The production process and international marketing

10. Lesotho’s textiles sector is dominated by the ready-made garments industry, which is divided into two distinct segments: factories producing garments manufactured from woven cloth (including denim jeans) and those producing garments manufactured from knitted cloth. One major factory producing fabric (jeans) has also emerged in 2003. Activities in ready-made garments are usually divided into cut, make, and trim (CMT). Consistent with the global trend to relocate labor-intensive operations to low-cost countries, only physical manufacturing takes place in Lesotho. Head offices overseas take care of design, sampling, purchase of raw materials, marketing of products, and financing of the operations.

11. The first stage of the production process is sampling and cutting the raw materials against specific orders. The next stage is printing or embroidery, if required; this is either done in-house or sent to subcontractors. The cut work is then loaded into the sewing floor. In the final stage, the garments will either receive a wash treatment, if needed, or they will be sent directly to pressing and packing. Most jeans require specialized washes to give them the desired finish. They are then sorted according to their orders and packed in cardboard cartons for transportation and shipping.

12. Sufficient orders are needed for uninterrupted production. More than 90 percent of Lesotho’s textiles exports are directed to the U.S. market, and there are two major sources of orders for that market: those placed directly by major brands and retail stores and those placed by direct importers. The major brands and retailers usually have their own design and range development departments, which produce technical specification sheets for each garment to be purchased. These “tech sheets” specify the quantities, size breakdown, delivery date, fabric, trims, seam measurements, tolerance measurements, printing, embroidery, washing, and packaging, as well as a host of other data.

13. Selling prices are determined on the basis of quotations provided by manufacturers in different countries and the technical specifications of the product. Reliability factors based on past relationships and loyalties also play a critical role. The overseas holding company, which owns the factory in Lesotho, has the full information on raw materials, labor, and overhead costs of all its manufacturing operations and usually quotes the price of garments produced in Lesotho.

14. In 2002, the structure of Lesotho’s textiles sector was as follows: (i) four company groups made denim jeans and employed about 11,000 people; (ii) nineteen company groups were manufacturing knit garments and employed about 18,500 wage earners; (iii) four company groups manufactured a mix of woven and knit garments and employed 2,200 employees; and (iv) two companies were pure service providers, supplying printing and embroidery services. All companies were foreign owned, and FDI played a key role in the establishment and growth of the industry.

Trends in FDI and its role in the development of the subsector

15. Lesotho does not possess the usual location advantages to attract FDI. It is landlocked, of small size, and with a relatively underdeveloped infrastructure. Lesotho has, however, been successful in attracting sizable inflows of FDI, due to the preferential market access as well as government efforts and investment promotion activities undertaken by the Lesotho National Development Corporation (LNDC). FDI flows jumped in 1994 and peaked more recently in 2001–02. FDI inflows have been concentrated in export-oriented textiles manufacturing and activities related to the Lesotho Highlands Water Project (LHWP). Foreign entrepreneurs have been instrumental in setting up the textiles industry in Lesotho. Of a total of 40 textiles factories in 2002, owners of 26 were based in Taiwan Province of China, and another four had their headquarters in Hong Kong, China (mainland), and Singapore.

16. About 90 percent of the FDI has gone into export-oriented garments manufacturing, but firm estimates are not available. According to the UN Conference on Trade and Development (UNCTAD), inflows of FDI excluding LHWP related investment were relatively stable at low levels through most of the 1980s with a peak of US$21 million in 1988 (Figure I.2). A surge occurred in 1994, when FDI reached US$41 million, mainly because of investment in the garments sector. After having remained relatively stable during the second half of 1990s, the flows have peaked again during 2001–2003 as a result of trade preferences awarded under AGOA. It is estimated that FDI created 14,000 new jobs in 2001 alone. Beginning in 2001 a Taiwanese investor has started the largest single investment project in the textiles sector estimated at about US$90 million over three years, thereby adding about 5,300 people to the workforce.

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Lesotho: FDI-and LHWP-Related Inflows, 1988-2000

(millions of U.S. dollars)

Citation: IMF Staff Country Reports 2004, 023; 10.5089/9781451823752.002.A001

Source: UNCTAD (2002).

