Building Innovative Capabilities

BUILDING INNOVATIVE CAPABILITIES

REVIEW OF THE AUSTRALIAN TEXTILE, CLOTHING AND FOOTWEAR INDUSTRIES

VOLUME 2

© Commonwealth of Australia 2008 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and enquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney General’s Department, Robert Garran Ofﬁces, National Circuit, Canberra ACT 2600 or posted at http://www.ag.gov.au/cca.

ISBN 978 0 642 72361 5

Note: The dollar amounts in this report are in Australian dollars, unless otherwise indicated.

Disclaimer The material contained within this document has been developed by the Review of the Australian Textile, Clothing and Footwear Industries. The views and opinions expressed in the materials do not necessarily reﬂect those of the Australian Government or the Minister for Innovation, Industry, Science and Research. The Australian Government and the Review of the Australian Textile, Clothing and Footwear Industries accept no responsibility for the accuracy or completeness of the contents, and shall not be liable (in negligence or otherwise) for any loss or damage (ﬁnancial or otherwise) that may be occasioned directly or indirectly through the use of, or reliance, on the materials.

Furthermore, the Australian Government and the Review of the Australian Textile, Clothing and Footwear Industries, their members, employees, agents and ofﬁcers accept no responsibility for any loss or liability (including reasonable legal costs and expenses) or liability incurred or suffered where such loss or liability was caused by the infringement of intellectual property rights, including moral rights, of any third person.

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Contents

EVALUATION OF THE PRODUCTIVITy COMMISSION MODELLING OF

TCF ASSISTANCE

1

INTERNATIONAL POLITICAL ECONOMy OF THE TEXTILE AND CLOTHING INDUSTRIES OF DEVELOPED COUNTRIES: EXAMPLES

FROM THE US, UK AND GERMANy

17

43

INDUSTRy POLICy FRAMEWORKS FOR A KNOWLEDGE ECONOMy

SUPPLy CHAIN CONSIDERATIONS FOR THE AUSTRALIAN TCF INDUSTRIES SURVEy OF STRATEGIC INVESTMENT PROGRAM GRANTEES DESIGN AND FASHION IN THE AUSTRALIAN TCF INDUSTRIES
95
113 137
LABOUR ADJUSTMENT: CHANGES IN EMPLOyMENT IN THE

AUSTRALIAN TCF MANUFACTURING SECTOR

177

iii

iv

EVALUATION OF THE PRODUCTIVITy COMMISSION MODELLING OF TCF ASSISTANCE

ASSOCIATE PROFESSOR RICHARD DENNISS CRAWFORD SCHOOL OF ECONOMICS AND GOVERNMENT AUSTRALIAN NATIONAL UNIVERSITy

IntroduCtIon

As part of the terms of reference for the Review of the Textile, Clothing and Footwear Industries, the Productivity Commission (PC) was commissioned to conduct economic modelling of the impact of changes to TCF tariffs and budgetary assistance. The Productivity Commission was asked to model a wide range of policy scenarios in order to shed light on the likely macroeconomic and sectoral impacts of policy change (see Productivity Commission 2008).

The approach adopted by the PC was to use a comparative static computable general equilibrium (CGE) model, the MMRF. In the words of the PC, ‘modelling requires a range of assumptions to be made about behaviour and other parameters, the validity and signiﬁcance of which always needs to be tested’ (PC 2008: XIII).

This paper begins with an overview of the PC’s modelling results and then discusses the limitations and ﬂaws in applying the PC model.

REVIEW OF THE AUSTRALIAN TEXTILE, CLOTHING AND FOOTWEAR INDUSTRIES VOLUME 2

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overvIew of the ProduCtIvIty CommIssIon modellIng results

The results of the PC’s modelling exercise, and additional commentary, were published on 8 July 2008 in a report entitled Modelling Economy-wide Effects of Future TCF Assistance. The key results, as deﬁned by the Productivity Commission, are presented in the table below.

