The June 29 truce in the trade war between the United States and China lasted just over one month. Thirty-three days after the presidents of the two countries met in Osaka, Japan, and agreed to resume negotiations, President Trump, frustrated by the slow progress of negotiations, announced that the U.S. would impose a 10% tariff on an additional $300 billion worth of Chinese imports on September 1. The financial markets were rocked by the sudden reversal, and analysts wondered: “What triggered Trump’s announcement?”
There appear to be two reasons for the change of heart. The first is relatively simple and easy to fix. In exchange for the U.S. agreeing to hold off on the imposition of tariffs on an additional $300 billion of goods from China, as well as delaying restrictions against Huawei Technologies and allowing American companies to resume sales to the telecom company, China agreed to begin purchases of agricultural products and to stem the flow of fentanyl into the U.S. But U.S. officials claim that China has not followed through on its commitments.
Controlling a large number of black market players and stopping the export of fentanyl in the free-for-all market that is China is admittedly a difficult proposition, and the Chinese argue that U.S. complaints are without merit. However, purchases of agricultural products are very straightforward and well within the control of Beijing. Also, China is a net importer of food products and needs to purchase soybeans and other agricultural commodities from somewhere. Why not the U.S.? If China demonstrated its good faith by purchasing U.S. agricultural products, U.S. officials would have more leeway to be flexible on fentanyl.
A Legalistic Approach Does Not Work
A more fundamental reason for the breakdown in talks, however, is that the legalistic approach being taken by the U.S. negotiators to resolve disputes under the agreement is precisely the wrong way for America to achieve its objectives.
When talks broke off in May after eleven rounds of negotiations, Larry Kudlow, the White House economic adviser, explained that China needs to agree to “very strong” enforcement provisions for an eventual deal and said the sticking point was Beijing’s reluctance to put into law changes that had been agreed upon. After Trump’s August 1 announcement, a New York Times article attributed the breakdown in talks as follows: “The United States has insisted that China buy more farm goods and agree to cement certain changes into Chinese law. Beijing has resisted codifying any changes into law and has said it will only enter into a deal that is mutually beneficial.”
Assuming that the explanations given by Larry Kudlow and the New York Times are accurate, the common thread is the U.S. insistence that China write into law the agreements it makes as part of the negotiations. While this type of legalistic approach may make sense in a country like the U.S., it is deeply flawed when it comes to China. If the intention, as Kudlow suggests, is to provide for enforcement, writing an agreement into law in China merely begs the question as to how the provision will actually be enforced when a law is broken.
For example, does the U.S. government, or the company that is the subject of an alleged violation, take the offending Chinese company or government to court in China? As many companies have learned over the years, there are many laws on the books in the country that are simply not enforced given that government activities—including the courts—are highly decentralized. “The mountains are high and the emperor is far away,” is an old Chinese saying that illustrates the point.
Moreover, if a foreign entity takes a Chinese organization to court in China, the jurisdiction will most likely be the Chinese entity’s hometown where the Chinese entity has a natural “home court” advantage. The reality is that any important Chinese company has a close relationship with the local government, including the Party Secretary who oversees the courts in that city. Assuming that reforming the entire China judicial system is beyond the scope of the current trade talks, seeking legal remedies through the court system in China is a non-starter for this reason alone.
Likewise, the option of taking an offending party in China to court in the U.S. does not make sense. Even if the U.S. entity receives a favorable judgment, there is no way for the judgment to be enforced in China, except through the Chinese courts. Speaking from experience, negotiation and arbitration, not taking a Chinese counterparty to court, have proven to be the most effective ways to resolve disputes in the country.
Apart from its inherent flaws as an enforcement mechanism, insisting that China write agreements into law is deeply offensive to the Chinese, and as discussed in my May 20 article, touches a very sensitive nerve in China. Furthermore, in private comments made by a member of the Chinese negotiating team, the Chinese feel “humiliated” by the overall approach taken by the U.S. negotiators, which includes a requirement for quarterly compliance reviews by independent organizations.
