China's Slow Growth and America's Missing Trade Deal

Brian Hanson: This is Deep dish on Global Affairs, going beyond the headlines and critical global issues. I'm Brian Hanson. "It's The Lowest Number in Nearly Three Decades". That was the headline this week when China announced its economic growth had slowed to just 6.6 percent last year, the lowest annual rate since 1990. At the same time Beijing and Washington remain locked in a trade war that shows no sign of resolution even as the March 1 deadline that they have agreed to draws nearer and nearer. Joining me to explain this situation is the Chicago Council on Global Affairs' own Senior Fellow on Global Economy Phil Levy. Welcome Phil, it's great to have you back on Deep Dish.

Phil Levy: Great to be here.

Brian Hanson: So I want to start with a basic question of why is the Chinese economy slowing?

Phil Levy: It's a good question. We've got a lot of uncertainty when it comes to understanding what's happening in China. I don't think we should take that number as gospel although it's pretty clear that there is a degree of slowing. They've got a couple of big things going on. One of course is the trade war. This is an economy that has been not completely dependent on trade but it's played a very important role in Chinese growth. Second big thing is they've had a growing debt problem that's been going on for years and every time they try to tackle it the economy falters. So both of those are going on at once and it's made for a very unfortunate circumstance as far as the Chinese are concerned.

Brian Hanson: So Phil certainly President Trump has claimed that the tariffs that he's put on Chinese goods is putting China under pressure and putting their economy under pressure hoping to bring them around. Do we have a sense of how important the trade war is to the downturn in the economy?

Phil Levy: I don't think we have a precise breakdown. It is worth keeping in mind that China has multiple trade partners and Europe for example is a very important market for them and they have not been facing retaliation from Europe. So it matters what the United States is doing but I don't think we're single handedly bringing them to their knees.

Brian Hanson: And before we jump right into talking about the details of the trade talks I want to just get a sense of what we see is at stake at least in the short term. Both sides have set a March 1 deadline for the deal as I mentioned. If there is no deal the U.S. has threatened to raise tariffs on something like 200 billion dollars’ worth of Chinese goods. How big a deal would this be for China and for the U.S. if the president follows through on that threat?

Phil Levy: It's a very big deal. To put this in perspective when this conflict started, this particular, we've had ongoing concerns with China for many years, but this particular version of the conflict came from an investigation into intellectual property rights violations by China and the Trump administration initially said 50 billion dollars of damage was being done, they were going to put tariffs on 50 billion dollars of imports. They did so across July and August last summer at the 25 percent tariff level. Then in September they said in the face of Chinese retaliation they were going to do an additional 200 billion dollars of tariffs. They initially did that at the 10 percent level. The reason I say all this is it's worth keeping in mind U.S. imports from China last year were just over 500 billion. That means we were getting roughly half. It was actually a difficult selection process that the government went through because they were trying to exactly go after those goods that would not hurt your average American consumer in their pocketbook as much as it might or would not be especially painful to heavily dependent American businesses.

Phil Levy: What that means is the remaining pile of Chinese goods are the ones where it'll be very painful for the U.S. to sanction them. And that was what was initially threatened to come into effect on January 1st where they were going to hit the rest of Chinese goods and they were going to raise tariffs on the 200 billion from September. That has been what's been postponed until March. So if these talks fail, this is at least the threat that President Trump has given, we will start seeing much higher tariffs on Chinese goods. It will hurt the Chinese if this happens. It will also really hurt the United States.

Brian Hanson: So I presume that's in terms of higher prices that we would pay for a hammer from Wal-Mart or that a manufacturer has to pay for the parts that they put into some product that they sell to us and that's how it would show up to the average consumer, have I got that right?

Phil Levy: Yes you do and it's important that we sort of note both of those channels. So there is the kid's tennis shoes or the T-shirt that you buy at Wal-Mart, there is also the fact that these are major inputs into businesses that you have a lot of global supply chains where goods go back and forth into China. There was a study just released by the San Francisco Federal Reserve. They were looking at when the U.S. spends money on Chinese goods where does that money go. They had a somewhat surprising finding that over 55 percent of the money spent on Chinese goods ends up staying in the United States.

Brian Hanson: Really? How can that be?

Phil Levy: Well so what's happening is you're getting goods that are finished in China but containing a lot of components that were made in the U.S.. It's a reflection of global supply chains. And I would notice they did this for a whole range of countries, for basically all of the U.S. trading partners. China had the highest percentage of U.S. content of any of those trading partners.

