By John F. Di Leo -
The short version – the one we know from the mainstream media (MSM) – is as follows: The TPP is a terrific trade deal which would increase our economic activity on both sides of the Pacific, and which might be the greatest lasting victory of the Obama administration. It involves some unsavory compromises, but the benefits far outweigh them, if the administration is to be believed.
And that may be true. But it may also be very wrong. The fact is, the Trans Pacific Partnership is a massive agreement that changes the entire scope of international trade policy, and merits at least as much critical analysis as did NAFTA, which – if you recall – we spent virtually an entire year fighting over, back in the early 1990s.
If we accept it, this agreement will alter many of America’s approaches to international commerce, not just between these twelve countries, but worldwide. And it doesn’t just affect exporters and importers either; this program affects manufacturers with completely domestic clienteles, and likely does much more that nobody has even predicted.
To begin to analyze the TPP, we first have to consider how import/export business is done, how all other Free Trade Agreements (known as FTAs) operate, and what their real purpose is.
International Trade 101
For as long as there has been international trade – thousands and thousands of years – government officials have charged taxes, known as duties, on goods arriving from abroad. (Nowadays, most countries tax their exports as well; we’re luckily exempt from that in the USA, thanks to a deal cut by Gouverneur Morris and Roger Sherman during the Constitutional Convention).
These taxes probably started out very simply: one shekel for every ten shekels of value, or one shekel per barrel of mead or bushel of grain. But over the centuries, it got more complicated. Countries would charge a higher duty on wine than on beer, or a higher duty on corn than on wheat, and the regulations grew and grew to fill notebooks, then handbooks, until by the mid-20th century, every country’s import book was a few inches thick.
Today, we don’t just have different duty rates for fasteners than we do for motors, we have pages of duty rates for different types of steel fasteners, and pages of duty rates for motors. Here in the USA, an imported steel screw over 6mm in diameter carries a duty rate of 8.5%, while a steel screw with shanks less than 6mm in diameter carries a duty rate of 6.2%... and steel bolts carry a duty rate of 0%, so they’re considered “unconditionally duty free," while steel coach screws and other steel wood screws are a whopping 12.5%. They might be much higher, or much lower, in any other country on earth (in fact, we tend to have low duty rates in the USA, compared to most other nations).
Every country has similarly complex breakdowns, for reasons that do make sense in today's economy, or for reasons that made sense a century ago but no longer do, or even for reasons that never made sense, and nobody has a clue of why they were established in the first place. Duties can range from zero to forty or fifty percent, sometimes even more, depending on each country’s level of protectionism. These ranges of duty are simply amazing.
But we’re stuck with them, and if we get it wrong and underpay our duty, it looks like tax fraud to the government, and can be prosecuted as such. Companies must hire licensed Customs brokers, and sometimes international trade lawyers as well, to help them navigate this maze of regulations.
There are significant costs in international trade – freight is expensive, the Customs export and import filings can be expensive, requiring bonds and insurance and time (SO much lead time!), and risk of transport damage, and risk of pilferage, and lots of government risk – so these import duties are only part of the cost of international trade. With some products, the duties are hardly noticeable; with others, they can be the primary cost. Depends on the product; depends on the trade lane.
Early Trade Agreements
By the 1970s, the developed world was interested in finding a way to help the undeveloped world, so the G-7 came up with the concept of one-way trade promotion programs that would encourage first world countries to import goods from the third world, in hope of helping establish growth economies there. The first such program was the Generalized System of Preferences (GSP), and was followed by several others, such as the Caribbean Basin Initiative, the Andean Group Promotion, the African Growth and Opportunity Agreement, and others, all still in place today.
The idea was that when we imported some things from those countries – not everything, just certain things, and only if they deserved it – then, if the products were provably sufficiently locally-produced and locally-grown in the beneficiary country, they would be duty-free when we imported them. Over 140 countries benefit from such agreements. So, not everything from these countries is duty-free, but much is.
They didn’t want Rwanda or Burkina Faso to just import a product from Japan and then repackage it and get the duty-break, so the regulators worked out a simple analysis requirement. The vendor has to do a calculation to prove that locally-produced materials and local labor constitute at least 35% of the price; imported parts and profit count against you. This simple requirement has been in place now since the first such program, the GSP, commenced operation in 1974. It’s been a win-win; that difference of a few percent of cost might get these struggling countries a bit more of an economic foundation from which to grow, and the importers might get the products a bit cheaper (though the cost of freight and other risks are still a mighty burden).
