RMG debate: Making policy support more inclusive

Thanks to Dr Rubana Huq for taking the time to read my piece and respond as clearly as she did. She has raised a few questions worthy of further debate.  These pertain to the link between the anti-export bias and export diversification, the status of garments in the exports product maturity space, and the workings of the policy support to tide over the pandemic.

Diversification and anti-export bias

Let me start from a common ground narrated by Dr Rubana: "all of us need to realize that we have not diversified enough… covid-19 has exposed extreme vulnerabilities in manufacturing.  This is a challenge that cannot be overcome by solely critiquing…" The need for product, process, skills, and market diversification in exports is beyond dispute.  Dr Rubana has been proactive on this front.

Our disagreements are in the details on what are obstructing diversification. Economists have long wondered why Bangladesh's manufacturing-based labor-intensive export transformation has remained so narrowly based. Covid-19 renewed attention to this pre-existing condition, rather brutally for many, particularly the workers.  One way to find the answer is to look at factors which contributed to the growth of garments.  The intention is not to critique but to lay out the facts to understand why the manufacturing export economy has continued to specialise in garments.

According to the World Bank's Diagnostic Trade Integration Study (2015), beyond the availability of cheap labor, the garments take-off is attributable to the bonded warehouse system and back-to-back letters of credit, both extended exclusively to garment exporters; low tariffs on capital inputs; technology transfer through FDI; and reduced tariffs in the EU and the Multi-Fiber Arrangement that imposed quotas on garment exports from Bangladesh's competitors. With relative profitability raised by trade policy support, this translated into fewer incentives to other potentially competitive sectors such as jute, leather-based products, furniture, agro-processed products, pharmaceuticals and so on. Fortuitous external factors and public policy played key roles.

Most assessments of Bangladesh's trade policy find it skewed towards garments. Variations in export incentives created a pro-garment bias within the exportable under an overall anti-export biased trade regime. High tariffs on consumer goods add to the drag on export diversification by making domestic market sales more profitable. SBWs have been mostly provided to RMG, although they are in principle open to all exporting sectors with a selected few getting it after much red-tape.

Poor governance, reflected in the frequently alleged leakage of duty-free imported fabrics in the domestic market, an argument used frequently by NBR against extension of SBW to other sectors, helped garment manufacturers absorb better the high cost of doing businesses. Concentration of policy support to the top garment items has arguably discouraged investments in the upmarket by improving positioning and quality, thus hurting diversification within garments. 

Getting past infancy

Dr Rubana makes a plea for looking "at the size and age of individual factories instead of the industry as a whole before drawing any conclusion" on the economic merit of the policy regime supporting garments. The fundamental economic merit justifying time-bound policy support is predicated on what economics textbooks call the "infant industry argument". Emerging industries need protection against pre-existing competition until they become mature and stable. Infant industries do not have the internal and external economies of scale gained by the older competitors as a result of historical accidents. An infant industry is worthy of protection if their cumulative net benefits are demonstrably higher than the cumulative costs of protecting the industry. 

No policymaker is omniscient and farsighted enough to know ex-ante who the infants with potential to grow on their own are. They look for demonstrated prospects whose growths are stunted by late mover disadvantage. The infants lack information and knowledge about the production process, market characteristics, labor market, and so on because they have not been in the industry long enough. Protection allows the time to "grow up" through learning how to improve productive efficiency. These learning effects spill over into the rest of the economy as managers and workers open new businesses or move to other industries.

This began to happen in Bangladesh's garment industry decades ago. As narrated by William Easterly in his book "The Elusive Quest for Growth", Desh Garments Ltd. agreed in 1979 that Daewoo of Korea would train 130 of its workers in modern technology and administration. By the end of the 1980s, 115 out of those 130 Korean-trained workers started their own garment firms. This worked as a way of moving knowledge through the sector. By the mid-1980s the rapid growth of Bangladesh's garment industry worried the then US President Ronald Reagan so much that he imposed quotas in 1985 to restrict US purchases of Bangladesh-made clothing.

