Global Policy Forum

The Price of Free Trade


Part I | Part II

By Mustafizur Rahman* and Tom Fawthrop*

September/October, 2004

Instituted some 30 years ago, the international Multi-Fiber Agreement (MFA) set export quotas on all textile manufacturing nations. Some poorer countries, like Bangladesh and Cambodia, received larger quotas, which enabled them to attract foreign investment and sharply boost their earnings. Artificially protected from competition, they built their developing economies around the textiles industry. Between 1990 and 2004, for instance, Bangladesh's apparel exports increased more than eightfold, from US$620 million to US$5.7 billion.

In a two-part series, we examine Bangladesh and Cambodia's options when, at the stroke of midnight on January 1, 2005, those quotas will be eliminated. In the first article of the series, economist Mustafizur Rahman reports that this transition will test Bangladesh, both financially and socially. Will the nation be able compete with the likes of manufacturing giant China? The country's clothing industry may survive this uphill battle, suggests Rahman, through a combination of carefully orchestrated domestic and international measures.

– YaleGlobal

The Price of Free Trade - Part I

With the abolition of quotas looming in 2005, textile producers like Bangladesh fear losing their advantage

Over the past several years, textile export has helped to lift Bangladesh out of its grinding poverty. But changing trade rules now threaten to take away those tools of enrichment. This drastic shift signals a major transition for the country's economic and social structure. How Bangladesh copes with this latest challenge will not only determine the country's future, but will also offer an example for other developing countries caught in globalization's shifting winds.

Production of ready made garments (RMG) has been one of the most important sectors of Bangladesh's economy, employing about 1.6 million workers, or one-third of its industrial labor force. Bangladesh was successful in translating its comparative advantage of abundant cheap labor into lower price for goods. And thanks to private sector entrepreneurship and financial incentives from the government, the sector saw robust growth in recent years.

Bangladesh's apparels sector has also, until now, benefited substantially from the quota system under the Multi-Fiber Agreement (MFA), which has shaped the global garment trade over the last three decades. The imposed limits offered protection to domestic industries in the importing countries; meanwhile, exporting countries were able create their own niche markets, since competitors were also restrained by quotas. This system allowed Bangladesh, along with a number of developing and least developed countries, to enjoy relatively secured market access in major apparels importing countries such as the US, the EU, and Canada. The favorable quota regime under the MFA enabled Bangladesh to gradually expand its export of apparels from US$620 million in 1990 to US$5.7 billion in 2004. In the US market, an expanding quota (quotas were increased yearly when countries succeeded in fulfilling them) allowed Bangladesh to enhance its market share.

All this is set to change after January 1, 2005, as a consequence of the final MFA phase-out dictated by the Agreement on Textiles and Clothing, an integral part of World Trade Organization (WTO) rules governing the industry. For countries like Bangladesh, whose apparel industries have only gradually attained a strong foothold in major developed country markets, the environment is set to undergo drastic changes. The phase-out means that entrepreneurs will also be unshackled from quota restraint, granting them potential to increase their exports in sectors where they have revealed competitive strength. Countries may also be able to enter into market segments where they had not previously been able to compete.

Despite this theoretical increase in opportunities, the rescinding of the quotas will present numerous challenges for small economies. In fact, earlier phases of MFA quota rollbacks reinforce the apprehensions of many garment-reliant countries. Bangladesh's trouser exports, for instance, suffered significantly, while China's more than doubled after its 2001 accession to the WTO. What will actually happen this time around, once the quotas are completely gone, hinges on a number of factors.

In the case of woven apparel, Bangladesh imports about 80 percent of its main raw material: fabrics. Since many fabric-exporting countries will begin to produce clothing themselves once the quotas disappear, the global price of fabrics may increase, thus eroding Bangladesh's competitive strength. In addition, buyers are increasingly looking for reduced lead time – the lag between placing orders and receiving goods. Competing with countries that already produce cotton and maintain strong internal spinning and weaving sub-sectors may not be easy. China has been especially quick to grab up foreign market space as quotas in other industries disappeared. India, Pakistan, Vietnam, and many Caribbean and African countries will be some of Bangladesh's other major competitors in the US market.

