Why Location-Specific Policy Can Negatively Impact Economic Welfare
By J. M. Lane
Executive Summary
Foreign-trade zones (FTZ) are restricted-access sites where domestic and foreign goods are stored, manufactured, or assembled. Products foreign-bound from an FTZ do not pay duties yet are considered domestic goods. These zones are outside of US Customs and Borders Protection (CBP) jurisdiction and are considered foreign territory. FTZs are intended to promote economic development, provide a competitive advantage to US firms, and improve access to foreign markets for US manufacturing firms. This policy brief is designed to analyze the impact of FTZs on income in North Carolina and provide policy suggestion for encouraging economic growth in underserved areas.
Key Findings
Counties in North Carolina with Foreign-Trade Zones have significantly higher economic output than counties without access to Foreign-Trade Zones, but no causal relationship exists between Foreign-Trade Zones and economic development.
Because Foreign-Trade Zones may have an impact on economic growth in some places, capital flight away from other counties can occur, thereby undermining their economic development.
Recommendations
Policymakers should focus on policy that helps impoverished areas and include these people in the decision-making process.
Economic development policy should be designed to help the general population. Organize policy around statistics that mean something. Statistics like unemployment rates overlook the rising homelessness in cities across the state.
Start this process by creating a community development corporation that will include community members in the decision-making process.
Contents & Background
Since the recession of 2007-2008, policymakers have been looking for ways to stimulate growth in underserved areas. Some policies, such as foreign-trade zones (FTZ), have been around for a long time but have somehow been overlooked. For this reason, it is beneficial to evaluate the effectiveness of FTZs for creating spillover and economic growth. In 1934, the first FTZs in the US were developed after an international meeting in Copenhagen. Upon return to the US, economists met together with prominent politicians and eventually passed the Foreign-Trade Zone Act. The early version of the act allowed for imported goods to be sorted and transported without taxation. There were four zones in the beginning of operations and the number stayed relatively low for several decades (Easterling, 2016). Original zones were often abstract geographic space and moved at will. Though tax laws were not strictly applied to these early zones, leaders argued that these zones were closely guarded and regulated by FTZ authorities. In a legal sense, FTZs are considered international territory while simultaneously existing within the US border (Orenstein, 2011).
Foreign-trade zones are a complicated gambit and require a more comprehensive explanation. According to the Foreign-Trade Zone Board (2018), “Foreign-Trade Zones […] are restricted-access sites in or near U.S. Customs and Border Protection (CBP) ports of entry” (p. 6). The Foreign-Trade Zone Board is the licensing and regulatory board for FTZs working directly underneath the Department of Commerce and liaison to the CBP. These zones are physical locations used for storage, manufacturing, assembly, and/or exhibition for foreign and domestic goods.
Any firm can apply for FTZ status, but they must provide rationale for acceptance. The FTZ Board states that the general purpose of the FTZ is to promote economic growth in the community for which it is located, however, the community is not involved in the decision-making process. This policy brief analyzes the economic impact of FTZs, discusses similar location-specific policy measures, and provides policy recommendations. In short, this policy brief reviews location-specific policy, focusing specifically on FTZs, and concludes that policymakers should pay close attention to the type data used to evaluate the economic quality of a specific location; a general approach to economic development may be more appropriate as well. Before any policy is instituted in an area, the local community should be involved in these policy decisions.
The number of FTZs has grown substantially during the years after its passage. The number of active FTZs fluctuate each year depending on decisions made by the FTZ Board. The total number of approved FTZs in 2016 was 263 with a total of 195 active zones. The number of people employed in FTZ operations were approximately 420,000 in the same year (McGilvray, 2017). The dramatic growth in FTZs has impacted the way they are applied across space. Today, the FTZ looks very different from the days of its inception. The original intention of the FTZ was to promote economic growth during the depression era by removing customs on goods intended for re-export. Lawmakers hoped that this would attract the use of United States’ modern port infrastructure by foreign freighters as a stopping point between long distance shipments (Kanellis, 1995). Some scholars have argued that the FTZ today resembles export processing zones of other countries rather than its original intent. The leader of each zone often has the power to determine the regulatory function separately from a state’s regulations (Easterling, 2016).
FTZs are in all 50 US states and Puerto Rico. The largest industries, as of 2016, located within these zones are as follows: oil refineries, automotive, electronics, pharmaceut-icals, and machinery. Approximately 63 percent of all materials received in US FTZs are of domestic origin and $75.7 billion worth of goods are exported from these facilities. Exports since 2009 dramatically increased and peaked in 2014 with a total of $99.2 billion in merchandise. Of the total value of merchandise within FTZs, $610.4 billion was received and $225.3 billion came from foreign origin (McGilvray, 2017). Scholars have argued that while the intention of FTZs was to promote exports, it has fallen short of its goals. These zones may have actually promoted the growth of imports. While failing to produce intended results, FTZs have improved the facilitation and transportation of foreign and domestic goods by promoting the development of centrally located distribution sites to alleviate intermodal costs (Seyoum & Ramirez, 2012).
