Emerging directions in the Trump Administration’s China Trade Policy
Trump and China. Will there really be a trade war?
By Mike Margolis and Matthew Thomas
When Donald Trump was campaigning to succeed Barack Obama as president of the United States, he promised a more aggressive approach to trade. His administration would take bold action to revitalize domestic manufacturing industries and create new jobs tied to the production of domestic goods. He singled out what he described as unfair trade practices by China, arguing for strategies to restrict imports of manufactured goods into the United States. He announced plans to increase tariffs dramatically and impose other restrictions on Chinese trade and investment in the U.S.
However, after Trump was sworn in as president, a more complex and thoughtful direction on China’s trade has begun to emerge. Yes, the Trump administration will pursue aggressive trade policies and indeed put new pressures on Chinese imports and investment, but the administration’s discussions are moving away from massive tariffs and other blunt instruments and toward more precise and creative trade policies. Although it remains uncertain what tactics the White House team will pursue in the coming months, the odds favor several legal and policy reforms that are now under serious consideration in the new administration and the Republican-led Congress.
A LARGE AND GROWING TRADE RELATIONSHIP
Several forces seem to be nudging the new administration toward a more considered approach to U.S.-China trade. President Trump’s ill-fated immigration executive order has shown him that the big and simple ideas of the campaign trail may not translate well into actual governance in a complex world. He has also seen that China can make sensible concessions without having a gun to its head, as in its new ban on importing North Korean coal. But surely the greatest force for moderation is a deepening understanding of how critically intertwined the Chinese and U.S. economies are and the rapid rate at which they are becoming even more interdependent.
Total U.S.-China trade in goods has risen from $2 billion in 1979 to $579 billion in 2016. China is currently the United States’ second-largest merchandise trading partner, its third-largest export market and its biggest source of imports, according to the Congressional Research Service. On the investment front, the average annual value of Chinese foreign direct investment transactions in the United States grew 30-fold to $500 million in the eight years from 2007 to $15.3 billion in 2015, according to the Rhodium Group, an economic consultancy group that recently testified to the U.S.-China Economic and Security Review Commission about the situation. Last year alone, Chinese investors spent a new record of $45.6 billion on acquisitions and greenfield projects in the United States -- three times as much as in 2015.
Total cumulative Chinese direct investment in the United States reportedly has now climbed to over $100 billion, according to the U.S.- China Economic and Security Review Commission.
When indirect investment is included as well, estimates of Chinese capital flows into the United States are much higher. In real estate alone, when counting both purchases of real estate and investment into related assets such as mortgage-backed securities and debt financing, aggregate Chinese investment exceeded $350 billion from 2010 through 2015, according to the May 2016 report “Breaking Ground: Chinese Investment in U.S. Real Estate,“ an Asia Society special report produced in collaboration with Rosen Consulting Group.
These same real estate investments are estimated by the “Breaking Ground” report to have created over 200,000 jobs in the United States. However, the rapid rate of Chinese investment is slowing this year. For China’s own domestic reasons, including slowing the depreciation of its currency and the drain on its U.S. dollar reserves, China has been imposing stricter controls on outflows of capital into overseas investments, including especially fixed assets such as real estate. These restraints are unlikely to loosen until well after the 19th National Congress of the Chinese Communist Party convenes in October. But the fundamental economic forces that impel investment money to flow from China to the United States remain unaffected.
For the Trump administration, it seems that trade policies are adjusting to the reality that any significant disruption of the huge flows of goods or capital between China and the United States threatens to undercut the core objective of domestic job-creation that has been central to President Trump’s agenda.
IMPORT TAX TREATMENT AND CURRENCY POLICIES
As a result, the pointed rhetoric of the campaign has given way to more evolved proposals. For example, while the Trump campaign threatened high tariffs on goods imported from China and elsewhere, focus now seems to have shifted to “border adjustment” tax policies being advanced by congressional leaders, which would change the tax treatment for imported and exported goods. At the most simple level, these proposals would limit domestic U.S. tax deductions for the cost of imported goods, and exclude revenues from export sales from taxable income, creating financial incentives to shift production to domestic sources. However, even these more modest proposals have come under attack from U.S. retailers, automakers, oil refiners and other industries that are reliant on imports and the outlook is uncertain.
During the campaign, Trump also talked about China’s currency. Given the widespread recognition that China has not been intervening to drive down its currency and stimulate exports in recent years, the administration seems to be shifting to a different track on this issue. The administration reportedly is considering adopting broad policy changes to countervailing duty measures to begin treating currency devaluation as export subsidy, which then could be offset by the imposition of duties. Such a change would serve more as a notice to prevent future currency issues by China and other countries with no likely immediate impact on bilateral trade. Also, if such measures are pursued, it is questionable whether such measures would be consistent with U.S. obligations in the World Trade Organization.
INCREASED FOCUS ON ANTIDUMPING, TRADE
REMEDY CASES AND EXPORT CONTROLS
While the new administration appears to be backing away from broad measures to restrict China trade, it is likely to take a more activist role in the context of specific trade cases and disputes with China. For example, Commerce Secretary Wilbur Ross pledged in his confirmation hearing before the U.S. Senate that he would use his Department's ability to self-initiate antidumping and countervailing duty investigations to send a message to foreign manufacturers and to assist smaller industries that lack the considerable resources needed to bring those regulatory actions to offset imports proceed below cost or supported by export subsidies.
