Chapter 6. China: Ready for Prime Time

In 1975, the U.S. television network NBC created a program of skits aired on Saturday nights that came to be known as Saturday Night Live. The program featured a cast of talented comedians known as the “not ready for prime time players.” These comedians were initially relegated to a bleak, late Saturday night timeslot that was all but ignored, but they beat the odds and went on to become legends in their craft. Over time, these original cast members and later cast members benefited from their growth in the entertainment industry through movies and their own television shows, rather than remaining confined to their live skits on Saturday nights. In many respects, if we trace the rapid ascent of the Chinese economy from its opening up in the 1980s under the leadership of Deng Xiaoping, we can find similarities between these two phenomena. China, although widely watched and even admired for its economic progress in the past couple of decades, has continually been cast as the economic version of the “not ready for prime time players.” That is, up until the global financial crisis of 2008 and 2009. In the years following the crisis, the world will continue to see more of the Chinese influence turning up in the prime-time slots of the global economy that had been previously dominated by the United States, Europe, and Japan.

To grasp why the financial crisis marks an inflection point in China’s modern history, we need a brief and modest historical context. Broadly speaking, during the past 4,000 years, China has developed a relatively continuous national identity. Perhaps due to the Confucian principle of studying history, many Chinese can appreciate their country in a larger historical context. Many understand that approximately 300 years ago China, alongside its Asian neighbor India, controlled 60% of the world’s GDP. In the 300 years that followed, paced by the Industrial Revolution, the world seemingly reversed hemispheres as it came to be dominated by the Western nations of Europe and the United States. These countries leveraged their industrial capabilities into military and commercial power. Meanwhile, during the twentieth century, as Western society achieved its heights, China suffered one setback after another. Invasions, occupations, civil war, political upheavals, natural disasters, famine, persecution, civil strife, and widespread poverty were all part of the Chinese experience of the twentieth century. In the time continuum of Chinese history, the majority of the twentieth century represented a low point. Even so, the fabric, national identity, and pride of the Chinese never wavered. Late in the twentieth century, Deng Xiaoping eventually assumed leadership of the country after the passing of Mao and the political defeat of his cronies in the late 1970s. He undertook the difficult chore of rebuilding China from decades of institutional mismanagement. In his search for answers, he examined several other Asian nations that had successfully constructed powerful economies, widespread prosperity, and peaceful, law-abiding environments that were still thoroughly controlled by their respective governments. Deng found in his travels and research that he wanted China to model itself after Singapore, South Korea, and Japan. In particular, he pointed out Singapore as the model China would both emulate and, in his mind, improve upon. The surprise of this one-time communist revolutionary singling out Singapore—Asia’s most sparkling example of the success of free-market enterprise and capitalism—as the model for China’s future cannot be overstated. Upon closer inspection, however, the Singaporean model was a natural fit for Deng and China. For starters, at one time Singapore was itself a microcosm of China when Deng came into power. In the 1960s, Singapore was a city-state that, after breaking off from Malaysia in 1965, basically had to find its place in the world. It did so by embracing the Western ideals of free markets, property rights, and capitalism in an attempt to join the global economy. Incidentally, this plan not only worked, but worked on an unprecedented scale. Importantly, based on the public accounts of Singapore’s original Prime Minister, Lee Kuan Yew,¹ Deng was impressed with the use of the capitalist model to create widespread home ownership, especially in the context of an authoritative government and large presence of ethnic Chinese (77% of the population). China was in a similar situation in the late 1970s when Deng came into power. It had been cut off from the rest of the modern world for half a century under Mao and was starting from scratch in a world that had left it behind. China too had to find its place if it were to restore its once-powerful place in the world order. According to Yew, after Deng’s 1978 visit to Singapore, he left to return to China with the comment, “You made use of capitalism to build a more egalitarian society; everybody owns their own home. I will do the same.”² As we now know, Deng returned to China and set his country on a path toward unparalleled economic growth. Productivity ascended from an exceptionally low economic base following decades of neglect due to social chaos and Maoist economic blunders. In the decades that followed, this growth accelerated and began lifting hundreds of millions of people out of poverty. This was based on the simple Asian tiger model of export-led growth, emphasis on education, and high savings rates. We also must recognize that although China embraced capitalism, it fashioned its own form of capitalism to meet Chinese ideals, rather than forcing the Chinese into an entirely Western model of society that includes democracy. In other words, China has possessed a long-standing backdrop of central authority, including both the Communist Party and the succession of dynasties leading up to the communist takeover. Although we should think of China as capitalists, the influence of government policy should continue to play a role in this growth.

