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January 1, 2007

Trade

A UN model for international trade that aims to help developing nations would do more harm than good.

Executives of United States Steel Corp. have established a high standard of content and thoughtfulness for their presentations to conferences. The September 2006 presentation of John H. Goodish, executive vice president and chief operating officer of the company, to a conference on China was no exception.

 In his comments, Goodish discussed the Economics of Entitlement, or an approach to global trade practiced by China and advocated, under other names, by the United Nations Conference on Trade and Development (UNCTD). UNCTD holds that the rules of global trade, established in agreements of trading nations to the requirements of the World Trade Organization, should be ignored when it comes to developing nations.

Goodish presents a compelling case for why the UNCTD position is untenable and harmful even to developing nations that attempt to benefit from it. His focus is China, now among the world’s largest economies, yet even so, an adherent to the UN point of view. Here are excerpts from his comments:

“We gather here at a time when government-directed steel policies are impacting global markets in a significant way. In North America, for example, we are absorbing a massive flow of government-subsidized imports from China and other countries.

There is a lesson here for government-subsidized steel producers, especially China: If the modern history of our industry has taught us anything, it is that government-subsidized, excess-capacity building inevitably leads to trouble.

If the global industry is to counter the rising threat of widespread market instability posed by government-subsidized steel capacity-building, production and exporting, we must first explore the Economics of Entitlement—a phrase that we have coined, but that aptly describes the economic model practiced by China and promoted by the UNCTD.

In its recently issued annual trade and development report, the UNCTD forcefully condemned the current Bretton-Woods Model of economic development, which relies on market-based reforms, privatization and global rules-based trade integration to drive economic growth in developing countries.

In its place, the Conference proposes a new model, whose core principle—by our interpretation—appears to be that developing countries are entitled to enjoy the benefits of rules-based trade without obligation to follow the rules. Thus, we have christened this model, “Entitlement Economics.”

The UNCTD justifies this Entitlement Model with the following logic:

First, in spite of recent strong global and developing country growth, the market-based model of development and reforms has failed to generate sufficient growth and timely poverty eradication.

Second, the rules-based system of global integration and trade as embodied in the World Trade Organization (WTO) has deprived developing countries of the very policy tools (subsidies, for example) that developed countries and late-industrializers employed to play economic catch-up, particularly in the last half of the 20th century.

And third, the global rules-based system is biased against developing countries, particularly in terms of providing a level “economic” playing field.
Simply put, the position of the UNCTD appears to be that the current market-driven, rules-based system of global trade is unfair and promotes, rather than remedies, structural imbalances between developed and developing countries.

From the Conference’s perspective, national institutions are a “critical determinant” of growth, and therefore, governments of developing countries should take a leading, activist and interventionist role in economic development.

To accomplish this, the Conference proposes developing country governments utilize proactive trade and industrial policies such as:

  • Temporary subsidies to drive innovation, technology investment and export growth
  • Temporary protection to facilitate industrial learning processes
  • Tariffs to promote technology change and productivity growth
  • A de facto stance on intellectual property rights to enhance technology transfer
  • As related to currency, the Conference recommends that developing countries engage in a managed-floating exchange rate regime as a viable solution in defense of “strategically favorable competitive positions.”

It is understood, of course, that many of the proactive trade policies that the Conference proposes run counter to the existing global rules-based trading regime, including currency manipulation. To circumvent this difficulty, the Conference recommends that, “in the spirit of global partnership for development,” developed countries should agree to a new framework of special and differential treatment for developing countries without “receiving concessions in return.”

Such an entitlement would then clear the way for developing countries to implement proactive trade and industrial policies in one of two approaches as prescribed by the UN Conference:

  • The first is a country-specific approach in which each country would be allowed to “selectively opt out of certain rules and commitments, depending on their specific national priorities.”
  • The second approach is an agreement-specific approach, in which developed and developing countries would apparently negotiate criteria under which developing countries can “opt out” of “negotiated disciplines.”

In comparing the two approaches, it seems that the first is not unlike a game of soccer in which the opposing team is allowed to decide—without discussion—what rules it will abide by and what rules it will ignore. The second approach is somewhat more rational in that the opposing team must at least negotiate the criteria under which it will be allowed to ignore the rules. For example, we would agree that if your team gets behind, my team would remove its goalie. These terms, however, are not reciprocal but concessionary. In other words, in the spirit of sporting development, we agree that your team is entitled to win.

