Oxfam International

Edited Reprint

The existence of winners and losers from the phase-out of MFA quotas and tariff reform is a key feature of the textiles and clothing trade at present. Exact predictions for a post-quota world are hard to make, but one recent IMF-World Bank study suggests that developing countries’ export revenues could rise by $22 billion a year thanks to the lifting of rich countries’ import quotas.1 Three facts about the distribution of benefits are generally accepted: first, the lifting of quotas will yield positive benefits for the developing world on aggregate. Second, countries that were highly constrained by quotas - notably China and India - will benefit significantly from the phase-out. And third, a number of developing countries which previously benefited from the restrictions on those large exporters will find it extremely difficult to deal with increased competition.

Not surprisingly, there are very conflicting predictions about the exact impact of MFA phase-out on China’s market share. In many of the less significant categories that have seen their quotas removed, China has exhibited enormous growth. For example, when infant wear was liberalised in Phase Two of the World Trade Organisation’s Agreement on Textiles and Clothing (ATC), China’s exports in this category grew by 298 percent in 2002 and 81 percent in 2003. In the same years, Bangladesh’s exports of infant wear shrank by 25 percent and nine percent.2

A well-publicised report by the American Textiles and Manufacturers Institute (ATMI) also suggests that imports from China in all categories will surge, to occupy more than two thirds of the US textiles and clothing market once quotas are removed. However, the US International Trade Commission estimates much more moderately that China’s share of the US apparel market will reach 28 percent by 2010.

Although China benefits from low labour costs these are not the lowest in the industry, as Figure 1 shows.3 Of course, other factors having an impact on competitiveness, such as the right to organise, should be factored in to make international comparison more meaningful.

In any case, it is unlikely that brands and retailers will choose to put all their eggs in one basket by sourcing from China alone. It should also be remembered that, even if China and India are the main beneficiaries of quota phase-out, the potential impact on poverty reduction from these countries’ gains is still considerable, given that their joint populations constitute more than 2.3 billion people, of whom 563 million live in abject poverty.4 Of course, where labour organisation is heavily restricted, the benefits for poor workers can be substantially reduced. However, denying jobs to those workers is not the solution. The aim must be to achieve more jobs and better employment conditions.

Notwithstanding the aggregate gains, the consequences for textile and clothing workers in countries that were protected by MFA quotas will be stark. Bangladesh and Sri Lanka, for example, benefited from tight quota restraints on their major competitors, and witnessed rapid growth in their exports, such that textiles and clothing came to constitute 86 percent and 54 percent of national merchandise exports respectively in 2001. One pessimistic estimate for Bangladesh suggests that more than one million workers will lose their jobs over the coming years.5 Industry forecasts for Sri Lanka estimate that around 40-50 percent of factories will close down, and that about 100,000 (one in three) jobs in the industry will be lost.6 Displaced women workers in particular will have great difficulty in finding employment, because of the limited alternative job opportunities for women.

Rich countries should help the losers from quota phase-out with increased financial and technical assistance, particularly given that the suddenness of job losses will largely be due to backloading of phase-out. However, preferential access granted by industrialised countries for the poorest and most vulnerable countries also has a crucial role to play in the industry’s survival in these countries.

The principle of preferential access for exports from the world’s poorest countries to industrialised-country markets is widely accepted: WTO members pledged in the 2001 Doha Declaration: ‘We commit ourselves to the objective of duty-free, quota-free market access for products originating from LDCs.’7 If such promises of preferences for the poorest and most vulnerable countries were actually realised, then losses due to quota phase-out would be partially mitigated. However, despite rich-country promises and a number of widely publicised preference schemes for Least Developed Country (LDC) exports, duty-free and quota-free access has not been realised for a sizeable proportion of the exports in question. Nor have preferences granted in trade agreements with other developing countries been fully realised. Contributing significantly to this phenomenon of ‘missing preferences’ are certain little understood but vital features of trade agreements, known as ‘rules of origin’.

Theory and practice of rules of origin: learning from Bangladesh
Rules of origin exist in order to determine which country a product ‘comes from’ for the sake of trade policy. In principle, they are desirable instruments. Without them, preferential schemes such as the ‘Everything But Arms’ (EBA) initiative and the ‘Africa Growth and Opportunity Act’ (AGOA), through which the EU and USA offer duty-free access to exports from many of the world’s poorest countries, would offer beneficiary countries little advantage over their competitors. As an example, take a T-shirt produced entirely in Korea, which would ordinarily face a tariff when entering the European market. If there were no way of determining where the T-shirt ‘came from’ for trade purposes, it could simply be shipped via Bangladesh (an LDC eligible for trade preferences under EBA) and thus gain duty-free access to the EU market. If this were to happen, the extra incentive that EBA should generate for producers to locate in Bangladesh rather than Korea would be lost.

