Phase One U.S.-China Trade Agreement

After twenty months of mutual tariff escalations and numerous rounds of negations, the U.S.-China trade dispute finally reached a temporary resolution.  The phase one trade agreement between the U.S. and China was signed on January 15 at the White House by President Trump and China’s lead negotiator, Vice Premier Liu He. 
 
The most tangible gains to the U.S. are immediate increases in Chinese purchases of American products.  China pledges to buy an additional $200 billion of American goods and services in the next two years, representing a 77% increase in annual purchases from the pre-dispute 2017 baseline level of $130 billion. Specifically, compared with their respective 2017 baseline levels, China pledges to purchase $77.7 billion more manufactured goods, $32 billion more agricultural goods, $52.4 billion more energy products, and $37.9 billion more services over the next two years.    
 
China also promises to protect intellectual property, to halt forced technology transfers, to dismantle barriers to market entry for certain key industries (agriculture and financial services in particular), and to not devalue its currency to gain an advantage in trade.
 
In return, the U.S. agrees to not implement the scheduled tariff increases, and to cut the tariff of 15% imposed in September on $120 billion of (mostly consumer) goods in half.  However, earlier tariffs that were put in place in the spring of 2018 -- tariffs of 25% on $250 billion Chinese goods -- will remain in effect.
 
It is not too surprising that the U.S. appears to have the upper hand in these trade disputes.  The U.S. buys much more from China than China buys from the U.S.  In 2017, China’s exports to the U.S. were worth $505 billion, or 4.1% of China’s GDP. By comparison, U.S. exports to China were $130 billion or 0.7% of U.S. GDP.
 
The vital economic interest China has in a normal trade relationship with the U.S. can be best seen from a historical perspective.  The U.S. has had a long history of helping China, granting China ‘most favored nation’ status starting in 1980, and shepherding China’s entry into the World Trade Organization in 2001.  With the help from the U.S., particularly in the area of trade, China’s economy has been transformed from one that was a mere 6% the size of the U.S. economy in 1978 to one that is 63% the size of the U.S. economy in 2017.

There is also a strategic interest for China to maintain a normal trade relationship with the U.S., as Chinese leadership has long held the view that the China-U.S. trade exchange is the “ballast stone” for bilateral relations.  Beijing’s yielding to Washington’s trade demands reflects a deep worry of the (nominally communist) regime about the possibility of decoupling from the U.S. and possibly repeating the fate of the former Soviet Union.

The de-escalation in the tariff war and promised increases in U.S. exports to China will certainly provide some benefit to U.S. consumers and producers - welcome outcomes of the phase one trade agreement.  Moving forward, two issues related to the trade agreement need to be closely watched.

First, there is some uncertainty about how well China will implement the changes specified in the agreement, in particular the promised purchases of American goods and services in the next two years.  Ironically, while the U.S. has blamed market intervention by China’s government for China’s trade surpluses, that government will be relied upon to deliver the specified reductions in these surpluses.  China’s will – and power – to make good on the agreement will no doubt be greatly tested in the next two years.         
 
Second, even if the agreement is perfectly enforced, questions still remain unanswered.  Will the U.S. trade deficit with China revert to old levels after this two-year period?  Structural changes to deal with this issue will perhaps be addressed in the next phase of trade negotiations. One fundamental structural problem is China’s government subsidies to large state-owned enterprises.   In addition, are government-directed industrial policies for strategic industries, such as the “Made in China 2025” strategic plan.  Future negotiations regarding long-term solutions to these structural problems will be tricky, as government subsidies and industrial policies are important tools by which the Chinese government exercises its power, and these tools often serve political as well as strategic purposes.
 
The success of the phase one U.S.-China trade agreement was shaped by the two countries’ domestic politics.  The U.S. election cycle brings a presidential election in 2020, and China has concerns regarding its slowing growth rate and the threat it poses to the “social stability” that Chinese leadership deems to be paramount.  The future of the U.S.-China trade relations will likely be shaped by developments in each country’s domestic politics.  While it took an unconventional U.S. president – one willing to impose considerable tariffs on $370 billion of imports from China despite objections from many economists as well as political constituents – to get the Chinese side to the negotiating table, it will probably also take a brave and persistent effort from the reform-minded policy makers within the Chinese government to successfully complete the phase two trade agreement that will, ideally, put this relationship on a more solid long-term footing.   
 

Posted: January 30, 2020 by Dennis W. Jansen, Liqun Liu, Andrew J. Rettenmaier