U.S.-China Trade: Is a Deal Imminent?

The trade standoff between the U.S. and China had the world riveted last year, although recently it seems that tensions are cooling. Charlene Barshefsky, a former U.S. trade representative who served during the Clinton administration, predicts there will soon be a trade deal with China that will secure some gains for the United States. But President’s Trump’s often combative negotiating style could harm the U.S. in the long run, she noted during an interview with Wharton Dean Geoffrey Garrett at a recent Penn Wharton China Lecture.

Barshefsky, who is a senior international partner at WilmerHale, was a cabinet member under President Clinton from 1997 to 2001. In her interview, she noted how China is increasingly diverging from Western capitalistic models. She further pointed out that laws allowing the Chinese government  to override Chinese companies on privacy-related issues make it impossible to know how much to trust Huawei’s technology — it could be compromised down the road regardless of today’s status. She also discussed how China’s true level of economic growth is likely far below official claims, and recommended the best ways for the U.S. to respond to the China’s growing economic influence.

The U.S. trade war with Beijing edged up in September when Trump levied a 10% tariff on $200 billion of Chines products. China retaliated with $60 billion in levies on various U.S. products. The U.S. was to raise the 10% rate to 25% in January, but has delayed implementation as new negotiations opened up. Earlier, both had applied tariffs to some $50 billion of each other’s products.

One reason to expect a U.S.-China trade agreement very soon is political considerations, according to Barshefsky. While President Trump threatens to raise tariffs to 25% on certain goods from China, such a high rate could cause him political problems in the U.S. because China’s retaliation would inflict economic pain on voters, she said. “He can say what he wants about who pays for tariffs, but it’s the importer who pays for the tariffs, consumers pay for the tariffs.” And so while a 10% tariff on Chinese goods is “absorbable” for the U.S., it has “hurt — it’s knocked a little bit off our growth.” But a 25% tariff is a “totally different gamble.”

What’s more, any further retaliatory tariffs by China would affect a lot of Trump constituencies directly — for example, in agriculture. “He already knows that with the farm community, [a 25% rate] is a no-go. That’s it, we are not going there.” That would severely affect “rural voters, and he can’t lose that rural base.” Trump, in theory, could shoot for a tariff rate somewhere between 10% and 20%, but Barshefsky says that would cause unacceptable problems for the President – the stock market would take a big hit. “The only thing Trump cares about is stock market volatility. When that volatility is beyond a certain range, and when it can be blamed on him, which it certainly would be if he went to 25% or anything above 10%, it would look as though his policy failed…. So there was always going to be a deal.”

“China’s argument, that the U.S. way is not the only way, was strengthened during the financial crisis.”

If that were not enough, pressure from businesses is ratcheting up. Key business lobbying groups wrote a letter to Trump in late April calling for removal of all added tariffs on Chinese goods in any trade deal. The groups, which included representatives of retailers, oil producers, fisheries and software companies, said anything less that total tariff elimination would be a “loss for the American people,” according to The Financial Times.

Imminent Deal?

One sign a deal could be imminent: On April 30, U.S. negotiators dropped a key demand that China stop alleged cyber theft of commercial secrets. Reports suggest the U.S. instead is “likely to accept a watered-down commitment from Beijing as an alternative.” U.S. officials are set to meet with their Chinese counterparts during the week of May 6, when many observers think a deal will be finalized.

Part of any agreement will likely involve export guarantees, noted Garrett. Barshefsky agreed. As for what China will buy from the U.S., she said “certainly the farmers are number one – rural America. Boeing would have been number two, but this is less clear to me now because of the Max 737 problem.”

There will be structural changes, too, suggested Garrett, including some intellectual property protections in China. “There will have to be something on forced technology transfer, something on IP (intellectual property) … there will have to be a series of ‘answers’ to problems the administration has identified repeatedly,” Barshefsky noted.

When it comes to Chinese concessions, in some service areas, China can afford to be more lenient than in the past, Barshefsky pointed out. Over the years, China was less protective of its manufactured goods and agriculture products than it was of services, an area where China lagged. That has changed. For example, China’s banks have grown in strength and market share. Where China once prevented a U.S. bank from owning 100% of a local bank, now that attitude is starting to change to “fine, let a U.S. bank own 100%. What do you think their market share is going to be – minimal,” said Barshefsky. As if on cue, on May 1, China unveiled a number of actions aimed at opening the banking and insurance sectors to foreigners, noted an article in the South China Morning Post. Many analysts saw the concession as pointing to a trade deal soon, similar to the administration’s move on cyber theft.

For years, China “cleverly” restrained foreign services companies while allowing Chinese companies to catch up in sophistication, “particularly on the tech side, financial services side, insurance, and other sectors that are important to China and that really go to the stability of state,” Barshefsky said. It was a form of import substitution. Now the Chinese attitude, according to Barshefsky, is to let foreign firms own 100% of some local firms. “What difference does it make? Instead of 2% of the market they’ll have 4%. They’re not going to have 15%. They’re not going to have 20%. They’re not going to have 30%.”

China, of course, continues subsidizing many companies, often ignoring international rules set out by the World Trade Organization (WTO), Barshefsky noted. It’s not even a “close question.” Various subsidies and regulations favor Chinese enterprises and “disfavor foreign enterprises…. China can complain that what the Trump Administration is doing is unilateral by willy-nilly imposing tariffs…. But it can’t complain that its practices comport with international rules. They don’t.”

China continues subsidizing many companies, often ignoring international rules set out by the WTO. It’s not even a “close question.”

