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The Philippine EconomyDevelopment, Policies, and Challenges$

Arsenio M. Balisacan and Hal Hill

Print publication date: 2003

Print ISBN-13: 9780195158984

Published to Oxford Scholarship Online: November 2003

DOI: 10.1093/0195158989.001.0001

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Services

Services

Chapter:
(p.254) 8 Services
Source:
The Philippine Economy
Author(s):

Ma. Joy V. Abrenica

Gilberto M. Llanto

Publisher:
Oxford University Press
DOI:10.1093/0195158989.003.0008

Abstract and Keywords

This chapter documents the changing face of the services industry over the past three decades (1970–2000). It makes a special reference to two case studies – telecommunications and banking. Both are largely positive cases of reform leading to a more efficient provision of a range of services. There are other cases of successful reforms in the sector, including domestic shipping and civil aviation. This chapter also closely examines regulations that distort trade in services.

Keywords:   banking industry, financial sector, financial services, General Agreement on Trade in Services, market structure, regulation, telecommunications, trade liberalization

8.1 Introduction

New technologies have instigated profound changes in the services sector. One major change has been the elimination of geographic factors in the provision and use of many services. Whereas, in the past, the co‐location of provider and user was required to effect a service transaction, digitization and internet technologies have made feasible the “virtual” delivery of services. This has allowed the cross‐border supply of a number of services that were previously considered non‐tradable. Internet banking (financial services), e‐commerce (distribution services), distance learning (education services), and telediagnosis (health services) are cases in point.

Another major change concerns the feasibility of delivering different types of services over a common platform, a development known as convergence. Historically, such services were differentiated by their technologies and infrastructure. With convergence has come a blurring of industry boundaries, as when broadcasting, information, and electricity services invade the traditional domain of telecommunications.

However, even as networks converge, service offerings are becoming increasingly stratified. Thus a single service offering may involve several layers of activities by different enterprises, not all of which are visible to the user. In telecommunications, for example, the international traffic of messages involves a number of entities engaged in the provision of high‐capacity facilities, large‐scale traffic aggregation, wholesale and retail marketing, bandwidth management, and value adding (ITU 1999a)—yet users interact only with the carriers to which they are directly linked. The emergence of these new activities has created market opportunities for new players, leading to an expansion of the services sector.

(p.255) Technology‐driven changes have set the stage for the liberalization of trade and investment in services. Although the initiative has come from developed economies, where the services sector already accounts for as much as 70% of GDP and 60% of employment, support from developing economies has not been lacking. In fact, a review of the General Agreement on Trade in Services (GATS) reveals that the commitments made by developing economies to all four modes of service supply do not fall short of those made by developed economies (Adlung 2000). The four modes of supply identified in the GATS are: (1) cross‐border supply, which is akin to the movement of goods; (2) consumption abroad, pertaining to the use of services by nationals of one member economy in the territory of another; (3) commercial presence, whereby a foreign service provider establishes a presence in a member's market; and (4) movement of natural persons, whereby foreign individuals (as opposed to establishments) supply services in the territory of a member economy.

What explains this liberal posture? For many developing economies, the impetus for reform originates in the high cost and poor quality of services, which have impinged on the competitiveness of their industrial sectors. The clamor for more efficient services is often strongest among producers of tradable goods exposed to competition in the global or domestic market, with business users thus comprising the main constituency for reform of the services sector.

A related issue is the increasing cost of infrastructure. Most service industries were previously closed to private capital, both domestic and foreign, because of “national security” or “public service” concerns, as in the case of electricity supply or air transport services. When governments ran into difficulties in meeting the investment and management requirements of such industries, they were compelled to turn them over to the private sector. In the Philippines, the campaign to attract the participation of the private sector in infrastructure development took off in the early 1990s, with the government providing financial guarantees to mitigate the investment risks.

As with the goods sector, the full market opening of the services sector may be stymied by institutional rigidities. In services, the impediments to opening commonly take two forms: market access barriers (discrimination against new suppliers in favor of incumbents); and national treatment barriers (discrimination against foreign suppliers in favor of domestic suppliers).1 In the Philippines, market access restrictions, manifested in terms of limitations on the number of service suppliers and on foreign equity participation, are prevalent in banking and other financial sectors as well as in some segments of the telecommunications industry. Examples of national treatment impediments can be found in financial services, where foreign suppliers are required to have a Filipino understudy in the firm to facilitate the transfer of technology, and education, where foreign providers are subjected to an economic needs test.

An even more potent impediment to market reform is posed by a regulatory regime that is unable to cope with the demands of a new market environment. Innovations in products and processes are challenging the rationales upon which traditional forms of regulation are based. A regulatory system that is not attuned to the new environment may fail to engender effective competition and promote efficiency, (p.256) even if explicit market access and national treatment barriers are removed. Weak regulation can therefore undermine the value of an economy's commitment to reform.

This chapter examines regulations that distort trade in services.2 These are barriers that elude the discipline of multilateral agreements such as the GATS and hinder the market from reaping the full benefits of liberalization.3 The discussion focuses on two of the most technologically dynamic sectors: telecommunications and banking. More reforms have been implemented in these two sectors than in any other branch of services. Their regulatory experience is therefore replete with lessons of relevance for other service sectors.

8.2 Reforms in the Services Sector

In the Philippines, a movement of labor from agriculture and industry to services has been observed since the early 1980s (see Balisacan and Hill, Chapter 1). The services sector has become an important contributor to employment and national output, its robust performance compensating both for the slump in agriculture from 1994 to 1997 and for the sluggish performance of industry during years of economic downturn. In 1999 services accounted for 44% of employment and 45% of GDP.

The composition of services in the Philippine national income accounts is shown in Table 8.1. Excluded from the accounts are construction and the distribution of energy and water, which are classified under industry. Over the past three decades trade has consistently accounted for about one‐third of gross value added in services. Finance grew faster than other sectors in the 1970s and 1990s but was severely affected by the economic crisis of the 1980s. It was in this decade (specifically, 1981–87) that a major banking crisis occurred, whose cost to the economy was estimated to be equivalent to 3% of GDP (Caprio and Klingebiel 1996).

Despite the expansion of the sector, the value of trade in services remains insignificant compared with that of trade in goods. Exports of services in 2001, for example, were only one‐tenth those of goods (Table 8.2). Nevertheless, until 1997 a positive trade balance in services compensated for a widening trade deficit in goods. There have been reversals in the trade balance since 1998, with a slowdown in economic activity depressing imports of goods, but not of services, and a depreciation in the exchange rate helping exports of goods, but not of services. Thus services trade has recently been in deficit and goods trade in surplus.

It should be noted that the trade in services detailed in Tables 8.2 and 8.3 does not include services supplied through mode 3 (commercial presence) or mode 4 (movement of natural persons). Thus far, the only comprehensive source of information on services trade is the IMF's annual Balance of Payments Statistics Year‐book, which does not fully cover trade by foreign affiliates or adequately capture transactions by natural persons.4 The implications vary by sector, but distribution and financial services are likely to be the most affected. Apart from these shortcomings, there is a lack of concordance between the IMF categories for services and those in the Philippine national income accounts. Moreover, the GATS maintains its (p.257)

Table 8.1 Composition of Services, 1970–2001 (%)

Component

Share of Gross Value Added

Growth Rate

1970–79

1980–89

1990–2000

2001

1970–79

1980–89

1990–2000

2001

Transportation, communication, & storage

12.7

13.6

14.1

16.4

8.4

3.1

5.0

8.9

Trade

34.7

35.7

35.3

35.6

5.7

2.3

3.7

5.6

Finance

9.0

9.0

10.3

10.4

9.3

0.6

5.1

0.6

Ownership of dwellings & real estate

17.4

13.9

12.4

10.6

1.1

1.7

2.0

−0.3

Private services

13.8

16.2

16.1

16.3

5.3

4.2

3.7

4.4

Government services

12.3

11.7

11.8

10.8

4.1

2.5

3.4

1.8

Total

100.0

100.0

100.0

100.0

5.3

2.5

3.8

3.4

Source: National Statistical Coordination Board.

own sectoral classification list, which is far more disaggregated than that of the IMF. These data constraints have hindered detailed quantitative assessment of trade in services.

