The risks of global supply chain concentration are numerous -- with the Covid -19 pandemic only serving to highlight the fault lines. Widespread supply chain dependencies (especially on China) have raised a number of issues, such as whether countries will leverage the economic power derived from intermediate exports to disadvantage other trading partners, or whether international institutions such as the WTO are robust enough to tackle such practices. And then there is the question whether countries dependent on such imports can themselves look to move away from their supply chain dependencies, including their dependencies on China, through their own policies.
In recent decades, there has been a dramatic increase in China's share of world trade. This is particularly true of China's manufacturing exports, which have risen from 8 to 18 percent of total global manufacturing exports in the last 15 years. China’s share of global intermediate goods exports has risen even faster, to over 30 percent of the global total, and now accounts for a substantial portion of total world trade.
Amongst China's trading partners around the world, these trends have generated 'competing' anxieties.
In the first place, export flows from China have created pressure in some sectors of the economies importing goods from China. Some US markets, for example, have been flooded with exports from China, displacing domestic low skilled workers from their jobs. The resulting de-industrialisation in the ‘rust belt’ of the US has had major ripple effects on the economy, as well as on US domestic politics. Similar concerns have arisen when India has contemplated joining free trade agreements such as the Regional Comprehensive Economic Partnership (RCEP). India ultimately decided to exclude itself from the RCEP agreement, principally because of fears about the impact of Chinese exports on the Indian domestic market and on Indian manufacturing jobs..
However, concerns are not limited to the domestic impact of large export flows from China; they also extend to the problem of import dependency on China. Governments around the world are wary that, once a dependency on Chinese exports is established in a particular range of intermediate goods, China’s leaders may in future exploit this economic leverage by restricting exports — thereby causing resilience issues for its trading partners.
There are three main issues, here, each of which I intend to illustrate by considering the specific case of trading in rare earths. The first question is whether fears about China's potential exploitation of economic leverage are legitimate. The second is whether the WTO/GATT rules, as currently conceived, are capable of deterring abuse of dominant positions. And the third is the question of whether China’s trading partners can effectively decrease their supply chain dependence on China, and hence increase their resilience, through domestic policy action.
The degree of supply chain dependency on China is well illustrated by the global supply chain for rare earths. While the traded volume of rare earths themselves is small, the value of the products that depend upon them is enormous -- with global sales of iPhones alone accounting for $150 billion a year. China currently has a dominant position in the rare earths market. It was responsible for over 40% of total global rare earth exports between 2008 and 2018, and (as shown in the chart below, source: CSIS China Power Project) its share of total global rare earth mining production rose from less than one third in the 1980s to almost 100% by 2010, with Chinese production still dominating global production into the 2020s.
This Chinese dominance in the rare earth market has become a matter of concern, partly because China has been willing to use its power over rare earth exports as a geopolitical tool. This became clear when the Japanese authorities arrested the captain of a Chinese fishing boat which had collided with a Japanese Coast Guard vessel in the waters near the contested Senkaku/Diaoyu Islands. China flexed its muscles by restricting rare earth exports to Japan for two months. Further evidence of the same tendency came to light when China simultaneously tightened its export quotas for rare earths and reduced rare earth production output by 37% in 2011. As shown in the chart below (source: CSIS China Power Project), the effect on global markets was dramatic; the average global price of rare earths jumped from $9461 per metric tonne in 2009 to nearly $65,000 in 2011.
In response to this disruption of world markets, the US, the EU and Japan filed a series of trade disputes against China at the WTO (of which, of course, China has been a member state since 2000). After prolonged and careful consideration of the case in the light of China's GATT obligations, the WTO ruled against China in 2014.
Whilst it is true that, in 2015, following the WTO ruling, China ended its export quota system for rare earths and normalised its trade practices, the case nevertheless illustrates two deficiencies of the current WTO process as a means of preventing abuse of dominant positions in global supply chains.
