• Under safeguard quotas, the mainland's exports of most affected textiles and clothing exports to the US and the EU declined in 2006.
  
  
• But some countries have taken the advantage of the quotas on China to increase their market share, while textiles and clothing production in the US and the EU has continued to fall.
  
  
• These trade diversion effects will likely remain in place until the safeguard quotas expire in the EU by end-2007, and in the US by end-2008.
  
  
• Even without such quotas, the US and the EU still have other measures to restrict mainland imports, notably anti-dumping actions, as well as global and China product-specific safeguards.

Under China's agreements with the US and the EU concluded in 2005, certain mainland-origin textiles and clothing exports to both markets are governed by safeguard quotas. Given these quotas, the mainland suffered declines in most of the 21 groups of restrained textiles and clothing exports to the US in 2006. Across the Atlantic, the mainland even suffered declines in all of the 10 categories of restrained textiles and clothing exports to the EU.

For their part, a number of countries, such as Bangladesh, Cambodia, India, Indonesia, Pakistan and Vietnam, have taken advantage of the safeguard quotas on the mainland to increase their market share in the US and the EU. For the US, textiles and clothing production and employment have continued to fall, with manufacturers shifting a larger share of their production offshore. Regarding the EU, textiles and clothing production has likewise declined.

Development in 2007 is expected to follow the pattern of last year. But the low utilisation of US quotas in 2006, marked by the utilisation rate for the hottest group standing at 86.2%, means that manufacturers on the mainland have much room to expand their sales to the US. Despite heavier quota utilisation in the EU, with five categories having a utilisation rate over 90% last year, mainland suppliers also have leeway to increase sales, as the utilisation rate for most categories has remained fairly low so far this year.

As for 2008, the outlook will be more uncertain. While safeguard quotas on the mainland will remain in force in the US and the same distortionary effects will likely continue to work, EU's quotas will expire by end-2007. But even without quotas, the EU still has a variety of defence measures to restrict imports from the mainland, notably anti-dumping actions, as well as global and China product-specific safeguards, which can also be applied by the US after its quotas expire by end-2008.

In view of the uncertainty amid quota expiration, Hong Kong's textiles and clothing exporters, most of which have substantial production and sourcing activities on the mainland, are advised to keep a close eye on regulatory developments, and take appropriate actions, such as undertaking production and sourcing in a global setting and diversifying into emerging markets. They should also move towards high-value activities, while making use of high technologies.

1. Background

In November 2005, the US and China signed a comprehensive bi-lateral agreement on textiles and clothing trade. The two sides agreed that the US would establish safeguard quotas on 34 categories (21 groups) of textiles and clothing imports from the Chinese mainland from the beginning of 2006 through the end of 2008. The agreement included a clause that requires the US to exercise restraint in the application of any safeguard quotas on products outside the scope of the agreement for the duration of the deal.

The EU reached a similar deal with China in June 2005, which provided for the establishment of safeguard quotas on 10 categories of textiles and clothing imports from the Chinese mainland through the end of 2007. Among other things, the EU committed to exercise restraint in the application of any safeguard quotas in 2008, and with respect to products not covered by the agreement.

These two arrangements have had a considerable impact on textiles and clothing trade patterns in both the US and the EU, diverting production that might have otherwise been performed by the Chinese mainland to other producers, primarily in Asia. These trade diversion effects have probably been more severe in the clothing market because the quotas focus much more heavily on clothing than textiles. These quantitative arrangements are expected to continue to have substantial distortionary effects on the market until their expiration date of 31 December 2007 in the EU, and 31 December 2008 in the US.

2. US Textiles and Clothing Import Trends in 2006

Total Imports

In 2006, the US's total textiles and clothing imports grew by 2.6% to 52,150 million square metres equivalent (SME) in terms of quantity, and by 4.6% to US$93,277 million in terms of value, with clothing imports increasing by 2.4% to 22,540 million SME (+4.2% to US$71,629 million) and shipments of textiles rising by 2.7% to 29,610 million SME (+5.6% to US$21,648 million). Growth was more subdued in 2006 than in 2005, when the textiles and clothing import market expanded by 8.3% in terms of quantity and 7.1% in value terms.

Imports from the Mainland

Despite the quotas in place on key clothing products such as cotton and man-made fibre trousers, shirts, socks and underwear, the mainland was able to strengthen its position as the largest US supplier of textiles and clothing in 2006, with total textiles and clothing shipments growing by 11% to 18,611 million SME in terms of quantity and 20.8% to US$27,067 million in value terms during this time. Within this total, US clothing imports from the mainland grew by 10.6% to 6,506 million SME (+22.3% to US$18,517 million), while US textile imports increased by 11.3% to 12,105 million SME (+17.7% to US$8,550 million). US imports of restrained textiles and clothing products from the mainland declined by 29.3% in terms of quantity, but rose by 7.1% in value terms in 2006, while imports of unrestrained merchandise grew by 18.9% in terms of quantity and 25.7% in value terms.

