Atty. Rami Hourani
A real obstacle to the competitiveness in the Philippines is the cost of logistics. It is no secret that an archipelagic country is probably going to have higher costs shipping items than one which is part of the mainland. The Philippines suffers acutely from this fact.
In the Philippines there are a lot of shipping routes, the overwhelming majority of which are monopolies or duopolies. This means that at the most important thoroughfares in the Visayas, our sealanes, there are effectively choke points controlled by select individuals. If you have money and can start a shipping line, you have no incentive to rock the boat, the status quo benefits you thoroughly. (Forgive the pun.)
Let’s take the case of Cebu, this means that the value and supply chains of enterprise must be limited to Cebu only or you’d bear the cost of inter-island shipping which would hurt your competitiveness. This automatically limits the complexity and volume of trade that Cebu can do both domestically and internationally. An easy fix would be to invite the entry of foreign capital and drive down prices, however, there are some problems to that which I will outline.
Barriers to Entry
The shipping lines are hit by a few different laws: First, the constitution with its ban on ownership of land for foreigners. A port is treated as land under the law and it is a large legal obstacle to not be able to own the land where you’d dock your ships to. Second, the public service act, in conjunction with the various rulings of the Supreme Court on the matter of the citizenship of juridical persons, makes it so that common carriers must be Filipino or a 60-40 Filipino Entity. Currently, amendments for the Public Service Act are pending in Congress.
The above are laws that all industries deal with however they are particularly onerous in the case of the shipping and transportation industry. The reason is because these are capital intensive industries with notoriously low profit margins and return on equity. I’ll use an example of a small store. It is trivial for a foreigner to find a business partner, create a 60-40 entity, and ask the business partner to pay him by either assigning his dividends or by having a higher salary. This is because the store, which is little more than an inventory and a lease, are a very small balance sheet to have to split up in the event of a failed venture or if the Filipino business partner leaves or becomes unreasonable in terms of his participation in the profits. The same logic applies to BPOs, development huts, software development firms, call centers which should explain their prevalence in the Philippines.
We can contrast the above scenario of a small enterprise, with that of a shipping line. A foreigner who wanted to break into the shipping industry has three options: First, do it illegally by appointing dummies. This is not possible because it’s against the law. Second, he can find a Filipino who would be the industrial partner but in creating the entity assign 60 percent ownership to said Filipino. This is dangerous because in the event of a liquidation this means that 60 percent of the assets would be distributed to said Filipino who may have contributed nothing in the way of equity. It is possible also to use lawyers to draw up onerous contracts but that does not provide anywhere near the protection of outright ownership and is expensive. Third, you can get a Filipino partner in the industry who can put up the 60 percent capital required. This is problematic because, first, there are only a few dozen of such individuals who even exist, second, as stated previously they have no incentive to rock the boat.
Lastly, even if you jumped through the above hurdles your participation in the profits would be limited to 40 percent of the profits of the venture by law. Which means if your profit margin in a given year is 5 percent, you’d be entitled to only 2 of the 5 percent. You could mitigate this by using corporate layering and employing debt instruments but that is just more money spent on lawyers, pens and ink.
A Way Out
If you want to reduce prices and increase competitiveness of our industries here we have to open up to FDI in the area of transportation by amending the Public Service Act and potentially the Constitution. This pattern repeats across sectors like Raw Materials, Telecommunications, and the dependence on importation among others. These laws are decades old and no longer reflect the new reality that the Philippines has a strong interest in not making it difficult for capital to enter our country.
Atty. Hourani practices law in Cebu City, Philippines. If you would like to set an appointment with him, you may reach him here.
An Assessment of Logistics Performance of Manufacturing Firms in the Philippines, Department of Trade and Industry
Philippine Domestic Shipping Transport Industry: State of Competition and Market Structure, Myrna Austria, Ph. D.