Leaping Backward and Reforming Forward: China’s Transformation into a Steel Superpower - MacroPolo Leaping Backward and Reforming Forward: China’s Transformation into a Steel Superpower - MacroPolo
Leaping Backward and Reforming Forward: China’s Transformation into a Steel Superpower

Perhaps no single commodity exemplifies China’s industrialization as much as steel. Per capita steel production in China ballooned from less than 20% to more than 260% of the global average between 1978 to 2017. The steel sector has played an instrumental role in China’s economic development since Reform and Opening began in 1978. For most of the ensuing forty years, China’s economic growth has been propelled by the secondary industry, of which steel is a significant component. This growth would not have been possible if not for the sweeping reforms that took place in the steel sector.

It wasn’t always so. Steel had also occupied an exalted place in Mao Zedong’s China. To the Chairman, this commodity was a symbol of political progress and a top economic priority. But Mao’s attempt in the late 1950s to mobilize the country to surpass Great Britain in steel production in just three years would end in disastrous failure. It would take another 16 years before Chinese steelmakers outpaced the British.

Steel, then, offers an important illustration of China’s industrial development and the nature of its growth over the decades of Reform and Opening. But, more importantly, an analysis of how the steel industry has evolved and stagnated also offers perspectives on China’s past reforms and its prospective future growth.

From Spectacular Failure to the World’s Largest Steel Producer

Since 1978, China’s steel production has risen from just 4.4% of global production to a staggering 49.7% in 2016 (see Figure 1). Such an accomplishment has far exceeded Mao’s dreams when he launched the catastrophic Great Leap Forward (GLF) in 1958.

Figure 1. China’s Share in Global Steel Production
Source: National Bureau of Statistics.

The main goal of the GLF was to dramatically increase steel production in an impossibly short period of time. To meet unrealistic production targets, in 1959 about 100 million people, or 40% of China’s labor force at the time, were mobilized to make steel. Prior to the GLF, China’s steel sector employed fewer than four million. Most of the steel was being produced by unskilled labor in shoddy facilities, including in the so-called “backyard furnaces,” much of which could not be used for industrial purposes.

Not only was the campaign unsustainable, it also resulted in one of the gravest tragedies in recent Chinese history. The GLF’s fixation on steel diverted a large portion of the rural labor force into steel production. This caused a dramatic reduction in food production, which was very labor-intensive in 1950s China, and led to perhaps the worst policy-induced famine in the 20th century.

Domestic Appetite for Steel Drove Production

The GLF came to an end in 1960, but not before laying waste to the steel industry. In fact, China’s steel production didn’t recover to its 1959 level until 12 years later in 1971 (see Figure 2). It would be another 20 years before China’s steel production began to skyrocket.

Figure 2. The Rise and Fall of Steel Production During the Pre-Reform Era
Source: World Steel.

Immediately following Deng Xiaoping’s famous 1992 Southern Tour that renewed confidence in economic reforms, domestic steel demand shot up by more than 50% in 1993, and 30% of steel consumption had to be met through imports. Far from an exporter of excess capacity, in the 1990s, China was actually a net importer of steel (see Figure 3). In fact, China only became a net exporter of steel in 2006, a decade after it surpassed Japan to become the world’s top steel producer.

Figure 3. China’s Steel Trade Balance as % of Domestic Production
Note: Negative value indicates net exports.
Source: World Steel.

What caused this unprecedented expansion? In short, China’s urbanization and industrialization. The top three sectors that drove steel consumption since Reform and Opening have been construction, machinery, and autos, with construction accounting for more than half of China’s domestic steel demand.

All these sectors benefitted from massive urbanization. Between 1978 and 2017, more than 600 million Chinese moved from the countryside into cities. Over the same period, average per capita residential area increased from 6.7 mto 36 m2. As a result of this large-scale urbanization, even after China became a net exporter of steel in the mid-2000s, on average, more than 90% of its steel production has been consumed domestically (see Figure 4). Therefore, unlike the supply-side dictates of the GLF, it was the rapid increase of organic domestic demand since the 1980s that drove steel production growth.

Figure 4. Steel Production Strongly Correlates with Real Estate Construction
Source: NBS.

