Magazine

Cautious Consumers


Meet the XUs. This typical Chinese middle-class family of three shares a two-bedroom apartment in Beijing, purchased four years ago for $40,600. The father, 51-year-old Xu Zhibao, takes home $454 a month from his job as a teacher at Beijing Pharmaceutical College. His wife, Zhang Xiaoping, 50, earns $260 a month as a nurse at a local hospital. Their 25-year-old daughter, Xu Hong, is a student at People's University. A Whirlpool (WHR) microwave oven and a Haier refrigerator command pride of place in the tiny kitchen. Among the family's other prized possessions are two Sony (SNE) televisions and a Mitsubishi air conditioner.

But it isnt just the things the Xus have bought that make them representative of China's bourgeoisie; its also what they choose not to buy. Like most mainlanders, the family members sock away tons of cash, close to 40% of their earnings every month. The Xus hardly ever go to restaurants, a movie outing is a rare treat, and they have no plans to trade in their bicycles for a motorcycle or car. "Only if a product is discounted heavily and I think it's worth it will I consider buying it," says daughter Xu Hong.

Isn't China in the grip of a consumer frenzy? Well, sort of. Car sales shot up 30% last year, while retailers from Wal-Mart Stores Inc. (WMT) to Carrefour are doing a brisk business as newly prosperous mainlanders stock their larders and living rooms. And not a day goes by without some big-name American company announcing a new China push. On Apr. 16, for instance, Hewlett-Packard Co. (HPQ)unveiled an energy- efficient computer aimed at the China market.

But look beyond the headlines and you'll find that China's 1.3 billion people are actually buying relatively little. Although the mainland's population is four times that of the U.S., Chinese consumers last year spent just 12% of what Americans did, figures investment bank UBS (UBS). And private consumption as a share of gross domestic product in China is falling, to less than 40% today from about 48% in 2000.

Prying open the wallets of tightfisted folks like the Xus is emerging as the hottest political topic in Beijing. Although the economy is still expanding at 10%-plus annually, China's economic mandarins are concerned that the country's growth depends too much on its soaring exports and investment in ever more factories and luxury high-rises. Exports leave the Middle Kingdom vulnerable to potential downturns in the U.S. and Europe while causing trade tensions with Washington. And too much investment threatens overcapacity in industries from steel to autos. So Beijing has cut taxes and boosted some social outlays to spur Chinese to spend more at the mall. "We need to adjust the balance between investment and consumption," Premier Wen Jiabao warned at the annual meeting of the National People's Congress on Mar. 5.

NOT TRICKLING DOWN

When might the Chinese consumer help really drive the global economy? Analysts at Credit Suisse Group (CS) have conjured a rosy scenario in which China becomes the world's second-largest consumer nation (after the U.S.) by 2020, up from No. 5 today. UBS is less upbeat, estimating that the middle class includes only about 25 million people—just 2% of China's population—hardly big enough to have much impact globally. And even Credit Suisse acknowledges that personal incomes, while climbing, aren't keeping pace with rising GDP. "If you think the purpose of rapid economic growth is to increase consumption and the general welfare, then China isn't doing a very good job," says Nicholas R. Lardy, senior fellow at the Peterson Institute for International Economics in Washington.

The problem is vexing not just for Beijing but also for the legions of global companies making big bets on China. With the more prosperous coastal areas already reaching saturation in everything from cellular phones to fried chicken outlets, foreign investors have to drive deeper into the interior in search of sales. "There are 900 million people in China" without mobile phones, says Michael Tatelman, president of Asia Pacific Mobile Devices at Motorola Inc. (MOT) in Beijing. "We are looking at how to reach the unconnected." Getting to those people can be tough. Rural consumers "are a very dispersed crowd," says Jonathan Anderson, chief economist for Asia at UBS. To address that, the Commerce Ministry is working on a project—likely to include Procter & Gamble (PG) Co.—that would seed the Chinese countryside with small retail outlets.

China used to approve foreign-owned factories only if most of the output would be exported. More recently, though, Beijing has shifted the emphasis to consumer goods for sale within China. Sony Corp. (SNE), for instance, once sold the bulk of its Chinese production abroad, but today it's devoting more resources to developing televisions, MP3 players, and other gadgets specifically for sale to Chinese consumers.

Ultimately, if Beijing wants to unlock consumer spending, it must do more to make ordinary Chinese feel secure about the future. With the market reforms of the past three decades, the safety net of lifetime housing, free education, subsidized health care, and a pension—all courtesy of the state—has been largely dismantled. As a result, Chinese "want to save every penny," says Chen Zhiwu, a professor of finance at the Yale School of Management. "In case of sickness, job loss, an auto accident, or old age, they will have some way to support themselves."

A BREAK FOR FARMERS

The Xus would agree. "Our money is limited," says father Xu Zhibao. These days he pays $270 a month for his mortgage, something he didn't have to worry about when the family lived in an apartment provided free of charge by his father's employer, a printing factory. And throughout much of the past decade, falling food prices meant that city dwellers such as the Xus could easily afford eggs, meat, and other staples. Now they face rising food prices, which increased by 2.3% last year. This year, inflation for the first quarter alone probably jumped an additional 3%, largely because of a surge in the cost of food, estimates Merrill Lynch & Co (MER).

To ease the burden, the government has been pumping more money into social initiatives. The national budget for education is slated to rise by 42% this year, while outlays for public health will nearly double—though government spending as a share of GDP continues to decline. Beijing also earmarked $3 billion for employment and worker-retraining programs. At the same time, in several provinces the government is trying out a new hybrid public-private pension system.

Beijing has also been tinkering with taxes. Last year, in a move aimed at kick-starting consumption, it doubled the income threshold at which citizens start getting taxed, to about $200 a month. And after years of being trampled on the road to progress, China's farmers are getting a break. Last year, Beijing abolished a 2,000-year-old agricultural tax and handed out billions of dollars in subsidies to grain farmers and schools. To spur creation of jobs in rural areas, and thus boost spending there, Chinese legislators in March left intact tax breaks for foreign companies that are investing in forestry, farming, and fisheries even as they did away with incentives in most other areas.

Economists have generally welcomed these steps. Yet many argue that China's leadership must move more aggressively to shift the economy toward higher- paying service industries and away from manufacturing. Services make up less than 40% of China's GDP, compared with 54% in India, with its thriving outsourcing sector. Despite regular hikes in legal minimum wages and efforts by Beijing to better enforce labor laws, salaries have declined from 53% of GDP in 1998 to only 41.4% in 2005, compared with 57% in the U.S. "If consumption is to go up, then the share of wages in economic growth will have to rise," says Bert Hofman, the World Bank's chief economist in Beijing.

Meanwhile, it's Saturday, and that usually means a Xu family shopping trip to the bustling Fangzhuang district Carrefour hypermarket, one of seven the French retailer operates in Beijing. The attraction? It's nearby and offers a wide range of goods, but just as important, Carrefour "has very low prices," says mom Zhang Xiaoping. Such words will surely strike both hope and fear into multinationals and Beijing policymakers alike as they attempt to persuade frugal families such as the Xus to dig deeper into their wallets.

By Dexter Roberts


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