IMPACT OF THE JONES ACT
The “Build American” Requirement
By Donald B. Frost, August, 2016
The Jones Act, also known as the 1920 Merchant Marine Act, requires that all goods carried between ports in the United States be moved in ships built, owned and registered in the United States and crews must be at least three-quarters American. The law specifies that it is meant to “guarantee a merchant fleet for the national defense and the development of the domestic and foreign commerce of the United States.” (Quotes from the law)
Britain’s Navigation Acts (1651, 1662, 1663 and 1673), the model for the U.S. law, were mercantilist by nature, but also meant to respond to threats to their naval hegemony. The laws apparently failed on both points and were repealed by 1849: not so in the United States. In the U.S. the Build American SHIPS (as opposed to tugs and barges, the backbone of the U.S. domestic fleet, the building of which does not require protection from competition) part of the law has been a bone of contention since the Act was made into law.
In the last 25 years the clamor to change the Act, especially the Build American part, has grown in intensity. Ship building in the United States has been a higher cost enterprise than in many parts of the world since the age of steam (See appendix note 1), but the spread in ship prices between U.S. and foreign yards has now widened so much that it has significantly negatively impacted the U.S. economy and indirectly resulted in the loss of many thousands of U.S. jobs ashore and afloat – without enhancing our national defense or the development of the domestic and foreign commerce of the United States.
The law itself was always meant to be protectionist. Whether it was intended to protect U.S. ship builders from foreign competition after World War I had destroyed shipbuilding capacity in the major shipbuilding nations of that period, or those with shipping and rail road interests who wanted to keep Alaska tied to the Seattle area, is still debated. Whatever the truth, we now live in a hyper-competitive global economy where protectionism does not help anyone. Thinking along these lines we can easily see why the non-contiguous states and territories of the United States are the most vulnerable to the law’s economic effects.
Outside of the non-contiguous trades let’s look at: (1) the measureable direct costs to our economy, (2) the state of the US merchant fleet serving the country’s defense needs, (3) the status of American built ships engaged in domestic and foreign commerce, (4) the possible disruptive effects to U.S. shipyard jobs if the Build American restriction were repealed, and (5) today’s regulatory climate in all other modes of commercial transportation.
COSTS TO THE COUNTRY and our ECONOMY
Most of the motor and heating fuel used on our coasts is carried at some stage to refineries and/or distribution points by ships built in the United States, as required by the Jones Act. Those who advocate maintaining the status quo admit U.S. ships are more expensive, but that “they only add a few cents per gallon” at the pump, reasoning that this is an acceptable cost to protect the jobs of U.S. seafarers and shipbuilders. However, the real cost is far higher, while the jobs protected are very few compared to the manufacturing, mining, farm and non-marine transportation jobs lost.
The following paper only addresses the difference in capital cost, NOT the higher costs of U.S. crews versus foreign crews.
The capital cost of U.S. built tankers and articulated tug-barges (ATBs ) moving crude oil or refined fuel along our coasts is between 4 and 5 times higher than that of similar vessels built almost anywhere else. The difference in the building costs represents about 3.5-4 U.S. cents (depending on the age of the vessel) per gallon of fuel transported. Today the difference averages about 4 cents per gallon and is increasing faster than in past years.
Using 2009 Census data (the latest available for population and Vehicles per Capita by State), there are 133 million motor vehicles registered on the two coasts --- 39.6 million on the West Coast (including Alaska but excluding Hawaii) and 93.4 million on the East Coast (including all of Florida, not just the Atlantic Coast but excluding Puerto Rico). This number includes personal automobiles, vans, and SUVs, pick-up trucks, local delivery trucks, long haul trailer trucks, city and inter-city buses, school buses, ambulances, police cars and fire trucks, airport vehicles, postal delivery vehicles, construction vehicles (roadway suitable and off-road types), etc.
If each vehicle travels 12,000 miles per year and averages one gallon for every 15 miles traveled it consumes 800 gallons per year making the total for the 133 million vehicles 106.3 Billion gallons/year. At 4 cents per gallon that comes to about $4.25 billion/year.
Home Heating Oil
Heating oil also must shoulder the additional 4 cents per gallon attributable to the higher cost of building tankers in the United States. According to the Congressional Research Service “The Northeast Heating Oil Supply, Demand and Factors Affecting Its Use” dated April 28, 2014, “demand for home heating oil in the Northeast has been declining over the last decade.”… “By 2012 (the latest information available) consumption declined by 43% to 2,673 million gallons.” Therefore, the Build American premium on the use of heating oil in just the Northeast came to $106 million for the 2012 heating season and about $100 million in 2014-15.
