The Jones Act

By : JAIME SANTIAGO

jaimes@caribbeanbusinesspr.com

Edition: August 4, 2011 | Volume: 39 | No: 30
caribbeanbusinesspr.com

Is it good or bad for Puerto Rico?

For decades, the Jones Act has been a hot topic of public discussion in Puerto Rico. Private industry, government and social groups have all been involved, more often than not with high-pitch passion.

Postures related to the law are diverse and highly charged, but essentially come down to two: detractors who insist the law costs local consumers $200 million to $1 billion in higher prices because products must come to Puerto Rico on U.S.-flag ships, and supporters who argue that those numbers are wildly inflated and the real price difference is more than made up by big savings and superior service on other fronts.

The problem, as CARIBBEAN BUSINESS discovered while doing research on this controversy to finally determine the facts and costs, is that no truly independent study has ever been done that proves one point or the other. The industry did commission one study in 2003, updated earlier this year, that argues its side, which is that the Jones Act should remain in place. Detractors, by contrast, have relied primarily on speculation.

The latest example came just weeks ago, when House Minority Leader Héctor Ferrer, who will run for resident commissioner for the Popular Democratic Party (PDP) in next year's elections, argued vehemently for repeal of the Jones Act, citing a 2001 report by John Stewart, then-director of economic analysis & strategic planning at the Puerto Rico Industrial Development Co.

The report, Ferrer said, "indicates that by eliminating the cabotage laws, Puerto Rico would incur savings of 20% on all products coming to the island. This represents a $220 million capital injection to the local economy. You don't need further analysis to know that those numbers have increased by now," Ferrer concluded.

The minority leader then introduced a House resolution to order the next resident commissioner to present a bill in Congress within the first six months of being sworn in, asking for Puerto Rico's exclusion from U.S. cabotage laws—specifically the Jones Act, or Section 27 of the Merchant Marine Act of 1920.

But wait. Here is what the Stewart report, obtained by CARIBBEAN BUSINESS, actually says: "I am aware of no credible studies that have focused on Puerto Rico's share in the burden created by the JonesAct. A serious study would require a detailed analysis of Puerto Rico's shipping costs by product and volume,with comparisons of other destinations not under the Jones Act."

Hmm. No credible study? So Stewart figured he would offer a one-paragraph "detailed analysis" of his own: "Maritime freight from the U.S. to Puerto Rico [southbound or incoming cargo] cost more than $900 million in 2000. Comprehensive data on northbound [outgoing cargo] shipping charges aren't available, but total tonnage is only about 36% of southbound traffic and rates are estimated to be 40% to 60% lower. Consequently, total charges for northbound traffic wouldn't exceed $194 million. Nonetheless, this means Puerto Rico's shipping costs are nearly $1.1 billion under the Jones Act. If eliminating the Jones Act created only a 20% reduction in these costs, it would result in a $220 million injection into the Puerto Rico economy at critical points that determine our competitiveness in manufacturing and as a transshipment hub. A World Bank study (1989) found deregulation of Chile's shipping industry had major benefits for that country's exporters."

Translation: By his own admission, Stewart didn't really know and had no study or evidence to prove his 20% cost-saving estimate, or his estimates comparing inbound and outbound rates and cargo volume.

As it turns out, information provided to CARIBBEAN BUSINESS by cargo carriers from a 2003 study by Reeves & Associates, a management & economic-consulting firm, shows the total revenue earned by all carriers in the U.S./Puerto Rico liner trade in 2000—actual reported revenue, not an estimate—was $767 million, or 15% lower than Stewart's estimate. Industry information also shows the 20% figure to be even more inflated.

'NO CONSENSUS'

Ferrer and other Jones Act opponents refer to yet another look at the matter, an April 2002 report by economist José Alameda Lozada of the economics department at the University of Puerto Rico's Mayagüez campus.

They claim Alameda estimated the annual cost of the Jones Act on the local economy to be $225 million to $400 million.

"That money could stay on the island to promote economic activity," Ferrer has insisted publicly.

However, here again, Alameda is first to admit his numbers are pure guesswork and shouldn't be used to set policy or change the law.

"There seems to be no consensus on the issue," says his report, also obtained by CARIBBEAN BUSINESS. "It has been estimated that the cost could fl uctuate from $300 million to $500 million," but he offers no source for these figures and agrees no definitive study has yet been done.

"The negative effects of the cabotage laws on the local economy have constantly been overestimated," said Mohinder Bhatia, president of Puerto Rico Management & Economic Consultants Inc., a firm that issued a report on the Jones Act in 1992. He added yet another twist: "Local businesspeople use the issue as an excuse to justify charging higher prices for their goods."

