• The EU's textile safeguard quotas expired at the end of 2007, and a joint system with China has been established to monitor EU imports of mainland products.
• Mainland exports to the EU have done rather well so far this year. Should this growth trend continue or even intensify, the EU may resort to a variety of defence measures to restrict imports from the mainland.
• By the end of this year, the US's safeguard quotas against mainland products will also expire. Likewise, the US will have a number of trade remedies at its disposal, notwithstanding their ineffectiveness in protecting US manufacturers.
• As an initial stopgap measure, the US could potentially duplicate for the mainland the anti-dumping monitoring programme currently in place for Vietnam.
• In view of the uncertainty amid quota elimination, Hong Kong exporters should keep a close eye on overseas regulatory developments, and take appropriate actions.

Summary

In 2005, China reached agreements with the US and the EU to establish safeguard quotas for certain mainland-origin textile and clothing exports to both markets. The US agreement, which covers 34 categories (21 groups) of products, is set to expire by 31 December 2008. For its part, the EU agreement, which governed 10 categories of products, already expired at the end of last year.

In general, the quotas currently in place on textile and clothing imports from the Chinese mainland have been largely ineffective in protecting US manufacturers. It appears that a certain share of orders in the restricted categories have been shifted by US importers to other suppliers, particularly in Asia, thus negating any potential benefits associated with the quotas.

Despite the expiry of quotas, regulatory developments will continue to affect the US's market outlook beyond 2008. If there is a surge in imports, the administration, under pressure from domestic industries, may use one of several trade remedies 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-initiating AD cases on behalf of US textile manufacturers if monitoring reveals evidence of injurious dumping.

In general, US importers will continue to source their merchandise from a number of locations, although the mainland may consolidate or even strengthen its position as the supplier of choice, in spite of an increasingly challenging production environment there. While the number of locations from which US importers source their merchandise may decline further in 2008 and beyond, a core number of locations will likely remain in the future, particularly in Asia.

The EU's textile safeguard quotas, on the other hand, expired at the end of 2007. Since then, a joint system with China has been established to monitor EU imports of mainland-origin textile and clothing products. This double-checking surveillance system, which will operate for one year, covers eight out of the 10 previously restricted categories, serving to maintain bilateral oversight over the trade flow.

Following the expiry of the EU's safeguard quotas and introduction of the surveillance system, the mainland's textile and clothing exports to the EU have expanded quite well so far this year. Seemingly, this increase has not had an overly negative effect on EU production, as output declines in some developed EU members have been mitigated by production increases in several Central, Eastern and Southern EU states. But should such a growth trend of mainland exports continue or even intensify, the EU may still resort to a variety of defence measures to restrict imports from the mainland, notably including AD actions.

In any event, EU textile and clothing importers are expected to continue to steadily shift their orders towards Asian suppliers during 2008 and beyond. In addition to the mainland, countries like Vietnam are expected to do well. Turkey and perhaps some other 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 future.

Hong Kong, in the meantime, will have to move away from outward processing arrangements with the mainland. While the outward processing arrangements in place between Hong Kong and the mainland for both the US and the EU are not expected to be utilised to any significant extent in a quota-free trading environment, these co-production schemes could be re-activated if the US or the EU takes some sort of trade remedy actions against the mainland.

In view of the uncertainty amid quota elimination, Hong Kong exporters should keep a close eye on overseas regulatory developments, and take appropriate actions. Apart from relocating their production across the border to enhance price competitiveness and profitability, Hong Kong textile and clothing manufacturers are advised to consider maintaining a diversified production base rather than just concentrating on the mainland.

In addition, they should further strengthen their relationships with overseas buyers, move towards sophisticated and high-value activities, especially design and branding, as well as make use of new and innovative technology in order to excel in high value-added production. Given the unabated protectionist sentiment and highly competitive environment in the US and the EU, Hong Kong exporters should also look to other fledgling markets around the world for diversification, not least the huge domestic market of the mainland.