Today only about 1% of the electricity generated in the United States comes from burning oil. There is still a Jones Act Build America premium to pay, but quantifying it is difficult. The same goes for the fuel used for snow blowers, lawn mowers, leaf blowers, diesel powered pumps and fixed and mobile emergency electric generators and other common home, garden and farm equipment.
This year (2015) the Jones Act’s Build American will cause Americans to pay at least $4.25 Billion more for fuel than if the vessels used to move it were built at globally competitive prices, just like other means of transportation in the United States such as cars, trucks, buses, trains, and aircraft.
In 2011, the last year MARAD published data for, 8 of the 11 deep-draft vessels built in the United States were delivered to the U.S. government (7 to the Navy and one to NOAA). The commercial ships were tankers.
Why can U.S. built tankers successfully operate under the Jones Act? The reason is that the demand for energy is virtually inelastic. That is, increases and decreases in the delivered cost of energy result in almost no change in demand. However, demand for almost every other material, commodity or consumer good is very responsive to delivered price changes. In our 21st Century hyper-competitive global economy, all sources compete. Just as goods and materials from suppliers all over the world compete, so should the building of the ships that transport them!
Today the only commercial ships built in the United States are for the Jones Act trades which are protected from competition, and thus the freight rates needed are many times higher than necessary. Usually the higher freight or delayed delivery forces domestic manufacturers of goods or processors of materials (other than energy) that would normally be sourced within the U.S. to import those needs. Similarly, U.S. sellers tend to seek foreign buyers to avoid using U.S. built ships. The carriage of domestic cargoes by water was far more common when the price of U.S. built ships was more in line with world prices.
The cost to move a container-load of anything between California and Hawaii is at least twice the cost to move that same container from California all the way to China. In 2015, with world freight rates at a low because of the over-supply of ships, the spread is nearly eight times. Alaska is similarly harmed, and the law’s impact on Puerto Rico is a major reason the Island’s economy is moribund. Puerto Rico cannot compete with nearby Dominican Republic, Jamaica and other Caribbean islands which do not have to use U.S. built ships to trade with the United States.
There once were more than 30 shipping lines serving America’s international commerce with U.S. built ships. There are none now. Exceptions would include non-commercial Government “impelled” cargoes such as US AID, military cargoes and whatever is left of those export cargoes insured by the EXPORT IMPORT Bank.
Pioneering Sealand Service was sold foreign to Maersk of Denmark, American President Lines was sold to Neptune Orient Lines of Singapore, Lykes Lines went to Canadian Pacific (CP Ships) and Farrell Lines went to P&O Nedlloyd. Although later repealed, U.S. tax code changes in the mid 1980’s (i.e. - the repeal of sub part F), was pretty much the final blow to U.S. international liner companies.
U.S. BUILT SHIPS - NATIONAL DEFENSE
The U.S. Maritime Administration (MARAD published a report titled “The Economic Importance of the U.S. Shipbuilding and Repairing Industry” May 30, 2013. The report counts 117 shipyards in the United States that are classified as “shipbuilders”. The definition of shipbuilder includes those yards that build shallow water vessels that are only classed to safely trade in rivers, and protected waters close to shore. For example tow boats, ferries, recreational craft and un-manned barges. In addition there are more than 200 shipyards engaged in ship repairs or capable of building ships but not actively engaged in shipbuilding.
Of the 117 there are only a very few US shipyards than have the size and capacity to build large deep draft “ships”. In fact in 2015 only two are building deep draft commercial ships. One of them builds for both the U.S. Navy, AND commercial users --- General Dynamic’s NASSCO yard in San Diego, California. The other yard only builds large commercial ships---the Norwegian controlled AKER Philadelphia Shipyard (now named Philly Shipyard) in Philadelphia. A third yard (VT Halter, New Orleans) has recently entered this market.
U.S. Department of Defense has stated: “… very few commercial ships with high military value have been constructed in US shipyards in the last twenty years” and reported that “In 2014 less than a third of the Maritime Administration’s Ready Reserve Fleet, which transports unit and combat support equipment and resupply, were American built.”
The 1936-onward argument for subsidizing U.S. ship yards was based entirely on the expectation that by keeping the yards busy with commercial work they would flourish and that would allow them to offer competitive prices for building ships for National Defense. That has not happened. The cost to build Naval vessels in the United States has followed the same soaring cost curve as commercial ships.
