Wednesday, March 7, 2018

The National Security Argument for Steel and Aluminum Tariffs

The reason behind the tariffs that President Trump has announced for steel and aluminum is an unusual one. The legal justification for the tariffs is based Section 232 of the Trade Expansion Act of 1962, which gives the President the power to impose tariffs if "national security" is at stake.

As Chad Bown of the Peterson Institute for International Economics has pointed out, this specific justification for import tariffs has led to a total of 28 investigations in the 56 years since the law was enacted. The most recent investigation as to whether national security should lead to import tariffs was in 17 years ago in 2001; the most recent time in which national security actually led to imports being limited was 32 years ago, when President Reagan used this argument to limit imports of certain machine tools.

However, the argument that it might sometimes be necessary to limit imports because of national security has a venerable history. Adam Smith, the intellectual godfather of free trade arguments, listed national defense as an exception in  Book IV of the The Wealth of Nations.. Smith wrote:
"There seem, however, to be two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry. The first is, when some particular sort of industry is necessary for the defence of the country. The defence of Great Britain, for example, depends very much upon the number of its sailors and shipping. The act of navigation, therefore, very properly endeavours to give the sailors and shipping of Great Britain the monopoly of the trade of their own country in some cases by absolute prohibitions and in others by heavy burdens upon the shipping of foreign countries."
By all means, the national security argument deserves serious consideration. And seriously, are the steel and aluminum tariffs actually about national security in the sense of military strength? Or is it "national security" in a more generic and rhetorical sense, really meaning that if it's good for steel industry profits, then it's good for "national security."

(Side note: Of course, this second argument is essentially similar to the line attributed long-ago to to Charles Wilson, a former head of General Motors who was nominated to be Secretary of Defense in 1953. Wilson was widely mocked for saying, "What's good for General Motors is good for the country." That's not actually what he said, as I explain in "What's Good for General Motors ..." (October 23, 2012). But the sentiment that if corporate profits for favored industries are vital to national security was certainly common enough, then and now.)

The US Department of Commerce has put forward the "national security" justification for the steel and aluminum tariffs in two January 2018 reports: "The Effect of Imports of Steel on the National Security" (January 11, 2018) and "The Effect of Imports of Aluminum on the National Security" (January 17, 2018).

As the reports point out, Section 232 allows for a broad definition of "national security." It quotes from a report back in 2001, the last time the national security justification for tariffs was considered (although not ultimately used), to note that“in addition to the satisfaction of national defense requirements, the term “national security” can be interpreted more broadly to include the general security and welfare of certain industries, beyond those necessary to satisfy national defense requirements that are critical to the minimum operations of the economy and government.” These reports have a lot of detail on levels of steel and aluminum imports and the difficulties of US steel and aluminum companies. But the details about just how national security is being affected are harder to find and to pin down. Here, I'll first give some details on the steel industry from the US Department of Commerce report, and then turn to the aluminum industry report.

Background on the US Steel Industry

The report sums up its case in this sentence: "It is these three factors – displacement of domestic steel by excessive imports and the consequent adverse impact on the economic welfare of the domestic steel industry, along with global excess capacity in steel – that the Secretary has concluded create a persistent threat of further plant closures that could leave the United States unable in a national emergency to produce sufficient steel to meet national defense and critical industry needs."

How much steel is actually used by the US Department of Defense? The answer is 3% of domestic US production. The report says: "The U.S. Department of Defense (DoD) has a large and ongoing need for a range of steel products that are used in fabricating weapons and related systems for the nation’s defense. DoD requirements – which currently require about three percent of U.S. steel production – are met by steel companies that also support the requirements for critical infrastructure and commercial industries."

What about the "critical industries" more broadly? The answer is about half of domestic production. The report says: '"[T]here are 16 designated critical infrastructure sectors in the United States, many of which use high volumes of steel (see Appendix I). The 16 sectors include chemical production, communications, dams, energy, food production, nuclear reactors, transportation systems, water, and waste water systems. ... The updated analysis in Appendix I shows that 49.1 percent of domestic steel consumption in 2007 was used in critical industries."

The report has a LOT to say about steel production in China. But when you look at US imports of steel, this table taken from the report shows that Canada is at the top and China is 11th. US steel imports from 2011 to 2017 are up considerably overall, especially from Brazil, South Korea, Mexico, Russia, Turkey, Germany, and Taiwan. But over that time, US steel imports from China are down by about one-third.

How much is US production capacity dropping off? Here's the figure from the report. There's a rise before the Great Recession and a fall after, but current steel capacity is about the same as it was in the early 2000s.  
Logically speaking, the number of jobs in the US steel industry shouldn't be part of the national security argument. After all, steel like pretty much every other industry is continually making more use of automation and robots. But here's what the report shows about steel industry jobs: a big drop from about 2000-2003, but not much change since then. 

