Home Economic Trends Companies Are Using a Depression-Era Law To Escape Trump’s Tariffs — And...

Companies Are Using a Depression-Era Law To Escape Trump’s Tariffs — And It’s Costing Them – Lydia DePillis, ProPublica (09/24/2019)

Companies Are Using a Depression-Era Law To Escape Trump’s Tariffs — And It’s Costing Them

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A few weeks ago, signs went up in the parking lots and loading docks at Fluid Equipment Development Co., a small manufacturer in Monroe, Michigan, a lakeside town a bit south of Detroit.

“WARNING,” they read. “This bonded facility is under the custody and control of U.S. Customs and Border Protection and any person entering these premises must comply to the laws governed therein.”

FEDCO is a U.S. company operating on American soil. It makes sophisticated pumps that turn seawater into fresh water. But to protect itself against punishing new tariffs imposed by President Donald Trump, it has turned to an obscure program that began 85 years ago — the last time tariffs soared as high as they are today.

Congress passed the Foreign Trade Zone Act of 1934 as an escape hatch to allow companies a safe harbor to bring in goods and warehouse them without tariffs as long as they weren’t meant for domestic consumption. With nearly 300 zones across the U.S, they help manufacturers compete — and preserve jobs — in a global economy where components often cross borders several times before coming together as a finished product.

Under the program, FEDCO will avoid paying tariffs on any imported parts that it manufactures into goods bound for sale abroad. Getting the government’s stamp of approval, with help from a consultant who knew the process, took about six months. Even though setting up the foreign trade zone will largely allow FEDCO to return to business as usual, having to do so has been a significant administrative burden — what one executive called “mental overhead” — that has distracted from other priorities like developing new products and finding new markets.

“As a small business, you’re so busy making your business profitable for the future,” said Lisa Leachman, the company’s vice president of finance and human resources. “For these types of things, you have to spend money to outsource that know-how, which costs you even more money. It’s a no-win situation.”

That’s the headache companies across America face as they struggle to cope with tariffs that have risen to 25% on top of regular duties. They are fitting their business models into a rapidly changing trade policy, sapping productivity and profits with little evidence that the effort is changing China’s practices one bit.

One of the administration’s stated goals with the tariffs has been to reinvigorate U.S. manufacturing. But in FEDCO’s case — and many others — tariffs alone wouldn’t have moved the needle.

FEDCO does buy much of what it needs domestically. But when the company’s engineers designed a new pump with intricate channels to drive pressurized salt water into a filtering membrane, the products delivered by American foundries were expensive, arrived late and sprung leaks when put to use.

After months of disappointment, the company turned to China.

“It was more driven by quality, why we went to China, rather than cost,” said company founder and president Eli Oklejas. “We lost fundamental manufacturing skills, especially in the foundries, and castings. Those are things based on training and experience over decades. Those people retired, there’s no one coming up through those industries, and it’s gone.”

FEDCO had just implemented its new supply chain when tariffs hit. The company ponied up to air freight some of the new parts from China to beat the deadline, but it still ended up paying hundreds of thousands of dollars to Customs. Desperate for a solution, Oklejas came across an article about foreign trade zones, and asked Leachman to find out more. It will save them from having to raise prices, which could have driven customers to competitors in the desalination industry that are larger and better able to absorb the costs.

“Plan B would have been to set up operations in China,” said Oklejas, who now employs 86 people in Monroe and has an overseas sales and maintenance facility in Dubai, which is close to many of FEDCO’s customers in the hotel, cruise ship, offshore drilling and municipal utility industries. “Expansion would not have occurred here.”

The popular notion of a “Free Trade Zone” is a border area in Mexico or other location where U.S. manufacturers have built plants to take advantage of tax breaks and lower wages. And there are plenty of those — 2,260 around the world, according to the World Free Zone Organization. But they can also exist anywhere in the U.S. where a company applies for a permit.

America’s foreign trade zone program was born in the early 1930s, after the Smoot-Hawley tariffs on agricultural and industrial goods had throttled both imports and exports, helping to propel the United States into a deep depression.

After Congress set up the program, the rules for operating a free trade zone were so restrictive that they weren’t used much in the beginning. Other countries actually set up free trade zones first, starting with Ireland, which established a duty-free international business park near the Shannon Airport in 1959 as an experiment in job creation.

The law was amended in the 1950s to allow manufacturing in foreign trade zones, but not much happened until the 1980s, when the rules changed again to ensure that duties wouldn’t be assessed on domestic value added if the finished product was then sold in the U.S. That finally made the zone designation useful for companies like automakers, which increasingly outsourced parts production to compete with cheap Japanese imports.

The program then grew fairly steadily, with pauses after the passage of major trade deals — like the North American Free Trade Agreement and the accession of China to the World Trade Organization — that ratcheted down import duties and incentivized production overseas. Despite a global trade regime and technological advancements (like shipping goods in containers and computerized inventory management systems) that for decades had made it easier and cheaper for goods to cross borders, foreign trade zones remained useful in mitigating any remaining friction.

In 2017, according to the latest report by the Commerce Department’s Foreign Trade Zones Board, $669 billion worth of both foreign and domestic material entered into zones and $87 billion was exported from them. About 3,200 companies operate in foreign trade zones. The biggest users by far are oil and petrochemical companies, like Exxon and Valero, which import crude oil and refine it into duty-free petrochemicals. Then come export-focused automakers, like Mercedes-Benz and Tesla, followed by pharmaceutical companies, including AstraZeneca and Bristol Myers Squibb.

