The downfall of Nepalese garment industry

My latest op-ed is about the downfall of garment industry in Nepal (thanks to Theo Birch for helping to fine-tune the article!). The inability of the industry to foresee changes brought about by globalization and an outdated industrial policy are the main reasons. My earlier pieces on the garment industry in Nepal here, here, and here.

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Demise of garment industry

Few people realized that 2010 began with unfavorable news for the Nepalese economy. The garment industry, once the highest foreign exchange earner for Nepal, has almost disappeared. In fact, only one firm still exports readymade garments to the US, once the biggest market for this industry. The growing Indian market has been the focus of attention of the few remaining firms that are struggling to survive. The demise of the garment industry demonstrates the failure of our trade promotion policy and industrial policy. To avoid recurrence of similar event, it is vital that we assess the causes of the downfall of garment industry and learn lessons from our mistakes.

An article in Republica accurately reflects the importance of the garment industry: “Through the first 16 years of journey, the industry with over 1,200 active production units in 2000 occupied about 7.2 percent share of the total manufacturing sector, earned one-third of the total export income, witnessed investment climb to Rs 6 billion and directly employed 90,000 people, supporting livelihood of 450,000 persons.”

Alas, this glory is now lost. Exports to the US, which previously accounted for more than 80 percent of total garment exports have been insignificant this year. Less than ten firms remain in operation. Hundreds of thousands of employees have been laid off. The country has lost a reliable source of revenue. Worse, the failure of this industry has led to the collapse of the whole exports sector.

Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization. Policymakers and garment investors failed to notice quite obvious signs of change in the international market. They failed to design corrective policies to restructure the outdated domestic garment industry. Instead of addressing the constraints that were making the garment industry uncompetitive, they basked on the already secured preferential agreements and wasted valuable time and resources in securing more of them.

In 1990, the WTO’s member countries signed the Agreement on Textiles and Clothing (also known as the Multi-Fiber Agreement), which eliminated quotas on the trade of textiles and clothing. This was to be implemented in four phases; commencing with 16 percent reduction in quota of 1990’s imports. Thus it was known two decades ago that all quotas in this sector would be abolished. There was ample time to invest and restructure the Nepalese garment industry. However, both investors and policymakers turned a blind eye to the necessity for the reorganization of this industry.

Traditionally, the Nepalese garment industry grew not because its products were competitive and superior, but because it got preferential access to the markets in the US and the EU. The guaranteed market access for Nepalese garments and the imposition of quota on exports from countries that had advanced capital and competitive production mechanism meant that even if our products were not competitive in terms of price and quality, they were still exported without any restriction on quantity.

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Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization.

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Prior to the first phase of quota elimination in 1995, Nepal had five years to upgrade its production structure so that firms could expand their size and tap synergies to exploit economies of scale, i.e. as you produce more of the same good, the average cost would decline. This would, in principle, improve price competitiveness of Nepalese garments. Unfortunately, it never happened. Meanwhile, garment investors in countries such as China, India, Vietnam, Cambodia, and Sri Lanka, with the help of their governments, were already working to ensure the competitiveness of their products and the consolidation of their production. They were already preparing for the competitive international garment market after 2005.

The first phase of quota elimination in 1995 was followed by further quota eliminations of 17 percent in 1998, 18 percent in 2002, and finally 49 percent at the end 2004. The second phase of quota elimination hit the Nepalese garment industry and the overall exports very hard, leading to a collapse of total exports, which have not recovered to the level reached in 1997. Though this was a catastrophic blow to the whole export-based sector, it was not appropriately heeded by investors and government. During the ten-year transition phase of MFA, the production structure in Nepalese garment industry hardly changed. Most of the firms had small-scale production units with little cost advantage in production. Some of the intermediate goods that were used to produce final output were simply imported from third countries whose garments exports were subjected to quota restrictions, marginally redesigned, and stamped with ‘Made in Nepal’ tag for export. This meant that producers were merely acting as distributors to earn quick profits, often by gimmickry. There was very little creativity used in enhancing productivity, efficiency, marketing and distribution. Meanwhile, the investors paid little attention to product diversification and eroding competitiveness of their products.

