STEEL INDUSTRY RENEWAL, POLICIES NEEDED
August 15, 2001
Introduction
The steel industry is in crisis, a fact which is obvious to most observers. The surge of
unfairly and illegally traded imports has caused severe damage to the industry. Much of
the industry has been driven into bankruptcy, parts into liquidation, and more will follow
if there is no change from present trends. There is an urgent need for the industry to
continue transforming itself through a combination of private effort and public policy.
The U.S. steel industry is embroiled in a structural transformation in response to
changing competitive dynamics in the global steel industry. In order for the U.S. steel
industry to continue moving in the direction of greater efficiency and market
responsiveness, the transformation process must be accelerated and encouraged through
the application of effective public policy.
The key questions posed by the Administration include:




What should the steel industry look like in the future?
Is the industry moving in the right direction?
How can we accelerate the process of global and domestic industry renewal?
How would we propose to deal with the global over-capacity issue?
What should the U.S. steel industry look like in the future?
Perhaps the simplest way to answer this question is to list the characteristics that typify
the more successful companies in the industry. The characteristics of successful
companies in the United States and elsewhere include:







Efficient use of inputs (manpower, energy, raw materials, etc.).
Lean, flat and streamlined organizations.
Work force incentives to increase productivity.
Effective management of by-products of steel making (emissions, scrap, other
by-products).
Effective use of capital, including low leverage debt ratios consistent with
financial stability in a cyclical industry.
Effective use of existing technology and the capital necessary to invest in and
exploit new technologies.
The ability to achieve consistent adequate returns well above the cost of
capital in the absence of governmental assistance, loan guarantees, debt
forgiveness and other forms of direct and indirect subsidy.
1

The ability to make costs variable to the greatest extent possible to achieve
maximum flexibility in responding to market cyclicality.
While the characteristics of successful companies are identifiable, the global business and
political environments affect the ability of companies to achieve global competitiveness.
The United States steel industry is now operating in a global environment. The global
rules of competition are not uniform and those WTO rules that do exist are not always
adhered to by foreign producers and their governments. Excess supply, in foreign home
markets, often triggers predatory trade flows to export markets without regard for WTO
rules and the trade laws of the target country. The U.S. market has long been a principal
target for such trade flows, and even highly successful U.S. companies have been
adversely affected by these trade practices.
What kind of private and public policy actions will foster the establishment and
growth of successful steel companies?
At a minimum we will need:







An international agreement prohibiting subsidies. The definition of what
constitutes subsidies must be complete and crystal clear.
Global incentives provided by governments to address social costs associated
with closures required to eliminate obsolete facilities.
Improving bankruptcy laws to eliminate Chapter 11 abuses.
Revised environmental regulations to foster the closure of obsolete capacity.
Elimination of cartels which limit access to, and which foster marginal cost
pricing (dumping) in, export markets.
Through international agreement, or otherwise, an enhanced ability of the U.S.
government to respond more rapidly to surges of unfairly traded steel imports.
Elimination of access to dumped semi-finished steel, which has forced U.S.
steel producers of both crude and finished steel to compete against unfairly
traded finished steel produced from imported semis.
Is the U.S. steel industry moving in the right direction?
The U.S. steel industry has made significant progress. It has gone through massive
structural changes as companies have responded to the competitive conditions
domestically and globally. Since the mid-1970s almost 50% of the steel making capacity
owned by integrated mills has been closed and a great deal was modernized. Roughly 60
million tons of older capacity was closed. During that same period, Electric Arc Furnace
(EAF) producers built approximately 30 million tons of new, efficient capacity to replace
that which was rendered non-competitive by market forces. Today in the U.S. almost
50% of the steel produced is melted in EAFs, a significantly higher percentage than in
most other industrial countries. While the industry achieved a net capacity reduction of
30 millions tons, the U.S. steel market grew by 25 million tons.
2
The result has been a much more favorable balance between supply and demand in the
United States. While this balance varies from product to product, the aggregate demand
versus capacity figures show a modest inadequacy in supply particularly during peak
demand. In fact, North America is the only major steel market in the world with capacity
and demand in balance, yet we have the largest national negative trade balance in steel.
The U.S. industry has been moving in the right direction for years with respect to cost
reduction, service to consumers, efficiency, environmental stewardship and many other
measures. Yet, the reverse has occurred regarding the most important measure of
success: return on invested capital. Despite the success of a few companies in the
industry, the U.S. steel industry, like its counterparts around the world, has not earned its
cost of capital. As a result, the market value of all steel companies, relative to cash flow
and book value, is extremely depressed. The industry is in serious jeopardy, having lost
most of its access to capital. This loss has virtually guaranteed that the process of
industrial renewal in the steel sector has ground to a halt.
How can public policy accelerate the process of renewal in the U.S. steel industry?
Our government can assist the process of renewal in this industry. Some of the more
important reforms that would allow market forces to work more efficiently include:









