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Are we spinning the right yarn?

Arvind Panagariya

November 17, 2004

The quota regime that has governed the exports of textiles and clothing from developing countries to the United States, European Union (EU) and a few other developed countries for nearly four decades will meet its demise on January 1, 2005. Is India ready to capture a much larger share of exports to these markets?

Clothing production, which involves cutting fabric into different pieces, grouping them by different parts and sewing them into complete garments is one of the most unskilled-labour-intensive activities. It requires minimal training and also offers ideal employment opportunities to women. Not surprisingly, clothing exports have played a crucial role in the early stages of industrialisation of virtually all successful labour-abundant economies including Japan in the 1930s, Korea and Taiwan subsequently and China more recently.

So far, India has not had spectacular success in textiles and clothing exports, however. Domestically, the sector is the second largest employer after agriculture. It also accounts for approximately a quarter of the country’s industrial output. Yet, with the exception of cotton yarn, India has had at best modest success in the world market. At $13 billion, it accounts for only 3% of the total world exports of textiles and clothing.

A key reason cited for India’s poor performance in these sectors is the presence of strict product-by-product and country-by-country import quotas imposed by the US and European Union. But now that these quotas are coming to an end on January 1, 2005, expectations are high. Union minister for textiles Shankersinh Vaghela is reported to have predicted that within two years of dismantling of the quota regime, India’s exports of textiles and clothing would double to $26 billion. A recent WTO study predicts India’s share in the US clothing imports rising fourfold from the current 4% to 15%!

While all forecasts (including mine) should be taken with a grain of salt — entrepreneurs have a nasty habit of disappointing forecasters — reality is far less rosy than suggested by Mr Vaghela and the WTO study. Admittedly, quotas have had a deleterious effect on India’s exports. But there are good reasons to believe that they are not the decisive factor behind India’s poor performance.

As just noted, India's share in the world textiles and clothing sector stands at 3%. This is less than the country’s shares in the US and EU textiles and clothing imports, which stand at of 5% and 4% (US) and 7% and 5% (EU), respectively. The implication is that India’s performance in the non-quota markets has been even worse than in the quota-ridden markets. The opposite holds true for the more competitive China despite its hefty shares of 14% and 16% and 11% and 20% in textiles and clothing markets in the US and EU, respectively.

In the US market, for which detailed data are available, India faces quotas on the exports of far fewer products than China. This is because India has not posed a threat to the local US producers in as many products as China. Equally, within the class of the products that India does face quotas, in a large plurality of the cases, it consistently fails to fully utilise its assigned quota. In these cases, high costs rather than quotas limit India’s export shares. Therefore, the removal of the quota regime will actually allow the countries currently facing binding quotas in these products to displace India’s exports.

A large expansion of exports without substantial cost reductions would only seem possible if India achieves massive expansion of exports of products in which it currently faces binding quotas. This is possible but not probable.

The next decade offers India a truly historic opportunity to capture the world textiles and clothing market. Until 2013, China will remain under the threat of special safeguard tariffs and quotas to which it agreed as a part of its WTO entry conditions with virtually all of the major WTO members. Until 2008, these actions can be taken under minor pretexts in textiles and clothing. These facts give India a major advantage over China during the next eight years.

But given the non-binding nature or the absence of quotas on many products currently, this advantage cannot translate into reality unless India undertakes major reforms of its own to bring costs down. One key requirement for large-scale expansion of exports is on-time delivery of consistently high quality items, which in turn requires large-scale factory production. In contrast, our apparel industry is fragmented with tiny units when compared to its counterparts in not just China but even in a small country such as Sri Lanka. India is not a part of any global production chains in the industry that are now sweeping across the world. Unless the remaining small-scale-industries (SSI) reservation is ended and labour laws are reformed to facilitate entry of large firms, the hope for achieving the necessary scale is minimal.

Among other policy measures requires to take advantage of the end to the global textiles quota regime are improved road, air and sea transportation, trade facilitation that allows goods to move rapidly in and out of the country and the replacement of the existing duty exemption pass book (DEPB) scheme by a duty drawback scheme that cannot be countervailed.

So far, the government has made modest progress on these fronts. It has focused, instead, on the restructuring of the sick firms under the National Textiles Corporation. A better course would have been to disband the unviable firms (which being done) and sell the viable firms to private agents who must play to the “profit or parish” tune of the market.

To be effective, the government too must specialise in its area of comparative advantage, which is the provision of public goods such as defence, police and roads that the market fails to provide adequately and not private good such as textiles and clothing that the market offers at better terms.