U.S.-China Trade Dispute

U.S.-China Trade Dispute

Aly Song/Reuters
from Member Conference Calls

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China

United States

Trade

Donald Trump

The two largest economies in the world are exchanging threats of retaliatory tariffs, arousing concerns of a trade war and its repercussions. The United States and China have both recently announced tariffs on each other’s products, which are set to go into effect on July 6. President Trump has also threatened additional tariffs at a rate of 10% on another $200 billion worth of Chinese goods. Speakers discuss the recent developments of additional tariffs, the implications of a possible trade war, and the impact on the future of U.S.-China relations.

Speakers

Elizabeth C. Economy

C.V. Starr Senior Fellow and Director for Asia Studies, Council on Foreign Relations; Author, The Third Revolution: Xi Jinping and the New Chinese State

Brad W. Setser

Steven A. Tananbaum Senior Fellow for International Economics, Council on Foreign Relations

Presider

Robert McMahon

Managing Editor, CFR Editorial, Council on Foreign Relations

MCMAHON: Hello, everyone, and welcome to the Council on Foreign Relations conference call on “The U.S.-China Trade Dispute.” I’m Robert McMahon. I’m managing editor of CFR’s editorial operations, and I’ll be moderating this on-the-record call. And we have a very strong expert panel with us today to help guide us through the dispute.

Elizabeth Economy is CFR’s senior fellow and director for Asia studies, and she is author of a new book, The Third Revolution: Xi Jinping and the Rise of the (New) Chinese State. She also blogs on Asia Unbound.

Brad Setser is CFR’s senior fellow for international economics and has been closely tracking developments on the China front on his blog, Follow the Money. Brad served as deputy assistant secretary for international economic analysis in the U.S. Treasury Department from 2011 to 2015.

I will be speaking with Liz and Brad for about twenty minutes or so before opening up the call to our members.

Brad, I want to start out with you actually. We’ll be talking a bit about the Trump administration tactics on the tariff front, but first, can you talk a little bit about how we got to this point? And there’s much talk about China’s Made in China 2025 strategy. Is this the trigger for all of this?

SETSER: I think the trigger is probably—predates in some sense the increased focus on China 2025. I would say there had been a growing sense that China’s entry into the WTO had not completely addressed the United States’ commercial concerns with respect to China, that China’s domestic market remained—so yeah, the domestic playing field has remained tilted against foreign firms; certainly tilted against foreign firms that weren’t producing in China, and often tilted against foreign firms producing in China if they weren’t producing with the right joint venture partner. And so there was a sort of an accumulated sense that the WTO, on its own, had—you know, had to constrain China in some ways on the tariff front. But it hadn’t created a level playing field inside China.

Then throw on to that China’s Made in 2025 industrial policy, which essentially tries to target—you know, in the Chinese sense, upgrading industrial—upgrading their industrial structure in some key sectors—semiconductors, robotics, aviation, medical equipment, and so forth—and those are the sectors where the U.S. and U.S. firms tend to export to China, tend to have a strong commercial position. And Made in China 2025 sets out explicit targets for the market share of Chinese firms in those sectors, so they’re not—it’s unclear if those targets are completely enforceable, but the goal of China 2025 was both to subsidize Chinese production in those sectors and to subsidize and encourage Chinese production in sectors where there are large amounts of imports today. And in that sense, I think it has directed attention towards, you know, the ongoing efforts by China to become more self-sufficient in high technology, and in the process, squeeze out America and other foreign firms—or at least that was the perception.

And then the third factor is—probably the true precipitating factor was the election of President Trump, who campaigned very explicitly on—against China and against—you know, on the grounds that the playing field was completely unfair, that everything was rigged, and that he was going to get tough. So I think that’s the—it’s the confluence of a shift in U.S. politics and ongoing Chinese efforts to support Chinese firms at the expense of foreign firms, and to condition market access to the Chinese markets on tech transfer and, in some sense, helping China develop.

MCMAHON: And so he has—the Trump administration has chosen tariffs as one significant lever to try to move China. July 6 is the next deadline for some tariffs to take effect, and there’s going to be two phases that will total $50 billion worth of Chinese goods.

Can you talk a little bit about what’s going to happen on July 6, and what kind of goods we should be looking at in terms of the impact?

SETSER: So on July 6, the first of the—so these tariffs are all pursuant to a Section 301 case, so the underlying rationale is that China has—you know, has this set of discriminatory policies on technology transfer that warrants a U.S. response outside of the WTO. And as part of that process, the U.S. has identified fifty billion (dollars) or has come close to identifying fifty billion (dollars) in U.S. imports from China that it will tariff.

There are 35 billion products where the process is complete, the specific products have been identified, and those tariffs will go into effect on July 6. Those tend to be either goods which are—the beneficiaries are in sectors that benefit from China 2025 policy support, or in sectors that have been—where the U.S. believes that there are opportunities to substitute away from Chinese production, which tends to be in capital goods input, so parts that go into the production of, say, construction equipment.

The next set of tariffs has been—will be—are in the process of being identified, but the U.S. hasn’t gone through the legal hoops of publishing the exact schedule for the next fifteen billion (dollars), but that is clearly forthcoming and has been promised.