Few would refute that the growth in Philippine services trade in recent years owes a great deal to the market reforms initiated in the first half of the 1990s. During this period structural reforms were introduced in historically sheltered industries such as telecommunications, banking, shipping, and air transport services. The impact of the reforms has been uneven—they were more successful in communications and finance than in transportation.

As there was considerable domestic momentum for reform even before the GATS, it is not surprising to find the Philippine record of external policy commitments to be almost as broad in coverage as that of advanced economies such as Australia, the European Union and the United States (WTO 1999, cited in Adlung 2000). Interestingly, the country's commitments go beyond those made by Singapore and Indonesia but have not been quite as far‐reaching as those made by Thailand and Malaysia.

The reform of Philippine services began in 1993 with the adoption of two major laws liberalizing major segments of the telecommunications sector. In the following year, banking and insurance services were opened to foreign suppliers. Air transport services and domestic shipping were liberalized in 1995, paving the way for entry of new local operators. A new national policy issued in 1998 deregulated the use of (p.258)

Table 8.2 Value and Growth of Trade in Goods and Services, 1985–2001

Component

Value ($ billion)

Growth Rate (%)

1985

1990

1995

1997

1998

1999

2000

2001

1985–90

1991–95

1996–2001

1991–2001

Goods

Exports

4.6

8.2

17.4

25.2

29.5

35.0

38.1

32.1

13.7

16.6

11.6

13.8

Imports

5.1

12.2

26.4

35.7

29.7

30.7

31.4

29.6

21.1

17.1

2.7

9.2

Balance

−0.5

−4.0

−9.0

−10.5

−0.2

4.3

6.7

2.6

Services

Exports

3.3

4.8

14.4

22.8

13.9

4.8

4.0

3.2

11.5

25.2

−15.0

3.3

Imports

3.3

4.1

9.6

17.1

13.2

7.5

6.1

5.1

3.3

19.7

−5.7

5.9

Balance

0.0

0.7

4.8

5.7

0.7

−2.7

−2.1

−1.9

Source: IMF (various years), Balance of Payments Statistics Yearbook; Bangko Sentral ng Pilipinas; National Statistics Office.

(p.259)

Table 8.3 Composition of Trade in Services, 2001

Component

Exports

Imports

Net Trade

Value

Share

Value

Share

Value

($ million)

(%)

($ million)

(%)

($ million)

Transportation

659

20.9

2,325

45.7

−1,666

Travel

1,723

54.7

1,224

24.0

499

Communication

330

10.5

215

4.2

115

Construction

64

2.0

298

5.9

−234

Insurance

48

1.5

116

2.3

−68

Finance

34

1.1

75

1.5

−41

Computer & information

22

0.7

83

1.6

−61

Royalties & license fees

1

0.0

158

3.1

−157

Other business services

219

7.0

537

10.6

−318

Personal, cultural & recreational

15

0.5

57

1.1

−42

Government

36

1.1

2

0.0

34

Total

3,151

100.0

5,090

100.0

−1,939

Source: IMF (2002), Balance of Payments Statistics Yearbook 2001.

international satellite communications. Major changes were made to the regulation of securities in February 2000 and to banking regulation in May 2000.

At least four major amendments to the Foreign Investment Act of 1991 (Republic Act (RA) 7042) have had a direct impact on the services sector. RA 8179 granted foreign investors full access to all tourism‐related activities except transport. RA 8366, also known as the Investment Houses Law of 1997, increased the foreign equity cap for an investment house from 40% to 60% of the voting stock. RA 8556, or the Financing Company Act of 1998, raised the allowable limit for foreign equity participation in a financing company to 60% of the voting stock. And in August 1998, private domestic construction contracts were de‐listed from the foreign investment negative list, removing all limits to foreign equity participation in construction services.

The Retail Trade Liberalization Act of 2000 replaced a half‐century‐old law restricting the right to engage in retail distribution to Philippine citizens, thus opening the door to entry of foreign investment in specified areas of retail trade. In the same year the government passed the E‐Commerce Law (RA 8792), which provided for legal recognition of electronically transmitted messages, documents, and signatures. The intent of the law was to facilitate and encourage domestic and international transactions conducted over the internet.

(p.260) Notwithstanding these initiatives, significant impediments related to market access and national treatment continue to prevail in the services sector. Many of these are stipulated in the Philippine constitution and hence are difficult to reform. For example, franchises on all modes of transport services can be awarded only to Philippine citizens, or to corporations or associations organized under Philippine law and at least 60% owned by Philippine nationals. The law on cabotage reserves all coastal trade for national vessels crewed by Filipinos.5 No cross‐ownership of telecommunications and broadcasting is permitted. Foreign investors can lease but not own land.6 Although the Retail Trade Liberalization Act has opened retail trade to foreign investors, the Philippines still has the highest minimum capital requirement for foreign retailers of any Asian economy.7 Moreover, retail enterprises with a paid‐up capital of up to $2.5 million are still reserved entirely for Philippine citizens.

The trading conditions for mode 4 supply of services (movement of natural persons) are also restrictive. Before a non‐resident alien is allowed to supply a service, it must be established that no Philippine national is able and willing to supply that same service. An alien who is permitted to hold a technical position in an enterprise can do so only within the first five years of its operation, and must have at least two Filipino understudies. In the case of activities reserved expressly by law for Philippine nationals, all executive and managerial positions must be held by Filipinos, although foreign investors can participate in governance in proportion to their share of capital in the organization. These restrictions apply even in the tourism sector, which tends to be treated liberally in most countries. Thus, only Filipinos can be employed in tourism‐oriented establishments, with some leeway given to hotels and resorts.

These impediments render the Philippine services market restrictive when compared with those of other Asia‐Pacific economies. Table 8.4 finds supports for this position based on comparative studies on trade restrictions in services undertaken by the Australian National University and the Australian Productivity Commission (Findlay 2001). Following Hoekman's (1995) methodology of ranking a sector's trade restrictiveness based on a count of the frequency of impediments, in Table 8.4 a value close to zero suggests market openness whereas a value close to 1 indicates restrictiveness. Separate indices are calculated for domestic and foreign suppliers. For all sectors except engineering, the Philippine values for foreign suppliers are higher than the average for selected APEC economies. Compared with the average for ASEAN economies, the Philippine values are lower only for telecommunications. The sector is indeed ripe for market reform.

Two other observations are suggested by these indices. First, although the Philippines has instituted more reforms in telecommunications and banking than in other service sectors, the values for these sectors are no lower than those of sectors in which fewer reforms have been introduced, for example distribution. Second, national treatment impediments are pervasive in all sectors and for all economies, as suggested by the consistently lower values for domestic than for foreign suppliers. In the case of the Philippines, the gap between the domestic and foreign supplier indices is widest in telecommunications, banking, maritime services, and legal services. (p.261)

Table 8.4 Index of Trade Restrictiveness in Services

Component

Philippines

Average for ASEAN‐5a

Average for APEC‐14b

Domestic Suppliers

Foreign Suppliers

Domestic Suppliers

Foreign Suppliers

Domestic Suppliers

Foreign Suppliers

Banking

0.1

0.5

0.1

0.5

0.1

0.3

Telecommunications

0.1

0.5

0.3

0.6

0.2

0.4

Maritime services

0.2

0.6

0.2

0.5

0.2

0.5

Distribution

0.1

0.4

0.1

0.3

0.1

0.2

Engineering

0.0

0.2

0.0

0.2

0.1

0.2

Architecture

0.1

0.3

0.0

0.2

0.1

0.2

Accountancy

0.3

0.6

0.2

0.5

0.2

0.4

Legal

0.1

0.5

0.1

0.5

0.2

0.5

(a) Comprises the Philippines, Thailand, Indonesia, Malaysia, and Singapore.

(b) Comprises the ASEAN‐5 plus the United States, Australia, New Zealand, Japan, Chile, Hong Kong, Canada, Mexico, and South Korea.

Sources: Kalirajan (2000), McGuire, Schuele, and Smith (2000), McGuire and Schuele (2000), Kalirajan et al. (2000), Nguyen‐Hong (2000), and Warren (2000), as cited in Findlay (2001).

How costly are these barriers? Findlay (2001) has reported the estimated divergence between domestic and world prices resulting from the imposition of restrictions on local and foreign suppliers for a wide cross‐section of countries. As might be expected, the cost of impediments is almost nil for the highest‐income group of countries (reflected in a divergence of 7% for banking and 2% for telecommunications) but overwhelming for the lowest‐income group of countries (with a divergence of 52% for banking and 138% for telecommunications). Specific calculations for ASEAN economies are shown in Table 8.5. It can be seen that, in the case of the Philippines, the price wedge is as high as 11–47% for banking and 21–73% for telecommunications.