That was all before Trump’s trade war.

Beginning with steel and aluminum tariffs imposed in early 2018 and continuing to a wider range of goods, companies have cast about for workarounds. Some seek exemptions, or route imports through other countries, or make small product adjustments that move them into a non-tariffed category, for example.

Foreign trade zones largely solve the tariff problem for companies that manufacture goods for export — ironically, bringing the program back to the purpose it had originally been created for and never fully served.

“Where we are today is in some ways similar to where we started in 1934, in that for many companies, the duty rates are really significant, and that changes the nature of their business completely,” said Marshall Miller, a principal with the Kansas City-based trade law firm Miller & Co. and general counsel for the nonprofit National Association of Foreign Trade Zones.

Unlike in 1934, the program is now relatively easy to use. Rather than having to locate in a designated area, a company can be anywhere and qualify as a foreign trade zone, with modest security precautions and tight controls over shipping and inventory that are reported to CBP. A 2012 rules overhaul cut the processing time for an approval from a year to about four months. Companies still must pay tariffs on components marketed domestically, but if the finished product has a different tariff rate than the parts, companies can pay whichever is lower. They are also able to better manage cash flow by paying only at the point of sale rather than as soon as the good arrives in the U.S.

An annual report to Congress with information about the dollar value transacted through foreign trade zones for 2018 has been delayed, and it’s difficult to parse the data available from the Foreign Trade Zones board for trends. But as a rough proxy for the year through August, the number of cases expanding activity in foreign trade zones has risen 37% since the same period in 2016 — the year before Trump took office — after staying relatively flat since the process was streamlined in 2012. Meanwhile, the public entities that administer the zones (known as “grantees”) say they’ve seen a surge in interest that will show up in official data by year’s end.

“About half of the growth you’ve seen is coming directly from the tariffs,” said David Panko, who manages a zone run by the City of El Paso, Texas. “We had started educating people on the FTZ program, and then the tariffs came, and we basically doubled the number of companies that were interested.”

The confluence of those factors has lured dozens of companies into the program, with more to come. Companies applying for foreign trade zone status over the past year — including Whirlpool, the fan maker Lasko, and the outdoor equipment manufacturer STIHL to name a few — frequently disclose that the materials to be imported are subject to the new tariffs. In recent months, companies that tried to avoid the time and expense of setting up a foreign trade zone are now biting the bullet.

“Each iteration of duties has really upped the urgency for people,” said Robert Stein, a vice president for regulatory compliance at Mohawk Global Logistics. “If you don’t sign up for an FTZ, you’re gambling that sometime in the next six months Trump is going to wake up and say ‘Hey let’s strike an agreement with Xi Jinping.’ Smart businesses really need to believe that this is the reality.”

Setting up a foreign trade zone, however, doesn’t entirely shield companies from trade policy chaos. Earlier this year, for example, new applications lagged when hundreds of customs agents were diverted to work on the southern border processing migrants. And the constantly changing tariff rates have created confusion about duties owed when a company’s products are sitting in a zone: Are they subject to the new tariff when they enter the stream of U.S. commerce, or the old one?

Erik Autor, president of the National Association of Foreign Trade Zones, said he’s gotten conflicting information about how the rules apply when new tariffs are instituted. “They’re like that,” he said, snapping his fingers. “No time to adjust. You get a tweet on a weekend and the next weekend they’re in effect.”

Autor has sent letters and testified in hearings before the Office of the U.S. Trade Representative asking for technical fixes in the tariff notices that result in duties being improperly assessed on imported goods. So far, he hasn’t had much luck. At the National Association of Foreign Trade Zones’s annual conference in Chicago earlier this month, the group pleaded with members to speak with their representatives in Congress about program changes — not to mention more funding for Customs and Border Patrol, which has been straining under its flat budget to meet the demands of volatile tariff policy.

Advocating for foreign trade zones is a delicate task. Although the program enjoys broad bipartisan support in Congress, with Trump berating American companies on Twitter for sourcing goods abroad, companies are reluctant to publicly defend their ability to avoid tariffs.

“It can be misconstrued as companies taking advantage of the system,” said Torrey Chambliss, manager of the Port of Tampa Bay’s foreign trade zone.

In Monroe, workers at FEDCO had to be trained on compliance with new foreign trade zone rules, and their bosses have also had to explain why they were setting up a mechanism to shield their imports from tariffs. The long manufacturing decline in the Detroit area has made outsourcing a sensitive subject, so Leachman emphasizes the parts of the business that still happen locally.

“We’re proud to say that this is engineered, designed and built in the USA,” she said.

Even if the tariffs on China are rescinded, Leachman and Oklejas figure they’ll keep the foreign trade zone operational. They also import parts from countries like Germany and India, and in this new protectionist era, it’s worthwhile to have an insurance policy.

“They don’t have tariffs now,” Leachman said. “But everybody has learned a valuable lesson, that at a snap of a finger, everything can be tariffed significantly.”

Do you have access to information about the trade war that should be public? Email lydia.depillis@propublica.org. Here’s how to send tips and documents to ProPublica securely.

For more coverage, read ProPublica’s previous reporting on how tariffs are affecting America’s pastime.