The amount of research on FTZs has largely been limited to the 1980s due to their rise in numbers. The increase in FTZs in the US may have corresponded to the decline of oil consuming industries beginning in 1973 during the oil embargo (Ferguson, 1989). During this period scholars began focusing on the potential of FTZs to reduce operational costs for US corporations. Many of these studies focused on ways that companies and states could take advantage of FTZ policy so as to promote economic growth. (Cornwell, 1989; Ferguson, 1989; McDaniel & Kossack, 1981; Robles & Hozier, 1986; Tansuhaj & Jackson, 1989).
After FTZs became adopted on a larger scale, scholars began to investigate the effects of these zones on the larger population. By the 1990s, FTZs were evolving into something very different from their original intent. Some research foc-used on the impact of FTZs on exports and their overall effectiveness within a societal context (Hazari & Sgro, 1996; Kanellis, 1995; Mathur & Ajami, 1995; Mathur & Mathur, 1997). Some evidence began to arise showing interesting policy implications. The use of FTZ status had, by the mid-1990s, shown significant impact to profit levels for medium to large businesses (Mathur and Ajami, 1995).
Evidence began mounting against the effectiveness of FTZs on reducing unemployment and increasing income levels. Kanellis (1995), going against reports by the Foreign-Trade Zone Board of the benefits to society, concluded that it was impossible to assess the value effects of FTZs on the population at large. Other problems arise throughout the FTZ approval process. If a firm pursues the grant of approval from the board, competitors only have sixty days to contest the approval. After the sixty days, the FTZ status is approved and no notifications are given to nearby competitors, forcing market mechanisms to favor the firm within the newly created FTZ. Other scholars have concluded that FTZs have fallen short of intended goals. Profits are increasing for businesses that participate, but there are negligible increases in exports (Mathur & Mathur, 1997).
Current literature regarding FTZs is limited to just a few studies. Some scholars have argued that, should US based firms wish to stay competitive with transnational corporations, the use of FTZ status is necessary. One study determined that companies working within the boundaries of these zones focus mainly on US markets, producing few goods with export in mind (Seyoum, 2017). Other authors focused on the unusual nature of the zones themselves. According to Orenstein (2011), FTZs are zones that exist within the boundaries of the US, yet they are not considered US territory. The author argues that FTZs were created as a way to avoid protectionist policies by wealthy corporations and still remain close to the market. FTZs allow companies to manufacture products within the borders of the United States, sell those items under the guise of ‘Made in the USA,’ while avoiding the same taxes that other companies are required to pay.
Methods and Analysis
Currently, there are four active FTZs in North Carolina (one in Wilmington has expired) and one of those is in Greensboro, overseen by the Piedmont Triad Partnership. There are currently no publications outlining the effective-ness of North Carolinian FTZs on their surrounding communities, so this paper intends to shed some light on FTZ 57 (Figure 2), 230, 93, and 214. All FTZs included are in and around major metropolitan regions within North Carolina.
FTZs have been used by businesses as a means of increasing exports and some scholars have argued that these zones are effective at increasing exports and profits for the firms that are involved (Mathur & Mathur, 1997). This conclusion shows that FTZs have been effective at one of the intended goals, however, there have not been any recent studies using current data. Data used in this study were gathered from the Foreign Trade Zone Board (under the US Department of Commerce) and the Census Bureau (McGilvray, 2017; U.S. Census Bureau, 2017). Data were compiled into a workable database using Microsoft Excel and converted to .csv format for usage within ESRI ArcMap10.6 and statistics were analyzed using R Statistical software, GeoDa 1.4.6.
At first glance, it appears that FTZs have a positive spatial relationship with median household income. Figure 3 shows a spatial relationship at the county scale. Two different methods were performed (a type of regression and two sample t-test) to see if counties with FTZs had significantly higher economic output than those without. Counties were placed in two groups: with FTZs or neighboring a county with FTZs (sample counties) and without immediate access to FTZs (control counties). These two groups were compared in the analysis.
Figure 5 shows the scatter plot from the logistical regression results. Both regression models showed that there is a significant relationship between counties with FTZs and higher economic output. These models found that counties with FTZs and counties next to FTZs perform significantly better in economic output than do counties without access to FTZs. These results imply that FTZs may have an impact on the economic performance of counties in North Carolina.
