Although production and documented exports had been somewhat controlled, illegal producers remained active. In this historical stage, China tightened its RE quotas and introduced specific policies on environmental protection and illegalities. We discuss illegal mining and smuggling first and then move to the policies and reaction of international RE customers.
The impact of production quotas and illegal mining—some success
Although a production quota would seem to be the most direct way to influence output, enforcement of the quota was incomplete. Not surprisingly, the Chinese central government was aware of the problem for quite a while. In 2012, the Chinese government released the “Interim Measures for the Administration of RE Mandatory Production Plan” and the “Measures for the Administration of Total Mining Quota” to enhance the implementation of the production quota and control the total amount of RE products on the market (MLR 2012b; MIIT 2012b). Stockpiling was one method the Chinese central government employed to deal with production created by the illegal operators. In 2014, the State Reserve Bureau of China purchased 10,090 t of RE products from the six largest RE firms and required the firms to further stockpile 30% of the amount sold to the government.
Published research tells very different stories about the size of illegal production. Figure 7 shows the ratio of Chinese illegal RE production to the total production from two studies. Adamas (2016) claims that the illegal production was about 30% of total production between 2005 and 2012 and dropped below 20% after 2014. This estimation supports the claim that the China’s RE regulation was effective and illegal activities were falling. Kingsnorth (2016, 2019) largely diverges from this estimation. He states that the illegal-sector production was equivalent to about 23% of total production before 2013, but increased drastically above 50% after 2017—implying that China’s policies failed to curtail the illegal production at all. Nevertheless, all the estimates support the theory that illegal upstream and midstream operators provided substantial cheap primary inputs to the downstream sector. Packey and Kingsnorth (2016) study the illegal mining of ionic clay deposits and estimate the illegal sector to be the equivalent of about 40% of legal production. They also assert that illegal mining not only reduced the profitability of the legal firms but also damaged the ecology substantially as illegal firms did not treat environmental damage and evaded taxes and fees. Moreover, illegal mines typically only take the high-grade reserves rather than optimizing the profit of the entire reserves.
Packey and Kingsnorth (2016), and others, note that local governments cooperate with illegal RE mining. Frequent explanations for this cooperation are that the localities benefit from more local employment and taxes than otherwise would exist. These two benefits may not provide sufficient explanation for the cooperation with illegal producers because, first, local officials arguably are not too concerned about the employment rate, and second, there is no incentive for illegal miners to pay resource and value-added taxes and administrative fees (CCDI 2014). There are three more likely reasons that explain the cooperation between illegal sector and local government. First, the illegal mining sector contributes to the local economy in terms of GDP—not directly, as illegal production is not likely counted into the local GDP directly, but rather indirectly as illegal rare-earth products enter the supply chain for legal downstream productsFootnote 8 (Packey and Kingsnorth 2016). Second, the development of the RE industry as a key industry contributes to the promotion of local officials. With the high RE prices after 2011, local governments in the areas of rich RE resources planned RE processing industrial zones that compete with each other. These flourishing midstream to downstream sectors demand raw materials in greater quantities than the official quotas. The third plausible reason is corruption. Local officials take cash bribes from the illegal owner, or the local officials invest in the illegal mining directly and earn dividends.Footnote 9 Besides, to generate government revenue, local officials leased state-owned forestlands for illegal mining (CCDI 2014).
The separation of ownership and the extraction right causes firms and local governments to have different objectives from those of the central government. Therefore, firms do not follow production and export regulations as expected. One may argue that the excess production comes from illegal firms without mining permits; however, illegal products will go to legal firms somewhere in the supply chain and the products become legal gradually. Therefore, the local government selectively ignores the illegal mining and the legal firms finally digest the illegal products and contribute to the local economy.
