Friday, January 14, 2011

Can Toyota Innovate and Avoid Importing Rare Earth Metals From China for the Prius? A Test of the Induced Innovation Hypothesis

Mike Ramsey's article in the WSJ provides an interesting case study of the induced innovation hypothesis.  When a company anticipates that a key input it uses in production is going up in cost, what does it do?   Economy theory predicts that such a firm will seek to innovate to reduce its long run costs of production.  In the case of Toyota, it now recognizes that its past production decisions have made it "too reliant" on Chinese exports and it now seeks to be able to produce the next generation of EV vehicles using production methods that reduce the potential "hold up" problem.

"Toyota has taken several steps to reduce its dependence on China for the materials, including investing in a lithium venture in Argentina and launching a joint venture in Vietnam to prospect for rare metals like neodymium."  Now, this does sound like a "pollution havens" case here.  Do any rich countries have mining efforts to liberate these rare metals? So does China specialize in this task because of "natural advantages"? Or because, they don't enforce certain environmental and worker safety laws and ordered certain workers to go out and mine this stuff?

"China produces about 95% of the world's supply of neodymium and last summer the country began restricting exports. In December, China announced a 67% increase in export tariffs on the metal and has declared new limits on exports this year."

In this age of uncertainty, no global firm should be so reliant on any one input provider.  Flexibility is the name of the game.

Induced innovation is an important idea in modern economics.  Part of my optimism about why I think we can adapt to climate change is based on my confidence in our collective ability to use human ingenuity to solve the problems that Mother Nature will pose for us.  People keep saying that the climate scientists don't know what we will face later this century.  But, at least some of our entrepreneurs today know that they "don't know".  People in the year 2070 will have the same basic needs and desires we have today of wanting to be healthy, and comfortable and able to trade with others.   Under ugly possible scenarios, the anticipation of our potential suffering creates opportunities today.  Economic theory predicts that no $20 bills lie on the ground for long!