March 5, 2019 / 3:06 PM / 6 months ago

Column: United States and China inch towards limited trade deal

LONDON (Reuters) - China and the United States appear to be inching towards a trade deal, with leaders in both countries anxious to avoid a further, politically unpopular slowdown in their economies.

FILE PHOTO: U.S. Trade Representative Robert Lighthizer (4thL), Treasury Secretary Steven Mnuchin (3rdL), Commerce Secretary Wilbur Ross, White House economic adviser Larry Kudlow and White House trade adviser Peter Navarro pose for a photograph with China's Vice Premier Liu He (4thR), Chinese vice ministers and senior officials before the start of U.S.-China trade talks at the White House in Washington, U.S., February 21, 2019. REUTERS/Joshua Roberts/File Photo

China has reportedly offered to boost its purchases of farm and energy products substantially while making more modest concessions on technology transfer, intellectual property, market access, industrial policy and subsidies (“U.S., China close in on trade deal”, Wall Street Journal, March 4).

China is already the world’s largest net importer of oil and is set to become the largest importer of liquefied natural gas within the next few years, so the purchases allow the country to source supplies it will need anyway.

By agreeing to buy LNG and crude from the United States, China is not making much of a concession; the only losers are rival suppliers such as Australia, Canada, Russia and around the Middle East Gulf.

Similar logic applies to farm products, where China is a major net importer; any bilateral trade deal will come mostly at the expense of third-country exporters such as Russia, Argentina and Brazil.

China’s import requirements could also be used to justify including major capital equipment purchases in any eventual deal, including aircraft and semiconductor manufacturing kit.

Major purchases of farm and energy products would give a boost to the White House, shoring up support in farm and energy-producing states critical to President Donald Trump’s re-election campaign in 2020.

By focusing on farm and energy products, both countries can reach a politically and economically necessary accord, while making limited progress on more difficult issues.

ADVERSARIES

Top policymakers in China and the United States have each identified the other country as their primary strategic competitor - and rivalry has heated up to the point where they regard each other as the top strategic adversary.

For both countries, that raises thorny questions about how far to rely on the other in terms of supply chains and technology systems, even as they prepare for possible economic, diplomatic and military conflict in future.

For the United States, increasing exports of commodity products such as oil, gas and soybeans avoids difficult decisions about exporting more sensitive dual-use high technology products.

For China, increasing imports of energy and farm products from the United States represents an unwelcome increase in dependence on a potentially hostile supplier.

But China’s policymakers may conclude import dependence is inevitable in any event, at least in the short term, either from the United States or other U.S.-aligned countries.

Moreover, buying large volumes of U.S. farm and energy products will create a powerful constituency inside the United States in favour of positive trade relations in circumstances short of armed conflict.

In any future downturn in trade relations, increased farm and energy exports will give China more leverage, since it could threaten to reduce them or cut them off completely.

U.S. farmers and energy companies will not want to see the recent tariff conflict repeated in the next few years because the stakes for them next time around will be even greater.

So China’s policymakers may well conclude increased import dependence is a price worth paying in the short term to secure more space to modernise the country’s economy and military.

ESCALATION

Even in the event of a future military confrontation, the risks of China’s dependence on U.S. imports may be exaggerated.

Future conflict between two nuclear superpowers with extensive naval and air capabilities, hypersonic carrier-killer and satellite-killer missiles is likely to escalate rapidly.

It is unlikely any conflict would last long enough though for the denial of energy supplies to have a significant effect on China’s war-fighting capability.

Many commentators continue to focus on the potential for China’s energy supplies and other imports to be interrupted by a blockade such as in the Strait of Malacca or naval action in the Pacific.

The model is Napoleon’s Continental System aimed at the United Kingdom in the early 19th century or Anglo-German submarine warfare and naval blockades during World War Two.

In practice, any future conflict between the United States and China is unlikely to be an extended war of attrition; the introduction of nuclear weapons has made such scenarios implausible.

They are more likely to remain indirect (Afghanistan) or come to a head quickly (Cuba), like the strategic competition between the United States and the former USSR.

China therefore has little to lose from boosting U.S. oil, gas and farm imports in the short term, while continuing to develop alternative suppliers and focusing on reducing its dependence on imports from all sources.

DEPENDENCE

Far more difficult for both countries is the question of how to manage their increasingly deep technology and communications relationship.

Future strategic competition and conflicts are likely to focus on information warfare, disabling command and control systems, and potential threats to critical infrastructure such as telecoms and power networks.

The United States has already launched a high-profile and aggressive campaign to shut China’s telecoms companies such as Huawei out of its domestic market and third countries.

U.S. officials have alleged, without providing proof, that using Huawei’s equipment could allow China’s spy agencies to eavesdrop on or disrupt communications networks.

There are also concerns about transfers of high-technology dual-use items from the United States to China and training China’s scientists and engineers at U.S. universities.

And the United States has upgraded its systems for blocking the transfer of sensitive technology and vetting sensitive foreign investment.

All these concerns apply in reverse. China is likely to remain concerned about allowing companies based in the United States, the European Union and Five Eyes countries (the intelligence alliance between the United States, Britain, Canada, Australia and New Zealand) to control domestic data and technology that could be used for espionage.

Questions about technology transfer, data-processing and information security are likely to prove much more difficult and probably cannot be resolved at this time.

In the best-case scenario, a limited agreement creates some goodwill to address these issues later and stabilises the deteriorating bilateral relationship.

By giving Trump and China’s Xi Jinping a personal stake in the success of a deal reached at a high-profile summit, it could create the atmospherics needed to resolve other tricky subjects.

In the worst-case scenario, a limited agreement or no deal leads to an escalating cycle of confrontation and distrust in other areas as the two countries fail to find any common ground, further poisoning the entire relationship.

John Kemp is a Reuters market analyst. The views expressed are his own.

Related columns:

- U.S. may have overshot in China trade talks (Reuters, Feb. 18, 2019)

- White House escalates China trade dispute to secure early breakthrough (Reuters, Aug. 2, 2018)

- U.S./China trade threats likely to slow global growth (Reuters, April 10, 2018)

- Markets underestimate risk of an accidental trade war (Reuters, April 5, 2018)

- With trade war, U.S. and China stumble into Thucydides’ Trap (Reuters, April 4, 2018)

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