February 22, 2002

February 22, 2002 | Backgrounder on Trade, Economic Freedom

The Ailing Steel Industry Needs Less Government Intervention, NotMore

The steel industry is once again pressuring the President to authorize subsidies and trade protection to curb what it calls a "surge" of steel imports into the United States. The U.S. International Trade Commission (USITC) added its voice to the debate last October by recommending that the U.S. government impose tariffs of up to 40 percent on steel imports. The President, who must decide on the commission's recommendation by March 6, should reject this recommendation, explaining why that policy is wrong and why the industry's claims are misleading.

Overall, since 1998, steel imports have been declining and the market share claimed by steel importers has fallen. Meanwhile, policies to protect the industry from competition over the past few decades have led to a glut of steel; production worldwide has exceeded demand, and costs connected with labor in the United States have become a burden.

Since the late 1960s, the industry repeatedly has sought protection from imports and subsidies to help alleviate its economic troubles. Following the 1997-1998 Asian financial crisis, which caused Asian currencies to fall sharply in value against the U.S. dollar and lowered the price of Asian goods, the industry claimed that U.S. firms were finding it increasingly difficult to compete with lower-priced Asian imports.

There is no question that the steel industry is suffering economic hardship, but cheaper imports are not the root problem. The problems the industry faces today are due in large part to government intervention, not foreign competition. Protectionist policies of the past continue to inhibit market efficiency and innovation. Imposing additional barriers to trade is no solution; that approach would raise prices for consumers, prolong a much-needed restructuring of the steel industry, and provide a precedent for other industries to seek similar subsidies. Raising tariffs to up to 40 percent on steel also could violate World Trade Organization (WTO) standards, frustrate America's trade partners, and disrupt trade worldwide.

Clearly, on trade, the President must lead by example and discontinue the practice of government intervention. By not raising trade barriers, the President would demonstrate in action, rather than rhetoric, that the United States is committed to advancing global free trade.

THE STEEL INDUSTRY'S CLAIMS

In June 2001, President George W. Bush asked the U.S. International Trade Commission to determine whether steel imports were injuring America's steel producers. Under Section 201 of the Trade Act of 1974,2 the United States can apply tariffs or quotas on a temporary basis--as long as it can be shown that the imports are seriously harming domestic manufacturers. Section 201 cases are not required to prove unfair trade, by which foreign governments subsidize products to give their goods an advantage over U.S. goods. Rather, these cases must only prove that imports are causing serious economic harm to the industry.

The USITC issued a positive ruling on the steel industry's complaint on October 22, 2001, finding that 16 out of 33 steel product categories (which account for about 74 percent of the imports under investigation) had been "injured" by steel imports. Despite the fact that the steel industry is already heavily protected, the USITC recommended that tariffs of up to 40 percent be applied to steel imports.

This policy, however, would increase government intervention in an industry that is already heavily protected. According to the Institute for International Economics, approximately 80 percent of all steel imports are already subject to tariffs under U.S. antidumping laws,3 which allow the government to apply tariffs to products that are subsidized by foreign governments and then "dumped" into the U.S. market.

Despite the protections that the U.S. steel industry has already received, it is struggling. Since the Asian financial crisis, 29 steel firms have declared bankruptcy and have laid off 21,000 employees.4 Over the past two decades, employment in the industry has fallen from 450,000 to 150,000.5

But these problems are not due to foreign competition. Steel imports since the Asian financial crisis have been declining.6 Chart 1 shows that after reaching a high of 4 million tons in August 1998, steel imports have fallen by 36 percent to 2.6 million tons in November 2001. Moreover, not only have imports declined, but the market share of foreign steel has fallen as well. According to the Congressional Research Service, the market share of foreign steel producers has fallen from 28 percent in 1998 to 21 percent in 2001.7

The evidence clearly shows that a "surge" of steel imports is not occurring. Competition from imports is not the problem. Steel manufacturers are suffering because of the worldwide excess capacity in, and overproduction of, steel products. Steel makers around the world are producing more than consumers demand. In 2000 alone, according to one report, steel manufacturers produced approximately 40 million tons more than consumers demanded.8

The overproduction of steel is due to government intervention in the marketplace. Steel producers, left to themselves, have an incentive to produce only what consumers demand. Otherwise, they would be adding needless costs to their operations. When government intervenes and offers subsidies or other protections, normal market incentives are altered. Government subsidies thus may encourage a steel firm to produce more steel even if it exceeds consumer demand.

