A rare-earths showdown looms

A rare-earths showdown looms

A strong legal case can be made that Chinese restrictions on exports of rare-earth elements violate world trade rules. Japan has said publicly that the Chinese are violating World Trade Organization (WTO) rules. Germany is urging the European Union to act. The US has refused to rule out doing so. But who ultimately will be willing to bring that case against China in WTO, and when? And can China itself afford to let things go that far?

The legal issues involved are fairly clear-cut. China has about half of the world’s deposits and accounts for about 93% of the world’s current production of the 17 rare-earth elements. These elements are essential ingredients in much of modern technology.

In the past two years, China has been stockpiling these and tightening an array of export restrictions. After cutting export quotas of rare earths last year, it has cut them again by 35% for the first half of this year. Reacting to these restrictions, and also to rising demand, global prices for rare earths multiplied fourfold last year, and doubled again in the first four months of 2011.

This is almost certainly contrary to the agreements China signed on to when it joined WTO in 2001. Under WTO rules, quotas and other quantitative restrictions on exports are generally prohibited unless they are applied “temporarily" where there are “critical shortages". There is little indication that the Chinese quotas satisfy either condition.

Beijing could argue it is acting within WTO rules that allow export controls that are applied to protect the environment. Rare earths are difficult and dirty to extract. But in an April ruling that is not yet public or final, a WTO panel reportedly rejected China’s assertion of an environmental defence in another trade dispute involving similar facts and essentially the same legal issues. Although subject to appeal, this ruling suggests a rare-earths case, too, would not go China’s way.

China has also done little to impose such restrictions on its domestic producers. An environmental defence is possible only for measures that are “made effective in conjunction with restrictions on domestic production or consumption". Likewise, China may well be vulnerable to legal claims that its restrictions on rare-earth exports act as implicit subsidies to domestic production. Such subsidies are illegal if they can be shown to have “adverse effects" in the marketplace.

Why, then, have China’s trading partners not yet pursued WTO action on rare earths if the legal case is so compelling? So far, other governments have attempted to resolve the conflict through negotiations such as the recent bilateral Strategic and Economic Dialogue in Washington. No country wants to act alone. And foreign companies, which often prompt their governments to launch WTO litigation, may be reluctant to do so. Many of the largest companies that rely on rare earths from China have other significant business interests there and would be understandably unwilling to antagonize the Chinese government.

But as rare earths grow more and more expensive, pressure for a WTO suit will build. And when such a suit does come, it is likely?to involve?some of China’s most important trading partners—especially the US, the EU and Japan—acting in concert. If China loses the case yet refuses to revise its offending export regulations—it will face retaliatory trade sanctions on multiple fronts at the same time.

More broadly, China risks much if it undermines WTO rules and embraces the illusion of self-sufficiency in trade. No other country benefits more from WTO tariff concessions or from WTO rules against non-discrimination in international trade. And no other country depends more on the willingness of other countries to export their raw materials and other limited natural resources in an interdependent world of increasingly elaborate and interlinked supply chains.

China can, at any time, lift its illegal export controls on rare earths. The sooner it does so, the better.

James Bacchus is a former Democratic Representative from Florida, the US, and former chairman of the Appellate Body of the World Trade Organization. He chairs the global practice of Greenberg Traurig Llp.

—The Wall Street Journal

Edited excerpts. Comments are welcome at otherviews@livemint.com