Fears about China’s slowing economy are overblown, authors Jeffrey Towson and Jonathan Woetzel argue in their new book, The One Hour China Book. (Both are professors at Peking University’s Guanghua School of Management in Beijing. Towson does private equity, mostly U.S.-Asia and Woetzel has been in Asia over 20 years and founded McKinsey’s Shanghai office in 1994. Woetzel has been called the “national archive of China business” and has run hundreds of CEO-level consulting engagements across China.) Despite rising incomes and three decades of over 10% GDP growth, Chinese consumers have not started spending. But, this is about to change in a big way. Household incomes are rising. Discretionary spending is expanding and China’s wealthy are among the world’s most underleveraged consumers. Brace yourselves—a great wall of Chinese money is about to hit the rest of the world. (Imagine how epic the fight for one billion Chinese consumers will be! The competition will be ruthless and the dynamics complex and volatile because the Chinese government will intervene frequently as an active player and sometimes as a competitor. Understanding which companies will capture these consumers is a complex and ever-evolving story—one we will follow closely going forward.)
Until now, China’s growth has been based on savings, investment and exports. As a result, consumer spending has looked small. Chinese consumption decreased from approximately 51% of GDP in 1985 to 43% in 1995, 38% in 2005, and 34% in 2013. By comparison, consumption is around 61% in Japan and about 68% in the U.S.
China’s small and decreasing consumption percentage is one reason why people keep talking about the need for “rebalancing”. But, Woetzel and Towson maintain that the numbers need to be considered from a different angle.
"First, from 2000 to 2010, the size of the Chinese economy more than doubled. So consumption grew from around $650 billion to almost $1.4 trillion. Regardless of its relative percentage of GDP, China’s consumption has been growing faster than just about any other country’s in absolute terms. Second, just getting consumer spending back to 43 percent of GDP, the level in 1995, would have a huge impact on “rebalancing.” It would also create the largest consumer market in the world."
Household income is key—without it there can be no spending. As the authors report: “China’s household income is huge. It is now likely above $5 trillion a year. Plus, lots of income is unreported, so this is really the lower boundary for true household income.”
Another key factor is the dramatic increase in discretionary spending. “Chinese citizens are now moving beyond being able to only afford the basics of life, and their discretionary spending is taking off,” the authors report, noting that Chinese have a strong appetite for everything from entertainment, to skiing, and to cafe lattes. This rise in discretionary spending has been growing 7% a year from 2010 to the present, and is expected to do so going into 2020. This is in contrast to spending on necessities, which is only growing 5% per year.
Most of the new spending is coming from the Chinese middle class, a group that really did not exist 10 years ago. (The authors define these middle class households as those with over $10,000 in annual income.) The most important consumer demographic in China today, this group is overwhelmingly an urban phenomenon. But, as the authors stress, “urban” is not exactly the same as cities.
"Most income (and therefore consumer spending) will not be in the big cities like Shanghai and Beijing. It will be in smaller cities because there are a whole lot more of them. A city with a 500,000 population is small by Chinese standards and there are about 600 of them. In the U.S., there are about 30.
. . .What we really have emerging in China today is rising middle class households living in linked “urban clusters”. These urban clusters each have 30-80 million people and 10-60 linked cities. And each cluster is about the size of a big European country."
At the same time, a critical new demographic tagged by McKinsey as “mainstream consumers” is also on the rise. As the chart indicates, this new group, which has household incomes of $16,000 to $34,000, represented just 6% of urban households in 2010. But by 2020, it will soar to 51%—an annual growth rate of approximately 26%.
Elaborating on the significance of the “mainstream consumer”, Woetzel and Towson write:
"To date, much of the China consumer story has been about “value” consumers. These are consumers with household incomes between $6,000 and $16,000 per year. And they tend to care most about getting good value for their money. They want a low price. They want acceptable quality. And they are pragmatic, as opposed to emotional. As the new mainstream group emerges, this value group is going to decrease from 82% of urban households in 2010 to only 7% by 2020."
The distinction between value and mainstream is important. What is really happening is a big upgrade in lifestyles and a shift of priorities. They are shifting from buying the basic necessities of life, such as housing, food and healthcare, to more discretionary purchases, such as cars, overseas trips and lattes. This new mainstream population can afford homes, cars and some small luxury items. They care about quality and experience, not just price. They save less and are willing to pay brand premiums. They also shop online a lot. By 2020, the number of mainstream consumers will be 400M, comprising about 167M households.
China’s affluent is also the world’s most underleveraged consumer. As the authors report: “Less than 50% of homes purchased in China use leverage. And overall household debt to income is less than 50%. While this has recently increased significantly, it is far less than the 90-110% seen in the U.S. So they have a lot of unused spending power in reserve.”
Meanwhile, a growing number of Chinese women are delaying marriage and motherhood and joining the workforce. A 2012 McKinsey study found that female participation in China’s workforce is now 76%, well above the 33% in India and the 58% in the U.S. Chinese women tend to be more financially ambitious than women in other countries, keen to advance their career and earning potential. As the authors report: “Basically, Chinese women have more money to spend before they marry and they often become the primary financial decision-makers after marriage.”
Finally, China’s affluent is also supremely confident about his or her future—an intangible that will propel consumption. Over 70% of this cohort believes their incomes will increase significantly in the next 5 years, compared with less than 50% in the U.S. Their optimism is well founded given the 10% annual uptick in urban income for the last decade.
The authors end the books with a final macro story, which speaks to the magnitude of Chinese consumers and their increasing impact on the world:
"In May 2014, a group of Chinese tourists took a one-week organized trip to Los Angeles. They flew from China, stayed in hotels and traveled around seeing the sights in tour buses. What was interesting about this particular tour group was that it had over 7,000 people. They boarded 86 planes in China, occupied 26 hotels in Los Angeles and traveled around in 160 buses. They also apparently had some fun descending on various locations en masse."
When was the last time you passed a caravan of 160 buses on the freeway? Now extrapolate this out 5 or 10 years. This one billion person “upward transition” will only happen once and it may end up being the most important event of our time.