China (is retaliating ?) against these tariffs, and the initial round of Chinese retaliation focuses on U.S. auto exports of SUVs that Mercedes and BMW make and the U.S. sells to China, and then on the full gamut of agricultural exports as well as some energy exports. But by far the most significant category there is soybeans. And presumably there will be another fifteen billion (dollars) in Chinese retaliation once the U.S. goes forward with the second wave of promised tariffs.

Trump has indicated that if China goes ahead with its retaliation, the U.S. will respond with another two hundred billion (dollars) in tariffs at 10 percent rather than at 25 percent, and then if China responds to that two hundred billion (dollars), he will go ahead with another two hundred billion (dollars). Right now those are threats. The legal process that would be needed to put those tariffs into place hasn’t yet started.

MCMAHON: OK, and there’s been a great deal of growing speculation on another area of that if this process continues to play out and tensions continue to build that, you know, what would happen if China turned to its considerable Treasury holdings and started selling off those.

You had a long blog post on that at the end of last week. Can you recap in a nutshell what you—what we should be—how we should be looking at this issue of China’s Treasury portfolio?

SETSER: So I think it’s—the threat that China will sell its Treasurys should be viewed as one of a range of non-tariff responses that China may consider as—you know, if the tariff war keeps up and if the scale of U.S. tariffs on Chinese goods increases. China can respond and will respond, almost certainly, asymmetrically, most obviously by finding ways to penalize and punish U.S. firms operating in China, but also potentially, given that the U.S. tariffs will lower its exports, it’s quite conceivable that China might want to manage its currency down and intentionally weaken its currency. And China probably has the capacity to do that without making it appear completely obvious. It need not be a Chinese announcement that they are weakening the currency for trade purposes; it could just be that there are market pressures that materialize that push the currency down, and China allows that to happen.

And then the third—which gets a lot of attention—is the possibility that China could use its 1.2 trillion (dollars) in Treasury holdings—and I would say that probably understates China’s true holdings—and it’s 1.5 trillion (dollars) in U.S. bond holdings as a source of leverage and start selling. You know—

MCMAHON: That’s the largest of any country, right? That’s the largest amount of any country, right? Japan trails China in second place.

SETSER: Yeah, it’s significantly larger. I mean, it’s not significantly larger; it is larger than the Japanese portfolio, and the Japanese portfolio doesn’t just come from one investor. In China’s case, it’s almost entirely the portfolio of the central bank and its reserve managers.

You could argue, though, it’s actually the second largest Treasury portfolio in the world because the Fed has a quite large Treasury and agency portfolio, and I think that’s actually critical. When China is selling, it is very analogous to quantitative tightening in its effect on the U.S. Treasury market. China will be selling long-term Treasurys and buying short-term bills in the first few days if there were a sudden increase or a sudden emergence of Chinese selling, but I think it is likely that that Federal Reserve would respond, and it would respond either by signaling that, with China selling and with higher U.S. rates, it will slow its pace of conventional monetary tightening so there will be one fewer or two fewer rate hikes as long as China is doing this, and that conceptually should offset the—much of the impact of China sales.

And then the Fed is currently reducing the size of its balance sheet, and it could quite conceivably say, well, since China is selling and that’s having an impact on long-term bond rates, we are not going to continue with our balance sheet reduction, and that would help offset the impact of any Chinese sales. So my conclusion—and obviously this is much debated—is that China doesn’t get much leverage out of its Treasury portfolio.

Its real—the place where the U.S. should be worried and where China really can respond asymmetrically in a way that would damage the U.S. is the possibility that the trade war will prompt China to let its currency weaken because that is something that is very difficult for the U.S. to counter.

MCMAHON: Great. Thanks, Brad, for clearing that up.

Liz, I want to turn to you and talk about—get into the U.S.-China relationship a bit at this point—and how we got to this point on the relationship. Was it inevitable that we would get in such a round of trade tensions that we have at this point and what seems to be some sort of open-ended escalation that has raised a lot of concerns globally? What kind of—could you say a little bit about the kind of contact the two sides have been having?

ECONOMY: So thanks, Bob. I don’t think that it was inevitable that we would end up at this point. I actually think that President Trump, despite all of his campaign rhetoric, either came into office thinking that he could make real progress in the U.S.-China trade relationship—you know, he established this new mechanism, the Comprehensive Economic Dialogue. He started off with that one-hundred-day action plan but, you know, didn’t get the sort of type of change that he wanted, and of course, you know, six months, seven months in, by their annual meeting in July, they—and he cancelled the news conference, there was no joint statement, the president was launching the 301 investigation, and so I think that began the process of ratcheting things up in terms of the tensions, but I don’t think it was inevitable.

You know, we began this year with a round of tariffs on solar panels and washing machines, and then went to steel and aluminum, but we were still talking and, you know, we’ve had three rounds up until now—three rounds of threatened tariffs that have not come to anything, that haven’t materialized. I know there aren’t technically any negotiations going on right this minute but, you know, I’m not without hope that we might be able to forestall the actual imposition of tariffs on July 6. I think there is, you know, push from the business community that, you know, could get some action.

