Leibowitz: End of the Phase One China Agreement—What’s Next?

At the beginning of 2020, China and the U.S. agreed to settle some of their trade differences by inking a deal that reduced some U.S. tariffs on Chinese imports (under Section 301 of the Trade Act of 1974) in exchange for a commitment from China to purchase considerably more U.S. products in specified sectors. In the aggregate, China promised to purchase $200 billion annually during the two-year period from the U.S. over the figures in 2017. The U.S. tariffs were kept under the deal, except that the most recent tariffs on $300 billion of imports from China were cut in half, from 15% to 7.5%.

Now that the two-year period is over, it’s time to add up the totals. China fell well short of the $200 billion mark. In agriculture, China committed to buy $73.9 billion from U.S. sources and actually has bought (through November 2021) $57.4 billion, a shortfall of $16.5 billion or about 20%. In manufacturing, China agreed on $210.7 billion in purchases and actually bought $117.8 billion, a shortfall of $92.9 billion or 44%. In energy, the commitment was for purchases of $67.7 billion, while the real number was only $24 billion—a gap of $43.7 billion or 64%.

The U.S. and China are continuing discussions about the reasons for this shortfall. A Chinese spokesman actually blamed the shortfall on the pandemic(!), which, as we know, originated in China.

Still, there were some benefits to the U.S. from the deal. For those who like to keep score on the basis of the bilateral trade deficit between the U.S. and China, the deal contributed somewhat to its reduction, at least temporarily. In 2018, the U.S. trade deficit with China was $423 billion. In 2019, the first full year of the Section 301 tariffs, the deficit fell to $360 billion, and in 2020 it fell to $324 billion, according to government figures. Through November 2021, the bilateral deficit with China was $267 billion, on track for the full year of about $291 billion.

The bilateral trade deficit with China is not a true indication of economic strength for the United States or any other country. It is simply the difference between our appetite for investment and for savings. The U.S. still has by far the largest global merchandise trade deficit in the world because saving is not in our blood but investment is. Imports increase our interdependence with other economies. That’s not only good for U.S. consumers, both families and businesses, but it’s also good for world peace. In order to shrink our global trade deficit, the U.S. will either have to save more or invest less. Neither approach is very palatable right now.

U.S. exports probably benefited from the deal too. The two-year total of U.S. exports to China in 2018 and 2019 was about $225 billion. In 2020 and 2021, the total will be, based on the 2021 data through November, about $250 billion. Given the sharp drop in U.S. exports to China in 2019 in the wake of the Section 301 tariffs (and resulting Chinese retaliation against U.S. exports), the two-year deal was something of a shot in the arm for U.S. exporters, especially in agriculture.

That said, the Phase One deal is not a blueprint for success in the future. China cannot be expected to purchase goods it does not want or need indefinitely. And the benefit to U.S. exporters was offset by the continued pain to U.S. companies paying high tariffs on Chinese goods that they can’t get from alternative sources.

So what’s next? There are not a lot of good options. But ending the Phase One deal with a deficient scorecard will not sit well with a lot of people in the U.S. The U.S. Trade Representative, Katherine Tai, is holding discussions this month with her Chinese counterpart to ascertain the degree to which China may have violated the accord. Then the appropriate remedies will be discussed.

The U.S.-China Business Council favors no more tariffs, and in fact fewer tariffs in China-U.S. trade. That is a predictable position for the USCBC, which favors increasing trade and investment between the world’s two leading economies.

On Jan. 1, the Regional Comprehensive Economic Partnership (RCEP) went into effect among 10 countries, with China the largest economy in the group. China, by this agreement, is enlarging its trade profile with other growing Asian economies, several of which are also in the Transpacific Partnership (TPP), from which the United States withdrew in 2017.

Will punishing China by increasing tariffs on U.S. imports actually punish U.S. companies and families more than their Chinese sellers? All the signs point to that. The overwhelming majority of punitive tariffs are paid by Americans, not Chinese. More tariffs will necessarily mean more costs for Americans. And China’s loss of sales will be made up for, at least in part, by liberalized trade opportunities through RCEP.

It’s apparent that U.S. policy toward China is immensely complex and actions that help further some objectives can also hurt others. For example, the Biden administration has an aggressive climate change policy. Cracking down on China will make it difficult to work together on climate issues, in which China must be a leader. The “worker-centric” trade policy theme of the administration in some industries works against the idea of bringing manufacturing back to the U.S. All these goals are useful and noble—but the actions to further them often don’t work well together in achieving all objectives.

During the 1990s and early 2000s, U.S. policy was geared to making China a responsible member of the world trading community, culminating in China’s admission to the WTO in 2001. The hope was that China would develop more market-oriented economic policies.

The results have been mixed to say the least. The U.S. did rein in China in certain areas in WTO cases, such as Chinese export taxes that pressured Chinese manufacturers to develop downstream industries. But overall, Chinese policy has not been steered by WTO rulings against it, any more than the U.S. has. And the U.S. sabotaged the workings of the WTO in 2018, rendering it impotent to decide important cases.

After the Trump tariffs, the Biden administration appears to be employing an eclectic strategy—not staking out a clear game plan with a singular objective. The Phase One trade deal with China did not help achieve any comprehensive goal. It’s one of many issues that may no longer have an effective role in China policy.

That sort of uncertainty is not pretty to see, but it is better than making (or continuing) policy mistakes. The analysis continues regarding how to juggle all the factors (economic, geopolitical, environmental, strategic) and apply a SWOT (strengths, weaknesses, opportunities and threats) analysis to each piece of the puzzle. There are constituencies within and outside the government favoring (and opposing) all the initiatives that are under discussion. We will see continued movement, but it is likely to be a while before a strategy emerges.

Lewis Leibowitz

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