Ang, Faith Eleanor Romarate, Elyssa Smith, Eric Paolo Deregulation of the Philippine Shipping Industry: Easing Restrictions

on the Cabotage Law

Economic Analysis Position Paper August 22, 2013

An archipelago, with 7,107 islands and islets, The Philippines has one of the longest coastlines of more than 230,000 square kilometers, of which 55 out of 76 are coastal provinces. The countrys archipelagic state provides various opportunities for coastal activities such as trade and marine transport among others, thus highlighting the importance of the local shipping industry and its contribution to socioeconomic progress in the Philippines, as well as its role to other trading partner countries. Playing an important role in the countrys development, the maritime industry provides the primary means of interisland transport of goods and passengers despite the increasing developments to air and land transportation, facilitating 98% of domestic interisland trade 1. Likewise, integrating active participation in the global market requires the local shipping industry to carry out efficient industry operations where goods and passengers are transported to their expected destinations on time, in good and safe condition, and at the least possible cost both to consumers and producers. Port container traffic for the Philippines has been increasing since 2009. This according to World Bank data, which shows total port container traffic (both domestic and foreign) for 2011 reaching 5,264,086 TEUs (Twenty-foot Equivalent Unit; a standard-size container); an increase of 6.4% from 2010.2 The Philippine Ports Authority also measured an increase in container traffic from 2011 to 2012, recording 5.7% increase in total container traffic to 5,212,577 TEUs in 2012. A 1% increase in 2012 for the domestic container traffic totaled to 40% of total container traffic. Passenger traffic, on the other hand, logged almost 50 million in 2012 by the PPA, up from about 49.5 million in 2011. 3 As of CY 2012, passenger service ships make up 60% of the total domestic merchant fleet profile and 28% for the cargo service ships. Single proprietors operate majority or 78.2% of the domestic shipping operators.4 The following are the industry players, either in the passenger or cargo service or both: Aboitiz Shipping Transport System Corporation, Cokaliong Shipping Lines, Herma Shipping & Transport, El Greco Jet Ferries, Inc., Lorenzo Shipping Corporation, Magsaysay Shipping Lines, MBRS Lines, Negros Navigation, PNOC Shipping Corp Via Marine, Sulpicio Lines, Inc., Via Marine and Viva Shipping Lines.5 In the study made in 2002, Negros Navigation, Sulpicio and WG&A were the largest players in both passenger and cargo services. To round up the top five players for the passenger service are Philippine Fast Ferry Corporation and Cebu Ferries Corporation, both of which were establish only during the deregulation and liberalization period. For the cargo service, Lorenzo Shipping Corporation and Solid Shipping Corporation round up the top five, both of which handle purely cargo services. 6
1

Joint USG-GPH Technical Team, Partnership for Growth: Philippines, http://www.state.gov/documents/organization/188309.pdf, 30. 2 http://data.worldbank.org/indicator/IS.SHP.GOOD.TU. 3 Summary on Port Performance, http://www.ppa.com.ph/ppa%20web/portstat.htm. 4 Philippine Maritime Industry: Prospects and Challenges, http://gpcci.org/home/wp-content/uploads/2013/05/FR-PH-MaritimeProspects-ChallengesGPCCI-5.23.pdf 5 Domestic Shipping (Passenger and Cargo), http://www.investphilippines.gov.ph/downloads/sector/Domestic%20Shipping.pdf. 6 Myrna S. Austria, Philippine Domestic Shipping Transport Industry: State of Competition and Market Structure, 2003-02 (Philippine Institute for Development Studies), 23.

