NEW YORK — The expiration of the quota system that has regulated the world’s apparel and textile trade for more than three decades will be an epoch-making event.
Since the early Seventies, apparel importers’ decisions about what they can buy, where they can buy it and how much of it they can get have been influenced by the quota regulations. The quotas created a world in which the apparel supply chain remained highly fragmented, with few nations’ industries holding a dominant position in any given category.
The nations of the World Trade Organization have been phasing out those quotas since 1995, with the goal of encouraging free trade in a category of business that’s served as an important first step up the economic development ladder for dozens of nations.
While executives in the U.S. and abroad have known for years about the looming change, there is still significant uncertainty surrounding just how the early months of 2005 will play out, as well as how the end of quotas will affect the apparel industry in the long run.
The immediate concerns revolve around China: That nation’s massive apparel industry makes it a prime contender to consolidate its position as the U.S.’ leading supplier of imported textiles and apparel. But China is also the only one of the 147 WTO nations that could still be subject to quotas next year.
When China joined the WTO in 2001, the quota phase-out period was already more than halfway complete. To ease smaller nations’ objections that China’s quick entry into the WTO would give it an unfair advantage in the apparel world, China agreed to a measure called safeguard quotas. The safeguard measures allow nations to impose temporary import limits on select categories of Chinese merchandise for up to three years.
Most industry executives said they expect the first months of 2005 to bring a massive surge in Chinese exports that will likely continue until the U.S. imposes safeguards. That would repeat a pattern that played out in 2002 and 2003, after quotas were lifted on categories including bras, robes and knit fabrics and safeguards were imposed in November 2003.
Peter McGrath, president of purchasing for J.C. Penney Co. Inc., based in Plano, Tex., said early 2005 will likely be “a period of uncertainty, particularly as it relates to safeguards on China by the U.S.…smart sourcing people are going to be really cautious until we see things settle down.”
This story first appeared in the September 28, 2004 issue of WWD. Subscribe Today.
Carlos Arias, executive vice president of Koramsa, a major pants manufacturer based in Guatemala City, said, “We certainly believe that there will be turmoil, especially around the issue of what…limitations the U.S. government might impose. That’s a critical item and that’s anybody’s guess.”
While they have some critical unanswered questions, importers are not predicting chaos, largely because most major companies won’t start the new year with major changes in their business patterns.
“This whole 2005 situation, I liken to the millennium and 1997 in Hong Kong,” said Bruce Rockowitz, president and chief executive officer of Li & Fung (Trading) Ltd., the Hong Kong sourcing giant.
He was referring to the “Millennium Bug,” which was expected to devastate computer systems worldwide when the calendar changed from 1999 to 2000, and the year the British handed over authority for their former possession to the Chinese. In both of those cases, Rockowitz said, advanced planning meant major problems were averted.
Beyond the safeguard question, another uncertainty importers will face early next year is whether many firms decide to hold off December shipments, not bringing their goods to Asian ports until January, to avoid quota charges and potential embargoes.
“Some semblance of order will return after this initial flurry,” said John Cheh, executive director of Esquel Group and chairman of Esquel China Holdings Ltd., a vertically integrated garment producer with factories in China, Hong Kong, Malaysia, Sri Lanka and Vietnam. “More fundamental shifts in trade patterns will take longer to work out.”
Over the long term, importers agreed, the most significant change the end of quotas will bring is a vast consolidation of apparel manufacturing. Today, the apparel industry is widely fragmented. For the year ended in July, the U.S. imported $78.88 billion worth of textiles and apparel. China, the number one supplier, had a 16.6 percent share of the market. Mexico came in second with 9.8 percent. After that, 20 countries held market shares of between 1 and 5 percent — valued from $1.32 billion to $3.85 billion.
Most major apparel firms said they expect to significantly reduce the number of countries from which they buy over the next five years.
Rockowitz said Li & Fung currently sources apparel in more than 40 countries. After the quota restrictions are lifted, he said, “What’s going to happen is, instead of 40 countries or 50 countries, it’ll be 20 countries.
That will make each country in which Li & Fung does business comparatively that much more important.
“You’ll need a greater depth [of experience] in each country,” he said.
While Li & Fung now has 18 regional offices in China, that number could grow to 40 by 2010, he said. Likewise, the firm expects to expand beyond its current four regional offices in India.
In recent years, the apparel industry has been particularly footloose, with buyers moving orders from nation to nation in search of lower prices, new factories and the all-important quota access. Importers said it has been important for them to have relationships with factories in multiple nations that made the same products so that they were assured of a constant source of supply if one nation filled its quota early in the year and faced an embargo — the government process for denying goods entry into the country.
As the U.S. government has inked free-trade agreements and offered trade-preference deals such as the North American Free Trade Agreement, the Caribbean Basin Trade Partnership Act and the Africa Growth & Opportunity Act, importers have steadily tested the waters of new nations, looking to see what their manufacturers had to offer.
With quotas out of the picture, observers said it’s likely that apparel firms will become a little less restless.
“The quota phaseout will bring the end to nomadic sourcing,” said David Birnbaum, a consultant with the firm Third Horizon Ltd. “The determining factor will not be where you buy goods, but from whom you buy goods. Within 10 years, 50 transnational factories — each shipping $2 billion to $3 billion [worth of merchandise] — will control 70 percent of the global export market.”
