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The logo of China's ZTE Corp is seen on a building in Nanjing, Jiangsu province, China April 19, 2018. Picture taken April 19, 2018. REUTERS/Stringer  ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY. CHINA OUT. - RC1E7CC92770
Order from Chaos

Trump’s hot-cold stance on China

Editor's Note:

There is still a lot of uncertainty, but the Chinese company ZTE will probably get a lifeline, writes David Dollar—and that will be part of an economic package and indirectly linked to the North Korea negotiations. It will take some time to judge whether what is given on ZTE is justified by the economic and security gains. This piece originally appeared in The Hill.

The Trump administration continues to run hot and cold on China trade issues. The big delegation led by Secretary Mnuchin in early May presented a set of maximalist demands on reducing the trade imbalance, opening up markets and protecting intellectual property.

China was asked to foreswear its World Trade Organization rights to challenge U.S. trade protection, a request that commentators in China likened to the “unequal treaties” imposed on China by imperialist powers in the 19th century.

The trade mission was quickly followed by sanctions on the Chinese telecom company ZTE that amounted to a financial death penalty. Just as it seemed that economic relations were at rock bottom, President Trump put out the surprising tweet that he wanted to work with President Xi Jinping to throw ZTE a lifeline:

So, how do we understand what is going on? First, the ZTE case: ZTE is one of the top 10 manufacturers of cell phones in the world, selling about 55 million units per year, as well as other telecom equipment and services.

It is not well known in the U.S. because it targets the low- to middle-market in China and elsewhere in the developing world. Last year, it had $17 billion in sales and 75,000 employees. It is an important Chinese company, ostensibly private but with good ties to the Communist Party.

Like other Chinese telecom brands, it is dependent on sophisticated parts and software from U.S. firms.

When a firm like ZTE buys high-tech parts from U.S. suppliers, it agrees to abide by U.S. technology sanctions like, most notably in recent years, the prohibitions on sales to Iran and North Korea. In 2017, ZTE was fined by the Commerce Department for making illegal sales to those two countries.

ZTE confessed to the illegal sales and agreed to punish the managers involved. It did not follow through on that agreement and instead gave the managers bonuses. In response to this transgression, the Commerce Department prohibited U.S. firms from selling to ZTE for seven years. The firm consequently stopped operating this month.

The death penalty seemed harsh, but it was a legitimate legal/regulatory decision in light of ZTE’s violation of important U.S. sanctions and its subsequent disregard for the penalty that it had agreed to accept. The message now from the Trump administration is that legal/regulatory penalties can be negotiated down.

China’s key vice premier for economic affairs, Liu He, is in Washington this week to negotiate economic issues. It seems likely that there will be an agreement that includes a reduced or suspended penalty for ZTE. In return, the Chinese have shown a willingness to buy more goods and services from the U.S. and to gradually open more markets.

China is not willing to consider the maximalist demands, such as committing to reduce the trade imbalance or dropping their “Made in China 2025” industrial policy aimed at developing their high-tech sectors. The Chinese position on the trade balance has a certain validity.

Given the rising fiscal deficit in the U.S., it is natural that the overall U.S. deficit is rising: the goods and services deficit in the first quarter was 18.5-percent higher than in the first quarter of 2017. Given that China is such an important trade partner, the bilateral deficit moved about the same: It increased 15.2 percent in the first quarter.

The Chinese are right that if we want to reduce our trade deficit, then we need to save more either by reducing the fiscal deficit and/or by higher private savings.

Another factor in the equation is denuclearization of North Korea. The Trump-Kim summit is now set for June 12 in Singapore. China supports a deal in which DPRK gradually winds down its nuclear and missile programs while the rest of the world gradually provides sanctions relief and economic aid.

President Trump seems intent on achieving a diplomatic breakthrough in Singapore and will need strong cooperation from China to get a deal and, more importantly, see it implemented.

There is still a lot of uncertainty, but ZTE will probably get a lifeline, and that will be part of an economic package and indirectly linked to the North Korea negotiations. It will take some time to judge whether what is given on ZTE is justified by the economic and security gains.

There is also the long-run question of whether it was smart to make a legal/regulatory ruling such an obvious bargaining chip. Much of the U.S. economic complaint with China boils down to a lack of regulatory and legal transparency and consistency. The Chinese may well feel now that the U.S. is really no different.

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