What’s the deal with the ‘Phase One’ Agreement?



Asia House Advisory

US President Donald Trump and Chinese Vice Premier Liu He signed the highly anticipated ‘Phase One’ trade agreement in Washington DC on 15 January.

After an 18-month-long trade war that has been waged through retaliatory tariffs, agreement is welcome news. It halts new tariff increases and also signals a modest de-escalation of the trade conflict between the world’s two largest economies, which will go some way towards increasing investor confidence and optimism.

Since the start of the trade war in 2018, higher tariffs and prolonged trade policy uncertainty have damaged investor confidence, disrupted manufacturing activity and trade flows, and reduced global economic growth due to supply chain disruptions. While the interim deal is a positive indicator, ultimately it only addresses a limited set of issues. Deeper structural issues, such as the controversy over Chinese state subsidies, have not been addressed.

The deal will not significantly alter the fundamentals: the wider US-China geopolitical competition and the battle over economic creativity and new technologies are set to continue, even if the ‘Phase One’ deal is fully implemented. A resolution of these underlying issues in any subsequent ‘Phase Two’ negotiations is anything but certain.

What has been agreed?

Under the ‘Phase One’ agreement, the US has promised to halve the existing 15 per cent tariff to 7.5 per cent on US$120 billion of Chinese imports ranging from food to technology. It has also promised not to proceed with planned 15 per cent tariffs on US$160 billion of Chinese products, including cell phones, laptop computers, toys and clothing, scheduled to go into effect on 15 December 2019.

This is in return for Chinese pledge related to its currency, intellectual property and a large US$200 billion increase in its purchase of US goods and services over the next two years. This is based on a 2017 baseline of US$183.8 billion. Specifically, this includes US$32 billion in new purchases of US agricultural exports, such as soybeans; and US$52.4 billion in energy exports, namely liquified natural gas and crude oil.

China has also promised to increase purchases of US manufacturing products, including pharmaceuticals, and boost imports of financial services. Access to China’s financial services market has for years been a source of complaint for the US.

The agreement on currency stipulates China to refrain from competitive currency devaluation, and not to use exchange rates for its trade advantage. In return, on 13 January, the US Department of the Treasury reversed its August decision to designate China as a ‘currency manipulator’, a label given to countries accused of ‘unfair currency practices’ – something China denies doing.

Regarding intellectual property – a key sticking point in US-China trade relations – the ‘Phase One’ deal promises stronger Chinese legal protections for patents, trademarks and copyrights. In particular, the deal details enhanced criminal and civil procedures to combat online infringement, pirated and counterfeit goods.

An agreement is only as good as its implementation

The key issue with the ‘Phase One’ deal is its implementation and enforceability. Will the US and China deliver on their promises? Given nearly two years of escalating trade tensions, it’s not surprising that mistrust runs high.

Since the start of the trade war in mid-2018, the US has imposed tariffs on over US$360 billion of Chinese imports. China has retaliated with tariffs on over US$110 billion of US imports.

Although the ‘Phase One’ deal averts new tariffs, it leaves in place tariffs on US$250 billion of Chinese imports. The promised tariff reductions will also not take place until there is ‘Phase Two’ deal, according to President Trump. This means companies and consumers will continue to pay more than they did pre-trade war.

Maintaining the tariffs has its rationale; it gives potential leverage to the US to negotiate the next stage of the agreement and reinforce Beijing’s promise on new purchases. Meeting the Chinese purchase targets would open new opportunities for US businesses. It would also reduce the US$419 billion US trade deficit with China.

There is, however, widespread scepticism among analysts about whether the targets, especially in agriculture, are attainable, given the previously low levels. Under the enforcement provisions of the deal, if China fails to meet its additional purchase commitments, a dispute resolution will be triggered, according to the US. If bilateral consultations do not resolve disputes, the President has the authority to increase existing tariffs or impose additional tariffs.

Meanwhile, China has also tempered expectations. During the ‘Phase One’ deal signing ceremony, Liu He said the purchases of agricultural products will be “based on market conditions”, adding that both countries should create favourable conditions for Chinese purchases of US products. This raises the question of potentially differing interpretations of the deal that would have the potential to renewed conflict.

Regarding financial services, the promise of greater market access in terms of the number of granted licenses and removal of equity limits for US banks and insurance services does not translate into equal opportunities overnight. China’s financial service sector is dominated by state-owned and private digital payment players.

While Beijing continues to open up the space for foreign players, it is likely to do so at its own pace. The same is likely to be true with intellectual property protections. While China has given its commitment to implement a comprehensive legal system of intellectual property protection, it remains to be seen how well the US can monitor and enforce this.


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