Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 259

The Chinese consumer and rising political risks

Where does the US café chain Starbucks have the largest of its 28,200 company-owned and licensed outlets that are found in 76 countries? In Shanghai, China.

On 6 December 2017, as a long line of Chinese waited to be let in, Starbucks opened a 2,800-square-metre roastery in the coastal city’s retail hub that people describe as about half a football field in area. Opening the outlet proved a bonanza because the Shanghai Roastery became Starbucks’s biggest revenue earner on day one. “We shattered every sales record in the history of the company,” said Starbucks chairman Howard Schultz. Such a result explains the Starbucks ambition to nearly double the number of outlets in China from 3,200 now to 6,000 by 2022, which would entail opening more than a store a day.

Risks and opportunities for multinationals in China

Starbucks’ plans for China mimic the strategy of countless other multinationals since China modernised its economy from the late 1970s – namely, to seek a slice of the 1.4 billion strong consumer market that is growing in wealth every year. The World Economic Forum this year forecast Chinese consumption to grow 6% p.a. from 2016 to 2027, to nearly double in size to US$8.2 trillion.

China’s consumer market is expanding for two reasons. The first is that China’s economy is poised to grow at a 6% to 7% pace in coming years and will be, after India, the world’s fastest-growing major economy. The other reason is that Beijing is trying to change China’s economic model to one driven more by consumption. The results point to a surge in consumer spending power in coming years.

China’s strength comes with global political implications

China’s emergence as the world’s number two economy carries political implications that complicate the ambitions of foreign companies, especially retailers. China’s increased economic might is making the country more assertive in global politics at a time when other countries are fighting back against the loss of their global influence (in what is a zero-sum situation), especially against China’s ‘unfair’ trading practices.

Foreign businesses in China risk being stigmatised, if not targeted, amid such disputes. One of Beijing’s options is to stoke boycotts against products from a country, a frequent Chinese response to international tensions and one that predates the Communist takeover in 1949.

Boycotts are effective in China because once a country’s products are stigmatised, enduring damage is usually done to sales. Last year Beijing initiated a boycott of South Korean products after the country installed a US missile-defence system to protect itself against North Korea. The extent of product targeting included:

  • Boycott of Hyundai and Kia cars
  • Blocked streaming of Korean TV shows and K-pop music videos
  • Near-halt of Chinese tourists to South Korea
  • Forced closure of over 80 Lotte stores in China because the South Korean company handed over land for the missile shield.

The boycotts are estimated to have shaved 0.4% off South Korea’s economic growth in 2017. Foreign companies seeking to profit from China’s growing consumption must recognise that political events might harm their investments.

Political considerations have long governed foreign investment in China. Chinese consumers value global, and especially US, brands, which gives these goods some protection from Beijing-inspired boycotts. Perhaps China and other countries including the US will resolve their differences, which some days looks likelier than others. But heightened nationalism among Chinese, Beijing’s growing confidence in international affairs, and a backlash against China’s emergence as a world power, especially in the US, are global political shifts that are likely to endure. Foreign investors must allow for political risks.

The secret behind the export miracle

In 2007, China’s then Prime Minister Wen Jiabao said the country’s export- and investment-led economic model was causing “unsteady, unbalanced, uncoordinated, and unsustainable” development. Beijing’s response was to shift more to personal consumption, but this new model came with challenges. The under-pricing of land and money (in the form of the exchange rate and interest rates) and cheap, labour-favoured investment over consumption had resulted in China spending about 50% of its GDP on new capital stock. At the same time, personal consumption only stood at about 35% of GDP compared with 50% to about 66% of output for most advanced economies. A cheap yuan made imports expensive for consumers while it helped exporters. Low interest rates cheated household savers of income while governments and enterprises enjoyed subsidised loans. Land grabbed for factories left peasant farmers impoverished while supressing production costs. Low wages gave people less money to spend while they reduced manufacturing costs. The result was a massive trade surplus, especially with the US.

