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    What’s the deal with the ‘Phase One’ agreement?

    Published On: 17 January 2020

    Asia House Advisory shares analysis on the initial trade deal between the US and China

    US President Donald Trump and Chinese Vice Premier Liu He signed the highly anticipated ‘Phase One’ trade agreement in Washington DC on 15 January.

    After an 18-month-long trade war that has been waged through retaliatory tariffs, agreement is welcome news. It halts new tariff increases and also signals a modest de-escalation of the trade conflict between the world’s two largest economies, which will go some way towards increasing investor confidence and optimism.

    Since the start of the trade war in 2018, higher tariffs and prolonged trade policy uncertainty have damaged investor confidence, disrupted manufacturing activity and trade flows, and reduced global economic growth due to supply chain disruptions. While the interim deal is a positive indicator, ultimately it only addresses a limited set of issues. Deeper structural issues, such as the controversy over Chinese state subsidies, have not been addressed.  The deal will not significantly alter the fundamentals: the wider US-China geopolitical competition and the battle over economic creativity and new technologies are set to continue, even if the ‘Phase One’ deal is fully implemented. A resolution of these underlying issues in any subsequent ‘Phase Two’ negotiations is anything but certain.

    What has been agreed?

    Under the ‘Phase One’ agreement, the US has promised to halve the existing 15 per cent tariff to 7.5 per cent on US$120 billion of Chinese imports ranging from food to technology. It has also promised not to proceed with planned 15 per cent tariffs on US$160 billion of Chinese products, including cell phones, laptop computers, toys and clothing, scheduled to go into effect on 15 December 2019.

     

     

     

    This is in return for Chinese pledge related to its currency, intellectual property and a large US$200 billion increase in its purchase of US goods and services over the next two years. This is based on a 2017 baseline of US$183.8 billion. Specifically, this includes US$32 billion in new purchases of US agricultural exports, such as soybeans; and US$52.4 billion in energy exports, namely liquified natural gas and crude oil. China has also promised to increase purchases of US manufacturing products, including pharmaceuticals, and boost imports of financial services. Access to China’s financial services market has for years been a source of complaint for the US.

    The agreement on currency stipulates China to refrain from competitive currency devaluation, and not to use exchange rates for its trade advantage. In return, on 13 January, the US Department of the Treasury reversed its August decision to designate China as a ‘currency manipulator’, a label given to countries accused of ‘unfair currency practices’ – something China denies doing.

    Regarding intellectual property – a key sticking point in US-China trade relations – the ‘Phase One’ deal promises stronger Chinese legal protections for patents, trademarks and copyrights. In particular, the deal details enhanced criminal and civil procedures to combat online infringement, pirated and counterfeit goods.

    An agreement is only as good as its implementation

    The key issue with the ‘Phase One’ deal is its implementation and enforceability. Will the US and China deliver on their promises? Given nearly two years of escalating trade tensions, it’s not surprising that mistrust runs high.

    Since the start of the trade war in mid-2018, the US has imposed tariffs on over US$360 billion of Chinese imports. China has retaliated with tariffs on over US$110 billion of US imports.

     

    ‘There is widespread scepticism

    among analysts about whether the targets,

    especially in agriculture, are attainable’

     

    Although the ‘Phase One’ deal averts new tariffs, it leaves in place tariffs on US$250 billion of Chinese imports. The promised tariff reductions will also not take place until there is ‘Phase Two’ deal, according to President Trump. This means companies and consumers will continue to pay more than they did pre-trade war. Maintaining the tariffs has its rationale; it gives potential leverage to the US to negotiate the next stage of the agreement and reinforce Beijing’s promise on new purchases. Meeting the Chinese purchase targets would open new opportunities for US businesses. It would also reduce the US$419 billion US trade deficit with China.

    There is, however, widespread scepticism among analysts about whether the targets, especially in agriculture, are attainable, given the previously low levels. Under the enforcement provisions of the deal, if China fails to meet its additional purchase commitments, a dispute resolution will be triggered, according to the US. If bilateral consultations do not resolve disputes, the President has the authority to increase existing tariffs or impose additional tariffs.

    Meanwhile, China has also tempered expectations. During the ‘Phase One’ deal signing ceremony, Liu He said the purchases of agricultural products will be “based on market conditions”, adding that both countries should create favourable conditions for Chinese purchases of US products. This raises the question of potentially differing interpretations of the deal that would have the potential to renewed conflict.

    Regarding financial services, the promise of greater market access in terms of the number of granted licenses and removal of equity limits for US banks and insurance services does not translate into equal opportunities overnight. China’s financial service sector is dominated by state-owned and private digital payment players. While Beijing continues to open up the space for foreign players, it is likely to do so at its own pace. The same is likely to be true with intellectual property protections. While China has given its commitment to implement a comprehensive legal system of intellectual property protection, it remains to be seen how well the US can monitor and enforce this.

    Outlook for trade

    The ‘Phase One’ deal is a positive step, signalling de-escalation of the economic conflict. Notwithstanding the questions surrounding the enforceability, the deal is a political victory for both US President Trump and Chinese President Xi Jinping. In 2020, the domestic economy and its stability will take centre stage in both the US and China. In the US, the deal is welcome news for Trump who is preparing to highlight his government’s achievements ahead of the November presidential elections. Similarly for Xi, easing trade tensions at a time of weakening Chinese economy is good news, particularly as he has pledged to eliminate poverty by 2020. Increased economic stability, confidence and growth are important for achieving this goal.

     

    Ultimately, the ‘Phase One’ deal only addresses a limited set of issues. It does not resolve the underlying US-China geopolitical rivalry and strategic competition over supremacy in technology that led to the trade war in the first instance. The core structural issues such as China’s preferential support of state-owned enterprises and technology transfer from US companies as a prerequisite of doing business in China have been left to the second phase of negotiations. Resolving these issues will be significantly more difficult.

    The significance of the ‘Phase One’ deal and further negotiations lies in the fact that they encourage continued dialogue as a tool for wider conflict prevention. Despite being at odds with each other, the US and China are engaged in a dialogue and willing to work constructively together to avoid further escalation.

    In the long-term, there is a high risk of renewed economic conflict, particularly if the ‘Phase One’ deal fails to hold. China will continue to pursue its core economic policies, such as its Made in China 2025 programme, which aims to upgrade Chinese industry to become a word-leader in emerging technologies, including artificial intelligence and super-fast 5G mobile networks. This is seen as a national security threat by the US, and there are indications that more hawkish factions within the Trump administration are pushing for a harder line on the tech front. As technology decoupling continues, there is a risk of a renewed tariff war, or more export and import controls and investment restrictions, following the model of restrictive measures taken by the US against Huawei, the Chinese telecom giant, in 2019.

    The mainstream focus of the trade war and the ‘Phase One’ deal has largely been on its impact on China-US bilateral relations and global trade. Looking ahead, perhaps the more interesting question will be around the impact of the deal and ongoing tech rivalry on Asian trade and supply chains. While increasing regionalisation of trade has been going on for much longer than the US-China trade war, the tensions and resulting trade diversions have led to the development of new supply chains that will transform both global and regional trade.

    This analysis was produced by Asia House Advisory, which helps organisations meet business-critical challenges through a range of bespoke services.  To find out more about Asia House Advisory and how it can help you, please email advisory@asiahouse.co.uk