How the U.S. and China Settled on a Trade Deal Neither Wanted

By Bob Davis in Washington and Lingling Wei in Beijing (WSJ)

Jan. 13, 2020 11:07 am ET

The world’s two largest economies will sign a compromise Wednesday that calms their trade war—here’s the back story

U.S. talks with China to complete a first-stage trade deal had hit an impasse around Thanksgiving, raising fears a nascent accord would collapse again—and with it, hope for a halt to the nearly two-year-old trade war.

Looking for a direct route to the president, Chinese Ambassador Cui Tiankai spoke with President Trump’s son-in-law and adviser, Jared Kushner, say people familiar with the episode. The U.S. offer didn’t roll back enough tariffs, he told Mr. Kushner.

It was time to settle, Mr. Kushner responded. If not, on Dec. 15 the president was ready to proceed with new tariffs on about $156 billion in Chinese imports, including smartphones and toys. “Don’t think in terms of tariff reduction,” he advised. “Think in terms of what will happen if you don’t make a deal.”

To Chinese negotiators dealing with a president they considered erratic, Mr. Kushner’s words at least offered certainty, say the people familiar with episode. They also recognized an opportunity: The agreement wouldn’t force them to make economic-policy changes Washington had long insisted on.

About two weeks later, both sides announced the compromise set to be signed at a White House ceremony Wednesday. “This is an attempt to work together and solve problems,” says Clete Willems, a former Trump White House trade negotiator who had worked on China issues. “It’s not everything the U.S. set out to do.”

Adds a Beijing regulator who has knowledge of the negotiations: “Hopefully, this deal can help prevent the bilateral relationship from getting much worse.”

Step by Step

The accord promises increased purchases of U.S. goods and services, greater access for American firms to China’s banking, insurance and other financial sectors, an end to tariff threats—and a chance to reset relations between the world’s largest economies. The two sides also have agreed to semiannual meetings to discuss trade and economic issues.

Even so, the deal isn’t what either side said it had wanted. The U.S. doesn’t get the fundamental reforms in Chinese economic policy it sought to help American businesses. And levies remain on about $370 billion of China’s exports.

Two days before Christmas, Chinese leader Xi Jinping dined with Japanese Prime Minister Shinzo Abe at the Great Hall of the People, where Mr. Abe said he hoped the so-called phase-one deal would encourage China to liberalize its economy further, say people familiar with the exchange.

China has already opened up significantly, replied Mr. Xi, trumpeting a World Bank survey showing China’s improved business environment. “It’s good to have the phase-one agreement,” he said, but added many issues remained unresolved and a deal “can’t solve everything.”

Trump on a warpath

This account of how the limited deal came together is based on interviews with policy makers in both capitals and people who have been consulted on the negotiations, and reveals the little-seen pragmatic side of a publicly fraught relationship.

As Washington and Beijing sweltered last summer, Mr. Trump was losing patience. Outraged that Beijing hadn’t come through with what he claimed were promised purchases of soybeans and other commodities, he threatened in August to raise tariffs on half of what China sells the U.S. and impose new tariffs on the other half. China, denying it made a purchase promise, retaliated by suspending buying U.S. farm products.

The president took to Twitter on Aug. 23 and “hereby ordered” U.S. firms “to start immediately looking for an alternative to China, including bringing…your companies HOME.”

By September, both sides wanted to pull back from the brink. In Washington, a succession of CEOs paid calls on Mr. Trump and his economic advisers, warning of the tariff battle’s dangers.

After the president’s tweet, Sheldon Adelson, the Las Vegas Sands Corp. CEO who contributed $20 million to Mr. Trump’s presidential campaign and whose Macau casinos depend on Chinese goodwill, warned the president new tariffs would hurt the economy and Mr. Trump’s re-election chances by increasing consumer prices.

Trump had long claimed China was paying the cost of tariffs. Executives from Best Buy Co. were among those pointing out the burden falls on U.S. businesses and customers. A spokesman for Mr. Adelson confirmed his lobbying. Best Buy declined to comment.

Beijing, which worried about the trade war’s impact on its economy, also signaled through U.S. business representatives that it wanted to negotiate. For China’s leaders, 2019 was supposed to focus on celebrating on Oct. 1, the 70th anniversary of Communist Party rule and its success in lifting hundreds of millions from poverty. Instead, the trade war threatened to tank the economy, as unrest in Hong Kong and other challenges highlighted Mr. Xi’s domestic problems.

