Don't Buy Those New Clothes Just Yet!

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Teacher Background

If you upgraded your wardrobe over the holidays, you aren't going to be happy about the latest news from the clothing industry: Most retailers expect clothing prices to fall 20-30% this year. And those aren't sale prices or special promotions; they're permanent reductions.

If it sounds like magic, it is - the magic of markets and of free trade. On January 1st, rules that restricted international trade in textiles and apparel were lifted, freeing the clothing markets. With freer trade comes increased competition, the entry of new, low cost producers, and - Voila! - lower prices and more affordable clothing.

Prices have been kept high by a series of agreements generally known as the MFA, or Multi-Fiber Agreement. A multi-lateral trade agreement in the 1960s allowed developed countries to regulate trade in cotton textiles in order to protect domestic industries against low-cost foreign competition. As new clothing fibers were developed, the agreement was expanded until 1974 when it was codified as the Multi-Fiber Agreement. Trade regulation under MFA took the form of strict import quotas, meaning that the political process, not comparative advantage in the market, determined where textiles and clothing were produced.

"The [MFA] . . . meant import quotas doled out by the U.S. and the European Union . . . have sustained garment and textile industries for three decades in countries throughout the world - regardless of their relative productivity and cost advantages." http://www.dailytimes.com.pk/default.asp?page=story_19-12-2004_pg5_28

By granting exclusive access to the lucrative U.S. markets, the quotas reduced competition. Additionally, Western clothing companies began out-sourcing to take advantage of cheaper labor in Asia. Thus, the MFA led to the growth of textile industries in a number of poorer countries: China, Cambodia, Bangladesh, Sri Lanka, Pakistan, and the Philippines, to name a few.

As the garment industries in those developing countries grew, so did their appetites for greater access to the marketplace. In 1994, ". . . international trade negotiations agreed to liberalize the textile industry and started phasing out the quotas. On January 1, the Multifiber Arrangement end[ed], . . . allow[ing] importers to buy textile products in any volume from any country." http://www.voanews.com/english/2004-12-16-voa57a.cfm A ten year window was granted to give the U.S. and European clothing industries time to prepare for competition from low labor cost regions. The phase-in period was a tacit acknowledgement that while trade creates wealth, it also creates winners and losers. The winners are the low cost producers and the consumers of clothing. The losers are high cost producers forced out of business by competition.

Ten years ago when it was agreed that the quotas would be abolished, China was just becoming a major player in world trade. Soon, China may be THE player in international clothing markets. The Pakistani Daily Times is one of many observers expressing concern – and with good reason:". . . China's highly productive and low-cost labor and its timeliness of delivery will eventually raise the country's global market share to 50 percent from 17% - 25% now, analysts say, with much of the increase at the expense of other Asian producers." http://www.dailytimes.com.pk/default.asp?page=story_19-12-2004_ph5_28

The great irony in all of this is that the problems fledgling textile producers now face are not the fault of ending trade restrictions, but the result of creating them in the first place. In the long run, comparative advantage always drives trade. The MFA allowed the arbitrary assignment of quotas to allocate production; and the not-surprising result was that individuals, businesses, and even national governments invested time, resources and money in industries that relied for their profitability on a barrier to entry. Now that the barrier has been removed, many of the investments prompted by the quotas will no longer be profitable.

Economic theory predicts that removing restrictions increases trade flows and creates wealth. It also tells us that economic change creates winners and losers. There will be losers as high cost producers are pushed from the market, but overall - as the new clothes in your closet may remind you - wealth will grow.

Lesson Guide

1. (Optional) Gather some fast-food certificates or other small prizes. Bet students that no one is wearing all American-made clothing. (Caution: Students must offer proof, so it's wise to specify outer clothing only! Include shoes, belts, jackets, hair ornaments. Don't worry; you're very unlikely to lose this bet, so it's relatively safe to offer a high-valued prize. Presenters in FTE workshops typically offer a $20 bill, and only one has lost in several years.)

2. Distribute the student handout and ask students to read it for homework or during class time.

3. Divide the class into small groups for discussion. Distribute the discussion question handout.
   OR
   Conduct a class discussion, and display the questions on an overhead transparency.

Student Handout

Made In . . . Where ?

Would you take this bet?

Nobody in your class is wearing all American-made clothing.

Go ahead; it's not that risky. The U.S. is the world's largest importer of clothing and textiles - 77 BILLION dollars worth, last year.

Check your own clothes. As you contort your body into impossible positions looking for labels, you'll probably find some that say "Made in China." Better get used to the "China" tags, because they're going to quickly become more and more common. While you were noisily celebrating New Year's Eve, a major change in international law quietly took place, setting up China's claim to more space in your closet.

The American quotas on clothing and textiles (2400 of them!) were the result of a series of trade agreements known as the MFA, or Multi-Fiber Agreement, which was designed to protect domestic industries in developed countries. Because cheaper labor was available in poorer countries, textile and clothing manufacturers in the United States and Europe worried that their business would be hurt by competition from low-priced imports. The MFA allowed them to limit imports by assigning quotas to developing countries.

