US-China Relations: Where Next?

On Mar. 6, 2019, The Economist Intelligence Unit (The EIU) held a webinar, "US-China relations: where next?" co-led by John Ferguson and Cailin Birch, The EIU's Director of Global Forecasting and Country Analysis, and Global Economist respectively. The webinar's content was presented in four parts:

THE STATE OF PLAY

Duties have been placed on roughly US$360bn worth of bilateral trade. Major tariff action includes the following:

• Metals tariffs under 232, and China’s response;
• Electronics and machinery tariffs (US$50bn);
• Miscellaneous manufacturing (US$200bn);
• Still no escalation to finished electronics goods; and
• Trade tensions to manifest in other areas (investment, tech). 

A flurry of negotiations has taken place since Jan. 2019 including:

• Four rounds of talks held in Beijing and DC since early January; likely more on the way;
• Extension offered by U.S. president Donald Trump in late Feb. 2019;
• Potential presidential summit and the likelihood of a deal; and
• Questions remain over structural issues and enforcement.

WHERE NEXT?

The webinar says a substantive trade deal looks unlikely as there are six areas of contention:

1. Agriculture (Chinese purchases of US agriculture goods, food and quality standards divergence, and biotech approvals for GMOs);
2. Currency (manipulation of the renminbi exchange-rate for exports and role of market forces in setting the renminbi exchange-rate);
3. Tech transfer (forced transfer of technology required under business terms and requirements for intellectual property and technology localization to participate in standards-setting processes);
4. Intellectual Property Rights (IPR) (infringement of US IPR by Chinese companies, lack of redress for US companies for infringements, and licensing and security reviews that lead to IP leaks);
5. Services (loosening of joint venture (JV) requirements in financial, technology (including cloud computing) services and market access for credit card companies and other services firms); and
6. Non-tariff barriers (uneven enforcement of local laws against Chinese and foreign companies (e.g., anti-money laundering, environmental compliance, etc.) and unfair subsidies, procurement offerings and other support to Chinese state-owned enterprises (SOEs)).

Prospects for a deal:

1. Agriculture (Good – China has made it clear it is happy to commit to additional US agriculture imports, but it is unclear whether China would agree to more GMO approvals);
2. Currency (Good – US and China both have an interest in a stable renminbi exchange-rate);
3. Tech transfer (Poor – any agreement difficult to enforce. China tends to see tech transfers as a business rather than policy matter, while abundance of local regulations would make implementation hard);
4. IPR (Mixed – China wants to improve local IPR standards, but enforcement and penalties remain weak);
5. Services (Mixed – liberalization underway in financial services, but less clear in other areas; national security is increasingly dominating discussion over technology-related topics); and
6. Non-tariff barriers (Mixed – enforcement across challenging, while greater push towards increasingly the role of SEOs in the economy points to more state support, not less).

The webinar importantly noted that China's president, Xi Jinping, is a dominant leader but still wants to avoid being seen as caving to US demands. Mr. Xi is viewed more as an economic nationalist versus a globalist.

Moreover, the webinar explained ideological divisions with the US trade team will hinder future negotiations. US Trade Representative Robert Lighthizer and Peter Navarro, the Director of the National Trade Council at the White House, are considered ideological hardliners; whereas, Wilbur Ross and Steven Mnuchin, secretary of commerce and of the treasury, respectively, are deemed as economic pragmatists.

MACRO OUTLOOK

The Chinese credit cycle has begun to turn that alongside a trade deal with the US, China’s economy may perform better than many expect in 2019. Moreover, China’s gross domestic product (GDP) will slow in the first half of 2019 before picking up.

Chinese reforms and policies to watch:

• Banks' reserve requirement ratios (RRR) cuts, lower interbank lending rates;
• Personal tax cuts and reductions in corporate costs (e.g., social insurance);
• Consumption stimulus policies (e.g., automotive); and
• Foreign direct investment (FDI) liberalization including foreign investment law.

