Global textile quotas end: watch China sew up the market.

On Jan. 1, the Multifiber Agreement--which for 30 years allowed nations to place quotas on the amount of textile and clothing imports allowed into their countries--expired for members of the World Trade Organization, the multilateral global trade body.

The elimination of global textile quotas is expected to drive garment production to China, benefiting consumers in North America and Europe at the expense of developing nations where apparel manufacturing has become a bridge to an industrial economy, say Wharton faculty and other analysts.

According to Wharton management professor Marshall Meyer, China, whose textile and garment industries have been sharply limited by quotas, is poised to use its giant, cheap labor force to steal market share from the rest of the world. "The country is going to end up producing in such quantity that it will take a huge whack out of the global market," he says. "This is totally predictable."

Chinese garments and textiles currently make up about 20 percent of the global market, but that could grow to between 45 percent and 70 percent now that the quota system is gone, says Oded Shenkar, author of "The Chinese Century: The Rising Chinese Economy and its Impact on the Global Economy, the Balance of Power, and Your Job," and a management professor at The Fisher College of Business at Ohio State. "It's a watershed. This is the first time in recent memory that you have an open market for garments and textiles."

Supporting Textile Workers

For decades, the quota debate revolved around the domestic politics of protecting textile jobs in the United States and Europe.

Indeed, just days after the new quota system took effect earlier this month, WestPoint Stevens, a Georgia textile maker operating under bankruptcy protection, said it would lay off 2,465 employees, or 21 percent of its work force, and close five of its 24 plants in the United States. The company blamed the cuts directly on the end of quotas on textile imports.

The textile industry should be moved offshore, but "that begs the question of what support do we offer U.S. textile workers," says Stephen Kobrin, professor of multinational management at Wharton.

As a trade-off for giving consumers better prices through increased free trade, the United States provides retraining benefits to workers who lose jobs in the process. "In theory we provide short-term training and let the consumer reap the benefits" of more open markets, he notes. "But we have never done this retraining very well."

Ironically, now that the quota system is finally gone, the bulk of the suffering will occur not in Western economies--most of which have already adjusted to lower apparel employment as workers moved over to other jobs--but in developing countries, Kobrin predicts.

Dozens of emerging economies have pinned their hopes over the past decade on the garment industry to make up for the global demand that China was unable to meet only because of quota limits.

"The more interesting question is, 'What about the other developing countries?'" Kobrin asks. "Will business shift from Mexico, Latin America and Asian textile manufacturers to China? Can you justify protecting workers in these countries?"

As many as 30 million jobs, many of them in poor countries, could be lost under the new trade rules, according to the Global Alliance for Fair Textile Trade, a U.S.-based organization of textile firms and 91 trade organizations in 49 countries.

"There is going to be a tremendous reallocation among developing countries in the production of textiles," predicts Witold Henisz, professor of management at Wharton. "This is going to generate more animosity or at least reduce common interest among countries that have been favored by the quota system."

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According to Phil Nichols, Wharton professor of legal studies, many of the developing nations that cultivated textile and garment industries would never have done so if not for the quota system. In a number of cases, these countries didn't use up their full quota allotment. Consequently, Chinese manufacturers might establish operations in a particular country to take advantage of its unfilled quotas, or ship Chinese-made products there for finishing work to be counted against that country's quota.

"A lot of countries were used as conduits" for products that could then "be cycled into the larger markets of the U.S., Canada and Western Europe," says Nichols. Now, with the elimination of the quotas, "China simply doesn't need to use them anymore."

He rejects the idea that the garment industry is a good way for a developing country to create industrial jobs and thus speed its transition from subsistence economy to value-added industrial producer. According to economic theories of comparative advantage, he explains, countries should focus on what they do best in comparison to themselves, not another economy.

"Clearly in a lot of these places the garment industry was only viable because of the (quotas). That's probably not what these countries do best," he says.

In the long run, the elimination of quotas "will force them to stop taking the easy path" and concentrate instead on their natural strengths and advantages.

Softening the Blow

Despite the end of quotas, the global trade system does provide certain mechanisms to reduce the impact of this move on other garment producers, notes Shenkar.

Under the rules governing China's accession to the WTO, other countries will be able to extend quotas in the case of an "import surge." But, he adds, any maneuvers will merely slow China's growth temporarily.

"From my perspective, the only thing this is going to do is delay the inevitable," says Shenkar.

