Last week, Katherine Tai was confirmed as the new U.S. Trade Representative. There are still some key deputy positions to fill in the U.S. Trade Representative’s Office, but the Biden administration can now begin developing its trade policy in earnest, including a promised “comprehensive review” of U.S. trade policy with respect to China. A key aspect of the China trade issue will be how to handle the legacy left by the Trump administration, which involved a tariff war and, eventually, a “Phase One” trade agreement that created new obligations while leaving most of the tariffs in place.
When Tai was asked about China’s compliance with the Phase One agreement during her Senate confirmation hearing, she replied that she would “not hesitate to make use of the agreement’s mechanisms when China falls short of its commitments.” And in response to questions about a Phase Two deal, she offered general assurances that work would proceed on issues not covered by the Phase One deal.
But can compliance with Phase One actually be enforced? And is there scope for a Phase Two deal between the United States and China at this moment? Are there alternative approaches that might work better than more bilateral negotiations? And what about all those tariffs? We consider each of these issues below.
Assessing Compliance with the Phase One Deal
Under the Phase One agreement, which was signed on January 15, 2020 and took effect on February 14, 2020, China made a number of commitments, the most high profile of which was to substantially increase imports from the United States of agricultural products, industrial products, natural resources, and services. Over the past year, however, China only purchased around 60 percent of the committed amount for trade in goods. This outcome is not surprising, as the purchase targets were set at a level that many people considered to be unrealistic, and on top of that the pandemic undermined trade flows in general.
In terms of how the Biden administration sees the value of the Phase One deal's purchase commitments, Agriculture Secretary Tom Vilsack recently stated that he was satisfied with China’s purchases so far, taking into account the impact of the COVID-19 pandemic. Nonetheless, the Biden administration has made clear that it is planning to review all aspects of the U.S.-China trade relationship, so how exactly Biden’s trade team approaches these purchase commitments remains to be seen.
China also took on other new obligations in the Phase One deal, including intellectual property protection, forced technology transfer, and regulatory trade barriers for various U.S. goods and services. While China has addressed many of these obligations in its recent legislative and regulatory actions, the implementation of these rules in China is still a bit uncertain. For example, in relation to technology transfer, a U.S.-China Business Council (USCBC) survey last year found that 13 percent of companies said they had been asked by their Chinese partners to transfer technology, a figure which had risen from the previous year. Whether this indicates an increase in forced technology transfer is unclear, and requires further investigation.
In their written questions for Tai as part of the confirmation process, senators raised issues related to China’s compliance with the Phase One deal multiple times, addressing topics that included agriculture purchase commitments, intellectual property protection, financial services, and regulatory trade barriers. Tai did not promise specific enforcement actions, but did offer some general assurances that she would “make use” of “the agreement’s mechanisms” to ensure compliance.
However, when thinking about enforcement of the Phase One deal, it is important to note that the dispute settlement procedure in the Phase One deal has some fundamental shortcomings. The deal sets out a multi-layer consultation process between the United States and China to address trade concerns. However, if the two sides cannot agree on a resolution, the complaining party (likely the United States, because most of the obligations in the deal are on China) can unilaterally impose a remedial measure. The other side (China) then has two options: Accept the remedial measure, along with a promise not to retaliate; or walk away from the deal. Unlike most trade agreements, there is no neutral dispute mechanism, with a panel of independent arbitrators to rule on disputes. The absence of neutral adjudicators is likely to make enforcement of the deal very difficult, as China is not likely to respond positively to unilateral determinations by the U.S. government.
With these shortcomings of the dispute settlement procedure in mind, it is not surprising that very few companies intend to use this mechanism. In a USCBC survey, only 16 percent of U.S. companies said they are likely or very likely to use it while 39 percent of companies said it is unlikely or very unlikely. To date, the mechanism does not appear to be having an impact, as there has been no information from either the United States or China about its use in specific cases.
Is a Phase Two Deal on the Horizon?
Senators raised the prospect of a Phase Two deal several times in their written questions to Tai, who again offered general assurances, noting that she was “commit[ted] to work, ideally with our allies, to address important areas that are not yet covered by the Phase One Agreement such as industrial subsidies and excess capacity,” and that she “intend[s] to explore every possible option available to address our longstanding concerns with China’s intellectual property theft and inadequate market access.”