While impressive, given the quantitative restraints in place, the overall performance of Chinese textiles and clothing in 2006 was naturally more subdued than the performance achieved by the mainland in 2005, when it saw its textiles and clothing shipments to the US market surge by 43.7% in quantity terms and 53.9% in terms of value.

A closer look at the evolution of US textiles and clothing imports from the mainland during 2006 shows that imports rose by 3.1% in quantity terms and declined 1.4% in value terms during the first half of 2006, but recovered with growth rates of 18.1% in quantity terms and 41.3% in value terms during the second half of the year. It appears that a number of factors had a dampening effect on imports from the mainland during the first half, including the inherently negative effect of the imposition of quotas at the beginning of the year (which forced US importers to adapt their sourcing strategies to a new reality), the seemingly conservative quota allocation policy pursued by the Chinese government during the first half, and the wastage of quota allocations by certain suppliers.

As a matter of fact, not a single quota ended 2006 with a utilisation rate of 90% or higher despite the apparent increase in demand for Chinese products during the second half of 2006 and the efforts of the Chinese government during this time to reduce quota wastage. Category 347/348 (cotton trousers) was the category with the highest utilisation rate through 31 December 2006 at 86.2%, followed by category 338/339 (cotton knitted shirts and blouses) at 83.1%, sub-limit 332/432/632 B at 82.4%, category 332/432/632 T (socks and baby socks) at 81.1% and category 638/639 (man-made fibre knitted shirts and blouses) at 80.8%.

Utilisation of US Quotas on Chinese Mainland

Source: US Customs and Border Protection

In all, China's share of the US clothing import market in terms of quantity rose from 26.7% in 2005 to 28.9% in 2006, while its share of the textile import market increased from 37.7% to 40.9%. In terms of value, the mainland's share of the US clothing market grew from 22% in 2005 to 25.9% in 2006, whereas its share of the textile import market expanded from 35.4% to 39.5%. China's impressive performance, despite the quotas in place, showcases the versatility of the Chinese textiles and clothing sector. Chinese manufacturers have the experience, know-how and flexibility to manufacture virtually any type of textiles and clothing. This edge enabled the domestic industry to shift part of its productive capacity towards non-quota products during 2006 with no apparent trouble.

In any event, the Chinese mainland suffered declines in every quota category, with the exception of category 338/339 and 638/639, where imports grew by 4.4% and 36.4% in volume terms respectively. For their part, a number of countries took advantage of the US quotas on certain textiles and clothing imports from the Chinese mainland to increase their share of the US market in these products. An analysis of the evolution of trade in quota categories during 2006 shows that in particular, certain Asian countries, such as Bangladesh, Cambodia, India, Indonesia, Pakistan and Vietnam, made significant strides in these categories at the expense of the mainland.

US Imports in Categories where Mainland is Subject to Quota

Source: US Department of Commerce

Imports from Hong Kong

US demand for textiles and clothing products from Hong Kong dropped markedly in 2006, with total imports falling by 15% to 613 million SME in quantity terms and 19.8% to US$2,893 million in terms of value. Within this total, US clothing imports from Hong Kong declined by 12.3% to 523 million SME (-19.9% to US$2,811 million), while US textile imports plunged 28.3% to 89 million SME (-14.8% to US$82 million).

US textiles and clothing imports from Hong Kong held up well during the first half of 2006, with shipments rising 0.9% in terms of quantity and 21.3% in value terms, but dropped precipitously during the second half of the year, down by 25.4% in terms of quantity and 39.6% in value terms. Unsurprisingly, the rise of the mainland during the second half of 2006 came hand-in-hand with a sharp drop in demand for clothing from Hong Kong, most likely as a result of a decline in outward-processing activity.

Hong Kong's share of the US clothing import market declined from 2.7% in 2005 to 2.3% in 2006, while its share of the textile import market fell from 0.4% to 0.3%. In all, it has appeared that a substantial share of the US orders that used to be placed with Hong Kong manufacturers has shifted to the mainland and other Asian countries, including, most notably, Indonesia, Cambodia, Bangladesh and Vietnam.

Imports from Other Sources

There were several other success stories besides the Chinese mainland in the US textiles and clothing import market during 2006, including Pakistan (+8.4% to 3,568 million SME), India (+13.7% to 2,656 million SME), Indonesia (+18.1% to 1,599 million SME), Bangladesh (+13.8% to 1,495 million SME), Vietnam (+20.8% to 1,148 million SME) and Cambodia (+17.6% to 870 million SME).

Just as there were winners, there were also many countries on the losing side of the textiles and clothing trade equation during 2006. Examples of such suppliers include Mexico (-11.8% to 3,425 million SME), Canada (-19% to 2,439 million SME), Honduras (-9.4% to 1,144 million SME), El Salvador (-17% to 744 million SME), Turkey (-14% to 725 million SME), the Dominican Republic (-18.9% to 588 million SME) and Israel (-14.3% to 507 million SME). Although some of these countries are expected to remain large suppliers in the future, they are finding it increasingly difficult to compete with the mainland and other Asian suppliers.

