Hi China Watchers. We're marking this week's second anniversary of the U.S.-China Phase One trade deal with a diagnostic that reveals where it worked and where it (mostly) fell short. We'll also look at the latest congressional scrutiny of the 2022 Beijing Olympics' sponsors, parse a potential Pacific "strategic surprise" and peek under the hood of China's "brotherly" outreach to Kazakhstan. Let's get to it. — Phelim President DONALD TRUMP hailed the Jan. 15, 2020, signing of the U.S.-China Phase One trade deal as a "momentous step … toward a future of fair and reciprocal trade." Two years later, that step looks more like a stumble — and prospects of a second trade deal appear as remote as ever. Trade experts and U.S. exporters complain that the Chinese government has failed to deliver on key commitments, including purchase of U.S. goods and services, regulatory changes to speed imports of genetically modified agricultural products and patent approval for U.S. pharmaceutical products. Those shortcomings underscore the need for future bilateral trade deals to look past short-term trade deficit reductions and tackle head-on Chinese subsidies that kneecap the competitiveness of U.S. producers. "The [deal's] main benefit was to put a halt to things getting worse by stopping the escalation of the tariffs … [and] simply not escalating a trade war makes the [bilateral] relationship more durable," said CHAD BOWN , a senior fellow at the Peterson Institute for International Economics. "What Phase One didn't deal with at all is the bigger fundamental underlying challenges between the [U.S.-China] economic systems because it didn't say anything about China's system of [industrial] subsidies." The Phase One deal took effect on Feb. 14, 2020 as a calibrated cease-fire in the U.S.-China trade war sparked by the Trump administration's imposition of steep tariffs on $350 billion in Chinese goods beginning in 2018. China responded with retaliatory tariffs that have harmed U.S. exporters. The agreement committed China and, to a lesser degree, the U.S. to regulatory changes in areas, including agriculture, financial services, intellectual property and technology transfer designed to pave the way for increased trade. It also obligated China to purchase $200 billion in U.S. goods and services by Dec. 31, 2021, above the value of total U.S. exports to China in 2017. The deal explicitly hinged future trade agreements to successful completion of Phase One. President JOE BIDEN has maintained the agreement while U.S. Trade Representative KATHERINE TAI engages with her counterpart, Chinese Vice Premier LIU HE, on shifting the trade relationship from a confrontational setting to what she has described as "durable coexistence." Some U.S. economic sectors have profited from the agreement. The deal streamlined China's import regulations that helped push U.S. agricultural exports to 83 percent of the Phase One 2021 target by November. Phase One also eliminated a 49 percent foreign ownership cap on financial service firms, allowing companies, including Goldman Sachs and J.P. Morgan to launch wholly owned China-based securities firms. But China's most glaring Phase One commitment failure is the massive projected shortfall in the purchases it promised to make by the end of last year. China's imports of U.S. goods were only 62 percent of the total dictated by the agreement as of Nov. 30. And China was unlikely to have significantly closed the gap in December absent purchases of Boeing passenger aircraft (which have not been announced). But trade experts say that China was saddled with impossibly high import targets that made under-delivery inevitable. "A lot of the goals were unrealistic right from the get-go, particularly in the energy space," said JENNIFER HILLMAN, professor at Georgetown University Law Center. "If you just look at how much LNG China would have had to have imported in order to meet these targets, we don't have the capacity to do that, we do not have enough LNG terminals, we do not have enough vessels on which to move the LNG and could not have met that goal under ideal conditions." The U.S.-China Business Council complains that the Chinese government has also dragged its feet in improving the transparency and predictability of regulatory approval for importing genetically modified U.S. agricultural products produced by Monsanto, Syngenta and other firms. And that the benefit to U.S. pharmaceutical firms by improvements in China's patent approval process has been offset by an apparently deliberate rapid increase in patent approvals for generic competitors of branded U.S. products. "There is definitely an argument to be made that Chinese industrial policy might be undercutting some of the improvements in intellectual property rights that we had anticipated," said CRAIG ALLEN, U.S.