Why the Pending U.S.-China Deal Will Not Suffice

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Why the Pending U.S.-China Deal Will Not Suffice

This is not the end of the drama.

Why the Pending U.S.-China Deal Will Not Suffice
Credit: Nicolas Asfouri/Pool Photo via AP

Along the National Mall in Washington, D.C. sits the renowned Smithsonian National Museum of American History. James Smithson, the institution’s founding benefactor, was not American but British. Born the illegitimate son of a British duke in France in 1765, Smithson was an Oxford-trained chemist who, despite having never set foot in the New World, gifted his estate “to the United States of America, to found at Washington, under the name of the Smithsonian Institution, an establishment for the increase and diffusion of knowledge.”

In this tradition, on the first floor of the museum, the Smithsonian Institute has dedicated a wing to showcasing America as the world’s “Innovation Nation.” On exhibit is the rise of Silicon Valley, the 1970s-80s chronicle of suburban garage hobbyists teaming with lab researchers to develop the groundbreaking technological platform of personal computing. You can also see the quaint home workshop of Ralph H. Baer, inventor of the “Brown Box,” the first video game console.

The museum display provides a fascinating juxtaposition given proceedings across the street at the U.S. Department of Commerce and Office of the U.S. Trade Representative (USTR). The current economic tensions between the United States and China are anything but a game. The struggle over the diffusion of knowledge is not a static set piece. The title of “Innovation Nation” – the marker of 21st century power – is up for grabs.

With reports indicating that Washington and Beijing may soon reach a trade agreement, questions persist as to whether this settlement can suffice in terms of scope, enforcement, and sustainability.

Following Through

In the fall of 2017, during his tour of Asia, U.S. President Donald J. Trump laid out his vision for a “free and open” Indo-Pacific and specifically called out China for alleged unfair trade practices. At Da Nang, Vietnam, Trump warned that the United States would no longer turn a blind eye to China’s trade violations and economic aggression, including the theft of intellectual property, forced technology transfers, subsidizing of state-owned enterprises, and cyberattacks.

The Trump administration has since followed through on a number of actions targeting Chinese trade. These have ranged from tariffs on Chinese goods, from solar panels to steel and aluminum, to criminal enforcement measures against Chinese corporations, such as ZTE, and even executives like Huawei’s Meng Wanzhou. Most substantially, Washington, led by the USTR, has targeted China’s alleged technology transfer regime under Section 301 of the Trade Act of 1974. On this basis, Washington rolled out a series of tariffs on $250 billion of Chinese goods, equaling about half the value of Chinese exports to the United States. Beijing has responded with tariffs on $110 billion of U.S. goods – approximately 90 percent of U.S. exports to China.

In the event ongoing negotiations fail, Trump has threatened to raise existing Section 301 tariffs on $200 billion worth of Chinese products from 10 to 25 percent, and add new tariffs on $267 billion of U.S. imports from China. Reciprocal action from Beijing is likely to follow. Given the trade imbalance, Chinese retaliation is likely to take other forms, such as a boycott of U.S. products, travel and investment restrictions, and administrative actions against U.S. companies doing business in China.

Despite rhetoric about cutting trade deficits and guarding American industry, the immediate economic fallout of the trade war is perhaps the Trump administration’s least important consideration. For the White House, the tariffs are primarily a geopolitical bludgeon to modify Chinese behavior. Trump administration officials have repeatedly described legal tools, like Section 301, as a “creative” means to disrupt the status quo and force change in U.S.-Chinese economic relations. “We have finally gotten China’s attention” is an oft-heard justification. In the words of U.S. Trade Representative Robert Lighthizer: “We are in a position to deal with this problem for the first time after decades of government inaction.”

At a recent conference at Georgetown University, I spoke with Clete Willems, who serves as an assistant to President Trump and is a member of the National Economic Council at the White House. Willems was appearing on behalf of Lighthizer, who was listed, but unable to attend. Earlier, during testimony before Congress, the U.S. trade representative had signaled that a deal with Beijing did not require Congressional approval because it would take the form of a settlement under Section 301. Given the lack of direct Congressional involvement, I asked whether Section 301 actions are a sustainable approach for U.S. trade policy? More broadly, I inquired as to whether this policy (periodic tariff wars to force negotiations) was a model for handling future trade disputes?

