Sustained economic development is crucial to China’s rise and underpins many elements of Chinese power. In recent years, China has been battered by the Covid-19 pandemic, a historic global recession, and mounting global pushback against Beijing’s economic practices, prompting Chinese leaders to formulate a new economic framework. One of the central elements of China’s new economic model is the Dual Circulation Strategy (DCS), which aims to shield China from global volatility and pivot the Chinese economy toward greater self-reliance. Beijing is making progress toward achieving some objectives of the DCS, but in other areas the government has pursued counterproductive policies. China also faces structural and short-term headwinds, including Covid-19 outbreaks and real estate market troubles, that are making it harder to pursue the DCS.
China’s Rationale for a New Economic Strategy
The last several years have presented China with enormous challenges. Chinese leaders, including Chinese Communist Party (CCP) General Secretary Xi Jinping, now frequently stress that the world is undergoing “profound changes unseen in a century” amid fluctuations in the existing international order and balance of power. While Beijing sees promise in some of these changes, Chinese leaders have concluded that China needs to chart a new economic course to avoid falling prey to global economic volatility and growing fears of geopolitical encirclement.
Underlying many of Beijing’s concerns is a growing sense that further integration into the global economy is not the reliable engine of growth that it once was. In the 1980s, when China first began opening to the global economy, the world outside of China was growing roughly 4 percent each year. By comparison, the world minus China only managed to grow about 1.6 percent per year during the last decade.
Adding to concerns about a structural slowdown in world economic growth, the last 15 years alone witnessed a historic global financial crisis and a catastrophic pandemic. China weathered these slowdowns better than other major economies, but they were nonetheless major shocks. Covid-19 proved particularly damaging for the Chinese economy. According to official government figures, China’s GDP fell 6.8 percent in the first quarter of 2020, compared to the same period in 2019. Industrial output and retail sales saw even sharper declines, dipping 8.5 percent and 19 percent, respectively.
Beijing’s “state capitalist” approach to managing the Chinese economy has also provoked a growing international backlash over the last several years. Under Xi Jinping, the CCP has significantly expanded its influence within private companies, prompting national security concerns for foreign governments. The state has also doubled down on a techno-nationalist approach to industrial policy under the banner of the Made in China 2025 strategy while also pursuing an aggressive mercantilist approach to trade policy that has advantaged Chinese companies at the expense of foreign counterparts.
The United States and others responded with efforts to blunt the impacts of Beijing’s policies. Since 2018, the United States and China have been mired in a trade conflict that has proved costly for Chinese (and American) exporters. The administration of former President Donald Trump also placed hundreds of Chinese firms on the U.S. Commerce Department’s entity list, prohibiting American companies from exporting to these Chinese firms. The Biden administration has left in place many Trump era policies toward China and has deepened cooperation with key allies and partners, heightening perceptions in Beijing that the United States and its partners are hostile to China’s economic interests.
Faced with an increasingly turbulent and unpredictable external environment, Beijing has become acutely concerned about China’s reliance on other countries for critical goods. Chinese officials have highlighted a few areas of particular concern, including high-technology goods like microchips (also known as semiconductors and integrated circuits), as well as more basic resources like food and energy.
Despite decades of efforts to build a globally competitive semiconductor manufacturing industry, China remains well behind industry leaders. Particularly concerning for Beijing, China remains heavily reliant on chips designed and fabricated by industry leaders such as the United States, Taiwan, South Korea, Japan, Germany, and the Netherlands—all of which harbor growing concerns about China and its global ambitions. China’s reliance on foreign chips is only getting worse. Worldwide demand for semiconductors has surged in recent months, and chipmakers have struggled to keep up, leading to ballooning prices. Official customs data shows that China spent nearly $434 billion on imports of integrated circuits in 2021—a 24 percent increase over 2020 and a 43 percent rise over 2019. Other countries are experiencing their own spikes. US chip imports were up 32 percent through the first three quarters of 2021; however, US imports totaled $29.4 billion, a small fraction of what China imported.
Recent developments have also highlighted basic Chinese vulnerabilities in the areas of food security and energy security. China’s growing demand for meat has led to a surge in imports of corn and soybeans, which are increasingly used as livestock feed in China. From 2000 to 2020, Chinese soybean imports grew nearly tenfold from 10.4 million metric tons to 100.3 million metric tons, making China the world’s largest importer of the legume by a wide margin. Amid US-China trade tensions, Chinese imports of US soybeans halved from 32.9 billion metric tons in 2017 to just 16.6 million metric tons in 2018. China turned to Brazil to help fill the gap, but China’s appetite for soybeans exceeds the production capacity of Brazil and most of the world combined, leaving China reliant on the United States.