First, although the ruling outlawed the use of export restrictions per se as a means of intervening in world markets, the precise terms of the ruling created an interesting precedent. China had argued during the WTO proceedings that its motive for imposing export restrictions on rare earths was its desire to conserve natural resources. In response, the WTO ruled that, although export restrictions could not be used as a means of conserving natural resources, reduced production could be justified on the basis of resource-conservation. So, while the ruling did not in this instance favour China, it clarified the possibility of production (and therefore supply) limits on critical elements of global supply chains being used (lawfully) as a form of global economic leverage.
Second, the time taken for the WTO to deliver its ruling (2011 to 2014) gave the Chinese a prolonged breathing space, during which they could lawfully maintain their export restrictions. Arguably, a trade weapon that can be used for three or four years is as much as any country needs in order to make that weapon effective in geoeconomics or geopolitics. Nor was this lengthy process in any way unusual. WTO proceedings tend to be long, with cases often taking several years to be resolved, potentially leading to enormous damage and disruption for trading partners in terms of prices and supply in the short run. In sum, given the length of time taken to provide rulings, the WTO is not an effective protection against short term abuse of a dominant position in a critical global supply chain.
Once these deficiencies of the WTO system were exposed, member states began to implement various policies to increase their resilience in the face of the supply chain risks caused by their dependence on Chinese rare earths: the Japaneses invested $250 million in Australian mining of rare earths; the United States ramped up its own production of rare earths, and declared rare metals to be essential to national defence, permitting the US federal government to protect and subsidise US rare earth production; and the EU sought technological solutions such as recycling magnetic waste in order to reduce dependence on rare earths.
However, despite these measures, the extent of diversification and the reduction in dependence on Chinese exports of rare earths remains very limited. As shown in the figure below (source: CSIS China Power Project), although some countries managed to reduce their dependence in 2011 — with South Korea and Japan cutting their reliance on Chinese exports from a high of 90% of total requirements to around 60% — the general level of reliance on imports of rare earths from China has been on a slow but steady upward trend over the past few years. In 2018, the EU, Japan, South Korea and the US were all dependent on China for more than 50% of their rare earths.
The first takeaway from analysing the case of rare earths is that the supply chain concentration risks are non-negligible. They are non-negligible from an economic and geopolitical perspective, given that countries have shown the ability and willingness to use economic leverage. Nor is this willingness to use or abuse economic leverage limited to China; as the US has shown in the case of semi-conductors, China’s trading partners are also willing to pursue such strategies.
The second takeaway is that while the WTO as a body may play a role in limiting extreme actions, it does not offer any effective guarantee against the use or abuse of economic leverage derived from an intermediate import dependency on one side and a dominant position on the other side. To take another non-Chinese example, the US imposed aluminum tariffs in an arbitrary fashion against various trading partners. While this was a clear violation of GATT/WTO rules, there has been, as yet, no action against the US by the WTO. Whichever way one looks at it, the WTO and its GATT rules offer very little protection — especially if a member state is willing to exploit the loophole of declaring a product important for national security (as the US did in justifying its tariffs).
Finally, despite the concentration risks and the trade tensions, the amount of decoupling has so far been very limited.
But the rare earths market is by no means an exception.
Despite the recent ‘trade wars’ between China and the United States, and the fact that tariff impositions have resulted in some production moving to Vietnam and Taiwan, the attractiveness of China as an efficient manufacturing platform still provides a powerful rationale for concentration, and hence a powerful cause of import dependency on China. The US is still dependent on China for a variety of critical intermediate goods, and for a variety of systemically significant goods such as computers, electronic products, and electronic equipment. And China is still dependent on the US for a range of critical technologies, as well as for a range of prized consumer goods.
This leads us to the conclusion that, notwithstanding trade tensions and policies pursued in the respective capitals, the underlying economic rationale for firms on each side to continue to import and export through complex and interdependent global supply chains remains strong. The move in the US and elsewhere to diversify away from import dependence on China therefore seems likely to remain limited, and its progress is likely to remain slow.
Dr Pravin Krishna is Chung Ju Yung Distinguished Professor of International Economics and Business at the School of Advanced International Studies and the Department of Economics in the Zanvyl Krieger School of Arts and Sciences at Johns Hopkins University.