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Preferential market access: ACP-EU agreement, AGOA, and the ATC (Agreement on Textiles and Clothing)

17. Preferential market access provided under trade arrangements with the EU and the United States is the critical factor that has determined the flow of FDI into the garments sector. In addition, the global quota regime under the MFA has also influenced the evolution of the industry. These trade agreements and the nature of market access are summarized below:

Infrastructure and the domestic business environment

24. Domestic incentives–like infrastructure, proximity to South African ports, fiscal incentives, and a well-organized workforce–also played an important role in the development of the textiles sector. Industry representatives and LNDC officials noted, however, that some of these factors had now begun to pose constraints to further growth:

• Legal framework for FDI. Lesotho’s FDI policy and legal framework are weak. A foreign investment law and, with one exception, foreign ownership restrictions in sectoral licensing laws are missing. In practice, the government has promoted FDI in manufacturing activities, including the textiles sector. ⁴ Foreign investors are treated the same as national investors in most areas. A clear and major exception is the treatment of land leases. Only Lesotho citizens and commercial entities that are majority controlled by Lesotho citizens may lease land. Foreign investors may only sublease land from Lesotho citizens. All transactions in leases and subleases, including issues, transfers, and mortgages, require ministerial approval.

• Factory shells, land, and water. The LNDC has provided factory shells and utilities in the industrial estates, which has helped to develop the industry. However, because of the spurt of growth in recent years, the shortage of serviced factory shells and water supply is now constraining the expansion. To address this problem the LNDC has begun building additional industrial estates with factory shells. It has also facilitated land transfers to the denim mill company and a few other companies that are willing to build their own factory sites. Water is, however, a major constraint. The poor supply of groundwater and lack of adequate funds for investment have prevented the water company from expanding its network to new industries.

• Container facility. Severe capacity constraints at Mascon (Maseru Container Terminal) have emerged as the key constraint on the timely movement of raw materials and finished products. Expansion and development of the facility require sizable investment, which the private sector is willing to undertake only if appropriate land and property rights are provided.

• Labor costs, labor markets, and regulatory environment. All industry representatives cited labor costs, minimum wage regulations, and constraints on hiring and firing of workers as major problems. Every year, the industry is engaged in tripartite wage negotiations with the trade unions, which is both a time-consuming and difficult exercise. In addition, expatriate employees have difficulties in obtaining work and resident permits that are valid beyond three months.

Impact of the phasing out of AGOA 1

26. Under AGOA, Lesotho has LDC status, which enables it to sell all products duty and quota free to the United States, while non-LDC countries pay duties averaging about 17 percent, and to procure inputs without restrictions until and including 2004 (AGOA 1). In the second phase (AGOA 2), from 2005 to 2008, Lesotho’s garments industry will still be allowed to sell its products duty and quota free to the United States, but it must purchase its inputs locally, from the United States or from other qualifying SSA countries, including South Africa. It is possible that AGOA 1 could be extended beyond 2004, even though there is no indication that the United States authorities will do so.

27. The time-bound nature of AGOA 1 has provided incentives for Lesotho’s textiles industry to integrate backward. One company has set up a denim mill, at a cost of about US$90 million over three years, which is expected to be fully operational in early 2004. The mill is expected to produce about 2 million meters of fabric a month out of a total demand in Lesotho estimated at 2.5 million meters a month. Another company has acquired a denim mill in KwaZulu Natal, South Africa, with a current capacity of 600,000 meters a month, which it will be eligible to use under the AGOA preference system.

28. The situation is more worrying in the knitted garments segment of the industry, which employs about 60 percent of the garments industry workforce. Some industrialists have stated that they would leave Lesotho if the advantages under AGOA 1 were lost, while others have discussed plans to manufacture knitted fabrics if the need should arise. A knitted fabric mill is smaller than a woven fabric mill, and the time span required for an investment is shorter. The industrialists are, therefore, in a position to defer any decision to set up knitted mills until they know the outcome of the negotiations to extend AGOA 1.

The impact of elimination of quota under the ATC

29. The elimination of ATC quotas, beginning in January 2005, is a potent threat to Lesotho and other smaller textile exporters. If current country-specific quotas are withdrawn, an influx of T&C exports from low-cost producers in China and South Asia will pose a competitive threat to small producers. Countries like Lesotho will face stronger competition, even if the AGOA tariff preference in favor of LDCs remains.

