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China Rare Earths Quotas — The Facts And The Law

Posted in China Business, Legal News

By Steve Dickinson

The purpose of this post is to provide a factual and legal background to China’s export quota program for rare earths.

The Facts

Rare earths are one of 49 products for which China imposes export quotas. Other products for which China imposes export quotas include grains such as corn and wheat, hydrocarbons such as coal and crude oil and various metals such as tin and zinc. As explained below, this entire set of export quotas appears to violate WTO trade rules prohibiting export quotas as a general principle. Mexico has challenged the quotas on metals other than rare earths in the WTO. The dispute resolution panel is expected to render its decision on that challenge in April of this year.

The U.S. has repeatedly threatened to challenge the rare earths quota system. If Mexico prevails on its metals claim, we can expect a challenge to the rare earths quotas to follow soon thereafter. It appears that the entire Chinese export quota system can be challenged as a violation of the GATT prohibition on numerical export quotas. We can therefore expect this issue to remain a critical trade friction item between China and the rest of the world.

China began imposing quotas on exports of rare earths in 2008. Quotas are issued on a six month basis. The quota for the first half of 2011 has been set at 14,446 metric tons. This is an 11.4% decrease from the quota for the equivalent period of the prior year. This decrease has led to concern that China is planning to substantially decrease rare earths exports in 2011. Representatives of MOFCOM have said, however, that the quota for the first half of the year should not be taken as an indication of China’s plans for the full year.

The history of China’s rare earths quotas is as follows:

Quota (tons) Year Period

23972吨 2007年 Second第二批

22780吨 2008年 First第一批

11376吨 2008年 Second第二批

15043吨 2009年 First第一批

16267吨 2009年 Second第二批

16305吨 2010年 First第一批

15952吨 2010年 Second第二批

14446吨 2011年 First第一批

As can be seen, there has been a gradual downward trend in the quota amount. In the general plans for management of the rare earths mining and export industry in China, the regulators have indicated that they intend to maintain the total annual quota in the range of about 35,000 tons per year. This means no dramatic increase or decrease in quota is expected through 2015. During that same period, world demand for rare earths is predicted to dramatically increase. Clearly, the new supply will have to come from some location outside of China.

Quotas for 2011 have been provided to 31 companies. This is an increase of 9 companies compared to last year. MOFCOM indicates that the 9 new exporters are all foreign owned enterprises. 

The large number of exporters means that no single exporter can strongly impact price. The Chinese believe that “ruinous competition” between this large number of exporters has led to an unreasonably low price. The regulatory authorities are considering several plans to reduce the number of exporters through merger and acquisition. However, there is strong resistance to this plan at the local level. For this reason, though several plans have been discussed, no plan has yet been adopted for addressing the price and competition issues.

Legal Basis

The legal structure for the export quota system is as follows. Trade in the PRC is governed by the Foreign Trade Law 对外贸易法 (Trade Law). Consistent with GATT, Article 14 of the Trade Law provides that export and import trade in goods and services is free in principle. However, Article 16 provides that export may be restricted for various reasons. Among the justifications for restricting exports is the protection and conservation of exhaustible natural resources. This is the justification for limiting exports of rare earths and other metals.

Export restriction is managed pursuant to the Regulations Concerning Management of Commodity Exports and Imports货物进出口管理条例 (Export Regulations). Pursuant to Article 35 of the Export Regulations, items falling under Article 16 of the Trade Law can be restricted through export quotas and export licenses. The actual administration of the system works in two steps. First, an Export Restriction Commodity Catalogue限制出口的货物目录 is published on an annual basis. This Catalogue currently lists 49 items for which export is restricted. See 2011年出口许可证管理货物目录. Rare earths are listed in the Catalogue as item number 21. No reason is given in the Catalogue for inclusion of this item. Second, MOFCOM and related agencies publish the export quota on a biannual basis. Typically, there is both a total quota and also a breakdown of quota by license holder. For rare earths, the most recent quota amount was promulgated on December 28, 2010. See 2011年第一批稀土出口配额的通知. The quotas were issued later than normal this year, presumably due to the various domestic and international concerns related to the reduction in quantity of quotas.

I have described the quota system in detail for a reason. Many foreign commentators have suggested that the rare earths quota system arose by surprise or that the system is a random restriction by the Chinese government as part of some sort of natural resources power play. This position is not correct. China’s rare earths quota system is part of a clearly laid out and carefully managed quota system that applies to 49 key commodities and manufactured products. The system is predicable and easy to follow. Moreover, the entire export quota system is based clearly on Chinese law and regulations and is implemented in a completely transparent manner. Anyone who expresses “surprise” at the system or confusion about its implementation is simply ignorant of very clearly documented Chinese foreign trade policy.