Warren (2000) shows further that in the telecommunications sector, trade impediments have retarded investments in the fixed and mobile telecommunications networks. A strong positive relationship is found between market liberalization and telephone penetration rates, despite variation in the elasticity of penetration for each of the countries studied. Unsurprisingly, the values are lower for advanced countries with an already high telephone density ratio than for developing economies where the scope for investment is much greater given their existing low penetration rates. Thus, whereas the elasticity is 2.8–4.8% for Singapore, it is 110–267% for China. This suggests that developing economies in particular stand to benefit from liberalizing their telecommunications markets. (p.262)

Table 8.5 Price Impact on Banking and Telecommunications of Trade Impediments (%)

Country

Banking

Telecommunications

Domestic Suppliers

Foreign Suppliers

Domestic Suppliers

Foreign Suppliers

Philippines

11

47

21

73

Singapore

8

31

2

3

Malaysia

22

61

7

16

Thailand

0

33

30

55

Indonesia

5

49

71

138

Source: Productivity Commission (1999), as cited in findlay (2001).

It is worth noting that these estimates of the impact of trade impediments, while already high, are based only on market access restrictions and discrimination against foreign suppliers (national treatment barriers). They exclude penalties from regulatory inefficiencies, which are less transparent and hence more difficult to quantify—let alone compare across economies. Yet the trade impediments created by the regulatory regime are often more serious and more difficult to rectify. Worse, they can stall the implementation of external policy commitments to the removal of market access and national treatment barriers, as the following discussion highlights for the cases of telecommunications and banking.

8.3 The Telecommunications Industry

The Philippines joined the league of early reformers of the telecommunications market in 1993. It was among the first 11 countries to permit competition in basic telecommunications services (the local loop), and among the first 14 to de‐monopolize the provision of international telephone services.

Market Structure

The imperative to liberalize came on the heels of complaints over the inadequate supply and poor quality of telephone services in the Philippines.8 For close to two decades telephone density had hovered at 1%, with consumers waiting an average of five and a half years to obtain a connection.9 Even then, the quality of the service was so poor that on average complaints were made about 17 per 100 phone lines per month in 1988, compared with seven in Thailand and nine in Indonesia (DOTC 1993: A‐13).

(p.263) The local telephone service was at the time a de facto monopoly of the Philippine Long Distance Telephone Company (PLDT), a private company with the sole national franchise. PLDT controlled 94% of local exchanges, with the rest owned by the government and small private carriers. It also controlled the long‐distance network by virtue of its ownership of the only nationwide backbone transmission network. PLDT dominated the international service, facing only minimal competition from two other international record carriers. The mobile telephone market was a duopoly dominated by a PLDT subsidiary.

Many countries elect to introduce competition in some market segments—usually the local loop—while retaining others (such as national long‐distance and international services) as a monopoly.10 The rationale for this is that higher prices and profits in the segments run as a monopoly will generate funds that can be invested in the segments where competition has been introduced. Unfortunately, this strategy of service segment cross‐subsidy has failed to spur the expansion of the telecommunications network in most developing economies (ITU 1999b: 16).

The Philippine regulator broke with tradition by introducing competition in all market segments in 1993, under the Universal Telephone Service Policy. This policy underpins the Service Area Scheme (SAS), a network development program based on a division of the country into 11 service or franchise areas. These service areas were assigned to nine new carriers such that, in each area, one or two new carriers had to compete with the incumbent, PLDT, in the provision of basic services (Table 8.6). The new carriers were cellular operators and/or international carriers. Their licenses obligated them to invest in telephone lines—by installing at least 400,000 lines within three years of being awarded a license in the case of the cellular operators, and 300,000 lines in the case of the international carriers. The SAS was ostensibly designed to hasten network development. Telephone density did indeed rise dramatically, from 1.2% in 1992 to 9.1% in 2000, which translates to 6.9 million telephone lines for a population of 76.3 million people. Interestingly, only 3.06 million of the lines (44% of total installed lines) were subscribed.

Some observers regarded the SAS as an ingenious scheme for averting cherry picking, or the overconcentration of investment in profitable segments that happens when entry barriers are removed simultaneously in all markets. The service obligations attached to the licenses of the new carriers ensured that some investment would be channeled to network development and that network coverage would expand to include unserved areas, some of them deemed unviable. Yet the ostensible logic of the scheme did not spare it from the criticism that it had been designed more as a political maneuver to accommodate competing interests than as an economic solution to the problem of underinvestment in telecommunications infrastructure. It could be argued that, by turning a blind eye to the need for scale economies, the regulator had eluded responsibility for selecting the suppliers with the most efficient and viable plans for network development. Rather, all those interested in riding the euphoria of market liberalization were accommodated through the designation of service areas.

Notwithstanding its political flavor, the scheme delivered a good number of tangible benefits. It compelled PLDT to double the size of its network, built over (p.264)

Table 8.6 Structure of the Philippine Telecommunications Market

Company

Foreign Partner

Market Share (%)

Locala

Internationalb

Cellularc

PLDT

55.6

71.4

SMARTd

NTT (Japan), First Pacific (Hong Kong)

3.8

2.3

44.3

PILTELd

1.9

10.2

Globe Telecom

Singapore Telecom (Singapore)

5.2

3.3

39.7

Islacom

Deutsche Telekon (Germany), Shinawatra (Thailand)

4.9

1.0

2.8

Digitel

Telia (Sweden), Jasmine International (Thailand)

11.3

4.1

BayanTel

Bell Atlantic (United States)

7.2

4.1

PT&T/Capwire

Korea Telecom (Korea)

1.7

1.7

Philcom

1.3

6.4

ETPI

Cable and Wireless (United Kingdom)

0.7

5.8

Other

6.2

3.0e

Total

100.0

100.0

100.0

(a) Based on subscribed lines as of 31 December 2000.

(b) Based on incoming and outgoing international traffic in 1997.

(c) Based on subscribed lines as of 31 December 2000.

(d) Subsidiary of PLDT.

(e) Share of Extelcom.

Source: NTC (2001); ITU (1998).

almost half a century, within just four years. Whereas in 1992 the network had reached only 19% of total districts in the country, by 1999 54% of cities/municipalities had access to a telephone service. By December 2000, only 93 of 1,600 cities/municipalities had no fixed lines, public calling office, or cellular mobile telephone service.11 Improvements were realized not only in supply but also in service quality. The waiting time for a telephone connection fell from 5.5 years in 1994 to 2.1 years in 1998, and the digitization of the network accelerated from 64% in 1994 to 92% in 1998 and 95% in 2000 (ITU 1999b).

The rapid growth of the network was impelled by the entry of new service providers, backed by huge pent‐up demand. There are at present 12 major local (p.265) exchange carriers, 11 international gateway facility (IGF) operators (that is, international service providers), five cellular mobile telephone operators, 15 paging companies, and 10 trunked mobile radio operators. In short, market access has been liberalized in all telecommunications services—local, national long‐distance, international, mobile cellular, data, telex, leased line, paging, cable TV, and satellite.

Few developing economies have been as bold as the Philippines in its telecommunications market reforms. Thailand and Indonesia, for example, have yet to allow competition in local services, while Singapore has only recently ended the monopoly of the state‐owned carrier, Singapore Telecom (SingTel).12 ITU (1999b) reveals that, as of 1999, only 32% of countries in Asia allowed some competition in local services, and an even smaller proportion, 24%, in national long‐distance and international services.

The legislative seal to the reforms initiated under the Universal Telephone Service Policy came with the passage of RA 7925, also known as the Public Telecommunications Act of 1995. However, it contained important stipulations that continue to bind the regulatory regime. For example, the act:

  1. made the provision of a universal service the centerpiece of telecommunications development;13

  2. mandated that IGF operators, cellular mobile phone operators, and inter‐exchange carriers should cross‐subsidize local exchange operations through payment of an access charge;

  3. institutionalized bilateral negotiation between carriers as a means of forging interconnection contracts;

  4. prohibited single entities from engaging in both telecommunications and broadcasting, either over the airwaves or by cable; and

  5. placed a foreign equity cap of 40% on telecommunications entities and retained the cap of zero for broadcasting entities.

