What Country Actually Manufactured This Product?

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The issue of international trade is in the headlines with the imposition of tariffs by the US administration, followed by reciprocal tariffs from the trading partners of the US. I am in a unique position to comment on international trade issues, because for years I worked for a large multi-national corporation on global supply chain issues. In fact, I helped to implement the computer infrastructure that enabled my employer to minimize global taxes on shipments that went from continent to continent. It makes it very difficult to determine, where is a product actually made? I will try to explain one supply chain I was involved with and hope that the readers can follow the product trail.

This particular supply chain started with an intermediate chemical compound. That is, one that took a good bit of chemistry to create, but was not a finished product. We either produced that material within our company in the US, or purchased it from a third party located in China.

That intermediate chemical was shipped to our affiliated company legal entity in Puerto Rico. This requires an understanding of what constituted a legal entity in our company. A legal entity is a wholly owned subsidiary that is incorporated under the laws of its location. Since Puerto Rico had different tax structures and tax benefits than the rest of the US, we had established a Puerto Rican legal entity for the manufacturing plants we used there. Our intermediate chemical underwent a complex reaction there in order to become an active herbicide. Then the active materials were packaged into bulk containers (mainly drums), and were set to be exported to other locations where they would be formulated into finished products.

But. It was not as simple as shipping directly from Puerto Rico to our locations in France, and Australia. For the product going to the US, it was shipped directly, but for the others, the transaction was done through a legal entity located in Switzerland. That legal entity assumed responsibility for securing the transportation of the chemical and dealing with all customs payments. All in exchange for a markup fee, which raised the price of the active chemical in the formulating location. Since the price at the formulating location is higher than the cost of the chemical plus transportation fees, the Switzerland subsidiary booked a profit. Did I mention that Switzerland has a low tax rate? So for the corporation as a whole, a portion of the profit for the material was taxed at a very low rate, thus benefiting the economics for the company as a whole.

I was involved in the first setup of what were called trading companies. When we in the SAP (SAP = business enterprise software used to transact business globally) group first heard about it, our legal antenna went up, and we specifically asked “Is this legal?” Because to us, this seemed like a lot of work in order to avoid paying taxes in the countries where we really did physical work on the material. We were assured that it was legal, and we went ahead and set up the first of several trading companies. When you hear about the use of low tax countries to shelter profits, this is one way it is accomplished.

So the material has been shipped from the last manufacturing location to the country where it is formulated. The transaction to move the material was handled by the Swiss entity, but the material never touched Swiss soil. Instead, the material was unloaded at our plant in France. Now any agricultural herbicide or pesticide is a combination of one or more active ingredients, blended together with inactive ingredients, or adjuvants. These materials help in the dispersion of the product so that it may be applied, or dissolved within a spray tank, and then applied to farm fields. This process is known as formulation, and can be very involved with may different ingredients involved. The plant in France then packages the material. first in a large container (for us, multiple kilogram containers). Then, for countries close to France, they will package the material into finished products at the French plant which contain all of the country-specific labeling and use instructions, and then the materials are shipped to the countries in pallet quantities for distribution and sales. The trading company is not used for these transactions.

Logistically, it may make more sense to ship the larger containers to another country directly, where it may be transferred to country-specific packaging. Often contracters are used to accomplish this. Where an individual country market is large enough, like Russia or Ukraine, this is the preferred method for the final stage, where a finished product that will be purchased by a consumer is created.

Given all of these steps, where is the product manufactured? You can see that this becomes a difficult question to answer definitively, because with the exception of the trading company, there were manufacturing operations at all of these locations. The first two manufacturing steps where the intermediate was produced and then converted to the active ingredient added the most value to the finished product, but then even that material may have been originally manufactured in the US, or it may have been sourced from China. So take today’s situation – a tariff may be applied to a material if it were sourced from China, but not if it were manufactured in the US. Then a material is exported from Puerto Rico to Europe. Is Puerto Rico considered part of the US for the application of tariffs in Europe?

