Horizon Advisory - Footholds and Friction

Actionable Geopolitical Insight

October 2021

HORIZON ADVISORY

HORIZON ADVISORY

FOOTHOLDS & FRICTION China’s European Steel Front

HORIZON ADVISORY Horizon Advisory, an independent strategic consultancy, helps businesses, investors, and government actors understand and respond to geopolitical, economic, and technological change.

HORIZON ADVISORY

Table of CONTENTS

Introduction

1

Battleground Europe

3

Transferring Excess Capacity

7

China’s Circumvention Playbook 13 A Growing European Footprint

16

Conclusion

21

Disclaimer: The mention of any individual, company, organization, or other entity in this report does not imply the violation of any law or international agreement and should not be construed as such.

HORIZON ADVISORY

ABOUT

HORIZON ADVISORY

Horizon Advisory

Horizon Advisory brings a new approach and unparalleled sources and methods to understanding geopolitics. Horizon Advisory was formed with the mission of analyzing Chinese industrial strategy and implications for critical security and economic competitions.

Decision-makers across sectors – national security leaders, stakeholders from the private sector, investors – face uncertainty associated with geopolitical, technological, and economic changes activated or impacted by China. Leveraging unprecedented primary sources, we apply updated strategic frameworks and novel analysis techniques to generate differentiated insights for clients including businesses, investors, and governments grappling with uncertainties.

HORIZON ADVISORY

Introduction The Biden Administration’s Build Back Better agenda has energized domestic debates about infrastructure investments and US productive capabilities in critical manufacturing sectors.

Serious consideration and action on these fronts are necessary: US infrastructure and production are critical not only for economic development, but also for addressing and competing with the Chinese Communist Party’s (CCP’s) non-market industrial policy. That industrial policy, the primary mechanism through which Beijing pursues its global project, poses grave economic and security risks that are only now being fully recognized.

The CCP is increasingly confident in its state-led system, the leverage it has developed over global commerce and industry, and the Chinese market’s ability to shape the “international cycle” – to leverage China’s industrial capacity to control global supply, prices, and markets. This confidence fuels growing aggression. Across key sectors of the economy, Beijing is adopting a more forceful industrial policy, both in terms of targeted geographies and tools deployed. Over the past decades, China has secured key trade, investment, and industrial footholds abroad. Now, China is using those to export its distortive approach to markets. This allows China to shape and distort global markets indirectly, through outside proxies, rather than just directly, through Chinese players. In doing so, Beijing is able to flout US defenses against China’s non-market behavior.

The steel sector presents a prime example of China’s industrial proxy wars, and one with important industrial and national security implications. Steel is a core input for the physical infrastructure, auto industry, and military modernization and hardening that are critical for US economic and national security, as well as pillars of the US approach to post-COVID recovery. Chinese sources emphasize the role of the steel industry as a foundational input into the basket of other industrial priorities of the CCP. As an article in Caijing put it in 2015: “Iron and steel are still the most important part of the development of the national economy.”1Accordingly, Beijing’s industrial policy targets control over the international steel sector – control that in turn promises influence over the supply chains built on it. Beijing pursues as much not only by propping up its domestic production but also by cementing influence in and access to foreign markets, making them conduits for the CCP’s agenda and, concretely, Chinese exports and broader market distortions.

Over the past three decades, China has leveraged non-market programs and policies to dominate the global steel industry. In 1996, China overtook Japan to become the world’s leading steel producer. China’s steel production in 2017 amounted to more than the rest of the world combined.

Steel is a fundamental building block for economic development. Consolidation of production at the hand of an authoritarian strategic competitor of the United States poses grave risks to our national security, our economic competitiveness, and the environment. Increasingly aware of this

1

“钢铁工业产能严重过剩 一带一路为走出去带来机遇 [Severe overcapacity in the iron and steel industry, the Belt and Road Initiative brings opportunities for going global],” Caijing, September 28, 2015.

1

HORIZON ADVISORY

risk, the US has responded with defensive legal mechanisms, like tariffs, targeted at China’s steel industry and designed to offset the non-market means propping it up.

Those defensive means focus on China itself. But China’s outsized presence – and market distortions – in the steel industry extend well beyond its national borders. Over the past decades, and especially since the financial crisis of 2008, Beijing has prioritized and supported the internationalization, or “Go Out,” of its steel industry. This effort is designed to build footholds in global markets and value chains, as well as to export excess capacity. As a result, non-Chinese markets end up avenues for China’s larger distortive approach in – and bid for control over – the steel industry. Beijing has also developed an arsenal of measures (e.g., localization, third-country re-export) designed to circumvent foreign trade enforcement, allowing it to flood markets that might at first glance appear protected against China’s non-market approach.

Chinese engagement with the European steel sector offers a ripe example – and also a ripe avenue through which China can influence US steel markets. Chinese investment has targeted European steel production for over a decade. More recently, China has escalated its approach, shifting from minority investments and joint ventures to outright acquisitions of production hubs and influence over downstream processing. In addition, Chinese sources describe, and Chinese companies advertise, mechanisms through which to evade European countries’ existing trade enforcement regimes. This approach takes advantage of a less robust European response to China’s steel distortions vis-à-vis the United States. This approach also threatens European countries’ industrial bases and long-term manufacturing prospects.

Moreover, China’s engagement with the European steel industry threatens those countries trading, partnering, competing with, and otherwise impacted by European steel operations, including the United States. Chinese encroachment into the European steel sector provides Beijing a beachhead from which to influence global prices and to reach the world’s developed markets and high-value add segments, including in the United States. For example, supply agreements secured through investments, joint ventures, or acquisitions in Europe lock in a role for Chinese steel in critical supply chains that stretch across the world.

