McLARTY FIRST TAKE: US Maintains Tariff Leverage in Phase One Trade Deal with China

January 16, 2020

KEY POINTS

Today, the Phase One deal between the United States and China was finalized and signed. The U.S. will maintain tariffs on $360 billion of Chinese goods as negotiating leverage for Phase Two.
The English version has been released, but a Chinese version has not, leaving open the possibility that translation issues may signal lingering substantive disputes.
Significant obligations were created regarding intellectual property protection, efficient processing of regulatory approvals for biotech products, prohibition of forced technology transfer, and Chinese agricultural purchases.
The enforcement mechanism will need to be further examined to determine its effectiveness, given than penalties are not enumerated.

Trump’s promised trip to China in the “not too distant future” is expected to create momentum for Phase Two negotiations.

The Long View

The Phase One Trade Agreement signed today by President Trump and Chinese Vice Premier Liu He is an important first step in resolving American complaints about Chinese trade and investment practices. The agreement itself is strong in some areas and weaker in others, and will necessarily fall short of the high expectations set by the Trump Administration when it first embarked on its tariff war with China. However, because it contains clear performance criteria that would have been the result of considerable negotiation and consensus, it is likely to be faithfully implemented.

But perhaps the most important dimension of the deal is that it represents a clear political commitment by the American and Chinese presidents to stabilize the overall U.S.-China relationship. For the United States it will be the centerpiece of Trump’s China strategy, and in fact was described by him as something of great significance to both countries and, moreover, the world. In his words,

“As we move forward to Phase Two I look forward to continuing to forge a future of greater harmony and prosperity and … commerce – and far beyond commerce – between the United States and China. This is something that, far beyond this deal, it’s going to lead to an even stronger world peace. We now have a big investment in each other, and in getting along with each other.”

No matter how well they are designed and managed the trade deal and the semiannual Comprehensive Economic Dialogue that the two sides announced will not – by themselves — be sufficient to erase the strategic mistrust that has been the hallmark of Sino-American relations in recent years. But by meeting the American president halfway on matters of central importance to him, Beijing will have shown Trump how compromise and “tough, honest, open and respectful” negotiations (Trump’s words to describe the trade talks) can lead to acceptable results. Perhaps Phase One of the trade deal will prove to be most important for its role in beginning to patch the trust deficit that has plagued relations between the two countries.

The Signing Ceremony

The White House signing ceremony was used by President Trump as an opportunity to reinforce his “America First” campaign slogan. He said “I will be going over to China in a not too distant future” and hailed his relationship with President Xi Jinping as “incredible.” Trump commanded the stage for much of the 67-minute event, appearing very much at ease as he introduced many of the 200 people in attendance, and praised the contributions of his aides and advisers, including his son-in-law Jared Kushner.

Vice President Pence praised the Phase One trade agreement for starting “a new chapter” in trade relations with China. He said that “the era of economic surrender is over.” He noted that the “greatest impact” would be the $40 billion – $50 billion of agricultural purchases China committed to make over the next two years. USTR Lighthizer and Treasury Secretary Mnuchin delivered remarks.

Vice Premier Liu He read a congratulatory letter from President Xi prior to offering his own remarks. Ambassador Cui Tiankai also spoke.

The Agreement

The agreement released by the USTR contains eight chapters: 1) intellectual property; 2) technology transfer; 3) trade in food and agricultural products; 4) financial services; 5) macro policies, exchange rate, and transparency; 6) expanding trade; 7) bilateral evaluation and dispute resolution; and 8) final provisions.

The agricultural and IPR chapters are by far the most detailed and dense. In a surprise move, the USTR published the specific numbers of China’s committed agricultural and energy purchases over the next two years, which many had speculated would not be disclosed due to Beijing’s concern that domestic critics would say it had given too much. As expected, state subsidies, SOE reform, and cyber issues are absent from the Phase One deal.

Phase Two?

