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February 11, 2020 – On January 15, 2020, the United States and the People’s Republic of China (“PRC”) signed a self-described “Phase One” Economic and Trade Agreement to address a number of complaints raised by the United States against China involving the bilateral U.S. – China trade and economic relationship. The Agreement will come into force on February 14, 2020. A Fact Sheet published by the Office of the U.S. Trade Representative (“USTR”) describes the principal features of the Agreement.
The Agreement covers a number of areas that have been long-running irritants to the United States in its trade and economic relationship with China. These include, principally, intellectual property protection for U.S. companies doing business in China and technology transfer practices affecting U.S. investment there; access to China’s financial services market; currency manipulation; structural barriers facing U.S. agricultural exports to China; and the imbalance in the value of trade between the two countries. The Agreement also includes what in the trade context is a somewhat novel dispute resolution process, giving the parties the ability to determine for themselves whether the other party has violated the Agreement and allowing them to take appropriate remedial actions unilaterally. In exchange, the United States agreed to a partial roll back of one of the four sets of tariffs that the United States has imposed under Section 301 of the Trade Act of 1974 in response to what the Trump Administration viewed as unfair practices by China.
As the title “Phase One” suggests, the current Agreement only partially addresses U.S. concerns; other, knottier problems, particularly U.S. claims that China’s industrial policies distort global markets and that China is involved in cybertheft of U.S. technology, have been put off until a Phase Two agreement. In the meantime, all of the other U.S. tariffs imposed on Chinese imports as a result of the Section 301 investigation will continue. Given the difficulties in reaching an agreement on the comparably easier Phase One issues and the realities of U.S. politics in a presidential election year, it is all but certain that further meaningful developments will have to wait at least until after November 2020.
Finally, a potential cloud hanging over smooth implementation of the Agreement is the current coronavirus outbreak in China, which as of this writing continues to spread rapidly. Beyond the human impact, there will certainly be adverse economic effects, the severity and duration of which cannot be known at this time. How all this may affect China’s ability to carry through with its commitments under the Agreement remains to be seen.
The Phase One Agreement can best be viewed as a partial (and perhaps temporary) truce in the ongoing U.S.-China tariff war, which began with the U.S. decision in August 2017 to invoke Section 301 to investigate certain Chinese government practices. Section 301 authorizes USTR to investigate foreign government measures that allegedly discriminate against and burden U.S. commerce, and to propose to the President appropriate remedies. In this case, the Chinese measures that were subject to the Section 301 investigation included government subsidies to state-owned enterprises, inadequate protection of U.S. intellectual property rights, cybertheft of U.S. companies’ technology, and forced transfer of technology by U.S. companies seeking to do business in China.
In response to the USTR’s April 2018 findings in the investigation, in June 2018 President Trump ordered the imposition of an across-the-board 25% tariff on $34 billion of goods imported from China. China imposed retaliatory tariffs, and the United States responded with 25% tariffs on additional categories of Chinese imports, in three additional tranches between August 2018 and May 2019, which ultimately came to $250 billion in Chinese goods. On August 30, 2019, the President directed that a fourth tranche of tariffs be levied in an amount of 15% on an additional $120 billion in Chinese imports. For more information on Section 301 tariffs, refer to our earlier reviews of the tariff actions on Tranches One, Two, Three, and Four, along with the exclusion process from Tranche Four.
Throughout the latter part of 2018 into 2019, the U.S. and Chinese governments were engaged in on-again, off-again negotiations toward an agreement resolving the U.S. complaints. The Phase One deal is the result of those efforts. As noted, the Phase One deal is only a preliminary deal. It does not purport to address the more difficult issues arising from the Section 301 investigation and sets no timeframe for addressing them.
