What you need to know about the “phase one” trade deal with China

On January 15, 2020, U.S. President Donald Trump and Chinese Vice Premier Liu He signed a “phase one” trade deal. Essentially a cease-fire agreement, this deal was aimed at calming the trade frictions that have rattled global markets over the past couple of years.

While this phase one agreement may ease some of the tensions between the world’s two largest global economies, the bulk of U.S. duties on Chinese imports will remain in place. In addition, the agreement does nothing to address the core issues that started the trade war—Trump’s contention that China’s state influence on business and its economy gives it an unfair advantage in global trade.

What’s in the trade deal?

In many ways, the phase one deal seems like a large purchase order. China has agreed to buy an additional $200 million in U.S. goods and services (based on 2017 pre-trade war levels) over the next two years. If successfully implemented, this agreement will open up export opportunities for American manufacturers, farmers and energy producers, as China has promised to buy the following:

  • Manufactured goods: Increase of $32.9 billion in 2020 and $44.8 billion in 2021
  • Agricultural goods: Increase of $12.5 billion in 2020 and $19.5 billion in 2021
  • Energy: Increase of $18.5 billion in 2020 and $33.9 billion in 2021
  • Financial & other services: Increase of $12.8 billion in 2020 and $25.1 billion in 2021

In addition to the promises above, China has pledged to make reforms in areas such as intellectual property and forced technology transfer.

On the U.S. side, President Trump canceled his plan to impose additional tariffs on $160 billion worth of Chinese goods and will decrease duties on another $110 billion. He will, however, maintain tariffs at current levels on the remaining $360 billion in Chinese imports.

What’s not in the trade deal?

The trade deal contains no significant easing of current import tariffs by either country. The U.S. will maintain its duties on approximately two-thirds of Chinese imports, and China will maintain its retaliatory duties on certain U.S. exports, including energy and agricultural products.

The most significant exclusion from the trade agreement is any mention of the systemic issues that led to the trade war in the first place—namely, China’s state-led economic model, which includes state-owned enterprises, massive subsidies to strategically important industries, currency manipulation and state-directed corporate espionage.

We expect these issues to be addressed in the “phase two” agreement.

Questions & observations

The first question is whether China can keep the promises they’ve made to buy U.S. goods and services. Many trade experts consider these promises to be extremely ambitious. For example, China would have to buy roughly $40 billion in U.S. agricultural products per year, even though the most they’ve ever purchased in one year is $26 billion. The only way to achieve these targets is by diverting trade away from other nations, such as soybeans from Brazil or fish from Canada. The European Union has already threatened bringing a complaint to the World Trade Organization if the phase one deal puts them at a disadvantage.

If China can’t live up to the import quotas that were established, that leads to the second question: how effective will the enforcement mechanism be? In this trade deal, disputes over the agreement can’t be debated with or settled by a third-party arbitrator. Enforcement is left up to the office of the U.S. Trade Representative and its Chinese counterparts. Ultimately, if the two parties can’t agree that the other is acting in good faith, it has no recourse except to leave the trade deal.

Our final observation is that this trade agreement breaks the U.S. further away from past trade policy that favored free trade above all else. Past policies sought to tear down trade barriers to achieve trade liberalization and reduce government interference in world commerce. However, according to Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics, “the only way for China to reach its commitments is to resort to Soviet-style managed trade.” He called the import quotas a “worrisome and radical change.” After decades of calling on China to act more like a market economy and rely on competition and free market forces to drive global trade, this pact marks a significant shift in direction.

What does it mean for U.S. businesses?

If you are an importer of finished goods, component parts or raw materials from China, you’ll likely notice no change under this agreement as the majority of import duties will remain in place. Since the trade war could continue for the foreseeable future, you may want to explore alternatives in your supply chain, investigate foreign trade zones or explore duty drawbacks on imported and exported goods.

If you’re a farmer, energy producer, financial service provider or exporter of manufactured goods to China, you may experience increased sales if target import quotas are achieved. Remember, though, many trade experts believe these targets are unattainable, so any benefit is uncertain at this point.

President Trump plans to continue trade talks with China to develop a “phase two” agreement that addresses many of the unanswered issues absent from the phase one deal, but the President stated that he’d prefer to wait until after the November election to finalize another, more comprehensive agreement.

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