John Cheh sells the shirt on his back. As chairman of Esquel China Holdings in Hong Kong, he runs a top producer of men's woven cotton shirts--or category 340Z under the World Trade Organization quota system that expired last week. "It's a high-end shirt with high yarn count. It has the feel of quality," he says, stroking his collar. Sold by Nordstrom for about $50, the label reads: MADE IN MALAYSIA.
That claim complies with the quotas hammered out by trade negotiators over the decades, to be sure. But Cheh's shirt--along with millions of other garments now sold in the United States and Europe--is a camouflaged Chinese export. The cotton grew in Xinjiang, became yarn at a spinning mill in the Silk Road oasis town of Turfan and journeyed some 3,000 kilometers by truck to be woven into fabric in China's Pearl River Delta. In local garment factories, thousands of young women cut the cloth into patterns, stitch panels together and gather buttons, zippers and clasps into kits that are then "finished" by workers who sew the pieces together in nations like Malaysia. Even the MADE IN MALAYSIA labels are made in China.
It was this wasteful supply chain that the World Trade Organization aimed to sever back in 1994, when it resolved to abolish quotas that have contorted the global garment industry like a bonsai tree. Quotas officially expired on Jan. 1 in what amounts to the largest simultaneous industrial rationalization in the history of, well, industry. What comes next is globalization's first great test of the new millennium. Most forecasts portend dramatic change: billions in savings on production costs, the death of an industry of middlemen who specialized in quota dodging and falling prices for shirts, shorts, scarves and socks as manufacturing consolidates in the nations that do it best. Nearly all analysts believe China will come out on top in a battle for control of the $350 billion industry, but not for the reasons you may think.
More than 60 countries now export garments to the West, and several dozen are likely to be driven out of the textile trade (following story). Nations like Cambodia that bet their futures on the promise of preferential access to U.S. and European consumers have now lost that special privilege. Unions and lobbyists around the world are fighting to erect new barriers to slow the exodus of jobs and contracts to China, claiming that its current and expected future dominance is built on a system of state-run "sweatshops," implying rock-bottom wages in miserable factories.
This is a distortion, at best. China's textile advantage has little to do with its wages (which are considerably higher than those in India, Indonesia or Vietnam) or even with labor costs more generally (which account for only about 10 percent of the cost of a shirt). Recent outbreaks of labor unrest in the Pearl River Delta are a story of worker expectations rising faster than wages--not "a race to the bottom," as some activists would have it.
What truly distinguishes China are its state-of-the-art factories, its rapidly improving transportation network--and its talent for exploiting the absurdities of the quota system. China estimates that it now turns out more than 20 billion finished garments a year, roughly four pieces of clothing for every person on Earth--the largest output by a single country ever recorded. And that figure does not even include the uncounted billions of kits that end up as clothes "made in" Malaysia, Mauritius or the Maldives.
China's current dominance of the textile trade extends well beyond its own official quotas, and lays the basis for its future expansion. The mainland's garment industry has grown 500 percent since 1990, from $10 billion to $50 billion, and now has 40,000 clothing manufacturers that employ some 15 million workers. In a recent Goldman Sachs poll of large American retailers, most expected China's share of the U.S. clothing market to double from 20 percent to 40 percent by 2007 and to peak at about 60 percent.
Austrian economist J. A. Schumpeter once observed that England's ascendance "can almost be resolved into the history of a single industry," namely textiles. The same might be said of China and the rest of East Asia today. The rise started in Meiji Japan, which used cheap labor to propel itself past England to become the leading global exporter of cotton garments by 1930. In reaction to the rising prowess of Japan's mills, Washington forced Tokyo to accept "voluntary" quotas in 1955. To keep their businesses alive, Japanese companies began funding and advising garment makers in Hong Kong, Taiwan and South Korea. This laid the roots of the "flying geese" development model, in which Japan led the Asian flock into more and more advanced technologies, and of the backlash that created the labyrinthine quota system.
Washington's response was to slap quotas on any Asian exporter that made sharp gains in the U.S. clothing market. By the early 1970s, the U.S. system had morphed into a global one, imposing complex quotas on dozens of nations in 800 categories of clothing. Though ostensibly "temporary," the system became increasingly entrenched, and illogical. Fortunes were spent on quota-filling garment factories from the United Arab Emirates to remote corners of Africa. "Mauritius? Madagascar? Who the hell would normally make garments in places so far-flung?" says industry consultant James P. Convery. "It is the ultimate case study on how intervention creates market distortions on a grand scale."
Over time the quota system became a cashless form of foreign aid. America and Europe granted needy countries preferential quotas, hoping labor-intensive garment factories would lay the seeds for broad-based industrialization. While many governments failed to capitalize on the protections, the development scheme worked in much of East Asia, though nowhere quite so spectacularly as in China after its opening in the early 1980s.
Protection seemed to have a different impact on China than on many developing nations, promoting enterprise rather than sloth. Though rules varied by country, manufacturers typically could sell to others up to half their quota allotment each year. Known as mothers, such sellers remained the exporters of record and kept their quotas year after year so long as none went unused. In competitive categories, quota rights sold at huge premiums; in recent years, for example, garment makers in China paid $5 per piece for quota rights to make wool sweaters, or nearly equal the cost of production. So-called matchmakers earned fortunes getting buyers and sellers together. "Several of them I know became quota millionaires," says a Western apparel buyer with decades of experience in Asia.
