The view from Beijing: China’s response to the advanced economies’ pursuit of supply chain diversification

Introduction

For Beijing, the drive by advanced economies to reduce dependence on China – as a market and as a supplier – and to constrain China’s access to global supply chains represents a significant threat to national security and economic stability. China’s leaders are taking this new threat seriously – even if actual supply chain decoupling remains mostly aspirational for now – and have placed China on an accelerated path to self-sufficiency in critical sectors.

This paper briefly addresses four interlocking initiatives Beijing is pursuing to build economic resilience by shoring up its supply chains in critical sectors: the Dual Circulation Strategy (DCS), innovation, the Belt and Road Initiative (BRI), and the counter-sanctions legal regime. It then touches on how these initiatives are playing out in Chinese policy across technology, agriculture, energy, and natural resources.

The strategies

China’s plan for dealing with advanced-economy supply-chain decoupling encompasses several broad, intersecting macroeconomic and geo-economic strategies, as well as an emerging legalistic toolkit to handle specific acts of external policy-driven hostility. In pursuing these dovetailing strategies, China wants to mitigate the risks related to global supply chains in critical sectors – particularly those entangled with antagonistic countries – and increase the world’s dependence on China, both as a customer and, ultimately, as a source of high technology. Each prong of China’s approach to its supply chain risks complements the others.

Dual Circulation

China’s top leadership first put forward the DCS in early 2020 amid falling global demand due to the COVID-19-induced economic downturn and a bruising trade war with the US.[1] At the heart of the strategy are efforts to buttress China’s economy against “external shocks” by making the domestic market (“internal circulation”) the main driver of the economy, reducing dependence on foreign markets and minimizing external vulnerabilities where possible.

The DCS is more than just a repackaging of China’s longer-term plan to transition toward a consumption-driven economy. It differs both in reframing China’s economic relationship with the world and in the extent to which it links this shift toward domestic consumption to national economic security.

The strategy posits that a more robust domestic market would allow China to regear its export-driven industries to serve the domestic market, thus reducing the economy’s reliance on global demand. At the same time, the DSC underscores the need for China to remain open to the world, including to imports and foreign investment. A crucial part of the strategy, however, is also ensuring that domestic capabilities in key technologies, in particular semiconductors, are sufficient to ensure China can weather being cut off from related global supply chains, while also ensuring food and energy supply chains are secured. Where domestic capabilities are wanting in these sectors, policymakers want to guarantee reliable and diverse sources of supply from overseas.

Increasing the world’s dependence on a growing Chinese “mega-market,”[2] meanwhile, would, in turn, give China a deterrence tool (i.e., cutting off access to this mega-market) against foreign acts of hostility (and deterring the complicity of foreign firms in those acts).

Innovation

China’s core economic policy documents – and the government spending that goes along with them – have never emphasized the need for home-grown innovation as much as they do now.[3] From the latest five-year plan (2021-25),[4] to the DCS, to Xi Jinping’s New Development Concept,[5] and even the recent push for “Common Prosperity,”[6] innovation has been underscored as China seeks to shed the “growth-above-all” economic model and achieve “high-quality, efficient, and sustainable development.”[7]

China is pursuing a whole-of-nation strategy to ascend technological value chains.

Most prominently, Beijing is throwing its policy weight behind everything from basic sciences to the development of “strategic emerging industries”[8] and other core technologies as it seeks to push domestic industry up global technological value chains. Key areas of focus include information technology, biotech, artificial intelligence, new energy, new-energy vehicles (NEVs), new materials, quantum computing, brain sciences, and more. Above all, China is relentlessly pursuing self-sufficiency in semiconductor production, an area where it is particularly vulnerable to advanced economies.[9]

In a best-case scenario for Beijing, China would not only escape its dependency on advanced economies for certain technologies, but would itself become the world’s supplier of the most cutting-edge technologies. Even if the push up technological value chains is only partially successful, China would be able to use its dominance in some critical technologies (and the world’s dependence on them) to deter other countries from cutting off supply from their own critical technologies.[10]

But China’s innovation push is not just limited to traditional hi-tech areas. It encompasses everything from domestic logistics systems, seed technology, industrial internet, education, consumption, data economics, environmental protection, government services, smart cities, digital currency, and many others. China’s leaders want innovation to permeate and transform all aspects of economic activity, creating a stronger and more resilient economy.

