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The Scorecard of the Phase One Trade Agreement

Published on February 14, 2020        Author: , and
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The United States President and the Chinese Vice Prime Minister signed a deal dubbed as the “Phase One Trade Agreement” (“the Agreement”) on January 15, 2020. The Agreement withholds further escalation of the on-and-off trade war, which has dragged on for over 18 months between the US and China. The Agreement will likely lay a foundation for the handling of managing the fierce competition between the U.S. and China moving forward, at least for the next several years. But as we discuss below, key issues such as Chinese government subsidies, disagreements over Huawei’s selling of 5G telecommunications equipment and U.S. export controls on high-tech goods were left unaddressed.

The 96-page Agreement contains eight chapters, covering intellectual property protection, technology transfer, trade in food and agriculture products, financial services, macroeconomic policies and currency, expanding trade, dispute resolution, and final provisions. The Agreement primarily focuses on addressing certain Chinese behaviors that have long been concerns for the U.S. and corporate America and aims at lifting the standards of conduct closer to those followed (at least in theory) by the United States. One of the most noticeable features of this Agreement is the obligations and structural changes China agrees to undertake: The phrase “China shall” appears 97 times in the text whereas the phrase “[t]he United States shall” only appears five times, two of which relate to promises undertaken by both China and the U.S. In certain areas, e.g., pharmaceutical-related IP rights and patent rights more broadly, China’s undertakings exceed those the U.S. secured from partners in other commercial treaties such as the United States-Mexico-Canada Free Trade Agreement (“USMCA”).

Hence the success of this agreement largely depends upon its implementation and enforcement by China, which has already generated doubts in several areas. Moreover, concerns have been raised over the Agreement’s consistency with the World Trade Organization (“WTO”). Some questions also arise regarding what exactly has been agreed upon given the vagueness of some of the language, particularly regarding China’s commitments to import more U.S. goods and services.

The Scorecard

The effort to halt further escalation of the ongoing trade war should be applauded. However, whether the Agreement is anything more than a two-year truce and will effectively address the underlying changing landscape in the bilateral relationship and the global economy, and with international trade rules, remains to be seen. Other than the U.S. assurances that its practices are equivalent to those required of it in the Agreement, there are only a few additional changes the United States undertakes. The United States promises not to impose 15% tariffs on the remaining $160 billion worth of Chinese goods imports and to reduce existing tariffs on $120 billion of Chinese imports from 15% to 7.5%. Yet, China receives few other benefits from the deal: some $370 billion of goods—about two thirds of U.S. imports from China—are still subject to punitive tariffs. Of course, tens of billions of dollars of U.S. exports to China are still subject to retaliatory tariffs, although some of those may be waived by Chinese authorities.

But does the U.S. get all it wanted, i.e., “righting the wrongs of the past and delivering a future of economic justice and security for American workers, farmers and families” as the President claimed? Not really. In fact, if one takes the United States’ concern about government subsidies and the concerns over high tech trade with China, the Agreement seems to be a far cry from what was intended.

First off, while the Agreement mandates comprehensive, specific, and detailed mechanisms that China is obligated to establish and adopt, the Agreement fails to address structural issues more broadly. Reducing deficits, especially through enhanced purchases promised by China may be one solution to right the wrongs of the past (although most economists would disagree). But issues relating to the systemic structure, such as WTO-illegal subsidies, industrial policies, state-owned enterprises, and national security concerns such as those surrounding Huawei and its sales of 5G equipment, are left unaddressed by this deal. China appears to implicitly pledge to address its skyrocketing outbound investments (its investment/industrial policy) in high-tech industry as a result of its “Going Out” policy in one sentence (Art. 2.1.3. of Chapter 2). But that is all. Perhaps one explanation is that the deal in theory responds to issues relating to Section 301 of Trade Act of 1974, which primarily regulates unfair trade practices concerning intellectual property. Thus, other issues may be addressed by a Phase Two deal if and when it could be concluded.

Secondly, many of the changes China agrees to undertake have already been implemented or are being considered for implementation under China’s domestic legislation and administrative authorities. For example, with respect to enhanced compensation and punitive damages in intellectual property rights, China has already increased statutory damages and provided punitive damages up to five times actual damages in trademark infringement cases (see Art. 63 of the Trademark Law of China). The legislature is also considering a similar increase in statutory damages and in introducing punitive damages in patent infringement cases in the fourth patent law amendment bill. In financial services, many promises made in the Agreement seemed to be addressed already by the newly effective Foreign Investment Law of China (“the Foreign Investment Law”) and the accompanying Implementation Measures for the Foreign Investment Law (Implementation Measures). Under the two domestic legislations, China is obligated to treat foreign investors and firms equally and in a non-discriminatory manner (see Arts. 4 (pre-establishment national treatment), 9 (equal application of national policy), and 16 (equal treatment in government procurement) of the Foreign Investment Law and Arts. 6 (equal treatment) and 41 (liabilities of violating the equal treatment obligation) of the Implementation Measures). The two domestic legislations further prohibit China from forcing foreign entities to transfer technologies to their Chinese counterparts or Chinese authorities as a condition of market access (see Art. 22 of the Foreign Investment Law and Art. 24 of the Implementation Measures). Also, in practice, China has already been giving greenlight to U.S. firms such as J.P. Morgan Chase & Co. in the financial services sector. Still, the Agreement provides an additional incentive for the Chinese government to fully implement these changes.

