WASHINGTON/BEIJING -- Despite being steps away from finalizing an agreement to end the trade war, negotiations between the U.S. and China have come to a screeching halt, largely over Chinese state subsidies to its core industries.
"The U.S. and China had agreed on over 90% of the trade pact," an official at an American economic group said. "But they were ultimately unable to bridge their rift on Chinese subsidies."
U.S. Trade Representative Robert Lighthizer expressed concern over the issue as early as a week before Trump's Sunday tweet vowing to raise tariffs, sources say. The U.S. thought they had agreed to include language on reforming Chinese subsidies as part of their pact. But China is believed to have reneged, wanting instead to address the issue without writing it into the deal.
"We have seen an erosion in commitments by China" over the last week or so, Lighthizer said on Monday. He is believed to have pushed Trump to take a tougher stance on China.
Subsidies form the foundation of China's version of capitalism, where provinces compete with each other to lure industry to boost tax revenue and employment. The U.S. considers low-interest loans from state-owned banks a type of state subsidy, but Xi is reluctant to make changes that would deeply affect financial institutions and regional businesses.
There is also speculation that Vice Premier Liu He, Beijing's chief negotiator, faced pushback when he presented the final draft of the trade deal to the Communist Party's 25-member Politburo.
"It seems that until recently there was no Chinese text of the trade deal draft and the discussions were based on the English text and verbal discussions," said Dennis Wilder, a former China analyst for the CIA. "At the end of the process, the Chinese text had to be circulated among the Politburo and my feeling is that comments were raised there."
The U.S. is now threatening to raise tariffs on $200 billion of Chinese goods to 25% from 10% on Friday. Trump informed Japanese Prime Minister Shinzo Abe of the plan to hike the levies in their phone call on Monday.
The U.S. and China agreed to start trade negotiations at a December summit. They have held several ministerial talks since, and Trump has repeatedly claimed significant progress.
Chinese President Xi Jinping's "Made in China 2025" initiative remained a sticking point. Launched in 2015, the goal is to turn China into a powerhouse for cutting-edge manufacturing through more than $500 billion in state subsidies.
The U.S. pushed China to scrap all subsidies that violate World Trade Organization rules, and China agreed to cutbacks in negotiations in a sign of compromise. But China began to look for loopholes at the last minute, such as by hesitating to curb regional government subsidies, the economic group official said.
The countries remain divided on other fine points, including legislation banning forced technology transfers from American companies, market access to cloud computing, and protections for pharmaceutical data.
A former USTR official told Nikkei that it is standard negotiating tactic for the U.S. to bring negotiations to a halt at the last stages to draw out maximum compromise from the other side. The Chinese Commerce Department announced Tuesday that Liu will attend negotiations on Thursday and Friday in the U.S. That he is taking part after Trump's threats in itself is a compromise.
China now faces a difficult decision between accepting higher tariffs or compromising on the subsidies -- a core feature of Beijing's state capitalism -- amid growing pressure at home to stand its ground.
With the 30th anniversary of the Tiananmen Square crackdown coming up on June 4, the Xi administration is especially sensitive to public opinion.
Ken Moriyasu in New York contributed to this report.