US Imports of Textiles and Clothing

Source: US Department of Commerce

In general, the quotas currently in place on textiles and clothing imports from the Chinese mainland were largely ineffective in protecting the US textile manufacturing industry because orders in most of these categories were merely shifted by US importers to other suppliers, particularly in Asia.

Impact on the US

The on-going increase in US demand for imported textiles and clothing merchandise has come hand-in-hand with a continued decline in US textiles and clothing production and employment.

• US clothing production declined 6.5% to 1,963 million units in terms of quantity and 7.1% to US$16,239 million in value terms in 2006, compared to 2005. For instance, production of men's and boys' tops dropped 14.6% to 431 million units and 25.3% to US$1,671 million during this period.
  
  
• US textile production weakened considerably in 2006, compared to the previous year, with yarn output down by 12.8% to 6,974 million pounds, broadwoven fabric output down by 31.2% to 6,221 million square yards and knitted fabric output down by 20% to 841 million pounds.
  
  
• Sales by the US clothing manufacturing industry experienced a significant letdown in 2006, declining by 3.7% to US$86,602 million from 2005. Net earnings were higher, however, increasing from US$6,415 million in 2005 to US$6,565 million in 2006.
  
  
• Sales by the US textile manufacturing industry fared a little better in 2006, declining by only 1.6% to US$48,477 million. Yet, net earnings fell from US$1,511 million in 2005 to US$1,448 million in 2006.
  
  
• US textiles and clothing manufacturing employment continued to deteriorate in 2006, with textile employment down by 7.9% to 356,700 workers and clothing employment down by 7.3% to 238,300 workers.
  
  
• According to the National Council of Textile Organizations, 59 textile mills closed their doors in 2006, up from 32 mills in 2005, 24 mills in 2004 and 50 mills in 2003.

The fundamental business strategy of the US clothing industry has remained relatively unchanged during the past several years. Clothing manufacturers have shifted, and are continuing to shift a growing share of their production offshore. A large number of companies are sourcing their entire product line from foreign manufacturers, to the extent that domestically produced merchandise accounted for only 14.7% of US clothing demand in 2006, down from 16.1% in 2005. While some US textile manufacturers have shifted part of their production offshore, including to the mainland, many US yarn and fabric manufacturers remain committed to producing in the US and developing and strengthening co-production linkages with textiles and clothing producers in Mexico, the Caribbean Basin and other Latin American countries.

3. EU Textiles and Clothing Import Trends in 2006

Total Imports

Total EU textiles and clothing imports increased by 6.1% to 10,361,945 tonnes in terms of quantity and 10.9% to €81,202 million in terms of value in 2006, compared to 2005. Within this total, clothing imports went up by 9.1% to 4,393,088 tonnes in quantity terms and 11.5% to €59,901 million in value terms, while textile imports grew by 4% to 5,968,857 tonnes in quantity terms and 9.3% to €21,301 million in terms of value. This performance compares favourably with 2005, when textiles and clothing imports increased by 5.8% to €73,218 million in value terms, but declined by 3.7% to 9,763,953 tonnes in quantity terms.

Imports from the Mainland

EU imports of textiles and clothing from the mainland performed moderately well, despite the quotas in place on 10 product categories. Total imports rose by 5.6% to 2,810,660 tonnes in terms of quantity and 12.8% to €23,857 million in terms of value in 2006, compared to 2005. Within this total, clothing imports edged up 1.9% to 1,640,818 tonnes in quantity terms and increased by 11.4% to €18,786 million in value terms, while textile imports grew by 11.4% to 1,169,842 tonnes in quantity terms and 18.6% to €5,071 million in terms of value.

In general, the utilisation of the quotas on restrained textiles and clothing products from the mainland was heavier in the EU than in the US. Five of the 10 quotas in place ended the year with a utilisation rate higher than 90%. Category 5 (knitted jerseys, pullovers, cardigans, anoraks, etc.) was the category with the highest utilisation rate through 31 December 2006 at 97%, followed by category 115 (flax or ramie yarn) at 96.8%, category 7 (women's and girls' shirts and blouses) at 95.6%, category 26 (dresses) at 94.5% and category 6 (woven trousers) at 92.8%. By comparison, the quota with the highest utilisation rate in the US (cotton trousers) ended the year at only 86.2%.

Utilisation of EU Quotas on Chinese Mainland

Source: European Commission

China's share of the EU clothing import market in terms of quantity declined from 40% in 2005 to 37.3% in 2006, largely as a result of the quotas in place. The Chinese mainland was able to increase its share of the textile import market, however, from 18.3% in 2005 to 19.6% in 2006. China's share of the clothing import market remained essentially unchanged at 31.4% in terms of value, while its share of the textile import market rose from 21.9% in 2005 to 23.8% in 2006.

Among the textiles and clothing categories subject to quota in 2006, imports in every one of these categories were lower in 2006 than in 2005. Knitted shirts, T-shirts, jumpers and pullovers (category 4) experienced the largest decline with a 51.1% drop to 61 million kilograms, followed by knitted jerseys, pullovers, cardigans and anoraks (category 5) with a 45.9% decline to 68 million kilograms, woven table, toilet and kitchen linen, except of terry fabrics (category 39), with a 42.8% decline to 7 million kilograms, and woven trousers (category 6) with a 37.7% decline to 110 million kilograms.

