Jones Act closed loophole that could help Hawaii

by Jonathan Helton, Grassroot Institute, January 31, 2021

A prominent Hawaii state senator told us at the Grassroot Institute of Hawaii recently that he agreed with many of the policies we advocate, but he could not bring himself to support our call for Jones Act reform.

Why?

Because, he said, if the Jones Act were really a problem, American companies would just ship their goods to Hawaii by way of Canada or Mexico.

Why would they want to do that?

Because the 1920 federal Jones Act requires that all goods carried between U.S. ports be on U.S.-built and flagged ships that also are mostly owned and crewed by Americans.1 This makes it significantly more expensive to transport goods to Hawaii, not only because of how the act limits foreign competition, but also because ships built in the U.S. are at least four to five times more expensive than ships on the world market.2

Essentially, these protectionist Jones Act measures add to the cost of shipping for virtually all Americans, while for Hawaii residents in particular, its strict regulations cost about $1.2 billion a year, or about $1,800 per average family, according to a 2020 study by the Grassroot Institute of Hawaii.3

But what about the Hawaii senator’s objection?  If the Jones Act is so expensive, why don’t U.S. businesses simply work around it? If they need to send merchandise from California to Hawaii, for example, why don’t they just send their goods via truck or train to a nearby port in Mexico, then have them shipped to Hawaii from there aboard less expensive foreign vessels?

Similarly, why can’t foreign ships pick up goods in, say, Texas or Louisiana, and deliver them to a Mexican port, from where they could be transported by another foreign cargo vessel to New York or Massachusetts?

American businesses surely would take advantage of such a workaround if they could, wouldn’t they? What’s the big deal? Why can’t American companies do that?

Well, the simple answer is: The Jones Act prohibits that, too.

Here’s how that came to be:

Before the days of the Jones Act, U.S. maritime “coastwise” laws were a little less strict. American waterborne transport companies still were protected from foreign competition, but savvy American companies doing business with Alaska figured out they could save money if they bypassed U.S. ports such as Seattle and instead sent their merchandise by rail to Canada, from where they could use foreign ships to carry their merchandise the rest of the way.4

This didn’t sit well with U.S. Sen. Wesley Jones, a Republican representing Washington state, who considered it an egregious loophole to America’s existing coastwise laws. Companies in his home state were losing money to foreign ships operating out of Canada’s ports, and he wanted to stop that.5

Thus, in the text of the Merchant Marine Act of 1920, of which the Jones Act is Section 27, Jones included wording that would eliminate the workarounds.

Today, the law’s wording is the same as it was in 1920: “A vessel may not provide any part of the transportation of merchandise by water, or by land and water, between points in the United States to which the coastwise laws apply, either directly or via a foreign port.”6

“By land and water” — that’s the critical part of the law. Trucks or railroads were now off-limits for U.S. businesses seeking a workaround. Anyone wanting to ship goods between U.S. ports would have to bear the brunt of the Jones Act’s requirements.

Ironically, while the Jones Act blocked the old workaround, a new one emerged, thanks to statute interpretation by the U.S. Customs and Border Protection. It materialized shortly after the Jones Act’s passage, and has been recognized policy since at least 1938.7

According to the CBP, “Merchandise is not transported coastwise if at an intermediate port or place it is manufactured into a new and different product, and the new and different product is thereafter transported to a coastwise point.”8

In other words, without violating the Jones Act, a company can use foreign ships to transport goods from one U.S. port to another, but only if at some point during the journey the goods are offloaded at a foreign port and substantially modified, after which they can continue their journey to the second U.S. port via a foreign vessel.

But who would want to use such a loophole?

Well, before the “mad cow” disease outbreak in 2003, Hawaii cattle ranchers, among others, had been using it to their advantage. Since there were no cattle ships in the Jones Act fleet,9 they had to look elsewhere for ways to transport their cattle to the U.S. mainland.

Enter the manufacturing loophole.

Under the CBP policy, Hawaii’s cattle ranchers had been sending about 40,000 head of cattle to Canada via foreign ships.10 Once in Canada, the cattle were fed and further fattened until they could be considered an altered product. Then they were transported again by foreign ship to the mainland U.S.11

In 2003, however, the United States and Canada both restricted the beef trade due to the mad cow disease scare.12 This threatened the ability of Hawaii ranchers to eventually sell their cattle in U.S. mainland markets, since Canada was blocking cattle imports from the U.S., and the U.S. was restricting cattle imports from Canada.

In an effort to remove the mad cow-related trade barriers, U.S. Rep. Ed Case worked with Canada’s U.S. ambassador and the U.S. Department of Agriculture to help restore the cattle trade between the two markets.13 But the role of the Jones Act in creating this odd situation for Hawaii was not lost on Case. At the time, he said he “couldn’t have invented a more perfect example of how the Jones Act hinders Hawaii exports.”14

The next year, Case proposed legislation to exempt Hawaii agriculture from the Jones Act.15 Failing to pick up support, his measure faltered and eventually died.

