Consolidation In Steel: Still Waiting

It’s a fact of life: economic forces within China tend to create overcapacity in every industry. Outside of China, rising quality and technology requirements and the forces of competition have reduced the numbers of companies making most products to a handful of global players. Yet, hundreds of companies may be making the same or similar products in China.

Steel is a good example. At the beginning of this century, China had approximately 100 million tons of steel-making capacity, approximately the same as the United States. Rising demand caused by China’s rapid development and industrialization, however, made steel a hot commodity, and every village, township and city in China wanted to have its own steel plant. A new steel plant creates not only employment, it also provides tax revenues. In China, local governments get to keep up to 25 percent of the 17 percent Value Added Tax collected from companies operating in their area.

The result, China now has 610 million tons of steel-making capacity, 100 million more tons than it needs. There are well over 1,000 steel companies in China scattered all across the country. No one really knows for sure how many. In 2007, Baosteel, the largest steel company in China, accounted for just 5 percent of the market

Earlier this year, we reported that China was preparing a three-year plan to consolidate its steel industry. The basic idea was to form three large steel groups, with each having a capacity of over 50 million metric tons by 2011. Shanghai-based Baosteel Group, Wuhan Iron & Steel, and the combined group led by Anshan Iron & Steel Group and Benxi Iron & Steel Group were to lead the consolidation, according to a draft of the government plan, causing the three to emerge as China’s steel giants.

We were doubtful this would actually happen for two reasons. The first is “China’s Two Markets,” a phenomenon which I described in a separate chapter in my book, Managing the Dragon, and which we have covered here on several occasions. The second are the tax incentives mentioned above. What city mayor would willingly agree to a factory closing and give up his city’s share of VAT receipts?

With this as background, I was interested to read an article in The Wall Street Journal last week describing how China is re-examining its steel industry policies. As reported by the Journal:

Frustrated in previous attempts to consolidate its fragmented steel industry, China is working on a new way to promote mergers and reduce capacity, possibly giving a boost to other global steel companies. China has hundreds of steel mills, many of them small and inefficient. But the central government’s desire to close small plants and consolidate the industry has been stymied at the regional level. Local government officials have resisted the potential loss of jobs and tax revenue.

Someone must have read that article. The new plan, it seems, is to reduce steelmakers’ national tax bills and convert some of that money to regional taxes. That would soften the blow of closed mills by giving regional governments additional tax revenue to stimulate their economies, fund social programs and help find jobs for displaced steelworkers. The lower tax burden would also leave steelmakers with more cash for acquisitions.

This new plan may have a better chance of working—at least it tries to address the forces  that prevent industry consolidation in China. The trick, however, will be matching up the new regional tax revenues with the townships, villages and cities actually impacted by plant closures. Given China’s decentralization, this may be difficult to actually accomplish in practice. Provincial and big city officials may decide to allocate those tax revenues differently, and the unhappy township that is losing its mill will resist.

We’ll see whether the new policy works any better than the old. But for the time being, China’s steel industry is likely to remain extremely fragmented.

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