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Will the U.S. and China Make a Deal on Trade?

eye on the news

Will the U.S. and China Make a Deal on Trade?

Drama on both sides notwithstanding, the two nations want to reach an agreement. May 31, 2019
Economy, finance, and budgets
Politics and law

Two lessons attach to the ongoing saga of the China–America trade negotiations. First, success—as in all diplomacy—never arrives until after some reverses and near collapses. Second, China and the United States are asking a lot of each other. For all the frustration, however, and the high hurdles involved, some favorable resolution seems likely. Both sides, for their own reasons, badly want a deal.

Certainly, this latest round of give and take has injected lots of drama into the story. Negotiations exuded optimism in April and early May, particularly when Treasury Secretary Steven Mnuchin suggested that the deal was 95 percent complete. Both sides implied that they were ready to discuss the logistics of a signing ceremony. Then things changed. China’s negotiators sent their American counterparts a draft document detailing their understanding of the agreement. The Americans accused the Chinese of reneging on previous promises, and not for the first time. President Trump lost patience and announced on May 5 that his long-postponed plan to raise tariffs on $200 billion in China goods from 10 percent to 25 percent would go forward.

Retaliating, China announced plans to raise tariffs on $60 billion of U.S. goods from 5 percent and 10 percent to 10 percent, 20 percent, and 25 percent, effective June 1. Talks have continued, though, unlike the last time the two nations traded tariff hikes. With Chinese Premier Xi Jinping’s blessing, the Chinese delegation traveled to Washington as previously planned. Last September, when Trump put the initial 10 percent tariffs on the $200 billion worth of Chinese imports, U.S.–Chinese trade discussions ceased entirely, and only began again after Trump and Xi met in December at the G-20 meetings in Buenos Aires. This time, despite the seeming acrimony, no such break has occurred. Xi wrote what Trump described as a “beautiful letter,” suggesting that the two leaders “work together” to “get something done.” They are expected to meet at the June G-20 meetings in Osaka, Japan, presumably to put trade talks back on track.

This latest breach highlights how far each side must go to reach agreement. The Americans want a curtailing of industrial subsidies, an easing in China’s laws demanding that foreign firms transfer technology to Chinese partners, and tighter protections for American intellectual property. The Chinese have offered to make regulatory changes, but they have refused to change laws. Their chief negotiator, Vice Premier Liu He, has explained that such demands trample on China’s national sovereignty. For the same reason, the Chinese have insisted that the enforcement of any treaty provisions go through Chinese law and not be part of the agreement, as the Americans want. They have asked the U.S. to “trust” them—a difficult request, given that China has not merited such trust in the past. The Americans would prefer to keep the tariffs in place until they can verify that China will change; Liu counters that China can agree only after the tariffs are removed. These are high, but not insurmountable, hurdles.

The United States holds the stronger position in the standoff. China depends much more for its prosperity on trade with the U.S. than the other way around. Fully 25 percent of Chinese exports go to America, while barely 8 percent of U.S. exports go to China, and China is much more export-oriented than the United States. China’ exports constitute more than 20 percent of its economy, while American exports amount to about 12 percent of gross domestic product (GDP). Less than 1 percent of the U.S. economy is tied to sales to China; more than 5 percent of China’s economy relies on sales in America.

Nonetheless, tariffs will not help the American economy. The 25 percent levy on $200 billion in Chinese goods will hit consumers directly and, by raising costs in the American supply chain, will also increase the price of domestically produced goods. If the administration follows through on its threat to raise tariffs on an additional $325 billion in Chinese imports, costs would spike further. But even a 25 percent burden on $525 billion in imports would cost our $20.5 trillion economy approximately $130 billion—barely more than 1 percent of all domestic purchases. Of course, the pain would not end there. U.S. exporters, especially in agriculture, would also suffer from China’s retaliatory tariffs. Output and employment would fall accordingly. Still, the administration estimates a 0.2 percentage point reduction in the economy’s growth rate, and even the most pessimistic forecasters are talking about only 0.5 percentage points off the economy’s annual growth rate, if the situation persists. These outlooks are neither positive nor catastrophic.

If the trade dispute were to stretch on for a year, however, it could become a matter of growth and recession in China. Even in the game of tit-for-tat tariffs, China already faces limitations. Beijing raised tariffs on the $60 billion of American goods on which it already levies, but it could not credibly threaten an expansion of tariffs on other American goods, because the rest of them are inputs to China’s own export products—most notably, components for iPhones and computer assemblies.

The Chinese economy has already suffered setbacks. Since Washington imposed 10 percent tariffs last September, China’s export volumes dropped between 4 percent and 5 percent. Imports have also declined, indicating an adverse impact on jobs and the Chinese consumer. Some regions in China report a 50 percent drop in auto sales. Even capital investment, presumably in export industries, has fallen by double-digit percentages. Though government figures show a still-robust Chinese jobs market, with unemployment at 4.9 percent of the workforce, help-wanted advertising has dropped, with ads for technology jobs off 20 percent in the last quarter of 2018, the most recent period for which data are available.

Of course, more than just tariffs are at work in China. Some of the country’s manufacturers are leaving for Vietnam, Cambodia, and elsewhere in Asia, where they can pay lower wages and get relief from American tariffs. China has also reached a point in its development where it is harder to maintain the rapid growth that its economy has sustained over the past two decades. As it matures, China has exhausted the obvious, high-return projects available to an emergent economy. The trade dispute comes at a particularly difficult time, as Beijing initiates massive infrastructure projects to energize GDP. Those efforts have succeeded in lifting the economic growth rate, but at great cost, and with an added debt burden. The government has also poured money into its financial markets to disguise the country’s vulnerability, especially when Trump announced his latest round of tariff hikes. Fluctuation in the yuan fell 2 percent against the dollar in the hours after Trump’s announcement, speaking volumes about those vulnerabilities.

Against such straitened circumstances, Beijing’s tough stance may just be bravado. Some suggest that Beijing hopes to buy time until a Democrat wins the White House, presumably someone more tractable than Trump. But that’s far from assured and a long way off, even if it happens in 2020. If China’s team made a calculated error, it may have rested on the hope that Trump wanted a deal badly enough to accept Chinese conditions. If that was what Xi believed, he was clearly wrong.

Whatever the miscalculations on either side, China’s circumstances clearly make Beijing eager for a deal, as shown by how quickly Xi invited Trump to work things out following the tariff announcement. Also, though Beijing has always insisted that it would never negotiate under threat, it quickly broke that rule in this case. But Washington wants a deal, too. The United States may have advantages in this stalemate, but the White House knows that the tariffs and an interruption of trade will hurt the economy, especially farmers, a key Republican constituency. Trump also wants to put substance behind his businessman’s promise that he’ll make better deals than previous administrations. He also might genuinely want to create a better, more equitable trade relationship with China.

Despite the recent rough and tumble, both sides want an agreement of some kind—and soon. It will probably include a formula to reassure the United States, without violating China’s fragile sense of sovereignty.

Photo: Pool/Getty Images

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