Saturday, December 1, 2012

When Government Interferes with Free Markets ... The Global Steel Glut ... Consequences of Government Actions to "Create and Save Middle Class Jobs"

The world is awash in steel making capacity, so guess what's happening?

In addition to a reluctance to shutter old facilities representing excess capacity, numerous additional new steel making facilities are being built to increase the global production capability. That's what.

And who other than the government knows best gang with lots of OPM to waste -- er -- invest would be so stupid to facilitate and often even insist on the industry building more output capability in the midst of a capacity glut? Nobody with MOM at risk.

As we know, French President Francois Hollande fought hard and won to make sure that ArcelorMittal didn't reduce its steel making capacity in France, but he's not the only one doing wrongheaded things like that. There are many others doing similar things to maintain employment in an already oversized industry. {NOTE: See yesterday's posts on the French government's threats to nationalize ArcelorMittal's France based steel facilities.}

In any case, this government insistence on not letting the free market work always results in excess capacity and turns an already bad economic situation into an even worse and longer lasting one.

Global Steel Industry Faces Capacity Glut has the details on excess steel making capacity and governments' role in both creating the initial problem and then later preventing its solution:

"Global steel has a big problem: It's too big and it's getting bigger.

This year, steel mills around the world have a production capacity of 1.8 billion tons but will take orders for only 1.5 billion tons. And instead of consolidating and becoming more efficient, the industry is building still more capacity.

By 2016, an estimated 100 new mills, with total estimated supply capacity of 350 million tons, are expected to come on stream, according to industry executives and consultants. Companies in Vietnam, Argentina, Ecuador, Peru and Bolivia, all backed in some way by their governments, are building or planning new mills.

Stainless steel coil in China, where steel production has boomed.

Officials in these countries say they want to invest in industrial development, supply homegrown steel to their manufacturers and cut imports. But what may appear to be welcome developments for local economies has reverberations through a global industry. . . .

"You can argue about what needs to happen next," said Charles Bradford, an analyst with New York-based Bradford Research Inc. "But no question: there is too much capacity."

Getting a definite count on the number of steel mills in the world and actual production capacity is difficult in large part, say industry officials and analysts, because there are hundreds of small, uncounted mills in China, which accounts for 46% of world steel output. Estimates for the number of steel mills in China range from 600 to 800 mills.

The oversupply issue has reduced steel prices and profits, as seen in the latest round of earnings, and led to renewed calls for consolidation and rationalization among industry officials and investors.

ArcelorMittal, which is the world's largest steelmaker by output but only has 6% of the global market, reported a loss of $709 million in the third quarter. CEO Lakshmi Mittal has said he believes the industry is far too fragmented and that the company would remain focused on consolidation "as long as the right opportunities arise." {NOTE: Arcelor agreed late yesterday that the company would keep operating its French steel complex after the French government earlier in the week had threatened to nationalize it.}

But at this point, there appears to be little industry progress toward doing so—and much opposition politically from governments. . . .

Earlier this year in Serbia, the government chose to buy a failing mill from U.S. Steel Corp. for $1 rather than see it go under. It is now looking for a buyer. . . .

ThyssenKrupp has so far been unsuccessful in selling a state-of-the-art steel mill in Brazil and a processing plant in Alabama—each with a capacity of five million tons—that it built for a combined $11.8 billion in 2007. The firm's struggles to sell the two plants, built with tax breaks and subsidies, illustrates how steel companies and governments are overinvesting in new capacity they then struggle to find use for.

The trillion-dollar-a-year global steel industry is expected to remain, for the foreseeable future, the most fractured of major industries. The world's top five steel companies control only 18.2% of global steel supply. By contrast, the world's top five car companies control 50.6% of the global market. And the world's top five sellers of seaborne iron ore— iron ore that is exported by ocean trade routes—account for 66.1% of that market. . . .

Meanwhile, governments continue to subsidize mills, despite weakening demand, to maintain jobs and sustain local economies.

Wolfgang Eder, CEO of Austrian steelmaker Voestalpine and president of the European Steel Association, has called for European politicians to organize a coordinated scheme of capacity-cutting.

"The steel industry could fall back into the mistake of the 1980s, in which it would demand subsidies and keep obsolete plants running for social and political reasons," he said in a recent interview.

But Thomas Veraszto, a vice president at Russia's OAO Severstal said closing a mill, especially when the economy is weak, is difficult.

"It's very easy to open a steel mill in good times and very difficult to close it in bad times," he said. . . .

The steel industry owes its fractured nature, in part, to its historic role as an economic engine. "No nation has ever industrialized without developing its own steel industry," said David Hounshell, a professor of industrial history at Carnegie Mellon University in Pittsburgh. Each region had its own mill to supply local industries. Once built, they become a source of jobs, which were protected with tariffs and subsidies. "The end result is always a lot of overcapacity," Mr. Hounshell said."

Summing Up

When governments interfere with markets, MOM and common sense go out the window. Capacity is built, and then even more is built, creating lots of temporary jobs in the process.

And then more capacity comes on stream and so on. Until the inevitable capacity glut occurs. Then when recessions hit, governments go into jobs protection mode.

When this happens, it's extremely difficult for companies to reduce capacity. That's because everybody wants to protect jobs in a down economy. Enter the government and its errant jobs protection policies, including cash subsidies, which foster more construction or at least inhibit the necessary industry consolidation. The result is a continuing glut of production capacity.

That's pretty much how the OPM effect works in government "stimulus" programs, crony capitalism projects, and government sponsored infrastructure spending of all kinds.

Capacity gluts are especially hard to solve when government is interfering in the market with its multifaceted OPM spending initiatives, subsidies and guarantees.

OPM spending's a losing way to invest, particularly when "do gooder governments come to the rescue and act as saviors of the middle class" in every "electable" way.

Meanwhile, MOM and taxpayers lose. Eventually the "saved" members of the middle class lose as well.

But fear not for the politicians. By saving the middle class, they'll be re-elected and manage to keep their jobs. It's the OPM way.

In effect, the politicians "win" by causing everybody else to lose, and especially MOM.

Got it? I thought so.

Thanks. Bob.

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