How is a commercial ship built in the U.S. priced? The 20th Century (and earlier) model was based on the cost of materials and labor plus a reasonable return on invested capital. Starting in the 1990s the new model, like the one we saw from ENRON, is “price to whatever the market will bear.” Without any competition among the few U.S yards capable of building deep draft self propelled vessels, or access to non-U.S. competitors, shipbuilding in the U.S. has followed the ENRON model.
Combatant ships have special needs and U.S. Defense Department purchasing rules differentiate commercial vs. Naval shipbuilding but the ENRON model is still used.
POSSIBLE DISRUPTIVE EFFECTS OF GLOBAL COMPETITIVE BIDDING TO BUILD SHIPS FOR THE JONES ACT TRADES
The MARAD report states that the shipbuilding and repair industry is responsible for 107,240 DIRECT jobs, plus about 295,000 INDIRECT jobs and about 5,500 INDUCED jobs for a total of 407,740 jobs. Impressive but misleading!
The two US shipyards that actually build commercial deep-draft ships in the United States directly employ 4,300 people --- about 3100 at NASSCO (San Diego, California) which also builds ships for the government and 1100-1200 at AKER (Philadelphia, Pennsylvania) which only builds commercial ships. The data comes from the yards’ websites.
Since 1960 NASSCO has built 63 large ocean going ships for the NAVY and 51 commercial ships - i.e. 45% commercial. More employees are employed on NAVY construction, but if we left the split at 45% for commercial ships, the direct impact of commercial work at NASSCO is 1705 direct jobs. That makes 1705 plus 1200 or 2,905 direct jobs possibly in jeopardy when the Jones Build American requirement is changed.
Weigh these possible job losses against the many billions of dollars paid directly by the taxpayer to the shipyards AND more, indirectly, via taxes to Federal, State and Local Governments each year for higher priced fuel for buses, police, fire and postal vehicles, ambulances, school buses, airplanes, and the Defense Department apparatus operating within the U.S. as well as higher prices on semi-finished manufactured goods in-transit and consumer goods. In effect the Build America law becomes a tax or surcharge on anything moved by ship on the Gulf, East and West Coasts and the Great Lakes.
INDIRECT and INDUCED JOBS
To determine the number of Indirect and Induced jobs claimed in the MARAD Study they used an economic model called MIG. MIG Inc. was formerly the “Minnesota IMPLAN Group". The MIG model uses classic input-output analysis in combination with regional specific Social Accounting Matrices and MULTIPLIER MODELS. It was developed for the US Forest Service in 1976 and updated in 1995 to make it more functional and accessible to a wider range of domestic users.
The multiplier that connects "direct jobs to indirect and induced jobs" (quotes are from the MARAD study referenced above) is derived mathematically. The Social Accounting System provides the framework for the PREDICTIVE (NB- keep that word in mind. The system “predicts” but DOES NOT MEASURE ANYTHING) Multiplier Model is used in economic impact studies. It uses purchases for the final use/product to drive the model. That is, industries that produce goods and services must purchase raw materials, products and services from other companies to produce their product.
The MIG shipyard model assumes that all the raw materials, products, intermediate assemblies. and the labor to manufacture the intermediate assemblies, are bought regionally. However, there is no secret that the shipyards building Jones Act ships source the ship designs, most of the raw materials, most of the manufactured sub- assemblies that are difficult to manufacture, the main engines, cryogenic fuel tanks and most of the critical mechanical and electronic devices needed to operate the vessels... from offshore---mainly South Korea. (see Appendix Note 2)
When the Build American part of the Jones Act is finally repealed there will be many more ships built for the Jones Act Trades. Most of them will be types of ships that are not currently operating under the U.S. flag in coastal trades such as roll-on/roll-off vehicle and trailer/container carriers, hi-tech chemical and gas carriers, and perhaps even conveyor belt self-discharging dry bulk carriers like those used in the Great Lakes that move industrial raw materials, fertilizers and road salt that are now imported.
The more ships employed here, the greater the number of routine maintenance and ship repair yard calls which will result in increased employment along our coasts, mostly in small to medium sized yards
If American built ships were priced at levels competitive with ship builders in other countries, American ship owners could afford to buy more ships for the Jones Act trades and thus employ MORE seafarers than now. That is, CHANGE will mean MORE jobs for American seafarers.
Financing U.S. built ships
The following is from a Letter to the Editor in the Journal of Commerce dated July 12, 1996 written by John S. Tottie, Sr. Economist, Tax and Budget Policy Citizens for a Sound Economy Foundation, Washington. The focus then was Title XI Government Mortgage Guarantees of ship building loans for ships built in U.S. yards.