Table 1:Assistance reductions deliver economy-wide gains, even with restrictive assumptions

Column/(scenario)

1 (R)

2 (O1)

3 (S2a)

4 (S3a)

5 (S1a)

6 (S4)

Tariff

To 5

per
To 5 per To 5 per cent cent

To 5 per cent

To 5 per cent To 5 per cent

cent
Budgetary assistance Sensitivity scenario

To 0 No change

To 0

No change

To 0

10 per cent 30 per cent remain pass through
Productivity increase
Minerals

boom

unemployed

National aggregates ($m) Real adjusted GNE Real GDP
63 71
63 71
50 58
18 23
114 121 309 332
12331 13458 -6935
4650
Export volumes Import volumes Sectoral output ( per cent change) Agriculture
385 344
324 336
362 238
378 334

0.02 0.08 0.05
-0.07
0.00
0.01 0.05 0.04
-0.06
0.01
0.02 0.08 0.05
-0.04
0.00
0.02 0.07 0.05
-0.08
0.00
0.01 0.04 0.03
-0.04
0.01
-1.56 14.03 -3.21 -4.12
0.80
Mining Food processing Manufacturing Services Textiles ( per cent change)

Output

-2.76

-3.09
-2.27 -2.53
-2.43 -2.72
-2.77 -3.10
-1.72 -3.54
-5.30

-6.19

Employment

Clothing ( per cent change)

Output

-5.12

-5.73
-4.55 -5.10
-3.05 -3.42
-5.12 -5.73
-3.91 -5.98
-11.81

-13.46

Employment

Footwear ( per cent change)

Output

-2.06

-2.48
-0.60 -0.85
-1.75 -2.08
-2.07 -2.49

1.41

-13.79

-16.25

Employment

-0.24

Note: A description of each of the scenarios is provided below. Source: PC (2008: XVII, Table 2).

The most important finding shown in the table is that the potential economic benefits flowing from a modest (1.5 per cent) increase in productivity, combined with tariff reductions ($121 million per annum), dwarf the potential benefits from reducing tariffs alone ($71 million). While the PC focuses on the potential benefits of tariff reductions alone, the analysis below suggests that the estimate of $71 million in potential benefits from tariff reductions is best interpreted as an upper bound. Including real-world assumptions such as labour market immobility, imperfect competition in the retail sector and low elasticity of export demand significantly reduces the potential benefits from tariff reductions. The benefits of increased productivity, on the other hand, are less sensitive to the choice of modelling assumptions.

This discussion of the results of the modelling begins with the scenario presented in column 1 of Table 1 (the reference scenario, which assumes that tariffs fall to 5 per cent and all TCF-speciﬁc budgetary assistance is abolished). The other scenarios will then be discussed in turn. The section ends with a critical analysis of both the conclusions and method contained in the PC report.

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SCENARIO 1—TARIFFS FALL TO 5 PER CENT AND BUDGETARy ASSISTANCE IS ABOLISHED

As noted above, the results of the modelling suggest that reducing tariffs to 5 per cent and abolishing budgetary assistance will lead to an increase in GDP of $71 million per year.

At the sectoral level, the model suggests that the pursuit of such policies would result in a 0.07 per cent decline in the size of the manufacturing sector, with the largest increases in the size of mining (0.08 per cent) and food processing (0.05 per cent). The mechanisms by which a reduction in TCF output will lead to an increase in mining are discussed in detail below.

At a ﬁner level of disaggregation the results suggest that the textile, clothing and footwear industries will decline by 2.76 per cent, 5.12 per cent and 2.06 per cent respectively, with reductions in employment across those industries estimated to be 3.09 per cent, 5.73 per cent and 2.48 per cent respectively.

To summarise the ﬁndings for scenario 1, reducing tariffs to 5 per cent and abolishing all TCF-speciﬁc budgetary assistance will lead to a very small increase in GDP, and the loss of thousands of jobs across the TCF sector, with the biggest reductions occurring in the clothing industry.

