Off the Mark The Wal-Mart Effect

Defying the global trend the export of ready made garment (RMG) from Bangladesh held up rather well during the worst global recession of the last seven decades (see Chart 1 below). The reasons for such a good performance have been the subject of much speculation and theorising. Initially it was thought that there would be some lag for the impact of the recession to show up on the RMG exports of Bangladesh. While this had some grains of truth, the continued good performance of RMG export needed a more cogent explanation.

Chart 1: Import of apparels by EU and USA from Bangladesh

The Wal-Mart Effect

Some people including industry leaders and economists came out with the hypothesis that this counter-intuitive behaviour of RMG export, i.e., increased shipment with falling world income, was rooted in the nature of the demand for the type of RMG products exported by Bangladesh. It was argued that Bangladesh specialised in the production and export of cheap mass products at the lower end of the price spectrum of RMG products. The recession increased the demand for these cheap products, which benefitted Bangladesh.

The recession in EU and USA, the two principal export markets of Bangladesh, reduced their income and consumption spending. To cope with the reduced income and spending, the consumers in these countries were induced to switch from more expensive RMG items to the cheaper varieties such that the demand for these products actually increased during the recession. Bangladeshi RMG exporters cashed in on this increased demand helped by its low costs. Consequently, RMG export from Bangladesh increased when most other countries suffered large reductions in their exports.

This phenomenon was given the fancy handle of  "Wal-Mart effect",  presumably because the giant retailer Wal-Mart of USA, which sells mostly cheap basic consumer products, did relatively well during the recession, and many people thought this was due to switching of consumer spending to cheaper products in order to meet ends at a difficult time. No notice was taken of the fact that Wal-Mart did rather well also before the recession when the economy was buoyant, and that many relatively poor countries, such as some of the African countries that also produce cheap apparel products, suffered reductions in apparel exports during the recession.

It may be noted that the goods that are susceptible to Wal-Mart effect are what economists call 'inferior goods'. Such goods exhibit negative income elasticity of demand. At low incomes people are forced to consume these cheap goods as they cannot afford more pricey goods. But as income increases, they substitute these cheaper goods for more tasteful and expensive goods. Thus the demand for these cheaper goods is higher at lower incomes.

Whether a good is inferior or not is an empirical question and must be settled by an appeal to empirical evidence. However, some preliminary remarks are possible on the basis of what is widely known. The demand for most of the knit and woven products that Bangladeshi exporters specialise in has been increasing over the years when both the EU and US economies were growing strongly. Since average prices of these products did not decline, it stands to reason to assume that the income elasticity of demand for these goods were positive, i.e., these were 'normal' goods in economist's parlance. There is no compelling reason to believe that they have all turned into inferior goods just because the world economy entered into a recession during 2008-09. If its main export items were really inferior goods, Bangladesh should be greatly worried, since the demand for its products will certainly fall as the western world moves out of the recession!

The first link in the chain of the arguments of the Wal-Mart effect implies that the recession, i.e. negative growth of income (GDP), has induced a reduction in consumer spending. This is borne out by data of both EU and USA as shown in Chart 2 and 3. A fall in quarterly income growth rates has been matched by a fall in consumer spending as would be predicted by the standard theories of consumption. A similar relationship also holds for Canada.

Chart 2: EU GDP and consumption growth (quarterly)

Source: Eurostat

The second link in the chain of arguments that a fall in income and consumer spending increased the demand for cheaper clothing items that are exported by Bangladesh is, however, not unambiguously corroborated by data currently available. The total import data (from all countries) of EU and USA (USITC and Eurostat) for the top 15 knitwear and top 15 woven garment items imported from Bangladesh reveal that during the five year period 2003-07, when both the EU and the US economy grew well, the total import demand for all these items save one increased markedly in the EU market. The increase continued during 2008 despite the recession due perhaps to adjustment lags. What is important for the Wal-Mart argument though is that for 7 of the 15 items the total demand increased during January-September 2009 compared to January-September 2008.

However, the increase is mostly slim, and it is quite possible that import data for the whole of 2009, when they become available, will change the picture. The import demand for each of the remaining eight items declined. For woven items, the evidence is very similar. The demand for all 15 items, except one, increased during 2003-07. The impact of the recession showed up by 2008 for ten of the fifteen items. The demand for only six of the fifteen items increased during January-September 2009 compared to the same months in the previous year. Again the margin is quite slim, and it is possible that the trend will reverse by the end of the year.

The evidence from US import data is more unambiguous. The global import demand of USA for all but two of the top 15 knit export items of Bangladesh to USA increased very considerably during 2003-07 when the US economy was buoyant. In the case of woven garment the global import demand of USA for 10 of the top 15 export items of Bangladesh increased. The recession of 2008-09 on the other hand caused a sharp decline in the import demand of 13 of 15 knitwear items and all 15 woven garment items. There is little doubt that the income elasticity of demand is positive for most of these items.

Although Bangladeshi exporters did relatively well in the EU and US market during the recession, its impact is gradually being felt. European import of both knitwear and woven items from Bangladesh started declining from about the mid-2009 and by the end of the third quarter the year-on-year growth rate turned negative, and continued to worsen in the fourth quarter. A similar picture also obtains for the US market. Import growth of both knitwear and woven items from Bangladesh started a southward march from early 2009 and entered the negative zone by mid-2009. Thus the full impact of the recession fell on Bangladesh RMG export with a lag of more than two quarters.

