The pitfalls of Special Economic Zones

While SEZs generate foreign investment and employment they also deprive farmers of their land and
distort the economy

Eduardo Climaco Tadem

Published: 8:35:23am November 10, 2016
Updated: 8:39:7am November 10, 2016
For 17 days in December 2012, at least 120 farmers and indigenous Agtas from the towns of Casiguran
and San Ildefonso in Aurora province along the Pacific coast of northern Philippines marched 350
kilometers to Manila.

Their intent was to directly petition then President Benigno Aquino III to stop the implementation of
the Aurora Pacific Economic Zone and Freeport(APECO). The 2,923-hectares of APECO would dislocate
some 3,000 farmers, fisherfolk and indigenous people from their farmlands, fishing grounds, and
ancestral lands. President Aquino met with the marchers but fell short of granting their main demand,
instead offering compromise measures that left the marchers frustrated and angry.For 17 days in
December 2012, 120 farmers and indigenous Agtas from the towns of Casiguran and San Ildefonso in
Aurora province along the Pacific coast of northern Philippines marched 350 kilometers to Manila.

The past decades have seen a proliferation of special economic zones (SEZ) in the Philippines.

SEZs are meant to attract investments (mostly foreign) to contribute to the country’s economic growth
and generate employment. Situated mainly in the countryside, however, SEZs also take up vast tracts of
mainly agriculturally productive lands. In this manner, they encroach on farmlands cultivated by small
farmers and indigenous groups.

Government systematically takes over these lands without regard for the legal rights of peasant and
other rural families who have been toiling on them for generations.

SEZs have been the rage among governments and private investors in recent years. As enclaves of
economic activities, they are preferred by both foreign and local investors because of the various
incentives granted including tax, tariff, and regulatory perks which would otherwise apply in a non-SEZ
environment.

At the same time, the Economist noted that they also “create distortions within economies” and many
actually fail, “leaving a long trail of failed zones that either never got going, were poorly run, or where
investors gladly took tax breaks without producing substantial employment or export earnings.”
PROTESTING. Members of Task Force Anti-APECO gathered outside the senate in 2015 to demand the budget
of APECO be totally cut. File Photo by Gerard Lim/Rappler

SEZ attractiveness

In a 2011 World Bank publication, Thomas Farole and Gokhan Akinci see SEZ rules and regulation as
being more free-market oriented than prevailing national and sub-national prescriptions, the latter
being suspended within the confines of the SEZ.

They include generous tax holidays on income taxes and as much as 100 % on import and export duties,
unrestricted repatriation of profits, government provisions for infrastructure including roads, bridges,
utilities, and factory buildings.

In return for these incentives, governments usually merely require the payment of a minimal percentage
of an SEZ investor-locator’s gross income.

As a further incentive, governments normally relax laws that protect workers’ rights and welfare.
Specific types of SEZs include: free trade zones (FTZ), export processing zones (EPZ), industrial estates
(IE), free ports, urban enterprise zones, tourism zones (including medical tourism), technology parks,
and others.

From the very first modern SEZ established in Shannon Airport, Ireland in 1959, the number has now
grown to over 4,000 SEZs in 73 countries. An estimated 68 million people work in them. The number of
zones could top 5,000 before long.

SEZ track record

Farole and Akinci point out that SEZ’s track record has been a mixture of successes and failures.

Many SEZs “have been successful in generating exports and employment, and come out marginally
positive in cost-benefit assessments.” Evidence, however, has also surfaced of SEZs turning into virtual
“white elephants,” investors “taking advantage of tax breaks without producing substantial employment
or export earnings,” of unsustainable zones due to rising labor costs or loss of preferential trade access,
and failure “to extend benefits outside their enclaves or to contribute to upgrading of skills and the
production base.”
Success indicators have to be redefined, writes Lotta Moberg. The normal parameters of “employment,
FDI, export and production growth” and comparing these “to previous trends and to the rest of the
country” are inadequate and may be too narrowly-focused.

Moberg argues that “the existence of economic activity in an SEZ does not make it a net positive to the
economy” as its success may be due mainly to “an abundance of government subsidies” or is “located in
an area naturally disposed to high growth.”

Employment generated may prove to be insecure “since multinationals may be more prone than others
to relocate from an SEZ or restructure when their costs rise.”

Concerns were also expressed in 2008 by the World Bank’s Foreign Investment Advisory Services which
cite “poor site locations, uncompetitive policies, poor zone development, subsidized rent, cumbersome
procedures, inadequate administrative structures, and weak coordination between private developers
and governments in infrastructure provision.”

The Bank further emphasized that “maximizing the benefits of zones depends on the extent to which
they are integrated with their host economies” via “the development of backward and forward linkages
and not as enclaves where their economic impacts are suppressed.”

The Economist writes that, in addition to the foregone tax revenues, SEZs also “create distortions inside
economies, … (and) are increasingly a haven for money-laundering through, for instance, the mis-
invoicing of exports.”

The takeover by SEZs of large tracts of often productive agricultural lands can be viewed in the context
of a global phenomenon of land grabbing that has come to characterize land transformations in recent
years, including the conversion of peasant-controlled lands for commercial plantations and biofuel
production.

In Southeast Asia, a prominent case is that of the Dawei Special Economic Zone in Myanmar which, at an
area coverage of 196,000 hectares, is billed as the region’s largest industrial complex with a deep
seaport, industrial estate, and a 350-kilometer road network that ends in Bangkok.