-China Business Council president. The Chinese government insists that it has honored its Phase One commitments in good faith despite challenges posed by the pandemic and supply chain disruptions. And it blames the U.S. government for obstructing China's ability to fulfill its U.S. exports purchase commitments. "Since the trade agreement came into force, the U.S. has continued to impose restrictions on China, including the inclusion of more than 950 Chinese entities on the list of sanctions and restrictions," LIU PENGYU , spokesperson for the Chinese embassy in Washington told China Watcher in a statement. "This has directly restricted Chinese companies' ability to purchase from the US and had a negative impact on the implementation of the agreement." The future of the Phase One agreement and possible follow-up bilateral trade talks is uncertain. There is pressure on USTR to ensure that China fully complies with the deal and that both sides lower tariffs. Agriculture Secretary TOM VILSACK promised the American Farm Bureau Convention on Tuesday that USTR will "continue to press China on the need for complete enforcement and complete implementation." But USTR's leverage is limited and potentially self-defeating. "China could agree to announce some new big purchases and a road map for going forward … or USTR could decide to go forward with the [deal's] enforcement mechanism, which could result in more tariffs or an increase in tariff rates," warned WENDY CUTLER, former assistant U.S. trade representative and vice president at the Asia Society Policy Institute. A sequel to the Phase One deal that seeks long-term resolution of U.S.-China trade conflicts will need to include enforceable mechanisms to limit or eliminate Chinese subsidies to key industrial sectors. A Nikkei Asia study estimated that the Chinese government allocated $33 billion in subsidies in 2020 to domestic firms in areas including semiconductors and pharmaceuticals. "The hardcore underlying problem with China is the role of the state, the volume of state subsidies, the level of state-owned enterprises that are engaging in unfair trading practices and the degree to which you are asking U.S. producers to effectively compete with the [Chinese] Communist Party," Hillman said. But effectively engaging China on industrial subsidies will require collaboration with the European Union, Japan and other allies. USTR Tai flagged the strategic importance of such cooperation in a speech Wednesday at the Institute of International and European Affairs that referenced "our trilateral partnership with the E.U. and Japan to address the global challenges posed by non-market policies and practices of certain countries." That effort is complicated by the fact that Japan, the EU and the U.S. have rolled out subsidies for their own semiconductor industries. Tai's office didn't respond to requests for comment. But Chinese embassy spokesperson Liu described the China-U.S. economic and trade teams as being "in normal communication." That said, HUO JIANGUO, former head of a think tank under China's Ministry of Commerce, told the South China Morning Post last week that the U.S.-China trade relationship has been "in a stalemate" since an October video call between Tai and Vice Premier Liu. That stalemate might persist because trade no longer dominates the bilateral policy agenda as it did when the Phase One deal was inked two years ago. Instead, the Biden administration is grappling with a more urgent set of China-related issues, including tensions in the South China Sea, human rights and pandemic control. "Under the Trump administration, the economics were really driving the conversation and we were trying to address unfair trade practices and level the playing field so that U.S. businesses could continue to do business in China, but at this point, no one's really talking about that," said KELLY ANN SHAW, a former Trump senior trade adviser and partner at the global law firm Hogan Lovells. "So I just don't see a Phase Two or a broader conversation about structural issues gaining much traction in the next year or two." TRANSLATING WASHINGTON — STATE: CHINA'S MARITIME SOVEREIGNTY CLAIMS 'UNLAWFUL': The State Department issued a report Wednesday that rejected the legality of the Chinese government's expansive sovereignty