A New Direction for the China-US Phase One Deal?

The “Economic and Trade Agreement between the Government of the United States of America and the Government of the People’s Republic of China,” commonly known as the Phase One deal, entered into force on February 14, 2020. Under the agreement, China would, among other things, make structural reforms, open its financial services, and strengthen intellectual property protections. China also pledged to buy at least $200 billion more U.S. goods and services over 2020 and 2021.

However, after almost two years, complaints have arisen about China not meeting its obligations under the Phase One deal. According to the Peterson Institute for International Economics, as of October 2021 China had reached only 62 percent of that target. As the Phase One deal is set to expire in December 2021, questions linger as to enforcement and compliance, as well as the deal’s future.

The Phase One deal came at a time when trade war between the largest economies in the world was still raging. It all began back in 2018 when the United States imposed tariffs on $34 billion worth of imports from China, such as aircraft parts. In return, China imposed 25 percent tariffs on certain imports from the U.S., including agricultural products. In the intervening years, the United States and China exchanged tariff exemptions for certain goods. However, in recent months, the trade war has resumed again, as the Biden administration, for instance, has extended its predecessor’s ban on U.S. investment in Chinese companies that have ties with the military.

Exemptions from tariff lists and other trade measures of both the U.S. and China seemed to work in calming trade relation between them. This piecemeal approach will continue unless Washington and Beijing agree to a new deal, something unlikely to happen. As an alternative, the Phase One deal can be renewed by tweaking the numbers involved, i.e. how much China would import from the United States. In this way, the United States can rely on the hard fought deal and shift its focus to enforcement. Biden’s trade representative, Katherine Tai, previously indicated that she intends to focus on implementation of the Phase One deal in conversations with her Chinese counterpart, Vice Premier Liu He.

According to the Phase One deal, the U.S. and China agreed to an innovative approach on enforcing their agreement, as laid out in chapter seven. The Phase One deal created a Trade Framework Group to discuss the implementation of the agreement, led by the U.S. trade representative and a designated vice premier of the People’s Republic of China, as well as a Bilateral Evaluation and Dispute Resolution Office for each party. As in a typical trade agreement, a complaining party can submit an appeal to the Bilateral Evaluation and Dispute Resolution Office of the other side when there is an issue regarding the agreement. If this issue is not resolved, then the matter can be raised to the designated deputy U.S. trade representative and the designated vice minister.

In article 7.4, the Phase One deal provides that if the concerns of the complaining party are not resolved by the U.S. trade representative and Chinese vice premier, then:

… the Parties shall engage in expedited consultations on the response to the damages or losses incurred by the Complaining Party. If the Parties reach consensus on a response, the response shall be implemented. But if the Parties do not reach consensus, the Complaining Party may resort to taking action, including by suspending an obligation under this Agreement or by adopting a remedial measure in a proportionate way that it considers appropriate.

This is the novelty of the Phase One deal: It permits either party – practically speaking, most likely the United States – to unilaterally retaliate to an alleged breech of the agreement by suspending an obligation or by adopting a remedial measure in a “proportionate way.” This response is supposed to be aimed at “preventing the escalation of the situation and maintaining the normal bilateral trade relationship,” and the party being complained against is not permitted to retaliate in turn as long as the action “was taken in good faith.”

The language used creates room for wide interpretation of phrases such as “proportionate way” and “good faith.” Rather than achieving the purported goals of the Phase One deal – managing trade in a peaceful manner – the dispute resolution language may lead to escalation of trade tensions between the United States and China. This is exacerbated by the fact that, according to the Phase One deal, it is the complaining party who makes the final determination that there has been a violation of the agreement. There is no independent panel or a tribunal to make that determination. The Phase One deal is not clear on the remedial measures that can be taken by the complaining party, whether it is the suspension of tariff or quota concessions or imposing additional tariffs, and for how long these measures can be taken. In sum, the United States (or, in theory, China) can unilaterally determine that a violation has occurred, decide on countermeasures, and set the duration for suspending concessions made in the Phase One agreement..

This leaves us with the question of whether it is expected for both parties, but mainly the United States, to take unilateral measures to enforce the Phase One deal. Statements made by U.S. officials indicate that this is likely to happen. However, thus far, evidence shows that enforcement under the Phase One deal may not happen for several reasons.

First, when the U.S. takes an action, China can either accept the remedial measure, along with a promise not to retaliate, or withdraw from the Phase One deal. The latter option would be more harmful than taking the remedial measure itself. From a purely economic perspective, whatever targets are achieved under the deal are better than the alternative of reverting to trade wars with China.

In addition, from a geopolitical perspective, there are few, if any, alternative venues to force China to abide by its trade obligations. The World Trade Organization (WTO) is in bad shape, especially its Appellate Body, the “crown jewel” of the organization responsible for the final say on trade disputes. Even if the WTO was fully functional, there is doubt over whether the Phase One deal can be considered legitimate under WTO rules. The WTO Agreement on Safeguards provides that:

… a Member shall not seek, take or maintain any voluntary export restraints, orderly marketing arrangements or any other similar measures on the export or the import side. These include actions taken by a single Member as well as actions under agreements, arrangements and understandings entered into by two or more Members. Any such measure in effect on the date of entry into force of the WTO Agreement shall be brought into conformity with this Agreement or phased out.

Clearly, measures such as bilateral voluntary export restraints, orderly marketing agreements, and similar measure that limit imports of certain products are prohibited under WTO rules.

Putting aside the political rhetoric, opening the Phase One deal to re-adjustment and negotiations seems the most plausible option in the short term. The agreement has been a success, despite the numbers and flaws in the deal’s text. No country should be forced to import from another country, but China was willing to import from the U.S. in increased quantities.

In the short term, both the U.S. and China will continue to exempt on an ad hoc basis certain goods and services from harmful tariffs and other trade practices by both countries. As that continues, Washington should give diplomacy and negotiations another try.