The Phase One Agreement
The Phase One Agreement is a 90 plus-page document divided into eight chapters, covering intellectual property; technology transfer; trade in food and agricultural products; financial services; macroeconomic policies and exchange rate matters; expanded Chinese purchases of U.S. goods; a dispute resolution procedure; and concluding provisions. Each of the first seven substantive chapters is summarized briefly below.
While the substantive chapters are frequently framed as mutual obligations, the obligations are largely on the Chinese side. The only specific U.S. commitment (not even stated explicitly in the Agreement) is to partially roll back the fourth tranche of U.S. tariffs by cutting the rate on affected goods from 15% to 7.5%, effective February 14, 2020, and to refrain from implementing new tariffs. All of the other tranches are likely to remain in effect unless and until a Phase Two deal is reached. For its part, China has announced that on February 14 it will halve its import tariffs on $75 billion of U.S. goods, which China had imposed in retaliation for the U.S. tariffs.
Intellectual property. Chapter 1 of the Agreement addresses a number of intellectual property concerns. These include the following:
China has made a number of commitments in these areas, although in some cases the Agreement reflects actions that China had already taken. (For example, while the Agreement requires China to implement additional statutory safeguards against trade secret misappropriation, the Chinese government arguably already enacted regulations in April 2019 to protect foreign intellectual property in China.) Further, certain areas of the Agreement’s intellectual property chapter provide few concrete details, e.g., the pharmaceutical portion of the Agreement (which does not identify specific drugs or targets), providing China a certain degree of latitude in determining how to comply with its Chapter 1 obligations.
Technology transfer. Forced technology transfer, one of the central U.S. complaints about Chinese policies, only covers two pages of the Agreement, reflecting the reality that the Phase One Agreement could not resolve this issue. Chapter 2 articulates the laudable principles that companies of one country should be able to invest in the other country without force or pressure from a government to transfer technology, and that transfer of technology from a company of one country to a company of the other country must be based on “market terms that are voluntary and reflect mutual agreement.” However, these principles may not address realities faced by U.S companies seeking to invest in China, which may feel that they have no choice as a practical matter but to agree to technology transfer if they want to be in the Chinese market. At this time it is unclear how effective these provisions will be; the United States will almost certainly want a Phase Two agreement to address this issue more forcefully.
Trade in food and agricultural products. Chapter 3 of the Agreement provides lengthy and detailed rules designed to facilitate trade in agricultural products between the two countries, primarily focused on facilitating U.S. access to the Chinese market. Annexes to Chapter 3 cover a number of specific areas, such as dairy products and infant formula; breeding cattle; meat, poultry, and processed meat; meat inspection; aquatic products; rice; feed additives; pet food; Chinese subsidies for its domestic agricultural producers; agriculture biotechnology; and food safety.
Financial services. Chapter 4 sets out commitments China has made to open its markets to U.S. financial service companies in the areas of banking; credit rating services; electronic payment services; financial asset management; insurance; and securities, funds management, and futures services. Some commentators have noted, however, that China already has provided for such access in its domestic law, so that the Agreement does not really give U.S. financial services companies a new level of access to China.
Macroeconomic policies and exchange rate matters. Chapter 5 is intended to address U.S. concerns about past Chinese manipulation of the renminbi exchange rate to boost China’s exports. This chapter does nothing more in that regard, however, than confirm China’s existing commitments to the International Monetary Fund not to manipulate its currency for the purpose of improving the trade-competitiveness of exports. Just before the signing of the Phase One Agreement, the U.S. Treasury Department removed its former designation of China as a currency manipulator.
Expanded Chinese purchases of U.S. goods. Chapter 6 of the Agreement commits China, by the end of 2021, to purchase a minimum of $200 billion dollars of U.S. goods over and above the 2017 level of U.S. exports to China, with specific targets for manufactured goods, agricultural goods, energy products, and services. A 20-page Annex to Chapter 6 spells out the commitments by sector and by year, and contains a detailed listing of the items covered by the commitments. It should be noted that some commentators have questioned whether these commitments violate China’s WTO obligations.