claims in the South China Sea. The report concluded that China "unlawfully claims sovereignty or some form of exclusive jurisdiction over most of the South China Sea [and that] these claims gravely undermine the rule of law in the oceans and numerous universally-recognized provisions of international law." China lays claim to large swathes of the South China Sea based on debunked assertions of "historic rights" and other legally spurious contentions that have fueled tensions with neighbors, including the Philippines, Taiwan, Malaysia, Brunei and Vietnam. — CAMPBELL FLAGS CHINESE 'STRATEGIC SURPRISE': U.S. Indo-Pacific coordinator KURT CAMPBELL warned Monday of a Chinese "strategic surprise " in the Pacific that could upend the region's traditional strategic calculus. Campbell provided no details but said that it may emerge "over the next year or two" and required the U.S. and regional allies "to step up their game across the board." The Chinese government has explored the possibility of potential dual-use port facilities in the Pacific island states of Kiribati and Vanuatu, but such outposts won't play to the People's Liberation Army's strengths, SCOTT HAROLD, senior political scientist at the RAND Corporation, told China Watcher. "Logistics is one of the weakest aspects of the PLA and so is long-range command and control," Harold said. "I would be more worried about China taking off the table a [Pacific location] that [the U.S.] had access to or planned to use than I would be that China would gain access to some place and have a small number of ships and air defense assets way out in the middle of nowhere." — RUBIO RIPS INTEL 'CAVING TO BEIJING': Sen. MARCO RUBIO (R-Fla.) on Monday called for the U.S. to bar Intel from federal funding under the CHIPS Act if it continued to "obscure the facts about U.S. law just to appease the Chinese Communist Party." Rubio was set off by a Wall Street Journal report that Intel erased mention from a Dec. 23 letter to suppliers of the need to avoid sourcing products and services from Xinjiang in line with the Uyghur Forced Labor Prevention Act. Angry Chinese public reaction to that letter prompted Intel to apologize on Chinese social media last month. Intel declined China Watcher's request for comment on Rubio's criticism. — MCCAUL APPLAUDS UYGHUR-AWARE OLYMPIAN: Rep. MICHAEL MCCAUL (R-Texas) tweet-praised U.S. pairs figure skater TIMOTHY LEDUC on Tuesday for "speaking about the horrifying human rights abuses and genocide" against Uyghur Muslims in Xinjiang. LeDuc said Sunday that "we absolutely acknowledge the horrifying things that we've seen happening to the Uyghurs." LeDuc also criticized the violation of rights of trans people in the U.S. and the moves by some states — including Texas — to restrict women's access to abortion. — USTR DECRIES 'ECONOMIC COERCION' AGAINST LITHUANIA: U.S. Trade Representative Tai told European Commission Executive Vice President VALDIS DOMBROVSKIS on Friday that the U.S. would support Lithuania and the EU against China's "economic coercion." The Chinese government has blocked imports from Lithuania as well as EU countries, including France and Sweden, that are dependent on Lithuanian supply chains in reprisal for allowing Taiwan to christen its new representative office in Vilnius the " Taiwanese Representative Office." Chinese Foreign Ministry spokesperson WANG WENBIN shot back Monday by accusing the U.S. of "using Taiwan to contain China at the expense of Lithuania's interests." — AIRBNB'S OLYMPIC SPONSORSHIP UNDER SCRUTINY: The Congressional-Executive Commission on China on Friday wrote to Airbnb, one of the 2022 Beijing Games Olympic Partner Program (TOP) sponsors, seeking clarification of the firm's "commitment to human rights and anti-discrimination in China." The inquiry seems well-justified considering Axios' revelations in November that the firm rented properties in Xinjiang "on land owned by an organization sanctioned by the U.S. government for complicity in genocide and forced labor." The Commission also raised concerns about Airbnb's business activities in Xinjiang. Airbnb management has "received and are reviewing the CECC's letter," a source privy to the company's operations told China Watcher on Monday. The CECC on Wednesday sent a letter to the International Olympic Committee expressing concern that IOC officials at the Games may wear "clothing contaminated by forced labor" due to IOC sourcing contracts with Chinese sportswear firms ANTA Sports and Hengyuanxiang Group. | 
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