Brian Hanson: That's fascinating because usually we think of China as kind of the workshop of the world sending us goods and not having very many imports directly to there. But it's a great illustration of the complexity of supply chains in today's world.

Phil Levy: Yeah and actually I would say when China ... it's a better way to think about it in terms of how China broke into the global trading scene that they've finished goods. So if you had 90 percent of the work done somewhere else and there was labor intensive assembly that was required at the end that was the part that China would take on. Because of the way we do trade accounting that had an exaggerated effect on our trade statistics because if a good is made 90 percent in Malaysia and then the last 10 percent is done in China when it finally comes to the United States that will count as 100 percent Chinese good. That's a big explanation for why we saw the U.S. trade imbalance with China move so much and also why we should not pay attention to bilateral trade imbalances.

Brian Hanson: Yeah that's fascinating. And it leads to the next place I want to go which is the trade talks themselves and what's on the table. You've pointed out in your writing that the administration has a pretty long list of things that it's seeking from the Chinese and it can be confusing to understand how China should react because of the length of this list and one indication is Vice President Mike Pence's speech at the Hudson Institute last year and he listed a whole set of trade concerns; the trade deficit that you just mentioned that we're importing more from China than we're exporting, intellectual property theft, forced technology transfer, industrial subsidies. That's a pretty long list of things. Is there any sense of how this administration prioritizes those things or what they're currently asking for from China in response to those concerns?

Phil Levy: I think this administration has had a great deal of difficulty with prioritization. You've had different voices. We've seen different players within the administration take on the lead role. At some points it's been Wilbur Ross, the Sector of Commerce. At some point Steve Mnuchin, the Treasury Secretary. Right now it's Robert Lighthizer, the U.S. trade rep. When the U.S. sent a delegation last May to China it didn't resolve its issues and send one lead, it actually sent a whole group who had loud vocal arguments with each other outside the negotiating room according to reports. So I think that reflects the fact that different people want different things. Some of it has to do with their desires. I think more economically inclined people tend to shy away from issues like the bilateral trade deficit but some of it also has to do with an assessment of what's feasible and even more so what's feasible in a very short timeframe. One of the important things to remember in these negotiations which were launched this latest round in a meeting in Buenos Aires in early December was they gave themselves 90 days. So it's rather arbitrary but this was this early March deadline. That's not a lot of time to get anything done which involves a great deal of complexity. And so there's the question what kind of compromises are they willing to make and what kind of compromises will they have to make.

Brian Hanson: And let me just jump over to the Chinese side. What do they want out of these negotiations? Do they have specific concerns or specific red lines that are shaping their position?

Phil Levy: I think the Chinese like many of the U.S.'s top trading partners at the moment would just like to have peace and stability. And so if they could get rid of the tariffs that are there now and if they could have some guarantee that you weren't going to have large tariffs imposed in the near future they'd probably be pretty happy about that. And it's worth remembering the Chinese have come ready to deal from the early days of the Trump administration. So they've made a number of deals, it's just none of them have stuck. And so I think there has been a serious Chinese concern which is it's nice to make a deal but you and I have some confidence that it's going to be durable.

Brian Hanson: Given the range of concerns inside the Trump administration and the short timetable to do these negotiations, is the U.S. at this point got some fairly specific proposals on the table for how to deal, at least how to deal with this whole range of issues?

Phil Levy: We don't know exactly what the U.S. has on the table. These negotiations are confidential and occur in private. The signals that have been coming out of the negotiations are that you do still have internal conflict within the Trump administration. There are some who are willing to settle for say Chinese commitments to purchase U.S. exports, things that they hoped would address the bilateral trade deficit. Others who are pushing for much more deep seated reform, things that would take on intellectual property, that would take on subsidies for example. I think there's an increasing understanding that you're unlikely to get the latter by early March and then the question is do you declare defeat or do you say well we'll settle for less and then keep talking. One of the big problems they face is that that's what a lot of administrations have done in the past is you take what you can get, you keep talking, and it's exactly the kind of behavior that the Trump administration has vehemently criticized.

Brian Hanson: So is there any indication that there might be a slimmed down or reduced size deal in order to meet that deadline of March 1?

Phil Levy: I think that's definitely a possibility. I think the Chinese are making offers and there is going to be a temptation. You've seen the U.S. stock markets rise and fall a bit as people's hopes for these talks have waxed and waned. That seems to matter a lot to the president. So I think there is a substantial amount of pressure on him to strike a deal and I think the Chinese will be very accommodating in offering fairly minor shallow concessions as they've done all along that should the president so choose he will be able to claim victory in early March. The difficulty is he's set the bar very high for himself by disparaging those kinds of agreements and by linking these issues not just to deep set economic issues but to strategic and national security concerns which are gonna make it very difficult to claim victory and walk away.

