US President Donald Trump and China's Vice-Premier Liu He signed the Phase One Trade Deal on January 15 in Washington. It signaled a truce in the protracted trade war between China and the United States. Observers are conflicted over whether this deal has been a true move forward. Some are underwhelmed by it and see more conflict on the horizon; others see it as a substantial step in the right direction with a cooling down of trade conflicts in the coming year that will instill much-needed business confidence.
The truth is likely to lie in between. The Phase One Trade Deal represents both a major effort to address some of the fundamental economic frictions between the US and China, but also a step backward towards managed trade. In the grander scheme of things, it represents a temporary shift sideways to bring a period of calm.
President Trump proclaimed the deal “a momentous step – one that has never been taken before with China.” However, the deal is lightweight in comparison to other trade agreements. It only runs 86 pages, while the new USMCA free trade accord runs to over 1800.
The deal does, however, represent a positive start in several areas. First, it has a strong commitment to China to crack down on the theft of American technology and corporate secrets. The intellectual property chapter is comprehensive and details commitments and expected results. It reaffirms China's considerable efforts to improve its intellectual property protection and become a hotbed for innovation. Technocrats scored a win here for both sides.
Second, the deal opens China's financial services market to Wall Street. The currency chapter mainly reiterates China's existing commitments. However, the pledge by Beijing to keep the Yuan exchange rate stable has given the Trump administration an opportunity to lift the designation of China as a currency manipulator, closing what was an embarrassing chapter for the US Treasury and ameliorating one more trigger for uncertainty.
The most important positive is that the deal lowers the uncertainty brought on by Trump's trade policy. Global investors clearly felt a sigh of relief, as reflected in the upward move in global stock markets immediately following January 15. Risks are now lower for companies in their investment decisions, though we are nowhere near back to the certainty in supply chains prevalent before the trade war started.
Uncertainty is also somewhat diminished due to the restarting of bilateral dialogue mechanisms and the establishment of a new trade framework group chaired by US Trade Representative Robert Lighthizer and a Chinese Vice-Premier. This provides a glimmer of hope that disputes between the two economic giants can be resolved via regular bilateral negotiations.
The deal clearly incorporates a substantial positive ledger. But it is balanced by an attempt to force China to close its trade imbalance with the United States. As any economist will point out, this trade imbalance is mainly driven by different consumption and savings patterns in the two countries. The effort by China to boost its purchases of US manufactured goods, agricultural products, energy, and services over the next two years by US$200 billion amounts to an attempt at managed trade.
Such a predetermined demand push can have adverse consequences elsewhere and will mainly shift the US trade deficit from China to other countries. It could alter trade patterns with multiple ripple effects, as when China purchases more American soybeans and cuts back on its imports from Brazil and Argentina, which in turn affects import demand in those two countries. Germany's Kiel Institute for the World Economy estimates that Chinese purchase commitments of American imports could end up costing the European Union around US$ 11 billion next year.
Beijing seems keenly aware of this problem. Vice-Premier Han Zheng told the World Economic Forum in Davos, Switzerland, that China's trade deal with the United States will not hurt other exporting nations. As other Chinese government officials, Han reaffirmed that China's commitments remain in line with its World Trade Organization obligations.
A mounting worry is that China simply cannot meet its obligations, creating the specter of another trade bust-up down the road (also depending on who wins the American presidential election in 2020). US exports to China would have to grow by 40 percent both in 2020 and 2021.
Analysts therefore are skeptical about the lofty purchase targets stipulated in the deal. They would require a significant reshuffling in Chinese trading practices. And with the rapid spread of the deadly coronavirus through China, Beijing's ability to meet these targets is even more questionable.
The virus outbreak is likely to have a negative impact on consumption and industry, driving down commodity prices, including important elements of the purchase commitments, such as soybeans and energy products. The longer the crisis lasts, the worse the damage to China's ability to meet its commitments.
Finally, the bulk of US tariffs on Chinese imports remain. While no new tariffs are a good sign, the remaining ones continue to affect global supply chains. The negative scorecard of the deal is thus substantial as well.
For the most part, though, the deal moves the US-China relationship sideways. The thorniest issues, such as Chinese industrial subsidies and the crucial role of state-owned enterprises in the Chinese economy are left unaddressed. Similarly, the brewing technology war, especially US efforts to circumscribe Huawei's role in building global 5G infrastructure continue to lurk in the background.
China will not bow to American demands to alter its development model, in particular the state's role in forging industrial policy. Negotiations on such issues, if demanded by the American side, are likely to end in another stalemate with the possibility of re-escalation. No wonder both sides, despite Trump's pronouncements, seem loath to begin phase two negotiations. As Chinese Vice-Premier Liu said after the signing, the focus should be on the implementation of Phase One.
Understandably, international traders and manufacturers remain very cautious. Some degree of economic decoupling is bound to occur between China and the United States. But both sides have come to the hard realization that they need to limit the damage the trade war has done so far. Moving sideways is better than escalation and open economic warfare.
