just be the size of banks per se, butwhether they are sound, competitive, and efficient.


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 since1983, and are now essentially market determined. The rediscount rate was also re-aligned to reflect prevailing market rates. The BSP influences interest rates throughindirect mechanisms, such as its overnight rates. However, as a result of the Asianfinancial crisis, the BSP entered into an informal arrangement or “gentleman’s agree-ment” with the Bankers Association of the Philippines (BAP) to bring down interestrates 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 Treasurybill rate, which the BSP supported by reducing reserve requirements in order to helpbring down banks’ intermediation costs, although the BSP was also prepared to im-pose sanctions on banks that violated the spread. This course of action clearly wentbeyond moral suasion and represented direct intervention in normal market mecha-nisms. Instead, the BSP should seek to develop other instruments and build up itstechnical capacity to maintain monetary control in an increasingly sophisticated fi-nancial world, as well as to induce the domestic financial system to intermediate moreefficiently.

RA 8791 also contained a general provision that allows the Monetary Board toprescribe the terms and conditions for various types of bank loans and other creditaccommodations, “taking into account the requirements of the economy for the effec-tive utilization of long-term funds” (Sec. 43). Thus, this aspect has once again becomepotentially subject to regulation.

3. Line-of-business restrictions and regulations on ownership linkages amongfinancial institutions

Table 1 presents the activities and functions that the different types of banks areauthorized to undertake. Reforms in the early 1980s to reduce the enforced specializa-tion of financial institutions and to broaden the range of their services significantlystreamlined the different types and functions of banks. The result was a more flexibleand dynamic institutional structure.

Ownership ceilings are currently still in place, which were originally aimed towiden the ownership base of commercial banks in particular, and hence, mitigate theproblem of insider abuse. Compared to RA 337 as amended, however, the ceilings setby RA 8791 are less restrictive but have stricter disclosure requirements. Previously,under the old General Banking Act, a Filipino individual and/or family group (indi-viduals related up to the 3rd degree of consanguinity or affinity) could not own morethan 20 percent of a domestic bank, while the ceiling for domestic corporations (notwholly or majority owned by an individual or family group) was set at 30 percent. RA7721 then accorded Philippine corporations, banks and nonbanks that are listed in thestock exchange, or are of good standing for at least ten years, the same right as foreignbanks to own up to 60 percent of the voting stock of a domestic bank, although they


could do so for only one domestic bank in both cases. With respect to foreign equityheld by an individual, a nonfinancial entity, or a nonbank financial entity not ownedor controlled by the bank, its subsidiary or holding company, the ceiling on totalforeign equity participation in a domestic bank was 30 percent. This was upgradeableto 40 percent subject to the President’s approval.

Under the new General Banking Law, the ownership ceilings were simplified andunified. Filipinos and domestic nonbank corporations are now subject to the same ruleas foreign individuals and nonbank corporations, that is, they may own or control upto 40 percent of the voting stock of a domestic bank. RA 8791 explicitly defines familygroups and related interests, whose stockholdings must be fully disclosed in all their

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

Table 1. Authorized Activities According to Type of Bank

Note: A - Authorized activitesC - Conditional/Authorized but subject to BSP approvalP - ProhibitedS - Through a subsidiary1 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.


transactions with the bank. Individuals related to each other within the fourth degreeof consanguinity or affinity, legitimate or common law, are considered as a familygroup or related interests, while two or more corporations owned or controlled by thesame family group or same group of persons are considered as related interests. Thecitizenship of a corporation is now determined based on the citizenship of the control-ling stockholders of the corporation, regardless of the place of incorporation (Secs.11-13). The simplified, more uniform, and even higher ownership ceilings make foreasier monitoring because of greater transparency, especially since it is very difficultto uncover indirect ownership through individuals or companies where no visibleconnection is evident. On the other hand, tighter disclosure requirements shift theburden of regulation to the banks themselves.

Recent developments, particularly Lucio Tan’s announcement that he had gainedownership 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 tighten-ing disclosure requirements for family and corporation ownership of bank shares.One loophole that the BSP recently addressed was the disclosure of ownership ofshares of stock lodged with the Philippine Central Depository (PCD), the country’ssecurities 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 foronly a few days. It was the brokers who knew the ownership details. The BSP nowrequires all bank corporate secretaries to disclose the ultimate beneficial owners oftheir respective banks’ shares in their consolidated list of stockholders which is re-ported quarterly.

There are also current restrictions on interlocking directorships and/orofficerships within the Philippine financial system. Interlocking facilitates collusionand the lobbying process (Tan 1991). Thus, such restrictions were also deemed neces-sary to safeguard against the exercise of undue influence over the operation and man-agement 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 interestsituations. However, there are no restrictions on interlocking directorates amongbanks and nonfinancial corporations. It is the latter that has implications on resourceallocation (Tan 1991).

4. Restrictions on the portfolio of assets that banks can hold (such as require-ments to hold certain types of securities or requirements not to hold othersecurities, including requirements not to hold the control of nonfinancialcompanies)

Table 2 presents the ceilings on equity investments of universal and commercialbanks under the new General Banking Law. Universal banks may invest in the equi-ties of both allied and nonallied enterprises, while commercial banks are limited onlyto allied enterprises. Both are subject to the prior approval of the Monetary Board.Overall, the ceilings have been relaxed under the new law.


Limits on loans, credit accommodations and guarantees continue to be imposedon banks for prudential reasons, such as to avoid the concentration of credit in favor ofa few individuals or groups. In this area, RA 8791 is stricter and affords the MonetaryBoard greater authority to govern such loans. The single borrower limit stipulates thatthe total credit commitment of a bank to any person, partnership, association, corpo-ration, 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 subjectto certain conditions, such as the additional liabilities being adequately secured.

The limits on loans to DOSRI were also tightened to make insider abuse moredifficult. In particular, RA 8791 requires loans to a director or officer of a bank to beapproved by the majority of the directors of the bank, excluding the director con-cerned, and reported to the supervising and examining department of the BSP. The

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

Table 2. Limits on Equity Investments of Commercial and Universal Banks

Notes: 1 To promote competitive conditions, the Monetary Board may further limit equity in-vestments of universal and commercial banks in quasi-banks to 40 percent.

2 For publicly listed universal or commercial banks; limited to only one other universalor commercial bank. Otherwise, the equity investment of a commercial bank in otherfinancial allied enterprises, including another commercial bank, is limited to a mi-nority holding.

Source: Bangko Sentral ng Pilipinas.


new General Banking Law’s inclusion of two independent directors in a bank’s boardof directors, who are not officers or employees of the bank, its subsidiaries or affili-ates, or related interests, was meant to further minimize the risks associated withDOSRI loans. The total outstanding credit accommodation should not exceed theunencumbered portion of a DOSRI’s outstanding deposits plus the book value of hispaid-in capital contribution in the lending bank. The definition of a DOSRI loan wasalso expanded to include investments of the bank in enterprises owned or controlledby the respective DOSRI. DOSRI borrowers are also required to waive the secrecy oftheir deposits in all banks in the Philippines.

In addition, loans and other credit accommodations against real estate should notexceed 75 percent of the appraised value of the real estate security, plus 60 percent ofthe appraised value of the insured improvements. Previously, the ceiling was 60 per-cent. There is also an aggregate limit on real estate loans of commercial banks, whichis 20 percent of their respective total loan portfolio. These two provisions were im-posed in May 1997, just before the outbreak of the Asian financial crisis.

As noted earlier, the policy of despecialization by widening the range of permis-sible activities and products of financial institutions aimed to enhance competitionand efficiency in the financial sector. Financial institutions were thus accordedgreater flexibility in responding to new business opportunities under changing de-mand and supply conditions. However, the separation of some securities-related ac-tivities from commercial banking has also been justified based on perceived conflictof interest reasons and concerns relating to the concentration of power in the financialsector (Broker 1989). In fact Yap et al. (1990) found that the interlocking of commer-cial banks with investment institutions increased the relative importance of somebanks 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 iswholly or majority owned or controlled by the bank (Sec. 7). The corresponding pro-vision in RA 7653 is more defined and restrictive, in that it also allows the BSP tosupervise and examine banks and quasi-banks’ subsidiaries (i.e., corporations wherea 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 votingstock, or is related or linked through common stockholders or other such factors asmay be determined by the Monetary Board) engaged in allied activities (Sec. 25).These restrictions and provisions, together with the limits on loans and credit accom-modations, are intended to mitigate insider abuse, which is still the primary cause ofbank failure in the Philippines.

This issue is particularly relevant with the failure of Urban Bank, which wasattributed to problems in its investment house subsidiary, Urbancorp Investments,Inc. Urban Bank was one of the smallest commercial banks before it was downgradedto a thrift bank last March 2000 because it was unable to meet the new capitalizationrequirement. Urbancorp operated as an investment house without quasi-banking


functions and engaged in trust operations. The latter, which had significant real estateexposure, suffered liquidity problems when its investors preterminated their holdingsdue partly to the failure of another investment house. Urban Bank, in turn, sufferedheavy withdrawals due both to the pretermination of placements by its subsidiary’sinvestors and to the loss of public confidence following its downgrade. The simulta-neous weakening of these two financial institutions was clearly interlinked. They areboth currently under receivership. Failure to detect problems in Urbancorp has beenattributed to some lapse in supervision/regulatory oversight, which in turn arose fromconfusion in the proper assignment of regulatory function over investment housesbetween the BSP and the Securities and Exchange Commission (SEC). RA 7653 alsoprovided for the transfer of regulatory powers over finance companies without quasi-banking functions and other institutions performing similar functions from the BSPto the SEC, within five years from the effectivity of the Act (Sec. 130). However, theimplementing rules and guidelines had not been drawn up at the time.

Abuses of conflicts of interest situations have significant implications on effi-ciency, 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 thesolution. Thus, the emphasis is once again on prudential regulation. Some tighteningin the trust operations of banks may be warranted, but ultimately the issue is not justthe lack of some detailed code of conduct but also the proper implementation of exist-ing 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 asoutlets for the presentation and/or sale of the financial products of its allied undertak-ings or of its investment house units” (Sec. 20) needs to be carefully evaluated andprudently applied because it could lead to conflicts of interest situations and undulyexpand the coverage of the financial safety net.

5. Compulsory deposit insuranceThe 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 inan insured bank (after deducting offsets) but not to exceed P100,000. The assessmentrate is a flat rate and not related to the risk of a bank, that is, the same rate applies toall 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 isequal to the amount of the rate times the assessment base or the total deposit liabilitiesof the bank, but shall not be less than P250. The semiannual assessment base is de-fined as the average of total deposits at the close of each quarter. Overall, the currentlevel of deposit insurance does not seem excessive. But the more relevant issue may beimplicit insurance, particularly the BSP’s explicit policy of not allowing big banks to fail.


The PDIC is also seeking amendments to its charter, which include higher de-posit 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 hasdeclared a bank holiday).

6. Restrictions on capital adequacyThe minimum capital requirement is differentiated according to type of bank,

and increases significantly the more functions or activities a bank is allowed to under-take. Over time, minimum capital requirements have been progressively increasedbecause authorities believed that bigger banks would lead to a more stable bankingsystem. For expanded commercial banks or universal banks, the increase was fromP500 million in 1980 to P1 billion in 1990, P2.5 billion in 1995, and P4.95 billion in1999. For commercial banks, the corresponding amounts are P100 million, P500 mil-lion, P1.25 billion, and P 2.4 billion, respectively. Still, Philippine banks are fairlysmall compared to banks in other countries in the region. Increases in banks’ mini-mum capital requirements have typically been used as a barrier to entry. Also, mergersand acquisitions are especially preferred as a means of meeting higher capitalizationrequirements to reduce the number and increase the size of banks in the Philippines.Thus, the BSP grants various incentives for bank consolidations, including temporaryexemptions from some restrictions.

The final stage of the mandatory capital build-up program was supposed to raiseminimum capital requirements by the end of 2000 to P5.4 billion and P2.8 billion foruniversal and commercial banks, respectively. The BSP decided to cancel this finalstage 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 toshift to this new framework for measuring capital adequacy was actually made by theMonetary Board in June 19936 , but its implementation was subject to the amendmentof 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 pre-scribed time period. Investors will then have the option to convert the Tier 2 notes intobank equity, although they have no voting rights and their shares are subordinate tocommon shares.

7. Reserve requirementsReserve requirements are imposed on all peso deposit liabilities, deposit substi-

tutes and common trust funds of banks and nonbank quasi-banks. They take twoforms—regular reserve requirements and liquidity reserves. Of the former, at least 25percent but not to exceed 40 percent must be held as deposits at the BSP, and thebalance in the form of cash in vault and government securities. Deposits maintained

___________________

6 Resolution No. 544 dated 25 June 1993.


with the BSP are paid an interest rate of 4 percent per annum based on the averagedaily balance and are credited quarterly, while eligible government securities mustbear an interest rate of not more than 4 percent per annum, be nonnegotiable andcarry BSP support. On top of the regular reserve requirements, liquidity reserves,which may be maintained in the form of short-term, market yielding governmentsecurities, were imposed beginning in May 1995 accompanied by reductions in theregular reserve requirements to allow banks to earn higher remuneration on theirrequired reserves. Regular reserve requirements for commercial banks currentlyrange from 7 to 9 percent, while liquidity reserves are set at 3 percent for all pesodeposits and deposit substitutes and 6 percent for common trust funds. The currentreserve requirements are significantly lower compared to previous levels. This, to-gether with higher interest rates paid on reserves, served to reduce banks’ cost ofintermediation, which in turn should have a positive impact on the level of inter-mediation activity.

Foreign exchange deposit liabilities of commercial banks authorized to operatean FCDU require a 100 percent asset cover, which may take the form of foreign cur-rency notes and coins on hand; foreign currency deposits with the BSP, foreign banksabroad, OBUs and other FCDUs; foreign currency loans authorized by the BSP; in-vestments in foreign-currency-denominated debt instruments; and other assets as maybe determined by the BSP.

8. Requirements to direct credit to favored sectorsThe government continues to direct credit to certain sectors of the economy

through both regulatory and statutory restrictions. The loan-to-deposit ratio or depositretention scheme requires that at least 75 percent of total deposit liabilities, net ofrequired reserves and cash in vault, accumulated by branches and other banking of-fices in a particular geographical grouping outside of Metro Manila, be investedthere. This is to help develop that particular area, for instance, by ensuring that fundsdo 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 group-ings from 13 to three (Luzon, Visayas, Mindanao) in 1990 has presumably reducedsuch adverse effects.

A longstanding statutory restriction on bank’s credit allocation is the 1975Presidential Decree No. 717, or the Agri-Agra law, that requires all banks to allocate25 percent of their loanable funds to agriculture, with at least 10 percent earmarkedfor agrarian reform credit. Because of banks’ frequent inability to meet this require-ment, they were allowed to hold alternative investments. In particular, unused fundsearmarked for agrarian reform credit can be invested temporarily in governmentsecurities that the BSP has expressly declared eligible for the purpose. But suchsecurities: (a) must be monetized, encashed, or repurchased whenever funds areneeded by the bank for lending to the beneficiaries of agrarian reform; and (b) cannot


be hypothecated or encumbered in any way or earmarked for any other purpose. Theunused funds set aside for agricultural credit in general may also be invested incommercial papers issued by entities engaged in agricultural production, processing,storage, marketing, or exportation of agricultural products; and importation, manu-facture, distribution of farm machineries and equipment, fertilizers, etc. used foragricultural production. All unused Agri-Agra allocation funds in the preceding yearshall also be invested in socialized and low-cost housing provided the utilized por-tion was solely devoted to agricultural and agrarian reform credit. Finally, loansextended by banks to finance educational institutions, cooperatives, hospitals andother medical services, low-cost housing, and those extended to local governmentunits without national government guarantee are included in determining compli-ance with the provisions of PD 717.

In 1991, RA 6977, or the Magna Carta for Small Enterprises, was signed into lawmandating all banks to allocate a certain portion of their total loan portfolio to smallenterprises. The effectivity of this law had a time period and set the mandated creditallocation at 5 percent in 1991, 10 percent in 1992-95, 5 percent in 1996, and possiblylifted 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 Smalland Medium Scale Enterprises. This law required all lending institutions, for a periodof 10 years from August 1997 to August 2007, to set aside at least 6 and 2 percent oftheir total loan portfolio for small and medium enterprises, respectively. Banks couldreport compliance on a groupwide basis, provided that the subsidiary banks are atleast 75 percent owned or controlled by the parent bank. Such loans are also eligiblefor guarantee coverage to be issued by the Small Business Guarantee and FinanceCorporation (SBGFC), which was also established under RA 8289.

For government corporations that perform banking or credit functions, credits tothe economic activities falling under Priority II (real estate loans, consumption andother non-productive, speculative activities) of the Schedule of Credit Priorities mustbe 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 recommendedthat the government abandon its mandatory lending policies because they only bringup 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 PhilippineDevelopment Plan for 1999-2004 was the amendment of the Agri-Agra Law to lift the25 percent quota of loanable funds to agriculture. It should also be noted that both theNew Central Bank Act and the General Banking Law have done away with the devel-opmental objective. Such requirements posed distortions in the banking system, andran 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 thesesectors, although the general consensus was that they were not very effective or suc-cessful (Magno 1988; Llanto et al. 1990; RIDA 1995). Strict compliance has been


fairly low. Efforts to make the requirements more flexible by allowing other means tocomply with the provisions (e.g., subscription to Erap bonds, bonds for socializedhousing) clearly defeat the purpose of such policies to direct credit to priority sectorsand magnify their overall ineffectiveness.

9. Special rules concerning liquidation, winding up, insolvency, compositionor analogous proceedings in the banking sector

The exit procedure in the banking sector is fairly well defined under the NewCentral Bank Act. A bank or quasi-bank that is found to be unable or unwilling tomaintain a condition of liquidity deemed adequate to protect its depositors and credi-tors may be placed under the authority of a conservator by the Monetary Board. Theconservator is empowered to overrule or revoke the actions of the previous manage-ment and board of directors of the bank or quasi-bank, as well as exercise all powers tobe vested by the Monetary Board as it deems necessary. The Monetary Board canterminate the conservatorship when it is satisfied that the institution can continue tooperate on its own.

If a bank is found to be insolvent, the Monetary Board may summarily and with-out need for prior hearing forbid the bank from doing business, and designate thePDIC as its receiver. If the PDIC finds that the bank cannot be rehabilitated, theMonetary Board shall notify the board of directors and direct the receiver with theliquidation. The bank’s assets will be converted to money for the purpose of paying itscreditors and other parties, in accordance with the rules on concurrence and prefer-ence of credit under the Civil Code of the Philippines.

Technically, the PDIC has 90 days to decide whether to rehabilitate or liquidate abank. The decision to close small banks, such as rural banks, is fairly quick andstraightforward. When it comes to bigger banks, however, there is an implicit policyof preventing their closure because of potential contagion effects on the entire bank-ing sector. Thus, the BSP, PDIC and the SEC have been heavily involved in the reha-bilitation of some failed banks such as Orient Bank, which failed in 1998, and morerecently, Urban Bank and Prime Savings Bank. Charges of fraud and engaging inunsafe and unsound banking practices have also been filed against the officials ofthese banks, as well as against a number of rural banks. Although similar cases havepreviously been filed, regulators have yet to successfully prosecute a banker accused offraud.

10. Industry regulatorThe 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 depart-ments help to carry out this function—the Supervision and Examination Sector(SES), which is the operating department, and the Supervisory Reports and SpecialStudies Office (SRSO), which receives the regular financial reports, generates thestatistical reports for the use of the operating departments, and reviews systems and


procedures related to supervision. The PDIC also monitors the activities of banks,although it primarily relies on information gathered by the BSP. The PDIC especiallyoversees rural banks, since RA 7653 (New Central Bank Act of 1993) transferred thereceivership and liquidation of rural banks from the BSP to the PDIC. Finally, theSEC registers the banks’ articles of incorporation, but only if they are accompanied bya certificate of authority to operate issued by the Monetary Board (Lamberte andLlanto 1993; Intal and Llanto 1998).

The BSP’s supervisory powers over the operations and activities of banks includethe issuance of rules of conduct or the establishment of standards of operation; theconduct of examination to determine compliance with laws and regulations; regularannual investigation to determine whether an institution is conducting its business ona safe or sound basis; inquiring into the solvency and liquidity of the institution; andenforcing prompt corrective action. RA 8791 also granted the BSP supervisory andregulatory 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 sys-tem, covering both banks and nonbank financial institutions (NBFIs), in the early1970s proved auspicious with the broadening of the range of services and activitiesthat banks, particularly commercial banks, were allowed to undertake in the early1980s. In particular, the cross-ownership and/or interlocking directorships of banksand NBFIs have resulted in overlapping regulatory and supervisory functions. Forinstance, the SEC, which acts as the registrar for all companies, also regulates andsupervises the securities market. Insurance firms, excluding government-owned in-surance corporations that are governed by their respective charters, are regulated andsupervised by the Insurance Commission of the Philippines. Given such overlaps,well-delineated roles for and coordination among all regulatory/supervisory bodies inany capacity are vital to properly regulate or supervise the financial sector, particu-larly the banking sector. This would help ensure that all risks are accounted for, andthat regulatory avoidance or arbitrage does not become a problem. In this context, theoff-loading of supervisory and regulatory functions over some financial institutionsfrom the BSP to the SEC, for instance, needs to be evaluated even though, as wasnoted earlier, there are provisions in the New Central Bank Act and General BankingLaw that allow the BSP to examine banks’ subsidiaries and affiliates, and thus ascer-tain the overall or consolidated condition of banks. The issue then is how to put theseprovisions into operation.

As this review of current regulations shows, the BSP continues to have pervasivepowers over banks from their entry to their exit. The new General Banking Lawserved to reinforce this by increasing both the depth and width of regulation. In par-ticular, it allows the BSP to potentially regulate areas that are not currently subject toregulation, including those that had been deregulated in the past. Thus, the BSP canstrongly influence the behavior of banks and the overall status and structure of thebanking sector.


Insurance sector7

The regulation and supervision of the insurance industry is the responsibility ofthe Insurance Commission, which was set up as an autonomous body in 1949 when itwas split from the Central Bank of the Philippines. It falls under the jurisdiction of theDepartment of Finance (DOF), although the latter’s role is not well defined and isweak especially with respect to its oversight functions. The Insurance Commission isa 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 frameworkgoverning the insurance industry. Although this resulted in overall financial sound-ness, it was also deemed as overly cautious and thus constrained the industry’s growthand development. The Philippine insurance industry was deemed as lagging behindin terms of product development and innovation. An even more adverse effect of thisstance was that it prevented the industry from playing a more active role in the devel-opment of the Philippine capital market. Unlike the mismatch between the maturitiesof banks’ assets and liabilities, for instance, life insurance companies can lend theirfunds 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 Actof 1966 was to ban the entry of new insurance companies. The restriction on entry wasalso retained under the 1978 Insurance Code, although it did not provide specificconditions for approval to engage in insurance business and was not particularly re-strictive. The rationale was also similar: there was a rapid growth in the number ofinsurance 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). Theindustry was also deemed as overcrowded, hence the restriction on new entry.

With respect to foreign participation in the industry, the Insurance Commissionwas also stricter relative to the general restriction on foreign investments in the coun-try. The Foreign Investment Act allowed foreign equity participation of up to 30 per-cent in certain industries including insurance. This limit was raised to 40 percent in1987. But in the insurance industry, the Insurance Commission further restricted for-eign 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 theforeign companies that were already in operation. This dichotomy in policy was dueto the difference in the structure of the nonlife relative to the life insurance sector. Theformer was characterized by a large number of weakly capitalized companies, whilethe latter was judged to be overcrowded but adequately capitalized. Thus, foreigninvestment 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-

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7 The historical discussion of regulation of the insurance sector draws on World Bank (1992).


ance companies because they mobilized domestic savings. This could also be the ra-tionale for the policy of limiting foreign banks to a minority position.

In contrast to the banking sector, the nature of regulation in the insurance indus-try did not evolve over time. However, the reform particularly of entry restrictions wasfairly quick when it occured in the 1990s. In March 1992, the Department of Financeissued an order that opened the insurance industry to new entrants.8 The restriction onforeign equity in the life insurance sector was also removed. In particular, foreignerequity participation of up to 40 percent in both existing and new life insurance compa-nies was allowed. However, significantly higher minimum paid-up capital require-ments were set for the new companies.

In October 1994, the Department of Finance issued another set of guidelines onthe entry of new foreign insurance or reinsurance companies or intermediaries.9 Inparticular, a foreign insurance or reinsurance company or intermediary was allowedentry under (only) one of the following modes: (i) ownership of the voting stock of anexisting domestic insurance or reinsurance incorporated in the Philippines; (ii) in-vestment in new insurance or reinsurance company or intermediary incorporated inthe Philippines; or (iii) establishment of a branch, but not for an intermediary. Toqualify for entry, the companies have to belong to the top 200 foreign insurance orreinsurance or intermediaries in the world or among the top 10 in their country oforigin, and have been in business for at least 10 years. To qualify as a branch or as anew company incorporated in the Philippines, a company also has to be widely ownedand publicly listed in its country of origin, unless it was majority owned by the gov-ernment. To be considered as “widely owned,” no single stockholder of the applicantmust own more than 20 percent of its voting stock.

A foreign insurance or reinsurance company that would operate as a branch, orwhere foreign equity in the company or intermediary was more than 40 percent, wasallowed entry only within two years from the effectivity of the Order. During thisperiod, the number of foreign insurance or reinsurance companies or intermediariesthat would be allowed entry was five each, although this could be increased to 10upon the recommendation of the Department of Finance and the approval of thePresident. No composite license was to be issued to an insurance applicant underthese 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 upto 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-

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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 acompany as either domestic or foreign, depending on its place of incorporation. Domestic com-panies are those formed, organized, or existing under Philippine laws. That is, the InsuranceCode considers foreign registration and not foreign ownership as the deciding factor.


ance company must satisfy capital, asset, and other requirements, such as qualifica-tions 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 tomaintain tight control over the industry. Authorization is also needed before an insur-ance company can transact both life and nonlife insurance business. There are alsopricing restrictions, lines of business restrictions, and restrictions on interlocking di-rectorships and officerships.

Other requirements under the Insurance Code include minimum paid-up capitaland contributed surplus, which are adjusted from time to time. The Code also con-tained specific provisions concerning capital and required reserves. The 1994 guide-lines, for instance, raised minimum capital requirements for new companies, with theamount increasing significantly as the foreign equity in the company increased (Table3). Aside from paid-up capital, stockholders are also required to pay a contributedsurplus in cash to the company. In addition, foreign insurance companies have todeposit with the Insurance Commission eligible securities equivalent to the actualmarket value of not less than the minimum paid-up capital required of domestic in-surance companies. At least 50 percent of such securities have to consist of bonds orother evidences of debt of the Philippine government and government-owned or con-trolled corporations (GOCCs), including the Philippine central bank. In the case ofdomestic companies, they have to deposit 25 percent of minimum paid-up capital withthe Insurance Commission, also in the form of government or associated securities.Foreign insurance or reinsurance companies seeking to establish branches are furtherrequired to deposit with the Insurance Commission allowable securities to the marketvalue of not less than P300 million or P500 million, respectively.

