Peter Passell
Editor, The Milken Institute Review; Senior Fellow
California and Capital Markets and Europe and Finance and Global Economy and Labor and Public Policy and U.S. Economy
Peter Passell is editor of The Milken Institute Review, the Institute's economic quarterly. A senior fellow, Passell joined the Institute after eight years as economics columnist for the news department of The New York Times. He previously served on the Times' editorial board and was an assistant professor at Columbia...
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China's growing pains
By: Peter Passell
November 19, 2010
Those inclined to view China's growing economic muscle as a threat got the shivers this fall. As widely reported, Beijing chose to express its displeasure with Japan in a symbolic territorial dispute by stopping exports of a critical class of minerals called "rare earths," used in an astounding array of high-tech products. Indeed, China only agreed to resume exports this past weekend.

As a rule, export embargos backfire: After President Nixon briefly barred soybean exports to hold down domestic prices, Japan underwrote production in Brazil, creating a formidable low-cost competitor for the American grain belt. And the rare earth embargo is likely to trigger a parallel long-term response, as consuming nations cut deals with suppliers in a dozen countries.

But the very existence of China's market power in rare earths points to a striking irony. China captured most of the market for these minerals in the same way it captured daunting shares of global markets for everything from furniture to computer displays - by undercutting the prices charged by competitors. And while that export-first policy worked for decades to sustain economic growth, it is now threatening both living standards at home and the smooth integration of China into the community of advanced industrial economies.

Start with the small picture. Rare earths are anything but - they're found all over the place. The catch is they typically are found in low concentrations, making them costly to mine. And the mining/refining process creates a host of environmental problems that scare away potential producers. None of that stopped China from using its cost advantages (tied in part to an undervalued currency) and its willingness to ignore health risks (including radiation poisoning) to become the dominant global producer.

In the case of rare earths, the government indicated that it would not hesitate to ration exports to protect reliable supplies for Chinese industry. And now that Beijing has used its leverage in rare earths to make a geopolitical point, importing countries have been forced to take notice. Japan has already announced projects with Vietnam and India to meet part of its rare-earth needs. Other potential suppliers in Australia, Canada, South Africa and the United States will almost certainly be able to cut lucrative long-term deals with buyers in the next few years, reducing risks of future shortages and taming China's geopolitical leverage - albeit at a high price.

There's a bigger issue here, though, and it's likely to dog China long after the brouhaha over rare earths is forgotten. Like the Asian tigers before it, China has systematically blessed its exporters with cheap capital, supine labor unions, featherweight environmental regulation and an overvalued exchange rate. But China has a far larger economic footprint than, say, South Korea or Taiwan. And its export policies are creating immense friction with the other industrial powers long before its economy has grown large enough to provide a decent standard of living for its underemployed masses.

Everybody (including the Chinese government) knows that China needs to direct far more of its economic resources into the hands of consumers and the industries that serve them. This process happened organically in the Asian tigers, as interest groups ranging from organized labor to environmentalists forced governments to redistribute income, bolster social services and rethink policies that cosseted exporters.

But China, with its largely voiceless underclass, is going to have far more difficulty in making the transition. And trouble for Beijing could easily mean trouble for the rest of the world as its leaders balance their own interests against those of the restless, unfulfilled majority.


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