LITERATURE REVIEW

This chapter starts with a theoretical framework. It discusses what quotas are followed by the models showing the effects of quotas on importing and exporting country's trade. A large body of literature attempts to predict the likely impact of removal of quotas on textiles and clothing. The results of these studies are included in this chapter.

3.1 Theoretical Framework

There are many forms of protection in world trade. They include tariffs and non-tariff barriers. Tariffs, which are taxes on imports of products into a country or region, are amongst the oldest form of government intervention in economic activity. They are implemented because they provide revenue for the government and protect the domestic industry from foreign competition. Non-tariff barriers include voluntary export restraints, technical barriers to trade, and import quotas. The effects of all these tariff and non-tariff barriers on importing and exporting countries are almost identical.

Quotas restrict the imports of specified products by setting a maximum quantity or value of goods authorized for import. Different types of quotas exist, such as global quotas, bilateral quotas, seasonal quotas, quotas linked to export performance, quotas linked to the purchase of local goods, quotas for sensitive product categories, and quotas for political reasons.

In this context, quotas refer to the limits placed on the quantity of different categories of clothing (e.g. knitted T-shirts, sweaters, gloves) and textiles (e.g. knitted fabric, acrylic yarn, cotton fabric) that can be exported to the US, Canada and the European Union (EU). Under the ATC system, garment and textile-producing countries were assigned a maximum quantity that they could legally export to the US, Canada and the EU during a particular time frame. The quotas set by the ATC differed by country and per product. The allocation of quotas was generally based on historical export levels (Appelbaum, 2004).

The quotas operated under the Agreement on Textiles and Clothing were originally introduced under the MFA. The main purpose of these quotas was that they were imposed only by specific countries, on exports from specific countries. Another purpose was that the importing countries allowed exporting countries to allocate the quotas. Quotas' effects are not easy to understand since they are very complex and require a global perspective to be taken.

To a better understanding of the effects of quotas on both importing and exporting countries can be gained from the use of, diagrammatic models. The first diagram model used here shows the effects of quotas on importing countries.

Importing countries imposed quotas as a device for restricting imports than tariffs. This is because they are more predictable. They ensure that imports cannot exceed a certain amount, whereas, with a tariff, the precise effect on the volume of imports is uncertain, depending on the slope of the demand and supply curves.

When the quota imposed the price of the product became OP* from OP. Sd + quota is the domestic supply curve with the quota added. Demand of the product falls to OQ3 because of the high price and domestic supply increases to OQ2. Imports, also falls, because of the quota constrained at Q2Q3 = WV.

In case of importing country profit goes to the person who imported the product at the price OP and sell it on OP*, not to the government (area C in Diagram). If government auctions the quotas than importers have to buy a licence of the quotas to import the products, than the profit will go to the government. The main advantage of the quota is that domestic production increases because the imports decrease, however, consumption of the product also decreases.

However, in some respects quotas are more damaging than tariffs for the importing country. Like quotas allocated on the basis of share of the importer in the market and once allocated, it is difficult for more efficient importers to import more if their quota has been already used up.

To understand their effects on exporting countries it is important to distinguish between the prices of restricted and unrestricted markets. A simple diagram model can be used to present the basic economic implications of the MFA quotas for exporters (Figure 3.2). As in Kathuria, Martin and Bhardwaj (2001), the diagram is kept simple by basing it on the Armington Assumption, which states that the products produced by this group of exporters are not the same as the products of other countries.

This assumption allows well-defined import demand curves to be drawn for quota-restricted products in the restricted country (DR) and in the unrestricted country (DU). The point where these two demand curves meet horizontally gives the global demand (DT) for the products of the restricted countries. In the absence of any quotas, as in figure 3.2, the price will be the same in restricted and unrestricted countries. In the unrestricted equilibrium represented in figure 3.2 the same price applies in both the restricted and unrestricted countries, because the restriction comes in figure 3.3.

When quotas are introduced in restricted markets the quantity exported to those markets declines' as shown in figure 3.3. The price received for exports to restricted markets increases from (PW) to (PR), because of the restrictions and the price received for exports to unrestricted markets declines from (PW) to (PU).

The overall demand curve of country (D'T) becomes steeper and less elastic. Because the original price of the output falls, the volume of output automatically declines. Whether static welfare increases or decreases depends on whether the net gain from quota rents in restricted export markets compared with the situation in figure 3.2, represented by the crosshatched area in figure 3.3 outweighs the losses in the vertically shaded area in figure 3.3.