The system drove Chinese manufacturers to make themselves hypercompetitive. Because quotas limited the number of garments China could export to the West in any single category--but not the value of those exports--local manufacturers strove to win upmarket clients. Better to sell $200 Hugo Boss sweaters than $20 Wal-Mart sweaters. And in the race to slash costs, cut delivery times, and raise quality, Chinese were driven to move upmarket more aggressively than their rivals in other nations, largely because they faced more domestic competition to fill their nations' limited export quota. "Retailers used to look at [just cost]: 'Your price is $3 and his is $2.90, OK, I'm going to Bangladesh'," says Bruce Rockowitz, president of the Hong Kong-based sourcing giant Li & Fung Trading. "It's not like that anymore. They think about delivery, quality, what the selling price would be in their store after markdowns to see which one is more cost-effective. China always comes up on top."
In Gaoming, a small city in Guangdong province, Esquel produces cotton shirts for clients ranging from Wal-Mart to Nike, Hugo Boss and Burberry. Automated assembly lines maximize each worker's output. Salaries, which have risen sharply across the Pearl River Delta in recent years, are fast approaching 90 cents an hour on average, which is 30 percent higher than in Bangladesh and more than double those in Indonesia, according to the International Labor Organization. To retain workers amid China's manufacturing boom, Esquel offers benefits like nearly free housing (line workers, mostly young women, bunk four to a room; managers get their own apartments), a gym, a library and free Internet access. Cafeterias serve a variety of regional cuisines to suit migrant workers from across China.
Esquel estimates that because it can buy yarn and fabric from its own mills inside China, garment assembly takes 30 percent less time in Gaoming than outside the country. Proximity to Hong Kong by either barge or truck speeds up the export process; containers arriving at one of the city's state-of-the-art freight terminals are usually aboard ship and on the high seas in a few hours. According to AT Kearney, labor for a shirt made in Bangladesh runs just $1.52, compared with $2.28 in China, but after factoring in materials and transportation, the total cost of the Chinese shirt is $11.15--almost a dollar cheaper.
China continues to refine its advantages in ways that echo the ongoing revolution in the retail industry, led by Wal-Mart. Through close coordination with suppliers, tight inventory controls and volume trade, the U.S. retailer slashed costs and passed the savings on to consumers. Trendy new fashion houses like Zara of Spain have cut the time it takes to introduce new styles from months to weeks. As the fashion seasons give way to a 24/7 cycle in which styles change constantly, China is building the high-speed factories and transport links that can meet demand. As a recent study of the quota system by the American Chamber of Commerce in Hong Kong put it: "Clothing is increasingly considered a perishable good."
Since global growth in consumption of clothing is flat, suppliers are fighting for shares of a stable pie. Rockowitz predicts that the "industry unto itself that rose up to dispense quota allotments" will die, and foreign investors will flock out of "quota countries." After Turkey gained tariff-free access to Europe in 1994, investments poured into its textile industry, "but people are exiting now because it became very expensive," says Hana ben-Shabat, a senior strategist at AT Kearney in London. "That has always been the case in the textile industry--people keep on moving from country to country."
Quotas hobbled that mobility, but no longer. With costs rising on the Pearl River Delta, the industry may push farther inland in China, or look again at rivals like Indonesia or Vietnam. One of the few nations showing some confidence in its ability to compete is India. Once the world leader in cotton-textile exports, India faded in the 18th century, when the British Empire created a virtual monopoly for its own manufacturers at home and in the Indian market, choking textile centers like Surat.
Today Surat is upbeat. More than one million of its 3.5 million people make their living in some way related to textiles. Even the Self-Employed Women's Association, an NGO that supports poor women, is upgrading cottage factories to meet international standards. "It's an opportunity that we don't want to let go," says Rema Nanavaty, who heads SEWA's garment venture. "We are trying to get our unit started by January to take our share in the post-quota period." One interested buyer: Wal-Mart. New Delhi hopes to boost textile exports from $11 billion last year to $50 billion by 2010, a goal analysts consider well within reach.
Yet to hit its target, analysts say, the government must copy China's massive investments in new roads and ports, and add $30 billion worth of new factory capacity. According to the Federation of Indian Chambers of Commerce and Industry, "The central theme of the developments taking place in the Indian textile industry is that players are gearing themselves up for effectively competing in the volume game" against China. Researchers at Purdue University's Global Trade Analysis Project forecast that by the end of 2005, China will capture half of the clothing market in the United States and 29 percent of Europe, and India will rank second, with 15 percent and 9 percent shares, respectively.
The most obvious winner will be consumers. In the United States, for example, clothing prices have already fallen by 8.5 percent since 2000; the elimination of quotas should drop prices further. Most analysts believe luxury prices won't come down, while retailers in the middle--like the Gap or H&M--will use the cost savings to cut prices, reinvest in better products or both. AT Kearney predicts that the upshot of this struggle will be an 8 to 18 percent drop in retail clothing prices in the coming years. More and more of those pieces will be labeled: MADE IN CHINA. Or maybe INDIA.