The countrys domestic shipping industry, however, has been regarded as inefficient with deteriorating quality of service, old fleets, and high cargo rates. This is rather unfortunate given the potential of coastwise trade and passenger transport. Past studies suggest the underlying explanation has much to do with government regulations and policies affecting the industry.7 Some as well have suggested that a cartel seems to exist among shipping operators, which charge high cargo rates.8 One government regulation is Republic Act No. 1937, also known as the Tariff and Customs Code of the Philippines, as it contains a provision that states that maritime transportation of goods and passengers within the country is reserved to Philippine registered marine vessels. This is generally regarded as the Cabotage Law. Cabotage means navigation or trade along the coast. 9 The United States Congress passed the Cabotage Law, previously known as the Jones Act of 1920, when the country was still its colony. Some see this as a fundamental provision within the law that limits competition and contributes to the inefficiencies regarded today of the industry. Sections 902 and 1009 of this Republic Act of 1937 still enforce the Cabotage Law principle today. The provision, the right to engage in the Philippine coastwise trade is limited to vessels carrying a certificate of Philippine registry vaguely defines the Cabotage Law. In 2004, the Domestic Shipping Development Act of 2004 or RA 9295 was passed and was seen to set forth the further deregulation of the Philippines shipping industry. One change it had enacted was the liberalization of passenger rates by leaving this to the market players to decide. It also provides the industry with tax and other incentives to encourage the modernization of the industry by requiring the retirement of old vessels, including wooden-hulled ships. The law also has provisions on ship safety standards, move toward ship classification, and compulsory insurance coverage of passengers and cargoes.10 Despite this, the Act reiterates the Cabotage restrictions of preceding laws. Section 5, Chapter 3 clarifies the Cabotage principle in saying no franchise, certificate or any other form of authorization for the carriage of cargo or passenger or both in the domestic trade shall be granted except to domestic ship owners or operators. Section 6 further states no foreign vessel shall be allowed to transport passenger or cargo between ports or places within the Philippine territorial waters, except upon a Special Permit by the MARINA when no domestic vessel is available or suitable to provide the needed shipping service and public interest warrants the same.11 Open and competitive markets support growth and further the interests of citizens and consumers. Government regulation and legislation, which supports this, must therefore give businesses certainty and clarity to enable investment in content and innovation that will lead to the development of the industry.12 The Cabotage Law is seen as a hindering provision as it limits competition and encourages inefficiency among local vessel operators since there is no forced competition between the local vessel operators, and the lesser cost and better service quality of international vessel operators. 13 An effect of the Cabotage Law is that it hurts domestic producers, especially the agricultural sector, since the mills would rather import from other countries due to the cheaper cost of transporting the produce, than from within the country. Aside from the producers, consumers are hurt as they face the higher
7 8

Austria, Philippine Domestic Shipping Transport Industry: State of Competition and Market Structure, 1. Neda Joins Call vs Cabotage Law, SunStar Davao, http://www.sunstar.com.ph/davao/neda-joins-call-vs-cabotage-law. 9 http://dictionary.reference.com/browse/cabotage. 10 Gilberto M. Llanto, Enrico L. Basilio, Leilanie Q. Basilio, Competition Policy and Regulation in Ports and Shipping, 2007-04. (Philippine Institute for Development Studies), 36. 11 Republic Act No. 9295, May 3, 2004. 12 Seminar 2: Competition in Content Markets, http://dcmscommsreview.readandcomment.com/wpcontent/uploads/2012/06/seminar2_competition_paper_alt.pdf, 1. 13 Bill Filed to Repeal Cabotage Law, SunStar, July 25, 2013, http://www.sunstar.com.ph/breaking-news/2013/07/25/bill-filedrepeal-cabotage-law.

prices of these products as the high costs of transport 14 are passed on in price. Stakeholders particularly those in the domestic shipping industry have been against the repeal or relaxation of the law, for reason that other countries also impose cabotage, and for fear that the by doing so would kill the industry.15 Many refer to the experience of Indonesia when they scrapped the Cabotage restrictions in the 1980s, leading to the entry and domination of foreign vessel operators into the co untrys inter-island trade.16 Recent developments have once again set the eyes of enhanced Philippine development and growth to Mindanao. Economic potentials from its agriculture, fisheries, and tourism industries still pose room for more growth, owing still however to lack of infrastructure, communications and transport linkages, and peace and order concerns as barriers to economic growth. The National Economic and Development Administration (NEDA) in its Philippine Development Plans 17 have noted the high cost of shipping rates as among the issues and challenges in the Mindanao region. In fact, studies have cited that compared to domestic shipping rates in Indonesia; the Philippines is 250% higher on a per-nauticalmile basis.18 Comparisons on rates for one TEU or Twenty-foot Equivalent Unit container show that it is indeed more expensive to ship locally than it is to abroad. One (1) TEU from Cebu to Manila on a domestic line is charged at about PhP 25,000 compared to UDS 300 or about PhP 12,900 from Cebu to Kaohsiung, Taiwan on an international carrier. 19 Shipping dry cargo from Davao to Taiwan costs about USD 450 or PhP 19,350, Davao to West Malaysia at USD 480 or PhP 20,640 compared to Davao to Manila shipped at USD 565 to USD 680 (PhP 24,295 to PhP 29,240) per TEU.20 These plans have also reiterated calls by Mindanao business and shippers associations to work on the Cabotage Law provision. Furthermore, President Benigno Aquino III, in his fourth State of the Nation Address (SONA) called on the 16th Congress to amend the Cabotage Law in order to foster greater competition and to lower the cost of transportation for our agricultural sector and other industries. Nine years from the passage of RA 9295, discussion and debate on the issue of the Cabotage Law and what to do about this continues to make the rounds in local media. Taking the Indonesian experience, Philippine socio-economic developments, and globalization into account, we have taken the position to deregulate the Philippine shipping industry further through the easing of restrictions on the Cabotage Law. Oligopoly and high prices in the local shipping industry, particularly on cargo shipping, exhibits disequilibrium where prices set by firms exceed the markets willingness to pay thus resulting in excess supply to demand and allocative inefficiency. The Cabotage Law prevents foreign firms from entering the domestic shipping industry thus limiting the number of market players and essentially is a regulated barrier to entry. Increasing market players in the industry will allow for market equilibrium as pricing will be subject to market forces.

