Uncommon Sense: China’s Transition to a Consumer-Led Economy – and How Businesses Can Help

Uncommon Sense: China’s Transition to a Consumer-Led Economy – and How Businesses Can Help

The slowing pace of Chinese economic growth underscores the country’s need to transition from an investment- and export-led growth model to one powered by consumption—a transition the government committed to five years ago. But how long will that transition take? The answer is crucial to companies looking to ride what will eventually be the next extraordinary surge in consumer spending in China.

Given the long boom in spending, it’s easy to overlook the fact that consumption as a share of GDP has actually been falling in China for six decades. In 1952, three years after the Communist Revolution, it stood at 76%. By 2011, it had fallen to 28%, according to the University of Pennsylvania’s Center for International Comparisons. A reversal of this trend could catapult consumer spending upward. But our research into the transitions made by 167 countries in the last 60 years shows just how hard it will be to nudge China’s super-tanker of an economy in a different direction. Indeed, while consumption’s share of GDP will very soon stop falling, our research suggests it is unlikely to start to rise significantly for another decade.

Consumption as a share of GDP is bound to fall as an economy starts to develop via investments in the industrial base and exports, as was spectacularly the case in China. But in cases in which development continues, consumption usually begins to rise as a share of GDP as the service and higher-value manufacturing sectors expand. This doesn’t happen universally, however. And our research suggests that economic conditions in China—including its current industrial structure—are similar to those in place in the few countries that saw consumption’s share of GDP stabilize after falling, but not rise.

Moreover, China finds itself in a particularly tricky starting position. Not only is the decline in Chinese consumption relative to GDP the longest on record, it’s also unique in that both the relevant drivers of consumption’s share of GDP have fallen—household income as a share of GDP, and the proportion of that income that householders choose to spend rather than save. Those countries that successfully managed to reverse a decline in consumption’s share of GDP only had one of these factors to tackle.

To be clear, consumer spending will continue to grow as the economy grows, whether or not the government takes measures to boost consumption. Modest growth in consumer spending of just 5% a year would see it rise by a total of 330 trillion yuan over the course of the next decade—the equivalent of 60%, even if consumption’s share of GDP doesn’t budge. On the other hand, if China manages to change course and follow the route taken by most countries transitioning away from investment and export-led growth, consumer spending could be worth as much as 420 trillion yuan by 2025, a rise of 126%. This would lead to represent a rise in consumption to 46% of GDP, a proportion typical after a transition in countries in which consumption’s share of GDP rises after a period of decline.

Government policy will dictate just how much progress China can make toward this upper target. For example, in Taiwan, consumption-led growth was boosted by labor policies that, in particular, led to a rise in unionization that helped raise wages. In Japan, urbanization and growth in the availability of technology (through state-supported electronics manufacturing) encouraged a consumer culture, lowering the savings rate.

It will be important for companies in China to track certain key indicators that reveal the likely impact of government policies, as the ways that stated policy objectives will be achieved are not always made entirely clear in China. Only then can they gauge the possible pace and magnitude of change and prepare accordingly.

But there is more they should do. While the power to initiate a transition to a consumption-led economy lies in government hands, what the government unleashes, companies can nurture. The fact that they may already be serving millions of eager, experienced Chinese consumers should not blind businesses to the efforts that will be needed to coax millions more cautious ones to participate in a consumer economy.

Now, perhaps more than ever, companies will need to adapt their products to the needs and tastes of different income, regional, and age groups. They will need to communicate the benefits of their products to build demand and loyalty. They will need to extend modern trade channels and distribution networks to make sure consumers outside the main cities get access to those products. And they will need to develop the financial services —car financing or credit rating systems, for example – that typically underpin increases in consumer spending. If they do, they will continue to be among those that benefit most from one of the greatest consumer spending expansions in history.