In contrast to the policy on entry, the Insurance Code’s requirements on invest-ment policies and practices are quite restrictive, which resulted in insurance compa-nies’ very conservative investment choices. The Insurance Commission defined itsrole in regulating investments as follows: “By the very nature of insurance business,insurance companies need investments which are safe and free from excessive market

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.


price fluctuations since a relatively small shrinkage in asset values could endangertheir solvency” (World Bank 1992:126). Restrictions on the portfolio of assets thatinsurance companies could hold include limits on investments in stocks, bonds andother certificates of indebtedness, real estate investments, investment in a single en-terprise, and investments in foreign currency. These restrictions, coupled with therequired security deposits, led to a relatively high proportion of the industry’s portfo-lio in short term assets and government paper.

Another important effect of the tight and conservative regulation of the insuranceindustry 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 regulationand 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 recentlyissued a circular10 that set limits on the investment portfolio of pre-need companies.The circular restricted pre-need companies’ trust fund investments to fixed incomeinstruments, mutual funds, blue chip equities and real estate in first-class cities andmunicipalities. There is also a pending bill in Congress, the Pre-need Plans SecurityCode, which seeks to strengthen the protection offered to pre-need plan holders byplacing this industry under the authority of the Insurance Commission. Consideringthe similar nature of their business, such a move would serve to harmonize the regu-lation of the pre-need industry with that of the insurance industry, and hence dissipateany undue advantage of the former over the latter.

Overall, the reform process in the insurance sector is just beginning and moreneeds to be done. The Insurance Commission is in the process of revising the Insur-ance Code to address significant changes brought about by financial liberalizationand globalization of financial markets. It would do well to learn from the experienceof the banking sector in this regard.

While it is important to monitor the evolution of financial policies, the broaderprocess of structural change in the financial system needs to be assessed as well. Inparticular, the use of indicators, which help to monitor the broader process of struc-tural change in the financial system, would provide a more critical and thoroughassessment of financial reforms. The government would then be better guided in itsreform 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 identifyareas 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

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10 Memorandum Circular No. 1, which took effect on 21 June 2000.


give a clear/full picture of the extent to which playing fields are being leveled inpractice. Thus, policy changes need to be considered along with changes in the com-petitive structure of the financial sector. The monitoring of structural change in thebanking and insurance sectors can be done through the use of some indicators ofchanges in competitive structure and indicators of gains in competitive efficiencyimplicit in financial market performance.

BANKING SECTOR

Financial structureThe Philippine financial system consists of banks and nonbank financial institu-

tions (NBFIs). RA 8791 classifies banks into commercial banks, universal banks (ex-panded commercial banks), thrift banks (savings and mortgage banks, stock savingsand loan associations, and private development banks), rural banks, cooperativebanks, and Islamic banks. NBFIs include, among others, insurance companies, in-vestment houses, financing companies, securities dealers and brokers, fund manag-ers, lending investors, pension funds, pawnshops and nonstock savings and loanassociations.

Figure 1 shows the total assets of the Philippine financial system from 1970 to1999. 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 in1988 as a result of the financial and economic crises in the mid-1980s. The ratio roseto around 140 percent in 1997, and again declined to 124 percent in the aftermath of

Sources of basic data: Bangko Sentral ng Pilipinas; National Statistical Coordination Board.

Figure 1. Assets of the Philippine Financial System, by Type of Institution, 1970-1999

(in billion P)


the Asian crisis. The total assets of commercial banks, in particular, grew signifi-cantly 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 andforeign banks.

The Philippine financial system has consistently been dominated by commercialbanks. In fact, the importance of commercial banks even increased over time. Thebanking system accounted for 81 percent of total financial assets in 1999, compared toaround 76 percent in 1970. The asset share of commercial banks also increased fromaround 57 percent in 1970 to 73 percent in 1999. In contrast, the asset share of ruralbanks fell from around 3 percent in the 1970s to less than 2 percent in 1999, while theasset share of thrift banks only slightly rose to 6 percent in 1999 from 4 percent in1970. On the other hand, the share of NBFIs in total financial assets fell from a highof 28 percent in 1975 to 19 percent in 1999.

Thus, there has been no significant structural change in the Philippine financialsector. A bank-dominated financial system is not necessarily bad. The issue iswhether 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 histori-cally 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 inthe mid-1990s. A theory on the relationship between financial development and eco-nomic development in a market-oriented economy posits that the banking system,which initially leads financial development, declines in importance as real growthand financial development continue (Goldsmith 1969). One observed characteristic ofthe process of economic development over time in a market-oriented economy is anexpansion and elaboration of the financial structure (institutions, instruments, andactivities). On the other hand, economic development is retarded if financial interme-diaries do not evolve (Patrick 1966). This was also borne out by more recent empiricalliterature (e.g., King and Levine 1996; Lee 1991).

Table 4 shows the number of offices of financial institutions operating in thePhilippines from 1980 to 1999. The easing of restrictions on bank branching was veryevident in the rapid growth of banking offices. Compared to just 0.5 percent in the1980s, the number of banking offices in the 1990s grew at an average annual rate of8.7 percent, with all bank categories posting significant growth. In particular, double-digit growth rates were recorded in the number of branches of rural banks beginningin 1990 and in commercial and thrift banks beginning in 1992. The period after thederegulation of foreign bank entry but before the Asian crisis was also marked by adramatic increase in the number of commercial and thrift bank branches. The in-crease in the number of head offices of commercial banks was largely due to the entryof foreign banks in 1995. However, foreign banks were at a serious disadvantage interms of number of branches. For instance, private domestic commercial banks had atotal of over 4,000 branches in 1999. In contrast, foreign bank branches and subsid-iaries had only around 219 branches.


Overall, the Philippine banking system continued to be characterized by the pres-ence 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 marketpower. Table 5 shows the number of commercial banks by ownership. In contrast toprevious decades, the period after 1995 was characterized by significant movement in

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


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


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.

Table 4. Number of Financial Institutions, 1980-June 1999

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 1 1 2 4 3 3 3 3

Note: Data for the first quarter of 2000 incorporate the mergers and acquisitions reportedin Table 6.

Source of basic data: Bangko Sentral ng Pilipinas.


the commercial banking sector in terms of new entries and consolidations. The num-ber of foreign bank branches and subsidiaries increased as a result of deregulation. Onthe other hand, the number of domestic private banks initially increased in the firsthalf of the 1990s as a result of deregulation of entry, then decreased toward the latterhalf due to mergers and acquisitions. Although the BSP encouraged mergers andacquisitions to meet the higher capital requirements, the latter primarily took placeamong the biggest banks (Table 6). Thus, the motivation would seem to be to protectmarket share.

Figure 2 shows the distribution of commercial bank assets according to owner-ship of banks. Private domestic banks consistently accounted for over 60 percent oftotal commercial bank assets. Private domestic banks’ share rose to as high as 77percent in 1994, before subsequently falling to around 67 percent in 1999, with theentry 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 sharerises to around 76 percent in 1999. On the other hand, the asset share of foreign bankbranches 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 27percent in 1980 (accounted for by PNB) to 12.6 percent in 1999.

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).


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

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

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

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

Table 7. Ownership Structure of Private Domestic Banks: Percentage Share

to Total Subscribed Capital, 1997/98

Filipino Foreign Filipino Foreign

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.

1


Measures of concentrationFigure 3 presents some asset concentration measures of the Philippine commer-

cial banking system. Although the actual value of the Herfindahl index (HI)11 may notbe indicative of undue concentration, given its very low values, it would also be usefulto look at the trend. The HI was fairly stable from 1990 to 1994. It began to decline in1995 with the entry of the new foreign banks, indicating that the system was becom-ing less concentrated. However, this trend was reversed beginning in 1998, whichmeans that the mergers and acquisitions also resulted in increasing concentration.

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11 The Herfindahl index, which is a commonly used measure of industrial concentration, iscalculated by squaring and summing the share of industry size accounted for by every firm inthe industry, with a maximum value of 1 (or 10,000 where the market share is measured inpercentage terms) indicating a monopoly.

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

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

Similar trends are also evident when one looks at the asset share of the three and fivelargest commercial banks, which are all domestic banks. Before the restriction on newbank entry was eased in 1995, the five largest commercial banks consistently ac-counted for around half of the sector’s total assets. Their share declined to around 37percent in 1997, but this trend has since been reversed. Also, the wide gap betweenthe five biggest and five smallest commercial banks is stark.

The concern with excessive concentration is that it is a potential source of mo-nopoly power. Tan (1989) further argued that the institutional setting was likely toenhance the power of dominant banks in the industry. First, all the head offices ofcommercial banks were located in Metro Manila. Second, their owners/managers be-longed to a loosely knit and geographically proximate social group. And in a numberof cases, their business interdependence extended beyond banking and included bank-


ing conglomeration in production and trade. Thus, there is a need to monitor theconcentration process even in a deregulated environment to detect any furtherstrengthening of the oligopolistic group and to ensure that it does not lead to misuse ofmarket power.

Operational efficiencyOperational efficiency is a microeconomic concept, but it is also used to charac-

terize a financial system. In particular, the market structure could be reflected in thespread between the cost of funds and the lending rate: a financial system is consideredoperationally efficient if the interest spread is low. The latter, in turn, arises from twofactors. On a microeconomic level, the more cost efficient banks are, the lower thespread will be under reasonably competitive conditions. On a macroeconomic level,systemic risks also affect the spread. A more stable and confident environment willlead to a lower risk premium over lending, thus leading to a lower spread (Ersel andKandil 2000).

A high intermediation margin would imply a smaller intermediation activity(Tan 1989). One of the structural weaknesses identified in the past in the Philippinebanking sector was the large spread between commercial bank deposit and lendingrates, which in turn was attributed to high intermediation costs mainly in the form oftaxes 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 totaxes, but to some monopoly power of the large commercial banks as well. Morerecently, the World Bank (1998) noted that high intermediation costs continued to bea feature of the Philippine banking system, especially when compared to other Asianeconomies.12 Average net interest margin as a ratio of total assets from 1988 to 1995was 4.2 percent. Figures for comparable countries like Indonesia and Thailand were3.5 and 3.1 percent, respectively (Demirguc-Kunt and Huizinga 1997; Claessens andGlaessner 1998).

In addition to high reserve requirements and the mandated credit requirementsdiscussed earlier, other contributing factors to the Philippines’ high intermediationcosts were high operating costs and insufficient competition (World Bank 1998). Op-erating costs of banks were found to be significantly higher in the Philippines com-pared to other Asian economies. In particular, average overhead costs as a ratio oftotal assets in 1988 to 1995 was around 4.4 percent, compared to 2.9 percent and 2.0percent 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 withcare because a number of country-specific regulatory, tax, macroeconomic and microeconomicfactors affect the costs of financial intermediation.


assets was around 2 percent for Philippine banks during the same period, against 0.9and 1.1 for Indonesia and Thailand respectively (Demirguc-Kunt and Huizinga 1997;Claessens and Glaessner 1998). Thus, the World Bank (1998) noted that the “highprofits despite high costs indicate lack of competition, which is also evidenced by thefact that there is high concentration in the banking sector…” (p. 23).

Tan (1989) has previously argued that the ultimate effect of the policy of re-stricted entry into the banking sector has been to shield both the big and small banksfrom competition which allowed the big banks to earn abnormal profits and thesmall banks to operate at high costs. Thus, it is important for the banking industry tobe sufficiently competitive if financial intermediation is to be carried out efficiently.The partial liberalization of foreign bank entry in 1994 precisely aimed to increasecompetition and improve efficiency in the domestic banking sector. By increasingcompetition, 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 impacton bank spreads. Table 8 shows domestic commercial banks’ average spread andrates of return both prior to and after the restriction on foreign bank entry was easedin 1995. Both only slightly declined during the post-liberalization years prior to theAsian crisis.

Recent studies have examined the impact of the entry of more foreign banks ondomestic banks’ interest rate spreads and efficiency (e.g., Manzano and Neri 2001;Montinola and Moreno 2001; Unite and Sullivan 2001). Overall, their results indicatethat foreign bank entry has had limited impact. Manzano and Neri (2001) noted thatthe effects on competition might not have been felt immediately because of a period ofadjustment for the foreign banks, and/or because liberalization did not go farenough. But ultimately, they attributed the persistence of high bank spreads to thegovernment’s macroeconomic policy mix. In particular, the overvalued exchangerate before the crisis encouraged foreign borrowing and dollar intermediation by

Pre-liberalization: 1991-942 4.733 2.51 25.66

Post-liberalization: 1995-97 4.345 2.23 18.83

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

Average Spread1 Average Rate of Return

on Assets on Equity

Notes: 1 Difference between lending and deposit rates adjusted for the gross receipts tax andchanges in required reserves;

2 1987-94 for Average rate of return.Source: Lamberte (1999).


banks, which dampened the competition for peso deposits and upward movements inthe deposit rate. On the other hand, the government’s high interest rate policy todefend the exchange rate caused banks’ lending rate to remain high. Thus, the im-pact of macroeconomic factors could have masked the impact of foreign bank entryon domestic banks’ interest spread. According to Montinola and Moreno (2001), thescope of liberalization was limited, hence its modest effects on competitiveness andefficiency.

A more in-depth study of the determinants of bank net interest margins would beuseful to establish the impact of the change in the structure of bank competition.Apart from the market structure component, regulatory components in the form ofreserve requirements and capital to asset ratios, and a risk premium component toaccount for uncertainty in the macroeconomic environment facing banks would havesignificant effects on bank net interest margins (Saunders and Schumacher 2000).With respect to the regulatory components, it has also been argued that part of thereason for the high bank spreads is that Philippine banks are heavily capitalized andless leveraged. In the years prior to the 1997 Asian crisis, Philippine banks’ capitaladequacy ratio, defined as the ratio of net worth to risk assets, was between 17 and 20percent compared to the Bank for International Settlement’s requirement of 8 per-cent. Holding equity capital is relatively costly when compared to debt, and so banksthat have relatively high capital ratios can be expected to try to cover some of thiscost by imposing an extra spread (Saunders and Schumacher 2000). On the otherhand, reserve requirements in the 1990s were significantly lower compared toprevious periods. This, together with higher interest rates paid on reserves,should have served to reduce banks’ cost of intermediation. Finally, the manda-tory credit requirements continued to act as a tax on banks that gets translatedinto a higher spread.

While the entry of more foreign banks in 1995 has not had a visible impact interms of reducing domestic banks’ interest spread, this does not mean that foreignbanks have had no impact whatsoever on domestic banks’ operations and on the levelof competition in the banking sector. Focusing on price or interest competition doesnot take into account the dynamic aspect of competition and efficiency. The latterrefers to the structural response of banks to deregulation as reflected for instance intheir 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 developedeconomies such as the European Union have been based on traditional static modelsand analyses of industrial organization, wherein technology and consumer demandare given and price (output) is the firm’s main, if not its only, choice variable. Incontrast to the static models’ focus on price competition, more recent dynamic modelsof industrial organization argue that firms in reality are “engaged in a continuingdynamic competitive process, constantly creating and adopting new products and pro-cesses in order to gain advantage over their rivals” (p. 618). And in a dynamiceconomy, the latter may have a more significant effect on welfare than the former in


the long run. The issue is especially relevant to financial markets as they operate inmore deregulated and globalized environments and become increasingly character-ized by technological advancements and product innovations. This emphasizes theneed to augment traditional analyses of industrial organization, such as Bain’s (1956)Structure-Conduct-Performance paradigm, with more dynamic analyses of marketsand institutions in order to come up with a fuller depiction of competition (Audretschet al. 2001).

In the Philippines, foreign banks traditionally competed with local banks prima-rily in corporate lending and nonbranch-based financial services. A survey of selectedlocal banks on their reactions to the entry of more foreign banks in 1995 indicated thatthe latter has led to a more competitive environment particularly in wholesale bank-ing (Hapitan 2001). The entry of more foreign banks further reduced the alreadythinning spreads from servicing corporate accounts because of the entry of more localbanks in the early 1990s. This induced local banks to tap other segments of the marketthat would generate higher returns. Thus, local banks shifted their focus toward de-veloping products and services for the middle and retail consumer markets, and, tosome extent, the previously neglected small- and medium-sized enterprises. Localbanks also sought to improve existing product lines and services, especially by intro-ducing technology- based enhancements such as phone banking, bills payment, point-of-sale transactions, and Internet banking (AAC 1998). But as Hapitan (2001) alsonoted, 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 persis-tence of high bank spreads, both from the cost and profit aspects. Banks whose ser-vices are directed more toward retail operations normally have higher operating costscompared to banks that are more oriented toward wholesale markets. This is due tothe former’s need for more branches, equipment and personnel to serve retail custom-ers. Higher operating costs then translate into a higher spread (Brock and Suarez2000). Branches of domestic commercial banks expanded rapidly especially in 1995-1997, which accounts for the increasing trend in their operating costs during thatperiod. The shift toward more profitable retail lending could have also allowed banksto maintain their profit margins. The New General Banking Law has allowed foreignbanks to fully own an existing local bank, thus relaxing the restriction on branchingby foreign banks. In December 2000, Hong Kong Shanghai Banking Corporation(HSBC) acquired a local thrift bank, which could further enhance competition in themiddle and retail consumer markets.

INSURANCE SECTORIt 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 theinsurance sector. In fact, the share of the insurance sector in total NBFI assets steadilyincreased over the past two decades, from 47 percent in 1980 to 71 percent in 1998


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

There are two broad categories in the insurance industry: life and nonlife. Thesetwo categories not only offer entirely different products, but also have different struc-tures, modes of operation, constituent characteristics and regulatory requirements.Although the industry is largely private owned, it also includes five government in-surance corporations: the Government Service Insurance System (GSIS), Social Secu-rity System (SSS), Philippine Crop Insurance Corporation (PCIC), PhilippineDeposit Insurance Corporation (PDIC) and the Home Mortgage and Guarantee Fund(HMGF). These government corporations are governed by their respective chartersand do not fall under the authority of the Insurance Commission. The governmentsector has consistently been twice as big as the private insurance industry in terms ofassets. Another important sector is the pre-need industry, which also operated outsideof the purview of the Insurance Commission. Thus, the pre-need industry grew sig-nificantly since it operated under a less restrictive regulatory environment relative tothe life and nonlife insurance sectors.

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

Table 9. Share of the Insurance Sector in Total Financial and NBFIs Assets,

1980-1998 (%)

Note: 1 SSS and GSIS.Sources of basic data: Social Security System; Government Service Insurance System;Bangko Sentral ng Pilipinas.


Table 10 shows the total assets of the private insurance industry. Total assets inreal terms grew very fast in the 1990s compared to the 1980—8.5 percent per annumfrom 1991 to 1998 as opposed to just 2 percent from 1980 to 1990. The real growthrates 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 lessthan 6 percent in 1998. The life insurance sector grew at a faster rate of 10 percent perannum in the 1990s, while the nonlife insurance sector grew by around 6 percent. Interms of percentage distribution, life insurance accounted for over half of total assets,with its share significantly growing in the 1990s.

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-ownedcompanies.Source of basic: Insurance Commission.

Table 10. Distribution of Total Assets of the Insurance Sector, 1980-1998

In contrast to the banking sector, there was significant foreign participation inthe insurance industry even prior to deregulation of entry. In particular, total assets ofthe life insurance sector were roughly equally divided between domestic and foreign-owned companies. Also, total assets of foreign-owned insurance companies in realterms grew at an average annual rate of 11 percent in the 1990s, which was doublethat of domestic companies. This was due to the deregulation of foreign entry. Most ofthe new foreign entrants were life insurance companies, which also accounted fortheir increasing share in this sector. In contrast, there was a decline both in the overall


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 allow-ing 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 privateinsurance companies (Table 11). There were around 148 private insurance companiesin 1998 compared to 129 in 1995, around 70-80 percent of which are domestic nonlifeinsurance companies. As noted earlier, most of the new foreign entrants were lifeinsurance companies that increased their number and asset share from 1995 to 1998.Although there were also more domestic life insurance companies, their asset sharedeclined 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 num-ber of domestic companies increased further to 96 in 1998. Taking into account thedecline in the asset share of the domestic nonlife insurance companies over this pe-riod, 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 doesindicate 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


largest life insurance companies which consistently accounted for at least 80 percentof total assets of this sector. In contrast, the asset share of the five largest nonlifeinsurance companies was less than 40 percent. However, the latter also signifies ahigh degree of concentration given the greater number of nonlife insurance compa-nies. The World Bank (1992) noted that these small, weak companies are one of theprincipal 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 tobe common in other countries as well. There was also a slight downward trend in theHI for the life insurance sector with the entry of more foreign companies. But as in thebanking sector, the oligopolistic structure in both life and nonlife insurance is veryevident.

The rapid growth of the insurance industry in recent years augurs well for thedevelopment of the country’s capital markets and overall economic growth. Life in-surance 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 canalso lend their funds on a long-term basis. It should also be noted that the industrygrew under a still restrictive regulatory framework.

Again, as in the banking sector, the danger inherent in a policy of closed marketsshould also be underscored and competition encouraged in the insurance industry. Inparticular, the presence of subsidiaries or branches of foreign insurers, as well as

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

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


foreign companies’ acquisition of minority or majority interests, contributes to thedevelopment of the domestic insurance sector. Foreign presence brings with it innova-tion and transfers of know-how, while at the same time giving access to additionalfinancial resources, improving insurance rules, fostering greater diversification ofbusiness, expanding capacity, broadening the scope of products offered, and increas-ing financial security (OECD 1997). But clearly, further reforms are needed tocomplement the deregulation of foreign entry into the Philippine market. Overly con-servative and restrictive investment policies and practices led to rather perverse re-sults in that they encouraged investments in short-term assets, especially governmentsecurities. This created an unfortunate mismatch between the maturities of theindustry’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 in-vestment 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 overtime. It was only very recently that deregulatory reforms in the insurance sector wereinitiated. Overall, the results indicate that one recent policy reform had an especiallysignificant positive impact on the competitive structure of the commercial bankingsector—the liberalization of entry of new banks. This led to less concentration andpresumably, 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 beenon going for more than a decade, is explored further in the next section, which looks atthe regulation of the financial sector in the overall context of competition policy.

COMPETITION POLICY ISSUES IN THE FINANCIALSECTOR

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

BANKING SECTOROverall, the banking sector in the Philippines is still subject to extensive govern-

ment regulation. This is not surprising since even banks in developed economies aretypically subject to substantial public regulation. While most of the current regula-tions are justified for prudential reasons, particularly to protect the stability andsoundness of the financial system, some longstanding restrictions are clearly meant toachieve some social objective. Furthermore, some regulations may no longer be nec-essary for prudential reasons, thereby restricting competition unnecessarily. Thus, anappraisal of existing regulations to ascertain their impact on competition and effi-ciency, and their overall effectiveness in the rapidly changing financial environmentis always instructive.


It has been repeatedly pointed out in the literature that better prudential regula-tion and supervision are of paramount importance in dealing with the consequencesof liberalization and globalization of financial markets. However, better regulationdoes not necessarily call for the institution of more or stronger rules, but a differentkind of regulation. New approaches to the supervision of financial institutions havebeen characterized by a shift in focus away from formulaic capital standards andmandated portfolio structures, toward improvements in transparency and in the su-pervision of risk management systems (Hendricks and Hirtle 1997). Prudential super-vision is designed for balance sheet regulation and the rise in off-balance-sheetactivities of banks diminish the importance and effectiveness of such regulation.Thus, there is also a need to strengthen disclosure, transparency, and bankruptcyrules. Reporting requirements seem to be comprehensive and adequate for supervi-sory needs in the Philippines. What needs to be ensured is that all data and informa-tion are effectively utilized.

In the case of the Philippines, the need for stronger prudential regulation andsupervision is partly due to the explicit, and more importantly, the implicit guaranteesin the financial system. Ultimately, the way to reduce the former would be to mini-mize the latter. Prudential regulation in effect substitutes the judgment of regulatorsfor 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 itsown risk exposure, regulators have an incentive to further limit the behavior of regu-lated institutions. But prudential regulation lessens competitive pressure and carriesefficiency costs (Wallis et al. 1997). It should be pointed out that regulators also havethe potential to engage in moral hazard, that is, regulators may cover up problems inthe financial system, whether to hide their mistakes or because of political pressure(Aoki 1997). Overregulation is costly, cumbersome, and counterproductive. The issuethen becomes, what constitutes appropriate prudential regulation?

One area of public policy that has had a significant impact on the structure andperformance of the Philippine banking sector is on entry and branching. In particular,restrictions on entry and branching led to an uncompetitive and inefficient bankingsystem. On the other hand, their deregulation enhanced the contestability and com-petitiveness of the market and facilitated changes in banking trends, such as the intro-duction of new products, services, and technologies.

Entry into the banking sector is one area that continues to be regulated even inthe most liberalized or deregulated financial system. For instance, even the OECDcountries 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 re-quirements, and more importantly, fitness and properness criteria for controllers andmanagers of banks. On the other hand, the entry of foreign banks is relatively morerestricted (OECD 1998a). Thus, regulation of entry to the banking industry is prima-rily a tool of prudential regulation. “Free banking,” or the removal of entry and other


restrictions without accompanying prudential regulations, is not deemed as tenablebecause it could lead to overcompetition and excessive risk taking, thus compromis-ing the stability and soundness of the banking system. In contrast, current entry regu-lations in the Philippines contain similar prudential requirements, as well as anoutright ban on new entry of commercial banks.

Overall, government barriers to entry are typically imposed to limit and reducethe number, as well as increase the average size of banks in the Philippines. Biggerand fewer banks, in turn, are seen to promote the safety and soundness of the financialsystem. But it is also recognized that their removal would enhance marketcontestability and the competitive process. A balance needs to be struck between thepotential costs and potential benefits of allowing greater competition. In particular,the potential adverse effects of enhancing competition through a lowering of barriersto entry can be addressed by properly applying prudential regulations and restrictionssuch as those currently in place, especially the fitness and properness criteria for bankowners and managers. The focus should not just be the size of banks per se, butwhether they are sound, competitive and efficient. Although in the Philippines, onemerit of having direct entry restrictions is that it frees monetary authorities frompolitical interventions in the licensing process. On the other hand, the policy bias hasshifted in favor of foreign banks.

The literature on foreign banking typically asserts that foreign bank entry canrender national banking markets more competitive, thereby forcing domestic banks tooperate more efficiently. For instance, Claessens et al. (1998) provide empirical evi-dence that significant foreign ownership share of banks does reduce the profitabilityand overall expenses of domestically owned banks. The results demonstrate how for-eign bank entry can improve the functioning of national banking markets, with posi-tive overall welfare implications for banking customers and the economy, even as itreduces domestic banking profits. An interesting finding of their study is that thenumber of entrants, rather than their market share, is the critical factor. That is, theimpact of foreign banks on competition is immediately upon entry rather than afterthey have gained substantial market share. Papi and Revoltella (1999) likewise con-cluded that foreign direct investment in the banking sectors of transitional economiesalso provided valuable opportunities for the development of the host banking sectorand the host economy as a whole. In this context, the recent move to further liberalizeforeign bank entry in the Philippines is a step in the right direction. Also, it wouldseem that the aggregate 30 percent asset share limit on foreign majority-owned banksis 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 stakescould increase further. To date, the asset share of foreign bank branches and subsidiar-ies is around 15 percent of total banking assets. With the higher limit on total foreignequity participation of individuals and nonbanks in domestic banks, there is still con-


siderable room for increased foreign participation in the banking sector. This couldserve not just to widen the ownership base of domestic banks, but also change thenature of ownership and hence, banking in the Philippines.

