Manufacturing in a Flatter World
31 Aug, 2007By: Kevin M. Mayer
The Foreign-Trade Zone
The world is flatter than it used to be. But it isn’t entirely flat, even though the title of a best-selling book (Thomas Friedman’s The World is Flat: A Brief History of the 21st Century) suggests that it is. In it, Friedman celebrates the wonders of global commerce, the possibilities that emerge when technology and trade policy effectively annihilate distance and people around the world compete on equal economic terms. To be fair, he also acknowledges the challenges.
The main challenge is all too familiar. The terms aren’t really equal. In other words, the world isn’t really flat. The production costs borne by manufacturers abroad are often significantly less than those borne by domestic manufacturers. Domestic manufacturers are, of course, already responding to this challenge…they are adopting outsourcing strategies. The expectation, to be fulfilled over the long term, is that the mixing and matching of imported and domestic content will free producers around the world to specialize, to devote themselves to doing whatever it is they do better than anyone else. If all goes well, manufacturers located in the United States will assemble finished goods from low-cost content produced abroad and high-value-add content provided domestically. And so, in this scenario, we get the best of both worlds: less expensive goods and high-skill, high-paying jobs.
Sounds good. But nobody ever said that making this vision a reality would be easy. In fact, in many sectors, exposure to foreign competition has brought about wrenching change. Domestic manufacturers in these sectors are often urged to accept this change philosophically. It is, they are told, for the greater good. And not only that, it is unavoidable. But some adverse consequences of global trade are avoidable. For example, tariff structures and duty schedules can have the unintended consequence of giving producers abroad an advantage over producers at home – for goods with identical content, producers abroad may actually qualify for lower duties. Fortunately, this particular problem has a solution: the foreign trade zone (FTZ).
An FTZ is a specially designated area licensed by the Foreign Trade Zones Board. The typical FTZ is located near a customs port of entry in the United States. And it is, for customs purposes, equivalent to foreign soil. Actually, it is better than that. In an FTZ, the following advantages apply:
1. Duties are reduced. Manufacturers are spared inverted tariffs. If foreign merchandise is brought into an FTZ and manufactured into a product that carries a lower duty rate, the lower rate applies. (It may seem odd that the duty on a finished product should carry a duty exceeding the sum of the duties of the product’s constituent parts, but such irregularities do occur. Typically they are not planned, but become evident only after large-scale trade negotiations take effect.)
2. Duties are deferred. No payment is owed on merchandise while it is being manipulated, repaired or stored in the FTZ.
3. Duties are eliminated. There is no duty assessed on domestic parts, materials or labor that is incorporated into the product. Also, there is no duty on re-exports. Finally, there is no duty on zone-to-zone transfers. A vendor located at one FTZ may sell goods to a buyer in another zone anywhere in the United States and transfer those goods with no duty paid on the goods.
These are the core advantages usually ascribed to FTZs. In addition, certain kinds of merchandise may be exempt from state and local taxes, and some quota restrictions may be waived. Finally, streamlined reporting procedures and consolidation of processing fees offer advantages to distributors as well as manufacturers.
Curiously, little is said about FTZs in the popular press. And when FTZs are mentioned, little is said about which businesses might benefit the most from FTZs, and which businesses might find the advantages less than compelling. In truth, much depends on the current standing of import rules and regulations. And because the rules change from time to time, from round to round of international trade negotiations, the rewards for certain businesses may become enhanced or diminished.
Because of these complexities, businesses may need to consult an expert in FTZs. Besides being familiar with the administrative and legal requirements of FTZs, consultants should be aware of the latest wrinkles in the trade rules and regulations, and how these may affect the plans of individual companies.
According to Greg Jones, a member of the Foreign-Trade Zone Corporation and a former president of the National Association of Foreign-Trade Zones, “The foreign-trade zone program is a way to remedy the unintended and counterproductive consequences of tariff initiatives. It can resolve tariff irregularities case-by-case, commodity-by-commodity, without undermining the tariff structure.”
The flexibility of the FTZ program is an important point, as is the need to respect the tariff structure’s intent. This is because the FTZ program is not a customs program so much as it is a trade policy program. When the Foreign Trade Zone Board considers whether to grant zone status, it tries to gauge the net economic impact. Zone status must do more than benefit a particular company. It must deliver a net benefit to the United States.
Adjusting to Shifting Trade Flows
When it was created in 1934, the FTZ program was meant to promote exports and trans-shipment trade, and thus preserve and expand employment within the United States. In 1980, zone activities accounted for less than $3 billion in shipments and only about 10,000 jobs. But by 2005, the value of shipments into FTZs totaled $410 billion. And approximately 340,000 persons were employed at some 2,500 firms associated with some 150 active FTZ projects. (This is the number of active projects out of the approximately 250 projects that have been approved.)
