Another Trade Policy Gone Wrong

A prominent big box retailer recently asked the Department of Commerce for a reduction in the duties on imported pet leashes because they claimed that no one makes them here in the US.  I considered that odd since my company, based in Rhode Island, makes them by the thousands every year.  And if I weren’t paying attention, the retailer would have been able to get the duties reduced or eliminated.  This is a real world example of how trade policy made in Washington DC goes wrong and how it has a direct negative impact on US manufacturing.

By now you’re probably wondering what policy would allow this to happen.  The answer is something called a Miscellaneous Tariff Bill (MTB).  Ironically, MTBs were created to help US manufacturers.  Their purpose was to allow manufacturing companies to more cheaply import parts that were not available from US vendors.  Sounds like a good plan, doesn’t it?

So how does a big box retailer end up with the wherewithal to import finished products with reduced or eliminated duties?  Quite simply, there’s no one minding the store.  The MTB process should be reserved for prime US manufacturers (not big box retailers) who are sourcing inputs (not finished products) that are unavailable domestically.  Instead, it appears that any type of company can request the reduction of duties on any type of finished product.  And in the event that the US based manufacturer of that product isn’t combing these MTBs to figure out who is requesting reduced duties on what, we end up with situations like mine.  Of course, that means that I have to pay attention every time an MTB is posted and spend my time carefully perusing it, instead of running my company.

Earlier this month, I was on Capitol Hill spreading the word about how this policy designed to help manufacturers was, in some cases, hurting us.  I’m hoping they listened and will get it right this time.

Why the Primary Arguments Against the Border Adjustment Plan are Wrong

Yesterday, I explained why the border adjustment plan is a good idea, particularly for US manufacturers.  Today, let’s look at the two major arguments against the plan – that it’s too complicated, and that it’s a regressive tax, particularly on lower income people.  Here’s why those arguments are wrong.

First, let’s address the idea that the plan is too complicated.  Now, I’m neither an accountant nor an economist; I just run a manufacturing company.  And since I was an English major in college, my mathematically-minded wife has jokingly referred to me as having a “fluff” degree.  So numbers are not my strongest suit.

But the central idea in the plan – that you would no longer be allowed to take a business deduction for the expense of imported parts – simply isn’t that complicated, even for someone like me.  Conversely, if you export products or parts, the value of the exports would not be considered taxable income.  So the border adjustment plan isn’t actually a tax – it’s a change in the tax code.  For those companies that manufacture in the US, taxes would actually go down.  The CFO of our manufacturing company grasped it in about two minutes (it took me about ten).  The best explanation I’ve seen is from the Wall Street Journal.  Here’s the link:

http://www.wsj.com/graphics/border-tax/

Multi-national companies that do a lot of importing are, of course, opposed to the plan because it will cut into their profits unless they begin sourcing more in the US.  Fair enough.  But when I read that they’re opposed to the plan because it’s too complicated, I chuckle a little bit.  They can pay millions of dollars to accountants and attorneys to maximize deductions and profits, but they can’t figure this out?  I’m not convinced – and I don’t think most people who take a look at the plan will be convinced either.  It’s just not that complicated.

The second argument against the border adjustment plan is that it’s a regressive tax on consumers, especially low income consumers.  Tough to argue with this one, since – over the short term – prices on imported goods are likely to rise.  So lower income consumers, given that their income remains the same, would be forced to spend a higher percentage of that income on basic necessities.

Let’s first consider the source of this argument.  It’s coming from a group named Americans for Affordable Products, comprised primarily of importing big box retailers like Walmart.  I expect that Walmart’s objections have more to do with how the border adjustment plan will affect their bottom line and disrupt their current overseas supply chains than it is about keeping products affordable for those with lower incomes.  But that argument on their behalf won’t win the day, so I think part of their strategic calculation is to scare the heck out of us, and elicit sympathy for Walmart (of which they don’t get a lot). I’m not saying that the Walmart folks are bad people; only that their job is to protect their company’s bottom line by maintaining the status quo.

But let’s grant the assumption that prices on imported products rise, and we pay a little more until the marketplace adjusts to sourcing more US manufactured goods.  What I’ve not yet heard mentioned by Americans for Affordable Products is the effect of the border adjustment plan on US manufacturing jobs.  It’s important to note at this point that both the labor force participation rate and real median household income in this country remain lower now than in 1999; which is, not coincidentally, the year that Congress granted China permanent normalized trade relations status and the massive wave of offshoring manufacturing jobs began.  The border adjustment plan would make it more profitable for companies to source domestically, which would clearly boost U.S. manufacturing jobs.  Since the job multiplier effect is higher for manufacturing than for most other industries, many lower income people would be trading slightly higher prices on consumer goods for a decent paying job.  Ask around and you’ll find out they’ll take that trade.