The design of the SAS, combined with the above provisions, has restrained competition, which in turn has hampered trade in telecommunications services. Notwithstanding a seemingly liberal policy, the expansion of the market power of the incumbent and the inability of the regulator to clip its powers has posed an impenetrable barrier to trade.

Flaws in Regulatory Design and the Market Power of the Incumbent

That PLDT remains dominant despite the entry of new carriers may be attributed to the design of the regulatory system. The geographical segmentation of the market prevents the new carriers from achieving scale and scope economies and network externalities. Since they are restricted to operating within their assigned franchise areas, their networks are too small for them to compete effectively against the incumbent. Individually, they have weak bargaining leverage against PLDT, as manifested in their negotiations for interconnection contracts. In 1999 PLDT retained control of 61% of local connections (the combined market share of PLDT, SMART, (p.266) and PILTEL), 55% of cellular mobile phone subscriptions (the combined market share of SMART and PILTEL), and 71% of international traffic (Table 8.6).

The incumbent's dominant market position is sustained by its ability to squeeze the margins of new entrants through interconnection fees. The SAS allows scope for this practice in the following manner. An important feature of the scheme is the cross‐subsidization of local exchanges by the mobile, national long‐distance, and international markets through access charges paid by the new carriers to the incumbent. The access charge (a universal service subsidy to the network owner for assuming the social responsibility for building and maintaining the infrastructure) is bundled with the interconnection fee (a payment to the network owner for providing access to its facilities). The lack of transparency inherent in this arrangement allows the incumbent to charge high interconnection fees while preventing new carriers from undercutting its prices. To add to the new carriers' difficulties, tariffs in the competitive markets are regulated; for example, IGF operators are permitted to offer special promotions for a limited period of only 60 days (ITU 1998).14

No doubt the squeeze on new carriers could have been averted had the Philippine regulator adopted a less light‐handed approach to regulating interconnection. The Public Telecommunications Act stipulates that interconnection agreements should be the outcome of commercial negotiations between private parties. Although in most countries the telecommunications regulator prefers to let carriers negotiate the terms of interconnection agreements for themselves rather than prescribe them, this does not mean that it abstains entirely from intervening. In countries where the inherent conflicts that arise in this area are well managed, the regulator assumes responsibility for enforcing non‐discriminatory, timely, and sufficient interconnection arrangements.15 This is done by defining pricing principles (whether cost‐based or revenue sharing, for example), setting a timetable for the completion of negotiations, and approving and supervising the agreements that have been negotiated. In order to curb the power of the incumbent to discriminate against newcomers, many regulators require the incumbent to disclose its costs or publish interconnection charges. This is the case even when interconnection agreements are treated as commercial contracts.

The role of the regulator in forging interconnection agreements becomes crucial when carriers have uneven bargaining positions, as in the Philippines. Yet the Philippine regulator leaves many of the critical issues—such as the pricing structure of interconnection agreements and the location of interconnection points—to the contracting parties to decide. This allows considerable room for bargaining, with the outcome often favoring the incumbent. Moreover, interconnection agreements remain confidential to the contracting parties, making it difficult to check whether there has been discrimination by the incumbent against newcomers.

Nor has the regulator acted decisively on the complaints of new operators that the incumbent is refusing to provide them with sufficient interconnection points, leading to traffic congestion on their networks and impairing the quality of their service. They have also complained about the incumbent's policy against co‐location of facilities,16 failure to supply sufficient interconnection trunks, and propensity to let disputes over revenue and charges drag on.17

(p.267) The regulator could have tempered the market power of the incumbent by allowing competition to flourish across market segments, but here again it is bound to safeguard the market environment created under the SAS. A clear illustration is found in the regulator's handling of internet telephony. Traditional, circuit‐switched telecommunications carriers are now facing competition from internet protocol (IP) based networks that can provide voice, data, and video services. There used to be a clear delineation of functions between telecommunications carriers, which provided only basic voice services, and value added operators, which provided additional services (such as computing and data storage using IP networks) over voice lines. New technology now allows value added operators—in particular internet service providers (ISPs)—to provide services that compete directly with those offered by the traditional carriers, such as long‐distance telephony. IP telephony remains prohibited in the Philippines on the grounds that if ISPs were allowed to provide IP telephony services, the resulting competitive pressures in the national long‐distance and international markets would undermine cross‐subsidy flows.18 The same reasoning explains the ban on call‐back, refiling, and international simple resale (ISR) services. Elsewhere, these innovations have led to steep falls in the prices of international calls.

Barriers to Trade in Telecommunications Services

Trade in telecommunications services is dominated by two modes of supply: cross‐border and commercial presence. The cross‐border supply of international telephone calls is more prevalent than supply through commercial presence, which generally takes the form of entry of foreign suppliers through direct investments.

Until recently, many economies were reluctant to relinquish national control over basic telecommunications services for reasons of national security or the public interest. But attitudes toward foreign equity in basic services have been changing, spurred by demand for investments to keep pace with the rapid modernization of basic telecommunications infrastructure. In Malaysia, for instance, in April 1998 the regulator raised the foreign equity cap on basic telecommunications services from 49% to 61%, to support new carriers facing bankruptcy (Abrenica and de Dios 2000). In April 2000 Singapore removed all restrictions on foreign entry in basic services to boost its infrastructure modernization program.19 And even China has announced that it will allow up to 49% foreign equity in basic services within the next four years. Meanwhile, the Philippine regulator is bound by legislation (RA 7925 and RA 7042) to restrict foreign equity participation in basic telecommunications services to 40%.20 In addition, the provision of value added services and the operation of cable TV and other forms of broadcasting remain the express preserve of Philippine nationals.

The imminent restructuring of the telecommunications industry that is being prompted by technological convergence continues to be stalled by foreign equity restrictions. Unexpectedly, opposition to the proposed Convergence Bill, which would have allowed cross‐sector ownership and service provision, came from cable operators. Although the bill would have enabled them to deploy their excess cable (p.268) capacity in the lucrative telephony business, they argued that they would face unfairly tough competition from telecommunications carriers (who are not bound by a 100% Philippine ownership rule).

There can be no doubt that the current foreign equity limits should be reconsidered in light of the pace of technological development. Yet, in terms of attracting foreign capital, this may be less significant than the need to level the playing field. From what has just been described, the exercise of market dominance by the incumbent, sanctioned by regulatory deficiencies, forecloses opportunities for profitable entry.

This profit squeeze is perhaps most severe in the international telephone services sector. The high access charge imposed by the incumbent is not only threatening the viability of IGF operators but, more importantly, it is undermining the regulatory intention to use revenues from international services to subsidize basic telephone services. New carriers point out that at the start of their local exchange rollout in 1996, as provided for under the SAS, the accounting rate—which traditionally forms the basis for international revenue settlements among national carriers—was $1.20 and PLDT's access charge $0.35, leaving them with a margin of $0.25 per minute to finance the rollout.21 During the last five years, the accounting rate has fallen by 40% (to $0.72 in 2000), but the incumbent has reduced its access charge by only 20% (to $0.28) (Figure 8.1). This translates to a 68% drop in the margins of IGF operators (that is, from $0.25 to $0.08 per minute of international traffic).

The issue is not just the behavior of the incumbent but also the fact that competition and technology are advancing more rapidly in international services than in other telecommunications sectors. Consequently, the accounting rate is being eroded in various ways.22 Many multinational corporations are now transporting their traffic over leased lines and private networks that bypass the accounting rate system. Where the resale and refiling of traffic are permitted, carriers are able to exploit pricing disparities in the accounting rate system to reduce their costs. And increasingly, traffic is being routed over networks (such as internet telephony networks) that do not use accounting rates at all.

Apart from facilitating the efforts of developed economies to drive down the accounting rate, new technologies are increasing bandwidth capacity and reducing the costs of transmission. As more transoceanic cables are laid and as more satellites come on stream over the next few years, current capacity is expected to multiply. In the immediate future, a new, cost‐based pricing structure for international traffic is likely to emerge, in which the individual components of the call are priced separately.

