Chinas exports are being hurt by the move away from fashion goods to commodity garments

China's exports are being hurt by the move away from fashion goods to commodity garments

Last month David Birnbaum argued that China's economic system lies at the heart of its changing share of the US garment import market. Here he looks at how shifts in the product mix have also affected China's exports - including the move overseas of higher quality fashion goods.

Much has been written about the underlying causes of declining Chinese garment exports. Industry specialists and economists point to macro-economic factors, such as currency revaluation, rising labour costs and labour shortages as well as trade subsidies and inflation, to name just a few.

However, while these are important to China's exports in general, their effect on China's garment industry is overrated.

The garment industry is different because the garment industry is all about product.

To understand the problem we must recognise that the garment industry consists of literally thousands of separate products, each fundamentally different from the next and each subject to individual changes in customer demand.

To the economist the garment industry has but a single product - garments - which includes different models, each differentiated only by design and price. To the economist, there is no difference between the garment industry and the automobile industry where trucks, cars and SUVs are simply different models of a single automobile product.

The economist certainly accepts that there are manifest differences between a Ford Fiesta and a Rolls Royce Phantom. For example, the Fiesta costs $15,000 while the Phantom costs $450,000. The Fiesta is produced in hours using robotic equipment, while the Phantom takes months using highly skilled craftsman. The Phantom is much larger and much more comfortable than the Fiesta. The Fiesta has no built-in champagne storage rack.

However to the economist these are not fundamental differences, but rather differences in degree.

  • They both use the same materials: steel, aluminum, carbon fibre, microprocessors, etc.
  • The manufacturing process is virtually the same. Build the chassis, construct the engine and the body and assemble the lot.
  • The Phantom may indeed cost 30 times more than the Fiesta, but that too is only a difference in degree.

The difficulty is that the single-product concept that works so well in the automobile industry falls apart in when applied to garments.

Consider an item: knitted pullover tops. This item includes garments as far apart as a Hanes cotton T-shirt and an Armani cashmere sweater. Unlike the Phantom/Fiesta comparison, the differences between the cotton T-shirt and the cashmere sweater go well beyond degree. They are fundamental.

  • They are constructed of very different materials. The Hanes T-shirt is made of cotton. The Armani sweater is made of cashmere.
  • The process is entirely different. The T-shirt is cut from fabric which is then sewn to produce the garment. The sweater uses no fabric whatsoever. It is knit directly to the shape of the garment pieces which are then linked together.
  • The Hanes cotton T-shirt is available at WalMart for $5.50, the Armani cashmere sweater is available at Giorgio Armani for $2875 - 553 times the cost of the Hanes T-shirt.

In the automobile industry, if SUVs are not selling well you can convert the SUV factory to produce trucks or cars. In the garment industry, if sweaters are not selling well, you close the factory. There can be no conversion to T-shirts because, other than the raw space, none of the existing plant and machinery can be used to produce any product other than sweaters.

Product performance
The key to understanding China's falling market share is in the product. The economist assumes that rising macro-economic costs have driven the customer elsewhere. However, when we factor in the products, we can see that the main problem facing China is not the customer that ran to another supplier, but rather the customer that disappeared altogether.

For example, China has always been the world's largest producer of silk garments as well as garments made from what we call "other vegetable fibers" (OVF) including linen, ramie and jute.

Between 2007 and 2011, US imports of silk garments declined by 40.6% while at the same time OVF garment imports declined by 42.9%. As a direct result, China's exports of these two groups declined by $1.3bn.

Add to that the additional loss of $510m resulting from falling demand in 39 other products, and we have a cumulative loss $1.8bn. Had US demand for these products continued unchanged, China's 2011 recorded market share of 37.8% would have risen to 40.2%, an all-time record.

The decline in demand for silk and OVF garments also goes a long way to explain China's reduction of average FOB prices compared to its competitors.

In 2011 FOB prices rose world-wide. However, prices for made-in-China garments showed a lower rate of increase. As of December 2011, FOB prices were at a discount of 9.7% to world average compared with a discount of 4.5% for the same period in 2010.

Most professionals assume that China's ability to maintain lower prices was due to export subsidies, currency manipulation, etc. While these are doubtless important factors they are secondary to the changes in product mix.

Going back to the silk and OVF example, we can see that the reduction of exports for these products would have a serious effect on China's average price, since the price of a silk garment was four times, and an OVF garment 1.6 times, China's average FOB price.

US Imports 2011: China - FOB Prices  
  FOB Prices PCT Difference
Average $3.02  
Silk $12.7 421%
OVF $4.86 161%

Changing product mix has affected China's exports in another more fundamental way.

Four basic commodity products - cotton T-shirts, cotton casual trousers, cotton woven shirts, underwear - account for 40%-45% of total US garment imports. Typically, when a country enters the global industry it concentrates its production in one or more of these products. As the industry develops, it diversifies into more difficult, higher value added products.