1. Background

In November 2005, the US and China signed a comprehensive bi-lateral agreement on textile and clothing trade. The two sides agreed that the US would establish safeguard quotas on 34 categories (21 groups) of textile 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 in 10 categories of textile and clothing imports from the Chinese mainland through the end of 2007. Among other things, the EU committed itself to exercising 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 an impact on textile and clothing trade patterns in both the US and the EU, somewhat 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. Notwithstanding the expiry of the EU agreement on 31 December 2007 and the US agreement on 31 December 2008, the likely imposition of further restrictions against mainland products is expected to continue to have distortionary effects on the market, although China should remain the preferred sourcing location.

2. US Textile and Clothing Import Trends in 2007

Total Imports

In 2007, the US's total textile and clothing imports grew by 1.8% to 53,113 million square metres equivalent (SME) in terms of quantity, and by 3.4% to US$96,408 million in terms of value, with clothing imports increasing by 3.5% to 23,335 million SME (+3.2% to US$73,923 million) and shipments of textiles rising by 0.6% to 29,778 million SME (+3.9% to US$22,485 million). Growth was a bit more subdued in 2007 than in 2006, when the textile and clothing import market expanded by 2.6% in terms of quantity and 4.6% 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 2007, with total textile and clothing shipments growing by 14.8% to 21,372 million SME in terms of quantity and 19.4% to US$32,321 million in value terms during this time. Within this total, US clothing imports from the mainland grew by 23.5% to 8,034 million SME (+22.8% to US$22,745 million), while US textile imports increased by 10.2% to 13,338 million SME (+12% to US$9,575 million). US imports of restrained textile and clothing products from the mainland grew by 14.8% in terms of quantity and 31.1% in value terms in 2007, while imports of unrestrained merchandise went up by 14.8% in terms of quantity and 14.0% in value terms.

The overall performance of Chinese textiles and clothing in 2007 was substantially similar to the performance achieved by the mainland in 2006, when its textile and clothing shipments to the US market increased by 11.0% in quantity terms and 20.8% in terms of value.

A closer look at the evolution of US textile and clothing imports from the mainland during 2007 showed that imports rose by 20.1% in quantity terms and 33.8% in value terms during the first half of 2007, but decelerated with growth rates of 10.7% in quantity terms and 10.2% 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 second half, including the relatively high utilisation of quota limits on a range of clothing categories. It is also possible that some of the orders for quota merchandise that used to be filled in the Chinese mainland may have been shifted to Vietnam not only due to the quotas themselves, but also as a result of the steady appreciation of the RMB versus the US dollar, and rising raw material and labour costs on the mainland.

A total of three quotas ended 2007 with a utilisation rate of 90% or higher. Sub-limit 332/432/632 B (socks and baby socks) was the category with the highest utilisation rate through 31 December 2007 at 93.2%, followed by category 332/432/632 T (socks and baby socks) at 92.7%, category 345/645/646 (sweaters) at 90.6%, category 647/648 (man-made fibre trousers) at 88.7%, category 347/348 (cotton trousers) at 88.5% and category 352/652 (underwear) at 86.8%. By comparison, not a single quota ended 2006 with a utilisation rate of 90% or higher. The table below shows that quota utilisation was generally brisker in 2007, especially for cotton and man-made fibre apparel categories.

In all, China's share of the US clothing import market in terms of quantity jumped from 28.9% in 2006 to 34.4% in 2007, while its share of the textile import market increased from 40.9% to 44.8%. In terms of value, the mainland's share of the US clothing market grew from 25.9% in 2006 to 30.8% in 2007, whereas its share of the textile import market expanded from 39.5% to 42.6%. China's impressive performance, despite the quotas in place, showcases the versatility of the Chinese textile and clothing sector. Indeed, Chinese manufacturers have the experience, know-how and flexibility to manufacture virtually any type of textile 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, and to shift back to a range of quota products in 2007 when their annual limits were increased.