Therefore, the more urgent issue confronting the Philippine regulator is whether it can preserve the present system of service segment cross‐subsidy in an increasingly competitive environment. It is evident that the accounting rate system is nearing its end. Of course, the regulator may choose to continue to maintain international calls at artificially high prices, but this would be at the expense of users, primarily the business sector. Moreover, as new technologies make it easier to bypass the traditional telecommunications network, revenue from international call services can be expected to shrink, thus diminishing the funds available for network development. (p.269)

                      Services

Figure 8.1 Settlement and Access Rates For International Telephone Services, 1996–2000 ($)

If cross‐subsidies cannot be depended on to finance future network development, then the only logical option will be to rely increasingly on foreign capital. Yet this will not be forthcoming unless barriers to foreign entry are removed, and, more importantly, unless the regulatory regime nurtures a competitive market environment.

8.4 The Banking Industry

The pressure for regulatory reform is no less palpable in financial services than in telecommunications.23 Over the past decade, the international financial market has grown more rapidly than the Philippine domestic market. New modes of financial intermediation have emerged; the era of derivatives trading and internet‐based banking has arrived. Technology is indeed changing the scope and character of financial services—a fact that regulators are only now beginning to grapple with.

Added pressure comes from the nexus between financial services and the macro‐economy. Of all services, the financial sector, especially its banking component, has the closest links to the economy at large. Prudent financial regulation and supervision underpin macroeconomic stability. Conversely, macroeconomic stability permits the exercise of prudence in the regulation and supervision of the financial system. The depth of the financial system has also been linked with per capita income growth (Berthelemy and Varoudakis 1996; Levine 1994; Haustmann and Gavin 1996). Thus, the stakes are high in ensuring the integrity and stability of the (p.270) system, as well as its efficiency in mobilizing savings and pooling resources for economic activities. This section examines the impact of a liberal trade regime on the Philippine financial sector, focusing in particular on banking, which comprises 75% of the sector.24

Market Structure

The Philippine banking sector consists of commercial banks, thrift banks, specialized government banks, and rural banks.25 The volume of its assets—equivalent to about 101% of GDP and 82% of total assets in the financial system as of the end of 1999—attests to its dominant position in the financial system. The second largest segment of the financial system pales by comparison: the contractual savings sector, composed of public and private pension funds, pre‐need plans, and life insurance companies, has total assets equivalent to only 20% of GDP (World Bank 2000b).

Commercial banks dominate the banking sector, their share in total bank assets rising from less than three‐quarters in the early 1980s to nearly five‐sixths in the early 1990s. The latest inventory (December 2000) reveals that 45 commercial banks account for 91% of total banking sector assets and 56% of the country's 7,553 banking offices. Table 8.7 traces the growth of commercial banks by ownership type.

Financial Sector Reforms

The rapid growth of the banking sector owes a great deal to the deregulation of financial markets and liberalization of bank entry and branching in the 1990s.26 However, the liberalization of trade in financial services was preceded by a protracted series of reforms beginning as far back as the 1970s.

In 1971, the IMF and the Philippine Central Bank Survey Commission conducted a joint review of the Philippine banking system, resulting in a redefinition of the various types of financial institutions. Responsibility for maintaining monetary stability remained within the ambit of authority of the Central Bank of the Philippines, which also took over supervision of the entire financial and credit system in view of the rapid growth of non‐bank financial intermediaries.27 As part of the structural adjustment program agreed between the Philippines and its international creditors, the government built a financial liberalization and deregulation program into its economic development plan. It was designed to foster competition in the country's financial markets, as a means of promoting efficiency and increasing the availability of long‐term funds for the expansion of the real sector.

The financial sector reforms of the 1980s included changes to the structure of the banking system, deregulation of interest rates,28 adoption of universal banking, and an increase in the minimum capitalization requirements for banking institutions. However, the reforms failed to adequately address the structural weaknesses in the banking system. The central bank maintained a restrictive policy on bank entry and a discretionary policy on bank branching, which, in tandem with limits imposed on foreign equity participation in domestic banks, restrained competition. The absence (p.271)

Table 8.7 Commercial Banks by Type of Ownership, 1980–2001 (No.)

Type

1980

1985

1990

1995

1996

1997

1998

1999

2000

Sept 2001

Private domestic banks

27

25

25

30

31

33

32

30

23

23

Foreign bank branches

4

4

4

14

14

14

13

13

13

13

Foreign bank subsidiaries

4

5

6

6

5

Government banks

1

1

1

2

4

3

3

3

3

3

Total

32

30

30

46

49

54

53

52

45

44

Source: Bangko Sentral ng Pilipinas.

of effective competition kept the spreads between lending and deposit rates wide open and depressed the quality of bank services.

It did not help that the central bank was lax in its regulation and supervision of banks. Self‐lending, particularly to directors, officers, stockholders, and related interests, was gravely abused; and banks maintained more risky portfolios than they would have done if adequately supervised. The eventual result was bank failures, magnified by a balance of payments crisis and political instability in 1983 (Lamberte 1985).

Policy changes were introduced in 1986 to strengthen the regulatory and supervisory framework of the banking system. They included the strengthening of supervisory procedures and prudential regulations, and new rules governing the establishment of banks and bank branches. The prudential regulations provided for higher minimum capitalization requirements; compliance with a minimum risk–asset ratio; limits on loans to directors, officers, stockholders, and related interests; and stricter auditing and reporting requirements. A major policy pronouncement was that weak banks would no longer be sustained, except in times of general financial emergency or when the bank concerned faced a liquidity (rather than solvency) crisis.

Yet bolder reforms were implemented in the 1990s. The decade saw the creation of a new, independent central bank;29 the rehabilitation and strengthening of two major government financial institutions, namely the Development Bank of the Philippines and the Philippine National Bank;30 a spate of closures, consolidations, and mergers among private commercial banks; and a liberalization of foreign bank entry and scope of operations. The New Central Bank Act of 1993 (RA 7653) created an independent central monetary authority called Bangko Sentral ng Pilipinas (BSP). As opposed to the former Central Bank of the Philippines, which also had a (p.272) development mandate, the BSP was charged solely with maintaining monetary and price stability and safeguarding the convertibility of the peso. The creation of the BSP was deemed an essential prerequisite for the envisaged greater participation of the Philippines in the global financial market.

During this period, the conditions for mode 3 (commercial presence) supply of financial services were also liberalized, under RA 7721 of 1994, to permit the entry of up to 10 foreign banks. Until the passage of this law, banking had been reserved expressly for Philippine nationals, with the exception of the four foreign banks already operating in the country before the passage of the General Banking Act of 1948.31 Section 2 of RA 7721 prescribed three modes of entry for foreign banks, namely: “(1) by acquiring, purchasing or owning up to 60% of the voting stock of an existing bank; (2) by investing in up to 60% of the voting stock of a new banking subsidiary incorporated under the laws of the Philippines, or (3) by establishing branches with full banking authority.” Since 1995 at least nine foreign banks and seven subsidiaries of foreign banks have established a presence in the country.

While it signaled a cautious attempt to introduce greater competition in the financial market, RA 7721 stipulated that “in allowing increased foreign participation in the financial system, it shall be the policy of the State that the financial system remains effectively controlled by Filipinos” (Section 1) and provided that “the Monetary Board shall adopt such measures as may be necessary to ensure that at all times the control of 70% of the resources or assets of the entire banking system is held by domestic banks which are at least majority‐owned by Filipinos” (section 3).

The General Banking Law of 2000 (RA 8791) permitted the monetary board to authorize the acquisition by a foreign bank of up to 100% of the voting stock of one bank organized under the laws of the Republic of the Philippines, subject to the guidelines set out under RA 7721. As well as improving market access, the General Banking Law upgraded the rules governing the operation of the BSP to conform to international standards. The aim was “to promote and maintain a stable and efficient banking and financial system that is globally competitive, dynamic, and responsive to the demands of a developing economy.” Other salient provisions of the law included:

  1. establishment of a strong legal basis for consolidated banking supervision;

  2. adoption of a “fit and proper” rule for individuals appointed or elected as bank directors or officers;

  3. a requirement that banks have at least two independent directors on their boards;

  4. adoption of a risk‐based capital requirement following the recommendation of the Basle Committee;

  5. stronger safeguards against connected lending;

  6. more comprehensive coverage of a single borrower's limit to include guarantees;

  7. liberalization to permit up to 100% foreign bank ownership of domestic banks during a seven‐year window of opportunity;

  8. establishment of a legal basis for the formulation of standards setting out sound and unsound practices by banks, quasi‐banks, and trusts; and

  9. (p.273)
  10. introduction of rules to ensure greater transparency of banking operations and stricter information disclosure requirements for banks.