SCENARIO 2—TARIFFS FALL TO 5 PER CENT AND BUDGETARy ASSISTANCE IS MAINTAINED

The most signiﬁcant feature of the modelling results for this scenario is how similar they are to those of scenario 1, which suggests that there is no macroeconomic case for ending budgetary assistance to the TCF sector. This does not mean that other arguments for the abolition of assistance might not be advanced, but the modelling suggests that such a change in policy would have no impact on GDP.

At the sectoral level there are, however, some important differences between scenarios 1 and 2. The most important difference is the way that the budgetary assistance helps soften the impact of tariff reductions in the TCF industries. The results of scenario 2 suggest that budgetary assistance is sufﬁcient to prevent almost all of the decline in output associated with tariff reduction in the footwear industry.

SCENARIO 3—TARIFFS FALL TO 5 PER CENT AND BUDGETARy ASSISTANCE IS ABOLISHED, BUT ONLy 10 PER CENT OF THE COST REDUCTION FROM TARIFFS IS PASSED ON TO CONSUMERS

This scenario focuses attention on the potential adverse impacts of market power in the TCF distribution chain being used to capture the benefits of tariff reductions for retailers and wholesalers rather than being passed on to consumers. One of the assumed major benefits of tariff reductions is lower prices for consumers, but if markets are not highly competitive then such price reductions may instead be converted into higher profits by distributors.

The modelling shows the potential signiﬁcance of imperfect competition in the TCF wholesale and retail supply chain. For example, column 3 shows that if only 10 per cent of the value of tariff reductions is passed on to consumers, then GDP is likely to rise by only $58 million rather than $71 million. That is, up to 18 per cent of the potential increase in GDP is contingent on the assumption of a high degree of competition in the TCF wholesale and retail chain.

The PC was strongly of the view that the existence of imperfect competition in the TCF wholesale and retail sector was highly unlikely, stating:

There is little evidence that retailers of TCF products have signiﬁcant market power: there are many retail establishments reﬂecting low barriers to new entrants selling these products (PC 2008: XX).

And:
In reality, both pass through scenarios appear implausible. Even in the event of extreme market power (a monopoly with no threat of competition) at least 50 per cent of tariff reductions would be

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passed on to consumers. However, there is little evidence of market power in the sector, let alone monopoly (PC 2008: 39).

The PC also includes the ﬁgure below as evidence of its view that tariff reductions will be passed on in full to consumers. The PC uses the ﬁgure to make the point that, following the tariff and quota reduction in the late 1980s, clothing and footwear prices stabilised while the CPI rose. However, it provides no explanation as to why a similar pattern did not emerge following the 25 per cent reduction in TCF tariffs in 1974.

Figure 1: Cuts in protection have preceded lower prices

1000

Mar 93 Quotas abolished
Jan 88
Phased tarif reductions begin
Mar 89 Quotas relaxed

800 600 400 200
0

CPI

Clothing and footware

Clothing and footwear and CPI (indexes, September 1972 = 100) Source: PC (2008: XXI, Figure 1).

A more detailed examination of the trends revealed in the figure does not support the view that there is full pass-through of either tariff cuts or currency appreciation. For example, the CPI for total footwear was 98 in March 1996 and 96 in March 2008. (The CPI has a base of 100 indexed to 1989/90 prices.) The relatively constant CPI was due largely to the deflationary shock from the growth of Chinese imports from the 1990s. For example, in 1995/96 the landed unit price (pre-tariff) of Chinese footwear was $7 per pair; in 2007/08 it was $7.70. (Similar small nominal price increases occurred for Chinese imported clothing.) China accounts for more than two-thirds of footwear imports, and imports represent over two-thirds of total domestic sales of footwear. However, over the same period there were a number of changes that should have contributed to a much larger reduction in either the landed price or the CPI for footwear. Between 2001 and mid-2008 the Australian dollar appreciated against the US dollar by 88 per cent. The Chinese currency maintains close parity with the US dollar. Given this very significant appreciation, the landed price should have reflected this near doubling in the purchasing power of the Australian dollar. In addition, the tariff on footwear fell from 30 per cent in 1995 to 10 per cent in 2005. If the exchange rate appreciation and the tariff had been fully passed through to consumer prices over the period, there should have been a large reduction in the footwear CPI. This did not occur.