In contrast to 2006, when it suffered declines in every quota category except 338/339 and 638/639, the Chinese mainland was able to increase its exports to the US in every clothing quota category but two - category 443 (men's & boys' wool suits) and category 847 (silk blend & non-cotton vegetable fibre trousers). Mainland suppliers achieved substantial growth in a broad array of products, most notably category 620 (+75.3%), category 345/645/646 (+73.2%), category 340/640 (+68.5%) and category 352/652 (+66.6%). At the same time, a number of countries that had taken advantage of the quotas on textile and clothing imports from the Chinese mainland to increase their share of the US market in these products in 2006 experienced a decline or stagnation in market share in 2007, as the mainland more than made up for any previously lost ground. One exception to this general rule was Vietnam, which increased its share of the US textile and clothing import market from 2.2% in 2006 to 2.8% in 2007.

Imports from Hong Kong

US demand for textile and clothing products from Hong Kong dropped markedly for the second consecutive year in 2007, with total imports falling by 28.1% to 440 million SME in quantity terms and 26.6% to US$2,124 million in terms of value. Within this total, US clothing imports from Hong Kong declined by 31.6% to 358 million SME (-27.6% to US$2,035 million), while US textile imports fell by 8.1% to 82 million SME in quantity terms, but grew by 8.9% to US$89 million in terms of value.

US textile and clothing imports from Hong Kong fared especially poorly during the first half of 2007, with shipments plunging 34.4% in terms of quantity and 41.3% in value terms. Imports also declined noticeably during the second half, down by 22.6% in quantity terms and 12.3% in value terms, but these declines were less severe due to a pick-up in outward-processing activity during November and December amid the relatively high quota utilisation of some categories on the mainland.

Hong Kong's share of the US clothing import market declined from 2.3% in 2006 to 1.5% in 2007, while its share of the textile import market fell from 0.3% to less than 0.3%. In all, it appears that a substantial share of the US orders that used to be placed with Hong Kong has shifted to the mainland and other Asian countries, notably Vietnam.

Imports from Other Sources

There were several other success stories besides the Chinese mainland in the US textile and clothing import market during 2007, including Vietnam (+31.2% to 1,506 million SME), Honduras (+7.9% to 1,235 million SME) and El Salvador (+10.7% to 824 million SME). Vietnam's success is particularly notable because it occurred despite the decision of the Bush administration to establish an anti-dumping (AD) monitoring programme on textile and clothing imports from that country.

Just as there were winners, there were also many countries on the losing side of the textile and clothing trade equation during 2007. Examples of such suppliers include Pakistan (-11% to 3,173 million SME), Mexico (-11.2% to 3,041 million SME), South Korea (-8.7% to 1,953 million SME), Canada (-21.6% to 1,913 million SME), Turkey (-9.5% to 656 million SME), the Philippines (-19.5% to 558 million SME) and Sri Lanka (-10.3% to 446 million SME). Although some of these countries are still expected to remain large suppliers in the future, they are finding it increasingly difficult to compete with Asian suppliers like the Chinese mainland and Vietnam, as well as Central American producers, such as Honduras and El Salvador.

In general, the quotas currently in place on textile and clothing imports from the Chinese mainland have been largely ineffective in protecting US manufacturers. It appears that a certain share of the orders in the restricted categories have been shifted by US importers to other suppliers, particularly in Asia, thus negating any potential benefits associated with the quotas. Some US textile manufacturers, on the other hand, have evidently benefited from the implementation of the US-Dominican Republic-Central America Free Trade Agreement (DR-CAFTA), which has kept a substantial amount of clothing production in Central America, a region that continues to rely on US yarns and fabrics.

Impact on the US

As in 2006, the moderate but steady increase in US demand for imported textiles and clothing merchandise in 2007 has gone hand-in-hand with a continued decline in US textile and clothing production and employment.

