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Sri Lankan T&C sector has demonstrated remarkable resilience in sustaining impressive exports despite the elimination of Multi-Fiber Arrangement (MFA) quotas under the WTO Agreement on Textile and Clothing on January 1, 2005 and a country’s rapid growth in GDP per capita implying also higher wages.<sup>11</sup> As for the latter, note that since (a) barriers to entry into clothing manufacture are very low and, thereby, easily accessible to countries at a very low level of economic development, and (b) in contrast to capital-intensive and increasingly research and development-intensive production of fabrics, clothing industries are far more fragmented and unskilled labor intensive; various stages of clothing production tend to be subcontracted as a country moves up the development ladder. Because of high labor intensity, preserving the competitive edge becomes increasingly difficult as the labor costs continue to rise. Many highly developed countries continue producing clothing but in order to withstand competition they had to specialize in higher value added activities calling for increased capital intensity, significant R&D content, and involving outsourcing of some operation to lower wage economies.

While most quantitative assessments of consequences of elimination of MFA quotas predicted that formerly restricted countries, such as China and India, would gain the most from the removal of the quota, at the expense of other developing countries (Francois and Spinanger 2001),<sup>12</sup> Sri Lanka’s firms not only survived fierce competition from formerly restricted suppliers but saw their exports growing in terms of value by 3 percent in 2005, 6 percent in 2006, 7 percent in 2007, and 5 percent in 2008. They fell 5 percent in 2009 but rebounded at 6 percent in 2010. Total exports of T&C network, with clothing accounting for around 85 percent of the total, grew at an impressive annual LSG rate of 6.1 percent over 2005-10 from around US$3 billion to US3.7 billion.

Sri Lanka’s T&C production and distribution network fully participates in international trading and generates substantial trade surpluses. T&C trade surplus, as percent of total imports into Sri Lanka was falling between 2001 and 2008, it increased from 14 percent in 2008 to 18 percent in 2009 and fell to 14 percent of the value of total imports in 2010. In other words, T&C surpluses covered between one fifth and one tenth of all imports. The surplus increased from US1 billion in 1999 to around US$1.8 billion in 2010 except in 2002 and 2010.<sup>13</sup> The continued full-scale participation as well as persistence in generating surpluses demonstrates that Sri Lankan firms have been very successful in devising strategies necessary to withstand strong international competition.

Whatever these strategies might be, the international experience suggests that it usually entails moving to new market niches (Dicken 2007, p. 251). Indeed, upgrading and shifting to new market niches appear to have been at the heart of Sri Lanka’s adjustment. Viewed through the lenses of foreign trade statistics, two developments suggest significant maturing of Sri Lanka’s T&C network and its capacity to reposition itself into a higher value added segment of the industry. First, although slow, there has been a shift away from activities easily accessible to virtually any developing countries, i.e., cutting and sewing of clothing to those requiring capital and higher specialization. This shift can be captured by a significantly faster growth of exports of fabrics in 2005-10 and progress in developing backward linkages. Textiles provide the major input to the clothing industry; they generate vertical linkages between the 11 Ironically, the emergence of a clothing production network was the result of MFA-imposed restrictions on this trade. In response to tightening of MFA restrictions, Hong Kong SAR, China firms set up firms in other Asian countries including Sri Lanka in the 1970s (Dicken 2007, p. 268).

12 Global gain for consumers, on the other hand, was expected to be huge, ranging from a few billion dollars to more than US$300 billion (Nordås 2004).

> 13 This was related to bomb attacks at the Colombo International Airport in July 2001 that triggered the imposition of war-risk insurance charges that led to bankruptcy of several small and medium firms (Kelegama and Wijayasiri 2004 quoted in Acevedo and Robertson 2011b). The reason for the contraction was increased demand for imported inputs as the value of T&C increased in 2010.