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China U.S. Dispute Over Raw Materials. Rare Earths Are Key.

Posted in Legal News

The U.S. has formally requested the WTO establish a dispute resolution panel concerning China’s recent decisions to restrict exports of certain key raw materials. This follows on the initial request for review made by the U.S. in June of this year.
These US government actions highlight the importance of China in the trade of certain key materials. The materials referenced in the complaint are: bauxite, coke, fluorspar, magnesium, manganese, silicon metal, silicon carbide, yellow phosphorus, and zinc, all of which are key inputs for numerous downstream products in the steel, aluminum, and chemical sectors across the globe.
It seems certain this complaint will fail.
Every country has the sovereign right to determine how to deal with its own natural resources. Entry into the WTO does not require a country to export any of its natural resources. All the WTO requires is that all purchasers who belong to the WTO be treated equally. If China refuses or limits access to all countries of the world on an equal basis, the WTO should have nothing to say. In the same way, the U.S. can decide that our own coal and oil and natural gas are too important for our own industries and people and therefore cannot be exported.
This complaint highlights a major issue for world trade down the road. Modern industry relies on certain metals that are actually quite rare. If export of those metals is disrupted, it will cause severe dislocations in many high tech and other businesses. For China, the big issue is actually not the metals listed above. The big issue is rare earths. China is currently overwhelmingly the largest supplier of rare earths in the world, with well over 90% market share. Rare earths are essential to produce the magnets required for motors for electric cars and for certain components used in wind power turbine manufacture. China recently imposed restrictions on the export of rare earths. It is clearly China policy to gradually force all manufacturing using China rare earths to occur in China. Without the location of an alternative supply, China is in a position to dominate electric car production market for many years. This no doubt helps explain why Warren Buffet’s Berkshire Hathaway chose to buy into BYD Company, a China based battery and electric car company. [Full Disclosure: Dan has been an investor in Berkshire Hathaway almost ever since Buffet-directed investments made his alma mater, Grinnell College, the "wealthiest liberal arts college" in the United States]
As part of a similar strategy, China is seeking to control the market for other key minerals by strategic purchases outside of China. Some of the target minerals are platinum, chromium and silica sand. Like it or not, China’s approach seems much more likely to succeed than the filing of disputes with the WTO.

  • Falen

    I also want to add that aside from the production of rare earth, China also currently dominates in the related processing and its technology, as well as leading in the research of rare earth usage.
    It’s no accident that this whole “rare earth” story has become the subject of many an “investment tip.” Anyone whose E-mail box has been flooded with investment newsletters should know the whole deal already: “China is limiting rare earth exports, therefore put your money into Lynas, Mountain Pass, or Greenland, etc”
    Personally, such investments are too risky for my blood. As if investment in mining isn’t among the riskiest of investments, betting on rare earth outside of China also means betting against China’s determination to control the market. I’d rather play with my money elsewhere… like gold.
    Nevertheless, the whole rare earth story is still interesting from an investment perspective, and one should definitely keep up on it.

  • Timjames

    Is anyone here of the opinion that a healthier and more understanding foreign policy with China might alleviate this kind of behavior without resorting to a cry to the WTO?
    That is if the U.S. wasn’t so actively pursuing baseless tariffs & continual criticism re: human rights, currency manipulation, environment etc., would China do this? Or, in the alternative, might they listen closer to our pleas before WTO action? Do we even plea to them now before using the USTR/WTO?
    Having lived in and of course loved the humility of China – and having understood the interdependence of our economies, I’ve always agreed generally with this blog that it’s in our govt’s best interest to build the strongest relationship possible with the country. Sometimes however I wonder if the opinions and prejudices of our gov/military/media/society-at-large are justified.

  • shah8

    That thinking is just begging for a resource curse situation that destroys the gov’t ability to control said resources. We in the west have had considerable experience in exploiting internal divides, not to mention the sort of infighting that rare earth metal utilization would cause–they are crucial in *every* aspect of a modern civilization and different departments/industries would have a need for them.

  • http://www.liquidassetdevelopment.com Greg

    It depends, the simple act of imposing export restrictions may not be a violation, but doing so to force more outsourcing, manipulate metals prices, etc could be seen as manipulating trade…just like fixing a currency’s exchange rate.
    But car batteries are just the tip of the iceberg. The heavy industry, space, electronics and military implications are immense. The US and Australia have considerable reserves as well. Rare earth minerals is a big reason why China wants to hold on to Tibet so badly, because the vast majority of China’s rare earth finds are in Tibet.
    China and the US also hold most of the world’s known phosphorous reserves, there is no real replacement for phosphorous in fertilizer.
    I keep in touch with the mining industry in Colorado and alarms are going off left and right.

