Use and Perceptions of AFTA

The importance of AFTA for Philippine firms can broadly be attributed to the fact that AFTA is the oldest implemented FTA in the country and connects exporters to regional production networks. Given the prominence of AFTA in the Philippines' trade policy, assessing its utilization rate by firms is fundamental to understanding the agreement's impact. This section sheds light on the first key question regarding whether or not firms use AFTA, by looking at broad patterns of use and supplementing the findings with an econometric analysis based on a set of firm characteristics predicting utilization. The influence of AFTA and other FTAs on Philippine firms that use or plan to use these agreements is also discussed by examining the responsiveness of firms in changing their business plans in response to FTAs.

3.1 Patterns of Use

20% of Philippine firms use AFTA. With 31 firms reporting using or having used AFTA, the results revealed higher than expected utilization rates (earlier studies reported much lower rates of use).⁸

41% of Philippine firms plan to use FTAs. Looking ahead, the overall FTA utilization rate is expected to increase dramatically. At least 63 firms (40.7% of all firms) stated that they plan to use AFTA or recently implemented and/or soon to be signed FTAs. Reflecting the growing interest in the Chinese market, the ASEAN-PRC FTA is becoming a priority agreement for Philippine firms and reflects a perception that the PRC is more of a market opportunity than a threat. While, at the time of the survey, only one firm reported using the ASEAN-PRC FTA and three firms that they plan to use it in the future, firm interviews showed that the ASEAN-PRC FTA ranks among the most important FTAs. Later, Section 3.3 will illustrate how firms in the food sector are eyeing strategic and emerging markets covered by FTAs, particularly the ASEAN-PRC FTA. Other FTAs that are regarded as important to business are JPEPA—which had not yet taken effect at the time of the survey but was generally viewed as a way to increase access to the Japanese market—the ASEAN-Korea FTA, and the ASEAN-EU FTA.

Table 3 [ PDF 21.3KB | 1 page ] shows the number of firms that use or have used AFTA and those that plan to use AFTA or other FTAs.

The transport sector uses AFTA the most. More than a third (38.9%) of transport sector firms use or have used AFTA.⁹ This is followed by food firms at 18.6% and electronics firms at 11.8%. The high usage of AFTA in the transport sector can partly be explained by the high margins of preference (5–43%) in their products (see Appendix 4 [ PDF 29.4KB | 1 page ] for a comparison of tariff rates on major Philippine exports to ASEAN). The successful implementation of the AICO scheme has also contributed to AFTA usage. The AICO scheme is ASEAN's industrial cooperation program to promote joint manufacturing industry activities between ASEAN-based companies. Large companies, such as Honda Cars Philippines; Toyota Motor Philippines; Philippine Auto Components, Inc.; and Ford Motor Company, have entered into several AICO arrangements and have received special preferential rates of 0–5%.¹⁰ The appeal of AFTA's high margins of preference for firms in the transport sector is also clear from an analysis of the benefits of using AFTA (see Box 1 [ PDF 22.1KB | 1 page ]). Transport firms identified lower tariffs as the most important benefit of using AFTA, stating that AFTA's preferential rates enable them to source cheaper raw materials and components from abroad, thereby reducing their production costs.

The lower AFTA utilization rate among food sector firms (18.6%) can be explained by the smaller margins of preference (0–5% for most major Philippine export products to Malaysia and Viet Nam). One food firm claimed that they use AFTA solely for sourcing packaging materials like high bars and plastic bags from other ASEAN countries. The similarity of food products produced by ASEAN countries also limits intra-ASEAN trade and, consequently, the use of AFTA by food firms.