US trade policies may offer another hurdle to Bangladesh's post-MFA development. Although the EU and Canada provide Bangladesh with zero-tariff access, the US does not provide similar incentives. The US has offered all 34 of Africa's least developed countries zero-tariff access for exports of apparels; again, Bangladesh has yet to receive the same advantages. In fact, in 2003, duties paid at US customs on Bangladesh's apparels items totalled US$306 million; in the same year, Bangladesh's gross receipt of bilateral US aid was less than US$35 million. Thus, an offer of barrier-free market access in the US (tariffs on Bangladesh's garments currently range from 5 percent to 30 percent) could be crucial to enhancing Bangladesh's competitive presence. A study by the Center for Policy Dialogue, a leading think tank in Bangladesh, estimates that such market access could result in an immediate US$1 billion increase in Bangladesh's US apparels exports, which currently total US$1.6 billion.

In a country where few new industries have emerged over the recent past years, the garment sector provides a major opportunity for employment. The changing marketplace could not only affect the economy, but social relations as well. Millions of women and girls, whose destinies are entwined with the fortunes of the country's garment sector, may be affected by the quota changes. Nearly 70 percent of the workers in the knit and woven apparels sectors are rural women who migrated to live and work in the cities.

Before the development of the industry, young girls from poor families had two choices: either live in rural destitution, or work as maids in affluent households. The garment sector provided an opportunity not only for gainful employment, but also for independence. Anyone who has seen hundreds of thousands of these girls walking to their factories in the morning, or returning to their homes in late evenings, will not fail to appreciate the change this sector has single-handedly brought to the social texture of the country.

There is an increasing understanding that a failure to address workplace compliance requirements may shift buyers to other countries. Consumers' groups, buyers, and international organisations, such as the ILO, are working with Bangladesh's entrepreneurs, government, NGOs, and workers to bring about positive changes in wages and workplace health.

The government of Bangladesh, in partnership with entrepreneurs, NGOs, and workers associations, has identified a number of projects addressing the possible adverse consequences of MFA phase-out. These include skills upgrades and retraining of displaced workers. Development partners from the international community, particularly the US, could also lend support to these underfinanced efforts, through aid and technical assistance.

There is a quiet confidence and resolve in Bangladesh that, in spite of the phase-out of the quota, the country's export-oriented garment sector will withstand its upcoming challenges. This confidence is based on Bangladesh's strong performance in the export of some of basic mass-produced items, such as T-shirts, jackets, pullovers, and sweaters. Increased production over the past years has also contributed to this faith. It would be wishful thinking, however, to ignore the large degree of uncertainty about Bangladesh's apparels sector following the MFA phase-out. Given the enormous social and financial costs of failure, all stakeholders – domestic as well as foreign – must coordinate their efforts to help Bangladesh remain competitive once the quotas disappear.

About the Author: Mustafizur Rahman is research director of the Center for Policy Dialogue in Dhaka, Bangladesh, and a professor of economics at the University of Dhaka.

The Price of Free Trade - Part II

The end of textile export quotas cushion may confront Cambodia with the hard realities of the global marketplace

Ten years ago, Cambodia, recovering from the legacy of the Khmer Rouge genocide, received a shot in the arm from Washington's lowered tariffs on Cambodian textile exports. Cambodia also benefited from a generous quota granted under the multifiber trade agreement. But with the end of the quota system looming in early 2005, Cambodia faces a world of tough competition for which it is unprepared. The country is about to learn the hard way that governments must be ever vigilant and nimble-footed to navigate with the shifting winds of globalization.

Only months ago, the Hun Sen government, encouraged by international donors, opted to fully embrace globalization by joining the WTO. The government believes it is the only path for breaking out of chronic poverty and underdevelopment. Free trade, however, comes with its price. Cambodia's weak economy rests on three main pillars: agriculture, textile exports, and tourism. In recent years, foreign investment has been concentrated in the flourishing garment sector, which employs 240,000 workers and provides family income for up to a million people. Most factory owners hail from the Chinese mainland, Hong Kong, Singapore, and Taiwan. Attracted by the export quota and cheap labor, they, along with a few Korean and European investors, flocked to Cambodia.

In 2003, the clothing industry accounted for more than 90 percent of Cambodian export earnings, mostly in US and European markets. Shipment value soared from US$28 million in 1995, when Cambodia was struggling to rebuild its civil-war-ravaged economy, to US$1.5 billion in 2003. A 1996 bilateral trade agreement with the United States in effect drastically reduced average US tariff rates for Cambodian garments and increased US imports from US$1 million in 1996 to US$1.1 billion in 2003. The price for these generous trade benefits was Cambodia's commitment to improving labor conditions. In 2001, the International Labor Organization (ILO) began to inspect factory working conditions, in cooperation with the Garment Manufacturer's Association of Cambodia (GMAC), and jointly financed by the US and Cambodian governments.

