The U.K. Must Not Turn to Protectionism to Save Its Steel

30/03/2016_Steel
A general view shows a detail of the Tata steelworks in the town of Port Talbot, Wales, March 30, 2016. Should the British government bail out its troubled steel industry? Reuters/Rebecca Naden.

There was a time in Europe when the political consensus was that national industries such as coal, steel and heavy manufacturing needed state sponsorship and protection. It was believed that employment could be generated, and economic growth fostered, by subsidizing domestic producers and slapping tariffs on imports.

That time was the 1930s and, as we know, things did not quite work out as planned. The protections granted to "national champions" came at the expense of domestic businesses and consumers, who faced higher prices as a result of the tariffs and the lack of effective competition. Protectionism made mutually beneficial trade between countries — French cheese for German cars — too costly to be worthwhile. An arms race of trade barriers ensued, as countries sought to penalize foreign firms more than their own were penalized abroad.

This beggar-thy-neighbor protectionism fed animosity between countries, who saw each other as rivals in a race to the bottom rather than partners in productive commerce. An impoverished citizenry sought redress in the promises of extremist strongmen on Left and Right. We know how badly that ended.

It might seem exaggerated to compare the interwar debacle to today's controversy about Chinese steel. Yet many of the same dynamics are at play now. After six decades of steadily freer trade that has lifted millions from poverty, brought an increasing variety of goods to consumers, and promoted world peace, the political pendulum is swinging back in favor of harmful protectionism.

U.S. presidential contenders, U.K. politicians and EU officials are all singing the same tune: struggling industries must be rescued and shielded from competition — trade must be curtailed.

China may well subsidize its steel production through cheap credit and below market price electricity. But this is hardly the primary, let alone the only, factor behind the woes of UK steel.

First of all, commodity prices — oil, gas, as well as metals — have plunged over the past two years.

This is partly a consequence of increasing supply, especially from the U.S., and also of slowing demand from emerging markets, not least China itself. In a low-price environment, the higher-cost producers will be driven out first. This has been the case with Canadian oil and the harder-to-reach U.S. shale, and it is also the reason why U.K. steel is struggling. Indeed, much of the "dumping" that China is charged with is really a business imperative in lean times: sell at cost to get rid of excess stock and sustain your market share.

Why are steel production costs so high in Britain? While steelmaking is not as labour-intensive as it used to be—that partly explains why employment in the industry has fallen—payroll is still a significant cost. With employment much more expensive in the U.K. than elsewhere, it is difficult to compete with firms from less developed economies. We may be better off producing higher-value goods and services where we have a comparative advantage.

Energy policy, in the form of green taxes, emission charges and other levies, also plays a role. It is the deliberate choice of the EU and the British government to discourage energy-intensive industries in order to meet our pollution reduction targets. There is reason to believe that there are more effective, market-driven ways to decarbonize. But the bottom line is that public policy has created a conflict between environmental policy and industrial policy.

All of this suggests that the crisis that U.K. steel currently finds itself in has to do with structural changes in global demand for industrial metals and heavy manufacturing inputs. This is compounded by our own policy choices regarding carbon emissions and climate change. The economic slowdown in China since the end of 2013 has likely contributed to its steelmakers' increased focus on Western markets, as domestic customers are no longer in a position to absorb its production volumes.

But it would be wrong to assume that taxing Chinese steel imports and bailing out our steel manufacturers will make us better off. All that protectionism will do is raise prices for ourselves and prevent valuable resources from being redirected to higher-value uses. Furthermore, protection will set the wrong precedent for economic policy at a time of great change, and encourage the damaging nativist trend that is growing on both sides of the Atlantic.

We should all feel sympathy for the steelworkers who face unemployment, as we should for anyone confronting temporary joblessness. But our economy is strong and able to absorb more workers than are laid off, while there are retraining programmes for those seeking to move to different industries.

As we face the challenges of globalization and technological change, it is crucial now more than ever to be conscious of its tremendous benefits—and the great costs of falling back into protectionism.

Diego Zuluaga is a Financial Services Research Fellow at the Institute of Economic Affairs.