by John F. Di Leo
October 3, 2018 A.D.
Bringing it in just under the wire, negotiators representing Mexico, Canada, and the United States announced a new trade deal, to be named the USMCA, on Sunday, September 30, enabling the replacement for NAFTA for which many have long clamored.
With the agreement to switch to this new program, the three nations are taking some steps – however small – back in the direction of the goals that Free Trade Agreements have always promised to support, but which have been largely forgotten in the quest for their side effects.
Free Trade Agreements, in fact, are not designed to reduce taxes and increase inexpensive imports. These may be benefits, certainly, for business and consumer alike, but they are really, primarily, just the incentives used to make some progress in obtaining the main goal: slowing or even reversing the ongoing loss of domestic manufacturing to third world competitors.
There was a time when the United States were a veritable powerhouse of manufacturing might, the greatest example of the industrial age on the world scene.
Generations ago, however, this position was lost, as American taxes, regulations, labor, and other political obstacles drove American businesses to look elsewhere for a home, and other countries both near and far turned out to be much more welcoming.
As the decades wore on, we lost manufacturing to Mexico and Japan, then Hong Kong and Singapore, then China and India. Many chose to blame those new destinations for our losses, forgetting that our own federal, state, and local governments were at least partially responsible for driving away our factories in the first place. Rather than trying to reduce the taxes and regulations that drove our jobs into the welcoming arms of distant countries offering lower-cost workers and less burdensome regulations, we tended to complain about the situation, and look for other solutions.
America’s first reciprocal Free Trade Agreement, the one with Israel, was implemented in 1984, and was based on earlier one-way duty-reduction programs such as the Generalized System of Preferences and the Caribbean Basin Initiative. These earlier programs encouraged generous countries like the USA to buy goods from third world beneficiary countries, in order to help those struggling countries to develop their nascent economies. The rules of origin in these agreements were designed to ensure that products only got this duty-free benefit if they truly deserved it, by being locally grown or by being manufactured from a preponderance of local materials and local labor.
So when we started having reciprocal Free Trade Agreements (FTAs), we promised to do the same here: these duty reductions and duty-free status were only to be granted to goods that deserved them.
Mathematical tests, known as the Rules of Origin, were written for these FTAs, and the governments signing the treaties required that manufacturers study their bills of material, their costs, and their purchased parts, and perform an analysis to determine whether their products deserved them or not. Some products could perform a Regional Value Content test, others could perform a Tariff Shift test… there are many tests with many different targets… all were designed to set what the regulators hoped would be reasonable thresholds for domestic content.
- If a product deserved it, the vendor could issue an FTA certificate… and the customer would be able to import the product duty-free.
- And if the product didn’t deserve it, then they could still sell it, and the customer could still buy it… it just wouldn’t enjoy the duty free benefit… because it doesn’t deserve it.
The real goal with an FTA – the true, key purpose – is to encourage more domestic sourcing and labor by our domestic manufacturers.
If we make a car here… or a pump, or refrigerator, or washing machine, or anything else… then that’s nice. But if we make it by assembling purchased parts that were all made in China, India, Japan and Singapore, then has that really helped our economy enough to reward it by giving it a duty-break?
These rules of origin were meant to encourage domestic manufacturers to resist the temptation to buy their raw materials and components from foreign suppliers. These rules were designed to encourage us, not only to make our finished products here, but to also give more business to our fellow domestic manufacturers, our neighbors up the supply chain – the makers of steel and aluminum, the molders of plastic, and the big and small factories making motors and seals and fasteners and compressors.
The more parts we import, the less likely our finished product would be to qualify for the program, so if our manufacturers understand these rules, the desire to participate in the program would encourage our factories to forge relationships with domestic suppliers of these raw materials too. It would be a ripple effect, with every qualification effort creating more and more market opportunities for other domestic manufacturers.
Unfortunately, somewhere along the way, this message got lost. In the NAFTA debates, 1990s politicians focused on the duty reductions as an invitation to import, and never really educated the public – particularly the business community – about the program’s effort to create demand for domestic production.
