“API Geoeconomic Briefing” is a weekly analysis of significant geopolitical and geoeconomic developments in the post-pandemic world. The briefing is written by experts at Asia Pacific Initiative (API) and includes an assessment of burgeoning trends in international politics and economics and the possible impact on Japan’s national interests and strategic response. (Editor-in-chief: Dr. HOSOYA Yuichi, Research Director, API & Professor, Faculty of Law, Keio University)

This article was posted to the Japan Times on November 3, 2020:

https://www.japantimes.co.jp/opinion/2020/11/03/commentary/world-commentary/china-dual-circulation-strategy/

API Geoeconomic Briefing

November 3, 2020

What China’s ‘dual circulation’ strategy means for the world

OYA Shin,
Senior Consulting Fellow, Asia Pacific Initiative (API)

 

 

 

China’s “dual circulation” strategy, referring to the parallel emphasis on internal and international circulation, has been grabbing global attention after the term was first used in a May 14 meeting of the Communist Party Politburo.

China’s central leadership proclaimed that the nation will “fully bring out the advantage of its superlarge market scale and the potential of domestic demand to establish a new development pattern featuring domestic and international dual circulations that complement each other.”

The new strategy could become a key priority in the Chinese government’s 14th five-year plan for 2021 to 2025.

It is believed that the strategy is being advocated by Vice Premier Liu He, President Xi Jinping’s top economic adviser who headed China’s negotiators in the trade talks with the United States.

Since no further details have been announced on the strategy, people have mixed views and interpretations of it.

Some see it as a continuation of China’s policy focusing on spurring domestic demand and believe the nation will maintain economic exchanges with other countries and even move toward economic reforms.

Others say the new strategy will hamper Beijing’s economic reforms, as the nation will reduce economic interactions with the rest of the world and shift to self-sufficiency.

Which way will China take?

 

Differing views

A China Daily article published on Aug. 14 says concerns that China will close its door by putting forward the new development concept “are not well-founded,” citing the country’s history of economic development over the past four decades.

The article says China’s economy expanded after it started to reform and open up in the late 1970s, but an increase in foreign trade led to a wider income gap between the eastern coastal region and the western region. And, in the late 1990s, the nation had already acknowledged the need to shift to a more balanced development mode focusing on domestic demand.

In 2006, China said it would make the expansion of domestic demand the basis for economic development and seek a coordinated development of investment, domestic demand and exports, the article said, adding that such a shift in development orientation has remained unchanged since then.

It stresses China will continue its economic exchanges with other countries and expansion of the domestic market will naturally require more imports and foreign investment, as well as the further opening of its financial sector.

Li Yiping, an economics professor at Renmin University of China, also pointed out that Xi, in his key speech at a symposium with corporate leaders in Beijing on July 21, ruled out the possibility of China closing its doors on other economies.

Li says the dual circulation development pattern centered on the domestic economy and aimed at integrating the domestic and global economies, is the right choice to not only give a much-needed boost to the Chinese economy but also revive the world economy.

Frank Tang, a reporter for the South China Morning Post, wrote, quoting Chinese government advisers and economists, that the new strategy is focused on competition and opening up, including lowering barriers for foreign investors, a motivation to secure regional trade pacts and a supply-side structural reform of state-owned enterprises.

Meanwhile, there are views that China will reduce economic exchanges with other nations.

Li Hong, an editor with the Global Times, writes that China’s dual circulation policy “aims to fight U.S. bullying and hegemony.”

“Trying to deflect the (U.S. President Donald) Trump administration’s trade protectionism and technology blockade, the new Chinese policy aims to set up a global economic and technological innovation center, rivaling that of the U.S.,” Li writes.

Although noting that focusing more on inner circulation does not mean China will give up on outer circulation, Li says, “to offset the U.S.-led decoupling bid, China may be forced to turn its back on North America (the U.S. and Canada) and Australia by keeping a greater distance from the three unfriendly countries, while focusing more on forming closer economic partnerships with the economies of Europe, Asia, Africa and other regions.”

Li also says the iconic Belt and Road initiative will be vigorously enforced and funded.

Lingling Wei of the Wall Street Journal wrote, citing Chinese officials, that Vice Premier Liu appears to be trying to use the new agenda to push through changes that could make more credit available to private companies rather than state-owned firms. But he has to balance that push with the need to adhere to Xi’s emphasis on state control, she added.

 

China’s economic development

After the creation of the People’s Republic of China in 1949, China’s policies focused on building heavy industries to replace imports. Since the 1960s, as the nation’s relations with the Soviet Union deteriorated, China leaned further toward “self-reliance.”

Its national savings rate at the time was around 20 to 30% of gross domestic product, relatively high compared with its income levels, and the funds were allocated to capital investment in heavy industries.

