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US and China are letting slip the dogs of trade wars

Amid deteriorating relations, Washington is exchanging carrots for sticks

When U.S. President Donald Trump took office in January, many people thought the harsh trade rhetoric emanating from the White House and his top advisers meant that a trade war with China might be imminent. It did not materialize. Six months on, however, the threat remains and if anything, is perhaps greater. It is of material consequence not just to China and the U.S, but also to the trade-dependent countries of Asia, the global trading system, and, ultimately, the integrity of the World Trade Organization. Why is this threat not disappearing?

Fears of a U.S.-China trade war receded earlier this year because Trump adopted a more flexible position on bilateral trade issues in return for help from Chinese President Xi Jinping to pressure North Korea to curb its ballistic missile and nuclear programs. Xi visited Trump in April at the president's Mar-a-Lago estate in Florida.

Afterwards, China agreed to resume U.S. beef imports, ending its lengthy trade ban, imposed amid fears of mad-cow disease. Beijing also promised to increase liquefied natural gas imports from the U.S. and further open its financial services market to U.S. payment system providers, asset managers and credit rating agencies.

But that deal has not worked out. Beijing has appeared reluctant to put too much pressure on Pyongyang out of fear that it would destabilize North Korea and perhaps the rest of Northeast Asia by possibly unleashing a flood of refugees that would pour across the border into China's Manchurian provinces.

Sino-U.S. relations have distinctly cooled as a result. The U.S. recently resumed arms sales to Taiwan and has sent naval warships close to contested islands in the South China Sea. While the two countries still display a high degree of interdependence, other factors are also in play. The recent round of bilateral trade talks under the newly labeled Comprehensive Economic Dialogue ended without any substantive agreement, the usual joint policy statement or even a joint press conference.

There was an agreed statement that both sides would try to reduce America's trade deficit with China, which reached $347 billion in 2016, and would work to a 365-day plan. If this actually happens, it would be a major achievement. But there was no mention of mechanisms or proposals to achieve that goal, and it is hard not to believe the statement was anything but bluster.

Both sides put a brave face on the meeting, albeit for different reasons. For China, it is important to keep Sino-U.S. relations on an even keel ahead of the crucial 19th Chinese Communist Party Congress later this year. It needs to convey the impression that Xi is not losing control of the relationship with Washington. The U.S., by contrast, wants to demonstrate that it is in control of the relationship despite being the supplicant -- at least as far as trade and commerce are concerned.

Ultimately, though, if the U.S. cannot use the carrot approach to persuade China to give ground on trade policy in any meaningful way, it is likely to revert to sticks. The first such action may be imminent.

High risk strategies

Any day now, the U.S. Secretary of Commerce Wilbur Ross is expected to issue a report to the president outlining how the U.S. might use national security legislation to act against steel -- and possibly aluminum -- imports from China. This approach to trade restraint has not been used in decades and carries some big risks. Other countries, including China, might retaliate against U.S. exports on similar grounds.

In addition, such action could spark a series of dispute filings against the U.S. at the WTO. If the organization ruled in favor of those bringing the case, the U.S. would either have to suffer the humiliation of backing down, or flout one of its own global rules-based institutions. The implications for world trade and investment would be ominous. The U.S. might refrain from implementing any new restrictive measures immediately if it chose to allow the G-20 forum some space to agree on a course of action for the global steel trade.

It is not even clear why the U.S. has chosen to prioritize steel. It accounts for about 1.4% of total U.S. imports. Employment in the U.S. steel industry has fallen by a third since 2000 to about 87,000 jobs, but that represents barely 0.1% of the U.S. employee headcount in June. China is not a major source of U.S. steel imports, half of which come from Canada, Brazil, South Korea and Mexico. Vietnam, to which Chinese steel companies have shipped some of their production, accounts for 3% of U.S. steel imports, while China accounts for barely 1.5%.

About half of total U.S. imports consists of electrical machinery and equipment, other machinery including computers, vehicles and parts, and pharmaceuticals, and most of the rest includes fuels, consumer products, optical and medical equipment, and plastics and chemicals. This leaves one wondering what the Trump administration is trying to achieve with its steel strategy.

The real trade and investment concerns for the U.S. lie elsewhere. The principal issue is actually about opening up the Chinese market to a wider range of U.S. goods, including autos, against which China levies punitive taxes and tariffs. The U.S. also has a strong case when it comes to discriminatory policies against American and other foreign companies operating in China. This includes laws and regulations related to intellectual property rights, cybersecurity, technology transfers, technology companies, market access, and service industry regulations and protection.

If the U.S. wants to cut its deficit with China and try to protect or boost U.S. jobs, these are the issues it should be addressing. And it does not necessarily have to wield sticks or threaten China to make progress. There is another way.

What the Chinese want from the U.S. in terms of trade policy, perhaps more than anything else, is "market economy status," which Beijing believed would be granted in late 2016 on the 15th anniversary of China's entry to the WTO. But the U.S. and EU blocked the move late last year. China has filed a complaint on which the WTO will rule eventually. Under MES, trade partners accept that domestic prices, including steel, for example, are set by open competition rather than by the government or through other diktat.

The lack of an MES designation means that a country could be accused of "rigging" the market, making it more vulnerable to anti-dumping and other countervailing duties. A China without MES continues to be an easy target for dumping claims when it comes to steel, for example, since Chinese overcapacity in the sector persists despite official targets to cut it back.

The best way to avert the risk of a Sino-U.S. trade war would be for Washington as well as the EU to promise MES to China in exchange for at least some of the most important changes in China's trade and investment policies. Yet U.S. Trade Representative Robert Lighthizer told U.S. Congress in June that any attempt to give China MES would have "cataclysmic" consequences for the WTO.

Neither side wants or is threatening an open trade war at this stage. The rumbles of trade friction, however, are clear. Over the coming months, they are only likely to get louder.

George Magnus is an associate at Oxford University's China Centre and former chief economist at UBS.

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