What’s Inside the U.S.-China Phase One Deal?

By Matthew Goodman, Scott Kennedy, William Reinsch, Stephanie Segal & Jack Caporal —

Photo: SAUL LOEB/AFP via Getty Images.

On January 15, President Donald Trump and China’s Vice Premier Liu He held a long-anticipated ceremony in the East Room of the White House to sign a “Phase One” U.S.-China trade deal. The document, entitled “Economic and Trade Agreement Between the United States of America and the People’s Republic of China,” runs to 96 pages with eight chapters, covering intellectual property, technology transfer, trade in food and agriculture products, financial services, macroeconomic policies and currency, expanding trade, and dispute resolution. As part of the deal, China has agreed to increase its purchases of U.S. goods and services by at least $200 billion over the next two years compared to 2017 imports. For its part, the United States will trim some tariffs but maintain them on $360 billion worth of Chinese imports, the bulk of the bilateral trade.

The deal is written like a traditional trade agreement, with a range of substantive and process commitments by both sides that will only be as strong as the degree to which they are implemented by both sides. For now, it puts a pause on trade tensions between the world’s two largest economies that had been escalating for much of the past two years. However, it leaves many structural issues — notably Chinese subsidies and other industrial policies—unaddressed. Whether, when, and how “Phase Two” negotiations between the two sides move ahead remains unclear.

Q1: What did the two sides agree to on intellectual property?

A1: China’s theft of U.S. intellectual property and its relatively weak intellectual property (IP) protections were among the original core complaints highlighted in the Office of the U.S. Trade Representative’s (USTR) Section 301 Report. China has made commitments to improve its intellectual property environment in the past; however, the Phase One agreement includes some procedural innovations that may result in better monitoring, implementation, and enforcement of China’s obligations. The agreement requires that China publish an action plan that details how and when China will implement its IP obligations. The agreement also requires that China increase IP enforcement actions in a number of areas and regularly publish data on the impact of those actions. The action plan, along with regularly published data on IP enforcement, should provide the United States benchmarks to measure China’s implementation of its obligations.

The Phase One agreement requires that China beef up its intellectual property regime in a number of areas, including in connection to counterfeit and pirated goods and pharmaceuticals. It also requires that China improve its protection of trade secrets and business confidential information. China has also agreed to harsher penalties for IP theft in order to deter theft from occurring.

Notably, the chapter does not require the United States to change or introduce any new measures. Rather, it affirms that the existing U.S. measures comply with the obligations in the IP chapter.

Q2: How significant are the agricultural commitments?

A2: U.S. agricultural exports to China have plummeted since 2017 when China was the United States’ second-largest destination for agricultural and related products. Amid the winnowing of a massive export market, two years of terrible weather, and collapsing commodity prices, farm bankruptcies and total farm debt reached record levels in 2019. The Phase One agreement on agriculture will provide two much-needed shots in the arm for farmers.

Chinese purchasing commitments are the first shot in the arm. The agreement requires that China purchase at least $40 billion in U.S. agricultural and related products annually for the next two years. While that purchase commitment locks China in as a destination for U.S. crops and keeps U.S. farmers busy, it is not clear that the United States can supply that amount of agricultural goods to China. At a minimum, the United States may have to divert exports that would have gone to other markets to China. Also unclear is whether China would allow itself to become more reliant on U.S. agricultural imports than ever before, or whether U.S. farmers are willing to put all their eggs in the China basket. U.S. agricultural exports to China peaked in 2013, when U.S. farmers sent some $29 billion worth of product to China, $11 billion below the Phase One obligation. Finally, purchasing commitments are more in line with a state-driven economic model than a market-driven model, the latter of which the United States aims for China to adopt.

The second shot in the arm comes from the elimination of Chinese non-tariff barriers, which have limited a variety of U.S. agricultural exports. The elimination of those barriers should create more long-lasting, structural improvement in the outlook for agricultural exports to China.

Q3: What commitments does the agreement include on currency and financial market opening?