In the electronics sector, only nine firms (11.8%) use or have used AFTA. AFTA usage among electronics firms is broadly in compliance with the requirements of the firms' mother companies or clients abroad. This low usage rate is generally attributed to: (i) low or zero MFN tariff rates and (ii) firms' use of export processing zones (EPZs) (or economic zones) and other investment schemes. Most of the electronics firms located in designated economic zones¹¹ are satisfied with duty-free importation and exportation and the tax and nontax incentives granted by the Philippine Economic Zone Authority (PEZA) and, as a result, have no incentive to avail themselves of FTA preferences. Firms that are not located in economic zones also enjoy the benefits of a customs manufacturing bonded warehouse, such as the suspension of payment of duties and local taxes.

Domestic firms favor using AFTA. Domestic firms show a higher AFTA utilization rate (23.6%) than foreign-owned firms (18.0%). Moderate AFTA usage by foreign firms could be explained by their traditional major export markets (like the US and the EU), with which the Philippines has no outstanding FTAs. As a result, foreign firms often avail themselves of the Generalized System of Preferences, rather than AFTA, when available.

Large and giant firms tend to use AFTA more. Large and giant firms have higher AFTA utilization rates (23.5% and 20%, respectively) than small firms (only 10 of 64 firms or 15.6%). The high usage rate among large and giant firms can be attributed to three factors: (i) they realize larger gains from tariff preferences because they export more; (ii) they have export departments—where the ease of complying with FTA documentation requirements encourages them to use FTAs; and (iii) they are either subsidiaries of or suppliers to MNCs, where origin cumulation in FTAs is implemented or required in their production networks.

Users are largely located outside EPZs. Of the 31 AFTA users, at least 61.3% are located outside the EPZs. Because non-EPZ firms do not enjoy tax and nontax incentives available to firms located in EPZs, they are more inclined to make use of FTA preferences.

3.2 Firm-Specific Factors Predicting AFTA Use

While the general patterns that emerge from the data suggest interesting distinctions between users and nonusers of AFTA on factors such as industrial profile, ownership, and size, a more rigorous analysis is needed to control for variations in fixed firm characteristics and to shed light on the precise relationship between firm attributes and their propensity to use AFTA (see Table 4 [ PDF 47.2KB | 1 page ] for a list of variables used in the model).

3.2.1 Model Specification and Hypotheses

Using the general patterns of AFTA use discussed above and other observations, a firm-level AFTA use function (FTA_USE) can be specified as:

FTA_USE = F(α0 + α₁EMP + α₂AGE + α₃FOR + α₄FTAMKT + α₅NCR + α₆EPZ + α₇CONSULT + α₈AWARE + α₁₀AUTO + α₁₁FOOD).

Hypotheses:

Firm size. The number of people a firm employs was generally expected to be positively correlated with AFTA use. Larger firms were regarded as being more capable of bearing the big investments and risks associated with exporting under FTAs. On the other hand, large domestic firms could prioritize local markets, where they could have de facto monopolies, and so would be less likely to prioritize export markets and FTAs.

Firm age. As a firm matures and gains more experience in the international market, it may perceive more benefits from using FTAs, recognizing market opportunities and having the means to take advantage of them. However, older firms may also have established a market orientation toward traditional non-FTA markets, which could reduce their propensity to use AFTA. In contrast, younger firms could be more dynamic and aggressive in responding to new and changing markets and economic shocks and so be more likely to use AFTA.

Foreign ownership. Foreign ownership and FTA use were generally expected to have a positive relationship. Access to sophisticated international networks and the knowledge of parent companies, along with international caliber production, technology, and management know-how, could make foreign firms more likely to tap into FTAs. Foreign firms are also generally larger, which could enable them to leverage their size in absorbing risks associated with exploring new FTA markets. On the other hand, foreign firms may be more oriented toward their larger, traditional markets (e.g., the US and EU), resulting in a weaker propensity to use AFTA.

Market orientation. Market orientation can determine a firm's likelihood to use AFTA. Philippine firms that export only to FTA markets were expected to use FTAs, while those that focus on traditional markets were expected to be less inclined to do so. One reason is that FTA markets tend to be smaller and more regional in focus and coverage. Also, ASEAN and the PRC have dense and well-developed production networks and manufacturing hubs, which have been instrumental in enhancing intraregional trade and sparking growth. To the extent that firms reap benefits from FTA use, using AFTA in these newer and increasingly integrated markets may give firms a competitive edge through cheaper intermediate goods (from lower tariff rates), streamlined production networks, and new business opportunities.