Clearly, it makes sense to require that a T-shirt exported from Bangladesh should have some Bangladeshi content if it is to qualify for preferential market access. In practice, however, rules of origin requirements are far more arduous than is necessary. Typically they prescribe heavy conditions on how much value must be added in the exporting country, and the sources of inputs to goods, if the goods are to be considered as ‘originating’ there.

The EU is currently reassessing its rules of origin, within a broader review of its preferential trade agreements. The reassessment should focus on the restrictive nature of rules of origin for developing country exporters, particularly in the textile and clothing sector, and propose changes in line with those introduced by Canada in its recent ‘Market Access Initiative for LDCs’. However there is a risk that attention will instead be diverted towards bureaucratic and administrative procedures, ignoring the development perspective. It is vital that this is not allowed to occur.

How rules of origin limit South-South trade and restrict exports
For a T-shirt to originate in Bangladesh under the EU’s rules, it must either have undergone two stages of transformation there (from yarn to fabrics, and fabrics to clothing), or have used fabrics from other South Asian countries and added more value in Bangladesh than in any other contributing country. Unfortunately, Bangladesh simply does not have the spinning and weaving capacity to produce enough fabrics to supply its clothing industry, nor does the value added in the last stage of production usually constitute the majority of the good’s value (the usual value addition at the assembly stage is 25-35 percent of the total export value).8 By using fabric inputs from other developing countries, Bangladeshi clothing exports face the high tariffs that are applied to non-LDC exports. Paradoxically, despite Northern politicians’ rhetoric about the desirability of South-South trade, current rules of origin requirements penalise clothing producers in the world’s poorest countries for using inputs from other developing countries.

Rich countries try to justify these heavy requirements by saying that they encourage poor countries to develop textile production to supply their clothing sector. However, historical experience and contemporary production patterns undermine this argument. No small, poor country with a significant clothing industry has ever succeeded in developing a matching supply-capacity in textiles.9 Bangladesh comes closest, having developed a textile capacity to cover 60-70 percent of its knit sector and self-sufficiency in certain accessories. However, even Bangladesh can provide only 12-15 percent of inputs for its woven sector, and this sector represents the majority of the country’s exports.10 Moreover, the garments industry is highly buyer-driven; retailers and clothing brands make very precise demands of their suppliers, and merely having a textile industry does not mean that a country will meet all the demands of its garment producers. It would be better for LDCs to get duty-free access for products that they have played some part in assembling, than to have preferences for the few goods produced entirely in their country. Canada’s recent ‘Market Access Initiative for LDCs’, which requires only 25 percent of value to be added in a garment’s country of export, and does not stipulate a double-transformation requirement, is the only rich- country initiative that takes this into account. The effect can be dramatic: more flexible rules of origin have contributed to the doubling of LDC exports to Canada over the past year.

In the typical preferential trade agreement, however, a developing country can satisfy the requirements of rules of origin by using fabrics from the rich country that grants the preferences. For example, under the EBA, if an African LDC imports fabrics from the EU, it will achieve both quota-free and duty-free access to the EU market. The same holds true for the US market. As such, agreements that are supposed to benefit poor countries actually serve to promote the production of textiles in rich countries, to the detriment of the developing world as a whole.
If rich countries really want to assist poor countries in developing more sophisticated industries, the best way to intervene is through financial or technical support, rather than through opaque trade instruments which have the perverse effect of blocking LDC exports. Bangladesh’s success in building backward and forward linkages from the clothing industry was arguably as much due to supportive government policy as to quota protection. From 1993 to 2002, the textile industry received a 25 percent cash subsidy, which has slowly been reduced to 15 percent in 2004. This subsidy was key to developing backward linkages in Bangladesh. There are also market incentives to produce fabrics domestically, for example in order to reduce lead-time, which are becoming increasingly important.

Denying preferences to the poorest countries
Ironically, the rules of origin requirements described above hit the very poorest countries hardest. The smaller and poorer a country is, the less able it is to establish a supporting textile industry that would enable it to meet the conditions to get duty-free access to rich-country markets. These countries are therefore penalised by ‘missing preferences’ to an even greater degree than the average developing country. As Table 1 shows, several of the world’s poorest countries miss out on more than half of the preferences they should be eligible for under the EU’s EBA initiative.

As mentioned earlier, clothing producers in South Asia can use a certain proportion of inputs from other South Asian countries in their production (so-called ‘regional cumulation’), without losing preferential access to rich-country markets. Rules of origin within the EU Generalised System of Preferences (GSP) allow similar regional cumulation of inputs to occur within the groupings of Central America, Mexico, the Andean Community, and East Asia. However, there is no development rationale for promoting regional rather than global cumulation. Sri Lanka, for example, which uses a lot of Indonesian fabrics in its garment production, incurs a penalty for doing so; it would receive tariff reductions if it used the same fabrics imported from India. There is no economic or development logic for discouraging trade between Indonesia and Sri Lanka in this fashion.

