Valdai Club

On October 10 and 11, the United States hosted another round of trade talks with China. While it has yet to be seen whether these negotiations will yield any tangible results, the White House went as far as to claim that an agreement could be inked as soon as in November 2019, during the upcoming APEC Leaders’ Meeting. At the same time, China made the cancellation of additional tariffs a prerequisite for assuming the proposed obligations. Still, the outcome of this round of talks cannot be overestimated.

In fact, the strategic significance of these talks can be broken down into three key points:

• first, both sides recognized that sealing the deal in a single go would be impossible, focusing on hammering out a “Phase 1” agreement, to be followed by Phase 2 and maybe even Phase 3;

• second, considering China’s current vulnerability, the US will seek to conclude the deal on the terms that are of strategic importance for it in terms of not only the potential short-term advantages, but also long-term strategic objectives underpinned by the strategic transformation of the Chinese economic growth model;

• third, it has to be emphasized that the two sides started working on a supplementary agreement setting out a mechanism for ensuring that they fulfill their commitments.

Quite predictably and hardly a surprise to anyone, the United States requested that China beef up its agricultural imports. After all, China has a large consumer market with immense potential, and this domestic market is about to emerge as a key economic growth driver. Experts from the ASEAN Secretariat and the Bank of Australia believe that the Chinese population will peak out by 2035.   Food consumption is expected to increase, while the availability of farming land would decline, as the economy undergoes a strategic transition and urbanization follows its path. In the long run, the demand for agricultural and food imports is expected to surge, considering efforts to relax the one-child policy and prop up domestic consumption.

Growing food consumption is accompanied by structural changes. World Bank experts pointed out that consumption patterns in China are marked by a gradual shift from plant-based products toward animal-based products. This goes hand in hand with higher growth in the consumption of higher quality crops compared to fodder grain. All these trends offer great opportunities to exporters from third countries, and the US is intent on taking advantage of them.

By requesting China to boost its agricultural imports, the United States wants to have its cake and eat it too. Not only does it guarantee its agricultural producers steady export revenue streams, but also strips China of one of its main tools for offsetting the pressure created by US sanctions. After all, slapping higher tariffs on American agricultural products has been until recently one of the key components of retaliatory measures whenever tension with the United States escalated.

Importantly, as China moves toward an economic growth model driven by domestic consumption, and as its middle class expands and consumption patterns change, the demand for civilian air transportation also increases, which entails a higher demand for civilian aircraft. In this context, China has hinted on several occasions that import tariffs on US aviation products could go up. Consequently, it is quite likely that if the Phase 1 agreement is signed, the central point during Phase 2 negotiations will be to secure more sales of US aircraft or reduce import duties on US aviation products.

There is no doubt that getting the deal done is in China’s best interests. The country desperately needs large tariff-free markets as it faces a slowing economy, negative growth of international reserves, increasing budget deficit and growing corporate debt, as well as unstable and extremely vulnerable and divergent capital flows. It is for this reason that talks on the Regional Comprehensive Economic Partnership intensified, and China went as far as to propose leaving India out of it for its role in slowing down the negotiating process. The Belt and Road Initiative is also designed to streamline access to major markets, and the same applies to trans-regional logistics corridors, including in Eurasia.

The stakes are quite high that the Phase 1 agreement will actually be signed. China has already confirmed that it begun to increase imports of US agricultural products. The main question now is whether this agreement takes shape as a long-term strategic initiative or merely provides for a provisional truce.

There are reasons to believe that the latter is true. It would be naïve to argue that the success of a Phase 1 agreement brings the relations between the two countries back into the fold of fair competition. The discord between China and the United States is underpinned by their struggle for strategic leadership in a world marked by the emergence of a new global development paradigm and technological shifts. The expectation that Phase 1 will be followed by the second and subsequent rounds of bilateral agreements means that the demands of the United States are set to expand as China assumes new obligations. There will be no end in the trade war between the two until the US feels that it achieved a definitive victory in the competition with China and consolidated global leadership in the digital space. Today, the global digital transformation is driven by US and Chinese companies. These two countries account for 75 percent of patents related to blockchain technology, 50 percent of global spending on technology and innovation, and 75 percent of the cloud computing services. By carrying out the Made in China 2025 program, China wants to obtain the capability to make semiconductors and microchips on its own. This would lead to a dramatic fall in prices and enhance China’s competitiveness, shattering the global technological leadership of the United States. While the US still dominates the digital market in terms of market share, China has the highest growth rates on the market for digital services, which naturally raises concerns in the US.

If signed, the Phase 1 agreement will not guarantee a success for the overall deal. A refusal by China to fulfill any of the requests coming from the White House could easily cancel out any preceding agreements. If experience is any guide, any deal, especially involving the United States, can be terminated just as easily as it was concluded. In today’s world, there is hardly an international agreement, be it bilateral, multilateral or even universal, without enforcement mechanisms. The sustainability of a deal is mainly determined by how long the parties abide by it, its scope and the involvement of contractors on behalf of the signatories (corporations, financial structures, etc.) in foreign economic operations covered by the agreement, and especially their special interests. The rapidly changing economic and political environment makes any new deal extremely vulnerable.

Just as other market forces, China needs guarantees. Therefore, the future of the trade deal is not so much about what is in the main treaty setting out the obligations of the parties as it is about the terms of the supplementary agreement or sections within the main treaty on enforcement mechanisms.

Market players will stick to hedging strategies as long as risks related to uncertainty persist. Major transnational corporations will adjust their business models in the light of negative shifts in the international landscape and diversify their operations by factoring geopolitical risks into their strategies. Diversifying the export deliveries’ geography will remain a priority for Chinese companies, primarily in consumer electronics. This would be accompanied by efforts to reduce their dependence on US technology and an increase in investment in high-technology sectors in Europe.

Investment flows will remain eclectic and contradictory, just as over the past years. Corporations targeting the US market will move manufacturing out of China, while companies working for Chinese consumers, including from the US and other countries, will seek ways of fusing into regional value chains and bring their manufacturing ever closer to their target market. This primarily relates to auto makers. BMW is expanding its manufacturing in China, Ford is looking for opportunities to launch car production there, and is likely to be followed by Daimler/Mercedes-Benz and even Tesla, since these are the companies that stand to lose the most from the escalating bilateral tension.

There was one more important takeaway from the latest round of talks that has to be taken into consideration. By de facto blackmailing China into agreeing to an almost four-fold increase in agricultural imports (compared to 2018), the United States once again showed the world that the principles of “fair competition” and “non-discrimination” in trade remain dead letters in today’s world. Agricultural producers from a number of countries, primarily Australia, New Zealand, Canada, France, Germany, the Netherlands, Brazil, as well as China’s Asian neighbors such as India, Vietnam and Thailand are all set to lose export revenue due to this deal.

Europeans have already voiced misgivings over the protectionist policies of the United States in violation of WTO principles. After an additional 25 percent tariff on European goods went into effect, the EU has “no alternative but to follow through in due course with our own tariffs in the Boeing case,” EU Trade Commissioner Cecilia Malmstrom said. In addition, it is already a fact that the EU is working on instruments enabling it to respond to actions by WTO members in violation of the key principles governing global trade. While it has yet to be seen what they present and how effective they are, the growing number of disaffected players could gradually lay the groundwork for the emergence of a global strategic alliance for reviving the principles of non-discrimination and free market competition.