- Foreign governments and companies are worried about China’s dominant position in the supply chain for rare earths, which are required for a range of high-tech industries.
- But China’s dominance, which derives from a historic willingness to tolerate pollution rather than from unique technological or geological endowments, is already in decline.
- Any decision by Beijing to cut off rare earth exports would only accelerate the decline of China’s dominant position, so Beijing would deploy such leverage only in an extreme scenario.
Rare earths are critical to a range of products including advanced military weaponry, personal electronics, electric vehicle batteries, and wind turbines. Concerns about China’s control over rare earth supplies have percolated since a 2010 incident in which the Chinese government temporarily halted rare earth shipments to Japan in response to a flare-up the territorial disputes in the East China Sea.
These concerns re-emerged in January, when China’s Ministry of Industry and Information Technology issued draft rules that could limit production and export of rare earths. In developing these rules, Chinese officials reportedly inquired with industry executives about the potential impact of restricting rare earth exports on the US defense industry, including production of F-35 fighter jets. The Chinese government’s recent restrictions on a range of exports from Australia has served as a reminder of Beijing’s willingness to use trade sanctions as a diplomatic weapon.
The 2010 incident prompted Japan to seek to diversify its sources of rare earths, including an investment by state-owned Japan Oil, Gas and Metals National Corp (JOGMEC) in an Australian miner, Lynas Corp. But China still maintains a powerful position, accounting for 90% of global production of all rare earth metals, alloys, and magnets in 2019, Similarly, China supplied at least 90% of all imports of rare earth metals and alloys to the US, EU, and South Korea, though Japan’s share had dropped to 49%.
Medium-term trends point to a gradual decline in China’s dominance. Despite the name, rare earths are not rare; deposits are widely dispersed around the world. China’s share of total rare earth mining production fell from 98% in 2010 to 63% in 2019, while its share of total reserves fell from 50% to 37%. After sitting idle for years, the US’ only rare earths mine, located in Mountain Pass, California, resumed production under new ownership in 2017. Where China’s position remains strong is in the processing of mined material into finished metals. This commanding position can be traced to industrial policies beginning in the 1980s that encouraged the industry’s development, just as producers in rich democracies were looking to outsource production due to the heavy environmental impact.
But as with mining, new sources of non-Chinese refining capacity are in the pipeline. The output of Mountain Pass is currently sent to China for processing, but Las Vegas-based MP Materials received Pentagon funding last year to build a processing facility at Mountain Pass. The Pentagon has also approved funding for Texas-based Blue Line two build two processing plants in Hondo, Texas that Blue Line says will eventually be able to supply a quarter of global demand. One of these, a facility to produce so-called heavy earths used in military applications, is a joint venture with Lynas, which will supply material from its Australian mine.
The Pentagon funding deals followed the Trump administration’s designation in April 2019 of rare earth metals and alloys as “essential to national defense,” which unlocked money for the Pentagon to support domestic production. US President Joe Biden’s 100-day review of critical supply chains, launched in February, includes rare earths and may contain new policies to support production in the US and allied countries.
Beijing’s coercion calculus
In a speech last year that attracted significant attention from foreign analysts, Xi Jinping said: “We will enhance the global value chain’s dependence on China and develop powerful retaliation and deterrence capabilities against supply cut-offs by foreign parties.” The statement seems to suggest the possibility of weaponizing supply chains, at least as a defensive measure. But Xi’s strategy requires a delicate balancing act: insofar as foreign “dependence on China” enables “powerful retaliation” by Beijing, other countries will seek to avoid dependence by decoupling from Chinese value chains. Accumulating “value chain dependence” therefore requires that retaliation be used selectively. US export controls against China, for example – though effective at crippling Huawei today – will arguably undermine US leverage over the long term, by incentivizing industry participants to reduce dependence on the US.
Barriers to entry in rare earths are low compared to high-value sectors like semiconductors. Any coercive leverage the Chinese government could exert using rare earths exports would be temporary, pulling the lever would only accelerate the development of alternative supply. Beijing effectively has one shot in the chamber. In an extreme scenario such as armed conflict or comprehensive trade embargo, the Chinese government might disrupt an adversary’s access to rare earths, but the resulting supply response would likely wipe out all future leverage.
A similar logic has guided Beijing’s decision to largely refrain from retaliation against US technology companies in response to US export controls. Beijing wants to preserve and enhance China’s role in global supply chains, which requires avoiding actions that would push foreign investors and trading partners towards decoupling. This same logic underpinned our forecast that nationalist outrage towards H&M and other foreign brands over Xinjiang will not doom those companies‘ long-term business in China, though Beijing might more willing to accept decoupling in fashion than in the various high-tech industries that rely on rare earths.
The leverage that the Chinese government is currently deploying against Australia presents an entirely different coercion calculus. With Australia, Beijing’s leverage derives from the asymmetry between China’s role as an irreplaceably large market for Australian exports and Australia’s mostly replaceable (except for iron ore) role as a supplier to China. Beijing appears more willing to deploy its leverage against Australia, since the underlying asymmetry in economic might is highly durable. By contrast, the tenuous nature of China’s rare earth dominance suggests that Beijing will proceed more cautiously.