Dual Circulation

China’s New Development Paradigm

The annual gathering of China’s National People’s Congress (NPC) took place in March, at the usual time this year. Premier Li Keqiang’s speech and government documents presented at the meet showed confidence on the country’s past achievements. China’s management of the pandemic and its standing as the only major economy to achieve positive GDP growth in 2020, at 2.3 percent, were high on the list. The meeting approved the country’s 14th Five-Year Plan (2021-2025) which centres around the ‘new development concept’ of dual circulation.
Introduction
To sustain growth, China is pushing a “dual circulation” development paradigm, which has been mentioned as a guiding thought in a blueprint for its development in the next 5 to 15 years. “China will advance the building of a strong domestic market and become a strong trading nation in a concerted way, based on the domestic circulation,” read the Outline of the 14th Five-Year Plan (2021-2025) for National Economic and Social Development and the Long-Range Objectives Through the Year 2035. Behind the technical-sounding phrase lies an idea that could change the global economic order. Instead of operating as a single economy linked to the world through trade and investment, China is poised to bifurcate its economy. One realm (‘external circulation’) will remain in contact with the rest of the world, but it will gradually be overshadowed by another one (‘internal circulation’) that will cultivate domestic demand, capital and ideas.

Background
Chinese President Xi Jinping first raised the idea in May last year and later elaborated that China will rely mainly on “internal circulation” – the domestic cycle of production, distribution and consumption – for its development, supported by innovation and upgrades in the economy.
Later, while addressing a symposium of entrepreneurs in July last, President Xi Jinping said, “Making the domestic market the mainstay does not mean we are developing our economy with the door closed.” By giving full play to the potential of the domestic market, both domestic and foreign markets can be better connected and utilized to realize robust and sustainable development, he said. “China will follow the new development philosophy, foster a new development paradigm, and pursue high-quality development by staying committed to deepening reform and opening wider to the world,” Xi announced.
The Concept
The concept has two equally strong components: “internal circulation,” which refers to domestic economic activities, and “external circulation,” which relates to China’s economic links with the outside world. It signals that China wants to reduce the role of international trade in its economy, and strengthen its domestic economy.
The key to building a new development pattern lies in unimpeded economic circulation and industrial connectivity, according to an article by Vice Premier Liu wherein he commented on the new paradigm. The fundamental requirements are enhancing the creativity and connectivity of the supply system, removing various bottlenecks of development and smoothing the circulation of the national economy.
Why the New Paradigm?
Despite the impact of the Covid-19 pandemic, the new development pattern comes not as a passive, short-term response, but as an active policy choice based on changes in the country’s development conditions and demand for long-term yet high-quality growth.
Since the 2008 global financial crisis, Chinese authorities have put forward strategies including expanding domestic demand and supply-side structural reforms, suggesting the gradual shift toward internal circulation has long been underway. Currently, protectionism and anti-globalization are on the rise, but the main driving force for the new development pattern is the shift in China’s comparative advantage from a cheap labour force to huge domestic consumption potential. It is a natural choice to focus on the domestic market as China’s per- capita GDP rises above 10,000 US dollars and its middle-income population exceeding 400 million, entailing mass opportunities at home.
The purpose of dual circulation is to make China more self-reliant. After previously basing the country’s development on export-led growth, policymakers are trying to diversify the country’s supply chains so that it can access technology and know-how without being bullied by the United States. In doing so, China will also seek to make other countries more dependent on it, thereby converting its external economic links into global political power.
Analysis
A critical link in the strategy is consumer demand. China’s high savings fuelled a strong investment rate, but intermediation through the banking system has been piling up debt. High investment also came with inefficiency and waste. Heavier reliance on consumption (and lower savings) is key then, but the 14th FYP offers little to address this. Pension and social welfare reforms, better health insurance and more equal development, as announced, could help but are also hard to do.
As part of the strategy, China announced its intentions to rely more on ‘indigenous innovation’ and aims for foundational technology breakthroughs, an area currently more dependent on foreign knowledge. It is in technology that Chinese companies were most vulnerable to actions taken by the US government under the Trump administration — measures yet to be reversed by the Biden team.
The 14th FYP makes an effort to reduce technological dependence. While the target on increases in research and development spending is modest, at 7 percent growth, the plans are not. More details should follow in the forthcoming Medium and Long-Term Plan for Science and Technology 2021–35, but the 14th FYP is filled with initiatives and programs to beef up research and development.
These include founding new and improving existing national laboratories in critical areas, supporting the development of science and technology platforms in regions such as Beijing, Shanghai and the Greater Bay Area, establishing centres for technology development and enterprise, promoting innovation talent, encouraging the immigration of scientists, and catalysing enterprise technology cooperation.
The plan also increases spending in basic research — long a weak spot. By the end of the 14th FYP, China aims to spend 8 percent of its research and development fund on basic research, up from 5.5 percent. This is only about one-third the share that the United States and South Korea spend on basic research, and half that of Japan.
The sectors that China seeks to promote innovation in have not changed much since the “Made in China 2025” initiative. No doubt the plan will receive some headwind, but the tide on industrial policy is turning worldwide. The United States now actively promotes a return of critical supply chains and the European Union seeks to revive its integrated circuit production. This is one area where China can claim to have set global standards.