Thirdly, the underlying U.S.-Chinese competition and power-seeking in setting new international trade and economic rules are not settled by the Agreement (and may not be resolved for decades). Most notably, but perhaps not surprisingly, the Agreement does not address emerging issues such as privacy protection and data regulation relating to digital trade, or environmental protection and climate change. Negotiations between the U.S. and China under the current U.S. Administration in reducing the U.S. trade deficits can be traced back to as early as April 2017. As the U.S.-China trade war escalated due to the tit-for-tat tariffs after the release of the Special 301 Investigation Report, the U.S. has expected to achieve an agreement that also addresses issues such as “non-tariff barriers, cyber intrusions [,] and cyber theft[.]” However, those issues were left off from the “big deal.” When the world is still grappling with the standards in non-tariff barriers in emerging areas such as privacy protection and data regulation, as exemplified by the different approaches of European Union (in its General Data Protection Regulation), California (in its California Consumer Privacy Act), the U.S. (still missing a uniform federal standard), and Japan (in the G20 communiqués), this Agreement arguably could have served draw initial line on these areas. Maybe a ‘Phase Two’ deal will take up the task.

Fourth, as alluded to earlier, the effectiveness of this Agreement largely depends on its good faith implementation. Experts have already questioned the practicality of China’s promise to purchase $32-$40 billion of agricultural goods as the figures far exceeds the peak of past purchases China made and the ability of the U.S. agricultural sector to produce the additional products. Moreover, Chinese officials have affirmed that “market demand” in China will govern such purchases, which presumably includes such factors such as prices and the reduced demand for pig feed as a result of the catastrophic swine virus. The effectiveness of this part of the Agreement is further called into question when the coronavirus spread within China, dampening its economic activities. Furthermore, a successful implementation may (ironically) implicate potential violations of obligations both China and the U.S. have under the WTO framework. Experts have already raised alarms over the legality of tariff-rate-quotas in agricultural goods, departures from the MFN principle, the unprecedented extent of managed trade that the Agreement contemplates, and the harm the Agreement may do other nations. Moreover, no serious attempt can be made to justify many terms of the Agreement under the GATT exceptions in Articles XXIV (free trade agreements) or XXI (national security). Therefore, the cloud of WTO challenges (with few, if any, justifications) by other countries will likely be a factor that would perhaps impact China’s good faith implementation.

Fifth, in the unfortunate event that the Agreement is not fully implemented or either the U.S. or China disputes the effectiveness of the implementation, the bilateral, dialogue-focused dispute solution mechanism may be insufficient to resolve the issues. Unlike the dispute mechanism provided in the USMCA, where panels comprising experts selected from a roster are expected to be adjudicating disputes arising from treaty implementation, the Agreement provides for no such list of outside experts nor the constitution of such panels, nor any form of independent third-party adjudication. Under the Agreement, high-level officials such as the United States Trade Representative and a designated Vice Premier of the People’s Republic of China will lead the Trade Framework Group (Art. 7.2.1. of Chapter 7) while the daily work will be carried out by the staff under a Deputy United States Trade Representative and a Vice Minister under the designated Vice Premier (Art. 7.2.2. of Chapter 7). A detailed appeal process is designed to bring about prompt bilateral resolution of disputes (Art. 7.4. of Chapter 7), under which both the U.S. and China under certain circumstances may “suspend[] obligations under Agreement or [even] … adopt[] a remedial measure” in good faith without fearing a counter-response. However, if neither the U.S. nor China is able to resolve the issue whether such action is taken in bad faith through consensus, then the last option is for the alleged aggrieved party to withdraw from the Agreement (Art. 7.4.4(b) of Chapter 7). If the ultimate goal of the Agreement is to hold both countries accountable and to ensure good faith implementation, then it will be unlikely that the withdrawal will achieve the goal. Under the mechanism, neither country is required to resume treaty obligations (because a withdrawing party does have to) nor to lift or suspend the remedial measures taken. Thus, instead, it will exacerbate the disagreements and disturb international trade.

Lastly, the Phase One Trade Agreement totally ignores the existential crisis challenging the future of the WTO. The Agreement, however, did provide the preservation of the U.S.’s rights under the WTO Dispute Settlement Understanding (see Annex 15, Chapter 3). When two great powers — both are beneficiaries of the WTO and its rules and regulations — try to straighten their differences without addressing the imminent threats to the very existence of the structural safeguard, it would be hard to imagine the sustainability of the deal and the externality to other countries. Whether the issue relating to WTO reforms will be addressed in the Phase Two deal remains to be seen, but given the Trump Administration’s opposition to the WTO, and to third party dispute settlement in general, this seems highly unlikely.

Conclusion

For those who have cheered at the signing of the Agreement, it is one of a kind between two great powers, as the depth and comprehensiveness indicate, and improves on the very unfortunate status quo. While there are issues that were much anticipated but not ultimately included in the ultimate text, the current deal may reduce but by no means will eliminate the uncertainties in international trade resulting from the trade war, particularly for enterprises that are currently producing goods in China for customers in the United States. It may also create a basis for further negotiations. However, the Agreement’s importance in resolving bilateral issues rather than primarily constituting a temporary truce should not be over-estimated.

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One Response

  1. Kishor Dere

    Congratulations to the authors for highlighting so many aspects of the Phase One Trade Agreement signed by the US and China. The very title of this deal indicates that there will be more such agreements to further sort out the trade-related differences between the two nations. No deal can be perfect nor can it be expected to last forever.

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