While other governments actively engaged in upgrading their garment industry by establishing Garment Processing Zones, Export Promotion Zones, increasing consultancy for better management, and extending capital and credit to their garment investors, the Nepalese government ignored the aggressive steps taken by other countries and did pretty much nothing. It simply requested more preferential agreements. It also failed to encourage and help investors find niche markets abroad. In addition, the government was unable to ensure the security of investors and the smooth flow of goods across the Nepalese border. Frequent strikes along the main highways led to an increase in transportation cost. This also increased the risk of delivery problems, leading to an escalation in the final price of garments. It further eroded the price competitiveness of Nepalese garments. To make matters worse, trade unions and militant youth wings made a mockery of property rights by occupying and confiscating private property, and forced an increase in wages and allowances, irrespective of labor productivity. The lack of a regular power supply also aggravated the situation.

The downfall of the Nepalese garment industry illustrates some important lessons which could be used to avoid a similar fate befalling other export-based industries. The Nepalese government should not be hankering after preferential export terms; it should be investing and ensuring that domestic firms are competitive in terms of price and quality and are constantly innovating to keep up with cut-throat competition in the international market. Meanwhile, it is imperative that the government keep investors and supply chains away from the clutches of the militant youth wings and the unions. An industrial policy and trade promotion policy designed to address these issues is a need of the hour to keep our industrial base intact.

[Published in Republica, January 19, 2010, pp.5]

Competition or Coordination Among Aid Suppliers?

Frot and Santiso argue that too much aid fragmentation is not an important issue; too little competition between the suppliers of aid is the main problem. This basically means that the efforts to coordinate aid among donors, in line with the 2005 Paris Declaration and the 2008 Accra Agenda, is a misplaced priority. For aid effectiveness, the priority should be to increase competition among aid agencies.

They argue that in 1960 each developing country received aid from, on average, two donors. In 2006, it was more than 28. They also show despite there has been a significant expansion of donors’ portfolio size, partnerships among them is extremely low.

 

a sectoral analysis reveals that fragmentation has become more pronounced in all sectors. The social sector is the most fragmented, and follows the most pronounced trend towards more fragmentation.

The aid community often debates about too much fragmentation, and so usually too many donors. But in many countries there are very few donors. Too little fragmentation, or more precisely too little competition among donors, is also an issue.

It is peculiar that an abundance of suppliers is criticised in the "aid market", when economics underline the virtue of competition almost everywhere. However in the world of aid, the presence of many donors does not imply competition among them, but more often superposition of costs and administrative procedures. Aid monopolies therefore appear desirable if they cut these costs while barely raising the already overinflated price of aid.

The current approach is institution-based. Donors and recipients meet in international meetings, and pledge to act. Progress is monitored by a multilateral institution (OECD’s Development Assessment Committee) that cannot constrain donors to implement their pledges, except through a delicate game of naming and shaming.

We wonder about the efficiency of this approach. To deal with a too heavy administrative weight by creating new administrations is somehow ironic. It remains to be proven that these new institutions will lower transaction costs and manage to implement a labour division that donors are often reluctant to effectively achieve. The problem with this approach is that it basically ignores why aid is fragmented. It does not attempt to change the incentives donors and recipients face, and so is unlikely to radically change their behaviours. In particular, it disregards the lack of competition that creates fragmentation.

This decentralised approach argues that fragmentation is a consequence of the current institutional setting where competition is absent. It directly tries to make fragmentation an unsustainable outcome instead of ruling it out by assumption. Its difficulty lies into designing the set of rules that provide the right incentives, and to make donors accept these rules. This is by no means an easy task, but it is more ambitious and promising.

Fragmentation increases cost for recipients, leading to reduction in aid efficiency. Dealing with donor’s requirements and consultants reduces the total value of aid for recipients. Sometimes, important human resources are diverted to addressing donor’s multiple conditions. However, sometimes it is better to have as little fragmentation as possible. Recently, a lack of cooperation among donors led to a disastrous health situation in rural districts in Nepal. Instead of competition among donors, a lack of coordination among those working in the health sector was the main problem in dealing with an emergency situation. In such a situation, it is hard to explain how competition among donors would have avoided the unfortunate incident; better coordination among donors would have avoided the health disaster.

