Sunday, 5 May 2013

Doing business in China, Part 2: Meeting the middle class consumer demands

The new leadership in Beijing is presiding over a period of Chinese history in which overseas investment in and purchasing of goods has seriously slowed down. The cause stems from a financial virus infecting economic systems in the Western world. The contagion threatens to collapse the European Union’s integrated economic model which is one of China’s biggest customers of cheap consumables. Beijing is now under popular pressure to provide a middle-class lifestyle for much of its desperately poor rural population to help soak up the goods it can’t sell to the Europe and the world.

China presently supports roughly one-fifth of humanity. That a single country can achieve this feat displays the enormous wealth and natural geographical benefits gifted to the Middle Kingdom. In other words, China is able to feed 23 percent of the world’s population with only 7 percent of the world’s arable land. Around 2000 people, many of them living in sub-Saharan poverty, are packed into the cultivated Chinese valleys and flood plains. China’s gift to the world was its willingness to seize the opportunity to become the source of low-cost manufacturing for the world’s developed nations. For better or worse, China became the workshop of the world.

It is a fact of the Chinese miracle that millions of Chinese families now consider themselves part of the exclusive club called the middle class. The club once was the strict domain of Western nations. That all changed when China’s speedy development from a large but insignificant backwater country into today’s powerhouse brought enormous wealth to China. Now the Chinese middle class is well on its way to becoming the most powerful social bloc on the planet.

But with great wealth also came great disparity. Over the coming decade, the biggest issue for the Beijing will be in shaping the social and economic development of nearly 800 million workers into consumers. One way Beijing is dealing with this problem is by concentrating on weakening the burdens on China’s middle class social groups and making their lives less miserable. If income inequality is not addressed it may become a significant constraint on the growth of the middle class in China, as Wang Xiaolu says: “If you reduce income inequality, you can improve domestic consumption.”

Economists tend to define the middle class in terms of income, but even here there is a wide range of definitions. A middle class is important for the preservation of social cohesion and as a source of domestic consumption to fuel economic growth. China needs both. The Chinese middle class - defined by the Organization for Economic Cooperation and Development (OECD) as those with the means to make spending decisions beyond just subsistence – is now at about 10 percent of China’s population and could be closer to 40 percent by the year 2020, and to over 70 percent in 2030.

Ideally, the middle class will act as a foundation for society. It’s comparatively higher economic status means it can bolster domestic consumption and help to sustain dynamic economic growth while naturally embracing progressive ideas and thus could facilitate gradual economic and political reform.

Of course, with social elevation inevitably comes education and access to information. Like the burgeoning middle classes throughout history, the Chinese middle class want more political engagement, but what they tend to ask for is the availability of safe food, access to good education, better health care services, and an overwhelming desire for safe air.

There is also s growing demand by China’s middle class for affordable housing. This is increasing the need to import unprocessed timber from around the world. China’s need for more houses has recently stretched to New Zealand where a Chinese government-owned company agreed to acquire part of the NZ Superannuation Fund’s North Island forestry assets.

According to a press release, Graeme Wong, Director of China Forestry Group NZ and spokesperson for the buyer said, “The parent company China Forest Group has made this investment on order to secure part of its overall demand for New Zealand logs from its own forests. This is a long-term investment and the forests acquired will be re-planted following harvest to maintain continuity of supply.” That continuity is important because China’s middle class will only grow. As in New Zealand, the priority of most middle class Chinese is home ownership. For both cultural and investment reasons, the middles class looks at home ownership as a stepping stone towards family building.

China will need many more houses in the future, but filling them might prove to be difficult. A common feeling among middle class Chinese is that affordable housing is far and away their largest burden. House prices rocketed upwards over the past decade all throughout heartland China, and especially in Beijing. Even rural areas have experienced a tripling of house prices. Mortgages for housing can consume a huge 30-60 percent of an average middle class income which not only limits socio-economic advancement it all but precludes lower classes from climbing higher on the economic ladder.

China is fostering the rise of its middle class at a time when small-to-medium sized manufacturers, China’s largest employers, are already hurting from weakening external demand, rising input costs, and limited access to state-backed credit. The central government understands that to boost domestic consumption and nurture a middle class it must raise wages, but doing so will intensify the financial burden on already struggling manufacturers and local governments and could trigger a premature collapse in the manufacturing sector. This phenomenon would be a shuddering form of the middle income trap.

The increasing need to divert emphasis from an overreliance on exports and state-led investment towards greater domestic consumption is driving Beijing’s economic policies. Chinese middle classes are growing but they might not be growing as fast as Beijing requires. China has by far the lowest domestic consumption rate of any major economy. In 2012, household consumption expenditure as a portion of gross domestic product barely nudged 37 percent. Two countries with comparably low domestic consumption are Bhutan and Luxembourg, neither one is a healthy comparison for an ambitious global power. To underline this point, the United States’ domestic consumption equals 72 percent of gross domestic product.

Creating a consumer base in China should be simple when a middle class expects to receive 5000 to 30,000 Yuan each month, depending on the region. However, with high prices for housing, mounting living and educational costs, and a weak social welfare system the Chinese middle class are the least happy social group and feel the least secure financially.

Another major burden on the rising middle class is, strictly speaking, their parents. The demographic effects of China’s one child policy have dumped care responsibility of up to four elders on the shoulders of a single Chinese worker. Exacerbating the pressure on middle class families is a lack of a robust medical network and few pension programs for retired workers.

The aged in China, along with the poor, are requiring more and more tax income to support. This money can only come from an employed middle class. Beijing’s previous attempts to decrease the pressure on China’s middle class have only reshuffled the deck without truly addressing the complaints of an over-burdened social group.

But there is light at the end of the tunnel. Even with household savings restraining the effect of a sustained increase in GDP per capita, Chinese household consumption has increased, year on year, by around eight per cent in the past two decades. As the country evolves from export-driven ideals towards greater domestic consumption, Beijing may be starting to understand the importance of supporting its middles class social groups. But how much of this does the leadership understand?

China risks stagnation of its GDP growth if the middle class does not rise to an adequate percentage of the population. However, the emergence of a robust middle class is threatened by considerable income inequalities and an unfair playing field. Avoiding the dreaded middle income trap will be key to Beijing’s economic plans.

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