These days, Hawaii’s cattle ranchers ship about 75% of their cattle16 to the U.S. mainland aboard either aircraft or Jones Act vessels. However, there still are no Jones Act-compliant livestock vessels. Instead, ranchers are forced to use “cowtainers” — specialized shipping crates just for cattle, which one prominent Jones Act researcher, Colin Grabow of the national Cato Institute, called “economic kludges not found anywhere else in the world”17

Further, Rep. Ed Case noted that these cowtainers cause “in-harbor cattle waste disposal challenges, higher in-transit cattle mortality and lower-weight cattle delivery to market.”18

Other U.S. businesses that have used the manufacturing loophole to circumvent the Jones Act include rice growers in California and oil refiners in Texas.

In California, rice growers sending their product to Puerto Rico decades ago managed to avoid the Jones Act by first sending it to the Virgin Islands for processing, then to Puerto Rico. A 1964 CBP review found this to be legal.19

In Texas, oil refiners wanting to sell their gasoline in other parts of the U.S. first shipped their product to the Bahamas, blended it with other gasoline, then shipped it back to the U.S. mainland.20

U.S. businesses happily take advantage of these loopholes when they exist, but they aren’t always predictable, since there are also times when the CBP has ruled against the manufacturing loophole.

Alaska’s seafood industry discovered this when it tried to process King Crab in South Korea. The customs agency held that even though the crab was cleaned, cut into portions and frozen in South Korea, it was not physically altered to an extent that exempted it from the Jones Act.21

In all, these Jones Act workarounds are a testament to the law’s high cost to American businesses and consumers. The manufacturing loophole surely would be less attractive if the price of transporting goods on Jones Act ships were lower. Indeed, absent the Jones Act’s restrictions, Hawaii cattle might make their way directly to the U.S. mainland on foreign-built ships designed specifically for livestock, not in “cowtainers” on expensive Jones Act ships — nor even on expensive jet aircraft, which still are cheaper than Jones Act vessels.

Sen. Jones wanted to reserve domestic water transportation for U.S. ships. And he made sure that loopholes were hard to come by. Today, the best loophole we could wish for is significant Jones Act reform.

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Footnotes:

1. John Frittelli, “Shipping Under the Jones Act: Legislative and Regulatory Background,” Congressional Research Service, Nov. 21, 2019, p. 1.
2. Ibid, p. 4.
3. “Quantifying the cost of the Jones Act to Hawaii,” John Dunham & Associates, for the Grassroot Institute of Hawaii, July 28, 2020.
4. John Frittelli, “Shipping Under the Jones Act: Legislative and Regulatory Background,” p. 3.
5. Thomas Grennes, “By Land or by Sea: Does the Jones Act Cause Land‐​Based Transport Congestion?” Cato Institute, Nov. 15, 2018.
6. 46 U.S. Code § 55102.Transportation of merchandise, Legal Information Institute.
7. See: “To Amend Section 27 of the Merchant Marine Act of 1920,” Committee on the Merchant Marine and Fisheries, United States House of Representatives, 67th Congress, First Session, p. 21, statement of A.L. Thurman, Oct. 28 and Nov. 3, 1921; and Robert L. McGeorge, “United States Coastwise Trading Restrictions: A Comparison of Recent Customs Service Rulings with the Legislative Purpose of the Jones Act and the Demands of a Global Economy,” Northwestern Journal of International Law & Business, Vol. 11, Iss. 1, Spring 1990, p. 67.
8. “The Jones Act,” U.S. Customs and Border Protection, September 2020, p. 12.
9. Michael Hansen, “Jones Act Does Not Bar International Trade From Hawaii,” Hawaii Free Press, Oct. 3, 2013.
10. Rosemarie Bernardo and The Associated Press, “Rep. Case asks Canada to accept Hawaii beef,” Honolulu Star-Bulletin, Jan. 1, 2004.
11. Michael Hansen, “Jones Act Does Not Bar International Trade From Hawaii.”
12. “What’s all the fuss about the Canadian border and beef imports?” Consumer Reports, March 31, 2005.
13. “Hawai`i beef caught in ‘mad cow’ crossfire,” Hawaii Star, Dec. 30, 2003.
14. Ibid.
15. Pat Omandam, “Case introduces bills to halt Jones Act,” Honolulu Star-Bulletin, July 25, 2003.
16. Senorpe Asem-Hiablie, et. al,“Management characteristics of beef cattle production in Hawaii,” The Professional Animal Scientist, Vol. 34, Iss. 2, April 2018.
17. Colin Grabow, “The Jones Act Fleet: High Costs and Limited Capabilities,” Cato Institute, March 11, 2019.
18. “Introductory Remarks for Jones Act Legislation,” Congressman Ed Case Speeches & Testimony, Dec. 20, 2019.
19. Robert L. McGeorge, “United States Coastwise Trading Restrictions,” p. 78.
20. John Frittelli, “Shipping Under the Jones Act: Legislative and Regulatory Background,” p. 10; and “US reaffirms non-Jones Act gasoline move,” Argus Media, April 7, 2015.
21. Robert McGeorge, p. 73.