For me, it's hard to look at these kinds of figures and see a national security crisis in the making in the military strength category. The report even notes that while steel prices are low all around the world, "Notwithstanding these effects, prices for steel in the U.S. remained substantially higher than in any other area. However, relative to prices between 2010 and 2013, prices are still relatively depressed."

The report does give a few examples of specific types of steel products that are important for defense production and where there are few domestic suppliers. The report notes:
"This is not a hypothetical situation. The Department of Defense already finds itself without domestic suppliers for some particular types of steel used in defense products, including tire rod steel used in military vehicles and trucks. ... In the case of critical infrastructure, the United States is down to only one remaining producer of electrical steel in the United States (AK Steel – which is highly leveraged). Electrical steel is necessary for power distribution transformers for all types of energy – including solar, nuclear, wind, coal, and natural gas – across the country. If domestic electrical steel production, as well as transformer and generator production, is not maintained in the U.S., the U.S. will become entirely dependent on foreign producers to supply these critical materials and products."
The report also notes that steel producers have reduced their capability to ramp up production in a national emergency:
"[D]omestic steel producers have a shrinking ability to meet national security production requirements in a national emergency. The U.S. Department of Commerce, Census Bureau regularly surveys plant capacity, and has found that steel producers are quickly shedding production capacity that could be used in a national emergency. The Census Bureau defines national emergency production as the “greatest level of production an establishment can expect to sustain for one year or more under national emergency conditions.” From 2011 to 2017, steel producers increased the utilization of the surge capacity they would have during a national emergency from 54.2 percent to 68.2 percent ...  As steel producers use more of this emergency capacity, there is an increasingly limited ability to ramp up steel production to meet national security needs during a national emergency."
As the report notes, ramping up steel production in the patterns that occurred during the Vietnam War or World War II would take time and effort. Of course, the notion that the US steel industry should be continually prepared to ramp up at high speed for the equivalent of World War II is a questionable one. Let's pause there for a moment, and turn to the aluminum report.

Background on the US Aluminum Industry

As the aluminium report explains: "Aluminum originates from bauxite, an ore typically found in the topsoil of various tropical and subtropical regions; the United States is not a significant source of bauxite as it cannot be economically extracted here. Once mined, aluminum within the bauxite ore is chemically extracted in a refinery into alumina, an aluminum oxide compound. In a second step, the alumina is smelted to produce pure aluminum metal."

One of the ironies here is that the US is worried about the national security importance of an industry that depends entirely on imported raw materials. However, as the report notes: "The U.S. Government does not maintain any strategic stockpile of bauxite, alumina, aluminum ingots, billets or any semi-finished aluminum products such aluminum plate."

How much aluminum is used by the US Department of Defense? The report blacks out this information. It reads: "The U.S. Department of Defense (DoD) and its contractors use a small percentage of U.S. aluminum production. The DoD “Top Down” estimate of average annual demand for aluminum during peacetime is XXXXX, or XXXXX percent of total U.S. demand." However, later in the discussion in the specific category of high-purity aluminum, the report reads: "The U.S. manufacturers of products based on aluminum require 250,000 metric tons of high-purity aluminum a year. Approximately 90 percent of this is for commercial aerospace and other applications. Ten percent is used to support the manufacture of defense-related products."

As with steel, the main source of US aluminum imports is Canada. In fact, this outcome is the result of long-standing polices. The report notes: 
"The U.S. in 2016 relied on imports for 89 percent of its primary aluminum requirements, up from 64 percent in 2012. Canada, which is highly integrated with the U.S. defense industrial base and considered a reliable supplier, is the leading source of imports. With Canadian smelters operating at near full capacity and with the vast majority of their production already going to customers in the United States, there is limited ability for Canada to replace other suppliers. ... 
"The U.S. and Canadian defense industrial bases are integrated. This cooperative relationship has existed since 1956 and is codified in a number of bilateral defense agreements. For example in 1987, DoD (all Services), the Defense Logistics Agency (DLA), the Office of the Secretary of Defense (OSD), and the Canadian Department of National Defence (DND) joined together to form a North American Technology and Industrial Base Organization (NATIBO). NATIBO is chartered to promote a cost effective, healthy technology and industrial base that is responsive to the national and economic security needs of the United States and Canada." 
How low is the price of aluminum? Here's a graph from the report showing aluminum prices since 1998. Prices peaked during the commodity boom in the lead-up to the Great Recession, then crashed, but presently are above where they were in the late 1990s and early 2000s. In other words, it's hard to make the case that prices have fallen below their usual historical range, rather than being pretty much in the middle of that range. 

