Cabotage Law Policy Brief

POLICY BRIEF

ISSN 2467-5571 (Online) Issue No. 2015 - 0003

JUNE 2015

REDUCING TRANSPORT COSTS FROM MINDANAO TO LOCAL AND INTERNATIONAL MARKETS:

REVIEW OF CABOTAGE LAW

BACKGROUND

ISSUES FACING THE DOMESTIC SHIPPING INDUSTRY

On July 22, 2013, President Benigno Aquino III called for the review and amendment of the Cabotage Law, following persistent demands of several sectors, including farmers and traders, to open the industry to more players and hoping this will reduce shipping cost.

Cabotage is defined as “the right to transport persons and commodities between two or more points in a country.”

President Aquino issued the call during his 2013 State of the Nation Address (SONA) to emphasize the significant role that domestic shipping should have played in internal trading and encourage a more robust production of goods.

For many years now, the call has been louder on the repeal of the Cabotage Law, and it comes from many Mindanao stakeholders, including various members of the House of Representatives who are willing to sponsor a bill to revise the Cabotage Law. The proposed amendment of this Law seeks to allow foreign vessels to directly transport domestic cargo between any two or more ports within the country.

In the Philippines, the shipping industry plays a very important role in the country’s development. According to the Asian Development Bank (2010), the industry facilitates 98% of domestic inter-island trade, accounts for about 80 million tons of cargoes every year, including agri-fishery products, and facilitates the movement of over 40 million Filipinos and foreign tourists within the country.

It accounts for around 13% of the total cost of transporting commodities from farms in Mindanao to domestic markets in the Visayas1 .

Considering this role, an efficient shipping industry that facilitates the movement of commodities, products and people is vital to the growth Mindanao and the rest of the country.

However, several studies show that the country’s domestic shipping industry is highly concentrated2 . The five largest cargo operators together carried 91 per cent of the total revenue3. The lack of meaningful competition has resulted to weak incentives to modernize, as evidenced by the old vessels used in transporting cargo, which are inferior compared to their foreign counterparts.

Llanto (2014), citing MARINA statistics, found out that domestic vessels for cargo were generally 20 years old, while the average age of passenger ships is between 18-20 years old4 . He added that the situation today has worsened compared to the situation in the early 1990s, where the average age of passenger vessels was only 5-10 years old5.

To add to this, the shipping industry is also generally regarded as unsafe. Over the last 26 years, 170 maritime disasters have been recorded by the Philippines Coast Guard.

Moreover, traders in Mindanao are complaining about the high cost of domestic shipping, and attribute this to the lack of competition in the shipping industry.

According to data from the Commission on Audit, it is more costly to ship goods from Mindanao to Manila, than it is to ship goods from Manila to Bangkok, China, and Singapore, as shown in Figure 16.

Drawing from the lessons in BIMP-EAGA, maritime transport routes that were explored by commercial operators were shown to have low load factors and cited cabotage restrictions as one of the hindrances in achieving economies of scale.

Mindanao Development Authority, A case study of the transport and logistics chain of vegetables in Misamis and Oil Palm in Central Mindanao, Mindanao Development Authority, Davao, 2014 Llanto et.al, “Competition Policy and Regulation in Port and Shipping” and Austria, 2003. Liberalization and Deregulation in the Domestic Shipping Industry: Effects on Competition and Market Structure. PIDS ,Metro Manila, 2005 3 ibid.

4 Llanto and Navarro. 2014. Toward Relaxing the Cabotage Restrictions in Maritime Transport. PIDS Policy Notes 5 ibid.

6 https://www.google.com.ph/webhp?sourceid=chrome-instant&rlz=1C1GGGE_enPH409PH409&ion=1&espv=2&ie=UTF-8#q=Freight+R ates+of+Domestic+Vessels+for+Export+Cargoes+Domestic+Shipowners+association/marinaph.freehostia.com/report/domestic/rates. doc. Access date June 11, 2015 7 Mindanao Development Authority, Cost and Benefit Analysis of Lifting Cabotage Law, Mindanao Development Authority, Davao, 2014 1

2

COST BENEFIT ANALYSIS From an economic standpoint, the lifting of cabotage may be beneficial to traders and port operators in the long run7 . Shippers, will experience a reduction of their profits, but are still expected to earn. The effect on farmers, consumers, and the economy as a whole still needs to be studied.

PIDS (2014) allayed fears of local shipping firms, citing that market limitations such as market size, lack of familiarity with the domestic markets, and institutional barriers may not allow foreign shipping companies to do business in all sectors of coastwise trade . The study further suggested that MARINA study appropriate modalities that would provide leeway for domestic shippers to adjust. For one, phased cabotage liberalization accompanied by regulatory reforms in the port sector may be adopted.

A flexible cabotage policy that applies only to certain tonnages of cargo and passenger volumes could also be pursued.

Box 1. A summary of expected benefits and costs of relaxing cabotage law

Cons 1.

2.

