Bilateral Relations

On the Eve of Phase 2: What Will the United States Bring to the Next Stage of Negotiations with China

Phase 2 (P2) of the US-China trade talks will be more difficult and painful than the first stage. Donald Trump suggested starting a new series of negotiations immediately after the signing of the Phase 1 agreement, but the Chinese considered it “unreasonable”. Trump said that “we take a momentous step, one that has never been taken before with China, towards a future of fair and reciprocal trade.” China, politely, said nothing in response.

If one thing could be said about the Phase 1 deal, it was not favourable for China. China was literally forced to buy $200 billion in US products, and beyond all the rules of free competition. At the same time, tariffs on part of Chinese imports to the United States, which had been increased to 25%, have not been lifted and the process of revisiting them has been reserved for the second phase of negotiations. On average, tariffs for both sides still make up about 20% of the level that existed before the trade war – six times higher than they were before the disputes. This shows that the Chinese were not able to eliminate the most pressing “trouble” – the higher tariffs – as a result of Phase 1 of the negotiations. Thus, the US measures of economic coercion were rather effective.

The Phase 1 deal presumed that China would sharply increase its purchases of American products, become strictly obligated to respect the protection of intellectual property rights, stop forced technology transfers in exchange for permission to work in the Chinese market, and refrain from manipulating the yuan exchange rate. China, to one degree or another, had to agree with all these conditions. Here, it is important to understand why this happened. China, in fact, did not manage to complete the creation of its economic macro-region, which is based on an alternative model and includes the banking and financial system, and is focused only on China’s trade, logistics and infrastructure system (Belt and Road). Most importantly, China did not have time to conclusively bind partners to Chinese technologies, although it invested as much as possible in the development of advanced new industries and scientific laboratories. So, China still has to use the old system. In addition, China made the bulk of its trades at the expense of the United States, that is, it turned out to be too closely tied to one partner, which also controls the global financial flows. This is what Washington took advantage of. As a result of the P1 agreement, China showed that it did not, in fact,  control the world. At least for the time being. And in order to prevent the PRC from advancing to the next stage of its development, that is, transforming the country into a global high-tech leader, Washington decided to strike precisely at the most underlying structures of the Chinese economy, the core of China’s economic system.

The next stage, obviously, will be about the requirements to limit state subsidies to Chinese enterprises, especially those participating in the ambitious “Made in China 2025” export programme, which promotes the country’s technological superiority. Many basic enterprises in the PRC are subsidised, primarily the basic cycle enterprises and some high-tech enterprises. This is carried out through direct subsidies (usually for heavy industry), the provision of non-repayable or at least interest-free loans, and the allocation of state long-term subsidised investments, etc. Formally, this contradicts the classical model of a liberal market economy based on free competition, but since the very beginning of the 80s, China has methodically built a state-oriented paternalistic model of an illiberal but competitive economy.

The second set of issues concerns measures to limit the global influence of China’s leading technology companies. When China was merely the “world’s factory”, releasing mass consumer goods, the United States did not care. But after companies such as Huawei, ZTE, and many others entered the world markets, it became clear that China was invading areas where the United States and its allies are monopolists, including artificial intelligence, high-speed data transfer, and genetic engineering. And such a rapid scientific and technological breakthrough in China has been achieved precisely due to government support. Every year, Huawei spends $ 15 billion on high tech research with $100 billion in revenue per year. The US believes that Huawei is engaged in the theft of intellectual property, and also receives subsidies from the state.

It seems to the US that this subjects American companies to unequal conditions. In addition, the US is going to discuss Chinese cloud technologies, demanding that their security control should be more transparent.

Another block of issues is related to the opening of the Chinese market to the American companies and, in general, to foreign firms, providing financial services. These companies should receive equal rights with Chinese players. If we discard significant nuances, today foreign companies formally enjoy almost the same rights as Chinese ones, because in 2018-2019 a noticeable liberalisation of the Chinese market occurred, opening almost all areas for foreign investment, except some extremely narrow areas from a “negative list”. The situation is more difficult with the financial sector: there are many restrictions and a lot of legal niceties, therefore foreign companies cannot compete on equal terms with the Chinese companies and in real life do not get equal access. Moreover, there are noticeable restrictions on participation in Chinese electronic payment systems, such as AliPay, WeChatPay and others. Therefore, the United States will demand to fully open the Chinese financial market.

The discussion will be again concentrated on the observance of intellectual property rights, and not only that stealing patents is bad, but about creating a simple and obvious mechanism for solving problems right on the spot, and in this scheme China will be obliged to track down such excesses.

The main levers of pressure in the Phase 2 talks will no longer be tariffs, but export-import control methods, investment restrictions, and possible sanctions against individual Chinese companies.

Source: Valdai Club

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