By Isabel ValverdeChina desperately wants to and must recover from its long-lasting dependence on exports as a means of economic growth. This is the objective of the dual-circulation strategy, which is set to become Beijing’s escape plan from the feared middle-income trap. However, with domestic consumption still weak, China is unable to survive without a good injection of public investment to boost its economic engine. The rush of rapid supply-side growth is hard to give up for a country used to abnormally high levels of GDP growth.
The Dual-circulation Model
Since China integrated into the world economy through its role as a low value-added manufacturer in the global production scheme, Beijing has known that this development model would fall apart eventually. As higher wages and tariffs make Chinese goods increasingly expensive, it is becoming evident that the unsustainable ‘Made in China’ model has come to an end. The time of China’s coming of age as a mature and developed economy has arrived.
Today, the Xi Administration appears more committed than ever to deploy a “new development model” propelled by internal consumption. It’s been months that Chinese policymakers have been talking about the ‘dual-circulation model’, a new term coined to define the country’s economic strategy for the post-COVID era. The mechanics are simple: prioritising the domestic market or ‘internal circulation’ to continue growing without over-relying on international trade or the ‘external circulation’, as it has been the case since China opened up its economy to the world. This is what the renowned Centre of Strategic and International Studies (CSIS) has coined as hedged integration: preserving the benefits of global integration while increasing economic self-sufficiency to achieve strategic autonomy. This does not mean, however, a comeback of isolationism, but that the ‘external circulation’ will not be the main driver of growth anymore. Not only that, but boosting internal consumption inevitably involves opening up the doors to foreign investment and providing better treatment of non-Chinese companies as Xi has repeatedly promised over the last months.
Introduced for the first time in a Politburo meeting on May 14th, the dual circulation model will be the running theme of the country’s 14th five-year plan. This new plan was presented on October 29th and serves as a roadmap of China’s national strategy for the period 2021-2025.
So, What’s New This Time?
The need to achieve economic growth through a more sustainable model has been a perpetual threat looming over China’s economic miracle. Deeply aware of this, Chinese policymakers, for the last decade, have focused resources and attention on solving the deep economic imbalances that burden China’s path towards becoming a high-income economy. However, they have done so by focusing on supply-side factors. From heavy investment in research and development to initiatives such as the Made in China 2025, Beijing has tried to make the country more independent from foreign technology while creating a more sophisticated productive system. What is different this time is Xi’s very public intention to make Chinese internal demand the centerpiece of his economic vision for the coming decade. Above all, the dual-circulation proposition comes to underscore Beijing’s commitment to reinventing its economic model as it loses competitive advantage in those activities that have traditionally been at the core of its export model.
But whilst this new concept certainly marks the introduction of a new grand strategy to counter running structural issues, the timing of the announcement also aims at countering circumstantial drawbacks. It exposes Xi’s urge to speed up the transition towards a consumer-driven economy. Contextualized in growing global economic headwinds, it has become paramount for Beijing to make the country less dependent on foreign firms, trade, and technology. In this regard, the push for this ‘dual-circulation’ strategy has been construed as a declaration of intentions in the face of mounting tensions with the US. From the trade war to the ban on certain tech companies such as Bytedance, Huawei or WeChat, the American market is becoming harder to navigate for Chinese businesses. More worrying perhaps are the exports’ restrictions on semiconductors which are depriving China of key components in supply chains of tech products. Even the European Union is now toughening its stance on mergers and acquisitions by Chinese companies in sensitive industries, as well as warning about the market-distorting effects of China’s anti-competitive practices. In this incipient protectionist context, reducing its overexposure to global markets has become vital for China’s economic future.
A Vicious Circle Not That Easy to Break
The objective is clear: to unleash the huge potential of a domestic market composed of 1.3 billion consumers. But while the growth opportunities are incomparable, escaping this vicious circle won’t be an easy task for Xi.
It seems paradoxical that whilst high-ranking officials preach about the wonders of the internal circulation, China has experienced a vigorous rebound precisely due to a heavy supply-side state stimulus. These investments have done nothing but feed the export machine, anchoring the recovery to the old model and surging public and private debt to worrying levels, accounting for a third of the country’s annual output.
This strategy has, however, paid off very well for Xi. The country that saw the virus emerge and, as a result, imposed the strictest confinement measures in the world has today become the envy of shrinking Western economies. Exports have surged again in September with a 9.9 percent increase, featuring an outstanding 4.9 percent interannual growth in the third semester, and recovering from a record 6.8 percent contraction in the first quarter.
Yet, the fast recovery of the Asian giant has been quite uneven. While supply-side indicators are performing extraordinarily well, especially considering the grim global economic outlook, consumption is struggling to return to pre-COVID levels. While retail sales have increased in September for the second consecutive month since the beginning of the pandemic late last year, these have been driven by demand for high-end luxury products. Meanwhile, industrial production in China went up by 6.9 percent in September following a seventh-month-long trend since the country started to recover from the COVID-induced contraction. Post-covid economic evidence clarifies that for the time being, exports will remain a reliable safety raft for the Chinese economy. As Western economies go into lockdown again in this second wave, China experts and officials alike wonder if internal consumption will be enough to cushion the shock of declining external demand. However, the truth is that without income distribution policies committed to lifting the spending of middle-income and below middle-income segments, Xi’s inward economic shift will hardly be executed. Unemployment and other social benefits are still insufficient and in many cases inaccessible to a large part of the migrant workers.
Indeed, pushing for both internal and external circulation is something of an oxymoron. In the long-run, one model must prevail over the other, but in the medium-term, the shift will entail certain trade-offs. Herein lies the fundamental problem that defines China’s conundrum. A consumption-driven economy requires enough money in the hands of the majority of the population to absorb domestic production, but this very fact clashes with an economic model hitherto based on cheap exports and low wages. Beijing has long shown its strong determination to strategically set the economy in the direction of ever-increasing growth. But in order to keep doing so, some financial power must shift now from the hands of the party to Chinese citizens. Indeed, even for a regime with the capabilities and legitimacy that the CCP enjoys, this carries a certain level of risk. Can Beijing bear the price of empowering its citizens? Time will tell, but Xi’s alternatives are few.
This article was first published in Global Risk Insights
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