• US clothing production declined by 40.3% to 987 million units in terms of quantity and 24.9% to US$9,287 million in value terms in 2007, compared to 2006. For instance, production of tops dropped by 41.8% to 403 million units and 25.2% to US$2,889 million during this period, while production of bottoms declined by 20.4% to 170 million units and 22.3% to US$2,012 million in value terms.
• US textile production weakened considerably in 2007, compared to the previous year, with yarn output down by 11.9% to 6,253 million pounds, broadwoven fabric output down by 21% to 4,941 million square yards and knitted fabric output down by 25.5% to 613 million pounds. Likewise, US production of bed sheets and pillowcases plunged 62.5% to 44 million units, while production of towels went down by 50.8% to 97 million units.
• Sales by the US clothing manufacturing industry declined for the second straight year in 2007, down by 0.6% to US$85,858 million from the previous year, after dropping 3.9% to US$86,391 million in 2006. Net earnings were also lower, decreasing from US$6,386 million in 2006 to US$6,090 million in 2007.
• Sales by the US textile manufacturing industry were appreciably lower in 2007, declining by 5.9% to US$45,410 million, while net earnings fell from US$1,401 million in 2006 to US$1,273 million in 2007.
• US textile and clothing manufacturing employment continued to deteriorate in 2007, with textile employment down by 9.2% to 328,300 workers and clothing employment down by 8.3% to 213,000 workers. US textile employment has declined by about 46% since 2000, while clothing employment is down by nearly 60%.
• According to the National Council of Textile Organizations, 27 textile mills closed their doors in 2007, on top of 72 mills in 2006.

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 8.5% of US clothing demand in 2007, down from 10.8% in 2006. An increasingly larger share of the clothing production that remains in the US focuses on higher value-added and niche products. 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 textile and clothing producers in Mexico, the Caribbean Basin and other Latin American countries.

3. EU Textile and Clothing Import Trends in 2007

Total Imports

Total EU textile and clothing imports increased by 6.3% to 10,947,001 tonnes in terms of quantity and 4.3% to €80,231 million in terms of value in 2007, compared to 2006. Within this total, clothing imports went up by 4.4% to 4,408,275 tonnes in quantity terms and 4.4% to €57,940 million in value terms, while textile imports grew by 7.7% to 6,538,726 tonnes in quantity terms and 4% to €22,291 million in terms of value. By comparison, textile and clothing imports increased by 5.6% to 10,297,745 million tonnes in quantity terms and 11.5% to €76,916 million in value terms in 2006.

Imports from the Mainland

EU imports of textiles and clothing from the mainland increased at a fairly brisk pace, despite the quotas in place on 10 product categories. Total imports rose by 17.7% to 3,434,210 tonnes in terms of quantity and 14.3% to €27,546 million in terms of value in 2007, compared to 2006. Within this total, clothing imports advanced 14.7% to 1,951,100 tonnes in quantity terms and 15.7% to €21,839 million in value terms, while textile imports grew by 21.8% to 1,483,109 tonnes in quantity terms and 9.3% to €5,707 million in terms of value.

In general, the utilisation of quotas on restrained textile and clothing products from the mainland was a bit heavier in the EU than in the US. Six 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 2007 at 98.1%, followed by category 7 (women's and girls' shirts and blouses) at 96.7%, category 26 (dresses) at 95.4%, category 6 (woven trousers) at 94.7% and category 115 (flax or ramie yarn) at 93.9%. By comparison, the quota with the highest utilisation rate in the US (the sub-limit on socks and baby socks) ended the year at only 93.2%.

China's share of the EU clothing import market in terms of quantity increased from 40.3% in 2006 to 44.3% in 2007 despite the quotas in place. The Chinese mainland was also able to increase its share of the textile import market, from 20.1% in 2006 to 22.7% in 2007. China's share of the clothing import market grew from 34% in 2006 to 37.7% in 2007 in terms of value, while its share of the textile import market rose from 24.4% to 25.6%.

Much to its credit, China was able to increase its exports to the EU in each of the categories that was subject to quota in 2007. Dresses (category 26) experienced the largest increase with a 81% surge to 13 million kilograms, followed by knitted shirts, T-shirts, jumpers and pullovers (category 4) with a 79.1% increase to 109 million kilograms, woven trousers (category 6) with a 76.9% increase to 195 million kilograms, and woven table, toilet and kitchen linen, except of terry fabrics (category 39), with a 65.7% jump to 12 million kilograms.

This exceptional performance is facilitated in part by the anticipation of the complete elimination of quantitative restraints this year, and in part by the accession of two new member states - Bulgaria and Romania - into the EU. For one thing, the import figures reflect the expansion of the EU from a 25-member union in 2006 to a 27-member union in 2007, which essentially means that the 2007 data for the Chinese mainland includes shipments made to Bulgaria and Romania, while the 2006 data do not.

