Eagle versus Dragon: Ceasefire in the U.S.-China Trade Conflict

Yokohama, China © Pixabay/megurawa

Yokohama, China © Pixabay/megurawa

After a year of tit-for-tat tariff increases, a glimmer of hope has emerged in the U.S.-China trade dispute since October 2019. Both countries agreed on a “Phase 1 deal“: China will buy more U.S. products and in return, the United States will not increase tariffs. However, most of the tariffs remain in force. Moreover, the major structural issues are still unresolved. This means that the uncertainty in world trade remains.

While the average U.S. tariff on imports from China stood at 3.1 percent at the end of 2017, it had climbed to 21.0 percent at the beginning of September 2019. The average tariff burden on U.S. exports to China almost tripled from 8.0 percent to 21.1 percent between the end of 2017 and mid-September 2019. The legal basis for U.S. tariffs is Section 301 of the Trade Act of 1974.

One Step Forward, One Step Backward, One Step Forward

After the G20 summit in Argentina at the end of 2018, hopes were high that the conflict would be resolved quickly. The parties to the dispute wanted to reach an agreement on market access, structural reforms in China, and enforcement mechanisms. At the end of April 2019, however, this sentiment changed abruptly. Trump criticized that Beijing had revoked previously made concessions. At the beginning of May 2019, Trump raised special tariffs on a trade volume of 200 billion U.S. dollars from 10 to 25 percent. Despite an agreement to return to the negotiating table at the G20 summit in Osaka at the end of June 2019, the conflict escalated further in August.

Early August 2019, immediately after the first round of resumed negotiations, President Trump announced further tariffs of ten percent on practically all U.S. imports from China not yet subject to special tariffs (volume of around 300 billion U.S. dollars). For the first time, these tariffs would have applied to consumer goods such as toys and clothing. But that was not all: Before the G7 summit in France in summer 2019, Trump announced that the United States would increase all special tariffs by additional five percent.

Early September 2019, the special tariffs of 15 percent on part of the so-called List 4 products with a value of 112 billion U.S. dollars came into force. Some List 4 consumer goods were not to be subject to U.S. tariffs until 15 December due to the Christmas business. In response, China levied tariffs on U.S. goods worth 75 billion U.S. dollars.

Additional uncertainty in the business community was caused by a tweet by Donald Trump, in which he instructed U.S. companies to look for alternatives to China. U.S. Secretary of the Treasury Steven Mnuchin explained that the President had the authority to order this on the basis of the International Emergency Economic Powers Act (IEEPA) but had not yet declared this state of emergency.

Sign of Progress: The Phase One Deal

A first glimmer of hope was that China exempted 16 product categories from tariffs in mid-September as a sign of good will. Trump subsequently postponed the increase of already announced special tariffs from 25 to 30 percent. After further negotiations, Trump and Chinese Vice Prime Minister Liu He announced a partial agreement in October 2019, the so-called “Phase 1” deal. In mid-December 2019, this agreement was further specified.

In mid-January 2020, President Trump and Vice Prime Minister Liu He signed the Phase One Deal. China agreed to import additional U.S. products and services worth 200 billion U.S. dollars over the next two years. This includes industrial goods worth a total of 77.8 billion U.S. dollars, energy sources such as LNG, crude oil, and refined products worth 52.4 billion U.S. dollars, agricultural products worth 32 billion U.S. dollars, and services (including patents, or tourism) worth 37.9 billion U.S. dollars. In addition, the People’s Republic wants to open up its markets more to foreign financial service providers. Beijing will also refrain from forced technology transfer in the future. It also wants to ensure that any technology transfer is voluntary and takes place on the basis of free market conditions.

In addition, the protection of intellectual property is to be strengthened. Furthermore, both countries agreed on new principles against targeted currency devaluations. Finally, the agreement includes a monitoring and dispute settlement mechanism. In return, the United States announced to reduce the tariffs on Chinese imports worth 120 billion U.S. dollars introduced early September 2019, from 15 to 7.5 percent. For the time being, the additional 25 percent tariffs on U.S. imports of Chinese goods worth 250 billion U.S. dollars will not change. This means that a U.S. import volume of 370 billion U.S. dollars is still subject to additional tariffs – about 70 percent of total Chinese exports to the United States. The United States thus maintains essential leverage. China, on the other hand, is halving its tariffs on U.S. goods worth around 75 billion U.S. dollars.

Partial Victory for Trump

With the agreement, President Trump was able to achieve a domestic political victory for himself. Surveys show that the majority of Americans support the Trump administration’s China policy. Farmers, who belong to Donald Trump’s core electorate, are suffering greatly from the collapse of exports to China. In 2019, the level of debt in the agricultural sector reached an all-time high. It was therefore all the more important for President Trump to conclude an agreement in which China commits itself to buying more agricultural goods from the United States.

For the time being, the agreement is an important de-escalation in the conflict. It is admittedly more than a purchasing directory for U.S. goods and services, since structural problems are also being addressed. However, numerous points of contention such as China’s industrial policy or the unfair subsidisation of Chinese state-owned companies remain unresolved and are set to be addressed in Phase 2. The agreement thus does not solve the fundamental conflict between the United States and China.

Competition of Systems

What is the reason for the trade conflict? The United States has had a huge trade deficit with China for years. In 2018, it amounted to 381 billion U.S. dollars.

The United States rightly accuses China of taking advantage of the international trading system while in many cases failing to respect its promises of accession to the WTO. President Trump rightly criticizes the lack of intellectual property protection, state subsidies, and forced technology transfer in China.

But the conflict between the United States and China is about more than that. For one, the United States is concerned about having to share its supremacy as the sole superpower in the world with China. The underlying conflict of values is even more significant, however. The trade conflict is an expression of an increasingly clear competition between completely different economic and political systems. The absolute power monopoly of the Communist Party and China’s economic hybrid model with a strong influence of the state collides in more and more areas with the market-based and democratic systems of the West. This conflict is therefore also about how the world order will be shaped in the future.Both sides are therefore seeking to reduce economic dependencies. This is reflected, for example, in revised export control rules and stricter controls on foreign direct investment in the United States. China, on the other hand, wants to reduce its dependence on foreign technology, for example in the area of semiconductors, microprocessors, and software.

However, a decoupling process between the two largest economies entails enormous risks and costs not only for U.S. companies and consumers, but also for the global economy.

Moreover, the agreement is contrary to the rules of the WTO. The basic principle is the Most Favoured Nation (MFN) clause. Accordingly, concessions granted to one WTO member must also be granted to the other members. An important exception to this is Article 24 of the General Agreement on Tariffs and Trade (GATT) and Article 5 of the General Agreement on Trade in Services (GATS). These allow members to conclude bi- and plurilateral preferential agreements if certain criteria are met. For example, substantially all trade must be liberalised. This is not the case in the present deal. Finally, it is also unclear to what extent companies from third countries can benefit from the legal improvements, such as the protection of intellectual property and regarding forced transfer of technology.