The t-tests proved to be less clear. While income growth rates in sample counties were higher than control counties in 2016, results were not statistically significant. However, income growth rates in 2017 were very different. Control counties had a significantly higher income growth rate, which seems counterintuitive to the preconceived hypothesis. Results from the other tests showed that sample counties had significantly higher income and lower real unemployment rates than the control counties (Figure 6). These results are conflicting and show that there FTZs may not have any major impacts on economic development at the county level in North Carolina.
Policy Alternatives: A Closer Look at Other Location-Specific Policies
FTZs are part of a larger attempt to reduce duties and taxes in certain geographic locations while continuing to tax other areas at a higher rate. Other examples of spatial economic growth policies used in North Carolina are science industrial parks (SIP) and economic and technological development zones (ETD). The Research Triangle, located between Durham, Raleigh, and Chapel Hill, is an example of how amorphous these zones can be (Easterling, 2016). The Research Triangle is categorized as a SIP, however, some of the manufacturing and warehousing facilities are considered subzones in FTZ 93. As much as $250 million of untaxed merchandise flowed through this particular FTZ in 2016, including $25 million worth of exports. This zone employed between 2,001 and 2,500 people in 2016 and contains firms such as Merck Sharp & Dohme and Revlon Consumer Products (McGilvray, 2017).
What makes the Research Triangle and other SIPs different from FTZs are the specific tasks of this type of zone. SIPs and ETDs are designed to promote research and technology, making them location specific. These zones are placed in and around major research institutions such as universities and government research facilities (Easterling 2016). More specifically, the Research Triangle was designed by regional authorities to promote technological research through the creation of research-based tax incentives. Both federal and state incentives were implemented in this region due to its relative location to the University of North Carolina at Chapel Hill, Duke University, and North Carolina State University (Porter, 2001).
What makes SIPs and ETDs so effective is their access to a highly educated labor pool. These zone types raise local land value, median income, and overall wages. This is especially the case in the Research Triangle. However, economic development in these locations came at a price. According to Porter (2001), economic development and population growth outpaced infrastructure development in and around the Research Triangle. In this case, high demand for infrastructure in the Research Triangle had taken the attention of policymakers and urban planners away from poverty-stricken areas that desperately needed the infrastructure. SIPs and ETDs are excellent strategies for attracting the wealthy technological elite, but they only mask the poverty lurking underneath.
SIPs and ETDs are often created by states in tandem with federal funding, making implementation of these zone types much quicker. In order for state officials to have a more hands-on approach to economic development state policy alternatives have been created, such as North Carolina Prosperity Zones. Passed in 2014, HB 1031 created a public-private partnership to oversee the development of 8 separate zones. These zones are designed to promote collaboration between the State Department of Commerce and local agencies (North Carolina, Department of Commerce, 2018b).
Since the signing of this bill into legislation, the Piedmont Triad Prosperity Zone (PTPZ) published a report outlining the past and present economic data. Since the creation of the PTPZ, employment has increased in every sector except finance and insurance. However, the number of businesses open in North Carolina has increased by 8.1% since 2010, while decreasing by 0.2% in the PTPZ (North Carolina, Department of Commerce, 2018a). Criteria is being developed by the North Carolina Department of Commerce to provide Opportunity Funds to certain firms and geographic locations but money has not yet been distributed by the US Treasury Department. Potential benefits include capital gains tax deferrals and permanent removal of taxes on reinvested capital gains (Rhoades, 2018).
Prosperity zones are markedly different from other zone types discussed in this report. The Prosperity Zone Act does not outline distinct geographic locations, instead relying on regional planners to distribute necessary funds to poverty-stricken areas. Location-specific economic policy often attracts capital and foreign direct investment (FDI), but does not provide jobs and income for those that need it the most. As of 2018, 51 underserved communities have been contacted by Prosperity Zone authorities and offered funding and planning assistance in the Piedmont Triad area (North Carolina, Department of Commerce, 2018b); however, long-term impacts have not been measured. Because the specific purpose of Prosperity Zones is to reduce poverty, there is potential to help households that need it the most. Unfortunately, it is too early to tell if they have been effective.
Discussion & Recommendations
The calculations performed in this report show some conflicting results. There is a link between income and access to FTZs, yet this does not mean causation. It is perfectly plausible that FTZs are attracted to urban centers of higher income. Data shows that there are pockets of development that aggregate around the major metropolitan centers of North Carolina. While FTZs, SIPs, and ETDs have provided income and jobs to certain locations, they have not alleviated poverty. Instead, these zones have dispersed poverty out into rural areas. Figure 7 shows the spatial relationship between FTZs and poverty rates throughout the state. This location-specific development policy approach is harmful to the state as a whole and hides a much deeper problem. It is recommended that North Carolina, and the Piedmont Triad respectively, move away from location-specific developmental policy.