Possible collapse of the domestic shipping industry. According to proponents of cabotage law, cabotage provisions are necessary to protect the Philippine domestic shipping market, and the jobs associated with them. They state that liberalizing domestic shipping in the Philippines poses serious problems for the sector as foreign ships are thought to be larger, more technologically advanced and are better subsidized by their governments.

Furthermore, foreign ships pay less tax to the Philippine government than their Philippine flagged counterparts. It is their contention that opening of the domestic shipping industry will result to the demise of domestic players and allied industries.

Security problems. This is because not all the ports, even the major ones, are capable of fully and comprehensively implementing a program on Customs, Immigration, Quarantine and Security (CIQS) services.

This increases the risks of smuggling, transmission of diseases, and even terrorism .

A summary of expected benefits and costs of relaxing cabotage law is reflected in Box 1.

Pros 1.

Competition in the shipping industry, which is expected to result to improved shipping services and reduced shipping rates. Mindanao businessmen claim that trading has become increasingly costly.

They cite the lack of competition as the main cause for the inefficiencies and high shipping costs that are characteristic of the industry. Domestic exporters and importers feel that because of this, they have difficulty competing in the international market.

2.

Increased trading activities. Agricultural interest groups in Mindanao believe that relaxation of Cabotage laws will ease the transfer of goods to Luzon and Visayas, and more importantly, increase the volume of Mindanao’s agricultural export to the rest of the country.

3.

Improved flexibility in shipping schedules. Mindanao businessmen argue that opening up the shipping industry to foreign players could result to more routes and more frequent shipping schedules. This issue adversely affects exporters who rely on transport efficiency and predictability to remain competitive.

4.

Increased economic activity in Local Ports. Port cities and authorities also contend that liberalizing cabotage laws would significantly contribute to the local economy, as foreign flagged-vessels would now be allowed to dock at local ports which are not necessarily international ports of entry. This would generally improve the economic welfare as ship calls would be expected to increase, thereby increasing income of the port authorities and economic activity in the localities where these ports are located.

LEGAL REVIEW The broader application of the cabotage principle can be found in the Constitution, which provides that public utilities can only be operated by Filipinos or corporations that are 60% Filipino-owned. A “public utility,” as defined by the Supreme Court, is a business or service engaged in regularly supplying the public with some commodity or service of public consequence such as electricity, gas, water, transportation, telephone or telegraph service. The term implies public use and service. (NATIONAL POWER CORPORATION, petitioner, vs. COURT OF APPEALS, G.R. No. 112702. September 26, 1997).”

Specific applications of cabotage are embodied in the Tariff and Customs Code and the Domestic Shipping Act of 2004. The Tariff and Customs Code limits the right to engage in Philippine coastwise trade to vessels carrying a certificate of Philippine registry.

The Domestic Shipping Act reinforces this provision, and explicitly denies foreign vessels from transporting passengers or cargo between ports or places within the Philippine territorial waters, except upon the grant of a Special Permit by MARINA. MARINA, Proceedings of MinDA-PPA Roundtable Discussion on Cabotage, Davao, Mindanao Development Authority, 2013

8

Figure 1. FREIGHT RATES

Notes: a\ Excludes terminal handling fee of P3,220 and documentation fee of $20. b\ Includes local arastre at ports of origin and destination, wharfage and document stamps.

Sources: Commission on Audit. Philippine Shippers’ Bureau and Domestic Ship owners’ Association

2

POLICYBRIEF TABLE 1. RELATED LAWS ON CABOTAGE Philippine Constitution, Section 11, Article XII (National Economy and Patrimony)

Tariff and Customs Code of the Philippines (TCCP), Sections 901, 902, 905, 1009

Section 11, Article XII. No franchise, certificate, or any other form of authorization for the operation of a public utility shall be granted except to citizens of the Philippines or to corporations or associations organized under the laws of the Philippines, at least sixty per centum of whose capital is owned by such citizens; nor shall such franchise, certificate, or authorization be exclusive in character or for a longer period than fifty years. Neither shall any such franchise or right be granted except under the condition that it shall be subject to amendment, alteration, or repeal by the Congress when the common good so requires. The State shall encourage equity participation in public utilities by the general public. The participation of foreign investors in the governing body of any public utility enterprise shall be limited to their proportionate share in its capital, and all the executive and managing officers of such corporation or association must be citizens of the Philippines.

Section 901. Ports Open to Coastwise Trade. All ports and places in the Philippines shall be open to vessels lawfully engaged in coastwise trade, subject to the provisions of law applicable in particular cases.

Section 902. Vessels Eligible for Coastwise Trade. The right to engage in the Philippine coastwise trade is limited to vessels carrying a certificate of Philippine registry.

Section 905. Transportation of Passengers and Articles between Philippine Ports. Passengers shall not be received at one Philippine port or any other port by a vessel not licensed for the coastwise trade, except upon a special permission granted by the Collector (Customs Commissioner); and subject to the same qualification, articles earmarked at a domestic port shall not be transported to any other port in the Philippines, either directly or by way of a voyage, in any other vessel than one licensed for the coastwise trade.