Concentration of ownership continues to be a concern essentially because of itsadverse implications on allocation of credit, the worst case being DOSRI abuses. Arelated issue here is interlocking ownership among financial and nonfinancial firms.The overall experience of developing countries has been that when industrial con-glomerates control financial institutions, this led to a worsening in resource alloca-tion, decreased competition, conflicts of interest, and problems of financialinflexibility and instability. These problems are particularly serious in developingcountries with weak prudential regulation and supervision as well as tight restric-tions on entry into the banking industry (Fry 1988). Ironically, such linkages couldhave contributed to the stability of the Philippine financial system, for instance, byhelping to avert massive loan defaults during the crisis in the early 1980s. Bankstypically restructured loans to allied firms to avoid provisioning and write-offs forbad loans, and thus protected both nonfinancial and financial firms from bankruptcy.More recently, the Bankers Association of the Philippines spearheaded efforts toassist other ailing investment houses in the aftermath of the Asian crisis. This shouldthwart further contagion effects on the banking sector and avoid the Urban Bankexperience.

But while such linkages may contribute to the stability of the commercial bank-ing sector in the short run, any resulting adverse efficiency effects would eventuallybackfire on the banks themselves. The cases of Japan and South Korea clearly demon-strated this, with grave consequences for the entire economy. As long as scarce loan-able funds are not channeled to borrowers who can use them most productively, thelevel and quality of investments and consequently, the rate of economic growth, willbe 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 intermedia-tion to one of explicit market based transactions would enhance competition and effi-ciency.

In addition to the policy on entry and branching, other key policy issues withrespect to competition in the commercial banking sector that need to be addressedinclude:

• Anticompetitive agreements: The question of collusion and cartelization is alongstanding one in the commercial banking sector. Another issue is thepotential misuse of market power with the continued dominance of a fewlarge commercial banks. One way to deal with both these issues is to makethe threat of potential entry available at all times. Two main areas of concernwith respect to market concentration and collusion are overpricing of finan-cial products and underprovision of services essential to economic growthand welfare. For instance, it has been observed among OECD countries thatanticompetitive practices, such as nonitemized charges and financial penal-


ties for account closure, occurred more frequently with the deregulation offinancial services. Also, as banks enter into more cooperative arrangements(e.g., the interconnection of networks such as ATMs; operation of interna-tional credit card systems or national debit transfer systems), these give riseto competition concerns. Finally, it should be noted that anticompetitiveagreements could transpire not just between banks, but between banks andregulators as well.

• Competitive neutrality: Although the government’s share in total assets ofcommercial banks has declined, it is still quite substantial. The two govern-ment-owned banks were the fifth and seventh largest banks as of the firstquarter of 2000, and together, accounted for almost 13 percent of total com-mercial bank assets. The strong presence of government banks in the indus-try could lead to distortions in competition, especially since they have shiftedfrom development financing to commercial and industrial lending to directlycompete with private banks. More importantly, they are very prone to “be-hest loans,” which was the cause of the collapse of government banks in theearly 1980s. Land Bank of the Philippines (LBP), together with the Philip-pine National Bank (PNB), again experienced financial difficulties andsought assistance from the BSP in 2000. The LBP even considered transfer-ring its losses to the national government, but the latter’s growing deficit didnot allow it. The government is also making moves to regain control overPNB. Clearly, undue advantages because of their direct link to the govern-ment served to compromise their competitiveness and efficiency.

• Unjustified regulatory restrictions on competition: In addition to market en-try restrictions, restrictions on competitive behavior, such as portfolio re-strictions (e.g., mandatory credit requirements), also need to be assessed. Buta distinction needs to be made here between credit restrictions designed tochannel funds to specific sectors to achieve some social objective, and thoseimposed for prudential reasons.

Obliging banks to subsidize and/or service certain activities compro-mise their efficiency and may not be sustainable in a competitive environ-ment. That is not to say that the credit needs of the targeted sectors are notvalid, but the issue is the effectiveness of directed credit. Their credit needscan be more efficiently dealt with through other means, such as direct gov-ernment funding, transfer payments or provision of services. For instance, ithas been suggested that the government banks, which have become increas-ingly involved in commercial lending, revert to their original mandate ofdevelopment financing.

It is also important to have an effective treatment of the “exit problem.”This is influenced by policies toward exit, downsizing, bankruptcy and pub-lic bailout commitments. It is desirable, from the viewpoint of efficiency, thatinefficient and noncompetitive institutions discontinue their operations. But


if a series of banking failures is not handled well, it could trigger a crisis ofconfidence and thus threaten the stability of the entire financial system. Ingeneral, insolvent banks should be allowed to fail. Competition is distortedby policies that prevent banks from exiting from the marketplace in the nor-mal manner. Policies that seek to prevent bank failures may also deter entryinto the industry. Competition is further distorted when the statutory powersof 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 pow-ers for the BSP and the PDIC in dealing with problematic banks. It shouldalso be noted that losses due to its bail-out of troubled banks in the 1980spartly caused the collapse of the Central Bank of the Philippines, which re-quired its rehabilitation in 1993.

• Mergers and acquisitions: In addition to their potential impact on marketpower, potential effects on competition and efficiency need to be clearly iden-tified and considered. It needs to be pointed out that not all mergers andacquisitions are healthy for the economy. They could also lead to some prob-lems especially if they are regulation driven, such as using capitalizationrequirements to drive consolidation. For instance, one problem of increasingcapital through mergers and acquisitions is the potential additional risks incredit. Combining banking with nontraditional activities, such as insur-ance,13 may also extend the financial safety net. There should be a thoroughevaluation of the potential effects of consolidation. This would include bothdirect effects (e.g., increased market power and/or improved firm efficiency)and indirect effects (e.g., reduction in the availability of financial services tosmall customers). There are also potential systemic consequences, such aschanges in the efficiency of the payments system and the safety and sound-ness of the financial system (Berger et al. 1998). On the other hand, thePhilippine commercial banking sector has been found to still exhibit econo-mies of scale in the 1990s (Okuda 1999). Thus, it stands to benefit from moreconsolidation, particularly among the smaller banks.

INSURANCE SECTORIt 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 alot from the way competition policy has been implemented in the banking sector. Onekey lesson is the importance of policy consistency. An essential policy reform in thebanking sector, which occurred rather belatedly, was the deregulation of entry. Incontrast, 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 regula-tory implications more fully.


be noted that the easing of entry restrictions in the banking sector was also precededby other deregulatory measures, such as those on pricing and range of operations. Inaddition, proper safeguards were instituted, including the buildup of regulatory ca-pacity. Given the complementary nature of these reforms, the full benefits of financialliberalization could have been realized sooner had their implementation been prop-erly or even simultaneously paced. But one benefit of the delay in liberalization ofentry 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 shouldbe established to ensure the soundness of the insurance industry as well as the protec-tion of consumers. Simultaneous with this, a regulatory and supervisory body that iscapable of carrying out these tasks must be put in place. The strengthening of theregulatory and supervisory framework should be in parallel with other market-ori-ented reforms, particularly with competition and liberalization measures, to improvethe efficiency of the insurance industry (Kawai 1997).

Another important issue that needs to be addressed with respect to the regulatoryand supervisory framework is the lack of consistent regulation. In particular, the regu-lation of the pre-need industry should be harmonized with the regulation of the pri-vate insurance industry (World Bank 1992). Furthermore, regulatory and supervisoryauthorities need to ensure that state-owned companies and private firms are treatedequally. Regulations should ensure fair treatment among the different insurers operat-ing in the same areas (competitive neutrality). At the same time, the importance ofhaving different regulations applying to different sectors (e.g., life and nonlife insur-ance) must also be recognized. Each of these sectors operates under its own con-straints and requires specific management and regulatory structures (OECD 1997).

Other fundamental aspects of insurance regulation and supervision that need tobe addressed to enhance competition and efficiency include:

• Investments: Regulations governing the management of assets are typicallybased on a list of admissible investments. Governing principles include thoseon diversification, spread and liquidity; localization; currency matching;and maturity matching. Over regulation should be avoided. The insuranceregulatory framework must encourage stability, while maintaining the nec-essary flexibility to meet developments in the market (OECD 1997).

• Liberalization and competition: A program of removing monopolies andprivatizing state-owned companies should be considered. Considering thesize of the public sector relative to the private insurance industry, efforts toimprove the competitiveness and efficiency of the latter could be hinderedunless similar efforts are undertaken by government-owned insurance corpo-rations.

• Distribution and management of insurance products: The emergence of newinsurance companies and products necessitates the development of moderndistribution networks, with the possibility of an adequate combination ofseveral types of intermediaries (insurance company staff, agents, brokers,


direct sales, etc.) (OECD 1997). In the Philippines, life insurance is almostexclusively sold through agents, while a mixture of agents and brokers sellsnonlife insurance. Thus, the focus is on the licensing of agents, while littleattention is given to the effectiveness of the agency management processeswithin the industry. But the structural inefficiencies of such a distributionnetwork hamper the industry’s potential for growth and unduly involves theregulatory body in the network’s management. Thus, the development ofmore effective networks is necessary. In other countries, agents are a lessimportant channel of distribution while other channels, such as banks, arerelatively well developed (World Bank 1992).

The current limit on a universal bank’s equity investment in an insur-ance company is 51 percent. Increasing bank ownership of insurance compa-nies may help to improve the capitalization of the insurance industry andthus improve the capacity to grow without further reliance on overseas capi-tal. But the issue then becomes the effective supervision of both the bankingand insurance sectors and the requisite coordination and cooperation be-tween their respective regulatory bodies.

• Taxation: This is a key issue in any discussion of the insurance industry’sgrowth and development. Taxes imposed on the insurance industry havebeen described as onerous. They are also not uniformly applied (World Bank1992). There are current proposals to amend the tax structure by simplifyingit, lowering the rates and leveling the playing field.

REGULATORY FRAMEWORKIdentifying 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 ser-vice, uncompetitive pricing, or slower economic growth. In order to control costs andensure effectiveness, regulation has to be placed within a consistent framework. To dothis, it is necessary to clearly establish what needs to be regulated and why, as well asto 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. Thedevelopment of a national competition policy is a necessary and useful step in this direc-tion, and enhancing the role of competition in regulation may be one guiding principle.

In the financial sector, there are two aspects pertaining to regulatory frameworkthat need to be considered. First is the appropriate regulatory framework for the wholefinancial sector. Second is how a national competition policy framework should applyto the financial sector.

In addition to economies of scale, Philippine commercial banks have also beenfound to exhibit economies of scope (Okuda 1999). As such, they could achieve moreefficient production if they broadened the scope of their operations. The current regu-latory framework is supportive of such move toward diversification, given that line-


of-business restrictions have been eased under the new General Banking Law. Cross-sectoral ownership restrictions have likewise been relaxed. The interlocked structureof the Philippine financial sector could further diminish the effectiveness of suchrestrictions. Convergence or consolidation among financial institutions, overlappingof functions and blurring of product boundaries (e.g., between banks and insurancecompanies; cross-selling) would necessarily have an impact on the effectiveness andefficiency of regulation. Furthermore, new technology has allowed the unbundlingand repackaging of individual products in a various ways. This makes it easier tocircumvent regulations that prohibit an activity through product innovation to pro-duce a close substitute (Herring and Santomero 1995). Thus, an important issue thatneeds to be considered is the competition effects of regulations affecting banks andinsurance companies separately, for instance, within financial conglomerates.

The different standards of regulation and supervision of financial institutions bythe various government agencies have become more problematic recently. There havebeen some efforts to harmonize regulations, such as the SEC’s attempts to coordinatemore with the Insurance Commission and the BSP to improve the regulation of pre-need firms and investment houses under its jurisdiction, respectively. But a morewholistic and formalized approach is warranted. The regulatory approach governingline-of-business restrictions in the Philippines is the “conglomerate” approach. Theformation of cross-sector financial conglomerates (through the use of subsidiaries orholding companies) is allowed but there exist separate regulatory regimes for thetraditional categories of financial sector institutions, including banks, securities firmsand insurance companies. It is worth considering whether or not this approach needsto be supplanted by a “coordinated” approach.14 That is, the separate regulatory re-gimes for the parts of the conglomerate would still exist, but they are combined withregulatory and supervisory practices that explicitly take into account the conglomer-ate nature of the regulated institution (OECD 1998b). The latter would ensure consis-tency of regulation and prevent regulatory avoidance or arbitrage. Tan (2000) goesfurther and suggests that, for efficiency and streamlining of regulation, an OmnibusAct for all financial institutions may be the inevitable way forward. Consolidatingexisting supervisory roles, regulatory structures and financial services legislation isdeemed to be more cost effective and efficient. Both accord with the view that thecomplexity of financial products and markets, their intrinsic risks and the detailedknowledge required to deliver efficient regulation in this sector argue strongly forcontinued specialized regulatory arrangements in the financial sector. In which case,a separate regulatory agency (or agencies) to conduct such specialized regulation isalso still necessary (Wallis et al. 1997).

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14 A third approach is the “pillars” approach, wherein separate regulatory regimes for the majortraditional categories of financial sector institutions exist, and line-of-business and ownershiprestrictions prevent these “pillars” from competing in each others’ markets (OECD 1998b).


Under the New Central Bank Act, the BSP has become, to some extent, the defacto “super-regulator” of the financial system with its authority to supervise andexamine banks’ subsidiaries and affiliates engaged in allied activities (Sec. 25). TheAct also gave the Monetary Board considerable leeway in defining a bank affiliate.Furthermore, the General Banking Law allowed the Monetary Board to examine anyenterprise that is wholly or majority owned or controlled by a bank (Sec. 7), and todefine the term “related interests” (Sec. 36). Finally, Section 38 of the New CentralBank Act allows the Monetary Board to “… determine and provide for such operatingdepartments and other offices, including a public information office, of the BangkoSentral as it deems convenient for the proper and efficient conduct of the operationsand the accomplishments of the objectives of the Bangko Sentral.” This provisionthen allows the BSP to set up the necessary structure to put into operation the provi-sions relating to its supervision of banking groups.

One advantage of the above option is that the BSP is a relatively more experi-enced regulator in the financial sector, especially in a deregulated environment. Itcould then set the standard for the other regulators in the sector. But the setup couldalso lead to duplication of functions which could result in conflicts with other regula-tory agencies. Thus, complementary arrangements in the other regulatory agenciesare also called for in order to minimize duplications as well as oversights, and tomaximize coordination efforts. Such coordinated approach would entail institutionalcapacity building for all regulators, and not just the BSP. Otherwise, the BSP mightbecome overstretched in fulfilling its supervisory functions over other financial insti-tutions for which it does not have the expertise. A related point to consider here wouldbe whether or not the BSP’s regulatory and supervisory functions need to be separatedfrom its monetary functions. But one problem with this option is that it is limited tofinancial institutions linked to banks and it preserves the centrality of banks in thesystem. The requisite buildup of other regulatory agencies would presumably trans-late to better supervision and regulation of the other financial institutions under theirseparate jurisdictions. But ultimately, what is needed is a broader perspective in thesupervision and regulation, as well as the strengthening and development of the dif-ferent sectors of the Philippine financial system. The BSP alone is not equipped toefficiently and flexibly address these tasks because its primary operational relationshipsare 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 nationalcompetition policy framework should apply to the financial sector. Clearly, there arespecific financial market characteristics and issues that may complicate the applica-tion of general competition principles to the financial sector, and which thereforeneed to be taken into consideration. But almost all OECD countries, for instance,apply their national competition law to the banking sector without exception. Mostenforce the competition law through the competition authority, although a few do sothrough the banking regulator. Major structural changes in the banking sector, par-ticularly mergers and acquisitions, also fall under the jurisdiction of both the banking


regulators and the competition authority, thus necessitating some mechanism for re-solving possibly conflicting regulatory decisions (OECD 1998a). Grimes (1999) like-wise argued that the general competition principles identified by the PacificEconomic Co-operation Council (PECC) to guide the development of an internationalcompetition policy framework, and that are intended to provide a framework for allindustries as well as investment and cross-border transactions, should apply to finan-cial institutions with just some clarifications.

Similar to the regulation of all goods and services markets, financial system regu-lation may be classified into three: general market regulation, regulation for (finan-cial) safety and regulation for social purposes (Wallis et al. 1997). General marketregulation aims to ensure that markets work efficiently and competitively. It includesconduct and disclosure regulation to prevent fraud and prohibit anticompetitive be-havior; ensure market integrity (i.e., that participants act with integrity to promoteconfidence in the efficiency and fairness of markets) and consumer protection (i.e.,that retail consumers have adequate information to facilitate informed judgments, aretreated fairly and have adequate avenues for redress); and promote the overall com-petitiveness of markets. Wallis et al. (1997) argued for specialized regulation in theareas of financial market integrity and consumer protection. But they also argued thatthe case for specialized arrangements in the area of competition regulation is rela-tively weak. Although financial products are complex and any assessment of compe-tition would require detailed analyses of markets, the key features relevant tocompetition assessment in this sector are not unique. Thus, the application of aneconomy-wide competition regulation to the financial sector would ensure greaterregulatory consistency and efficiency.

However, it is also recognized that the market mechanism is restricted by thenature and structure of the market itself, which in turn would necessitate some regu-latory intervention to achieve welfare-enhancing outcomes. Thus, there is also regula-tion for financial safety, particularly in the form of prudential regulations to ensuresoundness and stability. But again, prudential regulation lessens competitive pressureand imposes efficiency costs. In the case of the Philippines, there has been a tendencytoward increasing and tightening prudential regulation, which reflects the BSP’s biasfor soundness and stability. Thus, a better balance between the twin objectives ofsoundness/stability and competitiveness/efficiency needs to be achieved. One benefitof having a national competition policy/law administered by a separate agency is thatit could serve to complement, even check the BSP by specifically focusing on competi-tiveness and efficiency. Some mechanism for resolving any conflict in regulatory de-cisions would also be needed.

With respect to regulation for social purposes, requiring banks to service certainactivities or sectors compromises their efficiency. Even if it is deemed worthwhile topurposely restrict competition to pursue wider equity objectives, a national competi-tion policy can then require the government to justify its interventions and restrictionsin the market. That is, another aspect of competition policy would be to make such


government interventions and restrictions transparent and open to public scrutiny andassessment of their effectiveness at achieving distributional and other objectives(Cabalu et al. 1999).

SOME CONCLUSIONSFinancial reforms implemented in the Philippines from the 1980s to the 1990s

have been fairly extensive and intensive, particularly in the banking sector. But thereform process is not yet complete in the banking sector and more so in the othersectors of the Philippine financial system. Overall, despite the difficulties in its imple-mentation, financial liberalization per se is still a valid concept for efficiency en-hancement. It is in the implementation that the liberalization process is oftencompromised, 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 ofother financial institutions to provide savers and borrowers with alternatives. Forinstance, the insurance industry has a potentially more important role to play in thisregard. Thus, the scope of competition policy must be widened to include the othersectors of the Philippine financial system. An appraisal of existing regulations in theother sectors would also be very instructive.

The discussion especially highlighted the role of government in promoting astable and efficient financial system in terms of the regulatory framework. But themost important contribution that the government can probably make to promote thedevelopment of the financial system is to provide a stable and consistent macroeco-nomic environment (Herring and Santomero 1995). Financial stability is simply notfeasible without it. On the other hand, confidence in a country’s financial system isalso critical to macroeconomic stability. But as the Asian crisis demonstrated, unan-ticipated shocks do occur even in a stable macroeconomic environment. Thus, it isalso important for the government to nurture a resilient financial structure that iscapable of withstanding financial market volatilities and does not amplify the shocksto the real economy. In the more deregulated and globalized environment, a static anddynamically efficient financial structure coupled with effective regulation becomesimperative to enable the real economy to succeed in the global marketplace (Herringand 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 sys-tem. Financial liberalization does not take place in a vacuum and it must be coordi-nated with real sector policies. Ultimately, the performance of the financial sectorreflects that of the real sector, and even the best financial institutions will encounterproblems if real sector distortions persist. As long as there are market imperfectionsin the real sector, financial deregulation is not likely to develop a competitive marketstructure in the financial system (Park 1991). This underscores the importance ofdeveloping a national competition policy for the Philippines.


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8C H A P T E R

Government Policies and Regulations:Interface with Competition Policy

Erlinda M. Medalla

“To widen the market and to narrow the competition is al-ways the interest of the dealers... The proposal of any new law or regu-lation of commerce which comes from this order, ought always to belistened to with great precaution, and ought never to be adopted, tillafter having been long and carefully examined, not only with the mostscrupulous, but with the most suspicious attention. It comes from anorder of men, whose interest is never exactly the same with that of thepublic, who have generally an interest to deceive and even to oppressthe public, and who accordingly have, upon many occasions, both de-ceived and oppressed it.”

— Adam Smith

ABSTRACT

The paper aims to examine the major government policies in terms of how theyrelate to the objectives of competition; clarify what important trade-offs mayexist; and determine how and when conflicts between government policiesand competition policy objectives arise. Three sets of government policies are

discussed. The first is trade policy, in particular trade liberalization, where the impacton competition is most direct and apparent. The second group covers governmentpolicies and regulations that have direct impact on competition, namely: 1) govern-ment regulation of an industry, or a segment of it; 2) direct government equity partici-


pation; and 3) other regulatory restrictions. The third group of policies consists ofother major government policies with other development objectives and their inter-face with competition policy objectives. These include industrial policies, agriculturalpolicies and environmental policy and regulations. In general, the paper points outthe need to bring in more closely the principles of competition policy into analyzingand evaluating government policies. Indeed, competition policy would provide a newand different perspective that could help formulate a more effective and dynamic de-velopment policy for the Philippines.

INTRODUCTION

Conceivably, almost anything (and everything) the government does, could affectcompetition. There may not be any conscious, coherent, or concerted policy on com-petition, but government policy interventions will always alter, in varying degrees, forgood or bad, the state of competition. It is ironic that for a developing country withusually less perfect markets, there is a greater need for an effective competition policy toencourage better use of scarce resources. However, there is less recognition of this need.

Not that the government has done nothing to foster competition. The reformsstarting in the mid-1980s have done much to move the economy toward a more mar-ket-friendly policy environment. Since the mid-1980s, trade reforms, banking re-forms, foreign investment policy reforms, deregulation, privatization, and thepolicy thrusts in general have explicitly and implicitly recognized the benefits ofcompetition.

But government has done so much more that may need to be reexamined in thelight 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 usuallyexpected from competition. And if some government policy conflicts with competi-tion policy, there is enough reason to question whether or not this policy serves na-tional welfare and its stated objective. This sums up the main objective of thepaper—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 aimsto at least make a general assessment of the major government policies as to how theypossibly affect competition. As such, it hopes to give signals and insights on where moreanalysis or reform is needed in the various policy areas and how much could be gainedfrom incorporating competition policy in the framework used in these policy areas.

To organize the discussion, government policies are divided into three groupsaccording to how direct their impact is on competition. The first singles out the trade

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1 A background on competition policy, what it is, its objectives and rationale, is available in theintegrative paper of this volume.

GOVERNMENT POLICIES 309

policy regime, considered here as the first layer of competition policy, which has awidespread impact on the state of competition. This is discussed in the next section.The second group, covered in the third section, includes those government policiesand regulations directly intervening in the market. They regulate entry into the mar-ket or some aspects of the operation of the industry itself, like prices and rates toapply. The second-to-the-last section deals with the third group of other major gov-ernment policy areas as they relate to competition. This group would consist of gov-ernment policies aimed at achieving various other objectives that are not explicitlyrelated to competition but would nonetheless have significant, though less direct im-pact, on the state of competition. These include, for example, industrial, agriculturaland environmental policies.

PHILIPPINE TRADE POLICY AND COMPETITION

There is no question that the kind of trade regime adopted by the country affectsthe state of competition. By simply allowing imports to come in, some barriers toentry are broken down and the market becomes more contestable. The world marketis always a potential source of supply, so that in a relatively open economy, evena monopolistic or an oligopolistic domestic producer, faced with competitionfrom imported goods, would act like “perfect” competitors. Hence, with its per-vasive impact on the whole economy, trade policy could act as a major competi-tion policy tool.

The Philippine trade policy regime has changed substantially during the past twodecades—from a highly restrictive and protectionist system to a relatively open traderegime. 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 10percent for the majority of products. Tariffs of more than 30 percent are found mainlyin agricultural products (e. g., sugar, rice, corn, livestock not for breeding, etc.) andonly in a few industrial products (e. g., completely builtup cars). Nontariff importrestrictions, mainly in the form of import licensing requirements or outright importprohibitions have also been removed except for a few (less than 3 percent of commodi-ties at the 6-digit level of classification). There are a few remaining import restric-tions, again for some (basically the same) agricultural products and for reasons ofhealth, sanitation and national security. Tariff rates are expected to fall to a range of 0to 5 percent by 2004 (except for a limited number of products).

These reforms in Philippine trade policy have been well chronicled and well stud-ied and would not be further elaborated on in this paper. Suffice it to say that the seriesof trade reforms undertaken is largely due to the recognition of the huge costs of thethree decades of protection and to expected benefits from competition. Trade liberal-ization could thus be considered the first major layer of competition policies to beimplemented in the postwar era. Indeed, the major trade reforms implemented since


the mid-1980s have contributed much to improving the state of competition in thePhilippines.

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 costsacross borders (especially relative to domestic transport costs) diminish the impact ofthese factors, with the exception perhaps of the third and the last factors. Indeed, ifthese concerns would have some impact on the ability of foreign products to competewith local supply, they may even enhance, not diminish, the competitive edge of for-eign 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 chan-nels (the third and the last factors cited above are related to this). If the local distribu-tion channels are somehow tied up with local producers (e.g., through verticalintegration or some vertical agreement like exclusive dealing), then the impact oftrade liberalization may be limited (especially if substantial sunk costs are involved inputting 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 marketpower as foreign competition could potentially offer so much more. And if productdifferentiation leads to overall increased supply of goods, the impact isprocompetitive, resulting in a wider range of products and higher consumer welfare.

Although trade reforms during the past decade or so have substantially removedor reduced tariffs and import controls, there are still some important barriers to tradethat remain. Recently, newer forms of protectionism are becoming more important—antidumping measures and possibly to a lesser extent, the subsidies andcountervailing duties.

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2 This is a problem, for example, in the case of the downstream oil industry. This is discussedin greater detail in a separate paper by Peter Lee U in this PASCN series of studies on compe-tition policy.


Theoretically, the antidumping act and the subsidies and countervailing act couldbe considered as competition policies being carried out at a global level. They areallowed under the GATT-WTO codes to deal with “unfair” trade practices, whichcause trade distortions that hamper the efficient global allocation of resources. Theintention is to prevent predatory pricing (dumping price) and unfair trade prac-tices (subsidies giving exporting firm “unfair” competitive advantage) that gowith these acts.

The problem is how close to the spirit of the code would the cases filed be in mostinstances? 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 rulestransparent and predictable as much as possible. However, the current national lawson antidumping and countervailing duties would have to be more effective. Thus,improvements in the Philippine national laws have been made to make them moreconsistent with WTO rules.

In the end, however, even with the perfect rules, it is their actual implementationand administration that would matter. If cases could be easily filed and if authoritiescould easily find prima facie evidence, the mere threat of filing a case would be aneffective barrier to entry, whether or not the case is real. Although the number of casesbeing 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 toimplement them.

GOVERNMENT POLICIES AND REGULATIONSAND COMPETITION POLICY

Recognizing the extent of trade policy reforms that have been implemented, it isperhaps more crucial to examine government policies and regulations that directlyinterfere in the market. These are direct government interventions that control eitherentry into the market or some aspects of operation in the market, or both. In generalthese include:

• Government regulation of an industry, or a segment of it,• Direct government equity participation, and• Other regulatory restrictions.