Where is the world's aluminum produced? The report says: "Because aluminum production is highly energy intensive, the world’s leading producers are generally the countries with the lowest energy costs (including Canada, Russia, the United Arab Emirates (UAE), and Bahrain). The exception is China, where electricity costs are actually higher than those of the United States ($614 per metric ton of aluminum produced in China versus $532 per metric ton in the United States); China’ overall production costs were equal to that of U.S. producers." 

What jumps out at me from the previous table is the US capacity utilization rate in aluminum production is so very low. 

The report does note two particular issues that seem to me potentially relevant to national security in the military sense. One is the particular area of "high-purity aluminum:
"The U.S. currently has five [aluminum] smelters remaining, only two smelters that are operating at full capacity. Only one of these five smelters produces high-purity aluminum required for critical infrastructure and defense aerospace applications, including types of high performance armor plate and aircraft-grade aluminum products used in upgrading F-18, F-35, and C-17 aircraft. Should this one U.S. smelter close, the U.S. would be left without an adequate domestic supplier for key national security needs. The only other high-volume producers of high-purity aluminum are located in the UAE and China (internal use only)."
A somewhat related issue is that many of the high-tech uses of aluminum involve research into new alloys and their properties. But aluminum industry R&D seems to have died off:
"At this time most aluminum companies cannot afford to fund research. The importance of research in this industry is clear, however. More than 90 percent of all alloys currently used in the aerospace industry were developed through Alcoa’s research. ... Of the three remaining companies with U.S. smelting operations in 2016, Alcoa is the only company to report spending on Research and Development over the past five years in its financial statements; Century Aluminum and Noranda reported zero spending on R&D since 2012."
Some Thoughts about the National Security Argument for Protection

Imagine for a moment that you were firmly convinced that the US faced a national security problem with steel and aluminum--and I mean in the specific sense of being related to military and critical industry needs, not in the generic sense of just thinking some industries should have bigger profits. What would you propose? Here are some ideas: 
  • Focus on the specific areas where the dependence on imports of steel and aluminum is most concerning, like the areas of steel tire rods, electrical steel, and high-purity aluminum mentioned in the reports. 
  • Undertake a crash R&D program to find ways of substituting for steel and aluminum in various applications, and also to reuse and recycle existing steel and aluminum where possi le 
  • Stockpile bauxite and other raw materials, so as not to be vulnerable to import disruptions. 
  • Take all the subsidies that are proposed or enacted for favored noncarbon energy sources like solar and wind, and adapt them to apply to steel and aluminum: maybe tax cuts for these industries; or government guarantees that these companies could borrow large sums at subsidized or zero interest rates; or the  Department of Defense and other government purchasers would buy purchase steel and aluminum from US producers at above-market prices; or government could pay steel companies to keep unused excess capacity that could be ramped  up quickly. 
  • Make  contingency plans that would redirect steel and aluminum from noncritical uses to national security uses, if needed. 
  • Avoid undercutting Canada, which is both a key US ally and the largest outside supplier of steel and aluminum.
Just to be clear, I'm not advocating everything on this list of ideas. I'm saying that someone who is seriously concerned that the domestic production of steel and aluminum raises national security concerns should be considering all of these ideas, and advocating for at least some of them.

If the response to national security concerns over steel and aluminum is just "slap on tariffs, help domestic industry earn higher profits, and just kinda sorta hope that domestic industry uses those profits to build up capacity and specialized products and R&D"--well, that response doesn't actually seem like a serious concern over national security to me.  If the national security concerns are legitimate, seems like a remarkably sloppy and unserious way to address them.  

Speaking of being serious, one frustration for any economist reading these reports is that at no point do they acknowledge that imports tariffs or quotas have any costs to consumers and other industrial users of these products. After all, the key mechanism by which import restrictions benefit domestic firms is by allowing them to charge higher prices to buyers.  

I care a considerable amount about national security. But waving the words "national security" should not exempt anyone from an actual consideration of actual costs, benefits, and alternative strategies. 
There is zero question in the mind of any economist that import tariffs will offer short-run benefits to  the domestic steel and aluminum industries. Whether it benefits the country overall--either in the military or the economic sense of "national security"-- is considerably more dubious. The inevitable trade retaliation from other countries will only worsen these tradeoffs.

Finally, one sometimes hears the argument that these steel and aluminum tariffs are just an opening bid in the renegotiation of trade agreements. In this telling, the steel and aluminum tariffs could be bartered away for concessions in other parts of trade agreements. Maybe this is true. But if the tariffs are now bargained away or discarded so, I would conclude that the national security justification for their existence was not made sincerely in the first place.