U.S. and China Sign Phase 1 Trade Deal – A Large Purchase Agreement, While Tariffs Remain in Place

Dechert LLP

Dechert LLP

On January 15, 2020, U.S. President Trump and Chinese Vice Premier Liu He signed a Phase 1 trade deal between the countries. The agreement includes a pledge from China to increase its imports of U.S. goods and services by $200 billion in the next two years, along with general commitments relating to intellectual property (IP) protection, technology transfers, agricultural trade barriers, financial services barriers, and monetary policy. While the Agreement stopped the escalating tariff war, most tariffs remain in place with limited relief.  It also does not prescribe concrete measures for addressing the underlying trade conflict between the U.S. and China, such as government subsidies, IP protection, and joint venture technology licensing arrangements. Such measures will be reserved for a subsequent phase in the U.S.-China trade negotiation process, with the U.S. Administration promising a Phase 2. However, Wall Street rallied, with the Dow Jones Industrial Average and S&P 500 at record highs after the deal was signed, indicating the stock market’s enthusiasm for tariff certainty and improved relations between the countries.

Below is a summary of what the Phase 1 trade deal includes, what it does not do, and what U.S. companies can expect going forward. The full text of the Agreement is available on the website of the U.S. Trade Representative, with topic-specific fact sheets available here.

I.   What Is Included in the Phase 1 Trade Deal?

The 96-page agreement provides a general framework for addressing the U.S. government’s complaints against China’s economic and trade policies. It includes the following:

  • Chapter 1 – Intellectual Property. China agrees to undertake measures to strengthen its domestic laws protecting trade secrets, pharmaceutical-related IP, patents, geographical indications, trademarks, as well as its enforcement mechanisms against pirated and counterfeit goods. The U.S. affirms throughout Chapter 1 that it already has such measures in place. However, the mechanics remain vague: “Each Party shall determine the appropriate method of implementing the provisions of the Agreement within its own system and practice.”
  • Chapter 2 – Technology Transfers. This brief Chapter includes a statement that: “A Party shall not support or direct the outbound foreign direct investment activities of its persons aimed at acquiring foreign technology with respect to sectors and industries targeted by its industrial plans that create market distortion.” This is a reference to China’s “Made in China 2025” industrial growth policy, an impetus for the U.S. government’s revisions to its foreign direct investment review rules and its proposed new export controls on emerging and foundational technologies. See Dechert's related OnPoints here. The Chapter also states: “Neither Party shall require or pressure persons of the other Party to transfer technology to its persons in relation to acquisitions, joint venture, or other investment transactions.” However, detailed mechanics for enforcement are not specified.
  • Chapter 3 – Agriculture. This longer Chapter provides for the elimination of a range of non-tariff structural barriers to U.S. agricultural imports, such as bans on certain products and lack of acknowledgement for U.S. regulatory certifications.
  • Chapter 4 – Financial Services. This short Chapter contains a set of commitments on the part of China to enhance market access for U.S. financial service providers in the areas of banking, credit rating, electronic payments, distressed debt services, insurance, and management of securities, funds and futures. For example, a Chinese subsidiary of a U.S. financial institution can now use the assets held by the U.S. parent, rather than those just held in China, to demonstrate it meets local regulatory requirements. China also committed to permit branches of U.S. financial institutions to provide securities investment fund custody services.
  • Chapter 5 – Currency. Two days before signing the Phase 1 deal, the U.S. dropped its designation of China as a currency manipulator. Last year, the U.S. formally accused China of weakening its currency to devalue its exports to the United States, in an effort to offset U.S. tariffs. In exchange for lifting the designation, the parties both agreed to “refrain from competitive devaluations and the targeting of exchange rates for competitive purposes.”
  • Chapter 6 – Expanding Trade. During a two-year period covering 2020 and 2021, China commits to increasing U.S. imports of goods and services by $200 billion on top of 2017 levels. However, the Agreement contains a caveat that purchases will be made according to market prices and based on commercial considerations. That means if there is not sufficient demand in China, there is no mechanism to enforce this commitment.  The targets are as follows:
    • Manufactured goods: $77.7 billion
    • Agricultural goods: $32 billion
    • Energy products: $52.4 billion
    • Services (IP, travel, financial, IT/communications, and other): $37.9 billion
  • Chapter 7 – Dispute Resolution. This Chapter creates a framework for high-level and working-level bilateral discussions to evaluate the Agreement and address complaints.

