The textile industry: The great stitch-up

Restricting Chinese textile exports will only rebound on America and Europe

IT TAKES a lot of chutzpah to plead lack of preparation when a development has been ten years in the making. That, however, is precisely what western clothing manufacturers are doing. This January saw the end of the decade-long phase-out of a quota system that had protected the world's biggest textile markets - America and the European Union (EU) - from cheap imports, largely from Asia, for 40 years.

Predictably, exports from Asia, particularly China, have soared. In the first quarter of 2005, for example, the number of Chinese cotton trousers imported by America rose by 1,573%, cotton T-shirts and blouses were up by 1,277% and cotton underwear by 318%, according to America's Commerce Department. Total Chinese textile and clothing exports to America were over 60% higher in the first quarter of this year than in the same period in 2004.

In Europe, imports of Chinese pullovers more than quintupled, as did imports of men's trousers. Imports of T-shirts and blouses nearly doubled as prices fell by as much as one-quarter. “We simply don't understand how they can produce at these prices,” says Thierry Noblot of the Union des Industries Textiles, the French textile industry's main lobby group.

Such howls of anguish have had their effect on both sides of the Atlantic. Earlier this month, America said it would impose “safeguard” quotas on seven categories of Chinese textiles, including cotton underwear, shirts and trousers. These quotas, which restrict their year-on-year growth to 7.5%, can be renewed annually until 2008 and could be expanded to encompass other goods. Textile firms are also vigorously backing proposed legislation that would slap a tax on Chinese imports unless China revalues its currency, the yuan.

Them ol' cotton fields back home

The EU's trade commissioner, Peter Mandelson, who was this week negotiating fruitlessly with Chinese officials, has been more circumspect - so far. Although the European textile and clothing industry has been shrinking, the EU remains the world's leading exporter of textiles and the second-largest exporter of clothing.

Mr Mandelson says he opposes quotas, but has conceded that there needs to be a more gradual transition to the new regime. Last month he launched an investigation into nine categories of Chinese products, and is now discussing emergency limits on imports of T-shirts and flax yarn. During this week's talks between Mr Mandelson and Gao Hucheng, China's textile negotiator, the EU gave China until May 31st to convince it that it will scale back exports significantly. If China fails to be convincing by the end of this month, the European Commission will begin the process of reintroducing import quotas for those two categories of Chinese products.

To forestall further retaliation, on May 20th China said that it would voluntarily raise export taxes on 74 clothing products by up to 400% from the start of June. This was an astute move. China has already used the new bargaining power it offers by threatening to withdraw the new taxes from any items subjected to quotas. The economic cost should be minimal, since it covers barely one-fifth of China's apparel exports. Only 3% of the mainland's total exports will be hit, reckons Ma Jun, an analyst at Deutsche Bank in Hong Kong. Nor will America's revived quotas dent China's growth much, he says.

Joshua Lu at Morgan Stanley points out that, since China's exports had been restricted for so long, they are still small in absolute terms, and there is relatively little business to lose from renewed protectionism. Thus in T-shirts, trousers and underwear, China had just a 1-2% market share in America before January 1st. Although it is now 7-15%, that is still not very much.

The effect on mainland China's upstream textile industry will be more severe. The tariffs are small in absolute terms, with an average rise from 0.2 to 1 yuan (2.5 to 12.5 American cents) per item. But the new level represents about 6% of the overall cost of a piece of clothing - enough to massacre already thin operating margins. These range from 2% to 10%, with fabric producers, such as Fountain Set, and end-of-the-line distributors, such as Li & Fung and VF Asia, tending to be more profitable than contract garment-makers.

Still, Vincent Cheung of VF Asia says that the new tax will affect future shipments. “We can't raise our prices this year because they are set. In the future we have to charge our buyers more but it is not easy - we may have to go halfway and cut cost.” Bruce Rockowitz, president of Li & Fung, says that many textile factories in southern China “built up tremendous capacity in preparation for the lifting of quotas and that now has to be run down.”

The added pressure on profits may spur consolidation in what is still a fragmented sector with a large number of single-workshop manufacturers. So it could result before long in a more competitive industry with greater economies of scale. Meanwhile, most of the bigger firms are protected by two factors. The first is geographical diversification - the distortions of the old quota system forced Chinese-owned textile companies to finish clothes in other Asian countries to avoid the “made in China” tag. Luen Thai, for example, has factories in four foreign countries, accounting for three-quarters of its production. Second, the big Chinese manufacturers do not compete on price alone - their rivals elsewhere in Asia are cheaper - but on quality, scale, reliability, speed and sophistication that rivals struggle to match.

The quotas and tariffs will not save the American textile industry or restore the 1m jobs it has lost since the 1980s. “China isn't their problem,” says Laura Jones of the US Association of Importers of Textiles and Apparel. “It's the whole rest of the world.”

In Europe, the textile lobby's Mr Noblot thinks that the Chinese tariff rises will hardly alter his members' prospects. The price of a Chinese T-shirt for European importers will increase from €2 to €2.10 ($2.50-2.60) according to Mr Noblot. For shirts the difference will be one cent.

At most, the restrictions will slow Chinese export growth to the West. But any slack is likely to be taken up by other poor countries. The “safeguard” measures - a product of the tortuous negotiations on China's admission to the World Trade Organisation - cannot be used against other countries. One of the protectionist arguments used last year for prolonging quotas was that their abolition would wipe out export-based industries in poor countries that allegedly relied on quota protection from Chinese competition.

Spinning a yarn

Bangladesh was an often-cited example. Clothing makes up over two-thirds of its exports. It relies on imported fabric. Yet its clothing exports to America rose by 21% in the first quarter of the new regime. China's rivals continue to complain about unfair methods - such as an undervalued currency and hidden subsidies. But so far they have mostly withstood the deluge.

The true losers from any return of quotas will be American and European consumers and the retailers that cater to them. It will mean higher prices now, and hinder lower future prices by slowing the emergence of Chinese “supply-chain cities”, as UBS, an investment bank, calls them, that will handle the entire process of making a piece of clothing from sheep to shelf.

Chinese textile factories have tended to specialise in one process and finish goods overseas to avoid quotas. But unlike its main rivals, China has the advantage of huge domestic fibre and fabric production. Without quotas, it could build vertically integrated firms, lowering costs, raising quality and cutting time to market - great for western customers. That will surely happen, sooner or later. China's emergence as the ultimate one-stop textiles shop can be delayed - but not stopped.

Restricting China's textile exports will only rebound on America and Europe.