However, the overall effect of the ATC quotas on a country's economy cannot be determined simply by the economic effects shown in figure 3.3, although it does provide a basis for evaluating the partial effects of quotas on all restricted markets. This model is thus inadequate for evaluating the overall impact of the quotas on a country because it does not take into account the effect of restrictions on other exporting countries.

When restrictions applied to competing countries clearly increase the demand for exports from the country of interest, whether these restrictions are beneficial or not for any given country depends upon the importing countries, and on the relative magnitude of exports from each country.

To predict the reallocation of textile and clothing production among developing countries, a simple Ricardian analysis suggests that a country will produce and export goods in which it has a comparative advantage. A country has a comparative advantage in producing a good if the opportunity cost of producing that good relative to other goods is lower in that country than in other countries. This depends on the factor endowments of each country and factor requirement characteristics of the produced good. The textile and clothing industries are labour intensive, and the basic input is cotton. Thus, according to the Ricardian model, it is expected that countries with larger labour forces and higher production of cotton will benefit most from ATC expiration, as it will facilitate an increase in their production and exports of textiles and clothing.

The abolition of quotas in January 2005 eliminated some, but not all of the distortions affecting global trade in textiles and clothing. While the quotas have been abolished, tariffs on textiles and clothing remain, frequently at very high levels. Furthermore, some of Pakistan's competitors now benefit from preferential access to industrial country markets, either under preference schemes such as the EU's Everything But Arms (EBA), or through preferences provided under regional arrangements. Unlike tariffs or export taxes, export quotas are nontransparent in their effects on trade.

An analysis of the trade competitiveness situation shows that the phasing out of quotas implies significant changes in the worldwide trade structure, leading to strong output and employment shifts in and between countries.

3.2 Impact of quota elimination on textiles

Textile and clothing trade among World Trade Organization (WTO) members is governed by the Agreement on Textiles and Clothing (ATC), which came into force with the WTO Agreement on 1 January 1995. This agreement means that alongside the progressive application of General Agreement on Tariffs and Trade (GATT) rules, there will be progressive phasing out of quotas in the EU, US and Canada. These quotas were inherited from the Multi-fibre Arrangements (MFA). On 1 January 2005, the ATC expired and all quotas were abolished.

This means that all WTO members now have unrestricted access to the European, American and Canadian markets. This has obviously had an impact on major countries/regions concerned. This research addresses the possible impact of quota abolition on Pakistan's textile industry.

A considerable number of studies have aimed to quantify the economic and trade effects of the ATC phase-out as well as complete textiles and clothing market liberalisation. The majority of studies reviewed were undertaken by universities, economists and international organisations like the World Bank (WB), International Monetary Fund (IMF) and Asian Development Bank (ADB), and in the case of Pakistan, the Export Promotion Bureau (EPB), government organizations, and some institutions. Most of them foresee increases in global welfare as a result of gradual liberalization of the sector with the implementation of the 10-year transitional programme of the WTO's ATC, at the end of which the system of import quotas that has dominated the trade since the early 1960s disappeared.

Most of the research covers the global textile industry and the South Asian countries post ATC regime. There is not much research available specifically about Pakistan's textile industry in the quota free-regime, the opportunities and challenges Pakistan will face, and whether Pakistan will benefit from this regime or not. This literature review summarises briefly some of the available studies on the impact of the ATC phase-out on the textile and clothing industry.

A large body of literature attempts to predict or quantify the likely impact of the removal of quantitative restrictions. Different approaches have been used to address the issue; summary of these studies is given in table 3.1. Diao and Somwaru (2001) estimate that over the 25-year period following the ATC implementation, the annual growth of world textile and clothing trade will be more than 5 per cent than it would be in the absence of the ATC. According to their simulations, this acceleration translates into about $20 billion more trade in the short run (upon implementation) and as much as $200 billion in the long run (25 years). They also predict that, consistent with the trend in the historical data, the world clothing trade will increase twice as fast as the textile trade in the post-quota world. Similar results are reported by Avisse and Fouquin (2001), who found that, as a result of the ATC, the global trade in textiles and clothing will be about 10 per cent and 14 per cent higher, respectively.

Table 3.1 Results of Selected Analytical Studies related to ATC

Authors

Database

Model

Characteristics

Policy Simulations

General Results

World Bank (2004)

Data collected by authors

General equilibrium analyses

Quota Removal focus (Pakistan)

Overall, the short-run impact of MFA abolition will be positive on the textile sector, negative on clothing. The analysis suggests that Pakistan will benefit substantially from abolition of its own quotas, with the benefits resulting from improved efficiency of resource allocation outweighing the loss of quota rents.