Business groups have also been pushing for a Phase Two deal. A report from the American Chamber of Commerce in South China from last year argued that “unless the U.S. and China immediately return to the negotiating table to start Phase Two, a step that China has also indicated is not imminent, Phase One will go down as one of the biggest political and economic failures in a generation.” And the National Association of Manufacturers has been calling for a Phase Two negotiation “to improve trade certainty.”
The Phase One agreement was said to have dealt with the easier issues, and for the Phase Two deal to mean anything, it will have to address more sensitive ones. During Tai’s confirmation, Senator Ben Sasse stated that the Phase Two deal should address “critical issues” such as “excess capacity, state-owned enterprises, state-sponsored cyber-enabled theft of intellectual property, restrictions on cross-border data transfers, and regulatory transparency that were not fully addressed or accomplished in Phase One.” Similarly, the U.S. Chamber of Commerce and other business groups listed issues such as subsidies, cybersecurity, digital trade and data governance, and competition policy to be tackled in a Phase Two deal.
Past experience shows that negotiating an effective agreement on these issues will be no easy task. In 2015, President Obama signed a deal with President Xi Jinping on curbing cybertheft, but it is not clear how much the deal has delivered (see here and here). With regard to SOEs and subsidies, China made some commitments under the recently concluded Comprehensive Agreement on Investment with the European Union (EU), and also under the Regional Comprehensive Economic Partnership, but some analysts view these rules as insufficient to handle China’s practices. Bilateral negotiations on data will also be challenging, as the United States and China remain far apart on the issue.
The Next Phase: Working with Others?
Tai’s remark that negotiations would be undertaken “ideally with our allies” may be important here. A bilateral negotiation between the United States and China has two main drawbacks. First, the United States has less economic leverage on its own than if it works with others. And second, China does not want to look like it is being pushed around by a country that many people are referring to as its “Great Power Rival.”
It is easy to imagine an alternative negotiation carried out by the United States and its allies in a lower profile manner, which would lead to greater economic leverage and more opportunities for tradeoffs that could make the deal more palatable to China. While it is fair to say that China's recent economic growth means it should take on greater liberalization commitments, for political reasons it will need to be able to characterize the deal as at least somewhat balanced. Commitments from the United States and other countries to lift some trade barriers will help provide balance in the deal, as well as bring about more overall liberalization.
With this in mind, perhaps the next phase of trade negotiations with China could be an entirely new effort undertaken jointly by the United States, the EU, and others. This won’t be easy, because the United States has plenty of outstanding trade frictions with the same potential partners it hopes to work with against China. But it may be the best way to make progress on China's trade practices.
The Lingering Problem of Tariffs
Despite there being a Phase One trade deal, most of the tariffs from the U.S.-China trade war remain in place and the Biden administration has thus far shown little interest in lifting them. These tariffs are currently being imposed on $370 billion worth of Chinese imports (and have also led to retaliatory tariffs by China on $130 billion of U.S. exports).
In terms of the impact on businesses, surveys have found that more than half of U.S. companies operating in China listed lifting tariffs as a top priority last year. 65 percent of American companies say they are still feeling the negative impact of the U.S. tariffs. Similarly, another survey found that 39 percent of U.S. companies experienced a loss of sales due to the Section 301 tariffs and that a mere 7 percent think the benefits of the Phase One deal outweigh the costs of the tariffs.
If the Biden administration is interested in new negotiations with China, either as a Phase Two deal or a more comprehensive agreement, scaling back the existing tariffs should be a top priority. The political difficulties of such a move are clear, as any tariff reductions would be criticized as being “soft on China.” But if the ultimate objective is to change Chinese trade practices in areas such as state-owned enterprises, subsidies, and forced technology transfer, some sort of compromise will need to be accepted. The Trump administration may have been satisfied with having tariffs in place, but those seeking to advance U.S. economic interests and push for Chinese trade liberalization must think about the issue differently.
Conclusions
The Biden administration is in a difficult position with regard to trade with China, as it has been handed a flawed framework for dealing with the issue and foreign policy concerns may dominate the conversation. Nevertheless, the administration will have to do something here. It can take a few months to try to work out a new approach with the EU and others, but ultimately it will have to decide on a way forward that leads to something other than tariffs without end.