A Culture Well Suited for Capitalism

Irrespective of government influence, the ancient Chinese saying that “The hills are high and the emperor is far away” remains in effect. Despite the central authority, the Chinese are also accustomed to self-reliance. In this regard, capitalism has been a natural fit for the Chinese. It assimilates nicely with Chinese customs such as thrift that have been around for thousands of years. The simple fact is that the Chinese possess such a high savings rate because it is embedded in their culture. China, unfortunately, is a vast expanse of land that has been prone to some of the worst natural disasters ever recorded, as measured in the number of fatalities. Earthquakes, floods, fires, and famine have occurred often enough over time in China that they have been remembered, recalled, and warned against from generation to generation. To provide some perspective, we can see from U.S. Geological Survey earthquake data that China’s history is littered with well-recorded events of natural disasters that exacted horrific death tolls. See Table 6.1.

Table 6.1. China’s History of Major Recorded Earthquakes

As bad as these earthquakes have been, China’s history of devastating floods is equally shocking. Home to two of the world’s longest rivers, the Yangtze and the Yellow, China has always been plagued by floods. It is believed that throughout China’s history, the Yangtze River has flooded over 1,000 times. But in spite of this track record, it must concede the title for the most severe floods to the Yellow River, which has become known among outsiders as “China’s sorrow.” For instance, in 1887 the Yellow River flooded and took the lives of an estimated two million people. In 1931, a flood from the Yellow River is believed to have taken four million lives. In 1938, another million were lost to flooding from this river. Taking into account these shocking records of natural disaster, and China’s tremendous land mass, it has always been difficult for the central authorities to respond to these events in any sort of timely fashion. In the past, without motorized craft, routes were buried underwater, thus preventing travel. Over centuries of these collective experiences, the Chinese have conditioned themselves to prepare for catastrophe. Back in the time of imperial dynasties, this behavior was manifested in the form of searching for high ground on which villagers could stockpile grains and other provisions for when a flood eventually arrived. In modern Chinese society, based on the exchange of currency for goods and services, this behavior manifests itself through a high personal savings rate, as shown in Figure 6.1. Instead of floods and earthquakes as their primary concerns, though, the Chinese are more focused on saving for healthcare and retirement, to name a couple categories. The Chinese save for a number of practical reasons, but a large portion of this behavior ties back to a conditioned anxiety and a healthy respect for the risks tied to future emergencies.

Figure 6.1. China’s household savings rate

Source: Asian Development Bank

The point of this discussion of history and culture is to provide a context for what is occurring in the aftermath of the financial crisis. Since the Chinese moved into the global village of commercial trade and have been assimilating themselves into the world’s business scene since the 1980s, they have been well prepared for the metaphorical flood that nearly wiped out entire developed-market economies. In other words, China’s long-standing habit of preparing for calamity has served it extremely well in the capitalist system. For that matter, the behavior held in common among the most astute capitalists ever known in the West has been a common practice of thrift coupled with a sharp eye for opportunity in the wake of a crisis. The Rothschilds, Pierpont Morgan, Sir John Templeton, Warren Buffett—all these financial legends have practiced the art of possessing heavy savings that were ready to be deployed in the wake of a financial calamity. In this regard, as the capitalist system was shaken to its core in late 2008, China was safe from financial ruin. Now the country is realizing the rewards that flow to a saver when nearly every asset in the world goes on sale, all at once. So, just as all these capitalists increased their fortune in the wake of a crisis, China will do the same.

