US-China Phase One Trade Deal: Challenges for Trade Expansion

After a year since the United States and China signed the phase one trade deal agreement, it is evident there are several systemic challenges to its full implementation. China’s decentralized governance, limitations in the deal’s dispute resolution mechanism, and failure to address structural issues in the bilateral economic relationship limit the prospects of reaching phase one goals of trade expansion. The consequent market distortions may negatively impact international trading partners, whereas China’s search for alternatives to US imports will hinder progress in subsequent negotiations.

Chapter Six of the US-China Economic and Trade Agreement, signed by former President Donald Trump and Vice Premier Liu He on January 15, 2020, stipulates that China agrees to import goods and services from the US that exceed 2017 levels by $200 billion over a two-year period. However, China’s governance structures and Chinese Communist Party (CCP) interests complicate the implementation of the phase one agreement. Failure to reach specified targets risks decreasing the prospects of successful negotiations during the Biden Administration.

Economic Constraints

While the phase one agreement encompasses national import targets, China’s ability to reach these goals is limited due to variations at the provincial level and constraints at the corporate level. The economic slowdown caused by the COVID-19 pandemic makes current prospects of fulfilling import requirements unrealistic and China’s 2020 economic recovery masks regional differences. In particular, Hubei was the most severely impacted province with a decline in GDP of over 10% from September 2019 to September 2020. Given Hubei’s relative importance in automotive, electrical equipment, and ship-building supply chains, this has significant implications for China’s ability to meet its requirements in those sectors. US tariffs that remain in place further limit Chinese demand for US products, increasing the strain on Chinese exporters.

State Council and provincial government support has a limited ability to remedy this issue for small and medium-sized enterprises (SMEs), which hold considerable importance in China’s growth. The State Council’s fiscal measures introduced in February 2020 helped alleviate SME lending concerns. However, many provincial governments cut 2020 GDP targets and the Central Committee made no mention of growth rate targets during the Fifth Plenum, reflecting a reality in which the agreement’s targets are unlikely to be met. In October 2020, US exports to China had only reached 57% of year-to-date goals. 

Chinese importers will oppose purchasing goods and services if US exports are not competitively priced. Many Chinese firms have adapted to the trade war by establishing stronger relationships with other trading partners, such as Brazilian soybean exporters. These firms are incentivized to circumvent any state directives that would decrease profits, given the costs of switching suppliers.

Limitations of the Trade Deal’s Dispute Resolution Mechanism

The agreement’s trade expansion requirements provide China with additional leverage the CCP may utilize, depending on perceived threats to its fundamental interests. Article 6.2 of the agreement allows China to claim actions by the US as reasons for failing to fully implement trade expansion obligations. This provides an ambiguous mechanism through which negotiators will likely cite unwelcome US intervention in Chinese domestic politics. The CCP’s focus on domestic stability and emphasis on self-reliance will mean the prioritisation of these primary goals over trade requirements if there is a perceived threat from US policies. “Tough on China” policymakers may therefore worsen prospects for China reaching its import targets, as policies that impact Party interests will provoke the CCP to refrain from reaching minimum purchase amounts. Actions such as restrictions on Hong Kong and telecommunications firms are unlikely to fundamentally change the CCP’s policy preferences; the side effects will include decreasing China’s willingness to comply with the trade agreement. Additionally, US export control restrictions that have tightened on the basis of national security will decrease the types of goods the US can export. If the US criticizes China’s failure to meet purchase targets, Beijing will likely point to export controls in the dispute mechanism as unilateral US action disrupting trade.

During the opening of the National People’s Congress in May 2020, Premier Li Keqiang reaffirmed China’s commitment to phase one commitments. However, later that month, former President Trump threatened to revoke Hong Kong’s trade status after the national security law was introduced. The CCP responded by instructing state-owned enterprises Cofco and Sinograin to suspend US soybean purchases. The Party’s contradiction here is indicative of its broader priorities and reflects how the import commitment is a form of leverage that Beijing can introduce to its economic statecraft options. Much of China’s pork and soybean imports from the US have been replaced by Brazil in 2020. The dramatic increase in imports from Brazil implies that Chinese firms may not need to purchase as much from the US to meet domestic demand. 

The CCP’s emphasis on dual circulation and the Made in China 2025 initiative may indicate a preference for self-reliance and import substitution industrialization, a trend that clashes with trade liberalization objectives. Although it faces numerous challenges, the CCP is attempting to transition to a domestic growth-driven economy, emphasizing Chinese suppliers’ ability to satisfy demand rather than relying on imports that the US seeks to expand.

Implications and Risks

The trade expansion chapter of the agreement is significantly limited in addressing underlying issues. The steep requirements indicate that in order to meet targets, the Chinese government would need to direct firms to purchase US goods, thereby increasing state involvement and moving further from a market-driven economy. 
China’s central government may opt to import a lower quantity of US goods that are not covered in the deal, as an estimated $51.6 billion worth of goods are omitted from the agreement. This exclusion may negatively impact additional US firms and international trading partners. Contrary to US interests, this further incentivizes China to increase state-managed trade.

Tariffs on many products will remain in place, and if phase one requirements are unmet, it will be challenging to make headway on the next set of tariffs. In addition, the erosion of trust in US-China relations has coincided with Beijing investing heavily in strengthening ties with other states through the Belt and Road Initiative (BRI). Launched in 2013, the BRI is a multi-trillion-dollar initiative that encompasses a vast array of investment projects. By financing a variety of ports, railroads and highways both abroad and domestically, China aims to place itself in the center of a globally connected economic network. In November 2020, China and 14 other nations signed the Regional Comprehensive Economic Partnership. The move establishes what is arguably the world’s largest free trade agreement, and notably does not include the United States. The more China believes it is able to achieve its economic goals through other channels, the less reliant it will be on adhering to the requirements set in subsequent rounds of trade talks.

Source: Global Risk Insights