In March of this year, we saw a real life example of the game theory classic, "The Prisoner's Dilemma," in which the domestic steel mills in this country found themselves forced to choose a course of action from two very different alternatives, each with seriously different consequences.

In the textbook demonstration, two culprits who have been arrested for a crime they committed together must decide whether or not to turn state's evidence and rat out their fellow prisoner. They are not allowed to communicate with each other and are given the following scenario: If they talk, but their partner does not, they go free but the partner gets 20 years in prison. If they both talk, they each get five years. If neither talks, they each get one year.

The U.S. steel industry faced a similar situation after President Bush's enactment of 30% tariffs on imported steel. Domestic mills raised prices on hot-rolled steel from a base of $215/ton in the fourth quarter of last year to $280/ton in the second quarter of this year. Not coincidentally, that is a 30% increase. Keep in mind that the cost to produce steel at the most efficient producers is approximately $240/ton.

Foreign mills that were able to compete in the U.S. during the fourth quarter of 2001 were now able to compete with the very same margins they enjoyed before by simply paying the tariff. All that had happened was that steel buyers were now forced to pay an extra 30%, either to the domestic mill or to the U.S. government, and U.S. mills were making $40/ton instead of losing $25.

The dilemma facing the domestic mills was whether or not to continue raising prices. If they did, they would enjoy increased margins while steel buyers moved more and more to offshore sourcing at pricing roughly equivalent to the then current domestic price. If this happened, we would repeat what happened in the second quarter of 2000 when domestic mills raised prices $90/ton in the face of decreasing foreign prices, despite clear warnings that the pipeline was being filled with imported steel. Instead, prices fell $110 in six months and bottomed out at $130/ton below the May 2000 price.

The cause of this crash, and the genesis of the current Section 201 tariffs, was not that foreign steel was being dumped at below market prices. It was that there were no orders to give the domestic mills once the import pipeline began to deliver—not at any price. It was the mad scramble for something to roll that lead to the ruinous price competition among the domestic producers who were now faced with more capacity than the market could take, given the tremendous import volume that was beginning to arrive. The ironic thing from the steel purchaser's point of view is that they were actually paying a premium to foreign mills over the domestic spot price by the time the steel arrived here. On top of that, the value of steel inventories fell to the pricing levels of desperate mills seeking to generate cash to keep their doors open. Everyone in the steel business ended up losing.

The other option for U.S. steel makers in March of this year was to maintain pricing at the current level and enjoy an uninterrupted period of positive margins. Domestic capacity is not sufficient to meet domestic consumption, so imports are a necessity. At the then current level, there was a rough equilibrium where all the players could optimize the total good. Just as with the prisoners, the choice seemed obvious. It was not. Once again, without collusion, each mill had to decide what move to make. And once again, it was in the best interest of each mill to raise prices again and again, regardless of what the other mills did. If everyone else held pat, the mill simply made more money in a tight market, and the equilibrium was not disturbed. If everyone else went up, the mill made all it could before the crash returned. Either way, the individual mill was better off raising prices even though it would once again devastate the industry, probably before the year ended.

Since this was a real issue, not a textbook example, and since it seriously impacts thousands of employees, our domestic steel industry, our international trade policies, and the pocketbooks of every American, this dilemma was one that needed immediate attention. It did not get it.

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