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U.S. Foreign-Trade Zones Answer the Call to Globalize

30 Oct, 2017

By: Greg Jones
The FTZ program continues to serve as a reliable tool for American communities and their business constituents.

As change and unpredictability appear to intensify in many ways, the U.S. Foreign-Trade Zones (FTZs) program continues to serve as a reliable tool by which many communities – large and small – can enhance the competitive position of their local business constituents whose operating margins are under increasing pressure from foreign competition.

Much is heard about the ways in which cheap labor, poor working conditions and lax environmental standards are used by many foreign-based manufacturers to produce comparatively cheap products that can be imported into the United States at relatively low (or even “free”) rates of U.S. Customs duties, often displacing U.S.-based producers of those same goods within the U.S. marketplace. One also hears of the counterproductive effects of regional and worldwide tariff reduction initiatives. These are often the subject of intense debate, with proponents arguing that the net benefits of trade liberalization far outweigh the costs, and opponents arguing that those costs come in the form of economic and social devastation by those who, through no fault of their own, are forced to bear them. However, regardless of where one stands on the subject of trade liberalization, one cannot deny that the trend of globalization is accompanied by real challenges which must be successfully met if economic misfortune is to be avoided. 

Oddly, one tool that a number of local, regional and state economic development entities use to meet the challenge of globalization comes in the form of a federal trade program – the U.S. Foreign-Trade Zones (FTZ) program. One unusual characteristic of the FTZ program is that, like a pair of common pliers, it features two sources of leverage – one from the authority extended by the federal government (i.e., the U.S. Foreign-Trade Zones Board) – and the other from local, regional and state economic development organizations (e.g., municipal and county governments, chambers of commerce, port and airport authorities) that deliver the FTZ program to their local business constituents by virtue of grants of authority conferred upon them by the U.S. Foreign-Trade Zones Board. These Zone Grantees often have a significant stake in the attraction and retention of local value-added activity in the same manner as the federal government has a significant stake in the overall tax revenue derived from U.S.-based value-added activity.

Promotion of the FTZ program by local Grantee organizations is a matter of necessity because of the increasingly apparent effects of decades of globalization – most notably due to the long-term effects of decreasing tariffs on goods imported into the United States. The impetus for the fall in the effective tariff rates that apply to products imported into the United States can be easily identified. Multilateral tariff reductions such as the Tokyo Round of GATT and the Uruguay Round Agreements and regional and bi-lateral trade initiatives such as the Generalized System of Preferences (GSP), the Caribbean Basin Economic Recovery Act (CBI), the U.S.-Israel Free Trade area Agreement, the North American Free Trade Agreement (NAFTA) and the Andean Trade Preference Act have all contributed to the lowering of tariff barriers into the U.S. market.

In what might seem to be a counterintuitive development (given the significant fall in U.S. tariff rates), the use of the U.S. Foreign-Trade Zones program has grown significantly since the 1970s. In 1970 there were eight U.S. Foreign-Trade Zone projects in the United States. Included within these Zone projects were a total of three special-purpose subzones that involved value-added production activity. According to the most recent Annual Report published by the U.S. Foreign-Trade Zones Board, there are more than 180 active Zone projects with a total of more than 300 active FTZ production operations.

The reasons for the growth in the use of the U.S. Foreign-Trade Zones program during the same timeframe in which U.S. duty rates have fallen are twofold.

Duty rate reductions on imports into the United States have been accompanied by duty rate reductions by its trading partners. This has increased export opportunities for U.S-based manufacturers. However, duty rate reductions on imports into the United States have also created downward pressures on the operating margins of U.S.-based manufacturers as they compete for market or production share with their foreign-based counterparts.

In addition, the U.S. Foreign-Trade Zones program offers the unique ability to rationalize what would otherwise be irrational duty rate relationships between the Customs duty rates that, in specific instances, apply to imported materials and components, versus the rates that apply to imported finished products into which those materials and components may be incorporated. These irrational duty rate relationships are sometimes referred to as “inverted tariffs.” In a number of “Free Trade Zones” in other countries – particularly those in developing countries – the sole benefit is the avoidance of internal customs duties on products that are re-exported from the Zone. In some instances, U.S. Foreign-Trade Zones enable companies to reduce or eliminate duties on products produced for domestic consumption. This “tariff rate rationalization” benefit is a key distinction between the U.S. Foreign-Trade Zones program and many other free zone or customs duty regimes. Use of the U.S. Foreign-Trade Zones program for the purpose of obtaining relief from inverted tariffs offers a number of U.S.-based manufacturers an economically viable alternative to outsourcing their manufacturing operations to foreign locations.

