OMB’s Dangerous “Factory-less Goods Production” Rule

The Office of Management and Budget (OMB) is trying to cook the books on the trade deficits.  The agency is proposing a rule Apple products made in China by Foxconn may soon be reclassified as U.S. production that would include foreign factory goods production as U.S. production.

Imagine some guy with an idea for a new product and starts a company called New Widget, Inc. The company is just that guy with an idea. He gets financing and contracts with an Asian factory to produce the product. The guy runs New Widget from his mom’s basement.  OMB’s proposed rule would classify New Widget as a “factory-less goods producer”.

The “products of the world” crowd at the WTO and elsewhere are pushing this to render country of origin labeling, trade deficit data, trade enforcement, and Buy American moot.

CPA will, in the coming weeks, be asking all our support network to work together to kill this rule. This is a fight we can win.

Below is more information and questions about this Factory-Less Goods Production/Products of the World rule change.

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Factoryless Goods Production (FGP)

Information and Background

On May 22, 2014, OMB published a notice in the Federal Register seeking comments on a major change to how the government intends to classify firms in terms of the North American Industry Classification System (NAICS).   While often considered to be a technical discussion related to the collection, production and analysis of data, the repercussions are far reaching.   The classification of firms has a clear, direct and enormous impact on policy and rule making, legislation and the direction and implementation of government programs.

The changes deserve considerable review and analysis and should not be subject to a simple request for comments by OMB.  For more than a year, serious questions have been raised about the potential impact of the approach being taken under the changes identified in the request for comments and the publication of the notice would indicate that the Administration supports the changes identified therein.

The issue is complex, but the Federal Register notice provides a window into the OMB intent:

“Recent years have witnessed rapid and widespread specialization in goods manufacturing as global competition has motivated producers to seek more efficient production methods”….(the OMB should reclassify these firms as manufacturers) “even if the actual transformation is 100 percent outsourced….”Accordingly, OMB accepted the ECPC (the Committee developing the changes) recommendation that factoryless goods producers (FGPs) be classified in manufacturing.”                                   

What is a Factoryless Goods Producer (FGP) Establishment?

A factoryless goods producer (FGP) establishment outsources all of the transformation steps traditionally considered manufacturing (i.e., the actual physical, chemical, or mechanical transformation of inputs into new outputs), but undertakes all of the entrepreneurial steps and arranges for all required capital, labor, and material inputs required to make a good.

Thus, a FGP establishment may produce nothing, but be considered to be a manufacturer.   This would dramatically inflate the current industrial output figures, with no coincident increase in actual manufacturing employment.    The Administration’s “commitment to manufacturing”, touted by the President, could be achieved with a sleight of hand manipulation of data collection and definitions.

Dangerous Problems

The long-term repercussions of this change could be staggering.   Fundamental questions need to be asked.   Among them are:

  • Would a firm like Apple, which has virtually all of its production done by contract manufacturing in China now be considered to be a manufacturing firm?  And how would that contract production and those contract workers be classified?
  • Would Apple then be eligible for benefits under the federal tax code and other programs that now go to manufacturers despite the fact that it outsourced all its production?
  • Will this change promote further outsourcing of production?
  • Who is behind this change?   Have firms that have increasingly outsourced their production lobbied for these changes?
  • Would this change promote the value-added trade accounting approach promoted by the World Trade Organization that would, overnight, change the numbers on the merchandise trade deficit calculations and potentially eliminate the ability of domestic firms and workers who have been injured by unfairly traded and priced imports to seek relief?
  • Would the value-added amount of an import from another country which was outsourced by a U.S. firm count no longer count as part of the manufactured good deficit, but as a “service import”?
  • Would this calculation by the government artificially increase manufacturing employment to allow the President to achieve his manufacturing commitments through a far-reaching reclassification of firms?
  • Would companies that maintain profits offshore have greater incentive to do so, as the profits might be considered to be promoting “manufacturing”?
  • What opportunities will this change create to play additional games with transfer pricing to avoid paying taxes?

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