America’s trade war with the Middle Kingdom

June 2018 | EXPERT BRIEFING | GLOBAL TRADE

financierworldwide.com

President Trump’s administration, borne from his protectionist views espoused prior to his presidency, has set its sights on repairing what it deems major trade imbalances between the US and its trading partners. As such, the administration is taking a more aggressive approach to trade. The stated goals of this approach are to increase economic growth, promote job creation, promote reciprocity with trading partners, strengthen the domestic manufacturing base, strengthen the US’ ability to defend itself, and expand agricultural and services industry exports. While the US has various avenues by which to pursue remedies to actions it sees as unfair, the administration has mainly used Section 232 of the Trade Expansion Act of 1962, and Section 301 investigations under the Trade Act of 1974 – the latter more so than the former.

Section 232 investigations are conducted by the Department of Commerce and are used to determine the effect of imports on the national security of the US. The Secretary of Commerce generally focuses on whether an import, considering the quantity and circumstance in which it enters, impairs or threatens to impair the national security of the US. Section 301, in contrast, is an enforcement tool used to address a range of unfair acts conducted by US trading partners. Specifically, Section 301 sets to curtail three types of acts, policies or practices that a foreign country enacts that the US finds unfair: (i) trade agreement violations; (ii) acts, policies or practices that are unjustifiable (defined as inconsistent with US international legal rights) and that burden or restrict US commerce; and (iii) acts, policies or practices that are unreasonable or discriminatory and that burden or restrict US commerce. The Trump administration, while also imposing Section 232 tariffs on imported steel and aluminum, has focused its ire on China, proposing to impose Section 301 tariffs on over $50bn worth of Chinese imports.

While candidate Trump largely complained about China’s alleged advantage with low-skilled workers and its ability to manipulate the renminbi, the Trump administration is going after what it sees as China’s “actions related to intellectual property, innovation, and technology that may encourage or require the transfer of American technology and intellectual property to enterprises in China or that may otherwise negatively affect American economic interests”. The US Trade Representative (USTR) was charged to investigate these policies and determine appropriate tariffs on Chinese imports and possibly additional remedies to level the playing field.

However, these longstanding issues have troubled even the Obama administration, let alone prior administrations. When the US opened trading relations with the Middle Kingdom in the late 1970s, it enjoyed a trade surplus in the bilateral relationship of $2.7bn. Rapidly, that surplus turned to a deficit of $371bn in 2017. Even as the two nations grew increasingly economically interconnected with each other, tensions rose, mainly from the US side. Though China has significantly liberalised its economy in the last three decades, it is able to distort the markets by imposing state-directed actions that are antithetical to the American economic system. Policymakers have complained that China’s widespread economic espionage against US companies, weak enforcement of intellectual property rights, mixed record at implementing World Trade Organisation (WTO) obligations, and currency manipulation hurt Americans. Now it seems that the US is targeting China where it can hurt.

China has set several large-scale goals to be reached by 2025. Most notable are the Belt and Road Initiative (BRI) and the Made in China 2025 Notice (MIC). The BRI seeks to underwrite billions of dollars of infrastructure investment in countries, bringing the old Silk Road into a 21st century reality. China seeks to connect, through the BRI, a clear Asian road right up to Europe. Spending around $150bn a year, China has organised nearly 70 countries around its plan. Because this is President Xi Jinping’s most important foreign policy goal, according to foreign minister Wang Yi, US trade policy officials are concerned about a China-dominated Eurasia that will be an economic and trading area rival to the American-dominated transatlantic one.

In addition, China’s State Council released the MIC in 2015, China’s 10-year plan which targets 10 strategic advanced technology manufacturing industries for promotion and development. These industries are: advanced information technology, robotics and automated machine tools, aircraft and aircraft components, maritime vessels and marine engineering equipment, advanced rail equipment, new energy vehicles, electrical generation and transmission equipment, agricultural machinery and equipment, new materials and pharmaceuticals and advanced medical devices. It is understood that these industries would hold the key to the expansion of the BRI.