China’s encroachment in Europe – and Europe’s failure to seriously address its impact both at home and on other nations – compound the challenge as the United States seeks to respond to China’s market distortions: Traditional US trade remedies have not been updated for China’s global presence and the exported non-market behaviors that result. China’s threat to the global trading system is international. Its attacks the US domestic market from multiple fronts.

The United States may have a once-in-a-generation opportunity to stabilize and revitalize its domestic production capability. But US investment risks missing that opportunity if it fails to recognize the international presence Beijing has developed and is now leveraging. Europe stands as a crucial battleground. In it, US policy must be delicate but unambiguous. The global trading system needs rules and enforcement to guarantee its survival. So does Europe itself. Chinese rule breaking behaviors cannot be tolerated, even if those are entering the global trading system indirectly.

2

HORIZON ADVISORY

Battleground Europe Europe’s market size and deep economic engagement with the United States combine to make it a priority target for Beijing, as well as the strategic and physical terminus of a revitalized and reimagined Silk Road. Wang Xiangsui, a retired senior Colonel in the People's Liberation Army (PLA) and professor at China’s Beihang University, frames the opportunity of investment and partnering in Europe bluntly: “Building a network between Europe and the [Chinese] Mainland will change the status quo for China … Europe and Asia together will pose a strategic danger to the United States, because such a composition will outweigh the United States economically and, finally, militarily.”2 Chinese Overseas Direct Investment into Europe, 2003-2020 (USD mn)3

That strategic framing is borne out in Chinese industrial policy that prioritizes Europe, and, especially, European manufacturing. For China, European manufacturing provides access to key resources, including advanced manufacturing capabilities and technology. Footholds in European manufacturing also provide access to positions of leverage in key international supply chains, including those of the United States.

2

Wang Xiangsui, 三居其一:未来世界的中国定位 [Three in One: Positioning China for the Future World] (Beijing: Changjiang Literature and Art Publishing House, 2017), page 102.

3 PRC Ministry of Commerce.

3

HORIZON ADVISORY

Trends in China’s overseas direct investment in Europe, both overall and manufacturing-specific, bear this point out. China’s manufacturing investment in Europe spiked in 2016 after steady growth since 2008 and appears to remain at elevated levels. China’s emphasis on European manufacturing is also borne out in Chinese industrial discourse that gauges the suitability of overseas production facilities in emerging markets based on their preferential treatment under European trade laws and unfettered access to other European markets.4 Chinese Overseas Direct Investment in Manufacturing, 2003-2020 (USD mn)5

Unsurprisingly, this broad emphasis on European manufacturing applies also to steel, a – if not the – critical upstream input into the core manufacturing industries that Beijing prioritizes. Over the past two decades, Beijing has pushed its steel companies to internationalize, under the umbrella of both the “Go Out” national strategy and the “One Belt, One Road” plan.6 In many cases, that internationalization has been directed toward Europe. A 2019 article in China Steel about the launch of State-owned China Baosteel’s Research and Development (R&D) center in Germany notes that Europe – as a source of technology, talents, and markets – is core to China’s “steel technology development.” The article also describes Europe as a relatively easy target for the Chinese steel industry: Europe has the three major elements of international leading technology, talents, and market (users), and has always been at the forefront of steel technology development and a highland of talents. With the advancement of the "One Belt, One Road" initiative, Europe is increasingly open to China.7 4

China Industrial Textile Industry Association, “进军欧美市场, 埃塞俄比亚是跳板 [Entering European and American Markets, Ethiopia Is a Springboard],” Textile Weekly, 2017.

5 PRC Ministry of Commerce.

6 “‘走出去’化解钢铁行业产能过剩问题研究 [‘Going out’ to resolve the problem of overcapacity in the iron and steel industry],” Hebei University Journal of Economics and Business, Issue 2, 2018.

7 “The European R&D Center of Baosteel Group, the largest steel company in China, was established in Munich, Germany,” China Steel News, June 12, 2019, https://www.xianjichina.com/special/detail_434691.html.

4

5000.000

HORIZON ADVISORY

4000.000

Concrete resource allocations align with this argument and suggest an increasingly aggressive Chinese approach to the European steel ecosystem. In the early 2000s, China’s engagements with the European steel sector revolved around joint ventures and investments into processing facilities.

Recently a more forceful approach has emerged: Over the past five years, Chinese players have begun to acquire, outright, European steelmaking facilities – while continuing to expand investment, ownership, and financing of processing facilities. And these are the same Chinese players that have decimated their overseas competition by swamping the global market with the productive overcapacity derived from its government-backed steel production.

3000.000

2000.000

1000.000

Chinese Overseas Direct Investment in EU by Sector, 2003-2020 (USD mn)8

Manufacturing CN: Outward Investment: EU: Manufacturing Construction CN: Outward Investment: EU: Constructi on Financial Intermediation CN: Outward Investment: EU: Financial

Intermediation Estate IT CN: Outward Investment: EU: Information Transmission, Software and Information Technology Service Wholesale and Retail Trade CN: Outward Investment: EU: Whol esale and Retail Trade CN: Outward Investment: EU: Electricity, Gas & Water Production and Supply Electricity, Gas, Water Education CN: Outward Investment: EU: Education Real CN:Estate Outward Investment: EU: Real

There are both strategic and tactical reasons for this emphasis on European manufacturing, and steel in particular. Strategically, Beijing recognizes that key international industry chains rest on European production (e.g., Germany and the automotive sector). If Beijing can claim the upstream foundations of those, it can influence – and benefit from – the entire downstream value chain. It can shape the industrial layout. As a Hebei Daily article on a Hesteel/HBIS acquisition of a Serbian steel mill put it, “at present, the world economy is in a new stage of globalized industrial division of labor and layout adjustment. Whoever can Go Out earlier is likely to have a broader space for development and a brighter future.”9 Or, per a 2018 article in the Hebei University Journal of Economics and Business, “the Go Out of China’s steel production capacity…is an important link for the steel industry to enter the high-end global value chain.”10 8

PRC Ministry of Commerce. “让’走出去’的步伐更坚定: 坚决去、主动调、加快转系列谈之三 [Make the pace of ‘Go Out’ firmer: go resolutely, actively adjust, and speed up the third series of talks],” Hebei Daily, August 27, 2018.

