In the second article in a three-part series examining the failure of the US garment industry, David Birnbaum shows how US government policy to force consumers to buy made-in-America apparel succeeded in almost destroying domestic manufacturing.
As we saw in the previous article, with less than a 3% domestic market share it is clear that American consumers do not want to buy made-in-America garments; and with less than a 0.3% global export market share, it is equally clear that consumers outside of the US do not want to buy made-in-America garments.
How is it possible for an industry located in a country such as the United States, within a period of 50 years, to fall from second-to-none to second-to-all? We are talking about a country that even today is the world’s third-largest exporter of manufactured goods, but which ranks 23rd in garment exports – lower than even Myanmar? This is not just unusual, but rather what theoretical physicists term a singularity – a situation so bizarre as to have a probability approaching zero.
All of which leads us to some fundamental questions:
- Should we care what happens to the US garment producing industry?
- Should we make the effort necessary to understand why the industry has failed?
- Is it worthwhile to do anything to save the industry?
These are practical considerations. The value of the US garment-making industry has dropped to the level where if every US based garment factory were to go out business tomorrow, leaving only sample rooms and small workshops, GDP would not fall, unemployment would not rise, garment quality and retail prices would remain unchanged. So why bother?
On the other hand, if we do decide to analyse the problem, we might not like what we find.
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To understand what has happened, why it has happened, and the steps necessary reverse the trend, we must begin by first re-examining the commonly accepted reasons for the failure of the US garment industry.
The common wisdom is that it was simply part of the greater failure of US manufacturing in general. Both are cases of industrial murder perpetuated by foreign factories and governments located in cheap labour countries that together destroyed the US domestic industry’s ability to compete.
However, once we look at the data it becomes clear that the cheap-labour hypothesis makes no sense.
As we know, the US ranks third among exporters of manufactured goods and has held that position for the past 20+ years. Under the circumstances, it is fair to ask: “Why garments and not other manufactured products?”
Furthermore, once we see that the EU ranks first among exporters of manufactured products, we must also ask: “Why the EU and not Bangladesh?” Of the world’s ten largest garment exporters four – Italy, Germany, Spain and France – are Western European industrialised countries. Are they too part of some conspiracy perpetuated by cheap-labour countries organised to destroy US garment makers?
Once we have dispensed with the common belief, we can look for the actual causes. Herein lies the true cause of the failure of the US garment industry. It is not due to outsiders, nor is it a case of industrial murder. The reality of that failure is a case of industrialised suicide perpetuated by the US government which, in an effort to protect the US garment industry, protected it out of business.
To understand what happened, we have to go back to basics.
Success for companies, and indeed for entire industries, is predicated on two rules:
- Find out what your customer wants; and
- Give it to them.
In this regard the garment industry is no different to any other industry. Garment customers want low prices, high quality, good design etc. However, years ago, the US government created a new strategy. Rather than selling customers the garments they wanted, government decided to force customers to buy what the US industry produced, regardless of price, quality or design.
The Captive Customer Syndrome
This new strategy began in 1963 with the garment export quota regime. Up to that point the US was home to the world’s largest and most successful garment industry. However, a new garment export industry located in two countries and one city – Korea, Taiwan and Hong Kong – was in its nascent stage of development. That industry consisted almost entirely of small and medium size factories producing low quality cheap commodity goods such as cotton-Tshirts, underwear and cotton pants. Nevertheless, the US government decided to nip the new Asian-based garment industry in its bud by imposing strict quantitative limitation on their garment exports to the United States. The quota was divided into 23 separate categories.
Hong Kong was the first to be restricted. At that time the Hong Kong government was the great apostle of Adam Smith and his invisible hand and, as a result, decided that the quota should be governed entirely by market forces. The government therefore transferred the quota in its entirety to the industry; 50% going to the exporters and 50% to the factories, all based on past performance. The HK government then created a market, by allowing quota to be transferred either temporarily for a single year or permanently from one party to another, through the then Department of Commerce and Industry, thus ensuring both buyers and sellers an honest transaction.
I think it safe to say that no one could have predicted what happened next.
First of all, since the quota had become marketable, it was a capital asset – and indeed a very liquid capital asset. Almost immediately, quota brokers appeared whose responsibility was to bring buyers and sellers together. Through the quota-broker system, interested parties received information for each category every morning and throughout the day on demand.
Secondly, because the supply was by definition limited, while the demand continued to rise, the cost of quota increased. This in turn raised the garment FOBIQ (FOB price including quota) to the point where factories producing cheap commodities were forced to move to higher value-added products. This in turn raised the quota premium further; which in turn forced yet another move up to higher value-added goods, etc, etc. Eventually the point was reached where the quota premium for the old basic commodity categories (cotton T-shirts cat 338/339, cotton trousers Cat 347/348) exceeded the FOB price; with the result that quota holders found themselves with capital assets with values in excess of $10m – and in some cases in excess of $100m – all as gifts from the US government.
