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?

Forbes Magazine (which, BTW, does a consistently excellent job in covering China) has a new and interesting article out, entitled, “U.S. Talks Up WTO Piracy Ruling, But It’s All Wind” and subtitled, “Washington claims that the trade body took its side in a suit against China, yet the decision will not halt intellectual property theft.”

Piracy is a crime in China too. Sort of. (by Stephen Dann, http://bit.ly/1KhKZwO)
Piracy is a crime in China too. Sort of. (by Stephen Dann, http://bit.ly/1KhKZwO)

The article talks about how the United States government has been playing up its victory on two of its three claims, but since it lost the one really important one, its victory claim is little more than spin control. To grossly oversimplify, the WTO ruled that China’s criminal IP laws are not inconsistent with China’s WTO obligations.

China Law Blog’s own Steve Dickinson is extensively quoted downplaying the U.S. “victory”:

The U.S. claim was trivial and hyper technical. They won on the hyper technical issue. The only serious issue was the criminal sanctions issue, and they lost on that one. So what this means is exactly nothing,” said Steve Dickinson, a Qingdao, China-based lawyer and partner at Harris Bricken.

Moreover, piracy involving China’s own copyrighted films, music and other works is just as rampant as that for foreign-licensed goods. “If China cannot solve the problem for their own domestic industries, how can they solve it for the foreigners?” Dickinson asked. Indeed, Chinese copyright owners are as unhappy as American ones: the Music Copyright Society of China and domestic record companies last year sued popular Web portal Baidu for offering unlicensed music content.

This goes back to something we have been saying on this blog since its inception: China is getting tougher on IP violations and it will continue to do so in tandem with growing IP requirements of its own companies. IP in China is going to be much more closely tied to its own self interest, as opposed to the dictates of outsiders. Chinese companies are increasing their demands for IP protection within China, and as that continues we can expect to see IP protections in China continue to improve. But very, very slowly.