Potential Economic Effects on the U.S. Textile Industry

from the U.S. Korea Free Trade Agreement

U.S. International Trade Commission

June 20, 2007

Cass Johnson

National Council of Textile Organizations (NCTO)

Chairman Pearson and members of the Commission, thank you for the opportunity to testify today.  My name is Cass Johnson and I am the President of the National Council of Textile Organizations (NCTO).  The U.S. textile industry is one of the most highly-automated and advanced manufacturing sectors in the country and among the most export oriented.  U.S. textile companies invest on average 50 percent more capital in new plants and equipment as the rest of U.S. manufacturing.  The U.S. textile industry is also the third largest exporter of textile products in the world.

Unfortunately, foreign governments such as China, and, to an lesser but still significant extent, Korea, have long inserted themselves in their respective textile sectors and, as a result, the U.S. domestic industry continues to lose thousands of jobs annually due to unfair competition and inadequate enforcement of our trade agreements. 

The proposed U.S.-Korea FTA is a major issue for the U.S. textile industry.  In contrast to FTAs of recent years, the Korean FTA is the first agreement since NAFTA where the country in question has a large developed textile sector which exports significant amounts of textile products to the United States.  As a result, NCTO member companies have been carefully reviewing the textile portions of the agreement; however, the NCTO Board has not yet met to take a position on the agreement.

Industry Concerns

As an overall concept, the notion of an FTA with Korea has been problematic for the U.S. textile industry.  Since Korea is a large textile-producing country with a vertically integrated industry which has historically enjoyed extensive support from its government, NCTO members have repeatedly stated they do not expect significant new export business to be generated from an FTA.   In addition, portions of the U.S. industry are very concerned that an FTA could significantly harm existing U.S. business and trade flows, particularly from the CAFTA, NAFTA and ANDEAN regions. 

The Korean Federation of Industries confirmed these suspicions when it concluded that it expects Korean textile exports to increase by 25% or $400 million during the first year of the agreement.  The Congressional Research Service cites an ITC study[1] delivered to USTR before the negotiations began which concurred that Korean textile producers, not U.S. producers, are expected to be big winners if this agreement is enacted into law.

As a point of context, the U.S. textile industry has experienced large-scale plant closures and employment declines since the Asian currency crisis in 1998 and the resulting proliferation of undervalued government managed currency regimes throughout Asia, including China and Korea.  These sharp declines in Asian currencies, which average around 40 percent, have enabled Asian apparel prices to fall by 34 percent.  These artificially low prices have led to the worst crisis in the industry’s history. 

Furthermore, the removal of quotas beginning in 2002 only exacerbated the impact of these mercantilist currency policies.  As a result, over the last five years, U.S. textile mill production has fallen by one-third and U.S. textile employment by one-half.  

The U.S. textile industry is concerned that Korea, as a top supplier to the U.S. market in more than 20 textile and apparel categories (see Annex I), poses a real threat.  These concerns are magnified by the fact that Korea has a proven history of both dumping man-made fiber textile products in the U.S. market (as well as elsewhere) and of transshipping goods from China, a country with which it shares a common border and in which Korean textile firms have made significant investments.   Also, the development of large joint industrial zones with North Korea which offers a supply of labor reportedly even cheaper than Vietnam and which specializes in textile production, raise additional concerns for the U.S. industry. 

It is in this context that NCTO asked that sensitive textile and apparel products, including but not limited to products under safeguard with China, receive the maximum tariff phase-outs allowed in an agreement with Korea.  This request follows historic precedence. Tariff phase-outs in sensitive products under the NAFTA agreement were ten years long and covered 75 percent of textile tariff lines.  The phase-out period is particularly important as textile and apparel tariffs are relatively high and therefore the impact of tariff reductions needs to be spread out in as long of a timeframe as possible.  Unfortunately, as we will see, USTR chose instead to give Korea immediate duty-access to almost 90 percent of all textile and apparel tariff lines.

In view of South Korea’s history as a major transshipment center, NCTO also asked the government to include the strongest customs enforcement language possible as well as sufficient customs resources to effectively enforce the agreement.  Other key requests included a yarn forward rule of origin with no loopholes and the inclusion of a regional pocketing requirement.  I will now briefly review the textile results of the negotiations.

Textile Negotiation Results

Regarding the industry’s key requests, government was able to include a number of them.  These include a strict yarn forward rule of origin with no loopholes and strong customs enforcement language, which is an essential element in deterring illegal transshipments.  In addition, a limited textile safeguard[2] was included in the agreement.

Even with these elements, there remains widespread concern among NCTO member companies that a Korean FTA will, when fully in force, cause significant damage to the U.S. textile industry.  U.S. producers are particularly concerned about potentially damaging exports of Korean man-made fiber yarns and fabrics, knit fabric, socks, sweaters, shirts and trousers in addition to transshipments of many sensitive apparel items from China.  

