China Trade Policy Thwarts the Green Revolution

For some countries, trade policy is the stuff of arcane rules and wonky bureaucracy. But for centuries in China, trade has been the biggest bugaboo of foreign affairs. Every Chinese knows about the moment their country was forcibly "opened" to the West: British merchants compelled Beijing to allow imports of opium—a baleful product that many Chinese nonetheless desired—in the 19th century. More recently, though, the tables have turned. China has come to possess a raft of things coveted by those same foreign powers: cheap labor, abundant capital, and, as it turns out, the world's greatest supply of so-called rare earths—metals essential for everything from hybrid cars to iPods to precision-guided weaponry.

Which is why this past weekend's Sino-U.S. row isn't just about lowly rubber and poultry. (On Friday, President Barack Obama decided to impose a tariff of up to 35 percent on Chinese tires for the next three years; in response, Beijing threatened to return the favor with possible tariffs on American auto parts and chicken meat.) A Chinese Foreign Ministry spokeswoman called the U.S. move a "grave" form of protectionism, but episodes like these also give nationalistic Chinese an excuse to demand that Beijing hoard those rare-earth metals. It is already doing so, and its own protectionism may end up reshaping the global economy.

You're not alone if you can't name any of these rare-earth minerals. Words like yttrium, holmium, lanthanum, and thulium don't exactly roll off the tongue. All you have to know is that China has a near stranglehold on such ores, currently producing 95 percent of the world's supply and claiming about 60 percent of known reserves within its borders, mostly in the region of Inner Mongolia. The region's vice governor, Zhao Shuanglian, declared in early September that China planned to streamline the domestic rare-earth industry, impose export controls, and establish a national reserve mechanism. "We're not taking a short-term view of just trying to prop up rare-earth prices," he maintained.

Over the past decade, China has honed its competitive edge in producing rare earths, thanks to cheap labor, improved quality, and economies of scale. Extraction is a dirty job—in some cases crushed ore is doused with hot sulfuric acid—and therefore requires costly environmental-protection measures in developed countries. The combination of these factors, and a flood of cheap Chinese ores in the '90s, persuaded many mining enterprises in other countries with rare-earth reserves—from the United States to Russia—to reduce or even cease production. The biggest U.S. rare-earth mine at Mountain Pass, Calif., was closed, for instance, though it's now being revived by Molycorp Minerals.

Problem is, it takes up to a decade to develop a rare-earth mine on a commercial scale. Yet these 15 metallic elements happen to be essential in many emerging green technologies. They go into electric vehicles, into all the methods yet conceived for reducing carbon monoxide and microparticles in engine exhaust, and into high-performance metallurgy behind wind gearboxes. To name just one use that is bound to grow: rare earths are a key component (reportedly at least 12 kilos' worth per battery) in Toyota's famous green car, the Prius. Jack Lifton, a freelance analyst who works on rare-earths, estimates that global trade in these metals is roughly $2 billion annually, but the total market for the products that depend on them is up to $100 billion per year.

But just as these elements are becoming more essential, China is undertaking a new bout of resource nationalism. For some time, intellectuals representing what they call "patriotic" Chinese (that is, those who are hawkish about defending their country's national interests and skeptical of Western intentions) have demanded that their government play hardball in international trade–including rare-earth exports—and the decibel level has risen significantly since Western excesses triggered the global financial crisis almost exactly a year ago.

The government has fallen in line. China has already moved dramatically to curb export quotas for rare earths: last month a draft report by China's Ministry of Industry and Information Technology called for a total ban on shipments of terbium (a key ingredient in low-energy lightbulbs), dysprosium (used in the nuclear industry and lasers), yttrium (present in LEDs and TVs), thulium (which enhances medical imaging), and lutetium (used in alloys and polymerization). Other minerals, such as neodymium (crucial for hard-disk drives and wind turbines), europium (used in lasers), cerium (which reduces carbon monoxide in engine exhaust), and lanthanum (key for many hybrid and electric-car batteries), would face a combined export quota of 35,000 tons annually—woefully insufficient to fill global needs. World demand this year is an estimated 124,000 tons, and is expected to double by 2015.

Beijing officials say their goal is not to squirrel away the ores for themselves but rather to persuade manufacturers to build plants in China if they want to use Chinese-produced rare earths in manufacturing. But jitters have already swept through the Japanese government, which has drafted a "Strategy for Ensuring Stable Supplies of Rare Metals" that calls for stockpiling and securing supplies abroad. Japanese authorities are especially worried because their industries' hunger for rare earths is skyrocketing—it was 40,000 tons in 2008, meaning Tokyo's demand alone exceeded China's new export quota. Already, some Japanese users are compelled to rely on smuggled or illegally mined rare earths.

Other countries—namely Australia, the United States, Canada, and South Africa—are redoubling efforts to exploit their own reserves of rare earths. Molycorp (the owner of the Mountain Pass mine in California) and two Australian mining firms are slated to ramp up rare-earth production to some 50,000 tons by middecade. But these alternative producers cannot reach optimum capacity right away, so a crunch is inevitable. Among China's trading partners, there's some talk of invoking WTO commitments to try to prod the regime into more generous exports. But it'll be hard to force Beijing into magnanimity when it claims domestic supplies are needed just to meet internal demand. Worried about their own shortfalls, Chinese firms have scrambled to hook up with Australian rare-earth producers. One Chinese company doubled its stake (to 25 percent) in Arafura Resources Ltd., and another is awaiting Canberra's approval of its bid for majority share of Lynas Corp. Ltd.

In other words, rare earths are the sword of Damocles hanging over Beijing's trading partners. If and when they anger China, the People's Republic can cut them off on these essential elements. And nationalistic citizens will surely call on their government to play that card if China finds itself in a trade war like the one it is now spiraling toward with the United States. The effect would be felt across the developed world desperate for the technologies these metals enable. Tension would beset China's ties with the U.S. and Japan. And the long-term economic repercussions would affect the renewable-energy initiatives and defense industries of tomorrow—not merely the tires, car parts, and chickens at the heart of today's dispute.

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