- On January 15th, the U.S. and China signed phase one of a trade deal. The deal removes the threat of additional U.S. tariffs and cuts the existing tariff rate on over $110 billion in Chinese goods in half (from 15% to 7.5% in the next 30 days). Tariffs of 25% remain in place on over $350 billion (roughly two-thirds) of U.S imports from China. President Trump said he would remove these tariffs if the next round of negotiations is successful. However, there is no outlined timeline on this front.
- The deal has a number of provisions that improve on prior commitments, including strengthening U.S. intellectual property protection, prohibiting forced technology transfer, increasing access the Chinese financial service industry, abolishing competitive currency devaluation, and increasing market access and reducing non-tariff barriers to U.S. agricultural products. Ahead of the official signing of the trade deal, the U.S. Treasury said they no longer deem China a currency manipulator.
- Perhaps the most striking element is the commitment of China to raise imports of U.S. goods and services by $200 billion over the next two years, $77 billion in the first year and $123 billion in the second. This equates to a 60% increase from the peak pre-trade war level in 2017.1
- Specifically, the deal calls for increases in Chinese purchases in four major categories: agricultural goods would rise by $19.5 billion, effectively doubling (up roughly 100% by 2021 relative to 2017); energy goods would rise by $33.9 billion, nearly quadrupling (+300% increase) over the same period. Manufacturing goods would increase by $44.8 billion or close to 50%, making up the largest share of the increase in U.S. exports to China (at over 35%). Services would rise by $25.1 billion by 2021, an increase of 30% and representing about 20% of the total increase in imports.
- The deal contains an enforcement mechanism and dispute resolution process. If either party alleges that the other is not living up to the agreement, it would set off three rounds of bilateral talks over a period of 90 days. In the event that these talks are unsuccessful, the complainant can impose tariffs. If the offending party then imposes retaliatory tariffs, this would be taken as dissolving the agreement entirely.
Key Implications
- Overall, the trade deal is likely to be positive for U.S. growth, returning support to American producers of agricultural, manufacturing, and energy goods. At the same time, its implications for the rest of the world are more uncertain and possibly even negative. While Chinese officials have said increased imports from the U.S. would not come at the expense of other countries and would adhere to WTO requirements, it is unlikely that these targets for purchases can be met by doing so. This is especially true for goods like agriculture and energy, where China has less capacity to substitute imports for its own domestic production. With Chinese economic growth slowing, raising overall imports will be increasingly challenging in the absence of offsets against other countries. Indeed, commodity markets are skeptical that the deal will significantly boost total demand for commodities, with prices for most raw materials moving either sideways or down in its aftermath. It’s not hard to see why – China cannot simply create new demand by its companies at will.
- A second challenge to hitting the ambitious targets laid are capacity constraints and whether this deal gives American firms the confidence to take on long term investment to meet these ambitious targets. It’s possible there will be corresponding higher end-user price pressures that would spill out in the interim. The sheer size of the increase in exports is virtually unprecedented over a one or two year period. Conversely, if U.S. exports to China simply offset exports to other countries, there will be little benefit to overall U.S. growth. As an example of the difficulty in raising production to the degree necessary to hit these targets, maintaining soybean’s share of one-third of U.S. agricultural exports to China would require China to purchase the entire annual output of American soybeans, shutting out the rest of the world. This would clearly have distributive, and potentially, price impacts.
- The economic impact is difficult to assess, having no prior roadmap for this type of bi-lateral deal between economic giants. However, in anticipation that a deal would be struck, we had already built in upside to our export profile in our December forecast. This translates into a small positive for economic growth, but with given the size of the Chinese commitment to U.S. purchases relative to peak 2017 levels, there could be some upside to this estimate. Still, given the many crosswinds outlined above, the impact is likely to be a fair bit smaller than the 50 basis points cited by some within the administration.
- The deal had little detail on commercial cybertheft or reducing Chinese subsidies of state firms. However, a separate statement by officials from the U.S., Japan, and the EU called for additional prohibitions on such subsidies, including further restrictions on bailouts to failing firms. The statement also proposes reversing the burden of proof on offending countries, requiring members to demonstrate “that there are no serious negative trade or capacity effects” of subsidies. Expect these issues to play a bigger role in the next round of trade negotiations.
- The dispute mechanism included in the document, while ensuring that the two parties continue talking before immediately imposing counter measures, does little to reduce the risk of future flare ups in the trade war. Given the likely difficulty China will face in meeting its commitments, there is a real possibility that the U.S. falls back on imposing additional tariffs. The only recourse China has in this event is to walk away from the deal, taking us back to square one.