The Chinese certainly don’t want a trade war. I think they are—they have been confused and puzzled. You know, the reactions that I’ve seen emanating from China have run the gamut, you know, from, you know, saying the president’s efforts are irrational but that, you know, China is not going to back down, it’s going to fight back forcefully. You know, they are trying to call for calm. I think there is concern within China to go—you know, central bankers saying our economy is resilient and we’re prepared to manage this.

I think on the web, sort of the Chinese—the popular take—you know, there are lot of different discussions about why the administration is doing this. I don’t think that there is a belief that it’s really all about trade issues. You know, there’s talk of this being part of a broader strategy of containment, right, that this is an effort by the United States to contain China’s technological rise and Made in China 2025, that the U.S. is fearful of China’s technological prowess, that it’s part of a broader strategy of containment—once you link this with things like Taiwan where we’ve been sort of up in our relationship with Taiwan through the Taiwan Travel Act and, you know, sort of selling submarine technology that’s going on in the South China Sea.

And then I think there are also people that just say, you know, Trump is not only unpredictable, they’ve called him capricious. I saw one analysis that said that he was like a drunk driver driving through red lights and going the wrong way, that he needs constant attention, and he wants some kind of electoral advantage. So there’s a lot of, you know, musings to date on the Chinese web about what’s going on, but very little of it has to do with the actual issues, you know, from the U.S. perspective which are things like, you know, the subsidies and forced technology transfer, and so I think that—you know, there’s—and intellectual property theft. So I think there is a difference in understanding broadly about what the U.S. effort is all about here.

MCMAHON: I wanted to ask first a little bit of the atmosphere that you just mentioned and then get into the merits of the charges on the U.S. side but, you know, you mentioned this response from China that, you know, these charges of a, you know, irrational actor in the White House. Is this—does this mean that, you know, from China or a number of parts of the Chinese officials and they just—they felt they had figured Trump out but maybe didn’t and are still sort of sorting out where he could be going? Is there sort of a bunch of, you know, Trumpology going on in China right now?

ECONOMY: You know, I think that’s certainly the case. When I was there at the end of March, it was right after the president had announced the first potential imposition of fifty billion (dollars)—you know, tariffs on $50 billion worth of Chinese goods and had just announced—had signed into law the Taiwan Travel Act, and had announced that he was going to be meeting with Kim Jong-un. And so all of these things, you know, sort of put the Chinese analysts and officials with whom—as part of the delegation with whom we were meeting kind of put them on their back foot. You know, they were surprised by all of it and, you know, frankly, none of it in a very positive way. So I think, you know, they thought that we were talking and negotiating on the trade front. So that first threat of the big tariffs caught them by surprise.

And so I think they had begun—I think they thought they understood President Trump. They understood that he was unpredictable, but they had some sense that—in that unpredictability that they understood that there was a predictability, right, and they felt as though there were people within the administration that would keep things from spiraling out of control.

 

And so I think, yes, they’ve been surprised, and I think a little bit confused, not to mention the fact that they have come to the table now a couple of times with offers, and so I think—you know, what I heard also when I was there, that Liu He had just been there, China’s, you know, top trade negotiator, and that—he had just been there and had heard three different asks from three different parts of the administration. And so I think there was also a sense that there was not much cohesion within the administration, much coherency in what the administration was, you know, trying to get out of the negotiations and then later these threats on the tariffs.

So, yes, I think they are confused and, you know, again, they believed that they’ve, you know, come to the negotiating table in good faith, you know, offering to purchase $70 billion additional in U.S. goods and, you know, reduced auto tariffs, and opened up, you know, a range of markets, and you know, get rid of, you know, foreign ownership caps on banks, and made a bunch of different, you know, offers, and I think they are a little bit confused as to where we’re going with all of this.

MCMAHON: Liz, I wanted to follow up on some of the non-trade things you mentioned in your response, which included, you know, tensions in the South China Sea, with the Taiwan relationship, the North Korea denuclearization issue—just arriving maybe right as we’re talking or soon after is the Defense Secretary, Jim Mattis, for talks with China. How consequential or important are those talks in the midst of these trade tensions?

ECONOMY: You know, I actually think they are rather separate, and that’s not to say that Secretary Mattis couldn’t have an ameliorative, you know, effect on the overall relationship, but I think that the lines of discussion and debate are proceeding rather separately at this point. And Secretary Mattis has done a very good thing and said that he was going to China to listen, you know, going with a positive attitude. He doesn’t want to poison the well. I think that’s all very important.

You know, of course, he’s just cancelled Chinese participation in the RIMPAC exercises as a, you know, means of protesting what they’ve been doing in the South China Sea. And I was in Washington last week, and my understanding from some people in DoD is that, you know, they are prepared—this is a signal; you know, this is only a first step, and they have other sort of tools in their tool box—if the Chinese sort of make further assertive moves in the South China Sea—that they are prepared to unveil and release. So behind, you know, the velvet glove here of Secretary Mattis is definitely an iron fist.

So I think, you know, what he is doing—I think he’s going with the right approach. I think he wants to, you know, meet his new counterpart and have good discussions, but I think he—probably more than, you know, anyone else—has been out there on the front lines with the Chinese and, you know, not only dealing with China but I think also doing quite a good job, frankly, with maintaining alliance structures and developing good relations. So I think, to some extent, he’s going out there with a stronger hand and prepared to listen, but I don’t see that this is going to have an enormous impact on the trade relationship.