Subsidies are a common practice in the steel industry, both around the world and in the United States. For example, the American Iron and Steel Institute reports that between 1980 and 1992, foreign steel manufacturers received over $100 billion in subsidies.9 In the United States, the steel industry was the beneficiary of more than $1 billion in federal loan guarantees in 2001.10 When an industry produces more than consumers demand, the surplus puts downward pressure on the price of the product and makes it difficult for firms to earn a profit. As recently as January 10, 2002, even though the price of hot-rolled steel was rising, it was still being sold below cost.11

Homegrown problems are another reason why the U.S. steel industry is suffering. Prior to 1968, the year the steel industry began receiving government protection from foreign competition, average compensation in the industry was roughly equal to the average in the manufacturing sector. Today, the average total compensation for the steel industry is $37.91 per hour--56 percent higher than the average compensation in the manufacturing sector.12 One of the principal reasons for this high average compensation is that the steel industry's very strong unions, without the threat of foreign competition, are able to negotiate high compensation packages for employees.

The industry is also suffering because of increased domestic competition without a corresponding increase in demand. Steel is produced by two types of mills: integrated steel mills and mini-mills. Mini-mills require much less capital to produce steel and are able to produce steel much more efficiently than integrated steel mills can. According to the Institute for International Economics, mini-mills can produce a ton of hot-rolled steel at a cost of $315, compared with a cost of $350 at an integrated steel mill.13 This cost advantage enabled mini-mills to raise their market share from 37 percent in 1990 to nearly 50 percent in 2000.14

At the same time that domestic competition for producing steel has increased, steel productivity has also increased significantly. Output per worker increased from 400 tons in 1990 to 600 tons in 2000. Over this same time period, however, demand remained constant.15 With increased productivity and static demand, steel manufacturers have had to reduce their labor force. Furthermore, worldwide capacity has not fallen fast enough to reflect the stagnant demand.

WHY A SECTION 201 TARIFF IS THE WRONG APPROACH

If President Bush were to approve the USITC recommendation and raise tariffs on steel imports to as high as 40 percent, every American would feel the effects--and the U.S. economy would be set back even further--for the following reasons:

  • The price of steel would rise. Steel is a key ingredient in a number of products purchased by most Americans, such as automobiles, appliances, and housing; raising the price of steel raises the cost of these products as well, thereby affecting the overall cost of living.

A study by the Consuming Industries Trade Action Coalition (CITAC) indicates that the average family of four would pay an extra $283 per year in the form of higher prices on steel products if the President were to protect the industry with 40 percent tariffs. Even worse, the CITAC report estimates that the small benefits to the steel industry would be very costly: 8,900 steel jobs would be saved, but at a cost of $451,509 each. It would be cheaper for the U.S. government to pay these 8,900 workers their salaries than to protect the industry and impose costs on the rest of the U.S. economy.16

The higher price of steel would also affect other sectors, displacing workers and resulting in a loss of up to 74,500 jobs--approximately eight jobs lost for every job saved. CITAC reports that every state, including even those in which the steel industry is a key sector, will lose jobs if the recommended tariffs are imposed.17
  • The benefits that free trade brings to the U.S. economy would be undermined. Aside from the direct harm to consumers, raising tariffs on steel could disrupt worldwide trade flows that are a source of economic growth. According to the World Bank, countries that significantly increased their share of trade as a percentage of GDP since 1980 experienced an average annual increase in economic growth of 5 percentage points during the 1990s.18
If other countries retaliated in response to the U.S. decision to impose high tariffs on steel imports, the gains the United States receives from trade in other key industries, such as agriculture, automobiles, or financial services, would be jeopardized. Other countries are already threatening retaliatory action if the United States proceeds with the USITC recommendation. Australia has indicated, for example, that it will challenge the U.S. tariffs before the WTO. The European Union, which just received the right to impose $4 billion in sanctions on the United States in a recent WTO case, has also threatened action.