The demand from downstream processors for the mid-heavy REs was not being met with the existing production quotas, and thus illegal producers filled this gap. An increase in the production quota would decrease the motivation for illegal production. The complexity of the composition of RE deposits contributes to the challenges of allocating production quotas. Rare earth elements (of which there are 17) occur in ore deposits tightly bonded together and in varying proportions. For example, the deposits in the north have a relatively large proportion of the lower-valued lanthanum and cerium elements. These two products are frequently stockpiled at the mine because prices are very low. The illegal miners seek the higher valued REs—especially the magnet materials neodymium, praseodymium, dysprosium, and terbium—and simply dump onto the market the low-value elements regardless of price. This behavior further erodes the profitability of the legal northern firms.
The efficiency of export quotas and smuggling
Illegal RE products also escaped through the border of China and undermined the effectiveness of export quotas. China’s illegal RE exports were significant. For example, the export quota in 2008 was 57,000 t of RE gross products. However, Europe, USA, and Japan imported about 71,000 t of RE products (metals, compounds, oxides, and so on) from China, which is 14,000 t higher than the maximum legal export (Schüler 2011). Table 2 shows, except for 2009, the reported import of RE products from China was greater than the reported Chinese export for the same basket of products for the period 2009-2013.
Chinese exporters and foreign importers reacted to the price increases of 2010 and 2011, discussed below. Illegal exports followed higher prices—even as, in 2011, legal exports (China’s reported export) decreased due to weaker global demand as the high price drove substitution and encouraged mining outside of China. In 2012 and 2013, due to both the lower prices and the policies, we will see in the subsections below illegal exports apparently decreased (Wang 2012).
Reduction in export and production quotas and skyrocketing price
As we can see from Fig. 7, despite China having a cluster of policies around 2005 and 2006, illegal production kept stable at about 30% of production. Against this backdrop, in 2010, China implemented a stricter RE policy, especially the export quota and the MIIT production quota. The production quota from MIIT decreased from 119,500 metric tons of RE oxide to 89,200 or about 25% (Fig. 5). The export quota decreased from 48,155 metric tons to 30,258 metric tons, or 37% (Fig. 4). By making export permits more difficult to obtain, China was able to influence industrial and environmental standards and reward those firms who met the standards (Yang 2015, p261). As a result, RE prices increased greatly as we see in Fig. 1. Some argue that the price increase was a reaction to the territorial dispute between China and Japan in September 2010 (Morrison and Tang 2012; Kiggins 2015)—that is, China took advantage of its dominance of RE supply to Japan and suspended RE export during the sudden political conflict. However, we agree with Wübbeke (2013) that we should view the tightened Chinese RE policies in a broader framework as the MLR quota slightly increased from 2009 to 2011 and the decreasing of MIIT quota was announced in March, prior to the territorial dispute. For export policy, MOFCOM announced the second round of quota in July 2010, which happened before the dispute as well. We would argue to view the price determinant mechanism in a more systematic way. The focus on the influence of the territorial incident masks the underlying movement of market structure and misreads the policy makers’ and relevant firms’ understanding of long-term trends. Even though the magnitude of the change in quotas was surprisingly large, we can see a tendency of stricter policies when we look back at the 2000s. For example, the trend of decreasing export quotas started as early as 2006. From a different angle, we can infer that the targets of the Chinese central government were not fully achieved by the earlier policies.
In 2010, China was producing 97% of the world RE supply (Fig. 2). Given the long lead times for development of new mines, the rest of the world could not start to produce or expand capacity immediately in response to the surprising supply shortage. Because of the inelastic supply and the market panic, the prices began to climb in the middle of 2010 and reached the unprecedented level in the middle of 2011—a full year after the dispute with Japan. Most of the prices of RE metals and oxides experienced a thousand-percent increase (Fig. 1). This phenomenon was apparently triggered by the drop of the quota directly but was also impacted by the tightened policies in the past four to five years as discussed in the “Industrial order, more restrictions on foreign investment, and export taxes” section.
From 2011, other countries with considerable RE resources, such as the USA, Australia, and Russia began to increase or restart their production. The production of the rest of the world increased from 3380 t in 2010 to 21,200 t in 2016. Accordingly, China’s market share decreased to 83% (Fig. 2). By 2016, prices had returned essentially to the level of 2010. China had rescinded its export taxes and quotas per the World Trade Organization (WTO) settlement, described below.