The Rare Earths Quota System Violates GATT Prohibitions on Export Quotas

Though the rare earths quota system is firmly grounded in Chinese law and regulations, the program appears to violate basic WTO trade rules. Article 11 of the GATT provides as a basic principle that export quotas are prohibited. Article 20 of the GATT provides for limited exceptions to this general principle. For rare earths, the applicable exception is Article 20(g), which provides that it is acceptable for a contracting state to make use of a numerical export quota if two requirements are met. First, the quota relates to conservation of natural resources. Second, the quota is adopted in conjunction with a domestic program that imposes similar conservation restrictions on domestic producers.

It is not clear whether the Chinese quota program meets the first test. However, the Chinese quota system does not meet the second requirement and therefore it violates the provisions of the GATT. Though Chinese authorities have discussed imposing conservation limits on domestic production of rare earths, no such limits have been imposed. Moreover, the issue was not even discussed when rare earths export quotas were imposed in 2008. The threat of the United States and other countries filing a complaint with the WTO against this system should therefore be taken seriously.

UPDATE (1-22) Donald Clarke over at the China Law Prof Blog makes a very interesting comment on how the WTO does not forbid imposing export taxes and on how increasing those taxes could accomplish the same thing:

The odd thing to me is that WTO rules make evading this prohibition very easy, because they don’t prohibit export taxes, even those set at a prohibitively high level. Thus, by replacing the export quota with an export tax, China could restrict exports to exactly the same degree it does today and make a bit of money for the treasury in the process. I can only assume that there is some obscure reason related to politicking among domestic interest groups that explains China’s not doing so.

I am thinking China has chosen not to go the tax route because it does not provide nearly as good a cover for its claim to have reduced export quotas so as to reduce “ruinous competition” and better help preserve the environment. In other words, a tax would not go over as well politically as it would be viewed as the Chinese government getting greedy. What do you think?

  • Chris Simpson

    Excellent article!
    It explains things in a very clear rational way.
    Well done! Great reporting!

  • Stephanie

    This is fantastic explanation, Steve. Thank you for laying it out clearly for those of us who are non-trade lawyers.

  • http://www.foreignentrepreneursinchina.com Clara Muriel Ruano

    If you are interested in the topic, there is also today an article about rare earth quotas on The Wall Street Journal, trying to look for a reason why China is doing this now:
    http://blogs.wsj.com/chinarealtime/2011/01/19/rare-earth-quotas-big-bark-less-bite/

  • Robert Kawaratani

    Thank you for a clear, concise explanation of the situation. Too bad the various news media did not do the research required to provide an explanation of this quality.

  • Twofish

    One other thing to point out is that international trade law is not one of those situations in which a treaty provision that says X necessarily means X. For example, if one country insists on a strict interpretation of X, then that strict interpretation can be used against them, and so there are a lot of WTO provisions in which countries have agreed not to enforce strictly. A lot of these agreements end up creating precedents, and if you ever try to read an argument before WTO, it’s truly mind-numbing.
    Here is the commentary on article 11
    http://www.wto.org/english/res_e/booksp_e/analytic_index_e/gatt1994_05_e.htm
    If you want to read the full case in mind-numbing detail
    http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds394_e.htm
    http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds395_e.htm
    http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds398_e.htm
    The other important thing about trade law is that WTO does not have the power to force a nation to do anything. What WTO can do is to make a finding that a nation’s laws are inconsistent with WTO norms and then authorize countervailing measures.
    Something that makes the rare earth situation more favorable for China is that a lot of trade disputes involving China involve enforcing China’s accession agreement. When it comes down to an interpretation of the accession agreement, this doesn’t create any new precedents, and so other nations are not likely to get involved.
    In the case of rare earths, there is an issue of interpretation of GATT which applies to all WTO members, so there is going to be a lot of interest of third party nations who are going to be interested in seeing how precedents apply to them. A moment’s thought should explain why Chile and Saudi Arabia are participants in this case.
    Another point that gets lost, is that China tends to have more trade friction with Mexico than with the United States.
    One other odd note is that the cases were first filed in 2009, and are likely to go on for another year or so.

  • Duncan

    Very useful clarification Steve, thanks!

