manufactured goods

U.S.-China Phase I Agreement — Some Progress on Structural Changes; Far Behind on Trade in Goods and Services

In prior posts, I reviewed the U.S.-China Phase I Agreement and the commitments made by the parties. See https://currentthoughtsontrade.com/2020/01/19/u-s-china-phase-1-agreement-details-on-the-expanding-trade-chapter/; https://currentthoughtsontrade.com/2020/01/15/u-s-china-phase-1-trade-agreement-signed-on-january-15-an-impressive-agreement-if-enforced/. While for many the promised start of a Phase II was viewed as the more important in light of the issues not reached in the partial deal that was struck in January, the COVID-19 pandemic has absorbed much of the global energy for both countries, and no new talks have started.

Moreover, with both countries exchanging charges against the other in terms of the origin of the virus causing the pandemic and more recently concerns about transparency on the virus in China, there have been heightened tensions between the two countries. with some comments in the press calling for an end of the agreement by each country.

A recent telephone call between U.S. Treasury Secretary Mnuchin, USTR Ambassador Lighthizer and China’s Vice Premier Liu He seemed aimed at keeping the Phase I Agreement moving forward. The US press release on the call is reproduced below.

“USTR and Treasury Statement on Call With China

“05/07/2020

“Vice Premier Liu He, U.S. Treasury Secretary Steven T. Mnuchin, and Ambassador Robert Lighthizer participated in a conference call today. They discussed economic and trade issues, including the recently concluded Phase One agreement. The parties shared updates on COVID-19 and their assessments of its effects on economic growth as well as the measures their countries are taking to provide support to their economies.

“The parties discussed the ongoing process of implementing the Phase One agreement between the two countries that went into effect February 14. Both sides agreed that good progress is being made on creating the governmental infrastructures necessary to make the agreement a success. They also agreed that in spite of the current global health emergency, both countries fully expect to meet their obligations under the agreement in a timely manner. Meetings required by the agreement have been conducted via conference call and will continue on a regular basis.”

https://ustr.gov/about-us/policy-offices/press-office/press-releases/2020/may/ustr-and-treasury-statement-call-china.

Indeed, notices on Chinese Ministry websites as well as statements from U.S. government officials have made clear that China has been making progress on a number of the changes to laws and regulations where commitments were undertaken in the Phase I Agreement. For example on the large number of agricultural program changes that China agreed to make, USDA and USTR released a joint statement in late February, shortly after the Agreement took effect, reviewing the progress being made. See https://ustr.gov/about-us/policy-offices/press-office/press-releases/2020/february/usda-and-ustr-announce-progress-implementation-us-china-phase-one-agreement.

USDA-and-USTR-Announce-Progress-on-Implementation-of-U.S.-China-Phase-One-Agreement-_-United-States-Trade-Representative

Similarly, the United States has taken steps to address obligations that it undertook in the Agreement such as authorizing the importation of citrus products from China. See 85 FR 20975-20983 (April 15, 2020; https://www.aphis.usda.gov/aphis/newsroom/stakeholder-info/sa_by_date/sa-2020/sa-04/china-citrus.

“APHIS Authorizes Importation of Fresh Citrus Fruit from China

“Last Modified: Apr 14, 2020 Print

“The U.S. Department of Agriculture’s Animal and Plant Health Inspection Service (APHIS) is authorizing the importation of five types of commercially produced fresh citrus fruit from China into the continental United States. After thorough analysis, APHIS scientists determined that pummelo, Nanfeng honey mandarin, ponkan, sweet orange, and Satsuma mandarin fruit from China can be safely imported into the United States under a systems approach to protect against the introduction of plant pests. 

“A systems approach is a series of measures taken by growers, packers, and shippers that, in combination, minimize pest risks prior to importation into the United States. In this case, the systems approach includes importation in commercial consignments only, registration of places of production and packinghouses, certification that the fruit is free of quarantine pests, trapping program for fruit flies, periodic inspections of places of production, grove sanitation, and postharvest disinfection and treatment. This completes agreements on another Chinese commodity listed in Annex 11: Plant Health of the Economic and Trade Agreement between the United States of America and The People’s Republic of China, Phase One.

“This notice of authorization will go into effect on the date of publication in the Federal Register, April 15, 2020. The docket with information about this decision is available here upon publication on April 15, 2020: http://www.regulations.gov/#!docketDetail;D=APHIS-2014-0005.”