10 Ibid.

9

5

20 18

20 17

20 17

20 16

20 16

20 15

20 15

20 14

20 14

20 13

20 13

20 12

20 12

20 11

20 11

20 10

20 10

20 09

20 09

20 08

20 08

20 07

0.000

HORIZON ADVISORY

More tactically, China sees oversees investment as a way to transfer its overcapacity in the steel industry: To export overcapacity without facing trade barriers, cement positions in overseas industry chains and enduring cost advantages in them and claim downstream capacity that promises vertically integrate value chains.

Over recent years, Beijing has found itself faced with US trade mechanisms designed to offset its non-market support for its manufacturing, and especially steel, industry. For example, in 2016 the United States applied a series of duties on Chinese steel imports. 11 These moves largely shut Chinese steel out of the US market five years ago – when that steel was directly traded. As a result, non-US developed markets which did not deploy the same trade enforcement tools, became more attractive destinations for Chinese steel overcapacity, fueling distortion within them.

11

See, for example, the US International Trade Commission investigation of “Corrosion-Resistant Steel Products from China, India, Italy, Korea, and Taiwan,” https://www.usitc.gov/investigations/701731/2016/corrosion_resistant_steel_products_china_india/final.htm.

6

HORIZON ADVISORY

Transferring Excess Capacity Due to subsidies and other forms of government support, China produces, and exports, far more steel than it, or the world, needs. This overcapacity has forced international steel prices down, wreaking havoc on production and markets internationally. But despite hefty international pushback, Beijing has not addressed the problem.

Chinese Steel Production (Crude [Blue] and Product [Red]), 1997-2020 (ton th)12 1400000.000

1200000.000

1000000.000

800000.000

600000.000

400000.000

200000.000

20 20

20 19

20 18

20 16

20 15

20 14

20 12

20 11

20 10

20 08

20 07

20 06

20 04

20 03

20 02

20 00

19 99

19 98

19 96

19 95

19 94

19 92

19 91

19 90

19 88

19 87

19 86

19 84

19 83

19 82

19 80

0.000

Instead, Beijing has sought to address the international pushback by internationalizing its steel industry, overcapacity, and distortions. Europe has been a primary target for that internationalization. Doing so allows China to evade global pushback against China’s steel overcapacity; to capture new markets; and to capture new, downstream nodes within the steel industry. A 2018 article in the Hebei University Journal of Economics and Business put the logic in simple terms: “Going Out is one of the main ways to address overcapacity.” 13 That article explains this Go Out approach along a series of axes:

12

China Steel Industry Association. “走出去”化解钢铁行业产能过剩问题研究 [‘Going out’ to resolve the problem of overcapacity in the iron and steel industry],” Hebei University Journal of Economics and Business, Issue 2, 2018.

13

7

HORIZON ADVISORY

• • •

First, China can literally export overcapacity, flooding international markets with its subsidized steel to compensate for the insufficient demand at home. (“Some steel companies ‘Go Out’ in the face of domestic overcapacity, looking for demand in markets abroad.”)

Second, Chinese companies can establish production bases overseas, therefore evading international defenses against Chinese overcapacity while using proximity to lock in new international markets.

Third, Chinese companies can invest in downstream capacity overseas, largely through cross-border mergers and acquisitions (M&A) in more developed economies. These investments allow China to climb up the value chain and build vertically integrated monopolies that effectively leapfrog existing restrictions against Chinese overcapacity.

The article also explains that this Go Out approach constitutes a direct response to US trade remedies: “Foreign ‘anti-dumping’ investigations are forcing China into international cooperation in steel production capacity. Simply exporting steel products is likely to cause foreign trade frictions.”

This logic is borne out in official Chinese government discourse. A 2012 Central Economic Work Conference session devised a four batch, or segment, division of the steel industry in China. One segment was to be digested, or used at home. A second batch would be “integrated through mergers and reorganizations,” or, put otherwise, integrated into global value chains through cross-border investments and acquisitions. A third batch would be eliminated. And a fourth bath would be “transferred overseas,” through the accelerated “implementation of the Go Out strategy.”14 Two years later, in 2014, then-Premier Li Keqiang suggested that Chinese domestic iron, steel, cement, and glass “advantageous production” be transferred overseas through “investment, loans, and other methods.” Thereafter, China’s largest steel producing region promised that it would transfer 5 million tons of its excess capacity overseas by 2017, and 200 million tons by 2023.15 In a 2019 article, the director of the China Iron and Steel Association implored that the domestic industry must “accelerate the implementation of the ‘going out’ strategy and transfer one batch overseas.”16 The logic has also played out concretely in Europe. First, in direct overcapacity transfer, or exports: Consistently over the past decade, the European Union has imported significantly more steel from China than has the United States.17 Those imports jumped after US trade case investigations led to 14

“钢铁产能过剩分析 [Analysis of steel overcapacity],” September 28, 2019. https://www.wenmi.com/article/pyihgz02lasr.html 15 "中国钢铁产能能转移出去吗 [Can China's steel production capacity be transferred?]," Sina Finance, December 16, 2014.

