China's Struggle to Reform the Steel Industry

3 MINS READJun 20, 2012 | 10:00 GMT
China's Struggle to Reform the Steel Industry
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Employees at a steel mill in Hefei, eastern China

China's Ministry of Industry and Information Technology outlined a new steel industry standard that will ban some outdated steel products, including deformed steel bars and hot rolled silicon steel sheets, China Daily reported June 18. The new standard represents yet another effort by the state to reduce excessive capacity in the sector.

But despite Beijing's efforts to curb overcapacity in the steel industry, local government campaigns to increase the number of steel production bases and new central government moves to reinvigorate steel production will make it difficult to address underlying problems in the country's steel industry in the future.

China's steel industry has experienced an unprecedented production boom in recent years, especially following massive investment in real estate and infrastructure as part of the country's 2008-2009 stimulus package. But the industry has been hit hard by China's current economic downturn. Since 2011, Beijing's enforced slowdown in real estate and infrastructure investment — combined with dwindling external demand — has aggravated the severe imbalance between steel supply and slowing domestic demand.

This imbalance has been exacerbated by local governments' continued reliance on steel production as a source of employment. This drives up costs for raw materials used in steel production even as demand for the finished product falls off. As a result, steel profits have been declining rapidly; in the first four months of 2012, profits fell 96.7 percent from the same period in 2011, with some major steel companies reporting their first losses in a decade.

During the first half of 2012, Beijing appeared to be making moves to restructure the steel industry and encourage consolidation, facilitated by the restrictions on real estate and infrastructure investment. With more time, these efforts might have paid off by gradually shifting the industry's focus from rapid, politically oriented growth toward something more sustainable.

But now, faced with an economy slowing more rapidly than anticipated, Beijing appears to be switching back to a growth model. In the last month, China's State Council approved the creation of several new steel production bases — each with an annual capacity of more than one million metric tons — in a bid to reinvigorate the economy. This move is a pleasant surprise for local governments, which are far more focused on immediate employment and production numbers than on long-term sustainable growth. But it represents a setback for Beijing's efforts to reform the sector and, more generally, shift toward a model of growth driven by greater domestic consumption of finished goods rather than centrally funded fixed asset investment.

The steel industry in China is an important baseline indicator not just of economic growth, but of the specific kind of economic growth Beijing is pursuing. The post-2008 boom in steel production coincided with explosive growth in real estate and infrastructure development — and with system-wide overcapacity, inefficiency, waste and political nepotism. A return to that model now would make it more difficult for Beijing to address underlying structural problems in the steel industry in the future. But perhaps more important, it reflects Beijing's ongoing struggle to both maintain employment and build a more efficient, profitable and sustainable domestic economy. In China, this is not simply a matter of macro-economic policy, but a manifestation of the ongoing struggle between an overstretched central authority and regional forces that often have opposing goals.

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