What Derailed the U.S.-China Trade Talks?

PRC Vice-Premier Liu He, the lead Chinese negotiator in recent U.S.-China trade talks, speaks with reporters upon his May 9th arrival in Washington. Negotiations formally broke down the next day with the U.S. announcement of another major round of tariffs on Chinese goods. (Source: CCTV)

Introduction: The U.S.-China “Trade War” Since Early 2018

For over a year, the United States and the People’s Republic of China (PRC) have been engaged in a contentious trade dispute initiated by the Trump Administration over a host of alleged unfair Chinese trading practices: ranging from intellectual property theft, to industrial subsidies, to artificial barriers to market access for U.S. and other international companies. The first shots of the “trade war” were fired in January 2018, when the Trump Administration imposed import tariffs affecting Chinese-built solar panels and washing machines (PIIE, January 25, 2018). This was followed shortly thereafter by punitive tariffs imposed by the PRC on U.S.-grown sorghum (PIIE, February 6, 2018). By early 2019, the escalating trade frictions had resulted in U.S.-imposed tariffs on $250 billion in Chinese goods, across a range of sectors; with reciprocal tariffs imposed by the PRC on $110 billion in U.S. products, with many of the duties falling in the agricultural sector (CNBC, March 1).

Per the position of the U.S. side, the tariffs have been issued under the provisions of Section 301 of the Trade Act of 1974, which grants the U.S. Trade Representative (USTR), pursuant to direction by the U.S. President, authorities to “impose duties or other import restrictions on the goods of, [and] fees or restrictions on the services of, such foreign country” as may be conducting trade practices that “violate [or are] inconsistent with the provisions of… any trade agreement, or [which are] unjustifiable and [impose] burdens or restrict[ions on] United States commerce.” [1] The trade disputes have also occurred against the backdrop of a more assertive U.S. position regarding “China’s continued embrace of a state-led, mercantilist approach to the economy and trade,” and its rampant violations of World Trade Organization (WTO) commitments. [2]

Over the course of the past year, negotiations have been ongoing between the United States and the PRC to resolve the disputes through a comprehensive trade deal. The U.S. negotiating team has been led by Treasury Secretary Steven Mnuchin and USTR Robert Lighthizer. On the Chinese side, the lead negotiator has been Liu He (刘鹤), a Vice-Premier of the PRC State Council and a member of the Chinese Communist Party (CCP) Politburo. However, perhaps most importantly in terms of real clout, Liu is a senior aide to CCP General Secretary Xi Jinping, and the director of the executive office of the CCP Central Leading Small Group for Financial and Economic Affairs (Zhongyang Caijing Lingdao Xiaozu, 中央财经领导小组) (China Vitae, undated; SCMP, March 21, 2018).

Even as punitive tariffs escalated over the past year, the lead negotiators maintained an optimistic tone that a successful deal would ultimately be struck. In mid-April, Secretary Mnuchin commented that the talks were “close to the final round” (Reuters, April 13). Through the first week of May, official PRC government sources also maintained a generally positive message that the talks had “achieved positive progress,” and consistently reiterated vague talking points that the country was seeking “a mutually-beneficial agreement on the basis of mutual respect” (China Daily, May 3; PRC Foreign Ministry, May 6). A May 8th commentary from the PRC state news agency Xinhua stated that “Negotiation teams have been working overtime to reach a deal that is good for both sides… At such a critical stage, the people of China, the United States and the world don’t want to see the outcomes reached in previous talks return to square one” (Xinhua, May 8).

The Breakdown of U.S.-China Trade Talks in Early May

However, there were rumblings of trouble when the PRC delegation arrived in Washington, D.C. on May 9th for another round of talks. Beijing’s intent to reassert centralized role in the trade dispute was signaled by the fact that, for this new round of talks, Liu He was stripped of his previous designation as Xi’s “special envoy” (CNBC, May 9). This possibly indicated that Liu and his team of negotiators had stepped beyond the comfort zone of the top CCP leadership, and that Liu’s room for maneuver in negotiating a deal was to be significantly curtailed.

Almost as soon as this new round of talks began, the negotiations abruptly broke down. On May 10th, the Office of the USTR released a statement that the United States had “increased the level of tariffs from 10 percent to 25 percent on approximately $200 billion worth of Chinese imports,” and would further “begin the process of raising tariffs on essentially all remaining imports from China, which are valued at approximately $300 billion” (USTR, May 10). In retaliation, the PRC Finance Ministry has announced additional tariff hikes of up to 25% on $60 billion in U.S. goods, to commence in June (CNBC, May 13).

Messages from PRC state media in the aftermath of the May 10th tariffs announcement have been a mix of nationalist defiance—accusing U.S. negotiators of bad faith and unreasonable demands, while asserting that China will not submit to foreign pressure—alongside muted conciliatory calls to return to the negotiating table. Most strikingly, the week beginning May 12th saw a flurry of editorials about the trade dispute in the official CCP mouthpiece People’s Daily—editorials that employed the pseudonym Zhong Sheng (钟声), a signal of increased authoritativeness and importance. [3] A Zhong Sheng editorial on May 13th asserted that China would “never yield to the extreme pressure from the U.S., or compromise on matters of principle,” but also that “cooperation is the only right choice for both sides… as a sound bilateral relationship can benefit not only China and the U.S., but also the whole world” (People’s Daily, May 13). A similar Zhong Sheng editorial May 17th re-asserted the theme that “China will never make concessions on major issues of principle,” and stressed that “its core concerns must be addressed” (People’s Daily, May 17)—potentially a veiled message for U.S. negotiators to back away from demands seen as threatening to the CCP’s domestic authority (see further below).