Firm location. Firms located in the national capital region (NCR) were expected to be more likely to use AFTA (because of their proximity to the resources and developed infrastructure of large metropolitan areas) than firms situated in remote or rural areas. Firms located in EPZs receive special incentives and tax breaks, which may make them less inclined to use FTAs if the marginal benefits are small.

Consultations. Participation in consultations with government or the private sector was expected to be highly correlated with AFTA use. Firms that had responded to this type of outreach or had engaged with officials involved in the negotiation of FTAs were expected to be more vested in the success of trade agreements. Consultations also ultimately enhance the learning and capability building of firms and enable them to navigate the details of FTA provisions by stimulating dialogue and cooperation.

Awareness of FTA provisions. Firms with some or thorough and detailed knowledge of FTA provisions that affect their businesses were regarded as being more aware than firms with little or no knowledge of FTAs. Awareness is generally associated with AFTA use as firms that are informed have most likely invested time and resources to acquire information and are better equipped to take advantage of provisions.

Sectoral dummies. These were used in the model to control for variation in AFTA use based on the industrial profile of firms. In the earlier discussion of patterns of use, transport firms tended to have higher AFTA utilization rates than firms in the food or electronics sectors. This sectoral variation will be tested in the econometric model in the next section.

3.2.2 Probit Model of AFTA Use

A causal relationship between firm characteristics and the use of AFTA was estimated by means of a two-stage multivariate modeling strategy (binary outcomes for the probit model were 1 = firm is an AFTA user and 0 = firm is not an AFTA user) using the firm characteristics described above. After a general form of the model was tested, a reduced form was also tried in order to retest the significant variables from the general form. The findings of the analysis (below) reinforce and validate the patterns found in the data. Probit coefficients and results for both models are presented in Table 5 [ PDF 24.5KB | 1 page ].

Age is a significant predictor of AFTA use, with older firms more likely to be users. This highlights the critical link between experience (i.e., years in operation) and the likelihood of a firm using AFTA. On average, the probability of firms in the sample that are less than 10 years old using AFTA is about 10% or less, while the probability for firms in operation for more than 25 years increases to over 25%. Experienced firms are generally more confident, having developed core capabilities over their many years in operation and having gained leverage over time to better compete in the world market and take advantage of FTAs.

Domestic ownership and market orientation matter in predicting AFTA use. Local firms have a 29% probability of using AFTA, compared to only 8% for foreign firms. This may reflect the influence of market orientation in the Philippines. With their orientation toward the larger, traditional markets (e.g., the US and EU), foreign firms could be expected to have a weaker propensity to use AFTA. In contrast, domestic firms may aim for regional FTA markets because they are easier to access than international markets. In fact, market orientation is likely to be linked to AFTA use and to be a significant factor in predicting the likelihood of use. Firms that export exclusively to FTA markets have a predicted AFTA usage rate of 18%, compared to only 6% for firms that export to more traditional markets.

AFTA users are firms that have participated in FTA consultations with government or the private sector and have at least some knowledge of FTA provisions. AFTA use appears to depend on a firm's FTA awareness and technical capacity, which is highly predicated on whether or not firms have taken an active role in the FTA process. The average firm that has been involved in consultations has a 30% likelihood of using AFTA, compared to only 9% among firms that have never participated in such consultations. More tellingly, firms that are regarded as aware of FTA provisions have a predicted AFTA use rate of 40%, compared to a mere 11% for those that are less aware.

Industry plays a significant role in the likelihood of AFTA use. Underlying the strong sectoral patterns of use found in the data and described in the previous section is the fact that firms in the transport sector are significantly more likely to use AFTA (34%) that firms in other sectors (9%). The sectoral bias can be accounted for by the large margins of preference enjoyed by transport firms.