30. At the same time, Lesotho’s tariff advantages will probably be eroded through new rounds of WTO talks, as United States and other major importers are expected to reduce their average level of tariffs on textiles products. It is not clear what kind of safeguards will be in place to prevent large exporters like China and India, from dominating the export market. Possible impacts are as follows:

• Removal of ATC quotas on yarn, fabrics, and clothing (ready-made garments) will open up international markets and expose exports from developing countries to increasing competition from countries that produce efficiently have large export capacities, and fully utilize their current quotas. Major competitors in different lines of production are as follows: (i) for yarn, India and Pakistan; (ii) for fabrics, East Asia (Malaysia, Thailand, Korea, and Hong Kong); and (iii) for clothing, China, India, Bangladesh, and Pakistan.

• Elimination of quotas—which have provided guaranteed market access for small and less efficient producers—will open markets to more efficient and larger suppliers that have filled their previous quotas. Countries (or product lines) that have been facing more binding quota restrictions will become more competitive, while those that have been less restricted by quotas may find it difficult to maintain their current market share.

31. Simulations by IMF staff indicate that the removal of MFA quotas would have a sizable negative effect on exports of Southern Africa Customs Union (SACU) countries. As much as one-fifth of the export of T&C could be eliminated, while the negative welfare impact would be about US$200 million. The information is not detailed enough to assess the possible impact on Lesotho, but industry representatives have indicated that profit margins are thin. A comparison of wages, which is a major cost element, shows that Lesotho is better placed than some countries in the region, but Lesotho’s wages are higher than in Asian countries like Bangladesh and Indonesia (Table I.5). More critically, these countries have less stringent labor laws that allow significantly longer working hours and set few limits on minimum wages, overtime, and the hiring and firing of labor.

Table I.5.

Wage Comparisons in Selected Competitor Countries

Source: World Bank (2003).

Table I.5.

Wage Comparisons in Selected Competitor Countries

Country	Wages per Hour (In U.S. cents)
Lesotho	27
Bangladesh	13-20
Indonesia	20
China	30-60
Kenya	29
Mauritius	63
South Africa	93
United States of America unregistered factory	300-400

Source: World Bank (2003).

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Table I.5.

Wage Comparisons in Selected Competitor Countries

Country	Wages per Hour (In U.S. cents)
Lesotho	27
Bangladesh	13-20
Indonesia	20
China	30-60
Kenya	29
Mauritius	63
South Africa	93
United States of America unregistered factory	300-400

Source: World Bank (2003).

Measures to improve competitiveness and promote diversification

32. To promote diversification into new product lines (within and outside the T&C industry), Lesotho must implement a systematic strategy to reduce production costs and improve its global competitiveness. Several elements are important:

• In the area of infrastructure, there is a need to provide land rights (long-term lease) to foreigners so as to attract private investment in infrastructure. In addition, a sizable up-front investment to expand water supply will pay off.

• There is a need to introduce more flexibility in the labor market and to improve the regulatory environment governing employment and investment. In particular, more flexibility in setting minimum wages without the use of centralized tripartite negotiations and a relaxation of hiring-and-firing rules may help the industry to cope with the competitive pressure.

• Industry representatives welcomed the recent liberalization of the foreign exchange regulations and capital account, in particular the relaxation of rules allowing Lesotho residents and nonresidents alike to hold foreign currency accounts in banks.⁵

• It was also suggested that selective time-bound fiscal incentives could be provided to promote few sectors/product lines in which Lesotho has a comparative advantage. Developing credit institutions and marked based instruments to improve access to finance while reducing its cost can also help diversify the export and production base of Lesotho.

• Diversification into higher grade products within textiles, into other products within light manufacturing (leather and footwear, consumer electronics, furniture and agro-processing), and diversification to other markets such as SADC will strengthen the industry’s position in a competitive global market. This hinges on public policy to improve infrastructure and utilities, strengthen property rights, flexibility in the labor market and developing formal credit institutions noted above as well as simplifying regulations and facilitating the development of technical and entrepreneurship skills. Proactive measures, such as public-private initiatives in training, are needed to promote diffusion of skills from the export sector to the rest of the economy and create institution for vocational/technical training.⁶

33. Recent trade initiatives may favor Lesotho and other countries in the region. Lesotho is likely to benefit from the ongoing negotiations of a free trade agreement (FT A) between the U.S. and the SACU countries, which is expected to be concluded in 2004 and become operational in 2005. The FTA will allow duty-free access of potentially thousands of product lines to the U.S. market, thus providing a great opportunity for export diversification. Lesotho should also gain from EU’s Everything-But-Arms initiative, once the rules of origin are made clear. To seize the opportunity, Lesotho and other regional countries must improve their investment climate in order to attract sizable FDI in new product lines within the T&C industry, as well as in new industries.