A typical FTZ project involves two or three general-purpose sites and an assortment of special-purpose sites, or subzones. In 2005, the value of shipments was not evenly divided between two kinds of zones. A relatively small share (about 17 percent) was received at general-purpose zones. And the larger share (about 83 percent) was received at special-purpose subzones.
General-purpose zones typically encompass public facilities — ports and industrial parks —sponsored by state or local governments, port authorities, economic development agencies or nonprofit organizations. These facilities are used by multiple firms, which are often small- and medium-sized businesses.
Subzones, which are sponsored by general-purpose zones, are single-purpose facilities. In fact, the typical subzone is a site that belongs to a single firm. It is used to carry out relatively elaborate distribution or manufacturing activities.
To date, most of the value generated by zone activity has been due to manufacturing. However, logistics activity may begin contributing a larger share.
Building Local and Regional Economies
The FTZ Board must perceive public benefit before it approves any FTZ project or zone. But assessing the potential for such a benefit is inherently difficult. Few formal studies have attempted to measure the effect of FTZs on regional economies. Still, advocates of FTZs are able to cite examples of dramatically large projects and zones that deliver tangible benefits. Such benefits may include the cultivation of industry clusters that reach beyond the FTZs, encompassing tiers of interacting suppliers. Or an FTZ may provide a large number of jobs or contribute a great deal to the tax base. An infrastructure may also be created to attract a particular FTZ candidate to enhance a locality’s economic prospects.
Ideally, a community will pursue high-value projects. They will use FTZs to catalyze lasting prosperity and avoid specializing in cheap labor. An example of a “catalyzing” project is an auto-assembly plant. For example, in February 2007, the Community Development Foundation of Tupelo, MS announced that Toyota had chosen the Wellspring Project Site for its new plant. The new plant is expected to bring 2,000 direct jobs to the area, as well as 4,900 indirect jobs. Estimated revenue for the state is expected to total $698 million over the next 25 years, with a principal payback in 10.6 years.
An excellent example of a community’s infrastructure investment leading to further development can be found in Huntsville, AL. What was once a cotton field has become Huntsville International Airport. Near the airport are elements of FTZ No. 83. These elements include two industrial parks. There is also an intermodal center, an international air cargo center and a general-commodity port facility.
Finally, even if a sector or firm is in retreat, an FTZ could prove useful. According to Greg Jones, an FTZ could enable a rearguard strategy. Jones described a case that sounded almost like a parable. A manufacturing plant based in the United States, unable to match the production costs carried by a sister plant in Spain, lessened its disadvantage by qualifying for zone status. Then, having effectively bought time, the United States plant executed a switch. It moved from manufacturing VHS tapes to CDs, saving itself in the process. The lesson is that if an FTZ cannot be a launching pad, it might be a stepping stone.
Broadening the Appeal of FTZs
About 150 out of about 250 approved FTZs are fully active. What happened in the 100 or so that are still inactive? Evidently, at each of these sites there was the perception, on some applicant’s part, that an FTZ was needed. Was the perception incorrect or was there some difficulty in the FTZ’s execution? Were candidates for subzones not convinced of the benefits? Could they have been convinced, if the benefits had been better communicated? These questions are worth researching. And they may point to the need for better marketing.
There is also the possibility that underutilized FTZs could have been more successful had other incentives, besides the usual FTZ benefits, been available. For example, in Florida, the Port of Pensacola makes it clear that its FTZ overlaps with an enterprise zone. The enterprise zone designation opens a number of state and local tax incentives to businesses located within the zone. This approach may be attractive to other localities.
It is also possible that more businesses could be brought into FTZs, and hence into the mainstream of global commerce, if special efforts were made to accommodate smaller companies. To date, large companies have dominated FTZs. This may simply reflect that larger companies tend to have more complex sourcing patterns. But perhaps smaller companies would be more inclined to participate if procedures were simplified and expedited. In fact, the FTZ Board is working to enhance the pre-application process for small- and medium-sized companies by offering expanded counseling, providing sample applications and issuing simplified guidelines. In addition, there are now procedures for granting temporary/interim manufacturing (T/IM) authority. This authority applies to any FTZ space existing at the time the T/IM application is submitted. And it stays in effect for two years, during which time an application for permanent authority may be submitted.
One final possibility is, admittedly, speculative. It concerns services. FTZs already encompass manufacturing and logistics activities. But what about services, as in medical, financial and other services? Already there is talk of tarriffication in services. The idea that once barriers to trade in services are exposed and quantified, they may be gradually (and rationally) reduced. Then services, too, will be exchanged on a free-trade basis. If this idea proves practical, and takes hold, might irrationalities creep into tariff schedules for services, just as they do for manufactured goods? And if so, would the FTZ model be appropriate for making the necessary adjustments?