China bashing

I am just back from a meeting in Italy, where a US "learned society" (une société savante) organized a local event.  It was thus an effort from an overseas-based entity to reach out to a European beachhead, with some untold strategic agenda - probably to acquire more market share in the world of learned societies.

China was the Arlesian of Bizet in this meeting: it was not represented by any delegates, but was much talked about in several of the key interventions.

China is the largest steel producer in the world, a good enough reason for steel people to be interested in this country. China acquired this position in the early 2000s, when its growth jerked the world economic engine strongly forward and stopped the gloomy period of the "40 piteous years".

The US were the largest steel producer in the 1960s.  They lost that rank to Japan and also to Europe, although Europe is rarely seen as a geopolitical entity in the American press, which prefers to split it into its member states and to emphasize one or two of them, presently the most powerful one, economically, Germany.  A pity, because the second largest steel producer in the world is the EU, which is also the most populated and the highest in GDP.  This is a first example of the fact that how the story is told modifies the vision that is projected! The power of narratives!

China has been investing "crazily" in the steel sector, like in many other basic industries, on the rationale that the building of a modern state is based on a number of core commodities, of which steel is an essential one.  Decisions for investments are made in a decentralized way in China, which creates a competition among provinces and makes it difficult to balance the growth in capacity with the growth in demand: in China, recently, capacity growth has been outpacing demand's.  Moreover, these decisions are based on criteria different from those used in the Western world and expectations for the future are rated indifferent ways.  The result of this is that the steel sector has built more steel mills than it needs to feed its internal market and ends up with an overcapacity estimated at 250 Mt, 1/6 of the world overall production.

The meaning of overcapacity deserves some critical analysis, even though it is usually taken for granted in all the talks that use it - or instrumentalize it. 

First of all, the simpler concept of production capacity is not defined in a completely explicit way: how much steel a steel mill can churn out is a complex matter and steel companies, internally, debate this often and come up with a spread of answers. Let's forget this however for the time being, and assume that some think tank has done its homework properly and has produced an updated list of all the steel mills in the world and of their present capacity. 

Then some kind of reference capacity needs to be defined, in order to get an estimate of OVERcapacity.  The reference, usually, is the current year's production.  This means that overcapacity goes up and down with the structural fluctuations of production, which are common in a cyclic business like steel.  Moreover, when speaking of a particular country, the tendency is to refer to its national market: international trade is usually ignored and the "right" to export or import steel is somehow denied to it by this kind of conventional approach. 

The US, for example, have been structurally operating under capacity and therefore importing steel from Canada, Europe, Japan and Korea.  This happened because the business world there did not believe in steel as a promising activity in which to invest, locally, and it preferred to import steel from abroad, although under strictly controlled conditions - antidumping cases have been filed on a regular basis by steel producers, which has served as a powerful valve to limit the amount of imports.  A less often analyzed matter is that this made it possible for the US steel sector to avoid investing in the very high-grade production, which requires large R&D expenditures and investment in steel mills.  There was a revival of investment in the steel sector in the 1980s and 1990s, but it was based on rebuilding capacity based on EAF,  a much lesser level of investment than an integrated mill, especially since new technology developed in Europe was used (thin slab casting): it could not produce the very high-end steel grades that were imported and thus not disturbing the statu quo of relying on foreign mills to supply the most sophisticated steel for the automotive industry, for example.

In Europe, the narrative about one country flooding a neighboring one is never told, at least not loudly enough to be noticed.  In the EU, the steel association there, EUROFER, is talking about the region as a whole and internal exchanges among member states are a private issue inside the Union.

Now, China is different. With the present arguable definition of overcapacity, it is the country in the world which has built the largest one (300 Mt).  "Trigger happy" investors there have clearly invested above local needs and the mills, now running, are faced with the need to sell their production, which means exporting above their past practice. Either because their cost are low, but, most probably because they are ready to sell below cost (another complicated concept that would need more careful definition) to maintain employment and because costs are not as essential a criterion as in the West.  They export to the whole world, to Europe and the US and undercut the regional prices.  They are perceived as intruders dumping their products in EU and US markets. 

Therefore the whole world starts complaining, filing anti-dumping lawsuits and asking governments for relief.  And meetings, like the one I attended in Italy, are transformed into the antique choir of a Greek tragedy, blaming China for its unethical, anti-social and anti-fair trade behavior.

