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Cambodia's Garment Industry - Origins and Future Prospects

Working papers

 The paper, written largely before Multi-Fibre Agreement (MFA) quotas on developing country exports of textiles and garments were removed on 31 December 2004, argues that Cambodia's garment industry is well placed to withstand the increase in competition in its export markets that quota removal has brought. This conclusion is highly significant for the Cambodian economy, over 80% of whose exports now consist of garments.

Cambodia's export-oriented garment industry has emerged and grown very fast since the mid-1990s when Asian textile and garment (T&G) producers - from Hong Kong, Taiwan, Malaysia, and Singapore - started to produce for export in Cambodia, taking advantage of the country's then quota-free access to the US and EU markets and, secondarily, of its relatively low wage rates. Investors were encouraged by a policy environment in which there was domestic peace and security following the Paris peace agreement in 1991, a commitment to macroeconomic stability, and a business-friendly investment climate enshrined in the Law on Investment of 1994. Investors were able to overcome Cambodia's disadvantages in infrastructure and human capital development, inter alia by bringing in technical and supervisory personnel from abroad.

The industry, which uses as raw material cloth imported mainly from other Asian countries, has continued since its inception to attract foreign direct investment, and has enjoyed strong export and employment growth, despite the imposition of quotas on its exports to the US market in 1997. It now comprises some 200 enterprises, of which some 90% are foreign-owned, with approaching 250,000 employees.

The removal of T&G quotas on the exports of all exporting countries at the beginning of 2005 in compliance with the WTO's 1994 Agreement on Textiles and Clothing represents both an opportunity and a threat for Cambodia. Cambodia will be free to export beyond current quota limits to markets where these apply; but it will also have to compete with exports from other garment-exporting countries on which quotas bore more heavily, notably China.

Commonly used general equilibrium models of international trade predict that garment prices in international markets will fall sharply, but that the world market for garments will grow, when quantitative restraints on exports from competitive producers such as China are removed. This will lead to a significant increase in world welfare, and to income gains by the more competitive producers in formerly quota-restricted producer countries, but to potential losses from falling prices by less competitive producers in other exporting countries, both formerly quota-restricted and otherwise. The case of Cambodia is not identified separately in the most commonly used international trade model, but the group of (ASEAN) countries with which it is assimilated is shown in simulations to experience an overall welfare loss.

The question examined in the paper is how far Cambodia's garment industry is likely to be able to withstand the effect of falling prices. The methodology used for this purpose makes use of the facts that:

# Cambodia's main garment exports to the US have been quota-restricted for a few years,

# quotas have been auctioned,

# some of these quotas have been binding, and

# during these years quotas have been removed from certain garment types.

It is based on estimated export tax equivalents (ETE) of quota rents: where these have been high there are good prima facie grounds for thinking that enterprises subject to this form of tax could be competitive in a post-MFA world.

The empirical evidence is not overwhelming but it is sufficient to build a case for arguing that Cambodia's garment sector has become robustly competitive and able to withstand adverse price shocks:

# ETEs on quota-restricted exports to the US have averaged 8%, and have ranged up to 29%, of the FOB value of the goods sold in important product lines, although Cambodia's exports were not severely restrained by US quotas.

# Prices received by Cambodian exporters for significant exports to the US of garment types removed from quota under Phase 3 of the implementation of the Agreement on Textiles and Clothing declined only slightly, enabling Cambodia to raise its market share in the face of competition from previously severely restricted suppliers like China.

# Labour productivity in the garment industry in Cambodia has improved to a point where it has become comparable with China and India - and higher than in Bangladesh.

# The share of operating profit in value-added has risen, in spite of the negative effects of, first, the imposition of quotas on Cambodia by the US, and then the US's removal of quotas on supplies of certain garments from all sources.

# Materials and utilities constitute around 60%, industry-wide, of the costs of garment production; there is scope for further cost savings from improved procurement methods and domestic trade facilitation measures.

# Freight and insurance charges on exports to the US from Cambodia are comparable with those affecting exports from other South-East Asian suppliers.

The paper concludes that Cambodia's garment industry should, on these grounds, be able to withstand a decline in the unit value of export sales of 10-15% without overall contraction, through a combination of appropriation of the quota rents formerly paid for export licences, falling input prices and improvements in efficiency. The industry may, however, have to alter its export product mix, abandoning products for which external market competition becomes fiercest. A post-MFA rise in the import price paid by Cambodia for textile inputs is, however, a risk factor.

Even if the abolition of quotas on textiles and clothing leaves Cambodia's garment industry relatively unscathed, there is likely to be some static welfare loss for Cambodia as the government loses the revenue formerly earned from the auctioning of export licences. However, even a static welfare loss at the top end of the possible range would be dwarfed by the welfare gain from a single year's growth in the garment sector.

Omar Bargawi