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Hello from Brussels. The bilateral EU-China summit early in the week we were sceptical about actually produced more optimistic noises than we might have imagined about the prospects for the bilateral investment treaty, but we’ve had our hopes raised and then cruelly dashed before, so let’s see. Meanwhile, trade commissioner-designate Valdis Dombrovskis has been seen in public talking about trade and proved himself immensely capable of sticking to his brief with fierce tenacity. To be fair, despite having already passed through two confirmation hearings, he has to appear in front of the European Parliament again in October to check he’s OK to do the trade job, and with MEPs in a feisty mood he’s wise to say nothing controversial before then.
In today’s main piece we start to look at exactly what a significant supply chain diversification and reshoring campaign would look like, concluding that in the case of rare earths there has not been enough incentive in the past to overcome the barriers, and it’s not clear there is now either. Tall Tales is on USTR Robert Lighthizer’s comments on the WTO case that the US just lost, in which he proves to be generally quite right but specifically massively wrong. Our chart of the day looks at the surprising resilience of container shipping.
The missing imperative to secure supply
SUBHEAD TO BE CUT: Supply chains
So, this strategic supply chain resilience and reshoring thing we keep hearing about. If you’re the EU or the US, what would you target? We’ll take a look at various aspects of this in coming weeks, but first up is an obvious example to underline the difficulties is rare earth minerals — and vital industrial raw materials more generally.
Rare earth elements are inputs to a range of products, including green goods such as wind turbines and electric vehicles. They’re hard to substitute. They’re also difficult and expensive to produce, with huge set-up costs and a lot of (ironically, environmentally damaging) processing and recycling. And the global supply is dominated by China.
So the theoretical case for diversified or onshored production to reduce the risk of supply disruption is clear, matching the EU’s rhetoric about, ahem, “open strategic autonomy.” The EU recently expanded its list of vital raw materials, which includes rare earth elements, from 27 to 30. It also made a lot of noise about increasing research and production.
But it’s hard in practice to increase rare earths output, given huge entry costs, skills shortages, IP issues and environmental regulations. As a Financial Times piece detailed earlier this week, the US has been talking about building domestic rare earths capacity for a long time, not least because of the needs of its defence industry, but still hasn’t got much done.
This is partly because, as we’ll see below, in the past the problem somewhat fixed itself, reducing the imperative to act. And it’s not really clear that Covid-19 is going to be enough of an incentive to get much further this time.
Rare earth elements are inputs to a range of products, including green goods such as wind turbines © Pau Barrena/AFP
At the margin, the pandemic may concentrate minds by further souring relations between the US and China, and to a lesser extent the EU and China. But as we’ve said a few times, there haven’t really been major disruptions to any vital supply chains. Some factory and port closures, yes, but nothing dramatic or strategic.
Indeed, in the case of industrial materials in general and rare earths in particular, there’s been nothing recently to compare with policy-generated shocks in the past. In 2010 China created a genuine global supply crisis and massive price rises by cutting export quotas to divert the minerals to its domestic manufacturers of electronics and other downstream products.
The cunning plan was eventually foiled by a combination of market forces and global trade rules. Higher global prices made it profitable to open mothballed mines in Australia and elsewhere. Smuggling undermined the export controls: if you ever want secretly to dig up tens of thousands of tonnes of minerals and sneak them over a border, hiring a Chinese rare earths producer should do the trick. And a WTO case brought by the US ruled against China’s actions, with which judgment Beijing largely complied.
The exercise wasn’t necessarily pointless from China’s point of view. Downstream producers of high-tech goods outside China said the privileged supply of cheap rare earths bought their Chinese competitors a couple of years to develop products and capture markets, and encouraged them to move their own production to China. However, the supply disruption wasn’t really enough to give the US and other governments enough incentive to spend tens, maybe hundreds of billions of dollars on research and to rewrite regulations enough to secure long-term production.
And that’s the problem. Once you have a big enough market share in a product with inelastic supply and you’re not targeting short-term profit, you can maintain your dominant position by creating periodic gluts to bankrupt competitors with shallower pockets than yours, or your government’s. Then you can go back to hoarding when foreign producers go bust. In other words, the EU and US can try building up domestic mineral mining capacity if they want, but they’d better be prepared to absorb a lot of losses over a long period of time.
We’ll come back in future newsletters to what trade and regulatory tools governments could use to secure supply of rare earth minerals and other vital raw materials. For the moment we’ll content ourselves with observing that said elements are an obvious candidate for government intervention to diversify supply. And yet there evidently needs to be a much bigger incentive. So far a salutary lesson from a decade ago, a lot of good intentions and quite a bit of cash, certainly in the US, haven’t made much difference. As the saying goes: we don’t have a solution, but we do admire the problem.
The $180bn a year container shipping industry might be expected to be in a perilous state owing to the demand shock caused by Covid-19 — especially given its recent record of weak profits and overcapacity, write Michael Pooler and Thomas Hale. Yet six months after the pandemic brought chaos to the global economy, many of the container lines have navigated the crisis surprisingly well. By pulling services to prevent a glut, they have so far not only shielded themselves from a financial onslaught — many are making more money than before.
Tall Tales of Trade
Robert Lighthizer fulminated against the WTO being unable to constrain Chinese state capitalism © Andrew Harnik-Pool/Getty
As we discussed on Wednesday, possibly the least surprising WTO dispute settlement ruling ever came out this week and held that the US could not, in fact, block imports from China with its Section 301 actions simply because it didn’t like the cut of China’s jib — or, as Washington had it, to “protect public morals”. Pretending to be shocked and appalled, USTR Robert Lighthizer fulminated against the WTO being unable to constrain Chinese state capitalism.
Thing is, he’s right on that point. It doesn’t. It hasn’t got the rule book to do so, and China has been endlessly imaginative in finding new forms of state intervention to keep the letter while breaking the spirit.
But a dispute panel ruling against a transparently bogus US argument — that general distortions offend public morals so much they justify specific tariffs — doesn’t prove Lighthizer’s point at all. If the US can suspend most-favoured nation rules against a country on a whim with no sound reasoning and evidence, there’s simply no point in having a WTO. Episodes like this convince a lot of people that crippling rather than reforming the institution is precisely Lighthizer’s aim.
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