Putting Those Rainy-Day Savings to Work in the Worst Storm of the Past Century

The relevant question that follows is this: What will China buy with its massive hoard of rainy-day funds? Activity through the first three quarters of 2009 has left little doubt that China, a country hungry for commodities, has been gorging in the natural resource space. The country is interested in this space for many reasons. Rather than parade all the data points on China’s voracious consumption of copper, iron, oil, cement, scrap metal, and so on, suffice it to say that China is bereft of natural resources. It must import large amounts of these materials to continue growing its economy. During the years that led up to the financial crisis, China was beginning to feel the pain of requiring these materials in the midst of relatively limited supply and competing demand from other countries. These economic tensions were on vivid display in the iron market during the years leading up to the crisis. China basically had to accept whatever pricing the Western-controlled, three-firm oligopoly of BHP, Rio Tinto, and Vale imposed. This record of steeply rising iron ore prices, which China had little choice but to accept, was punctuated by an 86% increase negotiated for 2008, as shown in Figure 6.2.

Figure 6.2. Year-over-year iron ore price increases

Source: Oligopoly Watch; Ministry of Commerce, People’s Republic of China

China has spent heavily on mergers and acquisitions (M&A) in 2009. This is unsurprising in light of what happened in the years prior to the financial crisis and global recession. Another factor was the subsequent collapse in commodity prices that precipitated sharply lower valuations and even some financial distress among the companies in this space. Nor is it surprising to find that the bulk of the major transactions announced by Chinese firms have occurred in the natural-resources space, with a handful in iron ore companies. Table 6.2 and Figure 6.3 show the sharp decline in commodity prices as defined by the CRB commodity index, as well as the subsequent M&A transactions by Chinese firms.

Table 6.2. China’s Buying Spree by Major Deal Announcement Through the Third Quarter of 2009

Figure 6.3. Reuters Jeffries CRB commodity price index from 2008 through the third quarter of 2009

Copyright 2009 Bloomberg Finance LP

Based on the evidence so far, China has executed the role of an opportunistic capitalist close to perfection. This statement also is based on the strong probability that these types of transactions will continue underpinned by China’s lack of internal natural resources, combined with its $2 trillion war chest of foreign exchange reserves. In short, China has used the financial crisis as an opportunity to improve on what had been a key weakness for a country in great need of natural resources but possessing few of its own.

Urbanization Is the Growth Engine

This still leaves the question, What does China want with all these natural resources? The answer leads us into the heart of our discussion. China is in the midst of a multidecade construction of an economy that more closely resembles the developed world. To accomplish this feat, the Chinese are constructing numerous cities to house all the migrants who have yet to enter its developed economy from the countryside. To construct these cities and hopefully show its lower-income citizens a new, modern way of life, China must have access to all the raw materials that are necessary to build up a city, such as cement, steel, alloys for steel, iron, aluminum, and copper. Without access to these materials, the construction projects will slow, and the country’s rapid ascent to prosperity will sputter. Taking this knowledge, we can easily surmise that the significant bull market in commodities that occurred prior to the financial collapse has plenty of cause to resume in the coming years, and likely will. Despite the large run in commodity prices from the early 2000s through 2008, and all the economic incentive to expand mining production in copper, bauxite, and nickel, the havoc wreaked by the crisis through a commodity price collapse and tight credit stopped and in some cases reversed these mining expansions. As compelling as the commodity space may be, those discussions are saved for the chapters on protein and agribusiness, as well as oil and energy. This discussion instead focuses on the urbanization trend in China as it relates to the country’s domestic economy, and the manifest opportunities that will be presented to investors over the coming five to ten years.

Before we jump into the areas that investors will want to consider as they look for opportunities presented by the growing middle class of Chinese consumers, let’s quickly look at the size of the opportunity at hand. Chinese President Hu Jintao stated at the 17th Congress that he would like to quadruple China’s per capita GDP by the year 2020 from its 2000 level.³ This means that the standard of living in China is targeted to continue growing at just over 7% a year in the coming decade. The simplest way to replicate the growth of the past twenty years over the next ten is to keep doing what you have been doing. What the Chinese have been doing is relatively straightforward: They continue to incentivize the migration of citizens out of the countryside and into the urban centers. This recipe for economic progress has been cooking since the 1980s. In 1980, only 190 million people, or 20% of the population, were living in cities. But by 2000, this number had increased by 270 million, or to 36% of the population, based on World Bank estimates. As this migration has happened, the standard of living has risen sharply for the new urbanites as they are effectively assimilated into the global economy through China’s trade and local domestic businesses. The simple fact is that city-dwellers in China have incomes that are more than three times as large as rural inhabitants, as shown in Figure 6.4.

