At a time when the environment for international trade is becoming more vulnerable, China is moving ahead with its “dual-circulation paradigm”. Leading Chinese economist Justin LIN, a former HKUST scholar, explains why China is highlighting domestic demand as the main driver of growth in the new paradigm.
“A bigger economy means a bigger capacity for domestic absorption, and as the world’s second largest economy, China can rely on a domestic economy,” says Justin Lin, Dean of the Institute of New Structural Economics at Peking University.
Although it’s one of the world’s fastest growing economies, China was unable to dodge the wrath of COVID-19. As if that wasn’t destructive enough, the country remains in a contentious relationship with the world’s largest economy – the US. It feels like China is being tested on all fronts.
While its “V-shape” economic rebound is a strong testament to the speed at which China took control of the pandemic, the ongoing tensions with the US, and the spillover effects of that, will continue to pose challenges for the country in the coming years. So says Professor Justin Lin, former Chief Economist at the World Bank, and now the Dean of the Institute of New Structural Economics at Peking University.
“China will inevitably confront other natural and geopolitical challenges in the coming years amid these profound changes that we haven’t seen in a century,” says Lin.
So, while China’s swift and effective response towards COVID-19 resulted in a second quarter rebound in 2020 which showed a remarkable 3.2 percent growth, and then a further 4.9 percent growth in the third quarter, it doesn’t mean China can rest on its laurels. It must deal with the ramifications of the US-China tensions which will far outlive the pandemic.
The tensions between the two countries stem from many factors, including a US trade deficit with China, former US President Donald Trump’s penalty tariffs on China’s imports, a frothy exchange during the first high-level talk between the Chinese and US officials under new US President Joe Biden, and restrictive measures against Chinese companies in the name of intellectual property protection, just to name a few.
Amidst rising tensions between the two nations, Lin believes that China can still pursue its forward-looking policies and suggests that it is probably best to stay open while tapping into an eight percent annual growth potential, which translates to around six percent growth before 2030, and four percent growth before 2050.
If this is achieved, he says, China would have reached three new milestones. Firstly, by 2025, China’s per capita GDP will have exceeded US$12,535, meaning that the country has graduated to a high-income country. Secondly, China might have replaced the US as the world’s largest economy in nominal terms. Thirdly, China’s per capita GDP may have reached 50 percent and its total size will be two times that of the US by 2050.
Lin says that by the time that this happens, the two countries will have no choice but to “live in peace for common development”. He explains that the regional income disparity in China means that the per capita GDP for Beijing, Tianjin, Shanghai and the coastal provinces, which amounts to a population of 400 million, will be the same as the US. “This means that the technology level of that part of China will rival the US. The US will lose superiority in terms of technology,” he says.
China has another one billion people living in its central and western regions with a per capita GDP that is one third of that of the US. “They are still in the process of catching up and will grow faster than the US. In this scenario, the US will lose the possibility to overturn the power balance and will find that it is better to grow with China for its own benefit,” Lin adds.
A shift away from an export-oriented economy
To understand how China intends on achieving its economic goals, it is important to look closely at the intended development of the Chinese economy, namely the “dual circulation” model highlighted in the New Development Paradigm last year.
While domestic circulation continues to be the mainstay, the model says that domestic circulation and international circulation should promote each other. Since the start of the pandemic, all eyes have been on China and how it intends to move forward in terms of this paradigm.
“China is the largest trading nation in the world. If it shifts its development model from export-oriented to domestically oriented, it will affect other countries in addition to itself,” Lin points out. “That’s why domestic and foreign media have been focusing on this topic.”
Lin further explains why China is proposing to treat domestic circulation as the main circulation.
Obviously COVID-19 had a major impact on the world economy. International trade is predicted to shrink dramatically so as the world’s largest trading nation, China cannot rely on exports as the main driver of growth.
“This means that its domestically made products will have to be increasingly absorbed domestically via domestic circulation,” Lin explains.
China’s tensions with the US will become another factor which affects the country’s exports. “If its exports decline, its production will have to be absorbed domestically,” Lin says.
This is where China has a comparative advantage, as its population is four times that of the US. Based on the laws of economies, Lin believes that China can support a circular economy because it has much more capacity for domestic absorption compared to small economies.
“The modern manufacturer has a large economy of scale. If a country is a small economy with insufficient capacity for domestic absorption, it must rely on bigger foreign markets,” he explains. “A bigger economy means a bigger capacity for domestic absorption, and as the world’s second largest economy, China can rely on a domestic economy.”
Unleashing the power of the service sector
Another reason for China’s reliance on domestic circulation is that its service sector is only about 53.6 percent. Since a big part of the service sector is non-tradeable, there is a lower percentage of exports in its GDP.
China’s domestic absorption has already exceeded 80 percent. With a rise in China’s income, the size of the Chinese economy and service sector will continue to expand. As a result, Lin believes that it will continue to move towards 90 percent in the future. He says that a new statement on domestic circulation is a “clear-headed judgement of the trend in the present development stage and aims to change the general perception that China is an export-oriented economy.” That said, Lin stressed that unless it is an autarchic economy, every country actually has dual-circulation in its economy.
Outlook
Lin believes that if China carries on down this path, it will continue to be the main driver of growth in the world, as 30 percent of the world’s market expansion has come from China since 2008.
China will have to stay calm, pursue smart forward-looking policies with continuous reform, and open up, if it wants to tap into its potential, maintain stability, and grow dynamically.
Lin says the US can choose to work with China and exploit the Chinese market for the sake of its own growth. The two economies have no reason not to live in peace for common development.
Even though trade is a win-win situation for both trading partners, the smaller one tends to benefit more than the larger one. So, when the economic size of China is twice as large as that of the US, maintaining good relations and trade with China will be important for the US’ growth and the generation of jobs. “A growing China will be beneficial not only to itself but to the rest of the world,” Lin says.
A Backlash Against Global Trade?
According to Lin, the reason that the US buys from China is not because it cannot produce the products that they need, but because China can produce them at a much lower cost. That is how the comparative advantage-driven international trade works. To restrict trade with China and to hurt China, the US will have to pay a price.
While the US might be willing to pay the cost of maintaining its hegemony, if other countries join the US and restrict trade with China, they will be risking their own growth and jobs. China is the largest trading partner of more than 120 countries and is the second largest trading partner to more than 70 countries. Lin does not believe that other countries will be willing to sacrifice themselves for the sake of maintaining the US’s hegemony. As long as China remains open, the world is unlikely to fall back into a ‘Cold War’.