The Way Forward

Attracting FDI to revamp RMG sector

Hafiz G. A. Siddiqi

During the first four years of the new millennium (2001-04) we observed a series of intense debates on the possible impact of the phasing out of MFA on RMG industry of Bangladesh. Most frequent prediction was that in the early months of 2005, the first year of the post MFA era the Bangladesh RMG industry would collapse by an earthquake of new competition. Most experts predicted that Bangladesh would lose sizable ground in its largest market, namely, the US. By now, Bangladesh is deep into 2005, but no earthquake for its RMG industry has happened. In other words, exports from Bangladesh to US market did not fall; rather the falling trend that was observed during 2001-2004 has been reversed during the first six months of 2005. The total RMG export from Bangladesh has increased, although the rate of increase has slowed down.

Some interesting changes have occurred in export destinations and export mixes. Contrary to most predictions, not only the total export from Bangladesh to US market increased considerably (total- 29.52%) but also exports of woven wear (18.95%) and knitwear (116.01%) increased during January-June 2005 over the same period in 2004. Against this, Bangladesh lost part of its market in EU, again this was unexpected. The total export to EU declined by 2.3% but knitwear export increased by 15.31%. The gain in knitwear was neutralised by a sharp fall in women wear export. This makes EU market vulnerable. Bangladesh gained new ground, although relatively small, in Canada, and Australia, while it lost part its market in Japan (34.51%) compared to the first half of 2004. The relative position of knitwear and sweater in the export basket has improved.

But this does mean that earthquake will not happen in future. One must look into the reasons for pleasant turnaround in the US market. One important reason is that during January-June 2005, the total RMG import of USA increased phenomenally. The pie ( total market) became very large. The same, or even smaller share of the larger pie brought luck to Bangladesh. Another reason, perhaps more important one, is that China, the most powerful competitor, could not get its potential share in the US market due to restrictions imposed by the US on imports from China. In spite of restrictions, in 2004, China supplied more than 16% of the US total RMG imports. If restrictions are withdrawn, its exports to US markets will increase sharply, and Bangladesh is likely to be adversely affected. It is to be noted that because of unrestricted imports from China in the EU, Bangladesh's exports to this market recently decreased. It is however true that Bangladesh's export to US market in absolute value increased. But it is not necessarily true that it will continue to increase after China gets quota free access to the US market.

After China, Mexico is the second largest supplier in the US market. It supplies 10%. India has a strategic plan to increase its exports from current 4% to 15% in 10 years from now. In addition to the relatively large and stronger competitors, Bangladesh will have to worry about smaller competitors like Vietnam and Cambodia. Recent performance of Vietnam is quite impressive. In 2001, Vietnam's share of US market was well bellow that of Bangladesh. But in 2004, Vietnam's share (3.7%) surpassed the share of Bangladesh. Like Vietnam, Cambodia is also catching up with Bangladesh. Its share in the US market is growing fast. During 2000-2004, Cambodian exports to the US market increased by 57%. All these indicate that in the US market Bangladesh is losing ground not only to China, Mexico and India, it is losing ground even to Vietnam and Cambodia.

What are explanatory variables? Most experts believe that both the countries are FDI-driven. Recently, FDI in both Vietnam and Cambodia has shot up. In spite of the fact that many large garment factories are still owned and managed by the State, the RMG exports from these two countries to US increased substantially. Is it really due to the predominance of FDI firms? Bangladesh can gain new insights by analysing the causes of success of Vietnam and Cambodia.

To forestall the surge of competition Bangladesh must implement appropriate strategies. Important of these are : (1) improve productivity, both partial and total, (2) reduce production and other related costs, (3) develop appropriate backward linkages industries, (4) improve infrastructures -- roads, trucking, telecommunications, port-management, etc that will improve delivery system and reduce lead-time, (5) improve forward linkages in the supply chain, (6) diversify markets and get access to new markets, (7) diversify products with a view to moving to upper end and more expensive products, (8) encourage FDI so that access to new markets becomes easier, and (9) establish long term trade relations with current and potential buyers through high flying diplomacy.

FDI in the RMG Sector
If an MNC from a developed country makes direct investment in a developing country and operates a firm that is owned 100% by itself, it is likely to be more productive than domestic firms. The reason is that the MNC brings exclusive technology that adds to its core competence; more importantly, it brings established global marketing networks and firm-specific managerial efficiency that local firms lack. The productivity advantage of FDI is an established fact. Beside, joint-venture with local firms tends to create spillover effects. The positive spillover effect of FDI through technology transfer, including management technology is widely recognised. The garment industry of Bangladesh is an example of this.

The rapid development of RMG industry in Bangladesh in the early 1980s was to a great extent caused by two joint-ventures with South Korean firms. For example, (1) the joint-ventures between Desh Garments and Daewoo Corporation of South Korea, and (2) Treximp Ltd (the predecessor of currently operating Stylecraft -- a Bangladeshi RMG firm) and Youngone Corporation of South Korea proved the validity of this thesis.