The pattern of import demand in both EU and USA does not lend much support to the view that the RMG products that Bangladesh sells in these markets are mostly inferior goods. Hence, the relatively better performance of the RMG exports to EU and USA cannot be explained by the so-called Wal-Mart effect.

Comparative Advantage

The most cogent explanation of the competitive strength of the RMG exporters of Bangladesh would appear to lie in the time-tested comparative advantage theory of international economics. This advantage derives from abundant labour available at a very low wage and the skills of a sophisticated entrepreneurial class.

Bangladesh is a labour-abundant country with a large base of unskilled and semi-skilled labour force with a very low opportunity wage. Over the last three decades it has developed some skill in garmenting, especially CM (cutting and making). A fairly rapid population growth has ensured that there is always a substantial pool of underemployed or unemployed labour. This surplus labour prevents the wage rate from rising. Consequently the RMG manufacturers of the country can employ workers at a very low wage. Since wage is the major component of the cost of CM, a low wage helps to keep the cost down.

The average hourly wage rate of Bangladesh RMG workers is among the lowest in the world. The average wage rates in China and India are about 150 percent higher, while that in Cambodia and Vietnam are more than 50 percent higher than in Bangladesh (Jasin-o'Rourke Group, LLC). Despite the fact that the productivity of the workers in Bangladesh is also relatively low, the extremely low wages are sufficient to offset the low productivity of the workers, and thereby impart a competitive edge to RMG export by keeping the prices of RMG items correspondingly low. The RMG sector is essentially riding on the back of the low wage of these workers.

During the last three decades the RMG sector has spawned a large, sophisticated and dynamic entrepreneurial class who have acquired the skill and expertise to compete aggressively in the international apparel market. They have utilised the cheap supply of labour to produce apparels at a sufficiently low price to create a niche for Bangladesh in the international market. They have successfully lobbied to create a regulatory environment and public infrastructure such as back-to back LC, bonded warehouse and better port facilities that helped to reduce costs of doing business in this sector.

EU and US data suggest that Bangladesh was the most price-competitive exporter of almost all of its major RMG export items during 2009 among the major exporting nations (July-Sept for EU and July-Nov for US). During the previous year Bangladesh was the most price-competitive except for Pakistan and Viet Nam which sold some of the items at cheaper prices. A paradoxical feature of the EU import data is that all the major RMG exporting countries except China increased the unit prices of most of the major RMG export items of Bangladesh despite the recession.

The continued dependence of the RMG manufacturers of Bangladesh on the relatively cheap mass products might seem somewhat puzzling. With more than three decades of experience in garmenting that catapulted it to one of the largest RMG exporters of the world, Bangladesh should have made inroads in the market for more pricey apparel (and other) products. However, the low wage rate works as a deterrent to graduating to higher value products. A low wage rate necessarily implies low productivity of the workers. The low wage rate effectively condemns the RMG workers into low productivity manufacturing. The only apparel products that low productivity workers can profitably produce are the cheap mass products that do not require much skill. The RMG manufacturers of Bangladesh will continue to specialise in cheap mass products as long as the RMG wage rate remains at the current pitiful level and the market is sufficiently large. The wage rate is unlikely to rise much as long the population keeps growing at a rate that outstrips the growth of more productive employment opportunities.

The history of manufacturing shows that when the wage rate is low, a country specialises in the production of labour-intensive goods such as apparel products. Japan, Italy, Korea, Singapore and such other countries all had a very vibrant RMG sector in the earlier years of their development when their wage rates were low. As their wage rates rose with rapid economic development, their RMG sector lost the comparative advantage in producing the cheaper apparel items. They have all but abandoned this segment of the apparel market. Only very high valued designer clothing items that require highly skilled labour are still manufactured in some of these countries since the high prices that consumers are willing to pay for these items justify employing labour at the high wage rates attained by the workers of these countries due to skill enhancement.

The current recession has badly affected the major RMG exporters that have attained relatively high wage rates, such as Hong Kong, Malaysia and Thailand. It is unlikely that they would return in force to the RMG market in future.  This may open up new opportunities for export expansion of low wage countries such as Bangladesh, Cambodia and Vietnam.
Epilogue

Notwithstanding some reduction in the export of RMG products during July-January of FY2010 (EPB) the industry has emerged out of the global recession of 2008-09 as a stronger and more efficient competitor in the world apparel market. It has captured larger shares of the RMG (import) markets of Canada, EU and USA. The RMG exporters are now exploring other duty-free markets such as Japan and Australia. The recent stimulus package that provides financial incentives for exporting to new markets should raise the competitive strength in these markets. It seems most likely that the RMG sector will expand its market shares even more in the coming years and will become a major sourcing hub for apparels for all major importers.

However, Bangladesh is still a supplier of the cheap basic apparel items that can be profitably produced by unskilled and semi-skilled workers. If it wants to move up the value chain as new opportunities emerge in the post-recession global market, it will need to improve the quality (productivity) of its workforce and management. Such improvements will not be possible without a substantial increase in the remuneration of the workers.  If the sector fails to do so, and the wage rate rises nonetheless in response to positive developments in other sectors, it will find its comparative advantage pared away steadily.