Make trade, not war

Despite political tensions, economic relations between China and the Philippines are closer than ever before. The challenge is to move toward a win-win future.

Despite tough rhetoric across the South China Sea, bilateral economic cooperation between the two nations has increased dramatically.

Meanwhile, Philippine growth is attracting visits by influential Chinese trade delegations.

How could the growth leaders of East Asia and Southeast Asia foster a win-win future?

Deeper economic ties

Between 2000 and 2010, the destinations of Philippine exports changed. Overall, the share of exports to the United States was halved to under 15 percent. Meanwhile, exports to China soared more than five-fold, from 2 percent to 11 percent. In the process, Philippine exports have benefited from rising demand from China, which has become an important trade partner—almost as critical as the eurozone.

Over the past decade, the Philippines has developed tighter supply-chain linkages with China in electronics, particularly semiconductors. China’s share has increased in the intermediate goods exports of Asean economies, including the Philippines. Conversely, a slowdown in China will affect the Philippines through lower demand for intermediate goods from the electronics sector.

An important symbolic milestone was passed in the Philippines as business process outsourcing (BPO) exceeded the value of remittances flows. Meanwhile, diversification has been accelerating into non-electronic exports. In turn, these developments have contributed to the evolving shift in the Philippines from low-wage and low-skill services to labor-intensive manufacturing and high-value services.

Business environment

During recent visits to the Philippines, I have heard many arguments about rising domestic cost-competitiveness. However, the latter does not match realities in mainland China—at least not yet.

The rising costs of labor in China do not simply translate to relocation of jobs to the Philippines.

As Arthur Tan, CEO of Integrated Microelectronics Inc. put it recently: “Labor cost is just one variable.”

The electronics manufacturing unit of Ayala operates five factories on the mainland. Even if labor costs in China would continue to increase at a double-digit pace (which is less likely in the future), manufacturing costs there may remain lower in comparison to the Philippines, due to the lower price of electricity and the advanced supply chain.

In the past half-decade, the production cost differential between China and the Philippines has been halved to 15 percent.

However, it could improve if China would cut power costs and manufacturing facilities move to lower-cost locations.

Nonetheless, relocation is seldom motivated by labor cost alone. You really have to incorporate into the assessment the entire industrial ecosystem and the overall business environment.

Even more importantly, with the shift of China’s growth model, the very context of competition is changing in the mainland. The associated changes could benefit both China and the Philippines.

FDI deal

According to China’s Ministry of Commerce, foreign direct investment (FDI) to China fell 3.7 percent to $111.7 billion in 2012.

Abroad, this decline was portrayed as a sign of rising costs in China and new alternatives elsewhere. It is a compelling story—but flawed.

Data from China’s Ministry of Commerce show that new projects from abroad are being captured, but the data ignore reinvested earnings from foreign companies that already operate in the mainland (which are included in the central bank data).

While the number of new investment projects suggests relative decline, the volume of reinvested earnings indicates that existing multinational operations are actually expanding in China.

In effect, the mainland is now the world’s top destination for FDI flows, according to recent UN data.

As China moves higher in the value-added chain, FDI to manufacturing has stagnated in the mainland, but FDI to services is soaring.

In the past, most FDI was concentrated on the first- and second-tier cities. Now it is shifting to other tiers of megacities, the inland and the west.

Today, emerging Asia—including and especially the Philippines—can benefit from these low-cost advantages, as China once did.

Just as textiles has already begun to migrate from Guangdong to South and Southeast Asia, other low-margin industries might soon follow—even if the new locations in emerging Asia cannot compete with China’s scale, logistics and infrastructure.

Meanwhile, Chinese foreign investment is also relocating regionally, seeking cost efficiencies, asset and resources—and worldwide as evidenced by record deal volumes in both the United States and Europe in 2012.

These FDI flows are no drops in the ocean. According to current estimates, Chinese FDI abroad could total $1 to $2 trillion by 2020.

Preconditions for a win-win

With its increasing electronics capabilities, expansive information and communication technology industries, and English-speaking workforce, the Philippines has significant potential to benefit from the new deal in FDI within China and in emerging Asia.

The bilateral gains will not occur automatically, however.

While neither Manila nor Beijing can be expected to compromise over what each perceives as its core interest, both acknowledge the advantages of peaceful economic cooperation. From the Chinese perspective, the Philippines, despite its many attractive qualities, is one of many nations competing for Chinese FDI. Further, political friction creates potential for uncertainty, which translates to rising risk.

From Manila’s standpoint, the challenge is to defuse political tensions by instituting mutually acceptable negotiating mechanisms. This is vital to ensure that the two nations can deepen their trade and investment ties—even as they agree to disagree on many strategic issues.

Growth and prosperity do not materialize as a result of political friction and economic isolation. What these two great nations need is increasing bilateral engagement and cooperation.

It is this kind of a win-win that can contribute to the change of growth model in China and to the full industrial takeoff in the Philippines.

In addition to his consulting/advisory activities, Dr. Dan Steinbock is the research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China).