On the energy security front, China’s growing imports of crude oil have left it reliant on foreign countries and exposed to supply chain bottlenecks and price fluctuations. China surpassed the United States as the world’s largest importer of crude oil in 2017, and the gap between China’s oil consumption and domestic production continues to widen. China has sought to diversify its sources of foreign oil, but China still relies heavily on countries in the Middle East and Africa, where instability poses a threat to Chinese energy security. Additionally, according to the US Department of Defense, about 84 percent of China’s oil imports and 61 percent of its natural gas imports reach China by transiting the South China Sea and Strait of Malacca—areas that could become strategic chokepoints in the event of a military conflict.
Together, these developments have contributed to a growing sense in Beijing that China’s economic security faces significant threats. For China’s leaders, the solution to these challenges is greater “self-reliance”—a concept at the core of China’s new economic strategy.
Executing the Dual Circulation Strategy
In pursuit of economic security and self-reliance, China has formulated a “new development pattern” that, among other elements, features the “Dual Circulation Strategy.” Chinese President Xi Jinping first publicly articulated a vision for the DCS in May 2020 at a meeting of the CCP Politburo Standing Committee, in a session focused on managing the Covid-19 pandemic.1 The strategy was later incorporated into China’s central economic blueprint, the 14th Five Year Plan in March 2021, cementing its high-level status.
The DCS comprises two main components: the internal (domestic) circulation and external (international) circulation. The overarching goal of the DCS is to enable the internal and external markets to reinforce and sustain the other, with a focus on establishing the domestic market as the primary driver of economic development.
The DCS remains a nebulous collection of several high-level goals, but four key objectives form the core of the strategy:
- Reduce external demand as a driver of economic growth by boosting domestic consumption;
- Position China as a global manufacturing powerhouse in high value-added products;
- Attain higher levels of self-sufficiency in key areas by enhancing innovation; and
- Ensure access to critical inputs by diversifying supply chains and funneling investment into specific sectors.
The goals of the DCS are complex and sometimes contradictory, but they ultimately amount to a plan for “hedged integration” wherein Beijing seeks to engage with the world on its terms. The DCS is not an entirely new model, but a refinement of Beijing’s existing approach to ensure that the Chinese economy can withstand heightened global uncertainty and volatility.
The DCS is also not the only new element of China’s broader economic policy framework. Xi Jinping and other officials have increasingly voiced the need to pursue “common prosperity” to reverse the social and economic divides that have emerged among individuals and across regions as the Chinese economy has grown. The common prosperity campaign could potentially contribute to achieving some of the goals of the DCS, but details about the new program are still emerging and it is unclear how impactful it will ultimately be in the long-term.
The following analysis focuses specifically on the DCS. It includes assessments on the steps China is taking—or not taking—to achieve the strategy’s goals, and identifies some of the key structural and immediate challenges that Beijing faces in pursuing the strategy.
Boosting Domestic Consumption
The DCS aims first and foremost to pivot China away from export-led growth toward an economy fueled by domestic consumption. Beijing hopes that by relying more on China’s domestic market to drive demand, the Chinese economy will be less exposed to external volatility. At present, however, China is moving in the opposite direction needed to accomplish these goals. The pandemic is exacerbating China’s reliance on exports to achieve growth, and Beijing failed to design its pandemic recovery measures in ways that enhance domestic consumption.
Amid the pandemic, booming exports have been both a blessing and a curse for China. Economic recoveries in the United States and elsewhere have led to growing demand for Chinese products. While this has benefited China’s short-term recovery, it has propelled China back toward its old model of export-led growth and away from the consumption-led model desired by the DCS. In 2020, net exports accounted for 25.3 percent of the growth in Chinese GDP—the highest level since 1997. This trend continued into 2021, with net exports driving 20.9 percent of China's GDP growth that year—the second highest level since 1997. Notably, surging exports have not generated a sizable increase in productivity in China, as much of the growth in the value of exports in 2021 is due to higher input costs.
While exports have surged, Chinese domestic consumption has stagnated. In the runup to the Covid-19 pandemic, China was making some progress toward increasing household consumption. According to data from China’s National Bureau of Statistics, household consumption accounted for 39.1 percent of GDP in 2019, the highest level since 2005. Amid the pandemic, however, household consumption fell to 37.7 percent of GDP in 2020, wiping out five years of progress.
