NAFTA: The Textile and Apparel Sector

Eric Barry and Elizabeth Siwicki Canadian Textiles Institute

Two Different Industries

ANTICIPATING THAT "TEXTILES" ISSUES WOULD be contentious, the three NAFTA participants established a separate negotiating group to deal with them. In the negotiations, the term "textiles" is a broad label covering issues affecting both the textile manufacturing industry and the clothing manufacturing industry. This verbal shorthand blurs the fact that these are different industries with different economic characteristics and structure and that "textile" negotiations can affect them in different ways. The textile manufacturing industry includes producers of man-made fibres plus producers of yarns, fabrics, and textile products. The clothing manufacturing industry produces clothing. Statistics Canada's Standard Industrial Classification groups textile manufacturers under SIC 18, Primary textiles industry; SIC 19, Textile products industry; SIC 3257, Motor vehicle fabric accessories industry. Clothing manufacturers are in SIC 24, Clothing industries.Note

Canada's textile manufacturing industry has been transformed in the last 15 years. The key to its transformation has been substantial and sustained capital investment which has made it modern, efficient, decreasingly labour intensive and increasingly capital intensive, with rapidly growing productivity and better than average profitability. Industry, Science and Technology Canada 1991, Industrial Competitiveness; A Sectoral Perspective: Textiles, p. 111-118.Note

Shipments by Canadian textile manufacturers in 1989 were over $7.7 billion, making it the largest year in the industry's history. While shipments have declined since then because of the recession, the industry is well positioned to participate in the economic recovery.

While much new technology has appeared in clothing manufacturing, it is still essentially a labour intensive industry with relatively low capital investment.

Key statistics on both the textile and clothing industries are presented in table 1.

Click here to view Table 1: Key Statistics

As might be expected, the U.S. textile industry is a bit more than ten times the size of its Canadian counterpart. Shipments by American textile manufacturers in 1991 were valued at US$64.1 billion. Similarly, estimated shipments by U.S. clothing manufacturers in 1991 were valued at U.S.$52.9 billion.

The size of the Mexican textile industry is more difficult to gauge. An unpublished report by a leading consulting firm has estimated the value of 1988 shipments to be approximately Can$3 billion expressed in constant 1980 Can$ or about half of 1988 shipments by Canadian textile manufacturers measured the same way. No estimate was made of the value of Mexican clothing shipments.

Textile and Clothing Trade

Table 2 presents an overview of Canadian trade in textiles and clothing in 1991. Imports are substantially larger than exports for both industries but there is an important difference in import sources.

Click here to view Table 2: Canadian Textile and Clothing Trade Data Overview (1991)

In value terms, about 73 percent of textile imports come from developed countries (56 percent from the U.S. alone) with 27 percent coming from developing or "low-wage" countries. By contrast, nearly 80 percent of clothing imports come from developing countries and only 10 percent from the U.S.

Again in value terms, textile manufacturers export three times as much as clothing manufacturers with 64 percent of textile exports and 86 percent of clothing exports going to the U.S.

Trade with Mexico has been tiny. In 1991 only 1 percent of textile imports originated in Mexico and over half of these entered Canada duty-free. Only 0.5 percent of clothing imports came from Mexico. Textile and clothing exports to Mexico were even smaller.

Imports of textiles into the U.S. in 1991 were US$7.3 billion. Textile imports account for a much smaller proportion of the U.S. market than is the case for textile imports into Canada. Textile imports from Mexico into the U.S. for the same year were US$206 million or 2.8 percent of all imports. With U.S. 1991 textile exports to Mexico totalling $536 million the U.S. enjoyed a positive textile trade balance with their southern neighbour.

Imports of clothing into the U.S. in 1991 were US$27.7 billion and occupied a share of market roughly similar to that occupied by clothing imports into Canada. Clothing imports from Mexico were only 2.4 percent of the U.S. total.

The Canada-U.S. Free Trade Agreement

It became apparent very early in the NAFTA negotiations that the Americans were taking advantage of them to renegotiate the FTA rules of origin for textiles and clothing. Therefore, a brief review of these is essential background for what happened in NAFTA.