16 “钢铁产能过剩分析 [Analysis of steel overcapacity],” September 28, 2019. https://www.wenmi.com/article/pyihgz02lasr.html 17 This idea of tariff circumvention is not just hypothetical in the case of China’s steel trade with Europe. Chinese steel companies actively export to Europe, and have for some time. A 2013 piece in Sohu News reports that “250 tons of automotive steel from Tanggang Stainless Steel Company of Hebei Iron and Steel Group was successfully rolled off the production line and exported to European customers.” (“河北钢铁唐钢不锈钢公司汽车钢出口欧洲 [Hebei Iron and Steel Tanggang Stainless Steel Co., Ltd. exports automotive steel to Europe],” Sohu News, November 22, 2013.) A 2016 article in East Money covers the preparation of a 4,850 tons order of “special steel” from Nanjing Iron and Steel, bound for Europe. The article explains that this order marked “four firsts for Nanjing Iron and Steel: the first set of orders for special steel round bars with a volume of more than 1,000 tons, the first export of round steel with a diameter of under 210mm, and the first large-scale export to European countries with

8

HORIZON ADVISORY

a series of duties in 2015 and 2016. This suggests that – as the United States implements trade remedies to respond to Beijing’s non-market practices – China turns to the EU as an alternative.

This logic is explicitly laid out in guidance offered by the Shenzhen Shengbao International Freight Forwarding, a Chinese company that facilitates evasion of US tariffs and other trade remedies: Expand the market: to fight a trade war is to restrict market access and increase tariffs. As we are currently only engaged in a trade war with the United States, we should expand our other markets. The world is so big. For example, Europe is a foreign trade acceptance area for high-end products, and South Asia, Africa, Latin America and other places constitute emerging third world markets. Therefore, we must seize new opportunities and continue to develop our new markets to reduce our dependence on the United States.18 As a result, the Chinese steel market distortions against which US has enacted trade remedies find themselves warping the EU market. As long as that is the case, US-EU steel trade will be shaped

by Chinese non-market forces.

higher quality requirements, and the first time that European standards required the production of special steel lengths material.” (“2016 年 7 月 20 日，特钢事业部与国贸公司欧洲联合办接单的 4850 吨特殊钢圆钢在 [On July 20, 2016, the Special Steel Business Unit and China World Trade Corporation Europe jointly organized an order for 4850 tons of special steel round bars],” East Money, July 25, 2016.)

18 "中美贸易战解决方案,升宝转口贸易合理规避美国高关税 [The solution to the Sino-US trade war, Shengbao's re-export trade reasonably avoids high U.S. tariffs]," Re-Export Industry Information, November 13, 2019.

9

HORIZON ADVISORY

US, EU, and China trade of semi-finished iron or non-alloy steel, 2010-2020 900000 800000 700000

Kg (000s)

600000 500000 400000 300000 200000 100000 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 US imports from China

EU imports from China

US imports from EU

Second, in production bases overseas: In 2016, China’s Hebei Iron and Steel Group (HBIS) acquired the Železara steel mill in Smederevo from the Serbian government. Chinese sources touted this acquisition its positioning in Europe and the corresponding protection it offered against trade remedies: “Importantly,” reads an article in China’s Southern Weekend, “through operations in Serbia, HBIS can avoid the impact of European trade protection measures such as "anti-dumping and countervailing" on China's steel industry.”19 “This is part of China’s broader efforts to expand its influence and enter the European market” summarized another Chinese article at the time. A Serbian analyst echoed the point, “China does not need a Serbian plant … I think this is for entering the market and complicating the positions of the United States and Russia.”20 Serbia might not be in the European Union itself. But its presence on the European continent, and close ties to EU, make it a ripe foothold through which China can penetrate the EU market – and, in turn, that of the world.

In addition to helping circumvent trade remedies, overseas production bases also allow China even more aggressively to underprice competitors, and to do so in an enduring fashion. Overseas bases increase proximity to downstream consumers, reducing transit costs and logistical complexities.

That, in turn, provides the option for Chinese companies to capture the global steel market in the long-term – even should Beijing lessen its state backing of steel production. This logic was clearly explained as early as 2006, when Chinese industry observers contextualized early overseas investments of Chinese steel companies:

19

Zhang Xi, “Global steel surplus, the Chinese steel company is still buying and buying overseas,” Southern Weekend, April 21, 2016, http://static.nfapp.southcn.com/content/201604/21/c72110.html.

20 “Serbia's rundown steel plant was rescued by a Chinese company and was sold for $1,” Reference News Network, July 17, 2016, https://baijiahao.baidu.com/s?id=1573044915534600&wfr=spider&for=pc.

10

HORIZON ADVISORY

Experts in the steel industry believe that with the increase in shipping costs and fuel surcharges and other related expenses, steel products will inevitably face huge cost pressures in long-distance transportation. At the same time, experts believe that the export of domestic steel products has already had an impact on the international steel market … some steel companies in China chose to invest overseas to establish steel production and sales networks, which will help domestic steel companies in their long-term development.21 Third, investments in overseas downstream capacity: In 2011, China’s Baosteel invested in NSM Steel, a small steel processing and shearing company in Italy. The investment invigorated NSM and granted it a strategic partner that could provide a reliable upstream supply, at competitive costs. NSM’s high-profile clients in the automotive industry include Alfa Romeo, Fiat, and Maserati. Coverage in Chinese press emphasized that this deal would lock in a supply relationship, explaining that though Baosteel Italy’s products were imported from great distance, deals like the NSM position would guarantee that “European customers can enjoy the same affordable and convenient service as the local steel mills.”22 NSM imports its steel from Baosteel’s mills in China. Baosteel benefits in terms of revenue, resistant to anti-dumping campaigns. Baosteel also benefits in terms of market access. Through NSM, Baosteel can compete against and overtake Italian and other European mill competitors that lack the cost and coordination advantages of a Chinese-supported steel giant’s value chain.

