By Charles Daniel  

The Chinese government has found considerable success in stimulating economic modernization through its industrial policy. The development of the rare earths industry, in both upstream and downstream markets, exemplifies this success. Rare earths are a group of metals whose natural properties make them critical for many pieces of modern technology. Upstream, Chinese raw rare earth producers extracted minimal output in 1985; by 2001 they accounted for more than 90 percent of global production. China stimulated this growth beginning in 1990 with implicit and explicit subsidies for rare earth producers, which enabled them to enter the market and produce at lower marginal costs than other world firms. These lower costs enabled Chinese producers to assume a market-leading position, and this paper explains the resulting developments in the upstream rare earth market through the Stackelberg model, which describes sequential quantity competition. In 2006, China introduced an additional policy of export quotas on rare earths, intended to benefit downstream Chinese firms. These firms depend on rare earths as inputs for the final goods (such as batteries and personal electronics) they produce. After the quota announcement, Chinese downstream firms benefitted from continued unrestricted access to rare earths, while non-Chinese downstream firms faced higher costs on the world market for rare earth inputs. This paper uses the Bertrand model, in which firms compete on prices, to examine the subsequent effects on these downstream markets. While Chinese rare earth producers were harmed by the export quotas, the combination of the subsidy and the export quotas enabled China to complete its economic goals: to first gain leverage in the rare earths industry, and to second transition its economy toward higher-value products and services.

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Advisors: Professor Alexander Pfaff, Professor Michelle Connolly | JEL Codes: L5, L52, L13