Wait -- Don't Tell Me Chinese Don't Consume

China has experienced rapid growth in household consumption in recent years, with consumer performance far exceeding that in each of the world's 10 largest consumer countries.

By comparison, China's consumption is growing faster than what was seen in any other country during a phase of rapid industrialization. Japan's household consumption grew 9.2 percent annually during the 1970s, while South Korea's grew 8 percent every year? during the 1980s. But between 1999 and 2008, China's household consumption grew at an annual rate of 12.1 percent.

China was the world's fifth largest consumer nation in 2008. Based on household consumption trends worldwide, China may surpass Britain and Germany in then next two years to become the world's third largest consumer. And it could pass Japan in five years, making China second only to the United States. 
 
At present, I see a number of factors -- short- and long-term -- that offer powerful impetus for China's consumption going forward.

Short-term factor one: Economic growth will pick up in China in 2010, with GDP growth expected to reach 9.5 percent -- 1 percent higher than in 2009. Real income growth in urban and rural areas started overtaking real GDP growth in 2009, driving an increase in average household spending that far exceeds growth in GDP.

Short-term factor two: Real estate sales increased substantially in 2009. Sales by square meter grew 50 percent to a new high. As these homes are completed going into 2010, demand for renovation materials, furniture, appliances, cars and other downstream consumer goods closely linked to real estate will experience significant growth.

Analysis has shown that China's real estate transaction volume is closely linked to subsequent sales of related consumables. In central and western areas where purchasing of houses is driven by real demand rather than investment or speculation, the correlation is even greater. The real estate market, in terms of square meters, in urban areas outside China's first tier cities is several times larger than in the first tier, even though per capita income is lower. This means that in central and western regions, real estate will likely push consumption of domestically produced consumer durables, which is thus more favorable to domestic consumer goods manufacturers.

Mid- to long-term factor one: The demographic structure is an important impetus for consumption. Chinese born from the 1950s to early 1970s make up the largest part of the population. Their adult children -- more than 200 million people -- are now entering their 20s and 30s. This age group has the highest rate of consumption. And the group will be even larger by 2015.

China's 20- to 30-year-olds currently make up more than one-sixth of the population, meaning China is entering a golden decade for weddings. This demographic characteristic will drive demand for real estate and wedding-related consumption, as well as consumption related to travel, food, beverages, clothing, automobiles and entertainment.

The propensity to consume among young adults in China is considerably higher than their parents. Moreover, parents often “subsidize” consumption during their children's marriage and early employment phases. Currently, the group with the highest propensity to save (those born before 1970) is transferring life savings to the generation with the highest propensity to consume. This inter-generational transfer of income will speed China's consumption growth over the next few years.

Mid- to long-term factor two: Rural consumption is becoming urbanized. The global financial crisis in 2008 prompted large numbers of unemployed migrant workers to return from cities to their homes in the countryside. These migrant workers have had years of life in cities where all their durable consumer goods were provided by employers or landlords; they have never demanded their own goods.

After returning home, migrant workers began living independent lives. Rural consumption will rise if only a small portion choose to buy the goods they had in cities. And their consumption behavior will set an example for others, prompting more consumption among fellow villagers.

Looking ahead, future rural consumption growth will stem from increasing incomes. Rural per capita income has reached 6,000 yuan a year -- the income level at which urban consumption began to explode a decade ago. In coming years, demand should rise in the countryside for personal computers, air conditioners, cameras, refrigerators, mobile phones and cars. And as coastal, urban enterprises move operations inland, more workers will get long-term, stable employment that supports rural consumption.

Additionally, the government recently began gradually establishing a rural social security system, raising agricultural prices, and increasing investments in rural infrastructure. Each of these steps will increase the propensity to consume.

Mid- to long-term factor three: China's auto consumption is in a period of explosive growth, with car sales in 2009 growing at 40 percent, supported by government policies. This made China the world's largest automobile market for the first time, with a growth rate significantly higher than that of other countries. But on a per capita basis, China's automobile ownership rates are still low in absolute and relative terms. Even after the high growth of 2009, only 50 people in 1,000 own automobiles in China, far less than the 600 in developed countries and still below ownership rates in Russia and Brazil.

