April 17, 2011 | Commentary on China
If you're not familiar with rare earth elements, they are metals valuable in energy generation and advanced military equipment. Some are genuinely rare, others less so. Nearly all are currently being produced in the People's Republic of China (PRC).
Some commentators mix the value of rare earths and the location of their production and discover a crisis that demands various forms of government action. But an understanding of how markets work indicates that no crisis exists.
These commentators inevitably start by listing the uses of rare earths, and the list is impressive. The list, however, is even more impressive for air, coal, electrical engineers, bank deposits or many other things. Impressive uses do not justify government action.
The real question: Is there a problem, and should the government solve it? The crisis crowd says there is a problem, and its name is China. They observe that China makes nearly all rare earths, as if that should be convincing by itself. Yet the PRC has been producing nearly all rare earths for years.
First, Chinese producers cut prices and drove everyone out of the market. This was predatory behavior by the PRC that helped buyers of rare earths. Now the other shoe has dropped, as it typically does with China, and prices are soaring.
Rare earth elements show different results, but a quintupling of prices in two years is not uncommon, and some elements increased more than that.
Should the U.S. care? Rare earths do not fit neatly into trade categories. Adding up several categories that may contain rare earths, rising prices pushed the total the U.S. spent on rare earth imports to $1.4 billion last year. We spent $2 billion on Chinese fish. Rare earths are not contributing in any noticeable way to aggregate energy or defense costs.
Further, it is almost never wise for the government to respond to high prices. Price movements are how markets work. As prices of rare earths fell while the PRC sought to win the market, demand rose. Now that China's near-monopoly is driving up prices, demand will fall. Neither outcome calls for government action.
Higher prices will have other important effects. They encourage development of substitutes, as suggested in the American Physical Society's February report on "energy-critical elements." Higher prices also encourage more efficient use of rare earths, as in new recycling efforts led by Japanese companies.
Of course, higher prices also encourage greater production. Already, sizable amounts of capital are flowing to Australian miner Lynas and reborn American miner Molycorp, as well as smaller companies. Even more fundamental, higher prices encourage exploration. Current information on rare earth deposits will change dramatically if prices remain high, as intense exploration is done around the world.
No Government Action It is true that all of this will take a while. Exploration, mining, building refineries - even with a running start from the money pouring in, the best hope for a significant new supply is 2014. And it will be longer for some rare earths. Still, this is not any sort of argument for government action.
Inaction, maybe. If federal and state governments were to remove barriers they've imposed to market operations, that would be helpful. But active "support" would either do nothing or worsen matters. The market is responding perfectly: Participants have plenty of funds and are moving aggressively. Government aid cannot change production timing except to delay it.
It can also hurt in other ways. Some people who opposed rare earth mining a decade ago on environmental grounds now demand rare earth subsidies on environmental grounds, as part of alternative energy subsidies. The field has changed and continues to change rapidly. Government intervention based on current conditions will require years to take effect and risks marrying the U.S. to a high-cost path that turns out inferior products.
Another frequently urged measure - stockpiles - has many of these same drawbacks. Stockpiles distort market prices and tend to discourage innovation. They can become rapidly outdated. The government track record in creating and modifying stockpiles, so that they remain truly valuable, is mediocre at best.
The cries of rare earth crisis are loud, but the case for government action has little substance.
Derek Scissors is a research fellow in Asia economic policy at The Heritage Foundation.
First appeared in Defense News