The Science of the Deal: US-China Phase-One Agreement

Even before his White House ambitions, Donald Trump had marketed himself as a master deal-maker and campaigned on the promise of negotiating a fairer deal with China, calling the former setting “the worst ever”. 

A year into his presidency, Trump predictably unleashed his wrath on China, imposing tariffs on a hefty amount of imports from the country, which were immediately retaliated against. What followed was a full-blown trade war which gripped markets around the world in uncertainty. 

However, last week gave a ray of hope as the two countries finally signed the much-awaited phase one of the deal after a fair bit of stalling. At its core, the agreement addresses the massive trade imbalance that has existed in favour of Beijing – which Trump has long portrayed as a defeat – by getting China to buy more US goods. 

The Science of the Deal

The 96-page document is comprised of eight chapters that begin with intellectual property rights and then discusses technology transfer, trade in food and agriculture products, financial services, macroeconomic policies and currency, expanding trade, and dispute resolution. 

As per the details, China will now be required to push up its imports of goods and services from the US by an additional $200 billion from its 2017 levels (when it was worth $130 billion) over the next two years, giving the US president another thing to boast about in his upcoming election campaign. 

The commitment related to raising these purchases, in essence, captures the key achievement of the new agreement as it puts the target at an ambitious, possibly to the extent of being unattainable, level. China is expected to increase its imports of certain goods and services from the US by $76.7 billion in 2020 and $134.2 billion in 2021 from the pre-trade war volume of $134.2 billion in 2017. 

In 2017, China imported some US goods and services worth a total of $185.8 billion, which means that $51.6 billion of American exports are not covered by Phase 1 of the trade deal. 

The bulk of that committed increase is supposed to come from the manufacturing sector at $77.7 billion, with China required to buy at least $32.9 billion from the US in 2020 and $44.8 billion in 2021. Energy products are the next in line value-wise, with the agreed amount of imports over the next two years supposed to be no less than $42.4 billion. Finally, services imports have to be increased by at least $37.9 billion over the same timeline. 

Beginning with the chapter on intellectual property rights – a long-standing irritant that has irked Washington, and across partisan lines – the deal requires China to publish an action plan on how and when the country will implement its IP obligations. 

The two sides agreed “to ensure effective protection for trade secrets and confidential business information and effective enforcement against the misappropriation of such information.”

Confidential business information, as defined by the two, relates to not only trade secrets but processes, operations or even styles of work, production and source of income among other things, covering a broad range of areas. 

One major feature from this chapter is the burden of proof in trade secrets-related civil proceedings has been shifted to the accused. The party charged with misappropriation of a trade secret shall be required to produce the evidence, provided that the original holder can demonstrate certain conditions. 

Further, it lays out a series of areas where China is supposed to strengthen its IP regime, including the threshold for initiating criminal enforcement, criminal procedures and penalties, while making a specific mention of the pharma industry. 

The second chapter takes head-on the issue of technology transfer, a practice China forced upon companies and joint ventures entering the country. As per the agreement, no party shall subject market access, formally or informally, to the transfer of technology, be it in acquisitions, joint ventures or investment transactions or have any similar licensing requirements in place.  

Agriculture is the topic of discussion in the third chapter and it mandates China to pump its imports from the US in the sector by $32 billion cumulatively in 2020 and 2021, leading to an average annual total of $40 billion of imports. It also eliminates the Chinese non-tariff barriers and deals with issues related to standards, detailing into specific products such as pet food or dairy products. Consequently, both ensure greater market access for the US. 

Chapter four deals with the financial services and aims at reducing some barriers to entry for the US firms. For example, overseas assets of an American financial institution will now be taken into consideration when looking at asset requirements. 

On the other hand, the US has promised to acknowledge current pending requests by the Chinese institutions – specifically naming the CITIC Group, saying these will be considered expeditiously. 

In Macroeconomic Policies and Exchange Rate Matters and Transparency, the text states that both parties should follow a market-determined exchange rate and avoid manipulating its currency. 

Finally, the seventh chapter is about the dispute resolution mechanism, laying down a clear tiered process. Any issues relating to the agreement will be first consulted bilaterally at working-level groups and then rising through the ranks with Trade Representative and Vice Premier as the US and Chinese higher-most authorities, respectively. Both parties will have a Bilateral Evaluation and Dispute Resolution Office to the same end. 

If these talks fail to produce a consensus, then it lays down a process to follow, which includes appeals, for imposing tariffs and other penalties. 

But as far as tariffs are concerned, the deal gives little reprieve. While those meant to be effective from Dec 15 – on $160 billion of Chinese goods along with the retaliation on autos – have been withdrawn, the 25% tariff on $250 billion worth of Chinese goods will remain in place. Meanwhile, the September 1 tariffs on $120 billion of Chinese goods have been slashed by half to 7.5%. 

Now with the specifics addressed, let’s get to the finer details. Phase 1 of the deal touches upon some long-standing areas of dispute, in particular, the US trade deficit with China and the latter’s disregard for the former’s intellectual property. 

However, one area where it mostly emphasizes on is the increased imports. With a committed $200 billion of additional imports from the US, China has a monumental task at hand, which becomes even more difficult when one looks at its recent economic performance. The double-digit growth of the 2000’s is gone as the country’s GDP rate rose by 6.1% in 2019 – slowest in 29 years. 

In addition to an already slowing economy, China is still faced with steep tariffs from the US, which are hurting its exports and consequently, further denting the GDP growth rate. In such an environment, Beijing is supposed to increase its US imports by as much as 55%. 

Therefore, many believe that the desired targets would come through trade diversion rather than trade creation. What that means is that instead of importing a certain good from its current trading partner, China will shift the purchases towards the US to get to the agreed numbers. That would result in a managed trade framework where imports will be made by the origin of the country and not based on price, which any market mechanism should mandate. 

Take agriculture for example, where the average import value for the next two years should be $40 billion. However, details reveal that even when US agricultural exports to China peaked, in 2013, their value was $29 billion, well below the level mandated under the latest agreement. 

Other aspects of the deal, though just finalized and now to be boasted by Trump, had been in the offing for a while. For example, in November end, the Communist Party introduced new protections for copyrights and intellectual property. Similarly, a little while back, Washington had also un-designated Beijing as a currency manipulator. 

Whether there is going to be a second phase of this deal depends largely on China’s ability to manage the import targets, as on the rest of the issues, it had been converging, albeit gradually, for some time now.