China's Consumer-Focused Transformation

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China

After decades of growth based on a booming exports business, China must make a difficult transition from an export-driven economy to a consumer-driven economy.

Consider that in February, China imported $146 billion worth of goods, an increase of 40 percent compared to the same month a year earlier.1 Meanwhile, its exports went up only 18.4 percent, to $114.4 billion. In other words, the country that built the world’s second-largest economy by running massive trade surpluses actually posted a trade deficit of more than $30 billion for the month.

With worldwide demand growth for its exports slowing, China has no other choice: It must focus on building a strong domestic market for the goods it produces. By creating a huge consumer class within its own borders, China won’t need to rely entirely on exports for economic growth or political stability.

Let’s first discuss how China can make the transition from the export-driven model to a consumer-driven model. Then we will examine how businesses should target the new Chinese consumers.

While this transition is inevitable, the question is how China will make the transition without a hard landing that will disrupt the global economy.

To understand China’s limited range of options, it’s important to realize two critical facts about its economy. The first critical fact is that consumption accounts for only a relatively small share of China’s Gross Domestic Product. China has an extremely high savings rate because its culture encourages people to save rather than spend. Because interest rates on savings are tiny, the effect is that its economy has come to rely on cheap capital for its growth: The government takes the money that its population saves and invests it to fuel growth in the country’s GDP.

As a result — and this is the second critical fact — China has built a mountain of internal debt that many observers believe is unsustainable. According to Michael Pettis, a professor at Peking University’s Guanghua School of Management who specializes in Chinese financial markets, every country that has used an investment-driven growth model like the one China is still following has created a debt burden that either caused an economic crisis or a “lost decade” of minimal growth.2 The only way China can keep its debt from growing is to increase the level of consumption.

Pettis also points out that, on a global level, there must be an equilibrium between savings and investment. If a country like China has greater savings than investment, other countries must have greater investment than savings...

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