China’s leaders love a big project.
From the bygone majesty of the Grand Canal to today’s Belt and Road Initiative (BRI), its rulers rarely miss a chance to stamp their mark on history.
The echoes of those projects permeate Beijing’s plans to transform a middle-income nation into an advanced economy.
More information emerges all the time on its ‘dual circulation strategy’. But enough is known to be able to both say what is and predict the winners and losers.
With that in mind, let’s ask and answer a few questions.
First, what is it?
President Xi Jinping first mentioned the dual-circulation strategy (DCS) in May 2020.
Stripped down, it is a plan to massively boost domestic production, investment and spending. China wants to import far less and ensure more of the goods it consumes are made at home.
That, it reckons, is its ticket to wealth and power.
Explain dual circulation please.
A better description might be ‘internal circulation’. As Rhodium Group said in its note ‘Understanding internal circulation’ on August 5, China wants “less dependence upon external demand and foreign supply chains”.
In August, the Politburo’s review of the first half of 2020 included the phrase nei xun huan (internal circulation), pointing to a desire to be more self-reliant.
Why now?
Formulation of the new strategy been a slow-burn process, accelerated by the pandemic. The trigger was the US-China trade war that began in 2018 and damaged its relationship with the West.
That marked the start of a long wave of de-globalization. It also made China realise that despite its power, it was over-reliant on global supply chains and did not share the same political systems and values as its Western peers, according to a Nomura report in late October.
Is this China’s first bash at making it work?
No. It has been here a couple of times: in the wake of the Asian financial crisis and again after the global financial crisis.
Back then China was too weak to make its plans stick.
In the wake of the GFC, it set out to rebalance its economy and boost consumer spending by sucking in imports.
China wants to import far less and ensure more of the goods it consumes are made at home
It is richer now and feels that not only is it able to act decisively, but that it must do so.
DCS has been described as a hedging response to the changing nature of Beijing’s relations with the US.
Covid, which continues to wreak havoc on the world, has accelerated its plans.
What’s China’s ideal outcome?
In short, it wants to build world-class capital markets that channel capital into high-end manufacturing, cut its dependence on food and energy imports, and slash outbound lending and investment.
Less state support for property firms and more state-led financial subsidies should, Nomura says, boost productivity and growth and raise long-term return on capital.
Will there be losers?
There always are. Southeast Asia and India should benefit as multinationals move production from the mainland to save money.
But Japan and Germany will be hit as China imports less high-tech goods, while Australian exports of coal could collapse as China doubles down on renewables.
Keep an eye on the BRI
Nomura warns: “Beijing may gradually withdraw from some of its ambitious global investment plans, especially the BRI”.
Yes, this is Xi’s big geopolitical play, but it is costly and increasingly unpopular at home and abroad.
By slashing investment there, China can divert more funding into its key goals under the DCS.
The word autarchy springs to mind.
This isn’t the Ming court. China won’t close its coastlines and airports to trade; it needs to sell its wares to the world.
But while Beijing is been at pains to state that DCS is not a drift toward isolationism, Nomura says the risk of it turning inward “cannot be ignored”.
That would be calamitous for a country whose success is connected to global trade.
What challenges does China face?
Many. Perhaps too many.
Rising costs and external tariffs make China an increasingly unviable place to make goods for export, Rhodium warns.
It notes that household income as a share of GDP in 2019 was 48%, against 86% in the US. That weakens efforts to make consumption a key driver of demand.
Politicians must find a way to transfer more money from government and corporates to households. Given the make-up of the political system, that won’t be easy.
Rhodium reckons the best way to make the plan work is via “aggressive fiscal expansion”. It points to the potential for the central bank to monetise the fiscal deficit by directly buying government bonds.
So, what’s the outlook?
China is unlikely to deviate from its course. There’s no guarantee dual circulation will work for the leaders of the People’s Republic, but it will, Natixis says in a September note titled ‘China’s ‘dual circulation’ plan is bad news for others’ exports’, be “much more detrimental for the rest of the world than rebalancing” in 2009.
Be warned.