Brian Hanson: That's interesting. One of the things that I experienced when I worked in the U.S. Senate was that the aid administration can negotiate a deal and then usually Congress has some sort of role in formalizing that deal. If the administration were able to come to some sort of agreement, comprehensive or slimmed down agreement, what do you think the domestic politics in the U.S. look like? Is this something that would be readily adopted or do you expect that there'd be some resistance to any kind of a deal?

Phil Levy: Yeah. Good question. I think if you look to the role of Congress and domestic politics one of the notable things about this is the administration already had a fair bit of authority to act on its own because of this Section 301 which allowed the intellectual property investigation. Even so, they've been fairly cavalier in going beyond that. That was the authority that let them do 50 billion dollars in tariffs. It's not at all clear to me what authority let them do the additional 200 billion or the 250 billion they've threatened beyond that. Nonetheless they've done these things. Congress has not challenged them or at least we haven't seen any successful legal challenges yet. A deal most likely would be the administration pulling back. So it's hard to see how anyone would have grounds to sort of legally challenge it, it's not the sort of thing that would require a passage through Congress.

Phil Levy: The politics of it though are something different altogether. That you can identify these two groups who would have serious trouble with a limited deal. One is the president's base. He used very incendiary rhetoric in describing what China was doing to the United States during the campaign. He talked about China raping the United States in its trade practices. So if you get your base fired up it can be difficult to then back down and say "Well we've struck a modest deal, best we could do, no need to worry." We've actually had some experience with him trying to do that. That was where we were with the federal budget agreement in the week before Christmas where yes he had said things about the wall but let's back down and sort of paper things over, reach an agreement, keep the government funded. We saw what happened. The base rebelled. The president flipped and we are well into our longest government shutdown ever. You could have a similar effect with this China deal where the president feels the pressure, he tries to strike something minor and all those groups who actually believed him when he said he was gonna do something dramatically different, they rebel against him.

Phil Levy: The other feature which distinguishes this in fact from the government budget shutdown is Congress is if anything more hard line on China than the president. So whereas on the budget shutdown Congress clearly wanted to get a deal, on China you're getting a lot of warnings from leading members of Congress saying "Don't give in, don't stop short."

Brian Hanson: One of the other things that strikes me as I look at just the newspapers on this is that where the government shut down and the issue of the wall is basically a hard partisan issue, it seems that on trade and the trade deal with China you've got splits. You've got Democrats who are worried about labor conditions, you have businesses who are worried about intellectual property theft. So is this politics even more complicated than say for the shutdown?

Phil Levy: You very much have splits on trade policy, splits on things like whether the new NAFTA replacement should go ahead. On the China issue you have it seems almost universal concern in Congress about Chinese practices. And then the split can be on are tariffs the right way to deal with this or should one try a different approach. But most of the voices are saying this is very serious and you need to do something about it.

Brian Hanson: So how does this deal with China or this negotiation with China fit into the broader pattern of how the Trump administration has dealt with trade? They've had that renegotiation of NAFTA, a deal with Korea. Do we see any broader patterns here that helps us understand what's going on?

Phil Levy: I think the broader pattern is a fairly chaotic approach where the administration lashes out in a bunch of different directions in a fairly uncoordinated fashion and has shown very little success in bringing these things to a conclusion despite ambitious promises at the start. I think in fact there's an interesting interplay on the China issue because there's a strong sense that the U.S. could do a lot more with China if it worked in tandem with its major trading allies, countries like Canada, Europe, Japan. And while the U.S. has had discussions with them about concerns with China and they share many of the U.S. concerns with China, at the same time the U.S. is picking fights with these countries over things like steel and aluminum tariffs or potential car tariffs and that's inhibited a move to sort of make this a more concertive and effective effort.

Brian Hanson: Yeah it's kind of hard to get your allies to attack them on one hand and then say join together and help us together work on China at the same time. I want to turn to the business community and their reaction to this because there's been some recent reporting in which it appears that leaders of major corporations seem to be assuming that this trade deal is going to happen and that there shouldn't be long term concern. What do you make of those kinds of comments from corporate leaders?

Phil Levy: It's a little bit hard to tell whether they're saying the things that they hope are true or they're saying the things they actually believe are true. It's also a reflection I think of sort of how dramatic the shift is with the Trump administration. They seem to be working off an older playbook to the extent they actually believe this which says sooner or later presidents won't do really damaging things because they know better. I'm not sure that applies for this president. They're clearly hoping it does.