As it happens, the Model of Entitlement Economics as put forward by the Conference has found a skillful, sophisticated and aggressive champion in the world’s fastest growing economy: China.

On Aug. 31, 2006, when UN Trade Conference’s annual report hit the streets, the Chinese media was quick to seize on the UNCTD report’s validation of China’s government-driven economic policies, as well as its exchange rate scheme. The People’s Daily Online wrote that the UNCTD “praised China’s sharp economic growth in recent years, indicating that China’s characteristic growth, which highlights a government role in the market, could be a model for poor countries.”

With the Conference’s ringing endorsement pinned to its wall, the Chinese government—along with other developing countries—will be encouraged to continue its use of government-driven proactive trade and industrial policies, while simultaneously “opting out” of certain WTO commitments.

Implementing the Conference’s principle that developing countries should be allowed to pick and choose which global trade rules to follow and which to ignore, China continues to disregard several of the commitments it made upon accession to WTO membership in 2001. For the purposes of this speech, I will limit this considerable list to those that most impact the global steel industry. These include:

  • A commitment—upon accession—to limit or eliminate trade-distorting subsidies. China has continued to provide significant subsidies in steel and other sectors, a practice that threatens to destabilize the global steel industry.
  • A commitment—upon accession—to ensure that the government does not interfere with state-owned enterprises. As shown by its steel policy and orders from the National Development and Reform Commission, China continues to micromanage state-owned enterprises, including steel producers.
  • A commitment—upon accession—to dismantle export restrictions. China continues to impose WTO-inconsistent restrictions on exports of key raw materials, including coke and coal, artificially propping up the global prices of these commodities.
  • A commitment—upon accession—to end export subsidies. China continues to employ currency manipulation to effectively provide enormous export subsidies to domestic manufacturers, including the steel sector.

After five years of WTO membership, China has had more than enough time to fulfill these commitments. Apparently, as a developing country, China believes it is entitled to honor these obligations how and when it chooses.

The Entitlement Model of Economics represents a severe threat to the stability of the global steel industry.

Firstly, state-subsidized steel capacity in China has far surpassed domestic demand and continues to grow.

China’s steel supply, which is calculated as production plus imports, could reach 498 million tons, creating a steel surplus of 128 million net tons—an amount greater than apparent steel use in the U.S. market in 2005 (114 million net tons).

China’s story is that it wants to shut down about 100 million tons of inefficient and highly polluting capacity. In fact, China continues to invest heavily in subsidized capacity building. According to China’s National Development Reform Commission, second-quarter investment in the steel industry totaled $8.4 billion, up 106% over the first-quarter investment of $4 billion.

China’s excess steel capacity and product surplus have quickly transformed the country from a net importer to a net exporter. China—which was not on the list [of the top 10 steel sheet exporters] in 2004 and ’05—is aggressively and rapidly pursuing the sheet import market, capturing 7.2% of the U.S. sheet market in the first half.

As a WTO member, China is in numerous ways taking unfair advantage of its access to member country markets. As a champion of the Entitlement Model of Economics, China is driving the global steel market toward a period of supply/demand imbalance.

The critical flaw of the Entitlement Model is that it creates an artificial marketplace designed and administered by bureaucrats and supported by government-driven policies such as subsidies, protection and tariffs. Within such a system, there is little room for customers, consumers and enterprise to build the fundamentals of a market-based economy that will be truly sustainable and competitive on the world stage.

An economy based upon the Entitlement Model ultimately results in an economic house of straw built upon the shifting sands of government bureaucracy.

The sad story here is that eventually the Entitlement Model of Economics always destroys, rather than creates, value for shareholders and stakeholders alike.

While developed countries must—and do—have a responsibility to assist developing countries with global market integration, economic development and poverty reduction, supplanting the market-based Bretton-Woods Model with the Entitlement Economics Model will lead to increased trade conflict, rather than cooperation, between developing and developed economies. There is no doubt that, in such a circumstance, developed countries, including the United States, will vigorously defend their trade borders through strengthened trade laws—a position U.S. Steel strongly supports.

If China is allowed to continue unabated in its practice of Entitlement Economics, and if the UNCTD is successful in spreading the model to other developing countries, the very existence of the current rules-based system of global trade will be threatened. It is possible that the global steel industry will be the first battleground, and potentially the first casualty, of the economic war now brewing between the government-based model and the market-based model of economic development.”