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This essay will explain what the Multi-Fibre Agreement was and why it was felt necessary. It will then show, via a supply and demand analysis, the effects of the MFA on both developed economies and less developed countries (LDCs). The analysis will then identify who benefited and lost out from the MFA, the likely effects of removing the quota, including identifying who will gain most from doing so.
The Multi-Fibre Agreement was set up in 1974 as a set of formal quota agreements and restrictions, governing textiles and the clothing trade between developing countries and the developed world. The MFA replaced the 1964 Agreement in International Trade in Cotton Textiles. There are a number of reasons cited for the introduction of the MFA, although the most widely accepted is that of the developed world using it as a form of protectionism to secure their own textile industries against the threat posed by low-cost competition from less developed countries.
‘However, by giving quotas to individual nations, it also gave them a guaranteed share of the rich countries.’ (BBC News, 2004) This is in contrast to some other justifications for the MFA, for example ‘a major aim of the multi-fibre agreement has been to provide greatest scope for newly industrialised countries to increase their share of world trade in textile products whilst at the same time maintaining some stability for textile production in the developed economies.’ (Griffiths and Wall, 1997)
The quotas, operated under the Agreement on Textiles and Clothing (ATC), were originally introduced under the MFA. A key feature of these quotas is that they are imposed only by a subset of countries and only on exports from a subset of exporters. (Hamilton, 1990) Another important feature is that the importers allow exporters to allocate the quotas and hence potentially to benefit from the higher prices in the restricted markets. (Martin, Manole and Van Der Mensbrugghe, 2004)
The following supply and demand diagrams outline the theoretical affects of imposing quotas such as the MFA.
(Taken from Griffiths & Wall, 1997)
The diagram assumes that world supply is perfectly elastic, and represented by point Pw, the point of production assuming free trade. Production of clothes and textiles in the developed economy is represented by 0Q1; and the level of demand for these products is represented by 0Q2. There is clearly a difference between the level supplied and demanded at this price; therefore, the developed world needs to import Q2-Q1 from the developing world economies.
Assume now the introduction of the MFA, which is represented by the implementation of a quota, Q3-Q1, limiting imports from the developing economies to the developed world. The total supply into the developed economies is now represented by SH+Q, which results in a price rise from Pw to Pw’, and a reduction in demand from 0Q2 to 0Q5. In turn, the level of imports from the developing nations is reduced by the amount Q3 – Q1.
The imposition of the MFA therefore, leads to a situation of reduced consumer surplus, indicated by area 1+2+3+4. There is however, an area of producer surplus, indicated by area 1 on the diagram, although the quota leaves a net welfare loss represented by area 2+3+4.
This diagram explains the principles of the MFA as a quota system, and its effects. However, the MFA operates under a system where some countries are restricted and others are not. The following diagram looks at the effects of this situation.
(Adapted from Faini, De Melo and Takacs, 2001)
The assumptions for this diagram are as follows: there are two countries exporting an identical textile product. D represents the demand curve for developed countries, and S1 and S2 are supply curves for two developing countries exporting to the developed country. If free trade existed, then P0 would be the equilibrium price, and each country would export at levels X1 and X2 respectively, where their supply curves intersect at P0. The MFA is now used to introduce an export quota on country 2, placing a cap on the number of imports, reflected by level Q2. Country 2’s supply curve now becomes vertical at the level of the quota, because they cannot export further goods beyond this point. The total level of supply to the developed world now becomes S1+SQ2, raising the equilibrium price to P1. The level of exports from the country without a quota now increases to XQ1, to compensate for the loss of exports from the other country.
This diagram shows the inefficiencies created by implementing the MFA, through its restriction of imports from low-cost countries, shifting production to higher costs countries. If the MFA were removed, allowing the developing countries to produce at a cheaper rate then the production savings are represented by the grey area on the diagram. Therefore, consumers in developed countries pay more for their goods, and LDCs, subject to quotas, cannot generate the level of export earnings which they otherwise could.
There is an argument that developing countries actually benefit through the MFA, because they receive ‘quota rents’, meaning they receive higher prices than they would be guaranteed in a free market, as shown by area 1 on the first diagram above. However, this is not likely to be a valid argument given that a study by Balassa and Michalopoulos (1985) showed that the value of lost output, as highlighted by the diagrams, exceeds the quota rent by 9 times to the US, and by 7 times to the EU. In addition, ‘quotas on imports of textiles in the US have restricted the supply of certain apparel products and increased their price by as much as 70%’ (Tanzea, 2000 cited in Hill).
It is therefore argued that ‘the bilateral quotas that make up the MFA arbitrarily divide up markets and prevent trade flows from efficiently allocating production and efficiently distributing goods among consumers in different countries.’ (Faini, De Melo and Takacs, 2001)
In 1994, as part of the Uruguay Round of multilateral trade negotiations, it was decided that the MFA should be phased-out by January 1st 2005, as part of the Agreement on Textiles and Clothing. This was to ensure that the clothing and textile industry become better aligned with the principles of WTO, and the promotion of free trade. (See Appendix I for the Quota Removal under the ATC)
There will be a number of beneficiaries from the removal of the MFA, although large scale and low cost producers are likely to benefit most, such as China, India and Pakistan (See Appendix II). China is going to be by far the largest gainer from removal of quotas, the level of Chinese clothing exports raised from 11 million units in 1995 to 213 million units in 2004. (See Appendix III for the Top 10 Exporters of Clothing and Textiles in 2001)
The removal of the MFA is unlikely to benefit everyone, and smaller producers, and those with higher costs, such as South Africa, may lose out from its removal. Competition levels are also likely to increase following the removal of quotas, with those countries which depend on clothing and textiles exports likely to suffer the most, such as Mauritius, Bangladesh, and Lesotho.
‘The end of a global quota system means that Cambodia will have to compete with larger and cheaper rivals, like China and Vietnam. The garment industry provides jobs for 270,000 people in Cambodia and is the country’s biggest industry by some distance.’ (BBC News, 2004)
The removal of quotas is likely to have political, consumer and efficiency implications for the countries involved. Politically, this is likely to test the ability of the WTO to influence multinational trading agreements. As shown in the diagrams above, consumers stand to gain benefit from a welfare gain due to lower prices. The knock-on effect of removing quotas should also be an overall increase in efficiency as greater competition is introduced into the market, and removes the distortions to world market prices.
In conclusion, this essay has explained what the MFA was and why it was set up, including an analysis of the economic theory surrounding quotas. The essay has shown that the implementation of the MFA led to a situation of consumer welfare loss in developed countries, and a loss of potential export earnings for LDCs, and the inability to exploit their comparative advantage in this area.
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