China’s ‘dual circulation’ plan is bad news for others’ exports

Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow

Minds in Beijing are focusing increasingly on the upcoming meeting of the Chinese Communist Party Central Committee next month.

High on the body’s agenda will be sketching out a new official five-year plan for Asia’s largest economy. A freshly coined buzzword looks set to play a leading role in these discussions: “dual circulation.”

The new term has won a featured place in speeches and state media reports since May even though its precise meaning has been left rather ambiguous.

“Circulation” itself here refers to the production and consumption of goods and services. The first “circulation” in the “dual” formulation is about maintaining integration with the rest of the world. The second “circulation,” in the consensus view of economic observers, centers on increased reliance on domestic demand and reducing economic dependence on the rest of the world.

What matters for China’s foreign partners is that the arrival of the dual circulation strategy looks set to mark a drive to reduce dependence on imports, particularly of high-end manufacturing equipment and inputs.

While this would come in reaction to the U.S. push to decouple global supply chains, Beijing’s initiative is bound to raise new concerns with Japan, South Korea, Germany and others who have been profiting from exporting intermediate goods to Chinese companies looking to upgrade their output.

Talk of the dual circulation strategy first emerged in reports from a May meeting of the Communist Party Politburo. With preparations now starting on what will be the People’s Republic’s 14th five-year plan, planners are undoubtedly at work developing the concept so that it can be operationalized with specific performance targets for the years 2021 to 2025.

At first glance, it sounds similar to the grand strategy of rebalancing which Beijing applied in its response to the global financial crisis. When China introduced rebalancing, which then served as the intellectual underpinning of the 12th five-year plan, the world still looked open to China and multilateralism was in vogue. This is no longer a reality today with U.S. President Donald Trump talking of decoupling from China and taking concrete steps to realize his vision.

Rebalancing in 2008 also relied on raising the contribution of domestic demand in China’s growth. It was coupled with the idea that driven by faster growth in domestic consumption, China’s long-standing current account surplus would give way to a deficit as imports increased.

This time, the notion is to ensure more of that increased demand is met by domestic production, rather than imports. In this regard, the dual circulation strategy is a corollary of the government’s previous Made in China 2025 program for upgrading China’s technological capacities as it has become possible to substitute high-end goods only due to advances in key sectors.

Putting it another way, the old rebalancing was about reducing China’s dependence on exports. By contrast, the thrust of dual circulation is about reducing dependence on imports and increasing self-sufficiency.

This equates to “hedged integration” to protect the Chinese economy from volatility which could come from abroad while still benefiting from selling into overseas markets.

The rebalancing strategy was great news for the rest of the world as it boosted most countries’ exports into China. This time around, those countries which benefited then will probably be disappointed, in particular, those exporting higher-end products which China now can produce on its own.

While the old rebalancing was designed to move China away from excessive external imbalances, the dual circulation strategy aims at self-sufficiency, though with a continued push on exports as long as it is feasible. In fact, the new dual circulation is nothing more than an important substitution strategy while trying to keep foreign markets for Chinese goods.

This change in strategy is not a capricious move by the Chinese leadership but a hedging response to the changing nature of Beijing’s relations with the U.S. as the leading global power. In just 10 years, or the duration of two five-year plans, U.S.-China relations have evolved from deep engagement to decoupling.

China’s new push for self-sufficiency will have costs for economies that have gotten used to exporting high-end intermediate goods into the country. China will now do its utmost to substitute domestic products for such foreign inputs.

It goes without saying that if the technology of local producers is not yet up to standard for this, China will spare no expense to acquire the know-how, whether through overseas acquisitions or other means.

China’s dual circulation strategy is likely to be much more detrimental for the rest of the world than rebalancing was. With the leadership turning its attention to the design of the 14th five-year plan, dual circulation is likely to be enshrined as a medium-term goal, with consequences both for China and its trading partners.