The Belt & Road Initiative (BRI)

The two domestic policies outlined above dovetail with one of China’s key foreign policy initiatives: ever-stronger economic relations with BRI countries. The BRI, launched in 2013, began as an initiative to export excess construction-related capacity as domestic construction activity cooled following the post-2008-09 global financial crisis stimulus. Policymakers also hoped it would bring BRI partners increasingly into China’s sphere of influence. As advanced economies have brought increasing pressure against China, the BRI’s importance has been enhanced, and its utility expanded. One key goal now is to lock in supply chains for mineral imports and food and diversify the import sources for these goods, while still building up alternative, growing markets for Chinese capacity and goods – spurred by Chinese investment in BRI countries. As the BRI matures, the initiative will likely also take on an increasing role for China in demonstrating its global leadership in areas like climate change and as a provider of global public goods.[11]

Lawfare

Finally, throughout 2020-21, Beijing has been building a system of legal mechanisms designed to warn off companies and individuals from complying with foreign sanctions that target China. Although none of these new tools have been applied to any significant degree yet, their formal existence on the books has increased uncertainty for those with a stake in the Chinese market and given multinational companies pause. The anti-sanctions law,[12] the EU-style blocking regulations for foreign extraterritorial legislation,[13] and the Unreliable Entity List[14] collectively grant Beijing substantial authority to penalize companies that comply with (for instance) US rules designed to punish China or incentivize decoupling. The laws also allow Chinese companies to sue foreign counterparts in China for damages related to those companies complying with foreign sanctions.

Policy goals

The strategies and priorities outlined above are manifesting in different ways across China’s most sensitive industries and interests. Below we touch on three of the most important elements.

Technology

While we have already outlined China’s technology strategy above, below, we offer some additional thoughts, particularly concerning green technology.

For much of its modern history, China has relied on imports for its core technology components. Beyond headline-making dependencies like semiconductors, China has at times been reliant on foreign IP for power generation, engines, grid management, software, telecommunications, and more – all of which reached advanced levels in the West just as China was joining the ranks of the developing economies.

Now, however, China’s domestic technology has largely caught up with the developed world in many of these categories – and in some emerging areas, China is at the cutting edge. New energy technology presents a perfect example – as the world pursues an energy transition, China will have a prominent seat at the table in terms of innovating and commercializing key technologies for renewable generation, NEVs, energy storage, and renewable-driven grid management.

It is hard to overestimate the potential impact of which companies or countries emerge as leaders in these new fields. The specific technologies and broader standards adopted for new energy applications will drive multi-trillion-dollar global markets in one direction or another. What’s more, the ability to develop and control these technologies is, in the long run, likely to be much more geopolitically impactful than the geographic distribution of mineral resources. It is thus very much in China’s interest to make technical breakthroughs and commercialize them, even if these breakthroughs will likely create new long-term dependencies on certain mineral imports (see below).

Indeed, success in this endeavor could mean that, rather than depending on advanced economies for key energy technology as in the fossil fuel era, China could become a provider of key technologies, and benefit from global dependencies for years to come.

Agriculture

China is uncomfortably reliant on “antagonistic” countries like the US, Canada, and Australia for supply of staple grains, livestock feeds, and animal proteins. Efforts to reduce reliance on these traditional major exporters have been ongoing since shortly after the launch of the BRI in 2013. As diplomatic and trade relations with these countries deteriorate, these dependencies have become increasingly alarming for Beijing. Therefore, it is unsurprising that diversifying agricultural product import sources is a top priority in the most recent five-year plan (2021-25).

Self-sufficiency remains China’s ideal. But policymakers have come to terms with the fact that, as both population and per-capita income grow, imports of many agricultural products – from feed grains and oilseeds, to dairy and infant formula, to red meat – must also continue to rise for the foreseeable future. Thus, in addition to upgrading agricultural supply chains at home (e.g., through land reform that facilitates farm upscaling, improved seed technology, better logistics, and modern agricultural machinery), Beijing has undertaken heavy investment in the farming and food processing industries and agricultural infrastructure of some of its friendlier trading partners.

This effort serves two ends. By investing in agriculture in places like the Ukraine, Russia, Brazil, and Indonesia, China is helping to ramp up food production in those markets and diversify its supply of imports. Diversification of trade partners may not be efficient, but it is more secure from a geopolitical perspective than remaining dependent on the US or others for food.

Also, by investing in agricultural assets abroad, Chinese state-owned enterprises and financial institutions effectively become investors or part owners of the store wherein China is also the largest customer. While this scenario is not as ideal as self-sufficiency, it is also not as sub-optimal as total dependency.

Energy and natural resources

China’s energy policy in the medium term will be driven by efforts to achieve two overarching goals. The first is to gradually decarbonize the energy mix to fulfill the government’s climate commitments. The second is to strengthen China’s energy security and self-sufficiency – with energy security explicitly linked to national security.

Like many other nations, China is seeking to wean itself off fossil fuels. And, like everyone else, China is struggling to do so. However, progress is inevitable over time, particularly given China’s national security concerns over its dependency on imported energy inputs.

The slow transition away from fossil fuels will leave China less reliant on petrostates and regional coal suppliers. However, the same (green) transition will create new dependencies for copper, nickel, cobalt, lithium, rare earths, chromium, graphite, zinc, manganese, and more. China is relatively rich in many of these. However, it will still likely need to import more, and Beijing will also increasingly seek to offshore environmentally intensive processing steps – for rare earth materials, for example.

China’s approach to rising alternative resource dependencies will work similarly to its challenges with food: it will likely double down on its outbound investments along natural resource supply chains and will seek to solidify relationships with a diverse range of potential resource suppliers. In doing this, China wants to avoid bottlenecks and single-source dependencies while seeking influence and equity at the source.

