US/CHINA: Phase 1 ends tariff battle, but war shifts to new fronts

● Phase 1 deal probably marks the end of the tariff phase of US-China competition. ● China's purchase commitments could spark tensions with China's non-US trading partners who will suffer from lost exports. ● US-China competition will shift from tariffs to export controls, investment restrictions, and subsidies Chinese Vice Premier Liu He will formally sign the US-China phase one trade deal on 15 January. Uncertainty remains about the details of the agreement, but several key points are clear based on the broad outline that is public. First, most trade war-related US tariffs will remain in place, though additional tariffs are unlikely. Second, the deal sets ambitious targets for Chinese imports of US goods that, while achievable, will likely require China to divert purchases away from other trading partners. Third, many points of conflict between the US and China remain unaddressed, especially regarding industrial policy and technology. Read my lips: no new tariffs In the days leading up to the initial announcement of phase 1 on 13 December, negotiators wrangled intensely over how much existing tariffs the US would roll back. In the end, the degree of rollback was modest. Tariffs remain in place on USD 370bn worth of Chinese exports. The average US tariff rate on all Chinese exports will fall from 21% to 19.3% under the deal, compared to 3.1% before the trade war began, according to an analysis by the Peterson Institute. In the months leading up to phase 1, we argued that US President Donald Trump was increasingly worried about the economic impact of tariffs on the US economy as the November 2020 election approaches. In particular, Trump appeared reluctant to impose threatened tariffs on USD 180bn worth of consumer goods scheduled for 15 December. Nevertheless, the White House apparently persuaded Liu that Trump was prepared to follow through on this threat and that Beijing should therefore treat its removal as a significant deliverable, beyond the modest reduction in already-imposed tariffs. Phase 1 probably marks an end to the tariff-focused phase of US-China competition. Existing tariffs will remain in place for the foreseeable future, but new tariffs are highly unlikely before the US presidential election. Even after the election, further tariffs are unlikely, especially if a Democrat defeats Trump. Armed with a fresh electoral mandate in 2021, Trump would be more inclined than a Democrat to impose fresh tariffs as pressure for phase two. But even this scenario looks unlikely, since existing tariffs equip Trump with significant leverage. Chinese commitments to US will hurt other trading partners The official outline of phase 1 published by the Office of the US Trade Representative specifies that China has committed to increase total imports of US goods by USD 200bn in 2020-21 against the 2017 baseline. Though further detail is lacking, media reports indicate that this headline figure breaks down as follows: Manufactured goods: USD 80bn Energy: USD 53bn Agriculture: USD 32bn Services: USD 35bn Though ambitious, these targets are probably achievable. Beijing's ability to influence importers is strong, and the government is experienced at meeting numerical targets. Moreover, even partial completion of these commitments in 2020 — say, an increase of USD 60bn — could allow both sides to claim, semi-plausibly, that China is "on pace" to meet the two-year target. And given the 2020 US presidential election, Beijing may calculate that achieving "on pace" in 2020 — thereby avoiding snapback tariffs — matters more than fully achieving the USD 200bn commitment by end-2021. Still, the size of these commitments will probably require China to divert imports from other trading partners. In agricultural trade, Argentina, Brazil, Australia, and New Zealand could be hardest hit. For manufactured goods like autos and semiconductors, losers could include Japan and South Korea. The European Union could also suffer reduced exports in autos and auto parts, chemicals, and aircraft. Explicit Chinese purchase commitments to a single trading partner appear to violate the World Trade Organization's most-favored nation principle, which requires treating all members states equally. But given that the US has blocked appointments to fill vacancies in the WTO's Appellate Body, there is little prospect of enforcing the MFN principle. Though plaintiff countries could win an initial ruling, the lack of a functioning Appellate Body means the loser could force the case into legal limbo. US-China competition will shift to technology and industrial policy The apparent end to the tariff war will shift the focus of US-China competition to other areas, notably technology and industrial policy. The US Commerce Department continues to work on implementing regulations for the Export Control Reform Act of 2018 — notably lists of "emerging" and "foundational" technologies whose export will be restricted. How broadly these terms are defined will have a crucial impact on the ability of US technology companies to sell to China and the extent of decoupling. New investment restrictions will also lock in the recent plunge in Chinese investment in the US. On 13 January, the US Treasury Department released final regulations to implement the Foreign Investment Risk Review Modernization Act of 2018. The rules greatly expand the universe of deals that will require approval by the Committee of Foreign Investment in the United States. Chinese foreign direct investment into the US has already been decimated so severely — especially in the technology sector — that it does not have much room to fall further. But the new rules virtually foreclose the possibility of a rebound in Chinese inbound FDI. Headline US FDI into China has held steady, but technology investment has fallen substantially. Beyond export and investment curbs, the US wants to force China to halt state intervention to help Chinese national champion companies achieve leading positions in strategic industries. Washington's chief complaints are government subsidies and other forms of favoritism for domestic companies. On 14 January, trade chiefs of the US, EU, and Japan reached agreement on a years-long effort to amend WTO rules to broaden the scope of banned subsidies. If adopted by the full WTO, the rules would make it easier to challenge Chinese subsidies. These issues will be the ostensible focus of phase two negotiations, but the prospects for phase two are dim. China is fundamentally unwilling to abandon its industrial policy ambitions. Indeed, US export controls designed to choke off China's access to key technology have strengthened China's determination to achieve self-sufficiency key technologies. This stalemate will be the foundation of US-China competition for years to come.

January 14, 2020

US/CHINA: Phase 1 ends tariff battle, but war shifts to new fronts

BY Gabriel Wildau

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