The Hard Politics of U.S.-China Trade Talks
Since neither side benefits from a trade war, why are both sides threatening one?
The answer is straightforward. Although both sides could benefit from a deal, one side could benefit more — a lot more — depending on the final terms.
Two key issues dominate the current stalemate. The first is how many of China’s mercantilist practices will be rolled back. These include tariffs on imports from America, required partnerships with Chinese firms, forced transfers of intellectual property, and sometimes outright theft of trade secrets. The second is whether the terms are precise, enforceable, and undertaken as formal commitments by China’s highest-level institutions.
China’s problem is that its economy depends on these unfair practices, and communist leaders benefit from them, politically and financially. Some, like widespread theft of Western intellectual property, help lots of local companies. Others, like the coercion of foreign firms to accept local partners, help the party most because it picks the winners. As with any patronage system, the winners are politically connected firms that share the largess with their benefactors. (Economists call this “rent-extraction” politics.)
Chinese political leaders are understandably reluctant to alter these sweet arrangements. They wouldn’t change them at all without significant outside pressure, which is exactly what the U.S. is exerting. Since Beijing has to make some kind of deal, it would prefer informal commitments, the vaguer the better. Later, China could edge away from them, hoping the U.S. would not retaliate.
U.S. trade negotiators didn’t just fall off a turnip truck. They know the game. That’s why they want detailed, unambiguous commitments in writing, ratified by China’s highest-level political institutions. Equally important, the U.S. wants strong enforcement provisions it can invoke unilaterally without retaliation.
China negotiators grudgingly made most of these commitments and were well on the way to striking a final deal when, for unknown reasons, they suddenly backed out of key concessions two weeks ago. Their withdrawal may have been a negotiating ploy, or it may have reflected pushback from hardliners in Beijing. Whatever the cause, President Trump responded sharply, raising America’s current 10% tariffs to 25% on $200 billion in Chinese goods. He has threatened to extend those punishing tariffs to another $300 billion unless China changes course. Trump says he hasn’t made a final decision yet on additional tariffs, but his threat to impose them is credible.
Predictably, China retaliated with higher tariffs of its own, hitting some $60 billion in U.S. exports.
Who has the leverage here? Both sides, but their strengths are different, which is why they are testing each other. The United States’ advantage is that China depends much more heavily on our markets than we do on theirs. We can squeeze them harder. China’s advantage is that they don’t have elected leaders, who are acutely sensitive to constituent complaints. Dictators can usually hold out longer.
The stark asymmetry in trade volumes gives Washington enormous clout. American producers sold about $180 billion in goods and services to China in 2018, less than one-third what Chinese producers sold to us. Direct investments are uneven as well. They have more than $100 billion in direct investments here, all protected by the rule of law. American companies have less than half that in China, all subject to strict regulations and biased courts.
These striking differences matter for trade talks. For China, the American market is not just important, it is vital. We are far less reliant on them. That is Trump’s firm judgment, along with his calculation that his threats are credible.
The prospect of still more pain is crucial since this dispute could become a “war of attrition.” Like all such wars, the winner is the side that can hold out longer, or credibly threaten to. Trump thinks he can because China depends on the American market, the next election is a year and a half away, and the U.S. economy is in robust shape. Growth may slow slightly, but America can weather the effects.
America’s vulnerability is not macro-economic; it is micro-politics. Farm-state Republicans are already feeling the pinch from their constituents. That’s why Trump wants to compensate them. Support from Democrats, such as Senate Minority Leader Chuck Schumer (N.Y.) and Rep. Debbie Dingell (Mich.) helps some, but it will fade if the dispute drags on. They will claim “Trump can’t negotiate.” If the stock market plummets, the pressure will rise significantly. If the economy caves, so will Trump.
China has political problems of its own, many rooted in its slowing economy. It is simply wrong to think dictators don’t worry about instability and disruptions or about blows to their patronage system. If they didn’t worry, they wouldn’t have imprisoned a million Uighurs or devoted half their military budget to internal security.
Before resuming trade talks, Beijing leaders must resolve two crucial issues: (1) How long do they think they can hold out? (2) Is it more costly politically for them to change their fundamental economic policies or hold out for a better deal with Washington?
Saving face matters. So far, President Trump has avoided any attacks on Chinese President Xi Jinping. Quite the contrary. He emphasizes their “strong” relationship and blames previous American presidents, not China, for the bad deals.
Trump knows he cannot force the issue. That’s why he will keep the pressure on, threaten to ramp it up, avoid personal attacks (if he can), and wait for Xi to make his choice. Trump knows better than to call him first.
The two leaders will meet at the G-20 summit in Osaka, Japan, June 28-29, and could reach a deal there, before more economic damage is done. If they do strike an agreement, you can count on Trump to give credit to both sides, say that Xi is a great leader, and proclaim this is the biggest and best trade deal since man crawled out of the swamp and walked on two legs. For American farmers and tech innovators, it might be — if they can hold out.