Trade and Industrial Policy in Supply Chains:Directed Technological Change in Rare Earths

Laura Alfaro (), Harald Fadinger (), Jan Schymik () and Gede Virananda ()

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: Trade and industrial policies, while primarily intended to support domestic industries, may unintentionally stimulate technological progress abroad. We document this mechanism in the case of rare earth elements (REEs) – critical inputs for manufacturing at the knowledge frontier, with low elasticity of substitution, inelastic supply, and high production and processing concentration. To assess the importance of REEs across industries, we construct an input-output table that includes disaggregated REE inputs. Using REE-related patents categorized by a large language model, trade data, and physical and chemical substitution properties of REEs, we show that the introduction of REE export restrictions by China led to a global surge in innovation and exports in REE-intensive downstream sectors outside of China. To rationalize these findings and quantify the global impact of the adverse REE supply shock, we develop a quantitative general-equilibrium model of trade and directed technological change. We also propose a structural method to estimate sectoral input substitution elasticities for REEs from patent data and find REEs to be complementary inputs. Under endogenous technologies and with complementary inputs, input-supply restrictions on REEs induce a surge in REE-enhancing innovation and lead to an expansion of REE-intensive downstream sectors.

Keywords: Trade Restrictions; Industrial Policy; Global Value Chains; Rare Earths; Directed Technological Change; Input-Output Linkages; Downstream Sectors; Innovation (search for similar items in EconPapers)
JEL-codes: F13 F14 F42 O33 O47 (search for similar items in EconPapers)
Pages: 81
Date: 2025-12
New Economics Papers: this item is included in nep-cna, nep-ene, nep-int and nep-tid
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