Economics of steel production

Robert Miller, in his article “The Changing Economics of Steel” (Finance & Development, June 1991), did a fine job of surveying the changes that have occurred in the steel industry and suggesting various scenarios for future technological development. He, however, failed to consider two factors affecting the economics of steel production: the excess in global steel-making capacity and the need to protect the environment.

For many years, steel has been a sacred cow of industrial policy, both in developing and industrialized countries. For many policymakers, the existence of a domestic steel industry has been symbolic of industrial development itself. The historical intoxication with steel-making has led to vast oversupply of medium-and low-grade steel. As a result, many countries have resorted to production and export subsidies, and market protection measures to prop up uneconomic industries, and to maintain steel industry employment levels. [Examples may be found in the OECD, Comecon, and the developing world.]

Moreover, I find it disturbing that an article of this nature could totally avoid discussion of environmental concerns. As Mr. Miller states, investing in steel-making facilities is costly. However, adequate pollution control technology to protect the local and global environment adds a significant additional financial burden. Unfortunately, as experience reveals, environmental protection is usually the first casualty of tight budgets in developing countries. We need only look to Eastern Europe or Latin America for examples of that.

In closing, I would like to suggest that persons concerned with the distribution of international aid should consider whether it is wise to support capital investment that provides minimal employment, pollutes the environment, and soaks up scarce capital resources. Further, such investments will require future subsidies and most likely result in a scale of operations in excess of national or regional needs.

Peter Wieczorowski Steel Manufacturers Association Washington, DC

Environmental accounting

The article by Ernst Lutz and Mohan Munasinghe, “Accounting for the Environment,” (Finance & Development, March 1991) provides valuable insights regarding appropriate adjustments to the national accounts to adequately reflect environmental factors not captured by conventional GDP accounting. Some specific points require clarification or refinement, however.

The authors correctly note that environmental cleanup costs incurred by the public sector are considered as productive contributions to national output, but it is not necessarily the case that similar expenditures are netted out of final value added if incurred by private firms. Private firm expenditures on preventive measures, such as scrubbers, or on cleanup efforts to restore damaged environments represent payments to factors of production and are included in GDI and GDP.

Such expenses may not increase output of marketable goods and services, but for competitive industries these costs will be passed on to consumers in the form of higher prices. Only in the unlikely event that environmental protection costs are fully absorbed in reduced profits would such private firm expenditures not be reflected in nominal GDP figures.

It is quite proper, as the authors indicate, to deduct imputed charges for natural resource depletion and costs of environmental degradation from GDP to arrive at an environmentally adjusted net domestic product (EDP), and to then deduct environmental protection expenditures to arrive at an environmentally adjusted net income (ENI). Actual expenditures, whether incurred by governments, firms, or households, do show up in nominal GDP statistics, and adjustments, therefore are appropriate.

Finally, it is understandable that the authors do not include adjustments for natural disasters and naturally occurring erosion, presumably on the grounds that measures of our aggregate “success” should not penalize us for events beyond human control. However, one might argue for inclusion of such factors in EDP calculations, both because they do represent real reductions in human welfare and also because they are related to productive activities, in that prudent public or private sector investments can reduce the probable adverse social consequences of such natural disasters. These adjustments would enable the “benefits” from such expensive investments to be reflected indirectly in the national accounts.

James Hanson Willamette University Salem, Oregon, USA

And another view …

The article by Ernst Lutz and Mohan Munasinghe presents the general discussions well, but fails to mention some crucial points. The statements in question are the following:

1) GDP does not account for the consumption of natural resources.

The statement is correct. The assertion that natural resources are not at all included in the balance sheets of the national accounts is not. The national accounts consist of two parts, one portraying the production cycle and arriving at GDP, the other describing changes in value of capital assets. The system requires the depletion of natural resources to be recorded in the latter part—the reconciliation accounts.

Thus, the EDP is not primarily aimed at creating a broader system, but rather is concerned with the structural question of whether the depreciation of resources should be transferred from the reconciliation account to the income formation account.

2) In accordance with Hicks’ generally accepted theory, this consumption should be included in income calculation.

Here, again, the argument is initially correct. This procedure is used in the profit and loss accounts of enterprises. An oil company which possesses oil fields depreciates them by the amount of oil it has extracted from them, thus adjusting its profit. This does not mean, however, that the same system is applicable to the national accounts. The accounts used in calculating the GDP describe the national production cycle. They account for the use of the goods produced during a certain period. Thus, only such goods which have previously appeared in the form of a produced value will be depreciated. Natural resources are by definition not results of human activity. To include their depreciation in income calculations would wreak havoc on the system.

3) The EDP corrects this error.

The concept that one can depreciate something not previously recorded as a value contains a logical error. A sound accounting system can depreciate only such capital assets as have previously been activated in the form of an investment. The EDP concept currently supported by the United Nations ignores this and is, therefore, theoretically flawed.

4) By basing itself on the EDP rather than on the GDP, economic policy is forced to take natural resources into account in the decision-making process.

Good environmental policy cannot be derived from pure economics any more than it has proved possible to identify educational or social policies with the once popular term “human capital.”

Professor U.P. Reich Rheinland-Pfalz, Germany