When import quotas on textile products coming into the United States ended January 1, 2005, under World Trade Organization agreements signed 10 years earlier, a flood of clothing poured in from China. Within months, the U.S. responded with restrictions on Chinese apparel imports. Yet according to Wharton faculty and industry executives, these restrictions will only delay, not end, the global move toward quota-free garment trade.
While some large U.S. textile makers are opposed to the removal of quotas, the overwhelming majority of U.S. clothing manufacturers and retailers produce the bulk of their products overseas and support the elimination of all restrictions on imports. This group anticipated that the end of the 30-year-old quota system would not be entirely smooth, and in fact were braced for the latest restrictions, known as safeguards under the WTO agreement. Indeed, they expect more safeguards to come, says William Cody, managing director of the Jay H. Baker Retailing Initiative at Wharton.
“There is a lot of uncertainty,” Cody notes. “The retailers and the manufacturers don’t know what the next safeguards will be, so you will see a mad rush in the next couple of weeks” as importers hurry to get as much new apparel out of China as possible, before new restrictions can take effect.
From January 1 through April, imports from China of cotton pants surged 1,500% and cotton shirts were up 1,300%, according to U.S. trade data. Chinese exports of clothing and garments to the United States had a total value of $24.4 billion from January through May, up 17.2% from the same period a year ago.
In May, the U.S. put new import quota limits on seven categories of apparel, including t-shirts, cotton pants and underwear. The safeguards allow Chinese imports in those categories to rise only 7.5% this year. Manufacturers expect to hit those limits by the end of the summer. When the limit is hit, no more goods can be shipped into the U.S. from China for a year, forcing importers to scramble for new sources that may not produce goods of the same quality or as cheaply as Chinese manufacturers.
The Birth of Supply-chain City
U.S. textile quotas were first enacted to protect domestic producers facing a wave of goods produced by newly-emerging manufacturing economies in Hong Kong and Taiwan. For many countries, garment production is the first step of the economic ladder because it requires little capital investment and makes its profits off low-wage, low-skilled labor. As part of an agreement signed in 1995 leading to China’s membership in the World Trade Organization, U.S. and European trade officials agreed to end the quota system in 2005, but reserved the right to enact the safeguards that have just gone into effect.
Rick Helfenbein, president of U.S. operations for Hong Kong-based garment manufacturer Luen Thai Holdings Ltd., who will present a case study in supply management this fall at Wharton, says his company was prepared for the safeguards but is focusing on an eventual end to Chinese garment quotas. “When global trade officials put all these rules into place, everyone was nervous. These officials wanted safeguards to slow the process down,” he says. “Nobody should really be surprised” — given the 10-year warning — “but obviously there are certain factions in the U.S. that feel they need more time to react. The safeguards are slowing the process down, but not terminating it.”
In preparation for the demise of quotas, Luen Thai, whose customers include Polo Ralph Lauren, Liz Claiborne, Dillard’s and Limited Brands, has developed a major garment assembly complex in China, about an hour north of Hong Kong, known as Supply-chain City. The facility employs 14,000 workers.
With the latest restrictions, Helfenbein says Luen Thai will diversify production using other company factories around the world. In the meantime, it has geared Chinese production toward markets in Japan and Europe for the next few years, until the safeguards expire. “When we were building Supply-chain City, our strategy was to build it for Japan and Europe and over time it would evolve for the U.S.,” says Helfenbein.
Bob Zane, senior vice president of Liz Claiborne, says China will ultimately make 50% to 80% of all U.S. apparel. Everything being equal, “China produces better quality garments more reliably than any other country,” says Zane. “So it was normal that when quotas disappeared from China, people ran there to get the best production. This resulted in the surge, which resulted in safeguards.”
Companies that source garments internationally were disappointed by the latest Chinese import limits, he says, but are profiting from the January 1 end of quotas because other WTO countries reduced their prices to compete with China. “When we look at the world of sourcing in China, we can’t look at today or tomorrow,” says Zane. “We have to understand what things will be like at the end of the decade when all this silliness stops. By then there will be no quotas in China or anywhere else, and the arrangements in place will be very favorable to those of us sourcing product.”
Price is only one consideration, according to Wesley Card, chief operating officer of Jones Apparel Group, Inc., another major apparel importer. Quotas make it difficult for a company that designs coordinating sets to gauge where it can manufacture certain pieces because of the complicated quota system limiting production by country and type of garment. “We did not place a big bet on China in 2005,” says Card.
Looking forward, however, Jones is seeking contract suppliers in China and elsewhere that can provide a broader range of services than just cutting and sewing. While top designers will always remain in New York or Europe, Card says, many design-related technical work will probably move overseas. “We are focusing on factories with good technology and the ability down the line to allow more of that sort of service to take place at the point of production, which is more efficient.”