Sometimes coordination might be efficient than competition as it might clear information externalities and increase efficiency (by avoiding duplication of interventions). If there are many donors working in the same sector and same project, it is beneficial to align their interventions so that the final output is cost-effective and beneficial to the recipient country.

Both markets or aid agencies could bring the needed alignment. In an imperfect setting, the latter could do the job more efficiently if they coordinate interventions because they “know” what they are doing and what and where. The cost of alignment of interventions through the market might be inefficient with regards to cost and time needed to bring the needed change. The aid industry is not the same as commodity markets.

[Also see takes on similar issue by Owen Barder (who argues for a considered combination of market mechanisms, networked collaboration, and collective regulation for better aid effectiveness) and Bill Easterly.]

Climate Change 101: Separating Scientific Facts and Fictions

This is a guest post by Greg Shinsky from Monash University, Australia . An earlier blog post from Greg can be found here.

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The inquisitive nature of scientific study necessarily means that the details of something as complex as climate change can never be completely agreed to or understood. For example, the Hadley Centre recently released data demonstrating that the warmest year since records began was 1998.[1] On a straight reading, twelve years without a new record would, according to sceptics, be rather a large lull in what is supposed to be a rising trend. However, because heat can be trapped in other parts of the climatic system (such as the oceans) and not show up for a long time, modelling often shows the occasional decade in which no rise in surface temperatures is recorded.

This lack of scientific certainty does not however mean that policymakers and popular media outlets should be ignorant of established scientific principles – namely the reality of the much quoted but perhaps not widely understood ‘greenhouse effect’.

As demonstrated by the diagram below, the greenhouse effect is determined by two primary forces: (1) the amount of incoming shortwave solar radiation that strikes the earth, and (2) the amount of outgoing longwave radiation that is retained by the atmosphere. Within this system, the earth’s atmosphere, consisting of various gases, plays the vital role of a greenhouse. The atmosphere is essentially a blanket which selectively balances and traps the unequal wavelengths of radiation and remits them back to warm the earth’s surface.

The gases within the atmosphere, such as carbon dioxide (CO2), methane, nitrous oxide and water vapour, exist naturally and are very effective at absorbing thermal radiation expelled from the earth’s surface. However, small changes in the concentrations of these gases can drastically alter the heat-trapping capabilities of our atmosphere. Moreover, these gases have different lifetimes ranging from a few days to centuries.

The continual accumulation of these gases in the atmosphere (with CO2 being the largest by far), since the commencement of the industrial revolution, has led to a disruption of the carbon cycle.

This means the earth’s carbon ‘sinks’, such as forests and oceans, are no longer able to naturally absorb the amount of greenhouse gases emitted, with the result that concentrations of CO2 (in terms of parts per million [ppm]) are now approximately one third higher than pre-industrial levels. At the same time the earth has experienced a 0.6ºC increase in mean global temperature over the past century with most of this increase, according to the IPCC, being “attributable to human activities”.[2]

However, as temperature follows concentrations with a time lag, the full effect of current emissions is yet to be felt and is estimated to fall anywhere between 1.4 to 5.8ºC by the year 2100.[3]

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[1] See ‘The Economist’, January 9^th – 15^th article on p.70-71.

[2] International Panel on Climate Change (2001), Climate Change 2001: Synthesis Report, Summary for Policymakers. Available from http://72.14.207.104/search?q=cache:pQvAnSohe-8J:www.ipcc.ch/pub/un/syreng/spm.pdf+ipcc+2001+climate+change+summary+policymakers&hl=en&gl=us&ct=clnk&cd=2

[3] Ibid

Rebuilding Haiti

George Packer writes:

Yet Haitian political culture has a long history of insularity, corruption, and violence, which partly explains why Port-au-Prince lies in ruins. If, after an earthquake that devastated rich and poor neighborhoods alike, Haiti’s political and business élites resurrect the old way of fratricidal self-seeking, they will find nothing but debris for spoils. Disasters on this scale reveal something about the character of the societies in which they occur. The aftermath of the 2008 cyclone in Burma not only betrayed the callous indifference of the ruling junta but demonstrated the vibrancy of civil society there. Haiti’s earthquake shows that, whatever the communal spirit of its people at the moment of crisis, the government was not functioning, unable even to bury the dead, much less rescue the living. This vacuum, which had been temporarily filled by the U.N., now poses the threat of chaos.

