The economics behind China’s rare earths restriction

Henry Lin


September 4th, 2013

Has China been gaming the rare earth metals market? Henry Lin takes a look at what is an emerging diplomatic issue.

Rare earth metals are versatile elements which are central to the modern era and future technological advances.  We commonly recognize their existence through use in things such as iPads, plasma TVs and solar panels. Yet it also has a wide range of applications in other sectors such as industrial/manufacturing use as well as military component production and nuclear medicine, which have then given rise to things like fibre-optic technology, advanced batteries, high tech lasers and so forth. Given its importance in providing a new frontier of innovation in the modern economy, it is no wonder the world is concerned over China’s export quotas and production restrictions that have been in place from 2009 to now. This article will analyse the rationale behind the policy.

Despite their name, rare earths are actually about as abundant as your common industrial metals such as copper and nickel (gold on the other hand is drastically rarer than rare earths to put it into perspective). However, the problem is it is rare for them to form in economically viable deposits where extraction can take place through open pit mines – rather, it is spread out around the world in small concentrations. This is where China comes into the picture with its huge concentrations in Inner Mongolia and clay pits in southern China. Not surprisingly, the flood of cheap rare earth metals in the 1990’s from China pushed out the competition. This has made China a monopoly in the production of rare earths with 90% of today’s production coming from it, down from 95%+ in 2007 despite only having 37% of the worlds proven reserves of rare earth deposits. Fast forward to today, we see the government scaling back production and implementing export quotas, possibly to game the market. Every year from 2009 there have been tighter restrictions; export quotas dropped roughly 30% year-on-year across this period whilst mine closures and productions caps were implemented in 2011.

The Chinese government claims it is primarily for environmental reasons: to prevent over-exploitation and the residual environmental damage from the mining along with the processing of rare earths. However, if this were the case, wouldn’t it have been better to just have less production from the beginning? From an economics point of view, by implementing export quotas China was effectively hoarding the rare earths for domestic production and this drove up the price of the material for foreign countries. As most of you would have deduced at this point, this meant Chinese manufacturers gained a competitive advantage in manufacturing products that used rare earths. The Chinese government’s policy was to reduce exports of this material, but not the finished goods, and so this created an intentional loophole for foreign businesses that were dependent on rare earth materials to use. Those foreign businesses could avoid the risk of high prices for rare earths and supply shortages created by this policy if they moved their manufacturing to China, or even just the manufacturing some of components they need in China.

Now, remember that this policy was implemented after the height of the GFC, when countries were facing weak aggregate demand overall and firms were looking to restructure to become more competitive. There was more consequently incentive for rare earth dependent firms to move manufacturing to China, and also more incentive for the Chinese government to keep the economy stable from the woes of its major trading partners. China’s political system has always had an emphasis on economic numbers; as long as they look good, the communist party rule will continue without much concern for political upheaval. As more firms moved manufacturing offshore to China, it boosted employment and the GDP from it was essentially transferred into its own books. In addition, it also supported the urbanisation process that China was also transitioning through by creating more jobs and preventing unemployment from spiking during times of recession from its major trading partners. That’s not to say this policy contributed a lot to China’s economic performance during the period, but it would’ve been the economic rationale behind it and it did support the massive stimulatory policies which the government implemented.

This type of policy was only possible by way of leveraging their monopoly status in the rare earths market, as it takes time and money to start new uncompetitive supplies. On the other hand, China’s claims of environmental problems associated with rare earths production are true. The hazardous radioactive waste from mining, possible disruptions to underground water supplies and the polluting fumes from processing them into useable material are a concern policy makers need to take into account. Hence why reducing its production in the past two years has been supportive to China’s environmental policies, a recent addition to their political agenda. As long as they achieve their goals in a reasonable fashion, it will create political stability which the Chinese government strives to maintain.

The drawback of these restrictions of rare earths is the unfair anti-trade nature of the policy, which affects the rest of the world by pushing up prices of rare earths and limiting their supply – something foreign governments have been vocal about. The other concern for foreign governments has been centred on the military importance of rare earths metals. Some suggest that China can exert some influence over US presence in Asia, and also on Japan which is a top importer of these resources.

In all fairness, it was a well-thought-out and well-timed policy given the circumstances the Chinese government faced and the goals they strived to achieve. Although attempts to undermine the Chinese monopoly in the rare earths market are ongoing and may possibly succeed in the future, what we have here is an example of the technocratic economic policymaking the Chinese government is known for.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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