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DUAL CIRCULATION: on Unsplash Photo CHINA’S WAY of RESHORING? 29 October 2020

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DUAL CIRCULATION: on Unsplash Photo CHINA’S WAY of RESHORING? 29 October 2020 ALLIANZ RESEARCH DUAL CIRCULATION: on UnsplashPhoto CHINA’S WAY OF RESHORING? 29 October 2020 04 Declining growth and external hardships 06 The dual circulation strategy: a more inward-looking growth model 08 Taiwan, Malaysia, Singapore, Thailand and Chile are set to incur the most potential losses in the medium run 10 Innovating emerging economies to attract Chinese investment 11 Risks: rising debt, zombification, slow technological advancement Allianz Research Over the long run, the Chinese economy is facing two key challeng- es: declining potential growth and a deteriorating external environ- EXECUTIVE ment. Our growth potential model suggests China’s GDP growth is likely to average between +3.8% and +4.9% over the coming dec- ade (after +7.6% in the 2010s), due to declining labor supply and SUMMARY slowing productivity and capital investment. Meanwhile, China is also bracing for a long-term standoff with the U.S., which is currently its top export destination and the most innovative country at the global level. Looser economic ties with the U.S. will thus pose addi- tional risks to China’s slowing economy. In this context, the “dual circulation” strategy is likely to take center stage in China’s 14th five-year plan as a way towards more sustain- able growth, making the country less reliant on factors outside of its control. First introduced by President Xi Jinping in May 2020, this strategy prioritizes “domestic circulation” (increasing domestic de- mand and lowering dependence on foreign inputs), while Françoise Huang, Senior Economist for Asia-Pacific “international circulation” (maintaining export market shares and +33.1.84.11.34.27 liberalizing capital flows) works as a complement. While rebalanc- [email protected] ing towards domestic demand is not a new principle in China’s eco- nomic planning, China will aim in the long run to use domestic pro- duction to provide for increasing domestic demand, rather than imports. Taiwan, Malaysia, Singapore, Thailand and Chile are set to incur the most potential losses in the medium run as China moves to- wards industrial autonomy. Conversely, goods from the U.S., Japan and Germany are exposed to very limited risk of being substituted by Chinese goods in the medium term, thanks to their technological advancement. Losses for the Eurozone overall could amount to up to 0.9% of GDP in the medium run, with machinery & equipment, construction, agrifood and electronics the most exposed sectors. China is likely to increase direct investment into innovating emerg- ing economies, such as the electronics sector in Indonesia, India, Thailand, Mexico and Chile. Chinese outward investment has slowed but not stopped in the past years, and the Belt and Road Initiative remains part of Chinese authorities’ long term vision. Im- plementation challenges (e.g. related to financial risks) mean that Chinese policymakers are likely to aim for outward direct invest- ment to be more disciplined around national economic targets (e.g. industrial autonomy). Long-term risks include rising debt, zombification and slow techno- logical advancement. China’s R&D spending relies far more on gov- ernment funding compared to the U.S., Japan and Germany. Strong government intervention could risk leading to overcapacity issues and resource misallocation towards the overall less profitable and less innovative state-owned enterprises. 2 29 October 2020 Photo by onPhoto Markus Pixabay Spiske 3.8%-4.9% China's average growth over the coming decade, compared to 7.6% in the 2010s. 3 Allianz Research DECLINING GROWTH AND EXTERNAL HARDSHIPS The fifth plenum of China’s Communist The Chinese economy has been on a model for potential growth, we have Party Central Committee draws to a declining trend over the past decade, devised two scenarios, with (1) suc- close on 29 October 2020 after four with GDP growth averaging +7.6% in cessful structural reforms and (2) no or days of discussions partly focused on the 2010s, compared to +10.3% in the unsuccessful structural reforms (see the 14th five-year plan, which will de- 2000s. The downward trend is likely to Figure 1). In both scenarios, the nega- fine the economic policies and targets continue in the coming years as China tive contribution of the labor supply will for 2021-2025. The details will be fina- deals with structural issues, including deepen as a result of the aging popula- lized and made public in March 2021 capital misallocation, overcapacity and tion and expected low fertility rates. but we expect the “dual circulation” an aging population. However, policy Capital growth and productivity growth strategy, first introduced by President Xi measures such as reducing debt levels are set to