Trade Dispute Over Chinese Dumping Coated Paper

A New York Times page one story, “A Cry to Limit Chinese Imports Rings at a Troubled Paper Mill,” describes how the Chinese have been gaining market share in the coated paper, by allegedly dumping (selling below cost). Several things make this case unusual: first, likelihood that the Commerce Department will impose duties on Chinese paper which are permitted under WTO rules to counter dumping; second, that the US may also impose anti-subsidy duties. Typically, these duties are generally not sought because they are low and would have little economic impact. But in this case, they would double the cost of Chinese coated paper.

Now there are doubtless some readers who will see the proposed Department of Commerce intervention as protectionism, believing that “free markets” and “free trade” produce better outcomes for all. But predatory pricing, which drives competitors out of the market with the intent of giving the survivirs more pricing power, and government subsidies have long been recognized as anti-competitive and in the long run anti-consumer. The Bush Administration has never been sympathetic to unions, nor are the states where these mills are located big Republican strongholds, so there is no reason to regard the Commerce Department move as a sop to a Bush constituency.

The threat of coated paper duties, a shot across China’s bow, appears to be an effort to address the chronic US/Chinese trade imbalance. In addition to trying to get the Chinese to revalue the yuan (which has not been very successful; the Chinese are running a dirty float of their currency), the US is also starting to fight cases where the Chinese are subsidizing exports.

Why start with coated paper? The Times did not go through the economics (and in fairness, unless the Commerce Department made its data available, it would be difficult to develop independently), but even starting with some basic knowledge of the industry, the charge that the Chinese are giving illegal subsidies is quite plausible.

My limited knowledge of the industry comes from being a paper mill brat, specifically, a coated paper mill brat. My father, who got a masters in chemical engineering in a special pulp and paper program, ran coated paper machines, one of them in the Luke, MD mill profiled in the Times story, then start-ups and rebuilds of paper mills (he was eventually in charge of manufacturing for one of the large paper companies). My brother also works in a coated paper mill.

Why is it plausible that the Chinese are dumping? Coated paper is not only highly capital intensive, it is also very fussy manufacturing. Like other continuous process manufacturing (oil refining, steel), the single most important determinant of profit (aside, of course, from input costs and selling prices) is manufacturing up time, because the you can earn an adequate return on capital only if you run the machines 24 hours a day, 7 days a week. The only downtime is for scheduled maintenance (that is, unless you screw up).

What makes coated paper difficult is the coating process. The paper, made from pulp, is rolled thin on huge continuous sheets of mesh, then dried (this is a gross simplification, see here for more detail). But for coated paper (shiny paper, the sort you get in most magazines, catalogues, and in heavier weights, in photo stock and coffee table books). In the finishing stages, a coating is added, most commonly a clay compound. That is a very risky operation. If the paper breaks, you have to stop the entire process and then start up again. That is why coated paper is a vastly more difficult manufacturing process than newsprint.

Paper manufacture, and particularly coated paper manufacture, doesn’t fit the Chinese natural advantage of cheap labor. And having the newest machines doesn’t offer the advantages you might think it would. Older, narrower (in roll width) slower machines can be highly profitable if you run them on the most difficult kinds of paper, such as Bible paper (super thin) or very specialized photographic stock. On a very big fast machine, you’d have to run it uneconomically to produce those grades (either you’d have to run the machine slowly, or you’d have to change grades because a large machine would fill the market demand quickly, and changing grades is costly). So a manufacturer can successfully run older machines if he is clever about matching the grade of paper made to the machine’s capability and market demand. Speed and “newness” do not necessarily win the game.

And it’s an open question how well the Chinese operate these machines. Starting up a new mill is a complicated process. All the machinery is custom, inevitably something doesn’t work correctly and has to be retrofit. Shaking down the machines and training the workforce is a major undertaking. A single large machine costs well over $1 billion (note that’s just the paper machine, there is a lot of ancillary equipment and construction). A successful start-up takes 18 to 24 months and costs roughly 20% of the capital costs. A bad start-up is a sink hole. Men (they are all men) who can run start-ups successfully are a rare commodity in the industry. Query how the Chinese could have gotten enough (any?) to come to the hinterlands to run a start-up with a work force speaking an alien language.

So even if they bought the best equipment, it’s doubtful that the Chinese could have started them up and run them successfully enough to be undercutting the Americans as badly as they are (their prices for medium-graded coated paper are $800 a ton vs. the US price of $1000 a ton. And remember, you have to factor in shipping from China into the price too). Even with only kitchen-table knowledge of the industry I gleaned while growing up, it’s pretty obvious that the Chinese can’t be covering their true costs at that price.

From the New York Times story:

The problems of paper mills here and elsewhere around the country have become a test case for a possible new confrontation between the United States and China, which many industry officials and members of Congress hope could lead to new tariffs on imports not only of Chinese-made paper but also of steel, furniture, textiles and plastics.

In coming weeks, the Commerce Department is expected to decide whether to impose duties on high-gloss paper known as “coated paper” — the kind made here in Luke — that is imported from China. Many trade specialists in Congress and in the industry expect it to do so. Indeed, China has gone to court to block the decision in advance.

If imposed, the duties would set an important precedent, reversing 20 years of settled American trade policy in which the United States refrained from making accusations that “nonmarket economies” like China were granting illegal subsidies. In its court case, China argues that changing that policy without legislation or a full regulatory hearing would be illegal.