  • http://www.liquidassetdevelopment.com Greg

    I would counter Falen’s and Tim James with the knowledge that the global mining industry has knowledge of rare earth deposits outside of China. Environmental and labor costs have kept them out of those areas, but not any more. Expect to see an increased drive to recycle electronic components through near sourcing in Latin America. Don’t forget Carlos Slim made good money in recycling and it put him on the road to being the 3rd richest man in the world.
    Greenland still has to thaw out. There is still Alaska, Siberia and mining exploration is occurring in Antarctica. Attempting to corner a market and use that control to assert leverage, especially with regards to crucial materials, leads to various forms of backlash and alternative approaches.
    And gold is just another commodity.
    And don’t think natural resources aren’t considered

  • Falen

    Yes there are deposits outside of China, but the risk is that they will take many many years to develop before production can start. THEN once you have the production up and running, what about the processing? Very pointless if you still have to ship your ores to China for process…
    Setting up these facilities are very risky solely simply from an business perspective, but now we also need to account for China government prancing around these ventures, looking for ways to pull a rug from under your feet. Remember, China can keep the price and quantity simply at the right level to make these ventures unprofitable. The same goes for recycling (tho recycling is never going to fulfill any significant demand to diminish the monopoly)
    The only way to counter this stranglehold is with state intervention, guaranteeing investment in these mines and processing facilities… I am not sure that’s politically feasible given that rare earth still isn’t that big of a political story and once again the government would be betting against the Chinese government…

  • Falen

    BTW Greg… I thought the rare earth deposit is in Mongolia, not Tibet.

  • http://www.harrismoure.com Steve

    Correct, the rare earth mine is in Inner Mongolia. Tibet is an interesting place. So far, the mineral resources in Tibet are negligible.

  • http://www.liquidassetdevelopment.com Greg

    Oh, no. Tibet is loaded, but the they are not yet extractable due to the high altitude and rough conditions.
    Whatever is in Inner Mongolia will also be in Mongolia and the Russians, US and Japanese have extensive mining operations.
    And isn’t just the US filing the WTO complaint, it is the EU and Mexico.
    http://www.ft.com/cms/s/0/6b6956e6-cb01-11de-97e0-00144feabdc0.html
    @ Falen,
    China can try to manipulate the global price to its advantage, but only if it is willing to export the material. Since it is not willing to export the material, that leaves nations and industries free to set up their own agreements outside of the commodities exchange, which is becoming common practice anyway to dodge speculators.

  • http://docs.law.gwu.edu/facweb/dclarke/ Don Clarke

    Steve, I’m sorry to appear to be always disagreeing, but I must with respect disagree with your analysis here. (And anyway, what’s the point of comments that say nothing but, “Right on, brother!”?) To say that “every country has the sovereign right to determine how to deal with its own natural resources” is OK as an abstract proposition, but it’s not the rule that will govern this particular dispute. Countries don’t have a sovereign right to do that which they have agreed not to do, and so we have to look at the WTO rules and China’s accession protocol to see what China has agreed to. Section 11.3 of the accession protocol states in relevant part, “China shall eliminate all taxes and charges applied to exports unless specifically provided for in Annex 6 of this Protocol . . . .” (the omitted part is not at issue). The new export duties are not provided for in Annex 6. Thus, the US’s prima facie case looks quite sound to me.
    The issue for the WTO is whether China can claim the benefit of possible exceptions to this obligation. China has, since accession, already imposed export taxes on a number of products not listed in Annex 6, and has claimed it can do so under Articles XI and XX of the GATT. For various reasons I think those justifications don’t hold up, but that’s not important here. The point is that China itself has not suggested that these export taxes are justified by a general sovereign right to deal with its natural resources as it sees fit. China acknowledges that Section 11.3 of the accession protocol is both relevant and generally binding; it simply says that other parts of the GATT justify relief from its obligations in certain circumstances.
    It’s true that the WTO doesn’t normally have much to say about export taxes, but in China’s case there’s a ‘WTO-plus’ obligation in this area. Julia Qin of Wayne State Law School has an article coming out shortly that discusses this very case (“The Challenge of Interpreting ‘WTO-Plus’ Provisions,” 44 J. World Trade ___ (2010)).

  • http://www.chinalawblog.com Steve

    Don:
    Thanks for responding on this. In terms of disagreeing, I appreciate the time you take in doing it. The last time you disagreed with me, you were right and I was wrong. The whole point of blogs is to use dialogue to get at the truth.
    What Don is talking about in his comment is that for the WTO, China is subject to two sets of restrictions: first, the general rules of the GATT and second, specific rules that China agreed to when it joined the WTO. This second set of rules are contained in what is known as the “accession protocol.” Often China has a good argument under general GATT rules but a losing argument under the accession protocol.
    The difference was highlighted in the recent WTO dispute panel decision on Chinese import restrictions on books and other media. China suffered a major loss in this decision, most of which was based on the accession protocol, rather than on general GATT rules.
    What Don is pointing out with respect to the U.S. claim on raw materials, is that it is a mistake to refer only to GATT general rules. It is necessary, and often more important, to refer to the accession protocol when dealing with a special case like China.
    Don raises another fundamentally important issue for which I have no real answer at this time. It is pretty clear to me China will ignore the decision in the media import restriction case. If China loses on this export restriction case, it is pretty clear to me that it will also ignore that decision. The point of my post is: what happens when China does that? How does the world trade system respond in that case. It is a larger issue that merits discussion. Again, this is the point of my post: the China strategy is just to find a practical way to control the materials, 1) through control of its own resources and 2) through purchasing from sources that lie beyond its borders.

