Trump's Tariffs Will Harm U.S. Steel CompaniesSubmitted by Silverlight Asset Management, LLC on March 18th, 2018
Middletown, Ohio is my wife’s hometown. Generations of her family have worked for the local steel mill, Armco Kawasaki Steel (ticker: AKS). Although AK Steel is no longer the largest employer in the area, it is still a dominate topic of conversation at many family gatherings I’ve attended.
In his book Hillbilly Elegy, J.D. Vance describes the Middletown of yesteryear as follows:
“For my grandparents, Armco was an economic savior—the engine that brought them from the hills of Kentucky into America’s middle class. Even after most American car companies transitioned away from steel bodied cars, Pawpaw would stop at used car dealerships whenever he saw an old Ford or Chevy. ‘Armco made this steel,’ he’d tell me.”
The human side of the globalization story is complex and important. Mr. Vance tells it well in his book, through the prism of his family’s story.
In a similar vein, AK Steel’s story offers a prism to help bring context to the current trade and tariff issues being discussed across the nation. It’s just one company, in one town, but it’s also square in the middle of the current policy debate.
Trade vs. Technology
“AK Steel is the result of a 1989 merger between Armco Steel and Kawasaki. The Kawasaki merger represented an inconvenient truth: Manufacturing in America as a tough business since the post-globalization world. If companies like Armco were going to survive, they would have to retool. Kawasaki gave Armco a chance, and Middletown’s flagship company probably would not have survived it.” J.D. Vance, Hillbilly Elegy
AK Steel did survive and is the nation’s fourth largest steel producer. However, it has seen its share of job losses. There is a lot of talk in Middletown and around the country about how unfair trade policies have caused a mass exodus of American manufacturing jobs. That may be the case in certain areas, but it’s a distraction from the main issue—technological change.
The US steel industry shed about 75% of its workforce between 1962 and 2005: about 400,000 employees. This dramatic fall in employment had far-reaching economic and social implications. For example, between 1950 and 2000, Pittsburgh – which used to be the center of the US steel industry – fell from being the 10th largest city in the United States to the 52nd largest.
While employment in the steel sector fell by a factor of five, shipments of steel products in 2005 reached the level of the early 1960s. Thus, output per worker grew by a factor of five, while total factor productivity increased by 38%. This makes the steel sector one of the fastest growing manufacturing industries over the last three decades, behind only the computer software and equipment industries.
Collard-Wexler said, “we thought this was going to be all about trade,” but he and his research partner were in for a surprise. They found that steel production wasn’t leaving the United States as much as it was just requiring fewer workers. In short, steel’s decline was a technology issue.
In the time of Andrew Carnegie, steel production was a high-technology few companies or countries could produce. When Mr. Vance’s Pawpaw was growing up, the steel industry maintained some of that unique luster. Then something changed. Others caught up. When more companies and countries acquired the capability to mass produce steel, competition steadily drove prices down and ate away at excess returns.
I realize, though, that my extended family in Middletown and those in other manufacturing hubs, don’t care so much about whether their struggles are labeled a trade or technology issue. Rather, what they crave are honest solutions.
President Trump’s recently proposed solution is to enact protective tariffs. Unfortunately, protective tariffs are not a real long-term solution for Middletown, or other cities reliant on American steel and aluminum production. In fact, they could be quite detrimental to AK Steel, in particular.
In recent years AK Steel has worked hard to reinvent itself by innovating, with a focus on specialty products for the automotive and electrical power industries. AK’s average selling price is roughly a third higher than its rivals, who sell more commoditized metal that’s cheaper than most imported products.
AK Steel’s specialty focus seems like a logical, long-term strategy, but ironically, could be the most victimized by the tariff policy. That’s because higher domestic output resulting from steel tariffs will likely pressure scrap prices higher. Scrap is a key input cost for AK. While more commoditized producers of steel may benefit from replacement demand (as steel imports decline), AK could be left with little more than a margin squeeze.
Protectionism is a hollow policy that only protects governments; it does not produce sustainable growth or jobs.
Henry George said, “What protectionism teaches us, is to do to ourselves in time of peace what enemies seek to do to us in time of war.”
According to Gavekal Research, Chinese state-owned companies have an average return on assets of 3% and a debt-to-capital ratio of 160%. That’s certainly nothing to envy.
Tariffs act as a boomerang in that they come back to hurt the consumer. They also hurt the producer. If taxes make foreign goods less attractive here, so will U.S. goods be less attractive overseas.
Bottom-line: History shows economic prosperity comes from innovation. Those who pioneered the Golden Era of American steel were not chasing the past. They were chasing the future.
In the words of Henry Kissinger, “The task of the leader is to get his people from where they are to where they have not been.”
If we want to save steel producers, and other struggling manufacturing towns, we should be rewarding companies like AK who are trying to evolve in the right direction, not making their transition harder.
Originally published by RealClearMarkets. Reprinted by permission.
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