Disclaimer:
Opinions expressed in the case studies and any errors or omissions therein are the responsibility of their authors and not of the editors of this volume or of the institutions with which they are affiliated. The authors of the case studies wish to disassociate the institutions with which they are associated from opinions expressed in the case studies and from any errors or omission therein.

> Case Studies main page
> Introduction

ON THIS PAGE: 
> I. Overview
> II. The problem in context
> III. The players and their roles
> IV. Challenges faced and the outcome
> V. Lessons for others

I. Overview    back to top

The WTO Agreement on Textiles and Clothing (ATC) set up a transitional mechanism in 1995, with a view to phasing out quotas for trade in textiles and clothing by the end of 2004. Even though the total global imports of textiles and clothing will expand, competition is also likely to increase among many garment exporting countries around the world. It is expected that textile and garment companies in medium- to high-cost countries will reduce their manufacturing production. In contrast, those in low-cost countries with a strong competitive advantage will expand their production and export capacities to become preferred suppliers and to take advantage of liberalization. Lao textile and garment companies will be affected at different levels depending on their competitive capacities. In order to maintain its market shares or reduce losses, the garment industry needs to implement a product diversification strategy with the introduction of products in the medium to higher market segments and develop sufficient production inputs. Laos needs to develop modernized production facilities, better upstream industries (spinning and weaving) and well-trained workers to be prepared for trade liberalization. Support from the government is crucial, in particular on market access negotiations and trade facilitation. Nevertheless, a lack of capacity in terms of budget and expertise is the main constraint in the process.

II. The problem in context    back to top

The textile and garment industry is of great importance to the Lao economy. Currently, the industry comprises ninety-six factories and employs more than 25,000 workers. In 2003, garment exports, valued at US$115 million, accounted for approximately a third of total exports, second to electricity. Laos exports ready-made garments to forty-two countries. As one of the forty-nine least developed countries, Laos is granted duty-free and quota-free market access to certain developed countries under the generalized system of preferences (GSP). However, the garment industry benefits very little from the GSP due to strict rules of origin, particularly related to local content requirements. Garment companies in Laos mostly depend on imported fibre, yarn and fabric for assembling as finished garments that are then re-exported.

The phasing out of quotas at the end of 2004 will lead to a dramatic increase in exports from large developing countries such as China and India. This increase could have significant implications for smaller least developed countries including Laos. One of the expected results is price competition. It is expected that the price of textiles and clothing will come down by around 20-25% when the quota abolition takes its full effect. According to Mr Bounma, the president of the Lao Fashion Garment Co., the effects of price reduction due to increased competition can be felt even now: ‘Last year the price of a polo-shirt that we produced for a client in Hong Kong was US$5.50 per piece, but last week we received the order with a price offer of US$3.50.’

This is a big challenge for garment factories in Laos, where advantages in low wage costs may no longer exist. Even though the wages are relatively low workers’ productivity is also low, due to the lack of proper skills training and development. Garment manufacturers in Laos have become progressively highly concentrated on low-value-added products. The exporters have market shares in selected products that are by no means in the lowest price quartile in the European market. Lower prices and better quality garments from various supply sources are expected to increase when the ATC comes to an end. Some locally owned garment factories in Laos are manufacturing-oriented and work on a CMT (cut, make and trim) basis or use sub-contractors, mainly via traders in Thailand, Singapore and Hong Kong. The working procedure is such that brand-name sportswear is designed by the brand owners, for example in Europe. The orders are placed with a Hong Kong-based representative office which will then make contact with garment suppliers in the region including China, Cambodia, Laos, Thailand and Vietnam. If the order is for 5 million pieces, for instance, it will be divided up according to each country’s supply capacities. Suppliers in Laos are more likely to receive the smallest allocation in the light of their limited production capacities in comparison with those in China and Vietnam.

