U.S. Options Are Limited in the Ongoing Trade War with China

President Donald Trump said in early July that the COVID-19 pandemic has “severely damaged” the U.S.’s relationship with China. He added that he isn’t thinking about the next stage of the trade deal with the Asian superpower.

To get more context on how these tensions have affected trade between the countries, GLG spoke with David Dollar, a senior fellow in foreign policy and global economy and development programs at the John L. Thornton China Center with the Brookings Institution. He previously served as an economic and financial emissary to China and worked for the World Bank for 20 years. The following Q&A was edited for length and clarity.

Can you recap the agreements and stages of the phase one U.S.-China trade deal in terms of key issues, timeline, and progress prior to COVID-19?

The important thing in the phase one agreement would be some structural measures that China committed to, including opening its automobile and financial services markets and allowing foreign investment. There’s also the strengthening of intellectual property rights. These are things that China had in the works. But the big headline was about the purchase commitments. China was supposed to buy an additional $200 billion of U.S. goods and services relative to a 2017 benchmark. It’s divided into categories: $50 billion in energy, $80 billion for manufacturers, about $40 billion for services, and $30 billion for agriculture.

Most of us China watchers felt that these were almost impossibly ambitious numbers to start with. It would have taken a 40% increase in U.S. exports this year and an additional 40% increase next year to meet the targets. Ironically, the countries signed a deal mid-January, just as the COVID crisis was overtaking the world. So what’s actually happened in the first five months of 2020 is U.S. exports to China are way down. We’re far behind any target, and it seems quite impossible for China to meet those numbers.

I don’t think the deal’s fallen apart yet. U.S. trade representative Robert Lighthizer told Congress that the deal is still on track because the commitments are over two years. In theory, China could make a heroic effort to make these purchases, but it’s unlikely. Some of the other items, such as Chinese students and tourists coming to the U.S., we’re not allowing to happen, so that can’t possibly go up. We’re supposed to sell $50 billion of energy, but at current prices, the U.S. industry is basically shutting down a lot of facilities, so that doesn’t seem realistic. Agriculture has potential, and that’s what the administration is hanging on to.

Are there any key signs that we should be watching for with the agricultural purchases?

We’re definitely getting mixed signals. There’s definitely the potential for China to buy more soybeans, pork, and beef. But China is hedging to some extent. It’s importing a lot more from Brazil. It used to be that China’s soybean imports were split about evenly between Brazil and the U.S. With the trade war, Brazil took over almost the whole market.

Has the focus for tech companies changed in any way, considering the original true goal with the trade war sanctions before was more IP protections?

China is improving intellectual property rights protection. It has a new foreign investment law where there are strengthened provisions and penalties for violations. Some things are happening that tech companies would like. But it’s still the case that our social media companies can’t get into China. That’s not likely to change, but the hardware and manufacturing companies have a lot of sales and do a lot of production in China. So far, there’s not much change to that.

How will this affect Huawei and hardware companies in the intermediate term?

Somewhat separate from the trade war, but in parallel to it, the U.S. has stepped up a technology war with China that particularly involves limiting Chinese investment in the U.S. and high-tech sectors. That was already happening under President Obama, and that trend has continued, but what’s new is stepping up the export controls. There have always been export controls on technologies that have military applications, but the Trump administration has broadened that a lot.

The important, recent news is the administration is trying to prevent Huawei from buying U.S. semiconductors. Meanwhile, the biggest semiconductor manufacturing firm in the world, Taiwan Semiconductor, uses a lot of equipment made in the United States. In a bold move of extraterritoriality, the U.S. is preventing Taiwan Semiconductor from using American equipment at its factories in Taiwan to produce semiconductors for Chinese partners. That’s a problem for Taiwan Semiconductor. About 20% of its business is on mainland China, with about 50% with the United States. This is also a pretty serious problem for Huawei. It’s got a few months of inventory while stepping up its capability to make basic semiconductors. The company will try to switch some of that to Korea, which is also a major manufacturer. That’ll be an interesting battle. The U.S. will presumably put pressure on Korea, a key ally, not to sell semiconductors.

Huawei will clearly survive because it’s got multiple business lines, but the company will be set back in terms of its global expansion into 5G networks and other sophisticated things.