Section 1009. Clearance of Foreign Vessels To and From Coastwise Ports. — Passengers or articles arriving from abroad upon a foreign vessel may be carried by the same vessel through any port of entry to the port of destination in the Philippines; and passengers departing from the Philippines or articles intended for export may be carried in a foreign vessel through a Philippine port.

Upon such reasonable condition as he may impose, the Commissioner may clear foreign vessels for any port and authorize the conveyance therein of either articles or passengers brought from abroad upon such vessels; and he may likewise, upon such conditions as he may impose, allow a foreign vessel to take cargo and passengers at any port and convey the same upon such vessel to a foreign port.

Domestic Shipping Act of 2004 Chapter III, Sections 5 and 6

Section 5. Authority to Operate. - No franchise, certificate or any other form authorization for the carriage of cargo or passenger, or both in the domestic trade, shall be granted except of domestic ship owners or operators.

Section 6. Foreign Vessels Engaged in Trade and Commerce in the Philippines Territorial Waters. - No foreign vessel shall be allowed to transport passengers or cargo between ports or place within the Philippine territorial waters, except upon the grant Special Permit by the MARINA when no domestic vessels is available or suitable to provide the needed shipping service and public interest warrants the same.

According to legal experts, lifting of cabotage requires an amendment to the Constitution.

Afterwards, specific laws may be legislated to enact full liberalization of the shipping industry, or other modes of liberalization.

OPTIONS FOR LIBERALIZATION Five possible modes for liberalization of the shipping industry in the country are being proposed for consideration. These are as follows: 1. Fully liberalize the shipping industry 2. Allow phased liberalization 3. Allow limited number of foreign shipping companies (100% foreign equity) to operate domestically (akin to Foreign Banking Liberalization) 4. Specify specific routes, tonnage and passenger volume limitations, or 5. Define a more liberal foreign equity formula (e.g., 40-60, 20-80 in favor of foreign equity) These however, have yet to be further studied for their merits and projected implications and impact.

Other legal experts contend that there is a mode of liberalization that does not require Constitutional amendment. This is the option of foreign consortium shipping, or allowing co-loading of foreign cargoes for domestic transhipment. For this to happen, the REID Foundation recommends the amendment of Section 1009 of TCCP to read as follows: “Passengers or articles arriving from abroad upon a foreign vessel may be carried by the same or another foreign vessel through any port of entry to the port of destination in the Philippines; and passengers departing from the Philippines or articles intended for export may be carried in a foreign vessel through a Philippine port.”

Another liberalization option that is currently being practiced is MARINA Memorandum Circular 011-04. Said memo circular grants special permits to foreign ships allowing them to operate in domestic routes whenever (i) there is no existing vessel operating in the proposed route/ area of operation; (ii) there is no available local vessel to transport the cargo to meet the shipping requirement; (iii) the proposed vessel is contracted by private/public entities; and (iv) in the case of vessel carrying or bringing in foreign tourists, operation calls at domestic ports is part of its itinerary.

SUMMARY OF RECOMMENDATION The high cost of domestic shipping, and other related issues such as inefficiencies brought about by lack of competition may be attributed in part to the cabotage restrictions of the law.

This has hampered trading, and has made it more difficult for local businessmen to compete in the international market.

It is therefore recommended that cabotage law be eased. It is further recommended that the mode of liberalization best suited to the Philippine context be further studied.

3

REFERENCES https://www.google.com.ph/webhp?sourceid=chrome-instant&rlz=1C1GGGE_enPH409PH409&ion=1&espv=2&ie=UTF-8#q=Freight+Rates+of+Domestic+Vessels+for+Export+Cargoes+Domestic+Shipowners+ass ociation/marinaph.freehostia.com/report/domestic/rates.doc. Access date June 11, 2015 Llanto et.al, “Competition Policy and Regulation in Port and Shipping� and Austria, 2003. Liberalization and Deregulation in the Domestic Shipping Industry: Effects on Competition and Market Structure. PIDS ,Metro Manila, 2005 Llanto and Navarro. 2014. Toward Relaxing the Cabotage Restrictions in Maritime Transport. PIDS Policy Notes Mindanao Development Authority, A case study of the transport and logistics chain of vegetables in Misamis and Oil Palm in Central Mindanao, Mindanao Development Authority, Davao, 2014 Mindanao Development Authority, Cost and Benefit Analysis of Lifting Cabotage Law, Mindanao Development Authority, Davao, 2014 8

MARINA, Proceedings of MinDA-PPA Roundtable Discussion on Cabotage, Davao, Mindanao Development Authority, 2013

For further information, please contact

The Policy Formulation Division Mindanao Development Authority (MinDA) 4th Floor SSS Building, JP Laurel Avenue 8000 Davao City

Telephone Nos.: (63-82) 221-2185, 221- 4834 Fax No.: (63-82) 221-6920, 221-2180 E-mail: info@minda.gov.ph The MinDA Policy Brief is available online at www.minda.gov.ph\downloads MinDA Policy Briefs are observations/analyses based on researches and consultations done by MinDA Technical Staff on certain policy issues. The paper is holistic in approach and aims to provide useful inputs for decision-making.