December 2016 Flags of convenience

THE CURRENT SITUATION

A flag of convenience is the flag of a vessel for which the actual property and control are located in a country other than that of the flag under which it is registered. For the owners of these vessels, the benefits are numerous,[1] including in the field of taxation, of security or labor law.

It is a phenomenon related to globalization. In 2015, they represented 71% of the total tonnage of the merchant navy. [][2] The world fleet operated under 152 pavilions. Three of these pavilions, Panama, Liberia and Marshall Islands accounted for 42.8% of the total capacity; either, 710 million tonnes (Mt) and 12 000 flags of some 50 000 vessels navigating the oceans. Panama dominates with 20.7% of world tonnage with[3] 343 Mt and 6 745 ships. Followed by Liberia with 1990 Mt and 2 996 ships and Marshall Islands with 168.6 Mt and 2 345 ships.[4]

None of those countries are among the major owners. The real and principal owners are Greece, Japan , China and Germany, which accounted in 2015 a capacity of 864 Mt and 16 752 vessels. Greece is largest owner with 308 Mt and 4 252 ships, mainly of bulk carriers and oil tankers. Japan comes in second with 242 Mt and 4135 Ships and China with 190 Mt and the 4720 ships.  [5]

MARKET FAILURE

This disproportion between the ship’s country of registration  and of countries owners is symptomatic of a market which is not efficient (Market Failure ). Flags of convenience and tax havens have no economic impact to added value of services, products or the development of markets.

It is a vicious circle, because the oligopolistic structure of the industry encourages imitation in order to protect market shares; the initiative of one will necessarily be imitated by another. In the end, the market shares are the same, but without added value for society. In other words, the market fails to ensure by itself the optimal allocation of the resources of an industry. This inefficiency is reflected by social costs (negative externalities) which are not always apparent. These social costs are described in the text that follows.

2.1 Tax Havens

Tax avoidance represents one of these social costs. The possibility of declaring income in another country in order to avoid paying taxes represents a social burden for the country-owner because the Tax avoidance creates a lost of earnings which would have been obtained under the national flag. We are talking billions $.

However, some have mentioned a link between flags of convenience and the tax havens. For example, the International Transport Workers Federation (ITF) considers that these have long been a model in the field of tax havens. Panama has long been a tax haven and is at the source of the scandal of ” Panama papers” scandal. In fact, it is an important financial center composed of 100 banks managing an asset of some 82 billion US $. It is also the first place in the world to allow open registration of ships.

Another example is worth mentioning. In its policy to fight against tax avoidance, France maintains a list of the States and Territories Non-cooperative (ETNC). Marshall Islands is part of this list and is recognized as tax haven.  It is also one of the places in the world where open registry of ships has increased significantly. The Marshall Islands give a tax exemption on all non-resident corporations. Therefore, all foreign and offshore companies that do business in the islands are exempt from taxes. [6]

2.2 The exploitation of the maritime workforce 

The market fails to provide sailors decent remuneration which should be linked with the purchasing power of the industrialized countries. In an efficient market, wages should be in balance with the prices and costs of production. However, foreign flags have a reputation of providing miserable working conditions to their sailors. This, in a system where trade is made between rich countries,  where the purchasing power of individual is high.

Throughout the world, sailors hourly rates can be as low as $2/hour on certain ships. Often, these types of vessels tend to avoid inspection sites in order to reduce costs inherent to the regulatory obligations and the respect of minimum standards of work.

Several groups have challenged governments on this question. The “Nautilus International” recently requested to the British government to intervene against the companies exploiting foreign sailors in the waters of Great Britain. After the arrest of an Indian flag vessel, it was discovered that salaries of some 300,000 US$ were unpaid to sailors. A number of other problems such as the non-compliance with the contracts of employment were also discovered.

This situation is not unique to Great Britain and is continuously repeated in other countries.

