Media  International Exchange  2019.09.17

Breakdown in US-China trade talks: Concerns over China's aftereffect risks - will China's state leading members be wise enough to make a judgment from a long-term perspective? -

The article was originally posted on JBpress on June 19, 2019
1. What had been happening behind the scenes of the breakdown in the US-China trade talks

The US-China trade talks, agreed to be started at the US-China Summit Meeting held on December 1, 2018, had since been going well until around the end of this April.

When I visited Beijing in late April, optimistic views were spreading among Chinese government officials and economic experts that an agreement on the trade talks would be reached before long and that the US-China friction would at least be temporarily eased.

And yet, after Liu He, Vice Premier of the People's Republic of China, visited Washington DC and held talks with Robert Lighthizer, US Trade Representative, on May 9 and 10, the anticipated agreement was not reached, and the trade talks seemed virtually to break down.

What had been happening amid such an unexpected development of the trade talks?

From the personal interviews I held with several experts well-versed in the US-China issues in Washington DC around late May, I was able to roughly grasp the following situation.

While these experts were not negotiators of the US-China trade talks, their views were almost concordant although some guesses are included.

The trade talks until the end of April were going well between Vice Premier Liu He and US Trade Representative Robert Lighthizer, and a consensus document of one hundred and several dozen pages had been drawn up.

When Vice Premier Liu He presented the consensus document to members of the Politburo, which is the top level of the Communist Party of China, he was criticized for having conceded too much to US demands, and was forced to revise 20-30% of the consensus document.

When the proposed revision was presented to the US side, President Donald Trump was infuriated at China's last-minute sudden request for a major revision and thus ended the US-China trade talks. This is how the experts view it.

Furthermore, as another reason for the breakdown, the experts pointed out that the US side may have made a demand in the last-minute talks that was extremely difficult for the Chinese side to accept.

2. Cause for the breakdown in the US-China trade talks

The cause of such a situation in the last-minute talks is considered to lie with both the US and China.

The problem on the US side is that there is no one within the Trump administration who is well-versed in China and understands the situation there.

Consequently, in the negotiations with China, the US could not distinguish between what would be accepted by China and what would not in view of domestic political affairs. Having taken a hardline stance in pressing forward the negotiations, the US ended up adhering to matters that China could not decisively accept.

Since there was no one who could understand the points that were impossible for the Chinese side to accept and their background domestic political affairs, the US could not see the point of issue until the talks broke down.

The problem on the Chinese side is considered to be the conflict between Vice Premier Liu He, who is China's chief trade negotiator, and anti-US hard-liners who make up the majority of the Communist Party of China.

The policy fields that Vice Premier Liu He supervises other than the US-China trade talks include macroeconomic policy, monetary-fiscal reform (in particular, reform of regional finance) to avoid financial risks, and reform of state-owned enterprises.

These reforms aim to promote adoption of a market mechanism and free competition in China's economy, stimulate the economy, and build a long-term stable economic development basis, by taking away vested interests from those with vested interests, such as state-owned enterprises, local governments, and financial institutions.

Naturally, these reforms generate strong resentment from those with vested interests. However, it is assumed that it was difficult for those with vested interests to openly react against promoting reforms due partly to the strong support given by President Xi Jinping for the reforms.

The US's severe foreign pressure seems to have been used to thoroughly execute reforms on matters that were especially difficult to be achieved due to strong resentment by those with vested interests.

Since Vice Premier Liu He alone oversees the promoting of key domestic reforms and the US-China trade talks, he is in a position of being able to achieve a good balance between the two and carry out his duties.

Meanwhile, although those with vested interests cannot openly oppose the reforms which the Xi administration places emphasis on, they are thought to be criticizing the outcome of the US-China trade talks as material with which to denounce Vice Premier Liu He and thus impede his promoting of key domestic reforms.

A similar phenomenon had been seen at the point when US-China friction heightened in July 2018. Vice Premier Liu He was criticized for the outcome of his negotiations with the US and, by extension, for his way of promoting domestic reforms.

Since then, however, as it became clear that the US took a tougher-than-expected stance against China and certain attention was paid to the promotion of domestic reforms, criticism seems to have abated.

Such reactions against Vice Premier Liu He's promoting of reforms are strongly rooted among those with vested interests. The situation continues for such reactions to recur if an opportunity presents itself.

The Politburo is also thought to be dominated by members who have strong ties with those with vested interests.

It is thought that such a state of China's internal affairs exists behind the request for revision of the consensus document this time.

3. Ripple effect on China's domestic policy

If the request for revision by the Chinese side were to be the cause for the deadlock of the US-China trade talks, Vice Premier Liu He would be even more strongly criticized. He would be susceptible to censure for promoting domestic reforms, and lose his unifying force, which may lead to postponement of effectuating the reforms.

This would not have a very significant adverse effect on the Chinese economy in the short-term.

Since the current Chinese economy maintains stability backed by achievements of the economic policy administration thus far, it can fully absorb the negative effects of the trade friction with the US.

However, aftereffects of the postponement of reforms will gradually become evident after around 2025 when China marks the end of the period of high economic growth and enters a period of stable economic growth.

If China should enter a period of stable economic growth of around 3-4% without reforming the structural defects of state-owned enterprises, local governments, and financial institutions, the negative effects would rapidly begin to surface.

