Shipbuilders’ Shotgun Weddings

There may be no industry that has lost more money over a longer period of time than shipbuilding. If two recently announced mergers go through, governments may finally have figured out how to stanch the red ink—by putting an end to competition.

Governments have long considered shipbuilding a vital industry, largely because shipyards building oceangoing vessels routinely employ thousands of workers and are major consumers of steel. The lion’s share of the world’s commercial shipbuilding after World War Two—nearly two-thirds in 1960—occurred in Europe, more or less on a commercial basis, to replace merchant ships lost during the war. In the late 1950s, when Japan elbowed its way in, government aid for ship construction was relatively minor, except in the United States. Japan’s low labor costs gave it an edge in building oil tankers, while orders for passenger ships, general cargo ships, and then container ships kept European yards busy. But the 1973 oil crisis changed matters abruptly. Demand for tankers plummeted, and trade in other goods was hit hard by the spreading recession. Many ship owners refused to accept delivery of vessels they had ordered but no longer needed. Orders placed with Japanese shipyards fell 90 percent between 1973 and 1978, and the decline was nearly as steep in Europe. Governments began sending money by the boatload to keep their shipyard afloat.

It was at that moment, when the industry’s outlook already seemed dire, that South Korea determined to become a shipbuilding powerhouse. Korea’s rapid industrialization over the previous decade had depended on exports of labor-intensive products such as clothing and footwear. Government economic planners, concerned that rising wages and other countries’ trade restrictions would crush the apparel manufacturers, set a course for heavy industry. In 1972, they opened Pohang Iron and Steel Company, a government-owned steel mill that was perhaps the most highly subsidized industrial venture in history up to that point. This was followed by a shipbuilding development plan, which proposed to build nine shipyards by 1980 and five more by 1985.

Korean shipbuilders previously had made only small vessels for fishing and coastal trade, mainly out of wood. The government pressured industrial companies with no background in shipbuilding to build and operate the new yards, granting them tax holidays, low-interest loans from state banks, and guarantees that let them borrow cheaply overseas. Hyundai the country’s largest industrial conglomerate, was induced to build the first yard at Ulsan, thirty-five miles down the coast from the mill at Pohang, which could furnish steel at low cost. The late Korea scholar Alice Amsden recounted how Hyundai was granted scarce foreign currency in order to acquire foreign ship designs, but was so inexperienced that when it followed a design calling for building an oil tanker in two halves, the completed halves did not fit together. When the buyer refused to accept the ship, the government supported creation of a new ship line, Hyundai Merchant Marine, to take the unwanted vessels off the shipyard’s hands.

As a job-creation strategy, the shipbuilding development plan proved wildly successful. Subsidies to the shipyards and the Pohang steel mill, along with Korea’s low wages, allowed Korean yards to underprice competitors in Europe and Japan. By 1990, South Korea’s ship production was eight times higher than it had been in 1975, while every other major shipbuilding nation was producing far less tonnage than before. Subsidies flowed freely in Europe and Japan, keeping shipbuilders alive and delivering vessels to ship lines at bargain prices.

In 2006, the Chinese government identified shipbuilding as a “strategic industry” and set a goal of China becoming the largest shipbuilding nation within a decade. It backed this up with heavy state investments: thanks to an estimated $4.3 billion of subsidies, two state-owned companies, China Shipbuilding Industry Corporation and China State Shipbuilding Corporation, added more than 100 dry docks large enough to build commercial vessels within seven years. Chinese ship owners—many of them state-owned companies—went on a demolition spree, replacing their older tankers, bulk ships, and containerships with new, highly subsidized ships built almost exclusively in Chinese yards.

China quickly dominated the market for bulk ships, used to transport raw commodities such as coal and ore: between 2006 and 2012, 57 percent of new bulker tonnage worldwide was produced in China. Breaking into the market for containerships, far more complex vessels, was tougher. As late as 2005, almost all large containerships were built in South Korea and Japan.  But with ample state aid, China quickly moved up the learning curve. Building in a highly subsidized Chinese yard cost 20 to 30 percent less than building in a highly subsidized Korean yard. It was no wonder that between 2006 and 2012, China built about two-fifths of the world’s new containership capacity.

Over the past few years, the Korean yards and the Chinese yards have slugged it out, with plenty of government money financing the battle. Now, though, the Korean government has more or less directed the two largest shipbuilders, one of which is already under outright government control, to merge. The Chinese government responded in July by directing the two large Chinese yards to merge.  Between them, the two giant shipbuilders that will emerge from these shotgun weddings will control roughly 56% of the global shipping order book and an even larger percentage of the capacity to build complicated vessels such as mega-containerships and liquefied natural gas tankers. Subsidies are likely to go down, which means vessel prices are likely to go up. When it all shakes out, ocean shipping may be much less of a bargain.

Tags: China, competition, Korea, shipbuilding