 This is part of the game countries and companies play and since it follows strict rules, which have been invented to stabilize evolutions, it is probably fine. 

On the other hand, what is important, if one looks beyond SROs, short-term tactics and trends?

In Europe, steel production has not fully recovered since the 2008 crisis and production is still lingering 20% below the 2007 level (209.5 Mt), when it peaked.  Thus the estimate of overcapacity (62 Mt/y) refers to a situation, which is at least 30% below the past (2014/2008).  It amounts to 30% vs. 2008 or 41% vs. 2014.  If the drop in production is taken on board, then the overcapacity is either 1 or 2%. This is a trifle!!! 

Unless, of course, one believes that the drop is structural, as SRO economists would call it.  

This is the key point: either production in 2007 peaked for very specific and time-stamped reasons and production would not have continued to grow afterwards, even without the crisis.  However, what these specificities would be is part of another untold story.  The argument made in 1974, that the 30 glorious years period was coming to an end cannot be reformulated for the present economic conditions: Europe has long stopped being based on infrastructure building!  On the other hand, there is the modern talk about green growth, ecology transition and a decouple between growth and well being from commodity consumption, which is loud but not necessarily a consensus view.  I would not go along this view, with the rationale that material intensity in our economy would not decrease quickly, as the new paradigms based on green growth are actually often more material-intensive than the old technologies. 

I would thus point out that the economy is not yet back on track after the 2009 severe collapse and that this explains the present "apparent" overcapacity.  I would thus argue that this apparent overcapacity is not structural, thus that there is no overcapacity in Europe.

As an aside, the economy in Europe is slowly picking up some strength and this is seen in the SRO for steel production (+2.1% in 2015 and 2.8% in 2016) - at 2% growth, it would take 17 years to get back to the 2007 level.  This is not much and, moreover, the driver for this pick up is not clearly identified, except by those who claim that this is due to strict budget deficit control, which I do not believe for a second!

One must also acknowledge that steel mills cannot be run if the demand has dropped and that productivity gains should also be taken on board to evaluate the capacity (1% improvement per year?).  Thus the apparent overcapacity raises serious issues for steel companies, which cannot indefinitely idle mills, waiting for the economic recovery like waiting for Godot.

Now, back to China. The country is experiencing, quite believably, its transition from a fast growth period similar to the 30 glorious years of Europe and its economy is slowing down, although still growing at 7%, if official statistics are to be believed. Steel capacity has overshot demand, as was said before. 

Therefore the main questions is whether China will make it its policy to export steel massively on a structural basis - like it decided to export solar panels - or if it will let its capacity match its internal needs which will keep growing - in spite of the low SRO projections.  It is not reasonable to project trends, which are necessarily long term, based on  glitches of the production curve, that have a 1 or 2-year period.  I do not believe that China has decided, policy wise, to flood the world with steel, for example like Germany has decided to do in the EU.  The real question is whether China will react quickly enough to readjust its production to its national needs, by closing down obsolete and dirty capacity, which would help it match its climate change targets and solve its city pollution major problem. 

It might be good short term policy to cry wolf and to file lawsuits, but this should not be part of a vision that steel in the West is fighting step by step to resist a future of inevitable decay and decline.  

The production of steel in the world will continue to grow, because steel will continue to be needed to bring more well being to the poor of the world.  Population growth has been reevaluated by the UN in September 2015 and the projection is of 11.5 billion people by 2100 and no peak in 2050, as the previous narrative said.  

Steel will be needed, in China for several more decades, and in Africa for the next 100 years. It will be produced locally but it si also for Europe and NAFTA to decide whether they want to me part of this brilliant future, or not. 

Last, it should not be forgotten that the standard of living in China is growing, that salaries and income in general are also increasing and that operating costs for making steel are getting closer to world standards - actually the sector is selling below cost in its own market. 

And China is entering the modern world of industry, i.e. producing its own innovation, now that it cannot simply use the technology developed elsewhere.

This is not discussed very much in western circles, where China is perceived as a "copy-paste" culture in the area of technology, intent only on generating growth and wealth for the country.  But this has not been a viable model for Japan and Korea in the 20th century.  Why would it be true for China?