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Some thoughts on the dual circulation strategy

By Alfred Montufar-Helu, Beijing Director

With recent news that China became the largest recipient of FDI in 2020, I wanted to share my thinking about the ‘dual-circulation’ strategy (DCS), which has continued making the headlines due to its potential implications in a world of fractured supply chains and rising geopolitical risk. Since being announced in May 2020, some have voiced concerns about whether DCS will lead China to close its doors to the world and become an autarkic economy – my answer to this is a resounding ‘No.’

But there are reasonable questions regarding what China’s push to become self-reliant implies for business: will it limit foreign competition? And what about intellectual property protection? Because DCS will be one of the main pillars of the 14th Five-Year Plan, which will outline the development priorities of China for the coming years, making a sense of it is arguably front-of-mind for companies operating and investing in the Chinese market.

At its core, DCS is the Chinese Government’s response to what I regard as a new paradigm for China’s development process, which combines the imperative to continue transitioning to a high value-added economy with the need to increase its resilience to rising global volatility.

China has been undergoing a complicated restructuring process, with the disruption caused by the Covid-19 pandemic risking to reverse hard-won gains. While China’s rapid recovery over the past months has taken the world by surprise, data suggests a growing mismatch between the supply- and the demand-sides of its economy. In short, consumption is not increasing at a fast-enough pace to handle the increasing amount of output that is being generated, and which is being fuelled by copious amounts of credit and investment, subsidies and tax incentives.

Absent sustainable growth in consumption, China’s recovery in the short-term will continue depending on expansionary measures which target the supply-side of the economy, leading to a further widening the supply-demand gap, and exacerbating the economic imbalances that China was addressing before the outbreak, such as debt accumulation and excess capacity.

All this is compounded by an increasingly challenging geopolitical environment, with mounting economic, political and military tensions between China and several other nations, and with international perceptions about China at their lowest point in decades. Not only are Chinese firms facing difficulties in their overseas investments and operations, but China is also being cut off from accessing core foreign technologies.

Chinese authorities are certainly aware about the risks that the domestic and international contexts pose to their long-term growth aspirations. According to ‘Xi Jinping Thought,’ which has become a guiding principle for Party and government action after having been enshrined in the Constitution of the CPC:

  • By 2035, China will “basically realize modernization” by increasing its economic and technological strengths, and becoming a global leader in innovation; and
  • By 2050, China will become a “great modern socialist country” and a global leader in terms of overall national strength

Against this backdrop, DCS aims to reduce the vulnerability of the Chinese economy to external shocks by: (i) making the domestic economy the main driver of overall growth; and (ii) increasing the complementarity between the Chinese and the global economies.

To be clear, the goal of boosting the domestic economy has been a key priority for already more than a decade. But emphasizing this goal under the current international context has led to a lot of speculation, with some arguing that China will “turn inward” and only engage the global market when advantages can be gained.

Now, it is not surprising that given ongoing geopolitical volatility and the realization that global value chains are not as resilient as once thought, China is moving towards boosting indigenous capabilities and reducing import dependency in sectors that are critical for national security, chief of them all technology, but also food and energy

But the fears that China will completely shut its doors to foreign firms are misplaced, and this is simply because it is not in their best interest to do so. Boosting the domestic economy cannot simply be understood as increasing consumption. It is about raising overall economic productivity, as this is the onlyway to guarantee long-term, sustainable growth. This is precisely an area where, over the past decades, foreign companies have been playing a significant role by contributing their capital, technologies, expertise and high-quality products.

Even in the case of core technologies, it would be counterproductive for Chinese authorities to completely cut off foreign investment. The reality is that China is far behind economies like the US and Taiwan in the development of these technologies, and as the lack of domestic alternatives is a major bottleneck for its technology ecosystem.

Except in those areas explicitly – and understandably – forbidden by law, foreign firms can play a positive role in increasing China’s national security. For instance, by sharing best practices, expertise and technologies in renewables, environmental protection, advanced ‘green materials,’ as well as food safety and traceability. They can also further localize their value chains, which not only expands their addressable market, but also increases the resilience of their operations and that of the overall Chinese economy against external shocks.  

Having said this, it will be important for the Chinese Government to continue advancing its reforms to improve the business environment and further open-up the market. While China has certainly made notable progress over the past decade in these areas, it is fair to say that concerns remain, mainly around uncertainty about the policy and legislative environment; ambiguous rules and regulations; and market access barriers and policies that are disadvantageous to foreign firms. Further progress in these areas would go a long way in alleviating concerns about reciprocity of market access and unfair competition.