The “Phase One” Deal is a Sham

San Francisco / December 16, 2019
 
On December 13, the Trump Administration announced it secured a "Phase One" deal with China (link). This deal does not achieve the objectives that Donald Trump announced when he inaugurated the US-China war. The failure of the Phase One deal to make meaningful progress should throw Trump's trade strategy into doubt.
 
The Trump Administration had three primary objectives when it started this trade war. First, Trump wanted to reduce the trade deficit with China. Leave aside the notion that the trade deficit alone is not a significant indicator of the health of US-China trade. That indicator is important to Donald Trump. He wanted to post a better number. Second, the United States wanted changes on intellectual property. The theft of intellectual property is massive. According a bipartisan and independent commission, Chinese IP theft costs the United States $225 billion to $600 billion a year (link). Third, Trump wanted China to change their system of subsidies. The Chinese government helps their firms and disadvantages foreign firms. In 2018, Beijing and local governments paid $22 billion to Chinese firms (link). That figure counts only explicit transfers of money. The Chinese government also creates a range of implicit subsidies and non-tariff barriers that directly advantage Chinese businesses.
 
Those three issues -- the trade deficit, intellectual property, and subsidies -- were the core interests when Trump started the trade war. On all three dimensions, the Phase One deal does not advance the United States' position.
 
The Trump Administration claims the Phase One deal will lead China to purchase $200 billion more of US exports (link). Unfortunately, China has not confirmed this claim. The text of the Phase One deal has not been shared, so independent observers must wait for China to confirm specific claims in this deal. U.S. Trade Representative Robert E. Lighthizer claims that China will purchase $40 billion to $50 billion in US agricultural products annually, which would more than double 2017 levels ($19.6 billion). Experts who follow the trends in agriculture doubt this increase is feasible.
 
The US Trade Representative's office says the deal includes stronger protections on intellectual property (link). The issue with China's theft of US intellectual property hinges on enforcement. Since China entered the World Trade Organization in 2001, the country has repeatedly flouted promises to respect US intellectual property. China evaded the WTO's enforcement mechanism. The Phase One deal does not introduce anything new on enforcement. The Trump Administration asserts that in the Phase One deal, China is making sincere promises on IP that they will uphold. This is a foolish position. China has repeatedly mislead American negotiators during this trade war, made promises, and withdrawn those promises. Without a practical strategy for enforcement, China's IP promises are noise.
 
The Phase One deal also leaves untouched China's industrial strategy of subsidies. Read the White House's official statement carefully (link). It does not mention the word "subsidy".  The American negotiators did not get close to sparking any change in the subsidy system.
 
Also, consider the costs of the US-China trade war. For 18 months, US households have seen the cost of their goods rise. When the trade war increases the supply chain costs of an American technology firm, the costs are passed to the consumer. The Trump Administration's blunt methods have also interfered with a wide range of American firms. Large organizations in Silicon Valley have been put in a position where they must beg Donald Trump for exceptions to tariffs. Small startups cannot raise capital from Chinese investors because that might be a negative signal. The trade war has also done significant damage to the Chinese-American community. A generation of Americans who are rightfully proud of their Chinese heritage have been viewed with skepticism. They face increasing obstacles in universities, government service (link), and even the private sector. Many businesses give better opportunities to people who have a higher chance of winning the trust of regulators and policy makers. If senior strategists in the White House mistrust all Chinese Americans, businesses will not give those opportunities to people with Chinese heritage. There is a real price to this discrimination.
 
The failure of the Phase One deal is a byproduct of long-term trends. Wages are lower in China and workers’ rights are less developed. The Trump Administration cannot change this trend. Several US Presidents have attempted to pull China into the Western legal system and specifically sought to make China respect US intellectual property rights. Unfortunately, China makes and breaks promises on IP. A better strategy is for the US government is to help American firms acquire better technical defenses to prevent them from getting hacked. It’s technically complicated and expensive for even Fortune 500 firms to protect themselves from Chinese hackers. It would be very straightforward for the federal government to identify the leading providers of technical defenses and setup a program to distribute this technology to firms who will get targeted.
 
If Donald Trump wants to change the US-China trade dynamics, he needs leverage. The past 18 months shows he does not have leverage. His Administration must change their strategy.