This lays the foundation for Chinese sell to lock in a keystone position in the European auto supply chain. This also lays the foundations for Chinese steel to penetrate the US auto supply chain. NSM benefits indirectly from China’s industrial policy and subsidization. It is not subject to the trade remedies that direct beneficiaries of that subsidization face. As a result, NSM stands positioned to underprice competitors in the US market. Accordingly, NSM appears to ship to customers ranging from Tesla in California to Schaeffler Transmissions in South Carolina.

Finally, the Chinese government backs not only domestic steel production, but also the internationalization of the Chinese steel industry. In 2016 the People’s Bank of China enacted a set of measures meant to steer policy and financial development institutions in China toward increased “financial support for qualified steel and coal enterprises in international production capacity cooperation through syndicated loans, export credits, and project financing.”23 The Hebei University article notes that: “The policy incentives of the Chinese government have promoted the transfer of steel production capacity overseas.”

That support has yielded dividends, including a string of acquisitions across Europe and strategic partnerships along every step of Europe’s steel processing value chain: For example, the Jingye Group’s 2020 acquisition of UK and Dutch assets of British Steel; Hebei Iron and 21

“Baosteel 200,000 euros to build plants in Europe, domestic steel companies have aimed at overseas,” Beijing Business Daily, September 25, 2006, http://www.dzwww.com/caijing/cybd/200609/t20060925_1775308.htm.

22 “To the most discerning customers: Baosteel Europe's overseas development road,” Sohu, October 22, 2011, http://roll.sohu.com/20111022/n323024539.shtml.

23 “Alleviate domestic overproduction, China will transfer excess steel and coal overseas,” April 22, 2016.

11

HORIZON ADVISORY

Steel Group’s 2016 acquisition of the Železara steel mill in Smederevo, Serbia; and Baosteel’s research and development center in Germany. The result: substantial elements of the European steel industry have been vertically integrated into the PRC’s steel companies guaranteeing offtake for PRC semi-finished and finished steel and unfettered access to western nations’ commercial and government procurement markets.

12

HORIZON ADVISORY

China’s Circumvention Playbook Beijing has also developed and honed schemes to circumvent what measures Europe – and the US – have enacted against China’s non-market practices in the steel industry. As an article in the Hebei University Journal of Economics and Business on overcapacity in the steel sector puts it: “From the perspective of ‘going out’ countermeasures, most academic circles believe that it is necessary to form a multi-angle and all-round ‘joint force’ consisting of enterprises, governments, finance, and intermediaries.” Such discourse, and resource allocations reflecting it, have increased alongside geopolitical tensions with the US as well as US tariffs and other trade remedies intended to offset China’s non-market measures.

China’s schemes revolve around localization (当地化), transshipment (转运), and third country re-export (三国转口) in and through areas that do not maintain strong trade enforcement tools, and might even receive preferential treatment from the US. These mechanisms allow Chinese steel to evade European duties even in cases where the downstream steel product is fabricated from PRC-produced steel. Thanks to trade between the US and Europe, these mechanisms also allow Chinese steel to enter the US. Market.

• • •

Localization refers to the construction or acquisition of facilities abroad that allow Chinese companies to export goods while benefiting from the host country’s trade status, regardless of the source of upstream inputs; Transshipment refers to the export of a product to one country by way of another country, all on one bill of lading; and Third country re-export refers to the export of a product to one country by way of another via more than one bill of lading (e.g., the exporter arranges the sale through a middle-man).

Localization A 2011 article in the Journal of Party and Government Cadres explains that Chinese companies invest overseas – establishing local footholds in third countries – in order to “bypass tariff and non-tariff barriers of importing countries” while increasing material and technological resources.24 In addition, the Chinese government also sets up dedicated industrial parks abroad designed to serve as localization footholds through which to access the US, and other more protected markets.

24

Zhang Baiying, Wang Lina, “后危机时代美国贸易保护主义的应对之策 [Countermeasures of American trade protectionism in the post-crisis era],” Journal of Party and Government Cadres, July 16, 2011.

13

HORIZON ADVISORY

This localization approach explicitly targets the European market. Chinese industrial discourse consistently gauges the suitability of overseas production facilities in emerging markets based on their preferential treatment under European trade laws and unfettered access to European markets.25 And HBIS’s acquisition the Železara steel mill in Smederevo, Serbia offers a concrete example of China’s localization approach playing out on the European continent.

The localization can be applied in a number of ways in the steel sector. Slab re-rolling in overseas processing facilities provides an example of a path by which Chinese players might retain the highest value and job producing segments of the sector while using localization to evade trade remedies. Ninety percent of the cost of a finished hot rolled steel product lies in the original, raw steel slab.26 And, without specific rules, a Chinese-owned or -invested outpost anywhere in the world could re-roll semi-finished steel shipped from China, then export the semi-processed steel to the US as if it had been manufactured locally. Were Chinese players to segment their processes along these dimensions, they would gain beneficial treatment in the global trading system (i.e., duty-free treatment or “national treatment” in government procurements) while preserving core functions and values for the Chinese market and companies. If the 232 program is dismantled or undermined, they could be manufacturing 90 percent of a slab’s value in China, while still receiving duty-free treatment into the US market.

Transshipment and Reexport Transshipment and reexport offer what Shenzhen Shengbao describes as a “faster, more effective, and lower-cost solution” than localization to reach restricted markets. In a 2019 article, the company described the point and process of re-exporting as a “solution to the Sino-US trade war: “By means of re-export trade in a third country, products can be detoured to the third country before entering the U.S. market, which can reasonably avoid high U.S. tariffs.”27 Re-export trade is also presented as a means to evade European trade remedies.

The Shenzhen Shengbao piece explains how re-export works. The exporter declares that its container is headed to one country. The re-export agent arranges customs clearance, trailers, cabinets, and container replacements in that third country, as well as the role of a local agent in producing a certificate of origin, packing list, invoice, and bill of lading. The Chinese re-export agent then re-declares and exports the container “to any port you specify in the United States.”