However, China’s economic growth had been limited, with the nation occupying less than 2% of global GDP as of 1978 and its exports less than 1% of world trade.

And, in 1978, China’s reform and opening up began, led by Deng Xiaoping. China posted a tremendous average annual real GDP growth rate of 9.8% between 1978 and 2008.

Its exports posted an annual increase of 16% on average between 1979 and 2001, and an annual growth of 27% on average between 2002 and 2008, making the country the world’s top exporter.

As a result of the one-child policy adopted in the 1970s to control the rapidly increasing population, the proportion of working-age population rose with the fall in birthrate, creating the so-called “population bonus.”

Surplus labor in rural areas provided a labor force for factories in coastal areas, boosting China’s production and exports without seeing much increase in labor costs.

The national savings rate continued to rise, increasing to over 30% of GDP in the 1980s, over 40% in the 1990s and marking an astonishing figure of over 50% around 2010, encouraging active investment and, at the same time, creating a huge current account surplus.

 

Challenges for the Chinese economy

While China has achieved great economic development since 1978, prerequisites for growth are disappearing.

The period of demographic bonus has ended, labor costs have risen and the percentage of national savings to GDP has declined.

The recent U.S.-China trade dispute shows that it has become difficult for Beijing to maintain economic growth with excessive dependence on exports in view of the international environment.

China’s GDP per capita stands at $10,000, still low compared with $60,000 for the U.S. and $40,000 for Japan. China’s rapidly aging population is facing the risk of growing old before becoming rich.

Since the nation can’t expect its population to grow, the only other option would be to increase its productivity. But according to one estimate, China’s total factor productivity growth rate dropped from 6.1% between 1996 and 2004 to 2.5% between 2005 and 2015.

The key ideas vital to raising the total factor productivity are technological innovation and improving the efficiency of resource allocation.

Specifically, it is necessary to allocate funds to companies and sectors with growth potential. But in China’s financial sector, which is slow on liberalization, funds allocation and interest rates are determined not only by economic factors.

Some say that state-owned enterprises are given priority in funds allocation even though their productivity is lower than that of private firms.

 

U.S.-China conflict

Aware that there are limits to economic growth dependent on exports and investments, Beijing has been calling for the need to boost domestic demand since the 2000s.

Such a stance is unlikely to change under the dual circulation strategy, and while China will strengthen its focus on expanding domestic demand, it does not mean it will stop economic exchanges with the outside world. It will further open its markets and continue to welcome investments by foreign companies.

Yet, the reason behind China’s rush to adopt the dual circulation strategy is that the nation is being threatened by recent developments, including the U.S.-China conflict, Washington’s attempt to stop the flow of technology to Beijing, the U.S. restricting the activities of Chinese firms and Western countries rethinking their supply chains.

HiSilicon Technology Co., a subsidiary of Huawei Technologies Co., has been focusing on the design and development of semiconductors and entrusted production to Taiwan Semiconductor Manufacturing Co. (TSMC). But TSMC halted new orders from HiSilicon in response to U.S. sanctions on Huawei restricting its access to crucial chip supplies.

Since the products of Semiconductor Manufacturing International Corp. (SMIC), China’s top chipmaking manufacturer, are said to lag two generations behind TSMC’s, China should have an unwavering determination to develop self-reliance in the field of advanced technology.

As the U.S.-China conflict escalates, there is a risk that calls within China to focus on domestic demand could go beyond the push to rebalance distortion in consumption, investment and exports and transform into efforts to completely replace imports and become self-sufficient.

There are various voices also within the U.S., with some urging the country to completely decouple from China and others calling for partial disengagement in fields including tech.

There is a possibility that experts’ views on the dual circulation strategy differ even in China.

The strategy is a framework that could lead to a new growth model that does not depend excessively on exports or investments, based on improved productivity by resolving issues facing the Chinese economy, including reform of state-owned enterprises and financial sector liberalization.

We should pay close attention to how it turns out.

The global community should be on alert over China’s actions violating international law regarding various issues including the South China Sea, the Senkaku Islands, Hong Kong and the Xinjiang Uighur Autonomous Region. And it is necessary to conduct partial disengagement to a certain extent in areas like tech in order to protect a free society.

But if Western countries show excessive decoupling moves toward China to maintain their employment or based on mercantilist intentions, China will implement the dual circulation strategy in the form of reducing exchanges with foreign countries.

In September 2018, Xi, during an inspection tour to Heilongjiang province, said that rising protectionism means China is “forced to take the road of self-reliance.”

Actions bring about counteractions and nationalism amplifies interaction, and closed-door economic policies will not be beneficial to both China or the rest of the world.

All eyes are on China’s next move.

 

Disclaimer:
The views expressed in this API Geoeconomic Briefing do not necessarily reflect those of the API, the API Institute of Geoeconomic Studies or any other organizations to which the author belongs.