This is apparent if you recall Japan in the 1980s, when worsening business conditions of major state-owned companies, i.e., Japan National Railways, Nippon Telegraph and Telephone Public Corporation, and Postal Services Agency emerged at the same time.

When the period of high economic growth ended in Japan, democracy had been firmly established, enabling stable change of administration.

Furthermore, a charismatic leader, Toshio Doko, then chairman of the Japan Business Federation, powerfully pushed forward domestic reforms, receiving wide support from all levels of Japanese society, and made it through to realize the reforms in a period of stable economic growth.

China's period of stable economic growth corresponding to that of Japan in the 1980s is predicted to come in the 2030s. There is no guarantee that China would be able to realize reforms at that time just as Japan had been able to.

It is clear that it would be extremely difficult for China to promote reforms to address the structural problems it faces given the far greater proportion of state-owned enterprises in the overall economy and the seriousness of local financial and monetary issues compared with those of Japan.

Because such a situation can be predicted, President Xi Jinping entrusted Vice Premier Liu He with the steering of reforms after the National Congress in autumn 2017, and strongly pushed forward the reforms.

The opposition forces could not openly criticize the reforms, seeing President Xi Jinping's strong will and the structural outline.

If Vice Premier Liu He's unifying power to promote the reforms were to be impaired with the breakdown in the US-China trade talks this time, it is highly possible that negative effects of the structural issues would become fully evident around 2030 when China's economy nearly rivals that of the US.

China will confront serious economic problems such as financial deficits, largely due to local governments and state-owned enterprises, and the formation and collapse of a bubble economy due to inadequate financial control. These will raise the risk of China falling into long-term economic stagnation.

Although it is unthinkable that the Trump administration is so far-sighted in its strategy towards China, if those with vested interests gain a greater voice and prevent promotion of reforms, it is highly possible that China's economic growth would eventually end up as the Trump administration wishes.

This is the risk of the aftereffects of the US-China trade talks that China is predicted to confront in the future.

With the above taken into consideration, it would be wise for China to focus on promoting key domestic reforms during the remaining period of high economic growth by promptly alleviating the US-China trade friction even by making significant concessions to the US.

If China's economy continues to steadily develop, Japan and countries in Asia and Europe will be able to share the economic benefits.

Moreover, it is thought that a sound market economy will also be gradually formed in China, and the power of those with vested interests close to the so called "state capitalism" will follow a declining trend.

On the other hand, if progress is not made in the reforms, China's move toward a free market economy would slow down, reducing the economic benefits to Japan, US, Europe, and countries in Asia that are in win-win relationships with the Chinese economy.

4. Effects on the US economy and prospects for the future

The hopeful way to break the current deadlocked US-China trade talks is placed on modulation of the US economy.

In the first place, the main cause of the intensified trade friction between the US and China lies in the hard stance adopted by the Trump administration toward China. Its purpose is President Trump's re-election in the presidential election.

In order for the incumbent president to be re-elected, it is extremely important that economic stability be secured during the campaign period.

If the US economy were to enter a downward phase in the future, it would work against President Trump's re-election. As such, attention is focused on stock prices and economic conditions.

President Trump is said to always mind the movement of stock prices. If concerns grow over the negative effects of the intensifying friction between the US and China on the US economy, stock prices may also be adversely affected.

At the moment, the US economy remains relatively strong. Financial workers in New York think that the US economy would not be much impacted by the adverse effects of the US-China friction and can sufficiently absorb the impact.

Consequently, stock prices have not been much affected and continue to remain stable. Thus, President Trump has not softened his strong stance toward China.

Economic conditions in the US currently remain stable thanks to the success of the economic stimulus package put forth by the Trump administration.

However, it is pointed out that there is a possibility for the US economy to enter a downward phase from the second half of this year or from the first half of next year.

Furthermore, the impact of the tariff increase to 25% imposed from May 10 on 200 billion dollars' worth of goods and products imported from China, as an additional sanction for not being able to reach an agreement on the US-China trade talks, is expected to surface after June and prices to rise for US consumers.

The impact of economic sanctions of raising tariffs against China had so far been limited to some American companies and farmers exporting soybeans to China, but from now on it will become more widespread among consumers.

Attention is focused on how this will affect the overall US economy and the movement of supporters of the Trump administration.

If economic changes such as a decline in US stock prices and spreading of consumer backlash against tariff increases were to be seen, it is expected that they would influence the Trump administration's strong stance toward China and act as a certain incentive to evoke an agreement on the US-China trade talks.

The US-China Summit Meeting held during the 2019 G20 Osaka Summit in late June and maintaining of proper communication between the two leaders will have great significance in mitigating such US-China friction in the future.

While US experts see that there is little possibility for a new direction to be shown at the US-China Summit Meeting this time, they all agree that the Summit Meeting has extremely high importance in maintaining the two leaders' relationship.

Japanese Prime Minister Shinzo Abe has maintained a good relationship with President Trump from the very beginning, and recently his relationship with President Xi Jinping has also been rapidly improving.

Many expect Prime Minister Abe to play a certain role in promoting maintenance of good relations between the two leaders of the US and China.

The US-China relationship and Japan's role in the relationship continue to be watched.

(This article was translated from the Japanese transcript of Mr. Seguchi's column published by JBpress on June 19, 2019.)