Creative destruction

Dr Rubana appears to suggest that the garment is still an infant.  The evidence she provides makes one wonder whether every industry is forever doomed to infancy.  She points out "we have only two factories which are four decades old, and more than 50% of the factories have come into existence after 2000.  And over this period, out of the 6,459 factories established, only 1898 are surviving."  Note that industry boomed in the decade of 2000 following the phase-out of the Multi-Fibre Agreement, obtaining Duty Free and Quota Free Access under the EU's Everything but Arms arrangement and the relaxation of the rules of origin requirements. The structure of the industry has changed from many small factories towards hundreds of large factories—the hallmark of achieving dynamic efficiency.

The dynamics in garments followed Schumpeter's creative destruction. Any industry is driven by a stream of appearance and disappearance of firms. Product and process appearances lead to massive disappearance of existing ones. Dr Rubana's facts are empirical validation of the dominance of cascading competitive replacements.  Many garment entrepreneurs upgraded and recombined existing capabilities.  The Rana Plaza tragedy triggered restructuring and consolidation with the exit of many subcontractors and the expansion of successful ones. This reallocated resources toward more productive uses and increased market contestability with the often-debated consequence of depressing export prices.  Yet, garment exports reached a historic peak in FY19.

This is the story of Bangladesh's garment I surmise from data on the decreasing number of older firms.  It is not the doom and gloom story that we are used to hearing from the industry itself all the time.  Doom and gloom often serve to justify continuation and extension of policy support to the insiders. 

Government measures aim at an overall improvement of the export performance for the general benefit of the economy. Export promotion strategy targets the industries that have potential for developing and competing with rivals after the incubation period. An industry graduates out of policy support either by growing the capability to compete on its own or proving incapable of growing despite sustained support. Trade economists everywhere agree that government policy must be nimble enough to support for a finite period whatever is working and withdraw support from what is proven to be not working. Evidence seems clear that garments belong to the former except that the end of the finite period keeps eluding as seen, for instance, in the frequent reversals of decisions to reduce fiscal concessions.

Surviving the pandemic 

The case for support to garments based on the impact of the pandemic is not different from the case for support to other sectors.  No industry has any presumptive entitlement when the whole country is faced with a debilitating macro shock with the government stressed for revenues.  An industry the size and experience of garments is expected to pay their bills in bad times in their own self-interest. Whether to maintain their workers by paying what Rubana calls "non-productive wage" or retrench them even during a pandemic is their decision subject to compliance with the laws of the land. Her claim that "all the factories paid 65% to all the workers for the period shut down" are disputed by Industrial Police data.  TBS reported on May 6 that workers of more than 500 factories across the country did not receive their March salaries.

The core business risks arising from changes in wages, interest rates, exchange rate and world market prices of inputs and outputs must be managed by the firms themselves.  Dr Rubana's point about changes in the wage structure, utility, transport, and rents are as irrelevant to the case for support as the counterpoint that prices of their raw materials and intermediate inputs, which account for a much larger fraction of unit costs,  declined during the period she referred. For the record, cotton prices in international markets declined from $2.01 per kg in 2018 to $1.5 per kg in 2020, according to the World Bank's Commodity Markets Outlook 2020.

It is not the business of the government to insure the losses of private enterprises. We cannot have socialism for business losses and capitalism for everything else. 

Dr Rubana's point that "the dedicated Tk10,500 crores for export oriented industries is merely 10% of the total stimulus package" omits the fact that no other industry, except agriculture, has such a dedicated package with higher subsidies from the government budget. There is nothing preventing the garment exporters from accessing other parts of the packages for large and CMSMEs.  Garments enjoy access to the same policy support that others do, not vice-versa. Others are not allowed the same extent of regulatory forbearance in labor and foreign exchange as garments.

What am I proposing?

The point of my piece was to draw the attention of the policymakers to these asymmetries in policy design and implementation vis-à-vis garments.  So, what do we need to do differently, as Dr Rubana rightly asks?

First, ensure greater vertical and horizontal equity in the design and implementation of subsidies provided through the financial stimulus packages.  Public policies need to be more attentive to the voices that lack agency. In a pandemic situation, support must be geared to maximize the attainment of social objectives such as employment and livelihood protection of the population at risk.

Second, government policies should not lock in support for one product or industry or reverse failures of specializations that were previously succeeding. Business failures can be cushioned by generic policies such as trade adjustment assistance or bankruptcy protection.

Third, export promotion policy must mutate with changing business conditions and enable exploiting new opportunities as they arise.