US, EU, Japan Challenge China on Rare Earths

15 March 2012

Following months of speculation, the US, Japan, and EU have jointly launched a WTO challenge against China’s export restrictions on rare earths, as well as tungsten and molybdenum. The move - announced Tuesdayyes - comes just over a month after the global trade arbiter’s highest court confirmed that Beijing violated WTO law and its accession protocol by restricting the exportation of nine raw materials.

The 17 controversial rare earth elements have unique magnetic, heat resistant, and phosphorescent properties and are crucial ingredients in the manufacturing process of many high-tech and green energy products, including wind turbines, engines for electric and hybrid vehicles, and medical equipment.

The complainants in the case argue that China’s export quotas on the elements, combined with its near-monopoly over global production - some 97 percent of the world’s supply, according to EU estimates - are highly disruptive to domestic industries and result in higher production costs. Market prices experienced a 20-fold price increase between mid-2010 and mid-2011, but have since fallen back in line.

They further complain that the policy offers Chinese competitors an advantage by providing them with cheaper and easier access to the elements compared to foreign manufacturers.

Environmental grounds

In line with its rationale on restricting raw materials, China argues that the extraction process for producing rare earth elements is highly damaging to the environment and that the quota restrictions have nothing to do with trade disruptions.

“In previous communications, China has emphasised that the purpose of these measures is to protect exhaustible natural resources and environment as well as maintain sustainable development,” China’s Ministry of Commerce (MOFCOM) said in a statement. “China does not intend to protect domestic industry by distorting trade.”

While environmental grounds can be used in some instances to justify trade barriers at the WTO, the Appellate Body earlier this year ruled that Beijing’s export restriction policies for nine raw materials failed to meet the requirements set out by WTO law (DS394395398).

The Appellate Body ruled that these environmental exceptions could not be applied, as they were not explicitly referred to in the section of China’s accession protocol that prohibits export duties (see Bridges Weekly, 1 February 2012). They also confirmed that quantitative export restrictions for finite natural resources taken with conservation aims could only be justified if they were coupled with similar limitations on domestic consumption and production.

For its part, Brussels argues that, despite the intended environmental protection goal of China’s rare earth export policies, Beijing’s approach is unlikely to achieve such an outcome.

“The EU supports and encourages all countries to promote an environmentally friendly and sustainable production of raw materials,” the EU said in a 13 March press release. “However, the EU believes that export restrictions do not contribute to this aim; there are more effective environmental protection measures that do not discriminate against foreign industries.”

But this case might be different from the 2009 raw materials spat. As recently as this past January, China reformed its rare earths quota system, introducing additional environmental protection requirements as a prerequisite for receiving export permits.

The export restrictions are also part of a broader campaign by Beijing to address the pollution challenges that come with rare earths extraction. The government has wrestled with rampant illegal mining around the country for many years - a practice that will likely be exacerbated by any clampdown on production.

Meanwhile, some experts say that Beijing’s perceived stranglehold on rare earths extraction as a means to boost local downstream industries may not be as straightforward as previously thought.

A recent article by Indiana University professor Scott Kennedy for GK Dragonomics suggests that the policymaking process on rare earths in China is so fragmented among different levels of government that Beijing’s intentions may have little to do with reality on the ground.

“The general pattern has been for local governments to pretend to agree with central aims, and then go about doing whatever is needed to help their local firms,” Kennedy writes.

This fragmentation of rare earths policy prevents China from achieving many of its major objectives, including consolidating the industry and obtaining downstream technologies from foreign competitors, Kennedy argues, despite the country’s dominance in rare earths mining.

US election year

The joint challenge is the latest in a series of road bumps in China-US trade relations and the issue is likely to intensify as President Barack Obama shores up his defence from Republican accusations that he is not doing enough to improve the domestic job market.

Republican presidential candidates, particularly Mitt Romney - considered by many to be the frontrunner for his party’s nomination - have been hammering Obama on his China policies on the campaign trail, a strategy that will likely intensify as the November election draws nearer.

Obama, however, says he is on firm ground vis-à-vis China, recently boasting that his administration has brought trade cases against China at almost double the rate of that of previous president George W. Bush. In addition to recent skirmishes over China’s solar panel and wind power subsidies, Obama in February announced the creation of a new agency tasked with identifying unfair practices by US trading partners.

The president noted the new Trade Enforcement Unit in a statement Tuesday, suggesting that the US has taken on a new, less tolerant position on alleged trade violations.

“Our competitors should be on notice:  You will not get away with skirting the rules,” Obama said in a statement. “When we can, we will rally support from our allies.  And when it makes sense to act on our own, we will.”

China is also facing a once-in-a-decade leadership change this year, with Wen widely expected to be replaced by Vice President Xi Jinping. Trade featured prominently in discussions between Xi and Obama when the two met in Washington last month (see Bridges Weekly, 22 February 2012).

The request for consultations on the rare earths issue is the first step in the WTO dispute settlement process. Should the parties to the dispute be unable to reach a resolution after 60 days of talks, the EU, US, and Japan will have the right to ask that a WTO panel be established to hear the complaint.

ICTSD reporting; “AP source: US brings new trade case against China,” ASSOCIATED PRESS, 13 March 2012; “Obama Takes Aim at China With Plan for WTO Case on Rare-Earth Export Caps,” BLOOMBERG, 13 March 2012; “US to challenge China over rare earths,” FINANCIAL TIMES, 13 March 2012; “Trade Issues With China Flare Anew,” THE NEW YORK TIMES, 12 March 2012; “Deals Shows China’s Sway in Rare-Earth Minerals,” WALL STREET JOURNAL, 11 March 2012; “U.S. and Europe Move on China Minerals,” WALL STREET JOURNAL, 13 March 2012.

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