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THE BOTTOM LINE

US-China trade truce is becoming less - not more - likely

IT IS possible that a meeting between US President Donald Trump and his Chinese counterpart Xi Jinping at next week's G-20 summit will result in an "agreement to agree" on trade. But the chances of a more comprehensive deal appear remote. A key concept in negotiation textbooks is something called the "best alternative to negotiated agreement" - in other words, the best outcome that each party can hope for if talks fail. Mr Trump's "best alternative" is looking better than it was. This means that the prospects for an agreement are looking worse. A deal remains there for the taking. Both sides would benefit from a more open Chinese market with stronger protections for intellectual property. This would be an unalloyed positive for the US. In China, reformers would see the short-term costs as a price worth paying for a long-term increase in efficiency.

The details matter, of course. Which sectors would China open up and when? Would protections for intellectual property come in the form of new laws or just soft policy guidance? Still, hints at a mutually acceptable outcome in past rounds of negotiations, as well as China's moves to open its financial services and automotive sectors over the last two years, suggest ample room for agreement. China has also indicated a willingness to buy more US goods in order to close the bilateral trade surplus, which would address a key Trump concern.

Now, however, changing circumstances may be encouraging administration hardliners to hold out for more Chinese concessions. The one factor that seems to play on Mr Trump's mood is any sign that US markets are faltering. The Federal Reserve's gradual evolution from a focus on tightening monetary policy, to a patient pause, to hints at further easing has greatly reduced the risk of slumping growth or a market plunge. Pressure to reach a quick agreement has correspondingly declined.

At the same time, the incentives for Mr Trump, who officially launched his re-election bid this week, to stand tough on China are rising. The lesson of past presidential elections is that bashing Beijing is a vote-winning strategy with few downsides, politically speaking. By contrast, the concessions required to get a deal done would open up Mr Trump to criticism that he had gone soft at the last minute.

To make matters worse, China's "best alternative" to a deal may also be looking more attractive. Increased stimulus promises to put a floor under growth. Its leaders have at least some incentive to hold out and hope to confront a less adversarial US leader after November 2020. Also, after lower-level officials apparently reached agreement in earlier rounds of talks only for top leaders to retreat from commitments, trust between the US and China is in limited supply. Mr Trump's threat to impose tariffs on Mexico, even after successfully concluding talks on a free-trade deal, give Chinese leaders further reason to act cautiously.

Most importantly, US demands continue to shift between the narrow world of trade (where a deal is possible) and the broader universe of economic sovereignty (where it is not). China has chosen a particular model for running its economy, with a significant role for state ownership and industrial planning.

UNFAIR ADVANTAGE

In some respects, that gives China's firms an unfair advantage over foreign rivals. For example, state-owned companies can borrow from state banks at artificially low rates. Spread across the state sector, that subsidy is likely worth upward of US$100 billion a year. At the same time, the state model is integral to China's economic system. The government uses state firms to balance the ups and downs of growth, spending when private companies are cautious. Beijing sees them as engines of development that can make the capital-intensive investments necessary for China to climb the income ladder. They form patronage networks that are part of the power base for leaders. None of this is going to change. Indeed, Mr Xi has said that state firms should be "bigger, better and stronger".

Ultimately, China views US demands as part of its desire to retain its status as the world's biggest economic power. Concern about a world where China usurps that position from the US is easy to understand. China is a single-party state with a history of scant regard for human rights. The millions marching in Hong Kong in opposition to an extradition treaty with the mainland are an indication of the kind of fears that China's governance model engenders in those best placed to observe it close up. At the same time, "China agrees to stop developing until such time as its political system is acceptable to the US" is clearly not a contractual clause which Beijing can accept.

When Mr Trump and Mr Xi met at Mar-a-Lago in 2017, they enjoyed what Mr Trump called "the most beautiful piece of chocolate cake". This time around, friendly dinners will not make any difference until both sides determine what they really want out of trade talks. If Mr Trump is hoping for wins on market access, intellectual property and the trade balance, a deal should be easy to do. If the real US concern is China's economic and political model, markets should be bracing for a much longer struggle. BLOOMBERG