The Amsterdam-based Transnational Institute estimates that 22,000 to 44,000 indigenous people in 20
to 36 Dawei and Karen farming villages will be displaced.

The Dawei Development Association has also criticized the project for widespread human rights abuses
of local villagers including land seizures, forced evictions, insufficient compensation for confiscated
farmland, and denial of their right to sufficient food and adequate housing.”

SEZs in the Philippines

Philippine special economic zones were established through Republic Act No. 7916, otherwise known as
"The Special Economic Zone Act of 1995" as amended by Republic Act No. 8748.

The Philippine Economic Zone Authority (PEZA) administers these zones as an attached agency of the
Department of Trade and Industry. Several incentives enjoyed by establishments operating within
Philippine SEZs include:

income tax holidays

zero % duty on importation of capital equipment, spare parts, and accessories

exemption from wharfage dues and export tax, impost or fees

the simplification of customs procedures

a tax of 5% of their gross income to the national government

As of May 31, 2015, a total of 326 SEZs have been operating in the Philippines.

Information technology parks lead the list with 216, followed by manufacturing zones with 68. Agro-
industrial zones have 21, tourism zones have 19, while medical tourism zones have 2. Compared to the
December 2012 number of 277 operating SEZs, there has been a 17.6% increase in the number of SEZs
in the Philippines.

Evaluating Philippine SEZs

Similar to the record of SEZs in other parts of the world, the experience of Philippine SEZs has been
mixed. Rosario Manasan, in a 2013 publication of the Philippine Institute of Development Studies (PIDS),
outlines both the positive and negative outcomes.

On the positive side, PEZA improved the competitiveness of the country’s investment climate through its
one-stop-shop model which reduces the cost of doing business and encouraging the establishment of
privately-operated SEZs.

While FDIs in the country declined by 13% yearly from 2006 to 2010, FDIs in SEZs grew by 23% yearly
in the same period.

Thus, PEZA’s share of total approved FDIs grew from 46% in 2000-2004 to 52 % in 2005-2010 while
manufactured exports from SEZs increased from $19.5 billion in 2001 to $28.9 billion in 2009, an annual
growth rate of 5 %.

In contrast, manufactured exports from non-SEZ firms declined by 9% yearly during the same period
from $9.1 billion to $4.3 billion.

Employment-wise, SEZ workers increased by 10% yearly from 2001 to 2010 or from 289,548 to
735,672, doubling their share of total employment from 1% to 2 %. A rise in skill levels among SEZ
workers was also noted particularly in the electronics industries with the rise in design and research
related jobs.

On the negative side, SEZ performance has been deficient as forward and backward linkages remain at a
low level thus preventing any “dynamic economic benefits.”

Manasan notes that locator investments have also been overly concentrated (90%) in the electrical and
electrical machinery sectors thus increasing the country’s vulnerability to external shocks.

The import-dependent nature of SEZ firms resulted in low-value added electronic products which are
mainly assemble electronic components while the processes and designs of original manufactured
products are done by the foreign-based mother company.

Manasan observes that Filipino firms in the electronic sector are merely subcontracted to undertake low
technology and low value-added operations.

Costs outweigh benefits

As with other SEZs in other Asian countries, Philippine SEZs “have costs that outweigh their benefits.”

Manasan cites the Bataan Export Processing Zone (BEPZ) where “its costs (consisting primarily of
infrastructure development costs) exceeded the benefits (employment and associated wage income of
workers in the ecozone, exports and associated foreign exchange earnings, local input purchases by
ecozone enterprises, and government revenues).”

In APECO, despite “government investments amounting to P2.9 billion in an airstrip, port improvement,
paving and rehabilitation of the Baler-Casiguran Highway, flood control, and other on-site
improvements, there were only 10 approved locators as of April 2013 and only 3 of them have started
doing business.” The APECO official website appears to be inactive and is silent on the number of
investor-locators.

As a tool for spurring and encouraging regional development, SEZs have also “been, almost without
exception, a failure” especially in geographical areas located far from developing regions and are of low
economic density.

To make matters worse, Manasan says that some SEZs have become conduits for smuggling activities
particularly in used automobiles. This has cost the Philippine government P58 billion in lost taxes from
2007 to 2009.

Overall, the tax holidays and other incentives have caused the government to give up P61 billion in
foregone revenues from just 29 % of reporting locator firms in SEZs in 2011 alone.

The social costs of Philippine SEZs have been equally disturbing.

A 2015 study by Ateneo de Manila University scholars, Jerome Patrick Cruz, Hansley Juliano, and Enrico
La Viña, point to aggressive giant property developers and special economic zones in almost all regions
of the country as leading a drive for “aggressive land use change of agricultural and forest lands” in what
has now become the most prominent form of land conversions and transformations.

Cruz, Juliano, and La Viña further report the displacements of Filipino rural communities from their
inhabited lands, and typically accompanied by human rights abuses such as intimidation, forcible
evictions and killings … all suggest(ing) that a more aggressive drive for commercially-linked land
seizures is now under way.”

As early as 1990, Sixto K. Roxas was convinced that the SEZ strategy is harmful to the overall
development of the Philippine economy because it is being planned and implemented at the expense of
agricultural development.

Alternatives

In order to become viable contributors to a national development that is sustainable and inclusive, SEZs
have to establish strong linkages with the local economies and be diversified in their product lines.