Tensions with the United States
Tensions with the United States and the post-Covid-19 global economic outlook have increased the perceived need to move towards a dual circulation approach. It can be considered a risk management strategy in case the external environment deteriorates further. The 14th FYP also included targets on food and energy security. “We will give priority to domestic circulation,” said Li Keqiang in his government work report. A concern is that dual circulation in the hands of local officials across China may simply become import substitution.
Post-Covid-19 Scenario
Global demand is gradually responding as world health authorities get on top of the Covid-19 vaccination program, the threat of pandemic recedes and economic conditions finally begin to normalise. The global supply chain is well behind schedule, and there is massive pent-up demand for consumer and capital goods, minerals and raw materials. Looking ahead, the post-pandemic rebound is bound to be moderate as global demand conditions settle down and world trade begins to normalise. But it’s not likely to upend growth expectations in China too much, with Beijing planning to protect its economy from volatile global factors with its new “dual circulation” strategy, making the best use of external market conditions to promote faster domestic-led growth at home.
The China Shock?
The shift to a dual-circulation strategy raises the spectre of a new ‘China shock’ that could dwarf the impact of the first one, which struck Western economies after China’s accession to the World Trade Organization in 2001. Although China’s inclusion in the WTO generated a huge amount of wealth and lifted millions of Chinese out of poverty, it also created losers in places like the American ‘Rust Belt’ and the United Kingdom’s ‘Red Wall’ districts, setting the stage for the UK’s Brexit referendum and former US President Donald Trump’s election in 2016.
The West’s political class took a long time to wake up to the China shock, because it had committed to a strategy of ‘reciprocal engagement’, whereby Western consumers would benefit from low-cost Chinese imports and Western companies would profit from China’s economic growth by tapping its massive market. These dynamics, it was assumed, would pressure China into opening up its market and society even more. But this assumption has not been borne out.
The new China shock’s impact on the West will differ fundamentally from the first one. For starters, the dual-circulation strategy will affect different parts of the economy and society. Rather than endangering legacy industries, the goal is to dominate cutting-edge sectors and compete with legal and financial firms in the City of London, carmakers in Baden-Württemberg and biotech firms in Sweden.
Specifically, Xi’s ‘Made in China 2025’ plan emphasises sectors such as artificial intelligence, semiconductors, batteries and electric vehicles, and aims to increase the domestic content of core technological components to 40 percent by 2020 and 70 percent by 2025. The goal is to use state subsidies, export controls and controls on data to allow Chinese firms to replace foreign ones — or to make the foreign firms more Chinese. If Xi’s plan succeeds, the new China shock could hollow out as many high-paid jobs in tech and services as the first one did in heavy industry and textiles.
The shock will not end there. Today’s main geopolitical contest is not just about enforcing global rules; it is about who makes them. Whereas the West previously struggled to secure Chinese compliance with the trade, investment and intellectual property frameworks it had crafted, China is now also seeking to make and enforce the rules. There are already — or have been — Chinese heads at the International Telecommunication Union, the International Organization for Standardization, and the International Electrotechnical Commission, and Chinese companies are increasingly trying to define the future of technology. Huawei alone holds more than 100,000 active patents, particularly in 5G technology, where it is competing with Western companies like Ericsson and Nokia to set global standards.
Moreover, today’s competitive tensions are no longer contained within the relationship between China and the West. With its Belt and Road Initiative (BRI), China has already established a network of economic ties with more than 100 countries, and it will not hesitate to use these channels to export Chinese standards along with its model of state capitalism and state subsidies. Soon (if not already), Western companies will face the same uneven playing field in third markets as they do in China itself.
One implication is that the new rules on data, research and development, and standards will force prominent Western companies to acquire Chinese characteristics, unless they withdraw from China altogether. As one well-placed private-sector observer puts it: ‘China’s idea is that if companies like Daimler or Volkswagen want to work in China, they will have to move services, R&D and new products there. Beijing hopes that dual circulation will transform them into Chinese companies.’
Way Forward for the West
Needless to say, the new China shock demands a different set of responses than those to the old one. Rather than trying to transform China or make inroads into the Chinese market, the West’s priority must be to transform itself, not least by developing industrial and investment policies to spur innovation and protect its intellectual property. And to ensure that their economic ‘champions’ have access to economies of scale, Western countries must establish shared standards for privacy, data protection, carbon pricing and other issues. Ideally, this cooperation would formalise new trade agreements, investment packages, financing and regulations to expand the share of the global economy that is open to non-Chinese technologies and frameworks.
Conclusion
China’s leadership has underscored that enhancing independent innovation capabilities and making breakthroughs in key and core technologies are vital to establishing the new paradigm.
For the next five years, China’s research and development spending will grow by over 7 percent annually, according to the outline. For domestic circulation, the outline noted that China will deepen its supply-side structural reform and innovate its modes of production to provide high-quality products and services. Other measures include rectifying resource misallocation and allowing the financial sector to better serve the real economy.
Meanwhile, the country will strive to become a strong magnet for global resources and production factors, promote the coordinated development of domestic and external demand, imports and exports, as well as foreign and outbound investment. This will pose a daunting challenge to the Western world as well as countries like Japan and South Korea.
The writer is a member of staff.