Mahoshada

It is now one year since the end of the Multi-Fibre Arrangement (MFA) – the elimination of most international quotas on exports of garments and textiles to the US and EU. A few predicted imminent doom for the garment industry, that it would collapse like a house of cards in response to increased global competition. Most analysts looking ahead expected that the full impacts might take as much as several years to felt by the industry. This more moderate view now looks to have been more accurate.

It should be pointed out that there have been a number of countries where the impact of the end of the MFA has indeed been a catastrophe for their garment industries. Lesotho, Philippines, Fiji, Turkey, Nigeria, Kenya, El Salvador and Mexico all have had significant job losses during the last year.

These jobs did not disappear, however. For the most part they simply moved to countries whose producers were able to sell at a lower price – in other words, were more competitive. The biggest “winner’ has of course been China, but India, Bangladesh, Vietnam and Cambodia have also done relatively well. Overall, during the last year Sri Lanka was able to more or less hold on to its position in its largest market, the US, while it was losing some ground in the UK, its largest EU market.

The Oxfam Report
Recently Oxfam, an international NGO, issued an interim report as part of their study looking at the impact of the end of the MFA on the country’s garment industry. This report made headlines because it suggested that during the first nine months of 2005 some 15 garment factories have closed leading to a loss of 3,000 jobs. In fact the picture may well have been worse than suggested because they indicated that as many as 22 additional factories may have also closed; Oxfam is looking into this while preparing their final report.

Keeping in mind that this is only represents part of the total picture, it is worth noting that these were mostly small or medium scale producers – average employment was only 200. (Of the 15, there was one “large scale” producer which accounted for 592 of the job losses.) Almost all of these closed factories had large EPF defaults and many owed back wages to their workers. And according to Oxfam, 14 out of 15 of these factories were from rural areas. This should come as no great surprise because as difficult as the commercial environment is in Colombo, it is considerably more difficult in the rural areas.

300 Garment Factory Programme
Earlier this month Minister Rohitha Bogollagama (Investment Promotion and National Enterprise Development) announced that the government would immediately implement 50 of the 300 planned garment factories in rural areas. Although not described in these terms, this appears to be an attempt by the government to introduce a bigger and better programme than President Premadasa’s 200 garment factory programme in 1992, when Minister Bogollagama was heading the BOI.

There are, however, several major differences between then and now. One of the major incentives that President Premadasa had to offer was increased access to export quotas to those firms that signed up for the programme – with higher levels available to those firms willing to locate in the most difficult areas. He also offered very liberal tax concessions and easier access to credit through the state banks.

It may be the government does not yet appreciate the full implications of the end of the quota system. After all, Mahinda Chintana states that the president “will also make every effort to regain the lost US quotas.” That is not going to happen. The days of getting a quick fix through quota adjustments are over.

Back when MFA quotas covered substantially all exports in garments to the developed countries, a producer being given a quota was virtually guaranteed a sale of the finished garment. The system was set up in such a way as to allow even relatively inefficient garment producers to be able to manufacture and survive financially. Some of the least efficient producers were operating in the countries mentioned above, where the end of quotas has lead to significant reductions in production levels. At that time, Sri Lankan producers that shifted their factories to more costly rural areas were essentially competing with high cost producers in places like Lesotho, Fiji, Nigeria and El Salvador. Today, it is more likely that they would be competing head-to-head against producers in countries like India, Bangladesh, Vietnam and Cambodia, or even China. One of the biggest changes between then and now is that there is no longer anything like a guaranteed sale for what is produced. Firms must fight for every sale and do so on the basis of price, speed of delivery, etc.

Shrinking Margins
Ask anyone in the garment business here today and they will tell you that they are facing enormous pressures due to rapidly shrinking margins – the difference between what they can sell a garment for and what it costs to produce. This was described by someone in the business as an “increasingly impossible situation.”

Before the end of the MFA quota system, prices everywhere tended to reflect the high costs of inefficient producers, while today more and more the prices are being determined by the most efficient producers such as China. The reason – buyers are now free to shop around to find the lowest prices whereas before they had to shop around to find producers in countries that had quota available for the types of garments they needed.

The impact of the end of the MFA quota system on the prices of garments exported by China has been dramatic. Looking at several types of garments that are important for Sri Lankan producers – the average export price from China fell by about 50 percent almost immediately after quotas were lifted.

Fighting Back
Not surprisingly, the immediate response to the increased competitive pressures has been to look for a quick fix or easy short term solution aimed at changing relative market access. Some thought that Sri Lanka’s qualification for the EU’s enhanced Generalized System of Preferences (GSP plus) would be a panacea. But this overlooked the fact that both the EU and the US have offered virtually duty free access to their markets through GSP systems to developing countries for many years – but little actual increased trade has resulted. The main reason being that whenever preferential market access is granted, criteria are inevitably established to ensure that the good is actually produced in the country and not simply shipped there by someone aiming to take advantage of the preference. These criteria, so-called rules of origin, are typically difficult to document and even harder to comply with. This should not be surprising, since there are always producers who are not anxious to face increased competition in the countries granting the preferences. As a result, it appears that GSP plus will offer little actual benefit because of the restrictive rules of origin that go along with the programme.

In the important US market, there is some chance that Sri Lanka will be able to gain preferential access for a limited time, as one of the countries most adversely affected by the tsunami. A bill that would relax US trade barriers has been in the US Congress for some time and may yet become law. But this will also certainly impose relatively tough rules of origin aimed at ensuring that garments manufactured in China, India and elsewhere are not simply being transshipped through Sri Lanka.

Neither of these measures is going to help the garment industry to overcome the enormous challenge being faced. At best, they may provide a brief respite from the pressures. But even this looks doubtful.

Increasing Productivity
The only realistic answer for the industry is to find ways to improve productivity to enable them to continue to compete effectively. And as had been discussed in earlier articles, to be successful, this process must make significant progress on a number of different fronts, including, inter alia, strengthening macro-economic and fiscal policies, reducing the burden of regulations, improving infrastructure, increasing the capacity of the workforce and reducing the high costs associated with moving goods through the port. There is much to do in all of these areas. And most of what needs to be done will take some time and require capable political leadership.

Unfortunately, the ill conceived 300 garment factory programme, if it has any impact at all, will only tend to undermine the competitiveness of the industry. With over 80 percent of the fabric requirements of the industry being met by imports, locating factories far from Colombo will lead to significant additional costs both for bringing the fabric to the factory and the finished goods to the port. At a time when garment producers should be aggressively searching for ways to reduce their costs, a government programme that would raise these costs is unlikely to be of much help.

As mentioned above, according to the Oxfam report 14 of the 15 garments factories that closed had been operating in rural areas. Rural producers are the most vulnerable because their costs of production tend to be higher than those located near the port or close to the major transportation corridors. It should be no surprise that according to the BOI’s current count of the number of firms operating under the “200 Garment Factory Programme”, more than 20 percent are located in Colombo and Gampaha districts. And if one looks at the main transport corridors connecting Galle and Puttalam-Kandy with Colombo, nearly two-thirds of the existing 200 Garment Factories are located along these roads.

Unfortunately, it seems as though the industry and the government would much rather find any sort of quick fix for what is one of the most serious economic challenges facing the country, than to undertake the difficult and in many cases politically unpopular work to substantially strengthen the country’s economic foundation. Doing this difficult work will not only increase the chances of the garment industry to continue to exist and possibly grow, it will also improve the commercial prospects for virtually all types of economic activities. And in the end, this would do far more for the rural economy than any special incentive programme.