Incentives must be commensurate with the incomes they provide the national coffers and the costs
incurred by government. Planned SEZs must be the result of consultations with affected communities
and must not encroach on agricultural lands especially those covered by the Comprehensive Agrarian
Reform Program and tilled by small farm holders and the ancestral domains of indigenous peoples.

Pending an independent audit of SEZ performance in the country, there should be a moratorium on the
establishment of new SEZs.
While opposing the APECO project, residents of Casiguran and their support groups also proposed an
alternative vision of development, one based on “inclusive and sustainable agriculture by organizing
organic agriculture, microfinance, and disaster rehabilitation ventures.”

They have also been championing a form of development which begins by establishing a dialogue with
and respecting the rights of those whom it seeks to benefit.

The aim should be to heighten their capabilities as persons rather than treating them as passive and
incapable actors. – Rappler.com

Eduardo Climaco Tadem, Ph.D., is Professorial Lecturer in Asian Studies at the University of the Philippines
Diliman and President of the Freedom from Debt Coalition (FDC).

26 OCT 2018

10:00 – 13:00

XXIII

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SP E CIA L ECON OMIC ZON E S:

CH ALLE NG E S A ND O PPOR TUNITIE S
Special Economic Zones (SEZs) can be regarded as an investment in industrial
infrastructure and a services provider to attract and facilitate foreign investment, integrate
local firms into global value chains, promote export-oriented growth and generate
employment. For many countries, these zones are an important instrument
of socioeconomic development. They are widely deployed to kick-start industrial sectors
and to promote technology transfer to local economies and can contribute to improving the
overall investment environment, lowering transaction costs for FDI activities, increasing
the ease of doing business and streamlining administrative procedures, including the time
required to set up operations. According to UNCTAD’s estimate, there are now estimates of
over 4,800 SEZs worldwide and they are still front of mind for investment policymakers.

Despite the advantages and clear success cases, SEZs have a mixed record. The cost of
investments in zone infrastructure and maintenance in many cases outweigh the
benefits. Investors may also take advantage of tax breaks without delivering substantial
employment or export earnings. It often proofs difficult to extend benefits outside the
zones or to upgrade domestic skills and the production base. Many traditional export
processing zones have been successful in attracting investment and creating employment
in the short term but became uncompetitive when wages started to rise, or trade
preferences disappeared.
Moreover, SEZs today operate in an ever more challenging environment. Due to the new
industrial revolution (NIR) zones will need to rethink their competitive advantages, as the
importance of traditional locational advantages are eroding. At the same time, SEZs
will need to pursue business activities in a more socially and environmentally responsible
manner that advances the Sustainable Development Goals (SDGs). These challenges call for
a modernization of special economic zones.

In this session, organized in collaboration with FEMOZA, lessons learned for designing the
right infrastructure, facilitation services, and incentives, creating economies of scale and
promoting transfer of the latest technologies in the zones, will be shared and synthesized
for developing zone models that can be adopted and adapted to individual countries’
needs. It will specifically address challenges related to the modernization of SEZs, such as
those related to sustainable economic zones, strategic alliances, digitalization, domestic
and regional linkages and new sources of financing for innovation-driven zones, putting
theory into practice.

Issues for the debate:

 Best practices and lessons learned
 SEZs and the SDGs
 Modernizing SEZs
Background material:
Chapter III and Chapter IV of the World Investment Report 2018.

Special economic zones Not so special

The world is awash with free-trade zones and their offshoots. Many are not worth the
effort

Print version | Leaders

Apr 4th 2015
WHEN the first modern free-trade zone was established at Shannon airport in 1959,
few outside Ireland paid much attention. Now everyone seems to be an admirer of
“special economic zones” (SEZs) that offer a combination of tax-and-tariff incentives,
streamlined customs procedures and less regulation. Three out of every four countries
have at least one. The world now counts about 4,300 SEZs, and more are being added
all the time. Myanmar and Qatar have recently unveiled new ones; Indian officials call
their SEZ ambitions “revolutionary”; Shinzo Abe, Japan’s prime minister, announced
special strategic zones as part of his reform agenda.

Fans of SEZs can point to several success stories, none bigger than China’s zone near
Hong Kong, set up in 1980 and since dubbed “the Miracle of Shenzhen”. This was a
way to experiment with economic reforms that Chinese leaders were fearful of rolling
out nationwide in one go. Shenzhen attracted thousands of foreign investors, and the
policies tested there have spread to other cities. But the craze for SEZs suggests that
governments too often see them as an easy win: make an announcement, set aside
some land, offer tax breaks, and—hey presto!—deprived regions or struggling
industries are healed. If only it were that easy. Popular as they are, SEZs are often
flops (see article). Africa is littered with white elephants. India has hundreds that
failed to get going, including more than 60 in Maharashtra state alone in just the past
few years.
Nor are these efforts cost-free. The incentives offered to attract investors mean
forgone tax revenues (at least in the short term). They create distortions inside
economies, one reason why nationwide liberalisation is always better than patchwork
efforts. Zones are increasingly a haven for money-laundering through, for instance,
the mis-invoicing of exports. To ensure that these costs are more than offset by jobs
and investment, governments must learn from the failures.