In a related matter, there remain outstanding questions around the Chinese tech giant Huawei. Do its products pose a genuine spying or privacy threat? It’s not clear, said Barshefsky. U.S. intelligence agencies differ, though the U.K. and Germany seem poised to allow Huawei technology in. It’s also possible that risks can somehow be mitigated. Still, Bloomberg reported recently that Vodafone had found hidden backdoors – “a protocol used to control devices remotely” — in Huawei equipment back in 2011 and 2012. Vodafone reported that Huawei repaired the problems and in this instance the breach would not have allowed remote access. Still “the revelation may further damage the reputation of a Chinese powerhouse” noted the Bloomberg headline.

The bigger issue, said Barshefsky, is China’s national security law. That law indicates that if “China asks a Chinese company to assist it in intelligence gathering, the company must. So when [CEO Ren Zhengfei] of Huawei says, ‘I’d never do that’ – well goodbye, then; [off] to prison. Right? The law is quite absolute. He’s not going to do that. The state can compel … private companies, let alone state-owned or state-invested operations, to work with the state in intelligence gathering.”

In a video interview with former U.S. trade representative Charlene Barshefsky, Jacques deLisle, director of the Center for East Asian Studies at Penn, discusses the future of the U.S.-China trade war and how it evolved. Notes Barshefsky: “I think of it as a technology war rather than a trade war.”

 

Long-term Costs

When the U.S. and China do finally reach a trade deal, the price may not be measured in tariff changes or export guarantees alone — there could be a longer-term hangover for the U.S. The Trump administration’s methods of negotiating may come back to haunt them, Barshefsky said. “Trump has one dial, one speed, one mode of negotiation. I call it the two-by-four method – whack your negotiating partner on the head. And if your negotiating partner is still alive … you take what concessions you can extract and you declare victory.” There are other methods. She pointed out, for example, that if the U.S. had remained in the Trans Pacific Partnership multilateral trade agreement, it would have brought the Chinese to the negotiating table earlier. The Chinese “hated it” for many reasons.

But Trump got China’s attention “in a way I fear we will come to regret,” Barshefsky explained. Trump’s actions imply it’s still the 1950s and the U.S. is invincible – “the only economy standing after a devastating world war…. we will come to see: number one, that’s no longer the case; number two, that China is closing the gap significantly; number three, with our own diminishment of our alliances we’ve weakened ourselves to China’s favor; and number four, what happens when China whacks the U.S. with the two-by-four and says ‘but we’re only doing to you what you did to us’?”

China has obviously devised a very efficient economic machine for now. It was already forging its own economic model in 2000, though it was still more inclined back then to adapt to relations with key capitalist players. But since the financial crisis, China feels it has more than ample evidence for going its own way, Barshefsky pointed out.

China’s belief that the U.S. economic model is not the only way to go was strengthened during the financial crisis, Barshefsky added. “This was a complete shock to China and much of the world — the extent of economic mismanagement in the U.S., the extent to which CEOs of major companies were selling financial products which they themselves did not understand. [Add to that] the fact that nothing was done, the government bailed out what had to be bailed out, and no one seemed to be at fault.” That gave China more reasons to argue, “you see, we need more management of the economy.” It hurt reformist tendencies. It supported already building trends in China that said: “We need greater state control. We need state enterprises to be at the vanguard, particularly in strategic sectors.” Under Chinese President Xi Jinping, that divergence has accelerated dramatically.

What’s more, China was the principle source of global demand post crisis, Barshefsky pointed out. “This was crucially important to the United States. So China deserves credit for that.” It’s huge stimulus program went into infrastructure and other areas, “but also into very non-productive investments in real estate, leading to a real estate bubble” and some capital flight.

“If China asks a Chinese company to assist it in intelligence gathering, the company must.”

What’s the Real Growth Rate?

When Garrett asked Barshefsky for her views on China’s true economic growth rate, she replied: “China’s doing fine … they say 6.5% (GDP growth). A study just came out saying knock two points off of whatever growth rate has been published in each of the last 10 years….” The economy is “$1.5 trillion to $2 trillion less than they say it is.” In 2016, the plans were for just 4% growth. “That was three years ago. Then a study just came out that said the actual growth rate is 1.7%. So we don’t know what the number is.”

Nevertheless, China’s economic evolution has been unprecedented, Barshefsky acknowledged. “There’s no question that the number of people brought out of poverty in China has no historic parallel. It’s one of every 10 people on the planet. So it’s a remarkable story. But the gloss put on top belies some of the fragility underneath. And there’s a lot of fragility underneath.”

As a former government trade official and an expert on China, Barshefsky continues to be concerned about the balance of economic relations with the U.S. Fielding a question from the audience about how the U.S. should respond to China’s increasing economic influence globally, she said the key thing is for the U.S. “to get its own house in order – China is secondary to that.” Countries “lead from strength” and not from “being number two or three or four, or being in a corrosive or eroded position.” The U.S. should “double down” investments in what she terms are its strengths – education, R&D, a large middle class, and “the alliance structure and its importance in the projection of U.S. power and values.” More could be added to this stripped-down list, she said, but the main point is to first “get done what has to be done, including infrastructure in the U.S., then, look at China.” Bulking up in the above areas would provide “a perfect counterpoint.”

And that’s important, Barshefsky believes, because “we can’t control China and we can’t contain China, and China will be what it will be, and the U.S. will take the actions that the U.S. has to take in response.” But not doing the above is a “responsive and reactive position. You have to be in a proactive position….”

In answering an audience question about the best way to bridge cultural gaps during negotiations, Barshefsky was blunt. “I never think about cultural gaps. It’s economics. It’s money. What’s cultural about that?” She added that she was not trying “to be glib, but simply to say just take out of your mind the stuff that doesn’t matter. You always want to be respectful to people. Act with humor. Be kind. But really, cultural differences, when it comes to money — I want more than you have. That’s a cultural difference on both sides. Same thing. Then as a general matter … the body talks before the mouth ever opens. Watch more, talk less.”

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