1 American Footwear: Tariffs & Quotas, Protectionism and the Impact on Consumer Welfare Introduction From Adam Smith s theory on absolute advantage to the contributions Krugman made to explanations regarding external economies of scale, the fact has always remained true that open trade is the most beneficial policy any government can enact. It is the consumer that benefits from this and unless anyone can honestly claim they don t consume anything then everyone is effectively a consumer, which is why benefiting the consumer results in net gains, even at the cost of jobs. However, most governments seem to only ignore, or simply dismiss this idea; granted, this dismissal is most likely due to political pressure by domestic industry or labor. What are the costs associated with policies that restrict open markets from functioning? If political leaders hire economists to advise them and economists understand the costs associated with restrictive policies, then why do politicians still vote them into law? How is it that such great costs can be endured for so long by a nation s citizens and still nothing be done to reduce them? In order to address the above questions this paper will focus in on one case the American footwear industry in an attempt to highlight these costs and understand them. Furthermore, this paper will explain the evolution of the American footwear industry, why policies were enacted to restrict trade flows and what options there are to overturn them. History of the American Footwear Industry The footwear industry in the United States has existed longer than the United States has. Prior to the signing of the Declaration of Independence, the footwear industry was composed of local cobblers who resided predominantly on the East coast (specifically Massachusetts), which was where
2 they designed, manufactured and sold their shoes to the local market. Division of labor was nonexistent and the advantages of economies of scale were also absent. Therefore, the market demand dictated the location where cobblers chose to set up their shop. Eventually, the cobblers discovered that it was more efficient and less costly if each one specialized in making a certain section of the shoe, which was the beginning of division of labor in the American shoe industry. According to E.M. Hoover Junior in The Location of the Shoe Industry in the United States (1933), this didn t occur until approximately 1760, which was about 16 years prior to the signing of the Declaration of Independence. Furthermore, mass production found its place in the shoe industry and the development of the railroad enabled local, East coast producers to serve consumers as far as Ohio. As more people discovered that it was worth forgoing customization in order to take advantage of lower prices, they began to incentivize producers to become even more efficient. As technological advances continued to enable Americans to explore further and settle in new locations, so did it allow the shoe producers to do the same. The combination of westward expansion, technological advances and decreased transportation costs resulted in a shift in the comparative cost advantages originally realized on the East coast. According to The Location of the Shoe Industry in the United States (1933), producers located on the East coast resorted to driving their export business to the point in which shoes exported abroad were 5% of the total portion of shoes manufactured. Then, it was mainly Cuba and South Africa who imported most of the American shoes (Hoover, E.M., 1933). After World War I protectionist policies were enacted as governments perceived it more beneficial to be self-reliant. Also associated with this time was the rise in labor unions, which resulted from unfair wages and poor working conditions. The shoe producers were not immune to labor mobilization and therefore they were forced to improve conditions and wages, which increased
3 their costs. It increased costs so much that producers began to relocate from central hubs like Cincinnati, Chicago and St. Louis, to rural areas where labor was disorganized and spread out (Hoover, E.M., 1933). Even though the above history is a depiction of the domestic flow of production from the East coast to the Midwest, it is analogous with the flows in production from the United States to countries like China, Bangladesh and Indonesia. Just like the East coast lost its comparative advantage to the Midwest because of less expensive labor, land, transportation costs and economies of scale, so is it similar that the United States lost its comparative advantage to countries with abundant labor, like the ones listed above. As the economy of the United States grew throughout the 20 th century so did the standard of living for her citizens. This increase was recognized though higher wages, better working environments, stronger labor unions, etc. to a point in which the cost of employing expensive labor in the United States to produce labor intensive goods was greater than the cost of transferring operations overseas and employing labor from foreign countries. While this scenario appeared advantageous for capitalists and consumers, it did not for those who were losing their jobs to foreign competition. Footwear: Historical Perspective of Globalization and Protectionism Kofi Annan, the diplomat from Ghana, once pointed out, it has been said that arguing against globalization is like arguing against gravity and it s true; history has proven it. If one examines the historical dollar values of exports and imports in the context of the United States from 1970 to the present then they will find an apparent trend in greater and greater international commerce (greater international commerce is reflective of greater integration between factors of production, which can be