Brian Hanson: It's interesting because as they're saying this at almost the exact same time there was some reporting that Wilbur Ross, the Commerce Secretary, was saying that we're miles and miles away from a Chinese agreement. I guess the Commerce Secretary in many ways is the person who's closest to the business community. Why do we see these very different kind of messages coming out of these two places when you'd assume they're talking to one another and should have some sense of what one or another are thinking?

Phil Levy: You would think that the Commerce Department would be sort of the voice of American business. That's not what we've seen in a number of trade negotiations. That this administration is different and they tend to go their own way. We saw that with a number of things featuring say steel aluminum tariffs, auto tariffs and some of the provisions of the new NAFTA. We have also seen different factions within the administration putting forward different ideas as they do battle with each other. So you're right, you have Wilbur Ross saying this is very difficult, it's tough. About a week ago you had the Treasury floating the idea that maybe we would drop tariffs on the Chinese as sort of an act of good faith and a way to move these things forward. So these seem more like trial balloons than a sort of coordinated policy campaign.

Brian Hanson: It's interesting. So summing all of this up of how you see the current situation, the current prospect for a deal. If you were a betting man do you think this will get resolved by March 1st or something will get resolved by March 1st?

Phil Levy: It's pretty close to a tossup. I think probably the most likely outcome is that you do get some sort of resolution but then it's a question of whether that holds for hours, days or weeks. That's when we expect pressure to come. It's worth remembering we've had resolutions before under this administration with the Chinese. If you went back to last May on the eve of the tariffs a top Chinese official, [inaudible 00:20:46], came to Washington, he negotiated with the treasury secretary, they reached a deal. It lasted just about a week and then they threw it out the window because there was criticism of it. My best guess is we see something of a replay of that.

Brian Hanson: Yeah. So let's take a look at that since that does appear to be a possible model. In that case who objected and who made the decision to walk away from a deal that had been negotiated?

Phil Levy: We don't know exactly who made the decision. We do know that Peter Navarro who would normally be outranked by the Treasury Secretary made the announcement from the White House that that agreement didn't hold. Presumably he did so with the backing of the president.

Brian Hanson: That makes a much more complicated world. We've seen in other cases too where in this administration where deals seem to have been struck by different folks in the administration only to be overturned by the White House. So Phil finally as we close here. As we look back on this set of events from a perspective of like 10 years from now are we seeing a broader change in terms of a new sharper approach to China in Washington that's here to stay, that's even going to go beyond the Trump administration or is it something that's very specific to this point in time and this administration?

Phil Levy: It's good to take a step back like that. I think you're seeing a couple of broader trends that are worth noting which are not Trump administration specific. We are well into a trend where the business community has soured a fair bit, not completely, but they've moved in that direction on China. So if you went back a dozen years ago you had a lot of people decrying trade imbalances with China and the business community was taking the other side and saying it's not as bad as you think it is, it's really fine. They have sufficient concerns now that they're not taking that opposition role, they're saying well yes we do need to do something, maybe not tariffs but they're joining in the criticism. So that's notably different.

Phil Levy: Another trend that's going on which is important to focus on is a change in China itself. That China's appearance as a juggernaut which was relentlessly growing at double digit rates was based on among other things a demographic boom that has now phased out. So at the same time we are forecasting China to sort of continue on its incredible path, they are looking at a working age population that's starting to shrink and these desperate concerns about getting old before you get rich. So while we see China as this daunting foe, they're seeing a lot of domestic concerns that they're having to juggle. That means they would like to have trade peace with the U.S. but they're not terribly disposed to ideas like setting aside industrial policy altogether and giving up any hopes of moving up the quality ladder.

Brian Hanson: Very helpful. Thanks for helping put this into context. So Phil Levy, my colleague here at the Chicago Council on Global Affairs. Thanks so much for being on Deep Dish and I should mention to our listeners that you have a pretty much a weekly column, I think it's about five days a month on the Forbes Web site, www.forbes.com. It's a great place to keep following your commentary. Phil thanks so much for being on Deep Dish.

Phil Levy: Thanks for having me.

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Brian Hanson: As a reminder, the opinions you heard belong to the people express them and not the Chicago Council on Global Affairs. This episode of Deep Dish was produced by Evan Fazio. Our Audio Engineer is Andy Zarnecki. I'm Brian Hanson and we'll be back soon with another slice of Deep Dish.