Captive Tons

In two previous reports, the Specialty Steel Industry of North America
(SSINA), Washington, has described how the government of the People’s Republic of China has been using a wide range of direct and indirect subsidies as well as other support measures to carry out the Chinese government’s overarching plan to encourage the development of the Chinese specialty steel industry and to ensure its ongoing viability.

This report supplements SSINA’s earlier studies by explaining how China has been protecting and fostering, on an enormous scale and contrary to China’s international legal obligations at the World Trade Organization and at the International Monetary Fund, the long-term development of the primary downstream industries in China’s specialty steel sector by means of a striking array of illegal subsidies and other interventionist measures.

The Chinese government’s industrial policies have encouraged and directed certain "pillar" industries, which the Chinese government considers to be essential to China’s national economy and security. These favored industries—"the life-blood of the national economy"—include many of the specialty steel sector’s primary downstream industries.

State-owned enterprises in these "pillar" industries have been modernized and restructured to create large enterprises that are the principal actors or "national champions" in their industries and to displace imported products into China’s domestic market.

The Chinese government’s interventionist industrial policies to develop downstream industries in the specialty steel sector and the support measures used to carry out those policies have had a devastating impact on domestic industries and their workers in the United States by giving Chinese firms an unfair advantage when competing against U.S. domestic firms in the United States, in China and in third counties. In 2007 alone, the Chinese government’s industrial policies resulted in unfairly traded exports that contributed to the United States’ $262.1 billion trade deficit with China and the loss or displacement of more than 366,000 jobs in the United States.

China’s interventionist industrial policies also have unduly influenced the investment decisions of U.S. domestic firms operating in downstream industries in the specialty steel sector by providing an incentive for U.S. firms to cease manufacturing and curtail research and development in the United States and to relocate their production facilities to China.

Perhaps the most critical component of China’s overall plan and the Chinese government’s single greatest subsidy is China’s substantial undervaluation of its currency. Through protracted, large-scale interventions in the exchange markets, the Chinese government has kept the renminbi undervalued by an estimated 30 percent to 40 percent relative to the U.S. dollar for many years.

This undervaluation is contributing to global imbalances in trade and investment and has enabled China to amass at least $2 trillion in foreign reserves.

Downstream industries in China’s specialty steel sector benefit from government programs that subsidize the cost of raw materials, including outright grants and price discounts as well as export-restriction schemes.

The Chinese government provides raw materials to producers in key industries at preferential, subsidized prices. A recent report by the U.S.-China Economic and Security Review Commission concluded that "[p]rovincial and municipal governments subsidize purchases of…raw materials…by requiring other SOEs (state-owned enterprises) or pressuring their own suppliers to provide these inputs at below-market or even below-cost prices."

The Chinese government also has used a number of export-restriction schemes, including export-licensing schemes and differential-export-tax ("DET") schemes, to ensure abundant domestic supplies of critical raw materials and to maintain artificially low pricing for those inputs.

Until recently, the Chinese government used a licensing system to restrict the exportation of vital raw materials, such as metallurgical coke. In 2004, the European Union complained that the licensing scheme created significant imbalances in the global market and demanded that the Chinese government eliminate its program. While the central government agreed to a minimum quantity of coke to be supplied to the European Union, the Chinese government sought ways to ensure that the licensing scheme stayed in place and was vigorously enforced. The Chinese Ministry of Commerce, for example, began enforcing regulations forbidding the trading or selling of export licenses for metallurgical coke among Chinese coke producers.

In addition to the licensing scheme, the Chinese government has altered its tax regime to provide a differential export-tax scheme to restrain exports of key raw materials and basic specialty steel products while encouraging exportation of downstream products subject to a greater degree of manufacturing in China by not imposing similar export taxes and continuing to provide export rebates on value-added downstream products.

Nickel, for instance, is subject to the Chinese government’s increased export restrictions—in November 2006, the Chinese government increased the export tax levied on nickel raw materials and products from 2 percent to 15 percent for purposes of limiting Chinese exports of these materials.

At the same time, China has not imposed export taxes and has provided a rebate of the VAT (value-added tax) on many products produced by downstream industries in the specialty steel sector. In this way, China discourages Chinese producers from exporting raw materials and semi-finished materials.

The levying of export taxes on upstream products at the rate of between 5 and 15 percent has the effect of increasing the supply and thereby lowering the price in China of raw materials that are consumed in producing the downstream products. Second, the imposition of no export tax on these downstream products encourages increased exports of the value-added products.

The implementation of this differential export-tax scheme by the Chinese government, therefore, discourages the exportation of basic products, while encouraging the production and exportation of further-manufactured products. As observed in a study by the Organization for Economic Cooperation and Development (OECD), "The two main reasons for imposing export duties are: 1) fiscal receipts or revenue; and 2) promotion of downstream processing industries, i.e. by providing domestic manufacturing and processing industries with cheap raw materials and other inputs."

In addition to export taxes, China uses VAT rebates to promote exports.

Because Chinese producers benefit from this preferential tax rate only upon exportation of those products, the subsidy is contingent upon exportation and therefore is trade distortive.

Chinese authorities are resolved to foster the development of domestic downstream industries in the specialty steel sector capable not only of supporting China’s economic growth and largely replacing imports into China, but also of exporting large quantities of products from China to destinations such as the United States.

In the midst of China’s performance, it is important to keep in mind that the neo-mercantilist programs and measures on the part of China’s governmental authorities are incompatible with the economic theory of free trade and are fundamentally at odds with the major commitments the country has assumed at the World Trade Organization under public international law.