August 22 - 28, 2012
FinancialMirror.com
COMMENT | 9
Who Are Tomorrow’s Consumers? Luxury-brand companies’ stock prices plunged in July, after their financial results disappointed investors, owing largely to slower sales in emerging markets, especially in China. Meanwhile, news reports indicate that high-end shopping malls in India and China are increasingly empty. What is going on? Many analysts had expected emerging markets to generate exponential growth over the next decade. But now there is talk of how the global crisis is slowing down these economies and killing off discretionary spending. But a slowdown in China’s economic growth cannot really be blamed for slower sales of luxury goods or empty malls. The annual growth rate of China’s $7.5 trillion economy decelerated to 7.6% in the second quarter, from 8.1% in January-March – hardly a cause for panic. Moreover, two-thirds of the decline is attributable to slower investment rather than slower consumption. For all of China’s long-term structural problems, it is not exactly slipping into recession. The real problem is that many analysts had exaggerated the size of the luxury-goods segment in emerging markets. China is by far the largest emerging-market economy, with 1.6 million households that can be called “rich” (defined as having annual disposable income of more than $150,000). But this is still smaller than Japan’s 4.6 million and a fraction of the 19.2 million rich households in the United States. The number of rich households amounts to barely 0.7 million in India and one million in Brazil. The point is that developed countries still dominate the income bracket that can afford luxury goods. The explosive growth recorded by this segment in emerging markets in recent years reflected entry into previously untapped markets, with the subsequent slowdown resulting from saturation. The number of high-income households is still growing, but not enough to justify the 30-40% compounded growth rates expected by some.
This does not mean that growth opportunities in emerging markets have disappeared, but expectations do need to be recalibrated. Despite the economic boom of the last decade, China still has 164 million households that can be called “poor” (with annual disposable income of less than $5,000) and another 172 million that are “aspirant” (between $5,000$15,000). Similarly, India has 104 million poor households and 107 million aspirant households.
By SANJEEV SANYAL Deutsche Bank’s Global Strategist
The real story for the next two decades will be these countries’ shift to middle-class status. Although other emerging regions will undergo a similar shift, Asia will dominate this transformation. A study by the economist Homi Kharas of the Brookings Institution gives us a sense of the scale of this change. He estimates that 18% of the world’s middle class lived in North America in 2009, while another 36% lived in Europe. Asia’s share was 28% (after including Japan). But Kharas’s projections suggest that Asia will account for two-thirds of the world’s middle class by 2030. In other words, Asia will displace not just the West, but even other emerging regions. This is the real business opportunity. Of course, the rise of Asia’s middle class is not the only change we should expect. We are in the middle of a social and demographic shift that will both destroy and create consumer markets. The aging of developed markets is well known, but
the latest data show that emerging markets are aging at an even faster pace. China’s median age is today 34.5 years, compared to 36.9 years for the US. However, the average Chinese will be 42.5 years old by 2030, compared to 39.1 for the average American. The median Russian will be even older, at 43.3 years. The impact of aging is already being felt in these countries’ education systems. The number of students enrolled in primary schools in China has fallen by 18% since 1990, and by an astonishing 33% in South Korea. At the other end of the demographic scale, the share of the aged is growing explosively. Meanwhile, the nature of the basic consuming unit – the household – is also changing rapidly. In most developed countries, the traditional nuclear family is in severe decline and is being replaced by single-individual households. In Germany, for example, 39% of households consist of just one person. Couples with children now account for barely 19% and 22% of households in the United Kingdom and the US, respectively. Nevertheless, it is not all about consumer atomization. We are simultaneously witnessing the re-emergence of the multigenerational extended family, with as many as 22% of American adults in the 25-35 age group living with parents or relatives. By contrast, the extended family is giving way in India to nuclear families, which now account for 64% of households. All of these changes will profoundly affect the future of consumer markets. For example, we need to revise our mental image of the nuclear family from American suburbia to fit the rapidly expanding cities of India. By the same token, our mental image of the multigenerational extended family needs to include those in the West. An aging but increasingly middleclass Asia will be at the core of this new consumer landscape. © Project Syndicate, 2012. www.project-syndicate.org
