China's Twin Circulations

Lawrence Lau
(Ralph and Claire Landau Professor of Economics, CUHK )

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.

(The source of the article comes from

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