II.   What Is Not Included in the Phase 1 Trade Deal?

The Agreement does not tackle the following issues, leaving them for later rounds of negotiations:

  • Tariffs. As part of the negotiations leading up to the Phase 1 deal, the U.S. Administration refrained from imposing new tariffs scheduled to take effect in mid-December 2019, which would have impacted popular consumer tech items (List 4-B). In 30 days, the U.S. Administration also will cut the rate for tariffs most recently implemented this past fall (List 4-A), from 15% to 7.5%.  However, the List 4-A tariffs remain in effect, as do the 25% tariffs for Lists 1-3 that cover the majority of imports from China (including many components used by the U.S. manufacturing and tech sectors). Similarly, while China relinquished some of its retaliatory tariffs against U.S. imports during the negotiations for the Phase 1 deal, the Agreement does not provide for any further reductions in the retaliatory tariffs.
  • Subsidies. The Agreement does not address one of the major U.S. complaints against China: the practice of subsidizing Chinese businesses through a range of government support measures. There is a provision in the Agriculture Chapter that requires China to “respect its WTO obligations to publish in an official journal its laws, regulations, and other measures pertaining to its domestic support programs and policies.” While that could enhance transparency, enabling the U.S. government to exercise its rights under the WTO with respect to identified subsidies, the Agreement itself does not force China to undertake any structural economic changes.
  • Specifics on IP Protection. While China has made a number of commitments to increase IP protections, which will benefit local Chinese industry and innovation as well, the Agreement does not provide for specific metrics or an enforcement mechanism to quantify that commitment. The Agreement provides that it will be up to China to determine how to enforce its enhanced IP measures, and it may be difficult for the U.S. government to hold China accountable.

III.   What to Expect Going Forward?

Perhaps the most immediate impact will be felt by the beneficiaries of China’s new import commitments: U.S. manufacturers that sell high-value industrial technology products desired by the Chinese market, farmers, energy companies, and financial services providers. However, companies that rely on offshore production in China for goods they import to the United States, as well as U.S. manufacturers that incorporate Chinese origin components into their supply chain, will still feel the pinch of high U.S. tariffs on goods coming from China. Companies in that position are left to consider their options under the tariff exclusion process, restructure their supply chain, use customs drawback programs, and other customs strategies. See our recent China tariffs OnPoint here.  

As the Agreement does not tackle the state subsidy issue in China, it is likely that the U.S. government will continue to seek recourse through trade remedy proceedings. In those proceedings, the U.S. government may impose countervailing duties to counteract what it determines to be unfair trade measures that violate WTO rules. The use of countervailing duties, as well as antidumping duties, to target specific industries benefiting from unfair trade practices in China has been a favored tool for the U.S. government in recent years.

Finally, to the extent that the U.S. government remains dissatisfied with China’s efforts to curb forced technology transfers, we can expect that to be addressed through the Committee on Foreign Investment in the United States (CFIUS) as well as through export control measures implemented by the U.S. Commerce Department. U.S. companies in the high-tech space seeking to invest in China or partner with Chinese firms through joint ventures or Chinese investment should be prepared for hurdles in obtaining CFIUS clearance and any necessary export authorizations. Further, U.S. companies should continue to monitor and engage with the regulators on ongoing efforts to impose new regulations on emerging and foundational technologies, as well as remain alert to Commerce’s increasing use of export restrictions against Chinese companies accused of predatory technology practices.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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