Economist Joaquín Villamil of Estudios Técnicos seconded the motion. "I don't think the Jones Act has the negative effects on our economy that most detractors say. It isn't an obstacle to the growth of Puerto Rico's economy." He cautions, however, that his comments come with a big question mark, since "there haven't been recent studies done on the subject that I know of," at least none that are truly independent.

GAO STUDY

If Resident Commissioner Pedro Pierluisi has his way, we finally may have one. Earlier this year, Pierluisi submitted an official request to the U.S. Congress for a Government Accountability Office (GAO) study of the Jones Act and its effects on the local economy.

The resident commissioner said the proposed study should adhere to the GAO's general practices, under which all stakeholders are consulted, including Puerto Rico representatives from the manufacturing, agriculture and charter-vessel sectors.

"We see it as a very positive development," said William Riefkohl, executive vice president of the Puerto Rico Manufacturers Association. "We welcome the study so, once and for all, we will know the Jones Act's impact on our economy."

Manuel Reyes, executive vice president of the Chamber of Food Marketing, Industry & Distribution (MIDA by its Spanish acronym), agreed.

"We welcome the study and hope it is comprehensive," he said. "It not only should include information on any possible direct economic costs, but also indirect factors such as future availability and quality of ocean-transportation services for the island, if Puerto Rico were to be exempted from the law."

Both associations have opposed the law in the past.

Ferrer, convinced adequate studies already have been done, objected. "The local economy doesn't need any more studies or excuses; it needs action."

BEYOND SHIPS AND CREWS

So, what might a thorough independent study reveal? CARIBBEAN BUSINESS surveyed a wide range of economists and shipping-industry leaders and found consensus on certain key points.

The Jones Act requires all goods transported over water between U.S. ports (which includes Puerto Rico) be carried in U.S.-fl ag ships built in the States, and owned and crewed by U.S. citizens and/or permanent residents. The purpose of the law is to support the U.S. maritime industry.

Cargo arriving at Puerto Rico from non-U.S. ports, mostly on international ships, face no such restrictions.

Given the relatively high level of U.S. seafarers' wages on an international basis, as well as the high cost of U.S. shipyards where ships are built, it isn't surprising many observers believe there is a high premium associated with Jones Act shipping.

However, those costs aren't the only variables that factor into the net cost of shipping under the cabotage laws. In the broader, and mostly overlooked, context of cargo economics, the cost premium actually becomes rather small or turns into an outright gain for end consumers.

Most importantly, the Jones Act refers mainly to ships and crews. Yet, the total cost of shipping a product from the U.S. mainland to Puerto Rico includes a whole host of other items.

Fuel, terminal-handling charges, inland transportation (trains and trucks), and other such costs would be incurred at the same levels as today if the Jones Act didn't exist and non-U.S. ships and crews were able to service U.S. mainland-Puerto Rico routes.

Taking a load sailing out of Jacksonville, Fla., for example, a non-Jones Act carrier still would need staff at both ports, would require trucking or rail service to inland destinations, and would need to use marine terminals at continental U.S. and Puerto Rico ports. These costs would be identical for a foreign- fl ag carrier as for a Jones Act shipping company.

Even vessel and crew costs apply to international carriers, although Jones Act companies pay more. Industry executives estimate about half the portion of a vessel's cost still would be incurred by a foreign-fl ag operator regardless of nationality, meaning the actual cost of Jones Act provisions on the overall movement of a container is about 10% higher than non-U.S. ships, perhaps even less.

SIZE MATTERS

So would consumers save 10% by switching to an open market and ending Jones Act protectionism? Probably not.

A foreign carrier would need to achieve the same level of efficiency as the current U.S.-based carriers in such key areas as intermodal surface transportation within the U.S. and marine-terminal operations, which are both much larger components of carriers' operating costs than either crew or vessel capital costs.

The main driver of this efficiency is the size of the containers used by U.S. carriers vs. foreign ones. The bigger the container, the more cargo a manufacturer or retailer can move for a comparable cost, and therefore, the lower the net bill.

U.S. shipping companies have introduced a range of 45-foot, 48-foot and 53-foot containers and trailers similar in size and type as the equipment used by U.S. trucking and intermodal- transportation systems.

The bigger size has had an enormous impact on inland and terminal-handling efficiency. A 53-foot trailer can carry up to 67% more high-volume consumer-goods cargo than is characteristic of the trade—light cargo that can maximize equipment-space capacity without exceeding over-the-road weight limitations—at essentially the same cost for inland transportation as would be incurred by the standard 40-foot container used in international trade.