This was largely due to falling incomes coupled with higher savings as families cut back on spending. In the first quarter of 2020, during the height of the Covid-19 outbreak, Chinese per capita disposable income fell 3.9 percent. Retail sales took a much more dramatic hit, cratering 21 percent in January and February 2020, and they have not fully recovered.2 In the second half of 2021, retail sales grew at a pace well below pre-pandemic levels, and in March 2022, retail sales fell 3.5 percent year-over-year.
China’s economic policies during the pandemic likely contributed to lagging retail sales and household consumption. Through July 2021, China’s discretionary fiscal spending in response to the pandemic totaled RMB 4.9 trillion (roughly $770 billion), or about 4.7 percent of GDP. Much of this spending went toward boosting production and providing relief to businesses, with less going toward to households. By comparison, the US government dispensed more than $5.7 trillion in fiscal stimulus (more than 25 percent of its GDP), including multiple rounds of direct stimulus payments to households.
Beijing’s decision to provide limited assistance to its population of roughly 286 million migrant workers likely had a particularly significant chilling effect on retail sales. Many migrant workers not only lost their jobs but were also harmed by pandemic-related restrictions on the flow of people between cities and provinces.
Positioning China as a Global Manufacturing Powerhouse
While the DCS seeks to reduce China’s dependence on exports to fuel economic growth, it simultaneously holds the contradictory goal of maintaining or expanding China’s share of global exports in key areas. Specifically, Beijing is intently focused on positioning China as an exporter of high value-added, high-technology goods, which will require scaling up the nation’s advanced manufacturing capabilities.
China is undertaking significant efforts to broaden and institutionalize its access to foreign markets. In November 2020, China and 14 other Indo-Pacific countries signed the world’s largest trade agreement, the Regional Comprehensive Economic Partnership (RCEP). The trade pact, which went into effect in January 2022, promises to increase China’s trade with four regional economic powerhouses—Australia, Japan, New Zealand, and South Korea—as well as the ten member countries of the Association of Southeast Asian Nations (ASEAN), which includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.
China also announced its intent to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), a trade grouping once spearheaded by the United States until the Trump administration’s withdrawal. China’s prospects of being admitted to the CPTPP are low due to growing tensions with some members countries, but in applying for membership, Beijing intends to contrast itself with Washington and indicate its willingness to engage on trade.
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Yet signing trade deals will not alone accomplish Beijing’s goals of being a leader in exporting high valued-added goods. China will also need to significantly enhance its capabilities in advanced manufacturing. The Chinese government doubled down on efforts to advance China’s manufacturing sector in 2015 with the release of the “Made in China [MIC] 2025” industrial strategy. MIC 2025 called for a broader upscaling in manufacturing capabilities, but it prioritized making strides in 10 key industries: 1) information technology; 2) automated machine tools and robotics; 3) aerospace and aeronautical equipment; 4) maritime equipment and high-tech shipping; 5) modern rail transport equipment; 6) new-energy vehicles and equipment; 7) power equipment; 8) agricultural equipment; 9) new materials; and 10) biopharma and advanced medical products.
China’s 14th Five Year Plan echoes many of the goals put forward in the MIC 2025 strategy, and it specifically sets a target of having these strategic industries contribute 17 percent of China’s GDP by 2025. It also sets an ambitious goal of “ensur[ing] that the share of manufacturing in the economy remains stable” while also calling for “enhance[ing] the competitive advantages of the manufacturing sector with a focus on quality improvement.”
China will face an uphill battle in accomplishing these goals. In 2020, the value added from the manufacturing sector as a percentage of China’s GDP stood at 26.2 percent—down markedly from 32.5 percent in 2006. While the manufacturing sector in China remains more prominent than in other major economies, its contributions to economic growth have fallen swiftly as the country has been increasingly driven by an emergent services sector.
It is worth noting that Beijing’s manufacturing goals expose another major contradiction within the Dual Circulation Strategy. The relative decline of the manufacturing sector (and the rise of the services sector) has helped to slow the pace of growth in China’s demand for energy and raw materials. Reversing this trend will drive up China’s need for manufacturing inputs and thereby increase the exposure of the Chinese economy to supply chain bottlenecks and trade friction.
