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Three ways of looking at Chinese economic statecraft

Keith Bradsher reports on the latest move in Chinese economic statecraft:

China, which has been blocking shipments of crucial minerals to Japan for the last month, has now quietly halted some shipments of those materials to the United States and Europe, three industry officials said this week.

The Chinese action, involving rare earth minerals that are crucial to manufacturing many advanced products, seems certain to further intensify already rising trade and currency tensions with the West. Until recently, China typically sought quick and quiet accommodations on trade issues. But the interruption in rare earth supplies is the latest sign from Beijing that Chinese leaders are willing to use their growing economic muscle.

"The embargo is expanding" beyond Japan, said one of the three rare earth industry officials, all of whom insisted on anonymity for fear of business retaliation by Chinese authorities.

They said Chinese customs officials imposed the broader restrictions on Monday morning, hours after a top Chinese official summoned international news media Sunday night to denounce United States trade actions....

The signals of a tougher Chinese trade stance come after American trade officials announced on Friday that they would investigate whether China was violating World Trade Organization rules by subsidizing its clean energy exports and limiting clean energy imports. The inquiry includes whether China's steady reductions in rare earth export quotas since 2005, along with steep export taxes on rare earths, are illegal attempts to force multinational companies to produce more of their high-technology goods in China.

Despite a widely confirmed suspension of rare earth shipments from China to Japan, now nearly a month old, Beijing has continued to deny that any embargo exists.

Industry executives and analysts have interpreted that official denial as a way to wield an undeclared trade weapon without creating a policy trail that could make it easier for other countries to bring a case against China at the World Trade Organization.

So far, China seems to be taking a similar approach in expanding the embargo to the West.

Hat tip to Will Winecoff, who asks, quite reasonably, "What in samhell is China thinking?"

Assuming that the New York Times story is accurate, there are three ways to think about what Beijing is doing. First, this could just be all about domestic politics. Bradsher notes that the decision was made after a Central Committee meeting. It's possible that as the currency wars heat up, and as the U.S. starts complaining to the WTO, there was a need to assuage some nationalist outrage. Of course, no one really knows what Chinese domestic politics looks like, so who the hell knows how much validity to give to this argument.

The second way to look at it is that China's leaders have been reading The Sanctions Paradox. I argued in that book that high expectations of future conflict between the sanctioning and the sanctioned state would lead to frequent episodes of economic coercion, but each attempt would yield only minimal concessions. So far, this model holds up: the past month of China's rare earth export controls have yielded them exactly one returned fishing boat captain. Maybe they are hoping that extending the ban to the United States will force Washington to back down in their WTO complaints. Given rising conflict expectations, that's about the most they're going to get from this action.

The third way to think about it is that China is being ridiculously short-sighted in their use of economic coercion. As Patrick Chovanec notes at Seeking Alpha:

[China] really shot itself in the foot. By flexing its muscles so eagerly, over a relatively minor incident, it alarmed its customers and possibly frightened them off, when a softer approach might have lulled them into continued and deepening dependence. There's no question that China can extract rare earths at the cheapest price, in purely monetary terms. But now China's trading partners must be seriously wondering, what could the real price amount to, when the bill eventually comes due?

China's foreign economic policies with respect to raw materials suggests that Beijing doesn't think market forces matter all that much -- what matters is physical control over the resources. This is a pretty stupid way of thinking about how raw materials markets function, and it's going to encourage some obvious policy responses by the rest of the world. Non-Chinese production of rare earths will explode over the next five years as countries throw subsidy after subsidy at spurring production. Given China's behavior, not even the most ardent free-market advocate will be in a position to argue otherwise.

More importantly, China's perception of how economic power is wielded in the global political economy is going to have ripple effects across other capitals. If enough governments start reacting to China's economic statecraft by taking similar steps to reduce interdependence with that country, then China will have created a self-fulfilling prophecy in which geopolitics trumps economics. Another possibility is that the rest of the world will operate as before in dealing with each other, but treat China differently, developing CoCom-like structures and fostering the creation of explicit economic blocs.

That really would be the worst of both worlds for Beijing. China is growing, but the economic weight of countries that prefer market-oriented ways of doing business is still much, much larger.

In going for the short-term gain, China is inviting a long-term containment policy. That might allow for some rally-round-the-flag support at home, but it's going to be a massive net loss for their economy.

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