4 thought of as globalization). Below is a table of imports, exports, GDP and openness ((imports + exports)/real GDP) over time in the United States. United States: International Trade (1970-2013) Year Real Exports Real Imports Real GDP Openness (%) Units: Billions of Chained 2009 Dollars 1970 187 1,014.3 18,888 6.36% 1975 261.4 1,080.5 21,541.4 6.23% 1980 376 1,478.1 25,801.6 7.19% 1985 382.8 2,233.7 30,375.2 8.61% 1990 645 2,886.2 35,820.1 9.86% 1995 911.5 4,050.1 40,699 12.19% 2000 1,258.4 6,944.8 50,238.6 16.33% 2005 1,381.9 8,656.9 56,937 17.63% 2010 1,776.6 8,941.4 59,135.2 18.12% 2013 2,019.8 9,761.1 62,841.1 18.75% Source: http://research.stlouisfed.org/ According to the data above, which was collected from the St. Louis Federal Reserve website, the United States has seen substantial growth in the overall amount of its international trade. It is exemplified in the exports, imports, and in the openness index; in all cases, the numbers increase except for the change in openness between 1970 and 1975. Equally as important, the rate of increase in the amount of imports of goods and services has increased at a much faster rate relative to the rate of increase in exports. This confirms that the United States consumers, producers, and government are relying more and more on foreign production to meet their demands. Furthermore, even in the midst of commendable efforts to restrain the forces of globalization, through tariffs and non-tariff barriers, globalization has still worked its way into the fabric of the United States economy.
5 The footwear industry is a perfect example to assist in explaining the forces of globalization. As mentioned previously, in the 1920s and 30s, the footwear industry in the United States was experiencing a shift in their cost structure as labor began to mobilize and as work condition requirements began to take effect. The firms manufacturing in the central hubs of the Midwest were beginning to resort to rural, inexperienced labor in an effort to circumvent unions. On the East coast, shoe manufacturers were pushing their product to the Caribbean and South Africa in response to losing their comparative advantage to the Midwest. These strategies only assisted the industry in the short-term; labor unions were bound to develop a presence in the industry as a whole, whether it be rural or urban labor that was employed. Therefore, it was not a search for different domestic pools of labor, or resorting to exports that assisted in retaining domestic shoe manufacturing; it was the enactment of the Smoot-Hawley Tariff in 1930. This raised tariff rates on 20,000 different products that were imported into the United States, including footwear. According to Abraham Berglund s The Tariff Act of 1930, American importers of shoes and boots saw a 20% (the tariff rate varied as shoe type varied) increase on the price of their imported product. The drastic increase in the price of foreign shoes enabled domestic producers to continue producing and supporting local jobs in the United States. However, that trend only lasted so long; in the following decades the competition amongst domestic and foreign footwear producers increased dramatically. The General Agreement on Tariffs and Trade (1947) and the Trade Expansion Act (1962), later known as the Kennedy Round were major contributors to decreasing trade barriers amongst the United States and generally amongst all nations involved in the agreement. According to the Comptroller General s report to Congress in 1980, imports had captured approximately 50% of the footwear industry s domestic market share by 1979. Below is a table illustrating the greater dependence on footwear imports to the United States according to the Comptroller General s report.
6 Footwear Industry: Percentage of Import Business Over Time Pairs Dollar Value Year Percent Imported Revenue Percent 1955 >1% >1% 1960 4% 2% 1965 12% 5% 1969 26% 13% 1978 49% 36% 2012 98.6% Source: The Comptroller General of the United States Report to Congress, 1980 Even in the middle of greater globalization and integration, the Smoot-Hawley Act remained intact, which implies that domestic footwear producers were prepared to deal with the high tariff rates in exchange for foreign production. This might have been because they understood that American manufacturing was devolving and transitioning to low-cost foreign manufacturing. After all, as noted earlier in the paper, the structural costs changes that occurred between the East Coast and the Midwest of the United States were now occurring between the United States and other countries, which is most likely what the leaders in the footwear industry understood. Strategically positioning themselves in low-cost, foreign manufacturing hubs would be beneficial in the long-run. The difference between the positioning from the East Coast to the Midwest and from the United States to a foreign country is that there is an abundance of options in regards to countries while there is only one more option in regards to the United States the West Coast. It s no surprise that the footwear industry chose to transfer operations overseas rather than move to the West Coast; simply because moving West was kicking the proverbial can down the road.
