The New Iron Age: Steel’s Renaissance Beckons New Trade Policies

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Introduction

Recent media coverage of a U.S. International Trade Commissionproceeding concerning certain steel tariffs painted the issue as aclash between two U.S. industrial titans: the steel industry andthe automobile industry. Although the auto industry and scores ofsteel-consuming industries have been harmed by the aggressive levelof trade protection afforded the U.S. steel industry over thedecades, the real story is not about steel versus autos. The realstory is about the U.S. steel industry's historic metamorphosis andthe costly failure of trade policy to adjust to that newreality.

In a period of less than five years, the U.S. steel industry hasundergone an extraordinary and unprecedented transformation. Whatwas, as recently as 2002, a fragmented, perennially money-losing,capital-starved industry that relied on government for subsidizedloans, protection from creditors, and insulation from foreigncompetition has become one of America's strongest, most profitable,and most promising manufacturing industries. Massive industryrestructuring, the adoption of new and more flexible laboragreements, and a permanent outward shift in global demand forsteel explain the industry's reversals of fortune andprospects.

Despite the industry's renaissance, there remain in place some136 antidumping and countervailing duty measures that restrictimports of 21 different kinds of steel products from 32 individualcountries.1Thesemeasures have long outlived their purposes, as the steel industryis no longer injured and foreign producers have ample alternativesto selling steel on the cheap in the United States. Instead, thetrade remedy laws are serving only to bolster the market power ofan emerging U.S. steel oligopoly, which could have seriouslyadverse consequences for U.S. steel-using industries and theeconomy as a whole.

Then and Now

In 2002, the top three U.S. producers of flat-rolled steelcontrolled 25 percent of U.S. production capacity; today, afterlongoverdue industry consolidation, the top three control 70percent.2 That highdegree of concentration has delivered to the industry the capacityto manage output--in a way never before possible-- to control pricefluctuations and maintain profitability.

In 2002, most unionized steel workers were classified accordingto hundreds of job descriptions and dozens of rigid labor gradeclassifications and their compensation was unrelated to companyperformance. Today, most of the unionized workforce is classifiedunder six job definitions and five labor grades, and a portion ofcompensation is tied to company profitability and prices. Thesechanges have contributed to a significant decline in the industry'sfixed costs and have lead to large increases in laborproductivity.

In 2002, the world consumed 825 million metric tons of steel; in2005, world consumption exceeded 1 billion metrictons.3 Much of thatgrowth, which is projected to remain on a steep trajectory, isattributable to massive infrastructure projects and explodingconsumer demand for appliances and automobiles in the developingworld. This shift in developing country demand has caused globalsteel prices to rise to new heights and has rendered the U.S.market less attractive to foreign steel producers, accentuating themarket power of U.S. producers and compounding the effects onsupply of diminished competition brought about by industryconsolidation.

These changes have generated fantastic industry financialperformance. Since 2004--the first year after the most significantrestructuring was completed--the U.S. steel industry has achievedaverage operating profits of 10.3 percent. To put that inperspective, operating profits for U.S. durable manufacturing as awhole during the same period were 5.5 percent. And between 2000 and 2003, the steelindustry's operating profits averaged just 0.1 percent, whileprofits for durable manufacturing as a whole were 3.9percent.4 (SeeFigure 1.)

Figure 1

Comparison of Operating Profit Margins(2000â€ââ'¬Å"1H2006), Steel vs. All Durable Manufacturing

Comparison of Operating Profit Margins

Source: U.S. Bureau of the Census.

The same positive developments are evident with respect tomarket capitalization, asset investment, and stock valuations. InNovember 2006, the Dow Jones Steel Stock Index is valued nearly 400percent higher than it was in December 2002. (See Figure 2.)

Figure 2

Dow Jones Steel Index, Weekly Index Value (December2002â€ââ'¬Å"November2006)

Dow Jones Index

Source: Dow Jones MarketWatch,http://www.marketwatch.com/tools/industry/indchart.asp?siteid=mktw&bcin….

By every relevant financial yardstick, the industry isperforming phenomenally and investors are bullish about its future.Indeed, in the span of just a few years, everything has changed forthe U.S. steel industry--everything, that is, with the exception ofthe government's indulgence of the industry's sense of entitlementto trade restrictions.

Unsustainable Structure...

