It has become fashionable for many European policymakers to warn that Europe’s drive toward decarbonization should not lead to a new dependence on China for critical raw materials worse than its dependence on Russian natural gas that was exposed after the invasion of Ukraine. Fortunately, however, a sudden loss of “critical raw materials” from China is in fact not economically critical. The real economic risk for Europe is to waste taxpayer resources in alarmist and unnecessary attempts to follow the United States in decoupling from China. Instead, the European Union should pursue gradual market-led diversification of supply, innovative substitution, incentivized and mandatory recycling, and stockpiling.
The traditional definition of dependence is one in which a country cannot function without something. Since at least 1973, modern economies have depended on fossil fuels, suffering from inflation and recessions following fossil fuel price hikes. Europe experienced such difficulties after the (near) cutoff of piped Russian natural gas to the continent in the summer of 2022. Fossil fuels account for 20 percent of all EU imports, and energy remains about one tenth of the consumer price basket in the European Union. (The impact on producer prices tends to be even bigger.) European voters do not tolerate such disruptions for long.
But in contrast with fossil fuel disruptions, loss of “critical raw materials” has no discernable share of total imports or consumers’ purchases. As a result, hypothetical Chinese supply disruptions will not lead to a reduction in consumers' non-energy disposable income that would cause an economic downturn. For example, China’s cutting off rare earth exports in late 2010 did not cause a recession in Japan, despite serving as the most high profile case of using critical raw materials or rare earths as blackmail to date. Critical raw materials are further inputs into only specific—though often important—supply chains. A sudden stop in their delivery will not result in an economy-wide activity drop but would merely affect individual industries. The overall negative impact of critical raw materials trade restrictions is hence far smaller than for fossil fuels. They are in fact just not critical.
The European Union’s continued near total reliance on imported Chinese solar panels is often described as a key and dangerous EU dependency—a dependency deemed sufficiently damaging that the recent EU Net Zero Industry Act (NZIA) recommends striving for a 40 percent domestic production share of solar panels by 2030. Yet if China suddenly stopped exporting solar panels to the European Union tomorrow, there would be no economic disruptions like the skyrocketing natural gas prices after Russia stopped shipping natural gas through NordStream 1 in the summer of 2022. Europeans would not freeze in their homes the following winter if solar panel shipments to the European Union stopped. Existing solar panels would still produce electricity, though obviously Europe’s future solar energy plans would slow, possibly jeopardizing the European Union’s 2030 climate goals, but with scant short- or medium-term economic or political impact.
Several policies are available to promote critical raw materials supply security. The first is “diversification subsidies.” China’s current dominant position in many of these markets is not due to the raw materials themselves only being present in China but rather because Chinese extraction and processing of these minerals is often far cheaper than elsewhere. This differential is partly due to sometimes more lax environmental rules in China, China’s economies of scale, and China’s subsidies. EU governments can therefore diversify supply and subsidize the purchase of critical minerals from non-Chinese sources. Such a step would not entail implementing any trade restrictions, merely spending taxpayer funds on securing critical raw materials from places other than China. EU governments could do this by directly funding relevant transactions or by offering firms corporate tax credits to get them to pursue an even more diverse supplier base than rising market-driven corporate concerns over “China risk” would dictate.
It should be noted that, for domestic political reasons, the United States has chosen to very rapidly disentangle its supply of many critical raw materials from any Chinese sources. It is predominantly the anti-China provisions in the US Inflation Reduction Act (IRA) that currently compel the Biden administration to seek out new critical raw materials deals with other nations to ensure that US facilities manufacturing electric vehicle (EV) and other IRA-subsidy eligible products have the input materials they need in the coming years. This type of expensive policy-induced “forced exit” from Chinese sources is driven by anti-China sentiment in the United States, which the European Union ought not to emulate.
Instead, the European Union should pursue “substitution through innovation.” Unlike burning fossil fuels, critical raw materials are used because of the particular capabilities they give to the decarbonized products they are part of—whether they are lithium, nickel, or cobalt in batteries, or rare earth minerals in the permanent magnets in wind turbines or EV engines. This means demand for a given critical raw material is subject to innovative substitution, as scientists discover new and cheaper materials with the same capabilities with which to replace it. The incentive for private actors to pursue innovation substitution is directly related to the price of a given critical raw material, and de facto puts a cap on likely future price increases, and also makes it commercially risky to invest large sums in new extractive capacity for “critical green raw materials” that innovation may replace in the future. For example, the price of cobalt, much sought after for use in car batteries, has dropped more than 60 percent since early 2022, as new cobalt-free iron-phosphate based battery technologies have emerged. Similarly, sodium-based batteries are increasingly competing directly with traditional lithium batteries, effectively putting a price ceiling on the main ingredient in the latter, as lithium prices have dropped more than 75 percent since late 2022. Future innovative breakthroughs may likely bring about new, cheaper, and more available materials to replace expensive critical raw materials. Because of the risk of substitution innovation if prices remain high, no monopolies like the Organization of the Petroleum Exporting Countries will form for critical raw materials. EU governments can actively promote substitution innovation by funding basic materials research at universities and private entities.
Another way to keep supplies going would be for the European Union to incentivize and mandate recycling of critical raw materials. The record demonstrates that critical raw materials can be recycled for safe domestic supply. Recycling may not, however, be a viable strategy for particular rare earth minerals of which only tiny amounts are used in individual products. Mandating their recycling may add excessive costs to the process.
Finally, as the International Energy Agency demonstrated in 1974 by introducing the requirement that oil stock levels be equivalent to no less than 90 days of net imports, concerns about supply security can be addressed through incentivized or mandatory minimum stockpiles. Governments can either choose to do this themselves by simply buying and stockpiling the raw materials deemed sufficiently important, or they can incentivize businesses to do it themselves via tax benefits or prescribed firm-level inventory levels.
Bottlenecks will invariably emerge in an economic transition as dramatic as decarbonization. The risk of war over Taiwan and associated threats of sanctions on China is not zero, but the raw material dependence is not remotely as severe as its current fossil fuel dependency. The European Union has cost-conscious policies—diversification, substitution, recycling, and stockpiling—available to mitigate any concern about longer-term supply constraints.
Worrying excessively about future critical raw materials shortages in the European Union and prescribing US-style protectionism and huge national security–driven subsidies to address them ignores the economic flexibility granted by price-driven market forces and wastes scarce fiscal resources. There are better and more fiscally and politically sustainable ways forward.
2. The Chinese export restrictions, though, did only last an alleged few months in late 2010, and subsequent analysis suggests that the restrictions never constituted a total ban on exports to Japan but were rather related to an earlier aggregate reduction in Chinese rare earth exports.
3. My PIIE colleague Cullen Hendrix has pointed out that particular critical raw materials may be indispensable to specific defense industries and as such attain “critical importance” through their effect on national security considerations.
4. Fortunately, the NZIA is unfunded and as such, there is no money available to pursue this merely aspirational though reckless solar panel production target.
This publication does not include a replication package.