INDUSTRY–SPECIFIC REGULATIONSNo government measure and action could have a more direct impact on competi-

tion than government attempts to regulate an industry. Such a strong involvementshould also require a strong rationale. In general, the government would have reasonto intervene in cases of market failure. Among the most important and most recog-


nized of these are (1) the presence of economies of scale and (2) externalities.3 In suchcases, the intent of these regulations could, in fact, be basically procompetitive—sincethe market would not be able to function efficiently4 if left to itself. Thus, a regulatoryframework may be justified. What needs to be examined then is if the regulation isindeed intended and designed to perform its role of correcting market failures andhow well it is able to do so. Or does the regulatory framework only distort the marketfurther? If it is the latter, what reforms are needed? These are important questions toask which only in-depth studies of the particular cases could answer. Hopefully, how-ever, the following discussion could help shed some light on what could the is-sues be—particularly, how the regulatory framework limits competition andhow, in certain cases, expected benefits may not compensate for such loss incompetition.

Economies of scale and industry regulationEconomies 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 fromother stages or areas such as purchasing, marketing and R&D activities. Such gain inefficiency from economies of scale, however, is not by itself an argument for regulat-ing the industry and limiting the number of firms in the market.

Where the good is tradableThe 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 econo-mies of scale need not be derived from serving the domestic market alone. If there areprivate initiatives to enter the market even without any promotion and incentive fromgovernment, they could have very well realized the potential gains pf that good and itsentry 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 tointervene, especially when the industry is also considered “strategic.” The reasoningis 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 protectionistand import-substituting phase. This has been the main reason, for example, for thelocal content programs and for the promotion of certain heavy industries like steel andcement by the government during that time (and which remains in the present time insome cases). Generous incentives are granted to selected industries but at the sametime, some regulations are also imposed. There have also been cases of direct govern-ment 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 subse-quent discussion. See also Stiglitz (2000) on the role of government in a digital economy4 That is, match supply and demand at optimal levels.


As experience has shown, however, such a strategy has been very costly and inef-fective (Baustista et al. 1979) Their promotion only led to industrial concentrationsand to a further need for government regulation. The supposed export potential andeconomies of scale of the selected industry are not realized and only served to penalizedownstream industries (and ultimately limited the growth of the industry).

The lesson here is that restricting entry is not the best option. Restricting entry isnot enough to realize economies of scale and the export potential of the industry. Theprofits earned from the domestic market may already be enough because the incum-bent firms are able to charge high enough prices, being protected as they are fromthreats of new entry. Without the discipline of competition, there is no urgency toexport 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 prob-lems. The final outcome of restricting entry is an industrial concentration character-ized by underutilized redundant capacity (one objective the restriction to entry issupposed to prevent). Hence, by the mid-1980s, the need for reforms has becomeurgently 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 ofcapital. The more pressing problem is presented by concentration—the possibility ofabuse 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 tomake the market contestable.

Indeed, in general, where the good is tradable and if concentration naturally re-sults because of economies of scale, efforts should be made to make the market con-testable. Then, the monopoly would not present a problem since it would not be ableto earn excess profits because of the threat of entry. If there are sunk costs involvedcreating structural barriers to entry, the incumbent firm should be subject to the disci-pline of an antitrust law to prevent anticompetitive actions.

Where the good is a natural monopolyA 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. Thearguments 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 asduplication of investments may be, the cost of duplication may still not be largeenough 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 verylarge fixed capital and involves huge sunk costs such that duplication may indeed besocially and economically unviable. Moreover, this could often involve an essentialfacility (also referred to as bottleneck facility) where access is “essential” for the sur-vival of the firms using it. Access problems could arise due to the market power heldby the vertically integrated owner of the facility. Then, some regulation would beneeded and justified.


The foremost examples of such cases are said to be in electricity (transmission),interisland shipping (ports), civil aviation and telecommunications. Toward thisend, the government created corresponding regulatory bodies to address the prob-lem. These are the Energy Regulatory Board (ERB) for electricity, the National Tele-communications Commission (NTC) for the telecommunications industry, thePhilippine Ports Authority (PPA) and the Maritime Industry Authority (MARINA)for the shipping industry, and the Civil Aeronautics Board (CAB) for civil aviationindustry. (These are discussed in more detail in separate papers on telecommunica-tions and civil aviation by Serafica and Austria, chapter 5 and 6, respectively, of thisvolume).

The two main regulatory measures these bodies employ include, among otherthings:

• The authority to issue, amend or revoke license/permit to operate inparticular areas, and

• Control or fixing of rates/price.

For example MARINA has the right to determine what should be the capacity inall routes and on this basis, issue, amend and revoke franchise/permit to operate aroute. It also regulates the passenger fares, freight rates and other related charges. Atthe same time, it imposes a cap on the 12-percent rate of return. In the case of telecom-munications, although the franchise is granted by act of congress, NTC grants a pro-visional 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. Thereare other important measures the regulatory bodies use, depending on the nature ofthe industry. This could include standards and safety regulations, whose purpose maybe unquestionable yet may impact unnecessarily on competition and efficiency.

In general, the regulation is supposedly for the development and rationalizationof the industry. Invariably, efficiency is an explicit objective, so is competition insome cases, e.g., in the NTC. Another supposed objective of regulation is to provideaccess to less privileged sectors. Usually, the provision of a minimum level of good orservice to unserved or underserved areas at an affordable price is an additional objec-tive. This social objective is particularly important in the case of electricity, transpor-tation and telecommunications. Indeed, this provides one of the main guidelines forregulating the rates—to allow for some cross subsidization from more to less lucra-tive markets.

All these are undoubtedly worthy objectives. Nonetheless, considering the powerthat 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. Thisrequires a separate in-depth study of each industry. This paper can only point out therelevant issues that need to be looked into. So much depends on how the regulation isactually applied and how necessary are the regulatory measures used. In this regard,there are issues that have to be addressed.


First, there is a tendency for the regulation to cover a greater portion of the indus-try than what is necessary and for the regulator to “overregulate.” Is there a rationalefor the regulation in the first place? And if there is, how much of the industry could bederegulated, 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 subjectto competition? If any of these possibilities is true, the cost of the regulation could bevery high. Indeed, especially after the era of controls under the Marcos regime, therewas increased realization of the costs of regulation, which spurred the policy thrusttoward deregulation in the concerned industries. Deregulation has mainly been doneby easing entry into the industry and allowing more players to come in. The benefitsof deregulation are still being felt—in shipping, domestic air travel, and telecommu-nications, in particular. Nonetheless, much more could still be done. Specifically,there must be clearer delineation between segments (activities) in the industry, whichare natural monopolies, and those which should be subject to more competition.

Related to this is the second issue. Among the major reasons for regulating anindustry is the case of an essential facility. How “essential” is the essential facility? Isthere a clear policy on access? Is it essential enough to justify restricting entry offirms, i.e., disallowing other firms to put up its own facility? For example, if thefacility 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 aprerequisite to a clear policy on access. This would also help regulators identify andlimit 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 regulatoryframework. A general rule applicable to public utilities (including power, shippingand telecommunications) is the rate of return to base regulation, which limits returnsto 12 percent. In addition, some product (service) price setting is enforced. For ex-ample, in telecommunications, end-user rates are set by the NTC. Price setting is alsoenforced 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 itseems reasonable that this is where the regulator takes over. Price fixing is also verypolitically appealing. However, as often experienced in many countries, governmentprice fixing often creates more problems than it solves. A major reason is informationproblem. It is difficult to predict demand and supply. Data on costs are difficult tocome by.

Sometimes, the problem is the point of price of intervention. Take the case oftelecommunications. End-user price (price paid by consumers) is set by NTC but in-terconnecting carriers are allowed to negotiate access charges between them (interme-diate price). A firm (the one enjoying network externalities) can effect a price squeezein its effort to gain market power before the regulator can step in. One can thus ques-tion, 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 thecost of negotiation. Just imagine the costs involved with N carriers negotiating bilat-erally per product (service) for M types of products. Another example is the rate ofreturn 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 tomanage and determine. However, if government wants investments to happen, itshould not put limits on how much the firm can earn, certainly not at an unreasonablylow nominal rate of return of 12 percent, which is not even enough to cover interestcosts. It creates, for prospective investors, “regulatory risks” on top of the commercialrisks they already have to face. (If the firm makes money, it runs the risk of losingit because of the regulation.) Moreover, to a large extent, the regulation onlyencourages cheating and also effectively forces the honest new players out of themarket.

What then are the other options available? The first option should be to seek waysto make the market as contestable as possible. This, of course, is easier said than doneand there could be cases where the market cannot be made contestable. Another op-tion, which could be developed in the longer run, is to craft and implement an anti-trust 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 thefirm’s anticompetitive abusive behavior. (This includes both exclusionary abuse andexploitative abuse of market power. The first covers a firm’s efforts to shut out newplayers by means other than becoming more efficient. The second covers abuse ofmarket power by setting prices and reducing output levels that endow the firmexcess profits.)

The fourth question is the policy of cross subsidization, which complicates evenfurther the problem of price fixing. There is a need to reevaluate the costs and benefitsof cross subsidization. This has been used as a reason for limiting entry (to preventnew entrants from “skimming off the top”). In the first place, it is very difficult to setthe 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 as-sessment of how well objectives are satisfied very difficult to do.

Fifth, a problem common to all regulations is that the regulator could becomesubject to “capture” (Stigler 1968). The regulator could become beholden to the in-cumbent 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 regulatorycapture. Perhaps, the task of regulation could, in reality, be even in the hands of themonopolist. What safeguards are necessary to prevent such a situation?

Finally, another problem that is also common to all regulations is the tendencyfor regulators to use complicated and cumbersome procedures, which could negatewhatever procompetitive effects that may result. Regular reviews to update andstreamline the procedures would go a long way in increasing the efficiency of theregulatory process and the industry itself.


The case for financial sector regulationOf 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. Thefinancial sector regulation can be justified on two grounds, i.e., two cases of marketfailures: (1) the presence of asymmetric information and (2) the presence of systemicrisks (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 ofothers, if not of the whole system. Thus, regulation of the financial sector is indeedwell 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 ofthe banks and of the payment system. This means prudential regulations. It does notmean limiting the number of firms per se. This means disallowing entry only if theentrant could not prove its soundness and stability.

However, as in the other cases discussed above, the problem of regulation is thetendency to “overregulate.” Are the regulations really just for the soundness and sta-bility of the system? Or is entry unnecessarily restricted, weakening the disciplinefrom 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 mar-ket power is concerned, should also apply to the financial sector. Thus, another im-portant issue is how to make the competition policy work for the financial sector. Ofparticular relevance to the sector would be the competition policy rules on mergersand acquisitions. It should ensure that mergers and acquisition would result in greaterefficiency and/or increased welfare reflected in improved service and greater varietyof products, especially where the merger or acquisition would lead to a substantialshare of the market falling in the hands of a dominant player.

While there should be a universal competition policy rule for all firms, thereshould be very close coordination between the competition policy body (or the author-ity enforcing the antitrust law) and the financial sector regulator. What form the coor-dination, relationship or linkage between the two bodies should take would depend onwhat is most feasible and efficient. However, (especially during the capacity buildingyears of the competition policy body if such a body is created), the recommendationsof the financial sector regulator, having more resources and greater expertise in exam-ining the firms it covers, should carry a lot of weight. Such interrelationship between

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5 This tendency has two basic dimensions—depth and breadth. On the former, the issues areclearer. On the latter, there are more questions. Can one really regulate only a section of thefinancial sector (e. g., just the banking system) and leave the rest unchecked? If not, how muchshould financial regulation cover? Should there be just one regulatory body? (e g., BSP regulat-ing all, including investment houses) . A lot of the issues are really concerned with which ismost administratively efficient.


the regulatory body and the competition policy body is among the major issues inmoving 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 forthe other sectors as well.

The issues in competition policy for the financial sector are discussed in moredetail in Milo (this volume).

Other industry-specific regulationsThere are other industry-specific regulatory bodies. Possibly among the most im-

portant is the Land Transportation Franchising and Regulatory Board (LTFRB). Itsprimary objective is the provision of service in all areas at affordable costs. There arealso elements of public safety objectives. The same objective may also be important inother industry regulations. In most of the other cases, the objectives are social innature that could be far removed from efficiency concerns.

In general, granted that the stated objectives dictate the overriding guideline ofthe regulator, there is still the question of how best to do it. A different perspectivefrom competition policy objectives may prove beneficial. It could very well be the casethat incorporating competition policy in the framework of regulating bodies wouldclarify most of their problems and advance their objectives as well, since efficiencyshould always be a hallmark of any agency’s operation. Also, most of the issues raisedin 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 PARTICIPATIONAs 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 strategywas widely used during the Marcos administration. The social profitability is consid-ered high but due to some distortions (e.g., high private risks), the private sector is notinterested in entering the market because it is not privately profitable. Thus, the gov-ernment directly steps in by way of direct equity participation. (Of course, the govern-ment could simply provide fiscal and other incentives to make the activity privatelyprofitable.) Another reason the government intervenes in the form of direct equity isto provide stability in the market. But perhaps the most justifiable reason for govern-ment 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 im-

portant to reexamine the objectives and to analyze its impact on the economy. With


regards to the latter, it is important to consider in the analysis how governmentequity participation impacts on competition, as this would have direct bearing onefficiency and overall welfare. The public enterprise may be enjoying undeserved,unnecessary and unfair advantages, e.g., in terms of tax privileges, access to creditand loan guarantees. This could drive the more efficient private firms out of themarket.

Privatization has been part of the major reforms being implemented since theAquino administration. For some years, asset privatization has been a source of badlyneeded revenues. However, although it has been an important source of revenue espe-cially during the initial years, privatization is now viewed more as a tool to enhanceefficiency and encourage competition. This is part of the effort of reforming publicenterprises.

Various research studies have shown that publicly-owned and run corporationsare less efficient than private enterprises. This is due to a number of factors. First isthe hiring and firing scheme, which is constrained by civil service regulations thatmake it extremely difficult to hire and fire employees. The second factor is the incen-tive and compensation structure. Third is lack of accountability. These factors, amongothers, deprive the public enterprise of the usual motivation for profit maximizationas 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 setforth beforehand. Indeed, the problem may not be whether or not to transfer owner-ship but rather, how the competition process and discipline could be introduced. Ifthere would be transfer of ownership, all unnecessary advantages the firm previouslyenjoyed should be removed and competitive neutrality should be ensured. These is-sues need to be examined further in reforming public enterprises. But perhaps, thefirst step is to make antitrust policy universally applicable to firms, whether private orpublic.

OTHER REGULATORY RESTRICTIONSThe other regulatory restrictions could range from explicit restraints to entry re-

quiring firms to obtain permit or license to operate in a particular market, to stringentprocedural 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.


The rationale for the restriction varies—from public safety to monitoring andother reasons. Appendix Table 4 provides a listing of some special laws and provi-sions creating regulatory restrictions.

In the first, the local government is given leeway in its efforts to pursue its ownstrategy for development. While some autonomy should be exercised by the local gov-ernment, it should be made aware if its actions could have serious detrimental impacton 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 en-

courage innovation, a necessary condition for dynamic efficiency. Though it couldgrant temporary monopoly rights to the IPR holder, this should be balanced againstfuture dynamic gains from innovation.

Government procurement policies are among the issues being examined in theinternational fora on trade. There is increasing concern about how these could violatethe spirit of fair trade espoused by the WTO. The impact of government policies or fairtrade should not only be an international concern; its impact on domestic competitionshould also be an immediate concern. How much are auctions studies considered?

Finally the cumbersome process of registration procedures could also be an im-portant source of barriers to entry. This is especially true for the small and mediumscale industries. The checklists of requirements for doing business in the Philippinesand for business registration in Appendix Tables 5 and 6 illustrate the long processand numerous requirements a prospective business needs to hurdle just to be regis-tered. This could specially prove more difficult for small and medium enterprises.Regular review of these procedures should be done to simplify and modernize theprocess.

To summarize, these regulations are supposed to serve some objectives, eventhose that are procompetitive. Nonetheless, just looking at the host of governmentregulations, it is not difficult to imagine how they could interfere in how the marketfunctions and how they could limit the state of competition. There is a clear need toreevaluate these policies and review whether such policies and regulations could passa “competition” test or, if not, if they could be justified on grounds of public welfare orof the objectives they are supposed to achieve.

OTHER GOVERNMENT POLICIES AND THEIR INTERFACEWITH COMPETITION POLICY OBJECTIVES

Finally, this section deals with the third group of government policies, whichwould include those aimed at achieving various other objectives that are not overtlyrelated to competition policy but would nonetheless have significant, though less di-rect, impact on the state of competition. The list in this second group could be long butthe major policies would include, among others, the following:


• 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 includedhere because of other social objectives paramount to it. Also, there is no doubt thatthere are other major policies not included that would have a significant interface withcompetition policy objectives. This, however, hopefully illustrates the importance of ex-amining 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 de-velopment of the sector that will ultimately benefit the economy as a whole. Thequestion is how much competition policy should be considered.

INDUSTRIAL POLICIESThe 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 ismainly administered by the Board of Investments (BOI) basically through the promo-tion of selected activities in its Investment Priorities Plan (IPP) and the granting offiscal incentives. The OIC also has other provisions aimed at other specific objectives,of which the more important ones include: (a) regional development objectives spe-cifically through the promotion of industrial estates and (b) promotion of foreign di-rect investment (FDI).

For the investment policy as a whole, the objective is to aid in industrial growthand development. The rationale behind this is that there are market failures that pre-vent the industrial sector from developing naturally. Indeed, there is greater consciousconsideration of this rationale in the role of investment policy. This is reflected whenthe list of industries in the IPP was shortened, and there was a move toward a morepromotional body. The “measured capacity” concept in the OIC, which limits grant-ing of incentives when a certain capacity (some optimum scale) is reached, is clearlyanticompetition in nature and is not actually practiced. There is a move toward the“greening” of incentives with the realization of externalities involved. Export promo-tion remains in the list of priority. As noted above, regional dispersal of industries andpromotion of regional investment are among the stated goals of the Philippine gov-ernment.

These are arguably desirable objectives. Nonetheless, the industrial strategy cho-sen has probably been too preoccupied with simply trying to overcome the failures ofthe market (real or merely perceived). Less (or no) explicit consideration has beentaken about how the policies affect the state of competition. This is one area wheremore 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-


pacts on the state of competition. An obvious strategy, which has been overlooked, isto proactively support competition policy for industry, since competition and industrypolicy objectives largely merge. A major objective of industrial development policy isto enhance efficiency, which directly coincides with that of competition policy.

So the question is, could competition policy actually serve as one of the policytools for industrial development (together with trade, fiscal and monetary policies)? Isit even deliberately considered? Or, on the contrary, are there anticompetition effectsthat unintentionally go against the competition policy objective (defeating their pur-pose)? One that comes to mind is the inherent bias of an incentive granting systemagainst the entry of small and medium scale industries.

An industrial policy tool, which is particularly important with respect to its im-pact on competition, is the policy on FDI. Restrictions on foreign equity have a directimpact on entry of firms. Specifically, they represent (policy-induced) structural barri-ers to entry. Substantial liberalization was effected by the 1992 Foreign InvestmentAct that changed the regime from a highly regulatory system of positive list whereforeign equity is fully or partially allowed, to a more liberal system of negative listswhere 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 theRetail Trade Act. This could have a big impact on competition. It would also comple-ment well the effects of trade reforms.

Foreign equity participation is still limited for many sectors and this is suppos-edly because of some other social objectives (national security, sovereignty, and oth-ers). Clearly, there is a need to reexamine the issues to evaluate whether or not therestriction, in fact, serves the stated objectives, and assess the benefits and costs oflimiting competition with such restrictions.

AGRICULTURAL POLICIESWith respect to agricultural policy, a basic rule should be for government to inter-

vene only when market fails. However, for agricultural policies, there appears to bethe additional and equally important (possibly more so in some cases) equity objec-tive. This is where it could run counter to competition policy objectives. This is wherethe problems could become intractable. Often, the government hides behind the sup-posed interests of the farmer to justify interventionist policies in agriculture. Doesprotecting the agricultural sector necessarily imply foregoing the rules of competi-tion? One might actually be surprised to find that the local farmer understands com-petition 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 analyzeclearly what they are. Are they justified? That is, would the benefits (from equityconsiderations for example) outweigh the costs (e. g., efficiency losses from foregoingcompetition objectives)?

In particular, agricultural policy still relies much on tariff policy tools and othertrade controls that are clearly anticompetition. This is supposed to protect the income


of farmers (equity objective). Are the costs of protection commensurate to the benefitsof increased income for the farmer? Is protection even reaching the farmer?

Also very important to examine are the other policies that have anticompetitionelements, especially those involving direct state intervention in marketing. These arethe regulations implemented by the National Food Authority (NFA) and the SugarRegulatory Administration (SRA). Numerous studies of the impact of theseanticompetition policies on efficiency have been done but recommendations have al-ways fallen short of implementation. They face political constraints that often proveinsurmountable. This implies a need for intensive advocacy work. This implies a needfor a (respected and credible) body more committed to implementing competitionpolicy rules and whose functions and capability include advocacy and informationand education campaign.

ENVIRONMENTAL POLICY AND REGULATIONSPerhaps the policy that has the most direct interface with competition policy is

environmental policy and regulations. The environment is a public good character-ized by externalities. To illustrate, our air and water system would have a limitedabsorptive capacity, beyond which environmental costs become acute. Thus, environ-mental standards need to be set and some regulations need to be put in place to effi-ciently manage the environment and promote sustainable development. Wheneverfeasible, market-based instruments should be used, which would allow the market toperform its function. However, the use of command-and-control measures may, insome cases, be unavoidable (whether due to administrative constraints or other rea-sons) and more intrusive environmental regulations may be necessary.

Environmental regulations, for example, include preentry conditions such asthe environmental impact analysis (EIA), the environmental clearance certifi-cate (ECC) and some other permits or licenses. These clearly create barriers toentry. Hence, there is evident conflict between environmental and competitionpolicy objectives.

Should environmental concerns be the overriding objective? The ideal answer isthat both should be considered—environmental benefits must be weighed againstcosts from loss in competition. This weighing of costs and benefits, however, need notbe done directly. What is necessary is to implement measures that would lead to inter-nalization of external costs. If environmental costs were internalized properly, thenoverall welfare is optimized. That is, so long as good environmental policy is in placeand adequately enforced, whatever economic policy adopted would not impose undueburden because there would be “correct” pricing of scarce environmental resources.Indeed, to optimize welfare, there should be both good environmental policy and goodeconomic policy (including competition policy).

Pricing economic resources below costs would lead to waste of resources. Pricingabove costs, on the other hand, would impose undue burden on industry, unnecessar-ily raise costs and ultimately reduce overall welfare. The former comes from inad-


equate environmental policy and/or the lax enforcement of it. The latter arises fromtoo stringent policy and administration.

Environmental policy and regulations, however sound they may be, would beineffective if not complemented by a transparent and efficient implementing agency.The problem is, difficult as it may be to formulate sound environmental policies, it issometimes even more difficult to administer and implement them properly. Nonethe-less, the government must ever be reviewing the relevance and soundness of environ-mental policies, as well as the effectiveness of its administration, keeping in mind inboth cases the possible impact on the competitive environment.


This paper looked at an array of government policies to examine its interface withcompetition 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 ofcompetition. This applies whether government intervention is direct through someregulatory restriction, or indirect by influencing the incentive structure no matter howessential the stated objectives of the policy are. If it seriously conflicts with competi-tion 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, whatthe paper points out is that it is always wise to weigh the possible tradeoffs: the pos-sible 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 toexamine if, on the contrary, incorporating competition policy rules and principlescould even advance the major objectives of the policy.

The paper also suggests that among the government policies, perhaps the morecrucial to examine are government policies and regulations that directly interfere inthe market. This is mainly for two reasons: (1) their impact on the state of compe-tition is most direct and the needed competition policy reforms (removing un-wanted anticompetitive elements) are easier to isolate and will have greater andmore visible impact, and (2) because much has already been done with respect totrade 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 indus-try 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 tocompetition?

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.


This would also help regulators identify and limit what segment of the industry couldbe considered a natural monopoly.

Third, one should question the use of price/rate fixing as part of the regulatoryframework. Where competition as market regulator fails, the ultimate impact is in theprices 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 isinformation 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 alternativeto user price fixing and is much easier to determine. However, if government wantsinvestments 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 interestcosts.

The fourth question is the policy of cross-subsidization, which complicates evenfurther the problem of price fixing. There is a need to reevaluate the costs and benefitsof cross subsidization.

Fifth is the possibility of regulatory capture. The regulator could become be-holden to the incumbent firm. There should be safeguards to prevent this. This iswhere the need for a separate body that will oversee the whole competitive settingbecomes more apparent.

Finally, another problem is the use of complicated and cumbersome proceduresthat could negate whatever procompetitive effects there could be. Regular review toupdate and streamline the procedures would go a long way to increasing the efficiencyof the regulatory process and the industry itself.

In summary, what all these imply is the need to closely reexamine governmentpolicies in the light of competition objectives. Such an exercise would surely bringnew perspectives that would make for a more efficient administration of policies andthe 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 CompetitionPolicy 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 PhilippineEconomy. In The Philippine Beyond 2000: An Economic Assessment. Makati City:Philippine Institute for Development Studies.


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 APECStudy Center Network.

World Bank and the Organisation for Economic Cooperation and Development (OECD).1998. A Framework for the Design and Implementation of Competition Law andPolicy. Washington, D.C.


Appendix Table 1. Antidumping Cases, 1985-1995

Year

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

Total No. of

Cases

Originally

Filed

2

3

6

5

1

4

6

0

1

9 b/

3 c/

No. of

Cases

Dismissed

2

3

6 a/

5

1

3

4

0

0

5

1

No. of Cases

Imposed

AD Duty

0

0

0

0

0

1

2

0

1

2

0

Articles

Imposed

AD Duty

- - -

- - -

- - -

- - -

- - -

Refraction Bricks

Refraction Bricks

Safety Matches

- - -

Galvanized Malleables

Coated Fittings

Refraction Bricks

PVC Resin

- - -

Country

of

Origin

- - -

- - -

- - -

- - -

- - -

Thailand

Thailand

Indonesia

- - -

PROC

Thailand

Korea

- - -

a/ includes 1 case withdrawn.b/ 2 cases pending with the Department of Finance (DOF).c/ 2 cases pending with DOF.Source: Medalla (1996).

APPENDICES


Industry Regulatory Bodies/ Functions/ObjectivesImplementatingAgencies

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).

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

on Competition



Sources: Abad (this volume); Tabbada and Baylon (2000); USAID (1992); AdministrativeCode of 1987, E.O. 292.

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.


Grant franchises and permits or licenses

within the locality;

Grant of tax exemptions, incentives, or re-

liefs to entities engaged in “community

growth-inducing industries.”

Conduct hearings in case the dissolution af-

fects the rights of any creditor having claim

against the corporation;

Appoint a receiver to take charge of the liq-

uidation of the corporation.

Appoint a conservator to take charge of the

assets and liabilities of the bank or nonbank

as well as assume management (if in a state

of continuing inability to maintain a condi-

tion of solvency and liquidity);

Designate a receiver to take charge of as-

sets and liabilities and administer to the

benefit of creditors (if continuance in busi-

ness would involve probable loss to deposi-

tors 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).

Absolute jurisdiction, supervision and con-

trol over all corporations, partnerships and

associations in the Philippines; as a regula-

tory agency, it has the exclusive jurisdiction

to hear and decide on cases involving fraud

and misrepresentation committed by corpo-

rate officers and their organizations.