Expanding Trade -Growing Exports to China from the U.S. by $76.7 Billion in 2020

One of the important parts of the Phase I Agreement was the chapter on Expanding Trade and the commitments by China to increase imports from the United States by some $200 billion over 2020 and 2021 above the 2017 figures (i.e., U.S. exports to China ahead of the additional tariffs imposed by the U.S. and then China against goods from each other). The figures for 2020 were for increases of $76.7 billion, $64.9 billion in certain goods and $12.8 billion in certain service sectors.

The challenges to the Chinese economy in the first quarter because of COVID-19 and to the United States (and many other countries) for part of the 1st quarter and at least the second quarter of 2020 because of the pandemic makes the large increase in purchases seem unlikely. Certainly, first quarter figures for U.S. domestic goods exports paint a picture suggesting 2020 will not meet objectives. The goods categories that were included in Annex 6.1 and the Attachment thereto of the Phase I Agreement accounted for 59.1% of U.S. domestic exports to China in 2017 (the base year)– $70.9 billion of $119.9 billion total U.S. domestic exports to China. In the first quarter of 2020, the goods categories covered by the Annex showed U.S. domestic exports of $12.7 billion which would leave $122.1 billion to be exported in the last nine months of 2020 ($13.57 billion/month or greater each month than the U.S. exported in the first quarter of the year).

The remaining $49 billion of U.S. domestic exports don’t have particular export targets, but are running well below 2017 levels and indeed are more than 21% lower than the first quarter 2019 levels, suggesting 2020 levels of just $28.29 billion.

The table below shows the US exports for 2017-March 2020 and the objective for 2020 included in Annex 6.1. All figures are in $ Billions.

Product2017201820191st Qtr.
2019
1st Qtr.
2020
Manufactured goods
1. industrial machinery$10.949$12.288$11.062$2.318$2.500
2. electrical equip. &
machinery
$4.311$4.586$4.283$1.008$1.078
3. pharmaceutical
products
$2.089$2.126$2.362$0.483$0.665
4. aircraft* $0$0$0$0$0
5. vehicles$10.093$6.487$7.050$1.888$1.049
6. optical and medical
instruments
$3.135$3.398$3.527$0.763$$0.806
7. iron and steel$1.176$0.652$0.285$0.075$0.069
8. other manufactured
goods
$10.702$11.168$11.914$3.167$3.021
Total MFG goods$42.456$40.705$40.484$9.702$9.188
Agriculture
9. oilseeds$12.225$3.119$7.989$1.696$1.028
10. meat$0.559$0.440$1.193$0.110$0.727
11. cereals$1.358$0.696$0.313$0.015$0.119
12. cotton$0.973$0.921$0.707$0.197$0.290
13. other agricultural
commodities
$4.504$4.121$3.680$0.765$0.768
14. seafood$1.234$1.055$0.822$0.200$0.132
Total Agriculture$20.852$10.353$14.704$2.983$3.063
Energy
15. liquefied natural
gas
$0.424$0.464$0.063$0.036$0.059
15. crude oil$4.304$5.374$2.478$0.405$0.182
17. refined products$2.444$1.781$0.469$0.185$0.141
18. coal$0.403$0.311$0.127$0.047$0.048
Total Energy$7.575$7.930$3.138$0.674$0.429
Total Phase I Goods HS$70.882$58.987$58.326$13.360$12.680
Other domestic exports$49.028$50.593$36.005$9.435$6.798
Total domestic exports
to China
$119.911$109.580$94.331$22.795$19.478

Annex 6.1 has manufactured goods increasing $32.9 billion above 2017 levels for a total of $75.356 billion for 2020; leaving $66.168 billion for the last nine months of the year or $7,352 billion/month for the last three quarters.

Similarly, Annex 6.1 has agriculture imports by China from the U.S. increasing $12.5 billion over 2017 levels to $33.354 billion for 2020 which would leave $31.015 billion for the last nine months of 2020 ($3.446 billion/month).

Finally, Annex 6.1 shows energy increasing by $18.5 billion in 2020 over 2017 levels. That means 2020 has a target of $26.075 billion with $25.646 billion needing to be exported over the last nine months ($2.86 billion/month).