First, offering nothing but fiscal incentives may help get a zone off the ground, but it
does not make for a lasting project. The most successful zones are entwined with the
domestic economy: South Korea, for example, has been good at fostering links with
local suppliers. Zones need to be connected to global markets. Improving
infrastructure for this purpose has a bigger impact on the success of zones than tax
breaks do. This often requires public spending to upgrade roads, railways and ports to
handle the extra freight. Lack of such investment has been the downfall of many an
SEZ in Africa. Lots of the continent’s new zones will fail for lack of a reliable power
supply or because they are too far from a port.

Second, the right balance has to be struck between adequate political oversight and
freedom from government bureaucracy. Too much interference from the centre
negates the opportunity to experiment. There are legitimate worries that Japan’s new
zones will fail because central-government officials reject ideas for deregulation for
fear of offending vested interests. Bringing in private developers to run zones may
help: that was done to good effect in the Philippines. Yet ambitious ideas for “charter
cities”—zones built around new urban areas with the power to set their own laws—
may be too close to setting up states within states.

Zoning out

The concept also has its limits. Export-focused zones work best in relatively low-end
manufacturing, and have the biggest impact when trade barriers are high (think
Bangladesh and clothing). China’s new zone in Shanghai, centred on financial
services, has roused limited enthusiasm—the piecemeal deregulation of activities like
foreign-exchange trading is hard to pull off and potentially destabilising.

If they encourage experimentation in otherwise sclerotic economies, SEZs can be

useful. The failure of some may seem a price worth paying, if you end up with a
Shenzhen-style blockbuster. But they require patience and planning, and they are
always inferior to nationwide reforms that cut trade barriers and boost
competitiveness. The countries that don’t need zones at all are the really special ones.

The Philippines: Special Economic Zones

Exploring the Philippines for Factory Relocation

As part of the broad assessment of production bases in Southeast Asia, HKTDC

Research has undertaken a recent field trip to the Philippines to assess the country’s
conditions and suitability for Hong Kong companies’ manufacturing relocation or
diversification. While the previous article, The Philippines: The Prospect for
Manufacturing Relocation touches on the Special Economic Zones (SEZs) this article
examines the SEZs specifically, along with location choices facing Hong Kong companies
contemplating factory relocation.

SEZs in the Philippines

The Philippines started developing SEZs in the mid-1990s in order to promote

investment, including foreign direct investment (FDI). Over the past 22 years Philippine
SEZs have become a magnet for FDI, especially in attracting manufacturing investment.
The Netherlands, Japan, Singapore, the US, and, more recently, South Korea, have
been the top sources of investment in the Philippine SEZs.

In the Philippines, manufacturing facilities are concentrated in central and southern

Luzon, by far the most developed parts of the country, where there is an abundance of
SEZs, including those converted from former the Clark Air Base and Subic Bay Naval
Base.
With President Duterte adopting a diplomatic shift towards China, closer economic co-
operation between the two countries is expected. The positive repercussions bode well
for increased trade and investment from China in coming years, particularly in light of
the latter’s Belt and Road Initiative. This may tie in well with the Philippines’ ongoing
plans to accelerate infrastructure development, that is, President Duterte’s ‘Build, Build,
Build’ programme, with an expected rise in Chinese investment in Philippine
infrastructure projects.

PEZA - the SEZ Management Body

The Philippine Economic Zone Authority (PEZA) is the government agency mandated to
develop, manage and promote SEZs to attract investment, both local and overseas. As
of April 2017, there were 366 economic zones across the Philippines, of which 74 were
manufacturing zones. It is estimated that PEZAapproves more than half of the
Philippines’ inward FDI every year. In perspective, more than 40% of the FDI in 2016
went to the manufacturing sector.
As a government agency, PEZA identifies and tenders sites for SEZ development across
the country. Investors can rent slots in economic zones on long-term leasehold for 50
years, which can be renewed after expiry. PEZA is now looking to allow 99-year land
leases for SEZs to be on par with other ASEANcounterparts, such as Vietnam.

Alternatively, manufacturers or private land developers can identify and develop

suitable locations. Thereafter, they can apply for PEZA status in these privately
developed sites. In turn, eligible SEZ tenants need to register with PEZA to gain access
to the incentives and special customs status.

Inside a privately developed industrial park

in Cavite with PEZA zone status.

PEZA offices are set up in privately

developed SEZs.

Full foreign ownership is granted to export-oriented operations in the SEZs, with the
requirement that at least 70% of the output has to be exported. Businesses serving the
domestic market are limited to 40% foreign ownership, except for businesses qualified
for pioneer status and with a minimum equity of US$200,000[1]. Financial incentives
are offered in the SEZs to attract investment as outlined below.
 Investment Incentives Offered in SEZs

 Income tax holidays, generally for 4-6 years, capped at 8 years

 Special tax rate of 5% on gross income

 Tax and duty-free import of capital equipment, spare parts and supplies

 Tax and duty-free import of raw materials and supplies used in export

 Zero value-added tax

Other non-fiscal incentives available in economic zones include simplified import and
export procedures and assistance in arranging employment visas for non-resident
foreign nationals working in the zones. This is largely in line with industrial or economic
zones found in many other countries in Southeast Asia.

SEZs as the One-Stop-Shop for Investment

HKTDC Research was invariably in our meetings in the Philippines told that PEZA was
the recommended window for foreign investors to enter the Philippines. PEZA serves as
the body to align all government interfaces involved in the set-up and daily operations
of businesses.

