Historical Overcapacity in the U.S. Steel Industry

Recently, there have been a lot of analyses on China’s electric vehicles and other areas of capacity expansion, overcapacity, and volumetric competition. Most opinions view this as “abnormal” economic behavior, symbolizing its not-so-perfect market economy.

Theory is boring, but reality is wonderful. To supplement the above perspectives, I ask the following questions: Has structural overcapacity occurred in the Western market economy? If so, what was the historical background of its emergence and how was it eventually resolved? Here I add “structural” before overcapacity to exclude short-term overcapacity caused by insufficient demand in economic crises.

The first thing that came to my mind was the American steel industry in the 19th century. Preliminary explanations by ChatGPT were in line with my intuition. However, despite an afternoon of checking, I was unable to find articles dedicated to this issue. Therefore, I could only put pieces of information from a few essays (on the US industrialization, the UK steel industry, Andrew Carnegie, and the formation of US Steel) together to produce a vague picture of this topic.

The following text is a general introduction to this picture. Readers and scholars in related fields are welcome to provide critiques. General conclusions are as follows:

• During the second half of the 19th century, the U.S. steel industry experienced rapid expansion. From 1860 to 1900, U.S. steel production grew from 13,000 tons to 11,227,000 tons; by the turn of the century, the US produced more steel than the UK and Germany combined.
• Railroad construction, technological advances, and the role of entrepreneurs were the main factors driving the US steel capacity expansion against the background of protectionism and industrialization in the post-Civil War era.
• However, this rapid expansion also led to a serious overcapacity problem, with studies showing that nearly 50% of U.S. steel capacity was idle at the end of the 19th century.
• To solve this problem, in 1901, several steel companies merged to form the US Steel, which reorganized the industry and abandoned the cut-throat pricing strategies. Although putting an end to endless price wars, the giant company gradually saw its incentive to innovate waned.
• This interesting piece of history shows that overcapacity can occur in a market economy. More importantly, advocation for governmental intervention in overcapacity should be prudent, with serious considerations on fairness and the impact on future innovation.

The Great Expansion of U.S. Steel Capacity in the Second Half of the 19th Century

Like the steam engine, steel was the hallmark of the first industrial revolution. As the birthplace of the Industrial Revolution, Britain was the natural leader in global steel production. According to Taplin and Carr (1962), in 1875, Britain produced 40% of the world’s steel, and 40% of British steel production was exported to the United States. However, just 20 years later, in 1896, the global share of British steel production fell to 22.5%, and exports to the United States were virtually zero; even in the British domestic market, steel products produced in the United States were much cheaper ¹.

This was indeed a booming era for the development of the U.S. steel industry. One piece of research shows that, in 1860, the US produced 13,000 tons of steel; in 1880, 146.7 million tons; and in 1900, it soared to 1122.7 million tons, which exceeded the production of the UK and Germany combined ². According to another literature, from 1880 to 1900, the US annual stainless steel sheet production rose from 1.25 million tons to 10 million tons ³. A third study shows that during the period of 1867-1900, the number of employees in the U.S. iron and steel industry grew from 77,500 to 222,500, while capital investment in this industry increased from $120 million to $531 million [6]. These data, put together, corroborate the rapid rise of the US steel industry in the last three decades of the 19th century.

At the same time, American steel gradually gained a price advantage over that produced in the UK. According to Allen (1979), in 1881-1890, the selling price of steel rails produced in the US was on average 56.7% more expensive than that of British products, while in 1906-1913, American rails were 4.96% cheaper than those of British products; the author’s calculations also showed that by 1907, the productivity of U.S. steel (average output per worker) was already 78% higher than that of Britain, and its total factor productivity was 15% higher ⁴.

Drivers of capacity expansion

The US steel industry was a witness to the US rapid industrialization after the Civil War, which featured “trade protection + industrialization” policies pushing the US away from an agricultural economy exporting raw materials while importing industrial goods. The development of the steel industry, similar to many others, was by the combined efforts of politicians, capitalists, and industrialists.

Factor 1: the great railway expansion

The second half of the 19th century was an important period of great railroad development and prosperity in the US. Between 1870 and 1900, U.S. railroad mileage increased from about 55,000 miles to nearly 200,000 miles, eventually (see my previous article on this topic) ⁵. Steel rails lasted longer than iron ones, so railroad construction created a huge demand for steel. Even by the 1880s, rails were still the most important product of U.S. steel mills, followed by components of locomotives and cars; it was only in the last years of the 19th century that the construction steel (for buildings and bridges) became another key demand for mills ⁶.

