An Access Advertising EconBrief:
More Ghastly than Beheadings! More Dangerous than Nuclear Proliferation! Its…Cheap Foreign Steel!
The economic way to view news is as a product called information. Its value is enhanced by adding qualities that make it more desirable. One of these is danger. Humans react to threats and instinctively weigh the threat-potential of any problematic situation. That is why headlines of print newspapers, radio-news updates, TV evening-news broadcasts and Internet websites and blogs all focus disproportionately on dangers.
This obsession with danger does not jibe with the fact that human life expectancy had doubled over the last century and that violence has never been less threatening to mankind than today. Why do we suffer this cognitive dissonance? Our advanced state of knowledge allows us to identify and categorize threats that passed unrecognized for centuries. Today’s degraded journalistic product, more poorly written, edited and produced than formerly, plays on our neuroscientific weaknesses.
Economists are acutely sensitive to this phenomenon. Our profession made its bones by exposing the bogey of “the evil other” – foreign trade, foreign goods, foreign labor and foreign investment as ipso facto evil and threatening. Yet in spite of the best efforts of economists from Adam Smith to Milton Friedman, there is no more dependable pejorative than “foreign” in public discourse. (The word “racist” is a contender for the title, but overuse has triggered a backlash among the public.)
Thus, we shouldn’t be surprised by this headline in The Wall Street Journal: “Ire Rises at China Over Glut of Steel” (03/16/2015, By Biman Mukerji in Hong Kong, John W. Miller in Pittsburgh and Chuin-Wei Yap in Beijing). Surprised, no; outraged, yes.
The Big Scare
The alleged facts of the article seem deceptively straightforward. “China produces as much steel as the rest of the world combined – more than four times as much as the peak U.S. production in the 1970s.” Well, inasmuch as (a) the purpose of all economic activity is to produce goods for consumption; and (b) steel is a key input in producing countless consumption goods and capital goods, ranging from vehicles to buildings to weapons to cutlery to parts, this would seem to be cause for celebration rather than condemnation. Unfortunately…
“China’s massive steel-making engine, determined to keep humming as growth cools at home, is flooding the world with exports, spurring steel producers around the globe to seek government protection from falling prices. From the European Union to Korea and India, China’s excess metal supply is upending trade patterns and heating up turf battles among local steelmakers. In the U.S., the world’s second-biggest steel consumer, a fresh wave of layoffs is fueling appeals for tariffs. U.S. steel producers such as U.S. Steel Corp. and Nucor Corp. are starting to seek political support for trade action.”
Hmmm. Since this article occupies the place of honor on the world’s foremost financial publication, we expect it to be authoritative. China has a “massive steel-making engine” – well, that stands to reason, since it’s turning out as much steel as everybody else put together. It is “determined to keep humming.” The article’s three (!) authors characterize the Chinese steelmaking establishment as a machine, which seems apropos. They then endow the metaphoric machine with the human quality of determination – bad writing comes naturally to poor journalists.
This determination is linked with “cooling” growth. Well, the only cooling growth that Journal readers can be expected to infer at this point is the slowing of the Chinese government’s official rate of annual GDP growth from 7.5% to 7%. Leaving aside the fact that the rest of the industrialized world is pining for growth of this magnitude, the authors are not only mixing their metaphors but mixing their markets as well. The only growth directly relevant to the points raised here – exports by the Chinese and imports by the rest of the world – is growth in the steel market specifically. The status of the Chinese steel market is hardly common knowledge to the general public. (Later, the authors eventually get around to the steel market itself.)
So the determined machine is reacting to cooling growth by “flooding the world with exports,” throwing said world into turmoil. The authors don’t treat this as any sort of anomaly, so we’re apparently expected to nod our heads grimly at this unfolding danger. But why? What is credible about this story? And what is dangerous about it?
Those of us who remember the 1980s recall that the monster threatening the world economy then was Japan, the unstoppable industrial machine that was “flooding the world” with imports. (Yes, that’s right – the same Japan whose economy has been lying comatose for twenty years.) The term of art was “export-led growth.” Now these authors are telling us that massive exports are a reaction to weakness rather than a symptom of growth.