EU Imports in Categories where Mainland is Subject to Quota

Note: Data for category 2 do not include certain quota items classified under HTSEU 5811.00.00 and 6308.00.00. Data for category 39 include certain non-quota items classified under HTSEU 6302.59.00 and 6302.99.00.
Source: Eurostat

While the quotas on China probably had an impact on total textiles and clothing imports, other suppliers took advantage of these quotas to increase their shipments to the EU. In fact, in many instances, EU importers simply shifted their orders from mainland manufacturers primarily to other Asian producers, notably Bangladesh, India, Indonesia, Pakistan and Vietnam, in order to overcome these restraints. As it turned out, combined imports from all suppliers except the mainland rose in every category where China is subject to quota. This growth was fairly large in dresses (+54.3%), knitted jerseys, pullovers, cardigans and anoraks (+39.7%) and brassieres (+24.8%), and was much more restrained in woven table, toilet and kitchen linen, except of terry fabrics (+0.1%), flax or ramie yarn (+2.1%) and certain woven fabrics of cotton (+3.9%).

Imports from Hong Kong

EU imports of textiles and clothing from Hong Kong performed well in 2006, with total shipments surging by 38.9% to 152,849 tonnes in terms of quantity and 46.9% to €2,583 million in value terms. Within this total, clothing imports went up by 43.3% to 145,865 tonnes in quantity terms and 48.2% to €2,523 million in value terms, while textile imports declined by 15.6% to 6,984 tonnes in quantity terms, but rose 8.1% to €60 million in terms of value. In all, Hong Kong still holds a marginal share of the EU textile import market, despite the growth achieved in 2006. Hong Kong's share of the clothing import market rose from 2.5% in 2005 to 3.3% in 2006 in quantity terms and from 3.2% in 2005 to 4.2% in 2006 in value terms, as a result of increased demand for both knitted and woven clothing.

The solid excellent performance of EU clothing imports from Hong Kong strongly indicates that the co-production linkages developed between the mainland and Hong Kong during the Multi-Fibre Arrangement (MFA) era have been fully re-established, and are working seamlessly. These outward processing arrangements enable manufacturers in both the mainland and Hong Kong to participate jointly in the production of a garment, while ensuring that the assembly operations that confer origin are performed in Hong Kong. As a result, when a garment subject to quantitative restraints is imported into the EU, it is considered to be a product of Hong Kong, and is therefore not charged against the applicable quota on the mainland.

As was the case in the US, it seems like these arrangements were actively used during the first half of 2006, but were phased out during the second half as demand for mainland merchandise recovered. To wit, EU textiles and clothing imports from Hong Kong rose 109.3% in quantity terms and 248.1% in value terms during the first half of 2006, compared to the first half of 2005, but increased by a much more restrained 4.9% in quantity terms and dropped 14.1% in value terms during July-December 2006, compared to July-December 2005. At the same time, EU textiles and clothing imports from the mainland declined 4% in quantity terms, and grew 9.7% in value terms during the first half of 2006, but recovered with growth rates of 14.3% (quantity) and 15.2% (value) during July-December 2006.

Imports from Other Sources

Meanwhile, a number of suppliers performed well in the EU textiles and clothing market in 2006, including India (+8.9% to 881,426 tonnes; +14.2% to €6,007 million), Bangladesh (+17.6% to 658,716 tonnes; +29.6% to €4,810 million), Pakistan (+8.5% to 549,208 tonnes; +12.9% to €2,310 million), Indonesia (+14.2% to 290,618 tonnes; +17.9% to €1,861 million), Taiwan (+18.7% to 273,061 tonnes; +7.3% to €728 million), Vietnam (+118.4% to 198,738 tonnes; +46.7% to €1,137 million), Malaysia (+21.9% to 116,689 tonnes; +13.1% to €450 million) and Sri Lanka (+14.2% to 114,940 tonnes; +21% to €1,008 million).

EU Imports of Textiles and Clothing

*Became a member of the EU on 1 January 2007
Source: Eurostat

In general, trade continued to shift towards Asian suppliers, although EU regional partners performed better than some had anticipated. For example, EU textiles and clothing imports from Turkey, the EU's second largest supplier after the mainland, rose 10.2% to 1,306,960 tonnes in quantity terms, and 4.2% to €11,404 million in value terms in 2006. Imports from Tunisia fell 2.1% to 151,328 tonnes in quantity terms, but grew 0.4% to €2,689 million in terms of value, while imports from Morocco edged down 0.4% to 142,084 tonnes in quantity terms, but increased by 4.1% to €2,469 million in value terms. Likewise, imports from Egypt contracted 0.2% to 127,322 tonnes, yet expanded by 11.2% to €717 million. In all, the data clearly indicate that EU regional partners have been able to withstand increased competition from Asian suppliers more successfully than US regional partners.