With the ongoing pandemic and Chinese industry operating below full capacity and U.S. industry and agriculture still coping with the market problems in the U.S. from efforts to cope with COVID-19, it is hard to see the goods commitments being met in 2020.

The challenges for the US service sector in exports to China are equally daunting. Total U.S. exports of services to China in 2017 were $56.009 billion of which $55.458 billion are in categories covered by Annex 6.1. Specifically, category 19, charges for use of intellectual property were $7.591 billion in 2017 for U.S. services exports to China. Business travel and tourism (category 20) showed U.S. exports to China of $32.705 billion in 2017. Financial services and insurance (category 21) had exports to China of $4.208 billion in 2017, while other services (category 22) showed exports of $10.030 billion to China. Finally, cloud and related services had exports to China in 2017 of $0.924 billion.

U.S. services export data for 2020 doesn’t show the breakdown by category by country. However, China has a much larger percent of U.S. services exports in the travel and tourism category (about 25% for all countries vs. 58.4% for China). U.S. data for the first quarter of 2020 show exports of travel and tourism services to the world down 19.5% with March being down more than 50%.

With the travel limitations in place in the U.S. and that have been in place in China and with the slow ability of the U.S. to reopen much of the travel and tourism related sectors (transportation, hotels, restaurants, entertainment venues, etc.), there seems to be no realistic scenario by which US service exports to China grow $12.5 billion in 2020.

Conclusion

The U.S.-China Phase I Agreement was an important step in trying to find a path forward for normalized trade relations between the world’s two largest economies. The path requires the start of a Phase 2 but importantly needs the building of confidence between the two countries based on achieving results in implementing the Phase I Agreement.

There have been extraordinary events clouding the global community as nations struggle to address the COVID-19 pandemic. Those events have complicated the ability of the U.S. and China to achieve in 2020 what the Phase I Agreement contemplates, at least in terms of expanded trade. That said, both China and the U.S. have implemented certain provisions of the Agreement, and there has been a recognition by the U.S. Administration of efforts by China to comply with modifications to laws, regulations, etc. agreed to in the Phase I Agreement.

The first two months that the Agreement has been in place have not resulted in significant movement on implementing the important chapter of expanding trade. For the United States, struggling to right its economy amidst the pandemic, a strong effort by China to honor its commitments to expand trade significantly in 2020, would be a welcome development and hopefully lead to the reengagement by the two countries to start and complete a phase 2 Agreement.

U.S.-China Phase 1 Agreement – Details on the Expanding Trade Chapter

The retaliation that China has pursued against U.S. exports in response to the U.S. 301 investigation and resulting U.S. actions reduced total US domestic exports of goods by some $10 billion between 2017 and 2018 and a further $15 billion in the first eleven months of 2019.

While the U.S.-China Phase 1 Agreement does not include obligations for China to reduce retaliatory tariffs on U.S. exports, the Chapter 6 Expanding Trade obligations that China has assumed would not be plausible if China doesn’t unilaterally reduce retaliatory tariffs on many products. It has done that on some products in 2019 and it is assumed when the agreement takes effect in mid-February 2020 a significant number of retaliatory tariffs will be reduced at least temporarily to permit China to honor its purchase commitments.

The U.S. and China agreed to different levels of ambition in terms of increased U.S. exports depending on four broad categories of goods and services – manufactured goods, agriculture, energy and services. What isn’t immediately apparent is that the increases in goods exports does not cover all U.S. export categories but rather refers to levels of ambition for the categories shown in Annex I and detailed in the Attachment to Annex 6-1 of the Agreement (pages 6-4 to 6-23).

But in fact, manufactured goods (8 subcategories), agriculture (6 subcategories) and energy (4 subcategories) account for less than 60% of all U.S. domestic exports of goods to China in 2017 (59.17%). This suggests both larger percentage increases for the products that are covered to achieve the growth in goods exports and an unknown future for the 40.83% of export products not included in the Attachment, products which saw sharp declines in the first eleven months of 2019 of over $12 billion (a decline of 28.12% from the comparable period in 2018). While the service categories covered in the Attachment are also not inclusive of all service sectors, the select categories account for 98.97% of all service exports to China reflected in U.S. statistics for 2017.

Thus, the level of stretch in achieving the very ambitious figures in Annex 1 depends on a number of factors, including whether one compares increases to the products and services identified versus total goods and services and how one factors in U.S. exports of goods and service not covered by specific commitments.

