Remapping the Debate on China’s Industrial Policy

Our rival has one. Where's ours?

Remapping Debate has an interesting piece on how the U.S. finds itself at the mercy of the Chinese for a critical ingredient in a number of important technologies, like hybrid cars, missile tracking systems, and wind turbines, and what that says about our broader trade policies.

It gets at one of the core security issues caused by unrestrained free trade: Relying on other countries, especially countries that are not your allies, to supply you with things you really need.

It’s a pretty serious problem when we have free-trade policies and our trading partners don’t. Anyone who thinks China is ideologically committed to free trade need only look at what’s happened in rare earths over the last several months.

The Chinese have used their dominance of rare-earths production—the country produces some 97 percent of the world’s supply—as a cudgel in a territorial dispute with Japan. And until they adopted a more PR-friendly environmental excuse a few months ago, the Chinese admitted freely that they were using their rare earths monopoly to force foreign companies to move even more of their factories to China. Two weeks ago, China said it would slash rare-earths exports for the third-straight year, according to The New York Times’s Keith Bradsher, who has blanketed this story for more than a year now.

Remapping Debate’s Mike Alberti points out that the U.S. used to dominate the rare-earths trade but ceased production nearly a decade ago after environmental problems and cheap Chinese competition and asks:

But why was a vulnerability, now seen as requiring quick and decisive action, not addressed for so many years? Some experts argue that the free-market trade policies the U.S. has pursued did exactly what they were meant to do, and the current U.S. predicament shows that those trade policies may have been misguided.

“The failure of the United States to promote a much more aggressive stance on rare earth [elements] is indicative of the degree to which we are willing to stand idle while our manufacturing industries are stolen from us,” said Robert E. Scott, senior international economist at the Economic Policy Institute. “There’s no doubt that the promotion of free trade agreements has been tremendously destructive to U.S. manufacturing.”

China is not a friend of the United States and probably never will be. The realists over there must shake their heads in wonder at the bumbling superpower that transfers its manufacturing capacity, its critical resources production, and its technological secrets to a rising competitor.

Of course, the one-sided trade is hardly limited to rare earths. The Chinese artificially undervalue their currency, making our exports half again as expensive as they should be and making their imports half again as cheap as they ought to be in a “free market.”

Alberti quotes a couple of people from the Heritage Foundation and American Enterprise Institute who claim the markets will work it out:

“What’s the harm in allowing a single country to be your supply?” Scissors asked. “China can’t cut everyone off — they can cause a shortage over a certain period.”

That shortage, according to Scissors, will then be rectified by the market because domestic production will commence, and the intervening lag between foreign and domestic production as U.S. industries race to catch up cannot be blamed on a lack of government intervention. Rather, he says, it is the result of too much intervention in the form of environmental regulations.

The problem with relying on the market to guide our every policy is that Mr. Market doesn’t market price in critical externalities like environmental damage, economic security, and national security. So Alberti asks why we don’t price them in for it:

“This is just one example of how the United States has lost a capability that it used to have,” he said. By believing that “global free trade will provide all the answers that we need in terms of an industrial policy,” (Ed Richardson, vice president of Thomas and Skinner, an Indianapolis producer of permanent magnets) continued, “we made a big mistake.”

Jack Lifton, co-founder of the consulting firm Technology Metals Research, says the irony is that China is simply following the model that the U.S. set out for them.

The Chinese “did exactly what we asked them to do,” Lifton said. “They started low-cost manufacturing using raw materials they could also produce at the lowest cost.”

“The capitalists in New York were popping champagne, saying, ‘We have achieved low cost!’” Lifton continued, “And now the Chinese are saying, ‘Phase two: we’re going to be the supplier, you guys can go out of business, and the capitalists in New York are saying, ‘Oh, you evil people.’ It’s completely ridiculous.”

According to Scott, Margonelli and Appelbaum, by focusing on price alone, the U.S. allowed the market to determine the value of crucial components like rare earths.

Fortunately, a company is trying to re-open the rare-earths mine in California in the next couple of years, as market theory would predict. But in the meantime the delay will result in more harm to American manufacturing and a competitive advantage to the Chinese.

This story shows why trade policies toward China and industry in general need a serious re-examination.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum. Tags: , , , ,