In the meantime, most other suppliers were unable to take advantage of the restraints on the mainland to increase their shipments to the EU last year. This stands in contrast to 2006, when a number of large textile and apparel exporters, including Bangladesh, India, Indonesia, Pakistan and Vietnam, used these quotas to increase their respective shares of the EU import market. As it turned out, combined imports from all suppliers except the mainland declined in seven of the ten categories where China was subject to quota last year. These declines were rather sharp in knitted jerseys, pullovers, cardigans and anoraks (-26.8%), brassieres (-17.3%), woven trousers (-16.1%) and woven bed linen (-13.6%).

Imports from Hong Kong

EU imports of textiles and clothing from Hong Kong performed poorly in 2007, with total shipments dropping by 34.8% to 100,852 tonnes in terms of quantity and 32.8% to €1,729 million in value terms. Within this total, clothing imports went down by 35.7% to 94,704 tonnes in quantity terms and 33.2% to €1,679 million in value terms, while textile imports declined by 15.3% to 6,148 tonnes in quantity terms and 18.8% to €50 million in terms of value. In all, Hong Kong holds a marginal share of the EU textile import market. Hong Kong's share of the clothing import market declined from 3.5% in 2006 to 2.1% in 2007 in quantity terms and from 4.5% in 2006 to 2.9% in 2007 in value terms, as a result of decreased demand for both knitted and woven clothing.

The listless 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 gradually phased out, and are unlikely to be actively re-established now that the EU has eliminated the quotas on mainland merchandise. These outward processing arrangements enabled manufacturers on both the mainland and in Hong Kong to participate jointly in the production of a garment, while ensuring that the assembly operations that confer origin were performed in Hong Kong.

Imports from Other Sources

In contrast, a number of suppliers performed well in the EU textile and clothing market in 2007, including India (+13.9% to 1,012,194 tonnes; +3.6% to €6,250 million), Pakistan (+11.3% to 615,166 tonnes; +6.3% to €2,475 million), Vietnam (+31.0% to 264,375 tonnes; +10.8% to €1,278 million), Tunisia (+4.4% to 158,630 tonnes; +5.1% to €2,845 million), Egypt (+7.4% to 139,268 tonnes; +5.3% to €762 million) and Sri Lanka (+9.6% to 126,429 tonnes; +7.6% to €1,089 million).

In general, trade continued to shift modestly towards large Asian suppliers, predominantly the Chinese mainland and, to some extent, India, Pakistan and Vietnam, with several EU regional partners performing better than anticipated (especially in terms of value). In addition to Tunisia and Egypt, EU textile and clothing imports from Turkey, the EU's second largest supplier after the mainland, rose 2.7% to 1,424,405 tonnes in quantity terms and 6.7% to €12,801 million in value terms in 2007, while imports from Morocco went up by 0.9% to 143,950 tonnes in quantity terms and 6.6% to €2,641 million in value terms. 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.¹

Impact on the EU

The overall increase in textile and clothing imports has not had an overly negative effect on EU production as a whole, as output declines in some of the more developed EU member states (e.g., Denmark, Germany, Finland, France, Ireland and the UK) have been mitigated by production increases in several Central, Eastern and Southern European countries (e.g., Bulgaria, Czech Republic, Greece and Poland). It is evident that the development of robust co-production linkages with a range of Mediterranean and South-eastern European countries has contributed to the preservation of textile and clothing production in the EU.

EU textile and clothing production increased by an estimated 0.2% in 2007, compared to 2006.² Textile production dropped 0.2%, dragged by declines in preparation and spinning of textile fibres (-3.3%), manufacture of knitted and crocheted fabrics (-2.3%), textile weaving (-2.8%), finishing of textiles (-0.6%) and production of textile made-ups (-0.5%). Production of knitted and crocheted pullovers, cardigans and similar articles surged 12.1% in 2007, while output of knitted and crocheted hosiery went up by a more measured 1.6%. Output of all other clothing and clothing accessories rose 2.6%, spurred by higher production of outerwear other than work wear (+6.1%) and underwear (+0.6%).

