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Rare earth - no case for government intervention

  • Georg Zachmann

China has officially restricted exports of rare earth for several years and announced this year it will further tighten exports. Rare earth is a group of 17 different metals, usually found clustered together. These metals have hundreds of different industry applications. For example, they are used in certain high capacity magnets, batteries and lasers. As the rare earth elements are used in sectors that are assumed to have an over-proportionate growth potential (eg. green-technology), policy makers are paying particular attention to them. In the policy debate, the different elements are considered jointly, as they are typically clustered together. But each element has its own supply and demand characteristics. Consequently, prices for the individual elements might differ by factor 20 (in mid 2010, Samarium was quoted at $32 per kilogram while Terbium was quoted at $600).As China is currently the predominant producer of rare earth (>95% of total production), the reduction of Chinese rare earth exports will have effects on global supplies. Thus, rare earth elements have been very actively covered in the media and various G20 policy makers (secretary of state Clinton, chancellor Merkel, etc.) have expressed their concern. Business interest groups want to put rare earth on the official G20 agenda – regardless, the issue will be unofficially discussed in Seoul. But should policy makers really care? This depends on what China wants to achieve by restricting rare earth exports. Chinese export restrictions for rare earth could be interpreted in five different ways - (1) China wants to save rare earth resources for future generations. As rare earth elements are abundant in both China and the rest of the world, this is a rather unlikely explanation. But even if easily produced sources are rare, a slow exploration for fear of overexploitation should not merit political concern, as the Chinese interest of a stable, long-term supply would be aligned with the global interest. (2) China uses rare earth to exercise political influence. The current case-in-point is a supposed freeze in exports to Japan, allegedly due to political disputes. In Foreign Policy, Tim Worstall argues convincingly that rare earth elements are an unlikely tool for exercising political pressure as they cannot be effectively monopolised by China. The reason is, that rare earth can be produced in many different countries (China only holds about one third of the known resources), admittedly at higher cost. (3) China is trying to reduce the ecological impact of rare earth production. The production of rare earth in China is very environmental unfriendly and hazardous for the corresponding workforce. Consequently, Chinese export reductions might be a move to reduce the price paid by workers and the environment for growth going elsewhere. In this context, export reductions might be an important tool to gain control of production in illegal mines. Even though paying higher prices for rare earth would not be appreciated by the Western industrial consumer, correctly pricing pollution and labour are well-accepted principles in Western countries. (4) China tries to maximize the profits from exporting rare earth. As in the short-run Chinese rare earth could only be replaced by producers with significantly higher costs, China is currently able to increase its profits by restricting exports of rare earth as the decreased export volumes are offset by the increased prices. Numbers quoted in the press, arguing that in 2010 a 30% decrease in exports occurred while prices increased threefold, would be consistent with a profit maximisation strategy. Extracting monopoly rents on natural resources is common around the globe. Most oil producers for example employ duties on oil exports to ensure that the fuel is exported at prices above the production cost. Such a profit maximisation is constrained by the entry of new suppliers. If China raised the price above a certain level, profit seeking mining companies would start producing non-Chinese rare earth resources (eg. in the US or Australia). Consequently, either China keeps the price slightly below the entry threshold or a limited number of producers would secure stable supplies of rare earth at prices supposedly somewhat above the production cost of the most expensive supplier. (5) China is using export restrictions for domestic industrial policy reasons. Restricting exports lead to a de facto double pricing. Domestic prices of rare earth would drop, while foreign prices would rise. This would give domestic high-tech producers a cost advantage over their foreign competitors. This last point has been the most discussed in recent months, as it seems to be in line with China’s mercantilist economic policy. This raises the question - Could such a strategy be successful? And would this harm Western economic interest? Subsidizing Chinese high-tech companies’ by double-pricing rare earth could of course be effective in increasing these companies’ world market share or profit in the short run.

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Paper provided by Bruegel in its series Policy Briefs with number 474.

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Date of creation: Nov 2010
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Handle: RePEc:bre:polbrf:474
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