Trump’s phase one deal relies on China’s state-owned enterprises



Chad P. Bown and Mary E. Lovely | Peterson Institute for International Economics

President Donald Trump’s trade war with China has been counterproductive from the start. His tariffs raised prices and punished American consumers. China retaliated against US agricultural exports as expected, hurting American farmers. But now even Trump’s trade deal with China is undermining his administration’s professed policy agenda.

The phase one accord committing China to buy additional US goods seems certain to strengthen Chinese state-owned enterprises (SOEs) and state control of the economy—the very policies the administration’s trade war supposedly sought to combat.

The clock is now ticking on the phase one agreement, in which China says it will import an additional $200 billion of American-made goods and services before the end of 2021. Indeed, as Trump boasted in Davos: “We’ll be taking in an excess of $200 billion; could be closer to $300 billion when it finishes.”

It will be hard enough for China to meet this commitment as it stumbles through an economy now afflicted by the coronavirus disease. But a key flaw in the deal was baked in long before the COVID-19 outbreak: Beijing is not cutting its tariffs on billions of dollars of American exports, which would have made them less expensive for Chinese consumers. With few market incentives for China’s private sector to purchase US goods, Trump is apparently banking on the Chinese government to direct its SOEs to pick up the slack.

This contradiction adds to an increasingly long list of forces challenging the phase one agreement’s economic viability and jeopardizing the long-term health of the US-China relationship. By signing a deal that left in place Chinese tariffs on tens of billions of dollars of American exports, Trump has relegated to the sidelines the buyers who determine nearly 75 percent of Chinese purchases of imported goods.

As for the SOEs filling the $200 billion breach, the data do not look promising. But even if they did, Trump’s move undermines a separate and important pillar of stated US trade policy. In fact, the growing economic clout of China’s state-driven sector is one of the few trade policy concerns shared by many outside Trump’s narrow band of trade advisers.[1]

As a result, with the legal terms of this deal, Trump is effectively urging China to become more state directed. Here is why.

The phase one deal discourages the Chinese private sector from buying American exports

The cornerstone of Trump’s deal was a Chinese pledge to purchase an additional $200 billion of American exports over 2020 and 2021. But quizzically, the agreement’s legal text makes no mention of Beijing committing to cut its tariffs to facilitate those purchases. [2]

This omission is deeply puzzling. As of the agreement’s implementation on February 14, 2020, an enormous difference remained between Chinese tariffs on purchases from America relative to purchases from any other country (see figure 1).[3] Throughout the trade war, China repeatedly retaliated against Trump’s tariffs by increasing duties imposed on American companies and farmers. Meanwhile, Beijing lowered its tariffs toward exporters in the rest of the world during the conflict.

Figure 1 China’s tariff rates remain substantially higher than those on the rest of the world

Thus, the deal appears to lock in a number of American exporters as the least attractive choice for Chinese buyers. The second best choice for China’s 1.4 billion people are imports from farmers or companies in Brazil, Europe, or Japan, which face lower Chinese duties. And the best, of course, is to source from a local supplier and not face any tariff at all.

Trump’s deal promises an additional $19.5 billion of Chinese purchases from American farmers in 2021, for example. But Beijing has raised tariffs on US farm exports to 41.5 percent, on average, while lowering duties on agricultural exports from other countries to 16.4 percent.

As a result, American agricultural products remain 25 percent more expensive. This trade war penalty for being an American farmer exists in oilseeds (Iowa soybeans), meats (North Carolina pork), cereals (Kansas sorghum), seafood (Maine lobster), and cotton (Texas).

It’s not just farmers. US manufacturing companies scattered across the country have been promised an additional $44.8 billion of Chinese purchases in 2021, yet their products generally face higher tariffs than competitors in Germany, Japan, or South Korea. (Exceptions are pharmaceuticals, vehicles, and aircraft.)

And while Trump is campaigning on Beijing’s promise to buy an additional $33.9 billion of American energy products in 2021, the Chinese tariff differential for liquified natural gas, coal, and other refined products remains 25 percentage points or more.

Failure to address China’s tariffs is important for at least two reasons.

Politically, the deal illustrates the emptiness of Trump’s goal of reciprocal tariffs. His agreement “successfully” achieves such a relationship with China—each country now charges the other an (extraordinarily high!) average tariff of roughly 20 percent. The result of Trump’s version of reciprocity is reduced access for American exporters to the Chinese market.

But more critical is how the deal worsens—rather than resolves—one of the frictions underlying his trade war. Trump’s agreement pushes China even farther away from markets and toward a state-driven economy. China’s private companies now face strong disincentives to buy American exports. For Beijing to placate Trump between now and 2021 and get close to the targets, China’s SOEs will almost surely need to expand their purchases, as well as redirect them toward American sellers.


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