More generally, econometric studies of pass-through of tariff reduction and exchange rate movements ﬁnd that:

Price effects of global competition on domestic markets are normally not dominant; they are often delayed and they differ between products, in each case in contrast to the core postulates of standard trade and tariff theory (Coutts & Neville 2007: 1221).

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SCENARIO 4—TARIFFS FALL TO 5 PER CENT AND BUDGETARy ASSISTANCE IS ABOLISHED, BUT ONLy 30 PER CENT OF UNEMPLOyED TCF WORKERS FIND EMPLOyMENT IN OTHER INDUSTRIES

This scenario focuses on the potential macroeconomic costs of workers losing their jobs in the TCF sector and failing to ﬁnd employment elsewhere in the economy. The PC modelling results show that, if a long-run increase in unemployment were to accompany the reduction in tariffs, more than 6 per cent of the potential GDP gains of tariff reductions would be lost. That is, the modelling shows that GDP would rise by only $23 million, rather than $71 million as in scenario 1. Importantly, if the circumstances of scenarios 3 and 4 were combined, the impact of low pass-through and some permanent unemployment means that more than 85 per cent of the potential increase in GDP from reducing tariffs would be lost.

As with scenario 3 it is important to note that the PC expressed doubt about the plausibility of assuming that 30 per cent of displaced TCF workers would be unable to ﬁnd work. The PC describes this scenario as ‘an unlikely outcome in today’s labor market’ (PC 2008: 79), although data from DEEWR (2008) presented below suggests otherwise.

While unemployment in Australia is at historically low levels, there are a number of reasons to assume that some TCF workers will struggle to ﬁnd new jobs, particularly as the next scheduled round of tariff reductions is not until 2010 when the unemployment rate is likely to be higher than it is today.

The main reason to expect that TCF workers may struggle to ﬁnd new jobs is expressed in the PC’s Review of TCF Assistance (2003). In the chapter entitled ‘Adjusting to Change’ the PC concludes:

‘The non transferability of the skills used in many areas of the [TCF] sector could limit alternative job opportunities.’

‘Low educational attainment could also impede adjustment.’ ‘Labor mobility of the TCF workforce as a whole is lower than for industry in general. This is partly explained by the age proﬁle of TCF employment and the high proportion of female and migrant workers.’

‘Older people are more likely to have established family and community ties to the regions in which they live and to be more reluctant than younger people to move to ﬁnd work.’

‘For females, alternative work in male dominated manufacturing industries can be hard to find.’ ‘Many recent migrants have poor skills in English, as well as lower levels of educational attainment than those born in Australia. This is likely to add to their difficulty of finding alternative employment if displaced from their current jobs.’

‘Adjustment costs faced by individual displaced outworkers can be just as high, if not higher, than those faced by factory workers who lose their jobs.’

(PC 2003: 45–48.)

SCENARIO 5—TARIFFS FALL TO 5 PER CENT, BUDGETARy ASSISTANCE IS MAINTAINED AND PRODUCTIVITy IN THE TCF INDUSTRIES INCREASES By 1.5 PER CENT

The modelling for this scenario shows that the potential beneﬁts to the Australian economy that arise from a small increase in productivity are similar in magnitude to the most optimistic assessment of the potential beneﬁts from further tariff reductions and the abolition of budgetary assistance to the TCF industries. That is, compared to the $71 million increase in GDP forecast in scenario 1, the addition of a small increase in productivity delivers an additional $50 million in GDP, a 70 per cent increase.