Premier Li Keqiang and other top officials stressed to visiting American executives the importance of engagement to help prevent tensions from spinning out of control, figuring they would relay those views to the White House.

By mid-September, China was cracking down on shipments of the addictive drug fentanyl, a Trump priority. It also said it would exempt some U.S. soybeans and pork from tariffs. The U.S. responded by delaying tariff increases.

Best deal available

Behind the scenes, the U.S. also was debating how to compromise. Mr. Trump had long instructed his chief negotiator, U.S. Trade Representative Robert Lighthizer, to get a “great deal.” Now, Mr. Lighthizer was after the best deal available.

In May, the U.S. and China had been close to a comprehensive agreement. But it would have required China to change as many as 60 laws and regulations covering intellectual property, regulatory review panels, financial services and other areas. It fell apart when China’s lead negotiator, Vice Premier Liu He, couldn’t get the top leadership approval.

DEAL POINTS

· Highlights of the U.S.-China trade deal as described by U.S. Trade Representative Robert Lighthizer and his staff; Chinese officials haven’t yet given a detailed summation.

· Buy American: Beijing to ramp up purchases of U.S. goods and services by at least $200 billion over the next two years, using 2017 as a benchmark.

· Tariff relief: The U.S. to cut the tariff rate in half—from 15% to 7.5%—on levies it imposed Sept. 1 on roughly $120 billion in Chinese products, including shoes and apparel. The U.S. also agreed not to impose tariffs of 15% on roughly $156 billion in consumer products.

· Technology transfer: China to stop forcing foreign companies to transfer technology to Chinese companies as a condition for market access.

· Intellectual property: Unspecified measures to address intellectual property concerns.

· Financial services: Removal of barriers to help U.S. banking, insurance and other financial services companies expand in China.

· Currency measures: Measures aimed at stopping China from devaluing its currency.

· Dispute resolution: An arrangement for both sides to resolve disputes through consultations.

Mr. Lighthizer, White House economic adviser Larry Kudlow and Treasury Secretary Steven Mnuchin now sought to “pocket the gains,” as they called it, from prior negotiations even if that meant jettisoning for now demands for China to eliminate subsidies and revamp state-owned firms.

They counseled Mr. Trump to show restraint. During Oval Office meetings in August, the president had threatened to double to 50% the tariffs on $250 billion of Chinese goods. In the past, Mr. Lighthizer had urged him to increase rates to pressure China. Now, he joined the other two to persuade the president to threaten just a 5-percentage-point increase—as a warning to Beijing but small enough it wouldn’t disrupt negotiations. The president later delayed putting the increase into effect.

“Bob Lighthizer isn’t an ideologue. He is a realist,” says former Trump strategist Stephen Bannon. “His client wanted a deal, as good a deal as you could get to close.”

Negotiators on both sides started exploring a settlement with different phases, the first focused on agriculture purchases and other less contentious issues. That had long been China’s strategy. Since 2018, Chinese negotiators had pushed what they called a 40-40-20 plan: They said 40% of American demands were doable because they involved reforms China planned anyway, 40% were negotiable and 20% were off-limits, impinging on national security.

Mr. Lighthizer and other negotiators had earlier privately derided the effort because Beijing categorized as off-limits issues the U.S. considered priorities. That included further opening China’s cloud-computing market. Now the U.S. essentially was ready to accept China’s framework.

Chinese negotiators focused on three areas important to the U.S. team, starting with increased purchases of U.S. farm goods—a priority of Mr. Trump’s. China had largely stopped buying U.S. crops to retaliate against tariffs, hitting his supporters in farm states.

Beijing also offered compromises on the deal’s enforcement, a priority for Mr. Lighthizer, and financial liberalization, an issue for Mr. Mnuchin.

When Mr. Kudlow sketched out a possible deal for Mr. Trump in early October, the president responded, “I could be for that,” though he wanted to see what the Chinese offered.

The two teams of negotiators met Oct. 10 at Washington’s Metropolitan Club, a Lighthizer haunt, going over the outline of a deal. The next day, the president invited Mr. Liu into the Oval Office and with television cameras present announced what he called a “tremendous” deal.

