In light of the sectors targeted by China’s retaliatory tariffs against U.S. imports, it is not surprising that agriculture was a critical component of the Phase One Trade Agreement between the U.S. and China, that went into effect on February 14, 2020. Specifically, China committed to purchasing an additional $12.5 and $19.5 billion worth of U.S. agricultural products above 2017 levels in 2020 and 2021, respectively, implying total agricultural imports of $36.5 billion in 2020 and $43.5 billion in 2021 (see Section 6-1 of the Agreement). Essentially, these commitments by China constitute a voluntary import expansion (VIE), harking back to the era of so-called “managed” trade between the U.S. and Japan in the 1980s (Bown and Keynes, 2020).
As a trade policy instrument, VIEs have rarely been used by policymakers, and are not even covered by typical undergraduate textbooks in international economics. In principle, a Chinese agricultural VIE would work as follows: the targeted level of imports results in China’s import demand curve shifting out, driving up the price received by U.S. exporters, and at the same time driving down the internal Chinese price, in order that its market can clear. In other words, in the absence of an import subsidy from the Chinese government, agricultural commodity traders operating in China will incur a loss as they will have to sell the mandated extra imports at a loss. Part of this loss is transferred to Chinese consumers who benefit from lower prices, and part is transferred to U.S. exporters in the form of higher prices, the remainder being the “deadweight loss” due to inefficient U.S. production and Chinese consumption.
Research by Feenstra and Hong shows that, depending on a range of forecasts for Chinese economic growth, the gap between prices paid to U.S. exporters at the Chinese border and the price importers can charge Chinese consumers would require import subsidies in the range 12-23 percent for 2020, and 42-59 percent in 2021, in order that Chinese commodity traders could break even. This would represent a significant distortion to international agricultural commodity markets, with inefficient trade diversion to U.S. exporters away from other exporting countries, including Australia, Brazil, and Canada.
Of course, these are implicit import subsidies, the only realistic way for China to meet their agricultural import commitments being through mandates to state owned enterprises (SOEs) such as the China Oil and Foodstuffs Corporation (COFCO). However, as a practical matter, two interdependent factors militate against relying on SOEs to satisfy the import targets. First, private trading firms are mostly responsible for purchasing Chinese agricultural imports, for example, in 2015, they accounted for 72, 69, and 92 percent of Chinese imports of soybeans, cotton, and meat products, respectively (Bown and Lovely, 2020). Second, despite the Agreement, China has not reduced its retaliatory tariffs against U.S. imports, therefore private trading firms will have an incentive to purchase commodities from the world market at lower prices, thereby undermining the VIE.
Even before the current COVID-19 pandemic, many observers suggested that meeting such agricultural import growth targets would be difficult. Based on China’s growth rate prior to the COVID-19 pandemic, it has been predicted that by 2021, there will be a shortfall of $10.5 billion in imports from the U.S. relative to the target, and based on a declining growth trend projection, the shortfall will be even larger at $23.6 billion (see Bown, January 21, 2020). This expected shortfall has already been borne out in the January-May China Customs Statistics. While improving on 2019 totals at the height of the trade war, 2020 January-May totals of $7.5 billion suggest Chinese agricultural imports from the U.S. are running at 50 percent below the Agreement’s year-to-date target (Bown, July 2, 2020).
In light of the COVID-19 pandemic shock to the global economy, the World Trade Organization’s (WTO) forecast for China’s real GDP growth in 2020 of -4.0 to -9.9 percent (Beckers et al., April 8, 2020), it seems very unlikely that China will meet its import commitments under the Agreement, and even if it were able to do so, it would imply significant distortion to agricultural trade. This comes at a time when compensation to U.S. farmers for the trade war under the Market Facilitation Program (MFP), potentially violates U.S. commitments to the WTO on capping its farm subsidies, thereby raising the risk of retaliation by other countries (Bloomberg, June 18, 2020).