decline less in scenario (1). Jinping in May 2020, to take center (of firms and local governments), Overall, potential growth over 2021- stage. This strategy aims to respond to boosting labor mobility and human 2030 should average +4.9% in scenario two key challenges that China is facing capital and upgrading the manufactu- (1) and +3.8% in scenario (2) (see Fi- in the long term: declining potential ring base should help cushion the de- gure 2). growth and a deteriorating external cline in China’s capital and productivity . environment. growth. As such, using our proprietary Figure 1: China GDP – actual growth, forecasts and potential growth Figure 2: China potential growth estimates and breakdown estimates 15 2021-2030 2021-2030 Actual GDP growth 2001-2007 2008-2014 2015-2020 IMF GDP growth forecasts (1) reforms (2) no reforms 13 Potential growth estimates: (1) reforms GDP growth 10.7 8.7 6.6 4.9 3.8 Potential growth estimates: (2) no reforms (average p.a. %) 11 Average contributions: 9 Labour supply 0.6 0.2 -0.1 -0.3 -0.3 7 GDP per labour 10.1 8.5 6.7 5.2 4.0 5 Long-term 2.6 2.1 1.8 1.3 0.6 3 productivity Capital per 7.6 6.4 4.9 3.9 3.4 1 labour unit 00 02 04 06 08 10 12 14 16 18 20 22 24 26 28 30 Sources: : China National Bureau of Statistics, IMF, Euler Hermes, Allianz Research Sources: : China National Bureau of Statistics, IMF, Euler Hermes, Allianz Research 4 29 October 2020 Figure 3: Share (%) of surveyed who have an unfavorable view of China 100 2019 2020 90 80 70 60 50 40 30 20 10 0 Japan Australia South Korea UK U.S. Germany France Sources: Summer 2020 Global Attitudes survey (Q8b) Meanwhile, China is also facing a dete- pared with just 16% in 2013. This likely pression of “protracted war” to describe riorating external environment, which protracted standoff could result in loos- the problems the country is facing. Be- began with trade tensions with the U.S er economic ties in the coming years yond the U.S., China’s external environ- in 2017. Since then, these tensions have with the U.S., which is currently China’s ment overall is also turning less favora- spread into technology, financial, me- top export destination and the most ble, with a survey conducted in summer dia and geopolitical areas. Surveys innovative country at the global level 2020 showing that the public percep- conducted by the American Chamber (considering R&D spending and patent tion of China has starkly deteriorated in of Commerce in China show that 37% applications). The Chinese leadership developed countries (see Figure 3). of respondents were planning no fur- aims to prepare a sustainable response ther investment or declining investment to this long-lasting change, as the Polit- in their China operations in 2020, com- buro meeting in August used the ex- 5 Allianz Research THE DUAL CIRCULATION STRATEGY: A MORE INWARD-LOOKING GROWTH MODEL The domestic and international con- account will keep going as China aims What is now different compared to the text, coupled with vulnerabilities unco- to attract foreign investment and dee- post-GFC rebalancing is that China will vered by the ongoing Covid-19 pande- pen its capital markets. aim in the long run to use domestic pro- mic, has prompted the Chinese lea- duction to provide for increasing do- dership to rethink the country’s econo- It is important to point out that the prin- mestic demand, rather than imports. mic growth strategy. The dual circula- ciples behind the dual circulation stra- Such a strategy change has actually tion strategy hinges on a model where tegy are not entirely new for China. The been in the works since 2015, when “domestic circulation” is the focus and country has been aiming to rebalance authorities introduced the Made in Chi- “international circulation” works as a its economy towards the domestic mar- na 2025 program. Its aim was to up- complement. The rationale is to esta- ket for well over a decade – the Global grade China’s manufacturing base and blish more sustainable growth in the Financial Crisis (GFC) having been the allow some key sectors to become long run, making China less reliant on trigger for such a change. As in- more autonomous, i.e. less reliant on factors outside of its control. vestment and consumption grew faster foreign inputs. While Made in China (+8.7% and +12.0%, respectively, in real 2025 in its exact form is not mentioned More precisely, domestic circulation terms on average over 2009-2019), the by Chinese authorities anymore (being implies targets and reforms on both the share of exports in total GDP declined a point of tension with the U.S.), the demand and supply sides of the from 35% in 2008 to 24% in 2019. In the principles of indigenous technology Chinese economy. On the demand side, meantime, the share of imports in total and industrial autonomy live on with the aim is to capture consumer spen- GDP has been relatively stable over the the dual circulation strategy.
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