SOLVING BIG STEEL’S MILLENNIUM CRISIS:
OLD MISTAKES OR NEW SOLUTIONS
William H. Barringer Willkie Farr & Gallagher
12th Annual Tampa Steel Conference
February 13, 2001

No special interest has been as active in the early days of the Bush Administration than the steel producers and unions. Senators Rockefeller and Baucus have used the confirmation hearings of Secretary of Treasury O’Neill, Secretary of Commerce Evans and U.S. Trade Representative Zoellick as platforms to lecture the incoming Administration on the dire state of the U.S. steel industry and the need for strong enforcement of U.S. trade laws. The United Steel Workers (USW) have called for quotas on imported steel, a surcharge on all steel sales to cover the underfunded legacy costs of the integrated steel mills, and a massive steel loan program to revive the industry. The Steel Manufacturers Association (SMA), which represents primarily the non-integrated producers, has put forward its own proposal, which concentrates on import restrictions rather than subsidizing the integrated steel mills. The American Iron and Steel Institute (AISI), while calling for trade law enforcement and apparently endorsing the concept of section 201 relief, is split on domestic aspects of any recovery program and appears to favor use of antidumping laws over other import relief.

With 14 steel producers having entered into bankruptcy proceedings and more reportedly on the way, it is difficult to argue that the industry, or at least the integrated mill portion of the industry, is not in crisis. The more difficult issue is determining what caused the crisis and what should be done about it. While 30 years of blaming imports for Big Steel’s problems have provided a convenient rationale for subsidies to the domestic industry and protection from imports, 30 years of import protection and subsidies have not resulted in the U.S. integrated mills becoming competitive either globally or with their minimill competitors in the U.S. market. Contrary to claims by the industry, virtually all steel analysts have concluded that the integrated mills are among the highest cost producers of steel in the world. The industry has fallen behind its foreign competitors by failing to consolidate and failing to globalize. The legacy costs of the integrated mills remain remain enormous and, in and of themselves, are probably sufficient to prevent consolidation of the industry or any major infusion of outside funds. Investment continues to lag behind non-U.S. competitors. Profits of the second tier mills are small even in boom times such as the 1997 and early 1998 period of record demand and strong pricing. Not a single integrated U.S. mill is among the largest in the world, the most modern, the most efficient, the largest, the most cost competitive, or the most profitable. Indeed, most U.S. mills rank at the bottom.

Although arguably more widespread, the crisis we see today is not something new. Indeed, the U.S. industry has been in constant crisis since at least the mid-1970’s, and arguably the late 1960’s. These repeated crises reflect the fact that in the post-World War II era the U.S. steel industry has consistently failed to invest, to adopt the most modern technologies, and to ensure the efficient and effective use of labor.

In each and every one of the post-war crises experienced by Big Steel, the industry has attempted to point to imports as the cause of the industry’s problems. In each case -- 1978, 1983/84, and 1992 -- Big Steel received protection from imports. In 1978, this was in the form of minimum prices for imported steel, the so-called trigger price mechanism. In 1984/84 through the spring of 1992, this was in the form of so-called voluntary restraint arrangements which restricted steel import volumes. At the same time, the mills received billions in subsidies including the government’s assumption of pension liabilities, exemptions from environmental regulations, and tax breaks. Notwithstanding import protection and massive subsidies, the integrated steel mills are no more competitive today that they were before the approximately 100 billion dollars in protection and subsidies that they have received over the past 30 years.

Steel’s millennium crisis is playing out very much like its previous crises. Blame the imports for being unfair and causing the problem, seek protection from import competition, and get subsidies from the government to save Big Steel. Big Steel and the labor unions neither accept the responsibility for their present condition nor are willing to take the steps that are necessary to prevent its recurrence again and again. Blame the imports, give us a handout, don’t require anything of us, and we’ll be fine -- at least until the next time.

If we are to avoid this unending cycle, policies will have to be based on realities not myths. While we may not like these realities, a policy which is not based on them is a policy which is, like every previous bail out of the steel industry, destined to fail. The myths must be destroyed before there is any hope of a strong, competitive, world class integrated steel industry in the United States. The balance of this paper reviews the myths and the realities.

