While in Shanghai recently, I met with a friend to discuss the current state of the Chinese textile industry. Although he was generally positive about China’s textile industry overall, our conversation turned to the spinning sector–which he held in low regard.
He explained that labor was the biggest single cost for China’s spinning sector today. I found that interesting, but puzzling. Although there have been numerous press reports about rising costs in China, I thought the cost of cotton had a more significant impact on the cost of Chinese yarn.
My friend corrected me: “The price of cotton or polyester is important, but the cost of labor is even more essential to the final cost of Chinese yarn. In ten years, the average worker in a Chinese textile mill has seen his salary go from 250 RMB ($40) per month to more than 2,500 RMB ($402), but what makes this even worse for spinners is that they employ way too many people. Their efficiencies are very bad,” he said.
As I reflected on my friend’s observations, I began to better understand his point. There may have been a five-fold increase in the cost of labor, but when I considered the industry’s penchant for over-employment and expansion of unnecessary capacity, my friend’s observation became prescient. Government policies play a role as full employment continues to be a key goal of Chinese industrial planners. In fact, the more I thought about it, the more it made sense. I have visited dozens of spinners throughout China over the years and found the same things in common from mill to mill–many spinning frames were idle and lots of workers were standing around with little to do. I remember one mill in particular, where the workers moved the same boxes in fork trucks back and forth from one side of the mill to the other and back again for hours every day. So much efficient employment! I guess it is fair say that Chinese spinners are at a disadvantage to mills elsewhere–but there is more to the story.
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To discuss the global textile market is to discuss China’s textile industry. China’s industry is such a large portion of the global market that, plainly put, the global industry goes the way of China. If China’s textile industry struggles so will global textiles and all suppliers in that industrial chain, but this will also provide opportunities and challenges for producers elsewhere. Chinese companies understand competitive pressures better than anyone, however, government employment policy saddles spinners with excessive overhead costs and to make matters even worse, cotton policy skews domestic production, keeps domestic prices artificially high, and limits the amount of cotton that may be imported at any one time. In doing so, Chinese government policy pits the fortunes of cotton farmers against those of spinners. What results is an inefficient, barely profitable industry.
The local spinning sector is large, but its problems make it vulnerable to more nimble producers. To place China’s industry in perspective, it is the dominant producer of yarn in the world today. Whether measured in terms of short or long staple capacity, or in terms of open-end rotors, the Chinese industry accounts for at least a quarter of global capacity.
A vestige of state-run missteps, China’s yarn sector has struggled in recent years to upgrade the quality of its production and to price its products more competitively. Over-capacity continues to plague the sector, yet despite its size, the industry continues to lose ground to competing industries in countries such as India and Pakistan, which remain far more profitable. The last global downturn underscored the weaknesses of the industry. Moreover, the great challenge for producers in China and around the world remains sinister: What happens if the global economy falls back into recession? Would Chinese spinners be able to compete with mills in Vietnam, Indonesia, Bangladesh, India, Pakistan or elsewhere, if they were forced to slash prices just to keep pace in a declining global market? And, if China decided to slash prices, what would be the impact to other competing nations considering China stores huge inventories of cotton?
Other factors impact the efficiency and profitability of the sector. Most importantly, Chinese government policy regarding the importation of raw cotton, which not only artificially hikes the price of domestically produced cotton, but limits the amount of cotton that can be imported at any one time and skews the trade in favor of imported yarn from other countries while Chinese weaving and knitting mills look elsewhere for more competitive yarn.
As a result, domestic yarn spinners are squeezed on price from both above and below in the supply chain.
Spinners are forced to purchase high-priced domestic cotton, while being restricted from importing cheaper foreign cotton to help offset their cost. At the same time, Chinese weavers and knitters freely import low-cost yarn from elsewhere. Ironically, this squeeze has propelled some spinners to move out of China entirely in favor of places like Vietnam, Bangladesh and Cambodia where labor costs are lower, the Chinese market is easily serviced and foreign cotton can be imported as needed. China does not export much yarn these days, but it is exporting its yarn at a steady pace.
There is an additional factor that impacts the yarn business in China: over-capacity of man-made fibers. For example, polyester staple capacity utilization in China has dropped to just 70 percent. The fiber industry typically considers 80 percent utilization to be break-even, so the current utilization rates, which have fallen steadily in recent years, indicate that the industry as a whole is not profitable.
Indeed, lower utilization rates translate into lower prices thus helping the cost structure for many Chinese spinners, but locking out higher quality yarns made with cotton, which increasingly have to be imported by knitting and weaving mills.
Needless to say, it is challenging to be a textile mill in China today. The combination of the weak domestic yarn sector coupled with the inability to import unlimited amounts of cheaper cotton from around the world at will has placed many Chinese weaving and knitting mills at a competitive disadvantage in global markets.
