The Diaoyutai Divide: U.S.-China Trade Negotiations Highlight Deep Differences

By Scott Kennedy —

USTR Robert Lighthizer. Photo: Greg Baker/AFP/Getty Images.

For much of the past year, Chinese officials have complained that they did not know what the United States wants or who to speak with about our commercial disagreements. Those questions have been answered decisively in the last two days in negotiations at the Diaoyutai State Guest House in Beijing. The result: Be careful what you wish for!

The U.S. goal going in appears to have been to reestablish credibility that the United States is not looking just to increase sales of U.S. goods and that it is ready to implement penalties should no deal be reached. The Chinese side’s goal most likely had been to steer things away from escalation by dangling a few carrots of increased market access in the short term and promising more in-depth market reforms over the long term. It appears the U.S. side stuck to its plan and achieved its goals, while China was forced to abandon its own and shift gears.

Dueling Demands

The United States appears to have caught everyone by surprise by tabling a detailed, maximalist offer. The core of the U.S. position is that China become a genuine market economy on an expedited schedule and that the United States reserves the right to be judge and jury in determining compliance.

Many will highlight the U.S. demand that China reduce its bilateral trade surplus by $200 billion by the end of 2020, but the real core of the U.S. position is about the dismantling of China, Inc., including having China abandon industrial policies that favor domestic firms and force foreign companies to share their technology, fully liberalize its investment environment, eliminate tariff and nontariff barriers, and expand market access for U.S. services and agricultural products. To top it off, the U.S. side demanded that China not retaliate against any restrictions on Chinese investment the United States adopts for national security reasons and that the United States has the right to impose unilateral penalties on China should it not be found in compliance with the agreement.

Given the U.S. proposals, China likely felt compelled to respond in kind, though not kindly. Whereas the United States focused on structures and systems, China targeted specific products and sectors. China offered vague commitments to make “meaningful” liberalization of their trade or investment regimes, offering to discuss expanding imports of U.S. films and granting the United States more access to the Hainan Free Trade Zone. At the same time, China demanded that the United States fully open up to imports of Chinese high-technology products and services and eliminate barriers to U.S. companies selling high-tech products in China, including integrated circuits. It also expects the United States to begin treating China as a market economy in trade remedy cases and reconsider its decision banning U.S. firms from doing business with Chinese telecom manufacturer ZTE.

Breakdown

China’s Xinhua News Agency issued a statement afterward suggesting the talks were constructive and achieved consensus in some areas. But that is the kind of language they used to describe the outcome of the Comprehensive Economic Dialogue (CED) in July 2017, which ended in deadlock. Another sign that there was little progress is that in the days leading up to the visit it was reported that the group would meet with President Xi Jinping and Vice President Wang Qishan of China. But it appears those meetings were cancelled out of pique. The U.S. side did not issue a public statement before it departed Beijing, leaving open the possibility that there was not even agreement to continue discussions.

Although Treasury Secretary Steve Mnuchin was the formal head of the U.S. delegation, the list of American demands carries all the hallmarks of Trade Representative Robert Lighthizer. Heading into the talks there was worry expressed by commentators that the U.S. side had not adequately prepared or coordinated, that perhaps the apparent divisions between camps would be on full display in Beijing, and that China might be able to exploit those fissures by playing to the “soft-liners,” who they hoped would bring back a deal more to China’s liking to present to President Trump. That does not appear to have been the result.

Instead, by presenting a detailed list of demands, this document was the dominant axis around which discussions of U.S. concerns revolved, and there was no room for freelancing in search of a face-saving deal that would reassure financial markets. And given that the content of the two lists are now public knowledge, it will be hard for the Trump administration to accept a deal about just expanding exports of specific goods, which would now be seen as a massive retreat if not outright surrender.

Although international markets and other countries have consistently shown anxiety about the possibility of a trade war and the resulting collateral damage, short and long term, the Trump administration is now in a better position to gain sympathy for its vision of the relationship, particularly when contrasted with China’s very narrow demands. The most controversial U.S. demand, which other trading partners will look down on, is the U.S. desire to retain the right to impose unilateral penalties and not leave adjudication to the World Trade Organization (WTO), but China’s position isn’t exactly a ringing endorsement of the WTO either.

Toward Escalation

There should now be no doubt in anyone’s mind that the Trump administration is not bluffing and that it is willing to launch a full-scale trade war if China doesn’t radically rein in its industrial policy machine and create a more level playing field. Given China’s ornery response, it appears Beijing is also willing to go down this path if necessary to keep its system intact regardless of the consequences.

The next moment of high theater will be the May 15 hearing in Washington, D.C., on the Section 301 investigation and report. It will be the last formal occasion for stakeholders to take sides. Assuming no minds are changed or new proposals put forward, the United States will be legally permitted to institute tariffs on the $50 billion of Chinese goods starting on May 23. China has said that it would immediately retaliate with tariffs of $50 billion. Should it come to that, the United States has threatened further retaliation of tariffs on an additional $100 billion of Chinese goods. At the same time, the Treasury Department is also working along a separate track on its part of the Section 301 action to develop a plan to restrict Chinese investment, which may be even more economically consequential than the tariffs.

If that were not all, this bilateral commercial conflict is not occurring in a strategic vacuum. The United States is getting ready for a high-stakes summit with North Korea, and the outcome of these talks are amazingly central to Chinese national security. At the same time, Washington is in the midst of taking steps vis-à-vis Taiwan that do not sit well with Beijing, including in mid-June opening a new facility for its unofficial embassy in Taipei, the American Institute in Taiwan (AIT).

Any one of these issues in and of themselves could put significant strain on the U.S.-China relationship. Having them all come to a head at the same time creates a potentially combustible mix that could bring the entire relationship to the tipping point. The Trump administration should take several steps to shore up its position domestically and internationally. First, now that both sides have fully articulated positions, there needs to be a robust interagency discussion to determine if the United States can narrow its demands in breadth or depth and which, if any, of China’s demands are worth meeting. The administration also needs to game out how a conflict involving reductions in two-way trade and investment is likely to escalate and unfold, and then engage with industry stakeholders and localities around the country to take steps to shore up likely U.S. targets (for example, in agriculture), and thereby limit domestic opposition. Conversely, it is imperative to find a permanent resolution to the Section 232 investigation disagreements on steel and aluminum with Europe and other friends, since it would be quite difficult for the United States to win a trade war with China while engaged in a pitched commercial battle with others at the same time. And finally, the United States needs to keep the door open to discussions with China and maintain the possibility of finding a mutually acceptable off-ramp to the current conflict.

Even though the two sides are currently very far apart, deft and sophisticated diplomacy and a willingness to compromise by both sides could help us get through what could be a very hot summer.

Dr. Scott Kennedy is deputy director of the Freeman Chair in China Studies and director of the Project on Chinese Business and Political Economy at CSIS. His latest book is Global Governance and China: The Dragon’s Learning Curve (Routledge, 2017). Follow him on twitter @KennedyCSIS. This piece first appeared as a CSIS Commentary here.

Scott Kennedy

Scott Kennedy

Dr. Scott Kennedy is Deputy Director of the Freeman Chair in China Studies and Director, Program on Chinese Business and Political Economy at CSIS.

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