The rare earth chokehold and its counters
US–Australia rare earths deal aims to counter China’s hold over the industry. National comparative advantage comes down to an ability to pivot and adapt.
If one country has a chokehold over a key commodity or product, buyers of that product will seek counters to that chokehold. This is especially the case for products that are essential to military applications.
The Australia–US deal on rare earths needs to be seen in that geopolitical context. The market is not particularly large or remunerative. However, the potential cost of losing access to these minerals means that countries will not want their supply to be monopolised by a single country.
The rare earths situation highlights some limitations to the logic of comparative advantage driving trade patterns under free trade. Firstly, defence considerations might require countries to invest in industries that a pure comparative advantage calculus would not support. Secondly, comparative advantage is static and says little about the opportunities a country could or should take advantage of in future.
In jujitsu and other martial arts, you don’t only learn how to put someone in an arm lock or a chokehold. Even more important is to learn how to get out of them (especially for female practitioners, who are more likely to need to defend themselves than to attack someone else). Students spend at least as much time learning how to counter an attack as how to perform the attack itself.
This week’s US–Australia deal on rare earths investment can be seen as an effort to counter a chokehold, in this case China’s dominance of rare earth minerals production. This is not a new issue: China has dominated this industry for more than a decade and banned exports of rare earths to Japan for a period back in 2010. It was obvious that China could put the chokehold on. Indeed, we have previously highlighted access to rare earth deposits and processing capability as top priorities for Australia’s national security agenda. The Australia–US deal has apparently been in the works for some time, though its announcement so soon after China tightened export restrictions can hardly be a coincidence.
The bigger question is why it has taken so long for the US and other western countries to settle on a counter. Perhaps there was a belief that China would not really go through with a full chokehold for long. This would be surprising given that the US was already trying to do the exact same thing to China with advanced semiconductors, and has been since the Biden administration.
Another issue is that – were it not for the national security implications of delegating production of rare earths and magnets to a single country and potential adversary – the rare earths industry is not particularly attractive. The market is not that large; there is no iron-ore-size mining boom for Australia in this deal, as the RBA has recently pointed out in relation to critical minerals more broadly.
Moreover, despite their collective name the minerals themselves are not particularly rare. What is rare is the societal willingness to deal with the pollution involved in processing them. (Current processing methods generally involve toxic chemicals and, in some cases, radioactive by-products, thus our earlier call for research to develop cleaner methods.) It would be difficult for other countries to enter this industry and compete on price with (subsidised, state-owned) Chinese processing. Short-term financial incentives push buyers in the direction of the low-cost producer, even if that means that everyone is beholden to a single supplier, handing the latter the means to put on a chokehold in future.
The deep and counterintuitive insight of trade economics is that even if one country is more efficient at producing everything, the world is better off if it concentrates on the things it has a comparative advantage in, that is, where its relative advantage is greatest. Other countries will then produce the things where their absolute disadvantage is least, and thus they have a comparative advantage.
From this perspective of comparative advantage, it is easy to see why China has ended up dominating in critical minerals, especially rare earths. China has a large fraction of the proven deposits of the relevant ores, with more in countries it has close relationships with such as Myanmar. It is also more willing to subject itself to the level of pollution involved in processing these ores than western countries are and can therefore process them much more cheaply. While China may well have absolute cost advantages in other kinds of manufacturing as well, those are areas western countries are willing to engage in. The comparative advantage is therefore with rare earths, even before considering the deliberate policy steps the Chinese authorities took to consolidate that advantage.
The rare earths situation highlights that this insight only goes so far, though. Things can break down if the country that has the comparative advantage ends up being the monopoly producer of something that is a critical input into other countries’ production, and especially into defence applications. The theory showing that free trade is optimal presumes governments do not interfere in companies’ trading decisions. In the real world with real geopolitics, governments can choke off sales to an adversary nation.
Thus other considerations, such as national security, sometimes demand that countries invest in industries where they do not have a comparative advantage. One should want to avoid the risk of a future chokehold. The relevance of this risk to energy supply has long been known. It is also worth contemplating where else this consideration might apply, including other basic chemicals and active pharmaceutical ingredients.
The logic of comparative advantage is also only a static lens on a country’s advantages. Just because a country has no comparative advantage in a particular industry now does not mean that this will remain true forever. Comparative advantage tells you about the currently most efficient trade patterns. It does not tell you where to invest next to create future advantages and profitable niches. Comparative advantage four years ago would not have told you that Ukraine would now have a world-leading military drone industry. Comparative advantage ten years ago would not have told you that Australia would now have a $7½ billion export industry in software licences.
When considering Australia’s economic advantages, it is tempting to think only of the fixed, physical advantages such as our mineral resources and land suitable for various types of agriculture. And those are indeed advantages. The real advantage for a modern economy, though, is the ability to pivot and adapt to new circumstances. In that regard, Australia has a highly educated, English-speaking workforce; good health outcomes supporting labour supply; and high-quality, pragmatic policy norms and strong institutions. These support our national capacity to pivot when circumstances demand it, just as we have done in the past.
And while pivoting to a currently dirty, polluting processing industry might seem as incongruous for Australia as taking up jujitsu is for a fifty-something woman, it just might be that our longer-term wellbeing is better for it. Time for some of that quintessentially Australian pragmatism to approve projects quickly, mitigate the pollution risks and get the job done.
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