As was widely predicted, and perhaps predictable, Presidents Trump and Xi have agreed, again, to restart trade negotiations. President Trump says things are re-starting “where they left off.” Relieved that the talks netted agreement not to impose new tariffs, some easing of the administration’s ban on U.S. sales to tech behemoth Huawei and, potentially, increased Chinese purchases of U.S. agricultural products, markets and U.S. business groups reacted positively. But things are not really starting “where they left off.”
First, the U.S. 2020 election cycle is now in full swing. A weak deal or one that quickly unravels would be a political liability for President Trump and invite criticism from Democratic rivals. Another breakdown in the talks could also undercut U.S. markets, to which Trump looks for strength. In that light, and given bipartisan support for a tough stance on China, it may not hurt the President to keep the pressure on, while avoiding further escalation, even beyond the upcoming election. As he said himself, “The quality of the transaction is far more important to me than speed.”
Second, explicitly tying Huawei to the talks raises, and changes, the stakes. When the Commerce Department added Huawei to its “Entity List” on May 16, it established a de facto ban on billions of dollars in U.S. sales of critical inputs and services to Huawei, China’s largest telecoms company and the world’s seventh largest tech company. In Osaka, President Trump promised some relief for Huawei, saying he would allow some sales of “widely available” items to resume, but declared that the ultimate fate of sanctions on the company would be determined in the final stage of negotiations. Inserting an issue involving national security considerations makes it more complicated, and potentially harder, for the administration to achieve a worthwhile trade deal with China.
President Trump’s subsequent decision to ease restrictions on U.S. sales to Huawei may have been welcomed by some U.S. sectors, but it drew accusations by some in Congress that President Trump was selling out U.S. national security. Senator Rubio threatened legislation to keep the restrictions on Huawei intact, and Senator Schumer criticized the President’s decision to ease the ban. White House economic advisor Lawrence Kudlow stressed on Sunday that Huawei would not be removed from the Commerce Department entity list, and that although more licenses will be granted, proposed sales will still be denied if they pose a national security threat. “This is “not a general amnesty,” Kudlow stressed. The problem is that China will expect a substantial reprieve for Huawei, and it’s not clear that the Trump administration will be in a position to deliver, which could influence China’s negotiating position in the talks.
Third, China is hardening its attitude and bracing for protracted confrontation
Since the trade talks broke down in May, followed by the U.S. raising its tariffs on $200 billion of Chinese goods to 25% and imposing sanctions on Huawei and other Chinese tech companies, China has been reassessing U.S. intentions and prospects for improving the relationship with its biggest economic partner. China’s leaders have concluded that the U.S. aim is to impede China’s technological progress. While President Xi recently said he “can hardly imagine a complete decoupling between China and the U.S.,” he appeared to be preparing his citizens for a long and difficult chapter in relations with the U.S. by characterizing the challenge as a “new Long March.” This refers to the Chinese Communists’ 15-year struggle starting in 1934 to escape encirclement by Nationalist forces and eventually emerge victorious after sustaining grave losses. China has publicly laid down red lines for resumption of the trade talks and warned that China would not compromise its core interests. Following the Osaka meeting, China’s state media took a circumspect tone, cautioning that the two sides remained far apart in resolving fundamental differences on trade and emphasizing that the U.S. needed to show its sincerity with actions.
Fourth, U.S., Chinese and global economic conditions are more fragile. The International Monetary Fund (IMF) had already cut global, U.S. and Chinese growth projections due to the impact of U.S.-China trade tensions. While President Trump clearly believes that U.S. economic strength bolsters his negotiating position, his complaints about the Fed show that he is aware that this advantage may be at risk. He told reporters last week that the Federal Reserve “has not been of help to us at all” in trade negotiations with China. To minimize the negative impacts of U.S. tariffs and the Huawei ban, which have combined with domestic factors to slow growth, China’s central bank has already cut reserve requirements for commercial lenders six times since the start of 2018. And Beijing has cut taxes on Chinese businesses hurt by the trade war. The U.S. economy is at the end of a long business cycle, tax-cut stimulus has run its course, and U.S. CEOs are hiring and investing less and see an increasing risk of recession. Even widely-expected Fed rate cuts would be unlikely to fully offset headwinds that would be unleashed in the wake of substantial new tariffs on consumer goods from China.
So, what now? The task in front of negotiators is more daunting and the environment more complicated than it was when talks broke off in May. While U.S. officials note the progress they have made on trade issues with China, saying “we’re 90 percent there,” they acknowledge that resolving the remaining 10% will be extremely difficult, as it involves core features of the state-led economic model that China may see as essential to retain in order to stand up to U.S. efforts to block its access to technology. Even if a deal is reached that addresses some of China’s practices that tilt the playing field against U.S. companies and industries, the fundamental differences between the U.S. and Chinese economic systems will continue to fuel trade tensions. Managing the relationship between trade, technology, and national security will continue to test both governments. Any deal on trade would be but one step toward reconstructing the U.S.-China economic relationship and putting it on a more sustainable footing, for that is a project that will almost certainly require years to complete.
The disruption across multiple dimensions of the U.S.-China relationship is rapidly reshaping the environment for global business, potentially for years to come. Companies should be planning for the “new normal” in this relationship that is beginning to take shape — characterized by increasing competition, disengagement in the area of technology, and the potential for conflict in some areas — and adjust strategies accordingly to mitigate risks and capture emergent opportunities for different potential scenarios.
Anne Pence is a senior international advisor at Covington & Burling LLP and former State Department economic policy advisor.
Christopher Adams is a senior advisor at Covington and former Senior Coordinator for China Affairs at the Treasury Department and trade negotiator responsible for China.