CHANGSHU, China (NY Times) — China has long used access to its giant customer base and cheap labor as bargaining chips to persuade foreign companies to open factories within its borders.
Now, corporate executives say, it is using its near monopoly on certain minerals — in particular, scarce metals vital to products like hybrid cars, cellphones and energy-efficient light bulbs — to make it difficult for foreign manufacturers of high-tech materials to build or expand factories anywhere except China.
Companies that continue making their products outside the country must contend with tighter supplies and much higher prices for the materials because of steep taxes and other export controls imposed by China over the last two years.
Companies like Showa Denko and Santoku of Japan and Intematix of the United States are adding factory capacity in China this year instead of elsewhere because they need access to the scarce metals, known as rare earths.
"We saw the writing on the wall — we simply bought the equipment and ramped up in China to begin with," said Mike Pugh, director of worldwide operations for Intematix, who said the company would have preferred to build its new factory near its Fremont, Calif., headquarters.
While seemingly obscure, China's policy on rare earths appears to be directed by Prime Minister Wen Jiabao himself, according to Chinese officials and documents. Mr. Wen, a geologist who studied rare earths at graduate school in Beijing in the 1960s, has led at least two in-depth reviews of rare earths this year at the State Council, China's cabinet. During a visit to Europe last autumn, he said that little happened on rare earth policy without him.
China's tactics on rare earths probably violate global trade rules, according to governments and business groups around the world.
A panel of the World Trade Organization, the main arbiter of international trade disputes, found last month that China had broken the rules when it used virtually identical tactics to restrict access to other important industrial minerals. China's commerce ministry announced on Wednesday that it would appeal the ruling.
No formal case has yet been brought concerning rare earths because officials from affected countries are waiting to see the final resolution of the other case, which has already lasted more than two years.
Karel De Gucht, the European Union's trade commissioner, cited the industrial minerals decision in declaring last month that, "in the light of this result, China should ensure free and fair access to rare earth supplies."
Shen Danyang, a spokesman for the commerce ministry, reiterated at a news conference on Wednesday in Beijing that China believed that its mineral export policies complied with W.T.O. rules. China's legal position, outlined in W.T.O. filings, is that its policies qualify for an exception to international trade rules that allows countries to limit exports for environmental protection and to conserve scarce supplies.
But the W.T.O. panel has already rejected this argument for the other industrial minerals, on the grounds that China was only curbing exports and not limiting supplies available for use inside the country.
China mines 94 percent of the world's rare earths and accounted for 60 percent of the world's consumption by tonnage early this year. But if factories continue to move to China at their current rate, China will represent 70 percent of global consumption by early next year, said Constantine E. Karayannopoulos, the chief executive of Neo Material Technologies, a Canadian company that is one of the largest processors in China of raw rare earths.
For the last two years, China has imposed quotas to limit exports of rare earths to about 30,000 tons a year. Before that, factories outside the country consumed nearly 60,000 tons a year.
China has also raised export taxes on rare earths to as much as 25 percent, on top of value-added taxes of 17 percent.
Rare earth prices have soared outside China as users have bid frantically for limited supplies. Cerium oxide, a rare earth compound used in catalysts and glass manufacturing, now costs $110,000 a metric ton outside China. That is more than four times the price in China, and up from $3,100 two years ago, according to Asian Metal, an industry data company based in Pittsburgh.
For most industrial products that are manufactured in China using rare earths and then exported, China imposes no quotas or export taxes, and frequently no value-added taxes, either.
Companies do that math, and many decide it is more cost-effective to move to China to get cheaper access to the metals.
"When we export materials such as neodymium from China, we have to pay high tariffs," said Junichi Tagaki, a spokesman for Showa Denko, which announced last month that it would sharply expand its production of neodymium-based magnetic alloys, used in hybrid cars and computers, in southern China.
The company saves money by manufacturing in China instead of Japan because the alloys are subject to no Chinese export taxes or value-added taxes, he said.
Big chemical companies are also shifting to China the first stage in their production of rare earth catalysts used to refine oil into gasoline, diesel and other products. They are moving after Chinese state-controlled companies grabbed one-sixth of the global market by offering sharply lower prices, mainly because of cheaper access to rare earths. Chemical companies are also working on ways to cut the percentage of rare earths in catalysts while preserving the catalysts' effectiveness.
Production of top-quality glass for touch-screen computers and professional-quality camera lenses, now done mostly in Japan, is also shifting to China because it requires rare earths.
Factories are moving despite worries about the theft of trade secrets. Intematix takes elaborate precautions at a factory completed last month here in Changshu, 60 miles northwest of Shanghai, where the company manufactures the rare earth-based phosphors that make liquid-crystal displays and light-emitting diodes work. While Intematix hired Chinese scientists to perfect the industrial processes here, only three know the complete chemical formulas.
China's timing is excellent, said Dudley J. Kingsnorth, a longtime rare earth industry executive and consultant in Australia. Mines being developed in the United States, Australia and elsewhere will start producing sizable quantities of rare earths in the next few years, so China seems to be using its leverage now to force companies to move.
"They're making the most of it, and they're obviously having some success," he said.
Until Western governments, business groups and media began pointing out the W.T.O. issues, Chinese officials had repeatedly stated that the rules were intended to encourage companies to move production to China. They switched to emphasizing environmental protection as the trade issues became salient.
China stepped up enforcement this summer of mining limits and pollution standards for the rare earth industry, which has reduced supplies and pushed up prices in China, although not as much as for overseas buyers. The crackdown may help China argue to the W.T.O. that it is limiting output for its own industries.
But other countries are likely to say that the crackdown is temporary and that previous crackdowns have been short-lived.
Charlene Barshefsky, the former United States trade representative who set many of the terms of China's entry to the W.T.O. in 2001, wrote in an e-mail that one problem was that W.T.O. panels did not have the power to issue injunctions. So countries can maintain policies that may violate trade rules until a panel rules against them and any appeal has failed.
Even then, the W.T.O. can order a halt to the offending practice, but it usually cannot require restitution for past practices except in cases involving subsidies, which are not directly involved in the rare earth dispute.
China is offering carrots as well as sticks to persuade foreign companies to move factories to China. Under China's green industry policies, the municipal government of Changshu let Intematix move into a newly built, 124,000-square-foot industrial complex near a highway and pay no rent for the first three years.
Intematix pays $400 to $500 a month (2,500 to 3,000 renminbi) for skilled factory workers like Wang Yiping, the 33-year-old foreman on duty on a recent morning here. It pays $500 to $600 a month (3,000 to 3,500 renminbi) for young, college-educated chemical engineers like Yang Lidan, a 26-year-old woman who examined rare earth powders under an electron scanning microscope in a nearby lab.
It was also relatively cheap to buy the factory's 52-foot-long blue furnaces, through which rare earth powders move on extremely slow conveyor belts while superheated to 2,800 degrees Fahrenheit. With many Chinese suppliers competing, Intematix paid 10 to 20 percent of American equipment prices, said Han Jiaping, the factory's vice president of engineering.
Still, Mr. Pugh said that the company's decision to build the factory in China was based not on costs but on reliable access to rare earths, without worrying about quotas or export taxes.
"I think this is what the Chinese government wanted to happen," he said.