Published daily by the Lowy Institute

Signs of a deal between US and China, and a rethink

Both countries have good reasons to cool off the two-year trade war.

The Port of Los Angeles, the busiest container port in the US (Photo: Mario Tama/Getty Images)
The Port of Los Angeles, the busiest container port in the US (Photo: Mario Tama/Getty Images)
Published 11 Nov 2019 

It is not yet agreed, may yet fail, and is anyway unlikely to settle matters, but the impending “phase one” trade deal could be a useful ceasefire in the US economic war with China. Two years on from the US initiation of penalty tariffs on China, it is also a convenient moment to point to a few lessons from the trade war thus far.

The essence of the deal is that the US will suspend the new penalty 25% tariffs on a wide range of consumer imports to be imposed on China from 1 December, and probably also remove or moderate the 15% deal tariffs on clothing, appliances, and some consumer electronics imposed 1 September. In return, China will commit to buying more US farm exports, toughening intellectual property protection in China, and more liberal investment rules for US finance businesses in China. For China, a sweetener in the deal may be permission for Huawei to continue buy US computer chips.

Both sides want a deal. US President Donald Trump needs to have some sort of agreement well before the presidential and congressional contests get seriously underway in 2020. He would no doubt prefer not to impose more tariffs in December, because these will be on consumer goods.

The US has discovered limits to bilateral pressures. It has not sought or found useful allies in pressing China.

For its part, China has every incentive to give Trump something. It needs more soybeans anyway, because its pig herd is rebuilding after an epidemic of swine fever. Earlier this year, its National People Congress rubber-stamped legislative changes to ban forced transfers of intellectual property in joint ventures and to limit discretions in controlling inward foreign direct investment. Having made or foreshadowed these changes, the Chinese negotiators are now free to modify the detail and present them as a package to their American counterparts. Phase one will also likely include a mutual agreement that exchange rates will not be manipulated for trade advantage.

What China must get in return is an agreement about a schedule for the reduction or elimination of existing penalty tariffs, and the suspension of threatened new tariffs. From China’s viewpoint, this is the only point of the negotiation.

If that is indeed the deal, it is pretty much what might sensibly have been expected at the outset of this quarrel two years ago. There never was any chance that China would give ground on the role of the Communist Party or the state in economic management. There was no chance China would agree to drop plans as a tool of economic development. China may be willing to discuss industry subsidies, but only if the US and perhaps Europe and Japan are also prepared to put their subsidies on the table. That is unlikely.

Given the logic of the negotiations so far, subsequent rounds will be all about the further reduction of US penalty tariffs on China in return for China buying more from the US, and carrying out whatever commitments it makes in phase one. Anything grander than that is unlikely.

While a phase-one deal is more likely than not, and a serious phase-two discussion may be postponed at least until 2021, there are already some important lessons in the experience of the last two years.

One is that although the US is a bigger and more technologically advanced economy than China’s, and it imports a good deal more from China than China from the US, not all the cards are in US hands.

As multiple US studies over the last 18 months have established, the costs of the tariffs imposed on China are being borne by American customers, not Chinese suppliers. The tariffs show up as higher prices in US stores, which is why China’s exports to the US have fallen. They are essentially a tax imposed on American consumers, the revenue from which is then distributed as support payments to American farmers hit by reduced Chinese purchases.

US Trade Representative Robert Lighthizer (L) and US Treasury Secretary Steven Mnuchin (R) with Chinese Vice Premier Liu He (C) as he arrives for trade talks in Washington, 10 October 2019. (Photo: Saul Loeb/AFP/Getty)

It is certainly true that the US trade deficit with China has narrowed and Chinese exporters are hurt by the reduction in sales. Yet it is also true that US exports to China (which has imposed counter-tariffs) have proportionately dropped more than China exports to the US.

While US tariffs have affected China’s exports to the US, China’s exports overall are well up  on 2017, before the trade war began.

China’s GDP growth has slowed, but not because of reduced exports to the US, any more than the slowing of US growth over the last year (and by more than the slowdown in China over the same period) is due to the drop in exports to China.

The US has also discovered limits to bilateral pressures. It has not sought or found useful allies in pressing China. Japan and Korea have stayed aloof, and Europe has continued to negotiate amicably enough with China. Even Australia has refused to side with the US against China.

Another lesson is that decoupling is hard to do. Though often portended, there have been few major changes in manufacturing supply chains which include China, and very few significant departures of foreign businesses from China. Its consumer market is now too big, its industrial organisation too efficient and too competitive, for foreign businesses to leave the market to their competitors. At China’s international import trade fair in Shanghai, US exhibitors have taken more space than any other country.

Huawei, the telecoms infrastructure company most prominently targeted by the US, continues to do brisk business worldwide. A year ago, it estimated the losses to its business from US actions at US$30 billion; that figure has now been revised down to less than $10 billion. Like other threatened Chinese businesses, Huawei is developing alternative products to software and hardware currently sourced from the US. It illustrates the point that in cutting off US supplies to China, the US has been losing customers and at the same time creating competitors.

There have been important lessons for China’s leadership. It no doubt much regrets bragging about the ambitions of the now-unmentionable China 2025 plan, a program that was always more rhetoric than substance. Though still intent on reaching the front rank of technological development, China’s leadership may well conclude it is sensible to say less and do more.

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