To an outside observer, the negotiations appear to be riddled with miscommunication and mistrust. The Chinese say “trust me,” while the U.S. negotiators, mindful of Ronald Reagan’s maxim “to trust but verify,” understandably insist on some type of verification. Neither side seems to appreciate that trust takes a long time to establish—it requires both sides to reach an agreement through good faith negotiations and then live up to what has been agreed upon over a period of years, not weeks or months.
While offending the sensibilities of the opposite party is not in and of itself a valid reason for changing a negotiating strategy, insisting on an ineffective approach that also happens to offend the other side is hardly a recipe for success. Rather than taking a legalistic approach, the U.S. negotiators should develop some form of a bilateral arbitration mechanism to enforce the agreements that are made. Meanwhile, both sides need to find a way to correct the miscommunication and mistrust that obviously exists.
Sometimes, A Good Fight Is Necessary
The current state of the trade talks is reminiscent of a situation that ASIMCO Technologies found itself in soon after I established the company in 1994. On an infinitesimally smaller scale, negotiations that ASIMCO was having at the time with one of its Chinese partners were every bit as stalemated as the talks between the U.S. and China are today. A little over a year into the operation of the joint venture, mistrust and miscommunication between ASIMCO and the Chinese partner was in full bloom. At its low point, the head of the Chinese partner stormed out of a board meeting that had been specifically called to resolve the situation.
Like many such disputes, the falling out began with a small, seemingly insignificant event. Unbeknownst to senior management, the ASIMCO appointed Western manager stationed at the joint venture had canceled, at the last minute, a planned trip to the U.S. by the Chinese General Manager. While trips overseas are relatively commonplace in China today, they were a big deal back then, and ASIMCO’s Western manager was insensitive to the way in which his decision came across to the general manager and the other managers and employees in the company. To have his trip canceled, and by the foreigners no less, was an enormous loss of face that could have, and should have, been avoided. Needless to say, ASIMCO’s relationship with the general manager and local partner deteriorated from there, ultimately leading to the stalemate.
In an effort to resolve the dispute, ASIMCO appointed a team to investigate and identify the root cause of the conflict. After taking a deeper dive, the investigation team came to the conclusion that the ASIMCO manager was at fault, and that, all things considered, the Chinese partner was behaving quite rationally. With this new information in hand, I apologized to the head of the Chinese partner for the actions taken by ASIMCO’s representative and said that ASIMCO wanted to resolve the situation and let bygones be bygones. The Chinese partner was so relieved that his face lit up with a smile as he took my outstretched hand and went into a deep bow. There is another old Chinese saying that goes something like this: “Without a fight, it is difficult for two partners to get to know each other and become good partners.” That’s exactly what happened. ASIMCO’s relationship with its partner at that joint venture went on to become one of its strongest.
Change The Strategy, Or Change The Team
The purpose of relating this personal experience is not to suggest that either the U.S. or China has any reason to apologize to the other. However, it does make the point that, in order to overcome the miscommunication and mistrust that currently exists, something needs to change in the negotiations. Unless one side or the other changes the dynamic, the stalemate will never end and the talks will not get back on track.
The U.S. insistence that China write into law the agreements it makes as part of the negotiations should be scrapped. Solely from the U.S. point of view, such a requirement is not an effective enforcement mechanism and has the additional adverse effect of being overly offensive to the Chinese. Instead, the U.S. negotiators should learn from what has actually worked in China. By and large, the arbitration tribunals that have been established in the country and that are comprised of both Chinese and Western judges have been effective in resolving disputes.
If the individuals involved in the negotiations are so invested in taking a legalistic approach and relying on the Chinese courts for enforcement, an approach that has never worked in China, that they cannot bring themselves to alter their strategy, then perhaps the U.S. should consider changing its negotiating team. Meanwhile, the relationship between the two countries continues to deteriorate: new tariffs are set to go into effect in just over two weeks; stock markets in both countries have been hurt; China’s currency has passed the 7 yuan to the dollar mark, and the U.S. has now branded China a currency manipulator. If both sides truly want to make a deal, it’s time for a major re-set.
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