Expanding the domestic supply of steel to meet growing demand required building a formidable steel industry, one that had been wrecked by the GLF. As will be demonstrated below, market reforms played a significant role in unleashing the industrial potential that would eventually turn China into a steel superpower.

Getting the Price Right

Dismantling the centrally planned pricing system had an enormous impact on bolstering steel production. In the early days of Reform and Opening, steel prices, like those for most industrial goods, were fixed and were not responsive to market changes in demand. But by the 1980s, China began to liberalize prices under the so-called “dual-track” system. It was a deliberate and gradualist approach to adopting market pricing that would deliver similar outcomes without the disruptions that came with “shock therapy” methods advocated by Western liberal economists.

Under the dual-track system, industrial firms were allowed to sell incremental production above the official target at a price that was higher than the fixed price, though still within a set range. Over time, that range would get wider until eventually prices were basically fully liberalized.

That process would take nine years for the steel industry. Starting in 1984, steel producers were allowed to sell their incremental production within a 20% range of the planned price, a price ceiling that was lifted the following year. By 1987, more than 20% of steel production was sold at market prices, a share that reached over 90% in 1992. Price controls on steel were completely removed in 1993—the same year that price reforms were completed for many other industrial and consumer goods, including the abolition of food stamps.

The dual-track approach not only incentivized steel producers to raise production, it also helped to shelter state firms from the full effect of reforms. For instance, state firms that needed to purchase industrial goods were still entitled to continue buying a certain amount of goods, including steel, at the planned price—the equivalent of a subsidy. Therefore, end users of industrial goods could weather price increases. This approach reduced resistance from state-owned enterprises (SOEs), an important political constituency of the Chinese Communist Party (CCP).

In addition, pricing reform also weakened opposition to subsequent market reforms. For example, the former State Planning Commission (SPC), whose role was to design and implement price controls, was an obvious opponent to reform policies. But Zhao Ziyang, at the time China’s liberal-minded premier, blurted out in a private meeting that “economic reform is about dismantling the planning commission.”

In 1998, five years after dual-track pricing ended for most industrial and consumer goods, the SPC was replaced by the National Development and Reform Commission, whose new mandate was to focus on macro, rather than micro, economic management.

Private Sector Players Rise

By the mid-1990s, market pricing, rather than a central planning agency, determined the production and consumption of industrial goods. But another major hurdle to reforms remained, namely how to deal with the concentration of SOEs in industry. This was especially salient for the steel sector, where SOEs still accounted for more than 90% of output as recently as 2000.

Yet since the turn of the century, the share of steel production by China’s private sector rose from less than 8% to 56% in 2015 (see Figure 5). To put it differently, private steel producers contributed 65% of China’s total steel production over those 15 years.

Figure 5. Share of Steel Production by Firm Ownership
Source: China Iron and Steel Association.

The rise of private steel producers needs to be understood within the context of broader reforms that occurred in the previous decades. Like pricing reforms, unleashing the private sector came gradually and was embroiled in politics.

It’s perhaps unthinkable today, but up until the mid-1980s whether to even allow private entrepreneurs to hire more than seven employees was one of the most hotly debated issues at the highest echelon of Chinese politics. Conservatives opposed to reforms, for example, cited an endnote in Marx’s Das Kapital to argue that hiring more than seven employees is in fact labor exploitation and would be considered an unacceptable capitalist practice.

The political opposition was actually effective, as Beijing didn’t formally abandon this hiring constraint on the private economy until 1987, almost a decade after Reform and Opening had been launched. By the mid-1990s, things were looking up for private firms, which finally received formal recognition of having equal status as SOEs during the 15th CCP Congress in 1997. Private firms, alongside state firms, were now considered an indispensable part of the Chinese economy.

This set the stage for breaking the longstanding CCP taboo on private firms once and for all. It came on July 1, 2001, when Party Secretary Jiang Zemin’s speech celebrating the CCP’s 80th anniversary declared for the first time that private entrepreneurs could join the CCP. The enfranchisement of the private sector was part of Jiang’s “Three Represents Theory” that sought to rebrand the CCP as an establishment governing institution that embraced private businesses and tolerated capitalism.