“Through the above re-export trade operations, high trade war tariffs can reasonably be avoided.”

These practices qualify as unlawful “transshipment” under international trade law. In Chinese sources, these are labeled “trade war solutions.” They are not new. Nor do they exist only at the margins of trading activity. Shenzhen Shengbao is not anomalous. A healthy cottage industry of 25

China Industrial Textile Industry Association, “进军欧美市场, 埃塞俄比亚是跳板 [Entering European and American Markets, Ethiopia Is a Springboard],” Textile Weekly, 2017.

26 http://www.steelonthenet.com/cost-hrc.html 27 China Industrial Textile Industry Association, “进军欧美市场, 埃塞俄比亚是跳板 [Entering European and American Markets, Ethiopia Is a Springboard],” Textile Weekly, 2017.

14

HORIZON ADVISORY

trade export agents operating in China market services that include strategy and investment support for identifying markets in which to “localize,” as well as “re-export logistics support” for the process of re-declaring cargo at throughway ports on a convoluted journey into the US market.28 One describes its offerings as “cross border e-commerce anti-dumping goods reexport professional solutions.”29 Another notes in a set of guidelines for “re-export packaging of electric motors” that those goods “cannot have the ‘Made in China’ logo,” also that “the outer packaging has different requirements depending on the region.” Most European countries use “pure neutral packaging.”30 As that piece suggests, European countries serve not only as possible mid-way stops in thirdcountry reexport schemes, but also as possible destinations. Failure of European countries to address as much mean that Chinese products risk continuing to flood the European market – despite what trade remedies have been enacted – in neutral packaging and without Made in China logos. As long as that is the case, steel trade between Europe and the US risks being distorted by China.

28

See, for example, a representative pitch published on Sohu titled “反倾销（第三国转口操作流程） [AntiDumping (Third Country Re-Export Operation Process)],” Sohu, July 26, 2018.

29 深圳市保时运通物流有限公司 [Shenzhen Baoshi Express Logistics Co., Ltd.], http://www.kj56.net/ 30 “电动马达转口贸易方案 [Electric Motor Re-Export Trade Plan],” hif56.com. http://www.hif56.com/a/service/xinjiapozhuankoumaoyi/49.html

15

HORIZON ADVISORY

A Growing Footprint in Europe Chinese investments in European steel players offer concrete examples of China’s bid to circumvent trade barriers and to transfer overcapacity playing out. And Chinese discourse around those investments is explicit about its motivations. These examples also point to the growing aggressiveness of China’s engagement with the European steel industry: Investments and joint ventures in the early aughts have given way to outright acquisitions over the past five years.

Jingye Group The Jingye Group’s 2020 acquisition of UK and Dutch assets of British Steel offers a recent example. Chinese sources heralded this rescue of British Steel as “an important result of the implementation of the Belt and Road Initiative” and a “new impetus for China-UK relations and cooperation.”31 British Steel’s assets had been rolled up by Greybull Capital and included former assets of Tata Steel Europe, including production facilities formerly of the French concern Usinor.

British Steel’s strength in railway steel was particularly attractive for Jingye. Chinese press accounts raved at the potential value for Jingye: “Jingye Group's product structure and production technology will be greatly improved, which will help expand the international market and enter the railway steel field.” 32 Jingye certainly values this complementary product space and the international advantages it promises. Jingye also values the geography: For Jingye Group, there are two obvious benefits of spending huge sums of money to acquire the British Steel Company that is on the verge of bankruptcy: First, Jingye Group's road to internationalization has opened up. In the future, the sale of steel products can use goods from European factories, thereby reducing high tariffs. Second, British steel companies are good at manufacturing railway tracks, which can enrich Jingye Group's product line.33

31

“Jingye formally acquired British Steel and became the second European steel mill acquired by a Chinese steel company,” China Iron and Steel News Net, November 3, 2020.

32 “British Steel, a European steel mill acquired by Jingye Group from the beginning,” China Iron Making Network, February 21, 2020, https://www.zgltw.cn/m/view.php?aid=24123.

33 “这家中国企业要买英国最大钢铁厂，卖方是印度第二大钢铁集团！[This Chinese company wants to buy the largest steel plant in the UK, and the seller is the second largest steel group in India!],” Chengdu Zhiqu Interactive, October 11, 2020, https://baijiahao.baidu.com/s?id=1680149706009935808&wfr=spider&for=pc.

16

HORIZON ADVISORY

Hebei Iron and Steel Group This 2020 case was not China’s first foray into the regions’ steel sector. In 2016, China’s Hebei Iron and Steel Group (HBIS) acquired the Železara steel mill in Smederevo from the Serbian government. The mill has a storied history dating back to 1913. Chinese sources characterize the transaction as building on strong Sino-Serbian ties, highlighted by cooperation on the HungarySerbian railway construction, the development of industrial parks34, and participation in dialogues and international fora like the China-CECC meetings. But the acquisition was not just valued for the diplomatic ties it suggested. This acquisition was valued for its positioning in Europe and the protection it offered against trade remedies: “More importantly,” reads an article in China’s Southern Weekend, through operations in Serbia, HBIS can avoid the impact of European trade protection measures such as "anti-dumping and countervailing" on China's steel industry.”35 “This is part of China’s broader efforts to expand its influence and enter the European market” summarized one Chinese article at the time. And entering that market was well understood to not necessarily be about economies of scale or a value-based assessment. Rather, as one Serbian analyst put it, “China does not need a Serbian plant … I think this is for entering the market and complicating the positions of the United States and Russia.”36

A Long History These deals and collaborations built on a foundation set over a decade earlier with the Chinese steel sectors “go out” campaign in Europe. Ansteel, for example, had been an early player in the Chinese steel sector’s embrace of the European market. It acquired an Italian steel processing plant in 2010. That deal was praised for marking a shift from the “past exporting model of trading products to establishments of entire trading systems overseas.”37 Baosteel made an even earlier bet on the Spanish market through its European-focused subsidiary in 2006. That investment in Spain totaled only 200,000 euros. But this well timed and strategic investment gave Baosteel Europe a pivotal beachhead from which to continue its expansion across steel products, raw and auxiliary materials, equipment, materials, and spare parts in the European market prior to the downturn that would follow with the global financial crisis. At the time, the driver for China’s European push was clear: “The reason for choosing Europe is mainly due to the recent trade pressure of my country's steel industry from North America, Southeast Asia and other countries,” explained an article in Beijing Business Daily38 34

The Appendix of this report includes a list of key Chinese-backed industrial parks across Europe.

