Why does Australia export so much raw materials instead of steel and other value added products?

Question

According to the chart in this report although exports from Australia of iron ore and metallurgical coal are declining they are still quite high. On the other hand I see that Australia imports a lot more steel that it exports. Actually the imports are just a third of the production, but it is enough to trigger supply chain problems.

I thought that advanced countries tended to move up in the value chain of their exports. Why does Australia export so much raw materials instead of steel and other value added products?

Actually this is a question that could be asked also in the economics forum, but government policies like royalties on mining and taxation on exports have a big impact on the shape of supply chain and the entire system. The current situation is also a political choice

Answer 1

only considering that part of steel production that is exported back to Australia

Because China (where most of the Australian ore goes, and from where China imports most (2/3) of its ore for that matter) makes so much more steel, compared to everyone else basically.

(source).

Yeah, China ate the lunch of some of the domestic Australian steel industry too, but that's rather insignificant in the balance of things, with respect to ore exports.

Australian ore production/export growth basically mirrors that Chinese steel production growth:

(source).

---

Frankly China themselves would probably stop importing Australian iron ore if they could [for geopolitical reasons], but unlike with coal (which they've shifted their imports to Indonesia and Russia), they don't have an easy substitute for Australia when it comes to iron ore, given the volumes they use.

As a bit of a history lesson, Australia did impose an ore embargo on Japan in 1938. Somewhat surprisingly perhaps, the Australian export restrictions for iron ore were not lifted until 1960, when significant additional deposits had been discovered, and when Australia also experienced a significant trade deficit.

---

The Chinese government have no qualms when it comes to controlling the export of mineral resources. The story of the rare earths tells a lot. The Australian government has a rather different attitude. Why?

Iron ore exports are worth

$136 billion to Australia’s economy a year

Australia isn't going to embargo China [on that kind of sum] on the hope that China will later buy finished products... from Australia of all places.

Unlike Japan, which imports 100% of their iron ore, China has substantial domestic deposits, and some domestic extraction too. It's just that these Chinese deposit are of much lower grade than the Australian ones (30% vs 65% purity, on average, according to a 2010 USGS document), which makes the extraction of many Chinese deposits uneconomical, given import alternatives.

Another issue is that most of the Australian industry is/was located in the eastern part of the country, but the vast deposits discovered from the 1950s onwards were in the western part. As one book puts it "access to the world market was a precondition for the expansion of reserves" because these were gradually surveyed by and large only after Western Australia lobbied for exports. There was also a bit of secessionist political agitation related to that in the 1970s.

As for the comparison with rare earths, the entire world trade in (unprocessed) rare earths is only worth some $2.7 billion. And the value added by those is probably much higher than for iron/steel. Also, China lost some WTO disputes over rare-earth export controls.

---

You also have consider this from an employment perspective. China employed about 5 million in the steel industry in 2016 (according to the WSJ.) If hypothetically Australia would be producing all the steel that China needs, that would be pretty much everyone who's not working in education, retail, healthcare, construction, and public administration in Australia. (In comparison, mining only employees about 215,000 in Australia. The steel industry itself seems to employ about 140,000 in actuality, in Australia.)

This is to say nothing what kind of shocks such an workforce would experience on demand variations from China. During the 2016 overcapacity crisis in China, various figures for layoffs were advanced ranging somewhere between hundreds of thousands and over a million. Granted China probably had some reasons to inflate those, to placate the complaints from other countries, in terms of efforts it was making to deal with the problem.

(Assuming counting methodology is comparable, that 140K [actual] steel workers in Australia is still a lot. It's about the same number as in Turkey, or in half of the EU, both of which have substantially larger populations than Australia [25 million, Turkey - 85 mil., 1/2 EU: 220 million].)

Answer 2

Well, first thing to remember is that looking to add value to raw/intermediate resources is an old, old, goal pursued by many countries. One that fairly often goes wrong.