To soften the blow to other garment and textile producers, China has added duties to its own exports. The move may have been designed to fend off new protectionist measures from trading partners. China will impose an export duty on such products as underwear, pants, suits and overcoats, at rates ranging from 0.2 yuan (.02 cents) to 0.3 yuan per piece or ensemble.

"The Chinese are very sensitive to the fact that not only in this industry [but in others too] they walk a fine line" between expanding their own export economy at the expense of other countries that might then turn around and retaliate against China with new protectionist measures, says Shenkar.

"The duty is very minimal. It's not going to have a real impact. The idea is to alleviate some of the pressure," he says.

Gerald McDermott, professor of management at Wharton, says there are other barriers that could slow down the transition, such as environmental and fair-trade regulations.

One example could be provisions against products made in sweatshops.

"Whenever there are changes in rules of trade, for every lowering of one barrier there often comes a new sort of standard or requirement that is another sort of barrier," he says. "The response will be, 'We will have to restrict imports temporarily and investigate.' Then you have bought two years" during which trade will be slowed.

McDermott says other nations might be able to compete against China if they have developed more specialized custom processes. Delivery time to the client and the market will also be a factor.

"Investments are sticky," he notes. "Producers are not going to drop longstanding suppliers overnight to run to China."

Profitless Prosperity

According to Meyer, China is increasingly able to produce quality goods, along with massive quantities, through a process of hyperspecialization.

For example, one city may focus on the production of socks, and only socks, until it perfects the process. The quantity and quality of Chinese textile and garments will arise from networks of small-scale entrepreneurial businesses, he adds.

"What's so interesting is you are getting these whole urban areas full of garages with the same efficiencies as huge factories. Because of the sharing of technology and logistics and even marketing, these small businesses have become very efficient by managing to work together."

Although Meyer predicts Chinese exports will increase dramatically with the demise of the quota system, Chinese workers will not necessarily benefit because the value added to the products by their labor is such a small percentage of the total.

"The paradox is that China can swamp the global economy with toys, needle goods, and low-end consumer electronics and have a dramatic impact on industries outside of China but add very little to the standard of living in China. That's the paradox of global overcapacity."

In addition, the Chinese government may prop up low-margin industries with political muscle and foreign reserves, knowing that if Chinese companies are the ones to survive they will ultimately make some money even in a low-profit business, he says.

"I call it profitless prosperity. Money flows into the pockets of some of the entrepreneurs and a little goes to the workers, but this is a race to the bottom," he says.

The winner in all these scenarios is expected to be consumers in the United States and other developed countries who will benefit by paying less for clothes. According to Shenkar, when quotas for Chinese exports of bathrobes were dropped in 2002, the volume of exports rose 500 percent.

"That gives you the magnitude of the change. We have seen what the impact can be. Now it will happen across the board. The consumer will definitely enjoy cheaper merchandise," Shenkar insists.

Howard Pack, Wharton professor of business and public policy, agrees that, in situations like these, consumers benefit from lower prices and are much better off. But because their real income has increased, they should be willing to compensate--through general tax revenues--U.S. textile workers who have lost their jobs.

A dedicated fund with relatively small tax revenues could be used to finance retraining and relocation. Such funds exist and should be expanded.

"For U.S. consumers it's a good deal, but for workers it's not," he says. "Some workers will undoubtedly be made poorer and society as a whole should be helping them."

Agricultural Subsidies 

With the issue of textile quotas out of the way, agricultural trade barriers now take center stage as the stickiest point in global trade relations.

According to Nichols, Europe, which is the focus of developing countries' anger over agricultural protections, may soon give up on some of its protectionist measures. Maintaining agricultural protections is no longer sustainable in the current global trade environment, he says.

Before there is change, however, Europe must make some adjustments to benefit farmers who will be adversely affected.

"The issue of significant trade distortions caused by agricultural subsidies has reached a point where even in Europe they don't think these protections are sustainable," he says. "It's just a matter of sorting out politically how they will deal with their various constituencies."

The global trade structure that has eased up on textiles, and may do the same in agriculture, is also designed to open markets in developing countries for high-end products and services that are the developed world's comparative advantage.

"The economic reality is that we are better off if we have cheaper clothes and China will be better off if it opens its markets," says Henisz.

In addition, with the textile market open, China may be more open to negotiation on issues that are important to mature economies--such as intellectual property protection and the opening up of high-tech industries, including telecommunications.

Until the textile issue was resolved, Henisz notes, "there was no real potential for progress."

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