A Free Trade Primer

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A Free Trade Primer

Contents

Introduction

This mini-wiki provides a brief introduction to the free trade zones, foreign trade zones, free trade agreements and other duty-reduction programs that a large corporation involved in global trade in, or with, the Americas and Asia are likely to encounter. For a much larger list of free-trade agreements, the reader is referred to the SICE: Foreign Trade Information System website. For a complete list of duty reduction programs and free trade agreements that an importer in the United States can utilize, see the USITC web site

Foreign Trade Zones and Sectoral Promotion Programs

In the US, Foreign Trade Zones, which have grown since their creation by the Foreign-Trade Zones Act of 1934, are enclosed areas, operated as public utilities, under control of U.S. Customs with facilities for handling, storing, manipulating, manufacturing, and exhibiting goods. The merchandise may be exported, destroyed, or sent into Customs Territory from the zone, in the original package or otherwise. The advantage of the zone is that, although items shipped from the zone are subject to Customs duties if sent into Customs Territory, they are not subject to customs duties if reshipped to foreign points! Furthermore, the usual formal CBP entry procedures and payments of duties are not required on the foreign merchandise until it enters CBP territory for domestic consumption, at which point the importer generally has the choice of paying duties at the rate of either the original foreign materials or the finished product. Foreign Trade Zones can have a huge impact on your working capital and supply chain financing requirements.

In other countries, such as Brazil, India, and China, foreign trade zones, or their equivalent, are often known as Special Economic Zones, or SEZs (see Wikipedia) . SEZs, and the benefits they offer, vary widely by country, and are implemented using a variety ofinstitutional structures across the world, ranging from fully public to fully private.

In India, the government announced the introduction of SEZs in April of 2000 to enhance foreign investment and promote exports. An Indian SEZ is deemed to be foreign territory for the purposes of trade operations, duties, and tariffs and loosely follow the model introduced by the People's Republic of China. As of 2007, there are over 220 of these zones in India and over 300 additional zones have been proposed.

In the People's Republic of China, SEZs work differently than the FTZs in the US and the SEZs in India. China SEZs are given special policies and flexibile measures by the central government to allow them to encourage foreign investment. The policies allow them to utilize a special economic management system that contains special tax incentives and greater independence for international trade activities. In a SEZ, there is no tax on foreign investor funded companies during start-up years before making a profit, no tax in tax in the first two profitable years, and only half of the normal tax in the third and fourth years.

While the US has Free Trade Zones and India has Special Economic Zones, Mexico has Sectoral Promotion Programs that establish lower tariffs on the importation of inputs for use in the manufacture of various products. To find out which goods, by industry and sector, qualify, a company needs to refer to The Decree Establishing Various Sectoral Promotion Programs, published on December 31, 2000. To be eligibile for participation, the importer must apply to the Ministry of Economy and manufacture a specified end product.

Free Trade Agreements and other duty reduction plans

This section reviews some of the more common free trade agreements and other duty reduction plans that a large corporation involved in global trade is likely to encounter when based in, or trading with, the Americas.

Duty reduction plans differ from free trade agreements in that free trade agreements are bidirectional. Trade benefits are granted to all participants. Duty reduction plans are unidirectional. A developed country grants trade benefits to a developing country.

The buying company should be aware that all of these plans have a content requirement. A defined percentage of the manufacturing content of the product must come from an eligible list of countries. The content requirements and the list of eligible countries are defined in each trade agreement or duty reduction plan.


North American Free Trade Agreement

The North American Free Trade Agreement, or NAFTA, is a comprehensive trade agreement between Canada, Mexico, and the United States which eliminated nearly all tariffs between Canada and the US by 1998 and eliminates nearly all tariffs between the U.S. and Mexico by 2008 and removes many of the non-tariff barriers, such as import licenses, that have historically excluded goods from the Canadian and Mexican markets. The agreement is tri-lateral in nature in all covered areas with the exception of agriculture, in which stipulation, tariff reduction phase-out periods and protection of selected industries, were negotiated bilaterally. The agreement is quite extensive and, in addition to goods, covers Intellectual Property (IP) rights (patents, copyrights, trademarks), cross-border trade in services (including accounting, architecture, land transport, publishing, consulting, commercial education, environmental services, enhanced telecommunications, advertising, broadcasting, construction, tourism, engineering, health care, management, and legal services), temporary entry for business professionals, and government procurement, among other subjects.

