Beware China’s control of rare earth minerals

There was a time several years ago when the Australian business community viewed China in the same way we now see Japan: all opportunity and no real threat.

China’s penchant for building things saved our commodity-driven economy from a severe downturn during the global financial crisis. But as its rare-earth policies over the past couple of years suggest, trade policies are frequently treated as an extension of Chinese foreign policy.

Even if the Chinese economic miracle has decades more to run, there should be no more fairytales that its economic re-emergence will be trouble-free.

Rare earth metals are 17 metals that are used in a range of increasingly important commercial products such wind-turbines and hybrid cars, and also in the latest "smart phones",  iPods and iPads. Additionally, they are essential in a range of military technologies such as the United States's arsenal of "smart bombs" and other laser-guided weapons.

Up until the late 1980s, the US was the major supplier of these metals. In the early 1970s, China identified rare-earth metals as a "strategic priority". Through a combination of cheap loans to state-owned mines, cheap labour, and cost-efficient but poor and sometimes non-existent environmental controls, Chinese production increased by 40 per cent annually from 1978 to 1989.

Given economic and environmental costs of mining rare earths can be prohibitive, many foreign companies and governments were more than happy to stop mining and source these materials from China. Currently, 95 per cent of all mined rare earths originate in China. The US imports about 87 per cent of its needs from China while Japan is almost wholly dependent on Chinese suppliers.

In 2009, China’s Ministry of Industry and Information Technology released a white paper proposing to severely scale back, or even halt, all exports of rare earth metals. Before its release, Beijing was already cutting export quotas to economic and strategic competitors such as Japan by around 6 per cent each year. In the second half of 2010, export quotas were slashed by a further 72 per cent. A further decision to slash export quotas in the first half of 2011 meant only 14,508 tons are to be sold to foreign markets from January to June.

In reality, Chinese production of rare metals has been higher than official domestic and foreign targets indicates that a significant amount of the metals is sold to foreign firms without Beijing's consent.

Beijing justifies the quotas by claiming that it is in the process of shutting down many of the smaller and less-efficient mines that are doing enormous damage to the environment. Beijing also blames spikes in domestic Chinese demand for these metals – and Beijing openly admits that the needs of its state-owned clients will be met first.

There is an element of truth to these justifications. But it doesn't explain the scale of the increases for foreign quota restrictions which far exceed the closing down of inefficient and dirty mines, or statistics on domestic demand. Neither has there been any adequate explanation given for the sudden halt in all rare-earth metal shipments to Japan during the height of an ongoing dispute between Tokyo and Beijing over the Senkaku (Diaoyutai) Islands in September 2010.  

Unsurprisingly, Chinese policies have meant that per ton prices have increased from around $US14,400 in July 2010 to a peak of $US138,400 in February 2011 before settling at approximately $US110,000 a ton currently. This has been a boon for international rare earth miners such as Lynas Corp in Australia. But it casts doubt on the promises by China's Premier Wen Jiabao that rare earth metals will never be used as a point of leverage in economic or foreign affairs.

What is Beijing actually up to? It is well known that the Chinese Communist Party (CCP) pursues a policy of developing domestic champions that can compete with the leading international firms. When it comes to increasingly lucrative sectors that rely on access to rare earth metals, China seeks to give these domestic champions a head-start against established foreign giants by giving them privileged access to rare earth metals – whilst denying reliable supply to foreign competitors.

Moreover, given the number of years needed to mine enough rare earth metals from sites outside China, Beijing is attempting to force foreign companies who want access to large quantities of rare earth metals to form joint-ventures with local firms and base their manufacturing operations within China. Revealingly, any foreign company in such a joint venture is not subject to any quota restrictions.

In an economic environment where widespread industrial theft and espionage by state-owned enterprises is not just tolerated by authorities but encouraged, the country’s rare-earth quota policies begin to appear menacing.

Beijing’s policies have encouraged foreign miners to re-enter the rare-earth market, thereby diminishing China’s future supply dominance in this sector. But it leads to the broader point that China's rise will not mirror that of other East Asian powerhouses such as Japan or South Korea. Even before genuine democracy took hold in these countries, state involvement and interference in the economy was never as profound in these countries. Indeed, in the modern Chinese corporate-state, the captains of industry are invariably prominent CCP members and officials. 

Not long ago, critics of China's authoritarian political-economy and Beijing’s policies were dismissed by most Australians as lacking "nuance" and intent on stirring trouble. But the fairytale could be over. Australians are belatedly coming to the realisation that the greatest beneficiary of the open system over two decades might no longer be content to play by the same rules that has served it so well.

Dr John Lee is a Research Fellow at The Centre for Independent Studies in Sydney and a Visiting Fellow at the Hudson Institute in Washington, DC. He is the author of Will China Fail?.