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Buyer responsibility and the crisis in Bangladesh

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Via VOX EU

The developing world faces a crisis like no other with COVID-19. Past disasters have arrived one country at a time, and generally large flows of foreign assistance from both government and private sources have followed (Yang 2008, Cavallo et al. 2013). COVID-19 has hit everywhere more or less at once. Foreign aid flows into any country are likely to be limited and inadequate. Governments of developing countries face a particularly grim calculus of reducing both deaths from the virus and despair from the economic shutdown. They face severe pressure on their own resources and need to leverage any source of funding they can find.

Countries in Africa and South Asia face the challenge with very limited fiscal resources. Taxes as a share of GDP are typically less than a third of European levels. The governments cannot replicate the socioeconomic support programmes that have been implemented in Europe and the US for many reasons, most importantly because they lack the resources.

In Bangladesh, the very modest programme of direct aid to households reflects this reality. The offer consists of a doubling of households eligible to purchase up to 5 kilogrammes of highly subsidized rice every week, and a one-time payment of 2,000 Bangladeshi taka (₤20) to 1.5 million households programmed for May.

In this environment, support for Bangladesh’s export-oriented garment sector is particularly important (Baldwin and Tomiura 2020): the sector employed over 4 million workers and accounts for around one-sixth of the economy, but most factories have been shut for April and face production disruptions in the near term. Support is feasible because the sector is made up of large, formal firms that have formal records of past wage payments.

Given the Bangladesh government’s very limited financial resources, the support programme relies on loans rather than grants. The aim is to use a solvency buffer in large factories and liquidity in the banking sector. But there is a catch. The scheme provides low-interest loans with a six-month grace period to factories to give them the liquidity to pay workers. The government will pay workers directly through electronic transfers, but these payments will accrue as loans to the factories.

The factories face a choice: take the loans to maintain employment relationships with their workers or take the lower-cost option of laying off their workers. Which will they choose? Whether they decide to pay wages or to make the smaller payments associated with layoffs will depend largely on how they see future demand, and, thus, what value they put on continued relationships with workers.

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It is clear that the success of the government’s wage-support programme also heavily depends on the actions of foreign buyers. Will they honour the contracts they have with their suppliers? Buyers have thus far taken different stances on payments to factories. Some, such as H&M and Marks & Spencer, have agreed to pay for orders that are ‘in process’. But many others have cited force majeure clauses and said they would not take any shipments or make any payments. Still others have agreed to make payments but at steep discounts of 30% – essentially paying the factory for the materials but none of the labour embodied in the products – or even 50%, meaning that factories are not even compensated for the full cost of the fabric used to produce the goods.

In the near term, all factories face the challenge of starting production while implementing social distancing (Boeri et al. 2020). Most are likely to address this concern by dividing workers into two shifts, halving the density in the factory. However, even after they are able to restart production, factories will find themselves in very different situations for two reasons.

First, ‘in process’ has different implications for different products. For factories producing woven products made from imported material, ‘in process’ means the material has been shipped, usually from a foreign supplier. These factories have as many as six to eight weeks of production in process. For integrated light knit (t-shirt) producers, the fabric is produced locally and much more rapidly. For such factories, in-process orders are limited to seven to ten days of production.

Second, a factory’s share of sales to buyers who have agreed to pay full price for work in process varies. In the near term, decisions of buyers will most certainly have the greatest effect on the scale of the pandemic’s humanitarian cost in Bangladesh. Will buyers pay for the work in process? If so, how much? Or, will they find ways to renege?

The intermediate term: Will factories and employment relationships survive?

In-process orders are only a part of the uncertainty that factories face. There are additional risks in both the intermediate and longer terms. In the intermediate term, it is unclear how long the lockdowns will last in the consumer countries that buy these goods and how quickly demand will rebound as those economies restart, and whether the factories will face other supply-chain disruptions (Inoue and Todo 2020).

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There is also uncertainty about how long the lockdown in Bangladesh will last, and whether factories will be able to enforce enough social distancing to safely reopen. Even with the liquidity provided by the government wage-support programme, many factories will face financial constraints within a few months.

This is unlikely to be a pure Schumpeterian, survival-of-the-fittest process of weeding out the weakest firms. Consolidation of production has taken place in Bangladesh in recent years, with the most efficient firms expanding production. These expansions have left even some of the most productive factories financially leveraged and therefore fragile. Most are likely to survive some months without substantial revenues, but they may not survive much longer. While government loans cover continued wage payments to workers, such loans don’t cover other costs.

The longer run: The Zara model does not mean the end for Bangladesh’s ready-made garments sector

In the longer run, uncertainty comes from the possibility that brands adopt the Inditex (Zara) model. With the aim of better matching production to demand, Inditex (Zara) produces a large share of its fastest fashion products in Europe or very nearby. Starting with small quantities of many styles, Zara is able to very quickly restock those styles that prove to be popular with consumers while avoiding investment in inventories of styles that prove to be less popular.

Over the past several years, other brands have aimed to reduce inventory levels without shifting the location of production. Brands sourcing from Bangladesh have decreased order sizes and shortened delivery windows. These practices have increased pressure on suppliers while leaving a lot of product in the supply chain. The COVID-19 crisis is likely to increase the urgency for brands to adopt the Zara model more completely, including a movement toward reshoring, or more likely, near-shoring.

But even Inditex uses Bangladeshi factories to supply a large amount of product, mostly the more stable and predictable styles. Inditex is among the ten largest buyers from Bangladesh’s ready-made garments factories. Other brands adopting the Zara model may shift production in Bangladesh away from fast fashion to more stable fashion, but it is not clear how much this will reduce overall demand from Bangladesh. Brands vary in the share of their products that are seasonal or fast-fashion styles and those that are more stable. Some brands, such as H&M, have a very high share of sales in seasonal, fast-fashion wear; others, such as Levis, have a much smaller share.

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The constraint to Bangladesh’s growth in recent years has been more on the supply side than the demand side. China still produces more than a third of global garments exports. Wages in China are around three times those in Bangladesh, while labour efficiency is perhaps 1.5 times as high. Thus, the immediate loser in the spread of the Zara model is more likely to be China than Bangladesh.

Unwinding backwards

Brands are, of course, under severe financial stress themselves. It is natural to retrench to short-term thinking in this environment. But brands should realise that Bangladesh will be an important sourcing country even if buyers move the fastest fashion part of their production to near shore. That gives them an interest in maintaining relationships with factories beyond the moral imperative they may feel in the present circumstances.

Their decisions – on payments for orders in process and on providing clarity to and support for their supplying partners – are at the top of a chain of decisions that will have a very large impact on the extent to which the health crisis escalates into a humanitarian crisis.

References

Baldwin, Richard, and Eiichi Tomiura (2010), “Thinking ahead about the trade impact of COVID-19”, Economics in the Time of COVID-19, VoxEU eBook.

Boeri, Tito, Alessandro Caiumi and Marco Paccagnella (2020), “Mitigating the work-safety trade-off”, CEPR Covid Economics 2: 60–6.

Cavallo, Eduardo, Sebastian Galiani, Ilan Noy and Juan Pantano (2013), “Catastrophic natural disasters and economic growth”, The Review of Economics and Statistics 95(5): 1549–61.

Inoue, Hiroyasu, and Yasuyuki Todo (2020), “The propagation of the economic impact through supply chains: The case of a mega-city lockdown to contain the spread of Covid-19”, CEPR Covid Economics 2: 43–59.

Yang, Dean (2008) “Coping with disaster: The impact of hurricanes on international financial flows, 1970–2002”, The BE Journal of Economic Analysis & Policy 8(1): 1–45.


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