Francois

and

Spinanger

(2001)

GTAP 4 (Base

year 1995)

Quota prices

for Hong Kong

for 1998/99

Standard Static

GTAP model

Quota removal plus Uruguay Round trade liberalization in the context of China's WTO accession.

(Focus: Hong Kong)

Textile and clothing exports from Asia (especially south Asia) increase substantially. Preferential access to the United States and the EU would be reduced and there would be a shift in demand away from countries like Mexico and

Turkey.

Terra

(2001)

GTAP 4 (Base

year 1995)

Standard Static

GTAP model

(i) Quota removal

and (ii) Quota

removal plus tariff

reductions

(Focus: Latin

America)

Developing countries subject to the biggest quantitative restrictions would expand their exports at the expense of the importing developed countries, but also of other developing countries which are less restricted (i.e., Latin American countries).

Avisse and

Fouquin

(2001)

GTAP 4 (Base

year 1995)

Standard Static

GTAP model

Quota removal

Output share of Asia increases from 12 percent to 18 percent. China's exports would increase by 87 percent, South and Southeast Asia's would increase by 36 percent. Latin America and NAFTA would lose 39 percent and 27 percent, respectively.

Authors

Database

Model

Characteristics

Policy Simulations

General Results

Diao and

Somwaru

(2001)

GTAP 5 (Base

year 1997);

Counterfactual

analysis using an

intertemporal

version of GTAP

MFA phase-out

simulated by improving the

efficiency of textile and apparel exports

from constrained

Countries. Other

trade barriers on

textile and apparel imports are reduced by 30 to 40 percent in all countries.

The annual growth of world textile and apparel trade would be more than 5 percent higher. Market share of developing countries as a whole would increase by 4 percentage points following the ATC. China would gain almost 3 percentage points of the world Textile and apparel market, while other Asian

countries would capture more than 2 percent. Non-quota developing countries are predicted to lose about 20 percent of their markets.

Matoo, Roy,

and

Subramanian

(2002)

Data collected by

the authors.

Partial Equilibrium.

ETEs derived from Kathuria and Bharadwaj (2000).

Leontief production.

Export elasticities from 1 to 5.

Interaction between the ATC and the AGOA rules of origin for Mauritius and Madagascar

Under the current AGOA

system, the apparel exports of

Mauritius and Madagascar

would be about 26 percent and 19 percent lower, respectively, following 2005. If AGOA's rules of origin requirement is eliminated, the decline in Mauritius's exports would be only 18 percent, and Madagascar's exports could increase.

Lankes (2002)

GTAP 5 (Base

Year 1997)

Standard Static

GTAP model

Quota removal

Total export revenue loss

attributed to the MFA quotas

estimated to be $22 billion for developing countries and $33 billion for the world as a whole.

Source: Commission of the European Communities, 2004

Although the elimination of ATC quotas is predicted to result in an increase in global trade, the impact is likely to differ among countries and regions. For each country, quota elimination represents both an opportunity and a threat. It is an opportunity because markets will no longer be restricted but it will also represent a threat as other suppliers will no longer be restrained and major markets will be open to intense competition. For instance, Lankes (2002) argues that the ATC may lead to a reallocation of production to the detriment of developing-country exporters that have been “effectively protected” from more competitive suppliers by the quota system.

A World Bank (2004) study provides an analysis of potential gains and losses for Pakistan from abolishing the quota system. The study shows that whether Pakistan will be better or worse off depends on the extent to which exports from Pakistan are restricted relative to exports from other suppliers; the strength of the competitive relationship between suppliers; and the extent of complementarities associated with global production sharing, particularly the benefits from increased demand for textiles and clothing as inputs.

The general results of the study are, overall, that the short-run impact of ATC abolition will be positive on the textile sector, and negative on clothing. The analysis suggests that Pakistan will benefit substantially from the abolition of its own quotas, with the benefits resulting from improved efficiency of resource allocation outweighing the loss of quota rents. The implications for the clothing sector could be serious, however if no action is taken to improve productivity, output could decline by over 15 per cent, and exports by a quarter. Overall, Pakistan's real income may decline by perhaps 0.4 per cent, and real wages could decline slightly if no action is taken to improve productivity.