7 The source of foreign production has changed over time as the economies, working conditions and overall standards of living in developing countries has increased. Japan is a perfect example; according to the Comptroller General s report, they were the main source of footwear imports for the United States in the 1960s. However, as their economy developed and they required more capital investment to replace the higher labor costs, producers migrated to countries such as Spain, Italy, Brazil, Taiwan and Korea (By the Comptroller General of the United States Report to the Congress, 1980). In more recent years, footwear production has occurred in China, Vietnam and Indonesia. Current Trade Patterns As mentioned above, the sources of abundant, low cost labor have changed over time to countries with developing economies and unorganized work forces. As one economy becomes stronger and more developed, requiring higher wages and better conditions, shoe manufacturers migrate to the next country. Currently, the United States footwear retailers purchase footwear manufactured mainly in Vietnam and China. According to GlobalExchange.org, China and Vietnam prohibit the formation of labor unions, which is what makes them so enticing to labor-intensive manufacturers, like footwear producers. China is a major force in the international economy; according to the World Bank, they have a population of 1.3 billion and they have a labor force participation rate of approximately 64%, which equals a total number of 832 million job searchers. According to TradingEconomics.com, China s most recent unemployment rate was 4.5% of the labor force, which implies that if they aren t already, they are very close to full employment. The most probable reason that China is experiencing such a low unemployment is the fact that they have relatively inexpensive labor (i.e. abundant) and they have laws that support non-unionization. Therefore, many multinational companies utilize China in their production processes and supply chains.
8 Also supporting a large share of the shoe production is Vietnam; according to the World Bank they are a developing country with a GDP growth rate of 5.4% (2013) and a GDP dollar value of 171.4 billion. Their population is 89.71 million of which 77% are in the job market, either employed or unemployed. Also, the World Bank s data reveals that Vietnam s unemployment rate is near 2%. As mentioned above, they do not allow the formation of labor unions and they are in the Trans-Pacific Trade Agreement with the United States and 9 other countries. Current U.S. Trade Policy Snapshot of the Tariff Schedule in the United States General Type of Footwear General Rate -Footwear incorporating a protective metal toe-cap 37.5% -Covering the Ankle but not the knees 4.6% - 37.5% -Covering the Knee 37.5% -Designed to be worn over or in lieu of other footwear 25% -Having uppers of which 90% of the external surface area is rubber or plastic 37.5% -Golf Shoes 6% -Value over $3.00 and $6.50 per pair 76 /pr +32% -Value over $6.50 but under $12 per pair 76 /pr +17% -Value over $12 a pair 9% Source: United States International Trade Commission (http://hts.usitc.gov/) Over the last few decades, trade policy in the United States has been relatively consistent across almost all markets. One exception however is the shoe import market. While the tariff rates of many goods are kept at a reasonable rate as to not drastically inflate their prices,
9 footwear hasn t been as fortunate. On average, shoes have a tariff rate 10 times higher than that of other imported goods (Weisskoff, 1994). In 2011, this resulted in shoe imports accounting for roughly 1% of merchandise imports (Gresser & Riley, 2012). Still, footwear-related imports generated close to 8% of the total tariff revenue for the imports into the United States. A year earlier, approximately 2.3 billion pairs of shoes were purchased in the U.S. Most of these shoes were designed here at the company s headquarters, and manufactured and assembled overseas (Gresser & Riley, 2012). Due to foreign production, we must now import the shoes from the outsourced factories. The estimated value of these shoes at the border is roughly $22.6 billion, and after going through U.S. import duties, $2.3 billion is collected by the government (Gresser & Riley, 2012). Another issue that has plagued the shoe industry in the U.S. is the distribution of interest rates. Because of import laws and duties, the cheaper shoes cost far more than their border value. For instance, leather shoes incur a tariff rate of only 8.5%, and running shoes, 20%. On the other hand, less expensive sneakers that are usually purchased by low-income families have an astonishing tariff rate of roughly 60%. It is also worth noting that the 60% tariff rate on these cheap sneakers is the highest tariff rate imposed on any manufactured good that is imported into the U.S (Gresser & Riley, 2012). For further perspective on the amount of money that import duties and taxes have on the cost of footwear, a pair of canvas shoes that costs $10 dollars at the border receives a $2.90 import tax from the government. Then, after markup for sales tax, overhead costs, transportation etc. that $10 pair of shoes is sold retail for about $30 (Aw, 1991). The reason these shoes come into the country and have such drastic tariff rates, is directly related to the current trade policy the U.S. has in place in respect to the footwear market. Most of the inexpensive shoes imported
