Author: Shiro Armstrong, ANU

China briefly stopped exports of rare earth elements to Japan last year following a maritime collision near Diaoyu/Senkaku islands and the subsequent political fallout.

The reaction from Japan and other major buyers was alarm and protest as the metals are crucial to high-tech industries and China supplies over 90 per cent of rare earths globally (holding an estimated 37 per cent of the world’s reserves).

An unregulated, booming rare earths industry in China, combined with a very low international price for the metals, led to reductions in exports well before the collision in waters surrounding disputed territory in the East China Sea. China’s gradual tightening on exports turned to a screeching halt of exports after the incident last year with what was effectively a de facto export embargo, as customs stopped the shipment of rare earths. Exports were quickly resumed, partly because of the recognition that the ban wasn’t in China’s economic interests and partly because of the fear of WTO action by the US and Europe.

The unregulated rare earths industry in China has been a cause of significant environmental damage and the gradual restrictions on exports might also be seen in the context of an attempt to consolidate and regulate the industry in China. This is a second best policy instrument for dealing with the difficulty in internalising the price of the environmental damage in the industry.

The gradual tightening of exports of raw materials by China, including the use of quotas and export duties, was recently ruled illegal by the WTO. That serves as a warning on restricting exports of rare earths by the same methods. But the immediate damage to China’s trade interests came from the de facto export ban.

Some may think that there is no threat to China’s exports of rare earths, given its dominant position in global supply. But the temporary export ban had big consequences.

It raised the global prices of rare earths and, in the medium term, much larger supplies from outside China are coming on stream as previously unviable projects become economic. Those projects will take a little time to come on stream but China’s dominance of the market has been checked. There may be an over-supply as early as 2013 as there are over 200 rare earths projects under way at the moment, according to Jack Lifton.

China was right to recognise the potential damage to its industry and to lift the de facto export ban shortly after it was imposed. Japanese and other high-tech users will be stuck importing rare earths from China in the short run but the risks in dealing with China have increased. The long-term effect is to undermine China’s reputation as a reliable supplier — and not just for rare earths. With the increased risk factored in, foreign firms will look elsewhere to procure parts and components if the price is similar to that in China.

The United States learnt this lesson in 1973 with the temporary ban on exports of soybeans to Japan. The US lost market share in the long run and took a big hit to reputation. Brazil suddenly found itself making a large investment in soybean production out of Japan and became a significant supplier of soybeans to the global market.

While it’s difficult to know why or who in the Chinese system implemented the export ban, and why or who moved quickly to reverse it, the ban appeared principally designed to reduce domestic angst building up from the Japanese detention of the Chinese trawler captain off the Diaoyu/Senkaku Islands. It can also be reasonably assumed that the removal of the export ban was pushed by those who took a broader view of what was in China’s interests.

There was an attempt to limit the damage done. The robustness of the WTO as a constraint on such behaviour was also tested. The failure of the Doha Round raises questions about the future of the WTO and whether at some point in the future the WTO’s ability to restrain such behaviour might weaken.

Shiro Armstrong is a Research Fellow at the Crawford School of Economics and Government, The Australian National University, and Editor of the East Asia Forum.