It is apparent that the thrust of reform has been toward tighter prudential regulation and closer supervision of banks. To the extent that they prescribe new, higher standards of banking practice, rules to encourage “good” banking should be encouraged. But such rules are only as effective as their implementors. It remains to be seen whether the BSP does in fact develop a strong capacity to monitor and enforce standards.

Impact of Trade Liberalization

The liberalization of entry of foreign banks, albeit partial, has irrevocably changed the structure of the domestic financial market. The larger domestic banks now have some level of foreign equity; and more are willing to accommodate foreign capital in order to comply with the higher minimum capitalization requirements set by the BSP. However, while the share of foreign banks in domestic banking activities has been increasing steadily since 1995, this has not been sufficient to dislodge the domestic commercial banks from their dominant position in the market. As Table 8.8 shows, more than four‐fifths of assets, deposits, and loans remain under the control of the domestic banks.

As shown in Table 8.9, there has been a marked decline in the overall profitability of commercial banks in the post‐liberalization period, and a narrowing of the spread between lending and deposit rates. This suggests that the entry of foreign banks has provided the impetus to improve the efficiency of the domestic banking system, with some of the benefits flowing back to consumers.32

At this point competition among banks is limited to deposit mobilization, with clients being offered new banking technologies and a wider menu of financial instruments.33 But competition has not significantly reduced the deposit concentration ratio. Intal and Llanto (1998b) report that, as of the third quarter of 1997, the five largest commercial banks retained 49.9% of total deposits—an insignificant decline from the figure of 52% recorded in 1994.

If market competition can be nurtured, then the next stage will see banks chasing borrowers—tailoring their financial packages to meet the specific needs of clients. That future remains outside the current purview of banks, which still continue to ration loans to a select few.

Barriers to Trade in Financial Services

It is possible that bank competition will not advance much beyond its present level, despite the Philippine commitment under the GATS to pursue “progressive levels of liberalization.” In August 1999, the BSP issued Monetary Board Resolution 1224 declaring a moratorium on the granting of new banking licenses and on branch expansion by existing banks. This was formalized under the General Banking Law (p.274)

Table 8.8 Distribution of Assets, Deposits, and Loans Between Domestic and Foreign Commercial Banks, 1990–2001

1990

1995

1996

1997

1998

1999

2000

2001

Total assets (billion pesos)

488.9

1,386.4

1,885.6

2,581.1

2,638.6

2,744.1

2996.5

3,015.3

Domestic commercial banks (%)

88.6

91.3

87.3

82.5

84.4

83.6

82.6

81.4

Foreign commercial banks (%)

11.4

8.7

12.7

17.5

15.6

16.4

17.4

18.6

Total deposits (billion pesos)

306.1

898.0

1,249.5

1,476.4

1,652.2

1,767.3

1,903.0

1,922.0

Domestic commercial banks (%)

92.5

95.2

95.4

91.8

90.6

87.3

84.9

84.9

Foreign commercial banks (%)

7.5

4.8

4.6

8.2

9.4

12.7

15.1

15.1

Total loans (billion pesos)

181.8

810.0

1,122.6

1,366.0

1,369.1

1,269.9

1,628.2

1,625.0

Domestic commercial banks (%)

91.4

92.8

91.7

88.4

88.7

86.6

83.5

82.4

Foreign commercial banks (%)

8.6

7.2

8.3

11.6

11.3

13.4

16.5

17.6

Source: Bangko Sentral ng Pilipinas.

(p.275)

Table 8.9 Average Spreads and Rates of Return for Commercial Banks (%)

Spreada

Rate of Return

on Assets

on Equity

Pre‐liberalization (1987–94)

4.7

2.5

25.7

Post‐liberalization (1995–97)

4.3

2.2

18.8

Crisis period (1998–2000)b

5.5

0.6

4.7

(a) The spread is the difference between lending and deposit rates, adjusted for the gross receipts tax and changes in required reserves.

(b) Data for 2000 are as of June only.

Source: 1987–97: Lamberte (1999); crisis period: authors' computations.

of 2000, which placed a three‐year moratorium on the establishment of new banks. Although the moratorium did not extend to foreign banks, under RA 7721 they were in any case restricted to a maximum of six new branches. This effectively limits the options of foreign banks interested in entering the market to acquiring existing domestic banks.

To be sure, the moratorium is within the scope of prudential regulation allowed under the GATS, which recognizes the necessity for governments to implement measures to preserve the stability of the financial sector and, ultimately, the economy. Typical prudential measures of this type would include capital adequacy ratios, controls on market risk, minimum capitalization requirements, and disclosure and reporting requirements. Since the moratorium is not expressly designed to discriminate against foreign suppliers, it cannot be construed as a market access or national treatment barrier. Nor can it be deemed avoidance by the Philippines of its commitments under the GATS, since it will apply only for a limited period. Yet undeniably, the moratorium gives incumbents a reprieve from foreign competition.

Arguably, the intent of the moratorium is to curb the perceived problem of “over‐banking,” although it is not clear that the policy can avert the imminent failure of small and vulnerable banks. The stability of the banking system will continue to hang in the balance unless an orderly exit of inefficient banks can be arranged. It has been suggested that the financial market has become overcrowded to the extent that the viability even of efficient financial institutions is threatened. Although evidence for this claim is wanting, the rationale for the moratorium has hardly been questioned.

If the problem of overbanking is indeed real, then a less distortive response than trade protectionism is appropriate. One such response would be to raise the required level of bank capitalization. This would likely facilitate the consolidation of domestic banks, thereby helping to address concerns about the viability of individual institutions. Consolidation strengthens the competitiveness of domestic banks but does (p.276) not necessarily diminish competition if there is a real and pervasive threat of foreign competition. Thus the solution is not to foreclose entry, but to combine prudential regulation with a liberal trade regime.

8.5 A Regulatory Impasse

The challenges in telecommunications and banking may appear different, but the regulators in the two sectors are in a common bind that can rightly be said to be ubiquitous in services. One hurdle is to shake off the old policy paradigm reserving service sector activities for nationals. Apart from national sentiment in favor of protectionism, it should be understood that this paradigm was congenial to the nature of services in the past, when suppliers and consumers had to be in one place to effect a transaction. The technological impossibility of providing a service without a commercial presence lent some legitimacy to the paradigm. In banking, for instance, traditional regulation assumed the geographical location in the country of the financial institution offering the saving, loan, or investment service. Allowing a foreign bank to offer such services would have meant permitting a non‐citizen to operate on national territory. In telecommunications, voice signals had to be transmitted over land‐based infrastructure. If a foreign carrier had been allowed in, it would have been necessary to give it rights over the use of land. Consequently, the issue of accommodating foreign suppliers became a question of preserving the national patrimony.

When it became technically feasible to deliver services independently of geographic location, it also became impractical to continue to reserve their supply to nationals. It should have been a matter of course that old policy paradigms would be replaced by new ones more attuned to social and market conditions. But, in the case of services, the old paradigm was embodied in laws that could only be rewritten after a social consensus on the necessity for change had been reached.

To be sure, the Philippine government, through its commitments to the GATS, has made some progress in this direction. The allowable limits on foreign equity participation in telecommunications, banking, distribution, and insurance have been adjusted to allow some room for entry, although market opening has yet to be extended to such sectors as transport, business services, broadcasting, and education. Despite the progress that has been made, the policy of ensuring that majority control of services remains in the hands of Philippine nationals can still be found in new legislation.

Obtaining the social consensus required to amend laws that foreclose market access to foreign suppliers will be just as challenging as dealing with the market power of incumbents. With technological change, it is now possible to provide competitively many of the services that were supplied monopolistically in the past. Service regulators are caught in the dilemma of whether to give full play to new technologies at the risk of undermining the viability of incumbents.

In telecommunications, the regulator's decision on the extent to which it will allow the use of IP telephony will determine the fate of the incumbent. Liberalization (p.277) will mean entry of non‐facilities‐based carriers, hence lower call charges for consumers. But IP telephony will also facilitate the bypassing of the accounting rate, which serves as a funding source for PLDT. The choice between the incumbent's viability and consumer welfare would be straightforward if it were not for the fact that PLDT has been charged with the obligation of extending services to the poor.