Interestingly, Article 6.4 requires that the United States “ensure to take appropriate steps to facilitate the availability of U.S. goods and services to be purchased and imported into China.” Given that some of the goods listed in the Annex may require U.S. Government export licenses for export to China, there may be some tension between this part of the Agreement and U.S. policies to restrict the export of high tech items to China.
Dispute resolution. A common feature of many international trade and investment agreements is a dispute resolution process by which the parties may elevate their disputes to a third party, whose decisions the disputants agree to accept. The Phase One Agreement does not follow this model. Instead, Chapter 7 provides, first, for the complaining government to file its complaint with the other government which, following its review of the complaint, will begin consultations with the complaining government at a working group level. If the dispute cannot be resolved at that level, it will be escalated, ultimately to the level of the USTR and a designated vice-premier of the PRC.
If the dispute still cannot be resolved, the parties are to “expeditiously” consult on the damages or loss experienced by the complaining party. If no consensus can be reached, the complaining party is free to take action as it sees fit, such as by suspending part of its own obligations under the Agreement, or by adopting a remedial measure that is “proportionate” and “appropriate.” If the complained-of party believes that the remedial action taken by the complaining party was in bad faith, it may withdraw from the agreement.
As noted, disputes must be initiated by the government of a party. This means that U.S. companies with concerns about implementation of the agreement must convince the USTR to accept the complaint before raising the issue with China. Depending on the political climate in Washington at the time, companies may find the USTR quite receptive to accept and act on complaints of non-compliance.
Finally, Article 7.6.2 envisions that a natural disaster or other unforeseeable event outside the control of a party may impede a party’s ability to timely comply with its obligations. The current coronavirus crisis in China could be an early test of that provision.
What is Not Addressed
While the Phase One deal does begin to address some of the major sticking issues in the U.S.-China trade relationship, as the name “Phase One” makes clear, the Agreement only reflects a partial resolution of U.S. complaints, and the remaining issues may be much harder to resolve.
First and foremost is the issue of the Chinese government’s continued involvement in large sectors of the economy. It is difficult to envision that the Chinese will easily agree to give up the government’s leading role in setting industrial policy and in implementing it by means of complex regulatory interventions and subsidization, and the basis of an agreement that would significantly move the needle on these issues is difficult to imagine. Equally problematic will be issues related to cybertheft of intellectual property, cybersecurity requirements, and access to the Chinese government procurement market.
Second, one of the most important Phase One victories claimed by the Trump Administration was China’s agreement to increase its purchases of U.S. goods over the next two years by $200 billion. Assuming that China can even process that level of additional imports by the end of 2021, this Agreement may further entrench the Chinese government’s role in the economy and, in any event, may provide only transitory benefits to the United States.
Last, but certainly not least, and not addressed in the Agreement, is the larger and long-term economic and geopolitical rivalry between the two countries. Many in the United States believe that China’s drive (through its “Made in China 2025” project) to become the world leader in cutting-edge technologies threatens what the United States has long seen as its leading position in the global economy, particularly in the area of technology. This competitive dynamic manifests itself on the U.S. side by means of the multifaceted regulatory approach the Trump administration has undertaken. For example, the U.S. Government has been aggressive in its efforts to prevent the Chinese company Huawei from becoming the dominant global provider of 5G goods and technology. The United States has also revamped the rules used to examine foreign investments in the United States–the resulting enhanced scrutiny in the CFIUS review process is widely seen as an effort to restrict the ability of Chinse firms to invest in U.S. companies, particularly in high tech sectors. Other recent U.S. actions of this nature include stronger U.S. export controls that may target Chinese access to cutting-edge U.S. technologies and the recent U.S. Commerce Department proposal to provide for review of transactions involving information and communications technology and services. All of these interventions are beyond the scope of this alert. They will, however, certainly continue to loom over the fraught U.S.-China trade relationship.