China’s restriction on production and international trade on RE products, especially the latter, triggered protests of improper conduct mainly from the USA, Japan, and the European Union, whose high-tech industries were dependent on imported rare earths. These countries sued China at the WTO and argued that, first, China’s export taxes on ores and primary RE products, as well as on tungsten and molybdenum, were not listed in the Protocol on the Accession of the People’s Republic of China (the Protocol) and thus should be removed. Second, China’s substantial restriction of the export of RE products violated the terms of WTO and the Protocol. Third, China’s regulation and allocation of the export permit did not follow the promises in the Protocol. Meanwhile, China claimed that its export policies were reasonable according to the exceptions in Article XX and Article XI of the GATT 1994 since the purpose was to protect nonrenewable resources, the environment, and human health. China lost the WTO RE dispute case as the export restrictions did not meet the requirements of the exceptions in the Protocol. China canceled its export quota and export tax on RE products in 2015. Thereafter, firms need not get approval for exports and can acquire licenses based on trading contracts (Qian 2014; MOFCOM 2015; MoF 2015).
China could have tried to reserve the right to place restrictions on the export of natural resources through multilateral WTO negotiations during the 1990s. However, the motivation of spurring export through domestic (value-added) manufacturing overwhelmed the interest of protecting resources and environment even though the government had realized the importance and problems related to the RE ionic clays as early as 1991—suggesting some delay in China’s policy implementation. Moreover, Chinese RE reserves are located in more remote and less-developed regions where local governments need foreign exchange to relieve fiscal stress (Yang 2015, p122). Therefore, as noted earlier, there was conflict between the goals of economic development and resource and environmental considerations.
“Opinions” from the central government: declaration of objectives for structural change
Up to now, the paper has described the impacts of the export quotas, illegal mining, the spike in prices, and the WTO dispute. This section focuses on several additional policies adopted during this time period, 2010–2015. In May 2011, the State Council of China released a vital document that provides general ideas of the planning for the RE industry named “Several Opinions of the State Council on Promoting the Sustainable and Healthy Development of the Rare Earth Industry” (State-Council 2011a). Another document, “Situation and Policy of China’s Rare Earth Industry,” released by the State Council Information Office offered similar opinions (SCIO 2012).
The documents state that the Chinese central government attempts to, first, change the structure of industry by controlling the capacities of mining and separation and encouraging the innovation of new technologies in the downstream industry; second, to protect the environment and sustainability of resources by employing higher environmental standards, establishing industrial order, and imposing more efficient resource and environmental taxes; third, to weed out backward production technology that is not qualified according to the emission standards, and to promote the technical transformation of the mining industry; fourth, to complete the laws and regulations along the supply chain for a unified, normative, and efficient RE regulation system; fifth, to accelerate the process of merging and creating an industrial structure led by dominant firms, including the goal that the industrial concentration of the largest three southern ionic clay RE firms should be 80%; sixth, to coordinate the RE industry with the local economies and the interests between different entities (central government and local government, state-owned enterprises and private firms, local government and local firms, state-owned enterprise owned by the central government and local governments); seventh, to coordinate the relevant national ministries and departments in terms of planning and policy implementation; and last, to increase the qualification requirements for RE exporting firms and crack down on illegal exports.
Environmental regulations and treatment of illegal activities
Starting from this stage, China began to employ environmental policies and industrial standards for RE production emissions. Deteriorating environmental quality posed serious threats to public health and social stability. For the RE industry, according to official data in 2012, the city of Ganzhou, Guangxi province, needed US$ 5.8 billion solely for land reclamation not to mention health costs and other environmental pollution. By contrast, the average annual profit from 2002 to 2012 of Ganzhou’s RE industry was only about 0.3 billion US dollar. To help treat environmental issues, the central government gave fiscal support to local governments (MLR 2015c). Wübbeke (2013) provides another example of pollution in Inner Mongolia, northern China.
