Beijing, intoxicated by double-digit growth even as the west slogs through hard times, seems inclined to flex its economic muscles these days. It chose to express its displeasure with Japan in a largely symbolic territorial dispute by embargoing exports of vital industrial minerals called “rare earths.” And, for a while, it appeared that the embargo was aimed at the United States, too – perhaps to head off Washington’s inclination to use the trade laws to repel China’s aggressive foray into the market for green technologies.
Whatever the goal, the delay in shipments served as a wake-up call to the reality that China has a virtual monopoly in rare earths. But before governments invest in breaking China’s grip, it’s worth remembering there are potential costs in doing too much as well as too little. In particular, we’d hate to see this brouhaha used as a rationale for substituting government measures for more effective private ones.
Some perspective is in order. As a rule, selective export embargoes backfire – or at the very least, have unintended consequences. After President Nixon briefly barred exports of soybeans to counter soaring prices at home, Japan responded by underwriting production in Brazil. This eventually created a formidable, low-cost competitor for American farmers, eroding surpluses enjoyed by the United States in global grain exports.
The mother of all selective export embargoes was, of course, the Arab oil embargo in 1973-74 in retaliation for U.S. support of Israel in the Yom Kippur war. It certainly had a significant impact on the intended victim, triggering a recession and transferring a lot of wealth to oil producers. But much of the damage was self-inflicted, as Washington floundered in helping the economy adjust to higher cost energy.
Consider, too, that the oil embargo did not work as intended from the Arab perspective. The impact was not selective: Oil prices changed equally in all importing countries, friend and foe, because in a global market, fungible commodities have a way of ending up in the hands of the highest bidders. It only led to higher oil prices because the Arab producers had the market power to reduce total production.
The circumstances leading to China’s embargo of rare earths are hardly identical to those underpinning past manipulations of the oil market. But there are parallels with implications for governments on both sides of the market.
While China’s current grip on rare earth production is rock-solid, the monopoly is highly vulnerable to competition in the long term because the minerals are found in abundance in a dozen countries. In fact, the primary reason China dominates the market today is because the government has effectively subsidized exports by maintaining an undervalued currency and ignoring the very considerable costs of pollution in mining.
China’s embargo targeted Japan. But it is almost inconceivable that the selectivity would have worked very long – here, too, because the market is global and the commodity is fungible. Moreover, China, like the Persian Gulf oil producers, must tread carefully lest it lose market power altogether. Indeed, the scramble to diversify supplies of rare earths in the wake of this first brief embargo suggests just how fragile that power may prove to be.
So where should that leave policymakers in consuming nations? It’s tempting to respond with strategic countermeasures designed to break the monopoly, as we did with oil back in the 1970s. No doubt, technocrats (and corporate lobbyists) are already busy fleshing out the possibilities: government stockpiles, long-term government purchase guarantees, subsidies for developing technological substitutes, fast-track environmental regulations. But the always wasteful and often futile history of government efforts to free oil consumers from OPEC’s vise should give pause.
Before marshaling government power and money to ease dependence on Chinese rare earths, it makes sense to ask whether private markets could do the job alone, or with only minimal help. Why, for example, should Washington stockpile rare earths or stimulate production by guaranteeing future purchases if GE or Ford – or, for that matter, hedge funds – have adequate incentives to do it on their own? Why, if Toyota is prepared to invest in new sources, should Uncle Sam do the job for General Motors? Just because Vietnam or India seem willing to accept more pollution in return for a pot of gold from new mines, must California make the same bargain?
China scored an advantage in securing market power over some vital industrial minerals. But that advantage came at the cost of ignoring the health of its citizens and the loss of wealth implicit in under-pricing exports. The rest of us need rare earths – but we probably don’t need to emulate the worst aspects of Chinese capitalism to assure reliable supplies.
(This post was also published on Forbes.com.)