Unlike with fossil fuels, however, where legacy international players held the lion’s share of historical assets and had already built most of the necessary processing infrastructure, China still has room to get in at the ground floor as an “investor in the store” for the global mineral supply. This pattern is already evident in regions like Southeast Asia and sub-Saharan Africa.

Summary

Below we offer some summarizing thoughts on the above strategies and policy trends.

It is essential to underscore that China, although it has always closely managed its economic integration with the world, is not pursuing a strategy to separate from the global economy. Instead, it wants essentially to reverse its current trade relationship with the world, becoming a net importer of goods, while providing the world with the next generation of critical technologies from an upscaled manufacturing sector.

The end goal is to create a deterrence mechanism against other countries (and their firms) from cutting off supply to China, as these countries would face being cut off from China’s market and critical technologies should they do so. This system would ultimately make a world that is more accommodating to China’s pursuit of its national interests.
China’s transition to a green energy system will allow it to shed dependence on fossil fuel imports. But this transition will create new dependencies for other minerals, particularly as it seeks to offshore some environmentally intensive mining processes.
China’s ideal is “self-sufficiency” in energy and food. But it realizes this goal is perhaps unachievable. Instead, it wants to secure economic relationships with friendly countries and diversify its dependency across a range of markets, while seeking influence and equity at the source.

Dr Kelly Layton is a director at Trivium China, a Chinese policy analysis advisory headquartered in Beijing. He has advised governments and corporate clients on their China strategies in both public- and private-sector organizations, including at Brunswick Group and the Australian foreign and trade ministry. He holds a PhD in Asian Studies from the Australian National University.

[1] “中共中央政治局常务委员会召开会议习近平主持,” Xinhua News Agency, May 14, 2020,

http://www.xinhuanet.com/politics/leaders/2020-05/14/c_1125986000.htm.

[2] “中共中央政治局常务委员会召开会议习近平主持,” Xinhua News Agency, May 14, 2020,

http://www.xinhuanet.com/politics/leaders/2020-05/14/c_1125986000.htm.

[3] It is important to note, however, that China made pursuing “indigenous innovation” the most important aspect of all science and technology related work in 2006.

[4] Please find a Chinese-English translation of the plan here: http://tppckte.org.cn/2021-08/04/content_77671903.html.

[5] Xi Jinping, “Understanding the New Development Stage, Applying the New Development Philosophy, and Creating a New Development Dynamic,” Qiushi, May-June 2021, last modified July 8, 2021, http://en.qstheory.cn/2021-07/08/c_640514.htm.

[6] “Xi stresses promoting common prosperity amid high-quality development, forestalling major financial risks,” Xinhua News Agency, August 18, 2021, http://www.xinhuanet.com/english/2021-08/18/c_1310133051.htm.

[7] Xi Jinping, “Understanding the New Development Stage, Applying the New Development Philosophy, and Creating a New Development Dynamic,” Qiushi, May-June 2021, last modified July 8, 2021, http://en.qstheory.cn/2021-07/08/c_640514.htm.

[8] “China to expand investment in eight emerging industries,” Xinhua News Agency, September 23, 2020, http://www.xinhuanet.com/english/2020-09/23/c_139391545.htm.

[9] James Andrew Lewis, “China’s Pursuit of Semiconductor Independence,” Center for Strategic and International Studies, February 27, 2019, https://www.csis.org/analysis/chinas-pursuit-semiconductor-independence.

[10] Xi Jinping said as much last year: “[We must] tighten the dependence of the international industrial chains on China and form strong counter and deterrent capabilities against foreign parties artificially cutting off supply [to China]. There is unfortunately a mistranslation of this in English that is circulating the internet, which suggests Xi said China wants to proactively cut off supply to foreign countries (offensively) to create this deterrent. This is incorrect. See Xi’s original piece here: Xi Jinping, “国家中长期经济社会发展战略若干重大问题,” Xinhua New Agency, October 31, 2020, http://www.xinhuanet.com/politics/leaders/2020-10/31/c_1126681658.htm.

[11] See, for example, Xi Jinping’s announcement in September that China would not build any more coal-fired power plants abroad, a large portion of which has focused on BRI countries. See “Xi Focus: China to stop building new coal-fired power projects abroad,” Xinhua News Agency, September 22, 2021, http://www.news.cn/english/2021-09/22/c_1310201218.htm.

[12] Katja Drinhausen and Helena Legarda, “China’s Anti-Foreign Sanctions Law: A warning to the world,” Merics, June 24, 2021, https://merics.org/en/short-analysis/chinas-anti-foreign-sanctions-law-warning-world.

[13] Ministry of Commerce of the People’s Republic of China, “MOFCOM Order No. 1 of 2021 on Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures,” January 9, 2021, http://english.mofcom.gov.cn/article/policyrelease/questions/202101/20210103029708.shtml.

[14] Ministry of Commerce of the People’s Republic of China, “MOFCOM Order No. 4 of 2020 on Provisions on the Unreliable Entity List,” September 19, 2020, http://english.mofcom.gov.cn/article/policyrelease/questions/202009/20200903002580.shtml.