Foreign-fl ag carriers use 40-foot containers today in their international routes and would do the same if they serviced U.S. mainland-Puerto Rico routes.

That would raise the inland cost of moving products from origin to port in the mainland U.S. by up to 60%.

These savings, alone, more than compensate for the higher cost of Jones Act vessels and crews, according to industry executives interviewed by CARIBBEAN BUSINESS.

INTEGRATION

Moreover, the cost to load a 40-foot or 53-foot container or trailer is essentially the same. While a limited number of 45-foot containers are used in international trade, 48-foot and 53-foot equipment aren't used internationally since most foreign marine terminals and surface-transportation systems—mainly in Europe and Asia—are unable to accommodate them.

Consequently, international container carriers neither carry such equipment in their container fleets, nor do they design or build their vessels to those specifications.

The specialized, dedicated transportation carriers that serve the Puerto Rico trade have tightly integrated the island with the States' inland-transportation systems, allowing shipping and freight-handling companies to handle progressively higher volumes at little incremental cost.

"Unfortunately, studies emphasize rate costs, without considering other important factors such as quality of service, safety & security issues, labor laws and environmental issues," Alameda acknowledged in his 2002 report.

TRANSSHIPMENT

The same math would apply to a transshipment port on the island. Much has been said about the Jones Act being an obstacle to the development of a viable transshipment operation in Puerto Rico, whether at the Port of the Americas in Ponce or at Roosevelt Roads in Ceiba.

Unlike domestic cargo that arrives at local ports to be consumed on the island, transshipment loads arrive in big vessels, are unloaded at the port and reloaded to smaller ships that take the cargo to its final destination.

This can be done at any port with the correct geographical location, sufficient land area to stage unloaded containers, the needed operational capabilities and the correct draft and berthing space to receive ships.

Once these requirements are met, cost is the decisive factor for shipping companies deciding which port to use for transshipment.

A very important fact is that if cargo is transshipped through Puerto Rico, provisions of the Jones Act wouldn't apply to the cargo destined for foreign ports. The Jones Act only would apply to cargo unloaded locally for other U.S. domestic ports.

Contrary to public perception, if the current economics for cargo coming to and staying in Puerto Rico applied to transshipments, loads going to the mainland U.S. could move in Jones Act vessels at competitive rates.

If there is a Jones Act cost differential, then it would be evident in comparing freight rates for the Puerto Rico trade with those in similar routes, such as U.S. mainland shipments to and from the Dominican Republic and Haiti, where Jones Act provisions don't apply.

Two carriers in the Puerto Rico trade also serve the Dominican Republic and/or Haiti. In addition, a large number of carriers operating foreign-flag vessels also provide shipping services between the U.S. mainland and the Dominican Republic and/or Haiti.

The average all-inclusive southbound (incoming) port-to-port rate in 2010 for Puerto Rico actually was 1% lower than for southbound cargo carried to the Dominican Republic and Haiti.

The real difference occurs with northbound loads (outgoing cargo to the U.S. mainland), where rates from Puerto Rico are 44% less than the average northbound rate from the Dominican Republic and Haiti.

This would be the direction of transshipped loads moving to the mainland U.S. Based on this comparison, loads moving from a local transshipment port to U.S. mainland ports could move in U.S.-flag vessels at competitive rates.

Other factors prove to be bigger obstacles to transshipment operations in Puerto Rico than the Jones Act, with labor costs being the biggest. Puerto Rico's principal transshipment competition among Caribbean ports are the Dominican Republic, Panama, Jamaica, Colombia and the Bahamas. The average salary of stevedores at these ports is less than $10 an hour. In Puerto Rico, that figure is nearly $54. That labor cost contributes greatly to the cost of products locally.

Cargo-documentation transmission to the U.S. Customs & Border Patrol is another factor that increases the cost of a transshipment operation at any U.S. port, including Puerto Rico.

For security reasons, U.S. Customs requires vessels calling on U.S. ports from international locations to transmit documentation to federal authorities on all loads aboard ship 24 hours prior to departure from the port of origin, regardless of whether the loads stay at a U.S. jurisdiction or continue to another foreign port.

This procedure adds additional operating costs to the shipping lines and isn't required at nondomestic ports. However, this is a separate compliance problem that has nothing to do with the Jones Act.

A typical vessel used for transshipment in the Caribbean can carry 2,000 to 6,000 TEUs (20-foot equivalent units) and, when the Panama Canal expansion is completed in 2014, new bigger post-Panamax vessels with up to 12,000 TEUs could be making transshipments in the region. Document transmission of loads that massive is a daunting additional cost—again, having nothing to do with the Jones Act.