“Unstoppable” Japan suddenly stopped in its tracks. No country has ever ascended an economic throne based on its ability to subsidize the consumption of other nations. Nor has the world ever died of economic indigestion caused by too many imports produced by one country. The story told at the beginning of this article lacks any vestige of economic sense or credibility. It is pure journalistic scare-mongering. Nowhere do the authors employ the basic tools of international economic analysis. Instead, they employ the basic tools of scarifying yellow journalism.
The Oxymoron of “Dumping”
The authors have set up their readers with a menacing specter described in threatening language. A menace must have victims. So the authors identify the victims. Victims must be saved, so the authors bring the savior into their story. Naturally, the savior is government.
The victims are “steel producers around the globe.” They are victimized by “falling prices.” The authors are well aware that they have a credibility problem here, since their readers are bound to wonder why they should view falling steel prices as a threat to them. As consumers, they see falling prices as a good thing. As prices fall, their real incomes rise. Falling prices allow consumers to buy more goods and services with their money incomes. Businesses buy steel. Falling steel prices allow businesses to buy more steel. So why are falling steel prices a threat?
Well, it turns out that falling steel prices are a threat to “chief executives of leading American steel producers,” who will “testify later this month at a Congressional Steel Caucus hearing.” This is “the prelude to launching at least one anti-dumping complaint with the International Trade Commission.” And what is “dumping?” “‘Dumping,’ or selling abroad below the cost of production to gain market share, is illegal under World Trade Organization law and is punishable with tariffs.”
After this operatic buildup, it turns out that the foreign threat to America spearheaded by a gigantic, menacing foreign power is… low prices. Really low prices. Visualize buying steel at Costco or Wal Mart.
Oh, no! Not that. Head for the bomb shelters! Break out the bug-out bags! Get ready to live off the grid!
The inherent implication of dumping is oxymoronic because the end-in-view behind all economic activity is consumption. A seller who sells for an abnormally low price is enhancing the buyer’s capability to consume, not damaging it. If anybody is “damaged” here, it is the seller, not the buyer. And that begs the question, why would a seller do something so foolish?
More often than not, proponents of the dumping thesis don’t take their case beyond the point of claiming damage to domestic import-competing firms. (The three Journal reporters make no attempt whatsoever to prove that the Chinese are selling below cost; they rely entirely on the allegation to pull their story’s freight.) Proponents rely on the economic ignorance of their audience. They paint an emotive picture of an economic world that functions like a giant Olympics. Each country is like a great big economic team, with its firms being the players. We are supposed to root for “our” firms, just as we root for our athletes in the Summer and Winter Olympics. After all, don’t those menacing firms threaten the jobs of “our” firms? Aren’t those jobs “ours?” Won’t that threaten “our” incomes, too?
This sports motif is way off base. U.S. producers and foreign producers have one thing in common – they both produce goods and services that we can consume, either now or in the future. And that gives them equal economic status as far as we are concerned. The ones “on our team” are the ones that produce the best products for our needs – period.
Wait a minute – what if the producers facing those low prices happen to be the ones employing us? Doesn’t that change the picture?
Yes, it does. In that case, we would be better off if our particular employer faced no foreign competition. But that doesn’t make a case for restricting or preventing foreign competition in general. Even people who lose their jobs owing to foreign competition faced by their employer may still gain more income from the lower prices brought by foreign competition in general than they lose by having to take another job at a lower income.
There’s another pertinent reason for not treating foreign firms as antagonistic to consumer interests. Foreign firms can, and do, locate in America and employ Americans to produce their products here. Years ago, Toyota was viewed as an interloper for daring to compete successfully with the “Big 3” U.S. automakers. Now the majority of Toyota automobiles sold in the U.S. are assembled on America soil in Toyota plants located here.
Predatory Pricing in International Markets
Dumping proponents have a last-ditch argument that they haul out when pressed with the behavioral contradictions stressed above. Sure, those foreign prices may be low now, import-competing producers warn darkly, but just wait until those devious foreigners succeed in driving all their competitors out of business. Then watch those prices zoom sky-high! The foreigners will have us in their monopoly clutches.
