Strategical Insider Knowledge China for CEOs: China’s Dual Circulation Strategy (DCS), Article 1 of 2

 

In this first article, you will learn and understand

• The government will push for the use of more local components.
• Foreign companies should focus on leveraging China's high-end manufacturing base, while moving lower-end products elsewhere.
• China will no longer need to import high-end inputs
• Only those companies with a valid value proposition can continue to benefit from China as a major sales market.
• Governments are only willing to buy foreign products if the local technology cannot meet their needs.
• Domestic consumption is a key element of China's economic growth

In this article, you will get solutions for your business to be discussed in detail:

• to leverage deeper R&D facilities in the country to produce products for a huge, growing domestic market.
• understand the structural changes taking place in China—and adapt their strategies accordingly to the new realities
• to ensure that local supply chains are scalable
• the better to offer unique solutions to an increasingly sophisticated local consumer
• foreign companies need to recalibrate their engagement with China as a market, as a part of their value chains, as a source of innovation, and as a competitor in third markets
• foreign companies must offer tailor-made products to Chinese customers. 

For decades, China has acted as the world's factory, providing large-scale production opportunities for everyday goods used by consumers around the world. At the same time, China is also keen to raise the level of its economic development and gain new advantages in global economic cooperation and competition.

Amid global trade tensions and supply chain disruptions since Trump's inauguration, China launched its "dual circulation strategy" in May 2020. It has become a key national priority in the government's 14th Five-Year Plan (2021-2025).

It aims to pivot and create the domestic economy as the other pillar of its economic growth and reduce its vulnerability and dependence on exports and foreign investment, which has been the focus for decades. China's adoption of the "dual circulation strategy" is inevitable as it focuses on developing its economy to be more resilient, sustainable and balanced.

In pursuit of economic security and self-reliance, China has formulated a "new development pattern" that includes the "dual circulation strategy" (DCS). The strategy has given the Chinese authorities further impetus to push for the use of more domestically produced components.

The DCS has two main components: internal (domestic) circulation and external (international) circulation. The overall goal of the DCS is to enable the internal and external markets to reinforce and support each other, with an emphasis on establishing the domestic market as the primary driver of economic development.

The DCS remains a nebulous collection of several high-level objectives. While the following elements form the core of the strategy, they need to be taken into account:

• Reduce external demand or export as a driver of economic growth by increasing domestic consumption;
• Position China as a global manufacturing powerhouse in high value-added and technological products;
• Achieve higher levels of self-sufficiency in key areas by promoting innovation; and
• Ensure access to critical inputs by diversifying supply chains and directing investment to specific industrial and consumer sectors.
• The goals of the DCS are complex and sometimes contradictory, but they ultimately amount to a plan for "hedged integration" in which China seeks to engage with the world on its terms. The DCS is not an entirely new model, but a refinement of China's existing approach to ensure that the Chinese economy can withstand heightened global uncertainty and volatility. Technology, energy and food will be the sectoral focus under the DCS.

In the process, China is rapidly moving up the manufacturing value chain, producing more sophisticated goods and creating a skilled and higher-paid workforce. Rising wages and the Chinese government's policy goals are sending signals that foreign companies should focus on leveraging China's high-end manufacturing base while moving lower-end products elsewhere.

The dual-circulation strategy is not a decoupling strategy, as some news media have portrayed it, but rather China's coming to terms with the need to balance its economic growth with an opportunity to better control its economy.

However, China will see this period as a critical opportunity to deepen market-oriented reforms. This would address concerns about the allocation of production factors (land, labor, environment, capital, and data) in the market, further encouraging local producers to meet growing domestic demand and expand industrial production for both the domestic market and exports.

For key sectors linked to national security, such as technology, energy and agriculture, China's policymakers are expected to encourage more rapid foreign investment in high-end manufacturing and R&D, while also supporting global supply chain diversification.

However, a relevant consequence for the world is that China will no longer need to import high-end inputs, with obvious negative consequences for major technology exporters such as Germany, Japan, South Korea and the US[1]. For the EU, these shifts present both challenges and opportunities. On the one hand, competition with China will intensify; on the other hand, the EU can pursue openings for supply chain diversification with like-minded countries, thereby strengthening its open strategic autonomy. [2] 

The dual circulation strategy will result in some doors being opened to foreign investment and some foreign companies being treated better in certain sectors, but it will also inevitably result in some doors being firmly closed, or remaining firmly closed. As the report Decoupling: Severed Ties and Patchwork Globalization, companies will find themselves in either "business class," "economy class," or the "cargo hold," depending on the sector in which they operate and the extent to which they can help China achieve its policy goals. [3] Only those with a valid value proposition can continue to benefit from China as a major market.

Given factors such as China's huge domestic market, extensive supply chain network and strong business ecosystem on the one hand, and rising labor costs and an aging population on the other, many foreign investors are adopting "In China, for China" and "China plus one" strategies to tap into China's growing market demand while reducing costs, diversifying risks and accessing new markets. The strategy is to leverage deeper R&D facilities in the country to produce products for a huge, growing domestic market.

While the short-term challenges for investors in managing exposure to the pressures in the Chinese market are overwhelming, there are still great opportunities in China, whose economy is one of the strongest growth engines in the world.

The key question is whether and how your company can continuously anticipate rapid market developments. Companies that understand the structural changes taking place in China - and adapt their strategies accordingly - will be able to seize the immense growth opportunities created by this emerging economic superpower. 

China is simply too big and important in terms of market size and growth potential to be ignored. From this perspective, geopolitical "decoupling" does not mean retreating from China. Rather, multinationals should redouble their plans to tap the growth potential of China's domestic market. From a manufacturing perspective, it is critical to ensure that local supply chains are scalable and actively leverage value-added production to efficiently meet domestic demand. Global companies will need to work smarter as they'll face tougher competition from local companies that are increasingly digital and able to scale rapidly. Local teams will need to be close to the market and its latest developments to be inspired by the innovative business models emerging in China. Local design hubs and collaborations with digital natives will need to be forged to keep pace with new developments, so as to offer unique solutions to an increasingly demanding local consumer. To do this, MNCs will need to build empowered local teams and capabilities. In addition, China operations need to feel "local" and connected to the pulse of the consumer and the innovation ecosystem. [4] 

We see established foreign companies struggling to anticipate these local developments.

To succeed in China over the next decade - and to manage risk effectively - international companies need to develop more sophisticated strategies. They need to recalibrate their engagement with China as a market, as part of their value chains, as a source of innovation, and as a competitor in third markets. To succeed and manage risk in the face of the structural changes we've described, many MNCs will need to refine their approaches to China. 

[1] https://www.bruegel.org/...
[2] https://www.europarl.europa.eu/...(2020)659407
[3] https://www.europeanchamber.com.cn/...
[4] https://fortune.com/...