The Debate over Rare Earths
Recent Developments in Industry and the WTO Case

Interview with Yufan Hao and Jane Nakano
July 11, 2012

NBR reunited two leading rare earths experts—Yufan Hao (University of Macau) and Jane Nakano (Center for Strategic and International Studies)—whose previous NBR Q&A details the political and economic dimensions of China’s halt of rare earth exports to Japan in 2010. Their latest remarks assess the context, possible consequences, and implications of the WTO case—for China, the rare earth industry, and global trade and politics.

In March 2012, the United States, European Union, and Japan filed a complaint in the World Trade Organization (WTO) against China’s rare earth trade practices. Rare earth elements are critical to many clean-energy and defense technologies, and China’s 97% share of global rare earth mining enhances international interest in how the country permits or denies their trade. Although China argues that its policies are intended to promote environmental and economic sustainability, and has rejected a call for the establishment of a WTO panel, the United States, EU, and Japan claim that China’s measures violate trade rules that the country agreed to follow upon its ascension into the WTO.

To better understand this debate and the outlook for the WTO process, NBR reunited two leading rare earths experts—Yufan Hao (University of Macau) and Jane Nakano (Center for Strategic and International Studies)—whose previous NBR Q&A details the political and economic dimensions of China’s halt of rare earth exports to Japan in 2010. Their latest remarks assess the context, possible consequences, and implications of the WTO case- for China, the rare earth industry, and global trade and politics.

Given heightened concerns since 2010 about both China’s temporary halt of rare earth exports to Japan and environmental and economic sustainability, have there been any significant changes over the past two years?

Hao: In the past two years, there have been a few developments regarding China’s rare earth industry and exports. On the domestic level for China, 2011 was the beginning of China’s 12th five-year plan, and a series of policies about rare earths were issued by the Chinese government. According to these policies, China’s rare earth industry would be highly integrated and consolidated into an oligarchic industrial structure, headed by a few industrial giants, within a few years. In October 2011, the Ministry of Environmental Protection also issued the so-called pollutant discharge structure, which is expected to increase the environmental costs associated with rare earths enterprises and transform modes of production and development.

Another key development happened in April 2012, when China’s rare earth association (the Chinese Society of Rare Earths) was established. Consisting of 150 members, it includes industry giants and has the aim of promoting sustainable and sound development of the sector. The establishment of the association is accepted as a move to consolidate the rare earths sector, unify efforts in dealing with overseas buyers, and resolve trade disputes.

Nakano: At the international level, there has also been greater emphasis on R&D projects that would reduce the amount of rare earth materials that are required for high-tech and clean energy products. According to a number of recent press releases, many of the Japanese auto manufacturers have been making significant progress in this regard. Some of the projects look to reduce the amount of rare earths used to produce goods by improving efficiency, while other projects are looking to develop technologies that require less in general or use substitutes.

What actions, if any, have other nations taken to offset China’s near-complete monopoly on rare earth mining?

Nakano: Overall, there has been an accelerated effort to look into rare earth supplies outside China. The Japanese government and private companies have been busy looking into potential new projects. Most recently, there was a discussion with the government of Kazakhstan.

Hao: That is true, some countries have also done something to solve the supply side of the issue. For instance, the United States has opened the Mountain Pass mine in California, and others have started to seek cooperation with countries other than China. I think Japan has also started to cooperate with Vietnam, India, and others in addition to Kazakhstan to explore rare earth reserves.

Since NBR spoke with you last year, the United States, European Union, and Japan have filed a WTO case against China regarding how the country restricts rare earth exports. How would you characterize the WTO case and China’s response to this multilateral effort?

Hao: The basis for the three complainants’ case is the WTO’s support for free trade, and that the three parties think that China’s export restrictions on rare earths are against WTO rules. However, many people in China feel that this case is quite ironic. These countries never complained to the WTO about China previously dumping underpriced rare earth product, as they did with China’s export of low-priced steel and textiles. They urged China to sell them rare earths at a very low price, and denounced rare earth export restrictions from a liberal economic viewpoint. And at the same time, these three groups are also very reluctant to sell China high-tech products, not to mention arms, which are produced using rare earths.