Figure 6.4. Urban and rural per capita incomes in China

Source: China Statistical Yearbook

Because about 46% of the population in China is urban, it is easy to see that the rural workforce has latent capacity and that this proportion can and will change in the coming years. In fact, based on estimates by the consulting firm McKinsey,⁴ China’s urban population already accounts for 75% of the country’s GDP. This means that there is ample incentive to grow this economic engine and reduce the slack in the economy from the less productive rural areas of China. The same study from McKinsey estimated that by 2025, well over 926 million people will live in China’s urban centers, or an additional 350 million from the 2005 level. With two current megacities of more than 10 million people, these estimates suggest that six more cities of this scale will emerge in the coming 20 years. By 2030, 1 billion people will live in China’s cities, or over 60% of the population. Likewise, the World Bank estimates that by the year 2020, China will have between 70 and 100 cities with over 1 million inhabitants. These numbers are staggering by developed-market standards. For all intents and purposes, the Chinese are in the process of constructing a new urban population over the coming 15 years that is greater than the entire population of the United States. As this demographic shift continues from the rural areas to China’s cities, it will bring with it new markets and a need for new goods and services to match urban consumption patterns. Again, the scale for urban consumption trends presents a large market opportunity. We are talking about adding an urban market that, based on the earlier McKinsey projections, represents a level of aggregate consumption that will be twice the size of Germany’s entire economy by 2025. So although all this urbanization will drive continued demand for commodities and raw materials for infrastructure construction, the real sea change and new opportunity will unfold in the emergence of increased consumerism.

The Path Toward Consumerism and the Domestic Economy

Of course, before we make over the Chinese economy into a nation of spenders, we must address the long-standing tradition of Chinese saving. This phenomenon represents a perceived speed bump of sorts for Westerners who associate consumerism with the runaway levels of spending that have been witnessed in developed markets, such as the United States, during the past few decades. We should not expect the Chinese to ditch their custom of thrift anytime soon. But it is entirely reasonable to suspect that as the economy develops, these citizens might save less than their current run rate, while still maintaining ample financial security and long-standing customs. The government also wants to direct the nation toward a larger domestic economy. Therefore, one initiative it is pushing is to strengthen the country’s social security system in an effort to alleviate fears and induce less saving and more consumption. The prospective success of these efforts remains to be seen, but other trends may also precipitate less anxiety and more consumption. One development comes from the private market, where the growth in insurance products has been remarkably high, thanks to the low base of penetration and continued popularity. Insurance products and the companies that provide them in China play a significant role in the development of higher consumption levels since they effectively take over the traditional role of self-insurance from the Chinese household. In other words, rather than the Chinese household keeping cash deposits at the bank as reserves against life events related to health, retirement, or death, instead they can purchase an insurance product that accomplishes the same. In turn, this method frees up additional current income for consumption purposes, or saving for other items. Importantly, the scope of continued growth in the Chinese insurance market is easily recognized, with insurance premiums in China representing 3% of GDP compared to 10% to 12% in the OECD countries. Additionally, the insurance industry in China has become a growth market, with 95% controlled by three Chinese firms: China Life, Ping An, and China Pacific. Thanks to financial products such as insurance, there is additional room for the savings rate to loosen up through these private-market solutions. Aside from a stronger safety net from the government and private-market solutions, some of the high savings rate may erode from its current levels based on demographics.