Willems affirmed that Section 301 would be the basis for the China deal and described the law as providing sufficient means as an enforcement tool. He was also in full agreement with Lighthizer that Congressional approval, trade promotion authority, was not necessary given existing delegated authority. However, he demurred on the issue of using Section 301 as a model for the future. “We are not there yet.” Instead, before making this assessment, the White House must first solve the problem with China.

In his Congressional testimony, Lighthizer laid down a clear marker for measuring success: “What the president wants is an agreement that number one is enforceable, but that changes the pattern of practice of forced technology transfer, intellectual property protection, large industrial subsidies, and then a whole variety of specific impediments to trade and unfair practices in the area of agriculture, in the area of services. What we want is a fair trade that requires structural change and it has to be enforceable.”

Stopping China Inc.

If the goals are structural change in the China’s economy and readjusting the U.S. trade relationship, it is not clear that a Section 301 settlement provides adequate means to achieve these objectives.

For starters, by law, the Section 301 settlement with China must either take the form of compensation or the elimination of the particular barrier or practice in place. For example, when initiating the first two rounds of Section 301 tariffs, the USTR found that a 25 percent tariff on $50 billion worth of imports from China would be comparable to annual U.S. economic losses stemming from China’s technology transfer regime. However, U.S. tariffs and threatened tariffs against China have ballooned past this starting figure. This Section 301 analysis is impacting ongoing negotiations, with Beijing calling for all U.S. tariffs to be lifted and Washington refusing to remove initial tariffs on $50 billion of Chinese goods, the initial estimate of damages. More importantly, a formulaic requirement for just compensation does not address the root causes of U.S. grievances.

Section 301 also restricts the potential scope of a deal with China. As a case in point, the USTR is required to resolve any issues concerning trade agreements by following the formal dispute proceedings laid out in those same agreements, such as those under the Uruguay Round agreements in the World Trade Organization (WTO). Following the Section 301 investigation, the USTR filed a claim before the WTO against China based on Beijing’s alleged discriminatory technology licensing practices. Will the Section 301 settlement resolve this issue? Certainly the U.S. Department of Justice’s criminal indictments and investigations of Chinese activities will be on a separate track.

Indeed, reliance on the mechanics of Section 301 may not be sufficient to address the greater problem of what Harvard Law’s Mark Wu has called “China Inc.” In his view, China, Inc. is defined by six elements: (1) state assets oversight, (2) financial sector organization, (3) role of state planning, (4) forms of corporate networks, (5) political party involvement, and (6) state-private sector linkages.  The unique economic structure works as follows:

“Alongside the state is the Chinese Communist Party (“Party”), a separate political actor that plays an active role in the management of state-owned enterprises (“SOEs”). The economy embraces market-oriented dynamics, yet it is not strictly a free-market capitalist system. Networked hierarchies and embedded relationships exist among businesses, but not necessarily in the way they operate elsewhere in the world. It is an economy where the Party-state remains all-powerful, but private enterprise drives significant economic activity.”

The result is a significant challenge to U.S. economic relations and the global trading system. For example, Wu notes that foreign companies may stand at a competitive disadvantage due to the close relationships between – and coordinated action by – the Chinese party-state and Chinese companies, both state-owned and private. Given the power of the party-state, U.S firms may be coerced into shifting their manufacturing to China, joint-ventures with Chinese firms, and purchasing from Chinese suppliers. The state can also restrict market access to Chinese firms for importing, purchasing, marketing, and selling particular goods and services in China’s enormous domestic market.

These concerns are similar to the “economic aggression” described later in the Trump administration’s Section 301 investigation. The USTR, for example, found that China is unduly forcing or pressuring technology transfers from U.S. companies through joint venture requirements, foreign investment restrictions, and administrative review and licensing processes; restricting U.S. firms from receiving market-based return for their intellectual property through unfair licensing practices; directing large-scale technology and intellectual property transfers through targeted investments and acquisition to support state industrial programs, like Made in China 2025; and stealing valuable confidential business information through cyber-attacks.

A key question, therefore, is whether any U.S.-China deal – a Section 301 settlement or not – can offer sufficient recourse for the totality of U.S. grievances against Chinese trade practices. Beyond that, how do you measure compliance and enforce the deal?

