Beyond the mechanics of the “Phase One” deal and tariffs, the Biden administration is likely aiming for a broad rethink on how the U.S. approaches international trade and globalization.
- The Phase One trade deal was largely a failure. However, this failure is not likely to bring about new tensions because the Biden administration could de-emphasize the purchase targets in the agreement. Instead the focus will be on continued structural reform.
- While tariff removal is not likely, the focus is going to be more on non-tariff actions – like domestic subsidies and industrial policy – in order to encourage domestic manufacturing.
- The policy platform is still rife with contradictions, namely – how to move away from Trump’s brand of protectionism while largely pursuing similar economic goals, and how to re-assert American leadership while focusing on domestic investment and domestic production.
- The focus will likely be on competition rather than conflict. We believe increased economic integration in Asia can offset any American turn inward. Supply shifts will continue and investors can find opportunities both in China’s domestic market as well as exporters gaining market share such as Korea, Taiwan, and Vietnam.
As the Biden administration begins to formulate its policy agenda, a review of China policies has been launched, ranging from the “Phase One” trade deal, defense and security policies, and a review of critical supply chains. So how will this review shift the policy stance? And what do these shifts mean for investors? While there are still more unknowns than knowns, thankfully we have some insight into the thinking of top officials given that many have a long and clear track record of publications and public remarks.
Over the next few weeks we will look at U.S.-China dynamics one by one, including trade, technology, and geopolitical flashpoints. This week we will focus on trade policy.
How to think about the Phase One trade deal and existing tariffs
Over the course of 2020, Chinese, and broadly, Asian exports to the U.S. have been strong due to the large U.S. fiscal stimulus, as well as rising demand for technology products. As a result, China’s exports to the U.S. as a share of its total exports are back to pre-trade war levels, and China’s trade surplus with the U.S. is again at an all-time-high.
That said, there were several elements of the deal that can be deemed a success and are worth building on – such as China’s commitment to reduce non-tariff trade barriers and open up to foreign investment. China made progress on its commitments to better enforce intellectual property rights and reduce forced technology transfers, which can be a foundation for future progress in trade negotiations. While these parts of the agreement may stay, managing the bilateral trade relationship through purchase agreements has not worked and does not fit with Biden’s focus on engaging allies. Although enforcing the purchase targets could help the affected sectors, the fact that these managed targets increased tensions with allies may lead to a reduced emphasis on this aspect of the deal. Despite the nominee for United States Trade Representative stating that holding China to its trade commitments will be a priority, the administration’s emphasis on working with allies means their emphasis may lie with other structural aspects of the deal.
Lastly, there are also the questions of what will happen to tariffs, which have caused economic damage to both sides. This is a thorny issue. While there are economic costs to consider – for example, due to China’s retaliatory tariffs, U.S. auto exports to China fell by more than a third, and some auto-related manufacturing investment shifted away from the U.S. (Tesla, BMW) – tariff reduction will likely need to be reciprocal. Beijing has made overtures calling for tariff reduction, but amid large levels of U.S. stimulus, the economic incentives are lessened and the domestic political costs may be too high. At the moment it is hard to imagine a ready off-ramp for the Biden administration to reduce tariffs without major Chinese concessions. Although Biden has suggested in speeches that he wants to move away from a focus on tariffs, judging by the recent move to place tariffs on the UAE for national security reasons, this administration might not be as anti-protectionist as the market currently thinks.
A shift in trade philosophy, or more of the same?
Beyond the mechanics of the Phase One deal and tariffs, there are indications that the Biden administration is aiming for a broad rethink on how the U.S. approaches international trade and globalization. This could mean not just moving away from the Trump administration policies of punitive tariffs and coercive measures, but also a shift from decades of policy that prioritized opening foreign markets for U.S. corporates. In a speech earlier this month Biden outlined his approach to foreign policy stating “there is no longer a line between foreign and domestic policy…every action we take...we must take with American working families in mind.” National Security Advisor Jake Sullivan went further stating “policymakers must move beyond the received wisdom that every trade deal is a good trade deal and that more trade is always the answer…[trade policy] should also involve a laser focus on what improves wages and creates high-paying jobs in the United States, rather than making the world safe for corporate investment.”
