I spent a good part of 1990 to 1995 trying to figure out how to get American and European companies to invest in what we called “free-zones” and the Chinese call “Special Economic Zones” (SEZ).
We looked at all the main zones in the world and we interviewed companies who had recently decided to invest to understand what had driven their decision. Must have managed and analysed five hundred interviews over that time.
There were typically two parts for why people came, the first was an absence of “Gross Negatives”, the place had to work and the better it worked the more likely it was to attract investment, starting with utilities, then security, then logistic links; these days the marginal cost of logistics is mainly getting the stuff on or off the ship or the plane and how efficiently that’s managed, distance is much less important.
The second was tax. No one talked about that straight-up, but once you have an operation in a SEZ, you can get up to all sorts of tricks, if you like. There is no one to tell you how many years you got to depreciate a piece of equipment, and well it’s tax-free so you can work it that if you want to make money outside your "home", you can.
Sure the tax inspectors back home are looking at that, but what are they going to do? Fly across and get a local court to subpoena the books of your suppliers or your JV partner?
So you can use a free zone to unlock value that you hold in your home country, for example if you got a distribution set up in USA and Europe, and you spent a bunch of money on R&D and building up a brand equity, you can write that all off against tax, then you create an entity offshore that feeds into that, and keep all the profits outside.
That’s one reason the R&D and design stays in USA, it’s a long-term investment that you can use to cut your tax bill, that’s what creates the value, you just unlock it elsewhere.
One thing no-one was very interested in was the cost of labour, that’s a tiny part of any manufacturing operation, by the time you factor in the R&D, the distribution, the brand building, the logistics, the expensive machinery that can be obsolete in three years if the competitors catch up (and the tax-man will only let you depreciate over fifteen years), labour is small number; and if it’s more expensive, you automate.
Except of course you don’t employ Americans for the skilled jobs if you can possibly help it, because they pay tax even if they are not working in USA, so everyone else is 25% to 40% cheaper to employ. Then of course there is “Medical” – it costs three times more money to provide that in USA, thanks to the monopoly on supply of medical services in USA.
Plus also there is the legal aspect, if you are making something that could be the subject of a law-suit in USA, its good housekeeping to keep a big part of your investment out of reach of the US jury system.
Krugman’s Great Idea To Reverse The Tide
A 25% tax on Chinese exports to USA might hurt China, a bit, for a while; but 80% of those exports are produced in SEZ’s (often by “foreign” companies or JV’s).
So you just set up an operation in Vietnam, or India, or the Jebel Ali Free Zone, and re-label; it’s not hard. Manufacturing these days is about managing your supply chain, where the bits are located doesn’t make much difference, and worst comes to worst, you just move the factory.
What that would probably do is affect China’s imports of US goods, and there might be more pain, like paying more on all that debt. And if there was any effect, it would simply increase inflation in USA, without bringing any jobs back.
If the US Congress who managed almost single handed to create the credit crunch, along with the genius government minions who’s answer to anything is to create a thousand silly forms to fill in, think they can just stamp their foot and bring jobs back to USA, well all I can say is they are still smoking the same stuff they were smoking before.
Good businesses, good manufacturers, with world-class products, run away from government interference and micro-managing. That’s why a SEZ works, more than anything else; you don’t have to hire a lawyer to tell you when you can go to the toilet.
The best way to get American jobs back would be to bring in Value Added Tax, and just leave the people who make things, and create jobs, ALONE.
And think about setting up SEZ’s in USA; remember if one factory or process gets installed in a place; that creates a lot of jobs around it, servicing it.
The people who made great money out of taking jobs out of USA were the corporations, it's not personal, it's just business.
Disclosure: "No Positions"