Limits of a Deal  

The White House has indicated that monitoring and enforcement are key to resolving the trade dispute. Lighthizer has described a dispute resolution mechanism – involving quarterly and semiannual meetings – whereby U.S. companies can bring complaints, sometimes anonymously, for resolution at various levels of government up to the ministerial level. Ultimately, in order to enforce the deal, the United States is seeking to retain the ability to take “proportional actions unilaterally” in response to violations. This likely means, at a minimum, the swift reinstatement of tariffs.

A sovereign country, of course, reserves the capacity to act unilaterally to protect its interests. But it is hard to imagine Beijing agreeing to written terms to this effect without reciprocal rights. And if this is the final result, how does this deal materially alter current conditions? Under such terms, both the U.S. and China will be engaged in a temporary ceasefire subject to the unilateral reinstitution of tariffs or other forms of retaliation.

The uncertainty resulting from this type of tenuous arrangement between the world’s two largest economies will darken the growing cloud over the global economy. Moreover, this potential stress comes at a time when the Trump administration’s actions, including undermining of the WTO’s dispute settlement mechanism, has thrown the relevance of the WTO into question. However valid criticism directed at Geneva may be, there is no alternative international forum for regularizing global trade and avoiding escalating tit-for-tat tariff battles. Any long-term solution must include WTO reform.

The sustainability of U.S. trade policy must also be measured by its impact on the economy. Due to Trump’s tariffs to date, the International Monetary Fund has estimated a 0.2 percent reduction in U.S. gross domestic product growth annually. Some domestic producers, who compete with tariffed imports, stand to benefit because they can charge higher prices for their goods. But import tariffs serve as a broad tax on domestic consumption by increasing costs for American consumers and downstream U.S. industries that rely on products subject to tariffs. And retaliatory tariffs harm U.S. exports by decreasing prices and undermining sales of U.S. products abroad like in agricultural goods. In the past year a number of retaliatory tariffs on U.S. goods have been imposed ,accounting for $126 billion of U.S. annual exports, based on 2017 export values. Some have linked Trump’s trade war with the record number of suicides by American farmers during this period.

Congress is beginning to take note. The U.S. Constitution grants Congress sole authority to regulate foreign commerce. There are proposals on Capitol Hill to revisit past delegations of authority to the President to adjust tariffs and engage in other trade restrictions. For example, the Global Trade Accountability Act of 2019 (H.R. 723) amends Section 301, among other trade authorities, to require congressional approval of unilateral trade actions. Even if the White House makes a deal with China without approval from Capitol Hill, Congress could potentially override the Section 301 settlement through legislative action.

With the 2020 presidential cycle ramping up, there will certainly be tremendous scrutiny over any compromise. We have already seen this in the pronouncements of White House hopefuls on the Hill. Trump’s demonization of international trade has created a new, potentially volatile constituency in American politics.

The 2020 election also highlights another cost of the White House’s unilateral approach to trade and other foreign policy initiatives. Executive agreements, such as a potential Section 301 settlement, are subject to reversal by the next U.S. administration. President Barack Obama interpreted the Paris Climate Agreement as an executive agreement, not a treaty requiring Senatorial advice and consent. Thus, when he took office, Trump was able to abruptly terminate America’s participation. Non-binding political commitments by the executive branch are even more easily overturned. An example would be an agreement not to impose economic sanctions. We witnessed this with Trump’s quick withdrawal from the Iran Nuclear Deal. Facing re-election next year, what guarantee can Trump offer that his deal will be any more enduring?

Division in Washington has created a contentious and unpredictable global economic environment. This is a departure from past U.S. leadership which sought to build a stable, institutionalized global trading system. At the Smithsonian Institute, you can tour America’s historic advancement through world trade to the pinnacle of global power. The museum may someday have a wing dedicated to how America responded to the challenge of China, Inc. Certainly a new narrative is being written as the struggle unfolds. In this regard, any near term U.S.-China deal is not the end of the drama, but as Churchill once said, it is merely the end of the beginning.

Roncevert Ganan Almond is a partner at The Wicks Group, based in Washington, D.C. He has advised the U.S.-China Economic and Security Review Commission on issues concerning international law and written extensively on maritime disputes in the Asia-Pacific. The views expressed here are strictly his own.