China’s new economic ‘dual circulation’ strategy may not just be inward-looking, but also a pivot to Asia

Amid a challenging geopolitical environment, it is unsurprising that China is looking to bolster its domestic market, but it is unlikely to completely turn inward
While decoupling from the West, it is likely to expand regional cooperation

Hao Zhou

Published: 3:30am, 7 Oct 2020

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The Chinese Communist Party’s next plenum will be held at the end of October, at which the authorities are likely to roll out details of the 14th five-year plan (2021-2025). Given that Beijing still prefers this top-down approach, the plan is critical for China watchers to gauge the medium-term outlook for the country amid a challenging geopolitical landscape.

The market will pay particular attention to two areas. The first is whether China will set a numeric growth target for the next five years, which will be important for the country to avoid falling into the “middle-income trap”.

Media reports have started to speculate that policymakers will accept a significantly lower target for 2021-2025, compared with an implied average of around 6.5 per cent for the 13th five-year plan (2015-2020).

The second, probably more important, question is how China will design the “dual circulation” strategy, announced by the Chinese leadership in May.

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While the strategy focuses on the domestic market, given the unfavourable geopolitical dynamics, “internal circulation” (the domestic market) and “external circulation” (the world market) will have to be synergised. In the longer term, China wants to create a largely self-sufficient system.

Rising tensions with the US are likely to have been an important motive for this new strategy. As China seeks to become a regional and then a global superpower, it needs a fast-growing economy.

The emergence of a new great power will inevitably trigger tensions, with the established powers trying to defend their place in the sun. Thus, China has come into conflict with the US.

One element of US efforts to contain China is securing its lead in the hi-tech industry. Another is an increased security focus on the Pacific – the long-announced US “pivot to Asia” may finally be happening.

The US-China trade war and Washington’s halting of the supply of hi-tech goods to China have again brought to Beijing’s attention the vulnerability of its economy. Against this backdrop, China’s efforts to strengthen the domestic economy and become self-sufficient in critical sectors are not too surprising.

There are a few areas China will clearly focus on, which will be highlighted in the 14th five-year plan. In particular, Beijing plans to develop its domestic semiconductor industry and counter US restrictions, according this effort the same priority it did to building up its nuclear capability.

In July, President Xi Jinping stressed the importance of mastering key technologies and building strong domestic automobile brands. In line with long-standing practices, China will support strategically important sectors with cheap loans and tax breaks.

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Beijing will also prioritise food and energy security. Apart from working to ensure domestic food supply, the authorities have recently launched an initiative to reduce food waste.

Furthermore, China has accelerated regional integration. Domestically, it plans to promote economic cooperation between Hong Kong, Macau and nine cities in Guangdong province under the Greater Bay Area plan. Other regional plans centre around Shanghai and Beijing.

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However, China is unlikely to turn completely inward. After all, it is already the world’s largest trading nation, so has a lot to lose. Rather, Beijing is more likely to seek to decouple from the West and, as partial compensation, expand or dominate cooperation with its neighbours.

External circulation would then primarily encompass “Greater Asia” and not the entire world. Indeed, the Association of Southeast Asian Nations replaced the European Union as China’s largest trading partner earlier this year.

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To advance this process, China is pushing hard for the signing of the Regional Comprehensive Economic Partnership, a free-trade agreement with Asean countries, Japan, South Korea, Australia, New Zealand and India.

However, many of the neighbouring countries may not want to be drawn further into a Chinese economic empire. India is unlikely to sign the agreement any time soon.

The decoupling from the US, the EU and other Western countries is not without risk. China’s economic success, since 1978, has undoubtedly been based on the policy of “reform and opening up” initiated by Deng Xiaoping and it is likely to lose economic dynamism in the long run if it turns inward.

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In the short term, Chinese companies face the threat of further restrictions on their global supply chains if the confrontation with the US continues. For example, US sanctions against Chinese tech giant Huawei have completely blocked the company’s supply of sophisticated microchips since September 15.

To make up for this and catch up technologically with the US, China will have to invest heavily. However, it will certainly take some time for these investments to bear fruit.

This strategy also entails considerable costs in the long term. If China wants to become more independent and partially withdraws from the international supply chain, it will also lose the benefits of globalisation.

China may be able to produce most, if not all, of what it needs domestically, but at a higher cost, and not everything will be of the same quality. This will depress macroeconomic productivity and thus economic growth.

All told, China’s strategic change may be the inevitable outcome of geopolitical dynamics, but, as the Chinese saying goes, an arrow that has been released does not turn back. The 14th five-year plan is one of the first batch of policies to steer China through the coming headwinds.

Hao Zhou is senior emerging markets economist at Commerzbank

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