Malcolm Turnbull says a massive adjustment in global steelmaking needs to be managed very carefully, especially in the world's biggest steel-producing country China.
The G20 summit, which the prime minister is attending in the eastern Chinese city of Hangzhou, is expected to call for a new global forum on reducing excess steel capacity.
"As countries scale back excess capacity, they have to do so in a way that they feel is fair - this is why it's important for people to be frank and to collaborate," Mr Turnbull told reporters in Hangzhou on Monday.
The prime minister said the scale-back had the potential to put millions of people out of work in China, creating social problems and injustices.
"We've overlooked the fact that these adjustments have political consequences here (in China) just as they do in other countries."
European Commission President Jean-Claude Juncker said on Sunday that China must set up a mechanism to address its problem of industrial overcapacity, saying it was "unacceptable" the European steel industry had lost so many jobs in recent years.
"Overcapacity is a global problem but there is a particular Chinese element," he said.
China produces half the world's 1.6 billion tonnes of steel and has struggled to decrease its estimated 300 million tonne overcapacity, and rising prices have given companies there an incentive to boost production for export.
Mr Turnbull said China was going through an unprecedented economic transition, from heavy industry to innovation.
He had been told during the summit it would reduce its steel production by 150 million tonnes .
The prime minister talked down the impact on Australian iron ore.
"The fact is that Australian iron ore is of a higher quality and cheaper than a lot of the iron ore that is produced in China," he said.
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