14 15

Arangkada Philippines, Seaports, http://www.investphilippines.info/arangkada/seven-winners/infrastructure/seaports/. Gil C. Cabacungan, Shipping Firms Oppose Repeal of Cabotage Law, Philippine Daily Inquirer, August 31, 2000, B4. 16 Cielito Habito, Bill Filed to Repeal Cabotage Law, Philippine Daily Inquirer, April 26, 2010, http://services.inquirer.net/mobile/10/04/27/html_output/xmlhtml/20100426-266475-xml.html 17 Mindanao Strategic Development Framework 2010-2012, http://www.neda.gov.ph/Plans_and_Reports/Development_Frameworks/MSDF_finalforweb_2010-2020.pdf, 14. 18 Partnership for Growth: Philippines, 35. 19 Fidel O. Abalos, Cabotage Law = Exclusive Growth for Local Ship-Owners, The Freeman, July 29, 2013, http://www.philstar.com/cebu-business/2013/07/29/1026861/cabotage-law-exclusive-growth-local-ship-owners. 20 Rolando T. Dy, Does the Law Serve Development?, Philippine Daily Inquirer, June 30, 2013, http://business.inquirer.net/129639/does-the-law-serve-development.

Left-side graph shows the oversupply due to the high prices that shipping companies charge and the quantity at which consumers are willing to purchase at that price. Right-side graph shows the new equilibrium point (e) as new players are introduced to the market, current players reduce their prices to the old equilibrium point (e) and the supply curve shifts from s to s as a result of additional shipping capacities and improvements on infrastructures. Outright lifting of the regulation is seen to lead to the following effects: Entry of foreign shipping players will increase domestic shipping competition, allowing a range of shipping options for consumers. These foreign firms (assuming they are transnational firms) may be operating at higher economies of scale compared to the local players thereby are more able to charge lower rates as a result of relatively lower costs. Lower costs will translate to tempered mark-ups in final retail price determined by shipping firms, at the same time lower shipping costs shouldered by producers will allow consumers to enjoy commensurately lower end-user prices. Existing local players on all categories (large to small-scale players) may end up folding up their operations if they are unable to compete with competition prices. However, these local players may also end up entering into joint venture agreements, mergers, to increase market power, or seek foreign investments to infuse new capital to fund upgrades in shipping fleets and operations in the face of real competitive threats. The entry of foreign firms will put pressure on the countrys ports system and infrastructure, tempering demand as current infrastructure may be unable to respond to need for increased supply. Ports in all classifications will be required to be able to handle increased demand in port calls, and install or upgrade cargo and passenger handling facilities. Foreign firms will also bring their systems of practice that is assumed to have met international standards thereby similarly putting pressure to upgrade the safety, security, and service standards of the industry. With more industry players, there will be more ships plying the countrys maritime routes thus putting pressure on the maritime security and safety resources of government, in particular, with government agencies like the Coast Guard, Navy, and Bureau of Fisheries & Aquatic Resources. Demand for their regulatory resources will increase, commensurate to their legislated need to ensure the safety and security of our maritime domain. Similarly, demand will increase for updated Philippine marine and navigation maps, which are of international standards. If left unmonitored, competition from foreign operators may decimate the local shipping industry giving rise to economic national security.

Upgrading infrastructure in the countrys ports and improvements in related industries will increase government spending in this regard through the acquisition of domestic goods and services that go as inputs in these acquisitions. Support offices, and the purchase of various equipments may be setup to support the business. Employees hired may also increase purchases of residential investments thereby increasing general investment numbers.

An increase in government spending shifts the IS Curve to the right, given the same interest rate, output increases.