This concern has several root causes.  These include overexpansion of the Korean textile industry by the Korean government which has resulted in the development of excess manufacturing capacity.  As a result, many Korean textile manufacturers now see a duty-free U.S. market as an inviting target for excess supply.  This concern is particularly strong in the man-made fiber sector which reports that Korean textile conglomerates frequently resort to predatory pricing in export markets.  In addition, the ability of South Korean textile conglomerates or chaebols to use their allies in the banking sector to absorb losses over long periods of time also raises concerns and appears to remain unaffected by this agreement.   

In addition, with intense competition in the global textile industry and the prevalence of very low margins, U.S. textile companies believe that the removal of significant U.S. tariffs (some as high as 25 percent) will mean the difference between some U.S. companies staying in business and closing their doors.  The fact that South Korea’s government practices a mercantilist currency policy which keeps the won at artificially low levels raises additional concerns[3].   

Also of strong concern is the likelihood that China, as well as manufacturers in the North Korean Kaesong industrial zones, will use the FTA to transship products duty-free to the United States.   Rigorous Customs enforcement lies at the very heart of free trade agreements, particularly in sectors such as textiles where unscrupulous importers can save hundreds of millions of dollars by evading duties. 

China’s ability to underprice garments made in the CAFTA, NAFTA and Andean regions, which the U.S. textile industry relies upon for the majority of its exports of its yarns and fabrics, has been well demonstrated in the past.  In categories where China has had quotas permanently removed, Chinese market has rapidly increased from around 10 percent to around 66 percent.  (The next highest supplier is Thailand at 3 percent.)  As a result, CAFTA, NAFTA and Andean market share has fallen by half or two thirds.  Despite importer claims that they will retain significant business in the CAFTA, NAFTA and Andean region for quick turnaround purposes, the truth is that this business represents only a fraction of the production currently being sourced out of the region.

Concerns Regarding Customs Enforcement

Industry concerns over whether Customs management has the willingness and determination to properly enforce textile agreements have been growing over the past several years.  Three years ago, the industry was stunned to learn that Customs had never hired the additional textile enforcement personnel for which money had been authorized and subsequently appropriated per the 2002 renewal of Trade Promotion Authority.   Customs apparent willingness to defy a Congressional mandate on textiles became a major point of contention during the DR-CAFTA debate and NCTO’s support for the DR-CAFTA agreement was not secured until after Customs agreed to hire the additional enforcement officers.

Unfortunately, Customs leadership is now in the process of reversing their CAFTA commitments.  Over the past nine months, leadership in Customs has taken active steps to de-emphasize textile enforcement.  These steps began late last year, when Customs transferred textiles out of its operation division and into an international trade office with a facilitation focus.  It did so without consulting with the U.S. industry and despite the fact that a similar step, tried six years earlier, resulted in such poor enforcement results that it was eventually reversed.  Customs appears to have a very short memory where textile enforcement is concerned.

More recently, Customs has taken steps which undermines its own enforcement mandate.  Leadership at Customs has announced that it has reduced resources available for textile detentions, seizures and special operations, despite Customs statistics which show that these activities are effective enforcement tools that uncover significant levels of fraud.  These activities, which have been the cornerstone of textile enforcement for decades, were the very reason the industry demanded that additional Customs personnel be hired.  At the same time, Customs has also halted its dissemination of textile enforcement results to the domestic industry. 

Customs retreat on textile enforcement is especially troubling in regards to Korea because Korea has been the target of serious Customs enquiries during the recent past and has been a major transshipment point from Chinese products since almost the time since China was first put under quota, over twenty years ago.  Last year U.S. Customs and Border Protection conducted two Special Operations – Seoul I and Seoul II – targeting Korea.  This was the first time the agency conducted two operations within the same year focused on the same country.  The agency was so concerned with the high levels of fraud and transshipment found during the first operation that it conducted another operation several months later.  

Textiles have the highest fraud rate of any industrial commodity, accounting for 40 percent of all commercial fraud and South Korea has proven to be an epicenter of such activity.  For Customs to pull back its commitment to the textile enforcement program on the eve of signing a new FTA with Korea sends an unmistakable signal to the domestic industry that textile enforcement will be minimal if this agreement becomes law.

Again, I cannot emphasize strongly enough how the recent actions by Customs to pull back from a proven and effective enforcement regime have raised serious concerns within the industry, particularly in regards to this agreement.  If textile manufacturers do not have confidence that effective enforcement programs will continue to exist in the future then even beneficial FTAs will lack value and importance for the industry.

Tariff Phase-outs Concerns

Regarding tariff phase-outs, the NCTO member companies were angered to learn that, contrary to past agreements, 87% of textile and apparel tariff lines, covering over 50% of 2006 trade were given immediate duty phase-outs.  Many sensitive textile and apparel lines were included on this list.  This was done despite the fact that USTR knew full well, both from USITC reports and from industry advisors, that Korea posed a real and immediate threat in these product areas.