Generally speaking, foreign investors have to register and apply for permits through at
least eight to 10 government departments when setting up a business in the
Philippines. While the country’s extensive bureaucracy could be frustrating and
resources-draining, PEZA provides guidance on the investment application process and
mediates in the process if needed.

As an aside, the popularity of President Duterte owes much to the perception that he is
acting tough to weed out corrupt practices and shake up bureaucracy in the Philippines.

While developing privately owned sites may enjoy the benefit of picking the preferred
locations, along with higher flexibility in the desired mix of industry sectors and land
use, such an approach cannot sidestep prior dealings with local government nor ignore
the interest of people living in the vicinity. The red tape involved in the process can be
intimidating and a local partner is essential, particularly if the investment areas contain
an element of serving the domestic market with more than 40% of company output. In
contrast, those developed SEZs listed under PEZA provide a ready-made option for
foreign investors. Renting slots in listed SEZs is especially suitable for SMEs with limited
resources.

SEZ in Focus: Clark Freeport Zone

Developed SEZs like the Clark Freeport Zone (CFZ)offer a one-stop-shop option for
foreign investors. CFZdevelopment started in 1995 as part of a reconstruction
programme after the catastrophic volcanic eruption of Mount Pinatubo in 1991.

The CFZ, some 60km northwest of Metro Manila, was developed from the Clark Air
Base formerly used by the US, with ready transport links, infrastructure and utilities
available for development and expansion. Part of the CFZ is designated as a SEZ for
manufacturing and services investment.

The CFZ has had an accumulated investment of PHP121 billion (around US$2.5 billion)
since it started operations. Not surprisingly, the CFZ is now regarded as an economic
zone development model in the Philippines.

Factory premises in the Clark Freeport

Zone.

Inside a garment factory in Clark Freeport

Zone.

The CFZ has an advantageous location for manufacturers’ supply chain management. It
is within two hours drive from Metro Manila, the business and logistics hub of the
Philippines. The Port of Subic (POS) is also less than two hours’ drive for shipment of
raw materials and finished products. The Clark International Airport (CIA), which runs
both international passengers flights and cargo flights, is within 10 minutes’ reach from
the SEZ area by car.
As Metro Manila’s roads, airports and port are all notoriously congested,
the CIA and POS offer manufacturers the big advantage of bypassing the Metro Manila
traffic. Meanwhile, the Philippine government is promoting a ‘dual airport’ model with a
plan to expand services and usage of CIA to ease traffic at Manila’s Ninoy Aquino
International Airport. Shipments are also gradually shifting to POS due to the
congestion in Port of Manila. Looking to the future, the Subic-Clark Cargo
Railway project is a priority infrastructure plan. The flow of goods
between Clarkand Subic is expected to be further enhanced in the future.

Unlike any typical brownfield development for industrial use, the CFZ is a greenfield
project that promotes the zone as a place to work, live and play. Comprehensive
community and leisure facilities, such as sports ground, restaurants, shops, clinics,
international schools and golf courses are all available within the zone. Schools in the
area also work with the Clark Development Corporation and businesses to provide
relevant vocational training for businesses operating in the zone.Expatriates working in
the CFZare offered a pleasant living environment.

However, this development model places restrictions on the industries allowed in the
zone. The zone is designated for low-pollution light manufacturing, such as electronics.

Labour-intensive operations are especially welcome as the government is keen to drive

local employment through manufacturing. Nonetheless, investors should bear in mind
that Philippine wages are towards the upper end of ASEAN pay, as described in The
Philippines: The Prospect for Manufacturing Relocation.

Green environment in the Clark Freeport

Zone.
 Golf course in Clark.

Due to its advantageous geographical location and good infrastructure, the CFZ is much
sought after by local as well as international businesses, with high occupancy reported.
To meet continual demand, the Clark Green City project had been launched, developing
a new zone of over 9,000 hectares north of the existing SEZ. It is planned as an urban
satellite town, with local employment driven by services and manufacturing in the Clark
Green City.

Summary

The Philippines is gearing up to compete with other ASEAN manufacturing hotspots for
a share of foreign investment, banking on its proven formula of helping foreign
investors identify or develop SEZs, along with filling SEZ-based factories with skilled,
English-speaking workers. As Sino-Philippine relations begin to improve, it is expected
that Chinese investment in both manufacturing and SEZ development will increase.

BPO firms’ perks to stay under tax reform package, says

DOF
Ben O. de Vera - 2 years ago
FILE PHOTO
The Department of Finance (DOF) on Friday said business process outsourcing
(BPO) companies need not worry about the government’s first tax reform
package as they will continue to enjoy a number of fiscal perks so that the sector
can sustain robust growth.

In a statement, the DOF said foreign services of BPO firms operating within
special economic zones (SEZs) will stay value-added tax (VAT)-exempt;
meanwhile, those outside SEZs, especially those who had been registered with
the Board of Investments, will keep their zero-rated status.

In particular, Finance Undersecretary Karl Kendrick T. Chua said that the

proposed first package of the Duterte administation’s comprehensive tax reform
program dubbed Tax Reform for Acceleration and Inclusion Act (Train) aimed
“to limit the zero VAT rating to exporters and remove such a preferential
treatment similarly accorded to suppliers of exporters, or what are referred to as
‘indirect exporters.’”

“The fear that the Philippine BPO industry will lose its competitiveness because
of the proposed tax reform has no basis. Certain industry stakeholders are likely
misinterpreting the provisions of the bill. There is no change in tax policy here for
exporters,” Chua said.