  • Falen

    WTO ruling on export is worthless. What’s to stop China to issue more stringent “environmental policy” to in effect control the rate of export? Even more simply, it could order the company to lower production…

  • Don Clarke

    Thanks, Steve. You raise an interesting question in your last paragraph: what happens if China ignores a WTO ruling? I think we can break this down into two questions: (1) what is likely to happen in terms of measures taken in response, and (2) how should we think about what happens? The answer to (1) is easy: if a country refuses to implement a WTO ruling, its trading partners are then permitted to impose certain trade sanctions that they would otherwise be barred from doing by WTO rules (e.g., raising tariffs on products from that country).
    The answer to (2) is more difficult, and I don’t know enough about WTO law or international law generally to know what the real experts think and whether there’s any consensus. Here’s the issue: do we read the WTO rules as saying, “You may not do X,” or as saying, “If you do X you must pay a price”? The law-and-economics view of contractual obligations, for example, is not that a contract obligates you to do what you promise; it’s that a contract gives you a choice between performing as promised and paying for non-performance, with no moral opprobrium attached to the latter. If we view the WTO as a multilateral contract, we could take the view that violations of DSB rulings are quite acceptable provided the violator doesn’t object when sanctions are then imposed.
    So it’s possible to think that if China ignores a decision, its partners will impose sanctions, and that will be the end of the story. No breakdown of the world trading system; instead, we see it as functioning just as expected. This is not the only way to view a disregard of DSB rulings, of course. One could argue that even compensated-for violations are bad for the system if there are enough of them, and therefore states can be properly criticized for violations even if they’re willing to pay the price.

  • http://www.langmichener.ca Cyndee Todgham Cherniak

    Don Clarke and Greg have raised very good points about the WTO rules and China’s Accession Protocol. It is right for countries to ask whether China is living up to its WTO obligations. This case will likely go the distance and is not as simple as your analysis would suggest (sorry – this comes from the point of view of a trade lawyer who has represented MOFCOM and Chinese companies).
    The irony is that countries are also complaining that Chinese goods are too cheap and imposing antidumping and countervailing duties against goods from China. For example, Canada imposes AD/CVD duties against aluminum extrusions from China, copper pipe fittings and copper alloy pipe fittings from China, certain oil and gas steel tube from China, carbon steel screws from China – all on the basis that the the prices are too low. Other countries have long lists too. When China raises the export prices for raw materials by imposing export taxes, WTO members complain. A witness in Canada’s aluminum extrusion case also complained when the export fees on aluminum extrusions decreased calling it subsidization (which it isn’t). There seems to be no acceptable trade balance (in the minds of developed countries and emerging markets such as India and Mexico and others) when it comes to China.

  • http://www.liquidassetdevelopment.com Greg

    The issue of commodity exports, especially metals and fossil fuels, which affect each nation’s economic and political security.
    This pits >>10,000 years of tribalism and nationalism against the vision/specter, dream/nightmare of “one world government”.
    The fact is that we are all for global treaties, rules, etc except when it comes to rulings that negatively impact our country of birth the country we choose to make our permanent home, or our individual beliefs and pocket books.
    We live in a nationalist world and each nation has the inherent right to act in its best interests. Human society is not ready for globalization because everything we have built for 10,000 years has been on the foundation of separate political entities.
    While China’s banning of certain industrial and rare metals may be bad form and break its WTO agreements, don’t be surprised to see other nations do the same. Canada has nationalized its water resources. The US has done something slightly similar by calling every puddle a “water of the US”. This is so that dry nations cannot use WTO rules to buy water rights in the US, or export water rights they may have access to as investors.
    We’ve all heard about the future resource wars. Well, the future is near and the lines are being drawn.

  • Falen

    I can definitely imagine a world of tomorrow where knowledge and expertise are abundant and natural resources are scarce. It is a world whereby every natural resources are bartered for one another as well as political deals.
    I am sad about that because some places are just so poorly endowed yet so overpopulated, like my native Taiwan… or Japan, etc. By comparison, a place like Australia has similar population, yet enjoys expansive landmass, rich natural resources.

  • http://www.liquidassetdevelopment.com Greg

    @ Falen
    Australia is in deep trouble due a lack of fresh water, so minerals won’t do them much good.

  • http://www.terramagnetica.com Gareth Hatch

    “Whatever is in Inner Mongolia will also be in Mongolia”…
    Not necessarily. Inner Mongolia is a *big* place and useful ore bodies generally do not extend over large distances.