Johannesburg — IT WAS entirely coincidental that news of the dispute between iron-ore producer Kumba and steel maker Arcelor Mittal SA over their iron-ore pricing contract broke just days after the government's new industrial policy action plan was tabled in Parliament last month. Yet the one has a direct bearing on the other. And the history of that contract should sound a warning that when a government intervenes to favour one industry over another, the consequences may be unexpected.

To recap: the contract was signed in 2001, at the time that Kumba was unbundled from what was then Iscor. It committed Kumba to supplying Iscor with 6,25-million tons of iron from its Sishen mine (and a further 2-million tons from its Thabazimbi mine) a year at cost plus 3%.

The spin from Iscor at the time was that its "ownership" of that iron ore production was central to the deal, under which Iscor kept 21% of the Sishen mineral rights, while Kumba took the rest. It's that 21% that is crucial to the current legal battle, with Kumba arguing that it is no longer obliged to supply ore at cost plus 3% because Iscor missed last year's deadline to convert that 21% to a new-order mining right and therefore no longer owns that production. And there's big money involved: one analyst calculates it will cost Mittal almost R19bn in the next five years to pay a market-related price for that ore.

Of course, the iron-ore market was different in 2001, before Chinese demand rocketed and commodities began to boom. The steel market was different too. The deal was done in the context of a dispute between Iscor and the Industrial Development Corporation over their jointly owned and ailing Saldanha Steel, a dispute eventually resolved when Iscor was persuaded to take over Saldanha.

Perhaps the sweet iron-ore deal was part of the package. But there's no question that then trade and industry minister Alec Erwin and his officials were intimately involved in all these deals, and that included ensuring that Kumba went along with it.

Erwin was also involved in bringing a new foreign shareholder into Iscor at about the same time - the Mittal-family-owned LNM. And when LNM sought to raise its stake in Iscor to a controlling one, Erwin insisted on a "developmental" pricing agreement with the Mittals, under which Iscor would supply steel to the domestic market at prices that would encourage the development of downstream industries.

This was a long-held industrial policy aim and it was no doubt expected that Iscor would pass on the benefit of its cheap iron ore by way of cheap steel prices. It never did. And this was hardly surprising. The developmental agreement didn't really commit the steel maker to anything. And why should the company have sold its steel cheaply when it could take advantage of its market dominance to sell it at market rates, and more?

One of the reasons for the Department of Trade and Industry's hostility to Mittal over the years has clearly been the notion that it should have delivered on its side of an implicit bargain with the government - and no doubt the government hopes it can use the current iron-ore dispute as leverage to get the cheap- steel deal it always wanted.

But when governments meddle in these things, they had better know what they are doing. They are seldom as smart as the lawyers and experts the private sector can bring to bear. Nor are market forces as amenable to moral suasion as government ministers hope. That is one industrial policy pointer from this dispute. But another, perhaps more crucial, one is to "be careful what you wish for". Arguably, the 2001 agreement served simply to entrench the steel maker's market dominance, by giving it a supply deal that rivals couldn't get. The government may complain about inadequate competition, but how complicit has it been in that?

Mittal produces about 70% of SA's steel; it does not produce all of it. There are four other steel makers that produce steel using iron ore, which they have to buy at market prices, or from scrap metal - which, again, they buy on the market. Indeed, some argue that where Mittal's key input is in effect subsidised, the opposite is true for those steel makers that rely on scrap, much of which is exported - forcing local producers to pay international market prices or more.

Whether the Kumba-Mittal dispute will be settled, or will go to arbitration, is still unclear; so, too, is whether the government will intervene and how far it might tip the scales in Mittal's favour, if the company promises, say, to supply steel at below market prices, perhaps to some of trade and industry's favourite downstream sectors. If that does happen, spare a thought for Mittal's rivals. They survive and even thrive in Mittal's shadow because they are efficient. But they are also vulnerable. Mittal might be able to survive on cheaper prices, at least for a while, but smaller steel makers will find it far harder. So the government should weigh the possible consequences carefully if it intervenes in this or other sectors of the economy.

Joffe is senior associate editor.