A Fragile and Costly U.S.-China Trade Peace

By Scott Kennedy —

Photo: NICOLAS ASFOURI/AFP via Getty Images.

News broke late on Thursday that the United States and China have reached a “phase one” deal that would mark the beginning of the end to their long and bitter trade war. Pardon me if I don’t pop champagne, but aside from a cessation of continued escalation, there is not much worth cheering. There is still significant ambiguity about what is in the deal but based on what we can surmise, it is unclear if the struggles of the past two and a half years have been worth it. The costs have been substantial and far reaching, the benefits narrow and ephemeral.

Stop the Credits

I feel like we are watching a movie in which the credits start rolling only to fade away for the story to continue on, again and again. This is the fifth instance during the U.S.-China trade dispute that a deal has been prematurely declared. In July 2017, Secretary of Commerce Wilbur Ross seemed to accept a promise from Chinese vice premier Wang Yang that China would rapidly reduce overcapacity in its steel industry only for President Trump to nix the arrangement at the last second. In May 2018, Secretary of Treasury Steven Mnuchin reached a “framework agreement” with Vice Premier Liu He only for President Trump to again turn aside the deal a few days later. In late April 2019, with markets declaring that a big U.S.-China deal was within reach, the Chinese suddenly walked back much of their offer, leading the United States to raise tariffs and impose sanctions on telecom giant Huawei. In early October 2019, President Trump announced a phase one deal when what he really meant was that the negotiations were only just getting started.

And here we are again. Both sides tried to provide some additional clarity on Friday morning, but there were enough differences and gaps to leave one wondering if an announcement was once again made prematurely. The Office of the U.S. Trade Representative released a statement hailing:

an historic and enforceable agreement on a Phase One trade deal that requires structural reforms and other changes to China’s economic and trade regime in the areas of intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange. The Phase One agreement also includes a commitment by China that it will make substantial additional purchases of U.S. goods and services in the coming years. Importantly, the agreement establishes a strong dispute resolution system that ensures prompt and effective implementation and enforcement.

At a hastily arranged Friday night press conference occurring simultaneously in Beijing, Chinese officials confirmed the existence of a deal, but they were not precise about their commitments on purchases, market opening, structural reforms, or tariff reductions. And they emphasized that the text still needs to be legally scrubbed and translated into Chinese. Conversely, it is not clear that all of the U.S. federal government agencies participating in the talks have reviewed and approved the text either.

In short, we have at least an agreement in principle and perhaps a highly detailed deal, but given the contrasting emphases and history of the talks, it would be fair to call this arrangement “fragile.” It is not hard at all to see how it could collapse as a result of untoward actions by either side.

And the Winner Is . . .

Based on available information, in the short-term China and Xi Jinping are the clear winners. With only limited concessions, China has been able to preserve its mercantilist economic system and continue its discriminatory industrial policies at the expense of China’s trading partners and the global economy. Trump could reverse course and renew tariffs, but Beijing has bought itself a likely respite from the daily uncertainty for at least a few months and perhaps for the remainder of Trump’s current term.

Figure 1

President Trump can rightfully take credit for putting China and its economic system on the defensive and raising reasonable doubts about the historical U.S. approach toward China of patient multilateralism. This is no mean feat; yet by his administration’s own metrics, the trade war has not paid off. Total U.S.-China trade and direct investment have slowed (see Figures 1 and 2), but these changes reflect the diversion of trade to others, not the movement of manufacturing back to the United States. Moreover, far from abandoning its efforts to achieve technological independence, China is doubling down on what it calls “self-reliance.” The deal’s apparent big winners, U.S. farmers, were not in harm’s way before the trade war, and they likely would have sold just as much in aggregate to China had the trade war never commenced.

Figure 2

More important than the immediate score are the long-term effects, and here, everyone fares poorly. Beijing’s stubbornness and unpersuasive claims of victimhood have left most of the world agreeing with the U.S. analysis, if not policy approach, that its economic system is fundamentally unfair and needs to be heavily altered. In addition, the uncertainty from the extended tariff fight along with expanded export controls, investment restrictions, and steps against individual Chinese firms have sent everyone scrambling, accelerating the diversification of global supply chains away from China and likely hastening a broader effort by Western countries to limit technology sharing with the People’s Republic. Although China has made tremendous strides, it is still heavily dependent on the United States and others in some foundational technologies, such as semiconductors, materials, and engines, as well as in critical applications, such as aircraft, autos, pharmaceuticals, and certain kinds of energy. Despite its own substantial resources, large domestic market, and likely continued access to the developing world, China will find continuing its successful march forward much more daunting in a divided or fragmented world economy.

For its part, the United States appears to have over-corrected in its approach to China to such an extent that its access to the Chinese market will decline, not rise, over time. My meetings with U.S. companies over the last two years revealed an increasing anxiety that the United States is hurtling toward “decoupling” with China without really understanding the likely costs that will be incurred. Looking beyond business, it will become harder than necessary to find ways to cooperate with the Chinese on pressing regional and global issues such as climate change. The United States’ unilateral approach has also frayed relationships with its friends and allies in Europe, Asia, and Latin America. Moreover, the global economic system the United States has nurtured since the end of World War II has been badly damaged—first corroded from the inside out by Chinese mercantilism and then battered frontally by the administration’s liberal use of tariffs and its blocking continued operation of the World Trade Organization’s dispute resolution process.

A Pox on Both Their Houses

Although the Trump and Xi administrations deserve credit for finding their way to a deal, they both deserve blame for the downward spiral in the relationship. China has operated on the conceit that its market is so large that it could act with impunity and that even the United States would never press them in a sustained way. Conversely, Washington has acted under the incorrect assumption that denying access to the U.S. market in and of itself was sufficient leverage to force Beijing to change course. Both sides heavily miscalculated, resulting in an amazing amount of collateral damage.

But beyond the two parties, the defenders of the original grand bargain between the United States and China and of the broader international system also deserve blame for their complacency—a belief that the economic and security benefits of globalization are so obvious as to be beyond doubt. As a result, weaknesses in U.S. bilateral ties and the global economy have festered, making both highly vulnerable to nationalistic attacks. One consequence of a deal is that both Beijing and Washington may learn the lesson that bullying and brinksmanship pay off. For those who want to stabilize U.S.-China ties and rescue the multilateral system, they will need to develop a much robust rationale and strategy to counter this narrative. Otherwise, the world they seek will only be visible in history books.

Dr. Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at CSIS. Follow him on twitter @KennedyCSIS. This piece first appeared as CSIS Commentary here.  

Scott Kennedy

Scott Kennedy

Dr. Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at CSIS.

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