The banking regulator faces a similar quandary. Should it allow cross‐border supply of banking services without requiring a commercial presence? A potent technology that may undermine the present market domination of domestic banks is internet banking. The OECD (1999, cited in Orbeta 2000) estimates that the savings to consumers from using internet banking could be as much as 89%. But here again the issue arises as to how much competitive pressure can be placed on incumbents without compromising the stability of the financial system.

This leads to a final point concerning the choice of liberalization strategy. Notwithstanding the provision in the GATS on pursuing progressive liberalization, decisions about the speed of reform are left to individual member economies. In the Philippines, such determinations are made at the sectoral level to ensure that a consensus can be built among constituents. Public acceptance of reforms is deemed critical. There is, however, a downside to this protracted, sectoral approach to liberalization as opposed to the more general approach of introducing reforms simultaneously in all sectors. Delays in introducing reforms in one sector can prevent another from reaping the benefits of liberalization. A case in point is the delay in introducing air transport reforms, which is perceived to be dragging down growth in the tourism sector.

There is also the issue of the unequal preparedness for reform of different regulators. The inability of some to deal with the internationalized and complex structure of their sectors is slowing down the pace of reform. Regulators may insist on postponing reforms until the sector's institutions have built up the capacity to handle a liberalized environment; worse, the regulatory framework may be so poorly designed that the potential benefits of reform remain unrealized. When regulators are given a reprieve, however, the difficulty lies in distinguishing between a real constraint on the readiness to pursue liberalization on the one hand, and a contrived excuse to delay reform on the other.

In Philippine telecommunications and banking, there is a compelling case for the regulators to focus on the task of catching up with the demands of a global network economy. Old development strategies (cross‐subsidies in telecommunications) and traditional instruments for influencing economic behavior (pricing and licensing in banking) must be re‐examined; the relevance of the regulatory framework must be checked constantly against a fast‐changing global market. One can only hope that the regulators in these two core industries will be able to spark positive reforms in other service sectors.

(p.278) Notes

(1.) The GATS defines limitations on market access in services as: (1) limitations on the number of service suppliers; (2) limitations on the total value of service transactions or assets; (3) limitations on the number of service operations or on the total quantity of service output; (4) limitations on the total number of natural persons that may be employed in a service sector or that a service supplier may employ; (5) restrictions or requirements concerning the types of legal entities or joint ventures permitted; and (6) limitations on the participation of foreign capital.

(2.) Distortionary domestic regulations that are removed from the context of trade liberalization are not dealt with in this chapter. Examples include interest rate controls in the case of financial services and universal service obligations in the case of telecommunications.

(3.) The main constraint is imposed by the subsidiarity principle embraced by the World Trade Organization (WTO) community. This principle provides that regulatory decisions are to be made at the lowest level of governance so that they can be designed to take account of social goals (Feketekuty 2000).

(4.) Only transactions between residents and non‐residents are recorded in the balance of payments. By convention, factors of production that have stayed in a country for more than one year are regarded as resident. Thus, the transactions of a foreign affiliate in the domestic market are not registered as trade flows if the affiliate has been in the country for more than one year. In similar vein, only transactions by natural persons during their first year of stay are included in the balance of payments.

(5.) The law allows a foreign ship to transport goods between two local ports only if no suitable domestic ship is available.

(6.) The long‐term lease of private land to foreign investors is allowed, however, for a maximum period of 75 years.

(7.) China, Taiwan, Pakistan, South Korea, and Indonesia are among the countries with a nil minimum capital requirement.

(8.) This section draws on Abrenica (1999a, 1999b, 2000).

(9.) Telephone density or teledensity refers to the number of main telephone lines per 100 inhabitants.

(10.) As of 1999, of the 188 member states of the International Telecommunications Union (ITU), 32% had introduced competition in basic services. Only 26% had opened their national long‐distance and international service markets to competition (ITU 1999a).

(11.) This information was provided by infrastructure staff at the National Economic and Development Authority, Manila.

(12.) In May 2000, a year ahead of schedule, Singapore sanctioned the entry of a new carrier, StarHub, in local services.

(13.) A universal service has the social goal of extending access to the telecommunications network to all members of society. It therefore calls for the building of a network that offers nationwide coverage, widespread affordability, and non‐discriminatory access (ITU 1998).

(14.) The Malaysian regulator, Jabatan Telekom Malaysia, was caught in the same dilemma of having to preserve the cross‐subsidy when introducing competition in national long‐distance and international services. To safeguard the subsidy, the new long‐distance operators were prevented from offering discounts of more than 20% of current tariffs.

(15.) Philippine law defines the principle of “timely and sufficient interconnection” as having points of interconnection that are “required, within [a] reasonable time frame, and in sufficient capacity and number to meet all traffic demands for conveyance of messages” (EO 59).

(p.279)

(16.) This refers to the practice of allowing competing operators to install transmission and switching equipment within the incumbent's switching centers.

(17.) These issues are raised in the position papers on interconnection issues submitted by new carriers to the regulator in 1998.

(18.) A draft bill on voice over IP prescribes that only telecommunications carriers should be allowed to offer IP‐based services.

(19.) Singapore was initially scheduled to liberalize its basic telecommunications services in April 2002. Until recently foreign equity in the sector was capped at 49%, with StarHub and SingTel holding exclusive licenses to deliver basic services until 31 May 2002. The government was forced to compensate the incumbents for their rollout, capital expenditure, and losses following the early termination of these licenses. One may view Singapore's accelerated liberalization as a strategic move to ensure its lead over rival Hong Kong in the race to earn the title of regional communications hub. Hong Kong permits 100% foreign equity.

(20.) RA 7042 lists the investment areas reserved for Philippine nationals, among them basic telecommunications services. The maximum allowable foreign equity for investments on the foreign investment negative list is 40%.

(21.) The cost of an international telephone call is determined by three basic elements: the international gateway switch (located in the country in which the call originates), the international transmission link (submarine cable or satellite link), and the onward extension to the end user (located in the country in which the call is received). These charges are aggregated into an accounting rate negotiated bilaterally between national carriers. The value of traffic in each direction is multiplied by the mutually agreed tariff or accounting rate to yield revenue that is divided (usually on a 50/50 basis) between the two international carriers. The share of the local carrier, also called the settlement rate, is one‐half of the accounting rate; in this case, $0.60.

(22.) The accounting system works well when the balance of traffic flow is within an acceptable range and international services are supplied monopolistically by both parties, but it is now under pressure. In a given settlement period, the carrier that receives more traffic than it sends receives compensation from the other carrier. The large traffic disparity in favor of developing economies has prompted developed economies such as the United States to bring down the settlement prices. Moreover, since some of the facilities and services required to complete an international call are now being supplied competitively, a carrier with access to a competitive market would want to purchase these services from a supplier other than the carrier to which the end user is connected.

(23.) The GATS defines a financial services as any service of a financial nature, broadly classified as insurance and insurance‐related services and all banking and other financial services.

(24.) The section draws on Intal and Llanto (1998b).

(25.) Commercial banks are composed of universal banks and regular commercial banks; thrift banks consist of savings banks, private development banks, and stock savings and loan associations. Universal banks are commercial banks with expanded functions. They may perform the functions of an investment house, invest in non‐allied enterprises, and own up to 100% of the equity of a thrift bank, rural bank, or allied financial or non‐financial enterprise. Publicly listed universal banks are allowed to own up to 100% of the voting stock of only one other universal or commercial bank.

(26.) The reform experience is discussed extensively in Intal and Llanto (1998b), Llanto and Lamberte (1998), Lamberte and Llanto (1995), and Lamberte (1993).

(27.) The central bank and the government shared responsibility for achieving the objective of promoting economic growth.

(p.280)

(28.) McKinnon (1973) and Shaw (1973) had challenged the repressive financial policies (such as interest rate controls) thought critical to spurring investment and growth in the post‐World War II era. They argued that financial liberalization would promote growth by stimulating greater efficiency in financial resource allocation and greater mobilization of savings.

(29.) The former Central Bank of the Philippines had sustained huge losses arising from its quasi‐fiscal responsibilities. Under the 1986 debt‐restructuring program introduced in the aftermath of the balance of payments and financial crises of 1983, the central bank was forced to assume the foreign exchange liabilities of a number of public and private firms. Massive losses in forward and swap transactions contributed to a severe weakening of the financial position of the bank.

(30.) The Philippine National Bank is now a private bank with a minority government shareholding.