Zhang Xi, “Global steel surplus, the Chinese steel company is still buying and buying overseas,” Southern Weekend, April 21, 2016, http://static.nfapp.southcn.com/content/201604/21/c72110.html.

36 “Serbia's rundown steel plant was rescued by a Chinese company and was sold for $1,” Reference News Network, July 17, 2016, https://baijiahao.baidu.com/s?id=1573044915534600&wfr=spider&for=pc.

37 “Ansteel Vigano Company to be built in Italy,” Global Times, September 7, 2010, https://www.globaltimes.cn/content/570986.shtml.

38 “Baosteel 200,000 euros to build plants in Europe, domestic steel companies have aimed at overseas,” Beijing Business Daily, September 25, 2006, http://www.dzwww.com/caijing/cybd/200609/t20060925_1775308.htm.

35

17

HORIZON ADVISORY

Anshan Iron and Steel ThyssenKrupp Automotive Steel Co., Ltd. (TAGAL), established in 2002, offers a different type of example -- a joint venture rather than an acquisition. The TAGAL joint venture allowed China’s Anshan Iron and Steel to support the German operations of ThyssenKrupp Steel Europe with steel supplies and the development of steel products for the automotive industry, locking in the Chinese company’s role as a supplier. In December 2020, Ansteel Group’s Chairman and Party Secretary Tan Chengxu met with ThyssenKrupp Steel Europe’s president to confirm the benefits of their win-win collaboration and plot the trajectory of continued, long-term cooperation. Chinese press coverage of the meeting summarized the German objective with the tie-up: “ThyssenKrupp Steel Europe will continue to support the development of TAGAL, accelerate its transformation and upgrading, continue to explore the market, enhance its core competitiveness, and help TAGAL maintain its leading position in the industry.”39 The joint venture has also provided opportunities for broader Sino-European cooperation: The Ansteel joint venture has served as a convening authority for research and development (R&D) cooperation between ThyssenKrupp Steel Europe and the Chinese Metallurgical Industry Planning and Research Institute. These latter two bodies formed a cooperation agreement in 2018 to “accelerate the harmonious and inclusive development of the iron and steel industry.” 40 This relationship and the TAGAL joint venture’s market leading position puts Ansteel in place to feed supply into major downstream automotive producers across Europe, who in turn provide a global export platform.

Baosteel, Italy, and Low-Profile but High-Return Footholds In other less explicit and high-profile cases, Chinese companies deploy targeted investment to ensure footholds in European steel production and the industry chains built on top of it. NSM Steel is a small steel processing and shearing company in Italy. It is an unassuming operation. But it carries a rich history. And the company’s high-profile clients in the automotive industry reveal that it punches above its weight: Alfa Romeo, Fiat, Maserati.

In 2011, an equity investment from China’s Baosteel invigorated NSM and granted it a strategic partner that could provide a reliable upstream supply and competitive cost structures. The partnership was described as one focused on “processes to expand strategic cooperation with win-

39

“Ansteel Group and ThyssenKrupp Steel Europe hold high-level talks,” December 15, 2020, http://www.csteelnews.com/qypd/qydt/202012/t20201215_44495.html.

40 “Metallurgical Industry Planning and Research Institute and ThyssenKrupp Steel Europe AG signed a cooperation agreement,” August 5, 2018, http://www.mpi1972.com/xwzx/tpxw_449/201805/t20180508_76381.html.

18

HORIZON ADVISORY

win results.”41 Coverage in Chinese press emphasized that though Baosteel Italy’s products were imported from great distance, deals like the NSM position would guarantee that “European customers can enjoy the same affordable and convenient service as the local steel mills.” 42 Baosteel made the NSM deal through Baosteel Italy, which was formed in 2001 as one of Baosteel’s earliest overseas forays and a part of the Baosteel Europe family of subsidiaries.43 Baosteel Europe – and the Baosteel Italy investment into NSM – offer a prime example of Beijing’s approach to global expansion in the steel industry and corresponding supply chain control.

NSM imports its steel from Baosteel’s mills in China. But NSM does not advertise itself as selling a Chinese product to Maserati. When product placements in the US market show viewers their favorite Entourage characters driving a Maserati Granturismo, there is no footnote about the “Made in China” steel that was processed in Italy for its manufacture.

But the Maserati is built out of Chinese steel. And Baosteel benefits tremendously in terms of direct revenue and indirectly in terms of market access. NSM offers Baosteel and its upstream products an opportunity to compete alongside and overtake Italian and other European mill competitors that lack the cost and coordination advantages of this Baosteel Europe-conceived value chain. NSM also stands better positioned to penetrate the US market with competitive costs, because it benefits indirectly from China’s industrial policy and industry subsidization.

Accordingly, NSM it appears to ship to customers ranging from Tesla in California to Schaeffler Transmissions in South Carolina.

In 2011, Baosteel promised to “maintain its leading position in China, continue to promote its overseas business, and propose a transformation from ‘China to the world’.”44 The State-owned giant is delivering on that promise. This is vertical integration with Chinese characteristics.

