A Phase Two China Deal: Tough But Not Impossible

Even as the Coronavirus dominates the news from Asia, China and the United States have turned to the next, more difficult part of their trade negotiations. This next phase should make the first look easy. Indeed, the only reason the two countries could sign phase one is because they agreed to postpone the hard stuff.  Progress from now on is far from certain, even after the virus issue has receded.  Still, if the White House can keep its nerve, China’s clear need for trade with the United States may still lead to some agreement.  

This White House’s objectives were never new.  Every president going back at least to Bill Clinton had pressed China for the four major issues on Trump’s agenda: 1. China bought too little from the United States. 2. Beijing insisted that U.S. firms in that economy have a Chinese partner with whom they must share their technology. 3. China had closed its financial markets to U.S. banks and other financial firms. 4. China violated U.S. patents and otherwise stole U.S. technology.  With past presidents, China had reassured each that it would alter its behavior, most famously to President Barack Obama late in his second term.  But because in every case Beijing reneged on its promises, American negotiators this time have insisted on something more substantive from Beijing.  In some cases, they wanted to see changes in Chinese law, which Beijing resisted, calling it an infringement on its sovereignty.  

Phase one of these negotiations secures a good part of the White House agenda. China has promised to buy some $200 billion more from the United States over the next two years.   Beijing has promised to open Chinese financial markets to U.S banking, investment, and insurance.  China’s leadership has also promised to stop insisting that U.S. firms operating in China must have a Chinese partner to which the American firm must transfer its technology.  The agreement remains mute on the issue of cyber theft, but it does make provisions for Chinese firms to notify Americans when introducing products that might infringe on the American firm’s patent.  It further allows aggrieved American firms to approach Beijing through the U.S. Trade Representative.  In the past, U.S. firms had to go to the Beijing government themselves, where they risked retaliation just for complaining. 

In response to China’s concessions, the United States has agreed to ease some of the tariffs it had put in place over the last couple of years.  The White House has cancelled the so-called “penalty tariffs” it had scheduled to place on $156 billion of Chinese goods and cut from 15 percent to 7.5 percent the tariffs imposed last September on $120 billion in Chinese goods.  The United States retains the 25 percent tariffs it had imposed earlier on another $250 billion of Chinese imports.  Since the tariffs were only ever meant to pressure Beijing to make the changes now in prospect these reductions hardly constitute much of a U.S. concession.

Phase two will take up the question of cyber theft and the changes in Chinese law that China has resisted so vociferously over the last couple of years. Any further tariff reductions will depend on satisfactory Chinese assurances on this matter.  Future tariff reductions will also depend on how well Beijing complies with its pledges in the phase one agreement.  On the first of these questions, the next round of negotiations can hardly be expected to go smoothly.  Beijing remains sensitive on sovereignty issues, perhaps especially so now that it has already bowed to several American demands.  If the sides can ever reach agreement, it will depend on extremely sensitive language to give sufficient assurances to the Americans while allowing Beijing to assert that it has not changed domestic law in response to U.S. dictates.

It does, however, seem likely that Beijing, despite its history of deceit, will live up to its phase one promises.  Even before the agreement, China had begun the process of changing its regulations to allow U.S. insurance subsidiaries and wholly owned U.S. banks onto the mainland. Nor should China have trouble increasing purchases of U.S. goods.  Since China has lost half its hog herd to African swine fever, it certainly has reason to increase imports of American pork.  China has already made significant increases in its purchases of American soybeans and further has begun to change its “safety” rules to allow imports of genetically modified food from the United States.  If it were also simply to shift its energy purchases in the direction of this country’s huge natural gas surplus, it could easily comply with its commitment to buy $200 billion more from the United States over two years.  

Aside from such specific needs, Beijing has every reason to comply because it has no desire to see tariffs rise again, as they would if China failed on its phase one commitments.  China is well motivated by the reverses its economy suffers during the last 12-18 months of tariff pressure.  It has seen its pace off growth slow to rates not seen in a generation. Producers have moved operations outside China to avoid the American tariffs.  New hiring has plummeted, 20 percent for technology workers by some estimates.  Consumer spending has slowed dramatically as well, with car sales in some provinces down by half. To be sure, China faces other economic challenges as well.  Decades of one-child policies have created an aging demographic that has only just begun to have an adverse economic effect.  At the same time, China’s more advanced stage of development makes growth opportunities less obvious than in the past and all but compels a slower growth pace.  Though it is impossible to disentangle what part of that country’s economic problems accrue to tariffs and what parts result for others considerations, it should be clear that circumstances generally prompt Beijing to do what it must to avoid any increased American pressure, including any backsliding on this phase one agreement.

Given that the most difficult matters lie in the phase two negotiations, the coming talks will likely go on for even longer than the negotiations have to date.  It would be quick work if they end in 2021.  In the meantime, the Americans have in phase one significant Chinese concessions to show for their efforts and the Chinese have come out from under the worst tariff pressure.  If and when the two countries sign a phase two trade agreement, China may revert to its historic pattern and renege on its agreements, engage in cyber theft and otherwise force technology transfers.  But for the time being, the threat that any backsliding will bring on renewed pressure at a time when Beijing can ill afford it should keep the phase one agreement intact while the countries grapple with other, more difficult issues.