China: Skepticism abound despite U.S.-China “phase one” trade deal
January 23, 2020
On 15 January, the United States and China signed off on a “phase one” trade deal, as had been expected. The accord comes into force on 14 February, at which date the U.S. will lower tariff rates on approximately USD 100 billion of merchandise imports from China from 15.0% to 7.5%; tariffs of 25.0% on approximately USD 250 billion of imports from China will remain in place. A few days earlier, the U.S. also stopped labelling China a “currency manipulator”. In exchange, China has agreed to better protect intellectual property rights; increase transparency about foreign exchange policy; and to purchase USD 200 billion of additional U.S. goods and services compared to the 2017 baseline over the next two years. Overall, although Chinese economic growth should benefit from the accord this year, downbeat U.S. demand and considerable uncertainty about the long-term U.S.-China economic relationship will limit the boost.
The partial lowering of U.S. tariffs on USD 100 billion of merchandise imports from China, including apparel and electronic products, will be much welcomed by Chinese producers exporting to the United States; last year, shipments destined for the U.S. fell 12.5% on an annual basis, according to China’s General Administration of Customs. However, the boost is likely to be limited: Despite the partial lowering of tariffs on USD 100 billion of imports from China, those U.S. imports will still face a 7.5% tariff, while USD 250 billion of other U.S. imports from China will continue to face a 25.0% border tax. In addition, U.S. demand for imports is seen proving downbeat again this year due to a slowing domestic economy.
The standout Chinese concession in the deal was its commitment to purchase an additional USD 200 billion of imports from the United States compared to a baseline of 2017, covering four product categories: manufactured goods, agriculture, energy and services. However, it is not certain whether China will have the necessary demand to fulfill these purchases given its slowing economy and that African swine flu has devastated its pig herds—one of the key reasons it imports vast quantities of soybeans from countries such as the U.S. Indeed, the “phase one” deal text itself suggests both China and the U.S. are aware of this:
“The Parties acknowledge that purchases will be made at market prices based on commercial considerations and that market conditions, particularly in the case of agricultural goods, may dictate the timing of purchases within any given year”.
Thus, if the additional purchases do not materialize and the U.S. is not satisfied with the reasons why, it would be permitted to sanction China under the “phase one” deal by, for example, reversing its tariff reductions. If China considered the U.S. sanction was “taken in bad faith”, China could then withdraw from the whole pact. Consequently, although the U.S. and China have managed to reach a “phase one” trade accord, ostensibly reducing trade policy uncertainty in turn, this issue highlights the accord could easily become undone, which will leave businesses with a lingering sense of uncertainty. Meanwhile, if China made the necessary additional purchases, this could squeeze domestic production.
Expanding on this point, analysts at Nomura commented: “US-China trade relations remain a material uncertainty in 2020, as there is little evidence of agreement on long-standing issues, the purchase target appears to be challenging for China, manufacturing goods purchases may crowd out some domestic industrial production, while complaints about trade diversion from China’s other trade partners are likely. Also, some market participants are looking at whether a phase two trade deal is possible in the near term, especially before the November 2020 US presidential election.”
All in all, the “phase one” accord should support Chinese economic growth this year as producers exporting to the U.S. will benefit from lower tariffs. That said, the gains will be constrained, while the additional purchases of U.S. goods and services that China has committed to are not guaranteed to happen, causing uncertainty. Taking a longer-term view, the outcome of the U.S. presidential election this year, and whether the U.S. and China maintain close trade links or “de-couple”, will have a significant bearing on the Chinese economy.
Author: Edward Gardner, Economist