What are the alternatives? As discussed previously, a general strategy of local control allows local authorities to determine the best policies for their residents. It also allows for public involvement in the decision-making process. More data is needed to evaluate the Prosperity Zone legislation, but it looks promising. Policymakers should gather proper data on areas of extreme poverty and focus on these specific areas while also simplifying the tax code so that a lower tax regime can promote the growth of small businesses and entrepreneurs. Research shows that state enterprise zones (zones created by state governments for the specific purpose of promoting economic development) and federal empowerment zones (zones that are specifically tailored to poverty-stricken areas through the use of federal grants) have a significantly positive impact on economic development within the zone. While these policies benefit the zone specifically, they do not provide any tangible benefits in neighboring areas (Ham, Swenson, İmrohoroğlu, & Song, 2010).
Economic zoning has its benefits but takes attention away from other areas that need investment. Location-based economic policy also overlooks areas that may be underserved, yet do not fit within the government’s description of poverty. Due to the positive impacts of economic zoning policies in some areas, policymakers in North Carolina and the Piedmont Triad should expand these same policies throughout their entire jurisdiction. This will allow those underserved areas to reap the same benefits that others have been receiving for years.
Implementation
Location-specific economic policy such as scientific industrial parks, educational and technological development zones, federal empowerment zones, and state enterprise zones can all lead to a spatially unequal distribution of income. Once these policies are enacted, capital flight occurs away from rural areas and locations not considered under these policy initiatives. Even with the focus being placed on impoverished communities, location-specific development has its problems.
State and local communities should work together within their constitutional authority to promote economic development. Tax money should be distributed to counties according to population and development policies should be tailored to the communities within each county. In order to avoid graft at the state and local level, proper public oversight is necessary. A potential mechanism for gaining public support is the use of active public engagement in the policymaking process. The International Association for Public Participation (IAP2) is and organization that actively promotes the involvement of the public in policymaking, both locally and on the state level (International Association for Public Participation, 2019). Organizations like this can be created at the local-level to promote community engagement in economic policy creation. Capital that is invested in local communities by the state apparatus can be invested in a more intuitive manner when the population is involved in the process.
PB Greensboro, a program that promotes democratic participation in local budgeting, allows residents to submit investment plans to the city council and the city votes on these ideas every two years. This program allows the population to decide how to allocate $500,000 of the city budget, equally spread between city county districts (City of Greensboro, 2019). Programs like this should be implemented across the state in order to allow local control over economic policy.
Even with the involvement of local populations in the policymaking process, the problem of spatial inequality still exists. Zone-specific policies positively impact the space that has been designated; however, very little spillover exists under current zone developmental policy. The surrounding communities are not reaping the benefits (Ham, Swenson, İmrohoroğlu, & Song, 2010). Some have argued that location-specific economic policy has been designed specifically to encourage agglomeration. Policy experts expounding this philosophy argue that it promotes national growth, thereby making the benefits worth the costs. This view fails in a very important way; it assumes that the real world works the same way as economic models (Martin, 2008). In order to avoid regional disparity, policy should be produced with all of North Carolina, and more specifically the Piedmont Triad, in mind.
Conclusion
Foreign-trade zones (FTZ) have been an integral, but hidden, part of the US economy since the Great Depression. Seen as a way to alleviate economic turmoil brought on by the stock market crash of 1929, FTZs have taken on completely new characteristics than the original functions proposed by Congress.
While FTZs exist as a means to promote economic growth and give domestic firms a competitive advantage over foreign firms, there is not enough evidence that they have succeeded in their intended goals. Statistical evidence showed a positive relationship between access to FTZs and median household income in North Carolina; however, this does not signify causation. FTZs may very well be attracted to places with high income due to access to capital and current locations of businesses.
Other testing performed showed no significant differences in income growth rates in 2016 between counties with access to FTZs and those without. Interestingly, counties without access to FTZs had a significantly higher income growth rate in 2017 than those with access to FTZs. Not surprisingly, Median household income in counties with access to FTZs were significantly higher than those without and real unemployment was significantly lower in counties with access to FTZs.
Location-specific economic development policy can improve certain areas but often at the expense of other areas. Policy-makers should look to promote economic growth in areas that need the extra attention but be sure to account for the needs of the general population. It has been suggested in this paper that programs should be created like PB Greensboro, where local governments use the democratic process to include the population in the decision-making process. While these programs can be beneficial, non-governmental organizations like the International Association for Public Participation can also be created on a local level to actively engage people in the governmental policymaking.
Policymakers need to be sure and keep the entire community involved in the decision-making process. It is the ‘people’ that give policymakers the rights to make these decisions. The Piedmont Triad could benefit from instituting general economic growth strategies that help the entire population and alleviate spatial inequity.
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