Designed to benefit developed countries, the MFA had surprising benefits for a handful of poorer nations.

Through the last decades of the 20th century pressure to end the quotas grew as developing nations demanded greater access to the markets of the United States and Europe. In international trade talks in Uruguay in 1994, the participants agreed to phase out the quotas over a 10 year period, and at the stroke of midnight last New Year's Eve, the MFA ended.

While textile and clothing quotas officially expired on January 1, 2005, both domestic and foreign manufacturers have long been anticipating and trying to avoid the explosion of "made in China" labels.

Domestic producers aren't the only ones hurting. Ironically, some of the very nations who originally fought for the elimination of quotas are realizing that free trade won't guarantee them the market access they developed through political and diplomatic favor.

Both foreign and domestic producers are scrambling. Some, like Carolina Mills, are modernizing, downsizing, and refocusing their product line. Others are pursuing government-imposed solutions.

While it's certainly easy to sympathize with people who fear losing their jobs, we have to remember that there are two sides to trade. Don't forget about the clothing importers - companies like J.C. Penny and Gap. Anticipating that they'll be able to lower prices and stock a bigger variety of clothing, they haven't stood idly by while producers petition for action by the Commerce Department.

Foreign producers have turned to international governance for relief, arguing that China and India have an unfair advantage.

Actions on the part of the World Trade Organization or U.S. Commerce Department may provide some short-term relief, but they are unlikely to stem the tide of change. So, if you find any "Made in the U.S.A." labels on your clothes, you might want to cut them off and put them away. When they become rare collectors' items, maybe you can sell them on E-bay.

*Materials from Behind-the-seams.com are used with permission.

Discussion Questions

1. Explain how increasing clothing imports should reduce prices for U.S. consumers.

2. As textiles enter the U.S. without restriction, we should see prices fall. Some retailers, however, don't think that's going to happen.

   "The Polo Ralph Lauren store on Madison Avenue and 72nd Street in New York sells $160 women's cashmere knit hats, $598 quilted coats, and $397.50 cashmere sweaters. All are made in China.

   Those prices may stay at that level even after trade limits on textiles expire Jan. 1, flooding the U.S. with Chinese-made clothing and cutting costs for U.S. retailers by as much as 20 percent. Upscale merchants such as Polo Ralph Lauren Corp. will keep the difference, says Roger Farah, president and chief operating officer of the New York-based clothier.

   `The retailers that are really delivering don't have to pass on the savings,' says Michele Van Dyke, an analyst at Raleigh, North Carolina-based BB&T Asset Management Inc.

   Fashion chains such as Bebe will give back less than 25 percent of savings to customers, while specialty and department- store chains such as Plano, Texas-based J.C. Penney Co. may pass along 50 percent, Beder estimates. Discounters such as Bentonville, Arkansas-based Wal-Mart Stores Inc. may distribute more than 75 percent."

   http://www.bloomberg.com/apps/news?pid=10000103&sid=ajtpC2UYVKwk&refer=us

   Suppose the predictions in the article come about.

   • What would that tell us about competition for high end products (like those sold by Ralph Lauren) and competition in the market for low end products (like those sold by Wal-Mart)?
   • Use economic reasoning to explain why Steve Dobbins wants his company to concentrate on producing Polartec fibers.

3. Will Ralph Lauren be able to maintain his high prices in the long run?

4. There are two ways of thinking about the gains from trade:

   1. The Pareto Criterion specifies that something is wealth improving if at least one person can be made better off without injuring anyone else.

   2. The Compensation Criterion says something is wealth improving if wealth rises by more than enough to fully compensate anyone that was injured by the change.

   Does free trade satisfy the Pareto or Compensation Criterion? Explain.

5. French economist and philosopher Frederic Bastiat's famous article, "The Seen and the Unseen," argues that policy actions have both obvious and hidden effects. Bastiat said that a common mistake people make in reacting to economic policies is that they only consider the "seen" effects and overlook or ignore the "unseen" effects.

   • What were the "seen" effects of the era of Multi-Fiber quotas?
   • What were the "unseen" effects?
     
     

6. Suppose that we "see" the following predictions come true, at great cost not only to businesses like Carolina Mills, but also to poor countries like Cambodia.

   "The Polo Ralph Lauren store on Madison Avenue and 72nd Street in New York sells $160 women's cashmere knit hats, $598 quilted coats, and $397.50 cashmere sweaters. All are made in China.
   http://www.bloomberg.com/apps/news?pid=10000103&sid=ajtpC2UYVKwk&refer=us

   • What benefits may be "unseen"?
   • How could you use "the seen and the unseen" to counter someone who argued that the expiring of the MFA shows that free trade is not desirable?

7. Uncomfortable Questions
   When the quotas on textiles are removed it is clear that many workers in Bangladesh will be severely injured. Faced with lower cost competition from China and other countries, production and profits will unambiguously fall. The country will experience economic difficulty and its economic development may be halted or may even reverse. Leaving the quotas in place may or may not alleviate these problems.