Comparing the beneﬁts of increased productivity to those of tariff reductions is even more interesting when the increased productivity scenario is compared to the less optimistic tariff reduction scenarios. For example, the potential increase of $50 million in GDP associated with a 1.5 per cent increase in productivity

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in the TCF industries is nearly on par with the increase in GDP associated with the tariff and assistance reductions when it is assumed that there is 10 per cent pass-through ($58 million), and is more than twice as large as the increase in GDP in the scenario with 30 per cent of retrenched TCF workers remaining unemployed ($23 million).

While the PC modelling is critically evaluated below, given the policy goal of increasing productivity in Australia it is important to highlight the counterintuitive nature of some of the ﬁndings. For example, in response to a 1.5 per cent increase in productivity, the modelling ﬁnds that:

exports will fall across the economy TCF employment will fall TCF wages will fall

SCENARIO 6—TARIFFS FALL TO 5 PER CENT, BUDGETARy ASSISTANCE IS ABOLISHED AND THE REAL EXCHANGE RATE INCREASES By 10 PER CENT

This scenario aims to place the impacts of tariff reductions into the context of a rapidly rising Australian dollar, due primarily to the boom in world demand for Australia’s raw materials. To achieve a 10 per cent appreciation, the PC assumes that the output of the mining industry, and its exports, increase signiﬁcantly.

While the potential gains to the Australian economy from tariff and industry assistance reductions are modeled to be $71 million, the impact of the minerals boom is estimated to be $12 331 million. The impact on the TCF industries of a signiﬁcant appreciation of the dollar is also much larger than the impact of tariff reductions, with employment declining by 6.19, 13.46 and 16.25 per cent respectively across the textile, clothing and footwear industries.

Under this scenario, the impact of a rapidly appreciating exchange rate on the competitiveness of the Australian TCF industries is much more signiﬁcant than the small level of assistance provided by the existing low levels of tariffs.

OVERALL CONCLUSIONS OF THE PRODUCTIVITy COMMISSION MODELLING

In summarising the ‘high-level messages’ from the modelling, the PC states:
The modelling demonstrates that further reductions in TCF assistance are likely to generate net beneﬁts to the community. The greatest gains, as measured by real adjusted gross national expenditure (GNE), are produced under the reference scenario (scenario R), which is the (current) program of assistance reductions, involving the legislated reduction in tariffs to 5 per cent and removal of subsidies by 2015. The modelling indicates that this program would still yield net gains even when introducing some unusual assumptions about the effect of reducing tariffs on the prices of TCF products and on employment. In these simulations (S2 and S3), the gains in real adjusted GNE are less than those in the reference scenario, but are still positive.

(PC 2008: 71.) Unfortunately, the PC’s ‘high-level messages’ conceal the fact that the upper bound of the benefits associated with tariff reductions ($71 million) is only slightly larger than the potential benefits of a small increase in productivity ($50 million). That said, while the potential benefits associated with an increase in productivity are robust, and associated with a particularly small increase in productivity, the potential economic benefits associated with tariff reductions are heavily contingent on the assumptions that all retrenched TCF workers are re-employed, that all the benefits of tariff reductions are passed on to consumers and that export demand is highly elastic.

The PC also states:
The modelling indicates that this program would still yield net gains even when introducing some unusual assumptions about the effect of reducing tariffs on the prices of TCF products and on employment.

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In these simulations (S2 and S3), the gains in real adjusted GNE are less than those in the reference scenario, but are still positive.

(PC 2008: 71). In this statement, the PC asserts that it is ‘unusual’ to model the possibility that not all of the cost reductions that accompany tariff reductions will be passed on to consumers or that a permanent increase in unemployment might accompany structural change. While these views are critically analysed below, it is also important to highlight the disparity between the ‘high-level message’ being reported and the results presented in the PC modelling paper.