The Art of the China Deal

United States-China trade, investment and intellectual property rights (IPR)-related relations remain in the balance. While it was feared that an action-reaction cycle of trade sanctions and investment restrictions could have broken out as early as June 2018, that threat has been placed on hold. During the third week of May, the U.S. and China arrived at a principles-based consensus to defuse their trade, investment and IPR-related quarrels. In exchange for markedly increased Chinese purchases of U.S. natural gas and agricultural products as well as near-term, pro-market liberalization of its restrictive foreign inward investment regime, the threat of tariff raises on $50 billion worth of Chinese exports to the United States is to be suspended, going forward. While the U.S.-China trade war that Candidate and, thereafter, President Donald Trump had threatened now appears to be under control, episodic spikes in tension should not be discounted – particularly as the Trump administration jockeys for advantage to press home its market access demands during the implementation phase of their joint consensus. If that consensus falls through, though, during this implementation phase, the U.S. and China could well find themselves again on the cusp of one of the most significant trade conflicts witnessed in the international system in many decades.

The aggravated U.S.-China trade and investment frictions can be traced to the March 2018 release of an investigation report on China’s technology transfer, intellectual property rights (IPR) and innovation practices, conducted under Section 301 of the Trade Act of 1974. In the report, the United States Trade Representative (USTR) determined that China had consistently engaged in the acquisition of foreign technologies through acts, policies and practices by the Chinese government that were unreasonable or discriminatory and which had burdened, restricted and penalized U.S. commerce. Subsequently, the Trump administration laid out an elaborate course of follow-on actions, including the proposed imposition of a 25 percent duty on 1,333 tariff lines of Chinese exports to the United States worth $50 billion. Additional remedies were also proposed. In response, China threatened its own counter-retaliation. Dueling cases were also filed within the World Trade Organization’s (WTO) dispute settlement system.  

The United States is not wrong to argue that China uses foreign ownership restrictions, including joint venture requirements and administrative licensing procedures to induce and, in many cases, de facto pressure U.S. companies to transfer technologies to Chinese entities. Furthermore, a series of promises by China to liberalize its foreign inward investment regime to a more reciprocal basis, as well as cut down on its allegedly offending technology transfer policies and practices have not been translated into action. Equally, China is not wrong to argue that its foreign inward investment regime, including joint venture requirements, is de jure consistent with its international treaty obligations, notably the World Trade Organization’s (WTO) Trade-Related Investment Measures (TRIMs) Agreement and the Trade-Related Aspects of Intellectual Property Rights (TRIPs) Agreement. China is not obliged to provide unreciprocated concessions to the United States in excess of international treaty rules – rules that it had no part in writing in the first place but ones it faithfully adheres to. The bilateral promises constitute no more than ‘best endeavor’ efforts; they are not legal commitments.   

The United States is in the wrong to threaten the imposition (now placed on hold) of a 25 percent duty on 1,333 tariff lines that cover approximately $50 billion worth of Chinese exports to the United States. The tariffs, if imposed, will violate fundamental principles of international trade law such as the non-discrimination principle (most favored nation) and the predictability principle (related to tariff bindings). It will also procedurally violate the United States’ legal obligation to submit its claims first to the WTO’s dispute settlement body and, until that body rules, stay its hand on enforcement action. It is disturbing that the Trump administration would inflict the most regressive trade policy measures since the Smoot-Hawley tariff impositions of the early-1930s Great Depression era against a major trading partner on the basis of that partner having committed, at best, a marginal illegality. By its own account, USTR admits that China is broadly compliant with its international trade (TRIPs and TRIMs) commitments and that the United States’ legal case is confined to relatively technical second-tier lapses within China’s intellectual property rights (IPR) regime.

Going forward, if the United States wishes to penalize China for its allegedly abusive practices, it should restrict its actions to the area of investment flows. Investment rules in the multilateral system are shallow, so there is no bar to unilateral remedies, and President Trump enjoys broad domestic authority to impose a variety of tailored restrictions on Chinese inward investment flows and on China-bound U.S. technology transfer flows. The U.S.’ CFIUS (Committee on Foreign Investment in the United States) mechanism as well as the export control process confer wide-ranging authority to the president to impose restrictions or bans on investments in sensitive sectors. From a competitive economic standpoint, President Trump could decree that the embedded intellectual property of key systems technologies in the strategic advanced manufacturing sectors enumerated in the Made in China 2025 plan are barred from acquisition by Chinese entities in the U.S. Furthermore, if such core technologies are worked on in China by a U.S. enterprise, it must take place in the context of a fully or majority-owned investment structure. Be it batteries, drive or control systems in electric cars, advanced materials and flight control systems in the case of aircraft, or chips and power electronic applications in integrated circuits, President Trump could unilaterally proclaim that these technologies must be proprietarily retained in-house and cannot be sold to or shared with a Chinese entity. At this time, it appears that the U.S. executive and congressional branches are proceeding in unison with measures more or less along these lines.

It is worth pondering the effects of President Trump’s pressure on China to liberalize its foreign inward investment regime. Should President Xi Jinping engineer a far-sighted liberalization of China’s investment regime – much like Deng Xiaoping had engineered of its trade regime three decades ago – China will become the advanced manufacturing center, and leader, of the world by mid-century. And for having facilitated this dynamic shift of advanced industrial processes and technologies eastward, Donald Trump may well come to be remembered as one of the great offshoring presidents of the United States.