The American textile and clothing industries opposed the FTA. The price they exacted from their government for their forced participation was a set of rules of origin designed to limit the use of third-country inputs in textiles and clothing that would qualify for FTA rates of duty.

For example, a fabric can be woven, dyed and finished in Canada but will not qualify unless it is made from Canadian or American yarn. Similarly, a garment can be cut and sewn or otherwise assembled in Canada but will not qualify unless it is made from Canadian or American fabric. Of course, the same rules apply to U.S. textile and clothing manufacturers. A more detailed comparison of the FTA rules of origin and how they were changed in NAFTA is presented later in this chapter.

Canadian textile and clothing manufacturers rely more on inputs from the rest of the world than do their U.S. competitors. In partial recognition of this, the FTA included exceptions to the rules of origin in the form of three tariff rate quotas or TRQs. These permit non-wool fabrics made from imported yarns or apparel made from imported fabrics to be exported to the U.S. at FTA rates of duty subject to the following annual limits:

•For non-wool fabrics and made-up textile articles (such as sheets or towels) up to 25,083,900 million square metre equivalents

•For non-wool apparel up to 41,806,500 million square metre equivalents

•For wool apparel up to 5,016,780 million square metre equivalents

There are important differences in the relief provided to the Canadian textile and clothing industries by these TRQ exceptions.

First, the review mechanisms are different. The non-wool fabrics and made-up textile articles TRQ provides for a review of its "quantitative elements" before the end of 1992, while the two apparel TRQs remain in place at least until the end of the FTA transition period or January 1, 1998. Second, the fabrics and made-up textile articles TRQ level was set at a fraction of actual export levels, while the apparel TRQs represented a multiple (about six times) of apparel exports at the time.

The rates at which the TRQs have been utilized tell the story (see table 3). Textile manufacturers have heavily utilized their TRQ.

Click here to view Table 3: TRQ Utilization

Clothing manufacturers, on the other hand, have not heavily utilized the non-wool apparel TRQ so that their ability to import non-FTA fabrics, make garments, and export these garments to the U.S. at FTA rates of duty has not been impeded at all. Clothing manufacturer usage of the wool apparel TRQ has been heavier although even in this area nearly half of the quota remains unutilized.

Different NAFTA Positions

The Minister for International Trade was advised in September 1990 by the Canadian Textiles Institute that, if NAFTA was to happen, the textile industry and Canada needed to be part of it.

The textile industry did not perceive any short term threat or advantage stemming from free trade with Mexico but quickly reached the view that it was in its best long-term interests to participate in a trilateral NAFTA agreement. In September 1991, the Canadian Textiles Institute sent a detailed confidential submission to the International Trade Minister setting out the industry's NAFTA objectives.

The textile industry perceives its major challenge to be adjusting to the Canada-U.S. Free Trade Agreement. As the NAFTA negotiations got underway in late 1991, it became clear that the U.S. move to make the FTA rules of origin even more restrictive would impair the Canadian industry's access to the U.S. market. Canadian efforts to resist these U.S. initiatives, which were being supported by Mexico, were limited by our lack of negotiating leverage. Once it became obvious that the rules would be the way the Americans and Mexicans wanted them, Canada's efforts focused on seeking "compensation" in the form of expanded and extended tariff rate quotas.

The clothing industry took a different view which is best summed up in the official position of the Canadian Apparel Federation which opposed the U.S. demands for changes to the FTA rules of origin and urged the government:

. . . to pursue a triangular strategy for textiles and apparel in the North American Free Trade Negotiations, by signing a bilateral agreement with Mexico, and keeping the provisions of the Canada-U.S. FTA, with some modifications Canadian Apparel Manufacturer, September/October 1992, p.10.Note . . .

Canadian officials raised the possibility of a triangular approach for apparel at the negotiating table, but very much as a "last resort," preferring instead to continue to pursue a mutually acceptable trilateral agreement. The broader view was and remains that both industries are better off "in" the NAFTA agreement than "out" of it given the integration of the North American market and future prospects for an expanded "hemispheric" free trade area.

The end result was an agreement that makes everyone at least a little unhappy. This, at least in the trade policy bureaucracy, appears to indicate a successful negotiation.

