Encouraging consumer spending in China
Weak consumer spending in China is emerging as a big obstacle to the country’s sustained growth.
Gordon R. Orr
The McKinsey Quarterly, Web exclusive, December 2004
Over the past four years, business investment—particularly in industrial development and property—has become the engine driving China's economy. During this period, such investments, reflecting the country's determination to clear a backlog of much-needed infrastructure and housing projects, accounted for more than 40 percent of GDP growth. By contrast, consumer spending accounted for some 33 percent of GDP growth, down from 45 percent in the 1990s. This comparative weakness in consumer spending is creating a potential stumbling block for the economy.
To sustain rapid economic growth, the Chinese government will have to encourage consumers—especially the 250 million with household incomes of more than $1,000 a year and the 50 million with more than $3,500 a year—to spend more of their hard-earned cash. The good news is that Chinese consumers do have money to spend, having accumulated well over $1 trillion in savings. However, they are showing little sign of losing their caution, with the savings rate climbing to 44 percent of GDP last year, as opposed to 26 percent in Taiwan and 32 percent in South Korea. In big cities, such as Beijing and Shanghai, savings rates are as high as 50 percent, reflecting the consumers' propensity to save a higher proportion of their growing household income.
Government measures to stimulate spending through the consolidation of national holidays into week-long breaks appear to have had only a short-term effect. Consumers over the age of 45 are probably a lost cause. This generation has experienced so much economic and social upheaval that its propensity to save is now ingrained. Fortunately, this group accounts for a relatively small proportion of total savings, so its potential impact on economic growth rates is limited.
The government should target the segment of the urban population aged 25 to 45. Many of these people are rapidly joining the ranks of the Chinese middle class. Most are still saving for their first big purchase, such as a home—a "trigger" that will lead to further consumption. Only 30 percent of Shanghai residents own a modern apartment, compared with 15 percent in a typical second-tier city, such as Tianjin.
Over the past three to four years, the country has reached a first tipping point in the willingness of its consumers to invest in property. Pent-up demand from those who had saved enough to make such a big-ticket purchase has been released. However, while creating fabulous wealth for many developers, this property boom has failed to offset the continual rise in the overall savings rate.
While the first wave of property investment has now swept through several cities, the next wave will depend on the emergence of a new segment of consumers who have saved enough to purchase a home. It will also depend on the consumers' willingness to take out larger mortgages and their access to lower-cost apartments. This next wave should be a priority for government initiatives aimed at encouraging consumption. Yet home ownership is only one lever the government can use to stimulate consumption. It must also help to assuage concerns over a possible rise in personal expenses—concerns that have held back spending by middle-class consumers.
Few Chinese consumers, unlike their Western counterparts, are afraid of losing their jobs. Thanks to a booming economy, members of China's middle class are confident they can secure new employment almost at will and often at higher salary levels. But they do worry about a potential increase in health care, pension, and private-education expenses. Many estimate these potential costs to be much higher than they are likely to be. The instincts of these people have told them to save against the extreme case rather than the more likely outcome. As a result, they are oversaving for future events given what they would really have to pay if they could share risk through quality pension programs or health insurance products.
Greater tax incentives to stimulate savings in these products may be needed, along with measures to boost confidence in the providers. Allowing greater participation by foreign insurers in the sector can help by giving consumers access to a wider range of health care and savings products.
Over the past 20 years, we have seen a change in consumer behavior, toward lower savings and higher consumption, in countries such as Japan and South Korea. In Taiwan, savings rates have declined to 26 percent, from 34 percent. China must follow this trend by helping to dispel the misconceptions that its consumers have about future living and health care costs.
About the Authors
Gordon Orr is a director in McKinsey's Shanghai office.
This article was originally published as "Why thrifty is no longer so nifty" in the Financial Times on December 15, 2004. Reprinted by permission of the Financial Times.
mckinseyquarterly.com |
