Trade deal or no, China knows that times have changed

Signals emanating from the White House suggest significant progress has been in U.S.-China trade negotiations.

The recent visit by Vice Premier Liu He and high-level exchange with U.S. Trade Representative Robert Lighthizer have offered glimpses of progress toward a negotiated settlement.

{mosads}While the trade settlement has not been formally announced, it is anticipated that China may modify its stance on some key U.S. priorities, namely: 

• China agrees to purchase more U.S. goods and services including energy and agricultural resources;
• China agrees to open its domestic economy to greater foreign investment and reduced barriers to trade;
• China agrees to open its cloud-computing sector to outside companies;
• China agrees to enforce intellectual property rights and eliminate the requirement of sharing technology as a condition of entry; and
• China agrees to an enforcement mechanism. 

Should a trade agreement come to pass, there will be both short-term and long-term consequences to any proposed trade deal. An immediate impact will be on financial markets as they rally on the news that a degree of normalcy will return to bilateral trade between the United States and China.

Pent-up investments that were waiting on the sidelines will re-enter the game, and companies will begin to invest or expand in China as uncertainty is lifted and confidence is restored.

American companies such as GM, McDonalds, Coke, P&G, Nike and Boeing will all breathe a sigh of relief as they resume their activities with renewed spirit. American retailers will rejoice as their suppliers in China resume activities without the threat of tariffs.

Allied countries like Japan and South Korea will celebrate the news because many of their exports are intermediate goods shipped to China, integrated into finished goods and exported to the United States. 

Longer term, China is not out of the woods. The trade wars served as catalyst for firms to reconsider their longer-term China plans.

Manufactures, both foreign and domestic, have been shifting production out of China and into Vietnam and other Southeast Asian countries in order to diversify their operations and avoid future tariffs should the trade wars resume.

Companies are even pulling out of China altogether and returning production to the U.S. where automation has reduced labor costs while at the same time capturing lower transport costs.

The trade wars served as a wake-up call to China. The Chinese see the shift in global sentiment and anticipate a world that will be less accommodating than in years past.

During its first phase of growth, China took for granted the fact that the U.S. would allow it complete access to its consumer market without restrictions. Those days may be over, and as the saying goes, “The easy money has been made, now comes the hard part.” 

Getting tough with China is a part of the new political reality as both the Republican and Democratic parties find agreement on China and view it as a strategic rival. The Democratic Party will continue to advocate for fair trade and increased protection realizing President Trump and his fellow Republicans stole their thunder on this issue.

Moving forward, China will be forced to reconsider its export growth model as costs have risen and productivity in manufacturing is leveling off. High levels of debt also require China to rebalance and shift away from its dependency on infrastructure and investment-led growth.

What’s left is consumption, and China will focus on harnessing the power of its billion-plus consumers as the driving force behind its economy. Unleashing the power of the Chinese consumer is easier said than done because in order to do so it will have to make some painful tradeoffs.

China has underinvested in social services, particularly in health care. Chinese households are motivated to save due to the risks and uncertainties they face in their lives. The more they save, the less disposable income they have to spend.

In addition, high savings rates captured in passbook savings accounts provide liquidity on which the commercial banking sector depends. Those funds are then lent out to state and non-state enterprises and serve as an important conduit of credit.

{mossecondads}If Chinese citizens boost their level of consumption, this will result in lower savings and consequential reduction in deployable funds within the banking system. Credit and the allocation of credit have been the mother’s milk of China’s political system.

The loyalty of the state-owned sector is governed by preferential access to credit. Take away the credit and the foundations of the political system begin to weaken. 

If a trade deal comes to pass, both President Trump and Chinese President Xi Jinping will hail this as a major accomplishment ushering in a new era of U.S. China relations.

While markets will respond positively to the news of a trade deal, there are many issues on the horizon that will continue to be the source of tension between the United States and China.

Arthur Dong is a professor at Georgetown University’s McDonough School of Business. He specializes in legal and business engagements between China and the United States.