For the product I’ve traced, the system is easy in the US. The material is sent directly from Puerto Rico to the US without involving the trading company. It then is formulated and packaged for the specific US market at our plant in Illinois. By the way, did you know that there are multiple packages for use within the US? Often with herbicides and pesticides, it is necessary to have product labeling and use instructions for specific states, since some of them have requirements that are in addition to those from the Federal government. Each of these finished products have a specific bill of material, and each piece of paper or cardboard box used to hold the product had its own SKU (Stock Keeping Unit) that was included in the bill.

That was the world I worked in for the last 15 years of my career. Looking back on this process, I realized I was gaining quite a sophisticated knowledge of international business. I could look at the requirements by country, and I realized that those who complain in the US about overweening regulations stifling business activity, had never done business in Brasil. In that nation they require tracking of everything – copiers, pens, paper, costumes for demonstrations of insects, scientific instruments. Each of those things gained a material number so that they could be tracked coming into and going from their locations. I joked that I was surprised that they didn’t require bar codes on items flushed down their toilets. I was joking, but barely.

The world has become integrated by trans-national corporations. Supply chains stretch across multiple continents, and the systems are legally gamed to minimize taxes. Given all of these conditions, it is very questionable whether you could return to a process where a product is manufactured in a single country, out of components manufactured in that country, and sold not only in the country of manufacture, but exported to other countries and regions for the benefit of the country of manufacture. With the products I’ve described, I have difficulty in stating where the product was actually manufactured. Was it the last step where the product was packaged for the individual farmer? Or was it the location where the complex chemistry was performed? Or was it at the location where it was blended with its other inert ingredients? Each of those steps is a manufacturing operation. You tell me if it makes sense to identify a single origin for this material, and apply taxes and tariffs accordingly?

 

The Amateur Hour

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Amateur – 3. A person inexperienced or unskilled in a particular activity

The United States is conducting an experiment. An experiment that affects each and every person inside of the country, and many others around the world. This experiment involves turning over the operation of the executive branch of government to a group of amateurs, and observing what happens when amateurs are turned loose upon the gears of diplomacy, economics, and the military.

So far, the results have not been catastrophic. Taking the issue of the economy for example, the trends established since the economy bottomed in 2009 are continuing to result in gains in employment, and in measured economic growth. Despite claims of exceptional performance under the current administration, GDP growth averaged 2.2% from 2010 through 2016, while GDP growth during the current administration has been 2.6%. Using the statistical t-test, the two sets of data (past administration vs. current administration) are equivalent. There is not a statistically significant difference between 2.2% and 2.6% growth. But the one knob that this administration has turned, the tax cut, has yet to factor into the performance of the economy. The tax cut does have the potential to increase the rate of GDP growth significantly. However, the tax cut comes with a cost that has yet to be reckoned. The estimated deficits will increase greatly due to reduced tax revenues, and if there is an economic downturn in the next few years, the normal response of loosening fiscal policy to boost the economy will likely not be available. So we are at the mercy of the amateurs in the administration who believe it to be prudent fiscal policy to significantly cut taxes at a late stage in an economic recovery that has entered its ninth year. But what do experts know, anyway?

If you consider diplomacy, there is certainly a mixed bag to date. It does appear that twitter tirades and brazen bluster did result in at least enabling an initial meeting between North Korea and the US, with a generic agreement being signed. If this is indeed a first step towards a ratcheting down of tensions on the Korean peninsula, then this administration will have accomplished a worthwhile and noteworthy goal. But if the North Koreans continue playing Lucy with the football to the US’s Charley Brown, then relations may end up worse off than if there was no meeting.

