Export restraints: The key to getting rich

Why is it so difficult for economics writers to understand how countries use economic strategy to get rich?

For my money, the Financial Times is the best business/financial publication in the world. But there it was in yesterday’s lead editorial praising the World Trade Organization for chastising China over its use of restraints on exports of certain key commodities like zinc, coke, and rare earth metals (of which China controls about 97 percent of the world’s production). According to the FT, not only do such restraints distort the price mechanism and global supply chains, but they also never work for the export restraining country because other countries quickly seek new sources of supply that eventually undermine any advantages accruing from the monopoly position of the restrainer.

OPEC would seem to be a good example of how a cartel can gain benefits from export restraints for quite some time even in the face of discoveries of new sources of supply. But put that aside. The main assumption of the FT editorial was that the purpose of the export restraints is to increase income through the achievement of monopoly pricing. In fact, while this may be a consideration in some instances, it is a minor one. The main point of the restraints has little to do with commodity prices as such and everything to do with economies of scale and strategic positioning.

Take the case of rare earth metals the export of which China has severely restricted. Of course, since China controls almost the entire world supply, it may gain something from monopoly pricing. But China’s larger economic strategy is to get away from being a mere commodity supplier by moving up the scale of value added to higher technology and more skilled types of production. In this context, it is important to note that the production of a wide variety of advanced electronic products (smart phones, medical devices, weaponry) is dependent for its production on use of rare earth metals. By restricting the supply of such metals, China reduces the price for its own infant producers of these advanced electronics products while sharply undercutting the ability of more advanced foreign producers to continue to produce.

In effect, it can use the export restraints as a major incentive for the shifting to China of the production of the end products that use rare earth metals even though China presently does not have a comparative advantage in production of those products. Here is a classic example of how comparative advantage can be and is being shifted as a matter of strategic policy rather than resource endowment. As the production of the electronics end products is shifted to China, China based producers will gain economies of scale while foreign based producers will begin to loose the economies of scale they once enjoyed.

Once the economies of scale advantage has shifted to Chinese production, the price of the rare earth metals or other restrained commodities won’t matter and the restraint can be relaxed because the decisive cost factor is the economies of scale and not the price of the commodity resources.

No one should understand this better than the FT‘s editors. After all, England got rich and started the industrial revolution in large part by dint of introducing a similar scheme. In the late fifteenth century, England was the main supplier of wool to the wealthy Burgundian and Flemish textile producers. The wool was a relatively cheap commodity and England was thus relatively poor compared to the Burgundians and Flemish whose superior textile producing skills enabled them to cream off the bulk of the profits. After his coronation, Henry VII decided England was in the wrong end of the business and that it should be a leading maker of wool based products rather than just a grower and shearer of sheep. To induce a shift of wool textile production from Flanders and Burgundy to England, Henry first restricted and then banned the export of English wool while also offering tax relief and special incentives to producers who would move their production and their skills to England.

It worked and the rest is history, the history of an England and a United Kingdom that became rich and eventually the most powerful country in the world for a long time. Do economists and editorial writers think China and other developing countries are unaware of that history? And why do they think today’s developing countries should not imitate this kind of history? Because the WTO says that this sort of thing is now considered naughty by the very countries that got rich doing it?  That doesn’t sound very convincing.