The effects of laissez faire policy and free trade in Port Talbot.

The Port Talbot steelworks looks likely to close as Tata steel looks for a buyer.  Tata has made enormous investments in the plant but can't reasonably be expected to continue to do so. This is a case in which the government needs to intervene.

The Economist (April 9th) argues against anti-dumping previsions: "A general duty on steel would punish Britain’s most successful manufacturers. It makes no sense to save jobs in an ailing industry like steel by taking them away from a successful one like cars." This argument is completely spurious.

First, consider what has happened in the steel industry, world-wide. China built more capacity than it needed before its economic growth slowed.  Now it must either close the pants or prop them up and put the output on the market. Supply currently exceeds demand and the price of steel has fallen sharply to the point where no one is making money; most are making a loss. This is not a stable equilibrium but a temporary state until either demand rises to meet supply, unlikely in the short term, or supply falls to match demand. Once capacity is reduced prices will stabilize - but the question is who will shutter their plants first?

Next, consider the assertion that a duty would "punish" users of steel. This is of course nonsense. Restricting steel inputs or imposing a tariff would put the price of steel in the UK back to its pre-overcapacity equilibrium price. If manufacturers are indeed "punished" by such a price they couldn't have had a viable business model to begin with - which is clearly not the case.

The other interpretation is that this so called "punishment" is really about depriving them of a windfall from an unexpected fall input costs. The Economist traditionally goes on to argue that this hurts consumers as products cost more then they should. Again the argument is specious. First, taking the auto industry as an example, it assumes car prices would fall as steel prices did - but there is scant evidence that consumers benefit from a fall in manufacturers input prices.

Assuming users of steel had a viable business model, and savings are not passed on to consumers, a slump in prices means a possible windfall for only two groups; employees through higher wages or shareholders in higher dividends or stock prices. Employees have almost never been the beneficiaries of such windfalls, except in some small family owned business since managers incentives are increasingly aligned with those of shareholders so they will maximise shareholder returns rather than pay some of that windfall surplus to employees.

So to sum up; the steel glut leads to a transfer of wealth from shareholders in steel plants to owners of shares in manufactures that use that steel. And in the process thousands of people are put out of work.

Economists (and the eponymous weekly newspaper) would then argue that shareholders of steel companies should then replace the management that got them into the mess that tanked the values of their shares in the company; capacity will be closed and sanity and equilibrium will be restored.

That argument falls on two grounds. First, the majority of shares are held in funds that almost certainly are on both sides of the trade; just as shares in steel companies fall, shares in steel users - which they also hold - rise, effectively making the crisis a wash from the fund manager's perspective; so they won't do anything. And even if it weren't, fund managers rarely intervene actively, instead simply selling steel producers stock -- which is likely bought by other funds looking for a possible steel [sic].

Moreover, the 'culprits' here, if there are any, are the state planners in China who predicted continued growth and over-invested in production capacity; and I doubt they, or the mangers in Chinas steel companies will be fired. Indeed, China would probably prefer to keep their SOEs open correctly assuming that private firms like Tata will fold, leaving Chinese firms with larger market share and increased pricing power.

(Even if this weren't the result of state planning, forecasting uncertainty generally leads to a prisoners dilemma game in capacity; no one wants to be left out so everyone invests and overcapacity is the result -- see James Henderson's dissertation).

This suggest that a laissez faire policy will play right into China's hands. And China is right to assume that the British government, having discarded intervention in favour of free market dogma in the 1980s, will simply let Port Talbot die. It should not.

First it should impose duties on imported steel that maintain prices at a reasonable level relative to historical trends. This will hurt no one; users of steel will get steel a prices that they were able to support prior to the glut, their shareholders won't get windfall profits, customers and fund managers (and owners of those funds) will be unaffected anyway. The Port Talbot will make a modest profit, sufficient to keep it in business, its worker will keep their jobs,  and Chinese steel makers won't capture the UK market.

It will mean that Chinese exporters will look elsewhere to get rid of their excess capacity, but if everyone follows suit, China will have no option but to dismantle capacity.

But there will be retaliation the argument runs. China will stop importing British goods. There are only two reason China imports from Britain - because it can't replicate the product (for example Whisky) or because it hoping to eventually. Tit-for-tat import restrictions will hurt Chinese consumers at a time when there is considerable domestic unrest in part a function of the wild sings in the stock market and the housing market bubble. China's leaders may not want to exacerbate this by depriving them of imports they have grown accustomed to.

Anachronistic indicators

In the 1950 and 1960 "what was good for GM was good for America." Then it made sense to track proxy measure of well being such as GDP or the Dow Jones Industrial Average (an 'index' that tracks the share price of the top 30 largest companies on the New York Stock Exchange).

But in the 1990s a shift took place that had corporations senior managers focusing increasingly if not exclusively on shareholder value. Value appropriation began to dominate value creation. If creating shareholder value is all one cares about, there are far easier ways of doing that than competing with rivals to out-innovate one another.

When firms create value, shareholders generally benefit, but so do consumers, with better or cheaper products. But when value appropriation dominates, for example as industries consolidate and firms raise prices, consumer surplus is reduced as profits and shareholder wealth rises. Firm profits and broad-based societal welfare decouple.

The Economist, in its Briefing section this week, bemoaned corporate consolidation and high profits as a symptom of the tamping down of Joseph Schumpeter's "gales of creative destruction"; yet interestingly it didn't cross the writer's mind that one choice managers make concerns the allocation of resources in the wages paid to employees. Increasing consumer surplus through increased competition is certainly one way of making everyone (except shareholders) better off; but so is a pay raise for the company's employees.

Since few people working two part-time jobs to put food on the table have a portfolio of equity investments, they won't benefit from higher corporate profits, rising stock prices or, when they happen, dividend payments. Those profits in many cases come from the elimination of full time positions and their replacement with part-time ones that don't come with any benefits, not to mention job elimination from off-shoreing and the increasing use of cheapening technology.

And since GDP measures sales, not incomes, and as an average, is distorted by a widening distribution (rising mean but falling modal average) this too doesn't reflect most peoples; lived experiences.