Impact on the EU

The overall increase in textiles and clothing imports has had a modestly negative effect on EU production. EU textiles and clothing production declined by an estimated 1.4% in 2006, compared to 2005. Textile production dropped 1.7%, while production of knitted hosiery fell by 14.9%, and output of knitted pullovers and cardigans edged up 0.1%. Output of all other clothing declined by only 0.2%, with production of underwear, work wear and other outerwear up by 4.3%, 3.5% and 1.8%, respectively. In addition, textile weaving production dropped 2% in 2006, and knitted fabric output was 1.1% lower.

4. Likely Trends in the US during 2007, 2008 and Beyond

Trends in 2007 and 2008

Despite the sustained distortionary effects of quantitative restrictions, mainland manufacturers have an opportunity to achieve bigger US market share gains in categories subject to quota during 2007-2008. The relatively low utilisation of quotas in 2006 means that China can substantially grow its trade in key quota categories during 2007. For example, imports in category 338/339 (cotton knitted shirts and blouses) could potentially grow as much as 35.3% from 2006 levels, imports in category 347/348 (cotton trousers) could grow as much as 30.5%, imports in category 352/652 (cotton underwear) could increase as much as 57.2%, while imports in category 340/640 (men's and boys' cotton and man-made fibre woven shirts) could achieve a growth rate of as high as 70.6%. In the meantime, the Chinese mainland will also have extensive opportunities in a wide range of non-quota products.

Potential Maximum Growth of US Imports of Quota Merchandise from
Chinese Mainland during 2007

Source: US Customs and Border Protection

Preliminary data show that the mainland got off to a good start in 2007. US quota utilisation statistics show that the utilisation rate for most quotas on China was higher in the first half of 2007 than at the same time in 2006. For example, the limit on category 338/339 was 48.6% filled in the first half of this year, compared to 17.6% in the corresponding period in 2006. Meanwhile, the limit on category 347/348 was 58.2% filled (compared to 27.5%), the limit on category 352/652 was 42.9% filled (compared to 14.8%), the limit on category 638/639 was 40.8% filled (compared to 18.4%), and the limit on category 647/648 was 41.4% filled (compared to 24.2%).

Utilisation of US Quotas on China in First Half of 2006 and 2007

Source: Compiled by Sandler, Travis & Rosenberg, P.A. from current and historical quota statistics provided by US Customs and Border Protection

In addition, import data show that US textiles and clothing imports from the mainland increased briskly during the first quarter of 2007, up by 24.9% in quantity terms and 46.5% in value terms from the first quarter of 2006. US clothing imports from China went up by 58.3% to 1,656 million SME and 63.5% to US$4,897 million during this time, while US textile imports grew by a far more modest 11.2% to 2,845 million SME and 17.9% to US$2,100 million.

The Chinese mainland is also expected to do well in 2008. Again, mainland manufacturers will be expected to continue to thrive in a broad range of non-quota items, and are also likely to increase their shipments of quota merchandise. The 2008 quotas on key clothing categories such as 338/339, 347/348, 352/652, 638/639 and 647/648 will grow by 15% from 2007, while the quotas on most other products will grow by 15% to 17%, giving mainland manufacturers plenty of additional room to increase their trade.

Hong Kong, for its part, will continue to depend on outward processing arrangements with the mainland for a substantial share of its textiles and clothing trade with the US. It strongly appears that the relevance of these arrangements will diminish in 2007, continuing with the trend observed during the second half of 2006. As discussed, the mainland can significantly increase its trade in restrained categories during 2007, and is therefore expected to maximise its quota utilisation during this period. This would lessen the need for co-production schemes with Hong Kong, and would result in a decline in US textiles and clothing imports from Hong Kong in 2007 and, possibly, 2008.

As expected, US import data for January-March 2007 show that US textiles and clothing imports from Hong Kong dropped markedly during this period, declining by 37.8% to 87 million SME in terms of quantity and 47% to US$399 million in value terms. Evidently, Hong Kong's clothing trade with the US could be re-ignited, if there is heavy utilisation of the quotas on the mainland, and the need arises to re-activate the outward processing arrangements.

Meanwhile, the mainland will continue to face competition from a number of suppliers in 2007 and 2008. In particular, other Asian countries like Bangladesh, Cambodia, India, Indonesia, Pakistan and Vietnam appear well positioned to increase their share of the US market.

In general, US importers are and will continue to source their merchandise from a number of locations, although the mainland will strengthen its position as the supplier of choice. While the number of locations where US importers source their merchandise shrunk to some extent after the elimination of MFA quotas and may decline further in 2007, a core number of locations (comprising perhaps 30 or so countries) will likely remain in the future. Price and quality have been and are likely to remain the two pre-eminent concerns for US buyers, but other factors, including quick turn times (i.e., speed to market), timely delivery, efficient customer service and additional value-added services, are becoming increasingly important. Labour rights will also remain a fundamental concern for US buyers.