Empowered to look into intra-corporate prob-

lems of corporations, issue injunctive relief,

subpoena and subpoena duces tecum; im-

pose fines and penalties; and even suspend

or revoke the certificate of registration of any

erring establishment after a proper hearing.

Appendix Table 4. Special Laws and Agencies Affecting Competition

Local

Government Code

(RA 7160, 1991)

Insolvency law

(Act No.1956)

Bankruptcy Law

Corporation Code

(BP 68, 1980)

Revised Securities

Act (BP 178, 1982)

Local Government

Units (LGUs)

Private

Corporations -

Securities and

Exchange

Commission (SEC)

Banks and Financial

Institutions -

Bangko Sentral ng

Pilipinas (BSP)

Securities and

Exchange

Commission (SEC)

Laws Provision/Purpose Implementing Functions

Agencies

Licensing and Zoning or

Land Classification

Taxation

Seeks to effect an eq-

uitable distribution of

the insolvent’s property

among creditors

Deals with suspension

of payments, the relief

of insolvent debtors,

the protection of credi-

tors and the punish-

ment of fraudulent

debtors

Rules regarding merg-

ers and consolidations

and the acquisition of

all or substantially all

the assets or shares of

stocks of corporations

Prohibits and penalizes

the manipulation of se-

curity prices and in-

sider trading



Provide orientation to workers on their rights

and privileges under existing laws and regu-

lations.

Develop schemes and projects for the im-

provement of the standards of living of work-

ers and their families.

Examine applications for grant of letters,

patent for inventions and register utility mod-

els and industrial designs; register technol-

ogy transfer arrangements and settle dis-

putes;

Promote the use of patent information as a

tool for technology development;

Administratively adjudicate contested pro-

ceedings affecting intellectual property

rights.

Develop and implement a comprehensive

audit program that shall encompass an ex-

amination of financial transactions, ac-

counts, and reports, including evaluation of

compliance with applicable laws and regu-

lations.

Institute control measures through the pro-

mulgation of auditing rules and regulations

governing receipts, disbursements and uses

of funds and property consistent with the

total economic development efforts of the

government.

Bureau of Labor

Relations

National Labor

Relations

Commission

Intellectual

Property Office

(IPO)

State Accounting

and Auditing

Development

Office, Commission

of Audit (COA)

Provide adequate

protection to labor by

stipulating the mini-

mum conditions of

labor, labor relations,

formation of workers

organizations and

unions, termination

and retirement ben-

efits of workers

Protection of pat-

ents, trademarks and

copyrights and the

corresponding penal-

ties for infringement

Protecting locally-

manufactured or pro-

duced articles over

foreign-made prod-

ucts

Purchase of locally

manufactured prod-

ucts

Reserving to Filipi-

nos and Filipino-

owned corporations

the exclusive right to

enter into contracts

with any GOCCs,

company, agency or

municipal corpora-

tion for the supply of

materials, goods, and

commodities

Labor Code

(PD 442)

Intellectual

Property Code

(RA 8293, 1997)

Budget Reform

PD 1177

RA 5183

Laws Provision/Purpose Implementing Functions

Agencies

Sources: Abad (this volume); USAID (1992); Administrative Code of 1987, E.O 292.


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 fran-

chise 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)



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

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.


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.


Appendix Table 7. Major Policies with Competition Policy Interface

Policy Areas Regulatory Bodies/ Purpose/Functions/Objectives

Implementating Agencies

Industry and Investments

Policy

� Export

Promotion

� Promotion of

Catalytic Industry

� Regional

Development

� Foreign

Investment Policy

Department of Trade and

Industry (DTI)

Board of Investments

(BOI)

Philippine Economic Zone

Authority (PEZA)

Garments and Textile

Export Board (GTEB)

Bases Conversion and

Development Authority

(BCDA)

Subic Bay Metropolitan

Authority (SBMA)

Formulate and implement policies, plans, and

programs relative to the development, expansion,

promotion, and regulation of trade, industry, and

investments.

Coordinate the formulation and implementation of

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

individual enterprises;

Formulate policies and guidelines aimed at creating an

environment conducive to the expansion of existing

investments.

Tasked with the establishment, operation, and

management of world-class economic zones or

ecozones throughout the country.

Formulate negotiation strategies and the actual

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.

Administer and develop former military bases into other

productive uses.

Administer and develop the Subic Bay Freeport

(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.



Policy Areas Regulatory Bodies/ Purpose/Functions/Objectives

Implementating Agencies

Manage and develop the Clark Special Economic Zone

into a premier economic center and model township

promoting industrial, service, commercial,

recreational, residential, and ecological development.

Responsible for planning, formulation, execution,

regulation, and monitoring of programs and activities

relating to agriculture, food production and supply.

Responsible for food security and stabilization of

supply and prices of rice, corn, wheat and other

grains, and food stuffs; implements subsidized

marketing strategy.

Responsible for the regulation and development of the

sugar industry including the allocation of sugar

production and export quota.

Responsible for the regulation and development of the

coconut industry.

Administrative agency compelling compliance on

environmental laws and responsible for the issuance

of environmental compliance certificate (ECC) and

environmental permits—authority to construct (AC)

and permit to operate (PO).

Empowered to order the cessation of environmentally

harmful activities through cease-and-desist orders.

Recommend possible legislation, policies, and

programs for environmental management and pollution

control; formulate environmental quality standards for

water, air, land, noise, and radiations; formulate rules

and regulations for proper disposition of solid waste,

toxic and hazardous substances; recommend rules and

regulations for environmental impact assessments;

and provide technical assistance for their

implementation and monitoring.

Clark Development

Corporation (CDC)

Department

of Agriculture (DA)

National Food Authority

(NFA)

Sugar Regulatory

Administration (SRA)

Philippine Coconut

Authority (PCA)

Department of

Environment and Natural

Resources (DENR)

Pollution Adjudication

Board

Environment

Management Bureau

Agriculture

Policy

Environment Policy

� Establishment of

Environment Impact

Assessment System

(EIA)

� Establishment of

ambient, effluent

and input standards

� Comprehensive Air

Pollution Control

Policy;

ODS Phaseout

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

9C H A P T E R

Recommendationsfor Philippine Antitrust Policy

and Regulation

Anthony R. A. Abad

ABSTRACT

This short study has been commissioned as a means to develop specific recom-mendations for new antitrust policies and regulations. The scope of work andobjectives of this study are: (1) to review existing antitrust laws and regula-tions; (2) to examine the effectiveness and adequacy of these laws and regula-

tions; (3) to examine how well these laws conform with international rules; and (4) tosuggest recommendations for reform.

There have already been quite a number of studies conducted dealing with anti-trust and/or competition issues from an economic analysis point of view, but there alsohave been some based on industry or sector. In contrast, this study will focus on anti-trust issues from a legal and regulatory structure point of view and in a comprehensivemanner rather than a sector-specific approach. This study will also analyze the properadministrative structures for effective policy enforcement, and necessarily includesome insights on existing political economy conditions.


INTRODUCTION

BACKGROUNDThe recent introduction of economic reforms in the Philippines through substan-

tial trade and investment liberalization, deregulation, and privatization has led to aslow 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 in-creased competition from new products and services. Conversely, it can also be said ofthe Philippines that our long and sad history of underdevelopment can actually betraced to a lack of competition in our economy.

With this important realization, the Philippine government has adopted apolicy of introducing more competition-enhancing measures, such as the fur-ther lowering of trade and investment barriers and the reform of certain eco-nomic regulations. Unfortunately, government off icials have not evenmentioned the need for a new and comprehensive framework for antitrustpolicy and regulation, despite the central role it plays in economic reform mea-sures for enhancing competition. There have been quite a number of draft billsfor a proposed antitrust or competition law filed in Congress; however, theyhave yet to be fully appreciated by our political leaders and they have yet to befiled as part of introducing a truly comprehensive new framework for antitrustpolicy and regulation.

The introduction of a new framework for antitrust policy and regulation willrequire much more than merely passing a new law. To avoid committing the mistakesof the past, a careful and in-depth analysis of the current approach of the Philippinesto sustaining a market-oriented economy and regulating economic activity will beneeded. Reviewing existing economic laws and regulations and testing their effective-ness as tools for promoting economic efficiency and public welfare through competi-tion should also be done. This analysis can then form the basis for crafting aframework for antitrust policy and regulation.

RATIONALE AND SCOPE OF THE STUDYThis 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 re-search on laws and regulations in the Philippines, are drawn largely from the previouswork of the author in studies prepared by FTAsia Consulting for the Asia Foundationand Philexport-TAPS.

Since competition policy is a rather broad topic encompassing various aspects offunctioning market economies, there is need to focus on specific key areas. The em-phasis of this study is on the legal and regulatory aspects of competition policy, par-ticularly the framework for effective enforcement of competition in all sectors of thePhilippine economy. This is important because of its bearing on the actual implemen-tation 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 anti-trust and/or competition issues from an economic analysis point of view, but there alsohave been some based on industry or sector. In contrast, this study will be focusing onantitrust issues from a legal and regulatory structure point of view and in a compre-hensive manner rather than a sector-specific approach. This study will also analyzethe proper administrative structures for effective policy enforcement and will neces-sarily 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 isalso implicitly vested in various regulatory agencies and bodies. This sectionof the paper surveys these existing laws and regulations that are deemed asthe existing antitrust and/or competition policy framework of the Philip-pines. This survey also covers draft bills on the proposed antitrust or compe-tition law of the Philippines. Finally, this section also reviews a few “successstories” from other countries and regional groupings, both developed anddeveloping, which implemented their own antitrust or competition laws andregulations.

2. Analysis of Existing Antitrust Regulation in the Philippines – Knowing theexisting laws and regulations for antitrust enforcement at the disposal of thePhilippine government, what is then the actual effectiveness of these lawsand regulations in promoting competition in the Philippine economy? Thissection analyzes the state of antitrust regulation in this country and exam-ines the government’s capability to implement its antitrust laws and regula-tions. It studies the general regulatory structure in place, and identifies anumber of the regulators and institutions involved in the antitrust process.How have they managed to control the behavior of the players in variousindustries and sectors? How have they affected the structure of markets in thePhilippine economy? What are the major problem areas?

3. Recommendations for a New Legal and Regulatory Framework for AntitrustEnforcement in the Philippines – This section recommends a new antitrustpolicy and regulatory framework for the Philippines. Given the Philippines’long history of protectionism and over regulation, market distortions arerampant in the economy despite the existence of basic antitrust laws and


regulations. Therefore, there is still a need to propose a more effective frame-work for antitrust regulation in this country. Such a framework should firstlay down the basic policy objectives and principles, as well as spell out thebasic structure for regulation. This section also suggests certain basic provi-sions for new antitrust legislation and mechanisms for more effective en-forcement.

SURVEY OF EXISTING ANTITRUST LAWS ANDREGULATIONS IN THE PHILIPPINES

Antitrust regulation is not new to the Philippines. Apparently, old antitrust pro-visions of U.S. laws found their way into the Philippine Constitution, and Criminaland Civil Codes. Antitrust enforcement is also implicitly vested in various regulatoryagencies and bodies. This section of the paper surveys these existing laws and regula-tions that are deemed as the existing antitrust and/or competition policy framework ofthe Philippines. This survey also covers draft bills on the proposed antitrust or compe-tition law of the Philippines.

ANTITRUST LAW IN THE PHILIPPINES

THE CONSTITUTIONUnder the Constitution,1 the State is mandated to regulate or prohibit, for

the sake of public interest, monopolies, combinations in restraint of trade andother unfair competition practices. These provisions were based on the U.S.Sherman Act.

Note that the Constitution does not prohibit monopolies per se. Monopolies arenot illegal in themselves, in contrast with combinations in restraint of trade andother unfair competition practices that are illegal per se. The latter are to be prohib-ited without exception.

However, since the Constitution does not define what would constitute un-lawful monopolies, or combinations in restraint of trade or unfair competitionpractices, separate legislation and/or case laws are the bases for making suchdefinitions.

CRIMINAL LAWAct No. 3815 as amended, otherwise known as the Revised Penal Code, punishes

anticompetitive behavior that is criminal in nature. Article 186 defines and penalizesmonopolies and combinations in restraint of trade while Article 187 provides penalties.

____________________

1 Constitution, Article XII, Section 19.


Combinations in restraint of trade are defined as:• Any agreement, whether in the form of a contract or conspiracy or combina-

tion in the form of trust or otherwise, resulting in the restraint of trade orcommerce; 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 orobject of commerce, or with any other persons, for the purpose of makingtransactions prejudicial to lawful commerce, or increasing the market priceof such merchandise or object of commerce or any other article in the manu-facture, production, or processing, or importation of which such merchan-dise 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 anyother artifice to restrain free competition in the market.

The Revised Penal Code also penalizes other frauds in commerce and industrysuch as falsely marking gold and silver articles and altering trademarks.2

CIVIL LAWRepublic 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 dam-ages arising from unfair competition in agricultural, commercial, or industrial enter-prises or in labor.3 It also allows the collection of damages arising from abuse in theexercise of rights and in the performance of duties,4 e.g., abuse of a dominant marketposition by a monopolist.

Peculiarly enough, the Civil Code does not define unfair competition andmerely lists the means by which unfair competition can be committed: force,intimidation, deceit, machination, or any other unjust, oppressive or highhandedmethod.

Treble damages for civil liability arising from anticompetitive behavior is al-lowed under RA No. 165, otherwise known as An Act to Prohibit Monopolies andCombinations in Restraint of Trade.

____________________

2 Republic Act No. 166 (1947).3 Article 28.4 Article 19.


SPECIAL LAWSSpecial laws specifically address some unfair competition practices.

• RA 8293 (1997), otherwise known as the Intellectual Property Code of thePhilippines

This new law provides for the protection of patents,5 trademarks,6 and copy-rights,7 and the corresponding penalties for infringement.

• Batas Pambansa Blg. 68 (1980), otherwise known as the Corporation Codeof the Philippines

This law provides for the rules regarding mergers and consolidations,8 and the ac-quisition of all or substantially all the assets or shares of stock of corporations.9 It must benoted, however, that the Corporation Code does not address the problem of the probableabuse of a dominant position when horizontal mergers occur, e.g. merger of three ship-ping lines – Aboitiz, William Lines, and Gothong Lines into the WGA Super Ferry, or incase of vertical acquisitions, e.g. Philippine Long Distance Telephone Company withrespect 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 ma-nipulation 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 competitionpolicy. In this area, the significant laws are the Price Act and the Consumer Act of thePhilippines.

The Price Act defines and identifies illegal acts of price manipulation such as,hoarding, profiteering and cartels. Through price controls and mandated ceilingmechanisms, the Price Act also seeks to stabilize the prices of basic commodities andprescribes measures against abusive price increases during emergencies and othercritical 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 infraudulent acts in connection with the sale of securities. Sec. 27 prohibits manipulative anddeceptive devices, sec. 28 artificial measures of price control, and sec. 29 fraudulent transac-tions.


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

Agencies enforcing antitrust law in the PhilippinesUnder these various special laws, there are certain agencies that should be enforc-

ing competition:

General Agencies

• Department of Trade and Industry (DTI) and its attached agencies, includingthe Bureau of Trade Regulation and Consumer Protection (BTRCP), Bureau of Foodand 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 IPOis 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 LibraryThe National Library is in-charge of copyright registration. Together with

the Supreme Court Library, it is also the depository of copyrighted materials andother items.


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 theOmnibus Investments Code.

• National Telecommunications Commission (NTC), for telecommunicationscompanies

• Land Transportation Franchising and Regulatory Board (LTFRB), for com-mon 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 companiesand oil companies.

A more thorough listing of various laws and regulations affecting competi-tion is given in Appendix 1. Although these various laws and regulations do notexplicitly implement competition policy, all of them either directly or indirectlyrestrict or open market access or investment flows, and hence, affect competi-tion.

INTERNATIONAL COMMITMENTSThe World Trade Organization (WTO) agreements implicitly encourage interna-

tional competition through trade liberalization. The agreements that are directly rel-evant to competition policy and restrictive business practices are:

• Agreement on the Implementation of Article VI of GATT 1994 on anti-dumping

• Agreement on Subsidies and Countervailing Measures• Agreement on Safeguards, particularly Article 11:2 on voluntary export re-

straints, orderly marketing arrangements, etc., maintained by the govern-ment, and Article 11:3 on equivalent nongovernmental measures


• General Agreement on Trade in Service (GATS), particularly Article VIII onsupply of services by a monopolist in a member country, and required consul-tations with other member countries

• Agreement on Trade-Related aspects of Intellectual Property Rights(TRIPs), including trade in counterfeit goods, particularly Article 8 on theabuse of intellectual property rights by right holders and Articles 31 and 40on licensing practices and conditions on use

• Agreement on Trade-Related Investment Measures (TRIMs), particularlyArticle 9 on amending TRIMs to be complemented with investment policyand competition policy.

JURISPRUDENCESince the law itself is not clear, case law or judicial interpretation is particularly

important in defining unlawful monopolies, combinations in restraint of trade andunfair competition practices.

The Supreme Court has affirmed the need to “... recast our laws on trust, mo-nopolies, 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 aword, we need to perpetuate competition as a system to regulate the economy andachieve global product quality.”11

To date, there have been only two cases decided by the Supreme Court definingmonopoly. In the case of Gokongwei, Jr. v Securities and Exchange Commission, etal.,12 the Supreme Court narrowly defined monopoly as “unified tactics with regardto price.” Further, the Supreme Court apparently considered a monopoly as undesir-able in itself, and not the abuse of a monopoly or dominant position.

“A ‘monopoly’ embraces any combination the tendency of which is to prevent compe-tition 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 consid-eration in determining its existence is not that prices are raised and competition actu-ally excluded, but that power exists to raise prices or exclude competition whendesired. Further, it must be understood that the idea of a monopoly is now understoodto include a condition produced by the mere act of individuals. Its dominant thought isthe notion of exclusivity or unity, or the suppression of competition by the unification ofinterest or management, or it may be through agreement and concert of action. It is, inbrief, unified tactics with regard to price.”

____________________

11 Tatad v. The Secretary of the Department of Energy and The Secretary of the Department ofFinance, etc, G.R. Nos. 14360 and 17867, Decision En Banc dated 03 December 1997 on theMotion 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).


In the Gokongwei case, John Gokongwei, Jr. has acquired enough SMC shares ofstock 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 beermanufacturing 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 orcompanies, consisting in the exclusive right or power to carry on a particular businessor trade, manufacture a particular article, or control the sale or the whole supply of aparticular commodity. It is a form of market structure in which one or a few firmsdominate the total sales of a product or service.” (Citations omitted)

In the Gokongwei case, it was likewise held that a monopoly can be achievedthrough the “suppression of competition by the unification of interest or manage-ment, or it may be thru agreement and concert of action.”14 Thus, even mergers andconsolidations of companies, where these could lead to unfair competition, can beregulated.

The Tatad case15 also defined combinations in restraint of trade and differentiateda combination from a monopoly:

“On the other hand, a combination in restraint of trade is an agreement or under-standing between two or more persons, in the form of a contract, trust, pool, holdingcompany, or other form of association, for the purpose of unduly restricting competi-tion, monopolizing trade and commerce in a certain commodity, controlling its pro-duction, distribution and price, or otherwise interfering with the freedom of tradewithout statutory authority. Combination in restrain of trade refers to the means whilemonopoly 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 pricesor exclude competition when desired.”

With its ruling that the Senate did not commit a grave abuse of discretion inratifying the WTO Agreement and its three Annexes, the Supreme Court removedany judicial obstacle against the government’s adoption of a policy of trade liberaliza-tion by enlisting the Philippines in the WTO:16

“Moreover, GATT itself has provided built-in protection from unfair foreign competi-tion and trade practices including antidumping measures, countervailing measures and

____________________

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 Decisiondated 02 May 1997 (272 SCRA 18).


safeguards against import surges. Where local business are (sic) jeopardized by unfairforeign competition, the Philippines can avail of these measures. There is hardly there-fore any basis for the statement that under the WTO, local industries and enterpriseswill 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 Philippineshave been taken into account; thus, there would be no basis to say that in joining theWTO, the respondents have gravely abused their discretion. True, they have made abold decision to steer the ship of state into the yet uncharted sea of economicliberalization. But such decision cannot be set aside on the ground of grave abuseof discretion, simply because we disagree with it or simply because we believeonly in other economic policies. As earlier stated, the Court in taking jurisdictionover this case will not pass upon the advantages and disadvantages of trade liber-alization as an economic policy. It will only perform its constitutional duty of deter-mining whether the Senate committed grave abuse of discretion.

x x x

The WTO reliance on ‘most favored nation,’ ‘national treatment,’ and ’tradewithout discrimination’ cannot be struck down as unconstitutional as in fact they arerules of equality and reciprocity that apply to all WTO members. Aside from envi-sioning a trade policy based on ‘equality and reciprocity,’ the fundamental lawencourages industries that are ‘competitive in both domestic and foreign mar-kets,’ thereby demonstrating a clear policy against a sheltered domestic tradeenvironment, but one in favor of the gradual development of robust industriesthat can compete with the best in foreign markets. Indeed, Filipino managers andFilipino enterprises have shown capability and tenacity to compete internationally.And given a free trade environment, Filipino entrepreneurs and managers in HongKong have demonstrated the Filipino capacity to grow and to prosper against the bestoffered under a policy of laissez faire.” (Emphasis supplied)

PROPOSED ANTITRUST LEGISLATIONRealizing the deficiencies of the existing legal and regulatory systems for en-

forcing competition, the Philippine government, through the legislature, has beenattempting to pass new antitrust or competition legislation since the early 1980s. Thenumerous draft bills have been quite varied, having been adopted from various exist-ing antitrust and competition laws around the world. Unfortunately, a lack of ap-preciation and polit ical will have kept these proposed laws out of thegovernment’s priority list. Consequently, quite a number of draft antitrust orcompetition laws have accumulated over the years, but none of these have actu-ally been acted upon. Both Houses of the present 11th Congress already have anumber of draft laws submitted. These latest proposed bills have been attached tothis study as Appendix 2.


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, AppropriatingFunds Therefor and For Other Purposes.” - authored by Rep. Gerardo Espina;

House Bill No. 3780 — “An Act Prohibiting Monopolies, Attempt to Monopolizean Industry or Line of Commerce, Manipulations of Prices of Commodities, AssetAcquisition and Interlocking Memberships in the Board of Directors of CompetingCorporate Bodies and Price Discrimination among Customers, Providing PenaltiesTherefor and for Other Purposes,” - authored by Reps. Feliciano Belmonte Jr., JackEnrile, 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 andFunctions and for Other Purposes,” – authored by Reps. Neptali Gonzales II andManuel 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 ForOther Purposes.” - authored by Sen. Sergio Osmena III; and

Senate Bill No. 1792 - “An Act Prohibiting Monopolies, Attempt to Monopolizean Industry or Line of Commerce, Manipulations of Prices of Commodities, AssetAcquisition and Interlocking Memberships in the Board of Directors of CompetingCorporate Bodies and Price Discrimination among Customers, Providing PenaltiesTherefor 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 sofar, the measures have been put on hold. No committee report has yet been issued onthe 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. Inthe 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 theeconomic development program of the government, it has not even been declared apriority measure by the executive branch.

ANTITRUST ENFORCEMENT IN OTHER COUNTRIESA cursory review (Meyerman and Cuevas 1998) of the developments in antitrust

enforcement in other Asia Pacific economies may be useful to benchmark the progressof the Philippines, as well as to better appreciate the trends at the international andregional levels.


IndonesiaThe Indonesian Competition Law was only recently enacted on 5 March 1999

after lengthy deliberations in Parliament and as part of economic restructuring effortsfollowing 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 anticompetitivebehavior in order to safeguard the public interest, to increase the efficiency of thenational economy and to enhance social welfare. The Law is also designed to build aconducive business environment through fair competition that assures equal businessopportunity for all business actors, to prevent monopoly practices and unfair businesscompetition, 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 for-eign parties that may lead to monopoly practices and unfair business competition.Mergers and acquisitions are also prohibited if they lead to monopoly and unfair com-petition.

The Law includes the establishment of an independent enforcement agencycalled the Business Competition Oversight Commission, which reports to the Presi-dent. The Commission’s responsibilities include examining agreements that may leadto monopoly or unfair practices, investigating abuse of dominance, giving policy rec-ommendations to the government, and issuing and compiling implementation guide-lines. The Commission has the authority to conduct investigations and imposeadministrative and punitive sanctions. Administrative sanctions may be in the form ofcancellation of business permit or prohibition of interlocking directorships. Punitivesanctions are in the form of fines and imprisonment. Parties to a case may appeal theCommission’s decisions to a District Court or the Supreme Court.

MalaysiaEfforts to draft a competition law or trade practices law begun in 1993, but no law

has yet been promulgated. Various consultations and information campaigns havebeen 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 andprivatization. A regulatory body monitoring privatized public utilities promotes com-petition by allowing other firms to operate certain parts of privatized service throughlicensing arrangements. For example, eight firms have been licensed to operate tele-communications services in competition with the dominant privatized Telekom Ma-laysia, while several independent power producers have been allowed to generate andsell energy to the dominant Tenaga Nasional Berhad. As part of the WTO mandate oftrade liberalization, tariffs and nontariff restrictions are being dismantled to encour-age domestic and international trade.

There are also approximately 30 laws which regulate enterprises and promoteconsumer protection, as well as administrative rules and regulations such as those


administered by the Foreign Investment Commission that governs the acquisition ofassets, mergers, and takeovers.

SingaporeSingapore does not have any formal competition laws. Its “competition policy

framework” depends on a free and open market that, in turn, ensures a competitiveenvironment in the domestic economy. For the services sector, in which the govern-ment has traditionally been the sole provider, Singapore has commenced a program ofcorporatization and privatization in order to subject such services to competition andmarket disciplines.

JapanJapan’s Anti-Monopoly Act (AMA) was passed in 1947. The Japan Fair Trade

Commission (JFTC) is an independent regulatory commission created under theAMA. American laws exerted a strong influence on the AMA which had the follow-ing 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 constraintto business activities by prohibiting private monopolies, unreasonable restraints oftrade and unfair trade practices, and preventing excessive concentration of mar-ket power. In 1977, the AMA was amended to impose tougher sanctions againstcartel.

In addition to regulating common anticompetitive conduct, the AMA also regu-lates mergers, acquisitions, shareholdings and interlocking directorates that are sub-ject to filing requirements and scrutiny by the JFTC. The JFTC may direct the erringenterprises not to implement or to terminate or to take the necessary steps to lessenthe possible anticompetitive impact of a transaction. Almost all enterprises contem-plating mergers with antitrust concerns consult the JFTC before they formallyfile for approval and registration of mergers. The JFTC regularly publishes itsmerger guidelines and actual merger consultation cases in order to ensure trans-parency.

The JFTC also publishes recommendations for deregulation and exemption sys-tems under the AMA. On the basis of these recommendations, the concerned govern-ment agencies modify or abolish economic regulations. Thereafter, the JFTCmonitors the impact of these changes to determine if significant competition has comeabout.