The other possible problem is preference erosion. In the past, apart from quota limitation, exporters from countries which are not GSP beneficiaries have to pay 12-14% import duties. This means that Lao exporters used to have the advantage of cost saving of more than 10% over exporters from other countries for categories of garments exported under the GSP. After 2005, this advantage for Lao garment exporters will be minimized. In addition, being a land-locked country, Laos faces the transportation issue; most goods are transited via ports in Bangkok or Danang. Lao garment suppliers are thus at a clear disadvantage, the transport costs for Laos being relatively high compared with its neighbours. Mr Bounma explained that ‘It costs us around US$1,200 for a shipment of standard containers, while the exporters in Vietnam pay only US$250. It is estimated that taking both the preference erosion and transport costs into account, the cost-saving gap will reduce from 12-14% to only 3-5%.’

The preferred suppliers are those who will be able to take advantage of lower wages, higher labour productivity and quicker response to demand. In Laos, the labour productivity is generally low — even lower than in neighbouring Vietnam. Consequently, low productivity affects the added value of production and the capacity to diversify outputs. Given comparable clothing quality and marginal price difference, importers tend to prefer the supply sources that offer more convenience. This may be due to a cheap and large pool of labour. Easy access to sea transportation is also another crucial factor because it will affect the lead time of supply; Laos takes longer to transport goods via neighbouring countries to sea ports. From the point of view of the garment industry, the government should streamline import and export procedures to allow for fast importation of raw materials as well as quick clearance of finished garment exports. This will help to offset the disadvantage of location.

The Lao textile and clothing industry will face fierce competition in its export markets, particularly the European Union (EU), its main market for garments. Laos is not yet a member of the WTO and thus its textile and clothing trade is dependent on bilateral trade arrangements with its trading partners; membership of the WTO would give Laos its necessary predictable market access to major markets. In addition, Laos is a relative newcomer, having for example concluded a bilateral trade agreement with the United States only at the end of 2003, while its neighbours Vietnam and Cambodia have had access to the US market since 1994 and 1997 respectively.

III. The players and their roles    back to top

The key player in this case study is the Lao Fashion Garment Co., a locally owned company established in the capital, Vientiane. It employs some 230 workers, most of whom are women in their twenties, in the factory, which, equipped with 141 machines, is relatively small. Lao Fashion Garment mainly produces and exports polo-shirts, T-shirts, sweaters, jackets, brassieres and knitted items to the European market. Its performance has been reasonably successful so far. The management is aware of possible competition in the liberalized trade in textiles and garments after 1 January 2005; Mr Bounma commented that, ‘We are a relatively small company which has a production capacity of 720,000 pieces per year. Lao Fashion Garment imports most of its raw materials from other countries, mainly from China and Chinese Taipei. Like most garment companies in Laos, we receive production orders from overseas partner companies in Hong Kong and Thailand.’

The textile and garment sector in Laos is composed of ninety-six factories of which fifty-seven are producers and/or exporters. Textile and garment companies can be divided into four categories, foreign direct investment subsidiaries, joint-venture companies, (locally owned) medium-sized companies and small-sized factories working as sub-contractors. There are different levels of awareness among these companies in relation to quota abolition after 2005. The foreign direct investment firms and joint-venture companies form the groups who are more likely to feel least impact. They are relatively aware of what will happen after the quota regime expires, and many of them are preparing themselves for the upcoming increased competition. They have undertaken in-house training programmes to improve labour productivity and to increase their product diversification capacity. Some companies are also looking for cheaper sources of imported raw materials. In addition, the foreign subsidiaries and joint-venture companies also have good marketing channels as a result of their connection with parent companies or foreign-based partner companies abroad.

Lao Fashion Garment falls under the third category of company, that is a locally owned factory. Producers in this category are in the group that is more likely to face the biggest challenges after 1 January 2005. As a local factory receiving orders from middle-man firms overseas, Lao Fashion Garment cannot make direct contact with importers and therefore it only works on a CMT basis. Overseas companies are responsible for marketing its exports in Europe.