The Free Trade Agreement
By the 1980s, the USA began to think to ourselves, if this is such a good concept working one-way, wouldn’t it be even better working both ways?
And we began to look into the idea of the reciprocal free trade agreement. The beauty of an FTA is that it would help both countries, because our lower duty rate would enable us to import things more cheaply and it would help the partner country increase their exports… and it would enable them to import our goods more cheaply, helping us increase our own exports. Now, THAT’S a win-win.
So our first one – with Israel – went into effect in 1984, and it was based on the same rules as those one-way agreements: the product could have some imported materials and some profit for the manufacturer, but the manufacturer had to prove that at least 35% of his sale price was truly local materials and local labor and manufacturing costs. In other words, to be duty-free, the product had to really employ local people. It had to help develop the member countries' economies.
The concept worked so well with this little trading partner, the Reagan administration negotiated a similar deal with our biggest trading partner, Canada, and that one went into effect in 1989. And that one was expanded into a three-party deal in 1993 when we added Mexico, replacing the US-Canada FTA with the North American FTA, known as NAFTA.
For this new agreement, we needed new and different rules, much more complex than the simple “35% of sale price” rule that was sufficient for earlier agreements.
What if a product had tons of local labor, but relatively little in the way of materials? What if a product had tons of local materials, but very little labor? The regulators wanted to find a way to make sure that everything that really deserved the duty-free benefit would get it, but to also exclude things that really didn’t have enough local input to deserve it. And by now, they were also realizing that punishing profit was a downright un-American idea, so they wanted to find a way to ensure that the deal didn’t artificially keep prices low, punishing the manufacturer.
So the NAFTA process ushered in a whole set of complex new Rules of Origin. Some products qualify because they pass the De Minimis (Tariff Shift) test, some because they pass one of several very different Regional Value Content (RVC) tests. Some products are allowed to go through three tests, many products are only allowed one shot at it, with just a single test to pass or fail.
There are people who are incompetent, and just assume qualification for these agreements because they think “well, we made it, didn’t we?” – and such companies suffer severely when Customs audits them or their customers. They have no analysis records to produce for Customs, and suffer massive penalties as a result.
It is a complex process; obtaining a duty-free benefit shouldn’t come easily, and if you do it right, you only claim the benefit if it is deserved. Manufacturers typically find that one quarter to one third of the products that they genuinely do manufacture here don’t qualify for many or most of our FTAs. So they issue FTA certificates for the products that qualify, and they warn their customers that the others don’t, so everyone stays on the right side of the law.
Today’s Free Trade Agreement Environment
The USA currently participates in a lot of FTAs… and so do many other countries. Here are ours, at this writing:
The GSP style agreements (one test, 35%, pass or fail)
- US-Israel FTA
- US-Jordan FTA
- US-Bahrain FTA
- US-Morocco FTA
- US-Oman FTA
The NAFTA style agreements (multiple complex tests)
- NAFTA (US, Canada, Mexico)
- DR-CAFTA (US, Dominican Republic, Honduras, Nicaragua, El Salvador, Costa Rica, Guatemala)
- US-Chile FTA
- US-Australia FTA
- US-Panama FTA
- US-Peru FTA
- US-Colombia FTA
- US-Korea FTA (that’s South Korea, of course)
- US-Singapore FTA
Now, there’s a lot to discuss, and a lot to learn, from this list. Perhaps the main issue is the fact that these agreements – from the macro level – don’t make nearly as much of a difference as we might have expected them to. Before all these agreements, Canada was the USA’s biggest trading partner by most methods of analysis; 35 years later, it still is. Before all these agreements were signed, we had relatively little trade with Jordan, Bahrain, Oman, Peru and Colombia, that hasn’t changed significantly either.
The fact is, the main thing an FTA affects is the duty rate, which is only a very small part of the cost of a product. It doesn’t change the freight, the lead time, the quality concerns or the many other taxes involved. An FTA’s duty benefits can help, but they don’t change the world.
Who are we losing the vast majority of our manufacturing to? It’s still China and India, as it has been for decades; that’s not changing anytime soon. And we don’t have an FTA with either of them, do we?