The Bush administration’s decision to face the issue of subsidies comes at a time of mounting pressure by Congress for a tougher stance on trade. With the American trade gap with China widening to a record $232.5 billion last year — roughly one-third of the entire deficit — Democrats say that if the Commerce Department does not act, they will pass legislation forcing its hand.

Many lawmakers say it is time to stop treating China with kid gloves, arguing that Beijing no longer deserves a free ride in which it benefits from a special exemption generally forbidden to Japan, Europe and other advanced industrial powers.

“I’m glad the administration is finally doing something,” said Representative Sander M. Levin, a Michigan Democrat and chairman of the trade subcommittee of the House Ways and Means Committee. “They are beginning to recognize that there was an election last year.”

The travails of the Luke mill are similar to those of other aging factories. But the NewPage Corporation, the company that owns the plant and is the largest producer of the high-quality paper, argues that it has hardly stood still in the face of foreign competition.

Mr. Graham, the production manager, whose grandfather helped pour concrete for the mill’s old 600-foot smokestack, points out that in seven years, the mill has invested hundreds of millions of dollars in labor-saving computerized equipment while reducing its work force to 1,000 from 1,500 and increasing its output by a third….

Although Chinese companies also use modern equipment, NewPage maintains that their real advantage results from subsidies. They include government grants for modernization, low-cost loans, debt forgiveness, tax breaks for export-oriented companies and subsidies for suppliers of wood and pulp.

China’s market share in coated paper is still small, but rather than wait until Chinese producers dominate the business — as they have in things like toys and underwear — the paper mill’s backers are hoping to block what they see as unfair competition before it is too late.

The involvement of NewPage in the Commerce Department’s strategy was not accidental. Last year the department quietly informed critics of China’s trade policies that it would be willing to review its longstanding policy of not challenging Chinese subsidies as illegal if they could come up with a clear-cut case.

Lawyers for NewPage say that Chinese producers charge $800 for a midgrade roll of paper, compared with the $1,000 the American company charges. The price differential alone does not prove the case, but it has enabled Chinese producers to increase their share of the American market from less than 1 percent in 2000 to 5.4 percent last year, the company says.

Under the complicated rules of trade, countries may impose tariffs in two situations: if an import is deemed to have been “dumped,” or sold below cost; or if certain illegal subsidies were involved.

The first category of tariffs — to guard against dumping — are imposed, threatened, disputed, retaliated against and ultimately negotiated all the time. The United States and China have frequently accused each other of dumping, and antidumping tariffs are being contemplated in the coated-paper case.

What makes this case significant, however, is that the department announced last November that it was also investigating whether to seek duties above and beyond those, to punish China for illegal subsidies.

Antidumping duties are often low. But if antisubsidy duties are imposed, they could double the price of Chinese paper, eliminating it from the market entirely, lawyers for the Chinese government say.

The Commerce Department is expected to announce its decision by April 2. The argument for changing the policy is that China has become a major aggressive player on the world economic stage, and that a policy forged when Beijing was just beginning to move away from communism — and its subsidies barely produced a ripple — is out of date.

Franklin L. Lavin, the under secretary of commerce for international trade, said that he could not comment on the merits of the case, but that politics did not play a role in the decision to investigate.

“Look at the timeline,” he said. “This was not a response to the midterm elections or to politics. It’s a response to the fact that the China of today is very different from the China of 15 years ago.”

Lawyers handling the case for the Chinese government and for several Chinese companies say these subsidies are in effect being counted twice in the investigation of antidumping and antisubsidy actions.

“The fear is that this case is going to be exploited by industry after industry,” said William H. Barringer, a partner at Vinson & Elkins, which represents the Chinese government on the issue. “The first people in the door will be steel. If this is upheld, China will be overwhelmed having to defend all these cases.”

If China loses the case, it has the option of pursuing two kinds of appeals: one with the United States Courts of Appeals and the other with the World Trade Organization in Geneva. The lawyers for China say that Beijing would pursue these appeals rather than engage in any retaliatory tariffs on American goods.

Many experts see the coated-paper case as one of three recent administration moves to raise pressure on China and to try to pre-empt Congress, forestalling legislation that might dictate trade policy and possibly nullify past trade accords with China and other countries.

The other two were a February announcement by the United States trade representative, Susan C. Schwab, that the United States would challenge Chinese subsidies at the World Trade Organization in Geneva, and a parallel threat to seek relief at the trade organization if China did not do more to crack down on piracy and counterfeit goods.

The administration’s tougher stance also comes at a time of little progress in the so-called strategic economic dialogue with China, begun with great fanfare last fall by Treasury Secretary Henry M. Paulson Jr.

“It’s clear these steps are intended to slake Congressional appetites and avert legislation that would put President Bush in a bind,” said Gary C. Hufbauer, a senior fellow and trade expert at the Peter G. Peterson Institute for International Economics in Washington. “It’s also designed to give some heft to the ‘strategic economic dialogue.’ ”

Some in Congress also see the China actions as a sign that Mr. Paulson, who resigned as chief executive of Goldman Sachs to become Treasury secretary last summer, realizes that his policy toward Beijing is faltering. A main focus has been a failed effort to persuade China to stop interfering with its currency levels in a way aimed at promoting exports.

“When Paulson came in, he thought all you have to do is talk logic with the Chinese,” said Senator Charles E. Schumer, Democrat of New York and a vociferous critic of China. “They talked very nicely and gave him ice in the winter. Now he’s learning that you have to be tougher. It’s not like doing a deal with Goldman Sachs.”

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