MCMAHON: Interesting. Great. Well, thanks to both of you for framing this.

We’re going to turn it over to questions from members in a minute, and so while you get some of those questions sort of organized, I wanted to ask a final sort of broader question for Brad about, you know, the broader trade climate. It’s not just trade tensions between the U.S. and China at the moment, it’s with Europe, it’s with our North American partners as well.

Can you talk, Brad, a little bit about, as we go through each step of these tariff rounds, what has been the impact and, let’s say, projected impact on the economic front? What have we seen so far as an impact and what is the concern area—what are the areas of greatest concern as the trade tensions increase sort of across the board?

SETSER: So I think the effects so far have been limited to specific sectors, so the steel tariffs have increased the price of steel, and now we’re starting to see the retaliation for the steel tariffs which will have a direct impact on the specific sectors that our allies have targeted for the response.

That effect is very real within the individual sector, but it has almost no significance or measurable macroeconomic impact. It might have an impact of, say, ten basis points, and they are, you know, one-tenth of a percent, but it’s hard to pull out the effect of a tenth of a percent on the overall economy from natural fluctuations.

I think with the potential of tariffing up to four hundred and fifty billion (dollars) in goods from China, that would be a little over 2 percent of U.S. GDP, and with the added potential—and I think this is probably the one that would have the—conceivably the biggest macroeconomic impact—the threatened tariff on autos and auto parts, which would be another four hundred billion (dollars) and the proposed—or the number that are being batted around for the size of that tariff are pretty substantial. Then you are putting, potentially, tariffs on eight hundred billion (dollars) of goods, imports, which is about 4 percent of GDP that would be tariffed, and range between 10 and 25 percent, and you are looking at a—sort of like an estimated shock to the economy because, in the first instance, there are no real possibilities to shift towards U.S. production with the economy fairly strong right now, and just with the way supply chains and everything else are organized.

So I think in the first instance the primary effect would be an increase in the price of imports together with retaliation, and then you are looking, I think plausibly, at a drag from—you know, a short-run drag from the trade war of up to a percentage point of GDP. That obviously is coming at a time when the tax cuts and the increase in the spending caps are putting a fairly significant stimulus into the U.S. economy, but you would be really looking at the kind of measures that would be of the scale that would significantly offset the impact of the tariffs.

MCMAHON: Got it. Thank you.

Well, I think we’re ready to open this up now to members on the call, so operator, could you let us know if there is a question?

OPERATOR: Yes, sir. Ladies and gentlemen, at this time the floor is open for your questions.

(Gives queuing instructions.)

And we’ll give it just a few moments to populate for questions.

MCMAHON: So while that’s happening, I guess a quick—one more quick follow-up to Brad, which is there has been some new research indicating that Chinese investment in the U.S. declined by I think about 90 percent or more the first five months of this year. Are we going—is that—is that another sign of an abrupt change to come, and are we looking at—with the proposed U.S. move to curtail Chinese tech investments—a real sort of chill in Chinese investments in the U.S?

SETSER: I mean, I think there has been already a chill on Chinese investment in the U.S. at least if it is not the product of a specific agreement with the Trump administration. And clearly the proposed restrictions on technology investment will only add to that chill.

That said, it’s sometimes a mistake to look at—only at the U.S. and see the fall in Chinese investments in the U.S. simply as a function of U.S. policy. The surge in Chinese investment in the U.S. in the preceding year came in part because Chinese investors were looking to move money out of China, in part because of expectations that the yuan was going to fall.

And at the beginning of 2017, the Chinese—for their own reasons, to enforce their own capital controls—really did crack down quite significantly on outward direct investment. And so it’s not just that Chinese investment in the U.S. has fallen; Chinese investment globally has fallen because of this crackdown.

So on one level there has clearly been a chilling effect. On another level, China itself made a policy decision that it wanted to slow outward investment.

MCMAHON: Got it. Thank you.

Operator, turning back to you to see if there are any questions on the line from our broader membership.

OPERATOR: Yes, our first question comes from Steve Hallman (sp).

Q: Can you hear me?

MCMAHON: Yes, please go ahead.

Q: Yeah. So you guys described very well the sort of escalation process of the current situation. Do you—can you describe what a face-saving—and I would stress that because I don’t—it doesn’t seem like either side is particularly interested in backing down from their positions—what would be a face-saving eddy that we could get off on, you know, from this route? What would that look like and to what—I mean, what probabilities would you assign to it? And then can you describe the other—I mean, make the outcomes kind of discrete and assign some probabilities to them?

MCMAHON: OK, Brad, do you want to try that first, and then Liz?

SETSER: Yeah, everybody wants to try to assign probabilities. I find it an impossible exercise because unless you are inside the Oval Office and speaking directly with the president and know his mind and his mood, I don’t think it is possible to guess.