"Title XI is the only tool U.S. shipbuilders have left to compete in a heavily subsidized international market. But about 2/3 of the funds guaranteed since 1993 (Ed: about 95+% 1993-2015) involve Jones Act trade, which bars foreign competition. Why do U.S. shipyards need a subsidy to compete in a captive U.S. Market?
"Foreign shipbuilding subsidies (recall this is written when there were both direct and indirect subsidies everywhere - now they are mostly indirect like Title XI) are no more reason to subsidize shipbuilding here than China's use of cheap labor is reason to enslave U.S. workers---even if, contrary to fact, such government interventions lead to long-term competitive advantages."
In the 1930s (1936 Merchant Marine Act), when the competition was all foreign, the idea behind Title XI was to help the ship owners and seafarers. Now it seems to be a direct subsidy to shipbuilders without any compensating benefits to the country or the tax payer. (See previous comments on MARAD’s 2013 “The Economic Importance of the U.S. Shipbuilding and Repairing Industry”)
WHY CHANGE THE JONES ACT?
Regulation of marine transportation, like all other modes in the United States, follows the model established by the Interstate Commerce Act (1887) and the Interstate Commerce Commission. After almost a century US regulators realized that the 1887 model discouraged competition that resulted in higher freight costs for goods moved domestically making them far more expensive than need be, and uncompetitive internationally. Studies showed that regulation significantly increased costs and rates. Not only were rates lower without regulation, but service quality also was better.
President Kennedy’s 1962 message to Congress recommending a reduction in the regulation of surface transportation was followed by similar actions by Presidents Ford and Carter. The Motor Carrier Act of 1980 and then similar moves regarding rail rates culminating with the Stagers Rail Act also in 1980 were followed by the Bus Reform Act of 1982, the Trucking Industry Regulatory Reform Act of 1994, the Federal Aviation Administration Authorization Act of 1994 and the Interstate Commerce Commission (ICC) Termination Act of 1995. Ocean transportation, only being seen as a trade issue, had to wait until the Ocean Shipping Reform Act of 1984 and the Ocean Shipping Reform Act of 1998.
In every one of the above cases the lower freight rates produced economic benefits to the nation as a whole. Each mode flourished under competition --- both the carriers and the suppliers of their vehicles. Yet, the supporters of the 1920 Merchant Marine Act steadfastly refuse to recognize its effects in a hyper-competitive global market place.
When the law is finally changed the immediate impact on U.S. ship builders will be only be felt by those that build large commercial deep-draft SHIPS. If U.S. yards are unable or unwilling to offer globally competitive prices 2,905 direct jobs could be in jeopardy but not 400,000 as claimed by those who do not want change. On the other hand, if prices were globally competitive American ship owners/operators would build more ships for the Jones Act trades that would result in an increase in ship maintenance and repair jobs and more seafarers employed.
1. The 1936 Merchant Marine Act introduced a Construction Differential Subsidy (CDS) (46 CFR 251.1 subchapter V) payable by the Federal Government to cover the higher cost of U.S. labor. Initially the differential was 20%. By the 1980s the differential had risen to 50% and still more was demanded by the shipyards. In Fiscal Year 1982 President Reagan’s Administration ceased funding the CDS program for economic reasons.
2. The MARAD Shipyard Study apparently uses a multiplier of 3.7 (400,000 divided by 107,240). Judging from the facts that we know about outsourcing by the yards producing commercial ships the actual multiplier is probably less than 1.
3. Most recently The U.S. Coast Guard has been trying to get funding for a new arctic heavy duty ice breaker to support the country’s Arctic Policy. The Congressional Research Service (CRS) report issued in 2012 found that it would cost approximately U.S. $ 1 billion to build a new heavy ice breaker at a major U.S. shipyard with an estimated delivery time of between five and ten years. In contrast in 2015 the managing director of Arctech said that his Finnish shipyard can build a heavy ice breaker with all the latest arctic technologies for approximately U.S. $ 139 million within a reasonable delivery time of a couple of years (two).
About the Author
Donald B. (“Don”) Frost is a maritime arbitrator and expert witness in charter party disputes, and a maritime analyst and journalist based in Stamford, Connecticut. He is a USCG licensed deck officer (second mate) with a decades’ long commercial management career working with ship owners, shippers (i.e., merchant cargo owners) and merchant traders. His experience includes logistics planning and consulting covering all surface modes of transport and bulk materials handling. Among his various activities, Mr. Frost maintains his own consulting company, D. B. Frost & Associates Inc., and is the editor for the widely-respected Connecticut Maritime Association (CMA)’s newsletter and website.