Washington Backtracks On Enforcement Progress, Caves On Demands Beijing Scrap Industrial Subsidies

Despite Trade Rep. Robert Lighthizer's insistence that Washington leverage its position of advantage - i.e. the unassailable fact that its tariffs had contributed to a precarious deceleration in Chinese economic growth - the Trump Administration's trade team has repeatedly caved to Beijing. First, the administration compromised on enforcement (the administration has reportedly punted it to 2025) to the currency manipulation. And now it has reportedly softened its demands for the 'structural economic reforms' that Trump had insisted on as part of the final deal.


According to Reuters, US negotiators have 'tempered' their demands that Beijing roll back some of its industrial state subsidies as part of the trade deal. Washington's demands were reportedly met with 'strong resistance' from Beijing.

The issue is a thorny one because China's brand of state-directed capitalism is deeply tied up with the tax breaks and other advantages that Beijing bestows on state-owned firms, and it's possible that many of these firms could fail without the government's support, potentially setting off a destabilizing chain reaction.

The issue of industrial subsidies is thorny because they are intertwined with the Chinese government’s industrial policy. Beijing grants subsidies and tax breaks to state-owned firms and to sectors seen as strategic for long-term development. Chinese President Xi Jinping has strengthened the state’s role in parts of the economy.

And as the Trump administration looks to secure a deal in the next month or so, expect them to cave on more of their demands and focus on priorities that they consider "achievable."

These include: Ending forced technology transfers, improving intellectual property protection, expanding access to Chinese markets for American firms (and in particular American tech firms).

In what sounded like an attempt to spin Washington's walk-backs on subsidies and enforcement, Treasury Secretary Steve Mnuchin - one of the officials tasked with leading the trade delegation - said during a Monday morning interview that there was "more work to do" including on the issue of enforcement, after saying last week that the two sides had agreed to opening 'enforcement offices'.

When it comes to restrictions on state subsidies, expect any language in the deal to be vague, allowing Beijing substantial wiggle room to largely maintain the status quo.

So, if China's economy is in such dire straits, why is the US caving? Well, because President Xi can't accept a deal that would make him look weak, which gives him very little room to concede.

Washington has detailed more than 500 different subsidies it has said China applies in notifications to the WTO.

"It’s not that there won’t be some language on it, but it is not going to be very detailed or specific," one source familiar with the talks said in reference to the subsidies issue.

"If U.S. negotiators define success as changing the way China’s economy operates, that will never happen," said the other source with knowledge of the trade talks.

“A deal that makes Xi look weak is not a worthwhile deal for Xi. Whatever deal we get, it’s going to be better than what we’ve had, and it’s not going to be sufficient for some people. But that’s politics,” that source said.

China promised to end its subsidies earlier this year, but never said how it would accomplish this. To be sure, as Reuters points out, there are ways that maintaining subsidies could work to America's advantage, since most of the firms that would be making the tens of billions of dollars of annual agricultural purchases are mostly recipients of these subsidies.

One of the key sticking points in the negotiations is the removal of the $250 billion in U.S. tariffs. It is broadly expected in the trade community that U.S. negotiators want to keep some tariffs on Chinese goods, which Washington sees as retaliation for the years of damage done to its economy by Beijing’s unfair trade practices.

The role of the state firms may benefit the United States in another part of the trade deal. The Trump administration wants China to make big-ticket purchases of over a trillion dollars of U.S. goods in the next six years to reduce its trade surplus. The companies likely to make the purchases are the state-run firms, both sources said.

"The purchasing, for example, reinforces the role of the state sector because the purchasing is all being done through state enterprises," one of the sources said.

Another point of contention between the two countries, telecommunications, may drive China to increase the state’s role rather than reduce it, the source said.

In a separate report, Bloomberg said that China is weighing a request from Washington to shift some tariffs on key agricultural goods to other products to help the administration sell the trade deal to farmers, a key voting bloc for Trump, ahead of the 2020 election. While the exact nature of the arrangement proposed by the US wasn't reported, it shows that political considerations are increasingly becoming a factor as the talks enter their final stretch.

While some have argued that Trump could tout any deal as a win, even if China refuses to meet Washington's core demands and instead focuses on agricultural purchases, the political problem could become a serious Catch-22 for Trump.