I think the key thing here is that a lot of this is, by all accounts, coming directly from the president, so you are trying to handicap the president’s own decision making. I think there are some potential opportunities to at least slow the pace of escalation. I think the thirty-five billion (dollars) is I think pretty much baked in, but then there is a little bit of a lag before the U.S. can go up to the full fifty billion (dollars). And I think, you know, China’s retaliation of the first thirty-five (billion dollars) is baked in, but China could slow walk any further retaliation, in part because China’s best sectors to retaliate against in some sense have already been used up, and as they try to increase the scale of their retaliation, they start doing more harm to their own economy. And so if China were to maybe not explicitly move away from matching the U.S. dollar for dollar, but to walk back from matching the U.S. dollar for dollar at the time when tariffs are imposed, that could provide a little bit more time for negotiation. And then I think, you know, there is an intrinsic opportunity to negotiate after the tariffs that are now in train are put in place simply because the expansion of the tariffs threats to the—to another two hundred billion (dollars) or to another four hundred billion (dollars) requires a period of consultation, and there will be pushback from U.S.—affected U.S. industries during that period.

So it’s—there is like sort of an escalation ladder, and during—that escalation ladder takes time, and throughout that period there are opportunities to pull back. The—presumably the face-saving compromise, to the extent that there is one, would be a combination of the offer that China has already put on the table, and then an additional set of concessions, and those don’t seem to have been identified, that might go some way to addressing U.S. concerns around Made in China 2025.

The offers that are on the table so far are further purchases of agricultural goods, certainly for the purposes of U.S. LNG and energy. China, I’m sure, would like to co-invest in some of those LNG facilities. Reductions in auto tariffs—the timing and scale of that reduction could be changed. So far it’s going to be phased in, and it wouldn’t bring Chinese tariffs down to U.S. tariff levels, but China conceivably could give Trump full reciprocity and reduce Chinese tariffs on U.S. auto exports to the U.S. level of 2 ½ (percent). And then some lifting of the joint venture caps—if you take that package and start to add in some potential compromise—and this is where I think it is hard to see precisely what the compromise is—on China’s technological upgrading, Made in China 2025, which would create more opportunities for U.S. firms that invest in China to benefit from Chinese industrial upgrading, you know, as a mixed bag, I think, from the U.S. point of view, but that would offer some opportunity for more of a face-saving kind of compromise.

So if there is a deal, that would seem to me to be the deal space, and I think, in return for all that, China would certainly want the U.S. to pull back on the investment, and particularly the proposed export controls, which China no doubt perceives as a U.S. attempt to contain its industrial rise. So there’s going to be—there would need to be some kind of broad compromise where both parties—you know, where the U.S. shows more willingness to pull back from the tariffs that it has shown right now, and where the Chinese go beyond the offer that they’ve put on the table.

Maybe Liz has a different idea, though.

ECONOMY: No, thanks. Sorry, I got dropped from the call, but—so I think Brad has articulated it quite well. Maybe I would only say I—upping the offer from seventy billion (dollars) to a hundred billion (dollars) would probably be helpful as well. I think that was a number that President Trump had put out there to begin with.

But I think the other aspect maybe would be to begin actually implementing some of these pledged reforms, right, so that it’s a phased-in process, you know, where tariffs are—you know, tariffs are reduced in 2020 or 2022 or, you know, caps are released in, you know, another five years, but actually to see some change in Chinese practice up front as opposed to sort of phased-in targets that give the feeling that these things are never going to come or that the Chinese are going to find a number of alternative barriers, or regulations, or restrictions that in some way are going to neutralize what otherwise would be a positive impact from the changes that they have proposed. So I guess I would only add maybe upping the offer and actually taking action sooner rather than later.

MCMAHON: Great. Thank you. Thanks for that question. And a reminder this is today’s CFR on-the-record conference call—operator, do you have another question, please?

OPERATOR: Yes, our next question comes from Eric Wong.

Q: Hello? Hello?

MCMAHON: Yes, please go ahead.

Q: Yeah. Unfortunately, you know—

MCMAHON: Yes, you are on the line. Please go ahead.

Q: Navarro has spoken about keeping the tariffs there so that the entire supply chain in China might be shifted over time. Would there be a possibility that the intention is actually to keep the tariffs there instead of using the tariffs as a way of negotiation?

MCMAHON: Brad, do you want to get a crack at that?

SETSER: I’ll—yeah, I mean, I think that’s part of the confusion about U.S. goals. I think that is quite—that is a conceivable outcome, and I think that probably is Navarro’s end goal, and that he may well view across-the-board tariffs on Chinese goods as a positive for precisely that reason, that they would create an incentive over time for supply chains to relocate away from China, and from his point of view, it probably would be a good thing if that were just a relocation to Vietnam because he views Vietnam and others in Asia as, you know, less of a competitive threat.

And, you know, you could certainly look at the decision to lower the rates of the tariff from 20 to 10 percent as the U.S. expands the tariff list and they move in that direction. It makes it more tenable to hold those tariffs in place for a longer period of time. It doesn’t jack up prices to U.S. consumers quite as much, but it jacks up the frictions and costs along the supply chain enough that it would incentivize shifts.

Now there’s a couple of caveats there. One is that, as I mentioned, China wouldn’t sit passively as supply chains relocated away from China, and the most obvious response if you are hit by a shock to your exports is to let your currency depreciate, and that could offset the cost of the tariffs if the tariffs remain at relatively low levels, and that would put the onus on the U.S. to escalate again. But I certainly think that that is part—that is a realistic end-state outcome, and it may well be what the hawks within the administration want.

