US tariffs rebound on domestic free trade zones

“There’s a pestilence upon the land” is how one expert on foreign trade zones (FTZs) in the US describes the effect of import tariffs imposed by the Trump administration. He’s not alone in that view, as the new tariffs appear to be undermining the foundations of a programme that was designed to attract foreign investors to the US.

The new tariffs are contributing to an atmosphere of uncertainty surrounding FDI in the US, compounded by a new law that intensifies scrutiny of some types of acquisitions by foreign entities, tougher controls on immigration and visa applications, and the general unpredictability of US policy.

The goal of the FTZ programme is to promote US competitiveness by encouraging companies to maintain and expand their manufacturing and distribution operations in the US through incentives such as lower or deferred duties on imported components, and zero duties on goods exported from FTZs. 

It seemed to be working. According to the National Association of Foreign Trade Zones, in 2016 there were 195 active US FTZs. Exports from facilities in FTZs totaled $76bn, or 5.2% of all US goods exports.

But advocates for FTZs say Trump’s imposition of  “Section 201” tariffs on solar cell and washing machine imports, “Section 232” tariffs on aluminium and steel from certain countries, and especially of “Section 301” tariffs on a large number of imports from China – in the name of protecting US producers – now weaken the appeal of FTZs.  

Normally, products made overseas and imported into the US pay a duty rate based on the finished product. But a US-based manufacturer located in an FTZ may choose whether to pay duty at the rate applicable to those imports or on the finished product, whichever is lower – known as an ‘inverted tariff’.

The new 301 tariffs, however, are forcing many producers in FTZs to pay additional duties of between 10% and 25% on both targeted imported Chinese inputs and on all foreign content in the finished product when it enters the domestic market.

Furthermore, if the highest aggregate value component of the final product is of Chinese origin, the rules are being interpreted to classify the finished good as a Chinese import, even if it is made in the US and includes components that are not Chinese and not a tariff target. It is then subject to additional tariffs. 

As a result, US manufacturers in FTZs are paying significantly higher 301 duties than US manufacturers outside FTZs, according to NAFTZ president Erik Autor.

Efforts to get the US trade representative to correct this problem have had no success, he said, adding: “We are particularly concerned about the effect on FTZs if the US is seen as an unfriendly place for foreign companies to invest.” 

Rebecca Williams, managing director, FTZ Services at the Rockefeller Group, shares these concerns. She worries that if manufacturers in FTZs cannot get the lower duties of the inverted tariff that puts them on a more equal footing with importers of finished products, they may slowly but surely exit the programme.

“I think they will come to a point when the additional duty applied to the FTZ-made good far exceeds the cost of not using the FTZ,” Ms Williams said. 

And Adrienne Braumiller, a partner in the Braumiller Law Group in Dallas, TX, reported: “A number of my clients have said they may have to go out of business because of the 301 tariffs.” She advises companies to attempt to mitigate the damage. 

One strategy is to alter or engineer a product so that it falls into a different tariff classification. Companies can also attempt to change the country of origin by using components from countries other than China. Many companies are appealing to regulators to exclude specific products from the tariffs. And they are pressuring their legislators for help. “But at the end of the day, a lot of people can’t do anything,” said Ms Braumiller.

FTZs established purely as distribution zones are the one bright spot Ms Williams sees, because they are not much affected by the new tariffs. “They may even increase, because they are a landing space for goods subject to trade remedies to delay or eliminate the duties,” she said.

Meanwhile, she hopes that rather than rejecting FTZs altogether, foreign investors will continue to do the appropriate analysis and feasibility studies to evaluate the benefits of locating in a FTZ.