2.3 An unfair competition

The asymmetry of operating costs creates a distortion on the market. The competition becomes unfair because national registrations have to bear a structure of higher costs and must meet standards of the work of the national flag. The social cost is considered by the loss of market share, less innovation from companies under the national flag, decreased competitiveness and added value. It becomes easier for the latter to register the vessels under foreign flags.

According to a study conducted by the U.S. government, in 2009 and 2010, the daily operating costs of a ship under the flag of the United States amounted to 21 774 $US and 20 053 $US, respectively[7] .  In comparison, the same costs for the foreign flag vessels were 7 410 US$ and 7 US$ 454. On average, the per diem costs of operating expenses of American pavilions were 2.7 higher. The chart that follows illustrates the structure of the operating costs of the two types.

However, in analysing the entire costs structure, it is not clear that the competition between carriers generates substantial savings on the side of the buyers. For a more complete analysis, we need to compare the overall costs of a shipping route, which also includes travel costs (handling, mooring, towing, fuel oil, etc.) and the cost of capital.  [8]

Comparison of the structures of the costs of operation between vessels under foreign flags and Americans

Comparaison of operation costs between foreign flags and american flags

Source: U.S. Department of Transportation Maritime Administration 

Wages only impact the first category of costs, that is to say operating expenses. It is also to be noted that it depends on the specialization, the size of the vessels, their age and the technology. According to different sources, the operating costs would represent only 25% of total costs of a route, so that the proportion of wages is between 9% and 17% (35% and 68% of operating costs) of the whole, depending that the crew is composed of foreign seafarers or not.

A further analysis shows that wages represent between 7 % and 13 % of entire logistics chain (Maritime phase, phase port authority and the terrestrial phase) depending if seamen are foreign or not. The gap is then reduced at 6 %.

Finally, in putting this last percentage in relation to the value of the shipped goods (the hypothesis is that the transportation costs represent approximately 10% of the value of the shipped goods), the impact of this differential in salary becomes almost zero, or specifically ,6 %. Thus, the use of foreign sailors on foreign flag ships would have virtually no impact on the price of the goods sold to importers. The financial benefits go primarily to the ship owners.

2.4 The Environment

The environmental impact is another known example of negative externalities.  Some ships represent an increased risk for environmental accidents to age and maintenance problems. In several cases, it is the absence of control in the area of security, of airworthiness or of compliance with international regulations which creates the risk of accidents.

An article in The Journal of the National Action  is particularly eloquent and describes several types of disasters, including oil spill. When there are accidents, it is proving to be less costly for the shipowners to abandon their vessels and declare bankruptcy than to assume the responsibilities underlying. In other words, there is no mechanism to internalize (to assume) the environmental costs to the leaders of these disasters. It is generally up to the governments to undertake the costs.

All foreign flags vessels are not necessarily “dustbin vessels”. According to the International Transport Workers Federation, in 2001, 63% of all losses in absolute tonnage were related to only 13 flags, the first five being Panama, Cyprus, St-Vincent, Cambodia and Malta. [9]

TRENDS

In economics, the failure of market is a sufficient reason to invoke the intervention of governments. However, the inaction of governments on this question remains difficult to explain. The context and the complexity of international law maybe the cause.   It seems that there is no intention to solve this problem.

The facts are startling. According to firm More Stephens, the situation could get worse. In 2016, the financial difficulties of the international industry of the transport of goods are related to a oversupply and indebtedness caused by overcapacity. The costs of capital are higher, while the costs of fuel and port charges remain relatively incompressible and could even increased. In order to ensure their profitability, ship owners will put more pressure to control wage bill and thus could seek to replace of crews or renegotiate downward the wages.

Structural impacts in the long term of this situation are also to be predicted.  Consolidation of industry is carried out either by international strategic alliances or mergers and acquisitions. For reasons of profitability, ship owners will seek to assume a better control of the logistic chains, that is to say from suppliers location up to  the market of destination. This implies a complete integration of the supply of transport on all markets, including local markets, markets on which the vessels of convenience are prohibited in many countries.