In the United States, Japan and South Korea, car sales grew substantially when there were around 50 owners per 1,000 people. Demand in South Korea skyrocketed after 1989. Adjusted for purchasing power parity (PPP), Japan in 1964 had per capita GDP of US$ 1,500. China's current per capita GDP (adjusted for PPP) has already reached US$ 6,000 -- better than in Japan and on par with South Korea's.

After 3-5 years of rapid growth for car sales, South Korea entered a stage of stable growth. The same could happen in China. Automobile consumption will find further impetus as China's household incomes rise, and the high-purchasing-power, post-80s generation enters the automobile-consumption period, and automobile credit is improved.

Automobile consumption in China's central and western regions will also rise. Eastern China comprises only one-seventh of the country's total area and holds slightly less than half of the population. But three-quarters of the country's private automobile owners are in the east. One important reason is that the east has always led national economic development, and automobile buying power among easterners has reached a critical point.

An analysis of the east's automobile consumption path shows two clear upward inflection points. Before 2000, growth in automobile ownership was relatively steady. But in 2001, eastern per capita GDP grew to one-sixth the cost of a car, which was followed by a marked acceleration in growth. By 2005, the east's per capita GDP had reached one-quarter the price of a car, and private ownership experienced even more explosive growth.

This is of particular importance when attempting to predict when car sales in central and western China will take off. By 2007, central and western per capita GDP had also reached one-sixth the cost of a car, and automobile consumption began to take off. Per capita GDP in central and western regions is expected to reach one-quarter the cost of a car by 2011, further stimulating explosive automobile consumption. In fact, the growth rate of passenger car sales in central and western regions has far exceeded that of the east in recent years.

Another restraint on car consumption comes from the development of infrastructure such as roads. Previously, better infrastructure in the east worked to stimulate automobile demand in the region. However, in recent years, investment in infrastructure in central and western regions has been significantly faster than in the east, stimulating more local demand. Thus, even if the high growth rate of passenger car sales in 2009 was due to government policy factors and a low base in 2008, central and western regions have only begun the high-growth stage of automobile consumption, and consumers will be looking to catch up. The future sustainability of automobile consumption is guaranteed.

Moreover, rapid growth in car sales in 2009 is not primarily due to government policies. An obvious fact is that the explosive growth in car sales this year was not restricted to low-emissions vehicles eligible for government subsides. BMW, Mercedes and other high-end brands saw accelerated sales compared to the year before, reflecting the fact that auto market performance is not simply a matter of policy. Factors such as income and propensity to consume are also providing important impetus.

Despite China's massive consumption potential, policy adjustment will further promote the growth of consumerism, allowing China to quickly transform its growth model. These policies include income support, the building of public services and monetary policy.

An important constraint on China's consumption has been income distribution. For years, growth in corporate profits and state revenue have far outpaced growth in disposable income. The state-owned companies' profit sharing ratio should be greatly increased and used for income support and consumer subsidies, especially for low-income groups. Moreover, China's value-added tax is the highest in the region; there is room for a reduction. Besides, the purpose of a value-added tax is to curb consumption, and by nature it robs the poor and helps the rich.

In recent years, the government has increased efforts to build a social security system, but there is still much room for improvement. In addition to requiring that a portion of corporate profits of listed, state-owned enterprises go toward funding the social security system, using a portion of local land transfer profits to strengthen local social security systems should also be considered.

Finally, exchange-rate appreciation would benefit consumers. This is not only because yuan appreciation would stimulate demand for imported consumer goods, but more importantly because it would force more enterprises to move from coastal to inland areas, promoting urbanization and increasing employment. People in the inland generally have lower incomes but high marginal propensity of consume. With rising prices, an appropriate increase in interest rates would also benefit consumers. Inflation eats at consumer purchasing power, so it is necessary to use monetary policy to curb inflation. Moreover, raising interest rates would increase interest income levels among Chinese people who, in turn, would spend some of that income as willing consumers.