“I’d suggest the farmers have to go and immediately buy more land and get bigger tractors,” he said. Beijing would buy $40 billion to $50 billion annually in agricultural products, he said, about twice what it has ever bought from the U.S. Mr. Liu didn’t contradict him but didn’t confirm the claim.

Both sides wrangled over deal details during videoconferences over the next two months. Chinese negotiators continued to insist on what they called a balanced deal, not wanting to be seen as caving to foreign pressure.

To that end, enforcement provisions were relabeled “bilateral assessment and dispute settlement,” according to Xinhua, the Chinese state news agency. That put the emphasis on planned consultations to settle disputes rather than U.S. insistence it could impose tariffs if unsatisfied.

Beijing also wanted the U.S. to roll back tariffs sharply. Again, Chinese negotiators divided U.S. demands into hundreds of items and calculated their offer covered 72% of the demands, which they argued should be matched by commensurate tariff reduction.

No way, Mr. Lighthizer responded, the Chinese offer was worth maybe half that. On Oct. 31, the president tweeted their offer covered 60%.

Back and forth went the argument over percentages. Mr. Lighthizer offered to cut 15% tariffs on $120 billion of Chinese imports to 10% and drop plans to impose new tariffs. That represented the first U.S. offer to scale back tariffs since the trade battle started. But it left 25% tariffs on $250 billion of Chinese imports, about half what China sold to the U.S. Mr. Xi wanted all tariffs eliminated or at least a schedule to reach zero tariffs.

The Chinese ambassador relied on Mr. Kushner for a better read on what Mr. Trump wanted. To Beijing, Mr. Kushner was a trusted intermediary who had helped arrange a Mar-a-Lago summit between Messrs. Xi and Trump a few months after the president’s inauguration.

After listening to Mr. Kushner’s counsel, the Chinese side was ready to settle if Mr. Lighthizer approved one more compromise—reduce the 15% tariffs to 7.5% instead of 10%. Both sides could live with that and worked to clear remaining issues.

The U.S. side was exultant and started providing deal details on Dec. 12.

Beijing’s silence

The Chinese side was silent. The following workday in Beijing, none of China’s state-owned media outlets or government agencies commented on the negotiations.

First, Mr. Xi had to approve the deal, which he did. Then, Beijing had to decide how to spin the agreement to fend off any domestic criticism China made too many concessions.

Near midnight Dec. 13 in Beijing, about 90 minutes after Mr. Trump tweeted the sides had reached “an amazing deal,” a half dozen vice ministers held a rare press conference. They confirmed the deal but didn’t give details.

Negotiations continued, particularly over how to translate the text into Chinese, which could give Beijing wiggle room on commitments. China’s state media has stayed largely quiet about the deal.

“Because of the remaining uncertainty, we’re being told to be standing by,” said a senior editor at a state-owned news agency in Beijing. “But no news is good news,” the editor added. “It shows the top leader here wants to get it done.”

Before heading to a New Year’s Eve celebration at Mar-a-Lago, Mr. Trump told reporters he would head to Beijing in 2020 for talks on a second-phase deal and hinted Mr. Xi might travel to the U.S.—a suggestion the president had made before.

Beijing didn’t confirm any travel plans. Chinese diplomats say their priority is preparing for Mr. Xi’s planned state visit to Japan this spring.

The U.S. is counting on remaining tariffs to compel Beijing to continue negotiating and agree to economic-policy changes. Failing that, Washington could use other pressure points, such as limiting the ability of Chinese firms to list shares in U.S. markets.

Still, Chinese officials feel they have little to gain from a phase-two deal forcing Beijing to ease state control of the economy, and Mr. Trump recently said that a phase-two agreement probably wouldn’t conclude until after the Nov. 3 election. The Chinese government continues to plan for a future where the two economies would be less intertwined and China would develop technology rather than rely on American imports.

When Mr. Xi met with a group of foreign luminaries including former Secretary of State Henry Kissinger and former Treasury Secretary Hank Paulson in a November forum in Beijing, say attendees, he told them: “We did not start the trade war, but we won’t flinch from confrontation.…Why should we change policies that are working?”

Write to Bob Davis at bob.davis@wsj.com and Lingling Wei at lingling.wei@wsj.com