In 2011, the first industrial standards for air and water pollution of RE industry were introduced (MEP and AQSIQ 2011), followed by a specific inspection process associated with the environmental impact analysis (MEP 2011a). In 2013, standards became more detailed by specifying air pollutants (MEP and AQSIQ 2013). The industry entry standards prevented small and outdated technology from proposal approval. RE-specific environmental standards marked the latest focus of the new administration. As China achieved more economic progress, environmental issues became the top topic on policymakers’ agenda.
Environmental damages are highly related to illegal mining. Simultaneously, the government used environmental requirements to restrict illegal RE production. The crackdown on the illegal and black market activities mainly led by MLR and MIIT started in 2010 and was aimed at investigating and punishing illegal mining, processing, and trading. A crackdown campaign ending in April 2017, led by the RE office and with the participation of other related ministries, included investigations in 23 provinces and inspections of 415 firms in the RE supply chain. Figure 14 shows that there were such administrative activities in almost every year, which implies that the problems of illegal production are complicated to deal with for the central government (MLR 2010b; MIIT et al. 2011a, b; MIIT 2012c; MIIT et al. 2013a; MIIT et al. 2014, MIIT et al. 2016, MIIT 2017c).
Resource tax reform
In 2011, the RE resource tax increased from 0.4–3 yuan/t to 60 yuan/t for light RE ore (for example, bastnasite and monazite minerals) and 30 yuan/t for middle-heavy RE ore (for example, xenotime and ionic clay minerals). The resource tax reform intended to capture the scarcity of the RE resources and the externality caused by mining and processing. Starting in 2015, the resource tax for RE ore changed from quantity based to value based. The tax for three provinces—Inner Mongolia, Sichuan, and Shangdong—are 11.5%, 9.5%, and 7.5% of the value of sales of RE concentrate equivalent. The rate for middle-heavy RE ore is 27% of sales. The resource tax caused two problems. First, illegal mining that did not pay the tax drove down prices and thus reduced the profitability of legal firms. Without treating illegal production effectively, the resource tax made it harder for the legal firms to survive (Chen 2015). Therefore, the resource tax has to work together with policies that reduce illegal activities. Second, local governments, on one hand, collected extra fees beyond the resource tax that put the legal firms into a worse financial situation, while on the other hand failing to use the RE fees to deal with RE problems effectively. With the tax reform in 2015, the State Council required local governments to cancel resource compensation fees, price adjustment funds, and all other fees (State-Council 1994, 2011b; MoF and SAT 2015; MoF and NDRC 2015; Fu et al. 2017).
The development of the downstream sector
China’s policies actively encouraged the domestic downstream industry. The focus of the RE supply chain moved to downstream sectors along with the development of the entire mineral industry and China’s economy. Tse (2011) shows that China’s consumption of RE mineral increased from 19,000 t in 2000 to 77,000 t in 2010, an annual growth rate of 15%. Roskill (2015) has a similar estimation that, from 2004 to 2014, China’s consumption increased by 7.5% annually from 40,000 to 82,750 t and the consumption by downstream sectors of the rest of the world decreased by 3.8% annually. During this period, China’s share of world consumption rose from 43 to 70%. Adamas (2016) data verify the demand of RE products in Roskill (2015) and show that China’s production of RE end-use products increased from 56,984 t in 2005 to 81,858 t in 2015. By 2015, Chinese domestic consumption of rare earths grew to 80% or more of domestic production (Fig. 8).
The RE price was a key factor driving the size of the Chinese downstream RE sectors. During the period of export quotas and taxes, domestic Chinese prices were significantly lower than Chinese export prices available to customers in the rest of the world. Taking the price of cerium as an example, the dark gray area in Fig. 9 shows the absolute difference between the Chinese domestic price for cerium and export price. The line shows the relative difference. The price difference worked as an incentive for the expansion of the Chinese RE end-use production firms, as shown in Fig. 10.