While regional cumulation is a flawed trade instrument, some exporters do not even have this option. The EU’s EBA, which draws upon EU GSP rules of origin, makes no provision for regional cumulation in Africa. This forces exporters of garments containing inputs from other countries to access the EU market under the Cotonou Agreement (which has more liberal rules of origin requirements), even though in other respects it is a less favourable arrangement than EBA.

AGOA also contains imperfect rules on cumulation. The act stipulates that apparel exported from African countries to the USA must use either US or African fabrics to qualify for AGOA benefits, notably discriminating against fabrics produced in Asia. One recent study estimates that Mauritius would have seen its total exports increase by 36 percent between 2001 and 2004 under AGOA, rather than five percent, had restrictive rules of origin not been in place.12 Although a so-called ‘third-country fabric provision’ relaxes this rule for less developed AGOA beneficiaries (i.e. LDCs along with other poor developing countries), allowing them to source fabrics globally, this is only a temporary provision and it needs repeated renewal. Also, it is applicable only to a certain quantity of exports - beyond this ceiling, the standard provisions apply.

A ‘spaghetti bowl’ of rules
The complexity of current rules of origin adds strength to the argument that rich countries are exploiting them as protectionist tools, rather than using them in good faith. Rules of origin are not based on logical principles, but on political expediency. Thus, the US has different rules of origin for different trade agreements, such that the criteria for a garment to be classified as ‘Made in Malawi’ is not the same as for ‘Made in India’; it also has different rules for different products even within individual trade agreements.

Likewise the EU has different rules for different trading partners, often quite different from those of the US. As economist Jagdish Bhagwati puts it, this complexity creates a ‘spaghetti-bowl effect’ of regulations.13 In addition, the provisions within any single trade agreement may be extremely intricate: the rules of origin in the recent US-Singapore Free Trade Agreement, for example, run to more than 240 pages of detail. With such complexity, it is hard for developing countries to be involved in the determination of these rules, and in practice they rarely are.
Complexity is a heavy burden on producers, who have to make decisions about which imports to use in the face of often quite different rules for different markets. Administrative costs are another problem. Exporters have to provide documentation on the location of a good’s production, the number of machines used, the workers employed, and the production process used; manufacturers have to submit to on-site visits and inspections to verify the documentation. Even in relatively well-off countries, the administrative costs can be high: approximately three percent of the total value of the product.14 In poorer countries, they are likely to be much higher. It is a paradox that rules which are supposed to encourage the economic development of the poorest countries may actually deter investment through their complexity. Simpler rules of origin would require less documentary proof and therefore place less of a burden upon LDC exporters, helping these countries to realise greater benefits from trade preferences.

Notes
1 IMF-World Bank (2002), p.43. Predictions depend considerably on the assumptions made; studies predict global benefits ranging from $6.5 billion to $324 billion according to different scenarios of liberalisation in the textile and clothing sector
2 United States International Trade Commission, (last checked 29 March 2004 at www.usitc.gov)
3 Statistics on the Web site of the National Labor Committee for worker and human rights, though dating from the late 1990s, suggest similar patterns: China’s hourly wage in the apparel industry is reported as 23¢, while Bangladesh’s is just 1¢. Source: www.nicnet.org/resources/wages.htm (last checked 29 March 2004)
4 Population data taken from World Bank Data Query; data on proportion in poverty taken from World Bank research on progress towards the MDGS: www.developmentgoals.org/Goall.xls. India’s GDP per capita was $2,540 in 2003, putting it in 156thplace worldwide; China’s was $4,400, putting it in 129th place. Source: www.worldfactsandfigures.com/gdp-country-deso.php
(last checked 28 March 2004)
5 Hiller and Trygve (2003)
6 A forewarning of things to come was seen during the third stage of phasing out. When synthetic fibre luggage was integrated, China increased its exports in the category by 490 percent, global prices dropped by 26 percent, Sri Lanka lost 40 percent in a year, and three Korean firms located in Sri Lanka closed their factories and fled without fully paying statutory dues or compensation to their employees. Wijmenga and Fernando (2002), p.63
7 WTO (2001 b), paragraph 42
8 Brenton (2003), p.13
9 Author’s conversations with Paul Brenton (World Bank) and Chris Stevens (Institute of Development Studies, Sussex)
10 Bhattacharya and Rahman (a)
11 Quoted in Magretta (2002), p.6
12 Mattoo et al (2002), p.4 and p.14
13 Jagdish Shagwati and Arvind Panagariya, ‘Bilateral Trade Treaties are a Sham’, Financial Times, 13 July 2003.
14 Estevadeordal and Suominen (2003), p.7