Marshall Fisher, Wharton professor of operations and information management, says that in recent years garment manufacturers separated production of pieces of garments into various locations around the world, searching out specialists who could perform each function most efficiently. Those in the business call it “chasing the cheapest needle,” says Fisher. “The norm in sourcing apparel from Asia was that you could have a shirt made in six different countries and each country would specialize in each part of it. Companies bragged about this, but it was obviously very complex.”
Luen Thai, he says, represents a new model of integration — not only in design and production, but also for packaging and distribution directly to stores. Integrated production will cut costs and time to market which, in the trendy fashion sector, is crucial for profitability. For example, Fisher said designers in New York, working with patternmakers in Asia, now take weeks to come up with samples. Under the emerging system, designers could meet at fully integrated plants in Asia and come up with completed samples in hours.
Wharton management professor Marshall Meyer adds that the flap over textile quotas comes against a backdrop of other political tensions between the U.S. and China. The Chinese economy is already softening, increasing the prospect for higher unemployment in China. Millions of peasants have relocated from rural areas to urban slums looking for factory work, and Chinese leaders are concerned about the possibility of social unrest if unemployment increases significantly.
Losing a Foreign Policy Tool
In the weeks before the safeguards were enacted, China attempted to appease U.S. trade officials with an offer to raise tariffs on exports leaving the country. Ultimately, China withdrew that proposal when the U.S. held firm on its decision to enact the safeguard provisions. China averted European Union safeguards when it voluntarily agreed to limit textile exports in certain categories to an increase of about 10% over last year.
Wharton legal studies professor Phil Nichols suggests the conflict involves more than just the United States and China. Those hardest hit by the elimination of textile quotas are garment workers in countries such as India, Pakistan, Turkey and Egypt, not American workers, who at least stand to benefit from lower consumer prices. “The problem is the benefits are not going to those negatively affected,” says Nichols. In the countries mentioned above, “there is not the institutional capacity to handle these changes and offset the damages and redistribute the benefits.”
Opposition to the elimination of quotas remains strong in southern U.S. states where large textile companies continue to operate, although their ranks are shrinking. Lloyd Wood, spokesman for the American Manufacturing Trade Action Coalition (AMTAC), which represents about 150 garment and textile makers, argues that U.S. producers only hope to level the playing field against Chinese competition. He says Chinese manufacturers benefit from government subsidies — including reduced electricity rates, currency supports and tolerance of non-performing bank loans — which violate WTO accords. Since the passage of the North American Free Trade Agreement in 1993, U.S. garment and textile employment has dropped 57% from 1.55 million to 666,500, according to AMTAC.
Agreeing to the end of quotas eliminates an effective foreign policy tool, not only in dealing with China, but other nations as well, says Wood, adding that if China can get away with importing subsidized garments into the U.S., other countries may try the same thing in other areas. He points to Brazilian auto products as an example. “By giving easy access, you are going to see country after country around the world emulate the Chinese model which is to pick out a product and undercut everybody else’s price until you run the other players out of business.”
Under WTO rules, the textile safeguards can only be enacted through 2008. Card and others say they don’t expect the U.S. to come up with another plan to breathe new life into the quota system after that and risk offending the global trade organization. “I would be really surprised if the U.S. ever became that protectionist,” says Card. Zane, of Liz Claiborne, says the new restrictions damage U.S. credibility as a promoter of free-market systems. “It only shows that we are sore losers. I don’t think it makes us look very good.” Apparel manufacturers complain that quotas add cost and complexity to production that eventually are paid for by consumers. Zane estimates the total additional cost at about 15%.
As for retailers and their customers, the eventual demise of quotas will have little effect, says Wharton marketing professor Stephen Hoch, because other nations have lowered their prices to compete with China. “I don’t think the consumer will notice it because clothing is so cheap already and has been for some time.” Hoch points out that apparel importers have little competitive advantage between them because they all use large contract manufacturers in China. Deflating apparel prices — driven by increasingly lower production costs and fierce retail competition led by Wal-Mart and other discounters — is making it difficult for retailers to improve on their sales numbers year over year. The challenge for retailers is to get consumers to buy more clothes, says Hoch.
According to Cody, retailers are likely to hold the line on prices. “The party line among retailers was that prices are difficult to maintain. If a consumer is used to paying $29.99 for a pair of khakis, the retailer will keep the price the same and compete on quality. The last thing the garment industry needs is a price war.” He points to European retailer H&M, which he says sells clothing that is so cheap and trendy that it can be considered disposable. “It doesn’t have a long shelf life. You wear it one season and you’re done with it, but the price is so low it gives you the opportunity to buy more.”
Retailers hoping to use this strategy need to turn their inventory more frequently to encourage volume buying, says Cody. H&M and Zara, another European retailer, cycle products through their stores 12 to 20 times a year compared to 4 to 6 inventory turns at most traditional retailers. Cody also suggests that a movement to cheap, disposable clothing dovetails with a current strength of the luxury market. “If you have a fixed pot of income, you can buy a t-shirt at Target and then a bag at Coach or shoes at Neiman Marcus.”