4. Likely Trends in the US during 2008 and Beyond

Trends in 2008

Despite the sustained distortionary effects of quantitative restrictions, mainland manufacturers have an opportunity to achieve additional US market share gains in categories subject to quota in 2008, as they did in 2007. China can substantially grow its trade in key quota categories during 2008, despite the relatively high utilisation of the 2007 quotas. For example, imports in category 338/339 (cotton knitted shirts and blouses) could potentially grow as much as 31.5% from the 2007 level, imports in category 347/348 (cotton trousers) could grow as much as 27.4%, imports in category 352/652 (cotton underwear) could increase as much as 27.6%, while imports in category 340/640 (men's and boys' cotton and man-made fibre woven shirts) could achieve a growth rate as high as 33.5%. Imports in category 332/432/632 T and 345/645/646 will necessarily have to be somewhat more restrained, but still have the potential to grow by 21.7% and 23.2%, respectively. In addition, imports of wool clothing and non-apparel textiles currently subject to quota are effectively unrestrained in their ability to grow this year. Meanwhile, the Chinese mainland will also have extensive opportunities in a wide range of non-quota products.

US quota utilisation statistics show that the utilisation rate for a slight majority of the quotas on mainland apparel was lower in the first half of 2008 than at the same time in 2007. For example, the limit on category 338/339 was 29% filled in the first half of this year, compared to 48.6% in the corresponding period in 2007. Meanwhile, the limit on category 347/348 was 36.7% filled (compared to 58.2%), the limit on category 352/652 was 31.4% filled (compared to 42.9%), the limit on category 638/639 was 30.9% filled (compared to 40.8%), and the limit on category 647/648 was 28.4% filled (compared to 41.4%).

At the same time, utilisation of the limits on such categories as 332/432/632 T, 349/649, 359S/659S, 363 and 443 was a bit higher in the first half of this year than at the same time in 2007, although none of these categories were in danger of closing before the end of the year.

In addition, given the retrenchment in consumer expenditure amid the economic slowdown, import data show that US textile and clothing imports from the mainland were surprisingly lethargic during the first four months of 2008, increasing by only 0.4% in quantity terms and declining by 2.6% in value terms from the first four months of 2007. US clothing imports from China went down by 5% to 1,982 million SME and 6.8% to US$5,751 million during this time, while US textile imports grew by 3.4% to 3,993 million SME and 6.7% to US$2,948 million. The Chinese mainland is nonetheless expected to fare better during the second half of the year in anticipation of the complete elimination of quotas on 1 January 2009. 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.

Hong Kong, for its part, will continue to depend on outward processing arrangements with the mainland for a substantial share of its textile and clothing trade with the US. It strongly appears that the relevance of these arrangements will diminish in 2008, continuing with the trend observed during the previous year. As discussed, the mainland can significantly increase its trade in restrained categories during 2008, 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 textile and clothing imports from Hong Kong in 2008.

US import data for January-April 2008 show that US textile and clothing imports from Hong Kong did better than expected during this period, declining by only 1% to 112 million SME in terms of quantity and growing by 0.7% to US$519 million in value terms. Evidently, Hong Kong's clothing trade with the US could be temporarily re-ignited, if there is heavy utilisation of the quotas on the mainland and the need arises to re-activate outward processing arrangements, as it occurred during November-December 2007.

Meanwhile, the mainland will continue to face competition from a number of suppliers in 2008. For instance, Vietnam is expected to increase its share of the US market, despite the decision by the Bush administration to establish an AD monitoring programme on textile and apparel imports from that country and short-term challenges facing its economy. Other countries that could excel this year include Bangladesh, Indonesia, Cambodia, El Salvador and Honduras. On the other hand, countries like Mexico, Canada, Turkey, the Philippines, Sri Lanka and South Korea are likely to see their textile and apparel exports to the US decline further in 2008.

