Keynote Speech by Cecile Fruman: Increasing Philippine SMEs’ Participation in Global Value Chains

It is a great honor and privilege to be here today at this important policy workshop organized by the World Bank Group and the Philippine Institute for Development Studies.

I would like to thank all the speakers, panelists and distinguished guests for their participation. My special thanks go to Director Senen Perlada from the Philippines' Department Trade and Industry and Ms. Jothi Kandasamy, Deputy CEO of Malaysia SME Corporation, one of the leading SME development agencies in Asia.

I would like to start by commending the Philippine government, private sector, think-tanks, academics and other civil society members for the collaborative commitment in furthering the development of the Philippines' small and medium enterprises.

Looking around the room, your participation in today's workshop clearly signifies this commitment. I should add that our Senior Director for Trade & Competitiveness, Ms. Anabel Gonzalez, will be with your Minister of Trade and Industry, H.E. Ramon Lopez, later this month at the WTO in Geneva in a session on Growing Global SMEs for Inclusive Development. This says a lot about the importance of this topic.

I will organize my remarks around three themes: 1) Why SMEs matter for inclusive growth in the Philippines, 2) How well Philippine's SMEs are integrated into global value chains (GVCs) today, and 3) Actions to foster deeper participation in GVCs. I will conclude with some thoughts on how the World Bank Group can support this agenda.

Why SMEs matter for inclusive growth in the Philippines

As we all know, the Philippines has witnessed impressive growth. From 2010 to 2015, the country expanded its GDP by almost half and was the fastest growing economy in the region, a new Asian tiger. Growth prospects are also good, with the economy projected to grow at around 6% this year and next.

Unfortunately, fast growth has not yet translated into eradicating poverty, with almost a quarter of the population still living in poverty.

The Philippines' Micro, Small and Medium Enterprises (MSMEs) are critical to growth, employment and poverty reduction. MSMEs represent 99% of enterprises in the country, contribute around 36% of GDP and 60% of total employment. They are the backbone, the heart and the lungs of the economy.

But MSMEs face many challenges, including a low rate of business entry - the Philippines is among the bottom 15% of countries with the lowest rate of newly registered firms; low productivity and stagnation in the SME sector's structure - the more productive medium-sized firms represented only 0.4% of all MSMEs, the same proportion as 10 years ago. Moreover, labor productivity of the Philippines' SMEs is about only one-third that of Malaysia and one-twentieth of the SME sector in high-income countries. Finally, most of the MSMEs in the Philippines operate in low-productivity services, predominantly in the wholesale and retail sector and most MSMEs jobs are informal and vulnerable to poverty.

Globally, the picture is more or less the same: SMEs are between 10 to 50% less productive than large firms. Nearly one-third of new SMEs close down in less than two years. Only 10% of surviving SMEs grow after start-up.

Yet, according to a recent survey of nearly 50,000 firms in 104 countries, SMEs provide as much as two-thirds of all employment, with small firms contributing more to employment in low-income countries than high-income countries.

The survey also showed that for the 85 countries with positive net job creation, more than 50 percent of that net employment creation can be attributed to the smallest companies.

Therefore, supporting SME growth and productivity can help reduce poverty by boosting the quantity and quality of jobs and the income levels of their workers and ensuring growth that trickles down to all segments of society.

How well Philippine SMEs are integrated into GVCs today

Global value chains (GVCs) are a key driver of growth as evidenced by their impact on GDP and jobs in East Asia, in particular. Countries with the fastest growing GVC participation have GDP per capita growth rates 2 percent higher than the average.

GVCs provide an avenue through which countries can industrialize at a much earlier stage of development. Producing firms choose to offshore fragments of the production value chain to countries where labor is cheaper or where other locational advantages confer a competitive cost advantage on the whole GVC.