That loud groan you heard from the sidelines came from veteran economists, who would no sooner believe this than ask a zookeeper where to find the unicorns. The thesis summarized in the preceding paragraph is known as the “predatory pricing” hypothesis. The behavior was notoriously ascribed to John D. Rockefeller by the muckraking journalist Ida Tarbell. It was famously disproved by the research of economist John McGee. And ever since, economists have stopped taking the concept seriously even in the limited market context of a single country.
But when propounded in the global context of international trade, the whole idea becomes truly laughable. Steel is a worldwide industry because its uses are so varied and numerous. A firm that employed this strategy would have to sacrifice trillions of dollars in order to reduce all its global rivals to insolvency. This would take years. These staggering losses would be accounted in current outflows. They would be weighed against putative gains that would begin sometime in the uncertain future – a fact that would make any lender blanch at the prospect of financing the venture.
As if the concept weren’t already absurd, what makes it completely ridiculous is the fact that even if it succeeded, it would still fail. The assets of all those firms wouldn’t vaporize; they could be bought up cheaply and held against the day when prices rose again. Firms like the American steel company Nucor have demonstrated the possibility of compact and efficient production, so competition would be sure to emerge whenever monopoly became a real prospect.
The likelihood of any commercial steel firm undertaking a global predatory-pricing scheme is nil. At this point, opponents of foreign trade are, in poker parlance, reduced to “a chip and a chair” in the debate. So they go all in on their last hand of cards.
How Do We Defend Against Government-Subsidized Foreign Trade?
Jiming Zou, analyst at Moody’s Investor Service, is the designated spokesman of last resort in the article. “Many Chinese steelmakers are government-owned or closely linked to local governments [and] major state-owned steelmakers continue to have their loans rolled over or refinanced.”
Ordinary commercial firms might cavil at the prospect of predatory pricing, but a government can’t go broke. After all, it can always print money. Or, in the case of the Chinese government, it can always “manipulate the currency” – another charge leveled against the Chinese with tiresome frequency. “The weakening renminbi was also a factor in encouraging exports,” contributed another Chinese analyst quoted by the Journal.
One would think that a government with the awesome powers attributed to China’s wouldn’t have to retrench in all the ways mentioned in the article – reduce spending, lower interest rates, and cut subsidies to state-owned firms including steel producers. Zou is doubtless correct that “given their important role as employers and providers of tax revenue, the mills are unlikely to close or cut production even if running losses,” but that cuts both ways. How can mills “provide tax revenue” if they’re running huge losses indefinitely?
There is no actual evidence that the Chinese government is behaving in the manner alleged; the evidence is all the other way. Indeed, the only actual recipients of long-term government subsidies to firms operating internationally are creatures of government like Airbus and Boeing – firms that produce most or all of their output for purchase by government and are quasi-public in nature, anyway. But that doesn’t silence the protectionist chorus. Government-subsidized foreign competition is their hole card and they’re playing it for all it’s worth.
The ultimate answer to the question “how do we defend against government-subsidized foreign trade?” is: We don’t. There’s no need to. If a foreign government is dead set on subsidizing American consumption, the only thing to do is let them.
If the Chinese government is enabling below-cost production and sale by its firms, it must be doing it with money. There are only three ways it can get money: taxation, borrowing or money creation. Taxation bleeds Chinese consumers directly; money creation does it indirectly via inflation. Borrowing does it, too, when the bill comes due at repayment time. So foreign exports to America subsidized by the foreign government benefit American consumers at the expense of foreign consumers. No government in the world can subsidize the world’s largest consumer nation for long. But the only thing more foolish than doing it is wasting money trying to prevent it.
What Does “Trade Protection” Accomplish?
Textbooks in international economics spell out in meticulous detail – using either carefully drawn diagrams or differential and integral calculus – the adverse effects of tariffs and quotas on consumers. Generally speaking, tariffs have the same effects on consumers as taxes in general – they drive a wedge between the price paid by the consumer and received by the seller, provide revenue to the government and create a “deadweight loss” of value that accrues to nobody. Quotas are, if anything, even more deleterious. (The relative harm depends on circumstances too complex to enumerate.)
This leads to a painfully obvious question: If tariffs hurt consumers in the import-competing country, why in the world do we penalize alleged misbehavior by exporters by imposing tariffs? This is analogous to imposing a fine on a convicted burglar along with a permanent tax on the victimized homeowner.
