Free Chinese Lunch!

Leiden, a.d. Kal. Feb. MMDCCLXIX A.U.C.,

No, this is not an advertisement, this is about trade politics. The EU decided to increase import tariffs on Chinese steel with 9.2% to 13%, as a result of pressure from the European steel industry, which demanded protection from Chinese dumping practices. Dumping occurs when a producer sells products in a foreign market at prices lower than prices in its domestic market or lower than its producing costs.

While there several reasons for companies to engage in dumping practices, it is often a result of government interference in the domestic market. Whereas in many free and competitive markets overproduction leads to lower prices, in turn reducing production and possibly bankrupting less efficient producers, this does not happen in markets in which governments interfere to prevent exactly that.

The Chinese government in fact subsidizes steel producers, so even though the price of steel keeps declining in China, producers keep producing, because they do not respond to the price mechanism, but to the subsidies they receive. This is part of a Chinese policy to attract and stimulate industries which are not dependent on cheap labour, and in turn create more capital intensive industries. Moreover, the Chinese government is afraid that widespread bankruptcies and corresponding unemployment will lead to social unrest. Many steel producing companies report completely fictional profits, completely based on the subsidies they receive.

So what do Chinese producers do with demand decreasing and having more steel on their hands than Chinese consumers need? They sell it to Europe, where the steel prices are much higher. Of course, for European consumers of steel this is great, it is a transfer of wealth from the Chinese taxpayer to European consumers. However, for European producers of steel it is disastrous. Even if they are more efficient than Chinese producers, they still are competed away because of the subsidies of the Chinese government. This is both unfair to investors and employees of those companies, but also poses the long term danger of losing the know-how and capacity to produce steel if China ever recovers from its economic slow down. In that scenario Europe becomes more dependent on, by that time once more expensive, Chinese steel.

So the European Union has decided to impose countervailing tariffs, which are tariffs meant to offset the subsidies received by foreign producers. This should reduce the supply of Chinese steel to Europe, thus raising the prices of steel again. However, on all the steel that will still be imported from China a tariff will be paid. Seeing the size of European steel imports from China, around €3.7billion in 2014, the tariff, around 10%, and assuming that Chinese steel exports to Europe decrease with 10% because of the higher price: (€3.700.000.000*0.9)*10%=€330.000.000, we will receive a transfer of around €330.000.000 from the Chinese government.* That is roughly €1 per European citizen. They say there is no such thing as a free lunch, but this year there is and the lunch will be Chinese!

Bottom Line: There is such a thing as a free lunch, and the Chinese are paying it (contradiction in terms intended).

* I tweeted European Commissioner on Trade Malmström asking for preciser estimations of the total revenue from these import tariffs, but she did not reply.


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