In the meantime, the basic strategy on reforming the state sector was captured in the phrase “grab the large and abandon the small” (抓大放小). Beijing wanted to preserve central and strategically important SOEs because they held significant state assets and were directly linked to political power. As for the rest of SOEs, the vast majority of which were owned by local governments, Beijing’s attitude toward them was rather lax, willing to let them exit the market, get bought out, or even privatize.

As a result of these reforms, the 2000s were a great decade for private sector expansion, while the state sector shrank as a proportion of the overall economy. Between 2000-2017, the number of non-state industrial firms more than doubled, while the number of SOEs declined by 60% (see Figure 6).

Figure 6. Number of State and Non-State Industrial Firms
Note: The large drop in the number of non-state firms in 2011 is due to the change in criteria for inclusion in the NBS sample.
Source: NBS.

The steel sector was particularly affected by these reforms because of the high concentration of SOEs. According to the National Bureau of Statistics, some 3,000 new non-SOE steel producers have been created since 2000, while the number of SOE producers dropped by more than 300. Some of those SOEs simply folded, but many others, like China’s largest private steel maker, Sha Steel, were privatized during the early 2000s. Even accounting for the conversion of former SOEs into private firms, the 2000s nonetheless saw thousands of private steel makers emerge.

The unprecedented expansion of private steel producers led to one of the fastest growth periods for China’s steel sector. Between 2001 and 2013, not only did China cement its position as the world’s largest steel producer, in multiple years during that period, China’s annual incremental steel production exceeded the total production of Russia, the world’s fourth-largest steel producer.

Evolution of the Steel Industry and China’s Economic Future

From the epic failure of the GLF to becoming the largest steel producer in the world, China’s steel industry is a testament to how market reforms, not political mobilization, can transform scarcity into abundance. The Chinese steel industry is one that is now dominated by the private sector and produces more than it can consume domestically. Although Chinese steel exports have been caught regularly in trade tensions, particularly with the United States, this is a relatively recent phenomenon as China’s steel boom was fundamentally driven by domestic demand and economic growth.

But all booms eventually peter out. And starting in 2013, China’s steel production has become divorced from overall economic growth and has plateaued at around 80,000 tons/year (see Figure 7). Even as China’s GDP has expanded by more than 25% since 2013, its total steel production and demand has barely budged. The main reason is because the key drivers of steel demand, the industrial and construction sectors, are no longer the main source of China’s economic growth. These sectors’ contribution to overall GDP growth has been declining since 2013 and is currently around 36%–the second-lowest level of contribution since 1978.

Figure 7. Steel Production Growth Now Lags GDP Growth
Source: NBS.

In fact, the experience of other countries undergoing economic transition suggests that the decline of the industrial and construction sectors is likely to continue, largely because China has entered a new stage in which services is expected to be the key engine of growth. Since 2012, the services, or tertiary, sector has accounted for more than half of China’s growth, and its share has been increasing every year since then (see Figure 8).

Figure 8. Secondary and Tertiary Sectors’ Contribution to China’s Growth
Source: NBS.

The declining position of industry in the Chinese economy doesn’t mean lessons from China’s steel industry are no longer pertinent. In fact, many of the challenges that beset the steel industry can be applied to the services sectors. Like steel, it appears that certain services in high demand, such as education and healthcare, are already experiencing shortages (see Figure 9).

Figure 9. Healthcare Inflation Significantly Higher than Overall CPI
Source: Wind.

Similar to steel, this current imbalance between domestic supply and demand is partially being met through imports—for example, Chinese students studying abroad in the case of education and the growing popularity of medical tourism in the case of healthcare. Addressing this scarcity in services depends on multiple factors, including the removal of certain price controls and discrimination against private suppliers—policies and barriers that once also constrained the steel industry.

Industrialization in China and the growth of the steel sector would not have been possible without sweeping reforms that created the conditions for that growth. The results are beyond what any central planner in the 1950s could have imagined. Now that China is indisputably a global industrial power, it may need to apply some of the same lessons and approaches to the services sector that made steel such a roaring success over the last forty years.