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Economy

China Will Harm Itself By Cutting Shipments of Rare Earths to US

Jun 13 , 2019
  • Sara Hsu

    CEO, China Rising Capital Forecast

China is reportedly considering cutting off supplies of rare earth minerals to the US. There have been a number of articles discussing the immediate impact of this. Indeed, it would harm the US, however, this type of strategic economic warfare will end up also hurting nations that initiate the process in the long run—in this case, China. This is because threatening trade barriers will, over time, lead the US to pull away from gains made from trade with China and shift production elsewhere or induce trade partners to source elsewhere. Rare earths are a key example of this pattern.

Rare earths in the trade war

China provides 80% of US imports of rare earths, which are used in a range of goods, such as smart phones and electric vehicles. The US previously excluded rare earth elements from its tariffs, since they are key components in many electronics. Now, China has made several subtle threats that it will block exports of these elements from export to the US. Alluding to this possibility, last month President Xi Jinping traveled to a rare earth processing factory in Jiangxi province after President Trump moved to cut of Huawei's access to components. Also, the Global Times, a state newspaper, and National Development and Reform officials have both suggested that rare earths be used in the next stage of the trade war. This has led to growing concern among onlookers that rare earths will be the next target in the trade war.

As a response to the Chinese threat, the US is planning to undertake greater production or find alternative sources of these raw materials, though it will take some time. To this end, the Senate Committee on Armed Services included in its 2029 defense budget an increase in funding for the development of rare earth element production from coal ash. The US could also turn to alternative suppliers of rare earths, such as Australia or Brazil. In fact, in a clash with neighboring Japan, this is exactly what happened: China had cut the shipment of rare earths to Tokyo. However, rather than having a lasting negative impact on Japan, China lost much of its market share as Japan sourced the elements from elsewhere, permanently.

Long term shift to autarky

In the short run, the restrictions on rare earths will ratchet up tensions in the trade war and create a headache for US producers who rely on rare earths inputs into production. While the dollar amount imported isn't huge--the US imported $160 million of the materials last year in total--the elements play a critical role in production of high-tech goods and substitutes are not readily available. If the US is successful in shifting mining and processing of the elements domestically or to other countries, this will in the long run reduce demand of the goods from China and eliminate this category as an economic weapon against other nations.

In fact, this could apply to any relatively scarce resource that either side is willing to withhold from export or ban from import. For the US, tariffs on about half of goods imported from China -- about $100 billion worth of goods—have been especially harmful, since for these categories shipments from China represent over 50% of imports. This makes it extremely difficult to reorganize the sourcing of many products, but as the trade war deepens, entrenched supply chains are increasingly likely to shift.

In addition, the US has banned Huawei from receiving components and software from American firms, but experts say this will harm American companies economically without making the US more secure. There is a concern that Huawei and other Chinese technology firms will move away from sourcing from the US to other countries. This shift has precedent; before China re-committed to purchasing soybeans from the US, its tariffs on the agricultural goods induced retail and wholesale outlets to purchase soybeans from other countries, such as Russia and Brazil. This move shows that China will do its best to fulfill demand from countries other than the United States.

Losing game

The game could go on for some time, with either side pelting the other with new restrictions. Anything the other side exempted from tariffs likely represents a particular vulnerability. However, the longer the trade war goes on, the more likely it is that both the US and China will turn away from one another as trade partners and look for other sources of imports, or attempt to produce affected goods domestically. This will erase the strides made in negotiating free trade.

Ultimately, this is a losing game. Any weapon that will be used will ultimately be turned on the user. The US and China may be locked into confrontation, but these tit-for-tat maneuvers are looking less rational with every retaliation. 

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