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Phase 1: The Good, the Bad, and the Missing

Seldom if ever has the culmination of two years of intensive negotiation, capped by a Presidential signing ceremony and a 94-page document, left so many uncertainties about a topic as large as the fate of US-China relations.

Seldom if ever has the culmination of two years of intensive negotiation, capped by a Presidential signing ceremony and a 94-page document, left so many uncertainties about a topic as large as the fate of US-China relations. But uncertainty is the hallmark of reactions to the Phase One big reveal. Based on our framework of analysis, built from having worked in the US-China relations process at the White House-level and years of close interaction with the issues and individuals involved in the present negotiations, we can offer impressions of the now-released text of the signed agreement.

What’s In

The agreement proper consists of a preamble, seven substantive chapters and a closing chapter with a few legalities.  Here is our cheat sheet on the deal:

Chapter 1, Intellectual Property Protection: Shifts the burden of proof to defendants for some IPR theft allegations and makes criminal penalties more accessible.  Pledges greater protection for a handful of specific products – pharmaceuticals, medicines and unlicensed software – and generally more enforcement against counterfeit products and other IPR infringements, including with discipline on online venders.  But the specific IPR concerns of other industries are not addressed, and the institutional change necessary to facilitate implementation is not accounted for.

Chapter 2, Tech Transfer: Extremely thin two-page section, given the high expectations set.  Merely states that both sides will not compel technology transfer, something which Beijing has insisted all along it does not do.

Chapter 3, Trade in Food and Agriculture: A long (26 page) section of 17 annexes on specific food products and policy issues. The policy issues, such as Annex 15 on “domestic supports” (subsidies) generally restate existing commitments in the WTO and other organizations which US policy has lately undermined.  The whole of that anti-subsides section:

“China shall respect its WTO obligations to publish in an official journal its laws, regulations, and other measures pertaining to its domestic support programs and policies. For greater certainty, nothing in this Agreement limits the rights of the United States under the WTO Dispute Settlement Understanding against China with respect to China’s domestic support measures.”

A restatement of run of the mill existing obligations is neither the “best deal ever” nor justifies the past two years of bellicosity.

Annexes 2 through 10 provide Chinese promises to make exporting easier for Americans in 9 product areas (like beef, pork, rice, etc.), virtually all of which China has pledged to open previously (beef) and/or is ravenous to purchase regardless of a trade deal due to domestic supply problems (pork).

Chapter 4, Financial Services: This section mostly reiterates commitments China has already made to eliminating equity caps in insurance and brokerage firms by certain dates this year.  It also contains some language with clearer timetables for China to expedite licensing approvals for US electronic payment and bank card service providers (consistent with previous WTO rulings). There is a new commitment to open provincial licenses for distressed debt investors so that they can buy distressed assets from banks directly, but no timetable for nationwide licenses.

Chapter 5, Macro and Exchange Rates: This section contains no significant new commitments, and pledges data disclosure practices which China already observes, although the quality of disclosure may improve after this agreement.  On exchange rate policy, the agreement pledges that both parties “refrain from competitive devaluations and not target exchange rates for competitive purposes, including through large-scale, persistent, one-sided intervention in exchange markets.”  China of course continues to intervene in its foreign exchange markets, but over the past two years, those interventions have been much smaller than over the previous decade, and have occurred in both directions, according to official data.

Chapter 6, Expanding Trade: The most meaningful section of this agreement is this section laying out the terms of China’s commitment to increase imports from the US by at least $77 billion in 2020 and $123 billion in 2021 from 2017 levels, divided into quotas for manufactured goods, agricultural, energy products and services.  The chapter is onerous to market economists because it entails government planners contriving to manage outcomes, with specific floor values, regardless of the reality of supply and demand. Confusingly, the chapter also stipulates that outcome must be based on “market prices and conditions”, and respect “commercial considerations”.  Leaving aside this conceptual inconsistency, and the obvious difficulty of reconciling blame if these flows fail to eventuate due to market conditions, the actual trade numbers implied in year one are not so difficult to imagine achieving.  A $33 billion increase in manufactured goods sales, for instance – the number earmarked for 2020 – is not massive in the light of projected 2020 marginal household consumption growth of about $500 billion.

Chapter 7, Bilateral Evaluation and Dispute Resolution: Much touted by Team Trump as offering a conceptional breakthrough in strong enforcement, the dispute resolution system provides for a venue of talking and consultation (which we have no problem with, but this is nothing new), followed by this innovation:

If the Party Complained Against considers that the action of the Complaining Party was taken in bad faith, the remedy is to withdraw from this Agreement providing written notice of withdrawal to the Complaining Party.

The remedy is to withdraw from the agreement? Forgive us, but that doesn’t sound like a remedy, but rather a failure to find a remedy.

What Should Have Been In, But Isn’t

As noted, the deal offers special attention for a handful of products in the IPR section, and managed trade targets for increased exports in specified areas within the four major categories of trade. But there are myriad other industries and product areas that deserve better treatment in China, today, that could have been incorporated in an agreement after two and a half years of consultation, but were not.

Moreover, this managed trade approach does not even start to remedy the systemic concerns that are making market-oriented nations anxious globally – issues like the predominance of state enterprises, the prevalence of foreign investment limitations in the vast set of industries that did not get early attention in this deal, the lack of consistency in competition policy treatment and the general asymmetry of information and the playing field for private firms foreign and domestic.  These and other issues are to be discussed in a Phase 2, down the road, but it is unclear when.  The Chinese side immediately said after the January 15 signing that it wanted to go slow before any further talks.

What Won’t Be In

As we knew it wouldn’t, this deal did not address a host of growing challenges at the intersection of economics and national security. Huawei and 5G telecommunications, detentions and pressure on expatriates and travelers from the other side, foreign investment screening and export controls, and the threat of financial decoupling: all these issues and more continue to grow outside the fences established in this phase one undertaking.  Unless the relationship finds a broader footing on which to engage these issues, the area of uncertainty in US-China relationships will continue to outgrow the area of certainty, even if today’s deal expanded the latter.

What’s the Bottom Line

The agreement is a limited one, primarily capping the potential for further escalation of protectionism on both sides rather than taking serious steps to address long-standing issues in Chinese trade practices.  The managed trade outcomes in which China promises additional US imports are the most significant substantive commitments made, but China’s capacity and willingness to meet these targets remains in question.  Significant tariffs remain in place on both sides, uncertainty about the future path of the US-China relationship will persist, and the broader decoupling trends in security-sensitive areas of the bilateral relationship will continue.  Progress toward any Phase Two agreement is likely to be minimal in 2020.