Highlights
- A 2010 Chinese export restriction on rare earth elements triggered unprecedented innovation in global industries, particularly in Japan and the EU.
- Researchers found that supply shocks can stimulate technological change, pushing firms to develop more efficient and less dependent technologies.
- The study reveals that adversity can accelerate technological progress by forcing industries to innovate and reduce reliance on scarce critical inputs.
In a June 20 publication (opens in a new tab), the Centre for Economic Policy Research (CEPR) discussed how supply shocks to essential inputs—particularly rare earth elements (REEs)—can unintentionally spur innovation and economic realignment in third-party countries. The analysis, authored by Laura Alfaro, Harald Fadinger, Jan Schymik, and Gede Virananda, centers on a pivotal episode that began in 2010, when China, then the dominant global supplier of rare earths, imposed strict export controls. Though framed at the time as a crisis for global supply chains, this event ultimately served as a catalyst for technological advancement across much of the industrialized world.
Rare earth elements comprise a group of 17 metals that are critical to a range of advanced technologies, including electric vehicle motors, wind turbines, lasers, and medical imaging systems. A set of unique characteristics magnifies their importance: they’re tricky to substitute, challenging to extract and process, and overwhelmingly sourced from one country—China. At the height of its dominance, China was responsible for approximately 98% of global rare earth element (REE) production. When it cut off exports in 2010, prices skyrocketed, increasing up to 45 times for some elements. The move was widely interpreted as a strategic maneuver in China’s geopolitical toolkit, culminating in a WTO ruling that forced the rollback of the restrictions in 2015.
While much of the global response emphasized supply chain fragility and the need for diversification, the CEPR study takes a different angle: examining how scarcity of such an indispensable input can actually stimulate technological change. Drawing on the economic theory of “directed technological change” (notably advanced by Daron Acemoglu), the researchers propose that when a key input becomes expensive or uncertain—whether due to policy, market disruptions, or geopolitical tensions—firms redirect R&D efforts toward using it more efficiently, reducing dependency, or even substituting it altogether.
To rigorously evaluate this dynamic, the authors constructed a new input-output framework mapping REE usage across U.S. industries, incorporating data from the U.S. Geological Survey and rare earths price indices. Crucially, they also factored in the substitutability of each element using a metric from prior research that ranks the difficulty of replacing a given REE in industrial applications. This detailed mapping allowed them to identify which sectors were most vulnerable to REE shocks, and to quantify the responses in innovation, productivity, and export activity.
The results were striking. Outside of China, industries that heavily depended on hard-to-substitute rare earth elements (REEs) experienced faster growth in REE-saving innovations, improved productivity, and higher export performance following the 2010 shock. The effect was particularly pronounced in countries such as Japan and across the European Union. For instance, in Japan, a one-standard-deviation increase in an industry’s REE sensitivity translates to a 0.5 percentage point annual increase in total factor productivity. Similarly, exposed sectors saw their export growth outpace less vulnerable ones by about 0.3 percentage points per year from 2010 to 2018.
Interestingly, Chinese downstream industries—despite having access to cheaper domestic rare earth elements (REEs) during the export restriction period—did not benefit in the same way. This observation highlights a crucial point: simply controlling supply does not necessarily translate to a competitive edge unless it is complemented by dynamic innovation.
To explore these mechanisms further, the researchers constructed a global general equilibrium model that embedded directed technological change within a multi-sector, multi-country framework. They simulated how innovation shifts in response to changes in relative input prices, with a focus on the relationship between rare earth elements (REEs) and labor. A key insight was that these two inputs are gross complements in most sectors, meaning that higher REE prices prompt firms to innovate in ways that reduce their REE dependence, rather than simply switching to other inputs.
The model was calibrated using data from the World Input-Output Database and REE intensity metrics derived from U.S. industry data and global patent activity. Notably, the researchers utilized a large language model to classify patents related to REE efficiency and substitution, providing a high-resolution picture of innovation activity worldwide.
Their simulations showed that when innovation is allowed to respond endogenously, the negative economic impact of China’s export tax is significantly mitigated. REE-intensive sectors contracted inside China but expanded in third countries, supported by a wave of REE-saving innovation. By contrast, if technology is held constant in the model, the supply shock causes more profound disruptions and yields China greater relative gains.
The policy implications of this research are timely and far-reaching. In a world where trade and industrial policy are increasingly being deployed as strategic tools—especially in sectors such as semiconductors, electric vehicles (EVs), and artificial intelligence (AI)—the rare earth story offers a potent reminder that these tools can have complex and often unintended consequences. As CEPR notes, U.S. export controls on advanced chips to China have recently sparked a similar pattern, prompting rapid innovation in China rather than curtailing its tech ambitions.
Understanding the dynamic interplay between policy, scarcity, and innovation is crucial for developing more effective strategies to foster industrial resilience. As the CEPR analysis makes clear, the global rare earth disruption was not just a cautionary tale about the supply chain—it was also a case study in the unexpected power of adversity to accelerate technological progress.
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