10 into the U.S. come from non-fta partners, in particular China. Another reason that footwear products have these tariff rates is because these products are almost all excluded from the Generalized System of Preferences (GSP), which is a system that reduces import tariffs on goods originating from developing countries. With this lack of import policy on the footwear industry, the interest rates are uncontrolled and remain extremely high. The most recent attempt to curb the interest rates in the footwear industry came in the period between 1977 and 1981, when there was an Orderly Marketing Arrangement (OMA) that put in place a temporary check on imports entering the U.S. from both Korea and Taiwan, depicted in the graph on the next page. However, after this OMA expired, U.S. production and employment in the footwear industry plummeted. Domestic production fell from 600 million to roughly 167 million (Weisskoff, 1994). Conversely, foreign imports shot up from 37 million pairs to about 937 million pairs. The current trade policy in the foreign shoe market, or lack thereof, makes the interest rates on shoes quite absurd. The few policies that are in place were enacted as protectionist policies in the early 20 th century, and are subsequently out of date in the modern market that thrives on foreign imports and outsourcing (Aw, 1991). Policy Evaluation We discussed in a previous paragraph that the United States, which at a certain point in time represented the hub for footwear manufacturing, went on to lose its comparative advantage to countries such as Mexico, and China among others. The reason, as it remains true, was that these countries had low labor and transportation costs. To compete and keep costs down, the local producers found it necessary to resort to these places to manufacture footwear parts. As a result, the American consumer benefited, as did a few local producers and the manufacturing countries. We learned in class that a country ought to specialize in the production of the good in which it has a comparative advantage. For efficient trade to
11 occur, the Heckscher-Ohlin theory further suggests that a country with labor abundance export laborintensive goods, which in our case happens to be shoe parts production. Many local producers have since utilized foreign firms to manufacture their shoes or important parts thereof. Producers such as Nike, Timberland, and Reebok can attest to that fact. The issue lies in the fact that they charge the American consumer a premium for these shoes. How has that been possible? In reference to the legislations we ve already covered, the local capitalist minded producers have all been taking advantage of the American legal system. We understand that with trade, price levels direct investment. A country with lower price levels will attract consumers, while a country with higher price levels will lose out. As many low cost countries began to produce their own shoes and export to the United States, the local producers were left with two choices. They had to either lower their prices to compete with foreign exporters or convince the American government to impose duties on shoe imports, thereby maintaining their prices. They did the latter. Over the years, many duties have been imposed. It was recently reported US footwear distributors and retailers paid $297 million in import duties on products delivered from [Trans-Pacific] nations (Wingfield, 2010). Import duties have been set as high as 67.5%. Certainly, the local producers are not complaining. The government has no reason to complain either. As a result of the duties, the producers and the government gain at the expense of the consumer. We have seen and analyzed similar cases in our International Economic classes. The following trade model illustrates the effect of tariff duties in the American market.
12 Once the import tariff is imposed, the quantity of footwear imported decreases from Q2 to Q4. The quantity of footwear produced by local producers increases from Q1 to Q3; the price goes up, and many effects occur. First, it is the revenue effect wherein the government collects the import revenue associated with any further shoe imports. Second, the redistribution effect is the transfer of income from the American consumer to the domestic producer, as the consumer is required to pay a higher fee that the market and the tariff creates. The protective effect is third, and exemplifies the loss to the domestic economy that results from inefficient home production. This inefficiency happens when local producers forego efficient foreign production to meet certain criteria imposed by the U.S. government. These criteria make it clear that the materials (shoe parts) to make shoes are duty free, whereas imported shoes are not. On that account, local producers cannot profit from low labor costs abroad without paying import duties. Lastly, the consumption effect communicates the decrease in consumer consumption due to high prices.
