Economy

What are Subsidies?

June 9, 2015

According to Investopedia, a subsidy is “a benefit given by the government to groups or individuals usually in the form of a cash payment or tax reduction. The subsidy is usually given to remove some type of burden and is often considered to be in the interest of the public.”

The example accompanying the definition is agriculture: the U.S. commonly subsidizes farmers to supplement income, manage supply, and influence the cost and supply of agricultural commodities.

In the U.S. steel industry, local and state governments often use subsidization in the form of reduced taxes and financial incentives to attract steel production to the region or to rescue faltering mills.

Big River Steel is an example of a new steel mill that was actively pursued by the state of Arkansas to bring new jobs and economic benefits to the region. The Arkansas legislature provided $125 million in incentives to help build the $1.1 billion facility in Mississippi County. The county itself provided $14.5 million in economic development tax funds for the project.

US Steel will receive $11.3 million in tax abatements from Jefferson County, Ala. over the course of construction of an EAF at Fairfield Works and the ten years following its start-up.

ThyssenKrupp was lured to Alabama in 2007 with $850 million in incentives to build its Calvert mill. Unfortunately, the operation turned out to be a disaster for the company. Poor management, overly optimistic expectations and economic decline led to the decision to put the facility up for sale. After dropping the value significantly and adding the incentive of a six year slab purchase agreement from CSA, the mill was finally sold to ArcelorMittal and Nippon Steel & Sumitomo Metal Corp. for $1.5 billion.

The U.S. government has tried to intervene during tumultuous periods in the steel industry by subsidizing failing mills with loan programs. In the 1970s, the Carter administration provided $300 million in loan guarantees to five struggling steel companies. In 2001, Bill (HR 1664) provided $1 billion emergency steel loans to qualified midsize steel companies hurt low-cost foreign steel imports. The program was unsuccessful due to the difficulties of meeting the requirements to secure the loans. A rash of bankruptcies occurred, that although painful, tightened the steel industry and renewed its strength.

Canada came to the rescue of the bankrupt Stelco operations, offering an attractive deal to U.S. Steel in return for promises of steel production quotas and retention of employees. The details of that agreement were never fully revealed and are a point of controversy now that the US Steel Canada operations are in CCAA protection and up for sale once again.

Foreign subsidies differ in that they are designed to not only help companies remain solvent but to augment income and keep prices for steel products low. In the first half of 2014, subsidies accounted for 80 percent of Chinese steel company profits, jumping from 22 percent of profits the previous year, according to a Reuter’s analysis. By the end of 2014, subsidies accounted for 47 percent of total profits for the year. When subsidized products are exported, it creates unfair trade advantages for the exporting country.

Foreign subsidies are mostly given by local governments, in the form of cash, tax rebates or assistance with loan repayments. They are justified as research and development grants, environmental upgrades and other sundry reasons.

Currently it is estimated that there is over 553 million metric tons of excess steel capacity in the world, with most of it located in China. Despite weakening domestic demand and burgeoning environmental issues, the obsession with employment, target growth levels and availability of cheap iron ore and labor makes it difficult to close mills to cut capacity. Local governments are reluctant to lose jobs and tax revenue.

The alternative is to keep producing, subsidize mills and export steel worldwide with low pricing—an alternative that has resulted in numerous trade cases on a variety of steel products from China.

Steel exports from China rose 36 percents to 30.4 million in the first four months of 2015. US steel prices have dropped nearly 25 percent since the beginning of the year resulting in massive layoffs despite strong demand for steel products. That demand, say US steel mills, is being filled by Chinese imports.

This week’s filing of a trade case on corrosion-resistant steel from China will require US steel mills to prove that Chinese steel was sold below market-price or benefited from subsidization thereby stealing market share and causing injury to profits of domestic steel producers.

China has decided it will fight back the onslaught of trade suits that have been initiated on its steel exports.

A Wall Street Journal article recently quoted the Chinese ministry, “We encourage Chinese steelmakers and related businesses to actively participate in countersuits, and protect their legitimate interests according to World Trade Organization rules.”

In a response to an EU investigation into dumping of cold-rolled steel coil exports from China, Ministry spokesperson Shen Danyang said that Beijing opposes rolling back its steel exports. “I feel that it’s quite normal for Chinese steel exports to these countries to be rising, and it’s quite justifiable.” He added that Chinese steel products were “globally competitive.”