President Trump also selected Robert Lighthizer as U.S. Trade Representative. He is known as a highly effective U.S. trade attorney who has successfully represented U.S. steel interests and other groups in key antidumping and other cases. A longtime critic of U.S.-China trade policy, he is likely to be a voice in the administration for more resources and focus on domestic antidumping and countervailing duty cases as well as new WTO dispute settlement proceedings aimed at China’s market access barriers and support for domestic industries.
Similarly, President Trump’s new head of the National Trade Council, Peter Navarro is one of the country’s most outspoken critics on the issue of China trade. Among his announced priorities are new measures to protect U.S. intellectual property from foreign misappropriation, restricting heavily subsidized, state-owned enterprises from operating in U.S. markets, and using bilateral trade agreements to reduce trade deficits. How these broad objectives can be translated into legal or regulatory initiatives remains to be seen.
Another area of trade regulation which is likely to be given a boost by the Trump administration is export controls and sanctions enforcement. In the closing phase of the Obama administration, the United States continued to step up its enforcement of export restrictions on “dual use” -- civilian and military -- technology exported to China. These efforts culminated in forceful, high-profile responses to some alleged uses of U.S.-source technology in equipment sold in third countries subject to U.S. embargoes. Given the emphasis that members of the Trump administration have placed on protection of U.S. technology and intellectual property, it appears likely that additional attention and resources will be devoted to such export control matters. Moreover, the United States is increasingly turning to targeted trade sanctions to retaliate against companies that it accuses of being involved in cyber-crime, a trend likely to continue and broaden in the new Administration.
"HE IS LIKELY TO BE A VOICE IN THE ADMINISTRATION FOR MORE RESOURCES AND FOCUS ON DOMESTIC ANTIDUMPING AND COUNTERVAILING DUTY CASES..."
POSSIBLE UPDATES IN RULES FOR INBOUND FOREIGN DIRECT INVESTMENT
One of the most significant potential changes in U.S. trade regulation relates to inbound foreign direct investment, rather than the trade in goods. Various entities in the U.S. government are closely examining the process for reviewing inbound investment on national security grounds, which is administered by the Committee on Foreign Investment in the United States. The committee, an interagency committee led by the Department of the Treasury, is charged with reviewing and investigating foreign investments to identify threats to national security posed by such transactions. It has authority to initiate review of almost any foreign investment in a U.S. company that may negatively affect the national security of the United States. Key national security concerns historically considered by the committee include whether the transaction involves secured facilities, government facilities, export-controlled information, U.S. government contracts, critical infrastructure, a foreign government purchaser, the opportunity for surveillance or sabotage, the acquirer’s prior dealings with governments or entities unfriendly to the United States and the post-acquisition plans for the acquired business.
In the Obama administration, CFIUS issues led to the abandonment or blocking of a number of Chinese deals, recently and notably a Chinese consortium's $3 billion offer for a lighting unit of Philips, a $2.6 billion bid for Fairchild Semiconductor, and a proposed takeover by a Chinese company of German semiconductor company Aixtron. CFIUS has also objected to Chinese control of facilities close to sensitive U.S. sites; for example, in 2009, CFIUS reviewed a Chinese company’s acquisition of a U.S. mining company and raised concerns about the proximity of the properties to sensitive military facilities.
The CFIUS process has not been updated for ten years, but it appears increasingly likely that changes will be implemented this year or next. At the request of members of Congress, the Government Accountability Office is working on a set of policy recommendations for the next possible revision of CFIUS. Several of the policy proposals reportedly under consideration could impact Chinese investors. For example, under discussion are new restrictions tailored to industries like media, telecoms, agriculture and various technology sectors, as well as new restrictions aimed at policing foreign investor participation in domestic private equity funds and other investment vehicles.
Also reportedly under consideration are proposals to add restrictions on state-owned enterprises, new tests related to bilateral reciprocity, worker protection and net economic benefits. These changes could transform CFIUS into a much broader vehicle for policing Chinese investments into the United States, and indirectly positioning CFIUS as a lever to pressure China for further liberalization of certain domestic markets, like insurance and banking, where U.S. participation remains low. Such restrictions could significantly increase the complexity of evaluating Chinese investment opportunities in the U.S.
So while the United States remains an attractive opportunity for Chinese investors, certain planned domestic initiatives by the Trump administration – such as reduction of corporate tax rates, industrial and financial deregulation and incentivizing infrastructure investment -- could make American investments even more appealing in the future. However, prudent Chinese investors should stay alert to the possible changes to CFIUS and the other U.S. trade policies discussed above, understand the range of new risks and restrictions that might come into place and analyze the impact on their future business strategy. They should also consult with U.S. legal counsel regarding what reasonable measures can be taken to mitigate those risks and manage the evolving regulatory processes in Washington – including influencing policymakers where allowed. Significant changes probably are still well off in the future. But they will come.