In general, US importers will continue to source their merchandise from a number of locations, although the mainland may consolidate or even strengthen its position as the supplier of choice, in spite of an increasingly challenging production environment there. 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 2008 and beyond, 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 more 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 textile 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 AD monitoring programme currently in place for Vietnam, and commit to self-initiating AD 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 textile 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, which became effective on 11 January 2007, has not to date had any evident negative repercussions on textile and apparel imports from that country, however. 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 assessing the possibility of filing countervailing (CV) duty cases against textiles and 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 earlier, possibly during the fourth quarter of this year. 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, particularly in the medium-to-long run.

The US textile industry is also seriously considering the possibility of filing one or more China product-specific safeguard actions against mainland Chinese textiles and clothing under Section 421 of the Trade Act of 1974. Section 421 was added to the Trade Act of 1974 by the US-China Relations Act of 2000, and 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.

There have been four product-specific safeguard cases to date (on steel wire garment hangers, pedestal actuators, ductile iron waterworks fittings and circular welded non-alloy steel pipe), where the USITC determined that market disruption took place but the President decided against granting import relief. In two other cases, involving brake drums and rotors and uncovered innerspring units, the USITC found that there was no market disruption. Legislation has been introduced in the US Congress to limit the President's authority to deny import relief under Section 421.

In addition, the US has a number of other trade remedy options at its disposal, as summarised below.

• 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 entire 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 expired one year earlier than the US quotas.

5. Likely Trends in the EU during 2008 and Beyond

On 9 October 2007, the EU and China agreed to establish a joint monitoring system designed to manage the transition from restricted to unrestricted trade and monitor any surges in shipments. This so-called "double-checking system" entered into force on 1 January 2008, following the expiration of the 2007 quotas on certain mainland Chinese textiles and clothing, and was established with the intention of tracking the issuance of licences for export in China and the importation of goods into the EU during 2008. The product categories subject to this surveillance system are categories 4, 5, 6, 7, 20, 26, 31 and 115.

In the agreement that it signed with China in June 2005, the EU vowed to "exercise restraint" concerning the filing of any safeguard actions against textile 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 range of products in 2008, although any quotas would most likely be limited to one or more of the products under surveillance.

Data released within the scope of the double-checking system for the first half of the year show that imports of mainland textiles and clothing under surveillance have done rather well so far this year. For example, imports of dresses (category 26) and women's and girls' shirts and blouses (category 7) surpassed their 2007 quota limit during the first half, while imports of knitted jerseys, pullovers, cardigans and anoraks (category 5) accounted for 94.0% of their 2007 quota limit, imports of woven bed linen (category 20) accounted for 79.6% of their 2007 quota limit, and imports of woven trousers (category 6) accounted for 75.7% of their 2007 quota limit. The data generally show that imports from the mainland are growing at a brisk pace, but only dresses appear to be increasing at an overwhelming rate. Other categories that should be kept under watch for possible EU actions include women's and girls' shirts and blouses, and knitted jerseys, pullovers, cardigans and anoraks and, to a lesser extent, woven bed linen and woven trousers.

Mainland suppliers are expected to continue to do well in these and a broad range of additional textile and clothing products. For its part, Hong Kong will have to move away from outward processing arrangements with the mainland and into higher-value niche products in an effort to maintain its share of the EU import market for textiles and clothing. While the outward processing arrangements in place between Hong Kong and the mainland for the EU market are not expected to be utilised to any significant extent in a quota-free trading environment, these co-production schemes could be re-activated if the EU takes some sort of trade remedy actions against the mainland.

Like the US, the EU has a variety of additional trade remedies at its disposal. These remedies are summarised below.

• 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 in 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 textile and clothing importers are expected to continue to steadily shift their orders towards Asian suppliers during 2008 and beyond. In addition to the mainland, 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

Understanding and Monitoring Regulatory Developments

To start with, Hong Kong companies are advised to strengthen their understanding of the trade defence tools available in the US and the EU. Already, the Chinese mainland is by far the largest source of textile and clothing imports into both markets. Expiration of the EU's quotas last year-end, plus the imminent expiry of the US's restrictions by the end of this year, will only bolster the mainland's position. To no one's surprise, the mainland can hardly escape the attention of those who embrace protectionist beliefs in the US and the EU. Hong Kong companies are thus advised to closely monitor regulatory developments there, 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 defence requests, Hong Kong exporters can respond properly in the interim to minimise disruption.

