Oases of opportunity - cutting costs by locating in duty-free zones; includes related article

Nation's Business, July, 1989 by Steven Golob

Oases Of Opportunity

In a perfect world, nations' economies would be equally developed, and countries' labor and other production costs would be comparable. So there would be no need for protective tariffs or other barriers to trade. But in the real world of economic imbalances, countries impose duties, quotas, and other restrictions to protect their weaker industries.

Nonetheless, most of those countries also seek to stimulate trade in products produced by their competitive industries, in part by establishing areas where those industries can operate without paying import duties on the materials they use in manufacturing. The U.S. government calls them foreign-trade zones, and other nations call them free-trade zones.

Within these zones, no duties are assessed, and quotas are not applied to imported raw materials and unfinished goods. Such imports typically are transformed into finished products and then are shipped--also duty-free--to a third country. Or the finished product is shipped to the zone's host country, usually subject to tariffs, though such duties can be lower than the tariffs that would have been applied to the components of the finished product.

Use of duty-free zones here or abroad can be a highly effective cost-reduction tool for U.S. businesses whose products require imported parts or are labor-intensive. Berg Steel Pipe Co., for example, probably would not be in business in the U.S. today if it were not for foreign-trade zones.

Several years ago, Berg Steel Pipe, in Panama City, Fla., was forced by a quirk of the U.S. tariff system to make a fundamental business decision. The firm had been established "to fill a niche in the [American] market for some specific grades and sizes of large-diameter pipe," says Carl Seigler, the company's controller. Most of the steel plate that Berg fabricated into pipe was purchased from U.S. manufacturers, says Seigler, but a substantial percentage of the plate was imported. This put Berg at a severe competitive disadvantage with its foreign competitors because of what Seigler calls "an upsidedown duty."

Known in trade jargon as an inverted tariff, it occurs in instances when the import duty on a finished product is lower than the tariffs on the raw materials or components that go into the product. For Berg Steel Pipe, the duty was 6 percent on steel plate and 1.9 percent on pipe.

Since Berg is owned by West German and French companies, manufacturing easily could have been moved back to Europe, with finished pipe then exported to the U.S. subject to the 1.9 percent duty. But the company chose instead to spend $20.5 million to build a state-of-the-art plant in the general-purpose zone at the Port of Panama City, Fla. This arrangement allows Berg to import steel to the zone duty-free, make it into pipe, and ship it at the finished-product duty rate to the firm's principal U.S. customers--oil and gas producers located along the Texas and Louisiana coasts of the Gulf of Mexico.

Duties similarly hampered the international competitiveness of Smith Corona, of Cortland, N.Y. Several years ago Smith Corona found that the duty on typewriter parts it had to import because they were unavailable from U.S. suppliers was killing the company's manufacture of portable electronic typewriters. Yet fully assembled typewriters from Japan and elsewhere were entering the U.S. duty-free.

Drastic cost-cutting moves a few years earlier had failed to lift the company out of the red. What saved the firm was the U.S. government's designation of the Smith Corona plant as a foreign-trade subzone. This status enables Smith Corona to import parts, use them in typewriters made in the subzone, and sell the finished goods in the U.S.--all duty-free. Today, a healthy Smith Corona is holding its own in competition with Japanese typewriters in the U.S. and may start competing with the Japanese abroad.

Foreign-trade zones have existed in the U.S. since 1934, and their popularity has increased steadily since the early 1970s, says Julie A. Sio, administrator of the nation's largest zone, at Port Newark/Elizabeth, N.J.

Currently, there are about 150 general-purpose zones and 140 subzones in operation, and applications are pending at the Department of Commerce for about 70 more zones. Over 70 percent of the approximately 2,100 companies using these zones are small and midsized businesses, Sio estimates.

U.S. companies of all sizes also have saved on manufacturing costs by having labor-intensive work done at zones in foreign nations, where labor costs are relatively low, before shipping the finished products to customers around the world. Even when the customers are back in the U.S., it still can pay for a U.S. manufacturer to include a foreign zone in the assembly process.

Small and midsized firms often can find service companies within foreign zones that will pick up unfinished merchandise in the U.S., finish the goods in the zone, then ship the finished goods to the U.S. company's customers anywhere in the world.