MYTH 1: FOREIGN STEEL IS UNFAIRLY TRADED

At the heart of the problem of developing a rational steel trade policy and a strong industry is the need to recognize that the U.S. steel industry is not only already playing on a level playing field, the field is tilted heavily in its favor. The antidumping laws on which the claims of unfair imports are based are economic nonsense which essentially prohibit foreign steel mills from competing in the U.S. market on the same terms as U.S. mills. The U.S. countervailing duty law is so flawed that an attempt to codify the most used rule -- the rule determining whether pre-privatization subsidies survive a market value based privatization -- was blocked by other agencies of the U.S. Government (and has subsequently been declared inconsistent with U.S. international obligations by a World Trade Organization panel).

Proponents of antidumping duties say that such measures are necessary to stop unfairly traded steel from injuring the industry in the importing country. The operative word is “unfairly.” Originally, “unfairly” meant that the price on an ex-mill basis in the export market is below the ex-mill price in the domestic market. The theory being that high domestic prices are being used to subsidize injurious low priced exports. That is, extraordinary profits in the home market permit the exporter to act in a predatory manner in foreign markets at the expense of the industry in the foreign market. There are at least three serious problems with the theory of dumping as applied under WTO rules today. First, the definition of dumping bears little relationship to the theory of dumping. Second, the determination of dumping proscribes conduct that is legitimate business conduct when undertaken by domestic producers in the importing country. Third, there is little support in economics or competition theory for the notion of predatory dumping unless the party guilty of the dumping has market power.

Under the WTO rules, the concept of high domestic prices supporting dumped exports is not a consideration. Indeed, under WTO rules a company can be selling for a loss in the domestic market -- hence have no profits with which to subsidize low export prices -- and still be found to be dumping. This concept was introduced into the U.S. law in 1974 and incorporated into the Anti-dumping Agreement during the Uruguay Round. Thus, the basic underpinning of antidumping -- the notion that profits in one-market support low priced sales in another market -- is no longer applicable. Prices of sales below cost in the home market are not used as the basis for comparison with export prices; rather a hypothetical above cost price replaces actual home market prices when those prices are below cost.

Even more anomalous is the fact that mills selling for identical prices in the home market and the export market will be found to be dumping. Assuming that there is a world market price and a steel mill is selling at that price both in its home market and in the export market, that mill will be guilty of dumping to the extent that the costs of selling the product and getting the product from the mill to the customer are greater in the export market than in the domestic market. Given that transportation, related costs such as port charges and duties on sales to the export market guarantee that the costs are greater on sales to the export market, it would be exceptional to find no dumping on sales of a commodity such as steel.

Let’s take an example. Hot rolled coil of identical specifications is being sold in both the home market and export markets for $400 per metric ton with comparable terms (e.g. ex-dock duty paid for the export product and ex-mill for the home market product). This is the market price for this product in both markets. However, under this scenario the $400 ex-mill price in the exporting country would be compared with the $400 ex-dock duty paid export price only after deductions for duties, ocean freight, ocean insurance, port charges and other landing costs. These deductions from the export price typically will run $50 or more. Assuming $50, the export price being compared is no longer $400, but $350. The margin of dumping is $50 or roughly 16 percent. In order to avoid dumping, the exporter must charge the $400 plus the $50 landing costs or $450. Obviously, it is impossible to sell a product for $450 in the export market when the identical merchandise is being sold for $400.

In recent years the notion of high profit sales in the domestic market supporting low profit sales in the domestic market has increasingly been articulated using the so-called “profit sanctuary” theory. This theory holds that dumping is possible because the exporting entity enjoys a protected home market where high prices can be maintained either because of the absence of domestic competition or by agreement among domestic competitors. While one can debate the validity of this theory, neither U.S. antidumping law nor the WTO Anti-Dumping Agreement make either the existence of a protected home market or the lack of price competition within the home market a criteria for application of antidumping duties. If a sanctuary market is necessary to support dumping, shouldn’t there at least be some investigation of whether a sanctuary market exists in determining the existence of dumping?

The second serious problem with the theory of dumping as applied under WTO rules today is that conduct which is considered commercially reasonable and competitively desirable when undertaken by a domestic firm is the basis for imposition of antidumping duties when undertaken by a foreign firm. It is not unusual, particularly in an industry as cyclical as steel and with the high fixed costs of steel, for firms to sell below cost for periods of time, particularly at the bottom of the business cycle. Indeed, economic theory and current U.S. antitrust law do not view below cost sales as unreasonable unless the sales are below marginal cost. Yet, antidumping laws reject pricing that is below fully distributed costs when it is undertaken by a foreign source. In effect, the U.S. antidumping law forces offshore sources to stop selling anytime the prices in the U.S. market fall below fully distributed costs. What would happen if the same standard were applied to U.S. mills? Given current price levels in the U.S. market, few, if any, U.S. mills would be permitted to sell today!

