A Few Things to Like About the U.S.-China Trade Deal

More clarity and more questions emerged over the weekend about the terms of the U.S.-China trade deal, which warrants an update to this preliminary assessment published on Friday.

The deal is pretty good for what is seems to accomplish. That may sound like fingernails on a chalkboard to those more interested in preventing Trump from gaining traction with claims that he won the trade war than they are interested in actually ending the trade war.

The deal is pretty good because it reduces business uncertainty, confirms that the administration realizes its approach was unsustainable, and—by formalizing terms to resolve the variety of issues that, frankly, distract attention from the most difficult problems in the relationship—creates needed space to shift focus to the genuinely challenging matters.

That, of course, refers to the challenge for technological preeminence and its attendant considerations: industrial policy; technology subsidies; development and proliferation of standards; related security issues; and the impact on this race for primacy on commercial and strategic outcomes.

So, what was agreed upon? In a nutshell, Washington agreed to cancel tariffs on about $160 billion of imports from China, which were scheduled to take effect yesterday; keep in place the 25 percent tariffs currently imposed on about $250 billion of Chinese goods (rather than increase them to 30 percent, as was scheduled); and reduce tariffs from 15 percent to 7.5 percent on about $110 billion of Chinese products.

Relative to what was looming (higher tariffs on all imports from China), these terms should be welcome news to most consumers, workers, businesses, and investors in the United States and China, and throughout the world. The specter of an escalating tariff war, with all the commercial uncertainty that portends, is no longer casting such a large shadow on the global economy. That’s good.

Relative to the way things were 18 months ago, we are still torso deep in costly taxes. About half of the value of U.S. imports from China remain subject to a 25 percent tax (as opposed to an average tariff of about 2 percent in June 2018) and about one‐​fifth of the value of those imports remain subject to a 7.5 percent tax (as opposed to an average tariff of about 2 percent in June 2018).

Presumably, those tariffs are considered leverage and will be lowered or removed if, and when, Beijing demonstrates that it has held up its end of the bargain. Yes, it’s true that U.S. tariffs are taxes on U.S. consumers and businesses, which may raise questions about their value as leverage on Beijing. But the fact is that taxes on U.S purchasers dissuade purchases from Chinese producers. So, while the Chinese aren’t paying the taxes, those taxes are reducing demand for Chinese products. After all, something in the administration’s approach made Beijing agree to the “Phase 1” deal.

Beijing made no explicit commitments to reduce the retaliatory tariffs it imposed over the last 18 months, but it did agree to purchase, over the course of the next two years, $200 billion more goods and services from the United States than it purchased in 2017. The value of U.S. exports of goods and services to China in 2017 was about $185 billion, so the pledge to purchase $200 billion more is very significant—an average annual increase of 45 percent, which is, first, unheard of for a large economy and, second, strong confirmation—as if it were needed—that China’s is not a market economy. Realistically, it is hard to imagine how the Chinese economy can absorb that much in two years but then again, maybe U.S. companies will jack up their prices by a factor of five or ten!

U.S. goods exports to China year‐​to‐​date through October 2019 are down about 16 percent from where they were in the January‐​October 2017 period. Roughly translated, that means that U.S. exports to China are down about $25 billion from the pre‐​trade war period.

Despite reports that this deal does nothing to make amends for lost market share suffered by U.S. exporters as a result of the trade war, a $200 billion aggregate increase in exports over two years would certainly seem to more than make up for the average financial losses incurred by U.S. firms so far. However, those U.S. export gains most likely would come at the expense of other countries’ exports, as Chinese buyers divert their purchases from other suppliers in line with Beijing’s demands. And that, of course, would have ripple effects throughout the global economy, including a likely reduction in demand for U.S. exports in third countries.

So, what other commitments did China make to give Trump cover to begin lowering U.S. tariffs? Remember what started this whole trade war thing? In June 2018, the president first imposed tariffs as a result of a formal investigation conducted by the U.S. Trade Representative’s Office under Section 301 of the Trade Act of 1974, which found fault with a variety of Chinese practices, including intellectual property theft, cyber intrusions, discriminatory indigenous innovation policies, forced technology transfer requirements, and other related items.

But ever since then, the focus of negotiations has been on tangential issues, such as market access in China, trade balances, currency practices—pretty much everything EXCEPT those objectionable IP and technology practices. Well, to my surprise, the agreement worked out, and summarized by the White House Friday includes commitments from China to undertake effective measures to curtail, prohibit, and punish some of the kinds of forced technology and intellectual property transgressions that the United States wants resolved. Beijing also agreed to refrain from directing or supporting outbound investments aimed at acquiring U.S. technology. It also agreed to fix problems that have created non‐​tariff barriers to U.S. agricultural products in China, such as circuitous licensing practices and opaque sanitary and phytosanitary requirements.

China also committed to open wider and more transparently its financial services markets to allow more competition from U.S. banks, insurance companies, and brokerages. It also made certain commitments to ensure that it doesn’t intervene in currency markets in a way that suppresses the value of the Chinese yuan to secure a trade advantage. And, importantly, the parties agreed to create a mechanism that, ostensibly, will allow for rapid hearing, adjudication, and, hopefully, resolution of disputes.

Skeptics of the deal are quick to point out that—in the provisions regarding intellectual property rights enforcement and disavowal of forced technology transfer—Beijing didn’t agree to anything they hadn’t already agreed to or weren’t already doing, as a result of obligations under previous agreements. That may be true, but Beijing’s and Washington’s definitions of “forced” technology transfer (to use one example) have been very different historically. If this agreement includes a broader understanding by the Chinese of the term “forced,” it will be a step in the right direction.

Beijing’s pledge to stay away from backing or promoting technology acquisitions by state‐​owned enterprises is a nice gesture that amounts to very little, considering that U.S. policymakers are already ramping up scrutiny of these kinds of deals, as required under the new Foreign Investment Risk Review Modernization Act. It’s something that U.S. policymakers are intent on scrutinizing and, frankly, protecting sensitive U.S. technology in a systematic and transparent way is far superior to levying tariffs and encouraging divestment.

Commitments on currency, of course, have nothing to do with the impetus for the trade war. This is perennial gripe that should be of very low priority on the U.S. list of concerns.

Time will tell whether Beijing actually makes good on these commitments and whether the administration will work hard to address the outstanding issues. But for now (and probably through the 2020 elections), new or higher U.S. tariffs on imports from China seem to be unlikely. Of course, we will have to endure 25 percent tariffs on half of our imports from China and 7.5 percent tariffs on about one‐​fifth, but the uncertainty that has racked markets for over 18 months is likely to abate. This deal, for all its shortcomings, is an agreement to not escalate the trade war. There’s some value in that, right?

The United States and China are locked in a race for technological preeminence, which raises all sorts of strategic and security concerns that can no longer be treated with indifference. Technology bestows first‐​mover advantages with significant commercial and strategic implications. As 2020 progresses, the U.S. debate over China policy should shift focus away from tariffs and trade measures to the broader strategies, tactics, and domestic measures needed to stay on top in the race for technological supremacy.