Another factor is the growing generational divide between the adults who lived through the establishment of the People’s Republic and the Cultural Revolution, and the most recent generation. They are products of China’s one-child policy and are known as “Little Emperors” or the “Me Generation.” Based on available reports and surveys, a generational divide has appeared between the country’s older citizens, who survived Mao’s China, and the new generation of single-child youths. They have been exposed to advertising, branding, multiculturalism, rock and roll, hip-hop, video games, and everything else the consumer companies can throw their way. The society of the Me Generation has been loaded with consumer stimulus since it grew up alongside Deng’s globalization beginning in 1980. Because this culture is littered with only children, these young people are accustomed to receiving attention and gifts from their parents and grandparents. The urban youth of today have departed from the over-50 crowd insofar as they have not engaged in politics much, whereas the lives of their parents and grandparents were dominated by epic political battles and civil strife. Instead, the young Chinese of today are far more tuned into the good life that globalization has spawned, including the prevalence of consumer technology and the ability to travel. The emphasis that the Me Generation places on material goods among their top purchasing priorities is widely reported on an anecdotal basis. It’s also revealed in statistical surveys, such as MasterCard’s Worldwide Index of Purchasing Priorities. In the most recent available survey conducted in China for the first half of 2009, the disparity between consumer habits for Chinese older than 30 versus those younger than 30 was clear. For instance, measuring the top three categories for purchasing priorities, the survey showed that, for fashion and accessories, 71% of the crowd below 30 prioritized this expenditure versus 59% in the above-30 crowd. In the consumer electronics category, a similar trend was apparent, with 73% of the respondents younger than 30 prioritizing this purchase versus 51% in the above-30 group. Further evidence of the Me Generation’s relative tilt toward consumerism versus their parents and grandparents can be seen in the overall sophistication of the Little Emperors in the marketplace. This demographic has gained a reputation for brand awareness and being attuned to quality, and they obtain their knowledge through heavy online research and social networking, including blogging on products. Surveys among young shoppers suggest that 70% of Chinese youth use an Internet search engine before making a major purchase. This behavior is not surprising, because the youth in China spend far more time on the Internet than even their American counterparts. According to several estimates, young people in China spend approximately 20 hours per week on the Internet versus just 12 hours for the same age group in the United States. Taking these factors into consideration, the young shoppers of China are far more inclined to shop online as well. Based on recent surveys from MasterCard, 15% of Chinese people under the age of 30 perform 10% to 20% of their shopping online versus 6% in the above-30 age group (see Figure 6.5).

Figure 6.5. 10% to 20% of shopping is conducted online

Source: MasterCard Worldwide Index of Purchasing Priorities

These data points underscore a demographic trend in China in which the youth are far more comfortable, if not altogether obsessed, with technology. Recognizing trends such as these is critical for consumer goods companies that hope to sell or expand their businesses in China. It is widely forecast that much of the rapid growth in future urbanization may occur in what are called “second-tier” cities in China. The largest cities will increase too, but at a slower rate. When speaking of tiers, some disagreement has arisen over how to classify Chinese cities. In general, the first-tier cities are the four largest: Beijing, Shanghai, Guangzhou, and Shenzhen. The second-tier cities include the province capitals, and the third-tier cities include big, economically developed cities in the provinces such as Qingdao and Xiamen. We should exercise some caution in respect to the terms “second tier” and “third tier” when applying a Western perspective, because some “towns” in China hold three quarters of a million residents. Irrespective of what they are called, these smaller cities by Chinese standards have been growing faster. In particular, their retail sales growth has been outpacing growth in the first-tier cities by two to three percentage points during the past several years.

More growth has occurred in the second- and third-tier cities because these consumers start from a lower economic base. The first-tier cities, while still possessing very low per capita incomes by developed-market standards, are saturated with people. For that reason, the second- and third-tier cities will see better growth from people migrating out of the countryside, as well as an upward drift in their own per capita income levels toward the first-tier levels of income. For these reasons, and nationwide growth in consumerism notwithstanding, the second and third tiers should continue to see higher rates of growth. This has important implications for consumer companies and the investors who would like to own their shares. First, the second- and third-tier cities are less globalized and, therefore, less export-driven than the first-tier cities in many cases, which in turn means that their economies are more domestically led. This presents an opportunity for a consumer goods company, but it can also make the waters a bit trickier to navigate due to the less multicultural influences and stronger native Chinese taste preferences. In this regard, although the growth in these markets is promising, it is even more essential that companies understand their markets and consumer tastes. These distinctions are important for all consumer goods companies—in particular, for the Western multinational firms that are attempting to sell into these markets. For Western firms, the challenge can be even more daunting, because customs and taste preferences can vary by province and region. Some examples of Chinese taste preferences and how they may substantially differ from Western preferences can be most clearly seen in the grocery aisles. The first significant difference a Western food executive might find is that the Chinese are obsessed with fresh products when it comes to food. If you walk into a Walmart in China, you will find many of the customers crowding around large open-air fish tanks going after live carp, eels, and crabs with handheld nets. This may seem odd from a Western perspective, but Walmart would be unable to sell its fish in filets behind glass. The Chinese insist on freshness to the point of personally obtaining their fish and having it cleaned live, right before their eyes. This process might be too much for the American soccer mom, who desires considerably less knowledge of the preparation process. Likewise, Westerners might be confused by the large open case of turtles crawling over each other. But if you want to attract food shoppers in China, it is important that they can get the necessary ingredients for the traditional dish of turtle soup. Want to sell skin moisturizer in China? You would sell more if it contained sheep’s placenta. The point of these illustrations goes beyond highlighting distinctive consumer preferences among the Chinese. It shows that for a business to be successful in the consumer market, it is imperative to understand the Chinese consumer. In this respect, and from what we can easily see in the local practices of Walmart, a large Western multinational (or any firm, for that matter) cannot waltz through the Chinese consumer market without first studying and adapting to local tastes and preferences.

