The Office of the United States Trade Representative (USTR) announced December 13, 2019 that the US and China have reached a "historic and enforceable agreement" on a Phase One trade deal, though significant questions remain as to its terms and the future of the current US-China trade conflict.
While the text of the agreement has not yet been finalized, the deal purportedly includes concessions by China in the areas of intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange. Additionally, the agreement includes a commitment by China that it will make "substantial additional purchases of US goods and services in the coming years," according to the USTR. In exchange for these commitments, the United States has agreed to defer some tariffs on Chinese imports indefinitely, and to reduce others.
This client alert provides information on the Phase One agreement, the next steps in US-China trade relations, and issues that remain open after the agreement.
Key Provisions of the Phase One Agreement
As the text of the agreement has not yet been released, the only sources of information are the statements issued by the US and Chinese governments describing the terms of the agreement. In most cases these descriptions are consistent, though there are some differences that will need to be clarified by the text of the agreement itself.
In return for the concessions made by China, as described below, the US has announced it will suspend the planned Section 301 List 4B tariffs on US$180 billion in imports previously set to go into effect on December 15, 2019 and reduce the Section 301 List 4A tariffs on $120 billion in imports imposed on September 1, 2019 from 15% to 7.5%. Tariffs on Section 301 Lists 1-3, imposed on $250 billion in imports, will remain unchanged at their current 25% rate. USTR has already published a Federal Register notice suspending the List 4B duties, and has indicated that a notice reducing tariffs on List 4A will be issued "in the near future" – perhaps meaning not until the text of the Phase One agreement is finalized.
Increased Purchases of US Products
According to USTR, China has agreed to increase its purchases of US goods and services by $200 billion over the next two years. This overall purchasing agreement would include $40-45 billion in annual agricultural purchases. USTR Robert Lighthizer has stated that China agreed to guarantee $40 billion, but strive for $45 billion in agricultural purchases. Both USTR Lighthizer and President Trump have suggested that Chinese agricultural purchases may reach as high as $50 billion. Throughout the negotiations, China has demonstrated resistance to a numerical target and a desire to allow purchases to be governed by market forces. Consistent with that position, during a press briefing last week, Chinese officials did not provide exact figures for levels of agricultural purchases.
The USTR fact sheet says that China has committed "to import various US goods and services over the next two years in a total amount that exceeds China’s annual level of imports for those goods and services in 2017 by no less than $200 billion." Agricultural purchases beyond the 2017 level – which was $24 billion – will count towards the $200 billion over two years figure, suggesting that China has agreed to increase its US agricultural imports by roughly $16 billion per year and its US non-agricultural goods and services imports by roughly $84 billion per year, relative to 2017 levels. There have been no official comments to date, however, on whether the commitment to $200 billion in new purchases will be split evenly across the two years covered in the agreement. According to USTR, the terms of the Phase One deal, if adhered to, will cause US exports to China to roughly double. US goods exports to China were about $128 billion in 2017.
The financial services chapter is reported to remove barriers including “foreign equity limitations and discriminatory regulatory requirements.” The removal of these barriers will benefit “US providers of a wide range of financial services, including banking, insurance, securities, and credit rating services, among others.” The specific nature of China’s agreement on this point has not yet been described.
With regard to intellectual property, China has reportedly committed to implementing new protections for copyrights and trademarks. USTR Lighthizer called China’s commitments on intellectual property “a real breakthrough,” “very specific,” and similar to, though more detailed than, the intellectual property provisions in the US-Mexico-Canada Agreement. The USTR fact sheet states that the intellectual property chapter addresses “trade secrets, pharmaceutical-related intellectual property, geographical indications, trademarks, and enforcement against pirated and counterfeit goods,” without providing details on the nature of China’s commitments in these areas.
Forced Technology Transfer
With regard to forced technology transfer, USTR Lighthizer noted that the United States secured an “enormously important first step” in China’s commitment not to require companies to turn over their technology in order to receive administrative licenses. The USTR fact sheet adds that China has committed “to refrain from directing or supporting outbound investments aimed at acquiring foreign technology pursuant to industrial plans that create distortion.” The issue of forced technology transfer associated with inbound investment was one of the key issues identified in the Section 301 report issued in 2018, which formed the legal basis for the United States’ decision to impose additional duties on Chinese imports.
With regard to currency, China reportedly agreed to increase the transparency of the process by which it manages the value of the renminbi. USTR Lighthizer said that China also committed in a “binding and enforceable” way to not competitively devalue the renminbi.
Food and Agriculture
The agreement also includes commitments by China on certain food standards, commitments with regard to China’s biotech approval process, and commitments to increase the transparency of its domestic agricultural support programs. According to the USTR fact sheet, the Agriculture Chapter will address a number of structural, non-tariff barriers to trade, which will help facilitate a “dramatic expansion” of US exports, including of agricultural products, “meat, poultry, seafood, rice, dairy, infant formula, horticultural products, animal feed and feed additives, pet food, and products of agriculture biotechnology.”