China has always been the exception. In the past its product mix was always diversified. Twenty years ago China's top five export products were OVF sweaters, silk blouses, silk shirts, synthetic dresses and sports vests. During the same period, the big-four products accounted for 14.7% of total garment exports.

Ten years ago, China's top five export products were babywear, silk knit blouses, silk woven blouses, OVF sweaters and synthetic dresses. During the same period, the big-four products decreased to 12.6% of total garment exports.

China was always the consummate niche supplier because it dominated all the niches, leaving the rest of the world to fight over the big-four commodity products.

The past five years has brought a singular change to China's product mix.

The importance of the big-four products has changed little over the past 20 years. As of 2011, they still accounted for 40%-45% of total garment imports. On the other hand, with the exception of Bangladesh, the industries in most exporting countries have become more diversified.

In this regard, China is the big exception. Ten years ago the big-four products accounted for 12.6% of China's garment exports. Five years ago that figure rose to 18.9%; and in 2011 to 28.9%. Between 2007 and 2011 China's reliance on the big-four basic commodity styles increased by over 53%.

Big-four as a percent of total           
  Cotton T-Shirts   Cotton Trousers   Cotton Shirts   Underwear   TOTAL    
  2007 2011 2007 2011 2007 2011 2007 2011 2007 2011 PCT Chg
World 19.9% 18.5% 17% 15.9% 3.4% 3.8% 4.2% 4.5% 44.5% 42.7% -4.1%
China 7.6% 11.9% 7.8% 11.9% 2% 2.9% 1.5% 2.1% 18.9% 28.9% 53.1%
CAFTA 37.4% 37% 13.3% 8.5% 1.5% 1.9% 13.5% 13.3% 65.8% 60.8% -7.6%
Vietnam 26.2% 23% 17.8% 14.1% 3.2% 2.9% 0.7% 4.3% 47.8% 44.3% -7.3%
Bangladesh 10.3% 8.5% 34% 39.2% 12.1% 12.2% 5.3% 4.6% 61.7% 64.5% 4.4%
Indonesia 21.3% 24.7% 16.1% 12.4% 6.1% 5.3% 2.2% 1.5% 45.7% 43.9% -3.9%
Cambodia 33% 26.5% 28.1% 24.3% 1% 0.5% 3.1% 3.1% 65.3% 54.5% -16.6%
Mexico 15.8% 12.3% 40.1% 40.9% 1% 1.5% 2.2% 1.9% 59.1% 56.6% -4.3%

It is this move away from its previously successful strategy of diversity that is the root cause of the decline of China's garment export industry.

While it is undeniably true as we have seen above in the case of silk and OVF, much of this change is due to factors beyond its control, the move from high quality niche to basic commodity mainstream is based on the decisions of factory management.

It would appear that the average price of made-in-China garments is falling relative to its competitors not because Chinese factories are charging less for their products, but rather because Chinese factories are making cheaper commodity products

The underlying cause
This leaves us with a true enigma. Why should a sophisticated profitable industry choose to move away from fashion goods towards cheap relatively unprofitable commodity garments?

One possible answer lies in the nature of China's garment industry.

In fact, China is home to two separate garment industries.

The first includes the Chinese state-owned enterprises (SOE) which produce low cost commodity garments, while the second consists of mostly foreign-owned transnational factories which account for most of the higher quality fashion goods.

In the past both SOEs and transnational factories produced of silk and OVF garments, with the SOE's concentrating on commodities while the transnationals made the higher quality fashion goods.

When demand for these products fell, the SOEs returned to producing the big-four commodity products, while the transnationals returned to producing the higher quality fashion goods.

When costs began to rise, the transnationals began shifting production to their branch factories located outside of China. The SOEs, however, having few if any overseas factories, continue to produce the same cheap commodity goods.

China's garment export industry faced a double loss. Changing fashion caused some of China's customers to disappear, while changing costs have caused some of China's factories to go off-shore.

China's challenge
To the degree this analysis is correct, China faces a serious long-term problem. As China's economy develops, costs invariably rise, making labour-intensive production unprofitable. In this sense China is now facing the problem common to all industrialised countries, including the United States, Western Europe and Japan.

In every instance production moved off-shore, hollowing-out the industry.

As outsiders, our mistake was to assume that China was unique in that its export juggernaut would be an ever-increasing force, destroying everything in its path, unstoppable until China controlled the world economy.

We have forgotten that many countries, each in its own time, has been in the same dominant position. There is nothing unusual about China's current place in the global economy or the challenges China faces.

Clearly China must undergo serious structural and systemic change if it is to maintain the levels of growth necessary to satisfy its people. In this regard, past successes may yet prove to be obstacles to making the necessary changes.

Click here to read: China and its place in a changing US market.

David Birnbaum is the author of The Birnbaum Report, a monthly newsletter for garment industry professionals. Each issue analyses in-depth US garment imports of four major products from 21 countries, as well as ancillary data such as currency fluctuations, China quota premiums and clearance rates. Click here to visit David's website.