Trade defence measures aside, Hong Kong exporters also need to keep an eye on the proliferation of environmental protection regulations, not least in the EU. Two recent EU laws -- the Directive relating to the use of perfluorooctane sulfonates (PFOS) and the Regulation on the Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) -- are particularly noteworthy. The PFOS Directive, which restricts the marketing and use of the chemical, will likely affect a number of products bound for the EU, in particular textiles and clothing. The new chemical Regulation, REACH, for its part, requires manufacturers to provide detailed information on substances used in their products, while controlling the use of substances of very high concern (SVHC).

Considering Flexible Production and Sourcing

Apart from relocating their production across the border to enhance price competitiveness and profitability, Hong Kong textile 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, spurred by its WTO membership since the beginning of 2007, has become a competitive producer of textiles and clothing in the region, despite the US's AD monitoring programme, as well as the short-term challenges facing the Vietnamese economy. Of course, manufacturers can also consider undertaking production in Hong Kong through outward processing arrangements.

Besides manufacturing, Hong Kong exporters should further enhance their sourcing skills. US and EU buyers have long commended Hong Kong as a global textile 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.

Strengthening Relationships with Overseas Buyers

While Hong Kong companies already have good connections with US and EU buyers, developing further closer relationships is necessary. For one thing, retail distribution in both markets is increasingly dominated by large retail groups. As competition intensifies further after the removal of quotas, these large retail groups will face greater pressure to buy from sources which can offer the best price-quality mix. Not surprisingly, they have found that restructuring their global sourcing is a viable means of maintaining their competitiveness. Many of them are taking a new look at their existing sources, with a view to reducing the number of their suppliers as a way to be more efficient in terms of sourcing.

In view of this development, Hong Kong suppliers should forge closer links with US and EU buyers, particularly large retail groups. By developing strategic relationships with their buyers, they should be able to secure longer-term orders, in contrast with short-term orders, due to the uncertainty related to the availability of quotas. On the other hand, Hong Kong suppliers also have to better understand their competitors from other countries and regions. They need to know what these other companies can and cannot provide in terms of price, quality, variety, delivery and other services. Only then will they know if they are in a good bargaining position with their buyers.

Diversifying into Emerging Markets

Given the unabated protectionist sentiment and highly competitive environment in traditional markets, especially in the US and the EU, Hong Kong's textile and clothing exporters should further look to other fledgling markets around the world for diversification. Over the years, the 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 a surging oil windfall in recent years, are other prominent examples. Hong Kong's total clothing exports to the UAE, the distribution hub in the Middle East, grew by 13% in 2007, and further by 22.7% in the first four months of 2008. Though with a smaller base, sales to Russia jumped 21.6% last year, trailed by another 23.1% surge during January-April 2008.

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 textile and clothing producing countries. In such cases, however, these textile 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 parts and components. Indeed, while many emerging countries have a 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 textile and clothing products.

Moving towards Sophisticated and High-value Activities

In addition, Hong Kong textile 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 textile 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 arrangements, and retail and distribution. In particular, design and branding, which are the keys to product differentiation, play an important role in shaping competitiveness in the world market. According to a TDC survey conducted in 2007, 94% of the respondents in Hong Kong's clothing industry were involved in OEM business, compared with 57% and 32% in ODM and OBM, respectively. Given this limited engagement in ODM and OBM, Hong Kong companies should consider strengthening their design capability and introducing their brands to enhance their competitive edges.

Making Use of New and Innovative Technology

Apparently, Hong Kong's textile 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 textile and clothing community. While the use of technology among the majority of textile and clothing firms, particularly small and medium enterprises, has remained relatively rudimentary, quite a number of industry leaders have adopted advanced information and production technology for years. In addition to the use of advanced information and production technology, new materials and products, as well as innovative design and evaluation, have become 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, environmentally-friendly fibres, nano materials, as well as smart textiles and intelligent garments.
  
  
• Innovative Design and Evaluation: Cases in point include 3-dimensional computer-aided design (3D CAD), 3D measurement and evaluation, new mannequin for product development, a 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 should allow for unique circumstances prior to deciding on its own technology deployment.

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