A3: Commitments under the “Macroeconomic Policies and Exchange Rate Matters” chapter of the Phase One agreement do not go beyond what has already been agreed in the context of the G20, specifically to refrain from competitive devaluations and the targeting of exchange rates for competitive purposes; and the International Monetary Fund (IMF), specifically to avoid exchange rate manipulation. In fact, transparency commitments under the agreement explicitly acknowledge the absence of new commitments, indicating the United States and China “shall continue to disclose publicly” international reserves and balance of payments data. What is new is the potential dilution of Treasury’s role when it comes to resolving any disputes, which will be directed to the Bilateral Evaluation and Dispute Resolution Arrangement under USTR. USTR, in turn, may consult with other agencies, but there is no obligation, putting Treasury in a secondary role on macroeconomic and exchange rate matters. (On this point, it’s worth noting the agreement’s affirmation of monetary policy autonomy for both the United States and China; and that either party may request the involvement of the IMF.) Another aspect of the agreement is the tension between exchange rate flexibility — along the goal of U.S. engagement with China on exchange rates—and exchange rate stability. This tension likely reflects U.S. concerns that market forces may well weaken the Chinese renminbi against the dollar, a sentiment reflected in Treasury’s most recent foreign exchange report , which, while it lifted the August 2019 designation of China as a currency manipulator, noted concern with “continued dollar strength.”

Similarly, the financial services chapter largely affirms market-opening commitments made by Vice Premier Li last summer to end foreign investor ownership limits in the financial sector in 2020. On the margins, specific pledges—for instance, taking a parent company’s overseas assets into account when granting licenses in China—should lower barriers to entry in the Chinese market, while the enforcement mechanism may help achieve greater compliance with these commitments. While the chapter emphasizes the “mutually beneficial” nature of market opening, the idea may be challenged by an increased sensitivity to national security factors in both countries. Despite the traditional Chinese focus on “reciprocity” in negotiated documents, U.S. commitments in the financial services chapter essentially boil down to the United States acknowledging pending Chinese applications in banking, insurance, and securities sectors.

Q4: How strong is the enforcement component of the agreement?

A4: If measured by size, coming in at just six pages, the “Bilateral Evaluation and Dispute Resolution” chapter is the least significant element of the deal. But that doesn’t do justice to the significance of this component, which is relatively clear and straightforward. There is a tiered process. At the top will sit the U.S. trade representative and designated vice premier and below them the deputy U.S. trade representative and a designated vice minister. For day-to-day matters, both sides will create a “Bilateral Evaluation and Dispute Resolution Office.” If one side feels the other party isn’t keeping to their commitments, it may submit an “appeal” to the other side. If the standing offices can’t reach a resolution, the dispute is escalated to the deputies and then to the top leaders. Should no resolution be achieved, “the Complaining Party may resort to taking action based on facts provided during the consultations, including by suspending an obligation under this Agreement or by adopting a remedial measure in a proportionate way that it considers appropriate with the purpose of preventing the escalation of the situation and maintaining the normal bilateral trade relationship.” Critically, should one side take such a remedial action, the agreement states that the other side is forbidden from taking counter penalties; instead, the only remedy is to withdraw from the agreement, which either party can do with 60-day written notice.

Other U.S. trade agreements have had enforcement provisions, but this one is distinctive in the level of unilateral authority it gives both parties. Although U.S. commitments are most often summarized by the statement, “The United States affirms that existing U.S. measures afford treatment equivalent to that provided for in this Article,” China would also be within its rights to adopt penalties should it find the United States not in compliance, and the United States itself could not respond in kind.

What is unclear is how broadly the agreement applies to the relationship. It appears that enforcement only applies to the specific commitments in this agreement, but one can expect that there will be pressure from the U.S. side for other issues outside the deal to be addressed through this process. Conversely, another challenge will be what happens when either side takes market-restricting actions that they claim are not related to this agreement, yet the other side finds discriminatory and broadly relevant to the trade relationship.

In sum, although the enforcement element of the deal looks rather robust and could help keep China to its commitments, it is also possible to see how this element is not airtight and could generate unforeseen challenges in the future. As a result, successful enforcement will depend heavily on the consistent good-faith effort of both sides.

Mr. Matthew P. Goodman is senior vice president, senior adviser for Asian economics, and holds the William E. Simon Chair in Political Economy at CSIS. Follow him on twitter @MPGoodman88. Dr. Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at CSIS. Follow him on twitter @KennedyCSIS. Mr. William Reinsch holds the Scholl Chair in International Business at CSIS. Ms. Stephanie Segal is a senior fellow of the CSIS Simon Chair in Political Economy. Mr. Jack Caporal is an associate fellow with the CSIS Scholl Chair in International Business.This piece first appeared as CSIS Critical Questions here

Matthew P. Goodman

Matthew P. Goodman

Matthew P. Goodman is senior vice president and William E. Simon Chair in Political Economy at CSIS, with particular emphasis on Northeast Asia.

Share

Leave a Reply

Your email address will not be published. Required fields are marked *