In general, the most adversely affected category of garment companies is formed by the locally owned factories which are the sub-contractors for the first three categories. Given the fact that the companies in these categories are trying to cut down their production costs, one of the consequences will be to give up outside production lines and carry out all production activities onsite. As a result, sub-contractors may no longer be needed.

The Lao Textile and Garment Industry Group (LTGIG) has played a very important role in raising awareness in the garment and textile industry concerning quota abolition. The group held many workshops and invited key speakers from international organizations to talk to local businesses about the future of the world trade in textiles and garments after 2005 and its implications for the industry. ‘Much more needs to be done to create a clear understanding of the possible negative impacts of the quota abolition and what should be an appropriate response from the individual company itself and the industry as a whole’, commented Mr Bounma, who is president of the LTGIG.

The Lao National Chamber of Commerce and Industry (LNCCI) has worked hard to lobby the Ministry of Commerce, which is dealing with trade policy, trade negotiations and export promotion. Mr Bounma added that ‘Equally important, the chamber of commerce is a business association which addresses the government with their concerns and seeks support to help the garment factories to overcome the problems.’ The ministry has a direct responsibility for the promotion of exports, but it does not have sufficient funds to allow it to do so. This is unfortunate, as promotional support by government is one of the areas of support to the industry permitted under WTO regulations. This support is nearly always found in competing countries as the catalyst for helping small- to medium-sized garment companies, to move into direct exports in particular. A senior official in the Ministry of Commerce explained that ‘In most of the newly developing countries, the government provides export promotion support to their garment producers. It is doubtful whether the industry in Mauritius would have reached almost US$1 billion exports if there were no promotional support from the government. Similarly, this can explain why garment suppliers in Pakistan, India, Madagascar and Malaysia are much outperformed’.

IV. Challenges faced and the outcome    back to top

In general, the Lao textile and garment industry is not in the right position to face the coming competition. It is expected that global exports of textiles and garments will expand when the quotas are abolished. Lao garment companies are likely to face a considerable level of competition from larger economies such as China, Vietnam, India and Pakistan, which have the comparative advantage of a large pool of cheap labour and the production of high-quality garments. Mr Bounma said that ‘In recent years, Lao Fashion Garment has received fewer and fewer orders compared with the late 1990s’, expressing his concern about his own factory. This has become a sign of the keen competition in the world textile and garment market. The full effects would be realized by the end of 2004, when the quota system under the ATC was terminated and the textile and garment trade would be fully integrated into the WTO framework. Mr Bounma comments, ‘Consequently, the CMT work is reducing and will not be available in the future. This would have a great impact not only on my own factory but it would also affect the whole economy of Laos, in particular the textile industry that employs more than 25,000 workforces, accounting for 20% of the total population.’ This critical likely situation has obliged him to think over and over again what he should do in order to keep his factory competitive. The two burdens that he bears have inspired him to come up with some measures that will be applied in his own factory and offer this advice to the industry as a whole: ‘The government should provide training courses to match the needs of the industry and improve the bureaucratic procedures to facilitate the industry to manufacture and export efficiently.’

As the owner of the Lao Fashion Garment as well as being the president of the LTGIG, Mr Bounma has some advantages over other domestic factories, as he is aware of what the Lao garment industry faces after the quota abolition. Nevertheless, he is still not very sure about the actual negative impacts. When the group organizes brainstorming workshops for responsive solutions, local factory participation is very low compared with foreign-owned or joint venture companies. The business owners hardly realize the importance of consultations and teamwork in order to discuss their concerns and find mutual solutions. Some factories usually send an office clerk or an accountant to attend these workshops. Mr Bounma emphasized, ‘You need to know and understand the problems yourself in order to come up with a clear plan of action to deal with what is expected to be faced in the future.’ It is more likely that the quota abolition will put many small garment factories that are sub-contractors out of business if nothing substantive has been undertaken to prevent it. Given the fact that most garment factories in Laos rely heavily on orders from third parties, importers will tend to choose those suppliers who offer them the best terms and conditions. The quality that Lao garment factories can supply may be comparable and the price may be a little cheaper, but the importers will order from the suppliers who are most convenient to deal with. Hence small suppliers in Laos can do little more than face reality and, in the worst case, may have to close down their factories.

