Role Reversal in the Garment Industry Drama

In 2009 my company Third Horizon was retained by the Inter-American Development Bank to create a strategy to revive the Dominican Republic garment export industry.

From the outset, the situation appeared lay somewhere between serious and hopeless

As of 1994 The Dominican Republic ranked was the 6th largest garment supplier to the United States with a 5% market share. It was also the world’s 3rd largest cotton pants supplier with a 10% market share.  So important was pants exports that Dominican garment industry was nicknamed  Isola Del Dockers

By 2009 — when we were invited to effect the great change — the Dominican industry rank had slipped to 20th with a 0.97% U.S. total garment market share.  Market share for cotton pants had fallen to 0.79%

From the period 2000 to 2009 employment in the garment industry fell by 82%, from 141,945 to 25,200.  This was perhaps the greatest collapse in the history of the global garment industry.  In a country where 41% of the total population was living below the poverty line the loss of 116,700 was nothing short of catastrophic.

Remarkably the Dominican garment industry failed despite enjoying overwhelming advantages over its competitors

  • As part of CAFTA, Dominican Republic enjoyed duty free access to the U.S., its most important market, which at that time imposed an average of 18% duty rate on garment imports.
  • Its proximity to the U.S. provided a great speed-to-market advantage. Santo Domino is 828 miles from Miami

In the end the industry never did improve.  Currently, (as of the twelve months ending May 2014), the Dominican industry rank had slipped even further to 21st with a 0.84% U.S. market share and has 0.23% market share for cotton pants.

Clearly, Third Horizon did not help. Truth be told, this was not our finest hour.

 Yet the question remains, why did the industry collapse?

Our first conclusion was that the Dominican Republic garment export industry died by suffocation.  It was coddled to death by government assistance, which having made the most extraordinary effort to save the industry destroyed it.  For example:

  • To keep garment exports competitive, between 1994 and 2007 government undertook a series of devaluations, reducing the Peso from US$0.075 to US$0.029.  These devaluations severely reduced the real income of almost the entire population
  • To provide capital for expansion, government guaranteed loans totaling $60 million which were promptly taken up by leading players in the industry who used the money to pay off their workers in order to close down their factories.

 

  • To keep the industry competitive, government subsidized 25% of the cost of electricity.

One possibility was that all these government efforts forestalled necessary change. In economics 101, we are taught the value of creative destruction.  Thing change.  Those who fail to adapt die, to be replaced by those who do adapt and by doing so flourish.

It seemed that government efforts to support the industry allowed companies that should have gone broke to survive, albeit in a commercial zombie state, at the expense of companies that having received no benefits were forced to adapt to existing conditions.

There were indeed factories, operating in the domestic market, who developed and continued to prosper without government support.  Yet, because they had no voice with government, they were continually placed at a disadvantage.

This is destructive destruction, the counterpart of creative destruction.

However, in the course of our work we recognized that the problem went deeper.

We noticed that despite the many gifts bestowed by government, those Dominican operations, which could were fleeing the country.

  • Grupo M, the largest garment factory in the country (and whose owner was the head of the garment association) was moving across the border to Haiti.
  • Hanesbrands. A long time producer in the Dominican Republic was cutting down while expanding elsewhere.
  •   Levi Strauss was severely reducing their orders

Clearly government goodies were not helping.

In the end we realized that the Dominican government while providing benefits supposedly aimed at saving their garment industry, was simultaneously undermining that same industry by imposing substantial unnecessary costs.

Enter the Industry Mafioso:

  • Electric power:  Even after allowing for the 25% electric power subsidy, costs to Dominican factories might well have been the highest among all garment exporting countries.

  • Efforts by factories to import generators to produce electric power in-house were met with spurious attacks for supposed labor-law violations.

During the course of our work in the Dominican Republic we calculated that the industry could create an electric power cooperative which could provide electricity at less than 50% of the going rate and provide dividends to its members in the form of further electric tariff reductions.  In preliminary discussions with a major generator supplier, we were also informed that they would undertake to provide the necessary capital on very attractive terms to finance the project.

In the end nothing happened, as government informed us, that the project would never be allowed to go ahead.

  • Dominican Republic has a very decent road network which should allow for efficient low cost movement of finished goods and materials to and from the port. Unfortunately, despite the quality of the roads, trucking costs are among the highest in the world.  Trucking is in the hands of a small group of people who appear to have a monopoly on all road transport.

Once again going outside the imposed order is not possible.

In the end the Dominican garment industry failed.

The lesson to be learned form the Dominican Republic is that to succeed both government and industry must play their role, but that those roles are different.

Regrettably few governments and even fewer national garment export industries have yet to learn this lesson.

In the modern industrial economy, Government has a vital role to play

i:   Government must provide roads and railways to transport goods

ii:  Government must provide electric power to allow factories to operate;

iii: Government must provide trade polices, which allows a level playing field for all players;

iv:  Government must provide practical labor regulations, which protect the workers rights and conditions without unnecessarily restricting business

In the same modern industrial, industry has a vital role to play

i:  Industry must pay taxes to provide government with funds in order for government to provide the services listed above.

Unfortunately, today in many garment-exporting countries, governments do not provide road or railroads adequate to meet the needs of industry; nor do they provide sufficient electric power.

All too often, in these same countries labor regulations are a farce, where the only benefits are accrued to venal bureaucrats in the form of ever increasing bribes, and where trade policies exist only to ensure that the few maintain their oligsopsony, by preventing competition from imports of higher quality materials at lower cost.

Since these governments fail to play any positive role to support the industrial economy, we might ask just what role do these governments do play?

Here it comes role reversal:

Government plays the role of industry, by paying taxes to industry, in the form of subsidies, rebates and tax allowances.

At first glance, we might think this as some obscene political perversion.  However, in a society where government officials survive on bribes from industry, it is only reasonable that these same officials in turn bribe industry not to complain.

Finding a solution is very difficult.

The players — both government and industry — quickly accept both bribes and subsidies as entitlements to be preserved at all costs

Before completing work in Dominican Republic, I made a presentation to the major players, where I explained that irrational giveaways such continued devaluations and government guaranteed never-to-be-paid loans could not continue. The audience was shocked.  To the industry, these giveaways were entitlements, guaranteed by custom. It was not my place to speak out against benefits that was rightfully theirs. To the contrary. my role was to ensure that these entitlements were increased or at the very least ensured to continue into the future.

I could understand their concerns.  Their industry as then constituted could not survive without annual transfusion of government cash.  Without entitlements they would all be out of business.

It did not occur to the Dominican industry leaders that there was a choice: change or die. In the end they chose industrial suicide.

Role reversal is not limited to Central America. It has become endemic throughout South and Southeast Asia, where even now it is stifling growth

The only solution is for government to return to its role providing those things that government should provide, permitting industry to return to its role.

To survive companies and even entire national industries must follow a process of creative destruction whereby companies and industries either change or die, leaving room for newcomers more able to adapt.

However, countries where the entitlement dependent become dominant change has become increasingly more difficult

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One Response to Role Reversal in the Garment Industry Drama

  1. John says:

    Very insightful article. I remember in the late 1990′s when the DR was the place to be for woven cotton bottoms, knit underwear, and the like. Sad to see it decline, as the political stability and proximity to the U.S. are real advantages. But even those advantages can be eclipsed by the ills mentioned by the author. Thank you for continuing to write about the industry with such incisiveness.

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