In addition to the first model, which employs sectoral dummies (see above), another model was created to examine the link between industrial profile and potential benefits from margins of preference (see Appendix 5 [ PDF 22.7KB | 1 page ]). The second model's specification is identical to the first except that an indicator for margin of preference replaces sectoral dummies to account for the variation in industrial profile attributed to margins of preference. Reflecting firms' responsiveness to marginal differences in MFN and AFTA tariff rates, firms with higher margins (i.e., transport and food firms) have a 22% predicted likelihood of adopting AFTA. In contrast, firms for which the agreement provides no advantages in terms of tariff rates are just 8% likely to use AFTA. That the likelihood of using AFTA is predicated on margins of preference also validates firm perceptions of AFTA benefits. AFTA users reported access to cheaper materials and component parts, attributable to AFTA's preferential rates, as the most significant benefit of using AFTA.

Surprisingly, controlling for other firm characteristics, firm size (based on the number of full time employees) and geographical location (whether in EPZs or the NCR) were not significant predictors of AFTA use.¹³ Further research using larger samples may be required to verify these preliminary findings on AFTA use in the Philippines.

3.3 Business Response to AFTA and Other FTAs

Not only does firm-level evidence show higher than expected AFTA use rates, it also confirms that AFTA users factor in AFTA when they consider their business strategies. 45% of AFTA users and 51% of firms that plan to use AFTA or other FTAs reported that FTAs have influenced their business plans or may prompt them to change their business strategies (see Table 6 [ PDF 20.2KB | 1 page ]). This responsiveness can provide additional benefits to FTA users (e.g., increased market access), particularly if firms respond by adjusting their business plans to the specific FTA market.

Strong sectoral patterns are apparent in business response.¹⁴ Transport, which has the highest FTA utilization rate among the selected sectors, also has the highest rate of business response to FTAs (50% among AFTA users and 60% among those who use or plan to use AFTA). The electronics sector is second with 44.4% among AFTA users and 49% among those who plan to use AFTA. While a smaller share of food sector firms use AFTA (18.6%), a relatively large proportion of processed food manufacturers that use AFTA (38%) or that plan to use AFTA (40%) have adapted or may adapt their business plans to FTAs.

This discrepancy between FTA use and business response may be explained by the market orientation of food firms in the Philippines. Food firms generally consider market access to be one of the greatest benefits of using AFTA (see Box 1). Better access to markets brings opportunities for new business ventures and can trigger entry into new markets. A number of large and giant food firms in the Philippines have complained that the country's current FTA partners are limited to countries with which there are existing revenue streams and do not include other potential strategic markets such as the Middle East (Box 2 [ PDF 25.5KB | 2 page ] presents a case study of a how a food firm responded to FTAs). Furthermore, there is no food supply chain equivalent to existing production networks in the electronics and transport sectors in the region, which could deter a food firm from considering FTA use.

There is a similar pattern among small and medium enterprises (SMEs). About 40% of SMEs that are AFTA users and 54% of those who plan to use AFTA have changed or plan to change their business plans in response to FTAs. Interestingly, despite their lower utilization rates, this business response pattern among small firms is comparable to the response rate of large and giant firms. A possible explanation is that small firms may be responding to FTAs in a defensive manner for survival (e.g., new product development or intensified marketing).

While AFTA utilization rates are much lower for both food firms and SMEs in general, business response rates are higher than expected, suggesting that these firms, regardless of whether or not they use AFTA, may be changing their business plans in response to AFTA as a means of experimenting, engaging new markets, and testing business strategies. The econometric analysis discussed in the previous section supports this observation, with market orientation being revealed as a significant predictor of AFTA use. Firms that export exclusively to FTA markets tend to be AFTA users, while those seeking new markets not covered by FTAs tend not to be. Nevertheless, nonusers adapt and make adjustments—recognizing that a forward-looking stance, calibrated to potential growth markets, is especially critical in an increasingly FTA-oriented trading environment.

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