In an apparent attempt to keep the pressure on Beijing to enforce the Phase One deal, Trump said Phase Two will start “as soon as this [deal] kicks in”. He said the US tariffs on roughly $360 billion worth of Chinese products will stay. “I will agree to take those tariffs off if we are able to do Phase Two…They will all come off as soon as we finish Phase Two…”

A USTR draft notice was posted on the Federal Register, saying that the agency will reduce the additional duty on $120 billion (List 4A) worth of Chinese products from 15% to 7.5% starting February 14, 2020.

Traduttore, traditore?

The agricultural purchase section suggests that a part or parts of the Chinese translation have not been agreed, as it says only when the two sides “conclude and verify an agreed Chinese translation” of the annex will the English and Chinese versions become equally authentic. No Chinese version of the agreement has yet been made public.

Agricultural and Energy Purchases

Assuming the baseline of U.S. agricultural exports to China in 2017 was $23.8 billion, the agreement commits China to import at least $36.3 billion worth of US farm products in 2020 and at least $43.3 billion in 2021. No detailed breakdown was given.

In addition, China said it “will strive to” purchase an additional $5 billion of US farm products a year in the next two years, which would raise purchases to $41.3 billion in 2020 and $48.3 billion in 2021.

Compared with the 2017 baseline, China is also committed to importing in 2020 an additional $18.5 billion of energy products, including liquefied natural gas, crude oil, refined products and coal, and an additional $33.9 billion in 2021. Again, no breakdown was provided.

In total the agreement commits China to buying at least $200 billion more US manufactured goods, agricultural goods, energy products, and services in 2020 and 2021 than it would have at the base rate of 2017. The agreement remains vague on what would happen in subsequent years, except pledging that the “trajectory of increases” will continue.

IPR, Forced Technology Transfer, Financial Reform

In the IPR chapter, the U.S. side seems to have backed off the legislation requirement that led the bilateral talks to break down last spring. It reads: “If necessary, each Party shall provide suggestions for the amendment of laws to its legislative body according to its domestic legislation procedure.” The softened tone may raise questions about enforcement.

The agreement avoided laying blame on Beijing for forced technology transfer, creating prohibitions for both parties against “pressure…to transfer technology to its persons in relation to acquisitions, joint ventures, or other investment transactions.” Beijing never admitted to forcing technology transfer. Clauses improving transparency of administrative proceedings and preventing sensitive trade secrets from being leaked in regulatory reviews are included. This chapter marks a good start on a thorny issue. However, the lack of clear rules on penalties suggests that enforcement details may be addressed in Phase Two.

Beijing agreed to further liberalize the financial market, including allowing US electronic payment services suppliers to establish wholly-owned units in China. No later than April 1, 2020, China shall remove all foreign equity caps in the life, pension, and health insurance sectors. This same timeline applies to the removal of foreign stake limits on US-owned securities, fund management, and futures companies.

The U.S. side pledged to consider market-access requests from Chinese financial institutions including state-owned China Reinsurance Group, China International Capital Corporation, and CITIC Group “expeditiously”, but did not specify timing.

The currency section was largely expected and looks enforceable, with the parties agreeing to resolve disputes under a mutually agreed dispute resolution mechanism and to refrain from competitive devaluations.

Biotechnology

The agreement requires Beijing to implement a “transparent, predictable, efficient, science- and risk-based regulatory process for safety evaluation and authorization of products of agricultural biotechnology,” with reduced time frames for reviews and increased opportunities for interaction between Chinese authorities and the private sector. The devil may be in the implementation details, but these are significant commitments.

Dispute Resolution

As expected, the parties agreed to establish a Bilateral Evaluation and Dispute Resolution Arrangement. The US and China also decided to resume macroeconomic dialogues, expected to be led by Treasury Secretary Mnuchin and a Vice Premier counterpart.

The parties may agree in writing to amend this agreement. Either party may terminate the agreement by providing written notice of 60-days, common in trade agreements.

Please contact jholden@maglobal.com if you are interested in a more comprehensive briefing from our China team.