Essential Industries Fallacy

Well we're living here in Allentown
And they're closing all the factories down
Out in Bethlehem they're killing time
Filling out forms, standing in line
--Billy Joel

Nice example toward the bottom here of what might be called the 'essential industries fallacy.' It is often argued that certain domestic industries, such as steel, require protection from foreign competition to protect standard of living or to preserve national security.

The story goes something like this. Suppose that China seeks to drive US steel companies out of business. The Chinese government subsidizes steel production in its country, enabling Chinese steelmakers to 'dump' product in US markets much cheaper than domestic producers. Over time, US steel producers drop out of the market because they can't compete with subsidized Chinese steel. Once US steel production has been reduced to zero, China suddenly refuses to sell steel to America, leaving many industries high-and-dry with no supply of a critical input. With their large appetite for steel, American military sectors would be particularly vulnerable as, in turn, would national defense capability.

In short, because China exploits the dependence inherent to specialization and trade, this industry needs to be shielded to ensure a high degree of US self-reliance.

There are several problems with this argument. One is that China must subsidize its steel industry for some time--perhaps decades--which drains its public coffers and diverts steel from home base use. China can't build battleships, for instance, if it is subsidizing production of battleships in the US. All the while, the US enjoys an increase in standard of living from cheap steel--as well as a nice build-up in military capacity courtesy of the Chinese.

Meanwhile, US buyers of steel become aware of Chinese steel dumping and its logical endpoint. They begin to diversify their supply base. They begin placing orders with steelmakers in thirty or so other countries throughout the world who are eager to do business after being shut out of US markets by the subsidized Chinese steel.

Importing subsidized products increases standard of living--including self-defense capacity. Domestic consumers spend less for the same level of value and can plow their savings into more consumption or into productivity improvement projects. Meanwhile, the subsidizer gets comparatively weaker.