Labor inspections, never popular with business owners, now weigh on Cambodia as it prepares for life without quotas. After Cambodian admittance to the WTO at the 2003 Cancun summit, a major debate erupted over the post-quota future of the nation's garment sector. Will a minnow like Cambodia be able to swim in the same pool as the northern giant, China? Many clothing manufacturers, having thrived on the quota system, now dread New Year's Day 2005. Then, they will begin no-holds-barred competition with China for their most important market, the United States. The old system of US textile import quotas had capped China's market share and effectively assured manufacturers in smaller nations some American orders.

Trade officials predict that of the 50 nations exporting clothing to the United States, perhaps only 10 can survive unfettered competition from China, with its almost limitless supply of cheap labor and its capacity for high-volume production. Cambodia, they say, might not be one of them. At factories clustered in a new industrial zone in Phnom Penh, manufacturers acknowledge their inability to beat China's prices.

Production costs in Cambodia, though much lower than those in North America, are about 25 percent higher than China's. Manufacturers cite a host of reasons. For instance, electricity costs are three times those in neighboring Thailand or Vietnam. The companies also suggest that good labor practices – overtime pay, bathroom breaks, and union representation – further boost costs. Asian growth is expected to level off as higher oil prices bite; only 1.9 percent growth is predicted for Cambodia next year. When the garment quotas are eliminated, the country's medium-term prospect, according to IMF projections, is grim. The industry downturn could also hurt the most vulnerable section of Cambodian society. Once benefiting from garment-sector employment opportunities, most workers are young women with few alternative prospects after textile factories leave Cambodia. With scant education and families desperate for financial support, they will likely fall prey to recruiters for bars and prostitution in Phnom Penh, or sweatshops and brothels in other countries.

What, then, can Cambodia do? It must adopt an agile, multi-faceted strategy in order to salvage any future benefits from globalization. One certainty is the need for a reform package to make Cambodia more cost-efficient and attractive to foreign investors. In a recent study, the World Bank identified Cambodia as one of the most corrupt and inefficient countries in Asia; labor productivity is 62 percent below industry levels in China, and even 10 percent below those in Bangladesh.

The government's strategy, strongly backed by the international donor community, involves cutting red tape and investment tariffs, reducing corruption, and lowering costs of power, transport, and insurance. The World Bank argues that WTO membership will strengthen government reforms, assist the private sector, and improve the investment climate. Even if such reforms are zealously implemented, Cambodia must contend with the volatility of the market. Analysts say the end of garment quotas will favor manufacturing consolidation and economies of scale, as prices for non-quota garments have fallen continuously since 2000. Increasingly, textile production will become a volume-driven business: A few big companies will expand across borders, eliminating rivals by offering the lowest price.

Cambodia must pin its hopes, not on direct competition with China and India, but on touting its ethical label to the discriminating consumer. Cambodian garments are sold to the West with the certified seal of ILO approval, which entails recognition of trade unions, overtime payment, and acceptable working conditions. The country must promote its garment industry as a role model for ensuring compliance with international labor standards and preventing the exploitation of child labor. Unfortunately, trade is driven by cut-throat competition – not ethical standards. Van Sou Ieng told The Cambodia Daily, "Buyers still insist on cheaper prices, regardless of Cambodia's high labor standards. In countries that don't care about child labor, environmental protection, or social justice, of course, their prices will be cheaper. We believe the trend must change. If not, it will be a sad story for some factories." 1

Organizations like the ILO and Oxfam, touting the primacy of "fair trade" over free trade, have attempted to redress imbalances that limit poorer nations. US government support of Cambodia's good labor practices may also provide short-term help if Washington adopts the so-called "product specific" safeguard against Chinese imports, available until 2013, or the "special textiles" safeguard, which expires in 2008. According to the Cambodian minister for trade, "In a time of harsh and fierce global competition, the survival of our country depends on our ability to capture the right opportunities and at the right time." But even staunch advocates of free-trade globalization concede that in order for small countries to reap the benefits, they must be well equipped to navigate uncharted and possibly turbulent waters; otherwise, the costs may outweigh the benefits. Without a major swing toward more equitable trade, the prospects look gloomy. Strong doubts remain about whether Cambodia, with its weak economic base and donor-dependent government, has either the preparation or the capacity to meet the challenge.

About the Author: Tom Fawthrop is a freelance journalist based in Phnom Penh and Bangkok.

1 The attribution to "The Cambodia Daily" was inadvertently omitted. We regret the error.

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