MCMAHON: OK, thank you. Thanks for that question.

Operator, do we have another question, please?

OPERATOR: Yes, our next question comes from Irving Williamson.

Q: Yes, thanks. Excuse me.

Yes, I want to talk a little bit about this by talking about some of the issues that China might address, but one of the ones I didn’t hear that was much talked about was the things that have been really the central focus of the Section 301 complaint about the forced technology transfer practices of China, and intellectual property protection, and those things which I think would be most significant for U.S. companies.

And I was wondering whether the—is there any indication the Chinese are willing to do something in those areas?

ECONOMY: Well, I would just say—

MCMAHON: Brad, do you want to try that again?

Or Liz, sorry, go ahead.

ECONOMY: Oh, I was going to say something, yeah. I think from the Chinese—what the Chinese say is that they are constantly improving their intellectual property rights protection efforts, and indeed, there is evidence from, you know, the AmCham China and the U.S.-China—EU China Chamber of Commerce that that is the case; that the courts are being strengthened in Shanghai, for example. There are an increasing number of cases going, there are some problems with the number of staff that the courts have, that they are not really up to the job fully, but they are trying to make some progress moving that direction. It’s just not moving as quickly, of course, as many companies need, but that the direction overall is a positive one.

SETSER: Yeah, we’ve been working on this for almost (twenty ?) years now.

ECONOMY: So I that that’s part of it. I think in the forced technology transfer, the Chinese deny that they do that, so there’s not really a recognition that they do forced technology transfer and, you know, they make the case that companies, you know, make their own decisions about where to invest, and how to invest, and whether to invest. And so that’s their response to that. So I think they argue that they are doing a better job on IT protection—while not perfect but moving in the right direction—and the tariff goes a long way, by the way, to address this, and its, you know, unilateral approach is the wrong way, but if there is a problem then the United States should take this to the WTO, right—should takes cases to the WTO. And then on forced technology transfer, I’ve only seen them deny that.

MCMAHON: Thank you. Brad, anything to add on that?

SETSER: You know, I mean, I think, you know, the hard part—you know, the easiest solution to the forced technology transfer problem would be to allow U.S. firms to invest in China with wholly-owned subsidiaries so there was no need for a joint venture, and then there would be no negotiation with the joint venture partner over the terms of the joint venture, which frequently is where the technology transfer requirement is introduced. And you know, as we’ve said, it’s not a legal requirement; it’s a de facto requirement that emerges out of the need, in many cases, to have a joint venture partner for investment approval.

But even if you get rid of the—if you allow U.S. firms to set up wholly-owned subsidiaries, then there is a question about whether the wholly-owned subsidiaries would have the same opportunities as Chinese firms or firms that enter into joint ventures, and whether the playing field inside China would still be equal. And that ultimately requires a change in attitude and a shift—a real shift in policy inside China, and that I at least haven’t seen evidence that China has been willing to put on the table.

On the IP protection front, the counter, a little bit, to the progress that Liz cited, is that, you know, if you look at the Micron case that came out over the weekend, you know, in the sectors where China is trying to make a fast push to increase its industrial capabilities because it views its current reliance on imports as a strategic vulnerability, so in the semiconductor space where, you know, the ZTE case highlighted to China the risk that China faces from its—you know, the vulnerability that China now has because it relies so heavily on imported chips and imported chip designs. And in those sectors, it still seems that there’s a fairly aggressive effort to obtain needed technology by any means possible.

So, you know, I’m not sure that there is an easy solution in some of those areas in particular because those areas have, at least in my view, some of the deepest support inside China.

MCMAHON: Great. Thanks for the great question that cuts to the core of a lot of these issues.

Operator, do you have another question, please?

OPERATOR: Yes, our next question comes from Abby Cohen.

MCMAHON: Please go ahead.

OPERATOR: Ms. Cohen, your line is open. You may need to unmute your line.

Q: Oh, thank you. Can you hear me?

MCMAHON: Yes, we can.

Q: Excellent, thank you. Actually, the last questioner posed the questions that I was most interested in having to do with technology transfer and so on. It seems to me that this is a really critical area, as it cyber security in this category.

But if I can just use this opportunity to branch out a little bit in terms of the discussion, I understand that the speakers are focusing in on China, and perhaps other relationships within Asia, and so it would be interesting to me to hear about other disruptions that we see or are expecting to see in supply chain.

Just one anecdote is Harley-Davidson announcing today that they will be shifting some of their production out of the United States because of the possibility of imposition of tariffs. Have you seen this sort of movement you addressed before, that the Chinese would not be doing this much FDI, in some places perhaps would be willing to do more FDI in the United States, but what about U.S. companies and their FDI?

MCMAHON: Brad, do you want to take a first try at that?

SETSER: Well, I think U.S. companies—you know, I think there are those particular products where there already are meaningful tariffs in place, and where other countries have responded by targeting particular U.S. products and, you know, in some cases, you know, bourbon and the like, it is impossible to shift the location of production outside of the United States. In other cases, firms will respond to tariffs by adjusting their production patterns to try to limit the cost of the tariff on them, and I think that’s what’s driving the Harley-Davidson decision.