And the US remains in a record long-term economic expansion, but the rate of growth will slow:

• The US economy is in its longest expansionary period in history, but internal and external factors will cause growth to slow in 2019-2020;
• The temporary boost provided by the tax cuts will wear off in 2019;
• The trade tariffs currently in place are weighing on US firms' competitiveness;
• Knock-on effects of slowing demand from China and the European Union, as well as rising labor costs, will weigh on margins and limit business investment; and
• Forecast assumes no rate hikes by the central bank (Federal Reserve).

While not presented in the webinar, below is a forecast summary of real GDP growth (year on year) by percentage from The EIU's global outlook summary dated Feb. 13, 2019.

It is also imperative to understand the effect of the trade war on China's local economies, which may put pressure on the Chinese government to enter an agreement with the U.S. The EIU published an article on Sept. 26, 2018 explaining:

The impact of the trade war at the local level in China may be even more pronounced. We expect to see disruption in a number of provinces that rely heavily on trade for economic growth, including Guangdong, Jiangsu, Shanghai and Zhejiang. These areas are China's traditional export powerhouses, accounting for more than half of the country's total export flows in 2017. In addition, although the external sector occupies a smaller role in these provincial economies compared to a decade ago, trade growth remains an important pillar of economic activity: last year exports as a percentage of regional GDP stood at 50% in Guangdong, at almost 40% in Zhejiang and Shanghai and at around 30% in Jiangsu.

US-CHINA RELATIONS

While presenting a slide, "All quiet on the investment front: Crossing the river by feeling the stones," Ms. Birch noted: "China has implemented reforms to its business environment over the last few years, but for the most part, these have been moderate and the process of putting them in place has been largely stagnant." She added: "The latest and broadest set of reforms [implemented by the Chinese government] was unveiled last June, by they only moved the needle forward slightly."

Some of the proposed financial-sector liberalizations are listed in the chart below, which was originally provided by The EIU in an article, "Is China really planning to open its financial sector?" dated Apr. 30, 2018.

Ms. Birch said "the automotive, financial services more broadly, healthcare and critically, telecoms, remain either restricted or blocked to foreign direct investment." She acknowledged there have been some reforms in specific segments of the automotive and the financial services sectors, but only in "areas where Chinese domestic firms already have a very established competitive hold on the market."

The webinar further explained how security tensions between China and the US could become more prominent once a trade deal is reached:

• Returning to 19th century geopolitical rivalries as global power diffuses;
• US defense strategy identifies China as a "strategic competitor";
• Risks relating to Taiwan have risen; South China Seas remain a flashpoint; and
• Rifts emerging over Chinese influence operations and soft power, Belt and Road Initiative (BRI).

In presenting a slide, "The fracturing of the technology landscape," Mr. Ferguson remarked that "both countries are looking for one to remain in the global power and the other one wanting to become the global power" in the global tech sector. He added: "You can almost think two types of trade war. There is the type we are talking about right now which maybe there is a trade deal as we believe, but there is a more fundamental trade war that will carry on and this falls in the area of technology."

The webinar concluded with the showing of the image below in a slide titled, "The end of engagement? US-China relations appear troubled in the long-term."

In an article published on Dec. 4, 2018, The EIU says it has "identified four possible scenarios for 2019, owing to the high degree of uncertainty around the dispute." The have attached a 50% likelihood to their baseline assumption (outlined below), with Chinese real GDP growth of 6.2% for the year. The have assigned a likelihood percentage and outline the key impact of each scenario.

Lastly, as noted above, The EIU predicts a substantive trade deal between the US and China looks unlikely. In an article, "Settling for less," dated Mar. 4, 2019, The EIU writes:

Regardless of future developments, however, we expect US-China bilateral ties to continue fraying into the long term. This is because we do not expect US trade pressure to prompt China to introduce significant reforms to its economy, particularly as the country embarks on a conflicting policy push aimed at enhancing the role of both the central government and home-grown companies in economic affairs. The inability of the US to address these market access issues is likely increasingly to push US-China friction into areas of investment and technology policy, underpinned by a strategic rivalry aimed at technological dominance. The trade war remains far from over.

Where are your predictions for the future of US-China trade relations?

Aaron Rose is an advisor to talented entrepreneurs and co-founder of great companies. He also serves as the editor of Solutions for a Sustainable World.