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Chinese Mercantilist Policies Demand US Response

Paul Krugman writes about the Chinese rare earth issue today, which is part of the Administration’s Section 301 investigation. The deal basically is that China limits the export of the rare earth minerals used in making solar panels, to the extent that it’s more cost-effective for companies to build their plants in China than to find another trading partner for export of the necessary materials.

“There is oil in the Middle East; there is rare earth in China,” declared Deng Xiaoping, the architect of China’s economic transformation, in 1992. Indeed, China has about a third of the world’s rare earth deposits. This relative abundance, combined with low extraction and processing costs — reflecting both low wages and weak environmental standards — allowed China’s producers to undercut the U.S. industry.

You really have to wonder why nobody raised an alarm while this was happening, if only on national security grounds. But policy makers simply stood by as the U.S. rare earth industry shut down. In at least one case, in 2003 — a time when, if you believed the Bush administration, considerations of national security governed every aspect of U.S. policy — the Chinese literally packed up all the equipment in a U.S. production facility and shipped it to China.

The result was a monopoly position exceeding the wildest dreams of Middle Eastern oil-fueled tyrants. And even before the trawler incident, China showed itself willing to exploit that monopoly to the fullest. The United Steelworkers recently filed a complaint against Chinese trade practices, stepping in where U.S. businesses fear to tread because they fear Chinese retaliation. The union put China’s imposition of export restrictions and taxes on rare earths — restrictions that give Chinese production in a number of industries an important competitive advantage — at the top of the list.

What’s important is the piece at the top: China only has 1/3 of the rare earth deposits in the world. But other deposits are underdeveloped or ignored, giving China close to 97% of the current market. Second, this is a blatant violation of WTO rules, based on the above-mentioned trawler incident (a Japanese ship sailing in disputed waters) which led all Chinese exporters to “spontaneously” stop rare earth sales. China’s trying to claim that they’re conserving their dwindling deposits, but instead of using market forces by raising prices, they’re increasing their share of domestic manufacturing of goods with rare earth minerals by banning their sale outright.

China is acting as a bad business partner. Not only by raising currency, not only by playing games with raw materials, not only by subsidizing their domestic greentech manufacturers, but by bypassing international sanctions. Whatever you think of economic sanctions on Iran (I don’t think much), what’s clear in this episode is that China simply went back on their promises to gain economic advantage:

After the U.N. Security Council authorized enhanced sanctions against Iran in June, the United States, the European Union, Japan, South Korea, Australia and Canada passed laws to further restrict investment in Iran’s energy sector. The U.S. law authorized the president to sanction any company found to be selling gasoline to Iran or that had invested $20 million or more in Iran’s energy sector. INPEX, the Japanese energy giant, announced last week that it was pulling out of Iran.

China thus becomes the last major economy with significant investments in Iran’s energy industry. Russia does not have major investments there and recently canceled the sale of an advanced antiaircraft missile to Iran, refunding the $900 million sticker price.

“China now is the only country with a major oil and gas industry that’s prepared to deal with Iran,” the U.S. official said. “Everyone else has pulled out. They stand alone.”

Each nation, particularly permanent members of the Security Council such as China, is responsible for abiding by the U.N. sanctions.

China is essentially a runaway mercantile giant, and the rest of the world will either call them out for their various violations, or watch them rocket to the top of the economic ladder. Sherrod Brown writes today:

If the White House finds that the support violates international trade rules, Section 301 allows it to respond with a range of aggressive measures, including tariffs.

This strategy has worked before: in the 1980s and ’90s, the United States used its 301 authority to combat Japanese and Korean subsidies and trade barriers. Though critics warned of bitter trade wars, the get-tough approach actually led to more balanced trade relationships, and even encouraged foreign investors, like Asian auto companies, to build plants in America.

In trying to get China to play fair, though, Washington has instead relied on rhetoric and moral suasion. It hasn’t worked. Only rigorous enforcement of trade rules by the Obama administration can reverse the harm caused by the permanent normal trade relations agreement.

We’re beyond the point of diplomacy and persuasion. It’s time for action.

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David Dayen

David Dayen