In the first case, the local firm, Desh Garments provided necessary funds, and Daewoo transferred production technology and was responsible to market the entire production. (For further detail, see The Readymade Garment Industry of Bangladesh authored by Hafiz G.A. Siddiqi, UPL, 2004). In both cases marketing and production technology were provided by the foreign MNCs. It is a fact that because the Korean firms had exclusive technology and marketing network, the Bangladesh garments got into US and other markets.

The advantages of FDI have been reaffirmed in a study, ““Foreign Ownership and Firm Productivity in Bangladesh Garment Sector” completed by Dhaka Office of the World Bank in July 2005. The study found that the productive efficiency of the FDI firms in the RMG sector was on average 20% higher than that of the factories owned and managed by Bangladeshis. The study concludes, “the firms with foreign capital are the most productive of all firms” … and “knitwear firms are most productive. An average knitwear firm has 10% higher productivity than a woven firm and 17% more productive than a sweater firm”. The policy implications of these findings are clear: (1) To increase productivity the RMG sector must successfully attract FDI. (2) Production and export of knitwear should get higher priority. By implication, increased involvement of FDI will make RMG sector competitive.

But is it that simple? Bangladeshi firms have already succeeded in increasing the export of knitwear and sweater without FDI! Another important question is--does it imply that the future of RMG sector will have to be totally FDI driven as is found in Vietnam and Cambodia? To answer these questions, one needs to have a hard look into the findings of the study and prevailing trend of FDI in Bangladesh.

Many people would contest the conclusion that the FDI firms are 20% more efficient. However, the general conclusion seems to be acceptable, although the “percentage” may be debatable. Apart from the number (in this case we refer to 20%) which depends on the techniques of sampling and also on the degree of bias a particular sample may be vitiated with, the general conclusion that FDI firms are more productive than otherwise identical domestic firms operating in Bangladesh has to be interpreted carefully. There are hardly any 100% domestic firms that are identical to FDI firms. For example, no local firms (large) can match Youngone, the Korean giant in Bangladesh. Furthermore, there are about 130 large firms including FDI firms that employ 1000 or more workers. Of these firms, not even 10 are identical. They do not have identical capacity, employing the same number of workers, using the same number of machines, producing the same product categories, etc. It seems that the World Bank study compared the incomparables. However, it is true that in most cases the FDI firms--both 100% foreign owned and joint-ventures-are more productive.

Again, the conclusion made in the World Bank study that the FDI firms “produce more output given the same level of inputs, and thus a higher level of total factor productivity (TFP) than the solely domestic firms” has to be qualified. This conclusion may be true in cases of large established MNCs i.e. 100% large FDI firms. But in case of joint-venture between a domestic firm and a relatively small and less known foreign firm having relatively weak marketing and sourcing network, the conclusion may be different. A large 100% domestically owned firm having large marketing network and good image among the large buyers like Wal-Mart, JCPenny, etc. may have equally high total factor productivity. This means FDI is not a panacea.

Attracting FDI is only one way to increase competitiveness. However, in addition to attracting FDI, Bangladesh must implement other strategies to retain its highly visible position as exporter in the global apparel markets. To cope with post-MFA challenges, Bangladesh needs to deal with other major components of the supply chain without which full advantage of the FDI induced productivity increase cannot be taken. For example, increasing productivity is not enough. It may not automatically lead to increased export at profitable prices if there is restricted market access. One must analyse the relationship between the FDI firms and market access or the role of FDI firms in market diversification.

The World Bank study concludes that low level of FDI in the garment sector (only 15% of the Bangladeshi garment firms have foreign equity) is partly due to unfriendly government policy or the present investment act that adversely affects RMG sector. This conclusion can be contested. The real cause is limiting the supply to the low end of the market or low priced items. The FDI firms export relatively high priced items.

Bangladeshi entrepreneurs are now quite mature. Many of them do not need FDI to move up to the high end market. In some cases, to have access to the higher end of the market, FDI is likely to be helpful. Similarly FDI firms, with their designing, and marketing capability can enhance marketing capability of Bangladesh in general. Anyhow my strong recommendation will be that the policy be made to create FDI friendly environment in the RMG sector. But to maximise the benefits of FDI, certain conditions need to be applied. For example, special condition for MARKET DIVERSIFICATION (including access to new markets) and perhaps PRODUCT DIVERSIFICATION should be adopted. The FDI firms may be provided with special incentives if they agree to access new and large markets. For example, the FDI firms having a good promise, with their global marketing network, may be required to have access to such markets as India, Japan and China. If necessary, they should be encouraged with special incentives to invest in Bangladesh. Given the uncertainty in the US market Bangladesh desperately needs market diversification. Selective FDI firms may be helpful in this context.

The FDI firms may further be required to undertake Capacity Building initiatives through spillover effects. For domestic capacity building, more FDI may be encouraged in the RMG sector. The foreign FDI firms must transfer effectively all kinds of technologies, namely, production, designing, marketing, sourcing and image-building. Otherwise, encouraging FDI will only produce much larger benefits for the foreign MNCs. This will in turn keep the local firms permanently dependent on the FDI firms. This means that FDI is good only under certain conditions.

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The author is Vice Chancellor, North South University