BULK CARGO…A DIFFERENT SCENARIO

Jones Act provisions affect bulk-cargo transportation economics very differently. In containerized cargo, there is good service due to overtonnage (more space in vessels than the market requires). There are also four U.S.-flag companies dedicated to the Puerto Rico market, offering multiple weekly calls between local and various U.S. mainland ports.

By contrast, bulk-cargo service (noncontainerized cargo mostly transported via barges) to and from Puerto Rico and the mainland U.S. is a different story, given the far lower demand for bulk on the island. Containerized cargo is estimated to be 85% of the total. Only 15% is bulk.

"Container-cargo volume in this market is high," an industry source said. "On the other hand, bulk-cargo volume is much lower and sometimes seasonal. Because of this, bulk U.S.- flag vessels may not be available locally at any given time. Vessel owners can't have their equipment idle. They will take the equipment where there is business. If a local businessperson wants to have continuous availability of a vessel, the owner will ask for guarantees and a contract."

This creates problems for local users of bulk-cargo shipping services. The Puerto Rico Electric Power Authority (Prepa) is one such example.

"We sometimes have to transfer fuel from one of our depots to another," a Prepa executive told CARIBBEAN BUSINESS. "Barges are used for this. We use two different kinds of fuel and they can't be mixed, so any given barge can only handle one type of fuel. In Puerto Rico, there are only two barges, each handling a specific kind of fuel. If these barges aren't available when we need to transfer from one plant to another, our operations are disrupted."

The same applies to other industries. At a 2001 public hearing on the Jones Act, the president of a local fertilizer-manufacturing plant wrote to then- Sen. José Ortiz Daliot (PDP):

"Every month that goes by, it is more and more difficult for our company to secure the services of U.S.-flag bulk vessels interested in our business and can offer competitive prices. This creates a big risk for our industry, which is instrumental in keeping local agricultural production competitive in the world market.

"Our local manufacturing plant pays 100% more in transportation fees than our plant in Jamaica because of the need to use U.S.-flag vessels. At present, we can't secure any ship or barge to handle our required cargo volumes (12,000 tons). So, we ask that an exemption to Jones Act provisions for our industry be granted," he concluded.

Limited exemptions to provisions of the Jones Act have been granted in the past to the cruiseship industry in Puerto Rico and to various sectors in the U.S. Virgin Islands. Bulk cargo in the Puerto Rico trade lane could be next.

History, war and cabotage laws

The Merchant Marine Act of 1920 is a federal statute that regulates maritime commerce in U.S. waters and between its ports. Section 27, also known as the Jones Act, deals with cabotage (i.e., coastal shipping) and requires all goods transported over water between U.S. ports be carried in U.S.-fl ag ships, constructed in the States, owned by U.S. citizens, and crewed by U.S. citizens and/or U.S. permanent residents.

The law was enacted in the wake of World War I, the bloodiest and costliest in history up to that point. Congress and the White House decided to protect industry, in part to ensure ready access to U.S. ships and crews in case of war.

Cabotage generally refers to the transport of passengers and goods. Originally, it referred specifically to shipping, but cabotage also applies to airlines, trucking and trains. Many nations have cabotage laws that dictate the terms carriers must follow when transporting people or materials within their borders. Many of these laws are designed to promote the development of domestic transport companies, and some cabotage laws have been criticized because they can restrict free trade.

The word comes from the French caboter, which means "to sail along a coast." While the word initially referred to navigation and trade in coastal waters, it also has come to refer to the right of a country to restrict its airspace.

Cabotage rights are guaranteed to all nations because a threat to national airspace can threaten national security, and therefore, countries need to be able to protect themselves by protecting their airspace. In addition to keeping themselves safer, many nations used cabotage laws to protect their economies and to promote a strong national shipping industry.

Many countries give preferences to domestic carriers operating in their airspace and ports. The U.S. is one such example, with airlines operating domestic flights required to be U.S.-based, although foreign carriers may fl y into U.S. airports.

At ports, under the Jones Act, domestic cabotage must be carried out by U.S. ships, although foreign carriers are welcome in domestic ports with cargo and passengers. Foreign ships that make multiple stops, such as cruiseships, may receive special dispensation so they don't violate cabotage laws.

If you board a plane in France that is operated by a French airline, the plane can fl y to any international airport in the U.S. If the plane lands in Miami and continues on to New York City, you can choose to disembark in either city. However, the plane may not take on new passengers in Miami, because this would violate cabotage laws by transporting passengers domestically within the U.S.

There are two forms of cabotage: natural, which is trade or transport in coastal waters or airspace between two points within a country, and offshore, which treats offshore lands as if they were part of the nation's coastline. Puerto Rico fallsin the latter category.