Trends beyond 2008

The outlook for the mainland beyond 2008 will depend on a variety of factors. The textile industry and policymakers in the US will pay close attention to the evolution of textiles and clothing imports from China in the first few weeks and months after the expiration of the current quota arrangement at the end of 2008. If there is a surge in imports comparable to the surge that took place during the first half of 2005, the administration may be tempted to use one of several trade remedies at its disposal in an attempt to mitigate the impact of such a surge.

As an initial stopgap measure, the US could potentially duplicate for the mainland the anti-dumping (AD) monitoring programme currently in place for Vietnam, and commit to self-initiate anti-dumping cases on behalf of US textile manufacturers, if that monitoring reveals evidence of injurious dumping. Specifically, once the quotas on the mainland are removed, the US Department of Commerce (DOC) could establish a comprehensive programme to monitor import values and volumes of textiles and clothing products from China and work with the domestic industry to determine the inputs and other factors that contribute to the fair market prices of products of particular interest. If such a monitoring process were to indicate that dumping exists, and that the domestic industry fully co-operates in supplying available data indicating the existence of material injury, the DOC could self-initiate an AD investigation with respect to the relevant products. The US textile industry has already indicated its intention to lobby for the eventual application of such a mechanism to China.

The establishment of an AD monitoring programme could potentially scare orders away from the mainland, even if no actual AD cases are filed. The monitoring programme on Vietnam became effective on 11 January 2007, and will provide a good indication of what to expect if such a programme is ever applied to China. While the Vietnam monitoring programme will expire at the end of the current administration on 19 January 2009, the next administration could nonetheless be persuaded to apply this programme to China.

Even if a monitoring programme is not implemented, the US textile industry will have the option of filing AD cases against products from the mainland and other suppliers. The textile industry is also seriously considering the possibility of filing countervailing (CV) duty cases against clothing imported from China. It is not entirely clear, however, whether the industry would wait until the expiration of the quotas, or would rather file a potential action much earlier, possibly even this year. In any event, the National Council of Textile Organizations is not expected to make a final decision until the DOC makes a final determination in the on-going CV investigations on other products from China. What appears evident is that AD and CV cases will most likely be the weapon of choice for the US textile industry after the quotas expire at the end of 2008. Indeed, the US has a number of additional trade remedy options at its disposal.

• Section 421 China Product-Specific Safeguard: It implements the transitional product-specific safeguard provisions contained in China's WTO accession agreement. The ability to invoke this safeguard will remain available through 11 December 2013. A petition under Section 421 may be filed by an entity, such as a trade association, firm, union or group of workers, which is representative of an industry. Alternatively, the President, the Office of the US Trade Representative, the House Ways and Means Committee, the Senate Finance Committee or the US International Trade Commission (USITC) can request the initiation of an investigation. Under Section 421, the USITC determines whether a specific product from the mainland is being imported into the US in such increased quantities, or under such conditions, as to cause or threaten to cause market disruption.
  
  
• Section 201 Global Safeguard: Under Section 201, US industries may petition the USITC for import relief. In such investigations, the USITC determines whether an article is imported into the US in such increased quantities as to cause or threaten to cause serious injury to a US industry that produces the same product or one that is directly competitive with the imported article. Unlike the China product-specific safeguard, the global safeguard under Section 201, as its title suggests, is applicable to imports from all countries/regions.
  
  
• Section 422 China Trade Diversion Safeguard: Under Section 422, which will remain available through 11 December 2013, the USITC determines whether an action by the Chinese mainland to prevent or remedy market disruption in a WTO member country, or an action, including a provisional action, by a WTO member to prevent or remedy market disruption caused by imports from China, has caused, or threatens to cause, a significant diversion of trade into the US market. A petition for an investigation under Section 422 may be filed by a trade association, firm, union, or group of workers representative of the affected industry. Alternatively, the President, the USTR, the House Ways and Means Committee, the Senate Finance Committee or the USITC can initiate an investigation.
  
  
• Section 301 Investigation: This tool is arguably the most potent weapon in the US trade remedy arsenal. Section 301 requires the USTR to attempt to open foreign markets to US exports. Private party complainants who feel that their products are being unfairly targeted or denied market access can establish a Section 301 violation by showing that a foreign government or private sector is engaging in anti-competitive, discriminatory, unjustifiable or unreasonable acts that burden or restrict US trade policies.

Investigations under Section 201, Section 301 and Section 421 are very political in nature, as the final decision is made ultimately by the President. In addition, the President has wide discretion as to which remedy action to implement, including taking no action. The upside to this reality for US manufacturers is the fact that if an industry has significant political leverage, it has the ability to put immense pressure on the White House.

In this whole process the US will have the advantage of assessing the impact of any measures pursued by the EU against China, since the quotas in place in the EU expire one year earlier than the US quotas.

5. Likely Trends in the EU during 2007, 2008 and Beyond

Trends in 2007

While the EU quotas on certain textiles and clothing product categories from the Chinese mainland were more heavily utilised than the quotas in the US market in 2006, Chinese suppliers also have a good opportunity to increase their exports in these categories to the EU during 2007 and beyond. For instance, imports in category 4 (knitted shirts, T-shirts, jumpers and pullovers) could potentially increase as much as 41.6% from 2006 levels, imports in category 5 (knitted jerseys, pullovers, cardigans, anoraks, etc.) could grow as much as 19.6%, imports in category 6 (woven trousers) could increase as much as 23.6% and imports in category 7 (women's and girls' shirts and blouses) could advance 18.1%. Besides, the Chinese mainland is also expected to continue to do well in a range of unrestrained clothing products.