For the reasons discussed, it is easy to appreciate that when it comes to selling products to the Chinese consumer, local firms that understand Chinese tastes and customs have an edge. The good news for all competitors in the Chinese consumer market is that these purchasers prize quality above all else and have no qualms about paying more for premium products. Because of these behaviors, the market is indeed open to all competitors rather than only local Chinese companies. Evidence of meritocracy in the Chinese consumer is abundant in light of consumer surveys on branding in China. As it turns out, the Chinese are not against Western products, but the products must be of good quality to attract their discretionary income. Another positive sign for Western consumer goods firms is that perceived quality of American-made goods is high, especially among the younger demographic, who represent the key opportunity for consumption. Judging from the results of surveys conducted by Gallup, 44% of Chinese citizens aged 18 to 24 rate the quality of American goods as excellent, compared to only 22% for Chinese-made goods (see Table 6.3).

Table 6.3. Ratings of Goods Manufactured by the Chinese

This perception carries through into even more tangible measures that survey individual brand names and their ranking among the Chinese. Table 6.4 shows the first 25 names from a consumer survey conducted in China by the Asian-focused brokerage firm CLSA, which polled for the top 100 brands. In light of the earlier taste preferences we mentioned, it might be surprising that many firms outside China are on the list, including a good many Western names, such as Coca-Cola, Nokia, and Nike.

Table 6.4. Top Consumer Brands in China

Table 6.4, and its inclusion of iconic Western brands, underscores a few simple threads of consumer behavior in China that are important to grasp. The first important realization is that the Chinese are obsessed with brand names. The second is that the Chinese utilize the personal display of these brand names as the most visible outward manifestation of their success in business and having achieved a higher income. In other words, although the Chinese are savers, they are also materialistic, and high-quality brand names are status symbols. The purchase and display of premium brands represent aspirational consumption that serves as a calculated projection of one’s standing in society to other Chinese.

Prime-Time Products

Given our better understanding of the behavior of Chinese consumers, including their tastes and preferences, we can now turn our discussion toward the actual products they are consuming. We also can look at some of the consumer goods that investors may want to target as areas of growth for future consumption. We can consider this discussion in two ways. We can assess what consumers profess to purchase or even plan to purchase from a discretionary perspective. We also can assess what we can expect consumers to purchase in the context of increased urbanization. In other words, we can look at this equation from what consumers want to buy and what they do buy as they move from rural to urban areas.

Beginning with the discretionary discussion, the Chinese consumer is nearly rabid for consumer technology, including cell phones, computers, televisions, and music players. In many cases, it is not unusual to see these purchases come before household appliances such as refrigerators, microwaves, and vacuum cleaners in order of importance for planned purchases. As you can see in Table 6.5, as shown in a Gallup poll, Chinese consumers aged 18 to 24 ranked purchasing a cell phone above all other categories, as did consumers aged 25 to 29. Perhaps not surprising in this context, the poll also found that more Chinese households owned computers than vacuum cleaners. In keeping with our earlier comments, the cell phone is yet another product where Chinese consumers often try to distinguish themselves with a premium product. This device is a status symbol in China, as are the brand and model within the product category. In fact, a 2008 study by McKinsey⁵ found that young Chinese consumers are sometimes willing to pay as much as three times their monthly income for the latest cell phone. Finally, young Chinese are also believed to upgrade or switch their cell phone every 9 to 12 months, versus their developed-market peers, who average 18 to 24 months.