Granted we’ve got a lot of work to do as a country to ensure that people are adequately trained to fill those jobs.  And that’s precisely what our education system is for, right?  But that subject, my friends, is for a different blog post.

Why the Republican’s border adjustment plan is a good idea

The Border Adjustment Plan in the House Republican’s tax reform package won’t cause apocalypse.  Really, it won’t.  But that’s not what you’ll hear from the big box retailers and multi-national brands that are unleashing the attack dogs to kill it.  If you listen to those folks, it will cause rampant inflation, the collapse of the world economy, and we’ll all be living in the streets.  Now, I do understand their point of view.  They’ve built their business model on geographically extended supply chains that continuously sniff out the lowest cost overseas producer.  That model won’t be as profitable if the Border Adjustment plan is enacted, so it will adversely affect their businesses – but it won’t cause apocalypse.  In fact, it would be the first meaningful step taken by any presidential administration in decades to help level the playing field for U.S. manufacturers.

Why is the Border Adjustment Plan a good idea?  First, it’s not a tariff, which is basically a tax applied to imported goods.  Tariffs are a red flag for the World Trade Organization (WTO).  If we applied tariffs to goods imported from China, for example, the WTO – which can’t seem to find China at fault for much of anything – would take about ten seconds to decide that the U.S. is violating WTO guidelines.  Some might say we should assess tariffs anyway and ignore the WTO.  That would make me feel good, too, but why take the hard road when there’s an easier way?

The Border Adjustment Plan simply changes the way U.S. companies calculate their income taxes.  It’s not complicated.  Instead of a company taking a business expense deduction for everything they buy, they would no longer be allowed to take a deduction for what they buy overseas.  Will they now pay more taxes to the U.S. government if they import a lot of stuff?  Sure they will, but that’s precisely the point of the plan.  It’s why Walmart, Target, et al are circling the wagons.  But, I’m guessing those companies will find ways to stop doing so much of that and start buying more goods domestically.  They’re smart people; they’ll figure it out.  Also, since the Border Adjustment Plan is similar to the value-added tax that many countries already assess, there is a less of a chance that the WTO will raise a ruckus.

Another great thing about the Border Adjustment Plan?  It is part of a House Republican tax reform package that will reduce the corporate tax rate from 35% to 20%.  Of course, the big box retailers and multi-national brands love that part of it.  If you asked them they’d probably say, “Let’s kill the Border Adjustment Plan and keep the lower tax rate.”  I told you they were smart people, didn’t I?  But they shouldn’t be allowed to have it both ways.

Third great thing about the Border Adjustment Plan?  Because it is part of the proposed House tax reform package, there’s a good chance, if Trump gets behind it, the plan would make it through the House.  There would be tougher sledding in the Senate, but then it would be time for the “Great Negotiator” to do his thing.

Fourth and best reason the plan is a good idea?  It would provide a boost for U.S. manufacturers who have been playing on a wildly skewed field of battle.  I can tell you from personal experience that those of us who have survived the last 35 years are lean, mean and ready to rumble.  Imagine what we could do if we were allowed to fight overseas competition with two hands instead of one?

Trump’s 45% Tariff Proposal, and the History of the “Misguided Trade Policy” Forest

Money Magazine columnist Marc Bain recently wrote an article criticizing President-Elect Trump’s proposal for a 45% tariff on goods imported from China.  His analysis included a mathematics lesson and a bit of bluster about how this would raise the price of Chinese made goods.  Well, we didn’t need a math class to figure that out.  But, by focusing exclusively on Trump’s 45% tariff, Mr. Bain misses the forest for one tree; which is exactly the type of economic orthodoxy that got us into this mess.  So, to provide a bit of context for the President-Elect’s proposal, here’s the history of the “Misguided Trade Policy” forest:

In the 1980’s, Wall Street began placing higher valuations on “asset light” companies, according to a 2013 report from the MIT Taskforce on Innovation and Production. This gave larger U.S. based manufacturers an incentive to move production offshore. But the resulting offshoring was somewhat limited because no single country had the infrastructure and labor force to take advantage of the new environment – other than China.

However, in the ’80s and ’90s, China had not yet been granted “permanent normalized trading relations” (PNTR). Each year, Congress voted on whether China would have the benefit of normalized trading relations (hence, not yet permanent). This uncertainty restrained large U.S. based manufacturers – and buyers – from making investments in Chinese production capability.