Blaming "unfair" import competition for its woes has been astaple of the U.S. steel industry's public relations machine forseveral decades. But ironically, the industry's success at winningimport restraints only served to mask and exacerbate the realproblems confronting the industry. Import competition has played arelatively minor role in the U.S. steel industry's historicalunderperformance. Import restrictions and other short-sightedpolicies that discouraged structural adjustment are the realculprits.

Until recent years, there has been a chronic disparity betweenthe steel industry's actual and optimal composition. The industryhas comprised far too many firms given the high fixed cost natureof steel production. Steel producers must make and sell a lot ofsteel just to cover those fixed costs, and then they must produceand sell even more to have a shot at achieving profitability.Moreover, firms facing high fixed costs have additional incentiveto continue producing because their per unit costs of productiondecline more rapidly when there is more output over which to spreadthose fixed costs. Thus, long production runs and operation at highlevels of capacity utilization traditionally have been critical toprofitability in the steel industry. But because there have beentoo many firms pursuing those incentives, overproduction and pricesuppression have undermined profitability.

Furthermore, when there are too many firms in a highfixed- costindustry, it is difficult for any one of them to affect theaggregate price for steel. If one producer seeks to obtain higherprices or to respond to downturns in the business cycle by cuttingback its own production, other producers have incentive to produceand sell more as prices stabilize or rise. Such actions, of course,push the price back down. Steel producers have been caught in aclassic prisoners' dilemma. All firms would be better off if theycould cooperate and reduce production, but the assumption thatother firms will continue to produce inspires all firms to continueproducing, to their collective detriment.

Under normal market conditions, the stronger firms would bebetter situated to survive periods of price suppression anddeclining demand, while the weaker firms would respond to lowprices and negative profitability by shutting down and liquidating.And over time, an industry optimally structured for its conditionsof production would emerge.

...Plus Bad Policy

But over the past 35 years, those market signals have beendistorted by government interventions of one sort or another, whichleft the industry in a perpetual state of "crisis" (to use one ofthe industry's favorite terms). Permissive bankruptcy laws thatenabled failing mills to expunge their liabilities and return tooperations without any real consequences, tax holidays, buy-American provisions, loan guarantees, legacy-cost relief,uncompetitive bidding processes, environmental exemptions, and thetrade remedy laws all conspired to discourage the least efficient,least competitive mills from exiting the market permanently.Instead, that confluence of policies encouraged failing mills tostay in business and failed ones to return to operations, thuspreventing the industry from adjusting to the market's signals andperpetuating the industry's problems.

Instead of the stronger, more competitive firms being rewardedwith greater market share and stronger profitability, those firmswere dragged down by the uneconomic, pricesuppressing oversupply ofinefficient mills that should have liquidated but were preventedfrom doing so by politicians who fought to keep those millsoperating at all costs. And those costs were significant. TheAmerican Institute for International Steel estimates that Americanspaid $100 billion for the steel industry's trade restraints andsubsidies during the 30 years ending 1999.5

Equals Steel Crisis

By 2001, the U.S. steel industry as a whole was bleeding redink. Operating profits had declined from 3.4 percent in 1999 to2.8 percent in 2000to -2.2 percent in 2001. As a result, 8 steel producers accountingfor nearly 20 million net tons of production capacity (about 20percent of total U.S. capacity at the time) filed for bankruptcythat year. During 2002 and 2003, the trend of failures continued:10 more producers, accounting for another 21 million net tons ofcapacity, filed for bankruptcy.6

True to form, the domestic industry and its powerful lobbysucceeded in blaming its woes on surging import competition andconvinced President Bush to launch a Section 201 investigation atthe ITC.7 Duringthe investigation, which led to sweeping trade restraints againstall types of foreign steel, the structural problems that had beenafflicting the industry for many years were brought to the fore.There was vast agreement between industry executives, analysts, andpolicymakers that the steel industry needed to restructure and thatthe restructuring should involve retirement of inefficient capacityand consolidation of more efficient production capacity within thecontrol of fewer producers. But standing in the way of the mostsignificant potential mergers and acquisitions were billions ofdollars of unfunded pension and health care liabilities (i.e.,legacy costs) on the books of companies that were otherwise strongcandidates for acquisition.

Metamorphosis

What turned the industry around was its restructuring, startingwith the creation of International Steel Group in 2001, and ISG'ssubsequent purchase of the assets of the defunct and bankrupt LTVSteel Corporation in February 2002. LTV had been one of theindustry's largest producers prior to its second trip intobankruptcy in 2000. ISG's purchase of LTV was conditioned upon,among other things, the U.S. government's assumption of LTV'slegacy cost liabilities, and a presumption that a new, moreflexible labor agreement could be struck with the UnitedSteelworkers union.