This implies not just a turn from Trump’s measures, but a turn from decades of policy that often traded opening the U.S. market to imported goods in exchange for open markets for U.S. corporates. For example, if a U.S. corporate gains access to an overseas market as a result of trade negotiations but does all of its production locally and keeps its profits offshore, then it’s increasingly acknowledged that those gains fall primarily to shareholders. It was a trade-off of losing domestic jobs in exchange for higher corporate profits, and this administration has signaled they want to shift away from this policy. Instead this administration now appears focused explicitly on expanding exports, jobs, or tax revenue, rather than overseas corporate profits. How they make this shift away from Trump’s brand of protectionism while also prioritizing domestic job creation and exports remains an open question.
Is industrial policy the answer?
Industrial policy, which is a concerted government intervention to encourage economic activity, often in technology and manufacturing, is a cornerstone of President Biden’s “Build Back Better” agenda. It appears that the focus of this agenda will be onshoring manufacturing and boosting U.S. capex. Industrial policy is also a key part of his “competition, not conflict” policy with regard to China. There are two key elements to this agenda. The first is U.S. multinationals who enjoy tax benefits on foreign profits. The second is competing with China by encouraging manufacturing to return to the U.S. and securing supply chains.
To this end, President Biden issued an Executive Order (EO) to make sure key American materials are used in federally-funded infrastructure projects. While Chinese companies don’t feature prominently in U.S. government procurements, the order matters for multinational companies as it makes U.S.-made products more competitive when compared to non-U.S. products. It also cracks down on companies labeling products as Made in America when they are not (China was specifically mentioned here).
Second, included in Biden’s proposals is a 10% offshoring tax penalty aimed at those who offshore manufacturing and service jobs for U.S. sales, when jobs could have been located in the United States. On the flip side, a 10% tax credit is proposed for companies making investments that will create U.S. jobs. Lastly, President Biden signed an EO mandating a review of supply chain security aimed at easing the semiconductor shortage as well as reducing the reliance on China for strategic goods. This could be done through support for domestic manufacturing or as a bid to work more closely with other allies to jointly build secure supply chains for crucial materials and products.
The agenda would almost certainly hurt some multinationals from a tax perspective. It’s less clear if Biden’s policies will have a significant negative impact on China’s economy, at least in the near term. Over time, the incremental US dollar for manufacturing investment could go to the U.S. over China, but these trends have been in place as tensions have been elevated for quite some time and the cost advantage of offshoring in China has deteriorated over the years. On top of that, Beijing is similarly pushing domestic manufacturing investment via its 5-year plan. With the U.S. looking to reduce its reliance on China through non-tariff means and China doing the same through its focus on self-reliance, the trend is clear: regardless of if Biden shifts away from Trump’s policies, trade between the world’s two largest economies is likely set to decline.
What does this mean for Asia?
Above we questioned whether a move away from Trump’s protectionism while also promoting exports and jobs, is a contradiction. But there’s another question more pertinent to this region: can the U.S. reassert leadership in Asia while simultaneously prioritizing jobs at home? Economic influence generally stems from trade and investment -- the largest importers and those that invest heavily tend to set the rules. For example, China’s influence has surged since it surpassed the U.S. as the largest import market for the region. Although the U.S. is still the largest source of direct investment, Biden’s focus on industrial policy could change that dynamic. If the U.S. is encouraging manufacturing investment to remain at home and increasingly subsidizing domestic production over imports, it may be difficult to reassert leadership when China is increasingly integrated as a trading partner and the Belt and Road Initiative is driving investment throughout Asia. How the administration navigates this contradiction will be interesting to watch.
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