Factor 2: technological advances

In the middle of the 19th century, steel production technology underwent several major shifts. In 1856, the British inventor Henry Bessemer introduced the revolutionary “Bessemer Process”, which was the heart of steelmaking for the subsequent 100 years. It enabled the mass production of steel, greatly reducing costs. Further, in 1865, the Frenchman Pierre-Emile Martin, utilizing the Carl Wilhelm Siemens’ (a German) technology, introduced the “Siemens-Martin Open Hearth Process”, which facilitates more precise temperature control and made it possible to produce steel with low-grade iron ore ⁷. Although not pioneered by Americans, those new technologies were quickly mastered by American technicians.

Factor 3: entrepreneurs on stage

The steel industry in the United States during this period was a near-perfect competitive market, with abundant entrepreneurs. Andrew Carnegie was the most famous one As a railroad veteran, Carnegie knew the potential of the steel market and resolutely invested his fortune to create Carnegie Steel. With the application of the latest technologies, firm control of costs, vertical integration of the industry chain, and horizontal mergers and acquisitions within the industry, his steel business flourished. By 1890, his steel corporation was the world’s most profitable one ².

Overcapacity and Consolidation

Inherent characteristics of the steel industry in the 19th century brought about the fate of overcapacity. The steel industry, at that time in the US, was an empty market with seemingly endless demand. The emerging technologies, on the other hand, brought opportunities to enhance supply to fill the gap. With such mindsets, ambitious men, be they entrepreneurs or capitalists, all rushed to get a piece of the pie. In the face of fierce market competition, each enterprise hopes to accelerate investment to seize market shares, and, once fixed investments are sunk, they would adopt the strategy of “full production + variable cost pricing” to compete with others. Therefore, even during the demand bust resulting from the railroad debt crisis, the steel bosses seldom voluntarily exit the business. Rather, they would initiate further price cuts, hoping to exhaust their opponents.

The result was obvious. According to Potter (2023), by the end of the 19th century, nearly 50% of U.S. steel capacity was idle, while U.S. steel prices decreased by 80% between 1870 and 1896 ⁸.

Figure 1 U.S. steel prices⁸

What was the way out? The solution provided by the Americans was consolidation. In the efforts of Charles Schwab (then president of Carnegie Steel) and J.P. Morgan (the famous investment banker), in 1901, Carnegie Steel, Federal Steel, National Steel and few others merged into “US Steel”. And yes, this is the U.S. Steel that Nippon Steel intended to purchase but was recently vetoed by the US government.

A sad industrial story as it is in the 21st century, UUS Steel was a symbol of the rise of the US industrial capacity at the beginning of the 20th century. Upon its formation, US Steel produced nearly 9 million tons of steel annually, which was more than 60% of the US total production [^8. The company was valued at 1.4 billion US dollars, about three times the US federal fiscal expenditures in 1900 ².

Instead of aggressively squeezing out competitors, the newly formed steel giant maintained a high selling price of its products. At the same time, the company’s head Judge Elbert Gary would regularly convene “Gary Dinners”, inviting the leaders of other steel companies to agree on the steel prices to avoid price wars. Those non-compliances would be subject to the “common discipline” by the group ⁸. Since then, U.S. steel prices had remained largely stable in general.

Such strategies put an end to the endless price wars in the late 19th century and, surprisingly, withstood the test of antitrust investigations. However, the giant also gradually lost the gene of innovation and competition embedded in Carnegie Steel. The US Steel in the 1930s was mocked as “no inventions; no innovation”. Missing rounds of chances to lead new technological upgrading, its market share in the US gradually declined to 35% in 1941 ⁸.

Some thoughts

• In a market economy, explosions of demand, technological revolution, and the emergence of new enterprises will most likely bring the explosion of production capacity in excess to actual market demand. However, this is a natural process of market competition and sources of industrial upgrading.
• Advocation for governmental intervention for overcapacity should be cautious. Government efforts to tame production and regulate market entrance could be easily mis-used to protect low-efficiency firms, while industrial consolidation may erase incentives for further innovation.
• Technologies invented do not equal to technologies applied. Improvements in steel technology were not invented by Americans or by firms that resided in the US, yet they were quickly learned by Americans, benefiting the rise of the US steel industry. Facing technological gaps, ignorance was not the correct answer, but neither was capitulationism.

References

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