The Economist has for example been covering Indonesia's desire to promote adding value to bauxite and nickel and gives it about even odds of failure or success (with much cheaper labor), at great cost to the national treasury, and with the potential for WTO challenges as well.

The second is that the interests of Australia, its miners and its steelworking industry do not necessarily align. For a mining company, its interest lie in securing the best prices for its ore. Not in the pursuit of adding steel-working jobs in other companies.

Third, there are both structural problems and heavy Chinese competition (this article is from the interventionist side):

The sale of Arrium to British consortium GFG Alliance was completed in September 2017, thereby securing the continued operation of the Whyalla steelworks for the immediate future. However, the conditions creating the crisis that manifested most obviously in Arrium's collapse remain. This inquiry investigated a number of these conditions in detail and how they have impacted the Australian steel industry, including: inconsistent standards; issues in procurement policies; and unfair and uncompetitive trade practices, leading to dumped and subsidised imports and further price strains on steel produced in Australia.

.... The Australian steel industry has been affected by a global oversupply in steel occurring at the same time as an upsurge in production from China, where government support for the industry in the form of subsidies and tax remedies help to keep prices artificially down, as is the case in a number of other countries in Asia. The result of this oversupply is an increase of dumped products from around the world as countries seek to offload their excess steel at low prices. The pressures caused by the influx of dumped and subsidised steel into Australia are considerably greater than the normal pressures expected in naturally competitive markets, creating additional pressures on the Australian steel industry.

Now, keep in mind that the word "dumping" is a popular word when it comes to Western industries referring to their Asian competitors. Its meaning ought to be when the producer is selling below their cost (to purge local competition). In practice, when the overseas producer can make a profit selling below the cost the locals can match, the term often gets used as well.

Fourth, is the pursuit of manufacturing all that lucrative? Here we have an a by former Statistics Canada chief economic analyst claiming that it is not (Canada shares many of Australia's struggles with resource-dependence):

The largest downstream benefit from increasing the development of natural resources lies in the services required, not in manufacturing. Services jobs increase more than twice as much as manufacturing in response to growth in the resource sector, although certain manufacturing industries like wood, paper and primary metals expand during a resource boom.

The modern global economy offers no long-term guarantees for the success of any industry. But resource extraction and the services required to produce these resources have proven to be a secure and stable source of growth.

Fifth, labor and knowledge

More and more, trading Western nations find niches in which they hold a comparative advantage due to their reputation, processes and skilled labor. Australia has never had that much of a steel industry and it would be hard pressed to suddenly start competing against established players. In heavy industries, non-Western countries can compete on cheap labor against Western producers with high-cost labor and strong unions, unless Western companies really do something better because they have specialized skills and knowledge.

From The Diplomat, 2016- The Problem with Australia's Steel Industry:

Last week, Arrium, one of the two dominant steel manufacturers in Australia went into voluntary administration with debts of over $AU 3 billion ($US 2.3 billion).

With the failing of the company having the potential to affect up to 8,000 jobs nationwide, there have been calls for the federal government to bail out Arrium. The opposition Labor Party wants to instigate a national steel plan to try and prevent future occurrences of this nature.

...

Were the government to bailout Arrium, and also decide to build the new submarines in South Australia, the state could become dependent on the federal government for its subsistence.

... Iron ore remains Australia’s largest export; however native steel production is struggling to compete globally. It may be the case that should Arrium survive administration it will need to refocus their operations on “smart specialization.” That would mean moving the company away from the mass-produced steel used in large infrastructure projects (a market dominated by low-wage countries like China and India), and refocusing on specialized varieties of steel like those produced by Sweden for various blades and drill bits.

Sixth, market size.

If you look at steel production by country, you'll find many of them are larger countries, with heavy industrial bases (you'll also notice Australia was not producing that much more in 1980). If Australia was hypothetically go to steel production, whom would it sell all that steel to? Its internal market? If it sold it to China, it would be facing headwind from Chinese lobbying. If selling to Western countries/EU, most of those are also keen on protecting their own industrial bases.