It’s also quite interesting that the case was announced by the U.S. president Barack Obama rather than the United States Trade Representative (USTR) or other administrative officials at the departmental level. Many people in China thought that this was done with a view toward U.S. electoral politics—that he did this nominally for reelection considerations: to gain domestic votes by condemning China again and to show that he is tough on China over trade issues.

So China’s response has basically focused on two points. The first is that China’s export restrictions do not harm these three groups. The aim of China’s restriction is to limit rare earth products or rare earth elements production enterprises with low standards of environmental protection, and not to limit the imports of the EU, United States, or Japan. In fact, only 60% of China’s export quota was used in 2011, which means that if Japan, the EU, and the United States wished to buy more rare earth elements at the market price, they could have. So the Chinese government did not limit their purchases.

Second, China argues that its restrictions satisfy the exceptional provision of the GATT because they are “necessary to protect human, animal, or plant life,” and related to the consumption of exhaustible natural resources. Some in Beijing feel that the Chinese government should affirm that such efforts are most effective in conjunction with restrictions on domestic production and consumption, and that the government should even consider inviting Western media to visit the rare earth mines, to increase understanding of how terrible environmental conditions are in them.

Nakano: The March filing came as no surprise. It was one outcome of some years of unsuccessful efforts—whether in a Sino-Japanese or Sino-U.S.-Japanese context—to resolve the issue in a much less visible, quieter manner. The Chinese explanations seem to heavily focus on the environmental and sustainable resource development points which are generally protected under WTO rules.

Yes, China’s dominance of the global rare earth supply has come at a great cost, with serious environmental issues. But many consumer countries feel that China will have to provide a much more satisfactory answer as to why the export quota has been declining while the production quota has been increasing. Also, it’s one thing to have the overall level of export quotas unchanged, but it would be quite another to allow exports—in a sufficient amount—of the types of rare earth materials that consumers want. I would be interested in seeing how much of the overall export quotas break down into heavy rare earth materials (which are in much great demand) versus light rare earth materials. Additionally, I’m aware that the Chinese government spokesperson has explained that quality variation and Chinese customs practices may be contributing to the difference between Chinese domestic prices and international prices. But these explanations do not seem to be satisfactory to China’s rare earth trading partners.

Hao: I agree. I think that China indeed has some price differentiation between rare earth elements sold in China and rare earth exported to overseas markets. But I think that the extent of this difference depends on how you calculate it. As Jane correctly pointed out, some of this may be due to processing costs and the involvement of lots of middle agents in international transactions.

What led Japan to join this case? Is this a departure from how Japan typically engages on international trade issues?

Nakano: Japan has been strongly interested in resolving the rare earths case with China since the restrictive export quota policies were instituted. I’d imagine even from the Chinese side that the hope was to resolve it without taking it to a third party/international body.

In late June, Japan—together with the United States and the EU—decided to request the WTO to establish a dispute settlement panel. From what I understand, this is the first time Japan is taking China to the WTO over an energy case. But whether that’s a departure is another issue. I don’t necessarily see it as such. I think the Japanese decision underscores how essential rare earth materials are to the Japanese economy. As you recall from our discussions last year, Japan has many companies that are more intimately involved in the rare earths processing business than some of the countries in this WTO case. Many Japanese companies have been feeling pressure to relocate some of their facilities and, more importantly, production technologies or processes, to China to minimize impacts from rising costs and/or shrinking supplies. But it’s too early to conclude that this case signals a departure from overall Japanese trade policy and posture toward China.

How would China’s trade relations be affected were the United States, EU, and Japan successful in their WTO suit?

Hao: I would say not too much even if the three parties won the case. We know that the WTO procedure for a suit like this normally lasts one to three years. In such a long period, many changes will probably happen.

On the one hand, Western dependence on China’s supply of rare earths may decrease as more resources outside of China are exploited and more advanced technologies (including rare earth substitutes) may be developed and put into use. But China’s rare earth element export quota may not be significantly affected by these trends.