However, for this reason, it is expected that major international carriers will want to expand their presence on inland waters, the new markets, the sectors most in growth and the more lucrative. Foreign firms, for example, could prospect the market of short sea shipping on inland waters in the hiring of foreign workers.

In 2015, the Seafarers’ International Union of Canada (SIU) started new judicial proceedings against the Government of Canada challenging of temporary work permits granted to foreign workers working on vessels dealing in Canadian waters. Canadian law prohibits the hiring of foreign workers except if no Canadian qualified worker is available.

It is estimated that 2 100 Canadian jobs were lost due to incorrect interpretation of the federal government legislation. Since 2013, the SIU assesses that approximately 4 000 temporary permits have been issued to foreign sailors, although 25 per cent of Canadian maritime workers  are currently unemployed.[11]

In addition, in the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union, several provisions open the local market to foreign companies: the access to suppliers of services of international dredging will be authorized for contracts of more than $7.8 million. The cabotage services between Halifax and Montreal will be allowed on condition that the route is part of an international journey.  The vessel will be registered in the National Register of a Member State of the EU and fly the flag of that State.

However, the cost structure of these European companies will remain different from that of the Canadian local businesses  by virtue of differences in wages. For example, France, in order to combat tax avoidance, has created its own flag bis. This French flag allows French companies tax deductions and reduced salaries. They may employ up to 65 per cent of foreign seafarers outside the European Union paid to the conditions of their countries of origin. [12]

CONCLUSION

Some solutions have been advanced by trade union groups or by governments. But the source of the problem is at an international level. Only one country alone cannot solve the problem without the collaboration of partner countries.

The International Maritime Organization (IMO) is the agency of the United Nations that is responsible for the application of the Maritime International Law. Regulation is then integrated in the legislation of the country for the purposes of application. One of the solution referred would be to put in application  of  ” The United Nations Convention on Conditions for Registration of Ships “. This convention proposes that there should be is a link between the real ownership of the ships and the detention of a flag. [13]   This would ensure compliance with the national work standards and those related to security.

But this convention was never adopted. This situation can be explained by the lack of political will of some lax States.[14]

The countries most affected by this situation will have to assume a certain leadership. Canada could assume this role.

Louis Bellemare

New Maritime World

 RÉFÉRENCES 

[1] Wikipedia, flags of convenience, https://fr.wikipedia.org/wiki/Pavillon_de_complaisance

[2] Study on the maritime transport, 2015, United Nations Conference on Trade and Development, UNCTAD.

[3] Economic Atlas of the Sea 2016, the Sailor, ISMER, University of Nantes, pages 86-87

[4] Idem

[5] Idem

[6] http://paradisfiscaux.net/iles-marshall/ Paradisfiscaux.net

[7] Comparison of U.S. and foreign-flags operating costs, September 2011, U.S. Department of maritime transportation. Https://www.marad.dot.gov/wp-content/uploads/pdf/Comparison_of_US_and_Foreign_Flag_Operating_Costs.pdf

[8] Note: The costs of operation are compounds of wages of the sailors  and other related costs,  the costs of maintenance and repairs Insurance and Other overhead expenses.

[9] Idem

[10] Idem

[11] SIU launches two new proceedings to the Government, the Seafarers International Union of Canada

http://www.seafarers.ca/siu-lance-deux-nouvelles-poursuites-au-gouvernement/?lang=fr

[12] Wikipedia, France and the roof GIR, https://fr.wikipedia.org/wiki/Pavillon_de_complaisance

[13] Convention of the United States on the conditions for registration of ships http://unctad.org/fr/PublicationsLibrary/tdrsconf23_fr.pdf

[14] The rights of sailors, at the crossroads of the rights of the person… The hope, Oumar Niang

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