Viewed in this light, trade protection seems downright crazy. And in purely economic terms, it is. But in terms of political economy, we have left a crucial factor out of our reckoning. What about the import-competing producers? In the Wall Street Journal article, these are the complainants at the bar of the International Trade Commission. They are also the people economists have been observing ever since the days of Adam Smith in the late 18th century, bellied up at the government-subsidy bar.
In Smith’s day, the economic philosophy of Mercantilism reigned supreme. Specie – that is, gold and silver – was considered the repository of real wealth. By sending more goods abroad via export than returned in the form of imports, a nation could produce a net inflow of specie payments – or so the conventional thinking ran. This philosophy made it natural to favor local producers and inconvenience foreigners.
Today, the raison d’etre of the modern state is to take money from people in general and give it to particular blocs to create voting constituencies. This creates a ready-made case for trade protection. So what if it reduces the real wealth of the country – the goods and services available for consumption? It increases electoral prospects of the politicians responsible and appears to increase the real wealth of the beneficiary blocs, which is sufficient to for legislative purposes.
This is corruption, pure and simple. The authors of the Journal article present this corrupt process with a straight face because their aim is to present cheap Chinese steel as a danger to the American people. Thus, their aims dovetail perfectly with the corrupt aims of government.
And this explains the front-page article on the 03/16/2015 Wall Street Journal. It reflects the news value of posing a danger where none exists – that is, the corruption of journalism – combined with the corruption of the political process.
The “Effective Rate of Protection”
No doubt the more temperate readers will object to the harshness of this language. Surely “corruption” is too harsh a word to apply to the actions of legislators. They have a great big government to run. They must try to be fair to everybody. If everybody is not happy with their efforts, that is only to be expected, isn’t it? That doesn’t mean that legislators aren’t trying to be fair, does it?
Consider the economic concept known as the effective rate of protection. It is unknown to the general public, but is appears in every textbook on international economics. It arises from the conjunction of two facts: first, that a majority of goods and services are composed of raw materials, intermediate goods and final-stage (consumer) goods; and second, that governments have an irresistible impulse to levy taxes on goods that travel across international borders.
To keep things starkly simple and promote basic understanding, take the simplest kind of numerical example. Assume the existence of a fictional textile company. It takes a raw material, cotton, and spin, weaves and processes that cotton into a cloth that it sells commercially to its final consumers. This consumer cloth competes with the product of domestic producers as well as with cotton cloth produced by foreign textile producers. We assume that the prevailing world price of each unit of cloth is $1.00. We assume further that domestic producers obtain one textile unit’s worth of cotton for $.50 and add a further $.50 worth of value to the cloth by spinning, weaving and processing it into the cloth.
We have a basic commodity being produced globally by multiple firms, indicated the presence of competitive conditions. But legislators, perhaps possessing some exalted concept of fairness denied to the rabble, decide to impose a tariff on the importation of cotton. Not wishing to appear excessive or injudicious, the solons set this ad valorem tariff at 15%. Given the competitive nature of the industry, this will soon elevate the domestic price of textiles above the world price by the amount of the tariff; e.g., by $.15, to $1.15. Meanwhile, there is no tariff levied on cotton, the raw material. (Perhaps cotton is grown domestically and not imported into the country or, alternatively, perhaps cotton growers lack the political clout enjoyed by textile producers.)
The insight gained from the effective rate of protection begins with the realization that the net income of producers in general derives from the value they add to any raw materials and/or intermediate products they utilize in the production process. Initially, textile producers added $.50 worth of value for every unit of cotton cloth they produced. Imposition of the tariff allows the domestic textile price to rise from $1.00 to $1.15, which causes textile producers’ value added to rise from $.50 to $.65.
Legislators judiciously and benevolently decided that the proper amount of “protection” to give domestic textile producers from foreign competition was 15%. They announced this finding amid fanfare and solemnity. But it is wrong. The tariff has the explicit purpose of “protecting” the domestic industry, of giving it leeway it would not otherwise get under the supposedly harsh and unrelenting regime of global competition. But this tariff does not give domestic producers 15% worth of protection. $15 divided by $.50 – that is, the increase in value added divided by the original value added – is .30, or 30%. The effective rate of protection is double the size of the “nominal” (statutory) level of protection. In general, think of the statutory tariff rate as the surface appearance and the effective rate as the underlying truth.