I think the hard thing right now is that it isn’t clear where the safe harbor is—meaning if the U.S. is going to impose tariffs on—sorry—on China, one logical response would be to reorganize your supply chains around North America and do more of what is now done in Asia inside North America and likely inside Mexico. But there is still deep uncertainty about NAFTA, and that means that it is hard for companies to plan. And I think, you know, you go—you go—you can go through any—most sectors and that level of uncertainty is I think likely to impede shifts until the full extent of the Trump trade policy revolution, if it is one, is clear.

Let me give a concrete—couple of concrete examples, just to be precise. U.S. imports from China have actually been growing quite rapidly this year. That’s because the U.S. economy is expanding, so despite all the talk and the rhetoric to date, there isn’t actually much evidence of meaningful changes in the pattern of trade.

Mexican auto exports to the U.S. are also up this year. That’s makes logical sense because the Mexican peso has weakened because of some domestic Mexican factors, but also because of the uncertainty around NAFTA.

The dollar is, broadly speaking, now strengthening as well, which discourages the location of production in the United States. So I think companies, when faced with the combination of economic incentives, you know, rising wages in the U.S, and a stronger dollar that are not encouraging relocation of production in the U.S, and then with the uncertainty around where they should shift their supply chains, I think then, broadly speaking, you haven’t seen many examples of major reorganizations yet, but unambiguously, if the full contemplated tariffs are put in place, there will be major shifts in most industries.

MCMAHON: Thank you. Before moving on, I just want to see if Liz wanted to add anything on that front.

ECONOMY: No, that’s fine.

MCMAHON: OK. Thank you. Operator, do we have another question, please?

OPERATOR: We do. Our next question comes from Robert Hormats.

Q: Hi. One issue that has come up in the past relating to trade is its relationship with the negotiations between the two Koreas and America’s role. One notion earlier on which seems to have been eliminated by what has happened recently is that the United States would be kinder and a little bit more lenient to China on the trade front in return for which China would be more supportive and helpful on the Korea negotiations.

So my question now is do you see any linkage at all between what the United States may or may not be asking China to do vis-à-vis North Korea and the U.S. decisions going forward with respect to this whole variety of trade and investment issues? In other words, is there a link? If so, what kind? Or has that linkage simply gone by the boards?

MCMAHON: Thank you. Liz, can you take that one?

ECONOMY: I would say I think that the link has been gone for a while, Bob. You know, I think President Trump tossed that out there pretty early in his first six months or so, and I think, you know, very quickly we’ve seen these two sets of negotiations proceed on different tracks, on separate tracks, and so, you know, even if there were some sort of—you know, even if he raised it again, it doesn’t seem as though progress on North Korea or getting the Chinese to do anything more is going to be tied to the trade.

I think at this point the negotiations on North Korea have moved beyond the sort of potential even for this kind of trade linkage. I think, you know, Kim Jong-un is often a very independent actor. I think, you know, the one threat the Chinese might make is, well, they’ve already gone to the United Nations and, you know, started this discussion of sort of easing the sanctions on North Korea, but I don’t see the president then offering—he said we’re going to continue with—even if we’re not calling it maximum pressure—maximum pressure on the trade sanctions, and I don’t see him offering to the Chinese to lessen, you know, the—sort of step back from this tariff war to try to gain their support on North Korea, you know, and the sanctions there. I think he views that as, you know, we’ve all agreed to this process, and China could potentially look like a bad actor if in fact it stepped back from its, you know, trade sanctions before North Korea made any meaningful concessions.

So I personally don’t see any likelihood that that kind of linkage is going to be reintroduced, and I don’t think it has played an important role for a while.

MCMAHON: Thank you for that question. Operator, do we have another question, please?

OPERATOR: Yes, our next question comes from Fred Hochberg.

Q: Hi. Just a couple—(inaudible)—

MCMAHON: I’m sorry, but you are breaking up a little bit, so—I’m sorry, could you start again. You are breaking up a little bit. I couldn’t catch the first part of that.

Q: You know, why don’t I pass because I’m not in a great place—the cell service where I am is terrible, so I’ll just pass. It’s OK.

MCMAHON: Oh, OK. Thank you. Operator—

Q: I just—I mean, there’s a really bad connection here—

MCMAHON: OK, sorry about that. Operator, do we have another question, please?

OPERATOR: Yes, our next question comes from David Sandalow.

Q: Thanks. Could you please say more about ZTE? How does ZTE fit into this whole picture, and what explains President Trump’s approach to the company?

MCMAHON: Great question. Brad, would you like to take that first?

SETSER: I don’t think I know, to be honest, and I feel like I follow this pretty closely. It remains one of the more inexplicable, sudden presidential policy decisions. I assume that the Chinese made listing the export restrictions on ZTE a very significant priority. Supposedly it was a precondition for the restarting of any talks to avert the escalation in the trade war, and it may have been linked to China’s approach to North Korea and the run-up to the summit. The U.S. may have gotten some concessions in other areas, but it is a little—a little difficult to understand on its own—at least that’s sort of my view.

