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Can the Chinese Consumer Save the World?

What is the reality behind the booming Chinese consumer class?

November 2, 2007

What is the reality behind the booming Chinese consumer class?

Contrary to the consensus, it’s not all fast cars and fancy shopping malls for the average Chinese consumer. The importance of the Chinese consumer to economic growth in China has actually diminished over the past decade.

While personal consumption accounted for nearly 80% of China’s economic growth over the first half of the 1980s, consumption’s share of gross domestic product (GDP) has actually declined over the past few years.

Growth in household consumption has lagged the underlying growth of the overall economy for the balance of this decade — even though household consumption outlays in China virtually doubled between 2000 and 2006. It has been investment and exports that have fueled China’s boom of late, not the consumer.

While super-charged levels of capital investment and exports have diminished the role of the consumer in driving growth, something even more fundamental is at work.

The average consumer in China is not a credit-card-touting shopper roaming the malls in search of fashionable jeans or a large-screen television. Despite the popular image portrayed by the media, the reality is quite different.

There is a great deal more economic angst affecting the average Chinese household than the average U.S. household. China’s extraordinary savings rate is one metric of this anxiety.

The average Chinese household squirrels away a quarter of its after-tax income, one of the highest savings rates in the world. Why such a high level of savings? Prudence is one factor. Fear of the unknown is another.

While China’s economic rise over the past three decades has been nothing short of spectacular, many folks in the United States have paid too little attention to the wrenching social and economic issues facing China.

The average Chinese household can no longer count on the guarantee of lifetime employment once provided by the Iron Rice Bowl cradle-to-grave social welfare programs of the past.

Many of these social benefits have been scaled back or eliminated over the past decade, saddling the average Chinese consumer with the burden of paying for health care, pensions, education and housing.

China has an outsized savings rate and low consumption-to-GDP-ratio because the average Chinese citizen is petrified of getting sick, afraid of losing his or her job, insecure about retirement and bent on making sure that his child gets the best education money can buy.

But, after socking away a little cash for health care, retirement, education and a few extra yuan in case of being laid off, there is little spending power left. Throw in rising housing costs, and the cost of caring for the elderly — and the average Chinese consumer is feeling anything but solvent.

Times are rather trying for the average Chinese household since they have been burdened with financing many programs once funded by the state.

To a large degree, the days when most state-owned enterprises would provide workers not only with jobs, but also medical insurance, retirement pensions, unemployment benefits, education and other social benefits are long gone.

State benefits were slashed in the mid-1990s, and state enterprises dismissed some 21 million workers between 1997 and 2000. The majority of these workers have fallen outside of China’s social safety net, forcing households to save on a precautionary basis.

On the health care front, the share of health care costs covered directly by the government dropped from 36% in 1980 to 17% in 2004. During the same period, the share financed by state enterprises fell from 43% to 27%.

According to the OECD, just half of China’s urban population has basic health insurance, while fewer still are covered in the rural areas (less than 20% of the population). All tallied, China’s total expenditures on health care are rather low relative to the rest of the world, averaging less than 6% of GDP.

Total out-of-pocket health care expenditures by individuals rose from 20% in 1978 to a peak of 60% in 2001. That figure subsequently declined, but still hovers around 54% — more than two and a half times the share of 1978. According to recent figures from the Chinese Academy of Social Sciences, medical expenses now account for 11.8% of household spending.

While Chinese households have no choice but to save for unexpected and rising medical costs, the same holds true when it comes to retirement and expenses related to unexpected job losses.

According to Chinese government statistics, only 16- 17% of the population is covered under any basic government pension scheme, while in 2005, only 14% of China’s workforce was covered by unemployment insurance.

Education represents another significant expense for the average Chinese family. According to Chinese government statistics, per capita expenditures on education account for around 8% of total consumption expenditures and continue to increase along with escalating expenses related to school.

Households now confront rising fees for high school, traditional universities as well as private colleges.

Given that education is a national obsession in China, many parents find themselves financially strapped after paying for private tutors, extra classes and other items related to producing the best and brightest in the family. For many rural families, student fees associated with school can be the equivalent of one-year’s income.

Add to the above, soaring housing costs, which have increased as government subsidies on housing have declined.

Taking care of the elderly is another financial burden confronting many households, with government expenditures relative to China’s rapidly aging population inadequate for the nation’s burgeoning elderly demographic. In the absence of government assistance, households have been left to take care of the elderly.

Don’t bank on the Chinese consumer saving the global economy. While China’s global presence in certain industries has grown in significance over the past decade, Chinese consumers are not ready to drive global demand.

Unbeknownst to many in the United States, the average Chinese household is under tremendous pressure and burdened by social costs that continue to sap and subtract from their purchasing power. Should the U.S. consumer finally succumb and retrench over the near-term, the global economy could be in for rough times.