For the past 18 months, the U.S. and China have been embroiled in a tariff war. The two countries on January 15 signed an agreement that commits to addressing the problem. This Phase I agreement is widely viewed as a step forward.

According to Mauro Guillen, Wharton professor of management, while many challenges remain to be ironed out, the most important aspect of the agreement is that the two countries are finally talking. With the U.S. and Chinese economies being so tightly integrated, any outright confrontation, he believes, “would be a disaster for both countries and for the global economy.”

In a conversation with Knowledge at Wharton, Guillen shares his views on the implications of the deal for the U.S. and China.

Below is an edited version of the interview:

Knowledge at Wharton: The U.S. has described the recent U.S. – China trade deal as a significant agreement and China also has spoken positively about it. What will the deal really mean for both countries?

Mauro Guillén: It is clearly a first step; that’s exactly the way in which both governments are describing it; it’s a Phase 1 agreement. The agreement essentially is about not doing anything that would derail the relationship [between the two countries]. It contains some concessions by China in terms of imports from the U.S. of manufactured goods, farm products, and services, and some kind of a vague commitment to enforce intellectual property laws more strongly. This seems to be a truce rather than a comprehensive trade deal which is something that takes much longer to conclude.

Knowledge at Wharton: What do you consider the agreement’s positive achievements to be? More importantly, what does it fail to accomplish?

Guillén: The most important aspect of this Phase 1 agreement is that the two countries are finally talking and negotiating, and that the escalation of tariffs on both sides has come to an end. The United States, as part of the deal, is not implementing the last round of tariff increases that was supposed to come into effect on December 15, 2019. What’s missing here is a general framework about the relationship between China and the United States — a high-level framework as to what this relationship is going to look like. It is also important to note that none of the tariff increases has been rescinded.

The most important aspect of this Phase 1 agreement is that the two countries are finally talking and negotiating, and that the escalation of tariffs on both sides has come to an end.”

These are the two biggest economies in the world, the two largest trading nations in the world. They are tightly integrated in terms of trade, many [American] companies do business in China, and [Chinese companies] do business in the United States. For many American firms, having an operational base in China is essential even if they’re not selling in China because they are making goods that then they sell somewhere else. What’s also missing is a lot of the details as to how we’re going to de-escalate. They have agreed not to continue escalating, but there’s no agreement so far as to how we could go back to where the tariffs were before the trade war was initiated.

Knowledge at Wharton: What are some of the most contentious issues that still separate the U.S. and China?

Guillén: The agreement does include a commitment on the part of China to not manipulate its currency in order to regain competitiveness. And in exchange, the United States has taken China off the list of currency manipulators. That’s a step in the right direction because of all the protectionist measures that countries may adopt, the most dangerous is currency manipulation. It is indiscriminate. It affects every kind of goods and services and it triggers a chain of reactions around the world.

The biggest issue that remains unresolved is the one that lies at the core of the dispute, which is intellectual property. It’s one thing that as part of the Phase 1 agreement China has committed to enforcing intellectual property laws, and quite another that they will do so. And more importantly, that they will be able to enforce the regulations. Over the last two or three decades, Chinese companies have learned how to get around regulations, how to obtain technology without being detected. It’s going to be difficult for the Chinese, especially initially, to figure out all the ways in which Chinese companies are getting U.S. technology without paying for it.

It is a legitimate request on the part of the United States to have China enforce these laws because obviously intellectual property is valuable. But I think it’s going to take a while. Nonetheless, it is a step in the right direction. There is recognition on the Chinese side that something needs to be done.

Knowledge at Wharton: How has China been dealing with intellectual property issues and enforcement in recent years? Has it affected China’s ability to attract foreign direct investment?

Guillén: Unlike 20 or 30 years ago, the Chinese economy is no longer in a situation in which it either attracts foreign direct investment or it doesn’t grow. China has moved beyond that phase in terms of its economic development. In fact, the biggest development in China over the last 10 years has been the investment by Chinese companies outside China, as opposed to foreign companies in China. Having said that, in certain sectors China continues to welcome foreign direct investment and this is helping them further develop their economy.

