China’s “dual circulation” and what it means for the global economy

Updated: Sep 25, 2020

By Matthew Seet, BSc Philosophy, Politics and Economics student at the University of Warwick

Since Chinese President Xi Jinping first coined “dual circulation”, the term has since become the foremost buzzword on Chinese state media. Simply put, the “dual circulation” strategy entails a new development strategy whereby China will now focus more on expanding its domestic markets and enhancing its manufacturing capabilities while lowering its reliance on foreign inputs.

To the casual observer, it may seem that this is just another example of a rising trend in trade protectionism around the globe. Countries like India are starting to turn inwards, with its backing out of the Regional Comprehensive Economic Partnership (RCEP) and its ban on Chinese apps. However, China’s latest move is much more than that.

What exactly is “dual circulation”?

Here is what we know so far. The term first arose during a Politburo meeting on May 14, where President Xi urged China to “establish a new development pattern featuring domestic and international dual circulations that complement each other”.

The strategy comes at a fitting moment. Amidst a global economy suffering under the weight of COVID-19 and increasing hostility around the world towards China and Chinese companies (think about the US clamping down on ByteDance and Huawei), it is no small wonder that China is worried about its position in the global economy. With the world rethinking its economic relationships, China must do the same.

The jury is still out on what this means in practice. It is unlikely that this is indicative of a move for China to decouple itself from the global economy. “External circulation”, or China’s reliance on exports as the basis for its economy, has been around for decades and is likely to stay. However, the addition of a new tenet called “internal circulation” entails a strengthening of domestic demand to create a good consumption base that is resilient against external trade shocks.

At first glance, this seems like a sensible move. This is especially true in the technology, energy, and agricultural sectors. For instance, China relies on US$300 billion worth of imported semiconductors to meet 85 per cent of its domestic demand. With ongoing US-China trade tensions and the recent cancellation of the phase 2 trade deal, there is a sense of general distrust about the viability of China’s export-led model. Hence, from China’s perspective, developing domestic capabilities to offset external shocks is a sound economic decision.

The long road ahead

Yet, structural change, as always, is easier said than done. Chinese domestic consumption only accounts for 38.8 per cent of GDP, while in the US it accounts for 66 per cent. While China has always prided itself on enacting sweeping changes, its deep integration with the global economy formed over the past few decades means that this process could take years before it comes to fruition.

Ideally, China wants to create both strong exports and large domestic consumption, but oftentimes the two contradict each other. Rising wages in China are essential to developing a strong consumer base, but it is also one of the reasons why companies began moving out of China in search of cost savings. Higher costs, in terms of both labour and regulations, have led many foreign companies to relocate to Southeast Asia, where labour is cheaper and countries are more welcoming to multinationals. This shows that even seemingly domestic matters have an impact on its trade relationships. To build strong domestic consumption, must find a way to ensure that wages can rise with predictability, yet also find ways to incentivise companies to stay.

In a similar vein, China’s State Council recently issued guidelines to help exporters shift towards the domestic market, but this does little to help producers overcome the problems that they face currently. Switching gears to developing products suited for the Chinese domestic market would put additional pressure on export-led firms, which are already contending with the rise of e-commerce and changing consumer preferences.

What does this mean for the rest of us?

While this does not spell the end of the “Made in China” labels on our goods, it does mean that there may be a shift in the world order. For the average consumer, any changes would be relatively transparent. Prices are unlikely to change besides regular inflation, simply because prices are based primarily on how much the consumer values the product rather than the cost of manufacturing. Even to the average company, simply relocating part of its supply chain to low-cost countries allows it to equalise costs and leave the bottom line intact in the long run. In fact, this is something that advocates of the “China Plus One” strategy have been doing for years.

This bodes well for China’s Asian neighbours. Chinese firms will likely boost technological innovation and try and fight their way up the global value chain. This means that there are opportunities for nations with stable infrastructure and cheap labour costs, like Vietnam, to fill the lower value-added void left by Chinese manufacturers. In this respect, we can also expect to see China reaching out to these countries to ensure that its connectivity broadens, most likely through an acceleration of the Belt-and-Road Initiative to ensure that China has a stake in global transportation infrastructure. After all, the realisation of the end product will still require the movement of goods between China and the rest of the world.

In the long term, we can expect that this will propel China into the ‘first world’ if Xi plays his cards right. China could very well follow in the footsteps of Japan and South Korea, who went from low value-added players in the global supply chain to the economic powerhouses they are today. With the 14th five-year plan on the 2021 agenda, it remains to be seen what “dual circulation” entails, but it seems that China will become an even bigger player on the world stage in the years to come.

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