Demonstrating that turnabout is fair play, the Trump administration is specifically targeting these industries in its Section 301 action. It was no accident that testifying to the US Senate Finance Committee, USTR Robert Lighthizer listed 10 industries where the administration was focusing on increasing tariffs. Those industries are nearly identical to the 10 industries laid out in the MIC. If the US is successful in targeting these industries, it would likely significantly set back China’s 10-year goals.

In all this, the US is trying to maintain its edge in a shifting technology landscape. The consensus was that while the US ceded its apex in exports to China in 2007 and manufacturing in 2011, and is on track to lose its status of having the highest absolute GDP in 2030, the US will still be the leader in innovation because of Silicon Valley. However, after a couple of decades in which the US brushed off Chinese developments in the tech space, China is finally obtaining a degree of parity. Chinese tech leaders are no longer floored by Silicon Valley, as they once were. By market value, China’s Alibaba and Tencent are approximately on par with Alphabet and Facebook. The Section 301 action may be a way to stop this trend as well.

It is important to note that Section 301 has not been used within the last 15 years. The law, prior to this administration, was seen as outdated, especially since the nations of the world created a better system in which to remedy their grievances – the WTO. Since 1974, Section 301 has been invoked 122 times – particularly under the Reagan administration, in which Ambassador Lighthizer served as Deputy USTR. It was originally seen as a way for American companies, workers and other stakeholders to petition the government to investigate whether other nations were unfairly limiting exports from the US. However, even in its heyday, Section 301 was used far less frequently than other trade regimes, such as the antidumping and countervailing duties statute.

One of the most frequently discussed Section 301 investigations involved Japanese semiconductors in 1986. There, the issue was that Japan’s ‘protective structure’ made it extremely difficult for American semiconductor companies to compete within Japan. American companies complained that they were unfairly taken advantage of by unfair competition from Japanese firms and needed temporary relief to re-tool American production facilities. In this instance, Japan acquiesced, agreeing to open its market to US semiconductors and to prevent dumping of semiconductors in the US and other markets. However, relative to 1980s American economic might, Japan did not have the economic ability to enter a trade war with the US. To believe that China will acquiesce in the same way may be a pipe dream.

The US is not the only country to complain about China’s actions. The EU and Japan have consistently noted that China’s activities are unfair in light of the WTO rules. Japan, the EU and the US, in a joint statement issued at last year’s WTO summit in Buenos Aires, agreed to increase pressure on countries whose policies disadvantage foreign companies by subsidising domestic companies and requiring foreign firms to transfer technology to local entities (China was not explicitly mentioned in the joint statement).

While Section 301 action is a unilateral mechanism, the US has also used the WTO to redress its grievances in a multilateral context. On 23 March 2018, the US filed a complaint against, or more formally, requested consultations with, China for “Certain Measures Concerning the Protection of Intellectual Property Rights”. Japan notified the WTO that it intends to join the US as a third-party in that complaint. The EU also requested to join this action, stating that EU exports of high-tech products and services value at €680bn; of that amount, €30bn is exported to China. The EU’s actions are aimed to protect these investments because “much of the investments are concluded under joint-venture requirements and are thus potentially affected” by China’s practices as cited by the US representative. Ukraine and Saudi Arabia have also joined the US’ complaint.

With mounting pressure from the international community, China’s next step will be instructive on how it sees the global order, and itself in that order. Will it acquiesce to pressure from the US and other nations, or will it continue to set its sights on the BRI and the MIC?

Kathleen M. Murphy is a partner and Luke J. Karamyalil is an associate at Drinker Biddle & Reath LLP. Ms Murphy can be contacted on +1 (312) 569 1155 or by email: kathleen.murphy@dbr.com. Mr Karamyalil can be contacted on +1 (312) 569 1114 or by email: luke.karamyalil@dbr.com.

Kathleen M. Murphy and Luke J. Karamyalil

Drinker Biddle & Reath LLP