In recent months, I have become increasingly concerned about the next stage of development for China’s middle class. We have witnessed the tremendous transformation as hundreds of millions have moved into the middle class over the last 25 years, and in many families, now we have a younger generation born into the middle class with high expectations for further growth in their standard of living.

We have seen the projections of what this would look like, and the analysis of why it is important for China’s rebalancing to a consumption-driven, from an investment-driven economy. And while this can happen, my discussions with students at universities made me wonder if it automatically will, or whether we need a change of direction.

Students seem quite pessimistic about their future: wages upon graduation have not risen in real terms in 6 years, and many of the 7 million new graduates each year have a hard time finding a job. While graduates are only a small segment of China’s middle class, they are an important one, one that perhaps over time sets the trend for the rest of the middle class. I have concluded that this is indeed an issue, and that government and business action is required to address it.

So in the following three posts taken from a paper I prepared for the China Development Forum (an annual government-hosted forum to discuss ideas and potential policy solutions to China’s biggest economic issues) this month, I have set out to do the following:

  1. Describe the importance and impact of China having a successful and prosperous-feeling middle class.
  2. Lay out the trends reducing opportunities for China’s new graduates and the implications this has.
  3. Propose a number of actions that business and government could take to address these pressures.

 

Preparing For China’s Middle Class Challenge (Part 1)

The explosive growth of China’s middle class has brought sweeping economic change and social transformation to China. In this essay, we explore how the middle class could become economic drivers of China’s continued growth, but also caution that this may not happen without significant intervention to reshape how China’s youth are prepared to meet the needs of future, not past, middle class jobs.

The potential of the Chinese middle class

As recently as 2000, only 4% of urban households in China was middle class [1]; by 2012, that share had soared to 68%. Today, urbanites account for 52% of the entire Chinese population; by 2022, their share is likely to rise to 63%, with 170 million new urban residents. By then, China’s middle class could number 630 million – that is, 76% of urban Chinese households and 45% of the entire population.China is fast becoming a middle class nation. Central to this huge surge in middle class consumers has been the country’s urbanization, and with it, the creation of higher paying jobs.

The expanding urban middle class is increasingly made up of skilled white-collar workers who deliver higher productivity and earn higher wages. Their productivity is enabled both by ‘hard’ benefits in the form of infrastructure development, and ‘soft’ benefits through improved provision of, for instance, education and healthcare. The enormous growth in China’s urban infrastructure is well-known. Perhaps less appreciated, however, is the investment the government is putting into the soft enablers that unleash the economic potential of the middle class. Take insurance, for example: as recently as 2005, fewer than 150 million people had basic medical insurance in China; today, this figure has mushroomed to more than 95% of the population. In the case of those urban citizens that have insurance, their out-of-pocket expenditure ratio has fallen from 59% to 35%. This is an example of the Chinese government recognizing that the quality of middle class development is as important as the number of middle class citizens.

The ‘upper middle class’ should become the new mainstream

We divided the Chinese middle class into two segments: the mass middle class – those earning annual household income of RMB60,000 to RMB106,000, equivalent to US$9,000 to US$16,000– comprising 54% of all urban households in 2012. And the upper middle class – with household income of RMB106,000 to RMB229,000,equivalent to US$16,000 to US$34,000 – accounting for 14 % of urban households in that year.

The upper middle class punches above its weight in terms of consumption, accounting for 20% of China’s urban private consumption (Exhibit 1). This structure should look very different by 2022, when the upper middle class could comprise 54% of total urban households and 56% of urban private consumption by 2022,compared with around 13% in the case of the mass middle class. But this will only happen if household incomes continue to grow across the middle class.

Exhibit 1

Slide1

A successful shift towards the upper middle class will lead to a more mature and attractive market for businesses. Relative to the mass middle class, upper-middle class consumers are already more willing to pay a premium for quality products, have a higher level of trust in well-known brands, and spend more of their income on discretionary products and services (Exhibit 2). They are also much more international in their outlook, open to – and even eager for – international brands.

 

Exhibit 2

Slide2

China’s upper middle class consumers are becoming more mature. They decreasingly perceive shopping as a desirable family activity, spending significantly more time on leisure activities and travel than they did a decade ago. As a reflection of this trend, China’s hotel room capacity quadrupled between 2000 and 2012, and since 2010, the annual growth rate of cinema ticket receipts has exceeded 30%, with more than 1,000 new cinemas opening in 2013 alone.

Powered by higher incomes, upper middle class shoppers buy a wider range of products and at higher price points than their compatriotsin the mass middle segment. Nearly 60% of upper middle class consumers have bought digital cameras, compared with just 40% of mass middle class consumers. In the case of laptops, 51% of upper middle class consumers bought this item, compared with only 32% of the mass middle class. A similar pattern is evident in purchases of laundry softeners, where 56% of the upper middle class bought this product compared with 36% of the mass middle class (Exhibit 2).