Potential Maximum Growth of EU Imports of Quota Merchandise
from Chinese Mainland during 2007

Source: European Commission

As a matter of fact, recent half-year figures on the utilisation of quotas in the EU show that the utilisation rate for most categories remained fairly low, suggesting room for further expansion of related mainland textiles and clothing exports to Europe in the rest of 2007.

Utilisation of EU Quotas on China in First Half of 2007

Source: European Commission

For its part, Hong Kong will likely continue to depend on outward processing arrangements with the mainland for a substantial share of its textiles and clothing trade with the EU in 2007. Like the US, however, the importance of these arrangements is falling, and EU imports from Hong Kong are expected to decline further in 2007. Looking further ahead, the outward processing arrangements in place between Hong Kong and the mainland for the EU market will largely be abandoned once safeguard quotas are removed. But if the EU takes trade remedy action against the mainland, these co-production schemes could be re-activated.

Trends beyond 2007

As in the US, it is difficult to predict what is going to happen in the EU once the quotas on the Chinese mainland are removed. In the Memorandum of Understanding that it signed with China in June 2005, the EU vowed to "exercise restraint" concerning the filing of any safeguard actions against textiles and clothing imports from the mainland during 2008. This language is quite vague, and does not provide a clear indication of what the EU might do should there be a surge in imports from China during 2008. If such a surge takes place, the EU could potentially impose safeguard quotas on a broad range of products in 2008, although any quotas would most likely be limited to one or more of the products that were under quota during 2006-2007. Like the US, the EU also has a variety of additional trade remedies at its disposal.

• AD and CV Actions: The EU's AD measures are an instrument to counter dumping practices that occur when overseas suppliers sell goods in the EU below the sales price in their domestic market, or below the cost of production. While AD measures will likely continue to be the major trade defence instrument in the EU, CV measures are designed to combat subsidies made available to overseas manufacturers by public authorities, thereby distorting trade when subsidies help reduce production costs or prices of exports to the EU.
  
  
• Transitional Product-Specific Safeguard Mechanism (Regulation 427/2003): The mechanism, which applies to imports from the Chinese mainland and is available through 11 December 2013, can be triggered if there is market disruption by any product, including textiles and clothing, and also if safeguard/remedial action is taken by another WTO member to prevent market disruption on its territory, which in turn causes significant trade diversions of a product from the mainland to the EU.
  
  
• Global Safeguard Mechanism (Regulation 3285/1994): The mechanism, which applies to all imports from all countries, including textiles and clothing from the mainland, can be triggered if a product is imported in such greatly increased quantities as to cause, or threaten to cause, serious injury to EU producers. The EU will have to work harder to prove serious injury, compared to the other instruments' market disruption finding, which only requires injury to be proven.

In any event, EU textiles and clothing importers are expected to continue to steadily shift their orders towards Asian suppliers during 2007 and beyond. Countries like Bangladesh, India, Indonesia, Pakistan and Vietnam are expected to do well in the foreseeable future. Turkey and perhaps two or three additional regional suppliers are also expected to take advantage of duty-free access, geographical proximity to the EU market and production linkages with EU textile producers to compete with China and other Asian suppliers in the years to come.

6. Recommendations for Hong Kong Companies

Watching Out for Regulatory Developments

The Chinese mainland is already the most important production and sourcing base for Hong Kong's textiles and clothing companies. Availability of quotas there, plus the ultimate expiry of the current US/EU safeguard measures, will only bolster the mainland's position. Yet the mainland can hardly escape the attention of those who embrace protectionist beliefs in the US and the EU. Hong Kong companies are therefore advised to pay heed to trade and regulatory developments in the US and the EU, so as to plan ahead for any changes which might affect their business. As it takes time for the US and the EU to process any remedy petitions, Hong Kong exporters can respond properly in the interim to minimise disruption.

The US and the EU aside, Hong Kong exporters also need to keep an eye on regulatory developments on the mainland. Aiming to upgrade its industrial structure, increase environmental protection and reduce trade surpluses, the mainland is making policy changes in relation to processing trade, covering VAT rebate adjustment, expansion of the prohibited category and tightening of environmental regulations, which have far-reaching implications for Hong Kong textlies and clothing manufacturers, probably in terms of mode of operations, use of technologies, sources of raw materials, manufacturing localities, production costs and ultimately the overall profit margins.

Undertaking Production and Sourcing in a Global Setting

While relocating their production across the border to enhance price competitiveness and profitability, Hong Kong textiles and clothing manufacturers are advised to consider maintaining a diversified production base rather than just concentrating on the mainland. To alleviate the threat of restrictive import measures, they should consider undertaking production activities in a global setting rather than putting all their eggs in one basket. For instance, Vietnam, already a competitive producer in the region, has become a WTO member since the beginning of 2007, which should facilitate its textiles and clothing exports, despite the US's AD monitoring programme. Of course, manufacturers can also consider undertaking production in Hong Kong through outward processing arrangements.

