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 agricultural products and in return, the United States will not increase tariffs for the time being. An initial agreement on structural issues has been reached, but the trade conflict is anything from over.

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, which allows the executive branch, after prior investigation and consultation, to impose tariffs on countries that violate trade agreements or otherwise use unfair trade practices that disadvantage the U.S. economy.

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. After this further tariff increase, Trump threatened to impose additional tariffs of 25 percent on Chinese goods worth more than 300 billion U.S. dollars. 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, 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 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.

An equally worrying development is the accusation by the United States that China is manipulating its currency, thus extending the trade conflict to the realm of monetary policy. This increases uncertainty and can cause significant costs in currency hedging for global companies.

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 from the beginning of October to mid-October. After further negotiations, Trump and Chinese Vice Prime Minister Liu He announced a partial agreement in October, the so-called “Phase 1” deal. In mid-December 2019, this agreement was further specified. China agreed to purchase U.S. products and services worth an estimated 200 billion U.S. dollars. This includes agricultural products worth 40-50 billion U.S. dollars. The People’s Republic also wants to open up more to foreign financial service providers. Beijing also wants to terminate forced technology transfer. Finally, the United States and China agreed on new principles against targeted currency devaluations. In return, the United States waived the increases in special customs duties planned for October 15 and December 15, 2019. In addition, the United States cut the special tariffs in half from 15 to 7.5 percent on imports from China worth 111 billion U.S. dollars.  For the time being, the additional 25 percent tariff on imports from China to the United States worth 250 billion U.S. dollars will remain.

Competition of Systems

The United States has had a huge trade deficit with China for years. In 2018, it amounted to 381 billion U.S. dollars. U.S. President Trump therefore wants a better “deal” for the United States.

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.

Decoupling the Economic Giants

Both sides are therefore seeking to reduce economic dependencies. With more rigorous export controls and the so-called Entity List, Washington aims to restrict exports of certain high-tech products to China. The Executive Order on ITC and Supply Chains is to limit the employment of Chinese technologies and products in sensitive sectors. More stringent investment controls aim at preventing Chinese companies from investing in the United States if this entails a risk to national security. Efforts to reduce dependence on foreign suppliers of foreign technology, for example in the field of semiconductors, microprocessors and software, are also evident in China. A partial decoupling, especially in the high-tech sector, seems likely.

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.

The United States should thus rather invest more in research, education and infrastructure in order to strengthen its own competitiveness. It should also commit itself to reform the WTO and help to create modern trade rules. It should also work together with the EU to strengthen the transatlantic marketplace. Only in this way can the United States remain a powerful player in world trade.