In March 2002, the Pension Benefit Guarantee Corporation, ataxpayer-funded entity created by Congress to protectdefined-benefits pension plans from corporate underfunding, assumed$2.2 billion of LTV's legacy cost liabilities.8 Later that year, anew labor agreement was reached which radically restructured jobclassifications, work rules, compensation and benefits plans, andultimately helped to reduce fixed labor and pension costs andimprove labor productivity.

ISG hailed the new agreement as providing "greater flexibilityand increased productivity as compared to historical agreements atintegrated steel mills. The absence of significant defined benefitpension and retiree health care plans makes ISG's cost structuresignificantly more variable than most of its U.S. integratedcompetitors."9 Inother words, ISG's new competitiveness was achieved, in substantialpart, by a government intervention that essentially excusedmanagement and labor of their respective contractual obligationsand risks, thrusting them, instead, upon U.S. taxpayers.

The PBGC's assumption of LTV's legacy costs and the new laboragreement negotiated between ISG and the United Steel Workersserved as a model for subsequent acquisitions. During the course of2002 alone, the pension plans of nine steel companies were takenover by the PBGC at a cost to taxpayers of over $8.2billion.10 In2002 and 2003, ISG purchased the assets of other bankrupt steelcompanies, including Bethlehem, Weirton, and Acme, while U.S. Steelpurchased the assets of National Steel. Meanwhile, acquisitions byNucor Steel of Trico, Birmingham, Northstar, and Corus Tuscaloosa,as well as acquisitions by foreign producers of U.S. mills over thesame period, helped to transform the landscape of the U.S. steelindustry.11 Whathad been a largely disaggregated, high fixed-cost industrytransformed very rapidly into a highly concentrated, lower-costindustry with a few dominant players possessing significant marketpower.

In 2000, there were 27 U.S. producers of flat-rolled steeloperating 35 mills with a total production capacity of 81 millionmetric tons.12In 2006, there are only 14 producers operating 29 mills with atotal capacity of 73 million tons.13 While production capacity and the number offirms and mills have declined, capacity per firm and mills per firmhave increased by 69 percent and 63 percent, respectively. And thisconcentration of production is evident in the changes in marketshare.

In 2000, the top three U.S. producers of hot-rolled steelaccounted for 36 percent of consumption; in 2005, the top threeaccounted for 61 percent. Likewise, the top three's share ofcold-rolled steel consumption increased from 47 percent in 2000 to70 percent in 2005. For rebar, the share increased from 45 percentto 80 percent, and for tin plate, the share went from 60 percent in2000 to 100 percent in 2005. Similar patterns exist for every majorsteel product.14

With production capacity in the hands of fewer companies, thesteel industry is now better able to control output in response tochanging demand. And since the industry's fixed costs have declinedconsiderably, profitability now can be achieved at substantiallylower levels of output, which gives producers greater flexibilityto cut production in support of price levels.

Steel industry executives have not been shy about sharing thisstrategy with the public. John Surma, Chairman and CEO of U.S.Steel, was quoted in the Wall Street Journal as saying, if"we see inventories building in our shops, we would slow productiondown."15 MittalSteel reported that its "operating rates were reduced as part ofMittal's plan to lower global steel production to help reduceexcess inventory and restore equilibrium to supply and demand inthe marketplace."16 These types of proactive steps were impossiblebefore the wave of consolidation during2002â€ââ'¬Å"2003,which was made possible by new and improved labor agreements andthe foisting of nearly $9 billion of industry legacy costs onto thebooks of the PBGC.

At the very least, the U.S. steel industry that has emerged owesmore than a debt of gratitude to the victimized consumers andunwitting taxpayers whose resources were tapped to effect thistransition. The breadth and longevity of steel tariffs have put thesqueeze on U.S. steel-consuming industries, which have been forcedto endure higher costs and supply constraints, while at the sametime trying to compete at home and abroad with foreign companiesthat have access to market- priced steel. Meanwhile, subsidies andbailouts have siphoned tens of billions of dollars from federal andlocal treasuries. Yet, the steel industry continues to insist thatrestrictions on imported steel are an essential component of itslongterm viability, taxpayers and consumers be damned.