When the U.S. granted PNTR to China in 1999, the offshoring ball began to roll downhill. China’s entry into the WTO in 2001 – facilitated by the U.S. – was when that ball rolled off a cliff and we lost over 3 million manufacturing jobs to China. Why did the U.S. push for China WTO entry? Because large multi-national manufacturing companies and big box retailers were lobbying for it. And conventional economic wisdom (and the Clinton administration) believed that China would adhere to its WTO commitments (including guidelines on pollution, labor standards, currency manipulation, etc.). We all know how that has gone.

In spite of this history, economic pundits and politicians still labor under the assumption that trading manufacturing jobs for cheap imports will raise our standard of living. It is important to note that real median household income in the U.S. trended downward over the course of several years after China was granted PNTR in 1999, and still remains below 1999 levels even given last year’s 5% increase (according to figures from the Federal Reserve Bank of St. Louis). Also, when did the labor force participation rate peak in this country? Yup, you guessed it; 1999.

That, my friends, is the history – and the sad result – of the “Misguided Trade Policy” forest.

So my analysis of Trump’s proposal for a 45% tariff on Chinese-manufactured goods is that he is staking out a negotiating position that will be used to address the root cause of the problem – China flaunting WTO rules and forcing U.S. manufacturers to compete on a highly skewed playing field. And, as the CEO of a small manufacturing company, I’m not even asking for a level playing field, just a fighting chance. Perhaps President Trump can give me – and others – that chance.

A Real World Case of a Skewed Playing Field

If you were a sprinter and competing with someone who took drugs that allowed them to run four times faster than you, would you consider it fair?  Most small to medium-sized U.S. manufacturers competing with China are in exactly that position.

Those of you who have read my book know that I’m the CEO of a small manufacturer that competes with China every day.  My company, Trans-Tex, is not in what one would normally call an “advanced” industry.  We manufacture dye sublimated lanyards, which you might receive if, for example, you are an attendee at a trade show.  The lanyard is used to hold the badge that bears your name.  Search online for “images of dye sublimated lanyards” to see examples.

Recently, we bid on a government project for a significant number of lanyards.  We lost the bid to China because they bid 75% less than we did.  The lanyard they make overseas will not be of the same quality that we manufacture.  However, even given the difference in the quality of the parts and printing, the fact that a China manufacturer can make that lanyard at ¼ of our cost illustrates the huge gap in manufacturing costs between a U.S. manufacturer and a China manufacturer.  What accounts for the gap?  Extremely low wages, lax to non-existent enforcement of weak environmental laws, and generally bad working conditions, to name just a few of the reasons.

Although the bid was issued under “Buy American” provisions, the pricing gap was so substantial that the GPO (Government Printing Office) was able to award the bid to China under a loophole that allows for overseas purchases if the government would be forced to pay “unreasonably high costs” by buying domestically.

Despite such handicaps, we’ve become successful at Trans-Tex by following the American Dragon principles of FEWER, FASTER, and FINER.  Because we’re competing with China manufacturers that specialize in low cost and long production runs, we focus on shorter, more customized production runs, speed to market, and good quality safe products.  That focus has allowed us to quadruple in size during some of the worst economic times since the Great Depression.

That being said, the playing field – in spite of increasing costs out of China – obviously remains heavily skewed in China’s favor.  And China’s trade policy is to keep it that way.  Job One for the new Trump administration is to reset U.S. trade policy to protect U.S. manufacturers in the same manner that Beijing protects theirs.  And I’m not even asking for a level playing field – just give me a fighting chance.

Bad Trade Deals and the Flint Water Crisis

You might think that the drinking water crisis in Flint, MI, is unrelated to the decrepit state of roads and bridges in your state.  Well, think again.  Both problems are the result of a lack of available resources to update infrastructure that is decades old.  Why the dearth of resources?  The massive offshoring of manufacturing jobs over the last 25 years has eroded our tax base.  In a nutshell, we’ve traded good-paying manufacturing jobs for access to cheap imports.  It’s a bad trade-off, and it has left us with a tax base that does not provide enough money to rebuild or maintain infrastructure.

How did we get here?  One of the major culprits is bad trade deals.

For decades, politicians have operated under the false assumption that if we import cheaper goods it will raise our standard of living.  So they pursued trade deals that opened up our markets to imports, and created a wildly tilted playing field that placed US manufacturers at a grave disadvantage.  The ultimate result was the offshoring of over five million good-paying manufacturing jobs since 2000, with over two million of those lost to China alone.