Table 6.5. Plan to Buy in the Next Two Years

With all this emphasis on technology, it should be unremarkable that online shopping in and of itself is an important consideration when discussing the Chinese consumer. We already know the Internet usage habits of young Chinese people and their 20-hour-per-week habit. We should also point out that approximately 145 million of these users are registered with TaoBao, the most popular online shopping site in China. Online shopping in China is a growing secular trend that has been helped in part by better connectivity between Internet users and retailers. Despite all China’s infrastructure spending, its roads to some second-tier cities are still poorly developed. These physical impediments make establishing an already difficult distribution system even harder for retailers that don’t have a local presence, but online shopping has helped bridge this gap. In this respect, online shopping circumvents the lack of physical retail presence that many firms possess in the second- and third-tier cities. Additionally, the Chinese are open to shopping online to obtain the item they desire. Online shopping is also important to meeting the Chinese consumer’s need for market research on a particular product before making the purchase. This pursuit of market research and demand for technology devices coalesce in a detectable appetite for information and the speed at which information can be delivered. In the Gallup study shown in Table 6.6, Chinese people aged 18 to 24 consume more information across more media and also record far higher exposure and access to the Internet.

Table 6.6. Media Consumption in China

These discretionary trends are interesting in the ranks of the Me Generation, and so are their implications for future consumer purchases over the coming five to ten years. We can also appreciate that when a consumer relocates from a rural environment to an urban setting, certain new consumption patterns may also follow. Table 6.7 shows the tremendous disparity between goods and services that are owned by city dwellers versus rural citizens of China.

Table 6.7. Ownership Among First-Tier Cities and Rural Chinese

In Table 6.7, it is not hard to see that within large cities such as Beijing, ownership levels of some specific goods such as cell phones and even computers start to resemble developed-market benchmarks. This is supported by two phenomena: the higher level of income that accompanies urban residence in China compared to rural income levels, and the commonsense necessity of some of these items when living in a faster-paced urban environment filled with modern businesses. One product that stands out in particular is the low number of automobiles owned in both environments. This category has tremendous room for growth across the board in China as its standard of living rises over time. For example, when measured by automobile ownership per 1,000 people in China, approximately eight people own cars, compared to 750 in the United States.

Irrespective of the potential, and China’s emergence in prime time, it remains a work in progress. The long-term picture is promising, but to be clear, there are always bumps along the way in any developing nation’s progress. The prospects for future turbulence in the country’s financial or real estate markets as China comes of age should not be disregarded. At the same time, the occurrence of these events are always the case rather than the exception, as we witnessed during U.S. development suffering through a depression and the Asian Tigers who were temporarily sidetracked by the Asian Financial Crisis. The key question an investor must consider, though, is how he will take advantage of similar events should they unfold in China. In the prior cases of the United States and the Asian Tigers, investors were heavily rewarded for purchasing stock in the wake of these events or, as we say, at a point of maximum pessimism. With that said, should one occur in China, the same rewarding results may likely hold.

In any event, over the coming several years, China will have an important opportunity to leverage its strong potential for growth and its record of financial prudence into even greater economic rewards and higher standards of living. In short, the country is entering a phase of its economic progress that will continue to shift toward increasing levels of domestic demand and consumerism. One key will be the steady push by the central government to continue opening its economy to greater globalization and transparency. Nothing has done more for this country to date than its leaders allowing its people to enter global trade and compete with the rest of the world. We can take comfort in the fact that the Chinese understand this reality well. In an early 2009 interview with the Financial Times,⁶ Chinese Premier Wen Jiabao quoted in admiration the wisdom of a Western economist whose teachings had impacted more Chinese people than any other economist in history. This economist was not Karl Marx, but Adam Smith.

Endnotes

¹ Lee Kuan Yew. Interview by Charlie Rose, October 24, 2009. The Charlie Rose Show.

² Ibid.

³ Xinhua. “Hu sets goal of quadrupling per capita GDP under environment, resource restrictions.” http://english.people.com.cn, October 15, 2007.

⁴ McKinsey Global Institute. “Preparing for China’s urban billion,” March 2009.

⁵ Insights China. Annual Chinese Consumer Survey 08. McKinsey & Co.

⁶ Lionel Barber, Geoff Dyer, James Kynge, and Lifen Zhang. “Interview: Message from Wen.” Financial Times, February 1, 2009.