A Case of Diminished Returns

Thursday, April 23, 2009

With the expiration of the bilateral textile quota agreement between the U.S. and China at the end of last year, there's renewed talk in Washington of initiating safeguard quota actions to control imports and various sensitive product categories. Although it is certainly true that Chinese exports of certain products have indeed increased since the expiration of the quota agreement, I think the U.S. industry should take care in how it addresses imports going forward.

When the bilateral quota agreement was negotiated between the U.S. and China, there was a collective sigh of relief in U.S. textile circles that the Chinese export dragon had been slain. Yet it took just a few months for a new story to emerge: As imports from China leveled out due to the new quota restraints, exports from other quota-free suppliers soared.

I think there's a message in this for quota watchers: Unless there's a way of restricting all imports from all suppliers at the same time (and there isn't under WTO rules), then one-on safeguard actions are going to be of little help in protecting U.S. producers, as importers will simply switch their sources of supply to avoid such isolated restrictions. In turn, this also has the net effect of actually helping producers outside to establish themselves in the global market.

Several years ago, I ran the following article detailing some of the problems and challenges the then-newly established textile agreement between the U.S. and China posed for U.S. textile producers. With the benefit of hindsight, I think many of the observations in the article have held up quite well over time and that it should serve as a cautionary analysis for would-be safeguard advocates.

January 2006

With the recent signing of the new textile quota agreement between the US and China dominating much of the business news over the past few weeks, domestic cotton and textile leaders have praised the deal as being essential to the future viability of the industry. But after reviewing the terms and coverage of the agreement, the effectiveness of the deal as a shield for domestic producers against a flood of imports from China has to be questioned.

Industry leaders hailed the agreement as being “a victory” and “good news” for the U.S. textile industry, the “big winners” in the recent negotiations between the U.S. and China. Implicit in the industry praise is the hope of improved sales for domestic mills and that now with Chinese exports capped in some categories the surge in imports from China will slow.

Yet despite all of the superlatives, U.S. imports of textiles and apparel have continued to rise as other suppliers rushed to fill orders placed by skittish retailers looking to avoid the China trade row altogether. Through September, U.S. imports of apparel for all sources are up by nearly 12 percent, while imports from Bangladesh (up 20 percent), Indonesia (up 14 percent), India (up 27 percent), Pakistan (up 10 percent) and Sri Lanka (up 12 percent) have all risen sharply. Interestingly, imports from Jordan are also up sharply this year gaining 25 percent through September. In turn, all of these increases have been posted while imports of China have soared by 111 percent – despite the existence of safeguard quotas on many products.

How has the domestic textile industry performed since safeguards went into effect? If domestic consumption of cotton and man-made fiber is any indication, then the answer is: not well.

Average daily consumption of cotton by U.S. mills in September fell to just 21,163 bales in September, one of the lowest levels on record, while at the same time daily average consumption of man-made fibers fell to record low of 2.282 million pounds. In both cases, current consumption levels are more than 10 percent lower than September 2004 levels.

Nevertheless, supporters of the quota deal with China continue to see it as a good thing for domestic producers.

Although it is true that there has been some month-to-month improvement in domestic output, these comments are somewhat misleading as year over year results still depict an industry in decline. According to a just-released report by the Census Bureau, U.S. textile and apparel production is actually down in 2005 as compared to 2004. In fact, as reported in the Census Bureau’s Manufacturers’ Shipments, Inventories and Orders (M3) report, textile mill output is down by 6.6 percent for the year-to-date September as compared to comparable 2004 levels, while output of apparel is down 0.9 percent over the same time period. In turn, 2004 levels were well below those posted in 2003.

So despite the use of safeguards and a new bilateral quota agreement with China, imports continue to rise, while domestic production continues to fall.

One can argue politics, but the economic forces affecting the textile industry are still the deciding factors in who wins or loses in the textile stakes, not quota agreements. Domestic mills complain that producers in China have unfair subsidies, rig their currency and dump their products on world markets. Perhaps. But the bottom-line for domestic mills is simply a case of price and quality – making products that customers want to buy at competitive prices. After years of competing globally, it appears that foreign suppliers – be they in China, India or wherever – have gained the upper hand in the market at the expense of many U.S. producers.

Yet the message from the U.S. industry is that they are “big winners” because of the quota deal with China. The numbers suggest that it is not the case. In fact, it is difficult to see if the safeguard quotas with China have been of any direct economic benefit to the domestic textile industry.

Why is this? Because the coverage of the safeguards is so narrow. Even the new bilateral agreement is narrow – just 34 categories covered. The U.S. imports textiles in more than 150 categories. By blocking China, all that’s happened is that other suppliers have stepped up to fulfill the demand by U.S. importers to buy product. At the same time, Chinese producers have also moved production to other countries, too. Some of this movement is legitimate, while some of it is not. Transshipments may become a rallying cry for U.S. mills as 2006 unfolds – in fact, this may be exactly what they expect to see. More reason to expand safeguards to other countries, they will say.

Frankly, what the domestic industry should really be concerned about in the long run is the ability of the American consumer to continue to spend at historic rates of consumption. Quota agreements may solve political problems, but do little to solve economic ones. A saturated U.S. market has implications for all textile producers no matter where they a located around the world.

It is interesting to note that imports of apparel into the U.S. -- which are quota-free for most suppliers -- are up by 12 percent for the year, an increase in line with year-over-year import growth posted over the past dozen years or so. Ironically, the growth rate is actually lower than for some years when quotas actually restrained the bulk of the trade. It is also interesting to note that imports of non-apparel textiles – yarns, fabrics and made-ups – are up by just six percent in 2005, a modest result compared to previous years.

There was so much doom and gloom forecast by industry leaders when the Agreement on Textiles and Clothing (ATC) ended this past December. Without the previous system of global quotas in place, so the thinking went in domestic textile circles, imports were going to flood the market and would continue grow at accelerated rates. In light of the trade results so far this year, the question needs to be asked, with quotas eliminated for most suppliers, why aren’t these increases higher? Or, put another way, where’s the flood?

Answers to these questions lie with the market itself. Import growth has not soared simply because there is only so much market available and that market is largely saturated at this point. In terms of fiber consumption, the U.S. apparel market grows on average by just one percent a year – basically at the rate of population growth. Once imports carved out their share of the market – and, in turn, replaced domestic production -- then the realities of the market took over, as the rate of growth in imports moderated as the market became saturated with product. As a result, imports cannot keep growing forever at double-digit growth rates if there is not excess market growth to support higher imports. Certainly, this not only has implications for domestic mills, but exporters as well. As there is only a finite market available, a key question for the future remains: are there too many producers chasing the market?

The question of competing in a finite market should increasingly be the topic of discussion in Washington as well as in Beijing, not quotas. In the final analysis, market demand will be central to success for manufacturers everywhere. For exporters, questions also need to be asked about market growth in Europe and Japan, which have been anemic underperformers in recent years. Will those markets be able to support more imports? What happens to their domestic producers as a result? And then, of course, the big challenge for the next ten years or so will be if China’s burgeoning consumer economy will be able to absorb much of the production that had previously been used for exports only. What will happen to China’s export-driven textile industry if overseas markets fail to expand? What will happen if China’s consumer economy falters?

Stay tuned.

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