The deal as it applies to textiles and apparel is complex and must be assessed not by looking at each of its specific elements, but, rather, by looking at the overall "package." For each sector, and for each partner, there are good things and there are bad things, but it is the balance of what has been achieved that is relevant.

The following pages describe the key NAFTA provisions applicable to textiles and clothing and highlight some of the areas where these differ from the FTA.

Rules of Origin and Tariff Preference Levels (TPLS)

The NAFTA rules of origin applicable to textiles and apparel are spelled out in detail in Annex 401 of the text. The relevant section is "XI: Textiles and Textile Articles" (HS "HS" refers to the Harmonized Commodity Description and Coding System (Harmonized System).Note Chapters 50-63).

While most importers and exporters would consider the Tariff Preference Levels (TPLs) (explained and described in more detail later in this chapter) an integral aspect of determining which goods do or do not qualify for NAFTA rates of duty, these TPLs are actually described and itemized in an Appendix to a separate section of the text, "Annex 300-B: Textile and Apparel Goods," which is part of NAFTA Chapter 3.

Rules of Origin

Textiles and textile articles qualify for NAFTA rates of duty if they undergo specific manufacturing processes which are described by reference to a change in HS classification. Importers or exporters simply look up the HS heading or sub-heading under which the goods in question are classified to find the applicable rule.

Here is a simplified summary of the rules governing some commonly traded textile and apparel goods, along with an indication of where TPLs apply. The term "domestic" is used to denote materials produced in Canada, Mexico or the U.S.; the term "imported" is used to denote materials imported from outside the free trade area.Note

Yarns (HS Chapters 50-55)

Silk, wool/hair or vegetable fibre yarns qualify if they are produced in the free trade area, regardless of the origin of the input fibres.

Cotton or man-made staple fibre yarns qualify if they are spun in the free trade area from domestic cotton or man-made fibres.

Man-made filament yarns qualify if they are extruded domestically.

TPLs apply in the case of cotton or man-made staple fibre yarns made from imported cotton or man-made staple fibres.

Woven Fabrics (HS Chapters 50-55)

Silk or flax (linen) fabrics qualify if they are woven in the free trade area regardless of the origin of the input yarns.

All other fabrics qualify if they are woven in the free trade area from domestic yarns.

TPLs apply to cotton or man-made woven fabrics classified in HS Chapters 52 through 55 containing imported yarns.

Knitted Fabrics (HS Chapter 60)

Knitted fabrics qualify if they are knitted in the free trade area from: domestic man-made filament yarns; domestic cotton or man-made staple fibre yarns spun from domestic cotton and man-made staple fibres; domestic wool/hair yarns (regardless of the origin of the wool/hair fibres); domestic vegetable fibre yarns (regardless of the origin of the vegetable fibres); or imported flax (linen) or silk yarns.

TPLs apply to cotton and man-made fibre fabrics knitted in the free trade area from imported yarns.

Nonwoven Fabrics (HS Chapter 56)

Nonwoven fabrics, including felts, qualify if they are made in the territory from: cotton, wool/hair or vegetable fibres regardless of their origin; or domestic man-made staple fibres or filaments.

Coated Fabrics (HS Chapter 59)

Most coated fabrics incorporating a woven substrate qualify if they are made in the free trade area from domestic woven fabrics. Coated fabrics incorporating a knitted substrate qualify even if this substrate is imported.

The main exceptions are tire cord fabric (HS 59.02) and belting (HS 59.10), which, in addition to the above requirements, also require input fabrics to be made in the free trade area from domestic man-made filament yarns or from domestic man-made staple fibre yarns made from domestic man-made staple fibres.

Carpets (HS Chapter 57)

Carpets qualify if they are woven, tufted or otherwise produced in the free trade area from domestic yarns. Jute yarns and jute woven fabrics (the latter used as carpet backings) can be imported. Other types of carpet backings must be domestic in order for the carpets to qualify.

However, there is a different rule applicable to some carpets traded between the U.S. and Mexico (detailed in an Appendix to "Annex 300-B"). This requires man-made fibre tufted carpets to be made from domestic man-made fibre yarns made from domestic man-made staple fibres, and felt carpets and carpet tiles to be made from domestic man-made staple fibres in order to qualify for NAFTA rates of duty.