(31.) These were Citibank, N.A., Hongkong and Shanghai Banking Corporation, and Standard Chartered Bank, which opened branches in 1945, and the Bank of America, which established a presence in the Philippines in 1947.

(32.) In their study of the impact of foreign bank entry into the domestic banking markets of 80 countries, Claessens, Demirguc‐Kunt, and Huizinga (1998) observed that high margins and profits reflected an absence of competition, while high overhead costs indicated a less efficient management and organizational structure. Amel and Liang (1997) reported similar results for their study of local banking markets in the United States.

(33.) These include savings deposits in tandem with life insurance, NOW accounts, and, more recently, COMBO accounts. NOW accounts are interest‐bearing demand deposits which can be withdrawn by means of a negotiable order of withdrawal (NOW). COMBO accounts combine the yield of a savings account with the payment efficiency of a demand deposit or current account. The demand deposit account is automatically replenished from the savings account whenever the balance falls below the required minimum balance.

Notes:

(1.) The GATS defines limitations on market access in services as: (1) limitations on the number of service suppliers; (2) limitations on the total value of service transactions or assets; (3) limitations on the number of service operations or on the total quantity of service output; (4) limitations on the total number of natural persons that may be employed in a service sector or that a service supplier may employ; (5) restrictions or requirements concerning the types of legal entities or joint ventures permitted; and (6) limitations on the participation of foreign capital.

(2.) Distortionary domestic regulations that are removed from the context of trade liberalization are not dealt with in this chapter. Examples include interest rate controls in the case of financial services and universal service obligations in the case of telecommunications.

(3.) The main constraint is imposed by the subsidiarity principle embraced by the World Trade Organization (WTO) community. This principle provides that regulatory decisions are to be made at the lowest level of governance so that they can be designed to take account of social goals (Feketekuty 2000).

(4.) Only transactions between residents and non‐residents are recorded in the balance of payments. By convention, factors of production that have stayed in a country for more than one year are regarded as resident. Thus, the transactions of a foreign affiliate in the domestic market are not registered as trade flows if the affiliate has been in the country for more than one year. In similar vein, only transactions by natural persons during their first year of stay are included in the balance of payments.

(5.) The law allows a foreign ship to transport goods between two local ports only if no suitable domestic ship is available.

(6.) The long‐term lease of private land to foreign investors is allowed, however, for a maximum period of 75 years.

(7.) China, Taiwan, Pakistan, South Korea, and Indonesia are among the countries with a nil minimum capital requirement.

(8.) This section draws on Abrenica (1999a, 1999b, 2000).

(9.) Telephone density or teledensity refers to the number of main telephone lines per 100 inhabitants.

(10.) As of 1999, of the 188 member states of the International Telecommunications Union (ITU), 32% had introduced competition in basic services. Only 26% had opened their national long‐distance and international service markets to competition (ITU 1999a).

(11.) This information was provided by infrastructure staff at the National Economic and Development Authority, Manila.

(12.) In May 2000, a year ahead of schedule, Singapore sanctioned the entry of a new carrier, StarHub, in local services.

(13.) A universal service has the social goal of extending access to the telecommunications network to all members of society. It therefore calls for the building of a network that offers nationwide coverage, widespread affordability, and non‐discriminatory access (ITU 1998).

(14.) The Malaysian regulator, Jabatan Telekom Malaysia, was caught in the same dilemma of having to preserve the cross‐subsidy when introducing competition in national long‐distance and international services. To safeguard the subsidy, the new long‐distance operators were prevented from offering discounts of more than 20% of current tariffs.

(15.) Philippine law defines the principle of “timely and sufficient interconnection” as having points of interconnection that are “required, within [a] reasonable time frame, and in sufficient capacity and number to meet all traffic demands for conveyance of messages” (EO 59).

(p.279)

(16.) This refers to the practice of allowing competing operators to install transmission and switching equipment within the incumbent's switching centers.

(17.) These issues are raised in the position papers on interconnection issues submitted by new carriers to the regulator in 1998.

(18.) A draft bill on voice over IP prescribes that only telecommunications carriers should be allowed to offer IP‐based services.

(19.) Singapore was initially scheduled to liberalize its basic telecommunications services in April 2002. Until recently foreign equity in the sector was capped at 49%, with StarHub and SingTel holding exclusive licenses to deliver basic services until 31 May 2002. The government was forced to compensate the incumbents for their rollout, capital expenditure, and losses following the early termination of these licenses. One may view Singapore's accelerated liberalization as a strategic move to ensure its lead over rival Hong Kong in the race to earn the title of regional communications hub. Hong Kong permits 100% foreign equity.

(20.) RA 7042 lists the investment areas reserved for Philippine nationals, among them basic telecommunications services. The maximum allowable foreign equity for investments on the foreign investment negative list is 40%.

(21.) The cost of an international telephone call is determined by three basic elements: the international gateway switch (located in the country in which the call originates), the international transmission link (submarine cable or satellite link), and the onward extension to the end user (located in the country in which the call is received). These charges are aggregated into an accounting rate negotiated bilaterally between national carriers. The value of traffic in each direction is multiplied by the mutually agreed tariff or accounting rate to yield revenue that is divided (usually on a 50/50 basis) between the two international carriers. The share of the local carrier, also called the settlement rate, is one‐half of the accounting rate; in this case, $0.60.

(22.) The accounting system works well when the balance of traffic flow is within an acceptable range and international services are supplied monopolistically by both parties, but it is now under pressure. In a given settlement period, the carrier that receives more traffic than it sends receives compensation from the other carrier. The large traffic disparity in favor of developing economies has prompted developed economies such as the United States to bring down the settlement prices. Moreover, since some of the facilities and services required to complete an international call are now being supplied competitively, a carrier with access to a competitive market would want to purchase these services from a supplier other than the carrier to which the end user is connected.

(23.) The GATS defines a financial services as any service of a financial nature, broadly classified as insurance and insurance‐related services and all banking and other financial services.

(24.) The section draws on Intal and Llanto (1998b).

(25.) Commercial banks are composed of universal banks and regular commercial banks; thrift banks consist of savings banks, private development banks, and stock savings and loan associations. Universal banks are commercial banks with expanded functions. They may perform the functions of an investment house, invest in non‐allied enterprises, and own up to 100% of the equity of a thrift bank, rural bank, or allied financial or non‐financial enterprise. Publicly listed universal banks are allowed to own up to 100% of the voting stock of only one other universal or commercial bank.

(26.) The reform experience is discussed extensively in Intal and Llanto (1998b), Llanto and Lamberte (1998), Lamberte and Llanto (1995), and Lamberte (1993).

(27.) The central bank and the government shared responsibility for achieving the objective of promoting economic growth.

(p.280)

(28.) McKinnon (1973) and Shaw (1973) had challenged the repressive financial policies (such as interest rate controls) thought critical to spurring investment and growth in the post‐World War II era. They argued that financial liberalization would promote growth by stimulating greater efficiency in financial resource allocation and greater mobilization of savings.

(29.) The former Central Bank of the Philippines had sustained huge losses arising from its quasi‐fiscal responsibilities. Under the 1986 debt‐restructuring program introduced in the aftermath of the balance of payments and financial crises of 1983, the central bank was forced to assume the foreign exchange liabilities of a number of public and private firms. Massive losses in forward and swap transactions contributed to a severe weakening of the financial position of the bank.

(30.) The Philippine National Bank is now a private bank with a minority government shareholding.

(31.) These were Citibank, N.A., Hongkong and Shanghai Banking Corporation, and Standard Chartered Bank, which opened branches in 1945, and the Bank of America, which established a presence in the Philippines in 1947.

(32.) In their study of the impact of foreign bank entry into the domestic banking markets of 80 countries, Claessens, Demirguc‐Kunt, and Huizinga (1998) observed that high margins and profits reflected an absence of competition, while high overhead costs indicated a less efficient management and organizational structure. Amel and Liang (1997) reported similar results for their study of local banking markets in the United States.

(33.) These include savings deposits in tandem with life insurance, NOW accounts, and, more recently, COMBO accounts. NOW accounts are interest‐bearing demand deposits which can be withdrawn by means of a negotiable order of withdrawal (NOW). COMBO accounts combine the yield of a savings account with the payment efficiency of a demand deposit or current account. The demand deposit account is automatically replenished from the savings account whenever the balance falls below the required minimum balance.