Assessing Geopolitical Risk in Japan-China Trade Relations Amid Taiwan Tensions: Strategic Diversification and Rare Earths Supply Chain Resilience

The rare earth element (REE) supply chain has long been a focal point of geopolitical tension, particularly between Japan and China. With China dominating 70% of global rare earth mining and processing, Japan's reliance on its neighbor for critical materials-used in everything from electric vehicles to advanced military systems-remains a strategic vulnerability. Recent developments, however, suggest a recalibration of Japan's approach to supply chain resilience amid escalating tensions over Taiwan.

The Fragile Balance of Japan-China Rare Earth Trade

China's exports of rare earth compounds to Japan totaled $21.87 billion in 2023 according to trade data, underscoring the scale of interdependence. Yet this relationship is fraught with risk. In 2010, China imposed an effective rare earth embargo on Japan during a territorial dispute, forcing Tokyo to scramble for alternatives. While Japan reduced its dependence to 60% in subsequent years, recent data reveal a troubling reversal: reliance on China has now climbed to over 70%. This resurgence is partly due to the high cost and technical complexity of alternative sources, such as Lynas Rare Earths Ltd. in Australia, which produces heavy rare earth elements but cannot fully offset China's dominance.

The current geopolitical climate adds further volatility. Japanese leaders' recent remarks on Taiwan have drawn sharp rebukes from Beijing, raising fears of retaliatory measures. Yet analysts caution that China is unlikely to weaponize rare earths outright. As Bloomberg noted, such a move risks triggering global efforts to develop alternative supply chains and could alienate other trade partners. This restraint highlights the delicate balance China must strike between asserting geopolitical influence and preserving its economic interests.

Strategic Diversification: A New Era of Collaboration

Japan's response to these risks has been a multi-pronged strategy of diversification, anchored by international partnerships and domestic policy reforms. A landmark development is the U.S.-Japan Framework for Securing the Supply of Critical Minerals and Rare Earths, announced in October 2025. This agreement emphasizes joint investment in domestic mining and processing, streamlined permitting for projects, and the creation of high-standard marketplaces for critical minerals. By aligning with the U.S., Japan aims to reduce its exposure to Chinese supply chain disruptions while fostering a more resilient global network.

Domestically, Japan has accelerated permitting for rare earth processing facilities and is incentivizing private-sector participation in recycling and innovation. These measures are part of a broader push to localize value-added stages of the supply chain, such as refining and magnet production. While these efforts are still in their early stages, they signal a shift from passive dependence to proactive resilience.

Implications for Investors

For investors, the interplay of geopolitical risk and strategic diversification presents both challenges and opportunities. The rare earth sector remains highly sensitive to diplomatic shifts, with China's potential leverage over supply chains creating a "black swan" risk. However, Japan's collaboration with the U.S. and its focus on domestic processing could stabilize long-term access to critical materials.

Investors should monitor two key trends:
1. Policy Execution: The success of the U.S.-Japan framework hinges on its implementation. Delays in permitting or funding could slow progress.
2. Geopolitical Escalation: A direct confrontation over Taiwan could disrupt trade, but China's calculated restraint suggests a preference for indirect pressure, such as export restrictions on specific rare earths.

Conclusion

Japan's rare earth supply chain is at a crossroads. While its reliance on China remains high, strategic diversification efforts-bolstered by international alliances and domestic reforms-are beginning to reshape the landscape. For investors, the lesson is clear: geopolitical risk cannot be ignored, but proactive strategies can mitigate its impact. As the 2025 U.S.-Japan framework takes shape, the rare earth sector may yet become a model for resilient, geopolitically aware supply chain management.