Imposing a U.S. tariff on steel imports does appear to violate WTO rules. The WTO allows countries to impose tariffs on a temporary basis, but only when "such product is being imported into its territory in such increased quantities, absolute or relative to domestic production, and under such conditions as to cause or threaten to cause serious injury to the domestic industry...."19

Because steel imports have been decreasing (see Chart 1) along with foreign market share, the application of a Section 201 tariff would appear to be in violation of Article 2 of the WTO's Agreement on Safeguards. Thus, if the United States goes forward to protect the steel industry, the WTO is likely to issue a ruling against that action, opening the door for other countries to increase tariffs on other U.S. products.
  • Necessary restructuring of the U.S. steel industry could be delayed even further. The steel industry needs to undergo a restructuring to eliminate excess capacity and reduce production levels to consumption levels. A recent article in The Wall Street Journal reported that roughly 10 percent to 20 percent of global steel-producing capacity is unneeded.20

The only way to reduce the current overproduction of steel is for governments to stop protecting and subsidizing the industry. By protecting the steel industry, government essentially is allowing inefficient firms to survive that otherwise would be forced to become more efficient or exit the industry. As inefficient firms left the industry, capacity would be reduced along with production levels; the supply of steel would decline.

Similarly, without government subsidies, firms would have an incentive to eliminate excess capacity and to produce just enough steel to meet consumer demand. Increasing government intervention does not increase the incentive for steel manufacturers to reduce production to meet the lower demand. The only way to achieve that outcome is by eliminating government intervention in the steel industry.

OTHER WAYS TO SUBSIDIZE THE INDUSTRY'S INEFFICIENCY

The steel industry is also lobbying the government to assume its so-called legacy costs--the costs of funding pension and health care benefits for approximately 600,000 retired employees, estimated to run between $10 billion and $13 billion.

One reason why these "legacy" costs are so high is the effects of protections given to the steel industry over the past 30 years. Health care benefits in the steel industry are reportedly more generous than those of most Americans: According to a recent article, "At most steel mills, there are no deductibles and few co-payments, 100 percent coverage at the worker's doctor of choice, and dental, vision and prescription drug plans."21 Yet the steel industry is asking ordinary Americans who have less-favorable health coverage to foot the bill for well-paid retired steel workers' "platinum" health-care coverage.

The federal government already has a program to protect the pensions of retired individuals--the Pension Benefit Guarantee Corporation (PBGC), which currently has a surplus of $9.7 billion. The PBGC is designed to pay pensions when companies can no longer afford to pay them to their retired employees. In fact, since its inception in 1975, its largest beneficiary has been the steel industry: Approximately 29 percent of all claims have gone to steelworkers.22

Funding the steel industry's "legacy" costs would be nothing less than a disguised subsidy that enables the industry to allocate what it would have spent on these costs in other ways. This would allow the industry to delay the long-overdue restructuring that would bring it in line with the realities of the global steel market. Moreover, it would set a dangerous precedent. Other industries that experience financial difficulty could use this case as justification for government assistance to help them by absorbing their costs as well.

WHAT THE PRESIDENT SHOULD DO

The only long-term solution to improving the health of the steel industry is to eliminate government intervention, both at home and abroad. For this to be possible, however, the United States must take the lead. If the United States applies tariffs on steel imports, it is likely that other countries will respond in kind, protecting their steel industries or increasing the subsidies they give their firms. Such actions only reinforce the underlying problem in the industry: the incentive of manufacturers to produce more steel than consumers demand.