In the mid-1980s, the U.S. government alleged possible anticompetitive prac-tices17 of Japanese enterprises and associations. As a consequence, Japan improvedits enforcement of competition policy through the following measures: increased theJFTC staff and budget allocation; acted on price-fixing cartels and bid rigging; dis-closed detailed information on cases; increased the severity of penalties; and pub-lished JFTC guidelines on distribution and trade practices. In 1991, Japan raised thesurcharge rate on cartels to 6 percent from 1.5 percent of sales. In 1992, the maximumfine for criminal anticompetitive conduct was raised by 2000 percent or up to ¥100million or approximately P33 million.18

KoreaSince 1966, government intervention helped in South Korea’s rapid economic

development. However, such a strategy is no longer recognized as suitable in thecurrent international economic context. In 1996, the Monopoly Regulation and FairTrade Act (MRFTA) was amended to boost the effectiveness of competition law on awider spectrum. Remedial measures were the earlier focus of competition law whilepreventive measures were neglected. Thus, some monopolistic and oligopolistic en-terprises enjoyed the protection of “government supervision.” The Korean FairTrade Commission (KFTC) has begun concentrating on markets where monopolistsand oligopolists have become entrenched and has been identifying restraints on com-petition in these markets. The KFTC is also studying chaebols, that is large businessgroups engaged in group-based competition through mutual assistance. The fleet-likeexpansion and management of such groups are a disincentive to building individualcompetitiveness. Under the 1996 amendments to the MRFTA, the ceiling for debtguarantees among affiliates of large business groups has been decreased from 200percent to 100 percent of the individual firm’s assets. Penalties for anticompetitiveconduct have also become stiffer. For example, the KFTC imposed its highest fine, todate, on three paper producers the amount of 8.3 billion won (US$10 million or ap-proximately P437.8 million19) for engaging in collusive activity.

All anticompetitive mergers are now forbidden, regardless of the size of the en-terprises. Previously, only mergers involving assets exceeding 20 billion won (US$25million approximately P1.1 billion) were evaluated by the KFTC. Pre-merger notifi-cation 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 US574 (1986), a U.S. television manufacturer claimed that a Japanese company was exportingtelevision sets to the U.S. at dumped prices. The U.S. Supreme Court ruled that the actions ofJapanese 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).


The elevation of the KFTC to a ministerial-level agency signaled the importanceof competition policy. The KFTC chairman is now a Cabinet member. More signifi-cantly, the KFTC is specifically responsible for removing restraints to competitioncause by government policy and initiating procedures to review anticompetitive regu-lation. These changes reflect the growing recognition that competition policy is ex-tremely important in a globally-integrated economy and need to be coordinated withthe other economic policies of a country.

ChinaChina’s first competition legislation was the Regulations on Development and

Protection of Competition which the Chinese government promulgated in 1980through the State Council. It still featured characteristics of the centrally-plannedeconomy prevailing at the time. Nevertheless, the first Regulations had a signifi-cant impact since it shed new light on the theoretical research on competition inChina.

The Regulations were eventually modified on 1 December 1993, when the Lawfor Countering Unfair Competition became effective, after having been endorsed bythe 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 consistedof several departments, such as the State Legislative Bureau (now known as the StateLegislative Office) and the State Administration for Industry and Commerce (SAIC)and others, to draft a national law for competition. A new Antimonopoly Law is cur-rently being drafted.

In addition, competition law and policy are also embodied in other new laws suchas the Law of the People’s Republic of China for Protecting Consumer’s Rights andInterests (promulgated in 1993), as well as the Regulations on Antidumping andAntisubsidization (promulgated by the State Council in 1997).

TaiwanAfter 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 ofthe Fair Trade Commission. The Fair Trade Law covers a wide range of antitrust andunfair competition concerns. The antitrust portion of the Law regulates monopolies,mergers, and concerted actions. In general, the Law permits the existence of monopo-lies, as long as they do not abuse their market power. Mergers involving parties reach-ing a certain sales volume or market share must apply with the Commission forapproval. The Commission in principle forbids concerted actions but allows for ex-ceptions which require the Commission’s prior approval. The unfair competition por-tion of the Law regulates practices such as resale price maintenance, various othertypes of vertical constraints, acts which are likely to impede fair competition, falseand deceptive advertising, multi-level sales and other practices which are deceptive orgrossly unfair.


In order to keep pace with the current social and economic circumstances, as wellas to anticipate future developments, the Fair Trade Law has been amended as of 05February 1999. Salient points of the amendments include: increasing pecuniary pen-alties administrative and criminal fines directed at persons who and enterprises thatviolate the Fair Trade Law. This upgraded the Fair Trade Commission’s capability toregulate enterprises that do not comply with the Commission’s directives and to dealwith cases through administrative means before resorting to the judicial system, ex-cept for those cases involving illegal multilevel sales schemes.

AustraliaAustralia 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 sub-sequent related legislation, was not entirely successful until the enactment of theTrade Practices Act of 1974 which contains Australia’s basic competition law provid-ing for a comprehensive regime for business competition and regulation.

The competition laws were greatly enhanced following the adoption of the 1993Hilmer Committee recommendations and the development of the National Competi-tion Policy, agreed to in 1995 by the Federal, State and Territory governments. Keyfeatures of the new laws include the following:

• An independent regulator, the Australian Competition and Consumer Com-mission (ACCC), now undertakes compliance and education activities andenforces the law by pursuing court action.

• Universal application of the competitive conduct rules to all sectors of theAustralian economy, including government business activities and the unin-corporated sectors (e.g., the professions).

• Mechanisms that provide access to essential services through significant in-frastructure facilities; and price oversight of State and Territory governmentbusinesses through the Price Surveillance Act of 1983.

Australia’s competition laws apply to all forms of business and to all industrysectors. They fit within a competition policy framework that involves many otherinitiatives such as review of anticompetitive regulation and the application of a com-petitive neutrality policy to government businesses.

New ZealandNew 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 beinvestigated, and generally only prevented those considered contrary to the publicinterest. A change of approach was made with the enactment of the Commerce Act in1986. At the same time, a number of measures designed to increase the competitive-


ness and efficiency of the New Zealand economy was introduced such as reducingGovernment control and direct regulation of business activity. The Commerce Actwas seen as a necessary accompaniment to the market reforms as it ensured that pri-vate firms did not replace the previous government regulation with anticompetitivebehaviour. 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 wish-ing 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 com-petition through legislation which:

• Prohibits the establishment or operation of business arrangements which re-duce 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 enact-ment 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 industriesrather than their structure, and recognizes that in some cases, an efficient industrystructure may imply fewer competitors.

MexicoThe Federal Law on Economic Competition (FLEC) was enacted on 23 June

1993 creating the Federal Competition Commission as the agency in charge of enforc-ing the law. The Federal Competition Commission was designed to function as anautonomous administrative body of the executive branch within the Mexican Secre-tariat of Commerce (Secretaria de Comercio y Fomento Industrial or SECOFI). ThePresident appoints a panel of five commissioners, including the Commission presi-dent, 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 ofinterested 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 compe-

tition policy.


This antitrust statute consists of 39 articles that establish economic and legalregulations for all economic agents in Mexico. This includes all government agenciesor entities, individuals, private companies, state-owned companies or companies withgovernment participation, associations, professional organizations, trusts and the like.

ASSESSMENT OF ANTITRUST REGULATIONIN THE PHILIPPINES

Historically, developed countries have used and are using antitrust regulation tofoster and maintain competition that ensures an efficient, working market economyand modern democracy. Competition, through its allocative, distributive and incen-tive functions, can prevent undue concentration of economic power and the conse-quent concentration of political power in the economic elite who use their economicand political powers to have their inefficiencies subsidized by the majority of consum-ers and taxpayers.

Knowing the existing laws and regulations for antitrust enforcement at the dis-posal of the Philippine government, what is then the actual effectiveness of theselaws and regulations in promoting competition in the Philippine economy? Thissection analyzes the state of antitrust regulation in this country and examines thegovernment’s capability to implement its antitrust laws and regulations. It studiesthe general regulatory structure in place and identifies a number of the regulatorsand institutions involved in the antitrust process. How have they managed to controlthe behavior of the players in various industries and sectors? How have they affectedthe structure of markets in the Philippine economy? What are the major problemareas?

STRUCTURE OF MARKETS IN THE PHILIPPINE ECONOMY:A GENERAL ASSESSMENT

The Philippine economy is characterized by a high concentration of wealth andresources in a few groups comprising the nation’s elite class. The top 5.5 percent of allland-holding families own 44 percent of all tillable land and the richest 15 percent ofall 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, 40percent 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., themeasure of the market share of the top three or four firms to total market size incertain key industries: petroleum, iron and steel manufacturing, fertilizer, pulp andpaper, home appliance manufacturing, tobacco and cigarette, and tire manufacturing.

This high concentration ratio is a direct result of the failed economic policies ofthe past, particularly from a surfeit of regulation and a dearth of competition.


The Philippine government adopted a strategy of import substitution, protection-ism and the allocation of resources through regulation. In the guise of “nationalism”predominant in the 1950s and 1960s, domestic enterprises, especially the so-calledinfant industries, were pampered and protected from foreign competition through theimposition of high tariffs or outright quota restrictions on imported products andsimilar measures. These measures, which persist up to the present, encouraged therent-seeking, import-substituting, capital-intensive, and oligopolistic behavior ofPhilippine domestic enterprises.

The requirement for franchises and licenses was also used as a device to protectincumbents by disqualifying competitors. The main purpose and effect of such re-quirement is to reserve (specific) areas to franchisee or licensee, and hence excludeothers. Franchises are awarded by acts of Congress and are distinct from permits tooperate, which are dispensed by agencies regulating public utilities. The fact makesthe award of franchises potentially open to wider rent-seeking or political consider-ations.

The high concentration ratio in various industries is also directly attributable toentry barriers that prevent new participants from entering and competing in the sameindustry.

The Philippine economy, therefore, is largely captive to a small group of eco-nomic interests who have succeeded in maintaining market dominance by success-fully excluding other firms from entering to participate and compete in themarkets.

With this concentration of economic power, political power was likewise concen-trated in the hands of a small elite. Only 60 to 100 political clans control all electivepositions at the national level. The Philippine Congress, on the basis of reported state-ments of assets and liabilities submitted by its members, is composed largely ofmultimillionaires. The marriage of economic and political power presents a formi-dable hindrance to any form of change that may, or threaten to, alter the existingstatus quo.

The immediate past two government administrations saw the articulation ofplans and programs to reform the economy and open up the markets to competition.

From 1992 to 1998, significant executive and legislative reform measures pro-moted unexpected advances in economic growth and development for the Philip-pines. Annual growth rates experienced a dramatic increase from 0.5 percent in1992 to 7.1 percent in 1996. There were also tangible improvements of consumerwelfare in key sectors, such as telecommunications, air and water transport, con-sumer goods, and industrial inputs. The Philippines also joined various multilateraland regional trading and economic cooperation arrangements, such as the ASEANFree Trade Area (AFTA), the Asia Pacific Economic Cooperation (APEC), and theWorld Trade Organization (WTO). All these arrangements sought to liberalize tradeand investments, and provide the Philippines with the much-needed external pressureto introduce internal reforms.


However, trade and investment liberalization and deregulation were notsufficient to make the Philippines globally competitive. Merely liberalizingtrade and investments is not enough to achieve sustainable and stable competi-tiveness. One crucial lesson from the success of the recent economic reforms isthat competition played a key role in improving capital accumulation, factorproductivity, efficiency in resource allocation, technological advancement andinnovation.

It should be noted that throughout all these economic reform measures, theissue of maintaining competition and sustaining competitiveness has not been ad-dressed.

All these recent reform efforts may be actually be reversed and wasted unless thevarious measures are rationalized and embraced under well-articulated and compre-hensive competition policy framework. After having enticed and invited investors todo 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 ofexisting laws and the introduction of new measures to foster and maintain fair compe-tition in the Philippine economy.

INADEQUACY OF THE EXISTING ANTITRUST LAWS AND REGULATIONSPresent laws for promoting competition in the Philippines have been proven in-

adequate or ineffective to stave off the ill effects of anticompetitive structures andbehavior in the market, mainly due to lack of enforcement.

Despite the considerable number of laws and their varied nature, competition hasnot been fully established in all sectors of the economy, nor has existing competitionin other sectors of the market been enhanced. These laws have been hardly used orimplemented as may been seen in the lack of cases litigated in court. The same lawshave even worked to discourage competition.

Several reasons have been forwarded to explain the lack of enforcement of com-petition 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 account-

ability for implementation of the laws is difficult to fix.Some regulators are unable to relate all the different existing laws and regu-

lations (Khemani 1996). Moreover, there is a lack of expertise in the apprecia-tion and implementation of competition laws that rely heavily on economicthought, techniques of analysis, and value preferences as tools of enforcement(Khemani 1996).

Identifying a single specialized agency under a specific competition law, with thenecessary expertise and authority to oversee the enforcement of competition laws, istherefore 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 regulatesthe 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 lawsthat established them. The objectives behind each of these laws are unquestionablynoble. However, inasmuch as each law is meant to address specific situations, thereruns 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 thescheme of competition policy determined.

Since some of these laws are penal in nature, the quantum of evidence required sothat the case may prosper–proof beyond reasonable doubt–is difficult to obtain. Inaddition, the witnesses and/or aggrieved parties, because of the long tedious legalprocesses involved, are themselves not interested in putting the perpetrators behindbars; rather they are more interested in obtaining an injunction or cease and desistorders. Moreover, fines are inadequate to deter would-be criminals (Khemani 1996).An administrative enforcement mechanism that can be implemented faster, with heftyfines as penalties for unfair competition, would be more effective.

Although beyond the scope of this study, it must be pointed out that in addition tostudying the laws that directly bear on competition and competition policy, it is indis-pensable to consider the other laws which bear on economic development as these alsodeal with the elements of competition policy.

Lack of jurisprudence on competitionThe judiciary has scarcely had the opportunity to pass upon the proper applica-

tion of the various laws on competition, partly due to lack of enforcement. The silenceor ambiguities in these laws have thus remained. The lack of guidance has discour-aged full implementation.

OTHER CONSIDERATIONSThese 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 regula-tory system in the Philippines will not be a futile exercise.

Political capacityWith major powerful economic interests involved and entrenched, the develop-

ment of a comprehensive competition policy to guide future economic regulation inthe Philippines will definitely run into serious political obstacles if such interests areopposed. The accumulation of rents through monopolies over resources, factors of


production, and channels for economic activity goes back centuries to the colonialperiods.

Political capacity is intricately entwined with financial capacity, public support,and relative autonomy from pressures and influence of vested interest groups.

Budgetary constraintsAlthough government agencies may have relatively large budgets, the amount of

these resources compared to those at the disposal of vested interests for the purpose ofobstructing reform, appear quite meager. It is also important to note that the budget isessentially controlled by Congress and may be withheld from agencies involved in thereform effort.

Technical capacityMost officials in the bureaucracy, as well as politicians, nongovernment organi-

zation (NGO) members and consumers, still lack technical knowledge in competitionpolicy. This is the same for bureaucrats involved in the enforcement of fair trade andthose who could potentially be involved in competition regulation. A number of offi-cials of the Tariff Commission, Department of Trade and Industry, and the NationalEconomic Development Authority, have been attending various seminars and work-shops on competition policy, but all still lack the practical experience.

Management constraintsStrict rules on the management of government agencies and the allocation of agency

resources severely limit the organizational capability of these agencies. This makes itdifficult for an agency to institute innovations and reforms internally and react swiftly andflexibly to various external situations. Thus, government agencies are rendered ineffectiveand anticompetitive, especially when compared to private corporations.

Proper compensationFinally, 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 graduatesfrom 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 gov-ernment officials and employees highly vulnerable to corruption and undue influenceby vested interests.

The organizational capability assessment may put into question the feasibility ofthe initiative to develop and enforce antitrust measures. However, it is necessary atthis point to take stock of the different obstacles and threats this endeavor faces, aswell as of the actual capabilities of the key actors and decision makers. This can thenpave 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 theprocess, as well as the timing and sequencing of measures.


Ultimately, this initiative would still be the most logical next step in the strugglefor the economic renewal of the Philippines. If the obstacles appear daunting, thisshould only strengthen the resolve to push this initiative forward in the most creativeand strategic manner possible.

THE NEXT STEPThe above assessment of antitrust regulation and competition promotion does

yield disappointing results. Competition is undoubtedly an integral component of afunctioning market economy. Indeed, for a society to reap the benefits of wealth cre-ation, wealth distribution and the other major objectives of competition, the state mustensure that market forces are constantly at play within an economy.

Over and over, the Philippine government has made pronouncements about itsadherence to a modern capitalist market system. Our Constitution clearly declaresthat it is state policy to protect and promote competition. However, Philippine politi-cal and economic histories paint a totally different picture. Ever since the creation ofthe modern Philippine state, the rule has actually been to prevent and destroy compe-tition in order to protect the dominant political and economic elite of the country. Inkey industries and services, monopolies and cartels have been the standard vehiclesfor wealth creation. Hence, laws and regulations were structured in such a way thatcompetition could never flourish. There is an existing legal and regulatory system forpromoting competition in this country. Unfortunately, it has proven to be completelyineffective in meeting its objectives.

The Philippines has yet to craft a truly effective legal and regulatory frameworkfor enforcing competition in the economy. How such a framework is to shape up, willdepend on the design of a simple and enforceable model and a careful consideration ofthe political economy realities of this country.

RECOMMENDATIONS FOR A NEW LEGAL ANDREGULATORY 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 allcountries.

Recent international and regional developments indicate a pressing need forthese new regulatory frameworks in developing and developed countries alike.

The controversy and confusion surrounding the last WTO ministerial conferencein Seattle highlight the urgency for WTO member countries to prepare their respec-tive economic systems for competition in a so-called “Global Economy.” This adjust-ment process includes the introduction of new frameworks for economic regulationwhich prepare firms and industries for vigorous international competition. In fact, in


this last ministerial conference, a very important agenda item was the issue of tradeand competition policy. Although this topic has been the subject of much controversydue largely to the differences of opinion between the United States and the EuropeanUnion 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 otherinternational institutions such as the OECD and the World Bank, underscores itscrucial role in international economic relations and development.

The “shocks” that the financial systems of the East Asian economies sufferedillustrated the lack of responsiveness and relevance of existing regulatory frameworksto international economic realities. The Asian financial crisis was in fact a result ofthese fundamental conflict. Although certain countries, such as Malaysia and thePhilippines, chose to impose restrictions on market-based flows of capital and goods,many countries across the region, such as Thailand, chose to review their antiquatedeconomic regulations with the intention of amending and modernizing them. If asimilar crisis is to be prevented in the future, then Asian economies would be betteradvised to choose the latter approach.

The Philippines was certainly not spared the negative effects of the Asian finan-cial crisis, despite claims to the contrary. Many firms and industries did suffer fromthe drastic fluctuations of an unstable currency. Unfortunately, rather than acceptingthe crisis as a result of market forces conflicting with anticompetitive economic regu-lations, these firms even cited the crisis as justification for imposing economic con-trols and trade barriers. For example, the Philippine government has made moves toincrease trade protection for its textile, petrochemical, basic steel, and basic agricul-tural sectors. Such efforts only aggravate monopoly situations already prevailing inthese sectors. What is most disturbing about this is it reveals a highly inconsistentapproach in economic development policy and even a reversal of the Philippine gov-ernment pronouncements about adhering to open markets, liberalization and compe-tition. The problem is that the Philippines, despite the existence of numerous laws andregulations dealing with competition, really lacks a clear, coherent, comprehensiveand enforceable legal and regulatory framework for antitrust enforcement and theprotection of competition.

Therefore, there is still a need to propose a more effective framework forantitrust regulation in this country. Such a framework should first lay down thebasic policy objectives and principles, as well as spell out the basic structure forregulation.

REQUISITE FEATURES OF A COMPETITION LAWAs explained earlier, Philippine laws and regulations bearing on competi-

tion are actually numerous and varied. However, there still remains a need toenact an overall law on competition, particularly a comprehensive antitrust leg-islation. In this regard, some authors have suggested the requisite features forsuch legislation:


• Competition law should focus on the actual and, or potential business con-duct of firms in a given market, and not on the absolute or relative size offirms. It should look at the business conduct of firms and on the businessenvironment in which the firms operate.

• Competition law must be effectively harmonized and linked with other gov-ernment policies. Promoting competition in the business environment con-strains firms’ anticompetitive behavior and also inculcates sound businesspractices and ethics.

• Competition law should be a law of general application, addressing all sec-tors of the economy. Exemptions from its application may be allowed if theydo not limit competition, are based on sound economic principles and areaimed at facilitating legitimate economic activity.

• Competition law should contain provisions explicitly prohibiting businesspractices that are clearly against economic efficiency and consumer welfare,such as price fixing, bid rigging, restriction of output and market shares andallocation of geographic markets and customers which should be deemedillegal per se and subject to criminal law and severe penalties.

• Competition law should also provide for a “rule of reason” approach withrespect to horizontal and vertical mergers, specialization agreements, jointventures, vertical manufacturing and wholesale, retail distribution arrange-ments. Prior notification to and approval by the concerned agency of suchbusiness arrangements is recommended but only with respect to largesttransactions, taking into consideration size thresholds in terms of marketshare, assets, sales and/or employment of parties involved (Khemani 1996).

Ultimately, these measures should seek to establish a new national economic or-der with the private sector as the primary engine of growth and development, marketforces as the determinants of prices and wages, competition as the principal means ofeconomic, political and social control and discipline, consumer welfare, employmentand income expansion, and economic efficiency as the main benchmark.

Antitrust laws in the Philippines have been largely ineffective because their en-forcement is vested in different agencies. This breeds confusion, noncoordination andconflicts. It is not uncommon for benefits from enforcement in one area to be negatedby adverse effects from enforcement elsewhere.

The effective implementation and enforcement of anticompetition laws should bevested in a centralized agency with sufficient powers to oversee and monitor the com-petitive climate in the different sectors of the economy, to formulate and recommendsuch measures as would ensure the maintenance of the competition in the Philippinedomestic market and as would anticipate developments in the international market.

REALITY CHECKGiven 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


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 central-ized and comprehensive manner. This would necessitate the introduction of a newcomprehensive law, that outlines the anticompetitive structures and behavior whichneed to be curtailed and the procedures for enforcing these, as well the creation of anew competition agency to implement the new law.

The prime objective of this special reform effort is to institutionalize a “competi-tion culture” in the Philippines. If society as a whole accepts and even promotes com-petition as an integral part of economic reality, then antitrust regulation can actuallybecome self-sustaining. However, it will still require a legal and regulatory frame-work in which to operate. Furthermore, this framework will have to play that centralrole in an over-arching competition policy for the whole economy. This frameworkwill have to be imbued with the level of importance that would command the respectof the highest leadership as official state policy.

FIRST OPTION: COMPREHENSIVE APPROACHTherefore, the first option in introducing an effective legal and regulatory frame-

work for antitrust enforcement is the passage of a new law which is comprehensive inscope and central to economic policy. This new law will have to contain all the majorprovisions governing the conduct of antitrust enforcement and it will, in effect,modify the manner in which the government regulates the economic activities in thePhilippines. The new law will centralize the different interventions of the governmentwhich relate to competition policy.

The entity could be called the Philippine Trade Commission or the PhilippineCompetition Commission, composed of members with varied backgrounds in laws,economics, finance and various fields of industry and business. In determining thenature, powers, functions and duties of the Commission, it is proposed that the follow-ing guiding principles (Khemani 1996) be considered:

• The Commission should be independent and insulated from political inter-ference, or influence.

• The investigation, prosecution and adjudication functions should be separate.• A system of checks and balances with appropriate rights of appeal and re-

view of decisions and facts on legal and economic grounds should be pro-vided.

• The Commission should guarantee the expeditious resolutions of cases andrelated 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 com-petition laws in addressing different types of restrictive business practices.


Suggested scope and provisions for a competition lawA 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 areaccompanied by a brief commentary. It must be emphasized that the statutory provi-sions are only suggestions. Competition laws must be drafted to fit the legal andeconomic context of each country.

Scope of competition lawCompetition 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 entitiesengaged in commercial transactions irrespective of ownership or legal form. All excep-tions to the application of the law should be explicitly identified in pertinent legislation.

Suggested provisions:[Article ________] PurposeThis Law is intended to maintain and enhance competition in order ultimately to

enhance consumer welfare.[Article _______] Field of application1. This Law shall be enforced on the whole territory of the Republic of

_________and applies to all areas of commercial economic activity. TheLaw shall be applicable to all matters specified in [section(s) of the lawcontaining 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 andprotections conferred by other laws protecting intellectual property, includ-ing inventions, industrial models, trademarks, and copyrights. It does applyto the use of such property in such a manner as to cause the anticompetitiveeffects prohibited herein.

3. This Law shall apply neither to the combinations or activities of workers oremployees nor to agreements or arrangements between two or more employ-ers when such combinations, activities, agreements, or arrangements aredesigned solely to facilitate collective bargaining in respect of conditions ofemployment.

DefinitionsThe 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 amarket, limit each other’s ability to control the conditions prevailing in that market.


“Firm”—any natural or legal person, governmental body, partnership, or associa-tion in any form engaged directly or indirectly in economic activity. Two firms, one ofwhich is controlled by the other, shall be treated as one firm. Two or more firms thatare controlled by a single firm shall be treated as one firm. The competition officeshall 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 tosubstitute, and a specific territory, which could extend beyond the borders of theRepublic of __________ , in which are located sellers among which buyers are orwould be willing to substitute.

Abuse of dominant positionSuggested provisions:[Article_]Abuse of a Dominant Position1. “Dominant Position”—a firm has a dominant position if, acting on its own,

it can profitably and materially restrain or reduce competition in a marketfor a significant period of time. The position of a firm is not dominant un-less its share of the relevant market exceeds 35 percent. A firm having amarket share exceeding 35 percent may or may not be found to be dominantdepending on the economic situation in that market, including the firm’smarket share, competing firms’ market shares and their abilities to expandthose shares, and the potential for new entry into the market.

2. Actions of a dominant firm—including creating obstacles to the entry ofcompeting firms or to the expansion of existing competitors or elimina-tion of competing firms from the market—that have or may probablyhave as their result a significant limitation of competition are prohib-ited.

3. Section 2 of this article does not prohibit actions by a firm that createobstacles to the entry of new firms or reduce the competitiveness of exist-ing firms solely by increasing the efficiency of the firm taking those ac-tions, or that pass the benefits of greater efficiency on to consumers.

[Article__] Power to break up a firm abusing its dominant position1. 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 rectifythe situation or prevent recurrence of the abuse, the competition officemay 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 exer-cised in a manner designed to minimize any increases in costs of providingthe good.


The 35 percent “safe harbor” is found in the competition laws of several countrieseither expressly or in common law or practice. Although the 35 percent threshold issomewhat arbitrary, it is unlikely that a firm with a much smaller market share couldsuccessfully exercise market power unilaterally. There are some valid reasons for rais-ing the threshold. In a small country that is relatively closed to international trade andinvestment, high concentration may be necessary so that firms can grow large enoughto exhaust significant economies of scale and scope.

In some countries’ law, a market share of 65 or 70 percent creates a presumptionof dominance that the firm must rebut. But many think that the better practice is toplace the burden of providing dominance on the competition agency. A high marketshare is a necessary but not sufficient condition.

This provision employs a general legal standard: a “significant limitation ofcompetition.” In economic terms, this standard typically refers to restrictions thatwould 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. Itcan even vary over time within the same country in response to changes in the re-sources available for antitrust enforcement and in the efficiency of the competitiveagency.

The laws of some countries also list specific types of conduct, such as predatorypricing, tying, or exclusive dealing that can constitute abuse of dominance. Such pro-visions are more common in countries that employ a civil code legal system, as op-posed 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 mustalways be remembered that the specific conduct is not always abusive oranticompetitive, even if carried through by a dominant firm.