The degree of a quota's restrictiveness can thus serve as a useful, if imprecise means of broadly predicting the likely impact of its removal. Being able to determine which countries are quota constrained and which are not is useful in understanding how particular countries will fare following quota elimination. In the existing literature, the degree of restrictiveness of an MFA quota is often measured in terms of its “export tax equivalent” (ETE). ATC quotas are administered by exporting countries and impose a cost on exporting firms that is exactly analogous to an export tax. In order to export, a firm in a quota-constrained country has to obtain or purchase a quota (or an export licence). The more restrictive a quotas is, the higher the tax will be.

ETEs are obviously zero for non-restrained products or countries. Flanagan (2003) points out that although as many as 73 countries are included in the quota system, some do not fully utilize their quotas. Elimination of an unfilled or non-binding quota has little effect on a country's ability to export because it could have continued to export to the quota limit in any case.

Many estimates of ETEs exist, and they vary for different countries and time frames. Francois and Spinanger (1999) estimate that Hong Kong clothing exporters face an implicit export tax of up to 10 per cent for goods intended for the U.S. market and 5 per cent for the European Union (EU) market. Kathuria and Bhradwaj (1998) report that in 1996, Indian exporters to the United States paid an ETE of 39 per cent (cotton based) and 16 per cent (synthetics), versus 17 per cent (cotton based) and 23 per cent (synthetics) in the EU market. In USITC, the import-weighted ETEs for US imports were estimated to be about 21 per cent for clothing, and those for non-clothing, textile categories were around 1 per cent.

In general, the literature reveals that Asian countries are relatively more constrained than other regions. Flanagan (2003) categorizes countries into groups depending on how “quota constrained” they are in terms of the number of product categories where quotas seriously limit demand. In the group of “Countries seriously held back, almost across the board, by quotas” were Bangladesh, China, Hong Kong, India, Indonesia, Pakistan, Philippines, Korea, Sri Lanka and Thailand. At the other end of the spectrum, countries such as Nepal, Oman, Qatar and the United Arab Emirates (UAE) are categorized as “Countries whose quotas have been a valuable tool, now threatened”. According to Flanagan, China, India and Indonesia have shown the most consistent and widespread near-saturation of quotas for yarn, fabric and garments.

Many analysts predict that the market shares of quota-constrained suppliers will increase markedly following 2005. Terra (2001) predicts that clothing production of the restrained exporters, as a whole, will increase by almost 20 per cent, and their textile production will increase by almost 6 per cent. Meanwhile, Terra estimates that the market shares of non-quota constrained suppliers (e.g. Mexico and African countries) will shrink. She predicts a fall in the exports of Latin American countries, which will be displaced by the big exporters subject to restrictions. Mercosur and Chile are predicted to reduce their exports of clothing significantly and their exports of textiles moderately.

Avisse and Fouquin (2001) estimate that Asian clothing exports will rise by 54 per cent and their share of the world market will increase to 60 per cent, from 40 percent in 1995. Chinese clothing exports, in particular, will rise by 87 per cent, and their share of world clothing exports will rise by more than 10 percentage points. Both South Asia's and Southeast Asia's clothing exports will also experience substantial gains, increasing by 36 per cent, combined. On the other hand, Latin American clothing exports are predicted to decrease by 39 per cent. Avisse and Fouquin estimate that Chinese production will rise by 70 per cent, and that of other Asian countries, by 26 per cent. Within a broadly unchanged level of global output, Asia's share will rise from 12 per cent to 18 per cent. North American production of clothing 14 will decline by 19 per cent and European production will drop by 11 per cent according to estimates.

Diao and Somwaru (2001) provide similar estimates. According to their dynamic model, world market share of developing countries as a whole will increase by 4 percentage points following the ATC. China is predicted to gain almost 3 percentage points of the world textile and clothing market, and other Asian countries to capture more than 2 percentage points. Current non-quota holding developing countries are predicted to lose about 20 per cent of their markets (equivalent to 2.3 percentage points of total world textile and clothing markets) to the restrained ones.

In addition to the costs of quotas themselves, the nature or quality of the quota administration system can also restrict an individual country's exports, and lead to quota “underfill”. Whalley (1999) points out that many developing countries have built costly domestic administrative structures around the internal allocation of quotas. Krishna and Tan (1998) present empirical evidence that the costs of the export licence system within the restrained countries are significant and that both the licence cost and hidden administrative costs are added to the price of the product prior to entering the foreign market.