The Rare Earth Case against China at the WTO: Who Wins?

On 28th March 2012 officials from the United States, the European Union and Japan met in Tokyo to discuss how to cooperate to secure supplies of rare earths and other critical materials.  Emboldened by the recent decision of the WTO Appellate Panel on the previous set of raw materials, on 13th March 2012 these three parties made a formal request for consultations with China concerning a range of export restrictions imposed on 17 rare earths, tungsten and molybdenum. This followed the failure, at the end of January, of China’s appeal against the WTO decision concerning its export restrictions on a number of raw materials and the joint action taken earlier in March by the US, the EU and Japan to bring a case against China concerning rare earths, tungsten and molybdenum.


Lessons from the previous WTO case


On 30th January 2012 the Appellate Panel of the World Trade Organization (WTO) ruled against China in the case brought against it by the United States, the EU and Mexico concerning export restrictions imposed by China on a number of raw materials including bauxite, coke, magnesium, manganese and zinc. This ruling came more than two years after the three parties logged their original complaint in December 2009 following consultations that started in June of that year.


The two main findings of the Panel against China’s main export restraints were:

1.    Export duties. Under its Protocol of Accession to the WTO China has the right to apply export duties to only those 84 products listed in an annex to the Protocol. These materials were not on that list. Therefore China cannot invoke Article XX of the GATT (General Agreement on Tariffs and Trade) for these materials under any conditions.

2.    Export quotas. China’s export quotas could not be justified under Article XI: 2(a) of the GATT as being temporarily applied to relieve a critical shortage of foodstuffs or other essential products. Nor could the quotas be justified under Articles XX (b) or XX (g) which refer respectively to the need to “protect human, animal or plant life or health”, and to the “conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption”.


Of particular relevance was the introductory paragraph to Article XX which states that any restrictive measures must “not constitute a means of arbitrary or unjustifiable discrimination between countries” or “a disguised restriction on international trade”.


The current case


The current case is focused principally on rare earths and was triggered by events in the year 2010. China has imposed export quotas on the export of these materials since at least the year 2000, but these quotas were higher than external demand until 2010. On 7th July 2010 China’s government announced a reduction of 40% in the export quotas for rare earths for 2010 compared to 2009. Soon afterwards, an international incident occurred when on 8th September 2010 a collision took place between a Chinese trawler and two Japanese coastguard vessels. The Japanese coastguard arrested the captain and crew of the Chinese vessel, and kept the captain in custody after the release of the crew. In response China imposed a temporary “unofficial” ban on rare earths exports to Japan on 23rd September, though China has always denied such a ban existed.


In their consultations with China, the United States, the EU and Japan are likely to assert that any WTO arbitral panel will come to the same conclusions for these metals as it did in the previous case. Particular arguments may include (1) that these materials are also not on the list in the Accession Protocol of permitted goods on which export duties may be imposed, and (2) that China has not carried out measures in conjunction with the restrictions in order to constrain domestic production or demand, as required by Article XX. 



China’s management of its domestic REE industry


In response, China is certain to argue that it has been taking such measures since 2006 when it first started to develop policies to reduce the output of rare earths and to improve the regulation and management of mining and processing in this industry. Between 2005 and 2008 the export quota had been reduced by 25% and plans were drawn up to constrain production by closing hundreds of small-scale operations and consolidating larger operations. Initially, output exceeded the official targets because of poor policy implementation. But once the prices for rare earths started to fall in 2008 and 2009, following the global financial crisis, the government accelerated policy implementation. In this respect the program to close rare earth element mines resembles the campaign to close small-scale coal mines after the decline of coal prices following the Asian financial crisis in 1997. In both cases, an important objective has been to prevent the major state-owned producers being driven out of business by illegal small-scale operators.


The government drew up a formal Rare Earth Element Development Plan for 2009-2015 to address the poor regulation of the industry, especially:

        Smuggling, which amounted to 33% of rare earth element materials leaving China in 2008;

        Severe environmental damage in the form of poisonous gases, acidic and radioactive water, and mine tailings which damage waterways, land and health;

        Poor health and safety standards at mines, especially lung diseases and cancer.


The government has also been explicit in saying that it wants keep the nation’s rare earths for domestic consumption, a strategy that will clearly support an industrial policy to attract foreign manufacturers to China and that will promote its own industries to process and use these materials, especially for phones, wind turbines and electric vehicles.


In 2009 the Ministry of Land and Resources stopped issuing licenses for the exploration or mining of rare earths, and drew up plans to identify core mining districts and to reduce the number of companies that can mine and process rare earths from 90 in 2010 to 20 by 2015.  The Ministry of Industry and Information Technology started to put in place more effective regulatory and monitoring systems and the Ministry of Environmental Protection established new pollution standards for discharges from the rare earth industry. Official ceilings on annual levels of mine output have been steadily reduced and even some larger mines have been ordered to suspend production. Finally, the government plans, and has probably already started, to develop a strategic stockpile of these materials.


This is the sort of evidence that China is likely to present in its defense of the export quotas, drawing on Article XX (b) and (g), but any export duties are still likely to be condemned on account of the text of the Accession Protocol.


Improving the rare earth element supply chain


Interesting though it may be, the WTO case is a side show to the real business of improving the rare earth supply chain, which will have been the main focus of the discussions in Tokyo. China may have 95% of today’s production, but it has only about 30% of the proven reserves. Significant reserves exist on every continent. New mines are being opened and old ones re-opened. By 2015-2016 we should expect significant production, including of the geologically scarcer heavy rare earths, from North America, Australia, Vietnam, India, Australia and Russia. This will probably cause prices for the metals to fall and stay low until such time as demand catches up with supply.


Meanwhile technologists are working on ways to constrain the consumption of rare earths further down the supply chain, through efficiency measures, recycling and substitution. The quantity of rare earths used can be reduced in the manufacture of products such as wind turbines and catalysts for oil refineries. The greatest potential for recycling lies in permanent magnets, which is a high growth rate sector (for computers, cars and wind turbines) and in nickel-metal-hydride batteries. The key is to design the products so that they can be recycled easily and to design systems to help the end user participate in the recycling schemes. Substitution is likely to be more challenging in most cases. Two promising examples include the gradual replacement of nickel-metal-hydride rechargeable batteries which contain rare earths by lithium-ion batteries which do not, and the replacement of fixed magnet motors in vehicles by induction motors.


So, who wins?


If China has indeed been deliberately acting to distort the international market for rare earths by restricting exports, then this strategy will backfire, as was the case with the Arab oil embargo in the 1970s. The importers suffer short-term pain, but are stimulated to realize long-term gain by exploiting new deposits and enhancing efficiencies along the supply chain. In the case of oil, prices fell from US$ 30-40 per barrel in the late 1970s to just US$ 8 by 1986. So the revenues of China’s companies from the export of rare earths are likely to fall in just a few years. However, the country will (hopefully) have a better regulated and managed industry for mining and processing rare earths, and it will have built new manufacturing industries around the domestic supply these metals.


For the importing countries, mainly developed economies at present, the measures that are being implemented, primarily by the private sector, should greatly enhance short-term security of supply as well as the overall efficiency of resource use along the supply chain. Rather than treating the situation as a crisis caused by an actor (China) breaking the (WTO) rules, we should rather see this as a long overdue wake-up call to manage our resources better and to diversify our supplies. New technologies will be developed and companies in the West will make profits.

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