13 In addition to the four effects we mentioned, we conclude that the welfare of the United States is worse than it could have been had there been no tariffs. The consumption and protective effects combine to create a deadweight loss that represents this particular welfare. The degree to which national welfare is affected is commensurate to the size of the protection imposed and its effect on consumer consumption. As the United States attempts to further protect the footwear industry, the American consumer loses out. Whether it is through excessive taxation or through ridiculous fees for the numerous footwear items offered in the American market, we remain convinced that the consumer s welfare is currently very much affected. Policy Recommendations So as we have reviewed through the course of our research, the U.S. has some pretty outdated policies in regards to footwear imports and duties. The policies that were established in order to protect the footwear industry are no longer necessary because of the willingness companies have to outsource. So because of these policies shoe tariffs continue to be unnecessarily high, and it is costing American consumers billions. One such policy that would end this problem for consumers is a bill that was recently introduced to congress called the Affordable Footwear Act (AFA). This attempt at correcting the high tariff rates was introduced in 2009, reintroduced each year since and it still has not passed. Should the AFA ever be voted into law, it would save American families, on average, $3 billion per year (Gresser and Riley). As illustrated on the tariff diagram above, the $3 billion saved from a reduction in tariff rates would occur through a reduction in the price from P1 to PW. This would transfer the value of the production effect, the consumption effect and the redistribution effect back to the consumer. Recommendation to policy changes for the United States footwear industry would essentially be to pass this bill in an attempt to lower shoe tariffs to a somewhat reasonable level. If these duties were lowered, it would reduce and/or eliminate the regressive footwear taxation on the lower class. Also, any
14 footwear jobs already in the U.S. are that of high value or specialty footwear, which would be too costly for foreign countries to compete with when considering transportation costs. Currently, the only functions of these tariffs are the generation of substantial tax revenue and the placement of disproportionate tax burdens on the lowest income earners. Conclusion How have the low income earners paid a regressive tax that can be traced all the way back to the Smoot-Hawley Tariff of 1930? Furthermore, how have American consumers as a whole paid such high tariff rates in return for virtually no value? Economists stand united on the side of free trade vs. protectionism and they advise many political figures; why haven t they induced politicians to remove them? It comes down to the fact that political benefits are not always the same as economic benefits. Consumers do not have a lobbying group to fight on their behalf, which leaves them at a major political disadvantage when it comes to controlling against special interests and industry focused legislation. Even though economists understand the costs and benefits of policies that protect industries and policies that induce international trade, they normally do not have the podium to shout out their message. Normally, they are simply one of the many advisors to those who make the decisions, whether that be the president, or a congressman.
15 References Aw, B. (1991, January 1). Estimating the Effect of Quantitative Restrictions in Imperfectly Competitive Markets: The Footwear Case. Retrieved November 24, 2014, from http://www.nber.org/chapters/c6714.pdf Gresser, E., & Riley, B. (2012, April 24). Give Shoe Taxes the Boot. Retrieved November 25, 2014, from http://www.heritage.org/research/reports/2012/04/affordable-footwear-act-give-shoe-taxes-theboot Weisskoff, R. (1994, January 1). The Decline of the U.S. Footwear Industry and the Expected Impact of a Free Trade Agreement between Colombia and the United States. Retrieved November 25, 2014, from http://journals.ohiolink.edu.lib.ezproxy.uakron.edu:2048/ejc/article.cgi?issn=10629408&issue=v05i0001 &article=55_tdotufbcatus Wingfield, B. (2010). Duties on Imported Shoes Targeted by U.S. Lawmakers. Bloomberg. Retrieved from http://www.bloomberg.com/news/2013-07-11/duties-on-imported-shoes-targeted-by-u-slawmakers.html http://www.gao.gov/assets/130/128887.pdf http://fdra.org/wp-content/uploads/2013/08/cti_tpp-duty-eliminations-study_final.pdf http://www.census.gov/compendia/statab/2012/tables/12s1308.pdf http://www.economist.com/node/12798595 E.M. Hoover Junior in The Location of the Shoe Industry in the United States (1933),
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