Broken Trade Remedy Laws

Despite the industry's profound structural changes and thestrong performance those changes have delivered, the U.S.government still maintains 136 antidumping and countervailing dutymeasures that limit the access of steel-consuming industries toforeign steel. Although there are legal mechanisms in place, suchas "Sunset Reviews," to see that measures no longer necessary arerevoked, the sad fact is that that process rarely works.

The initiation of a sunset review is required five years afteran antidumping or countervailing duty order is imposed to determinewhether revocation would be likely to lead to a continuation orrecurrence of dumping and material injury. The Commerce Departmentis tasked with evaluating the likelihood of continuation orrecurrence of dumping, while the ITC evaluates the likelihood ofcontinuation or recurrence of material injury.

Since U.S. sunset reviews began in July 1998, the CommerceDepartment has determined that revocation would lead tocontinuation or recurrence of dumping in every single casewhere the domestic industry participated and supportedcontinuation. The ITC has voted against revocation in 75 percent ofcases.17

Since 2004 (the first full year after major restructuring hadoccurred), 12 sunset reviews have been completed concerning 62separate antidumping and countervailing duty measures on steelproducts. Only 13 measures have been revoked, while 49 have beencontinued.18That the ITC can still find this industry vulnerable to arecurrence of injury is boggling. Not only has the U.S. industryrestructured, but the global industry has consolidated andeliminated uneconomic capacity, as well. No longer do foreign millshave incentive to overproduce and then sell at prices just highenough to cover their variable costs. In fact, the same high pricesand shortages that have afflicted the U.S. market in recent yearshave been prevalent in Asia and Europe. And with demand growthstrongest, and projected to remain strong for years to come, indeveloping Asia, Eastern Europe, and the former Soviet republics,foreign producers have little incentive to ship large volumes ofsteel to the mature U.S. market.

What continues to drive industry consolidation in Europe andAsia is the desire to produce for regional consumption.Arcelor-Mittal, the world's largest steel producer with productionoperations in 27 countries on five continents, is highly unlikelyto endure high transportation costs, exchange rate uncertainties,and long delivery times to ship to the United States when italready owns Mittal Steel USA, the largest producer in the UnitedStates. The same can be said of several other foreign producers whoown production facilities in the United States.

One of the explanations for the failure of the sunset provisionsto have any real meaning is that in performing its analysis, theITC is required to give weight to the Commerce Department'sconclusions. Recall that Commerce always concludes that revocationwould likely lead to continuation or recurrence of dumping. Andthat should not be surprising, given the absence of rigor in theCommerce Department's analysis. That analysis involves nothing morethan looking back to the period before an order was in place,presuming nothing about the industry has changed since then, andconcluding that life without the orders prospectively would inspirepricing practices identical to those that existed during theoriginal period of investigation. Thus, if Commerce foundoriginally that foreign producers were dumping in the range of 20to 30 percent, the department would conclude that revocation of themeasures (regardless of how many years later and how much changehas transpired) would likely lead to a recurrence of dumping atthose same levels. It's as simple as that. Commerce gives nolatitude for, and gives no consideration to, the fact that theconditions of competition within the industry may have changedbetween the original period of investigation and the present.

Furthermore, in rendering its determination, the ITC is requiredto speculate about what might happen if an order is revoked, andthen it is required to speculate about the impact of thatspeculation on the industry in question. To get a feel for thenonsensical results these proceedings produce, consider the recentsunset review vote to continue the antidumping order on Tin- andChromium-Coated Steel Sheet from Japan.

The ITC voted to continue the order for at least five more yearsbecause it concluded that revocation would likely induce largevolumes of imports from Japan at prices likely to be low, whichlikely would lead to material injury because the domestic industrywas in a "vulnerable" state. That decision was issued in June 2006.The next month, the U.S. Department of Justice, concerned about theantitrust implications of mergers and acquisitions in the steelindustry, ordered Mittal Steel to sell one of its tin plateproduction facilities because the number of U.S. firms producingtin plate had declined to three, and the degree of concentrationwas deemed to be a threat to competition.

So, on one hand the Justice Department is ordering a company todivest because it has too much market power and there is too littlecompetition; on the other hand the ITC concludes that the industryis vulnerable and votes to keep out the competition. How can anindustry that is so concentrated as to inspire intervention fromantitrust regulators be considered vulnerable to a recurrence ofinjury because of import competition? If this outcome doesn't raiselegitimate questions about the efficacy of the Sunset Reviewprocess, nothing should.

