Why contract terms are in favour of the brands

A harsh truth about a market economy -- no, not a capitalist one, just any with a market in it -- is that whoever has the scarce thing gets to make all the money. This is still true in a political economy – it’s the power that is in short supply and determining desserts. 

It’s this we need as background when we consider the information passed on from Mostafiz Uddin about contracts in the RMG sector. He tells us that the cash flow and risk in those contracts are hugely slant- ed toward the manufacturer rather than the brand making the initial order. 

Goods are paid for after delivery with the manufacturer having to advance the monies to purchase material and so on. And yet there’s no final guarantee that the goods will be purchased at all -- as has happened recently. With the closures of most European stores, several brands have simply refused to take or pay for orders they made. 

To carry both the cash flow and the risk seems unfair and economically inefficient. This means that the RMG factories have to employ considerable working capital – they’ve got to spend money on supplies and then wait for however long to get paid after manufacture. 

But by definition, a poorer place is one with less capital in it and thus, that supply and demand thing, where capital is more expensive. So, this is an inefficiency, where capital has to be sourced by the people to whom it is most expensive. A major European brand could raise money at basis points (1 bps is one-hundredth of a percent) above the general interest rate, not something that a factory in Bangladesh can do. 

So, if this is arguably unfair and also inefficient, then why does it persist? Why is all that risk being placed upon the factories of Bangladesh, not the much wider shoulders of the international brands? As at the top there, it’s about who has the power in this economic relationship. 

The truth is that there are many -- thousands upon thousands spread across many countries -- factories capable of producing ready-made garments. Not as well perhaps, not as well priced, not as grandly sewn and all that, but the basic capability lives in many places and organizations. And the number of major brands willing to have clothes made for them? 

Sure, there are more fashion brands than you can shake a stick at out there but only a few are of any major size. The power thus belongs to those with the rare thing, the distribution network for a few million garments, not those with the more common, the ability to manufacture that same few million. That, sadly, is just the way it is. 

And it’s that way under any system of organization too. Replace a free market with a politically directed one and it’s still those with the rarity, political power, who get to decide. We are urged to consider a new way of doing things. For all to agree to a new contract which shares these burdens more fairly. That would be nice, yes, I agree. 

The question is how to bring this to fruition and there’s not all that much hope. For why would those currently with the power lessen the balance in their favour? And if it were true that their power faded, so that the manufacturers had more, then that simple change in the power balance would mean the lopsidedness of the contracts changed. 

There is always the possibility of the industry combining to insist. But this faces the problem common to cartels always and everywhere. This is in fact one of the standard setups in the economic exploration of game theory. It’s in everyone’s collective interest to uphold such an agreement or cartel, certainly. For that improves conditions for all suppliers. 

But it’s also in the interest of any individual supplier to cheat. For, if everyone’s insisting -- at least in public -- that the brands carry the risks and the cash flow costs then for any one manufacturer it’s possible to steal a contract by offering looser terms. By taking more of those costs onto the producer that is. 

There’s no point in our insisting that it shouldn’t be this way. Or even that absolutely one of our compatriots would ever cheat in such a way. For long observation of how people actually work shows us that this is indeed always what happens. Even strict government control doesn’t clear up this failure as the very existence of the informal and black markets out there prove. 

People will simply act in what they perceive to be their own economic best interests. And if that means breaking a cartel in order to steal a march on the competition then that’s what they’ll do. 

Proper empirical research -- an offshoot of the sort of work that gained Elinor Ostrom her Nobel -- shows that as the number of participants in a cartel rises the probability of it collapsing approaches one. And the number we need for it to be asymptotically approaching one is pretty small, a dozen or two participants is all we need for that. 

The sadness here is that there is really no solution to some economic problems. Unless and until the manufacturing capability of the RMG factories becomes the rare thing -- and while the brand capable of selling the product remains the rare thing -- then contract terms are going to be against the factories and in favour of the brands.  

Tim Worstall is a Senior Fellow at the Adam Smith Institute in London