An affirmative determination of injury on steel mill products followed by
effective remedial action under the Section 201 investigation initiated by the
President including limiting semi-finished imports.
An international agreement to reduce excess capacity globally.
Strengthening WTO-consistent U.S. trade laws.
Improving the flow and quality of information necessary to make rational
decisions relative to new investment and facility closures.
Limiting access to relief under U.S. bankruptcy laws. Update these statutes to
prevent abusive use to the detriment of competitive steel producers.
Eliminating the federal steel-specific loan guarantee program.
The defeat of legislation which would authorize the payment of subsidies to
individual steel companies to fund their legacy costs.
Providing incentives and environmental relief for closure and complete
physical elimination of uneconomic steel industry assets.
Participating in the establishment of an international program providing funds
to ameliorate the social impact of closures of uneconomic steel production
facilities.
3
How do we propose to deal with the global over-capacity issue?
The EU and Japan have capacity substantially in excess of domestic requirements. In the
case of Eastern Europe there is gross over-capacity and much of it is uneconomic by any
standard. In the case of other non-market countries, like China, capacity should be built
only to deal with domestic production shortfalls. In developing areas such as South
America new capacity is being built to a level suggesting that South America will have
double the capacity needed to serve its home markets. Often such new capacity is
subsidized. Moreover, equipment builders often take an ownership position in projects
with government encouragement and financial incentives.
There have been many business failures in the global steel industry. Based upon this
history, there appear to be four generic types of uneconomic capacity:
Old Inefficient Assets
Mills in this category do not generate enough capital to adequately maintain their
facilities. Their market and competitive positions are not strong enough to convince the
financial community to provide funding for upgrades in the absence of government loan
guarantees or other subsidies. As a result, these types of companies limp from crisis to
crisis, and usually end up in Chapter 11 here, or propped up by government support
overseas, before finally being shuttered. In many cases, overseas privatization creates a
false competitive situation when governments “forgive” social, pension and
environmental balance sheet liabilities that can give the illusion of a positive change in
relative cost performance. In essence, government is intervening directly in the
competitiveness issues that market forces should address. Such companies should be
permanently closed, rather than sold with the aid of government subsidies.
Unsuccessful Transformations
This group is comprised of companies with older facilities that could perhaps be
classified as worn out. Management may raise capital to reinvest and partially replace
obsolete facilities. The time required to bring the new technology on-line causes a
liquidity crisis and/or facility closure in the process. Ownership may then change, the
facility purchased for cents on the dollar or the company may enter Chapter 11 (or
foreign equivalent). The facility may be economically viable for the new owner, due to
the low capital cost of entry. This scenario will be repeated and finally some companies
may shut down their melting facilities and import semi-finished to support a marginal
“finishing” end. Often this process simply postpones an inevitable closure.
Greenfield Question Marks and Failures
This category of capacity consists of facilities built by an incumbent producer or an
entrepreneurial management team. The business idea that spawns the investment may
have been solid, but the project generally fails because of poor execution. Any one factor
or combination of factors may force a liquidity crisis or facility closure. So, while these
4
facilities may be economically viable they require additional capital and a more
experienced owner. The factors that lead to this form of failure include:






Poor choices of technology and facility layout.
Inexperienced management teams.
Excessive leveraging.
Inadequate production levels or market penetration.
Badly flawed business plan and market assessment.
Projects planned in a positive market and completed in extremely hostile
environment. (Numerous productive facilities, both operating and closed today,
fit this category.)
Perennial Problems
This category is comprised of businesses that consistently struggle to stay afloat. In
many cases the asset base and business performance are deteriorating. The business
remains alive only via a minor advantage such as a successful subsidiary in an unrelated
business. Those in this group do not generate enough cash to sustain themselves through
downturns and do not have the organizational strength to achieve a transformation.
These companies also limp from crisis to crisis until, all too often, they end up in Chapter
11. Turnarounds would require massive cash infusion and complete management
redirection.
Therefore, in a functioning free market all of these types of uneconomic assets would
eventually respond to market forces and would be eliminated. However, market forces
are not always allowed to run their course. These assets should not be artificially
maintained or resuscitated. Further, some of these categories typify the need for
incentives for closure. Estimates by industry experts suggest that roughly 25 million tons
of United States capacity fit these general categories. Of that, upwards of 2/3 of that
capacity is viable from an efficiency standpoint and could be operated successfully under
the right conditions.
Some facilities do not fit neatly into these categories. The factors that cause gross excess
capacity and the resultant predatory trade flows include:




Lack of relevant market information on the viability of markets for a new
facility.
Inaccurate assessments of global markets.
Harmful government policies.
Inaccurate cost assessments and lack of standardized methods and definitions
necessary to define costs.
5
Conclusion
Under conditions of fair competition the U.S. steel industry is unquestionably one of the
most open, dynamic, and competitive steel industries in the world. And while the
industry has gone through massive structural changes in the face of intense, and unfair,
global competition, much more needs to be done.
Unfortunately, in the current environment, even the most efficient steel producers in the
U.S. economy cannot make an adequate return on invested capital. They are fast losing
access to capital markets and as a result, have not made significant new facility
announcements since 1997. Thus, the companies and individuals that are most capable of
continuing the process of industrial renewal cannot do so until effective public policy
creates an economic environment with acceptable risk-reward trade-offs. This paper
identifies several specific items that must be addressed through public policy. These
items can be summarized in four broad categories:

Provide an affirmative determination of injury under Section 201 of the Trade Act, to
assure the industry has time for a period of adjustment to restructure itself further in
response to the effects of massive marginal cost pricing of imports dumped in the
U.S. market.

Participate where necessary to collect and disseminate information on supply,
demand, and trends to assist managers, owners, and prospective owners in making
better business decisions. An example of governmental assistance in this area is the
implementation of a Canadian type import monitoring–licensing system.

Strengthen WTO consistent U.S. trade laws, and make changes to the regulatory and
legal environment to encourage fast and efficient capital migration from failed
businesses to superior business models and technologies.

Through an international agreement, eliminate steel industry subsidies, create a
program to reduce global excess capacity, and develop a mechanism to permit rapid
responses to surges of dumped steel. This would create a more uniform, fair, and
open global trading environment, so that capital and steel move efficiently in
response to clear market signals, not to distortions caused by government
interference.
6