Commentary Type

US–China trade deal disappoints


Champagne corks popped on 15 January as US and Chinese officials signed phase one of their bilateral trade deal. But the celebration seems premature—the deal is flawed and likely to disappoint.

Despite the pact, the trade war continues substantially unimpeded. While the phase one deal avoids an escalation of tariffs and reduces US tariffs from 15 to 7.5 per cent on about US$112 billion of imports from China, most penalty tariffs imposed over the past two years remain intact.

The average US tariff on Chinese goods has risen from 3.1 to 19.3 per cent since the trade war began. Similarly, China continues to impose tariffs on almost 60 per cent of US shipments at rates that have increased from 8 to 20.9 per cent. China almost surely will have to reduce some penalty tariffs to meet the pact’s requirements to increase US imports.

The phase one deal has three main components: Chinese commitments to purchase agricultural, energy and manufactured goods, and services; and Chinese commitments to reform investment policies, enforce intellectual property rights and abstain from currency manipulation. The third component entails new high-level reviews to monitor implementation of the pact, settle disputes and pursue additional policy reforms in phase two.

China committed to increase purchases of US goods and services over the next two years above the baseline US exports in 2017 of US$186 billion. Growth targets for groupings of tariff lines covering agricultural, energy and manufactured goods, and services require increases above the baseline of US$77 billion in 2020 and US$123 billion in 2021, or $200 billion cumulatively. For example, US agricultural exports of the covered tariff lines were US$20.9 billion in 2017 and must double to US$40.4 billion by year-end 2021, and energy exports of US$7.6 billion in 2017 must soar to US$41.5 billion in 2021.

The target for increased services exports is more modest but still ambitious, growing from US$55.4 billion to US$80.5 billion. It is unclear what the 2017 baseline for manufactures trade is because the pact omits many tariff lines in that sector. Taking trade covered by the tariff lines for manufactured goods listed in the agreement, the 2017 baseline is US$50.2 billion and that would have to rise to US$95 billion by the end of 2021.

Reaching even the relatively modest first-year targets from the current depressed US export levels—down 16.2 per cent from 2017—is daunting. For example, soybeans accounted for US$12 billion, or 63 per cent, of 2017 US agricultural exports to China. But last year the total was US$7.5 billion.

US export capacity is limited because uncertainty caused by the trade war led farmers to reduce plantings and stocks, and Chinese demand for soy feedstock also fell because the African swine flu decimated pig farms. As for energy, substantial increases in US exports of liquefied natural gas are unlikely as it will take years to ramp up production to meet the targeted export levels in the US–China pact. China’s purchase commitments are wildly unrealistic and bound to disappoint, possibly provoking new recriminations and tariffs.

The second part of the deal involves Chinese commitments to address domestic practices that precipitated the trade war. This concerns forced technology transfer and the misappropriation of intellectual property, as well as nontariff barriers to agricultural trade, liberalisation of specific financial services, and currency practices. The required reforms are modest and largely replicate Chinese laws and regulations introduced over the past two years. The currency chapter largely codifies the current practice by the People’s Bank of China (PBOC).

Perhaps the most critical problem that precipitated the trade war, the unbridled Chinese support for state-owned enterprises (SOEs), is relegated to phase two talks. The Chinese were unwilling to discuss it. Instead, US officials are trying to engage support from the European Union and Japan on proposals to augment subsidy disciplines in the World Trade Organization. They posted a draft proposal the day before the US-China pact was signed, describing the types of reforms they expect from China regarding support for SOEs. Judging from those demands, phase two talks are going to face rough seas—if they are even able to launch.

The highly touted enforcement mechanism is nothing more than the existing process of high-level consultations between leaders of both countries, with lots of bells and whistles and easy recourse to unilateral retaliation when conditions suit. Expect that to be used early and often by US officials. If the Office of the United States Trade Representative dislikes China’s actions—as it did in filing the original section 301 complaint that launched the trade war—it can impose trade restrictions. China’s only recourse if it disagrees with the retaliation is to withdraw from the Agreement.

Why did China sign a deal that seems destined to fail?

First, it achieves short-term benefits by avoiding further escalation of bilateral tariffs in return for Chinese commitments to purchase needed agricultural and energy products. Second, the two-year time horizon for the purchase commitments creates some policy stability even if it means accepting the current high bilateral tariffs for the indefinite future. The pact also buys time to see how US policy will evolve in 2020 and especially after the US presidential election. Third, China basically agreed to domestic economic reforms that it is already pursuing as it implements its new foreign investment law, applies stronger penalties for intellectual property violations, and pursues the PBOC’s market-oriented exchange rate policies.

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