President Bush has until March 6 to act on the USITC recommendation. He can accept the recommendation, amend it, or reject it. To promote the necessary restructuring of the steel industry and improve its long-term health, both at home and around the world, President Bush should:

  • Reject the recommendation to apply 40 percent tariffs on steel imports. By doing so, the President would send a clear signal to other steel-producing countries that the United States is committed to free trade and to restructuring the steel industry. Such action would not impose enormous costs on U.S. consumers and would not threaten worldwide trade flows.
  • Demonstrate America's commitment to reform by eliminating government intervention in the industry and encouraging other steel-producing countries to do the same. President Bush will have a forum to discuss reforming the steel industry with other steel-producing countries when he meets with the leaders of more than 30 countries at an Organisation for Economic and Co-operation and Development (OECD) meeting in Paris. By rejecting the use of a Section 201 tariff, the President would demonstrate the U.S. commitment to real and long-lasting reform of the steel industry. His action would also encourage other countries to follow suit and reduce their subsidies and protectionist policies.
  • Reject the steel industry's request for subsidies of its pension and retiree health care costs. Bailing out these "legacy" benefits of retired steel employees would set a dangerous precedent that other industries could point to when they run into financial difficulties.

CONCLUSION

There is no question that the steel industry is suffering economic hardship today; but that hardship has resulted from excessive government intervention, which has delayed the necessary restructuring of the industry. Giving the U.S. steel industry more protection in the form of tariffs is no solution. It would raise prices significantly on steel, but also on other goods that Americans depend on, such as cars and homes. Instead, the President should make clear that restoring the competitiveness of the ailing steel industry means making hard choices to reduce government intervention and force the industry to take advantage of innovation and restructure to respond more effectively to consumer demands.

Aaron Schavey is a former Policy Analyst in the Center for International Trade and Economics at The Heritage Foundation.


1. The author would like to thank Anthony Kim, Research Assistant in the Center for International Trade and Economics (CITE) at The Heritage Foundation, for his contributions to this paper.

2. P.L. 93-618.

3. Gary Clyde Hufbauer and Ben Goodrich, "Time for a Grand Bargain in Steel?" Institute for International Economics Policy Brief No. 02-1, January 2002.

4. Ibid .

5.
Richard W. Stevenson, "Big Steel Is an Invalid that Can Roar in Washington," The New York Times , December 11, 2001.

6.
U.S. Bureau of the Census, Foreign Trade Division, January 2002. Data available at www.census.gov .

7.
Stephen Cooney, "Steel Industry and Trade Issues," Congressional Research Service, CRS Report for Congress No. RL31107, updated, November 5, 2001.

8.
Robert Guy Matthews, "World Steelmakers Agree to Cut Levels, But Amount Is Less than U.S.'s Request," The Wall Street Journal , December 19, 2001.

10.
Barbosa Rubens, "About Brazilian Steel," The Washington Post , op-ed, January 17, 2002.

11.
Robert Guy Matthews, "U.S. Steel Mills Lift Key Domestic Prices and Will Seek More Increases Midyear," The Wall Street Journal , January 10, 2002.

12.
Hufbauer and Goodrich, "Time for a Grand Bargain in Steel?"

13.
Ibid .

14.
Cooney, "Steel Industry and Trade Issues."

15.
Hufbauer and Goodrich, "Time for a Grand Bargain in Steel?"

16.
Joseph F. Francois and Laura M. Baughman, "Estimated Economic Effects of Proposed Import Relief Remedies for Steel," Consuming Industries Trade Action Coalition, December 19, 2001.

17.
Ibid.

18.
David Dollar and Aart Kraay, "Trade, Growth, and Poverty," World Bank, June 1, 2001, at http://econ.worldbank.org/vie.php?type=5&id=2207.

19.
World Trade Organization, "Agreement on Safeguards," Article 2, at www.wto.org/english/docs_e/legal_e/final_e.htm.

20.
David Wessel, "Big Steel Still Enjoys Outsize Clout on Trade," The Wall Street Journal , December 10, 2001.

21.
Leslie Wayne, "Parched, Big Steel Goes to Its Washington Well," The New York Times , January 20, 2002.

22.
Ibid

About the Author

Aaron Schavey Policy Analyst
Finance and Accounting