But if Haiti is to change, the involvement of outside countries must also change. Rather than administering aid almost entirely through the slow drip of private organizations, international agencies and foreign powers should put their money and their effort into the more ambitious project of building a functional Haitian state. It would be the work of years, and billions of dollars. If this isn’t a burden that nations want to take on, so be it. But to patch up a dying country and call it a rescue would leave Haiti forsaken indeed, and not by God.

Jeff Sachs proposes Haiti Recovery Fund for rebuilding Haiti.

How would a Haiti Recovery Fund be organized? It should receive emergency outlays from the United States and other donors; organize a board that includes members appointed by Haitian President René Préval, the U.N. secretary general and donors; and empower a management team to formulate and execute plans agreed to by the Haitian government.

Very soon, the first phase of recovery operations in Haiti will end. Tragically, tens or hundreds of thousands will have died under the rubble, with relief and equipment arriving too late. Now the race is on to save Haiti itself. Its capital, a city without reserves of food, water, power, shelter, hospitals, medicine and other vital supplies, faces the real possibilities of hunger, epidemics and civil unrest. And the rest of the country is like a body without a head. The port is shut, the government is overwhelmed, many U.N. peacekeepers have transferred to Port-au-Prince, and the normal operations of government, skimpy as they once were, have broken down entirely.

The recovery fund would focus first on restoring basic services needed for survival. For months to come, medical supplies from abroad should be stockpiled and then distributed in the capital and beyond. Makeshift surgical units and clinical facilities will be essential. Power plants on offshore barges will be needed for electricity until new plants can be constructed. The salaries of public workers -- especially teachers, police officers, nurses, reconstruction workers and engineers -- must be assured, despite an utter collapse of revenues. Haiti's currency will need to be backed by international reserves so that the demand for public spending does not create harrowing inflation. The Haiti Recovery Fund, together with a quick-disbursing grant from the International Monetary Fund, should provide the needed reserves and budget financing.

RTAs are not distortionary!

This paper reviews the theoretical and the empirical literature on regionalism. The formation of regional trade agreements has been, by far, the most popular form of reciprocal trade liberalization in the last fifteen years. The discriminatory character of these agreements has raised three main concerns: that trade diversion would be rampant, because special interest groups would induce governments to form the most distortionary agreements; that broader external trade liberalization would stall or reverse; and that multilateralism could be undermined. Theoretically, all of these concerns are legitimate, although there are also several theoretical arguments that oppose them. Empirically, neither widespread trade diversion nor stalled external liberalization have materialized, while the undermining of multilateralism has not been properly tested. There are also several aspects of regionalism that have received too little attention from researchers, but which are central to understanding its causes and consequences.

 

Source: RTA

Death of the global trade system???

Here is Paul Blustein:

Someday historians may look back on 2010 as the year the global trade system died -- or contracted a terminal illness. A pledge by world leaders to complete the Doha round of global trade negotiations this year looks increasingly likely to end in yet another flop, and that would deal a crushing blow to the trade system as we know it.

After eight painful years of standstill and failure, with each meeting just a shoveling of intractable problems forward to the next, the Doha talks might collapse once and for all in 2010, possibly taking the World Trade Organization (WTO) down in the process.

If Doha falls apart, the WTO's ability to continue performing its vital functions would be imperiled. If it can't forge new agreements, how long before it loses its authority to arbitrate disputes? The trade body won't disintegrate overnight, but the danger is that its tribunals will be weakened to the point where member countries start ignoring WTO rulings and flouting their commitments.

The demise of Nepalese garment industry

Here is a sad story:

Today Nepal has only one firm exporting garment to the US. A dozen other are trying to survive by turning their focus to the Indian market.

This is the same industry which was a big hit until 2005:

Through the first 16 years of journey, the industry with over 1,200 active production units in 2000 occupied about 7.2 percent share of the total manufacturing sector, earned one-third of the total export income, witnessed investment climb to Rs 6 billion and directly employed 90,000 people, supporting livelihood of 450,000 persons.

What caused the downfall?