China’s Next Transformation During three decades of favorable global economic conditions, China created an integrated global production system unprecedented in scale and complexity. But now its policymakers must deal with the triple challenges of the unfolding European debt crisis, slow recovery in the United States, and a secular growth slowdown in China’s economy. All three challenges are interconnected, and mistakes by any of the parties could plunge the global economy into another recession. To assess the risks and options for China and the world, one must understand China’s “Made in the World” production system, which rests on four distinct but mutually dependent pillars. The first of these pillars, the China-based “world factory,” was largely created by foreign multinational corporations and their associated suppliers and subcontractors, with labor-intensive processing and assembly carried out by small and medium-size enterprises (SMEs) that have direct access to global markets through a complex web of contracts. Starting modestly in coastal areas and special economic zones, the “world factory” supply chain has spread throughout China, producing everything from stuffed animals to iPads. The “world factory” could not have been built without the second pillar: the “China infrastructure network,” installed and operated mostly by vertically integrated state-owned enterprises in logistics, energy, roads, telecoms, shipping, and ports. This pillar relies heavily on planning, large-scale fixed investment, and administrative controls, and its quality, scale, and relative efficiency were strategic to Chinese competitiveness and productivity. The third pillar is the “Chinese financial supply chain,” which provided the financing needed to construct and maintain the infrastructure network. This supply chain is characterized by the dominance of the state-owned banks, high domestic savings, relatively under-developed financial markets, and a closed capital account. The final pillar is the “government services supply chain,” by which central and local officials affect every link of production, logistics, and financial networks through regulations, taxes, or permits. Most foreign observers miss the scale and depth of institutional and process innovation in this supply chain, which has managed (mostly) to protect property rights, reduce transaction costs, and minimize risks by aligning government services with market interests. For example, Chinese local governments became highly adept at attracting foreign direct investment (FDI) by providing attractive infrastructure and support-
ing services that facilitate the expansion of global production chains. With the onset of the current global crisis, and given dramatic changes in social media, demographics, urbanization, and resource constraints, all four pillars are now under stress. Production chains are facing labor shortages, wage increases, and threats of relocation to lower-cost countries. Meanwhile, global investors are questioning local governments’ solvency.
By ANDREW SHENG and XIAO GENG
Chinese experts are now debating a key governance question: which top-level architecture would enable the country to adopt the reforms needed to meet global and domestic pressures? Investors are concerned about Chinese equities’ erratic performance, regulatory risks, and policy surprises, as well as the uncertainties stemming from greater volatility in asset prices, including property prices, interest rates, and the exchange rate. What makes the Chinese economy more difficult to read is the increasingly complex interaction of all four of its production system’s components, with each other and the rest of the world. First, favorable conditions for the growth of the “world factory” have begun to dissipate. Production costs – in terms of labor, resources, regulation, and infrastructure – have been rising domestically, while consumption bubbles in the West have burst. Second, the early success of “China infrastructure” was built on cheap land, capital, and labor. But, despite modern infrastructure, logistical costs within China are 18% of production costs, compared with 10% in the US, owing to various internal inefficiencies. Third, the success of China’s financial system was built on state-owned banks’ financing of large infrastructure projects and foreign financing of export production through FDI and trade. The financial system has yet to address adequately the challenges of financial inclusivity, particularly funding of SMEs and rural areas, and exposure to excess capacity in selected industries.
Last but not least, the three pillars could not have remained standing without the anchor provided by the fourth. Until now, its success was based on positive competition between local governments and different ministries, benchmarked according to performance indicators such as GDP and fiscal revenues. Unfortunately, this has led to problems of social equity and environmental sustainability, which require complex coordination of bureaucratic silos in order to overcome the resistance of powerful vested interests. There is general recognition and consensus that the path of reform requires profound re-engineering of all four pillars. First, the production chain must shift from export dependence toward domestic consumption. Realigning China’s infrastructure means emphasizing quality over quantity, and reducing state ownership and controlled prices in favor of market forces. State orchestration should instead be focused on fighting corruption, reducing transaction costs, promoting competition, lowering entry barriers, and removing excess capacity. For the financial supply chain, the key is to address systemic risks and realign incentives in order to induce investors to support the engines of real economic growth, rather than the creation of asset bubbles. The Chinese miracle was engineered by institutional and process innovation at all levels of the government services supply chain. China requires nothing less than another radical reengineering to become a more balanced, socially equitable, and sustainable economy. That process has already begun with another round of experimentation through three new Special Economic Zones in Hengqin, Qianhai, and Nansha to pilot the emergence of a creative, knowledge-based services economy. Of course, such an economy relies crucially on the quality of governance. The real challenge for Chinese officials is how to balance creativity and institutional innovation with order, thereby ensuring the integrity of all four of its economy’s pillars. Andrew Sheng, President of the Fung Global Institute, is a former chairman of the Hong Kong Securities and Futures Commission and is currently an adjunct professor at Tsinghua University, Beijing. Xiao Geng is Director of Research at the Fung Global Institute. © Project Syndicate, 2012. www.project-syndicate.org