The issue with technology was that initially it was a requirement that every foreign company in China had to be a joint venture in which the Chinese party would have a majority. That was an arrangement that lent itself to technology transfer, either officially or unofficially. After 1989, after Tiananmen, China relaxed the rules for joint ownership of foreign ventures. Since then, it has been more difficult for Chinese companies to obtain technology without paying. But, as I was mentioning earlier, they have found different ways around that as well. So, this agreement, as difficult as it is going to be for the Chinese to implement or to enforce these regulations, at least signifies that China understands that the most important grievance for the U.S. involves intellectual property. As part of this deal, they have committed to enforcing, specifically in pharmaceuticals, intellectual property protections more strongly.

What’s missing here is a general framework about the relationship between China and the United States — a high-level framework as to what this relationship is going to look like.”

Knowledge at Wharton: One of America’s objectives for the trade war has been to bring back manufacturing jobs to the U.S. To what extent has that goal been met?

Guillén: That is going to be very difficult.

Knowledge at Wharton: Why?

Guillén: There is a study by the United Nations that was published in November 2019 that I think is the best analysis of the consequences of the tariff war between China and the United States. This study found two things. One was that consumers have been hurt, especially poorer consumers or lower middle-class consumers. Since a greater percentage of their income is [spent on] consumption, whenever there is an increase in tariffs they get hurt more.

“The biggest issue that remains unresolved is the one that lies at the core of the dispute, which is intellectual property.”

The other big finding was that the tariffs have not brought manufacturing back to the United States. Instead companies, in response to the tariffs, have moved their operations or have sourced whatever it was that they were making, in other countries. So other countries have benefited indirectly from these tariffs. The biggest beneficiaries — and this is a very interesting list — are Taiwan, Vietnam, South Korea, Japan, and the European Union. It’s worth mentioning that Taiwan has been the biggest beneficiary precisely at a time when there are growing tensions between China and Taiwan. In other words, companies that were making something in China or sourcing something from China destined towards the U.S. market, have essentially said, “Okay, we can find a supplier…or we can quickly switch production to Taiwan.” And they have done so.

Knowledge at Wharton: Have there been any winners in the U.S.-China trade war? If not, which country has lost more?

Guillén: Everybody loses from these protectionist episodes. While we all agree that the goal of the protectionist policies — to compel China to play by the rules — is a legitimate one, the method or the means used to accomplish that goal have not been so. Introducing protectionist measures is always dangerous because while it’s relatively easy to implement them, it’s difficult to take them away. Companies that are now enjoying the protection may become lazy and not work as hard. And they’re going to lobby for those protections to remain in place.

The other problem in this bilateral relationship is that China is not a small, powerless country. This is the second biggest economy in the world. It’s the biggest trading nation, bigger than the United States. So, China has retaliated — and it has retaliated where it hurts most. Iowa farmers, farmers in the Great Plains, have suffered immensely. The Trump administration has subsidized those farmers to the tune of nearly $20 million over the last 18 months since the trade war began.

Several industries in the United States have suffered. Consumers have suffered. And China’s entire economy has suffered. Given that it’s so much driven by exports, the fact that their biggest market — the U.S. — has become protectionist has had a large, aggregate effect in terms of reducing the growth potential of the Chinese economy. It’s safe to say that in addition to those industries that have been targeted, the entire Chinese economy has suffered because of this trade war.

Knowledge at Wharton: How do you see the long-term effect of the trade war on American companies? For example, how will U.S. tech companies such as semiconductor firms be affected? On the flip side, how will Chinese firms be affected?

Guillén: In general, companies have options at their disposal. They can in principle decide where to produce, where to sell. They can decide how much to invest in different parts of the world. Most of the time, they can switch those investments and move those operations relatively quickly. Companies have sensed — American companies in particular — that protectionism is here to stay in one way or another. But there is a strong public sentiment against free trade these days, and so they’ve been making decisions.

“The level of [economic] integration is so high that flat-out confrontation would be a disaster for both countries and for the global economy.”