That’s something executives from branded vendors have begun to call for in recent years — single factories that could manufacture all the products carrying a particular brand’s name, tops and bottoms, woven and knit garments. Some such factories are already under construction: Luen Thai International Group Ltd., for instance, is building what its executives call a “supply-chain city” in Dongguan, China, that will employ 12,500 workers and produce $250 million worth of goods per year. But not all observers agree on the feasibility of these so-called megafactories.
“You’re not going to see factories doing $5 billion worth of merchandise,” said Rockowitz. “It’s impossible to manage.”
His employer, Li & Fung, sells $5.5 billion worth of merchandise a year, which is produced at more than 6,000 contract factories around the world.
Importers and manufacturers also said they expect the end of the quota system to drive apparel prices down, for both short-term and long-term reasons.
The most immediate effect will be end of quota charges, which can be a significant cost in some nations, notably China. In that country and in other parts of Asia, quota rights trade informally as commodities. Toward the end of the year, the price importers must pay to gain access to quota typically rose and by late fall it could equal the cost of having a garment manufactured. With quotas out of the picture, most importers expect that charge to evaporate.
“Initially, most of the buyers negotiated the prices to be lower, at least to deduct the quota cost,” said George Ling, board chairman of Newtimes Group Holdings Ltd., a major sourcing company based in Hong Kong. “For the long term, they may negotiate further.”
McGrath of Penney’s said, “We expect prices to decline 8 to 18 percent over a two-year period of time.”
Still, quota costs are not a part of production in all nations, so importers won’t see declines of that magnitude in all their orders.
“In Latin America, you don’t have quota costs. Quota is present, but it’s not commercialized,” said Arias of Koramsa. “We did have customers and some representatives of our customers who didn’t understand that. At some point, some people asked us for reductions based on quota. We had to explain that was never present.”
Li & Fung’s Rockowitz also noted that it’s possible the U.S. and China will negotiate some sort of blanket informal quota-like agreement, rather than fighting out safeguard complaints on a category-by-category basis. In that case, he said, it’s likely that charges may continue to be a factor.
Over the longer term, importers said the increased competition allowed by the end of quotas will tend to drive down prices.
Birnbaum, the consultant, estimated that world manufacturing capacity exceeds current quota limits by about 50 percent, with much of the excess capacity in nations that are highly competitive.
“Once quotas have been lifted, this capacity will be available, creating the greatest buyer’s market in the history of the industry,” he said. “Customers will be able to make any demands they want.”
As factories and countries battle for a share of the world apparel business, many nations that are heavily dependent on garment exports may suffer economically, executives noted.
“In Asia right now, the manufacturing sector is a huge part of the economy, not like in the U.S.,” said Conrad Lung, chief operating officer of Mudd USA. Calling China “the 500-pound gorilla” of apparel manufacturing, he said many other Asian nations will be looking for ways to compete against it. Cost-cutting will likely be high on their list of options.
However, after a few years of shakeout, in which many factories will likely go out of business and some nations could lose most or all of their apparel exports, prices will likely level off.
“We do see a leveling of prices after the reshifting,” Penney’s McGrath said. “There’s only so much efficiencies we can get out of the manufacturing process. There is a direct cost associated with it.”
Over the long term, the greatest question surrounding the elimination of quotas is what overall economic effect it will have on the world. When the signatories to the GATT pact of 1994 that created the WTO mandated the end the quota system, the goal was to make it easier for developing countries to get started in this bootstrap industry, not to allow a handful of nations to dominate the apparel trade.
However, there has been great concern this year that nations in Africa, Latin America and some parts of Asia — particularly Sri Lanka and Bangladesh — will have difficulty competing in the new environment. Early this year, the International Labor Organization released a report predicting that Bangladesh and Indonesia each stood to lose one million jobs as a result of the change. The concerns led industry associations in more than 50 countries to sign the Istanbul Declaration, asking the WTO to reconsider the move.
Some executives remained concerned that the changes could hurt many countries in the developing world.
“We believe that our industry in Guatemala, as well as in Central America, will certainly be hurt by the elimination of quota,” said Arias of Koramsa. “Our industry has not evolved as we have hoped. We have a high potential of being hurt in the short term.”
Others suggested that China’s growth was already prompting strong economic development in that country, a trend that could over a long time turn it into a larger consumer of apparel. Overall, China currently runs a trade deficit because it is importing large quantities of industrial materials to fuel its growth.
Rockowitz of Li & Fung said apparel manufacturers along China’s coast are already facing labor shortages as the migrant workers they depend on to staff their factories opt to stay in their home provinces further inland.
“People can stay in their own provinces and get the same wage,” he said, reasoning that this will eventually prompt coastal manufacturers to raise the wages they offer.
Belief that Chinese consumption is on the rise prompted Invista last week to decide to build a $100 million spandex plant in Guangdong province, that will initially produce 12,000 tons of fiber a year, all of which the Koch subsidiary said is aimed at Chinese consumers.
“We’re not going to be making stuff in China to export,” said Bill Ghitis, president of apparel at Invista.
At Esquel, which has the bulk of its operations in China, Cheh said, “The gain is not simply based on China grabbing the lion’s share of the world’s textile and apparel market, but rather from China’s industry going higher upstream and achieving higher value-added production.”
Summing up the ideals behind free trade, he asserted, “It is a positive-sum game and not a zero-sum game. Some countries will face short-term adjustment problems and see certain sectors of their industries decline, but in the long run, the adjustment will pay off dividends in terms of efficiency gains.”