By the mid 1990s, as the number of quota imposing importing countries increased, as did the number of quota restricted exporting countries, the buying and selling of quota had become an international industry with an annual volume in excess of $9.5bn.
Assuming routine buying agent commission rates of 5%-10% and average factory net operating profit margins of 3%-7.5, by 1999 quota was the main source of income for Hong Kong and China companies, exceeding the total of both agent commissions and factory profit:
Third, in order to keep their initial cheap commodities customers, Korea, Taiwan and Hong Kong factories opened offshore branch-factories located in quota-free countries – and in doing so developed new national garment industries. When importing countries imposed quotas on these new countries, the same Korea, Taiwan and Hong Kong factories yet again opened new factories in other quota-free countries, which were later subjected to quota restrictions, and so on and so-forth.
What in 1963 had begun as a nascent industry located in two countries and one city producing cheap commodity garments, by 2005, when the quota regime was finally phased out, had been transmogrified into a global export industry that included more countries, regions and territories (212) than the total number of members of the United Nations (197), producing every type of garment from the cheapest commodities to expensive designer fashion goods.
At the end of the day, the quota regime initiated by the US government for the sole purpose of forcing US customers to buy made-in-America garments, succeeded only in almost destroying its domestic industry.
The punitive tariff barrier
Today, the US is considered to be a low tariff country, where tariffs average less than 3%. The exception is garments, which average more than 16%. Government believed that high tariffs would raise prices to the point where imports would become too expensive to compete with domestic goods.
The result, once again, as we can see from the graph below, was not as expected. In the event, the high tariffs forced exporters to increase productivity to the point where they totally overcame the cost of the tariff, with three unforeseen results.
- First of all, between 1998 and 2018, FOB prices declined by 18%, thus more than nullifying any tariff. In fact, a garment that would have previously landed for $10 duty free would now land for FOB $9.51 even after having paid the 16% duty.
- Secondly, by far the greatest decline came from China where FOB prices fell by an unbelievable 50%, with the result that the same garment that would have previously landed for $10 duty free would now land for FOB $5.80 even after having paid the 16% duty.
- Third, the benefit of increased productivity benefited the customer that most needed low garment prices, while those who could afford to pay more did so.
In a real sense the Captive Customer Syndrome was a great act of charity on the part of the US government.
- The US government’s policy provided a gift worth tens of billions of dollars to some of the poorest countries in the world.
- The US government’s policy created a global industry that was perhaps the greatest boon towards development for most Asian countries, taking citizens stuck in abject poverty through subsistence agriculture to substantially increased income, while at the same time providing foreign exchange for necessary imports.
- The US government’s policy ensured its own citizens saw reduced prices, thus helping to keep down inflation while at the same allowing cheaper clothing for those at lower income levels.
All this was accomplished at zero cost to the US government.
While it is undeniably true that the results of the Captive Customer Syndrome were all unforeseen – and equally true that this policy almost certainly caused the failure of the US domestic garment industry – the US government is entitled to some credit for the great benefits its policy brought to poor Asian countries as well as to its own citizens.
Trump vs China
The most recent move in the Captive Customer Syndrome epic is Mr Trump’s attempt to force US consumers to move away from made-in-China garments by imposing tariff surcharges on made-in-China imports. Clearly the obvious question is, move to where?
Generally, when we measure foreign trade, we do so by value (so many billions of dollars from here to there). However, moving production from one place to another has to be measured in units.
When we look at data in units, the picture is a little frightening. Here comes the first problem.
According to the US government’s Office of Textiles and Apparel (OTEXA), some 212 countries, territories and regions currently export garments to the US. However, the top ten account for a little more than 79% of exports measured in units. Clearly any shift away from China (Rank 1st) must be taken up by the other nine. However, China accounts for more units (42.7%) than the total of the other nine (37.0%). It would appear highly unlikely that each member of the other-nine would be able to more than double production within any reasonable period of time.
However, as we can see from the list of the other-nine, many, if not most, of these countries are basic commodity producers. As a result, they will be able to take up the slack only with regard to the basic commodities. Here comes the second problem.
As we can see from the next chart, China is not in the cheap commodity garment business (19.8% market share). Most of the cheap commodity garments are produced by the other-nine (56.0% market share). To put it another way, basic commodities – cotton T-shirts, cotton trousers, underwear – account for under 30% of US garment imports. Who is going to produce the other 70%?
Where do we go from here?
Today the US garment industry is in a state of failure. To the degree that the goal of the Captive Customer Syndrome was created to force US consumers to buy made-in-US garments, the 65-year strategy has been an all-time disaster.
However, new techology is about to create a new industry; one that will return production from developing countries to the major industrialised importing countries.
Reshoring will revolutionise the industry.
The question remains: Will reshoring benefit the US garment industry?
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