Enforcement and Dispute Settlement
A significant issue for the United States throughout these negotiations was developing a method to ensure the enforceability of China’s commitments, and the Phase One agreement purportedly includes a provision to this effect. USTR Lighthizer described the agreement’s dispute settlement system as a process whereby complaints would be raised initially at the staff level and could rise to the deputy and then principal levels in the event of an impasse. If a disagreement were to persist at that point, the aggrieved party could undertake a valuation of the offense and then implement a remedial response derived from that valuation. Companies will also be able to submit complaints anonymously to mitigate concerns of individualized punishment outside of the system.
USTR Lighthizer told reporters on December 13, 2019 that while China had not committed to reducing or rolling back any of the retaliatory duties it has imposed on US goods, he expects that China will use an exclusion process to remove duties from products it wants to import from the United States.
On December 15, China announced that although it would not roll back already-imposed tariffs, it would suspend additional tariffs on certain US products, including vehicles and auto parts, which had been set to go into effect that same day.
Additional US Concessions
In addition to the agreement to defer tariffs on List 4B imports and to reduce the duty on List 4A imports, Chinese officials indicated that the US had agreed to an increased number of product exemptions from the US tariffs on Chinese goods, and to an increase in Chinese agricultural exports to the United States. These terms have not been reflected in the information released to date by USTR.
Finalizing Phase One
China’s Vice Minister of Commerce Wang Shouwen said the US and Chinese delegations would move to quickly conduct a legal review, translation, and authentication of the reportedly 86-page Phase One agreement. USTR Lighthizer has said that he expects to sign the agreement in early January 2020 in Washington with Vice Premier Liu He, at which point it would be publicly released. The US has stated that the agreement will take effect 30 days after signing.
Starting Phase Two Discussions
President Trump said on December 13, 2019 that Phase Two talks would begin “immediately,” and would not be delayed until after the 2020 US presidential election. To date, the parties have not reported when the Phase Two talks would commence, and likely will not do so until the Phase One agreement is finalized.
If the Phase One agreement is consistent with public statements from the parties, it will be a significant step forward in reducing the trade tensions between the two countries. However, even the generally positive public statements raise questions and concerns about the specific terms and feasibility of the agreement.
Feasibility and WTO Consistency of China’s Agreement to Increase Agricultural Purchases
A centerpiece of the Phase One agreement is China’s apparent commitment to increase its purchases of US goods and services, including agricultural products, but this commitment is somewhat unclear and raises potential problems of its own.
As noted, both President Trump and USTR Lighthizer have reported that China’s purchases of agricultural products will be in the range of $40-45 billion annually, and could be as high as $50 billion annually. These targets substantially exceed the highest levels of agricultural purchases ever made by China from the United States. The high-water mark for these purchases was in 2013, when China purchased $29 billion in US agricultural products. By 2017, that figure had declined to $24 billion. Since 2017, prices for the largest US commodity exports have declined slightly, meaning that surpassing this threshold will require the United States to ship an even greater quantity of agricultural products just to meet this 2017 level, which is around half of the target range announced by the United States.
Assuming that China has agreed to increase its imports to these levels, it may be necessary for purchases to be made by the government, either directly or through state-owned enterprises. It remains unclear, however, how China could make such purchases in a manner consistent with its WTO obligations toward its third country trading partners like Brazil and Australia. An article published by Xinhua News Agency in the wake of the Phase One deal stated that imports from the United States would follow “WTO rules as well as market rules and business principles,” according to a translation. The same article went on to suggest that the deal would not impact China’s current purchasing relationships: “Expanding China-US trade will not affect interests of other trading partners.” How China will be able to meet these Phase One targets without affecting its relationship with its other trading partners remains to be seen.
Enforcement Mechanism and the Potential Return of Import Duties
Throughout these negotiations, USTR has insisted on a robust enforcement mechanism to ensure China’s compliance with its commitments, and based on USTR’s reports, such an enforcement provision will be included in the agreement. While the specific consequences of a breach of the agreement have not been publicly discussed, it seems clear that at least one possible remedial response would be the prompt reinstatement of, or increase to, Section 301 duties. This suggests that importers will continue to live under a threat of potential reimposition of duties, which means that importers should continue to explore duty mitigation strategies.
Prospects for a Phase Two Agreement
While the US has pronounced the Phase One agreement to be a “historic” agreement that addresses a number of longstanding irritants in the US-China commercial relationship, the reality is that the most intractable issues identified in the Section 301 report remain unresolved. Notable among these issues is China’s overall industrial policy, including its “Made in China 2025” plan to develop its indigenous capacity in ten key industrial areas. Given the importance of these industrial policies to China, it is difficult to believe that these issues could ever be resolved to the satisfaction of the Trump Administration, and certainly not in the short-term. It is equally hard to believe that this administration will be willing to reduce the remaining Section 301 tariffs unless and until significant progress is made on this follow-on agreement. Therefore, businesses should remain prepared to deal with the 25% tariffs on List 1-3 products for some time.