China is seeking to become even more self-sufficient. As a new Citi GPS report shows, this objective creates new risks and opportunities.
It’s been two years since China unveiled its 14th Five-Year Plan, which set the country on a new economic trajectory up to 2025 called “dual circulation.”
The idea is to rebalance from an export-led “international circulation” strategy to one that focuses more on the country’s domestic market through self-reliance, or “domestic circulation.”
That means more of a role for the state, and an investment drive. In a sense, by becoming more state-oriented, more protectionist, and more inward-looking, China has been reviving a form of what some economists call “neomercantilism.”
Rebalancing from export- to demand-driven growth is partly a reflection of China’s economic size. The country’s foreign trade dependency ratio, measured as the ratio of total goods trade to GDP, peaked at 64.2% in 2006 and has fallen continuously to 35.8% in 2019, and to 34.2% in 2021.
According to the authors of a new Citi Global Perspectives & Solutions (GPS) report – China’s Inward Turn: The Pursuit of Economic Self-Reliance – the transition is essentially to boost domestic demand and raise people’s living standards.
They also say it is simply unsustainable for an economy of so large to rely much on export demand.
Self-reliance has taken on added urgency in response to recent geopolitical events, in particular the US-China trade war.
The punitive economic policy measures the US imposed on China during the Trump administration gave China further impetus to pursue self-reliance, since it had become clear that China’s access to international markets was becoming increasingly constrained.
Then we had tightening export controls on US technology, as well as sanctions imposed on Russia after its invasion of Ukraine.
Those sanctions against Russia have likely led China’s authorities to consider their policy options to minimize the effect if similar policies were aimed at Beijing in the future.
Ideology has started to play a big part, too, with a more explicit ideological bias in Chinese policymaking becoming noticeable. President Xi Jinping is often understood to be deeply influenced by Marxist ideology, and the 19th Party Congress in October 2017 saw him emphasize the need for “stronger, better, and bigger” state-owned enterprises (SOEs).
Infrastructure investment has become a major theme when it comes to domestic circulation — at the expense of real estate investment.
A lot of this involves support for “new infrastructure” — that is, 5G, big data, artificial intelligence, blockchain, cloud computing, and robotics — and in linking traditional infrastructure to software, with the aim of creating smart cities and intelligent energy networks.
However, as the GPS report’s authors argue, China’s ability to achieve a pure form of self-reliance will be highly constrained. This has big implications for three key drivers of its economic future: technology, agriculture, and energy.
China’s tech decoupling from the US means a paradigm shift in its innovation model, switching from relying on foreign companies for leading core technologies to self-reliance under a “new whole-nation system.” This could be China’s “Sputnik” moment — an external trigger for an era of fast-track technological progress.
Yet it all hinges on developing competence in semiconductors.
The GPS report’s authors believe China will eventually catch up in semiconductors, but the obstacles are considerable. That’s because while China is the world’s largest consumer of semiconductors, growing hostility in the US-China relationship means that it will be much more difficult for China to develop a capability in advanced node chips — at a time when its self-sufficiency in this area is already extremely low.
In addition, breakthroughs in semiconductors could be difficult for China given that it’s a capital-intensive sector, with long investment cycles. China lags far behind Taiwan in terms of foundry technologies, for example.
China is also vulnerable because it relies heavily on imported chips and components. The enactment by the US of the CHIPS Act of 2022 in August 2022 adds to sanctions against China amid a government-led international chip race. And the frosty state of US-China relations is likely to increasingly inhibit technology transfer to China.
Since the great famine of 1958-61, food security has long been an obsession of Chinese policymakers, and it’s probably the number one priority of the 14th Five-Year Plan.
Yet while China is far from having a food crisis, food security concerns dominate policymakers’ thinking. The country’s net food import bill has been rising sharply, to some extent driven by feed grains.
China is especially reliant on soybean imports for feed grains to support its large and rapidly growing livestock industry.
As the geopolitical landscape changes and the Chinese economy grows larger, the security of primary products becomes a more central element of China’s sustainable development than ever before.
Rural revitalization has emerged as a top priority among Chinese policymakers, signaling renewed policy efforts for rural vitalization and agricultural modernization, centered on tackling bottlenecks in agricultural technologies; investing in rural infrastructure; strengthening farmland protection; and solidifying poverty alleviation outcomes.
The GPS report authors believe land reform is key to rural vitalization. Unlocking land value reform would increase farmers’ wealth and support their demand for automobiles, consumer electronics and other durables, as well as services.
Energy security is not an immediate concern for China, because coal still accounts for 56% of China’s energy mix, and China is largely self-sufficient on that front.
However, China’s dependency on imported energy is rising as demand growth outpaces domestic production, and while its decarbonization push raises the importance of energy security in the medium and long term.
The political will to meet its environmental targets remains strong in China, both for geopolitical reasons and for purely ecological reasons. But China has a long way to go to build a low-carbon economy, and the country’s promotion of coal reflects political objectives, above all.
The big takeaway from all this is that China will have to become more innovative in response to external challenges. The 14th Five-Year Plan elevated innovation to “core status” in China’s modernization, positioning core technologies as a matter of national security.
In a continually changing geopolitical setting, however, China’s innovation model may itself need to shift more towards self-reliance, and while foreign partnerships will still be important, China will have to rely more on its domestic companies and talents to drive innovation.
Self-reliance is far from a guarantee of successful innovations, but it may be a defining feature of policy in a decoupling world.