Shortages in Europe? Only When Markets Fail.

An article in the Deutsche Welle caught our attention last night. (click here to read).

The author is suggesting that Europe could be facing a severe shortage of raw materials that are critical for technological advancements. The European Commission announced that an expert group has listed 14 materials facing a critical risk of shortage. They have also reported that demand for the materials could more than triple within 20 years. The main reasons for the shortage, according to their report, is due to the deposits being geographically concentrated (China, Brazil, Russia), the production function having low elasticity of substitution between inputs, and recycling rates. The report also warns that materials markets could become highly volatile due to rapid technological change that can lead to a change in the demand for these raw materials.

They go on to include the way some of these countries use trade and taxation policies to reserve their resources. China, which accounts for 95% of global rare-earth mineral production, will soon allocate the mining of its materials to a select number of state-owned companies.

EU Commissioner for Enterprise, Antonio Tajani, claims there is a need for “fair play” on raw material markets to allow the European industry access to these scarce resources.

Some of the EU’s recommendations in order to overcome the problem of materials shortage include proposals designed to increase mineral recycling, identifying substitutes and promoting greater exploration. They also advocate “the merits of pursuing dispute settlement initiatives” in order to ensure the supply of vital raw materials to the European industry.

The Government officials and industry representatives are discussing the launch of a raw materials agency. The agency, put together within the German Federal Institute for Geology and Raw Materials, would monitor global raw materials markets.

Ullrich Grillo, chairman of Grillo-Werke, a chemicals and minerals company and of the raw material working committee of the Federation of German Industries (BDI), told Deutsche Welle: "Without high-tech metals and also basic materials such as aluminum, copper and zinc, German industry is in danger."

Here is what we think... the authors got it all wrong. If economics teaches us anything, it is surely that the invisible hand is present and markets will adjust accordingly. If there is an expectation of a price increase, demand goes up and creates a shortage. So change the price! Those who value it the most will pay, and those who do not will find try and find substitutes, or move production to China.

When a shortage occurs, market prices will rise unless constrained by government. The increase in price signals firms to find more of these materials. For a historical lesson, see what happened to oil exploration spending after OPEC raised the price of oil from $6/bbl to $36/bbl in the early 1970’s. We note that an article last week in the Huffington Post suggested that there were abundant supplies of these metals in Afghanistan. (Click here for article)

Perhaps in future, we will delve into the Heckscher-Ohlin trade model which is based on factor endowments. We could also comment on the hypocrisy of Europe preaching about unfair trade, but not today.