People who blame FTAs on our manufacturing losses over these past two generations are obviously just looking in the wrong place for a scapegoat. FTAs can make a difference, but they aren’t earthshaking.
In fact, FTAs can play an important role in this process, a helpful role, but they have their limits.
The Anti-China Weapon
While nobody really says this out loud, one of the key purposes of FTAs is that, together, they function as a weapon against outsourcing in general, ESPECIALLY to the major “low cost countries” like China.
Think about it. When you make a product here, you’re concerned with the big picture – where you source the parts, where your finished product will be most competitive, the desirability of the “made in…” label. FTAs don’t just affect the cost-competitiveness of the finished product; they also affect the cost-competitiveness of all the parts that go into it.
Let’s say you want to make a product here. A motor, a sump pump, a computer, a molding machine, whatever. Just by manufacturing it here, it can be labeled as a US product, which increases its value versus the same product made in a less reputable country.
But then there’s nothing to control where all those components were made. You could make it here by using foreign steel, foreign plastic, foreign cable, foreign wiring, and still honestly call it “Made in USA of foreign and domestic materials.”
The beauty of the FTA system is that the potential duty-free benefits that come from selling a qualifying product only come if you’ve met a certain threshold of local content and labor. People who want their products to qualify for NAFTA, CAFTA, and the others will therefore take some care in selecting their vendor base.
If you source some parts from Mexico, they’ll help in your NAFTA analysis, but hurt in all the others. If you buy parts from Honduras, they’ll help in your DR-CAFTA analysis, but hurt in all the others. Parts from Australia help only with the US-Australia FTA; parts from South Korea help only with the KOR-US FTA.
The only parts that contribute to passage of all the FTAs in which we participate are local USA parts that come in with their vendor’s certification.
So the wonderful effect of this process is, and has been all along, that the more FTAs we negotiate, the more our manufacturers reap rewards by sourcing their raw materials from domestic vendors... as long as all those FTAs remain separate agreements.
With all the different rules in all these different agreements, only a preponderance of domestically-sourced materials can ensure that our finished products qualify for all the agreements. And with more and more agreements in place, the trend has been to increase this benefit, at least with manufacturing companies that understand the process.
The TPP Turns the Tables
So for thirty years, what have we seen? A gradual progression of ever more FTAs, each of which contributed a bit more to the advantage of manufacturers sourcing their parts domestically. These thirty years of FTAs have helped keep manufacturing here, as vendors make sure to buy at least some percentage of their raw materials from their fellow US manufacturers.
It hasn’t been enough to completely stop the loss of American manufacturing that’s been caused by massive regulations, a litigious legal climate, a unionized workforce, and the highest effective corporate tax rate in the developed world. But FTAs have at least helped; they’ve been a net gain, through rewarding USA manufacturers for buying USA-made raw materials.
The TPP reverses that trend. If the United States joins the TPP (Congress will be considering it during the peak of the 2016 election season), we will be eviscerating this one key benefit for US manufacturers.
Consider: Today, if we find a supplier in Mexico or Canada who’s cheaper for our key components than our US supplier, we know our finished product will still qualify for NAFTA, but we’ll lose the ability to qualify for the US-Chile or US Australia deal. So we hold back, and we continue to use the US supplier. With every new client we get in an FTA partner country, we see more and more advantage to sourcing those parts domestically.
But if the TPP is passed, then those Mexican and Canadian parts will be just as helpful to the TPP as it is to NAFTA… so we WON’T lose the benefit for our customers in Chile and Australia. Or Brunei or Japan or New Zealand, for that matter…
In fact, TPP establishes a new block that undermines this longterm protection for American workers. For the first time, an FTA would reward manufacturers for outsourcing their components abroad. Why not buy your parts from Mexico, if they won’t cost you the business of lots of other customers?
Most of us didn’t worry when DR-CAFTA came out, because none of those countries (sorry, no offense intended, but it’s true) pose a competitive threat for most of the components of our manufactured goods. But everything in politics is precedent, and so by agreeing to the seven-country team of DR-CAFTA, we paved the way for the eleven-country team of TPP.
FTAs – done right, done normally, country by country, all separate – are good things. But an eleven-country FTA will undo a great deal of the progress we’ve made over the years, and jeopardize the sourcing of countless raw materials used in American manufacturing.