Considering the geopolitical tensions, the vulnerabilities of dependence on a global supply chain will come into focus. Will this increase a push for decoupling?

There are definitely some elements of decoupling going on. I don’t particularly like the word; it’s a little too sweeping. What I just described about semiconductors is obviously a decoupling. As things get worse between the U.S. and China, the firms that are servicing the Chinese market will likely source less from the United States to avoid the risk of a trade war flare-up. That’s a decoupling, but it’s likely not what a lot of American politicians have in mind. The result will probably be more production concentrated in China in quite a few sectors.

I’m not sure the Trump administration fully understands this complexity. Administration officials have said explicitly that they’d like to see production moved back to the U.S. There’s no evidence this will happen at any large scale, but there is some evidence that some production is shifting out of China to Vietnam, Indonesia, and Mexico. China’s increasing its exports to those countries because it’s now in the middle of a lot of value chains, producing technology, machinery, and components. Chinese exports didn’t go down during the trade war — they went up. Value chains cross many borders, so it’s hard to cut China out.

In terms of net exports, most of Western Europe is highly influenced by China’s economic output. Is there a potential that the U.S. could lose key markets and allies by continuing to lean on strict trade policy?

Absolutely. Most of our partners have more trade with China than with the U.S. right now. The U.S. economy is still about 50% bigger than the Chinese economy, but we’re actually less engaged in trade than China is, partly because we’re self-sufficient in energy. We’re an agricultural surplus country and a manufacturing and service powerhouse. If we try to push this radical decoupling, all of these partners will face a difficult choice. It’s possible that a key security ally like South Korea might go along with the U.S., but even that’s not clear because it’s deeply integrated with China. The U.S. has proved to be a somewhat unreliable trade partner over the past few years.

We don’t just have a trade war with China. We imposed tariffs on steel from Korea and Japan. We are threatening to put tariffs on trade from Europe. China, of course, has all these problems. But Europe, Japan, and Korea are about to enter into a free trade agreement with China. They’re all looking at China as gradually improving fast expansion of the market. They worry about China’s muscle, but their strategy is deeply integrating China into the global system. The U.S.’s strategy is not playing well with our allies.

It seems so far that the U.S. has ratcheted up rhetoric on China, but not on tariffs. Should we be expecting more tariffs to come?

The first couple of rounds were pretty serious. We got to the point where we’re taxing roughly half of our imports from China at 25%. That’s the most overall protections the U.S. has put in place since the 1930s. We rolled back a tiny bit of that as part of the phase one deal. But the main thing the Chinese got out of the phase one deal is no further escalation of U.S. tariffs.

While I can see that the trade deal may fall apart officially, I’m skeptical the administration will ratchet up more tariffs. The president may choose to make a very highly publicized announcement that China’s not meeting its standards and he’s going to punish them and raise tariffs, but most of the time that he’s raised tariffs on China, the U.S. stock market has reacted badly because it’s bad for the U.S. economy. Tariffs are paid by American consumers and firms. They’re not paid by the Chinese. It’s just creating uncertainty in business.

It’s not in the president’s interest to raise tariffs further and risk a bad reaction from investors and the economy. But if President Trump’s poll numbers continue to look bad, he may consider some things that are inherently risky.

---

About David Dollar

David Dollar is a Senior Fellow in the Foreign Policy and Global Economy and Development programs at the John L. Thornton China Center (the Brookings Institution). He is a leading expert on China’s economy and U.S.-China economic relations. From 2009 to 2013, he was the U.S. Treasury’s economic and financial emissary to China. In that capacity he facilitated the economic and financial policy dialogue between the U.S. and China. Based at the U.S. embassy in Beijing, Dollar served as Treasury’s eyes and ears on the ground and reported back to Washington on economic and policy developments in China. Dollar worked at the World Bank for 20 years, and from 2004 to 2009 was country director for China and Mongolia. His other World Bank assignments primarily focused on Asian economies, including South Korea, Vietnam, Cambodia, Thailand, Bangladesh, and India. From 1995 to 2004, Dollar worked in the World Bank’s research department.

---

This article is adapted from the June 22, 2020, teleconference “U.S./Chinese Tensions: Ramifications to the U.S. and Tech.” If you would like access to this teleconference or would like to speak with David Dollar, or any of our more than 700,000 experts, contact us.