On the other hand, in two years China will probably have accomplished its goal of integrating its rare earth industries, and may have found a way to improve efficiency and address environmental concerns. This may affect the export of rare earth elements, but is unlikely to go against a WTO ruling.

A successful WTO case against China may force China to drop its dual price system, but as China reduces production, there may not be excessive materials available on the market. China could also restructure its export quota system in line with WTO regulations to allow for the free trade of more prevalent, lighter rare earths that can be produced in California and other areas, but could reduce the export of the more rare heavy elements. This could flood the market with material that would make U.S. production less competitive and restrict the availability of materials that are critical to defense technologies. So that is actually a possible unintended outcome.

But the least possible scenario is that China may simply refuse to comply with the ruling. Although there are no police to enforce this strictly voluntary system, China has other interests to maintain and it is in China’s interest to go with WTO regulations and ruling. From a historical perspective, China’s entrance into the WTO contributed a lot to China’s internal reform, economic development, and industrial uplift. So the WTO case regarding rare earths may help China to upgrade and integrate China’s rare earth industry. If the case is won by the United States, EU, and Japan, costs for Chinese firms would eventually increase, resulting in domestic production and usage of rare earths that is more efficient and more environmentally friendly. The downstream industry in particular would be forced to upgrade technology. So I would say that looking at a larger picture, this is not a bad thing for China at all. Although China may feel pain from a negative ruling, it is more or less good for China in the long run.

Nakano: I agree with Yufan that the WTO dispute settlement process may take several years and many things can happen during this time. As far as the supply side goes, there has been general momentum led by the Chinese government to clean up and consolidate the industry to address environmental issues or to eradicate illegal mining since before the March filing with the WTO.

On the demand side too, there have been all these efforts put in place by the Japanese, even before the Senkaku dispute-led rare earth trade issue in 2010, to start diversifying supplies and to also increase R&D funding levels. So, the WTO process is valuable but may not necessarily be the most effective in addressing the fundamental supply security issue. The value that the United States, Japan, and the EU see may be that it is a formal message to China to play by the rule of law in international transactions as defined by the WTO. This doesn’t take anything away from the WTO process, but we just need to manage our expectations—both the upsides and downsides—on how the ruling may affect the fundamental supply security issue.

How, if at all, does the rare earths case affect Sino-Japanese relations?

Hao: I would say that it wouldn’t affect Sino-Japanese relations in a fundamental way. Facing disputes over other, more sensitive issues like Diaoyu/Senkaku and historical issues, both China and Japan hope to not make their bilateral relationship more complicated over the rare earth issue. Since Japan’s sources for rare earth supplies are also becoming more diversified, Japan’s rare earth dependency on China will decrease and so the impact of this issue may decrease steadily.

Nakano: Sino-Japan relations are multifaceted, and I do not expect the WTO case to negatively affect the overall state of bilateral relations. But it is possible for some tensions to arise over strictly bilateral trade relations. I wouldn’t necessarily overestimate this possibility, because there are so many types of stakeholders on both sides; trade officials from both countries might have a more similar view on the tone in which this case should be pursued than energy officials from both countries.

Whether Japan is involved or not, China may increasingly come under a greater level of expectation from the international community to play in accordance with the rule of law in terms of international transactions. Yufan earlier used the word “pain,” and I think this is part of a growing pain for China as it becomes an important global player. In other words, developed economies might have gone easier on China a few decades ago, but they now feel that they can go tough on China because it is a powerful economy. And many feel that it is in everyone’s interest for China to be much more integrated into the international system.

Hao: China is also learning to play its role as a responsible world power. As China grows, there are many, multiple level issues that China needs to learn to handle properly, particularly to meet the expectations of the world community. However, many people in Beijing also hope that the rare earth elements issue will not be politicized. It is more or less of a commercial dispute by nature, but if people outside of China—say the EU, Japan, or the United States—try to see it as a means used by the Chinese to pursue world domination or undermine a competitor, that is perhaps overstated. China hopes that the rare earths issue will not be politicized.

This interview was conducted by Clara Gillispie, Project Manager for Trade, Economic, and Energy Affairs at NBR, and Stephanie Pfeiffer, an Intern at NBR.