U.S. Foreign-Trade Zones Help U.S. Based Manufacturers Stay in Business
30 Jun, 2005By: Greg Jones
Listen to any talk show that addresses the subject of international trade trends and you will hear concerns about “outsourcing” U.S.-based manufacturing operations to foreign locations. You may also hear about manipulation of currency value by foreign governments that make “outsourcing” of value-added manufacturing operations even more attractive, and the continued proliferation of free trade agreements that enable products produced abroad to be entered into the United States at even lower tariff rates. You may hear some discussion about free trade initiatives as a means of promoting democratic and labor reform on a worldwide scale, and the promotion of U.S. exports. To the U.S. manufacturing plant manager and to his or her fellow plant workers, democracy and exports seem like good ideas only if the local manufacturing facility can manage to keep its doors open. In today’s multinational corporate environment, one can ask any well informed employee of a U.S.-based manufacturing plant who that plant’s biggest competitor is. The answer may surprise you. No, it’s not the Brand X plant across town. No, it’s not ABC Company in a nearby state. In terms of real production capacity, the answer often is, “Our own company’s sister plant in the Far East.” Solutions to the challenges imposed by today’s global trade environment may seem few and far between; however, one solution that shows continued popularity despite the apparent fall in U.S. tariff rates is the U.S. Foreign-Trade Zones program.
For the past three decades, U.S. tariff rates have fallen significantly, with many new products eligible for duty-free importation into the United States. Yet, over the same timeframe, the use ofthe U.S. Foreign-Trade Zones program – which is predicated on the ability to reduce costs associated with tariffs – has risen. In 1970, roughly 65% of total U.S. import value consisted of dutiable products, with Customs duties comprising 6.5% of the total value of all imports. In 2003, roughly 32% of total U.S. import value consisted of dutiable products, with Customs duties comprising only 1.6% of the total value of all imports. The fall in the effective tariff rates that apply to products imported into the United States can be traced to multilateral tariff reductions such as the Tokyo Round of GATT and the Uruguay Round Agreements, and, to 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. 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. Today there are more than 150 active Zone projects with a total of more than 200 active special-purpose subzones. Total Zone-related manufacturing activity exceeds $200 billion annually.
Most people who are familiar with Foreign-Trade Zones are familiar with the idea that companies use Zones to reduce their tariff-related costs. Given this understanding, one might well ask, “Hey – U.S. tariff rates are falling. Foreign-Trade Zone use is climbing. What’s the reason?” The primary reason is that U.S. Foreign-Trade Zones save U.S.-based manufacturers money in ways that are different than so-called “Free Trade Zones” in other countries. In a number of “Free Trade Zones” the sole benefit is the avoidance of internal customs duties on products that are re-exported from the Zone. In some instances – for example, the manufacture of computer-related products – 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.
The use of the Foreign-Trade Zones program by U.S.-based manufacturers of computer-related peripheral products provides an instructive example of how U.S. Foreign-Trade Zones enable American businesses to compete with their foreign counterparts on a level playing field in what would, in the absence of the Zones program, be an irrational tariff rate environment.
As previously noted, U.S. tariff rates have fallen as a result of several rounds of multilateral tariff agreements. Tariff reductions of the Uruguay Round Agreement, which commenced in 1995, were implemented in a number of strategic industries, including the computer industry. Because of the Uruguay Round tariff regime, a wide range of computer and computer-related products are traded freely around the world – that is, they can be sold and imported into numerous countries on a duty-free basis. This duty-free tariff regime has created new export opportunities for U.S.-based computer equipment manufacturers; however, it has also brought on new financial pressures to “out-source” the manufacture of certain computer-related 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 remain subject to U.S. Customs duties under the Harmonized Tariff Schedule of the United States.
For example, a U.S.-based manufacturer produces a data backup and recovery system for the U.S. marketplace. The plant is a part of a multinational high-tech company’s group of worldwide manufacturing facilities. In the case of the U.S.-based manufacturing operation, its competition is easy to identify: It’s the facility’s overseas “sister” plants. Under the United States’ pre-Uruguay Round tariff structure, the company enjoyed a 3.7% rate of tariff protection against imports of its finished product. Thus, for its multinational parent, it made economic sense to manufacture the data backup system in the United States. Today the same data backup system can be imported into the United States free of Customs duty. Unfortunately for the U.S.-based producer, the imported plastic film that is used to produce the backup tape for the system is dutiable at 5.3% of its value. Other imported components and materials are dutiable at rates that range from 2% to 4%. If the imported components and materials represent 25% of the cost-of-production for the complete system, then the U.S. tariff structure imposes an overall addition of 1% to the cost of manufacturing the system in the United States versus overseas. This is due to the irrational duty rate relationship between the finished product and its imported raw materials. In the absence of a means to restore a rational duty rate relationship between the two, the multinational company would be likely to shift its manufacture of the system to a foreign location.
The means for restoring the rational duty rate relationship between the raw materials and the data backup system is the U.S. Foreign-Trade Zones program. 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 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 the data backup system. The complete data backup system 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 finished product if it was 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 in order to compete with its overseas sister plants.
Use of the U.S. Foreign-Trade Zones program has been approved for a wide variety of manufacturing industries. Product lines include: electronics, computers, video and telecommunications equipment, plastics, food products, power tools and lawn care products, electronic business equipment, industrial and agricultural machinery, construction equipment, large and small appliances, climate control equipment, medical equipment, chemicals and petrochemicals, automobiles and auto parts, pharmaceuticals, ships, and sporting goods.
In a number of cases, Zone status contributes a significant part of the answer to the question, “How do we keep our factory doors open?” The bottom line for the U.S. Foreign-Trade Zones program is that it enables U.S.-based businesses to enhance their bottom line, and, more importantly, maintain their value-added economic activity here in the United States.