Embodied deep in the core of the Dual Circulation Strategy is a belief by Beijing that China can innovate its way out of many of the challenges it faces. For example, if China can improve its efficiency in utilizing energy, food, and other raw materials, it can produce more finished goods without the need to increase imports. Chinese leaders frequently extol the importance of “indigenous innovation” as crucial to becoming self-reliant. In a major 2018 speech on the importance of innovation, Xi Jinping stated, “Self-reliance is the foundation of the struggle for the Chinese nation to stand on its own among the nations of the world, and indigenous innovation is the only way for us to climb the world's technological peaks.“
China has made rapid progress toward becoming a global leader in innovation. This has largely been driven by increased spending on research and development (R&D). China’s R&D expenditure skyrocketed 42-fold between 1991 and 2020, from $13 billion to over $563 billion. In 2020, China spent significantly more on R&D than the next five countries—Japan, Germany, South Korea, France, and the United Kingdom—combined. Chinese R&D spending still lags that of the United States, but the gap between the two countries is narrowing. Yet Beijing’s efforts have faced difficulties. The 13th Five Year Plan set a target of spending 2.5 percent of GDP on R&D by 2020, and China narrowly missed this, reaching 2.4 percent of GDP.
Further increasing spending on R&D will be a key element of the DCS going forward. China’s 14th Five Year Plan set a goal of increasing R&D spending by seven percent each year in the 2021–2025 period. It specifically calls for focusing on boosting spending on basic research—an area where China has historically lagged—and highlights artificial intelligence, biotechnology, blockchain, neuroscience, quantum computing, and robotics as areas for prioritization.
As part of the DCS, the Chinese government is pushing to scale up China’s innovative capacity by bringing in foreign capital and know-how in the form of foreign direct investment (FDI). Beijing has steadily pared down its Foreign Investment Negative List, allowing greater opportunities for foreigners to invest in sectors such as finance, downstream manufacturing, transportation, and infrastructure. In 2020, China also concluded an agreement in principle on the China-EU Comprehensive Agreement on Investment (CAI), which could help to facilitate an influx of European investment into China, especially in electric vehicles and health services.
However, success in attracting FDI into China is far from certain. After Beijing put in place economic sanctions on European politicians and organizations in March 2021, the European Parliament halted progress on ratifying the CAI, leaving its prospects in question. The Chinese government also expects continued pushback in the coming years from the United States and its allies. In October 2021, the Chinese Ministry of Commerce released a five year plan on investment which warned of a “complex and grim” external environment and predicted modest increases in FDI into China through 2025.
Ensuring Access to Critical Inputs
Since it will likely take several years for investments in innovation to materialize into major advances toward self-reliance, Beijing is taking other measures to ensure access to the resources needed to feed its domestic industries. As part of the DCS, China is aiming to diversify its imports of energy, food, and other raw materials, and, where possible, localize supply chains. Chinese companies are also aiming to make targeted investments in foreign suppliers of such goods, but they face significant obstacles.
In the case of some high-value inputs, such as semiconductors and aerospace components, China has no short-term alternatives to relying on a few key foreign suppliers. In other areas, however, China is making some progress toward trade diversification or reshoring supply chains. China now sources its crude oil from more than 40 countries, many of which are “stable autocratic regimes” that are more willing to cooperate with, or tolerate, Beijing. In 2020, for example, roughly 15 percent of China’s crude oil imports came from Russia, a stable autocracy with which China shares a land border and increasingly close political ties. More fundamentally, China is making steady progress toward producing renewable energy at home. As of 2020, about 15.9 percent of China’s energy consumption was powered by renewable energies—compared to just 9.4 percent a decade earlier.
China is likewise moving to diversify its supplies of natural resources such as iron ore. Amid souring China-Australia relations and improving ties between Canberra and Washington, Chinese economic policymakers have called for diversifying imports of iron ore away from Australia, which supplies about 60 percent of China’s imports of the metal. China is currently eyeing the African country of Guinea as a potential new source of iron ore, but it will likely take years before investments there can begin offsetting reliance on Australia.
In addition to diversifying trade, the DCS would also see China push to acquire resources through targeted overseas investments and acquisitions. This has been a tried-and-true approach for China in years past. Since 2005, Chinese companies have invested roughly $1.3 trillion in foreign companies, with the energy and metals sectors attracting the greatest share of Chinese FDI. Under the auspices of Xi Jinping’s signature foreign policy, the Belt and Road Initiative, Chinese outbound FDI ballooned from $79 billion in 2013 to nearly $173 billion in 2017.
However, this approach may not be as successful as in years past. Chinese investors now face an increasingly complicated and uncertain environment. The global economic fallout of the Covid-19 pandemic led Chinese outbound FDI to plummet in 2020 to the lowest level since 2007. Prior to the pandemic, Chinese FDI was already falling rapidly amid fraying ties and heightened government scrutiny of Chinese investments in the United States and other countries.