Reading between the lines, there are indications that the collapse of the talks has rattled CCP leaders. A PRC Foreign Ministry spokesman declared on May 16th that China had the “confidence and capacity to fend off any external risks and shocks” that might result from the trade disputes; and further declared that, despite trade disruptions, China had seen an above-projection GDP growth of 6.4% for the first quarter of 2019 (Xinhua, May 16). However, this is a figure subject to some skepticism, as it accords closely with what internal CCP sources have discussed as the rate of economic growth required to fend off social unrest (China Brief, March 22).

Why Did the Trade Negotiations Collapse?

All of this begs a fundamental question: What brought about the seemingly abrupt collapse of the trade negotiations? There are varying accounts as to what went wrong behind the scenes in late April and early May. However, the primary reason appears to be that, in early May, the PRC team presented their American counterparts with a dramatically edited-down version of a draft agreement-in-progress. This red-inked version gutted both benchmarks for progress and proposed changes to PRC law (such as more explicit protections for foreign firms against forced tech transfer and cyber espionage). U.S. negotiators had demanded these provisions, as well as stipulated enforcement mechanisms and penalties for non-compliance (such as additional tariffs).

By this account, the text of the agreement-in-progress encountered stiff opposition when the draft document was circulated amongst the higher echelons of the CCP in late April—to include fears that, if the provisions were made public, the government would appear to be caving to foreign pressure (SCMP, May 16). Other accounts have also emphasized broad pressure exerted against any agreement by state-owned enterprises (SOEs), whose interests would be directly threatened by U.S. demands to restrict industrial subsidies and export subsidies (Nikkei Asia, May 16). Some sources further speculated that Xi Jinping and other senior CCP figures may have overestimated the eagerness of their American counterparts to cut a deal—and thereby miscalculated that they could slip through a dramatic set of eleventh-hour demands (New York Times, May 16).

Whatever the specific details, it appears likely that senior figures in the CCP hierarchy—almost certainly including Xi Jinping himself—intervened to demand major revisions to the draft agreement, decisively rejecting any provisions that either bound the Chinese government to painful reforms, or which might be construed as buckling to U.S. pressure. As paramount leader, Xi is faced with appeals from technocratic officials to get trade relations back on track, and the ongoing trade disputes are hurting the economy—thereby potentially weakening Xi’s own position, and leading to fears of social unrest (China Brief, August 1, 2018; China Brief, September 19, 2018; China Brief, March 22). However, Xi must also contend with harder-line voices intent on rejecting U.S. demands, and Xi’s own instincts as a statist and nationalist have likely inclined him to throw his support behind this latter group. [4]

Conclusions

For the time being, the prospects for a comprehensive deal to end the U.S.-China “trade war” appear to be dim. On the Chinese side, there are likely two primary sticking points. The first is a staunchly nationalist mindset amongst a large proportion of the CCP leadership (and Xi Jinping himself) that any and all “foreign interference” in China’s affairs must be rejected, even when those pressures apply to international commitments that the PRC has assumed as a member of the WTO. This connects in turn to leadership fears of a loss of face amongst the Chinese public if the imposition of enforcement mechanisms, changes to PRC law, or similar provisions are revealed.

The second major reason may be the most difficult of all to overcome. Many of the demands presented by U.S. trade negotiators—such as the reduction of industrial subsidies—threaten a core element of PRC industrial policy, as well as the interests of China’s huge and well-entrenched SOEs. Senior-level SOE officials are closely integrated into the CCP hierarchy, and SOEs represent a major constituency within the party-state. Furthermore, throughout his tenure Xi Jinping has been engaged in an on-going drive to reinforce the leading role of SOEs as both economic actors and as institutions that buttress the ruling status of the CCP. It is on this account that demands to decouple state-provided benefits to SOEs could be interpreted by Chinese leaders as a threat to the PRC’s domestic political order. Finally, potential job losses associated with diminished state support to SOEs could lead to “social instability,” the perennial bugbear of the leadership.

The trade war with the United States has placed the current CCP leadership in a quandary: whether to consider concessions that could get exports and economic growth back on track, or to dig in nationalist heels in defense of the PRC’s existing economic and political order. Barring a sudden and dramatic policy shift in Beijing, for the foreseeable future the latter course appears far more likely.

John Dotson is the editor of China Brief. Contact him at: [email protected]

Notes

[1] Trade Act of 1974 [Public Law 93–618], Section 301 (pp. 191-193). http://legcounsel.house.gov/Comps/93-618.pdf.

[2] Office of the U.S. Trade Representative, 2018 Report to Congress on China’s WTO Compliance (February 2019), p. 2. https://ustr.gov/sites/default/files/2018-USTR-Report-to-Congress-on-China%27s-WTO-Compliance.pdf.

[3] Zhong Sheng (钟声) means literally “the tolling of a bell.” However, it is also a homonym for Zhong Sheng (中声), an abbreviated form of “the Voice of China” (Zhongguo zhi Sheng, 中国之声). This pseudonym has long been attached to particular editorials in People’s Daily when the authorities wish to assert that these editorials carry the official weight of high-level CCP central authority.

[4] Comments by Dr. Willy Lam in an e-mail to the author, May 16, 2019.