Other Textile Made-Up Articles (HS Chapter 63)

Other textile made-up articles (such as sheets, blankets, towels, etc.) qualify if they are made from: domestic wool, cotton, man-made filament or most vegetable fibre fabrics made from domestic yarns; or domestic man-made staple fibre fabrics made from domestic yarns made from domestic fibres. Woven silk or linen fabrics, coated fabrics, or nonwovens can be imported.

TPLs apply to cotton or man-made fibre made-up textile articles made from non-originating inputs.

Apparel (HS Chapters 61 and 62)

Generally, apparel must be both cut (or knit to shape) and sewn or otherwise assembled in the free trade area from domestic fabrics made from domestic yarns. But there are exceptions.

Bras can be made from imported fabrics and still qualify. Man-made fibre sweaters traded between the U.S. and Mexico must be produced in the free trade area from domestic yarns made from domestic man-made staple fibres. In addition, there are several input fabrics which can be imported without disqualifying the garments. These include woven silk and linen fabrics; Harris tweeds; some cotton velveteens and corduroys; batiste fabrics; a variety of shirting fabrics; some circular knit fabrics; coated fabrics; and nonwovens.

TPLs allowing the use of imported fabrics, domestic fabrics made from imported yarns, or, in the case of knit-to-shape garments, imported yarns, apply to almost all apparel.

While a summary is helpful in providing an overview of the rules, importers or exporters should inform themselves of the specific rules covering the products they are trading as there are various technicalities not mentioned here that might apply.

Tariff Preference Levels (TPLs)

It is impossible to judge whether or not textiles or apparel goods qualify for NAFTA rates of duty simply by looking at the rules of origin. Importers or exporters must also consider the various "exceptions" that permit specified levels of textiles and apparel not meeting the rules of origin to also qualify for NAFTA rates of duty. These are referred to in NAFTA as Tariff Preference Levels (TPLs) and in the FTA as Tariff Rate Quotas (TRQs).

TPLs are detailed in Appendix 6.0 (B) "Annex 300-B: Textile and Apparel Goods." Specific levels apply to specific products traded between Canada and the U.S.; Canada and Mexico; and the U.S. and Mexico.

Two sets of TPLs cover apparel. One covers cotton and man-made fibre apparel (knitted and woven); the second covers wool apparel (knitted and woven). Details are provided in tables 4 and 5.

Click here to view Table 4: Cotton or Man-Made Fibre Apparel

Click here to view Table 5: Wool Apparel

As mentioned previously, there are a number of apparel items traded between the U.S. and Mexico that do not have access to the TPLs. These are apparel made from denim, oxford cloth and some circular knit fabrics, and man-made fibre sweaters. These apparel items must either meet the applicable rules of origin or pay regular MFN rates of duty. This exception does not apply to these apparel items traded between Canada and Mexico, or Canada and the U.S.

Also covered by a TPL are goods imported into the U.S. from Mexico under U.S. tariff item 9802.00.80.60 (more commonly known as U.S. 807) up to a level of 25,000,000 SMEs. This TPL covers apparel made from fabrics which are cut in the U.S., sewn or otherwise assembled in Mexico, and returned to the U.S. with duty payable only on the Mexican value-added.

Another set of TPLs cover cotton and man-made fibre knitted and woven fabrics and made-up textile articles of HS Chapters 52 through 55, 58, 60 and 63. These allow up to the specified amounts of fabrics and made-up textile articles made from non-originating inputs to still qualify for NAFTA rates of duty. Details are provided in table 6.

Click here to view Table 6: Fabrics and Man-Made Textile Articles

Finally, there is a "spun yarn" TPL, which allows up to the specified amounts of yarns classified in HS headings 52.05 through 52.07 or 55.09 through 55.11 spun in the free trade area from imported cotton or man-made staple fibres to still qualify for NAFTA rates of duty. Details are provided in table 7.

