The Chinese government has ordered the closure by the end of 2011 of steel mills with blast furnace capacities of less than 400 cubic meters. China’s 2009 steel production capacity was listed as 700 million tons, and the country’s mills produced less than 568 million tons in that year. Closing the mills is intended to improve both steel pricing and margins. China buys iron ore from BHP Billiton (BHP), Rio Tinto (RTP), and Vale (VALE), and all of these stocks have been affected by the move.

The government also said that it plans to shut down antiquated production capacity in sectors including power generation, coal mining, coal coking, and other industries in an effort to reduce the country’s energy consumption and to reduce polluting emissions. This year, coal-fired power plants totaling more than 50 gigawatts of capacity will be shuttered, as will 8,000 small coal mines.

The government’s effort to reduce the country’s steel making capacity is no doubt partly in response to rising iron ore prices. China buys iron ore from BHP Billiton (BHP), Rio Tinto (RTP), and Vale (VALE), all of which have recently shifted their pricing scheme to a quarterly contract and away from the annual benchmarking system that has been in effect for 40 years. The move has virtually doubled the price of iron ore, and China has so far resisted signing contracts at the new price.

Chinese iron ore miner Angang has indicated that it plans to double production in the next 10 years at a cost of about $2.15 billion. Angang now produces about 45 million tons of iron ore annually. To put those amounts in perspective, in the month of February, China imported nearly 50 million tons of iron ore.

Related: China Counters Iron Ore Price Hike with Boycott

Another reason for shutting down small steel makers is the effect these mills have on steel prices and margins. The small steelmakers in China, like the small coal miners, are essentially bootleg operations that run at the whim of local governments. Corruption and unsafe conditions are rampant, and the central government has really not been able to institute any real measure of control over local operations.

All the efforts of central planning get fouled up when local governments agree to do one thing with no intention of ever following through. Bootleg steel plants and coal mines provide income for local workers and payoffs for local officials, so no amount of central planning is likely to stop the operations. Only a central government show of force will do the trick, and China’s masters are not prepared to follow that path.

Finally, by announcing the closure of some of the country’s oldest and dirtiest coal-fired power plants, the Chinese government waves at reducing its CO2 emissions and cloaks itself in a mantle of green. China’s total generating capacity is about 874 gigawatts.

A reduction of 50 gigawatts of coal-fired generation could be offset by increased wind-power generation. China currently has installed about 25 gigawatts of wind-generated power, some 14 gigawatts of which was installed in 2009. But the country’s electricity grid can’t even transmit what it has. Building more wind farms won’t fix that.

Clearly, the government hopes that by closing down its least productive assets investment in productive capacity will grow. That would be good for China, and for the global economy as a whole.

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