There is one upcoming possible rabbit to pull out of the hat:

Hydrogen-based emissions-free steel (each ton of steel made by standard processes means roughly 2 tons of CO2). That's a whole new field to get into and Australia has both the steel and the potential for abundant solar energy.

May be something to try doing, but going into "old" steel seems unlikely to work.

Answer 3

Short answer...

specialization increases income for individuals and profit for companies.

Longer answer...

By comparing income and profit from domestic manufacturing with the alternative sources of income and profit, choices will be made. If domestic manufactured goods cannot compete, self-interest will guide companies and individuals to specialize in a different area which might be the export of the inputs to foreign manufacturing industries or it might be the domestic services sector.

If domestic manufactured goods can compete, it will draw workers and other resources. In the case of workers, it is easy to see that it is unlikely for a person to be simultaneously working in a steel mill and a coal mine. In the case of companies, a dollar spent for steel making equipment is a dollar no longer available for mining equipment. When those workers and other resources are drawn into domestic manufacturing, the workers will forego income from exporting the inputs to foreign manufacturing industries and companies will forego the profit from exporting the inputs to foreign manufacturing industries. Individuals and companies will compare actual income and profit with foregone income and profit. The comparison process leads some industries to increase in size and others to decrease.

The answer is prosaic... the balance of Australian coal production and steel manufacturing is the result of this comparison process.

Much longer answer...

This Wikipedia article on comparative advantage is a much longer answer. An interesting quote from the article...

David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries.

One implication is that if Australia were the most efficient coal producer and simultaneously the most efficient steel producer, the possibility of trade or decreases in the cost of international shipping would cause a re-balancing from one industry to another.

So to your question... "Why does Australia export so much raw materials instead of steel and other value added products?", the answer is that a self-interested comparison of the alternatives led to individual choices that resulted in the current balance.

A follow-up question might ask, what factors created the current situation in regard to the relative profitability of various industries and consequently the relative size of each industry. The financial return on investments determines the relative size of each industry in each country and the usual determinants of financial return will apply, such as the presence or absence of profitable ores, the cost of labour, the income foregone by denying labour to other industries when an employment situation is entered into, protectionism, and transportation cost. Comparisons will be made at the level of individual companies and workers. The other answers in this thread will list some factors that influence the financial return on investments. Individual companies and people in Australia have already considered those factors and they made their decisions such that Australia is specialized and diversified in the ways that it has. If your question can be generalized to "why does Australia produce what it produces and not more of other things", the ultimate answer is because people were reasonably free to choose and what you see is the result of individual choices. Governments influence those choices through subsidies and protectionism and regulation of safety and pollution, and taxes, which all affect the financial return on investment, which is essentially the difference between price received and costs paid, the value of which is tempered by uncertainty or volatility. Australia can trade with some countries where people are less free to choose so government influence crosses borders.

If you look at a list of factors you might encounter a factor such as "China's government is supporting an unprofitable steel maker" or "Australia has really high grade iron ore". There is no need to single out China; every government has at times supported activities that might make them more popular. We can consider these factors as isolated facts or anecdotes but fortunately, there is accounting. Individual companies have summed benefits (revenue) and costs in terms of currencies. Individual companies and investors decided if the financial returns are adequate and politicians have decided whether social returns to intervention are adequate. Australia's industry specialization or diversification is the result of that process.

Answer 4

Regarding iron ore, it's not for the want of trying.

The two major iron ore producers in Australia, BHP and Rio Tinto (formerly CRA - ConZinc Rio Tinto Australia) both had programs to convert iron ore into metal as a saleable product, but both programs failed.

CRA had its HIsmelt program and BHP its HBI (hot briquetted iron) program. Both began their programs in the 1980s and Rio Tinto terminated the HIsmelt program in 2011 which was "technically acclaimed but financially unviable".