Click here to view Table 7: Cotton and Man-Made Fibre Spun Yarns

All TPLs applicable to imports into the U.S. from Canada are subject to an annual growth rate for 5 years starting in 1995. These are: 2 percent for spun yarns, fabrics and made-up textile articles, and apparel made from domestic fabrics made from imported yarns or knit to shape from imported yarns; and 1 percent for wool apparel and for cotton or man-made fibre apparel made from fabrics imported from outside the free trade area.

Finally, there is a provision for a review, after 5 years, of the TPLs and of any applicable growth factors.

How NAFTA Rules Differ from the FTA Rules

The concepts are identical. In both agreements, textile and apparel goods "originate" if they undergo specific manufacturing processes in the free trade area. In both agreements, there are exceptions (albeit called by different names: TPLs in NAFTA; TRQs in the FTA) to the rules that allow "non-originating" goods to qualify for preferential rates of duty up to specified levels.

The main changes from the FTA origin rules are NAFTA requirements:

•that cotton or man-made fibre spun yarns (HS Chapters 52 and 55) be made from domestic fibres. The FTA allowed imported fibres

•that knitted cotton fabrics (HS Chapter 60) be made from domestic yarns made from domestic fibres. The FTA allowed imported cotton fibres

•that tire cord fabrics (HS 59.02) and belting (HS 59.10) be made from domestic man-made filament yarns or domestic man-made staple fibre yarns made from domestic fibres. The FTA allowed imported yarns

•that textile articles (HS Chapter 63) be made from domestic pile and terry fabrics as well as domestic knitted fabrics. The FTA allowed these to be imported

•that apparel be made from domestic fabrics made from domestic yarns or knit-to-shape from domestic yarns. The FTA allowed the yarns to be imported

While these changes require more domestic processing in order for goods to "originate," there are also changes that provide for more liberal rules for certain products, mainly in the apparel area. These include previously described exceptions for apparel made from a variety of specified fabrics as well as an exception for one yarn type used in sheer curtains.

As for TRQs/TPLs, the basic challenge for Canada in the negotiations was to achieve adjustments to the FTA TRQ levels covering its exports to compensate for what are generally regarded as more restrictive rules of origin in NAFTA as compared to the FTA. For example, FTA apparel TRQs covering "non-wool" apparel have been replaced with higher NAFTA TPLs to accommodate trade potentially affected by the rule changes. A spun yarn TPL was introduced to compensate for the new rule covering cotton or man-made staple fibre yarns. An increased fabrics and made-up textile articles TPL level is the result of a combination of factors, including rule changes and an FTA provision calling for renegotiation of the FTA TRQ level covering these goods before the end of 1992.

Other changes include growth factors for TPLs covering Canadian exports to the U.S.; specific review clauses covering rules of origin and TPLs; new provisions allowing rules of origin exceptions for goods that are mutually agreed to be "in short supply;" and new provisions allowing changes to TPL access for goods that are deemed to be "in ample supply."

Duty Drawback

Under the FTA, most exporters using imported (from third countries) inputs had been scheduled to lose duty drawback after January 1, 1994. There are only two exceptions: citrus fruits and apparel exported at MFN rates of duty.

NAFTA represents an improvement over the FTA as far as duty drawback is concerned. The new agreement extends the period during which full duty drawback will be available for two years beyond the FTA expiry (i.e. to January 1, 1996) for Canada/U.S. trade and allows for full duty drawback on trade with Mexico until January 1, 2001.

It also provides for continued duty drawback beyond these dates on the basis of a formula that permits exporters to draw back the lesser of (a) duties paid on non-NAFTA inputs used in the production of goods exported to another NAFTA country, or (b) duties paid to that NAFTA country on the exported product. In other words, an exporter cannot get more drawback on inputs than is paid on the exports in which they are incorporated.

The "lesser of" formula effectively means that exporters will not be able to claim drawback on inputs used in "originating" NAFTA exports once these become duty-free at the end of their respective transition periods. However, they will continue to be able to claim either full or partial drawback on inputs used in "non-originating" exports, as these will still be dutiable at regular MFN rates of duty.

Tariff Elimination

Tariffs on textiles and apparel traded between Canada and the U.S. will continue to be reduced as scheduled under the FTA.

Some textiles and apparel traded between the U.S. and Mexico will become duty-free immediately. Most tariffs will be reduced over a 6-year period, and some (but not many) over a longer period.

