Whatever happened to the Free Trade Zone?

By William H. Stewart
Special to the Saipan Tribune

First of two parts

The establishment of an “operating” Free Trade Zone (FTZ) has been discussed for several years and indeed the legislation to establish such a zone was in place as far back as 1998. Yet for some unfathomable bureaucratic reason the actual operation and marketing of the zone at Saipan’s International Airport appears to have remained in a morass of indifference and inaction. Why this is so in view of the economic slowdown on the islands is a mystery to me and many others concerned with the economic welfare of the islands.

Zone regulations stipulate import tax exemption on all raw materials and other goods involved in the export activity of the business occupant. Without such an exemption no free trade zone would be successful. All imported goods and raw materials must be exempt from local taxes in force as well as those imposed in the future, as long as such items remain in the free trade zone. Goods that are removed from the free trade zone into the general customs area of the Commonwealth would be considered as imports with the appropriate CNMI duty or excise tax imposed.

A truly functioning free trade zone in the Commonwealth will benefit both American and non-American export oriented firms who recognize the advantage of being situated under the stability provided by the American flag, the U. S. judicial and banking systems, along with U. S. copyright, patient and trademark laws, while benefiting from the CNMI’s lucrative tax rebate advantages and resort atmosphere, all within the monetary environment of the most stable currency in the world—the U.S. dollar. In short, such a zone would benefit American firms exporting to Asia and Asian firms exporting to the United States and Europe, making the Northern Marianas a “commercial crossroad” of the Pacific.

Free trade zones are normally established at seaports and international airports. Most of the nations in the western Pacific and many within the southeast Asia region have established such zones and are competing with the Commonwealth for foreign investment. However, none of these zones have the advantage currently afforded the Commonwealth, which permits duty free entry of qualified manufactured products into the U. S. Customs Territory as a result of Headnote 3 (a), and none can affix the “Made in the U.S.A.” label on their manufactured products as can those firms situated in the CNMI when exporting their production to the United States and elsewhere.

The CNMI government as the licensee, or its legally assigned representative, would provide a system of surveillance for the physical investments of the zone’s users, including strict controls at all access and exit points, as well as internally within the boundaries of the free trade zone itself, to assure the safety of all privately owned goods and any associated investment. All Commonwealth and federal laws, except those tax exemptions that are permitted by law, would apply to businesses granted the privilege of operating within the zone.

A free trade zone as described above is not the grand solution to the Commonwealth’s economic dilemma and is not a panacea for all of the area’s economic ills. It is only one more investment incentive to attract companies that otherwise might never consider the CNMI as a place to do business.

The Commonwealth is now at a critical junction in its economic evolution and diversification process. There are a number of serious issues confronting the islands each with the potential of having a severe adverse impact on the success of the proposed FTZ and economic growth in general. These issues are surfacing from both within and without the CNMI, any one of which, if materialized, can, in the opinion of this economist, render the FTZ concept of little value in the Commonwealth’s aspirations for additional economic growth.

The eventual possible loss of local control over immigration is an issue with the potential of having a devastating effect, not only upon the economy as a whole, but the FTZ in particular.

From within the islands there are those that would weaken any FTZ’s ability to offer the full range of tax relief as now being offered in other areas of the world, as well as provide the necessary public land at rental rates suggested by some FTZ committee members. Rates that would serve only as a floor from which higher rentals would be negotiated and then applied to businesses qualifying for entry into the FTZs. The idea being that such a legislated base or floor rental rate incorporated in the enabling legislation would protect any FTZ investor from land litigation now so frequently prevalent in the Commonwealth.

The question has surfaced as to whether the CNMI should offer firms located within the FTZ full tax relief. It is argued that the Commonwealth should derive some tax revenue from such businesses and not offer full tax relief. As a counterpoint, it should be realized that businesses that may avail themselves of a free trade zone location in the Commonwealth are not now present in the islands and most likely never will be present without an FTZ location beneficial to them for the simple reason that such a location is critical to their modus operandi and, if they can’t locate here, they will position themselves somewhere else.

Certainly the lifeblood of any government is its tax base. Governments take little or no risk in generating tax revenue, they simply levy a monetary assessment on the privilege of doing business within their jurisdiction and collect the revenue. Businesses on the other hand risk their investment capital, their time and other resources for an opportunity to earn a profit. The profit earned is the reward for taking the risk. This profit is also the source of much tax revenue generated for the businesses’ “government partner,” which very often does not participate whatsoever in the risks that businesses take.

Perhaps it is time for the government to consider also sharing in part of the risk in the development of the economy by offering the added incentive of a fully tax free trade zone. In doing so nothing would be lost to the treasury since these particular businesses are not now present on the tax rolls.

To suggest that the government consider a risk position is, of course, a heretical concept to some and abhorrent to many government legal advisors who rightly and justifiably strive to protect the government and the treasury from such adventures. Many no doubt lack the entrepreneurial spirit and have never been in business where they have to meet a payroll with the result that there is little real appreciation of the business side of the coin. But dire circumstances sometimes require drastic solutions. Once again the old adage rings true—“Nothing ventured, nothing gained.” It also applies to government.

The foundation of the free trade zone concept was established upon the ability of a “qualified” business to operate within the limits of the zone without taxation and permitted to do so based on its projected contribution in circulating money within the local economy. The question then arises as to what, if any, benefits would be expected to accrue to the Commonwealth? Simply stated, the CNMI would benefit in four major ways. These are: the provision of highly skilled, well-paid employment opportunities, (hopefully for local residents); inbound and outbound revenue generating freight shipments; land rental fees and, most important of all, the multiplier effect of the zone’s business activities and the “spin-off” outside the zone and throughout the entire economy.

Because business activity within the zone will require the support of many businesses outside the zone it is here that the FTZ and its occupants will provide the principal economic benefit to the economy. This is because the multiplier effect operates on the principle that one individual or firm’s local expenditures is another individual or firm’s locally generated income.

All money—yours, mine, and that of others—spent in the Commonwealth has a multiplier effect as it passes through the economy, up and down, in and out of various businesses, each of which pays taxes on the income received as the expenditure passes from one business to another, to attorneys, accountants, retail and wholesale outlets, the butcher, baker and law maker. This can best be illustrated when a zone business purchases building material from “local” businesses outside the zone. These local businesses purchase materials and services, pay rent, hire employees, etc. The employee must purchase food, the food store must purchase power, the utility agency must purchase oil—and on and on as the multiplier effect moves through the economy generating income for a variety of businesses, always paying taxes at each level of transaction. This is where the CNMI derives an increase in tax revenue—not directly but indirectly from zone users and their outside purchases from the local economy.

To be continued.

Editor’s Note: William H. Stewart, an economist, has spent the last four decades actively involved in the process of economic development within many foreign countries and financial institutions. His association with the U.S. State Department’s foreign policy involved the encouragement of the concept of private enterprise and capitalism within developing economies.