NSM and Italy are no outliers. The same story plays out across Europe. Chinese champions like Baosteel acquire, invest as minority shareholders, form strategic partnerships, or provide financing to guarantee access to the European market and the global export opportunities that European markets offer. The European campaign is explicitly backed by Chinese state guidance and financing. Take for example, Baosteel’s customer financing that was launched in the wake of the 2008 financial crisis. The China Export & Credit Insurance Corporation and Baosteel jointly launched financing services to assume capital risks for downstream customers willing to shift to

41

“First Step in Overseas Slitting Center Layout Plan,Baosteel Signed Partial Stock Purchase Agreement of Italian NSM Slitting Processing Center,” Baosteel News Centre, April 1, 2011, https://www.baosteel.com/group_en/contents/2863/39538.html.

42 “To the most discerning customers: Baosteel Europe's overseas development road,” Sohu, October 22, 2011, http://roll.sohu.com/20111022/n323024539.shtml.

43 “First Step in Overseas Slitting Center Layout Plan, Baosteel Signed Partial Stock Purchase Agreement of Italian NSM Slitting Processing Center,” Baosteel News Centre, April 1, 2011, https://www.baosteel.com/group_en/contents/2863/39538.html.

44 Wan Xiaoxiao, “Within 5 Years, China’s Steel Landscape will Change: Interview with Xu Legiang,” Economic Observer, http://www.eeo.com.cn/xinmeiti/read/tdss/250245.html.

19

HORIZON ADVISORY

Baosteel delivered supplies.45 This is the “joint force” approach that Chinese industrial policy applies in Europe and elsewhere.

In the grand scheme of trade flows and international corporate strategy, the Baosteel-NSM tie up does not register. It is a small blip; not fodder for profiles for US business media profiles or a Harvard Business School case study. But it offers an important anecdotal window into China’s “State backed, Enterprise driven” economic model. As Baosteel and countless others like it, “go out” into the global marketplace, they secure footholds that guarantee downstream market opportunities for Beijing’s subsidized upstream inputs. Those market opportunities are readily converted into supply contracts, processes, and products that lock in China’s overseas positioning.

Trade remedies are utterly inadequate for addressing this tack. And, as a result, the distortive effect of China’s subsidized overcapacity in foundational segments of the global economy is permitted to permeate without provoking anti-bodies.

These examples are only the tip of the iceberg of China’s embrace of the European steel sector and efforts to utilize the EU as a vehicle to expand the CCP’s economic success and influence. Minority investments and joint ventures, long-term supply contracts, and trade financing account for as much engagement, if not more, than these high-level relationships. So, too, do downstream acquisitions that provide supply relationships for Chinese steel, like the Maanshan Iron & Steel Group’s acquisition of the French wheel and axle company Wadun.46 This depth of engagement – spanning the industry chain through different means – has helped to short-circuit the skepticism that often accompanies Chinese investment. The steel sector is widely recognized as foundational to national economies and a necessary component of domestic defense industrial bases. The United States has deployed an array of legal policy tools to protect against dumping into the market and to scrutinize inbound foreign investments. But the United States is not alone: India, Indonesia, Thailand, Vietnam and other steel producing states have debated and enacted forms of industry protection premised on national and economic security grounds. Chinese sources over the past decade have closely monitored and parsed the relationship with Europe and the risk of similar anti-bodies arising. The conventional conclusion reached in those observations: For European countries, China is a much more important trading partner, so taking this approach is tricky. If high tariffs are introduced, it may trigger a trade war of retaliatory import tariffs.47

45

“To the most discerning customers: Baosteel Europe's overseas development road,” Sohu, October 22, 2011, http://roll.sohu.com/20111022/n323024539.shtml.

46 “New opportunities, new challenges, new features and future paths of China's steel internationalization,” China Metallurgical News, March 11, 2019, http://www.mpi1972.com/xwzx/xyyw_451/201903/t20190311_82332.html.

47 “中国廉价钢铁出口背后的真相 [The truth behind China's cheap steel exports],” April 26, 2016, http://www.99qh.com/s/news20160426102202060.shtml.

20

HORIZON ADVISORY

Conclusion A Multi-Dimensional Threat to the Build Back Better Agenda China’s pervasive and growing presence in the European steel industry threaten that region’s industrial base security and long-term manufacturing prospects. Because of Europe’s role in international value chains – and the international ambitions motivating China’s engagement – China’s presence also threatens the industrial base security and manufacturing prospects of countries trading, partnering with, and otherwise reliant on European steel.

US policy needs to understand what Chinese strategists say plainly: The European market is a gateway for upstream Chinese supply to meet higher-value segments of the market; an outpost for transferring the overcapacity that Chinese industrial policy has encouraged to decimate global competition; and a foothold through which China can penetrate economies seeking to defend themselves from its non-market practices.

The United States should require that allies and key trading partners in Europe adopt updated investment screening and trade policies. China has devised indirect modes for circumventing those protections just as well as evading tariffs through trans-shipment. And as the United States works to modernize its national security foreign investment and trade tools, it should take this moment as a chance to require the same of those who wish to increase their access to and engagement with the US market.

The United States cannot effectively deliver on the promise of building back better without protecting against China’s non-market behaviors. As China has become confident in the strength of its industrial champions and their dominance of the Chinese market, the State has aided and abetted their overseas expansion. Existing trade regimes and regulations have not been updated for the subversive positioning that CCP-backed actors have seized globally, and in Europe in particular.

These forces have directly contributed to the hollowing out of American industry over the past 30 years. Protections must be enacted and strengthened if an attempt to retain and reinvigorate American manufacturing capacity is to succeed.

21

Actionable Geopolitical Insight

Contact info@horizonadvisory.org www.horizonadvisory.org

22