Why the US and China settled for a trade truce

An irresistible force – President Trump’s trade agenda – has met an immovable object known as China Inc., and the result is an uneasy truce.

Both sides over the weekend backed away from threatened tariffs. China agreed to buy more US energy and farm goods and, on Tuesday, cut its tariffs on imported cars from 25 percent to 15 percent.  

The challenge for both sides is that the nub of their trade conflict – technological prowess – has no easy answers. The United States relies on its technological edge and its huge market to keep ahead of its economic rivals. China, which is by some measures a larger economy, is determined to rival or surpass the US in key technologies, such as artificial intelligence and robotics. For now, say trade analysts, this tension will likely play out as a soft rivalry rather than a trade war, as Mr. Trump had threatened to unleash.

The confrontation is part-and-parcel of the duel between two economic and political systems, one with lots of government control (China) and the other (the US) more market-oriented. And it’s unlikely to be assuaged by a face-saving trade deal, no matter how many Illinois soybeans China might purchase to try to reduce the US-China trade deficit.

“The trade imbalance, that’s the surface of the cannonball, but at the core of the cannonball is this techno-nationalism,” says Erik Lundh, senior economist with The Conference Board in New York. “There’s a little phrase that I’ve been hearing [in trade circles] and it goes: ‘No trade war but no trade peace.’ “

Technological tug of war 

The current tug of war over China’s ZTE Corp., a telecom manufacturer, has come to symbolize this technological conflict.

For the US, ZTE reflects the kind of double-dealing typical of China when it comes to keeping its word, in this case sanctions. After China pledged to uphold US sanctions against Iran and North Korea, ZTE nonetheless sold US technology to both nations from 2010 to 2016. The US Commerce Department investigated and last year ZTE agreed to pay a $1.2 billion fine and discipline the employees involved.

When ZTE didn’t discipline them and tried to hide that fact, the Commerce Department responded in April with a seven-year ban on buying US parts. That pushed ZTE to the brink of collapse because without US parts it couldn’t keep manufacturing its telecom equipment and mobile devices. Its Hong Kong-listed shares were suspended last month.

In an apparent move aimed at securing Chinese support for a planned North Korean summit, President Trump said last week the US penalty was too harsh on ZTE.

But he got a sharp bipartisan rebuke from Congress. On Tuesday, the Senate Banking Committee unanimously passed a bill prohibiting the administration from softening the ZTE penalties as well as imposing stricter export controls and national-security reviews of Chinese high-tech deals in the US. The same day 27 senators, including leaders from both sides of the aisle, wrote a letter urging US departments to reject any easing of tech-export controls in any future US-China trade deal.

China may draw a different conclusion from the ZTE debacle.

That one of its technology stars, employing nearly as many people as Google, could implode because of US policy serves as a reality check. For all its prowess in artificial intelligence and supercomputing – where experts say it may be a year ahead of US challengers – China remains woefully behind in other aspects of technology, such as specialized microprocessors. That means redoubling efforts to boost its own technology base to reduce its reliance on key parts from the US and Europe. 

“This punishment on ZTE does not encourage but forces the Chinese government and Chinese companies to depend on themselves more, because we have lost our trust in this global value chain,” says Tu Xinquan, executive dean of the China Institute for WTO Studies at the University of International Business and Economics in Beijing. “That's really serious….It will [erode] trust in the global value chain, especially in the US supply.”

But neither China nor the US can turn their backs on their technology trade without important economic consequences.

For the US, China serves not only as a source of finished goods – think cellphones and TVs - but also for low-cost tech components in complex global supply chains. And especially in the Chinese tech sectors that the US Commerce Department had targeted for tariffs, a large chunk of China’s exports to the US are really sales of components from US-owned or affiliated companies in China, according to new research by the Peterson Institute for International Economics.

Thus, the lion’s share of China’s high-tech exports are not coming from indigenous companies like ZTE but from foreign firms ranging from Apple to Cisco Systems that have expanded their manufacturing operations in China. And any tariff on those imports will be a tax on US or other foreign companies and their global supply chains, writes Mary Lovely, a senior fellow at the Peterson Institute. “US firms rely on global supply chains to remain internationally competitive.”

Fewer joint ventures for technology transfers

China, too, can ill afford to go it alone. Research published earlier this year shows how Chinese companies in recent decades have improved their technological know-how via mandatory joint ventures with foreign firms, such as US and German automakers. That practice has come under sharp criticism recently from the US.

This practice has waned since China joined the World Trade Organization in 2001. One reason is the rules of the WTO. Another is that fewer companies were investing in China, says Wolfgang Keller, professor of economics at the University of Colorado at Boulder. “If you require a domestic partner, you will have … fewer takers.”

While the initial tech transfer from joint ventures proved extremely useful, China – in an increasing number of areas – has allowed multinationals to set up their own operations.

These trans-Pacific realities make a trade war less likely, despite the current confrontation. “I don’t think this is going to be a sea change one way or another,” says Mr. Keller. “It’s going to be an evolving process.”