Rare earth minerals are a powerful arrow in China’s quiver

President Trump said early on, and has since repeated, that “trade wars are good and easy to win.” But this one does not look so easy to win, and it is not particularly good. 

China is hunkering down for a trade war that will continue to hurt its businesses, workers and consumers. But it is also seeking means to retaliate and has signaled that it will do its best to ensure that the U.S. feels maximal pain. On Wednesday, the People’s Daily stated in a commentary, “Don’t say we didn’t warn you!”

So far, the trade war has been confined to tariffs, and the U.S., as the bigger importer, has had more capacity to impose tariffs. Note, however, that in economic reality, as opposed to mercantilist fantasy, tariffs are most often a form of shooting oneself in the foot.

The tariffs the U.S. have imposed, so far largely on intermediate goods and raw materials, have hurt U.S. manufacturers. President Trump has claimed that China bears the brunt of these tariffs, which in theory could be partially correct, but the evidence in this case strongly contradicts his position.

What this means is that the tariffs make the U.S. a less-attractive place to produce all kinds of goods, and these tariffs, along with the uncertainty they engender, will make the U.S. an unattractive place to invest going forward. 

The existing tariffs, and the threat of tariffs on the remainder of Chinese imports, will also impose a great deal of pain on U.S. consumers and will act as a regressive tax on Americans.  

While President Trump has been most concerned with the bilateral deficit, he and others in his administration have also been concerned with China’s rise as a technological, and thus military, competitor. This concern rightly extends to cybersecurity, which extends to Huawei’s supply of equipment for 5G networks. 

So, as part of the U.S. overall approach to China, the Trump administration has prohibited imports of equipment from Huawei for use in government networks and has persuaded U.S. network companies to avoid Huawei equipment in their networks.  

But on May 16, the U.S. fired another salvo on this front, adding Huawei and its non-U.S. affiliates to the “entity list” under the Export Administration Regulations, with the effect that exports to these companies require a license. 

The determination adding Huawei to the entity list found “reasonable cause to believe that Huawei has been involved in activities contrary to the national security or foreign policy interests of the United States.” Limited exceptions to the license requirement have been provided for 90 days. 

Note that the U.S. measures against Huawei are motivated not by traditional trade concerns but by concerns to protect U.S. and allied cybersecurity as well as U.S. technological dominance.  

President Xi Jinping of China has been devising an appropriate responsive strategy. One element of this strategy has recently included threats of restrictions on exports from China of rare earth minerals. 

“Rare earths” are a group of 17 elements with properties of magnetism, luminescence and strength, important in the production of high-tech products, including weapons systems and clean energy products. China is the dominant producer of rare earths. 

This latest threat seems designed to respond to the U.S. inclusion of Huawei on its export control entity list, showing that China can impose reciprocal pain on the U.S. 

Interestingly, up until this point, China has seemed weak by virtue of the fact that it imports much less from the U.S. than it exports to the U.S., and therefore cannot impose tariffs in magnitudes that match the U.S. 

However, a core truth of trade economics, remarkably ignored by mercantilists, is of course that imports benefit the importing country, and so China can punish the U.S. by holding back on its exports here.  

By threatening to restrict exports of rare earths, China is demonstrating its export-based power. China is, in effect, rejecting and transcending a mercantilist view of trade power. This is especially salient in a world characterized by supply-chain manufacturing.  

Of course, the U.S. can purchase rare earths from other suppliers, and any export controls China may impose could be circumvented through smuggling, as they were to some extent when China imposed export controls on rare earths in 2010. However, China has taken measures to limit smuggling.

Furthermore, the U.S. could bring a case against export controls as it did in 2010, with success. Chinese export controls on exports of rare earths would be a fairly clear violation of the World Trade Organization (WTO) prohibition on export restrictions. 

Unfortunately, the U.S. has undermined the utility of WTO dispute settlement by violating WTO law with its tariffs and making excessive claims of national security justifications for its actions. So the WTO multilateral route seems less fruitful than it has been in the past.     

China’s rare earths export restriction threat is intended to maintain parity of threats — and pain — with the U.S. in the current trade war.

The U.S. can respond by further escalation to increase pressure on China, but China presumably has additional responses, outside of tariffs on imports, ready to deploy, including: 

• export restrictions on goods that are needed and not easily substitutable by the U.S.;
• currency manipulation to make the yuan cheaper; or
• reduction of U.S. government bond purchases. 

At some point, each party will look at the costs of trade war and determine that they are excessive and dominate any expected gains. It is possible that a process of de-escalation will begin at that point. 

But to the extent that this trade war is motivated by a competition for military dominance, it may be difficult to de-escalate a conflict that may be seen to harm the other more than it harms us. 

That is, we may be entering a world motivated by relative gains, rather than the rational economic world motivated by absolute gains. 

Joel Trachtman is a professor of international law at the Fletcher School at Tufts University.