That is the good news on the diplomacy front. Elsewhere, it is evident that this administration has zero respect for, and zero admitted need for diplomatic experience and expertise. Witness the exodus of State Department veterans over the first year of this administration. As of last November, 60% of the top management of the State Department had left government service, according to the American Foreign Service Association. A hiring freeze instituted under Rex Tillerson has been lifted by his successor, but nothing will replace the institutional memory and experience of those who were driven out by the bias of the current administration against subject matter expertise. The supporters of this President would say that this reduction in long-time employees is “draining the swamp”. What they do not realize is that this world is complex, and the diplomats at the front line in embassies around the world are essential in preventing US interests from being damaged. There will be costs, some of them severe, in the years to come due to the sabotaging of the diplomatic corps.

Meanwhile, the diplomatic style of this President was fully on display at the recent meeting of the G-7. The petty nature of the response to Prime Minister Trudeau’s press conference, replete with the denunciation of Trudeau as having “stabbed the US in the back” by declaring that Canada would not be bullied by the US, shows how much of this President’s actions are guided by his personal perception of slights. The threats unfurled against the strongest allies and trading partners of the US show that he has a vanishingly small knowledge of international trade and the risks to the economy of the world, by insisting on retreating to an era when America may have been great, but by imposing tariffs, we helped to drag the world into depression shortly thereafter.

Militarily, we are repeating the follies that have bedeviled military planners ever since military technology began changing year by year. That is, we are fighting the last war, not the next war. Thus the huge increase in the military budget over the coming years is earmarked for more ships, more fighters, more bombers, more in-air refueling capabilities, and keeping older hardware systems running. Meanwhile, the funding for cyber security ends up with a scant 4% increase when all of the ups and downs of spending by department are added up. Undoubtedly, there is a need for building ships to replace those that are near the end of their useful life. Likewise, replacement aircraft are needed. But the budget funds multiple generations of new weapons systems with no apparent overall strategy on what the military force of the future should look like.

The wars of the future will increasingly be economic or cyber in nature, and seeing funds spent on hardening the electric grid, purchasing large numbers of replacement transformers that could quickly be put in service should a grid disruption occur, these funds would be well invested for our economic and physical security. In fact, just as we used to have strategic metals reserves in case our supply got cut off, we should have a strategic transformer reserve, where these substation-level transformers that will be fried in an EMP (Electro-Magnetic Pulse) event can be quickly replaced. The best way to provide such a reserve was investigated by the Department of Energy and the report was issued to Congress in March of 2017. It does not call for a Federally owned reserve, but calls instead for increased coordination across utility companies. It does call for an increased reserve but one that is maintained and controlled by utility companies. Will such a program work when it is called upon? No one knows. But we do know that the huge increase in military spending is not going for what can happen in the present or future. No, it is going to the weaponry of the past.

Once again, the amateurs determining the strategy for national defense are insistent upon spending large to procure the weapons of the past, while ignoring the needs for the defense of our nation and our lifestyle from the real threats that we face.

The concept of amateurism is good. In athletics, we maintained the fa├žade of amateurism for many decades, but eventually it was broken down. In tennis, in the Olympics, in all sports, it is recognized that if you wish to have excellence in performance, it is necessary to have people who can dedicate their lives to the sport by being paid for their efforts. We followed the same principles in our government. Those who were willing to sacrifice much larger private sector paychecks for the limited compensation of government positions were recognized and honored for their expertise and their service. But in this misguided administration, we have sacrificed those who developed their expertise over decades, in order to promote the agendas of the amateurs who struggle against the current of events in their fields. The problem is that there are real consequences that come from having amateurs deal with issues that can cost real money, and real damage to international relations, and cost lives when dealing with the military.

 

Social Security – the Personal Option

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One of the greatest problems that we face as a country in the US, is that too many people end their working life without assets they can use for their years after work. Another issue is that many people do not benefit from overall improvements in the economy. They have no stake in the game. And a third problem is that Social Security will exhaust its trust fund within a small number of years. For the third problem, there are solutions that will push the day of reckoning for Social Security out decades longer into the future (raise the taxable base, limit further the benefits paid to workers who earn well above the median wage, small increase in the Social Security tax rate). But I’ve not seen any proposal to solve the first two problems. This post provides a potential solution for these critical issues.