On the other hand, the government authorities are not very aware of the impact of global competition, which requires short lead times, low prices, good-quality products and good-quality services. The garment factories expect to receive support from government authorities, particularly to provide timely import-export clearance. One area of support for productivity enhancement in the Lao garment industry is improvement in import procedures of raw materials and prompt service for the export of ready-made garments. The geographical constraint alone offers a sufficient disadvantage for Lao exporters; they should not be brought down by additional man-made difficulties. ‘We would like to see the government sector working harder to improve market access for Laos as in other countries. For example, in Thailand the Ministry of Commerce and trade representatives abroad are working with key agencies to negotiate market access and make contacts for business partnerships’, Mr Bounma commented. One of the biggest disadvantages for Laos, in comparison with Cambodia and Nepal, of not being a member of the WTO is that Laos is very reliant on bilateral market access. ‘We are not concerned about the import tariffs because they may not come down very much after the end of the Doha Round, but the real threat for us is import quotas’, added Mr Bounma. After the textile and garment trade is brought within the multilateral trade framework, any quantitative restrictions are forbidden among members. Without WTO membership, Laos has to live with bilateral trade arrangements which may be abused by importing countries even though they are WTO members.

The Lao garment industry’s productivity is relatively low in comparison with its competitors due to the lack of training, skills, labour and management. The difficulties in training workers are diverse. Most factory workers are women who may finish high school and then come to the city to find jobs. The garment factories have to train them completely on site. It is indisputable that the wages in Laos are low, but the workers also have low productivity. Lao companies are only producing low-grade products.

The other challenge for Lao Fashion Garment is the lack of marketing strategies. The company is manufacturing-oriented with a passive selling approach, waiting for production orders from representative companies overseas, for example in Hong Kong or Thailand. This may be acceptable for foreign direct investment companies as they can have transfer pricing with parent companies. In contrast, it is an increasing problem for some joint ventures and certainly for 100% Lao companies such as Lao Fashion Garment.

Even though Laos is qualified under the GSP to export to many developed markets such as the EU, Japan and Canada, most garment factories are not able to take full advantage of this preferential market access. Most of Lao Fashion Garment’s items are not exported under the GSP to the EU market. Mr Bounma commented that ‘Due to the lack of domestic upstream industries, we import most of our raw materials such as fibre, yarn and fabric from China and Chinese Taipei.’ Imported materials account for approximately 70% of total production costs and in turn these constitute quite a high proportion of the overall production costs. Due to increased competition as a result of the quota abolition, imported material cost components may not be reduced to the same extent as the garments’ price reduction. Labour costs will be cut instead and in some cases the profit margin will decrease, both of which are part of the local ‘value added’. The reduction in domestic value addition is a threat, especially for those who export under ASEAN cumulation rules of origin. In order to fulfil the GSP requirements of the EU, garment factories in Laos need to have local contents worth more than 50% of the total production costs.

In addition to being a non-WTO member, Laos has not yet enforced normal trade relations (NTRs) with the United States. Even though NTRs were recently rectified, many internal procedures for their effective implementation are needed. For Lao Fashion Garment and the garment sector generally, it could take six months or more to actually be able to export to the US market. In the next steps, the Lao Textile and Garment Industry Group in collaboration with the government will need to work hard to negotiate for market access for each category of garments. After Cambodia reached its bilateral trade agreement with the United States in 1997, garment exports doubled within a few years. Currently, Cambodia exports over 70% of garments to the United States and the rest go to the European market. When the ATC is ended and textile and garment trade is fully integrated into the WTO framework, the benefits of having a preferential bilateral market access may not be that great. Hence, after being granted the NTRs, the immediate positive effects on the Lao garment industry cannot be readily forecast. If Laos had had the NTRs in the last seven to eight years it would have been very useful.

