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Ed Dolan’s Econ Blog How Natural is Natural Monopoly? The Case of China and the Market for Rare Earths Posted May 12, 2015 Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.

A Collision Jars the High-tech
World  On September 7, 2010 a Chinese fishing boat collided with a Japanese Coast Guard vessel near a disputed chain of uninhabited islands in the East China Sea  The collision sparked a diplomatic row and led to a temporary cutoff of China’s shipments to Japan of rare earth elements, used in many high-tech products  Western officials confronted the alarming possibility that China, then home to some 97 percent of rare earth production, had natural monopoly in these strategic elements Senkaku (Diaoyu) Islands Photo source: Ministry of Land, Infrastructure, Transport and Tourism (Japan), National Land Image Information http://commons.wikimedia.org/wiki/File:Okinokitaiwa_of_Senkaku_Islands.jpg May 12, 2015 Ed Dolan’s Econ Blog

What is a Natural Monopoly?
 Economists define a natural monopoly as an industry in which long-run average cost is at a minimum when just one firm serves the market.  Sources of natural monopoly:  A technology such that limiting suppliers to one minimizes cost. For example, delivering natural gas to homes is least expensive when there is only one set of pipelines.  Ownership by a single producer of a unique natural resource that allows it to operate at a lower cost than any competitor  Does rare earth production fit this definition? May 12, 2015 Ed Dolan’s Econ Blog

What Are Rare Earths? 
Rare earth elements (REEs) are a group of 17 related elements near the middle of the periodic table of elements  They have many important applications in the high-tech world:  Magnets for electric car motors  Computer memories  Lasers  Superconductors  Catalysts  Lenses  and more . . . May 12, 2015 Ed Dolan’s Econ Blog

Rare Earths are Not Really
Rare  Despite the name, rare earths are not really all that rare  All of them are more common in the earth’s crust than gold, and some are as common as lead  However, they are hard to mine, because unlike gold or lead, they are never found in highly concentrated deposits May 12, 2015 Ed Dolan’s Econ Blog

China’s Dominance of REEs is
Relatively Recent  Until the 1960s, most REEs came from “placer sands” in India, Brazil, and South Africa  In the 1964, the rich Mountain Pass Mine in California became the largest producer  China’s dominance is relatively recent, dating from the 1990s when US production declined and world demand grew  What economic forces allowed China to become the world’s leading producer? May 12, 2015 Ed Dolan’s Econ Blog

The Role of Extraction Costs
 In part, China’s dominance of REEs came from lower extraction costs  At any given level of output, producers naturally draw from the lowest-cost sources first  China’s ore deposits are good, but not uniquely good  However, the combination of good ores with low labor costs helped China take market share away from US producers May 12, 2015 Ed Dolan’s Econ Blog

Tolerance of Environmental Damage Added
to China’s Edge  Mining REEs can cause serious environmental damage  Measures to protect or clean up the environment add greatly to the cost of production  Radioactive spills and costly pollution control regulations contributed to closing California’s Mountain Pass mine  Until recently, China tolerated severe pollution from primitive, low-cost, often illegal mining operations  Willingness to turn a blind eye to environmental damage contributed to China’s REE dominance May 12, 2015 Ed Dolan’s Econ Blog

Short-run vs. Long-run Supply 
Short-run supply of REEs is much less elastic than long-run supply  In the short run, supply can increase only through more output from existing mines  However, in the five years since 2010 several new suppliers have entered the market  California’s Mountain Pass Mine reopened and began shipping in 2013, using much more efficient technology than before its previous closure  Australia’s Lynas Corp. began production in Malaysia about the same time  Other projects are underway in Canada, Kazakhstan, and South Africa May 12, 2015 Ed Dolan’s Econ Blog

Short-run vs. Long-run Demand 
Similarly, short-run demand is much less elastic than long-run demand  In the short run, existing technology severely limits substitution for REEs  Over the past five years, however, new technologies have come on line  Better flash drives reduce need for REE- using hard drives  Ways have been found to build ulta-strong magnets with less of the REE dysprosium  Gasoline refining techniques have been modified to decrease use of REEs at only slightly reduced efficiency May 12, 2015 Ed Dolan’s Econ Blog

Low Short-run Elasticities Mean Volatile
Prices  Given low short-run elasticities of supply and demand, China’s attempts to restrict REE exports in 2010 sent prices soaring  However, prices peaked in early 2011. Since then, they have fallen by more than half  They remain higher than before the 2010 crisis, providing sufficient incentives for increased long run supply and substitution efforts Neodymium April $41/kg October $36/kg Cerium oxide April $4.70/kg October $92/kg Source: Bloomberg, http://www.bloomberg.com/news/2010-10-20/china- pledges-to-maintain-rare-earth-sales-official-says-exports-may-rise.html May 12, 2015 Ed Dolan’s Econ Blog

The Bottom Line: China Never
Had a True Natural Monopoly The bottom line:  Despite its 97% market share, China never had a true natural monopoly  Attempts in 2010 to exert tighter control over world supplies backfired by providing incentives for substitution away from REEs and entry of new producers  Like many monopolies or near- monopolies of the past—Polaroid, Xerox, Microsoft—China’s dominance of the REE market eventually succumbed to the forces of competition May 12, 2015 Ed Dolan’s Econ Blog

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