Besides manufacturing, Hong Kong exporters should further enhance their marketing and sourcing skills. US and EU buyers have already commended Hong Kong as a global textiles and clothing sourcing centre, where orders can be placed but with production allocated to different locations according to cost, level of sophistication and complexity required, as well as availability of quotas. As such, Hong Kong exporters should sharpen their sourcing skills to ensure that their service to overseas buyers will not be handicapped by any restrictive measures on mainland imports. Particularly for distributors, which may be exposed to higher risks of disintermediation amid the likely lowering of sourcing complexity in the long run due to quota removal, the ability to allocate different sources in view of market and regulatory changes is crucial.

Diversifying into Emerging Markets

Given the prevailing protectionist sentiment and highly competitive environment in the traditional markets, especially in the US and the EU, Hong Kong's textiles and clothing exporters should further look to other fledgling markets around the world for diversification, in addition to undertaking production and sourcing in a global setting. Over the years, economic growth of emerging markets has indeed outpaced traditional markets by a considerable margin, somewhat boosting their demand for quality garments. Most importantly, the mainland provides a huge domestic market that Hong Kong companies should not neglect. The Middle East and Russia, which have benefited from surging oil windfall in recent years, are other cases in point. Hong Kong's total clothing exports to the Middle East grew by 8.8% in 2006, and by another 9.5% in the first quarter of 2007. Though with a smaller base, sales to Russia even jumped 48.9% last year, trailed by a further 75.3% surge during January-March 2007.

But it should be noted that some emerging markets may well impose restrictive measures against imports from the Chinese mainland, especially if they are themselves textiles and clothing producing countries. In such cases, however, these textiles and clothing producing countries may not only be an alternative production base, but also a potential buyer of a wide range of raw materials, ranging from fibres, yarns and fabrics to machinery, equipment and their parts and components. Indeed, while many emerging countries have fairly substantial output of textiles and clothing, most of the production involves outward processing arrangements with foreign firms. Locally produced textiles and clothing available for domestic use are largely limited in variety and inferior in quality. There are thus ample opportunities for Hong Kong's textiles and clothing products.

Moving towards Sophisticated and High-value Activities

In addition, Hong Kong textiles and clothing manufacturers are advised to keep moving their manufacturing towards more sophisticated and high-value activities, with a view to fending off not only competition from other textiles and clothing producing countries, but also protectionist undercurrents in importing countries. Presumably, protectionist measures will target the hot items that hit the mass markets. In order to avoid being over-exposed to the low-to-medium end of the markets, it would appear advisable that Hong Kong manufacturers actively identify market niches higher up the scale. While keeping an unbiased focus on creating more value for their products generally, Hong Kong manufacturers should work consistently on product differentiation by upgrading quality, image and style.

More importantly, Hong Kong companies should strive to strengthen their long-term competitiveness by moving further towards more sophisticated and high value-added processes, such as design, branding, sales and marketing, fabrics procurement, financial control, production coordination, logistic arrangement, and retail and distribution. In particular, branding, which is the key to product differentiation and consumer loyalty, has played a more important role in shaping competitiveness in the world market. Hong Kong companies should consider introducing their brands to make the major difference, and to seek competitive advantages through high technology. In all, there will be limited prospects for Hong Kong companies unable to provide considerable added value to their products.

Making Use of High Technologies

Apparently, Hong Kong's textiles and clothing manufacturers should make use of new and innovative technology to excel in high value-added production. Yet the extent of technology application varies substantially among the players in Hong Kong's textiles and clothing community. On the one hand, quite a number of industry leaders have adopted advanced information and production technology for years. On the other hand, the use of technology among the majority of textiles and clothing firms, particularly the small and medium enterprises, has remained relatively rudimentary. Indeed, in addition to the use of advanced information and production technology, new materials and products, as well as innovative design and evaluation, have become other areas of strategic interest.

• Information technology: Examples of deployment include enterprise resource planning (ERP), electronic data interchange (EDI), supply chain management (SCM), customer relationship management (CRM) and various sales and marketing applications.
  
  
• Production technology: Cases of application include multiple functional treatment, rapid prototyping, computer-integrated manufacturing (CIM), automation and environmental protection.
  
  
• New materials and products: Examples of new materials and products include functional fibres, environment-friendly fibres, nano materials, smart textiles and intelligent garments.
  
  
• Innovative design and evaluation: 3-dimensional computer-aided design (3D CAD), 3D measurement and evaluation, new mannequin for product development, new garment fit system and advanced laboratory testing facilities.

Last but not least, while the increased application of high technology is vital, different companies have different dimensions of operation and orientation, and each of them should allow for its unique circumstances prior to deciding its own technology deployment.

This new report is available at TDC's Retail Outlets. It can also be purchased through the TDC Bookshop section in the TDC's trade portal: info.hktdc.com.