Central American Free Trade Agreement

The Dominican Republic-Central America Free Trade Agreement (DR-CAFTA) was created with the goal of establishing a free trade zone similar to that provided by NAFTA which, as was discussed in the last section, currently encompasses the US, Canada, and Mexico. If passed by all countries involved (El Salvador, Honduras, Nicaragua, Guatemala, and the Dominican Republic have all approved; the final country that needs to ratify the agreement, Costa Rica, holding a referendum late in 2007), tariffs on about 80% of US exports to the participating countries will be eliminated immediately and the rest will be phased out over the subsequent decade. Note that Canada is negotiating a similar treaty, which can almost be thought of as a companion treaty, called the Canada Central American Free Trade Agreement, C-CAFTA.

This is an important treaty since it is viewed by some as a stepping stone towards the Free Trade Area of the Americas (FTAA), a more ambitious free trade agreement that would encompass all the South American and Caribbean nations (except Cuba and Venezuala) as well as those of North and Central America.

MercoSur Latin American Regional Trade Agreement

Mercosur, sometimes known as the "Common Market of the South" is the largest trading bloc in South America. Established in the 1991 Treaty of Asuncion between the Argentine Republic, the Federal Republic of Brazil, the Republic of Paraguay and the Eastern Republic of Uruguay, it's goal was to eliminate obstacles to internal trade, including high tariffs, income inequalities, or conflicting technical requirements to bring products to market. However, Venezuala's recent addition to the group puts everything in question, especially considering Hugo Chavez's current drive to nationalize much of the major public industry in Venezuala, including the oil and banking sectors.

Generalized System of Preferences (GSP)

GSP This is a United Nations sponsored program that encourages developed countries to grant reduced duty rates to less-developed countries. The United States, Canada, Japan, the European Union, Australia and New Zealand are among the countries that operate GSP programs. Each importing country or region has its own rules and its own list of eligible countries.

The United States grants duty free treatment for GSP eligible products, and offers this status to more than 200 countries. The U.S. requires 35% of the manufacturing content come from an eligible country. Under the U.S. program, countries that are normally eligible for GSP treatment can lose that eligibility on specific products.

Indian Special Economic Zones

Probably the best place to go for information on Special Economic Zones in India is straight to the Ministry of Commerce & Industry Department of Commerce's website SEZ India. The regulations governing special economic zones in India are rather recent, with the union government policy coming into effect on April 1, 2000, and the new SEZ Act only coming into effect in 2005.

As hinted in the introduction, Special Economic Zones in India allow the government to experiment with radical (at least with respect to India) economic reform in a sufficiently large geographical area, but on a localized basis. Thus, regulations, as well as advantages and disadvantages, can vary on a zone by zone basis. The primary benefits available from such zones are exemption from customs and excise duties for authorized operations approved by the government.

Some of the zones currently in operation include:

China Special Economic Zones

Special Economic Zones (SEZs) established by the People's Republic of China are development zones set up to encourage foreign investment in China, bring jobs, technical knowledge, and future tax revenues in return for significant tax concessions at the start-up operational phase. The primary difference between a China SEZ and FTZ is that whereas your average FTZ eliminates import duties and tariffs, an SEZ eliminates taxes for a start-up operation before the operation actually makes a profit.

Currently, there are Special Economic Zones in:

  • Guangdong Province
  • Fujian Province
  • Hainan Province
  • Hunchun Province
  • Pudong Development Zone (Shanghai)

Author(s)

Michael G. Lamoureux, Ph.D. of Sourcing Innovation

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