Similarly, antidumping laws make discriminatory pricing illegal. However, under U.S. antitrust law, discriminatory pricing is rarely considered illegal and often deemed to be pro-competitive. Indeed, discriminatory pricing is often part of a larger strategy by a company to gain market share. Companies will in effect “buy” market share from competitors by offering lower prices to new customer or to customers with which they want to expand business. No mill sells at the same price to all customers or even to all similarly situated customers. Price discrimination is the rule not the exception. Yet, allegedly adverse effects of price discrimination are at the heart of antidumping laws.

Finally, dumping theory is totally inconsistent with current competition theory which does not view aggressive below cost pricing as predatory unless two factors are present: (1) sales below marginal costs; and (2) the ability of a firm to use low prices to drive competitors out of the market and thereby gain monopoly prices. A determination of dumping is not contingent on prices below marginal costs. Furthermore, there is no consideration of whether the firm with low prices has the ability to eventually drive competitors out of the market through low prices and subsequently reap monopoly profits. Indeed, antidumping is more often the result of excessive competition, with numerous producers driving prices down as they compete for sales, than any ability to use predatory prices to gain market dominance and the ability to control prices.

The theory used to find continued subsidies for privatized steel mills is even more absurd than the dumping laws. Here I like to use what I call the pencil analogy. Assume the Government of the United Kingdom gives a pencil to British Steel and, in exchange gets stock in British Steel. However, stock in British Steel is worthless. Thus, the pencil is in reality a gift or, in countervailing duty terms, an investment in an unequityworthy company. In this situation, the Department of Commerce correctly assumes a subsidy has been given and values the subsidy at the value of the pencil and amortizes it over the life of the pencil. It does, however, get what is then worthless stock for in exchange for the pencil.

A year later, the Government of the United Kingdom decides to sell British Steel for its market value. As part of that sale, it sells the pencil and receives the residual value of the pencil in exchange. The pencil had a market value of $1.00 and the Government, by virtue of its shareholding in British Steel, received $1.00 for the value represented by the pencil. The question here is whether the new owners of the pencil, having paid $1.00 to the Government of the United Kingdom as part of its purchase of British Steel for the pencil, have received a gift or subsidy. In other words, have the old owners of the pencil -- the Government of the United Kingdom in its capacity as the owner of British Steel -- passed on the subsidy benefit of the free pencil given to British Steel to the new owners?

The Commerce Department answer is that the new owners, whether or not they have paid the full value for the pencil included in their acquisition of British steel, have received a gift or subsidy. While one would think that if I gave you a pencil for free and you then resold it for $1.00 that the benefit (getting the pencil or the $1.00 free) would be a benefit to you. Under the Department of Commerce logic, the benefit remains with the pencil and the buyer of the pencil receives the benefit even if he pays you $1.00 for the pencil.

This is not a level playing field. This is not about fair and unfair. This is about a playing field tilted decidedly in favor of the U.S. steel industry. Even with this tilted playing field, the U.S. industry cannot compete.

MYTH 2: THE U.S. INDUSTRY IS INTERNATIONALLY COMPETITIVE

While the U.S. industry repeatedly claims that it is a world class industry, there is little to substantiate this claims. Indeed, the fact that the U.S. industry -- specifically the integrated steel mills -- is not competitive internationally and has not used protection over the past three decades to modernize is recognized by the very entity that keeps giving the industry protection and subsidies, the U.S. Government.

In 1989, 20 years after the first voluntary export restraints first limited competition in the U.S. steel market, the U.S. General Accounting Office identified the root causes of the problems of the U.S. integrated mills as: …slow productivity growth brought on in part by slow implementation of new technology and little effort at research and development, disproportionately high labor costs…old integrated plants that are too small for efficient production using modern technologies, and an abundance of cheap steel scrap available for use by minimills. This was not the first time that an agency of the U.S. Government identified the true problems of the integrated steel mills. In an earlier report in 1982, the Congressional Budget Office stated:

In recent years, steel industry management, for the most part, have been too cautious with regard to using technology as a tool to reduce costs, improve quality, and improve international competitiveness.

