Blame China’s steel glut on meddling by local governments

Winston Mok says Beijing must rein in local officials’ economic adventurism and destructive competition, as a root cure to the problems of excess capacity

PUBLISHED : Wednesday, 04 May, 2016, 12:55pm
UPDATED : Wednesday, 26 October, 2016, 2:59pm

China’s steel glut is not only causing a bloodbath domestically, but also globally. Losses at major steel companies exceeded US$10 billion last year. After its chairman committed suicide, Dongbei Special Steel defaulted on a US$130 million debt – rare for a state-owned enterprise. Australian steelmaker Arrium went into administration. And the rationalisation of China’s steel industry was a key topic raised by Australian Prime Minister Malcolm Turnbull when he visited Beijing last month.

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China now produces half the world’s steel. The expansion has been accelerated by the 400 billion yuan (HK$480 billion) fiscal stimulus following the 2008 financial crisis. China’s excess capacity now exceeds the total production of Japan, the US and Korea combined. With such a glut, prices have plummeted, leaving many steelmakers worldwide in an untenable position.

How did this happen, especially when so many of China’s leading steel companies are state-owned? While a few are directly under Beijing’s control, most are owned by regional governments. China’s steel industry is highly fragmented. Whereas Japan and Korea only have a few integrated steel companies, China has dozens – among its thousands of steel mills.

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Hence, the industry is very difficult to coordinate. Despite Beijing imposing limits on expansion, most regional governments turned a blind eye to unauthorised development of steel mills under their watch. Rule-abiding regions feared losing market share, thus creating incentives to push beyond the limits imposed by Beijing. Whatever the longer-term ramifications, new investments in steel plants provided immediate economic growth, giving a boost to local cadres whose performance is measured by short-term results. The destructive race among regional clusters spiralled out of control.

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To prevent a recurrence of such aggressive expansion, market liberals advocate privatisation. Managers of state-owned enterprises may not feel the direct effects of economic losses and are thus easily tempted by irrational exuberance to pursue reckless expansion. Bosses of private companies should be more circumspect, given that they risk destruction of their own wealth. However, a similar pattern of overexpansion has happened in the solar industry, which is mostly privately owned.

There may be a more compelling case to “nationalise” the steel industry – to centralise control in Beijing. It may also be expedient to consolidate the industry; mergers and acquisitions may help to control output. But any consolidation should ensure continued vibrant competition – so users of steel, from carmakers to construction industries, have access to quality steel at competitive prices. Using state power to rectify past state excesses may be an effective short-term measure but not a long-term solution.

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The root cause of such overexpansion is not ownership – public or private. It is the direct participation or meddling in the market by local states under China’s decentralised economic governance. Unlike Japan and Korea, whose central government could effectively coordinate dominant players in key industries – for a period in the past – such successes are few and far between in China. In industry after industry, active state participation or intervention has resulted in overcapacity and destruction of value.

So the fundamental way to fix the problem is to transform the role of the state. Local governments have long been key economic actors in China. They should reorient themselves to place a greater emphasis on social matters in the future. Realistically, local corporatism may persist. Thus, a clear boundary must be drawn on the limits of the state’s economic role.

Intrusive state activism which distorts the market, as in the case of steel, should be strictly off limits. The arbitrary power of local governments, in their indiscriminate and uncoordinated pursuit of growth, has weakened the central state’s capacity to shape outcomes. In the modernisation of China’s governance, if local governments face clear economic constraints, China’s state system will actually become stronger in guiding effective growth.

Winston Mok, formerly a private equity investor, is a private investor