Major Challenges to Implementing the Dual Circulation Strategy
Beijing faces major structural and immediate challenges to putting China on a sounder economic footing to achieve the goals of the DCS. First and foremost, Beijing faces an uphill battle in putting in place the necessary measures to fuel domestic consumption. On top of that, China’s zero-tolerance approach to Covid-19 continues to produce self-inflicted economic wounds, and a major real estate market slowdown threatens to stifle economic growth in the coming years.
Much of the long-term success of the DCS depends on boosting domestic consumption; yet the Chinese government has not put in place the necessary tools to accomplish this. China lacks important fiscal tools for transferring wealth from high-income households to low-income households. China also lacks a sophisticated welfare system—like those found in many advanced economies—capable of protecting low and middle-income households from economic hardships. Without these mechanisms in place, Beijing will find it difficult to unlock higher levels of consumption that would result from a larger and more robust middle class.
China’s new common prosperity campaign could aid in putting in place some protections and raising the wages of some low-income individuals. As currently envisioned, however, common prosperity will not entail the development of a more robust welfare system characterized by transfers of wealth from the government to low-income households. It instead appears more focused on transferring wealth from businesses to households, in the form of donations, meaning that it is likely to generate only marginal progress toward achieving the goals of the DCS.
In addition to long-term structural obstacles, China also faces several pressing challenges. Repeated Covid-19 outbreaks within China dampened Chinese economic growth throughout 2021. The number of cases associated with these outbreaks was low (by official counts) compared to the number of cases reported in many other countries, but Beijing’s “zero-Covid” approach led to sudden lockdowns for even small outbreaks. In October 2021, for example, China locked down the northwestern city of Lanzhou and its population of roughly 4 million people after 39 cases were reported there in a week.
The Chinese government’s strict Covid-19 containment policies largely helped to contain the virus within China until a major outbreak erupted in Shanghai in March 2022. The outbreak there led China’s daily new Covid-19 case totals to surge well past the official case counts during China’s initial outbreak in Wuhan in 2020. The Shanghai government responded by locking down millions of residents in their homes, dispatching thousands of workers, and setting up makeshift hospitals, which resulted in food shortages and growing criticism of China’s “zero-Covid” strategy.
China’s efforts to stop the virus have come at a significant economic cost. In August 2021, Chinese officials acknowledged that Covid-19 spikes during the summer contributed to a slowdown in typical vacation travels and slumping retail sales, and the Shanghai outbreak coincided with a 3.5 percent decline in retail sales in March 2022. China’s draconian border restrictions have also reduced the normal torrent of international travelers into China to a slow trickle, cutting off a major source of economic activity. In 2019, travel and tourism contributed nearly $1.7 trillion to China’s economy (11.6 percent of GDP) and supported the employment of roughly 82.2 million jobs. In 2020, travel and tourism contributed just $667 billion to China’s economy, amounting to a 60 percent decline from 2019. The United States and Europe saw a less severe decline in 2020, down 40 percent and 51 percent, respectively.
The Chinese economy also faces a bevy of challenges not directly related to the pandemic. The second half of 2021 witnessed the near collapse of one of China’s largest real estate companies, Evergrande Group, as well as a broader slowdown in the housing market. Official government figures show that real estate investment declined 13.9 percent year-over-year in December 2021, nearly matching the dramatic downturn during the Covid-19 outbreak in Wuhan.
These trends are not entirely unwelcome news for China. Beijing has long sought to rein in speculative investment in real estate that has caused home prices to skyrocket in recent years. Nevertheless, a continued slowdown in the real estate market would significantly inhibit China’s ability to sustain even moderate GDP growth rates. According to some estimates, the real estate and construction industries amounted to 29 percent of China’s GDP in 2016—a far higher level than in most other economies.
A prolonged real estate slump would also upend a key source of local government revenue: land sales. In October 2021, government land sales declined 13.1 percent year-over-year, following an 11.2 percent decline the month before. In the absence of sophisticated property tax schemes like those found in many other countries, declining land sales will force cash-strapped local governments to take on debt to pay for needed investments.
Chinese leaders acknowledged many of these challenges in December 2021 at the Central Economic Work Conference, an important annual convening of top officials. At the conference, Xi Jinping forecasted three main economic pressures facing China in the year ahead, including demand contraction, supply shocks, and weakening expectations among producers, and he stressed that “the external environment is becoming increasingly complicated, grim and uncertain.” The meeting also included discussions of the challenges facing the Chinese real estate market.
These developments all pose major obstacles to implementing the Dual Circulation Strategy, and, if left unchecked, they threaten to derail China’s economic growth in the coming years. Chinese leaders may still succeed at achieving the goals of the DCS and putting China down a stabler development path, but the challenges before them are daunting.