A good example of the manner in which the U.S. Foreign-Trade Zones program can provide relief from irrational duty rate structures created by larger trade initiatives can be found in the aerospace manufacturing sector. Before describing how the U.S. Foreign-Trade Zones program provides a solution of the problem, the problem and its origins must be understood. As previously noted, U.S. tariff rates have fallen as a result of several rounds of multilateral tariff agreements. Because of these tariff rate reductions, a broad range of aerospace products, including all manner of aircraft, satellites and space launch vehicles, and major parts and components for such products, are traded duty-free among a number of countries. This duty-free tariff regime has created new export opportunities for U.S.-based aerospace manufacturers; however, it has also brought on new financial pressures to “outsource” the manufacture of certain aerospace products to offshore locations. The reason for this is straightforward: in a number of cases, a given finished product may be imported into the United States at a “free” rate of duty, but one or more of that product’s key raw materials or components remain subject to U.S. Customs duties under the current tariff structure of the United States.

For a U.S.-based subsidiary of a multinational high-tech company that produces commercial aircraft for the U.S. marketplace, its competition is easy to identify: it’s the facility’s overseas “sister” plants. Under the tariff structure that preceded the aforementioned multilateral tariff reduction initiatives, a U.S.-based plant would have enjoyed a positive rate of tariff protection against imports of competing products. Thus, for its multinational parent, it made economic sense to manufacture the aircraft in the United States while maintaining a worldwide supply chain for the components used in its construction and assembly. Today, because of broad tariff reductions, the same finished aircraft can be imported into the United States free of Customs duty. Unfortunately for the U.S.-based producer, a number of the imported materials and components used to produce its finished aircraft are dutiable at the same duty rates that applied to them before implementation of the multilateral tariff reductions that now apply to finished aircraft. Thus, the current U.S. tariff structure imposes an irrational cost of manufacturing commercial aircraft in the United States versus overseas. In the absence of a means to restore a rational duty rate relationship between the company’s imported components versus its finished products, the reduced operating margins imposed by the irrational (or inverted) tariff structure would induce the multinational parent company to maintain an economic bias in favor of manufacturing its aircraft at a foreign location.

Now for the solution: the means for restoring the rational duty rate relationship between the raw materials and finished aerospace products – including commercial aircraft – is the use and implementation of U.S. Foreign-Trade Zones procedures. Upon application to and approval by the U.S. Foreign-Trade Zones Board, and upon approval of activation by U.S. Customs and Border Protection, the U.S.-based company can bring the imported components and materials into its Foreign-Trade Zone facility without paying Customs duty. The imported components and materials may then be used in the manufacture of its commercial aircraft. The complete aircraft may then leave the FTZ production facility and be entered into the U.S. commerce at the same tariff rate that would apply to the aircraft if they had been manufactured overseas – that is, “free.” This tariff rationalization feature of the U.S. Foreign-Trade Zones program enables the U.S.-based manufacturing operation to maintain the cost-of-production structure it needs to compete with its overseas sister plants.

Given the example just cited, one might ask, “Wouldn’t it be prohibitively expensive to move the manufacturing plant to a Foreign-Trade Zone?” Indeed, it would be. However, for those facilities where operations cannot be accommodated within an existing FTZ site, the local Grantee of the Zone project can apply to have the existing operation in its existing location designated as part of the Grantee’s existing FTZ project. This can be accomplished by the Grantee’s application to have the company’s existing site designated as a “special-purpose subzone” or, if the Zone project has been organized under the “Alternative Site-Management Framework” (ASF), the existing site can be designated as a “usage-driven site” of the Grantee’s General-Purpose Zone. In either case, the process by which the company applies for FTZ production authority is the same.

Thanks to an eight-year initiative by the U.S. Foreign-Trade Zones Board staff, culminating in a comprehensive regulatory rewrite adopted in 2012, the processes for FTZ site designation and obtaining FTZ production authority have become easier and faster. Under the pre-2012 regulatory structure, the process for obtaining subzone status and FTZ production authority required several months of processing time, even in circumstances in which it was immediately clear and evident that the economic interests of the individual company, its community and the United States would all be well-served by the company’s use of the FTZ program. Thanks to the flexibility provided by today’s regulatory structure, the process for obtaining FTZ production authority can take as little as 120 days, the process for obtaining FTZ subzone status can take as little as 90 days, and the process for obtaining ASF Usage-driven site designation can take as little as 30 days.

These developments have resulted in the ability of the U.S. FTZ program to better serve America’s small- and medium-size businesses, as well as larger production operations. America’s communities and businesses have responded. From 2007 through 2011 – the five-year period preceding the adoption of the current Foreign-Trade Zones Board regulations – the FTZ Board processed a total of 62 requests for new or expanded FTZ production authority. In the five-year period since the adoption of the current regulations, the FTZ Board has processed more than 200 requests for new or expanded FTZ production authority – a three-fold increase. This is clear evidence that the U.S. Foreign-Trade Zones program continues to serve as a reliable and increasingly efficient tool by which many communities and American businesses are answering the challenge of globalization.   T&ID

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Greg Jones

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