Seriously, why buy a switch or a fastener or an electric cord or a steel coil from a USA manufacturer if you can buy it cheaper from a Mexican, Malaysian or Vietnamese supplier, and still know that your finished product will be duty-free for your customers in Canada, Japan and Australia?
Does this really sound like a good idea to anybody?
The Truth of the TPP Choice
The Trans Pacific Partnership is not a new agreement. It is a replacement agreement for a number of existing ones, adding other countries to it. The current version – signed in October 2015 and in the process of being submitted to the member countries’ legislatures – includes the following countries:
- The United States
- New Zealand
Notice anything interesting about that list? We already have FTAs in place with six of these twelve countries. We’re one of them. So that means it only adds five countries to our FTA list, and what are they?
New Zealand, Malaysia, Brunei, Vietnam, and Japan.
Brunei is a tiny Islamic theocracy. Vietnam is communist. Japan is already a substantial trading partner, and we would certainly benefit from doing more business with it. New Zealand is a splendid country, but a small economy. And Malaysia is just another small Islamic developing nation, a potential “low-cost supplier” like India and China, but not yet big enough to make a big deal over.
In other words… the TPP brings us very little new potential trade outside of Japan, and at such a huge cost!
The Obama administration characteristically presents this agreement as a monumental accomplishment, opening up trade barriers and expanding our opportunities on both sides of the Pacific Ocean. It’s hogwash.
In fact, if we reject the TPP:
- We would STILL have NAFTA, the US-Australia FTA, the US-Chile FTA, the US-Peru FTA, and the US-Singapore FTA in place. We wouldn’t lose any of them; they could remain in place for another century. So we would not lose any of that trade if we said NO to the TPP.
- And we can certainly reach out to offer new FTAs to these other countries, one at a time. We could do an FTA with Japan, or one with New Zealand. We can kill this deal and start work on new, separate, better ones with each of the five new countries, tomorrow, if we really want to.
On the other hand, if we say YES to the TPP:
- We would be overturning a 30-year technique that has strengthened American manufacturing of both finished goods and raw materials alike.
- We would be opening the doors to other low-cost country providers – particularly Vietnam and Malaysia – in a way we never have before.
- We would force our manufacturing community to recalculate, re-source and potentially re-target their entire product lines, since many finished products that qualified for some or many of these agreements in the past will lose qualification in the new agreement, making their products bounce from competitive to non, and vice versa.
- And we haven’t even had a chance to study the boatload of other agreements that the Obama administration built into the TPP. We don’t yet fully understand the intellectual property conventions, the environmental and energy use commitments, the currency manipulation rules, the travel and immigration agreements, that this administration has promised but not yet released to the public. No doubt some of these changes will be good for many of us; no doubt others will be very destructive indeed.
Knowing what we already know of this treaty (yes, all free trade agreements are treaties), it is a bad idea for America. Even trade experts who generally favor FTAs (including this writer) must admit that the concept of the FTA is no longer beneficial at this size. Such an FTA rewards outsourcing to the lowest-cost country in the partnership, so just as NAFTA was especially helpful to Mexico, this TPP would be especially helpful to Malaysia and Vietnam.
Now, why would the Obama administration push a trade deal that’s most beneficial to Islamic theocracies, and bears so much risk for the United States?
Perhaps just because it’s what they do. Perhaps just because they like evening out the playing field across the world, like good little socialists, and pulling down the successful to the level of the unsuccessful is how they like to do it. Perhaps because they’ve been unsuccessful at passing the Kyoto accords or carbon credits or immigration amnesty, and they found a way to embed much of this leftist claptrap into an FTA.
There are a lot of possible explanations, more of which will surely become evident in the months to come.
But all we need to know for sure, today, is the basic issue: it’s a trade agreement; is it good for our trade?
And the answer is clearly NO.
Congress will get the chance in 2016 to vote on this, and there is only one possible answer. As more and more comes out about this millstone, it will only become more and more obvious.
Copyright 2015 John F. Di Leo
John F. Di Leo is a Chicago-based writer and international trade compliance trainer. A licensed Customs broker, he has been employed in the import/export world in various ways for almost forty years.
Permission is hereby granted to forward freely, provided it is uncut and the IR URL and byline are included. Follow John F. Di Leo on Facebook or LinkedIn, or on Twitter at #johnfdileo.