Restrictive agreementsCertain types of horizontal agreements, collectively described as cartel agree-

ments, are subject to stricter control than other types. In many countries this distinc-tion is not found in the law itself but in enforcement practice or regulations. Countriesthat are adopting competition laws for the first time, however, are better off makingthe distinction explicitly in the law. Doing so will help ensure that enterprises learnthe seriousness of violating cartel prohibitions and will help business people under-stand that although some vertical agreements may hurt individual competitors, theyare proscribed only if they harm competition industry wide.

Not all horizontal agreements are cartel agreements. Competitors may integratetheir operations to achieve greater efficiency, and the result may be procompetitive onbalance. Agreements of this type include joint ventures, joint research and develop-ment, and the setting of common standards that benefit consumers. These agreementsshould be subject to a more lenient legal standard and distinguished from cartel agree-ments in the competition law.


Finally, some horizontal and vertical agreements may be harmful to competitionin some sense, but may generate efficiencies that make them beneficial on balance.(Cartel agreements, by definition, cannot generate such efficiencies.) It is helpful ifthe law sets forth the standards that govern this analysis.

Suggested provisions:[Article___] Prohibited agreements between firms1. An agreement, concluded in any form including by concerted practice, be-

tween competing firms (including firms that could easily become competi-tors) is prohibited if such an agreement has or would likely have as itsprincipal 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 pur-

chases, 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, con-cluded in any form including by concerted practice, is prohibited if it has orwould 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 section1 of this article, cannot be found to significantly limit competition un-less the shares of the firms participating in the agreement collectivelyexceed 20 percent of a market affected by the agreement.

(b) An agreement solely among noncompeting firms cannot be found tosignificantly 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 nonethelesslegal if it has brought about or is likely to bring about gains in real as op-posed to merely pecuniary efficiencies that are greater than or that more thanoffset the effects of any limitation on competition that result or are likely toresult from the agreement.(b) The burden of proof under this section lies with the parties seeking theexemption, and includes demonstrating that if the agreement were not imple-mented it is not likely that the relevant efficiency gains would be realized bymeans that would limit competition to a lesser degree than the agreement.


Section 3(a)’s reference to “real, as opposed to merely pecuniary, gains in effi-ciency” is designed to exclude consideration of benefits such as reductions in incometaxes or greater quantity discounts obtained solely through exercising greater pur-chasing leverage. Such pecuniary gains are transfers rather than increases in theeconomy’s ability to satisfy consumer needs.

Section 3(b) does not require the parties to prove that the agreement is the onlyway to realize the claimed gains in efficiency, but that there are no practical, lessanticompetitive means of doing so.

Section 3(a), and an identical provision in section 9 of the article on concentra-tions, read together with article 1 (the purpose clause) implicitly applies a total wel-fare standard to the efficiencies defense or exemption. It does so by giving equal weightto both consumers and producers, thus ignoring any transformation of consumer surplusinto producer surplus resulting from the agreement. Section 3(a) permits agreements inwhich the deadweight loss – that is, the surplus lost to consumers but not transformedinto higher producer profits – from the fall in consumption due to a price increase is lessthan the value of resources saved in more efficiently producing the goods.

Instead of a total welfare standard, some countries might prefer to focus exclu-sively on consumer welfare, and therefore allow an efficiency defense or exemptiononly in cases where efficiency gains are expected to be so large that consumers willnot be harmed despite the anticipated increase in market power. To articulate such astandard, section 3(a) could be written as follows:

3. (a) An agreement prohibited under section 2 of this article is nonethelesslegal if it has brought about or is likely to bring about gains in real asopposed to merely pecuniary efficiencies that are greater than or that morethan offset the effects of any limitation on competition that result or arelikely to result from the agreement.

Mergers and acquisitionsA competition statute’s merger provisions should be permissive. In particular,

there is no need for systematic review and approval of all mergers. Mergers should beallowed unless the competition authorities can show that they will significantly limitcompetition. Furthermore, requiring notification of all mergers would unduly burdenthe 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 besubject to premerger notification requirements. In countries with high inflation, it isadvisable to measure the minimum-size threshold in terms that rise with inflation, forexample as a multiple of a standard minimum wage.

The same competition test should apply to all mergers, whether or not noti-fication is required. The competition office should thus have the power to orderthe dissolution of smaller non-notified mergers. To eliminate the uncertainty cre-ated by possible dissolution, merging firms should be permitted to make voluntarynotifications.


Suggested provisions:[Article ___] Review of concentrationsDefinition1. “Concentration”—concentration shall be deemed to arise when:

– Two or more previously independent firms merge, amalgamate, or com-bine the whole or a part of their businesses; or

– One or more natural or legal persons already controlling at least onefirm acquire, whether by purchase or indirect control of the whole orparts of one or more other firms.

2. “Control”—for the purpose of this article, control is defined as the ability tomaterially 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.

Notification3. When an agreement or public bid will produce a concentration larger than

the minimum size as provided in regulations issued pursuant to section 7 ofthis article, the parties to the agreement or bid are prohibited from consum-mating such concentration until ___ days after providing notification to thecompetition office, in the form and containing the information specified inregulations issued pursuant to section 7.

4. Before the expiration of the __day period referred to in section 3 of thisarticle, the competition office may issue a written request for further infor-mation. The issuance of such a request has the effect of extending the periodwithin which the concentration may not be consummated for an additional__days, beginning on the day after substantially all of the requested infor-mation is supplied to the competition office.

5. Parties to an agreement or public bid not subject to the notification require-ment in section 3 of this article may voluntarily notify and, if they do so, besubject to the same procedures, restrictions, and rights as are applied tocases of compulsory notification.

6. If, before consummation of a concentration, the competition office determinesthat such concentration is prohibited by section 8 of this article and does notqualify 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 modi-

fied by changes specified by the competition office;(c) Prohibit consummation of the concentration unless and until the perti-

nent party or parties enter into legally enforceable agreements speci-fied by the competition office.


Regulations regarding concentrations7. The competition office shall, from time to time, adopt and publish regula-

tions 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 concentrations8. Concentrations that will probably lead to a significant limitation of compe-

tition 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 orthat more than offset the effects of any limitation on competition thatresult or are likely to result from the concentration; or

(b) One of the parties to the concentration is faced with actual or immi-nent financial failure, and the concentration represents the least anti-competitive among the known alternative uses for the failing firm’sassets.

The burden of proof under this section lies with the parties seeking theexemption.

A party seeking to rely on the exemption specified in (a) must demonstrate that ifthe concentration were not consummated it is not likely that the relevant efficiencygains would be realized by means that would limit competition to a lesser degree thanthe 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 consumma-tion, that either a non-notified concentration or a notified concentration inwhich the provisions of sections 3-5 of this article are not fully compliedwith, has led or will probably lead to a significant limitation of competitionand does not qualify for either of the two exemptions set out in section 9 ofthis article. If it so determines, the competition office may:


(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 re-duce or eliminate the competition-limiting effects of the concentra-tion.

11. Noticeable concentrations that the competition office determines are pro-hibited by section 8 of this article and do not qualify for exemption undersection 9 may subsequently be authorized by a published decision of theGovernment of ________________for overriding reasons of public policyinvolving a unique and significant contribution to the general welfare of thecitizens of_________________.

Because delaying a merger can generate high costs for the parties involvedand increase the risk that confidential business plans might become publicknowledge, it is important to keep the delays mandated in sections 3 and 4 asshort as possible.

Although Sections 6 and 10 provide for both structural and behavioral remedies,the competition office should favor structural remedies. Behavioral remedies are gen-erally ineffective unless they are easy to monitor and the competition office has effec-tive means of ensuring compliance.

The basis for the efficiencies defense or exemption in Section 9(a) is discussed inthe commentary accompanying the article on restrictive agreements. If, as discussedthere, 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 competitionIn 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 havinglittle influence on the competitive process. To reduce that risk, the law should providefor enforcement through private actions. Every effort should also be made to ensurethat the unfair competition provisions are as clear as possible. Note that countriescould address this issue in their general consumer protection laws instead of in theircompetition statute.

Suggested provisions:[Article__] Prohibition of unfair competitionUnfair competition is prohibited, including:1. The distribution of false or misleading information that is capable of harm-

ing the business interests of another firm;


1. The distribution of false or misleading information to consumers, includingthe distribution of information lacking a reasonable basis, related to theprice, character, method or place of production, properties, suitability foruse, 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, tech-

nical, production, business, or trade information.

Organizational and enforcement matters

This section concerns a series of diverse provisions intended to improve the gen-eral effectiveness of a competition statute. Where applicable, comments will be fol-lowed by suggested statutory wording.

Specialized courts and rights of appealIn most countries the judiciary is involved with enforcing competition laws. The

competition authority may be required to apply to the courts for orders that wouldimplement its decisions. More commonly, parties involved may appeal the competi-tion agency’s decisions to the courts. If private parties have the right to institute com-petition cases, these cases may be brought before the courts.

Because the judiciaries in transition and developing economies are inexperiencedin dealing with free market problems, it may be advisable to set up specialized courtsto hear competition cases. Such courts could hear all commercial disputes or special-ize to hear only competition cases. Hearing these cases before specially-trained judgesshould speed up the acquisition of expertise and produce more consistent, predictabledecisions. Specialized competition courts could adopt procedures and rules of evi-dence specifically suited to competition cases. The composition of the court could betailored to the requirements of competition cases. For example, at least one economistcould be included in each tribunal.

Private enforcementIn some countries private actions for redress of injury by people harmed, re-

sulting from violations of the competition law may be instituted before an appro-priate court or tribunal. Such private actions have at least two benefits: theysupplement and reinforce public enforcement of the competition law, and theyfree the competition authority from having to obtain such redress on behalf ofprivate parties. To facilitate private rights of action, provisions could be added tothe competition statute to:

• Allow private plaintiffs to bring actions in courts for damages they can provethey sustained as a result of either a violation of the competition statute or a


party’s failure to comply with orders made under it, plus all reasonable coststhey may have incurred investigating and prosecuting the case.

• Allow private plaintiffs to bring actions for injunctive relief (for example, toprohibit mergers or to cease using certain anticompetitive contract terms).

• Require the competition office to transfer to private plaintiffs allnonconfidential information gathered in the course of the office’s investiga-tions.

• Facilitate the use of court records in cases brought by the competition author-ity as evidence in private damage suits.

• Allow group damage claims in competition cases.

Relationships between the competition office and other government bodiesIndependence from other parts of the government is important to the proper function-

ing of the competition office. Decisions of the office may affect the interests of entrenchedbusinesses, which may have strong influence in one or more government ministries. Thecompetition office should be free from the political influence of these interests.

Suggested provisions:[Article__] Independence of the competition office1. The competition office is under the authority of the [President of _______],

and receives its budget directly from and reports directly to the [legislatureof _________].

2. The [head] of the competition office is appointed by the [President of__________], for a renewable term of [a minimum of three] years, and canonly be removed by a [vote of the legislature] for patent inability to dis-charge his functions.

Though the competition office should be organizationally independent from otherparts of the government, it should also have the power to participate in governmentdecisions directly affecting competition. The competition office should thus have thepower to make recommendations or presentations, and in some situations to intervenewhen government bodies are making decisions affecting competition policy.

Suggested provision:[Article __] Representations and interventions by the competition office1. The competition office shall have the right to make submissions to state

administrative authorities engaged in designing or administering legisla-tion or regulations that could affect competition in any market in [the Re-public of ________]. When hearings are held with regard to the adoption oradministration of such laws or regulations, the competition office shall havethe right to intervene in such proceedings.

2. The competition office shall have the right to publish the submissions andinterventions referred to in Section 1 of this Article provided that confiden-tial information is not divulged.


Prohibition and remedial ordersThe 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 actionsto eliminate the effects of the unlawful practice. Punishment is also appropriate if theconduct is egregious. But some competitive harms are not readily apparent to businesspeople, who may have initially engaged in the conduct in good faith. Such cases mayinclude noncartel restrictive agreements, some abuses of a dominant position andsome acts of unfair competition. The competition law should empower the competi-tion agency to prohibit the conduct or redress the harm from it.

Suggested provision:[Article __] Prohibition and remedial ordersThe competition office [or appropriate court or tribunal] may issue orders prohib-

iting firms from carrying on the anticompetitive or unfair practices referred to in this Actand, if necessary, requiring such firms to take other specified actions to eliminate theharmful effects of such practices and to ensure against recurrence of such practices.

Fines and PenaltiesThe competition office should have the authority to impose fines for cartel agree-

ments, serious or repeated abuse of dominance, noncartel agreements, and unfaircompetition and to ensure compliance with merger notification requirements andcompetition office decisions.

To deter cartel agreements, fines must be considerably larger than the extra prof-its that firms anticipate earning through their illegal behavior: for example, considercompanies A and B that think they will be able to raise their profits by $500,000 byagreeing 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 $5million to effectively dissuade them. Some countries have found that the deterrenteffect of penalties is enhanced considerably if the anticompetitive acts are character-ized as criminal and if individuals as well as enterprises are made liable.

Interim injunctionsThe 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 isdifficult to break apart, and in cases involving other types of conduct in which prohibitionorders rather than fines, are relied on to eliminate or to prevent anticompetitive practices.

Suggested provisions:[Article __] Interim injunctions1. The head of the competition office may apply to [appropriate court of tribu-

nal] for an order to suspend business practices under investigation by thecompetition office or the consummation of concentrations. Before making


the order, the [court or tribunal] shall be satisfied that the proposed mea-sures are urgently required to avoid serious, imminent, and irreparableharm to the economic interests of the Republic of _________, as expressedin this Act. When the effectiveness of the order would not thereby be preju-diced, the [court or tribunal] shall permit the firms that would be subject tothe 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 theparties subject to it, together with reasons for the order and notice of theright to appeal.

3. All orders made under this Article lose effect twenty-one days after they areissued, unless renewed by express decision of the [court or tribunal].

4. Orders issued under this section may be appealed to the [pertinent appealcourt], but do not lose their effect pending the outcome of the appeal.

Enforcement guidelines and advance rulingsParties 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 ofenforcement guidelines articulating how the competition office will interpret and ap-ply the law. In addition, while protecting confidentiality, the competition officeshould be required to publish all prohibition orders and decisions imposing sanctionsalong with supporting reasons.

There is also a need for a process whereby parties can obtain advance rulingsfrom the competition office concerning planned courses of action. This informationwould be particularly helpful for exemptions given to horizontal or vertical agree-ments.

Suggested provisions:[Article __] Advance rulings1. Parties may apply to the competition office for advance rulings binding on

that office, regarding eligibility for exemptions from the prohibitions of ar-ticles ________ [relating to restrictive agreements and abuse of a dominantposition]. If it chooses to grant an advance ruling, the competition officemay include in it specified conditions and requirements. The advance rulingshall by its terms exist for a specified period of time.

2. Advance rulings may be renewed upon application by the parties. An ad-vance 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 inaccu-

rate, fraudulent, or misleading evidence; or(d) The applicant abused the exemption granted to it.


3. The competition office shall arrange for publication of its advance rulings,omitting any confidential information. It may arrange similar publication ofall other decisions taken under this act, again omitting any confidentialinformation.

Investigative powersTo ensure sufficient investigative capability, the competition office requires the

production of information. The office should be able to require that parties underinvestigation, as well as third parties, produce documents (in paper or other form),written answers to question, and oral testimony. In addition, the competition officeshould have the power to search the premises of subjects of an investigation and totake away evidence discovered in the search.

Such broad investigative powers should be subject to strict procedural safe-guards. In most countries, searches can be conducted only after authorization of acourt or tribunal—and the competition agency must show probable cause. The com-petition office should be required to permit any party submitting evidence tohave reasonable access to that evidence, and it should be required to return theevidence after the investigation and subsequent enforcement proceedings. Thesepowers should be reinforced with severe fines for willful destruction or withhold-ing of evidence or persistent refusal to supply requested information in a timelyfashion.

Protection of confidential information and avoidance of conflicts of interestIf 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 acquiresin the course of an investigation or proceeding. Also, it must ensure that its officialsare not tempted to profit privately from knowledge acquired in the course of theirduties.

Suggested provisions:[Article __] Confidentiality and conflict of interest rules1. Officials of the competition office, as well as their agents and consultants,

shall maintain the confidentiality of all business, commercial, or officialinformation of which they become aware during the course of their officialactivities, except that which is otherwise public. Disclosure of such confi-dential information may occur in the course of administrative or judicialproceedings arising under this Act, or otherwise as permitted by [the courtor tribunal].

2. All members of the competition office shall inform the head of the competi-tion office of any position held or activity carried out in an economic fieldby the member, including all agents thereof. The head of the competitionoffice shall take all necessary steps to ensure there is no conflict of interestarising from such positions or activities, including requiring that such posi-tions be resigned or activities cease.


To strengthen these provisions, fines and possible dismissal should be imposed ifgovernment employees willfully disclose confidential data or engage in conflicts ofinterest.

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 suggestedabove, take this comprehensive and centralized approach. However, these proposedlaws 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 combina-tions in restraint of trade with concomitant penalties. Interestingly, it even has a di-vestment requirement for erring firms, forcing them to offer to public ownershipcertain percentages of their capital stock.

The Belmonte bill covers the monopolization of trade both within and outsideof the country, and contains more detailed provisions on various antitrust activities.However, both the Belmonte and Gonzales-Roxas bills contain more exceptionclauses than the Espina bill, with the Gonzales-Roxas bill providing the most ex-ceptions.

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 monopo-lies. The Gonzales-Roxas bill also prohibits price discrimination with five exceptions:socialized pricing, volume discounts, competitive pricing, bona fide selection of cus-tomers, and changing market conditions or prices of goods. Any and all of theseexceptions may provide effective loopholes in the hands of creative law dodgers tocircumvent the intent of the law.

The Gonzales-Roxas bill affixes the adverb “knowingly” before the word “mo-nopolize” to punish only an entity which “knowingly monopolizes” any kind of ser-vice or article of trade, but enumerates four broad exceptions: monopolies authorizedby law, monopoly attained or maintained through superior skill, and intellectual prop-erty monopoly by reason of contractual rights. The Belmonte bill provides only for theexception 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 FairTrade Commission. However, the Espina bill provides for a more powerful Commis-sion compared to the Gonzales-Roxas version. The Espina Commission can adminis-tratively adjudicate violations of the Act as well as conduct formal investigationsindependent of civil and criminal action. As soon as a formal charge is filed, it mayissue 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 andseizure of products. The Gonzales-Roxas bill only enables the Commission to investi-


gate violations and prosecute these violations before the proper court. It has no adju-dicatory powers to issue writs, cease and desist orders or condemnation and seizure ofproducts.

In terms of penalties, the Belmonte bill provides the stiffest fines, with P10 mil-lion for corporations and P1 million for individuals. However, in terms of administra-tive and criminal penalties, the Espina bill provides for imprisonment of not less thanfive years to not more than 20 years, including possible closure and dissolution of theerring firm. The Belmonte bill provides only for imprisonment not exceeding fiveyears. 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. Itstrengthens the existing penal provisions prohibiting monopolies and combinationsin restraint of trade. It does not create an independent commission, but leaves anti-trust enforcement to the Courts and the Departments of Justice, Agriculture, andTrade and Industry.

The Osmeña version, on the other hand, is more of an administrative measure. Itcreates a Fair Trade Commission and outlines the various anticompetitive practiceswhich the Commission is supposed to regulate. It includes definitions of monopolies,trusts, and relevant markets, and provides for price regulation and threshold valuesfor notification, as well as fines, based on minimum wage levels.

These different draft bills have certain similarities to the proposed law in thisstudy. There are also certain significant differences. Many of these are actually combi-nations of provisions copied from the laws in other countries. The problem is thatthere is really no single model that will ensure success in the Philippines. That is whyit is better to keep the proposed law as simple as possible to allow room for evolutionwithin the unique context of the Philippine economy. The law proposed under thisstudy is actually drawn from certain basic principles and provisions discussed above.This includes provisions on defining the relevant market, monopolies and abuse ofdominant market position, horizontal agreements, mergers, other unfair trade prac-tices, and the administrative mechanism for enforcement.

One unique feature of this proposed law is that, instead of creating a new anti-trust/competition agency from scratch, the existing Tariff Commission be convertedinto a Philippine Trade Commission or Fair Trade Commission. First of all, this willaddress the problem of the current government policy that no new agencies or bodiescan be created unless it also involves the abolition of existing ones. Second, to acertain extent, the problem of capability may be partially addressed since the researchand investigation personnel of the Tariff Commission are already involved in study-ing market access issues, defining relevant markets and analyzing industry structure.Finally, it will bring under one roof trade policy formulation and international fairtrade enforcement (trade measures) and competition analysis and enforcement andconsumer welfare promotion, which are all closely related.


SECOND OPTION: PIECEMEAL APPROACHUnfortunately, the political economy realities, as well as the administrative and

other problems outlined above make the passage of a comprehensive antitrust/com-petition 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 andappreciate, attract all kinds of political interventions, give rise to various obstacles to itstimely passage, and render its actual implementation unwieldy.

First of all, the proposed law may be difficult to understand and appreciate be-cause 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 civilsociety 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 thosesectors opposed to its passage might conspire together to ensure its nonpassage ordelay, or they may intervene to insert exceptions or other onerous provisions. Thirdly,such public attention and political interventions would only lead to other obstacles tothe timely passage of the new law, such as endless public debates and media hype.Finally, a comprehensive approach to antitrust/competition law enforcement, espe-cially if it involves the creation of a new agency or institution may run into significantimplementation problems. As discussed above, the lack of capacity on the part of ourbureaucracy will most probably present the important challenge.

Therefore, even if the comprehensive approach may be the ideal option, it maynot be the most practical. This means that we need to explore other possibilities if onlyto ensure that this country still introduces some form of improved legal and regulatoryframework for antitrust enforcement. One other possibility is to approach the problemin a more “piecemeal” manner.

For example, rather than introduce a single comprehensive law, this could bedivided into components and introduced as separate draft bills. The portion outliningthe list of antitrust violations may be separated from the list of remedies and theportion creating a new antitrust body. The technical details or implementing theselaws could then be contained in rules and regulations.

Also, rather than introducing completely new legislation, the government couldinstead introduce only amendatory legislation and revise various existing laws relat-ing to antitrust/competition. The main objective would still be to operationalize theconstitutional provisions promoting competition. The following existing laws couldbe amended for more effective antitrust enforcement:

• Revise Penal Code: shifting the burden of proof from “beyond reasonabledoubt” to a less strict “preponderance of evidence,” increasing the penaltiesfor violations, and providing the administrative mechanism for effective en-forcement;

• Civil Code: providing greater ease for an aggrieved party to file a civil caseand collect damages from parties guilty of anticompetitive practices;


• Consumer Act: providing the legal mechanism for consumers to file casesfor anticompetitive practices; and

• Tariff and Customs Code: amending the charter of the Tariff Commission toconvert 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 apiecemeal introduction of an effective, improved legal and regulatory framework forantitrust enforcement. There are many other laws and also executive issuances whichwill have to be reviewed and amended.

Special mention should also be made of the role of foreign investments in compe-tition enforcement. Opening economic sectors to increased investment flows have theeffect of creating more dynamic operating environments for businesses, wherein tech-nology transfers and innovation are encouraged. Investment liberalization may alsohave the effect of providing local economic sectors with access to new and largerregional and global markets. Therefore, this piecemeal approach should also includethe passage of laws and issuance of regulations which encourage the entry of moreforeign investments.

There may be many different approaches to achieving our main objectives. Whatthis study attempts to present are the features of an effective legal and regulatoryframework for antitrust enforcement. It should also be emphasized that there is indeeda need for such a framework for the Philippines. Competition policy is an essentialelement for economic reform in this country. The lack of competition is precisely oneof the most significant reasons for our persistent underdevelopment. Therefore, one ofthe most important roles of government in promoting more equitable development isenforcing and preserving competition. The inadequacy of mere market-opening mea-sures has been highlighted. In the end, the government will have to intervene to en-force competition, and this requires effective laws and regulations. The passage ofnew legislation, whether comprehensive or merely amendatory, will be a necessaryfirst step in working towards our goal of institutionalizing that much needed “compe-tition culture” in Philippine society.

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pretive Summary. The International Bank for Reconstruction and Development/TheWorld 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 SocialMarket Economy: An Economic System for Developing Countries 27, edited byWinfried 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 STATUTESPhilippine 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 OtherPurposes (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 MeasuresAgainst Undue Price Increases During Emergency Situations and Like Occasions (PriceAct).

Republic Act No. 7227 (1992), An Act Accelerating the Conversion of Military Reservations intoother Productive Uses, Creating the Bases Conversion and Development Authority forthis Purpose, Providing Funds Therefor, and for Other Purposes (Bases Conversion Act).


Republic Act No. 7661 (1992), An Act Amending Republic Act No. 7181entitled “An ActExtending the Life of the Committee on Privatization and Asset Privatization Trust.”

Republic Act No. 7648 (1993), An Act Prescribing Urgent Related Measures Necessary andProper to Effectively Address the Electric Power Crisis and for Other Purposes.

Republic Act No. 7650 (1993), An Act Repealing Section 1404 and Amending Sections 1401and 1403 of the Tariff and Customs Code of the Philippines, as amended, Relative tothe 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 NumberedSeven 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 forthe Creation, Operation, Administration, and Coordination of Special Economic Zonesin 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 inthe Municipality of Sta. Ana and Other Neighboring Islands in the Municipality ofAparri, Province of Cagayan, Providing Funds therefor, and for Other Purposes.

Republic Act No. 7925 (1995), An Act to Promote and Govern the Development of PhilippineTelecommunications and the Delivery of Public Telecommunication Services (PublicTelecommunications 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 CompetitivenessEnhancement Fund, and for Other Purposes.

Republic Act No. 8179 (1996), An Act to Further Liberalize Foreign Investments, Amendingfor the Purpose Republic Act No. 7042, and for Other Purposes.

Republic Act No. 8180 (1996), An Act Deregulating the Downstream Oil Industry, and forOther Purposes.

Republic Act No. 8293 (1997), The Intellectual Property Code of the Philippines.

CASESG.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-1711Case 48/69 ICI vs Commission (Dyestuffs case 1972) ECR 619


Case T-7/89Re Polypropylene Cartel SA Hercules (1991) ECR II-1711Case 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 STATUTESPhilippine 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 theRates 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 theConstruction or Repair of Public Works.

Republic Act No. 337 (1948), An Act Regulating Banks and Banking Institutions and for OtherPurposes (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 forOther Purposes (Contractors’ License Law).

Republic Act No. 5487 (1969), An Act to Regulate the Organization and Operation of PrivateDetective, 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, Corporationsor Partnerships Owned in Whole or in Part by Foreigners to Engage in the Rice andCorn 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.


Presidential Decree No. 1853 (1982), Requiring Deposits of Duties at the Time of Opening ofLetters 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 OtherPurposes (Foreign Investments Act of 1991).

Republic Act No. 7076 (1991), An Act Creating a People’s Small-scale Mining Program andfor 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 MeasuresAgainst Undue Price Increases During Emergency Situations and Like Occasions (PriceAct).

Republic Act No. 7227 (1992), An Act Accelerating the Conversion of Military Reservationsinto other Productive Uses, Creating the Bases Conversion and Development Authorityfor this Purpose, Providing Funds Therefor, and for Other Purposes (Bases ConversionAct).

Republic Act No. 7642 (1992), An Act Increasing the Penalties for Tax Evasion, Amending forthis Purpose the Pertinent Sections of the National Internal Revenue Code, asAmended.