Stark disparities exist between the two segments with regard to what products they consider attractive.Basic functional benefits appeal to mass middle class consumers, two-thirds of whom mention ‘durability’as one of their top five buying factors for a washing machine, compared with less than half of upper middle class consumers citing this factor. In the case of smartphones, 62% of mass middle class consumers cited durability in their top five considerations,compared with only 36% of upper middle class consumers.

Emotional and social benefits are increasingly important to upper middle class consumers, who are more than 50% more likely than mass consumers to cite considerations such as‘showing my taste’ and ‘makes me feel that my family is living a better life’, when purchasing products such as shampoo or mobile phones.

China’s expanding upper middle class is much more outward-looking than the broad swath of Chinese citizens—a dramatic break from the past that has broad implications for their consumption behavior. This group is much more willing to buy foreign brands. Foreign-branded food and beverages are favored by 34% of upper-middle class urbanites compared with 24% of all city dwellers. The upper middle class is also much more likely to travel abroad—in 2012, 10%of the urban middle class travelled overseas,compared with 3% of all urban Chinese.

This international outlook reflects a number of factors. Upper middle class citizens are better educated and more likely to speak a foreign language – 34% of the upper middle class holds a bachelor’s degree or above, and 26% can speak and understand English. They have, as a result, been the beneficiaries of the newly created, higher paying jobs in financial services, professional services, and the travel industry.

Widespread adoption of the internet is another important ingredient in this internationalism; the upper middle class are more likely to buy online and spend a higher proportion of their income online. The Chinese market will continue to retain its own unique characteristics, but if the upper middle class becomes the new mainstream, we should expect it to bear an increasing resemblance to mature international markets.

The geographic center of middle class growth is shifting

Businesses looking to serve these consumers will need a granular understanding of where the greatest growth in middle class numbers will. While China’s middle class expansion is largely happening in cities and will continue there, it will become much more evenly spread geographically.

In 2002, 40% of China’s urban middle class livedin the tier 1 megacities of Beijing, Shanghai,Guangzhou and Shenzhen. However, this share is expected to decline to 16% in 2022, while the share will rise in tier 2 and tier 3 cities. Tier 3 cities hosted only 15% of China’s middle class households in 2002; by 2022, that share should reach 31% (Exhibit 3). This shift in the weight of the middle class households from megacities to medium-sized cities means that there is also a movement from the huge urban centers of the coast to urban areas inland. In 2002, only 13% of the urban middle class lived in inland provinces, but that number is expected to rise to 39% in 2022.

Exhibit 3

Slide3

Examples of two small cities illustrate this shift. Jiaohe in Jilin province is a northern inland tier 4 city, which is growing quickly due to its position as a transportation center. It has abundant natural resources such as Chinese forest herbs and edible fungi, and is China’s most important production base for grape and rice wine. In 2000, fewer than 900 households out of 70,000 were middle class; by 2022, the city is expected to grow to 160,000 households, and about 90,000, or nearly 60%, are predicted to be middle class.

Another city, Wuwei in Gansu province, is an inland tier 4 city with the advantages of being within the Jinchang-Wuwei regional development zone. It possesses rich sources of minerals, with its nearby ilmenite (the most important ore in the manufacture of titanium) reserves ranking among the largest in the nation. Wuwei is also conveniently located at the junction of major railways and several highways. In 2000, less than 900 of 87,000 households were middle class. By 2022, the city is expected to grow to 650,000 households, of which around 390,000, or 60%, will be middle class.

Geographic remoteness matters less and less in shaping consumer needs and purchases. When China inaugurated its high-speed rail lines seven years ago, many observers declared them an infrastructure boondoggle that would never be used at capacity. How wrong they were: daily ridership soared from 250,000 in 2007 to 1.3 million last year. Demand was simply underestimated. Now that trains run as often as every 15 minutes on the Shanghai–Nanjing line, business and retail clusters are emerging, and middle class consumers are making weekly day-trips to work and shop, rather than monthly overnight visits. There are already more than 9,000 kilometers of operational lines—and that figure is set to double within the next few years.

Another factor making geographic location less relevant is the fact that internet retail is “born national”. All products available in Shanghai can also be delivered in Wuwei. Physical retailers have a tough time competing and may now choose to never establish anything beyond a few flagship locations in third tier cities. In some segments like B2C apparel, where online sales almost doubled in 2013 over 2012, internet retail is rapidly becoming the mainstream channel.

In tier-3 cities, online contributed to 14% of luxury goods sales in 2012, compared to almost nothing in 2010. Chinese consumers already spend 55% of their media time online, compared to 38% for their U.S. counterparts. This is driving new behaviors which will shape the Chinese middle class of the 2020s, such as shopping through social media platforms like WeChat, or visiting malls primarily as a leisure and entertainment activity, instead of for purely shopping.

Notes:

1. We have defined ‘middle class’ as those with annual household disposable income of between RMB60,000 and RMB229,000, a range that – in purchasing power parity terms – is between the average income of Brazil and Italy. These consumers would spend less than 50% on necessities and demonstrate distinctive consumption behavior compared with other classes of consumers.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Photo: Cathy Yeulet / 123RF Stock Photo