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US-China trade deal leaves '900-pound gorilla' on the loose

For the U.S.-China trade war, the "phase one" deal being signed in Washington today represents more of a ceasefire than a peace treaty.

If phase two negotiations are as tricky as many commentators claim, the two sides may be headed for something like a Cold War.

Despite agreeing to cancel further tariffs on Chinese goods in exchange for a commitment to purchase $200 billion of U.S. goods and services, duties remain on billions of dollars of trade between the world's two largest economies and the thorniest issues have yet to be addressed.

Exactly what is in phase one and, therefore, what is left for phase two, remain a mystery, because of the secrecy around the specifics of the deal. The nine-chapter agreement does include measures that address U.S. concerns on Chinese intellectual property practices, forced technology transfer, and would create a dispute resolution chapter, according to a statement from the United States trade representative, but details are sparse.

'900-pound gorilla'

Issues including subsidies and state-owned enterprises will likely be left for phase two. They will be much more challenging because they threaten the heart of the Chinese economic system. State-owned companies comprised as much as 28% of the Chinese economy in 2017 and employed as much as 16% of the population, according to World Bank research. That compares with an OECD average of just 2.5% employment from SOEs.

"They have been the 900-pound gorilla in the room since negotiations began more than a year ago," said Doug Barry, a spokesman for the U.S.-China Business Council. "These will be difficult talks, and it will take time to see progress."

The council is keen to know how the proposed dispute resolution mechanism will work and anticipates that a further opening of the Chinese market to U.S. entertainment suppliers will likely be tackled in the early stages of phase two.

"Overall, we think conditions are favorable to successfully address many issues that have prevented U.S. businesses from competing with China on a level playing field," Barry said in an interview. "Visible, quantifiable progress will bode well for additional phases."

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Those expecting rapid progress on phase two may be disappointed, as the U.S. heads into an election year that U.S. President Donald Trump will be hoping delivers a strong economy.

Future trade negotiations with China will be "tedious," but there is unlikely to be further escalation on the part of Trump in order to keep the U.S. economy strong, said Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics.

Favorable economic policy

The trade conflict has upended company supply chains, led to factory closures, and resulted in higher production and consumer costs, giving Trump's political rivals ammunition to attack him. Those criticisms appear not to be working at present: last week, a Financial Times-Peterson poll showed a sharp increase in support for Trump's economic policies, with 51% saying that they had either "strongly" or "somewhat" helped the U.S. economy.

As well as the phase one deal, both sides have taken steps to ease their fraught relationship. The Trump administration announced Jan. 14 that it had stopped labeling China a currency manipulator, while in October 2019, China further opened its financial services sector, allowing for the creation of wholly owned foreign banks and the establishment of insurers by foreigners.

Calm markets

However, the U.S. will keep the existing tariffs imposed on imports from China until both sides finalize the second stage of their trade negotiations, Treasury Secretary Steven Mnuchin said Jan. 14.

"Trump will mainly be looking to keep the markets calm and avoid tariff escalation," said Simon Lester, associate director of the Stiefel Center for Trade Policy Studies in Washington. "A grander deal would be nice, but temporary trade peace is probably enough for him."