Presidents Donald Trump and Xi Jinping are scheduled to meet on the sidelines of the G-20 summit in Buenos Aires this week, and trade will be a key topic on the agenda. In the first episode of the new Brookings podcast on trade that I host—“Dollar and Sense”—Eswar Prasad and I discuss the U.S.-China trade conflict, its effect on the Chinese economy, and prospects for a deal in Buenos Aires.
The three main points that I took away from the discussion are that the United States has a mix of legitimate and unreasonable concerns; the direct effect of the trade war on the Chinese economy is modest so far; and there are some prospects for a deal if the Trump administration is pragmatic and drops its maximalist demands.
1Market access concerns are real
The legitimate complaint that the United States has with China concerns restrictions on market access. In some cases, these are old-fashioned tariffs—for example, 25 percent on cars, until recently brought down to a still-high 15 percent.
But in general, China’s tariffs are lower than those of other emerging markets. Where China stands out is in restrictions on direct investment. In a wide range of sectors—from autos to financial services to telecommunications—the ability of foreign firms to invest in China is restricted, and that makes it difficult for firms to sell into the China market. In most of these sectors, foreign firms can be minority partners in joint ventures, typically with state enterprises. That set-up leads to forced technology transfer. Indexes of investment restrictiveness show China to be an outlier compared to other emerging markets.
The United States has other intellectual property rights (IPR) concerns as well. China has set up a system of IPR courts, but foreign firms feel they cannot get a fair hearing against domestic firms. Penalties for IPR violations are weak. If a firm’s IPRs are not respected, then it does not have fair access to the China market.
Alongside these legitimate market access complaints, Washington has made a big deal about the bilateral trade imbalance between the two economies. China’s overall current account surplus has come down significantly and will be less than 1 percent of GDP this year. This is a reflection of the rapid growth of consumption in China and a decline in the national savings rate—healthy changes that make the country’s growth more sustainable. The United States continues to have a modest trade deficit because our savings lag behind our investment. The tax cut increased this gap, so it is no surprise that the U.S. trade deficit is rising, not falling, as the U.S. prosecutes its trade war. Trade protectionism is not likely to reduce the trade deficit because it limits imports, but also indirectly hurts exports as well.
2China’s economy is slowing down
China’s economy has been slowing down because of its domestic economic policies. China had a long credit binge that fueled investment—in infrastructure, housing, and manufacturing capacity. In recent years, total debt relative to GDP has been rising rapidly, a sign that much of this investment is not productive. Starting last year, China has been reining in the growth of credit and trying to stabilize the overall leverage in the economy—with considerable success. But a natural part of this process was that investment slowed and the economy has depended more and more on the growth of consumption. Overall GDP growth slowed modestly and was at 6.5 percent in the third quarter of 2018.
The trade war comes at an awkward time for China. It does not want to reverse its effort to stabilize leverage. It has loosened monetary conditions modestly but has not allowed any big surge in credit. Export growth has been surprisingly healthy. Partly, this may reflect some front-loading of exports to the United States in anticipation of U.S. tariffs rising from 10 percent to 25 percent on January 1. But most of China’s exports go to other countries and that demand seems robust.
The big worry for China is the indirect effect of the trade war. If the trade war undermines confidence among Chinese firms and households, then it could affect other parts of GDP beyond exports and have a more damaging impact. The economic impact of the trade war leaves Chinese leaders interested in making a deal, but not desperate and certainly not willing to cave into all U.S. demands.
3The outline of a deal
The Trump administration has sent mixed signals about the possibility of a deal. The Chinese sent a written proposal in mid-November. President Trump’s reaction was encouraging: The new Chinese list has “a lot of the things we asked for,” he said. “There’s some things—there were four or five big things left off. I think we’ll probably get them, too.” At the same time, the U.S. Trade Representative’s office put out an updated Section 301 investigation report (301 empowers the USTR to investigate unfair trade practices by foreign governments and to negotiate settlements) stating: “This update shows that China has not fundamentally altered its unfair, unreasonable, and market-distorting practices that were the subject of the March 2018 report.” Reading the USTR report, it is hard to see the two sides reaching an agreement soon.
The parameters of a realistic deal include some big purchases by the Chinese of agriculture and perhaps energy (such purchases have little lasting impact but they generate headlines); market opening commitments in autos, financial services, and other sectors; and some general commitment to strengthen IPR protection and penalties for violations. In return, the Chinese will want a halt to the tariff escalation scheduled for January 1 and ideally a rollback of all the tariffs aimed specifically at China. It would be difficult for China to make a commitment to reduce the bilateral trade imbalance because that is on the way up, owing to U.S. fiscal and monetary policy. Chinese leaders are also unlikely to give up on their “Made in China 2025” industrial policy or to make strong commitments on limiting state enterprises. The best hope for the United States in the latter two areas is to push to make Chinese practices consistent with World Trade Organization (WTO) rules and global norms.
There are a lot of possible outcomes coming out of Buenos Aires. It seems unlikely that there could be a detailed trade deal because there has not been enough preparation for that. Still, the two presidents could announce an agreement in principle, with key areas outlined, and details to be worked out in subsequent negotiations. If Washington found that this was sufficient progress to hold off on the January 1 tariff escalation, markets would no doubt react positively. But it is also possible that the United States will take a tough line and follow through with the January 1 tariffs. It is hard to see China actively negotiating in the wake of that, and I would expect at least some months of minimal dialogue and settling into a new reality of higher tariffs.
Some members of the administration have talked about the United States “decoupling” from China. If that is the objective, then it makes sense to go to maximum tariffs and leave them in place permanently. This will be quite disruptive to the U.S., Chinese, and global economies.
In that scenario, a key issue will be the extent to which American partners and allies go along with a policy of containing China. Many of our partners have much deeper economic relations with China and clearly benefit from the exchange. If they all continue to do business with China, then the risk is that the United States will be the one isolated, not China. Getting China to open up to the same extent as other emerging markets will not be simple, and the United States is more likely to have success if it works with partners and multilateral agreements, such as the Trans-Pacific Partnership, rather than going it alone solely through bilateral negotiations.
Even if the two presidents reach an agreement that avoids escalation of the trade war, the issues of market access and technology competition are likely to be with us for the foreseeable future.