US and China trade war moves to the trenches

Shanghai venue works no magic

One can appreciate President Trump’s sense of frustration. By all accounts, the Shanghai gathering achieved little. The talks themselves did not last long, if that is any measure of things. There was a working dinner and a half-day meeting the next day. Chinese media highlighted that the talks ended 30 minutes early, taking that as a bad sign. Each government issued bland statements and even the announcement about the next face-to-face meeting, a month later in September, suggested a lack of urgency. A far cry from the intense schedule of talks we saw before the May breakdown.

Notwithstanding a sense of relief that negotiations had resumed, expectations for this round of talks were low and the results were true to form. Apparently, the US delegation’s report to the President was franker than the polite official statement, which described the talks as “constructive.” According to accounts circulating on WeChat in China, an angry President Trump decided on the spot to move forward with tariffs — effective September 1 — on all remaining imports from China and his tweets went out even before the debriefing meeting broke up. Media reports say the President overruled his advisors on the new tariffs. The tweets reveal the President’s top complaints with China as a negotiating partner, with assertions that China has shown bad faith on promises to control fentanyl exports and increase agriculture purchases. In addition, the President criticized China for trying to “re-negotiate the deal prior to signing,” a reference to China’s decision in May to seek major changes in the draft agreement.

Tariff man strikes again

Tariffs were again the weapon of choice. The President seems convinced that tariffs will eventually bring China to its knees, and that in the meantime, China is paying the bill, or so he believes. The September 1 effective date means the new tariffs can still be cancelled and the 10% rate either leaves room for growth or is an indirect admission that these latest tariffs could be painful for American consumers because they include many common consumer goods. Imposing the tariffs at 25% would magnify the impact on pocketbooks and damage the President’s 2020 reelection prospects. At 10%, companies may absorb most of the costs and consumers — or should we say voters — will feel less pain.

China threatened to retaliate but Chinese tariffs already cover $110 billion of US imports, which is almost everything. Since China imports far less, they cannot match the US tariffs dollar-for-dollar. That’s why China has said it will use “qualitative” measures, a vague reference to weaponizing regulatory agencies to make life difficult for US companies – more inspections, delayed license approvals, slow Customs clearances, frequent audits and the like. China has plenty of options, including making good on the threatened “unreliable entity list.” Consumer boycotts are also a growing possibility, but that would represent a major escalation in tensions and be difficult to control once launched.

Tactical ploy or grand strategy?

It remains impossible to discern if the President’s actions are simply tactical or driven by a larger strategic vision of how the US-China relationship should look. Most observers believe the former. If so, the President’s playbook will not enhance prospects for a deal. Rather, his actions continue to drive apart the two sides and make it more difficult for President Xi Jinping to respond positively to the American demands. Stylistically, President Trump does little to give President Xi face, preferring instead to be in his face.

Of course, China isn’t helping. The Chinese media continues to blast the United States for its actions against Huawei, the use of tariffs, and demand that China amend its laws as part of any final agreement. In addition, other sensitive issues have recently entered the mix. China is blaming the United States for the unrest in Hong Kong and is angry about the latest round of US arms sales to Taiwan. Mixing these delicate political issues with trade matters is potentially combustible and worth watching carefully as it will further limit Beijing’s options.

In the United States, China hardly comes across as a good actor. Whether in the media, Administration statements, or comments from members of Congress, China is routinely portrayed as a cheat, thief, free rider or an authoritarian regime out to replace the United States as the preeminent global power. For Americans unhappy with their station in life or the country’s direction, China is a convenient scapegoat. As for American politicians, getting tough with China is one policy where Republicans and Democrats agree.

In short, the general public in each country faces regular exposure to a caricature of the other side and views the other party as a bad actor. This only raises the bar for reaching a deal. First, any deal must be explained to a skeptical public. Second, public skepticism raises the political cost of offering genuine concessions. This is true both for Beijing and for Washington.

The sincerity conundrum

Living in China, I am regularly exposed to the Chinese view of the trade talks and US-China relations in general. One cannot escape China’s growing focus on the “attitude” of the US government. We know that one feature of Chinese negotiating style is to focus first on general principles in the belief that, if two parties can agree on overall principles and objectives, everything else is a piece of cake. In contrast, Americans tend to dive into the details and not worry about philosophical differences.

This disconnect is increasingly evident in the current talks. Every time the US takes a step to increase its leverage, China inevitably condemns the move as showing a lack of “sincerity,” thereby asserting its moral superiority. For many Americans, this is hard to swallow. From their perspective, China is responsible for the trade war because of its failure to honor WTO commitments, protect intellectual property, and provide fair treatment of US companies. If there has been a lack of sincerity, it is on the Chinese side.   China’s drumbeat of accusations of US insincerity may strengthen Xi’s hand at home, but the impact in the United States is to aggravate growing mutual mistrust. That too makes a deal tougher to achieve.

What next?

Against this backdrop, it is hard to imagine a trade deal anytime soon. President Trump believes he has the upper hand with time on his side. Based on his logic, any delay means China must offer even more when it is finally ready to deal. Similarly, President Xi believes there is no point negotiating with a capricious counterpart who has no bottom line and whose real purpose may be to thwart China’s economic development and growing political power. Xi may not face a reelection campaign, but he still has domestic politics of his own.

US companies are the hapless victims in this geostrategic drama. At this point, most companies assume tariffs are here for the long term and that US-China tensions will persist. How companies respond is industry specific, but manufacturers are looking at relocation options for some operations. In relative terms, Southeast Asia — especially Vietnam — is the big winner so far, with some movement to India and Taiwan. There is very little reshoring back to the United States. Such shifts were reported by around 40% of US manufacturing companies in China, according to a May 2019 AmCham Shanghai survey. At the same time, many companies are delaying decisions about new investments, or reducing investment, and there has been a sharp drop in Chinese investment in the United States. In short, trade tensions are having a disruptive effect. If the Trump administration’s true goal is to see some economic “decoupling” they are getting their way.

This situation could persist until the November US presidential 2020 election. China can continue to press its key demands — no tariffs, end Huawei sanctions, purchase US products only as needed and drop demands that China amend its laws — but the US is unlikely to yield. This leaves President Xi little wiggle room. Similarly, President Trump has little reason to relax his demands. His tough guy act with China could help him in the upcoming election and he need not change course unless the economy takes a dive. In short, we have a stalemate. Most US companies have gradually come around to this painful recognition and that is now their operating assumption. For American companies operating in China, it means yet another “new normal.”

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