READ: BPOs face tax perk removal

The Finance official said they have no plans to change the status quo wherein
receipts from domestic services were slapped with 12-percent VAT. “This has
already been the case even before we proposed the Train bill,” he said, referring
to House Bill No. 5636 approved by the Lower House before Congress went on
sine die adjournment in May.

According to Chua, “receipts from foreign services within the SEZs of the
Philippine Economic Zone Authority will remain VAT-exempt, as is the case
now, because they are outside customs territory by legal fiction, or zero-rated if
the exporters are outside the special economic zone, including those that are BOI-
registered.”

“As for exporters outside SEZs, they are zero-rated on VAT payments and are
entitled to get back their VAT payments once they apply for such refunds under
the proposed 90-day refund system, while all other taxpayers, including suppliers
to exporters will have to pay the VAT,” Chua added.

Chua said the first tax reform package “provides that the zero-rated VAT
privilege of indirect exporters will be removed only ‘if and when a credible and
enhanced system is put in place’ that will allow affected companies to get cash
refunds of their VAT payments within 90 days after their filing of VAT refund
applications with the Bureau of Internal Revenue.”

“The concerns raised by the BPO sector against tax reform appear to be
misplaced. They will remain competitive as demand for their services are driven
 by the high quality of service and talent they offer. The tax policy in the BPO
sector will remain the same even after Train,” according to Chua.

The Philippines' business process

outsourcing sector expands into high-
value services
PhilippinesEconomy
Overview
View in online reader

Rarely has a new industry traced the trajectory from concept to prime economic driver
as quickly as business process outsourcing (BPO) has in the Philippines. In a very short
time span, BPO has grown from a handful of contact centres to a global back-office
resource hub and call-centre capital of the world, drawing jobs and investment from all
corners of the globe along the way. In fact, if the BPO sector sustains its annual
average growth of 15-18%, it could soon surpass the annual $25bn in revenue
contribution made by remittances from overseas Filipino workers (OFWs).

History
The Philippine BPO success story trades on many of the country’s key advantages, but
two are of prime importance. First, it is unlikely the BPO industry would be the
powerhouse it is today without a human resource (HR) base made up of a youthful,
95% literate population, armed with good communication skills – crucially, proficiency
in American-accented English. Second, without the 1995 establishment of a special
economic zone (SEZ) offering tax incentives and low rates on leases to call-centre
operators, the industry might have faltered or failed to take root.

The importance of the latter factor is clear from its early history. Just two years after
the SEZ was established, it attracted its first multinational, Sykes Asia. The industry
began to gain traction swiftly after this, attracting both the forerunners to and the
current who’s-who of the BPO industry in the Philippines. The country’s first outsourcing
facility began operations in 1999, when the HSBC-owned Cyber City opened at Clark Air
Base, a former US air force base, now an international airport and free zone. That same
year, eTelecare, the country’s first call centre, was established. Two years later, US firm
PeopleSupport moved its operations – and 8400 jobs – to the Philippines, and ePLDT
Ventus, a subsidiary of the Philippine Long Distance Telephone Company (PLDT), was
founded. ePLDT Ventus would go on to launch the country’s first data centre, spurring
development of the thriving data-driven IT-BPO industry that leads its economy today.
In 2000, Sitel opened its Philippine operations, eventually expanding to nine offices in
the country. Finally, in 2003, the Ohio-based Convergys Corporation joined up with two
call centres; it now operates out of 35 offices in the Philippines. By 2011, BPO had
become one of the Philippines’ leading private-sector employers, generating some
$11bn in revenue and employing 638,000 Filipinos.

Economic Impact
The BPO sector’s contribution to GDP has risen in tandem with the number of
companies setting up operations in the country. The industry accounted for just 0.075%
of GDP in 2000, rising swiftly to reach 2.4% in 2005, 4.9% in 2011, and 5.4% in 2012.
Its estimated GDP contribution was 6% in 2015, with expectations that it could
contribute up to 9% of GDP in 2016, according to the IT and Business Process
Management (IT-BPM) Roadmap for 2012-16 published by the industry group IT and
BPO Association of the Philippines (IBPAP).

A steady upward trend has continued in the industry’s record for revenue generation.
According to industry analysts, revenue from the country’s BPO industry grew 10-fold
from $1.55bn in 2004 to 15.5bn in 2013, reaching an estimated $18bn in 2014. In its
IT-BPM Roadmap for 2012-16, the IBPAP forecasted that annual revenue from the IT-
BPM industry could more than double from $9bn in 2010 to $25bn in 2016, a 10%
share of the global market. Meanwhile, property consultancy CB Richard Ellis (CBRE)
projects BPO revenue could double to $50bn by 2021.
Going from strength to strength, the BPO industry’s record for job creation has
experienced a similar rise, from 101,000 employees in 2004 to 900,000 in 2013.
Indeed, IBPAP projects that 372,000 new jobs will have been created in the BPO
industry between 2014 and 2016 and has targeted an employment figure of 1.3m
Filipinos by 2016. Furthermore, IBPAP estimates that the number of BPO employees
could reach 3.3m in 15 years, while CBRE projects the BPO industry will add 105,000
employees every year.

