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Sordid Steel Shenanigans

Bureaucratic and hypocritical aptly describe the latest U.S. proposal to reduce global steel production capacity.

Efforts to tackle worldwide overcapacity--the scapegoat for the domestic industry's woes--resumed in Paris this week under the auspices of the Organization for Economic Cooperation and Development. Feeling that it has now purchased redemption by granting a series of tariff exclusions, the Bush administration stands ready to resume its role as facilitator of a new world order in steel. But it truly lacks the credentials. Indeed, the U.S. steel industry needs to clean its own house first.

The U.S. proposal on overcapacity offers vague objectives, indefinite timelines, working groups and general frameworks. It also foreshadows the advent of some monolithic organization that could eventually set world steel prices. One can't help but wonder whether the U.S. is hinting in favor for an "OPECization" of the international steel industry. Does the U.S. want to join the phantom international cartel about which domestic steel executives have been spooking the government for years? Rather than jump off that bridge, a sober assessment of the facts is advisable.

The official justification for the March tariffs was that it would provide a shield under which U.S. consolidation, liquidation and cost-cutting could occur. In short, it would facilitate U.S. capacity reduction. But since that protective bubble was erected, no renaissance has begun. Rather, structural problems have been exacerbated.

What is the point of any country devoting efforts to talks about capacity reduction when tariffs of 8 to 30 percent themselves constitute a subsidy that discourages U.S. capacity reduction? The tariffs, in the end, have the same effect as foreign capacity reduction. And what has that brought? U.S. capacity increases. Like Pavlov's dogs drooling at the sound of a bell, the tariffs do nothing more than inspire reflexive, irrational decisions to defer liquidation and ramp up production in pursuit of a profit mirage.

And it's not just the current tariffs. Decades of import protection and industry subsidization have led to persistent excess capacity. Also to blame are the failure of bankruptcy laws to effect liquidations and the shortsightedness of unions that don't seem to appreciate that efforts to preserve jobs at one zombie plant threaten jobs at healthier ones. There is too much steel producing capacity in the world largely because unprofitable firms continue to produce and sell at below market prices. Those firms should be put down. Instead, today's steel industry landscape is like the movie set from Dawn of the Dead.

The domestic industry insists that cheap imported steel flowing from foreign excess capacity is the source of their woes. There is never any acknowledgement that domestic competition offered by much more efficient, low-cost "mini-mills" has contributed to the red ink and job attrition. Nucor -- the largest and most profitable mini-mill -- has been cross-subsidizing bargain basement prices for traditional steel products with the enormous profits it reaps from industry sectors (like steel joists) in which it has market dominance. The patented steel industry response to the suggestion that domestic mills are suppressing prices is that the mini-mills supported the imposition of tariffs, as if their interest in crippling foreign competition proves that they themselves have not been underselling.

And it's not only the mini-mills that are selling below market prices or even below the cost of production. In fact, every steel mill that has been losing money has been selling below cost, by definition. Further, a candid remark by a steel executive a few weeks ago should be taken at face value-it's the smoking gun that undermines any remaining credibility the industry should hold before the administration.

Last year, LTV Corporation returned to the bankruptcy courts. It ceased production entirely. Its exodus -- combined with the March tariffs -- shrunk supply and caused prices of hot-rolled steel to increase significantly. But before the tariffs were announced (and in Pavlovian expectation), LTV was purchased by an investment group that has recently brought the company back into production under the name International Steel Group (ISG). According to American Metal Market, ISG's president, Rodney Mott, said the company was offering hot-rolled sheet at lower-than-market prices to gain market entry.

"That's traditional in a start-up," Mott said. "You're asking your customers to bear with you as you ramp up and, as a result, your pricing comes in at below market. We have done that."

While that is how business is conducted in a competitive market, the steel industry is not a true competitive market because of the barriers to exit. When you have capacity that the market has already deemed inefficient, its continued output suppresses prices and threatens the whole industry.

The significance of Mott's statement cannot be overemphasized. It belies the official industry line and provides all the evidence necessary to abandon the misguided "global" steel capacity discussions. The solution is local.

Dan Ikenson is a trade policy analyst at the Cato Institute.