   • Should the quotas be left in place to minimize injury to existing producers?

   • Which is better; employing someone from Bangladesh in a textile factory or employing someone from China?

Teacher Guide to the Discussion Questions

1. Explain how increasing clothing imports should reduce prices for U.S. consumers.

   Removing the quota will increase both the supply of clothing and the competition among suppliers for the existing demand in the U.S. market. When supply increases and demand does not, prices fall.

2. As textiles enter the U.S. without restriction, we should see prices fall. Some retailers, however, don't think that's going to happen.

   Suppose the predictions in the article come about.

   • What would that tell us about competition for high end products (like those sold by Ralph Lauren) and competition in the market for low end products (like those sold by Wal-Mart)?

     It tells us that if there are many good substitutes for products, competition will quickly drive prices to cost. Product lines with few close substitutes are better able to resist that competitive force and maintain higher profit margins.

   • Use economic reasoning to explain why Steve Dobbins wants his company to concentrate on producing Polartec fibers.

     He would face less competition because branded, high-tech fibers have fewer substitutes.

3. Will Ralph Lauren be able to maintain his high prices in the long run?

   We would expect that as substitutes for Ralph Lauren products become more inexpensive, competition would force the company to lower prices.

4. There are two ways of thinking about the gains from trade:

   1. The Pareto Criterion specifies that something is wealth improving if at least one person can be made better off without injuring anyone else.

   2. The Compensation Criterion says something is wealth improving if wealth rises by more than enough to fully compensate anyone that was injured by the change.

   Does free trade satisfy the Pareto or Compensation Criterion? Explain.

   Free trade satisfies the Compensation Criterion. Although some individuals (producers and their workers) are injured by free trade, the mass of the society's consumers benefit enough to (in principle) compensate the losers for their loss.
   
   (Optional - for advanced students) Illustrate your answer with a graph.
   (A graphical explanation is shown in Figure 2. See appendix.)
   Increased consumer surplus of BCDEFGHI is larger than the loss to domestic producers of BE.
   
   This is still true in the face of moving from a quota to a free trade regime. Area EFGHI - the gain to consumers - is larger than area E - the loss to producers.
   
   It is important to point out that this analysis does not consider the wealth gains of exporters. The Compensation Criteria holds for them as well, and wealth is increased overall.

5. French economist and philosopher Frederic Bastiat's famous article, "The Seen and the Unseen," argues that policy actions have both obvious and hidden effects. Bastiat said that a common mistake people make in reacting to economic policies is that they only consider the "seen" effects and overlook or ignore the "unseen" effects.

   • What were the "seen" effects of the era of Multi-Fiber quotas?

     The development and growth of textile industries in some developing countries.

   • What were the "unseen" effects?

     The higher prices of clothing to people all over the world.
     The countries that were not able to develop or that experienced failure of textile industries because they could not compete with those that received quotas.

6. Suppose that we "see" the following predictions come true, at great cost not only to businesses like Carolina Mills, but also to poor countries like Cambodia.

   • What benefits may be "unseen"?

     Reduced poverty in China and India.
     Lower clothing prices throughout the world.
     A reallocation of resources in poorer nations that leads to comparative advantage and greater long-term growth.

   • How could you use "the seen and the unseen" to counter someone who argued that the expiring of the MFA shows that free trade is not desirable?

     The seen effects of the quotas that restricted trade were the development of clothing industries in places like Bangladesh and Pakistan. The unseen effects were the higher clothing prices paid by people (including poor people) everywhere and the continued poverty of places that might have been able to develop textile industries if they hadn't faced the lopsided competition from countries that secured quotas. It's important to emphasize to students that free trade did not create the problems that Cambodia - and others - will face; the lack of free trade created the problem.
     
     The negative effects of ending the quotas and freeing trade will be readily seen, especially in the short run. The benefits are more likely to be unseen, especially by the media. We tend to be more aware of hundreds of poorer people losing jobs than we are of millions being able to afford more and better adequate clothing.

7. Uncomfortable Questions
   When the quotas on textiles are removed it is clear that many workers in Bangladesh will be severely injured. Faced with lower cost competition from China and other countries, production and profits will unambiguously fall. The country will experience economic difficulty and its economic development may be halted or may even reverse. Leaving the quotas in place may or may not alleviate these problems.

   • Should the quotas be left in place to minimize injury to existing producers?

     Leaving the quotas in place will only perpetuate existing problems while preventing growth elsewhere, but removing them will result in serious consequences for people that have learned to rely on them.

   • Which is better; employing someone from Bangladesh in a textile factory or employing someone from China?

     There is no clear answer to this question. The question is meant to encourage a discussion of the welfare effects of changing economic policy. Discussions tend to focus on the people that will lose their jobs while ignoring those who will gain jobs. It is important to realize that in calling for the extensions of the quotas we are implicitly calling for unemployment in another country.

   For additional insight on the effect of quotas on consumer and producer surplus, please see Appendix 1.