For SMEs the best metaphor would not be a chain but a ladder. The disaggregation of production into separate stages allows firms not only to find their place on the ladder, but also to move up the rungs as their capabilities improve. GVCs encourage that upward movement by rewarding skills, learning, and innovation.

SMEs can participate in GVCs in two ways: through direct participation in exports or indirect participation by supplying other exporters. Both channels matter, but evidence indicates that it is indirect participation that is more important for SMEs - and often the most realistic route.

In terms of direct participation, firms in the Philippines are yet to catch up with their peers. The share of Philippine firms exporting is lower than neighboring countries, with only 7% of domestic firms involved in exports compared to 50% in Malaysia and 61% in Thailand. Moreover, domestic exporters in the Philippines export only 3.5% of their sales; at 16%, Philippine foreign firms show a better performance though still much lower than Malaysia, Vietnam and Thailand. This, in part, relates to the larger relevance of the Philippines' services sector.

In terms of indirect participation, more can be done to promote linkages between FDI and exporters with SMEs. With a large share of FDI being export-oriented and confined to the zones or in the service sector, the impact of FDI beyond job creation is structurally limited. SMEs are not capturing the full extent of market opportunities and spillover effects.

Actions to foster deeper participation of SMEs in GVCs

The Government of the Philippines has signaled in no uncertain terms its commitment to fostering private sector growth and greater participation in GVCs. Number 3 of the 10-point socio-economic action agenda aims to "increase competitiveness, the ease of doing business, and attract FDI".

The Department of Trade and Industry-Board of Investments (DTI-BOI) has launched an ambitious Manufacturing Resurgence Program which targets the manufacturing sector to create 15% of total employment and 30% of total value-added by 2025, up from 10% and 23%, respectively. GVCs-and the foreign investment embedded in them-play a key role in this effort.

International experience shows that to meet these ambitious goals, action is needed at two levels: economy-wide and at the firm level.

Key economy-wide reforms that the Philippines could consider include:

Foster a more conducive business environment, increasing regulatory certainty and decreasing costs;

Invest in infrastructure and connectivity, to improve transport, logistics and trade facilitation;

Facilitate the attraction of FDI, mostly those firms that will drive Domestic Value Addition, and support supplier development programs;

Improve access to finance for SMEs;

Foster greater competition in key sectors and create a level playing field for SMEs - significant strides have been taken with the adoption of the Competition Act in June 2015 and the establishment of the Philippines Competition Commission;

Strengthen the National Quality Infrastructure to enable SMEs to meet international product standards.

At the firm level, SMEs will need support to:

Improve labor and management skills;

Invest in technology upgrading and innovation, in particular through E-trade;

Invest in meeting quality and technical standards of lead firms in GVCs;

Strengthen supply chains to be able to supply goods and services reliably and within reasonable time.

The good news is that World Bank Enterprise Surveys tell us clearly that foreign investors actually prefer to source goods and services from local small firms, rather than import them internationally, as long as they can get what they need cost effectively. The potential to develop stronger linkages between lead firms and Philippine SMEs is undeniable.

In conclusion

Through this workshop, we hope to identify the 'what', the 'how' and the 'who' to increase Philippine SMEs' participation in GVCs by addressing the key constraints that SMEs face.

We are fortunate today to have speakers and panelists coming from the private sector, particularly the small and medium enterprises; the Philippine government agencies; the Philippine Central Bank, private banks and financial institutions; SME Corporation of Malaysia; Think-tanks and academics, and; last but not least, our partner in organizing today's event: Philippine Institute for Development Studies.

At the World Bank Group, we bring together different forms of technical and financial support, working with both private and public sectors, to support SME integration into the global economy. We hope to support the Philippines on this important agenda so that SMEs can fulfill their key role in creating jobs and opportunities for millions of Filipinos to improve their lives.

Thank you very much for your active participation. I look forward to a fruitful discussion today.

Cecile Fruman is a director in the World Bank Group's Trade & Competitiveness Global Practice

Source: World Bank