With increased domestic shipping operators, there will be more channels by which passenger and agriculture produce can be facilitated in travel and trade. Markets that once had no viable shipping routes may now be tapped thereby adding new trade value with new trade points. At the same time, markets that once had limited trade due to restrictions in shipping routes and schedules, or restrictions imposed by shipping fees can now be improved thereby increasing trade values in existing points. These will produce incentives to producers to increase production given new/increased demand for their products. Alternative ways of travel will become available increasing options for travellers and increasing the market opportunities in the tourism sector. With more goods throughput on the major ports, as well as more goods because of new markets, there is higher likelihood of growth in export numbers. Quicker trade transfer to international markets through these foreign firms may be enabled, as they can facilitate for transnational shipment from any of the major parts (for those that are international gateways). Consumers will also be provided with increased variety of goods to choose from. Increased demand for goods will lead to higher production of the goods, increasing labor demand and employing more Filipinos to facilitate this growth. Growth in labor demand is also seen in the entry of foreign shipping firms who shall be employing local workers for ground-based operations and shipping crew requirements. Higher output decreases unemployment however puts pressure on prices through increased wages. The rise of labor unions or port employee associations may come about with this growth leading to wage setting negotiations. Increases in income may fuel more consumption in the general market. However commensurate increases in prices due to wage hikes may offset the income hike leaving real wages to remain the same. Youtput = C0 + C1 (Yincome-T) + I + G Yproduction = N production labor output income

consumption

An outright lifting of the regulation may bring forth a more vibrant domestic shipping industry that will significantly contribute to domestic output through increased local trade and tourism opportunities. Producers and consumers will ultimately see the benefits of increased competition; however, the same may not be said for the local shipping firms, which may end up decimated by the

move if they will be unable to compete. However, this growth for the industry will still be tempered on other factors, particularly the capacities of Philippine ports to handle foreign firms. It may also spell a nightmare on maritime safety if government agencies cannot handle the increase in ship numbers, and strictly enforce safety and security standards. Learning from the Indonesian experience on Cabotage restrictions that has led to the almost death of their local shipping industry, we propose eased deregulation on the provision. Instead of an outright lifting, we prescribe entry of foreign players into the domestic shipping industry only for domestic passenger and/or cargo shipping between major domestic ports operated only by the Philippine Ports Authority (Manila North & South Harbors, Batangas Port, etc.) and those under the jurisdiction of independent port authorities (IPAs) like that of Cebu and Subic Ports. By restricting the foreign players only on these domestic routes and between these port classifications will limit the impact to existing local players (operating on private ports and LGU ports) and at the same time ensuring the foreign players can be adequately handled in the operations of the major ports. The effects of doing such a move may result to the following: Foreign players who are assumed to benefit from economies of scale will compete in their relevant arenas, which are the large/major ports of the country, particularly ports under the PPA and IPA. This way lower scale local shipping lines are not outrightly threatened to closure. These port classifications will also be able to better service the foreign firms. Maritime regulatory authorities will have an easier time regulating safety and security and enforce compliance to related standards of the increased number of ships in these routes. Doing so will allow them to cope effectively with the deregulation and provide the opportunity to create and sharpen guidelines on safety and security in preparation for future deregulatory expansion. Having foreign players ply only the major routes will ensure their documented trade figures, lessening chances of illegal activities that may be facilitated on other port classifications. Limiting foreign entrants on these domestic ports will still contribute to a significant deregulation of the industry, as these are still major ports of the country. Competition will be fostered and prices for shipment of passengers or goods along these routes shall be subjected to market forces. Producers of goods will have the incentive to ship out from specific trade points to take advantage of potentially lower costs of shipment.

The existence of foreign players may expose inefficient domestic players which may lead them to exit the industry, unable to grow within their capacity, thus leaving competitive and efficient players in the market.

Faced with increasing market opportunities in domestic growth, globalization and trade liberalization, as well as potential threats (and opportunities) from economic integration as in ASEAN by 2015, government must seriously consider the further deregulation of the shipping industry on the issue of cabotage. An outright abolishment without significant checks and balances to market competition may not be deemed feasible as it may lead to the downfall of domestic shippers, equally signalling cause for concern on national security with foreign market domination of our maritime domain and public utility. Eased deregulation that restricts foreign entrants to specific destinations as in port classifications for a period of time, may prove more beneficial to stakeholders and to overall national interest as it may also provide the time to allow the local players to act on improved efficiency as they are now faced with real threats in a more competitive industry.

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