China risks overplaying its hand by curbing rare earth exports

Mint

18 hours ago

China has once again weaponized its dominant position in the supply of rare earth minerals. It has imposed stringent export curbs on these elements that are critical inputs in a range of industries from automobiles to aerospace and defence. The move comes as a response to US restrictions on the export of semiconductor technology to China.
These battles are being waged against the backdrop of a broader truce in the once-escalating trade war between the world's two largest national economies.
The Chinese chokehold on the supply of rare earth minerals has sent a jolt through many industries in other parts of the world, including India. For example, there are fears that assembly lines in the automobile industry will grind to a halt in the coming weeks unless China starts exporting rare earth minerals again.
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This is not the first time that Beijing has restricted the flow of rare earth minerals across its borders. It did so in 2010 after a dispute with Japan on the high seas, and was forced to roll back its export curbs by the World Trade Organization in 2015.
Even though China's export ban was targeted at Japan, other countries naturally saw it as a signal of what could happen in the years ahead.
The effectiveness of any export restriction depends on three factors. First, how important the input is in the production structure of the country's economy. Second, how easy or difficult it is to increase the production of that input in response to higher prices that naturally follow restricted supplies. Third, how concentrated the production of that input is in one country or in a small cartel of countries.
Rare earth minerals are needed in many important industries, their supplies are inelastic and China has a massive share in their production.
That suggests that the rest of the world will be at the mercy of China.
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However, such events create incentives for governments as well as private companies to respond strategically. There is perhaps a lesson to be learnt here from what happened after the first oil shock to hit the world in 1973. The oil embargo that year brought many economies to their knees, but it also led to a search for new energy supplies as well as incentivized companies in sectors such as automobiles to build more fuel-efficient products.
Can that happen in the case of rare earth minerals as well?
In a recent paper titled 'Trade and Industrial Policy in Supply Chains: Directed Technological Change in Rare Earths, National Bureau of Economic Research Working Paper,' four economists have taken a closer look at the broader consequences of the earlier supply squeeze. Laura Alfaro, Harald Fadinger, Jan S. Schymik and Gede Virananda have shown that export restrictions on rare earth minerals imposed by China in 2010 triggered a surge elsewhere in technological innovations as well as exports in sectors that used rare earth minerals as inputs.
More specifically, they found a surge in patents in downstream industries that use rare earth minerals, both in terms of using them more efficiently as well as developing alternatives. This increase in patents in countries outside China exceeded the overall rise in patents in industries that use rare earth minerals. Productivity, as proxied by exports growth, also improved.
In other words, technological dynamism helped the rest of the world adapt to Chinese monopoly power in rare earth minerals.
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This is a more general lesson. Jensen Huang, the head of chip-maker Nvidia, said at a recent technology industry event in Taipei that firm attempts by successive US administrations to deny China access to advanced technology have actually spurred rather than hindered Chinese innovation. 'The local companies are very, very talented and very determined, and the export control gave them the spirit, the energy and the government support to accelerate their development," Huang was quoted as saying by The Guardian.
Parsing his statement provides two lessons. First, that there needs to be a private sector innovation ecosystem that has the ability to respond to either higher prices or restricted supplies. Second, there have to be at least some additional government incentives as well as policy clarity for innovators. They complement each other.
The point is not to tell a sanguine story about how all will be well in the long run. It is instead to point out that dynamic economies adapt to changing circumstances. 'In capitalist reality as distinguished from its textbook picture, it is not (traditional) competition that counts but competition from the new commodity, the new technology, the new source of supply, the new type of organisation," wrote the prophet of innovation, Joseph Schumpeter, in Capitalism, Socialism and Democracy, his classic work.
The Chinese dominance in rare earths is undoubtedly a strategic lever that Beijing will use to increase its geopolitical heft in an unsettled world. However, the overuse of such power will create strong incentives for others to adapt by innovation—as everyone from West Asians to Americans have learnt over the years.
The author is executive director at Artha India Research Advisors.