Republic Act No. 7661 (1992), An Act Amending Republic Act No. 7181entitled “An ActExtending the Life of the Committee on Privatization and Asset Privatization Trust.”

Republic Act No. 7648 (1993), An Act Prescribing Urgent Related Measures Necessary andProper to Effectively Address the Electric Power Crisis and for Other Purposes.

Republic Act No. 7650 (1993), An Act Repealing Section 1404 and Amending Sections 1401and 1403 of the Tariff and Customs Code of the Philippines, as amended, Relative tothe 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 theNational Internal Revenue Code, as Amended, Allocating Funds for Specific Programsand for Other Purposes.

Republic Act No. 7691 (1994), An Act expanding the jurisdiction of the Metropolitan TrialCourts, Municipal Trial Courts, and Municipal Circuit Trial Courts, Amending for thisPurpose Batas Pambansa Blg. 129, Otherwise Known as the “Judiciary ReorganizationAct of 1980.”

Republic Act No. 7700 (1994), An Act Providing for Concurrent Jurisdiction Between andAmong the First, Second and Third Divisions of the National Labor Relations Commis-sion to Further Ensure Speedy Disposition of Cases, Amending for this Purpose Article213 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 ofShares 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.


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 PurposesAmending and Repealing the Relevant Provisions of the National Internal RevenueCode, 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 Maintenanceof Infrastructure Projects by Private Sector, and for Other Purposes.

Republic Act No. 7721 (1994), An Act Liberalizing the Entry and Scope of Operations ofForeign Banks in the Philippines and for Other Purposes.

Republic Act No. 7844 (1994), An Act to Develop Exports as a Key Towards the Achievementof 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 Privatizationand the Asset Privatization Trust Amending for the Purpose of Republic Act NumberedSeven 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 theCity of Zamboanga Creating for this Purpose the Zamboanga City Special EconomicZone Authority, Appropriating Funds therefor and for Other Purposes (Zamboanga CitySpecial Economic Zone Act of 1995).

Republic Act No. 7909 (1995), An Act Granting a Franchise to Pacific Airways Corporation toEstablish 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 forthe Creation, Operation, Administration, and Coordination of Special Economic Zonesin 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 inthe Municipality of Sta. Ana and Other Neighboring Islands in the Municipality ofAparri, Province of Cagayan, Providing Funds therefor, and for Other Purposes.

Republic Act No. 7925 (1995), An Act to Promote and Govern the Development of PhilippineTelecommunications and the Delivery of Public Telecommunication Services (PublicTelecommunications 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 andOperations 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, asamended.

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 andNational Book Development Plan (Book Publishing Industry Development Act).


Republic Act No. 8103 (1995), An Act Granting a Franchise to All Asia Airlines Co., Inc. toEstablish and Maintain Air Transportation Services Throughout the Philippines and/orBetween 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 CompetitivenessEnhancement Fund, and for Other Purposes.

Republic Act No. 8179 (1996), An Act to Further Liberalize Foreign Investments, Amendingfor the Purpose Republic Act No. 7042, and for Other Purposes.

Republic Act No. 8180 (1996), An Act Deregulating the Downstream Oil Industry, and forOther Purposes.

Republic Act No. 8181 (1996), An Act Changing the Basis of Dutiable Value of ImportedArticles 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 ofPresidential Decree No. 1464, otherwise known as the Tariff and Customs Code of thePhilippines, 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 ofthe 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 theTariff and Customs Code of the Philippines, as amended by Republic Act No. 7843 andfor Other Purposes, (Anti-Dumping Act of 1999).

Republic Act No. 8762 (2000), An Act Liberalizing the Retail Trade, Repealing for the PurposeRepublic Act No. 1180, as amended, and for Other Purposes, (Retail Trade Liberaliza-tion Act of 2000).

EXECUTIVE ORDERSCentral 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 Assetsthereof, 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 ImportDuty 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 underExecutive Order No. 387.


Executive Order No. 3, Series of 1992, Creating a Presidential Anti-Crime Commission toidentify and cause the investigation and prosecution of criminal elements in thecountry.

Executive Order No. 8, Series of 1992, Restructuring the Rates of Import Duties and Amendingthe Classification of Certain Articles under Section 104 of the Tariff and Customs Codeof 1978, as amended.

Executive Order No. 59, Series of 1993, Prescribing the Policy Guidelines for CompulsoryInterconnection of Authorized Public Telecommunications Carriers in order to Create aUniversally Accessible and Fully Integrated Nationwide Telecommunications Networkand thereby Encourage Greater Private Sector Investment in Telecommunications.

Executive Order No. 79, Series of 1993, Modifying The Rates of Duty on Certain ImportedArticles as provided under the Tariff and Customs Code of 1978, as amended, in orderto implement the Minimum 50% Margin of Preference on Certain Products Included inthe Brand-To-Brand Completion scheme in the Automotive Industry under the BasicAgreement on ASEAN Industrial Complementation.

Executive Order No. 94, Series of 1993, Reducing the Import Duty on Cement Clinker underSection 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 DevelopmentCouncil into the Export Development Council.

Executive Order No. 106, Series of 1993, Lifting the Suspension of the Application of theTariff Concessions Granted by the Philippines on Refractory Bricks under the ASEANPreferential Trading Arrangements.

Executive Order No. 109, Series of 1993, Policy to Improve the Provision of Local ExchangeCarrier 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 Governmentand Private Sectors Members of the Council.

Executive Order No. 115, Series of 1993, Increasing the Special Duties on Crude Oil and OilProducts under Section 104 of the Tariff and Customs Code of the Philippines, asamended.

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 ImportedArticles as provided for under the Tariff and Customs Code of 1978, as amended, inorder to Implement the 1994 Philippine Schedule of Tariff Reductions on Articles In-cluded in the Accelerated and Normal Programs of the Common Effective PreferentialTariff (CEPT) Scheme for the ASEAN Free Trade Area (AFTA).

Executive Order No. 146, Series of 1993, amending Executive Order No. 43 of 1992, by modi-fying the margins of the preference and the applicable ASEAN preferential tariffs oncertain items included in the coverage thereof.

Executive Order No. 147, Series of 1993, Modifying The Rates of Duty on Certain ImportedArticles as provided under the Tariff and Customs Code of 1978, as amended, in orderto Implement the 10% Margin of Preference (MOP) Granted by the Philippines underthe 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 CertainImported Articles as provided under Presidential Decree No. 1464, as amended, other-wise known as the Tariff and Customs Code of the Philippines of 1978.


Executive Order No. 153, Series of 1994, Modifying the Rates of Duty on Certain ImportedArticles as provided for under the Tariff and Customs Code of 1978, as amended, inorder to Implement the Ninety Per Centum Margin of Preference on Certain ProductsIncluded in the Nestle ASEAN Industrial Joint Venture (AIJV) Projects, as provided forin 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 OilProducts Prescribed in Executive Order No. 115, Series of 1993.

Executive Order No. 172, Series of 1994, Increasing the Minimum Tariff Rate From Zero toThree 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 1994entitled Modifying the rates of duty on certain imported articles as provided under thetariff and customs code of 1978, as amended, in order to implement the minimumninety per centum (90%) margin of preference on certain products included in theNestle 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 AmendingE.O. No. 98.

Executive Order No. 151, Series of 1994, Creating a Presidential Commission to InvestigateAdministrative Complaints Involving Graft and Corruption.

Executive Order No. 185, Series of 1994, Opening the Domestic Water Transport Industry toNew Operators and Investors.

Executive Order No. 189, Series of 1994, Modifying the nomenclature and Rates of ImportDuty on Certain Imported Articles under Section 104 of the Tariff and Customs Code of1978, as amended.

Executive Order No. 204, Series of 1994, Modifying the nomenclature and rates of import dutyon certain articles under Section 104 of the Tariff and Customs Code of 1978.

Executive Order No. 212, Series of 1994, Accelerating the Demonopolization and PrivatizationProgram 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 theTariff and Customs Code of 1978, as amended.

Executive Order No. 237, Series of 1995, Modifying the Rates of Import Duty on CertainImported Articles as amended, in order to Implement the Decision Taken by the 35thmeeting 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 ImportDuty on Certain Imported Articles Under Section 104 of the Tariff and Customs Code of1978 (Presidential Decree No. 1464), as amended.

Executive Order No. 287, Series of 1995, Modifying the Rates of Duty on Certain ImportedArticles as Provided for Under the Tariff and Customs code of 1978, as amended, inorder to implement the 1996 Philippine Schedule of Tariff Reduction Under the NewTime Frame of the Accelerated Common Effective Preferential Tariff (CEPT) Schemefor the ASEAN Free Trade Area (AFTA).



Executive Order No. 298, Series of 1996, Providing for Alternative and/or Intermediate Modesof 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.







Appendix 2. Draft Bills in Congress

House Bill No. 1373. An Act Penalizing Unfair Trade Practices and Combinations in Restraintof Trade, Creating the Fair Trade Commission, Appropriating Funds Therefore andfor Other Purposes.

House Bill No. 3780. An Act Prohibiting Monopolies, Attempt to Monopolize an Industry orLine of Commerce, Manipulation or Prices Commodities, Asset Acquisition and Inter-locking Membership in the Board of Directors of Competing Corporate Bodies andPrice Discrimination Among Customers, Providing Penalties Therefore and for OtherPurposes.

House Bill No. 271. An Act Providing for Antitrust PenaltiesHouse 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 forOther Purposes.

Senate Bill No. 150. An Act Creating the Fair Trade Commission, Prescribing its Powers andFunctions in Regulating Trade Competition and Monopolies and for Other Purposes.

Senate Bill No. 1792. An Act Prohibiting Monopolies, Attempt to Monopolize an Industry orLine of Commerce, Manipulation of Prices or Commodities, Asset Acquisition and In-terlocking Membership in the Board of Directors of Competing Corporate Bodies andPrice Discrimination Among Customers, Providing Penalties Therefore, and for OtherPurposes.


ARTICLE I - TITLE AND POLICYSection 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 allforms of unfair trade, anti-competitive conduct and combinations in restraint of trade,in order to ultimately enhance consumer welfare.

Republic of the PhilippinesSENATE/HOUSE OF REPRESENTATIVES

Manila/ Quezon City

11th Congress

—————————————————————————————————

– Introduced by ________________________

—————————————————————————————————

_

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:

Appendix 3. Draft Bill for Discussion Purposes


ARTICLE 2 - SCOPE OF THE LAW AND DEFINITION OF TERMSSection 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 economicactivity. 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 resultfrom acts done outside the Republic of the Philippines.

Section 2. Limitations - This Act does not derogate from the direct enjoyment of the privilegesand protections conferred by Republic Act No. 8293 (1997), otherwise known as theIntellectual Property Code, and other laws protecting intellectual property, includinginventions, industrial models, trademarks and copyrights. It does, however, apply to theuse of such property in such a manner as to cause the anti-competitive effects prohibitedherein. This Law shall apply neither to the combinations or activities of workers or em-ployees, nor to agreements or arrangements between two or more employers, when suchcombinations, activities, agreements or arrangements are designed solely to facilitate col-lective bargaining in respect of conditions of employment.

Section 3. Definition of terms – Whenever used in this Act, the following terms shall be takento 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 mar-ket.

(b) “Commission” – the Philippine Trade Commission created in Article 7 of this Act.(c) “Firm” - any natural or legal person, governmental body, partnership or associa-

tion 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 morefirms 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 whichare located sellers among whom buyers are or would be willing to substitute fromwhom they would buy.

ARTICLE 3 - ABUSE OF DOMINANT POSITIONSection 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 marketfor a significant period of time.

Section 2. Safe Harbor – A firm shall not be deemed to have a dominant position unless itsshare of the relevant market exceeds the percentage set by the Commission in its guide-lines. A firm having a market share exceeding a percentage set by the Commission, mayor may not be found to be dominant, depending on the economic situation in thatmarBIBLIOGRAPHY

Section 3. Balancing Efficiencies - An agreement prohibited under Section 2 of this Articlemay nevertheless be permissible and allowed by the Commission if said agreement hasbrought 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


(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 arerequired to, among others, demonstrate that if the agreement were not implemented, itis not likely that the relevant real efficiency gains would be realized by means thatwould limit competition to a lesser degree than the agreement.

ARTICLE 5 - MERGERS AND ACQUISITIONSSection 1. Review of Concentrations - A concentration shall be deemed to arise when:

(a) two or more previously independent firms merge, amalgamate or combine thewhole 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 orindirect 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 materi-ally 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 toSection 7 of this Article, are prohibited from consummating such concentration untilthirty (30) days after providing notification to the Commission, in the form and contain-ing the information specified in regulations issued pursuant to section 7. An agreementconsummated in violation of this requirement shall be considered void and subject theparties to the corresponding penalties therefor.

Section 4. Further Information – The Commission may, in writing, request the parties to theagreement, for further information, before the expiration of the thirty (30) day periodreferred to in section 3 of this Article. The issuance of such a request has the effect ofextending the period within which the concentration may not be consummated for anadditional thirty (30) days, beginning on the day after substantially all of the requestedinformation is supplied to the Commission.

Section 5. Voluntary Notification -- Parties to an agreement who are not subject to the notifi-cation 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 ofcompulsory notification.

Section 6. Effect of Notification - If, before consummation of a concentration, the Commissiondetermines that such concentration is prohibited under Section 8, and does not qualifyfor 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;


(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 competi-tion 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 partiesestablish 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 offsetthe effects of any limitation on competition that result or are likely to result fromthe concentration; or

(b) a party to the concentration is faced with actual or imminent financial failure, andthe concentration represents the least anti-competitive arrangement among theknown alternative uses for the failing firm’s assets.

Section 10. Burden of Proof - The burden of proof under Section 9 lies with the parties seekingthe exemption.A party seeking to rely on the exemption specified in Section 9 (a) must demonstratethat if the concentration were not consummated it is not likely that the relevant realefficiency gains would be realized by means that would limit competition to a lesserdegree 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 iden-

tify 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 con-summation, 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 notqualify 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 competitionlimiting effects of the concentration.

ARTICLE 6 - UNFAIR COMPETITIONSection 1. Unfair Competition - Unfair competition is prohibited, including:

(a) the distribution of false or misleading information which is capable of harming thebusiness interests of another firm;

(b) the distribution of false or misleading information to consumers, including the distri-bution of information lacking a reasonable basis, related to the price, character,method or place of production, properties, suitability for use, or quality of goods;


(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 packag-

ing; or(e) unauthorized receipt, use, or dissemination of confidential scientific, technical,

production, business or trade information.

ARTICLE 7 - THE COMMISSIONSection 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 Commissionshall be composed of a Chairman and four (4) Associate Commissioners, all ofwhom shall be appointed by the President for a term of seven (7) years withoutreappointment. The Chairman and two (2) of the Associate Commissioners firstappointed 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 theirrespective 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 temporaryor acting capacity. The Chairman of the Commission can only be removed for patentdisability to discharge his/her functions.

Section 2. Qualifications - The Chairman and the Associate Commissioners shall be citizensof the Philippines, at least forty (40) years of age, of recognized probity, integrity, andcompetence in the field of law, economics, finance banking, commerce, industry and/orconsumer welfare, and must not have been a candidate for an elective national or localoffice 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 nocase 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 theirtenure, directly or indirectly, practice any profession, participate in any business orfinancially interested in any contract or any franchise, or special privilege granted bythe government of any subdivision, agency or instrumentality thereof, including govern-ment-owned and controlled corporations or their subsidiaries: Provided, however, thatthey may, with the prior permission of the President, teach part time in any institution oflearning. They shall, at all times, strictly avoid conflict of interest situations in theconduct of their office. They shall not be qualified to run for any office in any publicelection, regular or special, immediately preceding their cessation from office. Theyshall 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 benecessary on such days as the Chairman, or in his/her absence, as a majority of theCommissioners may fix. The notice of meeting shall be given to all members at leastone (1) day before the scheduled date of the meeting.

The presence of at least three (3) Commissioners shall constitute a quorum. In theabsence of the Chairman, one of the Associate Commissioner chosen by those presentshall act as the presiding officer of the meeting.


Section 6. Secretariat - The Commission shall have a Secretariat with a staff complement asmay be determined by the Chairman in consultation with the Department of Budget andManagement.

The Secretariat shall be headed by an Executive Director who shall be appointed bythe President. He/she shall act as the secretary of the Commission and shall be respon-sible for the effective implementation of the policies, rules and standards set by theCommission and oversee and coordinate the day-to-day activities of the different oper-ating units of the Commission.

Article 8 - Powers and Functions of the CommissionSection 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 agenciesunder this Act;

(b) undertake and prepare industry studies to determine industry structures, and thestate of competition and competitiveness of Philippine industries, and collate,compile, distribute and disseminate resource materials on competition policy, withthe end in view of creating a national database on competition;

(c) conduct workshops and seminars, information campaigns for the public, and trainor develop a pool of experts on competition;

(d) extend technical assistance to the Philippine delegations to international bodiesand meetings in regard to trade and competition law and policy;

(e) draft and recommend proposed administrative and legislative measures for respec-tive consideration and adoption/enactment by the Executive or Legislative Branchof government;

(f) make submissions to the government authorities engaged in designing or adminis-tering legislation or regulations which could affect competition in any market inthe Philippines, intervene in hearings and proceedings held with regard to theadoption or administration of such laws or regulations, and publish the submis-sions and interventions above referred to, provided that confidential information isnot divulged;

(g) administratively adjudicate violations of this Act and rules and regulations issuedpursuant thereto, by conducting a formal investigation, independent of the corre-sponding criminal and civil action for said violation(s). The imposition of adminis-trative penalties in the formal investigation is without prejudice to the impositionof penalties in the criminal action and/or judgment in the civil action and viceversa.

As soon as a formal charge is filed with the Commission and even prior to thecommencement of the formal investigation, the Commission may motu propio orupon verified application of any person, issue preliminary orders prohibiting firmsfrom 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 theharmful effects of such practices and to ensure against recurrence of such prac-tices. Before issuing any orders, the Commission shall be satisfied that the pro-posed measures are urgently required to avoid serious, imminent and irreparableharm to the economic interests of the Philippines, as expressed in this Act. Wherethe effectiveness of the order would not thereby be prejudiced, the Commission


may permit the firms that would be subject to the order to present their viewsregarding the proposed order. The Commission shall provide by rules and regula-tions the other procedures and restrictions for the issuance of such preliminaryorders.

All orders may, under this Section, lose effect twenty one (21) days after theyare issued, unless renewed by express decision of the Commission.

Upon its decision becoming final and executory, the Commission on its owninitiative or upon motion of the winning party shall issue a writ of execution. TheCommission shall deputize the Philippine National Police, National Bureau ofInvestigation or Armed Forces of the Philippines in the enforcement of any of itsdecisions and orders. Orders and decisions issued under this Section may be ap-pealed to the pertinent appeal court, but do not lose their effect pending the out-come 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 orassociation doing business in and/or with the Philippines or a Philip-pine firm;

(ii) determining and evaluating the practices, acts methods, schemes, ar-rangements and other trade conditions prevailing in an industry.

(i) the officials authorized to conduct the preliminary or administrative investiga-tions, including formal investigations for purposes of administrative adjudicationreferred to in the Section 1 (g) of this Article, shall have the power to administeroaths, issue subpoena duces tecum to compel the attendance of witnesses and theproduction of necessary papers and documents, and to punish direct and indirectcontempt as granted to superior courts under the Rules of Court;

(j) initiate or institute the appropriate civil action or proceeding before the propercourt or administrative agency in the implementation of the provisions of this Actand other fair trade laws or restrain any threatened violations thereof;

(k) institute the appropriate information and prosecute criminal cases for any and allviolations of this Act and other fair trade laws after conducting a preliminary in-vestigation motu propio or upon complaint of any person, when there is sufficientground to engender a well founded belief that the violation(s) complained of is/arebeing or has/have been committed, and in addition, and subject to the rules onprosecution of civil action under the Rules of Court, institute the appropriate ac-tion for the recovery of civil liability;

(l) To recommend the amendment of existing franchises when, based on its own evalu-ation, 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 trans-

portation, and the like;(2) papers, documents, and records found in such factory, shop, laboratory, estab-

lishment, store, warehouse, means of transportation, and the like;(3) equipment, finished or unfinished products, raw materials, containers, label-

ing and other pertinent properties found in such factory, shop, laboratory, es-tablishment, store, warehouse, means of transportation, and the like;


(4) activity being undertaken in such factory, shop, laboratory, establishment,store, warehouse, means of transportation and the like, which may be neces-sary 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 quantityof samples of the properties (except equipment) mentioned in Section 1 (m) (3) of thisArticle, 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 oractivity being undertaken inside the premises of such places. Receipts shall be issuedfor samples which may thereafter be so obtained;(n) require any person, firm, entity or association to submit to it periodically or when-

ever necessary, such report, data, information, paper or document in such form asmay be prescribed by the Commission;

(o) request the different government agencies for assistance in obtaining informationnecessary for the proper discharge of its responsibilities under this Act, and exam-ine, if necessary, the pertinent records and documents in the possession of suchgovernment agency;

(p) promulgate such rules and regulations as may be necessary to implement the pro-visions and intent of this Act. Such rules shall be take effect fifteen (15) daysfollowing their publication in at least two (2) newspaper of general circulation orin the Official Gazette; and

(q) To perform such other functions as it may deem appropriate for the proper enforce-ment of this Act.

Section 2. Advance Rulings - Parties may apply to the competition office for advance rul-ings, binding on that office, regarding eligibility for exemptions. If it chooses togrant an advance ruling, the competition office may include in it specified condi-tions and requirements. The advance ruling shall by its terms exists for a specifiedperiod of time.

Advance rulings may be renewed upon application by the parties. An advance rulingmay 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, omittingany confidential information. It may arrange similar publication of all other decisionstaken 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 busi-ness, commercial or official information of which they become aware during thecourse of their official activities, except that which is otherwise public. Disclosure ofsuch confidential information may occur in the course of administrative or judicialproceedings arising under this Act, or otherwise as permitted by a court of competentjurisdiction.


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 thereis no conflict of interest arising from such positions or activities, including requiringthat such positions be resigned or activities cease.

ARTICLE 9 - PENALTIESSection 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 respon-

dent shall cease and desist from and shall require him to submit a report of compli-ance 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 deemedappropriate by the Commission and in coordination with the proper authorities andremain 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 dispositionshall 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 OneMillion 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 MillionPesos (P100,000,000.00), and in both instances, an additional fine of Ten ThousandPesos (P10,000.00) for each day of continuing violation: Provided, That in case of vio-lations by corporations, associations, partnership or other juridical entities, individualfines may still be imposed on the officers directly or indirectly responsible for theimplementation of the prohibited act. The fine imposed herein shall be regardless of thelimit 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 underArticles 3, 4, 5, and 6 or shall violate any provision of this Act shall be guilty of a felonyand, upon conviction thereof, shall suffer the penalty of imprisonment of not less thanfive (5) years but not more than twenty (20) years and a fine of not less than ThreeHundred Thousand Pesos (P300,000.00) in the case of an individual, and not less thanThree Million Pesos (P3,000,000.00) in the case of a corporation or other juridicalentity: Provided, That in case of violation by corporations, associations, partnerships orother juridical entities, the penalty of imprisonment shall be imposed on the officersdirectly or indirectly responsible for the implementation of the prohibited act.

In addition to the foregoing penalties, the court may order the closure or dissolution ofthe establishment or firm where circumstances warrant and any property owned under anycontract or by any combination, or pursuant to any conspiracy, and subject thereof asmentioned 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 propertyby any other person or corporation shall recover the amount of damages sustained byreasoned of the act declared to be unlawful by this Act, including the costs of suit andreasonable attorney’s fees: Provided, That this Section shall be without prejudice to thefiling of the appropriate criminal action against the offending party.


Section 5. Alien Violation — If the person committing the violation of this Act be an alien or aforeign firm, he/its foreign officers/representatives shall, in addition to the above penal-ties, be deported after paying his/its fine and/or serving his sentence without need ofany 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 PROVISIONSSection 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 intolaw and thereafter.

Section 2. Repealing Clause – All laws, decrees, orders, rules and regulations and all otherissuance or parts thereof inconsistent with the provisions of this Act are hereby repealedor amended accordingly.

Section 3. Separability Clause - If any part or provision of this Act is held unconstitutional orinvalid, other parts or provisions hereof which are not affected thereby shall remain infull force and effect.

Section 4. Effectivity Clause - This Act shall take effect immediately upon publication in theOfficial 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) andChairman of the Board and President of Food Terminal, Inc. Before his appointmentat the NFA, he was a Commissioner of the Tariff Commission from 1995 to 2001. Heearned his Law degree at the Ateneo de Manila University School of Law in 1991 andpursued further studies at the Harvard Institute for International Development as aFellow in Public Policy and Management and Master in Public Administration at theHarvard University-John F. Kennedy School of Government in 1997. He attendedseveral local and international conferences and seminars on trade, competition policy,and other economic development concerns. Aside from his work in government, heteaches international trade, competition policy and institutions of the EuropeanUnion at the Ateneo de Manila University.

Rafaelita M. Aldaba is a Research Associate (on study leave) at PIDS and iscurrently 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. In1989, 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 anumber of papers on international trade, competition policy, and environmental eco-nomics.

Myrna S. Austria is a Senior Research Fellow at PIDS and Project Director ofthe Philippine APEC Study Center Network (PASCN) Secretariat, a regular compo-nent project of PIDS. She gained her Ph.D. from the Australian National Universityin 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 andinvestment policy, competition policy, and regional cooperation.

Erlinda M. Medalla is a Senior Research Fellow at PIDS. She obtained herPh.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 researchprojects handled by PIDS and other institutions since joining PIDS in 1981. Amongher earlier positions were as a Senior Economic Development Specialist at theNEDA, Professorial Lecturer at the UPSE, and Consultant at the then Ministry ofTrade and Industry. She conducts research on trade and industrial policy and haswritten a number of papers on trade and investment, shadow price estimation, tariffsand nontariff barriers to trade, and many others.

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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 policyissues. She received her Ph.D. in Economics from the Australian National Universityin 2000.

Ramonette B. Serafica is an Associate Professor (on leave) at the De La SalleUniversity-Manila. Before moving to the academe, she was an Industry Economist atSmart 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 researchinterests include telecommunications, competition policy, and infrastructure regulation.

Peter Lee U obtained his Ph.D. from Purdue University, U.S.A. in 1995 andpresently 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 taughtat the University of Texas at Dallas and North Lake College, Texas, U.S.A. He alsodid consultancy work for the Asian Development Bank in its project on Philippinepower sector restructuring. His research interests are energy economics, industrialorganization and regulation, antitrust, microeconomics, managerial economics, andpublic utility economics.

ABOUT THE PUBLISHERS

The Philippine APEC Study Center Network (PASCN) was established onNovember 23, 1996 by virtue of Administrative Order No. 303, as the Philippines’response to the APEC Leaders’ Education Initiative. Among the goals of PASCN areto promote collaborative research on APEC-related issues; facilitate the exchange ofinformation between or among government and nongovernment organizations, aca-demic or research institutions, business sector, and the public in general; encouragefaculty and students of higher education to undertake studies, theses and dissertationon APEC issues; undertake capacity-building programs for government agencies onmatters related to APEC; and provide technical assistance to government agenciesand 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 andthe 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 gov-ernment research institution engaged in long-term, policy-oriented research. It wasestablished 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 onsocial and economic development in order to assist policymakers and leaders in plan-ning and policymaking. The Institute has three programs, namely, research, outreach,and dissemination and research utilization.

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