U.S. President Donald Trump and Chinese President Xi Jinping may have agreed at the G-20 summit in Osaka to resume trade negotiations, but the path to ending the trade war remains far from clear.
After all, the two leaders reached a similar agreement at the previous G-20 summit -- in Buenos Aires last December -- and those talks ultimately failed, not least because Trump mistook China's conciliatory attitude for weakness.
Whether Trump makes the same mistake this time remains to be seen. In any case, it is worth considering how the trade war might unfold over the coming months and years, and what China can do to protect itself.
Import tariffs may, for the foreseeable future, remain steady -- neither escalating further nor being rolled back. The agreement in Osaka kept Trump from following through on his threat to impose additional tariffs on $300 billion worth of Chinese exports.
But it did nothing to reverse past measures, such as the 15-percentage-point tariff hike, to 25%, on $200 billion worth of exports that the Trump administration implemented after the last round of talks broke down in May.
While these tariffs have not yet had serious consequences for China's economy, their effects are likely to deepen over time. But China will be more likely to persuade the U.S. to remove them -- or at least not to raise them further -- if it refrains from retaliating with tariffs of its own.
Instead, China should focus on reducing its bilateral trade surplus with the U.S. on its own terms. It is increasingly clear that Trump's tariffs have done more damage to America's businesses and consumers than to China.
Already, opposition to Trump's trade war is intensifying within the U.S. For example, the U.S. Chamber of Commerce -- one of America's most powerful business lobbies -- has called for the reversal of all tariffs imposed over the last two years.
With the 2020 presidential campaign already underway, the last thing Trump needs is to stoke opposition within his own political base, let alone risk tipping the global economy into recession.
The effects of the trade war have already spread to cross-border investment. In recent years, rising Chinese production costs have driven many foreign companies -- and, increasingly, even Chinese companies -- to relocate their operations to lower-cost countries like Vietnam and Thailand.
The trade war is accelerating this process. According to Vietnam's government, inward foreign direct investment increased by nearly 70% year-on-year in the first five months of 2019, the largest such increase since 2015. Meanwhile, growth in U.S. investment in China is slowing.
The Trump administration wants U.S. companies to leave China. It is up to China to persuade them to stay. That means improving the local investment environment, including by responding to foreign companies' legitimate complaints -- say, by enhancing intellectual-property protections -- and, more broadly, strengthening adherence to World Trade Organization rules.
The pressure on China does not end there. The U.S. is also eager to exclude the country's high-tech companies from global value chains. Trump recently announced that he would allow U.S. companies to continue to sell to the Chinese tech giant Huawei, after a monthslong campaign against the company.
But it remains highly unlikely that his administration -- which reversed a similarly aggressive policy toward the smartphone company ZTE last year -- will abandon its efforts to strangle China's high-tech industries.
China has three options. First, it could accede to U.S. pressure to disengage from global value chains. Second, it could remain committed to integration, hoping that, thanks to existing interconnections, sanctions on Chinese high-tech companies will also hurt their U.S. counterparts (such as Qualcomm) enough that the Trump administration backs down.
The third option is to focus on supporting domestic high-tech companies' efforts to strengthen their own positions within global value chains and develop contingency plans.
China must also prepare for the possibility that the trade war will escalate into a currency war. If the yuan comes under devaluation pressure and the People's Bank of China does not intervene to stabilize its value against the U.S. dollar -- as it should not -- the U.S. may label China as a currency manipulator. And, unfortunately for China, there is little it could do about it.
China's prospects for coping with financial sanctions -- which the Trump administration is likely to use more often -- are similarly bleak. Last month, a U.S. judge found three large Chinese banks in contempt of court for refusing to produce evidence for an investigation into North Korean sanctions violations.
The ruling ignores the fact that, according to Chinese law, any request for banking records should be handled in accordance with the U.S.-China mutual legal assistance agreement.
The chances of resolving such disputes appear slim. Chinese financial institutions thus need to prepare for more troubles, including the risk of being blacklisted -- that is, deprived of the right to use the U.S. dollar and important services, such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT) financial messaging service and the Clearing House Interbank Payments System (CHIPS). It is a punishment few companies can survive.
Already, one Chinese bank is included on the Correspondent Account or Payable-Through Account Sanctions (CAPTA) list, meaning that it cannot open correspondent or payable-through accounts in the U.S. China must be prepared for worse to come.
China's government has few options here, but it can step up legislative efforts to protect Chinese banks' interests, while encouraging Chinese financial institutions to treat compliance with U.S. financial regulations with the utmost care. It should also continue working to internationalize the yuan, though there is still a long way to go on this front.
China remains committed to its 40-year-old process of reform and opening up. Today, that process must focus on redoubling efforts to strengthen property rights, adhering to competitive neutrality, and defending multilateralism.
But following through on this commitment will require China to find ways to manage escalating tensions with the U.S. and avoid a costly -- and potentially devastating -- reconfiguration of the global economy.