At this writing (February 19th) a Chinese delegation has come to Washington to meet with U.S. trade representatives with the hopes of making a deal to end the trade war between China and the United States. The aim is for the parties to agree to and sign a memorandum of understanding (MOU) outlining a way back from the tariff war and a path forward to an equitable economic relationship.

Blast from the Past

Back in the early 1960s a gameshow “Let’s Make a Deal” rose in popularity hosted by Monty Hall. The concept of the show was to challenge the guests in the audience to trade something they brought with them for a mystery item. Generally, the mystery item hidden behind the curtain was a high-end household appliance like a washing machine or refrigerator – products then manufactured in the U.S…. and now often imported from China.

Therein lies the rub. President Trump remembers (and cherishes) the U.S. post- World War II industrialization period and imported washing machines, refrigerators and smartphones from Peoples Republic of China (PRC) is anathema to that vision.

The monetary manifestation of China’s export drive is the growing trade deficit in goods the U.S. has with China – topping $380 billion through November of 2018. Easily, the largest goods deficit the U.S. has with any trade partner.

Somewhat buried in the recent rhetoric between China and the U.S. (and indeed China and virtually all its trade partners in the developed world) is the willing collaboration (and investment) in the industrial rise of China. Without Walmart and other mega-retailers in the beginning, or Apple and other mega-technology companies in more recent times, would China have grown so fast? The marriage of foreign markets with foreign investment in Chinese manufacturing that made it all possible – starting in the 1980s China’s GDP soared as increasingly sophisticated consumer goods flooded the shelves of stores around the globe. The success of being “factory to the world” created a dichotomy in the PRC’s approach to trade – on one hand China wished to be treated as a “developing” nation for trade preferences and a “developed” nation on the other occasions the status provided a commercial edge.

When the PRC joined the World Trade Organization in 2001, it was given “developing country” status. This enabled China to levy high tariffs on imports from developed nations like the U.S. and EU (to protect nascent domestic industries) while benefiting from low duties on its own exports. As the economy grew, China was expected to embrace market-based economic principles – essentially to trade like other “developed” nations. That never happened, giving credence to the “bad player” moniker China has in global trade. The quintessential example is autos. After joining the WTO, China imposed a 21%-25% tariff on imported autos. In comparison, the U.S. tariff on Chinese vehicles is only 2.5%. In December (2018), the PRC agreed to temporarily reduce the tariff to 15%.

Multilateralism vs Bilateralism

Trump’s not the first at taking exception to China’s three decades long export blitz but the Trump Administration is the first to shun multilateralism for a bilateral approach. There is some true irony in this flip flop. For years, the U.S. fostered a multilateral approach to international trade relations through the World Trade Organization (WTO). Various administrations adopting the viewpoint that an orderly trading environment was preferable to one where developing economies (i.e. China) undermined other trading partners to the detriment of all. The PRC was the giant outlier among the world’s trading nations until joining the WTO on December 11th 2001.

Now with the U.S. taking the bilateral approach, China has been forced into an uneasy embrace of the WTO trading regime – an organization whose trading rules it regularly flaunted. And unsurprisingly, Beijing has found few nations coming to its side in the squabble with the U.S. The European Union (EU) sharing the U.S. view that the PRC’s abuse of the global trading mechanism was a contributor to the current fiasco, while disagreeing with the Trump Administration over the remedy – preferring a multilateral solution to Washington’s lone wolf agenda.

How to Start a Trade War

The Trump Administration’s approach to trade put China and the U.S. on a collision course long before the inauguration crowd had dispersed from the front of the Capital Building in early January of 2017. In an April 6-7 2016, China’s President Xi Jinping visited to President Trump at his Mar-a-Lago estate, where they agreed to set up a 100-Day Action Plan to address their trade differences. But the program never really gained any traction with either party - President Trump, who had said during the campaign “We can’t continue to allow China to rape our country and that’s what they’re doing. It’s the greatest theft in the history of the world,” wasn’t interested in any policy that didn’t address the deficit and President Xi saw no compelling reason to offer anything substantially different than the assurances that China would buy more U.S. goods.

That all changed when on June 15th 2018, a Section 301 25% tariff plan on $50 billions of Chinese goods was announced. The same day China retaliated with their 25% tariff on $50 million U.S. goods. Subsequently, the U.S. and China have exchanged volleys of tariffs and retaliatory tariffs with Trump setting a March 2nd 2019 deadline for the next major blow.

With a March 2nd deadline (although President Trump has suggested it might be extended) on the U.S. raising the tariff from 10% to 25% on $200 billion in Chinese imports there is some urgency on both sides to make a deal.

On Friday February 15th, a delegation led by U.S. Trade Representative (USTR) Robert Lighthizer and Secretary of the Treasury Steven Mnunchin held talks with Chinese Premier Lui He and later met with Chinese President Xi Jinping before returning to the U.S. The talks were an extension of the meeting at the G-20 Summit in Argentina between President Trump and Xi Jinping and paved the way for the current meeting in Washington.

So, Let’s Make a Deal

As the delegates sit down in Washington, there are compelling reasons for both sides to sign a Memorandum of Understanding (MOU).

For the U.S., the tariff battle with China has hit soybean farmers and other exporters to the China market very hard. China’s retaliatory tariff has placed U.S. exports (especially agricultural products) at a huge disadvantage. Thus far the U.S. consumers have been spared the worse – but tariffs are ultimately paid by the consumers.

The tariff war hasn’t been easy on the PRC either. With growth slowing, the trade war with the U.S. and the EU is throwing a monkey wrench into Xi’s economic plans. Xi would like to concentrate on domestic growth and China’s December numbers show the first real signs of the impact. China’s overall December exports dropped 4.4% (y-o-y), the largest monthly drop in two years. Imports also unexpectedly dropped 7.6% in December – the largest decrease since July 2016.

And from the global perspective, the U.S.-China dust up along with other international trade issues, could trigger a global slowing if not checked soon.

Xi has already expressed a willingness to buy more U.S. goods like soybeans and semiconductors to reduce the deficit. Through November of 2018 (latest available statistics) the goods trade deficit with China rose to $382.3 billion, so there is a lot of room for negotiations. What is more problematical are issues like Intellectual Property (IP) and investment. Dr. Barbara Lauriat points out that China is moving from being an IP consumer to an IP producer (see Dr. Barbara Lauriat article on IP, AJOT issue 02-11-2019).

Xi reportedly told the U.S. delegation that China is willing to “cooperate” but added the caveat “[but]cooperation has principles.”

Exactly what those “principles” are is still a matter of conjecture but likely it means Beijing would be unwilling to alter the centralist economic structure.

Shortly, after the announcement of the new round of meetings, US-China Business Council (USCBC) President Craig Allen said, “It’s excellent that the two sides are drafting specific language in the form of an MOU. This process is not abstract and any agreement must be detailed, enforceable, time-bound, and result in market-access improvements that have a meaningful impact for American companies, workers, and farmers.”

And Allen’s remarks pretty much sum up what would make a desirable top prize for this round of Let’s Make a Deal.