In the new millennium, however, labor stir, instability, extortion and threats to industries started to add cost of production, contrary to the actual need of the industry, especially after the US extended duty-free facility to competitors in Caribbean and Sub-Saharan countries (2002) and quota phase out (2005). This started to take toll on the industry.

(add the impact of the end of MFA as well--see below)

What could have saved the industry?

Garment Association Nepal (GAN) had made clear that only three measures can revive the industry -- establishment of Garment Processing Zone (pushed since 1999) that lowers production cost; an order-based hiring system (sought since 2007) that frees manufacturers from undue labor cost and stir; and duty-free-entry facility for Nepali garments in the US (lobbied for since 2005).

Was this day expected? I think, yes! I have written about the sorry state of the garment industry several times, highlighting not only what ails this industry but also offering recommendations on reviving its past glory.

Nepalese garment investors and the government basked on quota system so much that they forgot how competitive its competitors had become (and how uncompetitive they were becoming):

What surprises me the most is the fact that our leaders and garment sector entrepreneurs have not yet realized the value of competition and the stark truth that the Nepali garment sector cannot simply compete with the big producers, who continue to take an advantage of agglomeration economies, from Cambodia, China, India, Vietnam, and Mexico, at least not in the current situation.

Instead of rectifying defective economic policies considering the changed circumstances in the market brought about by globalization, the bureaucrats are too bogged down and intent on getting the preferential treatment in the US market. It shows how misguided our economic priorities are and how ignorant and unyielding our policymakers are to change the course of economic policy for good.

The prevailing illusionary notion among the policy-makers and garment sector entrepreneurs -- who are already battered hard by the depression in the garment sector -- is that the industry can recoup lost jobs and revenues if they are able to secure special treatment in the US market.

However, what is hard to swallow is the fact that no such recouping would occur and greater revenue generation would just be a dream, unless a miracle happens in favor of Nepali products in the international market. After the end of the MFA, Nepal already has lost market pie to big producers from China, India, Cambodia, and Vietnam, among others.

Rather than addressing the constraints that were making the garment sector uncompetitive, the government engaged on a fruitless effort to secure preferential treatment in the US market. But, it never realized admitted that this was a distant dream!

After more than four years of lobbying, there is hardly any progress. The policymakers are bogged down into this issue as if this is the only sector that would help stimulate export-led growth and employment generation. Exploration of other comparatively advantageous sectors have been overshadowed by the obsessive focus on securing preferential access to a market that is already flooded with similar goods from countries which enjoy huge cost and competitive advantage over Nepali exporters.

A senior diplomat, who is quite familiar with these issues, from the State Department opined that it is very “unlikely” that Nepal would get preferential access to the US market under the present circumstance. Unfortunate this might be but it is not surprising. By now the Nepali lobbying troupe has a fair idea of how hard it is to secure preferential treatment from the US Congress; despite over four years of lobbying, things have not moved a bit in the positive direction.

It should have been a clear indication that the entire effort might be a lost cause, not because we don’t need to prop up this sector but because we can’t do it under present labor and economic conditions in particular and the incapacity to fulfill enhanced labor, quality and environmental requirements brought about by increasing globalization in general. The senior official advised Nepali leaders and lobbyists to be a bit more realistic and not chase for something that is not attainable.

I emphasized:

The illusionary notion that securing duty-free access to the US market would revive the garment and textiles sector is fundamentally flawed. Policymakers and investors should be a bit more realistic about our real manufacturing and export capacities.

I suggested:

This does not mean that we need to abandon the promotion of garment and textile industry abroad. It would be fruitful to look at regional markets, which has higher potential than markets abroad because of lower transportation and transaction costs. This sector could gain more if the same amount of political and financial capital is invested in lobbying to eliminate countervailing duty (CVD) of 4 percent in the recently signed Nepal-India trade treaty.

Expediting establishment of GPZs and giving tax credits and subsidy incentives to investors would also aid the process, though, to be frank, no one knows how much this will help the dying sector regain its past glory. To satisfy the never-ending fascination with Western markets, the government and the exporters need to look into niche markets rather than the entire garment and textile market, which, as argued before, are already conquered by competitive firms from other countries. Promoting selected products that reflect Nepali tradition and heritage would be one of the potential niche markets.

For more discussion about the garment industry in Nepal, check out this short paper.