Obviously it’s—to the Chinese it has highlighted their vulnerability to U.S. sanctions in a very real way, and ZTE is not Huawei. It is not their leading telecommunications equipment national champion, but it is a very important, significant, indigenous Chinese company, and the fact that one of their—what they view as a leading example of China’s technological success could be brought to its knees and almost put out of business because of a U.S. sanction highlighted their vulnerability, and I’m sure it was kind of critical that the Chinese made lifting those sanctions a pre-condition for a host of other negotiations.

That said, it is unusual for the U.S. to go down a process of enforcement against a company for violating sanctions and then violating an agreement, and as you know, then lift the enforcement activity as part of a broader deal. Usually enforcement sanction stands on its own. So I don’t feel like I fully understand the logic. Maybe Liz does.

ECONOMY: No, I think everybody was puzzled when the president said that, you know, he wanted to help Xi Jinping and, you know, there were going to be too many Chinese workers who were going to suffer from this. But it came at a very odd time, in particular, since, you know, American soybean farmers and pork producers were already feeling the pinch. He didn’t say anything about them.

You know, I wondered, frankly, in the background whether or not some U.S. companies that had dealings with ZTE, you know, that either, you know, that dealt with ZTE, that sold to ZTE, or used services, whether they might not have been also pushing in the background for the, you know, sanctions to be lessened in some way. So that was—my thought was that there was some activity going on, right, in the U.S. business community that was putting some pressure on the administration to change course.

MCMAHON: Thank you. Thanks for that question. I think we can fit in at least one more question here. Operator, is there another one on the line, please?

OPERATOR: Yes, our next question comes from Sean Randolph.

Q: Good morning.

MCMAHON: Good morning.

Q: Could you say a little bit more about the role of the WTO in this? You touched on it at the beginning, and I’m wondering to what extent, in the issues we are talking about this morning, is China in compliance with its WTO obligations, and to what extent could the issues being dealt with now by bilateral tariffs be addressed in the WTO, or is this really a non-WTO set of issues?

MCMAHON: Brad, do you want to take that?

SETSER: Well, I mean, there’s a debate about whether some of the specific concerns around tech transfer could be addressed through a WTO case. I think it’s—the way I would characterize it is that it is a debate, and some people believe that there are violations of China’s specific WTO commitments that could be pursued.

The bulk of the U.S. complaint, though, doesn’t necessarily lend itself to a WTO case now unless you want to go for a broad, non-violation violation kind of case where you are arguing that China has violated the spirit, even if not the specific law. As was mentioned, China doesn’t impose a tech transfer requirement on foreign investment into China. That would be a clear violation of its WTO commitment. However, when negotiating with a Chinese partner, if the Chinese partner wants to condition its investment in the joint venture on technology transfer, there is nothing in the WTO that precludes commercial negotiation between two parties over the terms of a joint venture. So the Chinese will always say that their activities are consistent with their WTO commitments, and it just happens that, as a matter of best commercial practice, Chinese companies want there to be tech transfer as part of any JV operating in China.

China engages in a lot of subsidies for various domestic industries. Subsidies—domestic subsidies are allowed under the WTO, and proving a specific subsidy in an economy where, in some sense, everything is subsidized through the state banking system has generally been fairly difficult, and in the WTO you have to wait until there is a—that domestic subsidies have an adverse impact on you before you can bring a case. So there will be cases, but in China 2025 those cases can’t be really pursued until the subsidies generate industries and those industries are demonstrably impacting the U.S. and the U.S. economy by reducing U.S. exports in China or by leading to a wave of Chinese exports back to the U.S.

So there isn’t necessarily a straightforward WTO case for addressing all of these concerns. I would really recommend—if I could only recommend one thing to read on China, Mark Wu of Harvard Law has a brilliant paper on the difficulties of fitting China’s party state into the WTO and its system of jurisprudence. The immediate WTO cases that are likely to arise because the Trump administration has not pursued the more narrow, available WTO options—the next step is that every other country that has been adversely impacted by the Trump tariffs, where they are the ones impacted by the 232 steel tariffs, or China, in response to the 301 tariffs, they will file cases into WTO saying that the U.S. is acting outside of its WTO rights and that the U.S.’s tariff are WTO illegal. And so the next round, I think, will largely be a round playing defense as other countries challenge what I think most would say are WTO-illegal tariffs that the U.S. has put forward.

MCMAHON: Thanks, Brad. Liz, anything to add on this WTO?

ECONOMY: No. I would just note that Brad is exactly right, and actually, countries have already gone to the WTO, including China, the EU. And China is talking about trying to forge a coalition with India and others, so I think, you know, Xi Jinping and the Chinese see this as an opportunity—the fact that we are, you know, fighting this multi-front tariff war, see it as an opportunity for China to appear as, you know, the stable, rules state, you know, globalizer and to invite other in to work, you know, against what the United States is trying to do, so—and I think they see it as an opportunity in that regard.

MCMAHON: The global stakeholder that the U.S. has sought, in other words.

Well, thanks, Liz, for that wrap-up. That’s the final word on this CFR on-the-record conference call on “The U.S.-China Trade Dispute.” My thanks to CFR Senior Fellows Elizabeth Economy and Brad Setser for guiding us through this, and thanks to all of you on the call.

This concludes this CFR call.

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