Four years into what was to be fourteen years of unbroken import protection, the Congressional Budget Office determined that the U.S. integrated mills were not using protection to become cost competitive producers of steel. More than a decade after trigger prices were first implemented, the General Accounting Office described an industry in much the same condition. Most analysts agree that even today the U.S. integrated mills are among the highest cost producers of steel in the world. World Steel Dynamics, for example, rates the U.S. integrated steel mills as being higher cost producers than Brazil, Korea, China, Russia, Japan, and most of the Europe. More recently, there has even been some honesty within the industry. A recent article on AK steel made the point quite dramatically:

AK Steel Inc. the best performing integrated steel producer in the U.S. and one of only two integrated producers that are expected to be profitable for 2000 wants its money-losing competitors to stop dragging the industry down. AK Steel’s chairman said Friday that he wishes that assets owned by his unprofitable competitors would just go away and stop interfering in the market..

Richard Wardrop told analysts, “Darwin was rights, the strong should survive.” Highlighting the woes of the domestic industry, Richard Wardrop said it would be foolhardy for a company such as his “to acquire or be given” assets of unprofitable steel companies, then hope that those assets would become profitable in the future. “We looked at everybody and, frankly, the baggage is not worth the ride”…The “baggage” includes high costs of pensions owed to the retired workers that, in many cases, outnumber the companies current workforce, environmental problems, and equipment and facilities that have been outdated for years.

One prominent analyst, Charles Bradford, in commenting on the recent United Steel Workers plan to bail out the industry with more protection and more subsidies made an important point -- the common thread among the failing steel mills is that only steel makers whose work forces are members of the United Steel Workers have failed.

MYTH 3: IMPORTS ARE THE CAUSE OF WEAK PRICES IN THE MARKET

Because they are no ones political constituency, imports provide the industry and unions with a convenient scapegoat for the problems of the integrated mills. However, if one goes below the surface, the allegations simply don’t stand up. Increases in import volumes in the past decade have been modes when compared with the increase in shipments (and capacity) by the U.S. based minimills. In the 1990’s, minimills increased capacity by over 22 million tons and more than tripled their share of the flat rolled carbon steel market, the market on which the integrated steel mills depend. Indeed, the increase in minimill capacity during the 1990’s was greater than the total annual imports of flat rolled steel in the peak import year. One might ask whether it is large increases minimill capacity or marginal increases in import volumes that have affected the market. Similarly, the minimills have a cost advantage over the integrated mills estimated at $50 per ton. With increased capacity and a distinct cost advantage, why are imports the culprit and not minimills. The answer is simple -- you can’t bring dumping cases against your domestic competitors and your domestic competitors are constituents of U.S. Congressmen and Senators.

The situation in the U.S. plate market is illustrative. Plate today is among the most protected of the steel product markets in the United States. There are outstanding antidumping duty orders against virtually every producer in the world with any significant capacity to provide plate to the U.S. market. Yet prices of plate remain weak, notwithstanding the virtual absence of imports from this market. The reason is simple: two minimills, NUCOR and IPSCO, are in the process of introducing 1.2 million tons of new plate capacity in the market. Just as the 20 plus million tons of new capacity by domestic producers, minimills, in the 1990’s made the market more competitive, the introduction of additional capacity, in this case plate, in the new millennium guarantees continued pressure from domestic minimills on integrated mills market share and pricing.

MYTH 4: IMPORTS ARE BAD

If one goes beyond all the rhetoric and looks at the facts, imports are essential to the U.S. steel market. The gap between U.S. production capability and U.S. consumption is on the order of magnitude of at least 25 million tons, even in a weak market. Indeed, the largest importers of foreign steel are U.S. steel mills themselves, accounting for at least a third and possibly as much as forty percent of all imports of steel To survive, many of the second tier integrated producers are substituting imported slab for their own steelmaking operations in order to take advantage of the lower costs of foreign suppliers. Imports have become part of the survival strategy of many mills. More important, imports are part of steel’s survival as a viable material in the U.S. market. Because of the gap between domestic supply and demand, absent imports U.S. jobs and the U.S. industrial based would be seriously eroded. If you are a manufacturer that needs steel and you can’t get it in the U.S., you have no choice but to move your facility to a location where steel of competitive price and quality is available. Given that there are 40 jobs in steel consuming industries for every job in the steel industry, the importance of access to steel supplies should be obvious!