Like oh-so-many economic principles, the effective rate of protection is a relatively simple concept that can be illustrated with simple examples, but that rapidly becomes complex in reality. Two complications need mention. When tariffs are also levied on raw materials and/or intermediate products, this affects the relationship between the effective and nominal rate of protection. The rule of thumb is that higher tariff rates on raw materials and intermediate goods relative to tariffs on final goods tend to lower effective rates of protection on the final goods – and vice-versa.
The other complication is the percentage of total value added comprised by the raw materials and intermediate goods prior to, and subsequent to, imposition of the tariff. This is a particularly knotty problem because tariffs affect prices faced by buyers, which in turn affect purchases, which in turn can change that percentage. When tariffs on final products exceed those on raw materials and intermediate goods – and this has usually been the case in American history – an increase in this percentage will increase the effective rate.
But for our immediate purposes, it is sufficient to realize that appearance does not equal reality where tariff rates are concerned. And this is the smoking gun in our indictment of the motives of legislators who promote tariffs and restrictive foreign-trade legislation.
Corrupt Legislators and Self-Interested Reporting are the Real Danger to America
In the U.S., the Commercial Code includes thousands of tariffs of widely varying sizes. These not only allow legislators to pose as saviors of numerous business constituent classes. They also allow them to lie about the degree of protection being provided, the real locus of the benefits and the reasons behind them.
Legislators claim that the size of tariff protection being provided is modest, both in absolute and relative terms. This is a lie. Effective rates of protection are higher than they appear for the reasons explained above. They unceasingly claim that foreign competitors behave “unfairly.” This is also a lie, because there is no objective standard by which to judge fairness in this context – there is only the economic standard of efficiency. Legislators deliberately create bogus standards of fairness to give themselves the excuse to provide benefits to constituent blocs – benefits that take money from the rest of us. International trade bodies are created to further the ends of domestic governments in this ongoing deception.
Readers should ask themselves how many times they have read the term “effective rate of protection” in The Wall Street Journal, The Financial Times of London, Barron’s, Forbes or any of the major financial publications. That is an index of the honesty and reputability of financial journalism today. The term was nowhere to be found in the Journal piece of 03/16/2015.
Instead, the three Journal authors busied themselves flacking for a few American steel companies. They showed bar graphs of increasing Chinese steel production and steel exports. They criticized the Chinese because the country’s steel production has “yet to slow in lockstep” with growth in demand for steel. They quoted self-styled experts on China’s supposed “problem [with] hold[ing] down exports” – without every explaining what rule or standard or economic principle of logic would require a nation to withhold exports from willing buyers. They cited year-over-year increases in exports between January, 2013, 2014 and 2015 as evidence of China’s guilt, along with the fact that the Chinese were on pace to export more steel than any other country “in this century.”
The reporters quoted the whining of a U.S. steel vice-president that demonstrating damage from Chinese exports is just “too difficult” to satisfy trade commissioners. Not content with this, they threw in complaints by an Indian steel executive and South Koreans as well. They neglect to tell their readers that Chinese, Indian and South Korean steels tend to be lower grades – a datum that helps to explain their lower prices. U.S. and Japanese steels tend to be higher grade, and that helps to explain why companies like Nucor have been able to keep prices and profit margins high for years. The authors cite one layoff at U.S. steel but forget to cite the recent article in their own Wall Street Journal lauding the history of Nucor, which has never laid off an employee despite the pressure of Chinese competition.
That same article quoted complaints by steel buyers in this country about the “competitive disadvantage” imposed by the higher-priced U.S. steel. Why are the complaints about cheap Chinese exports front-page news while the complaints about high-priced American steel buried in back pages – and not even mentioned by a subsequent banner article boasting input by no fewer than three Journal reporters? Why did the reporters forget to cite the benefits accruing to American steel users from low prices for steel imports? Don’t these reporters read their own newspaper? Or do they report only what comports with their own agenda?