First, some background. The Standard & Poor’s 500 stock index, known as the S&P 500, is an index of the largest companies by stock valuation that trade in the US. Since 1926, it has included at least 90 companies, so that its performance is nearly a century old. Since 1957, it has contained 500 stocks. If you invested money in the index in 1928, just before the Great Depression, it would have earned an average of 9.6% per year if you continued to reinvest the dividends. So over time, the investment earned at a higher rate than investing in bonds, and that covers all of the stock market declines since then. Other stock indexes exist that track US corporations, and they show similar rates of growth over time.

The proposal is this. Out of the current 12.4% of employee contribution (split evenly between employee and employer) that currently goes into the Social Security fund, allocate 2% of new employee contributions into a personal account that invests in a stock index fund of companies based in the US. All dividends from the stocks will be reinvested into the personal account. At the time when a person takes Social Security payments, this person will have the option of converting the account to an IRA rollover, or converting it to an annuity.

A simple spreadsheet model shows the potential value of this approach. For someone at the lower end of the income spectrum, a person with salary income of $30,000 per year whose salary increased by 3% per year for a 40 year working career, the personal account would be worth $220,000 assuming that the accounts earn an average 8% per year. The 8% is less than the 9.6% average of the S&P for the past 90 years. This would enable someone who retires to have a significant account that reflects the growth of the economy during their working years. If they choose to select the security of an annuity, it would be administered by the Social Security system in order to avoid additional expenses of going through an insurance provider. Using an annuity calculator, the income for a 67 year old investing $220,000 would be about $1200 per month. This would be a significant increase in the benefit available as compared to the Social Security benefit for an individual.

The Social Security benefit would need to be reduced to reflect the smaller amount of tax revenue that is allocated to the standard benefit pool. But that reduction would take into account the length of time that a person has paid into the personal account fund. Social Security uses a 35 year working career as its basis for calculating benefits. Therefore, someone who has paid into the personal account for 35 years would have a benefit reduction of 16%, since they paid 16% less into the program(2% going to personal account / 12.4 % going to Social Security originally). For those who paid into the personal account for fewer years, the benefit reduction would be approximately 0.5% per year that they paid into the personal account.

What would the effect be of this money being funneled into the stock market? It would be relatively small. In 2016, the amount of money going into the Social Security system accounts from wages was about $700 billion. The proposed personal account would be about $110 billion per year. That amount of increased demand for stocks would raise valuations somewhat, but the investment markets should be able to absorb the incremental demand for investment. This would need to be modeled by real economists, instead of armchair analysts armed with Excel spreadsheets.

Those who are wary of stock investment will point to the inherent risk of stocks. And yes, there will be times when the value of personal accounts will go down on a year over year basis. But the nature of the equity markets has tended to go up when viewed on a longer timescale, such as a person’s working career. Perhaps there could be a personal option for those who are philosophically opposed to investing in stocks, but it would be one that people would have to select, instead of being the default option.

Those of us who have had the fortune to be able to invest over a lifetime, know the benefits of our economic system. We’ve been able to build up our pile of equity. But many folks will work their entire lives and have little to nothing to show for it, except for a Social Security payment. This suggestion would allow for everyone to have a stake in the economy, and would allow for individuals to either opt for the security of annuity payments for their lifetime, or to assume control of a personal account for their own benefit, and for the benefit of their heirs. I believe it is time to think outside of the box in order to attack some of the intransigent problems that this country faces.

Back during the administration of G. W. Bush, Social Security privatization was proposed, and quickly abandoned due to the outcry from many supporters of the system. Those proposals included more diversion of accounts than this proposal, and added more complexity in terms of investment choices. This approach keeps it simple, stupid. And since it rolls out so gradually, everyone would see how well their accounts are doing over time, and should be pleased with the long-term performance of their fund. It’s been nearly 15 years since the last attempt was made to enable private accounts. It is past time to reconsider the approach, and recognize that this is a populist proposal instead of a free ride for Wall Street.