As I mentioned earlier, many of them have switched their sources of production or supplies from China towards Taiwan, Vietnam, South Korea, even the European Union, depending on the product. This will continue. That’s also the case in semiconductors. The three industries where we’ve seen the biggest shifts of production locations as a result of this protectionism or this trade war have been chemicals, electric machinery, and electronics — that would include semiconductors. And then there are mechanical devices. Those are important sectors in the economy.

As part of the Phase 1 agreement, a lot of emphasis has been placed on automobiles and auto parts. China has promised to increase their imports from the U.S. Ironically, those imports are not going to come from Detroit. They’re going to come mostly from the BMW and Mercedes factories in Alabama and South Carolina where they make BMW and Mercedes SUVs because those are in high demand in China. The Chinese are not going to buy American cars. They’re going to buy SUVs and they prefer the European ones. The expectation is that BMW and Mercedes are going to benefit from this, but not necessarily GM, Ford, or Chrysler. By the way, this comes in the wake of very bad news from Ford in terms of its Chinese operations. Ford has been reporting over the last few weeks that their sales in China are falling behind.

Knowledge at Wharton: What would be the best way forward for Phase 2 of the US-China negotiations?

Guillén: What’s important is to keep talking. It is also important to recognize that comprehensive trade talks take a long time. It’s not something that you can hope to conclude, let’s say, between now and the U.S. presidential election, for instance. The presidential election is only nine months away. That’s very little time. It would be a mistake to rush this conversation. You need to first establish a good framework that would inform the relationship over the long run, and then you can take care of all the details.

More importantly, during this process they should continue talking, they should continue negotiating. They should also continue to make acts of good faith. Both sides should continue to lower the tariffs that they have increased over the last 18 months. I think that’s very important. So good gestures, a lot of talking, and a lot of patience. I strongly believe that the deal will not be concluded until after the next presidential election, in which case it could be a different president who is in office in the United States. If the deal is concluded before the presidential election, then it will be another patch. It won’t be a comprehensive deal because there’s literally not enough time to do that. Trade negotiations are very time consuming.

Knowledge at Wharton: What might be the political implications of the trade war, especially the impact on the presidential election?

Guillén: An agreement already existed before Trump was elected, between people from or candidates from both parties, in that China’s behavior is not acceptable over the long run, that China needs to change — especially over intellectual property. There’s more of a disagreement in terms of how important it is to reduce the bilateral trade deficit between the U.S. and China. Relatively few people would say that is a priority because what really matters is the overall deficit. By increasing tariffs with China, all that we accomplish is that we reduce the trade deficit with China, but then it increases with Taiwan or with Vietnam or with somebody else. Very few of those manufacturing operations, let alone the jobs, are coming back to the United States.

The other issue is, it all hinges on who is the Democratic president. Some of them are far more radical in terms of trade. At one extreme you have somebody like Bernie Sanders who insists that every trade deal should also be a deal about the environment and about global warming. That introduces yet another degree of complexity into the negotiations. If Sanders were president and if that’s the way in which trade deals are going to be made after he becomes president, then it’s going to take even longer to do any one deal. If it’s somebody else like Biden, let’s say — and I’m just picking random names — but Biden I think would probably represent more of a continuation of the style of looking at trade and at potential agreements with other countries that has been the norm in the United States over the last 20 years or so.

Knowledge at Wharton: What is your long-term view of US-China economic and trade relations?

Guillén: Some people are saying that this is the new Cold War. I couldn’t disagree more. When we had the competition geopolitically between the U.S. and the Soviet Union, the two economies were separate; they were not interconnected. But in the case of the confrontation that potentially could be geopolitical between China and United States, it’s very different. The two economies are completely integrated, especially in the manufacturing area.

What is important here is to acknowledge that China and the U.S. are the biggest economies; they need to agree on fundamentals because otherwise the global economy wouldn’t be able to work. That means updating certain institutions including the World Trade Organization, the IMF, and the World Bank, so that we can have a set of tools and arrangements that help us with the situation today, not the situation that was created after World War II. We’re still using institutions that were put in place long ago. The important thing is that the U.S. and China need to talk to one another. They need to agree about basic issues. They can compete, but they also must cooperate. The level of integration is so high that flat-out confrontation would be a disaster for both countries and for the global economy.