  • Twofish

    Q: I am thinking China has chosen not to go the tax route because it does not provide nearly as good a cover for its claim to have reduced export quotas so as to reduce “ruinous competition” and better help preserve the environment. In other words, a tax would not go over as well politically as it would be viewed as the Chinese government getting greedy. What do you think?
    Nope….
    China has a 30% rare earth tax, but the EU and the US are trying to argue that these taxes are not permitted.
    General WTO rules do not forbid export taxes. However Article 11(3) of the China Accession Agreement states….
    Article 11.3. China shall eliminate all taxes and charges applied to exports unless specifically provided for in Annex 6 of this Protocol or applied in conformity with the provisions of Article VIII of the GATT 1994.
    Annex 6 lists a lot of metals, but it does not list rare earths.
    However, China is attempting to argue that Article 11.3 of the accession agreement is overridden by the environmental exception in GATT Article XX, and this argument *has* been successful in another context in the past. If the DSB finds that GATT Article XX does not allow China to undertake quotas under GATT Article XI, they will also likely find that the Accession Article 11.3 prevents China from imposing export taxes.
    There is a term called WTO-plus. There are a lot of WTO rules that apply to China and only to China. The prohibition on export taxes is one rule that applies only to China but few other countries. One thing that is curious, is that under international law, the United States is allowed to have export taxes, but Federal export taxes are illegal under the US Constitution (Article 1, Section 9).
    Also there are some tactical issues here. Suppose China cancelled all export quotas and just did the export tax. The US/EU would argue that this is not allowed by the special agreement China signed, and it would China versus the rest of the world. Now China puts in an export quota, so the US/EU now as to argue against *both* the GATT clause and the China accession argument. So it becomes China+Saudi Arabia+Chile+Argentina against US/EU.
    One reason I find trade law fascinating is that it’s like 20-dimensional chess.

  • Twofish

    Another chess move. The people that are screaming the loudest about Chinese rare earth exports are the US Steelworkers
    http://www.whitecase.com/alerts-09132010/
    Now what’s interesting is that the steelworkers likely want China to lose the case *and* refuse to comply with WTO. If China loses the case, and then changes its laws to comply with WTO, this would be bad for the steel workers.
    Why?
    Well, if China loses and then refuses to changes it’s laws, then the WTO can authorize the US to undertake countervailing measures, which would likely include allowing the US to reintroduce tariffs on Chinese steel that WTO ruled invalid in 2002.

  • Charles Liu

    It is also widely report fact China’s rare earth exports increased by 14.5% last year. It is also a fact the Chinese government is paying more attention to environmental issues and shuting down production that do not meet regulations.

  • Twofish

    One other thing. Newspapers like horse races where they can say “US wins!!!!” or “China wins!!!” The result of trade disputes is this long report of findings in which it’s often difficult to say “who wins.” In the case of the Audio Visual products case, it’s one of those things in which different people will read the report and conclude different things about “who won.”
    For example, if the panel concludes that Chinese restrictions on exports are inconsistent with Article XX(g) because China has not undertaking conservation measures, the report could then specify exactly what conservation measures are needed, and this gives China a chance to rewrite its regulations to comply with WTO.
    There are two findings which I think are likely
    1) First, the DSB is likely to find that Article XX(g) applies to China’s accession agreement. So the statement by China that “we will not have export taxes” will be modified to mean “we will not have export taxes unless there is a exception in GATT”. I think this is highly likely because another DSB has already ruled this in the Audio-Visual case
    2) I think it’s also very highly likely that the DSB will rule that production quotas are allowed under GATT. I just can’t imagine WTO declaring war on OPEC.
    This is one problem with the news media, because newspapers like to summarize things in one or two sentences “US wins” or “US wins, Ha!! Ha!!!”, and WTO rulings are something that you really can’t do that.

  • Anon.

    I believe they do have domestic mining and production quotas, and that there are actually three requirements in an Art. XX(g) defense, including the chapeau. Twofish, there needs to be an explicit textual basis in the relevant protocol obligation in order for GATT defenses to be applicable. They won’t just find that Art. XX applies to the “accession agreement” as a whole. There is no such basis in 11.3.

  • Suryavanshi

    Your anaylsis of China’s handling of its rare earths is proving accurate. Good job to you.

  • http://LSE student

    Interesting article and well explained so thanks. However I disagree that the information on export quotas is easily available. I have been trawling through MOFCOM trying to get numbers on the semi-annual rare earth quotas since early 2008 and apparently they only exist in Chinese and no translation is available. Writing to MOFCOM yielded nothing more. If you happen to have the numbers and the exact dates of the announcements (which is what I am struggling with at the moment), that would be of great help to my thesis.