For the Lao garment industry there is another disadvantage for not being able to access the US market. US buyers tend to make larger orders compared with those from the EU market. Receiving bulk orders do have economies of scale and enhance the expertise of the workers. Small quotas disrupt improvements in workers’ skills. They start to become familiar with certain production settings and their productivity rises. Then, suddenly, they have to learn new skills and adapt to new settings. Progress in labour skills may take some time.

V. Lessons for others    back to top

The success of the industry during the 1990s demonstrated that it can be a significant contributor to the government’s prime objective of poverty alleviation through job creation and earning of foreign exchange. For garment factories, CMT work is not sustainable and will not be available in the future. To solve these problems, strong marketing activities, as a means of having direct contact with retail buyers, are needed. Improvement in labour skills and productivity in the industry is also a key to helping Lao garment exporters stay competitive in importing markets.

Being the president of the LTGIG, Mr Bounma has actively participated in in-country and regional workshops on the issues and challenges related to trade in textiles and garments after 2005. ‘Creating public awareness among locally owned garment factories, including the sub-contractors, would be an activity that needs to be undertaken immediately’, commented Mr Bounma, adding that ‘The Ministry of Commerce should actively work in collaboration with the Chamber of Commerce and Industry.’ In order to minimize the possible negative impacts on the Lao garment industry, it is necessary for the government to make a comprehensive assessment of the potential adverse effects of quota abolition and to have a clear policy response.

Apart from raising awareness, support from the government authorities is a crucial factor. From interviews conducted with some garment factories, the general consensus is that the current legal framework should be more supportive of business operations. One example is that the government could review and improve the existing labour law. Flexible labour law is needed to allow for garment factories to compete with those in other neighbouring countries. Overtime work for workers is limited to only 30 hours per month. In addition, female workers constitute far the largest share of the workforce in the textile and garment industry but they are not allowed to work after 10 p.m. This is not enough for the factory to produce on time when bulk orders are received.

Talking about the difficulties that the textile and clothing sector in Laos has encountered, Mr Bounma had expressed some concerns resulting from his own experience and through discussions with managing directors of various other garment factories, whether wholly foreign owned, joint-venture or Lao-owned companies: almost all the companies have difficulties in developing mechanical skills, and all kinds of management skills. The result is that unit costs of production are higher than necessary, quality is inconsistent, orders are delayed and material utilization is excessive. Therefore he suggested that the government works together with the industry to create the appropriate types of vocational training institutes in Laos.

Besides, the government and the industry must work closely together to reach mutual understanding of others’ difficulties. Mr Bounma emphasized that the government should negotiate bilateral agreements in order to obtain an extension to the present terms of preferential access to the world’s important clothing importing markets, especially the EU, Norway and the United States. He commented further that the government should also speed up its WTO accession procedure, which will help to extend the market access for Laos on a multilateral basis. The WTO is a rule-based organization and membership will mean that Lao exporters will not run up against the risk of being discriminated against by any particular importing countries.

A regional forum to address the issue collectively is considered to be one of various means available to draw the attention of the garment importing countries. That was the view of Mr Bounma after coming back from the sixth ASEAN Federation of Textile Industries (AFTEX) meeting in mid-November 2004 in Hanoi, Vietnam, when he explained, ‘I fully agreed with all the positive measures that came out from the meeting and will be submitted to the ASEAN economic ministers for adoption.’ He also emphasized that there are some measures that the Lao government should undertake immediately, namely eliminating non-tariff barriers to facilitate intra-ASEAN inputs and securing the recognition of ASEAN cumulative rules of origin in all free trade area negotiations. ‘The establishment of skill training, design and merchandizing centres to build capacity for the Lao garment factories will also help the Lao textile and garment industry overcome the mounting challenges’, added Mr Bounma.

* Banesaty Thephavong is Deputy Director General and Khouanchay Iemsouthi and Buavanh Vilavong are Economists, Foreign Trade Department, Ministry of Commerce.