As a result, we have seen companies claiming FTA benefits by issuing FTA certificates of origin – not just for NAFTA, but for every other FTA too (we have them with 20 countries now, from big trading partners like Canada and Australia to small trading partners like Israel and Morocco) – without even knowing that such a thing as “rules of origin” exist… much less knowing that every agreement has completely different tests, so some products that would qualify for some agreements would fail the tests of other ones.
So, for all these years, both our Customs service and the Customs ministries of the other countries involved perform their random spot checks, their occasional audits, and they discover, again and again, that companies are issuing certificates in complete oblivion about the rules that govern such things.
When Customs finds that a company has been issuing these certificates on products that don’t qualify, that means their customers have to pay duty… retroactively… often going back several years. Plus interest. Compounded. Sometimes, plus other penalties as well. These audits can be both painful and expensive… and it sure doesn’t make a customer happy when he finds that your bad documentation caused him to be audited and fined.
This new agreement, the USMCA, nicknamed NAFTA 2.0, has built rigorous enforcement rules into the program. The negotiators expect both sellers and buyers to fully understand the process for qualifying for these agreements, and they will hold claimants’ feet to the fire when questionable documents are found.
This new USMCA has many high profile issues that have caught the mass media’s attention, such as these, for example:
- Robust intellectual property protections,
- Reduction of Canada’s unfair barriers against American agricultural products, especially dairy,
- Prohibition of our partners’ current discrimination against American financial services providers,
- A new salary requirement for the automotive industry, requiring that 40 to 45% of auto content must be made by workers who are paid at least $16/hour, for the autos to qualify.
But it also provides for greater enforcement measures than ever before, and new regional value content rules on many products.
These enforcement enhancements require that all manufacturers take a fresh look at their processes, and see whether they have FTA systems that would stand up in an audit. Not just FTA, but origin determination, Customs value, and Harmonized code classification processes, robust enough to ensure that their documents will be defendable when audited.
Every company, domestic or international, that ever wants to issue an FTA certificate to a customer – whether for NAFTA or USMCA, or any of the many other such agreements that we have with South Korea, Chile, Panama, Israel, and so many others – much have a solid process in place. Do we demand origin data from all our vendors every year? Have we built a computer tool to produce an analyzable worksheet to check the rules of origin? Do we have an internal “delegation of authority” rule for signing trade documents, ensuring that only people who understand these things can sign an FTC declaration, and banning salesmen, clerks, and middlemen from “helpfully” signing unauthorized documents for non-qualifying products?
American business is right to rejoice at the news of the USMCA. The protections and opportunities it provides are valuable and welcome. But American business also needs to recognize the challenges that the program delivers. Those of us who don’t yet have a robust process will need to develop one, and soon.
In the final analysis, a free trade agreement is still a tax cut, one that is dependent on somewhat complex requirements. Every business – from manufacturer to distributor, from mom-and-pop shop to multinational corporation – needs to implement a process that ensures accurate claims that will satisfy the Customs agents of 20-plus countries.
Put to use as intended, this program could deliver a rebirth in our manufacturing sector, as it brings home the manufacture of so many of the component parts that we lost to the third world over the years.
So, yes, the manufacturing world can certainly meet these targets and deliver the economic benefits intended, if they know that they need to. But how many businesses even realize that they’ve been missing these rules all these years? How many truly understand what is involved in utilizing an FTA in the first place? This is obscure stuff, almost never even mentioned in business school. The first time many companies ever hear of these rules is when they find themselves facing their first audit, or even their first fine.
The education of the business community needs to be as much a part of this ratification process as anything else.
Ben Franklin was famously asked, after leaving the Constitutional Convention, what kind of government they had settled on, and he replied:
“A republic, if you can keep it.”
A similar condition applies to this new free trade agreement (and likely, to all new and revised agreements yet to come, as well).
What has the American economy been given?
A lifeline, if we can qualify for it.
Copyright 2018 John F. Di Leo
John F. Di Leo is a federally licensed Customs broker who has been training companies on how to comply with free trade agreements and other areas of Customs compliance for over a dozen years. Also a Chicagoland-based actor and writer, his columns appear regularly in Illinois Review.