To understand our dismay, imagine that you are a business and the U.S. government has just enabled one of your biggest competitors to cut prices 18% overnight.  This is exactly what happened if you make socks in this country.  Korea shipped $80 million worth of socks to the U.S. last year with duties averaging 18%.  On day one of this agreement, those duties go to zero.   How are U.S. companies going to adjust to this hit?  The answer is they can’t, they will simply close their doors and go out of business. 

Socks are not the only example.  An NCTO member company has invested heavily in producing sweaters in the CAFTA region made from yarns produced in the United States.  This is a success story for the entire region.  But on day one of this agreement, tariffs on those products go from 30% to zero – no transition at all – and he has already been told by his West Coast buyers that they will move their business to Korea once this FTA goes into effect.

This list includes many sensitive items for which the industry requested the longest possible tariff reductions.  These include sweaters, brassieres, swimwear, man-made fiber shirts, certain man-made fiber filament and staple yarns and fabrics (including elastomerics) and carded cotton yarn. 

In addition, while most (but not all) heavily traded lines in the China safeguard categories have longer phase-outs, 422 lines in these same categories get immediate duty phase-outs, thus creating an opportunity for Chinese transshipments in these sensitive categories to begin upon implementation of the agreement.  The safeguard categories that contain at some immediate duty-phase-out lines are:

            Sewing thread

            Knit fabric (includes high trade lines)

            Special purpose fabric

            Cotton socks (all lines)

            MMF socks

            Cotton knit shirts

            MMF knit shirts

            Underwear

            Wool suits (all)

            Cotton sweaters

            MMF sweaters (all)

            Cotton trousers

            MMF trousers

            Wool trousers (all)

            Swimwear (all)

            Fiberglass fabric (all)

In reviewing the impact of this free trade agreement, it is also important to understand how tariff phase-outs will work.  Duties on goods in Basket D are scheduled for a 5-year duty phase-out and goods in Basket G are scheduled for a 10-year duty phase-out.  In fact, these phase-outs will occur, respectively, during the first four and nine years the agreement is in effect.  With a five-year phase-out, the first 20 percent duty reduction occurs the day the agreement goes into effect.  A year later, the next 20 percent reduction occurs.  The net result is a 40 percent reduction in duties during the first 12 months.  Further reductions occur in equal installments over the next three years to completely eliminate the duty in a four-year period.  The same process applies with the 10-year phase-out:  there is a 10 percent duty reduction the day the agreement takes effect, with the next phase occurring 12 months later.  Duties are completely eliminated after nine years.

Other points of concern:

While the government did not allow goods from the Kaesong industrial zone to gain access under the FTA, the agreement allows for consultations with South Korea on future access.  Any such access would require additional legislation but, as the industry has seen occur time and again with “troubled” regions, Congress would likely grant access for North Korean industrial zones once there is a diplomatic breakthrough in the Korean peninsula.  As noted earlier, textile production is a major component of the Kaesong project and South Korea projects that over 300,000 workers will be operating in these zones within five years of an FTA passing.  Even if these zones were never granted duty-free access, the likelihood of significant transshipments from these zones into the United States remains.

Finally, government failed to include a rule requiring regional pocketing for trousers but instead is allowing pocketing from China and elsewhere to qualify.  This was a major point of contention for portions of the industry during the CAFTA debate.  In fact, the deciding votes in favor of the CAFTA agreement came from congressional representatives who received a commitment from USTR that the pocketing rule would be changed in the agreement to require regional pocketing.  This commitment is now more than two years old and the pocketing change has still not been made.  The result has been a sharp decline in U.S. pocketing production and employment as orders for these products have moved to China.

Conclusion

In conclusion, NCTO member companies are worried and concerned about a number of aspects of the Korean FTA and the impact it will have on an industry that is already under enormous pressure in the global marketplace, particularly by countries who refuse to abide by international obligations and pursue trade policies that destabilize global trade in this sector.

Principal concerns regarding the proposed U.S.-Korea FTA include a strong belief that Customs’ efforts to enforce this agreement will be minimal.  This concern arises from continuing actions by Customs leadership to reduce textile enforcement at a time when its textile enforcement responsibilities under the many free trade and preferential trade arrangements continue to expand.  Other major concerns include the vulnerability of key textile sectors to Korean dumped and undervalued goods, including a large number of sensitive textile products that were given immediate duty free access to the U.S. market.

Thank you for the opportunity to testify before you today.  I will be happy to respond to any questions you may have.

Cass Johnson

President, NCTO

910 17^th Street NW, Ste 1020

Washington, DC 20006

www.ncto.org

202-822-8025

cjohnson@ncto.org

Annex I:  Categories Where Korea is a Top Supplier to the U.S.[4]

Category	Description	2006 Imports	Market Share	Supplier Rank
0	All Textile, Apparel, and Made-Up	1,666 billion
12	Total Fabrics	$593 million	11%	#3
62	Total MMF Non-Apparel	$611 million	5%	#4
222	Knit Fabric	$203 million	27%	#1
224	Pile/Tufted Fabrics	$24 million	7%	#4