More than 40 percent of imports to the United States today are sourced from Free Trade Agreement-partner countries, the result of FTAs signed with 20 nations over the past three decades. If the United States successfully enters the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (T-TIP) agreements, the share of FTA-sourced imports will rise above 60 percent.

These new trade realities stand in sharp contrast to the trade world that existed when Congress created America’s Foreign-Trade Zones program 80 years ago in a successful attempt to make U.S. business more competitive by reducing or eliminating some tariffs. But while this dramatic growth in free trade agreements has served the nation’s interests well on balance, it is now evident that some agreements are having unintended consequences that undermine Foreign-Trade Zones’ ability to keep U.S manufacturing competitive.

When the Foreign-Trade Zones Act was signed into law in 1934, U.S. duties were high and applied uniformly to imports on a most-favored nation (MFN) basis. The FTZ program allowed U.S. companies to eliminate duties on components that are re-exported from their zone, and defer or reduce duties on merchandise that enters the U.S. market. This allows those companies to compete more effectively against their foreign competitors, increasing the incentive to keep or re-locate production and distribution activity in the United States, rather than moving that activity abroad.

Under the responsible stewardship of the U.S. Foreign-Trade Zones Board, the program has modernized and thrived throughout the years. Today, more than 3,000 companies employ 390,000 workers to produce and distribute a range of goods in zones located throughout the United States. In 2013, FTZ activity again reached record highs for merchandize received ($835.8 billion), exports ($79.5 billion), and employment.

But although the program continues to deliver huge benefits, FTZ-user companies and their American workers are finding themselves increasingly at a disadvantage when competing against products made in countries that have entered free-trade agreements with the United States. While final products made in FTA-partner countries typically enter the U.S. market duty free, comparable goods made by U.S. workers on U.S. soil in an FTZ can still face significant duties.

The core purpose of the FTZ program has been to put U.S. producers on an equal footing compared to their foreign competitors when paying duties on imported materials and components. The international auto sector in the United States is a prime example. A foreign-made car imported to the United States is subject to a 2.5 percent duty, including all its foreign-sourced components. Yet a vehicle made in the United States can contain key imported components subject to duties higher than 2.5 percent, imposing a cost disadvantage on U.S. production. These “inverted duties” on intermediate inputs create an unintended but very real incentive to locate the entire production process offshore.

By locating in an FTZ, a producer can elect to pay the lower duty on the final product for all foreign-sourced components in the vehicle. This inverted-duty relief is a major reason why foreign-owned automakers such as BMW, Mercedes-Benz, Nissan, and Toyota have located their U.S. production facilities within foreign-trade zones.

What has changed in the past 30 years is that now American or foreign-owned automakers can produce vehicles in a country that has signed a free-trade agreement with the United States, such as Mexico, and then export the vehicles to the U.S. market, duty-free, as long as they qualify under the agreement’s rules-of-origin standards. The result is that a car manufactured abroad receives more favorable duty treatment than one made on American soil in a U.S. Foreign-Trade Zone. Surely this is not what a bipartisan succession of presidents and Congresses intended when they negotiated and ratified these agreements.

The National Association of Foreign-Trade Zones believes it is time for federal policymakers to recognize and document this disparity and work toward a realistic remedy. Some have suggested the FTZ Act should be amended to allow producers in a U.S. zone to qualify for the same duty-free treatment as comparable final products made in an FTA-partner country. Under that proposal, any car or other product made in a U.S. FTZ would qualify for duty-free entry if its FTA-country counterpart also qualifies for duty-free entry.

A related remedy is also long overdue to level the NAFTA playing field for Foreign-Trade Zone-based companies. NAFTA is unique among U.S. free-trade agreements in that goods produced within an FTZ are considered outside U.S. customs territory, but within NAFTA. The result is that products exported to Canada and Mexico from a U.S. FTZ must face NAFTA entry duties. Again, the Obama Administration and Congress should take a close look at this unintended consequence and determine whether the NAFTA law should be changed so that goods made within an FTZ that would qualify under NAFTA rules of origin would also qualify for duty-free admission to the NAFTA territory

These suggested improvements would give U.S.-based manufacturers the same duty treatment they can now get by producing in a free-trade agreement country — under the same rules that apply to imports from that country. As a result, U.S. producers would have less incentive to move production offshore and a greater incentive to locate and keep value-added production in the United States. Isn’t that what was intended, all along?

About The Author Daniel Griswold [Full Bio]

Daniel Griswold is senior research fellow and co-director of the Program on the American Economy and Globalization at the Mercatus Center.




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