For example, in 2017 total US domestic exports and U.S. service exports were $175.9 billion. From page 6-3 of the US-China Phase 1 Agreement, the total commitments for increased purchases by China over 2017 levels are $76.7 billion in the first year (Feb. 14, 2020-Feb. 13 2021) and $123.3 billion in the second year (Feb. 14, 2021 – Feb. 13, 2022). The level of increases versus 2017 total exports of goods and services would be 43.6% and 70.0%.

However, only $126.9 billion of goods and services are included in the Attachment to Annex 6-1. If the increases presented are against those smaller numbers, the level of increase needed is obviously greater — 60.4% and 97.2%.

And there doesn’t appear to be any level of trade projected for the $49 billion of goods exports and $600 million services exports not included in the Attachment to Annex 6-1. Since many of the goods exports are subject to retaliatory tariffs, there is not likely to be a rebound in exports from the U.S. to China of these non-specified goods in the near term suggesting that the experience in 2019 (data through November) is likely the best scenario for those products. If so, total U.S. goods exports would be $12 billion lower (services not covered are minor and unlikely to be negatively affected). Increases over 2017 actual (adjusted for the decline for non-covered goods in 2019) would represent an increase of 40.02% in the first year and 68.62% in year two.

Below is a review of the four categories to see the level of ambition being undertaken in each.

Manufactured goods

The manufactured goods listed in the Attachment to Annex 6-1 are broken into the following eight subcategories: industrial machinery, electrical equipment and machinery, pharmaceutical products, aircraft (orders and deliveries), vehicles, optical and medical equipment, iron ad steel, and other manufactured goods. The HS categories listed show total U.S. domestic exports to China in 2017 of $42.521 billion (and most non-covered US exports of goods would be in this grouping). The level of increase in exports of manufactured goods is $32.9 billion in year one and $44.8 billion in year two – increases over actual 2017 of 77.37% and 105.36% respectively.

Agriculture

The agriculture category in Annex 6-1 has six subcategories: oilseeds, meats, cereals, cotton, other agricultural commodities, and seafood. The 2017 U.S. domestic exports for the HS categories included under agriculture in the Attachment to Annex 6-1 were $20.851 billion. Annex 6-1 calls for increased U.S. exports of $12.5 billion in year one and $19.5 billion in year two, increases of 59.95% and 93.52% respectively.

Energy

The energy group products is broken into four subcategories: liquefied natural gas, crude oil, refined products and coal. The increased exports are the largest percentage wise for this category as 2017 exports are relatively modest, just $7.57 billion. With growth of $18.5 billion in year one and $33.9 billion in year two, the rate of increase needs to be 244.23% in year one and 447.53% in year two over actual 2017 levels. Presumably the aggressive increases reflect China’s energy needs and the developments in the U.S. energy sector in recent years.

Data on each of the goods categories is contained in the table below. For simplicity, year 1 is referred to as 2020 and year 2 as 2021.

Services

Data on U.S. trade in services with China show growing U.S. exports from 2016 to 2017 and continuing to grow in 2018. Data for 2017 show U.S. exports to China of $56.009 billion growing to $57.140 billion in 2018.

The service sectors covered in Annex 6-1 include charges for use of intellectual property, business travel and tourism, financial services and insurance, other services, and cloud and related services. These categories in 2017 accounted for $55.434 billion with one of the BEA categories not showing exports to China to preserve confidentiality. The growth objectives included in Annex 6-1 are for $12.8 billion additional US exports in year one and $25.1 billion in year two representing growth rates over 2017 action of 22.85% and 44.81% respectively. U.S. data are presented below.

As reviewed in the post on January 15, there are significant commitments by China in a number of the chapters which should make a significant expansion of exports from the U.S. doable in the short run. Such a result is envisioned in Chapter 6 of the Phase 1 Agreement with specific commitments on Chinese purchases broken down by categories and possibly by subcategories. Such commitments will require a reduction or elimination of retaliatory tariff on many products to permit results in the first two years of the agreement.

While a lot of attention understandably is focused on what remains to be done with China on a host of critical issues (industrial subsidies, SOEs, China 2025 policies, etc.), a strong growth in demand from China for U.S. products and services is important if achieved. Let’s hope that the Agreement surprises many by its early and complete implementation.