“The Philippine BPO sector will continue to thrive in the coming years,” Rick Santos, the
chairman of CBRE Philippines, told the local press in October 2015. “The country
provides a conducive environment for foreign investors – an excellent pool and low cost
of skilled labour, outstanding customer service, a quality destination and one of the
cheapest rental rates and highest yields in Asia.”

In terms of total revenue, employment and export sales, voice-centric services such as
call centres still dominate the BPO industry in the Philippines. But there are indications
that the industry is already expanding into the next level of outsourcing: knowledge
process outsourcing (KPO). KPO comprises back-office services such as health care
processing and coding, legal transcription, IT outsourcing, and animation and game
development. Additional services such as data analytics, business and financial
research, mortgage servicing, software development, legal process and patent research,
and engineering comprise many rich seams of potential KPO employment opportunities
that are already attracting the attention of multinationals and OFWs. Indeed, the future
of the industry may have already arrived in the form of KPO, which is already employing
about 200,000 Filipinos (see analysis).

Workforce
The country’s higher education institutions produce 500,000 English-speaking college
graduates per year, providing a steady supply of potential BPO employees with skills
matched to industry needs. This equips the BPO industry with a key advantage over its
main competitor, India. Indeed, a 2015 study by the Philippine Institute for
Development studies found that the Philippines produces one suitable graduate for
every two produced in India.

To ensure the sustainable growth of this supply of skilled workers for the industry,
IBPAP, in concert with the Commission on Higher Education (CHE), created the Service
Management Programme (SMP). A specialised course for students studying for careers
in business administration, management or IT, SMP is designed to assist students in
acquiring the skill sets required to gain an entry-level position in the IT-BPM industry.
Included in the SMP is the “train the teachers” programme, which ensures the
development of a critical mass of teachers trained for proficiency in teaching IT-BPO
subjects to meet the IT-BPO industry’s standards. Since 2013, SMP has been rolled out
across 17 state universities and colleges, and it has been expanded to private
universities as well.

Looking beyond the BPO industry’s labour requirements to those of KPO, it is clear that
students desiring a career in KPO will have to develop a different and enhanced set of
skills for the KPO industry to have the steady source of human capital that BPO already
has. Key here is having an informed student populace, because the choices students
make about what to study will determine whether they can provide the additional skills
demanded by KPO.

The good news is that many students already base their decision of what to study on
the type of career they hope to enter when they graduate, as well as the number of
employment opportunities available in each sector. Studies show that currently, more
than half of Filipino graduates have earned medical degrees in areas such as nursing,
while engineering, IT, business, accounting, and related fields make up another 40%
together. These are all skill sets that will be very much in demand as KPO gets under
way.

Services Expanding
Multinationals have shown strong interest in setting up shared services offices in the
country. Shared services are a system under which the operation and administration of
an organisation’s specific operational tasks – such as accounting, payroll, HR, legal and
IT – are rolled into one entity, and in this case it is off-shored to save on costs. CBRE
has named banking firms such as HSBC, Standard Chartered, Capital One, Citibank, and
JP Morgan, as well as enterprise solutions and software firms like Accenture, Oracle,
Microsoft and Dell as among those interested in expanding their BPO operations in the
Philippines to include shared services. Non-voice BPO operations are also coming in for
more demand. While the US has been the major export market for Philippine BPO firms
as well as the major country of foreign investment in the Philippine IT-BPO sector, most
of its demand has been for call centre (voice) BPO. However, demand from Japan and
the EU has been increasing, mostly in relation to animation and software development
services.

Top Of The Charts

Although India remains the overall leader in many global BPO rankings, according to
consultancy Tholons’s “Top 100 Outsourcing Destinations” report, Manila was the
number-two outsourcing destination for call centres (after Bangalore but ahead of
Mumbai, Delhi and Chennai) in 2014, and Cebu was number eight. The 2014 A T
Kearney Global Services Location Index ranked the Philippines seventh place, up from
ninth the previous year, calling its industry a “powerhouse” and “one of the most
sophisticated in the world,” and its qualified labour force “one of the deepest.” It sees
the Philippines’ BPO industry “expanding into higher value-added voice services as well
as into IT and BPO offerings”.

Meanwhile, Cushman Wakefield’s BPO and Shared Service Location Index placed the
Philippines second (after Vietnam) in its 2015 index. The index is weighted to evaluate
and measure each country’s relative cost, risk and quality. Because cost is a prime
determinant for many companies’ decisions about where to locate their BPO offices,
countries that scored well on costs appear in the top half of the index, making the
Philippines the second most price-conscious choice.

Manila & The Next Wave Cities

Office rental prices are on the rise in some of the most attractive business areas of
Metro Manila, such as Makati and Cebu, where almost 70% of BPO service providers
are located. Real estate services firm KMC MAG Group has projected growth of 5-7%
for rents and capital values in Metro Manila in the year to September 2016. According
to KMC MAG, Metro Manila’s financial district, Bonifacio Global City (BGC) will supply
half of the 2m sq metres of new office space in the market until 2018, with a 3-5%
increase in BGC’s rents and capital values occurring over the year to September 2016.

Because the outsourcing industry is so price-sensitive, any increase in rental prices has
the potential to adversely affect the industry’s critical need to provide a prime location
for outsourcing based on a positive ratio of cost (such as office rents) to quality
(availability of a skilled labour pool). In addition, the various natural disasters regularly
experienced by the country make it strategically wise to distribute operations across the
country: if a flood cuts the power in Manila, for instance, it will likely still be on in Cebu.