Keep in mind that the US granted China Permanent Normalized Trade Relations status in 2000 and facilitated their entry into the World Trade Organization the following year, unleashing a flood of cheap imports to our shores.  How has that worked out for us?  Since 2001, real median household income in our country has gone down, according to data provided by the Federal Reserve Bank of St. Louis.  Household income peaked at $57,843 in 1999 and was only $53,657 in 2014.  Thus, importing cheaper goods at the expense of good manufacturing jobs has actually lowered our standard of living.

But isn’t the latest news on employment gains positive?  After all, job data released by the Bureau of Labor Statistics shows an increase of 150,000 jobs in January 2016 and a drop in the unemployment rate to 4.9%.

Let’s take a closer look at those employment numbers.  What has replaced good-paying manufacturing jobs?  Jobs in service industries.  Of the jobs created in January, over 70% were in retail stores and restaurants.  This is not to denigrate the hard working people who need those jobs, but it’s no great secret that service industries pay less than manufacturers.  The Benefits of Manufacturing Jobs, a May 2012 report released by the Department of Commerce, concluded that total compensation for service jobs is 17% less than in manufacturing.  Lower wage levels means less total taxes paid, and less money to spend on our rapidly deteriorating infrastructure.

Yet, we learn little from our past mistakes.  The Obama administration is pursuing a new trade deal, the Trans-Pacific Partnership, that once again throws manufacturing under the bus.  Shortly after the text of TPP was released, the Wall Street Journal cited an analysis from the Peterson Institute for Economic Analysis estimating that TPP will lead to an additional $10 billion deficit in US heavy manufacturing, and an additional $20 billion deficit in light manufacturing.  Perhaps this explains the Department of Labor’s December 2015 projection that we will lose another 800,000 manufacturing jobs by 2024.

If our manufacturing base continues to erode, we will pay an increasingly higher percentage of household and business income on taxes and fees to rebuild roads and bridges.  And we can expect more tragedies like the drinking water crisis in Flint, MI.

How Trade Agreements Come Back to Bite Us – China’s Market Economy Status

You’ve heard it a thousand times.  The devil is in the details.  Nothing proves that point more than China’s insistence that, in December 2016, WTO countries – including the US – must grant them market economy status (MES).  Why is this detail such a devil?  Because if China is granted MES, it will lead to the massive dumping of excess China manufacturing capacity into the US and other countries, further eroding our manufacturing base.  To understand how we find ourselves in this predicament, we need to go back to 2001.

At the turn of the new millennium, the US facilitated China’s entry into the WTO.  As a direct result, we lost over 2 million manufacturing jobs in this country.  By manipulating their currency, paying manufacturing workers extremely low wages, putting those workers in often substandard or unsafe working conditions, and directly subsidizing state-owned enterprises, China was able to undercut the prices of US manufacturers and flood the US with cheap imports.  The net result is a trade deficit with China that ballooned from $84 billion in 2000 to $366 billion in 2015.

With the Chinese economy now in a skid, Beijing, afraid of labor unrest, is doubling down on this strategy, and subsidizing factories to keep producing even when there is decreasing worldwide demand for their factories’ products.  Because of the subsidies, the excess can then be dumped into the US at below market rates, further undercutting domestic manufacturers.

Under normal circumstances, to prove that a country is dumping, one uses the production costs in the dumping country to prove the case.  That doesn’t work with China because so many of their manufacturers are either state-owned enterprises or subsidized by the government.  As a result, because China was not a market economy when it joined the WTO, a clause was added to the original agreement to protect other countries from China dumping by allowing the plaintiff country to use cost comparisons from third party countries to prove their case.

Now, back to the devil.  When the agreement was drafted, a sub-clause was included in that provision which states that after 15 years the exception allowing a plaintiff to use a third party country for cost comparisons expires.  China is arguing that this sub-clause negates the entire clause.  If that is the case, then China must be granted market economy status under WTO rules.  This would open the floodgates to even more dumping by China, and the US would have little recourse.  Others argue, and I agree, that the sub-clause does not negate the entire clause, and that the use of a third party country for cost comparisons is still valid.  So the future of thousands of factory workers’ jobs throughout the country rests in the semantic interpretation of an arcane clause in a 15-year old trade agreement.

This is where Washington DC should draw a line in the sand.  Anyone with a shred of common sense knows that China is not a market economy.  According to Fortune magazine, the top twelve Chinese companies aren’t even privately held; they’re state-owned enterprises.  There are no circumstances under which this administration – or the next one – should grant China market economy status.

Of course, this is also a precautionary tale about TPP.  Are there any ticking time bombs in that agreement?