Most tariffs on textiles traded between Canada and Mexico will be reduced to zero over an 8-year period, as follows: a 20 percent reduction in the first year; no reduction in the second year; five 10 percent annual reductions; and a final 30 percent reduction in the last year. Some textile tariffs will reduce over 6 years; others (mostly those already-accelerated under the FTA) will go to zero immediately. Clothing tariffs will be reduced over a 10-year period.

As was the case in the FTA, NAFTA contains an "acceleration" clause which will permit a faster phase-in period for goods mutually agreed between two or more of the parties.

Also as in the FTA, there is a "tariff snapback" provision (Section 4 of "Annex 300-B: Textile and Apparel Goods") which allows a party to temporarily suspend the NAFTA rate of duty (i.e. return to MFN rates of duty) for specific products under specific conditions. Such actions require compensation (normally these would be equivalent tariff reductions on other products) to the affected Party by the Party taking the action.

Quotas, or Quantitative Restraints

The U.S. has agreed to eliminate its MFA "MFA" refers to the Multifibre Arrangement.Note quotas on "originating" imports from Mexico immediately. There is a phase-out period for quotas covering "non-originating" goods. These provisions are detailed in Schedule 3.1.1 in Appendix 3.1 to "Annex 300-B: Textile and Apparel Goods."

Canada has no existing quotas with Mexico.

NAFTA also contains a provision (Section 5 of "Annex 300-B: Textile and Apparel Goods") allowing the imposition of temporary quantitative measures as an "emergency action." This permits the U.S. or Canada to take an action against Mexico, or Mexico to take an action against the U.S. or Canada. However, any actions by the U.S. against Canada or vice versa remain governed by Article 407 of the FTA, which is commonly interpreted as precluding quantitative restrictions. The NAFTA Section 5 safeguard applies only to "non-originating" goods; no quantitative safeguards are permitted on "originating" goods.

What Lies Ahead?

Agreements of the magnitude of the FTA and NAFTA set forces in motion and experience indicates that the outcome is usually surprising.

The successful negotiation of the Canada-U.S. Free Trade Agreement was a watershed for the textile manufacturing industry. Up to 1989, the industry exported about 8 percent of what it made. About half went to the U.S. and the remainder went all over the world.

The reality of the FTA and the need to adapt acted as a psychological trigger and firms began to look beyond the domestic market. In 1990, with a recession in Canada and the U.S. with textile duties down by only two-tenths, and with a high Canadian dollar, textile exports to the U.S. increased by 28 percent. In 1991, exports held that gain and increased by another 15 percent. In 1992 they increased by yet another 30 percent.

In 1989 Canadian textile exports to the U.S. were $464 million. In 1992 they approached $900 million. In 1993 they will pass the $1 billion mark.

Many Canadian textile companies have set as an export target 50 percent of what they make. Some reached that goal in 1992. A few are exporting as much as 80 percent of their production. The growth has resulted almost entirely from exports to the U.S. but firms have begun to venture into non-North American markets for the first time.

Most of these firms could probably have been successful in U.S. markets without the FTA but generally they hadn't tried. The FTA was the psychological trigger necessary for them to make the effort.

In 1987, no one would have forecast increased Canadian textile exports to the U.S. of the magnitude that have occurred. In fact the FTA has caused textile trade between the two parties to grow to the benefit of both parties.

On the clothing side, it was widely assumed in 1987 that the Canadian market would be flooded with U.S. garments. This has not happened. Canada had a positive balance of clothing trade with the U.S. before the FTA. Since the FTA this positive balance has continued to grow at an increasing rate.

Textile and clothing trade between the U.S. and Canada began to increase before the FTA was really in effect. Interestingly enough this phenomenon is repeating itself with NAFTA. Exports of textiles from Canada to Mexico have grown by 85 percent in the first half of 1992 while exports of clothing have more than doubled. Imports of both textiles and clothing from Mexico have begun to increase too. While the absolute numbers are still tiny, NAFTA is giving early indications of a trade expanding effect even before it has come into existence.

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Last Modified: Wednesday, October 20, 1999.