Additionally, Chinese textile companies are faced with downward price pressures from local garment companies, which is the result of weaker demand for Chinese apparel overseas and higher labor costs at home. Due to these various factors, Chinese knitters and weavers have little choice but to import greater and greater quantities of yarn from Pakistan, India and elsewhere. There are no restrictions on the import of yarn, import tariffs are relatively low and imported yarn tends to have a better balance between price and quality than much of the domestically produced yarn. However, here is the rub for Chinese spinners: as more yarn is imported, sales of domestically produced yarns fall and margins are squeezed even further. The last recession reduced some inefficient capacity, but more still exists.
Many of China’s weavers and knitters rely upon the Indian spinning sector, an industry plagued by its own problems and inefficiencies. India’s spinning industry specializes in finer yarn production. Other spinners in countries such as Pakistan and Bangladesh are more proficient in the production of coarse count yarns. Even so, the Indian spinning industry has become large, yet its growth has largely occurred due to an expanding export business, particularly with China. Many Indian spinners are nearly as inefficient as China’s, but they do not have the handicaps with which Chinese spinners operate. Of course, Indian government efforts to restrain yarn exports, at times, disrupts the trade but those actions have always been temporary; in China, government actions are self-perpetuating. Nonetheless, the Indian spinning sector has expanded at a time when the rest of India’s textile industry has struggled. When compared to the weaving industry, the number of installed spindles has grown by nearly 30 percent since 2005, while the number of looms has declined by a similar percentage.
Chinese spinners do not control their own destiny. Despite being the largest single producer of yarn in the world, the Chinese spinning industry has to contend with government interference, high domestic cotton costs, limited import options and skittish customers. All of these factors combine to result in a weak link in an otherwise robust Chinese textile supply chain. Increasingly, domestic customers of Chinese yarn are turning away to foreign suppliers to meet their needs. This trend will only continue and will result in a diffusion of spinning around the away from China. Concurrently, many Chinese textile firms have made investments in countries such as Vietnam and Cambodia. Free trade agreements between ASEAN countries and China have also made it easier for Chinese companies to relocate their production to other countries.
And there is another factor to consider: China’s huge stocks of cotton. The handwringing in the cotton business over the fate of the country’s huge cotton reserves–which, according to some estimates, could be as large as half of annual world cotton production–is pervasive. This adds another layer of uncertainty in the global market. Will the government dump the cotton at a loss? What about all of the old cotton still in warehouses? Will that be discounted? How will this inventory be liquidated and when?
It’s not likely that the Chinese government will dump their inventories all at once, nor will they determine that disrupting the global markets is in their best long-term interest. Much of the cotton held in the reserve is high-priced and any liquidation will result in steep losses. However, losses may not be of highest concern for Chinese officials.
Another question needs to be asked: Why did the Chinese government buy so much cotton in the first place? Simply put, the government craved stability. A chief motivator of Chinese government decision-making is fear of civil unrest. The government bought up low quality Chinese domestic crops, while importing vast quantities of higher-quality cotton to the United States, Australia, India and elsewhere. Domestic purchases gave price guarantees to local farmers, while the textile industry enjoyed access to foreign varieties. Farmers, in turn, especially in more restive sections of the country, remained calm and satisfied with a consistent customer for their products, while the textile industry expanded employment.
Further, food security is more important to Chinese officials than cotton security. It took time for the government to establish the incentives and means by which China’s farmers could be encouraged to switch to foodstuffs. In parallel, eventually China’s rapidly growing economy would leave its textile roots behind in favor of more attractive business opportunities in shipbuilding, aerospace, technology and other value-added industries. As such, the days of the textile industry’s preeminence in the Chinese economy are numbered. The first such erosion of China’s textile industry is found in its weakening yarn sector. Rising labor costs in apparel cut and sew have also placed the overall industry supply chain under added pressure, opening the door for producers in other countries to undermine China’s traditional advantages in textiles.
For sure, there’s a changing market for cotton yarn in Asia. India has built an industry around servicing the export market, particularly China. Bangladesh, Vietnam and Pakistan have also sliced out sizable roles in the market. But, there are other players entering the market that, as recently as five years ago, could never have carved out a segment in the greater Chinese market, let alone the world market. Lo and behold in 2009, the U.S. exported about $500 million worth of cotton yarn to greater China; in 2013, exports soared to $850 million, a 70 percent increase. The U.S. has enjoyed a fairly robust export business in the Caribbean and Mexico—but in the latest “US Export Market Report” published by the Office of Textiles and Apparel (OTEXA), mainland China was the second largest destination for U.S. cotton yarn exports after Honduras.
How times have changed! A new world beckons.
By Robert P. Antoshak
Managing Director
Olah Inc.