Given these considerations, the industry is proactively laying the groundwork to expand
into alternative locations, dubbed the Next Wave Cities. These include Baguio, Bacolod,
Clark, Cavite, Cagayan de Oro, Davao, Iloilo and Laguna. Outside of Manila, a wealth of
talent exists, in addition to the benefit of lower rental prices. This includes but is not
limited to engineers in Pampanga, finance and accounting agents in Laguna, and
medical professionals and practitioners across the provinces of Visayas and Negros, all
of whom have the potential to help diversify and develop the industry from BPO to
higher-paying, value-added, knowledge-intensive services. Alfredo Marañon Jr,
governor of Negros Occidental, told OBG, “Increasingly, the services sector has been a
major driver for economic growth, diminishing the dependence of a province like
Negros Occidental on agriculture. The strong conversational English capability and
lower price point has generated a lot of interest for BPO players willing to move away
from the saturated Metro Manila and enjoy lower attrition rates in key provinces and
cities, provided – as we are doing in Negros Occidental – that the adequate
infrastructure, human resources and local government support are put in place.”
New Rules
Two key legal acts have underpinned the positive legal and regulatory atmosphere in
which the IT-BPO industry operates, reinforcing the Philippines’ reputation as a secure
and reliable offshoring destination and boosting investor confidence. One of these, the
Data Privacy Act of 2012, penalised the unlawful use and disclosure of personal
information collected by the government and the private sector. The act aligned privacy
standards with those of the Asia-Pacific Economic Cooperation Information Privacy
Framework and European Parliament.

The other, the Cybercrime Prevention Act of 2012, provided the legal framework and
resources to identify, prevent and impose punishment for internet-based crimes, adding
another level of protection against online theft and fraud. This is particularly relevant to
the IT-BPO industry because, as a rule, these companies use the internet and computer
technology to carry out their operations. The BPO industry benefits from the law’s
provisions on protection for data, devices and systems as well as the penalties incurred
by cyber-criminals for computer-related offenses.

ASEAN Integration
Integration into ASEAN presents the country’s IT-BPO sector with a unique opportunity.
With some help from the government and the education system, the sector could find
itself at the forefront of the country’s contribution to economic integration and growth
in ASEAN through cross-border trade of IT-BPO services. Although proficiency in the
English language has been a key component of the country’s success in BPO, it could
present an obstacle as the Philippines prepares to integrate into and enter ASEAN
markets. In few other ASEAN nations is English so widely spoken, and none speak it so
widely or so well as Filipinos. So when it comes to providing BPO and other outsourcing
services to ASEAN nations such as Cambodia, Thailand or Vietnam – or providing BPO
services to multinationals operating in many countries and wishing to consolidate their
operations in one place – Philippine BPOs could lose their competitive edge. However,
there is a potential upside to this as well. “We are already known as a call centre capital
of the world, we already have the expertise, so a lot of companies are saying, ‘We’re
doing this in my North American operations; why don’t we do it in our Asian operations
and consolidate in one location? … Logically we can do it in the Philippines,” Jose Mari
Mercado, the president of IBPAP, told local press in June 2015. “With the ASEAN
integration, it will be easier for us to attract Thai-speaking agents to come to the
Philippines and be part of the workforce here.”

In October 2015, Mercado took the regional shared service facilities concept further,
telling reporters there could be an opportunity in offering a multi-language BPO
platform and suggesting that the CHE could help the industry by deciding which ASEAN
language the Philippines’ schools should concentrate on teaching in order to provide the
best BPO service. “The opportunity is there from an attractiveness perspective in terms
of location, but the challenge is we don’t have the language capabilities,” Mercado said.

Sector insiders think that integration can only spell better times for the Philippine IT-
BPO sector. “With ASEAN expected to grow by $2.78trn in 2017, the integration will
only ramp up activity and interest in BPOs. There is a wealth of opportunity for the
Philippines to establish its seat with the top economies given the growing middle class,
robust domestic consumption, rising retail activity, and sustained growth in
manufacturing,” Santos told local press.

Slow To Load
One issue on which everyone in the industry agrees is that the country’s internet access
speeds are not fast enough to sustain the industry’s growth. The country’s connectivity
speed ranked 21st among 22 Asian countries and 176th out of 202 total countries as of
May 2015, according to the Net Index report, an index of web connectivity published by
internet metrics company Ookla. The average download speed was 3.64 Mbps, far
below the world average of 23.3 Mbps. Recognising that poor internet connectivity
could act as a drag on investor confidence in the sector, lawmakers have filed a bill
requiring telecoms firms and internet service providers to provide a minimum
connection of 10 Mbps for mobile broadband and 20 Mbps for fixed wireless broadband
access. Companies failing to provide these speeds would incur fines of up to P2m
($44,400).

Outlook
BPO shows no signs of dimming in the near future. As long as the government
continues to provide a supportive business and regulatory climate, the education
system continues to educate appropriately skilled workers, and the industry invests in
building for the future, there is no reason why IT-BPO should not meet or exceed its
targets.

Fixing the one major problem – the country’s slow and expensive internet infrastructure
– should not amount to an insurmountable obstacle, Greater connectivity will lead more
and more businesses to consider relocating to the Philippines. Updating this network
will provide benefits and value not just to the BPO sector but to the economy and
society at large.

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David Rizzo, Asia Pacific President, Teleperformance: Interview