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Economy

China’s Twin Circulations

Oct 12 , 2020
  • Lawrence Lau

    Ralph and Claire Landau Professor of Economics, CUHK

Dual circulation.jpg

On Aug. 24, in a meeting with experts in economics and sociology, China’s President Xi Jinping laid out the country’s course: “China should promote the formation of a new pattern of economic development, with domestic circulation as the principal focus, and the twin domestic and international circulations mutually reinforcing each other.”

From 1950 to the launch of economic reform and opening-up in 1978, there was essentially only a “single circulation” in China — a domestic one — featuring limited barter trade with the former Soviet Union and former Eastern European socialist countries during the decade of the 1950s. This was due in part to the trade embargo against China imposed by Western countries, led by the United States after the Korean War and in part to the dispute between China and the USSR beginning in the late 1950s.

With reform and opening-up in 1978, a second circulation — an international one — began again. This may be regarded as the resumption of the twin circulations. However, the primary focus in this early period remained domestic circulation. Moreover, the twin circulations were deliberately kept separate and insulated from each other, which enabled central economic planning to continue as before.

So in the 1980s and early 1990s, the twin circulations were completely independent of each other and not interconnected.  Goods and services produced in one circulation could not be used to supply the other circulation, and vice versa. The twin circulations of this early period of economic reform and opening may be described as two non-intersecting circles, one representing domestic circulation and the other representing international circulation, barely touching each other and with no overlap at all. The dominant circulation was still domestic.

Beginning in the mid-1990s, the twin circulations began to be interconnected. Foreign direct investors could purchase their inputs and sell their outputs within China. Similarly, domestic producers could use imported inputs and sell their outputs to anyone on the market, domestic or foreign (initially only after their obligations under the central plan had been fulfilled). 

China’s accession to the World Trade Organization in 2000 further expanded international circulation, which then became dominant until around 2010. At that time, the domestic market began to regain its prominence because of the rising value of the yuan, rising wages in China and the gradual saturation of export markets with Chinese goods. Rising wages increased the purchasing power of China’s rapidly expanding middle class, which brought significant demands for imported consumer goods, as well as products with imported components. 

Isolation vs. self-sufficiency 

While total isolation and total self-sufficiency at some level are possible in principle, as China demonstrated for much of the time before reform and opening-up in 1978 (and North Korea seems to be practicing it today), they are definitely not desirable from an economic point of view. 

China has been a major beneficiary of economic globalization, and so have its trading-partner countries. But while globalization has brought major benefits to all countries, it has also created winners and losers within countries. The free market will only reward the winners but does poorly at dealing with the losers.

Economic globalization actually generates sufficient gain in each country so that everyone can, in principle, be made better off. However, it is the responsibility of each country’s government to compensate its losers. The problem is that most countries have not compensated their losers adequately, whereas China has made sure that everyone wins, even though to a different extent, through its social safety net and poverty alleviation and eradication programs.

Total self-sufficiency is possible for China today only with a significant decline in its real standard of living. The quality of Chinese manufactured products has greatly improved over the past 40 years, in part because of competition with imported manufactured products and because of “learning by doing.”

However, there are still products that China is currently not able to make, such as large aircraft and advanced semiconductors. There are still commodities that China is currently unable to produce in sufficient quantity to meet domestic demand, such as food, oil, copper and iron. Large quantities of these products and commodities are imported today. If China were to give up international circulation altogether, it would mean either doing without or with limited quantities of these products and commodities.

It is not in China’s interest to return to single, or domestic only, circulation. It does need to be self-reliant, but self-reliance should not be equated with self-sufficiency. Economic decoupling from the U.S. does not and should not imply economic decoupling from the rest of the world. China cannot win by withdrawing. To maintain its international circulation, China needs the support of the other major trading countries, especially those in the eurozone.

Given the production capacity and consumption potential of China, the sustainability of the twin circulations, with the domestic on as the principal focus but with both reinforcing each other, is eminently feasible, subject to overcoming the foreign export restrictions of critical products and technologies, which may take some time.

The expansion of household consumption as a component of Chinese aggregate demand is a high priority. This requires an increase in the share of labor in GDP, which in turn requires an increase in the average level of wages. Low wages are a legacy from the times when all non-agricultural workers in China were employed either directly or indirectly by the central and local governments and rates were centrally determined. The challenge is how to loosen wage policy without causing massive wage inflation, which may in turn lead to massive inflation in the price of goods.

Of course, the Chinese people’s demand for a better life cannot be met entirely through increases in private household consumption: Increases in public consumption, led by the central and local governments, are also needed. This includes environmental preservation, protection and restoration; the creation or maintenance of blue skies, green mountains and clear water; the provision of affordable education, healthcare and eldercare; and an adequate social safety net for all.

The government must also take responsibility for supporting the expansion of indigenous innovation capacity, especially through basic research, so that the twin circulations are sustainable over time.

To emphasize a key point, as long as the economy is open, winners and losers will be created continually. But the free market system, on its own, will not compensate the losers. It is thus the duty of the government to tax the winners on their gains and use the proceeds to help support the losers. Unless the losers are compensated, they will resist economic globalization and favor protectionism and isolationism.

China has compiled an enviable record in the eradication of poverty. More than 800 million people have been lifted out of poverty in China over the past four decades. By the end of this year, there should be no one in China below the poverty line. Thus, China can proudly say that it has no losers. Everyone is and has been a winner compared with conditions in 1978.  Poverty alleviation and eradication not only equalizes the distribution of income but also increases aggregate household consumption demand because lower-income households have a higher marginal propensity to consume. 

The biggest risk facing China today is being isolated from the rest of the world once again. It must continue to participate actively in the world economy, contribute what it can and uphold the international order. The “three zeroes” strategy — zero tariffs, zero non-tariff barriers and zero subsidies — which can be reciprocally implemented with like-minded countries, is worth serious consideration, with exceptions, of course, for infant industries.

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