China-US goods trade relationship since 1981

Source: Thomson Reuters Datastream/Financial Times

A paradigm shift by boosting wages

Untangling the under-pricing of land and money while boosting wages was a risky step for Beijing because it heightened the risk of an economic slump. Policymakers needed to set GDP growth at a slower pace than consumption growth to enable consumer spending to become a bigger part of output. By allowing the yuan to move closer to its market value, liberalising many interest rates, boosting wages and compensating farmers for lost land and livelihood, Beijing has met this challenge.

Household spending has now become a bigger driver of the economy while growth has been maintained at about 7% p.a., even if policymakers relied on an increase in debt the equivalent of China’s GDP to achieve this feat.

The World Bank readings of China’s economy show household consumption has risen to 39% of GDP in 2016 from a record low of 35.8% in 2007. Perhaps a better way to highlight consumption’s growing importance is that since the start of 2016, household spending, on average, has propelled 65% of China’s growth each quarter.

What may the future hold?

For China, boycotts hold advantages over the other options. They are easy to orchestrate via social media while Beijing can hide its meddling. Boycotts appeal to the growing nationalism among Chinese that Beijing is stoking. Victim companies can only respond by applying political pressure at home to resolve whatever issue is angering China.

But boycotts carry risks for Beijing too. The first is that other countries retaliate like they would with tariffs. Another is that foreign companies might freeze expansion plans and shut off a source of innovation for China. Hundreds of thousands of Chinese are estimated to work for the companies of any one foreign country and they might resent any loss of income. Far more numerous (and so a bigger political concern) are Chinese consumers who respect foreign brands. Chinese shoppers might resent being told to avoid foreign brands and could ignore government sanctions against Nike runners and Apple iPhones.

The full version of this article is available here.

 

Michael Collins is an Investment Specialist at Magellan Asset Management. This article is general information only, not investment advice.

Magellan is a sponsor of Cuffelinks. For more articles and papers from Magellan, please click here.


 

Leave a Comment:

     

RELATED ARTICLES

Is China’s regulatory reform stifling ‘animal spirits’?

China’s new model is a plan for a hostile world

Five trends shaping investments in China: 2021 and beyond

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Australia’s bounty: is it just diversified luck?

Increases in commodity prices have fuelled global inflation while benefiting commodities exporters like Australia. Oftentimes, booms lead to busts and investors need to get the timing right on pricing cycles to be successful.

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Investment strategies

Five features of a fair performance fee, including a holiday

Most investors pay little attention to the performance fee on their fund but it can have a material impact on returns, especially if the structure is unfair. Check for these features and a coming fee holiday.

Interviews

Ned Bell on why there’s a generational step change underway

During market dislocation events, investors react irrationally and it should be a great environment for active management. The last few years have been an easy ride on tech stocks but it's now all about quality.  

SMSF strategies

Meg on SMSFs: Powers of attorney for your fund

Granting an enduring power of attorney is an important decision for the trustees of an SMSF. There are alternatives and protections to consider including who should perform this vital role and when.

Property

The great divergence: the evolution of the 'magnetic' workplace

The pandemic profoundly impacted the way we use real estate but in a post-pandemic environment, tenant preferences and behaviours are now providing more certainty to the outlook of our major real estate sectors.

Shares

Bank reporting season scorecard May 2022

A key feature of the May results for the banking sector was profits trending back to pre-Covid-19 levels, thanks to lower than expected unemployment and the growth in house prices.

Why gender diversity matters for investors

Companies with a boys’ club approach to leadership are a red flag for investors. On the other hand, companies that walk the talk on women in leadership roles perform better, potentially making them better investments. 

Economy

Is it all falling apart for central banks?

Central banks are unable to ignore the inflation in front of them, but underlying macro-economic conditions indicate that inflation may be transitory and the consequences of monetary tightening dangerous.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.