There is nothing wrong with industries evolving in ways bestsuited for their long-term viability--even if that means producersin the industry attain high degrees of market power. But it makesno sense for trade policy to accentuate that market power bypreventing foreign competition. In the case of the U.S. steelindustry, there can be no plausible justification for continuationof any of the 136 antidumping and countervailing duty measures.Next month the ITC will vote on the cases for which the media haspit the steel industry against the auto industry. Continuing tomaintain those 13- year-old restrictions, or any other steel importrestrictions, will only enhance the industry's market power to thedetriment of the same consumers and taxpayers who subsidized thesteel industry's metamorphosis, and it will--as it has-- deteroptimal adjustment within the industry.

Conclusion

The dramatic changes in the steel industry over the past fewyears have been long overdue. Through consolidation, the retirementof inefficient capacity, reduced fixed costs and greaterflexibilities brought about by new labor agreements, the industryis in a much stronger position than it has been in recent history.That does not mean, however, that steel production is no longerprone to cycles. Steel consumption is highly pro-cyclical, andundoubtedly there will be periods of slow growth or recession inthe future. But under its new structure, firms operating in theindustry will be much more capable of enduring demand downturns,and given the industry's new capacity to regulate its output moreeffectively, those downturns are unlikely to cause steep pricedeclines. In any event, the trade remedy laws are not intended toprotect industries from cyclical downturns.

Of greater concern to policymakers than ensuring the viabilityof the U.S. steel industry should be the impact that continuedantidumping and countervailing duty restrictions on behalf of ahighly concentrated industry could have on steel consumers and theeconomy at large. Taxpayers and consumers bore a heavy brunt forthe policies that preceded the steel industry's renaissance. Tocontinue to maintain trade restrictions on behalf of an industrythat is in enviable health, whose firms have been achieving recordor near-record profits, and which has a substantial degree ofmarket power, is an injustice to those same taxpayers andconsumers. And, as has been witnessed, it will distort marketsignals, frustrate optimal adjustment, and undermine the steelindustry's long-term health.


1. Compiled from data inU.S. International Trade Commission, "Antidumpingand Countervailing Duty Orders in Place as of October 23,2006."

2. Doug Cameron, "WarinessRemains as Sector Finds New Rhythm," Financial Times, June14, 2006, p. 5.

3. Peter F. Marcus andKarlis M. Kirsis, "Global Steel Mill Product Matrix: Core Report,"World Steel Dynamics, May 2006.

4. Compiled from"Quarterly Report for Manufacturing, Mining, and Wholesale TradeCorporation," first quarter 2000 through second quarter 2006, U.S.Census Bureau.

5. See William H.Barringer and Kenneth J. Pierce, Paying the Price for BigSteel (Washington: American Institute for International Steel,2000). This book gives comprehensive treatment to the various formsand costs of federal, state, and local government subsidization ofthe steel industry between 1969 and 1999.

6. Bankruptcy data isavailable on the website of the United Steelworkers of America,www.uswa.org.

7. Section 201 of theTrade Act of 1974, also know as the "Safeguard Law," allows forimport restrictions if imports are deemed a "substantial cause ofserious injury" to the domestic industry.

8. U.S. InternationalTrade Commission, "Steel: Evaluation of the Effectiveness ofImport Relief" (Investigation No. TA-204- 12; Publication3797), September 2005, p. Overview III-13.

9. United StatesSecurities and Exchange Commission, Form 10-K, International SteelGroup, 2004.

10. U.S. InternationalTrade Commission, Steel, p. Overview III-13.

11. International SteelGroup was subsequently purchased by LNM Steel, a Dutch-basedproducer, and merged with Ispat- Inland to create Mittal Steel USAin 2005.

12. ChristopherPlummer, managing director, Metal Strategies Inc., "Changing Faceof the U.S. & World Steel Industry," Presentation before theSteel Manufacturers Association Annual Members Conference,Washington, May 16, 2006; supplemental data provided by ChristopherPlummer to the author via e-mail.

13. Ibid.

14. Ibid.

15. Paul Glader, "U.S.Steelmakers See Profits Surge on High Demand," Wall StreetJournal, July 26, 2006, p. A2.

16. United StatesSecurities and Exchange Commission, Form 10-K, Mittal Steel, 2005,p. 22.

17. For details on thesunset review process, see Daniel Ikenson, "Shell Games and Fortune Tellers: The Sun Doesn't Set atthe Antidumping Circus," Cato Free Trade Bulletin no. 18, June20, 2005.

18. U.S. InternationalTrade Commission, "Trade RemedyInvestigations,"