OLD MISTAKES OR NEW SOLUTIONS

A large part of the success of the U.S. industry in obtaining subsidies and import protection from the U.S. government has been its ability to successfully characterize the foreign mills as “unfair” and the U.S. mills as “fair” traders. The fact that the antidumping law finds normal commercially acceptable behavior to be “unfair” is ignored. The fact that foreign mills are being labeled unfair for behavior that U.S. mills engage in every day is similarly ignored. The fact that U.S. mills have frequently been found to be dumping in other markets is ignored. The fact that access to the U.S. market has been restricted for most of the past 30 years is conveniently overlooked in the discussion of closed foreign markets. The fact that the U.S. market requires somewhere in the range of 25 million tons of imported steel per year, much of it imported by U.S. mills themselves, is never mentioned when comparing import penetration levels in the U.S. with import penetration levels in other countries. The fact that the U.S. integrated mills are among the highest cost producers in the world is never part of the debate. Politicians like sound bites and simple explanations and the U.S. steel industry has given them these sound bites and simple explanations -- imports are bad, imports are unfairly priced, imports are the cause of all of the industry’s problems.

There will not be a constructive solution to global trade problems as long as the debate focuses on fair and unfair and ignores the contribution of the domestic U.S. steel industry to its own problems and to the larger global problems. Foreign governments are no more immune to the pleas for subsidies and protection for their steel industries than is the U.S. government. Can we expect foreign governments to take steps to prevent the continued survival of uneconomic steel capacity if the U.S. is not willing to address measures that allow uneconomic steel capacity to continue in production in the U.S. market? Can we expect foreign governments to insist on the elimination of market access barriers if the U.S. is unwilling to discuss the elimination of its barriers to foreign steel, as it did in Seattle when it refused to include antidumping on the agenda of a new round of multilateral trade negotiations? Can we expect the Russian government to abandon its steel mills and steel workers when we are unwilling to provide the financial assistance through multilateral lending institutions to restructure and modernize the Russian industry into a smaller more economic sector more attuned to domestic needs than exporting?

What the U.S. industry wants is to force foreign governments to abandon practices that have governed steel and steel trade in the U.S. for nearly three decades -- subsidies and protection from imports -- while allowing the U.S. industry to continue to enjoy these same market-distorting benefits. Thus, the announced initiatives in President Clinton’s steel action plan and the Department of Commerce’s report on Global Steel Trade to address steel problems bilaterally and multilaterally are not well received by the U.S. industry or aggressively pursued by the Administration. For these initiatives to become meaningful, the U.S. industry and government would have to be willing to address the same issues as they pertain to the U.S. market as the U.S. seeks to address with foreign governments as they pertain to foreign markets.

Thus far, the signs of a constructive approach by the U.S. industry or government are virtually non-existent. The steel industry’s objections to a multilateral steel agreement, which might have created a basis for addressing the persistent problems of the global industry, led to the immediate abandonment of this effort by the U.S. government. The steel industry’s claims of a steel crisis have led the U.S. government to take extraordinary measures to protect the industry, often in violation of WTO obligations. The steel industry’s desire to maintain its ability to obtain protection on demand through the antidumping laws forced the U.S. government to block any discussion of reforming antidumping measures in any upcoming round of multilateral trade negotiations. The Department of Commerce report on Global Steel Trade was nothing more than a regurgitation of decades of accusations by the U.S. steel mills against foreign mills and governments without even a word about the failures of the U.S. mills to take advantage of import relief and subsidies to become competitive or about the effects of increased competition from minimills on market prices and, ultimately, on the health of the integrated mills. Notwithstanding multiple U.S. government reports and studies that have indicated otherwise, Global Steel Trade attempts to blame all of the U.S. industry’s problems on unfair foreigners.

If the U.S. wants a form of unilateral disarmament from its steel trading partners, it is unlikely to get it. Rather, it will simply accelerate the balkanization of steel markets through the use of antidumping measures as more and more countries apply them. A constructive dialogue requires the U.S. government and industry to admit that they are part of the problem. Until then they cannot become part of the solution and there will be no progress towards a solution.

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